jeff c. dodd jeffdodd@andrewskurth · recent cases should make software licensors review their...

AUDIT RESPONSE LETTERS: SKIRMISHES AT THE BOUNDARIES SET BY THE TREATY

JEFF C. DODD [email protected]

State Bar of Texas 10th ANNUAL

ADVANCED BUSINESS LAW COURSE November 1-2, 2012

Houston

CHAPTER 11

STRAIGHT TALK IS GOOD BUSINESS. ®

Jeff C. Dodd

Partner

600 TravisSuite 4200Houston, TX 77002P: 713.220.4736F: [email protected]

111 Congress AvenueSuite 1700Austin, TX 78701P: 512.320.9252F: 512.320.9292

INDUSTRIES Banking/FinancialServices

Finance

Internet/E-Commerce

Manufacturing andSales

Private Equity

Restaurant

Software/Electrical

Technology

Technology andEmerging Companies

Venture Capital

PRACTICES Banking/FinancialServices

Corporate

Corporate Compliance,Investigations andDefense

Economic Recovery andGovernmentOpportunities

Governance

Intellectual PropertyCounseling andLitigation

Patents, Trademarksand Copyrights

Private Equity

Technology andEmerging Companies

TechnologyTransactions

EDUCATION JD, 1979, summa cumlaude, University ofHouston Law Center

BA, 1976, magna cumlaude, University ofHouston

Corporate, Securities and Corporate Finance: experience in diverse domestic andinternational corporate transactions, including representing issuers and underwriters(and investment bankers) in connection with public and private securities offerings(including IPOs and secondary offerings); representing venture capital and otherinvestment groups or funds, as well as portfolio companies, in private debt and equityfinancing transactions; representing various participants (buyers, sellers, financingsources) in merger and acquisition and change of control transactions, public andprivate; counseling as to Securities Exchange Act of 1934 compliance and disclosure;advising regulated companies (including broker/dealers and investment advisers) as toregulatory and compliance matters; advising clients as to Investment Company Act of1940 issues; structuring financing arrangements and vehicles (including structuringvarious hedge, private equity and other investment funds); representing borrowers andlenders in lending transactions (including financing transactions relating to acquisitions);and structuring and documenting joint venture, corporate partnering and similararrangements.

Intellectual Property, Technology, Electronic Commerce and Communications: extensiveexperience in a variety of domestic and international intellectual property and informationtransactions; representing various parties in the planning, design and implementation ofelectronic commerce strategies and arrangements, domestic and international (includingthose relating to business-to-business exchanges, co-branding, hosting, developmentand other similar activities), electronic data interchange arrangements, and electronictrading transactions and activities; structuring, negotiating, documenting and unwindingstrategic ventures and alliances where intellectual property is the core asset; counselingas to intellectual property commercialization and exploitation strategies; structuring,negotiating and documenting technology acquisition, transfer and commercializationtransactions; general representation of various parties in registering, enforcing andlicensing intellectual property rights with respect to diverse technologies; performinginfringement and similar analyses; advising domestic and international clients on dataprotection, security and privacy laws and devising compliance strategies; representingsoftware developers, as well as distributors and end-users, in structuring, negotiating anddocumenting computer hardware and software ownership, acquisition and distributionagreements; representing companies acquiring software and other technologycompanies; representation of various communications companies and service providers.

PUBLICATIONS

SEC Issues Guidance on JOBS Act Research Provisions (September 24, 2012)


ADMISSIONS Texas 1979

SEC Proposes Amendments to Allow General Solicitation in Certain Private OfferingsPursuant to JOBS Act (September 21, 2012)

SEC Adopts Rules Implementing Dodd-Frank Requirements for CompensationCommittees and Compensation Advisers (July 9, 2012)

SEC Offers Additional JOBS Act Guidance (May 16, 2012)

SEC’s Division of Corporation Finance Issues JOBS Act Guidance (April 18, 2012)

Congress Passes the JOBS Act to Ease IPO Process for “Emerging GrowthCompanies” and Enhance Capital Formation (March 28, 2012)

A Sharply Divided En Banc Federal Circuit Decision Limits Intervening Rights ToClaims Textually Modified in Reexamination Intellectual Property & Technology LawJournal, July 2012 (March 21, 2012)

Patent-Eligible Subject Matter in Business Method Patents (March 19, 2012)

ISS Publishes Guidance on New Methodology for Evaluating Pay-for-PerformanceAlignment and Updates to its Governance Risk Indicators (January 10, 2012)

ISS Publishes 2012 Updates to Benchmark U.S. Proxy Voting Guidelines (December1, 2011)

Three Large States Revise Their Security Breach Notification Laws and Texas AppliesIts Law to Residents of Some Other States to Boot IP and Technology Developments- October 2011 (October 25, 2011)

Recent Ruling Allows a Shareholder Lawsuit to Proceed After a Negative Say-on-PayVote: Quirk or Harbinger? (October 6, 2011)

The Economic Observer, Texas Report (October 2011)

DC Circuit’s Proxy Access Decision to Stand, but SEC to Allow “Private Ordering” ofProxy Access (September 20, 2011)

Oil and Gas Companies Should Expect Increased SEC Scrutiny of Operations andReserves (September 6, 2011)

PCAOB Floats Possibility of Mandatory Audit Firm Rotation Financial Fraud Report(January 2012) (August 31, 2011)

Hitting Non-Practicing Entities Where It Hurts (August 16, 2011)

DC Circuit Panel Vacates Proxy Access Rule (July 28, 2011)

Recent Cases Should Make Software Licensors Review Their Distribution Methodsand License Terms (and They May Even Make Us Look at Open Source Licenses in aDifferent Way) IP and Technology Developments - July 2011 (July 21, 2011)

Therasense Inc. v. Becton, Dickinson and Company—The Federal Circuit tightens thestandards necessary to establish the inequitable conduct defense by requiring a“but-for” showing of materiality (May 27, 2011)

SEC Proposes Rules for Compensation Committees and Compensation Advisers(April 21, 2011)

Administration Unveils Over-The-Counter Derivatives Reform (August 28, 2009)

"Obama Administration Announces Financial Regulatory Overhaul" (June 24, 2009)

"E-Commerce: A Sticky Legal Arena" (December 31, 2001)

"Time and Assent in the Formation of Information Contracts: An Essay on theMischief of Applying Article 2 Inspired Contract Law to Information Contracts" Houston Law Review (1999)

Jeff C. Dodd


"Article 2B Offers Jurisprudence for All Forms" National Law Journal (September 21, 1998)

"Contracting in Cyberspace" SMU Computer Law Journal (Summer 1998)

"Licensing Law Update" Journal of Proprietary Rights (1995)

"Rights in Information: Conversion and Misappropriation Causes of Action in Intellectual Property Cases" Houston LawReview (1995)

Treatise

Modern Licensing Law (with R. Nimmer, a treatise covering all aspects of information and intellectual propertylicensing). For more information concerning this treatise, contact Jeff or visithttp://west.thomson.com/product/40276510/product.asp.

PROFESSIONAL RECOGNITION

2013 Lawyer of the Year in Information Technology Law in Houston, Best Lawyers (2013)

Named "One of the World's Leading Patent Practitioners" in Intellectual Asset Management magazine's IAM Patent1000: The World's Leading Patent Practitioners (2012)

Named a "2012 BTI Client Service All-Star" by BTI Consulting Group

The Best Lawyers in America, Corporate Law and Information Technology Law(1999-2013)

Profiled as one of the leading Technology (2005-2009) and Intellectual Property (2010-2012) lawyers in Texas, Chambers & Partners USA: America's Leading Business Lawyers

Texas Super Lawyer, Texas Monthly (2003-2005, 2011-2012)

BRIEFINGS, SEMINARS & SPEECHES

"Current Issues in IP Licensing," (October 29, 2012)

AK/BDO JOBS Act Seminar - "IPOs after the JOBS ACT: What Companies Need to Know" (August 8, 2012)

University of Texas CLE - 25th Annual Technology Law Conference (May 24, 2012)

New Issues in Today's Licensing Transactions Conference (August 29, 2011)

Licensing Transactions: New Case Law, Trends and Business Models (August 26, 2010)

2010 Trends in Annual Disclosures (January 13, 2010)

Speaker

"Trends in Electronic Contracting 2011," CLE Presentation (October 2011)

"IP Commercialization Strategies," CLE Presentation (September 2011)

"What Recent Licensing Cases Tell Us" and "Anatomy of a Complex License," IP Licensing, Seattle (August 2011)

"Licensing Law Update" and "Anatomy of a Complex License," 9th Annual Rocky Mountain Intellectual Property &Technology Institute, Denver (June 2011)

"Theories and Practices of Technology Licensing," Renmin University Law School—Intellectual Property Institute,Beijing, China (April 2011)

"International IP Protection Under Conditions of Economic Globalization," Beijing Normal University—Law School,Beijing, China (April 2011)

"Copyright Law Update," HIPLA 26th Annual Institute on Intellectual Property Law (October 2010)

"Analysis of Trends in Licensing Law" 8th Annual Rocky Mountain Intellectual Property & Technology Institute(June2010)

"What Recent Licensing Cases Tell Us" and "Anatomy of a Complex License," IP Licensing, Seattle (August 2009)

Jeff C. Dodd


"What Business Lawyers Need to Know about Licensing," Professional Education Broadcast Network Teleseminars(August 2009)


"Trademark Licensing—Developments in the Law" IP Licensing (March 2009)

"Current Themes in Complex Licensing and What Recent Cases Tell Us" and "Anatomy of a Complex License:Updating your Skills for Efficient and Effective Negotiating and Drafting," IP Licensing in 2008, Seattle (August 2008)

"Licensing Intellectual Property," Rice Alliance for Technology and Entrepreneurship (July 2008)


"Electronic Sales Contracts," 2008 ABA Section of Business Law Spring Meeting (April 2008)

"What the Recent Cases Teach Us" and "Anatomy of a Complex License," Modern IP Licensing, Phoenix (March2008)

"Electronic Sales of Goods Contracts," 2007 UCC 2/Sales Update," Professional Education Broadcast Network(December 2007)

"Modern Licensing for Transactional Attorneys," Professional Education Broadcast Network, Webcast (September2007)

"What the Recent Cases Teach Us" and "Anatomy of a Complex License," Current Issues in Complex IP Licensing,Seattle (August 2007)

"Licensing Law Update" and "Licenses in the Courtroom," 5th Annual Rocky Mountain Intellectual Property &Technology Institute, Denver (May 2007)

"Trends in Licensing: Lessons from Recent Cases," Advanced Intellectual Property Law Seminar Program,Association of Corporate Counsel, Houston Chapter (September 2006)

"Licensing Update," 21st Annual Intellectual Assets and Technology Law Institute, Dallas (October 2006)

“Modern Licensing Law: Recent Cases and Trends” and “Anatomy of a Complex License,” Modern Licensing LawConference Austin, Minneapolis, San Francisco, Vancouver (Summer 2006)

