Due Diligence for Accounting Firms
Due Diligence for Accounting Firms03.02.2017
Last month, President Trump signed executive orders to delay the implementation of the U.S. Department of Labor’s Fiduciary Rule and to roll back certain portions of the Dodd-Frank Act. This came up during a recent discussion I had with an accountant liability claim professional who was concerned that the public’s perception about less oversight in the industry will lead to an influx of claims, and wanted to talk with his insureds about such a possibility. It reminded me of the onslaught of claims against accountants during the economic crisis last decade for failing to provide the requisite due diligence in detecting fraud claims committed by others in the face of the lack of legislative or administrative oversight.
One such case involved comptroller Ellen Hauer who, in 2008, pled guilty in New York City for embezzling more than $1 million from her employer and related companies. She was sentenced to 3 to 10 years in prison and required to pay restitution without the assets to do so. As a result, Ms. Hauer’s employer and others commenced litigation against various accounting firms alleging they failed to discover the embezzlement during audits. In defending those claims, one of the threshold issues was identifying the scope of services performed by the accounting firms, and whether it could have been reasonably foreseeable to prevent the theft.
Typically, an accountant’s scope of services is reflected in an engagement letter. Too often than not, however, such letters are vague or void of needed detail, or are claimed to have been amended by a subsequent verbal agreement. Therefore, one of the risk management tools we discussed is the practice of periodic updated or revised engagement letters (at least annually if not semi-annually). I pointed out that there may be concern that a revised engagement letter could be viewed to undermine the trust between an accountant and his/her client. Under such a circumstance, I suggested that, at a minimum, an accountant should as an alternative document by email any change in the scope of work to be performed to eliminate any dispute that could arise later on.
We also discussed that, depending on the services performed by an accountant, the law will hold him or her to varying levels of scrutiny. An accountant retained to perform an audit is typically held to a higher standard of care than an accountant engaged to perform bookkeeping duties. (For example, an accountant preparing tax returns will likely be examined under the American Institute of Certified Public Accountants (“AICPA”) standard set forth in the Statement of Standards for Tax Services. In contrast, an accountant performing a compilation is usually evaluated under the AICPA standards contained in the Statements on Standards fir Accounting and Review Services.)
Despite these different levels of review, an accountant in an E&O case involving fraud or theft will also be judged on the actual work performed that could create liability that may not otherwise exist. For example, while an accountant performing bookkeeping duties may be held to a lesser standard of care, he or she may review checks or deposit slips that are the heart of many embezzlement cases. In other words, the documents reviewed and used by an accountant in his or her actual work may end up being the most critical pieces of evidence in defending a failure to defect fraud claim against an accountant. Therefore, in addition to the revised engagement letter mentioned above, I finally suggested that risk management or best practices should include maintaining copies in some fashion or a catalogue or an index of specific documents as part of the engagement.
The bottom line is that, absent specific oversight provisions to comply with, it is up to the accountant or financial professional to develop practice and procedures to protect himself or herself in the event an E&O claim is made.
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