AICPA Code of Professional Conduct Dr. Donald K. McConnell Jr. 9/19/2018

AICPA’S Code of Professional Conduct Attempts to balance general statements of ideal conduct (emphasis on positive activities) with specific rules (enforceability of minimum behavior) Contains four parts: Ethical principles Rules of conduct Interpretations Ethical rulings 9/19/2018

Ethical Principles (ET 51-57, vol II) Ideal standards of ethical conduct stated in philosophical terms: Responsibilities The public interest Integrity Objectivity and independence Due care Scope and nature of services Though not enforceable, burden of proof on CPA for noncompliance 9/19/2018

Rules of Conduct (ET 100-500, vol II Minimum standards of ethical conduct stated as specific rules These are enforceable Other organizations’ rules of conduct can be less or more restrictive than AICPA’s: SEC TSBPA 9/19/2018

Interpretations of Rules of Conduct For frequent, recurrent questions about a specific rule of conduct Though not enforceable, a CPA must justify departure Prepared by AICPA Division of Professional Ethics 9/19/2018

Ethical Rulings Explanations to specific important questions about rules of conduct Based on questions submitted to AICPA by practitioners Not enforceable, but a CPA must justify departure 9/19/2018

What Should You Do When AICPA Rules of Conduct Differ from SEC, TSBPA? Follow whichever is more restrictive Not sure about an ethics issue? Call TSBPA 9/19/2018

AICPA Rules of Conduct Had Been Considerably Changed in the Past Decade or So: Solicitation restrictions eliminated Restrictions on offers of employment eliminated Competitive bidding restrictions essentially eliminated Advertising restrictions eliminated Trade names no longer disallowed, unless misleading Vouching for achievability of forecasts no longer prohibited Contingent fees and commissions no longer prohibited for non attest clients Largely due to prodding by regulators: FTC: Department of Justice Advertising okay so long as not false, misleading, or deceptive. Otherwise, anything goes including testimonials, self-laudatory statements, direct comparisons, undignified advertising, or even advertising in poor taste Forecasts: would be foolish to vouch. We have enough trouble attesting to the fairness of historical financial information 9/19/2018

AICPA Also Recently Adopted a “Covered Person” Independence Perspective Previous AICPA rules took a “firm wide” Independence perspective Intended to modernize rules for auditor independence regarding: Investments in audit clients Employment relationships Scope of services provided to SEC clients Old rules were out of date and unnecessarily restrictive, given increasing numbers of dual income families Firm wide perspective: Partners could not own any stock in any client company Managers and below could not own stock of the client if they were in the office doing the audit for the client For example: Joe Abston, manager in Honolulu office, transferred to Dallas office and had to sell Dr Pepper 9/19/2018

What Are Covered Persons? Covered persons include: The audit engagement team members Persons within the chain of command in relation to the audit team [including concurring partner, Office partner in charge [PIC], regional partner] Partners and managers providing at least 10 hours of non-audit services to the audit client [SEC position] Other partners in the office of the engagement partner The firm and its employee benefit plans An entity controlled by a covered member Safe harbor provision for unsolicited gifts or a bequest that would have impaired independence: SEC 30 days 9/19/2018

Immediate Family Members Immediate family: spouse, spousal equivalent, or dependent These relationships are considered ascribed to the covered person 9/19/2018

Rule 101: Independence Independence would be impaired if a covered party had a direct financial interest in a client, or a material indirect financial interest in a client A direct interest is ownership of equity shares Indirect interests exemplified: A past due audit fee A relative or dependent owning client equity shares A “low-balled” audit fee Member ownership of shares of mutual fund which owns client shares 9/19/2018

Nevertheless, Some CPA Firms Are Continuing to Follow The More Conservative “Firm-Wide” Approach: You Cannot Own Stock in Any Client Company! 9/19/2018

Interpretation 101-1: Independence Impaired If Covered Party: Served as officer or director of an audit client Was trustee or executor having direct or material indirect financial interest in an enterprise [client] Had joint business investment with client or officer thereof material in relation to the member’s net worth Had any loan to or from client or officer thereof, except as per interpretation 101-5 This is a decision-making capacity. 9/19/2018

Honorary Director or Trustee Positions with Audit Clients: Independence not impaired if: Organization is a not-for-profit [charitable, religious] audit client Position is purely honorary CPA does not vote or participate in management functions 9/19/2018

