Malpractice for compensation planning professionals

By Stephan R. Leimberg, John J. McFadden

October 23, 2014 at 03:04 AM

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Errors in pension and employee benefit design and administration are an increasingly common source of malpractice claims. Those professionals wise enough to know that malpractice is a disease that may attack anyone do not ask the question, "Why Me?" Instead, they ask, "When?" Malpractice claims are made uncomfortably often against those who — out of ignorance, arrogance, or incompetence — thought it could not happen to them.

Suits are also brought against planners and agents with fine reputations who honestly thought they had done everything right. It is a dangerous misconception to think that only those who are clearly sloppy and unethical encounter malpractice claims.

Mere good faith and honest intent will not protect the practitioner who has caused a client loss. It may be true that a planner will not be held liable for the failure to foresee the ultimate resolution of a debatable point of law, or for an error in judgment if he acts in good faith and in an honest belief that his advice and acts are well founded and in the best interest of his clients. But such a planner can still be sued and still incur most of the costs of someone who in fact is guilty of malpractice.

Who are likely "targets of opportunity"?

DEEP POCKETS. When clients sue, they sue everyone in sight. But the bulk of the litigation effort is understandably against those from whom recovery is most likely. The appearance of success is a magnet.

INSURANCE. Certainly one contributing factor is the common knowledge that professionals carry insurance for malpractice. Some plaintiffs feel they are not suing the professional, but that they are suing the insurer.

TOUTED EXPERIENCE, SKILL, AND KNOWLEDGE. In general, professionals who obtain or retain clients by holding themselves out as possessing a higher level of skill than other practitioners will be held to that higher level. If an advisor's business card says, "Compensation Planner" or "Tax Specialist" or he has an advanced degree or a CFP, CLU, or ChFC designation or otherwise advertises greater expertise or skill than an ordinary practitioner, he is expected to exercise that expertise or skill.

IMPERSONAL. It is far easier to sue a party perceived as a "giant institution guided by computers rather than people" than to sue a long time advisor who has served with warmth, openness, compassion and has provided substantial personal attention in a respectful manner. This public image of banks, insurance companies, large law firms, and other institutions as impersonal money machines can best be changed from the top down by an insistence on courtesy and attention to the client from everyone in the firm.

"BIG GUY vs. LITTLE GUY." There is a feeling in this country, right or wrong, that the "Big Guys" are using their weight to beat up the "Little Guys." So when the little guy gets into the judicial system a jury may feel sympathetic and tend to punish the big guy with an angry vengeance.

FRUSTRATION WITH THE LAW. The potential for malpractice increases in proportion to the complexity, speed of change, and labyrinthine interrelationship of various federal and state corporate, tax, labor, and securities laws — and to clients' confusion and frustration. From the planner's point of view, this combination is a nightmare. If the planner feels this way, think of how angry clients must be when told that last year's law is now out and substantial time, money, and emotional energy must be invested all over again. Consider, for example, that a compensation planner for a client with employees in many states may have to consider variations in benefit plans to meet each state's requirements. Furthermore, a malpractice claim might be converted into an unfair trade practice claim in order to gain the advantage of a longer statute of limitations.

To whom is one liable?

This question is not always as easy to answer as it sounds. The simple answer is that one is liable to those who employ him. The general rule is that a duty is owed only to the person with whom he contracts, his client. But liability may extend to others as well.

An advisor is not liable — even for an act of negligence — to someone to whom he owes no duty. The legal term is "privity." But the defense that there is no privity, no duty to an injured party, can easily be forfeited and is currently being eroded in the courts. The test for privity looks at six important factors about relationship between the parties:

To what extent is the transaction intended to benefit the third person?
Can harm to that third person be foreseen?
How likely is it that the third person will suffer real injury?
How close is the connection between the advisor's conduct and the injury that the third party could suffer?
How "morally wrong" is the advisor's action?
Would future harm to this or some other client be served by finding privity here?

What can get you into trouble?

