LESSONS LEARNED FROM RECENT CORPORATE ...LESSONS LEARNED FROM RECENT CORPORATE SCANDALS An Overview...

LESSONS LEARNED FROM RECENT CORPORATE SCANDALS

An Overview of Recent

SEC Enforcement Actions Against Attorneys

PEGGY A. HEEG [email protected]

Fulbright & Jaworski, L.L.P. 1300 McKinney Suite 5100

Houston, Texas 77010 (713) 651-8443

State Bar of Texas 6TH ANNUAL ADVANCED

IN-HOUSE COUNSEL COURSE August 16 - 17, 2007

San Antonio

CHAPTER 12

PEGGY A. HEEG Fulbright & Jaworski L.L.P. 1301 McKinney, Suite 5100 Houston, Texas 77010-3095

(713) 651-8443 FAX: (713) 651-5246

PROFESSIONAL ACTIVITIES

American Bar Association State Bar of Texas District of Columbia Bar Association Energy Bar Association National Association of Corporate Directors (NACD), Advisory Board Member

PROFESSIONAL ACKNOWLEDGEMENTS

"Best Lawyers in America" for energy law, Best Lawyers, 2007 "Best Lawyers in America" for corporate governance and compliance law, Best Lawyers, 2007 "Lawdragon 3000" for corporation, banking and business law, Lawdragon magazine, 2006 "Super Lawyer" in energy, Texas Monthly magazine, 2003, 2004 and 2007 Who's Who in America Who's Who in American Law Who's Who of American Women Who's Who in Finance and Business The NACD Corporate Directors Institute - Certificate of Director Education

RECENT PUBLICATIONS

Co-Author, "The Current State of Corporate Cooperation Under DOJ Guidelines - Privilege Waiver and Advancement of Attorney's Fees," February 2007

"Corporate Internal Investigations: DOJ Modifies The Thompson Memo Guidelines," Fulbright Client Alert, December 2006

"Corporate Governance On The Frontline," Oil & Gas Financial Journal, December 2006

"Auditors Are Increasingly At Odds With Attorneys", The National Law Journal, November 20, 2006

"Protecting Privileged Information in the Post-Sarbanes-Oxley World: Can The Attorney-Client Privilege Survive?" October 2006

"Government Investigations: What the Government Expects, Privilege Issues and How Best to Protect Your Company," University of Texas School of Law, 28th Annual Conference on Securities Regulation and Business Law, February 2006

"Smart Moves: Private Equity Strategies for Energy/Chemical Deals," Fulbright & Jaworski L.L.P, January 2006

"What You Should Know About the Attorney-Client Privilege," Fulbright & Jaworski L.L.P. CLE, June 2004

Lessons Learned From Recent Corporate Scandals Chapter 12

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TABLE OF CONTENTS

I. INTRODUCTION................................................................................................................................................... 1

II. BACKGROUND..................................................................................................................................................... 1

III. RECENT SEC CASES AGAINST IN-HOUSE ATTORNEYS............................................................................. 2 A. Securities Violations and Aiding and Abetting Securities Violations............................................................. 2

Stanley Silverstein of Warnaco........................................................................................................................ 2 Mark Belnick of Tyco ...................................................................................................................................... 2 Steven Woghin of Computer Associates .......................................................................................................... 3 James Fitzhenry of FLIR Systems.................................................................................................................... 3 Jonathan Orlick of Gemstar ............................................................................................................................ 3 Leonard Goldner of Symbol Technology (Symbol) ......................................................................................... 4 Robert Graham of Gen Re............................................................................................................................... 4 Dale Rasmussen of Enron ............................................................................................................................... 4 Jordan Mintz of Enron .................................................................................................................................... 5

B. Failure to Act to Prevent Securities Violations or Other Violations of the Law............................................. 5 John Isselmann of Electro-Scientific Industries (ESI)..................................................................................... 6 David Drummond of Google ........................................................................................................................... 6 David Pillor of In-Vision Technology ............................................................................................................. 7

IV. THE HEWLETT PACKARD SCANDAL ............................................................................................................. 7

APPENDIX A................................................................................................................................................................. 1


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LESSONS LEARNED FROM RECENT CORPORATE SCANDALS I. INTRODUCTION The role of in-house counsel has never been more complex or rife with peril. Trusted business advisor, advocate, confidant and gatekeeper1 are terms interchangeably used to describe the role of an in-house attorney. Some argue that balancing these complex and often conflicting roles is impossible and requires attorneys to ignore their primary role as an advocate. Regardless of one’s philosophical view on the topic, there is little doubt that evolving governance expectations, the adoption of the Sarbanes-Oxley Act (SOX)2 and recent enforcement proceedings brought by the SEC against attorneys have made this a high stakes balance. The recent departures of the Fortune 500 general counsels illustrate that one lapse in judgment can result in an abrupt end to an otherwise distinguished career. II. BACKGROUND Recent corporate scandals have caused the public and the government to focus on the role of attorneys in corporate wrongdoing. A refrain echoed in response to the scandals is: Where were the lawyers? Did the lawyers assist in the fraud? Weren’t the lawyers in a position to stop the fraud? Although SOX and the SEC’s rules promulgated thereunder established minimum standards for attorneys appearing and practicing before the SEC, the scandals prompted a debate that went well beyond the specific requirements of SOX.3 The debate was crystallized when Stephen Cutler, the Director of Enforcement of the SEC, gave his now infamous speech in September 2004 describing his views on the role of attorneys as gatekeepers. 4 In the

1 Gatekeepers have been defined as “independent professionals who are so positioned that, if they withhold their consent, approval, or rating, the corporation may be unable to effect some transaction or to maintain some desired status.” See The Attorney as Gatekeeper, 103 Columbia Law Review 1293 (2003). 2 PL 107-204, 116 Stat. 745 (2002). 3 Section 307 of SOX requires the SEC to adopt standards governing the conduct of attorneys who represent companies before the SEC. On January 23, 2003, the SEC adopted rules implementing section 307 of SOX which establishes minimum standards of professional conduct for attorneys appearing and practicing before the SEC as well as reporting procedures to be followed if an attorney becomes aware of a “material violation.” 17 C.F.R. Pt. 205 (2006). 4 Stephen M. Cutler, Director, SEC Division of Enforcement, Speech at the UCLA School of Law: The

speech, Cutler described the SEC’s changing expectations of attorney conduct and the SEC’s increased scrutiny of attorneys. While espousing the significance of gatekeepers to the fair and honest functioning of the market, Cutler articulated three areas in which the SEC would scrutinize attorney conduct. First, Cutler described enforcement actions that the SEC would bring against attorneys “who we believe, assisted their clients in engaging in illegal [conduct].”5 Second the SEC is looking at lawyers “who assisted their companies or clients in covering up evidence of fraud, or prepared, or signed off on, misleading disclosures regarding the company’s conditions.”6 Finally, Cutler stated that the SEC was particularly focused on “the role of lawyers in internal investigations of their clients or companies …. [and that] lawyers may have conducted investigations in such a manner as to help hide ongoing fraud, or may have taken actions to actively obstruct such investigations.”7 Since Cutler’s speech, the SEC has made good on Cutler’s prediction and has aggressively pursued attorney misconduct. The SEC has brought a series of cases against attorneys for conduct including improper revenue recognition, failure to register stock options by improperly relying on advice that an exclusion was applicable, failure to disclose legal advice and risks to the board of directors and misleading outside auditors. The SEC’s continued commitment to aggressively pursue attorney conduct was recently reiterated by SEC Chairman Christopher Cox when he described attorneys as “crucial gatekeepers” and that when gatekeepers “fail to live up to their responsibility, the Commission will bring enforcement actions.”8 Although clearly there have been cases where lawyers have actively participated in a fraud, there are cases in which the law is less than clear, requiring a delicate balance between advocate and advisor on the one hand, and gatekeeper on the other hand. Attorneys that fail to recognize their gatekeeper status and the SEC’s shift in policy to hold attorneys accountable for not fulfilling SEC-mandated gatekeeper duties could find themselves under scrutiny.

Themes of Sarbanes-Oxley as Reflected in the Commission’s Enforcement Program (Sept. 20, 2004), available at http://www.sec.gov/news/speech/spch092004smc.htm. 5 Id. 6 Id. 7 Id. 8 Christopher Cox, SEC Chairman: Address to the 2007 Corporate Counsel Institute (Mar. 8, 2007), available at http://www.sec.gov/news/speech/2007/spch030807cc.htm.


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III. RECENT SEC CASES AGAINST IN-HOUSE ATTORNEYS

A. Securities Violations and Aiding and Abetting Securities Violations

The SEC has brought a series of cases against attorneys for approving the filing of reports with the SEC that the attorney knew or according to the SEC “should have known” contained false or misleading information. In these cases, the SEC has taken the position, with the benefit of hindsight, that if an attorney knew or should have known that materially inaccurate or misleading information was contained in an SEC filing, the attorney facilitated the corporation’s violation of securities laws. While most of the cases are settled, with terms subject to some degree of negotiation, it is important to note that in many of these cases, the SEC did not allege that the attorney had direct involvement with the underlying securities law violations. Rather, some of the cases appear to suggest that negligence, recklessness or some lesser standard can support a charge of aiding and abetting the violation of the securities laws. In fact, an attorney close to one of the cases argues that some securities violations have become strict liability offenses.9 Stanley Silverstein of Warnaco In this proceeding, Stanley Silverstein, Warnaco’s general counsel, was charged with aiding and abetting and causing Warnaco to violate the reporting provisions of the securities laws.10 Specifically, it was alleged that Silverstein “approved” the filing of Warnaco’s 10-K that “mischaracterized” the cause of Warnaco’s restatement. The SEC also alleged that Silverstein subsequently approved Warnaco’s 10-Q that improperly offset cash against debt in violation of section 13(a)11 of the Exchange Act and rules 12b-20 and 13a-1 thereunder.12 The SEC alleged that in restating its 1998 financials, Warnaco did not inform the public that the

9 According to Melinda Haag, partner with Orrick, Herrington & Sutcliffe and attorney for John Isselmann, failing to provide a material fact to accountants in connection with an SEC filing is essentially a strict liability offense. Tamara Loomis, Setting an Example, Corporate Counsel, Jan. 20, 2005, available at http://www.law.com/jsp/article.jsp?id=1105968930177. 10 See In the Matter of Stanley P. Silverstein, Litigation Release No.18701 (May 11, 2001), available at http://www.sec.gov/litigation/litreleases/lr18701.htm. 11 15 U.S.C. § 78m(a) (2004). 12 17 C.F.R. § 240.12b-20 (2006) & 17 C.F.R. § 240.13a-1 (2006).

restatement was the result of an inventory overstatement, but erroneously referred to a write-off of “start-up related production and inefficiency costs.”13 The SEC complaint did not allege that Silverstein advised Warnaco on the two accounting issues. Nor did the compliant allege Silverstein intentionally violated the securities laws. Rather, the SEC believed that Silverstein knew or “should have known” that the accounting and disclosures were inappropriate. Although the full extent of Silverstein’s involvement in the fraud cannot be ascertained from the SEC’s complaint, the complaint supports a reading that Silverstein did not intend to violate or cause Warnaco to violate the law. Rather a reasonable interpretation of the complaint is that Silverstein overlooked, or did not fully understand, the accounting involved. The SEC issued a cease-and-desist order against Silverstein and Silverstein agreed to disgorge $165,000. Mark Belnick of Tyco Mark Belnick, the former general counsel of Tyco was civilly and criminally charged for matters surrounding the implosion of Tyco.14 The SEC charged Belnick, who had been a partner with Paul Weiss, with aiding and abetting the violation of the Exchange Act for failing to disclose loans Belnick and other officers received from Tyco. Belnick was also indicted, tried and acquitted on 14 felony counts by the State of New York, including a charge of grand larceny. The SEC alleged that between 1998 and 2002, Belnick and two other Tyco officers received millions of dollars in low interest or interest-free loans from Tyco, and that Belnick received an unauthorized bonus from Tyco. The SEC alleged that Belnick prevented the disclosure of loans and thus aided and abetted Tyco in the violation of sections 10(b), 13(a) and 14(a) of the Exchange Act15 and Rule 10b-5, 12b-20, 13a-1 and 14a-9 thereunder.16 It was not alleged that Belnick was involved in the accounting schemes that led to billions of dollars in Tyco restatements. 13 See In the Matter of Stanley P. Silverstein, Litigation Release No.18701 (May 11, 2001), available at http://www.sec.gov/litigation/litreleases/lr18701.htm. 14 See SEC v. L. Dennis Kozlowski, Mark H. Swartz, and Mark A. Belnick, Litigation Release 19682 (May 2, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19682.htm. 15 15 U.S.C. §§ 78m(a) , 78n(a) (2004). 16 17 C.F.R. §§ 78j(b), 240.12b-5, 240.12b-20, 240.14a-9 (2006).


