Confidentiality, conflicts of interest, second opinions and corporate financial advice

Clients tell their auditors things they would not tell the public. They do so because they trust the auditor to keep the information private. That trust is the basis of the audit, and the duty of confidentiality protects it. The duty has limits: the law may demand disclosure, and a professional may have a right or duty to speak.

This topic also deals with conflicts of interest between firms and clients, and between competing clients, with second opinions, with when a firm should consult others, and with corporate finance advice.

It covers the rule and its three exceptions, the factors in deciding whether to disclose, improper use of information, working papers, the two types of conflict and the safeguards, the second opinion, the occasions when a matter must be referred for consultation, and the advice a firm may and may not give on takeovers and share issues.

Examiners test confidentiality and conflicts in scenarios, and a second opinion was set in a recent diet as a 7-mark requirement.

The duty of confidentiality

The Institute of Chartered Accountants of Nigeria (ICAN) Code applies the International Ethics Standards Board for Accountants (IESBA) rule. Confidentiality is a fundamental principle of professional behaviour: information from professional work must not be disclosed or used unless:

1. disclosure is permitted by law and the person to whom the duty is owed has consented;
2. disclosure is required by law; or
3. there is a professional duty or right to disclose, when the law does not prohibit it.

The reason is that an auditor needs full and frank information from the client. If the client is not sure that it will stay confidential, the client may hold something back.

Disclosure permitted by law and authorised by the client

The auditor asks the client’s authority before giving confidential information to a third party. Examples are a report to a bank on compliance with a loan covenant, and a report to a stock exchange on listing rules.

Disclosure required by law

Where the law requires it, the law overrides the duty of confidentiality. ICAN’s Code gives these illustrations: producing documents or evidence in legal proceedings, and telling the proper public authorities about infringements of the law that come to light. The leading example is money laundering.

A member must report to the authorities if he knows or has reason to suspect that a client has committed terrorism, drug trafficking or any other money laundering activity. The Act requires a report of mere suspicion, even if the suspicion proves false. The law protects the accountant from being sued by the client.

Professional duty or right to disclose, when the law does not prohibit it

Illustrations in the ICAN Code are:

• complying with a quality review by a member body or professional body
• responding to an enquiry or investigation by a member body or regulator
• protecting the member’s professional interests in legal proceedings, such as defending a claim of negligence
• complying with technical standards and ethics requirements
• similar cases

Factors in deciding whether to disclose

• whether the interests of all parties, including third parties, could be harmed if the client consents to disclosure;
• whether all relevant information is known and substantiated, so far as practicable. Where facts are unproved or incomplete, judgement decides what type of disclosure, if any;
• the type of communication expected and to whom it goes. The member should be satisfied that the recipients are appropriate; and
• if in doubt about a right or duty to disclose, seek legal advice or consult ICAN.

Improper use of information

A member must not use, or appear to use, confidential information for personal advantage or for a third party’s advantage. He should not deal in the shares of a client in a way that looks like using professional information (insider dealing).

Also, where confidential information from Client 1 affects an assurance report on Client 2, he cannot give an opinion on Client 2 that he knows from this other source to be untrue. If he is to continue as auditor to Client 2, he must carry out normal audit procedures to get the same information from another source. Nothing may be disclosed outside the firm, and the auditor may ultimately have to resign.

Working papers

Working papers contain confidential client information and belong to the accountant. They should not normally be shown to outsiders. If a government agency, such as the tax authority, asks to see the papers on a client, the accountant should act in the client’s best interests: if release is in the client’s best interests and the client does not object, they may be released.

The authorities are likely to have legal powers to obtain them anyway, and a lack of co-operation may increase suspicion. If the authorities ask to see a sample of papers from a firm, not for any one client, because they doubt the quality of the practice’s work, a best-interest approach applies again. A practical compromise is for an independent accountant to review the work and report to the authorities.

