Maintain Excellence, Cut Risk

Firms that operate at the highest standards minimize liability problems. Here are some pointers.
BY PATRICK J. MCDONNELL

EXECUTIVE SUMMARY
THERE ARE TWO BASIC RISKS IN the CPA profession: catastrophic service failure, such as that from providing inaccurate audit-related services, and business failure caused by losing top-quality clients.

A FIRM THAT CONCENTRATES ON IMPROVING leadership, staff and the client base can enhance partner, staff and firm performance and reduce risk. Exposure to risk increases exponentially when leaders can’t accept bad news.

TO GET GOOD STAFF, partners need to offer excellent training and advancement opportunities, approach the best area schools and make friends with the accounting program faculty. Demonstrate the firm’s values so they will recommend their best students.

A PARTNER SHOULD PLAN an audit engagement with the client’s CEO and CFO, identifying that business’s risk areas. The plan should schedule interim reviews of the work as it progresses. Doing this can reduce risk and unnecessary audit hours.

AN AUDITOR WHO SPOTS a questionable accounting practice must not let the client coerce or intimidate him with a threat of losing the business; must inform the boss and explain the concerns; must keep blowing the whistle until the issue is objectively resolved.

A FIRM NEVER SHOULD ACCEPT a client that has fired or has been fired by its former firm over a professional dispute. Excellence is cost effective.

PATRICK J. McDONNELL, CPA, president and CEO of the McDonnell Company, served 28 years at Coopers & Lybrand (the last five as vice-president of business assurance/audit). He is the author of Everybody Wants to Go to Heaven, Six Steps to Organizational Excellence. His e-mail address is Pat@themcdonnellcompany.com .

espite a year of bad headlines, we all know that most CPAs are “good guys”—that is, intelligent men and women of character who respect their role as the cornerstone of the U.S. capital formation process. Nevertheless, recent company failures caused by a few bad apples have vividly demonstrated some of the profession’s weaknesses and brought a spotlight to bear on the quality of audit and attest services. The public has said it’s fed up with accounting lapses, and the marketplace is urging CPAs to do a better job. The remedy—the Sarbanes-Oxley Act’s internal control certification requirements—has expanded CPAs’ responsibilities. Here’s how your firm can undertake a cultural tune-up, improve partner and staff performance and reduce risk and the potential for related litigation costs.

MAKE A COMMITMENT
There are two basic risks for firms: catastrophic service failure, such as that incurred from providing inaccurate audit-related services, and business failure caused by losing top-quality clients. A firm that merely reviews completed audit engagements to check whether staff complied with procedures or makes sure partners and staff members have met continuing education quotas isn’t doing enough to mitigate its risk.

What will cut risk is to have every member of the firm commit to excellence in every aspect of the business, from checking financial statement footnotes to ensuring the audit committee understands them. Partners can inspire and better manage their practices by hiring the best people, training them well, applying high development and performance standards, firing poor clients and vetting new ones carefully.

As a case in point, I became vice-chairman of business assurance (audit) for Coopers & Lybrand in 1993 after the firm had incurred multi-million-dollar litigation settlements related to clients that had paid modest five-figure audit fees. My first step to upgrade the firm’s risk profile was to appoint a committee of experienced audit partners to analyze the general counsel findings related to our more notable audit failures. They reviewed the litigation records to extract a detailed picture of those flawed audits and better understand what had gone wrong. The study showed those failures had resulted from a combination of factors: poor leadership and supervision, judgment errors in dispute resolution and working with undesirable clients.

Just Do It
A firm committed to excellence has

Strong leadership that faces problems squarely.

Devotion to high professional standards.

Technical procedures that encompass quality control.

Staff with both expertise and experience.

A career path and training for young talent.

Partners and staff with the ability to communicate clearly.

Top technical partners who make good calls and binding decisions.

Zero tolerance for clients that suggest it look the other way.

To begin to correct the culture that had led to those problems, we turned to the CPA profession’s long-established value proposition: The best people with the best leadership skills attract the best clients, which, in turn, provide firms with the financial and intellectual strength to attract, train and retain the best staff. Our risk mitigation program focused on three components: leadership, staff and the client base. By concentrating on developing a climate of excellence, we improved partner and staff performance, the quality of our clients and substantially reduced risk and related litigation costs.

TAKE ME TO YOUR LEADER
To analyze the quality of your organization’s leadership, answer the following questions:

Is integrity its fundamental operating value?
Does it create trust?
Does it give staff the courage to question policies, procedures and decisions?
Does it encourage a comfortable exchange of ideas, suggestions and opinions?
How do firm leaders react to bad news?

If they squelch discomfiting information, your firm soon will be in trouble. Leaders who can’t accept bad news surround themselves with people who withhold it. When that happens, exposure to risk increases exponentially.

