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Do Accountants Face Risk as Fiduciaries?

Outside accountants – including auditors, those providing other attestation and compilation services, tax preparers and even mere advisers – are increasingly facing allegations that they served their clients in a fiduciary capacity. These are not simply idle observations: In general, they are made by clients and third parties seeking to obtain monetary damages from the accountants as a result of, inter alia, errors in financial reporting, tax positions that are subsequently rejected by the IRS or other authorities and losses incurred by clients or third parties following advice presented by the accountants. The reason adverse parties seek to impute fiduciary obligations to the accountants is that this offers them the opportunity to seek larger settlements or court-imposed awards, if the defending accountants are found liable. Fiduciary duties pose major risk for accountants and for those writing insurance coverage for them.

Traditionally, accountants were not considered to be fiduciaries, and in some instances still cannot be held to be such, either because of the nature of the services being rendered or the character of the client organization. However, over time the threshold for finding (or, at least, being permitted to argue in litigation) that the accountants were de facto fiduciaries has been lowered by court rulings. The implications for the accountants are serious – and they warrant taking steps to mitigate, by use of appropriate engagement letter language, and by exercising greater caution in taking on clients and in performing services for them. Those underwriting accountants’ malpractice insurance should be equally concerned with how well, if at all, their insureds have dealt with this risk factor.

What makes a party a fiduciary?

Fiduciary status is not well defined under the law, and this lack of precision has led, over time, to a creeping extension that now sometimes even reaches to outside accountants. A fiduciary relationship gives rise to fiduciary duties, the primary one of which is that of loyalty. As expressed more expansively in a number of key court decisions, “[a] fiduciary relationship carries with it the duty of candor, rectitude, care, loyalty and good faith.”[1]

Fiduciaries are required to hold their beneficiaries’ (i.e., clients) interests uppermost. Generally, fiduciary relationships are characterized as involving two parties, with the one (the fiduciary) acting on behalf of another (the beneficiary). The acting party exerts control over a critical resource that belongs to the other party – for example, the fiduciary invests funds belonging to the beneficiary, or controls the official filings (e.g., financial reports or tax returns) that are the obligation of the other party. The other party must have a relevant vulnerability (lack of investing expertise, technical knowledge, etc.) that places the beneficiary in what amounts to a subservient position vis-à-vis the fiduciary regarding the object of that relationship.

A fiduciary duty arises by either of two means: by operation of law or by application of legal factors. The first of these connotes a formal relationship between the parties, whereas the latter arises from informal relationships. Furthermore, in matters that have been elevated to the domain of litigation, there have been various ad hoc determinations that fiduciary obligations have attached, beyond those set forth in established law.

Examples of formal relationships to which fiduciary obligations will be ascribed include trusts, guardianships, agency arrangements, partnerships and joint ventures, corporations (regarding the duties of directors and officers) and counseling relationships (this being the most controversial). Counseling relationships may be those of attorneys and accountants and their respective clients, medical doctors and psychiatrists and their respective patients and even clergy and their parishioners. More generally, counseling relationships may include any others where the giving of advice in confidential settings is a central defining condition.

Informal relationships may also be interpreted as requiring the duty of loyalty. To rise to this status, there must be “trust” or “confidence” reposed by one person (or entity) in another, and there must be a resulting “domination,” “superiority” or “undue influence” of or over the other party (the putative beneficiary of the fiduciary relationship). It is important to stress that neither trust nor vulnerability alone suffice – it is widely held that both must be present to successfully assert that such an informal relationship creates fiduciary obligations.

More generally, if any person solicits another to trust her in matters in which she represents herself to be expert as well as trustworthy, and the other party is not expert and accepts the offer and reposes complete trust in that person, a fiduciary relation is likely established.