“IP Roundtable—Current IP Issues,” Dallas (June 2006)

“Trade Secret Licenses,” 4th Annual Rocky Mountain Intellectual Property & Technology Institute, Denver (June 2006)

“Mergers & Acquisitions Trends and Developments in Public Transactions,” SEC Hot Topics Institute (May 2006)

“Negotiating and Structuring the Sale of Private Businesses: Non-Tax Considerations,” Professional EducationBroadcast Network (December 2005)

“Licensing Law Update- 2004-2005,” 20th Annual Computer and Information Law Institute, Dallas (October 2005)

“Fundamentals Of Licensing And Transferring Technology,” Professional Education Broadcast Network (June 2005)

“Article 2 Revisions Proposed by ALI-NCCUSL What the Revisions Would Mean to Practitioners,” ProfessionalEducation Broadcast Network (February 2005)

“Legal Issues in Effective Crisis Management," College Station (January 2005)

“Licensing Law Update- 2003-2004” 19th Annual Computer and Information Law Institute, Dallas (2004)

“Licensing Law Update- 2002-2003” 18th Annual Computer and Information Law Institute, Dallas (2003)

"Attack Web Sites" Fifth Annual Doing Business Online Conference, Seattle (2003)

"Licensing Law Update 2001-2002" and "New Developments Affecting E-Commerce" 17th Annual ComputerInformation Law Institute, Dallas (2003)

"E-Commerce: Alive and Kicking," Business Section, State Bar of Texas, Houston (2003)

"Attack Web Sites: Offense and Defense," Practicing Law Institute (April 2002)

Jeff C. Dodd


"Strategies and Structures for Commercializing Internally Developed Technologies," Fourth Annual Doing BusinessOnline Conference, Seattle (2002)

"Overview of Intellectual Property for the Business Lawyer," Houston (2002)

"Licensing Law Update 2001-2002," 16th Annual Computer and Information Law Institute, Dallas (2002)

"New Developments Affecting Doing Business Online," 16th Annual Computer and Information Law Institute, Dallas(2002)

"E-Procurement and E-Contracting in Government Contracts: The Impact of Electronic Contracting Legislation,"eGovernment Conference, San Diego (2002)

"The Impact of the PATRIOT Act on Electronic Transactions, Surveillance, and Privacy," Practicing Law Institute, NewYork and San Francisco (2002)

"Default Rules in Information Transactions and Commentary on UCITA," 39th Annual Institute on Intellectual PropertyLaw, Southwestern Legal Foundation, Dallas (November 2001)

"Electronic Contracting and Intellectual Property and Dissecting Electronic Commerce Websites," Third AnnualConference on Doing Business Online, Seattle (October 2001)

"Licensing Law Update and Selected Current Issues in Intellectual Property and Information Transactions," 15thAnnual Computer and Information Law Institute, Dallas (September 2001)

"International Joint Ventures and Transactions," FEI, Austin (2001)

"International Perspectives on Electronic Commerce Legislation," Cyber Law Conference, FundaoLuso-Americana, Lisbon, Portugal (June 2001)

"New Electronic Commerce Legislation: ESIGN, UETA, UCITA and the European E-Signature Directive," variousvenues (2001)

"Understanding Electronic Contracts—Certain Default Rules in Information Transactions," PLI (2001)

"Intellectual Property Law 2001 Course, Copyright Update," State Bar of Texas (2001)

"E-Commerce Models and Legal Developments," various venues (2001 and 2002)

"Building a Cathedral Over the Bazaar: A Preliminary View of Certain Licensing Practices in the Open Source andFree Software Communities," Second Annual National Conference on Doing Business Online (October 2000)

"Licensing Law and UCITA Overview," 14th Annual Computer and Information Law Institute (September 2000)

"Certain Default Rules in UCITA: Common Contractual Principles in Information Transactions," PLI (April and May2000)

"E-Commerce Models," ARMA Spring Conference (April 2000)

"Problems with Electronic Records: Evidence, Abuse and Privacy," ARMA Spring Conference (April 2000)

"A Preliminary Analysis of Certain Default Rules in the Uniform Information Transactions Act," Georgetown (February2000)

"New Hazards for the Business Lawyer: Hidden Intellectual Property Claims," Business Law Survival Course, TexasState Bar Continuing Legal Education Seminar (1999)

"Licensing in the Mass Market, Software and Database Licensing: Current Trends and Proposed New Laws," PLI(April and May 1999)

"Article 2B: Commercial Lawyers Invade the Land of Intellectual Property Redux," 11th Annual Computer LawConference (July 1998; also Federal Bar Association Annual Meeting, October 1998, and American CorporateCounsel Association Annual Meeting, November 1998)

"Article 2B: Commercial Lawyers Invade the Land of Intellectual Property," Intellectual Property Law Institute (1998)

"Responding to Inquiries from Regulatory Authorities," Rice Graduate School of Business, Houston, Texas (1998)

"Licensing Law 1995/1999," 13th, 12th, 11th, 10th, and 9th Annual Computer & Information Law Institutes(1995-1999)

"Contracting in Cyberspace," Cyberspace Law: A US and European Perspective (1997)

Jeff C. Dodd


"Software Development Agreements and Software License Agreements," Counseling High Tech Clients (1996)

"The Securities and Exchange Commission's 1996 Amendments to the Rules Under Section 16 of the SecuritiesExchange Act of 1934," Houston Chapter of the American Society of Corporate Secretaries, Houston, Texas (1996)

"Secured Financing for High Technology Companies," Commercial Lending Institute, Southern Methodist University,Dallas, Texas (1996)

"Power Struggles in Privately Held Companies," The University of Texas School of Law 18th Annual SecuritiesRegulation and Business Law Problems, Austin, Texas (1996)

"Law in the Information Age: Constructing the Information Highway," 1995 Computer & Telecommunications LawUpdate, Washington, DC (1995)

"System Integration Contracts," Eighth Annual Computer & Information Technology Law Institute (1994)

"Rights In Information: Conversion as a New Cause of Action In Intellectual Property Cases," 10th Annual Institute onIntellectual Property Law (1994)

"System Development Contracts," Seventh Annual Computer & Information Technology Law Institute (1993)

"Merger and Acquisition Transactions in the United States," Euromoney Institute, Mexico City (1992)

"New Developments in Corporate Compliance" (1992)

"Software Licensing: Comparison of Model Acts v. Model Agreements," American Bar Association Annual Meeting(1992)

"Acquiring Troubled Companies," Advanced Corporate and Securities Law Institute (1991, 1992, 1993)

"Guaranty and Suretyship," 20th Annual Institute on the Uniform Commercial Code (1986)

Teaching

Visiting Professor of Law, Beijing Normal University Law School (2011-2013)

Intellectual Property and Information Law Program, Licensing Law, Teaching: Adjunct Professor of Law, University ofHouston Law Center (1999, 2000, 2001)

American Constitutional Law Course, University of Houston, Political Science Department (1994, 1995)

Adjunct Professor of Law, South Texas College of Law, Business Planning (1989 and 1990)

AFFILIATIONS

Member

Houston Bar Association

Life Fellow

State Bar of Texas

Electronic Commerce Sub-Committee

Business Law Section

American Bar Association

Section on Business Law

Section on Intellectual Property Law

Forum Committee on Franchising

Licensing Executives Society

American Intellectual Property Law Association

Board Member - Board of Directors of the University of Houston Law Foundation

Advisory Board Member - Honors College of the University of Houston

Jeff C. Dodd


Fellow - Texas Bar Foundation, Houston Bar Foundation

IN THE NEWS

Jeff was quoted in the Financier Worldwide article "Treatment of Intellectual Property in M&A" (February 2010)

PRESS RELEASES

Jeff Dodd Named 2013 Lawyer of the Year (September 20, 2012)

35 Andrews Kurth Lawyers Named in Texas Super Lawyers 2012 (September 10, 2012)

62 Andrews Kurth Lawyers Named Best Lawyers in America 2013 (August 23, 2012)

Andrews Kurth Elects 2012-2013 Policy Committee (August 15, 2012)

Jeff Dodd, Gary Bush and Ping Wang Named Among the World’s Leading Patent Practitioners (June 28, 2012)

Andrews Kurth Receives High Marks from 2012 Chambers & Partners USA Guide (June 15, 2012)

Two Andrews Kurth Partners Named 2012 BTI Client Service All-Stars (February 7, 2012)

54 Andrews Kurth Lawyers Named Best Lawyers in America 2012 (September 22, 2011)

35 Andrews Kurth Lawyers Named in Texas Super Lawyers 2011 (September 12, 2011)

Andrews Kurth Announces 2011-2012 Policy Committee Election (August 2, 2011)

Andrews Kurth Recognized Twice for Deal of the Year in M&A Atlas Awards (March 22, 2011)

Andrews Kurth Represents GM in "Deal of the Year" (March 15, 2011)






Andrews Kurth Receives High Rankings in Chambers USA Guide (June 25, 2007)


Andrews Kurth Adds to its 2005 Chambers USA Ranking (June 16, 2005)

Jeff C. Dodd

Audit Response Letters: Skirmishes At The Boundaries Set By The Treaty Chapter11

i HOU:3246628.3

TABLE OF CONTENTS

I. OVERVIEW ......................................................................................................................................... 1

II. THE PROCESS .................................................................................................................................... 3 A. The Request. ............................................................................................................................. 3 B. Framing The Response (Herein of “Loss Contingencies”). ..................................................... 4

(1) What Does the Response Cover?—General Considerations. ....................................... 4 (2) Engagement and Substantive Attention. ...................................................................... 4 (3) Period Covered by Our Response. ............................................................................... 6 (4) Overtly Threatened Or Pending Litigation. .................................................................. 6 (5) Contractually Assumed Obligations and Unasserted Possible Claims or

Assessments. ................................................................................................................ 9 (6) Disclaimer Against Implied Waiver of Privilege. ...................................................... 15 (7) Limitations on Disclosure and Reliance. .................................................................... 15

C. Updates and Supplemental Responses. .................................................................................. 15 (1) Customary Follow-Up Updates. ................................................................................. 15 (2) Supplemental Responses. ........................................................................................... 16

III. SKIRMISHES AT THE BORDER .................................................................................................... 16

IV. CONCLUSION .................................................................................................................................. 18


1

AUDIT RESPONSE LETTERS: SKIRMISHES AT THE BOUNDARIES SET BY THE TREATY I. OVERVIEW

As a necessary part of the process of auditing a company’s financial statements, auditors search for support for the company’s accounting for its loss contingencies.1 In accounting parlance, “loss contingencies” are conditions, situations, or sets of circumstances “involving uncertainty as to possible loss…that will ultimately be resolved when one or more future events occur or fail to occur.”2 That capacious definition clearly would comprehend some matters that would customarily be entrusted to lawyers. So, auditors began turning to lawyers to provide descriptions of certain loss contingencies during the

