It has happened to many successful CPAs. A CPA is meeting with a valued client who asks for a referral. Perhaps the requested referral pertains to a lawyer, an investment advisor or an insurance agent. Often, CPAs provide these referrals without a second thought. What is wrong with recommending another professional in an effort to accommodate a client? The other professional may reciprocate by referring clients to the CPA. This type of networking should benefit the CPA, right? Not always. If the client suffers damages as a result of the referred party’s actions, the client may point the finger of blame at the CPA.
What is the risk?
The following claim scenario demonstrates the potential risks of providing a well-intentioned referral.
A sole practitioner provided bookkeeping and tax return compliance services for a number of years to a successful dentist. During a tax planning meeting, the CPA noticed that the dentist’s investment portfolio was performing poorly and asked if the client was satisfied with its performance. The dentist indicated she was unsure, but was open to meeting another investment advisor. The dentist was not necessarily ready to change advisors, so there was no compelling reason to offer an immediate referral. However, before the meeting ended, the CPA recommended an investment advisor used by many of his other clients, although the CPA had never used the advisor or vetted his qualifications.
The dentist and CPA met with the investment advisor, and the dentist subsequently moved her entire retirement portfolio to him. The advisor invested the funds in several investment partnerships that he organized. Income tax returns for these investment partnerships were prepared by the CPA.
Several years later, the investment advisor was convicted of operating a Ponzi scheme, and the dentist lost her entire retirement portfolio. Subsequently, the dentist filed a professional liability claim against the CPA, asserting that she relied on representations of the CPA regarding the investment advisor’s background, experience, and integrity. In addition, the client contended that the CPA had a duty to confirm the existence of the investments when preparing the returns for the investment partnerships.
The CPA denied making any representations about the advisor’s character. He noted that he had merely prepared the returns, and such preparation did not include an obligation to verify existence of the assets.
Because the dentist lost her entire investment portfolio, the CPA’s defense counsel indicated she would make a sympathetic witness in the event that the case was tried before a jury. In addition, the CPA’s actions compromised his defense as he:
- Proactively recommended the investment advisor to the client,
- Recommended one individual, rather than providing the client with at least three options,
- Did not advise the client to investigate the investment advisor’s qualifications,
- Met with the advisor and client, and
- Prepared the investment partnerships’ tax returns.
What can you do?
As trusted advisers, CPAs will continue to receive referral requests from their clients, and CPAs will probably continue to provide such referrals in an effort to be responsive to their client’s needs. In order to help avoid the risk of liability in offering a professional referral, CPAs should implement the following protocols:
- Before providing the names of any professionals to clients, perform high-level due diligence by investigating their background, training, experience, reputation, professional credentials and licensing.
- Offer clients more than one (1), preferably three (3). options when making professional referrals.
- Provide referrals of specific individuals, rather than the entity for which they work.
- Follow up any discussions with a letter or e-mail listing the individuals recommended, preferably in alphabetical order. Ensure that the client understands that they must take personal responsibility for evaluating, selecting, and engaging each recommended professional and that the CPA does not endorse and will not supervise such professional’s activities.
- Do not request copies of statements from investment or financial advisors or others unless it is essential to the services provided. To the extent investment statements are required, include a provision in the engagement letter that the statements are not being used to monitor transactions, investment activity, provide investment advice, or supervise the actions of any investment advisors.
- Refrain from meeting with the client and any professional recommended, even if only to make an introduction.
- ET §1.520 of the AICPA Code of Professional Conduct addresses commissions and referral fees received by CPAs. Generally, CPAs are prohibited from receiving a commission or fee for referring a product or service to a client for whom audit, review, compilation, preparation, or prospective financial information examination services are performed. If such fees are permitted, CPAs are required to disclose their existence to the client, preferably in writing.
Referrals may represent an opportunity to engage with clients but also may create professional liability exposure. To address this issue, CPA firms should consider establishing protocols for referrals, incorporating the recommendations noted in this article as part of the firm’s overall quality control policies and procedures.
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