Broker-dealer auditors failed to ascertain whether firms maintained appropriate internal accounting controls, segregated customer funds and kept sufficient minimum capital reserves, according to a review by a federal agency.
On Monday, the Public Company Accounting Oversight Board released an
interim report about the new authority over broker-dealer auditors given to it by the Dodd-Frank financial reform law.
The survey of 10 audit firms and 23 broker-dealer audits between October and February shows that in 21 of the audits, “firms failed to perform sufficient audit procedures” and that two of the nine broker-dealers who were supposed to maintain a customer reserve failed to do so. In seven of the 23 audits, the PCAOB found that auditors failed to test the broker-dealer's net capital calculation.
In addition, the PCAOB report indicates that in 13 of the 23 audits, firms didn't properly assess the risk of financial statement errors, while in 15 of 23 audits, they failed to sufficiently test revenue claims.
In two instances, the firm doing the audit was also the broker-dealer's provider of financial and accounting reporting services, a violation of SEC rules.
“PCAOB inspectors identified deficiencies in all of the audits inspected,” PCAOB board member Jeanette Franzel said during a media conference call.
“While the auditors and audits selected are not representative of all broker and dealer audits and their auditors, the results are of concern to the board,” she said. “The results indicate that in the audits that we inspected, the auditors were not properly fulfilling their responsibilities to provide an independent check on brokers' and dealers' financial reporting and compliance with SEC rules.”
The PCAOB was established under the Sarbanes-Oxley Act to regulate accounting firms that audit public companies. The Dodd-Frank law also gave the agency oversight over auditors of SEC-registered broker dealers.
Before the final Dodd-Frank rules are written, the PCAOB is using the interim reviews to calibrate its exam procedures and determine problem areas, according to Daniel Nathan, a partner at Morrison & Foerster LLP.
“It's a good thing that they're letting the industry and the world know before the real program gets going,” said Mr. Nathan, a former vice president and director of regional enforcement at the
Financial Industry Regulatory Authority Inc. and a former assistant director of the Securities and Exchange Commission's Division of Enforcement.
The audits in the interim report involved nine broker-dealers that had special reserve bank accounts and minimum capital requirements of between $250,000 and $6.5 million. The other 14 broker-dealers had no special reserve accounts and had to maintain between $5,000 and $6 million in net capital.
By the end of the interim inspection program next year, the PCAOB will have reviewed 100 broker-dealers and 170 audits. The effort will help shape the permanent inspection program that will go into effect when the SEC approves final Dodd-Frank rules on audits.
The timeline is unclear.
“The findings tell us that there is a need for improvement in the audit work being performed and that other auditors of broker-dealers should look closely at our findings and assess their own work,” said PCAOB board member Jay Hanson.
The Dodd-Frank law beefed up the oversight of broker-dealer auditors in part to prevent another investor scam such as the $65 billion Ponzi scheme perpetrated by Bernard Madoff. That scandal involved improper custody and use of customer money.
The PCAOB hopes to play a role in stopping the next big ripoff.
“This is part of that process,” Ms. Franzel said of the interim report. “It's a journey.”
Mr. Nathan said that the highlighted problems may not necessarily have to do with malfeasance.
“Given that [broker-dealers] haven't been subject to this scrutiny, it's allowed some bad habits to develop over the years,” he said. “I'm hoping that these results show a certain degree of sloppiness and inattention to financial details and don't speak to outright fraud.”
