Opinion
Civil No. 07-1606 (ADC/BJM).
February 9, 2009
ORDER
Defendant Jay Green ("Green") moved for an order compelling plaintiff Westernbank Puerto Rico ("Westernbank") to produce a report and related documents prepared by the accounting firm KPMG LLP ("KPMG") in connection with an audit of Westernbank's asset-based lending division and the Inyx loans in particular. (Docket No. 314). Westernbank opposed (Docket No. 354) and Green replied. (Docket No. 371). The court ordered Westernbank to produce the contested documents to the court for in camera inspection (the "January 8 Order") (Docket No. 389) and Westernbank complied. (Docket No. 402). The presiding district judge has referred this case to me for full pre-trial management, including ruling on all non-dispositive motions. (Docket No. 160). For the following reasons, Green's motion is DENIED.
References herein to the contested documents are identified as "Docket No. 402" along with the exhibit number corresponding to the set of documents Westernbank provided to the court for in camera inspection.
FACTUAL BACKGROUND
The dispute before the court concerns the report of an investigation conducted by the accounting firm KPMG. On June 26, 2007, the Audit Committee of the Board of W Holding Company ("WHI"), Westernbank's parent company, retained the law firm of Adsuar Muñiz Goyco Seda Pérez-Ochoa, P.S.C. ("AMGSP"). (Docket No. 354-4, ¶ 2). AMGSP was retained in order to conduct an internal investigation of both the lending transactions among Westernbank, Inyx, and Inyx's subsidiaries, as well as a broader review of the loan portfolio of Westernbank's Business Credit Division. (Id.). On the same day, AMGSP retained the accounting firm KPMG to provide forensic accounting services in order to assist in counsel's investigation. (Id.; Docket No. 402). Westernbank commenced the action before this court on July 6, 2007 (Docket No. 2) and filed an amended complaint on August 23, 2007. (Docket No. 3). KPMG delivered a report of its investigation of the Inyx loans shortly thereafter on September 14, 2007. (Docket No. 402).Green provides evidence of Westernbank's public disclosures of the existence of the KPMG report in support of his assertion that KPMG's investigation was undertaken in connection with Westernbank's reporting obligations to various financial regulatory bodies rather than in preparation for litigation. (Docket No. 314). Green also argues that Westernbank waived any applicable privilege through its disclosure of the report to its regular outside auditor, Deloitte Touche ("Deloitte"). (Id.).
In the June 25, 2007 Form 8-K filed with the SEC, Westernbank reported that on June 19, 2007, it had determined that one of its larger asset-based loans was "impaired." (Docket No. 314-2). The Form 8-K went on to state that the Audit Committee of the Board of WHI had decided to retain an independent firm "to review the impaired loan as well as the complete asset-based lending portfolio and the asset based lending division's system of internal controls." (Id.).
On September 20, 2007, Frank C. Stipes, Chairman, Chief Executive Officer, and President of Westernbank and WHI, along with counsel for WHI, appeared before the NASDAQ Listing Qualifications Hearing Panel in connection with the potential delisting of certain WHI shares due to the bank's delinquency in filing its quarterly Form 10-Q (the "NASDAQ hearing"). (Docket No. 314-3). During that hearing, George Mernick, counsel for WHI, stated that its annual 10-K filing was delinquent due to the Bank's investigation of the Inyx loans and, further, of its "entire asset-based lending portfolio" in order to "make sure these same kinds of problems weren't occurring with other loans." (Id., p. 7-8). Mernick stated that the bank had retained counsel and independent auditors KPMG to conduct this investigation at the direction of the audit committee. (Id., p. 8). He assured the panel that the "investigation now is essentially completed" and KPMG had determined that "there were not other problems of significance regarding any other asset-based loan." (Id., p. 8-9). Stipes stated that Deloitte had done "their review of the report and the [asset-based lending] division" starting October 1, 2007. (Id., p. 16; see also p. 39 (stating that the KPMG report "will be a good road map" for Deloitte)). The NASDAQ panel requested that, once the report was final, WHI provide a summary of its conclusions and recommendations to the NASDAQ panel. (Id., p. 49).
