Document Destruction Horror Stories

Arthur Andersen's demise is old news, so the recent Fifth Circuit decision affirming the firm's conviction for obstructing an SEC proceeding has received little attention. US v. Arthur Andersen LLP, 374 F.3d 281 (5th Cir. 2004). Because the case destroyed the firm, however, it is instructive to understand exactly what conduct made Arthur Andersen guilty.

In the summer of 2001, Enron's stock value had declined by 50%, and its CEO resigned. Within days of that resignation, an in-house Enron accountant who had formerly been at Andersen warned Enron's Chairman and two Andersen partners that Enron “could implode in a wave of accounting scandals.” By early September, Andersen had formed a “crisis response” group, which was assigned an in-house lawyer from Chicago.

In early October, Andersen contacted outside counsel about possible representation; notes from an in-house meeting of Andersen lawyers said an SEC investigation was “highly probable.” On Oct. 10, 2001 (the date Andersen's obstruction began, according to the indictment), a partner advised Andersen personnel to comply with the firm's document retention policy, saying: “[I]f it's destroyed in the course of normal policy and litigation is filed the next day, that's great … we've followed our own policy and whatever there was that might have been of interest to somebody is gone and irretrievable.” Unfortunately for Andersen, this was very bad advice.

The SEC informed Enron on Oct. 16th that it had opened an informal investigation in August. Andersen received a copy of that letter on Oct. 19th. The next day, Andersen's in-house lawyer “reminded” the crisis group “to make sure to follow the [document retention] policy.” Clearly, no one suspended the destruction of Enron documents. To the contrary, the lead audit partner at Andersen convened an “urgent” meeting in Houston and directed the Enron engagement team to comply with Andersen's policy, which called for the retention of “only the work papers of auditing efforts.”

Between October and the SEC's first subpoena served on Nov. 8, 2001, Andersen personnel shredded literally tons of paper and systematically purged computer hard drives and e-mail servers. On November 8th, Andersen's in-house counsel advised the audit partner that an SEC subpoena had been received, and the auditor then put out the instruction: “No more shredding. We have been officially served for our documents.”

Obviously, Andersen was not well counseled about the laws of obstruction of justice. In March 2002, the government charged that from about Oct. 10, 2001 to Nov. 9, 2001, Andersen obstructed or attempted to obstruct an “official proceeding.” As the statute itself provides, “an official proceeding need not be pending or about to be instituted at the time of the offense.” In upholding the conviction, the Fifth Circuit hammered that point home: “There is nothing improper about following a document retention policy when there is no threat of an official investigation … A company's sudden instruction to institute or energize a lazy document retention policy when it sees the investigators around the corner, on the other hand, is more easily viewed as improper.”

Banc of America Securities LLC

Extensive problems with BOA's e-mail and document preservation and production led the SEC to impose a $10 million penalty on BOA in March. In the Matter of Banc of America Securities LLC, SEC Rel. No. 49386 (March 10, 2004). The SEC's investigation of BOA (a broker-dealer) began in the summer of 2001, when the SEC received a tip that senior employees were trading positions for the firm in advance of the issuance of market moving reports from the firm's equity research department.

In early November 2001, the SEC issued a request for records, and specifically sought e-mail for seven senior managers for the previous 3 years. BOA told the SEC that e-mail back to June 2001 was readily available and would be produced, but that restoring e-mail prior to then would be burdensome, time consuming, and expensive. While it probably was, BOA in fact did promptly restore at least certain of the backup tapes in question, and had relevant e-mails in hand within 1 week of telling the SEC how burdensome the request was. Unfortunately, it did not tell this to the SEC.

The SEC's characterization of additional discovery abuses is eye-opening: BOA's broader e-mail production was haphazard and took almost 2 years to complete; certain compliance reports that had been requested were inadvertently destroyed at a vendor's premises, but BOA delayed telling this to the SEC; other compliance reviews were determined to be “missing,” but the SEC was not told; 28,000 pages of “missing” reports were discovered, but the SEC was not promptly told; other clearly responsive files (electronic and paper) were not produced.

In August 2003, BOA retained new legal counsel. These problems were identified, brought to the attention of the SEC, and corrected. The SEC's anger over the conduct of BOA's document production, however, is painfully evident in the $10 million penalty order it issued: “When a broker-dealer unreasonably delays producing documents sought during an investigation, it impedes the staff's fact finding capability, can prevent the staff from determining whether violations of law have occurred or are occurring, and can interfere with the Commission's ability to prevent future harm to investors. Such misconduct compromises the integrity of the Commission's processes and warrants immediate, independent enforcement action.”

United States v. Philip Morris USA Inc.

A similarly harsh opinion was handed down this summer by Judge Kessler in United States v. Philip Morris USA Inc., Civ. No. 99-2496 (D.D.C., July 21, 2004). The case was brought by the DOJ's Civil Division, and charged Philip Morris with marketing cigarettes to children. Judge Kessler rebuked the company for a pattern of e-mail discovery abuses, imposed a fine of $2.75 million, and precluded the company from calling certain witnesses at trial.

