Forum on Auditing Smaller Broker-Dealers - PCAOB · 2014-06-30 · Total firms that audit BDs—approximately 900 Withdrawals—692 * As of October 11, 2011. Broker Dealer Statistics

Forum on Auditing Smaller Broker-Dealers

October 28 2011

Jersey City, NJ

Opening Remarks

Daniel L. Goelzer

Board Member, PCAOB

October 28, 2011

Jersey City, NJ

Caveat

One of the benefits of today's session is that you will hear firsthand from one of the PCAOB Board members and numerous PCAOB staff. You should keep in mind, though, that when we share our views they are those of the speaker alone, and do not necessarily reflect the views of the Board, its members or staff. Therefore, unless it is clear that the Board has authorized the statement, you should not attribute it to the Board or staff.

PCAOB Overview

Mary M. Sjoquist, Director

Office of Outreach and

Small Business Liaison

October 28, 2011

Jersey City, NJ

Mission Statement

� The PCAOB is a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports. The PCAOB also oversees the audits of broker-dealers, including compliance reports filed pursuant to federal securities laws, to promote investor protection.

What is the PCAOB?

� Independent organization created by Sarbanes-Oxley to regulate the auditing profession

� Private, non-profit corporation

� But, under the oversight of the SEC for approval of:

� Budget

� Rules

� Disciplinary Sanctions

� 5-Member Board of Directors, appointed by the SEC

� Serve staggered 5-year terms

� Funded by fees from US-traded companies, broker-

dealers and, to a much lesser extent, accounting firms

Changes in Auditing Profession

Source: The New Yorker

The PCAOB in a Nutshell

Registration EnforcementInvestigationsInspections

Professional Standards

PCAOBPCAOBPCAOBPCAOB’s Standards Standards Standards Standard----Setting Process Setting Process Setting Process Setting Process

PPCCAAOOBB TTyyppiiccaall RRuulleemmaakkiinngg PPrroocceessss

Proposed

Rules Issued by PCAOB for Comment at Open Meeting

Rules Adopted by PCAOB at Open Meeting

Final PCAOB Rule Filed with S.E.C. on Form 19b-4

Comment Period

S.E.C. Publishes Notice of Filing and Opens Comment Period

Notice of Filing Printed in Federal Register

S.E.C. Issues Order Approving Rules (or Institutes Proceedings to Disapprove)

Rules (if Approved) Become Effective

Order Printed in Federal Register

SEC Comment Period

Other Steps in Standard-Setting

� Standing Advisory Group input

� Investor Advisory Group input

� Roundtables

� Outreach to individuals and entities with interest in the subject matter

� Concept releases

� Reproposals

PCAOB Statistics*

� Total firms registered—2411

� US registered firms—1504

� Foreign registered firms—907� 85 countries

� China-108; UK 66; India-65; Canada-52; Australia-42

� Auditors of BDs registered since 2009—560

� Firms that audit only BDs—approximately 507

� Total firms that audit BDs—approximately 900

� Withdrawals—692

* As of October 11, 2011

Broker Dealer Statistics

� Approximately 5500 registered BDs

� Approximately 4600 are FINRA registered

� Approximately 70 foreign registered BDs

Pre-Dodd-Frank

� Sarbanes-Oxley provided that auditors of BDs were required to register with the PCAOB

� SEC provided an exemption from this registration until December 31, 2008

� For fiscal years ended after 12/31/08, BD’s financial statements were required to be audited by a PCAOB-registered firm

� Dodd-Frank extended PCAOB’s authority to include oversight of auditors of BDs

Office of Outreach and Small Business Liaison

� Established on December 15, 2010

� Formalized and centralized currently existing small business initiatives

� Small business forums

� Outreach to smaller firms and issuers

� New functions

� Outreach to the broker-dealer community including forums for auditors of broker-dealers

� Central point of contact for:

� questions about the Board’s activities

� identifying areas where information related to the Board’s work is not well understood

� suggesting actions to address these areas

Dodd-Frank--Funding

� The Act provides that the Board must allocate the accounting support fee equitably among not only issuers but also brokers and dealers (see section 109(d))

� The Board may establish different classes of issuers and of brokers and dealers for funding purposes (sections 109(g) and 109(h)(2))

� The amount due from a broker or dealer must be in proportion to the net capital of the broker or dealer (before or after any adjustments), compared to the total net capital of all brokers and dealers (before or after any adjustments), in accordance with the rules of the Board (see section 109(h)(3))

Funding Rule

� As adopted, fee is based on “tentative net capital,” which under the SEC’s Rules is net capital before deducting certain securities haircuts and charges for certain commodities transactions (see SEC Rule 15c3-1(c)(15)).

� A class of brokers and dealers, each with average quarterly tentative net capital less than $5 million, will be allocated an ASF of zero. � Represents 86% of FINRA registered brokers and dealers or 1.1% of

the industry’s total net capital*

� 640 of the approximately 4,600 FINRA BDs will share in the fee*

� Adopted by PCAOB on June 14, 2011 and approved by the SEC on August 18, 2011

*See PCAOB Release 2010-09 (December 14, 2010)

Funding Rule (cont’d)

� Firm may not sign an audit report; consent to the inclusion of a report; or sign a document, report, notice, or other record concerning procedures or controls of any issuer, broker, or dealer required under the securities for a BD with an outstanding ASF

� Limited exception where broker, or dealer needs the audit report or consent in order to submit a report to, or make a filing with, the Commission

� Under those circumstances, the auditor must provide a notice to the Board the day after the filing is made; only good for 15 days; and is a one time exception

Rules on Periodic Reporting by Registered Public Accounting Firms--Annual Reporting

Form 2 includes –

� General information concerning the firm

� Audit clients and audit reports*

� Offices and affiliations

� Personnel

� Certain relationships

� Acquisitions

� Affirmation of consent

*Only applicable to issuers reports

Rules on Periodic Reporting by Registered Public Accounting Firms--Special Reporting

Form 3 triggering events and disclosures include –

� Name change

� Audit reports (withdrawn a report or consent, or crossed 100 issuer threshold)

� Certain legal proceedings

� Bankruptcy

� Certain relationships

� Licenses and certifications

� Changes in the firm’s Board contact person

� Catch-up Form 3s were due February 1, 2010.

Reporting Rules on Succeeding to a Predecessor Firm’s Registration Status

� Allows firms whose structure has changed to retain registration status under two scenarios:

� A registered firm changes its legal form of organization or jurisdiction in which it operates

� A registered firm is acquired by an unregistered firm or merges with another firm to create a new legal entity

Reporting Rules on Succeeding to a Predecessor Firm’s Registration Status

� The rules provide for:

� A form to be filed (Form 4),

� Within14 days after the event,

� With certain representations

� Continuity of registration is automatic, without the need for Board action.

� If deadline for filing Form 4 is not met, the registration process using Form 1 will be required along with Board action.

Confidential Treatment Requests

� Confidential Treatment Requests are more limited on these forms than on the registration application form

� Board has determined that certain information will never qualify

� In practice, this means no check box is available to request confidential treatment

� To request confidential treatment:

� Firm must represent that information is not public AND

� Firm must provide a detailed explanation of how the information is proprietary OR

� Firm must provide a detailed explanation of how the information is protected from public disclosure by applicable law, and must provide a publicly available citation to or a copy of the law

Questions?

