Chapter 11

Conflicts of Interest

During 1919, the nation was shocked by revelations that players on the Chicago White Sox baseball team had conspired with a well-known gangster to deliberately lose the World Series. After confessing that they were enticed by the offer of a big gambling payoff, several players were banned from ever playing professional baseball again.

Although Chicago lost the World Series, some say that the greatest loss was the tarnished reputation of a game known for integrity and sportsmanship. Baseball fans everywhere were dismayed that players selfishly would betray their teammates, their community, and the game itself by selling out to the highest bidder. As author F. Scott Fitzgerald described the key player in this World Series, “It never occurred to me that one man could start to play with the faith of fifty million people—with the single-mindedness of a burglar blowing a safe.”1

Financial professionals, like professional athletes, must maintain undivided loyalty to others who place trust in them. The Code of Conduct's Integrity and Objectivity Rule reinforces this mandate, stating that accountants “shall maintain objectivity and integrity [and] shall be free of conflicts of interest” in performing professional services, whether they work in public accounting, government, or industry.2 This chapter will discuss accountants' responsibilities when their professional duties diverge from their personal goals.

IDENTIFYING CONFLICTS OF INTEREST

Life is filled with constant temptations, and it is human nature to favor one's self-interest over others' interests. Author Charlaine Harris expresses this notion rather succinctly: “If I have to choose between you and me—I like me better.”

When opportunities for personal gain imperil our moral commitments, as Beyoncé's song “Fighting Temptation” reminds us, resolute character and self-control are needed to “fight the temptations” that lure us to “good sensations.”3 This is especially true when professionals' personal goals clash with ethical duties owed to others.

When a person is tempted to neglect or subordinate duties owed to others for personal gain, a conflict of interest is present. Conflicts of interest arise in a variety of circumstances in which a person's official, professional, or ethical duties clash with the pursuit of self-interest.

Sometimes, conflicts of interest arise when government representatives have the opportunity to violate their official duties for personal gain. For example, a judge might be inclined to interpret environmental regulations in favor of landowners to enhance the value of her own real estate interests. Similarly, to earn a favorable performance evaluation or job promotion for staying within budget limits, a government purchasing official might be tempted to skimp on needed public safety expenditures.

In other situations, advisers may be tempted to sacrifice their professional duties for personal gain. Surgeons, for instance, have an incentive to recommend surgical treatments rather than alternative forms of patient care because surgeons earn their livelihoods by performing surgeries. For similar reasons, an accountant might be tempted to advise a client to engage in a protracted dispute with the IRS concerning unpaid taxes rather than reach a quick settlement.

Conflicts of interest also can arise in family relationships. To illustrate, assume that your ill great-grandmother is thinking about giving a $1 million donation to a particular charity, and she has asked you to research whether this charity is trustworthy. If your great-grandmother makes this donation, the expected amount of your future inheritance will decrease substantially. Would you unquestionably honor your moral duty to be honest with your great-grandmother, or would you be tempted to skew your answer to preserve your full inheritance?

More broadly, conflicts of interest arise whenever an adviser has to choose between acting with integrity or acting out of self-interest. As an illustration, assume that you just drove into an auto repair shop to ask a store representative whether the left front shock absorber on your car needs to be replaced. He might tell you that “your shock absorber is in great condition and doesn't need to be replaced” or, at the other extreme, “you need to replace all four shock absorbers, along with a new flux capacitor and an inverted flagendorf rod.”4 Most people in this situation can only hope that the store representative has the integrity to make recommendations that are in the customer's best interest rather than the store's short-term interest. As you can see, conflicts of interest are omnipresent in both professional life and everyday life.

CONFLICTS OF INTEREST IN THE ACCOUNTING PROFESSION

Broadly, accountants may encounter two different categories of conflicts of interest.

As we have already intimated, the classic conflict of interest facing accountants and other advisers arises when professionals' personal goals diverge from their client obligations. In the accounting field, this is known more formally as the Accountant–Client Conflict.

c11f001

Figure 11-1 The Client–Accountant Conflict.

c11f002

Figure 11-2 The Dual-Client Conflict.

In addition, if an accountant provides professional services to two or more clients who have opposing interests, a second type of conflict emerges. To illustrate, assume that an accountant has numerous clients, including a shopping mall owner and a regional chain of beauty salons. If the shopping mall owner now is negotiating a commercial lease with the beauty salon chain, the accountant generally must refrain from assisting either party because one client's best interests are pitted against the best interests of the other. To use an old British phrase, an accountant may not “serve two masters.”

This kind of situation, known as a Dual-Client Conflict, can arise in numerous situations. Typically, it arises when an accountant contemplates representing both a seller and a buyer, a lender and a borrower, a licensor and a licensee, a corporation and its shareholder, business co-owners, business competitors, or multiple family members.

THE BROAD PROHIBITION AGAINST CONFLICTS OF INTEREST

Unlike the duty of independence, which applies only to attest engagements, an accountant's duty of objectivity applies to the performance of any professional service. Thus, accountants always must avoid conflicts of interests involving their clients, whether they are serving as a tax adviser, auditor, trustee, business manager, or consultant, or in another capacity.

To understand the Code of Conduct's rules concerning conflicts of interest, let's examine the meaning ascribed to the words client, conflict, and interest.

