Which of the following nonattest services are prohibited for attest clients under SOX

In Brief

The commitment to serve the public interest in accounting has eroded, as personal and business relationships with clients and client management increasingly create conflicts of interest. Many such relationships have created barriers to objective and impartial decision making and threatened the independence of the audit function. The 2014 recodification of the AICPA Code of Professional Conduct attempts to deal with a conflict of interests when providing attest services through a threats-and-safeguards approach. The problem with this approach is that conflicts may still be permissible as long as they can be sufficiently mitigated by safeguards—creating a situational ethic rather than an outright prohibition when such conflicts exist.

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Dramatic changes in ethical standards have taken place since the AICPA Code of Professional Conduct was first issued in its current form in 1973. At that time, the code prohibited several commercial practices, many of which are now permitted without restriction (or with minimal restrictions), thereby opening the door to promotion, solicitation, and ultimately growth in nonaudit professional services. Consequently, many leaders in the accounting profession have questioned accountants’ commitment to serving the public interest over the interests of the firm, the client, or even themselves.

Questions and concerns exist about whether auditors can maintain their independence while becoming more involved in business and financial relationships with clients and client management, and whether the performance of significant management advisory services impairs audit independence and unduly influences the auditor’s ability to make impartial and objective judgments. Can CPAs still provide independent audit services consistent with the profession’s long-standing commitment to serve the public interest?

The concept of “the public interest” was first defined in the AICPA Code of Conduct in 1988:

Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. The public interest is defined as the “collective well-being of the community and institutions the profession serves,” including “clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of [CPAs] to maintain the orderly functioning of commerce.” In discharging their professional responsibilities, members may encounter conflicting pressures from among each of these groups. In resolving those conflicts, members should act with integrity, guided by the precept that when members fulfill their responsibility to the public, clients’ and employers’ interests are best served. (Article II)

During the 1970s and 1980s, some in the accounting profession shifted their attention from providing independent audits to promoting lucrative advisory services for audit clients.

This wording has not changed and remains in the recodification that became effective on December 15, 2014, yet the commitment of accounting professionals to the public interest is still suspect. The revised code now includes an “Ethical Conflicts” provision that allows for greater judgment as to whether nonattest services impair audit independence, and whether the public interest is served by linking conflicts of interest to independence, as discussed below.

Changes in the AICPA Code of Professional Conduct: 1973–2014

During the 1970s and 1980s, some in the accounting profession shifted their attention from providing independent audits to promoting lucrative advisory services for audit clients. The revenue stream from audit services was limited, and audit clients increasingly looked to accounting professionals to provide advice on a variety of projects. Competition for audit services stiffened with the elimination of the ban on competitive bidding, and public accounting firms sharply reduced audit fees in an attempt to gain market share. Issues such as the lowballing of audit fees and opinion shopping raised concerns that auditors might cut corners and give in to client pressures in order to gain lucrative consulting services.

During that time, existing rules of conduct were the target of governmental challenges as anti-competitive. The AICPA and state boards were forced to remove outright bans on advertising (Rule 502) in place of setting guidelines that such practices could not be false, misleading, or deceptive. The outright ban on solicitation of clients was dropped and replaced by targeted bans of coercive, overreaching, or harassing solicitations. Additional practices were challenged, including the outright ban on commissions and referral fees (Rule 503) and contingent fees (Rule 302); these rules were modified to permit the acceptance or payment of such fees for services provided to nonattest clients, with the disclosure to and consent of the client. The rules retained the prohibition against accepting contingent fees when preparing tax returns.

A contentious issue developed during the 1990s regarding who could hold out as a CPA and whether all owners of a firm practicing public accounting should be required to be CPAs. The definition in the code included informing others of one’s status as a CPA through oral or written representations; at the same time, the practice of public accounting linked the performance of professional services to holding out as a CPA. Meanwhile, Rule 505 restricted the practice of public accounting to firms that were permitted by state law or regulation and whose characteristics conformed to resolutions by the AICPA Council, which required all shareholders of a corporation or association to include persons engaged in the practice of public accounting as defined by the code. Taken together, these provisions were interpreted as prohibiting CPAs from holding out as such when performing professional accounting services through firms not 100% owned by CPAs.

Professional accounting services (i.e., tax, bookkeeping, and personal financial planning) were increasingly provided through non-CPA firms, and CPAs working for such firms were not permitted to inform potential clients that they were CPAs. Legal challenges to the AICPA and state board rules claimed they unduly restricted “free commercial speech.” The profession lost its case and was required to change its rules to permit CPAs who provide professional accounting services through alternative business structures to advertise its services, as long as they were not false, misleading, or deceptive, and did not solicit clients in a coercive, over-reaching, or harassing manner.