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In a speech given on April 18, 2006 at the InsideCounsel SuperConference, Belnick presented a haunting description of the perils that can face in-house counsel when they get caught up in a perfect storm of governmental investigation.17 Belnick made it very clear that his policy was to disclose, and but for “management [losing] control of itself,”18 he would never have come under scrutiny. Belnick asserted that he did not do anything wrong, was never asked to do anything wrong, and that, given the chance, he would not have done anything differently.19 Belnick settled the SEC action and agreed to pay $100,000 in civil penalties and was enjoined from serving as an officer or a board member of a public company for a period of five years. Steven Woghin of Computer Associates Steven Woghin, former general counsel of Computer Associates, and a former Assistant U.S. Attorney, was charged with aiding and abetting Computer Associates in violating the securities laws.20 According to the SEC, Woghin allegedly signed documents filed with the SEC which contained materially false and misleading information. Woghin also allegedly approved backdated contracts, drafted a contract which contained misleading dates and allowed the legal department to approve sales contracts which contained false and misleading signature dates. The contracts allegedly enabled Computer Associates to prematurely recognize revenue from software contracts in violation of GAAP. Finally, the SEC alleged that Woghin counseled or coached employees on how to answer the SEC’s questions allegedly to keep information from SEC investigators and Computer Associates’ outside counsel. Based on these allegations, the complaint charged that Woghin had violated section 17(a) of the Securities Act,21 sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act,22 and rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.23

17 Mark Belnick: Keynote Presentation at the InsideCounsel SuperConference (Apr. 18, 2006). 18 Id. 19 Id. 20 See SEC v. Steven Woghin, Litigation Release No. 18891 (September 22, 2004), available at http://www.sec.gov/litigation/litreleases/lr18891.htm. 21 15 U.S.C. § 77q(a) (2004). 22 15 U.S.C. §§ 78m(a), 78m(b)(2)(A), 78m(b)(2)(B) (2004). 23 17 C.F.R. §§ 240.12b-5, 240.12b-20, 240.13a-1, 240.13a-13 (2006).

The charges were settled, and Woghin agreed to a permanent injunction from future violations of the securities laws, and a permanent bar from serving as an officer or director of a public company. Woghin also pleaded guilty to two counts of conspiracy to commit securities fraud and obstruction of justice. James Fitzhenry of FLIR Systems James Fitzhenry, general counsel for FLIR, was charged with making, or causing to be made, materially false, and misleading statements in connection with FLIR’s 1998 year-end audit.24 The SEC alleged that Fitzhenry misled the company’s auditors by attempting to negotiate the removal of contingencies in non-binding letters of intent associated with $4.1 million in sales contracts and signed two management representation letters asserting that the sales obligations were binding, when he knew that the contracts were conditional. Fitzhenry was charged with willfully violating rule 13b(2) of the Exchange Act,25 for making, or causing to be made, a materially false or misleading statement, or omitting to state a material fact necessary in order to make statements made not misleading to an accountant. Fitzhenry settled the charges and consented to a five year suspension from appearing or practicing before the SEC as well as a cease and desist order. Jonathan Orlick of Gemstar Jonathan Orlick, former general counsel and member of Gemstar’s board of directors, was charged with securities fraud and aiding and abetting Gemstar in its violations of the securities laws.26 The SEC alleged that Orlick was involved in the recording and reporting of fraudulent revenues by making misrepresentations to Gemstar’s auditors to provide a basis for recording revenues. The SEC alleged that Orlick knew, or was reckless in not knowing, that Gemstar improperly recognized licensing and advertising revenue from two companies. It was alleged that Orlick signed false management representation letters to Gemstar’s auditors, supporting a charge of lying to auditors. The SEC charged Orlick with securities fraud, falsifying Gemstar’s books and records, aiding and abetting Gemstar’s reporting and

24 See In the Matter of James A. Fitzhenry, Administrative Proceeding No. 3-10943 (November 21, 2001), available at http://www.sec.gov/litigation/admin/34-46870.htm. 25 15 U.S.C. § 78m(b)(2). 26 See SEC v. Henry C. Yuen, et, al., Litigation Release No. 19047, available at http://www.sec.gov/litigation/litreleases/lr19047.htm.


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record-keeping violations, and lying to auditors, in violation of sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(5) of the Exchange Act27 and Rules l0b-5, 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder28. The claim was settled and Orlick agreed to pay over $300,000 in disgorgement and other penalties, was prohibited from serving as an officer or director of a public company for 10 years, and was suspended from practicing as an attorney before the SEC. Leonard Goldner of Symbol Technology In one of the first stock option backdating cases brought against an attorney, the SEC in SEC v. Symbol Technology, Inc. et al.,29 brought a securities fraud case against Leonard Goldner, former general counsel and senior vice president of Symbol and ten Symbol executives. The SEC alleged that, while other executives were engaged in various fraudulent schemes, Goldner implemented a “look back scheme” that was not publicly disclosed and approved by Symbol’s board of directors. It was alleged that rather than using the actual exercise date, Goldner used a date chosen from a 30-day lookback period to calculate the cost of the exercise. To give the appearance that the options had been exercised on the chosen date, Goldner allegedly backdated forms filed with the SEC. Making matters worse from an SEC perspective, he also allegedly took advantage of the scheme, resulting in his reporting a lower tax gain to the IRS. On these facts, the SEC charged Goldner with violating section 17(a) of the Securities Act,30 sections 10(b), 13(a), 13(b)(2), 13(b)(5), 14(a), and 16(a) of the Securities Exchange Act,31 and Exchange Act rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, 14a-3, 14a-9, and 16a-3.32 The SEC issued an order prohibiting Goldner from practicing as an attorney before the SEC but withdrew its claim for disgorgement and other civil penalties against Goldner in view of his civil forfeiture payment of $2 million in connection with his guilty plea in a criminal case resulting from the same facts.

27 15 U.S.C. §§ 78j(a), 78m(a), 78m(b)(2)(A), 78m(b)(5) (2004). 28 17 C.F.R. §§ 240.12b-5, 240.12b-20, 240.13a-1, 240.13a-13, 240.13b2-1. 240.13b2-2 (2006). 29 See SEC v. Symbol Technology, Inc., et al., available at http://www.sec.gov/litigation/complaints/comp18734.pdf. 30 15 U.S.C. § 77q(a) (2004). 31 15 U.S.C. §§ 78j(b), 78m(a), 78m(b)(2)(A), 78m(b)(5), 78n(a), 78p(a) (2004). 32 17 C.F.R. §§ 240.12b-5, 240.12b-20, 240.13a-1, 240.13a-13, 240.13b2-1. 240.14a-3, 240.14a-9, 240.16a-3 (2006).

Robert Graham of Gen Re Robert Graham, former assistant general counsel for Gen Re, was charged civilly and criminally, along with other Gen Re executives, with aiding and abetting the securities fraud of AIG, Gen Re’s parent company.33 The SEC alleged that various Gen Re executives, including Graham, engaged in a scheme to help AIG concoct two sham contracts to make it appear as if AIG increased its loss reserves. The transactions allegedly enabled AIG to reverse a key Wall Street metrics, declining loss reserves. The SEC alleged that Graham knowingly drafted sham reinsurance contracts to provide apparent support for the false accounting entries in AIG’s books which significantly inflated AIG’s revenues. The SEC alleged that Graham knew the contracts were part of a scheme to falsify AIG’s accounting books and that the only economic benefit of the transactions to either party was a $5 million side payment to Gen Re for putting the deal together. Graham was charged with aiding and abetting AIG’s violations of sections 10(b), 13(a), 13(b)(2), and 13(b)(5)34 and rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 of the Securities Exchange Act. 35 Dale Rasmussen of Enron Dale Rasmussen, a former senior counsel for Enron’s North America West Power organization group, was charged with aiding and abetting Enron’s violations of the securities laws which resulted in Enron filing materially false and misleading financial statements in the company's 10-K.36 The SEC alleged that in 2000, an Enron accountant engaged in improper revenue recognition related to the sale of a power plant development project. According to GAAP, revenue from the sale could only be recognized over time as the project progressed. Rasmussen, the attorney in charge of the sale, allegedly worded the sales contract to allow Enron to circumvent GAAP. It was alleged that

33 See SEC v. Ronald Ferguson, Elizabeth Monrad, Robert Graham, Christopher Garand, and Christian Milton, Litigation Release 19552 (February 2, 2006), available at http://www.sec.gov/litigation/litreleases/lr19552.htm. 34 15 U.S.C. §§ 78j(b), 78m(a), 78m(b)(2), 78m(b)(5) (2004). 35 17 C.F.R. §§ 240.10b-5, 240.13b-20, 240.13a-1, 240.13a-13, 240.13b2-1 (2006). 36 See SEC v. David T. Leboe and Dale G. Rasmussen, Litigation Release 19653 (March 27, 2006), available at http://www.sec.gov/litigation/litreleases/lr19623.htm.


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Rasmussen worked closely with Enron’s accountants to ensure that the wording of the transaction documents did not jeopardize Enron’s efforts to circumvent GAAP. It was also alleged that Rasmussen knew that undocumented side agreements were being withheld from Enron’s auditors. Based on these facts, the SEC charged Rasmussen with violating sections 10(b) and 13(b)(5) of the Exchange Act37 and rules 10b-5 and 13b2-1 thereunder, 38 and with aiding and abetting violations of sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act39 and rules 12b-20, 13a-1 and 13a-13 thereunder. 40 The charges were settled and Rasmussen was permanently enjoined from engaging in future fraud, paid a $30,000 civil penalty and was ordered to pay nominal disgorgement. Jordan Mintz of Enron The SEC recently filed a complaint against Jordan Mintz, former general counsel of Enron’s Global Finance group, for violating and aiding and abetting Enron’s violation of the antifraud provisions of the federal securities laws.41 The case is noteworthy because Mintz was widely viewed as a whistleblower testifying before Congress that he wrote a memo to Andrew Fastow in 2000 raising issues about the propriety of certain transactions with Mr. Fastow. 42 The SEC complaint alleges that Mintz played a substantial role in a transaction purportedly aimed at taking a troubled project off of Enron’s balance sheets. It was alleged that in 1999, Enron sold an interest in a money losing Brazilian power plant to LJM1 (an entity controlled by Andrew Fastow). Allegedly, Enron orally agreed with Fastow that LJM1 would not lose money on the transaction. The SEC alleges that this agreement was not documented or disclosed to Enron’s auditors. In 2001, Enron bought back the power plant and paid LJM1 a profit. Mintz was responsible for drafting the documents pertaining to Enron’s

37 15 U.S.C. §§ 78j(b), 78m(b)(5) (2004). 38 17 C.F.R. §§ 240.10b-5, 240.13b2-1 (2006). 39 15 U.S.C. §§ 78m(a), 78m(b)(2)(A), 78m(b)(2)(B) (2004). 40 17 C.F.R. §§ 240.12b-20, 240.13a-1, 240.13a-13 (2006). 41 See SEC v. Jordan H. Mintz and Rex R. Rogers, Litigation Release No. 20058 (March 28, 2007), available at http://www.sec.gov/litigation/litreleases/2007/lr20058.htm. 42 “Mintz emerged in congressional hearings in early 2002 as one of the few within Enron to challenge manipulations and conflicts rampant in Fastow's LJM partnerships.”