Partners have a right and a responsibility to speak up if the picture formed in response to the above questions is negative, but getting cultural reform under way isn’t easy. When I had to do it, my goal was to get partners to understand how committing to integrity and excellence—and paying for it—could be cost-effective. I often went to my partner’s office, closed the door, stated the problems and gave details: poor hires, mediocre training, inconsistent audit procedures, including those caused by firm mergers, and lax staff oversight. I cited the cost of the resulting litigation, then made a pitch for a stronger, more positive approach that focused on integrity and offered higher pay for better hires, coordinated training for all staff and included thorough supervision of the audit process.

If something is “broken” at your firm, make fixing it a team effort. Get partners and managers together to brainstorm. A retreat is a practical way to bring leaders together to analyze problems and develop ways to solve them. Use one to refresh your mission statement and organize a strategic plan to achieve the firm’s goal: sustainable excellence (see “ Strategic Planners Lead the Pack, JofA , Dec.01, page 26). To get the ball rolling to analyze our firm culture, one question I used was, “Would you want your children to work here?” At any firm, once partners in charge start thinking about it, you’re halfway there. When the firm has a plan, have another retreat for the rest of the staff.

PEOPLE ARE THE KEY TO QUALITY
If you want your firm to be known for its commitment to excellence, remember that nothing is more visible than your staff and your clients. Do the top graduates coming into the profession want to work at your firm? “Top” is expressed by more than a high grade point average; you want recruits with character, communication skills and leadership potential as well.

To get first-rate hires, find the best colleges in your area and make friends with the accounting program faculty. Call the dean of the accounting program. Do more than discuss campus-recruiting procedures; establish a social relationship. Meet informally with professors; play golf with them, for example. You want them to know who you are and the ideals your firm stands for.

Demonstrate the firm’s values so they will recommend their best. If they understand your firm represents integrity and solid opportunity, they’ll want to introduce their outstanding students to you. When the time comes to recruit on campus, your top partners should prepare an appointment list to meet with the best students. Quality attracts quality.

Four Questions for the Board of Directors
When interviewing a potential client, get answers to the following:

Is there anything we need to know with respect to the integrity of any member of your management, the owners or the board?

Is there anything about the operations, products or customer practices that would raise questions of compliance with law, ethics or standards of fairness?

Is there anything your references might tell us that would cause us to not accept this engagement?

Are there any specific risks in the business such as—but not limited to—internal control weaknesses, loss of major customers, notice of noncompliance with law or an expired patent on an important product?

In the ’90s, about 80 university programs in the country produced candidates that consistently met our firm’s requirements. We approached the nearest of those schools, became acquainted with senior faculty and talked to them about our firm’s dedication to integrity. We described the quality of our clients so they could advise their students about how the firm’s business engagements would challenge and teach recruits. We had prepared handsome, informative brochures that described our teaching procedures and our commitment to the best professional training. We brought sample materials and patiently answered questions about the process.

Examine every aspect of your firm’s training program. Does it operate at a high standard? For years, our firm had conducted classes in low-budget hotel meeting rooms, employing as an instructor any staff CPA who wasn’t working on an engagement. After we committed to a culture of excellence, our training began with a 10-day, 10-hour-a-day immersion. Relocating to professional facilities and enlisting only our most talented and articulate people to teach dramatically improved its effectiveness.

Once a firm hires good people, it has to nurture them. Small firms should decide what work product they want to develop, then build training around that. Make sure your program is the best you can make it. If you’re a small firm and renting a teaching facility at Aetna or IBM isn’t possible but you want access to more technology than is available in your office, try to arrange weekend immersions at a client’s corporate headquarters or at a college.

In addition, a smaller practice can woo the excellent student by letting him or her know the firm will

Put sufficient resources into helping the new hire pass the CPA exam.
Help the new hire develop highly transferable skills.

The best recruits are ambitious and want to develop skill and range. That’s the opportunity you must offer them. Giving them inferior training and a poor career path is a sure way to lose them. People want to be treated fairly, have a chance to grow and be well paid. Let them know they will be. Make sure your advancement policy is both fair and firmwide to keep the process from becoming political and driving out your “keepers.” To do this, you need to

Define the promotion criteria at your firm (such as length of service, passing the CPA exam and mastering certain skills).

Educate everyone about the firm’s standards.

Have a system of frequent progress evaluations.

PARTNERS MUST BE HANDS-ON
There is a correlation between a firm’s excellent overall performance and ongoing partner participation in client service. When our committee reviewed the firm’s audit failure litigation records from the 1980s, we saw partners had delegated much of the audit work to teams composed of junior firm members. Only when the work was well along did partners check it, calling for corrections after the balance sheet date. Supervision that came so late in the process wasn’t effective and was among the factors that led to audits that were insufficient to uncover fraud, thereby exposing the firm to lawsuits.

