United States Court of Appeals
For the First Circuit
____________________
No. 01-2237
WILLIAM CAVALLARO; PATRICIA CAVALLARO,
Petitioners, Appellants,
v.
UNITED STATES,
Respondent, Appellee.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Patti B. Saris, U.S. District Judge]
____________________
Before
Torruella, Circuit Judge,
Stahl, Senior Circuit Judge,
and Lynch, Circuit Judge.
____________________
William H. Paine with whom Mary B. Strother and Hale and Dorr
LLP were on brief for appellants.
Edward T. Perelmuter, Attorney, Tax Division, Department of
Justice, with whom Eileen J. O'Connor, Assistant Attorney General,
Richard Farber, Attorney, Tax Division, Department of Justice, and
Michael J. Sullivan, United States Attorney, of counsel, were on
brief for appellee.
____________________
April 1, 2002
____________________
LYNCH, Circuit Judge. This case raises important
questions about the scope of the attorney-client privilege.
William and Patricia Cavallaro ("Cavallaros") owned Knight Tool
Co., Inc., founded in 1976. Their adult sons owned Camelot
Systems, Inc., created in 1987. The Cavallaros and their sons
merged their respective corporations in 1995 and, on July 1, 1996,
the merged entity sold for approximately $97 million.
Subsequently, the Internal Revenue Service began an investigation
into the Cavallaros' correct estate and gift tax ("transfer tax")
liabilities. The IRS suspected that the parties might have
undervalued the Cavallaros' Knight company and overvalued the sons'
Camelot company to disguise a gift to the sons in the form of post-
merger stock.
In the course of this investigation, the IRS served a
summons on Ernst & Young, an accounting firm that Camelot had
retained in June of 1994. The summons requested that Ernst & Young
produce "all records" in its possession regarding any work it did
between 1984 and 1995 for the Cavallaros, their sons, and their
respective corporations. The Cavallaros moved to quash the summons
as overly broad and calling for privileged materials. They argued
that the documents in Ernst & Young's possession were protected by
the attorney-client privilege because the documents were created
by, or provided to, Ernst & Young in the course of the efforts of
the law firm Hale and Dorr to provide legal advice; particularly,
advice sought in 1994 and 1995 concerning transfer tax and merger
issues arising from the close relationship between Camelot and
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Knight. The IRS counterclaimed for enforcement of the summons. On
July 27, 2001, the district court denied the Cavallaros' petition
to quash and allowed the government's motion to enforce the
summons. Cavallaro v. United States, 153 F. Supp. 2d 52 (D. Mass.
2001). Subsequently, the district court granted the Cavallaros'
motion for stay pending appeal, thereby permitting the Cavallaros
to continue to refrain from disclosing the documents that they
allege are privileged.
As in the district court proceedings, three categories of
documents requested by the IRS are at issue: (1) documents
pertaining to the December 19, 1994, meeting -- between the
Cavallaros, their sons, a Camelot accountant, accountants from
Ernst & Young, and at least one lawyer from Hale and Dorr --
addressing transfer tax issues; (2) subsequent transfer tax
communications arising from the December 19 meeting; and (3)
documents related to communications addressing the 1995 merger of
Knight and Camelot. All of the requested documents are in Ernst &
Young's possession. They are all documents either created by Ernst
& Young or transmitted to Ernst & Young, not documents preserved
solely in Hale and Dorr's files.
On appeal, as in the district court, the Cavallaros argue
that these documents are privileged under United States v. Kovel,
296 F.2d 918 (2d Cir. 1961), despite having been either created by
or disclosed to Ernst & Young, because Ernst & Young aided Hale and
Dorr in providing legal advice. They also argue that the documents
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fall within the common-interest exception to the rule that
disclosure to a third party waives the attorney-client privilege.
Assuming arguendo that this circuit would adopt the Kovel
rule, we conclude that the documents are not privileged. We follow
somewhat different reasoning than the district court. We need not
decide whether, in all instances, the attorney or client (as
opposed to some third party) must hire the accountant in order to
sustain a privilege under Kovel. Kovel requires that to sustain a
privilege an accountant must be "necessary, or at least highly
useful, for the effective consultation between the client and the
lawyer which the privilege is designed to permit." 296 F.2d at
922. Here, no party hired Ernst & Young for this purpose.
Therefore, the attorney-client privilege did not extend to the
documents in question under the Kovel doctrine. Having found that
the documents were not covered by the attorney-client privilege, we
also conclude that they cannot fall within the common-interest
exception, which presumes a valid underlying privilege in the first
place. Consequently, we do not reach the district court's
conclusion that "[u]nder the strict confines of the common-interest
doctrine, the lack of representation for [the sons and Camelot]
vitiates any claim to a privilege," Cavallaro, 153 F. Supp. 2d at
61, because Ernst & Young was providing accounting services and so
the Kovel extension of the privilege is inapplicable to the
summoned documents, all of which were created by or disclosed to
Ernst & Young.
