Can The U.S. Capital Markets Be Saved By Tinkering With The Legal Profession?

President George W. Bush once famously remarked:

"Our enemies are innovative and resourceful, and so are we. They never stop thinking about new ways to harm our country and our people, and neither do we."

This presidential malapropism is somewhat reminiscent of the famous Pogo observation: "We have met the enemy, and he is us."

Self-inflicted harm, of course, is not limited to national security and geopolitical issues. In March of this year, a blue-ribbon panel of esteemed people assembled by the U.S. Chamber of Commerce issued a report with numerous recommendations to help save the primacy of the U.S. Capital Markets (the "Commission"). A number of the Commission's recommendations are well-founded and, if acted upon, may (incrementally) make the U.S. financial services industry more competitive. A few of the recommended "reforms" relate directly to the legal profession. Whether these will help the capital markets, or be useful to our profession (and to our clients), are different questions altogether.

Federal Prosecutorial Authority

One of the Commission's principal critiques of the workings of the legal system concerns the McNulty Memorandum. Before identifying any infirmities of this critique, it will first be necessary to explain what the McNulty Memorandum is.

In December 2006, Deputy Attorney General Paul McNulty "amended" a 2003 memorandum issued by a predecessor, Larry Thompson. The Thompson Memorandum had come under increasing pressure/attack on, inter alia , two grounds: (i) corporate "cooperation" with the federal government being favorably judged when companies waived (or not) the attorney-client privilege; and (ii) said "cooperation" also being favorably judged when companies forewent (or not) the advancements of attorney's fees for employees targeted by the federal government (notwithstanding corporate by-laws either mandating or allowing for attorney's fees to be advanced).

The Justice Department's increasingly aggressive approach in the post-Enron era (using, inter alia , the Thompson Memorandum) received a significant push back in 2006 from U.S. District Judge Lewis Kaplan in the KPMG litigation. In that case, the accounting firm's efforts to avoid corporate indictment included waiving every privilege it could think of and also deciding to forgo advancing the attorney's fees of numerous KPMG officers indicted by the federal government. When that latter decision was challenged, Judge Kaplan (after extensive evidentiary hearings) not only ruled that the individuals' Sixth Amendment rights had been violated by the federal prosecutors' pressure on KPMG to cut off fee payments, but also singled out specific assistant U.S. attorneys by name for criticism.

With that as a background (and Judge Kaplan's ruling on appeal), the McNulty Memorandum was issued. What did it say? First came the "good" news: (i) no longer would a corporation be deemed "non-cooperative" if it declined to waive the attorney-client privilege; and (ii) no longer would a corporation be deemed "non-cooperative" it if complied with its bylaws (and applicable state law) and advanced legal fees to employees. The "bad" news was that - at least as to the waiver issues - the McNulty Memorandum: (i) reserved the right to weigh in on "egregious" cases; and (ii) indicated that companies that "voluntarily" waived the privilege would be granted affirmative "credit" for so waiving (and for doing other things deemed to be cooperative).

The Commission in its March 2007 report correctly noted that the "bad" news left the waiver issue front and center, and recommended that the federal government should not consider waiver (voluntary or non-voluntary) in any circumstance. And while this is an appropriate comment/critique, it would not really help corporate counsel in advising clients. Why? Because with the balkanized regulatory structure we have in this country, counsel also has to consider the views (expressed or un-expressed) of the Securities and Exchange Commission, various other federal regulators (e.g., the Federal Reserve Board), semi-governmental organizations (e.g., the NASD, the NYSE), and numerous state regulators (e.g., state attorneys general, state blue-sky regulators). In other words, merely getting the Justice Department (or even all federal regulators), to adopt a uniform, principaled position on waiver, does not mean all the other 800 lb. gorillas will agree with that position.1

Similarly, the fact that the Justice Department now appears willing to play nice on the advancement of fees issue (a fact applauded by the Commission) should not make corporate counsel relax or feel sanguine on that score. Why? Because a number of the other regulators have not adopted the same play book. Most notably, the New York Attorney General has been extremely aggressive in pressuring companies on the advancement of fees. For example, the NYAG has effected settlements with companies with no-indemnification provisions. In another case, the NYAG litigated with a corporation to compel an indicted executive to post a bond, so as to ensure that there would be funds to repay the fees advanced. Thus, until there is an across the board disarmament by all in authority, this issue will remain ajar.2

Selective Waiver

The Commission also recommended that Congress enact legislation to establish selective waiver, whereby a company could share privilege information with the SEC without there being a waiver to private litigants. This proposal -- limited for some reason only to information provided to the SEC -- constitutes a subset of a broader "reform" recently put forward by the U.S. Judicial Conference's Advisory Committee on Evidence Rules; by the Advisory Committee's proposal, there could be a selective waiver for information shared with any governmental entity (proposed amendment to FRE 502).