Kristen Hayes, SEC goes after lawyers, Houston Chronicle, Mar. 29, 2007, available at http://www.chron.com/disp/story.mpl/front/4670329.html.

repurchase of the project. The SEC alleges that Mintz knew or was reckless in not knowing about the oral agreement, and as such aided and abetted the fraudulent transaction. In its complaint, the SEC alleges that by engaging in this conduct, Mintz violated section 17(a) of the Securities Act,43 sections 10(b) and 14(a) of the Exchange Act44 and Exchange Act rules 10b-5 and 14a-9.45 In addition, the SEC alleges that Mintz violated Exchange Act section 13(b)(5)46 and Exchange Act rules 13b2-1 and 13b2-2,47 and aided and abetted Enron's violations of Exchange Act section 13(b)(2)(A).48 The complaint further alleges that through his conduct, Mintz also aided and abetted violations of Exchange Act sections 10(b), 13(a) and 14(a),49 and Exchange Act rules 10b-5, 12b-20, 13a-1, 13a-13 and 14a-9.50 The SEC is seeking monetary penalties as well as permanent injunctions. Mintz has stated that he will rigorously defend the accusations. B. Failure to Act to Prevent Securities Violations

or Other Violations of the Law Recently, the SEC has taken a more aggressive approach bringing enforcement actions against attorneys and executives in their perceived gatekeeper role even when the SEC cannot support a claim that the executive directly participated in the fraud. In the following cases, executives were charged with an omission or failing to act to prevent a fraud. These cases underscore the heightened responsibility of corporate counsel, who, in giving legal advice, are subjected not only to general rules of professional responsibility, but also to potential primary or secondary liability under various laws. The following cases illustrate that the quality of the legal advice and the diligence of the attorney in seeking advice and explaining risks to the board of directors are significant factors that the SEC will consider. These cases demonstrate that the SEC is increasingly willing to second-guess counsel or pursue attorneys who do not stand up to management. According to one commentator, “The SEC justifies

43 15 U.S.C. § 77q(a) (2004). 44 15 U.S.C. §§ 78m(b), 78n(a) (2006). 45 17 C.F.R. §§ 240.10b-5, 240-14a-9 (2006). 46 15 U.S.C. § 78(b)(5) (2004). 47 17 C.F.R. §§ 240.13b2-1, 240.13b-2 (2006). 48 15 U.S.C. § 78(b)(2)(A) (2004). 49 15 U.S.C. §§ 78j(b), 78m(a), 78n(a) (2004). 50 17 C.F.R. §§ 240.10b-5, 240.12b-20, 240.13a-1, 240.13a-13, 240.14a-9 (2006).


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these actions as consistent with Sarbanes-Oxley’s policy of improving the quality, transparency and integrity of corporate financial reporting as well as fitting comfortably within the SEC’s view of the securities lawyer as ‘gatekeepers’.”51 John Isselmann of Electro-Scientific Industries In what may be the most aggressive SEC enforcement action brought against a general counsel, the SEC instituted cease and desist proceedings against ESI’s general counsel, John Isselmann, for failing to provide material information to ESI’s board of directors and auditors regarding an accounting transaction that allowed ESI to report a profit rather than a loss during the third quarter of 2002.52 The SEC alleged that Isselmann, ESI’s 35 year old general counsel 1) failed to question the CFO’s statements to the ESI audit committee and external auditors that counsel had approved the termination of a benefit plan, 2) did not provide a legal opinion to ESI’s audit committee and external auditors that concluded that the benefit plan at issue could not be properly terminated, and 3) allowed the CFO to shut down discussion of the legal opinion in a disclosure committee meeting. The SEC alleged that by eliminating the benefits plans, ESI was able to increase profits. The case is interesting since initially, Isselmann believed that eliminating the benefit plan was legal.53 Approximately five months after the filing the 10-Q at issue, Isselmann learned that the CFO decided to improperly terminate the benefit plan resulting in an earnings overstatement. Isselmann immediately contacted the audit committee about the matter and ESI subsequently restated its financial statements. In a recent interview, Isselmann said that he did not even realize that he had done anything wrong. In explaining the case, Isselman stated that he had only been out of law school for eight years and knew little about accounting and “relied heavily on accounting people and outside auditors to flag those issues.” The SEC alleged that “Isselmann’s failure to fulfill his gatekeeper role was a cause of the company 51 Lewis Lowenfels, Alan Bromberg, and Michael Sullivan, Attorneys as Gatekeepers: SEC Actions against Lawyers in the age of Sarbanes-Oxley (The Berkley Electronic Press, Working Paper No.991, 2006), available at http://law.bepress.com/expresso/eps/991. 52 See SEC v. John E. Isselmann, Jr., Litigation Release No. 18896 (September 24, 2004), available at http://www.sec.gov/litigation/litreleases/lr18896.htm. 53 See Tamara Loomis, Setting an Example, Corporate Counsel, Jan. 20, 2005. available at http://www.law.com/jsp/article.jsp?id=1105968930177.

reporting materially false financial results.”54 The SEC appears to have not given Isselmann credit for bringing the fraud to the attention of the audit committee. The complaint charged Isselmann with violations of section 13(a) of the Exchange Act55 and rules 12b-20, 13a-13 and rule 13b2-2 thereunder.56 Isselmann settled the action by paying a $50,000 civil penalty and agreeing to a cease-and-desist order. David Drummond of Google In 2005, the SEC instituted cease and desist proceedings against David Drummond, general counsel of Google.57 Drummond was charged with causing Google to violate the securities registration and related disclosure provisions of the Securities Act. The SEC alleged that Drummond mistakenly advised Google that it did not need to register and disclose $80 million worth of stock options granted to its employees in the two years prior to its initial public offering. Drummond concluded, after consultation with outside counsel, that Google could rely on an exemption from the registration requirement of the Securities Act. Google viewed the public disclosures of Google’s detailed financial information as strategically disadvantageous. The SEC alleged that in 2003 when Google’s board approved a new stock option plan, Drummond did not advise the board that Google would be relying on exemptions from the registration requirement. Despite the fact that Drummond’s advice to the board was given in good faith, after receiving a legal opinion regarding Google’s qualifications for a registration exemption, the SEC alleged that Drummond was aware that his legal conclusion was risky and failed to advise the board of the potential dangers. As such, the SEC found that Drummond caused Google to violate section 5 of the Securities Act.58 The claim was settled, and Drummond was ordered to cease-and-desist, but was neither fined nor suspended. In settling the matter, Drummond did not admit or deny liability. Drummond also settled a similar claim under the California Corporation Code relating to the same option disclosures. 54 Id. 55 15 U.S.C. § 78m(a) (2004). 56 17 C.F.R. §§ 240.12b-20, 240.13a-13 and 240.13b2-2 (2006). 57 See In the Matter of Google, Inc and David C. Drummond, Admin. Proc. File No. 3-11795 (January 13, 2005), available at http://www.sec.gov/litigation/admin/33-8523.htm. 58 15 U.S.C. § 77e (2004).


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David Pillor of In-Vision Technology Although David Pillor was a senior vice president for In-Vision and not an attorney, Pillor’s case is instructive because Pillor was charged with a failure to act, thus, like Isselmann of ESI, failing in his role as a “gatekeeper.”59 Specifically, the SEC complaint alleged that by failing to establish adequate internal controls, Pillor aided and abetted In-Vision in violating the Foreign Corrupt Practices Act (FCPA).60 The violation of the FCPA involved improper payments to foreign government officials made by In-Vision agents in several Southeast Asian countries. The SEC charged that Pillor failed to conduct background checks on foreign sales agents, failed to formally train foreign sales managers regarding FCPA requirements and failed to monitor foreign agents to ensure compliance with the FCPA. The SEC alleged that Pillor violated the provision of the Exchange Act that requires corporations to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions and assets are properly maintained.”61 On these facts, the SEC charged Pillor with violating section 13(b)(2)(B) of the Exchange Act,62 and with indirectly causing the falsification of the company's books and records, in violation of Exchange Act rule 13b2-1.63 Pillor settled the complaint by paying $65,000 in penalties and was permanently enjoined from future violations. IV. THE HEWLETT PACKARD SCANDAL The recent HP board pretexting scandal is significantly different from most recent corporate scandals. Indeed, it did not involve securities law violations. In fact, it is unclear whether anyone actually violated any law, and in the end, all charges against corporate officers were dropped.64 In dismissing the final charges, Judge Ray E.

59 See SEC v. David M. Pillor, Litigation Release No. 19803 (August 15, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19803.htm. 60 15 U.S.C. §§ 78dd-1, et seq. (1998). 61 15 U.S.C. § 78m(b)(2)(B) (2004). 62 Id. 63 17 C.F.R. § 240.13b-1 (2006). 64 Final Charges Dropped in HP Pretexting Case, Silicon Valley/San Jose Business Journal, Jun. 28, 2007, available at http://sanjose.bizjournals.com/sanjose/stories/2007/06/25/daily60.html?surround=lfn.

Cunningham said that although the defendants' conduct was a "betrayal of trust and honor," it did not involve criminal activity.65 Nevertheless, the HP case is instructive in highlighting the pitfalls facing corporate counsel. The facts are fairly simple. Starting in April 2005, sensitive board discussions were leaked to the press. The new chair of the board, Patricia Dunn, hired a private investigator to determine who was leaking information to the press. In investigating the matter, the private investigator used pretexting, i.e. misrepresenting his identity to obtain information about the phone records of HP board members. It was only after receiving a written report from the private investigator that Dunn contacted Ann Baskins, HP’s General Counsel, to share the report and discuss the use of pretexting. Despite repeated discussions among board members about the need to maintain the confidentiality of board discussions, a second leak occurred and a new investigation was launched, this time headed by the legal department. Baskins had an in-house attorney head the probe. Baskins asked the in-house attorney to review the legality of pretexting. Baskins had previously asked the private investigator if pretexting was legal, and was told that it was a common practice and that no laws forbade it. In all, Baskins inquired six times whether pretexting was legal and referred the question to outside counsel. Each time, Baskins was told that pretexting was legal, but none of these answers were formal opinions, nor did she ever research the question herself.66 Baskins was not charged with a crime, but she lost her job and faced public ridicule. While one can question Baskins’ judgment, it appears that Baskins was doing her job in good faith, following the lead of the Chair of the board and trying to protect the company’s interests by resolving a serious breach of boardroom confidentiality. Given her inquiries into the legality of the investigator’s tactics, some have characterized Baskins as a scapegoat for a dysfunctional board.

65 Id. 66 For more factual details, see Sue Reisinger, Saw No Evil, Corporate Counsel, Jan. 2007, at 68-77.


APPENDIX A

THE CURRENT STATE OF CORPORATE COOPERATION

UNDER DOJ GUIDELINES – PRIVILEGE WAIVER AND ADVANCEMENT OF ATTORNEY’S FEES Peggy A. Heeg

Fulbright & Jaworski, L.L.P

With the December 12, 2006 announcement by the U.S. Department of Justice (“DOJ”) of modifications to its controversial corporate prosecution guidelines, corporate counsel are optimistic that the days of overreaching prosecutorial tactics have come to an end. The guidelines, set forth in a memorandum issued by Deputy Attorney General Paul McNulty (the “McNulty Memo”), modify the January 2003 memorandum issued by then Deputy Attorney General Larry Thompson (the “Thompson Memo”). The McNulty Memo, which sets out factors for prosecutors to consider when deciding whether to prosecute corporations for the misconduct of their officers or employees, keeps most of the Thompson Memo intact, but modifies two of its most controversial aspects. Specifically, the McNulty memo limits the circumstances in which prosecutors may (1) request that companies waive the attorney-client privilege and attorney work product protection by disclosing the results of internal investigations, and (2) deem a company to be “uncooperative” because it has agreed to advance attorneys’ fees to an individual in an investigation.

