Ethics rule would require CPAs to discuss suspected illegal acts with clients

By Joseph J. Tapajna, CPA

Editor: Heidi Ridgeway, CPA

On March 10, 2017, the AICPA Professional Ethics Executive Committee (PEEC) issued an exposure draft of a new rule requiring CPAs to take certain actions if they know or suspect that a client is engaging in illegal acts. This column addresses how this new rule may impact CPA tax practitioners providing services outside the scope of an audit or to a nonaudit client. (The exposure draft, Proposed Interpretations: Responding to Non-Compliance With Laws and Regulations, is available at www.aicpa.org.)

Background

The AICPA has long had guidance dealing with confidential client information. The "Confidential Client Information Rule" set forth in ET Section 1.700.001 of the AICPA Code of Professional Conduct provides that nonpublic confidential client information obtained by a CPA during the course of providing professional services cannot be disclosed to third parties unless the CPA obtains specific client consent for the disclosure. An example would be when the CPA prepares tax returns for the client, and the client subsequently directs the CPA to provide a copy of them to a potential lender to the client's business — consent would be required prior to providing the returns. There are exceptions to this client consent rule where the CPA is complying with a validly issued subpoena or summons, is complying with laws and regulations, is participating in certain professional practice reviews or investigations, or is a defendant in administrative or legal proceedings. In these cases, consent is not required prior to providing the requested information.

Additionally, ET Section 1.000.020 addresses how CPAs should respond to certain ethical conflicts. If, for example, a CPA suspects that a client is engaged in potentially fraudulent activity, the CPA would be required to take the necessary steps to gain a better understanding of the activity to determine if it was indeed fraudulent. If that investigation does not provide appropriate clarification, the CPA would alert the client to his or her concerns in an effort to rectify the issue. If the client refuses to engage in discussion or to take appropriate action, the CPA would need to consider whether to discontinue the client relationship. Under ET Section 1.000.020, the CPA's responsibility to maintain the confidentiality of client information would not allow disclosure of the suspected fraudulent activity to third parties unless the client consents.

Internal Revenue Code Secs. 6713 and 7216 also impose strict confidentiality requirements on tax return preparers, including CPAs, regarding the use or disclosure of any information provided by a taxpayer in connection with the preparation of a tax return unless the taxpayer provides informed written consent. This is further emphasized in Section 10.21 of Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), and AICPA Statement on Standards for Tax Services No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings, which provide that when a CPA discovers an error in a document previously filed with a taxing authority, the CPA must advise the client of the consequences of not correcting the error but is not required to notify the taxing authority if the client chooses not to correct it.

The new AICPA proposed ethics rules

The new AICPA proposal has its origin in a pronouncement issued in July 2016 by the International Ethics Standards Board for Accountants (IESBA) titled Responding to Non-Compliance With Laws and Regulations. As a member of the International Federation of Accountants (IFAC), the AICPA is required to adopt IESBA rules with appropriate consideration of local rules and regulations.

The AICPA proposal provides that, when a member, including a CPA tax practitioner, encounters a client engaged in illegal or suspected illegal conduct during the course of performing professional services, the member is required to obtain an understanding of the matter consistent with the professional services the member was providing. The member is not expected to search for illegal or suspected illegal conduct of the client outside the scope of the professional engagement or have an understanding of laws or regulations beyond the member's area of expertise or professional judgment.

The member is required to discuss the illegal or suspected illegal conduct with the appropriate level of client management or those charged with governance of the client to which the member has access. If the member determines that the illegal or suspected illegal conduct is significant, and client management or those charged with governance of the client refuse to take appropriate steps to address the matter, the member must consider whether withdrawal from the engagement or client relationship is necessary, or whether he or she needs to take further, more serious action.

The AICPA proposal recognizes that, often, federal and state laws and regulations may prohibit the member from disclosing the illegal or suspected illegal conduct to outside parties without the client's express informed consent. In certain cases, however, it may be appropriate to disclose without consent where a violation of criminal law has occurred, though the existing and proposed AICPA rules do not specifically address this situation. If such a situation is encountered, a CPA can look to other guidance; for example, the regulations under Sec. 7216, which allow for the disclosure of tax return information to the proper federal, state, or local authority for purposes of informing an official of a criminal law violation.

Ultimately, the member should document the steps taken to conform to this new proposed rule and other relevant laws and regulations, including discussions with client management and any other final course of action.

Application to CPA tax practitioners

As discussed, the AICPA proposal recognizes that the current body of federal and state laws and regulations in the United States does not generally allow the disclosure of confidential client information without the client's consent. Tax services are somewhat complicated since the preparation and filing of tax returns certainly involve the disclosure of confidential information to tax authorities. In some tax advisory engagements, for example, providing advice on aggressive tax positions, the CPA tax practitioner may also have direct reporting obligations to tax authorities. In addition, the client may engage the CPA tax practitioner to assist in resolving disputes that may be regarded as illegal conduct. Apart from these situations, which are not prohibited conduct under the new proposal, the CPA tax practitioner should continue to follow the ethical guidance under ET Section 1.000.020.

What does the future hold?

Some jurisdictions outside the United States require professional advisers, including professional accountants, to disclose client violations or suspected violations of laws and regulations to governmental authorities. A prime example would be money laundering or suspected money laundering activity. In some jurisdictions, these rules would prohibit the professional accountant from discussing the matter with the client prior to disclosure. Apparently, these jurisdictions believe that deputizing accountants to ferret out wrongdoing is a good idea. It will be interesting to see if these types of laws or regulations will be extended to CPAs in the United States.   

 

Contributors

Joseph J. Tapajna is an adjunct assistant teaching professor at the Mendoza College of Business at the University of Notre Dame. Heidi Ridgeway is a director of Tax Practice Policy & Quality at Grant Thornton LLP in Chicago. Mr. Tapajna and Ms. Ridgeway are both members of the AICPA Tax Practice Responsibilities Committee. For more information about this column, contact thetaxadviser@aicpa.org.

 

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