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Imagine that your doctor recommends a new medication. Later, you discover that they have an arrangement with the manufacturer that requires them to prescribe their drugs, even if there are better and cheaper alternatives. What if that doctor also received a hefty commission every time they wrote you a prescription for those drugs? Would you be skeptical?
That’s the situation we have today when auditors or the consultants working at their CPA firms recommend software to a client and receive a commission in exchange. It’s becoming more and more common, and managers should be wary of these recommendations if they want to ensure that they’re buying the right-sized software for their accounting and finance departments.
Sometimes these arrangements with the software vendors are exclusive, so auditors are discouraged from mentioning alternatives — even if the choice they’re pushing isn’t suited to that client or if there’s an option that’s more affordable and easier to implement and use.
CPAs are bound by the AICPA Professional Code of Conduct, which emphasizes objectivity, integrity, freedom from conflicts of interest and truthfulness. The code explicitly says that “advising a client on the purchase of a product or service while having a royalty or commission agreement with one of the potential vendors of that product or service” is a conflict of interest.
The code also says this about objectivity and integrity: “In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.”
But throw in a financial incentive, and professionals tend to act in their own self-interest.
In the aftermath of the 2001 bankruptcy of Enron and failure by its auditor Arthur Anderson, a group of researchers published a working paper on conflicts of interest among auditors. Not surprisingly, they found that “conflict of interest increases as financial incentives and professional obligations clash.”
Confronting professionals with these conflicts make them likely to dig in even deeper. I should know — I may run a software startup these days, but I started my career as a CPA and Big Four auditor. My fellow CPAs would dismiss concerns about ethical conflicts by saying that their professional standards prevented them from promoting their interests above those of their clients. But as the researchers say, “although such sentiments are noble, they do not constitute strong evidence for lack of bias.” Research by those same authors on unconscious bias confirms that accountants — just like everyone else — have a tendency to unconsciously prefer alternatives that benefit them personally.
Commission arrangements between CPA firms and software companies are common. Most CPAs resolve conflicts of interest and independence issues by disclosing them to the client and getting the client’s consent. But in my experience, these disclosures are often buried in the fine print of an engagement letter.
Where controllers and CFOs should draw the line is when the disclosures don’t fully describe all of the financial incentives that a CPA firm gets when a client buys software through them.
Sometimes the CPA firm benefits not just from commissions on the sale of the software, but also when their client hires them to implement the software. These implementation engagements may be worth hundreds of thousands of dollars or more, so there’s certainly an incentive for the CPA firm to get the client to sign up.
Accounting and finance leaders should also draw the line when the software company has an exclusive deal that discourages the auditors from mentioning a competitor, even when the competitor’s software would be a much better fit.
These exclusive arrangements violate the client’s right to choose the best software for their situation. And it violates the right of CPAs working in these accounting firms to do what’s best for their clients.
Unfortunately, large software companies often exert inappropriate pressure on CPA firms, which don’t have nearly as much financial muscle to fight back.
These arrangements violate the independence of the auditors who can’t discuss alternatives with their clients. Clients see auditors as the experts. I consider it deceptive when auditors are effectively muzzled and not allowed to provide their clients objective, unbiased advice.
While auditors have a duty to the public that prevents them from acting as fiduciaries, the consulting arms of their firms may not be under such a constraint. And when accountants are seen as the experts and clients are dependent on their advice, they’re moving into fiduciary territory, where their advice should be in the best interest of the client.
So before you sign on the dotted line for that new software, here are three questions you might ask so you can find out if your auditor has your best interests in mind:
1. Will your firm profit if we choose your recommended software?
2. Will your firm earn fees from helping us implement the software?
3. Based on your knowledge of the available options, do you feel this is the best one for us? Why or why not?
Sarbanes-Oxley clearly didn’t solve all the independence issues that led to the implosion of companies like Enron. Given the rapid growth of IT consulting services at CPA firms, it’s time for a real conversation about auditor independence.
January 4, 2019 at 07:09AM
Forbes – Entrepreneurs