Although the changes in the McNulty memo are a welcome step in the right direction, the DOJ still has considerable discretion in judging corporate cooperation. This paper discusses the background of the DOJ’s cooperation policy, the current state of the law and practical considerations relating to the attorney-client privilege and indemnification and advancement of attorney fees.

I.

BACKGROUND OF THE MCNULTY MEMO

In late 2001, the DOJ adopted several initiatives to accomplish more efficient, result-oriented investigations aimed at restoring confidence in corporate America. One of the primary initiatives was to decentralize prosecuting authority and create autonomy within the 94 U.S. Attorneys’ Offices throughout the country. This overarching strategy of decentralization created its own challenge: ensuring national uniformity in both investigative procedures and resulting enforcement. In response to this challenge, in January 2003, Larry D. Thompson, then United States Deputy Attorney General, modified a previous memo to all U.S. Attorneys setting out a statement of principles to provide guidance for prosecutors deciding whether to prosecute a corporation, and, if so, what penalties to seek.

The Thompson Memo’s unstated purposes were several-fold: (1) to promote corporate ethics; (2) to promote corporate self-policing of internal misconduct; and (3) to promote expedited discovery, investigation and disclosure of criminal conduct. The principal method employed by the Thompson Memo to achieve these goals was to reward compliant behavior by reducing or eliminating potential criminal charges against corporations. Under the Thompson Memo, the threat of criminal prosecution was used to elicit the one thing that could effectively expedite investigations: cooperation.

Although the Thompson Memo established nine factors for prosecutors to use in determining whether to bring charges against, and in negotiating plea agreements with, corporate targets, the assessment of a corporation’s timely disclosure of wrongdoing and “the adequacy of a corporation’s cooperation” with the government proved to be the most controversial. Specifically, Thompson guided prosecutors to consider (1) “the completeness of its disclosure including, if necessary, a waiver of the attorney-client and work product protections, both with respect to its internal investigation and with respect to communications between specific officers, directors and employees and


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counsel;”67 and (2) whether the company advanced attorney fees to employees, officers, and former employees who were subjects or targets of an investigation.68

A. PRIVILEGE WAIVER UNDER THE THOMPSON MEMO

When corporations receive a subpoena or are faced with an accusation of possible wrongdoing, they typically conduct a factual investigation to determine whether wrongdoing has actually taken place, and, if so, which company officials were involved. To carry out an investigation, corporations typically engage outside counsel and possibly other professionals, such as forensic accountants. Counsel often create memoranda of the witness interviews, reports summarizing their findings, chronologies, binders of key documents and other materials that summarize the important issues relating to the allegations of wrongdoing. Such materials can provide a roadmap to the underlying case, including identification of the witnesses with relevant information and the principal documents that evidence the wrongdoing.

It is because such materials can be valuable to the government in expediting an investigation that the Thompson Memo made the waiver of privilege a centerpiece of cooperation. Although the Thompson Memo purported to limit waiver requests to instances where “necessary,” in practice government requests became routine. In addition, requests were often made at the outset of an investigation, before the government had even attempted to conduct its investigation without the benefit of a privilege waiver.

As government requests to waive privilege become more prevalent, the legal and business communities, Congress and the judiciary began to focus on the public policy considerations of the Thompson memo. In a May 2005 American Bar Association Task Force report, the ABA reported:

... these practices are becoming increasingly widespread and are engendering substantial concern within the professional and corporate community that the protections of the attorney-client privilege and work-product doctrine are being eroded.69

Following these findings, in August 2005, the ABA House of Delegates adopted resolutions in support of the attorney-client privilege and opposing “[t]he routine practice of government officials of seeking to obtain a waiver of the attorney-client privilege or work product doctrine through the granting or denial of any benefit or advantage.”70

The ABA actions were a sign of building momentum for change. In March 2006, the Judiciary Committee of the U.S. House of Representatives held an oversight hearing to address issues raised by the Justice Department’s policies and implementation under the Thompson Memo.71 Following hearings before the Senate Judiciary Committee on the topic, Senator Arlen Specter, on December 7, 2006, introduced the “Attorney-Client Privilege Protection Act of 2006” (“ACPPA”). The ACPPA would make it illegal for any government agency to use the waiver of attorney-client privilege to determine the level of cooperation of companies under investigation. Specifically, it would make it illegal for any federal agency, in any criminal or civil enforcement investigation, to:

67 Memorandum from Larry D. Thompson, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Jan. 20, 2003), http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm. 68 A “target” of an investigation is defined as “a person as to whom the prosecutor or the grand jury has substantial evidence linking him or her to the commission of a crime and who, in the judgment of the prosecutor is a putative defendant. An officer or employee of an organization which is a target is not automatically considered a target even if such officer’s or employee’s conduct contributed to the commission of the crime by the target organization.” A “subject” of an investigation is “a person whose conduct is within the scope of the grand jury’s investigation.” UNITED STATES ATTORNEYS’ MANUAL, § 9-11.151. 69 Report of the American Bar Association’s Task Force on the Attorney-Client Privilege, http://www.abanet.org/buslaw/attorneyclient/materials/hod/report.pdf. 70 “ABA Delegates Support Resolution Opposing Gov’t Coercion on Privileges,” 37 Sec. Reg. & L. Rep. 1363 (BNA) Aug 15, 2005. 71 See http://judiciary.house.gov/oversight.aspx?ID-222.


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“demand, request or condition treatment on the disclosure by an organization, or person affiliated with that organization, of any communication protected by the attorney-client privilege or any attorney work product;”

“condition a civil or criminal charging decision relating to an organization, or person affiliated with that organization, on, or use as a factor in determining whether an organization, or person affiliated with that organization, is cooperating with the government” based on an valid assertion of the attorney-client privilege or attorney work product protection; or

“demand or request that an organization, or a person affiliated with that organization, not” make a valid assertion of the attorney-client privilege or attorney work product protection.72

B. ADVANCEMENT OF ATTORNEYS’ FEES UNDER THE THOMPSON MEMO A perhaps equally controversial aspect of the Thompson Memo was its provision regarding a corporation’s

advancement of attorneys’ fees and other legal expenses to officers or employees. Because of the complexity of white-collar cases, the government often requests interviews, or will seek grand jury testimony from, a large number of witnesses. For example, in an accounting fraud investigation, potential witnesses often include the chief financial officer, the chief accounting officer, lower level finance and accounting personnel, as well as personnel in compliance, internal audit and even in-house legal departments. Corporations will typically need to secure counsel for those witnesses.

Since the cost of defending white-collar cases is beyond the financial reach of most officers and employees, corporations must confront whether they will advance legal expenses. The factual issues tend to be complex, and the number of relevant documents is typically substantial. It does not take long for legal bills for individuals – even lower level employees – to run into the tens or hundreds of thousands of dollars even if the employee is not a “target” of the investigation. Costs for cases that go to trial often run in the seven digits. The advancement of legal expenses is therefore critical for most witnesses.

To address what the DOJ perceived as a corporate “circling of the wagons,” the Thompson Memo provided that in assessing whether a corporation “appears to be protecting its culpable employees and agents,” a prosecutor could take into account the company’s advancement of legal expenses.73 The Thompson Memo allowed that where a corporation was legally compelled to advance fees, its advancement could not be held against it.74 A corporation’s discretionary advancement of fees, however, could be counted against it if the government perceived the recipient to be a “culpable” party.75

As with requests for privilege waivers, prosecutors soon began to view advancement of legal fees as a sign of non-cooperation. Prosecutors routinely asked corporations whether they were advancing legal expenses for individuals, and often took the position that an employee was “culpable” before the facts had been thoroughly investigated.

As the opposition grew to the Thompson Memo’s policies on privilege waiver, its application to the advancement of attorneys’ fees likewise drew the ire of commentators and judges. In fact, the ACPPA included a

72 S.196, 110th Cong. (2007). As explained below, the ACPPA was reintroduced on January 4, 2007. 73 Memorandum from Larry D. Thompson, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Jan. 20, 2003), http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm. 74 See id. at n. 4. 75 Id.


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provision barring the government from taking into account a corporation’s advancement of legal expenses in any charging decisions.76

On the judicial front, United States District Judge Lewis Kaplan issued a strongly worded opinion in June 2006 in the case U.S. v. Stein.77 The case arose out of an Internal Revenue Service (“IRS”) investigation into tax shelters that a number of firms, including KPMG, allegedly helped to craft. KPMG entered into a deferred prosecution agreement, after which the government indicted several former partners and employees of the firm. The firm then stopped advancing their legal expenses. Following a hearing on the matter, Judge Kaplan found that the government had required KPMG to stop advancing attorneys’ fees, and held that the government’s actions violated the defendants’ Fifth Amendment due process right to a fair trial and Sixth Amendment right to counsel.78 As posed by Judge Kaplan, the issue was “whether a criminal defendant has a right to obtain and use in order to prepare a defense resources lawfully available to him or her, free of knowing or reckless government interference.”79 Judge Kaplan concluded from a survey of leading constitutional cases that “such a right is basic to our concepts of justice and fair play.”80 As such, the government’s actions were subject to the strict scrutiny test and thus invalid unless they were “narrowly tailored to achieve a compelling government interest.”81

As to the Thompson Memo, Judge Kaplan held that its attorneys’ fees provision unreasonably equated the advancement of fees with an unwillingness to cooperate with the government: “There is no necessary inconsistency between an entity cooperating with the government and, at the same time, paying defense costs of individual employees and former employees.”82 The policy, Judge Kaplan held, failed the strict scrutiny test in that it “discourages and, as a practical matter, often prevents companies from providing employees and former employees with the financial means to exercise their constitutional rights to defend themselves,” even where entities “obstruct nothing and, to the contrary, do everything within their power to make a clean breast of the facts to the government and to take responsibility for any offenses they may have committed.”83

II.

THE NEW POLICIES OF THE MCNULTY MEMO

In response to this criticism, and in an attempt to forestall more drastic legislative remedies, the DOJ responded. On December 12, 2006, the DOJ issued the McNulty Memo. Although the McNulty Memo left intact all but two of the Thompson Memo criteria for assessing corporate cooperation, its changes on the issues of privilege waiver requests and fee advancement were significant.

A. THE NEW POLICY ON PRIVILEGE WAIVER REQUESTS

On the issue of privilege waiver requests, the McNulty Memo steps back from the Thompson Memo policy. Most notably the McNulty Memo states that “[w]aiver of attorney-client and attorney work product protections is not a prerequisite to a finding that a company has cooperated in the government’s investigation.”84 With this general

76 S.196, 110th Cong. § 3014(b)(2)(B). 77 U.S. v. Stein, 435 F. Supp. 2d 330 (S.D.N.Y. 2006), appeal docketed, No. 1:05-cr-00888 (2d Cir. Sept. 18, 2006). On September 18, 2006, KPMG filed an appeal of Judge Kaplan’s order denying KPMG’s motion to compel arbitration of the issue of advancement and denying KPMG’s motion to dismiss the claims of the KPMG defendants for advancement of legal expenses for lack of ancillary jurisdiction. 78 Id. at 365. 79 Id. at 361. 80 Id. at 362. 81 Id. at 364. 82 Id. 83 Id. 84 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf.

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principle in place, the McNulty Memo carves out a more circumscribed set of circumstances in which waiver may be considered, and it set outs procedural steps before a privilege waiver request can be made.

