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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
John T. Hague
McGladrey
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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.
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Kevin G. Breard, CPA
Breard & Associates, Inc.
March 25, 2014 6
Broker-Dealer Audits: Tackling Pervasive
Deficiencies Identified by PCAOB
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7
Are CPA firm’s deficiencies on PCAOB’s radar?
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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.”
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9
Is the PCAOB funded for their mission?
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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
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“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.”
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Overview
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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
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Overview
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Source: PCAOB Release No 2013-006
August 19, 2013
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Inspection Report 1
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Observation
Almost 50% of audits are prepared by one-
off firms (46%)
5 or less greater than 80% (46% + 37%)
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Inspection Overview
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1st 2nd 3rd
Report date August 2012 August 2013 ?
# of firms 10 43 60 *
# of audits 23 60 90 *
* anticipated
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15
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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16
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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Inspection Report 1
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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%
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18
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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Slide Intentionally Left Blank
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Areas of High Risk
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Net capital rule
Audit failed to test components of net capital
computation
Fair value
Insufficient procedures
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What does that mean, failed to test
components of net capital?
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Insufficient testing
Haircuts
Classification allowable/non-allowable
Early warning notification. Means 120%
net capital $5,000, early warning $6,000.
Material inadequacy
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What does insufficient procedures
mean for Fair Value Measurement?
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Firms failed to test the valuation of
securities.
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23
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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25
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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26
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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Six Most Common Mistakes
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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
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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
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Slide Intentionally Left Blank
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Results of 2012 PCAOB Broker-Dealer
Inspections
John Hague, Financial Services Industry Leader
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Inspection Program
Objectives:
- Assess compliance - Permanent program scope
Status:
- 2 Progress reports - Plans for 2014 and beyond
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Inspection Process
Screening
Planning
Communication and scheduling
Planning week
Inspection week
Wrap-up/comment form issuance
Firm response
Reporting
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Inspection Process - Focus Areas
Mandatory
Presumptively mandatory
Conditional
Screening
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Inspection Process – Team Structure
Planning team
Inspection team
Reviewers
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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
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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?
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Accountant’s Supplemental Report on
Material Inadequacies
Deficiencies in 43 of the 60 audits
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
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Risk of Material Misstatement Due to
Fraud
Deficiencies in 37 of the 60 audits
Deficiencies related to:
- Audit response to identified fraud risks - Presumption that revenue recognition is a fraud
risk
- Journal entry testing
39
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Related Party Transactions
Deficiencies in 25 of the 60 audits
Deficiencies related to
- No procedures performed - Existence and identification of related parties and
related party transactions
- Examining identified related party transactions - Other
40
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Establishing a Basis for Reliance on
Records and Reports
Deficiencies in 30 of the 60 audits
Deficiencies related to:
- Completeness and accuracy of records and reports from service organizations
- Completeness and accuracy of records and reports produced by brokers and dealers
41
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Evaluation of Internal Control Deficiencies
in the Financial Statements
Deficiencies in 6 of the 60 audits
Deficiencies related to:
- Assessment of the severity of a control deficiency
- Evaluation of errors performed as part of substantive testing
42
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Auditing Financial Statements
Deficiencies in 29 out of 60 audits
Deficiencies related to:
- Omitted disclosures - Inaccurate or incomplete disclosures - Fair Value disclosures
43
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Understanding the Entity and its
Environment when Performing the Audit
Deficiencies in 4 out of 60 audits
Deficiencies related to:
- Obtaining an understanding of the entity and its internal control, in order to design the nature,
extent and timing of audit procedures
44
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Auditor’s Report
Deficiencies in 21 of the 60 audits:
Deficiencies related to:
- Auditor’s report on supporting schedules - Accountant’s supplemental report on material
inadequacies
45
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Slide Intentionally Left Blank
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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
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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
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PCAOB Disciplinary Process
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50
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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51
PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA
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PCAOB Forum on Auditing Smaller Broker-Dealers
November 8, 2012
San Diego, CA