DETERMINING WHEN THERE IS A JOINT ATTORNEY CLIENT RELATION

The question of who is the client and thus the holder of the attorney client privilege in the corporate context can raise difficult questions. Corporations, as artificial creatures, can only speak with counsel through individual employees and agents. This can present questions about the holder of the privilege – that is, does the corporation, the individual or both have an attorney client relationship with counsel? The question can become particularly difficult when the company waives privilege and seeks the content of communications corporate counsel had with various employees. A good example is the Broadcom option backdating case where corporate counsel furnished employee statements to the government for use in the criminal trials. Those statements were initially suppressed by the district court in an opinion that was reversed by the Ninth Circuit. U.S. v. Ruehle, 583 F.3d 600 (9th Cir. 2009), discussed here.

In Ruehle, the Circuit Court did not reach the question of when an employee is a joint holder of the privilege with the company. Last week, the Circuit considered that question in U.S. v. Graf, Case No. 07-50100 (Decided July 7, 2010). There, defendant James Graf was indicted for his involvement in the fraudulent operation of Employers Mutual LLC, a purported provider of health care benefits to 20,000 plan members. In reality the, company was a fraud and plan members had no benefits over coverage.

At trial, the government sought to introduce the testimony of three attorneys who had provided legal advice to the company. Although the trustee for the company waived privilege, Mr. Graf objected claiming that he was a joint holder of any attorney client privilege with the company. The district court rejected the claim, finding that Mr. Graf did not in fact have a personal attorney client relationship with any of the attorneys and that his subjective belief to the contrary was not sufficient to sustain his claim. Accordingly, the testimony of the attorneys was admitted as part of the government’s case in chief. Mr. Graff was convicted on all counts.

The Ninth Circuit affirmed the ruling of the district court on the privilege issue. In considering the question the Court adopted the test used by the Third Circuit in In re Bevill, Bresler & Schulman Asset Mgt. Corp., 805 F.2d 120 (3rd. Cir. 1986). In that case, the court held that any privilege as to a corporate officer’s role within the company belongs to the corporation.

To evaluate whether an individual officer has a personal privilege with corporate counsel, the Bevill court employed a five factor test: (1) the person must demonstrate that he or she approached counsel to seek legal advice; (2) the individual must demonstrate that it was made clear to counsel that they were seeking legal advice in their individual capacity; (3) they must demonstrate that the attorney communicated with them in their individual capacity, recognizing that a conflict might arise; (4) the conversations with the attorney must be confidential; and (5) the substance of the conversations with counsel must not have concerned matters within the company or the general affairs of the corporation. This test has been adopted by the First, Second and Tenth Circuits and cited with approval by the Sixth Circuit.

In this case it is clear that Mr. Graf did not have a personal attorney client relationship with any of the three attorneys who testified for the government. In each instance, the retainer letter of counsel was addressed to the company and the bills were paid by the business organization. Likewise, in each instance, the discussions in which Mr. Graf was involved with counsel concerned the company, not him. While one of the attorneys did personally represent Mr. Graf before the transactions in this case and later, any conversations involving those representations were not involved here. Rather, in each conversation involved in this case concerned only the company. Accordingly, under the Bevill test, it is clear that Mr. Graf did not have an attorney client privilege with any of the three attorneys regarding the matters testified to during his trial.

THIS WEEK IN SECURITIES LITIGATION (July 9, 2010)

This week in securities litigation fraudulent trading and insider trading cases were a focus of SEC Enforcement. Both DOJ and the SEC continued to bring FCPA cases and the CFTC filed a Ponzi case. The Second Circuit Court of Appeals reversed securities fraud convictions because the court failed to properly instruct the jury on conscious avoidance.

SEC enforcement actions

Fraudulent trading: In the Matter of Ephraim Fields, Adm. Proc. File No. 3-13962 (July 8, 2010). This is a settled administrative proceeding against Ephraim Fields, the owner and manager of registered investment adviser Clarus Capital Management and the general partner of Clarus Capital, LLC, a hedge fund. Here, Hawk Corporation, a Cleveland, Ohio based supplier of products used in industrial, agricultural, performance and aerospace, sought to avoid compliance with SOX Section 404. That Section requires the company to evaluate and report on the design and effectiveness of its internal controls. Extensions to comply with Section 404 were issued for, among others, companies with worldwide market values of less than $75 million. For Hawk, the closing price of its shares on June 30, 2006 would determine if it had to comply.

