Has 'privilege' lost its reward? Company officials can and sometimes should turn down auditors' requests to turn over privileged documents or waive attorney-client privilege. Recent calls for regulatory guidance may help, experts say.
However, the early 2000s saw a shift in government policy and standards of the auditing profession, encouraging companies to waive attorney-client privilege to be deemed "cooperative" with government investigations or substantiate tax positions--and by extension, other positions--to auditors.
Beginning with the "Holder Memorandum" issued by the Department of Justice (DOJ) in 1999, and continuing with DOJ's more widely known "Thompson Memorandum" in 2003, waiver of privilege was included among factors of cooperation to determine whether to indict a company and the level of charges filed.
In 2001, when the Securities and Exchange Commission (SEC) issued its "Seaboard" decision--touting Seaboard Corp. as a model of cooperation--it was released concurrently with a generic "framework for evaluating cooperation," which includes the role of waiver. Related amendments to the U.S. Sentencing Guidelines in 2004 were the final step in establishing waiver as a central tenet for companies to demonstrate cooperation with regulators.
Enter the auditors, who were swept into the waiver wave--pulling financial executives with them--by new rules issued by the American Institute of Certified Public Accountants (AICPA) in 2003. Now, auditors are required to obtain access to opinions of outside advisers on which client's rely, if the client's support for the tax accrual or matters affecting it, including tax contingencies, is based on that outside opinion--"notwithstanding potential concerns regarding attorney-client or other forms of privilege."
Although "other sufficient documentation"--such as client-prepared summaries--may suffice, some auditors insist that clients turn over privileged documents. That's because the rule also says that if an auditor can't obtain "sufficient competent evidence" about whether there is a "supported and reasonable basis" for the client's position, the auditor should consider the effect of this "scope limitation" and may issue a qualified opinion, or withhold its report.
The collective result of this "attack on privilege" triggered a response by the legal and business community. This has included formation of an American Bar Association (ABA) Presidential Task Force on Attorney-Client Privilege, which, along with the American Corporate Counsel Association (ACCA) and others, have entered into a dialogue with regulators to stem the erosion of privilege.
Recently, there has been a public backlash against waiver and other forms of coerced cooperation. In March, the U.S. Sentencing Commission amended the sentencing guidelines to remove waiver as a condition of cooperation. (The amendments become effective November 1, barring any objection from Congress.) In June, U.S. District Court Judge Lewis Kaplan ruled that DOJ pressure on KPMG to withhold paying legal fees for employees--specifically, employees accused by DOJ of involvement in illegal tax shelters--was unconstitutional. This shift in sentiment could assist in shoring up privilege, including in the audit arena.
CFOs May Be First Line of Defense Susan Hackett, senior vice president and general counsel of the ACCA, receives calls from legal counsel at various companies who are receiving pressure from "internal folks--the CEO, CFO" asking the general counsel to release privileged documents to auditors to meet a filing deadline.
However, Hackett warns that waiver is a "sleeper" issue that will come back to haunt people who don't recognize the consequences of turning over privileged documents to auditors. Once privilege is waived, these documents are obtainable by others--including competitors and adversaries--through the discovery process.
Some financial executives are told they must turn over a privileged tax opinion, which is not necessarily the case. Survey results released by the Tax Council Policy Institute last February showed that 53 percent of Fortune 500 companies had received requests from their outside auditors for privileged documents in the past two years. Of those, 46 percent had acceded to their auditor's request, 43 percent developed compromise solutions to avoid waiving privilege and 8 percent said the auditor pulled back when the company objected to waiving privilege.
Although a "treaty" struck between the ABA and AICPA in the mid-1970s set forth parameters for lawyer communications with auditors, and expressly recognized attorney-client privilege, some believe the treaty was "broken" in 2003 by AU 9326, which encouraged auditors to obtain opinions that clients relied on for their tax position, "notwithstanding concerns regarding attorney-client privilege."
Stan Keller, a partner with Palmer & Dodge and member of the ABA Task Force, says the original treaty "does not address the area where I think we're seeing the most pressure: communication between auditors and the companies." Additionally, tax accruals were not expressly within the scope of the original treaty, which dealt with loss contingencies. Although he does not personally believe AU 9326 broke the treaty, Keller says some auditors have not interpreted the new rules correctly by insisting that clients waive privilege when alternative documentation should suffice.
"The real issue," says Keller, "is when the auditor comes in and says, I want to see all the legal memos, all the advice from lawyers, regarding litigation.'" Keller warns financial executives that while they may provide the auditor with privileged information, they should do so only after being advised by counsel about the consequences of turning it over, and alternative ways that may fulfill the request.
Doug Carmichael, an accounting professor at Baruch College and former chief auditor of the Public Company Accounting Oversight Board (PCAOB), doesn't believe AU 9326 breaks the treaty, and argues that being a public company comes with special obligations. He views AU 9326 as "transcend[ing] any notion of attorney-client privilege being something a company can insert to prevent adequate disclosure to a user of financial statements."
David Becker, a partner at Cleary, Gottlieb, Steen & Hamilton and former SEC general counsel, observes, "My experience over the last 30 years suggests that it is a natural and healthy tendency of auditors to ask for 'everything,' whether or not the materials are privileged and whether or not the treaty permits them to do so. Well-versed lawyers routinely decline these requests." However, what's changed over the years is the level of insistence from auditors, and the resort to threats of scope limitations, which he doesn't believe are "warranted or useful."
