New England Biz Law Update
Recent progress in the ongoing battle to protect the attorney-client privilege is certainly noteworthy, but it’s primarily focused on protecting privilege rights from attacks made by outsiders: prosecutors, enforcement officials, and plaintiffs’ class action lawyers, to name a few.
The attacks from “without” are extremely important to address. However, this attention to attacks by prosecutors and enforcement agents has diverted focus from an issue of privilege erosion that has potentially greater long-term and widespread consequences than the challenges posed by outsiders.
I am referring to attacks on the privilege from within – namely, the problems associated with protecting privilege in the yearly audit process.
Every company is aware of the need to provide auditors with whatever information they need to conduct an effective review of the company’s financial health. We are painfully familiar with the twin lessons of transparency and accountability taught by Sarbanes-Oxley.
Auditors have heard the message as well: They are far more meticulous in the performance of their duties and the scrutiny that they know will attach to any lapses in their review in the post-Andersen era.
When auditors request production of material that is attorney-client privileged or work-product protected, what should a company and the general counsel do? To refuse an information request of an auditor could lead to the issuance of a qualified result or a partial finding or a refusal to certify the books, any one of which is the possible equivalent of a corporate death sentence.
But to produce privileged material – depending on the jurisdiction in which you work – is likely to be considered a waiver. The traditional rule of privilege is “waived to one, waived to all.”
Most companies don’t even foresee this issue until they are hit with it, so there’s little or no pre-planning for protections, the process or the response. Further, since the audit is an annual process that almost every major company, public and private, engages in, you don’t have to experience a failure or a federal prosecution to run head on into this privilege problem.
Accounting practices that can lead to waiver
The report issued by the American Bar Association’s Attorney-Client Privilege Task Force on Audit Matters indicates that current auditing practices affect the attorney-client privilege and work product doctrine in several general categories. They include:
Case law
Court decisions focused on such disclosures have discussed important principles in this debate as it unfolds, but have done little to help lawyers and accountants (not to mention clients) successfully navigate this process.
The results of these cases are split, some resulting in waiver decisions and others resulting in findings that documents produced were not waived.
The primary factor in deciding these cases is whether the court finds that a “common interest” exists between the client and auditors that would allow them to share privileged material without waiver.
In In re Pfizer Inc. Sec. Litig. (1993 WL 561125 (S.D.N.Y. 1993)), the company’s work product was not waived by production of documents to the auditors. The court held that auditors shared a common interest with the company in certifying the company’s books, and further held that the auditors should not be “conduit[s] to a potential adversar[ies].”
In Merrill Lynch & Co., Inc. v. Allegheny Energy Inc., (229 F.R.D. 441 (S.D.N.Y. 2004)), the company’s attorneys prepared internal investigation documents in response to a federal investigation, which were later given to Merrill Lynch’s auditors during its annual audit.
A third party (Allegheny) moved to compel the production of these internal reports. Allegheny argued Merrill Lynch’s earlier disclosure to auditors resulted in waiver.
The court rejected the assertion that transparency with the auditor results in waiver of the work product protections.
However, in a separate case in the same court the result was much different. In Medinol, Ltd. v. Boston Scientific Corp. (214 F.R.D. 113 (S.D.N.Y. 2002)), the corporation’s internal investigation results were presented at a board meeting where minutes were taken.
When those minutes were later produced to auditors, the court concluded that waiver resulted. The court’s logic was pinned to the notion that auditors and their clients cannot share a common interest because of the necessary independence of the auditor’s certification function. Therefore, the company’s work product protections were deemed waived.
Action plan
The Association of Corporate Counsel, along with our coalition partners and the ABA, will be addressing audit privilege issues in a variety of ways.
A first priority is education on the issue and how to navigate it. We’ll be working with our membership and the larger corporate bar to identify best practices, common problems and workable solutions that you can practically implement.
We’ve already begun that process and have produced several important resources. But we also need to attack the root of these issues and promote efforts to encourage courts and regulators to respect the “common interest” theory of cooperation between auditors and lawyers, both of whom are working to assure the integrity and effectiveness of financial compliance systems within companies.
We’ve only just begun to focus our full attention on these serious matters, and hope that you will join us in not only supporting reforms to audit practices that further erode your clients’ privilege rights, but also in our effort to collect more information and best practices we can disseminate to those who are only just starting to think about these issues.
Working together, we’ll find effective means to push back against these “attacks from within,” just as surely we’re succeeding in fighting to end prosecutorial privilege erosion in the external context.
Susan Hackett is the senior vice president and general counsel of the Association of Corporate Counsel. You can reach her at [email protected]. For more information about this topic, visit ACC’s website at www.acc.com.
