Apples + Oranges = Risks in nontraditional acquisitions

By Deborah K. Rood, CPA

CPA firms looking for growth often seek it from the acquisition of other firms or practices or by recruiting individual "rainmakers." However, more recent acquisitions are trending toward firms providing alternative services delivered by non-CPAs, rather than traditional audit or tax. Any acquisition by a CPA firm involves professional liability risk, but there are special considerations to identify and address with nontraditional acquisitions. Navigating through the acquisition, onboarding, and integration of nontraditional professionals can be tricky.

Consider one firm that acquired an IT consulting practice to help implement machine-learning capabilities for its client accounting services (CAS) practice and delivery of IT consulting services to the firm's clients.

Unfortunately, the machine-learning process implemented by the IT practice regularly misclassified nondeductible expenses as deductible. This error was detected when the IRS audited one of the firm's CAS clients. The firm's investigation identified the root cause of the error and the impact to more than 100 CAS clients. The CPA firm eventually lost many of these clients and faced claims for penalties, interest, and costs to amend the clients' tax returns.

What went wrong? To start, the IT practice was not integrated with the CPA firm, and this resulted in a lack of communication between the IT, tax, and CAS practices. Consequently, the scope and objective of the machine-learning project was not clearly understood by all parties. Additionally, because the CAS and tax practice did not fully understand the complexity of the IT team's work, it did not fully review or test the accuracy of the output, instead assuming it was correct. In the end, the CPA firm learned an expensive lesson on how not to work with nontraditional professionals.

As client needs and demands have become increasingly complex, CPA firms have evolved to meet these needs and will continue to do so. Whether it's IT, data privacy, human resources, or something else, the trend to acquire expertise in nontraditional practice areas is not going away and neither is the related professional liability risk. Just like apples and oranges, while CPA and non-CPA professionals are similar, the differences present unique risks, warranting a different approach to risk management, as explained in the following tips.

DUE DILIGENCE

Skills and experience

Evaluate the competence, skills, and expertise in a nontraditional professional's area of practice and/or industry. Research the potential target, along with its owners and key professionals to assess their experience and expertise. Ensure relevant credentialing and licensing are current and all professionals are in good standing. Consider the CPA firm that hired a litigation support expert who had misrepresented his credentials during the hiring process. After this was discovered and made public, the firm faced claims from clients asserting that their cases were irreparably damaged by the "expert's" work. If the CPA firm had verified his credentials during due diligence, it would have known to stay away.

Quality control

Determine whether a nontraditional practice has effective quality-control (QC) processes and evaluate its tone toward QC. Consider the CPA firm that acquired a medical billing company. The company's software contained an erroneous billing validation code that, because the QC process was ineffective, was not identified. The CPA firm identified the error after the acquisition when several medical practice clients sued the CPA firm for improper patient billing. Review the target's professional liability claim history to identify trends or systemic issues.

INTEGRATION

Culture

Do not underestimate the importance of culture. Integrating different "personalities" and cultures can prove challenging. Although both CPA and consulting firms deliver professional services to clients for fees, their processes and philosophies may be very different.

For instance, "business casual" for a CPA in Chicago may not be the same as it is for an IT professional in San Francisco. While a different dress code is not a professional liability risk, it is an example of how consultants' mindset may differ from CPAs'.

Consider differences in compensation and organizational structure. CPA firms tend to be more pyramid-like versus flat. Compensation at consulting firms may be more heavily weighted toward new business development than at a CPA firm.

Change can be challenging, but if differences are timely identified and addressed proactively, the combination will have a greater likelihood of success. Having the leaders of a nontraditional practice communicate and support the changes is important. If cultural differences are insurmountable, pull the plug quickly. While painful, it can save months, or even years, of unwanted stress, wasted internal time, increased risk, and discord within the firm.

CPA firm requirements

Nontraditional firms and CPA firms may operate very differently. As a result, there will likely be new considerations and practices for the nontraditional professionals to adopt, such as:

  • Professional standards: As CPA firm employees, nontraditional professionals are typically subject to the same professional standards as CPAs, regardless of not being a licensed CPA. Do they understand their responsibility to abide by AICPA professional standards such as the Code of Professional Conduct? One possible way to address this concern that firms could consider would be to have HR obtain affirmation from all non-CPA professionals that they understand the Code.
  • Engagement letters: Nontraditional firms may not use engagement letters. Educate both their professionals and clients about the purpose and importance of engagement letters. Additionally, because many consulting projects are fluid and change during the engagement, train these professionals on the importance of avoiding scope creep, emphasizing the need to obtain a new engagement letter or change order for additional work.
  • Client acceptance: Evaluate the nontraditional firm's client list to ensure the clients are a good fit for the CPA firm. Stay alert for situations that may impair independence or create conflicts of interest. Prioritize clients with work-in-process and then look at large and/or riskier clients if time is a factor. Consider the CPA firm that acquired a business valuation firm and did not compare client lists. The CPA firm discovered, too late, that the acquired firm's services impaired the firm's independence for a large attest client. The firm faced a potential claim when the client had to engage another firm to reperform the attest service.
  • Fees, profitability, and billing: Are the nontraditional practice's billing, collection, and profitability management processes similar to or different from the CPA firm's? How will the nontraditional professionals, and their clients, respond to changes? Contingency fees and commissions charged by the nontraditional practice may need to be revisited to ensure compliance with professional standards.

Oversight

Many professional liability claims arise when acquired firms or individuals are allowed to operate without oversight.

How do you oversee "experts" if the firm has no relevant technical expertise? Monitor the nontraditional professionals' compliance with the firm's QC procedures. Perform a "cold read" of deliverables. Ensure the professionals follow the applicable professional standards and regulatory requirements. If systemic issues are identified, consider incorporating these items with the training provided on the firm's policies and procedures.

ACT AS ONE FIRM

In sum, the acquired firm needs to become part of your firm. Include its staff members on engagement teams and firm initiatives. Provide them with "buddies," even at the principal level. Mix workstations so nontraditional professionals are sitting with CPAs. Invite them to social activities. Work to make sure everyone has a similar vision, strategy, and culture. Nontraditional acquisitions typically require more due diligence and integration efforts, but the result can be a delicious fruit salad, with just the right mix of apples and oranges.

Deborah K. Rood, CPA, is a risk control consulting director at CNA. For more information about this article, please contact specialtyriskcontrol@cna.com.


Continental Casualty Company, 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. All products and services may not be available in all states and may be subject to change without notice.

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