1 Certainly the company is responsible for the accounting reflected in its financial statements and related footnotes. See, Second Report of the Committee on Audit Inquiry Responses Regarding Initial Implementation of the Statement of Policy, at page 36 included in Committee on Audit Inquiry Responses, Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information <available at http://apps.americanbar.org/buslaw/attorneyclient/policies/aicpa.pdf (last visited July 2012)> (“The ABA Statement of Policy does not require the lawyer to make determinations of what should be included in financial statements or to undertake interpretation of FAS 5 or other accounting requirements”). It is also the obvious source for information concerning its loss contingencies. However, clients should be aware that furnishing information directly to auditors may undermine later claims of attorney-client and work product privileges. For a general description of some considerations concerning such disclosures, see http://emailcc.com/rv/ff00035c3a5e6362b40540c3a34a8d423907668a <visited August 27, 2012> 2 FASB, Accounting Standards Codification 450-10-20, available at https://asc.fasb.org/glossarysection&trid=2127146&analyticsAssetName=subtopic_page_section&nav_type=subtopic_page <visited August 27, 2012>. I note that the ABA Statement refers to FAS 5. That was the accounting standard when the ABA Statement was first promulgated. Since then, FASB has undertaken a codification of accounting standards and now the relevant standards have been codified in ASC 450-20. Since the substance of the standards concerning loss contingencies did not change, the ABA Committee on Audit Responses issued a statement in Statement on the Effect of the FASB Codification on Audit Response Letters, 65 Bus. Law. 491 (2010) that made clear that references in the ABA Statement to “FAS 5” encompassed the codification ASC 450-20. To make this clear, we say in our responses, “Statement of Financial Accounting Standards No. 5 (now codified as FASB Accounting Standards Codification Subtopic 450-20, Contingencies – Loss Contingencies”).”

course of the audit process. The legal profession resisted, noting that some disclosures to auditors could compromise the attorney-client privilege. 3 After the accounting and legal professions wrangled over whether, and to what extent, lawyers could respond to auditors’ requests, the AICPA and ABA struck a bargain—the so-called “Treaty” —in the mid-1970’s to balance the auditors’ need for support for the 3 ABA Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information, Preamble (“The public interest in protecting the confidentiality of lawyer-client communications is fundamental. ….The benefits of such communication and early consultation underlie the strict statutory and ethical obligations of the lawyer to preserve the confidences and secrets of the client, as well as the long recognized testimonial privilege for lawyer-client communication. Both the Code of Professional Responsibility and the cases applying the evidentiary privilege recognize that the privilege against disclosure can be knowingly and voluntarily waived by the client. It is equally clear that disclosure to a third party may result in loss of the "confidentiality" essential to maintain the privilege. Disclosure to a third party of the lawyer-client communication on a particular subject may also destroy the privilege as to other communications on that subject. Thus, the mere disclosure by the lawyer to the outside auditor, with due client consent, of the substance of communications between the lawyer and client may significantly impair the client's ability in other contexts to maintain the confidentiality of such communications.”). The complete ABA Statement of Policy consists of the original statement (adopted Dec. 8, 1975), related Commentary to the Statement of Policy, First Report of the Committee on Audit Inquiry Responses Regarding Initial Implementation of the Statement of Policy, Second Report of the Committee on Audit Inquiry Responses Regarding Initial Implementation of the Statement of Policy (the “Second Report”), Report of the Subcommittee on Audit Inquiry Responses and Third Report of the Committee on Law and Accounting (the “Third Report”) (all such materials are collectively referred to as the “ABA Statement”), which are compiled in The Auditor’s Letter Handbook published by the ABA. All references to the ABA Statement are to the compilation in The Auditor’s Letter Handbook. A copy of the original ABA Statement is also available at http://apps.americanbar.org/buslaw/attorneyclient/policies/aicpa.pdf (last visited July 2012). The AICPA also adopted a Statement on Auditing Standards No. 12, titled “Inquiry of a Client’s Lawyer Concerning Litigation, Claims and Assessments” (1976, supplemented through Jan. 1998) (SAS 12) (the “AICPA Statement”) , which is available at www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00337.pdf. Together the ABA Statement and the AICPA Statement comprise the Treaty. Though the two statements have a few differences, one of the more distinguished commentators on audit letters and opinions stated that “[t]he slight differences between the two statements have not been significant in practice.” James J. Fuld, Lawyers’ Responses to Auditors—Some Practical Aspects, 44 Bus. Law. 159, n.1 (Nov. 1988).


2

assessments that they make in conducting audits with the need to preserve confidentiality of client communications and the protections of the privilege.4 Under the Treaty, lawyers are allowed to make limited responses to appropriately crafted requests from clients to respond to auditors with respect to certain types of loss contingencies.

The Treaty has been in effect for over thirty years and the process of responding to auditors has become one of the recurring tasks that a lawyer must perform for her clients. In fact, for the first two or three decades after the Treaty, accountants and lawyers settled into a fairly routine pattern, with auditors not seeking evaluations beyond the scope fixed by the Treaty (and not considering gratuitous assertions in audit requests as compelling lawyers to cough up views on the same subject) and lawyers accepting that, if an auditor response were Treaty-compliant, the attorney-client privilege would not be imperiled.

Yet, even if some complacency seeped into the process, audit responses never realistically could be regarded as routine. They are not mere forms for mindless completion. Audit responses directly implicate one of the core duties of a lawyer to its clients. At the same time, over the past few years the legal landscape has begun to change as changes in legislation and regulation, coupled with suits against auditors by disappointed investors, forced auditors to conduct more searching reviews with respect to loss contingencies. Auditors, in turn, have been pressing at the boundaries of the Treaty, making more demands of lawyers as to disclosures of contingencies.5 (A cynic 4 Compare ABA Statement, Commentary on Paragraph 4 (“The Statement of Policy is designed to recognize the obligation of the auditor to complete the procedures considered necessary to satisfy himself as to the fair presentation of the company's financial condition and results, in order to render a report which includes an opinion not qualified because of a limitation on the scope of the audit”) with Commentary on Paragraph 1 (“In responding to any aspect of an auditor's inquiry letter, the lawyer must be guided by his ethical obligations as set forth in the Code of Professional Responsibility. Under Canon 4 of the Code of Professional Responsibility a lawyer is enjoined to preserve the client's confidences (defined as information protected by the attorney-client privilege under applicable law) and the client's secrets (defined as other information gained in the professional relationship that the client has requested be held inviolate or the disclosure of which would be embarrassing or would be likely to be detrimental to the client). The observance of this ethical obligation, in the context of public policy, "... not only facilitates the full development of facts essential to proper representation of the client but also encourages laymen to seek early legal assistance”). 5 In 2007, FASB began to reconsider the disclosure requirements for loss contingencies. According to the FASB staff, the “project was added to the agenda in 2007 when

might say auditors decided that it would be wise to shift some of the liability and responsibility to the profession that plagued them with enhanced regulatory burdens and vexing litigation.)

In this paper, I outline the Treaty provisions that are most relevant to the usual process of preparing a routine response to a client’s request. I will also discuss what I believe to be customary and current Treaty-compliant practices in responding to auditors. Finally, since accountants have devised sundry and ingenious ways to attempt to pry additional assurances and disclosures concerning loss contingencies beyond the strict boundaries set by the Treaty,6 I will briefly describe some of the skirmishes that have erupted at those boundaries.

users of financial statements requested enhanced disclosures to assist in assessing the likelihood, timing, and amount of future cash flows of loss contingencies, specifically those related to litigation.” Board Meeting Handout, Disclosure of Certain Loss Contingencies (July 9, 2012) <available at http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175824156738&blobheader=application%2Fpdf> In 2008 and later in 2010, FASB issued exposure drafts concerning revisions to accounting standards relating to loss contingencies, which, in the ABA’s view, could have had “significant prejudicial impact …on companies and their investors without, in most cases, providing material information to users of the financial statements. We also are concerned about the risks these disclosures would create for fundamental attorney-client privilege and work product protections, both as a result of the disclosures called for by the Revised Exposure Draft and because of the information auditors may seek in connection with auditing those disclosures.” Comments of The American Bar Association on the Financial Accounting Standards Board Proposed Accounting Standards Update Titled "Disclosure of Certain Loss Contingencies- File Reference No. 1840-100, p 1 (September 20, 2010)<available at https://apps.americanbar.org/buslaw/committees/CL965000pub/materials/20100910000000.pdf> As the FASB Staff noted, the Feedback received on both Exposure Drafts was similar; there was overwhelming opposition to the enhanced loss contingency disclosures. The main concerns identified related to the imposition of disclosures that could be prejudicial to the reporting entity. See, Board Meeting Handout, Disclosure of Certain Loss Contingencies (July 9, 2012). In July 2012, “FASB - in a 5-2 vote - decided to remove modifying accounting for loss contingencies disclosure from its agenda after four years of controversy and comment. The majority of FASB members agreed that ASC 450's requirements are sufficient.” See The CorporateCounsel.net Blog (July 10, 2012) <available at http://www.thecorporatecounsel.net/Blog/2012/07/ >. 6 According to my firm’s malpractice carrier, accountants have even “shown greater willingness to sue lawyers over audit letter responses, alleging that the lawyers should be liable for failing to disclose more information.”


3

II. THE PROCESS A. The Request.

The minuet of response to a client’s auditors begins with a request in writing signed by the client for disclosure of certain loss contingencies. 7 In the words of the ABA Statement, a

lawyer may properly respond to the auditor's requests for information concerning loss contingencies…to the extent hereinafter set forth, subject to the following: …Assuming that the client's initial letter requesting the lawyer to provide information to the auditor is signed by an agent of the client having apparent authority to make such a request, the lawyer may provide to the auditor information requested, without further consent, unless such information discloses a confidence or a secret or requires an evaluation of a claim.8 These sentences are packed with import. First, note that the client must send a letter

requesting a response and that request must issue from someone with apparent authority at the client. It cannot come from the auditor alone. Thus, the initial paragraph of my firm’s model form identifies the date and author of the letter on behalf of the client: “By letter dated ********** (the “Request Letter”), **********, ********** of **********, requested that we furnish you certain information…”

Second, the request triggers a process. In my firm, a client’s request to supply information concerning loss contingencies to auditors is to be routed to the partner with the primary relationship with the client. That partner is responsible for overseeing the review required, preparing the response letter and, if necessary, any supplemental responses.9 The partner’s assistant requests a report from our accounting department to determine which lawyers that billed time to the client’s files during the period covered by the request.10 We send a broadcast e-mail 7 Writings and signatures now can come in electronic form, of course. 8 ABA Statement, Paragraph 1(a). 9 Any requests for information concerning loss contingencies other than what we provide in response to the initial client letter and the customary update response would require a separate written request from the client. 10 This process is intended to implement the following procedures from the ABA Statement: “if a law firm or a law department, the auditor may assume that the firm or department has endeavored, to the extent believed necessary by the firm or department, to determine from lawyers currently in the firm or department who have performed

inquiry to all lawyers and a specific email inquiry to lawyers that have billed such time to provide information responsive to the request to the primary relationship partner. The partner reviews the responses, resolves questions or issues, and begins to prepare the response letter.11

