March 2001

Abiding by Professional Standards is Not Enough

A major characteristic of CPA liability issues is that the public holds accountants to standards that are higher than those set forth by the accounting profession. This is especially true in review and compilation engagements where fraud has caused a loss leading to a claim. A number of factors driving this phenomenon have been identified, four of which are described in the following discussion.

One is that the public generally does not understand the differences between the types of services CPAs perform. Many members of the public (including jurors and lawyers) are not familiar with accounting services and standards. Many are willing to believe that the CPA is in a superior position when it comes to accounting and even business issues, and that belief can lead to high expectations for CPA duties and responsibilities.

For instance, the accounting profession has a range of standards for levels of responsibility in audit, review, and compilation engagements, but the public does not always understand or agree with those standards. This point was illustrated in a jury study conducted by CAMICO, a Society-endorsed liability insurance provider for accountants, when the company collected responses to a statement made to jurors. The statement was:

“The purpose of having an accountant examine a company’s books is to uncover any and all irregularities, even if the accountant is not hired to conduct an audit.”

Sixty percent of jurors agreed with that statement, while 21 percent disagreed, and 19 percent were neutral. The accounting professional standards (SSARS No. 7) state that reviews and compilations cannot be relied upon to detect errors, fraud, or illegal acts, but those standards often have little relevance as far as a jury is concerned. As a consequence, most of the review and compilation claims handled by CAMICO are caused by losses due to fraud or defalcation. (See the Exhibit 1.)

A second factor behind high jury standards for CPAs is the benefit of hindsight judges, jurors, and lawyers have when assessing circumstances the CPA had to assess during the course of an engagement. Circumstances look considerably clearer after all of the facts have been detailed and laid out by a skilled attorney. The jury sees how the fraud took place and how it “should” have been detected. It is difficult for jurors to believe that a CPA, whom they perceive to be a financial expert, did not see before what they now see.

A third factor is the length of time an accountant has been working with a particular client. The more time a CPA has spent examining client records, the more he or she is presumed to know about that client’s bad habits, lack of controls, and other red flags that are easy to spot in hindsight. It is also hard for a jury to believe that a CPA did not know about certain facts after working with a client for several years, even though a client may have carefully concealed certain activities, falsified documents, and colluded with others.

A fourth factor with which CPAs must contend in court is the assumption that the CPA did something wrong if he or she is sitting at the defendant’s table. There is generally a stigma attached to being a defendant. Consider the following statement, also used in a CAMICO jury study:

“If a case comes to trial, it must have some merit.”

Fifty-six percent of jurors agreed with that, while 44 percent disagreed. The 56 percent who agreed will try to determine the extent of the CPA’s wrongful behavior even before the trial begins. When this attitude is combined with a lack of accounting knowledge and an abundance of hindsight, avoiding liability claims becomes paramount.

Professional standards are vitally important, but juries often consider such standards to be the minimum requirements a firm should meet. CPAs are often expected to follow the standards, get the job done right, and uncover any and all irregularities. If they do not, complying with standards may well be insufficient to avoid liability.

Loss Prevention Recommendations

The need for engagement letters in review and compilation engagements can be even greater than in audit engagements to prove that the accountant was not engaged to perform an audit. The engagement letter should describe: