The IRS v. Attorney-Client Privilege:

Wrestling Secrets From Your Client

May 1999

I was being entertained by the World Wrestling Federation match on the big screen at the Title 26 Inn when the low hum of the many conversations of the other patrons was drowned by a loud declaration.

"It's not just a matter of interpretation! It's a matter of geometric relationships!"

The bartender gestured toward the other end of the bar and said, "That's U.S. v. Ackert, 1999 U.S. App. LEXIS 3129 (2nd Cir. 2/26/99). He came in with U.S. v. Kovel, 296 F.2d 918 (2nd Cir 1961), and U.S. v. Adlman, 68 F.3d 1495 (2nd Cir. 1995). I knew they'd start arguing sooner or later."

I sensed that a lively discussion was in the making. I worked my way to the other end of the bar where Ackert, Kovel, and Adlman were standing with their backs toward me, leaning their elbows on the mahogany bar for support.

Kovel and I had worked together often. I knew of Ackert and Adlman but I had never actually met them. When I reached the trio I tapped Kovel on the shoulder and asked if I could listen in on their conversation.

Before Kovel could turn and reply, Ackert turned his head and asked, "Who are you?"

By then Kovel had fully turned around and grasped my hand.

"Hello, Counselor. Nice to see you again" said Kovel. "Don't mind my friend here. He's been lingering in the courts so long that he hasn't had a chance to learn much civility in public."

Kovel then proceeded to introduce me to Ackert and Adlman.

"You may also know my younger brother, U.S. v. Adlman, 134 F.3d 1194, (2nd Cir 1998) (Adlman II)," said Adlman as he extend his hand.

"Yes," I replied. "I've gotten some use from your brother's holding on the work-product doctrine to protect the communications among my clients, their accountants, and me from the prying eyes of the IRS. But, I'd feel a lot safer knowing that those communications were protected by the less ambiguous attorney-client privilege."

"They are protected by the attorney-client privilege," said Adlman, "assuming you can prove that the communication was to aid the attorney in rendering legal advice to the client rather than giving accounting advice to the client."

"That's an oversimplification!" shouted Ackert. "You also have to prove that the attorney has some need for, and is capable of using, the work produced by the accountant."

"Hold on, Ackert," said Kovel, "I think you've read too much into my use of the 'interpreter' metaphor."

I noticed the large crowd gathering around us. I suggested that we turn our discussion into a panel presentation for the benefit of all the patrons at the Title 26 Inn that evening. The trio from the Second Circuit agreed and we headed to the back room of the Inn.

I told the audience that we going to discuss the application of the attorney-client privilege to communication between an attorney and a third party, or between the third party and the client, specifically when the third party is an accountant or financial advisor for the client. After everyone settled in their chairs I identified the panel members to the audience.

"I'd be surprised if anyone in the room didn't already know U.S. v. Kovel, 296 F.2d 918 (2nd Cir 1961), who was responsible for the ground-breaking holding that communications between a client and an accountant are covered by the attorney client-privilege if the purpose of the communication is to aid the attorney in giving legal advice to the client."

Mr. Kovel received a warm round of applause from most of the audience. The enforcement provisions of the Internal Revenue Code sat on their hands.

Someone in the audience asked whether our discussion was out of date because of the recently enacted accountant-client privilege under IRC §7525.

"No," I replied, "because the statutory accountant-client privilege is limited to non-criminal federal tax proceedings. Thus, it doesn't cover federal non-tax proceedings, it doesn't cover federal civil tax proceedings, and it doesn't cover State tax or non-tax proceedings. Kovel's holding can be applied to a state matrimonial action as well as a federal civil tax proceeding. The statutory accountant-client privilege doesn't apply to either of those."

Someone else asked if IRC §7525 was intended by Congress to overrule the Kovel doctrine except under the limited circumstances to which the statutory accountant-client privilege applied.

"I don't think so," replied Kovel. "First, the legislative history of IRC §7525 doesn't refer to me; and second, my doctrine requires the participation of an attorney while the statutory accountant-client privilege applies in the absence of an attorney."

"Next," I continued, "I'd like to introduce U.S. v. Adlman, 68 F.3d 1495 (2nd Cir 1995), whom many of you already know. Adlman held that a privilege claim requires proof of the appropriate relationship to establish the application of the privilege." The welcome was less enthusiastic than that given to Kovel but the enforcement provisions of the IRC joined in this time.

"Finally, let me introduce you to our most recent decision addressing the application of the attorney-client privilege to communication with an accountant,

U.S. v. Ackert, 1999 U.S. App. LEXIS 3129 (2nd Cir 2/26/99)." The enforcement provisions of the IRC were on their feet wildly clapping and cheering, while the rest of the audience participated in cordial but tepid applause. I then asked each panel member to summarize their facts and holdings.

"In my case," said Kovel, "the defendant, Louis Kovel, was a former IRS agent employed by Kamerman & Kamerman, a law firm specializing in tax law. Mr. Kovel was subpoenaed to appear before a grand jury investigating alleged Federal income tax violations by a client of the law firm. Mr. Kovel refused to answer certain questions posed by the grand jury on the grounds that the attorney-client privilege prohibited him from disclosing any communications by the client and disclosing the result of any work done for the client, unless the client consented. The United States obtained a conviction of criminal contempt against Mr. Kovel on the argument that the attorney-client privilege did not apply to one who was not an attorney.

