July 7, 2010

A Post-Textron Opinion: IRS Denied Access to Documents Held by Auditor

Stan Keller of Edwards Angell Palmer & Dodge and Tom White of Wilmer Hale note:

Recently, the DC Court of Appeals issued a decision upholding the District Court’s decision denying the IRS access to three documents relating to the tax treatment of two partnerships owned by Dow Chemical that were in the possession of Dow’s auditor, Deloitte. Two of the documents were a memorandum prepared by a Dow in-house accountant and attorney and a tax opinion prepared by Dow’s outside counsel, both of which were furnished to Deloitte in connection with the audit to verify the adequacy of the tax contingency reserve for the transactions. The Court found that these documents were attorney work product entitled to protection, as conceded by the government, and that the protection was not waived by the documents being furnished to Deloitte.

This is the first Court of Appeals decision holding that disclosure to independent auditors did not waive work product protection. The Court found that the auditor is not a potential adversary or conduit to an adversary and Dow had a reasonable expectation that Deloitte would maintain the confidentiality of the documents, relying on professional standards requiring auditors not to disclose confidential client information.

The third document was a memorandum prepared by Deloitte that summarized a meeting with Dow officials and outside counsel to discuss potential litigation over the transactions. The Court held that this memorandum could be work product protected, notwithstanding that it was prepared by the auditor, because it reflected the thoughts and opinions of counsel with respect to anticipated litigation.

The Court rejected the government’s argument that the memorandum could not be work product because it was prepared in conncection with the annual audit, adopting the generally prevailing “because of” anticipated litigation test and rejecting the “primary motivating purpose” test of the Fifth Circuit and both distinguishing the First Circuit Textron decision as based on the particular documents at issue (ordinary tax workpapers) and rejecting Textron to the extent it adopted a more stringent “prepared for use in possible litigation” test as suggested by the dissent in Textron. Because the evidentiary record was insufficient to establish that all the information in the Deloitte memorandum was work product protected, the Court remanded to the District Court to review the memorandum in camera.

The decision is also notable because the Court clearly distinguishes the Supreme Court’s decision in Arthur Young as relating solely to whether there is accountant’s work product protection and not to whether attorney work product protected information continues to be protected in the hands of the accountant. The court notes the importance of preserving this protection because “independent auditors have significant leverage over companies” since “[a]n auditor can essentially compel disclosure by refusing to provide an unqualified opinion otherwise” and waiver under these circumstances “might discourage companies from seeking legal advice and candidly disclosing that information to independent auditors.”

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