Requirement to produce documents to an adviser’s regulator does not infringe client’s privilege

United Kingdom

The High Court has recently heard the first application by the Financial Reporting Council (FRC) to require a client to produce documents in connection with an investigation into its auditors under Schedule 2 of the Statutory Auditors and Third Country Auditors Regulations 2016. The court ruled that the recipient of a notice under the Regulations must use reasonable endeavours to comply with it and that a client could be required to produce privileged documents. Arnold J concluded, albeit “with some hesitation”, that the client’s rights were not infringed because the documents would be kept confidential and could not be used against the client.

In reaching his decision, he also confirmed that pre-existing documents do not become privileged merely by being sent to a lawyer for the purpose of seeking legal advice, and that it is possible to waive privilege vis-à-vis an adviser without also waiving privilege vis-à-vis the adviser’s regulator.

The client is expected to appeal.

Background

In Financial Reporting Council Ltd v Sports Direct International plc [2018] EWHC 2284 (Ch), the FRC was investigating the conduct of Sports Direct’s auditor and wanted to ascertain how much the auditor knew about tax advice which Sports Direct had received on its VAT position. It issued a notice to Sports Direct under Rule 10 and Schedule 2 of the Regulations (the “Rule 10 Notice”) requiring it to produce various documents relevant to this question.

The disputed documents

Sports Direct argued that it should not have to produce two groups of documents:

  1. Documents which could not be identified with certainty as falling within the Rule 10 Notice. A member of the auditor’s staff recalled being shown a report by a tax adviser recording the advice it had given to Sports Direct on the VAT treatment of distance sales and internet sales. The staff member was not allowed to have a copy of the report and had only a vague recollection of it. Sports Direct was able to identify a “pool” of documents that potentially matched this description, but could not determine which, if any, of these was the one seen by the staff member. The FRC asked Sports Direct to produce the entire “pool” of documents. Sports Direct argued that this went beyond the scope of the original Rule 10 Notice and that a new notice would be required.

  2. Documents in respect of which Sports Direct claimed legal advice privilege. In addition to tax advice on its VAT position, Sports Direct had also obtained legal advice on the issue. It claimed legal advice privilege in relation to (a) documents relating to its contractual arrangements with third parties that had been sent to its legal advisers in the context of seeking advice on restructuring its online sales arrangements; and (b) documents produced by the legal advisers that had been forwarded to the auditors under cover of a fax marked “Privileged – for audit use only”.

Identification of documents

Arnold J held that Sports Direct was obliged to “do what was reasonable” in order to ensure that it complied with the Rule 10 Notice. In the present case, it was reasonable to produce any documents that were capable of fitting the description given by the auditor’s staff member. It could not refuse to produce any of the documents simply because it could not specifically identify which one of them the staff member had seen.

Pre-existing documents sent to legal advisers

The accepted position in English law is that pre-existing documents do not attract legal advice privilege; documents are only privileged if they have come into existence for the purpose of obtaining legal advice.

Sports Direct challenged this understanding based on a line of cases dealing with the concept of the “continuum of communication”, to the effect that a communication that does not itself contain legal advice or a request for legal advice may still be privileged if it is part of a chain of communications relating to the giving of such advice. In particular, it relied on Property Alliance Group Limited v Royal Bank of Scotland plc [2015] EWHC 3187 (Ch). In that case, solicitors sent their client a status update which was used as the agenda for a conference call. The court held that the update was privileged, even though it did not itself contain or request any legal advice, because the conference call was intended as an opportunity for the client to give further instructions and/or seek further advice. In its judgment, the court stated that the source of the information contained in the status update was irrelevant.

On this basis, Sports Direct argued that legal advice privilege should apply to pre-existing documents that were later used as a source of information to instruct a lawyer. Arnold J rejected this argument, holding that the judge in the earlier case was not considering pre-existing documents when he made those remarks and had not been referred to any authorities on that point. He confirmed what he described as “the orthodox view” that privilege does not extend to such documents. Sports Direct therefore had to disclose the documents sent to its legal advisers regarding contractual arrangements with third parties.

