How to Manage Audits as In-House Counsel

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By Paige Zandri
| Legal Process Management

Audits

The rules of professional conduct dictate that lawyers owe a professional duty to their clients. This seems straightforward, but for in-house counsel, the lines of that duty can blur during audit season. Disclosure of pertinent and material information necessary for a successful audit (and opinion) can cut against the duty to preserve your client’s privileged communications and confidential positions on pending litigation. Counsel must judge when privilege should be waived, what opinions to disclose, and what information is necessary for creating a full picture of the company’s financial reporting. This often puts the lawyer and the audit team in a compromising scenario. Before responding to a written request for audit information from your client, here are some factors to keep in mind.

Negotiate an audit engagement letter.

Audit engagement letters allow in-house counsel to determine standards and guidelines of the audit before it begins. Consider these rules when drafting an engagement letter:

  • Require the audit to follow the “treaty.” In 1975, the American Bar Association and the American Institute of CPAs agreed to a treaty that balanced the tension between the work of auditors and lawyers. The treaty established a format that allowed an auditor to gather the information necessary to verify accurate financial reporting on the part of the company without imposing on the privileged relationship between a lawyer and his or her client. This is not a mandatory format, but it does provide additional protection to the lawyer, who could be accused of interfering with or misleading the audit if material information is not disclosed. Lawyers must strike a balance between meeting the demands of the auditor while maintaining privilege wherever possible. In some instances, it may need to be waived.

  • Include a confidentiality clause. During the audit process, you may be required to disclose privileged information. Include a confidentiality requirement in the audit engagement letter to ensure privileged information is kept confidential outside of the audit process.

  • Establish a materiality threshold. In-house lawyers are familiar with the tension between business and law, particularly when it comes to risk tolerance. Auditors introduce a third scale on which to measure risk. When calculating your client’s loss contingencies, it’s important to know what dollar amount will be of material importance to an auditor. Establish this number in the beginning and it will be easier for you to understand what information you need to disclose and what you can keep privileged.  

  • State your intent to maintain the attorney-client privilege. Your response should not disclose client privileges, and your engagement letter should expressly state that you do not intend to. Auditors under the treaty are required to make best efforts to gather the information they need without having you waive privilege.

Disclosures regarding risk.

One of the most significant roles of in-house counsel is to evaluate risk for the client. This includes assessing the company’s regulatory compliance, internal controls and risk of financial fraud. Auditors will want to see a current assessment of your client’s processes as well as the mechanisms in place for mitigating and assessing these risks on an ongoing basis. Also, if your risk assessment involves outside counsel, they will likely need to be involved in the audit.

Communicate with your client.

While the request for information may come from your client, remember the information is for the auditor, and you should consult with your client before responding. It’s important to discuss with your client all that will be communicated prior to disclosing the information to the auditor. Be sure to review all draft responses with your client to ensure you are providing all of the necessary information and are not unnecessarily disclosing confidences.

Watch what you say...

A significant part of an in-house counsel’s role in an audit is to report loss contingencies and present structured opinions on pending litigation. In fact, responding to an audit letter implies that you have already conducted an internal investigation to determine your company’s loss contingencies as they relate to your legal department. However, keep in mind that reporting an unfavorable opinion where the outcome is any less than “probable” or “remote” could land you in hot water. If there is still a fair amount of work to be done in the litigation process, it is wise not to express an opinion at all. Lastly, remain cognizant of the fact that verbal communications with your auditor will be documented in the audit report. Refraining from a written opinion means nothing if you communicate a verbal one.

As always, remember where privilege applies and where it is waived. Auditors will have access to all information communicated when lawyers act in non-legal roles, such as a business role, or when discussing advice with an accountant. This means advice given by a lawyer at a board meeting where an accountant is present will not be protected under privilege. All of the information communicated in these capacities will be accessible to the auditor.

More information on attorney-client privilege can be found here. Also check out our roundtable about the topic, coming up on February 2, 2017 in NYC. The conversation will be led by Priori network attorney Ted Weitz. 

 

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