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CPA Comfort Letter to Lenders
CPAs are regularly asked to provide a loan broker, lender or other third
party with a comfort letter on behalf of their clients. To guide you in
the right direction, read this
article about third party verification letters which includes a
sample letter provided by the
AICPA Professional Liability Insurance Program.
In addition, refer to this Journal of Accountancy
article for further information and suggested wording for comfort
letter preparation.Third Party Verification
Letters
Increasingly, CPAs are receiving requests from
clients, lenders, loan brokers, health insurance
providers, adoption agencies, regulators and various
other agencies to confirm client information. The
requested information may relate to a pending loan,
employee medical insurance, child adoption applications
or use-tax certification. Mortgages originated by
private mortgage companies, which were resold to Fannie
Mae and Freddie Mac and past due, are subject to
required quality reviews. Quality review standards may
require the mortgage originator to contact CPAs whose
comfort letters are contained within the loan file to
confirm the statements made in such letters. In most
cases, CPAs are asked to provide a confirmation letter
containing specific language, a verification statement,
a comfort letter, or a certification form (collectively
“Verification Documents”).
By providing such Verification Documents, a CPA may
unintentionally violate professional standards. The CPA
also may confront the risk of a malpractice claim in the
event that a third party detrimentally relies on an
alleged inaccurate statement made in a Verification
Document.
This article will discuss the types of requests for
Verification Documents that may be received by a CPA and
how the CPA can respond to such requests, manage any
associated risks, and comply with professional
standards.
Requests from Lenders
The most common type of request for a Verification
Document is associated with mortgage loan applications
of self-employed tax return preparation clients.
Examples of information requested by lenders and loan
brokers include:
- Confirmation of a client’s
self-employment status;
- Verification of income from
self-employment;
- Verification of a self-employed
borrower’s business ownership
percentage;
- Profitability or sustainability of a
self-employed client’s business; and
- The impact on a self-employed
client’s business if money is withdrawn
to fund the down payment on a real
estate purchase.
A self-employed borrower often uses business assets
from a sole proprietorship, partnership or corporation
to fund a down payment and closing costs for a home
mortgage. Lenders or brokers are required to assess the
borrower’s creditworthiness and verify the accuracy of
information provided by the borrower. Nevertheless, in
the case of a self-employed borrower, the means to
obtain available financial information may be limited.
By obtaining a comfort letter from a CPA, lenders or
brokers may attempt to shift the responsibility for
confirming the accuracy of the information — and
possibly the risk of non-repayment of the loan — to the
self-employed borrower’s CPA. If the self-employed
borrower later defaults on the loan, the lender may
raise the comfort letter received from the CPA, prior to
funding the loan. The lender may then take the position
that the representations made in the letter were a
substantial factor in its decision to extend credit.
As a result, the lender may be in a better position
to recover loan losses by suing the CPA, alleging that
it detrimentally relied on the negligent
misrepresentation(s) made in the comfort letter. The
comfort letter also may be used to establish the
lender’s legal standing to sue the CPA where such
standing may not otherwise exist.
Such mortgages often are resold to Freddie Mac, which
is a secondary market for residential mortgages.
Historically, Freddie Mac’s Single Family
Seller/Servicer Guide (the Guide) provided
secondary market sellers with two methods for analyzing
whether the withdrawal of business funds would
negatively affect the ability of the business to
continue operations. One of the methods described in the
Guide was to obtain a comfort letter from an accountant
stating, “[T]he Borrower has access to the funds and the
withdrawal of the funds for the down payment and closing
costs will not have a detrimental effect on the
business.” The Single Family Selling Guide
published by Fannie Mae, another secondary market for
residential mortgages, does not contain similar guidance
(see Section B3-3.2-01 of the Fannie
Mae guide, titled Underwriting Factors and
Documentation for a Self-Employed Borrower for the
relevant guidance).
In 2012, Freddie Mac revised the Guide by deleting the
practice of obtaining a comfort letter from an accountant as a method of
determining the impact of a withdrawal on a self-employed borrower’s
business. Section 37.13(b) of the Guide, which is related to stable
monthly income and asset qualification sources, now states that when
business assets are used for down payment and closing costs, financing
costs, prepaids/escrows and reserves:
- the assets must be verified in accordance
with the documentation requirements in Sections 37.20
through 37.23;
- the assets must be related to the business
that the borrower owns that is documented in the
mortgage file;
- the seller of the mortgage is required to
document a cash flow analysis for the borrower's
business using the individual and/or business tax
returns, as applicable; and
- the mortgage file must contain the seller's
written cash flow analysis and conclusions.
