Broker-Dealer Audits Are Still Sloppy, But Hey, Auditor Independence Violations Are Down, So That’s Something

The Public Company Accounting Oversight Board released its report on 2017 inspections of broker-dealer audits on Aug. 20, and once again, there was some disappointing news for those who champion audit quality.

According to a PCAOB press release:

In this inspection period, the PCAOB inspected 75 audit firms and reviewed portions of 116 audits and the related attestation engagements. Inspectors identified deficiencies at 68 of the 75 firms inspected, or 91 percent, down from 97 percent in 2016. Many of the deficiencies identified were fundamental to conducting audits, examinations, or reviews.

Well, 91% is a little bit better than 97% in 2016, 96% in 2015, and 100% in 2014, but I wouldn’t consider it worthy of a celebration.

Of the 116 audits and the related attestation engagements inspected, only 24 (21%) had no audit or attestation deficiencies, while 50 (43%) had both audit and attestation deficiencies, 38 (33%) had audit deficiencies but no attestation deficiencies, and four (3%) had attestation deficiencies but no audit deficiencies.

So, by my count, inspectors identified deficiencies in 92 of 116 (79%) broker-dealer audits in 2017, which is down from 83% of audits inspected at firms in 2016, but up from 77% in 2015.

Again, an improvement compared to 2016, but still not great.

The five areas with the highest percentage of audit deficiencies were:

  1. Auditing revenue: 65% of audits with deficiencies
  2. Assessing and responding to risks of material misstatement due to fraud: 64%
  3. Engagement quality review: 59%
  4. Customer protection rule: 48%
  5. Net capital rule: 36%

The five areas with the highest percentage of attestation deficiencies were:

  1. Examination procedures: 70% of attestation engagements with deficiencies
  2. Review procedures: 32%
  3. Engagement quality review (related to review engagements): 26%
  4. Engagement quality review (related to examination engagements): 20%
  5. Review report: 13%

While deficiencies remain high in broker-dealer audits, there were fewer auditor independence violations, according to the report:

Inspections staff identified independence findings in 4 of 48, or eight percent, of the audits covered by the inspections in 2017, compared to 11 of 115, or 10 percent of the audits covered by the inspections in 2016. For 2017, the selection of independence as a focus area was risk-based, taking into consideration the characteristics of the audit firm, as compared to 2016 when independence was a focus area for all inspections. Three of the four audits with independence findings in 2017, and all 11 audits with independence findings in 2016, were performed by firms that did not audit issuers.

In the 2017 inspections, the independence impairments in three of these four audits were based on the audit firms having performed bookkeeping or other services related to the broker-dealer’s accounting records, or having prepared, or assisted in the preparation of, the broker-dealer’s financial statements, supplemental information, or exemption report. In the other audit, Inspections staff observed that the firm’s independence was impaired because of an indemnification clause in the firm’s engagement letter that stated that the broker-dealer would indemnify the firm from any and all claims of the broker-dealer and third parties when there was knowing misrepresentation or concealment of information by the broker-dealer’s management, regardless as to the nature of the claim, including the negligence of any party.

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Image: iStock/PeskyMonkey

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