Views on improving the integrity of global capital markets
20 June 2019

Ethics in Practice: Auditor and Consultant. Case and Analysis–Week of 17 June

Check the analysis of this week’s case (17 June) to see if you made the right choice.

Case

Smithson, the CEO of Bolton Investment Management, uses JOLF LLP to audit its financial records, including checking the accuracy of client account records and verifying historical performance information. The annual cost of the audit is typically $10 million. Over time, Smithson hires JOLF to also provide consulting services to Bolton in a number of areas, including consulting on information-technology security, regulatory compliance, compliance with the CFA Institute Global Investment Performance Standards (GIPS®), and other “ad hoc accounting advice.” Eventually, Bolton pays JOLF close to $50 million per year for these other services. Smithson’s actions are

  1. acceptable because JOLF’s consulting work for Bolton improves the audit by enhancing JOLF’s knowledge of Bolton’s business.
  2. acceptable only if Bolton makes a determination that JOLF’s historical knowledge of the firm will uniquely inform its consultant work.
  3. acceptable only if Bolton discloses its use of JOLF as both its auditor and as a consultant for other financial services.
  4. not acceptable.
  5. none of the above.

Analysis

This case relates to independence and objectivity and conflicts of interest. An independent financial audit of a firm’s financial records can provide confidence to clients, investors, and counterparties that the firm is in good financial health and is not engaged in financial fraud. When an auditor has a thorough knowledge of a firm’s business, this knowledge can help the auditor to perform a compressive, in-depth, and accurate audit, which will benefit both the firm and its stakeholders by enhancing the effectiveness of the audit. But there may be the appearance of a conflict of interest and a concern that the auditor’s objectivity may be impeded if it also earns large consulting fees from the same client. If accounting firms sell extra services based on their knowledge of the company they are auditing, will independence related to the audit be compromised?

There may be a perception that an auditor is more likely to provide a favorable assessment of a company’s finances to protect a lucrative consulting relationship with the firm. In this case, JOFL collects five times more fees from Bolton for consulting services than for auditing their financial records. Smithson can avoid this conflict by hiring a third-party consultant, rather than JOFL, for these additional consulting services, or at least could restrict the consulting services (and therefore fees) given to JOFL. If Smithson did not want to lose the benefits of having JOFL, a firm intimately familiar with Bolton’s business through the audit relationship, provide advice on a number of other issues, Smithson could try to mitigate the conflict by being fully transparent about Bolton’s relationship with JOFL, including the nature of the consulting JOFL provides and the fees paid to JOFL by Bolton. In some situations, accounting firms should be able to offer additional services to their auditing clients. But with respect to verification of performance history, CFA Institute guidance on the GIPS standards would prevent JOFL from providing a third-party verification of Bolton’s claim of compliance while also providing assistance in the firm’s ongoing compliance with the GIPS standards. In regards to the GIPS verification and consulting, choice D is the best response.

For the other consulting services, it does not appear that regulatory rules would prevent JOFL from performing both audit and consulting services. In addition, it does not appear that JOFL’s performance of the audit on Bolton is influenced by its consulting work or that mitigation of the conflict through disclosure would not be effective. In these cases, choice C is an acceptable answer. But many accounting firms may determine to refrain from engaging firms for both audit and consulting work to maintain their independence.

Let us know what you think of Ethics in Practice by taking this short survey.

Have an idea for a case for us to feature? Send it to us at ethicscases@cfainstitute.org.


More About the Ethics in Practice Series

Just as you need to practice to become proficient at playing a musical instrument, public speaking, or playing a sport, practicing assessing and analyzing situations and making ethical decisions develops your ethical decision-making skills. The Ethics in Practice series gives you an opportunity to “exercise” your ethical decision-making skills. Each week, we post a short vignette, drawn from real-world circumstances, regulatory cases, and CFA Institute Professional Conduct investigations, along with possible responses/actions. We then encourage you to assess the case using the CFA Institute Ethical Decision-Making Framework and through the lens of the CFA Institute Code of Ethics and Standards of Professional Conduct. Then join the conversation and let us know which of the choices you believe is the right one and explain why. Later in the week, we will post an analysis of the case and you can see how your response compares.


Image Credit: ©CFA Institute

About the Author(s)
Jon Stokes

Jon Stokes is the Director of Ethics and Standards Education at CFA Institute. His responsibilities include design and creation of on-line ethics education, development and maintenance of the CFA Institute Code of Ethics and Standards of Professional Conduct, and the design and management of the CFA Institute Ethical Decision-Making and Giving Voice to Values education programs. Stokes holds a JD degree.

Leave a Reply

Your email address will not be published. Required fields are marked *



By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.

Close