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Business Valuation, Accounting, and Litigation Support

CPA Malpractice

CPA Malpractice

We have had considerable experience representing CPAs with malpractice claims.

The following narrative is intended to be applicable to a tax malpractice case in the state of Texas.

Accountants who agree to provide accounting services owe the client a common law duty to exercise reasonable care. This duty of reasonable care requires the Accountants to exercise the degree of care, skill, and competence that members of the profession would normally exercise under similar circumstances.

Accountants breach their duty by their failure to comply with the recognized industry standards of care. In particular, the Accountants fail to remain free from conflicts of interest and fail to maintain integrity and objectivity by subordinating their judgment to a client by Rule 501.73 of the Rules of Professional Conduct promulgated by the Texas State Board of Public Accountancy, and by failing to exercise due professional care in the performance of professional services as required by Rule 501.74 of the Texas State Board of Accountancy. Additionally, Accountants can violate the American Institute of Certified Public Accountants (AICPA) Professional Standards Code of Professional Conduct, and the AICPA Statement on Standards for Tax Services.

The AICPA Code of Professional Conduct, Rule 102, is clear: "In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interests, and shall not knowingly misrepresent facts or subordinate his or her judgment to others."

Conflict of Interest, Rule 102

When performing any professional service, Rule 102 requires that a CPA shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. As revised, interpretation 102-2 broadens the definition to include any existing relationship. The CPA firm is employed by the entity, and not the owners of the entity. Decisions regarding elections should be made by the owners, not the CPA firm. CPA practitioners should explain any election to the taxpayer and document in writing both the disclosure and the client's decision to authorize the election.

Determining Professional Liability

Tort principles provide that professionals have a duty to exercise a level of care, skill, and diligence commonly associated with that of other members of their profession under similar circumstances. Contract principles require practitioners to competently perform the task undertaken.

For a plaintiff to prevail in a malpractice action against a tax preparer, the plaintiff must prove: (1) the tax preparer owed a duty to the taxpayer, (2) there was a breach of that duty, (3) the plaintiff suffered injuries, and (4) there was a proximate cause between the injury suffered and the duty.

In cases of tax return preparation, illustrating these four elements and the interconnectedness is straightforward. The first element is typically memorialized in an engagement letter that delineates the scope of the accountant's duties and responsibilities to the taxpayer. Alternatively, the tax preparer verbally agrees to prepare the taxpayer's tax return and undertakes this task.

The second element arises when the tax preparer makes a significant error or omits salient information that results in the preparation and submission of a flawed tax return. The details of the Accountant's lack of due care have been mentioned.

The third element includes the direct and consequential damages that stem from a tax preparer's failure to fulfill his or her duties and responsibilities.

The fourth element draws a causal connection between the second and third elements.

The following terms and definitions may be helpful:

Audits and Auditor's Opinions
An audit is the verification of a company's books and records pursuant to federal securities laws, state laws, and stock exchange rules that must be performed by an independent CPA. Generally, accountants must use generally accepted accounting principles (GAAPs) and generally accepted auditing standards (GAASs).
Accountant's Liability to His or Her Client for Breach of Contract and Fraud
Under common law, accountants may be found liable to clients who hire them under several legal theories, including contract, fraud, and negligence.
Accountant Malpractice
Accountant malpractice occurs when the accountant breaches the duty of reasonable care, knowledge, skill, and judgment that he or she owes to a client when providing auditing and other accounting services to the client.
Accountant's Liability to Third Parties
Under Section 552 of the Restatement (Second) of Torts, an accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client's financial statements. The provides a broader standard for holding accountants liable to third parties for negligence than the Ultramares doctrine.
Foreseeability Standard
Under the foreseeability standard, an accountant is liable for negligence to third parties who are foreseeable users of the client's financial statements. This provides the broadest standard for holding accountants liable to third parties for negligence.
Accountant's Civil Liability
Accountants can be liable for violating various federal and state statutes, the most important of which is federal securities laws.
Accountant's Criminal Liability
Accountants can be criminally liable for violating certain federal and state securities laws and for other law violations.
Accountant / Client Privilege
Accountant/client privilege says that an accountant cannot be called as a witness against a client in a court action in that state. About 20 states have enacted laws to that effect. Federal courts do not recognize the privilege.
Accountant's Work Papers
Some states have enacted statutes that say an accountant's work papers cannot be used in a court action in that state. Federal courts do not recognize this statute.

