Among the many roles and responsibilities assumed by accountants, perhaps none is more critical or scrutinized than that of fiduciary. A fiduciary, by definition, is a person or group who holds assets for another party, often with the legal authority and duty to make decisions for the other party. Given this important accountability, a fiduciary is a person in whom someone has placed the utmost trust and confidence. The concept comes from Roman law, and the word comes from the Latin fiducia, meaning "trust." The fiduciary acts for the benefit of another and should treat the other party’s interests as paramount, while acting with a high degree of good faith consistent with their duty of loyalty.

Fiduciaries also have a duty of care and have to exercise the skill and care of a reasonably prudent person. They often take legal title to assets but not equitable title, which rests with the beneficiaries or principals. That being the case, they are in a special and unique position of trust and are held to the highest of standards.

Revered former U.S. Supreme Court Justice Benjamin Cardozo, while he was a Justice on New York’s highest court, once wrote: "Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of the courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a higher level than that trodden by the crowd."¹

Accountants often find themselves in the role of fiduciary, sometimes by choice and sometimes by circumstance. As such, they need to appreciate the expectations and the risks that come with this highly scrutinized task, and know how to avoid certain risks.

The Risks of Responsibility

The traditional accountant-client relationship usually is not fiduciary in nature, especially if independence is required. However, certain roles that accountants fill are universally regarded as fiduciary in nature, such as:

• Trustee;
• Executor or personal representative of an estate;
• Bankruptcy trustee or receiver;
• Investment adviser;²
• ERISA employee benefit plan fiduciary;³
• Attorney in fact (holder of power of attorney for taxes, financial matters or health care). ⁴

When accountants perform these duties, acting as fiduciaries, their actions are dissected and analyzed more closely than normal. The law also treats fiduciaries differently. For example:

• The statutes of limitations are often longer as compared with ordinary negligence statutes of limitations;
• Expert testimony may not be required to show liability as in ordinary negligence cases; and
• The defense of contributory or comparative negligence of the plaintiff is not available as is usually the case in negligence actions.

As a result, the burden of proof may shift to the fiduciary defendant to demonstrate that his or her acts were consistent with their fiduciary duties. Empirical evidence also suggests the possibility of punitive damages being awarded against fiduciaries is greater; it’s difficult for any actual or perceived conflicts of interest to be effectively waived; and the disgorgement of fees and profits is easier for claimants to obtain.

Court-assigned Accountability

Accountants sometimes will be deemed to be in a fiduciary relationship with their clients in other engagements, even though they have not accepted the role of fiduciary. There are no bright-line rules as to when a court might determine that a fiduciary relationship exists.

The courts have found the existence of a fiduciary relationship where there was a justifiably high level of trust and confidence in the professional, usually caused by a large disparity in levels of expertise between the parties as to the matter at issue. The plaintiff—who has the duty to establish that the defendant assumed the role of fiduciary—may do so by demonstrating the professional has made representations, either directly, on a website or in marketing materials, that he or she is an expert in a particular field.

Other factors that have been determinative in establishing a fiduciary relationship are the existence of a lengthy business relationship, the existence of a personal friendship between the parties, or the fact that the professional encouraged reliance. For example, in the 1988 case Dominguez v. Brackey Enterprises,⁵CPA Joe Dominguez was engaged to prepare tax returns, provide advice regarding tax implications of investments, counsel the client regarding investments and provide management advisory services. The Brackeys invested money in a seafood business based, at least partly, on Dominguez’ recommendation and suffered a loss. The court found the existence of a fiduciary duty in their relationship based on their long business relationship, personal friendship and the fact that the Brackeys were accustomed to being guided by Dominguez and were justified in placing confidence in the belief that he would act in their best interest.

Interestingly, as early as 1945, a court held that an accountant who provided audit, accounting and tax services to the plaintiff had and breached a fiduciary duty. In Cafritz v. Corporation Audit Company,⁶ CPA Barney Robins provided tax and audit services to a company owned by Morris Cafritz. One of Robins’ services was to deposit checks made payable to the client company into the client’s bank account. The checks, entrusted to Robins, were never deposited into the client’s account. Robins died shortly thereafter, and the evidence indicated that he had deposited some or all of the checks into an account of a company that he controlled, thereby converting the money to his own use. The court found that because Robins had occupied a position of trust and confidence based on superior knowledge, a fiduciary duty existed.

In another case decided more than a half century later, an allegation that an auditor used confidential information gained during the course of an audit to engage in unfair competition with the client was found to sufficiently state a cause of action for breach of fiduciary duty.⁷

Accountants may avoid becoming a fiduciary unknowingly and steer clear of associated liability by pursuing a few simple steps. An accountant should always:

• Ensure that conflicts of interest are disclosed fully and, with the assistance of legal counsel, obtain a waiver from the client. This will help to educate the client and document limitations regarding the accountant’s role.
• Obtain annual signed engagement letters specifically defining the scope of services, including appropriate caveats and disclaimers. Also, in certain instances, consider specifically stating what services will not be rendered. And avoid language that may imply a fiduciary role.
• Be aware that making representations of expertise in promotional materials, whether printed or on a website, may suggest a higher standard.
• Document information that demonstrates the client’s knowledge and sophistication regarding the issues involved in the engagement. This will tend to negate the dominance and dependency that usually are required for a fiduciary relationship to exist.
• Observe the formalities of a professional relationship even though the clients may be familiar.
• Not engage in acts that compromise independence, if the engagement requires independence, or act in ways that are inconsistent with their role.

