Professional indemnity insurance claims

Intro:
Hello, and welcome to the CPA Australia podcast. Your weekly source for accounting education, career, and leadership discussion.

Drew Fenton:
Welcome everyone today to CPAs podcast on lessons from professional indemnity insurance claims. Know your mandate. Using current professional indemnity claims has examples, we will discuss the risk public practitioners face if they operate outside their mandate and areas of expertise. For reference, can I confirm that this podcast was made on the 7th of September, 2020? My name is Frew Fenton, and I'm your host for today's podcast.

Drew Fenton:
Many of you may know me as a director of Fenton Green insurance brokers, and we have provided insurance to CPA and financial services firms throughout Australia for the last 15 years. Joining me today is Kevin Nhan, an Australian Pacific service manager for QBE. Claims against professionals can be stressinducing, but Kevin's team along with QBE strong legal panel aim to support insured through this stressful time in the claims process. Now, Kevin, can you tell us a bit about yourself and your experience.

Kevin Nhan:
Hi, Drew. Thanks for the introduction and thank you to CPA Australia for the opportunity to appear on this podcast. Before I launch into my answers, I just have a quick disclaimer and that the views and opinions expressed by me in this podcast are my individual views and opinions, and do not necessarily reflect the official policy or position of QBE Insurance Australia. My views and opinions expressed should not be construed as general or legal advice.

Kevin Nhan:
So I've been working in the insurance industry for around 10 years now with experience in managing claims at an insurance broker and now for an insurer, being QBE. I joined QBE about three and a half years ago, initially in the public liability claims area. And more recently I've moved into the professional lines claims team, and I've worked quite closely with Drew and his team. And in the last year, I've been managing the team. And my team is comprised of five claims officers and two technical services officers who predominantly are legally trained individuals. And given the number of litigated matters which we manage, this seems to be a good pairing with their skillset.

Drew Fenton:
Now down to today's topic, Kevin. We find that a significant portion of our large loss claims have arisen from non core accounting activities, such as executorships, business valuations, or providing secretarial services to publicly listed companies or financial institutions. Practitioners need to be conscious not to provide additional services in areas where they do not have sufficient experience or training. They also need to be careful in the current climate, not the step in areas that may be considered insolvency advice, if they are not registered when trying to assist clients in distress. QBE is a well-known insurer in the Australia market. Can you provide to us an indication of the number of claims in the professional indemnity area QBE has experienced in the last 12 months?

Kevin Nhan:
Absolutely, Drew. So my team looks after professional indemnity, management liability, directors and officers liability, and cyber claims. And in the professional indemnity space, if we insure various professions, including, but not limited to accountants, insurance brokers, real estate agents, lawyers, and barristers. And on average, every year, my team receives about 1500 to 2000 claims and notifications. And so the end of July this year, we have received approximately 900 claims and notifications.

Kevin Nhan:
Interestingly, we've seen a bit of an increase in the number of active accounting claims and the start of the year we had around 71 active claims, but that's now recently increased to 86 active claims, which is approximately a 21% increase. However, we don't necessarily attribute this increase in claims in the accounting portfolio to COVID-19, as the notifications we've received to date for the accounting profession has not been related to COVID-19 induced liquidations or areas in making applications for government support packages. But certainly there is that risk that there will be COVID 19 related claims for accounting professionals moving forward.

Drew Fenton:
Before we get into the topic today, Kevin, in this current climate, in the downturn in the economy, what, in your opinion, does this mean for the risk profile and claims for the accounting profession?

Kevin Nhan:
So our claims experience is that economic downturns correlate with an increase in claims against professional advisors, and this includes accountants. And this is a number of reasons. So with the ATO, we expect there to be increasing enforcement activity on the horizon, and that may not necessarily be at the moment. And certainly the experience we've had is that the ATO is working collaboratively with businesses. We expect moving forward that the ATO may have increased enforcement activity, and that might be a year or two from now. And the last experience that we had of that was post GFC. And following the GFC, there was an increased enforcement activity. So that's a risk moving forward and speaks to the risk of accounting claims.

Kevin Nhan:
Further, there's an increased appetite for pursuing claims against accountants where clients may be more financially distressed. So there might be claims previously that aren't home run, so to speak, but because they're in financial distress, they may be more likely to pursue those claims. Further, there are some COVID 19 related issues and these include more working from home for CPA Australia members. And as a result of that, there may be less supervision for more junior employees. And this may lead to more areas and more areas may lead to more claims. Further, we've heard that there's an increased workload with the constantly changing government support packages. And with legislation changes, there is always that added risk and layer that there may be claims that arise out of that just because of the increasing complexity of the environment. Further, there's a potential increase of cyber claims or privacy breaches because we have accountants that are working from their personal devices.

