1666 K Street, N.W.

Washington, DC 20006

Telephone: (202) 207-9100

Facsimile: (202) 862-8430

www.pcaobus.org

THIRD REPORT ON THE PROGRESS

OF THE INTERIM INSPECTION PROGRAM

RELATED TO AUDITS OF BROKERS AND DEALERS

PCAOB Release No. 2014-003

August 18, 2014
Executive Summary

The Public Company Accounting Oversight Board (the "PCAOB" or the "Board") 

is issuing this third report on the progress of its interim inspection program for auditors 

of brokers and dealers registered with the Securities and Exchange Commission ("SEC" 

or the "Commission"). This report describes observations noted during inspections 

performed during 2013; summarizes the observations from inspections performed under 

the interim inspection program since inception through December 31, 2013; and 

describes actions needed by registered public accounting firms and next steps of the 

interim inspection program. The Board issued its first progress report on August 20, 

2012 (the "First Progress Report") and its second report on August 19, 2013 (the 

"Second Progress Report"). 

The observations discussed in this report are not necessarily indicative of the 

population of firms or of audits of brokers and dealers because the selection of firms 

and of audits of brokers and dealers for inspection is not necessarily representative of 

these populations. 

Inspections of Registered Public Accounting Firms During 2013

This report describes audit deficiencies and independence findings, collectively 

referred to as "observations," noted in the Board's inspections during 2013 of 60 firms, 

covering portions of 90 audits. At the time of the inspections, 25 of the 60 firms were 

subject to regular inspection as they also audited issuers, generally referred to as public 

companies. Inspections staff identified observations in 56 of the 60 firms whose audits 

were selected for inspection. The four firms with no observations in the portions of 

audits inspected were firms that also audited issuers. One of these firms audited more 

than 100 brokers and dealers.

Failure to Satisfy Independence Requirements

In 21 of the 90 audits selected for inspection, it appeared to Inspections staff, that 

contrary to the requirements of SEC independence rules, auditors were involved in the 

preparation of the financial statements they audited. This conduct was observed in 19, 

or approximately 48 percent, of the 40 audits selected for inspection that were 

performed by firms that did not also audit issuers. Further, independence findings were 

observed in two, or four percent, of the 50 audits selected for inspection that were 

performed by firms that also audited issuers. Apparent independence violations have 

been, and will continue to be, reported to the SEC as such violations may have 
Executive Summary 

Third Report on the Progress of the 

Interim Inspection Program 

Related to Audits of Brokers and Dealers

August 18, 2014

Page ii

implications to the broker's or dealer's compliance with the requirements of Securities 

Exchange Act of 1934 ("Exchange Act") Rule 17a-5 ("Rule 17a-5").

Audit Deficiencies

Inspections staff identified audit deficiencies in portions of 70 of the 90 audits 

selected for inspection, which represents approximately 78 percent of these audits. The 

20 audits where Inspections staff did not identify any audit deficiencies in the portions of 

audits inspected were performed by 13 firms, of which 11 also audited issuers.

The most frequent audit deficiencies were noted in the following areas: the report 

on material inadequacies, the net capital rule, the risk of material misstatement due to 

fraud, revenue recognition, and reliance on records and reports.

Summary of Inspections Since Inception of the Interim Inspection Program

Since the inception of the interim inspection program through the end of 2013, 

the Board has inspected 101 firms, covering portions of 173 audits. Nine firms have 

been inspected more than once. At the time of the inspections, 35 of the 101 firms were 

subject to regular inspection as they also audited issuers. These firms performed 95 of 

the 173 audits selected for inspection.

Observations were identified in portions of 151, or approximately 87 percent, of 

the 173 audits selected for inspection. The 22 audits where Inspections staff did not 

identify observations in the portions of audits inspected were performed by 12 firms, of 

which 11 also audited issuers.

Inspections staff identified observations in a high percentage of the audits and 

areas inspected. Observations were identified across various stratifications of firm 

characteristics, such as whether or not the firm audited issuers and the number of 

broker or dealer audits performed by the firm. Firms that did not also audit issuers were 

noted to have a higher percentage of observations than the firms that also audited 

issuers. Firms that audited 100 or fewer brokers and dealers had a higher percentage of 

observations than firms that audited more than 100 brokers and dealers.

Observations were identified in portions of selected audits across the spectrum of

brokers and dealers in terms of their characteristics, such as reported actual net capital, 

revenues, and assets. Except for lower percentages noted for the selected audits of 

brokers and dealers with the largest amounts of reported actual net capital, revenues, or

assets, there did not appear to be a discernible relationship between the percentage of 

observations and these broker and dealer characteristics. In addition, the percentage of 

observations for audits of brokers or dealers that did not claim an exemption under 
Executive Summary 

Third Report on the Progress of the 

Interim Inspection Program 

Related to Audits of Brokers and Dealers

August 18, 2014

Page iii

Exchange Act Rule 15c3-3 ("Rule 15c3-3" or the "Customer Protection Rule") was lower 

than for audits of brokers or dealers that claimed an exemption under Rule 15c3-3.

The percentage of observations in the audits and areas inspected in 2013 was 

lower than that from the inspections performed during the interim inspection program 

through the end of 2012. For the nine firms that were inspected more than once during 

the interim inspection program, Inspections staff noted a lower percentage of 

observations when comparing inspections performed during 2013 to inspections 

performed through 2012. Nevertheless, the percentage of observations remained high.

Actions Needed by Firms and Next Steps of the Interim Inspection Program

The Board is concerned by the nature and number of these audit deficiencies 

and independence findings. Many of the observations in this report and the two previous 

progress reports are similar in nature and relate to fundamental auditing principles. The 

Board emphasizes the need for firms to improve the quality of their broker and dealer 

audits to achieve compliance with applicable standards and rules.

The Board reminds firms that information obtained through the interim inspection 

program may lead the Board to commence an investigation or disciplinary proceeding 

concerning the conduct of a firm or associated persons of such firms. In addition, when

it comes to the Board's attention that the financial statements appear not to be fairly

stated, in all material respects, in conformity with generally accepted accounting 

principles ("GAAP"), or there are possible violations of laws, rules, or regulations, the 

Board's practice is to report that information to the SEC and designated examining 

authorities.

Actions Needed by Firms

In light of the observations that continue to be identified by Inspections staff, 

combined with the need to adapt to amended SEC rules and to follow PCAOB 

standards, the Board urges registered public accounting firms that audit brokers and 

dealers to re-examine their audit approaches. 

All registered public accounting firms that audit brokers and dealers, and other 

interested parties, should read this report in its entirety and consider whether the audit 

deficiencies and independence findings described in this report might be present in 

audits they currently perform, and take appropriate action to prevent or correct any such 

audit deficiencies and independence findings. 

The Board also encourages registered public accounting firms that audit brokers 

and dealers to review the Staff Guidance for Auditors of SEC-Registered Brokers and 
Executive Summary 

Third Report on the Progress of the 

Interim Inspection Program 

Related to Audits of Brokers and Dealers

August 18, 2014

Page iv

Dealers issued on June 26, 2014, and to attend the Board's periodic Forums on 

Auditing Smaller Broker-Dealers.

Next Steps of the Interim Inspection Program

The Board will continue to conduct inspections of registered public accounting 

firms that audit brokers and dealers under the interim inspection program until rules for 

a permanent inspection program take effect. During 2014, the Board plans to select

approximately 60 firms and inspect portions of approximately 100 audits. The firms the 

Board selects will primarily include firms not previously inspected, but will also include 

some firms previously inspected under the interim inspection program. In addition, the 

Board may inspect audits of brokers or dealers whose past audits were previously 

inspected. In that context, the Board may evaluate whether, or how, firms addressed 

audit deficiencies or independence findings identified in previous inspections. 

The Board is continuing to take a careful and informed approach in establishing a 

permanent inspection program. The Board continues to obtain available information to 

evaluate the risk of loss to customers. The PCAOB staff is currently working to develop 

a rule proposal for the Board to issue during 2016 to establish a permanent inspection 

program and its scope, which will address whether to exempt any category of registered 

public accounting firm.

The Board will continue its efforts to protect the interests of investors and further 

the public interest in informative, accurate, and independent audit reports for brokers 

and dealers. Such efforts will continue to include issuing future progress reports that will 

describe significant observations from inspections, issuing guidance for audits of 

brokers and dealers, conducting forums, and participating in various other outreach 

initiatives. In addition, the Board will use information obtained from the interim 

inspection program and other research and outreach efforts to inform its future 

standards-setting activities relevant to the audits of brokers and dealers. 

* * * *
1666 K Street, N.W.

Washington, DC 20006

Telephone: (202) 207-9100

Facsimile: (202) 862-8430

www.pcaobus.org 

_____________________________________ 

 ) 

 ) 

) 

THIRD REPORT ON THE PROGRESS ) PCAOB Release No. 2014-003

OF THE INTERIM INSPECTION PROGRAM ) 

RELATED TO AUDITS OF ) August 18, 2014

BROKERS AND DEALERS ) 

 ) 

 ) 

_____________________________________ ) 

Background

The PCAOB is issuing this third report on the progress of its interim inspection 

program1 for auditors of brokers and dealers registered with the SEC.2

Under the interim inspection program the Board conducts inspections of 

registered public accounting firms in connection with their performance of audits, 

issuance of audit reports, and related matters involving brokers and dealers registered 

with the Commission3 to assess compliance with the professional standards, rules of 

the Commission and the Board, and the Sarbanes-Oxley Act of 2002 (the "Act"). 

The interim inspection program also helps to inform the Board's eventual 

determinations about the scope and elements of a permanent inspection program, 

including whether and how to differentiate among classes of brokers and dealers, 

whether to exempt any categories of registered public accounting firms, and the 

establishment of minimum inspection frequency schedules. 

 1

 On June 14, 2011, the Board adopted Rule 4020T to establish an interim 

inspection program related to the audits of brokers and dealers. See PCAOB Release 

No. 2011-001 (June 14, 2011). The SEC approved this rule on August 18, 2011. See

Exchange Act Release No. 65163 (August 18, 2011).

2 The Board issued its First Progress Report on August 20, 2012 and its

Second Progress Report on August 19, 2013, both of which are available on the 

PCAOB website at: http://pcaobus.org/Inspections/Pages/PublicReports.aspx.

3

 Under Section 15 of the Exchange Act, most brokers and dealers must 

register with the SEC and join a self-regulatory organization, such as the Financial 

Industry Regulatory Authority ("FINRA"). Hereinafter, the use of the terms "broker(s) 

and dealer(s)" or "broker(s) or dealer(s)" refers to brokers and dealers registered with 

the SEC.
PCAOB Release No. 2014-003

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RELEASE 

The Board's inspections of auditors under the interim inspection program assess 

the auditor's compliance with the requirements that govern the conduct of the audit. All 

of the audits selected for inspection discussed in this report relate to fiscal years that 

ended on or before June 30, 2013. Those audits were conducted before certain 

changes to applicable SEC rules took effect, including changes that now require audits 

of brokers and dealers to be performed in accordance with PCAOB standards.4 See the 

Appendix for references to certain releases issued by the SEC or PCAOB related to 

standards and rules for brokers and dealers and their auditors.

The audits selected for inspection were evaluated against the standards and 

rules applicable at the time of the audit, and this report's discussion of those audits 

refers to those standards and rules. For all audits selected for inspection discussed in 

this report, Rule 17a-5 generally required brokers and dealers to file with the SEC and 

other regulators, among other things, (1) annual financial statements, (2) supporting 

schedules related to the computation of net capital and the customer reserve, and (3) 

an accountant's supplemental report on material inadequacies. Refer to the Appendix of 

the Second Progress Report for an overview of net capital, customer protection, and 

annual reporting requirements for SEC-registered brokers and dealers. 

