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PCAOB annual report on the interim inspection program related to audits of brokers and dealers

The PCAOB conducted inspections of 67 firms during 2018 and published the “Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers in August 2019” (PCAOB Release No. 2019-002) to summarize the inspection results. The objective of the inspections was to assess the firms’ compliance with applicable laws, rules, and professional standards when performing audit and attestation engagements for broker-dealers. The report describes deficiencies identified and includes the PCAOB’s insights into the standards, as summarized below. The following is a summary of those items that were considered the most impactful.

System of Quality Control Observations – Engagement Performance

  • Audit methodology: Firms’ audit methodology either did not require appropriate consideration of all relevant factors resulting in high materiality levels or did not require evaluation of whether a lower materiality level was appropriate for certain accounts. Further, firms’ audit methodology allowed the determination of sample sizes for substantive tests of details that did not take into consideration the allowable risk of incorrect acceptance and tolerable misstatement resulting in insufficient sample sizes.
  • Engagement quality review (AS 1220): Evaluation of the engagement team’s significant judgments and related conclusions reached were not included in the reviews. Reviews were either not performed or reviewers had served as engagement partner for the financial statement audit for one or more of the previous two years, therefore not meeting objectivity qualifications required of an engagement quality reviewer.
  • Auditor’s Report (AS 3101): Auditor’s reports were not prepared under applicable auditing standards and did not accurately describe the financial reporting framework under which the financial statements were prepared.
  • Audit Documentation (AS 1215): A complete and final set of audit documentation was not assembled for retention as of the documentation completion date. Documentation added to audit work papers subsequent to the report release date did not indicate the reason for adding documentation, name of the person who prepared the additional documentation, and the date of the addition.

The PCAOB believes the following practices may result in enhanced quality of broker-dealer audit and attestation engagements:

  • Expanding accountability for audit quality beyond the lead engagement partner
  • Developing and refining guidance and training to assist auditors identify and assess risks of material misstatement specific to broker-dealer audit and attestation engagements
  • Providing additional experienced specialists and personnel not assigned to the engagements to perform independent reviews

Attestation and audit engagements observations

Deficiencies Identified in Examination Engagements (AT No. 1)

  • Planning: Firms did not obtain a sufficient understanding of certain financial responsibility rules or of the broker-dealer’s relevant controls with regards to compliance with the financial responsibility rules.
  • Internal controls over compliance: Testing of internal controls over compliance with financial responsibility rules was not performed or was not sufficient.
  • Compliance with the Net Capital Rule or the Reserve Requirements Rule: Testing was either not performed or was inadequate, including: deficient testing of the accuracy and completeness of the information being used within the schedules, insufficient evaluation of whether the amounts in the schedules were in accordance with the applicable rule, and insufficient testing to determine whether a special reserve bank account for the exclusive benefit of its customers was maintained.
  • Evaluating results: Evaluations were insufficient to assess whether individually or in combination with other deficiencies, one or more material weakness concerning internal controls over compliance existed.
  • Representation letter: Management representations were not obtained in writing.

Deficiencies Identified in Review Engagements (AT No. 2)

  • Performing review procedures: An understanding of exemption provisions and other rules and regulations relevant to the broker-dealer’s assertions in its exemption report was not obtained or was not sufficient. Inquiries of management to identify exceptions to the exemption provisions were inadequate and did not involve obtaining an understanding of management’s controls and monitoring activities to comply with the claimed exemption provisions. There was inadequate evaluation of evidence obtained that contradicted the broker-dealer’s assertion of compliance with the claimed exemption provisions.
  • Evaluating results: Evaluations did not include a consideration of information obtained that indicated that a broker-dealer’s assertion regarding the claimed exemption provision may not be fairly stated, in all material respects.
  • Reporting: The auditor’s review report inaccurately stated that the broker-dealer asserted that it met the identified exemption provision without exception when the broker-dealer did not make this assertion. The auditor’s review reports were dated prior to the date on which the firm had completed its review procedures.
  • Obtaining a Representation Letter: Management Representations were not obtained in writing.
  • Net Capital Rule: Firms did not perform or sufficiently perform procedures to test whether the following aspects of the net capital computations were determined in accordance with the Net Capital Rule:
    - Minimum net capital requirements
    - Adjustments to net worth
    -   Allowable assets and assets not readily convertible into cash
    -   Haircuts for securities positions
    -   Operational changes and other deductions
    -   Securities classified as marketable
  • Customer Protection Rule: Firms did not perform or sufficiently perform procedures to test whether customer reserve and PAB account reserve computations were complete and accurate.

