Today's General Counsel (Formerly Executive Counsel), V9 N2, April/May 2012

APR / MAY 2012 VOLUME 9 / NUMBER 2 E X ECUTI V ECOUNSEL.INFO

T H E

M A G A Z I N E

F O R

T H E

G E N E R A L

C O U N S E L ,

C E O

&

C F O

Protecting

IP

PROTECTING IP ASSETS

Combating Trade Secret Theft Abroad Protecting IP in Government Contracts Field Tilts Against NPEs What to Patent is a Strategic Question E-DISCOVERY

Can Internal Investigations be Kept from Shareholders?

Corporate Defendants Should Embrace E-discovery

Mistakes to Avoid when Confronting a Search Warrant

When Data is Subject to Export Control Laws

Unconscionability Claims Still Breathing Aggressive FCPA Enforcement Getting Mixed Results Carrots, not Sticks, to Fend off Unions

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Apr/ MAy 2012 E X ECUTIV E COUNSEL

Editor’s Desk

There is an article in this issue of Executive Counsel that you might want to save for reference, in case you ever find yourself facing the worst case scenario. William Shepherd, former prosecutor and Chair Elect of the ABA’s Criminal Justice Section, has some tips about how to conduct yourself when law enforcement agents hand you a search warrant.

You might think a Miranda warning would serve as a caution against some of the counter-productive behavior Shepherd describes, but you only get one of those if you’re taken into custody. Thus, there is no procedural counterweight to the temptation to “explain yourself” when all they want to do is search the premises. But explaining is a bad idea, according to Shepherd, almost as bad as actually interfering with the search, which will earn you a Miranda warning but at the expense of a trip to jail. Be quiet and polite, he suggests. If you can manage it, observe what the officers seem to be searching for and whether they seem to have prior knowledge about where to find it.

Government contracts can be lucrative, but as Scott Felder points out, there is a downside. The government often gains rights to the intellectual property used to fulfill them, and can share it with your competitors under some circumstances.

Mitigating that risk is a topic Felder addresses.

Philip Urofsky and his co-authors survey various jurisdictional claims the government has been making, with varying success, in its enforcement of the Foreign Corrupt Practices Act. Urofsky is a former prosecutor with knowledge of the difficulties inherent in proving foreign bribery. Generally speaking, settlements with companies seem to be the government’s preferred outcome in FCPA cases. Trials against individuals in which jurisdictional issues are likely to be raised are something

2

the feds prefer to avoid.

Jeffrey Lilly, a litigator, explains that e-discovery, which is commonly viewed as costly and fraught with peril for corporate defendants, can often be used to their advantage. He suggests aggressively pursuing e-discovery issues in your own defense, and notes that if a plaintiff destroys potentially relevant information, the defense has a strong argument for an adverse inference.

Look for us online at executivecounsel.info

Bob Nienhouse, Editor-In-Chief Editor@executivecounsel.info

apr/ May 2012 E X ECUTIV E COUNSEL

Features

50

AGGRESSIVE FCPA ENFORCEMENT GETTING MIXED RESULTS

54

LAW DEPARTMENTS LEVERAGE ANALYTICS

56

LENDERS CAN FORECLOSE DESPITE DEFECTIVE MORTGAGES

4

60

Philip Urofsky, Marina Moon and Jennifer Rimm Defendants prevail at trial.

Keith Okano Metrics have strategic value.

Robert A. Scott and Glenn A. Cline Courts find a way to uphold some flawed mortgages.

TOP FIVE MISTAKES COMPANIES MAKE WHEN CONFRONTED WITH A SEARCH WARRANT William Shepherd Don’t explain.

62

UNCONSCIONABILITY CLAIMS STILL BREATHING David T. Biderman and Miriam D’Jaen Farhi Arbitration still an issue after Concepcion.

Page 60

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apr/ May 2012 E X ECUTIV E COUNSEL

Departments Editor’s Desk Executive Summaries

2 10

Page 23

e-DIscovery

18 Why Corporate Defendants Should Embrace E-Discovery |

6

Jeffrey Lilly Rules apply to plaintiffs too.

21 | E-Discovery Data Subject to Export Control Laws Jayne Rothman Strict laws concerning transfer of data.