Drew Fenton:
Now, from the perspective of a claims managers position, know your mandate, this is very, very strong point put forward by CPA. You must know your mandate. What are you going to do for your client? What is your client expect. From your perspective, what does this mean?

Kevin Nhan:
Yeah, Drew, I absolutely agree with that and the importance of knowing your mandate, and what that means is that CBA members have to be really clear as to what their clients needs and expectations are. So exactly what work are they expecting the insured to do. And also knowing their skillset and meeting those needs. Further, it's really important to articulate this in writing because we see this at claims time and we'll touch on this later in the podcast where there are disputes around the terms of engagement and what scope that entailed. And it's very important to articulate this in writing, because if a claim does arise, then there is a document to fall back on to set out exactly what the accountant had been engaged to complete.

Kevin Nhan:
Lastly, it's very important to have a referral network for areas where you're not skilled in or experienced in. For example, this may relate to GST or research and development, and it's important to have experts, which you can refer your clients to so that they can have that work completed by those experts.

Drew Fenton:
Over the last few years, Kevin, you have seen a number of claims arising out of CPA firms stepping in their areas with a not experts. Can I have your thoughts on this?

Kevin Nhan:
No problems, Drew. You're right. My team is definitely saying a fair few claims where an insured has stepped outside of their expertise. And this has led to quite substantial claims.

Drew Fenton:
Can you provide an example of a claim where an accountant acted in the capacity of a company secretary or CFO?

Kevin Nhan:
No problems, Drew. I'll walk you through a claim which we had, and this was where the insured was engaged as the company secretary, the CFO, and the accountant for a small listed entity. And unbeknownst to the insured, the managing director of this entity was running an unlawful and fraudulent scheme to obtain benefits at the expense of the listed entity. And the fraud was eventually discovered and a claim was made against the former managing director, the insured, and listed entities, formerly engaged law firm, and the claim demand against the defendants was in the millions.

Kevin Nhan:
So in this claim, there was no evidence that the insured was aware of this game, but the following allegations were made against the insured and this included breach of contractual duties and fiduciary duties owed to the plaintiff, breaches of the corporations act relating to the disclosures it's the market. And for those breaches, it was alleged that the insured had not satisfied themselves, that the documents provided to the market did not contain misleading or deceptive representation or emissions.

Kevin Nhan:
And further, there was an allegation that there was failure to exercise reasonable care, skill, and diligence as accountant and CFO. Specifically, it was alleged that the insured did not make proper inquiries concerning the transactions, which they were asked to facilitate. Now there's also conduct alleged against the insured, which was in relation to the administrative matters that fell within his responsibilities as the company secretary and the accountants. Now, in this matter, the insured obtained no financial benefit at all from these games. And it appeared that the insured was coerced by the managing director to follow his instructions. Now, the insured in this incident, had never been a company secretary of a listed entity previously. And this example really highlights the perils that can be associated with agreeing to complete work in area which is outside of your expertise. Having reflected on this claim, it appears that the managing director may have deliberately engaged the accountant who was unfamiliar with the obligations of a company secretary or CFO of a listed entity, so that he would be able to facilitate this fraudulent scheme.

Kevin Nhan:
So it's really quite important to know exactly which areas you are familiar with and that you're an expert in so that you don't find yourself in a position where you're exposed to a claim. So this is clearly a claim where an insured has agreed to undertake certain work without fully appreciating the complexities involved with that.

Drew Fenton:
Kevin, that was an interesting case in relation to the public listed company. CPAs must always be aware of their own skillset and knowledge required to undertake specific work. And obviously listed entities are complex and difficult in this case, our CPA member wasn't well equipped for this particular task.

Drew Fenton:
Kevin, obviously these are difficult times and a recent statement by the Australian Bureau of statistics estimate. They're going to be in excess of 100,000 companies in Australia get into financial difficulty and ultimately insolvency. Can you provide an example of a claim involving actions by liquidators?

Kevin Nhan:
QBE has already started to say more actions commenced against the cannons by liquidators, usually relating to ATO debts. Now, one example of a claim that we had was where an insured had their client go into liquidation, and the liquidator made a claim against the insured and the previous directors alleging that the insured ought to have paid an outstanding pay-as-you-go liability. And that the failure to pay the liability caused the company to go into liquidation. A challenge for these types of claims is that liquidator extends high costs and high legal fees in pursuing the directors and the accountant, and the claims can be quite difficult to commercially settle for this reason. And outside of formal claims or preceding these formal claims, we have seen liquidators sniff around, see if I can obtain any documents to suggest that there has been any negligence or wrongdoing of the accountant. And if documents support the claim, then it assists the liquidators in obtaining litigation funding for the legal action. Over the last few months, we've seen a slight uptick in these new notifications and we expect to see more as businesses enter liquidation.

