Speech by SEC Commissioner:
Remarks at the Federalist Society Lawyers' Chapter of Dallas, Texas
by
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
Dallas, Texas
January 18, 2008
Thank you, Dan [Morenoff], for that kind introduction. It is an honor and privilege to be here today with you and the Dallas Lawyers' Chapter of the Federalist Society. Before I get started, I need to satisfy my own compliance people and tell you that the comments that I am about to make are my own and do not necessarily reflect official SEC policy or the opinions of my fellow Commissioners.
I very much appreciate your invitation to visit the Dallas Chapter of the Federalist Society and speak about the increasing pressure that is being brought to bear on the centuries-old attorney-client privilege by agencies of the Federal government.
But before we leap right into the attorney-client privilege controversy, we should first celebrate something that the Government got right. Shareholders had quite a victory this past Tuesday when the Supreme Court handed down Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc.,1 which decided the extent of primary liability in securities litigation under the Securities Exchange Act of 1934. The Supreme Court ruled five to three that plaintiffs cannot bring private lawsuits against third parties in corporate-fraud cases unless they relied on actions by those parties when making investment decisions. The majority opinion noted that the private right of action under section 10(b) is created by the courts, not by statute. The Court stated, "Though it remains the law, the section 10(b) private right should not be extended beyond its present boundaries." Well, certainly no emanations from penumbra there!
As you may have read in some press reports, there had been some disagreement within the SEC as to the appropriate position to take before the Supreme Court in Stoneridge. The SEC split on a three-to-two vote (I was one of the dissenters) in favor of the theory of "scheme liability," where a person can be deemed to be primarily liable for the issuer's fraud even if he was not the one who deceived investors. I voted against this expansive notion of primary liability, which was also opposed by the rest of the Administration (including the Federal Reserve) and later rejected by the Solicitor General and now the Supreme Court. The Supreme Court ruled that a private right of action does not reach these tangentially related companies because investors did not rely upon their statements or representations. The Court warned that if it adopted the plaintiffs' concept of reliance, the "cause of action would reach the whole marketplace in which the issuing company does business." In other words, had Stoneridge gone the other way, plaintiffs would have been able to reach into the deep pockets of customers, vendors and other firms that simply do business with issuers.
In his dissent in the Stoneridge case, Justice Stevens raised a point of law that he traced back to the Magna Carta.2 Although I take issue with the way Justice Stevens applied the principle of "a remedy for every wrong," the fact that judge-made law in the United States still refers back to a 13th century English document written in Latin is significant. It demonstrates a centuries-long continuity of the legal community working to solve difficult questions in the law as new circumstances arise, and that solutions worked out in one time and place can resonate in other times and places.
A legal right that dates back at least several centuries, and one that is more immediately relevant to your work, is the attorney-client privilege. When it first appears in surviving records, it was unquestioned. The Supreme Court in its landmark case of Upjohn Co. v. United States,3 cited Wigmore's treatise4 as stating the attorney-client privilege is the oldest of the privileges for confidential communications known in the common law. (An early chancery case, Berd v. Lovelace5 (1577), predated the founding of Jamestown by thirty years.) Wigmore stated that "In order to promote freedom of consultation of legal advisers by clients, the apprehension of compelled disclosure by the legal advisers must be removed; hence the law must prohibit such disclosure except on the client's consent."6 The Upjohn court also cited Fisher v. United States in recognizing the purpose of the attorney-client privilege is "to encourage clients to make full disclosure to their attorneys."7
What is astonishing is that the attorney/client privilege, one of the foundational rights on which rests Anglo-American legal culture, stretching back in time between the reigns of King John and Queen Elizabeth I, should now be under siege. The two Federal agencies that have been most vigorous in seeking waiver of the attorney-client privilege have been the Department of Justice and — unfortunately, I must say — the Securities and Exchange Commission.
Beginning in the late 1990's, the Department of Justice published four memoranda that were well-intentioned, but in effect undermined the attorney-client privilege. These memoranda attempt to illuminate the meaning of cooperation and some of the general principles that the Department of Justice follows when investigating business organizations. Each memorandum encourages Federal prosecutors to demand waiver of the attorney-client privilege and the work-product doctrine during investigations in return for some degree of leniency (called "cooperation credit").
