Is it Time to Break Up Professional Services Firms, aka CPA Firms?

I can remember years ago when I was studying accounting that the form of ownership of CPA firms was a partnership with all partners being licensed CPAs. Over the years, the forms of ownership have broadened, in part to limit the liability of partners. So, now it is common for firms to be Limited Liability Partnerships (LLP) and Professional Accountancy Corporations. Moreover, what used to be a requirement for 100% ownership by licensed CPAs—to hold out as a CPA firm—has changed, first to a supra-majority of 66 2/3% CPA ownership, then down to 51% ownership, which is how it stands today.

Non-CPAs can be part-owners of a CPA or sole proprietorship firm, but their ownership cannot exceed 49 percent in terms of financial interest or voting rights. The simple majority (51 percent) must belong to the CPA owners. Given that up to 49% ownership in CPA firms can be held by non-CPAs, the rules of conduct established by state boards of accountancy have specific provisions for what such an ownership should be like.?

Rules for Non-CPA-Owners

Given the significant percentage ownership of non-CPA-owners, the American Institute of CPAs Code of Professional Conduct has been providing guidance to such firms for many years. State Boards of Accountancy have done the same. Here is a sample of the provisions related to firms with non-CPA-owners.

Supervision of CPA Firms. Each office of a CPA firm must be actively and locally supervised by a designated actively licensed CPA whose primary responsibility and a corresponding amount of time shall be work performed in that office.

CPA Firm Requirements for CPA Ownership. A CPA firm and its designated supervising CPA is accountable for the following in regard to a CPA owner:

(1) a CPA owner must be a natural person or a general partnership or a limited liability partnership directly owned by natural persons;

(2) a CPA owner must actively participate in the business of the CPA firm.

CPA Firm Requirements for Non-CPA Ownership. A CPA firm and its designated supervising CPA owner is accountable for the following in regard to a non-CPA owner:

(1) a non-CPA owner must be a natural person, or a general partnership or limited liability partnership directly owned by natural persons;

(2) a non-CPA owner must actively participate in the business of the firm or an affiliated entity as his or her principal occupation;

(3) a non-CPA owner must comply with all applicable accountancy statutes and the rules of conduct;

(4) a non-CPA owner must be of good moral character and shall be dismissed and disqualified from ownership for any conduct that, if committed by a licensee, would result in a disciplinary action.

Professional Services Firms

CPA firms refer to themselves as professional services firms, in large part because of the broad array of non-audit/assurance services provided. This includes tax, advisory and consulting services. The revenue earned by the Big 4 in 2024 was: Deloitte ($67.2Billion); PwC ($55.4B); EY ($51.2B); and KPMG ($38.4B). In these and other large firms, more than ? of the revenue was earned through consulting and financial advisory services.?

Ownership structures have changed over the years. Initially, non-CPA owners, which could be accountancy corporations or other business entities, purchased an interest in the CPA firm. These were broadly referred to as alternative business structures. More recently, new forms of ownership have popped up including special purpose acquisition companies (SPACs) and private-entity ownership.

Merger of SPAC and Private Companies

SPACs are shell companies formed with the sole purpose of raising funds so they can buy an existing business. According to Statista, there were 248 SPAC IPOs in 2020, 613 in 2021, 86 in 2022, 31 in 2023, and 57 in 2020. The reason for the sharp decline is more stringent regulations by the U.S. SEC. In 2023, the SEC charged Marcum LLP with systemic quality control failures and violations of audit standards in connection with audit work of hundreds of SPACs.

Marcum LLP (now part of CBIZ) has dominated the market for SPACs. Over 400 have been audited by Marcum out of 860 SPACs that completed IPOS in 2020 and 2021. The merger with Marcum will make CBIZ the seventh-largest accounting services provider in the nation.

Effective July 1, 2024,?a final rule (the Final Rule) adopted by the U.S. SEC on January 24, 2024 (i) imposes new disclosure obligations in transactions involving special purpose acquisition companies (SPACs), including initial public offerings (IPOs) by SPACs and business combination transactions between SPACs and private company targets (de-SPAC transactions), and (ii) requires the tagging of additional items in SPAC IPO prospectuses and de-SPAC registration statements in Inline XBRL format (iXBRL), beginning June 30, 2025 (the Mandate).

