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Broker-Dealer Audits: Tackling Pervasive Deficiencies Identified by PCAOB Addressing Auditor Independence, Related-Party Transaction Challenges, Deficiencies in Applying SEC Net-Capital Rules and More MARCH 25, 2014 Kevin Breard John T . Hague Breard & Associates McGladrey kbreard@baicpa.com John.Hague@mcgladrey.com
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Broker-Dealer Audits: Tackling Pervasive Deficiencies Identified by PCAOB Kevin G. Breard, CPA Breard & Associates, Inc. March 25, 2014 6
Are CPA firm’s deficiencies on PCAOB’s radar? 7
Protecting Investors Requires a Strong PCAOB Commissioner Luis A. Aguilar U.S. Securities and Exchange Commission SEC Open Meeting, Washington, D.C. Feb. 5, 2014 “Additional concerns were raised by the PCAOB’s 2013 progress report on the interim inspection program for firms that audit broker-dealers. That report noted that 95% of the audits selected for inspection had deficiencies. In fact, deficiencies were found in one or more of the audits conducted by each of the firms inspected. It is particularly troubling that, in 37% of the broker- dealer audits selected for inspection, auditors appeared to have been involved in the preparation of the very financial statements they audited, a violation of the independence required by SEC rules. ” 8
Is the PCAOB funded for their mission? 9
Protecting Investors Requires a Strong PCAOB Commissioner Luis A. Aguilar U.S. Securities and Exchange Commission SEC Open Meeting, Washington, D.C. Feb. 5, 2014 “Today, we consider the PCAOB’s budget to fund its operations for the fiscal year ended December 31, 2014. I support the PCAOB’s 2014 budget and the accounting support fee because, in my view, the budget provides the PCAOB with an appropriate level of resources to fulfill its mission and because the PCAOB has demonstrated an ability to use those resources prudently. ” 10
Overview How many CPA firms audited broker- dealers with the SEC as of December 31, 2011? A. 800 B. 1,000 C. 1,250 D. 1,500 11
Overview Source: PCAOB Release No 2013-006 August 19, 2013 12
Inspection Report 1 Observation Almost 50% of audits are prepared by one- off firms (46%) 5 or less greater than 80% (46% + 37%) 13
Inspection Overview 3 rd 1st 2nd Report date August 2012 August 2013 ? # of firms 10 43 60 * # of audits 23 60 90 * * anticipated 14
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 15 San Diego, CA
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 16 San Diego, CA
Inspection Report 1 Exemption form Rule 15c3-3 Customer Protection Audit Insuffici % Reports nt Tested Procedu es Auditor Did not perform sufficient inquiries 14 14 100% Or other procedures 17
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 18 San Diego, CA
Slide Intentionally Left Blank
Areas of High Risk Net capital rule Audit failed to test components of net capital computation Fair value Insufficient procedures 20
What does that mean, failed to test components of net capital? Insufficient testing Haircuts Classification allowable/non-allowable Early warning notification. Means 120% net capital $5,000, early warning $6,000. Material inadequacy 21
What does insufficient procedures mean for Fair Value Measurement? Firms failed to test the valuation of securities. 22
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 23 San Diego, CA
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 24 San Diego, CA
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 25 San Diego, CA
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 26 San Diego, CA
PCAOB Forum on Auditing Smaller Broker-Dealers November 8, 2012 27 San Diego, CA
Six Most Common Mistakes First Report Second Report 1. Accountant’s 1. Same Supplemental Report of Material Inadequacies 2. Same 2. Revenue Recognition 3. Same 3. Consideration of Risks of a Material Misstatement due to Fraud 28
Six Most Common Mistakes (continued) First Report Second Report 4. Establishing a 4. Same basis for Reliance on Records and Reports 5. Related Party 5. Financial Transactions Statement disclosures 6. Financial 6. Related Party Statement disclosures Transactions 29
Slide Intentionally Left Blank
Results of 2012 PCAOB Broker-Dealer Inspections John Hague, Financial Services Industry Leader
Inspection Program Objectives: - Assess compliance - Permanent program scope Status: - 2 Progress reports - Plans for 2014 and beyond 32
Inspection Process Screening Planning Communication and scheduling Planning week Inspection week Wrap-up/comment form issuance Firm response Reporting 33
Inspection Process - Focus Areas Mandatory Presumptively mandatory Conditional Screening 34
Inspection Process – Team Structure Planning team Inspection team Reviewers 35
Independence Deficiencies in 22 of the 60 audits - 3 by auditors of issuers (triennially) - 19 by auditors of non-issuers Auditors of broker-dealers subject to SEC independence requirements: REG S-X Rule 2.01 Financial statement preparation 36
Polling Question Yes or No: The BD FINOP asks the engagement team for help in calculating deferred taxes. The engagement team informs the FINOP that they cannot perform the calculation due to SEC independence rules. However, the engagement team provides to the FINOP a template created by the engagement team. Did the engagement team comply with the SEC independence rules? 37
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