Unfortunately, seemingly benign actions do not always turn out to be so. Even small decisions or quick conversations may have significant — and expensive — consequences. Consider these real-life claims asserted against CPAs in the AICPA Professional Liability Insurance Program, and take note of lessons that were learned the hard way regarding a lack of engagement letters.
Failure to Search
- The case: A CPA prepared tax returns and provided bill-paying services for a client. When the client inherited a substantial amount of money, it asked the CPA to assist in managing this newfound wealth. The CPA agreed and invested approximately $2.5 million with an investment adviser who was recommended by another client of the CPA. Eventually, the invested funds were lost due to the adviser's alleged fraudulent activity. The client filed suit against the CPA for failure to exercise due diligence in selecting the adviser. While the CPA's actions were taken in good faith and in the belief that they were in the client's best interests, the CPA did not perform any due diligence procedures related to the adviser, relying solely on the recommendation of the other client. A simple internet search, however, would have revealed that the investor was previously convicted of financial crimes.
- The outcome: The case settled with defense costs and an indemnity payment of more than $500,000.
- The lesson: While the depth and type of due diligence procedures vary based upon the situation and service to be provided, performing a basic internet search before accepting a new client, or making a recommendation to an existing one, is a quick and easy — but crucial — step for a CPA to take, even if the referral source is a trusted one.
- The other lesson: Clients often seek a CPA's advice related to investments. However, providing incidental advice is fraught with risk, and the CPA may be blamed for poor investment performance. Avoid providing investment advice unless you have the requisite experience in the area or have been engaged via a separate engagement letter for the service.
- The case: A CPA prepared tax returns for a married couple for a number of years until the couple informed the CPA of their impending divorce. During the couple's divorce proceedings, the CPA provided advice to the husband for a short time without first obtaining a waiver from or officially terminating the relationship with the wife. The wife claimed that, within that period, the CPA wrongfully advised the husband that he could withdraw money held in joint bank accounts even though such withdrawals violated the couple's prenuptial agreement. The CPA recalled telling the husband that he believed he would be entitled to half of the joint account but did not have the prenuptial agreement in hand. As such, he verbally advised the husband to consult with his divorce attorney on the issue. There was no documentation related to this discussion with the husband.
- The outcome: The case settled with defense costs and an indemnity payment of approximately $1.5 million.
- The lesson: Answering seemingly benign questions based on incomplete or partial information can have significant consequences. Avoiding answering these questions, while preferable, is not always possible or practical. Whenever advice is provided, follow up the discussion with a written communication, such as an email.
- The other lesson: A conflict of interest, or even the appearance of an ethical violation, can greatly complicate the defense of a claim. Here, the defense expert opined that, despite the short period during which the conflict existed, the case would be very difficult to defend, and the CPA should not have discussed the issues with the husband.
In both of these cases, the engagement letter was nonexistent. Had engagement letters been in place, the outcomes may have been different.
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