The first case management order, entered in October 1999, required the parties generally to preserve “all documents and other records containing information which could be potentially relevant to the subject matter of this litigation.” Unfortunately, Philip Morris failed to take any steps to suspend its e-mail destruction policy. Like many businesses, Philip Morris automatically purged e-mail more than 60 days old on a monthly basis. The problem was not detected until February 2002. Even then, the recycling of e-mail tapes continued for another two months. Finally, in June 2002, counsel alerted the court and government to the issue.

The court was particularly troubled by the loss of e-mail from 11 employees holding “some of the highest, most responsible positions in the company,” including those with responsibility over “issues that are of central relevance to this lawsuit.” Moreover, the court found it “astounding” that these employees failed to follow the court's order, as well as Philip Morris's own “'print and retain' policy, which, if followed, would have ensured the preservation of those e-mails which have been irretrievably lost.”

Because no one could say what actual harm had been caused, Judge Kessler considered several sanctions. While noting she had the authority to impose an adverse inference instruction, she declined to do so finding “such a far-reaching sanction … simply inappropriate.” Instead, she precluded one of the offending individuals from testifying at trial, “as well as any other individual who has failed to comply with Philip Morris' own internal document retention program.” In addition, she fined the company $2.75 million, stating: “it is essential that such conduct be deterred, that the corporate and legal community understand that such conduct will not be tolerated, and that the amount of the monetary sanction fully reflect the reckless disregard and gross indifference displayed … toward their discovery and document preservation obligations.” In essence, the court fined Philip Morris $250,000 for each of the 11 key employees whose e-mail had been destroyed.

Conclusion

Document preservation and production are clearly serious business, and severe sanctions can result not only from deliberate misconduct but also from bad judgment calls. Even inadvertent mistakes can lead to severe monetary penalties, witness preclusion, adverse jury instructions, and the indictment of individuals or the business. For these reasons, smart companies are re-examining and strengthening their paper and electronic document retention and preservation policies. Given recent experiences, one could argue that doing so is as important as ensuring that the company's compliance program is in place and effective.

As corporate information systems expand and government investigations escalate, the incidence of electronic (and other) document discovery debacles is on the rise. In the September Business Crimes Bulletin, Steven F. Reich provided an overview of the various electronic discovery issues addressed a single civil lawsuit, Zubulake v. UBS Warburg LLC, including: Who bears the costs of producing e-mail? Who pays to restore backup tapes? When does the duty to preserve attach? What sanctions should attach to the failure to preserve potentially relevant electronic material?

Three recent cases involving government inquiries provide sobering lessons about electronic evidence to corporations and their lawyers. The most notorious, U.S. v. Arthur Andersen, LLP, resulted in criminal convictions. Another, In the Matter of Banc of America Securities LLC, involved SEC enforcement action. The third, United States v. Philip Morris, arose in a Department of Justice civil suit. If nothing else, the cases demonstrate that corporations exposed to such investigations must implement effective and well-maintained information management systems.

Arthur Andersen

Arthur Andersen's demise is old news, so the recent Fifth Circuit decision affirming the firm's conviction for obstructing an SEC proceeding has received little attention. US v. Arthur Andersen LLP , 374 F.3d 281 (5th Cir. 2004). Because the case destroyed the firm, however, it is instructive to understand exactly what conduct made Arthur Andersen guilty.

In the summer of 2001, Enron's stock value had declined by 50%, and its CEO resigned. Within days of that resignation, an in-house Enron accountant who had formerly been at Andersen warned Enron's Chairman and two Andersen partners that Enron “could implode in a wave of accounting scandals.” By early September, Andersen had formed a “crisis response” group, which was assigned an in-house lawyer from Chicago.

In early October, Andersen contacted outside counsel about possible representation; notes from an in-house meeting of Andersen lawyers said an SEC investigation was “highly probable.” On Oct. 10, 2001 (the date Andersen's obstruction began, according to the indictment), a partner advised Andersen personnel to comply with the firm's document retention policy, saying: “[I]f it's destroyed in the course of normal policy and litigation is filed the next day, that's great … we've followed our own policy and whatever there was that might have been of interest to somebody is gone and irretrievable.” Unfortunately for Andersen, this was very bad advice.

The SEC informed Enron on Oct. 16th that it had opened an informal investigation in August. Andersen received a copy of that letter on Oct. 19th. The next day, Andersen's in-house lawyer “reminded” the crisis group “to make sure to follow the [document retention] policy.” Clearly, no one suspended the destruction of Enron documents. To the contrary, the lead audit partner at Andersen convened an “urgent” meeting in Houston and directed the Enron engagement team to comply with Andersen's policy, which called for the retention of “only the work papers of auditing efforts.”

Between October and the SEC's first subpoena served on Nov. 8, 2001, Andersen personnel shredded literally tons of paper and systematically purged computer hard drives and e-mail servers. On November 8th, Andersen's in-house counsel advised the audit partner that an SEC subpoena had been received, and the auditor then put out the instruction: “No more shredding. We have been officially served for our documents.”

