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RICO: the threat is lifted.

For a long time, CPAs have been concerned about lawsuits brought under RICO. Under the federal RICO statute, CPAs and other professionals who are only indirectly associated with a troubled entity can be held liable for massive damages and be implicated in "a pattern of racketeering activity."

Fortunately, as this article demonstrates, recent case law shows a trend to dismiss RICO claims against outside accountants (and other professionals) who did not participate in the management or operation of the companies to which they provided services. As a result, CPAs can take a different approach to RICO lawsuits.


At the forefront of this trend is the U.S. Supreme Court decision in Reves et al. v. Ernst & Young, which clarified the degree of participation a defendant must have in an enterprise's operation to be held liable under RICO (see Legal Scene, JofA, May 93, page 24, and Dec.93, page 20). The Supreme Court decision dismissed the RICO claims against the accountant and narrowed the scope of RICO to exclude professionals who do not direct the conduct of the companies to which they provide accounting services. The decision effectively protects outside professionals, such as accountants, against RICO liability.

What is significant about this dismissal is that the Supreme Court, using a restrictive RICO interpretation, established a "participation" test to determine liability for violations under RICO--a test since adopted by the lower courts and one that appears to shield CPAs from RICO liability. The Supreme Court held that to be liable under RICO, a CPA must do more than simply supply accounting services; he or she must have a role in actually running the business of the company charged with the violation. The Supreme Court dismissed the RICO claims against the CPAs despite a jury's guilty verdict for fraud in connection with two audits. The decision made clear that in the absence of allegations that a defendant had some measure of control over, or direction of, the enterprise, courts must dismiss the plaintiff's RICO claims.

Since CPAs usually are not involved in a client's operation or management, common sense says the courts will refuse to sustain RICO claims against outside accountants unless managerial involvement can be shown.


A number of lower courts have followed the Supreme Court's lead and dismissed similar RICO claims, further reinforcing the degree of protection CPAs are provided. For example, in Chamarac Properties, Inc. v. Pike, the Southern District Court of New York dismissed RICO claims against a defendant who was not only an accountant but also a limited partner in one of the defendant's entities. There, the court held that even one's status as a limited partner in an enterprise did not itself demonstrate the degree of control or direction necessary to maintain a RICO claim. Moreover, the court made clear that allegations that the defendant partook in its clients' alleged fraud by receiving unwarranted and unjustifiable professional fees were not enough to sustain a RICO claim.

Similarly, the U.S. Third Circuit Court of Appeals, based in Philadelphia, in University Of Maryland at Baltimore v. Peat, Marwick, Main & Co., also dismissed RICO claims based on the Reves operation and management participation test. In that case, the defendant audited an insolvent insurer's books and allegedly prepared false and misleading financial statements for the insurer. Following the Supreme Court's lead, the Third Circuit dismissed the RICO claims because the plaintiff failed to allege the defendant had any part in operating or managing the insurer's affairs.

Although another case, Morin v. Trupin, involved attorneys, not accountants, it nonetheless provides additional support for dismissal of RICO claims against CPAs. The Southern District Court of New York held that a law firm could not be liable for RICO claims based upon legal advice given to its client if the firm did not participate in controlling the enterprise.

In Strong & Fisher Ltd. v. Maxima Leather, Inc., the Southern District Court of New York unequivocally stated that influence over an enterprise does not mean control of that enterprise; in this case the CPA firm was not only the accountants for but also a major creditor of the troubled corporation.


In light of the recent trend discussed above, perhaps the burdensome lawsuits containing RICO claims against accountants will decrease. However, even if such lawsuits continue, CPAs can rest assured that the threshold requirement of "participation in an enterprise's operation and management," established by the Supreme Court, creates a major obstacle to their liability. Practitioners should, in the future, take a very aggressive posture when faced with a lawsuit in which they are charged with RICO violations.


This list is adapted from the Accountant's Liability Newsletter, Second Quarter 1994 ([C] 1994, Aon Insurance Services, Trevose, Pennsylvania. Reprinted with permission of the original publisher. All rights reserved).

1. Choose clients carefully. Avoid clients in financial or organizational difficulties; clients that change firms often; clients that have inadequate recordkeeping. Interview prospective clients and chat with their former accountants; if your inner feeling is not to take an engagement, don't. You must be comfortable with your clients.

2. Establish a workable feepayment schedule before accepting an engagement. Spell out details in the engagement letter.

3. Always use an engagment letter. The letter should address the who, what, when and why questions, payment terms and schedules and dispute resolutions. Engagement letters should be reviewed annually and, if necessary, revised. The revised letter should then be signed by both you and your client.

4. Do not sue for fees. Follow the dispute resolution terms set out in the engagement letter.

5. Document everything. Doing so is a critical part of your work and defense if you're sued; documentation lapses probably will be an issue in court.

6. Educate your staff on the extreme importance of proper work paper documentation.

7. Don't accept an engagement for which your firm is not qualified. A majority of claims involve services a CPA performs only once a year. Don't accept a $5,000 fee if it creates the potential for a $1 million malpractice claim.

8. Keep current on applicable accounting standards and new developments, from subtle changes in local tax laws to federal tax reforms. Keep informed of what's going on in the profession.

9. Exercise caution when making representations and rendering advice. Insist on adequate information to make decisions and research properly. When in doubt, consult with a colleague. Never render legal advice.

10. Maintain a balanced book of business. Don't allow client pressure to hinder objectivity. Never represent two sides of a transaction--a real estate sale, buy-sell transaction or divorce.

11. Meet your deadlines with an automatic docket system that not only advises you well in advance to complete forms and file but also gives adequate warning about when to gather client data.

12. Practice quality control. When one employee completes work, another should review it. Sole practitioners should create checklists to make sure all steps involved in a project are followed consistently and establish relationships with other sole practitioners.


* RECENT CASE LAW shows a trend to dismiss claims under the Racketeer Influenced and Corrupt Organizations Act (RICO) against outside CPAs who did not participate in the management or operation of client companies.

* AT THE FOREFRONT of this trend is a U.S. Supreme Court decision, Reves et al. v. Ernst & Young, which effectively protects outside professionals, such as accountants, against RICO liability. The Supreme Court also established a participation test to determine liability for RICO violations.

* AS A RESULT OF THIS and subsequent decisions, CPAs should take a very aggressive stance when charged with RICO violations.
COPYRIGHT 1994 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1994, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Title Annotation:(includes related article on liability avoidance for accountants); Racketeer Influenced and Corrupt Organizations Act
Author:Jacobson, Andrea B.
Publication:Journal of Accountancy
Date:Oct 1, 1994
Previous Article:Ways to add value for clients.
Next Article:SEC chairman promises more investor protection.

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