The Attorney Client Privilege Protection Act passed the House of Representatives yesterday. The Act is backed by a broad coalition of business and legal groups. It is designed to end what has become known as the “culture of waiver,” a term used to describe the fact that many corporations and their advisors believe that fundamental rights must be waived as part of any effort to cooperate with the Department of Justice and the Securities and Exchange Commission to avoid prosecution.

The Act is intended, as its preamble notes, to “[p]lace on each agency clear and practical limits designed to preserve the attorney-client privilege and work product protections available to an organization and preserve the constitutional rights and other legal protections available to employees of such an organization.” Accordingly, the legislation would preclude any agency or attorney representing the U.S. from:

1. requesting the disclosure of privileged material; or

2. considering in a charging decision:
a. valid assertions of privilege;
b. indemnification agreements;
c. common interest agreements; or
d. the failure to terminate employees because of an exercise of constitutional rights.

The same bill has also been introduced in the Senate.

The bills were introduced following congressional hearings at which witness after witness testified to the pressure on organizations to waive fundamental rights such as the attorney client privilege and work product protections, as well as employee rights to indemnification and counsel and others in an effort to obtain cooperation credit from DOJ and the SEC and avoid prosecution.

Both DOJ and the SEC have repeatedly denied that rights must be waived in the name of cooperation. Portions of the DOJ cooperation policies in the Thompson memo, however, have been held to violate the Fifth Amendment right to a fair trial and the Sixth Amendment right to counsel in Stein v. U.S., 485 F.2d 330 (S.D.N.Y. 2006). Although those policies have been recast in the McNulty memo, which places limits on the circumstances under which prosecutors can request a waiver, critics contend that DOJ still pressures organizations to surrender rights in the name of cooperation. This fact was confirmed in a letter from E. Norman Veasey, former Chief Justice of the Delaware Supreme Court, to Senators Leahy and Spector, dated September 13, 2007. The letter (available here), was written in connection with the pending legislation, and chronicles instance after instance of prosecutors disregarding the restrictions of the McNulty memo and demanding waivers.

Although the SEC has repeatedly stated that organizations can receive cooperation credit without waiving privilege, the agency has made it clear that to have an opportunity to avoid prosecution, waiver is essential. The example in the Seaboard Release, which contains the SEC’s organizational prosecution and cooperation standards, suggests as much. The example is of a company which is not prosecuted because it cooperated and waived privilege, giving the staff evidence it could not otherwise obtain – that is, privileged material. This point was recently reiterated by Linda Thomsen, Director of the SEC’s Division of Enforcement in a speech which cited two examples of cooperation. In one example the company cooperated, did not waive privilege and was prosecuted. In the second the company cooperated, waived privilege and was not prosecuted. Remarks Before the Mutual Fund Directors Forum 7th Annual Policy Conference, available http://www.sec.gov/news/speech/2007/spch041207lct.htm.

While passage of the Attorney Client Protection Act may bar prosecutors and agency enforcement attorneys from requesting waivers or specifically considering certain factors in the charging process, it is doubtful that it will end the culture of waiver. As presently written, the statute would permit issuers to waive privileges and receive cooperation credit. Issuers facing the pressure of a charging position and reaching for any avenue that may score an additional cooperation point, will surely continue to waive any and all rights under these circumstances.

In addition, the legislation does not address one of the key issues in the battle over waivers: witness statements. Both the DOJ in Thompson and McNulty memos and the SEC in the Seaboard Release, encourage issuers to conduct internal investigations when an impropriety is discovered and immediately self-report. In many instances, employees and former employees may wish to cooperate with the investigation of the company, but not that of the government. This is particularly true if there are parallel civil and criminal investigations.

As part of the price of cooperation, DOJ and the SEC typically want the organization to produce the privileged lawyer notes of the witness interviews from the internal investigation. This key cooperation credit bargaining chip gives the DOJ and the SEC witness testimony which is otherwise constitutionally beyond their reach. At the same time, this byproduct of pressurized waivers undermines the constitutional protections of the employee and places that person at risk of criminal false statement and obstruction charges if the government decides the testimony is false, even though the statements were given to private attorneys. See, e.g., U.S. v. Kumar, Case No. 1:04-Cr-00846 (E.D.N.Y. 2006) (charging employees of Computer Associates with false statements in an internal investigation; defendants pled guilty); U.S. V. Singleton, Case No. H-04-314-SS (S.D. Tex. 2006) (Rule 29 motion for acquittal granted re charge of false statement from internal investigation).