23 | Digital Forensics and Discovery Management Are Certified Specialties Brad Berkshire It’s another kind of evidence handling, and it requires training.

25 | In-House E-Discovery Technology Invokes the Cloud Michele C.S. Lange Ask the right questions first.

Intellec tual ProPert y

28 | Rougher Litigation Terrain for Non-Practicing Entities Michael N. Rader Streamlined e-discovery and claim limits work in defendant’s favor.

30 | What to Patent is a Strategic Question John G. Rauch Strive for a right-sized portfolio.

34 | Protecting IP in Government Contracts Scott A. Felder Technical data could be shared with your competitors.

canaDa / cross-BorDer

37 | Combating Trade Secret Theft Abroad Through Legal Action At Home Michael Strapp ITC may be the most efficient venue – if it applies.

Governance

40 | Can Internal Investigations Be Kept From Shareholders?

Jonathan S. Sack Be aware of the fiduciary exception. human resources

44 | Carrots, Not Sticks, To Fend Off Unions A. John Harper III Kill them with kindness.

47 | Canadian Pension Plans are Private Equity Heavyweights Jamie S. Koumanakos and Jeremy Forgie International investors with clout.

49 | Private Equity Looks South Divya Balji Expertise priced to sell.

Editor-in-ChiEf Robert Nienhouse

Publisher Julie Duffy

MaNagiNg eDiTOr David Rubenstein

execuTive eDiTOr Bruce Rubenstein

MaNagiNg DirecTOr, execuTive cOuNsel iNsTiTuTe Neil Signore

arT DirecTiON & PhOTO illusTraTiON MPower Ideation, LLC

busiNess MaNager Amy Ceisel

DirecTOr Of circulaTiON Carol Spach

Contributing Editors and WritErs

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Divya Balji Brad Berkshire Glenn A. Cline Miriam D’Jaen Farhi, Scott A. Felder Jeremy Forgie A. John Harper III Jamie S. Koumanakos Michele C.S. Lange Jeffrey Lilly

Marina Moon Keith Okano Michael N. Rader John G. Rauch Jennifer Rimm Jayne Rothman Jonathan Sack Robert A. Scott William Shepherd Michael Strapp Philip Urofsky

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Executive Summaries E-DISCOVERY

10

PAGE 18

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Why Corporate Defendants Should Embrace E-Discovery

E-Discovery Data Subject to Export Control Laws

By Jeffrey Lilly Gordon & Rees LLP

By Jayne Rothman Epiq Systems, Inc.

Digital Forensics and Discovery Management Are Certified Specialties

The burden of preserving electronic information applies equally to defendants and plaintiffs. Defendants that have prepared in advance for e-discovery requests, and even those that haven’t, are well positioned to not only respond responsibly, but to use e-discovery to their advantage. While the costs of preserving, collecting, and producing e-data will almost always be significantly more for a corporate defendant, there are many ways ediscovery and the issues it raises can further a successful defense.

When plaintiffs use e-discovery requests as a weapon by making onerous and unreasonable requests, defendants should fire back immediately and aggressively pursue e-discovery issues, including whether and when litigation-related information has been discarded or manipulated. If a plaintiff has destroyed potentially relevant information after the incident at issue, the defense has a strong argument for an adverse inference.

One advantage for defendants is that plaintiffs typically do not expect or prepare ahead of time to be plaintiffs, so they likely will not have a system in place to preserve data. Yet they are as much at risk of suffering consequences for the loss of critical evidence as a corporate defendant.

E-discovery law is developing in a way that encourages cooperation. With cooperation, the risk of monetary sanctions diminishes. Agreements can be written that may limit costs or spread them over time. If reasonable steps are agreed upon to protect privileged information, the amount of attorney review time is reduced. The potential for significant cost reduction makes cooperation advisable.

The Export Administration Regulations (EAR), enforced by the United States Department of Commerce, and the International Traffic in Arms Regulations (ITAR), enforced by the United States Department of State, require that businesses in selected industries ensure the security of data or “dual use” commercial items that could assist in developing military capability.

Any corporation that conducts business in the aerospace, defense, automotive, chemical, engineering, construction and high tech industries may be subject to these regulations.