This report contains three parts: Part I describes the inspections of registered 

public accounting firms, audits selected and observations identified by Inspections staff 

for inspections performed during 2013; Part II provides a summary of inspections 

performed under the interim inspection program since its inception through December 

31, 2013; and Part III describes actions needed by registered public accounting firms

and next steps of the interim inspection program of the PCAOB. 

 4 On July 30, 2013, the SEC adopted amendments to its net capital, 

customer protection, books and records, and notification rules for brokers and dealers 

under the Exchange Act, see Exchange Act Release No. 70072 (July 30, 2013), and 

adopted amendments to Exchange Act Rule 17a-5, Reports to be Made by Certain 

Brokers and Dealers (see Exchange Act Rule 17 C.F.R. § 240.17a-5), and Exchange 

Act Rule 17a-11, Notification Provisions for Brokers and Dealers ("Rule 17a-11," 17

C.F.R. § 240.17a-11), see Exchange Act Release No. 70073 (July 30, 2013). Among 

other things, the amendments to Rule 17a-5 require that audits of brokers and dealers 

be performed in accordance with PCAOB standards, effective beginning with audits for 

fiscal years ended on or after June 1, 2014. With respect to audits for earlier fiscal 

years, such as those discussed in this report, Rule 17a-5, required that the audits be 

performed in accordance with generally accepted auditing standards ("GAAS"), which 

are promulgated by the American Institute of Certified Public Accountants ("AICPA").
PCAOB Release No. 2014-003

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RELEASE 

Part I: Inspections of Registered Public Accounting Firms During 2013

The following section describes registered public accounting firms that audit 

brokers and dealers, the selection of audits inspected during 2013, and independence 

findings and audit deficiencies identified by Inspections staff. 

Firms that Audit Brokers and Dealers

For fiscal periods ended during the period from July 1, 2012 through June 30, 

2013, there were 790 registered public accounting firms that issued audit reports on the 

financial statements of brokers and dealers that were filed with the SEC. Many of the 

registered public accounting firms audited as few as one broker or dealer, while several 

firms audited more than 100 brokers and dealers. 

Number of Broker or 

Dealer Audits per Firm Number of Firms5 Percentage of Firms

1 367 46%

2 to 206 385 49%

21 to 50 24 3%

51 to 100 8 1%

More than 100 6 1%

Total 790 100%

There were 4,302 brokers and dealers that filed audited annual financial 

statements with the SEC for fiscal years ended during the period from July 1, 2012 

through June 30, 2013. The following table expands on the information above to provide 

further information on which firms also audited issuers and the number of their broker 

and dealer audits:

7

 5 Information about the number of firms that audited brokers and dealers 

and their broker or dealer audits is based on financial statements filed with the SEC 

through May 27, 2014, for fiscal years ended during the period from July 1, 2012 

through June 30, 2013. These firms were registered with the PCAOB at the time the 

audit reports were issued.

6 There were 294 firms that audited 2 to 5 brokers and dealers that 

represented approximately 37 percent of the total firms that audit brokers and dealers.

7 Information about the firms that audit issuers is derived from data obtained 

from the most recently submitted annual reports on Form 2 filed through July 15, 2014. 

PCAOB Rule 2201 requires each registered public accounting firm to file an annual 
PCAOB Release No. 2014-003

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RELEASE 

Also Audited Issuers Did Not Audit Issuers

Number of 

Broker or

Dealer Audits 

Per Firm

Number of 

Firms

Number of 

Brokers and 

Dealers

Number of 

Firms

Number of 

Brokers and 

Dealers

1 110 110 257 257

2 to 208 157 883 228 897

21 to 50 10 290 14 395

51 to 100 4 270 4 278

More than 100 6 922 - -

 Total 287 2,475 503 1,827

Selection of Firms and Audits

During 2013, the Board inspected 60 firms and portions of 90 audits of brokers 

and dealers. The 90 audits selected for inspection had financial statement periods 

ended on June 30, 2012 through June 30, 2013. The selection of firms for inspection 

took into consideration the number of broker or dealer audits performed by the firms, 

whether they also issued audit reports for issuers and, thus, were subject to regular 

inspection by the PCAOB, as well as other characteristics, to obtain a cross section of 

firms that audit brokers and dealers. This approach for the selection of firms has been 

consistent since the inception of the interim inspection program. The selection of firms 

and audits of brokers and dealers is not necessarily representative of the population of 

firms or of audits of brokers and dealers. Further, the populations of firms and brokers 

and dealers are not homogenous. Therefore, the observations presented are not 

necessarily indicative of the population of firms or of audits of brokers and dealers.

The following table presents the number of firms inspected by the number of 

broker or dealer audits per firm as determined at the time of inspection:

 

report on Form 2 by June 30 of each year. The report covers the twelve-month period 

ending March 31. Information about the number of firms that audited brokers and 

dealers and the number of their broker or dealer audits is based on financial statements

filed with the SEC through May 27, 2014, for fiscal years ended during the period from 

July 1, 2012 through June 30, 2013. These firms were registered with the PCAOB at the 

time the audit reports were issued. 

8 There were 309 brokers and dealers audited by 99 firms, which also 

audited issuers and audited 2 to 5 brokers and dealers. There were 562 brokers and 

dealers audited by 195 firms, which did not audit issuers and audited 2 to 5 brokers and 

dealers. 
PCAOB Release No. 2014-003

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Number of Broker or Dealer 

Audits per Firm

Number of Firms 

Inspected

Number of Audits 

Selected

1 11 11

2 to 20 31 34

21 to 50 10 21

51 to 100 3 6

More than 100 5 18

Total 60 90

At the time of the inspections, 25 of the 60 firms were subject to regular 

inspection as they also audited issuers.9 The remaining 35 firms did not audit issuers 

and were not subject to inspection other than under the interim inspection program. 

Registered Public 

Accounting Firms

Number of Firms

Inspected

Number of Audits 

Selected

Also audited issuers 25 50

Did not audit issuers 35 40

Total 60 90

The selection of audits of brokers and dealers considered various characteristics

of brokers and dealers, such as the broker's or dealer's minimum net capital 

requirement and reported actual net capital under Exchange Act Rule 15c3-1 ("Rule 

15c3-1" or the "Net Capital Rule")

10 and whether or not the broker or dealer maintained 

a Special Reserve Bank Account11 under Rule 15c3-3. The Board did not exclude any 

registered public accounting firms or any audits of brokers or dealers from being eligible 

for selection. 

The 90 audits of brokers or dealers selected for inspection included 21 brokers 

and dealers that maintained a Special Reserve Bank Account and 69 brokers and 

dealers that did not. The following table presents the minimum net capital requirements 

and actual net capital reported for these brokers and dealers:

 9 Of these, nine firms selected for inspection audited more than 100 issuers 

and 16 firms selected for inspection audited 100 or fewer issuers.

10 17 C.F.R. § 240.15c3-1.

11 Brokers and dealers who do not claim an exemption under Rule 15c3-3, 

17 C.F.R. § 240.15c3-3, are generally required to maintain a bank account for the 

exclusive benefit of customers. At the time of the audits discussed here, Rule 15c3-3 

referred to a "Special Reserve Bank Account for the Exclusive Benefit of Customers," 

referred to in this report as "Special Reserve Bank Account." Effective March 3, 2014, 

Rule 15c3-3 refers to the relevant account as the "Customer Reserve Bank Account."
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RELEASE 

As indicated in the Board's release related to the adoption of Rule 4020T, the 

decision to include certain auditors in the scope of the interim inspection program 

should not be construed as a decision on the likely scope of a permanent inspection 

program or suggest that every auditor of a broker or dealer will be inspected as part of 

the interim inspection program. In addition, the criteria that were considered in making 

selections for the interim inspection program are not necessarily representative of any 

decision that the Board will make in its determination of the scope of a permanent 

inspection program.

Independence Findings and Audit Deficiencies from Inspections

The inspections focused on portions of 90 audits performed pursuant to Rule 

17a-5 that related to audit procedures on certain aspects of the financial statements and 

compliance with the Net Capital Rule and the Customer Protection Rule. 

The following tables present a summary of the independence findings and audit 

deficiencies in the order they are discussed in this report:

Number of 

Audits 

Selected

Range of Minimum 

Net Capital 

Requirements

Range of Actual 

Net Capital 

Reported at Fiscal 

Year End

Special Reserve Bank 

Account 21 $250,000 -

$600,000,000

$390,000-

$6,250,000,000

No Special Reserve 

Bank Account 69 $5,000 -

$1,230,000

$8,000 -

$2,340,000,000

Independence Findings

Number of 

Audits with 

Findings

Number of

Applicable 

Audits 

Percentage 

of Audits 

with 

Findings

Failure to Satisfy Independence 

Requirements 21 90 23%
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RELEASE 

The term "audit deficiencies," as used in this report, refers to failures by firms to 

perform, or perform sufficiently, certain required audit procedures. Audit deficiencies 

that exceeded a certain level of significance were communicated to the firms in writing. 

This report summarizes those audit deficiencies that Inspections staff determined were 

important to convey within this report based on their nature, severity, or frequency. The 

term "observations," as used in this report, refers to audit deficiencies and 

independence findings, collectively.

Observations described in this report were identified in 56 of the 60 firms whose 

audits were selected for inspection and in portions of 71 of the 90 audits selected for 

inspection. This includes audit deficiencies identified by Inspections staff in 55 of the 60 

firms inspected and in portions of 70 of the 90 audits selected for inspection, as well as 

one firm, which did not audit issuers, where Inspections staff identified an independence 

violation but did not identify an audit deficiency in the portions of the audits inspected. 

The 19 audits with no observations in the portions of audits inspected were 

performed by 12 firms, of which 11 also audited issuers. For 8 of these 12 firms, more 

than one audit was selected for inspection and Inspections staff identified observations

in one or more of the other audits.

The four firms with no observations in the portions of audits inspected were firms 

that also audited issuers. One of these firms audited more than 100 brokers and 

dealers.

Audit Deficiencies

Number of 

Audits with 

Deficiencies

Number of 

Applicable 

Audits 

Percentage 

of Audits 

with 

Deficiencies

Related to Customer Protection and Net Capital Rules:

Report on Material Inadequacies 38 78 49%

Customer Protection Rule 5 21 24%

Net Capital Rule 26 73 36%

Related to the Financial Statement Audit:

Risks of Material Misstatement 

Due to Fraud 36 90 40%

Related Party Transactions 15 90 17%

Revenue Recognition 53 90 59%

Reliance on Records and Reports 40 90 44%

Financial Statement Presentation 

and Disclosures 27 90 30%

Fair Value Estimates 8 32 25%

Evaluation of Internal Control 

Deficiencies 6 90 7%

Auditor's Report 5 90 6%
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Failure to Satisfy Independence Requirements

The independence of the registered public accounting firm is required under SEC 

rules and plays an important role in fostering high quality audits. SEC rules require 

auditors of brokers and dealers to comply with SEC independence requirements,12

which differ from AICPA independence requirements. SEC rules provide, among other 

things, that an accountant is not independent if the accountant provides bookkeeping or 

other services related to the accounting records or financial statements of the audit 

client unless it is reasonable to conclude that the results of these services will not be 

subject to audit procedures performed by the accountant during an audit of the client's 

financial statements.13

Inspections staff identified independence findings in 21 of the 90 audits selected 

for inspection and communicated these to the firms in writing. Independence findings 

were identified in two of the audits selected for inspection performed by firms that 

audited brokers and dealers and also issued audit reports for 100 or fewer issuers. In 

contrast, independence findings were identified in 19 of the audits selected for 

inspection that were performed by 18 firms that audited brokers and dealers but did not 

audit issuers.