Drew Fenton:
Thanks, Kevin. Our experience here is that, it can't be my fault. And what we mean by that is that if clients get into financial difficulty or a receiver manager is involved, they look to the professional firms who advise the client. The accountant is obviously at the top of the tree. Our view is that one must be extra cautious in these difficult times, as we have seen historically, that professional indemnity claims go up when the economy takes a down turn, and we see this no different this time. Can you now give us an example of does a claim involving an incorrect business structure?

Kevin Nhan:
So we had one claim where the insured's client had sought advice regarding the restructuring of the company for the purpose of protecting assets from an ex family member. And following the restructure, the client was audited by the ATO and the ATO in their position paper determined that the restructure amounted to an illegal dividend stripping scheme and an unlawful tax avoidance scheme under the income Tax Assessment Act. And the ATO determined that over $7 million would be considered assessable income for a particular financial year. And this resulted in a combined taxation liability, general interest charge and penalty of over $3 million. And the client issued proceedings against the accounts and alleging that negligent advice had been provided around the restructuring. And the insured conceited that the advice provided was incorrect and negligent. And ultimately this matter resolved for over one and a half million dollars.

Drew Fenton:
Kevin, this in my view is a classic example where we were trying to do the right thing by our client and act on their instructions. Tax law is certainly a specialty area. And in our view, this was a classic example of where they should have referred off this particular work in relation to structuring the companies. They didn't, and as a result have been involved in a very large piece of litigation.

Drew Fenton:
Can you now give us an example of, let's say, a claim involving a research and development advice?

Kevin Nhan:
Sure. So this is a very topical area, Drew, and over the last 18 months, QBE has seen a number of significant research and development claims against accountants. And I'll give you a couple of examples. So the first one is where the insured was engaged to provide specific advice about registering a project as an R&D project, which would then be the subject of an R&D offset claim. And the accountant advised what was required from the project to be entitled to the R&D tax offset and expected that the advice would be followed. The ATO audited the client's R&D offset claims, and this was during a period in around 2016 when the ATO was aggressively or auditing R&D claims. And the accountant was not involved in responding to the audit. But the client did not fully cooperate with the ATOs request for information.

Kevin Nhan:
And ultimately the ATO found that the client had failed substantiate and demonstrate a nexus between the registered R&D activities and the expenditure, which had claimed his deductions. The ATO ordered the client pay a tax shortfall and administrative penalties totaling over $150,000. The client made a claim against the insured for this amount plus legal fees and plus professional fees.

Kevin Nhan:
And there's also another example where an accountant advised on the structure of associated organisations. However, following an ATI audit, it was determined that a restructure was required to comply with tax legislation. And this caused the entities to be unable to claim the R&D tax offsets for a period of time, whilst the company was going through the restructure. The claim was made against the insured for the R&D offsets, which claimant says they would have otherwise been entitled to claim.

Kevin Nhan:
And both of these are live claims that have yet to resolve, but a real difficulty that we've experienced with these research and development claims is that they can be quite costly to defend. As we see usual arguments around whether a client would ever have been entitled to the R&D tax offsets, and whether the additional tax payable arising out of those breaches can be attributed to the insured's negligence. And this usually involves expert evidence from both sides, and this is from the accountant side and from their client's side. And going through this exercise can be quite costly.

Drew Fenton:
Yes, our experienced with R&D matters, they are difficult and certainly should be left to the experts. Now look, these, as we all know, are difficult economic times. Would you be able to give us some examples of fraud? And and from our perspective, we would see the possibility or the incidence of fraud, certainly going up, going forward for the next little while. Over to you, Kevin.

Kevin Nhan:
Well, I absolutely agree with that, Drew. And we've recently seen a number of fraud claims. So fraud claims generally present themselves in two ways. It can be third party fraud or can be first party fraud. So I'll walk you through an example of each of those. So an example of a third party fraud is where a client system is compromised and fraudulent instructions are sent to the accountant to transfer funds to the fraudsters account. Usually we call these social engineering claims. And the insured follows instructions without making any inquiries. When the fraudster has used different font in their email to the usual font of the client, and the client makes a claim in negligence against the insured for failing to have adequate measures in place to protect them from fraud.

