Client screening: how to reduce malpractice exposure.

Practitioners should at all times be selective and avoid high-risk clients. Knowing when to walk away from a client can be as important to a firm's survival as acquiring new clients.

There was a time when practitioners could accept almost every engagement without worrying about malpractice. However, with the increasing prevalence of fraud by management, clients' unwillingness or inability to pay for professional services, financial troubles affecting enterprises of all sizes, and dishonest professionals cloaking themselves in an image of integrity, screening clients before acceptance is becoming an important part of practice management. By establishing and remaining faithful to client-acceptance criteria and by documenting their efforts, practitioners can reduce their malpractice exposure. Clients who are untrustworthy and disreputable are too frequently involved in questionable financial transactions. A practitioner's connection in any way with such clients or activities may result in malpractice litigation by the wronged party.

Note: As part of the policy and procedure guidelines of the AICPA's Voluntary Tax Practice Review program, a thorough review of perspective clients is warranted to eliminate lawsuits.

Warning Signs

Practitioners should beware of the following characteristics when choosing clients:

[] Present or impending financial or organizational difficulty. Insufficient working capital, an industry experiencing many business failures, high turnover in key positions, the vesting of management responsibilities in one person when conditions warrant that they be shared by several persons, poor credit, dependence on a few select customers for products or services and companies that invest other people's money are all potential red flags. If a financially troubled client files for bankruptcy, there is a strong possibility that the practitioner will be named as a defendant in any resulting litigation.

[] Involvement in suspicious transactions. Practitioners should be alert to any activity that is (or appears to be) illegal, such as bribery, kickbacks, unauthorized corporate transactions, illegal contributions, or artificially improved financial statements. Increasingly, courts are expecting practitioners to detect fraud, embezzlement and other irregularities in a client's organization.

[] Unreasonableness and uncooperativeness. Practitioners should be wary of clients who balk at providing necessary documents and records in a timely fashion; fail to document underlying facts; have unrealistic expectations of the time needed to complete an engagement; blame the practitioner for their own company's financial problems; operate in an environment characterized by unfavorable tax laws and rulings and other circumstances beyond die practitioner's control; chronically change practitioners; provide vague, guarded responses to inquiries; threaten to take the company's business elsewhere; and request changes in the engagement.

[] Fee pressures. Some clients are only willing to pay an unreasonably low fee for professional services and regularly dispute their bills. Bargain hunters often withhold payment while they question bills--sometimes for months. If such a client is accepted, the practitioner may be forced to choose between losing money on the engagement or rendering services of lower quality. If malpractice litigation results, any deficiencies will be discovered and disclosed to a judge or jury. Moreover, the practitioner may have future collection problems with such a client. Once the engagement is accepted, the fee structure should not be allowed to affect professionalism, and the engagement should be completed as it normally would in the absence of fee pressures.

[] Refusal to sign engagement and representation letters. By accepting clients who will not sign these documents, practitioners expand their liability to these clients and to third parties.

[] Incompatible personality. Practitioners should learn as much as possible about a prospect's corporate and individual personality to determine if it is compatible with the firm's culture.

[] Frequent involvement in litigation. If the client has a tendency to rely on litigation to solve problems, chances are this will be his approach with his tax practitioner as well.

Other characteristics of prospects to be avoided include:

[] A need for an auditor toward year-end.

[] A weakness in or lack of internal controls.

[] A lack of organization.

[] Poorly maintained records and collection difficulties.

[] A failure to file income tax returns for several years.

It is particularly important not to rely too heavily on one client or group of clients for billings. For example, when one client represents 25% of a practice, or two clients represent 50%, or one publicly held client represents 10%, the practitioner's objectivity may be detrimentally affected, since the client (or clients) may exert undue influence on the practitioner's judgment.

Screening Procedures

By strictly adhering to client-acceptance guidelines and documenting all conversations and decisions made pursuant to them, a practitioner can increase the effectiveness of the screening process. A screening process that includes the following procedures is likely to result in a client base characterized by reputable, well-managed, financially secure clients who recognize the practitioner's responsibilities in providing quality professional services.

[] If the client approaches the practitioner first, determine why the client is interested in changing practitioners.

[] Visit a potential client's business premises to determine the conditions of its management, finances and internal controls. Some practitioners require that all new clients have their internal controls analyzed.

[] Meet a prospect's accounting and tax personnel to determine its specific financial needs and the condition of its accounting records.

[] Conduct a background check for all potential clients and check references to determine their reputation for honesty, credit history and rating, financial stability, cooperativeness and litigation history, potential conflicts of interest, quality of management, competency of personnel, personality and potential to be sources of new clients.

[] Determine if a prospect's industry or the services requested fall within the high-risk category. High-risk industries include savings and loans; health care, including hospitals, HMOs and nursing homes; property and casualty insurance; and not-for-profit organizations. High-risk services typically involve new financings; buy-sell situations; disputes between clients and third parties; liquidations, bankruptcies, going-concern issues or receivership engagements; tax returns, financial statements or tax opinion letters for limited partnerships; divorce proceedings (specifically, valuations of community property); and value determinations in which a practitioner represents both the buyer and seller of stock.

[] After receiving any necessary authorization, contact a prospect's former practitioner, as well as its attorney, bankers, credit bureaus, present and former business associates and employees. Inquiries to the Better Business Bureau, Chamber of Commerce, or applicable trade associations can be especially productive. Document all communications.

Value of Client Screening

It is far less complicated to refuse an engagement with a questionable client than it is to withdraw once services have already been provided. Should a practitioner decline an engagement, the prospective client must be informed of the decision verbally and in writing, and be advised that no action will be taken on the engagement. In some cases, it may be appropriate to inform the potential client of any approaching deadlines or statutes of limitations, and to advise him to retain another practitioner.

The value of client screening extends beyond client acceptance. It is equally important for client retention. The same review procedures should be systematically applied to existing clients annually, or whenever there is a substantive change in client circumstances. Such changes include developments in a client's financial condition or management, or changes in laws affecting the client, for example, Environmental Protection Agency regulations or hazardous-waste laws. Since a client's circumstances can change remarkably over time, a practitioner must immediately be made aware of any existing client that has become a high risk.

If the screening process does not produce sufficient information to warrant rejection of a prospective client or termination of an existing client, at the very least it identifies engagements that require extra precautions.

The creation of and adherence to strict client-acceptance and -retention guidelines yields a screening process that gets results. Maintaining client-acceptance and -retention programs is one method of reducing practitioners' exposure to questionable clients, thereby avoiding one possible road to malpractice litigation. A successful program is one in which the practitioner's representation of the client is in the best interests of both the client and the firm.

Editor's note: Mr Pascarella chairs the AICPA Tax Division Tax Practice Management Committee. Mr Murray, a technical manager in the AICPA's Technical Publications Division, is the author of Managing the Malpractice Maze," published by the AICPA. As an AICPA employee, Mr Murray's views, as expressed in this article, do not necessarily reject the views of the AICPA. Official Positions are determined through certain specific committee Procedures, due process and deliberation.

From Mark F. Murray, J.D., American Institure of Certified Public Accountants, Jersey City, N.J.