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Administrative Subpoenas of Securities and Exchange Commission v. Nicita


January 16, 2008


The opinion of the court was delivered by: Hon. Anthony J. Battaglia U.S. Magistrate Judge

Order Following Evidentiary Hearing Granting Petitioner's Motion to Compel Respondents Compliance With Administrative Subpoenas and Denying Respondents' Motion to Quash [Doc. Nos. 1 and 5]

The Securities and Exchange Commission ("SEC") seeks to enforce administrative subpoenas for documents and testimony served on Michael Nicita*fn1 and Edward Leonard*fn2 (collectively hereinafter "Respondents"). This matter involves the SEC's investigation of alleged fraudulent schemes to manipulate the earnings of Advanced Marketing Services ("AMS") from at least 2000 until 2003. Mr. Nicita was AMS's Chief Executive Officer and Mr. Leonard was AMS's Chief Financial Officer during this period.

In January of 2003, AMS management learned of the potential accounting fraud and undertook an internal investigation that resulted in a report stating that the accounting fraud was immaterial. That report was included in the FORM 10-K filed with the SEC on June 30, 2003. On July 23, 2003, the FBI executed a search warrant at AMS's Headquarters. AMS subsequently decided to cooperate with SEC's investigation, waived privilege and produced over six million pages of documents to the SEC. Respondents' contend that during this production, AMS produced documents that were attorney-client privilege based upon a joint defense agreement ("JDA") that was orally entered into between Respondents and AMS in August of 2003.

Respondents' move to quash these subpoenas on the basis that the SEC was in possession of documents Respondents' argue were attorney-client privileged and that the SEC's possession of these documents has irreparably tainted the SEC's investigation and issuance of the subpoenas. Respondents' move the Court for an Order requiring the SEC to return the materials listed on Respondents' privilege log to Advanced Marketing Services ("AMS") and disqualifying all SEC attorneys' and investigators who have had access to these materials. The Respondents requested an evidentiary hearing to further explore the depth of the taint to the SEC investigation and an interim stay on enforcement of these subpoenas pending this Court's findings from the evidentiary hearing. Respondents also requested that the Court find that they had proven the existence and terms of the Joint Defense Agreement ("JDA"). Alternatively, the Petitioner requested that the Court require Respondents to submit sworn affidavits from each of the members of the JDA and a Board resolution confirming AMS agreed to be bound by the

An evidentiary hearing was set for January 11, 2008 for Respondents to provide the Court with evidence demonstrating: 1) the parties, terms and duration of the JDA, and 2) that AMS's Board agreed that the company should be bound by the JDA. Respondents were further ordered to revise their privilege log and produce copies of the revised privilege log and any sworn affidavits Respondents intended to rely on at the evidentiary hearing to the Court and Petitioner on or before December 28, 2007. In addition to the declarations and revised privilege log, Respondents submitted categories of documents from the privilege log for in camera review by the Court.

I. Findings From the Evidentiary Hearing

The evidentiary hearing was held on the record before Judge Battaglia on January 11, 2008. Appearing on behalf of the Petitioner was Molly White and Ronnie Lasky. Charles La Bella and Teresa Gillis appeared on behalf of Respondent Michael Nicita and Christian Humphreys appeared on behalf of Respondent Edward Leonard.

Based upon the record*fn3 and the declarations*fn4 submitted by Respondents, the Court finds:

1. A JDA was orally entered into by and between AMS and Respondents Nicita and Leonard.

2. Respondents have failed to submit any evidence to support their prior contentions*fn5 that Kevan Lyon (represented by Hahn & Adema); Laurie Lingol (represented by Morrison & Forrester); Marty Vrable (also represented by OMM); Marcy Roke (represented by Frank Vecchione); Sandra Christie (represented by Fish & Richardson); and Steve Boyle (represented by OMM) were parties to the JDA.*fn6

3. The JDA was in effect from approximately August 2003 until February 2004.

II. Discussion

With the parties and terms of the JDA determined, the Court can now review 1) Respondents' claims of privilege with regard to the various categories of documents set forth in the privilege log; 2) Respondents' allegations of taint regarding the SEC's investigation and request for return of privileged documents and Respondents' request that the Court quash the administrative subpoenas and disqualify all SEC attorneys' and investigators who have had access to the privileged documents; and 3) Petitioner's request for enforcement of the administrative subpoenas.

A. Respondents' Claims of Privilege

Respondents' privilege log categorizes the documents, separating them into categories A through E. Categories D and E are designated by the Respondents as privileged as to AMS only or as not privileged and were to be removed from the privilege log. Respondents maintain their claims of privilege as to categories A, B, B1, and C. The Court will also consider the documents designated in the "*" (asterisk) category, which are documents that the SEC has agreed to delete from its database.

Upon review of the documents in categories A, B and *, the Court finds these categories of documents to be privileged communications as to the Respondents, because these communications were either communications solely between Respondents and their respective counsel or communications between members of a joint defense, namely Respondents' counsel and AMS. In either case, the content meets the standard of attorney client privilege.

