The marriage of private equity and public accounting

Accounting Today recently reported on the trend of private equity investments in the public accounting profession. How does this work in light of the fact that: (1) Licensed CPA firms must be at least majority-owned (and in some jurisdictions, 100%-owned) by licensed individual CPAs, and (2) Even when non-CPA ownership is permitted, those non-CPA owners must be actively engaged as members of the firm?

The answer is that, despite some of the confusing rhetoric in the marketplace, private equity firms are not literally investing in CPA firms; they are instead investing in a separate nonattest company that provides services to a CPA firm in a relationship known as an alternative practice structure.

What is an alternative practice structure?

The AICPA Code of Professional Conduct describes an alternative practice structure as “a form of organization in which a [CPA] firm that provides attest services is closely aligned with another public or private organization that performs other professional services.” A typical alternative practice structure has the following characteristics:

• The majority or all of the financial interests in the CPA firm are owned by individual CPAs as required.
• Some or all of the owners of the CPA firm are also employees of the closely aligned services company.
• All attest services are performed by the CPA firm and supervised by its owners.
• The CPA firm and the services company enter into a services agreement, pursuant to which the services company may provide employees, office space, equipment, technology, back-office functions such as billing and collections, and advertising in support of the CPA firm’s attest function.
• The CPA firm pays the services company a services fee in exchange for the services.
• The services company, in addition to providing services to the CPA firm, may provide permitted nonattest services directly to its clients.

When organized properly, the alternative practice structure allows the nonattest services company (and its owners) to receive a portion of the CPA firm’s attest revenue without violating CPA firm ownership rules or restrictions on the performance of attest services.
Key considerations for parties to an alternative practice structure

The Code of Conduct contains rules specifically applicable to the relationship of the parties in an alternative practice structure and the reach of the independence rules in such a structure. Some state boards of accountancy have also published guidance for alternative practice structures. Based on that guidance, parties considering setting up such a structure, or already operating in one, should bear in mind the following considerations.

1. The CPA firm must be a separately governed, distinct legal entity. CPA firm ownership requirements are designed in part to insulate attest services and related judgments from marketplace pressures. That means a CPA firm providing attest services must remain a separate legal entity from the aligned services company, with distinct governing documents and governance structures. Most importantly, a CPA firm must retain control over its attest function. Among other limitations, the CPA firm should control attest client acceptance and continuation determinations and attest engagement terms, and should not outsource employment decisions regarding the individual CPAs performing attest services.

2. The CPA firm and services company must hold themselves out as separate entities. In addition to being separate entities in fact, the CPA firm and services company must hold themselves out to the public in a manner that does not cause confusion. In particular, the services company should avoid creating any impression that it is a licensed firm or provides attest services to clients, and engagement agreements should make clear what entity is providing what services. Affirmative disclosures regarding the existence of two separate entities — one that is a CPA firm and the other that is not — are required in some circumstances.

3. The CPA firm must remain financially responsible for its attest work. The Code of Conduct states that CPAs must be at all times “responsible, financially and otherwise, for a firm’s attest work.” That requirement has at least two consequences. First, standard indemnification provisions in services agreements in other contexts may not be appropriate in the services agreement between the CPA firm and services company in an alternative practice structure. Second, a CPA firm must have the financial wherewithal to address any repercussions of its attest work. Parties must keep this in mind, along with a CPA firm’s other expenses, when determining the services fee paid to the services company. It is worth noting that some state boards have provided guidance that the services fee should approximate the fair market value of the services.

4. The independence rules will extend beyond the CPA firm. The independence rules that govern the CPA firm’s performance of attest services will extend at least to some extent to the services company. The extent of that reach is determined by several variables. If the CPA firm performs audit services governed by the SEC and PCAOB independence rules, the services company will be considered an “associated entity” of the CPA firm and treated as the CPA firm for purposes of the independence rules. That has implications for the owners and affiliates of the services company and potentially others. When the SEC and PCAOB rules do not apply, the reach of the independence requirements will depend on, among other factors, whether the CPA firm provides financial statement attest services as opposed to other attest services. The bottom line is that parties to an alternative structure must carefully examine the applicable independence regimes and implement controls to monitor the CPA firm’s independence.

5. The Confidential Client Information rule still applies. The CPA firm must remain aware of its duties pursuant to the Confidential Client Information rule. The services company may not be treated as an extension or division of the CPA firm for purposes of the rule. Parties to an alternative practice structure must analyze the Code of Conduct and applicable state law to determine whether and how the CPA firm may share Confidential Client Information with the services company.