Accountants and the Attorney-Client Privilege

Accounting concepts are a foreign language to some lawyers in almost all cases and to almost all lawyers in some cases. As financial litigation becomes more complex, this often-quoted statement helps explain why attorneys sometimes need to use the services of accountants. Litigation support has become so much a part of the accounting profession that the American Institute of CPAs Code of Professional Conduct defines the practice of public accounting as including litigation support services. For many lawyers, the need to consult a CPA is particularly acute when they work with financial statements, determine a clients net worth, try to understand a business books and records or handle tax matters.

An issue raised about the attorney-accountant relationship is whether use of an accountants services will jeopardize communications and work otherwise protected by the attorney-client privilege. This issue is grounded in the rejection of an accountant-client privilege by both common and federal law as well as the possibility that such communications may result in the waiver of an attorney-client privilege (see Berkowitz , 355 F.Supp. 897, affd 488 F.2d 1235, and Sidney Samuels , 155 F.R.D. 195 [N.D. Cal. (1994)]). From an accountants perspective, the inability to protect communications and work product from disclosure threatens client candor and the CPAs ability to deliver quality services.

Despite the rejection of a federal accountant-client privilege, accountant-related communications still may be shielded from disclosure when an accountant acts as an agent for an attorney providing legal services ( Judson , 322 F.2d 460 [9th Cir. (1963)]). Extending the attorney-client privilege to accountants in this way is intended to enhance open and candid communications and to enable clients to obtain sound legal advice. Recognition that the attorney-client privilege may apply to accountant communications and work product is evident in both the Internal Revenue Manual and Treasury Circular 230. Both say essentially that an accountant need not reveal information he or she in good faith reasonably believes to be privileged.

This article examines the possible extension of attorney-client privilege to accountants, and some related planning considerations. Knowing when to raise privilege is vital to CPAs not only to serve a clients best interests, but also to avoid unnecessary legal liability.

THE LANDMARK KOVEL DECISION
In United States v. Kovel (296 F. 2d 918 [2d Cir. (1961)]), the Second Circuit Court of Appeals extended the attorney-client privilege to communications between a client and someone an attorney retains to provide accounting-related services. The case concerned Kovel, a former Internal Revenue Service agent who had accounting skills.

A law firm had hired Kovel to help advise its clients. He met with a client who was under grand jury investigation and received a personal financial statement from the client, along with a letter indicating itss purpose. The grand jury subpoenaed Kovel, who refused to answer questions about his meetings with the client and the effect of certain transactions. As a result, he was held in contempt of court and sentenced to one year in prison.

The matter was appealed to the Second Circuit, where the contempt decision was reversed. Judge Friendly wrote that just as other parties have been recognized as necessary to providing legal servicessecretaries, clerks and messengersso should accountants. Consequently, when an attorney retains an accountant to provide services that enhance the legal advice being provided, the attorney-client privilege extends to the accountant.

As a result of Kovel , a case for applying attorney-client privilege to accountants can be made when

• An attorney-client relationship exists.
• An accountant is retained by the attorney.
• The accountant renders services that abet the provision of legal services.
• The parties do not waive the privilege.

MULLEN OFFERS FURTHER INSIGHT
Mullen and Company (766 F. Supp. 620 [D. Ct. Mass. (1991)]) is instructive for CPAs because it addresses the question of whether attorney-client privilege applies to communications between a client and someone who is both an attorney and an accountant. The issue was raised by a client of Mullen, which is an accounting firm. The client asserted that two of the three accountants who worked for Mullen were licensed attorneys and the services they sought were legal in nature.

According to the court, for privilege to apply an attorney-client relationship had to exist. Important factors in making this determination—identified by the court—include the following:

• Did the client seek legal advice from Mullen and Company?
• Did the client have other outside counsel?
• Were the attorneys of Mullen licensed in the state?
• Was their practice of law ethical and legal?
• Did only the attorneys in Mullen provide services?
• Was the nonattorney accountant subordinate to the attorneys?

U.S. SUPREME COURT STANDARD 503
The law recognizes attorney-client privilege for communications between a clients employees and the clients attorney (or attorneys agent) when the communications facilitate the provision of legal services ( Upjohn , 49 U.S. 383 [1981]). As a result, privilege may be used for in-house accountant-attorney communications. The potential application of attorney-client privilege can extend to an even broader array of people having relationships with an attorneys client, as is evident in U.S. Supreme Court Standard 503 (which while not adopted in the federal rules of evidence, has largely been relied upon) and the test pronounced by the Eighth Circuit Court of Appeals in Diversified Industries Inc . (577 F.2d 596 [8th Cir. (1977)]).

According to the Diversified standard, the attorney—client privilege applies to an employees communications if

• The communication was made to get legal advice.
• The employee making the communication did so at the direction of his or her corporate superior.
• The superior made the request so the corporation could get legal advice.
• The subject of the communication is within the scope of the employees corporate duties.
• The communication was not shared with anyone other than those who, because of the corporate structure, needed to know its contents.