First, the McNulty Memo requires approval of the Deputy Attorney General for any request for a privilege waiver.85 This requirement should end the practice of federal prosecutors making privilege waiver requests as a matter of course. It should also bring more uniformity to cases in which such requests are actually made.

Second, the McNulty Memo limits the circumstances in which prosecutors may seek privilege waivers. It permits privilege waiver requests only “when there is a legitimate need for the privileged information to fulfill . . . law enforcement obligations.”86 The McNulty Memo cautions that “[a] legitimate need for the information is not established by concluding it is merely desirable or convenient to obtain privileged information.”87 Instead, it provides that whether there is a “legitimate need” requires an assessment and balancing of four factors:

(1) the likelihood and degree to which the privileged information will benefit the government’s investigation;

(2) whether the information sought can be obtained in a timely and complete fashion by using alternative means that do not require waiver;

(3) the completeness of the voluntary disclosure already provided; and

(4) the collateral consequences to a corporation of a waiver.88

Third, even where prosecutors can establish a “legitimate need” for privileged materials, they must first limit their request to “purely factual information,” deemed as “Category I” materials. Only if such materials provide “an incomplete basis to conduct a thorough investigation” are prosecutors permitted to request “Category II” information. Category II consists of “attorney-client communications or non-factual attorney work product,” including “legal advice given to the corporation before, during and after the underlying misconduct occurred.”89

Where a request for Category I information is made, a corporation’s refusal to waive privilege and provide the materials may be used against the corporation in assessing its cooperation.90 A corporation’s refusal to produce Category II materials, however, can never be used against the corporation.91

Termination or sanctioning employees for failure to cooperate with an investigation, can also be considered by prosecutors in evaluating a company’s cooperation.92

B. THE NEW POLICY ON ADVANCEMENT OF ATTORNEYS’ FEES

While the McNulty Memo’s privilege waiver policy has been viewed by some as a minor modification to the Thompson Memo, its policy on advancement of attorney’s fees represents a virtual about-face. The McNulty Memo largely eliminates the advancement of attorneys fees as a factor that prosecutors may consider in assessing corporate

85 Id. at Sec. VII, p. 10. 86 Id. at Sec. VII, p. 8. 87 Id. at Sec. VII, p. 8-9. 88 Id. at Sec. VII, p. 9. 89 The McNulty Memo provides a caveat where a company asserts an advice of counsel defense. In that case, contemporaneous legal advice, which would otherwise fall under Category II, is deemed to fall under Category I. Id. at Sec. VII. 90 Id. at Sec. VII, p. 9. 91 Id. at Sec. VII, p. 10. 92 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf at Sec. VII, p. 11.


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cooperation. It provides generally that “prosecutors generally should not take into account whether a corporation is advancing attorneys’ fees to employees or agents under investigation and indictment.”93

Whereas the McNulty Memo contemplates privilege waiver requests as a continued practice – albeit in a more limited form than existed previously – its approach on advancement of legal expenses is more narrow. The McNulty Memo provides that advancement of legal expenses may be considered only “[i]n extremely rare cases” in which “the totality of circumstances show that [advancement] was intended to impede a criminal investigation.”94 In addition, approval of the Deputy Attorney General is required “before prosecutors may consider this factor in their charging decisions.”95

C. COMPARISON TO THE ACPPA

The McNulty Memo falls short of the legislation proposed by Senator Arlen Specter in December 2006 and reintroduced in January 2007. Unlike the McNulty Memo, the ACPPA would prohibit prosecutors from conditioning a charging decision on any valid assertion of the attorney-client privilege or work product protection, regardless of whether DOJ deemed the requested materials “purely factual.”96 While the McNulty Memo provides that prosecutors “generally should not take into account” consideration of advancement of fees or indemnification except in cases where payment of fees plus other facts show that the intent of the fee advancement is to impede government investigations and inappropriately shield company employees,97 the ACPPA categorically bars prosecutors from considering indemnification or advancement at all.98 In addition, the ACPPA provides that prosecutors may not pressure corporations to terminate employees for exercising constitutional, including Fifth Amendment, rights.99

III.

ISSUES UNDER THE MCNULTY MEMO’S WAIVER REQUEST PROVISIONS

The McNulty Memo represents a step back from the most controversial aspects of the Thompson Memo. Yet inevitably, the revised policies set out in the McNulty Memo leave a number of unresolved issues.

While the McNulty Memo precludes prosecutors from deeming a refusal to waive the attorney-client privilege to constitute a refusal to cooperate fully, it permits prosecutors to count a voluntary waiver in the company’s favor.100 In practice, this distinction may not lessen the pressure on companies to make a voluntary waiver, particularly where the other relevant McNulty Memo factors weigh against the corporation. Companies seeking to demonstrate cooperation will still have an incentive and, perhaps, prosecutorial pressure to waive privilege if they perceive that doing so could help stave off charges.

In the area of privilege waivers, the McNulty Memo opens up two particularly important questions. First, will the McNulty’s Memo’s criteria for establishing a “legitimate need” to seek a privilege waiver limit the number of such requests? Second, in those cases in which a privilege waiver request is made, how workable is the McNulty Memo’s distinction between fact and opinion work product as applied to internal investigation materials? Complicating an assessment of these issues is the uncertain state of the law on many important privilege issues. 93 Id. at Sec. VII, p. 11. 94 Id. at Sec. VII, n. 3. 95 Id. 96 S.196, 110th Cong. § 3014(b)(2)(A). 97 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf at Sec. VII, p. 11. 98 S.196, 110th Cong. §3014(b)(2)(B). 99 Id. at § 3014(b)(2)(E). This differs from the McNulty Memo which, like the Thompson Memo, includes termination of employees for exercising their Fifth Amendment rights as a factor in corporate cooperation and charging decisions. See Memorandum from Paul J. McNulty, supra, at Sec. VII, p. 11. 100 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf at Sec. VII, p. 8.


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A. THE LAW OF PRIVILEGE AND WORK PRODUCT

1. Attorney-Client Privilege

The attorney-client privilege is the evidentiary rule designed to encourage (by protecting) the free flow of information between an attorney and his or her client. The attorney-client privilege has as its core purpose “to encourage full and frank communication between attorneys and their clients and thereby promote broader public interests in the observance of law and the administration of justice.”101 The privilege applies to corporations, and it extends at least to communications relating to corporate affairs among individuals whose actions may be imputed to the corporation.102

The parameters of the attorney-client privilege in federal court were fully set forth in United States v. United Shoe Machinery Corp.,103 a frequently cited case from 1950, in which the court stated that:

The privilege applies only if (1) the asserted holder of the privilege is or sought to become a client; (2) the person to whom the communication was made (a) is a member of the bar of a court, or his subordinate and (b) in connection with this communication is acting as a lawyer; (3) the communication relates to a fact of which the attorney was informed (a) by his client (b) without the presence of strangers (c) for the purpose of securing primarily either (i) an opinion of law or (ii) legal services or (iii) assistance in some legal proceeding, and not (d) for the purpose of committing a crime or tort; and (4) the privilege has been (a) claimed and (b) not waived by the client.104

Federal courts applying federal law to determine whether communications between an employee and corporate counsel are privileged follow the Upjohn test. In Upjohn Co. v. United States,105 the United States Supreme Court rejected the “control group” test and held that the attorney-client privilege protects communication between corporate counsel and lower-level corporate employees under certain circumstances. This is now often referred to as the “subject matter” test and is employed in federal courts in non-diversity cases. In reaching its decision, the Court reasoned that:

In the case of the individual client, the provider of information and the person who acts on the lawyer’s advice are one and the same. In the corporate context, however, it will frequently be employees beyond the control group as defined by the court below – “officers and agents . . . responsible for directing [the company’s] action in response to legal advice” – who will possess the information needed by the corporation’s lawyers. Middle-level – and indeed lower-level – employees can, by actions within the scope of their employment, embroil the corporation in serious legal difficulties, and it is only natural that these employees would have the relevant information needed by corporate counsel if he is adequately to advise the client with respect to such actual or potential difficulties.106

In Texas, the attorney-client privilege is codified in Texas Rule of Evidence 503 (“Rule 503”). Under Rule 503, a client has the right to prevent third persons from disclosing confidential communications that are made for the

101 Upjohn Co. v. United States, 449 U.S. 383, 389 (1981). 102 Id. at 394. 103 United States v. United Shoe Machinery Corp., 89 F.Supp. 357 (D. Mass. 1950). 104 Id. at 358-359. 105 449 U.S. 393 (1981). 106 Id. at 391.

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purpose of securing legal representation for the client.107 Rule 503 applies to communications between the following persons: (1) attorneys; (2) attorney’s representatives; (3) clients; and (4) representatives of clients.108

A “client” includes a corporation, association or other organization or entity.109 Further, all communications between representatives of the client may be protected by the corporation’s attorney-client privilege.110 A “representative of the client” is defined as:

(A) a person having authority to obtain professional legal services, or to act on advice thereby rendered, on behalf of the client, or

(B) any other person who, for the purpose of effectuating legal representation for the client, makes or receives a confidential communication while acting in the scope of employment.111

In Rule 503(b)(1), the attorney-client privilege is defined as follows: “General Rule of Privilege. A client has a privilege to refuse to disclose and to prevent any other person from disclosing confidential communications made for the purpose of facilitating the rendition of professional legal services to the client.”112 Under this rule, before the privilege will apply, the communication must meet three tests. First, there must be a communication between the lawyer and the client.113 Second, the communication must be confidential.114 A communication is confidential if it is not intended to be disclosed to third persons.115 Finally, the communication must be made for the purpose of facilitating the rendition of professional legal services to the client.116 The attorney-client privilege covers the complete communication, including both facts and legal advice.117

2. Attorney Work Product

While the attorney-client privilege protects communications, the attorney work product shields the attorney’s thought processes as to conducting an investigation and outlining a defense strategy. The attorney work product doctrine applies to attorney work product compiled in anticipation of litigation.118 “[T]he work product privilege is . . . designed to balance the needs of the adversary system to promote an attorney’s preparation in representing a client against society’s general interest in revealing all true and relevant facts material to the resolution of a dispute.”119

107 TEX. R. EVID. 503. 108 Id. 109 Id. at 503(a)(1). 110 Id. at 503(b)(1)(D). 111 TEX. R. EVID. 503(a)(2)(A)-(B). Part (A) of Rule 503(a)(2) represents the codification of the “control group” test, while Part (B) represents the “subject-matter ” test. Texas Rule of Evidence 503 was amended in 1998, by adding (a)(2)(B), to adopt the “subject matter” test. 112 TEX. R. EVID. 503(b)(1). 113 TEX. R. EVID. 503(a)(5). 114 TEX. R. EVID. 503(b). 115 Id. at 503(a). 116 Id. at 503(b)(1). 117 See Pittsburg-Corning Corp. v. Caldwell, 861 S.W.2d 423, 425 (Tex. App.—Houston [14th Dist.] 1993, orig. proceeding) (attorney-client privilege applied to the whole document, not just parts relating to legal advice). 118 In re Grand Jury Subpoenas, 454 F.3d 511, 520 (6th Cir. 2006) (work product protection operates for a similar purpose as the attorney-client privilege, namely “people should be free to make requests of their attorneys without fear and that their attorneys should be free to conduct research and prepare litigation strategies without fear that these preparations will be subject to review by outside parties.”); Judicial Watch, Inc. v. Dep’t of Justice, 432 F.3d 366, 369 (D.C. Cir. 2005). 119 In re Subpoenas Duces Tecum, 738 F.2d 1367, 1369 (D.C. Cir. 1984) (citing Hickman v .Taylor, 329 U.S. 495, 509-12 (1947).