The Advisory Committee's proposal has been justified as "further[ing] the important policy of cooperation with government agencies, and maximizes the effectiveness and efficiency of government investigations." That sounds pretty good (and is aligned with the Commission's rationale); but it is too good to be true. And that is for at least three reasons.

The first is a practical one: it is highly doubtful that this proposed reform (in either form) will ever get through Congress. Because the people who would be impacted most negatively by selective waiver are the private plaintiff's bar, it seems unlikely that they will take this lying down; indeed, given that group's proven political muscle, it seems highly probable that they will be able to convince their congressional allies to block legislation enacting this "reform."3

A second reason is the proposed justification for it: companies will not "cooperate" with the government unless there is selective waiver; this rationale is not supported by any evidence. Every circuit court -- save one, the U.S. Court of Appeals for the Eighth Circuit about 30 years ago -- has concluded that there is no evidence whatever to support the notion that companies will not cooperate with the government, but for selective waiver. And this state of affairs (i.e., no evidence) was just recently re-affirmed by the U.S. Court of Appeals for the Tenth Circuit in In re Qwest Communications International Inc. Securities Litigation, 450 F.3d 1179 (6th Cir. 2006). The real impact of selective waiver -- a tactical advantage in civil litigation (to one side) - does not seem a just proposition.

The last, and perhaps most compelling reason to oppose the selective waiver is that it is directly at odds with one of the principal foundations of the attorney-client privilege: for a confidential communication to be protected it must be kept confidential. Moreover, and as the Qwest court correctly noted, rather than promoting the purposes served by the privilege and work product doctrine, selective waiver could well have the effect of making corporate officials reluctant to speak to company lawyers -- a result directly antithetical to why the U.S. Supreme Court extended the corporate attorney-client privilege to all employees in Upjohn v. U.S., 449 U.S. 383 (1981).

A Self-Evaluation Privilege

The Commission also recommended that a federal "self-evaluation privilege" be created for SEC-regulated institutions and their independent audit firms. All communications created in furtherance of "self-evaluation" would be protected from discovery by third parties (i.e., private plaintiffs).

The same problems inherent with selective waiver (detailed above) would apply with equal force to this proposal. What else is wrong with it? Currently, the "self-evaluation privilege" (unlike the attorney-client privilege) is a tenuous creation of a handful of judges, while being rejected by scores of other courts. More importantly, financial firms and their auditors would undoubtedly push every internal activity within the ambit of "self-evaluation" - the civil litigation discovery process would thus likely be rendered a virtual nullity. Even for a defense lawyer like me, that would be stacking the deck too much.


The perceived crisis facing the U.S. capital markets seems a bit over the top. Has there been a perceptible loss in market share? Yes. Have the costs of doing business, Byzantine regulatory complexity, and litigation risks, all contributed to the current state of affairs? Probably to some extent. Other (more prominent) factors include the fact that U.S. investment banks are more global today (and have exported their best practices to other markets), as well as the fact that a lot of foreign companies can now raise the necessary capital they need closer to home (e.g., Chinese capitalists).

Will tinkering with the legal profession and privileges make a material impact on financial globalization? Hardly; and it will likely have a myriad of unpleasant, unintended consequences (e.g., further weakening an already weakened attorney-client privilege). In the long run (when, as John Maynard Keynes said, we are all dead), so long as the U.S. capital markets remain committed to being the best regulated, most transparent, most stable, and most devoted to investor protection, those markets will continue to be attractive to investors.

1 As the Supreme Court noted in U.S. v. Upjohn, 449 U.S. 383, 393 (1981): "An uncertain privilege is little better than no privilege at all."

2 As a matter of full disclosure, the author was counsel to Theodore Sihpol, the first person ever arrested and criminally charged (by the NYAG) in the history of the United States for the alleged crime of late trading mutual funds. Because Mr. Sihpol's employer refused to advance fees after vetting the issue with the NYAG, we were compelled to file an action in Delaware to vindicate his right under the company's by-laws. After succeeding in that proceeding, Mr. Sihpol went to trial and was acquitted on 29 criminal counts, with the jury deadlocked (for acquittal) 11-1 on the remaining four counts (which were subsequently dropped).

3 I say this in full recognition that a selective waiver for materials disclosed to federal and state bank regulators was enacted as part of the Financial Services Regulatory Relief Act of 2006. That provision of the statute was quietly tucked into the law without any public (or congressional) debate. The Advisory Committee's proposal, as well as the Commission's, will not go (and have not gone) unnoticed.

Published June 1, 2007.