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For at least 30 years, the U.S. Securities and Exchange Commission has relied on private lawyers for some corporate misconduct investigations and for protection of the assets of firms already in hot water, but now this unusual version of outsourcing has become pervasive. If the SEC’s increased reliance on private counsel to investigate potential malfeasance were likened to the spread of a virus, it has gone from “an occasional outbreak of flu to a pandemic,” said Joseph Grundfest, a Stanford Law School professor and an SEC commissioner in the 1980s. In 2001, the SEC began offering favorable treatment to troubled companies that hire independent counsel to do internal corporate investigations and report back to the SEC. But with that has come a host of new legal challenges. Do companies that waive attorney-client privilege and turn over the results of internal investigations to the SEC also waive the privilege for third parties�such as plaintiffs’ lawyers representing shareholders? And have the outside counsel become, in effect, agents of the government so that cooperating employees need to be given Miranda warnings? Diverging opinions are emerging in state and federal courts around the country. “It is incongruent for the U.S. government to participate in withholding the reports,” said Elizabeth Cabraser. She recently convinced a California state appellate court to order the release of an internal corporate report that pharmaceutical distributor McKesson HBOC Inc. gave to the government as part of a cooperation agree- ment. California does not recognize partial waivers of privilege, the court held. Cabraser said that attempts to curry favor with regulators by doing internal reports, then being allowed to withhold the information from investors, creates a double standard. “The SEC was not empowered to get investors’ money back,” said Cabraser of San Francisco-based Lieff Cabraser Heimann & Bernstein. That requires civil actions, she said. The SEC practice of relying on outside counsel began in the 1970s while retired Judge Stanley Sporkin served as the SEC’s director of enforcement. The agency needed a way to leverage the agency’s capabilities. “We found that our budgets were so limited we couldn’t do all the mop-up work in these cases and we decided to enlist the private sector,” said Sporkin, now with New York-based Weil, Gotshal & Manges’ Washington office. “It worked out extremely well.” In its most benign form, the SEC seeks court appointment of independent distribution consultants under the Fair Funds Act to get money back into the hands of injured investors. That was the situation for Burton Wiand, a former SEC enforcement lawyer now with Fowler White Boggs Banker in Tampa, Fla. A federal judge in Florida appointed Wiand as receiver over a $73 million hedge fund that prosecutors claim had been operated like a Ponzi scheme until its owner committed suicide in May. Nearly 200 mostly wealthy investors from Los Angeles to Boston believed that Howard Waxenberg was earning 20% a year on daily trading in Standard & Poor’s 500 Index futures contracts on the Chicago Mercantile Exchange. But Waxenberg allegedly fabricated quarterly reports. Much of the investors’ money disappeared from the hedge fund. “In the last five years there has been a significant increase [in use of private counsel] and the practice has spread to state regulators,” Wiand said. He said he has represented a client in the Arizona Corporations Commission, for example. During the 1970s, the problem was American companies caught bribing overseas executives and officials to get business. Congress eventually passed the Foreign Corrupt Practices Act. Meanwhile, Sporkin said that the SEC has roughly 650 cases piling up. “We couldn’t get to them all so we came up with the concept of private lawyers to do private investigations,” he said. The Sarbanes era The latest era, the corporate corruption scandals of Enron Corp., WorldCom Inc., Adelphia Communications Corp. and others produced the Sarbanes-Oxley Act of 2002 and intensified the government’s reliance on private corporate investigation, paid for by the company in trouble. William McLucas, who spent eight years as head of the SEC enforcement division and who wrote the WorldCom investigative report released in 2003, said that a board of directors or its audit committee may retain special counsel if it sees a problem. It “basically persuades the government to stand down [its investigation] while they report,” he said. McLucas, of Wilmer Cutler Pickering Hale and Dorr’s Washington office, said that is basically what happened in the WorldCom and Enron cases. Companies suspected of improper accounting or sales tactics are increasingly under pressure to hire outside counsel and investigate, then report the results to the SEC. If the results are not reported, the government considers the company uncooperative and won’t give credit to it for the investigation if criminal charges result, according to Grundfest. Since the