Court Rules that Law Firm’s Oral Summaries to SEC of Interview Notes and Memoranda Constitutes Waiver of Work Product Protection

We previously reported that on October 31, 2017, two former executives from General Cable Corporation (“GCC”) moved to compel Morgan Lewis & Bockius LLP (“Morgan Lewis”) to produce interview memoranda and notes created during an internal investigation of GCC that were subsequently provided to the SEC and an independent auditor. In S.E.C. v. Herrera, et al., No. 17-20301, 2017 WL 6041750 (S.D. Fla. Dec. 5, 2017), the issue before the court was whether Morgan Lewis “waived work product protection when it voluntarily gave the SEC oral summaries of the work product notes and memoranda its attorneys prepared about interviews of its client’s executives and employees.” On December 5, 2017, Magistrate Judge Jonathan Goodman issued a ruling ordering Morgan Lewis to produce the notes and memoranda for the interviews the firm discussed with the SEC.

As a matter of background, GCC retained the law firm to conduct an internal investigation after the company announced that it had identified accounting errors related to inventory at its operations in Brazil. As part of its internal investigation, Morgan Lewis interviewed more than three dozen witnesses, many of which were conducted in Brazil, and prepared notes and memoranda of those interviews. According to the motion papers, Morgan Lewis “regularly communicated with the SEC, voluntarily produced documents, and routinely made Brazil-based witnesses available for interviews with the SEC.” Specifically, Morgan Lewis attorneys “met with SEC staff and provided oral downloads of 12 witness interviews.” Subsequently, a Cease and Desist Order against GCC was entered and shortly thereafter, the SEC filed suit against the defendants alleging that they actively concealing material inventory accounting errors in violation of various securities laws.

In their motion to compel, the defendants sought all of the law firm’s interview notes and memoranda on the basis that Morgan Lewis waived work product protection by providing oral downloads of some interviews to the SEC and by providing work product, both orally and in writing, to Deloitte, GCC’s independent auditor. For its part, Morgan Lewis argued that “the oral conveyance of information derived from interviews does not waive the work product protection as to the underlying attorney notes and memoranda[,]” and if a waiver had occurred, it did not extend beyond the specific disclosures made. As for the disclosures made to Deloitte, Morgan Lewis argued that the oral conveyance or actual provision of work product to a company’s auditors does not waive the work product protection.

As an initial matter, Judge Goodman noted that “[i]n the context of work product, the question is not, as in the case of the attorney-client privilege, whether confidential communications are disclosed, but to whom the disclosure is made – because the protection is designed to protect an attorney’s mental processes from discovery by adverse parties.” This protection is waived when otherwise protected materials are “‘disclosed in a manner which is either inconsistent with maintaining secrecy against opponents or substantially increases the opportunity for a potential adversary to obtain the protected information.’” Judge Goodman “easily conclude[d]” that the SEC was an adversary of Morgan Lewis’ client, GCC, since the SEC was investigating GCC and eventually imposed a $6.5 million civil penalty against the company. Judge Goodman dismissed Morgan Lewis’ argument that the oral conveyance, as opposed to the actual production, of the notes and memoranda did not constitute a waiver, finding the oral downloads to be the “functional equivalent” of the actual notes and summaries. Judge Goodman did agree that the waiver did not extend beyond the notes and memoranda of the 12 interviews the law firm provided oral summaries of to the SEC. Judge Goodman noted that the compelling the disclosure of attorney work product is disfavored and the defendants failed to demonstrate substantial need to overcome this high hurdle. In addition, Judge Goodman denied the defendants’ request for documents produced to Deloitte holding that the disclosure of work product to Deloitte did not constitute a waiver because Deloitte is not an adversary to GCC.

On December 12, 2017, Morgan Lewis filed a motion for clarification or reconsideration of Judge Goodman’s Order. In its motion, the firm represents that the attorney notes taken during a meeting with the SEC “reflect the substance of the oral communications conveyed to the SEC by Morgan Lewis concerning the twelve interviews at issue.” Morgan Lewis requests, to avoid “manifest injustice,” that the Court review these notes in camera and then modify its Order “to provide that, instead of the interview notes and memos for the twelve interviews at issue,” only the attorney notes and a portion of an interview memo read to the SEC be produced to the Defendants. This motion is still pending and we will report back when there are further developments.