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The work product protection has been incorporated into Fed. R. Civ. P. 26(b)(3), which provides that documents:

prepared in anticipation of litigation of for trial [may be discovered] only upon a showing that the party seeking discovery has substantial need of the materials in the preparation of the party’s case and that the party is unable without undue hardship to obtain the substantial equivalent of the materials by other means.120

The rule further provides that the court “shall protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of an attorney or other representative of a party concerning the litigation.”121

Texas Rule of Civil Procedure 192.5(a) provides protections for attorney work-product similar to that under Rule 26(b)(3), in that it protects from discovery:

(1) material prepared or mental impressions developed in anticipation of litigation or for trial by or for a party or a party’s representatives, including the party’s attorneys, consultants, sureties, indemnitors, insurers, employees, or agents; or

(2) a communication made in anticipation of litigation or for trial between a party and the party’s representatives or among a party’s representatives, including the party’s attorneys, consultants, sureties, indemnitors, insurers, employees, or agents.

a. Anticipation of Litigation

Disputes often arise whether the materials were prepared “in anticipation of litigation.” If materials are prepared for more than one purpose, the “primary motivating purpose behind the creation of the document [must be] to aid in possible future litigation.”122 Texas law employs a similar standard.123 Generally, work product generated in the course of an internal investigation will satisfy the “in anticipation of litigation” requirement.124

b. Fact Versus Opinion Work Product

Federal law distinguishes between fact and opinion work product. Fact work product, or ordinary work product, consists of factual material that is prepared in anticipation of trial.125 It includes raw factual information.126 Factual work product is not discoverable unless the party seeking discovery has a substantial need for the materials and the party cannot obtain the substantial equivalent of the materials by other means.127

Alternatively, where the selection, organization, and characterization of facts reveals theories, opinions, or mental impressions of a party of the party’s representative, that material is defined as opinion work product.128 Under the work product rule, interviews, statements, memoranda, correspondence, and briefs, as well as mental impressions and personal beliefs of legal counsel, are protected from disclosure.129 Pursuant to Rule 26(b)(3), 120 Fed. R. Civ. P. 26(b)(3). 121 Id. 122 United States v. El Paso Co., 682 F.2d 530, 532 (5th Cir. 2982) (internal quotations omitted). 123 See Flores v. Fourth Court of Appeals, 777 S.W.2d 38, 41 (Tex. 1989). 124 In re Linerboard Antitrust Litig., 237 F.R.D. 373, 381 (E.D. Pa. 2006) (“Generally, documents created as part of an internal investigation . . . are considered to be made in anticipation of litigation for purposes of the work product doctrine.”). See also Upjohn Co. v. U.S., 449 U.S. at 397-401; In re Grand Jury Subpoena, 599 F.2d 504, 511-512 (2d Cir. 1979). 125 Kintera, Inc. v. Convio, Inc., 219 F.R.D. 503, 507 (S.D. Cal. 2003). 126 See Gundacker v. Unisys Corp., 151 F.3d 842, 848 n. 4 (8th Cir. 1998). 127 See FED. R. CIV. P. 12(b)(3). 128 Kintera, 219 F.R.D. at 507 (citing United States ex rel. Bagley v. TRW, Inc., 212 F.R.D. 554 (C.D. Cal. 1995). 129 Hickman v. Taylor, 329 U.S. 495 (1947).








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opinion work product receives the highest protection from disclosure, and its production may be ordered only upon a demonstration of a compelling need, a significantly higher standard than for factual work product.130 Opinion work product receives almost absolute immunity from disclosure.131

Texas Rule of Evidence 192 codifies similar standards for discovery of work-product. “Core” work product -- “the work-product of an attorney or an attorney’s representative that contains the attorney’s or the attorney’s representative’s mental impressions, opinions, conclusions, or legal theories” -- is not discoverable.132 Any other work product — usually called ordinary work product — is discoverable only upon a showing that the party seeking discovery has substantial need of the materials to prepare its case and that the party is unable without undue hardship to obtain the substantial equivalent of the material by other means.133

In Texas v. Lowry, 802 S.W.2d 669, 673 (Tex. 1991), the Texas attorney general sued a number of insurance companies for violations of Texas antitrust laws. The insurance companies requested that the state produce all the statements that the state had gathered in its investigations prior to filing suit. The court found that the insurance companies had a substantial need for the statements because those statements were relevant to the state filing suit. The court further found that the insurance companies could not obtain the substantial equivalent of those statements because of the time and expense involved in attempting to retrace the state's investigation.134 The court ordered the state to produce the statements.

Not all documents created by an attorney constitute attorney work product. The written statement of a witness, whether prepared by the witness or later delivered to an attorney or drafted by the attorney and adopted by the witness, is not the work product of an attorney.135 Such a statement is considered to record the impressions and observations of the witness himself, and not those of the attorney.136 What a witness knows is not the work of counsel, and hence does not necessarily fall under the protection of the work product doctrine. However, discovery of a witness statement to an attorney is generally not allowed if that witness is available to the other party.137

c. Discovery of Attorney Work Product

The work product doctrine is a qualified immunity; hence, it is not absolute. A party may discover certain types of work product by demonstrating a “substantial need” for the materials in the preparation of the party’s case and is unable without undue hardship to obtain the substantial equivalent by other means.138 The rule allowing discovery of certain types of work product only allows discovery of factual or non-opinion work product and requires the court to protect against the disclosure of the mental impressions, conclusions, opinions, or legal theories of an attorney or other representative.139 In determining “substantial need” and undue hardship, Texas courts have looked to Federal Rule of Civil Procedure 26(b)(3).140

130 Conkling v. Turner, 883 F.2d 431, 434-35 (5th Cir. 1989). 131 See Baker v. General Motors Corp., 209 F.3d 1051 (8th Cir. 2000). 132 TEX. R. CIV. P. 192.5(b)(1). 133 TEX. R. CIV. P. 192.5(b)(2). 134 Texas v. Lowry, 802 S.W.2d 669, 673 (Tex. 1991). 135 Dobbs v. Lamonts Apparel, Inc., 155 F.R.D. 650 (D. Alaska 1994). 136 Id. 137 See In re Grand Jury Proceedings, 473 F.2d 840, 848 (8th Cir. 1973). 138 FED. R. CIV. P. 26(b)(3). 139 In re Echostar Communications Corp., 448 F.3d 1294, 1301-02 (Fed. Cir. 2006). 140 See, e.g., Flores v. Fourth Court of Appeals, 777 S.W.2d at 42 (“Although not addressed by the parties and often overlooked by those seeking discovery of privileged materials, section (3)(e) is the proper vehicle to alleviate much of the bench's and bar's struggle over what investigations will be deemed in anticipation of litigation. . . . [T]he bar would be well-served by utilizing section (3)(e) during discovery.”).









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The need to obtain corroborative evidence to counter the testimony of an available witness will not satisfy the “substantial need” test.141 The “substantial need” test can also not be satisfied where the information contained in the documents could have been readily obtained through other means, such as where the documents requested relate to underlying information personally known to the party seeking discovery of such documents.142

The “substantial need” test was satisfied where the condition of an explosion site changed through the passage of time and documents containing scientific test results of that site were necessary to support the plaintiff’s claim.143

It is extremely difficult to satisfy the “compelling need” test for opinion work product. That test was satisfied where a plaintiff sought to avoid the applicable statute of limitations by claiming that he did not learn of the defendant’s fraudulent conduct until his attorney discovered the matter.144 This is a rare case, though, as opinion work product receives almost absolute protection.145

3. The Selective Waiver Doctrine

Perhaps the most important area of privilege law for corporations facing the prospect of a waiver request is that of selective waiver. Under the doctrine of selective waiver, a company’s production of internal investigation materials to the government would effect a waiver of privilege only as to the government, not as to civil plaintiffs. Proponents of the doctrine have urged courts to adopt the notion of ‘selective waiver’ on the grounds that a company’s disclosure of internal investigative materials furthers important public interests by providing the government with information about corporate wrongdoing and saving prosecutors vast amounts of time and resources in bringing wrongdoers to justice.

Unfortunately, federal courts have almost universally rejected the notion of ‘selective waiver’ as applied to the attorney-client privilege.146 As courts have noted, the purpose of the attorney-client privilege is to encourage open communication between attorney and client; the privilege therefore attaches to such communications only if they are made in confidence, with an expectation that they will not be disclosed outside of the attorney-client relationship.147 Some courts have reasoned that a company that engages counsel to conduct an internal investigation with a view toward sharing the results of the investigation with the government never intended to keep the communications privileged.148 Other courts have held that even if such materials can be deemed to be privileged in the first instance, a ‘selective waiver’ exception to the typical waiver rule does nothing to further the privilege’s purpose of encouraging open communication between attorney and client.149

While the federal courts have almost universally rejected the selective waiver theory as to the attorney-client privilege, the notion of selective waiver of the attorney work product protection has found a somewhat more hospitable reception. The reason for the differing results lies in the distinct rationales for the attorney-client privilege and the attorney work product doctrine. As explained above, the attorney-client privilege protects communications. By contrast, the attorney work product doctrine protects an attorney’s thought processes and rests on the notion that

141 Baker, 209 F.3d at 1055. 142 U.S. v. Medica-Rents Co., 2002 WL 1483085, at *2 (N.D. Tex. 2002). 143 In re Terra Int’l, Inc., 134 F.3d 302, 304 (1998). 144 American Standard, Inc. v. Bendix Corp., 80 F.R.D. 706 (W.D.Mo. 1978). 145 See, e.g., In re Natural Gas Commodities Litig., 232 F.R.D. 208, 212-213 (S.D.N.Y. 2005) (denying discovery of information constituting attorney work product). 146 See, e.g., In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289, 295-302 (6th Cir. 2002) (discussing cases). The only exception at the circuit court level is the Eighth Circuit’s decision in Diversified Industries, Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1978). 147 United States v. Bergonzi, 216 F.R.D. 487, 493 (N.D. Cal. 2003). 148 See, e.g., id. at 493-494. 149 See, e.g., Westinghouse Elec. Corp. v. Republic of the Philippines, 951 F.2d 1414, 1425 (3d. Cir. 1991).






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an adversary should not have access to an attorney’s mental impressions concerning litigation strategy.150 Attorney work product protection is therefore not destroyed simply upon disclosure outside of the attorney-client context, but typically only upon disclosure to an adversary.151

A small but growing number of courts have applied these waiver principles to uphold attorney work product claims as to internal investigation materials produced to the government pursuant to confidentiality agreements. Such agreements typically provide, at a minimum, that the company producing the materials does not intend to waive the attorney-client privilege or attorney work product protection, and that both parties will keep the materials confidential.152 These decisions follow a handful of cases holding that the attorney work product protection was not waived where materials were produced to the government pursuant to confidentiality agreements.153 To be sure, this is still the minority view.154 Indeed, a decision in the Central District of California issued just a few months after the opinion in In re McKesson HBOC reached the opposite result.155

Moreover, the protections afforded by decisions such as In re McKesson HBOC extend only to attorney work product and are far more limited than the broad ‘selective waiver’ doctrine that companies have urged courts to adopt. The decisions do not even endorse a per se rule of ‘selective waiver,’ but instead adopt a case-by-case analysis that largely focuses on the sufficiency of the language in a confidentiality agreement to prevent disclosure of the materials to adversaries. In addition, as explained above, attorney work product protection may be overcome where the party seeking disclosure can establish a substantial need for the materials and an inability to obtain the information from another source without undue hardship.156 The magistrate judge in In re Natural Gas, for example, suggested that the plaintiffs might have established substantial need for the materials at issue “if the analyses had been based on oral information” from defendants’ employees, which is typically the case with internal investigation reports.157 The protection may also be waived if a party uses attorney work product affirmatively in litigation.158

Although Texas law adopts the general principle that a voluntarily disclosure of any significant part of the privileged matter effects a waiver,159 no Texas court has considered the precise question of whether production of materials to the government pursuant to a confidentiality agreement would effect a waiver.

