Do Prospective Inspections of Broker-Dealer Auditors Present An Opportunity?

This was originally published on Going on July 16, 2010.  The PCAOB is now responsible for inspecting auditors of broker dealers under the Dodd-Frank Act.

Congress is currently considering proposed legislation that would give the PCAOB full oversight authority for broker-dealer audits. In December 2008, the SEC discontinued the exemption from PCAOB registration previously applicable to accounting firms that audit the approximately 5,000 broker-dealers registered with the SEC. As a result, as of May 2010, more than 500 accounting firms with broker-dealer audit clients have registered with the PCAOB. The Sarbanes-Oxley Act, however, does not currently subject the audits for broker- dealers to the PCAOB’s standard-setting, inspections, investigatory, or disciplinary authority.

The new universe of registrants includes audit firms that only audit non-public broker dealers.  Many auditors of non-public broker dealers are also auditors of public companies and therefore are already registered and subject to inspection, although not inspections that cover this aspect of their audit because their audit probably does not cover this aspect of their client’s business. Of the approximately 5,000 registered broker-dealers, approximately 500 hold customer accounts or act as clearing brokers.

The PCAOB anticipates adding staff that need training in very specific technical requirements to complete these inspections. The PCAOB has to develop specific auditing or attestation standards pertaining to customer assets as well as for the report required by SEC Rule 17a-5. The PCAOB also may need to work with the SEC to determine the existing report on controls surrounding customer assets required by 17a-5 is sufficiently responsive to SEC requirements which require reasonable assurance.

It looks to me that more very small firms will register with the PCAOB because they are auditing non-public broker-dealers and the PCAOB may or may not be ready to inspect them well or on a timely basis. What’s the point of registering all these firms if the firms will not be inspected soon and are surely not ready to be inspected by the PCAOB?

Maybe the PCAOB can develop a pre-qualification for firms that register to do broker-dealer audits.  They may be doing the audits now but are they really ready to do it at the nationally regulated level?  Maybe the “nickel and dime” small firms should be taken out of the game before we raise expectations that these firms are now being monitored.

It’s going to be hard enough to effectively inspect the large audit firms who audit the broker-dealer piece of large issuers under these new rules. Even the big firms have trouble catching problems in these areas as evidenced by PwC’s £16bn miss at JP Morgan in the UK.

There’s nothing worse than the appearance of regulatory infrastructure and enforcement without the consistent and forceful execution of that regulatory mandate.

We saw with Madoff what happens when there’s a regulatory gap or a lack of will to enforce existing regulations. We see what happens when expectations are raised while there’s still a significant inability to satisfy them. For example, the PCAOB is perpetuating the illusion of regulation – in spite of publicizing the issue – by continuing to register foreign audit firms with the PCAOB when they no right to inspect them. The Dodd-Frank regulatory reform law, if passed, may improve the situation with regard to inspections of foreign firms but won’t cure it completely.

With the new broker-dealer rule, we’re setting up the PCAOB to register a long list of small audit firms who are only there because they audit non-public broker-dealers. They’ll be subject to inspection but the PCAOB will be unable to fulfill the promise in the near term. The small audit firms will probably whine and cry like Beckstead and Watts because they are unwilling or unable to step up and meet the requirements.

That’s unproductive all the way around.

It is possible for regional firm to play in the big leagues and capitalize on this new regulatory requirement – if they’re willing to focus. Wouldn’t it be better for investors and for regulatory efficiency to have just a few focused firms who were really good at auditing broker-dealers and can withstand the PCAOB inspection process?

Specializing in niche areas is profitable and effective from a quality and client service perspective. This means investing in top technical talent. Most prefer to work in a smaller firm where they can really shine. A firm like Rothstein Kass, a medium size east coast firm that specializes in hedge funds, is a good example.  Another is SAS 70 Solutions Inc., a CPA firm sticks to just what their name suggests – SAS 70 and related technology related attestation. Both firms are PCAOB registered and focus because that’s how they stay at the top of their game.

Rothstein Kass was inspected in 2009 and had no deficiencies.

Zip. Zero. Nada.

That’s how you serve investors.

That’s how you serve your clients.

That’s how you compete.

That’s how you succeed for your partners.

This was originally published on Going on July 16, 2010.  The PCAOB is now responsible for inspecting auditors of broker dealers under the Dodd-Frank Act.

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  1. […] LLP fits my criteria of a small to medium size firm that could use long experience and a strong reputation, as well as a […]

  2. […] It was great to see that the Dodd-Frank bill addressed a couple of key PCAOB issues. The bill facilitates the PCAOB’s ability to share information with foreign auditor oversight authorities and closes gaps in the Board’s authority to oversee audits of brokers and dealers. However, the regulatory oversight of broker-dealers may turn out to be a pantomime horse. […]

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