Inspections staff observed 21 audits, by 20 firms, where the firms performed 

bookkeeping or other services related to the accounting records or financial statements 

of the brokers or dealers. All of these firms prepared, or assisted in the preparation of, 

the financial statements or supporting schedules required by Rule 17a-5. In addition, 

some of these firms also prepared journal entries or source data underlying the financial 

statements of the brokers or dealers, each of which is prohibited under the SEC 

independence rules.

Audit Deficiencies Related to Customer Protection and Net Capital Rules

Accountant's Supplemental Report on Material Inadequacies

At the time of the audits discussed here, Rule 17a-5(g)(1) required the scope of 

the audit and review of the accounting system, the internal accounting controls, 

procedures for safeguarding securities, and the practices and procedures in making the 

periodic computations of aggregate indebtedness, net capital, and the customer reserve 

to be sufficient to provide reasonable assurance that any material inadequacies existing 

 12 Rule 17a-5 provides that the auditor must be independent in accordance 

with Rule 2-01 of SEC Regulation S-X. At the time of the audits discussed here, that 

requirement had been articulated since 1972 in Rule 17a-5(f)(3). It is now articulated in 

Rule 17a-5(f)(1). 

13 See Rule 2-01(c)(4)(i) of Regulation S-X, 17 C.F.R. § 210.2-01(c)(4)(i).
PCAOB Release No. 2014-003

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RELEASE 

at the date of the examination are disclosed in the accountant's supplemental report on 

material inadequacies.

14

Inspections staff identified deficiencies in 38 of the 78 audits selected for 

inspection where one or more of the requirements of the accountant's supplemental 

report on material inadequacies was inspected. In 4 of the 78 audits, Inspections staff 

identified deficiencies in both categories set forth in the table below:

At the time of the audits discussed here, when a broker or dealer claimed an 

exemption under the Customer Protection Rule, auditors were required under Rule 17a5(g)(2) to ascertain whether the conditions of the exemption were complied with as of 

the examination date, and whether facts came to the auditor's attention to indicate that 

the broker or dealer was not in compliance with the exemption during the period since 

the last examination. In 31 of the 69 audits of brokers and dealers that claimed an 

exemption from the requirement to maintain a Special Reserve Bank Account,

Inspections staff found that firms failed to comply with this requirement. In several 

instances, Inspections staff found that firms failed to perform any procedures to 

ascertain that the broker or dealer complied with the conditions of the exemption. In

 14 Effective for fiscal years ending on or after June 1, 2014, Rule 17a-5(g) 

requires an examination by an auditor of the financial statements and supporting 

schedules of the broker or dealer and, depending on the report filed by the broker or 

dealer, an examination of the compliance report or a review of the exemption report. 

15 This area was inspected for the 69 audits of brokers and dealers that 

claimed an exemption from the requirement to maintain a Special Reserve Bank 

Account.

16 One or more requirements of this area were inspected for 20 audits of 

brokers and dealers based on certain characteristics, including whether the broker or 

dealer was required to maintain a Special Reserve Bank Account or whether errors or 

deficiencies were identified that could have been considered indicators of a material 

inadequacy. Of the 20 audits, 11 brokers or dealers claimed an exemption under Rule 

15c3-3 and 9 did not.

Deficiencies Related to: Number of 

Audits 

Number of 

Audits 

Inspected

Exemption claimed under Rule 

15c3-3 31 6915

Other procedures to test the 

accountant's supplemental report 

on material inadequacies

11 2016
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other instances, the firms limited their procedures to inquiry alone and did not perform 

sufficient other inquiries or other procedures related to the exemption claimed by the 

broker or dealer under the Customer Protection Rule.

In addition to the deficiencies noted above, Inspections staff observed that in 11

audits, firms failed to perform sufficient audit procedures with respect to the 

accountant's supplemental report on material inadequacies. In five audits, firms did not 

perform sufficient procedures to obtain reasonable assurance that any material 

inadequacies existing at the date of the examination would be disclosed. Inspections 

staff noted some of these firms did not sufficiently test controls related to the broker's or 

dealer's practices and procedures in making the periodic computations of aggregate 

indebtedness, net capital, or the customer reserve. Inspections staff also found that in 

seven audits,

17 firms identified errors or deficiencies during other audit procedures but 

did not sufficiently assess whether these errors or deficiencies indicated the existence 

of a material inadequacy.

Procedures Regarding Compliance with the Customer Protection Rule 

Rule 17a-5(g) states that brokers and dealers shall include supporting schedules 

with the financial statements that present the customer reserve computation and 

information relating to requirements for possession or control of securities. Rule 17a5(g) also states that the audit shall include all procedures necessary under the 

circumstances to enable the independent public accountant to express an opinion on, 

among other things, the customer reserve computation and information relating to the 

possession or control requirements under Rule 15c3-3. AU-C sec. 725, Supplementary 

Information in Relation to the Financial Statements as a Whole, addresses the auditor's 

responsibility when engaged to report on whether supplementary information is fairly 

stated, in all material respects, in relation to the financial statements as a whole. In 

order to opine on whether supplementary information is fairly stated, in all material 

respects, in relation to the financial statements as a whole, the auditor should perform 

certain procedures using the same materiality level used in the audit of the financial 

statements.18

Inspections staff identified one or more deficiencies in 5 of 21 audits selected for 

inspection where brokers or dealers did not claim an exemption from the requirement to 

maintain a Special Reserve Bank Account. In three of the five audits with deficiencies 

related to the Customer Protection Rule, Inspections staff identified more than one

deficiency in the categories set forth in the table below:

 17 One audit was included in the previous example of five audits.

18 See Paragraphs .05 and .07 of AU-C sec. 725. For audits conducted 

under pre-clarified AICPA standards, see Paragraphs .05 and .07 of AU sec. 551,

Supplementary Information in Relation to the Financial Statements as a Whole.
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Deficiencies Related to: Number of 

Audits

Completeness and accuracy of customer debits or 

credits 3

Special Reserve Bank Account 2

Possession or control requirements 3

Completeness and Accuracy of Customer Debits or Credits

In 3 of the 21 audits, Inspections staff noted that firms failed to sufficiently test 

the completeness and accuracy of customer debits or credits included in the customer 

reserve computation. Inspections staff observed that these firms limited their 

procedures to agreeing the amounts reported in the computation to schedules prepared 

by the broker or dealer and did not perform procedures to determine whether customer 

debits or credits were consistent with Exhibit A of Rule 15c3-3.

Special Reserve Bank Account

Rule 15c3-3(f) requires a broker or dealer that maintains a Special Reserve Bank 

Account to obtain and preserve written notification from each bank that all cash and/or 

qualified securities on deposit are being held by the bank for the exclusive benefit of 

customers, are kept separate from the broker's or dealer's other bank accounts, and 

assets in the account may not be used by the bank as collateral nor may the bank 

attach any claim to the account. 

Inspections staff observed in 2 of the 21 audits, firms failed to verify the existence 

of a Special Reserve Bank Account or failed to determine whether the account 

agreements contained the required restrictive provisions of Rule 15c3-3(f). 

Possession or Control Requirements

Rule 15c3-3(b)(1) requires a broker or dealer to promptly obtain and maintain the 

physical possession or control19 of all fully-paid securities20 and excess margin 

securities21 carried by the broker or dealer for the accounts of customers. 

 19 Generally, "possession" of securities means the securities are physically 

located at the broker or dealer and "control" of securities means the securities are 

located at an approved "control" location, such as a clearing corporation or depository. 

20 Generally, fully-paid securities are securities that are purchased in 

transactions for which the customer has made full payment. See Rule 15c3-3(a)(3).

21 Generally, excess margin securities in a customer account are those 

securities with a market value greater than 140 percent of the customer's debit balance.

See Rule 15c3-3(a)(5).
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Inspections staff observed in 3 of the 21 audits, firms failed to perform sufficient 

procedures to test compliance with the possession or control requirements. Inspections 

staff noted that firms did not perform sufficient procedures to test the stock record, 

determine whether instructions were timely to reduce items to possession or control, or 

sufficiently test whether securities were located at an approved control location.

Procedures Regarding Compliance with the Net Capital Rule

Rule 17a-5(g) states that brokers and dealers shall include a supporting schedule 

to the financial statements that presents the computation of net capital. Net capital is 

also generally disclosed in the notes to the financial statements. Similar to the 

procedures regarding compliance with the Customer Protection Rule noted above, Rule 

17a-5(g) and AU-C sec. 725 were applicable to audits described in this section.

Inspections staff identified one or more deficiencies in 26 of the 73 audits 

selected where one or more components of the net capital computation was selected for 

inspection. In 10 of the 26 audits with deficiencies related to the Net Capital Rule, 

Inspections staff identified more than one deficiency in the categories set forth in the 

table below:

Deficiencies Related to: Number of 

Audits

Minimum net capital requirements 10

Additions to net worth 1

Allowable assets 19

Haircuts 6

Operational charges 2

Minimum net capital requirements

Generally, a broker's or dealer's required minimum net capital is the greater of (1) 

one of a number of fixed-dollar amounts prescribed in Rule 15c3-1 applicable to the 

broker or dealer relative to its line(s) of business,

22 or (2) an amount computed using 

one of two financial ratios.23 In 9 of the 10 audits, Inspections staff found that firms 

failed to assess the nature of the broker's or dealer's operations in relation to the 

required minimum net capital amounts in accordance with Rule 15c3-1. In 3 of the 1024

audits, Inspections staff found that firms failed to sufficiently test whether aggregated 

 22 See Rule 15c3-1(a)(2).

23 See Rule 15c3-1(a)(1).

24 This number includes two audits referenced in the previous sentence.
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indebtedness was calculated in accordance with Rule 15c3-1(c)(1)(i), and therefore,

failed to evaluate whether the calculated minimum net capital was in accordance with 

Rule 15c3-1(a).

Additions to Net Worth

Under Rule 15c3-1, as interpreted by SEC staff, certain discretionary liabilities

are allowed to be added back to net worth in the determination of net capital.25 In one

audit, Inspections staff found that the firm failed to test whether the amount of the 

liability for employee bonuses that was added to net worth in the determination of net 

capital was payable solely at the discretion of the broker or dealer, in accordance with 

Rule 15c3-1.

Allowable assets

Rule 15c3-1 requires that assets not readily convertible into cash ("non-allowable 

assets") be deducted from equity when computing net capital.26 Inspections staff 

observed 19 audits where firms did not perform sufficient procedures to test the broker's 

or dealer's classification of allowable and non-allowable assets when computing net 

capital. 

Under Rule 15c3-1, as interpreted by SEC staff, brokers and dealers are 

permitted to offset certain receivables and payables when specific conditions are met. In 

5 of the 19 audits, Inspections staff observed that firms failed to perform sufficient 

procedures to verify that the conditions necessary for the right of offset of certain 

receivables by related payables were met in accordance with the applicable sections of 

Rule 15c3-1. For example, in three of these audits, firms failed to test whether 

commissions receivable pursuant to Exchange Act Rule 12b-1 ("Rule 12b-1")

27 were 

allowable assets under Rule 15c3-1. As Rule 15c3-1 is interpreted by SEC staff, Rule 

12b-1 commissions receivable can be classified as an allowable asset only to the extent 

the receivables are offset by Rule 12b-1 commissions payable to sales representatives. 

