Big Changes Are In Store For 2017, 2018 Broker Dealer Audits

By Charles Pagano

January 31, 2018

It’s that time of the year again where most broker dealers, FINOPs, and auditors are hectically working to comply with the SEC requirement of filing annual audits 60 days after year end.

Despite SEC assurances that the act of filing will be smoother mechanically this year, there remains a difference of opinion among FINOPs as to whether filing electronically is a more efficient process. Now what about those new wrinkles from last year’s accounting developments?

Recent Developments and Their Effect On 2017 Audits

It has been an eventful year filled with significant rule changes (a new revenue recognition standard, the Tax Cuts & Jobs Act enacted in December 2017, and a new Auditor’s Report for audits under PCAOB standards) and feedback from regulators (another inspection report from the PCAOB).

PCAOB Jersey City Forum December 2017

The yearly Forum brought together over 350 broker dealer auditors and FINOPs to hear speakers from the PCAOB, SEC, and FINRA. The message from Bob Maday, Deputy Director in the Division of Regulation & Inspection of the PCAOB: be diligent, plan, execute, and document. Included in the presentation, was a discussion on the PCAOB’s Sixth Inspection Report on Broker Dealers, issued in August of 2017. See our article on this topic for further details regarding the latest inspection report.

New York State Society Of Certified Public Accountants Stockbrokerage Committee (The “Committee”) Meeting With PCAOB, FINRA And The SEC (Collectively The “Regulators”) December 2017 (“Joint Meeting”)

The second annual Joint Meeting gave representatives from the Committee, including auditors and FINOPs, an opportunity to express their views on many issues, including the 60 day audit requirement for broker dealers. Some issuers have due dates of 75 or 90 days depending on the type of filer. FINRA representatives stated that they were aware of the industry’s concern, however it is the SEC’s rule that governs the requirements and any change to these rules would have to be made by the SEC. A participant noted a proposal exists to eliminate audits for non-clearing, non-issuer firms under PCAOB standards; however this does not appear to be going anywhere soon. Our guess is no relief is in the foreseeable future.

Barbara Vanich, Associate Chief Auditor, Office of the Chief Auditor, PCAOB expressed that the auditor needs to be aware of the then pending tax legislation which will have an effect on tax disclosures and computation of tax accruals. That pending legislation of course became law with the enactment of the Tax Cuts & Jobs Act (the “Act”) in late December 2017. The SEC on December 22 issued Staff Accounting Bulletin No. 118 which discusses income tax implications of the Act. The FASB has also issued a proposed accounting standards update related to the reclassification of tax effects from accumulated other comprehensive income. The comment period on the proposed accounting standards update is due on February 2, 2018.

Also discussed was the effect of ASC 606, Revenue Recognition standard as its effects on broker dealer audits for 2017, and concerns on how broker dealers will approach the new standard, and how auditors will audit.

Audit Changes Affecting 2017 and Beyond

PCAOB Audit Reporting Model

The auditor’s report will change due to the recently approved “Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion” auditing standard. Originally proposed in 2010 by the PCAOB, and effective for fiscal years ended on or after December 15, 2017, the auditor is now required to include in the opinion the consecutive years that the auditor has been engaged and clarify the auditor’s role and responsibilities, which may give readers more insight. What is more significant, however, is the option for broker dealers’ auditors, to report critical audit matters in the auditor’s report. This is currently not a requirement for non-issuer broker-dealers, and we believe that most auditors will not choose to provide the optional disclosure (even after the effective date for critical audit matters). It remains to be seen whether there will be future amendments to the auditing standards that make the critical audit matters applicable to non-issuer broker-dealers.

Accounting Standard Codification (“ASC”) 606: Revenue Recognition

Of much more importance for the 2017 calendar-year audit is the long awaited enactment of FASB ASC Topic 606 (“606”), Revenue from Contracts with Customers. Announced in May 2014, and effective for years beginning after December 15, 2017 for public entities (non-issuer broker-dealers meet the definition of public entities), the standard can pose several issues for broker dealers.

