For the third year in a row, the Public Company Accounting Oversight Board (PCAOB) has found shortcomings in the audits of broker-dealers, a trend that could lead to firms spending more to get their books reviewed. The third progress report on the PCAOB interim inspection program of broker-dealer auditors shows auditing deficiencies or a lack of auditor independence in 56 of the 60 audit firms and 71 of the 90 audits inspected in 2013.
While the percentage of audits with inspection observations dropped slightly from that of previous years, PCAOB is concerned about the continuing high number and the nature of the observations. Net capital, customer protection, revenue recognition, fair value estimates and, fraud risks are specific areas demonstrating weak audit procedures. According to the PCAOB, many of the same audit problems keep cropping up year after year.
The PCAOB’s findings also show that auditors handling audits of broker-dealers need to develop a broader broker-dealer client base. Observations were identified in 100 percent of audits selected for inspection by auditors that had only one broker-dealer audit client. The percentage dropped slightly to 92 percent for firms that audited two to 100 broker-dealers. Observations for firms that audited more than 100 broker-dealers were even lower, at 63 percent.
Robert Maday, PCAOB leader of the broker-dealer inspection program, has strongly advised firms that audit broker-dealers need to reconsider their audit approach, including the establishment of independence rules that prohibit bookkeeping or financial statement preparation by the auditor.
PCAOB scrutiny will elevate broker-dealer audit standards and could reduce the supply of auditors, as the smaller auditors that can’t meet the higher bar are eliminated from the sanctioned auditing specialists. It is clear to industry players that another obvious effect of the heightened scrutiny will be to will raise additional regulatory costs and increased audit fees.
The PCAOB’s responsibility of monitoring broker-dealer auditors grew out of the Dodd-Frank financial reform law. The provision was at least partly a response to Bernard Madoff’s years-long fraud on investors and other schemes used to rip off investors.
One likely reason broker-dealers are stumbling is that they are still getting used to the auditing requirements. The net-capital and customer-protection rules are among the most complicated in securities compliance, and must be recalculated as a broker-dealer’s business model changes.
It is important that broker-dealers select an auditing firm that understands the industry and, ideally, that makes the broker-dealer industry a priority.