The 8 Key Steps to Avoid Liability Claims and Client Litigation
Most accountants know that tax season can also mean increased exposure to liability claims and litigation from clients. But even in the off-season, they face exposure to costly claims just by providing service. From demanding clients to tight deadlines, the list of potential issues is a long one. With the proper best practices and risk management solutions in place, accountants can breathe a little easier during tax season and all year long.
An important part of a strategic risk management program is an Errors and Omissions (E&O) policy. Today, more clients require the professionals they hire to an E&O policy. In fact, accountants run the risk of losing the opportunity to garner new clients without it.
Regardless the size of the firm, the risk of lawsuits is real. Even if you have solid relationships with your clients, many will not hesitate to take legal action if they feel the professional services provided failed to meet their expectations. Defense costs, even in frivolous cases, can be costly. So, the purchase of a quality professional liability policy can be both cost-effective and help protect a business and its financial security.
Recent litigation trends of note include claims for failure to detect fraud, embezzlement and corporate impropriety. While these claims can include allegations against auditors, they are sometimes also asserted against tax preparers. Clients often assume their accountants and tax preparers can be held liable for failure to detect fraud, and while that varies from case to case, the need to defend the accountants' conduct is apparent. As a general rule, tax preparers are responsible for ensuring the proper tax treatment of a corporation's transactions, not for ensuring compliance with corporate norms or monitoring corporate governance.
However, such allegations can result in significant potential defense costs, settlement amounts and damages—both financial and reputational. In one example, an accountant prepared a company's tax returns for four years. During this period, one of the client's partners allegedly stole from the company. The aggrieved partner sued the allegedly crooked partner, the company's general counsel, outside counsel and tax preparer. The plaintiff alleged that the accountant should have recognized and blown the whistle on the other partner's looting.
An E&O policy would cover defense costs and the potential resulting damages that the insured became legally obligated to pay as a result of a confirmed negligent act, error or omission in their performance of the professional services for their client.
How to Protect Yourself
Of course, insurance isn't the only tool accountants can use. For example, engagement letters with appropriate disclaimers related to fraud detection can prove to be effective risk management tools to address the exposure to allegations of failure to detect fraud, embezzlement or corporate impropriety. When purchasing an E&O policy, accountants should consider insurance companies that provide risk management guidance and contemporary solutions for proper client engagement letters, for example.
Of course, year-round accounting risks go beyond fraud, and are frequently tied to tax preparation. More common claims include allegations of improper tax treatment or advice, filing errors, breaches of confidentiality, and simple math errors. While some of these exposures may seem basic and easily avoided through proper risk management and oversight, they can also be the easiest mistakes to make. Accountants can protect against these exposures by implementing proven best practices and risk management solutions.
The following basic best practices are a good place to begin creating a risk management plan. They can help avoid "basic" as well as more complex mistakes, keeping a firm's finances and reputation intact.
- Service-Specific Documentation. Complete separate engagement letters for each service offered any given client, from audit, review, and compilation to tax, consulting, and other services. For example, while bookkeeping is less complex than other assignments and may be one of two or three services you provide to a client, it is important to be clear about the scope of bookkeeping services, especially when bank reconciliation is involved.
- Set the Scope. Define limitations of services from day one and enforce them; clients often try to expand the scope after a problem is discovered.
- Set the Tone. An engagement letter is a must. Failure to create this document can lead to broad interpretation of scope of services actually performed and lead to misunderstandings and unrealistic expectations.
- Coordinate. Make sure invoices match the scope of the engagement; embellishment could result in fraud risks.
- Set Realistic Standards. Don't overpromise. It's important that proposals align with the promise to deliver specific services, experience in accomplishing the services as well as the accountants' availability and resources.
- Enforce Your Limits: Do not accept unreasonable demands or deadlines from clients.
- Be Honest. Manage client expectations. Again, the lure of overpromising can be strong—it's better to over-deliver.
- Stay informed with IRS Updates. Stay apprised of all updates in the tax law and revenue ruling from the IRS by regularly checking the organization's "Latest News."
- Remember Your Role. Do not go outside the role of an accounting professional. Trying to be all things to all clients is a recipe for disaster. It's important that the accountants stay within their experience level, expertise, and available resources.
Having a risk management plan in place, along with an E&O policy, can be the key to having peace of mind during tax season and all year long.
About the author:
Catherine Putman, CPCU, is Product Manager, Portfolio Management, Bond & Specialty Insurance, at Travelers.