Broadening the services broadens the risks.

By John A. Dodsworth

In Brief

Steps to Take

CPAs have broadened their services to high net worth clients to include financial, retirement, investment, and estate planning. These services bring both higher rewards and higher risks.

To minimize such risks, CPAs should assess the following four key client characteristics before accepting such an engagement.

* The personality of the client.

* The client's financial IQ.

* The client's involvement in the planning process.

* The client's age.

A CPA should also evaluate other professionals working with the same client. This involves both their competency as well as the potential for fraud.

Other measures include good documentation, performance of due diligence on both clients and other professionals, and adequate insurance.

One of the largest and fastest growing areas of opportunity within the CPA profession today is working with high-net-worth clients (HNWC), either individuals or companies. The role a CPA now plays in a wealthy client's affairs has become far more dynamic and complex than ever before. It has broadened to encompass all facets of a client's assets--financial, retirement, investment, and estate tax planning-services previously undertaken only by a few specialists.

The CPA's focus has widened to embrace a larger market in need of expert assistance in overall asset management. Demographics indicate the United States is at the forefront of the most extensive wealth accumulation and transfer in the history of the world. This is happening as the Eisenhower generation transfers wealth to the baby boomer generation, and aging baby boomers establish financial plans to deal with their retirement and subsequent transfer of assets to the next generation. The recent significant increase in mutual fund investments is just one indicator of this $10 trillion phenomenon. As a result of this wealth accumulation, CPAs used to seeing the majority of their clients once a year can expect to encounter more opportunities for further involvement in their clients' affairs. Those who currently do only tax work may be called upon to handle estate planning engagements, and those who don't consider themselves financial planners will likely find themselves with clients looking for advice on financial matters. Due to public perceptions and commonly held expectations of CPAs, those who do not wish to take on work beyond tax preparation for an HNWC need to clearly communicate just that in an engagement letter. For the CPA who provides no advice to an HNWC risks being accused of having given bad advice.

Big Revenues, Big Claims

With greater risk comes greater revenues, and the financial rewards of being more intricately involved in a client's financial and tax planning strategies have propelled many a CPA beyond just the preparation of a client's tax returns. While providing services for the HNWC is an excellent source of practice development, CPAs must be aware of the risks they take on when entering the arena of personal asset management.

Work for HNWC seems to lend itself to a sliding scale of risk, and, often, the lines separating the various services are blurred. At one end of the scale, there is the process of sitting down with the client to discuss income and objectives for saving for retirement or increasing wealth. Further down the continuum, there is the dispensing of investment advice and often the execution of financial investment transactions, both higher risk investment management functions. Next lies the service of advising clients on what kinds and how much insurance to purchase for asset protection. Lastly, as CPAs are usually involved in the tax aspects of a financial plan, their services often cross over into, or integrate with, some degree of tax planning, including estate tax planning and trustee work, which can be highly volatile.

Since 1995 about 1 claim in 12 against accountants has contained an asset management or estate planning element. The average size of such claims exceeds $150,000. There has been a slow but steady growth in these claim areas over the past 10 years. The most common malpractice allegations involve late filings of Form 706, faulty IRC section 2056 marital deduction clauses, valuation issues (e.g., is the valuation "supportable?"), and generation skipping transfer tax issues.

Financial planning claims are often characterized by large investment losses coupled with allegations of negligent advice and conflicts of interest as a result of co-investing or "self-dealing."

Analyzing Potential Risk

Work for HNWC can be classified into two broad types of activities. The first is the planning function itself--work a CPA does with a client to sketch out the broad parameters of a plan. Such work may involve an analysis of income streams, spending patterns, asset allocation models, retirement targets, client risk tolerances, and all of the other issues that need to be resolved to establish a rational investment plan, including an analysis of the appropriate estate planning options.

The second set of activities comprises the implementation of the plan and is where the greatest risk to the CPA lies. This implementation function can include investment advice (often specific investment advice), investment management, investment monitoring, execution of the tax strategies employed, trustee work, and advice with respect to purchase of various types of insurance to protect a client's assets.