In McCaugherty (132 F.R.D. 234 [N.D. Cal. (1990)]), the District Court for the Northern District of California, although not applying the privilege on other grounds, said it did not see any need to distinguish between employees and those who acted as the functional equivalent of employees. Interpreting the standard in this way would make the privilege potentially applicable to accountants who serve as other than employees.

M ore recently, in In re Bieter Co . (16 F.3d 929 [8th Cir. (1994)]) the Eighth Circuit Court of Appeals upheld application of the attorney-client privilege to communications between an attorney and an independent contractor who was a real estate consultant the client hired to provide guidance on the development of land that became the subject of a legal dispute. The court noted that, from the projects outset, the consultant was intimately involved with the clients attempt to achieve its objective. The consultant also served as the clients representative in meetings with potential tenants and local officials and was relied on for his expertise much like one would rely on an outside accountant to establish proper accounting and tax practices. In the courts eyes, upholding privilege under the circumstances would encourage a free flow of relevant information to the clients legal counsel, where it was needed most.

In finding privilege applicable under the Diversified standard, the court noted that the burden of proof is on the party claiming the privilege to establish that all pertinent requirements have been met.

The Bieter decision is of great significance to accountants. By analogy, Bieter extends attorney-client privilege to certain communications and work product of accountants when

• The accountants serve a vital, substantial and continuous role in the clients operations and act substantially like an employee.
• The communications or work product furthers the provision of legal services.

Not all communications between an attorney and accountant are privileged. There are two common grounds for denying privilege

• When it is believed to have been waived.
• When the accountants services are not to be considered sufficiently related to the provision of legal services.

Waiver of privilege. Waiver can result from disclosure— intentionally or inadvertently—to a third party not considered sufficiently involved in providing legal services. Insight into the breadth of factors resulting in a waiver is provided by Cote (456 F.2d 142 [8th Cir. (1972)]).

Cote involved a taxpayer who had used a particular CPA for several years. On learning the taxpayer would be subject to an IRS examination, the CPA referred the client to an attorney. In turn, the attorney hired the CPA to audit the taxpayers net worth. As a result of the audit, the client filed an amended return showing an increase in his income and tax over that originally reported. No explanation was provided. The IRS issued a summons to the CPA, who claimed no response was necessary due to privilege. The matter was heard by the Eighth Circuit which found filing the amended return involved communicating part of the information sought and as such constituted a waiver of privilege.

Not related to legal services. The other common ground for denying privilege is that the accountants services are not sufficiently related to the legal services rendered. Such denial is particularly evident when

• The accountants services were performed before the client engaged the attorney, casting doubt about whether retaining the attorney was intended to protect the accountants prior communication or work.
• The accountants services were in the nature of tax return preparation or an audit.

The instance of individuals licensed as both attorneys and accountants who claim privilege raises additional questions about the nature of the services rendered. Merely alleging that one did work as an attorney is insufficient to protect the communications or work product when the service appears to be more in the nature of accounting work. The courts generally have classified tax return preparation as accounting work. Different conclusions have been reached about other accounting work, such as an examination of books, journals or a net worth statement related to the rendering of legal services. More recently in Bornstein (977 F.2d 112 [4th Cir. (1992)]), a court suggested that when an attorney-CPA hires an accountant to perform services allegedly related to the rendering of legal services, this raises questions as to why such services were needed since the attorney-CPA could presumably render similar services.

THE PAPER TRAIL
To enhance the likelihood of a successful claim of privilege, the legal purpose served by the accounting services should be documented as thoroughly as possible at the time the service is sought, provided and billed. The importance of doing this is underscored by Adlman (94-2 U.S.T.C. P50, 389 [May 1994]; 68 F.3d 1495 [2d Cir. (1995)]). In Adlman , privilege was denied to letters and memoranda Arthur Andersen prepared for a company at the request of Adlman, an attorney and the companys vice-president of taxes. The items in question concerned a proposed transaction, which later became the subject of an IRS investigation to determine the companys tax liability. In denying privilege, the court noted

• The invoices the company received from Arthur Andersen did not distinguish between the memoranda and other services the firm performed.
• No documents were offered reflecting that Arthur Andersens services were in furtherance of legal services.
• No separate retainer agreement was shown establishing that Arthur Andersens services were related to other than nonlegal work.

The Adlman holding is consistent with that in Fisher (51 F.2d 424 [D.C. NY (1931)]) in which privilege was denied to information uncovered during an accountants audit, despite the accountant later becoming an attorney for the client. The court found no evidence that the accountant had provided other than accounting services at the time the audit was performed.

PROMISE HELD
While neither federal nor common law recognizes an accountant—client privilege, accountant communications and work product may be protected if they fall within the attorney—client privilege. However, the mere fact that an attorney was retained and communications took place between an accountant and the attorney does not necessarily mean privilege will apply.

To enhance entitlement to privilege, CPAs must carefully document the work they do and how it relates to providing legal services. To strengthen the case for privilege, an accountant should perform work at the request of an attorney according to a written agreement that specifies how the work relates to and furthers providing legal services. In addition, all parties should take steps to ensure that privilege is not waived and that the service is not viewed as strictly accounting in nature. Bieter holds promise that the attorney—client privilege will apply to a new and broader array of situations involving accounting services.