Focus On - Companies must give auditors documents

The case involved an investigation by the staff of the Ontario Securities Commission (OSC) into the dealings of a public company, Philip Services Corp. In 1997, the company became aware that one of its officers had fraudulently diverted millions of dollars. It sought legal advice as to whether the information should be disclosed in a prospectus being filed in anticipation of a $364-million public offering. It did not disclose the fraud in the prospectus.

Shortly after the offering, the company made a series of other disclosures which substantially altered its financial picture. Its shares dropped dramatically and it sought bankruptcy protection.

 The OSC began an investigation under s. 11 of the Securities Act, based on staff concerns that Philip did not adequately disclose negative financial information prior to the public offering. In response to a summons, the company's auditors, Deloitte & Touche LLP, assembled more than 300 files for review by OSC staff. Philip also made disclosure in response to a summons. Included in the documents were several legal opinions obtained by Philip prior to the filing date. Notes of discussions with the audit committee after the filing were also turned over.

In the course of one of its own hearings, the OSC, which is both regulator and investigator, ruled that a range of documents, including the legal opinions and notes of conversations, were not privileged because Philip released the documents to its auditor without cautioning that it was not waiving lawyer-client privilege.

The judgment notes that the documents (mostly legal opinions from Philip's counsel) were given to Deloitte "in its capacity as auditor and not otherwise. That brings us to the heart of this case: what is the effect of giving privileged documents to your auditor? Does the privilege, or any part of it, survive?"

OSC staff took the position that the giving of privileged documents to the auditor, without cautioning that they were privileged for other purposes, amounts to a complete waiver of the privilege. But the Divisional Court disagreed, noting that "there is no free-standing duty on auditors to make public disclosure of everything they learn that might interest the criminal or tax authorities; their duties arise from their role as auditors as governed by law and professional obligations."

The role of the OBCA was crucial: Philip's counsel, David Byers and Bradley Davis of Stikeman Elliott LLP, submitted that "the statute creates a compulsion to disclose to the auditor which is inconsistent with the concept that disclosure to the auditor is voluntary and so forms the basis for an implied waiver of privilege for all purposes. Whether the statute is formally invoked or not, company and auditor alike are aware of it and the company must be deemed to have acted under it, as a form of practical compulsion."

Lane referred to the Supreme Court of Canada's 2002 ruling in Lavallee, Rackel & Heintz v. Canada, which he said sent a "clear" message on the issue: "restrictions on solicitor-client privilege to attain other important social objectives are to be closely scrutinized and restricted to what is absolutely necessary for the competing objective so as to achieve the minimal necessary impairment of solicitor-client privilege."

OSC staff argued that such a limitation of the waiver would prevent auditors from disclosing information revealing fraud, which they would otherwise be likely to do. But the court concluded that the auditor would be able to use the privileged documents across the full range of auditing responsibilities, including resigning as auditors, without the need for releasing the privileged documents to third parties, including securities regulators.

"With a regulated public company, the resignation of the auditor accompanied by a refusal to certify the accounts is the kind of weapon that renders the disclosure of legal advice redundant," the judgment says.

In fact, the privilege continued, even though some legal documents were released to the OSC by Deloitte. The auditor did not have the authority to release the opinions, the decision said.

"The mere possession of the documents did not carry the authority to waive the privilege. The fact that the disputed documents largely came into the possession of [OSC] staff via an unauthorized disclosure by Deloitte undermines their usefulness in the hands of staff," Lane wrote.

Lane also considered whether there was an implied waiver of the privilege as a result of extracts from some of the privileged material appearing in the statement of allegations prepared by OSC staff as a result of its decision to proceed against Philip. But he concluded the privilege is only so waived if the party entitled to the privilege is the one that chooses to put the contents of privileged material in issue.

"A party may act in such a fashion as to make it unfair for that party to continue to maintain the privilege. But the opposite party may not, by referring to the legal advice given to the party with the privilege, thereby put the privileged advice in issue."

Byers noted that the court was essentially dealing with competing public objectives and was looking for a balance.

"The court was dealing with some policy concerns," he noted. "They were that auditors should have full access to all the documentation that they would need to properly perform their function, and that the corporate statute says that the company has to comply with requests, or at least co-operate with its auditors.

"Then you have a conflict between [that] and the company objective of not waiving privilege against the world with respect to any legal opinions the auditors may want to look at," said Byers.

"Those [objectives] kind of collided. . . . The court had to deal with cases that were all over the map on the point and the court decided that both objectives could be accomplished if you were able to provide privileged documents to your auditors without waiving the privilege to the world."

Byers also suggested that the ruling on the effect of the OBCA was crucial.

"The company has no choice: if demanded by the auditors [under the statute] you have to give the privileged documents to the auditors," he said. "That is probably something that has never been said before."

Byers said he had not even gone that far in his argument but instead had submitted that the company should not be put in the position of having to choose between complying with the requests of auditors and losing privilege, or not giving the documents and taking the risk that the auditors would withhold their audit opinion.

"The court said the company is not in that choice, because they have no choice; if the auditors ask for it, you have to give it," he said. "I thought that was pretty interesting."

The OSC has decided not to appeal the decision and will be proceeding with the formal hearing, without the use of the disputed documents.

Karen Manarin and Judy Cotte, who represented the OSC, called the decision well-reasoned.

The ruling is significant, they believe, because it clarifies the law in an area where there are several conflicting decisions. The "interesting" thing about the case, Manarin said, is that, if the company decides to use the opinions in the OSC hearing for certain purposes, the OSC can renew its application to say the privilege has been waived.

"The really nice thing about this decision is that it puts the responsibility back on the commission, so that if they use the opinions in the course of the action to justify their actions, we can say, 'You know what, privilege has been waived.' The important thing about this decision is that it gives us a road map."