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Audit Firm Memo on Counsel's Tax Opinion on Company Partnerships Could Be Protected Work Product; Govt's Reliance on Arthur Young Misplaced

By Jim Hamilton

A memo prepared by a company?s outside audit firm recounting the thoughts of corporate counsel on the prospect of tax litigation over company partnerships could be protected attorney work product. Similarly, the company?s disclosure to the independent auditor of a tax opinion on company partnerships by outside counsel did not constitute a waiver of the work product privilege. Disclosure to an adversary or a conduit to an adversary could waive the privilege, noted a DC Circuit appeals court panel, but a company?s independent outside auditor of its financial statements is neither an adversary of the company nor a conduit to its adversaries. The government sought production of the documents in connection with ongoing tax litigation with the company. (US v. Deloitte LLP, US Court of Appeals for the DC Circuit, No. 09-5171, June 29, 2010).

The Supreme Court did rule in US v. Arthur Young that there is no auditor-client work product privilege. But the fact that it was the audit firm that prepared the memo on counsel thoughts did not turn this into an auditor-client case. The memo, while put out by the auditor, contained the thoughts of counsel on the prospects of litigation over the tax treatment of the company?s partnerships. Under the Supreme Court Hickman v. Taylor doctrine creating the attorney work product privilege, the question to ask is not who created the document but whether the document contained the thoughts of counsel developed in anticipation of litigation. Further, the fact that the document was generated during the firm?s annual audit of the company?s financial statements did not defeat the privilege since a document can be protected work product even when it serves multiple purposes so long as it was prepared because of the prospect of litigation.

Even more, the panel said that the government?s reliance on the Arthur Young ruling was misplaced. The Supreme Court refused to grant accountant work product the same protection as attorney work product because the attorney?s duty is to present the client?s tax position in the best possibly light while an independent auditor?s ultimate allegiance is to the investing public. In this case, however, the government is attempting to
discover not an independent auditor?s interpretations of the client?s financial statements, which Arthur Young would permit, but an attorney?s thoughts developed in anticipation of tax litigation, which the work product doctrine forbids.

With regard to the company?s disclosure to the audit firm of outside counsel?s tax opinion, the panel found that such disclosure did not waive the work product privilege. The outside auditor?s power to issue an adverse opinion on the company?s financials, noted the court, does not make it the sort of litigation adversary contemplated by the waiver standard. Similarly, the court said that any tension between an auditor and a company arising from the auditor?s need to scrutinize corporate books and records is not the equivalent of an adversarial relationship contemplated by the work product doctrine. In preparing the documents, the company anticipated a dispute with the IRS, not a dispute with its outside auditor. Further, the panel reasoned that documents concerning the tax implications of partnerships would not likely be relevant in any dispute the company might have with Deloitte.

The court also concluded that Deloitte?s independent auditor obligations do not make it a conduit to the company?s adversaries. The government asserted that there are a myriad of ways an independent auditor might disclose attorney tax opinion information obtained from a company whose finances it audits. For example, the auditor could make the company disclose its confidential tax analysis in footnotes to its public financial statements. Likewise, the auditor could testify about confidential information obtained from the company in proceedings brought by the SEC or private parties. Or the auditor might report illegal acts it detects during its audit in accordance with § 10A of the Exchange Act.

Rejecting these contentions, the appeals panel noted that the government has neither pointed to any regulation nor posited any specific circumstance under which the auditor would be required to disclose attorney work product on tax treatment of company partnerships. The panel reasoned that an independent auditor can fulfill its duties and render an opinion on a company?s SEC-filed financial statements without revealing every piece of information it reviews during the audit process. In short, the independent auditor obligations do not make it a conduit to the company?s adversaries.

Finally, while recognizing that independent auditors have significant leverage since they can essentially compel an audited company?s disclosure by refusing to provide an unqualified opinion otherwise, the panel said that a waiver of the work product privilege based on such disclosures could encourage the unfairness and sharp practices that the Supreme Court sought to avoid when it created the privilege in Hickman v Taylor. For example, it might discourage companies from seeking legal advice and candidly disclosing that information to independent auditors.

Full post as published by Jim Hamilton's World of Securities Regulation on July 12, 2010 (boomark / email).