IMGCAP(1)][IMGCAP(2)]Win or lose, CPAs providing financial and tax advice to their clients might be in treacherous territory.
Providing solid, accurate advice to these clients might not suffice. There’s trouble brewing even if the CPA’s advice is correct, as it could run afoul of securities administrators who might view the providing of financial and tax advice more broadly.
In addition, a CPA who provides erroneous financial and tax advice might be subject to malpractice claims. Through it all, the parameters of providing financial advice remain uncertain.
Turf Battle
There’s a turf battle brewing between state securities administrations and federal administrators. CPA firms find themselves on the short end of the stick. A virtually unknown but powerful financial administrators group sets professional-client relationships, the North American Securities Administrator Association, or NASAA.
Virtually every U.S. state and Canadian province that administer securities functions, along with Mexico, work together in the NASAA context. This organization sets rules limiting the provision of financial advice to customers.
NASAA sets up the rules, while the Financial Industry Regulatory Authority, or FINRA, implements NASAA’s rules, but FINRA provides waivers to certain financial professionals. The Chauncey Group International, Ltd. in Princeton, N.J., actually provides the certification and licensing examinations for NASAA and FINRA.
FINRA and NASAA exercise control over persons who provide investment advice by mandating that advisors pass a qualifying examination, called Series 65, the Uniform Investment Adviser Law Examination. The exam includes professional registration issues, securities markets, professional ethics, economics, investment strategies and financial analysis.
In February 2016 FINRA added new content to Series 65 for private equity funds, exchange traded notes, leverage, inverse funds and structured products. Congress treats an advisory firm as acting with the scope of the Uniform Securities Act where that firm makes investment recommendations, provides investment advice, or an individual holds herself or himself out as providing investment advice.
FINRA does not exempt CPAs providing investment advice from having to meet the Series 65 requirements. In contrast, FINRA exempts individuals who meet the following professional designations from the Series 65 examination requirements:
• Chartered Financial Analyst (CFA)
• Certified Financial Planner (CFP)
• Personal Financial Specialist (PFS)
• Chartered Financial Consultant (ChFC)
• Chartered Investment Counselor (CIC)
According to Mark Kokalowski in his blog, the Balance, these Series 65 activities would include a CPA “who seeks to offer investment advice in return for a fee.” He was previously with Touche Ross, now Deloitte, and then with Merrill Lynch, where his activities included transfer pricing. Providing transfer pricing in particular might create a NASAA/FINRA liability issue as transfer pricing specialists analyze the same comparable database as would investment firms.
When CPAs Provide Bad Advice
There is a risk that clients might sue their CPAs for giving bad advice, and some might sue a CPA for omitting a commentary in effectuating a transaction. Consider this sampling of seven cases, many of which involve major CPA firms:
• A client asked a CPA whether the stock redemption was free of tax. The CPA provided the client with an affirmative answer. The CPA forgot about Section 304 of the U.S. Code, which covers redemptions through use of related corporations, and the IRS imposed taxation on the transaction. The client then sued the CPA firm. See Bancroft v. Indemnity Insurance Co. of North America, 203 F. Supp. 49 (1962), aff’d 309 F.2d 959 (1962).
• A brokerage firm sought Section 1236 capital gains treatment where the brokerage firm had three accounts with differing tax determinations—capital gains account, inventory account and short sales. The brokerage’s CPA firm provided accounting, business planning and tax services. The IRS denied the brokerage’s capital gain rates, and the brokerage sued the CPA firm for that result. See Vernon J. Rockler & Co. v. Glickman, Isenberg, Lurie & Co. 273 N.W. 647 (1978).
• A CPA firm assisted a client in making a Section 1031 like-kind real property exchange, expressing its concerns about the tax-free nature of the transaction. The IRS denied Section 1031 like-kind treatment. The client then sued the CPA firm despite its uncertain response to the inquiry. See Mills v. Garlow, 768 P.2d. 554 (1989).
• In another redemption fact pattern, the CPA firm provided defective advice to the business under a Section 351 asset transfer situation. The asset transfer caused the corporation to fail to redeem at least 80 percent of its outstanding preferred stock. See Snydergeneral Corporation v. KPMG Peat Marwick (unpublished, Dallas, Texas, 1990). The jury awarded the company $10.9 million in actual damages and $2.3 million in exemplary damages.
• Code Section 103, as it existed during the 1980s, provided for industrial development bonds with a $10 million capitalization amount. A medical doctors’ partnership owned real estate in conjunction with its clinic. The doctors proposed to liquidate the partnership under Section 331 and build a larger facility financed by issuing Code Section 103 industrial development bonds. The doctors retained Peat Marwick Main & Company (now part of KPMG) to provide tax and accounting advice. The IRS claimed that reorganization constituted a capital expenditure, which then precluded the benefits. The doctors sued the CPAs and the law firm. See Billings Clinic v. Peat Marwick Main & Co., 244 Mont. 324, 797 P.2d 899 (1990).
• A company faced inventory recapture when it sold its business. The CPAs ignored the inventory recapture issue, and the company brought suit against the CPAs. See Deloitte, Haskins & Sells v. Green, 198 Ga. App. 849, 403 S.E.2d 818 (1991).
• A company owner contemplated exchanging his preferred stock in exchange for cancellation of his personal debt to the corporation. The company owner sought advice from his CPA firm. The IRS viewed the transaction as a constructive dividend. The company owner then sued the CPA firm. See Lien v. McGladrey & Pullen, 509 N.W. 2d 421 (S.D. 1993).
CPAs face many potential issues with legal liability, whether the financial and tax advice they give clients is good or bad. The phrase “damned if you do, damned if you don’t” comes to mind.
Robert Feinschreiber and Margaret Kent are attorneys and counselors with
