MINNESOTA LAWYER

QUARTERLY SPECIAL FOCUS

Supplement toMinnesota Lawyer

March 12, 2007ONLINE www.minnlawyer.com

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S-3 l JUNIOR HAS A

BRIGHT FUTURE

In-house legal departments

plan to fill their ranks

with more junior-level

attorneys.

By Dan Heilman

S-7 l DOWNGRADING

DATA DANGERS

Federal courts weigh in on

whether electronic infor-

mation should be kept

accessible.

By Amanda J.G. Karls

S-6 l WATCH YOUR

WORDS WITH EXPERTS

Written exchanges with

a testifying expert are

probably discoverable.

By James G. Bullard and

I. Daniel Colton

InsideS-5 l SEXUALHARASS-

MENT TRAINING

California mandates

sexual harassment

training for supervisors

in large companies.

By Jane Pribek

SPECIAL SUPPLEMENT TO MINNESOTA LAWYER, FINANCE & COMMERCE

AND THE ST. PAUL LEGAL LEDGER - MARCH 2007

IN-HOUSE COUNSEL

Photo by Bill Klotz

Dorsey & Whitney partner William Michael

explores the growing corporate dilemma of outside auditors

requesting privileged information from internal investigations.

Story on page S-4

S-8 l SAFEGUARDING

THE COMPANY JEWELS

A well-oiled hiring process

can protect trade secrets

while minimizing the

chance of litigation.

By Jennifer G. Daugherty

and David A. Schooler

S-4 ■ March 12, 2007 MINNESOTA LAWYER

MINNESOTA LAWYER QUARTERLY SPECIAL FOCUS

IN-HOUSE COUNSEL

Sarbanes-Oxley compliance has

outside auditors increasingly asking

for privileged information, putting

a company’s internal investigation

materials at risk of disclosure.

By William Michael

The waiver of the attorney-clientprivilege is a complex, legallychallenging decision often faced

by corporate management in today’slitigious world. Those waiver decisionsare usually associated with requestsfor information made by opposingcounsel in a lawsuit, or by governmentregulators or investigators who wantthe benefit of the corporate investiga-tion to jump-start their own independ-ent investigation.

However, there is an ever-increasingmovement forcing corporations to dis-close otherwise privileged materialsthat is coming not from corporateadversaries, but instead the company’sown auditors.

Determining whether to discloseattorney-client privileged materialslearned as a result of an internal inves-tigation to outside auditors hasbecome a modern corporate dilemmafaced by both public and private com-panies. Often, the eventual decisionwill be dictated by the required servic-es of the auditors and their willingnessto remain flexible concerning themethodology and substance of infor-mat ion tha t may u l t imate ly bereleased.

Auditing responsibilities

As a result of corporate scandals, vig-orous oversight, a thoroughness ofeffort and self-preservation interests,outside auditors have become increas-ingly interested in reviewing the under-lying documentation — and counsel’sconclusions — associated with theinvestigation of alleged corporate mis-conduct. Indeed, the auditor’s role andresponsib i l i ty has s igni f icant lyincreased in preventing and detectingcorporate fraud.

Ensuring truth in financial reportingis not only a laudable goal, but serves avital public interest. The public hasboth a need and a right to rely upon acorporation’s financial reporting, andthere must be a mechanism in place toensure accurate reporting. Outsideauditing firms play a crucial role in thetransparency, accuracy and reliabilityof corporate financial reporting.

However, as a result of the myopicapproach to cleaning up corporateAmerica and providing scrutiny of allthings financial, a fundamental processof corporate management — beingable to rely upon confidential advice ofcounsel — has been placed at risk.

In reaction to Enron and the manyother instances of corporate financialmismanagement, Congress enacted theSarbanes-Oxley Act of 2002. SOXnecessitates, under sec. 404, that thecompany publish information in itsannual reports concerning the scopeand adequacy of its internal controlstructure and procedures for financialreporting. The company’s auditors

must then attest to and report on theirassessment on the effectiveness of theinternal control structure and proce-dures for financial reporting.

Auditors have used this regulatoryrequirement as justification to demanda much broader range of information,and a much more in-depth level ofinformation, including attorney-clientprivileged material.

