Of all the worries that keep CPA firm owners up at night, chances are the specter of potential litigation is the one that causes them to lose the most sleep.
Unfortunately, there may be a good reason for that.
Since 2000 – on the heels of several corporate scandals and financial reporting fiascos – judges have been less likely to throw out cases against CPAs than they once were, according to CPA Mutual, a national risk retention group and accounting firm liability coverage provider. Judges today also grant fewer motions for summary judgment and seem to require additional discovery before rendering decisions on cases.
The numbers speak for themselves, said CPA Mutual President Bill Thompson. Firm claims with actual expenses paid have increased by 41 percent since 1998, while accounting firms can expect, on average, to experience one liability matter per every 38 employees each year.
And smaller firms – where the consequences of litigation can be much more catastrophic – are not exempt. Based on CPA Mutual’s total membership count and the number of reported incidents per year, nearly one out of every nine firms can expect to have some kind of legal issue annually, Thompson said.
It’s not that CPA firms have become more reckless in their practices. Rather, Thompson said, a combination of factors within the legal system and the CPA profession are driving this trend.
“I believe public perception may be at the forefront of this change,” Thompson noted. “CPAs may have lost a little of their ‘trusted profession’ luster post-Enron and all the other scandals in the early 2000s, when the accounting firms in many of these cases were implicated of shoddy accounting or looking away while the bad guys cooked the books.”
Plaintiffs’ lawyers in those cases also discovered two key factors that continue to haunt CPA firms to this day, Thompson said. They found accounting firms have deep pockets, and sympathetic juries were willing to believe the CPAs did, in fact, assist in the fraud or, at the very least, turned a blind eye to protect the relationship.
Add to that the CPA profession’s labor shortage and the fact that accounting firms carry professional liability insurance (which makes them an easy target for lawsuits), and you’ve created a legal climate rife with opportunities for litigation.
The labor shortage, in particular, Thompson said, has only exacerbated the problem.
“There is nothing worse for firm owners than to hear a staff member explain at deposition, ‘I had no idea what I was supposed to do, and there was no one on the job to answer my questions,’” Thompson said.
When it comes to diligent risk management against a legal claim, purchasing liability coverage isn’t enough, he added. The time and expense of a lawsuit can disrupt firm operations and cause clients to question their choice of advisor.
In addition to the right coverage, CPA Mutual advises firms to add the following five strategies to practice management. These steps can improve their odds of avoiding claims or, at the very least, properly manage them should they occur.
1. Invest in consistent staff training. Plaintiffs’ attorneys like the idea of “kids” doing audits; that is, less-experienced auditors. Firms need to have enough senior-level staff people to adequately supervise each engagement. Before adding a new client, think long and hard about whether you have the right people to take on the engagement. For quality control, make sure that qualified staffers are positioned at every level and phase of the engagement – and documented as such.
2. Update and enforce document-retention policies. Paper and electronic files are discoverable in a lawsuit. These include workpapers, but also emails, text messages, instant messages, blogs, and any other message stored electronically. The firm’s document-retention policy should include electronic communications even on personal home computers and phones used for business. Remember, Arthur Andersen wasn’t found guilty of performing a bad audit – it was found guilty of a cover-up based upon one bad email. Train staff on saving client and firm communications in all forms.
3. Review communication protocols. Remind staff that anything they write – regardless of its form – may be discoverable. When in doubt, speak about sensitive information in person and determine how to communicate it to the client or other staff. Electronic documents are extremely expensive to produce for a subpoena, and there is a very complex set of rules for their retention and safekeeping once a claim is imminent or threatened. This alone will require the help of an attorney.
But how can you hammer this point home with text-happy millennial employees?
“Emphasize ‘never write anything that can be said,’ which can be applied perhaps when discussing internal issues or personnel differences,” Thompson said. “I wouldn’t want to be in the middle of a claim and discover that one of the junior staff persons texted an associate with a comment such as, ‘The senior on this job is so over his head, all he does is surf the Internet while I do all the work! L.’ We’d probably be forced to settle even a defensible claim. This would apply to personal comments regarding a client, as well.”
However, any recommendations or comments made to the client relative to the engagement should be in writing, he added. Those comments should be brief, but enough to understand the point you are trying to make, as well as the client’s response. It wouldn’t hurt to have an email in the file outlining your conversation. Send it to the client, and ask to confirm his or her understanding of the discussion, Thompson said.
4. Revise contracts and invoices. One of the most dangerous liability risks to CPA firms today is contract language. Firms are adding a number of specialized service niches in order to differentiate and compete, but they are not updating their letters of engagement and invoicing to clarify the exact nature of services rendered or the CPA’s role in the engagement. Firms run into problems in areas such as consulting on tax implications that tie to investments or estates. An innocent conference call, improperly documented, can create the appearance that the accountant offered investment or legal advice. If the client’s investments or estate run into trouble, the accounting firm must be able to clearly demonstrate its role.
5. Choose insurance providers carefully. As claims statistics worsen, insurance companies that recently entered the accounting market may be heading for the exits. It happened in the mid-’80s and then again in the early 2000s, so CPAs should not be surprised if they receive a nonrenewal letter in the mail informing them that the company to whom they have paid premiums all these years won’t be around to service their claims. The last thing CPAs want to deal with is claim litigation serviced by an insurance company that no longer serves their market, Thompson said.
He recommends two strategies to find a reliable insurance carrier. First, ask how long the carrier has written professional liability for CPAs. Have they ever written it before, but then withdrew from the market only to re-enter in the future? Carriers like to enter and leave markets depending upon results.
“You don’t want to file a claim with a carrier only to see them exit our market. The claim will be handled in a runoff department with little regard to insured satisfaction because they know renewing the firm is no longer a concern,” Thompson said.
Secondly, seek out the confidential opinion of a local attorney who defends CPAs. Ask the attorney about his or her knowledge of the claims philosophy and claims-handling procedures of a prospective carrier. Some carriers pay claims a little faster than others, and some like to dispute every exclusion or coverage term with their insured [the CPA firm itself] even before dealing with a plaintiff.
Over the years, Thompson said he’s seen lawsuits filed against even some of the most well-intentioned, cautious CPA firms, usually as the result of one of two incredibly common mistakes.
First, firms accept engagements they are not fully qualified to perform and then don’t seek a second opinion or review from someone who is qualified before releasing the work product. The other mistake is being too concerned about the client relationship in attest engagements.
“Some firms face a lawsuit from attest work because they believed the client could turn around and straighten the Titanic before it sank,” Thompson said. “You need to be honest and direct in attest engagements, even if findings may threaten a long-term client relationship. Be prepared to walk away.”