Gain a better understanding of the unique risk management strategies a California CPA firm may need to utilize to help mitigate risk with high-net-worth clients.
As a CPA in California, there’s a good chance your client portfolio includes high-net-worth clients or even those who fall in the ‘celebrity’ category. This “rich and famous” client mix presents a unique set of risks for professional advisors, such as CPAs, and may result in a CPA becoming just as famous, or infamous, as the client served.
You may have read about pop stars, actors, and professional athletes alleging that they were “driven to bankruptcy” by unscrupulous accountants and financial advisers. This often stems from the hands-off attitude of the rich and famous and their reliance, actual or perceived, on professional advisors to handle their financial affairs. Unfortunately, this often puts the advisor at risk of being blamed for a decline in the client’s net worth. While it may feel good to be the trusted advisor to a high-profile client, such relationships are generally fraught with risk and disputes are often played out in the court of public opinion.
High-profile clients often desire a mix of traditional and non-traditional services. Services may include traditional family office services, tax, accounting, financial planning, wealth management, and administrative support for both personal and business assets. Nontraditional services may include concierge-type services including booking travel, checking in on extended family members, or even paying bills. This mix of traditional and nontraditional services for a higher-risk client can lead to unique, and potentially costly, professional liability risks.
Gaining a better understanding of the unique risk factors and claim experience in this market can help you anticipate and assess your clients’ needs while employing targeted risk management strategies at the same time to help reduce the likelihood of costly claim.
Claim experience of the AICPA Professional Liability Insurance Program suggests serving these types of clients can be risky business. Why?
Claim allegations can be quite inflammatory, typically alleging mismanagement of money, provision of poor tax and investment advice, and even embezzlement of client funds.
Jurors, enamored by a client’s celebrity status, wealth and/or success, are often sympathetic to their claims.
Common factors that may complicate the defense of claims in this area of practice include the following:
There is frequently no annual engagement letter memorializing the scope of agreed-upon services. While an initial engagement letter may be issued, it may not be reissued or revised when services expand or change. Moreover, the laisse fare structure of the initial agreement encourages an informality that leads to increased risk over time due to scope creep and a lack of clarity around responsibilities.
Services may be managed by senior partners, with minimal oversight by other firm personnel. Additionally, a partner’s book of business may consist of a handful of high-net-worth clients, each individually generating significant fees. Therefore, the partner may treat the client’s interests as paramount, creating a threat to objectivity.
To illustrate these points, consider the following claim scenarios provided by CNA, the endorsed underwriter of the AICPA Professional Liability Insurance Program and an insurer of the accounting industry since 1962.
CLAIM SCENARIO CASE #1:
Area of Practice: Business management services
Alleged Cause of Loss: Mismanagement of finances
Outcome: Approximately $1 million spent in indemnity & expenses
The Plaintiff was a long-term client for whom the CPA performed a variety of services, primarily business management functions and income tax return preparation. The client had outspent his income and found himself in financial distress. For the client to meet financial obligations, the CPA arranged for a multi-million dollar short-term loan, allegedly at an exorbitant rate and terms. When the client subsequently defaulted on the loan, he initiated a claim against the CPA for over $5 million in damages.
While many of the allegations against the CPA involved general mismanagement of the client’s accounts and a failure to advise the client of the severity of his financial troubles, the primary focus was on the CPA’s recommendation of the loan with alleged unreasonable rate and terms.
The CPA asserted that the client’s financial problems were caused by his own excessive spending, not the high-interest rate loan. However, complicating the defense was that this client was a successful actor who was going to be able to convincingly portray a sympathetic story to a jury. Additionally, the CPA’s workpapers were not well documented, and no engagement letter was used to define the scope of the CPA’s responsibilities.
CLAIM SCENARIO CASE #2:
Area of Practice: Financial planning and tax
Alleged Error: Excessive fees charged
Outcome: Approximately $450,000 spent in indemnity & expenses
The CPA provided financial planning and tax services for the Plaintiff, a wealthy individual, for five years. The Plaintiff became unhappy with the CPA’s fees. Unable to work out their differences, the Plaintiff filed suit alleging the CPA charged over $1 million in excessive fees. Although the CPA believed the suit was frivolous at the onset, when the Plaintiff had the CPA's work reviewed by an expert as part of the litigation process, the expert identified several unamendable errors the CPA made in previously filed tax returns which resulted in tax overpayments of more than $400,000.
CLAIM SCENARIO CASE #3:
Area of Practice: Trustee Services
Alleged Error: Breach of fiduciary duty
Outcome: Approximately $1 million spent in indemnity & expenses
The CPA was the Trustee of a celebrity’s Trust and delivered services to one of the beneficiaries (“First Beneficiary”). When the celebrity died, the CPA authorized the First Beneficiary to take an expensive family heirloom, which the CPA believed the First Beneficiary was entitled to receive under provisions of the Trust. A Second Beneficiary of the Trust learned that the First Beneficiary had the heirloom and sued the First Beneficiary to recover it, believing it was an asset of the Trust and improperly given to the First Beneficiary. The First Beneficiary ultimately won the suit, but incurred millions of dollars in litigation fees in the process. Thereafter, the First Beneficiary filed suit against the CPA alleging the CPA should have invoked a clause in the Trust which would have placed the Second Beneficiary’s entire interest in Trust assets in jeopardy by contesting any of the distributions of Trust property; and the CPA’s failure to do so was a breach of his fiduciary duty.