More than 30 years ago, the AmericanBar Association and American Insti-tute of Certified Public Accountantsaddressed the concern of the release ofattorney-client privileged material toauditors relating to “audit letters.” Atthat time, it wasrecognized thatthe need for pub-lic confidence incorporate finan-cial statementscould be betterserved by preserv-ing the integrity oft h e p r i v i l e g e dnature of commu-nications betweenthe company andits attorneys, thusencouraging man-agement to seekout, listen to andadhere its actionsto the legal adviceobtained.

However, com-panies increasing-ly have been con-f r o n t e d w i t hrequests by audi-tors for privileged information regard-ing potential “contingent liabilities.”Auditors often seek further informa-tion based on their need to know ofany loss contingencies when there is a“reasonable possibility” that a loss mayhave been incurred. Accordingly, the

auditors are interested in what is theloss contingency, what are the possibil-ities that it will be incurred and, evenmore so now, what are the attorneysadvising on the potential risk and dam-ages based on the information uncov-ered during the internal investigation.

Attorney-client privilege

in jeopardy

In today’s ever-increasingly litigioussociety, lawsuits are but a momentaway from any corporate action.

Certainly, information obtained bycounsel in anticipation of litigation —and work product that was produced

to assist counseli n p r o v i d i n gadvice on thosematters to corpo-rate management— has as its fun-damental charac-teristic the needfor confidentiality.Courts have longrecognized thate n c o u r a g i n g acorporate client’scandor by protect-ing the confiden-t ial i ty of thesecommunicationswill promote theobservance of lawand administra-tion of justice.

Companies areincreasing theiro w n e f f o r t s t oinvestigate poten-

tial wrongdoing and to create effectivecompliance programs that not onlydeter, but also detect misconduct. As aresult of these increased efforts, attor-neys are routinely brought in not onlyto assist in the investigations, but alsoto offer advice as to what action is

appropriate, creating work productand providing advice that is ostensiblyconfidential.

This confidentiality encourages fulland frank communications and assistsin the detection and thorough uncover-ing of misconduct.

Auditors’ requests for this informa-tion, however, now place the compa-ny’s privileged status of this material atrisk. If the privilege is later determinedby a court to have been waived throughrelease to the auditors, then this mate-rial will likely be available to third par-ties for their use in litigation againstthe company or its management. Gov-ernmental agencies, shareholders,plaintiff’s counsel and disgruntled for-mer employees now may have accessto this formerly privileged information.

Potential ramifications

If an arrangement cannot be met tosatisfy the legitimate needs of the audi-tors while balancing the legitimateneeds of the company to maintain itsprivileges, significant ramifications areat stake. The company faces a Hob-son’s choice.

If the company elects to maintain theprivilege, it faces the potential of audi-tors refusing to make the attestationunder sec. 404 of SOX, issuing a quali-fied audit opinion or perhaps providingno opinion at all. This could cause therequired financial reporting to bedelayed, or potentially allow financialinstitutions to call due significant loansand result in a public relations outcry.

If the company waives the privilegeand releases those materials to theauditors, the company has likely lostthe ability to keep its confidential legaladvice and the confidential materialsthat were prepared in anticipation oflitigation will now potentially assist itslitigation adversaries.

The AICPA’s Code of ProfessionalConduct states that no confidentialclient information may be disclosedabsent consent of the client. However,this section goes on to allow the disclo-sure of this confidential informationpursuant to a validly issued andenforceable subpoena. Likewise, Minn.Stat. sec. 326A.12 states that informa-tion provided by a client shall not bedisclosed absent consent of the clientor when required to be disclosed incourt proceedings.

Thus, these sections provide no prac-tical support for maintaining the confi-dentiality of privileged material provid-ed to the auditors when sought vialegal process by third parties involvedin litigation with the client company.

Courts present diverging opinions

What first appeared to be a commonbreach of contracts case in Texasrecently became an omen of things tocome on this issue. In Stone & Webster,

Inc. v. AES Wolf Hollow, AES request-ed in discovery all of the plaintiff’s“financial losses and all chargesagainst profits claimed with respect tothe [c la im] .” The pla int i f f thenresponded that “[t]he answer is con-tained in [the company’s] May 2003

Corporations face a Hobson’s choice on privilege waivers

Analysis

“

”

As a result of the myopic

approach to cleaning up cor-

porate America and providing

scrutiny of all things financial,

a fundamental process of

corporate management —

being able to rely upon

confidential advice of counsel

— has been placed at risk.

