Being served as the defendant in a lawsuit can be an extremely unpleasant experience - and the risk to accountants has risen dramatically in the past few years.
Not only are judges less likely to dismiss a case on a motion for summary judgment, but juries are more likely to side with the party they perceive as a victim, said Bill Thompson, president of CPA Mutual Insurance Co. of America. Moreover, the economic downturn has affected the professional liability market in a number of ways, he indicated.
"Having a good professional liability plan helps me sleep better at night," said Vincent J. O'Brien, a Long Island, N.Y.-based CPA and lecturer. "We use engagement letters and screen our clients carefully."
Most carriers discourage suits for unpaid fees, O'Brien explained. "One of the biggest recommendations we make at our CPE lectures is to cut off services before you end up with a large unpaid fee. That eliminates the issue. It's important that practitioners be bold enough to do that because it's the best way to manage the situation."
Keeping up with industry knowledge is important in avoiding client risk, noted Louis E. Feinstein, CPA, a New York-based practitioner. "I'm on four tax committees of local and state associations, as well as a tax study group," he said. "That helps me keep up with what's happening in the field."
"When I deal with clients, I make sure that I put [everything] in writing so there's evidence I've told them about the issues and forms they need to comply with," he explained. "I try to get responses by e-mail, so there is a record of our correspondence."
"Every client signs an engagement letter - every one, even the Form 1040 clients," said Martin Davidoff, CPA, Esq., of Dayton, N.J.-based E. Martin Davidoff & Associates. "And for larger accounting clients, we have a conversation with the predecessor CPA. Sometimes we've already had that conversation in one context or another. For example, we might be called in to do a review or some specialized tax work, and the client lacks confidence in the predecessor accountant. It's possible we won't take on the client because of the risk involved, or because of our relationship with the other accounting firm."
Contrary to the advice of most carriers, Davidoff will sue for fees if necessary. "We're suing more clients because we're fed up with not getting paid," he said. "Some people just don't value accounting services."
Several years ago a client came in for a Form 1040 return, but never paid for it, Davidoff said. "Two years later, the same individual came in and asked if we did tax returns. He forgot that he had already scammed us two years ago!"
"There has been an increase in the number of firms that have asked me about unpaid fees," said Ralph Picardi, CPA, Esq., who specializes in helping firms avoid client risk. "What's going on is that in the past, firms were a little more aggressive. They would bill regularly, and when clients started to fall behind, they were more likely to suspend services and disengage. Now, they're more likely to give their clients some breathing room, and you're not seeing them being so aggressive. In a sense, it's firms saying, 'These are long-term clients, so let's cut them a little slack. It also comes out of the reality that it is a bad economy and firms are not that willing to get rid of clients. It's anathema to firms to be driving away businesses when they're not sure where new business is coming from."
This leads to a dilemma whether to sue for fees, or let things slide.
"I usually advise them that the percentage of suits for fees that spawn counterclaims for malpractice has been going up, so it is a prescription for a bad outcome," Picardi said. "I don't have these questions in better times."
IRREGULAR STAFFING LEVELS
Another result of the economic downturn is skewed staffing at many firms, which can create risk.
"During 2008 and 2009, accounting firms that had been doing well started to see their revenue slipping," Picardi said. "So firms that had been very active in hiring yearly classes of recruits either stopped doing it or cut back significantly. The need still existed, but they started trying to meet the need through their existing staff. Now that things are beginning to turn around, these firms are missing an entire generation in their firms. What would normally be a class of third-year people ready to take an in-charge role is not there. For three or even four years, these firms were in a holding pattern, and they're trying to fill the gaps with people in lateral positions. The problem is that these people didn't wait around. When they weren't hired out of school they went into industry, and the ones that did have accounting jobs and could move laterally have decided to go into industry as well. There's a large group of firms that don't have the staff to service the new business they're getting, so now there's a feeding frenzy for accountants with three to five years' of experience. There will be winners and losers, but the losers will have to make do with the staff they have."