Conflicts of interest

Conflicts arise between the member and a client, and between competing clients. In both cases, the test is whether a reasonable and informed third party would consider the conflict likely to affect the judgement of the member or the firm.

Between the member and the client

Members should not accept or continue an engagement where there is a conflict between the firm and the client. Examples: the member competes directly with the client, or the member gets a commission from a third party for introducing a client.

Between competing clients

A firm might act for two clients that compete directly. It owes confidentiality to both, and will not disclose one’s information to the other. Where accepting or continuing an engagement would materially prejudice the interests of any client, the appointment should not be accepted or continued. In other cases, safeguards might include:

• considering carefully whether to accept an engagement from a new client that competes directly with an existing client, and declining if appropriate;
• using different staff on the two engagements;
• full and frank disclosure to the clients, with steps to manage the conflict;
• procedures to prevent access to information, such as physical separation of teams and confidential, secure data filing, known as Chinese walls;
• clear guidelines on security and confidentiality, and confidentiality agreements;
• regular review of the safeguards; and
• advising one or both clients to seek independent advice.

The procedures a firm should have

A firm should identify possible conflicts, evaluate the problem, and manage or avoid the conflict where needed. Procedures include regular review of relationships with all clients and considering conflicts before taking on a new client.

If a conflict is found, the firm may notify the clients and discuss it, set up Chinese walls (different staff, in different offices, communicating only officially), or consider resigning from or declining one of the competing engagements.

Second opinions

A second opinion arises when a company asks an ICAN member who is not its auditor for an opinion on how an item in the financial statements should be treated. The syllabus gives one rule: the member must get the company’s permission to contact the company’s auditor. If permission is refused, the member must refuse to act.

Background: The reason for the rule is the risk of opinion shopping, where a client looks for a firm that will give the answer it wants. A second opinion is legitimate when the client genuinely needs advice. It is unethical when the aim is to undermine the auditor.

Before accepting, the adviser should therefore consider:

• contact with the existing auditor, with the client’s permission, to understand the facts and the reason for disagreement
• whether it has all the facts, including management’s case and the auditor’s technical reasoning
• why the client is asking
• whether the opinion rests on the same facts and assumptions the auditor had
• whether it has the competence to give a credible opinion

The self-interest and advocacy threats must be addressed before acceptance.

When to refer a matter for consultation

International standards on quality management require firms to seek help from people with the right knowledge and skill. The situations in which to consult should be part of the firm’s quality control. Regardless of that, a matter should be referred for consultation when:

1. the client believes that complying with an International Financial Reporting Standards (IFRS) requirement will conflict with the objective of the financial statements, to avoid bias that might affect objectivity;
2. there is a difference of opinion with a regulator on IFRS or another accounting issue;
3. there is a difference of opinion between member firms providing accounting, joint audit or other services on an engagement;
4. there is a material disagreement about the treatment of an account balance against global IFRS requirements, where the law or standard is unclear;
5. the issue turns on the local laws of a jurisdiction other than the firm’s own; or
6. a complex transaction needs judgement or expert consultation, especially where the firm lacks the skill, since an objective view reduces errors and supports consistency and compliance.

Corporate financial advice

Some corporate finance services create such significant advocacy and self-review threats that the work should not be taken on. Audit firms shall not:

• promote, deal in or underwrite an audit client’s shares; or
• give corporate finance advice to an audit client where the usefulness of the advice depends on a particular accounting treatment or presentation in the financial statements being audited.

In other cases, safeguards such as making no management decisions, an independent review of the audit or corporate finance work, and using people who are not on the audit team should be considered.

Takeover bids and share issues

Where clients are involved in a contested takeover bid, the auditors may find themselves acting for both sides. The firm may be unable to give objective advice in the best interests of both parties, and may hold confidential information about each, which risks leaking to the other. The guidelines are:

• in principle a firm may act for both parties, but should not be the sole or main adviser to both;
• if the firm holds material confidential information and its position is questionable, it should take advice from the proper financial regulator, such as the stock exchange or the national market regulator; and
• similar conflicts arise on share issues to the public, where the accountants may advise both the issuing company and potential investors.