Stuart Stein, counsel for WHI, described the investigation and noted that the issue of the Inyx loans was the subject of "at least five different lawsuits going on around the world since it was a pretty large international fraud." (Id., p. 18; see also id., p. 32, 36 (referencing "RICO Act", "collection suit", and UK bankruptcy suit currently proceeding against Inyx and Kachkar)). He went on to state, "[t]he KPMG examination, however, was quite broader. It was to look at the entire system of disclosure controls and the entire operations of the asset-based lending division." (Id., p. 19). Stein later distinguished counsel's review from KPMG's larger review: "the investigations, both, . . . [counsel] focusing on what happened with Inyx, . . . KPMG looking at the whole portfolio and the operations." (Id., p. 39). The intended outcomes of the investigation, as Stein described them, included recommendations of any necessary changes to the bank's controls or operations, which would be part of any subsequent 10-Q filing. (Id., p. 39). In addition, Deloitte, as the bank's regular outside auditor, was performing its own review following the independent KPMG review as part of Deloitte's regular year-end audit. (Id., p. 39).
WHI filed a Form 8-K on February 6, 2008, reporting that certain of its prior financial statements should not be relied upon and would need to be restated in order to correct for the Inyx loan impairment. (Docket No. 314-5). The 8-K stated that the Audit Committee had "engaged outside advisors to review the Inyx loan, the Bank's asset-based lending division loan portfolio, and the system of internal control at the division" and concluded "that there were certain matters in the Company's internal controls requiring corrective action which, individually or in combination, would be considered material weaknesses in the Company's system of internal control." (Id., p. 4).
In addition to a public company's annual (10-K) and quarterly (10-Q) reporting obligations, it is required to file a Form 8-K "to announce major events that shareholders should know about." Form 8-K, http://www.sec.gov/answers/form8k.htm.
The June 27, 2007 engagement letter between AMGSP and KPMG, which was provided to the court for in camera inspection, sets forth the scope of KPMG's review as examining the Inyx loans in particular, and the asset-based portfolio more generally. (Docket No. 402, ex. 1). One of KPMG's central tasks was to "assess the procedures and controls in place during the life cycle of the credit extended to Inyx, Inc. . . . in order to determine how the alleged irregularities occurred, the individuals involved, and the policies and procedures circumvented, if any." (Id.). KPMG was also tasked with conducting an "[o]verall analysis" and credit risk assessment of Westernbank's asset-based portfolio. (Id.). KPMG summarized the findings of its investigation into the Inyx loans in a September 14, 2007 report (the "KPMG report"). (Docket No. 402, ex. 3). Along with the report, Westernbank also produced for the court's in camera inspection eleven documents which appear to be KPMG's workpapers analyzing data concerning the Inyx loans. (Docket No. 402, exs. 5-15). Green's motion did not identify the specific documents (as described to him by Westernbank's privilege log) or even the quantity of documents for which he seeks to compel production, and thus the court assumes that the KPMG report and eleven workpapers Westernbank submitted for in camera review represent the complete universe of documents at issue on this motion (collectively the "contested documents"). (See Docket No. 314 (stating only that Green seeks to compel "a report prepared by the accounting firm of KPMG LLP . . . as well as related documents and workpapers in the possession of Westernbank").
The findings of KPMG's investigation of Westernbank's asset-based lending division are summarized in two other September 14, 2007 reports which Westernbank provided to the court in response to the January 8 Order: (1) "Overall Assessment of Policies and Procedures, General Reserve Methodology, and SOX 404 controls within the Business Credit Division", and (2) "Testing of Westernbank Puerto Rico's Loan Classification and Specific Reserve as of June 30, 2007 for Selected Loan Relationships within the Business Credit Division" (collectively the "Business Credit Division reports"). (Docket No. 402, exs. 2, 4). Green's motion did not identify the specific discovery request to which he believes the contested documents are responsive, and it is not clear to the court that the Business Credit Division reports are relevant to this case. More importantly, it is not clear to the court that these reports have been requested in Green's motion to compel or what privileges or defenses Westernbank is raising with respect to them. Therefore, the court leaves it to the parties to resolve any outstanding issues concerning the production of the Business Credit Division reports and does not treat them as part of the motion to compel.