Among other things, the sales representatives must sign a written agreement with the 

broker or dealer waiving payment of their commissions until the broker or dealer is in 

receipt of the Rule 12b-1 commissions.

28

 25 See Interpretation 15c3-1(c)(2)/02. This citation form refers to a 

compilation of the substance of certain SEC staff interpretations available at 

http://www.finra.org/industry/regulation/guidance/for/. The interpretation referred to here 

is identified as number /02 associated with Rule 15c3-1(c)(2) in that compilation.

26 See Rule 15c3-1(c)(2)(iv).

27 17 C.F.R. § 270.12b-1.

28 See Interpretation 15c3-1(c)(2)(iv)(C)/09.
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When a broker or dealer has its proprietary assets and clearing deposit in a 

proprietary account held by a clearing broker, Rule 15c3-1, as interpreted by SEC staff, 

permits these assets to be classified as allowable assets in the net capital computation 

provided certain conditions are met.29 In 6 of the 19 audits, Inspections staff observed 

that brokers and dealers reported assets held by a clearing broker as allowable assets, 

but the firms failed to test whether these assets met the requirements of an allowable 

asset under Rule 15c3-1(c)(2)(iv)(E).

Rule 15c3-1(c)(2)(iv)(C) states that commissions receivable from other brokers or 

dealers that are outstanding longer than 30 days from the date they arise are nonallowable assets. In 6 of the 19 audits, Inspections staff observed that firms failed to 

perform sufficient procedures to test the aging of commissions receivable to determine 

whether the amount reported as an allowable asset met the requirements of Rule 15c3-

1(c)(2)(iv)(C). 

Haircuts

When computing net capital, Rule 15c3-1 generally requires brokers and dealers 

to apply percentage reductions (referred to as "haircuts") to the values of securities 

owned by the broker or dealer.30 As a result, the valuation of the securities and the 

appropriate haircut percentages can be critical to the net capital computation. 

Inspections staff observed six audits where firms did not perform sufficient procedures 

related to haircuts on securities. 

In all six audits, Inspections staff found that firms failed to perform procedures to 

evaluate whether the appropriate haircut percentages were applied by the broker or 

dealer, including tests of the relevant characteristics of the securities positions. For 

example, firms failed to test whether haircuts on securities positions were based on the 

percentages applicable to the categories of securities and maturity dates, if applicable, 

pursuant to SEC Rule 15c3-1(c)(2)(vi). In one of the audits, Inspections staff found that 

the firm failed to perform sufficient procedures to test the completeness and accuracy of 

supporting records obtained from an external party that provided the amount of haircuts 

used in the computation of net capital. 

Operational charges

In computing net capital, Rule 15c3-1 requires brokers and dealers to deduct 

amounts related to operational charges such as aged fail to-deliver balances.31 In two

 29 See Interpretation 15c3-1(c)(2)(iv)(E)/021. 

30 See Rule 15c3-1(c)(2)(vi).

31 See Rule 15c3-1(c)(2)(ix).
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audits, Inspections staff observed that firms failed to perform sufficient procedures to 

test the completeness or accuracy of operational charges deducted from the broker's or 

dealer's net capital. 

Deficiencies Related to the Financial Statement Audit

Consideration of Risks of Material Misstatement Due to Fraud

An auditor conducting an audit in accordance with GAAS is responsible for 

obtaining reasonable assurance that the financial statements as a whole are free from

material misstatement, whether caused by fraud or error.

32 AU-C sec. 240 describes the 

auditor's responsibilities for, among other things, identifying, assessing, and responding 

to the risks of material misstatement due to fraud.33 The two types of misstatements that 

are relevant to the consideration of fraud in a financial statement audit are 

misstatements resulting from fraudulent financial reporting and misstatements resulting 

from misappropriation of assets.34

Inspections staff identified one or more deficiencies in 36 of the 90 audits 

selected for inspection. In 13 of the 36 audits with deficiencies related to the 

consideration of risks of material misstatement due to fraud, Inspections staff identified 

more than one deficiency in the categories set forth in the table below:

 32 Paragraph .05 of AU-C sec. 240, Consideration of Fraud in a Financial 

Statement Audit. For audits conducted under pre-clarified AICPA standards, paragraph 

.01 of AU sec. 316, Consideration of Fraud in a Financial Statement Audit, provides that 

"[t]he auditor has a responsibility to plan and perform the audit to obtain reasonable 

assurance about whether the financial statements are free of material misstatement, 

whether caused by error or fraud."

33 For audits conducted under pre-clarified AICPA standards, see AU sec. 

316.

34 See Paragraph .03 of AU-C sec. 240. For audits conducted under preclarified AICPA standards, see Paragraph .06 of AU sec. 316.

Deficiencies Related to: Number of 

Audits

Identification and assessment of the risks of 

material misstatement due to fraud 11

Responses to the assessed risks of material 

misstatement due to fraud – management override 32

Responses to fraud risk related to revenue 

recognition 6
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Identification and Assessment of the Risks of Material Misstatement Due to 

Fraud

When identifying and assessing the risks of material misstatement due to fraud, 

the auditor should, based on a presumption that risks of fraud exist in revenue 

recognition, evaluate which types of revenue, revenue transactions, or assertions give 

rise to such risks.

35 If the auditor has concluded that the presumption that there is a risk 

of material misstatement due to fraud related to revenue recognition is overcome in the 

circumstances of the engagement, the auditor should include in the audit documentation 

the reasons for that conclusion.36

The auditor should treat those assessed risks of material misstatement due to 

fraud as significant risks and, accordingly, to the extent not already done so, the auditor 

should obtain an understanding of the entity's related controls, including control 

activities, relevant to such risks, including the evaluation of whether such controls have 

been suitably designed and implemented to mitigate such fraud risks.37

In 10 audits, Inspections staff observed that firms did not identify a fraud risk 

related to revenue recognition or document their conclusion that no such risk existed. In

one audit, a firm identified a fraud risk related to revenue recognition but failed to obtain 

an understanding of the broker's or dealer's control activities related to revenue in order 

to evaluate whether such controls were designed and implemented to mitigate the 

identified fraud risk.

Responses to the Assessed Risks of Material Misstatement Due to Fraud –

Management Override

The auditor should address the risk of management override of controls apart 

from any conclusions regarding the existence of more specifically identifiable risks by 

designing and performing audit procedures to: (a) test the appropriateness of journal 

entries recorded in the general ledger and other adjustments made in the preparation of 

the financial statements, including entries posted directly to financial statement drafts;

(b) review accounting estimates for biases and evaluate whether the circumstances 

producing the bias, if any, represent a risk of material misstatement due to fraud; and

(c) evaluate whether the business rationale (or the lack thereof) of significant

 35 Paragraph .26 of AU-C sec. 240. For audits conducted under pre-clarified 

AICPA standards, see Paragraph .41 of AU sec. 316.

36 Paragraph .46 of AU-C sec. 240. For audits conducted under pre-clarified 

AICPA standards, see Paragraph .83 of AU sec. 316.

37 Paragraph .27 of AU-C sec. 240. For audits conducted under pre-clarified 

AICPA standards, see Paragraphs .44 through .45 of AU sec. 316.
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transactions that are outside the normal course of business suggests that they may 

have been entered into to engage in fraudulent financial reporting or to conceal 

misappropriation of assets.

38

Inspections staff observed in 32 audits that firms failed to perform sufficient 

procedures to address risks related to management override of controls, including 

sufficiently testing the appropriateness of journal entries recorded in the general ledger 

and other adjustments made in the preparation of the financial statements. In 24 of 

these audits, firms failed to: (i) obtain an understanding of the entity's financial reporting 

process and controls over journal entries and other adjustments, and the suitability of 

design and implementation of such controls; (ii) make inquiries of individuals involved in 

the financial reporting process about inappropriate or unusual activity relating to the 

processing of journal entries and other adjustments; (iii) consider fraud risk indicators, 

the nature and complexity of accounts, and entries processed outside the normal 

course of business; (iv) select journal entries and other adjustments made at the end of 

a reporting period; or (v) consider the need to test journal entries and other adjustments 

throughout the period.39 In addition, in 9 of the 32 audits, Inspections staff noted that 

firms failed to review accounting estimates for bias, or evaluate significant transactions 

outside the normal course of business, or that otherwise appear unusual, to address the 

risk of management override of controls.

In 9 of the 32 audits, Inspections staff observed that firms did not test the 

completeness of the population of journal entries from which they selected a sample for 

journal entry testing.

40

Responses to Fraud Risk Related to Revenue Recognition

Inspections staff observed six audits where firms failed to design or perform audit 

procedures whose nature, timing, and extent were responsive to the assessed risks of 

material misstatement due to fraud related to revenue recognition.41 For example, 

 38 See Paragraph .32 of AU-C sec. 240. For audits conducted under preclarified AICPA standards, see Paragraphs .58 through .67 of AU sec. 316.

39 See Paragraph .32a of AU-C sec. 240. For audits performed under preclarified AICPA standards, see Paragraphs .58 through .62 of AU sec. 316. 

40 See Paragraph .09 of AU-C sec. 500, Audit Evidence. For audits 

performed under pre-clarified AICPA standards, see Paragraph .10 of AU sec. 326, 

Audit Evidence.

41 Paragraph .06 of AU-C sec. 330, Performing Audit Procedures in 

Response to Assessed Risks and Evaluating the Audit Evidence Obtained. For audits 

conducted under pre-clarified AICPA standards, see Paragraph .07 of AU sec. 318,
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Inspections staff noted that in instances where the firm's approach to address the 

identified fraud risk consisted only of substantive procedures, some firms used 

substantive analytical procedures but did not perform tests of details as required by AUC sec. 330.

42 In another example, a firm identified cutoff to be a fraud risk but did not 

perform sufficient procedures to respond to this risk.

Auditing Related Party Transactions

Related parties often play a significant role in the operations of brokers and 

dealers, for example, through direct participation in the activities of the brokers and 

dealers by principals or affiliates under shared service agreements. The nature of 

related party relationships and transactions may, in some circumstances, give rise to 

higher risks of material misstatement of the financial statements than transactions with 

unrelated parties.

43 For example, related parties may be improperly used by brokers and 

dealers in scenarios such as: overpaying for goods or services and disguising capital 

withdrawals; avoiding the imposition of higher capital requirements and various capital 

charges; structuring a broker's or dealer's business to avoid certain rules; and 

transferring customer assets to parties that are not approved custodians.

Auditors have a responsibility to perform audit procedures to identify, assess, 

and respond to the risks of material misstatement arising from a broker's or dealer's 

failure to appropriately account for or disclose related party relationships, transactions, 

or balances.44 The auditor should design and perform audit procedures to obtain 

sufficient appropriate audit evidence about the assessed risks of material misstatement 

 

Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit 

Evidence Obtained.

42 See Paragraph .22 of AU-C sec. 330. For audits conducted under preclarified AICPA standards, see Paragraph .54 of AU sec. 318.

43 See Paragraph .03 of AU-C sec. 550, Related Parties. For audits 

conducted under pre-clarified AICPA standards, Paragraph .31 of AU sec. 314, 

Understanding the Entity and Its Environment and Assessing the Risks of Material 

Misstatement, provides that "the business risk of significant transactions with related 

parties may increase the risk of misstatement of a range of significant account balances 

and relevant assertions."

