Practitioners who provide personal financial planning (PFP) services have expressed concerns about several insurance, professional liability, and regulatory issues. In particular, they ask

• Whether CPAs must be registered as investment advisors for investment planning activities to be covered under AICPA Professional Liability Insurance Program policies.
• If the AICPA Professional Liability Insurance Program policies cover firms for financial planning and investment advisory services.
• Which activities put CPA firms most at risk.

A review of AICPA Professional Liability Insurance Program data reveals that about 14 percent of the CPA firms it insures provide some level of personal fiancial planning services -- a number that is expected to increase. It is not surprising, therefore, that CPAs are becoming increasingly concerned about professional liability coverage for their investment planning activities.

Together with the AICPA Professional Liability Insurance Program committee, CNA and Aon Insurance Services have addressed these concerns by clarifying and enhancing Program coverage for personal financial planning services to mirror the needs of practitioners.

Registration as an investment advisor

Although registration as an investment advisor is not required for coverage under the AICPA Professional Liability Insurance Program, it may be required by government regulations. Prior to incorporating personal financial planning services into the practice, CPAs need to investigate the federal and state laws which regulate such services to ensure compliance.

The Investment Advisors Act of 1940 (IAA), as well as various state laws, define the registration requirements for professionals who provide financial planning services or investment advice to clients. The IAA exempts from its definition of investment advisor, "Any lawyer, accountant, engineer, or teacher whose performance of such advisory services is solely incidental to the practice of his profession."

CPAs who provide generic financial planning advice to clients which is solely incidental to tax and accounting services being rendered, generally are not subject to federal or state registration requirements. CPAs who hold themselves out to the public as financial planners or investment advisors generally are required under the provisions of the IAA to register with the SEC, however.

State regulations applicable to financial planners or investment advisors exist in all states except Colorado, Iowa, and Wyoming. CPAs who provide financial planning advice to clients should consult with their individual state CPA societies and knowledgeable local counsel about compliance with both the IAA and any state laws that may apply. Additionally, the personal financial planning division of the AICPA publishes a practice aid, Guide to Registering as an Investment Adviser, which provides further guidance on this subject.

Types of investment services

Many activities that might be construed as investment advice are within the scope of a CPA's professional services. The AICPA Program protects insureds and firms for covered claims arising from the following investment advisory services:

• Discussing generic information about investments.
• Outlining various types of investments and their individual implications.
• Providing general asset category recommendations.
• Assisting in selecting investment advisors.
• Evaluating the suitability of investments selected by clients or recommended by other advisors.
• Developing an appropriate investment strategy.
• Suggesting criteria for selecting mutual funds based on a client's goals and objectives.
• Monitoring the performance and results of money managers.
• Identifying mutual funds for a client to investigate.
• Recommending investments in a specific stock, bond, or mutual fund to a client.
• Managing an investment portfolio on behalf of a client.

Certain of these investment advisory services are considered high-risk activities that could lead to a higher frequency of claims. These include recommending specific investments, such as individual stocks or bonds, especially if CPAs receive commissions or manage an investment portfolio on behalf of a client when exercising discretionary authority over the client's funds and assuming direct custody of those funds. While the manner in which CPA firms are compensated for services has no bearing on the applicability of insurance coverage under the AICPA Professional Liability Insurance Program, the acceptance of commissions for products or services is an underwriting consideration. Many states prohibit by statute or regulation CPAs or CPA firms from accepting commissions.

As part of their professional services to clients, some financial planners with CPA firms may be authorized by their clients to place orders to buy and sell securities on their behalf. Protection is afforded under the AICPA Program for covered claims arising from placing such orders with a licensed broker or dealer. Claims arising from acting in the capacity of a broker or dealer in securities are not covered, however, nor are criminal proceedings, such as those that arise from violations of statutes or regulations.

To minimize their liability exposure, CPAs providing personal financial planning services should have a financial plan or engagement letter outlining both the investment goals of their clients and the amounts of risk their clients are willing to accept. It is also important to avoid making representations that could be construed as guaranteeing the performance of any specific investment or individual financial plan.

In general, high-risk activities result from actual or apparent conflicts of interest. The appearance of a conflict of interest or impaired objectivity is one criterion to use in determining whether an investment advisory service has a high probability of generating claims.

High-risk scenarios

Suppose that a CPA recommends a specific investment and receives a commission, in addition to receiving a customary fee for services. At the very least, the CPA must disclose to the client the commission arrangement if the recommended security is purchased. Additionally, accepting commissions, charging fees that are contingent on the volume or frequency of a client's investment transactions, or accepting any type of reciprocity from third parties can create the appearance of impaired objectivity and a conflict of interest. CNA, as underwriter of the AICPA Program, actively discourages CPAs from accepting commission-based income because of the high risk of generating claims.

Imagine that a CPA owns an interest in a closely held limited partnership. The client decides to invest in the limited partnership after being introduced by the CPA to the general partner. Although the CPA receives no commission or referral fee, he or she has created a potential conflict of interest. Even if the interest in the limited partnership is disclosed to the client, the exposure and potential for a claim still exist. It is good business practice for CPAs to keep their personal investment involvement entirely separate from any investment recommendations to clients.

Depending on the size of the CPA's ownership interest in the limited partnership, this situation could trigger a CNA policy exclusion. This exclusion eliminates coverage while performing professional services for any organization if the CPA or his or her spouse is an officer, director, partner, manager, or holder of more than a 10 percent ownership interest.

If a CPA assumes discretionary authority or direct custody of client funds, he or she is assuming the role of a fiduciary. This results in a significantly higher risk of lawsuits and requires the adherence to more stringent disclosure and financial standards.

For example, the CPA may be required to disclose any material information that could cause a conflict of interest and to follow specific regulations on segregation of client funds and record keeping. State and federal laws establish stringent requirements that go beyond AICPA professional standards for professionals acting in a fiduciary capacity on behalf of clients. In the event of a malpractice lawsuit, opposing counsel will highlight these duties and attempt to demonstrate that the professional did not meet this higher standard of care.

Both CPAs and clients benefit when CPAs can provide knowledgeable financial planning and investment advice. The AICPA Professional Liability Insurance Program recognizes these activities as legitimate professional services and provides insured firms with coverage for claims arising from most financial planning and investment advisory services, subject to the terms, conditions, and exclusions of the policy. Be aware, however, that some of these activities could increase the risk of claims.

-by F. Kyle. Nieman, CNA Pro, an operating division of CNA, 36 South, CNA Plaza, Chicago, Illinois 60685, and Ken Mackunis, Aon Insurance Services, 4870 Street Road, Trevose, Pennsylvania 19049, tel. (800) 221-3023