They must control their data sufficiently to avoid the “export” or “deemed export” of certain information and commercial items outside the United States without a license and to prevent access by “foreign persons,” whether they are inside or outside the United States.

A “foreign person” is “not a lawful permanent resident” of the United States. A foreign person can be a foreign corporation or other entity that is not incorporated or organized to do business in the United States. It can also refer to international organizations, foreign governments or any agency or subdivision of foreign governments. It is critical for any business that possesses data subject to the EAR and ITAR regulations to maintain strict protocols for any and all receipts and transfers of technical data. This responsibility extends to any third party providing services to the data owner, including outside counsel and any e-discovery service provider.

The author provides a checklist of recommended procedures that will mitigate the risks associated with these regulations.

By Brad Berkshire Planet Data

How electronic evidence is acquired can vary widely depending on whether the case is a criminal investigation, government investigation or civil litigation, but all these situations have common elements. Potential data sources have mushroomed so they now include, among others, PCs, servers, portable drives, tablets, mobile devices and the cloud. At the same time, circumstances have become more complex, often including cross-border data transfers.

The net result, the author says, is that the person managing evidence acquisition needs to be a specialized and highly trained expert. The author makes the case that, for those who need to retain this kind of expertise, formal certifications like CCE, or Certified Computer Examiner (under the aegis of the International Society of Forensic Computer Examiners) are a useful guide.

CCE training, the author says, is “technology-agnostic,” meaning it emphasizes defensible techniques of evidence handling, regardless of the specific technology employed. The fundamental principles remain the same: proper acquisition techniques; chain of custody documentation; complete, objective analysis and reporting; and thorough documentation to insure defensiblity.

The author notes differences between gathering data evidence in criminal versus civil cases, but he notes also that as technology improves and costs go down, forensic imaging is becoming a more common feature of civil as well as criminal matters. It has become more common for lawyers to capture a drive image of a custodian’s computer and then later extract email and documents containing material relevant to the litigation.

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APR/ MAY 2012 E X ECUTIV E COUNSEL

Executive Summaries

12

E-DISCOVERY

INTELLEC TUAL PROPERT Y

PAGE 25

PAGE 28

PAGE 30

In-House E-Discovery Technology Invokes the Cloud

Rougher Litigation Terrain For Non-Practicing Entities

What to Patent is a Strategic Question

By Michele C.S. Lange Kroll Ontrack

By Michael N. Rader Wolf, Greenfield & Sacks, P.C.

By John G. Rauch Brinks Hofer Gilson & Lione

A recent Harris Interactive-Kroll Ontrack survey found that 86 percent of Fortune 1000 corporations and medium-to-large law firm respondents “insource” some aspect of e-discovery.

Striking the right balance between in-house and outsourced provider-based services can be difficult. In an outsourced model, service providers allow organizations to concentrate on core business functions or the merits of the case. Insourcing achieves more control, but the organization’s staff is responsible for maintaining and operating the systems in a defensible manner.

Any organization considering inhouse e-discovery technologies should consider the status of its existing infrastructure and likely future litigation demands. E-discovery response teams should analyze their strengths and weaknesses before deciding whether a task should be insourced.

Use of cloud-based technologies is growing. Presently, according to the survey, approximately 46 percent of companies and 37 percent of law firms indicate comfort with storing data or conducting e-discovery in the cloud. Two fundamental concerns about discovery in the cloud remain: data security and privacy.

Legal and IT teams can mitigate these concerns by doing their homework before entering into any cloud-based service agreement. Inquire as to the provider’s storage capacity and the location of the data, the underlying technology infrastructure, data-center physical security, user profiles and authentication methods, and monitoring and penetration testing protocols. Cloud-based solutions must be designed to meet the needs of the organization, at the same time they provide the level of security required by clients, ethics rules and IT managers.

Recent trends in patent litigation have made lawsuits brought by non-practicing entities (NPEs) somewhat easier and cheaper to defend. Historically, many of these cases have settled based not on merits but as a function of defense costs. The new developments may shift the balance in the direction of merits-based case valuations.

