Professional Referrals

Know the Liability Risks

By CNA Accountants Professional Liability Risk Control

Clients often ask CPAs for referrals to other professional-service providers. However, such referrals carry professional-liability risk. CPAs may not recognize or address clients’ expectations that they have screened these professionals or will supervise their activities. And CPAs who participate in discussions between clients and third-party professionals may fail to define their role in the discussion, leading to miscommunication and “expectation gaps.”

This case illustrates the risks associated with mismanaging professional referrals.

A sole practitioner provided bookkeeping and tax-return preparation services for several years to a successful physician. The CPA noticed that the physician had been making large payments for life-insurance premiums and other investments. The physician asked the CPA to recommend a financial planner. The CPA recommended an acquaintance and suggested that he, the client and the financial planner meet to review the client’s insurance needs and estate plan. During the meeting, the financial planner introduced the client to an investment advisor who was promoting his investments through the financial planner’s business.

The client later made substantial investments in companies the investment advisor owned and operated. Subsequently, the CPA obtained the investment advisor’s personal financial statement and provided a copy to the client. The personal financial statement indicated a net worth of more than $20 million.

The investments later proved to be worthless because the underlying companies did not exist. The investment advisor was convicted of defrauding the client and several other investors.

The client was unable to recover her losses from the uninsured investment advisor, who later was found to be
unregistered with the state securities division. She filed a claim against the financial planner, whom the financial advisor also had duped, and received a partial recovery. Finally, the client sued the CPA, alleging that she relied on his representations about the investment advisor’s background, experience and financial stability.

The CPA denied making any representations about the investment advisor’s character. The CPA noted that the advisor’s personal financial statement included a warning indicating substantially all the disclosures required under GAAP had been omitted, and that the statement should not be used for any purpose requiring independently verified information.

The client asserted that she asked the CPA to screen the investment advisor before making the investments and disputed the timing of receiving the personal financial statement. The matter was settled before trial. Defense counsel determined it would be difficult to defend the claim because the CPA 1) recommended the financial planner to the client; 2) participated in investment discussions with the client, the financial planner and the investment advisor; and 3) requested a copy of the investment advisor’s personal financial statement and provided it to the client.

In this case, the CPA attempted to help a bookkeeping and tax-return preparation services client who needed personal financial services. The CPA failed to recognize the risks associated with professional referrals and assumed a fiduciary duty to the client.

How can CPAs in similar situations respond to a client’s request for referrals and manage the related risks?
           

  • When they identify the need for professional advice beyond their experience and capability, CPAs should recommend that clients engage other professional advisors with expertise in the requested area.
  • Before providing the names of other professionals to clients, perform some high-level diligence to investigate their background, training, experience, reputation, professional credentials and licensing. Provide referrals to individual service providers, rather than entities. Provide clients with several referrals from which to select, rather than recommending only one.
  • Follow up with a written communication to the client, alphabetically listing the recommended professional advisors. Inform the client that, although you’ve provided the names of several professionals, the client must evaluate, select and engage them and that you won’t supervise their activities.
  • Tell clients to seek independent professional financial planning, investment and tax advice before making investment decisions. If you provide tax advice related to prospective investments, document the scope of the service and additional fees in writing; delineate the limits of the advice; define the client’s responsibilities; and reference the application of the terms and conditions included in the previously issued engagement letter. If there is a significant change in the scope of client services, execute a separate engagement letter.
  • Section 473.3205, Florida Statutes (F.S.) and Rule 503 of the AICPA Code of Professional Conduct address CPAs’ commissions and referral fees. CPAs are prohibited from receiving a commission or fee for referring a product or service to a client for whom certain services, such as audits or reviews of financial statements, are performed.1 If such fees are permitted, CPAs are required to disclose them to the client. Section 473.3205, F.S. requires this disclosure to be written.

CPAs provide an important service to clients by helping identify other qualified professionals. Although CPAs should be responsive to client-service needs, they should avoid “engagement creep” by inadvertently providing services beyond the scope of the engagement letter and assuming an unintended fiduciary duty.

CPAs also should use caution before agreeing to participate in meetings between clients and other professionals. Clearly inform the client, orally and in writing, of the purpose of participation (to obtain information needed to provide the client with related tax advice, for example). Finally, consistently inform the client that you will not provide financial planning or investment advice, and remind the client of his or her responsibility to supervise other advisors. 

This article provides information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.
 
Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions and exclusions for an insured.
 
All CNA products and services may not be available in all states and may be subject to change without notice.

SIDEBAR:

Executive Summary

  • Providing clients with referrals to other professional advisors, such as investment advisors or attorneys, can present unintended risk.
  • Carefully managing interactions with a client’s other professional advisors is important, especially if the CPA participates in meetings with these advisors.
  • Managing client expectations regarding referrals to, and interactions with, other professional advisors. This helps minimize the “expectation gap” and professional-liability risk arising from services these advisors render to the CPAs’ clients.
  • Section 473.3205, Florida Statutes and Rule 503 of the AICPA Code of Professional Conduct requires CPAs who are paid (or expect to be paid per Rule 503) a permissible commission or referral fee to disclose this to the client.