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A Shield For Accounting Firm Docs Under PCAOB Inspection
Law360, New York (October 29, 2012, 2:42 PM ET) -- It has been seven years since the Public Company
Accounting Oversight Board began to inspect accounting firms. From the start, private plaintiffs — those
suing accounting firms or public companies — saw these inspections as a potential source of
ammunition for their own lawsuits. So these plaintiffs have repeatedly tried to compel accounting firms
to produce documents that the firms created for PCAOB inspections.
Accounting firms have resisted, mostly by citing a statutory privilege that protects certain inspectionrelated documents. In response, private plaintiffs have argued that this privilege is too narrow to protect
many of the documents that accounting firms create while working on PCAOB inspections.
Only two available opinions have addressed this dispute, and they have split on the answer. A 2010
decision, Silverman v. Motorola Inc.[1], reads the privilege quite narrowly, while a 2012 case, Bennett v.
Sprint Nextel[2], reads it much more broadly. The source of the privilege is the Sarbanes Oxley Act — the
familiar “SOX” — which created the PCAOB and the inspection process.
Bennett reflects the better understanding of SOX’s privilege provision. Bennett does not, however, set
out the statutory analysis that clinches its reading of the provision. That analysis confirms that the
privilege is broad: It protects all documents that accounting firms create for PCAOB inspections. This
article explains why.
The Problem: Can Plaintiffs Force Accounting Firms to Produce Materials That the Firms
Prepared Solely for PCAOB Inspections?
A PCAOB inspection is a complex, multistage, process. It includes extensive give-and-take between the
PCAOB staff and the target firm. An inspection inevitably requires the target accounting firm to create
an extensive volume of new documents.
For example, a critical part of the inspection is the PCAOB staff’s examination of workpapers from
various audits. After the staff examines the workpapers, it sends detailed comments to the target firm.
Some of these comments identify possible audit deficiencies.
The firm drafts responses to the comments, a process that typically requires input from an array of firm
personnel: audit staff, technical experts and sometimes senior members of the firm. This team
generates written materials that include emails, technical analyses and other documents discussing the
details of the audits.
This activity leads, in turn, to a series of additional exchanges between the firm and PCAOB staff. At
some point, the staff provides a draft report. The firm reacts to this draft by conducting another internal
review process, then responding with additional information, analysis and comments. Ultimately, the
PCAOB issues a report, of which part is public and part is confidential.
The result, in short, is a lot of new material created by the accounting firm, much of it providing candid
discussion of the firm’s compliance with professional standards. To private plaintiffs, of course, this new
material looks like a potential gold mine for their own lawsuits. Thus the efforts of private plaintiffs to
compel accounting firms to produce these documents.
But Congress anticipated these efforts. It saw that making these internal documents available to third
parties would damage the inspection process, so it shielded the process from public view by creating a
statutory “privilege.” Congress set out this privilege in section 105(b)(5)(A) of SOX, where the key
language states that “all documents and information prepared or received by or specifically for the
Board ... in connection with an inspection ... shall be confidential and privileged as an evidentiary
matter.”[3] The provision goes on to say that these documents “shall not be subject to civil discovery” or
“other legal process.”[4] It even exempts them from disclosure under Freedom of Information Act.[5]
Some core applications of this privilege seem to be fairly well settled: It shields all documents in the
hands of the PCAOB, and it shields documents in the hands of an accounting firm if the firm has actually
submitted copies of those documents to the PCAOB.
What is not settled, however, is whether the privilege applies to materials that an accounting firm
created for its work on an inspection but did not send to the PCAOB. This is the question on which the
two federal district courts have split.
2010: Silverman v. Motorola Inc.
In 2010, the United States District Court for the Northern District of Illinois addressed this question in
Silverman v. Motorola Inc. The court and the parties focused on the words “prepared ... for the Board ...
in connection with an inspection.” The court held, in effect, that these words limit the privilege to
documents specifically requested by and submitted to the PCAOB.[6]
The court stated that the privilege does not apply to documents merely because an accounting firm —
here, KPMG — “created” them “in response to a PCAOB inspection,” or because the documents “reflect
the substance of” the inspection process.[7] It is not enough, the court said, that the firm’s documents
“relate to” or “concern” the inspection process.[8] Therefore, the court concluded, the privilege did not
apply to “internal KPMG communications that discuss ... communications with the” PCAOB staff.[9]
2012: Bennett v. Sprint Nextel
A more recent opinion, from the District of Missouri, disagreed with Silverman’s narrow reading of the
SOX privilege. In Bennett v. Sprint Nextel, the court held that the privilege extended to all internal
materials that the target firm — KPMG again — prepared while responding to a PCAOB inspection.[10]
The court reasoned that, “[b]ecause the final version of PCAOB comments and KPMG responses to those
comments are all privileged, then ... any internal KPMG communications that reveal those comments, or
the work to develop the responses to those comments, are also privileged.”[11] The court went on to
conclude that the internal documents were prepared “specifically for the Board because, absent the
inspection, these documents and communications would not exist.”[12]
Bennett gives a much better reading than Silverman of the words “prepared ... for the Board ... in
connection with an inspection,” as Congress used those words in the context of the privilege provision.