� The Impact of Economic Trends on Broker-Dealers; the Broker-Dealer Landscape

Tim Gustafson

Office of Research and Analysis

Decline in Broker-Dealer Population

SIPC Membership 1998 to 2010

4,000

5,000

6,000

7,000

8,000

1002003004005006007008009001,000

Total 7,542 7,315 7,033 6,791 6,679 6,466 6,153 5,959 5,654 5,435 5,208 4,956 4,773

Added 721 638 644 616 632 471 444 347 298 234 227 186 214

Terminated 753 865 926 858 744 684 757 541 603 453 454 438 397

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: SIPC Annual Reports 1998 to 2010

Recent Trends – FINRA Member Firms

Source FINRA Statistics

FINRA Member Firms 2006 to 2010

4,120

4,320

4,520

4,720

4,920

5,120

5,320

5,520

570,000

590,000

610,000

630,000

650,000

670,000

690,000

710,000

730,000

FINRA Member Firms 5,029 5,005 4,895 4,720 4,578

Registered Reps 658,173 672,688 664,975 633,280 634,382

2006 2007 2008 2009 2010

Recent Trends – Corporate Finance

Corporate Financing 2006 to 2010

470

570

670

770

870

970

100

110

120

130

140

150

160

170

180

Total Corp Filing 914 961 521 684 907

Other Filings 111 134 114 125 166

2006 2007 2008 2009 2010

Source FINRA Statistics

Recent Trends – Revenue & Expenses

Source SIFMA Statistics

Total NASD & NYSE

Revenue & Expenses 2006 to 2010

205,000

255,000

305,000

355,000

405,000

455,000

Net Revenue 436,796 474,192 290,541 278,936 254,752

Total Expense 403,712 473,414 324,668 207,286 219,963

2006 2007 2008 2009 2010

Recent Trends - Profitability

Total NASD & NYSE

Pretax and After Tax Income 2006 to 2010

-30%

-20%

-10%

0%

10%

20%

30%

% Pretax Income 8% 0% -12% 26% 14%

% Net Income 6% 1% -9% 18% 10%

2006 2007 2008 2009 2010

Source SIFMA Statistics

Macroeconomic risks for Broker-Dealers

� Market volatility

� Very low interest rates

� US credit rating

� European sovereign debt crisis

The Broker-Dealer Landscape

� Who are their Designated Examining Authority?

� How Many are Subsidiaries of Issuers?

� Who Audits Broker-Dealers?

� Broker-Dealers Classified by…

� Exemptions from 15c3-3

� Minimum Dollar Net Capital Amount

� B-Ds Dual Registered as RIA

� Size

� SIPC Membership

Broker-Dealers Classified by DEA

Non-FINRA

CBOE

61%CHX

13%

ARCA

9%

AMEX

8%

PHLX

6%SEC

3%

FINRA vs Non-FINRA

FINRA

97%

Non-FINRA

3%

Broker-Dealer Subsidiaries of Issuers

Issuers, 10%

Non-Issuers,

90%

26%

5%

74%

95%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Issuers Non-Issuers

Claim Exemption

No Exemption

Broker-Dealers Classified by Auditors “Issuer” Inspection Program

No

Exemption Claim

Exemption

66%

18%

16%

18%

35%

47%

0%

50%

100%

OtherFirms

TriennialFirms

AnnualFirms

Broker-Dealers Classified by Auditors “Issuer” Inspection Program

Subsidiary of Issuer 86 21 148 111 366

Not a Subsidiary of Issuer 61 27 253 228 569

147 48 401 339 935

Subsidiary of Issuer 1 3 35 15 54

Not a Subsidiary of Issuer 33 15 719 685 1,452

34 18 754 700 1,506

Subsidiary of Issuer 2 3 5 Not a Subsidiary of Issuer 31 19 1,041 867 1,958

31 19 1,043 870 1,963

6 7 13

0 5 5212 85 2,204 1,921 4,422

Most recent B-D audit report data Per SEC as of April 1, 2011; FINRA FOCUS Report data as of December 31,2010

Issuer audit report data, with filing dates from December 1, 2010 to July 21, 2011 Per Audit Analytics

Total FINRA

B-Ds

Indicator Key

Introduce and do not Carry

Neither Carry nor Introduce

Unclassified

Do Not Report

CustomerDebits or Credits

B-Ds that are NOT 15c3-3 Exempt B-Ds that are 15c3-3 Exempt

B-D Filed an Unaudited Annual Report Total

Report Customer Debits or Credits Inspection Program

B-Ds that are Audited by Annual Firms

B-Ds that are Audited by Triennial Firms

B-Ds Audited by Firms that don't Audit

I II III IV

B-D Clients of Attendee Firms vs General Population

FINRA B-Ds Audited by Attendee Firms 23 10 602 443 1,078

FINRA B-Ds within 30 mils of Jersey City 83 33 598 470 1,184

All FINRA B-Ds 212 85 2,204 1,921 4,422

Report Customer

Debits or Credits

Do Not Report

Customer

Debits or Credits

Introduce and do not

Carry

Neither Carry nor

Introduce

Total

FINRA

B-Ds


Minimum Dollar Net Capital Amounts as an Indicators of Business Activity

- - 777 1,630 2,407

- - 25 89 114

- - 20 15 35

- - 334 13 347

- 11 632 81 724

125 67 331 74 597

38 6 37 1 82

30 - 1 - 31

19 1 47 18 85

- - - - -

Total 212 85 2,204 1,921 4,422Most recent audit report data per SEC as of April 1, 2011; FINRA FOCUS Report data as of December 31,2010

Total

FINRAB-Ds



Carry

$250,000 (Carrying B-Ds and various other B-Ds)

$1,000,000 (Market Makers and CFTC FCMs)

$1,500,000 (Prime Brokers)

$25,000 (B-Ds of only mutual funds, insurance, etc)

$45,000 (CFTC Registered Introducing B-Ds)

No Data- Non-FINRA B-Ds

Report Customer

Debits or Credits

Do Not Report Customer

Debits or Credits

Not Comparable

$50,000 (Introducing B-Ds that receive but don't hold)

$100,000 (Dealers or (k)(2)(i) expemt B-Ds)

$5,000 (B-Ds that don't receive, hold, owe, carry, etc.)

Neither Carry nor

Introduce

Broker-Dealers Registered as RIAs

Number of Dual Registrants 52 11 354 55 472 Total Active B-Ds 212 85 2,204 1,921 4,422 % of B-Ds that are Dual Registrants 25% 13% 16% 3% 11%

Total ($ Millions) $620,471 $18,590 $585,674 $84,931 Average ($ Millions) $11,932 $1,690 $1,654 $1,544 $2,788

Median ($ Millions) $2,279 $229 $89 $33 $105Most Recent Form ADV Data Per Audit Analytics as of June 14, 2011; FINRA FOCUS Report Data as of December 31,2010

Total

FINRA B-

Ds

$1,309,667

Assets Under Management of Dual Registrants


Introduce and do

not Carry

Neither Carry nor

Introduce

Report Customer

Debits or Credits

Do Not Report

Customer

Debits or Credits

Broker-Dealers Classified by Number of Business Lines Reported

0 Business lines - - - 1 1

1 Business line 6 7 69 459 541

2 Business lines 7 13 96 763 879

3-5 Business lines 36 30 497 592 1,155

6-10 Business lines 78 21 954 98 1,151

11-20 Business lines 73 14 582 8 677

20-25 Business lines 12 - 6 - 18

Total 212 85 2,204 1,921 4,422

Introduce and do

not Carry

Neither Carry nor

Introduce

Form BD Data as of January 11, 2011; FINRA FOCUS Report Data as of December 31,2010

Data prepared by SIPC for PCAOB regarding membership as of March 25, 2011


Total

FINRA

B-Ds Inspection Program

Report Customer

Debits or Credits

Do Not Report

Customer

Debits or Credits

Broker-Dealers by Classification and Size

Total

FINRA

B-Ds

- 18 131 148 297 Introducing (Per Form BD) but not carrying 241 913 978 72 2,204 Activities of B-Ds that Neither Introduce Nor Carry

1 Private placements of securities only 95 66 29 - 190 2 Mutual fund retailer only 17 24 3 - 44 3 Variable life insurance/annuity retailer only 10 4 7 - 21 4 Tax shelter/limited partnership sales only 9 4 3 - 16 5 Form BD "Other" only 46 57 31 - 134 6 Combination of two or more of activities 1-5 only 369 301 133 3 806 7 Not Classified 212 260 213 25 710

Total 999 1,647 1,528 248 4,422 Form BD data as of January 11, 2011; FINRA FOCUS Report data as of December 31,2010

Carrying (i.e., Not 3-3 Exempt)

More than

$100,000,001 12/31/2010 Total Assets:

$100,000

or less

$100,001 -

$1,000,000

$1,000,001 -

$100,000,000

Form BD Classifications of Business Activity

1 P riv a te p lac e m en t s o f s ec u r i tie s 5 3 % 4 0 % 4 8 % 6 5 % 5 5 %

2 M u tu a l fu n d re ta i le r 6 0 % 3 1 % 6 8 % 2 7 % 4 9 %

3B ro k e r o r d ea le r re ta i lin g c o rp o ra te eq u it y s e c u rit ie s o v e r-t he - c ou n te r 7 7 % 4 1 % 8 4 % 4 % 4 8 %