On June 30, 2006, a company executive called Mr. Fields. Based on the call, he concluded that the company wanted to make sure its share value fell below the required dollar level. Accordingly, Mr. Fields had Clarus sell a total of 40,000 shares of Hawk stock in eight limit day orders the day of the call. Since the average daily trading volume is just over 11,000 shares per day, the trades were unusual. The trades were also priced to cap the share price at a level which ensured that Hawk would not have to comply with SOX Section 404. The Order alleges these trades violated the antifraud provisions of the federal securities laws. To resolve the case, Mr. Fields consented to the entry of a cease and desist order and a censure. He also agreed to pay a penalty of $50,000.

Insider trading: SEC v. Binette, Case No. 3:09 cv 30107 (D. Mass. Filed July 15, 2009) is an insider trading action against Carl Binette and Peter Talbot. According to the complaint, discussed here, Peter Talbot concluded from analyzing a number of pieces of non-public information he learned through his employment at The Hartford Financial Services Group, Inc. that the company was evaluating the potential acquisition of Safeco Corp. Mr. Talbot tipped his nephew, Carl Binette, who purchased out of the money Safeco options in April 2008. Later that month, Liberty Mutual Insurance Company announced it was acquiring Safeco. Mr. Binette sold the options for a profit of $615,833.06. Mr. Binette agreed to resolve the action by consenting to the entry of a permanent injunction prohibiting future violation of Exchange Act Section 10(b). The judgment provides that Mr. Binette will pay disgorgement and a penalty determined by the court on motion of the Commission.

Fraudulent trading: SEC v. Abdullah, Civil Action No. 10-4957 (S.D.N.Y. Filed July 6, 2010) is an action against Aamer Abdullah, the former head of ICP Asset Management LLC’s mortgage backed securities desk. This case is related to the action against ICP Asset Management, discussed here. The complaint here alleges that defendant Abdullah engaged in a series of transactions that defrauded ICP’s advisory clients. In some instances, trades were undertaken which favored one client over another. In other instances Mr. Abdullah and ICP President Thomas Priore are alleged to have executed cross trades among various CDOs, trading bonds at prices that vastly exceeded their market prices and which inflated the clients’ overall assets. The complaint alleges violations of the antifraud provisions and aiding and abetting. Mr. Abdullah consented to the entry of an injunction prohibiting violations of the antifraud provisions to resolve the action. Issues regarding any disgorgement and a penalty will be resolved by the court.

Offering fraud: SEC v. Wright, Civil Action No. 2:10-cv-00602 (D. Utah Filed July 2, 2010) is an action alleging violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a) against Travis Wright. The complaint alleges that Mr. Wright made false and misleading representations when raising about $145 million from 175 investors. The investors were sold promissory notes issued by Waterford Loan Fund, LLC. Those representations included claims that investor funds would only be used to make loans secured by commercial real estate, that the notes were secured by a deed of trust and that the company would never lend more than 50% of the value of the real estate in question. Waterford is in Chapter 11 and being liquidated. The Commission’s case is in litigation. See also Litig. Rel. 21586 (July 2, 2010).

Insider trading: SEC v. Santarias, Civil Action No. 09-CV-10100 (S.D.N.Y. Filed July 2, 2010) is a settled insider trading case against former Ropes & Gray attorney Brian Santarias. Mr. Santarias is alleged to have misappropriated material non-public information about two corporate acquisitions from his law firm. Mr. Santarias, along with Arthur Cutillo, is alleged to have tipped Zvi Goffer, a trader at Schottenfeld Group, LLC in exchange for kickbacks. To resolve the case Mr. Santarias consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreed to pay disgorgement of $32,500 and a penalty in the same amount. The disgorgement will be credited against any forfeiture order entered in the criminal case. Mr. Santarias has also agreed to be barred from practicing before the Commission as an attorney in a related administrative proceeding. In the Matter of Brian Santarlas, Esq., Adm. Proc. File No. 3-13958 (Filed July 7, 2010); See also Litig. Rel. 21587 (July 7, 2010). The action against Mr. Cutillo is discussed here while the case against Schottenfeld Group is discussed here.

