This Week In Securities Litigation (August 29, 2008)

This week, the Department of Justice revamped the McNulty memo on cooperation and privilege waivers in criminal prosecutions in an effort to stave off congressional action on the passage of the Attorney Client Protection Act of 2008. As Deputy Attorney General Filip announced the new memo, the Second Circuit Court of Appeals affirmed the dismissal of criminal charges against thirteen former KPMG partners based on Fifth Amendment violations stemming from an application of the McNulty memo’s predecessor, the Thompson memo.

In other cases, a tentative settlement was reached in the Juniper option backdating derivative litigation; the SEC filed a significant settled FCPA case while concluding a long running financial fraud case; the D.C. Circuit upheld the constitutionality of the PCAOB; the Ninth Circuit rejected a damage action against three clearing agencies based on their short selling policies as preempted; and three new settlements were reached in the ARS market probes. Finally, the SEC entered into a new mutual assistance agreement with Australia.

New DOJ Memo on Cooperation: The Filip memo

As promised last month (discussed here), DOJ replaced the McNulty memo regarding corporate charging and cooperation principles. Gone are Category I (work product privilege) and Category II (attorney client privileged material). Gone are the procedural and substantive limitations on waiver requests which were supposed to end the “culture of waiver” under which business organizations were stripped of privilege and frequently their employees lost their rights in the name of “voluntary cooperation” with law enforcement.

The Filip memo, authored by Deputy attorney general Mark Filip, replaces the McNulty memo. Authored under pressure from Congress, which is considering passage of the Attorney Client Privilege Protection Act of 2008, the Filip memo is supposed to strike the appropriate balance between the needs of law enforcement and the rights of business organizations and their employees.

Mr. Filip’s memo hits the key points:

• Cooperation will be measured by the production of the facts which is what prosecutors need to make a charging decision, not privilege waivers;

• Prosecutors cannot request a waiver of what use to be called Category II material, that is, attorney client communications;

• Prosecutors are instructed not to consider whether a corporation has advanced attorney fees to its employees, officers, or directors when evaluating cooperation;

• Prosecutors cannot consider whether the company and its employees entered into a joint defense agreement when evaluating cooperation; and

• No longer can prosecutors consider whether a corporation disciplined or terminated employees for purposes of evaluating cooperation.

There are however, other points in the memo. While discussing corporate internal investigations, Mr. Filip notes that although many times they are conducted by attorneys, in others they are done by non-attorneys. The latter do not present any privilege issues when the facts discovered are given to the government. And, what yields cooperation credit is producing all the facts. While prosecutors cannot consider indemnification agreements, they can inquire about them – which is all that was done in Stein (discussed here) to cause KPMG to limit or terminate them (see discussion below). While joint defense agreements cannot be considered in evaluating cooperation, the government does have a concern about sensitive information being disclosed concerning its investigation. And, while the retention or termination of employees cannot be considered in evaluating cooperation, that fact can be used in evaluating remediation.

Mr. Filip’s memo has all the right sound bites, which he detailed in a speech yesterday. But under the Filip memo, organizations seeking cooperation credit must still make sure that all material from their internal investigation is produced either by waiving privilege or avoiding privilege by not having lawyers conduct the inquiry. At the same time the organization will still face questions about the advancement of fees, other concerns regarding cooperation agreements and questions about the retention of employees. So what has changed?

Stein is affirmed

The Second Circuit Court of Appeals affirmed the decision of Judge Kaplan dismissing the indictments brought against thirteen former KPMG partners. The district court dismissed the indictments after concluding that the government had deprived the defendants of their Sixth Amendment rights to counsel by causing KPMG to place conditions on the advancement of legal fees, to cap those fees and to ultimately terminate them. The court did not find it necessary to reach the Sixth Amendment violations found by the district court. In a separate order the court also dismissed as moot the government’s appeal from the order suppressing proffered statements made by two former KPMG partners. U.S. v. Stein, No. 07-3042-cr (2nd Cir. August 28, 2008).

