the Public’s Trust: Third-Party Service Providers
Richard G. Brody, John M. Coulter, and John Jewell
2006 - While many of the high-profile corporate failures (e.g.,
Enron and WorldCom) have been associated with the large public
accounting firms involved, other changes have also occurred
beyond the view of the general public. Calls for increased
transparency and concerns about ethical behavior have led
to increased regulation over the financial reporting process,
with the profession having lost a great deal of its credibility
role of the AICPA changed with the passage of the Sarbanes-Oxley
Act (SOX) in 2002. Now, the Public Company Accounting Oversight
Board (PCAOB) oversees accounting firms with respect to
services performed for publicly-held corporations. While
the AICPA still maintains its regulatory role for nonpublic
company audits, its previously issued standards are being
superseded as the PCAOB issues its own.
recent years, there has been an increasing trend toward
the outsourcing of services through third-party service
providers in many industries, including public accounting.
Such outsourcing offers
cost advantages to an accounting firm and enables it to
accept more clients than it would otherwise be able to support.
But from a client standpoint, such outsourcing may raise
ethical issues of credibility and confidentiality regarding
information shared with third parties.
area where the AICPA continues to play a major role is in
advising its members when ethical issues arise. The AICPA’s
Professional Ethics Executive Committee (PEEC) issues Technical
Ethics Rulings on significant issues. AICPA members can
also submit questions that are specific to their situation
and receive guidance from the Professional Ethics Division.
On October 28, 2004, the PEEC approved two new rulings and
a revision to one existing ruling (respectively, Ethics
Ruling 112 under Rule 102–Integrity and Objectivity;
Ethics Ruling 12 under Rule 202–Compliance with Standards;
and Ethics Ruling 1 under Rule 301—Confidential Client
Information) that were, in part, intended to mitigate concerns
regarding the credibility and confidentiality of client
information in an outsourcing arrangement.
Ethics Ruling 112 under AICPA Code of Conduct Rule 102,
in response to a question regarding mandatory disclosure
to a client of the use of a third-party provider, the PEEC
stated: “Accordingly, before disclosing confidential
client information to a third-party service provider, a
member should inform the client, preferably in writing,
that the member may use a third-party service provider.”
While one this ruling seems to “settle the issue,”
important uncertainties remain regarding its interpretation
and implementation. Of particular concern is the use of
the word “should” as opposed to “must.”
Furthermore, it is not clear that a client may truly understand
what is being agreed to if the outsourcing disclosure is
vague, is made only verbally, or is buried among legal and
other disclaimers. Also at issue is whether a client is
apt to view overseas outsourcing of information as being
different in kind or magnitude from the simple use of a
third-party service provider, and whether the disclosure
to a client, if made, must indicate the location of the
third-party service provider.
light of these lingering issues, it is fair to ask whether
the AICPA adequately addressed the overall disclosure issue
as it relates to outsourcing, and whether the recent ethics
rulings were in the best interest of the accounting profession.
of Outsourced Income Tax Returns
(for example, see “Outsourcing Income Tax Returns
to India: Legal, Ethical, and Professional Issues,”
by Richard G. Brody, Mary J. Miller, and Michael J. Rolleri,
in the December 2004 issue of the CPA Journal)
have focused on the process of outsourcing income tax return
preparation. In summary, a client’s tax information
is sent via a secure server to India for processing. The
completed information is then sent back to the United States
for review and delivery to the client. Because of the time
differential, work done in India can be ready the next morning.
To help maintain security, the server containing the client’s
information is maintained in the United States.
still remain regarding the mechanics of outsourcing, the
safety of information (including issues related to the Gramm-Leach
Bliley Act, which requires firms to protect clients’
privacy), the potential for the information to be compromised,
and the views of the malpractice insurers.
Profession and the AICPA
AICPA members were uncertain how much information had to
be disclosed to clients regarding the outsourcing of their
income tax return preparation to India. After all, in the
end, a CPA is ultimately responsible for the tax return
and provides a review of the return before signing off.
