Principles for Accountants
Legal Issues and Business Opportunities
Mary J. Hildebrand and Matthew Savare
MAY 2008 - Europe has taken an aggressive stance on protecting individual
privacy with its comprehensive European Union Privacy Directive.
The United States, however, has, until fairly recently, adopted
a more laissez-faire approach. Over the last several years,
there has been a dramatic increase in the incidents of identity
theft and high-profile data security breaches—many involving
accountants, tax preparers, and auditors. For example, in January
2006, some H&R Block clients’ Social Security numbers
appeared on mailing labels. Similarly, Deloitte & Touche, the
AICPA, and even the IRS have also suffered from data breaches. In
light of these problems, American consumers and legislators have
begun to focus on the privacy of personal information.
theft is the most rapidly growing white-collar crime (Daniel J.
Solove, “A Taxonomy of Privacy,” University of
Pennsylvania Law Review, January 2006). Surveys estimate
that approximately 10 million consumers are victimized each year
by some type of identify theft. The Federal Trade Commission (FTC)
estimates that identity theft cost businesses approximately $50
billion in 2003 (Joel Winston, “Identify Theft and Social
Security Numbers,” E-Commerce Law Report, April
2006). In this environment, protecting consumer privacy is rapidly
becoming one of the most significant legal and technological challenges
facing businesses. Respecting and safeguarding consumer privacy
is not just a legal issue, however. It is also a business issue
that can profoundly impact a company’s risks, reputation,
and bottom line.
Legal and Compliance Issues
Privacy, a vague, abstract concept, means different things to
different people. It is one aspect of disparate legal issues such
as abortion, wiretapping, airport screening, disclosure of medical
or financial information, police searches, and journalism. Solove’s
article quoted one privacy scholar’s lament: “Privacy
seems to be about everything, and therefore it appears to be nothing.”
This article uses the AICPA’s definition of “privacy”
as “the rights and obligations of individuals and organizations
with respect to the collection, use, retention, and disclosure
of personal information.” Viewed in this context, CPAs need
to comply with a host of information privacy laws, regulations,
Gramm-Leach Bliley Act. The Financial
Modernization Act of 1999, also known as the Gramm-Leach-Bliley
Act (GLBA; 15 USC sections 6801–6809), and its accompanying
FTC regulations govern the collection, use, disclosure, and protection
of consumers’ “nonpublic personal information.”
16 CFR section 313.3(n)(1) defines “nonpublic personal information”
as “(i) Personally identifiable financial information; and
(ii) Any list, description, or other grouping of consumers (and
publicly available information pertaining to them) that is derived
using any personally identifiable financial information that is
not publicly available.” GLBA applies to “financial
institutions” that are “significantly engaged”
in providing individual clients with “financial products
or services” for personal, familial, or household purposes
(i.e., nonbusiness purposes). Significant for accountants, the
statute covers the preparation of individual tax returns and the
provision of nonbusiness tax or financial planning advice. As
such, accountants who provide these types of services to individual
clients must comply with GLBA.
GLBA imposes two significant requirements upon accountants who
are covered by the statute. First, accountants are prohibited
from disclosing to a nonaffiliated third party any nonpublic personal
information of their clients, such as Social Security numbers,
tax return data, and account information (15 USC section 6802).
GLBA does permit “financial institutions” to disclose
certain information if a client is provided an opt-out notice
and a reasonable opportunity to opt out of the disclosure. As
noted later herein, IRC section 7216 restricts accountants’
use and disclosure of clients’ federal tax return information.
Furthermore, FTC staff has stated unequivocally of the GLBA’s
exemption: “The Privacy Rule does not supersede the restrictions
in section 7216. The GLB Act and the Agencies’ implementing
regulations do not authorize a financial institution to disclose
nonpublic personal information in a way that is prohibited by
some other law. Therefore, you may not avoid the restrictions
of section 7216 by providing your customers with an opt-out notice
and a reasonable opportunity to opt out” (FTC, “Frequently
Asked Questions for the Privacy Regulation,” www.ftc.gov/privacy/glbact/glb-faq.htm#A)
Disclosure is permitted, however, to effect or administer a client
transaction (e.g., disclosure of a tax return to a tax return
processor); to participate in a peer review; to comply with federal,
state, or local laws; and to comply with court orders.
