broker-dealer audits: tackling pervasive deficiencies...

Broker-Dealer Audits: Tackling Pervasive

Deficiencies Identified by PCAOB TUESDAY, MARCH 25, 2014, 1:00-2:50 pm Eastern

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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

Breard & Associates

[email protected]

John T. Hague

McGladrey

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Kevin G. Breard, CPA

Breard & Associates, Inc.

March 25, 2014 6

Broker-Dealer Audits: Tackling Pervasive

Deficiencies Identified by PCAOB

7

Are CPA firm’s deficiencies on PCAOB’s radar?

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

8

“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.”

9

Is the PCAOB funded for their mission?

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

10

“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.”

Overview

11

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

Overview

12

Source: PCAOB Release No 2013-006

August 19, 2013

Inspection Report 1

13

Observation

Almost 50% of audits are prepared by one-

off firms (46%)

5 or less greater than 80% (46% + 37%)

Inspection Overview

14

1st 2nd 3rd

Report date August 2012 August 2013 ?

# of firms 10 43 60 *

# of audits 23 60 90 *

* anticipated

15

PCAOB Forum on Auditing Smaller Broker-Dealers

November 8, 2012

San Diego, CA

16


November 8, 2012

San Diego, CA

Inspection Report 1

17

Exemption form Rule 15c3-3 Customer Protection

Auditor

Did not perform sufficient inquiries

Or other procedures

Audit

Reports

Tested

Insuffici

nt

Procedu

es

%

14 14 100%

18


November 8, 2012

San Diego, CA

Slide Intentionally Left Blank

Areas of High Risk

20

Net capital rule

Audit failed to test components of net capital

computation

Fair value

Insufficient procedures

What does that mean, failed to test

components of net capital?

21

Insufficient testing

Haircuts

Classification allowable/non-allowable

Early warning notification. Means 120%

net capital $5,000, early warning $6,000.

Material inadequacy

What does insufficient procedures

mean for Fair Value Measurement?

22

Firms failed to test the valuation of

securities.

23


November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

Six Most Common Mistakes

28

First Report

1. Accountant’s

Supplemental Report

of Material

Inadequacies

2. Revenue

Recognition

3. Consideration of

Risks of a Material

Misstatement due to

Fraud

Second Report

1. Same

2. Same

3. Same

Six Most Common Mistakes

(continued)

29

First Report

4. Establishing a basis for Reliance on Records and Reports

5. Related Party Transactions

6. Financial Statement disclosures

Second Report

4. Same

5. Financial Statement disclosures

6. Related Party Transactions

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

Accountant’s Supplemental Report on

Material Inadequacies


Deficiencies related to:

- Reasonable assurance that any existing material inadequacies would be disclosed

- Exemption claimed under Rule 15c3-3 - Evaluation of reported net capital deficiencies as

indicators of a material inadequacy

- Evaluation of error in net capital computation as an indicator of a material inadequacy

- Timely notification of material inadequacy to SEC/FINRA

38

Risk of Material Misstatement Due to

Fraud



- Audit response to identified fraud risks - Presumption that revenue recognition is a fraud

risk

- Journal entry testing

39

Related Party Transactions


Deficiencies related to

- No procedures performed - Existence and identification of related parties and

related party transactions

- Examining identified related party transactions - Other

40

Establishing a Basis for Reliance on

Records and Reports



- Completeness and accuracy of records and reports from service organizations

- Completeness and accuracy of records and reports produced by brokers and dealers

41

Evaluation of Internal Control Deficiencies

in the Financial Statements



- Assessment of the severity of a control deficiency

- Evaluation of errors performed as part of substantive testing

42

Auditing Financial Statements

Deficiencies in 29 out of 60 audits


- Omitted disclosures - Inaccurate or incomplete disclosures - Fair Value disclosures

43

Understanding the Entity and its

Environment when Performing the Audit

Deficiencies in 4 out of 60 audits


- Obtaining an understanding of the entity and its internal control, in order to design the nature,

extent and timing of audit procedures

44

Auditor’s Report

Deficiencies in 21 of the 60 audits:


- Auditor’s report on supporting schedules - Accountant’s supplemental report on material

inadequacies

45

47

Challenges to Anticipate Client prepared financial statements

elongates the audit cycle.

Significant increase in the documentation

of audit steps

Exemption & Compliance reports Effective June 1, 2014

More time, fees increase

Best Practices

Observation

1.Net capital rule

Auditor failed to

test components of

net capital

computation

Document your procedures

• Added steps to our audit

program

•Tickmark FOCUS report

•Retest haircut

2.Fair Value

Insufficient

procedures

•WSJ.com

•Document price

comparison tested

3.Independence

Preparation of

financial

statements

• Engage CPA firm to draft

financial statements

•FINOP

•QuickBooks report – not

bad, good starting point

48

49

PCAOB Disciplinary Process

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November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

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November 8, 2012

San Diego, CA

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