Whose Interests Are Protected?

In evaluating client conflicts of interest, the concept of a client is defined expansively.

Conflict of interest rules apply to all accountants, regardless of whether they work in public practice, industry, or government. In the latter situations, accountants must protect their employers' interests because the employer is considered to be the client.

Conflicts of interest arise frequently in the workplace, especially when an employee is in a position to spend company money on outside vendors. For example, you are in charge of ordering food for lunch meetings, and your mother owns a catering service. If your mother charges higher prices than other caterers charge for comparable food, you have a duty to get the best possible deal for your employer, even if that means bargaining for a discount from your own mother.

A similar set of issues can arise when a person is involved in hiring new employees. Hiring decisions are critically important because employers commit substantial resources to training and compensating new employees. Moreover, careless or biased hiring decisions can lead to substantial additional costs, such as severance pay to terminate an incompetent employee, malpractice lawsuits attributable to employee incompetence, and sexual harassment claims by aggrieved colleagues. Thus, accountants must always remain loyal to their employer's best interests, even if they have a personal interest in hiring a friend, relative, or prospective romantic partner.

Workplace conflicts of interest also arise when employees compete against their employer or provide assistance to competitors. Employees must carefully protect company trade secrets, policies, and procedures from being disclosed to competitors.

Conflicts of interest particularly thrive in the workplace when ambiguous facts and judgment calls have to be made, such as in the budgeting process. For instance, by skewing departmental profit forecasts, cost accountants can help protect a friend's job in a struggling business segment, even though an accountant's primary duty is to prepare truthful and objective projections.

Finally, accepting kickbacks and submitting overstated expense reports and time sheets are not just conflicts of interest; they are brazen acts of thievery that must be meticulously avoided.

An accountant's obligation to protect employer interests does not end on accepting employment elsewhere. Even after quitting one job, accountants may not share or utilize a prior employer's confidential information at their new place of employment. However, as the IFAC Code states, “when a professional accountant changes employment or acquires a new client, the professional accountant is entitled to use prior experience.”5 Thus, upon leaving one job for another, accountants must walk a fine line between using prior experience, which is allowed, and using confidential information, which is not. Because our experiences are the sum total of all information we have learned, both confidential and nonconfidential, challenging practical issues often arise in complying with these mandates.

When Does a Conflict Exist?

The concept of a conflict also is defined expansively. It includes actual conflicts, perceived conflicts, and even potentially opposing goals that have not yet arisen.

Actual Versus Apparent Conflicts

Like the rules governing independence, an accountant must avoid not only actual conflicts of interest, but also the appearance of a conflict of interest. As an illustration, assume that when clients ask for help with their insurance needs, you always recommend a particular insurance agent, who also happens to be your boyfriend. Although you sincerely believe that your boyfriend is a superb insurance agent, your clients reasonably might wonder if you are subordinating their best interests to enhance your personal goals. To avoid creating even the appearance of a conflict, you never should give advice that might cause a client to justifiably doubt your sincerity and objectivity.

Situations that create an appearance of a conflict of interest also can arise in an employment context. To illustrate, assume that your job in the credit department of a large company is to objectively review credit applications submitted by corporate customers. If you own stock in a corporation that just applied for credit, you might be tempted to compromise your job duties by slanting your credit evaluation in favor of this corporate applicant.

To prevent actual and apparent conflict of interests from occurring, many company codes of conduct forbid employees from having outside financial interests in entities whose activities may intersect with their employer's activities. For instance, LinkedIn's Code of Business Conduct and Ethics prohibits employees from:

  • Serving as a director, employee or contractor for a company that has a business relationship with, or is a competitor of, LinkedIn
  • Having a financial interest in a competitor, supplier or customer of LinkedIn
  • Receiving something of value from a competitor, supplier, or customer of LinkedIn beyond entertainment or nominal gifts in the ordinary course of business, such as a meal or a coffee mug

Employee conflicts of interest also can complicate a company's auditing and accounting processes. For instance, if a company officer has a significant interest in a company that does business with her employer, an auditor has an elevated duty to evaluate the propriety of these related party transactions.6

Existing Versus Potential Future Conflicts

Because accountant–client relationships often are enduring, accountants cannot myopically just consider whether their clients' interests currently are aligned with their own interests. Rather, they must look ahead to contemplate the possibility of adversarial interests arising in the future.

According to the Code of Conduct, a conflict of interest presently exists if it is reasonably foreseeable that parties' interests will diverge in the future.

Conflicts That Emerge Later in a Relationship

To paraphrase the rock tune “Changes,” client relationships and interests change course over time like ripples of water in a stream.7 Because of this continuous ebb and flow, accountants must periodically reevaluate client relationships to see if a conflict of interest has developed in a previously harmonious professional relationship.

If a conflict of interest is later discovered, an accountant has a duty to eliminate the conflict of interest. Sometimes, this requires an accountant to withdraw from a professional engagement.

Deciding Whether a Conflict Exists

The determination of whether a conflict of interest exists is made by accountants themselves, not by an outside review board or third party. In exercising professional judgment, accountants are expected to assess their own impartiality from the standpoint of a reasonably informed, disinterested outsider.

What Is an Interest?

Identify the Relevant Interest

When the presence of a conflict of interest is evaluated, people tend to think of an interest as referring to a financial stake in the outcome of a matter. However, the notion of an interest extends well beyond a monetary goal or desire.

