Exhibit 4-2 summarizes the disciplinary system in Canada arising from the creation of

CPAB. AASOC and AcSOC stand for the Auditing and Assurance Oversight
Council and the Accounting Standards Oversight Council, respectively, and PICA
stands for Provincial Institutes of Chartered Accountants (or other relevant
professional accounting bodies). The exhibit illustrates that standard setting (right side
of exhibit) is separate from the monitoring of audit process (left side of exhibit). As
noted, this is not the case in the U.S. Note also that the CPAB can report PA firms to a
professional body, which can then subject the firm to a provincial institute/association
disciplinary process, as described previously.

Source: “Busy Year Ahead for Oversight Council,” The Bottom Line, March 2003, p.
21.
EXHIBIT 4-2
PUBLIC OVERSIGHT MODEL (CANADA)
Page 122

As noted in Chapter 2, the provincial securities commissions sometimes file

complaints with the Professional Conduct Committees of the provincial institutes or
associations. In addition, some securities commissions, notably the OSC, have been
assertive in not accepting financial statements that they consider at odds with GAAP.
The OSC issues staff accounting communiqués (SACs) in which it highlights major
problem areas. Any company attempting to use the disfavoured technique may find
that its financial statements are unacceptable to the OSC even though there is no
reservation in the auditor's report.

The OSC is going even further: it plans to increase its supervision of auditors and
other financial advisers and to gain the power to take disciplinary action against them.
Although these proposals have yet to be enacted, the OSC already exerts some control
over firms via out-of-court settlements, as indicated in the box below.
Public regulation disciplinary actions are also conducted by the SEC. Its authority
comes from its rules of practice, one of which, Rule 2(e), provides that the SEC can
deny, temporarily or permanently, the privilege of practice before the SEC to any
person (1) not qualified to represent others, (2) lacking in character or integrity or
having engaged in unethical or improper professional conduct, or (3) having willfully
violated any provision of the federal securities laws or their rules and regulations.
When conducting a “Rule 2(e) proceeding,” the SEC acts in a quasi-judicial role as an
administrative agency.

The SEC penalty bars an accountant from signing any documents filed by an SEC-
registered company and effectively stops the accountant's SEC practice. In a few
severe cases, Rule 2(e) proceedings have resulted in settlements barring not only the
individual accountant but also the accounting firm or certain of its practice offices
from accepting new SEC clients for a period.

PREVENTIVE MEDICINE

In response to problems arising from the audit of National Business Systems, Inc., the
OSC agreed that the partner in charge of that audit would not act as the senior or
second partner in charge of the audit of a public company for a year. It was also
agreed that procedures and systems would be reviewed by an auditor from another
firm and that the results would be resubmitted to the OSC. Moreover, arrangement
was made to have the Toronto office inspected by a partner from outside Canada to
ensure professional standards were met. The firm agreed to pay $70,000 to cover OSC
expenses.

Source: J. Bedard and L. LeBlanc, CA Magazine, November 1991, p. 42.

The OSC and other Canadian regulators have been pushing to have similar
disciplinary powers. Clearly, if the self-regulating process of the institutes is not
deterring bad practices, regulators are willing to step in. In 1991, members of the
ICAO approved a proposal giving the institute the power to subject firms to
disciplinary action. In 2002, the Ontario legislature passed legislation that not only
opened up public practice rights to CGAs and CMAs but also increased the penalties
for auditors associated with misleading reporting.

In the next chapter, we will see how, in reaction to a Supreme Court of Canada ruling
in the Hercules v. Ernst & Young Case, new securities laws that have been passed in
some provinces hold auditors firmly liable for any negligence in financial statement
audits. Other regulatory developments include greater independence and enforcement
powers for Ontario and Quebec securities commissions, and increased harmonization
procedures between the Alberta and British Columbia commissions. These structural
changes in the regulatory climate are likely to increase regulatory disciplinary actions
against PAs in the future.

Page 123

The Canada Revenue Agency can also discipline PAs as a matter of public regulation.
It can suspend or disbar from practice before it any PA shown to be incompetent or
disreputable or who has refused to comply with tax rules and regulations, as well as
levy fines for improper practices. The Revenue Ministry has made public its
willingness to prosecute those accountants it suspects of “deliberate attempt to
defraud the federal treasury.”20

J. Middlemiss, “Too Many Accountants Guilty of Fraud, Liberals Vow Crackdown

20

on Shady Advisers,” The Bottom Line, March 1994, p. 1.

According to a study by Brooks and Fortunato, most disciplinary actions by the ICAO
stem from violating the standards affecting the public interest (200 level).21

L. Brooks and V. Fortunato, “Disciplines at the ICAO,” CA Magazine, May 1991, p.

21

45.

Over a roughly three-year period (1988–90), most violations involved just four rules:

Rule Good Reputation of Profession representing 20 percent of all violations 36 v

201:
Rule Integrity and Due Care representing 16 percent of all violations 29 v
202:
Rule False and Misleading Representations representing 11 percent of all violations 20 v
205:
Rule Expressing an Opinion Without Complying with GAAS representing 12 percent of all 21 v
206: violations
EXAMPLE OF PUBLIC DISCIPLINARY NOTICE
Member Found Guilty of Breaching Rule of Professional Conduct 215

Re: Contingent Fees

A member has been found guilty of a charge of professional misconduct, laid by the
professional conduct committee, under Rule of Professional Conduct 215, for
agreeing to render professional services for a fee contingent on the results.

It was ordered that

 the member be reprimanded in writing by the chairman of the hearing

 the member be assessed costs of $1,500 to be paid within a specified time

 the decision and order be published in Check Mark

It was determined that the publication of the member's name was not necessary in the
circumstances, as there was no evidence of any intent to breach the rules of
professional conduct or of moral turpitude on the part of the member, and this was a
matter of first instance.

