Broker-Dealer Audits, Reporting Model on PCAOB Agenda


Broker-dealer audits, the auditor’s reporting model and foreign inspections will be among the PCAOB’s top priorities in 2011, according to the board’s acting chairman, Daniel L. Goelzer.


The Dodd-Frank Wall Street Reform and Consumer Protection Act gave the board authority over auditors of all SEC-registered securities broker-dealers. Those auditors had previously been required to register with the PCAOB, but were not otherwise subject to its authority.   


“This new responsibility will have a significant effect on our work,” Goelzer said during his keynote speech Tuesday at the AICPA National Conference on SEC and PCAOB Developments in Washington. “There are about 5,200 broker-dealers. In the past two years, over 500 accounting firms have registered with the board because they audit broker-dealers. In addition, many previously-registered firms that audit issuers also have broker-dealer practices.”  


There are three issues on which the board broker-dealer oversight will focus:


  • Creating a broker-dealer funding system.
  • Developing auditing standards applicable to broker-dealer financial statement audits and attestation standards applicable to their compliance reports.   
  • Developing a broker-dealer auditor inspection program.


Under Dodd-Frank, broker-dealers, like public companies, will pay fees to PCAOB. Based on an estimate of next year’s costs, broker-dealers will be funding about 7 percent of the board’s 2011 budget, Goelzer said, adding that he expects the PCOAB will consider a proposal on the new funding system at an open meeting next week. The PCAOB recently approved an 11.5% increase in its 2011 fiscal-year budget, a spending plan that the board says reflects its new responsibilities under the Dodd-Frank act.  


With regard to auditing standards, the SEC recently issued an interpretive release advising the profession to continue to apply AICPA standards until the commission engages in further rulemaking. 


“I anticipate that the SEC’s rulemaking will begin soon and that the Board will propose standards in this area early next year,” Goelzer said.  


Developing a broker-dealer audit inspection program will be a “formidable task,” because of the need to address the smaller broker-dealer firms, which make up the majority, he continued.


Less than one percent—33 firms—have net capital in excess of $1 billion. Those 33 firms hold over 80% of the net capital in the entire broker-dealer industry. At the other end of the spectrum, 70 percent of all broker-dealers have tentative net capital under $1 million. Collectively, those firms have less than 1 percent of industry net capital, he said.  


“This diversity raises questions about whether we should devote resources to inspecting the auditors of all of these categories of brokers and dealers or whether some of their auditors can safely be exempted from PCAOB oversight without compromising investor protection,” he said. “I anticipate that the Board will propose rules for an interim inspection program at an open meeting next week. That program would allow the board to begin inspections with a focus both on reviewing audit work and on gathering facts to inform the board’s consideration of a permanent program.” 


The Auditor's Reporting Model


The 2008 report of the Treasury Advisory Committee on the Auditing Profession recommended that the Board reconsider the audit report, and several bodies outside the U.S. are studying ways in which the report could be expanded.


“It is clear that there is considerable investor hunger for more insight from the auditor into the audit process and the company’s financial reporting … Therefore, it should be a priority for both the profession and the board,” Goelzer said.  


The board will have to make some “difficult choices” next year if it decides to change the pass/fail report, he said, but added there is “no shortage of ideas.” 


Some have suggested that the auditor should provide more information about the audit itself and how it was performed. Others want the auditor's views on the management judgments embodied in the financial statements regarding such things as estimates and the selection of accounting policies. Auditors have proposed that their reports should be clearer about limitations on the ability to detect fraud. Some users have suggested expanding the auditor's current opinion to include new material; others have suggested that the pass/fail report should be accompanied by a separate auditor's report akin to the MD&A.


These ideas raise several questions, such as what standards would apply and what audit work would have to be performed if there are new auditor disclosures and what liability the auditor would have if statements in these new reports proved to be inaccurate, Goelzer noted.


The PCAOB’s Office of the Chief Auditor is conducting research, including focus group discussions, to explore reporting model alternatives. The staff plans to present its findings to the board at a public meeting in early 2011. If the PCAOB decides to proceed, the current standard-setting agenda contemplates a concept release in mid-2011, followed by a public roundtable.


Foreign Inspections


The PCOAB also must address obstacles in conducting inspections of the auditors of U.S. public companies in certain foreign jurisdictions. 


To date, the board has conducted 268 inspections of firms located in 34 jurisdictions, many of which were performed jointly with the local auditor oversight authority. However, it cannot conduct inspections in some jurisdictions, including China, the European Union, and Switzerland.  


“We are in various stages of negotiation with these jurisdictions, and I hope that we will eventually open the doors to inspections in every country where there are firms that audit U.S. public companies,” Goelzer said. “Robust oversight of audit work done in other countries is critical to the protection of U.S. investors, given that significant operations of many U.S. public companies are located beyond our shores.”


The Dodd-Frank act authorized the PCAOB to share information with its non-U.S. counterparts, removing one of the obstacles to agreement in some countries, he added.


Future approaches could rely on disclosures that could provide important information to investors or for the Board to establish a system under which firms that cannot be inspected would have to arrange for their U.S. public company audit work to be supervised by a firm that can be inspected.  


“This sort of special supervision would at least provide for indirect Board oversight of the uninspectable firm's audit work through inspections of the supervising firm, Goelzer said. “Both the disclosure approach and the special supervision approach would raise some difficult issues in terms of our relationships with other regulators and in terms of the way cross-border issuer audits are conducted, [however]”.  


A full copy of Goelzer’s remarks is available on the PCAOB website .


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