However, sharing expertise with another party is not, per se, enough: It is clear that not every expert is or can be held to be a fiduciary.[2]  There is a wide range of informal relationships, not all of which will connote fiduciary obligations. As the Restatement of Trusts notes, “Although the relationship between two persons is not a fiduciary relationship, it may nevertheless be a confidential relationship. Conversely, a fiduciary relationship may exist even though the parties do not enjoy a confidential relationship.” Thus, this is a grey area in the law, and this very ambiguity is what creates risk for the unwary.

For example, a financial reporting expert may advise a client on the various ways a particular transaction or event might be reported, or even opine that only a single approach would meet professional standards, but the ultimate decision remains that of the client, who may reject such advice or seek other opinions. The accountant does not dictate how the transaction or event has to be reported in the client’s financial report (although, if serving as independent auditor, the accountant may elect to render a less-than-unqualified opinion if the client elects an improper method of accounting having material impact on those financial statements).

As already noted, determinations establishing fiduciary obligations have been sometimes made on an ad hoc basis by the courts. Of greatest relevance to the present discussion, this tendency has increasingly brought accountants under the fiduciary duty umbrella, sometimes to the accountants’ great surprise and dismay. Most commonly, in the author’s experience as a practicing accountant, this has involved tax preparers who may rather casually offer investing advice to their clients. For example, upon noting a particular client’s high tax bracket, some tax preparers will make offhand comments about the virtues of, say, municipal bonds or real estate as investment options, or wax enthusiastic about a specific bond issue or mutual fund, which is more of a concern. More recently, this logic – applying fiduciary obligations to accountants offering investment counseling – has been extended to those offering a range of non-tax services, even if tradition and professional standards clearly prohibit the accountants performing those services from also serving in a fiduciary role.

What are the duties of a fiduciary?

Being defined as a fiduciary (whether or not a formal fiduciary relationship has been documented) brings with it a range of obligations. As noted, the most significant of these is the duty of loyalty. The interest of the principal (the beneficiary, or the client) must come first – even to the exclusion of the interests of the fiduciary. For example, if our hypothetical tax preparer suggests a certain class of investment to his client, it must be believed that this is an optimal investment strategy for the client, unrelated to the accountant’s own investment interests. Touting an investment in the hopes that, e.g., an increased demand will lift prices and thus benefit the accountant’s own holding of the same asset would clearly be a breach of this obligation.

In addition to making (or seeking to make) a hidden profit from advice given to the beneficiary, competing against the beneficiary (e.g., putting in a bid for property sought by the beneficiary, or “front running” an investment in securities), or simultaneously acting on behalf of another party whose interests are adverse to the beneficiary, would constitute breaches of the loyalty obligation. Because accountants typically have a large number of clients, there is a real risk that this prohibition could inadvertently be contravened.

A fiduciary also has a duty to disclose all relevant facts to its beneficiary. Again harking to the tax preparer/adviser situation, if the accountant is positioned to benefit if the client follows this investment advice (e.g., will obtain a referral fee or commission), this must be clearly communicated to the putative beneficiary. If an accountant is placed in the role of a fiduciary, the duties to exercise reasonable care and to maintain client confidences, found in the professional technical and ethical standards, must still be observed. Additionally, the fiduciary has a duty to maintain client confidences, which might carelessly be disobeyed even in the course of casual conversations with the accountants’ other clients.

Why is being held to be a fiduciary a risk for accountants?

Being held accountable as a fiduciary has one very crucial implication. Whereas assertions of failure to exercise due care (the normal standard to which outside accountants are held) lie within the domain of tort law, assertions of failure to meet the requirements of loyalty are found within fiduciary obligations. In the instance of allegations of breach of fiduciary duty, the burden of proof shifts to the respondent accountant, who must show, inter alia, that all material facts had been provided to the beneficiary and that all other fiduciary obligations have been satisfied.

In the event of a finding of failure to exercise ordinary due care, as defined in the professional standards with which the accountant is obligated to comply, damages are limited, typically, to actual damages suffered by the plaintiff, assuming that the tripartite required demonstrations of liability, reliance and damages have been achieved by the complaining party. In contrast, a failure to meet fiduciary obligations may result in punitive damages as well as the awarding of plaintiff’s legal fees, and thus presents a significantly greater financial risk for the accountants and for their insurers. The burden of proof, coupled with the potentially greater monetary damages, makes defending against well-founded accusations of having been a fiduciary and having breached associated duties to the beneficiary a much more serious concern.

