Financial Services

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2014 Audit Year Developments for Broker-Dealers

Charles J. Pagano and Charles V. Abraham

This has been an especially busy year for broker-dealers with PCAOB and SEC regulations being finalized, and more proposed regulations under discussion. As broker-dealers and auditors prepare for post June 1, 2014 audits, the following items require consideration:

  • Effective for fiscal years ending on or after June 1, 2014, audits of non-public broker-dealers will now be under Public Company Oversight Board (PCAOB) standards, rather than Generally Accepted Auditing Standards (GAAS).
  • The PCAOB’s third progress report on the interim inspection program for broker-dealer auditors is expected to be issued in August 2014. Together with the two previous progress reports issued by the PCAOB, which covered 100 of the approximately 700 public accounting firms that audit broker-dealers, there is a trend of concern from the Board on crucial audit areas and this will likely affect this year’s audit.
  • Amendments to SEC Rule 17a-5 will affect the audited financial statements.
  • Other potential changes on the horizon, including the PCAOB’s release of proposed modifications to the auditor’s reporting model.

Auditing Under PCAOB Standards

In 2008, all auditors who audited broker-dealers were required to register with the PCAOB, although audits were still under GAAS. Five years later, as a result of Dodd-Frank legislation, the honeymoon period ended and those audits will now be performed under PCAOB standards.

Some differences between GAAS and PCAOB standards include:

Engagement Quality Review (“EQR”) (PCAOB Auditing Standard No. 7)

All broker-dealer audits will require a second partner-level review (EQR) and approval, prior to the issuance of the audit report. An EQR cannot be performed by someone below the partner level and he/she must possess expertise in the area. This process will add additional time pressures to the issuance of the report.

Communication with Audit Committee (PCAOB Auditing Standard No. 16)

The auditor must communicate with the audit committee (or in cases where there is no audit committee, those charged with overseeing the accounting and financial reporting process) on a timely basis, and the communications should be conducted throughout the audit. The auditor is required to communicate significant issues discussed with the management of the broker-dealer in connection with the retention of the auditor, ensure the audit committee understands the terms of the audit and obtain information from them regarding relevant matters (such as violations of law), as well as provide a synopsis of the overall audit strategy and timing, and significant risks.

Prior to issuance of the audit report, the auditor must also communicate the results of the audit, which include discussion items such as: critical accounting estimates, significant unusual transactions, evaluation of the company’s financial reporting, uncorrected and corrected misstatements, difficulties encountered in performing the audit, and material written communications provided to the management of the broker-dealer.

Non-carrying broker-dealers will be required to prepare an exemption report, and the independent public accountant will prepare a review report…”

SEC Rule 17a-5 Changes as a result of SEC Release No. 34-70073

The Internal Control report no longer applies to broker-dealer audits. All carrying broker-dealers (i.e. broker-dealers that clear customer transactions, carry customer accounts, or hold custody of customer cash or securities) will now be required to prepare a compliance report which will be examined by the independent public accountant. This report will include assertions that:

  • The broker-dealer has maintained internal control over compliance, and it was effective during the fiscal year and at year end.
  • The broker-dealer was in compliance with the net capital rule (SEC Rule 15c3-1) and the customer protection rule (SEC Rule 15c3-3).
  • The information was derived from the books and records of the broker-dealer.

The compliance report must be examined by the independent public accountant, who will also issue a report commenting on the broker-dealer’s assertions. When a material weakness exists, the broker-dealer must explain the circumstances, and if there was non-compliance with Rule 15c3-1 and/or 15c3-3, the broker-dealer also needs to describe the non-compliance with the Rule(s).

Non-carrying broker-dealers will be required to prepare an exemption report, and the independent public accountant will prepare a review report commenting on the assertions made by the broker-dealer. Those assertions will include:

  • The exemption under which the broker-dealer operated.
  • A statement stating that “the broker-dealer met the exemption provisions under SEC Rule 15c3-3 throughout the year.” If the exemption was not met, the approximate date(s) that the exception(s) existed and the nature of each exception.

It is imperative that the non-carrying broker-dealer have supporting documentation available for the auditor to inspect, including:

  • Basis of the exemption (typically a pre-membership agreement with FINRA, Form BD, copy of FOCUS filings reflecting exemption claimed, etc.).
  • Documentation as to the procedures in place to ensure that the broker dealer is complying with the exemption.
  • Documentation that controls are in place that ensure compliance, including evidence of a review of those controls by supervisory personnel.
  • Customer logs reflecting receipt and timely delivery of any funds to the clearing broker.

