Privilege Under SOX in a PCAOB Inspection of an Audit Firm
The Public Company Accounting Board or PCAOB was created under the Sarbanes Oxley Act of 2002. Under the SEC, the board is charged with overseeing the audit of public companies that are subject to the securities laws to protect investors. As part of those protections the PCAOB is empowered to conduct inspections and investigations of registered accounting firms that audit public companies. A key question in conjunction with those inspections is the extent to which materials and information related to the process is protected from disclosure from privilege.
The court in Bennett v. Sprint Nextel Corporation, Case No. 11-90144 (W.D. MO.), in an order and opinion dated October 10, 2012, defined the scope of that privilege. It also created a conflict with a ruling in another district.
The question arose in the context of a putative class action against Defendants Sprint Nextel Corporation and others. The complaint alleges securities fraud based on the merger of Sprint and Nextel tied to accounting issues for the fourth quarter of 2006 and the first three quarters of 2007.
In July 2006 the PCAOB began an inspection of KPMG, the outside auditors for Sprint. The audit firm circulated an Engagement Profile and Appendix A to various employees to be completed and sent back to Board inspectors. The next month the audit firm made a presentation on the Sprint 2005 audit to PCAOB inspectors. As the inspection continued KPMG had additional meetings with inspectors and prepared material for them. At the conclusion of the process the audit firm prepared responses to an inspection report from the Board.
Plaintiffs issued subpoenas to KPMG for documents. While a number of documents were produced, certain materials relating to the inspection were withheld based on privilege assertions which were challenged in a motion to compel. The privilege assertions are based on SOX Section 105(b)(5)(A) which provides in part: “[A]ll documents and information prepared or received by or specifically for the Board, and deliberations of the Board and its employees and agents, in connection with an inspection under section 104 . . . shall be confidential and privileged . . .” The statute thus provides for privilege in two circumstances, according to the court. The firstinvolves requests to the Board, a question not involved here. The second concerns requests to the target of a Board investigation which is the question here. In this regard the court held that “the privilege protects those who are under investigation from being required to divulge their responses to that investigation . . . [but] does not extend to documents from the underlying transaction or work . . . “
The court went on to hold that the privilege extends beyond materials held by the board to include those in the hands of third parties, here KPMG. The court thus rejected a claim by the plaintiffs that would have limited the privilege to materials held by the board. The court also held that the term “Board” as used in the statute includes the staff of the PCAOB, not just the Board itself as plaintiffs argued.
Central to the decision is the question of whether internal KPMG materials were privileged under the statute. Plaintiffs argued that documents created internally at the audit firm about the PCAOB inspection but which are not specifically communication with the Board are not privileged, citing Silverman v. Motorola, No. 07-C-4507, 2010 WL 4659535 (N.D. Ill. 2010). The district court here concluded that the Silverman court read the statute too narrowly. The court adopted Silverman’s overall holding that the protection of the statute is limited to materials that are “specifically for” the Board. It broadened the reach of the privilege, however, concluding that “internal KPMG communications that discuss confidential questions or comments made by the Board or which reflect KPMG’s development of responses to board inquires are also protected.” The privilege thus includes any internal communications that reveal those comments or work to develop the responses to the comments.
Applying its holdings to the issues in this case, the court found that a series of documents are privileged. Those include: direct communications between the Board inspectors and the audit firm; forms labeled “Public Company Accounting Oversight Board Inspection Comment Form,” including the board comments and KPMG responses and drafts; spreadsheets of data prepared for the Board; materials that would reveal specific questions or inquiries from the Board and drafts and final versions of responses; drafts and final versions of the Engagement Profile and Appendix A; and the presentation file for the initial meeting with the Board. The court rejected KPMG’s claim that the privilege extends to materials that might reveal some aspect of its deliberations. Rather, it only extends to materials that are prepared or received by or specifically for the Board.