When sharing information obtained over the course of an internal investigation with a government agency, one should consider the implications such conduct has on privilege and waiver. The decision above serves as a reminder that even oral disclosures of work product to an adversary can constitute a waiver.

SEC Awards More Than $4.1 Million to Whistleblower Despite a Finding that Whistleblower Unreasonably Delayed Reporting Misconduct

The SEC announced earlier today that it has awarded more than $4.1 million to a former company employee who “alerted the agency to a widespread, multi-year securities law violation and continued to provide important information and assistance throughout the SEC’s investigation.” Press Rel. No. 2017-222. To determine an appropriate award amount, the SEC considers a number of criteria that are outlined in the Rule 21F-6 of the Exchange Act, including (1) the significance of the information provided to the Commission, (2) the assistance provided in the Commission action, (3) law enforcement interest in deterring violations by granting awards, (4) participation in internal compliance systems, (5) culpability, (6) unreasonable reporting delay, and (7) interference with internal compliance and reporting systems. 17 C.F.R. § 240.21F-6.

In its Order, the Commission found that the whistleblower’s positive contributions were “somewhat offset” by the whistleblower’s “unreasonable delay in reporting the misconduct,” which is one of the criteria used to evaluate the award amount. However, the Commission noted that it did not weigh the whistleblower’s delay in reporting as heavily as it might have otherwise due to several mitigating factors. First, the Commission noted that a large part of the whistleblower’s reporting delay “occurred prior to the establishment of the whistleblower award program in July 2010,” and the Commission has generally not penalized whistleblowers as heavily due to the absence of the benefits provided by the program, such as monetary awards, anonymity, and heightened confidentially protections. Second, the Commission noted that the whistleblower “was a foreign national working outside the United States,” and therefore, it was unclear whether the whistleblower anti-retaliation provision of the Exchange Act would apply to the whistleblower.

When balancing the whistleblower’s contribution with the unreasonable delay in initially reporting the misconduct, along with the totality of the circumstances, the Commission found that the award determination was justified.

According to the press release, the agency has “now awarded more than $179 million to 50 whistleblowers since issuing its first award in 2012.” The awards come from an investor protection fund that was established by Congress and financed through monetary sanctions that are paid by violators of securities laws.

Ex-Executives Move to Compel Law Firm to Produce Notes from Internal Investigation

On October 31, 2017, two former executives from General Cable Corporation (“GCC”) filed a motion to compel Morgan Lewis & Bockius LLP (“Morgan Lewis”) to produce interview memoranda and notes created during an internal investigation of GCC that were subsequently provided to the SEC and an independent auditor. In S.E.C. v. Herrera, et al., No. 17-20301 (S.D. Fla. filed Jan. 24, 2017), the government alleged that Mathias Francisco Sandoval Herrera (“Herrera”) and Maria D. Cidre (“Cidre”), acting as CEO and CFO of the Latin American operations of GCC, violated various securities laws when they “actively concealed from GCC executive management material inventory accounting errors at the company’s subsidiary in Brazil, including the overstatement of inventory by tens of millions of dollars and allegations of a massive theft by GCC Brazil employees.”

GCC, a global manufacturer of copper, aluminum, and fiber optic wire and cable products, announced in October 2012 that “it had identified accounting errors relating to inventory at its Brazil operations, that its previously issued financial statements for 2009-2011, audited by [Deloitte & Touche LLP], should not be relied upon, and that it intended to issue a restatement of financials.” Following this announcement, GCC retained Morgan Lewis to conduct an internal investigation, which consisted of interviewing more than three dozen witnesses, many of which were conducted in Brazil, preparing notes and memoranda of those interviews, and preparing memoranda related to other aspects of the investigation. “After retaining Morgan Lewis, GCC reported the accounting errors to the SEC, which launched its own investigation . . . . [that] led to a Cease and Desist Order against GCC in December 2016, which required the payment of a civil monetary penalty in the amount of $6,500,000.”