The first memorandum was sent by Deputy Attorney General Eric Holder8 to all Department Component Heads and U.S. Attorneys in June 1999. This memo focused on the prosecution of corporate criminal activity and included a document called "Federal Prosecution of Corporations," which outlined factors and considerations to be taken into account when charging corporations. The second memorandum was sent by Deputy Attorney General Larry Thompson in January 2003 and included much of the same text from the Holder memo, with some changes to reflect findings of the Corporate Fraud Task Force. Mounting criticism regarding lack of policies and procedures in this regard led acting Deputy Attorney General Robert McCallum in 2005 to amend the U.S. Attorney's manual to require that U.S. Attorneys establish a written waiver review process for their respective districts.
The bottom line is that the Thompson and Holder memoranda stated explicitly that a corporation's willingness to waive the attorney-client and work product privileges should be considered in determining whether a corporation has cooperated adequately with the government.
Former Attorney General Edwin Meese testified before the Senate Judiciary Committee that
experience has shown that the [Thompson] Memorandum has resulted in the dilution of essential rights encompassed by the attorney-client relationship… the Thompson Memorandum itself pressures companies to fulfill its nine factors, including by waiving their attorney-client privilege and cutting off their employees' attorney fees. Even if no prosecutor ever mentions either factor to a company, the fact that the Thompson Memorandum requires federal prosecutors to take all nine of its factors into consideration when deciding whether to indict a business organization necessarily places great pressure on the company to take these two steps.9
Explicitly responding to this "concern that our [DOJ] practices may be discouraging full and candid communications between corporate employees and legal counsel," Deputy Attorney General Paul J. McNulty issued a superseding memorandum (the "McNulty memorandum") on December 12, 2006.
The McNulty memorandum provides standards and procedures to guide federal prosecutors when they request disclosure of privileged information, but it does not remove from consideration a company's willingness to punish employees who assert their constitutional rights or to enter into valid joint-defense or information-sharing agreements with the employees. In addition, it bars prosecutors from urging companies not to pay their employees' legal fees in cases where payment is statutorily or contractually required. But, that bar does not apply when payment is discretionary or in those instances when prosecutors believe that "the totality of the circumstances show that it was intended to impede a criminal investigation."
The most important weakness of this current situation is that DOJ still gives entities credit for turning over work product as well as other material that may be privileged. Privileged material is divided into two categories. So-called "Category I" material includes witness statements, interview memoranda, internal reports, and the like. Companies may be considered uncooperative for not producing it. Category II material includes other highly sensitive information including attorney's opinion work product, the contemporaneous advice of counsel, lawyer mental impressions, and other legal advice.
Does categorizing these materials solve the problem? No.
A company that refuses to waive its privilege and turn over Category I material risks being labeled as "uncooperative," which may severely damage shareholder value, brand, and relationships with customers and suppliers. Being labeled as uncooperative also increases the likelihood that a company will be indicted. The opportunity to receive credit for Category II material also increases the pressure to turn privileged information over. Who at a corporation wants to be responsible for not striving to receive every bit of credit possible, regardless of the collateral consequences to the corporation in civil litigation and to other parties, such as officers, directors, and employees in both criminal and civil proceedings? Remember, accountability is usually assessed in retrospect with 20/20 hindsight.
