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February 2000
Society Adopts Ethics InterpretationsThe NYSSCPA Executive Committee adopted the following ethics interpretations at its December 14 meeting. The AICPA also has adopted these interpretations. See www.nysscpa.org for the complete revised Code of Professional Conduct. These interpretations become effective with the publication of this issue of The Trusted Professional. 101-14, The Effect of Alternative Practice Structures on the Applicability of Independence Rules New ethics interpretation 101-14 deals with alternative practice structures. This interpretation together with existing quality control requirements is intended to provide safeguards to protect the public when using the services of firms that practice in alternative structures. The interpretation follows: 101-14--The effect of alternative practice structures on the applicability of independence rules. Generally, Rule 101, Independence, and the related interpretations and rulings (collectively referred to as the "independence rules") apply only to a "member or member's firm." That term is defined in interpretation 101-9 to include (1) the member's firm and its proprietors, partners, and shareholders, In many "nontraditional structures," a substantial (the nonattest) portion of a member's practice is conducted under public or private ownership, and the attest portion of the practice is conducted through a separate firm owned and controlled by the member. All such structures must comply with applicable state laws, state regulations, and Rule 505, Form of Organization and Name. In complying with state laws, state regulations, and Rule 505, many elements of quality control are required to ensure that the public interest is adequately protected. For example, all services performed by members and persons over whom they have control must comply with standards promulgated by appropriate bodies. Finally, and importantly, the members are responsible, financially and otherwise, for all the attest work performed. Considering the extent of such measures, PEC believes that the additional independence rules set forth in this interpretation are sufficient to ensure that attest services can be performed with objectivity and, therefore, the additional rules satisfactorily protect the public interest. Rule 505 and the following independence rules for an alternative practice structure (APS) are intended to be conceptual and applicable to all structures where the "traditional firm" engaged in attest services is closely aligned with another organization, public or private, that performs other professional services. The following paragraph and the chart below provide an example of a structure in use at the time this interpretation was developed. Many of the references in this interpretation are to the example. PEC intends that the concepts expressed herein be applied, in spirit and in substance, to variations of the example structure as they develop. The example APS in this interpretation is one where an existing CPA practice ("Oldfirm") is sold by its owners to another (possibly public) entity ("PublicCo"). PublicCo has subsidiaries or divisions such as a bank, insurance company, or broker-dealer, and it also has one or more professional service subsidiaries or divisions that offer to clients nonattest professional services (e.g., tax, personal financial planning, and management consulting). The owners and employees of Oldfirm become employees of one of PublicCo's subsidiaries or divisions and may provide those nonattest services. In addition, the owners of Oldfirm form a new CPA firm ("Newfirm") to provide attest services. CPAs, including the former owners of Oldfirm, own a majority of Newfirm (as to vote and financial interests). Attest services are performed by Newfirm and are supervised by its owners. The arrangement between Newfirm and PublicCo (or one of its subsidiaries or divisions) includes the lease of employees, office space, and equipment; the performance of back-office functions such as billing and collections; and advertising. Newfirm pays a negotiated amount for these services. APS Independence Rules for Members The term "member or member's firm" ("Member") in an APS includes any person (leased or employed) or entity included in the definition of a member in interpretation 101-9, as described in paragraph 1 of this interpretation. The "firm" in such definition would be Newfirm in the example APS. All such persons and entities (Newfirm and entities controlled by one or more individuals included in the definition) included in Member are subject to Rule 101 and its interpretations and rulings in their entirety. For example, no person or entity included in Member could have, among other things, a direct financial interest in or a loan to or from an attest client of Newfirm. Owners of one Newfirm generally would not be considered Members with respect to the attest clients of another Newfirm except in situations where those owners perform services for the other Newfirm or where there are significant shared economic interests between owners of more than one Newfirm. If, for example, owners of Newfirm 1 perform services in Newfirm 2, such owners would be considered to be owners of both Newfirms for purposes of applying the independence rules. Similarly, individuals with a managerial position (leased or otherwise) in one office (which, for the purpose of this discussion, may be an entire Newfirm) may, at times, be considered to also have a managerial position in another office. Judgment should be applied in determining whether or not an individual should be considered a managerial individual in more than one office. Factors to consider would include the attributes of a managerial position as stated in interpretation 101-9 and the amount of time the individual devotes to such a role in each office. APS Independence Rules for Persons and Entities Other Than Member As stated above, the independence rules normally extend only to those persons and entities included in the definition of Member. This normally would include only persons who own or are employed by the "traditional firm"--Newfirm in the example APS--and entities controlled by one or more of such persons. Because of the close alignment in many APSs between persons and entities included in Member and other persons and entities, to ensure the protection of the public interest, PEC believes it appropriate to require restrictions beyond those required in a traditional firm structure. Those restrictions are divided into two groups: 1. Direct Superiors. Direct