Segregation of risk in an accounting firm
Insurers have broadened the scope of professional liability insurance available to CPAs to include is Personal Financial Planning [“PFP”] services.
Traditionally, this practice involves broad based investment planning and asset monitoring services for a fee, but recent developments on micro and macro levels have begun to undermine the once-perceived, simple and benign nature of the work.
In the past the largest claims against CPAs arose from attestation services – that is, failure to detect fraud. While infrequent, these claims were often catastrophic and costly. Recently there have been large claims arising from PFP services. PFP claims commonly arise from:
- Failure to undertake adequate due diligence for an investment.
- General market conditions and portfolio value fluctuation.
- Conflicts of interest – using affiliates or owned investment vehicles.
- Specific types of investments: REITs, Options, “Alternative” Investments Limited Partnerships or Hedge Funds.
- Failure to properly advise on the tax consequence of an investment scheme.
- Claims arising from a particular product promoted by an adviser.
- Fraudulent investments or Ponzi schemes.
- Failure to meet Fiduciary standards.
Each type of claim has the potential to cost a CPA millions of dollars, and destroy their practice.
As mentioned previously, the downside to expanding coverage to include PFP is that any claim from this service has the potential to reduce or even completely use up coverage for conventional areas of practice. This means less, or no, coverage for Audit, Review, tax and bookkeeping services, etc., and at the time of writing, no insurer of accountants’ professional liability [“APL”] insurance has offered a separate limit of liability for PFP services. Also, the PFP subsidiary may have additional non-CPA owners which can risk the firm’s APL coverage by their conduct. An affiliated Broker-Dealer may not accept the APL coverage as and press the firm into purchasing coverage via a sponsored shared limit program.
There are, however, several options for specific professional liability coverage for investment advisers and financial planners. If the PFP practice is managed as a specific business unit, and/or ideally as a wholly owned subsidiary, it is possible to purchase relatively low-cost coverage. This coverage can also be expanded to include activities as a Registered Representative, Life Insurance Sales and Fiduciary roles. Unlike coverage for Registered Representatives and Life Agents offered via Broker-Dealers and Life Insurers, it does not share coverage between thousands of representatives or agents, is completely controlled by the CPA, portable, and not tied to any other coverage. If structured correctly, claims that arise from PFP services will be covered by the separate policy and will have no impact upon their accountants’ professional liability coverage.
Independent coverage for PFP can also bring other advantages:
- The coverage often includes Cost of Corrections, which means incidents that might have the potential to develop into a claim are fixed quickly and early.
- There is often affirmative coverage in the definition of services (as opposed to stating that services are not excluded), including activities as a Fiduciary.
- Separate PFP coverage can be written with a reduced deductible and tailored endorsements to add special features to the policy.
- Coverage may be written as excess over mandatory coverage provided by an affiliated Broker-Dealer and/or drop-down primary coverage for other (Fiduciary) activities.
While broadening the definition of professional services seems beneficial on paper, the inherent risks that it presents to a practice as a whole suggest that the best course of action is to address change specifically with care and attention and not simply rely on what is convenient.