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I.
The following facts are undisputed except where otherwise
noted. In 1976, the Cavallaros formed Knight Tool Co., Inc., to
manufacture tools to be used by companies such as McDonnell
Douglas, Polaroid, and Raytheon to assemble their products. Seven
years later, in 1983, William Cavallaro and one of his three sons,
Kenneth, developed a rudimentary glue-dispensing machine, which,
for several years, was commercially unsuccessful due, at least in
part, to difficulty in marketing the machine.
In 1987, the Cavallaros formed a new company, Camelot
Systems, Inc., to give the Cavallaros' three sons an opportunity to
pursue the glue-dispensing machine business. In addition to paying
its own employees, Knight paid the salaries of Camelot's employees.
The three sons were named as Camelot's sole shareholders and,
although Knight continued to make the glue-dispensing machines,
Camelot became the machines' only distributor. Knight was
Camelot's biggest supplier. In fact, Camelot's only business was
selling glue-dispensing machines and accessories manufactured by
Knight. The sons, working at Camelot, completely redesigned the
Knight glue-dispensing machine and developed several new models of
the machine. As a result, Camelot became a lucrative business.
In 1992, the Cavallaros contacted attorney Louis Hamel
Jr. Hamel was a long-time senior partner at the Hale and Dorr law
firm, specializing in trusts and estates, exempt organizations, and
pensions. He, along with other Hale and Dorr attorneys,
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periodically counseled the Cavallaros regarding Knight corporate
matters.
The Cavallaros again contacted Hamel, in October 1994,
this time for help with estate and retirement planning. Hamel
considered, among other things, potential transfer tax issues
arising in the context of the close business and family
relationships between Knight and Camelot. Between December 19,
1994, and December 31, 1995, Hale and Dorr provided legal advice to
Knight and the Cavallaros, acting on Knight's behalf, with respect
to the merger of Knight into Camelot. Hale and Dorr advised the
Cavallaros on, among other things, the drafting of affidavits
purporting to establish the pre-merger values of Knight and
Camelot.
While the Cavallaros were receiving legal advice from
Hale and Dorr, their sons, as agents of Camelot, had begun
receiving tax planning advice from Ernst & Young. Camelot began
meeting with Ernst & Young in June of 1994. On November 16, 1994,
Ernst & Young documented its relationship with Camelot in a letter
of engagement, stating that Ernst & Young would be providing a
"Review of Corporate Structure and Recommendations," a "Tax
Checkup," and "Transfer Planning." The letter, addressed to David
Frac, Camelot's Chief Financial Officer, further stated that "[a]ll
advice and other services we provide pursuant to this engagement
are solely for the benefit of Camelot . . . and not for the benefit
of anyone other than the corporation and its shareholders." Frac
signed the letter and returned it to Ernst & Young.
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A draft of the invoice, however, for Ernst & Young's
services rendered through December 31, 1994, which explicitly
included tax services rendered pursuant to the November 14
engagement letter, refers to services rendered to both Camelot and
Knight. It was addressed and mailed to Mrs. Cavallaro at Knight.
In addition, Lawrence Goodman, of Ernst & Young, testified in his
October 27, 2000, deposition that, in 1994, he was involved in
providing tax advice to Camelot, Knight, and the Cavallaros. He
also testified that around November or December of 1995, an Ernst
& Young employee began providing services to both Camelot and
Knight. The district court, nonetheless, concluded that "the
undisputed evidence is that Ernst & Young was paid by, and worked
solely for, Camelot and its shareholders." Cavallaro, 153 F. Supp.
2d at 58.
On December 15, 1994, Ernst & Young sent a letter to
William Cavallaro recommending the merger of Knight and Camelot and
suggesting a strategy for minimizing transfer tax liability. Ernst
& Young understood that the Cavallaros and their sons would
consider selling their respective companies, and proceeded to
explain how the parties might structure the corporate relationship
in order to facilitate a transfer of some of the proceeds from such
a sale from the Cavallaros to their children while minimizing tax
liability. Ernst & Young stated that the letter would "serve as
the discussion document" for an upcoming meeting between Ernst &
Young, Hale and Dorr, the Cavallaros, their sons, Kevin McGillivary
(an accountant working for Camelot), and David Frac of Camelot.
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The letter explained that the IRS would scrutinize the
pre-merger values of Knight and Camelot to determine the proper
allocation of the post-merger sale proceeds between the Cavallaros
and their sons. The pre-merger values were important because they
would be the benchmark for determining whether the Cavallaros had
disguised a gift to their sons in the form of post-merger stock
and, if so, the size of that gift and the resulting transfer tax
liability. Ernst & Young stated that the pre-merger profit
disparity between Knight and Camelot did not reflect the true
values of the companies:
The current structure and resulting profit split does not
seem to reflect the economic reality of the business
arrangement. If one were to combine the entities, as
currently structured, approximately 70% of the profit is
earned by the Company that bears no risk with respect to
product development, has no employees, does not bear any
costs of sales, does not service or provide any warranty
coverage on the product or own any of the technology. In
a normal distributor relationship . . . . this
arrangement does not exist.
