Lateral exposures heightened by scandals
By Gene Mason
With Arthur Andersen and other big accounting firms coming under fire, many accountants are on the move and they're taking their clientele with them. Are underwriters properly addressing this increased exposure in light of the Enron debacle? They should be.
The recent rise in accounting scandals has sent shock waves throughout all sectors of the business industry. A number of companies, including Enron, WorldCom, Tyco and AOL Time Warner have recently restated their earnings and are now facing serious issues. The large accounting firms that represented these and other companies are now facing increased legal exposure. These professional firms not only will suffer from legal problems and damage to their reputations, but they will also experience increased professional turnover.
Lateral accountants exposure is an aspect of underwriting that did not stand out as an overall concern in the past. An accountant who joined a firm and became a partner rarely left that firm, particularly a big accounting firm.
But in the present climate, an underwriter must take into consideration that many accountants at big firms are very concerned about their careers and personal reputations. Talented accountants will not wait around to find out if their firm will experience problems similar to Arthur Andersen or whether their professional career will be threatened by being associated with a troubled firm or client. Many have moved to other big firms or smaller firms to carry on their professional careers and have taken their clients with them. All this moving around has a significant impact on underwriting.
"The professional liability policy is really an asset of the accounting firm," says Anthony Greene, CIC, director of Herbert L. Jamison & Co., LLC, which develops professional liability programs for accounting firms. "It's there to protect the firm from claims in connection with work performed by the accounting firm."
This current situation in underwriting accounting firms is similar to how large law firms have traditionally been underwritten. Historically, lawyers have done a lot of job-hopping and underwriters considered the lateral exposure when underwriting a particular risk. Originally, large lawyer policies (similar to accountants' E&O policies) were not designed to pick up lateral attorneys. They were designed to cover the firm so that any lawyer representing it and billing clients on its behalf would be covered from day one going forward.
But soft market conditions, a large number of primary companies competing for business, and a number of large legal firms requesting that newly hired rainmakers be covered for their prior acts have all led to some underwriters presently including coverage for lateral exposures. Now this same consideration must be given to accounting firms. For larger accounting firms, coverage should not be automatic.
Says Greene: "The question for the new firm is do you want to subject your asset/professional liability policy to claims in connection with work that was not performed by your firm?"
In the past, clients of the Big 5 would not think of moving their business relationship outside a large accounting firm. But because of all the bad press some major firms have been receiving, there is going to be a flight to smaller accounting firms that have a good reputation. Today, Fortune 1000 companies are currently exploring that option.
Accounting firms need to protect their professional reputations now more than ever.
"Everyone involved needs to be asking if these firms have the competence and the resources to take on the larger assignments," says Tom Manisero, an attorney who represents several of the second-tier accounting firms. "And are there any historical issues with the lateral partner or his or her business that would generate successor liability for the new firm?"
When advising insureds, Greene points out, "As the Lateral Accountant is evaluating alternatives to protect him or her from claims stemming from an association with a prior firm, consideration must be given to claims against them arising out of work performed by partners and others in the prior firm. In many cases the most cost effective way to address these vicarious exposures is to handle them under the prior firm's policy or with an extended reporting endorsement or tail."
To help insureds avoid any possible exposures, underwriters must know what clients an individual accountant is bringing to the insured firm. Here are some underwriting questions to consider:
* Does the insured accounting firm wish to pick up prior accounts brought by the lateral accountant? If yes, the underwriter should:
1. Identify open and closed client matters and decide if they need to be excluded from coverage.
2. Review each lateral accountant's history with respect to claims, sanctions or formal reprimands.
* Is the lateral accountant leaving a bankrupt practice? If so, is there a predecessor insolvency exclusion in the policy?
* Is the lateral accountant making a clean break from predecessor firm?
* Is the lateral accountant involved in litigation over client ownership?
* Has the predecessor firm gone through any recent mergers or acquisitions?
Underwriters must dig deeper and evaluate all business activities the individual accountant was involved in prior to joining the new practice. The goal of this heightened awareness is to identify potential exposures before they can cause any damage to the insured.
The same diligence must be applied by the accountant.
The bottom line is heightened awareness and more questions being asked.
"Accountants who leave firms are going to be more cognizant of how their prior acts exposure is handled," says Greene, "and it'll be more and more a subject of negotiations with the insurance carriers of lateral accountants' new firms and prior firms."
The author
Gene Mason is global product P&L leader-errors & omissions for GE ERC Global P&C with responsibility for strategic and technical initiatives. He provides technical E&O support to various GE ERC business segments, including portfolio analysis, underwriting audits, technical product market analysis, class-specific product development, client seminars, and state-of-the-art Internet ideas.