PCAOB Issues Supplemental Checklist For Review of Broker-Dealer Audit Engagements

Integrity audits of Securities and Exchange Commission-registered broker-dealers are vitally important to building investor confidence, but PCAOB inspections of such engagements have revealed that some firms must put more attention on various areas.

Good practices include understanding the activities described in a broker-dealer exemption report and taking into account evidence obtained during review that contradicted those assertions. Other best practices involve assessing and testing controls over financial responsibility rules.

Relevance and Reliability
Dodd-Frank mandates that the PCAOB develop an inspection program for auditors who provide services to broker-dealers. An interim program began operating in 2011, while they gathered and assessed information in preparation of creating a rule proposal detailing permanent program.

Just as in issuer inspections, broker-dealer inspections often uncover failure to secure sufficient audit evidence on relevant assertions. Teams frequently fail to thoroughly test trading prices and quantities as well as commission/fee/interest rates/percentages applied during an audit inspection of broker-dealers.

As part of today’s economic environment, broker-dealers may experience reduced revenues due to depressed stock prices and decreased M&A activity that may reduce investment banking fees, clearing fees, and trailing fees. Therefore, fraudulent revenue recognition risks increase significantly; engagement teams must carefully consider such risks when developing audit procedures that reflect them.

Completeness and Accuracy
An information-packed supplemental checklist will enable peer reviewers to make an informed decision when considering whether to grant a clean or unqualified opinion. Furthermore, improved reporting should encourage buyers to prioritize audit quality over price-comparison when searching for audit services that offer comprehensive assurance at comparable costs to less reliable options.

Additionally, the Board’s ongoing inspection program affords an opportunity for the gathering and assessment of additional information for use in its rule proposal to establish permanent inspection programs for registered firms that audit broker-dealers. The proposal will include audit standards related to engagements conducted on broker-dealers as well as audit attestation standards.

As of June 1, 2014, all auditing engagements of brokers and dealers with fiscal year ends beginning after June 1 must comply with PCAOB standards. To help with compliance auditing engagements of this nature, PCAOB offers auditor outreach programs as well as hosting forums dedicated to discussing inspection results, standard-setting activities and enforcement issues.

Internal Control Over Compliance
PCAOB found the third biggest area of deficiencies was where EQRs failed to follow appropriate procedures in evaluating whether supplemental information accompanying financial statements conforms with applicable regulations, specifically whether original and amended FOCUS reports filed with SEC were reconciled together and any material differences explained.

Additionally, EQRs failed to thoroughly examine management’s assertion of internal control over compliance with Bank of Depository requirements (i.e., the requirement that banks develop and implement internal controls that give reasonable assurance against noncompliance with these rules being detected on time).

The PCAOB recommends that audit firms consider the areas highlighted by its report when planning and evaluating procedures related to supplement information for broker-dealer audit engagements, as well as when engaging with management and audit committees of these BDs they inspect.

Exemption Reports
The PCAOB has also proposed to institute new attestation and audit standards that require independent public accountants to review broker-dealers’ assertion that they qualify for one of several exemptions under Rule 15c3-3. This initiative may impose additional processes and controls, increasing costs for some broker-dealers.

Exemption Reports provide an assessment of a firm’s control system for identifying, authorizing, accounting for, and disclosing related party transactions and relationships. Firms often failed to gain sufficient understanding of rules and performing procedures necessary for designing and conducting tests of details responsive to assessed risks; as a result, deficiencies often existed here.

The PCAOB has noted with alarm a worrying rise in deficiency rates among broker-dealer audits; in 2022 it rose from 49 percent in 2021 to 58 percent – an alarming trend which it plans to address with future rulemaking; currently it is collecting and assessing inspection results as part of developing its permanent program proposal.