IF YOU SAY YOU KNOW, YOU'D BETTER. Compensation and retirement planning is too complex to be a sideline. Failure to exercise reasonable care and skill in performing duties for a person induced to rely on an advisor because of his professed skills, knowledge, or experience ("John Jones, Benefit Consultant") can result in liability for loss incurred If you holds yourself out as an expert and directly or indirectly promises to provide a product or service to serve a specific purpose or accomplish a particular objective, he assumes the liability for the achievement of that purpose or objective. The skill, knowledge, diligence, and care used must equal or exceed that standard ordinarily exercised by others in the same profession. In short, by calling yourself a professional, you assume the responsibilities and duties generally associated with such a status — and can be held liable for the client's loss.

NOT KNOWING WHO THE CLIENT IS. Is the client the employer or an executive negotiating for benefits and compensation? If there is any question or inherent conflict in their positions, separate advisors for each may be best.

There are many cases where the planner never or seldom meets the client. For instance, suppose that a benefit advisor prepares a form and explanatory material for a wife to waive spousal benefits under a pension plan. If the advisor never met the wife, how can it be argued that she has been properly advised or that she understood what she signed? The situation is a "lack of informed consent" case in the making.

IF YOU SAY YOU WILL, YOU'D BETTER. Never create false expectations by making promises that cannot be kept or by assuring clients of impossible — or even unlikely — results. Planners have an obligation to finish substantially the task begun for a client, decline the appointment, or, with the client's consent, accept the employment and associate a lawyer who is competent. Prepare adequately for, and give appropriate attention to, the work you have accepted.

OVERNIGHT EXPRESS. Clients often want various plans implemented almost overnight — just before government filing deadlines or when they are about to leave on an extended vacation or business trip. This means there is insufficient time to collect, analyze, and act upon complete information. Be prepared to work quickly, but refuse to be rushed if the things that must be done simply can't be accomplished within the clients' deadline.

Staying out of trouble

HIRE THE RIGHT CLIENTS — AND FIRE THE WRONG ONES. Ask why the client chose you. It's flattering to think one has been selected because of one's expertise or reputation, but the reason may be that another practitioner decided not to represent the client. Obtain as much information about the client's background with other professionals as possible before agreeing to work with the client. The first interview should be considered a primary opportunity to screen and qualify the client. Perhaps the potential client should be discarded if he seems to be a perfectionist, unrealistic, hurried, angry, overly optimistic, overly fee-conscious, or if he wants services one is not positive he can provide cost effectively. Be aware of clients who are wealthy but in constant cash flow difficulty, seem immature, refuse to accept responsibility for their own actions, or appear constantly ambivalent. These personality types are likely to present a future litigation problem.

TRUST YOUR INSTINCTS. Turn down a client who requests something that is not quite right. If a client has outgrown the advisor's capacity, he should either recommend another firm or bring a specialist in to work with the client. Do not work with a client if you feel that the client cannot be trusted.

RISK-TAKING PROPENSITY. One of the biggest causes of claims is that the professional misjudges or never considers or does not reevaluate the risk-taking propensity of the client as his circumstances change. The solution is constant communication.

EXPERTISE BOUNDARIES. Do only those things that you are competent (and licensed) to do — and do those things competently. Should a life insurance agent review a pension plan? Should an attorney or accountant judge the adequacy or appropriateness of a client's life insurance portfolio? Should a trust company review documents? Should a financial planner serve as trustee?

Document examination exposure is real. Should one disclaim any liability for review of document viability or efficacy? Incompetent, inconsistent, and informal review is a formula for disaster. If the task is undertaken, it should be done by a person with the appropriate training, expertise, and time to do the job competently and enthusiastically.

Furthermore, the planner has a duty either to avoid involving a client in "murky" areas of the law if viable alternative tools or techniques exist, or to inform the client of the risks and let the client make the decision.

Lack of specialized investment knowledge on the part of the planner or fiduciary often results in investment problems. Numerous trust funds are managed by individuals who adopt a passive and simplistic approach. The need for professional investment management and the complexity of modern portfolio theory is ignored or overlooked and too little time is spent in making investment decisions or addressing overall investment policy and asset allocation.

