Privilege and Maxwellisation – what can we learn from recent FRC cases?
Article first published in ARDL newsletter and republished on LinkedIn with permission
The same issues often crop up across an array of regulatory work. Legal professional privilege is the most obvious example, with a number of high profile cases arising out of SFO investigations. A second example concerns the rights of third parties to prevent the publication of adverse comment about them in regulatory reports and decisions (‘Maxwellisation’). In this article, Jamie Smith QC and Helen Evans explain how these two issues have arisen in the context of disciplinary investigations and proceedings undertaken by the Financial Reporting Council (FRC), which plays an important role in the regulation of accountants.
Legal professional privilege
A starting point for any regulatory investigation is the request by the regulatory for documentation in the hands of the professional person or firm. What if that person or firm holds information that is arguably subject to client privilege? This problem is not exclusive to accountants, but it arises frequently in the audit context. Often, the auditor must have sight of, say, a legal opinion as to the prospect of success in a major piece of litigation, in order to test the accuracy of the financial statements. If the FRC demands sight of that legal opinion, as part of a regulatory investigation, is the auditor obliged to hand it over?
The answer to this question was given by Arnold J in FRC v. Sports Direct  EWHC 2284 (Ch). In that case, the FRC applied for the arguably privileged material to be provided by the audit client directly, but the analysis applies equally to the auditor.
Arnold J addressed two separate questions:
- Is privilege lost when the client provides the document/information to the auditor? The Judge answered this question in the negative (para. 56). Privilege was not destroyed by being placed in the auditor’s hands. Instead, the auditor was brought within the circle of confidence;
- Would it contravene client privilege for the auditor (or the client) to provide the document/information to the FRC? The Judge also answered this question in the negative. His primary reason for so going was that the provision of information to the FRC for the purposes of a confidential investigation into a regulated person was not an infringement of privilege (para. 84). Arnold J drew heavily on authorities relating to the regulation of the solicitors’ profession, and in particular R (Morgan Grenfell & Co Ltd) v Special Commissioner of Income Tax  1 AC 563. The Judge also accepted a secondary submission made by the FRC, namely that any infringement of privilege was authorised by the state (para. 92).
The Sports Direct decision is awaiting appeal. The case has attracted some criticism, on grounds of both principle and practice. The objections of principle include the argument that allowing disclosure for the purposes of a confidential investigation conflicts with the absolute nature of privilege. The practical objections include the lack of clarity about what a regulator granted access to a document for investigatory purposes is then allowed to do with it. What happens when the regulator brings a formal complaint? What if there are information sharing gateways with other regulators?
‘Maxwellisation’ and the protection of the rights of third parties
As with most regulatory disciplinary regimes, the FRC Accountancy Scheme and Audit Enforcement Procedure are designed to be public. The glare of publicity for the audit engagement partner and his/her team is an inevitable consequence of being regulated persons. But, what of the chief executive of the audited company? What if a key aspect of the disciplinary proceedings against the auditor is that dishonest practices are said to have taken place within the audited entity?
It may therefore be, and often is the case, that FRC disciplinary proceedings lead to a decision by the Tribunal that contains highly adverse comment as to third parties working within the audited entity. Settlement agreements, which are equally designed to be made public, may too contain such comment.
What rights do those third parties have to prevent publication of such adverse comment and the attendant reputational damage?
In general terms, this issue has been around for a while, not least in the context of financial regulation. Under s. 393 of FSMA 2000, where the FCA publishes a Warning Notice or a Decision Notice setting out a case against a regulated firm and that notice (a) identifies a third party and (b) may be prejudicial to that third party, a copy of that Notice has to be provided to him/her. The third party is then entitled to make representations, and often does so. The third party may also complain that, whilst he/she is not identified by name, there is enough detail in the Notice to enable his/her identity to be deduced. Recent cases on third party rights in the FCA context include: FCA v Macris  1 WLR 1095 (SC) and FCA v Grout  EWCA Civ 71 (CA). In UK Innovative TI Limited v FCA  UT 0136 (TCC), the Upper Tribunal held that Supervisory Notices are not caught by the third party rights procedure set out in s. 393 of FSMA 2000.
Turning specifically to the FRC disciplinary context, there is no underlying statute affording third party protection; nor do the FRC regimes yet cater explicitly for Maxwellisation or other measures of protection. Third parties must fall back on common law and ECHR rights.
In R (Lewin) v FRC  1 WLR 2867, the complainant was the subject of highly adverse comment in a Report produced by the FRC’s Disciplinary Tribunal, following a lengthy disciplinary hearing arising out of an audit engagement. He had taken no part in the disciplinary proceedings; nor had been requested to do so. He became aware of the content of the Report immediately prior to its publication and sought judicial review of (a) the Tribunal’s decision to hear the matter in his absence and/or to set down adverse comment about him in the Report and of (b) the FRC Conduct Committee’s decision to publish the Report (without applying a suite of redactions to ensure his anonymisation).
The judicial review application was dismissed by Nicola Davies J. on the grounds that:
- The Tribunal had had to investigate the nature and extent of the fraud at the company in order to determine whether there had been any culpability on the part of the auditors;
- There was nothing in the FRC’s Accountancy Scheme which permitted the sending of a draft Report to a third party in order to invite comments in advance of publication;
- Given the public nature of the scrutiny of the FRC, a director of a public company could have had no reasonable expectation of privacy arising from the disciplinary proceedings; and,
- There was a strong public interest in publishing the full Report.
The consolation for the complainant in R (Lewin) was the Court’s acknowledgement that the Report should have on its front page a disclaimer stating that he had not been a party to the proceedings, had not been invited to provide evidence to the Tribunal and that it would not be fair to treat any part of the Report as containing findings made against him.
A few months after Nicola Davies J.’s judgment in R (Lewin), on 12 June 2018 the FRC announced terms of settlement with PWC and the audit engagement partner in relation to audits of BHS and the Taveta Group. In accordance with its guideline publication procedures, the FRC wished to place the settlement documents on its website. As is routine, these documents included particulars of facts and misconduct agreed by the parties for the purposes of the settlement. Taveta (the audit client) sought an injunction to prevent the publication of what it regarded as “unwarranted criticism” of it.
This led to the judgment of Nicklin J. in Taveta Investments Ltd v FRC  EWHC 1662 (Admin). The Judge held that there was a serious issue to be tried as to whether the agreed settlement documents were defamatory and whether the FRC owed a duty of fairness to Taveta. However, in the result, Taveta had not showed that there it was the sort of exceptional case that permitted the grant of an interim injunction restraining publication pending resolution of the substantive issues.
Although Taveta’s application failed, Nicklin J rejected the submissions of counsel for the FRC that R (Lewin) was authority for propositions that:
- The FRC could include in published documents findings that were seriously defamatory of a third party and was under no duty to permit the third party an opportunity to make submissions to the FRC before publication;
- The interests of the third party were adequately protected by safeguards such as the inclusion of a disclaimer upon publication.
Alternatively he suggested that if R (Lewin) was authority for those propositions, then it was contradicted by earlier authorities.
We therefore currently have a fluid situation for third parties. Both R (Lewin) and Taveta recognise that third parties facing adverse comment by regulators do have common law and ECHR rights to fair treatment. What is not yet clear is what practical steps are needed by regulators by way of adequate protection of these rights. Watch this space!
Disclaimer: this article is not to be relied on as legal advice. The circumstances of each case differ and legal advice specific to the individual case should always be sought.