SIFMA: Surprise audits estimated to cost $200K

A proposal by the Securities and Exchange Commission that would require advisory firms holding custody of client assets to be audited by accountants inspected by the Public Company Accounting Oversight Board would cost each firm an average of $200,000, according to one new estimate.

A proposal by the Securities and Exchange Commission that would require advisory firms holding custody of client assets to be audited by accountants inspected by the Public Company Accounting Oversight Board would cost each firm an average of $200,000, according to one new estimate.

The Securities Industry and Financial Markets Association cited figures in a recent comment letter showing that the average cost of a surprise audit would actually be more than 20 times the $8,100 that the SEC estimated.

SIFMA conducted a survey of 17 member broker-dealers and their accounting firms to measure the potential cost of a surprise audit.

These respondents indicated that the costs of the surprise examinations ranged from $165,200 to $282,800, “with a surveywide average estimate of $206,294,” SIFMA wrote in a July 28 comment letter.

Five firms received estimates from their accounting firms of $500,000 or more, and one firm received an estimate of $1 million for the surprise exam, SIFMA said.

“The cost of a surprise examination and an internal-control report greatly outweighs any potential benefits to clients,” according to SIFMA’s letter, which was written by Mark Shelton, chairman of the association’s Private Client Legal Committee and general counsel for the Americas at UBS AG of Zurich, Switzerland.

The size of the advisory firm, the number of accounts, the number of custodians and the number of holdings would affect the cost of the surprise exam, SIFMA said.

The Financial Planning Association did its own estimate of the cost of another provision of the proposed rule, which would require advisory firms that automatically deducted fees from client accounts to undergo annual surprise audits.

Although the FPA’s survey found that the cost for its member firms would be considerably less than the cost for SIFMA members, the estimates still were well above the SEC’s estimate. The FPA said in its July 28 comment letter that the surprise audits would cost advisory firms between $15,000 and $24,000.

JUST ONE PROBLEM

The cost, however, is just one problem cited by those who have recently offered comments on the SEC proposal.

“The PCAOB does not have authority to oversee audits of private companies as a general matter,” Colleen Brennan, spokeswoman for the PCAOB of Washington, wrote in an e-mail.

“It is unclear … what these in-spections would entail,” accounting firm Deloitte & Touche LLP of New York wrote in its comment letter on the proposal.

The Sarbanes-Oxley Act of 2002 gives the PCAOB authority to inspect auditors only of public companies.

“This may limit the PCAOB’s ability to review the investment adviser internal-control and surprise-examination engagements even of those public accounting firms that are registered and perform audits of issuers,” Deloitte & Touche wrote.

Deloitte & Touche is inspected by the PCAOB and would be qualified to conduct the audits.

The proposal also would duplicate requirements already in place for many custodians, said Karen Barr, general counsel of the Investment Adviser Association in Washington.

“There are all kinds of bank and broker-dealer custody rules,” she said. “I understand what [the SEC was] trying to get at, but it was done in an over-broad fashion.”

The SEC issued the rule proposal in response to frauds such as the massive Ponzi scheme perpetrated by Bernard L. Madoff Investment Securities LLC of New York. That firm held custody of its client assets and was audited by an accounting firm that wasn’t regulated by the PCAOB.

CHARGED WITH FRAUD

Madoff’s accounting firm, Frieh-ling & Horowitz CPAs PC of New City, N.Y., and its principal, David Friehling, have been charged by the SEC with fraud in connection with the case.

The SEC did not return calls for comment on the rule proposal.

Rep. Paul Kanjorski, D-Pa., chairman of the House Financial Services Committee’s Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises, introduced legislation in February that would require auditors of all broker-dealers, including privately held brokers, to be inspected by the PCAOB. SEC Chairman Mary Schapiro has called for enactment of such legislation.

Most of the focus on the proposed custody rule has been on a requirement that would impose annual surprise audits on advisory firms that automatically deducted fees from client accounts. Advisory firms have strongly opposed that proposal as costly and unnecessary.

Another part of the proposed rule, however, would require the approximately 370 advisory firms holding physical custody of client assets to receive internal-control reports, known as SAS 70 reports, from accounting firms registered and subject to inspection by the PCAOB. In addition, those firms also would have to undergo annual surprise audits from PCAOB-registered auditors.

E-mail Sara Hansard at [email protected].