The IRS, Ernst & Young said, would likely attribute most of the
value of the post-merger corporation to the Cavallaros, which would
defeat the tax saving goal of allocating most of the profits of the
pre-merger corporations to their sons. The letter stated that
"[b]ased on the facts that exist today, it would be hard to justify
Camelot taking more than a small amount of the allocated proceeds"
from a sale of the businesses. More specifically, Ernst & Young
suggested that, upon merger, as much as 85% of the shares of the
merged entity would go to the Cavallaros, with only 15% of the
shares going to their sons.
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It appears that the Cavallaros desired a post-merger
distribution more favorable to their sons, but that a post-merger
redistribution would create significant transfer tax liability.
Ernst & Young proposed a solution. Ernst & Young recommended a
"two step approach" to "eliminate[ ] the exposure related to
reallocation of income." Step one was to merge Knight and Camelot.
Step two "involve[d] the gifting of stock in the merged entity by
[the Cavallaros] to [their sons] in the amounts that would result
in the desired ownership split." Ernst & Young recommended that
the gifting be done using a Grantor Retained Annuity Trust. This
gifting was necessary, according to Ernst & Young, because of the
real pre-merger distribution of assets, which heavily favored
Knight and the Cavallaros and disfavored Camelot and the sons.
Prior to December 19, 1994, the parties agree that Ernst
& Young and Hale and Dorr were not working together or in a
coordinated fashion, even if each firm knew that the other was
somehow involved in advising the Cavallaros, their sons, or the
companies. On December 19, the Cavallaros, their sons, a Camelot
accountant, accountants from Ernst & Young, and at least one lawyer
from Hale and Dorr met as planned. This meeting is important to
the case because the Cavallaros assert that, at this meeting,
"Ernst & Young began assisting Hale and Dorr with respect to
providing advice on transfer tax issues." The Cavallaros say that
Ernst & Young continued in this role, as an assistant to Hale and
Dorr, through 1995. At the meeting, neither Camelot nor the sons
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were represented by an attorney; Hale and Dorr represented only the
Cavallaros.
It is unclear what happened next. As the IRS has stated,
this is, at least in part, what they are attempting to investigate
by way of the challenged subpoena. What we do know is that the
Cavallaros did not follow Ernst & Young's December 15, 1994,
recommendations. Instead, on May 23, 1995, Mr. Cavallaro and one
of his sons signed affidavits that were at odds with Ernst &
Young's conclusion that "it would be very hard to justify Camelot
taking more than a small amount of the allocated proceeds" from a
sale of the businesses. Hale and Dorr, not Ernst & Young, prepared
these affidavits. In these two separate, but nearly identical
affidavits, Mr. Cavallaro and his son stated that Knight had
transferred, for no compensation, its glue-dispensing machine
technology to Camelot when Camelot was formed in 1987. They stated
that, at the time of the transfer, the technology "had no
ascertainable value," "had no reasonable prospect of realizing a
profit," and was "no more than a promising but raw idea." They
stated that Camelot "entirely redesigned the original dispensing
product." Knight and Camelot then supplemented these affidavits
with a confirmatory bill of sale, also dated May 23, 1995,
purporting to confirm the previously undocumented gift from Knight
to Camelot. The Cavallaros say that Hale and Dorr had prepared
drafts of all of these documents before the December 19, 1994,
meeting.
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This claimed, undocumented transfer was important to the
pre-merger valuation of the companies and hence to the correct
post-merger distribution of shares. On December 31, 1995, Knight
merged into Camelot. As part of the merger, the Cavallaros
received 19% of Camelot's stock. This allocation was based on
Ernst & Young's December 31, 1995, valuation of the companies,
which reflected the alleged, but undocumented, technology transfer.
Ernst & Young's December 1995 valuation, attributing most of the
value of the post-merger corporation to Camelot, was at odds with
its 1994 suggestion that Camelot shares would form only a small
part of the post-merger corporation's value. On July 1, 1996, the
merged corporation was sold for approximately $97 million. The
1995 merger, based on the 1995 valuation, resulted in a
distribution of assets to the Cavallaros' sons that substantially
reduced the Cavallaros' transfer tax liabilities.
Suspicious of these circumstances, the IRS began a tax
fraud investigation into the Cavallaros' correct federal tax
liabilities for the years 1987 through 1996. The investigation
focused on whether the Cavallaros had manufactured a prior gift to
their children, through the use of the alleged technology transfer,
to avoid transfer taxes. The IRS sought to determine whether
Knight was undervalued and whether Camelot was overvalued at the
time of the merger because, if this were the case, then the
Cavallaros would have disguised a gift to their sons in the form of
post-merger stock.
