Kovel Protections Upheld | Government Loses Aggressive Arguments for Waiver of Privilege for Controversy Advice
On October 27, the US District Court for the District of Minnesota issued an opinion in United States v. Adams, No. 0:17-cr-00064-DWF-KMM (D. Minn. Oct. 27, 2018), addressing attorney-client privilege issues relevant to accountants working alongside tax attorneys. The court adopted a narrow, nuanced view of the waiver that applies when the taxpayer discloses an accountant’s work to the Internal Revenue Service (IRS) by filing an amended return.
In Adams, the taxpayer is facing a 17 count superseding indictment in which the government alleges he spearheaded a scheme to defraud investors in two companies and to embezzle corporate funds for his personal benefit. In late 2017, the government added three counts of tax evasion to the indictment, alleging that amended returns the taxpayer filed in late 2011 for the 2008, 2009 and 2010 tax years were willfully false under IRC § 7206(1).
The addition of the tax evasion charges is significant for the government’s arguments for waiver of privilege and work-product protection. It appears that the taxpayer filed the amended returns at issue in late 2011 under advice of counsel, working with the taxpayer’s accountant under a Kovel arrangement. (We have previously discussed the scope of Kovel protections.) In our experience, filing of amended returns in advance of a criminal investigation or trial is one potential strategy to demonstrate good faith and lack of criminal intent and, if combined with payment, amended returns may have the added benefit of reducing the tax loss at issue in a criminal case. Of course, every case is different, but it appears this may have been the strategy at work in Adams.
The government sought a range of communications among the taxpayer, his attorneys and his accountants prior to the filing of the amended returns, and argued that the filing of the amended returns waived any applicable privileges or protections. Further, the government argued that the crime-fraud exception to attorney-client privilege would apply, permitting discovery of the communications.
The court rejected the government’s arguments for waiver through filing of amended returns, and rejected the government’s arguments for application of the crime-fraud exception. Regarding the argument of waiver by filing, the court carefully evaluated the types of information disclosed to the IRS on the amended returns, and held that privilege still applied to a range of information, advice, and data that was not disclosed on the returns. Citing and quoting an US Court of Appeals for the Eighth Circuit case, United States v. Cote, 456 F.2d 142 (8th Cir. 1972), the court held that this information remained protected because it consisted of “workpapers [that] contain detail of unpublished expressions which are not part of the data revealed on the tax returns[.]” The court therefore recognized the important dual role that an accountant may play in a tax controversy—as return preparer, where much information and advice may ultimately become non-privileged and as trusted tax advisor, where privilege and work-product protection may continue to apply.
The court also held that the government had failed to make the showing necessary to invoke the crime-fraud exception to waiver of attorney-client privilege. The government argued that the amended returns themselves were prepared and filed in furtherance of the taxpayer’s overall scheme to defraud. In particular, the government alleged that the taxpayer had falsely represented on the returns that his income was derived from the sale of stocks rather than warrants. The court evaluated these arguments in light of the two-part test for application of the crime-fraud exception:
First, there must be a prima facie showing that the client was engaged in criminal or fraudulent conduct when he sought the advice of counsel, that he was planning such conduct when he sought the advice of counsel, or that he committed a crime or fraud subsequent to receiving the benefit of counsel’s advice. Second, there must be a showing that the attorney’s assistance was obtained in furtherance of the criminal or fraudulent activity or was closely related to it.
Internal citations and quotations omitted.
The court held that the government’s allegations in the indictment met the first element of the test, but the government could not establish the second element—that the advice itself was obtained in furtherance of the criminal activity. After reviewing the specific communications in camera, the court held that there was not reasonable cause to believe that the taxpayer had sought advice of counsel in order to misrepresent the type of income he reported on his amended returns.
Practice Point: As controversy attorneys, we are frequently consulted after a transaction closes and after an original return is filed, but before a civil examination or criminal investigation begins. Here, the prosecution took a highly aggressive stance in seeking waiver of privilege and work-product protection for advice and analysis that occurred after the controversy at issue in the criminal case (or, at very least, after the taxpayer’s reasonable anticipation of litigation) had begun. The court endeavored to apply the waiver rules carefully to protect the taxpayer’s right to counsel.
The Adams case explores a number of interesting elements of attorney-client and accountant-client privilege and work-product protection, only two of which are discussed here. The case is definitely worthy of a close read.
We would like to thank McDermott law clerk Terence McAllister for his contributions to this article.