E-discovery is one of the pressure points available to NPEs when they go after a target. Typically NPEs have only a modest number of documents to produce in connection with the patents they assert, while their targets must produce huge volumes of materials. Leveling the e-discovery playing field would have a profound effect on NPE settlement dynamics, and courts have increasingly sought to streamline the e-discovery process to control patent litigation expenses.

Federal Circuit Chief Judge Randall Rader and the Advisory Council of the Federal Circuit have developed a “Model Order” imposing significant limits on email production – for example, by limiting production requests to five custodians and five search terms per custodian.

Courts also have taken steps to prevent patent cases from proceeding to summary judgment or trial with unreasonable numbers of asserted claims still pending. Attorneys’ fees have been awarded to defendants in a few cases.

The legal environment for NPE patent litigation is shifting in ways that will make it harder for NPEs to extract settlements. How far the pendulum swings will depend on how far district court judges and the Federal Circuit are willing to extend these trends.

The strategic importance of a wellmanaged patent portfolio has the attention of many C-suite executives.

For example, in 2011 Google Inc. offered $12.5 billion for a portfolio of 17,000 patents and 7,000 pending patent applications from Motorola Mobility. It was a clear indication of Google’s intent to expand and defend strategic growth in the smartphone market.

Even smaller portfolios can yield significant value. Tegal Corporation, for instance, sold a portfolio of patents related to nanolayer deposition technology for $4 million.

Companies don’t need thousands of patents to achieve strategic advantage. Many would be better served with a right-sized patent portfolio that supports specific business goals. Patents help companies defend a key technology or product feature that gives them a competitive advantage. For a small company or one focused on particular technology, a patent on a core feature is the most important component of a patent portfolio.

A related defensive strategy is acquiring patents of other companies that relate to your key technology or core feature.

Less well appreciated in the C-suite is the fact that patents can be used offensively. Offensive actions include asserting a patent against an infringer in a lawsuit, or licensing the patent to another company with an interest in the technology. Because it can create revenue stream in the form of royalties, licensing is especially useful for patents on technology that is no longer of interest to your company but is valued by others.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Executive Summaries GOVERNANCE

INTELLEC TUAL PROPERT Y PAGE 34

PAGE 37

PAGE 40

Protecting IP in Government Contracts

Combating Trade Secret Theft Abroad Through Legal Action at Home

Can Internal Investigations be Kept From Shareholders?

By Scott A. Felder Wiley Rein LLP

The laws and regulations that dictate the rights the federal government receives in a contractor’s software and technical data are complicated. They differ depending on whether the contract is with a defense agency or a civilian agency, and whether the procurement is commercial or non-commercial.

Historically, the government has received the same rights as the general public when purchasing commercial items. Although the distinction between commercial and non-commercial acquisitions remains important, recent changes in the rules applicable to Department of Defense (DoD) contracts have blurred the line. These changes reflect a trend towards expanded government rights in contractor IP and increased administrative burdens on contractors. Contractors, particularly those less familiar with public contracts, must be wary of the risks presented by these changes and informed as to how to mitigate them. Otherwise they may surrender rights unnecessarily. Subcontractors that provide slightly modified commercial components as contributions to a larger whole are most vulnerable.

The longstanding statutory presumption has been that commercial items are developed exclusively at private expense, and that contractors retain all rights. This presumption was partially reversed by the 2007 and 2008 National Defense Authorization Acts. The contractor now has the burden of demonstrating development at private expense.

The author lists some best practices to mitigate risk. Among them is keeping close track of your development cycle. An item is “developed” when it exists and is workable. Try to reach this point prior to accepting any government funds.

By Michael Strapp Goodwin Procter LLP

By Jonathan S. Sack Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C.

A federal appeals court recently determined that the International Trade Commission has authority to bar importation of products made abroad using misappropriated trade secrets developed in the United States.

The case involved Amsted Industries, which owned a secret process for manufacturing cast steel railway wheels, but no longer used it in the United States. It licensed the process to several foundries in China, but could not come to terms with Chinese manufacturer TianRui Group, which also had sought a license. TianRui later hired employees from one of Amsted’s Chinese licensees, Datong.

Amsted proved before the ITC that some of those employees had disclosed the process, and that TianRui had imported the wheels it had manufactured into the United States.

