More on Applying the Attorney-Client and Work Product Privileges to Internal Investigations

At a compliance conference last Spring, I was asked what the recent case Aronson v. McKesson
HBOC, Inc., 2005 WL 934331 (N.D. Cal., Mar. 31, 2005), says about application of the
attorney-client privilege (ACP) to the fruits of a corporate internal investigation that are shared
with the government.  The short answer is nothing, because the court’s decision rested on the
work product privilege, which has a much narrower application than the ACP.  This post
discusses the McKesson opinion as well as its implications (or lack thereof) for the ACP.

McKesson is a shareholder suit that arose out of the merger of McKesson, Inc. and HBO &
Company.  In the wake of a post-merger announcement of accounting problems, the merged
company’s audit committee charged outside counsel with investigating.  The company disclosed
the investigation report and materials to the government on condition that the government would
keep those materials confidential.  When the shareholders sought those materials in their private
civil suit, the company asserted the ACP and work product privilege.  The plaintiffs argued that
disclosure to the government waived both privileges.

For those who are interested, here is the court’s full discussion of the background facts:

A.    The Merger and Restatement

    On January 12, 1999, HBO & Company ("HBOC") and McKesson, Inc. merged.
McKesson, Inc. was renamed McKesson HBOC, Inc., while HBOC became the wholly owned subsidiary of McKesson HBOC now called McKesson Information Services ("MIS"). Four months after the merger on April 28, 1999, McKesson HBOC (hereinafter "McKesson") issued a press release in which it announced the company's discovery of more than $42 million in improperly recognized revenue, which would have to be reversed. Following that announcement, the share price of McKesson stock fell by more than 40% from $65.75 to $34.50, representing a $9 billion drop in market capitalization. Soon after the announcement, several dozen shareholders' suits were filed in federal and state court naming McKesson, its current and former directors,
officers, and employees as defendants.

B.    The Disputed Materials

    On or about May 3, 1999, McKesson's Board of Directors authorized its Audit Committee to review McKesson's accounting policies and procedures and make recommendations to prevent a recurrence of the issues that gave rise to the April 28 announcement. Soon thereafter, the Audit Committee retained Skadden to provide legal advice and assist in reviewing the circumstances and accounting policies, procedures, and controls that had resulted in the overstatement of revenue.
At the same time, McKesson hired Skadden to represent it in anticipated shareholder suits. Skadden retained PricewaterhouseCoopers LLP ("PWC") to assist in the internal investigation. Skadden, working with PWC as accounting consultants, conducted an extensive investigation, including document review and 55 attorney interviews of 37 present and former employees of McKesson and HBOC. Skadden compiled a report and supporting materials, including memoranda regarding the interviews its attorneys had conducted ("Skadden Report and Back-up Materials").

    On May 10, 1999, McKesson and PWC met with SEC investigators. Thereafter, Skadden, on McKesson's behalf, entered into substantially identical confidentiality agreements with the Securities and Exchange Commission ("SEC") on May 27, 1999 and the United States Attorney's Office ("USAO") on May 28, 1999 under which Skadden would provide the government with any report which might result from the internal investigation and the materials upon which such report would be based.  McKesson also agreed to provide "periodic oral summaries concerning the status of the review being conducted under the direction of the Audit Committee."

    In the letter agreements, McKesson set forth that it was disclosing the information to the SEC and USAO on the basis of common interest.  Both letter agreements asserted that the materials were protected by attorney-client and work product privileges. The agreements provided that McKesson did not waive any applicable privileges by agreeing to produce or producing the Skadden Report and Back-up Materials, but that the material therein would assist the SEC and USAO "in carrying out its law enforcement responsibilities."  The agreement with the USAO permitted use of the disputed materials "in any criminal investigation or prosecution, including any prosecution of [McKesson]." Further McKesson agreed that the USAO could use
the disputed materials "as it deems appropriate in furtherance of the investigation and any resulting prosecutions" and specifically consented "to the disclosure of the Report and Back-up Materials to a federal grand jury as the [USAO] deems appropriate, and in any criminal prosecution that may result from the Office's investigation."  The SEC agreed "not to disclose the Report or Back-up Materials to any third party, except to the extent that the [SEC] determines that the disclosure is otherwise required by federal law or in furtherance of the [SEC's] discharge of its duties and responsibilities."

    On July 14, 1999, McKesson announced that it would restate its revenues. Five days later, on July 19, 1999, the SEC issued a formal order of investigation of McKesson. Skadden submitted the final report to the Audit Committee on July 22, 1999. McKesson gave the Skadden Report to the SEC and USAO between July 27 and August 5, 1999.

