Positive ID.

Identifying and Resolving Conflicts of Interest

Pop quiz.

1) What is a conflict of interest?

2) How do you avoid one?

3) Are you sure?

How did you do? Did you pass with flying colors, or did you find yourself scrambling for reference materials?

THE CHANGING TIDE

Conflicts of interest always have spelled trouble for CPAs, but historically, the profession's focus on auditing and independence has helped to keep accountants' hands clean. In the past, if CPAs maintained their independence, the presumption was that no conflicts would arise.

While independence is still important--as is evident from last year's headlines about the SEC and its rules on auditor independence--today, integrity and objectivity are recognized as the primary guidance for all CPA-provided services. The AICPA Code of Professional Conduct is clear: "In the performance of any professional service a member shall maintain objectivity and integrity, shall be free of conflicts of interest and shall not knowingly misrepresent facts or subordinate his judgment to others." (AICPA ET Sec. 102)

Often, common relationships, such as those described in the sidebar on Page 11, spring unanticipated disillusionment and disenchantment from individuals who perceive harm, or who actually have been harmed by others. Under such circumstances, a claim is often made that the CPA somehow was conflicted by the engagements. A skillful plaintiff's attorney will seek to characterize innocent relationships as self-minded and profit-guided. This trend requires you to be constantly aware of and sensitive to your role in such relationships.

WHO IS THE CLIENT?

To evaluate potential conflicts of interest, you need to clearly identify who your client is and to whom your duties are arguably owed. According to the AICPA Code of Professional Conduct, "A client is any person or entity other than the member's employer that engages a member or a member's firm to perform professional services or a person or entity with respect to which professional services are performed." (AICPA ET Sec. 92)

For example, a CPA prepares a tax return for a professional service corporation and the related individual tax returns. One of the shareholders is considering leaving the professional corporation and consults with the CPA prior to advising his existing shareholders. In this case, the clients are the professional service corporation and each of the individuals for whom the tax returns are prepared. The clients, however, may have adverse interests and the CPA should not provide services to the shareholder who is considering leaving the corporation without obtaining a waiver of the conflict of interest. The practical solution is to recommend that the departing shareholder seek separate advice from another CPA or attorney.

Both the client and public-at-large expect that CPAs will be guided by a clear distinction between a client to whom duties are owed and others to whom no such duties exist.

WHAT ARE CONFLICTS OF INTEREST?

The standard for defining conflicts of interest is objectivity. The practitioner's conduct and whether a conflict of interest may exist are governed by whether a reasonable person would view the CPA-client relationship as impairing objectivity regardless of the practitioner's good intentions.

Generally, conflicts of interest take two forms: the first involves two clients, such as a wife divorcing her husband, and the second involves the client and the CPA himself. The AICPA Code of Professional Conduct gives the following examples of potential conflicts:

* A CPA provides litigation services for a plaintiff in connection with a lawsuit filed against a client of the CPA's firm.

* A CPA provides tax or personal financial planning services for a married couple undergoing a divorce.

* In connection with a PFP engagement, a CPA recommends that a client invest in a business in which the CPA has a financial interest.

* A CPA has a significant interest in a company that is a major competitor of a client.

* A CPA provides tax or PFP services for several members of a family who may have opposing interests, such as to the assets of a trust.

* A CPA has been approached to provide services in connection with the purchase of real estate from a client.

Ron Klein, CAMICO's vice president of claims, says, "It's all about perception. Whether or not a CPA gets into trouble is determined more by the alleged aggrieved party's perception than the absence or presence of an actual conflict." Although there is no litmus test, Klein recommends looking at the situation from the client's perspective. If there is a chance that the client will feel as though you have not done your duty, you might find yourself slapped with a suit alleging a conflict of interest. The longer your client has been with you, the more intensified this perception becomes.

Another easy way to determine if you are entering into a conflict of interest is if you find yourself justifying your actions. "If you have to convince yourself to provide your services to a particular individual, or have to justify refraining from disclosing information to a client, it may be time to back off" says Klein. In fact, he adds, "if in doubt, bail out."

NOTIFICATION

If a conflict exists, but you believe professional service can be performed with objectivity, you may accept the engagement provided that certain disclosures are made and client permission is received. You should obtain such consent in writing from the client. Also, you want to be sure that your client is providing you with informed consent (see the conflicts of interest disclosure checklist, this page). In California, lawyers are required to advise clients in writing that they may seek the advice of an independent lawyer of their choice and are given a reasonable opportunity to seek that advice. Depending upon the circumstances, as a CPA, you may wish to consider the advisability of recommending that your clients seek independent advice.

You also have a responsibility to maintain confidentiality. According to the AICPA Code of Professional Conduct, "A member in public practice shall not disclose any confidential client information without the specific consent of the client (emphasis added)." (AICPA ET Sec. 301) Thus, the CPA cannot disclose client information unless the client provides specific consent. Such confidential information could be construed as most any information obtained during the course of the professional relationship.

For example, if a CPA represents clients with adverse interests (i.e. the professional service corporation and a departing shareholder), the CPA's ethical quandary would be to what extent should there be a disclosure of the departing shareholder's pending decision to leave, and what impact would that disclosure have on each party.

HOW TO DISCLOSE

Written disclosures that allow clients to evaluate the client-CPA relationship have taken on new importance. For example, a commission by its very nature gives rise to a conflict of interest. The recent law that permits California CPAs to accept commissions, Business & Profession Code Sec. 5061, requires that client disclosure:

* Be in writing and be clear and conspicuous.