The appeals court rejected TianRui’s contention that ITC jurisdiction cannot reach trade secret misappropriation outside the United States. The statute at issue focused on the inherently international transaction of importation, the appeals court explained.

Domestic corporations that learn of trade secret theft abroad can now get an ITC order excluding from importation into the United States goods that are made using the stolen trade secrets.

An exclusion order from the ITC is not the only U.S. legal tool to combat the theft of trade secrets abroad. The Economic Espionage Act, passed by Congress in 1996, makes theft of trade secrets a federal crime. The author addresses the question of how to determine which is the best remedy to invoke under various circumstances.

Addressing the question that titles this article, the author first considers the case of Mark Hurd, former chairman, president and CEO of Hewlett-Packard Company, as a cautionary tale.

Internal investigations of sensitive issues in the corporation typically but not always fall under the attorneyclient privilege or the work-product doctrine. An exception, discussed in the article, is related to corporate governance issues and the so-called “fiduciary exception” in the context of a shareholders’ suit.

Hurd, as head of HewlettPackard, hired a woman to host HP executive events, after seeing her on tv. According to the woman’s attorney, he then pressured her for sex over a period of two years, and along the way disclosed some inside financial information. The HP board retained Covington & Burling to do an investigation, which determined that no sexual harassment had occurred, but that Hurd had violated HP’s “Standards of Business Conduct.” As part of an agreement the board then negotiated with Hurd, he was granted a severance package reportedly worth $35 million. This prompted a wave of shareholder “books and records” demands and shareholder litigation.

One case, originally filed in the Delaware Court of Chancery, was appealed to the Delaware Supreme Court.

It determined that accessing the privileged report was not “essential” to the plaintiff’s case, but did not rule directly on the central issue of privilege.

This decision, the author says, should give companies “comfort – but only limited comfort – that internal investigations will remain confidential.”

13

APR/ MAY 2012 E X ECUTIV E COUNSEL

Executive Summaries HUMAN RESOURCES

14

CANADA /CROSS-BORDER

PAGE 44

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Carrots, Not Sticks, to Fend Off Unions

Canadian Pension Plans Are Private Equity Heavyweights

Private Equity Looks South

By A. John Harper III Haynes and Boone

By Jamie S. Koumanakos and Jeremy Forgie Blake Cassells & Graydon LLP

New federal labor rules concerning unionization alter the current regime by limiting pre-election hearings to determining whether there is a “question concerning representation.” That question arises when a union files an election petition with the NLRB, supported by evidence that a requisite number of employees support a union but the employer has refused to recognize the union. If the Board’s regional director concludes there is such a question, an election is called to resolve it.

The new rules reduce the opportunity for pre-election hearings and eliminate the recommendation that election be set no sooner than 25 days after the election is ordered. A Bloomberg analysis has found that unions win 58 percent of elections held 36 to 40 days after a request, while that rate rises to 87 percent when the vote takes place within 11 to 15 days.

While noting the new rules are not a positive development for employers, the author suggests they could be an occasion for management to make its case that there is little value in joining a union, before any unionization effort begins. “The right plan can boost employee morale for the long-term, increase productivity and avoid legal missteps if a petition is filed,” he says.

Among the policies he suggests: avoiding favoritism, paying fairly, maintaining good working conditions and competitive benefits, and expecting and rewarding high performance and efficiency. If a unionization effort occurs, he suggests consulting legal counsel and budgeting for a countercampaign.

Canada’s public pension plans continue to be involved in high profile mergers and acquisitions globally despite the recent economic turmoil. They have developed a reputation as committed, patient investors who can understand and deal with the “J-curve” path of returns associated with many private equity investments. Their investments include passive limited partner investments in private equity funds, investments in fund-of-funds structures (particularly smaller to mid-size pension funds), direct investments either alone or as a co-investor alongside a private equity fund, and, increasingly, active direct and co-sponsored buyouts.

Several of the larger Canadian public sector pension funds have established long term relationships internationally with private equity firms. A pension fund may want to establish strategic relationships with a private equity firm where, for example, the fund wants access to specialized industries and markets where it does not have the resources or experience to invest directly, or where there is a high probability of co-investment opportunities and the manager or equity firm has a good record in the application of consistent management strategies.