The writing was on the wall. Nonattest services were increasingly provided by a variety of entities, some of which were not 100% owned by CPAs. At the same time, the expanded scope of services meant that non-CPA experts were providing professional services (i.e., financial information systems design and installation) through CPA firms, and these expert professionals wanted ownership stakes. The AICPA reacted by changing Rule 505 at its May 1994 Council meeting, reducing the 100% CPA ownership requirement to a super majority—66⅔% ownership of the firm in terms of financial interests and voting rights. The non-CPA owners had to be actively engaged as firm members in providing services to the firm’s clients as their principal occupations and abide by the rules of conduct in the code. In October 1997, the code was amended to reduce the supermajority requirement to a simple majority of ownership.

This broadening of ownership interests opened the door to non-CPAs who were not steeped in the ethics of the profession and entities that were accustomed to a different standard of behavior. These changes marked a significant erosion in what it meant to be a professional and contributed to a shift in the culture of firms, from providing independent attestation and serving the public interest to providing commercial services and serving private interests.

The Public Interest and Independence in Accounting

Early on, leaders in the profession questioned what it meant to be an accounting professional and the profession’s commitment to serve the public interest. John C. (Sandy) Burton stated in a speech in 1970 that there was little evidence that the “public” in public accounting has been emphasized (John C. Burton, “An Educator Views the Public Accounting Profession,” Journal of Accountancy, September 1971, 47–53). Max Block lamented that “accounting profession” was “a term that has lost some relevance” and that “some of the major firms do not refer to themselves as Certified Public Accountants or Accountants and Auditors” thereby eliminating “the service limitation implicit in such titles” [S. Weinstein and M. A. Walker, eds., “Is There More than One Accounting Profession (U.S.A?),” Annual Accounting Review, 1982, pp. 163–195].

The expansion of management advisory services in the 1970s and 1980s created concerns about whether auditors might compromise their professional values and commitment to the public trust in the name of profit. The audit function had become a loss leader, and revenues from consulting services rose to a level almost equal to audit fees. In the SEC’s 1978 annual Report to Congress, Chairman Harold M. Williams wondered about the appropriate range of services, asking, “Are there situations in which the magnitude of the potential fees from management advisory services are so large as to affect adversely an auditor’s objectivity in conducting an audit?” (Report to Congress on the Accounting Profession and the Commission’s Oversight Role,July 1, 1978, http://bit.ly/2EEFzFq).

Congress passed the Sarbanes-Oxley Act (SOX) in 2002 to regain the public trust by restricting the performance of certain consulting services for audit clients and creating the PCAOB to serve as a government regulator.

Art Wyatt and Jim Gaa examined the changing culture in the accounting profession, observing: “The firms had gradually changed from a central emphasis on delivering professional services in a professional manner to an emphasis on growing revenues and profitability. Audit partners too often acquiesced to the client views in the current period, agreeing to fix the problem next quarter or next year … Concurrence replaced healthy skepticism” (“Accounting Professionalism: A Fundamental Problem and the Quest for Fundamental Solutions,” The CPA Journal, March 2004, pp. 22–33).

Stephen A. Zeff has pointed out that the dramatic growth of consulting services rendered by the big firms fueled the widespread perception of auditors’ lack of independence from their clients (“How the U.S. Accounting Profession Got Where It is Today: Part II,” Accounting Horizons, December 2003, http://bit.ly/2EmglYP). As accounting firms became more invested in consulting services, auditors were more susceptible to pressures imposed by management to compromise independence, objectivity, and integrity. Warnings about a loss of professionalism rang true as consultants, most of whom lacked a background in the profession’s ethics culture, clashed with auditors who were committed to independence.

The well-publicized financial failures of Enron and WorldCom shed light upon all of this, leading to the demise of professional self-regulation and the birth of government regulation. Congress passed the Sarbanes-Oxley Act (SOX) in 2002 to enhance auditor independence and regain the public trust by restricting the performance of certain consulting services for audit clients and creating the PCAOB to serve as a government regulator. At the same time, the SEC modernized its independence rules to reflect changed relationships between auditors and management and the likelihood that independence could be compromised.

The formation of the PCAOB ended 70 years of professional regulation. PCAOB Chair James Doty addressed these issues: “As sophisticated as our markets and economy are, they are dependent on trust. We cannot take trust for granted. Independent audits provide that trust, and thus bridge the gap between entrepreneurs who need capital and lenders who can provide capital” (AICPA, 41st Annual National Conference on Current SEC and PCAOB Developments, December 2012, http://bit.ly/2CdpPrM).