Deficiencies Identified in Auditing Financial Statements

  • Revenue: Deficiencies in the audit response to the assessed level of risk of material misstatement of revenue accounts were caused by insufficient risk assessment procedures, inappropriate design or performance of sampling for substantive tests of details, insufficient evaluation of data reliability utilized in setting expectations for substantive analytical procedures, and insufficient evaluation of controls at the broker-dealer’s service organization.
  • Risk of material misstatement due to fraud: Risk assessment procedures were not performed or sufficiently performed due to firms not identifying improper revenue recognition as a fraud risk. Audit responses to risk of material misstatement due to management override of controls were not sufficient because journal entries and other adjustments were not examined or sufficiently examined. Audit responses to risk of fraud related to improper revenue recognition were not sufficient because tests of details specifically responsive to assessed risks were not performed.
  • Related parties: Firms failed to appropriately perform procedures to understand the broker-dealer’s process for identifying, authorizing, accounting for, and disclosing related party relationships and transactions.
  • Financial statement presentation and disclosures: Firms did not sufficiently evaluate for conformity with GAAP requirements with relation to: related party disclosures, going concern disclosures, revenue recognition policy disclosures, risks and uncertainties disclosures, and fair value disclosures.
  • Receivables and payables: Sampling procedures were not appropriately designed and performed and as such, the extent of testing was insufficient. Information used as audit evidence was not sufficiently tested for accuracy and completeness. Confirmation procedures were not sufficient because the audit approach to nonresponses to positive confirmation requests did not provide sufficient evidence necessary to reduce the risk to an acceptably low level. 
  • Fair value measurements: An understanding of the broker-dealer’s process for determining the fair value of assets was not obtained or was not sufficient to develop an effective audit approach.

Testing of fair value measurements was not sufficient because procedures did not include testing management’s significant assumptions, valuation model, or underlying data as well as reviewing subsequent transactions and developing independent fair value estimates for corroborative purposes.

Deficiencies Identified in Auditor’s Report on the Financial Statements and Supporting Schedules

  • Auditor’s Report: A number of elements were omitted or not properly presented, including: dating of the audit report prior to completion of audit procedures, incorrect identification of the financial statements and notes to the financial statements that were the subject of the audit, inaccurate description of the financial statement framework under which the financial statements were prepared, incorrect firm tenure and insufficient disclosure of supplemental information including associated audit procedures and whether the supplemental information complied, in all material respects, with the specific regulatory requirements. 

Deficiencies Identified in Auditor Communications

  • Communications to the Audit Committee (or equivalent): Firms did not make the annual independence communications required by PCAOB Rule 3526 and/or did not comply with communication or documentation requirements of AS 1301. 
  • Communications about Control Deficiencies: Firms did not perform or sufficiently perform procedures to evaluate the severity of identified control deficiencies in financial reporting and appropriately consider required communications of significant deficiencies to management and the audit committee prior to audit report issuance.

Deficiencies Identified in Engagement Documentation (AS 1215) and Auditor Independence

  • Engagement documentation: Firms did not properly complete an engagement completion document, assemble a complete and final set of audit and review documentation by the documentation completion date, or properly document additions to the engagement file after the documentation completion date.
  • Auditor independence: Firms’ independence was impaired when these firms assisted in the preparation of the broker-dealer’s financial statements or supplemental information, which is not permissible as prescribed by Rule 2-01 of Regulation S-X.  

PCAOB suggestions based on results

The PCAOB believes significant positive impact on audit quality can be achieved if: (i) auditors focus on improving their systems of quality controls; (ii) auditors advance their knowledge and understanding of PCAOB standards; and (iii) auditors focus on improving their performance in testing internal controls when employing controls-reliance audit strategies and for examination engagements.

The above was a summary of the key takeaways from the PCAOB inspection relating to the broker-dealers for 2018. These comments should be taken into consideration by the auditing firms as well as the broker-dealers themselves to ensure proper disclosures and filings. A copy of the complete annual inspection report is available at

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.


  1. Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers

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