ANALYSIS
Westernbank argues that the contested documents are protected by the attorney-client privilege, but then all but concedes that even if the privilege applies, it would have been waived by Westernbank's disclosure of KPMG's reports to outside auditor Deloitte. (Docket No. 354, p. 8). Westernbank argues, in the alternative, that the documents were protected by work product privilege and this protection was not waived by the disclosure to Deloitte. As the party asserting the privilege, Westernbank has the burden of establishing its applicability to the contested documents as well as the burden of showing that it has not been waived. United States v. Wilson, 798 F.2d 509, 512 (1st Cir. 1986); In re Raytheon Secs. Litig., 218 F.R.D. 354, 357 (D. Mass. 2003). After briefly discussing the attorney-client privilege and related waiver issues, the court turns to an analysis of the work product doctrine.
1. Attorney-Client Privilege
Attorney-client privilege attaches to documents where (1) legal advice is sought from (2) a professional legal advisor in his capacity as such, (3) the communications relating to that purpose (4) were made in confidence (5) by the client, and thus (6) are at his instance permanently protected (7) from disclosure by himself or the legal advisor (8) except if the protection has been waived. Cavallaro v. United States, 284 F.3d 236, 245 (1st Cir. 2002). However, "[w]hen otherwise privileged communications are disclosed to a third party, the disclosure destroys the confidentiality upon which the privilege is premised." XYZ Corp. v. United States (In re Keeper of the Records), 348 F.3d 16, 22 (1st Cir. 2003). Disclosure to outside auditors generally waives the attorney-client privilege. See, e.g., In re Pfizer Inc., Sec. Litig., No. 90 Civ. 1260 (SS), 1993 U.S. Dist. LEXIS 18215, at *22 (S.D.N.Y. Dec. 23, 1993) (disclosure to outside accountant "destroys the confidentiality seal required of communications protected by the attorney-client privilege"). The privilege may be maintained in light of disclosure to accountants only when an accountant's assistance is "necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit." Cavallaro, 284 F.3d at 247-48 (citing United States v. Kovel, 296 F.2d 918, 922 (2d Cir. 1961)). In other words, communication to the accountant must be made for the ultimate purpose of "obtaining legal advice from the lawyer", not simply "accounting advice." Id. (citing Kovel, 296 F.2d at 922).
Westernbank concedes that the KPMG report was provided to its outside auditors Deloitte, and does not argue that Deloitte (unlike KPMG) had any role in assisting Westernbank's counsel provide legal advice to Westernbank. (Docket No. 354, p. 8, n. 1). Evidence in the record demonstrates that Westernbank provided the KPMG reports to Deloitte in order to assist Deloitte in its regular auditing function. (Docket No. 314-3, p. 29 (KPMG report "will be a good road map" for Deloitte)). Therefore, Westernbank waived any attorney-client privilege by providing the KPMG reports to Deloitte and they are thus not protected by that privilege. Therefore, the court turns to the work product rule in order to determine whether that privilege protects the KPMG report.
2. Work Product Doctrine
a. Applicability of Doctrine
The work product rule, established in Hickman v. Taylor, 329 U.S. 495 (1947), and codified by Federal Rule of Civil Procedure 26(b)(3), protects from discovery materials prepared "in anticipation of litigation" by a party or a party's representative. However, the rule withholds protection for otherwise-privileged documents upon the opposing party's showing of "substantial need" for the materials and an inability to obtain equivalent materials without "undue hardship." Fed.R.Civ.P. 26(b)(3).
The phrase "in anticipation of litigation" has been the source of substantial discussion among courts and commentators. The First Circuit adopted the standard applied by a number of other appellate courts holding that documents serving both a litigation and business purpose may be protected work product "if, `in light of the nature of the document and the factual situation in the particular case, the document can be fairly said to have been prepared or obtained because of the prospect of litigation.'" Maine v. U.S. Dep't of the Interior, 298 F.3d 60, 68 (1st Cir. 2002) (citing United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998)) (original emphasis). Under this rule, the privilege does not attach to documents that were prepared in the ordinary course of business or that would have been prepared in "essentially similar form irrespective of the litigation." Adlman, 134 F.3d at 1202. The First Circuit recently considered this issue and held that tax accrual workpapers prepared for the dual purposes of complying with securities law as well as preparing for anticipated litigation with the IRS were protected under the doctrine. United States v. Textron, Inc., No. 07-2631, 2009 U.S. App. LEXIS 1538 (1st Cir. Jan. 21, 2009). The court made clear that in the case of "dual purpose" documents, the fact that anticipated litigation "also triggered certain business and accounting obligations does not bar the protection of the work-product doctrine." Id. at *26.