However, with regard to Respondents' claims of privilege for categories B1 and C, the Court finds that Respondents have failed to meet their burden to establish an underlying privilege. The joint defense privilege is "not an independent basis for privilege, but an exception to the general rule that the attorney-client privilege is waived when privileged information is disclosed to a third party." Cavallaro v. United States, 284 F.3d 236, 250 (1st Cir. 2002); E.S. Epstein, The Attorney-Client Privilege and the Work-Product Doctrine 168-69, 194 (4th ed.2001).

Respondents' allege that documents in category B1 are privileged attorney-client communications and attorney work product involving counsel for AMS advising Respondents with respect to their personal rights and liabilities. There are only three pages of documents in this category, which include 2 copies of an email from AMS counsel to Respondents' on August 1, 2003, enclosing an article on the implications of CEO and CFO certifications and the other is an email from AMS counsel to Respondents on August 1, 2003, enclosing a preliminary draft of the language to be included in the Form 10-Q as Item 1 under Legal Proceedings with regard to the investigation. These communications do not include opinion or legal advice and are merely forwarding public documents to the Respondents.

After the July 23, 2003 execution of the search warrant by the FBI, AMS counsel recommended that AMS officers retain independent counsel to avoid any potential conflicts of interest. Promptly thereafter, both Respondents' retained private counsel in August 2003, so there does not appear to have been any direct attorney-client relationship between AMS counsel and Respondents.*fn7

In determining whether a corporate officer may claim an attorney-client privilege in communications with the corporation, the burden rests with the individual to evidence the privileged nature of the communications they seek to protect. See United States v. Bay State Ambul. & Hosp. Rental Serv., Inc., 874 F.2d 20, 28 (1st Cir.1989). Respondents have not met this burden. AMS advised Respondents to retain separate counsel after the July 23, 2003 search by the FBI and Respondents' did, and shortly thereafter discussions began regarding the JDA. These communications would not be protected under the JDA, because the JDA had not been orally agreed to by the parties as of August 1, 2003. As such, the Court finds that the documents in category B1 are not privileged.

With regard to the documents in category C, Respondents claim these documents are privileged attorney-client communications and attorney work product involving AMS counsel and joint defense/common interest efforts participated in by Respondents. The Court finds Respondents' have failed to meet their burden of establishing the privileged nature of these communications for several reasons. First, Respondents have not established that there was any attorney-client relationship between them and AMS counsel. In fact, Respondents' counsel's declaration states that Respondents were instructed by AMS counsel after the July 23, 2003 search by the FBI to retain independent representation to avoid any potential conflicts. See Decl. Charles La Bella, [Doc No. 6-4], at 2. Second, Respondents' retained counsel were not involved in any of the communications in category C, and Respondents' counsel freely admitted during the hearing on January 11, 2008 that AMS counsel knew that Respondents were represented and would not have spoken directly with Respondents regarding their liabilities or defenses as a result. Third, the documents in category C represent Respondents' participation as corporate officers in the business affairs of AMS. Respondents had a fiduciary duty as corporate officers to assist AMS in the investigation and defense of matters pertaining to the employer's business. See United States v. Sawyer, 878 F. Supp. 295, 296 (D. Mass.1995).

In In re Bevill, the Third Circuit set forth a test that enumerates five benchmarks that corporate employees seeking to assert a personal claim of attorney-client privilege must meet.*fn8 The fifth prong of In re Bevill, properly interpreted, precludes an officer from asserting an individual attorney client privilege when the corporate officer's communication concerns the corporation's rights and responsibilities.*fn9 These communications would only be privileged as to AMS, and AMS has waived privilege with respect to these communications. Garner v. Wolfinbarger, 430 F.2d 1093, 1101-04 (5th Cir.1970).

In addition to the reasons set forth above, Respondents also face difficulties with regard to the forth prong of In re Bevill where copies of documents claimed to be privileged were provided to other corporate officers or third parties, thereby destroying the confidentiality required to maintain their claims of privilege. See In the Matter of Bevill, 805 F.2d at 123. Since the Court has found that only AMS, Necita and Leonard were parties to the JDA, the sharing of any privileged documents with any other corporate officers or third parties would destroy the confidential nature of these documents and they would no longer be privileged.

For all the aforementioned reasons, the Court finds the documents in category B1, C, D and E are not privileged as to the Respondents. Documents in categories in A and B are privileged. The SEC shall delete or destroy all copies these documents in categories A, B and *.

B. Respondents' Allegations of Taint Regarding the SEC's Investigation and Request for Return of Documents Produced by AMS to the SEC

Respondents contend that the SEC's possession of documents produced by AMS, which Respondents' argue are attorney-client privileged, has irreparably tainted the SEC's investigation and issuance of the subpoenas. Respondents contend that the SEC subpoenas "are the fruit of hundreds of privileged documents improperly turned over to the SEC" by AMS. (See Doc. No. 6, Resp. Opp., at p. 2.) Respondents argue that the "SEC's investigation is already hopelessly tainted by the privileged material it has held for years, and no doubt utilized during the course of its investigation." Id. at 8. Respondents claim that their privilege would be further violated "by allowing the SEC's continued use of these privileged documents in questioning Respondents during the course of the depositions." Id. at 2, 8.

