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Avoiding Conflicts of Interest

Professional Liability, Practice Management, Other

Avoiding Conflicts of Interest

When it comes to conflict of interest, most certified public accountants (CPAs) feel confident that they would know it if they saw it. But when asked to define what constitutes a conflict of interest, CPAs often struggle to find the right words or provide a consistent response. While being able to recite a definition may not be an effective strategy to avoid an actual or potential conflict of interest, it can assist in confronting possible conflict situations and represent an initial step in adopting appropriate risk management practices.

Defining a Conflict of Interest

Black’s Law Dictionary provides two definitions of conflict of interest –

  • A real or seeming incompatibility between one’s private interests and one’s public or fiduciary duties.
  • A real or seeming incompatibility between the interests of two of a lawyer’s clients, such that the lawyer is disqualified from representing both clients if the dual representation adversely affects either client or if the clients do not consent.

Although these definitions apply to the legal profession, they also are relevant to the duties of a CPA in the practice of public accounting. Certainly an accountant can encounter situations where his/her own professional interest conflicts with the best interest of a client. An accountant also may be asked to provide services to two clients in a situation where the clients have competing interests that render the relationship incompatible. A common situation may involve both clients seeking tax advice regarding a prospective transaction between them.

The American Institute of Certified Public Accountants (AICPA) professional standards take a slightly different approach to describing conflict of interest. The Code of Professional Conduct (ET Section 102.02) describes a conflict of interest as follows:

A conflict of interest may occur if a member performs a professional service for a client or employer and the member or his or her firm has a relationship with another person, entity, product, or service that could, in the member’s professional judgment, be viewed by the client, employer, or other appropriate parties as impairing the member’s objectivity.  If the member believes that the professional service can be performed with objectivity, and the relationship is disclosed to and consent is obtained from such client, employer, or other appropriate parties, the rule shall not operate to prohibit the performance of the professional service….
Certain professional engagements, such as audits, reviews, and other attest services, require independence.  Independence impairments under rule 101 [ET Section 101.01], its interpretations, and rulings cannot be eliminated by such disclosure and consent.

Although these two approaches are substantively similar, they may be distinguished by the express reference to objectivity and, where required, independence in the AICPA’s Code of Professional Conduct.
For the CPA, objectivity is -

….a state of mind, a quality that lends value to a member’s services. It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest.  Independence precludes relationships that may appear to impair a member’s objectivity in rendering attestation services . . .

For a member in public practice, the maintenance of objectivity and independence requires a continuing assessment of client relationships and public responsibility. Such a member who provides auditing and other attestation services should be independent in fact and appearance. In providing all other services, a member should maintain objectivity and avoid conflicts of interest. (AICPA Professional Standards, ET Section 55)

The ability to provide service with objectivity and, where required, independence, also applies to CPAs in evaluating professional relationships for conflicts of interest.

The boards of accountancy, regulatory agencies and professional organizations address conflict of interest in governing standards, rules and regulations. Allegations of engaging in a conflict of interest can lead to disciplinary action, including fines, suspension and even revocation of practice privileges.

In situations where a malpractice claim results in a trial, a plaintiff’s attorney may exploit a conflict of interest, regardless of whether the conflict caused damage to the plaintiff. While juries have difficulty following the complexities of alleged accounting malpractice claims, they readily comprehend conflicts of interest.  Juries have, of course, been exposed to such conflicts, which have been frequently alleged against politicians and other public servants, and are aware of the pervasive nature. When a conflict exists, it tends to adversely influence the judgment of juries regarding the facts subject to dispute.

Conflict Situations for CPAs

Scenarios that present potential conflicts of interest are seen frequently in accounting malpractice claims. For example, a CPA provides:

  • Tax and financial planning advice, and prepares income tax returns for a married couple. The couple initiates a divorce proceeding, and the CPA continues to provide these services to both of them as individual clients. After the divorce, the ex-wife alleges that the CPA provided tax advice to the ex-husband that caused her to pay excessive taxes in the year the divorce was finalized. 
  • Tax planning, estate planning and tax return preparation services to a married couple, and prepares tax returns for two of their four adult children. The CPA also agrees to serve as the trustee of a family trust established for the benefit of the four children. After the couple’s death, the CPA must manage and distribute the assets of the trust (including the family business now run by one of the children) while providing tax advice for the two children who are continuing clients. The non-client trust beneficiaries allege that the CPA favored the interests of the children who were continuing clients over their interests in managing and distributing the assets of the trust. 
  • Consulting advice to a real estate venture contemplating an acquisition, while owning a small interest in this business. The CPA recommends the venture as an investment to several of her other high net worth clients, but does not disclose to them that she has an ownership interest in the business. The venture fails, and one of these clients sues the CPA, alleging that she provided negligent investment advice, had an undisclosed conflict of interest, and engaged in self-dealing.
  • Financial statement review and tax return preparation services to a manufacturing client. Another client requests that the CPA provide assistance in negotiating the purchase of real estate from the manufacturing company client. The CPA assists the purchaser in negotiating the terms of the sale, and concludes that this is not a problem because the seller is aware that the CPA represents the purchaser in the negotiations. The seller later sues the CPA firm, alleging that the CPA disclosed confidential client information to the purchaser used to negotiate more favorable terms for the sale.
  • Tax planning and tax return preparation services to a partnership of doctors, and individually to one of the three partners. A dispute arises between two of the partners, leading to the decision that two of them will buy out the interests of the third. At the request of one of the two partners planning the buyout, the CPA performs a valuation engagement, which is used in setting a price. Although all three partners are aware of the fact that the CPA was engaged by one of the partners to perform the engagement, the CPA does not obtain signed consents from the partners to perform the engagement notwithstanding the existence of the conflict. The sale is concluded. A year later, the selling partner files suit against his former partners and the CPA, alleging that he did not consent to allow the CPA to perform the service, and that the CPA favored the interests of the other partners in preparing the valuation report in order to retain the business as a client.

Managing Conflict Risk

All firm personnel must be vigilant in identifying relationships and situations that could be viewed by others as presenting a conflict of interest. All firm personnel should receive training on the subject. Staff professionals should be instructed to immediately bring potential conflict situations to the attention of firm management.

In order to avoid potential and actual conflicts of interest, client and engagement screening procedures should be implemented. Knowing the potential client is critical. Firms should inquire about the prospective client’s major business relationships, such as key clients, lenders and vendors. Determine the intended use of the proposed service and distribution of the related workproduct, if applicable. If there will be third party users, identify known users and determine if the CPA firm has professional relationships with the users that present an actual or potential conflict. Also recognize that providing professional services to individuals employed by business clients can lead to conflicts of interest. Carefully consider the ramifications prior to agreeing to provide new services to these individuals.
But the process does not end there. A client’s business and its business relationships change over time. Evaluating client relationships for conflicts should remain an ongoing process, rather than confined to an annual client continuance review.

Client Data Base

All firms should maintain a database of client information. New clients should be added to the database when the client relationship is established. The database should be routinely updated as information changes.
The database should be user-friendly and readily accessible. Any system, however, is only helpful if it is properly maintained. The firm’s quality control procedures should specify the responsibility of firm personnel to transmit current information to those assigned to its maintenance.  In addition, compliance with this requirement should be monitored.
Conflict of Interest Questionnaires
Potential and actual conflicts of interest can develop through employment and ownership relationships resulting from the activities of CPA firm employees, owners, and their family members. A firm should require all employees and owners to complete and submit conflict of interest questionnaires to management on an annual basis. The information provided should be compared with information in the client database. If an actual or potential conflict of interest is identified, it should be disclosed to affected clients.

Potential conflicts should be disclosed before they become actual conflicts. Explain to clients obligations under applicable professional standards and regulations regarding conflicts of interest. While in some cases obtaining conflict waivers from affected clients may be an acceptable solution, in other cases withdrawal from the engagement may be required. Consult with competent legal counsel for assistance in drafting both conflict of interest questionnaires and conflict waivers enforceable under applicable law.  

CPA firms must be committed to avoiding conflicts of interest while providing clients with quality, professional services. Vigilance in identifying potential conflicts and remaining objective in evaluating them represents an essential element of risk management.

Updated September 2012

Accountants Professional Liability Risk Control, CNA, 333 South Wabash Ave., 36S Chicago, IL 60604.
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The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA.

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To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental.  In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy.  Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured.  All CNA products and services may not be available in all states and may be subject to change without notice.

IRS Circular 230 Notice: The discussion of U.S. federal tax law and references to any resources in this material are not intended to: (a) be used or relied upon by any taxpayer for the purpose of avoiding any federal tax penalties; (b) promote, market or recommend any products and/or services except to the extent expressly stated otherwise; or (c) be considered except in consultation with a qualified independent tax advisor who can address a taxpayer’s particular circumstances.

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