The Auditor's Need for Its Client's Detailed Information vs. The Client's Need to Preserve The Attorney-Client Privilege and Work Product Protection_ The Debate, The Problems, and Proposed Solutions[1].pdf

uditor

’s N

eed

ts Client’s Detailed

nformation

lient’s Need to Preserve the Attorney

-C

lient Privilege and

rk Product Pro

ection

e Debate, The Problems,

roposed Solutions

resented by

atham & Watkin

LLP

behalf of

he Corporate Counsel Consortium

2004

62087.1

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005

The Association of Corporate Counsel’s

Board of Directors endorsed the following

position paper on October 24, 2004.

ABLE OF CONTENTS

NTRODUCTION

...............................

.........

HE PUBLIC INTEREST

N PRESERVING AND ST

ENGTHENING

HE PUBL

C COMPANY AUDIT FU

CTION

...............................

.........................

II.

HE PUBLIC INTEREST

N PRESERVING THE AT

ORNEY

LIENT PRIVIL

GE AND WORK PRODUCT PROTECTION

...............................

HE WAIVER PROBLEM

...............................

...........................

ASE LAW REGARDING W

IVERS OF PRIVILEGES

ASED UPON DISCLOSU

E TO AUDITORS

...............................

.............

LOSING THE FLOODGATES: CUR

ENT LEGISLATION

GNED TO MITIGATE SI

ILAR WAIVERS OF

ILEGES

...............................

1. H

.R. 2179

...............................

.............................

2. S

ection 105 of The Sar

nes

-O

xley Act

...............................

...............

ONCLUSION

...............................

...........

PPENDICES

“

DETECTING” CORPORAT

FRAUD: AUDIT STAND

RDS,

EGISLATION AND

ECENT REGULATORY IN

TIATIVES …………………………. PAGE 17

ISTORICAL SIGNIFICA

CE OF THE ATTORNEY

-C

LIENT PRIVILEGE AND

ORK

-P

RODUCT DOCTRINE …………………………………… PAGE 23

URVEY OF CASE LAW REGARDI

G WAIVER OF

TTORNEY

-C

LIENT

RIVILEGE AND WORK

-P

RODUCT PROTECTION

ASED UPON DISCLOSUR

O AUDITORS ……………

……………………

…………………... P

GE 26

-30

62087.1

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NTRODUCTION

his paper addresses an emerging problem of vital public interest identified by a

oad consortium of public companies.

The

role of independent auditors in detecting financial

tatement fraud within public co

panies

ontinues to receive

nhanced scrutiny, and companies

re expected

bot

h to implement controls for dealing with alleged fraud internally and to

rovide

heir auditors with detailed information on a wide range of corporate issues, even where such

mation may include attorney

-c

lient privileged

ommunications or work product

Com

panies involve legal counsel

both external and internal, for all manner of inquiries and

dvi

, from

onducting comprehensive investigations of alleged fraud to inquiring about

mployment problems, answering questions about

histleblower letters, advising the Board on

heir duties in connection with an acquisition, or establishing the bases for tax positions. Views

nd advice on these and a myriad of other daily issues are now routinely being asked for by

uditors to

but

tress their reliance on

anagement representations. However, providing

ccess

uditors

uch

ivileged information

auses

ompanies

isk the waiver of privileges and, as

result,

rovides almost a

omatic access in

ivil lawsuits

dversaries lying in wait.

his situation poses a serious threat to the public interest in

eserving the

ttorney

-c

lient privilege and work product protections, which companies have long expected will

maintained by

he courts: If the privileges are lost

or even if there is an expectation that

ounsel’s work and advice may be exposed to adversaries

then companies

ay well

deterred

rom seeking the advice of counsel regarding the best way to comply with the law,

terred

rom conducting thorough internal investigations of potentially illegal conduct

ith the goal of

aking remedial action.

hat good corporate governance and full cooperation in the audit process would

ead to this result is incongruous and a m

tter of serious concern

. I

t is also, we believe,

unne

cessary

; w

e will

therefore,

ropose

solution to this growing problem at the conclusion of

his paper.

Thi

s paper proceeds from the propositions that auditors must

ontinue to

ovided with as m

h information as they deem necessary to perform their important public

unctions and that, at the same time,

t is in the public interest to protect the ability of companies

o maintain the confidentiality of attorney

-c

lient communications and

ttorney

rk product.

hus, t

s paper discusses these two vital public interests

–

the public company audit function

nd protection of the attorney work product doctrine and attorney

-c

lient privilege

–

as well as

heir intersection. While auditors have historica

ly planned and performed their audits in such a

anner that they can obtain reasonable assurance that a company’s financial statements are not

aterially misstated due to the existence of corporate fraud

–

and auditors continue to do so

–

ecent developme

s in federal law and policy have focused attention on strengthening the

he General Counsel Working Group, convened by The Ass

ciation of the Bar of the City of New York, is

n informal group of approximately fifteen General Counsels of major public companies in the

etropolitan New York area. Led by Michael Fricklas, General Counsel of Viacom, the Working Group

eets periodical

y to discuss issues of importance to General Counsels and the companies they advise. It

as in the course of such a meeting that the present issue was identified. As a result of that discussion,

atham & Watkins was retained to prepare a White Paper on

he issues, as well as make recommendations

o the appropriate regulatory and governmental entities to help resolve the problems identified.

62087.1

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uditors’

gilance

Sparked by the corporate scandals of 2001

-2002

, legislation, regulations of

he Securities & Exchange Commission (“SEC”) and standards and rules of the Public C

pany

ccounting Oversight Board (“PCAOB”) have impacted

how ge

nerally accepted auditing

tandards (“GAAS”)

re applied

nd have increased scrutiny on auditors’ procedures to verify

ompany positions and representations

he same developments in law and policy and the same corporate scandals are

ausing companies

tep up their own efforts to maintain

nd bolster

ffective internal

ocedures for

he conduct of their businesses so as to

tect

nd respond to allegations of

nappropriate conduct, wrongd

ng, or even

raud

. C

ompanies

etain

ounsel to

edesign

ocedures,

dvise of appropriate roles for officers and directors in corporate management and

gove

rnance and, on occasion,

onduct investigations,

ll the time generating

ork product and

municating advice and

esults to the companies

–

in seeming confidence. Once auditors

rform their

anned

ocedures, and

eek and then

obt

ain access to the company’s privileged

nformation regarding a variety of circumstances and issues, companies are increasingly losing

ny expectation that this information will remain confidential. Instead, companies now must

xpect that this sensitive information will find its way into the hands of litigation adversaries

–

erely because the company consulted with

ts attorneys, then cooperated with its independent

uditors.

t is our perception that recent events have brought about

a s

ubtle but importa

hange in how auditors carry

out

their responsibilities regarding

publ

ic company oversight

The

CAOB’s an

the SEC’s roles overseeing auditors’ compliance with GAAS in the detection of

raud and public companies’ compliance with securities laws have been strengthened. The

uditors’ role in performing procedures regarding the fair presentation of a company’s

inancial

tatements has been

potlighted

It is the companies, however,

hat

re charged with developing

oper internal controls and

ooperating

ith their auditors in the first in

tance. And yet, their

eward

ay be

st exposure to civil litigations. As recognized whenever the attorney

-c

lient

ivilege and work product doctrine are debated, the kind of

dvertent, inadvertent, and

ometimes virtually compelled

ivilege waivers that companies are facing now serves to deny

ompan

es the effective assis

ance of counsel. While one public policy is being strengthened,

one

herefore, is being weakened. The societal detriment caused by imprudent and unnecessary

aivers of the privileges associated with the advice and involvement of counsel

–

a problem

h has been highlighted by the shift in policy currently being experienced in the regulations

urrounding Corporate America

–

is well

-doc

umented, and is discussed in this paper.

he waiver problem is very real. Judicial development in the law governing

ver of privileges is, at best, mixed

thus affording no assurance to companies that privileged

nformation disclosed to auditors will remain protected

rom adversaries. The solution is not

–

nd we emphasize that it is not the purpose of this White Paper to seek

– t

hat auditors

rom obtaining clarification or substantiation of facts from their corporate clients.

ather, t

EC Enforcement Director Stephen M. Cutler recently referred to auditors as one of the three principal

“

gatekeep

rs” in our capital markets, or “sentries of the marketplace

”

tephen M. Cutler,

irector of

he Division of Enforcement at the SEC,

marks at the

CLA

hool of

os A

geles,

(Se

ptember 20, 2004),

“

emes of

arbanes

-Ox

ley as reflecte

the Commission’

s En

forcement

ogram

”

(transcript available at

ttp://www.sec.gov/news/speech/spch092004smc.htm

62087.1

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olution

– a

s has already been recognized with regard to the SEC and the PCAOB

–

must be

egislative

otection of the priv

leges,

ecognizing that it is

ust

mportant

or companies to

urnish necessary information to their auditors while protecting it from disclosure to

heir

dversaries as it is

or auditors to seek what they need to fulfill their role as “gatekeepers

.”

HE PUBLIC INTEREST

N PRESERVING AND ST

ENGTHENING THE

UBLIC COMPANY AUDIT FUNCTION

hether or not the current political climate and regulatory developments

onstitute what could be considered

hanges to

AAS with respect to the detection of fraud

– i

her words, whether auditors are expected to apply

ore stringent standards t

uncover

orporate fraud, or whether there is simply greater public and government oversight of

ong

tanding

uditing standards

–

is debatable. Whatever the impetus, howeve

, the consortium of

publ

ic companies whose concerns prompted this paper cite a sharp increase in requests from

ndependent auditors not simply for relevant factual information from the company, but also for

ivileged information, either as conditions of

ngagement or as requirements for completion of

inancial statement audits and reviews.

iven the reg

atory trends discussed above,

his reported increase in such

equests is not particularly surprising. Recent comments by the SEC’s Deputy Chief

cco

unt

ant, Scott Taub, pointedly suggest that auditors should seek out privileged information in

upport of audits of litigation loss and tax contingency accruals under FAS 5. Mr.

aub

emarked as follows:

he difficulty in auditing [loss contingency accrual

under FAS

, however,

hould cause the auditor to spend more time on them, not less.

f a company’s

out

side counsel is unwilling or unable to provide its expert views, the auditor

hould consider whether sufficient alternate procedures can actually be

rformed to allow the audit to be completed

s Mr. Taub suggested, “[a]udit documentation” in this area should “follow the same high

tandards that apply to other areas of the audit” and warned “

hat the PCAOB inspection teams

ill be looking at the aud

t work done in these sensitive areas

”

n August 26, 2004, in fact, the PCAOB released limited inspection reports on

ach of the four major accounting firms.

The Board “cheerfully admit[ted] it is being harsh” in

cknowledging that the reports appea

to be “laden with criticism” and “an unflinching candour

ee Appendix A for a comprehensive analysis of the audit standards designed to detect fraud and the recent

egislative and regulatory init

atives in this regard.

EC Deputy Chief Accountant Scott A. Taub, Remarks at the University of Southern California Leventhal

chool of Accounting SEC and Financial Reporting Conference (May 27, 2004) (emphasis added)

(

transcript available at http://www

sec.gov/news/speech/spch052704sat.htm).

ee id

(emphasis added).

ach of the four 2003 Limited Inspection Reports issued by the PCAOB are

vailable at

ttp://www.pacobus.org/Inspections.

62087.1

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ith firms about the points on which we see a need for improvement.”