Waiver of privilege

The FRC claimed that by sending documents that were subject to legal advice privilege to its auditors, Sports Direct had waived the privilege. Sports Direct accepted that there was a limited waiver of privilege, but denied that this extended beyond the auditors to allow use by the FRC. The FRC argued that a waiver of privilege vis-à-vis the auditors necessarily entailed a waiver vis-à-vis their regulator, since the regulator could not properly assess the conduct of the audit without having access to the same materials as the auditors.

The court accepted Sports Direct’s arguments on this point. The process of audit was distinct from the process of the regulatory investigation and “not in any sense part of a single process”. By sending privileged documents to its auditors for the purposes of the audit, Sports Direct did not waive privilege against the FRC. The documents produced by the legal advisers therefore remained privileged despite being forwarded to the auditors.

Lack of infringement

The FRC argued that requiring Sports Direct to produce privileged documents to assist in the investigation of the auditor’s conduct would not infringe privilege. It relied on earlier cases in which the courts held that there was no infringement of a client’s privilege where a solicitor was required to produce privileged documents to the Law Society in connection with an investigation into the solicitor’s conduct (Parry-Jones v Law Society [1969] 1 Ch 1, as interpreted by Lord Hoffman in R (Morgan Grenfell & Co Ltd) v Special Commissioner of Income Tax [2001] UKHL 21) or to HMRC in connection with an inspection of the solicitor’s tax records (R v Inland Revenue Commissioners ex p Taylor (No 2) [1990] 2 AER 409).

Arnold J stated that this was the most difficult as well as the most important issue raised in the case. He noted that the interpretation of Parry-Jones in Morgan Grenfell was heavily criticised in authoritative textbooks, that other common law jurisdictions had not followed it, and that Schedule 2 of the Regulations expressly preserves legal professional privilege. However, based on his review of the case law, he concluded that the current state of the law was that the production of documents to a regulator solely for the purposes of a confidential investigation into the conduct of the regulated person was not an infringement of any privilege belonging to a client of the regulated person. It did not matter whether the person who was required to produce the documents was the client or the regulated person. The fact that the regulator would not be entitled to use the documents for any purpose other than the investigation and would be obliged to maintain their confidentiality was a significant factor in reaching this decision.

As regards the provision in Schedule 2 of the Regulations preserving privilege, Arnold J held “with some hesitation” that this was designed to apply in a situation where the privileged document related to a potential claim by the client against the auditor, so that requiring the client to disclose it would be more than a mere “technical” infringement. He therefore ordered Sports Direct to produce the privileged documents it had sent to its auditors, despite his earlier finding that the privilege had not been waived.

Comment

This decision represents the first known case in which a client has been ordered to disclose privileged documents directly to an adviser’s regulator, as opposed to the adviser making the disclosure itself. Arnold J granted Sports Direct permission to appeal his decision to the Court of Appeal, and the discomfort which he expressed with the current state of the law on the disclosure of privileged documents to regulators is likely to encourage Sports Direct to pursue that route. Meanwhile, the success of the FRC’s application means that corporates are likely to face increased requests from regulators to produce documents in connection with investigations into outside advisers.

Some practical takeaways from this decision include:

  • Showing a document to an adviser without allowing copies to be taken will not necessarily be sufficient to protect it from disclosure at a later date. Regulators may be able to require production directly from the client, in addition to the existing provisions for third-party disclosure in the Civil Procedure Rules.

  • Regulators’ powers of investigation may override a client’s entitlement to legal professional privilege where the client is not itself the target of the investigation nor involved in a potential dispute with the regulated person. However, the regulator must keep privileged documents confidential and cannot use them for any purpose other than its investigation.

  • As most corporates will already be aware, simply copying a document to a lawyer is not sufficient to bring it within the protection of legal professional privilege if it was not originally created as part of the process of seeking legal advice.

For further information about legal professional privilege and how to manage document risk to maximise protection for your business documents, please email the authors or your usual CMS contact.