Four Years After Madoff, Audits and Auditors of Broker-Dealers Still Lousy

Four Years After Madoff, Audits and Auditors of Broker-Dealers Still Lousy

Last week I posted a column at Forbes: Already Behind The Eight-Ball: Auditors of Broker-Dealers Are A Disaster

The Public Company Accounting Oversight Board, the US audit industry regulator, issued its first report on the auditors of broker-dealers this week and it was ugly.

The PCAOB inspection team found serious auditing deficiencies in all 23 audits they reviewed. The PCAOB released the report on August 18, the first anniversary of the SEC's approval of temporary rules that gave the regulator the authority, under the Dodd-Frank Reform Act, to require registration and, therefore, inspection of the auditors of broker-dealer firms, a majority of which do not audit any other SEC registered companies.

This was the first time most of these firms were scrutinized by anyone but their peers in the accounting industry.

According to the PCAOB's first report, there are 800 registered public accounting firms that issued audit reports for financial statements of brokers-dealers for fiscal period 2011 that were filed with the SEC. Some of these firms audited as few as one broker-dealer, while others audited over 150 broker-dealers. Approximately 300 of the 800 firms also reported issuing audit reports for public company issuers. There were approximately 4,400 broker-dealers that filed audited annual financial statements for fiscal periods ended during 2011 with the SEC.

As of October 1, 2010, there were approximately 12,000 investment advisors registered with the SEC. There were 2,636 registered investment advisers that had an affiliated broker-dealer. Investment advisors are not required to have an independent audit of their financial statements. However,there is a new auditor attestation required for investment advisors. I talked about that in my column this week in American Banker regarding the relationship between private equity firm Bain Capital Partners and PwC.

As of March of 2010, investment advisors like Bain Capital Partners that have custody of customer funds and securities must hire an "independent" auditor to do a "surprise" examination. The auditor that performs the "surprise" examination must be registered with the PCAOB and subject to its inspections. The PCAOB, however, has no authority to review the "surprise" examination. And an investment advisor is not obligated to have a full audit by an independent auditor.

The broker-dealers that were inspected by the PCAOB were not judged by any new rules. The auditors operate, for now, under generally accepted auditing standards ("GAAS") issued by the American Institute of Certified Public Accountants ("AICPA"). The new "surprise" examination of investment advisors who have custody of customer funds or securities is also performed under AICPA attestation standards.

Broker-dealer audit firms will soon have to start auditing those firms under PCAOB standards. One wonders how, given their poor performance under well-known AICPA standards, how most of them will ever be able to make the transition and stay in business. From my Forbes column:

The SEC has not yet finalized the rules - 17a5 - under Dodd-Frank that officially require broker-dealers to use a PCAOB-registered firm. Broker-dealer auditors are not yet officially required, therefore, to use PCAOB standards for conducting their audits. The inspections were performed under GAAS, the AICPA audit standards, since the broker-dealers whose audits that were reviewed are not public companies. Once the SEC's rules are approved, all broker-dealers audits will be conducted under the PCAOB audit standards.

SEC spokesperson Judy Burns told me the agency has not publicly stated when it will adopt the broker-dealer auditor rules under Dodd-Frank.

One very difficult complication is that auditors of broker-dealers are required to be independent of their clients under SEC rules, not AICPA rules. AICPA independence rules are more lenient and do not prohibit auditors from also preparing the financial statements they audit and supporting firms with accounting software and IT expertise.

Read this article in its entirety at the re: The Auditors, a blog by Francine McKenna.

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