Blood in the Shark Tank: Chum(p) Avoidance

2008 International Conference

Golden Opportunities or Fool’s Gold? • November 5-7, 2008 • San Francisco

Blood in the Shark Tank:Chum(p) Avoidance

MODERATOR:

Michael W. Early, JD, Assistant General Counsel, Chicago UnderwritingGroup, Inc.

PANELISTS:

Anjali C. Das, Esq., Partner, Wilson Elser

Jane R. DiGioia, JD, Senior Claims Attorney, Monitor Liability Managers, Inc.

Kimberly Pihlstrom, JD, CPCU, RPLU, Senior Vice President and Product Manager, Lawyers’ Professional Liability, OneBeacon Professional Partners

Ronald S. Safer, Esq., Managing Partner, Schiff Hardin LLP

Blood in the Shark Tank:Chum(p) Avoidance

Overview

• Heightened Responsibilities Post SOX

• E-Discovery

• Underwriting Implications

• Potential Liability

• Indefensible Claims Defense

• Current Trends

• Takeaways

• Q&A

Heightened ResponsibilitiesPost SOX

• Sarbanes-Oxley Section 307

• Lawyers are the “Gatekeepers”

• SEC and Prosecutors Target Attorneys

SEC Targets General Counsel

• SOX Section 307

1) Requires an attorney to report evidence of a material violation of securities law or breach of fiduciary duty to the Chief Legal Officer or CEO of the company

2) If the CLO or CEO does not appropriately respond and take action, the attorney is required to report the evidence the to company’s Audit Committee or to the Board of Directors

SEC Targets General Counsel

• SEC Chairman Cox observed that “lawyers are what today we call crucial gatekeepers responsible for safeguarding shareholders’ interests by advising companies on disclosure standards”

• Chairman Cox questioned “where were the lawyers” and “where were the gatekeepers” in the stock option backdating cases?

• The SEC has carefully scrutinized the role of General Counsel in the backdating cases and has filed suit against a number of these individuals seeking injunctive relief, disgorgement, penalties, interest, and D&O bar orders

SEC Targets General Counsel: Comverse

• SEC charged General Counsel of Comverse Technology and two others with engaging in a fraudulent scheme to grant undisclosed “in-the-money” options to themselves and others by backdating stock option grants

• SEC also accused Comverse’s GC of creating records which falsely indicated that Comverse’s Compensation Committee had approved the stock option grants on a particular date when this was not the case

• Comverse GC settled with the SEC, agreeing to an officer and director bar order, payment of $1.67 million in disgorgement of proceeds from exercising backdated option, pre-judgment interest, and a $600,000 civil penalty

SEC Targets General Counsel: Monster

• SEC filed a civil action against Monster Worldwide’s former GC for participating in a securities fraud scheme to secretly backdate Monster stock options

• SEC claims that Monster’s GC prepared false backdated documentation for the company Compensation Committee

• Monster overstated its net income by $340 million from 1997 through 2005 by failing to recognize compensation expense for backdated options

• Monster’s GC is alleged to have “personally profited” from the receipt of backdated options

SEC Targets General Counsel: Monster

• Monster’s GC has since pled guilty to charges of securities fraud and conspiracy for backdating options

• The charges carry a total maximum penalty of 25 years imprisonment.

SEC Targets General Counsel: McAfee

• SEC charged McAfee’s former GC with securities fraud for wrongfully re-pricing McAfee stock option grants awarded to him and others in an effort to secretly increase the value of the grants

• McAfee’s GC allegedly re-priced his own grants to confer a potential personal benefit of $197,500

• McAfee’s GC is also accused of falsifying Compensation Committee minutes and backdating the CEO’s grants to confer a potential benefit of an additional $739,200

• McAfee’s GC apparently confessed his option re-pricing to the company’s Board when it was conducting its internal investigation of backdating practices

SEC Targets General Counsel: Apple

• SEC has accused Apple’s former GC of participating in a fraudulent backdating scheme that caused the company to under-report its expenses by nearly $40 million

• The backdating scheme includes two large option grants to Apple’s Executive Team and CEO

• Apple’s GC is also alleged to have directed her staff to prepare documents falsely indicating that Apple’s Board had approved the Executive Team and CEO grants

SOX Section 307

• Can we expect more claims against lawyers as a result of SOX 307?

