Many CPAs don’t realize how everyday tasks can easily expose them to malpractice litigation. The causes of litigation are well known, and so too are the mitigation techniques that prevent it.
Some mistakes happen despite your best efforts to prevent them. Some of the more frequent mistakes include the following:
Generating a tax-return error. Tax-return work can be risky. Some forms are difficult to prepare, especially when clients haven’t done their homework. Clients also pay a lot of attention to the financial impact of their tax filings. If the results are unexpected, they can be quick to file lawsuits.
Straddling both sides of a transaction. If you do work for multiple firm owners or partners or for two spouses, you might receive conflicting instructions. CPAs trying to serve multiple parties can become a target of abuse and eventually litigation.
Business deals with clients. Partnering with clients on outside deals while also providing accounting services is a risky gambit. If the deal goes bad, clients may accuse you of self-dealing and take you to court.
Not documenting engagements. Not documenting terms or failing to confirm key client decisions can lead to costly malpractice litigation. The failure to explain terms is often the genesis for incorrect client expectations. When your performance takes them by surprise, even though appropriate, you may be on the receiving end of a malpractice action.
Similarly, when an engagement takes a new turn and has a bad outcome, guess who may get blamed if it hasn’t been confirmed in writing? Written confirmation of revised instructions is a powerful protective tool.
Practicing in an area where you lack experience. The temptation to chase revenue in a new area is hard to resist, but lack of knowledge is a recipe for making mistakes. If your work product is flawed and harms a client financially, you will be a sitting duck.
High-Risk Practice Areas
Some practice areas, simply put, are litigation-prone. For example, it is well known that tax planning and compliance services account for a large portion of malpractice claims, followed by audit and attest services, consulting services, bookkeeping, and fiduciary services. Failing to implement quality-control systems may result in mistakes that, in these practice areas, spark expensive malpractice settlements or judgments.
Audit malpractice suits may not be common, but when they occur they can be disruptive and damaging to a CPA firm’s reputation. They often arise when CPAs fail in their due diligence on client statements and materials or when a client is a bad-faith actor manipulating data to make financial statements come out better than they should.
Trustee-related work can be dangerous, too. CPAs often take on these assignments from long-term clients. They can run into trouble when the assignment puts them into conflict with third parties who believe the CPA’s decisions financially harmed them. For example, mismanaging trust affairs or mishandling assets might put a CPA and trust beneficiary at loggerheads.
Mitigating Risks
The best way to avoid malpractice litigation is by practicing defensively. This requires adopting a loss-prevention mindset in every aspect of your practice. Here are a few strategies for accomplishing this:
Become a student of your clients’ businesses. Learn the difference between normal and aberrant business practices in their world, and always stay current on their financial results and initiatives.
If a client is showing weak financials and entering new business arenas, that should set off warning bells. Also, you should document all client conversations and decisions.
Beware the nonpayment trap. Due to the high risk of payment-tardy clients filing countersuits, it’s best to pursue non-litigation measures to collect owed funds. If you’re not sure how to do that, consult with an experienced debt-collection attorney.
Research all prospective clients. Avoid doing business with financially tenuous clients. Those who are on the edge of bankruptcy will be more likely to commit fraud, ensnaring you in their crimes. Also, try to determine a prospective client’s litigation history. Companies that have sued a prior CPA may be more likely to sue you than those who have avoided legal disputes in the past.
Read up on accounting ethics. Mastering your profession’s ethical standards will make it easier to avoid conflicts of interests and other practice errors that can land you in court. Study the AICPA’s Code of Professional Conduct. This document lays down the bright lines that distinguish ethically acceptable behavior from unacceptable behavior. Appropriate professional conduct will go a long way in inoculating you against malpractice lawsuits.
Even if you do everything right, there is always a chance you still might get sued. This is a big reason why malpractice insurance is vital.
Good insurance will provide a defense attorney and cover other legal expenses, such as court and expert-witness fees. If you lose your case, malpractice insurance will pay for settlements.
Even if a lawsuit is without merit, it can be expensive to defend yourself and get it dismissed. With malpractice insurance, you can continue doing what you do best – the work of a CPA – and delegate nuisance lawsuits to your insurer-provided attorney.
Before purchasing coverage, make sure it provides enough protection. Ask yourself the following:
- Are your limits of liability large enough to adequately cover your current risk exposures?
- Does your policy cover emerging risks, such as cybercrime and data breaches?
- Have you reviewed the policy to make sure it covers changes in your firm? (i.e., scope of practice, growth of revenue, etc.)
Mitigating your malpractice risks will take time and cost money, but both of those investments will pale in comparison to the potentially catastrophic outcomes of a malpractice lawsuit.
The original article appeared in the Pennsylvania CPA Journal, the official publication of the Pennyslvania Insitute of CPAs.
