by
Duncan B. Will, CPA/ABV/CFF, CFE
| Jan 26, 2023
Conflicts of interest have long been a major factor in professional
liability claims against CPAs. Part of the problem is that potential
conflicts of interest are hard to recognize or identify until
something goes wrong. When clients are satisfied, they tend
to perceive the CPA as a competent advisor who has their best
interests at heart. It's not until clients become disappointed
that their perception of the CPA begins to change. The CPA
appears to no longer be prioritizing the client's best interests.
Sometimes the CPA may even appear to have sacrificed the
client's best interests to benefit the CPA or another party to the
client's detriment.
One common claim scenario is that of the CPA advising both
parties to a transaction, or helping the parties resolve a dispute.
For example, the CPA will sometimes agree to represent both
the husband and the wife in a divorce when they are still friendly
and cooperative. Many times though, the relationship in a divorce
will deteriorate rapidly, and the CPA is then caught in the middle.
The same is true for dissolutions or disputes between business
partners. Disputes between partners or owners often result
in the CPA's advice becoming perceived by one of them as
favoring the other.
Participating in business deals or investments with clients is
another common scenario where everyone is happy while the
investment performs well. But as soon as it takes a downturn
or falls apart, the client's perception of the CPA erodes.
Case Study
Consider the following case study (the names have been
changed):
For decades, Paul Noble, the founder and managing partner
of his CPA firm, had served as a trusted financial advisor to his
clients. Like many CPAs, he also had his own personal financial
advisor—stockbroker Rich Arrington. Noble frequently shared
advice he received from Arrington with his firm's clients and
partners.
Chad Pennyworth, a junior broker at Arrington's brokerage
house, worked with some of Noble's clients and took on many
of Arrington's accounts when Arrington retired. Noble trusted
Arrington's judgment in Pennyworth's training and development.
Though Noble did not refer any of his clients or acquaintances to
Pennyworth, he did inform several of them that he had elected
to work with him. Because of Nobl's reputation, many of his
clients chose to engage Pennyworth as their own broker when
they learned of Noble's faith in Pennyworth.
Almost immediately after Arrington left, Pennyworth sold Noble
some bonds, based on incorrect information that misidentified
the bonds' guarantor as the state, when the bonds were instead
guaranteed by a financially challenged local school district.
Pennyworth acknowledged the mistake to Noble, and the
brokerage firm agreed to repurchase the bonds from Noble's
portfolio, subject to a nondisclosure agreement, which Noble
signed. Noble was pleased when a safer alternative was
substituted for the bond investment a couple weeks later.
Two years later though, Noble was troubled when he read of
the financial disaster that was all over the news: the local school
district's failure and worthlessness of the bonds the district had
guaranteed. Pension funds and investors, including some of
his clients, were hurt badly by the losses. Noble felt sorry for
the investors but was relieved he had avoided a similar fate.
His relief turned to dismay, as some of his clients called to discuss
the impact of the losses they sustained and their intentions to
sue Pennyworth and the brokerage house.
Noble's hands had been tied because of the nondisclosure
agreement. He had not warned his clients of the elevated risk
of the bond investment, and his clients were now surprised to
learn that he was not "in the soup" with them.
During the class action lawsuit against Pennyworth and the
brokerage house which followed, Noble's initial investment, the
reversal of that transaction, and the nondisclosure agreement
became public knowledge. Noble's reputation was ruined. He was
now seen as a greedy, self-interested collaborator. Ultimately,
Noble and his firm were added to the list of defendants in the
class action lawsuit. His former clients alleged that Noble and
his firm had a duty to disclose the concerns regarding their
investment, had ignored the apparent conflict of interest, and
had prioritized their own interests over those of their clients.
Loss Prevention Tips
Recognize and communicate potential conflicts of
interests. Project the scenario forward to anticipate what would
happen if things were to go wrong. Juries tend to sympathize
with clients — especially with the benefit of hindsight and the
evidence laid out by a skilled attorney.
Embrace "active ethics." The CPA should recognize that his or
her own personal interests can be adverse to client interests
and should not agree to sign nondisclosure agreements without
first protecting vulnerable clients. Moreover, disclosing a conflict
of interest, while helpful, does not resolve the problem, even if
clients acknowledge and sign the CPA's disclosure regarding
the potential conflict of interest. Clients could later argue that
their consent was not "informed" by a third party (such as an
attorney). Do not get too comfortable with disclosure as a form
of protection. In the end, the issue will be whether there is a
perception that the CPA's loyalty to his or her clients waned.
Recognize that there are risks associated with providing
referrals. Clients often link the CPA who gives a referral to the
professional who ultimately performs the services. In instances
where it may be perceived that a CPA is offering a referral,
the CPA should be careful to name three or more qualified
candidates to perform the service and encourage the client
to perform their own due diligence in assessing the suitability
of the professionals' qualifications.
Duncan Will leverages his more than 30 years of
experience in accounting, including public accounting,
forensic accounting, consulting, and audit and tax
compliance. He advises policyholders through the
CAMICO Loss Prevention hotline and writes articles on a
wide range of topics.
This article appears in the winter 2023 issue of the Washington CPA magazine. Read more here.