Among its limited

nspection reports, the PCAOB criticized two firms for not having adequate support in one audit

or continge

liabilities under FAS 5, including the analysis of counsel.

s members of the Corporate Counsel C

ons

ortium ha

reported, a company’s

ivileged information and the work product of its attorneys are increasingly being requested by

uditors under vari

ous

circumstances. Auditors are requiring clients to provide detailed

nformation or open their files regarding whistleblower allegations, investigations and outcomes

or example, in connection with their obligation under Section 10A of the Exchange Act to

ollow “procedures designed to provide reasonable assurance of detecting illegal acts that would

ve a direct and material effect on the determination of financial statement amounts,”

auditors

equire public company clients to provide information abo

potential illegal acts and

emediation efforts. Under the Section 10A structure, if an auditor becomes aware of

nformation “indicating that an illegal act (whether or not perceived to have material effect on

he financial statements of the issuer) has or may have occurred,” the auditor must take certain

teps to inform itself, advise the issuer and ultimately satisfy itself that the company has

ppropriately remediated the matter. Companies and/or their audit committees typically launch

nternal inves

igations, led by legal counsel and resulting in an accumulation of attorney

-c

lient

ommunications, witness interviews, advice of counsel and other legal work product and

nalyses. Thus, the information required by auditors frequently includes privileged

ttorney

lient communications and work product.

imilarly, pursuant to Section 307 of the Sarbanes

-O

xley Act (by which Congress

rected the SEC to set forth “minimum standards of professional conduct for attorneys

ppearing and practicing before the Co

mission”) and the SEC’s implementing regulations

hich require attorneys to report “evidence of a material violation of securities law, or breach of

iduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel

chi

f executive officer of the company,” corporate counsel is required

–

much like auditors

unde

r Section 10A

–

to report evidence of misconduct up the corporate ladder and to satisfy itself

atchdog Promises “Unflinching Candour

” The Financial Time

, 2004 WL 90109536 (Aug. 27, 2004).

n the inspection reports, all of the firms came in for criticism with respect to the adequacy of audit

ocumentation. The PCAOB also criticized the firms for having insufficient audit support of provisions for

ax re

erves and valuation allowances.

ee PCAOB, Report on 2003 Limited Inspection of Ernst & Young

LP (Aug. 26, 2004) at 23

-2

4, n.5,

vailable at

ttp://www.pcaobus.org/documents/Inspections/2004/Public_Reports/Ernst_Young.pdf; KPMG Report,

upra

at 23, n.4

CAOB, Report on 2003 Limited Inspection of Deloitte & Touche LLP (Aug. 26, 2004) at 19

-2

vailable

ttp://www.pcaobus.org/documents/Inspections/2

04/Public_Reports/Deloitte_Touche.pdf

;

PCAOB,

eport on 2003 Limited Inspection of KPMG LLP (Aug. 26, 2004) at 19, n.4,

vailable at

ttp://www.pcaobus.org/documents/Inspections/2004/Public_Reports/KPMG.pdf.

5 U.S.C. § 78j

-1

. Section 10A is modeled

fter the predecessor of SAS 82, a GAAS requirement that

“

[t]he auditor has a responsibility to obtain reasonable assurances about whether the financial statements

re free of material misstatements, whether caused by error or fraud.” AICPA, Auditing Stand

rd Board,

tatement on Auditing Standards No. 82: Consideration of Fraud in a Financial Statement Audit (codified

n AICPA Professional Standards, AU § 316). Section 10A imposes essentially the same auditing

bligations, but adds a potential “reporting ou

” requirement to the SEC and explicitly exposes auditors to

EC sanctions for non

-c

ompliance.

62087.1

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hat the company has taken appropriate remedial action.

The Sectio

307 structure, therefore,

lso spawns internal investigations which generate attorney

-c

lient privileged communications

nd attorney work product. Auditors are requiring public company clients to disclose this

nternal investigation information, includin

whether corporate legal counsel has advised the

ompany of evidence of any material violations of the law in the first place.

uch internal investigations

requently

re undertaken by co

panies and their

egal counsel

whether or not there is a paralle

SEC investigation or proceeding. Indeed,

ompanies’ roles in establishing the primary controls to detect and respond to allegations of

raud

–

through their audit committees

–

has grown considerably under the Sarbanes

-O

xley Act.

ursuant to the Act, au

t committees are charged with establishing procedures for receiving and

ndling complaints “regarding accounting, internal controls or auditing matters” and

onfidential submissions by corporate employees “regarding questionable accounting or auditing

tters.”

In implementing these responsibilities, many public companies and their audit

ommittees have gone beyond the minimum requirements of the law and established procedures

or receiving and investigating all whistleblower complaints, on any subject relevant to the

ompany, from any source. Internal investigations are conducted pursuant to these procedures

outinely in response to all disputes, whether or not litigation is involved, and attorney work

oduct is generated as a result.

uditors may re

qui

re public company clients to disclose legal advice and analyses

oncerning other specific issues that could impact the financial statements of the company. As

rt of an audit of the company’s financial statement assertions regarding tax assets, liabil

ties

nd contingency reserves, auditors frequently require companies to provide legal advice,

nalyses and judgments provided to the company concerning the potential tax consequences of

ransactions.

In addition, as part of their audit inquiry into comp

ny loss contingencies

pur

suant to FAS 5, auditors ask

hat

orporate legal counsel disclose their judgments and

upporting information regarding potential outcome, range of loss and other issues resulting from

itigation, claims and assessments against th

company.

hile in light of Mr.

aub’s comments and the criticisms levied in the PCAOB’s

imited inspection reports, as discussed above, auditors may conclude that it would be imprudent

n this climate

not

to demand expansive access to a company’s litiga

ion files in these and other

ituations, this is neither entirely new nor

r se inappropriate. Certainly, this paper takes the

pos

ition that the audit process has long been set up such that public companies have been giving

heir auditors access to the

nformation that the auditors need

–

including sensitive information

–

o conduct their audits. The public interest in continuing and strengthening this system, in which

uditors have access to all information required to conduct a proper audit, including inquiries

7 C.F.R. Part 205.

he Sarbanes

-O

xley Act of 2002, Section 301, 15 U.S.C. § 78j

-1

ndeed, pursuant to an auditor’s obligations regarding loss continge

cies for litigation, claims and

ssessments pursuant to FAS 5, GAAS provides that the “opinion of legal counsel on specific tax issues

hat he is asked to address and to which he has devoted substantive attention … can be useful to the auditor

n forming

is own opinion.”

ee AU §9326.17. The same standard warns further, however, that “it is not

ppropriate for the auditor to rely solely on such legal opinion” in conducting the audit regarding this

ssues.

62087.1

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nto corporate fraud, is laudable and undeniable. In other words, barring some notable

xceptions, this is how the audit system has worked and should continue to work. And the

xceptions should be, and are being, corrected. Fixing the problem

which led to those

xceptions, however, need not come at the expense of other public interests that are just as

mportant.

hen companies are required to provide their independent auditors with attorney

ork product and privileged communications,

he wai

r problem is

quarely presented.

que

stion then becomes whether the public interest in preserving the attorney work product

doc

trine and attorney

-c

lient privilege is important enough to be protected at the same time that

he public interest in the pu

ic company audit function is being strengthened . . . or whether a

ompany’s good corporate governance and cooperation with

uditors should come

t the cost

waiver of these protections.

II.

HE PUBLIC INTEREST

N PRESERVING THE AT

ORNEY

-C

LIENT

RIVILE

E AND WORK PRODUCT

ROTECTION

legal system that fails to assure public companies the protection of the attorney

lient privilege and work product protection denies those companies the effective assistance of

ounsel when potentially illegal corporate b

havior is discovered.

As the Supreme Court has

tated, impairment of these privileges and protections would “not only make it difficult for

orporate attorneys to formulate sound advice when their client is faced with a specific legal

oblem but also t

eaten to limit the valuable efforts of corporate counsel to ensure their client’s

ompliance with the law.”

bsent assurance that attorney

-c

lient communications and work product can be

otected as confidential, companies that seek the assistance of l

gal counsel would only do so in

he face of an unacceptable risk that counsel will be converted “into a conduit of information

tween the client” and its adversaries.

ee Appendix B for a comprehensive analys

s of the historical

ignificance of the attorney

-c

lient privilege

nd work

-p

roduct doctrine.

or example, in disclosing information to auditors regarding the handling of whistleblower allegations,

ompanies risk waiving privileges to the extent that t

e information includes attorney

-c

lient

ommunications, witness interviews, advice of counsel, and other legal work and analyses. This type of

nformation is at the heart of what companies reasonably expect

–

through long

-s

tanding and sound

recedent

–

l be protected from actual and potential litigation adversaries.

pjohn Co. v. U.S.

449 U.S. 383, 392 (1981). This point was made forcefully in the recently

-p

ublished

omments of the ABA’s Section of Antitrust Law On The Proposed Amendments To The Se

tencing

uidelines For Organizations

at 5

-7

vailable at

ttp://www.abanet.org/antitrust/comments/2004/sentencing guidelines0704.pdf.

nited States v. Chen

99 F.3d 1495, 1500 (9th

ir. 1996) (the “valuable service of counseling clients

nd bring

ng them into compliance with the law cannot be performed effectively if clients are scared to tell

heir lawyers what they are doing, for fear that their lawyers will be turned into … informants”); Joint

rafting Committee of the American College of Trial Lawyers,

he Erosion of the Attorney

-C

lient

rivilege and Work Product Doctrine in Federal Criminal Investigations (March 2002), at 11. In additon,

he Antitrust Law Section’s paper, discussed

upra

makes the point that companies that cannot protect

62087.1

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hese concepts supporting the protection of attorney work product and privileged

omm

uni

cations are not incompatible with the function of auditors and their ability to obtain the

omprehensive information that they need to conduct proper audits. In 1975, the audit and legal

ofessions debated the issue

and reached an accord

–

or “Treat

,” as it is sometimes called

–

egarding the

aiver problem arising when auditors ask their clients for privileged information

elated to the judgments of company counsel regarding loss contingencies

itigation, claims

nd assessments.

s “Stateme

of Policy Regarding Lawyers’ Responses to Auditors’

equests for Information,” as adopted by the ABA

nd consented to by the AICPA, struck a

lance between two very important public interests: first, to promote confidence in the capital

arkets by assu

ing reliable financial reporting of loss contingency accruals and disclosures

unde

r FAS 5, and second,

o encourage companies to consult freely with counsel by protecting

he confidentiality of lawyer

-c

lient communications. The ABA Statement of Policy st

ruc

k the

lance by limiting the range of acceptable disclosures that lawyers may make to auditors with

he client’s informed consent, and thus define

the scope of what the auditors may request from

awyers regarding confidential attorney information.

1977, the AICPA

ffirmed this

ileged information from litigation adversaries naturally will be deterred from conducting thorough

nternal investigations and documenting findings, analyses and recommendations. Likewise, employees

ill be deterred from cooperating in investigations if

hey know that candor will only expose them to

ersonal liability or make them witnesses for the company’s adversaries.

omments of the ABA’s

ection of Antitrust Law

, s

upra

at 11

-1

aw review articles at the time discuss the tensions that led t

it, including incidents of auditors asking

awyers open

-e

nded questions seeking general information about the client’s potential illegal acts and

iability exposures.

ee Erbstoesser and Matson,

awyers’ Letters to Auditors,

hpt. 8, Drafting Legal

on Letters, at 366, nn. 1

& 2

(2d ed. 1992); Deer,

awyers’ Responses to Auditors’ Requests for

nformation

28 Bus. Law. 947 (1973). The ABA Statement of Policy and SAS 12 ended these types of

road requests by clarifying that GAAS did not require them.

merican Bar Association, “Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for

nformation” (1975),

vailable at htpp://www.abanet.org/buslaw/catalog/5070426i/secure.html.

he accord involves three pieces of professional litera

ure. The obligation of lawyers to limit their

esponses to auditor inquiries is set forth in the ABA Statement of Policy. The obligation of clients to

ccrue for and/or disclose loss contingencies properly is set forth in FAS

, which is part of general

ccepted accounting practices (“GAAP”).

inancial Accounting Standards Board, Statement of

ccounting Standards No. 5: Accounting for Contingencies (March 1975).

he obligation of auditors to

nquire concerning litigation, claims and assessments

s governed by GAAS and, specifically, SAS

dopted by Auditing Standards Executive Committee of the American Institute of Certified Public

ccountants (“AICPA”) in the wake of the ABA Statement of Policy.

