Managing conflicts of interest

A CPA firm performed bookkeeping and tax services for an optometry practice, as well as its two doctors. One doctor decided to retire. The CPA discussed options with the retiring doctor, who decided to sell his practice to the other doctor on an installment basis. Following the sale, the CPA continued to provide services to the remaining doctor and the practice. Two years later, the practice was not doing well and the remaining doctor defaulted on the installment note. The retired doctor brought a claim against the CPA asserting he had provided inadequate advice regarding the drawbacks of an installment sale. He further asserted that the CPA had a conflict of interest as a result of the CPA’s desire to retain the practice and the other doctor as clients.

According to the AICPA Code of Professional Conduct (the Code) (see paragraph .02 of Interpretation 1.110.010), “[a] conflict of interest creates adverse interest and self-interest threats to the member’s compliance with the ‘Integrity and Objectivity Rule’ ([see ET §]1.100.001).” In this scenario, the CPA provided services to the optometry practice and both doctors. The conflict arose because the CPA advised both the purchaser and seller of the practice.

When a conflict of interest arises, you may get the same queasy feeling you had before the CPA Exam. Fortunately, CPAs can “ACE” conflicts of interest by considering these important areas:

• Awareness.
• Communication.
• Exit.

AWARENESS

The first tip to ACE conflicts of interest is “awareness.”

Be aware of areas where potential conflicts of interest may develop. These may include, but are not limited to:

• Providing services to clients in the same industry;
• Advising the client to invest in a business in which a member of the CPA firm has a financial interest; or
• Providing forensic investigation services to a client in anticipation of litigation against another CPA firm client.

After a conflict has been identified, it should be evaluated. The Code (see paragraph .09 of Interpretation 1.110.010) instructs the CPA to evaluate the significance of an identified threat and provides guidance.

Simply preparing an individual tax return for a couple using the married-filing-jointly status represents a potential, albeit minimal, conflict of interest. However, if the clients are involved in a pending divorce, the threats to integrity and objectivity are more significant.

Conflicts of interest can arise at any time during the client service process. Consequently, CPAs should remain aware of this risk throughout the engagement.

COMMUNICATION

“Communication” is an important safeguard to help ACE conflicts of interest and involves the three D’s—disclosure, decisions, and documentation.

Disclosure

The Code (see paragraph .12 of Interpretation 1.110.010) recommends that the CPA “disclose the nature of the conflict of interest to clients and other appropriate parties affected by the conflict and obtain their consent to perform professional services.” For a particular conflict of interest, a specific disclosure to affected clients is recommended to enable the clients to make informed decisions as to whether to continue to engage the CPA firm’s services. It is recommended that a disclosure, whether general or specific, be made in writing.

In addition, Section 10.29 of Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), requires that “[e]ach affected client waives the conflict of interest and gives informed consent, confirmed in writing by each affected client, at the time the existence of the conflict of interest is known by the practitioner.”

Once identified, a conflict of interest should be reviewed with the CPA firm’s attorney to ensure that it can be waived. If the conflict can be waived, the attorney should draft a waiver for the clients to sign. The article “Practical Approaches to Common Conflicts of Interest,” The Tax Adviser, May 2014, contains recommendations for addressing conflicts of interest and drafting a conflict waiver.

Decisions

When a conflict of interest exists, it is especially important that CPAs refrain from making decisions on behalf of clients or advising or appearing to influence any party affected by the decision. This approach should help avoid the assertion by one party that the CPA made a decision to benefit another.

Instead, CPAs should establish a decision-making protocol with the client. For divorcing taxpayers, the CPA generally should advise the couple to obtain separate legal representation. When decisions are required, both spouses should consult their own legal counsel and each provide a decision in writing to the CPA firm. For other clients, a similar protocol may be followed if there are a limited number of underlying stakeholders. Otherwise, a decision-maker should be selected by all stakeholders and designated in writing to the CPA firm.

While the CPA can orally present the pros and cons of certain positions to all parties, it is recommended that the CPA follow up in writing. The decision of each party should also be documented, preferably with the rationale supporting the position.

Documentation

A conflict of interest creates stress for the affected parties. However, documentation demonstrates the firm’s objectivity, integrity, and professionalism. Moreover, in the event of a professional liability claim, documentation is critical to its defense. With stress and the passage of time, memories tend to fade and documentation provides a contemporaneous record of what transpired.

EXIT

In many circumstances, the CPA firm can establish and implement safeguards to reduce the threat to integrity and objectivity to an acceptable level. In addition to communication, other examples of safeguards may include, but are not limited to:

• Implementing mechanisms to prevent unauthorized disclosure of confidential information, including the creation of separate engagement teams and physical and electronic separation of confidential information, including workpapers, of the clients at issue; and
• Having workpapers and deliverables reviewed by someone independent of the client services engagement team to assess whether key judgments and conclusions are appropriate.

Circumstances may exist, however, where the identified threat is so significant that no safeguards will eliminate the threat or reduce it to an acceptable level. In such instances, the CPA firm should discontinue the services that result in a conflict or exit the client relationship. For instance, if the conflict cannot be waived, all parties do not agree to waive the conflict, or a party will not sign the conflict-of-interest waiver, the CPA firm should consider ceasing services. The CPA should strive to remain fair, objective, and above the fray.

BUT WAIT, THERE’S MORE

Conflicts of interest can be stressful for the CPA and create additional professional liability exposure. Many conflicts may be successfully managed to reduce risk. Therefore, as soon as a potential conflict of interest is identified, appropriate steps should be taken. Contact the firm’s attorney and professional liability insurance carrier or broker. These resources generally are experienced in addressing conflicts and may be able to provide additional, situation-specific guidance.

Deborah K. Rood (deborah.rood@cna.com) 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. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available 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.