In response, the SEC argues that Respondents' allegations of taint are without merit. The SEC's investigation focuses on events that occurred before July 23, 2003, when the FBI conducted a search of AMS's headquarters. The documents contained in Respondents privilege log all post date July 23, 2003, and therefore are only marginally relevant, if at all, to the SEC's investigation. (See Declaration of Molly M.White Supporting Supplemental Brief at ¶ 7; Declaration of Ronnie B. Lasky Supporting Supplemental Brief at ¶ 12.)

When asked to identify what if any documents from Respondents' privilege log the SEC has relied on to date, the SEC identified nine (9) investigative exhibits.*fn10 Of these, four have been removed from the privilege log or identified as not privileged, and the remaining documents are all category "C" documents on the privilege log, which the Court has determined are not privileged as to the Respondents. The Court finds that none of the nine documents relied upon by the SEC are privileged as to Respondents. Furthermore, the SEC has offered to segregate the documents listed on Respondents' privilege log and to refrain from using or relying on all of those documents in its investigation.

Based upon the foregoing, the Court finds Respondents claims of taint to be without merit. There has been no evidence presented that the SEC's staff has engaged in any misconduct to obtain the documents at issue, a fact Respondents' readily agreed with at the evidentiary hearing. While some privileged material was inadvertently produced by AMS to the SEC, this privileged material was buried among the roughly six million pages of documents produced by AMS in this investigation. Furthermore, there has been no evidence presented that shows that the privileged documents in any way effected the course or scope of the SEC's investigation.*fn11 To the contrary, the fact that the SEC's investigation focuses on a period that predates the privileged documents, that none of the documents used to date has been privileged as to Respondents, and the fact that the SEC has agreed to refrain from using or relying on all those documents in its investigation, clearly demonstrate that the inadvertent disclosure by AMS of Respondents' privileged documents has not tainted the SEC's investigation.

As such, Respondents' motions to quash and or stay these subpoenas is DENIED. Respondents' request that the Court disqualify all SEC attorneys' and investigators who have had access to the privileged documents is DENIED since the disclosure was inadvertent and did not change the course or scope of the SEC's investigation.

C. Petitioner's Request for Enforcement of the Administrative Subpoenas

The standard for judicial enforcement of administrative subpoenas is set forth by the Supreme United States v. Morton Salt Co., 338 U.S. 632 (1950). The Court stated that an agency's investigation is lawful if "the inquiry is within the authority of the agency, the demand is not too indefinite and the information sought is reasonably relevant." Id. at 652; see also United States v. Stuart, 489 U.S. 353, 360 (1989).

The Ninth Circuit has stated that the scope of our inquiry into an agency subpoena is narrow. NLRB v. North Bay Plumbing, Inc., 102 F.3d 1005, 1007 (9th Cir.1996); see also EEOC v. Children's Hosp. Med. Ctr. of N. Cal., 719 F.2d 1426, 1428 (9th Cir.1983) (en banc). Generally, a court must ask "(1) whether Congress has granted the authority to investigate; (2) whether procedural requirements have been followed; and (3) whether the evidence is relevant and material to the investigation." Children's , 719 F.2d at 1428. An affidavit from a government official is sufficient to establish a prima facie showing that these requirements have been met. See Stuart, 489 U.S. at 360. Finally, "[i]f the agency establishes these factors, the subpoena should be enforced unless the party being investigated proves the inquiry is unreasonable because it is overbroad or unduly burdensome." Children's Hosp., 719 F.2d at The Petitioner met the requirements set forth above in filing the ex parte application to compel compliance with the administrative subpoenas [Doc. No. 1] filed on April 27, 2007. Since the Respondents have not demonstrated any reason why these subpoenas should not be enforced, the Court hereby ORDERS Respondents' immediate compliance with the administrative subpoenas.

III. Conclusion

For the reasons set forth herein, the Court finds that a JDA existed between the Respondents and AMS from August of 2003 until February of 2004. Upon review of Respondents' privilege log and the categories of documents submitted for in camera review, the Court finds that the documents in categories A, B and * are privileged communications as to the Respondents and documents in categories B1, C, D and E are not privileged as to the Respondents. As such, Petitioner shall delete and destroy all copies of documents in categories A, B and * set forth in Respondents' privilege log forthwith and confirm same in writing to Respondents' cousel. Respondents request to disqualify members of Petitioner's staff is DENIED. Respondents motions to quash or stay the administrative subpoenas is DENIED. The Court hereby ORDERS Respondents' immediate compliance with the administrative subpoenas. Counsel are ORDERED to meet and confer within ten days from the date of the order to schedule the depositions and Respondent's compliance with the administrative subpoenas.


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