by: Robert J. Derocher

It is a somewhat simple scheme, Craig Greene says: A tax accountant for a Chicago company sets up a fictitious tax that the company needs to pay each week. The accountant sets up a separate payment for the special tax. It just so happens that he is the only one with access to it.

Simple? Yes. But eight years and $4.2 million later, the company is looking for the responsible parties. And it’s not just the embezzling tax accountant.

"The first question from the company’s attorney was, ‘Where was the auditor?’" explains Greene, a partner at the Chicago CPA consulting firm of McGovern & Greene and a CFE who helped track down the fraud. "The auditor didn’t even bother to fill out the auditing checklist required by his firm for assessing fraud in the client’s statements.

"Let’s face it," he adds. "It’s a good time to sue accountants."

With the accounting and financial services industry still suffering from the hangover of Enron, WorldCom, Andersen and Tyco, among others, industry observers are noticing a slight increase in claims activity directed at accounting firms. While larger firms are bearing the brunt of the action, smaller and medium-sized firms are reporting a steady to somewhat higher amount of claims.

But people in the insurance and finance industry say it’s not really the specter of past accounting debacles that’s haunting CPAs and finance professionals. A sour economy has left more people looking for somebody to blame when things go bad.

That doesn’t mean that the taint of Enron, et al, has gone away. For many finance professionals, the scandals have meant sharper questions and more calls for accountability, not only from clients, but from attorneys and judges involved in litigation, as well.

With their integrity questioned and their insurance premiums on the rise, many small and medium-sized accounting firms in Illinois are moving to tighten their practices and bolster their reputations. It’s a wise move, industry watchers say, in a more hostile environment.

More claims, higher premiums "Accountants have really just started to see increases in liability insurance premiums, and they’re likely to continue going up a little longer," says Michelle Duffett, co-founder of Insight Insurance Services, a professional liability underwriting firm in Geneva, Ill.

The increases are representative of a general increase in liability coverage for virtually all professionals, not just accountants, says Duffett, a 25-year veteran of underwriting such coverage. Some insurance carriers have left that market altogether, while others are becoming more cautious in policy writing.

Aon Insurance Services, which writes policies for more than 24,000 accounting firms nationwide and more than 1,000 in Illinois, is witnessing a leveling off in rates—particularly among clients with less than
$10 million in billings. What company President Ken Mackunis is seeing, though, is "a slight up tick in claims" in Illinois.

A likely reason for the increase is pure economics. "When the economy goes bad, claims tend to increase," Duffett explains. "People are less tolerant about losing their money."

Let’s look at the accountants Peter Sullivan, a partner in the Chicago law office of Hinshaw & Culbertson, concentrates on defending accountants and other professionals in malpractice claims. He, too, is seeing an increase in claims, and agrees that when times are bad, people who are losing money look within for people to take the fall. "They say, ‘Here’s a loss. Who do we look at? Let’s look at the accountants and the lawyers.’"

While Sullivan believes the fallout from past accounting debacles is fading, it doesn’t mean the shadows aren’t lingering. "There are a lot of my accountant clients who feel that’s the only reason they’re being sued," he says.

According to Duffett, there also is growing anecdotal evidence that CPAs and finance professionals don’t carry the same clout in court that they once did, whether they are directly involved in a malpractice case or involved in some other litigation where their services are being called into question.

"It’s more of a ‘guilty until proven otherwise’ kind of approach," she says. "CPAs are having to prove more and more that they weren’t part of the financial wrongdoing. It’s an extra burden."

Reports from Insight Insurance Services’ claims representatives indicate that judges are becoming more skeptical of accountants’ testimonies and statements, Duffett explains, while the Internal Revenue Service appears to be getting tougher with accountants in outstanding cases.

In some instances, plaintiffs’ attorneys are banking on a lingering poor public image of accountants and finance professionals to bolster their cases, says Mackunis. "We do see now that plaintiffs’ attorneys are bringing up the image issue. They say, ‘You don’t want to go to a jury trial, where the jury may feel that the CPA is responsible for detecting fraud in whatever type of engagement.’"

McGovern & Greene frequently represents plaintiffs, and Jim McGovern, Greene’s partner, says the questioning of CPAs in court cases is only going to get tougher. "Just because the guy is a CPA doesn’t mean he’s not going to be looked at. There’s going to be a greater scrutiny of the CPA."

Accountants also are becoming more attuned to the industry’s image problems in claims cases, Mackunis adds. "When a firm does have a claim, we see that the firm wants to get it resolved as fast as it can. There’s this apprehension about being pulled out into the press."