The work product doctrine extends to protect materials prepared by non-lawyers so long as they are "prepared in anticipation of litigation or for trial by or for another party or its representative (including the other party's attorney, consultant, surety, indemnitor, insurer, or agent)." Fed.R.Civ.P. 26(b)(3)(A). As the Supreme Court explained,
the doctrine is an intensely practical one, grounded in the realities of litigation in our adversary system. One of those realities is that attorneys often must rely on the assistance of investigators and other agents in the compilation of materials in preparation for trial. It is therefore necessary that the doctrine protect material prepared by agents for the attorney as well as those prepared by the attorney himself.United States v. Nobles, 422 U.S. 225, 238-239 (1975).
Courts have held that material prepared by accountants, in particular, may be protected by the work product doctrine. See,e.g., In re Grand Jury Proceedings, 601 F.2d 162, 171 (5th Cir. 1979) (protecting financial analyses prepared by accountant to assist counsel in determining client's potential liability);Evergreen Trading, LLC v. United States, 80 Fed. Cl. 122, 142 (Fed.Cl. 2007) (protecting documents prepared by accountant acting as agent for attorney); In re ContiCommodity Services, Inc., Sec. Litigation, 123 F.R.D. 574, 577 (N.D. Ill. 1988) ("To the extent, however, that Odom [an accountant] was an agent of the customers' attorneys involved in an investigation for purposes of the district court suit, documents he prepared for that purpose are protected by the work product immunity"); Adlman, 134 F.3d at 1204 (memorandum prepared by accountant evaluating tax implications of potential merger would be protected by work product doctrine if it "would not have been prepared but for" anticipated litigation with IRS).
Here, a review of the parties' submissions and of the contested documents themselves demonstrates that the contested documents merit work product protection. The court notes at the outset that, contrary to Westernbank's assertions, the simple fact that Westernbank's counsel (rather than Westernbank itself) retained KPMG is not sufficient to determine that KPMG's work deserves protection. The court must focus on the actual function of the contested documents — that is, whether they were prepared in anticipation of litigation — and not on the formalities of the relationship. Nonetheless, during the time that KPMG undertook its review, from June through September 2007 (Docket No. 402, exs. 1, 3), this case and a number of similar ones were proceeding around the world. (Docket Nos. 2 (complaint filed July 6, 2007); 314-4, p. 18 (in September 2007 referencing five different suits against Inyx)). The engagement letter makes clear that KPMG was retained, at least in part, to assist in analyzing facts relevant to Westernbank's claims and defenses in its litigation against Inyx. (Docket No. 402, ex. 1 (KPMG tasked with performing analysis "in order to determine how the alleged irregularities occurred, the individuals involved, and the policies and procedures circumvented, if any"). It is also reasonable to assume that related litigation was a foreseeable concern at this time, as Westernbank urges. (Docket No. 354, p. 8, n. 2). KPMG's analysis of Westernbank's "procedures and controls in place during the life cycle of the credit extended to Inyx, Inc.," and of whether any of those procedures were "circumvented" appears designed to assist Westernbank's analysis of potential liability, claims, and defenses in such litigation. (Docket No. 402, ex. 1). Indeed, the KPMG Inyx report summarizes "the investigation of allegations of improprieties by [Westernbank's] management." (Id., ex. 2). This investigation into "allegations of improprieties" appears, upon the court's in camera review, to have been conducted in order to assist counsel for Westernbank in responding to Inyx's defenses in this case and to claims made in related litigation.
The court also rejects Westernbank's suggestion that this court simply adopt the decision of the Florida court denying a similar motion to compel the KPMG reports. As Westernbank concedes, decisions of that court are not binding here and the court will conduct its own analysis of this motion.
