People are generally optimistic, and no one wants to think about a good situation falling apart. CPAs like the idea of doing clients a favor, but it’s easy to underestimate the potential risk that some engagements may open a Pandora’s box of conflicts, disputes, lawsuits, and emotional stress, as well as lost time, income, and reputation. Predicting which engagements are likely to go wrong can be difficult, but insurance claims experience sheds some light on the subject. For example, emotionally charged scenarios often lead to conflict of interest allegations. Such scenarios include entity dissolutions, acquisitions, trusts, bankruptcies, mergers, and divorces. Representing an entity and all or some of its owners is another example.
Being prepared to prevent losses requires projecting a current situation into the future and assuming that something will go wrong. What is the most likely negative occurrence? What can be done to prevent that from happening? How can the firm position itself to minimize future losses? Should the firm consider disengaging? Many potential claims situations are so complex and critical that the best first step is to consult with legal counsel or a risk advisor for assistance.
The following case studies, drawn from the author’s experience with professional liability insurance claims, illustrate some of the complexities, dangers, and pitfalls. All of the names have been changed.
Ethical Dilemma 1: Divorcing Couple
John and Jane Doe are getting a divorce. John and his longtime CPA, Andre, are old friends; Andre has provided tax and accounting advice to him for over 15 years, and to the couple since they wed 10 years ago. As part of his high-touch client service philosophy, Andre has met quarterly with the couple to discuss their tax needs as individuals and owners of a successful real estate agency. John and Jane trust Andre implicitly and ask him to assist them in this troubling time. Given their long relationship, and impressed by their desire to settle the divorce amiably, Andre agrees. Not anticipating difficulties, Andre does not request that they sign a conflict of interest waiver.
Over the following months, however, negotiations between John and Jane steadily deteriorate, and they eventually communicate with each other only through their attorneys. Andre is in the process of finalizing the preparation of their joint federal and state personal income tax returns, when John sends him an e-mail stating that his attorney has advised him to file separately on his return instead of jointly, as he and Jane had agreed. John also says, “Jane will need to figure out her own tax situation with her attorney. You are my advocate, not hers.” Andre is not sure what John means nor, more importantly, how it may impact the services he has agreed to provide both John and Jane.
What should Andre do?
Ultimately, Andre may need to disengage from one or both parties, but if he doesn’t consult his risk advisor or legal counsel first, he may inadvertently create even more risk. For example, Jane may allege that he favored John in the tax filing, arguing that he abandoned her a few days before the deadline and took an adverse filing status position to her detriment. In addition, if he disengages before completing work for John or Jane, and a successor CPA is unable to finish the returns by the deadline, the delay could lead to penalties or missed opportunities. In a divorce situation (or business partners in litigation with each other), CPAs must treat each spouse equally, regardless of any prior relationships, who has more marital assets, or who is paying the fees.
CPAs should keep their professional relationships separate from their personal relationships during the normal course of business.
Another option is to send both spouses a conflict-of-interest consent and require them to sign it before deciding what to do next; however, this is unlikely once the spouses’ relationship has deteriorated. John has already staked his claim to Andre’s advocacy.
Andre’s risk advisor or legal counsel can assist him in determining the extent of his potential conflict of interest through use of the “reasonable person” test. They will also help evaluate alternatives in light of his professional obligations to each spouse. No one solution fits all divorce scenarios.
Although there is no prohibition against representing both spouses in a divorce, it is rarely advisable. Any CPA entering such an arrangement should inform both spouses in writing of the potential ramifications and the potential for a conflict of interest; each party should acknowledge and consent to the joint representation and waive the potential conflict of interest beforeproceeding.
CPAs should keep their professional relationships separate from their personal relationships during the normal course of business. An allegation of breached client confidentiality through the sharing of private information with a third party (e.g., a spouse or other confidant) can only make matters worse.
Ethical Dilemma 2: Business Partners
Barbara provides tax services for a general partnership client with two partners. One partner has a 70% share of the partnership, and the other has the remaining 30% share. The majority partner also engages Barbara separately to provide individual tax preparation services. Barbara has worked for the partnership and its majority partner for the past three years.
One day the majority partner requests Barbara’s confidential advice and guidance regarding how to finance some large debts he has accumulated. Without hesitation, she provides him with some preliminary advice. However, the partner later leaves her a voice message suggesting that she come up with some “creative financing” regarding the partnership to help deal with this debt. He also reminds her not to share any of his problems with the minority partner.
CPAs should not provide preferential treatment to any partner in a general partnership.
The request troubles Barbara and puts her in an awkward position: maintaining confidentiality of the information could jeopardize her obligation to the minority partner.
What should Barbara do?
Disengagement at this point does not eliminate potential liability exposure from the minority partner. What if the majority partner has been taking money from the partnership to help cover his debt? The minority partner could allege that Barbara and the majority partner conspired against him and that, had he known about his partner’s debt problems, he would have acted to address the potential risks of embezzlement. He would have grounds for suing Barbara for a conflict of interest.
Disclosing this information to the minority partner without informing the majority partner would only further complicate the situation. Professional standards are merely the minimum level of what is expected; juries often expect that CPAs “be the watchdog” and “do the right thing.” Barbara should focus on good risk management and have her risk advisor or legal counsel weigh in before taking a misstep.