4 B ro k e r o r d ea le r s e ll in g c o rp or a te d e bt s e c u rit ie s 7 0 % 4 5 % 7 0 % 4 % 4 1 %5 M u n ic i pa l s e c u r it ie s b ro k e r 5 9 % 3 6 % 5 6 % 7 % 3 5 %

6B ro k e r o r d ea le r s e ll in g v ar ia b le l if e in s u ra n c e or

a n nu i tie s 3 6 % 1 9 % 4 7 % 2 1 % 3 4 %

7 U .S . g o ve r nm e nt s e c u rit ie s b ro k e r 6 3 % 3 5 % 5 7 % 2 % 3 3 %8 P ut a n d c a ll b ro k e r o r de a le r o r o p ti on w r it e r 5 9 % 2 8 % 5 5 % 1 % 3 2 %

9N on -e x c h a ng e m e m b e r a rr an g in g f o r t ra n s ac t io n s

in li s te d s e c ur itie s b y ex c h a n ge m e m b e r 2 4 % 2 9 % 4 7 % 2 % 2 6 %

1 0U nd e rw r it e r o r s e l lin g g ro u p p a rti c ip a n t (c o r po ra t e s e c u rit ie s o th e r th a n m u tu a l fu n ds ) 5 3 % 3 4 % 3 7 % 7 % 2 5 %

1 1B ro k e r o r d ea le r m a k in g in te r- de a le r m a rk e t s i n

c o rp o ra te s e c u ri t ie s ov e r-t h e- c ou n te r 3 3 % 1 5 % 3 2 % 8 % 2 1 %

1 2B ro k e r o r d ea le r s e ll in g ta x s h e lt e r s o r lim it e d

p a rtn e rs h ip s in p rim a ry d is t r ib u tion s 1 5 % 1 2 % 2 2 % 2 0 % 2 1 %1 3 T ra d in g s e c u rit ie s f o r o w n ac c o u n t 5 8 % 4 2 % 3 1 % 2 % 2 0 %1 4 M u n ic i pa l s e c u r it ie s d e a le r 4 7 % 2 7 % 2 0 % 2 % 1 4 %1 5 U .S . g o ve r nm e nt s e c u rit ie s d e a le r 4 3 % 2 6 % 1 4 % 1 % 1 0 %1 6 S ol ic i to r o f t im e de p o s its in a fin a n c ia l in s ti tu tion 2 2 % 8 % 1 4 % 1 % 9 %1 7 B ro k e r o r d ea le r s e ll in g o il a nd g a s in te re s ts 5 % 4 % 8 % 5 % 7 %

1 8B ro k e r o r d ea le r s e ll in g in te r es t s in m o rt ga g e s o r

o th e r re c e iv ab le s 2 5 % 8 % 9 % 2 % 6 %

1 9

B ro k e r o r d ea le r in v o lv e d in a n e tw o r k in g , k io s k o r

s im i la r a r r a ng e m e n t w it h a : ins u r an c e c o m p a n y o r a g en c y 3 2 % 1 2 % 9 % 0 % 6 %

2 0 M u tu a l fu n d u nd e rw rit e r o r s po n s o r 1 7 % 8 % 4 % 8 % 6 %

2 1E x c ha n g e m e m be r e ng a g ed in e x c ha n g e

c o m m is s io n bu s ine s s o t he r th a n flo or a c tivi ties 4 3 % 9 % 7 % 0 % 6 %

2 2

B ro k e r o r d ea le r in v o lv e d in a n e tw o r k in g , k io s k o r s im i la r a r r a ng e m e n t w it h a : b a n k , s a v in g s b a n k o r

a s s o c ia ti on , o r c r ed i t u n io n 1 6 % 6 % 9 % 0 % 5 %

2 3B ro k e r o r d ea le r s e ll in g ta x s h e lt e r s o r lim it e d p a rtn e rs h ip s in th e s e c o n da ry m a r k e t 1 1 % 4 % 6 % 2 % 4 %

2 4 R ea l e s ta te s y nd ic a t o r 1 % 1 % 2 % 4 % 3 %

2 5 E x c ha n g e m e m be r e ng a g ed in f lo or a c tiv itie s 2 2 % 1 2 % 3 % 0 % 3 %

2 6B ro k e r o r d ea le r s e ll in g s e c ur itie s o f no n -p ro f it o rg a n iz a t io n s (e .g . , c h u rc h e s , h o s p ita l s ) 1 1 % 5 % 3 % 1 % 2 %

2 7 I n v e s tm en t a dv is or y s e r v ic e s 6 % 2 % 3 % 0 % 2 %

2 8i s s ue r o r a s s o c ia te is s u e r s (o th e r th a n m u tu a l

f un d s ) 3 % 2 % 1 % 2 % 1 %

2 9 O th er 4 9 % 5 4 % 3 5 % 5 4 % 4 4 %

C ou n t o f F IN R A B -D s 2 1 2 8 5 2 ,2 0 4 1 , 9 2 1 4 ,4 2 2

I I I I I I IV

B -D s th a t a re N O T 1 5 c 3 -3 E x e m p t B -D s th a t a re 1 5 c 3 -3 E x e m p t

T o ta l

F IN R A B -D s

R ep o rt C u s to m e r D e b its o r C r ed its F o rm B D B u s ine s s A c t iv i ty *

N e ith e r C a r ry n o r In tro d uc e

D o N o t R e p o rt

C u s to m erD e b its o r C re d i ts

In tr o d u c e a n d d o n o t C a r ry

Broker-Dealers Classified by SIPC Membership Status

SIPC Members 212 85 2,194 1,683 4,174

Exempt from SIPC Membership - - 10 238 248

Total 212 85 2,204 1,921 4,422 Data prepared by SIPC for PCAOB regarding membership as of March 25, 2011; FINRA FOCUS Report data as of December 31,2010

Total

FINRA

B-Ds


Report Customer

Debits or Credits

Do Not Report

Customer

Debits or Credits


Carry

Neither Carry nor

Introduce

Broker-Dealers Subject to Liquidation or Direct Payment Procedures Under SIP Act Commenced After 1/1/95 and Paid as of 12/31/10

� Excluding Madoff, 82% of SIPC liquidations and 65% of customer advances were for non-carrying/clearing B/Ds

� The average customer advances paid for carrying/clearing B/Ds was $4 million (excluding Madoff)

� The average customer advances paid for non-carrying/clearing B/Ds was $2 million

Clearing B/Ds (Except Madoff) 11 14% 48 5%

Introducing and Other B/Ds 62 81% 112 12%No Classification Data 3 4% 12 1%

Madoff Liquidation (in process) 1 1% 755 81%Total 77 100% 927 100%

Data prepared by SIPC for PCAOB regarding customer advances as of December 31, 2010

Number of B/D

Liquidations % of Liquidations

SIPC Customer

Advances in

Liquidations

(Millions $)

% of Customer

Advances

Questions?

Break

(15 minutes)

46

Cecil MakProfessional Accounting Fellow

Office of the Chief AccountantU.S. Securities and Exchange Commission

October 28, 2011Jersey City, NJ

The Securities and Exchange Commission, as a matter of policy,

disclaims responsibility for any private publication or statement by any

of its employees. Therefore, the views expressed today are my own, and

do not necessarily reflect the views of the Commission or the other

members of the staff of the Commission.