We decided to provide better supervision throughout the engagement. The process went something like this: To plan an audit due on December 31, the partner in charge met in August with the audit team and client CFO and CEO. Based on those discussions, he or she developed an audit plan that addressed the risk areas of the particular business. The plan included scheduled interim reviews of the work in process. At intervals, as work went along, the partner checked it against the plan and kept unpleasant surprises from developing. Yearend fieldwork could begin only after these interim reviews had been completed.

Some partners balked at first, thinking their workload would escalate. However, we were generally paid a flat fee for audits, and the new procedures cut 10% of the staff hours in the first year. In the 1993–1998 time period, no significant new litigation developed, and our revenues jumped to more than $1 billion from $700 million with a substantial improvement in margin. The moral: Build quality into your product from the beginning, rather than trying to add it on or “inspect it in” later.

SERVE ONLY TOP-NOTCH CLIENTS
Managing your client portfolio is a big part of risk mitigation. Examine each client for risk, profitability, intellectual capital, growth potential and reputation; then place them in one of four categories. The top group, usually no more than 20%, consists of the crown jewels. These are the ones that pay well and reflect virtually no risk. The next group (about 35%) consists of excellent clients that reflect minor but acceptable risk; an example might be a client with poor internal controls who’s willing to improve. The next group (about 30%) are the marginal clients with serious risk or economic flaws that must be addressed; for example, an industry in decline. In one case of managing a risk promptly, we learned a client company planned to hire a CFO who had committed a fraud and was an admitted felon. We explained the risk potential (including that of losing our services). After consulting counsel and his board, the client came to his senses, didn’t hire that CFO and we continued to do the work.

Your firm’s viability depends on devoting energy to your best clients, not your worst ones. If the risk can’t be mitigated, as in our example, the client belongs in the final category—the 15% pool of clients that should be culled immediately. If it’s any encouragement, bear in mind that these highest risk clients also are the most demanding and least willing to pay a fair fee—all while driving out your best people. In firing them, a firm substantially lessens risk while improving revenues and reducing stress to its staff. The way to do it is simply to say, “We’ve chosen not to work with you anymore.”

To upgrade your service to the clients you want to keep, however, try this: The next time you check over a proposal to a prospective client, ask yourself whether you’re providing your best established clients the services you’re promising the new one? If not, “repropose” to your good clients to offer them even better service—before a competitor does.

In a middle-market practice I once managed, we had promised clients we would deliver tax returns “timely.” Yet we delivered many returns for signing on September 15. In our reproposals, we committed to delivering them no later than June 30—and did it. We demonstrated commitment to quality, and meeting those earlier deadlines generated more work assignments. Your competitor has the same problems you do. Whoever solves them best wins risk-free revenue and marketplace distinction.

BE HARD TO GET
No client for any fee is worth any risk. Your firm’s bias should be toward not accepting a prospective client, so a sponsoring partner must demonstrate that the new client meets all requirements of excellence. Its business must be viable, have reasonable growth prospects and be in an industry you understand. Talk to the entity’s management and board. Get references and consult your business contacts to confirm their reputation, competence and integrity (see “ Four Questions for the Board of Directors ”). The prospective client must be willing to pay an appropriate fee for quality service.

One rule we established was that under no circumstances would we accept a client that had fired or had been fired by its former firm over a professional dispute. Every study indicates the risk of litigation increases dramatically in such circumstances. In one case a client who fired us over an accounting dispute subsequently filed for protection under Chapter 11 of the U.S. Bankruptcy Code. In doing so it cost the firm that took over from us millions of dollars in litigation and settlement costs.

The Firm You Save May Be Your Own
If you’ve spotted a questionable accounting practice

Do not allow yourself to be intimidated by a client demanding compliance.

Do not allow yourself to be coerced with a threat that you’ll lose the business.

Pick up the phone, call your boss and explain the situation and your concerns.

If you do not agree with the boss’s response, insist that the issue be taken to the supervisor, manager or partner at the next level.

Keep blowing the whistle until the issue is objectively resolved.

The primary source of catastrophic service failure is accepting a client’s questionable accounting methods. Make it a rule that when a professional dispute with a client arises, no partner or group of partners can put your firm, or the entity’s shareholders, at unacceptable risk. If necessary, an audit team must stand its ground and bump a dispute or suspicious practice up to the technical partner for resolution (see “ The Firm You Save May Be Your Own ”).

Most firms want to be the best and serve the best clients, so follow the tips in this article to help ensure that integrity permeates your business. Promote values, policies and procedures that attract and retain the best people. Develop client acceptance and dispute resolution processes that mitigate risk and contribute to the highest standards. Commitment to excellence may not protect your firm from every risk of catastrophic service failure, but without it, a firm is driving without a steering wheel—and a crash is inevitable.

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