New Federal Rule of Evidence 502

• An Overview of FRE 502– On 9/19/08, President Bush signed FRE 502 into law– Rule 502 provides protections for waiver of attorney-

client or work-product privilege– Rule responds to concerns of inadvertent waiver in

cases involving E-discovery


• Section (a)– A voluntary disclosure in a federal proceeding only

results in the waiver of the communication or information disclosed

– Subject matter waiver occurs when party intentionally puts protected information into the litigation in a misleading and unfair manner

– An inadvertent disclosure never results in a subject matter waiver


• Section (b)– Inadvertent disclosure in a federal proceeding does

not constitute a waiver if the party took reasonable steps to prevent disclosure and to rectify the error

– Multi-factor test for reasonableness


• Section (c):– FRE 502 applies to federal proceedings– A state court order finding no waiver in a state

proceeding is enforceable in a subsequent federal proceeding


• Section (d):– A confidentiality order in a federal proceeding is

enforceable against non-parties in any federal or state proceedings

– Rule contemplates enforcement of “claw back” and “quick peek” arrangements


• Defense and Claims Handling Issues– In the event of multi-court proceedings, make sure

that a confidentiality agreement is in place – Obtain a confidentiality order from court since it is

enforceable against non-parties in federal or state proceedings

– Particularly useful in multi-insurer coverage litigation

Attorney-Client Privilege Issuesfor Business Attorneys

• Lawyer’s Dual Role: An Overview– Oftentimes attorneys wear “2 hats” in a business and

legal capacity– Apparent in business transactions– In-House counsel face unique risks– Consider the lawyer that provides both business and

legal advice


• Implications for “Attorney-Client” Privilege– What happens when a business deal ends up in

litigation– Are all attorney-client communications privileged in

the litigation– Short answer: NO


• Overview of Attorney-Client Privilege:– Protection of written and oral communications

between lawyer and client– Purpose of privilege is to ensure candid

communications without fear of disclosure– Beware: Not all attorney-client communications are

privileged


• Business versus Legal Advice– Many courts draw a distinction between privileged

legal communications and non-privileged business communications

– Consider relevant cases


• More Cases re Unprotected Business versus Legal Communications by Counsel


• Work-Product Privilege– What is it– When does it apply– Consider cases discussing application of work-

product privilege


• Underwriting and Claims Issues– Does firm engage in transactional work– How does it distinguish between legal and business

advice to clients– Should firm that negotiated transaction be prohibited

from defending ensuing litigation– Conflicts of interest– Special coverage for in-house counsel

E-Discovery After Qualcomm

• Qualcomm failed to produce electronic documents– Over 100,000 relevant, responsive documents during patent infringement lawsuit, including

documents residing on computers never searched during discovery– Judge ruled that the sheer volume of documents not produced on its face ruled out any

argument that non-disclosure was inadvertent and awarded attorneys fees and sanctions

• Heightened duties for lawyers– Know your client’s IT systems and capabilities – Educate client as to litigation holds (destruction of documents in anticipation of discovery is

still not permissible)– Beware of metadata– Costs of production

• Potential issue in all cases involving bad faith or hiding information (e.g. subprime)


• Overview: Qualcomm v. Broadcom – Patent infringement case– Document intensive– 1.2 million documents produced – 46,000 responsive documents not produced– Court sanctioned Qualcomm and its counsel


• Attorney misconduct(1) Intentional concealment by Qualcomm

(2) Ineptitude of lawyers

(3) Intentional concealment by lawyers

(4) Lawyers “turned a blind eye”


• “Red Flags” re Missing Documents– 21 emails discovered but not produced– No further investigation for more emails– No pointed questions asked of witness– No search of computers of 30(b)(6) witnesses


• Federal Rule of Civil Procedure 37– Failure to comply with discovery requests– Sanctions imposed for “negligent” conduct– Award of reasonable attorney’s fees – See also F.R.C.P. 26(g)– Rule 11 sanctions– Disciplinary action


• For Lawyers “Ignorance Is Not Bliss”– Know your client and its IT systems– Work with client’s IT department– Retain outside vendor– Search computers of all witnesses– Stipulate to electronic word searches


