RULES AND REGULATIONS
Title 49--PROFESSIONAL AND VOCATIONAL AFFAIRS
STATE BOARD OF ACCOUNTANCY
[49 PA. CODE CH. 11]
Commissions and Referral Fees
[31 Pa.B. 147] The State Board of Accountancy (Board), amends § 11.24 (relating to commissions and referral fees) to read as set forth in Annex A.
The amendment revises § 11.24 to permit licensed public accounting firms and licensed certified public accountants and public accountants engaged in public practice to receive or accept commissions and to accept or pay referral fees in accordance with section 12(p) of the CPA Law (63 P. S. § 9.12(p)) which was added by the act of December 4, 1996 (P. L. 851, No. 140) (Act 140 of 1996). The existing § 11.24, adopted in 1970, prohibits commissions and referral fees absolutely. The amendment requires licensees to notify the Board when they receive or intend to receive commissions; to allow peer reviewers access to compensation records for purposes of verifying that commissions were not received for referring products or services to attest clients; to acquire and maintain in good standing any licenses or registrations required by other governmental or private standard-setting bodies relating to the receipt of commissions; to disclose commissions in client engagement letters and representation letters; and to maintain workpapers that document the basis for recommending particular products or services to clients. The amendments also require licensees who accept or pay referral fees to disclose the fees in client engagement and representation letters.
Summary of Comments and Responses to Proposed Rulemaking
The Board published a notice of proposed rulemaking at 30 Pa.B. 1271 (March 4, 2000) following which the Board entertained public comments for 30 days. The Board received comments from the Pennsylvania Institute of Certified Public Accountants (PICPA), the Pennsylvania Society of Public Accountants (PSPA), the two major professional organizations that represent the public accounting profession in this Commonwealth; H. D. Vest, a leading financial services company; and 158 individual licensees.
The Board received comments from the House Professional Licensure Committee (House Committee) on April 11, 2000, and the Independent Regulatory Review Commission (IRRC) on May 4, 2000, as part of their review of the proposed amendment under the Regulatory Review Act (71 P. S. §§ 745.1--745.14). The Board did not receive comments from the Senate Consumer Protection and Professional Licensure Committee (Senate Committee), which also reviewed the proposed amendment under the Regulatory Review Act.
Following is a summary of the comments that the Board received during proposed rulemaking and of the changes the Board has made to the proposed amendment in response to the comments:
The House Committee asked the Board to explain why it took more than 3 years to publish a proposed rulemaking that is intended to implement the provisions of section 12(p) of the CPA Law. In developing an exposure draft of the regulation for preproposal comments under Executive Order 1996-1 (relating to regulatory review and promulgation), the Board considered several policy options. In June 1998, the Board finalized its exposure draft, and in August 1998 submitted the exposure draft to the major professional organizations for preproposal comments. The Board received preproposal comments through January 1999. In June 1999, the Board conducted a poll of other jurisdictions regarding their restrictions on commissions and referral fees before settling upon a final version of its proposal. In November 1999, the Board submitted its proposal for prepublication regulatory review, which concluded with publication of the notice of proposed rulemaking in March 2000.
§11.24(b) (Notification to the Board)
Section 11.24(b) requires licensees who receive or intend to receive commissions to report that fact on their applications for biennial renewal of licensure. In its notice of proposed rulemaking, the Board stated that the notification requirement will assist it in determining which licensees require monitoring to ensure compliance with section 12(p) of the CPA Law and § 11.24.
IRRC asked the Board to explain the need for monitoring and how the monitoring will be implemented. The Board believes monitoring is complementary of the complaints process, which is the Board's usual source of information about licensees who may not be in compliance with the CPA Law and the Board's regulations. Consumers who are referred by licensees to commission-based products or services may be unaware of the requirements relating to commissions, and thus may not report noncomplying licensees to the Board. The greatest risk to consumers in the area of commissions stems from licensees who violate the prohibition, in section 12(p)(1) of the CPA Law, against referring or recommending clients to commission-based products or services when the licensees or their firms also perform audit, review or certain other attest services for the clients. To monitor compliance with this prohibition, the Board would furnish peer review administering organizations with a list of licensees who report receiving commissions. The CPA Law mandates periodic peer review of licensees who perform audit or review engagements. The peer reviewers would scrutinize the compensation records of those licensees who report receiving commissions to determine whether commission-based products or services were referred or recommended to attest clients.
IRRC also asked the Board to explain what is meant by the phrase ''intends to receive commissions.'' Licensees will be asked to indicate on their license renewal applications whether they have received commissions during the preceding license renewal period and whether they intend to recommend or refer commission-based products or services to clients during the upcoming license renewal period.