"I held," continued Kovel, "that the attorney-client privilege could apply to communication between a client and a non-lawyer where the communication with the non-lawyer was for the purpose of aiding the lawyer in giving legal advice. I saw the issue as one requiring a delicate balance:

"But," said Ackert, "despite your reference to the rather broad concept of agency, you went on to limit the application of the privilege to situations where the non-lawyer acted as an interpreter for the attorney with respect to the information being provided by the client."

"I'm not so sure my opinion should be read that restrictively," replied Kovel. "I used the 'interpreter' analogy only to illustrate the fallacy of the position taken by the government. The government had argued that the privilege should be restricted to client communications with non-lawyer employees acting in a menial or ministerial capacity solely for purposes of relating communications to an attorney. I felt certain, however, that the attorney-client privilege would apply to communication between the client and an interpreter for the purpose of aiding the attorney in giving legal advice to a client who spoke only a foreign language, regardless of whether the interpreter was an employee of the lawyer. I then characterized the language of accounting as a foreign language, leading me to the analogy between the client-interpreter communication and the client-account communication. I concluded that both types of communication would be covered by the privilege so long as the communication was made in confidence for the purpose of obtaining legal advice from the lawyer, whether or not the accountant was an employee of the lawyer."

"So you are saying," asked Adlman, "that Ackert misread your opinion?"

"Hey, buddy!" exclaimed Ackert, "I think you are misreading my opinion so that you could conclude that I misread Kovel's opinion. If there is anyone who can't read around here it must be you. And where did you get that silly bow tie? Did it come with clown shoes?"

At that point I knew it was time to start moderating again. "Now, gentlemen, please settle down and let's stay focused on the issues!" I quickly replied as I stepped between Ackert and Adlman, trying to keep the discussion from degenerating into a wrestling match.

"O.K.," said Ackert. "Let Adlman tell us what he thinks he said so the rest of us won't have to think about what he said."

Although Adlman was again inching in Ackert's direction, I was able to gently guide him back to his seat and focus his attention on the discussion by asking him to outline his facts and holding.

"My case," said Adlman, "arose from an IRS summons enforcement action against Monroe Adlman, who was an attorney and vice president for taxes of Sequa Corporation. The summons sought production of a final and preliminary drafts of memoranda prepared by Sequa's accountants, Arthur Andersen & Co. The documents at issue discussed the probable tax consequences of a proposed reorganization of Sequa's subsidiaries. The reorganization took place in the manner suggested by the accountants in the memoranda at issue. The IRS sought disclosure of the memoranda but the defendant refused on the basis of the attorney-client privilege and the work-product doctrine. The district court had held that the memoranda were not protected by either the attorney-client privilege or the work-product doctrine. I upheld the district court's decision with respect to the attorney-client privilege, but I remanded for further consideration of the application of the work-product doctrine. My younger brother, U.S. v. Adlman, 134 F.3d 1194, (2nd Cir. 1998) (Adlman II), subsequently held that the memoranda at issue were protected from disclosure by the work-product doctrine."

"The circumstances sound a lot like the interpreter circumstances I described in my opinion," said

Kovel. "Why did you conclude that the memoranda were not protected by the attorney-client privilege?"

"Actually," replied Adlman, "all I really concluded was that the district court's findings were not clearly erroneous. I felt that the record supported the district court's determination that the accountants were engaged to render advice to the client rather than to aid the attorney in rendering advice to the client."

"What factors did you consider in reaching that conclusion?" I asked.

"First," replied Adlman, "letters and memos among the attorney, the accountants, and the client indicated that the accountants were engaged to render advice to the client rather than to aid the attorney in rendering advice to the client. Second, the attorney, Mr. Meyers, admittedly lacked the necessary expertise to assess the tax implications of the proposed restructuring."

"But," said Kovel, "isn't the attorney's lack of knowledge the basis on which we justify covering non-lawyer advisors with the attorney-client privilege? As I said in my opinion, accounting is like a foreign language to attorneys, and the need to employ an accountant to interpret that language justifies extending the attorney-client privilege to cover accountants who have been engaged to aid the attorney in giving legal advice."

"That's correct," replied Adlman, "but the attorney has to have some capacity to use the information presented by the accountant. If the attorney can't use the information because of lack of capacity to comprehend it, then the accountant has been retained solely for the client rather than for the purpose of aiding the attorney in rendering legal advice."

"Hey!" said Ackert. "What about an attorney who is also an accountant? He or she wouldn't need an interpreter because accounting would not be a foreign language. Would you rule under those circumstances that the privilege did not apply to the accountant-client communication because an interpreter was not needed?"

"No," replied Adlman, "I would rule that the privilege did apply because in that situation the account would be performing a mere 'menial' or 'ministerial' role and even the government concedes that anyone playing such a role is covered by the privilege."

