August 1998 Issue


EPA CHALLENGES PRIVILEGE ISSUE IN ENVIRONMENTAL SELF-AUDITS

By Michael M. McKinney and Mark E. Steadman, East Tennessee State University

n environmental audit is a self-initiated, voluntary inspection of a company's facilities and records to evaluate and identify compliance (or noncompliance) with environmental regulations. To encourage more companies to conduct these audits voluntarily, many states have enacted evidentiary privilege to protect information obtained during these engagements. CPAs need to be aware of the limitations of this privilege.

The scope of an environmental audit can vary greatly. Audits may be conducted to gauge compliance, including operational controls, with regulations protecting the air, water, and soil. An audit might be specifically dedicated to issues governed by a particular statute or review compliance with several statutes.

Company personnel, through an internal evaluation or external consultants (such as public accounting firms), can conduct environmental audits.

Public Disclosure Requirements

Many of the environmental laws require that companies discovering violations of environmental regulations report them to the Environmental Protection Agency. Also, many states are authorized by the EPA to administer the various Federal programs established under environmental statutes. In those states, documents containing sensitive information regarding violations must be turned over to the state agency in many situations.

Once submitted to a state agency, the documents can easily become public information through either state public access laws or the Freedom of Information Act if the documents are transferred to a Federal agency such as the EPA. Other audit documents, which may not have to be submitted to authorities under self-reporting requirements, can be obtained by agencies through the discovery process in a legal proceeding. Because of these requirements, companies may be hesitant to conduct environmental audits in order to assess compliance.

In 1986, the EPA issued a policy statement which encouraged voluntary audits and considered the practice a demonstration of management commitment to environmental protection. In 1991, the Department of Justice, which prosecutes criminal cases for the EPA, encouraged the practice of self-auditing by businesses.

Despite these assurances, many companies will not conduct a voluntary environmental audit because of the legal discovery issue.

The Privilege Issue

Addressing these concerns, several states have attempted to encourage self-audits by enacting evidentiary privilege to protect information obtained during audits.

Some companies hire environmental attorneys to conduct audits of their facilities and claim attorney-client privilege to protect audit findings if a third party, such as a state agency, attempts to gain access to the audit documents. Companies that hire environmental engineers or external CPAs to conduct audits aim to protect the disclosure of documents through privilege by requiring the consultants to report findings directly to attorneys, who then submit the results to the company.

At least 19 states have passed laws offering privilege for information discovered during an environmental audit. The states enacting audit privilege statutes believe that more companies will audit their facilities and correct violations if information discovered during the audit is not accessible to enforcement authorities or the public.

Basis of the Conflict

The EPA has been reluctant to allow privilege even if a state legislature grants the right. While the EPA's pronouncement in 1986 strongly encouraged environmental audits and voluntary disclosure, the agency has expressly refused to acknowledge amnesty from enforcement actions. In 1995, the EPA released an audit policy specifically opposing privilege for environmental audits.

This position recently culminated in a standoff when the EPA challenged the environmental audit law enacted by the state of Texas, concerned that the law would severely limit the collection of information about environmental violations and prohibit the admissibility of most audit materials in litigation. Because the EPA believed the privilege statute seriously limited the ability of government to enforce the environmental laws, the agency implicitly threatened to revoke its delegation of enforcement authority to the state of Texas. Without this delegation, Texas would not have the authority to supervise and enforce EPA programs.

Although this Federal/state conflict is currently unsettled, the ultimate outcome holds numerous implications for companies and CPA firms. States argue that companies will not attempt to discover and correct environmental violations without audit privilege. Despite the EPA's position against privilege, additional states are currently contemplating the enactment of confidentiality statutes.

The potential impact of this legal battle on CPAs is twofold. First, CPAs must advise clients of the risk associated with environmental self-audits. This risk can arise from public disclosure of audit findings which the company believed to be internal and private. Such disclosure can damage the company's reputation and lead to penalties, fines, and liabilities for cleanup costs.

Also, CPA firms that conduct environmental audits must recognize that audit findings, even if privilege has been adopted in a particular state, might not be fully protected. *

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