More On Legal & Compliancefrom The Advisor's Professional Library
- Using Solicitors to Attract Clients Rule 206(4)-3 under the Investment Advisors Act establishes requirements governing cash payments to solicitors. The rule permits payment of cash referral fees to individuals and companies recommending clients to an RIA, but requires four conditions are first satisfied.
- Meeting and Exceeding Clients and Regulators’ Expectations Although it can be difficult, there are ways for RIAs to meet or exceed client expectations, increase customer satisfaction, and help firms retain current clients and attract new ones.
The Public Company Accounting Oversight Board’s (PCAOB) first report on the interim inspection program for auditors of brokers-dealers registered with the Securities and Exchange Commission (SEC) has uncovered some “disturbing” results, the board says.
The 25-page report, released Monday, covered an initial group of 10 audit firms and 23 broker-dealer audits. PCAOB started its interim inspection program last August in response to the board’s new oversight authority over broker-dealer auditors provided in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Congress decided to give PCAOB more oversight authority following Bernie Madoff's Ponzi scheme.
In its first look, carried out from October 2011 to February 2012, PCAOB says its inspectors “identified deficiencies in all of the audits inspected.” On a conference call with reporters to discuss the findings, PCAOB member Jeanette Franzel said that “Even with this small group of audits inspected thus far, the results are disturbing.”
Said Franzel: “While the auditors and audits selected are not representative of all broker and dealer audits and their auditors, the results are of concern to the board” and “indicate that in the audits that we inspected, the auditors were not properly fulfilling their responsibilities to provide an independent check on brokers’ and dealers’ financial reporting and compliance with SEC rules.”
Jay Hanson, another PCAOB member, said on the call that the audits selected for the first report included broker-dealers with a net capital under $1 million. “It is a start,” Hanson said. “When we complete our inspection of a cross-section of about 100 firms and 170 audits,” through 2013, “we will have a better picture to share with you of the state of compliance among audits of all broker-dealers.”
In 2012, PCAOB plans to inspect approximately 40 firms and 60 audits.
Franzel said the deficiencies from the first round of inspections fell mainly into three categories: audit procedures for customer protection and net capital requirements, audits of financial statements, and auditor independence requirements.
In 21 of the 23 audits, PCAOB inspectors said they found that “auditors failed to perform sufficient audit procedures to provide reasonable assurance that any material inadequacies would have been found in the accounting system internal accounting controls, and procedures for safeguarding securities.”
Violations were also found under the SEC’s customer protection rule, Rule 15c3-3, which is designed to protect customers by requiring broker-dealers to segregate customer securities and cash from the broker’s or dealer’s proprietary business activities.
For two of the nine audits of broker-dealers that were required to maintain a customer reserve, the report says that inspectors found that firms “failed to verify that the special reserve bank accounts were designated for the exclusive benefit of customers and that the account agreements contained the required restrictive provisions.”
Regarding net capital, SEC rules require brokers and dealers to maintain certain specified levels of net capital based on types of activities and business lines.
In seven of the 23 audits, PCAOB inspectors found that firms failed to sufficiently test components of the broker’s or dealer’s minimum net capital computation.
As to audits of financial statements, in the majority of the audits inspected, the auditors did not conduct sufficient work to comply with auditing standards. The report notes that those findings were in the areas of the auditors’ consideration and response to the risk of fraud, auditing related party transactions, auditing revenue recognition, establishing a basis for reliance on books and records, auditing fair value measurements, evaluating control deficiencies, and testing the accuracy and completeness of disclosures.
The third category of deficiencies dealt with meeting SEC rules on auditor independence. PCAOB explains that those rules state that an accountant is not independent if the accountant provides bookkeeping and other accounting and financial reporting services related to the financial statements of the audit client. In two audits of this group, PCAOB found that the auditors prepared, or assisted in preparing, the financial statements that they were auditing.
Hanson said the findings of the first report “tell us that there is a need for improvement in the audit work being performed, and that other auditors of broker-dealers should look closely at our findings and assess their own work.”
He noted that while only two audits were noted for independence problems, “this is of particular concern to the board, because we think it is due to a lack of understanding and information about the rules. Broker-dealer auditors are required to comply with the independence rules of the SEC, however many have told us they thought they only needed to abide by [American Institute of CPAs] AICPA rules, which are not as strict.”
As to whether any of the broker-dealer deficiencies had been referred to the SEC or Financial Industry Regulatory Authority (FINRA), Hanson said he couldn’t comment for confidentiality reasons.
Franzel added the interim inspection program will continue beyond 2013, until rules for a permanent inspection program take effect.