Superiors are defined to include those persons so closely associated with (1) an owner of Newfirm or (2) a person with a managerial position employed or leased by Newfirm and who is located in an office participating in a significant portion of the attest engagement, that such persons can directly control the activities of the owner or managerial employee. For this purpose, a person who can directly control is the immediate superior of the owner or managerial employee who has the power to direct the activities of that person so as to be able to directly or indirectly (e.g., through another entity over which the Direct Superior can exercise significant influence) derive a benefit from that person's activities. Examples would be the person who has day-to-day responsibility for the activities of the owner or managerial employee and is in a position to recommend promotions and compensation levels. This group of persons is, in the view of PEC, so closely aligned through direct reporting relationships with persons included in Member that their interests would seem to be inseparable. Consequently, persons considered Direct Superiors, and entities over whose activities such persons can exercise significant influence, as defined in interpretation 101-9, are subject to all the same independence requirements as Member. 2. Indirect Superiors and Other PublicCo Entities. Indirect Superiors are those persons who are one or more levels above persons included in Direct Superior. Generally, this would start with persons in an organization structure to whom Direct Superiors report and go up the line from there. PEC believes that certain restrictions must be placed on Indirect Superiors, but also believes that such persons are sufficiently removed from those included in Member to permit a somewhat less restrictive standard. Indirect Superiors are not connected with persons included in Member through direct reporting relationships; there always is a level in between. PEC also believes that, for purposes of the following, the definition of Indirect Superior also includes the spouses, cohabitants, and dependent persons of the Indirect Superior. PEC carefully considered the risk that an Indirect Superior, through a Direct Superior, might attempt to influence the decisions made during the engagement for a Newfirm attest client. PEC believes that this risk is reduced to a sufficiently low level by prohibiting certain relationships between Indirect Superiors and Newfirm attest clients and by applying a materiality concept with respect to financial relationships. If the financial relationship is not material to the Indirect Superior, PEC believes that he or she would not be sufficiently financially motivated to attempt such influence particularly with sufficient effort to overcome the presumed integrity, objectivity, and strength of character of Members involved in the engagement. Similar standards also are appropriate for Other PublicCo Entities. These entities are defined to include PublicCo and all entities consolidated in the PublicCo financial statements and (1) not included in the definition of Member and (2) not subject to the same rules as Member because they are not entities over whose activities a Direct Superior can exercise significant influence, as discussed above. The rules for Indirect Superiors and Other PublicCo Entities are as follows: A. Indirect Superiors and Other PublicCo Entities may not have a relationship contemplated by interpretation 101-1.A (e.g., investments, loans, etc.) with an attest client of Newfirm that is material. In making the test for materiality for financial relationships of an Indirect Superior, all the financial relationships with an attest client held by such person should be aggregated and, to determine materiality, assessed in relation to the person's net worth. In making the materiality test for financial relationships of Other PublicCo Entities, all the financial relationships with an attest client held by such entities should be aggregated and, to determine materiality, assessed in relation to the consolidated financial statements of PublicCo. In addition, any Other PublicCo Entity over which an Indirect Superior has direct responsibility cannot have a financial relationship with an attest client that is material in relation to the Other PublicCo Entity's financial statements. B. Further, financial relationships of Indirect Superiors or Other PublicCo Entities should not allow such persons or entities to exercise significant influence (as defined in interpretation 101-9) over the attest client. In making the test for significant influence, financial relationships of all Indirect Superiors and Other PublicCo Entities should be aggregated. C. Neither Other PublicCo Entities nor any of their employees may be connected with an attest client of Newfirm as a promoter, underwriter, voting trustee, director, or officer. D. Except as noted in C above, Indirect Superiors and Other PublicCo Entities may provide services to an attest client of Newfirm that would impair independence if performed by, for example, Member. For example, trustee and asset custodial services in the ordinary course of business by a bank subsidiary of PublicCo would be acceptable as long as the bank was not included in the definition of Member or subject to all the same independence requirements as Member (see item 1, "Direct Superiors," above). Other Matters 1. An example, using the chart below, of the application of the concept of Direct and Indirect Superiors would be as follows: The chief executive of the local office of the Professional Services Subsidiary (PSS), where the owners and managerial employees of Newfirm are employed, would be a Direct Superior. The chief executive of PSS itself would be an Indirect Superior, and there may be Indirect Superiors in between such as a regional chief executive of all PSS offices within a geographic area. 2. PEC has concluded that Newfirm (and its owners and employees) may not perform a service requiring independence for PublicCo or any of its subsidiaries or divisions. 3. PEC has concluded that independence would be considered to be impaired with respect to an attest client of Newfirm if such attest client holds an investment in PublicCo that is material to the attest client or allows the attest client to exercise significant influence [as defined in interpretation 101-9] over PublicCo. 