Broker Audits Marred by Conflicts of Interest, Watchdog Says

The watchdog of U.S. accounting firms found deficiencies in more than 95 percent of brokerage audits it reviewed last year, including where auditors were checking statements prepared by their own firms.

The Public Company Accounting Oversight Board’s examination of 60 broker-dealer audits discovered “troubling” failures, according to a report issued today on its second interim inspection program. Some auditors were involved in preparing financial statements that they also audited, a breach of U.S. rules, according to the document.

“We’ve got a long ways to go to ensure compliance with the audit requirements in this area,” said PCAOB member Jay D. Hanson. “It points to a need for the firms we inspected to really up their game and show a strong desire to improve.”

Created by the 2002 Sarbanes-Oxley law, the PCAOB was given responsibility after the financial crisis to inspect auditors of U.S. brokerages. Congress expanded the watchdog’s authority after Bernard Madoff carried out the biggest Ponzi scheme in history while using an accounting firm that failed to conduct a meaningful audit of Madoff’s securities business.

The PCAOB’s review found some audit firms are still having trouble complying with Securities and Exchange Commission rules designed to ensure independence from the client that hired them. The board’s watchdogs found evidence that auditors were involved in preparing the financial statements in 22 of the 60 audits inspected by the board.

Brokerage Auditors

Auditors who worked only for brokerages, as opposed to public companies, were more likely to have erred, the PCAOB found. The review found 80 percent of audits done by firms that only audited brokers strayed from independence standards, while 8 percent of auditors who also reviewed public companies made the error. Under a temporary rule approved in 2011, the board doesn’t disclose the names of auditors examined in the review.

“Any firm that wants to continue auditing a broker-dealer has to immediately stop doing that work of preparing the financial statements,” Hanson said.

While the PCAOB’s review looked at audits by 43 firms, the board oversees 783 registered accounting firms that audited the financial statements of at least one brokerage in 2012. More than 360 of those firms audited just one brokerage, while almost 300 more audited fewer than six brokers.

“Some may choose that it’s not worth it to continue doing audits of broker-dealers,” Hanson said. “Every firm really needs to up their investment to make sure they are adequately complying with the rules.”

The PCAOB’s examination found that 72 percent of audits failed to sufficiently test a broker’s internal controls for detecting material accounting weaknesses. In some cases, the auditor “limited their procedures to inquiries of management” and didn’t try to corroborate that information, the board’s report said.

The board also found that 38 percent of the audits it reviewed failed to adequately test the broker’s compliance with SEC rules designed to protect customer assets.

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