Mitigating CPA Malpractice
By: John F. Raspante, CPA
Professional liability claims faced by CPAs will never be eradicated, but they can be reduced if solid risk management and constant adherence to professional standards are followed. Follow these techniques to help lessen exposure in the increasingly litigious environment in which CPAs practice.
Client Screening, Selection and Retention
Client screening, selection and retention is often the first line of defense when it comes to a solid risk management program. With today's technology, CPAs have a plethora of information at their fingertips. Also consider using companies that specialize in background checks. Some firms even utilize client selection committees as part of their client selection and retention policies. It's imperative that firms perform background checks on all new and existing clients. Less-elaborate, but no-less effective, screening techniques include:
- Discussions with the previous CPA.
- Discussions with the referral source.
- CPAs should ascertain the time to complete the engagement.
- CPAs should determine if they have the requisite knowledge and industry expertise for the engagement.
- Confirm potential clients' litigious nature, if any.
- Search engine background checks.
For additional guidance, refer to American Institute of CPAs Practice Alert 2003-03, Acceptance and Continuance of Clients and Engagements.
Enhanced Engagement Letter Language
In recent years, engagement letters have become more common and more of a requirement to satisfy professional standards. "Enhanced engagement letters" embrace the changes that have taken place in the profession and have been successful in claims defense. Firms that have standard 1040 engagement letters may not be capturing engagement letter language that encompasses the heightened Report of Foreign Bank and Financial Accounts regulations; the greater oversight by taxing authorities; and the disclaimer for responsibility in nexus examinations. Jurisdiction paragraphs may not be used, and firms may be unknowingly governed by laws other than in the state in which they are domiciled. As the profession and liability exposure changes, so should the engagement letters that govern these engagements.
The following recommended language can be used to mitigate damages that may occur as a result of having claims adjudicated in jurisdictions other than the home state:
"Notwithstanding anything contained herein, both accountant and client agree that regardless of where the client is domiciled and regardless of where this agreement is physically signed, this agreement shall have been deemed to have been entered into at accountant's office located in [specific county], [specific state], U.S., and [specific county], [specific state], U.S., shall be the exclusive jurisdiction for resolving disputes related to this agreement. This agreement shall be interpreted and governed in accordance with the laws of [state]."
Communication and Documentation
The CPA profession relies on solid client communications for success. Equally important is the need to timely document those communications. Many an attorney has said, "If the advice to a client wasn't documented, the advice essentially wasn't provided."
Consider the following scenario: A long-term client asks for advice regarding its desire to take a minimum required distribution (MRD) from a retirement account. The practitioner responds that there is no need to take a MRD because the practitioner suggested the client contribute to Roth 401(k) years earlier. The client responds that no such advice was ever provided and if the client now owes taxes on this MRD, it is the practitioner's fault. Documentation quickly mitigates a he-said she-said scenario. CPAs cannot always document, nor is documentation always feasible. However, certain litigious client types, high-risk engagements including non-filers, and sophisticated transactions may require elevated communications and timely documentation.
Education and Training
Constant training and education in a respective field is the mark of a true professional. CPAs are expected by the public and their clients to be knowledgeable and up to date in the field of accounting. Falling below this expectation can be construed as negligence. State boards and professional societies require satisfying CPE requirements, and many insurers ask in insurance applications whether these requirements were satisfied. If sued, a CPA may have his/her CPE records and affirmations of satisfying CPE requirements subpoenaed by the plaintiff as an indication of performing substandard work. Firms must monitor each professional's CPE requirements and whether those requirements have been fulfilled. CPAs should also be trained in the newest technologies and in the industries in which their clients operate. A recent CPA firm was considered negligent in not employing data-mining technology in its audit procedures. The jury felt that data mining applications used during the audit would have caught the undetected embezzlement.
For the same reasons CPAs use engagement letters, they should also use termination letters when applicable. Many professional liability claims are due to client terminations. Termination letters should be used regardless of which party initiates the termination process. The letter language will vary depending on which party initiates the termination, but a letter should be used nevertheless. Exercise care in considering last-minute terminations, and consider completing all work before the termination occurs. The following circumstances - not all inclusive - could result in client termination:
- The client fails to provide all information needed to complete the engagement.
- A conflict develops, such as in a divorcing spouse engagement.
- The client fails to consider the advice provided.
- The client acts unethically or unlawfully.
- The accounting fee remains unpaid.
A carefully drafted termination letter will eliminate some exposure that could develop. List the termination reason, pending due dates, work and fee status, CPA willingness to communicate and cooperate with the successor CPA (after the client provides written consent), and wording that the items listed may not be all inclusive.
While CPA malpractice cannot be eliminated, claims CPAs face can be mitigated thru a comprehensive risk management program and adherence to the ever-changing professional standards imposed upon CPAs.
John F. Raspante CPA, M.S.T., CDFA, is the Director of Risk Management for the North American Professional Liability Insurance Agency, LLC. He is a member of the New Jersey Society of CPAs Accounting and Auditing Standards Interest Group and the New Jersey CPA Editorial Advisory Board. Contact him at email@example.com or 508-656-1300.