As one example, an interest might be a personal allegiance to a family member or friend. For instance, assume that an accountant employed by a debt collection agency discovers that his company's actions might cause an unemployed friend to lose her house in foreclosure. A conflict of interest may well exist because the company's goal of collecting an outstanding loan might run counter to the accountant's interest in aiding her friend's welfare.

As another example, an interest might be an accountant's goal of promoting the goals of a particular charitable, civic, or social cause. To illustrate, assume that your client, a health insurance company, hopes to avoid paying for an expensive new diabetes treatment. As a result, this client has asked you to advocate to regulators that the costs of this treatment far exceed its benefits. If one of your close relatives lost his eyesight due to diabetes, your emotional commitment to public policies that improve diabetes care might preclude you from aggressively promoting your client's interests.

When Others Are Tainted by a Colleague's Conflict of Interest

When one member of an accounting firm has a conflict of interest with a client, an important question arises: Is only this one accountant disqualified from serving the client, or is every member of the accounting firm disqualified?

When one CPA firm member has a conflict of interest involving a client, others within the firm ordinarily are not precluded from serving this client as long as the firm establishes adequate safeguards. Typically, this is accomplished by erecting preventative barriers that segregate client information from flowing between the disqualified member and others within the firm.

CLIENT WAIVERS OF CONFLICTS OF INTEREST

Actual Consent

A comedian wryly once observed that business relationships are a lot like marriages, except that business relationships usually last longer. Although conflicts of interest create ethical obligations for accountants, many clients have such unwavering trust in their accountants that they are willing to overlook actual or perceived conflicts of interest.

When a conflict of interest potentially exists, an accountant may utilize either of two forms of disclosure.

First, accountants commonly include general disclosures in their engagement agreements. A general disclosure typically states that it is common for an accountant to serve numerous clients, including some who may be competitors, suppliers, or customers. This type of disclosure is generic in nature and is made without reference any anticipated or pending conflict of interest.

Second, an accountant might make a specific disclosure about a particular situation that already has arisen. This type of disclosure should be sufficiently detailed about relevant threats and safeguards to allow a client to make an informed decision about whether to give its express consent.

After being informed about an accountant's conflict of interest, a client may choose to give its consent. This consent may be provided orally or in writing. If consent is given orally, though, an accountant should document the client's consent in its records.

Alternatively, a client may refuse to give its consent. In this case, two main choices are available: An accountant may discontinue providing professional services to the client, or the accountant may preserve the client relationship by terminating other relationships or personnel that originally created the conflict of interest.

Implied Consent

A client's consent generally does not have to be expressly communicated in words. If surrounding circumstances reasonably would lead a disinterested person to conclude that a client understands and acknowledges an accountant's conflict of interest, a client is considered to have given consent. This form of client acceptance is known as implied consent.8

To illustrate, assume that two business partners ask their accountant to determine the fair price that a continuing partner should pay to a retiring partner for his share of the business. Every businessperson readily understands the adversarial conflict inherent in this task because the buyout price determined by the accountant shifts money from one partner to the other. As a result, by their act of jointly submitting this request to their accountant, the partners impliedly have given their consent.

When Client Consent Is Not Permitted

Although clients generally are permitted to waive their objections to an adviser's conflict of interest, this waiver right is not absolute. Private citizens may not consent to overlook a conflict of interest that could adversely harm the interests of the general public. In an audit engagement, for example, the investing public has a compelling public interest in an auditor maintaining objectivity and professional skepticism. As a result, a client may not consent to an auditor's conflict of interest if this conflict compromises the auditor's independence.

c11f003

Figure 11-3 Evaluating Conflicts of Interest.

BEHAVIORAL ASPECTS OF CONFLICT OF INTEREST DISCLOSURES

When an adviser discloses a conflict of interest, it is reasonable to think that, after learning of an adviser's potential bias, a decision maker will make a more informed and sensible decision. However, despite the logic of this supposition, psychological research suggests that this commonsense perspective often is nonsense. Investigators cite two reasons for challenging the supposed benefits of fuller and more transparent disclosures.

First, when an adviser comprehensively discloses a self-interest bias, decision makers often respond to this information by commensurately discounting the adviser's recommendations. For example, if a seller with an acknowledged self-interest claims that his product is a “superb 10 out of 10,” skeptical buyers might mentally counteract this suspiciously high ranking by giving the product an adjusted score of, say, 8 out of 10. Somewhat perversely, however, some decision makers might admire the seller's refreshing honesty so much that they become more receptive to the offered advice, not less.

To illustrate, assume that you asked pharmacists at two different stores to recommend an ointment for alleviating your discomfort from an irritating skin rash. The first pharmacist succinctly said, “I assure you that Product X is the best ointment for your skin condition.” The second pharmacist more expansively told you, “I make a tremendous profit margin from selling Product X, and its manufacturer sends me on a free Hawaii vacation each year for selling large quantities of it, but I assure you that Product X is the best ointment for your skin condition.” Would the second pharmacist's disclosed self-interest lead you to discount his veracity and buy a different product? Or, would the second pharmacist's extensive disclosure increase your trust in his credibility and product familiarity, making you even more likely to follow his recommendation? If you perceive the second pharmacist to be especially trustworthy, his forthright disclosure, in effect, functions as a sales tool that helps overcome your resistance to buying the recommended product.