Interpretation 101-2: Former Partners or Shareholders Working for Audit Clients Firm independence is not affected if: Retirement benefits are fixed as to amounts and dates Benefits can be adjustable for inflation Benefits cannot be “participatory” Former partner does not participate in firm business after reasonable transition Former partner does not appear to participate in firm’s business However, Sarbabes-Oxley precludes accepting employment with an audit client if you were on that audit in the past year. 9/19/2018

However, Sarbanes-Oxley [SOX] Prohibits: Hiring a CEO, controller, CFO, chief accounting officer who had been employed by the issuer’s CPA firm in the one-year period prior to the audit 9/19/2018

Interpretation 101-2: Former Partners or Shareholders Working for Clients (con.) Former partner’s name should not be associated with the CPA firm in: Office building directories Membership lists of civic or professional organizations Providing office space to a former partner, including admin. support: Acceptable, unless Significant influence with a client 9/19/2018

Interpretation 101-5 Greatly Restricts Loans with Client Financial Institutions. What Is Permitted? Car loans and leases in customary terms (no sweetheart deals) Credit card and advance balances not to exceed $5000 Loans on CSV of whole life insurance policies Loans collateralized by cash deposits (passbook loans) Mortgages existing as of 1992, but no “upside down” loans Bank or Savings and Loan 9/19/2018

All Other Loans Are Now Prohibited, Including: Home mortgages Other secured loans Other immaterial loans However, new financial institution audit clients can be accepted by CPA firm where covered persons have existing: Fully collateralized loans 9/19/2018

Litigation Involving Clients: Is Independence Impaired? Ordinarily not, e.g. in a typical class action suit However, independence impaired if client and auditor might file counterclaims suits “You were negligent in conducting the audit.” “You were contributorily negligent, because your controls were bad.” 9/19/2018

Past Due Audit Fees A violation of ET 191.103 Considered to be a loan to client Fee for last year must not still be due at time report is issued for the current year, even if immaterial 9/19/2018

Can An Auditor Own Shares in a Mutual Fund Which Owns Shares in an Audit Client? This is an indirect interest in client securities If material to CPA, independence would be impaired (ET 191.35) Practically speaking, such would rarely be material 9/19/2018

What If an Auditor Audits a Mutual Fund and owns Shares in that Mutual Fund? Is independence impaired? Yes: this is a direct financial interest There is significant potentail influence over the mutual fund’s audit results Such as her if an in 9/19/2018

Can a CPA Perform Write-up Work and be Independent of an Attest Client? For non-SEC clients, yes if: CPA retains the appearance of not being an employee of the client Client must accept responsibility for financial statements CPA does not assume role of employee or management: Cannot consummate transactions Cannot have custody of assets Cannot prepare source documents Cannot change client data without concurrence Not independent if an SEC client 9/19/2018

Can a CPA Be Independent If Both the CPA and an Audit Client Own Stock in Another Entity? (text, pg. 87) This is a joint endeavor; the two have a common interest (an objectivity problem) Assume the following: CPA owns immaterial amount of Jackson Company Audit client also owns Jackson Company stock If client investment > 5% of client’s total assets or pre-tax operating income, whichever is more restrictive, CPA is not independent 9/19/2018

Sarbanes-Oxley Prohibits for Public Audit Clients : Information systems [IT] design and implementation consulting Internal audit outsourcing Bookkeeping Management and HR services Appraisals or valuation services Actuarial services Broker-dealer and investment banking services Legal or expert services related to audits Other services the Board may deem impermissible All but first two had already been prohibited for AICPA SECPS members 9/19/2018

Rule 102: Integrity and Objectivity CPA must maintain objectivity and integrity Must avoid conflicts of interest Cannot knowingly misrepresent facts or subordinate judgment Even as expert witness: CPA cannot be a “cheerleader” That is, CPA cannot knowingly bias his/her opinion toward client position 9/19/2018

Interpretation 102-3: Members in Industry or Government (MIGI’s) Is it a violation for a MIGI to knowingly misrepresent facts or knowingly fail to disclose material facts? Yes 9/19/2018

Interpretation 102-4: Members in Industry or Government (MIGI’s) Assume a MIGI and his/her supervisor have a disagreement concerning preparation of F.S.’s or recording of transactions OK to accept supervisor’s position if authoritative support for such position, or effect is not material Otherwise report to higher levels if supervisor’s position could cause material misstatement Consider resignation, if no action Consider reporting to regulatory authorities and external accountant CPA who had to resign in such case, sued AICPA for loss of livelihood 9/19/2018