Note the following facts from the case:

• The private shareholder litigation was filed BEFORE the internal investigation had begun.
• The same firm that conducted the internal investigation was retained to defend the shareholder suit.
• The company’s confidentiality agreements with the SEC and USAO were concluded BEFORE the company disclosed its investigation materials.

First, consider the ACP.  The court explained that the ACP attaches:

"1)Where legal advice of any kind is sought; 2) from a legal adviser in his capacity as such; 3) the communications relating to that purpose; 4) made in confidence; 5) by the client; 6) are at his instance permanently protected; 7) from disclosure by himself or by the legal adviser; 8) unless the protection be waived."

The court held that the ACP did not apply to the company’s investigation materials because those
materials were not “made in confidence”:

McKesson agreed to disclose the Skadden Report and Back-up Materials and provide oral updates as to the progress of the investigation to the government in late May 1999. The Skadden Report was not yet in existence at the time the letter agreements were signed.  McKesson received the final report from Skadden around July 22, 1999--well after McKesson had agreed to share the Report and Back-up Materials with the government--and subsequently shared the information with the government. Where, as here, there is an agreement by the client that provides for the disclosure to a third party of the communications between a client and attorney in advance of those communications being made, the communications disclosed pursuant to that agreement are not confidential and the goals of the attorney-client privilege are not in play.

Because the ACP never attached, the court never reached the question whether selective
disclosure to the government waived the privilege.

Next, the court turned to the work product privilege.  All parties conceded that that privilege
applied because, as noted above, the investigation was carried out in anticipation of defending
pending litigation.  The question was whether selective disclosure of the investigation materials to
the government waived the privilege.  The court noted a split in the circuits weighing heavily in
favor of waiver, but also explained that the Ninth Circuit had not taken a clear position on the
issue.  The court then adopted a narrow allowance of selective disclosure without waiver:

     The court finds [the minority view] persuasive with regard to recognizing a distinction between disclosure to a private entity (resulting in waiver) and disclosure to a government entity pursuant to a confidentiality agreement (maintaining work product protection).  Permitting disclosure to the government under a confidentiality agreement would not undermine the underlying principles of the work product doctrine. "The work product privilege rests on the belief that ... promotion of adversary preparation ultimately furthers the truth-finding process." AT & T, 642 F.2d 1285, 1300 (D.C.Cir.1980). Its ultimate aim is "to promote the proper administration of justice." In re Grand Jury, 138 F.3d 978, 984 (3d Cir.1998). As the D.C. Circuit acknowledged in AT & T when considering common interest between MCI and the government in pursuing parallel antitrust cases, permitting "MCI to contribute the fruit of its analysis to the Government on those issues common to their two cases will further the Government's preparation for trial and eliminate some duplication of effort." Id. While the alignment of issues and goals may be insufficient to constitute a common interest where, as here, the disclosing and receiving parties are potentially on opposite side of the litigation, the presence of a confidentiality agreement ensures, to the extent possible under the law, that disclosure of the protected materials will not reach adverse parties.

    . . . .

    The Skadden Report and Back-up Material have resulted in significant benefits to the government: permitting the government to focus its investigation on the primary wrongdoers, filtering documents produced to the SEC, and permitting the government to deploy fewer employees to investigate McKesson. Therefore, taking into consideration the benefit to the public of permitting disclosure of work product to the government and in light of the cases cited above rejecting selective waiver but endorsing the preservation of work product protection under negotiated confidentiality with the government, the court finds that the facts presented by this case warrant the conclusion that McKesson did not waive work product protection as to the Skadden Report and Back-up Materials.

Before getting too excited about this holding, one should note three important limitations.  First,
the work product doctrine attaches only to investigations conducted in anticipation of litigation.
In McKesson, this thorny question was not at issue because litigation was already pending when
the investigation started.  In most compliance situations, however, an organization must begin its
investigation upon receiving an internal report of wrongdoing, long before litigation has entered
the mind of a plaintiff or prosecutor.  In such instances, the work product privilege will
be inapplicable if the court believes that the investigation was conducted for purposes of risk
management or internal compliance, and not in anticipation of litigation.  Without the privilege,
waiver is never even an issue.

Second, the investigation materials must be produced to the government under a confidentiality
agreement.  If confidentiality is discussed or promised after disclosure, the McKesson holding
does not apply.

Third, McKesson is truly a minority position. Whether its rule gains traction outside of the
Northern District of California (and that can occur only in the Circuits without directly contrary
precedent) remains to be seen.  (A recent decision from the Southern District of New York
applies Second Circuit precedent in allowing similar selective disclosure.  See In re Natural Gas
Commodity Litigation, 2005 WL 1457666 (S.D.N.Y., June 21, 2005).)