B. APPLICATION OF THE “LEGITIMATE NEED” CRITERIA

While the McNulty Memo policy regarding privilege waivers sets new procedural bars and limits the circumstances in which prosecutors can seek and take into account privilege waivers, the new policy does not completely overturn the Thompson Memo’s privilege waiver policy. In particular, it permits waiver requests where prosecutors can establish a “legitimate need” for the materials. The application of these criteria raises procedural and substantive questions.

150 Bergonzi, 216 F.R.D. at 493-494. 151 Id. at 497. 152 See, e.g., In re McKesson HBOC, Inc., 2005 WL 934331, at *1 (N.D.Cal. March 31, 2005); In re Natural Gas Commodities Litig., 2005 WL 3288007 (S.D.N.Y. Dec. 2, 2005). 153 See, e.g., Saito v. McKesson HBOC, Inc., 2003 WL 31657622 (Del Ch. Nov. 13, 2002); Maruzen Co., Ltd. v. HSBC USA, Inc., 2002 WL 1628782 (S.D.N.Y. July 23, 2002); In re Leslie Fay Cos., Inc. Sec. Litig., 161 F.R.D. 274, 284 (S.D.N.Y. 1995). 154 See, e.g., In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d at 297; Mass. Inst. of Tech., 129 F.3d at 686, 688; Westinghouse Elec. Corp. 951 F.2d at 1427; Permian Corp. v. U.S., 665 F.2d 1214 (D.C. Cir. 1981); Bergonzi, 216 F.R.D. at 487 (citation omitted). 155 In re Syncor ERISA Litig., 229 F.R.D. 636 (C.D. Cal. 2005). 156 Fed. R. Civ. P. 26(b)(3). 157 In re Natural Gas, 2005 WL 1457666, at *8. 158 Moore’s Federal Practice § 26.70[6][c](3d ed. 1997). 159 Berger v. Lang, 976 S.W.2d 833, 836-37 (Tex. App.—Houston[1st Dist.] 1998, pet. denied); Terrell State Hosp. of Texas Dep’t of Mental Health & Mental Retardation v. Ashworth, 794 S.W.2d 937, 940 (Tex. App.—Dallas 1990, orig. proceeding); see also Krug v. Caltex Petroleum Corp., No. 05-96-0079-CV, 1999 WL 652495, *4-5 (Tex. App.—Dallas, Aug. 27, 1999, no pet.).





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1. Procedural Limitations

While the McNulty Memo requires prosecutors to obtain approval of the Deputy Attorney General prior to making a request for a privilege waiver, it does not afford companies the right to notice that approval has been sought or an opportunity to make a submission as to the “legitimate need” factors that prosecutors must assess. This is unfortunate, because a corporation is most likely to be in the best position to articulate the extent to which the factors are met in the case, particularly with respect to collateral consequences (as discussed more fully below). Practitioners would do well, therefore, to make a written request early in an investigation for notice of a request proposal and an opportunity to address in an oral or written submission the relevant McNulty Memo factors.

2. Assessment of the “Legitimate Need” Criteria

On the substantive issue of the McNulty Memo’s criteria for assessing the government’s “legitimate need” for the information sought, it is unclear how the criteria will be applied in practice.

a. Benefit to the Investigation

The first McNulty Memo factor – the likely benefit of a privilege waiver to the government’s investigation – should be the easiest for prosecutors to meet. As discussed above, internal investigation materials can provide the government with a roadmap to the underlying case, likely saving hundreds or thousands of hours in prosecutors’ and agents’ time. The resource savings can be particularly helpful in the area of electronic data. Typically, a dump of e-mail files and hard drives for even a relatively small number of employees yields a tremendous volume of data. Outside counsel can parse through the data and locate e-mails, restore deleted documents, and the like. The resource savings from tapping outside counsel’s work product will often weigh in favor or a waiver.

b. Alternative Means

As a counterweight to the first factor, corporate counsel can rely on the second McNulty Memo factor. Corporate counsel can argue that through “alternative means,” the government can obtain the information “in a timely and complete fashion by using alternative means that do not require a waiver.” Corporate counsel, for example, can point the government to relevant documents and witnesses without having to provide internal investigation materials. Indeed, in those instances in which the government seeks a privilege waiver simply because outside counsel has already done the difficult work of digesting voluminous materials, the first factor may weigh in favor of a waiver, but the second factor should not. This is because the government could obtain the information through a less drastic means. It can limit the scope of document requests to minimize the volume of documents that it receives, and it can seek witness interviews on its own. In short, where a privilege waiver would simply serve the end of saving the government resources, it should fail the second prong.

More difficult questions may arise under the second prong, however. Prosecutors are likely to be more aggressive in seeking privilege waivers where witnesses are not being cooperative. For example, in an accounting fraud investigation, a paper trail may tell the story of how accounting adjustments were made, but on their face they may not demonstrate that the participants acted with fraudulent intent. In such a case, if a discussion about cooking the books took place, it would not be reflected in e-mails or notes. Rather, the government would need a cooperative witness to admit to the discussion.

In an instance such as this, the government traditionally either asks the witness to appear for an interview (often with a limited form of proffer immunity). Otherwise, the government may immunize the witness and obtain the witness’s grand jury testimony, hoping to build a case against more culpable individuals.

In such a case, prosecutors may hope to secure outside counsel’s interview memoranda. The government may be able to find inconsistencies among witnesses’ accounts that can then become a wedge to break a perceived logjam among witnesses. Prosecutors may argue that without such memoranda, they will be unable to obtain


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cooperation from witnesses “in a timely and complete fashion by using alternative means that do not require a waiver.”160

c. The Completeness of Voluntary Disclosure

The third McNulty Memo factor addresses the completeness of a corporation’s voluntary disclosure to date. This factor poses perhaps the greatest amount of uncertainty. A production of documents pursuant to a subpoena, for example, is a compelled, rather than a voluntary, disclosure. Presumably, then, this factor contemplates voluntary productions of documents and, perhaps, disclosures that fall short of full privilege waivers. Often, corporate counsel will share information with prosecutors orally and in an informal manner. They may, for example, explain certain issues or key events or documents, or even summarize what a potential witness would likely say if asked about a particular issue. Although such informal disclosures may incorporate attorney work product or even touch upon information learned in privileged interviews, in practice corporate counsel can present such information with qualifications so that no one can credibly argue that any waiver took place. With the McNulty Memo, such disclosures may become more prevalent.

d. Collateral Consequences

The fourth McNulty Memo factor requires prosecutors to assess the potential collateral consequences to a corporation of a privilege waiver. This factor may often be the one weighing most heavily in the company’s favor. In practice, however, the potential collateral consequences may be difficult to quantify.

As explained in Section III.A.3, above, the law regarding selective waiver is uneven, to say the least. In certain jurisdictions, selective waiver has been rejected completely, while in others it has been adopted, at least as to attorney work product. Even here, however, courts within the same district, even on the same case, have reached opposite results. All of this means that corporate counsel, if addressing the potential consequences of a privilege waiver, will need to argue that the uncertainty places a corporation at grave risk of having waived privilege, even if production is made pursuant to a confidentiality agreement.

Corporate counsel’s task in this regard will be more difficult where litigation is not currently pending. In that instance, corporate counsel will have to argue that the mere prospect of litigation arising from the events disclosed in the internal investigation materials should be counted in the corporation’s favor.

e. Oral Presentations

As stated above, corporate counsel typically make informal oral disclosures to the government which fall short of the kind of comprehensive information contained in internal investigation materials. They may also, however, elect not to prepare a written investigative report, and they may instead prepare to make a formal oral presentation to the government that incorporates the detail that would be included in a written report. It is unclear whether such a waiver of privilege satisfies a request for Category I materials.

C. THE DISTINCTION BETWEEN FACT AND OPINION WORK PRODUCT

Finally, even under the new guidance, a company’s refusal to waive privilege may still be used against it. While the McNulty Memo bars prosecutors from taking into account a company’s refusal to waive privilege as to Category II information, it provides that “[a] corporation’s response to the government’s request for waiver of privilege for Category I information may be considered” in assessing the genuineness of a corporation’s cooperation.161 This distinction is notable, because while Category I ostensibly reaches only “purely factual” materials, it is defined to include materials that almost certainly reflect the work product of company counsel.

160 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf, Sec. VII, p. 9.

161 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf, Sec. VII, p. 9.


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The McNulty Memo’s distinction in this regard is not unfounded. As explained above, case law on the attorney work product doctrine has traditionally recognized the distinction between fact and opinion work product. Yet the kinds of documents that the McNulty Memo defines as falling within Category I – “witness statements, purely factual interview memoranda” and other materials prepared by counsel, such as factual chronologies, summaries or reports – may more validly be described as at least incorporating opinion work product.

Although defined in the McNulty Memo as “purely factual” materials, these materials can reflect counsel’s assessment of the issues, events and documents that are material to the case. A chronology will reflect counsel’s assessment of the relevant events. Even an interview memorandum will reflect counsel’s choice of topics and assessment of the relevant issues.

In practice, therefore, parties that are confronted with requests for waivers with respect to Category I information may find themselves arguing with the government over the scope of such a request. In all likelihood, corporate counsel will take the position that their opinion work product is inextricably intertwined within preexisting interview memoranda, chronologies, summaries and reports. If the government accepts this position, it may permit counsel to redact these materials, or to create new versions that are purely factual. If the government insists that the preexisting materials do not reflect attorney work product, the corporation will be in a quandary: either refuse to comply, and risk having non-cooperation for refusal to disclose Category I materials counted against the corporation, or comply, but risk having to produce those same materials to civil plaintiffs in related civil litigation.

IV.

ISSUES UNDER THE MCNULTY MEMO’S ADVANCEMENT PROVISIONS

The McNulty Memo’s policy on the advancement of legal expenses represents a much cleaner break from the policy articulated in the Thompson Memo. Under the McNulty Memo, in most instances a corporation’s decision to advance legal expenses will be dictated by the corporation’s obligations and policies governing advancement. Nonetheless, the McNulty Memo leaves open the possibility that advancement of expenses may be considered in evaluating corporate cooperation, albeit in “extremely rare” instances, where such advancement is furthering some obstructionist posture. This section explores the general law concerning advancement and explores how the narrow exception set out in the McNulty Memo may be applied.

A. The Law Governing Advancement of Attorneys’ Fees

Corporate indemnification and advancement of legal fees are related but distinct concepts. Indemnification is the corporation’s obligation to make one of its officers, directors, employees or agents whole for losses suffered because of actions taken in the scope of employment and on the company’s behalf, in this context losses arising from an investigation or government proceeding. Practically, advancement requires the company to evaluate whether it is obligated to advance legal fees or whether it is in the company’s best interest to extend an officer, employee, director or former officer, employee or director a line of credit for their legal expenses. A leading case has expounded the nature of the relationship:

The right to advancement is a subsidiary element of the right to ultimate indemnification . . . . [T]he narrow scope of an advancement proceeding prohibits an ultimate determination of indemnification and liability owed by a corporate official for sums already advanced. While the rights to indemnification and advancement are correlative, they are still discrete and independent rights, with the latter having a much narrower scope.

162

Statutory law in the company’s state of incorporation defines the scope of any obligations to corporate indemnification and advancement. The relevant provisions of the Delaware General Corporation Law (“DGCL”) are codified in Title 8, Chapter 1, Subchapter IV of the Delaware Code.163 Except where prohibited by express 162 Kaung v. Cole Nat’l Corp., 884 A.2d 500, 509-10 (Del. 2005) (internal quotations and footnotes omitted). See also Homestore, Inc. v. Tafeen, 888 A.2d 204, 212 (Del. 2005) (“Although the right to indemnification and advancement are [sic] correlative, they are separate and distinct legal actions.”); Advanced Mining Sys., Inc. v. Fricke, 623 A.2d 82, 85 (Del. Ch. 1992) (noting that “indemnification rights and rights to advancement of possibly indemnifiable expenses” are “legally quite distinct types of legal rights”). 163 The comparable provisions of the Texas Business Organizations Code are codified in Title 1, Chapter 8.