FCPA

U.S. v. Snamprogetti Netherlands B.V., Case No. H-10-460 (S.D. Tex. Filed July 7, 2010 is an FCPA action against the Dutch subsidiary of Snamprogetti S.p.A., an Italian company. The information, which contains one count of conspiracy and one count of aiding and abetting violations of the FCPA, is based a scheme which involved Kellogg Brown & Root and Technip S.A. According to the court documents in each of these cases, the defendants entered into a joint venture to secure contracts from Nigeria LNG Ltd. to build LNG facilities on Bonny Island, as discussed here. Bribes to Nigerian government officials were paid through two agents. To resolve this case, the company entered into a deferred prosecution agreement and agreed to pay a criminal fine of $240 million. In the parallel action brought by the Commission, SEC v. ENI, S.p.A., Case No 4:10-cv-02414 (S.D. Tex. Filed July 7, 2010), the parent and subsidiary agreed to settle by consenting to the entry of permanent injunctions prohibiting future violations of the anti-bribery, books, records and internal control provisions of the FCPA. In addition, the defendants agreed to pay a penalty of $125 million in addition to the one paid in the criminal case. See also Litig. Rel. 21588 (July 7, 2010).

U.S. v. Carson, Case No. 8:09-cr-00077 (C.D. CA. Filed April 8, 2009) is an FCPA case which names six former executives of Control Components as defendants, discussed here. One executive, Italian citizen Flavio Ricotti, the former vice president and head of sales for Europe, Africa and the Middle East of the company, was extradited from Germany to stand trial. Mr. Ricotti is charged with one count of conspiracy to violate the FCA and the Travel Act, one count of violating the FCPA and three counts of violating the Travel Act. He is alleged to have caused company employees and agents to make corrupt payments valued at $750,000 to officers and employees of state owned companies. He is also alleged to have caused an additional $380,000 in corrupt payments to be made to officers and employees of private companies. The payments were made in connection with projects in the UAE, Kazakhstan, India and Qatar. Previously the company and two other executives pleaded guilty.

CFTC

Investment fund fraud: CFTC v. Milton, (S.D. Fla. Filed June 22, 2010) is an action initially filed under seal and later announced on July 6, 2010 against Phillip Milton, Gregory Center and William Center and their controlled entity Trade LLC. The complaint claims the defendants raised about $28 million from at least 900 investors. The funds were to invest in a commodity pool. Investors were told that the defendants were successful in trading commodity futures and that the pool had a profitable track record. Those representations were false. In addition, only a portion of the funds were placed in a pool while substantial amounts of the investor funds were misappropriated. Investors were paid principal and purported profits by using funds from new investors. The complaint alleges solicitation fraud and misappropriation of pool funds as well as a failure to register with the CFTC as commodity pool operators. An order entered at the time the complaint was filed froze the assets of the pool and directed that the books and records be preserved.

Court of Appeals

U.S. v. Kaiser, Case No. 07-2365-cr (2nd Cir. Decided July 1, 2010). The court reversed the securities fraud convictions of Mark Kaiser, a former executive of U.S. Food Services. The convictions were based on the financial fraud at the Royal Ahold subsidiary, discussed here. The scheme centered on the improper recognition of payments from vendors and the government’s claims that Mr. Kaiser deceived the auditors and tried to cover up the fraud. In reviewing the convictions, first the court rejected the defendant’s claim that the instruction on “willfulness,” a key intent element required by Exchange Act Section 32(a), was inadequate. Since the jury was told that it had to find Mr. Kaiser knew that his statements were “false and fraudulent” and were made “with intent to create a deception” the jury had to find he knew his acts were wrongful. Accordingly, the instruction was sufficient. However the instruction on “conscious avoidance” was incorrect since it lacked two key elements: “(1) that a jury may infer knowledge of the existence of a particular fact if the defendant is aware of a high probability of its existence, (2) unless the defendant actually believes that it does not exist.” Indeed, the instruction given may have permitted the jury to find conscious avoidance based on a negligence standard which is wrong. Accordingly, the conviction was reversed.