Both the compliance and exemption reports on which the independent public accountant will issue an examination or review report, respectively, must be in accordance with PCAOB standards. For the first year of reporting, the reporting period for both the compliance and exemption reports will be from June 1, 2014 to the end of the fiscal year.

Concerns raised by the PCAOB Interim Inspection Program

The PCAOB issued progress reports in August 2012 and 2013 based on their interim inspections of broker-dealer auditors. Based on the progress reports and comments made at recent PCAOB public forums, the Board remains concerned about the following areas:

Auditor Independence – Auditor independence is governed by SEC Rule 2-01 of Regulation S-X, PCAOB rules (with certain exemptions for broker-dealers), and AICPA ET Section 101 and 102. Auditors of non-public broker-dealers will not be subject to partner rotation, nor will they be prohibited from preparing tax returns for those individuals charged with governance of the broker dealer. However, preparation (drafting) of the annual financial statements to be audited, bookkeeping services including preparation of accounting records, preparation of journal entries, financial information design, and other management functions are prohibited. Word processing, collating, and filing the financial statements on behalf of a broker-dealer have all been interpreted as prohibited activities which would violate independence. We believe the PCAOB and SEC will identify additional violations of independence in the coming year as the regulators move to curtail such activities.

Revenue Recognition – The inspections have uncovered repeated instances where auditors have not been diligent in auditing material streams of revenue. Auditors are expected to focus on source documentation review including trade tickets, underwriting agreements, investment management agreements, and clearance agreements, to ensure that transactions are reflected properly on the broker-dealer’s books and records. Where revenue or expenses involve a clearing broker or parent company to the broker-dealer, the ability of the broker-dealer to demonstrate their review and approval of transactions is also important.

Net Capital – Auditors also need to test minimum net capital requirements, allowable assets, haircuts, and document interpretations that a broker-dealer relies on. Therefore, broker-dealers must ensure that internal documentation and appropriate controls are in place for net capital computations. In addition, FINRA has raised concerns regarding the timing of capital infusions and net capital compliance immediately prior to such an infusion. Broker-dealers must ensure that they document the evidence of processes in place to review net capital compliance.

Other Changes

A new designation of accountant notification (SEC Rule 17a-5(f)(2)) will have to be filed before the 10th day of the last month of the broker-dealers’ fiscal year (for calendar year-ends, by December 10, 2014). The statement must be dated no later than the first day of the last month of the broker-dealer’s fiscal year. This is due to the additional information required in the designation of accountant form – as stated in SEC Release 34-70073 “a representation that the independent public accountant has undertaken a report regarding the broker-dealer’s financial reports and a report regarding the broker-dealer’s compliance or exemption report, as applicable.”

Additionally the SEC Release allows both the SEC and a designated examining authority’s access to the accountant’s work papers for clearing or carrying broker-dealers. Therefore a representation regarding access to the accountant’s work papers is required in the designation of accountant form for clearing or carrying broker-dealers.

What Lies Ahead?

PCAOB Docket Matter 034

On August 13, 2013 the PCAOB presented the Auditor’s Reporting Model Proposal in Docket Matter 034. The proposal was intended to enhance investors’ ability to make investment decisions and to enhance the auditor’s report by requiring it to include critical audit matters. The disclosure would also require the auditor to describe considerations that led the auditor to determine that there was a critical audit matter and refer to the accounts affected and their related disclosures. In early April of this year, WeiserMazars Partner Charles Pagano attended the PCAOB Forum in Washington D.C., where he presented before the PCAOB and the SEC Chief Accountant as to the impact on non-carrying broker-dealers and small broker-dealers. Concerns brought up included the small amount of carrying broker-dealers (311 of 4200 per the PCAOB’s Office of Research Analysis) who have access to customer funds and securities, additional auditing costs to comply, the time constraints of 60 days after year-end for issuance, uniformity amongst auditors, and the already robust system of regulation imposed on broker-dealers. The PCAOB is currently considering input from the Forum and we expect the PCAOB to re-propose the rule with modifications.


In light of these important changes, and proposals, prudent broker-dealers will begin planning for the future as soon as possible. One major effect may be a reduction in cost effectiveness of service for those auditors who only audit a few broker-dealers, leading broker-dealers to face additional costs. After the PCAOB issues its third inspection report, scheduled for August 2014, and establishes a permanent inspection program, further auditing and reporting rule changes may be proposed, significantly affecting the final regulatory regime.


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