ICPA, Auditing Standards

oard, Statement on Auditing Standards No. 12: Inquiry of a Client’s Lawyer Concerning Litigation,

laims and Assessments (Jan. 1976) (codified in AICPA Professional Standards, AU § 337). The ABA

tatement of Policy is an exhibit to SAS 12.

ursuant to the ABA Statem

nt of Policy, a lawyer may provide information to a client’s auditors on

atters to which the lawyer has devoted substantive attention regarding overtly threatened or pending

itigation and, with the client’s further specific consent, regarding unasserted possible claims or

ssessments or contractually

-a

ssumed obligations, and may provide specific confirmations regarding the

awyer’s role for the client. Only in rare circumstances may the lawyer express to the auditors any

rofessional judgment regarding

he potential outcome of the matters. The lawyer may only provide

nformation and evaluation of unasserted possible claims specifically identified by the client if the client

as determined that it is “probable” the claims will be asserted, that there is

“reasonable possibility” that

he outcome will be unfavorable and that the resulting liability will be material to the client’s financial

ondition. ABA Statement of Policy, par. 5.

62087.1

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005

otection and limitation regarding auditor access to confidential information and work product

aintained by the client.

s recognized by both the auditing and legal professions through the continued

ability of the Tre

ty today

–

promoting effective corporate governance and responsiveness to

llegations of wrongdoing depends, in part, on protecting the attorney

-c

lient privilege and work

oduct doctrine. The ABA Statement of Policy, in fact, begins with this recognitio

he public interest in protecting the confidentiality of lawyer

-c

lient

ommunications is fundamental

The American legal, political and economic

ystems depend heavily upon voluntary compliance with the law and upon

eady access to a respected body of professionals able to interpret and advise

the law. The expanding complexity of our laws and governmental

egulations increases the need for prompt, specific and unhampered lawyer

lient communication. The benefits of such communication and early

ultation underlie the strict statutory and ethical obligations of the lawyer

o preserve the confidences and secrets of the client, as well as the long

ecognized testimonial privilege for lawyer

-c

lient communication.

hus, while it is the auditors who r

quire access to such attorney

-c

lient information

–

as part of

heir job of performing audits

–

they recognized the importance of the privileges enough to

gree

o a “Treaty” insisting that the public interest in protecting these privileges be upheld.

EC is also on record promoting work product protection for the internal

nvestigation files of a public company’s counsel.

The SEC recently argued in one case,

nited States v. Bergonzi

that its responsibilities would be frustrated if companies were de

erred

rom sharing their work product from internal investigations with the SEC, and because of this

oncern, the SEC argued that such production “should not result in waiver of work

-p

roduct

ee AICPA Professional Standards, AU § 9337 (4), Documents Subject t

Lawyer

-C

lient Privilege (March

977). The interpretive release poses the question

“[SAS 12 states:] “Examine documents in the client’s

ossession concerning litigation, claims, and assessments, including correspondence and invoices from

awyers.”

d this include a review of documents at the client’s location considered by the lawyer and

he client to be subject to the lawyer

-c

lient privilege?” and answers as follows: “

o. Although

rdinarily

n auditor would consider the inability to review infor

ation that could have a significant bearing on his

udit as a scope restriction,

n recognition of the public interest in protecting the confidentiality of lawyer

lient communications, [SAS 12] is not intended to require an auditor to examine documents t

at the client

dentifies as subject to the lawyer

-c

lient privilege

”

(

Emphasis added)

BA Statement of Policy, Preamble (emphasis added).

ndeed, a Practicing Law Institute conference on securities litigation and enforcement held September 1,

004 i

cluded a panel of attorneys who practice before the SEC who commented that internal

nvestigations conducted by a company to respond to fraud allegations “may cause more harm than good”

ecause the SEC now regularly demands waiver of privileges, and “[t]h

t information is then discoverable

y plaintiffs’ lawyers in civil litigation.”

onference Panelists Discuss Securities Litigation and

nforcement

SEC Today (CCH Sept. 16, 2004), at 1. One panelist suggested that “the waivers of

ttorney/client privile

e will have a chilling effect on the information provided by clients to their lawyers,

hich is what the privilege is intended to protect.”

d. at 2.

62087.1

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005

otection because preserving work

-p

roduct protection is in the

publ

ic interest. . . .”

The SEC

poi

nted out that there are “significant benefits to the public” when a company can share its work

oduct with the SEC, thereby allowing the SEC to fulfill its oversight function, without fear by

he company that its work

roduct will end up in the hands of its adversaries: “The choice is

hus between disclosure only to government agencies, which will increase the effectiveness and

fficiency of governmental investigations, and no disclosure at all

–

not a choice between

sclosure only to government agencies and disclosure to all parties.”

he same policies underlie public companies’ disclosure of work product to their

uditors. Disclosure of such material may be part

an effective and comprehensive audit, but it

oul

unf

air for companies to be exposed to a waiver of their privileges as to their

dversaries

–

who stand ready to use this sensitive information to file civil lawsuits and obtain an

mmediate advantage over the companies in litigation

–

simply because t

companies maintain

ffective internal controls for responding to allegations of wrongdoing and cooperat

ng with their

uditors. This is the waiver problem, and it is growing.

HE WAIVER PROBLEM

hile it may be true that both the attorney

-c

lient protect

ons and the public

ompany audit function serve important public policies, it is not the case that, today, each is on

qual footing with the other. In the wake of the recent, high

-p

rofile corporate scandals, the

publ

ic and governmental response has been

o strengthen the audit function

–

and appropriately

o. This renewed focus has led to increased government scrutiny of auditors and, as reported by

any public companies, increased requirements by auditors for confidential information that go

ar beyond

xchange

ontemplated by the 1975 ABA Statement of Policy

s becoming

ncreasingly clear

hat corporations have reason to be concerned. The attorney work product and

onfidential communications generated through internal investigations involving

ounsel,

ecognized as privileged by long

-s

tanding public policies, may

–

simply because a company

stablishes prompt, effective controls for responding appropriately to allegations of wrongdoing

–

be sacrificed to civil litigation adversaries for the mere reason that the corporation and their

uditors are doing their jobs.

nited States v. Bergonzi

Cir. Case No. 03

-1

0024, Brief of the Securities and Exchange Commissio

003 WL 22716310 (Apr. 29, 2003), at *3

-4

. The ABA Section of Antitrust Law recently echoed this

ame argument, stating its belief that a waiver of these protections based upon disclosure by a company of

ts privileged or work product materials to the

overnment “will reduce the availability of information from

n organization’s management and employees, and impede the development and operation of effective

ompliance programs.”

omments of the ABA’s Section of Antitrust Law

, s

upra

at 2

d. at *16

-1

7. The SEC also took the position that, “[t]he Commission cannot compel public companies to

roduce work product, and even cooperative companies generally will not produce work product for fear

hat production will waive work

-p

roduct protection as t

third parties.”

d. at *22

-2

3 (as support for this

osition, which the SEC stated was the “likely” result,

d. at *30, the SEC cited to pages of the record on

ppeal but did not describe the information therein). This paper disclaims any suggestion tha

, as to its

uditors

companies do not provide requested work product; companies have a vested interest in ensuring

hat their auditors obtain the information that is needed to assess whether an unqualified audit opinion may

e given.

62087.1

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005

ASE LAW REGARDING W

IVERS OF PRIVILEGES BASED UPON

ISCLOSURE TO AUDITO

he ABA Statement of Policy expressed the drafter’s expectation that judicial

velopments regarding disclosu

e of confidential information provided to auditors would not

ejudice clients “engaged in or threatened with adversary proceedings,” but also provided that if

udicial developments were adverse, revision of the ABA Statement might be needed.

Indeed,

the

case law has been neither favorable nor consistent with respect to the protection of

onfidential information disclosed by clients to auditors.

ith respect to the attorney

-c

lient privilege, courts generally hold that disclosure

attorney

-c

lient commu

cations to auditors, as independent third parties, constitutes a

aiver.

ourts in s

e states, however

–

those

tates

hich, through legislation or otherwise,

ve created an accountant

-c

lient privilege

– r

each the opposition conclusion regarding the

sclosure of attorney

-c

lient communications to auditors

egarding the work product doctrine,

here is even less consistency among courts

ome courts

onsidering the discoverability of attorney work product disclosed by a company to

ts auditors hol

that most such work product was prepared in the ordinary course of business,

not “

in anticipation of litigation or for trial,” which is the language used to describe the work

oduct protection in Federal Rule of Civil Procedure 26(b)(3),

nd thus that,

cause the work

oduct doctrine never applied, it is discoverable. Other courts hold that such work product is

not

discoverable because it does not constitute relevant evidence in a litigation.

ne court

cided that the company’s disclosure waives the protection of the work product doctrine

ee Appendix C fo

a comprehensive analysis of the case law regarding waivers of the attorney

-c

lient

rivilege and work product protection based upon a company’s disclosure to its auditors.

BA Statement of Policy, Commentary, par. 1 (“The Statement of Policy has been p

epared in the

xpectation that judicial development of the law in the foregoing areas will be such that useful

ommunication between lawyers and auditors in the manner envisaged in the Statement will not prove

rejudicial to clients engaged in or threaten

d with adversary proceedings. If developments occur contrary

o this expectation, appropriate review and revision of the Statement of Policy may be necessary.”).

989, following an early adverse court decision on the issue of waiver, another ABA comm

ttee sought to

itigate the risk of further waiver rulings. The committee issued a report advising lawyers to state

xpressly in their communications to auditors that neither the client nor the auditor intended any waiver of

he attorney

-c

lient or work p

oduct privileges.

ee Subcommittee on Audit Inquiry Responses, Law and

ccounting Comm., ABA Section of Business Law, Report by the American Bar Association’s

ubcommittee on Audit Inquiry Responses (1989), reprinted in

awyers’ Letters to Auditors

, s

upr

at 381

4. As the committee said, such language “simply makes explicit what has always been implicit, namely

…

that neither the client nor the lawyer intended a waiver.” The AICPA agreed with the ABA committee

n a 1990 interpretation of SAS 12 advisi

g auditors that such language in a lawyer’s letter did not impose a

cope limitation requiring a qualified audit opinion.

ee AICPA, Auditing Interpretation: Inquiry of a

lient’s Lawyer Concerning Litigation, Claims, and Assessments

–

Use of Explanator

Language about the

ttorney

-C

lient Privilege or the Attorney Work Product Privilege, J. Acct. (Feb. 1990), reprinted in

awyers’ Letters to Auditors

, s

upra

at 384

-8

, e

.g.

, G

utter v. E.I. Dupont De Nemours and Co.

1998 WL 2017926, at *3 (S.D. Fl

. May 18, 1998);

n re Pfizer Inc. Securities Litig.

1993 WL 561125, at *6 (S.D.N.Y. Dec. 23, 1993).

nly fifteen states have any such statute and, of those, only seven have expressly extended the privilege to

ndependent auditors by statute or judicia

ruling.

ee Appendix C for further analysis.

62087.1

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005

cause there are no “common interests” between an auditor and the client

;

other courts

sagree

any courts employ still other

–

and vastly different

–

lines of reasoning

. T

bot

tom line is that,

whi

le most a

horities support the argument that disclosure of work product

o auditors should not waive the protection as to adversaries, some courts

ffirmatively hold that

sclosure constitutes a waiver.

ecause the case law is not uniform, companies have no

gua

ee that courts will protect attorney work product from waiver as to

he companies’

dversaries if these materials are disclosed to auditors. This uncertainty

ompletely

unde

rmines

he purpose of the privilege: As the United States Supreme Court said,

“

[a]n uncertain privilege,

one which purports to be certain but results in widely varying applications by the courts, is

ittle better than no privilege at all.”

nfortunately, the uncertainty has only grown with the onset of the post

arbanes

-O

xley Ac

world. To the extent that some courts

hav

e protected privileged information

sclosed to auditors from discovery by third

-pa

rty adversaries, as outlined

Appendix C

the

ynchpin has been the auditors’ professional obligation to maintain the informati

onfidence.

ertified Public Accountants

re members of the AICPA and th

bound by

ICPA Code of Professional Conduct Rule 301, which prohibits disclosure of client confidential

nformation without “the specific consent of the client.”