PCAOB Forum for Auditors of Smaller

Broker Dealers

47

Agenda

� Broker-Dealer Rulemaking

� Current SEC Annual Reporting Requirements

� Proposed Amendments to SEC Annual Reporting Requirements

� Selected Areas of Public Comment

� Applicability of Auditor Independence Rules to Broker-Dealer Audits

48

Broker-Dealer Rulemaking Broker-Dealer Rulemaking

49

Broker-Dealer Rulemaking

� July 21, 2010 – Section 982 of the Dodd-Frank Wall Street Reform and Consumer Protection Act granted the PCAOB oversight over audits of brokers and dealers registered with the Commission

� Sept. 24, 2010 – Commission published interpretative guidance to clarify the application of certain rules, regulations, releases, and staff bulletins in light of the PCAOB’s oversight

� Nov. 18, 2010 – Letter issued by SEC Director of Trading and Markets and SEC Chief Accountant concerning requirements for broker-dealer annual audits pursuant to Rule 17a-5

50


� June 14, 2011 – PCAOB adopted final rules for allocation of the Board’s accounting support fee among issuers, brokers, and dealers, and other amendments to the Board’s funding Rules

� June 14, 2011 – PCAOB adopted temporary rule for an interim program of inspection related to audits of brokers and dealers

� Commission order approving these rules on August 18, 2011

51


� June 15, 2011 – Commission proposed amendments to broker-dealer financial reporting rules to:

� Update existing requirements of Rule 17a-5

� Facilitate the ability of the PCAOB to implement oversight of independent public accountants of broker-dealers

� Eliminate potentially redundant requirements for certain broker-dealers affiliated with, or dually registered as, investment advisors

� Other amendments include:

� Access to audit documentation

� New Form Custody

52


� July 12, 2011 – PCAOB proposed two new attestation standards:

� Examination Engagements Regarding Compliance Reports of Brokers and Dealers

� Review Engagements Regarding Exemption Reports of Brokers and Dealers

� July 12, 2011 – PCAOB proposed auditing standard, Auditing Supplemental Information Accompanying Audited Financial Statements

53

Current SEC Annual Reporting

Requirements

� Broker-dealers are required to file an annual report with the SEC and the broker-dealer’s designated examining authority pursuant to Rule 17a-5

� Annual report must contain audited financial statements and certain supporting schedules and supplemental reports, as applicable

� The audit is conducted in accordance with GAAS (i.e., not PCAOB standards)

54

Current SEC Annual Reporting

Requirements

� Report on internal controls

� The auditor is required to obtain reasonable assurance that any material inadequacies existing at the audit report date in the following areas are disclosed:

� Accounting system

� Internal control

� Procedures for safeguarding securities, and

� Practices and procedures specified by Rule 17a-5

� Study of practices and procedures followed, including consideration of control activities for safeguarding securities

� Broker-dealers that are exempt from Rule 15c3-3

55

Proposed Amendments to SEC Annual

Reporting Requirements

� In addition to existing requirements to file audited financial statements and certain supporting schedules (“Financial Report”), proposed Rule 17a-5 would also require the following new reports:

� Carrying broker-dealer

� Compliance Report

� Examination Report of independent public accountant

� Non-carrying broker-dealer

� Exemption Report

� Review Report of independent public accountant

56



� Audit of the Financial Report, the examination of the Compliance Report and the review of the Exemption Report would be conducted in accordance with PCAOB standards, instead of GAAS

� Examples of PCAOB standards containing additional requirements compared to GAAS include, but are not limited to:

� Auditing Standard No. 3, Audit Documentation

� Auditing Standard No. 7, Engagement Quality Review

57



� Carrying broker-dealer required to file a Compliance Report which would include management’s written assertions of whether:

� It was in compliance in all material respects with the Financial Responsibility Rules as of its fiscal year-end;

� The information used to assert compliance was derived from the books and records of the broker-dealer; and

� Internal control over compliance with the Financial Responsibility Rules was effective during the most recent fiscal year such that there were no instances of material weakness.

58



� Carrying broker-dealer could not assert compliance with the Financial Responsibility Rules if it identifies one or more instances of material non-compliance

� Carrying broker-dealer would be required to engage an independent public accountant to:

� Prepare an Examination Report based on an examination of the broker-dealer’s assertions contained in the Compliance Report

59



� Material non-compliance

� A failure by the broker-dealer to comply with any of the requirements of the Financial Responsibility Rules in all material respects

� Material weakness

� A deficiency, or a combination of deficiencies, in internal control over compliance with the Financial Responsibility Rules, such that there is a reasonable possibility that material non-compliance with those provisions will not be prevented or detected on a timely basis

� Existing term “material inadequacy” replaced

60



� Non-carrying broker-dealer would be required to:

� File an Exemption Report to assert that it is exempt from the provisions of Rule 15c3-3

� Engage an independent public accountant to prepare a report based on a review of the broker-dealer’s assertion that it is exempt from the provisions of Rule 15c3-3 contained in the Exemption Report

61



� Proposed requirement for independent public accountant to notify the Commission, within one business day, if instance of “material non-compliance” exists with respect to the Financial Responsibility Rules

62



� Proposed access to audit documentation

� Clearing broker-dealer would consent to permitting its independent public accountants to:

� Make available to the Commission and Designated Examining Authority (“DEA”) examiners the audit documentation associated with its annual reports required under Rule 17a-5

� Discuss findings relating to the audit reports with the Commission and DEA examiners

� Proposed new Form Custody

63



� Proposed to be effective for annual reports filed with the SEC for fiscal years ending on or after December 15, 2011

� Proposed transition period for carrying broker-dealers required to file Compliance Reports with fiscal years ending on or after December 15, 2011 but before September 15, 2012

64

Selected Areas of Public Comment

� Comment period closed on August 26, 2011

� 26 comment letters received

� Areas of public comment included:

� Material non-compliance and material weakness

� Reporting of remediation of material weaknesses

� Relationship between internal control over compliance with Financial Responsibility Rules and internal control over financial reporting

� Internal control considerations related to broker-dealer’s books and records

65

Selected Areas of Public Comment

� Areas of public comment included (cont’d):

� Period or “as of date” exemption of Rule 15c3-3

� Notification requirements to the Commission

� Effective date and transition period

� Access to audit documentation

� Interaction with other regulatory rules and requirements

66

Applicability of Auditor Independence Rules to Broker-Dealer Audits

Applicability of Auditor Independence Rules to Broker-Dealer Audits

67

Applicability of Auditor Independence

Rules to Broker-Dealer Audits

� Auditors of both issuer and non-issuer broker-dealers are required to be qualified and independent in accordance with the Commission’s auditor independence requirements in Rule 2-01, Qualification of Accountants

� No currently proposed changes to current requirements

68

Applicability of Auditor Independence

Rules to Broker-Dealer Audits

� Office of the Chief Accountant: Application of the Commission’s Rules on Auditor Independence Frequently Asked Questions

� Auditors of non-issuer brokers-dealers are not subject to rules related to:

� Partner rotation requirements

� Certain partner compensation arrangements

� Auditors of non-issuer broker-dealers are also not subject to rules related to:

� Audit committee administration requirements

� “Cooling off” period requirements

69

Questions?Questions?

FINRA Broker-Dealer Audit Reviews

PCAOB Forum on Auditing Smaller Broker-Dealers - 2011

Susan DeMando Scott

Office of Risk Oversight and Operational Regulation, Financial Operations Policy Group

PCAOB Forum on Auditing Smaller Broker-Dealers � © 2011 Financial Industry Regulatory Authority, Inc. All rights reserved

• Review conducted by a firm’s assigned Regulatory Coordinator

• Summary Review Conducted within 5 days of receipt

• Completeness

- all required documents pursuant to SEA Rule 17a-5

• Auditor’s Report or Opinion

- Unqualified, qualified due to scope, or opinion with explanatory paragraph (e.g. going concern)

• Indication of material inadequacies / weaknesses

if applicable explanation of what occurred and how will be resolved

71

Annual Audit – Summary Review


Annual Audit – Full Review

• Review occurs no later than 60 days after receipt

• Review for:

• Whether audited statements convey a consistent portrait of thefirm’s business activities with the FOCUS submissions

• reconciliation of total balances, assets, liabilities, revenue earnings, contributions and distributions with relevant FOCUS filings

• Unexpected financial reporting practices

(e.g., valuing traded securities at other than market price)

• Consolidation with other entities

should see summary financial balances related to other entities in the notes

• Nature of commitments guarantees and contingencies

72


FINRA’s Treatment of an Annual Audit

• FINRA’s By-Laws (Schedule A) permit/require us to treat any annual audit as “not to have been filed” if it contains “material inaccuracies”.

• FINRA has treated audits with material inaccuracies as not filed.

• Automatically accessed a $1,000 “late fee”

• In general, firm has 21 days to cure to avoid suspension.