But outsourcing companies have suggested that clients do
not need to be specifically told; that is, a blanket disclosure
could be used, or a general comment about the potential
use of third-party providers would suffice as permission.
real issue is that tax preparers are not required to indicate
specifically that a tax return would be sent to India. Setting
aside the security issues, the focus should be on the ethical
nature of this process. Public accounting firms often claim
their clients do not care about the outsourcing issue. If
so, then why not tell them directly that their return is
going to be processed outside of their offices and, more
specifically, sent to India?
potential concern is that this could lead to a request for
reduced fees (because outsourcing generates greater profits),
but this could, perhaps, be mitigated by assurances from
the CPA that the return will be checked and signed by the
CPA. Additionally, other industries make use of outsourcing,
and there have not been widespread calls for service-charge
reductions in those industries.
Birth of a Technical Ruling
tone of the introduction and background section of the exposure
draft of the AICPA’s Technical Ethics Rulings in August
2004 was fairly narrow in scope; it centered on whether
use of a third-party provider was a “release of confidential
client information,” and not on the fairness or desirability
of transparency in the required disclosure itself (aicpa.org/members/div/ethics/ed_outsourcing.htm).
Thus, a generic disclosure with some mention that a third
party was being used formed the basis of the proposed ruling.
Many comment letters received by the AICPA called for stricter
disclosure of whatever outsourcing was occurring. Some letters
suggested the banning of overseas outsourcing.
final rulings, however, did not require specific disclosure
of outsourcing, and indeed, the PEEC noted that they “believed
it was appropriate to focus on the ethical issues when a
member uses the services of a third-party provider and not
(to) address the geopolitical concerns associated with outsourcing.”
Thus, the ruling merely called for disclosure in some general
sense (“preferably in writing”).
lost in the rationale of the above explanation is that the
geopolitical concerns themselves have ethical implications.
the public accounting profession attempted to regulate itself
through what it perceived to be adequate disclosure to clients
with respect to the outsourcing of returns. In December
2005, however, the IRS issued a proposed regulation that
would significantly strengthen the disclosure requirement
when the third-party provider was in a foreign country.
It would specifically require the taxpayer’s prior
written consent before return preparation could be outsourced
overseas. While the regulations are not finalized, it is
safe to assume that once again the profession’s attempts
at self-regulation will be superseded by the federal government,
much as the PCAOB regulates the auditors of public companies.
gather evidence on taxpayers’ perceptions concerning
public accountants’ disclosure of tax return preparation
outsourcing, a convenience sample (where participants were
selected at the convenience of the researchers and no attempt
was made to ensure that the sample was an accurate representation
of the entire population) was taken of 345 taxpayers in
a major city in the southeastern United States. As with
any convenience sample, there is always the issue of the
ability to generalize the results beyond the actual sample.
The size of the sample was fairly large, however, and there
was no bias in the data-collection process. The authors
believe the survey results still provide some fairly significant
insights into the issues, and the subjects provided consistent
responses that the authors suspect would be obtained by
a larger or random sample.
subject was asked six questions regarding outsourcing and
to Question 1 indicate that approximately 60% of those surveyed
use a paid tax return preparer, consistent with the 56%
figure noted in a recent GAO report (http://www.senate.gov/~finance/
question was asked to analyze the responses of those who
use a paid preparer separately from those who do not. The
results for respondents with a paid tax preparer (209 subjects)
are shown in Exhibit
1 and the results for respondents without a paid tax
preparer (136 subjects) are shown in Exhibit
interpretation of the responses to Question 2 underscores
an important fundamental issue: In an environment of purportedly
mandated disclosure, do individuals know when their tax
preparers are outsourcing the preparation of tax returns?
Only 6.2% of respondents who use a paid preparer indicated
that they know that their returns are outsourced, while
45% said that they did not know.
second fundamental issue is addressed by Question 3. The
results indicate that approximately 72% who use a paid preparer
do care if their return is outsourced.
4 and 5 provide further evidence of the significant concerns
taxpayers have. More than 84% of respondents who use a paid
preparer said that it would make a difference to them if
their preparer outsourced a return overseas, and more than
90% said that they were not aware that their preparer is
not obligated to inform them if the preparation of a return
is going to be outsourced.
