Update on PCAOB Inspection of Broker-Dealers

In August 2011, the interim inspection program of auditors 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.

The PCAOB issued its first two progress reports in August 2012 and 2013. In August 2014, the PCAOB released its Third Progress Report. The PCAOB expressed that there has been a decrease in independence issues and other audit deficiencies from the first two reports, but the repeat offenses are alarming. On January 28, 2015, the PCAOB released a report (the Observation Report) noting its observations from five recent inspections.

The third interim inspection included 60 firms covering 90 audits. The PCAOB identified observations in 93 percent of the firms inspected. The most frequent deficiencies identified were around independence, the net capital computation, the risk of material misstatement due to fraud, revenue recognition, and reliance on records/reports. The nature of these findings has been consistent over the last three years. As a result, the PCAOB has urged auditors to reexamine their audit procedures.

The recently released Observation Report noted deficiencies in all five audits. Although this is a smaller sample size, all of the most frequent deficiencies from the third interim inspection were present in the Observation Report. The top problem areas noted in the Observation Report were: revenue recognition, risk of material misstatement due to fraud, financial statement presentation and disclosures, and engagement quality review.

Many broker-dealers are currently in the midst of their 2015 audits for the 2014 calendar year. Some practical aspects of these PCAOB reports are as follows:


The primary concern was that auditors were assisting in drafting or preparing the financial statements. Broker-dealers need to prepare their financial statements, including footnotes and supporting schedules.

Net Capital Computations

The concern was that auditors were not testing the unallowable and allowable assets. Broker-dealers can expect to give their auditor reports that break down the unallowable and allowable assets, including valuation and haircut of securities. Auditors may also dig into the rules surrounding net capital computations to determine that the unallowable asset list is complete.


The PCAOB noted that it was concerned that auditors were not addressing fraud risks. Broker-dealers can expect additional inquiries of management from their auditor and some enhanced elements of unpredictability to their audit procedures. Broker-dealers can also expect testing of journal entries posted throughout the year and testing performed on the general ledger to ensure a complete population.

Revenue Recognition

The auditor is required presume a risk of fraud due to revenue recognition. It was noted that some auditors did not address this risk. Broker-dealers can expect their auditor to extend their audit procedures on revenue.

Reliance on Records and Reports

In the past, a significant amount of auditors would obtain reports from the third party administrators and agree amounts to the Broker-Dealers’ books and records. Broker-dealers can expect their auditor to request a SSAE-16 report from the third party administrator, inquiries and documentation of user controls surrounding the third party’s controls that the client relies on.

Engagement Quality Review

The PCAOB found that the reviewers were not qualified or did not catch issues in the reports and supporting workpapers. Broker-dealers can expect their audit firms to ratchet up the review process – in some cases by adding an additional layer of review so that the reports and workpapers are thoroughly reviewed.

As the PCAOB continues to ratchet up their review of broker-dealer audits, audit firms will continue to make adjustments to their audit process to meet the PCAOB’s requirements. The impact to broker-dealers will be the audit firm’s response of increased scrutiny, more extensive document requests, and less help in accounting and financial reporting matters. In fact, many broker-dealers have engaged a second CPA firm (in addition to the CPA firm providing audit services) to help draft financial statements.

The PCAOB’s plan for next year is to inspect 60 firms covering approximately 100 audits. They are working towards developing a rule proposal for the PCAOB to issue during 2016 to establish a permanent inspection program.

The press release on the Third Progress Report is available here.

The press release on the Observation Report is available here.

We will be happy to provide further information relating to this subject. For more information, contact Thomas A. Peters, Director, Audit & Accounting at tpeters@kmco.com or Matthew J. Spiegle, Senior Accountant, Audit & Accounting at mspiegle@kmco.com.

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