RESOURCE LIMITS. Do not accept engagements that will require resources beyond what you can cost-effectively deliver. For example, if your operation does not have the backup personnel to properly service a high number of clients, do not agree to do deferred compensation and benefit planning for a firm's top 100 executives.

OUTSIDE EXPERTS. Seek help before it is needed. When appropriate, recommend that another professional be used, either in conjunction with your services or in your place. If you make a specific recommendation, you may be held liable for the in appropriate actions of that professional. One way to protect yourself is by giving out the names of at least three qualified professionals (make sure the criteria for "qualified" extend beyond mere reputation), or stay involved with the representation.

Put it (all) in writing

Protecting yourself means meticulous record keeping starting at throughout the relationship. Changes in risk-taking propensity or attitude of the client or his family, comments at meetings, phone conversations, and other special instructions should be noted. Your files should clearly reflect and support your recollection of events and should be dictated and transcribed as soon as possible after the occurrence. The more complete and organized your files, the more likely the judge, jury, or board of arbitrators will consider them to be persuasive (assuming, of course, the files corroborate what he is now saying).

The client's instructions must be followed — correctly. This entails first truly understanding what those instructions are. Then it requires a written memorandum (preferably signed by the client). Meticulous records of all conversations should be made and kept. If investments are or will be involved in the relationship, an investment policy should document agreed-upon investment objectives, risk parameters, return targets, volatility tolerance, and asset allocation ranges. Written consent should be obtained for actions outside the scope of the relationship as contained in the engagement letter.

Whenever possible, quote the client's exact words. This is particularly important whenever a client — or one of his other advisors — decides to pursue an aggressive tax policy or take an investment risk (and doubly important if you have advised against that course of action). For instance, if an attorney tells a client that the business does not need all of the life insurance the agent is suggesting, the agent should attempt to take down as accurately as possible the exact words of the attorney. The attorney should do the same.

Contemporaneous and near verbatim notes should also be taken if the client asks you to do anything that you would not normally do. Detailed notes are particularly important if the client seems uncooperative or unwilling to provide the information or documents that are necessary to do the job properly.

The engagement letter

The engagement letter is the first and primary step in insulating yourself from a successful malpractice suit. An engagement letter should be obtained in every client relationship at the first possible time. The letter spells out the extent and limits of the services to be performed. The following are critical elements of such a letter:

Scope of services and description of work product;
Period of time covered;
Responsibilities undertaken;
Responsibilities the client is expected to assume;
Fee arrangements — amount, terms, and frequency of billing;
Arrangements for update and extension of service;
List of parties represented — and exclusion of those not represented;
Intended use and potential distribution (or restriction) of the advisor's work product; and
Client's acceptance signature and date.

Fees

Fees should not be set at levels that will require cutting corners or operating at a loss for this engagement. The fee must be large enough to justify internally the time that should be invested in a case — otherwise the case should be turned down. Fees should include the costs that will be incurred to meet high ethical standards and avoid malpractice by implementation of systematic quality control and other appropriate courses of action.

A fee dispute that results in litigation with a client may trigger a malpractice case. The solution is to secure a written agreement as to fees and billing procedures at the onset of the relationship with the client. Think carefully about the wisdom of suing the client and the likelihood and expense of a malpractice lawsuit by the client. It is wise to communicate clearly the basis or rate of the fee or other method of compensation to a new client in writing before or as soon as possible after the relationship begins. The client should be billed periodically and provided detailed information about the services rendered and the time invested.

A client's existing compensation arrangements should be verified from the documents themselves. It is astounding how often otherwise competent attorneys draft plans that do not match the facts. One needs to check benefit plan documents, insurance contracts, and employee benefit booklets and summary plan descriptions rather than rely on the client's memory. Current insurance policy information should be confirmed by writing to the insurer.

Records and systems

Many times the error or omission of the planner is due to an incomplete or incorrect understanding of the facts. Obtain comprehensive and accurate data by developing a data gathering system. Some planners feel they can gather data without forms or checklists but inevitably forget to ask basic questions. One must be sure to confirm with the client the facts gathered before acting upon them.