6, perhaps the most important issue, shows that a huge percentage
of respondents (80.8%) who use a paid preparer said that
the failure of their tax preparer to inform them that their
return had been outsourced would affect their perception
of the preparer’s trustworthiness.
indicated in Exhibit 2, the results of respondents who do
not use a paid preparer were similar to the responses for
those who do. Specifically, in response to Question 3, approximately
73% of these respondents indicated that they would care
if their accountant outsourced the preparation of their
return. This was not a statistically significant difference
from the responses of those who use a paid preparer. Regarding
Question 4, almost 88% of those who do not use a paid preparer
stated that it would make a difference if their return was
outsourced overseas. This response was also not statistically
significantly different from those respondents who use a
was a significant difference between the two groups with
respect to their awareness of whether a preparer is required
to inform a client about outsourcing (Question 5). Despite
this difference, there is no apparent practical significance
associated with this result and it has no bearing on the
overall results. In the end, 83% and 90%—both overwhelming
majorities—were still not aware that disclosure of
outsourcing was not required.
in the response to Question 6 were only marginally significant,
with those not using a paid preparer being slightly more
likely to say that failure to disclose outsourcing would
affect their perception of the trustworthiness of their
provider (86.8% versus 80.8%).
it is clear that the respondents share similar views, regardless
of whether or not they use a paid preparer. Additionally,
the data obtained strongly suggest that preparers who do
not adequately disclose information are negatively perceived
the AICPA issues its technical rulings, an exposure draft
is issued and AICPA members are able to respond with comment
letters. An exposure draft was issued on August 9, 2004
(Omnibus Proposal of Professional Ethics Division Interpretations
and Rulings), and less than five of the 48 responses were
in support of the exposure draft.
overwhelming majority of the comment letters received voiced
concern about the proposed ethics rules (see Exhibit
3, Panel A). Even the majority of the “positive”
responses (see Exhibit
3, Panel B) did not completely support the exposure
draft, primarily because the draft did not mandate disclosure.
some comments addressed the issue of foreign outsourcing
as a primary problem, others emphasized the importance of
complete and full disclosure and wanted to make disclosure
to clients mandatory. Given that the final wording said
that a tax preparer “should”—not “must”—disclose
the use of a third-party service provider, many have been
left frustrated, disappointed, and, sadly, worried about
clients’ reactions when they discover this practice.
the comment letters received by the AICPA and the results
of this survey clearly indicate that people care passionately
about this issue. While one concern is related to the security
and privacy of confidential information, a bigger concern
may be disclosure. Individuals want to know if their information
is not being processed by the person they are paying, and
if their information is being sent outside the country.
The authors believe this was a known problem, and the AICPA
consciously made a decision that many find to be inadequate
and not in the best interest of the profession.
AICPA had another chance to do the right thing, but despite
the objections received in many of the comment letters,
the final ruling was “soft.” It did not state
that clients had to be informed in writing that their information
might be provided to third-party providers. It also did
not state that clients had to be told that their information
might be sent to India.
issue has not been widely disseminated among the general
public, and many AICPA members are not familiar with it.
As awareness grows, however, one must wonder if this decision
by the AICPA will further tarnish the reputation of the
accounting profession. The AICPA still retains some power
with respect to the profession, but this lack of forthrightness
may do further harm to its reputation. To quote an individual
responding to the exposure draft:
this information is not disclosed to the client, I believe
this issue is a time bomb waiting to go off. It is only
a matter of time before clients discover that outsourcing
to foreign countries is being widely utilized …
As CPAs we are charged with restoring investors’
faith after the wake of Enron and WorldCom[;] telling
clients upfront that a third party may be used as part
of the process is a preventative measure that we should
G. Brody, CPA, CFE, is an associate professor of
accounting at the Robert O. Anderson Schools of Management
at the University of New Mexico, Albuquerque, N.M.;
John M. Coulter is an associate professor
at the school of business at Western New England College,
Springfield, Mass.; and
John Jewell, CPA, JD, LLM, is an instructor
of accounting and law at the University of South Florida,
St. Petersburg, Fla.