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Control of client funds

employee theftby Rickard Jorgensen, FCII, ARM, ACIArb

If your CPA firm has control of client funds and can write checks on clients’ bank or investment accounts you may have an exposure to CPAs or firm staff abusing the signatory authority by stealing or misusing the client funds in the firm’s custody and control.  This could apply to bill paying, investment advisory services (executing trades) or even payment of taxes. This can be especially problematic if your firm provides “business management” services in which the CPA has considerable control over a client’s finances.  Trustee or Executor assignments also present an increased risk of the misuse of client funds.

Additionally. CPAs when managing client funds the CPA is acting as a fiduciary which itself presents additional risk.  This fiduciary role overrides the usual obligations and the firm will be held to a higher standard of care, which creates a greater malpractice risk.

Public expectation is that the CPA plays role in preventing and detecting defalcation.  But what if this occurs internally because you failed to establish adequate controls that results in the theft or misdirection of client funds?  The probability of a lawsuit from any aggrieved client is very high.

The following steps may help to mitigate the possibility of a problem:

  1. Investigate if the firm has any engagement that involves control or disbursement of client funds.  Check authority levels and personnel involved.
  2. Implement internal procedures to screen new engagements that require signatory authority over client funds.  Centralize this process.
  3. Establish internal controls like:
    • Arrange for the client’s bank to requirement written confirmation from the client for disbursements over a certain amount.
    • Background checks for staff working in check preparation.
    • Cash disbursement services should take mandatory take time off.
    • Cross train employees to review each other’s work.
    • Have a partner perform a surprise review and/or perform check preparation and signing.
    • Have a two-signature requirement for all checks (over a maximum amount (pre-agreed with client).
    • Have someone other than the check preparer open and review bank statements.
    • Have your client to review and sign a list of recurring expenditures on a regular basis.
    • Present the client with a list of checks disbursed for review and written approval.
    • Require client’s written authorization for all disbursements.
    • Restrict access to check register and statements
    • Segregate of roles between preparation and signing of checks, and statement reconciliation.
    • Undertake a second review, partner on staff, partner on partner.

4.    Purchase comprehensive crime coverage (a fidelity bond) with includes a third party extension for client funds,

5,   Use a background check company where partners or employees have authority for large amounts.

6.   The engagement letter for the engagement should be in place which outlines the services, the level of authority and the personnel with check signing authority.

Most professional liability insurance companies include an exclusion for theft of client funds.

For example, Hanover Insurance Company’s policy 915-0001 02 12 contains the following in E. EXCLUSIONS 1 h.

This policy does not apply to claim(s): …..

h.   Any insured’s conversion, commingling, defalcation, misappropriation, or other intentional misuse or illegal use of funds, monies or property;

CPAGold™ (QBE) policy employs the following wording:

7.      EXCLUSIONS

This Policy does not apply to any Claim made against you based upon, arising out of or resulting from: ……

 7.10  your gaining, in fact, any personal profit or advantage to which you are not legally entitled, including misappropriation, commingling or defalcation of funds or property;

There is an argument that if a claimant can prove negligent supervision coverage can be obtained, and in the past CPAGold™ has paid claims of this nature. Claims from misuse or theft of client funds can be hard to detect and may increase during period of economic downturn.  However, if you have adequate risk management protections in place, insurance coverage and you have clarified the clients’ expectation, you can minimize the probability of a lawsuit.

Special circumstances

A recent inquiry about paying taxes on behalf of clients was made by one of the CPAGold™ policyholders.  Much of the same considerations apply AND the additional risk of under-estimating the amount of the taxes to be paid with the consequent exposure to late filing penalties and interest. A CPA should take extra care when making payment of taxes on behalf of client, especially partial payments or estimates, and ensure the client is fully aware of the consequences of inaccuracies or late instructions.

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Jorgensen & Company are not attorneys and do not offer any form of legal advice. Consult with appropriately qualified local counsel for more assistance. Rickard Jorgensen is President and Chief Underwriting Officer for the CPAGold™ program and may be contacted at (201) 345 2440 or rjorgensen@jorgensenandcompany.com

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