This Waiver Rule Is Unfair

Companies turning over material to government investigators may boost their risk of shareholder lawsuits. Now's the time to change the law

The U.S. Supreme Court on Nov. 13 refused to hear an argument concerning a problem many companies face: If a company shares sensitive information with the Securities & Exchange Commission or Justice Dept. during an investigation, does it relinquish the right to keep that information from third parties, including prospective litigants?

Qwest Communications International (Q) is fighting to keep some 220,000 pages of corporate documents provided to federal investigators away from shareholders who brought suit against the company. The question of whether these documents can be kept confidential could be worth billions of dollars to Qwest and scores of other companies cooperating with federal agencies. It's also of great interest to those companies' shareholders and employees.

At issue: Qwest had turned over reams of material to the SEC and Justice Dept., which were conducting investigations of the company's accounting practices. Shareholder plaintiffs suing Qwest gained access to that material through an appeals court ruling, and Qwest was asking the High Court to overturn that appeals court decision.

Investigation Targets in a Tough Spot

The plaintiffs' argument? Once Qwest turned over those documents to the SEC and the Justice Dept., the company then couldn't use the defense of "selective waiver" to keep the documents from being produced to future third parties.

In other words, the court agreed that Qwest had waived key confidentiality privileges once it produced the documents to the federal agencies conducting the investigations. Therefore, it could not resurrect these privileges under the selective waiver doctrine to prevent these documents from being produced to third parties.

For Qwest and many other companies, it's a "damned if you do, damned if you don't" scenario. Qwest's dilemma: Cooperate with federal enforcement agencies to try and avoid prosecution, and you run the risk of open season on corporate data.

Alternatively, the company could try to protect corporate information, refuse to waive legal privileges, and, as a result, it would face potentially lengthy and costly legal battles with the government that distract from bottom-line efforts. Ultimately, the market and shareholders want prompt resolution to such legal woes.

Qwest is not the only company affected by the High Court's refusal to settle the issue. Thousands of public companies are conducting internal audits in wake of the options backdating scandal. More than 130 probes have been opened into stock option grant processes at U.S. public companies. As many as 2,200 companies may have backdated options, leaving them vulnerable to regulatory review and the threat of shareholder litigation.

If these companies conduct an internal investigation to assess potential exposure, do they share their findings with the SEC or Justice Dept. to minimize their prosecutorial risks? If they do, the current case law means they are knowingly exposing themselves to shareholder class-action suits. It's the proverbial dilemma of being between a rock and a hard place.

The Weight of Waivers

Companies now work in an era of empowered investigative agencies. One weapon in the governmental arsenal is the Justice Dept.'s "Thompson Memorandum," which governs the department's policy on corporate charging decisions. Specifically, it outlines the factors that federal prosecutors must take into consideration when deciding whether to bring criminal prosecutions against companies.

One factor that weighs heavily in favor of nonprosecution is a company's willingness to waive its privileges surrounding attorney-client communication and work product, or the protection of materials prepared by an attorney or others in anticipation of litigation. The Justice Dept. strongly encourages such waivers. And companies that do waive these privileges and disclose their information invariably hand the government very sensitive corporate information.

So why did the Supreme Court decline to hear Qwest's argument about whether companies can use selective waiver when cooperating with the feds? One reason is that the majority of the federal district courts do not recognize a selective waiver of privileges. To the Supreme Court, there appears to be no conflict among the federal circuits worthy of its attention on this issue.

Reform Movement Begins

The Court might also be sending a signal to Congress that the burden rests on its shoulders to change the law. Indeed, change is in the wind. High-profile associations and other organizations have told the U.S. Sentencing Commission that Justice Dept. demands on companies to waive their attorney-client and work-product privileges have gone too far.

Former U.S. Attorneys General testified that the Thompson Memorandum has created a "culture of waiver" in which prosecutors expect companies under investigation to waive attorney-client or work-product protections. Federal District Judge Lewis Kaplan of the Southern District of New York declared in June portions of the Thompson Memorandum unconstitutional and violations of Fifth and Sixth Amendment rights.

Legislators are listening. In July, as summer and midterm election campaigns hit their stride, the Federal Evidence Rules Advisory Committee drafted for Congress an amendment to the Federal Rules of Evidence that would let corporations and others waive attorney-client privilege and work-product protection in dealing with federal agencies without fear of disclosure to third parties.

The advisory committee's report allows selective waivers because they "further the important policy of cooperation with the government agencies, and maximize the effectiveness and efficiency of government investigations." The report fell short of recommending that Congress approve the "selective waiver" provision and suggested the Standing Committee seek public comment on the proposal.

As a result, selective waiver remains in limbo as legislative leadership switches parties. If Congress decides to change the rules of evidence, the Supreme Court may be vindicated by letting the legislative branch of government take responsibility for changing the law.

Business Must Raise Its Voice

A business caught up in the stock option grant investigations or any other inquiry—with or without an enforcement agency breathing down its neck—must perform an internal study to assess its risks of civil and/or criminal prosecution, as well as potential shareholder litigation. Ignoring the obvious can precipitate a government investigation or worse: civil action or indictment.

In January, Senator Arlen Specter (R-Pa.) will resign his chairmanship of the Judiciary Committee. He then intends to introduce legislation that would mandate the Justice Dept. to reconstruct the Thompson Memorandum.

This movement against the Thompson Memorandum has been led by a coalition composed of the Washington-based U.S. Chamber of Commerce, the Chicago-based American Bar Assn., and the New York-based American Civil Liberties Union. Specter's replacement as chairman of the Judiciary Committee, Patrick Leahy (D-Vt.), has already expressed support for Specter's legislative efforts.

The time is ripe for businesses to take an active part in these initiatives. They must stay alert and actively participate in this remarkable and rare opportunity to bring about a real change in the law that can protect and preserve these vital privileges.

They should work with their industry representatives and government lobbyists to let their senators and congresspeople know they will not be extorted into waiving their legal privileges so they can be seen as a good corporate citizen in the eyes of the government, only to be faced with increased liability from third parties for doing so. The time to act is now—while there is still a chance to make a difference.