In their motion to compel, the defendants state that during the internal investigation, Morgan Lewis “regularly communicated with the SEC, voluntarily produced documents, and routinely made Brazil-based witnesses available for interviews with the SEC.” The defendants allege that Morgan Lewis shared work product with the SEC both orally and in writing, and with this work product, the SEC had a “decided advantage” in the litigation by being able to “focus its investigation and decide which of the nearly 40 witnesses – many of whom where GCC employees in Brazil – to interview and from whom to elicit sworn statements during the investigation.” Additionally, during Morgan Lewis’ internal investigation, “Deloitte independently formed a forensic team to assess the sufficiency of the Morgan Lewis investigation.” Deloitte served as GCC’s independent auditor and issued unqualified opinions on GCC’s financial statements during the relevant time period. The defendants state that Deloitte had reason to believe that it would be charged by the SEC in connection with its audits of GCC and that Morgan Lewis “regularly shared its work product” with Deloitte, both orally and in writing.

In light of these disclosures, the defendants served Morgan Lewis with a subpoena seeking, among other items, notes and memoranda from Morgan Lewis’ witness interviews. In response, Morgan Lewis “declined to produce any documents on the basis of privilege, including the attorney-client privilege, the work-product doctrine, and the certified public accountant-client privilege.” While the defendants do not dispute that the interview memoranda were prepared by Morgan Lewis in anticipation of litigation, they argue that Morgan Lewis waived privilege when it provided written interview notes and memoranda to the SEC, an adversarial investigative agency, as well as oral downloads of each. As for documents and information shared orally with Deloitte, the defendants concede that the majority of courts have held that independent or outside auditors typically share a common interest with the corporation for purposes of the work-product doctrine and waiver analysis, but argue that in the present case, Deloitte does not share a common interest with GCC due to the fact that Deloitte was potentially a target of the SEC. Specifically, defendants argue that “Deloitte was a potential adversary to GCC because Deloitte was motivated to claim that GCC personnel had misled Deloitte regarding accounting practices at GCC[,]” and “Deloitte was a potential conduit of information to the SEC in an effort to avoid or minimize its own liability.”

In opposition, Morgan Lewis makes three primary arguments as to why it should not be compelled to produce its interview memoranda and notes: (1) courts strong disfavor ordering the production of such materials; (2) defendants failed to demonstrate that Morgan Lewis waived the work product protection; and (3) defendants failed to demonstrate a substantial need for these materials. As an initial matter, Morgan Lewis notes that the materials sought are neither transcripts nor witness statements, but rather are attorney summaries of relevant information derived from witness interviews. Morgan Lewis relies on the Supreme Court’s Upjohn decision to argue that “‘[f]orcing an attorney to disclose notes and memoranda of witness’ oral statements is particularly disfavored because it tends to reveal the attorney’s mental processes[,]” and absent a showing of waiver, defendants must show a substantial need for the materials to prepare a defense.

As for defendants’ waiver argument, Morgan Lewis argues that the PowerPoint presentation prepared for the SEC is not work product, but a collection of facts and therefore the issue of waiver is inapplicable in that instance. In addition, Morgan Lewis contends that “the oral conveyance of information derived from interviews does not waive the work product protection as to the underlying attorney notes and memoranda[,]” and if a waiver has occurred, the waiver does not extend beyond the specific disclosures made. As for the disclosures made to Deloitte, Morgan Lewis argues that the oral conveyance or actual provision of work product to a company’s auditors does not waive the work product protection.

Finally, Morgan Lewis states that defendants have failed to show a substantial need for the sought after materials. Morgan Lewis argues that a speculation that the passage of time has causes witness memories to fade does not rise to a level that overcomes the work product protection. In any event, defendants are in possession of the 400,000-plus documents that General Cable produced to the SEC, which can be used to refresh the recollections of the witnesses.

We will monitor the pending motion and report on further developments.