§ 11.24(c) (Cooperation with peer reviewers)
Proposed § 11.24(c) required licensees who receive commissions and who are subject to peer review to furnish peer reviewers with the necessary documentation to establish the licensees' compliance with section 12(p) of the CPA Law and § 11.24.
IRRC recommended that the Board define what is meant by ''necessary documentation.'' As stated, to determine whether licensees may have received unlawful commissions under section 12(p)(1) of the CPA Law, the peer reviewers must review the compensation records of licensees who perform attest engagements. The Board has revised § 11.24(c) to specify that compensation records comprise the required documentation. (Because their scope of authority is limited to evaluating licensees' quality control procedures and policies for attest engagements, peer reviewers are unable to serve as the Board's agents in monitoring licensees' compliance with disclosure and other requirements unrelated to the attest function.)
In its notice of proposed rulemaking, the Board stated that licensees who sell commission-based products or services to attest clients would not receive unqualified peer reviews. The PSPA observed that under section 12(p)(1) of the CPA Law, licensees are permitted to sell commission-based products or services to attest clients when the attest services involve compilations of financial statements in which the licensees have disclosed their lack of independence. The Board agrees with the PSPA's clarification that the licensees' receipt of commissions in these circumstances would not make them ineligible for unqualified peer reviews.
§ 11.24(d) (Related licensure/registration)
Proposed § 11.24(d) required licensees, prior to receiving commissions, to acquire and maintain in good standing any licenses or registrations required by other governmental or regulatory bodies for the purpose of receiving commissions. The Board stated by way of example in its notice of proposed rulemaking that licensees who desire to receive commissions for the sale of securities may need to be registered with entities such as the Securities Commission (SC), a State agency that regulates certain non-Federally covered broker/dealers, agents and investment advisors and representatives who conduct business in this Commonwealth, or the National Association of Securities Dealers (NASD), a self-regulatory organization that credentials broker/dealers and registered representatives who sell securities on the Nasdaq Stock Market and the over-the-counter securities market.
IRRC asked the Board to explain the purpose of the related licensure/registration requirement and to provide examples of the required licensure or registration in § 11.24(d). IRRC also commented that the NASD is not a governmental or regulatory body but a private standard-setting body, and recommended that the wording of § 11.24(d) be revised to include private standard-setting bodies.
The purpose of the related licensure/registration requirement is to ensure that licensees have acquired a sufficient level of training, understanding and experience regarding commission-based products or services so that they can make knowledgeable and informed recommendations and referrals of those products or services to clients. The minimum competence is established through the licensure/registration requirements of governmental or private standard-setting bodies that regulate or mediate commerce in those products or services. The most common examples of commission-based products and services for which licensure or registration may be required are the sale of securities (such as, PSC, NASD), the sale of insurance (Insurance Department), and the sale of real estate (State Real Estate Commission).
Consistent with IRRC's recommendations, the Board has revised § 11.24(d) to clarify that licensees must obtain appropriate licensure or registration from other governmental or private standard-setting bodies that may be required in order to receive commissions. The Board also has added to § 11.24(d) the examples of the governmental or private standard-setting bodies.
§ 11.24(f) (Workpapers)
Section 11.24(f) requires licensees who receive commissions to maintain workpapers that document discussions regarding their clients' investment needs, the investment strategies considered, and the bases for the investment strategies recommended. The purpose of this requirement is to ensure that licensees have exercised professional judgment in the course of recommending or referring commission-based products or services to clients.
H. D. Vest questioned the Board's legal authority to establish a workpaper requirement, commenting that section 12(p)(4) of the CPA Law only references the Board's authority to promulgate regulations on matters relating to a licensee's disclosure of commissions and referral fees to a client. While section 12(p)(4) of the CPA Law clearly directs the Board to promulgate regulations relating to disclosure requirements, the Board does not interpret that language as limiting the Board's rulemaking authority on commissions and referral fees to matters of disclosure only. Section 3(a)(11) of the CPA Law (63 P. S. § 9.3(a)(11)), authorizes the Board to promulgate rules of professional conduct for licensees, while section 3(a)(12) of the CPA Law, authorizes the Board to promulgate other regulations, consistent with the CPA Law, that are necessary and proper to implement the provisions of the CPA Law. Recommending or referring commission-based products or services to clients plainly implicates standards of professional conduct; if that were not the case, there would be no reason for the CPA Law's prohibition against licensees' recommending or referring commission-based products or services to certain attest clients. Section 11.24(f) represents a lawful exercise of the Board's authority to establish a standard of professional conduct.
