The Advice-of-Counsel Defense and the Corporate Employee: A Loss of Balance

W.R. Grace's Balancing Test

In W.R. Grace, several current and former employees, who were indicted along with the company, argued that privileged company documents supported an advice-of-counsel defense and should be admitted at trial, despite the company's objection. After viewing the documents in camera, the district court agreed that they were potentially exculpatory and held that the company's attorney-client privilege must “yield” where it is incompatible with a criminal defendant's Sixth Amendment right to present a defense. The court adopted a “balancing test” weighing “the nature and content of the privileged evidence” against “the purposes served by the attorney-client privilege” to determine whether the privileged communications are “of such value as to require” disclosure.

W.R. Grace's balancing test was subsequently adopted in several other federal criminal cases. See United States v. Mix, 2012 WL 2420016 (E.D. La. June 26, 2012); United States v. Weisberg, 2011 WL 1327689 (E.D.N.Y. Apr. 5, 2011); United States v. Renzi, 2010 WL 582100 (D. Ariz. Feb. 18, 2010).

Although the Sixth Amendment right to present a defense does not apply in civil cases, the court in SEC v. TenFold Corp., 2005 WL 7874298 (D. Utah Aug. 19, 2005), took a similar approach. There, the company's former president moved to compel the production of privileged company documents that would support his good-faith defense, arguing that “fundamental fairness” required it. TenFold, which had previously settled with the SEC, opposed the motion; the SEC, notably, supported it. “[B]alancing the interests of the moving parties with the possible prejudice to TenFold,” the court ordered TenFold to produce the documents, holding that “the attorney-client privilege[] must give way in proper circumstances where there is a demonstrated specific need for evidence and I believe that that has been met.” (8/17/05 Oral Arg. Tr.) See also People ex rel. Spitzer v. Greenberg, 851 N.Y.S.2d 196 (1st Dep't 2008) (holding that former directors and officers of AIG wee entitled to view privileged documents where their conduct was called into question and the inspection was needed to prepare their defense).

Wells Fargo and Present

In Wells Fargo, the government brought a civil action against Wells Fargo and Vice President Kurt Lofrano, alleging misconduct related to residential mortgage loans. Lofrano asserted that he had sought advice from in-house attorneys about the legal requirements he allegedly violated, and that he had acted in accordance with that advice. The government sought discovery of Lofrano's communications with counsel, arguing, in the alternative, that if it could not gain access to those communications, then Lofrano should be barred from asserting an advice-of-counsel defense. Wells Fargo disavowed any advice-of-counsel defense on its own behalf and objected to disclosure of the privileged communications.

Last September, Judge Jesse M. Furman of the Southern District of New York ruled that “Lofrano is precluded from asserting an advice-of-counsel defense in light of Wells Fargo's refusal to waive its attorney's client privilege.” Swidler, the court found, “all but foreclosed” Lofrano's argument. In Swidler, the Supreme Court held that the attorney-client privilege survives the death of the client, rebuffing an attempt by investigators to gain access to former Deputy White House Counsel Vincent W. Foster's communications with his personal lawyer. In so doing, the Court explicitly “rejected use of a balancing test in defining the contours of the privilege,” because it would “introduce[] substantial uncertainty into the privilege's application” and thus inhibit clients from sharing confidences with attorneys in the first place.

The Wells Fargo court reasoned that, under Swidler, the type of balancing favored in cases such as W.R. Grace “has no role whatsoever to play in the analysis.” Recognizing that this result “is arguably harsh in this particular case, as it may well deprive Lofrano of his best defense to liability for tens of millions of dollars,” the court deemed such unfairness to be “the price that must be paid for society's commitment to the values underlying the attorney-client privilege.” The court also noted that the only Court of Appeals decision on point, Ross v. City of Memphis, 423 F.3d 596 (6th Cir. 2005), read Swidler the same way. The court distinguished W.R. Grace on the ground that it was a criminal prosecution, but also made clear that in its view, the case was wrongly decided: “even if Grace did call for a different result here, the Court would decline to follow it.”

Two months later, in Present, Judge Leo T. Sorokin of the District of Massachusetts followed Wells Fargo. In Present, the SEC charged the former CEO of F-Squared Investments, Inc. with violations of the Investment Advisers Act, and both the SEC and the former CEO subpoenaed F-Squared for privileged documents that he claimed bore on his state of mind. While recognizing that Swidler “arguably does not squarely control this case,” the court nonetheless agreed with Wells Fargo that Swidler's “rejection of balancing considerations” prevented it from weighing the CEO's interest against that of F-Squared, and thus granted F-Squared's motion to quash.