In 2001, the SEC adopted the so-called "Seaboard Report."10 The Commission intended this report to be a guide to encourage corporations to co-operate in investigations. The Seaboard report mentions disclosures of protected confidential information among the criteria that the SEC would consider when assessing how a company's self-policing and cooperation efforts will influence whether to bring an enforcement action. Let me briefly quote from that footnote:
The Commission recognizes that these privileges, protections and exemptions serve important social interests. In this regard, the Commission does not view a company's waiver of a privilege as an end in itself, but only as a means (where necessary) to provide relevant and sometimes critical information to the Commission staff.11
I am sure that it would not come to the relief of many in this room that the SEC's primary guiding document on attorney-client privilege waiver states that obtaining a waiver is not an end in itself, but only a means to extract useful information. It is important to emphasize, however, that waiver is not itself listed as one of the Seaboard criteria for determining whether, and how much, to credit self-policing, self-reporting, remediation, and co-operation. Thus, attempts to interpret Seaboard as allowing the SEC to reward companies for waiving privilege must be resisted. Rewarding companies for co-operating by waiving privilege may sound nice, but its effect is the same as punishing them for not waiving privilege — both effectively strip the attorney-client privilege. Our Division of Enforcement has not yet put in place policies and procedures to ensure that this does not happen. Resisting efforts to characterize waiving companies as co-operative (and non-waiving companies as non- cooperative) is particularly important after the SEC's January 2006 Statement Concerning Financial Penalties.12 Pursuant to the Statement, the extent of cooperation in an investigation is also an element in determining how high civil monetary penalties against corporations could be set.
We have seen that the SEC's penalties statement already has had its challenges in implementation. Even after the penalty statement, too often our penalties seem to be justified on little more than that they "feel right." The poor shareholder! We must remember that it is the shareholders who suffer the most from the financial fraud of unethical corporate managers — their stock price gets hammered when the fraud is disclosed and it is their equity from which corporate penalties are paid. Some have defended this situation by asserting that large penalties against corporations in financial fraud cases act as deterrence. But if, as in the recent case of Nortel Communications, the company has paid $2.6 billion in settling private litigation for an egregious fraud with management collusion, who can say with a straight face that the SEC penalty of $35 million is deterrence! It is little more than a public relations gesture that the SEC gets because it can.
As the SEC and other Federal agencies press to have the attorney-client privilege waived, the entire privilege is weakened. As knowledge of its weakening spreads, corporate employees will be less candid and forthcoming, corporate internal investigations will be less trustworthy, and shareholders and government investigators will be frustrated in their efforts to prevent misdeeds.
A significant problem for many companies is that information obtained by the SEC or the Department of Justice can open them up to third-party plaintiffs seeking the same documents. For example, in the 2006 Qwest Communications International, Inc.13 case, the 10th Circuit Court of Appeals held that Qwest waived its attorney-client and work-product privileges because it disclosed privileged information to the SEC and the Department of Justice in the course of an investigation, even though it had a confidentiality agreement. The confidentiality agreement specifically stated that Qwest was not waiving the privileges, but allowed the agencies to disclose the information to other state, local, or federal agencies, as required by law, or "in furtherance of the discharge of their duties."
While the investigation proceeded, a number of private plaintiffs had sued Qwest for alleged securities violations and argued that Qwest had waived the privileges by producing the documents to the agencies. Qwest asserted that it had only "selectively" waived the privileges and that its waiver only applied to the agencies, not to other parties, such as the plaintiffs. The Tenth Circuit rejected the doctrine of "selective waiver" and upheld the trial court's order requiring Qwest to produce the information to the plaintiffs.
Quoting the D.C. Circuit, the court held that a litigant should not be permitted to "pick and choose among his opponents, waiving the privilege for some and resurrecting the claim of confidentiality to obstruct others." The court also cited Supreme Court decisions that the privileges should be expanded only with caution.
The court rejected Qwest's argument that permitting selective waiver would encourage parties to cooperate with investigating government agencies, suggesting that Qwest was really advocating a "new privilege" for information provided to investigating agencies. It held that adopting such a new privilege was for Congress, not the court, but also pointed out that both Congress and the SEC had declined to adopt selective waiver with regard to the Securities Exchange Act. Though the court did not hold that confidentiality agreements were "irrelevant," as other circuits have, it concluded that Qwest's confidentiality agreement "does not support selective waiver" because it allowed widespread disclosure at the discretion of the agencies.
Not only does the SEC and Department of Justice policy of pressing corporations to waive the common law attorney-client privilege open them to disclosure to the world, but it also can have the effect of individuals' waiving the Fifth Amendment Constitutional right against self-incrimination by pressuring the business organization to do what the SEC or the Department of Justice could not do directly.