We have posted model form response letters and any supplemental letters to our intranet. If no loss contingencies are being disclosed, the audit response and any customary update response can be signed by the primary relationship partner. But if a response letter lists any loss contingencies, we recommend that the primary relationship partner sign the response only after consulting with one or more other partners, especially a litigator, if a listed loss contingency is pending or overtly threatened litigation.12 Third, note what information the ABA Statement permits, and even more importantly does not permit, lawyers to provide in response to the traditional client request for a response to auditors—at least in the first instance and without additional client approval. Lawyers may comply with a client’s request to furnish auditor with “information concerning loss contingencies” without further consent from the client—but with three important exceptions. If the response by the lawyer would disclose a confidence or a secret or would include an evaluation of a claim, the lawyer cannot provide information in response to the request unless the client otherwise consents after consultation with the lawyer. As the ABA Statement states, in “the normal case, the initial request letter does not provide the necessary consent to the disclosure of a confidence or secret or to the evaluation of a claim since that consent may only be given after full disclosure to the client of the legal consequences of such action.”13 “Confidence,” “secret” and “evaluate” all have specific meanings. Thus, where “confidences” means “information protected by the attorney-client privilege under applicable law,” “secrets” are broader: they are

services for the client since the beginning of the fiscal period under audit whether such services involved substantive attention in the form of legal consultation concerning those loss contingencies referred to in Paragraph 5(a) below but, beyond that, no review has been made of any of the client's transactions or other matters for the purpose of identifying loss contingencies to be described in the response.” ABA Statement, Paragraph 2. 11 Copies of the response not only go to the client file but also are sent to our records department. 12 The role of the consulting partner(s) is simply to determine, based on discussions with the primary relationship partner, whether firm procedures have been followed. 13 ABA Statement, Paragraph 1.


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“other information gained in the professional relationship that the client has requested be held inviolate or the disclosure of which would be embarrassing or would be likely to be detrimental to the client.”14 A lawyer’s ethical obligations comprehend

a much broader range of information than that protected by the attorney-client privilege. As stated in Ethical Consideration 4-4: ‘The attorney-client privilege is more limited than the ethical obligation of a lawyer to guard the confidences and secrets of his client. This ethical precept, unlike the evidentiary privilege, exists without regard to the nature or source of information or the fact that others share the knowledge.’15

Certainly every lawyer understands that disclosure of a part of a privileged communication could jeopardize the privilege as to the entire communication and, perhaps, infect the privilege as to communications on the same subject. Disclosures of secrets can do equal harm: to the extent that the lawyer conveys knowledge about the client’s matters gained as a result of the representation, the client could be prejudiced. The ABA Statement views revelation of evaluations of claims as creating equivalent mischiefs: “It might be argued that any evaluation of a claim, to the extent based upon a confidential communication with the client, waives any privilege with respect to that claim.”16 Moreover, “in evaluating claims, …an adverse party may assert that any evaluation of potential liability is an admission.”17

So, if the client’s initial request is to provide information that would reveal a confidence or secret or require a claim evaluation, the lawyer must withhold a response until the lawyer consults with the client as to whether such a disclosure would be in the client’s interest. The lawyer must make “full disclosure to the client of the legal consequences of” communicating the confidence, secret or claim evaluation to the auditor.18 The ABA Statement also suggests that the lawyer “may wish to have a draft of his letter reviewed and approved by the client before releasing it to the auditor; in such cases, additional explanation would in all probability be necessary so that the legal consequences

14 ABA Statement, Commentary on Paragraph 1. 15 ABA Statement, Commentary on Paragraph 1. 16 ABA Statement, Commentary on Paragraph 1. 17 ABA Statement, Paragraph 1(c). 18 ABA Statement, Paragraph 1(b).

of the consent are fully disclosed to the client.”19 After describing the confidence, secret or claim evaluation that would be revealed and the legal consequences of its revelation, the lawyer, if the client so directs, may disclose the requested information as long as the lawyer satisfies himself that person representing the client “understands the legal consequences thereof and has authority to provide the required consent.”20

B. Framing The Response (Herein of “Loss

Contingencies”). (1) What Does the Response Cover?—General

Considerations. The ABA Statement frees us, when

properly requested by the client…to furnish to the auditor information concerning the following matters if [we have] been engaged by the client to represent or advise the client professionally with respect thereto and he has devoted substantive attention to them in the form of legal representation or consultation:

(a) overtly threatened or pending litigation,

whether or not specified by the client; (b) a contractually assumed obligation

which the client has specifically identified and upon which the client has specifically requested, in the inquiry letter or a supplement thereto, comment to the auditor;

(c) an unasserted possible claim or assessment which the client has specifically identified and upon which the client has specifically requested, in the inquiry letter or a supplement thereto, comment to the auditor.21

(2) Engagement and Substantive Attention.

Note that the ABA Statement allows a lawyer to limit her response to matters as to which (a) she has been “engaged by the client to represent or advise the client professionally” and (b) she has “devoted substantive attention …in the form of legal

19 ABA Statement, Paragraph 1(d). However, as I discuss more fully below, the letter issues from the firm and the firm ultimately must control the content. Accordingly, the approval sought is as to factual matters and correction of inaccuracies. 20 ABA Statement, Commentary on Paragraph 1. 21 ABA Statement, Paragraph 5 (emphasis added).


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representation or consultation.”22 Thus, for example, a lawyer’s response should not be read as providing information relating to matters as to which she merely had knowledge—i.e. outside the scope of an actual engagement as to the matter giving rise to loss contingencies. Moreover, as stated in the Commentary to Paragraph 2 of the Statement, “the lawyer will not necessarily have been authorized to investigate, or have investigated, all legal problems of the client, even when on notice of some facts which might conceivably constitute a legal problem upon exploration and development. Thus, consideration in the form of preliminary or passing advice, or regarding an incomplete or hypothetical state of facts, or where the lawyer has not been requested to give studied attention to the matter in question, would not come within the concept of "substantive attention" and would therefore be excluded. Similarly excluded are matters which may have been mentioned by the client but which are not actually being handled by the lawyer.”23

We make the limited scope of our response clear in a variety of ways throughout our response letter:

• Description of the Engagement (“In addition,

our response is limited to matters involving professional engagement of this Firm as counsel, and does not include information received by lawyers in this Firm in any other role.” In some cases we are even more explicit, say, for example, where we were engaged for a limited project).

• Definition of Scope (“Accordingly, subject to the qualifications and limitations set forth

22 ABA Statement, Paragraph 2 (“Unless the lawyer's response indicates otherwise, (a) it is properly limited to matters which have been given substantive attention by the lawyer in the form of legal consultation and, where appropriate, legal representation…”). 23 ABA Statement, Commentary on Paragraph 2. The Commentary goes on to state, “As the lawyer's response is limited to matters involving his professional engagement as counsel, such response should not include information concerning the client which the lawyer receives in another role. In particular, a lawyer who is also a director or officer of the client would not include information which he received as a director or officer unless the information was also received (or, absent the dual role, would in the normal course be received) in his capacity as legal counsel in the context of his professional engagement. Where the auditor's request for information is addressed to a law firm as a firm, the law firm may properly assume that its response is not expected to include any information which may have been communicated to the particular individual by reason of his serving in the capacity of director or officer of the client. The question of the individual's duty, in his role as a director or officer, is not here addressed.”

below, we advise you that as of ********** and as of ********** (the date our internal review procedure for purposes of preparing this letter was commenced) we were not engaged on behalf of the Company in giving substantive legal attention to, or representing the Company in connection with, any Loss Contingency, except as set forth in Exhibit B hereto”).

• Incorporating and Referencing the ABA Statement (“This response is limited by, and is in accordance with, the ABA Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information (December, 1975) and the accompanying Commentary (collectively, the “ABA Statement of Policy”).

In addition, we define the limited scope of our

diligence in preparing the response by including a brief description of the process that we employ in determining the lawyers in our firm that may have been engaged “on behalf of the Company in giving substantive legal attention to, or representing the Company in connection with, any Loss Contingency…”

In connection with the preparation of this response, we have made no examination of the records or files of the Company nor have we reviewed any of the transactions or contractual arrangements of the Company or interviewed any of the officers or employees of the Company or made any other investigation of the Company whatsoever. On the contrary, our procedures in the preparation of this response have been limited to an endeavor to determine from lawyers presently in our Firm who, on behalf of the Firm, have performed services for the Company since ********* whether such services involved substantive attention in the form of legal consultation or legal representation (as distinguished from general legal advice) concerning …[any Loss Contingency]…. However, we disclaim responsibility to comment on any matters to which any lawyers of our Firm may have given substantive attention prior to joining our Firm but to which substantive attention has not been given by that lawyer after joining our Firm. This paragraph in our standard response is rooted

in Paragraph 2 of the ABA Statement and attempts to make very clear exactly what we have done: unless a


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“lawyer's response indicates otherwise…, if a law firm or a law department, the auditor may assume that the firm or department has endeavored, to the extent believed necessary by the firm or department, to determine from lawyers currently in the firm or department who have performed services for the client since the beginning of the fiscal period under audit whether such services involved substantive attention in the form of legal consultation concerning those loss contingencies referred to in Paragraph 5(a) below but, beyond that, no review has been made of any of the client's transactions or other matters for the purpose of identifying loss contingencies to be described in the response.”24

(3) Period Covered by Our Response.

We also limit the temporal scope of our response. Paragraph 2 of the ABA Statement provides that it

…is also appropriate for the lawyer to indicate the date as of which information is furnished and to disclaim any undertaking to advise the auditor of changes which may thereafter be brought to the lawyer's attention. Unless the lawyer's response indicates otherwise, (a) it is properly limited to matters which have been given substantive attention by the lawyer in the form of legal consultation and, where appropriate, legal representation since the beginning of the period or periods being reported upon…25

Thus, our model form states,

By letter dated ********** [the Company]….requested that we furnish you certain information in connection with your examination of the accounts of the Company as of ********** and for the year then ended. Accordingly, subject to the qualifications and limitations set forth below, we advise you that as of ********** and as of ********** (the date our internal review procedure for purposes of preparing this letter was commenced) we were not engaged ….

Our form also disclaims any undertaking “to advise the auditor of changes which may thereafter be brought to the lawyer's attention.”

24 ABA Statement, Paragraph 2 (emphasis added). 25 ABA Statement, Paragraph 2 (emphasis added).

(4) Overtly Threatened Or Pending Litigation. Unlike contractually assumed obligations and

unasserted possible claims or assessments that require specific identification by the client and specific request for comment to trigger a response, if the client requests comment on overtly threatened or pending litigation, it need not specify the litigation on which the lawyer is to comment. Since specific identifications of contractually assumed obligations or unasserted possible claims or assessments are extremely unusual in initial requestsin my experience at leastresponses typically relate to overtly threatened or pending litigation only.

