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Understanding valuation services in a
post-Sarbanes-Oxley world
When
Congress passed the Sarbanes-Oxley Act last year, choosing a valuation
professional suddenly became more complicated. Not only has the new law
spotlighted the issue of independence, it has also led to confusion about
which experts can service a client’s valuation and related expert witness
needs. Let’s clear up some misconceptions about valuation services in today’s
world.
Effect on valuation services
The Sarbanes-Oxley Act prohibits CPAs from providing nine specific consulting
services to their public audit clients. Valuations and expert witness
services (which often go hand-in-hand) are among those prohibited under the
new law.
Congress used a three-pronged test to select which services to prohibit under
Sarbanes-Oxley. When hiring a valuator, attorneys should keep these criteria
in mind to avoid conflicts of interest. Namely, an auditor cannot:
1. Audit his or her own work,
2. Function as a member of management, or
3. Serve as the client’s advocate.
In many instances, a client’s audit firm is the logical go-to place for
valuation and expert witness services. After all, they’re trusted advisors
already familiar with the company’s operations. But, if using the audit firm
commits a congressional independence faux pax, a valuator from outside the
client’s CPA firm should be chosen.
Private companies take note
Technically, the Sarbanes-Oxley Act applies only to public companies. But
private companies would be foolish to overlook it. The courts, IRS and
opposing counsel will likely use the act as a basis for discrediting CPA
experts whose objectivity is questionable — regardless of whether the company
is publicly traded or privately held.
Furthermore, in March 2003, the American Institute of Certified Public
Accountants (AICPA) drafted a revision of Interpretation 101-3 dealing with
auditor independence under the Code of Professional Conduct’s Rule 101. This
proposed change would clarify requirements for performing non-attest services
(including business valuations) for all attest clients (not just audit
clients); again, regardless of whether they’re publicly traded or privately
held.
Once the AICPA finalizes its proposed changes (tentatively scheduled for the
end of 2003), private companies that use a CPA for audit, review or other
attestation services will also be forced to follow independence rules similar
to — though less stringent than — those imposed by Sarbanes-Oxley.
Limitations on CPAs
A company’s CPA cannot perform a valuation if it affects the company’s
financial statements where the same CPA is performing an attest function.
This rule applies if he or she is required to test the valuation during an
audit or other attestation engagement. For instance, a CPA may be required to
test that valuations are prepared in accordance with Statement of Financial
Accounting Standards (SFAS) 123 (fair value of employee stock options), SFAS
133 (fair value of derivatives), SFAS 141 (allocation of purchase price in a
business combination) or SFAS 142 (fair value/impairment of goodwill).
Privately held companies should discuss potentially compromising valuation
needs with their audit firms. Furthermore, a company’s CPA should carefully
consider his or her independence when providing expert witness services to
audit/attestation clients, to avoid having the opposing party suggest he or
she is an advocate for the client.
Conversely, if a valuation performed for other than litigation purposes won’t
be subject to audit procedures, it may be acceptable to use the company’s
CPA. Among these valuation "safe harbors" are valuations performed
for tax or management planning purposes.
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