Investment, Inc. (Investco), an audit client of PT LLC’s (Firm or PT) Albuquerque practice office, is in the process of preparing for an initial public offering of its common stock. Investco was formed in 2000 to develop, market, and support computer software products. During the past three years, it has grown from 100 to 1,200 employees and increased its revenues from $35 million to $105 million. Investco expects to file an initial registration statement with the SEC during the third quarter of its fiscal year ending June 30, 2015. PT has served as Investco’s independent auditors since 2009, earning relatively modest recurring annual fees relating solely to annual audit procedures and related consultations. PT has been attempting for the past few years to introduce both their tax specialists and management consultants to Investco but has been unsuccessful. Senior management of Investco has consistently cited limited cash flows and time constraints for their unwillingness to spend any substantive time with these other PT specialists.

Mike Martin, the Albuquerque practice office engagement partner for Investco recently had a meeting to discuss the initial draft of the registration statement with John Spillman, Investco’s Chief Financial Officer. Until August 2014, John had been a Senior Manager in the Albuquerque practice office where he had served as the manager on the Investco audit engagement for the past three years. In July 2014, during PT’s fieldwork for the audit of Investco’s June 30, 2014 financial statements, senior management of Investco approached John about taking Investco’s CFO position. Senior management had explained that due to Investco’s recent growth and its anticipated public offering during the next year, Investco believed it was necessary to hire a qualified CFO to oversee Investco’s finance and accounting department. Senior management believed that John’s experience at PT and his specific understanding of Investco made him a logical choice for the CFO position.

PT had considered John as a partner candidate. John indicated that he viewed Investco’s offer as unexpected. Accordingly, he asked senior management of Investco if he could have several weeks to consider their offer. After considering Investco’s offer for approximately two weeks, John accepted the CFO position in early August, which coincided with the completion of the audit of the June 30, 2014 financial statements. This timing was a relief to Mike since it meant he did not have to identify a replacement senior manager for the engagement until next year.

While Mike viewed the loss of John as significant to PT, he believed John would greatly enhance the quality of the accounting function at Investco, thereby favorably impacting any potential audit risks. Mike also viewed John’s knowledge of PT’s capabilities in tax and management consulting as a positive factor in obtaining an opportunity with Investco senior management to discuss their capabilities in these areas.

During Mike and John’s meeting to discuss the initial draft of the registration statement, John emphasized that, as outlined in the business section of the prospectus, Investco believed its long-term growth and success would be based in part on its ability to establish strategic business alliances and partnerships with other leading software companies, consulting firms, and complementary vendors. John indicated that Investco was close to entering into joint development projects and marketing agreements with both Oracle and SAP. John further indicated that Investco was focusing its attention on establishing relationships with major consulting firms, including Andersen Consulting and IBM Consulting, to enhance the image of Investco’s products and facilitate the availability of a sufficient number of qualified consultants in the marketplace to assist clients in implementing its products. John stated that based on his representation of PT’s capabilities in these areas, Investco’s management would like to explore the establishment of a strategic business alliance with PT. Mike stated that this opportunity sounded like it would be beneficial to both parties, and he would have one of the regional PT Consulting Group partners contact John later in the week.

The next day, Mike contacted Fred Smith, a PT Consulting Group (PTCG) principal in Los Angeles (which is 800 miles from Albuquerque), to inform Fred about the discussion Mike had with John about Investco’s business imperatives. After hearing the background, Fred said he was vaguely familiar with Investco. He explained that his brother-in-law, Harry Nelson, had taken a seat on Investco’s board of directors several years ago after investing in Investco. Harry and Fred’s wife’s sister, Mable, live in Phoenix (which is approximately 370 miles from Los Angeles). They began their careers with a well-known software company (a PT client) during its early years and moved to the Southwest several years ago after retiring in their early 40’s. Fred stated that he believes Harry and Mable are active investors in start-up computer software and other high-tech companies. However, he does not know what is included in their investment portfolio. He generally only sees Harry and Mable once or twice a year at family functions. Mike recalled that the Principal Stockholders section of Investco’s draft registration statement does, in fact, identify Harry as a director who owns only a de minimis number of Investco common shares.

Fred informed Mike that PTCG had entered successful strategic alliances with several other businesses in the software industry. This type of arrangement helps the parties bring services together in a single joint proposal facilitating one-stop shopping. He indicated that such relationships often include agreements to use each other’s name in marketing materials or exclusive referrals of clients to each party.

Fred and Mike agreed that the Investco situation appeared to be an excellent business opportunity for PT. Fred suggested that, for competitive reasons, it was important to act on the lead before Investco completed its IPO. He planned to contact Investco later that day. Mike asked him to wait until Mike had the opportunity to determine whether any Firm policies needed to be considered regarding this and other matters, he had discussed with John regarding Investco’s IPO.

Required:

1. List the potential independence issues that are involved in this case?
2. List the alternatives that are available to the Firm to remedy any potential independence issues identified in Question 1.
3. What would you advise?