Auditors performed complete and correct audits of at least three brokerage firms last year, the Public Company Accounting Oversight Board said Monday.
That amounted to only 5 percent of the 60 audits reviewed by the board, but it may still be a sign of progress. During the previous year â€" the first in which the board reviewed such audits â€" none of the 23 audits examined were found to be acceptable.
If this were baseball, the combined industry would be batting .036 for the two years combined.
“The nature and extent of audit deficiencies and independence findings included in this report are troubling,†said Robert Maday, the deputy director of the board’s division of registration and inspections. “We encourage registered public accounting firms to take action and conduct audits with due professional care, including professional skepticism.â€
The audit problems do not necessarily mean that many of the brokerage firms’ financial statements were wrong. Instead, they indicate that the auditing firms either had conflicts of interest that prevented them from doing an independent audit or that those audits failed to do the work needed to qualify as acceptable.
In most â€" 37 of the 60 audits reviewed in 2012 â€" the auditors failed to do enough work to assess the “risk of material misstatement due to fraud,†the board reported. In some cases, auditors made no effort to verify entire revenue streams received by the firms.
There were also a substantial number of audits with deficiencies in the review of related party transactions â€" including one case in which the board said the auditor had evidence that such a transaction had been accounted for incorrectly “to avoid an adverse effect on net capital.†Net capital rules, issued by the Securities and Exchange Commission, determine how much capital a brokerage firm needs to protect its customers.
In 22 of the audits, the audit firm was not independent of the brokerage firm, as required by audit rules. In some cases, the auditor had helped to prepare the financial statements and was therefore reviewing its own work.
The statistics indicate that many firms auditing brokerage firms may know little about the industry and may not have made the effort to keep up with all the rules pertaining to broker-dealers. The board report said that 783 accounting firms in the country audit at least one broker-dealer â€" and that 83 percent of those firms audit fewer than six brokerage firms.
“This may cause some firms to reassess their strategy of doing broker-dealer audits,†said Jay D. Hanson, a member of the accounting oversight board, and decide that they should not do such audits.
Audit firms in the United States were generally subject to little oversight until 2002, when the Sarbanes-Oxley law established the accounting oversight board and said every accounting firm that audits public companies would have to be registered with, and inspected by, the board.
But firms that audited broker-dealers were not subject to the regulation unless they also audited public companies. That changed after the Bernard L. Madoff Ponzi scheme, which was able to go on for years in part because Mr. Madoff’s auditor, a small firm that was not subject to inspection by the oversight board, failed to spot the fraud.
In 2010, the Dodd-Frank financial overhaul law stated that auditors of brokerage firms should also be subject to inspection but left open the question of whether auditors of small, and relatively simple, brokerage firms should be inspected. The board said it hoped to propose rules covering that in 2014. Under those rules, some of the audit firms might be exempt from the inspections.
The 2012 round of inspection covered in the new report looked at the work of 43 audit firms. Of those, 24 did not audit public companies, and only nine of them audited more than 100 public companies. The board said that all of the 43 firms had at least one audit that was not adequate but did not say which types of audit firms conducted the three audits the board’s inspectors deemed acceptable.
