now going to the referred broker/dealer or investment adviser. Instead, CPAs have taken a more pro-active approach to managing their clients' assets on a more consistent and regular basis. Along with their accounting and tax advice, CPAs are charging a distinct fee for their financial advisory advice. However, certain restrictions apply that limit the CPAs ability to do this.
Limitations upon the CPA as investment advisor
The regulations to which CPAs are subject impose barriers to the types of accounting clients they can offer investment advice, the manner with which they may be compensated, and the financial arrangements/revenue sharing with the partners in their firm.
1. Practice of public accounting includes investment advisory services
To be licensed, CPAs are required to follow the ethical rules of practice mandated by their state, usually modeled after the AICPA Code of Professional Conduct. Most CPAs also join the AICPA and become subject both to state and AICPA rules, to the extent there are differences. It is important to realize that the AICPA, as well as the respective state regulatory umbrella, applies to all of the CPA's services--including investment advising.
CPAs, when providing investment advisory services, must keep in mind that they are still practicing "public accounting" and, as such, are covered by the AICPA's rules notwithstanding that they may be also governed by state and federal securities regulations. The AICPA's Code of Professional Conduct contains the following definitions of the CPA's status:
* The practice of public accounting consists of the performance for a client, while holding out as a CPA, the professional services of accounting, tax, and personal financial planning. ET Section 92.09
* Professional Services include all services performed by a CPA while holding themselves out as a CPA. ET Section 92.10
* In general, any action initiated by a CPA that informs others of his status as a CPA constitutes holding out as a CPA. This would include any oral or written representation to another regarding CPA status, use of the CPA designation on business cards or letterhead, or listing as a CPA in local telephone directories. ET Section 92.11
The AICPA rules that the CPA in public accounting is required to similarly apply to all of the services performed by the CPA. This includes objectivity, honesty, and independence when making judgments. Engagement in two professions may be a conflict of interest under Rule 504 without proper disclosure to the client.
2. AICPA rules on commissions
The current AICPA commissions rule (ET Section 503) prohibits the acceptance of commissions with respect to an "attest" client. Attest clients are those clients for whom the CPA performs: a) an audit or review of a financial statement; b) a compilation of a financial statement when the CPA expects or reasonably might expect that a third party will use the financial statement and that compilation does not disclose a lack of independence; or c) an examination of prospective financial information. The rule against commissions being received from attest clients is designed to ensure that the CPA remains objective when performing an audit of a client's financial statements or other engagements that similarly require that the CPA remain independent. If the CPA's independence, and hence integrity, are questioned, then the value of the audit or prepared financial statements will be diminished.
In the past, most states did not allow CPAs to receive commissions. Recently, however, state boards of accountancy have increasingly recognized that the public good will be enhanced by allowing CPAs to expand their services above traditional CPA tasks (e.g., auditing, financial reviews, etc.). The AICPA rule, which is currently followed in forty-three states, permits the receipt of commissions by CPAs performing services for non-attest clients, provided the commission arrangement is disclosed. Because the CPA will still be unable to charge a commission to his or her attest clients, this reduces the potential clients to whom investment advisory services may be sold.
Like the restrictions the SEC imposes, a CPA that is paid, or expects to be paid, a commission is required to fully disclose, in writing, that fact to each client to whom the CPA recommends or refers a product or service, to which the commission relates. Similarly, state regulations generally require CPA and/or CPA firm referral arrangements with financial institutions to be memorialized in writing.
All CPAs engaged in referring or selling financial products for compensation/commission should check with their state regulators and their state CPA societies for specific practice guidance. By understanding the AICPA's Code of Professional Conduct, CPAs will avoid violation of their membership requirement and at the same time will be in a position to understand and comply with their state regulatory requirements.
3. Form of organization
AICPA Rule 505 states that CPAs may practice public accounting only in a form of organization permitted by state law and must be 51 percent owned by CPAs.
SEC regulation of transaction-based compensation
The CPA's requirement to register as an investment adviser or as a broker/dealer may impact the formation of the strategic alliance with a non-CPA (e.g., broker/dealer or investment adviser). Under the Investment Advisers Act of 1940, CPAs are exempt from registration as investment advisers where the advice on individual securities is offered as part of an overall financial plan for the client that is considered "solely incidental" to their professional practice. Investment Advisers Act Release No. 471 (August 20, 1975). In other words, if the advice is included in the professional services and/or paid for by the professionals own fee, then it will likely be considered incidental to the practice. However, the receipt of "special compensation," the establishment of a separate advisory business, or the advertising of investment advisory or financial planning services is a strong indication that a CPA's advisory activities are not solely incidental to the CPA's services.
Once advice is no longer incidental it is considered "investment advice," which then triggers a registration requirement. Once this happens, the CPA is required to be registered under the Securities Exchange Act of 1934 ("Exchange Act") and will be subject to restrictions on how fees collected can be distributed to unregistered individuals. At the same time, the CPA must determine, based on the CPA's total amount of assets under management and the nature of compensation received, where he or she must be registered. Under the National Securities Market Improvement Act of 1996 ("NSMIA"), if an investment adviser is being paid for investment advice and manages greater than $25 million, then the CPA must register with the SEC; if less than $25 million, then the state(s) in which the investment adviser is doing business. If the compensation is transaction based, then the CPA is required to be registered as a broker/dealer. Because most partners in a CPA firm are not likely to be registered with the SEC as a broker/dealer, alliances between registered broker/dealers and CPAs may be faced with an additional problem. Often CPAs have entered into a partnership arrangement that provides that the aggregate of all revenues earned must be shared by the entire partnership and the profit allocated among the partners in proportion to their ownership percentages. An unregistered CPA firm would indirectly receive securities commissions earned by a CPA registered representative, thereby giving it a financial stake in the revenues generated by the registered representative's securities transactions. At the same time, the CPA firm is in a position to influence the registered representative's actions and to direct customers to the registered representative. Such sharing of brokerage commissions is not allowed due to the SEC's prohibition against receipt of both direct and indirect transaction-based client compensation by non-registered individuals. (Fretag, Pery, LaForce, Rubinstein and Teofan, SEC No-Action Letter publicly available January 4, 1988).
In a recent SEC no-action letter, the issue was whether, under Section 15(a) of the Exchange Act, a registered broker-dealer may enter into arrangements with a CPA and/or CPA firm to pay securities-based commissions without those CPA firms or certain partners registering as broker-dealers in accordance with Section 15(b) of the Exchange Act. The SEC noted that receipt of transaction-based compensation related to securities transactions is a key factor that may require an entity to register as a broker-dealer. Should an agreement, whether formal or informal, require the registered representative to turn those commissions over to an unregistered CPA firm, the SEC may recommend an enforcement action under Section 15(a). This conclusion is consistent with the SEC's position in the above-cited Fretag letter. (1st Global Securities SEC No-action Letter publicly available May 7, 2001).
Absent an exemption, an entity that receives commissions or other transaction-related compensation in connection with securities-based activities that fall within the definition of 'broker' or 'dealer' generally is required to register as a broker-dealer. Persons who receive transaction-based compensation generally have to register as broker-dealers under the Securities Exchange Act because, among other reasons, registration helps to ensure that persons with a "salesman's stake" in a securities transaction operate in a manner consistent with customer protection standards governing broker-dealers and their associated persons, such as sales practice rules. (1st Global No-Action Letter, publicly available May 7, 2001).
Alternatively, where the CPA chooses to refer the client to an investment adviser who charges a fee based on assets managed, then the SEC has allowed the CPA to receive a percentage of the investment adviser fee. (Fretag, Pery, LaForce, Rubinstein and Teofan, SEC No-Action Letter publicly available January 4, 1988). However, where the CPA refers the client to a broker/dealer, both the SEC and the NASD requires registration of CPAs as a broker/dealer agent even where the CPA merely acts as a solicitor because the compensation is based on the frequency of customer transactions. (1st Global No-Action Letter, publicly available May 7, 2001).
Determining the success of the alliance for both broker/dealers on the one side and CPAs on the other side has always been about determining the level of involvement of the CPAs and how to navigate the regulations. While some CPAs may be content to merely refer clients, others may desire more extensive involvement in assessing, reviewing, and providing investment advice to clients. As relationships become increasingly complicated to fit the respective parties' needs, it is important to stay in
tune with the guidance provided by the SEC, AICPA, and state regulators.
Illinois Secretary of State announces new services in its Chicago office
Please note that the Illinois Secretary of State is now accepting filings in its Chicago office on an expedited basis of the following documents:
* Corporate Articles of Incorporation (for profit only);
* Corporate Articles of Dissolution;
* Corporate Withdrawals;
* Corporate Name Reservations;
* Corporate Foreign and Domestic Annual Reports;
* LLC Articles of Organization;
* LLC Dissolutions;
* LLC Withdrawals; and
* LLC Name Reservations.
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