Terms:

  • Accountant Malpractice - occurs when the accountant breaches the duty of reasonable care, knowledge, skill, and judgment that he or she owes to a client when providing auditing and other accounting services to the client.
  • Audit - the verification of a company's books and records pursuant to federal securities laws, state laws, and stock exchange rules that must be performed by an independent CPA.
  • Certified Public Accountant (CPA) - an accountant who has met certain educational requirements, has passed the CPA examination, and has had a certain number of years of audit experience.
  • Engagement - a formal entrance into a contract between a client and an accountant.
  • Foreseeability standard - a rule that an accountant is liable for negligence to third parties who are foreseeable users of the client's financial statements. Provides the broadest standard for holding accountants liable to third parties for negligence.
  • Generally Accepted Accounting Principles (GAAPs) - standards for the preparation and presentation of financial statement.
  • Generally Accepted Auditing Standards (GAASs) - standards for the methods and procedures that must be used to conduct audit.
  • 1976 Tax Reform Act - an act that imposes criminal liability on accountants and others who prepare federal tax returns if they (1) willfully understate a client's tax liability, (2) negligently understate the tax liability, or (3) wrongfully indorse a client's tax refund check.
  • Privity of Contract - the state of two specified parties being in a contract.
  • Racketeer Influenced and Corrupt Organizations Act (RICO) - an act that provides for both criminal and civil penalties for securities fraud.
  • Section 10(b) - a section of the Securities Exchange Act of 1934 that prohibits any manipulative or deceptive practice in connection with the purchase or sale of any security.
  • Section 11(a) - a section of the Securities Act of 1933 that imposes civil liability on accountants and others for (1) making misstatements or omissions of material facts in a registration statement or (2) failing to find such misstatements or omissions.
  • Section 18(a) - a section of the Securities Exchange Act of 1934 that imposes civil liability on any person who makes false or misleading statements in any application, report, or document filed with the SEC.
  • Section 24 - a section of the Securities Act of 1933 that makes it a criminal offense for any person to (1) willfully make any untrue statement of material fact in a registration statement filed with the SEC, (2) omit any material fact necessary to ensure that the statements made in the registration statement are not misleading, or (3) willfully violate any other provision of the Securities Act of 1933 or rule or regulation adopted thereunder.
  • Section 32(a) - a section of the Securities Exchange Act of 1934 that makes it a criminal offense for any person willfully and knowingly to make or cause to be made any false or misleading statement in any application, report, or other document required to be filed with the SEC pursuant to the Securities Exchange Act of 1934 or any rule or regulation adopted thereunder.
  • Section 552 of the Restatement (Second) of Torts - a rule that an accountant is liable only for negligence to third parties who are members of a limited class of intended users of the client's financial statements. Provides a broader standard for holding accountants liable to third parties for negligence than the Ultramares doctrine.
  • Ultramares Doctrine - a rule that an accountant is liable only for negligence to third parties who are in privity of contract or a privity-like relationship with the accountant. Provides the narrowest standard for holding accountants liable to third parties for negligence.
  • Uniform Securities Act - an act that has been adopted by many states. It was drafted to coordinate state securities laws with federal securities laws.
  • Work Product Immunity - a state statute that says an accountant's work papers cannot be sued in a court action in that state. Federal courts do to recognize this statute.
For our presentation on CPA Malpractice, click here.

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