The only

xceptions under Rule 301

re when disclosure is compelled by legal process (

.g.

a subpoena), or required in connection

ith review of the auditor’s professional practice or with investigative or disciplinary

oceedings conducted by the AICPA or another oversight body. In the latter circumstances,

ule 301 prohibits the AICPA and other oversight bodies from disclosing any auditor’s

“

confidential client information that comes to their attention in carrying out those activities.”

urther, auditors have

ccepted the constraints on disclosure under the ABA Statement of Policy,

hich provides that a lawyer’s responses may be used by the auditor only in connection with the

udit, and may not be quoted or referenced in the client’s financial statements, or fi

ed with any

gove

rnment agency, or disclosed in response to any subpoena or other process without the

awyer’s consent or upon at least 20 days’ prior notice.

The expectation of confidentiality

afeguards in the audit system has been key to those decisio

denying waivers by a company’s

ooperation with its auditors.

ompare

edinol, Ltd. v. Boston Scientific Group

214 F.R.D. 113, 115 (S.D.N.Y. 2002)

ith

n re Pfizer

993 WL 561125, at *6; and Appendix C for further analysis of the cases.

pjohn

449 U.S. at 392.

awyers, of course, are bound by rules of ethics and professional responsibility not to reveal client

onfidences without client consent; hence, informed consent is a central feature of the ABA Statement of

olicy.

ee Rule 1.6 of the ABA Model Rules of

rofessional Conduct, available at

ttp://www.abanet.org/cpr/mrpc/rule_1_6.html.

ICPA, Rules of Professional Conduct, ET Section 301: Confidential Client Information, Rule 301.01

(

Jan. 1992, as amended) (“A member in public practice shall not disclose

ny confidential client

nformation without the specific consent of the client.”)

BA Statement of Policy, par. 7.

onfidentiality agreements have, therefore, likewise been crucial in the handful of decisions finding non

aiver despite disclos

re of work product to government investigators.

ee, e.g.

, S

aito v. McKesson

62087.1

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-2

005

nder the Sarbanes

-O

xley Act, however, the PCAOB

–

not the AICPA

–

harged with establishing standards for auditing, attestation, quality control, ethics and

ndependence with respect to

publ

ic company audits

subject to SEC approval.

In April 2003,

he PCAOB adopted interim, transitional standards in each of these areas which generally

rected

publ

ic company

uditors to continue to comply with AICPA standards. The interim

thics stand

rds selectively identify only certain rules of the AICPA Code of Professional

onduct for adoption

– not i

ncluding Rule 301.

While auditors

hould

bide by Rule 301

embers of the AICPA

the rule has been given no force by the PCAOB. This omission m

ace public companies at greater risk that courts will find waivers when privileged information

s disclosed to auditors.

LOSING THE FLOODGAT

S: CURRENT LEGISLAT

ON DESIGNED

O MITIGATE SIMILAR

AIVERS OF PRIVILEGE

real and significant waiver p

oblem presented by auditor requests for access

o privileged information

ttested to by the fact that legislative efforts have been made to

nsure that

he government agencies charged with overseeing compliance with the securities

aws and accounting s

andards

–

the SEC and PCAOB

–

may be exempted from the waiver

oblem, thereby increasing their ability to be effective. This has been addressed through two

ignificant pieces of federal legislation

–

H.R. 2179, currently pending before Congress, and

ion 105 of the Sarbanes Oxley Act. Both pieces of legislation provide that disclosure of

ivileged information to the government does not waive privileges as to anyone else. Both are

signed to enable the government to obtain work product and attorney

-c

lient communications

rom regulated entities without exposing those entities to claims of waiver and wholesale

scovery by other adversaries. Both recognize that questions of preservation of privileges

ollowing disclosure to the government cannot be l

ft to the courts, which are bound to apply

ommon law principles of waiver. Neither, however, solves the waiver problem presented in this

per.

1. H

.R. 2179

he SEC will consider a company’s voluntary cooperation with an investigation

s a mitigating fa

tor in determining appropriate enforcement action, if any. The SEC has

omulgated guidelines identifying factors that it will consider in assessing the quality of a

ompany’s cooperation, and those guidelines emphasize the importance of a company’s deci

ion

BOC, Inc.

2002 WL 31657622, at *6, 11 (Del. Ch. Ct. Nov. 13, 2002) (“[P]ublic policy seems to

andate that courts continue to protect the confidentially disclosed work product in order to encourage

orporations to comply with law enforcement agencies.”);

aruzen Co., Ltd. v. HSBC USA, Inc.

2002 WL

628782, at *2 (S.D.N.Y. June 23, 2002) (denying motion to compel because defendants had

onfidentiality agreements with U.S. Attor

ey’s Office to whom documents were disclosed (citing

n re

teinhardt Partners, L.P.

9 F.3d 230, 236 (2nd Cir. 1993))).

he Sarbanes

-O

xley Act, Section 103, 15 U.S.C. § 7214.

ee PCAOB R. 3500T, adopting Interim Ethics Standards. The complete stan

ards and rules of the

CAOB are available at http://www.pacobus.org/documents/rules_of_the_board/all.pdf.

62087.1

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-2

005

o waive attorney

-c

lient privileges and work product protections.

The threat of an enforcement

ction that might be avoided by cooperating fully places strong pressure on companies to waive

ivileges, which, in turn, risks further waiver and compel

ed disclosure to other adversaries.

ecognizing this serious dilemma for companies, the SEC has adopted the

pos

ition that waiver of privileges in order to cooperate with the SEC should not result in a

oader waiver as to other parties.

This “selective

aiver” concept, however, has been rejected

many courts which hold that a company’s production of privileged information to the SEC or

nother government agency constitutes a full waiver of all privileges and protections that

herwise might have applie

against any other adversaries.

iven the SEC’s strong desire to obtain the fruits of investigation by a company’s

awyers and other privileged information

–

and recognizing that the waiver problem is a serious

mpediment to this

–

the SEC recommended th

t Congress enact legislation to “enhance the

ommission’s access to significant, otherwise unobtainable, information.”

Members of

ongress responded with H.R. 2179, introduced on May 21, 2003, which, as currently drafted,

oposes an amendment to the 19

Securities & Exchange Act, as follows:

otwithstanding any other provision of law, whenever the Commission or

n appropriate regulatory agency and any person agree in writing to terms

pur

suant to which such person will produce or disclose to the Commis

ion

the appropriate regulatory agency any document or information that is

ubject to any Federal or State law privilege, or to the protection provided

the work product doctrine,

uch production or disclosure shall not

onstitute a waiver of the priv

lege or protection as to any person other

ne of the questions the SEC asks itself is “Did the company produce a thorough and probing written

eport detailing the findings of its internal r

view?”

n the Matter of Gisela de Leon

-M

eredith

Exchange

ct Release No. 44970 (October 23, 2001),

vailable at http://www.sec.gov/litigation/investreport/34

4969.htm.

he DOJ has taken a similar position on cooperation; thus, under its guidelines, “[

]ne factor the prosecutor

ay weigh in assessing the adequacy of a corporation’s cooperation is the completeness of its disclosure

ncluding, if necessary, a waiver of the attorney

-c

lient privilege and work product protections, both with

espect to its in

ernal investigation and with respect to communications between specific officers, directors,

nd employees, and counsel.” Memorandum Regarding Principles of Federal Prosecution of Business

rganizations, U.S. Deputy Attorney General Larry D. Thompson, Ja

uary 20, 2003,

vailable at

ttp://www.usdoj.gov/dag/cftf/corporate_guidelines.htm.

ee Amicus Brief of the United States Securities and Exchange Commission,

cKesson HBOC, Inc. v.

dler

No. 99

-C-7

980

-3

(Ga. Ct. App. Filed May 13, 2001).

, e

.g.

, I

n re Columbia/HCA Healthcare Corp. Billing Practices Litig.

293 F.3d 289, 291 (6th Cir.

002);

ank of America, N.A. v. Terra Nova Ins. Co.

212 F.R.D. 166, 167 (S.D.N.Y. 2002);

nited States

. Massachusetts Inst. of Tech.

129 F.3d 681, 687 (1st Cir. 1

97);

estinghouse Elec. Corp. v. Philippines

51 F.2d 1414 , 1458 (3d Cir. 1992);

n re Martin Marietta Corp.

856 F.2d 619, 622

-2

3 (4th Cir. 1988).

.S. Securities and Exchange Commission, Report Pursuant to Section 704 of the Sarbanes

-O

xley Act of

002 (Jan. 24, 2003), available

ttp://www.sec.gov/news/studies/sox704report.pdf

at p

45.

62087.1

-1

-2

005

han the Commission or the appropriate regulatory agency to which the

doc

ument or information is provided

his legislation is designed to help the SEC secure maximum cooperation from

ompanies in the form of dis

losure of privileged communications and work product by

lleviating the potential harm to companies from a waiver of privileges as to other adversaries.

ut even if H.R. 2179 becomes law, the contemplated protection for companies

ay be illusory. While a company’s privileges would be intact with respect to information

ovided to the SEC, if the

audi

tors obtain disclosure of the same information, the company will

ace the same waiver problem. H.R. 2179 does not shield any disclosure to the auditors fro

ope

rating as a waiver: Thus, the company’s adversaries will simply look to the company and its

uditors for the privileged information.

2. S

ection 105 of The Sarbanes

-O

xley Act

he Sarbanes

-O

xley Act establishes a blanket evidentiary privilege and discover

mmunity for all information provided to the PCAOB or prepared in connection with PCAOB

nspections and investigations of registered audit firms. Section 105(b)(5) provides:

[

A]ll documents and information prepared or received by or specifically

or the [PCAOB], and deliberations of the [PCAOB] and its employees

nd agents, in connection with an inspection under section 104 or with an

nvestigation under this section,

hall be confidential and privileged as an

videntiary matter (and shall not be subject to civil discovery or other

egal process) in any proceeding in any Federal or State court or

adm

inistrative agency, and shall be exempt from disclosure …

ection 105(b)(5) goes on to provide that, “without the loss of its status as confidential and

leged in the hands of the [PCAOB],” the foregoing information may be provided to the SEC

nd, at the discretion of the PCAOB, to other federal and state regulators. State regulators are

asked with maintaining “such information as confidential and privil

ged.”

This provision has

en implemented in the PCAOB’s Ethics Code and Rules.

.R. 2179, 108

Cong. 1

Sess. (May 21, 2003). On June 1, 2004, H.R. 2179 was discharged by the

ouse

ommittee on the Judiciary and placed on the Union Calendar for a vote.

ee Securities Regulation & Law

eport (July 5, 2004), vol. 36, no. 27 (BNA), at 1225 (emphasis added).

he Sarbanes

-O

xley Act, Section 105(b)(5)(A), 15 U.S.C. § 7215(b)(5)(A

)

(emphasis added).

Section 105(b)(5)(B), 15 U.S.C. § 7215(b)(5)(B).

ee EC9 (“Unless authorized by the Board, no Board member or staff shall disseminate or otherwise

isclose any information obtained in the course and scope of his or her employme

t, and which has not

een released, announced, or otherwise made available publicly.” The requirement of confidentiality

xtends even after the member’s or staff’s termination of employment with PCAOB.);

ee also PCAOB

108(a) (“

nformal inquiries and formal investigations, and any documents, testimony or other

nformation prepared or received specifically for the Board or the staff of the Board in connection with

nquiries and investigations, shall be confidential unless and until presented in public

roceedings or

eleased in connection with Section 105(c) of the Act, and the Board’s Rules thereunder

”

62087.1

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005

ection 105(b)(5) addresses the same waiver problem that gave rise to H.R. 2179.

t reflects Congress’ recognition that disclosure of confidential information by audit f

rms to an

ove

rsight body exposes the audit firm to waivers of privilege.

