3 Key Audit Risks That Affect Broker-Dealers

Financial statement audits are part of doing business, but for broker-dealers, they play a particularly vital role. As a public entity that is not a public company Securities Exchange Commission (SEC) registrant, your organization faces a bevy of requirements from the SEC, Financial Industry Regulatory Authority (FINRA), and other regulatory bodies and authorities. A financial statement audit helps evaluate your organization’s financial reporting environment for weaknesses that pose a compliance risk and illuminate potential improvements that simplify future compliance efforts.

To get to that roadmap for reporting, your organization needs an auditor who understands the nuances of the broker-dealer sector. This can be easier said than done since every organization is unique; audits cannot be cookie-cutter. Nevertheless, there are issues that affect audits of nearly all broker-dealers. Understanding these audit risk areas can help guide your organization’s selection of a qualified auditor. Read on to learn how.

1. Revenue

The new accounting standard introduced under ASC Topic 606 affected processes and practices for contracts, which potentially changed how entities have traditionally recognized revenue. Broker-dealers often come across a high volume of contracts in their work with their clients, including commissions, trading gains and losses, investment banking fees, investment and other advisory fees, and success fees which makes auditing of those transactions particularly time-consuming.

Audit Impact: Because of the standard change, auditors already are expending extra energy toward the processes and controls involved in recognizing revenue to ensure revenue is not being materially misstated. Further impacting the auditing of revenue is that the 2020 Public Company Accounting Oversight Board (PCAOB) inspection found that nearly 47% of the broker-dealer audits that it reviewed had deficiencies in the audits of revenue. The PCAOB found that auditors did not sufficiently test revenue recognition, particularly as it relates to occurrence and accuracy. Look for an auditor who has found a way to gather specific audit evidence needed in a way that’s minimally intrusive to your team, such as through the use of technology and data analytics.

2. Related Parties

Broker-dealers face stringent requirements in their dealings with and reporting on related parties. Of particular interest to regulators are transactions or transfers of property, services received or provided, use of property or equipment (lease or no lease), and borrowing, lending, or guarantees with principal owners, parents or subsidiaries, subsidiaries of common parents, and affiliates. 

Audit Impact: Every broker-dealer will have slightly different testing needs when it comes to related parties. Auditors will be taking a hard look at contracts to gain a clear understanding of the transactions with related parties and the process for identification and recognition in the financial statements so that the testing approach is specific to the risks identified for your organization.  

3. FOCUS Report and 15c3-3 Testing

Broker-dealers face financial responsibility rules from the SEC, including a Financial and Operational Combined Uniform Single (FOCUS) Report filed with FINRA that contains financial information as well as net capital calculations and reconciliations. Additionally, they may be eligible for exemptions under SEA Rule 15-c3-3, which requires testing and analysis to determine applicability and compliance.

Audit Impact: Auditors of broker-dealers will need a specific approach to reviewing the FOCUS Report and net capital calculation, along with understanding processes and controls in order to accurately attest to FOCUS Report compliance. Similarly, auditors need a specific approach to 15c3-3 exemption testing; the provider needs a strong grasp of the process for complying with exemption provisions in order to efficiently test and provide meaningful recommendations for potential areas for reporting improvement.

Next Steps

Choosing a provider who understands your data and processes, along with revenue recognition and testing requirements, is the best defense against financial reporting challenges. Talk to your auditor about your audit plan keeping in mind their approach for addressing these higher risk areas.  

For more information on how to navigate common broker-dealer audit risks, contact the experts at MHM.

Published on October 12, 2021