* Be signed by the recipient of the product or service.

* State the amount of the commission or the basis upon which it will be computed.

* Identify the source of the payment and the relationship between the source of the payment and the person receiving the payment.

* Be presented to the client at or prior to the time the recommendation of the product or services is made.

Using this as a guide, the conflicts of interest disclosure checklist on Page 12 may provide a way to disclose information to a client and permit the CPA to continue to provide services. Our professional rules provide that "if the member believes 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." (AICPA ET Sec. 102-2)

BE PROACTIVE

Given the profession's emphasis on integrity and objectivity (including conflicts of interest) and the need to disclose, CPA firms should develop policies and procedures for dealing with conflicts of interest. This should include policies and procedures for written disclosure and obtaining consent of clients before accepting engagements that may give rise to potential conflicts of interest.

Michael Ueltzen, CPA, partner in Sacramento-based Ueltzen & Company, LLP, is chair of CaICPA's government relations committee and a former Ca/CPA president.

Randall Dean, Esq. is a partner in the Los Angeles-based law firm of Chapman, Glucksman & Dean that provides legal services in defense of professional malpractice claims.

CONFLICT OF INTEREST WAR STORIES BY RON KLEIN

One of the best ways to avoid conflicts of interests is to learn from others' mistakes. The following war stories outline some common conflict of interest scenarios and tips for preventing such sticky situations in your own practice:

Scenario 1: A general partnership owned by two partners engages a CPA who provides services to the partnership and each of the partners. One partner has a 70 percent share and the other 30 percent. Two years into the engagement, the majority partner asks the CPA for confidential advice on how to finance some large debts he has accumulated. The CPA advises him for a short period but stops when the partner suggests some corporate "creative financing" of the debt. The CPA mulls the situation over for several days before deciding to disclose this information to the minority partner. Meanwhile, the majority partner has managed to embezzle funds from the corporation and disappear.

Loss prevention tips: A general partnership requires equal treatment of each partner by the CPA regardless of the ownership percentages. If you are refraining from disclosing information to one partner because of the confidentiality considerations of another partner, you already are caught in the middle, and it's time to talk with your risk adviser or legal counsel. The victimized partner might have been able to prevent the embezzlement had he known about the other's debt problems, but now, he has good grounds for suing the CPA for conflict of interest and lack of disclosure.

Scenario 2: A CPA does tax work for a limited partnership as well as for the partnerships' general partners. After three years, the CPA notices that the general partners are paying themselves fees that are larger than those specified in the limited partnership agreement. The CPA decides to ignore the issue, and nothing comes of it until the investment hits hard times and the limited partners stop receiving any annual distributions. The limited partners hire an attorney to investigate and discover the excess fees paid to the general partners. The limited partners sue the CPA for conflict of interest and lack of disclosure. They also allege that the CPA is responsible for their lost investment in the now crumbling limited partnership.

Loss prevention tips: A CPA who provides services to a limited partnership has duties to the partnership and to the limited and general partners. The CPA should not become biased by the fact that the general partners pay the CPA's fees and should avoid being on one side or the other. When something looks amiss, it is better to be on "the side of the angels," usually the passive limited partners. The CPA should have verified that the information, or evidence of wrongdoing was correct, and insisted that the general partners notify the limited partners of the excess management fees. If the general partners refuse to disclose to the limited partners, then the CPA should disclose. Sometimes the general partners will fire the CPA in an attempt to avoid disclosure. In such circumstances, the CPA still has a duty to disclose even if fired. Consult your risk adviser for guidance in these instances.

Scenario 3: A CPA has a client in Beverly Hills who owns a highly successful women's clothing boutique. The boutique owner is approached by two outside investors with the idea of opening two more boutiques in La Jolla and Carmel. The owner decides to incorporate and go public, bringing in the outside investors and asking the CPA to sit on the corporation's board of directors. The CPA accepts the board position, buys stock in the corporation, discloses his lack of independence, and recommends stock purchases to another client, who also invests. After a few years, the boutiques take a severe downturn, causing the investor-client to suspect a scam on the part of the corporation and CPA. The client sues the CPA for a lack of due diligence, negligent investment advice and conflict of interest.

Loss prevention tips: Investing in business deals with clients is often a mistake, especially when the CPA also provides professional services to the business. Everyone is usually happy as long as the deal performs well. The CPA is perceived by the client as a competent adviser with the client's best interests at heart. When the deal goes south, however, the client's perception of the CPA changes. The CPA appears to no longer have the client's best interests at heart, and juries tend to sympathize with clients, especially with the benefit of hindsight and all the facts laid out by a skilled attorney. The CPA is portrayed as the financial expert who sacrificed the best interests of his client to benefit himself. Also, disclosing a conflict of interest to the client, while helpful, doesn't solve the problem, even if the client signs the disclosure. It can be argued later that the client's consent was not "informed" by a third party (such as an attorney). Don't get too comfortable with disclosure as a form of p rotection. In the end, the question is whether there is a perception that the CPA no longer has unfettered loyalty to his client.

Ron Klein is CAMICO's vice president of claims.

CONLICTS OF INTEREST DISCLOSURE CHECKLIST

CPAs should consider using the following as a disclosure checklist for conflicts of interest. Your disclosure should:

Be written.

Be provided to the client at or prior to the time that the conflict is known.

Be on firm letterhead and signed by the CPA.

Be signed and dated by the client with acknowledgement that the client has read and understands the information contained in the disclosure.

Be provided to the client with signatures.