The independence of CPAs is the hallmark of the profession. As such,
accountants put forth significant focus and effort to comply with
independence requirements related to everything from investments to
business and employment relationships to services delivered to
clients. But being what accountants call independent in “fact” isn’t
enough. CPAs also must be independent in appearance as well—a
requirement detailed in various professional guidelines, including the
AICPA Code of Professional Conduct.
INDEPENDENCE IN APPEARANCE
There is good reason for such ethical fastidiousness, especially when legal disputes arise. Questions of independence in appearance, beyond those specifically addressed by Rule 101, Independence, of the Code of Professional Conduct, are typically alleged in malpractice claims as a secondary assertion in an attempt to strengthen a plaintiff’s position against a CPA and/or compel settlement. This is due to the subjectivity inherent to an assessment of independence in appearance.
The Conceptual Framework for AICPA Independence Standards defines “independence in appearance” as: “The avoidance of circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team has been compromised.”
This definition of independence in appearance offers no bright-line standards but rather should be used as part of a risk-based approach to analyze independence matters not explicitly addressed by Rule 101.
Problems with independence in appearance occur when practitioners become too close to their clients. A familiar and congenial working relationship with a client thus becomes a double-edged sword. On one hand, CPAs are able to perform the audit more efficiently and effectively when they have prior knowledge of the company’s operations; past dealings and transactions; and the company’s systems, personnel, and processes.
On the other hand, auditors often get to know the client closely through many years of service and working together during late nights and weekends. This familiarity ultimately may pose a threat to an auditor’s independence in appearance if, by the CPA’s actions, it appears the auditor knows the client too well. Consequently, heightened risk arises that the auditor is unduly influenced by the client, which, in turn, raises questions regarding the auditor’s integrity, objectivity, and ability to exercise professional skepticism.
Assessing whether a particular situation impairs independence may lie with the interpretation of the individual making the assessment. An individual’s decision-making process is influenced by his or her experiences, knowledge, relationships, and the unique circumstances of the decision at hand. One auditor’s judgment may be completely different from another’s, and what may be perceived as “crossing the line” by one person may not be perceived in this manner by another. Moreover, if a dispute arises in the future, those drawing conclusions regarding an auditor’s independence are doing so after the fact, as unrelated third parties to the dispute, rather than as the auditor or client.
The following examples illustrate these potential problems. In both circumstances, the defendants in the accounting malpractice cases felt compelled to settle, in part, due to allegations of impaired independence in appearance. They concluded that the jury’s perception of the defendant could be negatively influenced if this information were introduced at trial.
Example 1. A CPA firm was engaged to perform a financial statement audit of a family-owned, closely held financial institution. The CEO of the financial institution perpetrated a significant fraud against the company involving the embezzlement of millions of dollars. The company ultimately filed for bankruptcy, and the CPA firm was sued by the bankruptcy trustee for negligence in its failure to detect the fraud.
As part of the claim analysis, defense counsel noted the auditor was vulnerable to allegations of impaired independence, which could color the jury’s perception of other evidence in the case, including whether the audits complied with GAAS. Specifically, the following was noted:
- The lead audit and client relationship partners appeared to have a close friendship with the CEO that developed over the course of the firm’s multiyear relationship with the company.
- Email exchanges between the lead audit partner, relationship partner, and CEO contained crude language and inside “jokes” that could be viewed as inappropriate.
- The relationship partner and the CEO communicated via email on personal matters frequently, often during college football games.
- The relationship partner accompanied the CEO as a guest at a high-profile and exclusive sporting event.
Example 2. A CPA firm was engaged to perform a financial statement audit of a privately owned machinery sales company. The company was engaged in a Ponzi scheme fraud whereby equipment used to secure loans either didn’t exist or was overvalued. The company ultimately filed for bankruptcy protection when the Ponzi scheme collapsed, and the company’s lenders discovered they had been defrauded out of millions of dollars. The bankruptcy trustee and the secured creditors sued the CPA firm for negligence, alleging failure to perform appropriate audit procedures relating to the valuation and existence of the equipment.
During discovery, emails between the company CEO and a senior audit associate revealed comments reflecting a close, personal relationship. Specifically, the following was noted:
- The audit staff requested the use of the company’s private jet to travel to the client's location.
- Emails contained profanity and other language that could be viewed as inappropriate.
- The CEO requested a change in audit sample selection that appeared to have been obliged by the audit senior with little or no discussion.
RISK CONTROL CONSIDERATIONS
As the examples illustrate, certain activities may give rise to assertions of questionable independence in appearance. They include:
- Numerous casual emails between the client and CPA on topics other than work. The use of unprofessional, vulgar, or profane language in emails poses the greatest threat to an auditor’s independence in appearance.
- Attendance by a CPA and a client at each other’s significant life events (weddings, birthday parties, etc.)
- Frequent social outings between a client and a CPA, including sporting events, lunches, or after-work entertainment.
- Acceptance of gifts or other favors, even if they are de minimis.
- Frequent social contact with a client outside of a traditional working relationship.
To help CPAs avoid situations that may lead to a third party’s perception of impaired independence, keep in mind these simple, yet important, risk control principles:
- Independence is a state of mind and should be reinforced with all levels of a client engagement team. Responsibility for maintaining independence rests with everybody.
- Keep communications professional and engagement-related—especially written communications such as email. That’s because email is discoverable, permanent, and an easily searchable medium for plaintiff counsel to identify potential evidence against a CPA firm. Even seemingly benign comments may be interpreted out of context and viewed negatively. Don’t write something that you would be embarrassed to have read in court.
- Consider the appropriateness of the audit engagement partner assignment. If a partner’s prior relationship with a C-level client executive helped the firm win the business, that partner should not be the audit engagement partner. Thus, interactions as the “relationship partner” should focus on the overall quality of service delivered, rather than engagement specifics.
- Consider rotating engagement team members. While not required by the professional standards, this protocol serves to bring a fresh perspective to the engagement and may demonstrate the firm’s commitment to preserving independence and objectivity.
- Consult with disinterested managers or partners within the CPA firm, peer firms, or state society ethics hotlines if questions arise regarding independence.
- Consider developing an internal policy to govern social relationships with clients.
- During planning, evaluate potential threats to independence and document the firm’s safeguards against them. This demonstrates that the firm understands the importance of independence in appearance and has taken steps to address any perceived issues.
Sarah Beckett Ference ( firstname.lastname@example.org ) is a risk control consulting director at CNA.
Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. For more information, call Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, at 800-221-3023 or visit cpai.com.
This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.
Examples are for illustrative purposes only and not intended to
establish any standards of care, serve as legal advice, or
acknowledge any given factual situation is covered under any CNA
insurance policy. The relevant insurance policy provides actual
terms, coverages, amounts, conditions, and exclusions for an