The accidental investment adviser

As a client’s trusted business adviser, a CPA is often asked to “look over” an investment a client is considering. In other cases, CPAs sometimes obtain a client’s monthly investment account statements in connection with tax and/or bookkeeping services. But based on the experience of the AICPA Professional Liability Insurance Program, such scenarios can lead to professional liability claims alleging the CPA provided erroneous investment advice. This column provides examples of common claim scenarios—including problems involving engagement expectation gaps—as well as risk management tips that may help prevent professional liability claims.

“Please Review This Investment”

A client asked his CPA for his opinion regarding an investment the client was considering. The CPA did not have experience with this type of investment and knew the client was working with a financial adviser. The CPA advised the client to consult with his own financial adviser, but he did not document the conversation in either email or follow-up correspondence.

The client made the investment, and the CPA prepared the client’s tax returns. While preparing the tax returns, the CPA contacted the client with questions regarding the investment but again did not put anything in writing.

A subsequent IRS audit determined that the investment was an impermissible tax shelter and assessed the client substantial penalties and interest. The client sued the CPA, seeking recovery of lost investment returns, penalties, interest, and attorneys’ fees. The client alleged the CPA provided negligent investment and tax advice and made errors in preparing the tax returns. The claim investigation revealed that there was no written communication with the client regarding conversations that took place before the investment. There also was no documentation of the investment-related questions the CPA posed to the client in connection with preparing the tax returns. As is often the case, several factors contributed to this dispute, but the lack of documentation, such as an engagement letter, to support the CPA’s version of the events made the claim difficult to defend. As a result, the claim was settled.

Other common claim scenarios involve long-term clients asking their CPAs to evaluate a potential investment in a closely held business or real estate venture. In one example, the CPA presumed the client was seeking advice regarding the tax consequences associated with the structure of the investment and provided related advice. However, the advice was not documented, nor was an engagement letter defining the scope of services issued. Later, the client lost his entire investment. He sued the CPA, alleging the CPA failed to warn him of the risks associated with the investment. Due to the lack of documentation or an engagement letter defining the scope of services, the claim was settled.

Receiving Brokerage Statements

A CPA provided tax compliance and planning services to the widow of a long-term client. The husband was a sophisticated investor, but his wife was not and had been instructed by her late husband to “trust the CPA.” The CPA recommended an investment broker—recommending just one is a common mistake made by many CPAs—and the widow transferred all of her investments to the broker. Periodically, the CPA, the client, and the broker met to discuss the widow’s investment portfolio. The CPA also received monthly brokerage statements.

Over the next several years, there were few distributions to the widow, and the assets declined significantly in value. The widow sued both the broker and the CPA, alleging that the broker “churned” her account to generate commissions and claiming the CPA was negligent in providing investment advice, recommending the broker, and failing to supervise the broker’s activity.

The investigation revealed that the broker did, in fact, “churn” the account. Engagement letters issued by the CPA did not address the scope of advisory services, but rather indicated that tax compliance and limited planning services would be provided. The broker did not have errors and omissions insurance and had limited assets. As a result, the widow vigorously pursued her claim against the CPA. The lawsuit was settled for a portion of her claimed losses.

Risk Control

As these cases demonstrate, many practitioners, especially those who provide “only” tax services, fail to recognize the risks associated with providing advice related to client investments. Below are items a CPA may wish to consider in order to avoid a misunderstanding regarding the scope of services to be provided:

Engagement letters. Engagement letters issued for tax compliance services should indicate that tax planning services are not within the scope of the engagement and are available as an additional service. Engagement letters for tax planning services should define the scope of services, including advice regarding the tax consequences associated with investments considered by the client. If the CPA receives monthly brokerage statements or has online access to review a client’s investment account activity, the engagement letter may include language limiting responsibility to preparation of tax returns. Other provisions can be considered (e.g., advice on listed transactions, reliance on other advisers, etc.) depending on the circumstances of the engagement.

Declining to provide investment advisory services. Without additional training, CPAs are typically not qualified to provide specific investment advice regarding the suitability of specific investments for clients. Additionally, investment advisers are subject to state and federal regulations. CPAs with appropriate qualifications should consult the resources available to members of the AICPA Personal Financial Planning Section, including the new Statement on Standards in Personal Financial Planning Services issued in January (see “Official Releases,” page 78, and “Checklist: The New PFP Standards,” page 18).

Brokerage statements. CPAs do not customarily receive original investment account statements or have access to online information regarding client investments. To the extent it may be necessary to obtain these statements to provide requested services, consider obtaining duplicate account statements or securing “read only” access to online account information.

Discussions with client brokers and investment advisers. When required, CPAs may seek to limit such discussions to obtaining only information necessary to provide tax advice to the client.

Referrals. When providing clients with a professional adviser referral, a CPA should provide at least three options, advise the client to conduct due diligence on the advisers, and disclaim, in writing, any responsibility for selecting or supervising the adviser or monitoring investment results. Before providing referrals to investment advisers, the CPA should verify that the advisers are licensed and in good standing and advise the client to do likewise.

CPAs often are solicited for advice regarding potential investments. A CPA should refrain from providing specific investment advice unless he or she has been adequately trained and licensed to serve as an investment adviser. Establishing a clear understanding with the client regarding the scope of services to be provided and documenting related conversations, including further actions required by clients, may help eliminate misunderstandings and resulting professional liability claims related to investment advice.

Deborah K. Rood (deborah.rood@cna.com) is a risk control consulting director at CNA.

Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author’s 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.