The concept of independence was first introduced into law by the Securities Acts of 1933 and 1934, which provided for certification of financial statements by “an independent public or certified accountant.” Several public opinion surveys in the 1960s, 1970s, and 1980s showed that a significant number of financial statement users believed that consulting or advisory services could impair audit independence. Critics claimed that “lucrative consulting engagements increased the client’s financial power over the accounting firm. The more services an accounting firm provided to a client, the more pressure the audit partner felt to submit to the client’s wishes rather than risk losing the engagement” (Paul M. Clikeman, Called to Account: Fourteen Financial Frauds that Shaped the American Accounting Profession, Routledge, 2009).

The rise of management advisory services is generally considered to have fundamentally changed the culture and tone at the top at CPA firms.

The U.S. Senate Metcalf Committee Report in 1978 raised a red flag about the subordination of judgment by observing that the big firms seriously impaired their independence by becoming involved in the business affairs of their corporate clients and by advocating for their clients’ interest on controversial issues. A critical comment in the report led to soul-searching on the part of the profession:

The “Big Eight” are often called “public accounting firms” or “independent public accounting firms.” This study finds little evidence that they serve the public or that they are independent in fact from the interests of their corporate clients. For that reason, this study refers to the ‘Big Eight’ simply as accounting firms (Metcalf Committee, December 1976, http://bit.ly/2oiaX32).

The profession had already formed the Cohen Commission to explore whether an “expectation gap” existed between what the public expects and what auditors can and should expect to accomplish. The Cohen Commission report discussed the minority of users’ view that the performance of management advisory services for a client might impair audit independence. The report concluded that, except in the Westec case, the SEC had not found instances in which an auditor’s independence had been compromised by providing other services (Commission on Auditors’ Responsibilities, Report, Conclusions, and Recommendations, AICPA, 1978).

A seminal opinion on the importance of an independent audit was issued by the U.S. Supreme Court in U.S. v. Arthur Young & Co (104 S. Ct 1495, 79 L.Ed.2d 826, March 21, 1984):

By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment responsibility with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This ‘public watch-dog’ function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust.

The AICPA code requires auditors to be independent in appearance as well as in fact. The independence requirement serves two related, but distinct, public policy goals, as the SEC laid out in its revision of the Independence Rule (Feb. 5, 2001, http://bit.ly/2HbkMaL):

One goal is to foster high-quality audits by minimizing the possibility that any external factors will influence an auditor’s judgments. The auditor must approach each audit with professional skepticism and must have the capacity and the willingness to decide issues in an unbiased and objective manner, even when the auditor’s decisions may be against the interests of management of the audit client or against the interests of the auditor’s own accounting firm. The other related goal is to promote investor confidence in the financial statements of public companies. Investor confidence in the integrity of publicly available financial information is the cornerstone of our securities markets.

Management Advisory Services

The rise of management advisory services is generally considered to have fundamentally changed the culture and tone at the top at CPA firms. The possibility of conflicts of interest when providing management advisory services to audit clients was recognized as far back as 1925, when Price Waterhouse chief executive George O. May warned that unrestricted expansion of services was “fraught with danger” (“Letter,” Journal of Accountancy, September 1925). Robert Mautz and Hussein Sharaf warned in The Philosophy of Auditing that auditors’ performance of management advisory services could erode their perceived independence (American Accounting Association, 1961, p. 223).

By the 1960s, the AICPA felt compelled to respond to criticisms about the inherent conflict when management advisory services were provided to audit clients. In 1963, its Committee on Professional Ethics issued Opinion 12, stating in part that “normal professional or social relationships would not suggest a conflict of interests in the mind of a reasonable observer.” The committee cited the 1947 statement of the AICPA Council, asserting that independence is an attitude of mind, but that to maintain the public confidence it was imperative also to avoid relationships that have the appearance of a conflict of interest. Opinion 12 clarified the AICPA’s position that no conflict of interest exists when providing management advisory services and tax practice, so long as the CPA’s services are limited to advice and technical assistance instead of making management decisions. If the CPA makes such a decision on matters affecting the financial statements, however, “it would appear that his objectivity as an independent auditor … might well be impaired” (John L. Carey and William O. Doherty, Ethical Standards of the Accounting Profession, AICPA, 1966, pp. 206–208).

