Update on 2015 PCAOB Inspection of Broker-Dealers and Areas of Focus for Upcoming Audits

Several years ago, the interim inspection program of auditors of broker-dealers was implemented due to new authority given to the Public Company Accounting Oversight Board (PCAOB) over auditors of SEC-registered broker-dealers by the Dodd Frank Wall Street Reform and Consumer Protection Act.

This summer, the PCAOB released its fourth inspection report. It continues to identify deficiencies in broker-dealer audits, despite publicizing four years of inspection findings covering over 275 audits.

The fourth interim inspection included 66 firms and covered elements of 106 audits. In its report, the PCAOB indicated that is has identified deficiencies in portions of 92 of the 106 audit engagements inspected. The most frequent deficiencies identified were around independence, revenue recognition, reliance on records/reports, fair value accounting estimates, financial presentation and disclosure, and the customer protection rule.

It is important to note that while these deficiencies were identified by the PCAOB, it does not mean that the financial statements and/or supporting schedules of the broker-dealer were materially misstated or that the broker-dealer violated SEC rules 15c3-1 and or 15c3-3. Rather, audit deficiencies described by the PCAOB are failures by firms to perform, or perform sufficiently, certain required audit procedures.

The following includes some of the key points identified in the PCAOB’s report.


Independence remains a primary concern of the PCAOB. One in four of the audits inspected had an independence finding, many of which related to the auditors’ assistance with the preparation of the audit clients’ financial statements.

As a refresher on independence, auditors cannot be in a position to audit their own work. As a result, auditors are prohibited from, among other items, maintaining or preparing the audit clients’ accounting records, preparing or originating source documentation underlying the financial statements, or preparing financial statements that are filed with the SEC or that form the basis of financial statements that are filed with the SEC.

Broker-dealers should be preparing their own financial statements, including disclosures, and maintaining all documentation required to support the financial statements.

Revenue Recognition

At least one deficiency was found in 76 of the 106 audits selected for inspection. Of these, at least half had multiple deficiencies related to testing of revenue recognition. For example, some firms did not test material classes of revenue transactions or did not perform sampling procedures correctly to test revenue transactions. It was also noted that some firms did not perform sufficient procedures to test the relevant assertions for revenue.

Broker-dealers should review their own policies and procedures surrounding revenue recognition, as this will be an area their auditors will focus on during the audit.

Reliance on Records and Reports

More than 55 percent of the audits that were selected for inspection had a deficiency related to establishing a basis for reliance on records and reports. Inspections staff observed that firms did not perform sufficient procedures on information produced by service organizations that were used to perform substantive audit procedures or test of controls.

For example, in some instances the PCAOB indicated that the auditor obtained a clearing broker statement, and the auditors’ procedures were limited to agreeing the clearing broker statement to the cash receipts or general ledger of the audit client. Auditors should be establishing some basis to conclude that they can rely on the clearing broker report. Broker-dealers should expect their auditors to request additional information to collaborate the data in the clearing brokers’ reports.

Broker-dealers can also expect their auditors to request an SSAE-16 report from the clearing broker or other third party service providers. Broker-dealers should also obtain a copy of these reports and ensure they have implemented and documented the user controls noted in the SSAE-16 report.

Fair Value Accounting Estimates

Deficiencies were found in nearly half of the inspections related to valuations. For fair value accounting estimates, broker-dealers should expect their auditors to test how management’s estimates are formulated and the inputs being used, as well as the controls surrounding the inputs for the estimate and any information that could have an impact on the estimate up through the date of the auditor’s report.

Financial Presentation and Disclosures

In nearly 45 percent of the audits that were examined, there was a deficiency related to financial statement presentation and disclosures. Broker-dealers should review their policies and procedures for ensuring all required disclosures are complete and accurate. These procedures should include the completion of a disclosure checklist and a review by someone other than the preparer of the financial statements. This review should focus on the reader’s ability to understand the financial statement disclosures without additional explanation from the broker-dealer’s personnel.

The Customer Protection Rule

When a broker or dealer claims an exemption under the Customer Protection Rule, auditors are required to ascertain whether the conditions of the exemption were complied with as of the examination date and whether anything came to the auditor’s attention to indicate that the broker-dealer was not in compliance during the period since the last examination. Broker-dealers should reconsider how their compliance with their exemption from Rule 15c3-3 is monitored and be prepared to discuss these matters with their auditors. They should also be prepared to demonstrate how their compliance with the exemption is monitored, and to detail any exceptions that occurred during the year.

PCAOB Staff Inspection Brief

In addition to the results of the interim inspection program, the PCAOB staff also released a Staff Inspection Brief during 2015 which identified key areas of PCAOB inspection focus. Many of the items are recurring, including revenue recognition, service organization reports utilized as audit evidence, auditor independence, and auditing supplemental information, including the broker-dealers’ computation of Net Capital under SEC Rule 15c3-1 and the Compliance or Exemption Reports under SEC Rule 15c3-3.

As part of the planning process for your upcoming audit, look at the PCAOB inspection results and the focus of upcoming inspections, and review your policies and procedures in those areas. This review will help you to discuss these matters with your auditor, and to understand your auditor’s increased focus and testing on these areas.

In 2016, the PCAOB plans to increase its inspections to 75 firms covering portions of approximately 115 audits. It continues to work toward developing a rule proposal to be issued during 2016 that would establish a permanent inspection program.

The PCAOB Interim Inspection Report is available here.

The PCAOB Staff Inspection Brief is available here.

We will be happy to provide further information relating to this subject. For more information, contact Todd E. Crouthamel, Director, Audit & Accounting at tcrouthamel@kmco.com or Frank L. Varanavage, Manager, Audit & Accounting at fvaranavage@kmco.com.

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