United States: PCAOB’s Report On Broker-Dealer Audit Deficiencies Points The Way For Bds To Improve Their Financial Reporting And Compliance

Last Updated: September 3 2013
Article by Daniel Nathan and Ana-Maria Ignat


For two years, the Public Company Accounting Oversight Board (PCAOB) has been reviewing the work of auditors of broker-dealers, with a view to assessing their work and enabling the PCAOB to develop a permanent program for inspection of broker-dealer audits. Last week, the PCAOB issued its second progress report on this interim inspection program. For broker-dealers, PCAOB's report provides a useful preview of the issues on which their auditors will be increasing their focus in future audits; PCAOB's criticisms of the auditors that it regulates will most likely cause the auditors to beef up their audits in the areas criticized, and broker-dealers are bound to feel the effects in future audits.

Broker-dealers should review the second report, the most significant findings of which are summarized below. The PCAOB found deficiencies in audit procedures related to customer protection and net capital, certain financial statement areas, and auditor independence.

The Dodd-Frank Wall Street Reform and Consumer Protection Act amendments to the Sarbanes-Oxley Act provided the PCAOB with oversight authority with respect to audits of brokers and dealers registered with the Securities and Exchange Commission. A June 2011 rule adopted by the PCAOB and approved by the SEC established an interim inspection program related to broker-dealer audits with the dual purpose of assessing compliance of registered public accounting firms with the applicable statutes, regulations, and professional standards in connection with their performance of broker-dealer audits, and informing the Board's decisions about the scope and elements of a permanent inspection program to be announced in 2014 or later.

SEC Rule 17a-51 requires broker-dealers to file with the SEC and other regulators, among other things: (1) annual financial statements, (2) supporting schedules relating to the computation of net capital and customer reserve, and (3) an accountant's supplemental report on material inadequacies. Rule 17a-5(f)(3) requires auditors of broker-dealers to comply with SEC independence requirements, which provide that an accountant is not independent if it provides bookkeeping or other services related to the accounting record or financial statements of a client unless it is reasonable to conclude that the results of the services will not be subject to audit procedures performed by the accountant during an audit of the client's financial statement.


The PCAOB found a high level of audit deficiencies: in every one of the audit firms inspected and in 95% (57 of 60) of the audits selected for inspection. Some of the deficiencies identified relate to fundamental concepts of auditing, and the PCAOB characterized the audit deficiencies and independence findings as troubling.

Specifically, the PCAOB concluded that audits, as they related to customer protection and the net capital, were deficient as a result of:

  • Insufficient testing of controls related to the broker-dealer's procedures for safeguarding securities, and periodic computations of aggregate indebtedness, net capital, or customer reserves;
  • Inadequate inquiries or procedures for determining whether the broker-dealer properly claimed an exemption from the requirement to maintain a special reserve bank account under the customer protection rule;
  • Failing to evaluate whether a material inadequacy existed when the broker-dealer reported a net capital deficiency in its financial statements;
  • Failing to assess whether a net capital rule computation error indicated the existence of a material inadequacy;
  • Failing to notify the SEC or FINRA of material inadequacies related to the customer reserve computation within the required time frame after the broker-dealer failed to provide notification;
  • Failing to sufficiently test the completeness and accuracy of customer credit or debits included in the customer reserve computation;
  • Failing to perform sufficient procedures to test the broker-dealer's classification of allowable and non-allowable assets when computing net capital; and
  • Failing to perform sufficient procedures for haircuts on securities in the net capital computation, including by failing to test the completeness and accuracy of supporting records received from the broker-dealer or third parties.

Auditors were also found to have failed to follow applicable standards in the financial statement area by:

  • Failing to perform audit procedures to respond to the identified risk of fraud for revenue recognition, or failing to identify such fraud risk altogether;
  • Failing to perform sufficient journal entry testing;
  • Failing to perform sufficient procedures to test for related parties or related parties transactions;
  • Performing insufficient testing for material classes of revenue transactions, including trading gains and losses, commission revenue, and principal transaction revenue;
  • Performing insufficient procedures to test the valuation of securities, including the reasonableness of the fair value estimates;
  • Performing insufficient assessment as to whether the control deficiencies identified represented significant deficiencies or material weaknesses, or would affect a financial statement audit;
  • Failing to identify and address omission of disclosures regarding related parties and transactions, fair value of securities, or revenue recognition policies, despite the fact that they exceeded materiality thresholds;
  • Failing to identify incomplete disclosures or address evidence that was inconsistent with the disclosures made in financial statements;
  • Failing to obtain an understanding of the entity and its environment, including its internal control before designing the nature, timing, and extent of audit procedures; and
  • Applying incorrect definitions of "significant deficiency" and "material weakness" in the evaluation of identified control deficiencies.

These detailed deficiency findings illustrate the level of scrutiny which the PCAOB will apply to audit reports in its permanent inspection program, and auditors are likely to apply in their future audits of broker-dealers' financial records.


The Board stated that it expects audit firms to consider whether the audit deficiencies and independence findings in the report might be present in the audits they are performing, and should correct such deficiencies.

In connection with the audits analyzed in the report, auditors may need to assess their ability to support previously expressed audit opinions, which may entail performing additional audit procedures, informing the broker-dealer of the need to make changes to its statements, schedules, or the audit report on material inadequacies, or take steps to prevent reliance on previously expressed audit opinions. If the financial statements of a broker-dealer appear not to present fairly, in all material respects, the financial position, result of operations, or cash flows of the broker-dealer in conformity with GAAP, the Board reports that information to the SEC. The Board may report information suggesting violations of law and rules, including independence rules, by broker-dealers to the SEC and other regulators.

PCAOB counseled audit firms to stress to their personnel the need to conduct audits with professional care, including professional skepticism. Audit firms should also heed independence rules, and review policies for supervision and review to ensure that their partners and supervisory personnel are paying attention to various broker-dealer audit aspects.


For a permanent inspection program, the Board is particularly focused on how the auditor's role contributes to the protection of assets of broker-dealer customers. To make the audit as useful as possible in promoting customer protection, PCAOB is evaluating whether the risk of loss to customers can be assessed based on certain attributes of broker-dealers. For example, PCAOB is considering differentiating among firms based on whether the broker-dealer: (a) receives, handles or holds securities or cash from the purchase or sale of securities by customers; (b) carries customer accounts; (c) engages in lines of business transacting with customers; (d) reports financial measurements of net capital, revenues, or assets that represent a differentiation of risk of loss to customers; (e) has features in its business model potentially indicating heightened fraud risk or has been the subject of regulatory sanctions; and (f) is a member of the Securities Investor Protection Corporation. The Board anticipates presenting a rule proposal for a permanent inspection program in 2014 or later.

PCAOB advised audit firms to stress to their personnel the need to conduct audits with professional care, including professional skepticism. Broker-dealers should pay attention to the deficiency areas identified in the PCAOB's report, so that they can be prepared for the Board's expectations once it establishes its permanent inspection program.


In preparation for future audits, broker-dealers should review their procedures for financial reporting and net capital and customer protection calculations with an eye towards the specific deficiencies identified in the PCAOB's report. Additionally, although abiding by independence rules remains an auditor's responsibility, broker-dealers should be at least familiar with the governing independence rules, and stay clear of arrangements with their accountants that might taint the auditors' independence.


1. For a discussion of recent revisions to Rule 17a-5 which expanded auditor responsibilities in connection with broker-dealer audits, increased reporting by broker-dealers, and subjected broker-dealer audits to PCAOB standards, review our Client Alert.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Daniel Nathan
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.