 

Effectively Discharging Fiduciary Duties

The fiduciary will be held to the highest standard that exists under the law, and each decision that is made will be scrutinized closely. Therefore, the fiduciary should always send a confirming e-mail or letter after an oral discussion. The professional will be expected to explain what happened and why certain decisions were made, oftentimes years after the fact. Thus, it would also be helpful to draft memoranda to the file explaining the thought process behind more important decisions that were made in the course of the engagement.

In one case that illustrates these ideas, an accountant provided tax services for a wealthy client and was the trustee of her living trust. The will and trust provided that one of the two daughters was to inherit the entirety of the client’s estate. That being the case, the accountant trustee was lax in his duties and allowed the favored daughter to dissipate trust assets before the mother’s death and did not document communications between them. After the mother’s death, the other daughter challenged the will and trust saying that, in exchange for certain consideration, the mother had promised to treat the daughters equally in the will and trust. She brought suit against the estate, the favored daughter and the accountant alleging that the accountant had breached his fiduciary duty as trustee. It was challenging to recreate what transpired during the time in question and the accountant’s actions were difficult to defend. This caused him to appear less than professional and created legal exposure. These issues, and other factors, prompted a settlement of the case.

The most common situation that produces claims and lawsuits against an accountant trustee is when the accountant is a co-trustee with an heir/beneficiary of the estate and a dispute arises with a sibling beneficiary about the distribution of assets. The sibling typically alleges that the accountant trustee is the non-conflicted trustee and, as such, has a duty to be a "watchdog" over the co-trustee and the trust assets and should closely monitor the acts of the other trustee, especially if they involve decisions that may benefit the co-trustee beneficiary. These cases are sometimes difficult to defend given the heightened standard of care of a fiduciary. They are also expensive to defend given the emotions that exist between family members as litigation decisions often are made more on an emotional level than on a rational level.

When agreeing to serve as a fiduciary, it is important to observe the formalities of a professional relationship while documenting every communication of substance. By not compromising independence, disclosing all conflicts, issuing thorough engagement letters and documenting the client’s involvement, accountants can help avoid unwittingly becoming a fiduciary, while discharging the critical duties they accept in a manner that mitigates liability.

Of course, even the most diligent accountant cannot eliminate all risk exposures. So, understanding the scope of liability coverage is important. Accountants’ professional liability policies may limit or exclude coverage for certain services or resultant damages where a fiduciary relationship is established. Accountants should consult with their insurance agents or brokers regarding coverage for any services they may be rendering.

Executive Summary

• Fiduciaries are held to the highest standard under the law. Accountants can either assume fiduciary responsibilities knowingly and voluntarily, such as in the cases of a trustee or executor engagement, or the law will consider them to be fiduciaries because of their position and relationship with the client.
• Fiduciaries have greater exposure due to increased scrutiny, longer statutes of limitations and increased potential for punitive damages and disgorgement of fees. Also, expert testimony is often not needed to establish liability, the defense of comparative negligence is not available and the burden of proof will be on the fiduciary to show that their acts were appropriate.
• To avoid unknowingly becoming a fiduciary, clearly define the scope of your engagement in an annual engagement letter; disclose and obtain a waiver for any conflicts of interest; document the client’s knowledge and sophistication of the issue; and, if the engagement requires independence, do not engage in acts that are inconsistent with that role.
• To effectively discharge the duties of a fiduciary, it is important to diligently document and confirm conversations with the client or beneficiaries. Memoranda to the file will help the accountant document the thought process underlying more important or complicated decisions.

 

April 2011

By CNA Accountants Professional Liability Risk Control, CNA, 333 South Wabash Avenue, 39S, Chicago, IL 60604.

¹ Meinhard v. Salmon, 249 N.Y. 458, 464 (1928)

² The Dodd-Frank Wall Street Reform and Consumer Protection Act recently signed into law authorized the SEC to conduct a study that would allow it to impose a fiduciary standard on broker-dealers as well. The study was released in January 2011 and recommended a uniform fiduciary standard for brokers, dealers and investment advisers. http://www.sec.gov/news/studies/2011/913studyfinal.pdf

³ Fiduciary responsibilities under the Employee Retirement Income Security Act of 1974 (ERISA) are defined by this statute and related federal laws, and are subject to regulations and guidance issued by the U.S. Department of Labor. Related information is available at http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html. The Department of Labor has recently proposed expanding the definition of "fiduciary" within the meaning of Section 3(21) of ERISA as it relates to persons rendering investment advice to a plan for a fee or other compensation.

⁴ In certain instances, the accountant is the most trusted person in the life of an elderly client. Thus, the client will sometimes grant a durable health care power of attorney to the accountant to make future health related decisions for the client if the client becomes too ill or is otherwise unable to make those decisions.

⁵ 756 S.W.2d 788 (Tex. App. 1988)

⁶ 60 F. Supp. 627 (1945)

⁷ Stern Stewart & Co. v. KPMG Peat Marwick, LLP, 1997 N.Y. Misc. LEXIS 737, 218 N.Y.L.J. 17 (1997)

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