Don't Let Clients Drag You Down

Being sued for something you've done wrong is bad enough, but getting sued when you have performed your work diligently and correctly can be devastating. Yet that's what oftentimes happens when accountants fail to communicate with their clients exactly what to expect.

"The result is that firms are being sued for work that goes beyond the scope of the services they were assigned to perform," said Ricard Jorgensen, president and chief underwriting officer at Jorgensen & Co., a professional liability and risk management consulting firm. "In one case, a claimant alleged failure to detect a fraud, when the firm merely performed tax services. This places the firm in a defensive position where they must prove a negative -- that they were not assigned, or paid for, the services alleged."

"Always get an engagement letter or some agreement from the client about the work to be performed and be careful of engagement letter drift," he cautioned. "Do not perform additional services for a client without a new engagement letter or signed rider. You may think it's just tax work, but it doesn't stop the client from suing for failure to detect a fraud."

To replace an engagement letter for tax services, many firms are now using tax packets that spell out the firm's responsibilities and have an affirmative statement that says that if the client accepts the package, they are agreeing to the terms of the engagement.

"The latest trend in professional liability we're seeing is that firms are coming out of the recession and beginning to grow a little," observed Suzanne Holl, a CPA and vice president of loss prevention services at Camico. "They're reaching the point where they want to expand a little, and are taking on new clients or creating new niches for themselves. We get the sense from our clients that things are starting to improve. There are many fewer calls from CPAs with clients who aren't paying - for awhile during the recession those were common."

"More often, we're seeing CPAs get caught in the middle of potential conflicts such as divorcing spouses and partnership breakups," she continued. "Just yesterday we had a call from someone who was rendering straightforward tax compliance to a trust, and conflicts developed between the trustee and the beneficiary. It's important to remember who the client is -- in this case, the trustee who is representing the entity. In a case like that, you have to examine it and, to the extent you feel the trustee is not doing the right thing, consider disengagement. "

Holl advised exercising "active ethics." "Don't just follow professional standards, but do the right thing," she said. "Make sure you realize the potential for a conflict and get out of the middle of it."



More people are buying professional liability insurance because a client or landlord require them to have it, according to Kevin Kerridge, director of small-business insurance for Hiscox Insurance. "They just got a new client and the client said, 'I need you to have E & O [errors and omissions - another name for professional liability] coverage.' Or the landlord demands it. We're seeing a healthy increase in demand not necessarily because people are becoming more sensitive to their need for insurance, but because they were told they must have it by people they deal with as part of their business."

"In many cases, it's a discretionary call for small businesses," Kerridge indicated. "A top-line corporation will have a chief financial officer or risk manager who will take care of this," he said. "But premiums for a small firm will take quite a bite out of revenue. On the other hand, one lawsuit can put you out of business if you're small, even when you haven't made a mistake."

Make sure that the policy you purchase covers all of your activities, Kerridge cautioned. "It's common for one- or two-person firms to provide a blend of services to different customers. They want to grab as many revenue streams as they can. Just remember that you can be sued for any of those services, so make sure that the activities you are engaged in are covered by the policy."

With the amount of wealth being transferred, an increase in estate claims and financial planning issues is expected, said Bill Thompson, president of CPA Mutual Insurance Co. "Other areas we're seeing are failure to detect fraud, defalcation, and loss of client files."

Engagement letters continue to be the first line of defense for accountants, according to Tom Henell, chief operating officer of NAPLIA (North American Professional Liability Insurance Agency).

"They set expectations with the client, clarify services provided and not provided, as well as limit liability," he said. "We're frequently seeing these to include limitation-of-liability provisions. Enforcement of these provisions may vary by jurisdiction, but include limiting liability to fees, or multiple of fees, and shortening statute of limitations. The Massachusetts Supreme Court recently upheld that a limitations period in a contract shortening the time in which a claim may be filed is valid and enforceable."



Protection of client data is a growing area of concern, Henell indicated. "Forty-six states currently have unique state security breach laws in place. With the amount of personal identifiable information that accountants handle, this is a growing area of liability. Accountants need to be aware of their state-specific laws, and take extra steps to protect this information."

"The largest exposure to accounting firms is not external threats, but internal threats -- employees and carelessness," he added. "Firms should be aware of their exposure, determine the amount of expenses they could personally incur, and then evaluate insurance options."

A number of issues have the potential to surface in the form of malpractice insurance claims, according to John Raspante, a CPA and senior vice president and director of risk management with NAPLIA. "FBAR [foreign bank and financial accounts] reporting is one of them," he suggested. "The Internal Revenue Service is now in the third round of allowing taxpayers to come forward and file delinquent FBARs with substantial penalties, but at least avoiding criminal charges. We're getting a lot of calls from CPAs in which their clients are accusing them of failing to inform them of the necessity to file FBAR. And we've gotten claims for the actual penalty. They typically take the form of, 'If you had told us about this, we could have avoided these penalties.'"

Although it is too soon to see claims resulting from the fiscal cliff, the possibility is out there, Raspante said. "There's a potential claim avalanche. Right before the end of the year, we didn't know what to do. It looked as though 50-plus tax provisions were about to expire, so we started to advise clients based on what we thought would happen - rates would rise, deductions and credits were set to expire, and so on. But Congress pretty much extended most of the cuts, so accountants did make errors in the urgency to take action based on the fiscal cliff."

Sometimes it's difficult to turn away business just because it seems there is risk involved, admitted Ralph Picardi, an attorney and CPA who specializes in defending malpractice claims against CPAs. "If you can't turn away a client that has red flags, then you need to have something that will compensate for this," he advised. "Be prepared to tell clients to go elsewhere, but if you're not in the position to freely do this, you need to have internal processes that will allow you to keep a close eye on the engagement and manage it in a way that will minimize the risk involved."

"I always advise a risk assessment body, or a committee that has the agenda to check in on and discuss the high-risk engagements of the firm."

Jorgensen offered these additional pointers:

Be aware of what is a reasonable fee, especially when dealing with trusts, unsophisticated or elderly clients. A judge or jury may ultimately see it as gouging.

Where you have access to client funds, consider supervision of your own employees and arrange for an employee dishonesty bond with a third-party extension.

All engagement letters should include an alternative disputes resolution or mediation clause, or even better, if permitted, a limitation of liability clause.

Screen new clients. There may be a reason why a potential client needs to switch accountants.

Manage client expectations at the outset and throughout the term of the engagement. Do not make unattainable promises or predict outcomes, and communicate progress regularly.

Be cautious of new areas of practice and high-risk activities. Securities and Exchange Commission attest and work for financial institutions is considered high risk for a reason. However, changes in the economy may make other clients high risk. For example, recently investment funds, mortgage bankers and brokers or real-estate-related businesses have been problematic.

Make sure that you have the expertise to provide the services offered to the client. Often firms will move out of their professional comfort zone because they wish to round out the services to a client. This is unwise.

Ensure that you have strong data protection procedures in place and reinforce this with encryption and firewall software. Don't allow client electronic records to be removed from the office. Buy cyber-liability insurance.

Trustee work can cause problems, especially when a family becomes dysfunctional. Make sure that the trust agreement provides for indemnification of the trustee in the case of legal liability claims, and back this by purchasing an appropriate trustees' liability insurance policy.

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