Second, FTC regulations require accountants to “develop,
implement, and maintain a [written] comprehensive information
security program” that outlines the ways in which they protect
client information (16 CFR section 314.3). The program must be
tailored to the size and complexity of the accountant’s
practice, the nature and scope of the services, and the sensitivity
of client data. As specified by 16 CFR section 314.4, under the
security plan accountants must do the following:
- Designate the employees to coordinate the safeguards;
- Identify and assess risks to customer information;
- Create, monitor, and test a safeguards program that addresses
the risks identified during the assessment;
- Select appropriate service providers and require them by
contract to implement these safeguards; and
- Evaluate the plan and adjust it as necessary.
Because AICPA Code of Professional Conduct Rule 301 mandates
that “[a] member in public practice shall not disclose any
confidential client information without the specific consent of
the client,” the safeguards program should not require accountants
to perform many additional tasks. At minimum, accountants should
document their existing safeguard plan, designate someone to coordinate
it, and require their service providers to comply. Requiring service
providers to agree to safeguard client data comports with the
recommendations outlined in AICPA Rule 391, which states: “[T]he
member should enter into a contractual agreement with the third-party
service provider to maintain the confidentiality of the information
and be reasonably assured that the third-party service provider
has appropriate procedures in place to prevent the unauthorized
release of confidential information to others.”
With more tax-return preparation work being sent overseas, accountants
must recognize that although they can outsource certain job functions,
they cannot outsource their legal liability for privacy violations.
According to Amy E. Yates [“Sit, Walk, Heel, Stay (or How
to Train Your) Outsourcer,” SciTech Lawyer, Summer
2006], privacy experts recommend that covered entities such as
accountants employ six rules to meet their obligations under data
privacy laws and to manage their risks when outsourcing to third
- Enter into a contractual agreement with the third party that
delineates that party’s specific obligations, rather than
simply stating that the party will comply with all applicable
laws and regulations.
- Perform a “gap” analysis and determine if the
third party’s privacy and security policies are adequate.
- Become familiar with the third party’s processing practices.
For example, is the third party collecting more confidential
information than is necessary to complete the required job?
- Perform privacy audits on the potential and existing outsourcers
on a periodic basis.
- Establish a strong working relationship with the vendor’s
chief privacy officer.
- Employ and maintain strong privacy protections in the accounting
Prior to October 13, 2006, GLBA required accountants to provide
annual notices to clients regarding their privacy policies. On
that date, President Bush signed into law the Financial Services
Regulatory Relief Act of 2006, which contained a provision exempting
CPAs from this requirement (“President Bush Signs into Law
Bill Giving CPAs Exemption from Gramm-Leach-Bliley Annual Notification
Notwithstanding this exemption, the AICPA still strongly recommends
policy does not need to be personalized for each client. Instead,
it can be posted to the accountant’s website or provided
in conjunction with a bill, engagement letter, or newsletter.
The policy, which should be clear, conspicuous, and accurate,
should describe the following items:
- Types of nonpublic personal information the accountant collects;
- Types of such information that the accountant discloses;
- Parties to whom the accountant discloses such information;
- Circumstances under which the accountant discloses such information;
- The policy regarding sharing information of former clients;
- The practices for protecting such information.
one, can expose the accountant to claims of breach of contract,
negligence, or unfair and deceptive trade practices.
IRC and Treasury regulations. IRC section
7216 prohibits tax preparers from “knowingly” or “recklessly”
disclosing or using tax-related information other than in connection
with the preparation of the return. The statute provides for fines
and possible imprisonment for such violations. Disclosures pursuant
to a court order or to third parties assisting in the processing
of the return are permissible. Currently, there are no requirements
to inform a client that a third-party provider, including an overseas
provider, is being used. Similarly, IRC section 6713 imposes a
$250 civil penalty for each improper use or disclosure of client
information, with the total penalty not to exceed $10,000 for
any person for a calendar year.
Treasury Department regulations enacted pursuant to the IRC permit
accountants to disclose or use tax return information for three
discrete reasons, provided the client signs a formal written consent
(26 CFR section 301.7216-3). First, the regulations permit accountants
to use tax return information to solicit from their clients additional
non-IRS services that they provide to the general public [26 CFR
section 301.7216-3(a)(1)]. The regulations provide three examples
of when such a consent is required [see 26 CFR section 301.7216-3(c)].
Examples of such services include refund anticipation loans, balance
due loans, mortgage loans, mutual funds, IRAs, and life insurance.