(a) What is Overtly Threatened Or Pending Litigation? Identifying pending litigation is pretty straightforward, but what is “overtly threatened litigation”? According to the ABA Statement, that term “means that a potential claimant has manifested to the client an awareness of and present intention to assert a possible claim or assessment unless the likelihood of litigation (or of settlement when litigation would normally be avoided) is considered remote.”26 So, overtly threatened is much broader than one might think. It applies to possible—not probable—claims or assessments. The only triggers are two: (i) the claimant manifests awareness of a possible claim or assessment and (ii) the claimant manifests a present intention to assert the possible claim or assessment. Only if the lawyer concludes, in the face of such awareness and present intention to assert that the likelihood of litigation is “remote” can the lawyer issue the audit response without a description of the threatened litigation.27

Let us consider how governmental investigations would be treated under the foregoing tests for “overly threatened” litigation. The ABA’s Second Report addresses this situation:

In many cases, the lawyer will have been engaged to represent the client in connection with a governmental investigation involving the client, such as a Federal Grand Jury impaneled to investigate possible antitrust violations or an investigation by the staff of the Securities and Exchange Commission concerning possible violations of the Federal securities laws. Where no charges have been made against the client or with respect to its conduct, such situations do not involve overtly threatened litigation, since there has not been manifested to the client an

26 ABA Statement, Paragraph 5. 27 “Remote” is really remote. See discussion at Section II(B)(4)(b) infra.


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awareness of and present intention to assert a possible claim or assessment as contemplated by Paragraph 5(c) of the ABA Statement of Policy; for that reason, doubt has been expressed whether it is proper for the lawyer to describe the matter to the auditor when the client has not specifically requested comment thereon in the inquiry letter. 28

Interestingly, however, the Second Report goes on

to say, that if “the client wishes the lawyer to report such investigations and similar matters to the auditor in a manner similar to reports by the lawyer of pending litigation which the lawyer is handling, it would not be improper for the lawyer to do so since a third-party inquiry (which may develop into the assertion of a claim or assessment) already will have been commenced.”29 This muddies the water a bit. The Second Report suggests that governmental investigations really present a middle case: they are third party inquiries that may develop into the assertion of a claim or assessments and so the lawyer may comment without further leave (though the lawyer must be consistent in her approach in reporting as to a client).30 Nonetheless, I would recommend treating the client’s request to report such investigations as the equivalent of a request to discuss unasserted claims and counsel the client as to the consequences of disclosure. Moreover, the client would need to consider whether it might be compelled to describe potential other claims (though I would not do so31), for it is not unusual for shareholder and other lawsuits to 28 ABA Statement, Second Report (emphasis added). 29 ABA Statement, Second Report (emphasis added). 30 If one decides in these intermediate cases to make disclosures of governmental investigations, the Second Report recommends consistency in approach:

Whichever approach is adopted for a particular client—regularly reporting such matters or only reporting those as to which the client has determined the matter to involve an unasserted possible claim considered to be probable of assertion and to have a reasonably possible chance of an adverse result—that approach should be consistently followed with respect to such client until the auditor has been advised of a change in approach.

ABA Statement, Second Report. 31 ABA Statement, Second Report (“Consideration of the possible assertion of one or more private claims by reason of the investigation, as suggested by Paragraph 5 of the ABA Statement of Policy, would usually be premature until such time as charges stemming therefrom are actually made against the client.”)

follow in the wake of governmental proceedings. Even if the client persists in its request, I note that, as the Second Report observes, in “most cases…the lawyer will not be able to provide any information to the auditor concerning the investigation other than the existence thereof and the fact of the client's involvement.” 32

Contrast the case of mere investigation with the case where there has been an assessment by an agency. Here is a question based on a situation discussed on the ABA Committee on Audit Responses listserve: Company X has been importing product based on the believe that the product qualifies for duty-free treatment. U.S. Customs has made a determination that product does not qualify for duty-free treatment, and Company is challenging that determination. If U.S. Customs denies the protest, and if Company X decides not to appeal, Company X will owe back-duties and interest, but no penalties or any other surcharges. For purposes of this inquiry, assume that the magnitude of the back-duties and interest would be material.” Various members of the ABA Committee on Audit Responses properly concluded that the US Customs determination was not an unasserted claim at all: the US Customs had manifested an awareness of and present intention to assert a possible claim or assessment and the likelihood of proceedings (if not settled) was certainly not remote. (b) What do we say when we report overtly threatened and pending litigation? As permitted by the ABA Statement, we give the equivalent of “name, rank and serial number”; we provide “an identification of the proceedings or matter, the stage of proceedings, the claim(s) asserted, and the position taken by the client.”33

Now, of course, many accountants want far more information than that. Their inquiries often attempt, in one way or another, to get us to evaluate the likelihood of an unfavorable outcome and estimate the amount or range of potential loss with respect to the overtly

32 ABA Statement, Second Report. 33 ABA Statement, Paragraph 5. See Byron F. Egan, James D. Goldsmith, and Charles R. Lotter, Dealing With Accountants, p. 58 (27th Annual Corporate Counsel Institute 2005) (“The Response Letter approach in the ABA Statement is intended to reduce the likelihood of any waiver of privilege as to unasserted claims. The ABA Statement is structured such that ordinarily a Response Letter states little more about loss contingencies than what is in the public record, which may explain a paucity of reported cases in which a Response Letter has been held to have resulted in a privilege waiver”), available at http://www.thecorporatecounsel.net/member/FAQ/AttorneyClient/03_31_05_Accountants.pdf


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threatened or pending litigation that we identify. But what lawyer can fathom the workings of the mind of judges or juries or arbitrators or prognosticate the course of litigation? As the ABA Statement cautions, in “view of the inherent uncertainties,” lawyers should refrain from hazarding predictions as to outcome “except in those relatively few clear cases where it appears to the lawyer that an unfavorable outcome is either ‘probable’ or ‘remote.’”34 Note: both elements must be present. An “unfavorable outcome for the client is probable if the prospects of the claimant not succeeding are judged to be extremely doubtful and the prospects for success by the client in its defense are judged to be slight.”35 Moreover, “remote” is truly remote: an “unfavorable outcome is remote if the prospects for the client not succeeding in its defense are judged to be extremely doubtful and the prospects of success by the claimant are judged to be slight.”36

I read these standards as setting an exceptionally high bar to venturing predictions as to outcome or loss. In my view, I could only hazard such a guess only when I believe (and in my case only after consulting with litigators!) that the client would win or lose on summary judgment. Otherwise, I do not believe that I could conclude that a favorable or unfavorable outcome was probable or remote. This is so high a standardone that I cannot imagine satisfying save in the most extraordinary casethat I, as a matter of course, decline to offer any prediction as to outcome and believe that auditors should not expect that we would be in a position of making such a predication.

Nor do I believe that it would be misleading to decline to offer a prediction as to outcome even if we had recommended settlement or even if we had performed a confidential assessment for the client that painted an unfavorable picture of the prospects for a case. Also, even where settlement discussions were ongoing I would not offer a prediction as to outcome (or use the settlement range as a basis for estimating losses). For, all of these cases illustrate the wisdom of that philosophical giant Yogi Berra’s observation, “It

34 ABA Statement, Paragraph 5. 35 ABA Statement, Paragraph 5 (emphasis added). 36 ABA Statement, Paragraph 5. But even if a lawyer were to offer an assessment as to outcome, as the ABA Statement says if “in the opinion of the lawyer, considerations within the province of his professional judgment bear on a particular loss contingency to the degree necessary to make an informed judgment, he may in appropriate circumstances communicate to the auditor his view that an unfavorable outcome is "probable" or "remote," applying the above meanings. No inference should be drawn, from the absence of such a judgment, that the client will not prevail.” ABA Statement, Paragraph 5.

ain't over 'til it's over.”37 Certainly, we must be mindful of the obligations under Rule 13b2-2(b) under §303 of Sarbanes-Oxley not to mislead auditors.38 But the demands of client confidentiality are so great and the standards for probability and remoteness are so high that I cannot think of one instance in my career where I would have concluded that disclosure of a prophecy as to outcome was warranted even where we have recommended settlements or performed assessments.39 Matters are, in my experience, never so clear as to justify a conclusion of probability or remoteness required to support conjectures as to outcome.

As a general rule, I would recommend against explaining the reason for declining a forecast as to outcome, though I am aware that some lawyers go further and state that they are unable to form an opinion about the case because the claim is at an early stage (e.g. in discovery.). All the Treaty requires is an analysis of whether an unfavorable outcome is “probable” or “remote.” The issue is not whether a case is an early stage: the issue is whether the lawyer really can express a judgment as to probability or remoteness as to outcome of litigation.40

Further, in my view, if a lawyer cannot speculate authoritatively about outcomes, she certainly cannot begin to estimate a range of loss that may arise from an

37 http://www.yogiberra.com/yogi-isms.html <visited on 9-3-12>. From my reading of the posts to the ABA Committee on Audit Responses listserve, most firms would decline to set forth the range of settlement offers, even where the client has revealed that information to the auditors. 38 See 17 C.F.R. § 240.13b2-2(b)(1)(“No officer or director of an issuer, or any other person acting under the direction thereof, shall directly or indirectly take any action to …. mislead… any independent public or certified public accountant engaged in the performance of an audit or review of the financial statements of that issuer that are required to be filed with the Commission pursuant to this subpart or otherwise if that person knew or should have known that such action, if successful, could result in rendering the issuer's financial statements materially misleading”) (emphasis added).

39 In fact, our policy is to include a specific disclaimer after the listing of a loss contingency to the effect that we are not assessing outcomes; if a response letter is not to include such a disclaimer, a member of the Opinions/Auditor Response Committee must approve the letter. 40 Some fear that relying on the status of the case might imply that an opinion on outcome can be given at a later stage. I think that is not a necessary implication or even a fair or reasonable one. However, the point—and a excellent one—is that lawyers should be very careful in the response—just as they would counsel their clients to be.


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unfavorable outcome of litigation."41 Estimates of loss are, as the ABA Statement states, “inherently impossible to ascertain, with any degree of certainty….”42 Since it is appropriate for us “to provide an estimate of the amount or range or potential loss (if the outcome should be unfavorable) only if …[we believe] that the probability of inaccuracy of the estimate of the amount or range of potential loss is slight,”43 I decline the invitation to do so.

(c) Materiality. The ABA Statement also allows lawyers to indicate that the response is “limited to items which are considered individually or collectively material to the presentation of the client's financial statements.”44 As the Commentary in the ABA Statement makes clear, if a lawyer “takes responsibility for making a determination that a matter is not material for the purposes of his response to the audit inquiry, he should make it clear that his response is so limited. The auditor, in such circumstance, should properly be entitled to rely upon the lawyer's response as providing him with the necessary corroboration.”

