Year: 2009

Waiving the Attorney-Client Privilege By Seeking Tax Advice

john-adams-courthouse for the Mass SJC

The Massachusetts Supreme Judicial Court focused on the issue of whether the attorney-client privilege protected  communications between an in-house corporate counsel and outside tax accountants. Commissioner of Revenue v. Comcast Corporation, et al., SJC-10209 (March 3, 2009). The general rule is that the voluntary disclosure of privileged information to a third party consultant for the company’s business purposes will be deemed to waive the privilege.

We saw a similar issue addressed in the context of SEC filings in the case of  Roth v Aon. In the Roth case, they were trying to compel the release of draft SEC filings. That court rejecting the request and recognized that the process of preparing SEC filings involves legal judgments throughout, even where the disclosure in question concerns operational rather than legal matters.

In Comcast, Corporate counsel retained two Massachusetts-based Arthur Andersen partners to provide Massachusetts tax law advice in connection with a proposed stock sale. The Andersen partners spoke with in-house counsel and prepared several memoranda discussing options for the company relating to the stock sale. Litigation ensued concerning the tax implications of the stock sale. The Commissioner of Revenue sought production of the Arthur Andersen memoranda, which Comcast withheld on the basis of the attorney-client privilege and/or work product doctrine.

The SJC held that the memoranda were not protected by the attorney-client privilege.

In addressing whether the attorney-privilege exists, Comcast bears the burden of proof and needed to show:

“(1) the communications were received from a client during the course of the client’s search for legal advice from the attorney in his or her capacity as such; (2) the communications were made in confidence; and (3) the privilege as to these communications has not been waived.”

Comcast argued that the memoranda fell within the “derivative privilege” recognized in United States v. Kovel, 296 F.2d 918 (2d Cir.1961). In the Kovel decision, the Second Circuit held that the attorney-client privilege is not waived when disclosure to a third party consultant is necessary to facilitate communication between the attorney and the client and assist the attorney in rendering legal advice to the client. One example of the derivative privilege is that of an interpreter brought in to translate for a client and his attorney who speak different languages.

With respect to accountants, the Court in Kovel held that the privilege is waived unless the communication is made for the specific purpose of the client obtaining legal advice from the lawyer. The privilege is waived if  (a) what is sought is not legal advice but only accounting services, or (b) if the advice sought is the accountant’s rather than the lawyer’s . In Comcast, the SJC agreed that the Kovel doctrine applies only when the accountant’s role is to clarify or facilitate communications between attorney and client. The majority of courts take the same position.

Lesson? Tax advice from your accountant is unlikely to be protected by attorney-client privilege.

Before disclosing attorney-client communications to a third party, ask yourself whether the third party is being consulted in order to (a) simply to provide her own advice, or (b) facilitate communication between the attorney and the client. If your answer is (b), disclosure of the confidential information will likely waive the attorney-client privilege.

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Madoff Goes From His Penthouse to the Big House

madoff

Bernie Madoff filed past a sea of reporters and camera flashes to enter his guilty plea in front of Judge Denny Chin. Several victims spoke, asking the judge to reject the plea and force a trial. They want grueling trial to make Madoff suffer and to bring more facts out to the public.

Since he turned himself in to authorities back in December, Mr. Madoff has been living in his multi-million dollar penthouse. Back in December, the magistrate ruled that Mr. Madoff was not a flight risk and allowed him to stay confined in his palatial home.

But now Mr. Madoff is guilty. Mr. Madoff’s attorney, Ira Sorkin, tried to argue for bail. But Judge Chin would have none of it. Judge Chin revoked Madoff’s bail, calling him a “flight risk” in light of the severity of the charges for which he just entered a guilty plea. He granted the government’s request for remand. The prosecution did not even have to rebut Mr. Sorkin’s argument for bail.

