United States: Broker-Dealer Audits: PCAOB Disciplinary Orders And Extraordinary Cooperation Credit

Last Updated: July 20 2015
Article by James C. Freije and Jessica E. Morrison

Despite a decreased budget in 2015, Public Company Accounting Oversight Board (PCAOB) Chairman James R. Doty believed there would be enough resources to continue with the PCAOB's strategic plan to serve as the oversight body Congress envisioned. As we reported back in February, Doty noted that the 2015 budget would allow for 75 inspections of firms that audit broker-dealers. Highlighting the PCAOB's 24 settled disciplinary proceedings in 2014, Doty followed up these results by announcing late last week additional settled disciplinary orders by the PCAOB against audit firms performing broker-dealer audits.1 Doty added that the PCAOB declined to pursue disciplinary action against one audit firm due to extraordinary cooperation.

Disciplinary Orders

Securities and Exchange Commission (SEC) rules, specifically Exchange Act Rule 17a-5, require broker-dealer audits to be conducted in accordance with PCAOB standards. Rules 17a-5(e)(1)(i) and 17a-5(g) of the Exchange Act require that audits be conducted by independent public accountants and performed in accordance with generally accepted auditing standards (GAAS). GAAS require auditors to maintain strict independence from their audit clients. Pursuant to Rule 17a-5(f)(3), broker-dealer accountants must be independent in accordance with SEC standards (provided in Rules 2-01(b) and (c) of Regulation S-X) and not provide bookkeeping and other non-audit services related to financial statements.

In the recent announcement, the PCAOB determined that seven audit firms violated such independence requirements in connection with the audits of their broker-dealer clients by preparing client financial statements. Doty stated:

Auditor independence is fundamental to audit quality. Firms should not disregard basic requirements that are central to investor protection and the public interest; many other firms are working hard to audit in a compliant and conscientious manner.

Two of the audit firms censured received $20,000 civil penalties, and one-year prohibitions on accepting new broker-dealer clients, and were ordered to take remedial measures. The heavier penalties here, in contrast to those imposed on the other firms discussed below, evolved from the auditor's previous PCAOB inspection comments indicating independence issues. Notwithstanding inspection comments regarding their preparation of financial statements for their broker-dealer clients, these firms proceeded to prepare that same client's financial statements the following year. In addition to penalizing these audit firms, each firm's engagement partner was censured and sanctioned with a one-year ban from association with a registered public accounting firm.2

Two other firms censured by the PCAOB received $7,500 civil penalties and were ordered to take remedial measures. Each of these firms previously received an inspection comment noting independence issues from the PCAOB. Despite making changes in the following year's audit, the audit firms continued to engage in financial statement preparation for their broker-dealer clients.

The other three censured firms received $2,500 civil penalties, along with orders for remedial measures, for preparing financial statements for their broker-dealer clients.

Extraordinary Cooperation

The PCAOB elected not to initiate disciplinary action against one audit firm because of that firm's extraordinary cooperation. Back in April 2013, the PCAOB released its Policy Statement Regarding Credit for Extraordinary Cooperation in Connection with Board Investigations. This guidance was meant to demonstrate how cooperation by auditors could be considered in determining the outcome of a PCAOB investigation. Enforcement and Investigation Director Claudius Modesti had this to say about the policy:

[E]xtraordinary cooperation – whether voluntary and timely self-reporting, remedial actions, or substantial assistance to the Board's investigative processes or other law enforcement authorities – may also influence enforcement decisions and outcomes.

In this case, the firm's timely and voluntary self-reporting to the PCAOB Tip Line after discovering potential independence issues, along with its timely, voluntary and meaningful remedial actions resulted in non-action by the PCAOB. The PCAOB notes that the firm communicated violations to the broker-dealer client and discussed the conduct and violation at an annual firm training session for all audit personnel.

As we noted back in May of 2013, the PCAOB's guidance was designed to encourage cooperation as a result of increasingly complex cases and decreasing government budgets. Examples of how audit firms and the PCAOB address these extraordinary cooperation opportunities provide insight on how best to advise audit firms in these situations to achieve maximum results. We continue to monitor these announcements to better understand the PCAOB's sanctioning and extraordinary-cooperation criteria.


1 All Respondents consented to the respective orders without admitting or denying the PCAOB's findings. The investigations originated with information obtained through the PCAOB inspection program.

2 One of the engagement partners also was served with a $10,000 civil money penalty.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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