When considering ways to minimize areas of risk in Personal Financial Planning (PFP) services, keep in mind that CPAs are subject to a number of professional liability concepts that will impact the way CPAs and their services are perceived by clients and others. This is true no matter what services the CPA provides. Examples of those concepts include:
- CPAs are not judged by professional standards in the liability world. The way they are judged depends upon the perceptions of jurors—average, hard-working individuals who, for the most part, understand little if anything about what CPAs do in their profession. CPAs may also be judged by other professionals, such as judges or arbitrators, who are hampered by the same ignorance or lack of experience.
- The length of the CPA’s relationship with the client, multiplied by the breadth of services, equals the amount of risk exposure to the CPA. This formula, also known as the “geometry of duty,” means that the CPA at a certain point becomes a trusted financial advisor with fiduciary responsibilities to monitor the client’s financial resources.
- Clients expect CPAs to advise them of opportunities and warn them of risks. If a claim involves any type of fraud, clients generally believe that the CPA should have known that it was occurring, and jurors generally believe that a CPA’s job is to catch fraud, or at least to warn the client of the risks.
Special services such as PFP and fiduciary services produce higher losses than standard services because of the high level of judgment and advice required in special services. If the client suffers a loss, the client is more likely to call into question the CPA’s judgment and advice than they would with standard services.
As a trusted financial advisor, the CPA’s risk comes primarily from the types of services performed as well as client characteristics and the involvement of other professionals. The two general types of financial planning services are the planning function and the implementation of the plan.
The planning function addresses the following questions:
1) What are the facts, circumstances and current situation concerning the client now?
2) What are the client’s objectives?
3) What is the plan you are to provide to the client? For example, a synopsis or summary of: a) their current situation, b) their objectives, and c) the plan to get from their current situation to their objectives, based on information the client has given the CPA.
Incidentally, never tell the client what his or her objectives should be, as this will raise your risk exposure. The client will say they relied on your knowledge and recommendations when something goes awry.
Complex engagements often require expertise from other professionals such as estate planning attorneys, insurance agents and investment advisors, thereby creating more risk exposure for the CPA. When financial planning leads to the need for estate planning, claims can arise when there is a communication gap between the client’s expectations and the services the CPA thought were being provided to the client.
The implementation function addresses the following areas:
1) Investment advice
2) Investment management
3) Investment monitoring
4) Tax aspects
The best risk management approach for a financial planner is to keep the planning function separate from the implementation function. Implementation should be considered separate from PFP services, so it’s important to avoid drifting into implementation when you document the financial plan to the client. A good loss prevention rule is “don’t do both,” as implementation brings with it a different set of risks.
For example, if the CPA chooses a compensation structure other than fee-only and accepts a percentage fee or a commission, the CPA’s interest will be considered adverse to the client’s in the event of a lawsuit. This type of fee structure is often chosen in the implementation stage.
Another risk comes from inadvertently becoming the client’s “quarterback.” In other words, if asset management has been turned over to other professionals but you continue to receive reports from them, the client may have the expectation that you are analyzing the reports—that you’re their quarterback and calling the shots.
Clarify in writing with the client that you will charge for reviewing reports for certain time periods, at least quarterly. If the client is unwilling to pay you for reviewing reports, you can lower your risk exposure by simply not receiving the reports.
If the client is willing to pay you for reviewing reports, and you are considered the quarterback, review the performance and fees of the professionals who are responsible for implementing the plan against benchmarks and goals. At least annually, reassess: 1) the fees charged for the services, and 2) the assets and whether they are underperforming or meeting the goals.
If you implement the client’s plan, regularly report back to the client, pegging the reports to their goals and benchmarks. Implementation is a full-time job: If your firm has limited resources (e.g., staffing capabilities, qualifications, experience) for this type of work, you might not have the appropriate oversight of the work and will have significant risk exposure as a result.
Determining your client’s characteristics is an integral part of the client screening process, whether you are preparing a financial plan or implementing it. You need to know whether this client is a good fit for your firm, including responsible staff.
The client’s financial IQ is crucial to acceptance. The less a client understands about basic concepts of the financial markets, the less responsibility the client will take for their decisions regarding recommendations.
A similar pattern is seen with clients who do not want to be involved in the details of the process or the decision making. They will blame the CPA for “steering” them in the wrong direction if a problem develops later on.
Even client personality is a factor. If the client is too litigious, demanding, unreasonable, unrealistic, inflexible, uninvolved, indecisive, or irresponsible, you may not want them as a client.
Age is also becoming more of an issue in our aging society. If there is a perception that the CPA did not appropriately advise or warn older clients, a jury will be more inclined to punish the CPA. This is especially true if the CPA had a long-term relationship with the client and provided extensive services (geometry of duty); even more so if third-party beneficiaries are involved. Hidden clients can also emerge in the form of dysfunctional children and other beneficiaries, including charitable organizations.
Involvement of Others
If you are going to be working with other professionals, due diligence is recommended in order to have sufficient information about the people involved and to help avoid fraud and incompetence. Documentation of the understanding with the client and the other professionals will help maintain clarity and avoid confusion. Also make sure that other professionals carry errors and omissions insurance to protect the client and you from losses and claims.
There are almost always large dollar amounts involved in PFP claims, and conflicts of interest will be perceived by jurors if the CPA is a co-investor or accepts a commission. Relationships between the CPA and others who are involved with the investments should be disclosed in writing. Better yet, maintain your independence: Avoid investing in deals with your client, be careful with commission-based fees, and beware of quid pro quo referrals.
Document and Communicate
Good documentation ultimately means that the CPA is more likely to win a case or a claim if one is made. When communications with the client and third parties are not documented, the CPA is more likely to lose a claim. Documentation is a vital function for PFP, because so much of what CPAs do is fact-dependent and calls for judgment based on those facts. Use engagement letters, document the planning process, document all advice to the client and important interactions, and keep the client informed throughout the process.
By staying informed and in control, you will help safeguard your firm from potential litigation and maintain good client relations. When problems begin to develop, contact your professional liability carrier or attorney.
Randy R. Werner, J.D., LL.M./Tax, CPA is a Loss Prevention Executive with CAMICO. She responds to CAMICO loss prevention hotline inquiries and speaks to CPA groups on various topics.
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