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provision, a company can incorporate more specific and narrowly tailored indemnification and advancement obligations into its bylaws or employment contracts, such that the statutory requirements “shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise.”164 Companies that elect not to include indemnification and advancement provisions in their bylaws, or omit them inadvertently, may conclude individual indemnification agreements with certain actors even in the middle of that official’s ongoing employment.

Delaware law, for example, permits corporations to extend indemnification to anyone who “is or was a director, officer, employee or agent of the corporation.”165 Indemnification covers “expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person” in a proceeding.166

The statute itself contains a good faith limitation, allowing indemnification only “if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.”167 Even a conviction in a criminal proceeding “shall not, of itself, create a presumption that the person did not act in good faith.”168 Good faith is a question to be resolved internally by the company through its directors, stockholders or outside counsel. Indemnification can only be made upon a determination of good faith by: (1) majority vote of non-party directors; or (2) a committee of directors designated by a majority of non-party directors; or (3) independent legal counsel through a written opinion at the direction, or in the absence of, non-party directors; or (4) the stockholders. Subsection (i) defines good faith largely in fiduciary terms, requiring the corporate actor “to have acted in a manner not opposed to the best interests of the corporation.”169

Indemnification is mandatory, however, if “a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding.”170 This provision changes the operating framework. It mandates indemnification of vindicated officers and directors (but not employees).171

The DGCL’s indemnification section serves a very clear purpose: to encourage capable people to serve on corporate boards with the confidence to resist unjustified suits, claims and investigations.172 Typically, companies

164 Del. Code Ann. tit. 8, § 145(f) (LexisNexis 2006). Under Texas law, the “certificate of formation of an enterprise may restrict the circumstances under which the enterprise must or may indemnify or may advance expenses to a person.” TEX. [BUS. ORGS.] CODE ANN. § 8.003 (2006). 165 Del. Code Ann. tit. 8, § 145(a). Pursuant to § 8.101 of the Texas Business Organizations Code, “an enterprise may indemnify a governing person, former governing person, or delegate.” TEX. [BUS. ORGS.] CODE ANN. § 8.101. The terms are defined in § 8.001. 166 Del. Code Ann. tit. 8, § 145(a). Under Texas law, indemnification covers a judgment and “expenses, other than a judgment, that are reasonable and actually incurred by the person in connection with a proceeding.” TEX. [BUS. ORGS.] CODE ANN. § 8.102(a). 167 Del. Code Ann. tit. 8, § 145(a). See also Del. Code Ann. tit. 8, § 145(d); TEX. [BUS. ORGS.] CODE ANN. § 8.101 (a)(1). 168 Del. Code Ann. tit. 8, § 145(a). See also TEX. [BUS. ORGS.] CODE ANN. § 8.101(d). 169 Del. Code Ann. tit. 8, § 145(i) (internal quotations omitted). 170 Del. Code Ann. tit. 8, § 145(c). See also, TEX. [BUS. ORGS.] CODE ANN. § 8.051(a). 171 Witco Corp. v. Beekhuis, 38 F.3d 682, 691 (3d Cir. 1994) (describing “the strong and clear mandate of the Delaware General Corporation Law” granting “an absolute right of indemnification” where corporate actors mount successful defenses). 172 See Witco, 38 F.3d at 691; see also Merritt-Chapman & Scott Corp. v. Wolfson, 264 A.2d 358, 360 (Del. Super. Ct. 1970) (“Indemnification statutes were enacted in Delaware, and elsewhere, to induce capable and responsible businessmen to accept positions in corporate management . . . and to give vindicated directors and others involved in corporate affairs a judicially enforceable right to indemnification.”) (internal citations omitted).




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simply adopt or adapt the language of the applicable statute, frequently converting permissive statutory indemnification into a mandatory bylaw provision.173

Delaware grants corporations discretion to advance fees incurred in defending against any civil, criminal, administrative or investigative action. The scope is limited to current officers and directors, again excluding employees, and advancement is conditioned upon the recipient’s promise, usually in a written undertaking, to repay all funds “if it shall ultimately be determined that such person is not entitled to be indemnified.”174

The sparseness of statutory guidance and restriction on fee advancement allows for wide variation among corporate bylaws on the issue. Still, many conform to the basic provisions of the Delaware statute. For example, WorldCom’s bylaws contain the DGCL’s requirement of a promise to repay before advancements will be made:

No advancement or reimbursement of expenses to officers, employees or agents in accordance with Sections 3 or 4 of this Article X shall be made unless the proposed indemnitee furnishes the corporation a written affirmation of his good faith belief that he has met the standard of conduct set forth in the corporation’s Articles of Incorporation with respect to directors, and he furnishes the corporation a written undertaking, executed personally or on his behalf, to repay any advances if it is ultimately determined that he is not entitled to indemnification under this Article X or Part 5 of Article 8 of the Georgia Business Corporation Code.

Delaware law leaves to the company’s discretion advancement as to former officers, directors and employees “upon such terms and conditions, if any, as the corporation deems appropriate.”175 Former officers and directors may be advanced funds even in the absence of an undertaking, though the Delaware Supreme Court has noted that even where corporations “do not have advancement provisions that expressly require an undertaking, the ultimate right to keep payments characterized as an ‘advancement’ depends upon whether the corporate official is entitled to indemnification.”176

Even for current officers and directors, corporations have latitude in their construction of advancement provisions.177 Further, “Section 145(e) leaves to the business judgment of the board the task of determining whether the undertaking proffered in all of the circumstances, is sufficient to protect the corporation’s interest in repayment and whether, ultimately, advancement of expenses would on balance be likely to promote the corporation’s interests.”178 Significantly, because “[t]he corporation maintains the right to be repaid all sums advanced” and because the undertakings or promises to repay monies advanced need not be secured, “the [board’s] advancement decision is essentially simply a decision to advance credit.”179 The decision to advance “should ultimately give rise to no net liability on the corporation’s part,”180 because either the corporate actor is entitled to be indemnified, in which case the company would ultimately have had to outlay the cash anyway, or the advancee will have to repay any and all fees advanced if it is determined that he is not entitled to indemnification.

The permissiveness of the statute means that corporations end up sketching the contours of their advancement obligations through provisions in bylaws or individual agreements. In addition to the requirement of a 173 See Advanced Mining, 623 A.2d at 83 (“[M]ost corporations and virtually all public corporations have by by-law exercised the authority recognized by Section 145 so as to mandate the extension of indemnification rights in circumstances in which indemnification would be permissible under Section 145.”). 174 Del. Code Ann. tit. 8, § 145(e). 175 Id. 176 Homestore, 888 A.2d at 211. 177 See Brooks-McCollum v. Emerald Ridge Serv. Corp., Civil Action No. 147-N, 2004 Del. Ch. LEXIS 105, at *7 (Del. Ch. July 29, 2004) (“This allowance is permissive, not mandatory. Thus, a corporation is free to limit the terms of advancement and even preclude advancement entirely.”) (footnote omitted). 178 Advanced Mining, 623 A.2d at 84. 179 Id. 180 Id.


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formal undertaking embodying a promise to repay in the event indemnification is not due, a corporation can require the advancee to prove an ability to repay or post bond or otherwise secure the advance.181 It can also dictate that advancement is only available when the corporate actor is defending an action, not prosecuting her own action even if the cause of that action develops by reason of the fact of her employment. Importantly, the time for a corporation to impose these conditions on advancement is during the drafting of the bylaws, not on an ad hoc basis in an ongoing proceeding in order to evade a preexisting obligation to an officer or director who has fallen out of favor with the board.

Despite the freedom to draft unique advancement provisions, the extent of a corporation’s advancement obligation is frequently judicially determined. The Court of Chancery has exclusive jurisdiction to hear all actions for advancement or indemnification as well as the authority to “summarily determine a corporation’s obligation to advance expenses (including attorneys’ fees).”182 Subsection (k) therefore gives rise to what are known as “summary” advancement actions in the Chancery Court.183 In such actions, the critical factor is the nature of the claims against the corporate actor, an inquiry that can be resolved by reference to the pleadings in the case.184

Courts have also read a reasonableness requirement into the statute:

Section 145(a) expressly limits the amount of indemnifiable expenses to those “reasonably” incurred. Section 145(e) does not, however, specifically provide for a reasonableness limitation for expenses that are advanced. Nevertheless, this Court has held that all contracts providing for the advancement of expenses are implicitly limited to those that are reasonably incurred.185

When the company makes the statutory permission mandatory, it may inadvertently open itself up to absurd situations. Not even a guilty plea in a criminal case for conspiracy to defraud the company absolves a corporation of its obligation to advance fees and expenses to former corporate officials in ongoing civil cases where it has agreed to do so.186 Even Homestore’s firm belief that a former officer’s looting of $15 million left him with unclean hands is irrelevant to advancement, an issue that only concerns a right to interim costs of legal proceedings and not an ultimate determination of a right to indemnification.187

B. The McNulty Memo’s Rare Circumstances Exception

The McNulty Memo provides that prosecutors can consider advancement of legal expenses in assessing a corporation’s cooperation only in “extremely rare” circumstances in which advancement of legal expenses appears to be for the purpose of impeding the government’s investigation.

Just when advancement could be deemed to be obstructionist conduct is unclear. Presumably, the McNulty exception contemplates a circumstance in which a corporation attempts to purchase the silence of certain witnesses. This scenario could arise when, for example, a number of witnesses represented by company-funded lawyers invoke their Fifth Amendment privilege and refuse to the cooperate with the government. Prosecutors could argue that the corporation was using the advancement of legal expenses as a means of securing the non-cooperation of its employees. Yet the Supreme Court has made clear that the invocation of the Fifth Amendment, although having the

181 See Homestore, 888 A.2d at 212. 182 Del. Code Ann. tit. 8, § 145(k). Texas law also provides for applications to be made to a court for a judicial determination that the claimant is “fairly and reasonably entitled to indemnification in view of all the relevant circumstances.” TEX. [BUS. ORGS.] CODE ANN. § 8.052. 183 See, e.g., Fasciana v. Elec. Data Sys. Corp., 829 A.2d 160 (Del. Ch. 2003). 184 Id. at 167. 185 Homestore, 888 A.2d at 217-18. 186 See Bergonzi v. Rite Aid Corp., Civil Action No. 20453-NC, 2003 Del. Ch. LEXIS 117 (Del. Ch. Oct. 20, 2003) (company provided for contractual, not statutory, right to advancement until final disposition of criminal proceedings, which a guilty plea is not). 187 See generally Homestore, 888 A.2d 204.




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literal effect of impeding a government investigation, does not in itself arise to illegal conduct.188 Again the ACPPA goes further than the McNulty Memo. As set forth above, the ACPPA would prohibit prosecutors from pressuring a company to terminate or sanction employees who exercise their Fifth Amendment rights. S.196, 110th Cong. §3014(b)(2)(E). Under both the McNulty and Thompson Memos, termination of employees exercising their Fifth Amendment rights remains a factor for consideration of corporate cooperation and charging decisions.189

188 Arthur Andersen LLP v. U.S., 544 U.S. 696, 707 (2005) (holding that while “[b]y definition, anyone who innocently persuades another to withhold information from the Government ‘get[s] in the way of the progress of’ the Government,” such innocent conduct is not sufficient to rise to the level of obstruction of justice). 189 Memorandum from Paul J. McNulty, Deputy Attorney General to the Heads of Department Components and United States Attorneys (Dec. 12, 2006), http://www.usdoj.gov/dag/speech/2006/mcnulty_memo.pdf at Sec. VII, p. 11.


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