U.S. v. Arthur Young & Co., s. 15

Citation49 A.F.T.R.2d 82,677 F.2d 211
Decision Date13 April 1982
Docket NumberNos. 15,D,16,s. 15
Parties82-1 USTC P 9320, 10 Fed. R. Evid. Serv. 906 UNITED STATES of America, Petitioner-Appellee, v. ARTHUR YOUNG & COMPANY, Respondent-Appellant, and Amerada Hess Corporation, Intervenor-Respondent-Appellant. ockets 81-6048, 81-6056.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Leona Sharpe, Asst. U.S. Atty., New York City (William M. Tendy, Acting U.S. Atty., S. D. N. Y., David M. Jones, Michael H. Dolinger, Asst. U.S. Attys., New York City, of counsel), for petitioner-appellee.

Carl D. Liggio, Gen. Counsel, New York City (John E. Matson, Richard I. Janvey, Associate Gen. Counsel, New York City, of counsel), for respondent-appellant Arthur Young & Co.

Robert G. Morvillo, New York City (Obermaier, Morvillo, Abramowitz, Milbank, Tweed, Hadley & McCloy, Roger B. Oresman, Russell E. Brooks, John C. Maloney, Jr., New York City, of counsel), for intervenor-respondent-appellant Amerada Hess Corp.

Willkie Farr & Gallagher, New York City (Kenneth J. Bialkin, Louis A. Craco, Howard C. Buschman, III, Diane K. G. Weeks, New York City, of counsel), for amicus curiae American Institute of Certified Public Accountants.

Donald Dreyfus, Chicago, Ill., for amicus curiae Arthur Andersen & Co.

James F. Strother, Chicago, Ill., for amicus curiae Alexander Grant & Co.

Harris J. Amhowitz, New York City, for amicus curiae Coopers & Lybrand.

Allan Kramer, New York City, for amicus curiae Deloitte Haskins & Sells.

Kenneth H. Lang, Cleveland, Ohio, for amicus curiae Ernst & Whinney.

Barry S. Augenbraun, Philadelphia, Pa., for amicus curiae Laventhol & Horwath.

Victor M. Earle, III, New York City, for amicus curiae Peat, Marwick, Mitchell & Co.

Eldon Olson, New York City, for amicus curiae Price Waterhouse & Co.

Richard A. Meyer, New York City, for amicus curiae Seidman & Seidman.

Richard H. Murray, New York City, for amicus curiae Touche Ross & Co.

Before FEINBERG, Chief Judge, and MANSFIELD and NEWMAN, Circuit Judges.

FEINBERG, Chief Judge:

This is an appeal from an order of the United States District Court for the Southern District of New York, Kevin T. Duffy, J., enforcing an Internal Revenue Service (IRS) summons to Arthur Young & Co. (AY). The summons, issued pursuant to 26 U.S.C. § 7602, 1 directed AY to produce all files related to its client, Amerada Hess Corp. (Amerada), for whom AY served as independent auditor. In response to an enforcement proceeding initiated by the IRS, Judge Duffy, in a decision reported at 496 F.Supp. 1152 (S.D.N.Y.1980), ordered the production of all the items requested by the IRS with two exceptions discussed below. The parties consented to a stay of production pending resolution of this appeal. In this court, AY challenges the district court's order, objecting primarily to the request for its audit workpapers file and for its tax pool (tax accrual workpapers) file. Amerada, utilizing the procedure available under 26 U.S.C. § 7609, 2 has intervened to challenge production of the tax accrual workpapers file. Because we find that the audit workpapers are relevant to determining Amerada's tax liability and thus fall within the scope of the IRS summons power, we affirm that part of Judge Duffy's order requiring their production. However, we reverse that part of the district court order enforcing the summons of the tax accrual workpapers. Although we find that this material is also relevant to the determination of tax liability, we believe that these documents should remain confidential in order to protect the reliability of the independent audit process.

I.

The involvement of Arthur Young & Co., a firm of certified public accountants, with Amerada Hess Corp. began in November 1971, when AY was retained as Amerada's independent auditor. Among its other duties, AY was responsible for reviewing the financial statements prepared by Amerada in satisfaction of the disclosure requirements of the federal securities law. 3 An AY partner also signed Amerada's tax returns, even though AY did not prepare the returns.