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As part of this investigation, the IRS, on December 7,
1999, issued a third-party recordkeeping summons to Ernst & Young.1
The summons began by requesting "[a]ll records relating to [Ernst
& Young's] engagements with William, Patricia, Paul, Kenneth, or
James Cavallaro[ ], Knight Tool . . . or Camelot Systems . . . at
any time from 1984 through 1995." The IRS issued the summons
because, in response to a prior summons it had issued in the
investigation, it had obtained a copy of the December 15, 1994,
Ernst & Young letter, which it believed "to be materially
inconsistent with subsequent sworn statements made [by] William
Cavallaro and a subsequent valuation rendered by Ernst & Young."
The IRS stated that the 1994 valuation "sets forth a pre-merger
analysis which is materially inconsistent with a subsequent
valuation rendered by Ernst & Young . . . . [and] materially at
odds with sworn statements submitted by William Cavallaro."
The Cavallaros moved to quash the summons as overly broad
and calling for privileged materials. They argued that the
summoned documents are privileged because Ernst & Young helped Hale
1
The IRS issued its summons under the authority granted by
26 U.S.C. § 7602 (1994 & Supp. V 1999). That section states that
[f]or the purpose of . . . determining the liability of
any person for any internal revenue tax . . . the
Secretary is authorized -- (1) To examine any books,
papers, records, or other data which may be relevant or
material to such inquiry; [and] (2) To summon the person
. . . to appear before the Secretary . . . to produce
such books, papers, records, or other data, and to give
such testimony, under oath, as may be relevant or
material to such inquiry.
Id. § 7602(a) (1994).
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and Dorr provide legal advice beginning on December 19, 1994. They
also argued that the documents fall within the common-interest
rule.
Subsequently, the Cavallaros provided the IRS with a
substantial number of documents, including excerpts from the
diaries of Ernst & Young employees who worked for Knight or Camelot
and what the Cavallaros say are nearly all of Knight's and
Camelot's accounting records. This dispute is over those remaining
documents that the Cavallaros have refused to produce.
The IRS counterclaimed for enforcement of the summons.
On September 19, 2000, the district court heard arguments and
authorized the IRS to depose Lawrence Goodman, a senior manager in
Ernst & Young's tax department, primarily to determine whether any
additional documents existed relating to Ernst & Young's work for
the Cavallaros, their sons, and the two companies. Fed. R. Civ. P.
30(b)(6). After the deposition, Hale and Dorr provided the IRS
with an amended privilege log and a letter stating the reasons why
it believed each of the documents in the log to be privileged.
On July 27, 2001, the district court denied the
Cavallaros' petition to quash and allowed the government's motion
to enforce the summons. Cavallaro, 153 F. Supp. 2d 52. The
district court noted that the communications in question -- that
is, those documents that the Cavallaros continued to assert were
privileged -- fell into three categories: "(1) notes from the
December 19, 1994 meeting addressing transfer tax issues; (2)
follow-up communications arising from the Dec. 19th meeting; and
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(3) subsequent communications addressing the merger of the two
companies." Id. at 56. These same categories of documents remain
at issue.2
The district court reasoned that the documents were not
privileged under Kovel, 296 F.2d 918, because the Cavallaros had
failed to demonstrate that one of the key elements of a Kovel
privilege was met: that is, the Cavallaros had not shown that Ernst
& Young's role was to facilitate communications, between the
Cavallaros and Hale and Dorr, made for the purpose of obtaining
legal advice. Cavallaro, 153 F. Supp. 2d at 58. The "case does
not fit into the Kovel paradigm," the district court held, because
Ernst & Young, at all times, acted as an agent of Camelot and the
sons, not as an agent of Hale and Dorr or the Cavallaros. Id. at
59.
As to the common-interest argument, the district court
concluded that, at the December 19, 1994, meeting, and going
forward, Hale and Dorr represented only the Cavallaros, and
possibly Knight, but not the sons or Camelot. Id. at 61.
Therefore, the district court held that, "[u]nder the strict
2
With respect to the notes from the December 19 meeting
and any follow-up communications arising from this meeting, the
Cavallaros state that they have already produced all of the
requested documents that Ernst & Young created. They say that all
of the transfer tax documents still claimed as privileged were
either created by Hale and Dorr or sent to Hale and Dorr by other
accountants working for the family or their businesses, with one
exception: a letter from David Frac of Camelot to Lawrence Goodman,
an Ernst & Young senior manager, regarding preparation for a
meeting with Hale and Dorr. With respect to category (3), the
merger, the Cavallaros say that several of the documents still
withheld were created by Ernst & Young.
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confines of the common-interest doctrine, the lack of
representation for the remaining parties vitiates any claim to a
privilege." Id. "[B]ecause only one party to this purported
common-interest arrangement was represented by counsel," the
district court held, "there is no valid claim of privilege under
the common-interest doctrine." Id. at 62.3
II.
