Executive Summary:

• Providing clients with referrals to other professional advisors, such as investment advisors or attorneys, can present unintended risk.

• Careful management of interactions with a client’s other professional advisors is important, especially if the CPA is asked to participate in meetings with such advisors.

• Managing client expectations with respect to referrals to, and interactions with, other professional advisors helps minimize the “expectation gap” and professional liability risk arising from services rendered by these advisors to the CPA’s clients.

• Rule 503 of the AICPA Code of Professional Conduct requires CPAs who are paid or expect to be paid a permissible commission or referral fee to disclose this fact to the client.  

Clients often ask CPAs for referrals to other professional service providers, and most CPAs respond to such requests.  However, professional liability risk is associated with such referrals.  Many CPAs fail to recognize or address the client’s expectation that the CPA has screened the professional or will supervise their activities.  CPAs who participate in discussions between the client and third party professionals often do not define the CPA’s role in the discussion, leading to miscommunications and “expectation gap” problems.

The risks relating to failure to properly manage professional referrals is illustrated in the following case:

A sole practitioner provided bookkeeping and tax return preparation services for a number of years to a successful physician.  While rendering services to the client, the CPA noticed that the physician had been making large payments for life insurance premiums and other investments.  The physician asked the CPA to recommend a financial planner.  The CPA recommended an acquaintance and suggested that he, the client, and the financial planner meet to review the client’s insurance needs and estate plans.  During the meeting, the financial planner introduced the client to an investment advisor who was promoting his investments through the financial planner’s business.

The client subsequently made substantial investments in companies owned and operated by the investment advisor.  Subsequent to making these investments, the CPA obtained the investment advisor’s personal financial statement and provided a copy to the client.  The personal financial statement indicated a net worth in excess of $20 million. 

The investments later proved to be worthless as the underlying companies did not exist.  The investment advisor was convicted of defrauding the client and several other investors.

The client was unable to recover her losses from the uninsured investment advisor, who was later found to be unregistered with the state securities division.  She filed a claim against the financial planner, who likewise had been duped by the investment advisor, which resulted in a partial recovery.  Finally, the client sued the CPA, alleging that she relied on representations made by the CPA regarding the investment advisor’s background, experience, and financial stability. 

The CPA denied making any representations about the investment advisor’s character and noted that the investment advisor’s personal financial statement included a warning that indicated substantially all of the disclosures required under GAAP had been omitted, and that the statement should not be used for any purpose which required independently verified information. 

The client asserted that she had asked the CPA to screen the investment advisor prior to making the investments and disputed the timing of receiving the personal financial statement.  The matter was settled prior to trial.   Defense counsel determined that it would be difficult to defend the claim because the CPA 1) recommended the financial planner to the client; 2) participated in investment discussions with the client, the financial planner and the investment advisor, and 3) requested a copy of the investment advisor’s personal financial statement, and provided it to the client.

In this case, the CPA attempted to assist a bookkeeping and tax return preparation services client in need of personal financial services.  The CPA failed to recognize the risks associated with professional referrals and assumed a fiduciary duty to the client. 

So, how can CPAs in similar client service situations respond to a client’s request for referrals and manage the related risks?

• Upon identifying the need for additional professional advice beyond the CPA’s experience and capabilities, recommend that the client engage other professional advisors with expertise in the requested area. 

• Prior to providing the names of other professionals to clients, perform some high-level diligence to investigate their background, training, experience, reputation, professional credentials and licensing.  Provide referrals to individual service providers, rather than entities.  Provide the client with several referrals from which to select rather than recommending only one.

• Follow up the client discussion with a written communication to the client alphabetically listing the professional advisors recommended.  Inform the client that while names of several professionals have been provided, the client must bear the responsibility to evaluate, select, and engage other professionals and that their activities will not be supervised by the CPA.

• Tell the client to seek independent professional financial planning, investment, and tax advice prior to making investment decisions.  If the CPA provides tax advice related to prospective investments, document the scope of the service and additional fees in writing, clearly delineate the limits of such advice, define the client’s responsibilities, and reference the application of the terms and conditions included in the previously issued engagement letter.  To the extent there is a significant change in the scope of client services, a separate engagement letter should be executed.       

• Rule 503 of the AICPA Code of Professional Conduct addresses commissions and referral fees received by CPAs.  Generally, CPAs are prohibited from receiving a commission or fee for referring a product or service to a client for whom audit, review, compilation, or prospective financial information examination services are performed.  If such fees are permitted, CPAs are required to disclose their existence to the client.  From a risk management perspective, this disclosure should be in writing.

 

CPAs provide an important service to clients by helping identify other qualified professionals outside the scope of the CPA’s expertise.  While CPAs should be responsive to client service needs, avoid “engagement creep” by inadvertently providing services beyond the engagement letter scope and assuming an unintended fiduciary duty to the client. 

In addition to the above risk management recommendations, CPAs should exercise caution before agreeing to participate in meetings between clients and other professionals.  Clearly inform the client both orally and in writing of the purpose of participation (to obtain information needed to provide the client with related tax advice, for example).  Finally, consistently inform the client that you will not provide financial planning or investment advice and remind the client of his or her responsibility to supervise other advisors.

Updated July 2013

CNA Accountants Professional Liability Risk Control, 333 South Wabash Ave. 36S, Chicago, IL 60604

For more than 50 years, CNA has been serving accounting firms with solutions that help reduce the risks of managing their practice and insurance that helps cover a firm and its employees.  With products and services designed for accountants by experienced professional risk consultants with practical experience in the profession, CNA insures more accountants than any other carrier.  CNA’s broad portfolio includes professional liability, general liability, cyber liability, property, employment practices liability, and our industry-leading P&C package for small firms.  We are proud to be the endorsed professional liability insurance carrier for the American Institute of CPAs® member insurance program.

This information is produced and presented by CNA, which is solely responsible for its content.

The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA.

Any references to non-CNA Web sites are provided solely for convenience, and CNA disclaims any responsibility with respect to such websites.

To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental.  In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy.  Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured.  All CNA products and services may not be available in all states and may be subject to change without notice.

IRS Circular 230 Notice: The discussion of U.S. federal tax law and references to any resources in this material are not intended to: (a) be used or relied upon by any taxpayer for the purpose of avoiding any federal tax penalties; (b) promote, market or recommend any products and/or services except to the extent expressly stated otherwise; or (c) be considered except in consultation with a qualified independent tax advisor who can address a taxpayer’s particular circumstances.

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program.

CNA is a registered trademark of CNA Financial Corporation. Copyright © 2013 CNA.  All rights reserved.