Insightful lessons can be learned by reviewing professional liability issues. With this in mind, Gallagher Affinity provides this column for your review. For more information about liability issues, contact Irene Walton at firstname.lastname@example.org.
In the legal arena, a practitioner’s duty is informed by professional standards and technical literature, but it is not defined by it. What defines a CPA’s duty in the legal system is a combination of civil law and conventional thought. That is, what a jury is told about the law by a judge, and then how the jurors fit the facts and the law into their own sense of how the world works. This makes for a somewhat unpredictable and evolving standard. It is unpredictable because it is based on a given judge and jury, and it is evolving because it is influenced by news coverage, particularly on financial scandal.
To best manage professional risk, a practitioner would do well to recognize the disconnect between the technical standards of the profession on the one hand and the standard to which you would be held in the court of public opinion on the other. In fact, it would be best to own it; to embrace it. See yourself and your work product the way it would be viewed by the proverbial “man on the street.” Do this, and you will greatly decrease the odds of a liability claim.
For context, consider where claims come from and how serious they tend to be. In risk-management-insurance-speak, the terminology is “frequency” and “severity.” By far, the most frequent claims arise from tax engagements, followed by audits (a distant second), then bookkeeping, trusts, litigation support, compilations and reviews, business consulting/investment advice, and personal financial planning. In terms of severity (i.e., dollars at risk), audit claims have earned this distinction, followed by tax claims, reviews and compilations and bookkeeping (roughly equivalent), and then all other categories.
Now, compare the two most frequent sources of claims, as they are seen by the public.
Audits, perhaps more than any other common engagement, capture the public’s eye. Audits have an air of detective work to them; they imply the possibility of management misstatement, or worse. An auditor’s perceived job is to protect the users of the financial statements, and by extension the business and investing communities as a whole. Auditors must be clever, steadfast, and, above all, thorough. Auditors are bloodhounds at the end of a police officer’s leash. In a courtroom, the jury gets to find out at the beginning where the body is buried, allowing them to judge an auditor in hindsight.
Tax compliance, by contrast, is seen as rote and arcane. Practitioners are expected to get everything right, every time, without exception.
The practitioner’s professional self-image is somewhat better aligned with that of the public’s when it comes to tax compliance rather than auditing. The pubic sees tax work more or less for what it is. Not so when it comes to an audit.
So, what can the auditor do to meet professional standards while also anticipating how a lay jury might view their work? Here are a few suggestions – think of them as preventive measures – that should be easy enough to follow.
Audit engagement letters are best when signed and returned before any substantial work begins. This demonstrates the importance of the engagement agreement terms, which include weighty responsibility on the part of management, and not just a promise by the auditor to provide the specified services for a price. Too often, the engagement letter is treated without due fanfare and winds up being signed and backdated. This is not a best practice.
Management representation letters deserve some stagecraft, too. I might suggest a transmittal letter/email in which a few basics are called out, such as how management’s duties are an integral part of the audit process. Encourage management to carefully consider each and every item covered, and to bring to your attention any questions or concerns. The management representation letter can be a powerful liability shield for the auditor, but that shield will be surrendered when letters are issued and signatures are attached at the last minute. Don’t squander this critical opportunity. If management can truthfully say, “The auditor just told me to sign the letter,” imagine what a jury will make of this.
Avoid the “same as last year” trap. It is a powerful argument in the hands of your former client’s counsel to undermine the value of your audit plan and risk assessment. Things change. Your clients have good years and bad years; bad years can lead to worse years; and that can lead to business failure. (Nearly 60 percent of all audit claims arise from business failure.) A failing business is a greater risk. Plan accordingly. An audit plan that demonstrably changes and evolves is the ideal. A static plan seems stale and thoughtless.
The permanent file should not be out of sight nor out of mind. The items within need a little sunlight now and then. Loans, leases, guarantees, operating agreements, and the like come and go; they are amended, modified, and revoked from time to time. Speaking of operating agreements, to the extent that they address authority to take actions (or not), juries expect auditors to be informed and to have an opinion.
When it comes to fraud detection, take little comfort from the notion that a generally accepted auditing standards audit is distinguishable from a fraud audit. In the minds of jurors, it isn’t – or barely is. Think: if fraud was happening in this organization, where would it likely take place? Then, take your due skepticism out for a walk, speaking with a varying cast of individuals each year.
Professional liability bears little resemblance to peer review. Keep in mind that your work product could ultimately be judged by a dozen individuals who have little understanding of what you do, but who will be applying common sense to what they may, or may not, understand.
Jonathan S. Ziss, JD, is a partner with Goldberg Segalla LLP in Philadelphia. He can be reached at email@example.com.
Related Professional Education
- Valuation & Forensic Accounting Conference
Nov. 13 | Malvern or Webcast