The latest flexing of the federal government’s muscle to pierce attorney-client privilege is the Treasury Department’s efforts to force the Dallas-based law firm of Jenkens & Gilchrist to reveal the names of more than 600 clients who used certain tax shelters that the Internal Revenue Service considers abusive. The IRS wants to audit the investors.
Other agencies seeking privileged information include the Securities and Exchange Commission (SEC), the Department of Justice (DOJ) and the Federal Trade Commission (FTC).
Some lawyers, including those of Jenkens & Gilchrist, are fighting back. They accuse the government of moving dangerously close to damaging the centuries-old privilege that lies at the heart of this country’s adversarial legal system.
The IRS obtained the summons against Jenkens & Gilchrist on June 19 in U.S. District Court in Chicago, in an ex parte proceeding. “The IRS approach to this issue is a novel legal theory that has yet to be challenged in court,” said William P. Durbin, managing partner of the firm. “We have advised the IRS that we simply cannot comply with that request, because to do so would be a violation of our ethical, moral and legal duties.”
Durbin explained that the privilege belongs to the client, not the firm. If it is broken, “The client might choose to withhold or misstate material facts necessary to render sound, accurate advice. The confidential/trust relationship between the client and her attorney would be lost or destroyed.”
An IRS spokesman said Jenkens & Gilchrist is “choosing to disobey a court order,” and that tax attorneys are evaluating what steps to take next, including seeking an enforcement action in court.
In a speech last month before the Texas Federal Tax Institute, IRS Deputy Chief Counsel Emily A. Parker defended the agency’s approach. She characterized law firms that provide tax shelters as “promoters” and their clients as “customers,” in claiming that the traditional attorney-client privilege does not apply.
The spark for this pierce-the-privilege trend seems to have begun with passage of the Sarbanes-Oxley Act last year. The SEC then adopted guidelines that reward companies under investigation if they voluntarily disclose privileged information. The DOJ followed with its own guidelines in January, saying that disclosure can help a corporation avoid criminal prosecution as a company.
The guidelines did not entice some companies to bite. Tyco International Ltd., for example, has chosen not to disclose, and the SEC probe of Tyco is ongoing.
David Boies of Boies, Schiller & Flexner conducted an internal investigation for Tyco, but he declined to discuss in an interview why the company would not waive its privilege.
“The attack on privilege is not new,” Boies said, “but you have this reaction to instances of corporate abuse right now, and the government is being given a lot of leeway.” If the attacks continue, Boies added, “there is a danger that privilege could be unduly restricted in a way that it becomes meaningless.”
But Enron Corp., for one, decided to disclose privileged information to the SEC and DOJ. William Powers Jr., dean of the University of Texas School of Law in Austin, led the group that conducted Enron’s internal probe and that convinced the Enron board to waive its privilege.
“Enron was a very specific situation,” Powers explained. “In order to write a full, impartial and credible report, we had to discuss privileged information and to share those documents with the SEC and with the public.”
WorldCom Inc. also chose to share privileged information with the SEC and DOJ. Paul C. Curnin of New York’s Simpson Thacher & Bartlett declined to discuss WorldCom’s decision. But in general, Curnin said, “In my experience, waiver is becoming more routine in government inquiries and can have a significant impact on how the government reviews a client’s cooperation.”
One securities lawyer, who asked not to be named, said, “The idea that a company has to squander a valuable asset such as attorney-client privilege to get a fair hearing is just wrong. And breaking privilege has gone from being something extraordinary to becoming the tool of the moment.”
Lawyers fight back but momentum seems to be shifting.
First, the SEC has quietly pushed aside its hotly contested “noisy withdrawal” proposal that would have required attorneys with knowledge of a company’s fraud to resign and announce the reason. Although that rule could arise later, the SEC instead has chosen to require attorneys with knowledge of fraud to report “up the ladder” to company executives. The “up the ladder” rule takes effect on Aug. 5.
Then, the IRS recently backed off a demand that the Houston law firm of DeGuerin, Dickson & Hennessy identify the names of its criminal clients who paid their fees with at least $10,000 in cash. DeGuerin v. U.S., No. 01-1053 (S.D. Texas).