In my experience, the client’s initial inquiry will specify materiality levels (often setting forth materiality thresholds for each individual matter and for all matters collectively). Thus, in our response letters we would make clear when we were adopting the materiality standards set by the client: ‘“Loss Contingency’ means (i) any overtly threatened or pending litigation (as defined in the ABA Statement of Policy referred to below) which we have recognized as involving a potential loss to the Company of ********** or more….”

But lawyers are not bound to accept the materiality thresholds specified in the audit inquiry. However, if “the audit inquiry sets forth a definition of materiality but the lawyer utilizes a different test of materiality, he should specifically so state.”45 41 ABA Statement, Paragraph 5. 42 ABA Statement, Paragraph 5. 43 ABA Statement, Paragraph 5. 44 ABA Statement, Paragraph 3. This materiality discussion would be applicable to any loss contingencies covered by the response letter. 45 ABA Statement, Commentary on Paragraph 3. The commentary goes on to say that the “lawyer may wish to reach an understanding with the auditor concerning the test of materiality to be used in his response, but he need not do so if he assumes responsibility for the criteria used in making materiality determinations. Any such understanding with the auditor should be referred to or set forth in the lawyer's response. In this connection, it is assumed that the test of materiality so agreed upon would not be so low in amount as to result in a disservice to the client and an unreasonable burden on counsel.”

(5) Contractually Assumed Obligations and Unasserted Possible Claims or Assessments. (a) Response where no unasserted possible claim or assessment is identified or comment thereon is requested.46 I am not aware of any initial request from a client that specifically identified contractually assumed obligation or unasserted possible claim or assessment as to which the client specifically requested comments to the auditor. Without such specific identification or request, we cannot even initiate the process that would be required (and that I discuss below) to divulge such loss contingencies. That said, auditors compel the client to assert in the initial request that the client has represented to the auditors that there are no unasserted claims requiring financial statement disclosure, even where the client does not identify an unasserted claim.47 So, our model form says,

You are further advised that pursuant to clauses (b) and (c) of paragraph 5 of the ABA Statement of Policy, it would be inappropriate for us to respond to a general inquiry relating to the existence of any Loss Contingencies that constitute contractually assumed obligations or unasserted possible claims or assessments involving the Company. We can only furnish information concerning those types of Loss Contingencies if and to the extent that the Company has specifically requested in the Request Letter that we comment on them.

46 I will generally refer to “unasserted possible claims or assessments” in what follows, but many of the standards described below would apply to contractually assumed obligations. 47 Here are two examples of catchall assertions that find their way into audit requests:

We have represented to our auditors that there have been disclosed by Management to them all unasserted possible claims that you have advised are probable of assertion and must be disclosed in accordance with Statement of Financial Accounting Standards No.5 in the financial statements currently under examination.

Or:

We have represented to our auditors that there are no unasserted possible claims that you have advised are probable of assertion and must be disclosed in accordance with Statement of Financial Accounting Standards No. 5 in the financial statements currently under examination.

ABA Statement, Third Report.


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We also cannot comment upon the adequacy of the Company’s listing of any such Loss Contingencies or its assertions concerning the advice, if any, that we have given the Company about the need to disclose same. 48

Typically, I add, just to be clear, “Since the Company has not specifically identified in the Request Letter any contractually assumed obligations or unasserted possible claims as to which it requests comment, we decline to comment on or discuss such contingencies, if any, or to comment on any statements by the Company relating thereto.”49

48 In the Third Report, a predecessor to the ABA Committee on Audit Responses addressed concerns with catchall assertions by freeing lawyers to add the language upon which our model disclaimer was modeled. ABA Statement, Third Report. See also, ABA Statement, Paragraph 5 (“It would not be appropriate, however, for the lawyer to be requested to furnish information in response to an inquiry letter or supplement thereto if it appears that (a) the client has been required to specify unasserted possible claims without regard to the standard suggested in the preceding paragraph, or (b) the client has been required to specify all or substantially all unasserted possible claims as to which legal advice may have been obtained, since, in either case, such a request would be in substance a general inquiry and would be inconsistent with the intent of this Statement of Policy. As indicated in Paragraph 4 hereof, the auditor may assume that all loss contingencies specified by the client in the manner specified in clauses (b) and (c) above have received comment in the response, unless otherwise therein indicated. The lawyer should not be asked, nor need the lawyer undertake, to furnish information to the auditor concerning loss contingencies except as contemplated by this Paragraph 5.”). 49 As the ABA Committee on Audit Responses has reported, the Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”) on Accounting for Uncertainty in Income Taxes made “Paragraph 38 of FAS 5 inapplicable to income taxes, and proceeds on the assumption that, in assessing whether the client satisfies the “more likely than not” criterion for success, it is to be presumed that the client’s tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information (see Paragraph 7a of FIN 48). Thus, the client’s judgment that a claim is not likely to be asserted by a taxing authority ceases to be applicable in determining what the client may need to disclose in the financial statements with respect to unasserted contingencies relating to income taxes.” ABA Committee on Audit Responses--Statement on Effect of FIN 48 on Audit Response Letters (10-16-08), which is available at http://meetings.abanet.org/webupload/commupload/CL965000/otherlinks_files/fin48statement.pdf. Id. However, the ABA Committee on Audit Responses has counseled that for “purposes of preparing an audit response letter, a lawyer should continue to follow the usual practice under the Treaty

(b) What if an unasserted possible claim or assessment were identified? In the unlikely situation where a client would identify an unasserted possible claim or assessment, and solicited our comment—after I stumbled back up on my feet after falling over from shock—I would discuss with the client the perils of a response on unasserted claims,50 make sure that I had obtained consent after the disclosure and counseling described above,51 and ascertain whether the client had concluded that it was “probable that a possible claim will be asserted, that there is a reasonable possibility that, if asserted, the outcome will be unfavorable, and that a resulting liability would be material to the financial condition of the client.” Note that unless the client has made such determinations, a response would not be warranted. 52

regarding whether or not to comment on the expected outcome of asserted and unasserted claims disclosed in the audit response letter under the “probable” or “remote” standard, leaving it to the client to determine for financial reporting purposes whether the “more likely than not” determination can be made. Accordingly, because it would be a departure from the ABA Statement, a lawyer, if requested to do so, may appropriately decline to comment in the audit response letter on the determinations required to be made under FIN 48.” Id. 50 Cf. ABA Statement, Commentary on Paragraph 1 (“The lawyer's ethical obligation therefore includes a much broader range of information than that protected by the attorney-client privilege. …In recognition of this ethical obligation, the lawyer should be careful to disclose fully to his client any confidence, secret or evaluation that is to be revealed to another, including the client's auditor, and to satisfy himself that the officer or agent of a corporate client consenting to the disclosure understands the legal consequences thereof and has authority to provide the required consent.”) If I did receive a request explicitly demanding that we furnish information concerning contractually assumed obligations or unasserted possible claims or assessments, and after counseling the client and obtaining its consent to disclosure, I would need to be clear to frame the contours of the response, for “the auditor may assume that all [such] loss contingencies specified by the client …have received comment in the response, unless otherwise therein indicated.” ABA Statement, Paragraph 5. 51 See Section II(A). 52 ABA Statement, Paragraph 5 states

With respect to clause (c), where there has been no manifestation by a potential claimant of an awareness of and present intention to assert a possible claim or assessment, consistent with the considerations and concerns outlined in the Preamble and Paragraph 1 hereof, the client should request the lawyer to furnish information to the auditor only if the client has determined that it is probable that a


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In this regard, consider the following situation based on an inquiry posted to the ABA Committee on Audit Responses listserve. “Suppose the firm is defending several suits that have received public attention. There are others that might file similar claims based on the same events, but have not done so. Should the firm disclose the possibility/probability of additional suits?” The consensus of those who responded on the listserve was that the possible, or even probable, additional claims were still unasserted claims within the meaning of the Treaty. That said, a response letter could mention the possibility of additional claimants if the client consented to the disclosure, assuming that it had received the counseling described in Section II(A) above, if the client determined that it was probable that a possible claim will be asserted, that there was a reasonable possibility that the outcome (assuming such assertion) will be unfavorable, and that the resulting liability would be material to the financial condition of the client.

(c) Assumption Concerning Consultation As To Matters Recognized to Involve Unasserted Possible Claims or Assessments That May Call For Financial Statement Disclosure. Even though a lawyer can decline to respond to general statements as to unasserted claims or even to specific statements that do not meet the standards described above, the Treaty incorporates a compromise assumption concerning unasserted possible claims or assessments:

The auditor may properly assume that whenever, in the course of performing legal

possible claim will be asserted, that there is a reasonable possibility that the outcome (assuming such assertion) will be unfavorable, and that the resulting liability would be material to the financial condition of the client…. In assessing whether or not the assertion of a possible claim is probable, it is expected that the client would normally employ, by reason of the inherent uncertainties involved and insufficiency of available data, concepts parallel to those used by the lawyer (discussed below) in assessing whether or not an unfavorable outcome is probable; thus, assertion of a possible claim would be considered probable only when the prospects of its being asserted seem reasonably certain (i.e., supported by extrinsic evidence strong enough to establish a presumption that it will happen) and the prospects of non-assertion seems slight.

ABA Statement, Paragraph 5 (emphasis added).

services for the client with respect to a matter recognized to involve an unasserted possible claim or assessment which may call for financial statement disclosure, the lawyer has formed a professional conclusion that the client must disclose or consider disclosure concerning such possible claim or assessment, the lawyer, as a matter of professional responsibility to the client, will so advise the client and will consult with the client concerning the question of such disclosure and the applicable requirements of FAS 5.53

As the ABA Second Report notes, “lawyers are usually requested in audit inquiry letters to confirm as correct a statement of the client's understanding” that such assumption is correct.54 Thus, our model form paraphrases the foregoing, but we add a sentence at the end to clarify the scope of consultation:

Consistent with the last sentence of paragraph 6 of the ABA Statement of Policy, you are advised that whenever, in the course of performing legal services for the Company with respect to a specific matter which we have recognized as involving an unasserted possible claim or assessment that may call for financial statement disclosure, we have formed a professional conclusion that the Company must disclose or consider disclosure concerning such possible claim or assessment we, as a matter of professional responsibility to the Company, will so advise the Company and, if requested to do so, will consult with the Company concerning the question of such disclosure and the applicable requirements of Statement of Financial Accounting Standards No. 5 (now codified as FASB Accounting Standards Codification Subtopic 450-20, Contingencies – Loss Contingencies”). Furthermore, while we will upon request so consult with the Company, we will not ordinarily make an independent investigation of facts furnished to us by the Company.