Both H. D. Vest and the PSPA observed that for commissions related to securities, § 11.24(f) may duplicate the paperwork requirements of Federal and State securities regulations. The Board does not intend to require licensees to maintain redundant workpapers; workpapers maintained by licensees under securities regulations would be considered adequate so long as they reflected discussions of clients' investment needs, the investment strategies considered, and the bases for the investment strategies recommended.
IRRC recommended that because failure to maintain workpapers could expose licensees to disciplinary action, and because there are expenses associated with the retention and storage of those workpapers, § 11.24(f) should be amended to state how long licensees must retain workpapers. The Board does not believe a specific retention period is necessary for licensees' commission-related workpapers. Section 11 of the CPA Law (63 P. S. § 9.11) requires licensees to produce client records upon request but does not establish a specific retention period. Moreover, the workpapers required under § 11.24(f) are not likely to be voluminous; therefore, the costs associated with their retention and storage are likely to be minimal. Significantly, not one of the 158 individual licensees who commented on the proposed rulemaking raised any objection to the costs of retaining workpapers under § 11.24(f).
§ 11.24(g) (Attest client)
Proposed § 11.24(g) would have provided that for purposes of section 12(p)(1) of the CPA Law, licensees who perform attest services for clients--except for compilations of financial statements likely to be relied upon by third parties and accompanied by disclosures of lack of independence, as permitted under section 12(p)(ii) of the CPA Law--may not receive commissions for recommending or referring products or services to individuals or entities that can exercise significant influence over the operating, financial or accounting policies of the licensees' attest clients.
Proposed § 11.24(g) would have defined the term ''significant influence'' to include situations in which the individual or entity: (1) is connected with the client as a promoter, underwriter, voting trustee, general partner or nonhonorary director; (2) is connected with the client in a policymaking position related to the client's primary operating, financial or accounting policies, such as chief executive officer, chief financial officer or chief accounting officer; or (3) meets the criteria established in Accounting Principles Board Opinion 18, ''The Equity Method of Accounting for Investments in Common Stock,'' and its interpretations, to determine the ability of an investor to exercise the influence with respect to the client. The proposed significant influence standard was derived verbatim from the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct's Ethical Interpretation relating to the effect that a certified public accountant's financial interest in a nonclient has on his independence with a client when the nonclient has an investor or investee relationship with the client (ET § 101.10).
Proposed § 11.24(g) was intended to address a situation, not expressly covered by section 12(p)(1) of the CPA Law, in which licensees receive commissions for products or services sold to individuals or entities that, while not the attest clients of the licensees, could nevertheless substantially impact the business affairs of other clients for whom the licensees perform attest services. The Board strongly believes that licensees' receipt of commissions in those circumstances may impair their independence as auditors. The licensees' financial interests in receiving commissions could result, intentionally or unintentionally, in the weakening of their objectivity in evaluating the financial enterprises of attest clients who are subject to the significant influence of the licensees' commission clients; in some cases, licensees could be in the position of auditing the value or financial consequences of products or services for which they received commissions.
The commentators questioned the Board's legal authority to promulgate proposed § 11.24(g). Most significantly, the House Committee, noting that the prohibition in section 12(p)(1) of the CPA Law specifically relates to recommendations and referrals made to clients for whom licensees perform certain types of attest services, opined that the Board had ''no apparent statutory authority'' to expand the scope of section 12(p)(1) to cover other parties, regardless of whether those parties are in a position to exercise significant influence over clients for whom licensees perform attest services. IRRC, in turn, stated that the House Committee's comments ''clearly indicate that the legislative intent was to limit [Section 12(p)(1)] to transactions involving attest clients.'' IRRC recommended that the Board seek clarification from the General Assembly before attempting to establish a rule of professional conduct that extends beyond what is currently contemplated by the CPA Law.
In deference to the House Committee's and IRRC's view that proposed § 11.24(g) exceeded the Board's rulemaking authority, the Board has deleted it from the final-form rule. However, the Board remains steadfast in its belief that the current prohibition in section 12(p)(1) is inadequate to protect the public against the adverse impact that commissions may have on licensees' ability to perform attest services with the requisite independence. The Board intends to ask the General Assembly to amend the CPA Law to specifically prohibit a licensee's receipt of commissions in circumstances like those set forth in proposed § 11.24(g) or, alternatively, to give the Board express authority to establish such a prohibition by regulation.
