Managing liability risk after a merger or acquisition

A CPA firm owner may find himself or herself ready to retire and in need of a suitor to take over the client portfolio. A firm wishing to expand into a new geographic market or delve into a niche area of practice may seek to acquire another firm to help it get a head start. Regardless of the reason, CPA firm merger-and-acquisition activity is on the rise. A good amount of analysis and diligence is generally performed by both sides in arriving at the decision to enter into a transaction. With the amount of effort that is often expended before the closing date, one might think a sigh of relief is warranted when the deal is finally closed.

Think again. The real work begins the day after closing with the start of the integration process. Not only is effort required to reap the financial benefits of a transaction, but effort is also required to manage the professional liability risks of the new firm, which, depending on the size of the transaction, may have grown exponentially overnight. Just as a client that has significantly changed its size or operating model is considered to be a higher-risk client, the same is true for a CPA firm that has completed a merger or acquisition. Failure to integrate the operations, culture, and quality control into a single cohesive unit after a merger or acquisition can pose increased professional liability risk.

Heeding the following three lessons will help CPA firms manage professional liability risks stemming from integration issues. These lessons can be applied to any size or type of transaction—from an acquisition of another firm’s client portfolio or niche practice to a merger of equal-size firms.

Lesson 1: Carefully Select Continuing Clients and Engagements

When a CPA firm completes a merger or an acquisition, hundreds or even thousands of new clients and engagements are accepted instantaneously. While some evaluation of the acquired firm’s client portfolio was likely performed during the due-diligence process, the analysis may not have been deep enough. After the transaction, the acquired portfolio of clients should be further screened through the filter of the acquiring firm’s acceptance process. As part of this analysis, ask questions such as:

• How does this new client compare to the firm’s “ideal” client profile? Would the firm have accepted the client absent the transaction?
• Are the services provided to the new client consistent with the combined firm’s business strategy and risk appetite?
• Do any potential or actual conflicts of interest or threats to independence exist?
• If the new client presents risks to the firm, can the firm adequately manage these risks?
• Does the firm have the knowledge and experience to serve the new client competently?

If the answer to any of these questions is “no,” the firm should decline to provide services to the client and send a termination letter memorializing this decision and directing the client to find another CPA firm. While this decision may result in hurt feelings or even anger at the loss of a client, client relationships are owned by the firm, not a single partner. While maintaining client relationships is important, managing the firm’s professional liability risk is paramount.

If the firm is not in a position to review acquired clients individually, consider starting with higher-risk clients, such as clients with collection issues or going concern issues, or high-net-worth individuals or families, and perform a detailed client continuance review.

Lesson 2: Oversee All Personnel, Regardless of Level

Failure to exercise appropriate oversight, supervision, and control of the work and personnel after the consummation of a merger or acquisition can result in significant liability exposure.

CPA firms that have acquired a firm in a new geographic location may question how they can properly oversee the activities of the new location without stepping on toes. If the purpose of the acquisition was to enable the firm to enter into a new area of practice or specialized service, the acquiring firm may wonder how it can provide appropriate oversight in an area where it is not a “technical expert.” While the firm may not have the same level of technical proficiency as the firm or practice it acquired, the acquiring firm’s quality-control procedures and processes should be followed in the delivery of those specialized services.

Adherence to professional standards, regulatory requirements, and firm policies and procedures is the responsibility of all members and employees of a firm and should be appropriately monitored. Training or Q&A sessions for new personnel can help them understand the acquiring firm’s processes and expectations. Work performed by personnel of the acquired firm should be reviewed by the acquiring firm for adherence to quality-control procedures. For new locations, consider placing a firm leader in the new location to provide on-site guidance and oversight.

Lesson 3: Think and Act Like ONE Firm

Firms that choose to undertake a merger or acquisition often look to acquire firms with a similar vision, strategy, and culture. While it is difficult to quantify these intangible considerations, a failure to integrate firm culture is generally the primary reason firms do not realize the financial benefits and synergies of a merger or acquisition.

If each firm continues to operate separately, it may lead to poor employee engagement and confusion regarding which standards or protocols to follow. Merged firms may not think of themselves as one firm, operate as one firm, or run their businesses in the same manner. Failure to integrate can result in internal issues, and unnecessary distractions may increase the likelihood of an error in the delivery of client services.

The “one firm” mindset starts with the leaders of each firm. Championing and providing resources to support integration efforts, welcoming new personnel, and setting the example for all members of the firm to follow are of the utmost importance in establishing an appropriate tone at the top. If a smaller firm has been acquired, the owners of that firm must recognize that they need to adopt and conform to the practices and controls of the larger, continuing firm. Failing to do so puts the total firm at risk. By the same token, management of the acquiring firm should swiftly integrate the personnel and work of the acquired firm into its operations, activities, and practices. The earlier the combined firm is operating as one entity, the easier it will be to manage potential risks and focus on executing its post-merger strategy.

Example

To illustrate how an acquisition can go awry, consider the following scenario:

A CPA firm acquired the lucrative practice of a sole practitioner who specialized in delivering family office services to high-profile clients and families. The practitioner was seen as an expert in her field. After the transaction date, the acquiring firm allowed the practitioner to continue to work from her home office and met with her quarterly to discuss revenue targets and new business opportunities. What the acquiring firm did not know was that the practitioner was advising one of her clients on the most advantageous structure for a business combination, and another client of the firm was on the other side of the transaction. The firm did not realize that it was delivering services to two clients in direct conflict with each other until the seller brought a multimillion-dollar claim against the firm, alleging the firm had a conflict of interest and favored the other party in the delivery of services. If the acquiring firm had performed appropriate client screening procedures, the conflict of interest might have been identified and the claim avoided.

Sarah Beckett Ference (sarah.ference@cna.com) is a risk control director at CNA.

Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. For more information, call Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, 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. All products and services may not be available in all states and may be subject to change without notice.