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Broker-Dealer Audit Problems Found in Madoff-Inspired Review

Nearly four years after Bernard Madoff admitted using his firm for a massive Ponzi scheme, the PCAOB says it is disturbed by problems that persist in audits of broker-dealers.

NEW YORK -- Nearly four years after Bernard Madoff admitted using his firm for a massive Ponzi scheme, a U.S. audit watchdog group says it is disturbed by problems that persist in audits of broker-dealers, including a failure to assess the risk of fraud.

In its first report on inspections of broker-dealer auditors, the Public Company Accounting Oversight Board said on Monday it found problems in all 23 audits it reviewed, including failure to test controls over customer funds.

The problems were found during inspections of small broker-dealer audits conducted between October 2011 and February 2012. Broker-dealers are typically people or firms that both execute orders for others and deal in trades for their own accounts.

"Even with this small group of audits inspected thus far, the results are disturbing," PCAOB board member Jeanette Franzel said at a news briefing on the report.

The inspections were authorized by the 2010 Dodd-Frank financial reform law, which expanded the PCAOB's authority over broker-dealer auditors after loopholes helped Madoff perpetrate his investment fraud.

The PCAOB did not name the broker-dealers or audit firms it targeted in the first round of inspections, citing confidentiality requirements. It said it would report any broker-dealer violations of laws or rules to the U.S. Securities and Exchange Commission.

BROKERAGE FRAUDS PERSIST

Madoff used an obscure auditing firm, Friehling and Horowitz, which was not registered with the PCAOB.

In a March 2009 complaint, the SEC said Friehling did not do meaningful audits or confirm that customer assets even existed.

Madoff admitted to operating a Ponzi scheme for decades at his investment advisory business, paying early investors with money from new clients. He also operated a registered broker-dealer.

Additional scandals at brokerages MF Global Holdings Ltd and Peregrine Financial Group have increased pressure on regulators to better protect customer money.

INDEPENDENCE VIOLATIONS FOUND

Federal securities law requires brokers to segregate customers' cash from the brokers' own business accounts. Auditors are supposed to check controls for assuring that customer assets are safe.

In 13 of the 23 audits the PCAOB checked, audit firms did not do enough to assess and respond to risks of material misstatements due to fraud, the board said.

In two cases, audit firms helped prepare the financial statements that they audited, a violation of SEC independence rules.

Franzel called on broker-dealer auditors to read the PCAOB's report and be sure they are not making the mistakes inspectors found.

The PCAOB was created by the 2002 Sarbanes-Oxley Act to police auditors after accounting scandals led to the collapse of Enron and WorldCom. That law gave the PCAOB the authority to inspect auditors of public companies, though the board did not have inspection authority over nonpublic broker-dealer auditors until the passage of Dodd-Frank.

The PCAOB said it planned to look at about 170 audits of broker dealers by year-end 2013 under an interim inspection program. It will then create rules for a permanent inspection program.

Copyright 2010 by Reuters. All rights reserved.

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