44 See Paragraph .04 of AU-C sec. 550. For audits conducted under preclarified AICPA standards, Paragraph .01 of AU sec. 334, Related Parties, provides that 

"when he [the auditor] is performing an audit of financial statements in accordance with 

generally accepted auditing standards to identify related party relationships and 

transactions and to satisfy himself concerning the required financial statement 

accounting and disclosure."
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associated with related party relationships and transactions and should remain alert 

when inspecting records or documents for arrangements or other information that may 

indicate the existence of related party relationships or transactions that have not 

previously been identified or disclosed.45

Inspections staff identified one or more deficiencies in 15 of the 90 audits 

selected for inspection. In 5 of the 15 audits with related party deficiencies, Inspections 

staff identified more than one deficiency in the categories set forth in the table below:

Inspections staff observed seven audits where firms failed to perform sufficient 

procedures to determine the existence of related parties and material related party 

transactions. In five of the seven audits, Inspections staff found that firms limited their 

procedures to inquiries of management and did not inspect records and documents for 

the purpose of identifying significant related party relationships or material transactions 

that had not been previously identified or disclosed. 

In 13 audits, Inspections staff observed that firms identified related parties or 

material related party transactions, including service agreements, fee agreements, or 

intercompany balances, yet the firms did not perform procedures necessary to obtain 

sufficient appropriate audit evidence to respond to the assessed risks of material 

misstatement associated with related party relationships and transactions. For example, 

firms did not perform sufficient tests for the completeness and accuracy of identified 

related party transactions. In three of these audits, Inspections staff observed that the 

firms failed to perform procedures to evaluate the financial capability of related parties 

to pay their debts to the brokers or dealers in order to test the valuation of the related 

party receivables.

Auditing Revenue Recognition

Brokers and dealers may generate revenue from a variety of securities-related 

lines of business. When testing revenue, the auditor should design and perform audit 

procedures whose nature, timing, and extent are based on, and are responsive to, the 

 45 See Paragraphs .16 and .21 of AU-C sec. 550. For audits conducted 

under pre-clarified AICPA standards, see Paragraphs .07 through .09 of AU sec. 334. 

Deficiencies Related to: Number of 

Audits

Existence and identification of related party 

relationships and or transactions 7

Examining identified related party transactions 13
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assessed risks of material misstatement at the relevant assertion level.46 The auditor 

must obtain sufficient appropriate audit evidence to be able to draw reasonable 

conclusions for his or her opinion on whether the financial statements are presented 

fairly, in all material respects, in conformity with GAAP.

47

Inspections staff identified one or more deficiencies in 53 of the 90 audits 

selected for inspection. In 30 of the 53 audits with deficiencies related to revenue 

recognition, Inspections staff identified more than one deficiency in the categories set 

forth in the table below:

Inspections staff observed that in 29 audits, the extent of testing was insufficient 

for material classes of revenue transactions, including trading gains and losses, 

commission revenue, and advisory fees. For example, Inspections staff observed 

instances where firms: (a) did not perform any procedures to test material classes of 

revenue transactions; or, (b) sampling procedures for testing revenue were insufficient 

because: (i) firms did not have a basis to reduce the extent of substantive tests of 

material classes of revenue transactions, because some of these firms did not 

sufficiently test controls yet reduced the extent of their substantive tests; (ii) the sample 

was not designed to address the relevant risks and other characteristics of the 

population; or (iii) firms failed to select a sample of revenue transactions for testing that 

was representative of the underlying population. 

When designing and performing analytical procedures, either alone or in 

combination with tests of details, as substantive procedures, the auditor should: (a) 

determine the suitability of substantive analytical procedures for given assertions; (b) 

evaluate the reliability of data from which expectations are developed; (c) develop an 

expectation and evaluate whether the expectation is sufficiently precise to identify a 

misstatement; and (d) determine the amount of difference from the expectation that can 

 46 See Paragraph .06 of AU-C sec. 330. For audits conducted under preclarified AICPA standards, see Paragraph .07 of AU sec. 318.

47 See Paragraph .01 of AU-C sec. 500. For audits conducted under preclarified AICPA standards, see Paragraph .01 of AU sec. 326.

Deficiencies Related to: Number of 

Audits

Extent of testing 29

Substantive analytical procedures 24

Other procedures to test revenue recognition 36
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be accepted without further investigation.

48 If analytical procedures performed identify 

fluctuations or relationships that are inconsistent with other relevant information or that 

differ from expected values by a significant amount, the auditor should investigate such 

differences by (a) inquiring of management and obtaining appropriate audit evidence 

relevant to management's responses and (b) performing other audit procedures as 

necessary in the circumstances.49

Inspections staff observed 24 audits where firms performed substantive 

analytical procedures that did not provide the intended level of assurance because the 

firms failed to (a) develop expectations that were sufficiently precise to identify 

misstatements; (b) investigate significant unexpected differences; (c) test the 

completeness and accuracy of the underlying data used in the analytical procedures; or 

(d) determine that the substantive analytical procedures were based on plausible,

predictable relationships.

Inspections staff identified deficiencies in 36 audits selected for inspection that 

related to the failure of firms to perform sufficient procedures to test the relevant 

assertions for revenue. For example, firms failed to: (a) evaluate, or evaluate 

sufficiently, the effect of specific terms or provisions of significant contractual 

arrangements related to the recognition of revenue; (b) test whether revenue was 

recorded in the correct period; (c) determine whether assets under management used 

to calculate fees were complete and accurate; (d) determine whether the commission 

rates used to calculate commission revenue were consistent with the underlying 

agreements; or (e) evaluate whether revenue recognition policies were in conformity 

with GAAP.

Procedures to Establish a Basis for Reliance on Records and Reports

Inspections staff identified one or more deficiencies in 40 of the 90 audits 

selected for inspection. In six audits with deficiencies related to establishing a basis for 

reliance on records and reports, Inspections staff identified more than one deficiency in 

the categories set forth in the table below:

 48 See Paragraph .05 of AU-C sec. 520, Analytical Procedures. For audits 

conducted under pre-clarified AICPA standards, see Paragraphs .13 through .20 of AU 

sec. 329, Analytical Procedures.

49 See Paragraph .07 of AU-C sec. 520. For audits conducted under preclarified AICPA standards, see Paragraph .21 of AU sec. 329.
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Auditing Information Produced by Service Organizations

Many brokers and dealers use the services of other brokers and dealers to 

perform trade processing and related back-office functions, primarily in the clearing and 

settling of customer transactions. AU-C sec. 402, Audit Considerations Relating to an 

Entity Using a Service Organization, applies to audits where an entity uses services 

from a service organization that affect the company's information system, including 

related business processes, relevant to financial reporting.

50 AU-C sec. 402 also 

discusses the user auditor's requirement to obtain an understanding of how the 

company uses the services of a service organization in the company's operations, the 

user auditor's requirement to obtain an understanding of internal control relevant to the 

audit, and the user auditor's response to assessed risk of material misstatement, 

whether through further audit procedures or tests of controls.51 In responding to the 

assessed risk of material misstatement, the auditor should (a) determine whether 

sufficient appropriate audit evidence concerning the relevant assertions is available 

from records held at the broker or dealer and if not, (b) perform further audit procedures 

to obtain sufficient appropriate audit evidence or use another auditor to perform those 

procedures at the service organization on the user auditor's behalf.

52

Inspections staff observed in 31 audits that firms did not perform sufficient 

procedures on information produced by service organizations that were used to perform 

substantive audit procedures or test of controls. 

Inspections staff observed in 30 of those 31 audits that firms used information 

produced by a service organization, such as records or reports from a clearing broker, 

but failed to obtain sufficient appropriate audit evidence on such information. Some 

firms used clearing broker statements as audit evidence and did not perform sufficient 

substantive audit procedures on the statement. In several instances, firms limited their 

 50 See Paragraph .03 of AU-C sec. 402. For audits conducted under preclarified AICPA standards, see Paragraph .03 of AU sec. 324, Service Organizations.

51 See Paragraphs .09 through .22 of AU-C sec. 402. For audits conducted 

under pre-clarified AICPA standards, see Paragraphs .05 through .21 of AU sec. 324.

52 See Paragraph .15 of AU-C sec. 402.

Deficiencies Related to: Number of 

Audits

Auditing information produced by service 

organizations 31

Testing records and reports produced by brokers 

and dealers 15
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procedures to agreeing the clearing broker statement to cash receipts or the general 

ledger. Other firms obtained and evaluated a service auditor's report to rely on the 

operating effectiveness of controls at the service organization, but did not perform 

sufficient substantive audit procedures to address the relevant assertions related to the 

account balance. 

Inspections staff observed that in seven audits, six of which are included in the 

30 audits discussed in the previous paragraph, firms obtained a service auditor's report, 

but failed to sufficiently evaluate the service auditor's report or consider whether the 

service auditor's report provided evidence about the design and operating effectiveness 

of the controls being relied upon. For example, Inspections staff observed instances 

where firms failed to sufficiently evaluate whether the broker or dealer had designed 

and implemented the necessary user entity controls identified in the service auditor's

report or sufficiently tested those controls.

Testing Records and Reports Produced by Brokers and Dealers

When information produced by the entity is used by the auditor in designing and 

performing audit procedures, the auditor should evaluate whether the information is 

sufficiently reliable for the auditor's purpose, including obtaining audit evidence about 

the accuracy and completeness of the information and evaluating whether the 

information is sufficiently precise and detailed for the auditor's purposes.

53

Inspections staff observed that in 15 audits, firms failed to perform procedures to 

obtain evidence about the completeness or accuracy of records and reports produced 

by the brokers and dealers that were used in the performance of tests of controls or 

substantive tests. Examples of these records and reports included trade blotters, 

account statements, and schedules or spreadsheets prepared by broker or dealer 

personnel. Such records and reports were used by firms in performing tests of certain 

accounts or disclosures without testing the completeness or accuracy of the information 

in those records and reports.

Auditing Financial Statement Presentation and Disclosures 

The auditor should evaluate whether the financial statements, in conformity with 

GAAP, provide adequate disclosures to enable the intended users to understand the 

effect of material transactions and events on the information conveyed in the financial 

statements.54 In addition, the auditor should evaluate (a) the overall presentation, 

 53 See Paragraph .09 of AU-C sec. 500. For audits conducted under preclarified AICPA standards, see Paragraph .10 of AU sec. 326.

54 See Paragraph .16e of AU-C sec. 700, Forming an Opinion and Reporting 

on Financial Statements. For audits conducted under pre-clarified AICPA standards, 

Paragraph .02 of AU sec. 431, Adequacy of Disclosure in Financial Statements, 
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structure, and content of the financial statements and (b) whether the financial 

statements, including the related notes, represent the underlying transactions and 

events in a manner that achieves fair presentation.55

Inspections staff reviewed the audit work performed related to financial statement 

disclosures for those areas included in the inspections. Inspections staff identified one 

or more deficiencies in 27 of 90 audits selected for inspection. In 6 of the 27 audits with 

deficiencies related to financial statement presentation and disclosure, Inspections staff 

identified more than one deficiency in the categories set forth in the table below:

In nine audits, Inspections staff observed instances in which firms failed to 

identify and evaluate the omission of required disclosures pertaining to areas such as 

related parties and related party transactions or revenue recognition policies.