CPAs should not provide preferential treatment to any partner in a general partnership. The percentages owned are irrelevant when it comes to professional and ethical responsibilities. If an advisor refrains from disclosing information to one partner because of the confidentiality considerations of another partner, she is already caught in the middle. In this situation, next steps might involve appropriate disclosure to both partners and, if appropriate, disengagement. CPAs should consult their risk advisor or legal counsel before taking actions that could exacerbate the situation.
Ethical Dilemma 3: Former Fraudster
One of Steve’s tax clients, a small dental practice, e-mailed him to introduce its new office manager, Josephine Smith. As Steve reads the e-mail, he realizes that he knows Josephine Smith. Several years back, Josephine was the office manager of a pediatric group for almost four years, using her position to embezzle nearly $60,000. She occasionally had one of the pediatricians sign blank checks, which she would then make payable to her creditors, including her credit card accounts, utility companies, and others that mirrored her employer’s. She would also sometimes forge a doctor’s signature. She then booked the expenditures under utilities and other miscellaneous expense categories.
At first, Josephine stole small amounts—$200 one month, then $400—but the amounts increased as she grew bolder. The pediatricians fired her upon discovering the embezzlement, but they never pursued legal action. Josephine was a single mother caring for a special needs child, and out of sympathy, the doctors agreed to accept small monthly payments in restitution and forgo legal proceedings.
Steve became the pediatricians’ accountant shortly after this incident. The doctors have occasionally mentioned the embezzlement in passing. Without asking, he is fairly certain that the pediatricians would not be willing to allow him to disclose this information to a third party.
Steve’s knowledge of Josephine’s previous embezzlement, and its implications for his dental practice client, concerns him. The dentist had worked with the former office manager, Kathy, for over 20 years, trusted her implicitly, and had her handle most of the practice’s financial affairs, including preparing checks for signatures, making entries on day sheets, and taking deposits to the bank. If the dentist expects Josephine to fill that same role, he may be assuming risks greater than he realizes.
What should Steve do?
Steve could rationalize doing nothing, because he was not the pediatricians’ accountant when the embezzlement occurred. He therefore has no first-hand knowledge, nor was he privy to the settlement agreement between the pediatric group and Josephine. As such, he has no obligation to share this information with the dental practice.
While this course of action might seem appealing, particularly in light of client confidentiality standards, doing nothing would expose the dental practice to an unexpectedly higher risk of potential embezzlement. Jury studies show that most jurors—members of the public—expect CPAs to advise and warn clients about their exposures to fraud. Steve would clearly be perceived as falling below the standard of care expected by most jurors, regardless of whether he followed professional standards.
Disengaging at this stage does not eliminate the potential allegation that Steve failed to advise and warn the client of this fraud exposure. Hoping that Josephine has cleaned up her act is just wishful thinking. Confronting Josephine is not the best solution from a risk management perspective either. Steve has had no prior connection with her. If he confronts her, he runs the risk that she will file a claim against him for harassment, libel, or wrongful termination.
Instead, Steve should work with his risk advisor or legal counsel to determine an appropriate strategy to advise and warn the dental practice in a way that does not jeopardize his current relationship with the pediatrician group or the confidentiality of any information received from them. Claims experience indicates that CPAs should “stay on the side of the angels.” This situation is not easy to navigate and requires some delicate balancing between 1) sharing enough information with the dental practice to prevent any potential embezzlement and 2) not sharing so much information with them that he potentially breaches client confidentiality with the pediatric group.
CPAs are subject to several professional liabilities that impact the way they and their services are perceived by clients and others. It is important to remember that CPAs are not judged by professional standards in court: they are judged by jurors, who, for the most part, understand little about the profession. CPAs may also be judged by other professionals, such as judges or arbitrators, who can be hampered by the same lack of experience. Even when a CPA does everything by the book, an unfavorable verdict can still put the firm in jeopardy. Public expectations of a CPA’s responsibilities have risen significantly over recent years, putting even the best and most cautious CPAs at risk.
Skillful and professional disengagement—an important aspect of practice management—is often the best option to avoid liability.
Furthermore, friendly clients don’t always stay friendly. Everyone is happy as long as things are going well; the CPA is perceived as a competent advisor with the client’s best interests at heart. When a situation takes a downturn, even for reasons unrelated to the CPA’s work, the client’s perception of the CPA may change. Suddenly, the CPA no longer seems to have the client’s best interests at heart. With the benefit of hindsight and the rhetoric of a skilled attorney, CPAs may find themselves cast as a financial expert who sacrificed the best interests of their clients to benefit themselves. Remember that juries tend to sympathize with clients.
Skillful and professional disengagement—an important aspect of practice management—is often the best option to avoid liability. CPAs should terminate problematic relationships professionally and formally, in writing. At a minimum, the disengagement letter should always contain clear statements, a description of the completed and remaining work, and a list of any due dates or filings. A client need not feel antagonized in any way. When done effectively, disengagement can leave the client feeling that the CPA has acted in the best interests of both parties.
CPAs should call their risk advisor or legal counsel as soon as they become aware of situations such as those described above. Early intervention is critical for minimizing the potential risks to a firm and its clients.