"On an appeal respecting a privilege claim, the standard
of review depends on the issue." United States v. Mass. Inst. of
Tech., 129 F.3d 681, 683 (1st Cir. 1997). We review district court
rulings on questions of law de novo; we review district court fact
findings for clear error; and we review "discretionary judgments
such as evidentiary rulings" for abuse of discretion. Id. Here
the parties contest the formulation of both the Kovel doctrine and
the common-interest doctrine, legal questions which we review de
novo. The parties also contest the district court's findings of
fact. Indeed, the Cavallaros assert that "the District Court found
no facts," a claim which is an overstatement.
Neither the United States Constitution, nor any federal
statute, nor any Supreme Court rule governs the proper scope of the
attorney-client privilege in this case. Nor does state law provide
the rule of decision. Fed. R. Evid. 501 states that in such cases,
the issue "shall be governed by the principles of the common law as
3
The district court did not address the government's
argument that the documents fall under the crime-fraud exception.
Cavallaro, 153 F. Supp. 2d at 58 n.3.
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they may be interpreted by the courts of the United States in the
light of reason and experience."
Before discussing exceptions to the attorney-client
privilege, and exceptions to those exceptions, we first lay out the
essential elements of the privilege, as described by Wigmore and
previously endorsed by this court:
(1) Where legal advice of any kind is sought (2) from a
professional 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) except the protection be
waived.
8 J.H. Wigmore, Evidence § 2292, at 554 (McNaughton rev. 1961),
quoted in Mass. Inst. of Tech., 129 F.3d at 684.
The rationale for the privilege is that safeguarding
communications between attorney and client encourages disclosures
by the client to the lawyer that facilitate the client's compliance
with the law and better enable the client to present legitimate
arguments should litigation arise. Mass. Inst. of Tech., 129 F.3d
at 684. The privilege is well established; indeed, it "first
appeared in the sixteenth century," P.R. Rice, Attorney-Client
Privilege in the United States § 1:1, at 6 (2d ed. 1999), and it is
"the oldest of the privileges for confidential communications known
to the common law," Upjohn Co. v. United States, 449 U.S. 383, 389
(1981); see also Wigmore, supra, § 2290, at 542. We note, but do
not rely on, the doctrine of construing the privilege narrowly,
which has particular force in the context of IRS investigations
given the "congressional policy choice in favor of disclosure of
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all information relevant to a legitimate IRS inquiry."4 United
States v. Arthur Young & Co., 465 U.S. 805, 816 (1984). Even in
other contexts, there is a more general reason for construing the
attorney-client privilege narrowly: the belief that "[t]he
investigation of truth and the enforcement of testimonial duty
demand the restriction, not the expansion, of these privileges."
Wigmore, supra, § 2192, at 73; see also In re Grand Jury Subpoena,
274 F.3d 563, 571 (1st Cir. 2001) ("[T]he privilege applies only to
the extent necessary to achieve its underlying goal of ensuring
effective representation through open communication between lawyer
and client.").
In contrast to the attorney-client privilege, "no
confidential accountant-client privilege exists under federal
law."5 Couch v. United States, 409 U.S. 322, 335 (1973), quoted in
Arthur Young, 465 U.S. at 817; see also United States v. Arthur
Andersen & Co., 623 F.2d 725, 729 (1st Cir. 1980) (declining to
depart from Couch's general rule). The parties to this litigation
4
"As a tool of discovery, the § 7602 summons is critical
to the investigative and enforcement functions of the IRS." United
States v. Arthur Young & Co., 465 U.S. 805, 814 (1984). While
§ 7602 is "subject to the traditional privileges," United States v.
Euge, 444 U.S. 707, 714 (1980), we are cautious of "recognizing
exceptions to the broad summons authority of the IRS or in
fashioning new privileges that would curtail disclosure under
§ 7602" absent clear congressional directions. Arthur Young, 465
U.S. at 816-17.
5
In 1998, Congress established a limited privilege for
accountant-client communications. Pub. L. No. 105-206, title III,
§ 3411, 112 Stat. 685, 751 (codified at 26 U.S.C. § 7525 (Supp. V
1999)). The privilege, however, applies only to communications
occurring after July 22, 1998. Id. § 3411(c). Because all of the
communications at issue occurred before this date, neither party
argues that the statutory privilege applies here.
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recognize as much, but agree, correctly, that accountant-client
communications are privileged if they meet the traditional
requirements of the attorney-client privilege. With this
foundation laid, we turn to the Cavallaros' privilege claims.
The Cavallaros argue that the attorney-client privilege
protects the three categories of subpoenaed documents, all of which
are in Ernst & Young's possession. For a communication to be
covered by the attorney-client privilege, the communication must be
made in confidence. Wigmore, supra, § 2292, at 554. Another
requirement is that the privilege not be waived. Id. The presence
of third parties during an attorney-client communication is often
sufficient to undermine the "made in confidence" requirement, 3
Weinstein's Federal Evidence § 503.15[3] (J.M. McLaughlin, ed., 2d
ed. 2002), or to waive the privilege, E.S. Epstein, The Attorney-
Client Privilege and the Work-Product Doctrine 168-69, 189 (4th ed.
