April 2001

CPAs and Conflicts of Interest

By Ron Klein

Objectivity and independence have long been central values of the accounting profession, although one could argue that they are less central today than they have been in the past. The growing diversity of services offered by CPA firms can put firms and CPAs in situations that could be perceived as conflicts of interest.

When clients and third parties become disenchanted with a CPA’s objectivity—due to perceptions that are accurate, faulty, or somewhere in between—their view of the CPA begins to change. The CPA no longer is perceived as having their best interests in mind. Instead, the CPA is perceived as motivated by self-interest at the expense of clients and third parties. Given the possibility that things can go from good to bad, CPAs should be cognizant beforehand of the way dynamic situations can change the perceptions of clients and third parties.

Engagements that require equal treatment of parties by the CPA can trigger complaints if one party perceives that another party is receiving favorable treatment. That perception can lead to allegations of conflict of interest, negligence, lack of disclosure, lack of due diligence, and other complaints. Again, perception is paramount in understanding the potential for such allegations.

Consider the following scenarios and the accompanying loss prevention tips.

Scenario 1. A CPA does tax work for a limited partnership as well as for the general partners of the partnership. 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 the excess fees paid to the general partners are discovered. 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 responsibilities to the partnership and to the limited and general partners. The CPA should not be influenced by the fact that the general partners pay the CPA’s fees. When something looks amiss, it is better to be on “the side of the angels”—usually the passive limited partners. The CPA should verify that the information or evidence of wrongdoing is correct and insist 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. The CPA should consult a risk advisor for guidance in these instances.

Scenario 2. A CPA has a Manhattan client who owns a successful women’s clothing boutique. The boutique owner is approached by two outside investors with the idea of opening two more boutiques in Westchester and the Hamptons. 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 the 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. As long as the business deal performs well, everyone is happy. When the deal goes south, however, the CPA appears to have become self-interested at the expense of the client, and juries tend to sympathize with the client. With the benefit of hindsight and all the facts laid out by a skilled attorney, the CPA is portrayed as a financial expert who sacrificed the best interests of his client to benefit himself. Also, disclosing a conflict of interest to the client, while helpful, does not necessarily prevent future problems from arising, even if the client signs the disclosure. It later can be argued that the client’s consent was not “informed” by a third party (such as an attorney). CPAs should not rely too heavily on disclosures as a form of protection. In the end, the big question to ask is whether there is a perception that the CPA no longer has unfettered loyalty to the client.