Cleaning up the profession: clients take a stand on commissions & contingency fees.

After many years of investigations, discussions, analysis and rules, in August, 1990, a final consent order from the Federal Trade Commission (FTC) became effective. The American Institute of Certified Public Accountants agreed with the FTC not to restrict accountants from accepting contingent fees and commissions from non-audit clients.

The Federal Trade Commission had been concerned with this issue of commissions and contingent fees for a long period of time. In 1985, the FTC began an extensive investigation of the accounting profession and its code of ethics. Upon completion of its inquiries and deliberations, the Commission concluded that several professional rules of conduct discouraged competition among public accountants. Specifically, the FTC suggested that the code be amended to allow accountants to accept contingent fees and commissions, to pay for referrals to use trade names, to vouch for the achievability of forecasts and to engage in unrestricted advertising.

The FTC complaint that led to the final consent order charged that the AICPA illegally restrained competition and deprived consumers of information about the "availability, price, and quality of CPA services" by:

* preventing CPAs from accepting work on a contingent-fee or commission basis for those for whom they are not performing audit or other attest services;

* preventing CPAs from accepting work on a contingent-fee or commission basis for those for whom they are not performing audit or other attest services;

* restricting truthful, nondeceptive advertising, such as the use of truthful claims in comparative advertising;

* restricting CPA solicitation of clients and the use of referral fees; and

* banning the use of nondeceptive trade names.

Prior to the challenge by the FTC, both the AICPA and state legislation had prohibited the taking of commissions. The AICPA Code of Professional Conduct Rule 503 stated:

"Commissions. A member shall not pay a commission to obtain a client nor shall such licensee accept a commission for a referral to a client of products of services of other."

In addition, Rule 103 of the National Association of State Boards of Accountancy (NASBA) Code of Professional Conduct and Rule 9 of the National Society of Public Accountants (NSPA) Rules of Professional Conduct reiterate the language of the AICPA.

The agreement between the FTC and the AICPA now permits a CPA to accept commissions or contingent fees from clients for whom no "attest services" are performed. Attest services are defined as: 1) any audit; 2) any review of a financial statement; 3) any compilation where the CPA does not disclose a lack of independence; and 4) an examination of a prospective financial statement. A practitioner would be allowed to pay or accept referral fees for all services. However, the AICPA is not precluded from requiring a CPA to disclose any commission or referral fee.

But in October, 1991, the AICPA revised its position and decided to help states enact legislation to uphold their bans on commissions and contingent fees. Since state-legislated rules would not be subject to Federal regulations, it would be possible for a state to legislate a different approach to this problem than had been agreed upon in the decree between the AICPA and the FTC. AICPA president Philip Chenok stated in a Wall Street Journal interview that "many accountants are concerned that taking commissions impairs the objectivity of accountants and erodes their reputation for integrity with the public." Now there is empirical evidence to support that view from a national survey of corporate shareholders.

Position of State Societies

After the final order, each CPA State Society had to vote on whether or not to adopt the AICPA agreement with the FTC. Many state societies had patterned their rules after the AICPA's newest by-laws, which allow commissions for products or services supplied by third parties to nonattest clients. However, many other states did not automatically incorporate changes made by the consent decree. Accounting practitioners in some states have, with the assistance of the AICPA, encouraged state legislatures to pass bills restricting public accountant's acceptance of commissions and contingent fees. Arkansas, California, Connecticut, Florida, Iowa, Nevada, New Mexico, Oregon, Rhode Island and Tennessee already have such statutes prohibiting commissions and/or contingent fees. The Accountancy Board of Ohio recently reaffirmed its rules prohibiting CPAs from accepting commissions and contingent fees.

In New York, the Board of Regents, which is empowered to prescribe rules and regulations for many professions including accounting, specifically prohibits as unprofessional conduct "directly or indirectly offering, giving, soliciting, or receiving or agreeing to receive, any fee or other consideration to or from a third party for the referral of a ... client or in connection with the performance of professional services." The Board further prohibits accountants from offering a service where the fee is otherwise contingent upon the findings or results of such services.

Exhibit 1 outlines a current summary of jurisdictions prohibiting commissions, contingent fees and referral fees. Exhibit 2 is a summary of jurisdictions permitting commissions, contingent fees and referral fees.

Empirical Results

Now substantial empirical evidence supports the position that accountants should not be able to accept commissions or contingent fees under any circumstances. In an effort to quantify practitioners' opinions of referrals, commissions and contingent fees, Beets and Martin surveyed, by means of a questionnaire, accounting personnel or representative offices of two national accounting firms and one large regional firm. |See S. Douglas Beets and Dale R. Martin, "Recent Changes in the AICPA Code: What They Mean for CPAs and Clients," The Woman CPA, 1990, pp. 18-21.~

In one of the cases presented in the questionnaire, a CPA had paid a fixed annual fee to an attorney to refer potential clients to him. More than 90% of the surveyed public accountants believed that such referral fees should not be allowed by the AICPA. In response to a case in which a CPA accepted a contingent fee on a tax engagement, approximately 98% of the respondents believed that the former rule 302 which prohibited such an action was appropriate. In the most recent survey, Louis Harris and Associates surveyed for the AICPA a wide range of leaders including executives, outside board members, attorneys, academics and security analysts along with a sample of households. The study found that all of the key groups surveyed opposed CPAs accepting commissions and contingent fees from audit clients. These same groups opposed the accepting of commissions and contingent fees from non-audit clients but by a lesser margin. A Survey of Shareholders