Second, self-interested advisers who disclose their potential biases often feel less inhibited thereafter about exaggerating their claims. This tendency of advisers to amplify the falsity of their claims after making self-interest disclosures is consistent with the well-known psychological concept of moral licensing. Moral licensing occurs when people who have performed a good deed, such as honestly disclosing a conflict of interest, feel entitled to engage in a bad deed. As a simple example, when a person who diligently works out at the gym all week long “feels entitled” to gobble up a triple-deluxe order of chili cheese fries on the weekend, she is engaging in moral licensing.

In sum, although disclosed conflicts of interest may lead to heightened scrutiny of an adviser's reliability, the magnitude of the mental discount applied usually is insufficient to fully correct for the degree of exaggeration present.

To illustrate this idea, assume that an adviser who fully discloses a conflict of interest exaggerates her advice by, say, 30%, but a skeptical listener typically discounts the reliability of such advice by only, say, 10%. In this case, people will make inferior, suboptimal choices because the decision-making process will, in net effect, have about 20% more distortions than if disclosure had never occurred.9 As academic researchers concluded in their article “The Dirt on Coming Clean,” parties receiving recommendations “may not discount advice from biased advisers as much as they should when conflicts of interest are disclosed and…in some circumstances, disclosure may even lead [people] to put greater weight on biased advice.”10

RESISTING TEMPTATION

At the movie theater, snacking on buttered popcorn usually trumps eating celery sticks, and at the mall, buying fashionable shoes on sale usually trumps saving for retirement. We make these common choices because our brains prompt us to select immediate gratification over deferred benefits, concrete rewards over abstractions, and certain gains over probabilistic, statistical gains.

The same observations hold true regarding professionals' conflicts of interest. When a tax return preparer helps a client claim an undeserved tax credit, the preparer gets immediate praise, prompt payment of fees, and a loyal source of other client referrals. In contrast, by rejecting an unethical client demand, the benefits to society are abstract, and the fellow citizens who might have to pay more taxes to make up for the government's shortfall are unidentifiable. Similarly, in an auditing engagement, pleasing a client has immediate rewards, but adhering to professional responsibilities merely generates potential statistical benefits to an unidentifiable set of investors and to the abstract concept of more efficient capital markets.

Knowing that our brains are preprogrammed to prefer immediate, certain gains over delayed, uncertain gains, are we hopelessly condemned to succumb to conflicts of interest? Experts make two suggestions.

First, by recognizing how automatic response systems control our actions, people can begin to tame their impulses. We do that every time we resist a fattening dessert or resist a friend's invitation to skip work to go skiing. We likewise can resist the temptation to violate ethical duties by consciously focusing on our self-image, reputation, and long-run career goals. Otherwise, as Rita Carter observed in her book Mapping the Mind, when conscious, effortful thought battles against our emotional instinct to react intuitively, “the latter is designed by the neural circuitry in our brains to win.”11

Second, we should avoid making critical, conflict-filled decisions during period of cognitive overload. Cognitive overload arises when people have so much analytical information occupying their minds that their calculating, effortful System 2 brain function becomes too clogged up to override reflexive System 1 impulses to grab instant gains. To demonstrate the impact of cognitive overload, one intriguing study asked participants to memorize a number and then grab a snack of either chocolate cake or fruit salad as they walked down a hallway to share their memory recall. Participants who merely had to memorize a two-digit number tended to select the healthful fruit salad, but participants whose cognitive resources were strained by having to recall a seven-digit number were much more likely to gorge themselves on chocolate cake!12

Figure 11-4

CONFLICTS OF INTEREST VERSUS THE DUTY OF CONFIDENTIALITY

An especially perplexing ethical quandary arises when an accountant's duty of confidentiality to one client collides with the duty of loyalty owed to another client. This dilemma was highlighted by two court cases in which CPA firms had to walk an ethical tightrope between these two conflicting duties.

Which of these duties take precedence—the duty of confidentiality or the duty of loyalty? As the following two cases illustrate, our judicial system does not seem to have a consistent view on this issue.

The Fund of Funds Case

In the Fund of Funds case, a major CPA firm had two separate audit clients who happened to do business with one another. These clients were The Fund of Funds, Ltd. and King Resources. After issuing an unqualified opinion on Fund of Funds' financial statements, the CPA firm discovered while auditing King that King had defrauded Fund of Funds by charging grossly inflated prices for certain asset sales.

The CPA firm faced a dilemma: Should it violate its duty of confidentiality to King by informing Fund of Funds about the fraud, or should it remain silent? The auditor chose to keep its mouth shut, believing that its duty of confidentiality to King prevented it from telling Fund of Funds that it had been duped. A court later disagreed with how the CPA firm balanced its obligations, though, and awarded Fund of Funds $50 million in damages.13

How should this auditor have handled this ethical quandary? Some commentators have suggested that it should have withdrawn from the second audit engagement after discovering the conflict of interest. Others have contended that, at minimum, the auditor should have implemented safeguards by assigning different personnel to work on each engagement and prohibiting them from sharing information.

The Consolidata Services Case

In the Consolidata Services case,14 a CPA firm's duty of confidentiality to one client also collided with its duty of loyalty to other clients. However, in this case, the judicial result was notably different.

