October 2003

No Time to Be Working Without a Net

The CPA profession has been on everyone’s radar since late 2001 because accounting played a crucial role in the collapse of Enron and in serious problems at other corporations. Public awareness of CPAs has increased, and although its reputation suffered as the scandals kept coming, the profession’s bruises do not seem to be permanent: In the latest Gallup poll on honesty and ethical standards, CPAs still rate higher than lawyers and business executives.

More important than shifts in public perception is the passage last year of the Sarbanes-Oxley Act and its establishment of the Public Company Accounting Oversight Board (PCAOB). The PCAOB is now actively functioning, beginning its work of overseeing audits of public companies in order to protect the investing public. The NYSSCPA, anticipating that the PCAOB may refer ethics cases to New York State and wanting the Society to be able to work effectively in those cases, amended its bylaws so that within the bounds of due process it can share information on members’ ethical violations with federal and state agencies. The search for misdeeds goes beyond fraud: For example, we’re seeing regulators attacking corporate and individual tax-avoidance schemes.

The regulatory focus on accountability will also undoubtedly lead to litigation and increased professional liability. For example, the PCAOB’s standards apply only to public companies, and its auditing standards will not necessarily apply to audits of nonpublic companies. The AICPA’s auditing standards remain in force for audits of privately held businesses. Two sets of conflicting standards could not only cause confusion in the professional and business communities (think about the problem of a private company considering a public offering), two sets of standards increases the possibility that an active plaintiff’s bar will become more aggressive in suing CPAs over auditing issues, especially if the two standards diverge significantly on required audit work. How could an auditor respond to a plaintiff attorney’s questions if the application of PCAOB standards would have discovered a fraud that the CPA missed because AICPA standards did not require the same type of audit evidence? Judges and juries might not care whether PCAOB standards legally apply; moreover, they might not accord self-regulatory standards the same respect as those coming from a body authorized by statute.

Don’t Underestimate Exposure

Camico, a specialist in CPA liability insurance and other risk-management services whose sponsors include the NYSSCPA, tells us that a major premise of CPA liability is that the public holds accountants to standards higher than those set forth by the profession itself. Indeed, the public views such standards as a minimum that should be met, not a maximum. Camico’s statistics indicate that this is especially true in review and compilation engagements. These statistics predate the passage of the Sarbanes-Oxley Act and the PCAOB’s standards, but they illustrate that merely abiding by the profession’s self-prescribed standards is not always sufficient to protect a CPA from liability. With two sets of standards, will the public—as represented by a trial jury—expect the CPA to follow the standard that is applicable, or the standard that is higher?

This question has significant implications for CPAs because some rudimentary research and considerable anecdotal evidence indicate that small CPA firms and sole practitioners are more likely than midsized and large firms to have no professional liability coverage. Anecdotally, perhaps as many as 50% of small firms don’t have liability insurance, under the mistaken belief that they won’t be sued because of close personal relationships with their clients, or because clients may assume sole practitioners or small firms don’t have deep pockets. This reliance on the laws of probabilities looks increasingly misplaced, and has always been bad business.

The medical and legal professions provide some interesting comparisons. In several states, doctors are required by law to carry malpractice insurance; one state (Oregon) mandates malpractice insurance coverage for attorneys practicing there. There are plenty of anecdotes about doctors choosing to abandon certain specialty areas because malpractice insurance is so expensive. CPAs are nowhere near that point—yet. But with the hardening of the insurance market following the events of September 11, stock market losses, and corporate scandals, one must be aware of the potential impact on all areas of the insurance marketplace, including CPA liability coverage.

The bottom line is that every CPA practice needs a defined risk-management program, including professional liability insurance. Better to be well insured now, before a claim, because you may not be able to get insurance when you need it the most, after a claim. I urge you to evaluate your own business and ask, “Is my risk management program adequate—if not comprehensive? Is my insurance coverage sufficient?” In an environment of increased professional scrutiny, this is no time for a CPA practice of any size to be working without a net.

Louis Grumet
Publisher, The CPA Journal
Executive Director, NYSSCPA

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