2001).
Here, however, the Cavallaros invoke two doctrines to
support their claim that disclosing the subpoenaed documents to
Ernst & Young neither undermined the confidentiality requirement
nor waived the privilege. First, they say that the documents were
all created or received by Ernst & Young after it began to assist
Hale and Dorr in rendering legal advice and so the documents fall
under the Kovel doctrine, which they characterize as holding that
the presence of some third parties that are "necessary, or at least
highly useful," to facilitating attorney-client communication does
not destroy the privilege. 296 F.2d at 922. Second, they say that
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the documents fall within what they call the "common-interest
privilege." The Cavallaros bear the burden of establishing that
the attorney-client privilege is a defense to the enforcement of
the IRS's summons, but, if the privilege is established, the
government bears the burden of showing that the privilege is
defeated by an exception. Fed. Deposit Ins. Corp. v. Ogden Corp.,
202 F.3d 454, 460 (1st Cir. 2000).
A. Kovel
Generally, disclosing attorney-client communications to
a third party undermines the privilege. United States v. Ackert,
169 F.3d 136, 139 (2d Cir. 1999) (stating that "the attorney-client
privilege generally applies only to communications between the
attorney and the client"); Weinstein's Federal Evidence, supra, at
§ 503.15[3]; Epstein, supra, at 168-69, 189. An exception to this
general rule exists for third parties employed to assist a lawyer
in rendering legal advice. Sup. Ct. Standard 503; Weinstein's
Federal Evidence, supra, at §§ 503.12[3][a] and [4][b]. In Kovel,
the Second Circuit held that, because "the complexities of modern
existence prevent attorneys from effectively handling clients'
affairs without the help of others," the attorney-client
"'privilege must include all the persons who act as the attorney's
agents.'" 296 F.2d at 921 (quoting Wigmore, supra, § 2301, at
583).6
6
We will assume arguendo that this circuit would adopt the
Kovel test or a similar standard, as so many other circuits have
done, but we need not decide the question. E.g., United States v.
Bornstein, 977 F.2d 112, 116-17 (4th Cir. 1992); United States v.
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This logic applies to accountants: "[T]he presence of an
accountant, whether hired by the lawyer or by the client, while the
client is relating a complicated tax story to the lawyer, ought not
destroy the privilege" when "the accountant is necessary, or at
least highly useful, for the effective consultation between the
client and the lawyer which the privilege is designed to permit."
Id. at 922. The communication, however, must be made "for the
purpose of obtaining legal advice from the lawyer." Id. "If what
is sought is not legal advice but only accounting service . . . ,
or if the advice sought is the accountant's rather than the
lawyer's, no privilege exists." Id.; see also United States v.
Adlman, 68 F.3d 1495, 1500 (2d Cir. 1995).
The district court concluded that "Kovel requires that
either the Cavallaros, Knight, or Hale and Dorr hired Ernst & Young
for the purpose of facilitating a legal communication with Hale and
Dorr." Cavallaro, 153 F. Supp. 2d at 57. It said that the
Cavallaros must show that "Ernst & Young was an agent of Hale and
Dorr, Knight or the Cavallaros." Id. at 58. We know that such a
showing is not sufficient to sustain the privilege: as the district
court recognized, an attorney, merely by placing an accountant on
her payroll, does not, by this action alone, render communications
El Paso Co., 682 F.2d 530, 541 (5th Cir. 1982); In re Grand Jury
Proceedings, 220 F.3d 568, 571 (7th Cir. 2000); United States v.
Cote, 456 F.2d 142, 144 (8th Cir. 1972); United States v. Judson,
322 F.2d 460, 462-63 (9th Cir. 1963); Fed. Trade Comm'n v. TRW,
Inc., 628 F.2d 207, 212 (D.C. Cir. 1980). See also Sup. Ct.
Standard 503(b) and 503(a)(3).
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between the attorney's client and the accountant privileged.7 Id.
at 57; Kovel, 296 F.2d at 921. We need not reach the question of
whether such a showing is necessary. That is, we need not
determine whether, in all instances, the attorney or client (as
opposed to some third party) must hire the accountant in order to
sustain a privilege under Kovel.
Here, the record does not show that any party hired Ernst
& Young to assist Hale and Dorr in providing legal advice, and we
note that the agency relationship between the parties is relevant
to, but not dispositive of, this question. Kovel requires that to
sustain a privilege an accountant must be "necessary, or at least
highly useful, for the effective consultation between the client
and the lawyer which the privilege is designed to permit." Kovel,
296 F.2d at 922. This requirement resolves the Kovel dispute
because the evidence shows that Ernst & Young was not employed for
this purpose.
