How to comply with the new AICPA ethics standards for M&A

By April Sherman, CPA, CGMA

As the nation’s Baby Boomers retire, practice discontinuances and sales of all or part of CPA firms are on the rise. The rise in firm discontinuances and sales brings with it a host of practitioner concerns regarding independence, confidentiality, and the transfer of client files.

To address these concerns and provide specific guidance, the Professional Ethics Executive Committee issued two new interpretations of the AICPA Code of Professional Conduct (the Code) and revised an existing interpretation:

Are you considering the purchase, sale, or discontinuance of all or part of a CPA firm? Consider the following cases as to how the Code might apply to the transaction.

Case examples

Prior to the stages illustrated in the following case scenarios, members who are considering the purchase or sale of all or part of a CPA firm should understand the “Disclosing Client Information in Connection With a Review or Acquisition of the Member’s Practice” interpretation. Before Oct. 31, 2016, the interpretation already required the selling firm to take appropriate precautions to ensure that a prospective purchaser does not disclose confidential client information obtained through the prospective purchaser’s review of the seller’s firm.

The interpretation also prohibited the prospective purchaser from using such information to the prospective purchaser’s advantage. The recent revision clarifies that the prospective purchaser should also not disclose confidential client information gained through the actual acquisition and refers members to the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation.

Case 1: Member X (a partner in Firm A) currently also acts as chief financial officer (CFO) of Company ABC. Company ABC is currently an audit client of Firm B. Firm A plans to acquire all of Firm B, including Firm B’s clients. What actions should be taken by Firm A and Firm B to comply with the Code?

Independence

The “Firm Mergers and Acquisitions” interpretation would require the following actions to maintain independence:

  • Member X must terminate his CFO relationship with Company ABC prior to the closing date of the acquisition.
  • If the audit will cover any period that includes his CFO relationship,
    • Member X must be precluded from participating on the audit engagement team for Company ABC’s audit; and
    • Member X cannot be an individual in a position to influence the audit engagement (as defined in ET §0.400.23).
  • Member X must disassociate from Company ABC. To do this, Member X must apply all of the safeguards listed in paragraph .04 of the “Former Employment or Association With an Attest Client” interpretation [ET §1.277.010] (meaning that he may need to cease participation in employee benefit plans sponsored by ABC Company and collect or pay off loans to or from ABC Company, and he must dispose of any direct or material indirect financial interests in ABC Company). In this regard, Member X must also consider if there are other threats that may require additional safeguards.
  • As soon as practicable but prior to the issuance of the audit report, a responsible individual within Firm A must assess Member X’s prior relationship with ABC Company and Member X’s current position with Firm A to determine if additional safeguards are needed. At a minimum, if certain conditions are present, an individual in Firm A with the appropriate stature, expertise, and objectivity must review the audit engagement prior to issuing the audit report to determine whether the audit engagement team maintained integrity, objectivity, and, as appropriate, professional skepticism. The conditions that would trigger the need for this review to be done are:
    • Member X will have interaction with members of the audit engagement team regarding Company ABC; or
    • The audit engagement team will be in a position of evaluating Member X’s representations and/or work performed while he acted as Company ABC’s CFO.

Transfer of client files

Since the owners of Firm B will not retain ownership in Firm A and Firm A will acquire all of Firm B’s clients, paragraph .01a of the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation will require Firm B to send a written request to all of Firm B’s clients, requesting the clients’ consent to transfer their files to Firm A.

The request should also notify the clients that, if the clients do not respond within 90 days, the clients’ consent will be presumed. Absent a legal or state board of accountancy prohibition, Firm B would be able to transfer a client’s files to Firm A once the client consents or the 90 days have passed.

Paragraph .05 of the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation will require Firm A to become satisfied that guidance in paragraph .01a has been followed by Firm B.

Case 2: Firm C provided nonattest services to Company X throughout 2017 that impaired independence. Company X is currently an audit client of Firm D and will need an audit of the year ended Dec. 31, 2017. Firm C plans to acquire Firm D’s audit practice (rather than Firm D’s entire practice). What actions must be taken by Firm C and Firm D to comply with the Code?

The “Firm Mergers and Acquisitions” interpretation would prohibit Firm C from performing the audit of Company X’s 2017 financial statements due to Firm C’s independence impairment. This position is consistent with the Nonattest Services subtopic [ET §1.295] of the Code.

Since Company X will not be subject to the sale of Firm D’s audit practice to Firm C due to the independence prohibition above, the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation will require Firm D to make arrangements to return any records that Firm D is required to return to Company X as set forth in the “Records Requests” interpretation [ET §1.400.200] unless Firm D and Company X agree to some other arrangement.