The SPACs work this way. Investors give money to SPACs without knowing what they will do with the funds. The SPAC undertakes an IPO. The SPAC merges with the private company. The private company receives the invested funds and becomes a public company at which time the SPAC/IPO is dissolved. These kinds of relationships raise conflict of interest concerns because the audit firm of the SPAC/IPO may remain the auditor after the de-SPAC transaction occurs and a public entity is formed.

The merger of a SPAC with a private company to form a public company is depicted below.

Private Equity Firms

An growing form of ownership is private-equity (PE) ownership. A PE firm provides capital and strategic expertise to help accounting firms grow. It enables the firms to leverage their existing client relationships and cross-sell complementary services. One problem with PE ownership is they may be less independent, which could compromise the reliability of financial reporting. PE firms are designed, in part, to provide the capital that the firms might not be able to attract on their own. In part, this is because the number of new personnel in these firms is declining, a response to the so-called pipeline problem.

KPMG Law Firm

KPMG recently passed key steps in forming Big Four's First US Law Firm. This is, no doubt, the result of a shrinking client base that all Big 4 firms are dealing with. KPMG won preliminary approval to form a legal services arm in Arizona, moving it closer to becoming the first Big Four accounting firm to practice law in the US.

On January 28, 2025, the Arizona Supreme Court put a hold on KPMG's application by requesting more information. KPMG Law US, faced several questions from the Alternative Business Structures committee at a January 14 meeting. It seems the committee is not yet satisfied with the information provided.

KPMG leaders have said the new venture will provide clients with post-transactional legal services such as integrating legal contracts and tech systems between merging parties. “This focused effort is a natural extension of our capabilities and will complement the services of traditional law firms,” KPMG has said in a statement.

According to?Bloomberg Law reporters Justin Henry and Roy Strom, committee members are concerned how the firm will provide services in other states that lack Arizona's fee-sharing regime. David Rizzo, the designated compliance lawyer for KPMG Law US, told committee members that the firm "will use staffing agencies and co-counseling relationships with other law firms to serve clients in other jurisdictions. It's going to be my job to ensure that Arizona lawyers are not holding themselves out as lawyers in other jurisdictions," Rizzo told the committee. "We are aware of the kind of trouble that sloppy operations can get us in."

According to a report in the Wall Street Journal, most US states’ professional ethics rules limit the practice of law and firm ownership to licensed lawyers. Arizona is among a handful of states experimenting with new structures to boost efficiency and expand access to services by allowing lawyers to share fees and business ownership with non-lawyers. Traditional US law firms have viewed the Big Four accounting firms as a potential competitive threat.

The Big Four firms seek to integrate legal services with other consulting divisions, including tax and accounting,” said David Wilkins, director of the Center on the Legal Profession at Harvard Law School. “This is a natural extension of what they’ve been trying to do for the past decade or more,” Wilkins said. “They went from trying to be like law firms but bigger to pushing a multidisciplinary model that is tech-enabled.”

Break-up Professional Services Firms?

One of my articles was published in The CPA Journal about the need to operationally split audit and nonaudit services. Given the rapidly changing forms of ownership, the question now is: Should these professional services firms be split into two separate entities??

I believe they should be operationally split into two parts: auditing and assurance services in one firm and consultancy/advisory services in the other. This would strengthen independence because the influence of non-CPA owners would be kept at bay. It also best reflects the different cultural standards of auditors, who value independence and protecting the public interest, and consultants who provide more commercialized services where independence is not a requirement and where selling services is the goal.

The PCAOB and SEC should move on this issue now because it will require a great deal of discussion and take a long time to get it done. The discussion has been ongoing in the European Union for several years. Meanwhile, new forms of ownership are likely to expand and challenge the ethics of those practicing in professional services firms, in large part because of the conflict of interests that results from a different motivation when providing audit/assurance services as compared to advisory/consulting services.

Posted by Steven Mintz, aka Ethics Sage, on January 29, 2025. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/.