The evolution toward fiduciary obligations for accountants has accelerated over the past few decades. During the 1970s and 1980s, claims against CPAs were commonly based on fraudulent misrepresentation and negligence (i.e., professional malpractice), as well as on contractual breaches (in the case of suits by clients against their accountants, who had purportedly failed to perform the assignment for which they had contracted). The 1990s witnessed an increase in claims made against CPAs that argued that they had served as financial advisers. This led to allegations of breach of fiduciary duty and a range of other assertions, such as functioning as an unlicensed investment adviser.

In the early 2000s, courts readdressed fiduciary duty claims, as they might pertain to CPA liability matters. In a seminal case, Miller v. Harris, decided in 2013,[3] a state appellate court reversed and remanded the trial court’s dismissal of a complainant’s breach of fiduciary duty claim against the respondent accountants. It found that contracts (such as that between the accountant and his client) between litigating parties do not control a claim for breach of fiduciary duty, because the latter are not based on contract law. This distinction is a vital one, establishing an important principle. Further, the court stated that a claim for breach of fiduciary duty must allege the existence of a fiduciary relationship and a breach of duties imposed as matter of law as a result of that relationship. The net effect of the Miller v. Harris appellate decision was to set a new, lower bar for fiduciary status by operation of law (i.e., for an informal relationship).

Given this decision and others, there is an enhanced likelihood that future actions against accountants will attempt to assert as fiduciary those relationships that, in the past, were not deemed to be such. Accountants, and their insurers, thus would be wise to give increased attention to this risk, and take steps to mitigate it, where possible.

What steps should be taken in actual practice to guard against this risk?

Although the record has been mixed, there has been some expansion of fiduciary duties over past decades to include accountants. Traditionally, of course, accountants generally had not been deemed fiduciaries. Indeed, their obligations to third parties and requirement for independence historically confirmed non-fiduciary status on accountants, inasmuch as duties to third parties could not coexist with loyalty to the client entity’s management.

Whereas at one time any attempt to attribute fiduciary status to accountants, for the purpose of alleging breach of fiduciary duty by them, would have been almost automatically dispensed with, today accountant defendants are very unlikely to obtain summary dismissal of breach of fiduciary duty claims. Instead, courts are holding this matter to be a fact issue to be resolved at trial. For the accountants, one important implication is that, even if the defense ultimately prevails, they will be forced to incur costs to defend against such claims. In litigation, even when you win, you often lose.

The existence of a fiduciary relationship is now defined to be a question of fact. If the facts support the assertion that an accountant acted as a fiduciary for the client, that accountant will be exposed to liability for breach of fiduciary duty, which may result in economic harm greater than in the situation of a garden-variety failure to exercise due care in a professional negligence suit, including the possibility of punitive damages and attorney’s fees being levied. The burden of proof is essentially placed on the defending party once the existence of a fiduciary relationship has been established by the complainant. Summary dismissals of fiduciary obligation claims against accountants are now unlikely to be obtained, meaning costs of defense must be borne even when ultimate exoneration is achieved.

Engagement letter limitation of damages language will often not be effective in precluding punitive damages, so this risk element cannot easily be protected against, if a fiduciary relationship can be established by the complaining party.

Contractual language defining the assignment as not implying fiduciary duties may not be sufficient to defend the suit. Nevertheless, having a well-crafted engagement agreement with clients remains an important defensive strategy – and such letters are mandated under professional standards for most ordinary accounting and auditing services. In the author’s opinion, the role of “adviser” should be avoided or severely constrained, if later allegations of breach of a fiduciary relationship-based obligation are to be averted.[4]

If advice is provided in circumstances in which the client can later plausibly claim to have been in a subservient role – thus, where the accountant was effectively making decisions for the client – there will be risk. Obtaining “informed consent” for recommendations made to the client would be one procedure providing some reduction in such risk. All recommendations should be couched in language that requires the client to consider and then independently conclude upon the matter, by either accepting and acting upon it, or rejecting it.