This provision is designed to

acilitate effective oversight by the PCAOB and cooperation by audit firms by assuring that

onfidential information will not be discoverable by other

s with H.R. 2179, however, this provision does nothing to address the waiver

oblem facing companies whose

audi

tors obtain privileged information. If a company’s

ivileged information winds up in the hands of the PCAOB during an inspection or

nve

tigation of the audit firm, Section 105(b)(5) assures that no one can take discovery from the

CAOB. But the company remains exposed to the risk of waiver by having provided privileged

nformation to its auditors in the first place. Both the company and its auditors may be subject to

scovery attempts by the company’s adversaries, simply because of the company’s good

orporate governance and compliance with its obligations to cooperate fully with its auditors.

ONCLUSION

he Preamble to the ABA Statemen

of Policy eloquently presents the public

nterests at stake in the waiver problem. While “our legal, political and economic systems

pend to an important extent on public confidence in published financial statements,” this

onfidence should not come by means of intrusion upon the relationship between companies and

heir legal counselors:

n the contrary, the objective of fair disclosure in financial statements is

ore likely to be better served by maintaining the integrity of the

onfidential relation

hip between attorney and client, thereby

trengthening corporate management’s confidence in counsel and

ncouraging its readiness to seek advice of counsel and to act in

ccordance with counsel’s advice.

n other words, the importance of the public com

any audit function, as well as the oversight

unctions of the SEC and PCAOB, must not be allowed to jeopardize a company’s ability to

ilize one of the primary tools it has at its disposal to comply with its corporate governance

obl

igations

–

its legal c

ouns

el. Unless the attorney work

-pr

oduct doctrine and attorney

-c

lient

ivilege are maintained when companies provide otherwise

-pr

otected information to their

uditors, companies will be penalized for their compliance efforts and

ull and complete

udit

coope

ration by

aying the groundwork

heir litigation adversaries to obtain

ensitive

herwise appropriately

-pr

ivileged

nformation.

nder prevailing legal doctrine, the courts do

May 17, 2002 report by the General Accounting Office, based on a study by an agency then

-c

harged

ith oversight of the public accounting professi

n, found that “[t]he self

-r

egulatory system lacks the power

o protect the confidentiality of investigative information regarding alleged audit failures or other

isciplinary matters concerning members of the accounting profession. As the Panel reported, the lack of

uch protective power hinders the timing of investigations.”

.S. Gen. Accounting Office, “The

ccounting Profession: Status of the Panel on Audit Effectiveness Recommendations to Enhance the Self

egulatory System,” GAO Rep. No. 02

-4

11 (May 17, 2002)

BA Statement of Policy, Preamble.

62087.1

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-2

005

not

provide assurance that disclosure of privileged information to

uditors will not result in such

aivers as to others.

his result is untenable and, we submit, unnecessary

. I

nstead, we offer a proposal

or resolving the

ension between cooperation with auditors and protecting appropriate

ivileges:

he SEC and PCA

joined by the

orporate counsel

ommunity

nd the principal auditors of the vast majority

.S. public

ompanies,

hould propose and support federal legislation,

odeled on H.R. 2179, that would permit companies to provide

ivileged and attorney wor

product information to their auditors

n connection with audits, reviews, attestations and compliance

ith Section 10A of the 1934 Securities and Exchange Act without

aiving any privilege

as to others.

62087.1

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005

PPENDIX A

“D

ETECTING” CORPORATE FRAUD: AUDIT STANDARDS, LEGISLATION AND

ECENT REGULATORY INITIATIVES

enerally acceptable auditing standards have long recognized that auditors have

rticular responsibilities with respect to the discovery of corporate fraud during an audit. SAS

1, C

odification of Auditing Standards and Procedures

in fact, provides that the auditor has a

esponsibility to plan and to perform financial statement audits in order to obtain “reasonable

ssurance” about whether the financial statements are free of material misstatement

whether

aused by error or fraud.

In October 2002, the Auditing Standards Board issued SAS No. 99,

onsideration of Fraud in a Financial Statement Audit.

SAS No. 99 establishes standards for

uditors to fulfill that responsibility as it relates to fr

ud in an audit of financial statements

onducted in accordance with GAAS.

AS 99, consistent with its predecessor, recognizes that

“

it is management’s

esponsibility to design and implement programs and controls to prevent, deter, and detect

raud.” The

uditor’s

“

interest,” however, is in obtaining evidential matter regarding intentional

cts that “result in a material misstatement of the financial statements.” Thus, the auditor is

equired to exercise professional skepticism when planning and performin

the audit, to consider

hether the presence of certain “risk factors”

– i

.e.

red flags

–

indicate the possible presence of

raud and, if risks of fraudulent, material misstatement are identified, consider the impact of this

inding on the audit report a

whether reportable conditions relating to the company’s internal

ontrols exist and should be communicated to the company or its audit committee.

uditor’s obligations to gather evidential matter to satisfy itself regarding the presence of fraud

ludes making inquiries “about the existence or suspicion of fraud” to any appropriate

rsonnel within the company, and SAS 99 suggests that the auditor “may wish to direct these

nquiries” to the company’s in

-hous

e legal counsel.

ee AICPA Professional Standards, AU § 110.02,

esponsibilities and Functions of the Independent

uditor

AS No. 99 superseded SAS No. 82, also entitled,

onsideration of Fraud in a Financial Statemen

Audit

AS 82 provided that “[t]he auditor has a responsibility to obtain reasonable assurance about whether the

inancial statements are free of material misstatement, whether caused by error or fraud.” AICPA,

uditing Standards Board, Statement on Au

iting Standards No.

onsideration of Fraud in a Financial

tatement Audit (codified in AU § 316). This standard, however, expressly disavowed any

er se

bligation on auditors to uncover all instances of corporate fraud; indeed, SAS 82 recognized tha

roperly performed and executed audit may fail to detect fraud. As it explained: “An auditor cannot obtain

bsolute assurance that material misstatements in the financial statements will be detected. Because of (a)

he concealment aspects of fraudul

nt activity, including the fact that fraud often involves collusion or

alsified documentation, and (b) the need to apply professional judgment in the identification and

valuation of fraud risk factors and other conditions, even a properly planned and pe

formed audit may not

etect a material misstatement resulting from fraud.”

U § 316.10.

AS 99, ¶¶ 5, 12, 31, 80.

d. at ¶¶ 24

-2

5. Other guidance found in GAAS suggests that an auditor may wish to obtain evidential

atter through company counsel. For example, pursuant to an auditor’s obligations regarding loss

ontingencies for litigation, claims and assessments pursuant to FAS 5, GAAS states that the “opinion of

62087.1

-1

-2

005

hile GAAS, therefore,

s outlined the obligations of auditors to obtain

easonable assurance that a company’s financial statements are free of material misstatement due

o error or fraud, several recent developments have focused heightened attention on the function

the audi

or in the discovery of public company fraud. In particular, the financial reporting

candals that have washed over the capital markets since 2001, leading to the Sarbanes

-O

xley

ct of 2002 and other laws and regulations, have placed new emphasis on assur

ng accurate

inancial reporting. Further, in today’s political and regulatory environment, audit firms and

ndividual auditors are exposed to vastly greater risk of draconian liability and professional

anctions for shortcomings in the performance of aud

ts and reviews.

his renewed emphasis is apparent through legislative and regulatory creations.

or example, Section 10A of the 1934 Securities & Exchange Act,

which was added by the

rivate Securities Litigation Reform Act of 1995 (“Reform Act”), req

res auditors to employ

ocedures, in accordance with GAAS, designed to provide “reasonable assurance of detecting

llegal acts” that would have a material effect on the financial statements. Like SAS 82, auditors

re required to report evidence of frau

up the corporate ladder to management and to the audit

ommittee under certain circumstances, but Section 10A added a requirement that the auditor

eport not only up, but

out

to the SEC if

–

after investigation of evidence of an illegal act

unc

overed dur

ng an audit

–

the auditor determines that (1)

he audit committee or board is

dequately informed of the illegal act, (2)

he illegal act has a material effect on the financial

tatements, (3)

he illegal act has not been appropriately remediated and (4)

s a result, the

uditor will be required to issue a qualified audit opinion or resign.

Because auditors face

pot

ential civil liabilities imposed by the SEC under Section 10A for mere negligence

–

there is

scienter requirement for proceedings brought

nder Section 10A

–

this provision has grown,

hrough the scandals of 2001, as a regulatory tool for increasing scrutiny of the performance of

udits.

he public interest focus on the public company audit function has also been

irrored by the SEC in its r

cent initiatives to enforce federal securities laws. In January 2002,

hen

-S

EC Chairman Harvey Pitt, discussing what he called the “Enron situation,” directed strong

hetoric towards auditors:

[

T]here is a need for reform of the regulation of our account

ng profession.

e cannot afford a system, like the present one, that facilitates failure rather

han success. Accounting firms have important public

esponsibilities

ve had too many financial and accounting failures. ... [T]he potential loss

egal counsel on specific tax issues that he is asked to address and to which he has

evoted substantive

ttention . . . can be useful to the auditor in forming his own opinion.”

ee AU § 9326.17 (warning further

hat “it is not appropriate for the auditor to rely solely on such legal opinion” in conducting the audit

egarding these issue

5 U.S.C. § 78j

-1

. Section 10A was modeled after SAS 53, the predecessor to SAS 82.

5 U.S.C. § 78j

-1

62087.1

-1

-2

005

of c

onfidence in our accounting firms and the audit process is a burden our

apital markets cannot and should not bear.

his proved to be more than rhetoric. The Sarbanes

-O

xley Act, enacted later that

ar, directed the SEC to study enforcement actions over the prior five years to identify areas of

inancial reporting most susceptible to fraud.

The SEC’s review, presented in a January 2003

eport to Congress (the “704 Report”), showed that of 515 enforcement actions in total, 18

ctions were filed against

udit firms and 89 against individual auditors.

In the vast majority of

hese actions, auditors were sanctioned, in the SEC’s words, for “failing to gain sufficient

vidence to support the issuer’s accounting, failing to exercise the appropriate level of skepticism

n responding to red flags, and failing to maintain independence.”

The 704 Report concludes

hat “audit failures most often arise from auditors accepting management representations without

rification, truncating analytical and substantive p

ocedures, and failing to gain sufficient

vidence to support the numbers in the financial statements.”

dministrative and enforcement actions filed in 2003 and 2004 reflect even

eater scrutiny of the work of auditors who failed to catch fraud by thei

clients.

ecent

EC Chairman Harvey L. Pitt, Public Statement by SEC Chairman: Regulation of the Accounting

rofession (Jan. 17, 2002) (transcript available at http://www.sec.gov/news/speech/spch535.htm.)

he Sarbanes

-O

xley Act, Section 704, 107 P.L. 204, Title VII, Section 704, 116 Stat. 745.