According to the New York Law Journal’s Mark Hamblett, Mr. Madoff was taken out of court in handcuffs. I have not seen pictures of that yet, but I am sure there are many people looking to get a copy of that picture to frame. In handcuffs, he was delivered to Manhattan Correctional Center. (If you were thinking of sending some money to Bernie to help his cause, you should take a look at the Bureau of Prison’s Inmate Money Policy.”The deposit must be in the form of a money order.”)

Fox Business takes us on a tour of his new home until his June 16 sentencing hearing:

Presumably, Mr. Madoff’s lawyer will appeal the bail revocation. The chances of Mr. Madoff being released on bail are slim and none, and slim’s 401(k) has turned into a 201(k). After all, the appellate court gives lots of deference to the district court on bail decisions.

The next question will be how much time will Mr. Madoff serve and where. Lets add up the charges:

  • Count 1: Securities fraud. Maximum penalty: 20 years in prison; fine of the greatest of $5 million or twice the gross gain or loss from the offense; restitution.
  • Count 2: Investment adviser fraud. Maximum penalty: Five years in prison, fine and restitution.
  • Count 3: Mail fraud. Maximum penalty: 20 years in prison, fine and restitution.
  • Count 4: Wire fraud. Maximum penalty: 20 years in prison, fine and restitution.
  • Count 5: International money laundering, related to transfer of funds between New York-based brokerage operation and London trading desk. Maximum penalty: 20 years in prison, fine and restitution.
  • Count 6: International money laundering. Maximum penalty: 20 years in prison, fine and restitution.
  • Count 7: Money laundering. Maximum penalty: 10 years in prison, fine and restitution.
  • Count 8: False statements. Maximum penalty: Five years in prison, fine and restitution.
  • Count 9: Perjury. Maximum penalty: Five years in prison, fine and restitution.
  • Count 10: Making a false filing with the Securities and Exchange Commission. Maximum Penalty: 20 years in prison, fine and restitution.
  • Count 11: Theft from an employee benefit plan, for failing to invest pension fund assets on behalf of about 35 labor union pension plans. Maximum penalty: Five years in prison, fine and restitution.

That’s a maximum penalty of 150 years. Some of these may end up being concurrent sentences. But given that Mr. Madoff is 70, it would be a good guess that he will end up spending the rest of his life in prison.

Where will he be spending that time? Jeff Chabrowe of the Blanch Law Firm told Esquire that he thinks it will be the Federal Correctional Institute in Otisville, New York because it is one of the few with a kosher kitchen. Sounds like a wild guess to me.

It is good to see justice happening swiftly and effectively. After all the fear of prosecution is one of the better ways to stop Ponzi schemes. It seems like Mr. Madoff just wants this to end and accept his punishment.

The compliance officer in me wants to hear more about the underlying facts of what made Madoff go bad. In his allocution Madoff states that:

When I began the Ponzi scheme, I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible.

What made him begin the scheme? What would have stopped him from starting the scheme? What lessons can learn from Mr. Madoff to deter the next Madoff from going to the dark side? How did he think he could extricate himself?

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Seven Questions to Ask to Optimize Your Compliance Programs

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Compliance Week put on a webinar covering Practical Guidance: Seven Questions to Ask to Optimize Your Compliance Programs. Bruce McCuaig, Vice President, Risk and Compliance and Mike Rost, Vice President, Marketing of Paisley presented.

Mike started off with some background of Paisley, then moved onto the “Why?” of Compliance. Companies want to avoid the downside that comes from compliance failures.

Bruce then took over and set forth the seven questions:

  1. Do you have an effective compliance program?
  2. Have you assessed the scope of your compliance program?
  3. Is your compliance program risk-based?
  4. Do you have effective controls over your compliance risks?
  5. Is your compliance program integrated?
  6. Are you leveraging technology to support your compliance program?
  7. Do you have a plan to instill and sustain your compliance program processes?

Effectiveness has a basis in the federal sentencing guidelines. You need to have culture of compliance. You need to be effective in prevention. You need to document standards and procedures. You need to communicate and report. There is a need for continual improvement.

