LITIGATION ALERT: Proposed Change to International Code of Ethics for Accountants Would Negatively Impact Privilege and Confidentiality

Proposed Change to International Code of Ethics for
Accountants Would Negatively Impact Privilege and Confidentiality

February, 2013

Authors:
Jennifer Brownell
Michael Attaway
Clients often simultaneously retain a lawyer and an accountant who work together to meet the client's legal needs.  For example, in the course of a transaction, the client may need an attorney to address legal issues and document the transaction and an accountant to analyze financial statements or advise on tax implications of the proposed structure of the transaction.  In litigation, the client may need an attorney to investigate, prepare, or defend a case and an accountant to participate in the investigation or act as a consulting or testifying expert throughout the case.  To be effective in this tri-partite relationship, the accountant necessarily becomes privy to materials and communications that are confidential and subject to the attorney-client and work product privileges.  The client holds these privileges and, with few clear and limited exceptions, no one else can waive them.

A proposed change to the IESBA's[1] Code of Ethics for Professional Accountants (the "Code") would broaden those exceptions and substantially erode confidentiality and privilege protections inherent when a client, attorney, and accountant must work together on a legal matter.  Under the proposed change, if an American CPA [2] providing non-audit services subject to the Code suspects a client has committed an illegal act the CPA must take reasonable action to confirm or dispel those suspicions and discuss the matter with the appropriate level of client management.  If she is not satisfied with management's response, then the CPA is required to escalate the matter to higher levels. Finally, if she determines higher levels of client management have not responded appropriately and external disclosure is in the public interest, the CPA must disclose her suspicion to the client's external auditor for disclosure to the appropriate authority.  Under the proposed new rule, the external auditor would always need to disclose the suspected conduct to the appropriate authority.

The proposed rule change is intended to protect against illegal activity.  But it is a significant change from the current confidentiality standards American CPAs must follow when performing work under the Code.  The change imposes a new duty to disclose based on little more than the accountant's suspicion and subsequent dissatisfaction with the manner in which the client and client management reacted to the reported suspicion.  If adopted, under the changed rule a client and attorney who engage an accountant to work with them under circumstances subjecting the CPA to the Code will have to consider the potential for the accountant's subsequent unilateral determination that disclosures of confidential or privileged information must be made externally if the accountant is not satisfied with the client's response to a reported suspicion of illegal activity.

The most troubling aspect of the proposed rule change is the heightened potential on mere suspicion for disclosure of confidential client information that may be subject to the attorney-client or work product privilege.  While internal reporting by the CPA to client management generally would not violate privilege or confidentiality, tensions arise if the CPA is not satisfied with any action or inaction by client management with respect to the reported suspected illegal acts and the CPA then determines that she is duty-bound to take further action.  In that situation, under the proposed rule change, the CPA must always report her suspicions to the external auditor who will then disclose to an appropriate agency.[3]

Communications the CPA made when escalating her suspicions up the client's corporate chain are likely protected from disclosure by the attorney-client or work product privilege.  Any privilege cloaking communications on which suspicions were formed belongs to the client, as a matter of law, and cannot be waived unless an exception applies.  For example, if the suspicion concerned current and ongoing activity instead of past suspected illegal activity, then the crime-fraud exception to privilege might apply.  But if the CPA followed the proposed rule change and reported her suspicions to the external auditor, absent an applicable exception she would be violating the attorney-client and/or work product privileges – privileges that belong to her client.

External disclosures put the client, attorney, and accountant in precarious positions. It is likely the CPA obtained information about what she alone determined to be a suspected illegal act through her engagement by the client, work with the client and its attorney, and in reliance on confidential or privileged information.  If a confidentiality agreement were in place, she would be relying on and disclosing confidential and possibly privileged information to make her external report.  Doing so would breach any confidentiality or non-disclosure agreement with the client; subjecting all parties to potential litigation related to the disclosure.  The disclosure and attendant breach of confidentiality based on untested suspicion are especially damaging if the suspicions are unfounded.

The proposed rule also raises practical business issues impacting the tri-partite relationship.  It would inevitably strain relationships and create potential conflicts between attorneys and accountants who need to work and communicate freely with each other when mutually representing a client.  Attorneys will presumably hesitate to hire or work with an accountant who would be ethically bound to break client confidences and externally disclose privileged and confidential information based only on suspicion followed by what the accountant solely determined to be an inadequate response by client management.

While the intent and purpose of the proposed rule are commendable in an increasingly global economy, its practical application and reach create a broadened exception to client confidentiality and privilege as well as conflicting duties between the client's accountants and attorneys.  The proposed change could potentially override confidentiality and privileges to which the client should otherwise be entitled.

The comment period for the proposed rule ended December 15, 2012, and the IESBA is currently considering whether to adopt it in a final version.

This Litigation Alert is a summary of recent developments in the law and is provided for informational purposes only.  It is not intended to constitute legal advice or to create an attorney-client relationship.  Readers should obtain legal advice specific to their situation in connection with topics discussed.

Copyright © 2013 Kane Russell Coleman & Logan PC.  All rights reserved.  Unless otherwise indicated, the authors are not certified by the Texas Board of Legal Specialization.

jschultz, mattaway