If your gut tells you a client is risky, you're probably right.
"We frequently hear accountants say, 'I knew this client was going to be trouble,'" said Tom Henell, chief marketing officer at the North American Professional Liability Insurance Agency, which specializes in providing professional liability insurance. "You wonder why they took them on in the first place. With some prospects, it's better to lose them even before they become a client, rather than taking on someone that you have doubts about from the beginning."
Ron Parisi, executive vice president of risk management at California-based Camico, agreed. "Client acceptance and re-acceptance are the most important aspects of risk management," he said. "It's really who the clients are that get you in trouble more than your work product."
To that end, Parisi recommended getting background searches on significant engagements: "It can be a simple Google search or a full-fledged background search. If it's an audit client or there's a majority shareholder that has a big part of ownership, we suggest a professional background search."
Part of a due diligence investigation should be communicating with the prospective client's former CPA, suggested Parisi. "By talking to the predecessor and going through the financials, you can get a fairly good picture of where the client is."
A simple tax return would not require an extensive background check, but more complex engagements increase the need for knowledge about the prospective client. "You need to guard against opinion shopping," Parisi said. "We see this frequently in complex industries like oil and gas."
"And even in the tax area, client acceptance procedures should be followed," he said. "CPAs have been caught in a professional liability trap for tax engagements when there's fraud or embezzlement at the client level."
He also warned of engagement creep: "Just because you're only doing a tax return for a client doesn't meant you can't be sued for business advice during the engagement. For example, if the client asks certain business questions while you're doing the return, it can turn into more of a consulting engagement than just a tax engagement. It's important that you are cognizant of who the client is and exactly what services you are providing."
OPINION SIGNALS
An accountant wishing to disengage from a client should put it in writing in a formal disengagement letter, and should do it earlier, rather than later.
"Often, banks or other lenders are waiting for opinions, and if a CPA disengages at the last minute it signals that there may be a problem," Parisi said. "The CPA can get sued for creating insolvency by causing the bank to take away the client's line of credit."
The disengagement letter should declare the status of work and any upcoming deadlines, so the former client can seek alternatives. "When quality firms disengage from mediocre clients, there are still firms out there willing to pick up the work," Parisi noted.
Protection from potential lawsuits begins before an engagement letter is signed, according to Rick Jorgensen, president and chief underwriting officer of Jorgensen & Co. "It starts with posing tough questions to the potential client," he said (see "Ask before you leap," above). "Tough questions are designed to identify clients that are in a high-risk business, encountering financial difficulties, have a tendency to sue, or just don't pay their bills.After failure to secure a well-written engagement letter, accepting a troublesome client is one of the most frequent reasons for claims against accounting firms. A methodical and systematic approach should be part of an accounting firm's risk management procedures, and a balance should be struck between the fees charged versus the potential for a claim."
"When you're assessing new clients, remember that risk prevention is always preferable to defending a lawsuit," said Nancy M. Reimer, a partner in the Boston office of law firm LeClairRyan. "Fee suits are definitely a factor," she said. "Clients who give trouble at the outset are more likely to assert a counterclaim for malpractice when they are sued to collect on a fee."
"In many cases, it's easier for an accountant to just write off the fee," she said. "In some cases it involves a significant amount of revenue, so you don't want to just walk away from it. In those cases, we go through the papers and make sure the records are clean so there's a minimal risk of liability if the accountant is hit with a malpractice claim."
Reimer recommended going through your roster of clients at the beginning of each tax season. "Over time, accounting firms change," she said. "Make sure the client falls within your business parameters as they evolve."
PLAYING DEFENSE
Client risk assessment is the first line of defense against malpractice claims, emphasized Ralph Picardi, CPA, Esq., a partner at law firm Lapping & Picardi. "It's the first opportunity you have to make a major impact on the risk your firm will take on."
Midsized firms and faster-growing small firms are especially vulnerable, he noted. "The reason is that they usually start with a small group of partners that get together, and each has his or her own client base," he said. "They may be sharing space and there may be some overlapping work, but for the most part each partner is managing his or her own business. That usually means that each partner can bring in whomever they want as a client. They don't feel the need to run it by anyone or get approval, so you end up with a group of partners each doing their own thing."
"That needs to be corrected," he said. "The partners need to understand that the work done by each of them exposes all of them to risk, and they need to decide collectively what they will work on."
Firms need to have a mechanism in place to accumulate information over the course of the year about existing clients, said Picardi: "Red flags such as not paying on time, difficult personnel, or concerns about the integrity of management need to be preserved and not just committed to memory and forgotten. That way, when it comes time to make decisions about whether to keep serving a client, there's a resource to tap into."
TOUGH DECISIONS
A client that presents a high level of risk shouldn't necessarily be turned down, indicated Picardi. "It just means there is a need to make an informed decision based on the risk. There needs to be some monitoring on how it's going. When the firm has its monthly meeting, it should not only consider new and existing clients, but also monitor how the risky client is doing."
"Bring in the partner working with the client, and stay engaged," advised Picardi. "Over time, there should be fewer uncomfortable situations with problem clients and a diminished number of claims or reportable events to a firm's insurers. The partners will be working together as one firm, as opposed to a collection of separate practices."
Ask Before You Leap
Some tough questions to ask about potential clients:
* Is the potential client in a high-profile or high-risk business?
* What is the potential client’s financial health?
* Is there an outside entity with a controlling interest?
* Has any regulatory authority investigated the potential client?
* Does a person or entity related to the accounting firm have any interest in the potential client?
* Does the potential client have financing from unusual sources?
* Why is the potential client interested in the accounting firm?
* Who was the previous accounting firm and why are they being terminated?
* How often has the firm changed accounting firms in the past five years?
* Was the former firm competent? Aggressive? What reasons does the firm give for termination?
* Does the information given by the potential client match what you are told by the previous accounting firm?
* Can we see the previous accounting firm’s work papers?