Sarbanes-Oxley Act, companies find themselves being told by regulators that they should pay their lawyers to do an investigation, then turn the results over to the regulators�and if they don’t, they face the risk of prosecution. The SEC requires a waiver of attorney-client privilege so that its lawyers can see the report. In some cases, a partial waiver is negotiated, allowing the firm to give the report to the government but keeping it from prying public eyes. In the current climate of distrust of corporate leaders, “the reality is companies and boards feel they don’t have an alternative” but to agree to waivers of attorney-client privilege, McLucas said. If the civil practitioners then get the information, “then you have done the work for the private bar,” he said. But when an investigation turns up material information of wrongdoing, disclosure rules would demand its release to the marketplace, according to Sporkin. Sporkin said that “If [the information] is material and relevant to the SEC it is clearly relevant to shareholders.” He added that this information has been divulged since the 1970s, and “they used to raise [privilege claims] all the time. It is just something for people to use as an excuse.” The 6th U.S. Circuit Court of Appeals hashed out and rejected the selective-waiver argument in 2002 in In re Columbia/ HCA Healthcare, 293 F.3d 289. Columbia negotiated a settlement of fraud claims by the government, paying $840 million in fines and penalties for overbilling on health care. A ‘poster child’ case One case that has become the poster child of the waiver disputes that spring from these internal investigations is the McKesson HBOC Inc. matter. McKesson Corp. of San Francisco bought more than it bargained for when it took over HBO & Co. (HBOC) in 1999, only to have the merged company accused of improperly recording $42 million in HBOC revenue�in essence cooking the books. The SEC began an investigation and the U.S. attorney launched a criminal probe. McKesson hired Skadden, Arps, Slate, Meagher & Flom of New York to defend it against shareholder suits and perform an internal review, including 37 employee interviews. Skadden lawyers told the government that the company was willing to give the report to the SEC and federal prosecutor, provided that the government kept it confidential. Then lawyers for shareholders went after the Skadden report, followed by criminal defense lawyers representing former executives of HBOC. So far, a Delaware state court embraced the selective waiver and refused to release the Skadden report, applying the work-product protection in an unpublished ruling, Saito v. McKesson HBOC Inc., 2002 Del. Ch. Lexis 139 (2002). A Georgia state court granted release and rejected the work-product claim. McKesson HBOC Inc. v. Adler, 254 Ga. App. 500 (Ga. Ct. App. 2002). In the California state appellate court, Cabraser, who represented two Merrill Lynch funds that lost $150 million when McKesson’s stock plummeted, was granted access to the report. The California courts do not recognize partial waivers of privilege. McKesson HBOC Inc. v. Superior Court,115 Cal. App. 4th 1229 (Calif. Ct. App. 1st Div. 2004). But a federal judge a few miles away in another McKesson securities class action refused to order production of the report and the case settled. In re McKesson HBOC Inc. Securities Litigation, No. C-99-20743 RMW (N.D. Calif.). Still another federal judge in a separate criminal case against a former HBOC president, Albert Bergonzi, found that McKesson waived the work-product protection by sharing the report with the government. U.S. v. Bergonzi, 216 F.R.D. 487 (N.D. Calif. 2003). Skadden attorney James E. Lyons said that the ideal solution depends on whether the company is a target of the government investigation. If it is not, the privilege protection should not be considered waived because the two sides are not adversaries. If a company is a target, whether there is a waiver should be negotiated with the government. “Ultimately, the government gets more cooperation with a carrot than a stick,” he said. The conflict may require a legislative solution,” he said. Cabraser likened the conflict to any other criminal case. “You may get a plea bargain but you can’t expect to be shielded from civil liability. Companies can’t shield from the marketplace the very information [investors] were entitled to in the first place,” she said. Cabraser also warned that partial privilege waivers should not be used as a ploy to delay normal discovery. “It was a wonderful gilded carrot the SEC began to use, but there was never a guarantee [partial waiver] was going to work,” she said. One former McKesson executive, Charles McCall, has recently asserted that the Skadden lawyers were in effect agents of the government, which gives the questioned employees the right to Miranda warnings and to assert Fifth Amendment protections. The courts have not yet resolved the issue. Meanwhile, McCall awaits trial in San Francisco.

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