Whether Hale and Dorr, as opposed to the Cavallaros or
their sons, hired Ernst & Young is, as the district court
recognized, probative when considering whether Ernst & Young was
employed to help Hale and Dorr render legal advice. Typically,
"[a]gents of an attorney are . . . retained by or at the discretion
of the attorney and under the attorney's supervision." Rice,
7
Accordingly, were the Cavallaros to show that they
employed Ernst & Young, or that Knight or Hale and Dorr did so,
this alone would be insufficient to bring the disputed
communications within Kovel. See United States v. Gurtner, 474
F.2d 297, 299 (9th Cir. 1973) (stating that not all consultations
with accountants, acting as attorneys' agents, are privileged).
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supra, § 3:5, at 30. Here, the bulk of the evidence supports the
claim that, at the December 1994 meeting, and going forward, Ernst
& Young acted as an agent for the sons or Camelot, but not for Hale
and Dorr, the Cavallaros, or Knight.
No one disputes that Camelot initially hired Ernst &
Young. Only one month prior to the December 1994 meeting, Ernst &
Young sent Camelot a letter of engagement stating that "[a]ll
advice and other services we provide pursuant to this engagement
are solely for the benefit of Camelot . . . and are not for the
benefit of anyone other than the corporation and its shareholders."
Camelot's CFO, David Frac, signed the letter and returned it to
Ernst & Young. Everyone also agrees that Camelot hired Ernst &
Young to provide financial advice, not to assist any lawyers.
Prior to the December 1994 meeting, Ernst & Young was not in any
way coordinating its accounting advice with Hale and Dorr's legal
advice.
The Cavallaros say that things changed at the December
1994 meeting. At that meeting, they say, it was "clear to all
parties" that "Ernst & Young began assisting Hale and Dorr with
respect to providing advice on transfer tax issues." They claim
that Ernst & Young continued in this role, as an assistant to Hale
and Dorr on transfer tax and, later, merger issues, through 1995.
More specifically, the Cavallaros argue that Ernst & Young assisted
Hale and Dorr in providing legal advice, and improved that advice,
by, "[a]mong other things, . . . review[ing] the factual basis of
Hale and Dorr's analysis to help determine whether it was
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consistent with the accounting records that Ernst & Young had
reviewed." The district court properly rejected the argument.
The district court found that "[t]he Cavallaros have not
produced any contemporaneous documentation to suggest that, as of
December 19, 1994, Ernst & Young's professional relationship with
the Cavallaro parents changed in a way that would trigger a
privilege." Cavallaro, 153 F. Supp. 2d at 59. The Cavallaros urge
that the district court overlooked some evidence. First, that the
bill for Ernst & Young's services rendered through December 31,
1994, refers to services rendered to both Camelot and Knight.
Second, that Ernst & Young mailed this bill to Mrs. Cavallaro at
Knight. Third, that Lawrence Goodman testified that, in 1994,
Ernst & Young was involved in providing tax advice to Camelot,
Knight, and the Cavallaros. The district court did not mention
this evidence, but it does not change the outcome here. None of it
is "contemporaneous documentation" of the relationship between the
parties at the meeting. The bill was presumably drafted after
services were rendered. The parties never formally commemorated
this purportedly changed relationship. Mr. Goodman's statement was
made after the fact, in the midst of litigation, with little
support in the contemporaneous record. The district court did not
clearly err when it found as it did.
But all of this is slightly off-topic. The agency
question aside, the evidence is strong that Ernst & Young acted to
provide accounting advice rather than to assist Hale and Dorr in
providing legal advice. Cf. United States v. Judson, 322 F.2d 460,
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462-63 (9th Cir. 1963) (Kovel exception covers documents created by
an accountant at an attorney's request for the purpose of advising
and defending the client). Prior to the December 1994 meeting,
Ernst & Young provided accounting advice to Camelot independent of
Hale and Dorr. After that meeting, the evidence supports the
conclusion that Ernst & Young and Hale and Dorr continued to work
on their respective, separate tracks, albeit in a more coordinated
way.
We are skeptical of the Cavallaros' claim that Ernst &
Young was present to assist attorney Hamel of Hale and Dorr, who
was a senior partner of over twenty years' experience, and a
specialist in trusts and estates, including, necessarily,
consequent tax advice. Recognizing that an attorney's experience
alone is not prima facie evidence that an accountant was not
"necessary, or at least highly useful," Kovel, 296 F.2d at 922, to
the lawyer in providing legal assistance, we note that when a party
hires an accountant to provide accounting advice, and only later
hires an attorney to provide legal advice, it is particularly
important for the party to show that the accountant later acted as
an agent necessary to the lawyer in providing legal advice. See
Rice, supra, § 3:5, at 33-34 (noting that "when the client has
previously employed the agent independent of the attorney-client
relationship, to perform the same services that he will perform for
the attorney[,]. . . . [t]his creates a risk that the agent's
retention by the attorney is simply a subterfuge"); id. at 35 n.66
(citing Swarthmore Radiation Oncology, Inc. v. Lapes, No. 92-3055,
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1994 U.S. Dist. LEXIS 1970, at *9-12 (E.D. Pa. Feb. 18, 1994)).