EC, Report Pursuant to Section 704 of the Sarbanes

-O

xley Act of 2002 (Jan. 24, 2003), available at

ttp://www.s

c.gov/news/studies/sox704report.pdf.

at 3.

at 40.

or example, in

atter of Barbara Horvath, CPA

Admin. Proc. File No. 3

-1

0665, Accounting and

uditing Enforcement Release No. 1483 (Dec. 27, 2001), the SEC censured a Deloitte & Touche audi

or placing reliance on management representations as her principal source of audit evidence for the

ompany’s capitalization of expenses which, it turned out, were fraudulent. The SEC contended that she

hould have demanded more supporting documentat

on and followed up on “red flags.” The SEC imposed

two

-y

ear suspension from practice upon another auditor (involved in the same audit) for sampling too few

tems when auditing the company’s contract acquisition costs.

n the Matter of Jeffrey Bacs

k, CPA

dmin. Proc. File No. 3

-1

0664, Accounting and Auditing Enforcement Release No. 1482 (Dec. 27, 2001).

he SEC’s enforcement record includes numerous similar cases.

e.g

, In the Matter of

ricewaterhouseCoopers LLP

Admin. Proc. File No. 3

-1

83, Accounting and Auditing Enforcement

elease No. 2008 (May 11, 2004) (corporate fraud) (action against PwC in connection with audit of the

arnaco Group’s financial statements from 1998 and alleged failure to correctly characterize the cause of

n inve

tory overstatement as resulting from internal control deficiencies as opposed to changed

ccounting rules, as misrepresented by Warnaco in a press release); In the Matter of Grant Thornton LLP,

t al.

Admin. Proc. File No. 3

-1

1377, Accounting and Auditin

Enforcement Release No. 1945 (Jan. 20,

004) (corporate fraud) (administrative proceeding against Grant Thornton for aiding and abetting fraud

nd violating Section 10A, by allegedly failing to obtain sufficient audit evidence despite “red flags” that

ent failed to disclose material related party transactions);

n the Matter of Carroll A. Wallace, CPA

dmin. Proc. File No. 3

-9

862, Accounting and Auditing Enforcement Release No. 1846 (Aug. 20, 2003)

(

probable corporate fraud) (KPMG auditor suspended fo

one year for undue reliance on management

epresentations, failure to maintain an appropriate attitude of skepticism, failure to obtain sufficient

vidential material to discover that the client investment fund’s financial statements improperly stated th

ll of its shares were unrestricted);

n the Matter of Richard P. Scalzo, CPA

Admin. Proc. File No. 3

1212, Accounting and Auditing Enforcement Release No. 1839 (Aug. 13, 2003) (corporate fraud) (auditor

62087.1

-1

-2

005

publ

ic statements by the Director of the Division of Enforcement,

tephen Cutler

, c

all

ttention to the role of

uditors, among others,

ing

“the

sentries of the marketplace

” the

hange in the Enforcement Division’s approach regardi

“deficient audits” by focusing now on

irm responsibility for those audits and the hope of the Enforcement D

vision that “accounting

irms will take an even greater role in ensuring that individual auditors are properly discharging

heir speci

l and cri

ical gatekeeping role

these factors

eflect the expectation that

crutiny on auditors will continue to increase as expectations for their increased role in

onitoring and finding inappropriate corporate accou

ing behavior continue to grow.

ina

ly, the PCAOB, established by the Sarbanes

-O

xley Act, has been given a

publ

ic mandate to inspect, investigate and discipline auditors conducting public company

udits.

Although the PCAOB has only a short track record on inspections and enforcement, it

s signaled an intention to be tough

-m

inded in enforcing this mandate. In an August 2, 2004

nterview, PCAOB Chairman, William McDonough, stated his view on whether it is the

uditor’s

obl

igation to detect client fraud.

He said:

ermanently barred from public practice based o

audits of Tyco between 1997 and 2001 in which he

ecame aware of facts that put him on notice regarding the integrity of Tyco’s management but failed to

erform additional audit procedures or reevaluate his risk assessment);

n the Matter of Warren Marti

Admin. Proc. File No. 3

-1

1211, Accounting and Auditing Enforcement Release No. 1835 (Aug. 8,

003) (auditor suspended from public practice for two years for undue reliance upon management

epresentations regarding the interpretation of contracts, t

ereby ignoring “unambiguous contractual

anguage” that affected revenue recognition and led to a $66 million restatement);

n the Matter of Michael

. Marrie, CPA and Brian L. Berry, CPA

Admin. Proc. File No. 3

-9

966, Accounting and Auditing

nforcement R

lease No. 1823 (July 29, 2003) (corporate fraud) (suspending two auditors from public

ractice for failing to act with sufficient skepticism and obtain enough audit evidence with respect to

onfirmation of accounts receivable, sales returns and allowances

and a $12 million write

-o

ff);

n the

atter of Phillip G. Hirsch, CPA

Admin. Proc. File No. 3

-1

1133, Accounting and Auditing Enforcement

elease No. 1788 (May 22, 2003) (corporate fraud) (suspending PwC auditor for one year in settlement of

llegations

hat he did not ensure that sufficient audit procedures were conducted in light of PwC’s risk of

raud assessment and that he placed undue reliance on management representations despite awareness of

vidence “from which he should have realized further audi

work was required.”);

EC v. KPMG,

ivil

ction No. 02

-c

-0

671 (S.D.N.Y. January 29, 2003), Accounting and Auditing Enforcement Release No.

709 (possible corporate fraud) (civil injunction against KPMG seeking disgorgement of fees and civil

enalties in connection with the firm’s audit of Xerox based on allegation that auditors had evidence of

anipulation of financial results and failed to ask Xerox to justify departures from GAAP).

EC Enforcement Director, Stephen Cutler, Remarks at the UCLA Scho

l of Law,

ngeles, C

(

ptember 20, 2004

)

, “The themes of Sarbanes

-Ox

ley as reflecte

in the C

mmission's

forcement

rogram”

vailable at http://www.sec.gov/news/speech/spch092004smc.htm)

he Sarbanes

-O

xley Act, Sections 101

-1

05, 15 U.S.C. §§

211

-1

AAS expressly recognizes that a properly performed and executed audit may fail to detect fraud. SAS 82,

onsideration of Fraud in a Financial Statement Audit

explains how fraud is less likely to be detected

hen it involves concealment and

ollusion: “An auditor cannot obtain absolute assurance that material

isstatements in the financial statements will be detected. Because of (a) the concealment aspects of

raudulent activity, including the fact that fraud often involves collusion or fal

ified documentation, and (b)

he need to apply professional judgment in the identification and evaluation of fraud risk factors and other

onditions, even a properly planned and performed audit may not detect a material misstatement resulting

rom fraud.”

U § 316.10.

62087.1

-1

-2

005

e have a very clear vie

that it

s their job [to detect fraud]. If we see fraud

hat wasn’t detected and should have been, we will be very big on the tough

nd not so [big] on the love. … [A]uditors [need to] understand that, with

elatively few exceptions, they should find it

To me, the relatively few

xceptions are those cases where you would have some extremely dedicated,

apable crooks. In most cases, though, the crooks either are not that smart or

hey don’t cover their tracks that well.

nder the Sarbanes

-O

xley Act an

the PCAOB’s implementing regulations,

any

olation of laws, rules or policies by individual auditors or firms detected during inspections of

elected audit and review engagements will be identified in a written report and may be handed

ove

r to the SEC o

other regulatory authorities and become the subject of further investigation

nd disciplinary proceedings.

The PCAOB has stated that inspections will assess compliance

t all levels

– i

.e.

actions, omissions, policies and behavior patterns “from the s

nior partners to

he line accountants.”

The inspections will allow the PCAOB, in its own words, to “apply

essure to improve a firm’s audit practices.”

he recent wave of scrutiny on auditors’ detection of fraud has also extended to

he companies th

mselves. It has always been the obligation of a company, of course

ooperate fully with its independent auditors. Recent legislation and regulatory developments

ve focused additional pressure on companies to do so

–

again, in the interest of stren

hening

he functionality of audits. Reaffirming the company’s obligation to cooperate fully with its

uditors, the SEC promulgated Regulation 13b2

-2,

“Representations and conduct in connection

ith the preparation of required reports and documents,” eff

ctive June 27, 2003.

The

egulation prohibits officers and directors of public companies from making a “materially false

misleading statement [or a material omission] to an accountant in connection with” an audit or

her filing with the SEC. It fur

her provides that officers and directors may not “directly or

ndirectly take any action to coerce, manipulate, mislead, or fraudulently influence any

ndependent public or certified public accountant engaged in the performance of an audit or

eview of th

financial statements. . . .”

he Enforcer

CFO.com (Aug. 2, 2004) (emphasis added).

hen the PCAOB believes that an act, practice or omission by a registered firm or individual auditor may

iolate the Sarbanes

-O

xley Act, PCAOB rules or other professional standar

s or any securities law or

egulation pertaining to audit reports or to the duties of accountants, the PCAOB may open an

nvestigation.

ee PCAOB R. 5101. Such an investigation can lead to disciplinary proceedings, exposing

he offending auditor or firm to penalties ranging from compulsory training and mandated quality control

rocedures to heavy civil fines and temporary or permanent suspension from audit practice.

teven Berger,

CAOB

—B

eyond The First Year

2004 WL 69983842, Monday Business Briefing (July 15,

004).

ublic Company Accounting Oversight Board 2003 Annual Report, p. 4,

vailable at

ttp://www.pcaobus.org/documents/PCAOB_2003_AR.pdf.

7 C.F.R. § 240.13b2

-2

d. at § 240.13b2

-2

(a) & (b).

62087.1

-1

-2

005

y both design and effect, these regulatory developments

–

Section 10A, SEC

nforcement and PCAOB inspections and rule

-m

aking

–

have led in recent years to a framework

or enhanced government oversight of audited financial

tatement disclosure and auditors. These

xemplify the strong public interest in preserving and strengthening the audit function. They

lso may reflect why auditors are perceived by their corporate clients to be seeking more

ivileged and work

oduct p

otected materials than what appears to

ve been the case in years

st.

62087.1

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-2

005

PPENDIX B

ISTORICAL SIGNIFICANCE OF THE ATTORNEY

-C

LIENT PRIVILEGE

-P

RODUCT DOCTRINE

he public interest in protecting the confidentiality of attorney

-c

lient

ommunicatio

and work product should be, like the public interest in a strong public company

udit function, incontrovertible.

he attorney

-c

lient privilege is “the oldest of the privileges for confidential

ommunications known to the common law.”

The purpose of the privilege is to “encourage

ull and frank communication between attorneys and their clients and thereby promote broader

publ

ic interests in the observance of law and administration of justice.”

he strongest criticism of the attorney

-c

lient privile

ge –

and, indeed, of any

videntiary privilege

–

is that, in court proceedings, potentially valuable evidence may be

uppressed and the “truth” harder to find. This debate has been raised countless times, and no

doubt

it is being raised again now as the r

sk of waiver by companies increases in proportion

ith the volume of auditor requests for disclosure of the company’s confidential information.

ut in our society, the debate has been settled consistently; as one court has described: “The

ocial good de

ived from the proper performance of the functions of lawyers acting for their

lients is believed to outweigh the harm that may come from the suppression of the evidence in

pecific cases.”

As the Supreme Court has held, this social good appropriately e

ends to

orporations as well as to individuals.

rotecting the confidentiality of work product likewise furthers vital public

nterests. “[T]he work product privilege [exists] … to promote the adversary system by

afeguarding the fruits of an attorney’

trial preparations from the discovery attempts of the

oppone

nt.”

Work product protection encourages parties and their counsel to prepare for

itigation and trial without concern that their work will be discoverable by the opposition. Work

oduct prot

ction supports a fair adversary system by “by affording an attorney ‘a certain

gree of privacy’ so as to discourage ‘unfairness’ and ‘sharp practices.’”

As one Supreme

ourt Justice wrote in a concurring opinion to the seminal decision supporting the

doc

trine,

“

[d]iscovery was hardly intended to enable a learned profession to perform its functions . . . on

pjohn Co. v. U.S.

449 U.S. 383, 389 (1981).

nited States v. United Shoe Mach. Corp.

89 F. Supp. 357, 358 (D. Mass. 1950).

rammel v. United

tates

445 U.S. 40, 50 (1980) (the privilege “promotes a public goal transcending the normally

redominant principle of utilizing all rational means for ascertaining the truth.”).

pjohn

449 U.S. at 389

-9

n re Raytheon Securities Litig.

218 F.R.D. 354, 359 (D. Mass. 2003) (quoting

nited States v. Amer. Tel

Tel. Co.