The legislation is entitled The Attorney Client Protection Act. Before it is finally passed into law, we would do well to ask if in fact it really protects the fundamental organizational and individual rights which are at stake in the charging and cooperation process.

Some of the most noteworthy insider trading cases brought by the SEC this year are based on allegations of trading on information about mergers prior to the public announcement. TXU, New Corp/Dow Jones and Petco garnered headlines as the SEC brought insider trading cases alleging illegal trading prior to the announcement of the deal. In each instance, the SEC brought its case within days of the transaction announcement. In each case, the SEC obtained a freeze order over millions of dollars of assets from the claimed illegal trades. In two of the cases, the identity of the traders was unknown at the time the SEC brought its complaint.

These cases may also present the SEC with some of its greatest challenges. Insider trading cases are notoriously difficult to prove. Frequently, they are based on circumstantial evidence keyed to the trading pattern. In these cases, the SEC did not have the opportunity to conduct its usual investigation, marshalling its extensive investigative powers to gather and examine each bit of evidence before deciding to file a court action. Rather, examination of these complaints suggests that the Commission filed these cases with little more than the basic information that could be obtained from the brokerage where the now frozen accounts are maintained: the trading records and, perhaps, evidence of money transfers from other accounts. Whether the SEC can develop sufficient evidence in discovery to prove these cases at trial remains to be seen.

The first of these cases was brought on March 2, 2007, just four days after the February 26 announcement that a KKR-led group would acquire TXU. SEC v. One or More Unknown Option Purchasers, Civil Action No. 1:07-cv-01208 (N.D. Ill. March 2, 2007). The SEC’s complaint alleged that unknown traders purchased 8,020 call options for TXU from February 21 to February 23. The purchases were made through Credit Suisse, Zurich and Firmat Banque Frankfurt. After the announcement, the options were valued at $5.4 million. The SEC’s motion for a TRO to freeze the accounts, filed along with the complaint, was granted.

The SEC has amended its initial complaint twice. First, on March 28 Sunil and Seema Shgal, a married couple residing in the U.S., were added as defendants. According to the amended complaint, they purchased 700 TXU options in January and February with a value of $270,000. A second amendment was filed on May 3, adding Hafiz Naseem as a defendant. According to the amended complaint, Mr. Naseem is an investment banker at Credit Suisse, which was a financial advisor to TXU. Mr. Naseem is alleged to have furnished material non-public information to a Pakistani banker who bought 6,700 call options for a profit of $5 million. In addition, Mr. Naseem is alleged to have tipped eight others. Mr. Naseem was also charged in a parallel criminal case, U.S. v. Naseem, Case No. 1:07-mj-UA-1 (S.D.N.Y. May 3, 2007).

The second case is based on the News Corp. acquisition of Dow Jones, which was announced on May 1, 2007. Seven days after the announcement, the Commission filed SEC v. Kan King Wong, Civil Action No. 07 Civ. 3628 (S.D.N.Y. Filed May 8, 2007). According to the complaint, the defendants are a married couple residing n Hong Kong. Between April 13th and 30th, they purchased 415,000 shares through their Merrill Lynch account in Hong Kong. Those purchases were paid for, in part, with funds wired from the father’s account at JP Morgan in Brussels. On May 4, the husband ordered the sale of the stock at a profit of $8.1 million. The SEC’s Complaint alleges that the couple traded while in the possession of material, non-public information, but does not describe how or from where they obtained that information. Instead, the Commission alleges that they engaged in “highly profitable and highly suspicious purchases.” The SEC obtained a freeze order over the account at the time the complaint was filed. This case is pending.

The third case involved Petco shares. It was brought on July 18, 2007, just four days after the animal supply company announced that it would be acquired. SEC v. One or More Unknown Purchases, Case No. 06 CV 11446 DMS (S.D. Cal. Filed July 18, 2007). According to the complaint, in June and July, the defendants purchased 1,400 call options in accounts in Switzerland and England. The options were out of the money and set to expire shortly. Following the acquisition announcement, the share price rose 43%. The SEC obtained a freeze order at the time the complaint was filed.

On August 3, the SEC amended its complaint, naming Taher Suterwalls as a defendant. The amended complaint claims that the defendant purchased call options through a Swiss financial institution. It also alleged that defendant purchased derivative instruments called spread bets through U.K. brokerages. This case is also pending.

The first test of whether sufficient evidence will be developed to prove these cases will come next month in New York. On December 10, 2007, U.S. v. Naseem, the criminal case based on the TXU takeover is scheduled for trial. The SEC clearly deserves significant credit for developing and bringing these cases in such a rapid fashion. The challenge now, however, is to prove them.