• Substantial Costs of E-Discovery– Use of outside vendors– In-house IT charges by law firms– Attorney time to search databases– Increasing volume of email exchanges

Underwriting Implications

• Stoneridge Impact – U.S. Supreme Court found secondary actors (e.g., law firms) could not be

held liable for securities fraud of clients because they made no statements or representations on which investors relied

– An opposite decision would have had significant impact on insuring securities and corporate lawyers

– State claims such as aiding and abetting fraud and breach of fiduciary duty are expected to increase

– Economic conditions expected to impact claims alleged by clients and 3d parties relying upon lawyer’s advice

– Underwriters looking more closely at financial condition of clients: claims by bankruptcy trustees are on the rise

Malicious Prosecution

Commenced at defendant’s direction

Terminated in plaintiff’s favor

Brought without probable cause

Initiated with malice

Probable Cause

Objective standard

Reasonableness of defendant’s conduct

What did the defendant know when he filed suit?

Probable Cause

· Requires a showing of an unsuccessful prosecution of a criminal or civil action, which any reasonable attorney would regard as totally and completely without merit for the intentionally wrongful purpose of injuring another person.

Malice

Improper purpose

Potential Liability: Third Party Claims

• Overview: Third Party Claims Against Lawyers– Rise in third party claims against attorneys– > 20% of claims by non-clients (adversaries)– Increase in aiding and abetting tort claims – Different standards applied by different courts


• Aiding and Abetting Breach of Fiduciary Duty

(1) Client owed fiduciary duty to third party

(2) Client breached its fiduciary duty

(3) Lawyer provided “substantial assistance”

(4) “Knowing participation” in the client’s breach

(5) Burden of proof on plaintiff


• Standards Differ State by State:– “Actual” versus “constructive” knowledge– “Substantial assistance” (i.e, more than provision of

routine services or merely acting as a scrivener)– Qualified privilege for lawyers’ acting within scope

of attorney-client relationship


• Examples: Hefferman v. Bass (7th Cir.)– Lawyer purported to represent both business partners

in car wash venture– At request of one partner, lawyer obtained a release

of other partner’s interest in venture– 7th Circuit held this was sufficient to state a claim for

aiding and abetting breach of fiduciary duty


• Examples: Reynolds v. Schrock (Oregon S.Ct.)– Safeguarding lawyer- client relationship is integral to

the protection of the legal system– Qualified privilege for lawyer acting within scope of

attorney-client relationship– No protection for lawyers acting in their own self-

interest and contrary to client’s interest– Rejection of “substantial assistance” test


• Examples: Alpert v. Crain, Cato & James (Tex.)– Texas law discourages lawsuits against opposing

counsel– Aiding and abetting claims require specific

allegation of fraud, conspiracy to defraud– Independent fraudulent conduct of lawyer beyond

rendition of legal advice to client


• California Civil Code §1714.10– Disallows civil conspiracy claim against lawyer in

conjunction with representing client, unless court determines there is a “reasonable probability” that plaintiff will prevail


• Defenses, Avoidance, and Coverage:– Easy to plead, hard to prove– Know your client– Know your client’s clients– Document scope of representation– Coverage under lawyers professional liability

policies

Indefensible Claims Defense

• Real Life “War Stories”

Current Trends

• Decrease in aiding and abetting liability against lawyers under federal securities laws (in light of Stoneridge)

• Increase in aiding and abetting breach of fiduciary duty claims against lawyers under state law

• Underwriters will be looking more closely at financial stability of clients, conflicts of interest and areas of practice

Takeaways

• Qualcomm is just the tip of the iceberg with respect to E-Discovery issues

• Attorneys who play dual roles as legal and business advisors may not benefit from attorney-client or work-product privileges

• Don’t forget the basics• Current financial crisis may trigger increased

emphasis on duty to disclose information by lawyers either through e-discovery obligations or SOX duties

Many Thanks to

• Michael Early, Esq.

• Anjali Das, Esq.

• Jane R. DiGioia, Esq.

• Kim Pihlstrom, JD

• Ronald Safer, Esq.

Blood in the Shark Tank: Chum(p) Avoidance

Documents

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