SEC Announces Enforcement Division Cyber Specialty Unit

On September 25, 2017, the Securities and Exchange Commission announced the creation of an Enforcement Division “Cyber Unit” that will focus on cyber-related violative conduct. The timing of this is much more than coincidental; indeed it’s obvious. Just last week, SEC Chairman Jay Clayton disclosed: 1) a 2016 intrusion of the SEC’s EDGAR system due to a software vulnerability in the test filing component of the system, resulting in access to nonpublic information; and 2) the creation of a senior-level cybersecurity working group. Since the disclosure of the EDGAR breach, the financial press has reported that SEC Enforcement, the Secret Service, and the FBI have been investigating, and that Chairman Clayton asked the SEC’s Office of Inspector General to investigate. On September 26, 2017, Chairman Clayton appears before the Senate Committee on Banking, Housing, and Urban Affairs where he will provide testimony and likely be subject to intense questioning.

Returning to the SEC’s Cyber Unit, while not specifically described as such, it appears to be created in the mold of the other Enforcement Division Specialty Units. This new unit’s mandate includes targeting cyber-related violative conduct, such as: market manipulation schemes involving false information spread through electronic and social media; hacking to obtain material nonpublic information; misuse of distributed ledger technology; misconduct perpetrated via the dark web; intrusions into retail brokerage accounts; and cyber-related threats to trading platforms and other critical market infrastructure. Consistent with this being a new specialty unit, the “Chief” is a former Co-Chief of the SEC’s Market Abuse Specialty Unit. Thus, registrants can expect the Cyber Unit to evolve much as the SEC’s other specialty units have previously. Specifically, this unit will likely: develop and expand SEC internal cyber knowledge; seek to hire external cyber experts; and dedicate its efforts and resources to this specialty area. Consistent with the evolutions of the other specialty units, the Cyber Unit will likely pursue cases that the Enforcement Division generally and historically might not have pursued, such as non-fraud violations considered more technical in nature.

While it’s ironic that the SEC announced the Cyber Unit on the heels of its recent breach, issuers and registrants should take this opportunity to self-assess and implement plans to avoid the SEC’s Cyber Unit in the future. Among various strategies, actively monitoring and assessing the SEC’s cybersecurity guidance and, in particular, the Office of Compliance Inspections and Examinations Risk Alerts, and documenting this work will support arguments of reasonable and diligent efforts. For further and more detailed guidance, look to FINRA’s February 2015 Report on Cybersecurity Practices. While FINRA’s oversight is limited to its member broker-dealer firms, this 46-page report provides plain-language guidance that any company or firm may want to consider reviewing and implementing as appropriate.

D.C. Circuit Split on Constitutionality of SEC’s Administrative Judges

We previously blogged about the D.C. Circuit’s decision in Raymond J. Lucia Cos v. SEC, which rejected the petitioner’s constitutional challenges to the SEC’s use of administrative law judges that are not appointed by the President. Yesterday, the D.C. Circuit issued a two sentence per curiam order denying an en banc review by an equally divided court.

We noted that the panel’s original opinion was the first appellate ruling of its kind. Although the panel’s decision remains in effect because the full court did not rehear the case, the strength of that ruling is now severely undermined. As we previously reported, the Tenth Circuit has already disagreed with the D.C. Circuit’s panel and held that the SEC’s administrative law judges are subject to the Constitution’s Appointments Clause. Yesterday’s order likely sets the stage for a Supreme Court challenge.

SEC Names Co-Directors of Enforcement

Last week, the Securities and Exchange Commission (SEC) announced that Acting Enforcement Director Stephanie Avakian and former federal prosecutor Steven Peikin had been named Co-Directors of the Division of Enforcement. In making the announcement, SEC Chairman Jay Clayton advised:

There is no place for bad actors in our capital markets, particularly those that prey on investors and undermine confidence in our economy. Stephanie and Steve will aggressively police our capital markets and enforce our nation’s securities laws as Co-Directors of the Division of Enforcement. They have each demonstrated market knowledge, impeccable character, and commitment to public service, and I am confident their combined talents and experience will enable them to effectively lead the Division going forward.