642 F.3d 1286, 1299 (D.C. Cir. 1980)).

oint Drafting

ommittee of the American College of Trial Lawyers,

he Erosion of the Attorney

-C

lient

rivilege and Work Product Doctrine in Federal Criminal Investigations (March 2002), at 6, quoting

ickman v. Taylor

329 U.S. 495, 510

-1

1 (1946).

62087.1

-1

-2

005

its borrowed from the adversary.”

The work

-p

roduct doctrine is simply a recognition that a

awyer’s work on behalf of a client preparing a respon

e to litigation or a potential claim

–

even

hen not subject to the attorney

-c

lient privilege

–

must also be protected, lest all lawyers be

scouraged from conducting those preparations effectively, the clients be punished and their

dversaries be unfair

y rewarded. Those who fear that the work product generated by their

ounsel in determining an appropriate response will be disclosed to their adversaries and

omptly used against them will, not surprisingly, be reluctant to seek legal assistance at all.

rotection of work product is codified in Federal Rule of Civil Procedure

26(

b)(3), which extends protection to the work of a party’s representatives, “including an

ttorney, consultant, surety, indemnitor, insurer, or agent” in anticipation of litigati

or for trial.

ork product is not discoverable by an opposing party absent a showing of “substantial need for

he materials in the preparation of the party’s case and [inability] without undue hardship to

obt

ain the substantial equivalent of the materi

ls by other means.” But even when an opposing

rty makes this showing, courts must protect against disclosure of the “mental impressions,

onclusions, opinions or legal theories of an attorney or other representative of a party.”

ule 26(b)(3) codi

ies, disclosure of the diligent work performed by an attorney to his client’s

itigation opponent would undermine the adversarial underpinnings of our legal system itself.

nd it is because of this underlying rationale that work product protection may no

t –

unlike the

ttorney

-c

lient privilege

–

be waived by mere disclosure to a third party, “but rather only if a

sclosure runs counter to the principles embodied by the adversary system.”

Protecting work

oduct from adversaries is the policy goal of th

doctrine; it is grounded on sheer fairness. It is

onl

y when it would not be unfair for an adversary to obtain that work product

– i

.e.

when the

dversary meets its burden to show that it “

s substantial need of the materials in the

eparation of the

rty’s case and that the party is unable without undue hardship to obtain the

ubstantial equivalent of the materials by other means”

–

that the policy to protect work

oduct will not apply.

ompanies expect that the work product of their counsel prepar

d as a result of an

nternal investigation will be protected, and legitimately so. Increasingly, companies and, on

casion when the circumstances call for it, their audit committees or other independent

ommittees, are using counsel to investigate evide

e of alleged corporate or employee

rongdoing by interviewing company employees, identifying relevant documents, analyzing the

acts and law and formulating conclusions and recommendations. Internal investigations,

onducted by and at the direction of l

gal counsel, are a critical tool by which companies and

heir boards learn about violations of law, breaches of duty and other misconduct that may

xpose the company to liability and damages. Internal investigations are an essential predicate to

nabling companies to take remedial action, and to formulate defenses

, w

here appropriate. They

re, therefore, entitled to and afforded work product protection from adversaries, so long as the

nvestigations are not merely being conducted in the ordinary course o

business. As one

ommentator has noted: “The general rationale for finding work product protection is that

ickman v. Taylor

, 3

29 U.S. 495, 516 (1946) (Jackson, J., concurring).

ed. R. Civ. P. 26(b)(3).

hilippines v. Westinghouse Elec. Corp.

132 F.R.D. 384, 389 (D.N.J. 1990).

ed. R. Civ. P. 26(b)(3).

62087.1

-1

-2

005

itigation is virtually assured if the investigation confirms the allegations. Since the corporation

ould be required to report the results to

hareholders and government agencies, the possibility

a suit following is considered inevitable.”

he application of the work product doctrine does not mean that, where internal

nvestigations involving legal counsel are conducted, all facts related

o the issue under

nvestigation are inherently protected against disclosure to auditors or third parties. The

acts

ncluding underlying documents, regarding an issue are properly discoverable, and routinely

oduced, in litigation. By contrast, what i

protected from disclosure is the work performed,

aterials generated and considerations of the lawyers in connection with the investigation and

ny recommendations to the company

–

this is the heart of what is protected by the work product

doc

trine, due

o the inherent unfairness of giving an adversary access to these categories of

aterials. The distinction is an important one that is well

-a

ccepted in the law.

ohn William Gergacz,

ttorney

-C

orporate Client Privilege § 7.37 (West 2000), at 7

-5

3 (reporting that

“

[m]ost of the cases hold that intracorporate investigations of possible corporate illegal activity are

erformed with sufficient anticipation of litigation to give rise to work product protection”). The author

lso r

ports that it is not only the inevitability of litigation, but also “the importance of not discouraging

orporate self

-i

nvestigation, [which] provides the underlying basis for the finding of work product

rotection.”

d. at 7

-5

porck v. Peil

9 F.2d 312, 315 (3rd Cir. 1985) (lawyer’s choice of documents with which to prepare

eponent is work product even if the underlying documents themselves are not, “[b]ecause identification of

ocuments as a group will reveal defense counsel's selection pro

ess, and thus his mental impressions…”);

ee also

n re Grand Jury Subpoenas Dated October 22, 1991 and November 1, 1991

959 F.2d 1158, 1166

7 (2d Cir. 1992) (noting that work product exception is only found when there is “real, rather than

peculative

oncern that the thought process of [the client's] counsel… would be exposed,” and allowing

roduction of all telephone records from a specified period) (internal citations and quotations omitted);

e Grand Jury Subpoenas Dated March 19, 2002 and August 2, 2002

318 F.3d 379, 386

-8

7 (2d Cir. 2003)

(

finding that lower court was correct in allowing discovery of disputed materials because producing party

ad failed to disclose any strategy

x parte to the district court judge, making it impossible for judge to

etermine whether the responsive subset of documents reflected lawyers’ selection or was simply the

roduct of document retention policies);

helton v. American Motors Corp.

805 F.2d 1323, 1326 (8th Cir.

987) (“We hold that where, as here, the depone

t is opposing counsel and has engaged in a selective

rocess of compiling documents from among voluminous files in preparation for litigation, the mere

cknowledgment of the existence of those documents would reveal counsel’s mental impressions, which

re work product.”).

62087.1

-1

-2

005

PPENDIX C

URVEY OF CASE LAW R

GARDING WAIVER OF A

TORNEY

-C

LIENT

RIVILEGE AND WORK

-P

RODU

T PROTECTION BASED

PON

ISCLOSURE TO AUDITO

ttorney

-C

lient Privilege

ourts generally hold that disclosure of attorney

-c

lient communications to

uditors waives the attorney

-c

lient privilege.

Courts reason that because the purpose of the

ivilege i

to protect the confidentiality of the communications, almost any disclosure to an

out

sider breaches the confidence and waives the privilege. Thus, unless an accountant is helping

he attorney to advise the client (a role that an auditor could rarely, if ever, undertake given

ndependence constraints), disclosure to the outside accountant waives the privilege.

he only jurisdictions in which disclosure may not result in a waiver are states

hat, by statute, recognize an accountant

-c

lient privilege. On

y fifteen states have any such

tatute and, of those, only seven have expressly extended the privilege to independent auditors by

tatute or judicial ruling.

In every other jurisdiction, including all federal courts, the common

aw rule applies that com

unications between outside auditors and clients are not privileged.

, e

.g.

, G

utter v. E.I. Dupont De Nemours and Co.

1998 WL 2017926, at *3 (S.D. Fla. May 18, 1998)

(

“[d]isclosure to outside accountants waives the attorney

-c

lient privilege”);

n re Pfizer Inc. Securities

itig.

1993 WL 561125, at *6 (S.D.N.Y. Dec. 23, 1993) (“Disclosure of documents to an outside

ccountant destroys the confidentiality seal required of communications protected by the attorney

-c

lient

rivilege, notwithstanding that the federal securities laws require an independent audit”).

erko Nat’l Assoc. for Stock Car Auto Racing

218 F.R.D. 125, 135 (E.D. Tex. 2003), citing

nited

tates v. Kovel

296 F.2d 918, 921

-2

2 (2d Cir. 1961), which extended the attorney client privilege to

ttorney

-a

ccountant communications for t

e purpose of assisting the lawyer to advise the client.

he fifteen states are listed below and the seven states that have clearly extended the privilege to the audit

ontext are underlined:

rizona

, ARIZ.

§ 32

-7

49;

olorado

, CO

§ 13

-9

-1

07;

lorida

, FL

§ 90.5055;

eorgia

, GA.

§ 43

-3-3

daho

, ID

AHO

-2

03A

AHO

ST.

, R

15;

llinois

225

450/27;

ndiana

, IN

. CO

§ 34

-4

-2-1

ansas

, KS. ST

§ 1

-4

01;

ouisiana

, LA. CO

. a

rt. 515;

aryland

, MD.

& J

§ 9

-1

10;

ichigan

, MICH. CO

339.732;

issouri

, MO.

§ 3

26.322;

ew Mexico

, N

.M. S

§ 38

-6-6

;

ennsylvania

, PA.

. t

it. 63

9.11;

ennessee

, TE

. §

-1-1

16.

ther states have statutes requiring accountants and auditors to maintain the confidentiality of client

aterials, but not purporting to establish any evidentiary privilege from discovery.

labama

, AL

-1-2

ali

ornia,

. t

it. 16, § 54

; C

onnecticut

, CO

. §

81j;

owa

, IO

. §

542.17;

entucky

, KY.

. §

325.440;

assachusetts

, MA

. c

h. 112 § 87E;

innesota

, MI

. § 3

26A.12;

issi

sippi

, MI

-3

-1

ontana

, MO

-5

-4

02;

ew Jersey

, N

.J. S

5:2B

-6

orth

akota

, N

.D. C

-0

2.2

-1

regon

, OR.

§ 673.385;

hode Island

, R

.I. G

-3

-2

ermont

, VT.

81;

ashington

, WA

8.04.405.

ee Couch v. United States

409 U.S. 322, 335 (1973) (“no confidential accountant

-c

lient privilege exists

nder federal law, and no state

-c

reated privilege has been recognized in federal cases”).

62087.1

-1

-2

005

ork Product Doctrine

ith respect to whether work product protection survives disclosure to auditors,

ourts have divided at several analytical points. Some courts never reach the qu

stion of waiver,

but

nonetheless refuse to compel third

-pa

rty discovery on the grounds that attorney analyses of

oss contingencies are neither evidence nor relevant

–

or, to the extent that these analyses have

ny probative value,

hat value

s outweighe

by unfair prejudice and public interest concerns.

n another line of authority, courts have held that any evaluation of litigation risk

nd loss exposure prepared in response to an audit inquiry does not constitute work product at all

cause the work w

s prepared primarily for a business purpose (

.e.

auditing financial

tatements), rather than “in anticipa

ion of litigation or for trial.

”

This line of authority,

how

ever, is older, has attracted no recent followers and reflects a minority view.

he m

jority view, followed in several recent cases, is that work product includes

ny material prepared “because of” actual or potential litigation, thus encompassing analysis of

itigation exposure prepared in response to an audit inquiry.

These authorities reject the earlier,

n the following cases, courts rejected attempts by client adversaries to discover documents created by

ounsel and provided to auditors, including audit

-i

nquiry responses concerning assessment of pending and

otential litigation.

ee Tronitech, Inc. v. NCR Corp

108 F.R.D. 655, 655

-5

6 (S.D. Ind. 1985) (attorney

etter to auditors was not discoverable under Fed. R. Civ. Proc. 26(b)(1) because it was not legally relevant

r reasonably calculated to lead to the discovery of admissible evidence);

nited States v. Arthur Young &

1984 U.S. Dist. LEXIS 22991, at *11 (N.D. Okla. Oct. 5, 1984) (“If some theory of relevance can be

dvanced concerning the documents under review, the Court would conclude its probative value is

ubstantially outweighed by the dange

of unfair prejudice and public interest concerns.”);

n re Genentech,

nc. v. Securities Litig.