Rule 301: Confidential Client Information CPA cannot disclose confidential client information without client consent However, confidentiality waived in compliance with: Rule 202 (proper GAAP) and 203 (compliance with GAAS) obligations A validly issued subpoena or summons AICPA or state sanctioned peer review Responding to inquiry by a recognized investigative body 9/19/2018

Contingent Fees What is a contingent fee? What is an attest client? A client for whom we perform: an audit or review report A compilation report not containing a lack of independence paragraph An examination of prospective financial information A non-informed reader might assume you are independent, absent such a paragraph. 9/19/2018

Rule 302: Contingent Fees A member shall not receive a contingent fee for any professional services from an attest client A member shall not prepare an original or amended tax return for a refund for any client. Why? Fees fixed by courts or based on results of judicial proceedings or governmental findings are not contingent fees; hence permitted 9/19/2018

Does the Following Situation Violate Professional Ethics? A CPA has a bookkeeping and consulting practice. No audits or reviews are done. The CPA wants to charge clients based upon savings achieved from consulting recommendations. Yes, but only if… compilation reports with a “lack of independence” paragraph are being issued for those consulting clients. [An example in AR 100.19, vol. II.] If no such paragraph, this is an attest client, and this is a contingent fee 9/19/2018

Rule 503: Commissions and Referral Fees A member in public practice may not accept a commission for recommending a product or service to an attest client, nor accept a commission for recommending an attest client’s product or services This prohibition applies during the period covered by any historical attest financial statements Member must disclose allowable commissions to party to whom recommendation was made 9/19/2018

Commission Examples and Issues CPA could receive a commission for recommending a non attest client’s software or hardware to another party CPA could receive a commission for recommending real estate, insurance, or securities to a non attest client by a third party Why does independence matter? We’re in a business relationship with a party (the client) toward whom we are required to be independent and objective Commissions: an objectivity dilemma? Objectivity: some feel we should not accept commissions, even from non attest clients. Public thinks of CPA’s as being objective. If someone can truly be objective when they recommend one product over another when the former pays a larger commission, I would like to see that! [A state board of Accountancy member] 9/19/2018

A Case Situation In 1999 a CPA recommended an investment to a tax client and received a commission from the promoter. Client now wishes to obtain bank financing and has asked the CPA to perform a review of its F.S.’s for the year ended December 31, 1999. Is this a violation? Yes, as recommendation and receipt of commission was received during the period covered by the financial statements 9/19/2018

Rule 501: Acts Discreditable Retaining client records (checkbooks, journals, ledgers) after client has demanded them is an act discreditable A CPA may keep “PBC” analyses for CPA; need not make available to client A CPA may keep audit documentation with information not reflected in the clients books (AJE’s, closing entries, consolidating entries) until payment of fees has been received. Once CPA has complied, not required to provide that information again (In. 501-1) 9/19/2018

Rule 502: Advertising and Other Forms of Solicitation Advertising OK, if not false, misleading, or deceptive False, misleading, or deceptive advertising is prohibited (Int. 502-2): Creates false or unjustified expectations Implies ability to influence a court, tribunal, or regulatory agency Contains unrealistic future fee estimates Would cause a reasonable person to misunderstand or be deceived Otherwise, anything goes including testimonials, self lauditory statements, direct comparisons, undignified advertising, or advertising in poor taste[so long as not false, misleading, or deceptive] 9/19/2018

Rule 505: Form of Practice and Name Firm name may include past partners A remaining individual (after death, withdrawal) may practice in name of a former partnership for up to two years Firm name may include a fictitious name or specialization, if not misleading Firm cannot designate itself as AICPA member, unless all partners or shareholders are members Mr. Ernst and Mr. Young had been gone for a long time! 9/19/2018

Non CPA Ownership of CPA firms Allowable, if: CPAs own majority of firm’s financial interests and voting rights CPAs have ultimate responsibility for all attest and compilation services Non-CPA owners: Must provide services to clients as their principal occupation Cannot hold themselves out as CPAs Must abide by AICPA code of conduct Must have a bachelor’s degree* Meet same CPE requirements as CPAs After 2010 must meet the AICPA 150 hour education requirement 9/19/2018