Juniper derivative suit settlement

A settlement was reached in the derivative suit brought by shareholder of Juniper Networks, Inc. in their stock option backdating litigation. Under the terms of the settlement, the company will recover $22.7 million as a result of stock re-pricing by some if its senior officers and directors. Under the terms of the settlement, three individual defendants have re-priced more than one million in-the-money options to their correct and higher exercise prices. A fourth defendant has been precluded from exercising more than 430,000 properly priced and vested in-the-money options that expired unexercised because the board of directors declined to extend the option exercise period.

According to plaintiffs, the company will receive a benefit of $22.7 million representing recovery of about 45% of the damages to the company as a result of all exercised options with incorrect measurement dates. The company will also adopt several significant corporate governance reforms. Finally, the company will receive an assignment of claims against several others. In re Juniper Derivative Actions, 5:06-cv-03396 (N.D. Cal.).

A Settled FCPA Case

The settled FCPA actions filed this week by the SEC should serve as a clear warning to issuers regarding the necessity for FCPA compliance programs and for strong controls not just at the company but with regard to transactions with business partners and agents (discussed here). SEC v. Con-way, Inc., Civil Action No. 1:08-CV-01478 (D.D.C. August 27, 2008); In the Matter of Con-Way Inc., Adm. Proc. File No. 3-13148.

The complaint and Order for Proceedings keyed on alleged FCPA violations by Con-way and its subsidiary stemming from payments made by Philippine-based Emery Transnational to Philippine customs officials and to officials of numerous majority foreign state-owned airlines to obtain and retain business. Con-way and its subsidiary received a yearly 55% dividend from Emery and required that Emery report its net profits. The action was settled with a cease and desist order and the payment of a $300,000 civil penalty.

Short selling

In Whistler Investments, Inc. v. The Depository Trust and Clearing Corporation, Case No. 06-16088 (9th Cir. Aug. 22, 2008), the court rejected damage claims against three clearing agencies based on their policies related to short sales. The suit claimed that Whistler’s stock had been artificially depressed as a result of those policies. The court rejected the claims as preempted as discussed here.


The D.C. Circuit upheld a grant of summary judgment in favor of the Public Company Accounting Oversight Board, created under the Sarbanes Oxley Act (discussed here). The district court granted summary judgment in favor of the Board, rejecting a constitutional challenge to the board based on the constitutional appointment power of the president and separation of powers discussed here. Free Enterprise Fund and Beckstead and Watts, LLP v. Public Company Accounting Oversight Board, No. 07-527 (D.C. Cir. Aug. 22, 2008).

ARS settlements

The multi-state ARS Task Force and New York Attorney General Andrew Cuomo announced three new settlements in the auction rate securities market probes this week. The agreements are with Merrill Lynch, Goldman Sachs and Deutsche Bank. The terms of the three settlements, discussed here, are similar to those of earlier settlements. Essentially, they focus on the repayment of retail investors in the near term while creating liquidity over the longer term for institutional investors and the payment of civil penalties to the states. The SEC also announced a tentative settlement with Merrill.

Financial fraud

The SEC concluded its long running financial fraud action involving the Fleming Companies with settlements against three former company executives this week. SEC v. Shapiro, Civil Action No. 4:05-CV-0364 (E.D. Tex. Filed Sept. 15, 2005); See also Release No. 18884 (Sept. 14, 2004) (listing other actions). The initial complaint claimed that the company, its executives and certain vendors engaged in a scheme which improperly accounted for a number of transactions to sustain an illusion of growth and meet Wall Street expectations as discussed here. The three settling executives consented to the entry of permanent injunctions and the payment of civil penalties.

Mutual assistance agreement

The SEC announced another mutual recognition agreement this week. The agreement is with the Australian Minister for Superannuation and Corporate Law and the Australian Securities and Investments Commission. A key facet of the arrangement is an Enhanced Enforcement Memorandum of Understanding and a new Supervisory MOU to aid enforcement as discussed here.