The co-founder of an investment management company, who is the subject of a Securities and Exchange Commission lawsuit, is not entitled to the corporation’s attorney-client communications even though he claims they are necessary for his advice-of-counsel defense, a U.S. District Court judge has found.
The SEC sued the defendant, Howard B. Present, for various violations of the federal Advisers Act based on his conduct as CEO of F-Squared Investments.
Present argued that fairness required the disclosure of communications he had with outside counsel during his tenure as F-Squared’s CEO so he could show that he lacked the state of mind the SEC needed to establish liability.
But Judge Leo T. Sorokin found no reason to pierce the privilege held by F-Squared, particularly given that the SEC commenced its investigation while Present served as the company’s CEO, and, therefore, Present had notice of potential personal liability.
“At that time, as the CEO of F-Squared, Present 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. He chose not to do so,” Sorokin wrote. “These circumstances mitigate the fairness considerations advanced by Present.”
The seven-page decision is Securities and Exchange Commission v. Present.
The defendant was represented by Boston lawyers Anthony E. Fuller, Michael A. Collora, Justin P. O’Brien and Lauren A. Graber. Fuller declined to comment on the case.
However, the defense attorneys in their brief argued that Present would suffer “substantial prejudice” in defending against the SEC’s allegations of fraud and misrepresentation should he be precluded from offering evidence of his interactions with counsel in his capacity as F-Squared’s CEO.
“The required element of intent is central to the claims against him, and any evidence tending to negate this element is critical,” the defense brief states. “Present should not be deprived of vital evidence that negates scienter and negligence in order to serve the nominal rights of a legal fiction.”
F-Squared appeared in the case as an interested party. The company was represented by Kara B. Coen of Washington, D.C., and Aric H. Wu of New York City. Coen did not respond to a request for comment prior to deadline.
In her brief in support of the company’s motion to quash and for a protective order, Coen argued that because “a corporation’s attorney-client privilege cannot be overcome or waived by an employee’s desire to use privileged information in litigation, Mr. Present cannot waive F-Squared’s privilege by asserting an advice-of-counsel defense.”
The SEC was represented by Rachel E. Hershfang and Jennifer A. Cardello, of the agency’s Boston regional office. The SEC took no position on F-Squared’s assertion of privilege and declined to comment.
Jeffrey J. Trapani, a civil litigator in Springfield, Massachusetts, credited Sorokin for drawing a “bright line” in his decision and protecting a privilege that should not be “watered down.”
“From the judge’s perspective, it’s a question of who has the privilege,” Trapani said. “In this case it was the company, and they’re not waiving it.”
Trapani added that the case illustrates how important it is for attorneys in such situations to explain to the executive that they are representing the entity rather than the individual.
Theodore J. Folkman, a business litigator in Boston, said while he agreed with the decision, it seemed an “unfair” result for the defendant.
“It has the appearance of unfairness because the poor guy was in the meetings [with counsel] and isn’t allowed to get discovery about the material that he relied on,” Folkman said.
But Folkman noted that assertions of unfairness are common in privilege disputes.
“The whole point of the privilege is to take privileged communications out of the realm of weighing and balancing that courts do when facing other evidentiary issues,” he said.
Advisers Act claims
The defendant co-founded and became CEO of F-Squared in 2006. Until he resigned in 2014, Present was the executive responsible for statements to the public regarding the products of the Wellesley, Massachusetts, company. Throughout his tenure as CEO, he regularly consulted with outside counsel.
In 2013, the SEC began an investigation into both F-Squared and Present. During the course of the investigation, F-Squared refused the SEC’s request to waive its attorney-client privilege.
After Present left F-Squared in November 2014, the company admitted liability for making materially false statements regarding certain investment products and paid a $35 million fine. F-Squared subsequently filed for bankruptcy protection.
The following month, the SEC sued Present for various violations of the Advisers Act. Specifically, the SEC alleged that Present made false and misleading statements about AlphaSector, the company’s flagship investment product that was based on so-called “exchange-traded funds.”
In addition to injunctive relief, disgorgement and a fine, the SEC is seeking to bar Present from working in the securities industry in the future.
As an affirmative defense, Present claimed he “reasonably relied upon the work, advice, professional judgment, and opinion of others, including but not limited to legal and compliance professionals.”
In seeking to establish the advice-of-counsel defense, Present served a subpoena on F-Squared seeking all documents concerning legal advice the company received between 2008 and 2013 pertaining to public statements about the company’s products.
Asserting that the materials sought by Present were protected by the attorney-client privilege, F-Squared filed a motion to quash the subpoena and for a protective order.
Balancing test rejected
In addressing F-Squared’s motion, Sorokin noted that Present had conceded that F-Squared held the privilege with respect to the subpoenaed materials and that he was not in a position to waive the privilege himself.
The judge further recognized that Present could not rely on an established exception to the privilege.
Instead, Sorokin viewed Present’s discovery request as requiring the court to find the communications outside the privilege by balancing Present’s interest against the interest of his former company.
Sorokin concluded that such a balancing test was precluded under the U.S. Supreme Court’s decision in Swidler & Berlin v. United States. In the 1998 case, the court held that an individual’s attorney-client privilege survived his death, rejecting the argument that a prosecutor could breach the privilege to gather evidence for use in a criminal trial.
In reaching that conclusion, the Supreme Court was not persuaded by the government’s position that the privilege should be subordinated to the important public interest of obtaining evidence in an ongoing criminal investigation.
While Sorokin acknowledged that Swidler & Berlin did not squarely control Present’s case, he noted that both the 6th U.S. Circuit of Appeals and a U.S. District Court judge in New York followed the Supreme Court’s decision to bar the disclosure of privileged communications sought by a former employee who was privy to those communications in a corporate capacity.
Accordingly, Sorokin granted F-Squared’s motion to quash in “light of the undisputed application of the unwaived privilege, the Supreme Court’s rejection of balancing considerations — which other courts have applied even when individuals seek access to information disclosed previously to them, the consequences of permitting the subpoenas to proceed, and the particular circumstances of this case.”
Sorokin sympathized with Present’s policy argument, writing that “the Court observes a tension arising from legal rules that encourage corporate officials to seek legal advice about their actions on behalf of the corporation, and protect those communications from disclosure, but, as here, prevent the corporate official from defending himself personally based (possibly) on the very advice he received when the corporation and the official differ on whether to waive the privilege.”
Yet Sorokin concluded that Present’s case for disclosure was undermined by the fact that he had notice of the SEC investigation while he was CEO.
“Here Present does not face the situation in which he cannot access the privileged information merely because he failed to anticipate the possibility of a future investigation or need and, therefore, at the commencement of his employment failed to bargain with the corporation for the right to future access to the information,” Sorokin wrote.