Chuck Landes, vice president of Professional Standards at the AICPA, says, "Nothing in AU 9326 says you 'have' to ask for or obtain that attorney's opinion if the client has other sufficient evidence and documentation to support their position." However, he cautions, "What often happens is, the client, rather than saying, 'here's what we did and here's our work to support our position,' says only, 'we relied on the attorney's opinion in arriving at our tax position.'"
In that example, the auditor should obtain the tax opinion, says Landes. Alternatively, if appropriate analysis is done by the client, the auditor may be able to say, "'this is sufficient audit evidence, I can test this, look at the evidence and assumptions, and bring in my own tax specialist to formulate a conclusion.'"
Landes says balancing the sensitivity of tax accruals with the need for auditors to obtain evidence "puts us between the proverbial rock and a hard place." He adds that "investors, the PCAOB and the SEC are expecting us to do our job; we can only do that when we have access to sufficient appropriate evidence to support clients' assertions and to support our opinion.'"
ABA's New Recommendations
To address concerns about auditor requests for waiver, the ABA issued a recommendation in August that the SEC, PCAOB, AICPA and others "adopt standards, policies, practices and procedures" to ensure that attorney-client privilege is preserved in connection with the audit process. ABA's 2006 recommendations follow its August 2005 recommendations aimed at reducing government pressure on waiver as part of "cooperation."
An ABA report, also issued in August, provides "Examples of Potential Implementation Actions" that regulators can provide guidance for auditors on with respect to waiver, including:
* tax advice and opinions;
* litigation reserves;
* environmental contingencies/conditional asset retirement and internal investigations;
* clarification of audit documentation requirements in PCAOB Auditing Standard 3;
* confirmation of continued application of the ABA-AICPA treaty
* auditor safe harbor; and
* confidentiality of information disclosed to auditors.
Hackett believes the PCAOB should issue some form of guidance that makes it clear that privilege wavier is not necessary for a client to be considered cooperative and supportive in producing the necessary information for successful completion of the audit. "The PCAOB needs to reassure accountants who respect the attorney-client privilege that they are not being potentially derelict in their duty if they do so."
Landes says the AICPA has no current plans to amend AU 9326, and notes that with the creation of the PCAOB, the AICPA no longer has authority for audits of public companies. He has not heard any calls for amending the standard from private companies, but added, "if the PCAOB were to make amendments [to AU 9326], it is quite likely we would follow suit."
Carmichael believes AU 9326 "is clear as it is and that no additional information or clarification needs to be issued by the PCAOB or AICPA." He adds, "there is a presumption that if the client is relying on a tax opinion for its accounting, then the auditor has to see it." However, he adds, there is "limited flexibility," in that "the auditor would have to decide whether a client summary [without turning over the privileged opinion] is enough."
Becker states, "On the whole, my instinct is that the odds are against the PCAOB being able to do anything useful by rule here. That is because these things are intensely situational." He adds, "My guess is that this is a matter best left to foment between the professions as experience accumulates." Additionally, he says, "Certainly, the PCAOB could play a constructive role in getting the professions together to air the issues."
Asked for comment, a PCAOB spokeswoman said, "The [PCAOB] board is aware of the issue, but has not taken a position on it."
Is 'Culture of Waiver' Here to Stay?
In spite of any potential regulatory changes to de-emphasize the role of waiver as part of "cooperation" or a necessity in satisfying auditors, is the "culture of waiver" here to stay?
"Goodness, I hope not," Hackett says. "The whole point of our efforts--and we'll see pretty much how successful we're going to be in the next year or so--is to kick the legs out from under the culture of waiver stool."
She adds, "If we get the DOJ to reverse the Thompson Memo language, if we get the SEC to agree to similar enforcement practices and if we get courts to more actively intervene in favor of client's corporate privilege and defense rights--all of which we're on track to see happen in the next year--then the culture of waiver will be dead, and anyone trying to re-install it in their audit or in their investigation will be called to task.
"The only reason it works now," Hackett adds, "is that clients who encounter waiver demands feel powerless to push back and have no champions to call upon for protection of their rights."
Keller doesn't believe the ABA's actions will change the "culture of cooperation, because it has become ingrained as a part of the emergence of independent directors providing active oversight of corporate compliance." He adds, "Waiver will continue to be a part of the culture of cooperation from time to time, but the difference is that it will not necessarily be universal, and companies will be in a position to decide when to waive and when not, what to waive and what other means of cooperation will be available."
ABA Task Force Chair Bill Ide adds, "The needs of the enforcement community are centered around facts: 'who did what and when?' If companies answer those questions, they should be deemed cooperative without having to waive privilege."
Becker doubts a "culture of waiver" is here to stay, but calls it "a culture of high anxiety--as a result of high risk--for anyone who touches financial reporting. Understandably, everyone wants maximum reassurance and maximum protection." In time, he believes, "that will abate, and people will perceive the system as behaving less erratically." But, "for now, this will continue to be a major irritant between the professions."
(Additional resources for financial executives on this topic, published by Financial Executives Research Foundation (FERF), can be found online at www.fei.org/ferfbookstore.)
Edith Orenstein (email@example.com) is Director, Technical Policy Analysis for FEI.
RELATED ARTICLE: takeaways
* The early 2000s saw a shift in government policy and audit standards, encouraging companies to waive attorney-client privilege to be deemed "cooperative" with government probes or to substantiate tax positions.
* Friction between company attorneys and auditors has been rising. One reason: auditors must obtain access to opinions of outside advisers on which clients rely. Some are insisting that clients turn over privileged documents.
* As a result, there has been a public backlash against waiver and other forms of coerced cooperation. This shift in sentiment could assist in shoring up privilege, including in the audit arena.
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|Date:||Sep 1, 2006|
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