While lenders and brokers have always been responsible for
conducting their own due diligence prior to making a credit decision,
the revision to the Guide places the burden of determining the impact on
the ability of the business to continue operating as a result of the
withdrawal solely on the lender or broker.
If a self-employed borrower is informed
that he/she will not qualify for a mortgage unless his/her accountant
provides a comfort letter, accountants should challenge this assertion
by referencing the fact that such guidance does not exist in either the
Fannie Mae or Freddie Mac seller guides for residential mortgages.
Other Requests
Recently, other types of Verification Document requests have emerged.
Examples include:
- Requests from adoption agencies and foreign
countries for a Verification Document confirming the
client’s self-employment, citizenship status and the
financial stability of the client’s business;
- Requests from health insurance providers for a
business Verification Document from a CPA, Certified
Management Accountant (CMA), licensed tax consultant or
attorney attesting that the listed, eligible employees
worked the minimum hours required under state law, and
that the business is a bona fide business qualifying as
a small employer under state law and health plan
underwriting guidelines; and
- Requests from state taxing authorities for a
Verification Document from a CPA, enrolled agent or
attorney certifying that the taxpayer and the
"authorized representative" have reviewed the books and
records of the taxpayer and determined that there is no
use tax due or reportable.
Regardless of the nature of such requests, there is one basic
principle that should be followed - CPAs providing written assurance
must comply with the AICPA Statements on Standards for Attestation
Engagements (SSAE). Attesting to client information without performing
attestation services in accordance with the SSAE constitutes a violation
of professional standards, resulting in licensure implications.
In response to such requests, CPAs should remind clients that tax
returns are prepared based on their information and representations,
which are neither audited nor verified. CPAs also should inform clients
that assurances cannot be provided to a third party about information in
tax returns or with regard to any other client matters.
An Alternative
Although it is preferable, from a risk control perspective, to avoid
confirming any client information to a third party, refusing to provide
any information may alienate clients. As an alternative, the CPA may
send a letter to the third party confirming only that the firm prepared
the applicable income tax return(s) for the client to meet the client’s
tax-filing obligations.1 If the individual income tax returns
were filed electronically on the client’s behalf, the letter also could
state that the client provided the CPA with a signed copy of IRS Form
8879, which includes a declaration that the taxpayer examined a copy of
his or her electronic individual income tax return and accompanying
schedules and statements for that tax year and declared that it is true,
correct and complete to the best of his or her knowledge.2
2. If electronic tax returns are prepared, signed copies of IRS
Forms 8878 and 8879 (as applicable) must be retained for CPA’s records
and as part of the working paper file for the client engagement.
Ideally, clients should provide any requested information directly to
third parties. If a client asks the CPA to send a copy of his or her tax
return to a third party, the CPA must obtain the client’s signed written
consent prior to doing so. Protecting the confidentiality of client
information is required under professional ethics standards, the
Gramm-Leach-Bliley Act, the Internal Revenue Code, state board of
accountancy rules or regulations, and federal and state privacy statutes
and regulations.
Even after offering this practical solution, clients may continue to
implore you to provide the specific representation that a lender, broker
or other third party is seeking. The third party may assert that the
client will not be approved for a loan or may otherwise fail to meet
their requirements if the CPA does not provide the requested
Verification Document. When this occurs, the CPA may wish to remind the
client about the limited nature of the scope of services provided, and
why the Verification Document is inconsistent with such representations.
Summary
Third parties are responsible for performing their own due diligence
rather than relying on a representation or verification of information
by a CPA. This is especially true when the requested representations are
outside the scope of the CPA’s engagement and the requested verification
relates to information that comes from the client, for which the CPA has
no first-hand knowledge. Additionally, while clients desire the
flexibility to obtain credit in the marketplace, the responsibility for
underwriting a loan and determining the creditworthiness of the borrower
lies with the lender — not the client’s CPA.
