Filing A Form 10-K Does Not Waive Privilege As To Drafts

In Roth v. Aon Corporation, Case No. 04 C 6835 (N.D. Ill. Ruling Jan. 8, 2009), the district court concluded that a draft of part of a Form 10-K transmitted to in-house counsel and several employees of the company during preparation remained privileged when the final Form 10-K was filed with the SEC. The opinion is important for those who prepare disclosure documents. It is also significant to the work of in-house counsel since it can be difficult to draw the line between their privileged legal work and non-privileged business dealings.

The issue arose in a securities class action based on Aon’s claimed role in, and reliance on, contingent commission kickbacks and steering arrangements with insurers. Plaintiff’s sought the production of an e-mail which solicited thoughts and comments on an attached a memorandum which contained an expanded draft version of part of the company’s Form 10-K. The memo was from the CFO to the CEO and General Counsel. The e-mail was from the CFO to the Deputy General Counsel, the Controller and an employee in the controller’s division. The Deputy General Counsel stated that he received the e-mail and memo in connection with rendering legal advice about the draft From 10-K.

In denying plaintiff’s motion to compel production, the court began by noting that it is to be expected that legal counsel would be involved with drafting a Form 10-K: “Consultation as to the scope of the provisions of the Act, as to language, and as to how best to legally comply with SEC regulations, for instance, are precisely the type of day-to-day guidance for which a corporation would likely rely on counsel. … The Court finds that the communications contained in the Bolger [CFO] e-mail did reasonably seek legal advice.”

The court then turned to the question of whether the e-mail and draft remained privileged after the final version of the Form 10-K was filed with the SEC and became public. Here, the court concluded that the filing did not waive the privilege as to the e-mail and draft. On this point the court concluded that “most courts have found that even when a final product is disclosed to the public, the underlying privilege attached to drafts of the final product remains intact.”

Finally, the court held that circulating the papers to a number of corporate officials did not waive the privilege: “To disallow corporations the space to collectively discuss sensitive information with legal counsel would be to ignore the realities of large-scale corporate operations. For this reason, there is no doubt that the inclusion of these individuals in the e-mail correspondence did not destroy the attorney-client privilege.” Circulating the e-mail and memo to a number of employees does not necessarily result in a waiver of privilege. Rather, the question is whether consulting those employees was, as here, a necessary part of rendering legal advice by in-house counsel.

The Ninth Circuit On Tellabs And Confidential Witnesses

In Zucco Partners, LLC v. Digmarc Corporations, Case No. 06-35758 (9th Cir. Jan. 12, 2009) the court ruled on two key PSLRA pleading issues for securities class actions. First, the court harmonized the Supreme Court’s teachings in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007) regarding pleading a strong inference of scienter with its prior precedents on the subject. Second, the court ruled on the requirements for using information from confidential informants to support a strong inference of scienter.

Digmarc Corporation, a provider of secure personal identification documents, and two of its officers were named as defendants in a securities fraud case. The complaint alleged that defendants purposefully manipulated the financial results of the company by capitalizing internal software development expenditures that should have been expensed. These improper practices resulted in a restatement of Digmarc’s financial statements. The district court dismissed the second amended complaint. The circuit court affirmed.

The Court began by considering the application of Tellabs in the context of its prior jurisprudence, a question that it had not previously considered. In Tellabs, the court concluded that a strong inference of scienter is pled if a reasonable person would deem the inference “cogent and at least as compelling” as any opposing inference. The Supreme Court’s test is based, the circuit court noted, on a holistic approach which requires that all of the allegations and inferences be considered. The Tellabs analysis is inherently comparative because it requires consideration of both those inferences which support a strong inference and opposing inferences.

The Supreme Court’s formulation of the PSLRA strong inference requirement is not inconsistent with the prior holdings of the circuit court, according to the opinion. Previously, the circuit court held that a securities law plaintiff must allege that the defendant made false or misleading statements “either intentionally or with deliberate recklessness.” This standard was adopted by the court in In re Silicon Graphics Inc. Securities Litigation, 183 F.3d 970 (9th Cir. 1999). To evaluate whether inferences based from allegations which met this pleading standard establish a PSLRA “strong inference” of scienter, the circuit court used what it called a “segmented” analysis. Under this approach each inference was individually.

The Ninth Circuit concluded that its “segmented” approach is not sufficient under Tellabs. Rather, the Supreme Court requires that the allegations be considered collectively. To harmonize its approach with Tellabs, the circuit court concluded that both its prior segmented approach and the Supreme Court’s holistic approach should be employed. Under this approach the allegations must meet the Silicon Graphics pleading standard and the strong inference of scienter will be gauged by Tellabs.

No other circuit had adopted the “deliberate recklessness” standard of Silicon Graphics. While Tellabs did not discuss the definition of scienter, the Ninth Circuit’s requirement here seems at odds with the overall approach of the Supreme Court. The Ninth Circuit did not discuss this question, however. Rather, it simply assumed that the Silicon Graphics standard should be used.

Second, the court addressed the issue of using inferences from information supplied by confidential witnesses to meet the Tellabs standard. Information from these witnesses must meet a two-prong test to support a strong inference of scienter. In the first instance, the allegations “must be described with sufficient particularity to establish their reliability and personal knowledge.” This requires not just an identification of the witnesses’ job title and employment information, but also facts pled with particularity demonstrating that the “confidential witnesses were in a position to be personally knowledgeable of the information alleged.” In addition, the statements themselves must “be indicative of scienter.”

Here, the totality of the allegations from a series of confidential witnesses failed this test largely because the statements were vague and lacking in detail. The court’s ruling on this issue is consistent with that of other courts which have considered this issue. See, e.g., Western Pa. Electrical Employees Benefits Fund v. Ceridian Corp., No. 07-2707 (8th Cir. Sept. 11, 2008), discussed here.