Obviously, Andersen was not well counseled about the laws of obstruction of justice. In March 2002, the government charged that from about Oct. 10, 2001 to Nov. 9, 2001, Andersen obstructed or attempted to obstruct an “official proceeding.” As the statute itself provides, “an official proceeding need not be pending or about to be instituted at the time of the offense.” In upholding the conviction, the Fifth Circuit hammered that point home: “There is nothing improper about following a document retention policy when there is no threat of an official investigation … A company's sudden instruction to institute or energize a lazy document retention policy when it sees the investigators around the corner, on the other hand, is more easily viewed as improper.”

Banc of America Securities LLC

Extensive problems with BOA's e-mail and document preservation and production led the SEC to impose a $10 million penalty on BOA in March. In the Matter of Banc of America Securities LLC, SEC Rel. No. 49386 (March 10, 2004). The SEC's investigation of BOA (a broker-dealer) began in the summer of 2001, when the SEC received a tip that senior employees were trading positions for the firm in advance of the issuance of market moving reports from the firm's equity research department.

In early November 2001, the SEC issued a request for records, and specifically sought e-mail for seven senior managers for the previous 3 years. BOA told the SEC that e-mail back to June 2001 was readily available and would be produced, but that restoring e-mail prior to then would be burdensome, time consuming, and expensive. While it probably was, BOA in fact did promptly restore at least certain of the backup tapes in question, and had relevant e-mails in hand within 1 week of telling the SEC how burdensome the request was. Unfortunately, it did not tell this to the SEC.

The SEC's characterization of additional discovery abuses is eye-opening: BOA's broader e-mail production was haphazard and took almost 2 years to complete; certain compliance reports that had been requested were inadvertently destroyed at a vendor's premises, but BOA delayed telling this to the SEC; other compliance reviews were determined to be “missing,” but the SEC was not told; 28,000 pages of “missing” reports were discovered, but the SEC was not promptly told; other clearly responsive files (electronic and paper) were not produced.

In August 2003, BOA retained new legal counsel. These problems were identified, brought to the attention of the SEC, and corrected. The SEC's anger over the conduct of BOA's document production, however, is painfully evident in the $10 million penalty order it issued: “When a broker-dealer unreasonably delays producing documents sought during an investigation, it impedes the staff's fact finding capability, can prevent the staff from determining whether violations of law have occurred or are occurring, and can interfere with the Commission's ability to prevent future harm to investors. Such misconduct compromises the integrity of the Commission's processes and warrants immediate, independent enforcement action.”

United States v. Philip Morris USA Inc.

A similarly harsh opinion was handed down this summer by Judge Kessler in United States v. Philip Morris USA Inc., Civ. No. 99-2496 (D.D.C., July 21, 2004). The case was brought by the DOJ's Civil Division, and charged Philip Morris with marketing cigarettes to children. Judge Kessler rebuked the company for a pattern of e-mail discovery abuses, imposed a fine of $2.75 million, and precluded the company from calling certain witnesses at trial.

The first case management order, entered in October 1999, required the parties generally to preserve “all documents and other records containing information which could be potentially relevant to the subject matter of this litigation.” Unfortunately, Philip Morris failed to take any steps to suspend its e-mail destruction policy. Like many businesses, Philip Morris automatically purged e-mail more than 60 days old on a monthly basis. The problem was not detected until February 2002. Even then, the recycling of e-mail tapes continued for another two months. Finally, in June 2002, counsel alerted the court and government to the issue.

The court was particularly troubled by the loss of e-mail from 11 employees holding “some of the highest, most responsible positions in the company,” including those with responsibility over “issues that are of central relevance to this lawsuit.” Moreover, the court found it “astounding” that these employees failed to follow the court's order, as well as Philip Morris's own “'print and retain' policy, which, if followed, would have ensured the preservation of those e-mails which have been irretrievably lost.”

Because no one could say what actual harm had been caused, Judge Kessler considered several sanctions. While noting she had the authority to impose an adverse inference instruction, she declined to do so finding “such a far-reaching sanction … simply inappropriate.” Instead, she precluded one of the offending individuals from testifying at trial, “as well as any other individual who has failed to comply with Philip Morris' own internal document retention program.” In addition, she fined the company $2.75 million, stating: “it is essential that such conduct be deterred, that the corporate and legal community understand that such conduct will not be tolerated, and that the amount of the monetary sanction fully reflect the reckless disregard and gross indifference displayed … toward their discovery and document preservation obligations.” In essence, the court fined Philip Morris $250,000 for each of the 11 key employees whose e-mail had been destroyed.

Conclusion

Document preservation and production are clearly serious business, and severe sanctions can result not only from deliberate misconduct but also from bad judgment calls. Even inadvertent mistakes can lead to severe monetary penalties, witness preclusion, adverse jury instructions, and the indictment of individuals or the business. For these reasons, smart companies are re-examining and strengthening their paper and electronic document retention and preservation policies. Given recent experiences, one could argue that doing so is as important as ensuring that the company's compliance program is in place and effective.