Malpractice claims in 2021 and future predictions

By Sarah Beckett Ference, CPA

The tumultuous and unpredictable environment of recent years has resulted in increased stress for CPA firms and their clients. While uncertainty has been the norm, one constant remains: When people lose money, they often look for someone to blame, and CPAs can get caught in the cross hairs.

This article examines the types of claims asserted against CPA firms in the AICPA Professional Liability Insurance Program in 2021 and predicts what future claims may arise.

CLAIMS BY AREA OF PRACTICE

The chart "2021 Claims by Area of Practice," below, reflects the volume of professional liability claims asserted against CPA firms in the AICPA Professional Liability Insurance Program in 2021, the majority of which stem from tax services. While tax claims are more frequent, they are typically not severe or costly in terms of defense costs and indemnity payments. Higher-severity tax claims include those involving aggressive tax strategies such as syndicated conservation easements, U.S. filing obligations related to foreign financial assets, estate and gift tax returns, and state and local nexus issues. Areas of practice and allegations that also typically result in high-severity claims include audit services, fiduciary services, and claims asserting the CPA firm failed to detect a theft or fraud, irrespective of the service rendered.

pro-li-1-claims-area-practice

TAX SERVICES

Current claim trends

The leading cause of loss for tax claims asserted in 2021 was a filing error (see the chart "Tax Services Claims Asserted in 2021 by Cause of Loss," below). In prior years, the leading cause of loss was the provision of incorrect advice or failure to advise. However, due to the multiple changes in 2019 and 2020 return filing deadlines, the increase in this claim assertion is not surprising.

pro-li-2-tax-services-claims-2021-cause-loss

Consider this claim asserted in 2021:

A CPA firm was engaged to prepare a client's individual income tax return and returns for its businesses. The partner indicated that all returns would be extended but got busy and failed to timely file the individual extension. The client was assessed a failure-to-pay penalty of $20,000, the IRS denied the penalty abatement request, and the client demanded payment of the penalty and interest.

Future considerations

The timing of claims related to tax services may lag longer than what is customarily anticipated. Why? The IRS continues to work through its massive correspondence backlog, including requests for penalty and interest abatement. Moreover, the flurry of changes to filing dates, legislation enacted immediately preceding and during tax season, and new services requested of tax advisers have increased the potential for error and, consequently, claims against CPA firms.

Additionally, the IRS has been aggressively pursuing abusive tax-avoidance schemes. IRS settlements related to these schemes have been significant and have led to expensive claims against CPA firms.

AUDIT AND ATTEST SERVICES

Current claim trends

Similar to prior years, the primary causes of loss related to audit and attest services claims include a failure to detect a misstatement or disclosure error and a failure to detect a theft or fraud (see the chart "Audit and Attest Services Claims Asserted in 2021 by Cause of Loss," below). What is different from prior years' claim data is which party asserted these claims. In 2021, over half of the audit and attest services claims were instituted by third parties, primarily lenders or sureties.

pro-li-3-audit-attest-services-claims-2021-cause-loss

Consider this claim asserted in 2021:

A CPA firm had a long-term financial institution audit client. The client discovered that one of its employees embezzled funds by misusing the company credit card and manipulating bank records. The client performed an investigation, determined that $2 million was stolen, and submitted a claim to its fidelity insurer. The fidelity insurer brought a claim against the CPA firm, asserting that the firm's audit failures allowed the fraud to perpetuate.

Future considerations

The volume of 2021 audit and attest services claims decreased by nearly 50% compared with 2020. While this may seem like a cause for celebration, such may not be representative of future loss experience. Courts were closed or only partially open in 2020 and 2021. Stimulus funds kept many businesses afloat during tenuous economic times. Therefore, we may see an uptick in claims once courts are operating at full capacity and when the economic dust settles.

Another trend in claims — particularly those related to audit services — has been the increase in damages asserted when a claim is made. Class action lawsuits and "nuclear" verdicts, whereby juries award an exceptionally high figure that is disproportionate to the actual damages, have become commonplace, fueled in part by an increase in litigation funding, whereby a third party funds a lawsuit in exchange for a share of any award.

CONSULTING SERVICES

Current claim trends

Consulting services claims comprised 9% of all claims asserted in 2021. This percentage may sound insignificant. However, compared with 2020, consulting claim volume is up 50%, an unsurprising trend as more firms expand their service offerings beyond the traditional audit and tax.

Consider this claim asserted in 2021:

A CPA firm was engaged to provide bill payment, cash management, tax preparation, and tax planning services to a wealthy couple and the adult children from the wife's first marriage. After the wife died, a separate investment account solely in the husband's name was revealed. The wife's children brought a claim against the firm alleging that the engagement partner helped the husband create and fund the separate account, thus diminishing the amount of the wife's assets inherited by her children.

Future considerations

Claims related to consulting services will likely continue to increase as this area of practice grows and CPAs lean further into the role of trusted business adviser. Why? Claim history has demonstrated that the more services a CPA firm delivers to a client, the more likely that the CPA firm may be blamed for a client's losses and, consequently, face a claim.


Sarah Beckett Ference, CPA, is a risk control 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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