Finally, for both insureds and insurers, it would be wise to consult with a qualified attorney regarding the language used or proposed for accountants’ engagement letters for the various services being offered. Only in this way will risks, including that of being held accountable for breach of fiduciary duties, be most effectively addressed and, to the extent possible under evolving legal standards, contained.



[1]  See, e.g., Miller v. Harris, 2013 IL App (2d) 120512, ¶21; In re the Estate of Abernethy, 2012 Tex. App. LEXIS 4272; and Gracey v. Eaker, 2002 Fla. LEXIS 2662.

[2]  Burdett v. Miller, 957 F. 2nd 1375, 1381 (7th Circuit, 1992).

[3]  Miller v. Harris, Appellate Court of IL, Second District, 2013

[4]  Somewhat ironically, the trade association of public accountants, the AICPA, long promoted the catch-phrase “trusted (business) adviser” as a marketing tactic for CPAs to employ. It no longer does this, but a review of recent on-line articles and firm web sites reveals that this proclamation, or a close variant, continues in wide usage. Knowingly or not, many accountants are playing a dangerous game, wanting to tout their roles as adviser while rejecting status as fiduciaries.

Opportunities in Latin America

The Latin America insurance outlook for 2015 is generally favorable, with high-single-digit premium growth across the region presenting complex risks and opportunities. Although real economic growth has slowed recently in the largest markets of Brazil and Mexico, stronger economic growth and inflation in some areas continue to drive premiums. Long-term trends (reduced poverty, shrinking unemployment and a population increasing above the pace of most mature markets) are bolstering consumer demand for insurance products.

In general insurance, catastrophic risks from floods, hurricanes and earthquakes are driving premium growth in a number of Latin American countries. Premiums peak following major losses as demand increases and supply becomes more costly. In contrast, the underwriting cycle slowly reduces premium rates after benign catastrophe-loss periods, such as those experienced in the last few years. The development of efficient distribution systems to increase insurance market penetration and encourage product acceptance remains a critical challenge.

As economic, political and regulatory environments evolve inconsistently across the region, inflation risk continues to persist at varying levels. While Chile’s, Peru’s and Colombia’s annual inflation rates averaged 2% to 3% from 2009 through 2013, Argentina’s and Venezuela’s percentages were the highest in the region. Argentina’s battles with its creditors, and its governmental hand in business, have destabilized its currency. In contrast, Mexico’s government remains stable and is progressing with reforms to modernize insurance and other business sectors.

From a tax perspective:

  • Brazil imposes the highest income tax in the region, with insurer profits taxed at 40%. Popular products include health insurance and term life insurance, as well as auto and property covers, which are sold by independent brokers. Tax incentives for retirement accumulation plans are growing in popularity.
  • Mexico’s tax incentives, promoting retirement savings and a reasonable income tax structure, are contributing to growth. In a country where third-party auto liability coverage is mandatory in several cities, auto insurance generates the highest premiums.
  • The scenario is similar in Chile, where auto insurance is also compulsory and characterized by intense price competition. Provisional life and retirement products are part of the national social security system. Approximately half of all insurers are subsidiaries of international firms. Although an open market has led to stability and a competitive balance, insurers continue to adapt in the wake of earthquakes and other natural disasters.
  • In Argentina, independent agents and brokerage firms account for an estimated 75% of total premiums. The nationalization of private pension funds in 2008 changed the insurance industry structure, sharply reducing the size of the life and annuity market and the number of insurers in the country. Argentina imposes a high income tax burden, with profits taxed at 35% and a 10% dividend withholding tax.
  • Colombia, the fifth largest Latin American insurance market,
    is partially focused on investing in infrastructure to encourage demand for guaranty bonds. Automobile insurance, compulsory personal auto accident protection and reinsurance and earthquake insurance are the most important product lines. The industry aims to develop catastrophe insurance markets and enhance risk models, hoping that a stable commercial market will help deter government response to gaps in market coverage.
  • Peru has upgraded its economy in recent years to manage its rapid growth. Significant changes are being made in consumer protection, tax legislation and new regulation. Peru’s growth forecast is 6% this year, compared with predicted growth of 1.5% for Brazil and 1.1% for Mexico. Many foreign companies are considering Peru as a safe and desirable country for investment.

