SIFMA: Surprise audits could carry a $200K price tag

A proposal by the Securities and Exchange Commission that would require advisory firms that hold custody of client assets to be audited by accountants that are inspected by the Public Company Accounting Oversight Board would cost each firm an average of $200,000, according to one new estimate.

A proposal by the Securities and Exchange Commission that would require advisory firms that hold custody of client assets to be audited by accountants that are inspected by the Public Company Accounting Oversight Board would cost each firm an average of $200,000, according to one new estimate.

The Securities Industry and Financial Markets Association cited figures in a recent comment letter showing that the average cost of a surprise audit would actually be more than twenty times the $8,100 that the SEC has estimated.

SIFMA conducted a survey of 17 member broker-dealers and their accounting firms to measure the potential costs of a surprise audit.

These respondents indicated that the costs of the surprise examinations ranged from $165,200 up to $282,800, “with a survey-wide average estimate of $206,294,” SIFMA said in a July 28 comment letter.

Five firms received estimates from their accounting firms of $500,000 or more, and one firm received an estimate of $1 million for the surprise exam, SIFMA said.

“The cost of a surprise examination and an internal control report greatly outweighs any potential benefits to clients,” SIFMA said in its letter, which was written by Mark Shelton, chairman of SIFMA’s Private Client Legal Committee and general counsel for the Americas of UBS AG, which is headquartered in Zurich, Switzerland.

The size of the advisory firm, the number of accounts, the number of custodians and the number of holdings would affect the cost of the surprise exam, SIFMA added.

The cost, however, is just one problem cited by others who have recently offered comments on the SEC proposal.

“The PCAOB does not have authority to oversee audits of private companies as a general matter,” PCAOB spokesman Colleen Brennan wrote in an e-mail.

“It is unclear … what these inspections would entail,” accounting firm Deloitte & Touche LLP of New York wrote in its comment letter on the proposal.

The Sarbanes-Oxley Act of 2002 only gives the PCAOB authority to inspect auditors of public companies.

“This may limit the PCAOB’s ability to review the investment adviser internal control and surprise examination engagements, even of those public accounting firms that are registered and perform audits of issuers,” Deloitte & Touche wrote.

Deloitte & Touche is inspected by the PCAOB and would be qualified to conduct the audits.

The proposal also would duplicate requirements already in place for many custodians, said Karen Barr, general counsel of the Investment Adviser Association in Washington.

“There are all kinds of bank and broker-dealer custody rules,” she said. “I understand what [the SEC was] trying to get at, but it was done in an over-broad fashion,” Ms. Barr said.

The agency issued the rule proposal in response to frauds like the massive Ponzi scheme perpetrated by Bernard L. Madoff Investment Securities LLC of New York. The Madoff firm held custody of its client assets, and the firm was audited by an accounting firm that was not regulated by the PCAOB.

Madoff’s accounting firm, Friehling & Horowitz CPAs PC of New City, N.Y., and its principal, David Friehling, has been charged by the SEC with fraud in connection with the case.

The SEC did not return calls for comment on the rule proposal.

Rep. Paul Kanjorski, D-Pa., chairman of the House Financial Services Committee’s Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises, introduced legislation in February that would require auditors of all broker-dealers, including privately held brokers, to be inspected by the PCAOB. SEC Chairman Mary Schapiro has called for enactment of such legislation.

Most of the focus on the proposed custody rule has been on a requirement that would impose annual surprise audits on advisory firms that automatically deducted fees from client accounts. Advisory firms have strongly opposed that proposal as costly and unnecessary

Another part of the proposed rule, however, would require the approximately 370 advisory firms that hold physical custody of client assets to receive internal control reports, known as “SAS 70” reports, from accounting firms that are registered and subject to inspection by the PCAOB of Washington. In addition, those firms also would have to undergo annual surprise audits from PCAOB-registered auditors.