Rules, rules, rules. Rules define life as an auditor, and they even seep into more comforting aspects of personal life, like hobbies or even watching football (the American kind), for example. Fall, the season where the best professional and college games play on big screens across the United States, is also the season of rules. But, what if you woke up this weekend and found your favorite athletes were no longer “footballing” the way you expected? What if they started playing under rugby union rules instead? Now, there are too many men on the field (which should be a penalty) and too few stoppages of play (which makes it hard to refill the cooler and bowls of dip)! The line of scrimmage has been replaced by lineouts and scrumming! How are you supposed to make sense of it all?

A similar “rule changing” transpired in the accounting world on June 1, 2014, when the broker-dealer audit game transformed again. You woke up that day to find out your audits of SEC registered broker-dealers must now be performed in accordance with PCAOB standards. Oh, and don’t forget about the new PCAOB Auditing and Attestation Standards! What happened to the glory days of using U.S. GAAS under the familiar auspices of the AICPA?

If you found yourself in this exact position more than a year ago, and you are still struggling to sort out the practical changes to your audits of broker-dealer entities, keep reading. This post will shed light on a few important requirements and recent inspection results regarding independence, auditing and attestation considerations!

Independence

Both PCAOB and SEC independence requirements now apply for auditors of SEC registered broker-dealer firms. In cases where both sets of standards are applicable, the auditor must comply with the more restrictive requirement. One specific area where questions have arisen is the role that the auditor plays in preparing financial statements on behalf of a broker-dealer.

Even before last year’s changes, broker-dealer auditors were subject to SEC rules for independence. These rules state that an accountant cannot audit its own work as it pertains to bookkeeping or other services related to a client’s financial statements. However, the PCAOB inspection staff has found audit firms performing these prohibited services in 25% of audits inspected this past year! In nearly all cases, the audit firm prepared or assisted with the preparation of financial statements and other supplemental information that were filed with the SEC! This support is a big violation of SEC independence rules, and the PCAOB is cracking down on firms that do it (read: sanctions and settlements). If you haven’t done so already, start the conversation with your clients that they will need to be solely responsible for producing their financial reports this year!

Auditing

With the move to audits performed under PCAOB standards, public accounting firms must consider all the existing standards enacted by the Board, Auditing Standards (AS) 1 through 18. One of these standards relates almost exclusively to broker-dealers, AS 17 Auditing Supplemental Information Accompanying Audited Financial Statements. This standard targets those supporting schedules filed along with the other financial statements and disclosures according to applicable regulatory guidelines. AS 17 specifies certain audit procedures to test this supplemental information and to evaluate whether it complies with applicable requirements such as SEC Rule 17a-5. These procedures should be risk based, and also planned and performed in conjunction with the audit of the financial statements.

A key term to remember when evaluating supplemental information is its “form and content.” This phrase pops up frequently in the standard itself and also in inspection comments from the PCAOB. In a publication issued in January 2015, inspections staff observed instances of auditors not properly evaluating whether the computation of net capital and customer reserves complied with SEC rules, including the “form and content” of these calculations. Specifically, no procedures were performed to determine whether components of these computations, such as allowable assets or haircuts on securities positions, were determined in accordance with SEC Rule 15c3-1. Essentially, the auditor did not comply with the new standard and did not actually evaluate the “form and content” of the information according to the specific conditions outlined in this rule. Avoid this deficiency by documenting the link between SEC or other requirements to each component of these calculations.

Attestation

Two brand new requirements under the PCAOB regime include Attestation Standards (AT) 1 and 2 for examinations of Compliance Reports and reviews of Exemption reports, respectively. These standards address the amended requirements of filing supplementary information according to SEC rules, which require broker-dealers to file:

• a Compliance Report (to assert that it has complied with the net capital and reserve requirements and that its internal controls over compliance functioned properly throughout the year) or
• an Exemption Report (to affirm that it meets one or more exemption provisions for the entire fiscal year and identify any exceptions to these provisions).

The PCAOB inspection staff has already noted deficiencies when performing examination and review procedures for these promulgations. For instance, it found an audit firm failed to sufficiently test controls over compliance, which is an understandable issue since the standard specifically calls out testing for these controls. In another instance, though, the staff believes a public accounting firm did not perform sufficient attestation procedures because it did not properly test the completeness and accuracy of data related to net capital computations. This decision sounds like an audit finding. However, because of the nature of deficiency, it also affects the adequacy of attestation procedures. A similar situation arises when misstatement in a financial statement audit affects the opinion issued for internal control over financial reporting. Consider how procedures for both your audit AND your attestation affect each other — since the standard requires you to plan and perform these procedures concurrently!

Conclusion

Change can be scary, especially for broker-dealer audits, but it doesn’t need to be. Everyone needs a refresher sometimes. Read through the broker-dealer specific standards, and make sure your audit plan addresses the points in each one. Also, while you may be more worried about these new rules, don’t lose sight of other areas of focus identified by the PCAOB such as auditing revenue recognition and fair value measurement.

If you’re stretched for time and need a more comprehensive look at issues impacting broker-dealer audits, let us know! We offer a full-day course focused on the nuances of broker-dealer audits, including PCAOB oversight and other regulatory changes. Contact us today to learn more.