For some small and medium sized firms, the severity of claims in this area has now surpassed that of audit claims. Mistakes made on an audit of a successful business are often undetected, or of a nature that does not concern the client. With HNWC work, however, the CPA can expect any error made to be detected by the client or other stakeholders--who will not only care very much, but also expect the CPA to pay.

Accountants enjoy a very favorable reputation in the business community. The rating of accountants is only slightly less than the rating of doctors, and is significantly higher than lawyers and stockbrokers, two groups that also engage in advising HNWCs. The implications of this finding appear to predict success for accountants in this relatively new practice area. The flip side of this is that juries can also be counted on to hold high expectations for CPAs and their power over the outcome of a client's finances. In cases that end up going to court, a jury's perception of the CPA as trusted professional advisor will often lead to decisions awarded in favor of the client, despite other pertinent facts.

Great Expectations

The following characteristics are factors that most often determine a CPA's exposure to liability for personal asset management work:

* The personality of the client

* The client's financial IQ

* The client's involvement in the planning process

* The client's age

Personality. An initial step toward analyzing the risk of any HNWC engagement is to take an objective look at the client's personality and individual approach to planning. Questions to ask include, "Is the client too demanding? Is this person reasonable, or inflexible? Does he or she seem to understand that life holds no guarantees--or look for someone to blame?" CPA malpractice cases frequently involve individuals who display these characteristics and place unrealistic expectations on both the CPA and actual investments.

Financial IQ. There is a close correlation between a client's unrealistic expectations and his or her financial IQ. The less a person understands about basic concepts of the financial market--like the differences between stocks and bonds, risk vs. reward, and market volatility--the more dangerous a client he or she is. Clients who have no basic knowledge of these concepts tend to be much less tolerant of returns that don't meet their expectations. It is much easier to defend a CPA in front of a jury when the client is perceived as knowledgeable. A client who has very little knowledge of financial matters may more readily take a CPA's advice. However, that same lack of financial knowledge will tend to increase the jury's expectation with respect to the CPA's expertise and investment outcomes.

In addition to taking time to sit down with potential clients to determine whether or not they fit the low-risk, reasonable-client profile, CPAs should go so far as to conduct background checks on new clients.

Involvement of the Client. A significant number of claims involving asset management arise from clients who don't want to take the time to participate in the investment, insurance, or tax planning that must be done to increase their wealth. Clients who want a CPA to just "take care of" their financial affairs, without "bothering" them with "details" pose a higher risk than clients who seek a team approach, want to make decisions, and want to hear the details of their financial plans. It's not unusual for the person who doesn't want to be involved to suddenly have a change of heart once things go wrong. This may be in spite of significant attempts on behalf of the CPA to ensure the client was involved in the process and had "given his or her consent" to transactions. Documentation is one the best defenses in this situation. Some CPAs turn away clients who refuse to be involved in their own financial plans.

The Client's Age. The older a client is, the greater the jury's expectation with respect to the planner's performance. The age issue can cross-correlate with some of the issues mentioned above to produce an even more volatile situation.

CPAs providing financial planning services must be aware of this risk factor, for responsibility to the older person is significantly higher than it is to someone who is younger and actively in business. Clearly, an 80-year-old shouldn't be put into a high-risk investment that requires 10 years to work out. But another consideration the CPA should keep in mind is that the older person is protected by laws designed to prevent the elderly from being financially abused by opportunists and crooks. These laws can also be used to punish financial advisors in hindsight, and are supported by strong public perceptions to which the CPA should be sensitive. In one case, an insured was sued by his 70-year-old, high-earnings actress client when she suffered a loss on one out of five real estate investments he advised her to make. While her overall investment return was satisfactory by reasonable standards, she sought better, and held the CPA responsible for the one investment's nonperformance. Pleading ignorance of the risks inherent in her investment choices, she claimed to be totally reliant on her CPA's judgment and expertise. And while it could probably be argued that this client's expectations were unrealistic, her age would have most likely elicited sympathy from a jury had the case gone to trial.