Taxes, taxes, taxes While high-profile accounting liability cases have looked at issues such as phony billing, hidden accounts and elaborate fraud schemes, the world of liability claims for small and medium-sized accounting firms is much less glamorous. About half of the total claims nationwide, and in Illinois, arise in the area of tax work, says Mackunis, although the greater dollar-amount claims (about half) arise out of audit claims.

The most vulnerable work for accountants is in the area of auditing for publicly traded companies, and this is an area many smaller accountants are staying away from because of the liability concerns, says Sullivan. Still, he explains, the litigation environment for CPAs and financial professionals in Illinois is relatively stable, with most cases occurring in Chicago, Cook County, the collar counties and in Madison County.

"Illinois has some reasonably favorable laws for accountants," says Sullivan, noting the two-year limit on bringing a suit after a claim, and a five-year statute of limitations from the engagement date. But he adds that some recent court decisions in the state might widen the scope of accountant liability in third-party cases. And although it’s a rarity, he says, accountants can be sued for punitive damages in Illinois. He wants to see accountants exempted from that statute, much like doctors and lawyers.

Investments is another area of growing concern. "As the market has turned, clients have come back to their financial advisors and said, ‘You should have known better than to let me purchase such-and-such investments,’" says Duffett. "We’ve taken a tougher stance on insuring investment sales by accountants."

Fighting back Despite the increasing hurdles they face, small and medium-sized accounting firms are fighting back to help reclaim not just their own reputation, but that of an entire industry.

According to Greene, an increasing number of professionals from smaller firms are attending the fraud prevention training courses he offers. And, Aon’s Risk Management Hotline for its accounting customers saw a 40-percent increase in call volume in the first half of 2003 compared to the same period in 2002, according to Mackunis. "We’re getting more inquiries about contractual issues, engagement issues, disengagement issues, conflict of interest issues and merger issues," he says.

While the litigation and insurance environment for small and medium-sized firms might be a bit more uncomfortable than it was before Enron, Andersen and a tepid economy, many firms appear to be prepared to weather the problems.

"In a strange way," says Greene, "you might see all of this helping CPAs."

 

Seven Steps to the Litigation-free Zone

While CPAs and finance professionals can’t control the malpractice insurance market, there is still plenty they can do to limit their liability and risk, and to protect their practices. Some cautious steps might even help to keep higher premiums at bay.

Here are some pointers from the pros:

Prepare—and use—a solid engagement letter

"It’s the ‘Rules of War’ drawn up during peacetime," says Aon’s Dave Sukert. A good engagement letter clearly defines the scope of the work, as well as the responsibilities of both accountant and client. Letters should be used for each engagement, and should be updated at least annually for longstanding assignments—sooner if there is a change or addition to the services provided. Engagement letters also play a role in insurance acceptance and rating guidelines, says Insight Insurance Services’ Michelle Duffett, although many insurers won’t say so directly.

Exercise care in client selection

"There are bad clients out there. There are clients who are difficult to work with. There are overbearing clients. There are unreasonable clients," Duffett warns. "A lot of times, it comes down to trusting your gut instincts." Research needs to be done into not only your direct clients, but also others who work with your client, and who might lead to your involvement in third-party litigation, says Aon’s Mackunis.

Stick to your areas of expertise

"You shouldn’t be doing work that’s outside your area of capability," says Peter Sullivan, a partner in the Chicago law office of Hinshaw & Culbertson. Firms not only should have the right people, but also the right number of people to do the job properly, Duffett cautions. Firms should perform a self-evaluation before an engagement and avoid overselling to get a job. "Flowery marketing phrases like ‘the best’ or ‘exceeding your expectations’ will come back to haunt you when presented to a judge or jury as a rebuttal to your position that your services met industry standards," Duffett explains.

Avoid fee disputes with clients

"If you sue your client for fees, you’re going to get hit with a malpractice suit in return," Duffett warns. "As much as it hurts, swallow it." "Letting a fee dispute elevate to a court battle will only draw time and resources away from the firm and give an insurer an opening to raise premiums or cancel a policy based on claims history," Sullivan adds.

Stay technically up to date

"These days, CPAs have to be much more cognizant of the standards and know what they’re doing," says Craig Greene of McGovern & Greene. Continuing education, especially when concerned with knowing the latest accounting rules or finding out the best ways to spot fraud, is important.

Avoid real or perceived conflicts of interest

Conflicts, whether actual or not, can be difficult to defend in court, according to Duffett. "Third parties have a tendency to either disown knowledge of the conflict or claim that they were unduly persuaded by the accountant’s involvement," she says.

Keep good internal records

Producing clear, dated documents that offer evidence of services provided and conversations with clients can help head off disputes with clients. If the dispute goes to court, those documents can help bolster the accountant’s reliability and credibility.