Accountants today face much more risk today than they did even five years ago.
And according to Bill Thompson, president of CPA Mutual Insurance Co. of America, there are a number of reasons behind that increase in risk. "Since 2000, judges have been less likely to throw out cases against CPAs than they once were," he explained. "Fewer motions for summary judgment are granted, and judges seem to require additional discovery before making decisions on cases."
"In almost every case, CPAs are required to perform an extensive amount of discovery before they can possibly reach a settlement," he said. "Of course, this entails subpoenas, depositions, hiring expert witnesses, and countless hours of time."
Thompson cited the claims history of CPA Mutual, comparing those from the 1990s to newer claims. "In every case where a CPA calls up and says, 'We have a problem,' we open a file. In the cases prior to 1998, we only paid out on 32 percent. Since 1999 we have paid on 49 percent, so now on almost half of all our liability cases we actually end up making payments."
Due to the financial scandals of the past 20 years, CPAs are squarely in the crosshairs of plaintiffs' attorneys, Thompson observed. "They're the last men standing - and they carry insurance, which, to the attorneys, equals deep pockets," he said.
Ron Parisi, executive vice president of risk management at professional liability insurer Camico, said that accounting firms haven't increased their liability policy limits to match their increase in revenue over the last five to seven years. "The sophistication of accounting practices has increased, as they have taken on bigger clients with larger exposures," he said. "This is partly due to extending into niche practices, and partly due to the cascading of larger clients down the chain."
Parisi recommended that firms evaluate their policy limits so that they match both the firms' revenue and the composition of practice. "They should calculate their limits based on the complexity of services they offer, and the size of their clients," he said.
Parisi cautioned small and midsized firms against giving tax advice in areas they're not expert in: "Federal and state authorities are being very aggressive, and we've seen an increase in claims related to tax services both in preparation and advice."
BAD ECONOMY = MORE CLAIMS
The merging of smaller firms into larger firms is also causing higher-than-average claims activity, Parisi said. "The smaller firm may not have the same level of risk management that the larger firm performs, and there is often a lack of attention to individual client issues during the merger period," he said. "Basically, the individual partners may not have been minding the shop during the transition period as well as they could."
A reduction in staff as revenues slid during the economic downturn has caused firms to do more work with less staff, explained Dan Reed, second vice president of professional services at Travelers Insurance. "This causes some potential stretching of resources, which can lead to increased liability exposure."
"At the same time," he added, "many of their clients are experiencing their own economic downturn, and are less forgiving of mistakes. They're more willing to pursue a professional liability claim to recoup any loss."
Failure to detect fraud is a growing issue, Reed said. "Normally, an obligation to detect fraud is not a part of the traditional audit service, but we're seeing more claims in this area," he said. "The problem is that so often an accountant has not used an engagement letter to spell out the scope of the audit. If there's no engagement letter, the client has an argument that he reasonably believed fraud detection was part of the audit engagement."
Accountants' claims to collect unpaid fees often generate a malpractice counterclaim, Reed observed. "This is especially prevalent as a result of the poor economy," he said. "The accountant gets behind in billing, and the counterclaim complains about the quality of the work that was performed."
Reed offered several examples of malpractice cases generated, at least in part, by the economy. "In one case, an accountant had a busy tax practice, but did not have time to do engagement letters for every client," he said. "He thought he had an understanding that his practice was limited to tax services. The office manager of one of his clients embezzled a substantial amount, and the client then turned and brought a claim against the accountant alleging that the accountant was responsible for failing to detect the embezzlement. The CPA said he was only engaged to do tax work, but the client said he was also responsible to audit the books and detect fraud. Because there was no engagement letter, it became a swearing match, and resulted in a substantial settlement."
In another situation, an accountant was forced to lay off experienced staff because of falling revenue. "However, to meet the demands of tax season, he hired an inexperienced relative," recalled Reed. "One of their clients experienced a tax loss because of an alleged misstatement of income. The accountant was sued for the interest and fines and additional tax owed. This was all due to laying off more experienced staff and not having the time to properly review the work done by the inexperienced hire."
INTERNAL THEFT, CYBER THREATS
"There's been an increase in client employees committing thefts," agreed Greg Leffard, vice president of professional liability at The Hartford. "For the most part, accounting firms are doing a good job of identifying those situations and bringing it to the owners' attention."
Lessard also cited the growing prevalence of cyber liability exposure as a major issue. "Almost anyone who has client data has an exposure. The issue is how will they deal with it - do they make use of encryption, and the most up-to-date anti-virus software? Do they train their employees to avoid 'phishing' schemes?"
Most professional liability policies now are not explicit about cyber liability, according to Leffard. "We're currently drafting an endorsement that will provide some limited coverage for no additional charge," he said.
Electronic files include not only work papers, but also e-mails, text messages, instant messages, blogs and any other message stored electronically, cautioned Thompson. "Remember, it's all discoverable - even information stored on personal home computers and phones used for business," he said. "And people write differently than they speak. Andersen wasn't found guilty of performing a bad audit - it was found guilty of a cover-up based upon one bad e-mail."
"At our practice, we do our best to make sure there are no errors or consequences due to unintentional mistakes," said Cliffwood, N.J.-based practitioner Salim Omar. "This helps minimize the exposure in the event that something happens."
Omar recommends making sure that coverage matches risk exposure. "It doesn't increase your premiums by much to get additional coverage. Look at it as a cost of doing business," he said.
"I've never been sued, but it only takes once to devastate your practice," he said.
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