Involvement of Other Professionals

The involvement of other professionals in an HNWC engagement can be like a double-edged sword. When the other professionals involved are competent, everyone benefits; when the other professionals turn out to be incompetent, though, the CPA will surely suffer.

A distinction must be made about other professionals. Other professionals fall into the category of potential team members, and the risk associated with their involvement is usually associated with their level of competency. There is another group, however, that is made up of individuals who sell or promote financial products to the CPA's client. The risk in dealing with these "promoters" often takes the form of fraud, and CPAs should beware. A significant number of claims in this area are the result of the CPA either investing the client's money with a third party promoter, or referring the client to a promoter who turns out to be a white-collar criminal.

The CPA who doesn't conduct proper due diligence in the form of contact reference checks, background checks, and "gut" checks, can fall prey to the fraud scams, incompetence, or mistakes of others working with the same client. An example of one such case involved some unsuspecting CPAs who unwittingly introduced a number of wealthy individuals to a promoter who proceeded to perpetrate a major fraud involving life insurance and VEBAs. While the promoter was eventually jailed, the millions of dollars he swindled from his victims remain in foreign bank accounts, and a number of liability insurance companies were left to pay damages in the lawsuits filed against the CPAs involved.

A number of claims stem from errors made by attorneys in the course of setting up an estate plan, by insurance brokers in the placement of insurance, and by investment managers. In some cases, these errors are a matter of someone having exercised professional judgment that resulted in an unfavorable outcome. In others, the other professional involved made an outright error in execution of the transaction, did not have insurance, or did not have adequate insurance, and the CPA was named as a defendant simply as a way to bring additional compensation to the client. Still, in other cases, the CPA had referred the other professional and the client held the CPA responsible for failure to exercise due diligence on his or her behalf.

Even in the best arrangements, such as when a CPA refers a client to a known investment professional without receiving any compensation, things can still go awry. One case involved an executive who was the client of both a CPA and an insurance broker. While the CPA did not make, or assist in the making of, insurance arrangements for the client, he did have an exclusive arrangement with the broker to manage all insurance proceedings for the client. When the executive's home was destroyed by a fire, the insurance coverage he had in place fell short of being able to pay for the replacement of his home and its surrounding exotic landscaping, as well as his home contents that included a fine art collection. He sued the insurance broker and CPA, alleging that his possessions were inadequately insured, and that he should have been alerted to other insurance coverage available for his residence. While the CPA adamantly denied having ever made any kind of insurance arrangements for the client, the client's perception was that the CPA was in charge of his financial well-being. CPAs acting as investment or business managers are very often held responsible for financial losses suffered by their clients, regardless of their actual degree of responsibility.

Loss Prevention Protective Measures

CPA firms can implement a number of loss prevention procedures to mitigate the risks of working with HNWCs. Following are some loss prevention techniques that can form a solid foundation for any CPA.

Documentation. Good documentation with respect to HNWC transactions or engagements is critical, and it can overcome many of the risks inherent in dealing with a client who has some of those undesirable characteristics. CPAs should have in place a signed, updated engagement letter that explicitly defines the duties and services of each client engagement.

A good engagement letter will clearly lay out the nature of the work, indicate the limitations of financial planning work, what is expected from the client, and what work is to be performed by any other professionals involved. Engagement letters should always include a statement clarifying that the client understands that he or she assumes risk in any investment and understands that the CPA is not responsible for the outcome of investments.

In addition to the engagement letter, CPAs should thoroughly document the planning process and the advice given to the client, particularly any investment advice. This becomes even more important when other professionals are involved, or when some of the other significant risk factors are present, such as the client having a low financial IQ. CPAs should use letters and other forms of documentation to keep the client informed periodically of what is transpiring with respect to the financial plan. When doing estate planning work, the CPA should try to include beneficiaries in the communication process.

Due Diligence. A large part of effective loss prevention involves taking the time to conduct due diligence, by obtaining sufficient background information on clients and other professionals to ensure as best as possible that they are reputable. This should also be done with respect to any investments made on behalf of a client, or with respect to any investment the client brings to the plan. Credit reports should be run on insurance brokers, lawyers, real estate agents, stockbrokers, or other investment managers. All new investments should be approached with a great deal of skepticism, and any situation that looks "too good to be true" should be avoided.

