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Sept 1993

Disclosure guidelines for CPAs who accept commissions in nonattest engagements. (Personal Financial Planning)

by Mintz, Steven M.

    Abstract- The AICPA has revised Rule 503 to allow its public-practice members to receive commissions from third parties for referring a financial product or service to a client provided that the clients are appropriately informed of the situation. The rule is inapplicable to situations when the member also conduct audit or other attest-related services for the client. Although disclosure is a critical factor in Rule 503 and other similar regulations, there remains a need for a standard in determining what constitutes adequate disclosure. It is recommended that a notification statement be provided to clients during the final product or service endorsement. This statement should consist information on the nature of the relationship between the CPA and the company whose product or service is being recommended, the nature of the compensation structure, the types of financial products investigated and the amount of compensation for each one, and the reasons for the endorsement.

Disclosure Requirements in Rules of Conduct

The disclosure of permitted commissions is an integral part of the AICAP's Rule 503, National Association of State Boards of Accountancy's (NASBA) Rule 103, and the rules of professional conduct in effect in seven of the nine states that allow licensees to accept commissions in nonattest engagements. Generally, the disclosure requirements are consistent in these codes. However, some differences do exist.

The AICPA commissions rule is the most lenient of all the rules. It only requires disclosure of the fact that a commission has been or will be paid to a member. No guidance is provided as to the proper folrm of such disclosure or whether specific information should be provided. At the other extreme is NASBA's recommended rule on the receipt of other compensation that a licensee disclosure in writing to a client, "the nature, source and amount of all such compensation." These disclosures should be made regardless of the amount of the other compensation involved. Only nine states follow NASBA's recommendation to permit commissions in nonattest engagements. Seven of the nine states that have disclosure requirements similar to those recommended by NASBA are Colorado, Kansas, Maryland, Oklahoma, Texas, Utah, and Wisconsin.

The rules in Vermont permit a licensee to pay a commission to a third party to obtain a client if the fact and amount of such commission is disclosed to the client in writing. However, the rules are silent on the specific issue of commissions for referring products. According to the director of the Vermont Board of Public Accountancy, commissions would be permitted in nonattest engagements.

In South Dakota the rules prohibit a licensee from accepting "a commission or contingent fee if doing so impairs his independence or objectivity in rendering professional service that requires or is based on independence or objectivity." According to the Board, the rule is interpreted as prohibiting comissions only when attest-related services are performed for a client.

State board rules in Kansas and Wisconsin require disclosure to the client of the amount and reason for the commission. Guidance is not provided whether the "reason" means that the CPA should discuss the alternative investments examined or the fee arrangements for each investment. The Kansas rules do contain a useful provision that personal financial planners who accept commisssionsa in nonattest engagements should "have attained the designation of accredited personal financial specialist conferred by the AICPA, or attained other personal financial planning designations requiring similar testing, education and experience requirements as may be approved by the board."

The disclosure issue is important because a client should be provided with sufficient information to evaluate whether the CPA is biased when recommending a particular financial product. Presumably, the CPA would objectivity appraise his or her relationship with the provider of any financial product under consideration, prior to recommending a product to the client. However, the client must evaluate the relationship and the nature of the commission payment prior to deciding whether to accept the recommendation. Therefore, a critical issue is what constitutes adequate disclosure to protect the client's interest.

Establishing Disclosure Guidelines

The disclosure requirements in rules of conduct are not specific enough to assist the client in determining whether the CPA is biased in making his or her recommendation. The AICPA and states boards of accountancy in those states that permit disclosure commissions should provide additional disclosure guidelines to assist both CPAs in meeting their professional obligations and clients in evaluating the circumstances surround the CPA's recommendation of a particular financial product.

What follows are specific recommendations which provide needed disclosures about the form and substance of payments received by the CPA financial planner in a financial planning engagement.


The CPA should provide the client with a notification statement at the time of making the final product recommendation. The statement should include information about the following items: 1) the nature of the relationship between the CPA and the investment company whose financial product is being recommended, 2) the nature of the compensation arrangements, 3) the types of financial products investigated and the form of compensation for each one, including the product that is being recommended, 4) the amount of compensation to the CPA for each product that is included in item 3) above, and 5) the reason for selecting the product that is being recommended to the client. The recommended disclosures should assist the client in evaluating whether a conflict exists between the interest of the client and the CPA.










Nature, Source, and Amount of Commissions

Information about the relationship between a CPA and the investment company whose financial product is being recommended should be provided to the client because it may affect the client's perception whether the CPA is biased when recommending a particular product. If the CPA has an on-going relationship with a particular investment company it could be that he or she is "pushing" the products of that company to earn bonus commissions based on total sales through the CPA. The client needs to know whether the investment company directly pays the commission to the CPA or if an intermediary organization pays it.

