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News Room Articles
Small Brokers Fight Auditing Proposal
By Carol E. Curtis December 14, 2009
Small brokerage firms are taking their fight against having their accountants subject to regulation by the Public Company Accounting Oversight Board to the Senate.
The focus on the Senate comes after a compromise in the House of Representatives last week, first reported by Securities Industry News, that would give the Board the authority to decide whether auditors of small brokers need to register with them, rather than leaving the issue up to lawmakers. Like the original House proposal, the Senate plan-part of Banking Committee Chairman Christopher Dodd's financial regulatory package-seeks to broaden the regulatory scope of the public accounting board so that auditors of all broker-dealers would be required to register with and be subject to inspection by the Board.
Smaller broker-dealers say the proposed law would hike audit costs for independent broker/dealers so much that some firms would go out of business. Instead, "an amendment is needed to redirect the attention of the PCAOB auditors to the custodial broker-dealers where scams like [Bernard] Madoff's are more likely to be uncovered," an industry source said last week.
The PCAOB is a private-sector nonprofit corporation created by the Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies to make sure they have adequate systems in place to prepare and deliver fair and informative financial reports to investors.
The National Association of Independent Broker Dealers (NAIBD) has been raising awareness of the issue by focusing on the nuts-and-bolts impact of the proposal on small broker-dealers. Stephen Distante, chief executive of Vanderbilt Securities and chairman of NAIBD, told Securities Industry News that the issue centers on heavy PCAOB requirements for auditors of public companies. For an auditor to become PCAOB-approved, the firm must complete an application and pay a fee. The Board then inspects the accounting firm, which must prepare in a way that can require internal system changes and operational shifts, says Susan Coffee, senior vice president at the American Institute of Certified Public Accountants (AICPA).
For example, quality control documentation is required on policies and procedures, compliance with rules and regulations, and independence, among other things. The PCAOB's oversight of Sarbanes-Oxley requirements and accounting standards focuses on making sure, among other things, that adequate controls are place to make sure that financial assets accumulated in balance sheets and other reports actually exist; that verifiable documentation is maintained; and that adequate tests of those controls have been performed.
There are also operational impacts relating to how employees must be deployed, as staff members are moved from other tasks to monitor and control the procedures used to collect and report financial data. This hikes personnel costs.
The result, according to Coffee, is that broker-dealers can be hit with a double whammy: The PCAOB charges the broker-dealers fees to cover the inspections, and accountants also charge more for the audit, passing along their own costs associated with the inspections.
An Expensive Audit If these requirements are extended to auditors of all broker-dealers, "That becomes a very expensive audit," Distante says. "My audit fee now is $8,000. I would be looking at between $50,000 and $100,000 if this is put in place. If the provision passes, small firms may have to determine whether they want to be in business any longer" (see box).
There are two distinct types of broker-dealers: introducing broker-dealers and custodial broker-dealers. It is the clearing broker-dealer - usually a large firm - that actually holds custody and invests client funds and where a clear risk to monies exists.
By design, introducing broker-dealers have lower minimum capital requirements and smaller staffs and back office infrastructure. While they are often the broker-dealer who has direct contact with investors, they are prohibited from holding customer funds. Instead, they are required to have protocols in place to make sure that investors' funds go directly to larger clearing-custodial broker-dealers which then make investments on behalf of the client.
There is broad agreement that when investors' money is at risk - i.e., at firms that hold assets -- a higher degree of regulatory scrutiny makes sense. That was the rationale for the creation of the PCAOB in the first place. The current disagreement is over whether the more-than-700 auditors of introducing broker-dealers should also have to register and be inspected by the PCAOB. "Since introducing broker-dealers are forbidden from holding client funds, that argument is not strong," said Barry C. Melancon, president and CEO of the AICPA, in a November 3 letter to the House Financial Services Committee.
The AICPA also says the requirement could drastically cut the number of auditors available to inspect introducing brokers. Currently, about 700 firms audit introducing broker-dealers, while fewer than 500 firms audit clearing brokerage firms, according to AICPA estimates.
But that number could be cut because auditors may decide not to do the upgrades to their systems and procedures necessary to pass PCAOB inspection. In the event that fewer auditors are available, that would be another factor driving up the cost of a small broker-dealer audit, AICPA says. Momentum for broadening the audit requirement increased in the wake of the Madoff scandal, which involved allegedly fraudulent audits provided by New York accountant David Friehling. One goal of the new requirement would presumably be to prevent accountants like Friehling from rubber-stamping brokerage operations like Madoff's.
But the brokerage industry counters that it is only those brokers who custody assets that need the extra oversight. Putting smaller brokers into the mix would be overreaching where there is little risk of harm, they say.
The industry clearly views the House compromise as a positive development. "Rather than having a [legislative] mandate, the best route is going to be giving regulators maximum flexibility," says Mat Young, director of Congressional and political affairs at the AICPA, which joined with brokers in advocating for the House compromise.
The compromise is "a step in the right direction," said E. John Moloney, president and CEO of Moloney Securities Co., Inc., and chairman of the small firms committee of the Securities Industry and Financial Markets Assn., in an interview. He added that the "proof of the pudding" will come in how effective the PCAOB will be in granting small firm exemptions.
Looking forward, industry executives say it is highly unlikely there will be any movement in the Senate on the audit issue before year's end. Dodd has tasked each Democrat on the Senate Banking Committee to take a section of the bill and review it with their Republican counterpart. That has not yet happened yet, so the mark-up process -- the phase where the Committee considers amendments to the bill before voting on it -- has been delayed.
Meanwhile, "we definitely still have concerns," says David Bellaire, general counsel and director of government affairs at the Financial Services Institute (FAI), which represents independent broker dealers of all sizes. "We know the audit expense would be significant. We think it is an over-reaching of regulatory resources in an area where there is little chance of investor harm." http://www.securitiesindustry.com/issues/21_23/-24382-1.html |
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