In assessing the scope of your compliance program, you need to look at the laws, standards and regulations that you must comply with. What jurisdictions to you operate in? What subjects do I need to pay attention to? You need to take a top-down risk-based approach to address the scope of your program. You need to find the most significant risks to compliance.

To think about if your compliance program is risk-based, you need to look at the root cause of possible failure. They break it into three pieces. You need to look at behavioral or cultural factors, impact factors and external factors. Behavior focuses on people. Do your people know the rules. Impact factors look at systems and external are things outside your control.

For effective controls you need to know the rules, know the rules have to be followed. You also need to know when the rules are broken. If they are broken they need to be penalized for failure. It is important that employees read and certify that they understand the rules. Where compliance failures are a risk, the regulators expect there to be a dedicated compliance officer. You need to use compliance metrics.

An un-integrated approach has redundancy in testing and documentation, with common activities across business lines. Bruce sees five point of convergence:

  • Shared context in organization and process structure
  • Common language of risk and control
  • Common methodology
  • Enterprise wide reporting
  • GRC convergence technology

Bruce thinks technology is important. You need a library of intelligent information on laws and regulations. You need to manage the life-cycle of the policies and procedures. They are useful to show that everyone has read and affirmed their understanding of the policies.

Bruce labels the four steps of maturity: (1)  reacting, (2)  anticipating, (3) collaborating, and (4) orchestrating.

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Conducting C-Suite Investigations

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EthicsPoint presented a webinar on conducting C-Suite Investigations, with Sally Rhys, BA, MS, CCEP of Business Ethics Focus.  No-one wants to believe that allegations against the C-suite (Senior Executives) could be true. But with daily news reports of more cases of illegal and unethical transgressions by senior leaders, we all know that every organization is potentially at risk. It can happen at any time, even in your own organization. Are you prepared to handle such a crisis? These are my notes from the presentation.

sally

Sally Rhys started off with a fraud scenario involving the CFO: A call from someone that she thinks the CFO is overstating earnings and has convincing reports.” What do you do now?

Investigating C-suite involves bigger risks. There are also psychological barriers involving loyalty to the organization and its management. Sally points out the need for a plan:

  1. Secure a sponsor.
  2. Engage a a stakeholder team to act as a sounding board.
  3. Identify the positions which require an investigation protocol.
  4. Create plans for each position that needs a protocol. You may want to have an outside investigator for some positions. You may also want to have a PR plan and methods for dealing with clients, employees and other stakeholders. You also want to well document the steps and the investigation. You also want to be clear about the non-retaliation policy.
  5. Seek board approval. Craft a persuasive message to convince the board to approve a C-suite protocol.
  6. Publish the protocol. Write it down, publish it in the code and make it accessible. Only do this if you are actually going to follow the protocol.

It is good to have some method for quickly determining if there is some basis for the claim. You need to show that take the allegation seriously, but you want to move quickly to respond appropriately.

It is important to show the board where executives go wrong.

The attendees said the most likely chilling effect on a C-Suite investigation is the concern that you will not be supported.  Of the attendees, 46% picked this choice out of the four.

It is important to protect yourself. Make sure you have support of the board or other key stakeholders. Be professional and leave emotions at the door. be respectful and thorough. You need to stay credible.

Sally thought it was important to separate the role of general counsel and the compliance officer/investigator. Of course, you need to have a protocol for yourself/your position.

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Investor Relations 2.0

ebay_logo

eBay took a bold move yesterday, using Web 2.0 tools for investor relations. During its first analysts’ meeting in three years, eBay management had a live twitter stream with live coverage of the meeting and bloggers with just less than live coverage of the meeting.

The securities industry seems to be struggling with Web 2.0 tools. (In fairness, most industries are struggling to with Web 2.0 tools.) Blame uncertainty about these relatively new tools. Blame securities class action law suits. Blame the SEC for a lack of guidance. It looks like eBay was tired of excuses and decided to jump into the world of Investor Relations 2.0.