The Latin America insurance environment is becoming more similar to mature markets. Strong economic growth rates and regulatory reforms in the past decade(s) have attracted a number of global insurers, reinsurers and insurance brokers to the region. Mergers and acquisitions continue to help these global players build their positions. And cross-regional expansion efforts by Latin American-based insurers have increased their size and market reach, as well. These deals are enhancing insurers’ capabilities in product development and risk management. The implementation of new Solvency II insurance capital management regulations in 2015 is expected to result in a shift toward greater insurance industry consolidation and increased sophistication in risk management.

Low penetration rates in Latin America are caused by a number of factors and afford significant room for growth if economic expansion continues. Factors include:

  • Wealth disparity
  • Insufficient tax incentives for retirement products
  • Lack of knowledge among the general population about the value of insurance

Also contributing to potential opportunity is the changing perception of insurance as a necessity or investment, rather than a cost. This comes about with a change to the region’s income disparity, which in most countries is shrinking. Brazil is expecting double-digit declines in premiums across many low-hazard markets. In this heightened competitive environment, many insurers believe they can accelerate premium growth by targeting rapidly growing market clusters.

In comparison, Argentina is experiencing high inflation, tight regulation and a fluctuating economic market; nevertheless, insurance is a fast-growing industry that continues to show resilience in premiums and tolerance for expansion in a challenging environment. Argentina and Venezuela also have strict foreign-exchange control regimes. These generally do not allow residents to pay dividends or inter-company services/royalties outside of the country — in some cases, also limiting the deductibility of certain payments.

In general, it is worth discussing the value added tax (VAT) system in these countries,which is a key concern for insurers.TheVATpaid on the local purchase or importation of goods or services constitutes “input VAT” that typically should be credited against the “output VAT” generated on the taxable sale of goods or services. VAT should not be a cost of doing business. However, VAT is often an unexpected cost when entering a market. In the case of Latin American insurers with VAT taxable and non-taxable activities, the VAT calculation methodology is complex and usually generates some level of irrecoverable VAT.

Some products sold by insurance companies are exempt from VAT, meaning that any VAT incurred on the local purchase of goods or services becomes an irrecoverable cost for the insurance company (although deductible for local corporate income tax purposes). For example, the following are exempt:

  • Argentina’s life insurance and workers’ compensation policies
  • Mexico’s life and pension insurance
  • Certain insurance contracts in Chile, including those related to international trade, insurance of assets located outside of Chile and earthquake-related coverage

Brazil deserves a separate analysis because Brazilian insurance companies are subject to Social Integration Program (PIS) and Contribution for the Financing of Social Security (COFINS) taxes on gross revenues, at a combined rate of 4.65%. PIS/COFINS are not a VAT type of tax but, rather, they are paid on a cumulative basis: any PIS/COFINS paid by the local insurance company is not a recoverable cost. Brazil has a state VAT (ICMS) and a federal VAT (IPI), but these taxes do not apply to the sale of insurance products.

Property/casualty, auto insurance, professional liability, environmental and finance solutions are generally subject to VAT in Latin America, so any VAT paid should be fully recoverable for the local insurance company.

In addition to the VAT, some Latin American countries impose additional layers of indirect taxes that should be carefully reviewed by local insurers (e.g., gross revenue taxes, taxes on financial transactions, net worth taxes and stamp taxes, among others).