Consolidata Services was a payroll processing firm that received funds from client companies and then disbursed these funds on payday to these companies' employees. During the course of providing Consolidata with various accounting services, a CPA firm discovered that Consolidata was suffering severe cash flow problems that jeopardized its financial survival. Fearing that companies who used Consolidata's services might suffer losses, the CPA firm warned its clients about the risks of depositing money with Consolidata.

Soon thereafter, as numerous clients stopped using Consolidata's payroll services, Consolidata became illiquid and unable to continue in business. Angered by its accountant's conduct, Consolidata sued the CPA firm for disclosing Consolidata's precarious financial position. Would you have held the CPA firm liable?

In its ruling in favor of Consolidata, the court essentially held that an accountant's duty of confidentiality to a particular client must take precedence over its duty to loyally protect its other clients. This outcome starkly contrasts with the Fund of Funds decision, which concluded that an accountant's duty to inform one client that it had been defrauded superseded its duty of confidentiality to another client.

MANAGING CONFLICTS OF INTEREST

As many professional service firms have become diversified global behemoths, it has become increasingly important for them to track and monitor possible conflicts of interest. Some conflict check techniques include the following:

  • Establishing databases of all clients. This database should include all clients, including former clients and near-clients who interviewed the firm but did not retain it. Information concerning each client's major competitors, suppliers, and customers should be associated with each client.
  • Creating strict controls over access to client files and protocols for who may access information.
  • Creating information barriers, or virtual walls, that filter emails from reaching unauthorized parties who otherwise might have a conflict of interest.
  • Educating staff members about the need to avoid conflicts of interest.
  • Developing reward systems that provide staff members with incentives to report potential conflicts of interest.
  • Developing a systematic review process for accepting new clients that includes an evaluation of actual and potential conflicts of interest.

Client arrangements and relationships frequently change over time, so the process of checking for conflicts must be updated periodically on an ongoing basis.

CONFLICTS OF INTEREST IN TAX PRACTICE

Some tax practitioners encounter conflicts of interest nearly every day as clients nudge and prod them to neglect their duty of fidelity to our tax system in favor of parochial client interests. Accordingly, tax practitioners need to constantly remind themselves that, according to professional standards, they owe “responsibilities to both the taxpayer and the tax system.”15

The IRS also has established strict guidelines regarding conflicting interests that may arise when an accountant provides taxpayer representation services. According to these rules, if an Accountant–Client Conflict or a Dual-Client Conflict arises, a tax practitioner may represent a client in an IRS matter only if the following conditions are all met:

  • The tax practitioner reasonably believes that he or she will be able to provide competent and diligent representation on behalf of each affected client
  • Representation is not prohibited by law
  • Each client is fully informed about the nature of the conflict
  • Each affected client promptly waives the conflict in writing on being informed of it

A tax practitioner must retain a copy of the client's written consent for at least three years.16

EXERCISES

Identifying Conflicts of Interest

  1. When you recently were dining at a restaurant, you asked your food server whether the seafood appetizer uses fresh, top-quality crab and shrimp, or whether you should just skip ordering an appetizer. The food server told you that the seafood appetizer was “decadently delicious and only used fresh seafood.” Did the food server have a conflict of interest in giving this advice?
  2. You have been retained to testify as a damages expert at a binding arbitration about the financial loss your client sustained when a supplier shipped it defective raw materials. Several days before the arbitration proceeding, you discovered that the arbitrator is a member of your country club who occasionally plays golf with you.
    1. Do you have a conflict of interest in testifying under oath on behalf of your client?
    2. Should you discuss this case with the arbitrator if you see him at the country club?
    3. Does the arbitrator have a conflict of interest?
  3. A CPA became fascinated by the precious metals trading industry while auditing a client in that industry. A few years later, this CPA discontinued the practice of accounting and become an independent precious metals trader. Her former client was one of several major competitors in that industry. Did this CPA violate the Code of Conduct's rules against conflicts of interest?
  4. Varda operates a financial consulting firm that gives advice to small business owners. Varda prepared a loan amortization schedule that assisted Gupta in winning a court judgment against Nguyen for unpaid sums owed him. Now, Nguyen is being sued by another of his creditors. Even though Varda previously was his adversary, Nguyen admired the quality of Varda's work when she helped Gupta. As a result, Nguyen has asked Varda to prepare a loan amortization schedule on his behalf that will assist Nguyen in defeating this other creditor's claim. Does Varda have a conflict of interest?

    Appearances of a Conflict

  5. “Sleazy” Slenoso, is a convicted ex-governor who has been indicted by a federal grand jury for running a Ponzi scheme that cost investors millions of dollars. As part of the government's allegations, Sleazy is accused of murdering angry investors. As a result, if Sleazy loses, a judge might impose the death penalty on him. Sleazy is a notorious character because he has a large tattoo of a pink flower on his forehead, and he is the son of a well-known supermodel and famous boxer.

    Sleazy wants to hire you to prove that he properly accounted for investment funds and show that no one lost “even one dime.” He cannot afford to hire you, though, so he has offered to give you the exclusive rights to any movie or book written about him in return for your services. Do you have a conflict of interest in testifying on his behalf at a criminal trial?