• Firm has a right to a hearing (if requested within 21 days); such request stays suspension.

• 90 days to “cure” suspension by filing compliant audit. Otherwise firm’s membership in FINRA is cancelled.

• Possible referral to PCAOB

73


Determining Material Inaccuracies

• The audit reports and the financial presentation and disclosure do not:

• align with guidance given to firm by FINRA

• comprehend action taken by FINRA staff

• reflect interpretative position of SEC staff

• address internal (i.e. known only to FINRA and the firm) information

• comprehend negative “publicly-available” information

• reflect an understanding of key SEC financial responsibility rules and related interpretations

74


Questions to Ask of a Prospective Client

“Know Your Client” and thoroughly understand the context of the financial statements

• What are the business activities and practices of the broker-dealer and how might they affect its accounting practices and the reported balances

• Does the firm’s financial success (or lack thereof) make sense given its demographics?

• Who prepares the firm’s financial records? If outside FinOp, how does the arrangement work? (Notice to Members 06-23)

Relationship Considerations

How many auditors has the BD had in the past?

If the audit client found you, how?

Does the client’s choice of you, as an auditor of a BD, make sense?

Where is the location of the BD’s operations versus that of the auditor?

75


Questions to Ask/Matters to Consider on an On-Going Basis

• Does the firm’s financial success (or lack thereof) make sense given its demographics?

• Does the BD engage in any non-securities business activities?

• Does the BD have affiliates?

• What are their business models?

• What is the interplay among them?

• Revenue Side

• Expense Side

• What access do you have to the books of the affiliate(s)?

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Key Considerations for Auditors of Broker-Dealers

• Risks to an auditor are raised if he/she concentrates solely on a firm’s net capital requirement or regulatory requirements as a guide with respect to dictate the extent/scope of audit work.

• What is a “small” broker/dealer?

• Firm/Auditor over-reliance on SEC/SRO examination.

• Regulators conduct exams, not audits.

• Practical implications of the exemptive provisions (paragraph (k)(1), (k)(2)(i), and (k)(2)(ii) of SEA Rule 15c3-3).

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PCAOB Standards

Keith WilsonDeputy Chief Auditor, Office of the Chief Auditor

Barbara K. VanichAssociate Chief Auditor, Office of the Chief Auditor

Caveat

The views we express today are our own and do not necessarily reflect the views of the Board, individual Board members, or other members of the Board’s staff.

Agenda

� Existing PCAOB Standards

� Standards of the PCAOB

� AS No. 3, AS No. 7, and AS Nos. 8-15

� Interim Attestation Standards

� Proposed PCAOB Standards

� Attestation Standards

� Audit Standard Regarding Supplemental Information

� Standards-setting Agenda

SEC’s Proposed Amendments to 17a-5

� On June 15, the SEC proposed amendments to Rule 17a-5 regarding the annual reporting by broker-dealers.

� The proposed amendments include requiring:� Audits for years ending on or after December 15, 2011 to be

performed under PCAOB standards.

� To require the annual report of a broker-dealer to include a financial report and a compliance report or an exemption report.� The proposing release to the 17a-5 amendments includes a

discussion of a transition period for certain carrying brokers or dealers with fiscal years ending on or after December 15, 2011 but before September 1, 2012 who are required to file compliancereports with the SEC. During this transition period the assertion regarding internal control over compliance would be a point-in-time assertion as of the date of the compliance report, rather than covering the broker’s or dealer’s entire fiscal year.

Proposed Standards Related to Audits of Broker-Dealers

Existing PCAOB Standard

Existing PCAOB Standards


For FYE Ending on or after 12/15/2011 but before 9/15/2012

Proposed Review Standard

(Based on the effective date in the Proposed Attestation Standard)

Proposed Examination Standard



For FYE Ending on or after 9/15/2012

N/AN/AGAASCurrently required under Rule 17a-5

Exemption Report

(as proposed by amendments to SEC

Rule 17a-5)

Compliance Report (as proposed by

amendments to SEC Rule 17a-5)

Broker-Dealer Financial

Statements

Standards of the PCAOB

� Interim Standards� Auditing, attestation, quality control, ethics and independence

standards and related rules

� Adopted by the Board in April 2003; standards remain in effect until superseded or become permanent

� PCAOB Issued Standards, Rules, and Guidance� Auditing standards No. 1 – 15, including audit documentation,

ICFR, EQR, and risk assessment

� PCAOB rules related to standards� Rule 3101 – certain terms used in auditing and related

professional practice standards� Rules 3501 to 3526 – ethics and independence

� Staff questions and answers

� Staff audit practice alerts No. 1 – 7

� Staff guidance for auditors of smaller companies on AS No. 5

Auditing Standard No. 3:Audit Documentation

Auditing Standard No. 3 – Audit Documentation

● Auditor must document procedures performed, evidence obtained, and conclusions reached

● An experienced auditor must understand the work performed

● An experienced auditor has a reasonable understanding of audit activities and has studied the company's industry as well as the accounting and auditing issues relevant to the industry


● Two new dates defined in this standard –

● Report release date

● The date the auditor grants permission to use the auditor's report in connection with the issuance of the company's financial statements

● Documentation completion date

● A date not more than 45 days after the report release date when a complete and final set of audit documentation should be assembled for retention


● Engagement completion document

● Multi-location audits

Auditing Standard No. 7:Engagement QualityReview

� Applies to all registered firms

� Under AS No. 7, all registered firms conducting audits in accordance with PCAOB standards are required to perform an EQR

AS No. 7 – Engagement Quality Review


� Requires EQR for audits and interim reviews conducted pursuant to the standards of the PCAOB

� Tailored requirements, for the EQR of audits and the EQR of interim reviews

� Requires concurring approval of issuance prior to granting permission to the client to use the engagement report

Reviewer Qualification Requirements:

� Must be an associated person of a registered firm

Note: A person not already associated with a registered firm would become associated if he or she (1) receives compensation for the EQR from the firm issuing the report, or (2) performs the EQR as agent for the firm issuing the report.

� May be from outside the firm that issues the engagement report


Reviewer Qualification Requirements (Cont’d):

� A reviewer from the firm that issues the engagement report must be a partner or another individual in an equivalent position

Note: At a firm that is not organized as a partnership, “an individual in an equivalent position” is someone with the degree of authority and responsibility of a partner in a firm that is organized as a partnership.



� Must possess the level of knowledge and competence related to accounting, auditing, and financial reporting required to serve as the engagement partner on the engagement under review

� Must be independent of the company, perform the engagement quality review with integrity, and maintain objectivity in performing the review



� “Cooling-Off” Period: The person who served as the engagement partner during either of the two audits preceding the audit subject to the engagement quality review may not be the engagement quality reviewer

� Exemption: Registered firms that qualify for the exemption under Rule 2-01(c)(6)(ii) of Reg. S-X are exempt from this “cooling-off” period requirement


Specific Required Procedures:

� To evaluate significant judgments made and conclusions reached by the engagement team in forming the overall conclusion on the engagement and preparing the engagement report, the reviewer should -

� Hold discussions with the engagement team, and

� Review documentation


Concurring Approval of Issuance:

� The engagement quality reviewer may provide concurring approval of issuance only if, after performing with due professional care the review required by this standard, he or she is not aware of a significant engagement deficiency


Concurring Approval of Issuance (Cont’d):

� A significant engagement deficiency in an auditexists when -

� (1) the engagement team failed to obtain sufficient appropriate evidence in accordance with the standards of the PCAOB,

� (2) the engagement team reached an inappropriate overall conclusion on the subject matter of the engagement,

� (3) the engagement report is not appropriate in the circumstances, or

� (4) the firm is not independent of its client.


Auditing Standard Nos. 8-15: The Auditor’s Assessment and Response to Risk

Risk Assessment Standards Overview

� Auditing Standard No. 8, Audit Risk

� Auditing Standard No. 9, Audit Planning

� Auditing Standard No. 10, Supervision of the Audit Engagement

� Auditing Standard No. 11, Consideration of Materiality in Planning and Performing an Audit

� Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement

� Auditing Standard No. 13, The Auditor’s Responses to the Risks of Material Misstatement

� Auditing Standard No. 14, Evaluating Audit Results

� Auditing Standard No. 15, Audit Evidence

� http://pcaobus.org/Rules/Rulemaking/Pages/Docket026.aspx


� Covers the entire audit process from initial planning activities to forming the opinions to be expressed in the auditor’s report.