The rules in more depth

Why the law can override confidentiality

Confidentiality exists to help the audit work, not to hide wrongdoing. Where the public interest in detecting serious crime outweighs the private interest in secrecy, the law steps in. That is why money laundering reports are compulsory and protected: if auditors could be sued for reporting wrong suspicions, they would stay silent.

Why Chinese walls only work if they are real

A wall is more than a policy. It needs different people, separate offices or secure files, and limits on contact. If the same partner supervises both clients, the wall is only on paper, and the firm cannot claim it has managed the conflict.

Why second opinions need the auditor’s involvement

An outsider who sees only the client’s side of a disagreement will tend to give the client’s answer. Contact with the existing auditor makes sure the adviser sees the full facts. A client that refuses is more likely to be shopping for an opinion, so refusal means the member must decline.

Worked example: three requests in a week

1. Second opinion. The member must obtain permission to contact the existing auditor. Gamma has refused, so Peters must refuse to act. The refusal also suggests a risk of opinion shopping.
2. Competing client. The test is whether a reasonable and informed third party would think judgement is affected. If the engagement would materially prejudice either client, decline. Otherwise, safeguards: tell both clients, use different teams and offices, set up Chinese walls, agree confidentiality rules and review them regularly. Peters may decline Beta.
3. Share purchase. Using confidential information for personal advantage, or that of a third party, is improper, and buying shares on the strength of merger news is insider dealing. The manager must not deal, and the firm should deal with it as a disciplinary matter.
4. Conclusion. Decline Gamma, assess and probably manage or decline Beta, and stop the share purchase.

How to score full marks

• For confidentiality questions, start with the three conditions. Law permits and client consents; law requires; professional duty or right. Give an example of each.
• Name the exceptions for money laundering. Mere suspicion must be reported, and the reporter is protected.
• For conflicts, state the test. “Reasonable and informed third party”, then give the safeguards in order of strength: disclose, separate teams, Chinese walls, decline or resign.
• For second opinions, give the concept, the rule and the factors. Concept; permission to contact the auditor or decline; then the factors: facts, motive, assumptions and competence. Each earns a mark.
• For consultation questions, give the occasions with a reason. Disputed standards, regulators, other jurisdictions, complexity.
• For corporate finance, remember the two prohibitions. No promoting, dealing or underwriting; no advice that depends on an accounting treatment.
• Time. Spend time in proportion to marks and apply each rule to a fact in a scenario.

Common mistakes in the exam

• Saying confidentiality is absolute.
• Saying a money laundering report needs proof. Suspicion is enough.
• Forgetting that working papers belong to the accountant, and that a best-interest approach applies.
• Setting up a Chinese wall without different staff.
• Accepting a second opinion without the client’s permission to contact the auditor.
• Treating a second opinion as always wrong. It is legitimate if the motive is genuine and the facts are complete.
• Allowing the firm to underwrite an audit client’s shares with a safeguard. It is prohibited.
• Saying a firm may never act for both sides in a takeover. It may, but not as sole or main adviser to both.

Quick revision

• Disclosure allowed: law permits and client consents; law requires; professional duty or right. Doubt: legal advice or ICAN.
• Do not use information for personal advantage. Do not deal in client shares.
• Working papers belong to the accountant. Best-interest approach; an independent accountant may review.
• Conflicts: firm and client, competing clients. Test: reasonable and informed third party. Safeguards include Chinese walls.
• Second opinion: permission to contact the auditor or refuse. Consider facts, motive, assumptions, competence.
• Consult on disputed IFRS, regulator disputes, other jurisdictions, complex matters.
• Corporate finance: do not promote, deal in or underwrite client shares; no advice dependent on accounting treatment. Takeovers: not sole adviser to both.

Practice questions

These are original questions written in the style of the ICAN exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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