The court takes judicial notice of putative securities class action and derivative suits filed against WHI and Westernbank, involving claims related to the Inyx loans, which are currently pending before this court. Hildenbrand v. W Holding Co., Inc., et al., 07-cv-1886 (JAG) (BJM) (D.P.R. filed Sept. 21, 2007); Wylie v. Stipes et al., 08-cv-1036 (GAG) (D.P.R. filed Jan. 11, 2008).
Green argues that the contested documents should not be protected because they were not prepared in anticipation of litigation, but instead in order to analyze Westernbank's financial exposure and internal controls in connection with WHI's financial reporting obligations. (Docket No. 314). However, the First Circuit instructs that dual purpose documents are within the scope of work product protection. Maine, 298 F.3d at 68 (adopting Adlman test); Textron, 2009 U.S. App. LEXIS 1538. As inTextron, the fact that "the anticipation of [] disputes" with Inyx and potential others "also triggered certain business and accounting obligations", such as an investigation of loan impairment to prepare revised financial reports, does not bar the protection of the work-production doctrine." Textron, 2009 U.S. App. LEXIS 1538 at *25. Thus, the work product doctrine protects the KPMG report so long as it was prepared "because of expected litigation", even if also "intended to inform a business decision influenced by the prospects of litigation." Maine, 298 F.3d at 68 (citing Adlman, 134 F.3d at 1197). As discussed above, the KPMG report was certainly prepared "because of" pending litigation with Inyx and anticipated litigation with shareholders concerning Westernbank's losses as a result of the Inyx loans, and the protection it thus merits is not altered by the fact that KPMG's work may have also informed Westernbank's regulatory filings and financial statements. Therefore, the court concludes that the KPMG report is protected by the work product doctrine.
Green also requested a series of charts prepared by KPMG concerning the Inyx loans. (Docket No. 314-7, 314-8). In response to the January 8 Order, Westernbank produced these documents, a series of spreadsheets containing financial information and analysis relating to the Inyx loans. (Docket No. 402, exs. 5-15). Based on the court's review of these documents, they appear to reflect KPMG's underlying analysis on which it based the KPMG Report. Although the work product doctrine does not protect the "facts contained within work product" Resolution Trust Corp. v. Dabney, 73 F.3d 262, 266 (10th Cir. 1995), these spreadsheets themselves contain KPMG's analysis (albeit in rougher form) and not simply "facts". The analysis conducted in preparation for drafting the KPMG report was created for the same reasons as the KPMG report itself: in anticipation of pending and future litigation, as well as in connection with WHI's financial reporting obligations. For the same reasons that the KPMG report itself is protected by the work product rule, the analyses on which it is based are also entitled to protection.
b. "Substantial Need"
Green urges that even if the contested documents are protected by the work product doctrine, he has made a showing of a "substantial need" for them that outweighs any work product protection. (Docket No. 314, p. 7). Rule 26(b)(3) provides that protected materials may be otherwise discoverable if the opposing party "shows that it has substantial need for the materials to prepare its case and cannot, without undue hardship, obtain their substantial equivalent by other means." Fed.R.Civ.P. 26(b)(3)(ii). Green claims that he has a substantial need for the KPMG report in order to ascertain (1) whether Westernbank was aware of the alleged conduct by Inyx which forms the basis of Westernbank's claims here and (2) whether Westernbank violated its own system of internal controls and procedures. (Docket No. 314, p. 8). Green does not argue that he has a substantial need for KPMG's analysis in and of itself, but rather for the facts which are the subject of that report. Resolution Trust Corp., 73 F.3d at 266 (work product doctrine "does not protect facts concerning the creation of work product or facts contained within work product").
However, Green fails to show that the underlying information is unavailable through other means. See, e.g., Picard Chem. Profit Sharing Plan v. Perrigo Co., 951 F. Supp. 679, 687 (W.D. Mich. 1996) (report of internal investigation protected by work product rule where plaintiffs in shareholder class action failed to show that information was not available through other means). In fact, Westernbank claims that it has already produced to Green and the other defendants "the same documents on which the KPMG Report was based" and Green has not disputed this assertion. (Docket No. 354, p. 11). While Green vaguely asserts that Westernbank refuses to answer questions about the facts underlying the KPMG report, he does not identify any particular deposition in which Westernbank thwarted his efforts to obtain such information. (Docket No. 314, p. 8). He alludes to a "hostile witness," but does not identify any particular witness, and in any event, production of otherwise privileged materials "will not be required if the moving party can compel the hostile witness to submit to a deposition." 8 Charles Alan Wright Arthur R. Miller, Federal Practice and Procedure § 2025 (2d Ed. 1994). Therefore, Green has failed to demonstrate a substantial need for the contested documents.
