The following scenarios illustrate several situations that could arise when a firm's clients display poor tone at the top:
- A client refused to file income and sales tax returns in a state where nexus exists. After the state takes action to collect the past due amounts, the client accuses the CPA firm of not advising it to file and failing to inform it of the potential penalties for not doing so and brings a claim against the firm to recover penalties and interest.
- A CPA firm performed a valuation of a company in contemplation of a sale. The company's CEO pressured the firm to include slow-moving inventory at a questionably high price. The purchaser subsequently brought a claim against the CPA firm after the company performed poorly in its first year of new ownership.
- While performing routine bookkeeping services for a partnership, a CPA firm noted several company credit card transactions that appeared to be personal expenses of one partner. When asked about the transactions, the partner was dismissive and indicated that the CPA firm should not question how he runs his company. The other partner later sued the CPA firm for failing to detect the fraud when it was eventually discovered by the partnership's new controller.
- A client's CFO pressured the CPA firm to delay issuance of an audit opinion, which included an emphasis-of-matter paragraph related to doubts about the entity's ability to continue as a going concern. The client indicated it was seeking financing from a bank to help address the going concern issue. After the client defaulted on its loan, the bank brought a claim against the CPA firm, asserting that its losses may have been less had it known about the going concern issue sooner.
While the scenarios above relate to different services, they share a common element—a client with poor tone at the top. "Tone at the top" is generally understood as the level of commitment toward openness, honesty, integrity, and ethical behavior as embodied by the actions, directives, and behaviors of an organization's leaders. This concept is noted in the Committee of Sponsoring Organizations of the Treadway Commission's Internal Control—Integrated Framework (2013) as a significant element of the control environment. Why? The tone established by an entity's leadership permeates throughout the organization. When management acts with integrity and promotes and adheres to ethical values, its employees will follow suit.
THE IMPORTANCE OF TONE AT THE TOP AT CLIENT ORGANIZATIONS
How does a client's tone at the top affect the CPA firm? As demonstrated in the above scenarios, a lapse in client integrity or ethics can negatively impact an engagement. Most CPA services depend on the client's cooperation in providing accurate information and representations. Thus, questionable ethics or lack of integrity could manifest itself in the information provided to the CPA, which, in turn, may lead to an inappropriate firm work product. Even a flawlessly executed engagement can be placed at risk by a client with poor tone at the top. Unethical clients not only increase the likelihood of a professional liability claim, but they also expose the CPA firm to other risks such as nonpayment of fees and increased exposure to regulatory and criminal complaints. As a result of these risks, all CPA firms should focus on evaluating a client's tone at the top.
RISK MANAGEMENT RECOMMENDATIONS
Consider the following techniques to address issues relating to tone at the top:
- Do your homework on new clients. Client acceptance is the first opportunity to identify a client with questionable ethics or integrity. A robust client-acceptance process helps a CPA firm avoid risky clients by addressing issues before an engagement begins. Potential red flags in evaluating new client relationships include disputes with the predecessor accountant, disputes between owners of the client's organization, regulatory or business complaints, failure to obtain proper permits or licenses, or even taking aggressive positions on tax returns. The potential upsides of a new client, such as fees or a new relationship, should not overshadow concerns about a client's ethics.
- Continuously evaluate. The acceptance process is not the only opportunity to evaluate the client's tone at the top. Situations often arise during an engagement, and management's responses to these situations often speak volumes about the client's ethics. If a client does not address difficult situations appropriately, a firm should consider terminating the engagement.
- Consider reputational risk. A CPA firm may suffer harm to its own reputation by rendering services to an unethical client. Third parties likely will not hesitate to include the CPA firm in a lawsuit, regulatory complaint, or criminal investigation, and clients lacking integrity similarly will not mind sharing the blame with the firm. Even if the accusation lacks merit, the CPA firm will waste valuable time responding to and defending the charge, and may incur considerable costs. In addition, consider the reactions of other CPA firm clients. One questionable client may cause other clients to reevaluate the firm's ethics and question their association with the firm.
- Prepare for the worst. Even a longtime, seemingly ethical client may act inappropriately if faced with an unexpected challenge. If a claim arises, how the CPA firm has documented its work and client communications will be important to the defense of the claim.
Documentation of recommendations, discussions with management, and internal-control-related matters may help demonstrate the firm's commitment to due professional care.
Communication with the client should always be clear, concise, and professional. Additionally, two engagement team members should be involved in any difficult client discussions to ensure proper communication of the message. If the discussion becomes a subject of dispute, the presence of other team members can help provide accurate recall. The discussion should also be documented in a memo to the file.
THE IMPORTANCE OF TONE AT THE TOP AT CPA FIRMS
Of course, CPA firms must also maintain and demonstrate a commitment to integrity and ethical principles. Firms should consider the following when assessing their own ethical climate.
- Everyone is the "top." Tone at the top in an accounting firm is ultimately communicated from its partners and owners. However, each individual in an accounting firm may demonstrate leadership, whether that person is a partner or brand-new associate. Instilling leadership values and a commitment to ethics and integrity at all levels of the firm helps reinforce appropriate decision-making and the ability of all personnel to "do the right thing." Raising issues and consulting with other team members when faced with a difficult situation should be encouraged and supported.
- Develop the future. A focus on ethics and integrity through responsible leadership should be included in training and mentoring at all levels. This gives all firm professionals greater awareness of the potential impact of ethical- or integrity-related conflicts and also helps to prepare the firm's future leaders. In addition, the firm should develop and disseminate to all personnel its policies regarding conflicts of interest and independence. Ethics training also should be provided routinely.
- Monitor your firm. A CPA firm's personnel is its greatest asset. Just as a CPA firm may recommend to its clients, its own internal controls should be established, implemented, and updated to deter improper actions. Strict adherence to firm policies through proper oversight, review, and approval should reinforce the firm's tone at the top and help demonstrate its commitment to integrity and ethical values.
Daniel J. Gartland is a risk control consultant 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 insured. All products and services may not be available in all states and may be subject to change without notice.