7 Ways to Prevent an Accounting Malpractice Lawsuit

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Ralph Q. Summerford
President
Forensic Strategic Solutions Inc.
Columnist
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Have you ever had the passing thought, “What could be worse for my business than losing my best client?” Sure you have; everyone senses that empty feeling right in the middle of their gut at one time or another. It is a weird feeling, right? And it's real; no one wants to lose something so important to his or her self-esteem and pride.

Consequently, we work hard to try to please all clients. Losing a client, however, pales in comparison to that emptiness in the gut you will get when a process server delivers a complaint against you and your firm. You open the legal document and learn that you have been sued for accounting malpractice. This claim is not only professional, it is personal. The lawsuit is an attack on your character and integrity.

Although I have written articles and given many speeches about how to handle an accounting malpractice lawsuit, other than just doing a good job, very little ink has been given on the subject of how to prevent the suit in the first place. From my perspective of having been an expert witness in dozens of accounting malpractice cases, I will share categories of where many, if not most, of those lawsuits arose. More importantly, I will share how most of those lawsuits could have been prevented.

1. Research and investigate clients. You will certainly want to do this for all new clients, but do this for existing clients. It is so simple and quick to Google anything or anybody, and it can be done regularly. You will learn about litigation by or against your client, which provides great insights; news of events; contracts; employees; or anything else newsworthy (and a lot not newsworthy). Consider your professional risks from what you learn.

2. Understand your client's business. This is much easier said than done, but is an absolute must. When sued, you will face the questions: Did you know what was going on? Were you aware of the events? If you didn't know, why did you not know?

Knowledge is power – and you must have knowledge. However, if you don't understand the business, you will more than likely miss the big picture. Also, as a side benefit of thoroughly understanding your client's business, you will be in a great position to offer your client advice, consulting, and/or additional services.

3. Don't work without getting paid (regularly). It is surprising the number of CPAs who when sued are owed substantial fees by their clients. Rather than love, tolerance, or kindness, the CPA is much more respected when a client has to pay a reasonable price for the services, paid when those services are rendered. Remember the adage: The value of the service depreciates rapidly after the service has been performed.

Secondly, when a CPA has to threaten or demand payment, clients often find a reason to sue the CPA. The struggle to get paid is extremely expensive, time-consuming, and nasty. My best recommendation is to make certain you are paid before or at the presentation of the deliverable. This pay-for-product is the only leverage the CPA has to get paid.

Finally, make absolutely certain the deliverable is timely. Other than receiving a low-quality product replete with errors, there is nothing to infuriate a client more that getting the deliverable late. Late delivery will help the client build a damages claim against the CPA.

4. Avoid clients with financial problems. Statistics of unscrupulous activity show that one-third (33 percent) of people will commit fraud if they feel forced to save a business (or for personal reasons). Furthermore, I have seen that most (greater than 50 percent) of corporate executives will commit fraud rather than face the embarrassment of failure. And when a business fails, who do you think is to blame? Someone else, of course – and because CPAs have deep pockets and lots of insurance, they are a likely candidate to get sued.

5. Get an executed engagement letter. State what you will do. More importantly, state what you will not do. For example, if it is write-up work, state that you will reconcile the bank accounts to see that the balance of the account is correctly reported; however, you will not review the cancelled checks, deposits, or examine documentation. Your work is not designed to look for improprieties and cannot be relied upon to find mistakes in the records. An engagement letter is a contract that deserves a lot of thought, planning, and preparation.

In your contract, be sure to provide for disputes to be settled first by mediation or, if unsuccessful, by arbitration. Arbitration for a CPA is a far-better forum to settle disputes than in a court of law. Remember, lawyers make a living in a court of law, and unless you want to fight with alligators, it is best to stay out of the swamp where they live.

In your contract, you also cannot claim you will not do something in your engagement when professional standards require that you do it. For example, in an audit you might claim that your examination is not designed to look for fraud and you cannot be expected to find it. However, professional standards require you to identify risks of material misstatements due to fraud and require CPAs to perform many procedures in consideration of fraud. By the way, be sure to perform those procedures and document them very well in the workpapers. Understand that if a client has suffered from fraud that was not discovered by the CPA, in my opinion, there is a 90 percent chance the CPA will be sued (guilty or not) for not finding the fraud.

6. Understand professional ethics and conflicts. Putting oneself in an ethical dilemma is absolutely insane and a sure prescription for getting sued. Many lawsuits are successful in such cases as: a CPA performing a fraud examination also performs attest services, a CPA providing merger and acquisition services also performs attest services (even nonattest services), the CPA purchases property at a bargain price from a decedent tax client's estate, and the list goes on and on. The facts and circumstances of each case will dictate where the lines are crossed, even if a bright line cannot be drawn. Just remember that juries are usually sympathetic to the poor plaintiff and will draw their own bright line.

7. Complete the checklist/program. CPAs are great at preparing forms, checklists, and programs. In several malpractice cases, I have found forms not completed or audit steps marked as not applicable (n/a) when the step was applicable. In fact, I have found entire pages marked with lines pointing to one n/a notation. Especially when it comes to a stock form designed for a multitude of different-type jobs, an n/a notation may be appropriate. But the wholesale marking of n/a in most cases is a mistake.

Bottom line: The wholesale marking of forms and the failure to mark other forms may indicate sloppy or incomplete work, suggesting the work was never done or even considered. This may just be the dead ringer to prompt a lawsuit for accounting malpractice. Make certain that every single item on the checklist is considered and, in addition to marking the item as n/a, provide a short explanation of why it is n/a. This step alone may be the only documentation in workpapers of the procedure and may be just enough to show that your work was thorough, complete, and well-documented.

By the way, if you include other items of documentation in your workpapers, make certain each supports the work you have performed. In my experience, most accountants “overdocument” their work by including items that should have never been kept in their file!

About the author:
Ralph Q. Summerford is the president of Forensic Strategic Solutions Inc., a full-service financial investigation firm offering a range of services across five integrated practices: fraud examination, investigative financial consulting, litigated business valuation, forensic technology, and accounting malpractice. Ralph has worked in more than two dozen malpractice cases. He often testifies as an expert witness in federal and state courts, and has published articles in multiple publications. He serves on the faculty for the Association of Certified Fraud Examiners and has held multiple leadership positions in the organization.  

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Sep 30th 2015 22:09

It's too bad that our sue-happy society makes it so that legitimate businesses (including accounting firms) have to devote some amount of attention and incur at least some amount of stress about being wrongfully sued.

Our system of laws has grown so complicated that even those with the best of intentions and efforts to be squeaky clean can be subject to those who might want a quick buck from a lawsuit.

Those things being said, this is all good advice, Ralph. The potential for a suit is worth doing this amount of risk planning.

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Oct 1st 2015 13:28

What a great article and advice. When setting up AuditProposal.com, I asked my brother-in-law, who is an attorney about lawsuits. His reply was anyone can sue for almost anything.

The sad part is the impact a lawsuit can have on a small to midsize CPA firm regardless of fault. Great advice to minimize the chance of a malpractice lawsuit.

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