Apart from their objection to the Board's legal authority to promulgate proposed § 11.24(g), the commentators raised other concerns about proposed § 11.24(g) that should be addressed in view of the Board's desire to seek its implementation through legislation.
Except for the House Committee, all commentators expressed concerns that the significant influence standard was either vague, ambiguous or confusing. The PICPA, echoing the concerns of the PSPA, H. D. Vest and the individual commentators, said that by linking together two separate engagements (attestation and investment services) and two separate clients (attest client and shareholder, employe, and the like of attest client), the Board had created a difficult interpretative issue because the ethical rules governing licensee independence are written to include only attest activities and thus provide no measurement standard for determining how independence may be impaired by the receipt of commissions. The PICPA had made these same comments in response to a preproposal draft of § 11.24 that would have simply provided that a licensee may not receive a commission from any individual or entity that could impair the licensee's independence, either by appearance or in fact, with respect to an attest client of the license; the PICPA's recommendation to the Board at the time was to either delete the provision or replace it with the AICPA Code of Professional Conduct's significant influence standard, which would provide licensees with definitive criteria for assessing when the receipt of commissions could impair independence. Proposed § 11.24(g) incorporated the significant influence standard initially recommended by the PICPA.
IRRC commented that the ambiguity in proposed § 11.24(g) was the use of the word ''includes'' to introduce the three situations that define how an entity or individual may exercise ''significant influence'' on the business affairs of an attest client. IRRC observed that ''includes'' suggests that there are situations other than those listed in the regulation that may define significant influence. IRRC recommended that if the significant influence standard were retained in the final-form amendments, the term should be defined to set forth a complete list of applicable situations. The Board notes that under the AICPA Code of Professional Conduct, the three situations descriptive of significant influence are not considered all-inclusive. The Board will propose that the amendatory language to the CPA Law set forth as comprehensive a definition of significant influence as is possible under current ethical standards.
IRRC also recommended that the reference in proposed § 11.24(g) to section 12(p)(ii) of the CPA Law either be deleted as unnecessary or, if retained, be revised to mirror the exact statutory language. IRRC noted that the Board's shorthand reference to section 12(p)(ii) had the unintentional effect of expanding the exception to the prohibition of receipt of commissions from attest clients to include situations involving compilations of financial statements with no disclosure of lack of independence; the statutory exception only applies to compilations where lack of independence is disclosed. The Board agrees with IRRC's recommendation, and will propose that the amendatory language to the CPA Law be consistent with the existing exception in section 12(p)(ii).
IRRC, the PICPA and the individual commentators also raised concerns that proposed § 11.24(g) would have an adverse fiscal impact on licensees by limiting their ability to offer a full range of services to clients. Clients with financial planning or investment needs may take their business to other financial service professionals in this Commonwealth or to licensees in border states of this Commonwealth with less restrictive commission requirements.
As the Board stated in its notice of proposed rulemaking, the adoption of a significant influence standard would certainly result in loss of unspecified commission opportunities for certain licensees. While some of those lost commission opportunities could end up benefitting out-of-State licensees as well as the financial services industry at large, other commission opportunities would simply be transferred to those in-State licensees whose independence would not be impaired by the receipt of commissions. The Board considers it noteworthy that none of the commentators from the public accounting profession have suggested that lost commission opportunities would likely cause financial hardship to licensees, such as the laying off of personnel or the closing of offices. In the absence of a showing of financial hardship to licensees, the Board believes that the salutary impact of the significant influence standard on licensee independence--a factor that redounds to the benefit of attest clients and to those who rely on the attestation services of licensees--outweighs the loss of potential earnings to licensees in the form of commissions.
Statutory Authority
Section 3(a)(11) and (12) of the CPA Law empowers the Board to promulgate, respectively, regulations relating to professional conduct and administrative regulations necessary to carry out the provisions of the CPA Law. Section 12(p)(4) of the CPA Law empowers the Board to promulgate regulations specifying minimum disclosure requirements when receiving commissions or accepting or paying referral fees.
Fiscal Impact and Paperwork Requirements
The amendment will not have a fiscal impact on the Commonwealth's agencies or its political subdivisions.
The amendment will require licensees to maintain records of their disclosures of commissions and referral fees as well as workpapers documenting the appropriateness of recommending or referring particular commission-based products or services to clients. The amendment will require the Board to revise its biennial license renewal form to include a question about whether licensees have received or intend to receive commissions; the Board will use this information for the purpose of monitoring compliance with section 12(p)(1) of the CPA Law. The amendment will not create new paperwork requirements for the Commonwealth's other agencies, the Commonwealth's political subdivisions or other segments of the private sector.
