CSCP Internal Controls & Auditing 3 — Questions and Answers
Question 1: In securities compliance auditing, a 'material weakness' differs from a 'significant deficiency' primarily because:
- A material weakness involves fraud while a significant deficiency involves error
- A material weakness creates a reasonable possibility of a material misstatement while a significant deficiency does not rise to that level (Correct answer)
- A material weakness must be reported externally while a significant deficiency is only reported internally
- A material weakness applies to trading controls while a significant deficiency applies to financial reporting
Correct answer: A material weakness creates a reasonable possibility of a material misstatement while a significant deficiency does not rise to that level
A material weakness is a deficiency where there is a reasonable possibility that a material misstatement will not be prevented or detected on a timely basis, which is a higher threshold than a significant deficiency.
Question 2: Which FINRA rule requires broker-dealers to establish and maintain a system to supervise the activities of associated persons?
- FINRA Rule 4511
- FINRA Rule 3110 (Correct answer)
- FINRA Rule 2010
- FINRA Rule 4370
Correct answer: FINRA Rule 3110
FINRA Rule 3110 requires broker-dealers to establish and maintain a supervisory system, including written supervisory procedures, reasonably designed to ensure compliance with applicable securities laws.
Question 3: An investment adviser's internal audit finds that the firm's portfolio managers are receiving research from brokers in exchange for directing client trades to those brokers. This arrangement must be evaluated under:
- Section 28(e) of the Securities Exchange Act of 1934 (Correct answer)
- Section 17(a) of the Securities Act of 1933
- Section 206 of the Investment Advisers Act of 1940
- Rule 10b-5 under the Securities Exchange Act of 1934
Correct answer: Section 28(e) of the Securities Exchange Act of 1934
Section 28(e) provides a safe harbor for soft dollar arrangements where advisers use client commissions to pay for brokerage and research services that benefit their clients.
Question 4: A risk-based audit approach in a securities firm prioritizes audit resources based on:
- The size of each business unit by headcount
- The relative risk and potential impact of each auditable unit or process (Correct answer)
- The number of regulatory examinations previously conducted in each area
- Alphabetical order of business units to ensure systematic coverage
Correct answer: The relative risk and potential impact of each auditable unit or process
Risk-based auditing allocates audit resources to areas with the highest risk exposure and potential impact on the firm, ensuring coverage is proportionate to risk rather than uniform.
Question 5: During a FINRA examination, which document would the regulator most likely request to assess the adequacy of a broker-dealer's supervisory system?
- Written Supervisory Procedures (WSPs) (Correct answer)
- The firm's strategic business plan
- Employee performance review records
- Marketing materials and advertising copy
Correct answer: Written Supervisory Procedures (WSPs)
Written Supervisory Procedures (WSPs) document how the firm supervises its representatives and operations, and are a primary document reviewed during FINRA examinations.
Question 6: Under the PCAOB Auditing Standard AS 2201, when testing the operating effectiveness of internal controls, auditors must:
- Only test controls that are identified as key controls by management
- Test all controls documented in the company's control inventory
- Perform enough testing to provide a reasonable basis for assessing control effectiveness (Correct answer)
- Rely exclusively on management testing results to reduce audit costs
Correct answer: Perform enough testing to provide a reasonable basis for assessing control effectiveness
AS 2201 requires auditors to perform sufficient testing to provide a reasonable basis for their opinion, which typically includes a mix of inquiry, observation, inspection, and re-performance.
Question 7: A broker-dealer's compliance audit reveals that registered representatives are using personal email accounts to communicate with clients about securities transactions. This violates which core compliance requirement?
- Anti-money laundering record retention rules
- Books and records requirements under SEC Rule 17a-4 (Correct answer)
- Net capital requirements under Rule 15c3-1
- Customer identification program requirements
Correct answer: Books and records requirements under SEC Rule 17a-4
SEC Rule 17a-4 requires broker-dealers to preserve business-related electronic communications, and using personal email circumvents this record-keeping obligation.
CSCP Internal Controls & Auditing 3
In securities compliance auditing, a 'material weakness' differs from a 'significant deficiency' primarily because: