SEC Shoots Down Contingent Fee Loophole

The Securities and Exchange Commission's chief accountant has ruled that a tactic some accounting firms have used to justify charging audit clients contingent fees for tax advice flies in the face of auditor-independence rules.

The ruling puts a damper on a lucrative practice for some firms, who are also suffering a revenue dip from shutting down questionable tax shelters.

The Wall Street Journal reported that under a contingent-fee deal, a firm charges a percentage cut of whatever savings a client realizes as a result of the firm's advice. When sold to a large corporation or wealthy individual, a single tax shelter, for instance, can generate millions of dollars in fees. The arrangement is usually allowed for nonaudit clients, but the SEC generally prohibits such fee arrangements between accounting firms and audit clients because they create mutual financial interests.

The loophole exists when in situations where fees are determined by courts or government agencies and some accounting firms have taken advantage of that loophole.

According to the Journal, the accounting firms argue that if a fee is set at 30% of a client's tax savings, it might appear to be a contingent fee. However, the act of submitting a tax return creates an expectation that the client might undergo a government audit, which could lead to a higher tax bill. As a result, this argument goes, the accounting firm's fee isn't a contingent fee because it is the government that ultimately determines how big it will be.

SEC Chief Accountant Donald Nicolaisen rejected the interpretation in a letter on Friday. "The fact that a government agency might challenge the amount of the client's tax savings and thereby alter the amount of the fee paid to the firm heightens, not lessens, the mutuality of interest between the firm and client," he wrote. "Accordingly, such fees impair an auditor's independence."

He wrote that the exception applies "only when the determination of the fee is taken out of the hands of the accounting firm and its audit client and is made by a body that will act in the public interest."

Bruce Webb, chairman of the professional-ethics committee for the American Institute of Certified Public Accountants, requested the clarification in an April 30 letter. The AICPA had advocated the more expansive interpretation, the Journal reported.

You may like these other stories...

Here's a CPA who truly walks the walk. On March 15, Frank Ryan, CPA, departed San Diego, California, with plans to be in Ocean City, Maryland, by July 2 to teach a course at the Maryland Association of CPAs’ (MACPA...
When Theodore J. Flynn first joined the Massachusetts Society of CPAs (MSCPA) in 1970, it was a different world and a different profession.  The "Big Eight" were still headquartered in Boston. Vietnam War...
Accountant Rickey Charles Goodrich had it a little too good. Many bean counters would kill to serve as financial guru to the likes of Pearl Jam. Goodrich was hired in 2005, and the following year, he became the CFO of Curtis...

Already a member? log in here.

Upcoming CPE Webinars

Aug 26
This webcast will include discussions of recently issued, commonly-applicable Accounting Standards Updates for non-public, non-governmental entities.
Aug 28
Excel spreadsheets are often akin to the American Wild West, where users can input anything they want into any worksheet cell. Excel's Data Validation feature allows you to restrict user inputs to selected choices, but there are many nuances to the feature that often trip users up.
Sep 9
In this session we'll discuss the types of technologies and their uses in a small accounting firm office.
Sep 11
This webcast will include discussions of commonly-applicable Clarified Auditing Standards for audits of non-public, non-governmental entities.