Silverman, never explains why these words apply only to materials actually provided to the PCAOB or its
staff.
(Nor can Silverman square its narrow reading of the words “prepared,” “for,” and “in connection with an
inspection” with the accepted broader reading of the related word “Board.” It seems established that
“Board” is not limited to its narrowest meaning, which would include only the five members of the
PCAOB; rather, it receives its natural meaning in the context of this SOX provision, so that it includes the
entire PCAOB staff.)
An example from a different context helps explain why the Bennett reading is better. Say that, to
prepare for a trial, a lawyer creates working documents to make detailed calculations of damages. The
lawyer puts the damages totals into summary exhibits. The lawyer presents the summary exhibits at
trial.
Surely, common language would say that counsel created the underlying calculation documents “for
trial.” In the same way, common language would say that an accounting firm that created internal
working documents, then used those documents to draft submissions for the PCAOB, created the
internal documents “for the Board ... in connection with an inspection.” And again, recall that the word
“Board” is read broadly to include the agency’s entire staff. The Silverman opinion cannot account for
this common usage of the words at issue.
Statutory Evidence That Clinches the Broad Reading of the Privilege
Nor can Silverman be squared with other language in the SOX privilege provision — language that
clinches the broader reading. (KPMG pointed out this analysis but the court did not adopt it. Id. at *7.)
These other words — “received by the Board” — rule out the narrow privilege adopted in Silverman.
Here is how. We know that the words “prepared ... for the Board” cannot mean “received by the
Board,” because the statute already contains those words. And as Silverman said, correctly, “[i]t is a
"cardinal principal of statutory construction" that a court must "give effect, if possible, to every clause
and word of a statute."[13]
So “prepared for the Board” must refer to something else: It must refer to some documents that were
not actually “received by the Board.” And the most obvious application is to materials that lead to
documents that a firm actually sent to the board, but that the firm did not send. Again, see the above
example about the working calculations that the lawyer prepared “for trial.”
The conclusion about the privilege’s broad scope is further confirmed by its neat fit with the purpose of
the SOX inspection provisions. As explained by the PCAOB, that purpose is to institute an inspection
process that is “supervisory,” rather than “adversarial,” and that leads to “remediation” before it leads
to sanctions.[14] To date, real-world experience with inspections indicates that the statute is, in fact,
serving this intended purpose.
This purpose would be frustrated by the narrow view of the privilege adopted in Silverman. That view
would hinder the PCAOB’s ability to conduct exams, for the obvious reason that accounting firms dislike
creating documents that private plaintiffs can use to sue them. Under a rule that made internal firm
documents available in civil discovery, any responsible firm would avoid putting candid analysis in
writing. It would proceed instead through conversations and meetings.
Firms also might begin to run inspection-related activities through counsel, creating another layer of
cost and generating a new thicket of issues involving the attorney-client privilege. The narrow privilege
would, in short, force target firms to shift from a cooperative posture to a defensive one. This shift
could, it is fair to say, change the basic nature of the PCAOB examination process. It also would drive up
the cost of inspections (to the PCAOB and to accounting firms) and stretch out the time required to
complete inspections.
The broad privilege created by SOX does not, by the way, alter the pre-existing discovery rights of civil
litigants. The rules of civil discovery already entitle plaintiffs to workpapers and other documents from
audits, if the audits are relevant to their lawsuits. Any competent plaintiff’s counsel who seeks
inspection-related material from an accounting firm already has obtained these materials.
Conclusion
Bennett v. Sprint Nextel gives accounting firms new support for the argument that the statutory
privilege shields all materials that firms generate because of the PCAOB inspection process. Although a
split in authority now exists, Bennett gives the better reading of SOX Section 105(b)(5)(A). And the
analysis set out above explains even more clearly than Bennett why the statutory language rules out the
narrow privilege adopted in Silverman.
--By Andrew J. Morris, Morvillo LLP
Andrew Morris is a partner in Morvillo's Washington, D.C., office,
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
[1] No. 07-4507, 2010 U.S. Dist. LEXIS 81671 (N.D. Ill., June 29, 2010)
[2] No. 11-9014, 2012 U.S. Dist. LEXIS 145902 (W.D. Mo., October 10, 2012)
[3] Sarbanes-Oxley § 105(b)(5)(A); 15 U.S.C. § 7215(b)(5)(A) (emphasis added).
[4] Id.
[5] Id.
[6] Silverman, No. 07-C-4507, 2010 U.S. Dist. LEXIS 81671, *11.
[7] Id at *10
[8] Id at *11-12
[9] Id at *10
[10] 2012 U.S. Dist. LEXIS 145902 at *10.
[11] Id at *11
[12] Id
[13] Silverman, 2010 U.S. Dist. LEXIS 81671, at *10-11
[14] The PCAOB discussed the purpose and goals of the inspection program in Pub. Co. Accounting
Oversight Bd. Release No. 104-2006-077, The Process for Board Determinations Regarding Firms; Efforts
to Address Quality Control Criticisms in Inspection Reports (March 21, 2006)
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