An article from Dominic Jones of the IR Web Report caught my eye: SEC Disclaimers in the Age of Twitter. Was eBay really going to use Twitter as part of its investor relations? YES.

Apparently Richard Brewer had already been live-tweeting eBay’s quarterly earnings conference calls. Management knew he been using his eBay Ink Blog to report the quarterly earnings results, but were unaware of his use of Twitter. He was called in to meet with the lawyers. But rather than shut him down, they worked out some best practices.  They came up with New Social Media Guidelines for Reporting Company Information.

“Plain and simple, eBay Inc. is a public company and, as such, must comply with SEC regulations. We feel that these guidelines will make that compliance more transparent. What follows is by no means a final set of micro-blogging/live-blogging best practices for companies but it is a step – and a very significant one at that. Something that I realize I will have to refine and evolve over time.”

That seems very sensible. The SEC’s Guidance on the use of company web sites (SEC Release 34-58288) does not give the clearest guidance but certainly opens the way for public companies to use 2.0 tools as part of their investor relations.

Richard kicked off his live Twitter coverage of the meeting with the new disclaimer crafted just for Twitter:

ebay twitter disclaimers

Which included a link to the a longer legal disclaimer. Its more than 140 characters, but still very concise.

An interesting thing about Twitter is the ability to tag the updates, allowing others to follow on that same topic. Richard used #ebayinc. This allowed you to follow not just Richard’s updates, but all of the reactions to Richard’s updates.

Richard also compiled the twitter updates into a traditional blog post: eBay Inc. Portfolio Roadmap Preview by John Donahue. (Did I just call a blog post traditional?)

With all of that live information and feedback, eBay’s regular investor relations page looks very cold and lifeless. It does not seem to have as much information. Perhaps it is even less relevant?

In the end, Web 2.0 tools are just communication tools. They are not that different than traditional read-only web pages or email. They do allow for easier, faster and more robust communications. You can see the difference in the comparison between the traditional eBay Investor Relations website and the eBay Ink 2.0 website.

How is your company using web 2.0 tools for investor relations?

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Connecticut Hedge Fund Regulation

connecticut

The folks over at the Hedge Fund Compliance Blog point out that the Connecticut legislature has three bills pending that would regulate the hedge fund industry in that state. It seems strange that a state with such a big hedge fund industry would make their businesses more difficult. But these are strange economic times. It is too early tell if any of these will be passed and how they may be changed in legislative process. But it is worth keeping an eye on them.

Disclosure of Financial Information to Prospective Investors

Hedge funds domiciled in the state and with Connecticut-based pension fund investors need to disclose to prospective pension investors certain financial information, including detailed portfolio information. The act does not bother trying to define a hedge fund. [Raised Bill No. 6480]

An Act Concerning Hedge Funds

This one has a few things going on:

    • Connecticut-based hedge funds would have to meet higher accreditation standards for their investors. To qualify, the investor would have to have not less than $2,500,000 in investment assets and institutional investors would have to have not less than $5,000,000 in assets.
    • hedge fund managers would have to disclose to investors any conflicts before making an investment.
    • Hedge fund managers would have to disclose to investors any changes in investment strategy and the departure of key employees.
    • Hedge fund managers would have to disclose to investors any major litigation or investigation of the fund.

This act does not define hedge funds and leaves it up to the Connecticut Banking Commissioner to figure that out. [Raised Bill No. 953]

Licensing of Hedge Funds and Private Capital Funds

All Connecticut- based hedge funds would need to be licensed by the state. This act does not define hedge funds and leaves it up to the Connecticut Banking Commissioner to figure that out.[Raised Bill No. 6477]

The Subprime Boomerang: After the Writedowns Comes the Litigation

boomerang

Securities Docket put on a great webinar on The Subprime Boomerang: After the Writedowns Comes the Litigation.