The nature of the compensation arrangement should be disclosed to enable the client to determine the total costs of the financial planners' services. There are three forms of commission-based compensation.

Commissions Only. These planners do not make any money unless they sell a product. Typically, they would not evaluate non-commission products.

Fee and Commission. These planners make most of their money from commissions but also charge a fee for their services. Since the fee usually i small compared to the amount of the commission, the CPA could be biased in recommending the product with the largest potential commission, even though the fee associated with that product is the smallest.

Fee Offset. These planners set a fee for their advice which may be capped. The fee can be determined on an hourly basis, by the engagement, or as a percentage of the total amount invested. Any commissions earned by the planner are offset against the fee. Therefore, the client should pay the same amount whether purchasing the recommended product or not. However, the client needs to be informed if the commissions exceed the fee and whether the balance is credited to the client.

The client also should be informed of the amount of percentage basis of determining the commission for each product that was evaluated or, at a minimum, for those products considered to be finalists in the overall evaluation. This information has a direct bearing on whether the CPA acted objectively and with integrity in making the recommendation to the client. For example, what if the CPA investigated for different mutual funds, three of which did not provide any commission or other compensation to the CPA, while the fourth one did, and the latter fund was the recommended one. In this situation the client might believe that the CPA was influenced by the opportunity to receive a commission.

As another example, let's assume that the CPA investigated three products with the following commissions: 1) 1%, 2) 2%, and 3) 5%. Let's further assume that the CPA recommendes that 5% commission product. In this situation, the client might wonder whether it was made with the best interest of the client in mind or because of the commission size.

In some situations the CPA may receive a small commission for recommending a particular product to a client but that same product was recommended to a number of clients, resulting in a much more significant total commission. For instance, let's assume the CPA recommends the same product to four different clients who invest different amounts and the CPA receives a 5% commission. Exhibit 1 illustrates the problem. From client "B's" perspective, the amount of the commission is not very large aind it might not have any effect on that client's evaluation of the CPA's objectivity in recommending the product. However, if client B knows that the $1,000 commission represents only 5% of the total commission received by the CPA in recommending the same product to four different clients, then this disclosure might affect the client's perception of objectivity.

To protect the interests of all clients, the amount of the total commission received from a particular vendor within a relevant time period should be disclosed to all clients receiving a recommendation to buy the same product. The time period for disclosure should be long enough to be represenative of recommendations made to other clients. Ordinarily, a one year time period should provide a reasonable cut-off point in determining objectivity.

The final disclosure would be the reason for selecting the product that is being recommended to the client. This is where the CPA would be expected to justify the recommendation as bein in the client's best interest. The CPA should address to have as a result of the aforementioned expected to have as a result of the aforementioned disclosures. The reasons for selecting a product should be consistent with the clients's investment objectives. For example, if a CPA recommends a mutual fund that pays the highest commission but makes the riskiest investments, and the client has stated to the CPA a preference for risk-averse investments, then the CPA's motives are likely to be questione by the client.

Source of Disclosure Requirements

Situations already exist where guidance is provided in the AICPA Code to assist a CPA in determining the applicability of the rules of conduct in the performance of professional services. For instance, Interpretation 302-1 of Rule 302 in the code provides examples of circumstances where a contingent fee in a tax matter would be permitted. A new interpretation describing what is meant by disclosing the nature, source, and amount of commissions received in a financial planning engagement would help to protect the client's interests. Similarly, state boards should consider developing guidelines to assist licensees to determine what is meant by their disclosure requirements.

Statement of Responsibility in PFP (SRPFP) No. 1 recommendes that the CPA should document his or her understanding of the scope and nature of the financial planning services to be provided. Such documentation could be in the form of an engagement letter in the form of file memos that document oral understandings. From the perspective of protecting the client's interests, this information should be disclosed in an engagement letter. The client should be requested to sign and return a copy of the engagement letter to indicate acceptance of and agreement with the contents of the letter. These procedures should ensure that the client knows before the engagement begins that the CPA will be considering commission products and, therefore, the client can determine whether he or she wants to engage this CPA financial planner.

The detailed disclosures recommended for the notification statement that were described in the previous section should be incorporated into a new SRPFP. While they do not constitute enforceable standards, the advisory nature of these statements provide useful guidance for CPAs and would support the requirements in the interpretation by providing examples of possible disclosures.

The Public Interest Must Be Protected

The acceptance of a commission by a CPA would not reduce his or her obligation of objectivity. The acceptance of a commission in a financial planning engagement creates an apparent conflict of interest for the CPA. CPAs who are licensed to practice in states that permit commissions should be sensitive to the potential for bias that can result from a commission relationship with the provider of financial products. The public interest must be protected by putting the client's best interests ahead of any desire on the part of the CPA to become enriched by commission payments.

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