Ethics & Regulations Q & As

By Ann Spaulding

Q. What is the focus of the new independence interpretations?
A. Essentially, the new independence interpretations change the basic structure for determining who must be independent with respect to individual clients from a firm-wide approach to one that focuses on the engagement team and others who are able to influence the engagement.

Q. Which of the independence interpretations changed?
A. Several changes have been made. The definition of “member” (that is, persons and entities to whom the independence rules apply) has been significantly narrowed; the new term “covered member” has been incorporated (along with several other new and revised definitions) into the Definitions section of the Code of Professional Conduct. In addition, broad-based interpretations on financial, employment and certain other business relationships, including those on family relationships and former associations with clients, have been consolidated under Interpretation 101-1—Interpretation of Rule 101. Lastly, the independence interpretations on certain engagements under the attestation standards that result in restricted use reports (Interpretation 101-11, “Modified application of rule 101 for certain engagements to issue restricted-use reports under the Statements on Standards for Attestation Engagements”) have been amended. It is important to note that none of the interpretations on non-attest services have changed, that is, those rules still apply to “a member or his or her firm.”

Q. When do the new interpretations go into effect?
A. The interpretations become effective on May 31; however, members may choose early adoption.

Q. Have all of the interpretations under Rule 101—“Independence”— been changed in light of the changes?
A. The many interpretations under Rule 101 affected by the changes have not yet been conformed. Those conforming changes—which will conform the rest of the Code to interpretation 101-1—and the new definitions are expected before May 31. Until such changes are made, members should apply the interpretations in a manner that is consistent with the changes.

Q. How will these rules changes affect firms?
A. Generally speaking, small firms—especially those that perform all professional services from a single office location—will see fewer changes than medium and large, multi-office firms. This is partially because all partners in the office where the lead partner conducts a client’s attest engagement are considered to be “covered members” under the interpretations. Accordingly, for single-office firms, all partners will continue to be subject to the interpretations. Nevertheless, new definitions of “key position,” “close relative,” and “significant influence” should impact professionals from firms of all sizes.

Q. Are there any special allowances built into the new interpretations?
A. Yes. Since the new interpretations are significantly different from the previous ones, members are allowed up to six months to adopt them. Until May 31, members have the option of applying the old interpretations. Early adoption is encouraged (see question below about the state’s and other regulators’ rules). Also, because the interpretations become more restrictive for some members, two special provisions have been incorporated to prevent undue hardships. One allows the immediate family and close relatives of a covered member, who were previously in compliance with existing rules, to remain in employment relationships with clients. Another provision provides professional employees who are serving as an employee or member of management of a client (for example, as a board member) a six-month period in which to sever their relationship with the client and retain their firm’s independence. So, as long as the member was in compliance with preexisting rules, and the relationship is severed by May 31, independence will not be considered to be impaired for past periods during which the member served as an employee or management. All of these provisions appear in Interpretation 101-1—Interpretation of Rule 101.

Q. How do the new rules compare to those of the Securities and Exchange Commission (SEC)?
A. The new independence interpretations are substantially consistent with SEC rules as they relate to financial, employment and certain other business relationships; however, there are some relatively minor differences. The American Institute of CPAs has posted a comparison between the two sets of rules (see their website at www.aicpa.org/members/div/ethics/
edutools.htm).

Q. What about the New York State Board for Public Accountancy or other regulators that have rules on independence? Do I need to be concerned with those rules?
A. The Society asked the office of the New York State Board for Public Accountancy what the Board’s position is on the new interpretations. The Board answered the following:

“The NY Board for Public Accountancy has not taken a formal position on the new independence rules. If 29.10(a)(5) of the Rules of the [New York] Board of Regents needed to be amended due to the new independence rules, the [New York] State Education Department would have to submit those changes to the Board of Regents for formal action after receiving input from the Board for Public Accountancy and advice from the Department’s Office of Counsel.”

Regents Rule 29.10 (a)(5) is as follows: “Unprofessional conduct shall…include the following…expressing an independent opinion or knowingly permitting his or her firm to express an opinion on financial statements of an enterprise, whether such enterprise is a for-profit or a not-for-profit enterprise, if the licensee or a partner or employee in the firm is not independent with respect to such enterprise. Independence will be considered to be impaired if the public accountant, or a partner in the firm, owns or is committed to acquire any direct or material indirect financial interest in the enterprise or had a direct or material indirect financial relationship with any officer, director, employee or principal stockholder of the enterprise. Independence will be considered to be impaired if the licensee, a partner in the firm or a member of his or her or the partner’s immediate family, is or has been a director or officer of the enterprise, or is or has been involved in any situation creating a conflict of interest, during the period covered by the examination or at the time of issuance of a report…”

New York State CPAs must remember that their licenses to practice are subject to the Regents Rules and failure to follow those rules puts their licenses at risk.

The Society is attempting to meet with the New York State Board representatives and is offering its encouragement and assistance to bring the Regents Rules in sync with the Society’s new rules.

Firms that perform attest services for entities subject to additional regulations (such as those of the Department of Labor) should contact that regulator directly. The AICPA is actively encouraging the state boards and other regulators to harmonize their rules to those of the AICPA and SEC.

Q. What other guidance on the new interpretations is available?
A. The AICPA has developed a white paper that explains the interpretations in greater detail and provides background information on the changes and a description of comments received. The paper is available on their website at www.aicpa.org/
members/div/ethics/edutools.htm. Also, the AICPA has posted an updated version of the AICPA’s Plain English Guide to Independence (www.aicpa.org/members/div/ethics/plaineng.htm) to their website.

Q. Which specific interpretations are more restrictive than the old rules?
A. In terms of who is subject to the interpretations, the new “covered member” definition (as opposed to “member”) includes—for the first time—managers who provide non-attest services that are located outside the office performing attest services. In addition, professional staff members are barred from owning greater than 5 percent of a client’s securities or serving as an employee or member of client management. The old rules permitted staff not participating on the attest engagement to invest in a client without limit and to be a member of the client’s management (for example, a board member), provided they did not serve on that client’s attest engagement or reside in the office performing a significant portion of the engagement. For further information about specific areas of change, see Appendix 5 of the white paper mentioned above.