Inspections staff also observed in 16 audits that firms failed to identify incomplete 

disclosures or respond to evidence that was inconsistent with disclosures included in 

the financial statements. In another four audits, Inspections staff observed that firms 

failed to evaluate the broker's or dealer's classification of fair value measurements of 

securities owned within the hierarchy required by FASB ASC 820, Fair Value 

Measurement ("ASC 820"). 

In addition, Inspections staff observed in four audits that firms failed to evaluate 

whether the financial statements presented and disclosed the underlying transactions in 

a manner that complied with GAAP. For example, in some of these audits, firms failed to

identify and address that the broker or dealer reported multiple revenue streams as a 

single line item on the statement of income, which is inconsistent with the financial 

statement format contained in Form X-17-5 Part II or Part IIA in accordance with Rule 

17a-5(d)(2).

 

provides that "[t]he presentation of financial statements in conformity with generally 

accepted accounting principles includes adequate disclosure of material matters."

55 See Paragraph .17 of AU-C sec. 700. For audits conducted under preclarified AICPA standards, see Paragraph .02 of AU sec. 431. 

 

Deficiencies Related to: Number of 

Audits

Omitted disclosures 9

Incomplete or inaccurate disclosures 16

Fair value disclosures (FASB ASC 820) 4

Fair presentation 4
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Auditing Fair Value Accounting Estimates

Brokers and dealers account for and disclose securities at fair value.56 AU-C sec. 

540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and 

Related Disclosures, describes the auditor's responsibilities relating to accounting

estimates, including fair value accounting estimates, in an audit of financial 

statements.

57 The term accounting estimate is used for an amount measured at fair 

value when there is estimation uncertainty, as well as for other amounts that require 

estimation.58

In responding to the assessed risks of material misstatement, taking into account 

the nature of the accounting estimate, the auditor should undertake one or more of the 

following: (a) determine whether events occurring up to the date of the auditor's report 

provide audit evidence regarding the accounting estimates; (b) test how management 

made the accounting estimate and the data on which it is based; (c) test the operating 

effectiveness of the controls over how management made the accounting estimate, 

together with appropriate substantive procedures; (d) develop a point estimate or range 

to evaluate management's point estimate.

59

Inspections staff identified deficiencies in 8 of the 32 audits where the auditor's 

procedures to test securities valuation were selected for inspection. The following 

presents a summary of the deficiencies discussed below:

 56 See FASB ASC 820 and FASB ASC Subtopic 940-320, Financial Services 

- Brokers and Dealers, Investments - Debt and Equity Securities, ("ASC 940-320").

57 See Paragraph .01 of AU-C sec. 540. For audits conducted under preclarified AICPA standards, AU sec. 328, Auditing Fair Value Measurements and 

Disclosures, established standards and provided guidance on auditing fair value 

measurements and disclosures contained in financial statements; see Paragraph .01.

58 See Paragraph .07 of AU-C sec. 540. For audits conducted under preclarified AICPA standards, Paragraph .01 of AU sec. 342, Auditing Accounting 

Estimates provides that "an accounting estimate is an approximation of a financial 

statement element, item, or account."

59 See Paragraph .13 of AU-C sec. 540. For audits conducted under preclarified AICPA standards, Paragraph .23 of AU sec. 328 provides that the auditor's 

approach to performing substantive tests of fair value measurements may involve: (a) 

testing management's significant assumptions, the valuation model, and the underlying 

data; (b) developing an independent estimate of fair value for corroborative purposes; or 

(c) reviewing subsequent events or transactions.
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Deficiencies Related to: Number of 

Audits

Auditing fair value accounting estimates 6

Auditing accounting for investments 2

In 6 of the 32 audits, Inspections staff observed that firms did not perform 

sufficient procedures to test the valuation of securities. For example, in two audits, 

Inspections staff observed that firms relied on the fair values provided by the brokers or 

dealers and failed to undertake, or sufficiently undertake, one or more of the procedures 

described in the second paragraph of this section. 

Brokers and dealers are excluded from the scope of FASB ASC Topic 320-10-

15-3, Investments – Debt and Equity Securities ("ASC 320"). Brokers and dealers 

should account for investments at fair value,60 with changes in fair value recorded as 

income from operations in the statement of income. In two audits, Inspections staff 

observed that firms failed to identify that the brokers or dealers had applied ASC 320, 

and therefore, had inappropriately accounted for investments as securities that were

held to maturity or available for sale.

Evaluation of Internal Control Deficiencies in the Financial Statement Audit

In a financial statement audit, the auditor should obtain an understanding of 

control activities relevant to the audit, which are those control activities the auditor 

judges necessary to understand in order to assess the risks of material misstatement at 

the assertion level and design further audit procedures responsive to assessed risks.

61

During the course of an audit, the auditor may become aware of deficiencies in internal 

control. If the auditor has identified one or more deficiencies in internal control, the 

auditor should evaluate each deficiency to determine, on the basis of the audit work 

performed, whether, individually or in combination, they constitute significant 

deficiencies or material weaknesses.

62 If the auditor determines that a deficiency, or a 

combination of deficiencies, in internal control is not a material weakness, the auditor 

should consider whether prudent officials, having knowledge of the same facts and 

 60 See Paragraph .30 of ASC 940-320.

61 See Paragraph .21 of AU-C sec. 315, Understanding the Entity and Its 

Environment and Assessing the Risks of Material Misstatement. For audits conducted 

under pre-clarified AICPA standards, see Paragraph .40 of AU sec. 314. 

62 Paragraph .09 of AU-C sec. 265, Communicating Internal Control Related 

Matters Identified in an Audit. For audits conducted under pre-clarified AICPA 

standards, see Paragraph .08 of AU sec. 325, Communicating Internal Control Related 

Matters Identified in an Audit. 
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circumstances, would likely reach the same conclusion.

63 In addition, the auditor should

consider whether a deficiency, or a combination of deficiencies, identified in internal 

control is an indicator of a material inadequacy that would be disclosed in the 

accountant's supplemental report on material inadequacies.

Inspections staff identified one or more deficiencies in 6 of the 90 audits selected 

for inspection. In one audit with deficiencies related to the evaluation of internal control 

deficiencies, Inspections staff identified more than one deficiency in the categories set 

forth in the table below:

Deficiencies Related to: Number of 

Audits

Assessment of the severity of a control deficiency 2

Evaluation of errors performed as part of 

substantive testing 5

In two of the six audits, Inspections staff observed that firms identified one or 

more internal control deficiencies while performing procedures to obtain an 

understanding of internal control. Although the firms identified these deficiencies, the 

evaluations by the firms did not include a sufficient assessment of the severity of the 

control deficiency to determine whether the deficiency, individually or in combination, 

represented a significant deficiency or material weakness.

When evaluating the operating effectiveness of relevant controls, the auditor 

should evaluate whether misstatements that have been detected by substantive 

procedures indicate that controls are not operating effectively.

64 In five of the six audits, 

Inspections staff observed that firms identified errors during the performance of 

substantive tests. However, the firms failed to evaluate the severity and nature of the 

errors, both individually and in combination, and the circumstances of their occurrences, 

including whether the errors were evidence of one or more control deficiencies.

Auditor's Report

Generally, brokers and dealers are required under Rule 17a-5 to file with the 

SEC audited financial statements and supporting schedules on the computation of net 

capital, the computation of the customer reserve requirement, and information relating 

to the possession or control requirements of the Customer Protection Rule. At the time 

 63 Paragraph .10 of AU-C sec. 265. For audits conducted under pre-clarified 

AICPA standards, see Paragraph .16 of AU sec. 325. 

64 Paragraph .16 of AU-C sec. 330. For audits conducted under pre-clarified 

AICPA standards, see Paragraph .34 of AU sec. 318. 
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of the audits discussed here, Rule 17a-5 also required brokers and dealers to file an 

accountant's supplemental report on material inadequacies. The auditor's report on the 

supporting schedules should include the elements required by AU-C sec. 725,

65

including an opinion on whether the schedules are fairly stated, in all material respects, 

in relation to the financial statements taken as a whole.

Inspections staff identified deficiencies in 5 of the 90 audits selected for 

inspection related to the auditor's report. Inspections staff found that in four of the five 

audits, the auditor's report on the supporting schedules failed to include one or more of 

the elements required by AU-C sec. 725, such as a statement that the supplementary 

information is the responsibility of management and was derived from, and relates 

directly to, the underlying accounting and other records used to prepare the financial 

statements.

 65 See Paragraph .09 of AU-C sec. 725. For audits conducted under preclarified AICPA standards, see Paragraph .09 of AU sec. 551. 
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Part II: Summary of Inspections of Registered Public Accounting Firms Since 

Inception of the Interim Inspection Program

Since inception of the interim inspection program through December 31, 2013,

the Board has inspected 10166 registered public accounting firms that conducted audits 

of the financial statements and other requirements of brokers and dealers. Nine of these 

firms were inspected more than once. These inspections covered portions of 173 audits. 

The following discussion summarizes the selection of firms and audits made 

during the interim inspection program through December 31, 2013, and independence 

findings and audit deficiencies identified by Inspections staff from these inspections.

The Board advises readers to consider the information presented within the 

remainder of this section in light of the following factors. The selection of firms and 

audits of brokers and dealers made since inception of the interim inspection program is 

not necessarily representative of the population of firms or of audits of brokers and 

dealers. Further, the populations of firms and brokers and dealers are not homogenous. 

Therefore, the observations presented are not necessarily indicative of the population of 

firms or of audits of brokers and dealers. In addition, the information presented within 

this section cannot support a conclusion that audit quality has improved or deteriorated 

for the reasons just mentioned.

Nevertheless, the continued occurrence and percentage of audits selected for 

inspection with audit deficiencies and independence findings observed during the 

interim inspection program provide a useful point of reference for discussions about 

areas for improvement when performing audits of brokers and dealers.

Selection of Firms and Audits

The firms and the audits were selected in order to have a cross section of firms, 

as well as a cross section of brokers and dealers, based on varying characteristics of 

both. Selection of registered public accounting firms for inspection took into 

consideration various characteristics, including the number of audits of brokers and 

dealers performed by the firms or whether the firms also issued audit reports for issuers. 

The selection of brokers and dealers considered various characteristics, such as 

whether or not the brokers or dealers maintained a Special Reserve Bank Account 

under Rule 15c3-3, the minimum net capital requirement, and reported actual net capital 

under Rule 15c3-1. The Board did not exclude any audits of brokers or dealers from 

being eligible for selection. 

 66 This number represents the inspection of 10 firms reported in the First 

Progress Report, 43 firms reported in the Second Progress Report, and 60 firms 

covered in Part I of this report. Three firms were included in all three reports and six 

firms were included in two reports.
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Further, the selections were intended to meet the following objectives: 1) assess 

compliance with the applicable audit standards and rules of the Commission and the 

Board, and the Act; 2) help inform the Board's eventual decisions regarding the scope 

and elements of a permanent inspection program; and 3) assist in the development of 

the approach to inspections under a permanent inspection program. 

Nine firms were inspected more than once since the inception of the interim 

inspection program. None of the audits selected for inspection were inspected more 

than once.