Abraham Briloff, a frequent critic, pointed out that the profession’s view of potential conflicts from management advisory services differed from the public’s. Briloff concluded, based on years of research, that gaps existed between the understanding by the profession and the corresponding understanding by the financial community, thereby creating a “crisis of confidence” in the “integrity which presently confronts the profession” (Carey, The Rise of the Accounting Profession to Responsibility and Authority 1937-1969, AICPA, 1970). In a 1994 CPA Journal article, Briloff also distinguished between the mindset required of an auditor and consultant, pointing out that “a consultant is an ally and advocate of management, whereas an auditor is responsible to the public and must maintain professional skepticism” (“Our Profession’s Jurassic Park,” August 1994, http://archives.cpa-journal.com/old/15703001.htm).

Is the profession relying too heavily on the threats and safeguards approach when conflicts of interest exist—rather than prohibiting attest services outright?

In February 2001, the SEC issued its long-awaited Revision of the Commission’s Auditor Independence Requirements, modernizing the independence rules to reflect growing relationships with audit clients (https://www.sec.gov/rules/final/33-7919.htm). The revised Independence Rule 2-01 provides that an accountant is not independent if the accountant provides certain nonaudit services to public company audit clients. These services are also identified in SOX section 201. Section 201 provides that the following services should not be performed for attest clients in addition to bookkeeping or other services related to the accounting records or financial statements of the audit client:

• Financial information systems design and implementation
• Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
• Actuarial services
• Internal audit outsourcing services
• Management functions or human resources
• Broker-dealer, investment advisor, or investment banking services
• Legal services and expert services unrelated to the audit
• Any other service that the board of directors determines, by regulation, is impermissible.

SOX allows an accounting firm to “engage in any nonaudit service, including tax services” not listed above only if the activity is preapproved by the audit committee of the issuer company. This requirement is waived if the aggregate amount of all such nonaudit services provided to the issuer constitutes less than 5% of the total amount of revenues paid by the issuer to its auditor.

The issue of whether professionalism and commercialism can coexist was explored by author Vincent Love, who examined the expanding scope of professional services and threats to independence, objectivity, and integrity. He cautioned that:

Professionalism needs to be nurtured and preserved for the good of the profession and the public interest. The tone at the top is an extremely important aspect of quality and professionalism, and it should be set by CPAs who have been ingrained by the principles set forth in the AICPA’s Code of Professional Conduct.” (“Can Professionalism and Commercialism Coexist in CPA Firms?,” The CPA Journal, February 2015, pp. 6–10)

Serving Private Interests Instead of the Public Interest

Rule 2-01 is designed to ensure that auditors are qualified and independent of their audit clients both in fact and appearance. Auditors serve as gatekeepers of financial reporting and disclosure through their independent audits, and this role requires auditors to serve the public interest ahead of private interests.

Several settlements between the SEC and large accounting firms since 2013 illustrate the problem firms are having separating the public interest from commercial interests. The following are examples of threats to independence that were not adequately managed by firms, thereby impairing objectivity and integrity in rendering audit opinions:

• Deloitte violated auditor independence rules after its consulting arm maintained a relationship with a trustee who served on boards for funds Deloitte audited. The trustee was paid consulting fees for external client work by Deloitte’s consulting arm while auditing funds even though the trustee was serving on the funds’ boards and audit committees.
• Ernst & Young violated independence rules when a senior partner on an audit engagement maintained an improperly close friendship with the client’s chief financial officer. A different partner on another audit served on the engagement team while romantically involved with the client’s chief accounting officer.
• Grant Thornton violated independence rules when two of its partners sat on the boards of an Australian company’s subsidiaries and provided prohibited nonaudit services to the audit client. As directors, the two partners had signatory authority over the bank accounts of the subsidiary and provided management representations in connection with the parent company’s statutory audits.
• KPMG was forced to withdraw its audit opinion and withdrew from the audits of Herbalife and Skechers after it was disclosed that its lead engagement partner had provided nonpublic client information to a third party in exchange for cash and gifts.
• PricewaterhouseCoopers (PwC) failed to discover fraud in its audit of Colonial Bank and issued clean audit opinions for six years after the bank collapsed. It was determined that huge chunks of Colonial’s loans to a defunct mortgage lender were secured against assets that did not exist.

Ethics education should emphasize what it means to be a CPA and the character of a professional accountant and auditor.

Lynn Turner, a former chief accountant for the SEC, criticized PwC for continuing to audit Colonial after a senior manager who worked on those audits was hired by Colonial in a top financial oversight position. Turner, who helped draft SOX, said that PwC should not have cited an emergency exemption to standards banning accounting firms from auditing a company for a year after it makes such a hire. The one-year “cooling-off” period was put in place to ensure that the former auditor cannot use his familiarity with the auditing strategy to help the client circumvent it (Nathan Hale, “Ex-SEC Accountant Tells Jury PwC Violated Auditing Rules,” Law360, August 24, 2016, http://bit.ly/2Ep5CkD).