The treatment of how revenue is recognized has always been a critical audit procedure, but the new standard establishes specific steps which can change when this happens. Effective January 1, 2018 (for calendar-year broker-dealers), the broker dealer will have to demonstrate that revenue has been recorded properly, in accordance with the new standard. Each material revenue stream requires a five step approach to the analysis:

  1. Identify the contract with the customer (contract may either be written or oral)
  2. Identify the performance obligation in the contract
  3. Determine the transaction price
  4. Allocate the price to the performance obligation in the contract
  5. Recognize revenue when the entity satisfies a performance obligation

A series of AICPA Recognition Task Force papers and working drafts (which may soon become an issued paper and become authoritative) on specific industry topics, provide guidance for broker dealers. The papers issued and their predicted impact:

  • Selling and Distribution fee revenue (Minimal)
  • Soft dollars (Minimal)
  • Costs associated with underwriting (Minimal)
  • Costs associated with investment banking advisory services (Moderate)
  • Commission income and trade vs settlement date (Minimal)
  • Investment banking M & A advisory fees (Moderate)
  • Underwriting revenues (Minimal)
  • Asset management (Moderate)

Principal transactions, repurchase, and securities lending are scoped out, as well as revenue from financial instruments such as interest and dividend recognition (see AICPA Guide Revenue Recognition for proper treatment in those areas).
Although the effect of the standard could be minimal for many revenue types, some, such as soft dollars and advisory, could be significantly impacted.

The effects of new pronouncements should be disclosed in the footnotes and the broker-dealer should be ready to apply the new standard, including the cumulative effect of such transition, as of January 1, 2018. So despite ASC 606 being effective January 1, 2018 for calendar-year broker-dealers, management needs to ascertain the effect on that date as all financial reporting, including FOCUS reporting are on U.S. generally accepted accounting principles (“GAAP”). At various conferences, the SEC has made clear that a footnote that the company is still reviewing the effect would not seem appropriate, as the auditor needs comfort that the period subsequent to balance sheet date and prior to issuance does not have a material effect on the company which would require disclosure. Broker-dealers need to design the relevant disclosures (see Securities and Exchange Commission Staff Accounting Bulletin 74), and consider the impact of a disclosure for those issued, but not enacted, standards. The auditor would need to audit that conclusion and determine if management’s conclusion as to materiality or immateriality is proper.

FINRA representatives noted that firms should be aware that there may be a net capital impact resulting from the new standard. As the change is effective on January 1 for calendar-year broker-dealers, a retrospective cumulative effect would need to be booked that date.
On December 14, 2017, a panel of NYSSCPA’s Stockbrokerage Committee Members, including this author, presented a discussion on the impact of the new standard. The panel emphasized that from a documentation standpoint, auditors will be looking to document how broker dealers have complied with the new standard and how they have assessed the impact of the standard for their 2018 FOCUS filings.

Tax Reform

As a result of the Tax Cuts & Jobs Act, significant year-end tax accrual changes, particularly on net operating loss carry-forwards and deferred taxes, will have to be accounted for by management. Auditors will need to evaluate if the broker dealer has sufficient internal controls surrounding the tax reporting processes, and whether management possesses the skill, and ability to reflect the proper accounting. If this is not the case, this could indicate deficiencies in the broker dealer’s internal control over financial reporting.

In Close

Broker dealers need to be diligent, and document their key judgments in the application of the new accounting pronouncements, as an ever evolving accounting and audit landscape brings increased responsibility for year-end December 31, 2017 audits. These increased challenges for broker dealers will undoubtedly bring significant scrutiny by FINRA and the SEC with respect to broker dealers, and the PCAOB with regard to auditors.


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Disclaimer of Liability

The information provided here is for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.

Mazars USA LLP is an independent member firm of Mazars Group.

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