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When Boston Scientific Corp. was sued by Medinol for allegedly taking advantage of its position as licensee of Medinol’s manufacturing rights to a heart stent, it did what many other companies would have done: It hired outside counsel to conduct an investigation and report the results to a special litigation committee of the board of directors. When outside counsel reported the investigation results to the special litigation committee, the corporate secretary kept minutes; the minutes were subsequently turned over to Boston Scientific’s auditor to satisfy an audit of the company’s litigation reserves. Subsequently, Medinol sought production of the minutes in discovery. Boston Scientific refused, citing the attorney-client and work-product privileges. A federal judge ruled that by sharing the minutes with its auditor, Boston Scientific had waived any claim of privilege and thus had to disclose the minutes, which detailed not only the litigation reserve analysis, but also how a number of high-ranking employees had been terminated pursuant to the investigation. Faced with the forced discovery, Boston Scientific ultimately settled the case. Medinol v. Boston Scientific Corp., 214 F.R.D. 113 (S.D.N.Y. 2002). Although some view Medinol as an anomaly, similar scenarios are playing out in corporations every quarter. Auditors are aggressively encroaching on the boundaries of the privilege to protect themselves from liability and heightened regulatory scrutiny, and companies often cede to their demands rather than risk a qualified audit report. To that end, then-Securities and Exchange Commission Deputy Chief Accountant Scott Taub, in a speech at the SEC and Financial Reporting conference in 2004, promoted auditors’ withholding financial statement approval “[i]f a company’s outside counsel is unwilling or unable to provide its expert views” regarding loss contingencies. In this era of competing interests, corporations are faced with a daunting dilemma: risk waiving the attorney-client privilege to get the financial statements filed on time, or preserve the privilege and risk auditor, SEC and shareholder backlash. Despite the recent emergence of this conflict, the relevant guidelines date from the 1970s. In 1975, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 5 (SFAS 5), entitled “Accounting for Contingencies.” Under SFAS 5, auditors must accrue a charge to income if a loss contingency is both “probable” and the amount of loss can be “reasonably estimated.” Typical loss contingencies covered by SFAS 5 include uncollectible accounts receivable, potential litigation losses and liability uncovered pursuant to an internal investigation. Regardless of the nature of the claim, legal advice is frequently necessary in resolving both the probability and the amount of the loss, thus implicating attorney-client privilege issues at the outset of SFAS 5 determinations. In response to SFAS 5, the American Institute of Certified Public Accountants (AICPA) issued Statement on Auditing Standards No. 12 (SAS 12), “Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments,” which established the practice of auditors asking clients to send “inquiry letters” to counsel requesting, among other things, a description of any loss contingencies to which the lawyer has devoted substantive attention. SAS 12 is also rife with potential attorney-client privilege conflicts, so the American Bar Association (ABA) reacted by issuing its “Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information,” which limits the disclosure that lawyers may make to auditors. See 31 Bus. Law. 1709 (April 1976). In order to minimize the possibility of a privilege waiver and to protect lawyers’ ethical duty of confidentiality, the ABA statement advises that attorneys need not disclose much more than what is available publicly, thus limiting the damage even if the response letter is adjudged discoverable. The AICPA affirmed the ABA’s position with SAS 337, which concluded that auditors must respect the attorney-client privilege, despite any resulting “inability to review information that could have a significant bearing on [the] audit.” Nearly 30 years of harmony This harmony between accountants and lawyers constructed by SFAS 5, SAS 12 and the ABA statement came to be known as the “treaty,” and resulted in nearly 30 years of cooperative, largely incident-free practice whereby outside counsel carefully crafted response letters to protect the privilege, and auditors seldom made further inquiry to satisfy audit demands. Today’s enhanced scrutiny of the auditing process and the auditors’ response thereto have upset the delicate balance created in the 1970s to protect the attorney-client privilege. Although the Sarbanes-Oxley Act of 2002 did not directly address loss contingencies, it fundamentally changed the role of the outside auditor and resulted in increased scrutiny of auditors by both regulators and plaintiffs’ lawyers. The act amended the Securities Exchange Act of 1934 and created the Public Company Accounting Oversight Board (PCAOB), which mandated stricter enforcement of existing regulations. The PCAOB was created to ensure that auditors serve investors’ and public interests in obtaining informative, fair and independent audit reports, and in furtherance of these purposes was directed “when necessary, to apply pressure to improve an auditing firm’s audit practices.” Public Company Accounting Oversight Board, Annual Statement, Fiscal Year 2003. This pressure includes the power to discipline both individual accountants as well as their respective firms. See 15 U.S.C. 7215 (2006). Soon after its establishment in 2002, the PCAOB took a hard line in its oversight of auditors’ positions on loss contingencies. In 2004, the PCAOB criticized Deloitte & Touche for not obtaining documentation from outside counsel concerning a “potential contingent liability,” for which the company determined no accrual was necessary, despite the company’s financial statement referral to such documentation. PCAOB, Report on 2003 Limited Inspection of Deloitte & Touche LLP, at 