Bruce Carton moderated a panel of Veronica Rendon of Arnold & Porter, Richard Swanson of Arnold & Porter and Jeff Nielsen of Navigant Consulting, Inc.

Jeff started off my showing how much complicated the picture is for securitized lending compared to traditional lend hold lenders. There is now a dozen + parties involved with very different interests. There are lawsuits between many of these relationships with fingers being pointed in many different directions.  There are also lawsuits within the parties as shareholders are bringing securities class action suits against the investors. Some of the parties changed roles through the the lifecycle of the loan. (Such as the originator becoming an investor.) Here is a snapshot of the parties:

securitization

Jeff identified 866 subprime related federal filings, including borrower class actions, securities class actions, contract claims, employee class actions and bankruptcy related claims. Of those 576 are in 2008. California has 17% of the suits and New York has 33%. (California has some tough laws that are the basis of borrower lawsuits.) They are also seeing two new cases for every case that is resolved.

Veronica pointed out that the securitization market grew from $157 billion in 200 to $1200 billion in 2006. That was staggering growth over a very short period of time.

Now we are in a period of rising interest rates, declining home prices, rising unemployment and forced sales.

Unfortunately 50% of adjustable rate mortgage originations over past four years have been subprime. There was some bad underwriting with lots of no-doc loans and high debt-to-income ratios.

The current bulk of suits are now “stock drop” case because the institutions failed to disclose their exposure to subprime risk.

Richard focused on some interesting aspects of the pleadings, hearings and decisions coming out of the cases.

There are increasing suits by purchasers of subprime assets. Lots of the focus on misrepresentations in the offering documents and a failure to disclose risks. These are generally very sophisticated parties doing war including state law claims.

There are also criminal investigations on the horizon. Both the FBI and SEC are looking at possibly bringing charges.

You can listen to webcast and see the slides on the  Securities Docket Webcasts page.

SEC’s Notice and Access Rules: What Do They Mean For Your Company?

noticeandaccessComputershare has put together a White Paper that they distributed through Compliance Week: An Explanation of the SEC Notice and Access Rules: What Do They Mean for Your Company? (.pdf)[For Compliance Week Subscribers]

Pamela Eng, Product Manager for Computershare Investor Services takes us through The SEC’s Shareholder Choice Regarding Proxy Materials rules in Release No. 34-56135 (.pdf) issued July 26, 2007.

[I mentioned some of my confusion about the Notice and Access Rules in SEC Requirements for Online Annual Reports and Proxy Statements. (Thankfully, the rule is not in my domain.)]

Pamela points out that there are now three ways to provide annual meeting materials to shareholders:

  • Notice Only. You can send just a notice with a link to materials on the website.
  • Full-Set. When you send the full set of printed materials.
  • Mixed Set.  When you send some and leave the rest online.

The idea behind the “notice only” delivery was to save printing and delivery costs. Theoretically, the information is more useful online because it searchable and linkable.

It seems even Pamela is not completely happy with the rule. She offers six recommendations to the SEC on how the rule could be improved.

  • Allow more flexible timing for posting online documents
    We requested that the SEC allow the online documents to be made available one or two days
    after the initial mailing has been sent, rather than on the mailing date. This would give extra
    time for companies to get their documents approved and programmed for the website.
  • Allow more time to fulfill holder requests
    The rule gives only three days to fulfill requests for registered holders, yet gives nine days
    to fulfill the requests of beneficial holders. Our recommendation was to allow six days for
    fulfillment on both sides.
  • Change the 40-calendar-day timeline
    A number of companies had problems meeting the 40-day deadline for notice-only mailings,
    which led us to request that the deadline be moved to 30 calendar days before the meeting.
    Shareholders will still have plenty of time to request materials before the meeting date.
  • Allow educational information to be included with the notice-only mailing
    Because of shareholder complaints about confusion and issuer concerns about holder
    education, we advocated the inclusion of educational information with the notice. This
    information could explain the regulations and why holders are receiving a notice.
  • Allow the voting telephone number to appear on the notice
    The SEC was concerned about possible uninformed or capricious voting by registered holders,
    who would vote without first viewing the proxy materials, so it did not allow the voting
    telephone number to appear on the notice. We believe that holders understand the issues, and
    that allowing the number to be placed on the notice will help holders better understand the
    overall process.
  • Issue an FAQ, Q&A or other written clarification of the rules
    The new notice and access rules are potentially confusing to both issuers and shareholders, and
    confusion may increase as many more companies begin the process in 2009. We asked that the
    SEC issue some written clarifications, possibly including a frequently asked questions document
    (FA Q); a question and answer bank; or, in some cases, a rewrite of the rules themselves.