The following table presents the number of firms inspected and audits selected 

for inspection stratified by the number of broker or dealer audits per firm, as determined 

at the time of the inspections:

Number of Broker or Dealer 

Audits per Firm

Number of Firms 

Inspected

Number of Audits 

Selected

1 19 19

2 to 20 48 60

21 to 50 22 45

51 to 100 8 14

More than 100 5 35

Total 10167 173

The next table presents the number of firms inspected and audits selected for 

inspection based on whether or not the firms audited the financial statements of an 

issuer at the time of the inspections:

Firms that Audited

Brokers and Dealers

Number of Firms 

Inspected

Number of Audits 

Selected

Firms that also audited issuers 35 95

Firms that did not audit issuers 66 78

Total 101 173

The 173 audits of brokers and dealers selected for inspection had financial 

statement periods ended on December 31, 2010 through June 30, 2013. These audits 

included 43 brokers or dealers that maintained a Special Reserve Bank Account and 

130 brokers or dealers that did not. The following table presents the ranges of minimum 

net capital requirements and actual net capital reported for these brokers and dealers:

 67 The sum of the number of firms inspected does not add to 101 because 

one firm that was inspected more than once is reported in multiple stratifications due to 

a change in the number of broker or dealer audits performed by the firm. 
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Independence Findings and Audit Deficiencies from Inspections

Observations were identified in portions of 151, or approximately 87 percent, of 

the 173 audits selected for inspection. The 22 audits where Inspections staff did not 

identify observations in the portions of these audits inspected were performed by 12 

firms, of which 11 also audited issuers.

Independence Findings

Independence findings relating to a firm's involvement in the preparation of the 

financial statements were identified in approximately 26 percent of the 173 audits 

selected for inspection. Inspections staff noted a significantly higher percentage of

audits inspected with independence findings for the audits performed by firms that did

not audit issuers. The following table presents a summary of independence findings by 

whether or not the firms also audited issuers:

Exhibit 1: Independence Findings

 68 Excluded from the range of actual net capital reported at fiscal year end is 

one instance of reported negative net capital.

69 The independence findings were identified at firms that issued audit 

reports for 100 or fewer issuers.

Number of 

Audits

Selected

Range of Minimum 

Net Capital 

Requirements

Range of Actual 

Net Capital 

Reported at Fiscal 

Year End

Special Reserve Bank 

Account 43 $250,000 -

$600,000,000

$310,000 -

$6,250,000,000

No Special Reserve 

Bank Account 130 $5,000 -

$6,100,000

$8,00068 -

$2,340,000,000

Number of 

Audits with 

Findings

Number of 

Applicable 

Audits

Percentage 

of Audits 

with 

Findings

Failure to Satisfy Independence Requirements

 Firms that also audited issuers 569 95 5%

 Firms that did not audit issuers 40 78 51%
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Audit Deficiencies

Inspections staff identified audit deficiencies in portions of 150 of the 173 audits 

selected for inspection. The 23 audits where Inspections staff did not identify any audit 

deficiencies in the portions of audits inspected were performed by 13 firms, 11 of which 

also audited issuers. The following table presents a summary of certain areas that were

reported in the First and Second Progress Reports and in Part I of this report:

70

Exhibit 2: Audit Deficiencies

The remainder of this section presents observations stratified by certain firm 

characteristics or broker and dealer characteristics, a comparison of inspections 

 70 Audit deficiencies related to understanding the entity (approximately two 

percent) that were reported in the Second Progress Report are not included in this 

table.

71 Seven audits that were reported within the Accountant’s Supplemental 

Report on Material Inadequacies section in the First Progress Report have been recategorized to Auditor’s Report to conform to the presentation in the Second Progress 

Report and this report.

Number of 

Audits with 

Deficiencies71

Number of 

Applicable 

Audits 

Percentage 

of Audits 

with 

Deficiencies

Related to Customer Protection and Net Capital Rules:

 Report on Material Inadequacies 102 161 63%

 Customer Protection Rule 12 43 28%

 Net Capital Rule 57 156 37%

Related to the Financial Statement Audit:

 Risk of Material Misstatement 

 Due to Fraud 86 173 50%

 Related Party Transactions 50 173 29%

 Revenue Recognition 110 173 64%

 Reliance on Records and Reports 82 173 47%

Financial Statement Presentation 

and Disclosures 63 173 36%

 Fair Value Estimates 19 60 32%

 Evaluation of Internal Control 

 Deficiencies 16 173 9%

 Auditor's Report 30 173 17%
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performed during 2013 to inspections performed through the end of 2012, and 

information on firms inspected more than once. 

Observations Stratified By Certain Firm Characteristics

Number of Broker or Dealer Audits per Firm

Inspections staff identified a high percentage of audits and areas inspected with 

observations. Observations were identified in 100 percent of audits selected for 

inspection for auditors with only one broker or dealer client, while the percentage was 

slightly lower for firms that audited 2 to 100 brokers and dealers, and significantly lower 

for firms that audited more than 100 brokers and dealers. The following table presents 

the percentage of audits and areas inspected with observations stratified by the number 

of broker or dealer audits per firm as determined at the time of inspection:

Exhibit 3: Number of Broker or Dealer Audits per Firm

Percentage of Audits 

with Observations

Percentage of Areas 

with Observations72

1 100% 52%

2 to 20 93% 42%

21 to 50 91% 40%

51 to 100 93% 38%

More than 100 63% 19%

Firms that Audited Issuers Compared to Firms that Did Not Audit Issuers

Inspections staff noted that the percentage of audits and areas inspected with 

observations was significantly higher at firms that did not audit issuers. Of the 95 audits 

selected for inspection that were conducted by firms that also audited issuers, there 

were 21 audits where Inspections staff did not identify any independence findings or 

audit deficiencies in the portions of the audits inspected. 

 72 The term "areas" used within this section represents the portions of audits 

included in the inspection (revenue recognition, related party transactions, net capital, 

etc.) by Inspections staff and reported within the First and Second Progress Reports 

and Part I of this report, as presented in Exhibits 1 and 2. The "Percentage of Areas

with Observations" presented within Exhibits 3 through 8 represents the sum of the 

"Number of Audits with Findings" and "Number of Audits with Deficiencies" disclosed 

within Exhibits 1 and 2 above divided by the sum of the "Number of Applicable Audits"

disclosed within Exhibits 1 and 2 above. 
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The following table presents the percentage of audits and areas inspected with 

observations stratified by firms that also audited issuers and those that did not audit 

issuers, at the time of the inspection:

Exhibit 4: Firms that also Audited Issuers and Firms that did not Audit Issuers

Percentage of Audits 

with Observations

Percentage of Areas 

with Observations

Firms that also audited issuers 78% 29%

Firms that did not audit issuers 99% 48%

Observations Stratified by Certain Broker and Dealer Characteristics

Reported Actual Net Capital, Revenues, and Assets

Inspections staff noted a high percentage of audits and areas inspected with 

observations across the spectrum of audits of brokers and dealers in terms of their 

characteristics, such as reported actual net capital, revenues and assets. There did not 

appear to be a discernible relationship between the percentage of audits and areas 

inspected with observations and these broker or dealer characteristics, except for lower 

percentages noted for the selected audits of brokers and dealers with the largest 

amounts of reported actual net capital, revenues, or assets.

For illustrative purposes, the following table presents the percentage of audits 

and areas inspected with observations stratified by the reported actual net capital of the 

brokers and dealers at the time of the audit:

Exhibit 5: Reported Actual Net Capital by Brokers and Dealers

Percentage of Audits 

with Observations73

Percentage of Areas 

with Observations

Less than $100,000 89% 42%

$100,001 to $2,000,000 96% 45%

$2,000,001 to $15,000,000 90% 37%

$15,000,001 to $6,250,000,000 69% 24%

Special Reserve Bank Account

Inspections staff noted a high percentage of audits and areas inspected with 

observations, regardless of whether the broker or dealer maintained a Special Reserve 

 73 The number of audits selected for inspection for each of these 

stratifications is 28, 56, 50, and 39, respectively.
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Bank Account. The percentage of audits and areas inspected with observations was

higher for audits of brokers or dealers that did not maintain a Special Reserve Bank 

Account.

Inspections staff also noted that for firms that also audited issuers, the 

percentage of audits and areas inspected with observations was higher for audits of 

brokers and dealers that did not maintain a Special Reserve Bank Account compared to 

those that did. For firms that did not audit issuers, there was no discernible relationship 

between the percentage of audits and areas inspected with observations and these 

types of brokers or dealers.

The following table presents the percentage of audits and areas inspected with 

observations stratified by whether or not the broker or dealer maintained a Special 

Reserve Bank Account at the time of the audit:

Exhibit 6: Special Reserve Bank Account

Percentage of 

Audits with 

Observations

Percentage of 

Areas with 

Observations

No Special Reserve Bank Account 90% 39%

Special Reserve Bank Account 79% 31%

Comparison of Inspections during 2013 to Inspections through the end of 2012

The Board began conducting inspections under the interim inspection program 

during October 2011. Observations from the inspections performed through the end of 

2012 were compared to those from the inspections performed during 2013. There were 

slightly fewer audit deficiencies and independence findings in portions of audits 

inspected during 2013 than in portions of audits inspected previously, but nevertheless, 

observations remained high. 

The following table shows a comparative summary of the percentages of audits 

and areas inspected with observations for inspections performed during 2013 with 

inspections performed through the end of 2012:

Exhibit 7: Comparison of Inspections during 2013 to Inspections through 2012

Percentage of Audits 

with Observations

Percentage of Areas 

with Observations

2013 79% 30%

Inspections through 2012 96% 45%
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Inspections staff did not identify any observations in the portions of 19 audits 

inspected during 2013 and portions of 3 audits inspected through 2012. All but 1 of the 

22 audits was performed by firms that also audited issuers.

Independence Findings

Inspections staff noted that, in the 2013 inspections, the percentage of 

independence findings among audits that were performed by firms that did not audit 

issuers was slightly lower than for inspections through 2012. The following table 

presents the percentage of audits selected for inspection during the interim inspection 

program with independence findings:

Exhibit 7A: Comparison of Independence Findings

Audit Deficiencies

Inspections staff noted a lower percentage of audits selected for inspection with

audit deficiencies when comparing 2013 to inspections through 2012 for each of the 

areas inspected. For both periods, the areas with the highest frequency of deficiencies

were: report on material inadequacies, revenue recognition, reliance on records and 

reports, and the risk of material misstatement due to fraud. The following table presents 

the percentage of applicable audits with deficiencies for the portions of 173 audits 

inspected during the interim inspection program:

Percentage of Audits with 

Findings

2013 Inspections 

through 2012 

Failure to Satisfy Independence Requirements

 Firms that also audited issuers 4% 7%

 Firms that did not audit issuers 48% 55%

Total 23% 29%
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Exhibit 7B: Comparison of Audit Deficiencies

Firms Inspected More Than Once 

There were nine firms that were inspected more than once during the interim 

inspection program through the end of 2013. Inspections staff noted a lower percentage

of audits and areas inspected with observations when comparing inspections performed 

during 2013 to inspections performed through 2012. 

The following table shows a comparative summary of the percentage of audits 

and areas inspected with observations for the nine firms that were inspected more than 

once:

Exhibit 8: Firms Inspected More than Once

Percentage of Audits 

with Observations

Percentage of Areas 

with Observations

2013 57% 16%

Inspections through 2012 90% 35%

Percentage of Applicable 

Audits with Deficiencies

2013 Inspections 

through 2012 

Related to Customer Protection and Net Capital Rules:

 Report on Material Inadequacies 49% 77%

 Customer Protection Rule 24% 32%

 Net Capital Rule 36% 37%

Related to the Financial Statement Audit:

 Risk of Material Misstatement Due to Fraud 40% 60%

 Related Party Transactions 17% 42%

 Revenue Recognition 59% 69%

 Reliance on Records and Reports 44% 51%

 Financial Statement Presentation and 

 Disclosures 30% 43%

 Fair Value Estimates 25% 39%

 Evaluation of Internal Control Deficiencies 7% 12%

 Auditor's Report 6% 30%
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Part III: Actions Needed by Firms and Next Steps of the Interim Inspection 

Program

The Board is concerned by the nature and number of these audit deficiencies 

and independence findings. Many of the observations in this report and the two previous 

progress reports are similar in nature and relate to fundamental auditing principles. The 

Board emphasizes the need for firms to improve the quality of their broker and dealer 

audits to achieve compliance with applicable standards and rules.

