By Jim Koerber, MSCPA Member

While there is an abundance of articles written about steps to avoid malpractice lawsuits for a Certified Public Accountant (CPA), resources related to defending the CPA in a malpractice claim appear to be limited.

CPAs know to discontinue providing services to a client when issues such as unpaid fees or client integrity occur. However, even if a CPA complies with the professional requirements of the CPA profession when preparing an income tax return or conducting an audit, the CPA may still find that a client, other entity, or individual files a lawsuit because of an event that they allege is related to the services provided by the CPA. The plaintiff usually alleges some type of negligence on the part of the CPA.

After the lawsuit is filed, the process begins to analyze the alleged economic damages claimed by the plaintiff. The attorney defending the CPA will have a background in accounting malpractice claims and knowledge of related Federal and state case law. The CPA’s attorney will hire experts to assist in this analysis. While there can be multiple experts, the primary experts for a CPA malpractice lawsuit are usually a CPA who is knowledgeable in the standard of care and a CPA who is knowledgeable in the area of economic damages. For example, if the lawsuit involves the audit of a manufacturing company, the attorney should retain a CPA who has extensive knowledge in auditing manufacturing companies. While hiring a CPA who is knowledgeable in auditing in general might appear prudent, it can be a weakness if the CPA has a limited area of expertise for auditing a specific industry.

A CPA knowledgeable in economic damages is also vital to defending the claim. Just as the standard of care CPA should have extensive knowledge in the auditing of a specific industry, the economic damages CPA should be knowledgeable in issues related to quantifying economic damages. Often in a CPA malpractice lawsuit, the plaintiff’s attorney will hire a CPA or economist to opine to the economic damages, which might relate to lost profits or loss of business value. The CPA’s expert will review the damage calculation of the plaintiff’s expert to determine if the damages comply with peer-reviewed publications. If there are shortcomings to the plaintiff’s economic damages, the defendant’s economic damages CPA should be able to identify those issues.

For example, if the economic damages relate to a lost profits claim against the CPA, the following are areas that must be established by the plaintiff:

1. Proximate Cause – Is there evidence to make a connection between the services performed by the CPA and the alleged damages?
2. Foreseeability – Is there evidence that the alleged damages were foreseeable when the CPA was engaged to perform the services?
3. Reasonable Certainty – Is there evidence to calculate the plaintiff’s economic damages with reasonable certainty and not speculation?

In reviewing the alleged economic damages presented by the plaintiff’s expert, the economic damages CPA may be able to discover flaws in the report prepared by the plaintiff’s expert. Some of these might include:

1. Failure to deduct avoided costs, which are those expenses that would have been incurred to generate the lost revenues. Since case law requires net profits to be determined in lost profit cases, if the plaintiff’s expert fails to deduct avoided costs, then the damage calculation may be deemed flawed. Avoided costs are generally variable expenses, but, under certain circumstances, may include fixed expenses.
2. Failure to comply with one of the generally-accepted methods for calculating lost profits, which may include the “before and after” method, the “yardstick” method, and other methods. In this area, some experts mistakenly state the damages are under the “but for” method. However, “but for” is the concept for lost profits and not a method. Even if the plaintiff’s expert complies with these methods, the expert’s opinion regarding damages may still be flawed because of the underlying data relied upon and other issues.
3. Failure to consider mitigation, which requires the plaintiff to take realistic steps to prevent future losses and/or to reduce the lost profits. If the plaintiff does not attempt to mitigate, the defendant CPA may have an affirmative defense.
4. Failure to consider relevant factors, which could include changes in competition, government regulations, the economy, the industry, changes in operations, and the loss of key personnel and how these other factors affected the plaintiff. These relevant factors must be considered and addressed by the plaintiff’s expert.
5. Failure to calculate the damages with reasonable certainty, which has been described in How Judges Think (2008) by the Honorable Richard A. Posner as, “Does the court think that, given all of the circumstances, this plaintiff has presented sufficient evidence to make it fair to award it the damages in question?” While an exact damage calculation is not required, the damages cannot be based on speculation.
6. Failure to connect the damages to the services provided by the CPA, which is the “proximate cause” requirement. As the U.S. Fifth Circuit Court of Appeals found in Gallagher v Babcock (706 F.3d 284, 5th Cir. 2012), “The comparison of profits before and during a period of alleged illegal activity, without proof, does not prove causation.” Therefore, the report of the plaintiff’s expert should be based on economic reality.

While the experience of a malpractice lawsuit against a CPA or a CPA firm is something all CPAs wish to avoid, it can happen. The plaintiff will attack the CPA defendant in an attempt to establish alleged damages. However, with professional advice and guidance from qualified and knowledgeable attorneys and experts, these alleged damages can be examined closely in order to possibly reduce or eliminate them.

Jim Koerber, CPA/ABV/CFF, CVA is a shareholder with The Koerber Company, P.A. in Hattiesburg. Jim and those in his firm provide business valuation and litigation services to attorneys, CPAs, and their clients.