� Establishes a process for obtaining evidence to support the auditor’s risk assessments.

� Strengthens the requirements linking audit tests to the assessed risks.

� Integrates fraud considerations into the core audit process.

� Focuses more audit attention on financial statement disclosures.

Auditing Standard No. 8, Audit Risk

� Describes audit risk and the relationship among the various components of the audit risk.

� Discusses risk of material misstatement:

� At the financial statement level.

� At the assertion level.

� Emphasizes the importance of performing substantive procedures to reduce detection risk to an appropriately low level.

Auditing Standard No. 9, Audit Planning� Describes the auditor’s responsibilities for properly

planning the audit, including determining the audit strategy and audit plan.

� Requires an evaluation of the importance of certain matters to the company’s financial statements and internal controls over financial reporting (ICFR) and their effect on the audit procedures.

� In multi-location engagements, establishes requirements for selecting locations for testing and determining the procedures to be performed based on the risk associated with the location.

� Requires the auditor to determine whether persons with specialized skill and knowledge are needed and, if so, the knowledge of the subject matter that the auditor needs.

Auditing Standard No.10, Supervision of the Audit Engagement

� Describes responsibilities of the engagement partner and others who assist the engagement partner with supervision.

� Sets forth the nature and extent of supervisory activities necessary for proper supervision.

� For example, the extent of supervision should be commensurate with the risk of material misstatement.

Auditing Standard No.11, Consideration of Materiality in Planning and Performing an Audit

� Uses the concept of materiality that currently applies under the federal securities laws, which reflects a reasonable investor’s perspective.

� Requires the auditor to:� Establish an appropriate materiality level for the financial

statements as a whole.

� Establish lower materiality levels for particular accounts and disclosures when misstatements of lesser amounts are likely to influence the judgment of a reasonable investor.

� Determine tolerable misstatement at the account and disclosure level and, in multi-location engagements, for individual locations.

� Reevaluate materiality level(s) when necessary based on circumstances or additional information.

Auditing Standard No.12, Identifying and Assessing Risks of Material Misstatement

� Establishes a process that prompts the auditor to “connect the dots” to identify and appropriately analyze the risks of error or fraud in the financial statements.

� Designed to be scalable based on the size and complexity of the company.

� Requires the auditor to obtain sufficient evidence that provides a reasonable basis for his or her assessments

� Includes procedures for identifying and assessing fraud risks.

� Includes new requirements related to forming expectations about disclosures and considering risks of omitted, incomplete, or inaccurate disclosures.

Auditing Standard No.12 – Risk Assessment Procedures

� Obtaining an understanding of the company and its environment.

� Obtaining an understanding of ICFR.

� Considering information from client acceptance and retention evaluation, audit planning activities, past audits, and other engagements performed for the company.

� Performing analytical procedures.

� Conducting a discussion among engagement team members regarding risks of material misstatement.

� Inquiring of the audit committee, management, and others within the company about risks of material misstatement.

Auditing Standard No.12 – Assessing Risks of Material Misstatement

� Risk assessment involves:

� Assessment of the risks of material misstatement due to error or fraud at the financial statement level and assertion level, including consideration of fraud risk factors.

� Identification of significant accounts or disclosures and their relevant assertions.

� An account or disclosure is a significant account or disclosure if there is a reasonable possibility that the account or disclosure could contain a misstatement that, individually or when aggregated with others, has a material effect on the financial statements, considering the risks of both overstatement and understates. The determination is based on inherent risk, without regard to the effect of controls.

Auditing Standard No.12 – Assessing Risks of Material Misstatement

� Risk assessment involves (cont.):

� A relevant assertion is a financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated. The determination is based on inherent risk, without regard to the effect of controls.

� Identification of significant risks, including fraud risks.

Auditing Standard No.13, The Auditor’s Responses to the Risks of Material Misstatement

� Requires the auditors to respond to risks of material misstatement due to error or fraud through:

� Overall responses.

� Responses involving the nature, timing, and extent of audit procedures.


� Tests of controls

� Required only when auditor plans to assess control risk below the maximum, except in certain specified situations.

� More evidence is needed the greater the degree of reliance on controls.

� Must obtain evidence for the entire period of reliance.

� Substantive procedures

� Required for each relevant assertion of each significant accountand disclosure, regardless of the assessed level of control risk.

� The higher the risk, the more evidence is needed from substantive procedures.


� Required responses to significant risks, including fraud risks, include:

� Audit procedures that that are specifically responsive to the risks.

� Substantive procedures that include tests of details.

Auditing Standard No. 14, Evaluating Audit Results

� Describes the auditor’s responsibilities regarding the process of:

� evaluating the results of the audit to form the opinion on the financial statements, and

� determining whether sufficient appropriate audit evidence has been obtained.

Auditing Standard No. 14, Evaluating Audit Results

� The standard covers evaluation of:

� Analytical procedures in the overall review.

� Misstatements accumulated during the audit.

� Qualitative aspects of the company's accounting practices.

� Conditions identified that relate to the assessment of fraud risk.

� Presentation of the financial statements, including disclosures.

� Sufficiency and appropriateness of evidence obtained.

Auditing Standard No. 15, Audit Evidence

� Describes what constitutes audit evidence and establishes requirements regarding designing and performing audit procedures to obtain sufficient appropriate audit evidence.

� Discusses the concepts of sufficiency, appropriateness, relevance, and reliability of audit evidence.

� Discusses the auditor’s responsibilities for selecting items for testing.

Questions?

Lunch

(60 minutes)

AT 101, Attest Engagements and AT 601, Compliance Attestation













Exemption Report


Rule 17a-5)




Statements

AT101 and AT601

� AT 101 and AT 601 are the current applicable standards for performing the SEC's proposed compliance examination or review.

� The review will be performed pursuant to AT101

� The examination will be performed pursuant to AT101 and AT601

AT101

� AT 101 serves as a framework for attestation engagements and includes:

� General standards

� Fieldwork standards

� Reporting standards

AT101

� Work should be adequately planned and supervised

� Factors to consider in planning include:� Preliminary judgments about attestation

(noncompliance) risk and materiality

� Nature of the subject matter or items within the assertion that are likely to require revision or adjustment

� Conditions that may require extension or modification of attest procedures

AT101

� The nature, extent, and timing of planning will vary with the nature and complexity of the subject matter or the assertions and prior experience with management

� The auditor should consider the nature, extent, and timing of the work to be performed to accomplish the objectives of the engagement

� Changed conditions may make it necessary to modify planned procedures

AT101

� Sufficient evidence shall be obtained to provide a reasonable basis for the conclusion that is expressed in the report

� Selecting and applying procedures

� The more effective the controls, the more assurance they provide about the subject matter of the assertion

� High level of assurance (examination)

� Moderate level of assurance (review)

AT101

� Extent of procedures is based on level of assurance provided and:

� Nature and materiality of information to be tested

� Likelihood of misstatements (noncompliance)

� Knowledge obtained during current and previous engagements

� Extent to which information is affected by judgment

� Inadequacies in the underlying data

AT101

� Consideration of subsequent events

� Documentation

� AS No. 3 applies to all engagements performed pursuant to PCAOB standards

Examination Engagement

� SEC’s Proposed Rule 17a-5 requires a broker-dealer’s compliance report to contain the following assertions:

� Whether, as of the fiscal year end, the broker or dealer was in compliance in all material respects, with Rule 15c3-1, Rule 15c3-3, Rule 17a-13, and any rule of the DEA of the broker or dealer that requires account statement to be sent to customers of the broker or dealer (the “specified Financial Responsibility Rules”)


� SEC’s Proposed Rule 17a-5 requires a broker-dealer’s compliance report to contain the following assertions (cont.):

� Whether the information used to assert compliance with the specified Financial Responsibility Rules was derived from the books and records of the broker or dealer

� Whether internal control over compliance with the specified Financial Responsibility Rules was effective during the most recent fiscal year such that there were no instances of material weakness


� SEC’s Proposed Rule 17a-5 requires a broker-dealer’s compliance report to contain the following assertions (cont.):

� During the SEC’s proposed transition period, the assertion regarding whether internal control over compliance with the specified Financial Responsibility Rules was effective such that there were no instances of material weakness as of the period ended.