Case No. C

-9

-4

038 (N.D. Cal. 1999) (unpublished) (noting that attorney’s

pinions are not relevant or at issue in the lawsuit);

omerica Bank of Calif. v. L

oyd Raymond Free

Case

o. 88

-2

0880 (N.D. Cal. 1999) (unpublished) (noting “tangential relevance” of information and finding

ublic policy in favor of protecting attorney’s work

-p

roduct to be more important);

eberg v. Am. Pacific

nt’l, Inc.

Case No. C

96448 (Los Angeles Superior Ct., April 29, 1982) (unpublished) (relevance of

ocuments was outweighed by the public policy of promoting candid and full disclosure by counsel to

uditor and by the right of privacy).

ee Fed. R. Civ. P. 26(b)(3);

nited S

ates v. Gulf Oil Corp.

760 F.2d 292, 296

-9

7 (Temp. Emerg. CA

985) (attorney letters in response to audit inquiries, although containing the mental impressions of

efendant’s attorney regarding litigation exposure, did not qualify for work product protec

ion because they

ere not created in anticipation of litigation, but rather “created, at [the auditor’s] request, in order to allow

[

the auditor] to prepare financial reports which would satisfy the requirements of the federal securities

aws”);

nited St

tes v. El Paso Corp.

682 F.2d 530, 543

-4

4 (5th Cir. 1982) (lawyer’s analysis and

emoranda “written ultimately to comply with SEC regulations” were prepared “with an eye on [the

ompany’s] business needs, not on its legal ones” and did not “contemplate l

tigation in the sense required

o bring it within the work product doctrine”);

ndependent Petrochemical Corp. v. Aetna Cas. & Sur. Co.

17 F.R.D. 292, 298 (D.D.C. 1987) (work product protection did not apply to lawyer’s letters to an auditor

ecause the letters were not prepared to assist the company in litigation but rather to assist the auditor “in

he performance of regular accounting work”).

he following courts rejected the narrow construction of “work product” and found that litigation analysis

epared for auditors is work product.

ee United States v. Adlman

134 F.3d 1194, 1202 (2d Cir. 1998)

(

observing, in

icta

that the work

-p

roduct doctrine would protect an audit

-i

nquiry response and approving

he rule adopted by the Third, Fourth, Seventh

Eighth, and D.C. Circuits that a document is work product

f “in light of the nature of the document and the factual situation in the particular case, the document can

airly be said to have been prepared or obtained

ecause of the prospect of litigation

”

) (emphasis in

62087.1

-1

-2

005

rochial construction of “work product” and find the “because of” construction to be more

aithful to the language of Rule 26(b)(3) and to the purpose of the work product doctrine.

here courts find that attorney letters to auditor

are, indeed, work product, they

lso generally conclude that disclosure to auditors does not waive the protection

is à vis the

lient’s litigation adversaries.

These courts acknowledge that, unlike the attorney

-c

lient

ivilege, which protects the con

identiality of the communication, work

-pr

oduct protection is

riginal);

n re Honeywell Int’l, Inc. Securities Litig

., 2

003 WL 22722961, at *6 (S.D.N.Y. Nov. 18, 2003)

(

rejecting plaintiff’s argument that the “preeminent business purpose” of an audit rendered the work

roduct doctrine inapplicable an

finding that defendant’s “assertion of work product protection for …

udit letters and litigation reports prepared by its internal and external counsel, as well as PWC documents

emorializing … opinion work product, is proper.”);

outhern Scrap Material

o. v. Fleming

2003 WL

1474516, at *9 (E.D. La. June 18, 2003) (“The audit letters … were prepared by outside counsel at the

equest of [party’s] general counsel with an eye toward litigation then ongoing. [Thus] … they are attorney

ork product of the

pinion/mental impression/litigation strategy genre.”);

n re Raytheon Securities Litig.

18 F.R.D. at 358 (citing cases in the Third, Fourth, Seventh, Eighth and D.C. Circuits that have adopted

he “because of” definition of work product);

anguard Sav.

nd Loan Assoc. v. Barton Banks

1995 U.S.

ist. LEXIS 13712, at *11

-1

2 (E.D. Pa. 1995) (lawyer letters regarding litigation, prepared to assist client

n reporting loss contingencies for a regulatory examination, were work product and protected even thoug

reated “primarily” for a business purpose);

ronitech, Inc.

108 F.R.D. at 657 (“an audit letter is not

repared in the ordinary course of business but rather arises only in the event of litigation. It is prepared

ecause of the litigation … [and] shou

d be protected by the work product privilege”).

rotection of work product under Rule 26(b)(3) reaches not only documents “prepared . . . for trial” but

lso prepared “in anticipation of litigation.” As the Second Circuit observed, “[i]f the drafters

ntended to

imit [work product] protection to documents made to assist in preparation for litigation, the ‘prepared ...

or trial’ language would have adequately covered it.”

dlman

134 F.3d at 1198

-9

9. Further, while an

dverse party may obtain discov

ry of ordinary work product upon a showing of “substantial need,” mental

mpression or opinion work product is not discoverable at all. Fed. R. Civ. P. 26(b)(3). Thus, “it would

ddly undermine [the work product doctrine’s] purposes if such documents we

e excluded from protection

erely because they were prepared to assist in the making of a business decision expected to result in the

itigation.”

at 1199.

ee Southern Scrap

2003 WL 21474516, at *9 (finding no waiver because disclosure of legal a

alysis to

uditors was not like “one of those cases where a party deliberately disclosed work product in order to

btain a tactical advantage or where a party made testimonial use of work product and then attempted to

nvoke the work product doctrine to a

oid cross

-e

xamination”);

utter

1998 WL 2017926, at *5

(

“[t]ransmittal of documents to a company’s outside auditors does not waive the work product privilege

ecause such a disclosure ‘cannot be said to have posed a substantial danger at the time that th

document

ould be disclosed to plaintiffs’”);

anguard Sav. and Loan Assoc. v. Barton Banks

1995 U.S. Dist.

EXIS 13712, at *13

-1

4 (finding no waiver because company did not make disclosure to auditors with

“

conscious disregard of the possibility that a

adversary might obtain the protected materials”);

n re

fizer

1993 WL 561125, at *6 (finding no waiver because auditor was not reasonably viewed as a conduit

o a potential adversary);

ramm v. Horsehead Indus., Inc.

1990 U.S. Dist. LEXIS 773, at *19

(

S.D.N.Y.

an. 25, 1990) (finding no waiver upon disclosure to auditors because “disclosure to another person who

as an interest in the information but who is not reasonably viewed as a conduit to a potential adversary

ill not be deemed a waiver of prote

tion of the rule”);

ronitech

108 F.R.D. at 657 (no waiver upon

isclosure of work product to auditors since “audit letters are produced under assurances of strictest

onfidentiality”);

rthur Young & Co.

1984 U.S. Dist. LEXIS 22991, at *10 (“[t]here is no waiver of the

ork product privilege where, as here, the documents were provided to [the auditors] under a specific

ssurance of confidentiality”).

62087.1

-1

-2

005

“

intended only to prevent disclosure to the opposing counsel and his client”

–

so, it is not

cessarily waived by disclosure to other third

-pa

rties.

As one federal court explained:

[

T]he work product privilege does not exist to protect a confidential

elationship, but rather to promote the adversary system by safeguarding

he fruits of an attorney’s trial preparations from the discovery attempts of

he opponent. The purpose of the work produc

privilege is to protect

nformation against

oppos

ing parties

rather than against

l others

der to encourage effective trial preparation.

nder this analysis

–

which is consistent

ith the

upreme Court’s decision

stablishing the doctrine in

man v. Taylor

–

waiver of work product protection only occurs if

disclosure substantially increases the opportunity for potential adversaries to obtain the

nformation. Thus, most courts find that disclosure to auditors does not waive the protection

bec

ause disclosure is made on an assurance of confidentiality and auditors are not considered to

conduits to potential adversaries.

ignificantly, however, there is a split of authority on the issue of waiver of

ttorney work product protection

At leas

one federal court recently held that disclosure of work

oduct to auditors waives the protection. In

edinol, Ltd. v. Boston Scientific Group

214

.R.D. 113, 115 (S.D.N.Y. 2002), the defendant engaged counsel to perform an investigation

nto the termi

tion of several high

-r

anking employees and to report the results of the

nvestigation to a Special Litigation Committee (“SLC”) of the Board. Minutes of the SLC

eeting reflecting counsel’s investigation were provided to the defendant’s auditors in

onn

ction with their audit of loss contingency reserves. The court held that the disclosure

aived the work product protection:

hile Boston Scientific held meetings of its Special Litigation Committee

ith an eye to litigation, the disclosures to the indepe

nde

nt auditor had no

uch purpose.

oston Scientific and its outside auditor Ernst & Young did

not

share ‘common interests’ in litigation

and disclosures to Ernst &

oung as independent auditors did not therefore serve the privacy interests

hat the work product doctrine was intended to protect.

n holding that the auditor and client did not share “common interests,” the court

ited the “independent” role of the auditor as described by the Supreme Court:

y certifying the public reports that collective

y depict a corporation’s

inancial status, the independent auditor assumes a

publ

ic responsibility

ranscending any employment relationship with the client. The

ndependent public accountant performing this special function owes

ronitech, Inc.

108 F.R.D. at 657.

n re Raytheon

218 F.R.D. at 359.

ee cases cited in note

upra

14 F.R.D. at 116

-1

7 (emphasis added).

62087.1

-1

-2

005

timate allegiance to th

corporation’s creditors and stockholders, as well

s to the investing public. This ‘public watchdog’ function demands that

he accountant maintain total independence from the client at all times and

equires complete fidelity to the public trust.

he “

ommon interest” concept on which

edinol relied is derived from

uthorities holding that co

-pa

rties or allies, such as co

-de

fendants, may share work product

ithout waiving the protection as to a common adversary.

Since the auditor

-c

lient relationship

doe

s not fit neatly into this analytical box, the

edinol court found a waiver. The “common

nterest” analysis in

edinol also has been invoked by other federal courts in considering the

ssue of waiver following a disclosure to auditors.

o summarize th

case law, while most authorities support the argument that

sclosure of work product to auditors should not waive the protection as to adversaries, the case

aw is not uniform and some courts would hold that disclosure constitutes a waiver. Companies,

herefore, have no guarantee that courts will protect the work product generated from internal

nvestigations from waiver as to adversaries if these materials are disclosed to auditors. This

unc

ertainty undermines the purpose of the privileges: As the Un

ted States Supreme Court said,

“

[a]n uncertain privilege, or one which purports to be certain but results in widely varying

pplications by the courts, is little better than no privilege at all.”

at 116 (quoting

rthur Young & Co.

465 U.S. at 817

-8

18).

, e

.g.

, S

tix Prods. Inc. v. United Merch. and Mfrs., Inc.

47 F.R.D. 334, 338 (S.D.N.Y. 1969).

lthough the Massachusetts District C

urt in

n re Raytheon

citing

edinol

noted that “the existence of

ommon interests” was relevant to whether disclosure to auditors created a waiver, the court also found that

“

there is no evidence that materials disclosed to an independent auditor are l

kely to be turned over to the

ompany’s adversaries except to the extent that the securities laws and/or accounting standards mandate

ublic disclosure,” and concluded that the record was inconclusive on the ultimate waiver issue. 218

.R.D. at 360

-6

ee In re Pfizer

1993 WL 561125, at *6 (finding that a company’s legal counsel and

utside auditors share “common interests” in information generated by counsel for purposes of an audit

nd, accordingly, there was no waiver of work product).

pjohn

449 U.S. at 392.

62087.1

-1

-2

005