(i) What does this undertaking really entail? I think that the undertaking implied by this confirmation imposes important, but narrow, obligations on the lawyer:

53 ABA Statement, Paragraph 6. 54 ABA Statement, Second Report.


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• First, the lawyer must recognize that a matter involves an unasserted possible claim or assessment. The undertaking does “not require the lawyer to go out of his way to search out or develop facts or other information regarding unasserted possible claims which do not otherwise become apparent to him from the legal work for the client for which he was retained and in which he is engaged.55 The test is a subjective one: “Does the lawyer recognize the existence of an unasserted possible claim in connection with a matter upon which he is working and that such claim may call for financial statement disclosure?”56

• Second, the lawyer must recognize that the claim or assessment may “call for financial statement disclosure." This extends only to “matters recognized by the lawyer as having sufficient substance and merit so as to warrant some measure of focused attention, first by the lawyer and, if the lawyer concludes the matter must be brought to the attention of the client, then by the client.”57

• Third, the lawyer would have to come to a professional conclusion that the client must consider disclosing an unasserted possible claim or assessment. The lawyer does not need to carry out an investigation once it comes to the recognitions described above; the lawyer’s notification to a client would only be based on …facts and information beyond such as are already available to him from the assigned legal work in which he is engaged.”58 Based only on those facts and that information, the lawyer must only “ask himself whether he can form a conclusion, as a lawyer, that there is sufficient likelihood that (i) the unasserted

55 ABA Statement, Second Report. 56 ABA Statement, Second Report (“The Undertaking was not intended to place new responsibilities on the lawyer to ferret out unasserted possible claims or to make lawyers accountable on "should have known" theories. ….The lawyer does not commit to the client that he will devote substantive attention to a search for such claims, or that he will recognize those claims which may call for financial statement disclosure, but only that he will not dismiss without consideration an unasserted possible claim if, in fact, he realizes that one is present in connection with the matter or matters with respect to which he is providing legal services to the client and recognizes that it may call for financial statement disclosure”). 57 ABA Statement, Second Report. 58 ABA Statement, Second Report.

possible claim is probable of assertion, (ii) if asserted, there is a reasonable possibility that the outcome will be unfavorable, and (iii) the unasserted possible claim is material to the client, so that the client must consider whether disclosure of the unasserted possible claim is required.”59 Note, however, the lawyer is not required to come to professional conclusion as to likelihood: the client ultimately “must determine whether or not the assertion of a claim not yet asserted is “probable”; as pointed out in Paragraph 5 of the Commentary to the ABA Statement of Policy, that judgment will infrequently be one within the professional competence of lawyers.60

• Fourth, the lawyer’s role is confined to advising and consulting with the client’s responsible officers. If all three of the conditions described above are present, the lawyer’s duty is “to bring the existence of the matter to the attention of a responsible officer or employee of the client (in many cases, inside counsel may provide a suitable channel of communication) so that the client may deal with the matter in such appropriate manner as the client may determine.”61 While the lawyer must offer to consult with or assist the client’s consideration of “the probability of assertion, the risk of unfavorable outcome, and the materiality to the client of the possible claim” that offer is limited to the confines of “his knowledge and training.”62 Thus, the range of consultation will normally be limited to describing the claim and the analysis the lawyer undertook in coming to the conclusion that she needed to advise the client of the matter. Indeed,

[t]he lawyer has discharged his responsibilities to the client if he has notified an appropriately responsible officer or employee of the client concerning the existence of the unasserted possible claim

59 ABA Statement, Second Report. 60 ABA Statement, Second Report, note 5. 61 ABA Statement, Second Report (“The lawyer should satisfy himself that the officer or employee so notified is generally aware of the disclosure requirements of FAS 5 in respect of unasserted possible claims and understands the lawyer's view that the reported claim must be considered by the client in relation to such obligations”). 62 ABA Statement, Second Report.


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which the lawyer has concluded must be considered by the client for disclosure, has satisfied himself that the person so notified understands the need to consider disclosure of such matter in relation to the requirements of FAS 5, and has provided such person with such information or views as the lawyer has on the basis of his professional competence and experience and of his presently available knowledge of the matter. If the client does not request the lawyer to proceed further, the lawyer need not do so, and he has no responsibility with respect to the client's consideration of and conclusions in respect of disclosure of the unasserted possible claim unless the lawyer has advised the client that the lawyer has concluded, as a matter of law, that the unasserted possible claim is probable of assertion and must be disclosed. If the client does not request the lawyer to proceed further, the lawyer need do so—and should do so—only to the extent that he has the professional competence and experience to assist in the client's further consideration of the matter.63

In no event, however, is the lawyer responsible for determining what financial disclosures should be made. That is the task of the client, in consultation with its auditors.64 But while it is the client’s obligation to make whatever disclosures as to material loss contingencies that may be required, and the lawyer’s role is to consult and to advise as described above, in some extreme circumstances the lawyer may be required to withdraw if the client elects not to

63 ABA Statement, Second Report. 64 ABA Statement, Second Report (“When the ABA Statement of Policy refers to disclosure, in the context of financial statement presentation, the disclosure which is intended is whether or not the unasserted possible claim must or should be brought to the attention of the auditor by the client. It is not intended that the lawyer make a determination as to the need for the disclosure to be made in the client's financial statements as such, since such a determination is one to be made by the client (subject to review by the auditor)”).

make a disclosure. According to the ABA Statement, where

in the lawyer's view it is clear that (i) the matter is of material importance and seriousness, and (ii) there can be no reasonable doubt that its non-disclosure in the client's financial statements would be a violation of law giving rise to material claims, rejection by the client of his advice to call the matter to the attention of the auditor would almost certainly require the lawyer's withdrawal from employment in accordance with the Code of Professional Responsibility.65

(ii) Disclaimers and Qualifications Affecting the Assumption. The auditor’s ability to assume that the lawyer will consult with the client as to disclosure does not turn on the type of law that the lawyer practices. A delicate and difficult balance is struck here. The Second Report states, “Whether or not the lawyer confirms to the auditor the client’s understanding, a response to a letter of audit inquiry stated to be in accordance with the ABA Statement of Policy permits the auditor to make the assumption set forth in the last sentence of Paragraph 6 thereof…”66 Hence the Commentary to Paragraph 6 states: 65 ABA Statement, Commentary on Paragraph 6. The Commentary goes on to say:

Accordingly, in the context of financial accounting and reporting for loss contingencies arising from unasserted claims, the standards for which are contained in FAS 5, clients should be urged to disclose to the auditor information concerning an unasserted possible claim or assessment (not otherwise specifically identified by the client) where in the course of the services performed for the client it has become clear to the lawyer that (i) the client has no reasonable basis to conclude that assertion of the claim is not probable (employing the concepts hereby enunciated) and (ii) given the probability of assertion, disclosure of the loss contingency in the client's financial statements is beyond reasonable dispute required.

There may be other obligations as well. Cf. Sarbanes-Oxley Act of 2002 § 307(1), 15 U.S.C. § 7245; 17 CFR § 205.1, et seq. 66 ABA Statement, Second Report, note 2.


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The client must satisfy whatever duties it has relative to timely disclosure, including appropriate disclosure concerning material loss contingencies, and, to the extent such matters are given substantive attention in the form of legal consultation, the lawyer, when his engagement is to advise his client concerning a disclosure obligation, has a responsibility to advise his client concerning its obligations in this regard. Although lawyers who normally confine themselves to a legal specialty such as tax, antitrust, patent or admiralty law, unlike lawyers consulted about SEC or general corporate matters, would not be expected to advise generally concerning the client's disclosure obligations in respect of a matter on which the lawyer is working, the legal specialist should counsel his client with respect to the client's obligations under FAS 5 to the extent contemplated herein. Without regard to legal specialty, the lawyer should be mindful of his professional responsibility to the client described in Paragraph 6 of the Statement of Policy concerning disclosure.67 However, the ABA Statement does not forbid

lawyers from qualifying the confirmation as to advising and consulting with the client as to financial statement disclosures. The issue is what the lawyer’s role is. As the ABA Statement notes, independent “of the scope of his response to the auditor's request for information, the lawyer, depending upon the nature of the matters as to which he is engaged, may have as part of his professional responsibility to his client an obligation to advise the client concerning the need for or advisability of public disclosure of a wide range of events and circumstances.”68 Indeed, the Second Report goes further: “Accordingly, no lawyer is obliged to enter into an understanding with his client conforming to the ABA Statement of Policy, nor is he obliged to confirm to auditors that such an understanding exists; indeed, if no such undertaking by the lawyer is seriously intended, it would be entirely wrong for the lawyer to do either.”69 So, a lawyer could expressly disclaim any undertaking to consult with a client as to financial disclosures (but since auditors are allowed to assume such an undertaking, the disclaimer should be expressly stated in the audit response). Here are some examples of disclaimers from

67 ABA Statement, Commentary on Paragraph 6. 68 ABA Statement, Paragraph 6. 69 ABA Statement, Second Report.

a paper circulated prior to a meeting of the ABA Committee on Audit Responses:

• We are not in a position to confirm that

our engagement by the Company involves advice and consultation respecting financial disclosure of unasserted possible claims or assessments.

• Please be further advised that [Firm Name] does not represent the Company generally with respect to its legal matters. In light of the limited extent of our representation of the Company, we are not in a position to determine whether the Company must disclose or consider disclosure in its financial statements of unasserted possible claims or assessments that may call for such disclosure, and consequently we do not undertake to advise the Company with regard to financial statement disclosure matters involving unasserted claims or assessments.

• Since we only represent XXX or the YYY Entities on specific matters referred to us from time to time, we would not be in a position to form a professional conclusion that any unasserted claim or assessment may call for financial statement disclosure, and we cannot undertake to so advise XXX or the YYY Entities or to consult with XXX or the YYY Entities concerning the question of such disclosure and the applicable requirements of Financial Accounting Standards No. 5 (now codified as FASB Accounting Standards Codification Subtopic 450-20, Contingencies – Loss Contingencies”).

Yet, the Second Report also warns that such a

disclaimer may have adverse effects on the client and that the auditors will search for some confirmation, perhaps from other lawyers, in order to satisfy itself as to the client’s accounting for loss contingencies. So what is a lawyer who has a limited scope of representation to do if he does not elect to disavow the assumption that the lawyer will consult with the client concerning financial statement disclosure within the scope of his engagement and expertise as anticipated by the ABA Statement? Some law firms will include the standard confirmation but then add some qualifying statement concerning the scope of representation. Here are some examples of qualifications from the same paper described above:


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• It should be pointed out, however, that in light of the limitation on our representation of the Company and our lack of familiarity with its affairs, as set forth in the second paragraph of this letter, it is unlikely that we would form a professional conclusion with respect to the Company's obligation to disclose or consider disclosure concerning an unasserted possible claim or assessment, and we would probably not, therefore, advise the Company or consult with it concerning such disclosure.

• You are reminded, however, that this firm is not engaged to represent the Company generally regarding disclosure obligations. Accordingly, it is unlikely, in the absence of a specific request by the Company, that we would form a professional conclusion regarding financial statement disclosure of an unasserted possible claim or assessment.

(6) Disclaimer Against Implied Waiver of Privilege.