� The auditor’s objective in the examination is to express an opinion regarding whether the assertions made by the broker-dealer in its compliance report are fairly stated, in all material respects.


� Reasonable Assurance

� A high level of assurance that the broker-dealer complied with the criteria, in all material respects

� Express an “opinion” on the broker-dealer’s assertions

� Includes designing the examination to detect both intentional and unintentional material noncompliance


� Materiality

� Affected by:

� Nature of the compliance requirements which may or may not be quantifiable in monetary terms

� Nature and frequency of noncompliance identified

� Qualitative considerations


� Material Noncompliance – a failure by the broker-dealer to comply with any of the requirements of the specified financial responsibility rules in all material respects

� Instance of noncompliance – any failure by the broker-dealer to perform any of the procedures enumerated in the Financial Responsibility Rules

� Aggregating instances of noncompliance


� Examples of Material Noncompliance

� Failure to maintain the required minimum amount of net capital

� Failing to maintain the minimum deposit requirement in a special reserve bank account for the exclusive benefit of customers

� There can be other instances


� Material Weakness – A deficiency of combination of deficiencies, in internal control over compliance with the Financial Responsibility Rules, such that there is a reasonable possibility that material non-compliance will not be prevented or detected on a timely basis

� There is a reasonable possibility of an event occurring if it is probable or reasonably possible

� Reasonably possible – more than remote, but less than likely

� Probable – likely to occur


� Control deficiency – would exist when the design or operation of a control does not allow the broker-dealer, in the normal course of performing its assigned functions, to prevent or detect non-compliance with the Financial Responsibility Rules on a timely basis

� Aggregating instances of control deficiencies

� Not only the specifically identified instance of non-compliance but also any additional possible effect that the control deficiency or deficiencies could have on compliance


� Planning the engagement

� Obtaining an understanding of the specified compliance requirements

� Obtaining sufficient evidence including testing compliance

� Multiple locations

� Work of a specialist

� Internal Audit


� Performing the Examination Engagement

� Controls over compliance

� Obtain an understanding

� Can consider the work performed in the audit of the financial statements and the supporting schedules

� Test design effectiveness

� Test operating effectiveness


� Performing the Examination Engagement (cont.)

� Compliance with the specified financial responsibility rules

� Consider work performed on 15c3-1 and 15c3-3 supporting schedules

� Testing 17a-13

� Testing Account Statement rule


� Performing the Examination Engagement (cont.)

� Testing that the information used to assert compliance was derived from the books and records of the broker-dealer

� Consider work performed on 15c3-1 and 15c3-3 supporting schedules

� Consider compliance work performed for all the specified financial responsibility rules


� Obtaining Sufficient Evidence

� Evidence from exam procedures

� Evidence from the audit of the financial statements and supporting schedules


� Reporting

� Reporting on the assertions (not the process)

� Legacy report in AICPA guide would no longer be applicable

� Would follow the reporting requirements in AT101 and AT601� Restricted use statement is unnecessary

� Examination was conducted in accordance with the standards of the PCAOB

� Also in compliance with paragraph (i)(1)(ii) of proposed 17a-5 (e.g. manually signed)


� Reporting

� Modified or adverse report� Can have clean opinion on one or more of the

assertions along with an adverse opinion on one of more of the assertions

� For example, BD was in compliance as of year end and compliance was determined from the books and records, however, a material weakness exists in internal controls over compliance with the specified financial responsibility rules

Review Engagement

� The SEC’s Proposed Rule 17a-5 would require a broker-dealer’s exemption report to contain an assertion by the broker-dealer that it is exempt from the provisions of Rule 15c3-3 because it meets conditions set forth in paragraph k of Rule 15c3-3, and identify the specified conditions

Review Engagement

� The auditor’s objective is to state a conclusion regarding whether, based upon the results of the review procedures, the auditor is aware of any material modifications that should be made to the broker-dealers assertion for the assertion to be fairly stated in all material respects.

Review Engagement

� Moderate Assurance

� AT sec. 101.55 states that “[i]n an attest engagement designed to provide a moderate level of assurance (referred to as a review), the objective is to accumulate sufficient evidence to restrict attestation risk to a moderate level. To accomplish this, the types of procedures performed generally are limited to inquiries and analytical procedures (rather than also including search and verification procedures).

Review Engagement

� Moderate Assurance (cont.)

� AT sec. 101.56 states there will be circumstances in which inquiry and analytical procedures:

� Cannot be performed

� Are deemed less efficient than other procedures

� Yield evidence indicating that the subject matter or the assertion may be incomplete or inaccurate

Review Engagement

� Planning the review

� Required by standards of fieldwork

� Changed conditions may make it necessary to modify planned procedures

Review Engagement

� Review Procedures

� Analytical procedures not relevant

� Inquiries regarding

� Compliance with the exemption criteria

� Known instances of non-compliance

� Nature and frequency of customer complaints that are relevant to compliance

� Controls in place to maintain compliance

� Nature and frequency of monitoring controls

Review Engagement

� Review Procedures (cont.)

� Other review procedures

� Reading correspondence with SEC and DEA

� Reading reports of internal auditors, others who perform an equivalent function and compliance functions that are relevant to compliance

� Reading regulatory filings that are relevant to compliance with the exemption conditions

Review Engagement

� Review Procedures (cont.)

� Audit procedures which may provide evidence for review engagement

� Will vary based on type of exemption claimed

� Testing of transactions related to customer trades

� Testing of specially designated cash accounts or other audit procedures regarding cash

� Testing investment inventory or transactions related to the broker-dealer’s proprietary trading

� Audit procedures performed on the clearing agreement, test of commission revenue, or clearing expense

Review Engagement

� Reporting

� Can follow reporting requirements in AT101 for both clean, modified, or adverse review reports

� Also in compliance with paragraph (i)(1)(ii) of proposed 17a-5 (e.g. manually signed)

Proposed Standards Related to Attestation and Audit Engagements of Broker-Dealers


� On July 12, the PCAOB proposed three standards

� Examination Engagements Regarding

Compliance Reports of Brokers and Dealers

� Review Engagements Regarding Exemption

Reports of Brokers and Dealers

� Auditing Supplemental Information

Accompanying Audited Financial Statements













Exemption Report


Rule 17a-5)




Statements

Proposed Standards Related to Attestation Engagements of Broker-Dealers

� The proposed attestation standards would apply to the examination and review engagements described in the amendments to Rule 17a-5 and include amendments to AS No. 7 to require an engagement quality review be performed for these engagements

� Both standards establish tailored requirements designed specifically for the examination and review engagement required by SEC Proposed Rule 17a-5

� Both standards require coordination with the audit of the financial statements including the supporting schedules

Attestation Engagements Related to Broker and Dealer Compliance or Exemption Reports

� Both standards include requirements related to the auditor’s consideration of fraud risks, including the risk of misappropriation of customer assets

� Both standards are designed to be scalable based on the broker-dealer’s size and complexity.

� Both standards provide sample reports which include examples for potential modifications

158

Examination Engagements Regarding Compliance Reports of Brokers and Dealers

� The examination standard

� Establishes a risk-based approach, focusing on the risk of material non-compliance

� Provides considerations relating to materiality which are consistent with the requirements in AT sec. 601 and in the proposing release for 17a-5

� Requires the auditor to perform certain procedures to assess risk of material noncompliance

� Requires the auditor to assess the risk of fraud, including the risk of misappropriation of customer assets, when identifying and assessing risks of material non-compliance


� Includes requirements regarding the selection for testing of controls over compliance and procedures for testing controls

� Provides requirements for the auditor to perform tests of compliance, which include taking into account the tests of controls over compliance

� The testing of the information used to assert compliance is generally performed in connection with compliance tests


� Provides requirements regarding evaluating the results of the examination procedures

� Includes procedures regarding subsequent events which supplement those performed for the financial statement audit

� Includes communication requirements to the audit committee and/or management regarding instances of non-compliance and control deficiencies and information used to determine compliance

� Provides requirements for the auditor’s report which address both clean and adverse reports

Review Engagements Regarding Exemption Reports of Brokers and Dealers

� The review standard

� Includes risk factors that affect the nature, timing, and extent of the necessary inquiries and other review procedures

� Requires review procedures to be performed which are consistent with a moderate assurance engagement

Review Engagements Regarding Exemption Reports of Brokers and Dealers

� In the case where information indicates that one or more instances of non-compliance might exist that might cause the assertion not to be fairly stated, requires the auditor to perform procedures to address the matter

� Provides requirements regarding evaluating the results of the review procedures

� Includes communication requirements to the audit committee and/or management regarding instances of non-compliance

� Provides requirements for the auditor’s report which address both clean and adverse report

Auditing Supplemental Information Accompanying Audited Financial Statements

� The proposed audit standard, Auditing Supplemental Information Accompanying Audited Financial Statements, would apply when the auditor of the financial statements is engaged to audit and report on supplemental information that accompanies audited financial statements.

