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Frank Vinluan
Tips for reducing professional liability risk in business valuation

Using engagement letters and adhering to AICPA valuation standards are among the best practices that can help CPAs protect themselves.

January 21, 2015
by Frank Vinluan

The risk of a lawsuit can start with the most innocent of questions. Take, for example, a client asking an accountant, “How much do you think my business is worth?”

Even if the accountant initially declines to answer, the client may persist. After all, says Mark S. Warshavsky, CPA/ABV/CFF, the client may believe that who else but the company’s CPA, someone who has worked with the company’s financial records for years, would know the value of the business. With more prodding, an accountant may relent and provide a number—without performing the due diligence required by AICPA Statement on Standards for Valuation Services No. 1 (SSVS No. 1). If the client uses that off-the-cuff valuation on a financial statement, tax return, or loan application, or for some other financial transaction, the CPA could be held liable for failing to comply with the professional standards and face a professional liability claim.

Warshavsky, partner-in-charge of Gettry Marcus’s Business Valuation and Litigation Services Group, says that these impromptu and incomplete valuations are examples of how accountants expose themselves to the risk of a professional liability claim. Such risks exist even for accountants who are experienced business valuation professionals. Warshavsky says practitioners should be aware of the types of valuation work they are qualified to perform, and then clearly communicate these capabilities to the prospective client. Even with all of his business valuation experience, Warshavsky says he will turn down valuation engagements outside his areas of expertise.

“If they can’t do the valuation,” he says of practitioners, “they should hand it to someone who can.” Professional competence is addressed in SSVS No. 1, paragraph 11, as well as in the general standards included in the AICPA Code of Professional Conduct.

Business valuation claims are not as common as other litigation risks facing accountants. The majority of professional liability claims brought against CPAs in the AICPA Professional Liability Insurance Program emanate from tax work, notes Stan Sterna, Claim Director for the Accountants Professional Liability Claim unit at CNA, the underwriter of the AICPA Professional Liability Insurance Program. However, professional liability claims related to valuation services do exist, particularly when the valuation report becomes the basis for financial decisions made by businesses, regulatory agencies, and lenders, among others.

Valuation analysts face potential professional liability exposure, such as when valuations are prepared using the market approach. Practitioners can protect themselves by ensuring that they follow the proper steps in conducting a business valuation. Those steps include researching the appropriate companies when seeking comparable businesses. Problems can arise in doing something as simple as looking for businesses within a standard industrial classification code(SIC), Warshavsky says. Sometimes the SIC code is a catchall for a wide range of companies in a particular industry. But a closer look at the companies within the SIC code may reveal that the companies are not comparable at all.

Heading off problems

Even when a practitioner follows proper due diligence in conducting the valuation, a party who relies on a valuation may later be unhappy about what was paid—and then blame the accountant, Sterna says. These situations can arise when an asset underperforms after the transaction.

The role of valuation analysts is not unlike that of a judge—parties are bound by the decision of a business valuation professional, says Richard Witkowski, an attorney with Nicola, Gudbranson & Cooper. A CPA can have some protection with indemnification whereby both parties hold the accountant harmless, regardless of the valuation outcome. That way if someone is unhappy, the accountant does not become a litigation target. Indemnification and hold harmless language should be drafted with the assistance of an attorney and included in the client engagement letter.

“Generally, when you have to decide an issue in controversy, either one side is unhappy or both sides are unhappy,” Witkowski says. “That’s something you have to anticipate when you accept the engagement.”

If there is a conflict in a valuation engagement, the CPA must fully disclose the nature of the conflict to the client(s) and obtain a waiver. Obtaining a written waiver signed by the client(s) and describing the conflict(s) before performing the work is highly recommended. In some cases, full disclosure with a written waiver may be sufficient to avoid problems later, Witkowski says. In other cases, even a written waiver may not be enough to overcome a challenge to the CPA’s objectivity and propriety of the work performed. In such cases, the sufficiency of the disclosures relating to the conflict is frequently challenged. If an accountant has any interest in the outcome, such as a fee that is contingent upon the outcome, the practitioner will not able to obtain an effective waiver. SSVS No. 1, paragraph 14, sets forth the requirement of objectivity, the need for affirmative disclosure of the conflict, and the need to obtain client consent.

“It’s not enough for a CPA to be objective. Practitioners must also take care to express that objectivity in all aspects related to a valuation engagement,” Sterna says. Take care with electronic communications, whether in social media or email, which may be misinterpreted by a third party and interpreted as a signal of a CPA’s motivations. As an example, he cites a scenario in which a CPA and his client attended colleges that competed in the same football conference. Over email, they had a friendly exchange about an upcoming game. “What is generally an innocuous email was taken by the client’s attorney as a lack of objectivity,” Sterna says.

The value of engagement letters

Engagement letters can help avoid some professional liability risks. These letters establish the expectations for the work to be performed, the purpose of the valuation, and the standard of value that will be applied. Engagement letters can help limit the exposure of a CPA, though limitations of liability may or may not be upheld if a dispute goes to court.

An engagement letter can also lay the groundwork for dispute resolution outside of court. For example, an engagement letter can state that parties must first attempt to resolve disputes through mediation or arbitration. That’s important, Sterna says, because even an ironclad engagement letter won’t head off all disputes. But if the engagement letter states that alternative dispute resolution will be used to handle a dispute, that may be the preferred venue. Compared to a jury, arbitrators might have a better appreciation for the nuances of valuation work and that could weigh in a CPA’s favor.

“You can’t stop someone from litigating, but you can set forth the parameters of litigation,” he says. For more information on standards for establishing an understanding with the client or assumptions and limiting conditions, see SSVS No. 1, paragraphs 16, 17, and 18.

The SSVS No. 1 Toolkit provides engagement letter templates, compliance checklists, and sample reports to help you comply with the AICPA Statement on Standards for Valuation Services No. 1. FVS Section members and credential holders can access the toolkit by clicking here.

Disclaimer: This article provides information, rather than advice or opinion. It is accurate to the best of the author’s and contributors’ knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy.

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Frank Vinluan is a freelance writer based in Raleigh, N.C.