In this article, Helen Evans and William Harman of 4 New Square argue that the recent decision in Financial Reporting Council Limited v Sports Direct International Plc[2018] EWHC 2284 (Ch) reignites the debate about whether regulators should be better off than insurers when it comes to seeking privileged documents belonging to the clients of professionals that they regulate or insure.  

What did Quinn Direct and Sports Direct decide?

1.In last week’s decision in Sports Direct, Arnold J held that the FRC (as regulator of the auditing profession) was entitled to call for privileged documents in the hands of that auditor’s client even if that client did not consent. By contrast, 7 years ago in Quinn Direct v Law Society [2011] 1 WLR 308 the Court of Appeal held that insurers were not entitled to see documents belonging to a solicitor’s client in circumstances where the client had not waived privilege. Is there a principled reason for this difference in approach?

2 Although the outcomes were different, both Sports Direct and Quinn Direct drew heavily on the speech of Lord Hoffman in R (Morgan Grenfell & Co Ltd) v Special Commissioner of Income Tax [2003] 1 AC 563. Having reviewed the case law (much of which concerned the Law Society) he set out at [32] two alternative justifications for the principle that regulators may inspect documents held by a professional even though they are privileged in favour of the professional’s client. 

3. Firstly, Lord Hoffmann suggested that there was in fact no infringement of the client’s privilege in circumstances where the regulator was not entitled to use information disclosed by the professional for any purpose other than the investigation. Secondly, he pointed out that if there was an infringement of privilege in the reported cases, it was limited and authorised by the statutory powers of the Law Society. His decision- and the authorities reviewed in it- provide an important part of the backdrop to both Quinn Direct and Sports Direct.

The decision in Quinn Direct

4. In Quinn Direct, the Court of Appeal had to consider whether a professional indemnity insurer was entitled to require the Law Society (who had intervened in a firm of solicitors) to produce privileged documents belonging to the solicitors’ clients that might have a bearing on whether insurers could decline cover to the solicitors on grounds of fraud. The Court of Appeal found that the insurers were not entitled to see the documents. They rejected Quinn’s argument that insurers should be part of what Lord Hoffman had called a “circle of confidence” for the purposes of seeing privileged material in Morgan Grenfell. They drew on Lord Hoffman’s observation that privilege was a “fundamental human right” and stated that any claims that it should be relaxed should be subject to “the greatest circumspection” [23].

 5. The decision caused some controversy at the time. The Court of Appeal acknowledged that a consequence of it was that where a former client had not waived privilege[1] by making a claim, solicitors were constrained in what they could tell their insurers about circumstances that might give rise to a claim in future. The Court of Appeal went so far as to say that “if the client will not waive his privilege to enable proper disclosure to be made, the consequence of the resulting conflict of interest will be that the insurance is vitiated or the notification inadequate but that is the problem of the solicitor not the client” [24]. The Court of Appeal treated that problem as a necessary side-effect of protecting a client’s privilege.

 6. Criticisms of the decision included the fact that, for many types of cover, the client is likely to be the one who suffers if no insurance is in place. The Court of Appeal’s decision was also criticised for placing too little weight on the public interest in having an appropriately insured solicitors’ profession, or the establishment of the Minimum Terms and Conditions by the SRA in order to achieve that aim (factors arguably not dissimilar to the public interest function performed by regulators)

The decision in Sports Direct

7. By contrast, in Sports Direct, the Court held that the production of documents belonging to an auditor’s client to the FRC for the purposes of a confidential investigation into that auditor was not an infringement of any legal professional privilege of the underlying clients in respect of those documents. Arnold J also relied heavily on the decision of Lord Hoffman in Morgan Grenfell, although he drew on the matters set out at para. 4 above rather than the parts of the decision relied on by the Court of Appeal in Quinn.

8. In Sports Direct, Arnold J concluded that when a client sends his auditor privileged documents for the purposes of an audit[2], he does not waive privilege in them as against the auditor’s regulator [56]. However, he went on to decide that “production of documents to a regulator by a regulated person solely for the purposes of a confidential investigation by the regulator into the conduct of the regulated person is not an infringement of any legal professional privilege of clients of the regulated person in respect of those documents” [84].

9. It seems to us likely that the Sports Direct decision will also attract its critics:

  • As Lord Hoffmann noted at [8] in Morgan Grenfell, privilege is a fundamental human right which can only be overridden by primary legislation. 
  • The proposition that disclosure to a regulator solely for a confidential investigation avoids infringing privilege does not sit easily with the idea that privilege is absolute. To suggest that infringement of privilege depends on the purpose for which the document is disclosed is (according to Phipson on Evidence “novel and dangerous” because “the use to which a document is put is often not black and white but a shade of grey”.[3]
  • Once the FRC has seen a document for the purposes of a confidential investigation, what is it supposed to do next if it wants to rely on it in proceedings against an auditor? What if it knows that another regulator with whom it has a Memorandum of Understanding and a disclosure “gateway” (e.g. the FCA) would like to see the document for instance because it relates to a large corporate collapse? Would using the document for those purposes infringe privilege?  
  • Any public policy grounds for enabling regulators to obtain privileged material could be said to apply by analogy to insurers who perform an important public function in providing the professional indemnity insurance (sometimes on mandatory minimum terms imposed by a regulator such as the SRA).

10. Pending appeal, the Sports Direct judgment is likely to cause difficulty for professionals deciding whether or not they are entitled to provide privileged material belonging to their clients to regulators. In some circumstances it will be possible to get round this difficulty by seeking a waiver of privilege by the client. In other cases that will not be possible, particularly if an investigation is high profile and the client fears adverse publicity. If no consent can be obtained, should auditors be confident that the decision of Arnold J in Sports Direct will hold?