Waivers l Page 10

S-10 ■ March 12, 2007 MINNESOTA LAWYER

MINNESOTA LAWYER QUARTERLY SPECIAL FOCUS

IN-HOUSE COUNSEL

can and should be protected from disclo-sure while still providing fair notice of thefull scope and factual basis of the expert’sexpected testimony. This is an acknowl-edgment by the ABA that the currentmajority position is to the contrary andthat, as litigation counsel, you are actingat your peril if you continue to communi-cate in writing with a testifying expertabout sensitive subjects.

These developments are best under-stood in perspective. The 1993 amend-ments to the Federal Rules of Civil Proce-dure changed significantly the rules forobtaining discovery from expert witness-es. For experts who are “retained or spe-cially employed to provide expert testi-mony” or “whose duties as an employee... regularly involve giving expert testimo-ny,” a detailed report “prepared andsigned by the witness” became mandato-ry.

Such testifying experts are also freelyavailable for depositions. However, it wasnot widely recognized at the time thatthese rule changes would make availablefor discovery virtually all written commu-nications exchanged between litigationcounsel and their testifying experts.

Unless the case can afford the luxuryof consulting experts or experts who arenot expected to testify, litigation counselmust communicate with their testifyingexperts for many important reasons.Such reasons include assisting theexpert in learning the facts of the case,exploring with the expert differentapproaches to handling scientific and

technical issues, discussing with theexpert what discovery or other inves-tigative efforts may be needed, decidingwith the expert how to prepare the casefor trial, and helping the expert toexplore different hypotheses or to refinethe presentation in light of the key factsand applicable law. Such communica-tions are likely to encompass “core” or“opinion” work product, including the“mental impressions, conclusions, opin-ions, or legal theories” of trial counsel.

Counsel’s opinion work product —including strategies, assessments of thestrengths and weaknesses of the case,and the significance attached to key evi-dence — can be vital to your case. Its dis-closure to a litigation adversary could beas disastrous as allowing battle plans tofall into the hands of the enemy on theeve of a decisive engagement. For thisreason, opinion work product ordinarilyreceives a very high level of protection inthe litigation process. It is essentiallyimmune from discovery.

And, prior to the 1993 amendments,opinion work product that was shown toor shared with a testifying expert as away of expediting the communicationprocess remained immune from discov-ery, unless the expert relied on counsel’swork product in forming opinions.

However, the 1993 amendments man-date that a testifying expert’s report mustinclude “the data or other information

considered” by the expert in formingopinions. The advisory committee notesindicate that the purpose of this require-ment was to ensure that litigants couldno longer “argue that materials furnishedto their experts to be used in formingtheir opinions — whether or not ulti-mately relied upon by the expert — areprivileged or otherwise protected fromdisclosure when such persons are testify-ing or being deposed.” It is in response tothis language that the courts developedthe bright-line rule recently adopted bythe 6th Circuit in Regional Airport

Authority.The reasoning behind the bright-line

rule may be suspect — and it clearly side-steps Rule 26(b)(3)’s prohibition againstdisclosure of the “mental impressions,conclusions, opinions, or legal theories”of counsel — but it has the virtue of sim-plicity. It saves the courts from having tosort out precisely what “data or otherinformation” should be disclosed pur-suant to the report requirement of Rule26(a)(2)(B).

It also saves the courts from having todecipher precisely what Rule 26(a)(2)(B)intends by limiting the disclosure require-ment to just that subset of data or otherinformation “considered” by the expert.Indeed, it is notable that when stating thebright-line rule, most courts substitutesome other word for “considered.” Forexample, in Regional Airport Authority,

the 6th Circuit formulated its statementof the rule in terms of information “pro-vided” or “given to” the testifying expert.In other words, the courts do not want tobe in the business of separating opinionwork product from ordinary work prod-uct or simple factual information — nordo they want to be in the business of fig-uring out what “consideration” the expertgave such information. Any writtenexchange with a testifying expert willautomatically be deemed discoverable.

For practitioners, the simplicity of thebright-line rule can also be a virtue. Youmay not like the rule, but you knowexactly where the boundaries are: If youcare about disclosure of communicationsmade to a testifying expert, do not makethem in writing. This includes draftreports.

Practitioners also need to keep in mindthat the scope of discovery under thebright-line rule potentially includes thelawyer’s notes of meetings and telephoneconversations with the expert. Suchnotes are obviously “writings,” and theyreveal the contents of “data or otherinformation” provided to the expertevery bit as much as counsel’s annota-tions on a draft report. Therefore, cautionmust be exercised by counsel as well asthe expert in deciding when to take notesand what to record.

