Alert January 02, 2013

Federal District Court’s Holding that Fund Adviser Waived Attorney-Client Privilege During SEC Investigation and Subsequent Lawsuit Highlights Need for Companies to Take Steps to Preserve the Privilege

The United States District Court for the District of Minnesota (the “Court”) held that a mutual fund adviser and its founder had waived the attorney-client privilege by disclosing emails exchanged with their counsel to the SEC during the SEC’s investigation and subsequent discovery related to a lawsuit brought by the SEC against the adviser and its founder alleging breach of fiduciary duty with respect to the mutual fund.  (The suit filed by the SEC asserted that the defendants had breached their fiduciary duty by obtaining loans from a third party in return for directing the fund to invest in securities recommended by the third party and in securities of an affiliate of the third party.)  The Court’s decision, discussed in more detail below, highlights the need for companies to conduct an in-depth review of documents for possible privilege issues prior to producing such documents to regulators.  In addition, companies must carefully consider whether asserting certain defenses might support an argument that the company waived the attorney-client privilege and that the plaintiff is entitled to conduct discovery on that particular subject matter.

Background. In July 2011, the SEC issued subpoenas to the adviser and CEO while investigating allegedly improper investment of fund assets in companies with which the adviser had other business transactions.  Defendants produced documents in August 2011 pursuant to those subpoenas, including over two hundred emails between defendants and their counsel.  The SEC then filed a complaint and served defendants with discovery requests.  Defendants’ answer to the Complaint also asserted affirmative defenses that they relied on the advice of counsel.  In April 2012, defendants produced many of the same emails with their counsel, and also introduced some of those emails at the deposition of the fund’s Chief Compliance Officer.  The Court noted that those emails related to the “central issue” in the lawsuit:  the agreements between the adviser and the entities in which fund assets were invested.  Five weeks after that deposition, defendants sent a letter to the SEC claiming that their document production inadvertently disclosed attorney-client privileged communications, and the SEC moved for an order finding that defendants had waived the privilege.

Waiver of Attorney-Client Privilege.  The Court held that defendants did not intentionally waive the privilege while producing documents, but that other factors warranted a finding of waiver.  Defendants argued that the SEC’s pre-lawsuit subpoenas had an aggressive and unreasonable time frame for production, but they never asked the SEC for an extension of time.  Nor did defendants indicate what sort of review was conducted to prevent disclosure, such as a key-word search with the attorney’s name.  The Court also noted that defendants produced over two hundred emails in the pre-suit investigation and produced many of the same documents again in discovery, and concluded that “more than two hundred communications could not have gone unnoticed during a cursory review of the documents produced given the identity of the parties to the communications,” i.e., the adviser’s CEO and his counsel, which “warranted a heightened level of scrutiny,” but “defendants failed to employ basic screening procedures.”  The Court further pointed out that defendants did not take any measures to rectify the pre-lawsuit disclosures, which inactivity weighed in favor of waiver.

The sheer number of privileged documents was not the sole determining factor in the Court’s decision.  It cited one case where waiver was found regarding a single document out of 95,000 where a party’s counsel merely assumed that prior counsel reviewed the documents and failed to describe any reasonable steps taken to prevent disclosure.  In contrast, another case found no waiver where only four pages out of more than 2,000 pages were privileged, three different attorneys checked the documents prior to production, and once the mistake was discovered counsel immediately requested that they be returned.  The Court thus noted the importance of “robust screening procedures,” as well as the promptness of remedial measures, in analyzing whether waiver has occurred.

Subject-Matter Waiver.  The Court next examined whether a broader subject-matter waiver had occurred, requiring defendants to further disclose related, protected information in order to prevent a “selective and misleading presentation of evidence to the disadvantage of the adversary.”  The Court found that defendants’ use of the emails at deposition did not warrant a finding of subject-matter waiver because nothing in the record suggested that defendants deliberately disclosed those documents to gain a tactical advantage.  However, the Court held that defendants’ affirmative defenses did support a finding of subject-matter waiver.  Although defendants later amended their answer to delete explicit references to the reliance of advice of counsel defense, the remaining defenses “necessarily revolve around Defendants’ knowledge of the law and the legality of their actions, as well as the basis for their understanding of both,” and the attorney’s input “undoubtedly influenced” such understanding.  The Court found that defendants “have voluntarily injected the advice they received from [the attorney] into this dispute and placed it at issue,” and the SEC thus was entitled to examine conversations that defendants had with their attorney to explore the basis of defendants’ “good faith” beliefs and state of mind and assess the validity of those defenses.  The Court further noted that defendants amended their answer six weeks before the close of discovery and offered no explanation for the delay, and because the SEC had developed its case unimpeded with respect to privileged communications with defendants’ attorney, fairness required a finding of subject-matter waiver.

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The Court’s decision serves as a reminder that companies should take all possible steps to implement “robust screening procedures” to prevent disclosure of privileged materials, as well as create a record of those steps, to support an argument that any disclosure of privileged materials was inadvertent.  They should also promptly notify their adversary if they learn that any such disclosure took place.  All defenses asserted in the case -- especially a reliance on advice of counsel defense -- should be weighed against the risk that the plaintiff will be allowed broad discovery of privileged material in order to explore the basis for that defense.

SEC v. Welliver, No. 11-CV-3076 (RHK/SER)(D. Minn. Oct. 26, 2012).