Results of a recently completed national study support the attitudes of corporate shareholders toward corporate annual reports and auditors where shareholders were asked their views related to contingent fees. |See Marc J. Epstein and Moses L. Pava, The Shareholders Use of Corporate Annual Reports, JAI Press, Inc., Greenwich, CT, 1993.~ Questionnaires were mailed to approximately 2,300 shareholders throughout the United States. The shareholders were selected at random from a list of corporate shareholders with at least one round lot (100 shares of one stock) on either the New York or American Stock Exchange. Two mailings of the questionnaire were conducted: After the first mailing, a second mailing was sent to non-respondents. This was done to be confident that those shareholders who did not respond to the first mailing did not have different opinions than those who did respond. Non-response bias was checked through the use of appropriate statistical tests, and the two groups were judged to be from the same population and no significant difference between the groups was detected. In total, 246 usable responses were reviewed and tabulated from the 12-page questionnaire. This provided sufficient data to provide statistically significant results.

Shareholders were asked whether "aiding in acquisition or sale of subsidiaries based on contingent fees if offered to a client by an accounting firm would cause a conflict of interest that would compromise the accounting firm's independence and thus should be prohibited." The results were clear, with 62.4% of the respondents wanting a prohibition of contingent fees by auditors. (The only other potential conflict with very strong shareholder views on prohibition was executive recruitment services.)

Summary

The shareholders' views are clear: They disagree with the position taken by the FTC. As has been shown, most CPAs are still constrained by state rules and laws from accepting commissions and contingent fees and paying referrals. This position is in agreement with that of the public. They are significantly more concerned with the issue of conflict of interest than with issues involving restraint of trade.

The public is concerned with corporate governance and accountability. They want the auditor to assume more responsibility for the continued economic viability of the firms they audit and want more investigation of potential fraud and mismanagement among these firms. They want the auditor to be independent and want conflicts of interest avoided. Lawsuits from shareholders and other third parties have been very critical of the auditor's performance in various audit situations and the courts have entered many multimillion dollar judgements. The auditor must not only remain independent. The auditor must avoid any appearance of a conflict of interest. The survey results are clear. Corporate shareholders--the owners of the company--do not want auditors accepting contingent fees. The national survey of shareholders strongly supports the position of the AICPA that contingent fees should be prohibited.

Exhibit 1

Summary of Jurisdictions Prohibiting Commissions, Contingent Fees, and
Referral Fees(*)

Prohibited by           Commissions                   Contingent Fees

Board Regulation   Alabama, Alaska, Arizona,      Alabama, Alaska, Arizona,
                   Delaware, DC, Georgia,         Delaware, DC, Georgia,
                   Guam, Hawaii, Idaho,           Guam, Hawaii, Idaho, Illi-
                   Illinois, Indiana, Kentucky,   nois, indiana, Kentucky,
                   Louisiana, Maine, Massachu-    Louisiana, Maine, Massa-
                   setts, Michigan, Minnesota,    chusetts, Michigan, Minne-
                   Mississippi, Missouri,         sota, Mississippi, Missouri,
                   Montana, Nebraska, New         Montana, Nebraska, New
                   Hampshire, New Jersey, New     Hampshire, New Jersey,
                   York, North Carolina, North    New York, North Carolina,
                   Dakota, Ohio, Pennsylvania,    North Dakota, Ohio, Oregon,
                   Puerto Rico, Rhode Island,     Pennsylvania, Puerto Rico,
                   South Carolina, Virginia,      Rhode Island, South Caro-
                   Virgin Islands, Washington,    lina, Utah, Virginia, Virgin
                   Wyoming                        Islands, Washington, West
                                                  Virginia, Wyoming

State Statute      Arkansas, California,          Arkansas, California, Con-
                   Connecticut, Florida, Iowa,    necticut, Florida, Iowa, Ne-
                   Nevada, New Mexico,            vada, New Mexico, Tennes-
                   Oregon, Tennessee              see

No Rules           Maryland, West Virginia        Maryland

* AICPA State Legislation, July, 1992.

Exhibit 2

Summary of Jurisdictions Permitting Commissions, Contingent and Referral Fees(1)

Approaches

AICPA/FTC(2)        Independence(3)

Kansas, South       Colorado,
Oklahoma            Dakota, Utah,(4)

Texas, Vermont(5)
Wisconsin

1 From a table received from the AICPA, through the NSCPA on September 3, 1992. 2 AICPA/FTC approach means that a separate commission rule following AICPA/FTC consent agreement exists. Prohibits commissions/contingent fees during attest services. In non-attest engagements, commissions are permitted with disclosure requirements.

3 Independence approach means that commissions/contingent fees prohibition for attest services is part of the independence rules. Allows commission/contingent fees in non-attest engagements.

4 Permits commissions during non-attest services by statute. Disclosure is required. Contingent fees are prohibited by regulation.

5 Commissions and contingent fees for attest services prohibited by statute. Commissions and contingent fees for non-attest services permitted with disclosure requirements.

Marc J. Epstein is visiting professor of business administration at the Harvard Business School in Boston. He has taught at several universities and has served as a consultant to business and government for over 20 years.

Wayne A. Label is director of external affairs for the College of Business Administration and Hilton Distinguished Professor of Accounting at the University of Nevada, Las Vegas. He has written several articles and books on accounting.