Swidler's Sway

There are, it would seem, salient distinctions between Swidler and the situation presented in Wells Fargo and Present. Swidler involves a situation where someone wholly outside the privileged communications seeks to invade the privilege to learn new facts about the conduct and/or motivations of the privilege-holder. A corporate employee who seeks to rely on the advice of corporate counsel, however, is not a stranger to the communications. He was a participant in them, with the corporation's consent. More than this, the employee claims he was induced to act, on the corporation's behalf, as a result of the privileged communications, and seeks to use the communications solely to prove facts about his own state of mind.

In analogous circumstances, some courts have recognized what has been called a “corporate employee's self-defense exception.” John W. Gergacz, Attorney-Corporate Client Privilege ' 5.27. Under this exception, former officers and directors have been allowed to use privileged communications to which they were privy to defend themselves against claims by the corporation. See, e.g., Newmarkets Partners, LLC v. Sal. Oppenheim Jr. & Cie , S.C.A., 258 F.R.D. 95 (S.D.N.Y. 2009) (“Because Mathes already rightfully possesses these materials, it would seem obvious that Plaintiffs cannot prevent her from relying on them in defending the lawsuit against her.”); In re Braniff, Inc., 153 B.R. 941 (M.D. Fla. Bankr. 1993) (corporate officers and directors who “are the very persons who prepared or received the communications at issue” should have greater access to the documents “than would a third party stranger to the communication”); Ed Miniat, Inc. v. Globe Life Ins. Co., 1989 WL 26838 (N.D. Ill. Mar. 20, 1989) (“The employer ought not be allowed to sue its employee while shielding itself from detrimental statements by its employee.”).

This is not the only context in which courts have held that a corporation's general right to control its privilege must yield to the legitimate interests of corporate constituents. Under the well-established doctrine recognized in Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970), a stockholder may, upon a showing of “good cause,” gain access to privileged communications to prove fiduciary breaches by those in control of the corporation. See also Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Trust Fund IBEW, 95 A.3d 1264 (Del. 2014) (adopting Garner doctrine under Delaware law). This is a form of “balancing” the corporation's rights as privilege-holder that has co-existed with Swidler for quite some time.

As these cases illustrate, and as the Supreme Court has explicitly recognized, “[t]he administration of the attorney-client privilege in the case of corporations ' presents special problems.” CFTC v. Weintraub, 471 U.S. 343 (1985). Ironically enough, Swidler itself reinforces this point when the rule it announced is compared with its analogue in the corporate context: whether the privilege survives the death of the corporation. While this question remains unsettled under federal law, the “weight of authority ' holds that a dissolved or defunct corporation retains no privilege.” SEC v. Carrillo Huettel LLP, 2015 WL 1610282 (S.D.N.Y. Apr. 8, 2015).

In short, whether or not one thinks that an exception to the corporate attorney-client privilege should exist to obviate the unfairness inherent in denying a corporate employee an advice-of-counsel defense, it is hard to see how Swidler can fairly be read as definitively answering that question.

Other Considerations

Wells Fargo and Present also articulate several reasons why barring a corporate employee from asserting an advice-of-counsel defense might not be so unfair to the employee after all. These justifications are also questionable.

First, Wells Fargo posited that if the rule were otherwise, the corporation may not have generated the privileged communications in the first place, so that “the loss of evidence is more apparent than real.” But this overlooks the fact that, if the privileged communications had not been generated, i.e., if the employee had not been told that his actions were legal, the employee presumably would not have engaged in the allegedly illegal conduct in the first place.

Second, Wells Fargo stated that, by indemnifying the employee, the corporation can ensure that “the company is the one to pay the financial price” for a decision not to waive privilege. But corporate indemnities typically exclude intentional wrongdoing or other acts not taken in good faith, which is precisely what most government enforcement actions allege as a basis for liability. Moreover, corporations generally cannot indemnify employees for criminal acts or scienter-based violations of the federal securities laws.

Third, Present asserted that F-Squared's former CEO was still in office when the SEC investigation commenced, and thus was “in the position either to waive the privilege or to obtain in his personal capacity the right to be able to waive the privilege in the future,” yet “chose not do so.” This reasoning is curious, insofar as it appears to blame the former CEO for failing to take action as CEO that would have been purely in his personal interests without regard for whether it was in the best interest of the company or the investment fund to which he owed fiduciary duties.

Conclusion

Whether the W.R. Grace balancing test or the Wells Fargo balancing ban will prevail is uncertain, but one thing seems fairly clear: With the government placing ever-greater emphasis on prosecuting corporate employees, this is an issue that will only grow in importance in the years ahead.

Gary Stein, a member of this newsletter's Board of Editors, is a partner with Schulte Roth & Zabel, LLP.