The Board reminds firms that information obtained through the interim inspection 

program may lead the Board to commence an investigation or disciplinary proceeding 

concerning the conduct of a firm or associated persons of such firms. The Board has 

started this process for certain firms. In addition, when it comes to the Board's attention 

that the financial statements of a broker or dealer appear not to present fairly, in all 

material respects, the financial position, results of operations, or cash flows of the 

broker or dealer in conformity with GAAP, the Board's practice is to report that 

information to the SEC, which has jurisdiction to determine proper accounting of the 

financial statements of brokers and dealers. Similarly, detailed information related to 

possible violations of laws or rules, including independence rules, by brokers and 

dealers may be, and has been, reported to the SEC as well as designated examining 

authorities.

Actions Needed by Firms

In light of the observations that continue to be identified by Inspections staff, 

combined with the need to adapt to amended SEC rules and to follow PCAOB 

standards, the Board urges registered public accounting firms that audit brokers and 

dealers to re-examine their audit approaches. 

All registered public accounting firms that issue audit reports for brokers or 

dealers should consider whether the audit deficiencies and independence findings 

described in this report might be present in audits they currently perform, and should 

take appropriate action to prevent or correct any such deficiencies and independence 

findings.

Under GAAS, when audit deficiencies are discovered after the date of the audit 

report, a firm must take appropriate action to assess the importance of the deficiencies 

to the firm's present ability to support its previously expressed audit opinions.74

 74 See AU-C sec. 585, Consideration of Omitted Procedures After the Report 

Release Date. For audits conducted under pre-clarified AICPA standards, see AU sec. 

390, Consideration of Omitted Procedures After the Report Date. The firm might have 

further responsibilities under AU-C sec. 560, Subsequent Events and Subsequently 

Discovered Facts. For audits conducted under pre-clarified AICPA standards, see AU 

sec. 561, Subsequent Discovery of Facts Existing at the Date of the Auditor's Report.
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Depending upon the circumstances, the firm may do one or more of the following: (1) 

perform additional audit procedures; (2) inform a client of the need for changes to its 

financial statements, supporting schedules, or the firm's supplemental report on material 

inadequacies; or (3) take steps to prevent reliance on previously expressed audit 

opinions. The Board expects firms to take appropriate action. Many firms have 

represented that they have taken, are taking, or will take action. The Board has not 

conducted a review of any remedial actions taken by the firms to address audit 

deficiencies or independence findings identified in these inspections but may review 

those actions through its inspection process in the future.

The Board urges registered public accounting firms to be proactive in considering 

how to prevent similar or other deficiencies and findings by seeking ways to better 

anticipate and address risks that might arise in specific broker or dealer audits. The 

Board encourages registered public accounting firms to continually stress to their 

personnel the critical need to conduct audits with due professional care, including 

professional skepticism. The Board also encourages registered public accounting firms 

to take action to review the following:

Independence:

• Agreements for services performed for broker and dealer audit clients to ensure 

that services, including preparation of financial statements, that would violate 

SEC independence rules will not be provided.

• Guidance and training to ensure all professionals are aware of the SEC 

independence requirements applicable to audits of brokers and dealers. 

• Quality control procedures to ensure compliance with applicable SEC auditor 

independence requirements, including prohibition of involvement in the 

preparation of financial statements that the firm audits.

Audit Deficiencies:

• Firm guidance and training to determine that the topic areas of the observed 

audit deficiencies identified in the report are given appropriate attention.

• Policies for supervision, including review, to ensure their partners and 

supervisory personnel are placing appropriate attention on these areas.

The Board also encourages registered public accounting firms to review the Staff 

Guidance for Auditors of SEC-Registered Brokers and Dealers issued on June 26, 

2014, and to attend the Board's periodic Forums on Auditing Smaller Broker-Dealers.

In addition to the actions needed by registered public accounting firms, 

management and audit committees, or the equivalent, of brokers and dealers may want 
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to consider inquiring of their auditor about how these areas are being appropriately 

addressed in their audits and take steps to ensure that independence violations are 

avoided.

Next Steps of the Interim Inspection Program

Future Inspections

The Board will continue to conduct inspections under the interim inspection 

program of registered public accounting firms that audit brokers and dealers until rules 

for a permanent inspection program take effect. There were approximately 750

registered public accounting firms that issued audit reports on the financial statements 

of approximately 4,000 brokers and dealers75 that were filed with the SEC for fiscal 

periods ended during 2013. 

Number of Broker or 

Dealer Audits per Firm Number of Firms76 Percentage 

of Firms

1 355 47%

2 to 20 360 48%

21 to 50 22 3%

51 to 100 7 1%

More than 100 6 1%

Total 750 100%

During 2014, the Board plans to select approximately 60 firms and inspect 

portions of approximately 100 audits. The firms the Board selects will primarily include 

firms not previously inspected, but will also include some firms previously inspected 

under the interim inspection program. In addition, the Board may inspect audits of

brokers or dealers whose past audits were previously inspected. In that context, the 

Board may evaluate whether, or how, the firms addressed audit deficiencies or 

independence findings from the previous inspection. 

 75 This information is based on the number of brokers and dealers who filed 

financial statements with the SEC through May 27, 2014, for fiscal years ended during 

2013, that included audit reports issued by firms registered with the PCAOB.

76 Information about the number of firms that audited brokers and dealers 

and their broker or dealer audits is based on financial statements filed with the SEC 

through May 27, 2014, for fiscal years ended during 2013. These firms were registered 

with the PCAOB at the time the audit reports were issued.
PCAOB Release No. 2014-003

August 18, 2014

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RELEASE 

During 2015, the Board will inspect audits of brokers and dealers, which are

required to be performed in accordance with PCAOB standards, in order to assess 

compliance with the applicable standards and rules. In addition, information obtained 

from these inspections will be used to identify risk factors relevant for selecting firms 

and audits of brokers and dealers for inspection under a permanent inspection program

through the analysis of relationships between inspection observations and 

characteristics of the firms and the brokers and dealers that were audited.

Scope of a Permanent Inspection Program

The Board is continuing to take a careful and informed approach in establishing a 

permanent inspection program recognizing the complexity and diversity of the brokers 

and dealers, as well as working through the challenges in obtaining relevant information 

for these non-public companies. The Board continues to obtain available information to 

evaluate the risk of loss to customers and whether this risk can be assessed from 

attributes that characterize brokers and dealers in an effort to provide for differentiation 

of the brokers and dealers. 

The Board plans to review the contents of the compliance and exemption reports 

and the respective auditors' reports related to, for example, the brokers' or dealers'

compliance with the provisions of the customer protection rule, to evaluate risk of loss to 

customers. The Board will also continue to gather information regarding customer 

losses due to fraudulent activities or liquidations of brokers and dealers, and regulatory 

sanctions imposed on brokers and dealers to evaluate whether correlations exist 

between these matters and characteristics of the brokers and dealers. 

The PCAOB staff is currently working to develop a rule proposal for the Board to 

issue during 2016 to establish a permanent inspection program and its scope, which will 

address whether to exempt any category of registered public accounting firm.

Other Board Initiatives

In its efforts and initiatives to protect the interests of investors and further the 

public interest in informative, accurate, and independent audit reports for brokers and 

dealers, the Board has, and will continue to, among other things:

• Conduct forums for auditors of brokers and dealers that provide information 

about the Board, the interim inspection program, observations from the interim

inspection program, and audits of brokers and dealers; 

• Participate in various outreach initiatives, including conferences and other events 

to inform registered public accounting firms that issue audit reports for brokers 

and dealers about observations from the interim inspection program, 

developments in the Board's standards-setting initiatives, and updates from the 

SEC and FINRA; and
PCAOB Release No. 2014-003

August 18, 2014

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RELEASE 

• Issue guidance for audits of brokers and dealers to assist with the 

implementation of PCAOB auditing and attestation standards and will consider 

utilizing communication tools such as webcasts and stored media presentations 

to effectively deliver guidance and information to auditors of brokers and dealers.

The Board will issue future progress reports that will describe significant 

observations from inspections, the publication of which may otherwise be appropriate to 

protect the interests of investors or to further the public interest. In addition, the Board 

will use information obtained from the interim inspection program and other research 

and outreach efforts to inform its future standards-setting activities relevant to the audits 

of brokers and dealers. 
Appendix

References to Certain Releases for Standards and Rules Related to Brokers and 

Dealers and Their Auditors That Were Adopted During 2013 and 2014 

Audits of brokers and dealers with fiscal years ended on or after June 1, 2014 

are required to follow PCAOB standards. The following table provides a list of PCAOB

releases and guidance that describe requirements applicable to audits of brokers and 

dealers. 

Title Release Date Release and Link

Standards for Attestation 

Engagements Related to 

Broker and Dealer Compliance 

or Exemption Reports Required 

by the U.S. Securities and 

Exchange Commission and 

Related Amendments to 

PCAOB Standards

October 10, 2013 See PCAOB Release No. 

2013-007 

http://pcaobus.org/Rules/Rulem

aking/Pages/Docket035.aspx

Auditing Standard No. 17

Auditing Supplemental 

Information Accompanying 

Audited Financial Statements 

and Related Amendments to 

PCAOB Standards

October 10, 2013 See PCAOB Release No. 

2013-008 

http://pcaobus.org/Rules/Rulem

aking/Pages/Docket036.aspx

Amendments to Conform the 

Board's Rules and Forms to the 

Dodd-Frank Act and Make 

Certain Updates and 

Clarifications

December 4, 2013 See PCAOB Release No. 

2013-010 

http://pcaobus.org/Rules/Rulem

aking/Pages/Docket039.aspx

Staff Guidance for Auditors of 

SEC-Registered Brokers and 

Dealers

June 26, 2014 http://pcaobus.org/News/Relea

ses/Pages/06262014_Staff_Gu

idance.aspx
PCAOB Release No. 2014-003

August 18, 2014

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RELEASE 

The following table lists SEC releases and guidance that describe the 

amendments to the reporting requirements for brokers and dealers under Exchange Act 

Rule 17a-5 and the SEC's financial responsibility rules, including Exchange Act Rules 

15c3-1 and 15c3-3.

Title Release Date Release and Link

Broker-Dealer Reports July 30, 2013 See Exchange Act Release No. 

34-70073

http://www.sec.gov/rules/final/fi

nalarchive/finalarchive2013.sht

ml

Financial Responsibility Rules 

for Broker-Dealers

July 30, 2013 See Exchange Act Release No. 

34-70072 

http://www.sec.gov/rules/final/fi

nalarchive/finalarchive2013.sht

ml

Frequently Asked Questions 

Concerning the Amendments to 

Certain Broker-Dealer Financial 

Responsibility Rules

March 6, 2014 http://www.sec.gov/divisions/m

arketreg/amendments-tobroker-dealer-financialresponsibility-rule-faq.htm

Frequently Asked Questions 

Concerning the July 30, 2013 

Amendments to the BrokerDealer Financial Reporting Rule

April 4, 2014 http://www.sec.gov/divisions/m

arketreg/amendments-tobroker-dealer-reporting-rulefaq.htm