  6. You and your client have agreed to jointly buy an apartment building. Your client respects your knowledge of real estate financing and has always looked to you for financial advice. Do you have a conflict of interest if your elderly father rents an apartment in that building?
  7. You are the accountant for a very successful import brokerage business. Customer goodwill is its largest asset. The three co-owners wish to enter into a buy–sell agreement that will require the surviving co-owners to purchase a departed partner's ownership interest upon the departed partner's withdrawal due to retirement, death, or permanent disability. One of the co-owners is 60 years old and the other two co-owners are about 40 years old. All three co-owners have retained you to develop a buyout formula that will result in the withdrawing partner receiving a fair price from the surviving co-owners. The formula will apply equally to all owners, and no partner has any current plans to withdraw from the partnership.
    1. Do you have a conflict of interest?
    2. Is there a remedy for this conflict of interest?
    3. Are you obligated to make disclosures to these partners to continue to perform this engagement?
  8. A parent company owns 83% of a subsidiary. When the parent corporation recently bought valuable patents from this subsidiary, the minority shareholders in the subsidiary allege, the parent company paid a below-market price. The three largest minority shareholders of the subsidiary claim that the subsidiary sustained damages by virtue of the parent company underpaying for these patents. These shareholders want to hire you to determine the amount of damages that they suffered. You do not have any interest in the parent company. Do you have a conflict of interest in representing these three minority shareholders?

    Anticipated Adverse Client Interests

  9. Most of the employees at a factory are unrepresented by a union, but about 10% with specialized skills are unionized. All the employees believe that their employer has not been abiding by state wage rules that govern overtime pay. The nonunion group and the unionized group jointly have asked you to calculate the amounts owed to all workers. They also want you to negotiate with the employer to obtain the unpaid compensation that is owed to them, they believe, under state overtime rules. You are concerned that a conflict of interest might arise because the nonunion group might want a quick settlement with their employer, but the unionized group might prefer a protracted battle that will spur angry workers to join the union. Do you have a conflict of interest in representing both the nonunion and the union employees?
  10. A CPA firm has been retained by a major corporation to analyze whether its bank overcharged it interest on a bank loan, in violation of Oregon usury laws that establish maximum interest rates. This same CPA firm has been retained by an Arkansas bank that has been accused by Arkansas state regulators of charging excessive interest on consumer loans. Does the CPA firm definitely have a conflict of interest?

    Imputed Conflicts of Interest

  11. In response to a new banking regulation, the consulting department of your CPA firm has been retained to determine the amounts that a bank client overcharged customers on their credit cards. A customer is entitled to either accept a refund equal to the amount calculated by the CPA firm or submit its disputed claim to arbitration against the bank. As a new partner at this CPA firm, you have been put in charge of dealing with all such claims, which encompasses over 40,000 bank customers.

    In reviewing this list of claimants, you noticed that one of the bank's customers is your former college roommate. You still socialize with this former roommate frequently. Does your CPA firm have a conflict of interest in determining the refund amount owed to your former roommate?

    Conflicts of Interest in Management Accounting

  12. Ryan and Kim are married and commute to and from work together each day. Ryan, a CPA, works in the Project Budgeting Department of Carson Company, and his wife, Kim, works as an engineer in the company's Research and Development Department. Kim loves new challenges and cutting-edge technology. She really is hoping to get a new, state-of-the-art Tommy-Jaden machine for her laboratory, but she recognizes that this machine is extremely expensive and its benefits are difficult to quantify. Carson Company evaluates project proposals, including the pending proposal to buy a new Tommy-Jaden machine, by using a standard net present value approach. Ryan despises people who “cook books” and bias projections, and he never would do so.
    1. Does Ryan have a conflict of interest?
    2. Does Ryan have a duty to make any disclosures to his supervisor?
    3. How could Ryan alter his projections to maximize the odds of the company giving “green-light” approval to this capital expenditure?
  13. Your employer, Megan Manufacturing, has asked you to negotiate the sale of certain tangible fixed assets to a German company. When you were discussing this sale, Kyle, the German company's representative, mentioned that he was a huge fan of a German national soccer team. You also are a loyal fan of this same team because its star player is from your home country of Jordan. As a result, you attended this team's soccer game together.
    1. Do you now have a conflict of interest in negotiating this sale?
    2. Would you have a conflict of interest if Kyle paid $300 to buy your ticket to the game?
    3. Would you have a conflict of interest if Kyle bought you a beer at the game, but you each bought your own tickets?
  14. You have a very outgoing personality and are extremely friendly with a staff member named Adelana. Adelana reports directly to you in the company's Billing Department. You are a CPA, but Adelana is not. The two of you are not dating and you would never even consider asking her out on a date. However, four of her coworkers overheard you and Adelana discussing a romantic scene in a popular movie and inferred that you were flirting with her. The company relies on performance evaluations in determining promotions and pay raises. Do you have a conflict of interest under the Code of Conduct in submitting a performance evaluation of Adelana?
  15. A company pays bonuses to its production employees based on them achieving favorable standard cost variances.
    1. Does company management have a conflict of interest in setting these standard costs?
    2. Do the workers have a conflict of interest in setting these standard costs?
    3. How should standard costs be set?