Keep research documents that indicate decisions were made in a methodical and logical manner and that a deliberate investigation preceded and supported each suggestion. Retain documents that illustrate the tax law as it existed at the time tax decisions were made. Memos to the file, prepared contemporaneously with conversations with a client and decision making, are highly useful in establishing the background and intent at the time an action was taken. Make controversial decisions only with the informed knowledge and written consent of the client. Document any oral advice immediately.

Develop and use a presentation system that will prove that regular discussions covering all of the important areas of benefit planning with a client took place. A checklist should be incorporated into that system in order to demonstrate that these issues have been discussed with the client and reflect the client's circumstances and objectives.

A retrieval system should be established to locate documents or plans that need updating for specific changes. For example, all qualified plans, active or inactive, must be regularly amended to reflect changes in the law.

Plan your follow-up

A checklist of follow-up procedures should be developed so that time-sensitive responsibilities will be met by the appropriate parties and unreasonable delays in the preparation and implementation of the plan can be avoided. Set deadlines, establish priorities, and specify responsibilities. Create a "tickler" file (i.e., a docketing system) to meet all deadlines, statutes of limitations, and filing and payment deadlines. Set up a centralized system to personally remind the party responsible for action and review at given times or events. Incorporate into the system a series of client reminders (e.g., "Major new tax law changes suggest we should review your qualified plans as soon as possible").

Quality control

An advisor is responsible for the errors or omissions of his partners, associates, and employees. Quality control is therefore not a luxury; it is a business necessity.

In any operation larger than a one-person firm, it is essential that the activities of the entire staff be coordinated by a "quarterback" who accepts responsibility. This person must be sure that all staff members are kept informed and that there is a logical and automatic flow of necessary information, that no tasks have been overlooked, and that no efforts are duplicated. He must also be sure that information received by staff members is properly recorded and relayed to him and to the central file on each client.

Compensation planning, almost by definition, requires the input of many professionals. An effective method of quality control is to have the final product reviewed by a well-qualified associate before it is shared with a client.

Most planners not only must cooperate with other planners outside their offices but must also rely on associates within their offices. Staff members must be currently competent, and they must be well trained in and conform to standardized office procedures, policies, and proper file management techniques. Appropriate supervision for all levels of staff should be built in. Continuing education should be a part of any firm's ongoing business plan.

External communications

Almost every authority who speaks and every article that is written on malpractice states that many lawsuits could probably have been avoided by a simple solution: "Communicate, Communicate, Communicate!"

Many, or even most, of the grievance complaints and malpractice actions can be headed off if the advisor will communicate clearly and often. Avoid technical jargon. Do not assume clients understand terms like "qualified plan," "QDRO," or "ESOP." Use word pictures, graphs, flow charts, or diagrams to illustrate his points — and give the clients copies to take home. Study the client's verbal and body language to be sure you are understood, and encourage the client to call or write to after the meeting to ask questions if things are unclear, or new questions come up.

Continually inform clients of all actions you and your staff have taken (or not taken); forward to clients copies of documents sent to other professionals; provide the client with periodic written reports even if a particular report merely explains why no progress has been made since the last report; and confirm in writing all transactions, expenses, fees, income, or other events of importance.

Be sure to inform the client of any changes in the relationship or responsibilities of the parties; make sure reports are understandable; and use graphs, charts, and checklists to show the progress he has made.

Schedule regular reviews and give special emphasis to contacting clients from whom he has not heard or had contact with in a given period of time. Document attempts to contact those who do not respond.

Keep copies of all correspondence and conversations with other professionals who are working with his client.

Avoid casual or informal advice. Do not give advice at cocktail parties or other social events. Liability can be imposed even though no fee has been charged for services if a client relies on information he has been provided.

Return calls promptly. A careful advisor will return telephone calls promptly. If this is impossible, administrative staff or other another associate should do it so the client does not feel ignored. Avoid "heel cooling. Don't keep clients waiting on the phone or in an office. Do not allow a phone call to interrupt a meeting with a client.

