After exploring the potential conflicts of interest that investment advisers, broker-dealers, and lawyers have, we move on to consider potential conflicts involving accountants. In the previous articles, we were concerned with service provider conflicts and how those conflicts affected their ability to serve their clients. As you will see, conflicts involving accountants are a bit different. These service providers can provide a variety of services to their clients, as accountants audit financial reports but also provide tax services and a variety of consulting services. Each of those areas presents its own challenges, and we should approach them in a thoughtful manner.

The accountant industry is quite large and is dominated by the “Big Four.”[1] In 2023 these accounting firms had worldwide revenues that exceeded $212 billion.[2] Of that amount, $71 billion (33%) was from auditing, $85 billion (40%) from advisory/consultancy, $45 billion (21%) from tax services, and $7 billion (5%) from other areas. In the United States, their revenue was $147.5 billion, or just over 60% of the total revenue in the U.S. accountant industry.

The capital markets, investors, and creditors depend on the availability of reliable information about the financial condition of firms that have investors and creditors. A key element supporting the reliability of that financial information is a periodic audit of a company’s financials performed by a qualified and objective independent public accountant.

No Shortage of Potential Conflicts

Accountants face a variety of potential conflicts of interest that can affect the performance of their important functions. As we consider conflicts of interest for accountants, it might be helpful to develop a broad sense of some of the types of potential conflicts they face. Here are a few categories of the types of conflicts that accountants can face:[3]

• Self-Interest Conflicts: When an accounting firm or professional stands to gain personally, financially, or professionally from a specific decision.
• Familiarity Threats: When an auditor becomes too close or familiar with its client.
• Advocacy Threats: These materialize when an accounting professional promotes or advocates for a client’s interest instead of maintaining professional skepticism and objectivity.
• Self-Review Threats: These occur when the accounting firm reviews its own work.
• Intimidation Threats: These arise when an accountant feels coerced or threatened by a client or employer, potentially influencing its professional judgment.

You will note that the conflicts that are identified here are not necessarily conflicts that the accountant has with its client but rather conflicts that might adversely affect the accountant’s ability to perform its duties as an accountant in an objective and independent manner.

Accountants are professionals who recognize the need to perform in an independent and objective manner. They have a wide variety of requirements to comply with as well as internal policies, procedures, and other controls to enable them to perform their duties properly and maintain the public trust. With that in mind, let us explore a few of the potential conflicts of interest that can affect accountants and the performance of their professional services.

The Client’s Role

Beginning with the adoption of the first federal securities law in 1933,[4] Congress recognized the need for financial statements of issuers audited by independent auditors as essential to our capital markets and to investors. The most important elements of competent auditing are independence, objectivity, and professional skepticism.[5] So what are some of the conflicts of interest that can potentially compromise those audits?

Interestingly, the first conflict is one that the client, not the accountant, might have. This is quite a contrast from the other conflicts we have examined. This conflict arises because the company selects and compensates the accounting firm while asking it to audit its books in an independent manner. By auditing a company’s financial statements, the independent public accountant effectively is performing a “public watchdog” role. In performing this role, the independent public accountant “owes ultimate allegiance to the corporation’s creditors and shareholders, as well as to the investing public. This ‘public watchdog’ function demands that the accountant always maintain total independence from the client and requires complete fidelity to the public trust.”[6] Indeed, the independent audits are not intended for the client but rather for others, yet the client selects and pays the firm that performs the audits.

Recognizing the importance of this function performed by the auditor, there are any number of legal and accounting standards that address the independence and professional requirements governing accountants.[7] Typically, these standards identify certain types of relationships that would result in an auditor not being considered independent. Those relationships can include certain lending relationships, investments, family relationships, and the provision of certain non-auditing services. As the intended beneficiary of the audited financial statement is not the client but rather shareholders, investors, and others, the traditional notion of informing the client of a conflict and obtaining the informed consent from that client is generally not available regarding “independence” matters. Supporting the determination of their independence, auditors typically provide the company’s audit committee with detailed information demonstrating their independence. Also, while auditing firms are not permitted to provide any number of non-audit services, they may provide certain other tax and non-audit services related to internal control over financial statements, provided the client’s audit committee approves them in advance. It is critical that the firms auditing financial statements meet the highest standards of independence and that shareholders, other investors, and other financial participants believe they are independent.

Internal Issues

Within the accounting firm, there are some potential conflicts of interest that can have an impact on the firm’s ability to provide professional, independent audits of the financials of clients. A few of those are discussed below.