    Conflict of Interest in Nonprofit Organizations

  16. Dalbeck, a CPA, serves on the Alumni Admissions Committee of his alma mater. As part of his duties, he interviews and evaluates applicants for this prestigious college and ranks them on a scale of 1 to 10. If he gives an applicant a high ranking, the Alumni Admissions Committee reviews the applicant's credentials and makes the final recommendation concerning admission. If he gives an applicant a low ranking, their admission is automatically denied. In accepting this volunteer position, Dalbeck agreed to be impartial.
    1. Allison, the high school valedictorian in Dalbeck's community now is applying for admission to this college. Allison is a close friend of Dalbeck's daughter Emily. Does Dalbeck have a conflict of interest?
    2. Does Dalbeck have a conflict of interest if valedictorian Allison attends the same church that Dalbeck attends?
    3. Does Dalbeck have a conflict of interest if Allison is a member of an underrepresented ethnic group and Dalbeck feels strongly that the college needs to admit more members of this ethnic group?
    4. In which of these cases, if any, does Dalbeck, have a duty under the Code of Conduct to make appropriate disclosures to the university?
    5. Assume instead that Dalbeck was providing bookkeeping services to the Alumni Organization on a pro bono basis. Would the scope of Dalbeck's disclosure duties be affected by the fact that he was donating his services as an unpaid volunteer?

    Behavioral Issues Involving Conflict of Interest Disclosures

  17. Great Deals on Earth, a chain of office supply stores, sells paper shredders. Its profit margin on paper shredders is $40. If a salesperson successfully sells a customer extended warranty coverage, the retailer collects an additional $35 fee for the warranty coverage. Whenever the extended warranty coverage is purchased by a customer, Great Deals on Earth gives the salesperson a commission equal to 20% of the selling price, and Great Deals on Earth sets aside a “repair reserve” equal to 40% of the warranty's selling price. This repair reserve reflects the company's typical warranty claims experience.

    When customers ask the salesperson if the extended warranty is a good deal, salespeople uniformly say that it is worthwhile because “repair costs can be a killer” and “only a brave soul” would leave without also buying extended warranty coverage.

    You walked into a Great Deals on Earth store and told a salesperson that you were interested in buying a paper shredder.

    1. Does the salesperson have a conflict of interest in answering your question about the suitability of purchasing warranty coverage?
    2. Should the sales personnel have to disclose to you their conflict of interest?
    3. Consider the economic impact if the salesperson had explicitly told the customer, “Hey, I make an extra commission on the extended warranty, so I'm telling you that I want to sell it to you. That said, I have sold this product for over seven years and know that the warranty really is awesome.” Would you expect this disclosure to increase sales or decrease sales?
  18. A doctor has recommended that you have a CAT scan procedure to see if you suffered a concussion in a recent auto accident. The doctor has informed you that she wants you to get a CAT scan procedure performed at a clinic in which she is “a major part-owner.” She has assured you that “this is the best way to go because I know and trust the radiology technician there, and I know that the equipment is well maintained.”
    1. Did the doctor's disclosure positively influence the likelihood that you will get this procedure done at that clinic, or negatively influence you?
    2. Does the doctor's disclosed financial interest make you concerned that you might not even need a CAT scan done at all?
    3. Does this example cause you to doubt the value of disclosures, especially when they are made by a subject-matter expert and involve a technical matter?
  19. “Moral licensing is like a Prepaid Asset T-account. When people put a bunch of debits in it, they feel like they are entitled to take a few credits out too.” Do you agree with this analogy?
  20. During a period of cognitive overload, is it advisable, or not advisable, to make ethical decisions?

    Conflicts of Interest in Tax Practice

  21. An Enrolled Agent serves private-sector clients in her professional practice located in Norfolk, Tennessee. Prior to working in the private sector, she worked as a sales tax auditor for the state of Tennessee.

    A client who has a state sales tax problem has asked her for advice about how the Tennessee sales tax authorities are likely to challenge her tax position.

    1. Is this Enrolled Agent subject to any restrictions or duties in continuing to represent this client?
    2. Do you have any recommendations for this Enrolled Agent?
  22. Should candidates running for political office be required to disclose their tax returns?
  23. A large publicly traded company encourages its production-line employees to invest their tax-deferred retirement money in the company's own stock. The company believes that this creates allegiance among company employees and gives them an incentive to diligently strive to improve the company's performance.

    The company recently hired you to advise employees in individual counseling sessions about how they should invest retirement funds in company deferred compensation plans and Individual Retirement Accounts.

    1. Do you need to make any disclosures to the employees?
    2. Is it wise for employees to invest retirement savings in their company's stock?
  24. You have prepared the tax return for a married couple for many years. This couple now has approached you with the question: “Should we file married filing jointly or married filing separately?” You like both spouses equally and do not have a preexisting social or personal relationship with either of them. Do you have to make any special disclosures before you answer their question?
  25. When your clients need tax-sheltered life insurance coverage, you always recommend a particular insurance agent. This agent appreciates your referrals and frequently refers clients who need accounting services to you. You, in fact, have a formal referral agreement that compels you and this insurance agent to refer client leads to one another. You sincerely believe that this insurance agent is highly competent and offers the same wide range of policies and premiums that other agents offer.
    1. Do you have a duty of disclosure prior to recommending this insurance agent to your clients?
    2. Assume instead that you do not have a formal referral agreement with this insurance agent, but you respect his professional skill and he respects yours. Is disclosure required?