While the CPA argued he was under no obligation to invoke the no-contest clause, complicating the defense was the First Beneficiary and the CPA’s long-time professional relationship. The First Beneficiary alleged that this relationship created a fiduciary duty of the CPA to the First Beneficiary about all matters in which the CPA was involved that could financially affect the First Beneficiary.
Putting Risk Management Strategies into Practice
While serving the rich and famous presents some unique challenges, adopting appropriate risk management practices may help mitigate the related professional liability risks. Consider the following.
Considering Client Acceptance and Continuance
The sophistication of clients and their related knowledge of financial affairs can vary widely. Clients may have inherited wealth, be successful entrepreneurs, or be entertainers or athletes earning large sums over a short career. Understand a client’s service needs and expectations, level of financial sophistication, as well as their desire and availability to manage their financial affairs and their experience with prior service providers.
Upon identifying prospective clients, screen them and determine their service needs. For example, do they require investment, tax, and estate planning advice? If personal concierge services are desired, what will be the scope of services? Do they have other professional advisers? Are complex estate and trust matters involved? Determine whether the firm has professionals on staff that are qualified to meet their service needs and identify whether third-party service providers will be needed to provide additional expertise or assistance. If so, make sure you screen and supervise those third-party service providers. Also consider requiring approval by a second partner or oversight committee before accepting or continuing client relationships.
Addressing Conflicts of Interest
Conflicts of interest may develop when CPAs serve multiple family members and their trusts. Investment, tax, and estate planning advice rendered to one family member may conflict with the interests of other family members. Thus, it may become necessary to refrain from rendering services to some family members and to advise them to engage their own advisers or to request a conflict waiver. Continuously monitor the situation as services expand and renew, and relationships change. Even the appearance of a conflict of interest can complicate the defense of a claim.
Refining Engagement Letters
An annual, signed engagement letter that clearly defines the scope and limitations of the CPA firm’s services and outlines the firm and client’s responsibilities is a critical tool in the defense of professional liability claims.
- Obtain a signed annual engagement letter defining the scope of all service needs and revise when there is a change in circumstances.
- Consider using an appendix to the traditional engagement letter terms and provisions that lists, in table format, the services to be provided and the respective service description, frequency, client responsibilities, and service deliverables.
- When practicable, have the client designate an individual with sufficient time and expertise to oversee all services the CPA firm provides, communicate the day-to-day tasks to be performed, evaluate the adequacy and results of the services rendered, and accept responsibility for all decisions made.
- Include risk allocation provisions in the engagement letter such as limitation of liability and damages and indemnification of the CPA firm to help limit the firm’s exposure should a dispute arise.
Family office clients may own and operate multiple businesses for which tax, accounting, and related services may be required. Issue separate engagement letters for each engagement performed for a particular business. Meet in person with the client at least annually to discuss their service needs, answer any questions, and review the engagement letter(s). Document the meeting in correspondence to the client.
Executing the Engagement
Restrict engagement activities to those defined in the engagement letter. If the client requests additional services or scope changes, execute written change orders, issue engagement letter amendments, or send email correspondence confirming the same.
Document oral advice in the workpapers and in a written communication to the client, noting the client’s responsibility for acting on recommendations made. Include the meeting date and the names of participants in your documentation.
Avoiding the Assumption of Management Duties
Clients may travel extensively or otherwise be unavailable to make day-to-day business decisions, and they may expect the CPA to act on their behalf in their absence. The client may wish to delegate decision-making authority to the CPA under certain circumstances. If such responsibilities are contemplated, discuss it with the client and consult with competent legal counsel about documenting the agreement to make management decisions on the client’s behalf, including legal provisions to protect your interests. Professional liability insurance policies may limit or exclude coverage when a CPA performs management duties for clients. Review the details of your policy with your attorney and insurance agent or broker.
Supervising the Relationship
Often, family office services are managed or delivered by senior members at a CPA firm. Firm management should institute appropriate controls to monitor the relationship with the client and the performance of services. Family office services tend to increase a client’s reliance on the practitioner and raise the risk of compromising the objectivity of those closest to the client. The requirement to adequately plan and supervise the performance of professional services extends to all firm personnel — even senior partners.
“The exposures of affluent, or high-net-worth clients in California can be highly complex,” according to Rudy Rudolf, AICPA Risk Advisor at Aon. “Employing practical risk management practices can help you to be more proactive and take preventive steps to mitigate risk. It’s important that CPAs stay informed of the unique risks and understand there are a range of specialized insurance products available to address them such as cyber liability, employee theft, employment practices, and more may be endorsed to create the appropriate coverage.”