On 11 September 2018, Arnold J handed down his judgment in FRC v Sports Direct, the first case (so far as we are aware) in which the question of client privileged documents in audit working papers has been considered.
The need for a review of audit-related papers in relation to client privilege is a familiar practical challenge in many FRC cases, particularly where there may have been an earlier (potentially privileged) client investigation into alleged fraud or misconduct within the business.
The overall effect (for now – appeals look likely) is that client privileged documents held by the auditors can be provided to the FRC (or other regulator) without infringing the client's privilege. This could have far–reaching implications as to how clients can share with auditors privileged material without the risk that such material will re-surface in a regulatory investigation.
The decision
The FRC argued (as they have done in other cases) that client privileged documents were disclosable by the auditors under investigation (and by Sports Direct itself which had been served a production notice under the Audit Enforcement Procedure) because:
- Disclosure to the auditor amounted to a waiver of privilege vis-à-vis the regulator. That argument was rejected by Arnold J;
- Disclosure to the regulator was not an infringement of privilege at all because of a Court of Appeal decision (Parry-Jones v Law Society), approved by Lord Hoffmann in the House of Lords' decision in Morgan Grenfell.
This second argument was accepted by Arnold J as representing the current state of the law:
"Thus the production of documents to a regulator by a regulated person solely for the purposes of a confidential investigation by the regulator into the conduct of the regulated person is not an infringement of any legal professional privilege of clients of the regulated person in respect of those documents."
Appeal
The judge gave leave to appeal on this "infringement" point. The order for production of the documents has been stayed pending the outcome of the appeal.
What next?
We understand that the FRC are considering the implications of the decision and will be in touch with parties on affected cases as appropriate.
On the face of it, if upheld, this decision would mean that there is no need for a client privilege review on FRC investigations any more – often a very time-consuming exercise.
But there are significant ramifications for audit clients, particularly in liaising with auditors in relation to privileged investigations, which could make appropriate information-sharing problematic.
Although the FRC investigation phase is confidential, any subsequent enforcement proceedings are not. Equally, documents could be shared between regulators under statutory gateways. There is a substantial risk in such scenarios that privilege will be lost altogether.
A pragmatic solution at this stage would be for the FRC to keep the current practice (withhold client privileged material) until this case goes to appeal, not only in relation to Sports Direct but all other affected cases.
This is a point which may be worth firms discussing with the FRC team sooner rather than later. It is also an issue which audit teams may wish to highlight to their clients, or seek to address expressly in engagement letters.