The request for this type of consent must be made before the taxpayer
receives his completed return, and if the taxpayer refuses to
give consent, no follow-up request may be made. Second, the regulations
allow accountants to disclose tax return information to such third
parties, including marketers, as the taxpayer may direct [26 CFR
section 301.7216-3(a)(2)]. Finally, with the proper consent, accountants
may disclose or use the tax return information from one client
to aid in the preparation of a tax return for another client [26
CFR section 301.7216-3(a)(3)].
As provided for by 26 CFR section 301.7216-3(b), the accountant
must obtain a separate written consent signed by the client for
each separate use or disclosure. The consent must contain the
- Name of the tax return preparer;
- Name of the taxpayer;
- Purpose for which the consent is being furnished;
- Date on which such consent is signed;
- Statement that the tax return information may not be disclosed
or used by the tax return preparer for any other purpose; and
- Statement by the taxpayer that he consents to the disclosure
or use of such information for the specified purpose.
In December 2005, the IRS issued proposed amendments to 26 CFR
section 301.7216 (Department of the Treasury, “Guidance
Necessary to Facilitate Electronic Tax Administration—Updating
Section 7216 Regulations,” December 8, 2005). The proposed
changes included broadening the definitions of “tax return
preparer” and “tax return information”; revising
the manner and form of obtaining client consent to use or disclose
tax return information; and introducing a new requirement to obtain
taxpayer consent before sending any tax return information outside
the United States, including to subcontractors doing the actual
tax preparation. The IRS’s proposed wording for consents
to disclose and to use tax information stated the following:
We generally are not authorized to disclose your tax return
information for purposes other than the preparation and filing
of your tax return. We may disclose your tax return information
to third parties only if you consent to each specific disclosure.
Your consent is valid for one year.
Warning: Once your tax return information
is disclosed to a third party per your consent, we have no
control over what that third party does with your tax return
information. If the third party uses or discloses your tax
return information for purposes other than the purpose for
which you authorized the disclosure, under Federal tax law,
we are not responsible for that subsequent use or disclosure,
and Federal tax law may not protect you from that disclosure.
We generally are not authorized to use your tax return information
for purposes other than the preparation and filing of your tax
return. We may use your tax return information for other purposes
only if you consent to each specific use. Your consent is valid
for one year.
As of the publication of this article, these proposed changes
have not been adopted. Indeed, many experts, including William
Stromson, the AICPA’s director of taxation, believe that
Congress will petition for even greater privacy protections, including
a possible outright prohibition from sharing a client’s
tax return information, even with formal, written consent.
Individual states’ privacy laws.
Federal privacy legislation tends to focus on specific economic
sectors, such as the financial industry, which is regulated by
the privacy and security provisions of GLBA. Nevertheless, state
data-security laws typically extend beyond particular industries.
For example, as of January 2008, at least 39 states and the District
of Columbia have enacted security breach notification laws that
impose security and privacy standards that are generally applicable
across industries (National Conference of State Legislatures,
“State Security Breach Notification Laws,” www.ncsl.org/programs/lis/cip/priv/breachlaws.htm).
These states include California, Florida, New Jersey, New York,
and Texas (see David Leit and Matthew Savare, “New Jersey
Enacts Identity Theft Prevention Act,” The Metropolitan
Corporate Counsel, February 2006). CPAs are well advised
to research whether their state has passed additional privacy
legislation that could impact their business operations.
One example of this type of legislation, New Jersey’s Identity
Theft Prevention Act, requires businesses to notify New Jersey
consumers if their personal information has been compromised;
requires businesses and public entities to thoroughly destroy
customer records that are no longer to be retained; and limits
the use and display of Social Security numbers.
Facing these statutory requirements and similar laws from other
states, accountants should take the following measures to mitigate
- Adopt and implement robust electronic and physical safeguards
to protect and monitor clients’ personal information.
For example, all filing cabinets containing tax-related information
should be locked, and all computers, laptops, and networks should
be password-protected. Electronic data, particularly data stored
on laptops and networks, should be encrypted using industry-standard
protocols (i.e., 128-bit secure socket layers). Laptops are
especially vulnerable. A 2006 survey report indicated that 81%
of the companies questioned reported the loss of at least one
laptop containing sensitive data during the past 12 months (David
Lazarus, “Data Theft May Hurt Workers,” www.sfgate.com).
