Carmelo Cruz is a sole practitioner in the professional accounting firm of Cruz & Lopez, operating from a small office in Alice Springs, Northern Territory. The firm has two employees:

Susan Gomez, the receptionist/data entry assistant, who has just completed her higher school certificate. She completed two week's work experience at Cruz & Lopez prior to being hired. Her only accounting knowledge is based on feedback that 'she did well in an MYOB assignment at school'.

Fred Soto, who was hired 18 months ago as a junior accountant. Prior to joining Cruz & Lopez, Fred was attending a course in Certificate-III in Bookkeeping at the local community college.

Carmelo believes that continuous professional development is a waste of time and money and has consistently turned down staff training requests. The firm's core assignments are monthly bookkeeping jobs for local owner-operated small businesses, personal income tax returns of public servants from the local Alice Springs Water Authority and Carmelo's friends in his volunteer rural fire brigade.

However, Cruz & Lopez has one major client, which comprises the audit of R&D Equities (R&D), a boutique private investment fund based in Darwin. Craig Smith, its founder, chairman and chief executive officer (CEO), is a high-profile personality in the Australian investment community and a governor of the Australian Securities Exchange (ASX), as well as a founding member of the Darwin Futures Exchange. In the world of finance and investment, his word is law.

R&D's funds under management exceed $15 billion and its annual reports and brochures issued to investors boast annual returns after tax of 35% against the industry average of 12%. Smith claims that this is a direct result of his proprietary investment strategy, which he keeps as a closely guarded secret. R&D's fund requires a minimum investment of $15 million and its main clients are wealthy individuals and large private organisations.

In August each year, Cruz & Lopez receives a package from R&D containing a fully completed set of typed-up financial statements, tax and all other statutory returns with 'sign here' stickers on all relevant pages for Cruz's signature. A large cheque for Cruz & Lopez's fees accompanies this parcel with a with-compliments slip personally notated by Smith with the following message: 'Ready Monday, please!' Last year's cheque for $500,000 was an amount set by Smith, who always sets the fee.

The first time Carmelo Cruz received the package, he called Smith to discuss the prospective engagement and queried the figures as he knew nothing about finance and investment. The technical terms were foreign to him and still are. However, Smith ended the phone conversation by screaming down the phone: 'There are hundreds of accountants who would give anything to be associated with me, so be honoured that I chose you. My team of internal accountants and auditors go through every last detail with a fine-toothed comb so you can be assured it's 100% correct. All you have to do is sign the stuff and return it - and the deadline is tomorrow!' Cruz caved in under pressure and obliged and has continued to do so each year thereafter.

There were shockwaves in the financial community late last year when Smith confessed that he was operating a Ponzi scheme and R&D's supposed portfolio was non-existent. Smith was convicted and heavily sentenced under a string of serious charges. The authorities have now arrested Carmelo Cruz for his role in the scheme.

REQUIRED:

a)Refer to the APES110 Code of Ethics for Professional Accountants and identify the key fundamental principles that Carmelo Cruz has breached. Explain your answer.

b)Identify two (2) threats to compliance with the fundamental principle identified in (a) above.

c)Outline two (2) safeguards that may have eliminated these threats or reduced it to an acceptable level.