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How Your Story Will Be Told to a Jury

                                                                                              By Ron Klein, J.D.

Among its many roles, CAMICO acts as a gathering and disseminating agent for CPA liability experiences across the nation. For more than 35 years, we have gathered hundreds of thousands of CPA experiences and distilled the learnings those experiences provided so that we could tell CPAs about the real-world risk implications to their firms.

A perspective that is important for CPAs to reflect on is how their actions – for which they are getting sued – will be portrayed to the jury. The gap between the experienced reality and the story told at trial can be significant and is illustrative of what CPAs need to do today to minimize risk tomorrow.

When looking at a situation in hindsight, it is important to note that history can sometimes be “rewritten” to benefit the client: “Why didn’t my CPA warn me about what was going to happen? I was relying on my CPA’s expertise for financial help.” The good news, however, is that CAMICO’s vast experience and research help to inform us as to what factors and preconceived notions sway jurors. As such, the advice and guidance you will find in this article are designed to raise your awareness and help you to recognize (before the “milk is spilled” and a claim occurs) what the triggers are that may sway jurors, as well as proactive risk management steps you can take to improve your chances of having history favorably rewritten with a jury to your benefit.

For example, let’s take a “garden variety” embezzlement claim. As the CPA experiences it, it goes something like this:

For the past six years, the CPA has been providing tax preparation services as well as occasional assistance to the sole accounting employee, including closing the books at the end of the year. During this period, the CPA meets face-to-face with the client/owner less than a dozen times, visits the client’s office another dozen times, and communicates by email and phone several times a month, usually with accounting. While helping to close the books at the end of year six, the CPA finds a number of vendor payments in a suspense account. When the CPA asks the owner about the payments, the owner does not recognize any of the vendors. And the embezzlement quickly unravels. It turns out that the accounting employee had embezzled over $275,000 over the past ten years, having begun four years before the CPA even obtained the client.

After a few years of litigation, including over 700 written interrogatories, 80 hours of depositions and 90,000 documents, the attorneys on both sides now have a better understanding of what occurred than any of the participants, including the CPA. What does the jury hear? Given the necessary compaction of time, each attorney, for the plaintiff and the defendant, will focus their cases. Each of them will select four or five key documents and some testimony each feel is particularly impactful (usually from an expert and one or two eyewitnesses). The jury will have no sense of the actual expectations of the client/plaintiff before the discovery of the embezzlement. Juries most often place little weight on the professional standards that guided the CPA.

From the testimony, evidence and argument, each juror will decide. From jury research and many previous embezzlement claims, CAMICO knows that juries will likely decide based upon:

  • Whether the jury believes the CPA “warned the client of risk and advised the client of opportunity” in financial and tax matters. In embezzlement cases, this burden is increased because juries believe CPAs are the fraud police and embezzlements are common. Most juries believe that the CPA’s “advising and warning” antennae should be hyper-sensitive during difficult economic periods. Some even believe “anyone can do a CPA’s job when times are good, but when we really need the CPA — that’s when the CPA should really be tuned in.” In other words, expectations are elevated when economic times are challenging.
  • Written documentation (“in plain English and not legalese-speak”) to support the scope and limits of the services the client engaged the CPA to render. It is ideal to have a signed engagement letter that is current and specifically mentions that the services contracted for are not designed to detect fraud. Second, a written communication informing the small business client of embezzlement risk, which needs to include ways the client can manage embezzlement risk, including the importance of timely bank reconciliations, requiring substantiation for each check, and monthly review of the bank statement by the owner. This written communication allows the CPA’s attorney to make the argument that the CPA warned the client of the risk of embezzlement and advised the client of actions to take that will reduce the risk to client. With the good evidence described above, the CPA attorney will be able to turn the tables on the client, forcing the jury to consider whether the client met his obligations to protect himself. The best offense is a good defense.

Is it necessary to have the engagement letter signed and current, and the communications in writing? Absolutely. Jurors do not like to rely upon verbal communications. Verbal communications are always disputed. Further, the jury expects the party with the power and knowledge (CPA) to have the burden of documentation. This is especially true of CPAs because juries view CPAs’ job as documenting everything significant.

What happens at trial if the CPA did not fully meet the expectations of the jury to warn and advise? Without a good written warning communication about small business risks of embezzlement, instead of the CPA’s attorney arguing that the CPA warned about embezzlement risk and that the client failed to do what was necessary, the client’s attorney will argue that the CPA left the financially unsophisticated client unaware of the risk and unprepared to deal with it. It is not unusual for clients who signed blank checks (for convenience) to argue that their CPA never advised them not to sign blank checks. Thus, rather than the jury’s focus being on how well the CPA warned the client and whether the client took appropriate defensive action, their attention is turned to how and how often the CPA had a chance to catch the embezzlement but failed.

Did the CPA know that bank reconciliations were months behind, or how vendor payments were processed at the client’s office? A jury’s expectations are that the CPA, after six years of service to the client, will have a profound knowledge of how the business works, even with limited services. The CPA’s duty expands with time, in the jury’s mind.

Just as it is the CPA’s job to inform the client of embezzlement risk, it is CAMICO’s job to inform the CPA of embezzlement risk as well. So, it is highly recommended that you consider our guidance, especially for small businesses:

  • Have a signed and current engagement letter that specifically addresses embezzlement and fraud, and warns that the services requested are not designed to detect them.
  • Send an initial written warning letter informing the client about embezzlement risk, the appropriate way to process payments, bank reconciliations, and monthly review of the bank statements and checks by the owner.
  • Be aware of the importance of timely bank reconciliations. If the client is more than two months behind with bank recs, that is an embezzlement alert, likely requiring at least a written communication with the client.

The struggling economy in the aftermath of the COVID-19 pandemic exacerbates the potential for embezzlement claims, as many businesses and individuals are under growing financial strain. Increased financial need will likely increase pressure and rationalization for fraudulent behavior (e.g., “My line of credit has been canceled.” “My retirement funds shrank.” “I need this money.”) Understanding the gravity of these pressures is crucial to effective fraud prevention and detection. Public perception is that CPAs are expected to have a “nose for fraud,” regardless of the limitations of the engagement. The expectation that CPAs will detect fraud is extremely difficult to meet, but the expectation to advise and warn is much less difficult. By advising and warning clients of their fraud/defalcation exposures and responsibilities, CPAs can minimize liability stemming from the expectation CPAs will detect fraud.

The best thing about our recommendations above is that, if followed, not only will they provide you with the best defense should you get sued, but there is also a very good chance that they will prevent or discover embezzlements. In which case, that will make the CPA a hero to the client rather than a target – the best win-win of all.

Ron Klein, J.D., is Risk Management Counsel with CAMICO. He has been with CAMICO since its inception in 1986 and managed the claims department for 25 years.

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