Compliance with Executive Order 1996-1
In accordance with Executive Order 1996-1 (relating to regulatory review and promulgation), the Board in developing the preproposal version of the amendment, solicited comments from the PICPA and the PSPA on behalf of their memberships.
Regulatory Review
On February 23, 2000, as required by section 5(a) of the Regulatory Review Act (71 P. S. § 745.5(a)), the Board submitted copies of a notice of proposed rulemaking, published at 30 Pa.B. 1271 to IRRC and the House and Senate Committees for review and comment.
In adopting the final-form rule, the Board considered comments from IRRC, the House Committee and the general public. The Board did not receive comments from the Senate Committee.
On October 30, 2000, the Board submitted the final-form amendment to IRRC and the House and Senate Committees. Under authority of section 5.1(d) of the Regulatory Review Act (71 P. S. § 745.5a(d)), the final-form rule was approved by the House Committee on November 13, 2000, and deemed approved by the Senate Committee on November 20, 2000. Under section 5.1(e) of the Regulatory Review Act, IRRC met on December 14, 2000, and approved the final-form rule.
Additional Information
Individuals who desire additional information about the amendment are invited to submit inquiries to Steven Wennberg, Counsel, State Board of Accountancy, P. O. Box 2649, Harrisburg, PA 17105-2649.
Findings
The Board finds that:
(1) Public notice of the Board's intention to amend 49 Pa. Code Chapter 11, by this order, has been given under sections 201 and 202 of the act of July 31, 1968 (P. L. 769, No. 240) (45 P. S. §§ 1201 and 1202) and the regulations thereunder, 1 Pa. Code §§ 7.1 and 7.2.
(2) The amendment adopted by this order is necessary and appropriate for the administration of the CPA Law.
Order
The Board, acting under its authorizing statute, orders that:
(a) The regulations of the Board, 49 Pa. Code Chapter 11, are amended by amending § 11.24 to read as set forth in Annex A.
(b) The Board shall submit this order and Annex A to the Office of Attorney General and the Office of General Counsel for approval as required by law.
(c) The Board shall certify this order and Annex A and deposit them with the Legislative Reference Bureau as required by law.
(d) The amendment shall take effect upon publication in the Pennsylvania Bulletin.
THOMAS J. BAUMGARTNER, CPA,
Chairperson(Editor's Note: For the text of the order of the Independent Regulatory Review Commission, relating to this document, see 30 Pa.B. 6964 (December 30, 2000).)
Fiscal Note: Fiscal Note 16A-557 remains valid for the final adoption of the subject regulation.
Annex A
TITLE 49. PROFESSIONAL AND VOCATIONAL STANDARDS
PART I. DEPARTMENT OF STATE
Subpart A. PROFESSIONAL AND OCCUPATIONAL AFFAIRS
CHAPTER 11. STATE BOARD OF ACCOUNTANCY
GENERAL PROVISIONS § 11.24. Commissions and referral fees.
(a) General. A licensee engaged in public practice is permitted to receive commissions and accept or pay referral fees subject to the requirements in section 12(p) of the act (63 P. S. § 9.12(p)) and this section.
(b) Notification to Board. A licensee who receives or intends to receive commissions shall report this fact on the application for biennial renewal of the license.
(c) Cooperation with peer reviewer. A licensee who receives commissions and who is subject to peer review under section 8.9 of the act (63 P. S. § 9.8i) shall furnish peer reviewers with compensation records for purposes of verifying compliance with section 12(p)(1) of the act.
(d) Related licensure/registration. Prior to receiving commissions, a licensee shall acquire and maintain in good standing any license or registration required by another governmental or private standard-setting body for the purpose of receiving commissions. Examples of bodies that may regulate the receipt of commissions are:
(1) The Pennsylvania Securities Commission (sale of securities).
(2) The National Association of Securities Dealers (sale of securities).
(3) The Insurance Department (sale of insurance).
(4) The State Real Estate Commission (sale of real estate).
(e) Disclosure to client. A licensee who receives a commission or who accepts or pays a referral fee shall make the disclosures required by section 12(p)(4) of the act in an engagement or representation letter that is signed by the client.
(f) Workpapers. A licensee who receives a commission shall maintain workpapers that document discussions regarding the client's investment needs, the investment strategies considered, and the basis for the investment strategy recommended by the licensee.
[Pa.B. Doc. No. 01-27. Filed for public inspection January 12, 2001, 9:00 a.m.]
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