7542 Communication with Entity’s External Legal Counsel

Sep-2022

OAG Guidance

Document the reasons, if any, for the exclusion of the entity’s legal counsel from the circularisation of letters.

Generally, the request letters we send to external legal counsel, after being agreed with management, also contain a paragraph requesting that external legal counsel provide, for each material item of litigation, the following information:

• Whether this litigation is a present or possible obligation.
• Whether the likelihood for an outflow of resources is probable or remote.
• If the likelihood for an outflow of resources is probable, whether this can be reliably estimated.

Legal letters are ordinarily obtained from the entity’s external general counsel, from other external legal counsel known to be handling important matters, and from the entity’s in-house legal counsel, when applicable. Additionally, consider whether to send letters to other external legal counsel the entity has used in the past or those to whom payments are being made, even though we are not aware of any specific matters.

When legal counsel provides us solely with confirmations relating to the completeness of litigations and claims such information provided by legal counsel is not in his/her capacity as a management’s expert. Legal counsel is considered a management’s expert when making estimates which the entity uses in the preparation of its financial statements. See OAG Audit 3111 for guidance when legal counsel is acting as management’s expert.

Further guidance related to certain aspects when preparing legal confirmations:

• CAS 501 (CA25b-CA25c) and OAG guidance state that engagement teams may obtain legal letters from in-house legal counsel of the entity. In these cases engagement teams should consider the relevance and reliability of the information obtained. However, generally internal legal counsel should only be used if the client does not have external legal counsel or if the aggregate possible claim amount is not material.

• In cases where management is uncertain which factors are appropriate to include in the legal letter, engagement teams should encourage management to discuss these matters with the law firm before finalizing the legal letter.

• Generally, a threshold should only be used if there are a significant number of claims or possible claims. Engagement teams need to apply professional judgment when determining the threshold, but the threshold should be set between SUM posting level and performance materiality and applied based on the potential claim amount. Engagement teams should consult with Audit Services if they are any questions on the applicability of the threshold.

Oral Communications

There are circumstances where it may be appropriate for us to obtain responses from legal counsel at a conference. While written responses to the audit inquiry letter are preferable, it is recognized that there will be instances involving complex judgments and situations where a conference is desirable. The lawyer needs to understand that we will give the same weight to information orally transmitted to us as that given in a written response. In these situations, where practicable, two OAG representatives would be present to minimize possible misunderstandings on our part of the lawyer’s representations.

We fully document in the working papers the discussion and conclusions reached. A copy of our documentation (or a summary of it) would be sent to the lawyer, with a request that we be notified (either orally or in writing) that our understanding of the matters discussed in the conference is correct. Alternatively, we could send a copy of the documentation to an entity official who attended the meeting to initial and return to us, thereby providing evidence of the corroboration process.

Discussions with the lawyer about less important matters to obtain clarification or updated information may take place in person or by telephone. The correctness of related documentation about these less important matters need not be confirmed with the lawyer.

In the above instances, keep in mind that this form of evidence is less persuasive than a written response in satisfactory form received directly from legal counsel and its adequacy needs to be addressed before concluding in complex situations.

Update Procedures

Obtain legal representations as close as possible to the date of the audit report.

In the event the effective date of the response is not reasonably close to the date of the audit report, the following factors may be considered in determining the appropriateness of a supplemental inquiry:

• The length of time between the date of the response (or an earlier effective date if the response so indicates) and the date of the audit report.

• The number and significance of matters included in legal counsel’s response.

• The probability of more current developments relating to matters included in legal counsel’s response.

• The reliability of the entity’s policies and procedures for identifying, evaluating, and accounting for litigation and claims.

While it is preferable that the supplemental inquiry be made in writing, timing considerations may necessitate that it be made orally. Our working papers need to document the results of any oral inquiries, and a supplemental letter would be obtained if the lawyer’s response indicates any significant changes from the original letter.

OAG Guidance

Evaluate each response received, whether written or oral, for adequacy and completeness in the light of the following considerations:

• contains all matters in the letter of inquiry;
• is clear and precise;
• contains the required representations, such as advising the entity if legal counsel is aware of unasserted claims that were omitted from the detailed listing.

Consider responses, including any caveats contained therein, in our assessment of the entity’s accounting for, and disclosure of, contingencies, and in the determination of any resulting effects on our audit scope and report. Evaluate the entity’s estimates and disclosure in light of the responses.

Additional considerations when reviewing legal responses include:

• Qualifications of legal counsel. In evaluating legal counsel’s response, consider whether there is any reason to doubt the individual’s professional qualifications and reputation. If we are familiar with legal counsel’s standing, there is no need to make specific inquiries. In other instances (for example, if legal counsel with whose standing we are not familiar is representing the entity in what appears to be a significant case), we may inquire into legal counsel’s professional background, reputation, and standing in the legal and financial community and consider information available in legal publications. Once we are satisfied, we can accept legal counsel’s opinion regarding a legal matter unless it appears to be unreasonable.

• Extent of investigation. It is expected that when legal counsel responds to a matter they will have given substantive attention to such matter. However, the term “substantive attention” is vague and can have different meanings. Read the response carefully to try to determine whether the entity’s counsel has studied the case or has just read the complaint. If counsel uses a phrase such as “based upon the information available to me . . .” and does not expand further, there may be a question of whether the opinion expressed is nothing more than a “negative assurance.” In other words, we expect the content of the letter itself to be substantive. The absence of any reasoning behind legal counsel’s conclusion might make it advisable to request that further information be submitted in writing.

• Consider all factors. Although we place reliance on legal counsel for judgments concerning litigation and claims, consider all information relative to the lawsuit that has been accumulated during the audit. If the known facts appear to contradict the information upon which counsel has placed reliance, satisfactorily resolve the contradiction before expressing an opinion.

• Consistency. Assess whether counsel’s current position is consistent with opinions expressed at earlier points in time. For example, if the matters discussed in a letter to us were also referred to in earlier correspondence determine whether counsel’s opinion has changed. Unless the effect of subsequent developments is readily apparent, have the entity’s counsel assess any substantive changes of the matters at issue.

• Changes or resignations of legal counsel. If we become aware that any legal counsel to whom a letter of audit inquiry was sent has resigned or indicated an intention to resign, inquire of the entity about the reasons and consider what, if any, further procedures are necessary. Document these inquiries and the entity’s responses in the working papers.

Consider also when reading opinions received from legal counsel that legal counsel is an advocate for the entity and may be inclined to place the best construction possible on issues involved. To do otherwise might be prejudicial to the entity’s interests and to client relations. Reputable counsel will not deliberately misrepresent the facts or the law but, if counsel believes it is in the entity’s interest not to acknowledge publicly the possibility of extensive liability, he or she may seek to minimize the significance of a matter to the extent possible without compromising his or her integrity.

Responses from counsel that we initially believe may result in the need for accrual or disclosure or a qualified opinion may in some instances be resolved to a point that accrual or disclosure is not necessary or an unqualified opinion may be given. Sometimes, the entity may be able to persuade counsel to furnish information previously withheld. In other instances, the entity may authorize counsel to investigate the matter more thoroughly or may produce additional evidence for counsel to consider, which could lead counsel to change his or her evaluation. Occasionally, the apparent problem is counsel’s choice of language, which can be remedied by requesting counsel to revise the letter.

OAG Guidance

Document issues related to legal representation matters whether raised through oral or written communication as significant matters describing discussions and conclusions reached, including the reasons and any conclusions.

See OAG Audit 1143 for further guidance on documenting significant matters and related significant professional judgments.