It is a good idea to reward staff members for being extra polite. In short, give the client respect and common courtesy.

Avoiding (or neutralizing) conflict of interest problems

The duty of loyalty requires any planner to be extremely cautious about serving a client in more than one capacity. For instance, the client of an attorney or CPA may want that person to serve as an executor or trustee — while at the same time desiring that person to continue to provide planning advice and other services to various family members. Can the advice be disinterested and objective? Can the professional ethically charge fees for both services? Can those fees honestly be set at "arm's length?"

Although there is no legal prohibition against representing more than one client in a single transaction, planners should be particularly alert for situations in which there is an obvious or potential difference in their interests. For instance, a defined benefit plan typically favors older long-service employees while profit sharing and defined contribution pension plans usually are to the benefit of younger employees.

Another conflict of interest problem that often occurs where more than one person is represented is the disclosure of confidential information. Can a planner freely tell a wife what her husband has disclosed? Can a planner share information from one shareholder with others? The planner needs to inform all parties that information may not be privileged or confidential as to other members of the group unless specific direction is given.

Any possible conflicts of interest should be disclosed — in writing — to the client as quickly as possible or the planner should withdraw without disclosure if confidential information is involved. Recognition of disclosure and acceptance of its consequent risks should be acknowledged in any instrument signed by the client.

Avoid — or very careful with — any financial involvement in a client's business or in a business venture, and should ask yourself whether acceptance of a client will create a conflict with respect to more desirable work with another client in the future.

Deal with problems promptly. If a problem occurs, he must call or write the client immediately and explain the problem and the potential consequences and alternatives. If a client is angry or dissatisfied, he ought to take immediate action — talk to the client and resolve the problem. He cannot safely assume the problem will go away or that the client will forget it.

A good idea is to create a "Problem Team" in the firm that meets immediately every time the potential for a dissatisfied client is recognized. That team should not only review the file in the case in point but also any other procedures, activities, omissions, or oversights that may trigger future problems that could develop into litigation.

Use early, active remedial conciliatory efforts. The quicker an attempt is made to resolve the problem to the client's satisfaction, the less likely there will be litigation. Providing a large apology might avoid writing a small check. Writing a small check might avoid defending a large lawsuit. Sometimes, assigning a new person to speak to the client will serve to quell the objection.

Malpractice insurance

The first step in evaluating current insurance is to see if there is enough insurance to cover any likely risk. Most malpractice coverage is sold on a "claims made" basis. This means the policy covers only claims that are first asserted and reported to the insurer within the policy year.

The action alleging malpractice often does not occur until years after the alleged negligence occurred. If the policy has a "prior acts" coverage, it covers a claim asserted during a policy year even though the negligence giving rise to the claim occurred in some prior year. If a policy lacks or excludes prior acts or limits prior acts coverage, it is likely that there will be a "coverage gap." There will be no coverage under the policy in effect when the alleged negligence occurred because the claim was not made in that policy year. The current policy will not cover the alleged negligence because negligence alleged to have occurred before the present policy year is excluded or omitted from the coverage.

A "tail" is an extended reporting option somewhat related to prior acts coverage. If one purchases a tail, he is permitted (usually at the end of each policy year or earlier if the policy is canceled during the term) to convert "claims made" coverage to "occurrence" coverage for any negligence allegedly committed — but not yet reported — up to the end of that policy year. The extended reporting of claims option available through a tail is expensive. The premium is a multiple of the regular annual premium. Tails should be considered by retiring planners who will no longer keep their full malpractice coverage in force or by attorneys who are forced to switch malpractice insurance carriers because of a cancellation or a refusal of a carrier to renew coverage (typically due to claims made) if the new carrier refuses to provide prior acts coverage. Tails are "cut off" after some period of time unless the tail is unlimited. Under an unlimited tail, the insurer remains liable for negligence occurring before the policy period expires regardless of when the claim is asserted.