� Examples of supplemental information would include the supporting schedules required by SEC Rule 17a-5 for broker-dealers.


� Defines “supplemental information” specific to the PCAOB’s statutory authority.� Supporting schedules required by SEC Rule 17a-5

� Supplemental information required to be presented pursuant to the rules and regulations of a regulatory body other than the SEC and included in an SEC filing

� Information included in SEC filings that is ancillary to the audited financial statements, derived from the company’s accounting books and records, and not otherwise required to be presented pursuant to the rules and regulations of the SEC or another relevant regulatory body


� Retains “in relation to” opinion

� Some changes to required reporting language to better reflect auditor’s responsibility for the SI, but “in relation to” was retained

� Establishes requirement that promotes enhanced coordination between the work performed on the supplemental information with work performed on the financial statement audit and other engagement, such as a compliance attestation engagement for a broker-dealer


� Requires the auditor to perform certain audit procedures to test and evaluate the supplemental information including

� Determining that the SI reconciles to the underlying account and other records or to the financial statements, as applicable

� Perform procedures to test the completeness and accuracy of supplemental information to the extent that it was not tested as part of the audit of financial statements


� The comment period for the proposed standards closed on September 10, 2011.

� Eleven comment letters were received for each of the proposals.

� Attestation standards: 10 letters from auditors and associations and 1 letter from an individual

� Supplemental information standard: 9 letters from auditors and associations and 2 letters from others


� Areas of comment on Proposed Attestation Standards

� Clarify Material Non-compliance

� Clarify extent and timing of procedures regarding the existence of customer funds or securities

� Guidance on how results of FS audit and results of examination interact

� Guidance on interaction between ICFR and internal control over compliance


� Areas of comment on Proposed Attestation Standards

� Reporting

� Effect of interpretations

� Additional examples of modifications

� Scalability

� Provide examples / guidance

� Proposed Amendments to AS No. 7

� Should not apply to review

� Provide steps for EQR to perform


� Areas of comment on Proposed Supplemental Information standard

� Definition of supplemental information

� Certain procedures unnecessary for “in relation to” report

� Reporting on form and content of supplemental information

� Reporting

� Additional examples

Standard-setting Agenda

� Near-term standard-setting projects

� Auditor’s Reporting Model

� Auditor Independence

� Audit Transparency

� Broker-Dealer Audit and Attestation Standards and Staff Guidance

� Communications with Audit Committees

� Part of Audit Performed by Other Auditors (Principal Auditor)

� Assignment and Documentation of Firm Supervisory Responsibilities (Failure to Supervise)

� Fair Value Measurements of Financial Instruments

� Related Parties

Keeping Current with Standards

� Our Web site - www.pcaobus.org/Standards/index.aspx

� PCAOB standards and related rules, including interim standards

� PCAOB proposed standards

� Staff questions and answers

� Staff audit practice alerts

� Standing Advisory Group

� Contact us at [email protected]

� Sign up for the PCAOB Updates service to receive a notification via e-mail that briefly describes significant new postings to our Web site:

http://pcaobus.org/About/Pages/Subscribe.aspx

Questions?

Temporary Inspection Rule and Interim Inspection Process

Bob Maday

Division of Registration and Inspections

October 28, 2011

Jersey City, NJ

Introduction

� Pre-Dodd-Frank

� Dodd-Frank Provisions

� Interim Inspection Program

� Scope

� Nature and Focus

� Findings

� Other Significant Developments

� Interim Inspection Process

Pre-Dodd-Frank

� Sarbanes-Oxley provided that auditors of broker-dealers were required to register with the PCAOB

� SEC provided an exemption from this oversight through December, 2008

� Broker-dealers’ financial statements for fiscal years ended after December 31, 2008, are required to be audited by a PCAOB-registered public accounting firm

Dodd-Frank Provisions

� Dodd-Frank expanded the PCAOB’s inspection authority to include audits of registered securities brokers and dealers.

� Gave PCAOB the authority to:

� Differentiate among different classes of broker-dealers

� Consider whether different inspection schedules would be appropriate with respect to auditors that issue audit reports only for brokers or dealers that do not receive, handle, or holdcustomer securities or cash or are not members of the Securities Investor Protection Corporation (section 104(a)(2)(B))

� Exempt any public accounting firm from such an inspection program, and the firm would not be required to register with theBoard (section 104(a)(2)(D))

Temporary Rule

� SEC order dated August 18, 2011 approved the Temporary Rule for an Interim Inspection Program for the Audits of Brokers and Dealers

� Allows the PCAOB to inspect audits of brokers and dealers

� Provide a source of information to help guide decisions about the scope and elements of a permanent program

Scope of theInterim Inspection Program

� Temporary Rule

� Does not differentiate between any classes of brokers and dealers

� Does not exempt any category of public accounting firm

� Judgments about what, if any, differentiation and exemptions appropriate for a permanent program to be informed by observations during course of Interim Inspection Program

Scope of theInterim Inspection Program

� Scope in the Temporary Rule not to be construed as likely scope of a permanent program or suggest every broker or dealer auditor will be inspected as part of the interim program

� Board expects to be able to gather information necessary without having to inspect most firms during the interim program

� Focus on assessing compliance with applicable Board and Commission rules and professional standards

Nature and Focus ofInterim Inspection Program

� At this time, the standards that apply to audits of brokers and dealers have not changed from what they were before the Dodd-Frank amendments

� SEC has provided transitional guidance stating that references to GAAS should continue

� Consideration will be given to current audit guidance

Interim Inspection Program Findings

� Annual report on significant observations obtained during the inspections

� No reports will be firm specific

� Identify and address with the inspected firm any significant issues in its audit work

� Where appropriate, information about potential violations by brokers or dealers would be referred to the SEC and other authorities

� May lead to an investigation or disciplinary proceedings regarding the conduct of the firm

Other Significant Developments

� SEC proposed amendments to Rule 17a-5

� PCAOB proposed new standards and/or amendments to current standards related to the audits of broker-dealers

� PCAOB to issue guidance related to the implementation of new or changed standards

� PCAOB to amend rules to include audits of broker-dealers

Interim Inspection Process

� Objectives

� Communication and coordination with the registered public accounting firm

� Information gathering

� Inspection of audit work

� Communication of findings/observations

� Reporting

Objectives

� Assist in making fully informed judgments about the scope of permanent rules for inspections

� Gather information to consider whether to differentiate among classes of broker-dealers

� Determination of minimum inspection frequency

Communication/Coordination with the Firm

� Initial contact with the firm

� Inspection commencement date

� Formal letter sent to the firm with document request

� Meeting with the firm

� Obtain information about:

� The firm and its professional staff

� Its broker-dealer clients

� Engagements selected for inspection

Information Gathering

� Assist in making fully informed judgments about the scope of permanent rules for inspections

� Relevant to the inspection of the firm

� Some examples for the firm and its broker-dealer clients:

� Demographic information

� Quality control policies and procedures

� Fee information for audit and non-audit services

� Restatements

� Auditor changes

Inspection of Audit Work

� May be completed in one week or may require s

Documents

Forum on Auditing Smaller Broker-Dealers - PCAOB · 2014-06-30 · Total firms that audit BDs—approximately 900 Withdrawals—692 * As of October 11, 2011. Broker Dealer Statistics