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  Copyright© 2007 - 2013 Colin M. Cody, CPA and TraderStatus.com, LLC, All Rights Reserved.
 
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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1136 Tenants Corp. v. Max Rothenberg & Co.
Certain accountants may also have felt there was no obligation on their part to perform any procedures if they discovered what could be a potential irregularity. As an example, in 1136 Tenants Corp. v. Max Rothenberg & Co., which took place in 1967, the CPA firm was sued by the client co-op apartment house for negligent failure to discover an embezzlement by the managing agent who hired the firm to write up the books. The firm was held liable for failure to inquire or communicate concerning missing invoices despite a legend on the financial statements stating, "No independent verifications were undertaken thereon." The firm moved to dismiss the case but the court denied the motion and held that even if a CPA "acted as but a robot, merely doing copy work," there was an issue as to whether there were suspicious circumstances relating to missing invoices that imposed a duty on the firm to warn the client. When the case went to trial, the court found an engagement to audit and entered a judgment for more than $237,000 despite the firm's oral evidence that it was employed for $600 annually to "write up" the books.

 

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