"O.K., Ackert," I said "it's your turn to explain yourself. As I recall, this entire conversation started with you claiming that your opinion expressed some type of geometric solution to the issue?"

"Well," said Ackert, "you first need to understand the facts to put my holding in its proper perspective. David Ackert was employed by Goldman, Sachs, and Co., an investment banking firm that had approached Paramount with an investment proposal. The proposed transaction was expected to reduce Paramount's federal income tax liability by generating significant capital losses that would offset Paramount's recent capital gains from the sale of a subsidiary. Mr. Ackert pitched the investment proposal to representatives of Paramount. Although Mr. Ackert was an attorney, he functioned solely as an investment banker while at Goldman, Sachs. Although he discussed the possible tax consequences of investments with potential clients, including Paramount, he did not provide them with legal or tax advice.

"After the initial meeting with Mr. Ackert, Eugene I. Meyers, Paramount's senior vice president and tax counsel, conducted legal research and analysis in order to advise Paramount about the tax implications of the proposed investment. In the course of this research, Mr. Meyers contacted Mr. Ackert, and the two men had several follow-up meetings to discuss various aspects of the Goldman, Sachs proposal. Mr. Meyers initiated these discussions to learn more about the details of the proposed transaction and its potential tax consequences, so that he could advise his client, Paramount, about the legal and financial implications of the transaction.

"Paramount ultimately decided to enter into the proposed investment, but used the services of another investment banker, Merrill Lynch & Co. Paramount paid Goldman, Sachs a fee of $1.5 million for services rendered in connection with its proposal. Seven years later, the Internal Revenue Service was conducting an audit of Paramount and its subsidiaries for its 1989 through 1992 tax years. In connection with the audit, the IRS issued a summons to Mr. Ackert seeking his testimony about the 1989 investment proposal. Paramount asserted the attorney-client privilege with respect to questions concerning any conversations Mr. Ackert had with Mr. Meyers or in Mr. Meyers' presence.

"The district court agreed with Paramount, apparently on the theory that the conversations at issue were privileged because Mr. Meyers had been collecting information from Mr. Ackert about the proposed investment in order to give legal advice to Paramount. The United States appealed and argued that the conversations at issue were not privileged because they were between an attorney an a third party rather than between an attorney and a client. Paramount asserted that the conversations between Mr. Myers and Mr. Ackert were protected by the attorney-client privilege under the Kovel doctrine. I rejected Paramount's attempt to apply Kovel to the situation at hand, and I stated that

"That principle, however, has no application to this case. Meyers was not relying on Ackert to translate or interpret information given to Meyers by his client. Rather, Meyers sought out Ackert for information Paramount did not have about the proposed transaction and its tax consequences. Because Ackert's role was not as a translator or interpreter of client communications, the principle of Kovel does not shield his discussions with Meyers.

"I concluded that Paramount had failed to demonstrate a basis for applying the attorney-client privilege to the communication between Mr. Meyers and Mr. Ackert."

"In other words," said Adlman, "you concluded that Mr. Ackert was not acting as an interpreter for Mr. Meyers. Therefore the attorney-client privilege did not apply to the communications between Mr. Meyers and Mr. Ackert. Correct?"

"Well, Adlman," replied Ackert, "my opinion is subject to at least two interpretations. First, as you characterized it, is the view that my opinion limits the application of the attorney-client privilege for accountant-client communications to situations where the accountant is acting as an interpreter for the attorney."

"However," Ackert continued, "that view may be too restrictive and it was not necessary to reach my conclusion. I may have decided only that Paramount failed to establish that the communication between the third party (Mr. Ackert) and the attorney (Mr. Meyer) was in the line of communication from client to accountant to attorney. As I said in my opinion, Mr. Ackert (the third party) was not communicating with Mr. Meyers (the attorney) about information obtained from Paramount (the client). Rather, Mr. Ackert (the third party) and Mr. Meyers (the attorney) were discussing information that was unknown to Paramount (the client). In essence, the third party, the client, and the attorney were in a triangle of communication with each of them representing a point of the triangle. The Kovel doctrine, however, should be limited to instances where the third party, the client, and the accountant are on a line of communication with the third party in the middle and the client and attorney at opposite ends. My reference to Kovel's interpreter analogy could be nothing more than an illustration of one of the many types of relationships that qualify for the necessary 'in-line' arrangement, but the interpreter role is not necessarily the only such relationship."

"Well," I interrupted, "it looks like the final match of Monday night wrestling is about to begin and I want to get back to my seat at the bar and get a tall one before it starts. So I'll try to sum up what I think we've learned from this discussion.

"First, the Kovel doctrine is alive and well despite the recently enacted statutory accountant-client privilege under IRC §7525. Second, as we learned from Adlman, attorneys and accountants would be wise to maintain contemporaneous documentation of their Kovel arrangements, such as the example Kovel letter agreement that can be found at http://www/TaxLawCenter.com. Third, Ackert appears to hold that Kovel applies only to 'in-line' relationships and not to 'triangular' relationships among the attorney, the client, and the third party."

And with that, we hoisted our beverages and turned our attention to the drama about to play out in the "quadrilateral" arena on the tube.