It’s “that time of year” again. No, it’s not tax season, but rather the time for your client to prepare its audited financial statements and requisite disclosures to the Securities and Exchange Commission (SEC) and/or any other party to which it agreed to provide an annual audit.1 As part of this disclosure, your client has asked its accountant to prepare financial statements and issue an opinion that these statements fairly present the true financial picture. The accountant, in turn, sends you and/or your client an “audit inquiry letter” that asks you to describe any event that may affect your client’s financial status, including pending and potential litigation. The most likely next step is for your client to send you a letter that simply requests that you respond. Typically, this would be the extent of your client’s involvement in this process because it has confidence that you can accurately describe the matters that you are handling, or have discussed potentially handling.
However, despite a split of authority, many courts hold that the response to the audit inquiry letter waives the attorney-client privilege and/or the work product doctrine. Thus, the response, drafts and underlying documentation could be discoverable by your client’s adversary in litigation and/or your client’s creditors.2 In order to limit the potentially damaging impact that the disclosure of such sensitive information can have, you need to implore your client to take an active role and work in concert with you to carefully craft a reply that is at once forthcoming and at the same time preserves their rights.
When your client’s accountant prepares the financial statements and issues its opinion on them, the accounting firm must comply with, among other things, Statement of Financial Accounting Standards Number Five (FAS 5) and Statement on Auditing Standards Number 12 (SAS 12). FAS 5 establishes standards of financial accounting and reporting for loss contingencies and provides that “one such loss contingency is pending or threatened litigation.”3 SAS 12 gives the accounting firm guidance on the procedures that it should consider for identifying litigation, claims and assessments and satisfying itself that the financial accounting and reporting for such matters is in accord with the generally accepted auditing standards.4 SAS 12 requires disclosure of (1) a list that describes and evaluates pending or threatened litigation and (2) a list that evaluates claims that have not yet been asserted.
Given that these statements command the accountant to gather as much information as possible, you and your client should be aware that there is no federal accountant-client privilege as a matter of federal common law and no such privilege under Federal Rule of Evidence 501.5 In fact, the U.S. Supreme Court has expressly disapproved of the so-called accountant-client privilege, stating that “no confidential accountant-client privilege exists under federal law, and no state-created privilege has been recognized in federal cases.”6 Most states do not recognize an accountant-client privilege. Thus, without any other applicable privilege, information that is provided to the accountant could be the subject of discovery by a litigation adversary or a creditor.