Importance of Consulting and Other Practices: As was noted above, auditing services accounted for only about one-third of the total revenue of the largest accounting firms. The importance of the other revenue sources for the accounting firms (which represent twice the revenue from auditing) can potentially have an impact on the firm’s resources that are dedicated to the auditing practice and its importance within the firm. This can be of particular concern especially as those other practices can be more profitable to the firm.

Consultancy and Advisory Practices: As the regulatory approach to the necessary independence of auditors limits other services auditors can provide to audit clients, an accounting firm faces internal tensions among the area that provides audits and the areas that provide consultancy and advisory practices. This tension, arising from competition among different constituencies, can have significant consequences within the firm, potentially affecting allocation of resources and partner and personnel compensation. The inability of firms to provide certain non-audit functions to audit clients can, on a macro level, limit the availability of certain accountants for audit work. The potential problems increase as non-audit practices grow in firms and can provide greater financial rewards than auditing.

Other Conflicts: There are a variety of other services that an auditing firm can provide to audit clients without affecting the auditor’s “independence.” Clients may be inclined to select the audit firm to perform these services, and the auditing firms may have an incentive to recommend that they provide those services. There can be any number of benefits that can be realized from such a selection, but there also can be potential conflicts in the recommendation of services to the client and the selection of the audit firm by the client that should be recognized.

A few thoughts on those potential conflicts:

• The client may have some concerns, whether justified or not, that if it retains the accountant to perform those additional services, the audit will go easier, or if it does not, the audit may be a bit more difficult.
• The accountant may benefit from encouraging the client to retain the firm to perform more functions whether they benefit the client or not.
• The accountant may have concerns that if the client selects a different accounting firm to perform non-audit functions, it may face an increased risk of losing that audit client.
• The accountant may have concerns that if the client is retaining a different firm to perform non-audit functions, it is alerting the accountant that the auditing work is at risk.

To be clear, these are potential conflicts and potential concerns that clients and auditors might have. My experience has been quite to the contrary, as the clients and auditing firms have been very professional, discussing the issues openly, and decisions are made on a professional basis.

Non-Audit Services

When considering the potential conflicts of interest that accountants may have in providing non-audit services to any clients, the analysis is quite similar to that which we explored in previous articles. A few are:

• Fees: As is true with all service providers, there is always a potential conflict of interest between an accountant and the client when setting fees, especially when determining fee structures. An hourly fee structure potentially creates an economic incentive for the accountant to spend more time on a matter, whereas a fixed fee potentially creates an incentive to spend less time on the matter. That is not to say the accountant will necessarily spend more or less time than is required based on that structure, but rather that the accountant will have that conflict, and that should be recognized.
• Recommendations: When accountants provide a variety of potential services for clients there is an incentive for the accountant firm to cross sell clients. This can result in clients being pitched for services they may not need or, if needed, that may be better provided by other service providers.
• Regulatory Backdrop: There are any number of regulatory requirements that impact the services that accountants provide to their clients. Those requirements are quite extensive, can seem quite complicated at times, and are way beyond the scope of this article. On a basic level, however, it is important to remember that accountants are professionals and are required to:
  
  • be independent in the performance of professional services,
  • maintain objectivity and integrity,
  • be free of conflicts of interest, and
  • not knowingly misrepresent facts or subordinate their judgments to others.

What’s a Board to Do?

So, what should fund directors do? How should they view potential conflicts of interest regarding accountants? I have the following thoughts for your consideration:

• When engaging the accountant to audit the fund’s financial statements, always bear in mind the important watchdog function they perform. While the fund is the client and is selecting and paying them, the auditing service that is being provided is principally for the benefit of the investors in the fund.
• When selecting an auditor for the fund, bear in mind that you, not the auditor, face the potential conflict.
• When considering an accounting firm to perform services, ask them to discuss with you the conflicts of interest they or others have, how those conflicts might impact the services they are providing, and how those conflicts might best be eliminated or otherwise mitigated.
• Ask the accountant to discuss the policies, procedures, and other controls they have in place to identify and mitigate any conflicts of interest they might have.
• Bear in mind the nature of the services that the accountant is engaged to provide and then evaluate how potential conflicts of interest might impact the ability of the accountant to provide those services to you.
• Ask questions to make sure you understand the conflicts and their potential impact on the services being provided.
• Maintain a positive relationship with the accountants where you each can have candid discussions regarding potential conflicts of interest and resolve them responsibly.

Accountants have a difficult and challenging job, and they perform an incredibly important function. In my experience, they use their best efforts to do so in an independent, professional, and objective manner. We all should remain vigilant about potential conflicts and provide support to the accountants so they can continue to provide the important services on which we all rely.