Incorporated CPA firms.

Marvin L. Stone, CPA, 1967-68 president(*) of the American Institute of CPAs, says incorporation is needed to protect innocent partners' personal assets when their associates incur legal judgments.

The imposition of enormous judgments against CPAs makes it clear the accounting profession must change the ground rules if it is to survive. Current efforts to limit liability through legislation that substitutes proportionate liability for joint and several liability certainly will be helpful if they succeed. Moves to restrict the scope of Racketeer Influenced and Corrupt Organizations Act attacks and to cap tort awards also will help. However, none of these moves can provide the stability and security that would be fostered by extending the right to incorporate to all practice units.

AN UNREASONABLE BURDEN

The demise of Laventhol & Horwath provides a stark example of what can happen when a partnership is forced into bankruptcy:

1. The partners lost all the capital invested in the partnership, which averaged $175,000 per partner.

2. Pension payments to retired partners ranging from $20,000 to $80,000 per year ceased.

3. The active partners plus all partners who had retired in the preceding seven years were assessed a total of $47.3 million, which represented only a small percentage of the amounts owed to unsecured creditors. Such payments to the bankruptcy court averaged about $76,000 per partner, with some as high as $300,000 to $400,000. For many retired partners, this meant they not only lost their lifetime pensions but also were required to contribute funds to the bankruptcy settlement.

The consequences of the firm's demise go far beyond even the enormous losses mentioned above. A number of partners declared personal bankruptcy. Many older partners have been unable to obtain medical insurance because the firm was self-insured, even though its health plan was administered by a major insurance carrier.

PROTECTING PERSONAL ASSETS

Incorporation merely would serve to protect the personal assets of the innocent associates of a person whose work was the cause of a huge judgment. Of course, it would not have eliminated any of Laventhol & Horwath's financial losses except for the $47.3 million assessment against the personal assets of active and recently retired partners. Further, incorporation obviously would not limit the liability of a CPA committing an error, and his or her firm's assets still would be at risk.

Since the value of an owner's firm interest usually is a significant part of his or her net worth, all owners still would have a significant stake in their firm's welfare and the quality of its work. However, it makes no sense for each owner's personal assets to be at risk in an action stemming from an engagement performed at some remote location with which he or she had no connection. If a huge judgment or combination of judgments was imposed on an incorporated accounting firm, the firm might be brought to its knees. However, if its owners were not stripped of their personal assets, they still might be able to regroup and rebuild the firm's practice from the ashes of its predecessor.

PARTNERSHIP IS INAPPROPRIATE

The corporate form clearly provides a better way to organize human resources and capital. Most sizable firms already have adopted many corporate characteristics. Partnership agreements have been fashioned in ways that simulate corporate characteristics such as perpetuity and centralized management and decision making, which normally are not partnership attributes.

Assume you have a client that

* Has 5 (or 50 or even 500) partners.

* Plans to admit more partners continually.

* Does business in more than one state.

* Is highly vulnerable to damage suits.

* Has ever-increasing capital needs.

Wouldn't you advise such a client to incorporate?

A STEP IN THE RIGHT DIRECTION

Last year, the AICPA council recognized the birth of a new kind of entity--the limited liability company (LLC)--in several states. Although such companies are not incorporated, their owners' liability is limited by law when specific conditions are met. AICPA rules were amended to permit members to practice in any form permitted by state law. LLCs, like professional corporations, can benefit firms practicing in a single state but probably are of little use to firms operating in more than one state.

Although I was not present at the council meeting at which the LLC matter was discussed, I understand at least one practitioner suggested his unlimited personal liability had a salutary effect on the care he exercised in his work. Certainly, I would not tell that practitioner or others of a similar mind that they must incorporate. I would only recommend that the rules be changed to permit anyone who desires the protection of corporate form to do so.

If one took that practitioner's comments to their logical extreme, one would have to conclude that errors and omissions insurance is undesirable because it diminishes the amount of a practitioner's risk. Those who recommend obtaining insurance coverage but reject incorporation would probably tell a trapeze artist, "It's all right to buy life insurance, but using a net during your act will make you careless in your work."

ACTION PLAN

In states where the stockholders of professional corporations do not bear the burden of joint and several personal liability, we have almost 25 years of experience with thousands of practice units in which CPA stockholders effectively have obtained the same liability limitations that general corporations have. To my knowledge, the limited liability of these firms' stockholders has had no detrimental effect on the firms, on the public or on our profession's image. It's time to grant the same limited protection to the owners of all CPA firms.

To accomplish that goal, the AICPA should

* Amend any rules that place greater restrictions on CPAs practicing in corporate form than on those in unincorporated entities.

* Revise the Uniform Accountancy Act to permit practice in general corporate form and in LLCs.

* Undertake a concerted campaign to urge state CPA societies to seek amendment of their respective accountancy laws and any other laws that might prevent incorporation of CPA firms.

* Seek to allay members' misapprehensions that practice in corporate form is unethical.

* Consider whether preemptive federal legislation is desirable and feasible. One proposal for such action was put forward in March 1993 by the Public Oversight Board, which recommended that "Congress should adopt [such] legislation to permit the practice of accountancy in a form that appropriately limits the liability of individual members of the firm."

Our profession's antiquated and self-imposed limitations on incorporation have long since outworn their usefulness. Even Lloyds of London is proposing to limit its investors' liability, reversing a 306-year tradition. In today's litigious environment, insisting that every CPA must be liable without limitation not only for his or her own acts but also for the acts of each partner is suicidal. It's time to allow CPAs to incorporate, too.

(*) The title of the chief elected officer of the Institute was changed in 1974 to chairman of the AICPA board of directors. The chief staff officer became the president.