AICPA “Recodification” of the Code of Professional Conduct

The AICPA Code of Professional Conduct was recodified on June 1, 2014, and became fully effective on December 15, 2015. A significant change in the revised code is the creation of a new section on “Ethical Conflicts” (1.000.020), which now links independence to the conflicts of interest provision. Conflicts may exist that create a potential impairment of integrity, objectivity, or professional skepticism, and given that the independence rule is inextricably linked to objectivity, the assessment of when a conflict of interest exists that impairs objectivity directly influences whether independence may be impaired.

Independence is a state of mind that permits a CPA to perform an attest service without being affected by relationships and other influences that create a conflict of interest that impairs professional judgment. The significance of the conflict is determined by considering whether a reasonable and informed third party with knowledge of all relevant information would conclude that professional judgment has been compromised. The compromise may occur because these relationships and other influences impair the ability of the firm or member of the attest engagement team to provide attest services free of any influences that compromise integrity, objectivity, or professional skepticism.

The Conceptual Framework for Independence (1.210.010) provides a structure to assess the importance of a conflict of interest with respect to independence in appearance. When a conflict exists, the CPA should determine whether such influences, if present, create a threat to compliance with the rules. An example is a familiarity threat that exists because of a long or close relationship between senior personnel of the firm and the client or employee of the client with a key position. If a threat exists, the member should determine whether the threat can be mitigated by any safeguards applied (e.g., quality controls). If adequate safeguards exist, then the firm or member of the attest engagement team can provide attest services; if the identified threats cannot be mitigated by any safeguards, then independence is impaired.

A familiarity threat existed in the Ernst & Young example cited above. On September 19, 2016, the firm agreed to pay $9.3 million to settle charges from the SEC that two of the firm’s audit partners became too intimate with their clients and violated rules designed to ensure firms maintain their objectivity and impartiality during audits. It should be pointed out that the violations of the auditor independence rules occurred during 2012 through 2014, prior to the effective date of the revised code. Nevertheless, it is reasonable to ask what would happen now if the firm could demonstrate that it had adequate safeguards in place to mitigate the threat to independence.

Is the profession relying too heavily on the threats and safeguards approach when conflicts of interest exist—rather than prohibiting attest services when certain relationships exist? It seems questionable to leave assessments of threats and safeguards to professional judgment when conflicts exist, especially in light of the code provision that “the effectiveness of safeguards will vary, depending on the circumstances.” The problem with this situational ethic is that it leaves the question of whether independence is impaired open to interpretation. Given the ethical responsibilities of CPAs in attest engagements, the AICPA may be backing away from the profession’s public interest obligation by creating the conflict of interest link to independence.

Reimagining Ethics Education

How can educators better prepare their students to assume roles in the profession that build trust with the public? Ethics education should emphasize what it means to be a CPA and the character of a professional accountant and auditor. The public relies on the ethics and professionalism of CPAs to protect their interests. Professionalism is demonstrated by behavior that is consistent with the ethical obligation to serve the public interest; it requires a level of ethical judgment because the rules in the AICPA code need to be interpreted by the circumstances of each situation.

What is missing from today’s ethics education is emphasis on building the character of tomorrow’s leaders in the profession. Who will speak up for the public interest in years to come?

Ethics education attempts to deal with the issue of professional judgment by exposing students to ethical reasoning methods, applying them to hypothetical or real-world dilemmas, and deciding what to do. The problem is that students often parrot back what they believe the professor wants to hear rather than what they truly feel. What is missing from today’s ethics education is emphasis on building the character of tomorrow’s leaders in the profession. Who will speak up for the public interest in years to come?

Educators should instill a desire to act in accordance with the basic professional values of integrity, objectivity, and independence. These values should inspire students to reflect on the moral significance of their emotions and how it can guide ethical decision making to advance serving the public interest. This is not an easy task; accounting educators tend to shy away from moral education because they fear being labeled as “preachy.” The idea that teachers are telling students what to do by teaching a moral point of view is, however, misplaced. Accounting is an inherently moral calling, with the public interest served above all else.

Finally, accounting educators should resist the temptation of rationalizing not teaching ethics by invoking the claim that their purpose is not to impose their values on students. By not teaching ethics, accounting educators promote another value—that ethics education is not important. Nothing could be further from the truth.

Steven Mintz, PhD, CPA is professor emeritus of accounting at California Polytechnic State University, San Luis Obispo, Calif.

What are examples of non attest services?

What services audit firms are prohibited from providing to clients?

Which one of the following is not a covered member for an attest engagement under the independence rule of the aicpa code of professional conduct?

What are examples of attest services?