Imagine a hypothetical CPA, Franklin Connors, providing bookkeeping and tax services to an equally hypothetical fast-growing online retailer named Cats Eats, which sells gourmet pet food. One day the owner tells Franklin, “Business is booming! I want to hire a CFO, but I can’t afford one yet! Can you help out?”
Franklin might wonder if he is getting in over his head. If something goes wrong, could it get him in trouble? He wants to add “Chief Financial Officer (CFO) services” to his list of marketable skills, so he accepts the engagement. Over the next month, the owner increasingly relies on Franklin’s experience and knowledge of the company’s operations. To make him feel like part of the family, he has business cards printed up with Franklin’s name, the company’s logo, and the title “Chief Financial Officer.”
As time goes on, Franklin becomes more involved in Cats Eats’s activities. The demands on the owner’s time are great; he is training ten employees added over the past three months. The company has grown to more than 50 employees in less than a year, and the owner can no longer keep up with all of the day-to-day management activities, or the tax, accounting, and legal compliance requirements. One day the owner tells Franklin, “Put on your human resources hat. I want you to interview two job candidates for the new IT manager’s job, and give me your recommendation.”
Franklin has hired a number of employees over the years, and feels he can handle this assignment. The first candidate is a 62-year-old woman who has provided IT support for Cats Eats since it was founded; the owner tells Franklin she is undergoing kidney dialysis. The second candidate is a recent Stanford graduate who is relatively inexperienced but very knowledgeable, and willing to work for less than the older candidate. Following the interviews, Franklin tells the owner, “I would recommend the Stanford grad. He’ll give your company more mileage in the long run. You should interview them both. But I’m not an employment lawyer, and you should consult with one before making your decision.”
The owner has a brief telephone interview with the recent graduate, and hires him—without consulting his attorney. Several months later, the female IT consultant files a discrimination complaint against Cats Eats with the EEOC. The owner immediately calls Franklin. “The lawyers to defend this are going to be expensive. You told me to hire the student! I hope you’ve got good insurance.”
Franklin decides to terminate his engagement with the owner and writes off some unpaid fees. Not long after, he is served with a cross-complaint by Cats Eats for indemnity and contribution in an employment practices lawsuit filed by the female IT consultant.
Cats Eats had already incurred more than $50,000 in defense costs in the employment practices case. At this point, Franklin decides to call his insurance broker.
Franklin’s story ends with the words insurance professionals hate to utter and policyholders fear to hear: “You may have a coverage problem.”
CPAs and Management Responsibilities
Professional liability insurance policies generally exclude coverage for services rendered when the policyholder also performs management duties or assumes management responsibilities on behalf of the client. In addition, it does not matter whether a formal title like CFO is used to describe these activities. Once an allegation is made that a CPA performed management duties for a client, it raises a potential insurance coverage problem associated with the exclusions that exist in all professional liability policies. CPAs are consultants; once they start performing management duties, or the client thinks that they are doing so, they have crossed a line.
If Franklin had been hired as an individual by Cats Eats to serve as CFO, he would have been afforded coverage under the company’s directors and officers’ liability insurance policy, presuming it maintained this coverage. But in this case, the owner of Cats Eats did not want to incur the cost of having a CFO on staff or purchasing this insurance coverage. It was cheaper and easier to hire Franklin’s CPA firm to render the services he wanted.
The irony of the situation is that Franklin is accused of having made bad management decisions, but does not receive the benefit of insurance coverage under the client’s directors and officers’ policy. In addition, he has jeopardized insurance coverage under his CPA firm’s professional liability policy. He could end up footing the bill to hire his own attorney to assist in disputing a coverage position taken by his professional liability insurer.
An Old Issue, an Emerging Risk
This issue has been around for decades. Today, many companies are run online, and with the technology available, they can achieve accelerated business growth in months rather than years. Many of these owners lack the skills to manage rapid business growth, so they turn to their CPA.
CPAs do not have to decline this type of work. It is possible for a CPA to render the services needed by the client, but practitioners should seek guidance in addressing liability exposure and framing their role before agreeing to perform such services. A client may not fully understand what services are needed; it may be that consulting and controller services will suffice to manage day-to-day accounting and tax functions, rather than a full CFO. When CPAs frame the engagement as consulting, accounting, and tax services, they minimize the risk that the client will expect them to assume management duties or perform management functions. Once the client considers the CPA to be a decision maker, the liability exposure changes.
If a client actually needs a temporary CFO, CPAs should consult with both their lawyer and their insurance broker about the potential legal and insurance coverage issues before deciding how to proceed. Depending on the circumstances, it may be appropriate to have a lawyer draft an independent contractor agreement that limits the CPA’s legal liability. While this will result in reporting self-employment income when filing tax returns, it may be a more effective way to avoid liability under the circumstances while serving the client.
Risk Management Guidelines
Be specific when marketing services.
The work needed by these types of clients usually consists of traditional tax, accounting, and consulting services. Promoting managerial or CFO services in advertising materials creates an expectation that CPAs can serve in a senior management role for clients. A more effective means of communicating about these services is to promote them as “outsourced tax, accounting, and consulting services.”
Do not make management decisions.
Stay in the consulting role. Provide written recommendations to the client, requiring the client to make all management decisions and to provide instructions in writing. E-mails can be written quickly and serve as important evidence in the event of a misunderstanding or dispute later. Franklin did all his communicating by phone. If there had been an e-mail chain confirming the conversation he had with the business owner, the lawsuit by the client likely never would have been filed; even if it had, the written communications would have served as critical evidence both in defending Franklin and in avoiding a coverage dispute.
Do not sign contracts for the client.
Binding agreements and contracts should be left to the business owner. Only parties vested with the necessary written legal authority should enter into agreements on behalf of a business.
Clarify the role in the engagement letter.
Engagement letters should clearly define the scope of services to be rendered. The professional standards that apply to the services to be performed should be specified. In most cases, these will be the Statements on Standards for Consulting Services (SSCS) and the Statements on Standards for Tax Services (SSTS). During the engagement, the client may also request that financial statements be prepared or compiled for their use; these services are subject to the Statements on Standards for Accounting and Review Services (SSARS). When new services are added, an updated engagement letter should describe them and list the applicable standards. The client should sign the letter before these services are rendered.
Depending on the circumstances, it may be appropriate to have a lawyer draft an independent contractor agreement that limits the CPA’s legal liability.
Stay within the scope of services.
Once the scope of services has been defined, CPAs should not stray into performing services not covered by the professional standards listed in the engagement letter. Review the content of SSCS, SSTS, and SSARS. Performing management duties or making management decisions for a client are not within the scope of these standards.
Document all communications.
Document all conversations and recommendations in an email to the client. Be concise when explaining recommendations and providing information needed to make business decisions. Specify the client’s responsibility for making final decisions based on the recommendations provided.
Act Now to Prevent Trouble Later
It’s not unusual for a small business owner to attempt to deflect business decisions that are difficult or involve areas where they lack experience. Many CPAs may think, “My client is a friend. He would never sue me.” Even if a CPA-client relationship has been close for many years, that can change if the client ends up in dire financial straits and is looking for someone to blame.
Working with the simple precautions listed above in mind will allow CPAs to better protect themselves, their firms, and their stress levels.