- All paper and electronic files that are to be discarded should
be obliterated. Paper documents should be cross-shredded or
destroyed by a third-party vendor that specializes in document
destruction. Floppy disks should be thoroughly destroyed, not
simply erased or reformatted. Similarly, before an old computer
is discarded or sold, its hard drive should be removed and then
either physically destroyed beyond reconstructability, or encrypted
and then permanently stored. No deletion, reformatting, or wiping
function can completely guarantee that a hard drive has been
stripped of all confidential information (David Beckman and
David Hirsch, “Hard Drive Homicide: Old Hard Drives Must
Rest in Pieces for Lawyers to Truly Rest in Peace,” ABA
Journal, August 2006).
- Whenever possible, employ the principles of “data minimization”
and “retention limitation.” The former means that
“unneeded data is not collected in the first place.”
The latter means that “data that is outdated or no longer
needed is securely and effectively deleted or destroyed”
(Ann Cavoukian, “Fighting Identity Theft Starts with Businesses,
Not Consumers,” SciTech Lawyer, Summer 2006).
Accountants should not be overzealous in practicing this “retention
limitation,” however, because IRC section 6107(b) requires
them to retain copies of completed tax returns or maintain a
list of all returns, including clients’ names and Social
Security numbers, for three years after the close of a return
Privacy is a risk-management issue for businesses. Conceptualizing,
implementing, monitoring, and enforcing strict privacy safeguards
are instrumental in reducing such privacy-related risks as identity
theft, extortion, litigation, lost business, and a reduced stock
price. Moreover, enhancing privacy protection protects valuable
business assets, preserves and enhances a company’s brand
and reputation, and preserves and augments customer loyalty. Accordingly,
businesses, particularly those with an online presence, have retained
privacy lawyers and information consultants to address their privacy
needs. Increasingly, businesses are also engaging accountants
for a broad array of privacy services.
Accountants possess the technical skills and training to provide
information assurance, compliance testing, independent verifications,
and attestations of management reporting. Historically, accountants
have provided these services as they relate to financial reporting.
With the current emphasis on information privacy, many accountants
now offer the following privacy services as well:
- Strategic privacy and business planning
- Privacy gap and risk analysis
- Privacy-policy design and implementation
- Performance measurement
- Independent verification of privacy controls (privacy audits)
- Attestation of management’s privacy reports.
As noted above, privacy legislation is a patchwork of federal
and state statutes and regulations. As such, accountants are well
advised to consult with an experienced privacy attorney before
offering privacy services to the public. At minimum, however,
accountants should have at least a rudimentary independent understanding
of the following privacy statutes:
Health Insurance Portability and Accounting Act (HIPAA).
HIPAA [PL 104-191, 110 Stat. 1936 (1996)] and the regulations
promulgated under it are the first set of comprehensive rules
on health privacy. However, these regulations do not apply to
all people or entities that have access to an individual’s
health information. Instead, they apply only to “a health
plan,” “a health care clearinghouse,” and “a
health care provider who transmits any health information in electronic
form” (45 CFR section 160.102). These “covered entities”
are defined in 45 CFR section 160.103 as follows: a “health
plan” is “an individual or group that provides, or
pays the cost of, medical care.” This definition encompasses
health insurers, HMOs, and group health plans. A “health
care clearinghouse” is a public or private entity that processes
health information into a standard format or into specialized
formats for the needs of specific entities. This definition includes
billing services, repricing companies, community health management
information systems, and community health information systems.
Finally, a “health care provider” is a “provider
of medical or health services … and any other person or
organization who furnishes, bills, or is paid for health care
in the normal course of business.” Examples of healthcare
providers include physicians, hospitals, and pharmacists.
HIPAA’s privacy rule creates standards for electronic transactions,
data security, patient identification numbers, and the privacy
of health information.
Gramm-Leach Bliley Act (GLBA). As discussed
in detail above, GLBA applies to “financial institutions.”
The statute governs privacy issues for personal financial information.
Children’s Online Privacy Protection Act (COPPA).
COPPA (15 USC sections 6501–06) regulates the collection
and use of children’s information by websites. It applies
to “an operator of a website or online service directed
to children, or any operator that has actual knowledge that it
is collecting personal information from a child.”
