December 17, 2013
PCAOB-2013-01
34-70842
i support this rule regarding engagement letters and review letters.
i support the idea that if a broker does not comply with net capital requirements or securities regulation in even one instance, that this causes the auditor to render a lower grade opinion. audits begin with internal controls. if the broker-dealer has not established successful procedures for processing transactions, then one material misstatement causes the auditor to find that internal controls have failed.
i agree with the requirements of the audit, as in this rule. auditors should be familiar with securities regulation and audit procedures in order to perform the audit. auditors cannot report on compliance with regulations if they don't understand the regulations for the industry.
i think a physical count of inventory is necessary to conclude that the broker-dealer has care and custody of the assets. the auditor should contact the depositories and clearinghouses in order to assess these requirements. broker-dealers have the fiduciary duty to their client and an audit should give their customers some assurance that the broker-dealer is complying with legal requirements.
reading this rule, i wonder about how the rule would affect the situation of introducing brokers or affiliated brokers, foreign or domestic. if a broker-dealer has an agreement with an introducing broker and transactions are reported, then the broker-dealer has a duty to make sure all transactions from introducing brokers comply with securities regulations. likewise, introducing brokers or affiliated brokers also have a duty to make sure all transactions have complied with securities regulations. acceptance of a transaction would cause the broker to be responsible for complying with securities regulation. therefore, the introducing broker or affiliated broker or clearinghouse would also be responsible for the same transaction. the introducing broker or affiliated broker is a customer of the transacting broker. all customers must comply with securities regulations, as well as all broker-dealers must comply with the same regulation.
if a client is claiming exemption from a securities requirement, then the broker-dealer should have to give the auditor proof that the client is exempt from the requirement and this proof should be cited by the auditor in their opinion.
if a broker-dealer also has a clearinghouse business or does self-clearing, the audit should state this. in my opinion, additional insurance and capital should be allocated to the clearinghouse business. there is a possibility of additional losses from a clearinghouse business that clears for other brokers. if the clearinghouse assets and the broker-dealer assets are co-mingled, the financial statements should so state.
i would like to note that all uncleared transactions may be valued at a low price, not a median price. shortselling, for instance, is increasing the number of outstanding shares and the price will trend downward as a result. valuation of an outstanding short position must include an allowance for the probable price increase if the transaction is cleared by buying in. the financial statements should indicate if options are expected to cover a short position as the issue then becomes production of the shares within a deadline set by securities regulations. options entail a buyer and seller and the option is a contract to provide an asset at a particular point in the future. if an option is intended to cover an equity transaction, the option is a promise from another party, rather than a fulfillment of a transaction and there is a risk of failure/delay with that transaction also. failure-to-deliver should actually not exist, because if all parties to the transaction were to comply with securities regulation, then no failure-to-deliver would exist. if some securities transactions are in a state whether there is a failure-to-deliver, then the transaction is likely out of compliance with securities regulations. therefore, uncleared transactions should be examined for compliance with securities regulation. since securities regulation does not permit manipulation, then no manipulation should occur because of price considerations or clearing deadline considerations.
so if a customer is placing orders that do not comply with securities regulation, then the broker-dealer's software and/or procedures are failing on internal controls and the audit opinion should reflect this.