c. Waiver of Work Product Privilege
Finally, Green argues that even if the KPMG report is protected under the work product rule, Westernbank waived the privilege by disclosing the report to Deloitte, its outside accounting firm. (Docket No. 314). While attorney-client privilege is generally waived by disclosure to any third party because such disclosure "destroys the confidentiality upon which the privilege is premised," XYZ Corp., 348 F.3d at 22, more lenient rules apply to the disclosure of documents protected by the work-product doctrine. Disclosure to a third party will not automatically defeat the purposes of the work product doctrine and the protection need not be deemed to have been waived. As the D.C. Circuit has explained:
the work product privilege does not exist to protect a confidential relationship, but rather to promote the adversary system by safeguarding the fruits of an attorney's trial preparations from the discovery attempts of the opponent. . . . A disclosure made in the pursuit of such trial preparation, and not inconsistent with maintaining secrecy against opponents, should be allowed without waiver of the privilege. We conclude, then, that while the mere showing of a voluntary disclosure to a third person will generally suffice to show waiver of the attorney-client privilege, it should not suffice in itself for waiver of the work product privilege.United States v. American Tel. Tel. Co., 642 F.2d 1285, 1299 (D.C. Cir. 1980). Thus, "[t]he pivotal question is whether disclosure of documents protected by the work product doctrine to an independent auditor substantially increases the opportunities for potential adversaries to obtain the information." In re Raytheon Secs. Litig., 218 F.R.D. 354, 360 (D. Mass. 2003).
The majority of courts to consider the issue have held that disclosure of work product protected materials to outside auditors does not constitute waiver of the privilege. See, e.g.,id., 218 F.R.D. 354 ("there is no evidence that materials disclosed to an independent auditor are likely to be turned over to the company's adversaries except to the extent that the securities laws and/or accounting standards mandate public disclosure"); Merrill Lynch Co. v. Allegheny Energy, Inc., 229 F.R.D. 441, 446 (S.D.N.Y. 2004) (disclosure to auditors did not constitute waiver of work product protection); In re Pfizer, 1993 U.S. Dist. LEXIS 18215, at *21 (disclosure to outside auditor did not constitute waiver of work product protection because auditor is not reasonably viewed as "a conduit to a potential adversary"); Gutter v. E.I. Dupont de Nemours Co., No. 95-CV-2152, 1998 WL 2017926 (S.D. Fla. May 18, 1995) (same).
In support of his claim that Westernbank waived work product protection, Green relies heavily on Medinol v. Boston Scientific Corp., 214 F.R.D. 113 (S.D.N.Y. 2002), which held that disclosure to outside auditors waived work product privilege. However,Medinol has been roundly criticized for its holding and analysis.See, e.g., Vacco v. Harrah's Operating Co., No. 07-CV-0663, 2008 U.S. Dist. LEXIS 88158, at *20 (N.D.N.Y. Oct. 29, 2008) ("Medinol, however, has been almost uniformly rejected");American S.S. Owners Mut. Prot. Indem. Ass'n v. Alcoa S.S. Co., No. 04 Civ. 4309, 2006 U.S. Dist. LEXIS 4265 (S.D.N.Y. Feb. 2, 2006) (declining to follow Medinol "because it appears to be directly in conflict with Adlman"); Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., 237 F.R.D. 176, 183 (N.D. Ill. 2006) (disapproving of Medinol's rationale because "the fact that an independent auditor must remain independent from the company it audits does not establish that the auditor also has an adversarial relationship with the client as contemplated by the work product doctrine").
The court agrees with the majority of courts, cited above, which have held that disclosure of work product protected material to outside auditors does not constitute waiver of work product protection. Therefore, Westernbank has not waived work product protection over the contested documents.
CONCLUSION
For the foregoing reasons, defendant Green's motion to compel is DENIED without prejudice to Green's right to raise any outstanding issues concerning the Business Credit Division Reports.