Kevin Nhan:
And the Australian Professional and Ethics Standards Board standard 325 prescribes that accounts and shall develop policies and procedures that identify, assess, and manage all key organisation risks, including financial risk and technology risk. And specifically, APS 310 relates to client monies and states that an accountant firm shall address risks associated with instructions, including those received by email and should develop administrative protocols that address matters including the authenticity of the instructions. So in this particular example, there are a number of emails sent to the insured alleging to be or purporting to be from their client. And these were for large sums of money. And the insured had failed to check that these were the correct bank account details to transfer those funds to, and this led to quite a substantial loss and a claim being made against the accountant.

Kevin Nhan:
Now, another type of fraud claim that we see is for first party fraud. And we've seen a number of these over the years where clients funds have been misappropriated. And we say these claims in particular professions where those professionals have control over their client's funds. So this includes accountants and real estate agents. And we've seen a few of these over the years and they can be purely an employee misappropriating those funds. We've also seen some schemes deployed by fraudulent employees that are much more wide-scale and for significant amounts of funds. So this may be misappropriating clients' funds. This also could be falsifying invoices to gain reimbursement from the firm. And what these claims really highlight is the importance of having dual controls in place when dealing with clients funds, and also for there to be sufficient oversight of the business and of employees in the business.

Drew Fenton:
Thanks Kevin, that's given us a good insight over a number of claims examples that CPAs face. Do you have any tips now for CPA firms that might in the future experience a professional indemnity claim? Are there any key things that can assist you and your team when these matters arise? For example, wriggle keeping file notes, engagement letters, and ultimately what would make a good file for you to defend?

Kevin Nhan:
So Drew you've mentioned three really key areas that are important comes claims time, and this is around record keeping, engagement documentation, and employees. So I'll walk through each of those. So for record keeping and file notes, it's extremely important because many times me and my team speak to CPA firms when there is a claim and there appears on face value to be a reasonable defence to a claim. However, there is little to no supporting file note or documentation to support the accountant's version of events. And what this leads to is a he-said she-said situation, which exposes the CPA firm to a finding of negligence. And whether it be an insurance broker, lawyer, accountant, or any other professional, courts are scathing of professionals where there is no paper trail to support their version of events. And it is our experience that courts will place a higher duty on the professional and will prefer the evidence of their clients. And accordingly it is essential that accountants keep records of verbal advice provided, either via file note or email to the client, confirming the advice provided.

Kevin Nhan:
Now on the topic of engagement documentation, as we touched on earlier in this podcast, it is important to have an engagement document which includes a very clear scope on what work the CPA firm is engaged to advise on. We sometimes see claims where the CPA firm argues that they were not retained to provide advice on the particular issue. However, it is problematic when there is no supporting engagement document. Again, this exposes the firm to a claim as it can become arguable that the insured was engaged to provide such advice. And I've got multiple claims at the moment on this very issue where the client says that the insured was engaged to complete certain work and to advise on certain issues where the insured says that simply wasn't the case. But we have quite a general engagement document, which then makes the claim arguable.

Kevin Nhan:
And on the final point of employees, and it is a very important one because people make up businesses. It's important to ensure that employees have sufficient supervision and their work is reviewed thoroughly. Otherwise, this exposes the firm to potential claims. And this is particularly the case in the COVID environment where supervision and review of work can be more challenging because you don't have that face-to-face time where you're walking past someone's desk and they ask you for your help or your advice on work. And it's a challenge for me as well, because we see in the remote environment where you have built in interaction when you're in the office that falls away. So it's very important that you maintain your contact with your employees and that there is sufficient oversight and support there.

Kevin Nhan:
When an employee is departing a firm, it is important to complete a thorough handover. As we have seen many claims where this is either caused a claim or it has made it more difficult to defend. So there may have been an email account that has been deleted. There may be no paper record. And also we've found that ex-employees are less likely to assist in defending a claim.

Drew Fenton:
Now, as we all know, CPA Australia has a wonderful library. And there within the library, you can find further information on strategies for public practitioners to help manage your risk, including claims examples in the importance of engagement documents, risks posed by colleagues and clients, and the use of file notes in our earlier podcast on reducing the risk of professional indemnity insurance claims, which can be found on CPA Australia podcast channel. Kevin, thank you for your time today. Do you have a couple of parting words for those who are in public practise?

Kevin Nhan:
Thanks, Drew and thanks CPA Australia for having me on this podcast. And my departing comment would be to engage early with your broker Fenton Green and your insurer QBE because we want to work with you through that claims process to make it as stress-free as possible.

Drew Fenton:
In conclusion, we would like to thank everyone for listening to this podcast and the appropriate links are at the bottom of this podcast page.

Outro:
Thanks for listening to the CPA Australia podcast. For more information on today's episode, please visit the show notes at www.cpaaustralia.com.au/podcast. Never miss an episode by subscribing to our podcast on Apple podcasts, Spotify, or Stitcher.