Most planners opt for a higher deductible in order to reduce the premium outlay. But one should check to see if legal costs he would incur in a malpractice suit apply against his share of the deductible. Does the deductible apply "per claim" or "per policy year"? Where there is more than one claim in a given policy year, a per claim deductible becomes a hidden cost: a second deductible must be satisfied in the event of a second claim within a year. A per year deductible means the deductible amount need be paid only once in a given year regardless of the number of claims. Because when it rains, it pours, a per claim provision might prove quite costly.

Some policies give the insurer the right to limit its exposure through a provision entitled "Settlement." This means the insurer can force a settlement with the plaintiff (regardless of the insured's wishes) because of the cost. Some settlement provisions state that if one does not wish to settle under specified terms, the insurer will limit its payment to the amount specified in a settlement agreement at which point all other exposure (including defense cost) becomes the insured's obligation. Why might an insured not want to settle — even though economically it might make sense? The psychological cost of admitting wrongdoing or malpractice — coupled with the loss in reputation — are strong reasons why he may want to maintain the right to say "NO" to a settlement. One should be sure that right does not expose him to a loss of coverage above the limits in the proposed settlement.

A "duty to defend" policy requires the insurer to appoint defense counsel and pay that attorney's fee as billed. An "indemnification" policy allows the insured to select counsel but he must fund his defense unless he can reach an interim fee agreement. He will not be reimbursed for defense costs until the case is concluded. Obviously, interim funding can be a problem.

The way covered "damages" is defined is crucial. One may be exposed to fines, penalties, and punitive, or even treble, damages. Check with the insurance agent to clarify how broadly or narrowly the policy construes the term "damages."

Does the policy provide coverage for the defalcations of another member of the firm? One is liable for his partner's embezzlement even if he has not benefited by it. The insurer will deny a claim based on the partner's fraud and/or criminal activity unless there is "innocent partner" coverage.

A malpractice policy ideally will provide coverage for the defense costs if it is claimed the insured is guilty of intentional conduct (even though the policy does not indemnify the costs of the intentional conduct). Does the policy cover libel or slander or defense of RICO claims?

It is important to check the financial stability of the insurer and to be sure the insurer has a solid reputation for integrity and responsiveness. It is worth finding out if the insurer itself has been involved in litigation with its own insureds. The lowest premium will not compensate for the aggravation and other costs of suing the carrier to get it to defend properly a malpractice case.

The total cost

Malpractice premiums for compensation planning are in the highest classification — along with corporate securities work — for a very good reason: the dollars at risk are substantial. The cost of a malpractice suit cannot be measured merely in terms of the court judgment or out of court settlement or the cost of attorneys. The cost to a professional's reputation (win or lose) may be staggering. For instance, it would be difficult to attract new partners or new associates if one has been successfully sued for malpractice.

Compensation planning is a process based partially on knowledge and largely on trust. A malpractice suit calls into question competence, which in turn destroys confidence, not only of current and potential clients but also the confidence of other members of the planning team with whom one must deal.

A planner who becomes a defendant in a lawsuit must deal with the incredible pressure and emotional trauma of being sued. Often, the planner (and perhaps office associates, partners, and friends) will see the action taken by the client as an attack on his professional ability, integrity, or judgment. This cannot help the practitioner's morale and will probably result in adverse fallout on other projects. This psychological strain is compounded by time; the legal process is typically long and drawn out over a period of years even if the claim is unfounded.

Colleagues from whom the practitioner received referrals and the general public may hear about the lawsuit. This will cause almost certain financial damage. Furthermore, the planner is required to participate in his own defense whether or not he is adequately insured. This, in turn, translates into dozens, sometimes hundreds, of unbillable hours spent gathering facts and records and recreating the facts, giving depositions, briefing defense attorneys, and testifying at trial.

Creating and maintaining a successful compensation planning practice requires a methodical, systematic approach to risk management. Planners are vulnerable to litigation no matter how careful they are. But the risk of a claim and the potential for a successful claim can be substantially reduced through continuing a vigorous and systematized policy of internal and external positive communication, commonsense courtesy, quality control, and a strong emphasis on high-quality, continuing education of every member of the firm.

While malpractice claims can be scary, the suggestions above can help to create the blueprint for a vigorous office organizing and client market-building campaign.

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