Although we live in a litigious age, it's never a good feeling waiting for a summons and complaint from a disgruntled client to be delivered to your door. And as the severity of claims against accountants has been on the rise, limits on professional liability policies have remained level, according to Ron Parisi, executive vice president for risk management at Camico. "The limits on E&O [professional liability] policies have been stagnant over the last five to 10 years, while the verdicts are getting higher," he observed. "I would urge CPAs to be mindful of the limits of liability on their insurance as verdicts and losses are tending higher."
Parisi cited the recent lawsuit brought by noted author Patricia Cornwell against Top 100 Firm Anchin, Block & Anchin, which resulted in an award of $50 million. "A lot comes down to documentation, both between the client and the CPA, and internally within the CPA firm," he said. "When there's a lack of documentation, it creates a vacuum that juries tend to fill in negatively."
"What I've seen recently is representation on both sides of a transaction," he said. "Conflict of interest-based lawsuits are on the rise, as CPAs find themselves on both sides of transactions during a business combination or a divorce. Further, CPAs acting as trustees must be vigilant of the potential conflicts between beneficiaries, trusts and clients. Over the past year, we have seen a lot of these conflict-of-interest accusations against CPAs."
DO THE WORK RIGHT
"You can discuss risk management as much as you want, but at the end of the day, you've got to do a good job; otherwise there will be claims," said Ralph Picardi of Lapping & Picardi LLP.
An attorney and former CPA who specializes in defending malpractice claims against CPAs, Picardi said to think of risk management in chronological order. "First, it starts when clients come in through the door," he said. "In the firm's decision to take on a client, you need to think in terms of risk exposure the client will bring, and is the firm prepared to take that on? If you don't have the resources or expertise, the chances are you won't do a good job servicing the client. So create a good system for assessing the risk of doing work for particular clients."
The second step, according to Picardi, is that when you decide to take on new business, you need to create a good engagement letter or contract for the performance of services. ("There's a whole range of sub-issues as to what constitutes a good engagement letter," he added.) "Third, once the engagement has begun, you need to properly staff the work, and assign the appropriate number and quality of staff at all levels."
And fourth, said Picardi, "Once the engagement is underway, you need to maintain effective communication with the client throughout the engagement. This includes things like strong billing practices. You want to bill frequently and discuss things that might be occurring during the engagement that might increase the amount of the fee above the client's expectations. If the fee will be a lot higher, make sure that clients know early or you will have trouble collecting it down the road."
Picardi advised that during the engagement, firms communicate any issues that might arise of a substantive nature. "Bring them to the attention of the appropriate level of the client organization, and try to resolve them. Don't just muddle through and save the big issues for the end when everyone is stressed out and trying to move on."
"Then, when you move to the end of the engagement it's a good idea to communicate to the client the things that you noted during the engagement that might put the client at risk. For example, if you notice their internal control is weak, communicate that to the client. A management letter, typically done in an audit, is also useful in lower level engagements as a risk management tool. If you don't do that and the client suffers a loss, the tendency is to blame you for not alerting the client."
Rickard Jorgensen, president of Jorgensen & Co., agreed: "Have an engagement letter that appropriately describes the work you are performing and outlines the client's expectations, and then stick to it," he advised.
"Within the engagement letter itself, you can actually build in certain protections and ways to resolve disputes before they become a full-blown lawsuit," he said. "Also, engagement letters can include payment mileposts, where upon completion of certain services there is an expectation of payment. This way, payments can be made during the course of the assignment, rather than holding back all invoices until the client gets presented with a huge bill at the end. Moreover, if during the course of the assignment the client fails to pay that part of the incremental bill, you can resolve the problem right away."
THE WRONG CLIENTS
"It always goes back to client selection," said Wes Marston, vice president of claims for CPA Mutual Insurance Company of America. "There are certain clients you can do the worst job for and they won't sue, but there are others that you can do the best job for, and they will sue you."
"For a lot of our insureds, there are just certain people that enter their office and it just seems not to be a good fit," he continued. "It might start off on the wrong foot. Down the line there might be such things as billing issues, failing to provide or timely provide information, or tending to obstruct the process. They find that every part of the engagement, from billing to getting information, just doesn't flow well."
Also of concern, advised Marston, is a client who has skipped from one professional to another, especially if they've sued or brought claims against other advisors. "That merits investigation into why, and the validity of those claims. Some people are just litigious."
Marston recommends an annual evaluation process: "This should be done well before any deadlines, since it would prevent disengagement if you wait too long. Some of the red flags to watch for are overly aggressive tax positions, or the feeling that they're not disclosing all their income or may not have documentation for deductions. If the client is less than forthcoming, it becomes time to disengage."
"Along the same lines, the intake process is important," Marston noted. "It's so much easier to never take the engagement, rather than take it for a year or more and then disengage, but the practical reality is that it's not easy to turn down business."
Firms should be screening new clients better in order to protect themselves against lawsuits, according to John Raspante, senior vice president of risk management for North American Professional Liability Insurance Agency.