This same study also found that “all but one of the ICAO convictions we examined
resulted in disclosure of the convicted member's names, and 95 percent resulted in
levying the costs of hearing on that person. Of those convicted 78 percent were
reprimanded, of which 44 percent were also suspended; 17 percent of the total
convicted were expelled from the profession.” The average fine levied for these cases
was $5,695.22
22
Ibid, pp. 42–43.

An updated list from a more recent survey indicates that the findings in the Brooks
and Fortunato study have not changed much in the last 20 years.23

S. Arihara, “The importance of being ethical,” CA Magazine, August 2008, p. 26.

23

Page 124
REVIEW CHECKPOINTS

12. What options does the Canada Revenue Agency have for disciplining PAs?

13. What organizations and agencies have rules of conduct that must be observed
when practising public accounting? internal auditing? management
accounting? fraud examination?

14. What penalties can be imposed on CAs by provincial institutes in their “self-
regulation” of ethical code violators?

15. What penalties can be imposed by the CPAB on PAs who violate rules of
conduct?

CONSEQUENCES OF UNETHICAL/ILLEGAL ACTS

Ethics is serious business. Several sectors of professional and public activity exist
under general clouds of suspicion. Even though many practitioners of accounting,
business management, finance, journalism, law, medicine, and politics conduct
themselves in an exemplary fashion, some people hold generally unfavourable
perceptions of them. PAs used to rank near the top of trustworthy professions, but in
the post-Enron environment since 2002 one could argue they have moved down in the
rankings (see Chapter 1). This is a major problem because, without the public's
confidence, the accounting profession cannot meet the public interest.

However, conforming to rules of ethical behaviour is not always easy. A reason for
this is the potential conflicts in the rules. The most troublesome potential conflict lies
between the rules related to confidentiality on the one hand, and the prohibition
against association with misleading information on the other. Whenever there is a
conflict of interest situation for the auditor, there is a potential to create a threat to the
auditor's independent state of mind. Brooks identified the following deficiencies in
professional codes of conduct:

 No or insufficient prioritization is put forward to resolve conflicting interests.

 Consultation on ethical matters is encouraged for some members, but is

inhibited for others.
  A fair reporting/hearing process is not indicated, so members are uncertain
whether to come forward.

 Protection is not offered to a whistle-blower.

 Sanctions are often unclear, and their applicability is not defined.

 Resolution mechanisms for conflicts between professionals and firms, or

employers, or employing corporations are not put forward.24
24
L. J. Brooks, Professional Ethics for Accountants (Minneapolis/St. Paul:
West Publishing Company: 1995), p. 126.

According to an article by Sandra Rubin, the latest round of mergers among the
accounting firms is making these deficiencies even more critical to the integrity of the
financial reporting system.25
25
S. Rubin, Financial Post, November 13, 1997.

The problem is the perception of increased conflict of interest and the fact is the
problem, along with the fact that the merged firms will be so big that no single nation
(or national body) will be able to regulate them. The role of the International
Organization of Securities Commissions (IOSCO) will likely increase the future
regulation of the huge international PA firms.

CHAPTER APPLICATION CASE

Ther e are two boxes near the beginning of this chapter. One is entitled “To Tell or
Not to Tell?” and the other is called “Conflicting Duties.” How would you resolve the
ethical dilemmas presented in these cases?

LEARNING OBJECTIVE

5 Apply and integrate the chapter topics to analyze a practical auditing

situation/case/scenario.

Page 125
APPLICATION CASE AND ANALYSIS:
TO TELL OR NOT TO TELL?

The key issue in the first scenario is the “innocent mistake.” It does not take much
moral imagination to sympathize with the cashier's plight. The president of the
company, on the other hand, has a reasonable expectation to keep the risk of mistakes
acceptably low. Rather than blaming the cashier, the root of the problem might be in
the petty cash system. Has the cashier been properly trained in the way petty cash
funds work? Is the petty cash fund too large or replenished too infrequently. Are there
proper reconciliation procedures for the fund? By focusing on the system rather than
on the cashier, the auditor can minimize mistakes and save the cashier's job. The
critical thinking steps from Exhibit 4-1 involved here are steps 3, 4, and 5. The claims
made by the various parties are as follows: cashier—innocent mistakes are impossible
to avoid; the president—innocent mistakes can be avoided; and the auditor—innocent
as well as intentional mistakes can be avoided with proper procedures, training, and
controls.

APPLICATION CASE AND ANALYSIS:

CONFLICTING DUTIES

For the second case, we can apply the IFAC framework as it relates to auditor
effectiveness. This case is an example of a false dilemma, as it is a situation that could
easily have been avoided through the use of some forward thinking and moral
imagination. Although IFAC does not mention it, moral imagination is at the heart of
the thinking process behind identifying threats to fundamental principles. If the public
accountant had warned the board of the confidentiality principle and its consequences
to them, there would be no dilemma as the public accountant would not have to reveal
confidential information. As it stands now, the public accountant should reveal that
she or he has a conflict, without revealing the confidential information. The board can
then decide if it is willing to keep the accountant as a director.

The problem remaining for the PA is then one of integrity and possible association
with misleading information by not revealing the problem loan. IFAC argues for
avoiding the conflict entirely, most likely through resigning from the board once the
PA is aware of the confidential information.

In some cases it may be too late to resign, and then the accountant may have a conflict
of principles. The framework would be improved if it contained a hierarchy of
principles so that, in cases such as this one, when a conflict is unavoidable, the
hierarchy would determine which principle has “conceptual primacy,” to borrow a
term from accounting frameworks. In this chapter, we have suggested that the primary
principle should be that of not being associated with misleading information. That
means either avoiding such associations, or making sure the misleading information
has been corrected.