4. When making referrals of services among Newfirm and any of the entities within PublicCo, a member should consider the provisions of interpretation 102-2, Conflicts of Interest. Interpretation 101-3 Under Rule of Conduct 101: 101-3, Performance of Other Services Interpretation 101-3 was revised to address the various types of nonattest services that a member may perform for an attest client in today's practice environment and the impact of such services on the member's independence. The interpretation sets forth general principles that the member should consider in evaluating the effect on independence of performing a service, and provides examples of general activities that would be considered to impair independence. Examples follow that apply the general principles and activities to specific services. In general a member's independence would not be considered impaired provided the member does not perform any management functions or make management decisions for the attest client. As revised, the interpretation permits a member to make electronic payroll tax payments through the Electronic Federal Tax Payment System for an attest client without impairing his or her independence, provided the client has made arrangements for the financial institution to limit such payments to a named payee. The revised interpretation follows: 101-3--Performance of Other Services. A member in public practice or his or her firm ("member") who performs for a client services requiring independence ("attest services") may also perform other nonattest services ("other services") for that client. Before a member performs other services for an attest client, he or she must evaluate the effect of such services on his or her independence. In particular, care should be taken not to perform management functions or make management decisions for the attest client, the responsibility for which remains with the client's board of directors and management. Before performing other services, the member should establish an understanding with the client regarding the objectives of the engagement, the services to be performed, management's responsibilities, the member's responsibilities, and the limitations of the engagement. It is preferable that this understanding be documented in an engagement letter that indicates the member will not perform management functions or make management decisions. In addition, the member should be satisfied that the client is in a position to have an informed judgment on the results of the other services and that the client understands its responsibility to--
1. Designate a management-level individual or individuals to be responsible for overseeing the services being provided.
General Activities The following are some general activities that would be considered to impair a member's independence:
* Authorizing, executing, or consummating a transaction, or otherwise exercising authority on behalf of a client (for example, negotiating a transaction), or having the authority to do so
Click here to view examples which identify the effect that performance of other services for an attest client can have on a member's independence. These examples are not intended to be all-inclusive of the types of other services performed by members. Revision to Interpretation 501-4, Negligence in the Preparation of Financial Statements or Records
Interpretation 501-4 relates to a member who, because of his or her negligence, makes or permits another to make materially false and misleading entries in an entity's financial statements or records. The revision expands the interpretation to include those members who have the authority but fail to correct an entity's financial statements or records, which are known to be materially false and misleading, or sign a document containing materially false and misleading information. Interpretation 501-4--Negligence in the preparation of financial statements or records. A member shall be considered to have committed an act discreditable to the profession in violation of Rule 501 when, by virtue of his or her negligence, such member--
a. Makes, or permits or directs another to make, materially false and misleading entries in the financial statements or records of an entity; or
Revision to Interpretation 102-1, Knowing Misrepresentations in the Preparation of Financial Statements or Records Interpretation 102-1 relates to a member who knowingly misrepresents facts in the preparation of financial statements or records. The revision expands the interpretation to include those members who have the authority but fail to correct an entity's financial statements or records, which are known to be materially false and misleading, or who sign a document containing materially false and misleading information. The revised interpretation follows: 102-1--Knowing misrepresentations in the preparation of financial statements or records. A member shall be considered to have knowingly misrepresented facts in violation of Rule 102 when he or she knowingly--
a. Makes, or permits or directs another to make, materially false and misleading entries in an entity's financial statements or records; or
New Interpretation 501-7, Failure to File Tax Return or Pay Tax Liability Interpretation 501-7 has been added to the code. The interpretation relates to a member who fails to timely file his or her personal tax returns or tax returns on the member's firm, including the firm's payroll tax returns and the remittance of related taxes. PEC believes that because the public has associated CPAs with the performance of quality tax services, a member who fails to timely file his or her own or firm's tax returns has discredited the profession. In the case where a member fails to timely file or remit payroll taxes of the firm, the member's actions also constitute a breach of his or her fiduciary responsibility on behalf of firm employees. The new interpretation follows: 501-7--Failure to file tax return or pay tax liability. A member who fails to comply with applicable federal, state, or local laws or regulations regarding the timely filing of his or her personal tax returns or tax returns of the member's firm, or the timely remittance of all payroll and other taxes collected on behalf of others, may be considered to have committed an act discreditable to the profession in violation of Rule 501. Deletion of Interpretation 505-1, Investment in Accounting Organization Interpretation 505-1 relates to a member who has an investment in an entity that practices public accounting through a corporate form. This interpretation is considered obsolete and is covered under Interpretation 505-2, Application of Rules of Conduct to Members Who Own a Separate Business. The following interpretation is deleted:
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