Prior to being named Acting Director in December 2016, Ms. Avakian served as Enforcement’s Deputy Director since June 2014. Mr. Peikin joins the SEC for the first time from private practice. Prior to that, from 1996 to 2004, Mr. Peikin served as an Assistant U.S. Attorney in the Southern District of New York. He was Chief of the Office’s Securities and Commodities Fraud Task Force, where he supervised some of the nation’s highest profile prosecutions of accounting fraud, insider trading, market manipulation, and abuses in the foreign exchange market. As a prosecutor, Mr. Peikin also personally investigated and prosecuted a wide variety of securities, commodities, and other investment fraud schemes, as well as other crimes.

As Chairman Clayton continues to appoint the Division leadership at the SEC and establish his own agenda for the Commission as its new Chairman, these Co-Director appointments bear a strong resemblance to those of his predecessors, Chair Mary Jo White and Chair Mary Schapiro. First, in 2009, Chair Schapiro appointed a former federal prosecutor for the first time to lead the SEC’s Division of Enforcement. Second, in 2013, Chair White appointed another former federal prosecutor, Andrew Ceresney. In furtherance of the striking similarities, Chair White appointed Mr. Ceresney as a Co-Director with the then Acting Director. Mr. Ceresney eventually took over the Directorship on his own. Thus, while many forecasted that the new Commission may perhaps be friendlier to the industry, with these Co-Director appointments Chairman Clayton looks to be following the lead of his recent predecessors rather than breaking from them. Lastly, if the precedent of the only prior Co-Directorship is any indication, then at some point in the foreseeable future Mr. Peikin will be occupying the Director’s chair on his own, as Mr. Ceresney ultimately did.

Acting SEC Chairman Limits Delegated Formal Order Authority

Acting SEC Chairman Michael Piwowar has apparently revised the staff’s ability to subpoena records and investigative testimony (“formal order authority”) by returning the authority to grant formal order authority to the agency’s Director of Enforcement. While the SEC has not formally recognized this policy shift, multiple sources, including Law360 and the Wall Street Journal, have reported that Acting Chair Piwowar has recently implemented this change, which revokes the delegated authority to regional directors and enforcement associate directors to approve the staff’s requests for formal order authority.

In 2009, under Chair Mary Schapiro and as part of certain initiatives to enhance enforcement’s capabilities in the aftermath of the financial crisis, the SEC delegated its authority to authorize formal order authority to the Director of Enforcement. The Director of Enforcement, in turn, delegated this authority to regional directors and enforcement associate directors. As a result, the staff could, within an hour (when necessary) obtain formal order authority, as compared to the days, weeks, or at times months, that it had historically taken to obtain formal order authority from the Commission. Not unexpectedly, the number of formal investigations opened by the staff dramatically increased.

Acting Chair Piwowar’s recent move eliminates the second layer of delegation by limiting the 2009 delegated authority to the Director of Enforcement. While the effect of this change on the number of SEC investigations remains uncertain, multiple sources report that Acting Chair Piwowar enacted the policy not to reduce that number, but to bring greater oversight and consistency to the investigation process. Further, while he is not authorized to take the step alone, as it would require a vote of the Commission which is currently comprised of only two members, Acting Chair Piwowar and Commissioner Kara Stein, the acting chair has asked the SEC’s general counsel to consider whether the agency should further restrict formal order authority by returning the power to grant it to the SEC Commissioners. Thus, at Acting Chair Piwowar’s direction, the SEC is considering a return to the pre-2009 formal order authority review and approval process.

The revocation of the regional and associate directors’ delegated ability to approve formal order authority is the latest action taken by Acting Chair Piwowar, who stepped in as acting chairman after former Chair Mary Jo White stepped down at the conclusion of the Obama administration. His actions have included requesting that all authorities granted to staff members be reviewed and that public disclosure rules required by Dodd-Frank be reconsidered.  Such actions indicate efforts to begin the reshaping of the agency as it awaits the confirmation of President Trump’s nomination for chairman, Jay Clayton.

11th Circuit Nixes CPA’s Claim That SEC Sanctions Preclude Criminal Prosecution

On February 3, 2017, the United States Court of Appeals for the Eleventh Circuit rejected an accountant’s argument that the imposition of both criminal charges and SEC sanctions on the basis of the same alleged conduct violated the Fifth Amendment’s Double Jeopardy Clause. This appellate court ruling illustrates that defendants in SEC investigations and enforcement proceedings must be mindful that the imposition of civil penalties, disgorgement, and permanent bars do not preclude the prospect of criminal prosecution.

