FRC v Sports Direct : the latest regulatory challenge on privilege

FRC v Sports Direct : the latest regulatory challenge on privilege

The FRC has successfully persuaded a court to order an audit client, Sports Direct International Plc (SDI), to disclose privileged documents relevant to the FRC’s investigation of SDI’s auditor. What next?

FRC v Sports Direct : the latest regulatory challenge on privilege

Recent legislation enables the FRC to obtain documents for its investigations direct from third parties. The FRC can now ask audit clients for documents to assist its investigation of the auditor. We have little doubt we will see more such applications in the future.

The SDI decision raises these issues for auditors and audit clients:

  • Could a company lose privilege over documents it has disclosed to its auditors? (Both as against the FRC and – worryingly – against the world at large.)
  • Could this fear mean audit clients seek to withhold privileged information from their auditors? What would the consequences be?

From one perspective, it makes complete sense that the FRC should get to see privileged information disclosed to auditors. Auditors make decisions on the basis of privileged information. The FRC investigates the decisions of auditors. How can the FRC do its job without having all the information?

Conversely, the FRC – and the world at large – has an interest in audit being effective. And that depends on an auditor being given all the facts. Any chilling effect on audit clients handing over privileged material is a real problem. And what about material already handed over? Audit clients rightly have no wish to spend time and money tussling with a regulator to which they are not subject – and indeed which is there to protect audit clients themselves!

In short – it’s a tricky one!  But it needn’t be an insuperable problem, and we set out below some relevant considerations.

The case

The FRC is investigating the conduct of SDI’s auditors and successfully argued that SDI should give up the privileged documents. The FRC’s basis for that argument was that the disclosure did not actually infringe SDI’s privilege – the documents would only be used by the FRC for the purpose of its investigation, and the FRC would keep them confidential.

The FRC also argued that to the extent privilege was infringed by disclosure to the FRC, it was only a technical infringement because the documents would not be used against SDI.  As such, SDI did not benefit from the statutory protection given to those subject to FRC Notices (providing that they need not hand over privileged information).  The judge agreed with the FRC “with some hesitation”.  The decision is on appeal. 

What are the implications of this?

There are a number of cases where the courts have allowed disclosure of privileged documents to regulators. However, this is mainly disclosure to HMRC to ensure the correct amount of tax is paid, and to the Law Society to enable it to investigate whether solicitors have complied with the Solicitors Account Rules.

Fair enough. But there are differences between these cases and that of the FRC.

  • First difference – in Law Society / HMRC cases, the court is compelling disclosure of documents by the entity under investigation. That’s a world away from compelling disclosure by an audit client of its documents. The audit client is not under investigation, but that is not how it will feel, and such differences matter, particularly as companies are increasingly at risk of investigation where its financial affairs are publicly criticised or, say, consumers suffer.
  • Second difference– in Law Society / HMRC cases, it may be easier for the regulator to keep documents confidential. In FRC cases, the investigatory phase is confidential but the disciplinary phase is not. If the privileged information is relevant, it may inform considerations in an open tribunal or in a published document.
  • Finally – It may be straightforward for the HMRC to limit use of client privileged material to its calculation of tax. However, an investigation by the FRC into an audit of a public interest entity encompasses the audited company’s affairs, the conduct of the directors, and third parties’ legal position vis-à-vis the company.  A very different type of investigation.

This could have serious consequences for the audit client. There is a reason for legal privilege – a company needs to be able to tell its lawyers everything, including information that should be kept private and confidential. And so-called ‘regulatory gateways’ may mean the information gets passed to other regulators. Concerns over retaining privilege in short are real, not “technical”.

A Court of Appeal decision is needed

We need a clear decision from the Court of Appeal which deals fully with these issues. The appeal court might follow the approach taken by the Tax Tribunal in August last year, which when considering whether to order disclosure of audit working papers, weighed up the competing public interests – tax collection and effective audit. The Tax Tribunal decided not to order disclosure of audit papers because there was no clear statutory basis to override the protection from disclosure of certain information and documentation held by auditors, which is we think analogous to the position for privileged communications.  As the judge in SDI rightly put it, the starting point is that privilege is a fundamental human right “that can only be abrogated or overridden by primary legislation”.

There may be good arguments for the FRC getting access to privileged documents. But if this is where we’re headed, there needs to be protection of the audit client’s fundamental right to claim privilege.

Richard Highley is a partner and Julian Bubb-Humfryes is a solicitor with international law firm DAC Beachcroft.

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