Watchdog finds problems in dozens of U.S. broker-dealer audits

Mon Aug 19, 2013 4:39pm EDT

* Problems found in 95 percent of broker-dealer audits

* Inspections mandated after Madoff Ponzi scheme

* Some auditors not checking accounting fraud risks -report

By Dena Aubin

NEW YORK, Aug 19 (Reuters) - Many financial auditors are failing to properly check for accounting fraud risks at U.S. broker-dealers or test controls over customer funds, new inspections mandated by Congress after Bernard Madoff's massive Ponzi scheme have found.

In its second inspection report on broker-dealer audits, the Public Company Accounting Oversight Board, an auditor watchdog, said it found problems at 95 percent of the 60 audits it checked.

The results were similar to the first round of inspections conducted last year "and in one word, disappointing," PCAOB board member Jay Hanson said on a conference call with reporters.

The results do not necessarily mean that there were problems at broker-dealers, just that auditors did not do enough work for inspectors to tell, Hanson said.

Regulators have stepped up oversight of broker-dealers, the firms used by millions of investors to trade stocks, since Madoff was arrested in 2008 for running a fraud of up to $65 billion at his investment advisory firm.

Madoff, who also operated a broker-dealer, had used an obscure auditing firm, Friehling and Horowitz, which was not registered with the PCAOB. The audit firm's founder, David Friehling, pleaded guilty to fraud in 2009 and is awaiting sentencing, which is set for Oct. 18.

INDEPENDENCE VIOLATIONS FOUND

SEC rules require broker-dealers to be audited by an outside firm, which is supposed to assure that customer funds are protected and that the broker-dealer has enough capital to stay afloat.

Yet many auditors failed at some fundamental steps, such as testing revenue or making sure journal entries were not fraudulent, the PCAOB inspection report said.

Some auditors also helped prepare the same financial statements that they audited, a violation of U.S. Securities and Exchange Commission independence rules, the report said.

Names of auditors inspected were not released, as the inspections are in an interim stage and auditors are being given an opportunity to improve, Hanson said. The inspections were mandated by provisions written into the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act in response to the Madoff fraud.

ONE-CLIENT SHOPS CITED

Hanson declined to say whether any broker-dealer auditors were disciplined as a result of the inspection findings, citing confidentiality rules. The 2002 Sarbanes-Oxley Act, which created the PCAOB, requires the board to keep enforcement actions private until an auditor has exhausted all appeals.

However, Robert Maday, head of the PCAOB's broker-dealer inspection program, said the board is authorized to take enforcement actions during the interim inspections.

The PCAOB said it plans to inspect another 90 audits this year and propose rules for a permanent inspection program a year or so after those are completed. Those permanent inspection reports will single out audit firms by name.

The PCAOB was created to oversee auditors after accounting frauds led to the collapse of Enron and WorldCom. The Sarbanes-Oxley Act made the PCAOB responsible for inspecting auditors of public companies, but the board was not required to inspect nonpublic broker-dealer auditors until Dodd-Frank was passed.

Firms that audit only a small number of broker-dealers may want to get out of that line of work rather than invest the time needed to become an expert, Hanson said.

Nearly half of the 783 firms that conducted broker-dealer audits last year had just one broker-dealer client, according to PCAOB data. (Editing by Howard Goller and Matthew Lewis)

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