Case 3a: Company Y is an audit client of Firm E and will need an audit of the 2017 financial statements. Firm E has already completed the audit of the 2016 financial statements. Firm F provided bookkeeping services to Company Y from January 2016 to December 2016 such that Firm F’s independence is impaired. Firm E plans to acquire all of Firm F in 2017, including Firm F’s partners and employees. What actions should be taken by Firm E and Firm F to comply with the Code?

According to Paragraph .06 of the “Firm Mergers and Acquisitions” interpretation, Firm E’s independence would not be impaired with respect to Company Y, so Firm E has to take no additional actions. (However, the Nonattest Services subtopic will prohibit the continuance of the bookkeeping services unless the services are modified to comply with the subtopic.) Both firms must still apply the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation as described in Case 1.

Case 3b: Company Y is an audit client of Firm E and will need an audit of the 2017 financial statements. Firm E has already completed the audit of the 2016 financial statements. Firm F provided prohibited bookkeeping services to Company Y in 2017 such that Firm F’s independence is impaired. Firm E plans to acquire all of Firm F in 2017, including Firm F’s partners and employees. What actions must be taken by Firm E and Firm F to comply with the Code?

Independence

Firm E’s independence will be impaired with respect to Company Y unless the following safeguards are applied:

  • Prior to the closing date of the acquisition, Firm F must discontinue the prohibited bookkeeping services or modify them so that they do not impair independence;
  • Individuals who participated in the bookkeeping engagement may not participate on the audit engagement nor may they be in a position to influence the attest engagement (as described in ET §0.400.23);
  • If Firm E will take responsibility for the prohibited bookkeeping services performed by Firm F, Firm E should evaluate the prohibited bookkeeping services that Firm F performed for Company Y since the prohibited services were performed during the financial statement period that Firm E will cover in its next audit report (2017). Ultimately, threats must be determined to be at an acceptable level or reduced to an acceptable level with the application of safeguards.
  • If Firm E will not take responsibility for the prohibited bookkeeping services performed by Firm F, Firm E should evaluate the prohibited bookkeeping services that Firm F performed for Company Y during the period beginning with the commencement of the merger or acquisition negotiations through the closing date of the merger or acquisition. Ultimately, threats must be determined to be at an acceptable level or reduced to an acceptable level with the application of safeguards.

Paragraphs .08–.10 provide additional considerations when evaluating the significance of threats, as well as examples of safeguards. Prior to the issuance of the next audit report, the nature of the bookkeeping services and the safeguards implemented should be discussed with those charged with governance (as defined in ET §0.400.48) of Company Y. The Code encourages documentation of such discussion.

Transfer of client files

Both firms must still apply the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation as described in Case 1.

Case 4: Company Y is an audit client of Firm E. The husband of Member X (a partner in Firm F) is the CFO of Company Y. Firm E plans to acquire Firm F in 2017, including Firm F’s partners and employees. What actions must be taken by Firm E and Firm F to comply with the Code?

Since this case does not involve threats related to the performance of nonattest services or Member X’s employment or association with Company Y, the “Firm Mergers and Acquisitions” interpretation requires the members to take whatever pre-merger actions are necessary to be satisfied that Firm E is in compliance with all relevant rules prior to the closing date of the merger or acquisition.

The “Immediate Family Member Is Employed by the Attest Client” interpretation [ET §1.270.020] prohibits covered members from having immediate family members who are employed at attest clients in key positions. Therefore at a minimum, to retain Company Y as an audit client, either Firm E would have to prohibit Member X from becoming a covered member of Firm E, or Member X’s husband would have to resign as Company Y’s CFO. Both firms must still apply the “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation as described in Case 1.

Case 5: Member Y was unable to sell Member Y’s practice; therefore, the practice will be discontinued. What actions should Member Y take to comply with the Code?

The “Transfer of Files and Return of Client Records in Sale, Transfer Discontinuance or Acquisition of a Practice” interpretation will require Member Y to notify each client in writing regarding the discontinuance of the practice. The interpretation encourages Member Y to maintain documentation evidencing such notification. Member Y is not, however, required to notify former clients. Finally, Member Y is also required to return client records as described in the “Records Requests” interpretation.

If Member Y is unable to contact a client, Member Y must retain the client’s records in a confidential manner according to the practice’s record retention policy. However, if a legal or regulatory body (such as the IRS) imposes a longer retention requirement, Member Y must comply with the longer requirement.

Other guidance

In addition to the interpretations discussed above, Frequently Asked Questions: General Ethics Questions provides additional nonauthoritative guidance regarding the reassignment of client files between partners in the same firm and the disclosure of confidential client information to a successor firm after the consummation of a purchase, sale, or merger.

April Sherman (April.Sherman@aicpa-cima.com) is a manager, AICPA Professional Ethics Division, in Durham, N.C.

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