Corporate & Securities Law

By Jim Hamilton

Legal and Corporate Communities Ask Supreme Court for Uniform Federal Rule on IRS Discovery of Tax Accrual Work Papers

Two Fortune 500 companies and a global law firm have asked the Supreme Court to hear the Textron appeal and provide national consistency and certainty on when the IRS can discover attorney tax accrual work papers used to inform the audit firm preparing the company?s financial statements. In their view, the First Circuit?s en banc decision that tax accrual work papers are discoverable by the IRS since they are done for SEC-mandated financial statements and not litigation vitiates work product protection, not only with regard to tax issues, but in a wide range of common litigator-to-client communications and threatens to impair companies? abilities to obtain frank evaluations of all types of litigation risks from both in-house and retained counsel.

More broadly, argued the amicus brief, if allowed to stand the First Circuit?s holding will severely and adversely affect the way companies seek and lawyers provide advice, and will fundamentally change important dynamics in civil litigation. Indeed, the First Circuit?s significant narrowing of the work product privilege is a game-changer in civil litigation.

The US Supreme Court has been asked to review the 3-2 opinion by the full First Circuit Court of Appeals. The Court is expected to act upon the Textron petition early this spring. The outcome of the case has broad implications beyond the tax field and affects public companies and audit firms with public issuer clients. Textron Inc. v. United States, Dkt. No. 09-750.

Amici posited that there are many situations in which clients need legal advice regarding potential litigation exposures, and need to share that advice with aligned parties, but in which the lawyer does not intend to use his or her risk assessment at a future trial. The brief noted that companies making SEC filings must divulge their lawyers? litigation risk assessments to their accounting firm in connection with the auditor?s attestation as to the
adequacy of financial statement reserves for uncertain tax and other legal exposures. Amici emphasized that, in the wake of corporate accounting scandals, auditors are asking their corporate clients for a broader range of documents, including privileged documents, than ever before in this country?s history.

In addition, corporations? in-house and outside lawyers often respond to auditor inquiries about threatened litigation and its potential impact on the financial statements. Public companies must establish reserves on their financial statements for uncertain tax positions, and frequently must obtain the advice of counsel in that regard. They need to disclose that legal advice to their outside audit firm during the attestation process regarding the percentage likelihood that the company will prevail in litigation regarding that exposure if challenged by federal or state taxing authorities

More broadly, amici argued that the First Circuit ruling profoundly changes the way companies seek legal advice and the way in which counsel provides it. The Supreme Court recently held that an adverse ruling on a claim of attorney-client privilege is not immediately appealable. The combination of this decision and an intact Textron opinion would produce a non-appealable ruling that an attorney?s most sensitive mental impressions are freely discoverable by the adverse party, This would be a game changer in civil litigation that puts hydraulic pressure on the company to settle.

Full post as published by Jim Hamilton's World of Securities Regulation on February 15, 2010 (boomark / email).