For the third year in a row, a federal watchdog has found shortcomings in the audits of broker-dealers, a trend that could lead to the firms spending more to get their books reviewed.
Earlier this week, the Public Company Accounting Oversight Board released its
third progress report on its interim inspection program of broker-dealer auditors. The study showed auditing deficiencies or a lack of auditor independence in 56 of the 60 audit firms and 71 of the 90 audits inspected in 2013.
Among specific areas demonstrating weak audit procedures were net capital, customer protection, revenue recognition, fair value estimates and fraud risks. The PCAOB said many of the same audit problems keep cropping up year after year.
“We again urge firms that audit broker-dealers to re-examine their audit approaches, and we remind firms that independence rules applicable to broker-dealer audits prohibit bookkeeping or financial statement preparation by the auditor,” Robert Maday, PCAOB leader of the broker-dealer inspection program, said in a statement.
PCAOB scrutiny will elevate broker-dealer audit standards and may reduce the supply of auditors, as the smaller auditors that can't meet the higher bar are winnowed out, according to Todd Cipperman, managing principal of Cipperman Compliance Services.
“The downside for B-Ds is that it will raise additional regulatory costs,” he said. “Audit fees will go up.”
The Dodd-Frank financial reform law gave the PCAOB responsibility to monitor broker-dealer auditors. The provision was at least partly a response to investor rip-offs, such as the multi-billion dollar fraud perpetrated by Bernard Madoff.
Since 2011, the PCAOB has conducted an
interim inspection program, which has found a total of 151 deficiencies in 173 audits through last year. In 2014, the PCAOB will review 60 audit firms and about 100 audits. The interim program will continue in 2015, and the PCAOB will propose a permanent inspection program in 2016.
As of June 1, B-D audits are required to comply with PCAOB standards. The PCAOB is a self-regulatory organization that reports to the Securities and Exchange Commission.
“The stakes are raised at this point,” said Daniel Nathan, a partner at Morrison & Foerster and former head of regional enforcement at the Financial Industry Regulatory Authority Inc. “They have to start getting these audits right.”
One reason broker-dealers are stumbling is because they're still getting used to the auditing requirements.
“A lot of what we're seeing in the deficiencies is the adjustment period, the newness of it all,” said Amy Lynch, president of FrontLine Compliance. “Everyone's just getting their feet wet.”
The net capital and customer-protection rules are among the most complicated in securities compliance, Ms. Lynch said, and must be re-calculated as a broker-dealer's business model changes. They should be careful to select an auditing firm that understands the industry.
“Get references,” Ms. Lynch said. “Find out what their history has been. Try to hire a firm that is making the B-D business a priority.”
The PCAOB results are an assessment of the auditing firms and procedures. They don't necessarily indicate, for instance, that broker-dealers are having net-capital problems.
The PCAOB is “taking a process-based look at things,” Mr. Nathan said. “They're watching the watchers.”