21. And, in a limited inspection of an audit by KPMG LLP, the PCAOB found the auditor had failed to examine appropriate legal reports to support the calculation of an accrual for a litigation contingency. PCAOB, Report on 2003 Limited Inspection of KPMG LLP, at 19, n.4. Since the documentation of litigation reserves falls squarely into the realm of financial statement materials subject to concealment or falsification, some auditors have taken the PCAOB’s criticism as a mandate to delve into the thought processes of attorneys to verify the authenticity of management’s position on a loss contingency. Report of the ABA’s Task Force on the Attorney Client Privilege, 60 Bus. Law. 1029 (May 2005). Such behavior can lead to the perverse result of auditors second-guessing counsel’s opinion-a role for which the auditor is neither experienced nor trained to fill. As recognized by the AICPA in SAS 12, “[a]n auditor ordinarily does not possess legal skills and, therefore, cannot make legal judgments concerning information coming to his attention.” The realization that the PCAOB seems to expect auditors to verify lawyers’ thought processes is not only ironic in the face of SAS 12, but also spells trouble for the attorney-client privilege. Distinguishing the doctrines In navigating the treacherous waters of privilege waiver, companies must distinguish between the attorney-client privilege and work-product doctrine. The attorney-client privilege is an evidentiary rule stemming from public policy concerns that clients should be entitled, even encouraged, to seek legal advice without fear that their discussions with counsel will be made public. Upjohn Co. v. U.S., 449 U.S. 383 (1981). The work-product doctrine, in contrast, immunizes only material containing attorneys’ mental impressions which is prepared in anticipation of litigation, such as legal memoranda, risk assessments, reports of consultants, and settlement analyses. In re Subpoenas Duces Tecum, 738 F.2d 1367, 1371 (D.C. Cir. 1984). With certain limited exceptions, the attorney-client privilege is waived by voluntary disclosure of any significant part of the privileged communication; in general, courts have held that information subject to the privilege is discoverable once shared with outside auditors or other third parties. See U.S. v. Stewart, 287 F. Supp. 2d 461 (S.D.N.Y. 2003) (Martha Stewart waived attorney-client privilege by forwarding an e-mail sent to her lawyer to her daughter); Stenovich v. Wachtell, Lipton, Rosen & Katz, 756 N.Y.S.2d 367 (New York Co., N.Y., Sup. Ct. 2003) (law firm waived privilege with respect to documents shared with investment bankers and other third parties); but see Ferko v. NASCAR, 218 F.R.D. 125 (E.D. Texas 2003) (disclosure to third-party accountant did not waive privilege when accountant assisted attorney in providing legal advice). Courts are more willing, however, to uphold the work-product privilege when work product is shared with an outside auditor, especially when a company either has a “common interest” or has entered into a confidentiality agreement with the auditor. See Merrill Lynch & Co. Inc. v. Allegheny Energy Inc., 229 F.R.D. 441 (S.D.N.Y. 2004) (work-product immunity upheld even though Merrill Lynch did not share a common litigation interest with its auditors, with whom it had provided internal investigative reports); but see Diasonics Securities Litigation, No. C-83-4584-RFP, 1986 WL 53402 (N.D. Calif. 1986) (disclosure of documents to third-party accountants waived privilege). As evidenced by Medinol, however, courts are free to determine what constitutes a “common interest.” The court in Medinol held that since the auditor did not share a common litigation interest with the client, the disclosure waived work-product immunity. Medinol, 214 F.R.D. at 115. Further, the court reasoned, the auditor’s interests were not aligned with those of the client, since that would violate auditor independence rules highlighted by the recent accounting scandals. Id. at 116. Notwithstanding Medinol‘s reasoning, the majority of courts agree that disclosure of work product to an auditor or other third party does not vitiate the work-product privilege, provided that the third party cannot “be conceived of as an adversary or a conduit to a potential adversary.” Merrill Lynch, 229 F.R.D. at 447. Despite the likely protection of work-product immunity, a fine line separates acceptable disclosure from privilege waiver, and thus lawyers, auditors and their clients must tread carefully to protect the valuable corporate asset that is privileged information. The Sarbanes-Oxley-created environment has upset the harmony between required disclosure to auditors and the attorney-client and work-product privileges. As a result, companies and counsel must navigate the fine lines defining when a privilege waiver occurs, and take heretofore unprecedented steps to protect the valuable corporate asset that is the privilege. First, though negotiating with auditors may seem a foreign concept to many companies, by negotiating disclosure issues at the outset of the relationship, companies can prevent privilege waiver simply by insisting that auditors adhere to the long-standing, still-valid treaty between the ABA and the AICPA. Second, companies must take care to minimize the paper trail that can lead to inadvertent waiver. The proliferation of e-mail and electronic document formats has made sharing information simple, but also heightens the chances of an unintended waiver when a third party is copied in an e-mail, as Martha Stewart found out. 287 F. Supp. 2d 461. Finally, when appropriate, companies sharing work product should insist on a confidentiality agreement. Although far from a guaranty that the privilege will be preserved, when used in combination with these other steps, a confidentiality agreement will at least demonstrate awareness of privilege issues should the company wind up in court. And, ultimately, companies, auditors and the PCAOB must realize that shareholders’ interests are served by protecting and preserving privileged information.

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