The ABA Statement provides that in “the normal case, the initial request letter does not provide the necessary consent to the disclosure of a confidence or secret or to the evaluation of a claim since that consent may only be given after full disclosure to the client of the legal consequences of such action.”70 We make this clear by stating,

It is our understanding that the Company, by making the request set forth in the Request Letter, does not intend to waive the attorney-client privilege with respect to any information which the Company has furnished to us. Moreover, please be advised that this response should not be construed in any way to constitute a waiver of the attorney-work product privilege with respect to any of our files involving the Company.71

70 ABA Statement, Section 1(b). The Statement goes on to provide that, “Lawyers should bear in mind, in evaluating claims, that an adverse party may assert that any evaluation of potential liability is an admission. ….In securing the client's consent to the disclosure of confidences or secrets, or the evaluation of claims, the lawyer may wish to have a draft of his letter reviewed and approved by the client before releasing it to the auditor; in such cases, additional explanation would in all probability be necessary so that the legal consequences of the consent are fully disclosed to the client.” ABA Statement, Paragraph 1(c) and (d). 71 This is based on language contained in the Report of the Subcommittee on Audit Inquiry Responses December 1989. The Subcommittee preparing the Report stated that “We believe that language similar to the foregoing in the letters of the client or the lawyer simply makes explicit what has

(7) Limitations on Disclosure and Reliance. Following the suggestion in Paragraph 7 of the

ABA Statement, we include the following limitations:

This letter is solely for your information and assistance in connection with your audit of the financial condition of the Company and is not to be quoted or otherwise referred to in any financial statement of the Company or related documents nor is it to be filed with or furnished to any governmental agency or any other person without the prior written consent of this Firm. This does not bind the client, of course, so do not

be surprised if the audit responses are provided by the client during the course of due diligence to investors, underwriters, and acquisition counterparties. What can you do?

C. Updates and Supplemental Responses. (1) Customary Follow-Up Updates.

We are often asked to update an earlier response, especially just before the auditor is prepared to issue its opinion. Unfortunately, the auditor often waits to the last minute and asks for a rushed confirmation. Demands for informal oral updates are not uncommon. I resist such requests. I provide updates in writing, as seems to be the practice common to the most active commentators on the listserve of the ABA Committee on Audit Responses.72 Also, I repeat the process used to collect information during the initial preparation of the response, though the canvass would include lawyers who have worked on the client's matters since the initial response (for the auditors insist on updates to the date of the updated response).

However, the update response is far more terse. We typically state that there has been no change since the earlier letter except as described in the update and always been implicit, namely, it expressly states clearly that neither the client nor the lawyer intended a waiver. It follows that noninclusion of either or both of the foregoing statements by the client or the lawyer in their respective letters at any time in the past or the future would not constitute an expression of intent to waive the privileges. On the other hand, the inclusion of such language does not necessarily assure the client that, depending on the facts and circumstances, a waiver may not be found by a court of law to have occurred.” 72 In addition, some lawyers will only provide an update after receiving a written request from the client to do so; some may send an email to the client alerting the client that an update has been requested and confirming that the original request authorized updates; some lawyers view the original request as authorizing an update to the requested response since the usual practice is for auditors to request them.


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we explicitly state that the qualifications and limitations from the earlier letter roll forward into the update. Here is an example:

By letter dated **********, **********, ********** of ********** requested that we furnish you certain information in connection with your examination of the accounts of the Company and certain of its subsidiaries and other related entities identified in Exhibit A to such letter as of ********** and for the year then ended. We responded by letter dated ********** (the “Initial Response Letter”). We refer to the Initial Response Letter reference for all purposes and all capitalized terms used but not defined herein shall have the meanings set forth in the Initial Response Letter. We have this date been requested to advise you of any change in the matters described in our Initial Response Letter. Subject to the other limitations, restrictions and qualifications described or incorporated herein, you are advised that we are not aware of any change in the information furnished to you in our Response Letter, and such information continues to be correct as of ********** (the date our internal review procedures for purposes of preparing this supplemental response were completed) [except that we supplement our response as follows:] This letter responding to such request is subject to all of the limitations, restrictions and qualifications contained in our Response Letter and, like our Response Letter, is limited by, and in accordance with, the ABA Statement of Policy. We disclaim any undertaking to advise you of changes which hereafter may be brought to our attention.

(2) Supplemental Responses. Sometimes an auditor on its own initiative will

call to interview the relationship partner to fish for additional information beyond the boundaries of the response. Sometimes a client will ask the lawyer to explain a matter. The lawyer should not generally stray beyond its written response or blunt the response’s efficacy by improvident statements that would qualify or undermine the limitations in the response. For example, our practice is not to pass on probabilities of outcome or ranges of potential loss when quizzed over the phone by the auditors any more than we would do so in our written response. Privilege considerations counsel restraint here.

But the privilege is the client’s to waive, of course, so if a client requests specific responses beyond the scope of the response, I would recommend consulting the client as to the scope of any such response (attempting to narrow and focus it) and advise the client of the risk of waiving attorney-client privilege and work product protection by making such disclosure. That is, I would undertake the consulting process described in Section II(A).

III. SKIRMISHES AT THE BORDER

Very often auditors attempt to push on the boundaries of the Treaty by soliciting, or enlisting the clients to solicit, information that would be out of bounds. Also, there are recurring issues in the proper application of the Treaty standards. In this part, I will canvass some of the issues in providing audit responses that have arisen in my experience and that have been bruited about in communications among members of the ABA Committee on Audit Responses on its listserve.

• Requests related to a former client.

Sometimes a lawyer will receive a request from a former client asking for a response to its auditors. Putting aside the questions of compensation and the scope of re-engagement, I note that most lawyers addressing this issue on the ABA Committee on Audit Responses listserve reported that they would typically respond by referring the auditor to successor counsel, though they would consider a response in limited circumstances. Our response concerning former clients would typically read something like:

By letter dated ********** (the “Request Letter”), **********, ********** of **********, requested that we furnish you certain information in connection with your examination of the accounts of the Company as of ********** and for the year then ended. We wish to inform you, however, that at no time during 20____ or subsequent thereto were we engaged to represent the Company in connection with any matter. [We understand that ************* has been engaged as ************’s general outside counsel.]

• Responses with which the client might disagree. Suppose, for example, the response expresses a

view that conflicts with the views that the client shared with the auditor. If a client objects to statements that the lawyer believes to be material and required, the lawyer’s only option may be to refuse to send the letter or resign from the representation. The duty of


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confidentiality generally would weigh against disclosure of concerns to the auditor, though in some states lawyers may be required to report certain frauds or misstatements. There may also be separate reporting obligations.73 Tread carefully.

• A bald request, whether in an initial request

letter or otherwise, to confirm there are no unasserted claims. Such a request would be clearly out of bounds and

no lawyer should respond to such general requests. Indeed, our model form contains a disclaimer against any implication that by not responding we are implicitly confirming that are no unasserted claims.

• A request to confirm that any illegal activity of

which counsel is aware has been reported to the audit committee and the auditors. This is clearly out of bounds. I think that the

blanket disclaimers in response letters against non-Treaty requests should be sufficient to dispel any implication that one is responding to such a request, but some lawyers responding on the ABA Committee on Audit Responses Listserve indicated that they would expressly call attention to the request and decline to respond to it.

• Requests for organization and capitalization

and other opinions. In my view, these requests are clearly out of

bounds. Some may argue that, if the client was not properly organized or if its stock had been improperly issued, there could be unasserted possible claims or assessments. Even if that were the case, the standard response’s demur as to commenting on unidentified unasserted possible claims or assessments should suffice. Moreover, I would argue that the ABA Statement governs only responses regarding certain loss contingencies as to which the lawyer has been engaged. Here the auditor, at best, is seeking for an open-ended hunt to determine whether there is an unasserted claim at all. The auditor is effectively demanding that the lawyer to undertake a new engagement, not to prepare a response as to matters covered by the initial request by the client as to which the lawyer had, prior to the response, been engaged and given substantive attention.

Now, capitalization opinions can, of course, be given; and they are in various contexts, complete with all of the accruements, qualifications and assumptions typically ladled on such opinions. But mixing third party opinion processes with auditor response practices is, in my view, dangerous business. I recommend not including such opinions in the audit response letter.

73 See, e.g., 15 U.S.C. §7245, 17 C.F.R. §205.1, et. seq.

Any such opinion should be the subject of a new engagement and a separate opinion letter. This will entail expense and effort that should be the subject of a separate discussion with the client, who will, if anything like my clients, be loathe to expend money on such endeavors.

• A request for assurance that all securities

offerings by a private company over the past few years have been made in compliance with available exemptions under the Securities Act. Again, in my view this is not within the bounds of

the Treaty and, even if we would give such an opinion in the appropriate circumstances, I would treat it no differently from a request for a capitalization opinion. Such an opinion is not the grist for an audit response.

• A request that a "draft version" of the

response be submitted by X date and that the "final" response be submitted by Y date. Certainly if this were to be read as a request to

submit a draft to the client, I would do so, though I would submit it not for approval or consent, but for review and comment so that I can correct factual errors. Ultimately, the audit response expresses a view that must be the fruit of professional judgment.74

I would not provide a draft to the auditors, but rather only the final letter. Lawyers do not have a duty to consult with or engage in negotiations with auditors and I would not want the cloud of any implication that I was seeking comment from the auditors in crafting the response.

• A request to confirm that the firm is in

"overall charge and supervision" of any pending or threatened litigation being handled. The consensus of those responding on the ABA

Committee on Audit Responses listserve was that such a request was out-of-bounds and should be ignored without comment. Also, if the firm were not lead counsel on the matter, most would mention that there was other litigation as to which the firm was not acting as lead counsel and that the auditors should direct inquires as to such other litigation to other counsel.

74 Obviously if confidences, secrets, or claim evaluations were to be revealed, consent would be required as described in Section II(A); if contractually assumed obligations or unasserted possible claims or assessments were to be addressed, the consents and determinations described in Section II(B)(5)(b) would need to be obtained and made. Indeed, many lawyers provide their clients with a draft of any response letter that includes a description of a loss contingency, even where no consent as to such matters is required.


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• A request with respect to periods several years before the date of the response. This is not out of bounds, but it might be difficult,

given that lawyers who were handling matters long past could have retired or left. Certainly, the response would need to define the processes followed with greater detail and care, depending on the distance in time. And, of course, I certainly would inquire about prior responses and about why they were not sufficient. I would also work with the client to determine whether alternative sources of information than our firm would be more promising and counsel the client as to the effort (and attendant cost and expense) that would be required.

IV. CONCLUSION

While the now commonplace response to auditors may seem to be routine, I hope that this paper has demonstrated that they are anything but routine. We have seen and will continue to see auditors demanding additional information concerning our clients’ affairs, since regulatory and other trends over the past 10 years have greatly expanded range and depth of disclosures extracted from our clients. However, we, as a profession, must resist attempts to erode the most important expectations inhering in an attorney-client relationship—that which the lawyer discusses with the client or learns about the client’s matters during the course of her representation will not be subjected to discovery or compelled disclosure, absent the most exigent demands of countervailing public policy. We should stand our ground at the border set by the Treaty.