James G. Bullard and I. Daniel Colton are share-holders at Leonard, Street and Deinard in Min-neapolis and co-chair the firm’s SciTech LitigationPractice Group.

Reasoning behind the 6th Circuit’s bright-line rule may be suspectExperts l From Page 6

through current 10Q and 10K filings.”Even though there were state auditor-

client privilege protections in place,the court ordered that the informationprovided by the plaintiff to its auditorswould be discoverable, enabling AESto test the validity of the reported 10Qand 10K filings and to have access towhat would otherwise have been privi-leged.

Texas is not alone in addressing thisissue, although the various courts — asexpected — are divergent on their con-clusions regarding this waiver argu-ment. In Merrill Lynch & Co., Inc. v.

Allegheny Energy, Inc., the courtdeclined to find a waiver of the attor-ney-client privilege after internal inves-tigation reports had been provided toMerrill Lynch’s outside auditors fortheir use in preparing its annual auditand SOX 404 attestation. The court rea-soned that finding a waiver would dis-courage companies from conductinginvestigations and disclosing thoseresults to auditors.

However, in Medinol, Ltd. v. Boston

Scientific and numerous other cases,courts have taken the oppositeapproach and found that disclosure toauditors results in waivers of the privi-lege. In Medinol, the court stated that“in order for auditors to properly dotheir job, they must not share commoninterests with the company they audit.”It went on to say that in order to per-form properly, there must be adversari-

al tension between the auditor and thecompany. Additionally, by certifyingthe financial statements, the courtfound that the independent auditorassumed a publicresponsibility thattranscended anyrelationship withthe company.

A legal

crap shoot

At this time thereis very little silverlining to this issue.Proposed legisla-tion regarding theselective waiverdoctrine has beenlimited to produc-tion of materials tog o v e r n m e n t a la g e n c i e s a n dremains just that— proposed legis-lation.

Confidentialityagreements havealso been inadequate to protect theprivileged nature of the materials, andsec. 105 of SOX — which specificallyaddresses the protection of privilegedstatus for material provided to the Pub-lic Company Accounting OversightBoard — is inapplicable to the compa-ny’s own auditor’s requests for infor-mation.

The Securities and Exchange Com-mission has taken an affirmative rolein advocating, although unsuccessfully,for the maintenance of privileged sta-

tus for materialsturned over to itsinvestigators by fil-ing amicus briefswhen court chal-l e n g e s a r ereceived regardingthe waiver issue.

In the 8th U.S.Circuit Court ofAppeals, there isargument underthe Diversified

line of cases thatselective waiver isappropriate whenprivileged materi-als are provided tothe government.However, thesearguments may beu n p e r s u a s i v ewhen advocatingtheir applicability

to materials provided to auditors.Additionally, with the emergence of a

national, if not global, economy andindustry that transcends jurisdictionallines, the limited jurisdictional applica-bility of Diversified continually nar-rows with time as Minnesota compa-nies face litigation in venues far fromhome.

Facing potential litigation in venuesall over the country, and with this issuein such a state of legal flux, any deter-mination of whether the release ofprivileged information to the auditorswill constitute a waiver is nothingmore than a legal crap shoot. Accord-ingly, the waiver of privilege over suchmaterials and subject matters releasedto the auditors should generally beexpected, and its appearance in thehands of l i t igat ion adversar iesassumed.

For any relief on this subject, atten-tion must be brought to this issuethrough a concerted effort by corpo-rate advocates to address it legislative-ly on the federal level, so as to elimi-nate a smorgasbord of state laws andcourt decisions.

Unfortunately, as a result of the sameunderlying corporate conduct that pro-duced this problem, Congress isunlikely to be sympathetic to arguingthe need to withhold certain materialfrom financial auditors, even for neces-sary and legitimate reasons.

William Michael is a partner with Dorsey &Whitney in Minneapolis and a member of thelaw firm’s White Collar Crime and Civil FraudPractice Group. He frequently lectures nation-wide and is a media commentator on a varietyof issues, including terrorism, internal investi-gations and complex federal investigations.

“

”

If the privilege is later

determined by a court to

have been waived through

release to the auditors,

then this material will likely

be available to third parties

for their use in litigation

against the company or its

management.

No silver lining on the issue of privilege waiversWaivers l From Page 4

Analysis