In testimony before the United States Sentencing Commission, Kent Wicker, representing the National Association of Criminal Defense Lawyers, testified:
This compelled waiver of the attorney-client privilege forced my client to give up the protection at the heart of our criminal justice system: The privilege under the Fifth Amendment against self-incrimination. It is not enough to say he could have just given up his job and retained his Fifth Amendment rights. This is a real person, with a real family to support.14
Mr. Wicker also pointed out that, ironically, the Federal officials who may be responsible for making a private citizen choose between keeping his job or waiving his Fifth Amendment Constitutional right would never be in the same predicament. The Supreme Court's 1967 decision in Garrity v. New Jersey15 protects them. Garrity concerned police officers who were under investigation and were given a choice either to incriminate themselves or to forfeit their jobs. The Supreme Court ruled that the confessions were not voluntary but were coerced, and the Fourteenth Amendment prohibited their use in subsequent criminal prosecution.
All of this Government pressure on the attorney-client privilege has changed the perception of just how much this privilege may in fact protect individuals. According to a survey conducted at the request of the U.S. Sentencing Commission by the Association of Corporate Counsel, almost 75 percent of the respondents agreed with the statement that a "culture of waiver" has metastasized (even to agencies like HUD and EPA) in which Government agencies believe that it is reasonable and appropriate for them to expect a company under investigation to broadly waive attorney-client or work-product protections. Corporate counsel surveyed also indicated that when Government investigators state a reason for requesting privilege waiver, the Holder/Thompson policy memoranda were identified most frequently.16 In addition, a recent Fulbright and Jaworski survey of in-house counsel found that in the past year 17% of respondents had waived attorney-client privilege for employees in SEC enforcement proceedings.
It is disappointing that Federal agencies so far have not taken their own initiative to address this issue so fundamental to our legal system. Congress is taking steps to enact legislation to guard against the continued erosion of the attorney-client privilege. The House has already passed H.R. 3013, the "Attorney-Client Privilege Protection Act of 2007." It has a companion bill in the Senate, S. 186. These bills forbid Federal agents from requesting or conditioning treatment of persons or organizations based on waiver of the attorney-client privilege or attorney work product, the provision of counsel or contribution of legal fees to the accused, the entry of a joint defense, or failure to terminate the employment of an individual because of that employee's decision to exercise these legal protections or Constitutional rights.
A remarkable letter dated July 30, 2007 from former senior Department of Justice officials endorsing these bills was sent to every member of the Judiciary Committees — and some of the signatories of the letter are very familiar to Federalist Society members: Ed Meese, Dick Thornburgh, Stuart Gerson, Carol Dinkins, Walter Dellinger, Jamie Gorelick, Seth Waxman, Ken Starr, and Ted Olson. Organizations working to support passage of these bills include groups as diverse as the American Civil Liberties Union, the American Chemistry Council, Association of Corporate Counsel, Business Civil Liberties, Inc., Business Roundtable, Financial Services Roundtable, National Association of Criminal Defense Lawyers, National Association of Manufacturers and the U.S. Chamber of Commerce.17 As this legislation moves forward, it is causing the SEC to re-examine its policies and procedures with respect to "cooperation credit" and penalties.
The genius of James Madison's construction of the Constitution is no more evident than in the way power is divided against itself in the American polity. When one branch of the Federal government has over-reached its bounds, the other branches should intervene to set it aright. If the Executive Branch is unwilling to correct itself in eroding personal freedoms, it is time for the other branches to step in. Former Attorney General Edwin Meese stated in his testimony before the Senate Judiciary Committee on the attorney-client waiver, "Those who commit crimes — regardless of whether they wear white or blue collars — must be brought to justice. The government, however, has let its zeal get in the way of its judgment. It has violated the Constitution it is sworn to defend."18
It is fitting that I raise these hard truths before members of the Federalist Society, the heirs of James Madison's legacy. Robert Frost, who perhaps of all America's poets understood our Nation's character best, discerned that "the best dreamer" of America's dream was James Madison, and that those who share Madison's dream participate in a centuries-long mission.
Thank you for your attention.
Endnotes
http://www.sec.gov/news/speech/2008/spch011808psa.htm