In April 1976, AY became further enmeshed in Amerada's affairs. Around that time, it became known that many American companies had made illegal payments abroad. In response to this publicity, Amerada's board of directors formed a special committee to investigate the possibility of Amerada wrongdoing. The law firm of Milbank, Tweed, Hadley & McCloy, and AY were engaged as independent investigators to assist the committee. This inquiry apparently, and despite the minor nature of the improprieties it uncovered, prompted the IRS in August 1977 to institute a criminal investigation of Amerada's tax returns for the years 1972, 1973, and 1974. Because a regular audit was then in progress, the IRS and Amerada designed a procedure in September 1977 to apprise the corporation of the progress of the criminal investigation. According to their agreement, Special Agent Kenneth Kalemba, who was in charge of the criminal investigation, would issue all summonses relating to that inquiry. In April 1978, a summons signed by Kalemba was issued to AY, requiring it to make all its Amerada files available to the IRS. 4 A quarter of a million pages of documents are involved in this request.

The IRS sought to enforce this summons by an order to show cause, dated October 9, 1979. Judge Duffy tested the summons against the four criteria set forth in United States v. Powell, 379 U.S. 48, 57-58, 85 S.Ct. 248, 254-255, 13 L.Ed.2d 112 (1964):

(The Commissioner) must show that the investigation will be conducted pursuant to a legitimate purpose, that the inquiry may be relevant to the purpose, that the information sought is not already within the Commissioner's possession, and that the administrative steps required by the Code have been followed....

He found that with the exception of two types of documents, the summons satisfied all the prongs of the Powell test and, accordingly, enforced it. The exceptions related to AY's audit program and to the documents prepared by the special committee that investigated Amerada's questionable payments. Judge Duffy held that the audit program was irrelevant because it "stands many steps removed from the question of the actual tax liability." United States v. Arthur Young & Co., 496 F.Supp. at 1157. He found that the committee report was protected by the work-product privilege under the doctrine of Hickman v. Taylor, 329 U.S. 495, 67 S.Ct. 385, 91 L.Ed. 451 (1947), since the material was prepared under the auspices of Milbank, Tweed in anticipation of litigation, id. at 1157-58. The IRS does not appeal this portion of the district court's order. Among the documents that Judge Duffy did order turned over are AY's audit workpapers and tax accrual workpapers. The challenges advanced on appeal relate to these two categories.

II.

AY alone objects to the production of its audit workpapers. These documents consist almost entirely of factual data generated from the books when accountants verify the financial statements prepared by Amerada's own personnel by spot-checking selected bookkeeping entries and records. They include third-party confirmations of transactions, as well as the auditor's own judgments about the implications of the company's transactions. Some of the workpapers contain material learned during confidential discussions between Amerada and AY employees. This material is not used in preparing Amerada's tax returns.

AY makes two objections to disclosure of these documents. First, it focuses on the second Powell criterion-relevance-and it claims that the IRS bears an enhanced burden of showing relevance when it seeks documents from a third-party, that is from an entity other than the taxpayer whose return it is auditing. Thus, AY attempts to distinguish our holding in United States v. Noall, 587 F.2d 123 (2d Cir. 1978), cert. denied, 441 U.S. 923, 99 S.Ct. 2031, 60 L.Ed.2d 396 (1979), where a summons forcing a taxpayer to produce its own internal audit workpapers was enforced, on the ground that Noall did not involve a third-party. Where, as here, a stranger to the audit is involved, AY argues that this court's opinion in United States v. Harrington, 388 F.2d 520, 524 (2d Cir. 1968), controls and it is insufficient for the IRS merely to allege that some chance of relevance exists.

In Harrington, the target of the summons was a lawyer who had as his client the ex-wife of the taxpayer in whom the IRS was interested. In the course of enforcing the IRS summons, the court did point out that it was "particularly appropriate" that the lawyer and his client receive "judicial protection against ... sweeping or irrelevant order(s) ..." because the demand was "directed not to the taxpayer but to a third-party who may have had some dealing with the person under investigation." Id. at 523. But AY is not a stranger to Amerada's concerns in the same way that lawyer Harrington was to the husband taxpayer in Harrington. AY was hired to investigate Amerada's financial affairs, and to involve itself in matters that were likely to be the object of governmental inquiry. We do not believe that Harrington dictates the result sought by AY.

Moreover, we do not understand whose interests AY seeks to protect by this claim of an enhanced burden. Amerada does not need this protection: it can intervene in its own behalf under § 7609, see generally, Kenderine, The Internal Revenue Service Summons to Produce Documents: Powers, Procedures, and Taxpayer Defenses, 64 Minn.L.Rev. 73 (1979). And, in fact, it has done so. Since Amerada does not object to production of the audit workpapers, it would be anomalous to deny enforcement on the strength of its accountant's objection. Nor can AY assert any particular burden on it. Judge Duffy carefully protected AY from such possibilities by requiring the IRS to shoulder the costs and to inspect on site, United States v. Arthur Young & Co., 496 F.Supp. at 1160.

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