The result, he said, is that they will either have more experienced people doing work at a lower level than they should, or they will have junior people out of college thrust into things above their level of experience. "Either result can create risk," he said. "People at a lower level of experience doing work above their pay grade will likely lead to errors, while higher-level people doing lower-level work leaves them less time to do review work, so that mistakes are less likely to be caught."
KNOW YOUR PARAMETERS
CPA firms should avoid putting themselves in possible risk situations by assessing what the firm is best suited for, observed Suzanne Holl, vice president of loss prevention services at Camico. "Look to make sure you have the right clients for the services you offer," she advised. "And be especially sensitive to the potential for engagement creep on existing clients. That's a trend on our hotline right now because our firms are struggling coming out of the economic downturn. They don't want to lose existing clients, and they want to grow their practice, so sometimes they're not as sensitive to engagement creep and they go into areas beyond those that they're comfortable in performing."
When clients need and are pressuring the firm to get into areas in which it's not competent, the firm may need to decide whether to develop its expertise, refer out, or partner with another firm, advised Holl. "With new clients, now more than ever it's critical that firms emphasize the way they screen clients," she said. "It's not always easy to collect fees, so screen potential clients to make sure there's a good fit. It's important to balance risk versus reward. If the client or the industry is risky, it may not be a good fit. A good number of our hotline calls relate to client screening and retention."
Holl sees a trend in larger client expectation gaps: "For example, when they feel they trusted you to warn them of a potential problem. When clients feel they've been damaged, they'll look to any and all deep pockets."
The way to mitigate this is through defensive documentation, she said. "You can do wonderful work, but if the client down the road, and in hindsight, alleges that you failed to warn or advise them, the fact that the work you did was great doesn't mitigate your potential for exposure. No level of service is risk-free - the only risk-free environment is if you have no clients."
Defensive documentation should clarify limits, and specify potential issues.
"CPAs are good about doing engagement letters, but not as diligent in defensive documentation," she said. "It's hard to defend against a client who charges that you didn't warn them about the limits of your services - for example, the failure to detect the embezzlement of a client's bookkeeper. If there's no clarity to the engagement, it could put the accountant in a defensive position, and juries tend to side with the client."
CAN'T HAVE IT BOTH WAYS
Conflict-of-interest cases hold especially grave potential for risk, said Thompson: "For example, in a divorce situation, the CPA has a natural tendency to want to keep one of the divorcees as a client. Although it may be possible to represent both sides, it's not generally a good idea. The parties should sign a waiver stating they are comfortable with the CPA representing both sides. States vary on issues with waivers, so the CPA should consult a local attorney."
Divorces are normally not an amicable situation, added Thompson. "Normally, someone will feel they were shortchanged, and this may not happen right away. It might be three years later when a spouse who kept the business sells it, say, at three times what the CPA valued it," he explained. "At this point, they usually can't go after the other spouse, but the CPA is still there and makes a pretty good target. Divorcing clients are rarely pleased with the terms of their divorce - engagement letters are helpful, and they may aid in limiting damages, but they won't keep the accountant from being sued. Standards for client retention and acceptance may keep the accountant out of a lawsuit altogether."
Rickard Jorgensen, president of Jorgensen & Co., an insurance broker and managing general underwriter specializing in professional liability insurance, noted that it's not only important to get an engagement letter or some agreement from the client about the work to be performed, but it is vital to watch out for engagement letter drift. "Do not perform additional services for a client without a new engagement letter or a signed rider," he said. "You may think it's just tax work, but it doesn't stop the client from suing for failure to detect a fraud."
Engagement letters should contain a mediation clause and, if permitted, a limitation-of-liability clause, Jorgensen said. And the accountant should manage client expectations at the outset and during the term of the engagement. "Do not make unattainable promises or predict outcomes, and communicate progress regularly with your client. Agree and adhere to a strict billing schedule."
Never sue for fees, and be aware of what is a reasonable fee, he cautioned, especially when dealing with elderly or unsophisticated clients. "What you see as reasonable may be seen by someone else as gouging," he said.
Jorgensen agreed with Shakespeare's "Neither a borrower nor a lender be" with regard to clients. "It creates a conflict of interest," he said. "Don't invest in clients, loan money to clients, or borrow from clients."
