As you strive to generate referrals, you do your best to provide outstanding customer service. But you could open the door to liability if you step outside the bounds of the engagement letter.
In the following case study, a CPA unknowingly steered customers toward a Ponzi scheme. His attempt to provide top-notch service turned into a large claim for damages.
"John" was a CPA who offered tax preparation and tax advice services for his clients who were wealthy business owners involved in complicated investments.
John developed a friendship with "Bob," a neighbor who was new to the area. Bob had managed a hedge fund on the east coast and was now going to register and manage his own fund. John ran into Bob at neighborhood cookouts and other gatherings and got to know him well.
Bob was looking for office space for his new business, and John advised Bob that there was space in his building. Bob moved in and set up his business. After a few years, the new fund was reporting above-average returns, and Bob entertained the idea of opening another fund with slightly different investment goals. Bob offered John the opportunity to invest in the new fund, and John took him up on the offer.
Over time, both of Bob's funds consistently beat their market indexes. John moved more and more of his personal wealth into Bob's fund and advised his extended family members to move their money into Bob's fund.
Each year, John had a face-to-face meeting with his clients to review their tax situation. The clients were all sophisticated businesspeople and investors. At each yearly meeting, clients often asked, "What's the next big thing I should be considering for investing?"
John was not a registered investment advisor and never gave specific investment advice. However, John started telling his clients, "I invest with Bob, and I've done well. If you are interested, he's right across the hall. Tell him I sent you."
Many of John's clients met with Bob and invested in his funds. The funds performed well for years until federal agents raided Bob's office, confiscated his computers and records, and arrested Bob for running a Ponzi scheme.
Lawsuits were filed against Bob, and eventually suits were filed against John for breach of fiduciary duty and for providing negligent financial advice. John's defense counsel argued that he never entered a fiduciary relationship with his clients, and that John merely facilitated an introduction to Bob while never providing financial advice. Motions to dismiss both counts were filed.
The judge opined that when John provided a testimonial about his personal satisfaction with Bob's fund and recommended clients go see Bob, the CPA had stepped out of the limited scope of the engagement letter, which stated: the professional service provided was only tax preparation, and a fiduciary duty had been created.
Further protests by defense counsel were met with the judge's comment: "When your barber gives you investment advice, that’s small talk. When it comes from your accountant, that's investment advice."
The lesson here is to secure an engagement letter each year that clearly states the scope of the assignment. CPAs should only offer professional services that fall within the four corners of the engagement letter.
This article was written in conjunction with GenStar, and it is provided for informational purposes only. None of it constitutes legal advice, nor is it intended to create any attorney-client relationship between you and the author. You should not act or rely on this information without seeking the advice of your own attorney.