    Conflicts Involving Confidentiality Duties

  26. X and Y are about to start an online ad placement service that they will conduct as a partnership. X is contributing substantially fewer tangible assets to the partnership than Y is contributing, but X's prominence in the business community and his business connections are vital to the success of the partnership. Both X and Y have asked you to determine the relative percentage ownership that each should have in their new partnership. Y is aware that you have had a long-standing social and professional relationship with X and have consented to waiving this conflict of interest.

    Based on your friendship with X, you know that he has a serious heart condition that might soon prevent him from actively working in furtherance of the new partnership. You have asked X to disclose his health condition to Y, but X does not want anyone to know about this potential physical limitation. X reminded you that, years ago, you agreed to respect his medical condition as private and confidential. Can you perform this professional engagement for X and Y?

    Comprehensive Problems

  27. Mr. Bayfront has a listing to sell a townhouse. When sold, his commission will equal 3% of the selling price. These townhouses sell quickly when they are priced at $120,000, but it can take months of hard work for a realtor to find a buyer who is willing to pay $130,000. Your client, the owner, has told Mr. Bayfront that she ideally will obtain a $130,000 selling price, but she will carefully consider any offer that is above $120,000.
    1. Does Mr. Bayfront, the realtor, have a conflict of interest if a buyer makes a $120,000 purchase offer?
    2. Assume that Mr. Bayfront can sell this townhouse for $120,000 by spending an average of 20 hours of marketing effort, but can sell this townhouse for $130,000 only if he spends 60 hours of marketing effort. What is Mr. Bayfront's compensation per hour at each of these two sales prices?
    3. What is the client's optimal price?
    4. Can you think of a different compensation structure that will better align the realtor's incentives with the homeowner's goals?
  28. An insurance company issued a malpractice policy to an accountant. The malpractice policy covers the accountant's liability to clients for negligence, up to the maximum $1 million face amount of the policy. The insurance company also has to pay the accountant's legal fees in the event that a claim proceeds to trial. Legal fees if the case goes to trial will be an additional $40,000.

    A client has now sued the accountant for $2 million. The insurance company and the accountant believe that the odds are 50% that a jury will award a $2 million judgment against the accountant and 50% that the jury will find the accountant not liable, awarding zero.

    1. How much will the insurance company lose if the case is settled right away for $1 million?
    2. How much will the insurance company lose, on average, if the case proceeds to trial?
    3. How much will the accountant lose, net out-of-pocket, if the case settles?
    4. How much will the accountant lose, net out-of-pocket if the case goes to trial?
    5. Does the insurance company have a conflict of interest?
  29. Huang started a small CPA firm several decades ago when he immigrated to the United States. Now, he is the managing partner of the firm, which has grown to have 40 partners and over 90 professional staff members. One of Huang's clients is Taiwan Western Bank, located in northern California. Many of Huang's small business clients maintain their checking accounts there. Also, Huang has always had a good working relationship with executives at that bank. Many of the bank's loan officers find Huang to be trustworthy, and some even call him “charming.” Because of his personal goodwill, Huang can often get his clients' loan applications approved faster there than at other banks.

    Huang has been asked to serve on the bank's Board of Directors. He has been assured that the Board meets only one night each month and that this position will not interfere with his duties as managing partner of his CPA firm. Huang has asked you to weigh the “pros and cons” for him of accepting the director position at the bank. What are your thoughts?

  30. Alex, a prospective client called Yavorsky, Nick, and Associates, a full-service accounting firm where you work, to obtain a quote for bookkeeping services. During your phone call, Alex told you that he was “cash-poor, but had a rapidly growing business.” You sensed that Alex would not be willing to pay your firm's comparatively high fees. As a result, you told the client that you would you be willing to perform services for Alex from your home during the evening for fees equal to 75% of what your employer would have charged. Alex agreed.
    1. Does this pose a conflict of interest?
    2. What if you decided to perform services for Alex at a reduced rate, with the intention of luring Alex into becoming a client of Yavorsky, Nick, and Associates once his business grows? Do you still have a conflict of interest?
  31. Before issuance, most corporate and governmental bonds receive a credit rating that usually ranges from a high of triple-A down to B-. Nearly all bond ratings are issued by one of three credit rating services—Moody's, Standard and Poor's, or Fitch. A bond issuer selects and pays one or more of these companies to issue a credit rating on its bonds. Literally trillions of dollars are invested each year in the bond market, in part based on the credit ratings issued by these private, for-profit companies.

    Because bond issuers select and compensate the rating services that evaluate their creditworthiness, these agencies have an overwhelming conflict of interest. Critics contend that these credit rating services enhance their ability to generate repeat business by giving bond issuers unduly favorable evaluations. Supporters of the current system disagree, noting that these companies' survival depends on them maintaining reputations for credibility and objectivity.

    1. Do auditors face a similar conflict of interest in certifying their clients' financial statements?
    2. Do tax accountants face a similar dilemma in dealing with shady but lucrative clients that insist on claiming exaggerated tax deductions?
    3. Nearly 99% of all bond issuances are rated by one or more of these three companies. Thus, these ratings companies are a classic oligopoly. Does the oligopoly power of these companies enhance, or harm, their ability to give objective credit ratings?

Notes

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
3.135.192.185