Many accounting firms have developed client acceptance checklists for accounting and auditing engagements. A similar kind of checklist can be prepared for the HNWC. Factors such as age and financial IQ are relatively easy to determine during a face-to-face, preliminary meeting. Other factors, particularly the personality profile of the potential client, can be very difficult to determine in one or two meetings. The best initial way to get this type of information is to check with the client's prior accountant. The prior accountant can give indications as to how involved the client was with their financial affairs, the level of their financial IQ, expectations and ability to communicate, as well as how promptly he or she pays their bills.

CPAs should pay particular attention to promoters that clients bring to the process in any HNWC engagement. Part of the problem with white-collar criminals is that they do not appear to be dishonest. It is for this reason that background and reference checks should always be performed with special attention paid to the individual's integrity and competency.

Finally, CPAs should insist that any professionals involved in the financial planning functions for a client have errors and omissions (E&O) coverage. This coverage will not only help to insulate the CPA from claims directly related to his or her work, but will also help insure the client can be adequately compensated if a mistake is made by one of the professionals.

Claims Protection Through Insurance

Insurance coverage becomes important for the CPA who provides services to the HNWC. Policy language varies from carrier to carrier and from state to state, depending on the laws of each jurisdiction, but the insurance issues to be concerned with are the areas of financial planning, investment advice, and trustee work.

Most carriers include personal financial planning in their definitions of "professional accounting services"; however, many surcharge or exclude coverage for certain, critical aspects of financial planning work (e.g., advice on investments such as limited partnerships, securities, and syndications). CPA firms should be aware of and read the specific insurance policy exclusion language pertaining to financial planning coverage and be especially alert to red-flag exclusion wording such as "performance or nonperformance of investments," "specific financial advice," "investment management," and "sale of products." Since financial planning claims generally arise from the investment performance of the transaction, this type of exclusion serves not only to deny indemnity in the event a claim is brought but may also serve to deny the defense of the claim, since it does not require there be any advice involved with respect to the investment. This may allow the carrier to issue a denial even when the plaintiff has wrongly accused the CPA of rendering the advice. Any policies containing exclusions related to the performance of investments should give serious pause to financial planners.

While general advice is often covered by an accountants' E&O carrier, more specific financial advice is often not covered. CPAs should call their insurance carrier's underwriting team to obtain information and discuss details regarding policy coverage pertaining to its specific financial planning engagements. In addition, a CPA may need to purchase additional coverage for securities and insurance-related services. When dealing with a high-value trust, he or she should consider higher limits.

With respect to commissions, the majority of professional liability policies do not provide coverage if there has been a commission involved in a financial planning transaction. Some policies have language that specifically addresses the "promotion, solicitation, or sale of securities by the insured." For other carriers, the previously mentioned performance language will not cover claims for any investment, whether or not a commission has been involved. As a consequence, either by specific exclusion or a derivative, transactions for which a commission was derived are generally not covered.

Any questions with respect to these coverage issues should prompt CPAs to ask for coverage clarification in writing to avoid future problems.

Rewards for the CPA

As with any area of practice for CPAs in today's environment, working with HNWCs involves some unique risk characteristics. Investment planning, advising, and monitoring is a major discipline that requires a significant amount of education; estate tax planning is one of the most complex and risky services provided by CPAs today. Fortunately, there are a number of educational and networking resources available to CPAs who wish to obtain further education and develop the expertise needed to become truly proficient in this area. The AICPA and state societies can assist by providing information on professional memberships and education opportunities. A great deal of material, including practice aids, handbooks, and forms, has been developed on the complicated array of HNWC services.

While CPAs who are new to dealing with HNWCs do expose themselves to greater risk than those who have experience as specialists, the value of these services, both to the client and to the CPA, are well worth the risks involved. By being aware of the dangers, and by implementing some relatively simple loss prevention concepts, CPAs should be able to reduce their risk to a manageable level and enjoy this lucrative and rewarding work. *