(Updated November 2012)
How CPAs Should Handle "Comfort Letter"
Requests from Lenders, Mortgage Brokers/b>
AICPA members have contacted the AICPA to clarify their professional
ethical obligations when asked for "comfort letters" by lenders and
mortgage brokers. Depending on how practitioners respond to such
requests, they may be at risk for failing to comply with AICPA
professional standards. In these situations, a number of CPAs may
violate professional standards unknowingly; others may succumb to
brokers' threats to undermine the CPA-client relationship. CPAs can
ethically and effectively address these situations if they are aware of
and stick to their professional obligations.
The letter at issue is usually associated with stated-income loans,
which are mortgages that do not require borrowers to document their
income. Such loans usually are sought by borrowers whose income sources
are difficult to verify or fluctuate from year to year. Self-employed
people and individuals with investment income or with sales jobs of
varying commissions often apply for stated income loans. Lenders,
lacking documentation to support borrowers’ income claims, take on the
risk that borrowers’ claims are inadequate. Because of the higher risk,
lenders charge higher interest rates. To gain more comfort in extending
loans, some lenders look to the borrowers' CPA for assurance or comfort
about certain information. The information requested often includes
assurance about the client's self-employed status, verification of
income, profitability of the client's business, and the impact on a
client's business if cash is withdrawn from the company.
In an effort to minimize their risk, brokers typically ask CPAs to vouch
for their clients with a letter supporting clients' claims. If they
arise, these situations can place you at risk in two ways. First,
your response must be in compliance with professional standards.
Secondly, if you point out to the broker that reporting on solvency
in this situation would be unethical or that a request requiring
examining a personal balance sheet and earnings forecast would be
expensive, the broker may exert pressure by threatening to suggest
the client change CPAs.
You can protect yourself against the risks associated with these
situations, but first you must understand what is and is not
permissible. Attestation Interpretation No. 2, "Responding to Requests
for Reports on Matters Relating to Solvency" in AT section 9101, Attest
Engagements: Attest Engagements Interpretations of Section 101 (AICPA,
Professional Standards, vol. 1), provides guidance to the
practitioner when he or she receives requests asking the CPA to report
on matter relating to solvency. Essentially, this interpretation states
that CPAs should not provide any form of assurance relating to matters
of solvency, but there are services that may be performed. If a
mortgage broker or lender wants an attest report from you, then you may
audit, review or compile the personal financial statements of the
borrower, you may report on pro forma or prospective financial
information of the borrower, or you may perform and provide to the
client and lender an agreed-upon procedures report, as long as the
agreed-upon procedures do not provide any assurance on matters relating
to solvency. Brokers tend to ask for as much assurance as they can
get without understanding or knowing the cost or consequences. However,
once you explain to your client and the broker the cost entailed,
they typically back off their request. Instead, the brokers may be
satisfied with a simple letter from the CPA acknowledging that the
income reported to the broker or lender is the amount that has been
reported to the Internal Revenue Service on the tax return.
Obviously, the client would need to agree to have the CPA send such a
letter.
In these situations, you can avoid risk by sticking to your professional
responsibilities, following professional standards and not caving in to
undue pressure. Also, many insurance providers are aware of this
practice and as a result have developed sample letters or templates for
CPAs to use in these situations. CPAs should contact their insurance
providers and inquire whether they have any additional guidance or
sample letters that could be used for these requests.
http://www.aicpa.org/download/cpaltr/2007_02/feb07.pdf on page
10 of 12
CPA Letters for Loan Brokers and
Lenders
More and more CPAs
are receiving requests from clients, lenders, and loan brokers to
confirm client information in connection with a pending client loan
application. In some cases, CPAs are furnished with specific language
to be included in a confirmation letter. Generally, these requests
originate with individual tax return preparation clients, and examples
of requested information include:
·
Confirmation of a client’s self-employed status
·
Verification of income from self-employment
·
Profitability of a client’s business
·
The
impact on a client’s business if money is withdrawn to fund the down
payment on a real estate purchase
When presented
with such requests, it is imperative to assess the situation and ask
yourself two important questions. Why are lenders and loan brokers
seeking this information? And how should you respond?
