Ethics and Regulations Q & As

July 1999 Issue

Ethics and Regulations Q & As

The NYSSCPA offers assistance with members' questions on ethics and regulation. The following are rulings recently adopted by the AICPA. Although the Society does not officially adopt rulings, the Professional Ethics Committee uses them as guidance.

A member is an officer, director, or principal shareholder of an entity, and that entity has a loan to or from the member's client. Would the independence of the member or member's firm be considered to be impaired with respect to the client?

If a member has control over the entity, as defined in Financial Accounting Standards Board Statement No. 94 (FASB Current Text, AC section C51), the existence of a loan to or from the client would impair the independence of the member or member's firm unless the loan is specifically permitted under Interpretation 101-5.

If a member who does not control the entity is connected with the entity as an officer, director, or principal shareholder, he or she should consider Interpretation 101-2, which provides that a conflict of interest may occur if a member performs a professional service for a client and the member or his or her firm has a relationship with another entity that could, in the member's professional judgment, be viewed by the client or other appropriate parties as impairing the member's objectivity. If the member believes that the professional service can be performed with objectivity, and the relationship is disclosed to and consent is obtained from such client and other appropriate parties, the rule shall not operate to prohibit the performance of the professional service.

When making the decision as to whether to perform a professional service and in making disclosure to the appropriate parties, the member should consider Rule 301, Confidential Client Information.

A member or member's firm provides investment advisory services for an attest client for a fee based on a percentage of the client's investment portfolio. Would the member be considered to be in violation of Rule 302, Contingent Fees?

Yes. However, the fee would not be contingent upon portfolio performance and, therefore, would not be in violation of Rule 302 if all of the following conditions are met:

The fee is determined as a specified percentage of the client's investment portfolio.

The dollar amount of the portfolio on which the fee is based is determined at the beginning of each quarterly period (or a longer period of time, as may be agreed upon) and is adjusted only for additions or withdrawals made by the client during the period.

The fee arrangement is not renewed with the client more frequently than on a quarterly basis.

When performing such services, the member should also consider Rule 101, Independence, especially Interpretation 101-3.

We are a CPA firm whose shareholders are A, B, and C. C is A's son. B is not related to either A or C. In 1996 a corporate client engaged our firm to prepare its annual audited financial statements and provide advisory services. Prior to and since our audit engagement, we also have rendered substantial tax services to the client. We prepared the annual audit reports for 1996 and 1997. C is the partner in charge of the audit.

In 1998 the client hired C's brother to perform office management functions. He is under the supervision of the client's chief operating officer, who reports to the chief executive and chief financial officers.

Does C's brother's employment by the client impair the independence of our firm? If an independence problem exists, can it be ethically resolved by the substitution of B for C as partner in charge of the engagement?

The independence of a member's firm would be considered to be impaired with respect to an enterprise if during the period covered by the financial statements, the period of the professional engagement, or at the time of expressing an opinion: a) an individual participating in the engagement has a close relative who could exercise significant influence over the operating, financial, or accounting policies of the enterprise or who is otherwise employed in a position in which the person's activities are audit sensitive; or b) a proprietor, partner, or shareholder, any of whom is located in an office participating in a significant portion of the engagement, has a close relative who could exercise significant influence over the operating, financial, or accounting policies of the enterprise.

Since a brother is a close relative, if he exercised significant influence, your firm would not be independent with respect to the corporation.

Interpretation 101-9 states that an individual exercises significant influence if that individual "is connected with the entity in a policy-making position related to the entity's primary operating, financial, or accounting policies, such as chief executive officer, chief operating officer, chief financial officer, or chief accounting officer."

In the NYSSCPA Professional Ethics Committee's opinion, if the brother is under the supervision of the client's chief operating officer, who reports to the chief executive and chief financial officers, he is not in a position of significant influence. The brother's activities are, however, audit sensitive. Therefore, if C does not participate in the engagement, his brother's employment would not adversely affect your firm's independence with respect to the corporation. *