Online Social Networking: Is It a Productivity Bust or Boon?

lawpracticemagazine

I recently had an article on Faceblocking published in the March 2009 issue of Law Practice magazine: Online Social Networking: Is It a Productivity Bust or Boon for Law Firms?

Steve Matthews and I conducted an informal poll to see if we could confirm that law firms were blocking access to social networking sites. Our theory was proven in the results. (You can download the raw survey data (.xls) if you want to see the underlying data.)

Of those responding to the survey, 45% said their firms blocked access to social networking sites. The three most blocked sites: Facebook, MySpace and YouTube. Those are also 3 of the top 10 most visited sites on the web. We also published some of written comments from the survey respondents: Speaking Out on Social Networking.

The survey is very unscientific. Steve and I thought that it would be useful to get some data about what law firms are doing about access to social networking sites. I was surprised that 45% of firms blocked access to some social networking sites. Perhaps those working at firms subject to blocking were more likely to respond to the survey. I was also surprised that the 45% blocking percentage was fairly consistent across firm size. So small law firms were just as likely to block access as big firms.

I conducted two surveys of the summer associates at my old law firm, the vast majority went to Facebook at least once a day. It seems to me that if you are recruiting young workers, you should not cut off one of the ways they communicate. Deacons published a survey indicating that an employer’s policy regarding on-line social networking would influence a significant percentage of workers’ decision to join one employer over another.

Although I am an advocate of open access, I do so with the caveat that you need to let the people in your organization know what is proper use and to monitor their compliance. I fear that many firms use blockage as their policy. That may have worked 10 years ago, but not today. You can just as easily access these sites from iPhone or blackberry as you can from a firm computer. Blocking does not stop the bad behavior that it is trying to prevent. Blocking merely changes the access method.

There is a fair amount of research, the most prominent of which are two reports from McKinsey, showing that access to social networks at work, coupled with a good policy results in a more engaged, more motivated and potentially more innovative workplace. You should set sensible policies and set reasonable expectations for your employees. Social networking sites at their core are communications platform. You should be able to adapt your policies on email, confidentiality, marketing and similar policies to easily include social networking sites. If not, those other policies probably need updating anyhow.

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FINRA Announces Creation of “Office of the Whistleblower”

finra_logoFINRA announced that they have created a new Office of the Whisteblower to expedite review of high-risk tips.  FINRA Senior Vice President Cameron Funkhouser will oversee this new office. What’s not clear to me is how this new initiative differs from the existing File a Regulatory Tip procedure.  According to the press release, this new initiative “will not replace the exist process for handling the thousands of tips and complaints that come through the existing hotlines.”

FINRA states that they receive between 4,500 and 6,000 formal investor complaints annually, which are vetted by FINRA’s Front End Cause Unit. (I find it interesting that the Front End Cause Unit is missing from the FINRA website.) I am not sure if these numbers include regulatory tips.

I am disappointed that the FINRA whistleblower lines vary widely in the information collected and the method of filing:

So what if I am an investor and I think my broker is violating a regulation and committing serious fraud. Do I fill out all three? Is there going be a turf war inside FINRA over who is handling which types of complaints?

It is a great move by FINRA to focus on the whistleblowing and complaint process. Unfortunately, it looks like they made it more complicated instead of easier.

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