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There are approximately 3,400 brokers and dealers (“broker-dealers”) registered with the U.S. Securities and Exchange Commission (SEC). These broker-dealers are required to submit their annual reports to the SEC, which must include their financial statements and supporting schedules, along with audit reports prepared by PCAOB-registered public accounting firms.
The PCAOB (Public Company Accounting Oversight Board) plays a vital role in ensuring the integrity of financial reporting by monitoring the audits of broker-dealers. These entities, which include firms that buy and sell securities, need accurate and reliable audits due to the difficulties and risks associated with their activities. The PCAOB’s mission is to ensure that the investors are protected and to promote the public interest, which hinges on ensuring that audit reports are accurate and independent.
PCAOB reviews the audits conducted by the firms. The results from the PCAOB interim inspection report highlight a concern that there is a requirement for improvement in the quality of audits and attestations for broker-dealers. This situation underscores the importance of rigorous oversight and quality control in the auditing process to ensure that investors and the public can rely on the financial statements of these firms.
Since the PCAOB standards for broker-dealer audits came into force in 2014, the PCAOB has inspected 325 registered audit firms conducting these audits as of the most recent inspection period. During its inspections, PCAOB identified that the deficiency rates in broker-dealer engagements remain very high and issued a report for the auditors on the reasons for such deficiencies.
The broker-dealer industry remains relatively unexplored. This is mainly because various compliances and complex regulations require specialized knowledge and experience of market complexities.
The broker-dealer industry is regulated by Generally Accepted Accounting Principles (GAAP) for financial reporting, alongside regulatory requirements that are specific to the industry. Auditors are required to have a mix of technical and on-the-job training, self-study, and experience to be adept in these areas. Additionally, auditors are required to have adequate knowledge of the rules applicable to Broker-Dealers, some of which are as follows:
Let us start with what professional skepticism is.
Professional Skepticism is an attitude that includes questioning the mind and being alert to any condition that may indicate or highlight any possible misstatement due to error or fraud. An auditor shall plan and perform an audit while taking professional skepticism into consideration. The auditor can neither assume that management is dishonest nor assume unquestioned honesty while performing professional skepticism during the audit.
During the PCAOB inspection, the PCAOB inspection staff identified various instances in which audit and attestation engagements showed a lack of due care and professional skepticism. Some examples of the same are –
Auditors are not required to test the Internal Control over Financial Reporting (ICFR), unlike other audits of certain public companies, which are mandatory. However, as part of their risk assessment and audit planning, an auditor should examine the broker dealer’s internal control.
The Engagement team, i.e., the auditor, specifically focuses on obtaining a high-level understanding of the broker-dealer and its environment but often fails to take an understanding of the following significant areas-
During its inspection, PCAOB identified that a substantial number of broker-dealers are audited by firms that do not serve any public companies and serve 50 or fewer broker-dealers. Out of approximately 3,400 SEC-registered broker-dealers, over 1,000 were audited by 162 of these firms during the period reviewed in the 2022 inspections.
PCAOB also inquired about the number of hours audit firms spend completing broker-dealer assignments. It identified that most of the broker-dealer assignments completed by audit firms not engaged in the audit of public companies take less than 100 hours.
It is identified that there is a very high rate of non-compliance with the PCAOB standards for first-time inspections. Generally, these non-compliances are reduced during the subsequent inspections of these audit firms.
PCAOB has identified that in 73% of audit examinations, firms that audit fewer than 100 broker-dealers were found to be non-compliant. It has been reduced from 86% deficiency since the inception of the interim inspection program.
Some audit firms may not devote adequate time to thoroughly comprehend the requirements of the Exchange Act Rule 17a-5, the Broker-Dealer Financial Responsibility Rules, and the related internal controls over financial reporting at broker-dealers because of their limited experience with these engagements.
Engagement Quality Reviews are reviews conducted with the objective of evaluating the significant judgments made by the engagement team and the conclusions reached thereon.
Over the years, deficiencies pertaining to the engagement quality review (EQR) reviewer’s inability to adequately assess the engagement team’s solutions to material risks that the engagement team identified have been repeatedly documented. Many audit firms don’t have EQR partners with experience in the Broker-Dealer Industry.
There have been numerous instances where Engagement Quality Reviewers have failed to understand the relevant requirements of the industry and the GAAP.
Small audit firms should appoint a qualified EQR for the broker-dealer assignments who know the industry. Otherwise, to increase the efficiency of the reviews, the firms should conduct various training for the EQR assignments.
Standardized audit programs can be very effective in engagement planning and execution.
Some firms regularly use standardized programs provided by vendors to conduct audits according to the PCAOB standards, including broker-dealer attestation engagements performed pursuant to Attestation Standard No. 1 and Attestation Standard No. 2.
Typically, these tools give the user access to the text of a PCAOB requirement together with related references to the actual criteria. These instruments might not be comprehensive and may represent just a few of the standards’ requirements and could have a restricted range of operations to be finished. These programs typically must be changed to reflect the nature of the broker-dealer’s business operations, internal controls, financial reporting, and various risks.
Utilizing standardized audit programs can help meet PCAOB standards requirements. Still, it is crucial for the auditor to carefully review recommended procedures to make sure they accurately reflect the risks that were found during the planning and risk assessment process of the engagement. The type, timing, and scope of those procedures should be adjusted as needed to guarantee that the audit response to the risks found complies with relevant PCAOB criteria. The comprehension of PCAOB criteria by auditors cannot be replaced by reliance on standardized audit programs.
Many broker-dealers often tend to appoint small firms to save on costs, as smaller firms comparatively charge lower fees than larger audit firms.
Further, during the PCAOB inspection in 2022, it was identified that 34% of the firms had changed their auditors in the last three years. This clearly shows how frequently broker-dealers change their auditors.
It has also been found that many audit firms engage with broker-dealers and don’t have enough resources. The maximum number of Broker-Dealers has a fiscal year ending December 31 and multiple other filing deadlines during that period as well. This hugely impacts the time engaged in these audits, which in turn affects the quality of the work.
In conclusion, the shortcomings found during the audits of broker-dealer annual reports point to important directions for the auditing profession’s development. Restoring trust in financial reporting will require addressing these issues, which include developing industry-specific expertise, encouraging professional skepticism, and guaranteeing thorough risk evaluations. To effectively fulfill compliance standards, both auditors and broker-dealers must prioritize continual education and adaptation as the regulatory landscape continues to change. By doing this, they can maintain the integrity of the financial markets and better safeguard investors, which would ultimately increase public confidence in the financial system.
At Mercurius, you can rely on our experts for professional guidance in broker-dealer audit services. We are registered with the Public Company Accounting Oversight Board (PCAOB) and licensed to conduct audits of broker-dealers in the United States. We can assist in a timely and accurate risk assessment and diagnostic process. If you have any questions, feel free to contact us.