Important elements of COPPA include: 1) a requirement that children’s
websites post their privacy policies, describing “what information
is collected from children by the operator, how the operator uses
such information, and the operator’s disclosure practices
for such information”; 2) a requirement that operators of
such sites “obtain verifiable parental consent for the collection,
use or disclosure of personal information from children”;
3) a prohibition of websites conditioning a child’s participation
in a game or receipt of a prize on the disclosure of more personal
information than is necessary to participate in that activity;
and 4) a requirement that operators of such sites “establish
and maintain reasonable procedures to protect the confidentiality,
security, and integrity of personal information collected from
Controlling the Assault of Non-Solicited Pornography
and Marketing (CAN-SPAM). The CAN-SPAM Act establishes
requirements for those who send commercial e-mails, spells out
penalties for spammers and companies whose products are advertised
in spam if they violate the law, and gives consumers the right
to ask e-mailers to stop spamming them. The law has four significant
- It bans false or misleading header information. The “To,”
“From,” and routing information—including
the originating domain name and e-mail address—must be
accurate and identify the person who initiated the e-mail.
- It prohibits deceptive subject lines (i.e., the subject line
cannot mislead the recipient about the contents or subject matter
of the message).
- It requires that the e-mail provide recipients with an opt-out
method. In other words, the sender must provide a return e-mail
address or another Internet-based response mechanism that allows
a recipient to ask the sender not to send future e-mail messages
to that e-mail address. Once the sender receives such an opt-out
demand, it must honor the request within 10 business days. In
addition, the sender cannot help another entity send e-mail
to that address or have another entity send e-mail on its behalf
to that address.
- It requires that commercial e-mail contain a clear and conspicuous
notice that the message is an advertisement or solicitation
and must include the sender’s valid physical postal address.
Federal Trade Commission Act (FTC Act). Since
1998, the FTC has been suing companies that violate their own
privacy policies (Daniel J. Solove, The Digital Person: Technology
and Privacy in the Information Age, New York University Press,
2004). These actions are brought under the FTC Act (15 USC section
45), which prohibits “unfair or deceptive” business
practices. The FTC has interpreted this statute as being violated
AICPA’s “Generally Accepted Privacy Principles:
A Global Privacy Framework.” Most companies
above, “financial institutions” covered by GLBA, “covered
entities” governed by HIPAA, and websites directed at children
that fall under COPPA are all required to maintain and enforce
then it must comply with its provisions or it risks facing an
FTC action or a breach-of-contract lawsuit. The AICPA has
developed “Generally Accepted Privacy Principles: A Global
Privacy Framework” (infotech.aicpa.org/Resources/Privacy/
Generally+Accepted+Privacy+Principles.htm), which is an invaluable
resource for accountants to address the privacy-compliance issues
of their clients, including drafting and enforcing privacy policies.
The AICPA states that the framework’s privacy objective
is that: “Personal information is collected, used, retained,
and disclosed in conformity with the commitments in the entity’s
privacy notice and with criteria set forth in Generally Accepted
Privacy Principles issued by the AICPA/CICA [Canadian Institute
of Chartered Accountants].” Page 7 of the document lists
10 “Generally Accepted Privacy Principles” and provides
objective, measurable criteria against which accountants audit
each of the principles:
- Management: “Entity defines, documents, communicates,
and assigns accountability for its privacy policies, and procedures.”
- Notice: “Entity provides notice about its privacy policies
and procedures and identifies the purposes for which personal
information is collected, used, retained, and disclosed.”
- Choice and consent: “Entity describes the choices available
to the individual and obtains implicit or explicit consent with
respect to the collection, use, and disclosure of personal information.”
- Collection: “Entity collects personal information only
for the purposes identified in the notice.”
- Use and retention: “Entity limits the use of personal
information to the purposes identified in the notice and for
which the individual has provided implicit or explicit consent.
The entity retains personal information for only as long as
necessary to fulfill the stated purposes.”
- Access: “Entity provides individuals with access to
their personal information for review and update.”
- Disclosure to third parties: “Entity discloses personal
information to third parties only for the purpose identified
in the notice and with the implicit or explicit consent of the
- Security: “Entity protects personal information against
unauthorized access (both physical and logical).”
- Quality: “Entity maintains accurate, complete, and
relevant personal information for the purposes identified in
n Monitoring and enforcement: “Entity monitors compliance
with its privacy policies and procedures and has procedures
to address privacy-related complaints and disputes.”
CPAs seeking to provide privacy advisory services are well advised
to counsel their clients to employ the framework’s 10 privacy
principles. In addition, they should consider using the objective
criteria in the framework when evaluating an entity’s privacy
policies, procedures, and controls.
Mary J. Hildebrand, Esq., is a senior member
of Lowenstein Sandler, PC. She can be reached at
Matthew Savare, Esq., is an associate, also of
Lowenstein Sandler, PC. He can be reached at email@example.com.