Thomas D. Melvin (“Melvin”), a certified public accountant, agreed in April 2013 to pay the SEC a civil penalty of $108,930 and disgorgement of $68,826 to settle alleged violations of Sections 10(b) and 14(e) of the Securities and Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. According to the SEC, Melvin purportedly had disclosed confidential insider information that he received from a client that pertained to the pending sale of a publicly traded company. A Rule 102(e) administrative proceeding in September 2015 also permanently barred Melvin from practicing before the SEC as an accountant. Exchange Act. Rel. No. 75844.

The Department of Justice instituted a parallel criminal proceeding against Melvin that involved the same alleged wrongful activity. Melvin moved to dismiss the eventual indictment on the ground that the collective sanctions the SEC had levied upon him constitutionally precluded a criminal prosecution under the Double Jeopardy Clause. After a federal district court denied his motion to dismiss, Melvin pleaded guilty to six counts of securities fraud pursuant to a written plea agreement. He then appealed the district court’s denial of his motion to dismiss.

In United States v. Melvin, No. 16-12061 (11th Cir. Feb. 3, 2017), the Eleventh Circuit conducted two inquiries to determine whether the imposition of the civil penalty, disgorgement and professional debarment against Melvin were so punitive that they rose to the level of a criminal penalty. For the initial inquiry, the court found that Congress intended the sanctions imposed by the SEC to be a form of civil punishment because monetary penalties are expressly labeled as “civil penalties” and the legislative branch empowered the SEC to prohibit an individual from appearing or practicing before it.

As to the second inquiry, the circuit court examined seven “useful guideposts” articulated by the United States Supreme Court in Hudson v. United States, 118 S. Ct. 488, 493 (1997). These guideposts included whether:

  1. “the sanction involves an affirmative disability or restraint”;
  2. “it has historically been regarded as a punishment”;
  3. “it comes into play only on a finding of scienter”;
  4. “its operation will promote the traditional aims of punishment—retribution and deterrence”;
  5. “the behavior to which it applies is already a crime”;
  6. “an alternative purpose to which it may rationally be connected is assignable for it”; and
  7. “it appears excessive in relation to the alternative purpose assigned.”

Applying these guideposts, the Eleventh Circuit believed that the sanctions at issue “constitute no affirmative disability or restraint approaching imprisonment” and observed that “neither money penalties nor debarment have historically been viewed as punishment.” It also noted that “penalties for security fraud serve other important nonpunitive goals, such as encouraging investor confidence, increasing the efficiency of financial markets, and promoting the stability of the securities industry.” As such, the appellate court concluded that Melvin’s criminal prosecution did not constitute a violation of the Double Jeopardy Clause.

This ruling is the most recent cautionary reminder that, even in this era of headline-grabbing civil penalties that far exceed those the SEC sought and obtained just a few years ago, defendants should never lose sight that the resolution of SEC charges does not preclude the prospect of a parallel criminal proceeding. Indeed, any time the SEC’s prosecutorial theory is potentially fraud-based, defendants and their counsel must remain extremely cautious to the possible involvement of criminal authorities and develop their legal strategies accordingly.

The SEC’s Form 1662 underscores this point. This form, which is provided to all persons requested to supply information voluntarily to the SEC or directed to do so via subpoena, states:

It is the policy of the Commission … that the disposition of any such matter may not, expressly or impliedly, extend to any criminal charges that have been, or may be, brought against any such person or any recommendation with respect thereto. Accordingly, any person involved in an enforcement matter before the Commission who consents, or agrees to consent, to any judgment or order does so solely for the purpose of resolving the claims against him in that investigative, civil, or administrative matter and not for the purpose of resolving any criminal charges that have been, or might be, brought against him.

The disposition of an SEC proceeding also does not prevent the SEC from sharing any information it has accumulated with criminal authorities. Instead, as Form 1662 warns, the SEC “often makes its files available to other governmental agencies, particularly United States Attorneys and state prosecutors” and there is “a likelihood” that the SEC will provide this information confidentially to these agencies “where appropriate.”