RRecently,
no-documentation or low-documentation loans have increased in
popularity within the lending community. The information a
prospective borrower is asked to furnish in connection with such loans
is limited; however, lenders or brokers are still required to assess
the borrower’s creditworthiness. By obtaining confirmation from
you, the CPA, lenders or brokers attempt to shift the responsibility
for confirming the accuracy of information provided to them by the
borrower. If the borrower later defaults on the loan, the lender will
be able to prove that this information came from you prior to funding
the loan. As a result, the lender may be in a better position to sue
your firm directly to recover the loan losses, claiming to be in
privity of contract with the firm. This written communication may be
intended as a tool to overcome privity defenses available to CPAs in
those states where case law or statutory law provide protection
against unwarranted, third-party claims asserted against
professionals.
In response to
such requests, you should remind clients that tax returns are prepared
based on the information provided and that this information is neither
audited nor verified. You should inform clients that you cannot
provide assurances to a third party about information in tax returns
or any other client matters. Attesting to client information outside
of the scope of an audit or attestation services engagement may be
construed as a violation of professional standards and have licensure
implications.
Although from a
risk management perspective it is preferable to avoid confirming any
client information to a lender or broker, refusing to provide any
information may alienate your clients. As an alternative, you could
offer (after obtaining the client’s approval) to send a copy of the
client’s tax return to the lender or broker and confirm that it was
prepared by you. Obtaining client consent before providing any
confidential information to a third party is required under
professional ethics standards, the Gramm-Leach-Bliley Act, the
Internal Revenue Code, and federal and state privacy statutes and
regulations. The following is a sample letter that could be used in
this situation:
Date
ABC Company
Address
City, State Zip
Dear Mr.
_______________:
I am writing
to you at the request of Mr. & Mrs. ____________________.
The purpose
of this letter is to confirm to you that I prepared the 20XX federal
income tax return of Mr. & Mrs. ______________ and delivered this
return to them for filing with the Internal Revenue Service (IRS). At
their request, I have attached a copy of the tax return and related
schedules provided to them for filing.
This return
was prepared from information furnished to me by Mr. & Mrs.
_______________. This information was neither audited nor verified by
me, and I make no representation, nor do I provide any assurance
regarding the accuracy of this information or the sufficiency of this
tax return for your credit decision-making purposes.
I prepared
Mr. & Mrs. ___________________ tax return in accordance with the
applicable IRS rules and regulations solely for filing with the IRS.
As a result, the tax return does not represent any assessment on my
part as to creditworthiness and does not include any statement of
their financial position or income and expense for the year 20XX in
accordance with generally accepted accounting principles and should
not be construed to do so.
As you know,
a credit decision should be based on a lender’s exercise of due
diligence in obtaining and considering multiple factors and
information. Any use by you of Mr. & Mrs. __________________ 20XX
federal income tax return and this letter is solely a matter of your
responsibility and judgment, and this letter is not intended to
establish a client relationship with you nor is it intended to
establish any obligation on my part to provide any future information
to you with regard to Mr. & Mrs. ____________________.
Sincerely,O:P>
____________________________________
(Firm Name)
cc: Mr. &
Mrs. ______________________ (client)
Even after
offering this practical solution, clients may continue to press you to
provide whatever a lender or broker is seeking. The lender or broker
may also assert that the prospective borrower will not be approved for
a loan if you do not provide the requested letter. When this occurs,
it is appropriate to educate the client about the limited scope of
services provided and to explain why you are limiting your contacts
with the lender or broker. While clients need to have the flexibility
to obtain credit in the marketplace, the responsibility for
underwriting a loan lies with the lender — not the client's CPA.
March 2006
By John McFadden,
CPA, CFE, Risk Control Consulting Director, CNA, Accountants
Professional Liability, CNA Center, Chicago, IL 60685.
The information,
examples and suggestions presented in this material have been
developed from sources believed to be reliable, but they should not be
construed as legal or other professional advice. CNA accepts no
responsibility for the accuracy or completeness of this material and
recommends the consultation with competent legal counsel and/or other
professional advisors before applying this material in any particular
factual situations. This material is for illustrative purposes and is
not intended to constitute a contract. Please remember that only the
relevant insurance policy can provide the actual terms, coverages,
amounts, conditions and exclusions for an insured. All products and
services may not be available in all states.
CNA is a service
mark registered with the United States Patent and Trademark Office.
http://www.cpai.com/show-article?type=print&id=124
http://pcps.aicpa.org/Resources/CPA+Comfort+Letter+to+Lenders/AON+Comfort+Letters.htm
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