The amount of risk your firm is willing to take depends upon a variety of factors. You make a business decision to accept client that are in industries that may be considered high risk. However, you must be aware of the risks associated and undertake thorough research and evaluation of the client. Using the standard axiom, 80% of your malpractice risk will come from 20you’re your clients. You need to apply additional controls to this 20%.
Analyzing and Reducing the Risks
After completing the above prudent steps you may have a better picture of how well the client’s business is run and their financial status. After a risk-reward evaluation you may decide to accept the engagement. You can set up the engagement to protect yourself from a financial and liability point of view.
You have these options:
- Asking the client to indemnify you against suit;
- Assigning your most thorough CPA to supervise the engagement;
- Collecting fees in advance;
- Conducting a ·cold~. third-party review of the work product;
- Documenting all parts of the engagement thoroughly;
- Drafting a very comprehensive engagement letter addressing the risky parts of the engagement including a mediation clause and limitation of liability clause in an engagement letter.
- Making a provision in your engagement letter for regular progress billings if the work is to be extensive;
- Pricing the engagement to reflect the additional risk; and,
- Terminating the client. Categorizing Problem Clients Although problem clients can come in all shapes and sizes, its expedient to classify them into three general categories:
- clients who lack integrity;
- clients who have financial problems; and,
- clients who make themselves vulnerable to being deceived.
A client who lacks integrity can be identified by some of the following signs:
- cheats on business deals;
- cheats on taxes;
- experiences fast turnover In professional staff;
- falsifies financial data;
- haggles on bills;
- has prior criminal record;
- is highly litigious (many suits have been filed by and/or against the client);
- pressures you to take extreme positions; and/or
- refuses to sign engagement or “rep” letters.
A client in financial difficulty may act in some of the following ways:
- goes out of business and leaves creditors and you unpaid;
- takes financial risks which no prudent person would take; and/or cuts back on safeguards (insurance, etc,), creating vulnerability.
Signs of financial difficulty include:
- decline in inventory turnover;
- loan defaults,
- sheet ratios; and/or
- slow payment of bills;
- weak operating and balance
- working capital deficiencies;
A client vulnerable to being deceived and taken advantage of may operate in this manner.
- demonstrates lack of competence,
- has few or no internal controls;
- personnel; and/or
- places undue trust in hired personnel;
- refuses to read prospectuses (“just tell me what to do”);
- retains incompetent or untrustworthy staff.
Assume that you have decided one of your clients fits one of the three profiles given above. What can you do? Here are some specific measures you can take to deal with these clients:
Dealing with clients who lack integrity:
- Assume you are the next victim;
- Use your best personnel on the engagement;
- Don’t reduce your fees to keep the client;
- Don’t let the client get behind in payments;
- Use second partner review;
- Stand your ground during disagreements;
- Insist on signed engagement and rep letters; and
- Remember the headlines (so you don’t end up in them!)
Dealing with clients in financial difficulty:
- Avoid conflicts of interest;
- Be wary of signs of financial trouble;
- Don’t hesitate to withdraw numbers found to be materially in error.
- Protect privacy defense if possible; and
- Watch critical ratios;
Clients who make themselves vulnerable to being deceived and taken advantage of:
- Warn them of dangers of lack of internal controls:
- Don’t make their problems your problems;
- Make them do their own work;
- Disclaim liability in writing; and/or
- Insist on expanding the engagement at their expense
Most CPAs are reluctant to terminate a client. But it may be better to end a relationship under your terms than at someone else’s terms. Possibly you discovered a conflict of interest. Maybe there are signs of odd behavior: rudeness, inconsistencies, hints of illegal activities, business decisions that seem bizarre. Your firm may no longer have the required expertise to service the client. Perhaps the client is a bad payer and your do not want to chase bills.
The decision to terminate a client can be emotional. If it is one of your own clients it can be even harder. That’s why the client evaluation process must be objective and fair. Each client should be rated using a common process and a standard scoring system. While each client is unique, the numbers will provide a discrete evaluation that can form the basis of a constructive discussion.
You need to be able to make an objective, informed judgment about any client’s risk to your firm. The purpose of this paper is to help you to understand the possible consequences of that decision.
How to Terminate an Engagement
Terminating an engagement is a serious step. There will be a loss of income, friction with the client and the potential of a lawsuit. But there are ways to mitigate the difficulties of the situation.
The timing of termination should be planned and avoid the year-end or business periods to minimize any unduly inconvenience and maintain any goodwill. You should also terminate the relationship at a time that is convenient for your firm. At the same time, terminate the relationship at a time that is appropriate for you. Obviously, April is not the time for most firms to take on the extra stress of an unhappy client.
Collection of invoices after a client has been terminated is tough, so ensure that services are wound down before the termination and that most or all of the outstanding balance has been settled.
It is undesirable to terminate a relationship with a client mid-engagement. If you feel this is necessary, contact your attorney, your agent, or malpractice insurer hotline before taking the action. Careful conduct will be necessary to minimize the possibility of litigation.
All client records should be returned in good condition. As part of the termination you may receive calls from the ex-client’s new accounting firm. You must be circumspect about what you say to the new firm and you must stick to the facts. Request an unconditional and unrestricted authorization from the ex-client before you give any information to the new accounting firm. Disclosing confidential client information without permission could lead to a lawsuit.
Answer all questions from the new CPA firm truthfully. Do not volunteer information but stick to responses to specific questions. Avoid opinions and don’t hand over any work papers unless requested by the client. If so requested, only provide those work papers that are necessary to perform the engagement. Do not internal items such as internal memoranda.
You should keep a record of all files and work papers that are provided to the new CPA firm. Keep the work papers (as well as records of what was released to the new CPA firm) in your files for ten years after your relationship finishes.
It may also be prudent to let all other interested parties that you have terminated your engagement with the ex-client. Also, you should consider notifying your insurance agent and malpractice insurer hotline. Especially if your ex-client seems disgruntled by your actions. Your agent of malpractice insurer hotline may be able to help you decide how to handle potentially difficult situations. You will also want to notify those awaiting publication of any reports, and other parties such as banks, creditors and attorneys.
A Client Evaluation Committee
It may be wise to establish a Client Evaluation Committee to assist partners with the evaluation process. Typically the committee is composed of senior members of the firm who meet monthly or quarterly to discuss potential clients an changes at current clients. These committee members must be independent and liability conscious and not afraid to make tough decisions.
Trust your gut. If you sense that a client doesn’t share your ethical standards and you get a bad feeling, then gather more information, tread cautiously and take protective measures. You can only protect you clients if you protect yourself first.
Rickard Jorgensen, FCII, ACIArb, ARM is a specialist professional liability agent and risk management consultant. He can be contacted at (201) 345 2440 or firstname.lastname@example.org