"There are different degrees of potential risk," he noted. "When a senior citizen walks in and needs a simple tax return completed, it doesn't lend itself to heightened screening. On the other hand, a startup business that just got rid of its former accounting firm requires more elevated screening."
Accounting firms should also look at existing clients, he indicated. "It probably doesn't happen as often as with new clients, but existing clients should be examined often for their risk potential. Some things to look at include changes in a client's net worth, and the firm's expertise in the profession the client is in. Does the firm have the ability and competency to service a client whose scope of practice is changing?"
A SCARY CASE
One case that Raspante is watching closely is the $1 billion FDIC action against Big Four firm PricewaterhouseCoopers and Top 100 Firm Crowe Horwath.
As the receiver for a failed financial institution, the FDIC may sue professionals who played a role in the failure of the institution in order to maximize recoveries.
According to the complaint, the Alabama State Banking Department closed Colonial Bank and named the FDIC as receiver. Colonial's closure was triggered by the discovery that its largest mortgage banking customer, Taylor Bean & Whitaker Mortgage Corp., had committed a massive, multi-year fraud against Colonial, resulting in financial statements that grossly misstated Colonial's true financial condition.
PwC served as the external auditor, and Crowe performed internal audit services, during the time that Taylor Bean & Whitaker Mortgage Corp. was carrying out its costly fraud against Colonial.
"[The case] has the potential to impact the accounting profession if it results in that large a loss, considering that this is the first time the FDIC has become a litigant against an accounting firm," said Raspante.
Crowe Horwath addressed the matter in the following statement: "In the past few weeks, there has been a court ruling on one motion in this matter. A number of other motions are awaiting rulings and Crowe Horwath LLP plans to defend itself to the fullest possible extent. Crowe was engaged by the holding company to assist with specified internal audit services at the direction and approval of company management. The firm did not serve as the company's independent external auditor, nor did it serve as the company's internal auditor. Throughout the period of our firm's involvement, company management was required to, and did, maintain ownership of the internal audit function. We stand behind our work and the people who performed it, and we believe that all claims against Crowe are totally without merit."
PwC's outside counsel, Elizabeth Tanis of King & Spalding, stated: "The Colonial Bank executive who spearheaded the fraud on the Colonial Bank side has testified that her actions were motivated by a desire to prevent loss to the bank and to save an important client relationship. She further testified that Taylor Bean was paying Colonial Bank $20 million to $30 million per month in interest. Auditors cannot be expected to have uncovered a fraud that was so well-concealed that neither the FDIC nor the [Office of the Controller of the Currency] discovered it, even when they performed targeted exams of the mortgage warehouse lending division, where the fraud occurred."
SETTING STANDARDS
When professionals follow their own risk management standards, there is rarely a problem, observed Tom Henell, chief operating officer of NAPLIA. "When they stick to their areas of expertise, sign a completed contract or engagement letters, and use common-sense business practices, there is rarely a problem, and when one does arise, it tends to be minimal. Usually, when one of these areas is stretched, larger issues arise. For example, when accountants take on projects outside their expertise, or if they forego getting a signed contract or engagement letter, that's when we see issues arise."
"Every time we talk to accountants after a large claim, there tends to be steps they saw along the way such that they were not surprised a claim arose," he said. "They knew the client was a problem, or they shouldn't have gone into that area, or they bent a rule. So we recommend that every year you do a risk management assessment and take a look at your clients."
Several factors to consider when evaluating clients are covered by the acronym PACE -- profitability, alignment, culture and exposure. "On the surface, profitability appears to be common sense," said Henell.
"However, no one likes to turn away a customer, and depending on the financial stability of your business, sometimes it can be several years before we make the determination that a customer is not profitable. In addition, this analysis can be complicated, as some customers may be 'loss-leaders' whose value is not directly connected to the bottom line," he said.
By alignment, Henell explained that, "Businesses evolve, and sometimes we don't provide - or at least specialize in - the areas that certain clients need. It's important to be honest with our clients and ourselves when something is simply not the right fit for our business."
"In our company, culture is a priority," said Henell. "We treat our employees and clients with respect. As such, we expect the same from those with whom we do business. Any client who is chronically abusive to you or your staff is usually not worth it in the end."
"Finally," he said, "there are clients who create a larger exposure for your business than they generate in revenue. "If not addressed appropriately, clients from any of the three categories - profitability, alignment, or culture - can fall into this category. Furthermore, there are a number of specific warning signs that can signify a client exposure that should be evaluated."
These warning signs include the following, said Henell:
- Clients not paying on time;
- Clients not taking your advice;
- Clients that consistently cause stress in your office;
- Clients that fail to provide paperwork on a timely basis;
- Clients that you do not trust;
- Clients that do not understand the services you are providing;
- Clients that don't appreciate your expertise;
- Clients that challenge the need for documentation;
- Clients that are a bad fit for your business model; and,
- Clients that test your bottom line.
"Any one, or combination, of these warning signs are reasons for further assessment of a client relationship and exposure," said Henell.