The Cavallaros have failed to make a sufficient showing here.
Contrary to the Cavallaros' assertion that a mere finding
that an account was "useful" is all that is required under Kovel,
"[t]he available case law indicates that the 'necessity' element
means more than just useful and convenient. The involvement of the
third party must be nearly indispensable or serve some specialized
purpose in facilitating the attorney-client communications. Mere
convenience is not sufficient." Epstein, supra, at 187. The
Cavallaros' claim that Ernst & Young "had the capacity to benefit
the quality of the legal advice that Hale and Dorr would render"
and that, "[a]mong other things," Ernst & Young double-checked Hale
and Dorr's legal advice to make sure "it was consistent with the
accounting records that Ernst & Young had reviewed" is not enough
to show that Ernst & Young was necessary, or at least highly
useful, in facilitating Hale and Dorr's provision of legal advice.
That ends the matter.
B. Common Interest
The common-interest doctrine is typically understood to
apply "[w]hen two or more clients consult or retain an attorney on
particular matters of common interest." Weinstein's Federal
Evidence, supra, § 503.21[1]; Wigmore, supra, § 2312, at 603-09.
In such a situation, "the communications between each of them and
the attorney are privileged against third parties." Weinstein's
Federal Evidence, supra, § 503.21[1]; see also In re Grand Jury
Subpoena, 274 F.3d at 573; Fed. Deposit Ins. Corp., 202 F.3d at
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461. Similarly, the "privilege applies to communications made by
the client or the client's 'lawyer to a lawyer representing another
in a matter of common interest.'" Weinstein's Federal Evidence,
supra, § 503.21[2] (quoting Sup. Ct. Standard 503(b)(3)).
Whether one refers to either or both of these instances
as "common interest," "joint defense," "joint client," or "allied
lawyer" doctrines does not change the outcome of this case. The
common-interest doctrine, like the rule announced in Kovel, is "not
an independent basis for privilege, but an exception to the general
rule that the attorney-client privilege is waived when privileged
information is disclosed to a third party." Epstein, supra, at
196.
Our resolution of the Cavallaros' Kovel argument resolves
their common-interest claim as well. Although the district court
directed its inquiry toward the alignment of interests between all
of the parties in the case and then decided that, "[e]ven if there
were a sufficient commonality of interest, . . . . [u]nder the
strict confines of the common-interest doctrine, the lack of
representation for [the sons and Camelot] vitiates any claim to a
privilege," 153 F. Supp. 2d at 60, we do not need to reach these
issues.
Ernst & Young was not covered by the attorney-client
relationship between Hale and Dorr and its clients. Even if the
Cavallaros, their sons, and their respective companies all had an
exact unanimity of interest, it would not render communications
created by or shared with Ernst & Young privileged when Ernst &
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Young was providing accounting services, not facilitating
communication of legal advice between Hale and Dorr and its
clients.
The common-interest doctrine prevents clients from
waiving the attorney-client privilege when attorney-client
communications are shared with a third person who has a common
legal interest with respect to these communications, for instance,
a codefendant. The doctrine does not extend to prevent waiver when
an accountant, not within the Kovel doctrine, is made privy to the
attorney-client communications. In such an instance, the
accountant does not share an interest in receiving legal advice
from the lawyer and cannot logically be said to have an interest in
common with the represented party or parties. Under Kovel, we know
that when a client, a lawyer, and an accountant are present, the
accountant's presence will destroy the privilege if the accountant
is not "necessary, or at least highly useful, for the effective
consultation between the client and the lawyer." 296 F.2d at 922.
It follows that the client -- in this case the Cavallaros -- cannot
resurrect the privilege by adding another party (their sons) and
that party's accountant to the mix. This is true even if the sons
share a common interest with the parents. To hold otherwise would
be to create a loophole in Kovel whereby the privilege is
undermined when a client and his attorney disclose information to
an accountant who is not "necessary, or at least highly useful, for
the effective consultation between the client and the lawyer," 296
F.2d at 922, but the privilege is preserved when the client brings
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another party with a common interest on board and that other
party's accountant is present.
The Cavallaros' argument that every party to the
communication need not have his own lawyer in order for the common-
interest doctrine to apply, although relevant to the district
court's reasoning, is in the end beside the point, whether or not
the argument is valid. Our conclusion that the documents are not
privileged under Kovel resolves the common-interest claim because
the common-interest rule presumes a valid underlying privilege.
There is no valid underlying privilege here because, by having
discussions with, and disclosing the documents to, Ernst & Young,
an accounting firm not necessary to permit Hale and Dorr to
communicate legal advice to its client, the Cavallaros either
waived the attorney-client privilege or undermined the privilege's
confidentiality requirement. One cannot create a privilege, where
previously there was none, simply by introducing a third party
(with or without a common interest) into the circle within which
documents are shared.
III.
For these reasons, the district court's judgment, denying
the Cavallaros' motion to quash the summons and allowing the United
States's motion to enforce the summons, is affirmed.
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