While the Canadian pension plan investments continue to cover a wide spectrum of industries, two areas in which they have been increasingly involved are infrastructure (including, for example, utilities, roads, bridges and ports) and real estate.

These assets can be attractive investments for pension plans due to their long term investment horizon, the possibility of stable returns and, in some cases, the relatively high rate of return.

By Divya Balji mergermarket

Canadian financial institutions are doing better than their U.S. counterparts, so they are buyers in cross-border mergers and acquisitions. They are acquiring capital and expertise while the global economy works in their favor. Law firms that figure prominently in these deals include Blake, Cassels & Graydon, and Torys LLP from Canada, and White & Case, Latham & Watkins and Watchtell, Lipton, Rosen & Katz, from the United States.

Canada’s TD Bank Group made several acquisitions. Its most recent purchase was the purchase of MBNA’s $8.5 billion Canadian credit card portfolio from Bank of America. Before that, in April of 2011, TD spent $6.3 billion to acquire Chrysler Financial Services from Cerberus Capital Management.

Deal activity in the middle market continues strong, with private equity firms seeking reliable cash-producing businesses. Companies that are at a stage where they are ready to grow but might need additional capital or expertise will likely be targets for private equity firms, according to Michael Gans, of Blake, Cassels & Graydon. A recent example is CI Capital’s purchase of IntraPac, for an undisclosed sum.

Canadian utilities also looked south. Canadian companies Fortis Inc and Gaz Metro fought to acquire Central Vermont Public Service (CVPS) last year. Gaz Metro won, and it acquired Central Vermont for $666 million. Fortis recently announced the acquisition of CH Energy for about USD $1.5 billion.

Fortis has said that it will look to the United States to grow, due to the abundance of U.S. takeover targets.

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APR/ MAY 2012 E X ECUTIV E COUNSEL

Executive Summaries PAGE 50

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Aggressive FCPA Enforcement Getting Mixed Results

Law Departments Leverage Analytics

Many Defective Mortgages Are Salvageable

By Philip Urofsky, Marina Moon and Jennifer Rimm 4 Shearman & Sterling LLP

By Keith Okano Bridgeway Software

By Robert A. Scott and Glenn A. Cline Ballard Spahr LLP

The metrics gleaned from analyzing data can help the law department emerge as a strategic partner in the business. Outside counsel fees represent a significant portion of overall spending in many departments, and e-billing solutions can provide the insight necessary to control those costs. However, to optimize performance, gain greater efficiency and make more informed decisions, legal departments need to analyze all costs, internal and external. For valueadding departments, understanding and leveraging metrics can unlock the hidden value of an organization’s legal data. Metrics can change a law department from a cost liability to a strategic asset.

Exposing metrics is changing the way some legal departments work.

“By generating more precise intelligence and reporting from legal activities, we are able to see exactly what’s happening at any given time, and how to react and correct any issues,” says Chad Andrews, Legal Systems Services Leader at Dow Chemical Company. Dow’s in-house team has become better at rejecting invoices that do not adhere to approved billing rates.

Rockwell Automation Inc.’s law firm selection is based on comparisons by venue, practice area and firm performance. Costs can be charged to the appropriate business center.

The quarterly accrual process is streamlined by a high level of data accuracy. Last year Rockwell was able to ascertain that 27 percent of the department’s total spending was tied to its top 10 matters, and their top 10 firms were tied to 57 percent of total spending.

A mortgage may be legally defective for a variety of reasons: The property description may be flawed; it may lack an essential affidavit; or it may be missing a signature.

Such seemingly minor defects can cause problems when a bank seeks to foreclose and faces adverse claims from judgment creditors, competing mortgagees and tax authorities who insist that their liens should take priority over the bank’s legally defective instrument. A bankruptcy trustee may also move for the mortgage to be declared invalid, allowing the estate to avoid the lien entirely.

In some cases, courts turn to equitable doctrines that can salvage the situation for the holder of the defective lien. Under the doctrine of “equitable subrogation,” courts at times impose an equitable lien in cases where the proceeds of a loan were used to pay off a pre-existing lien. Lenders may still suffer a loss, however, because the lien amount is often limited to the amount paid to satisfy the prior lien.

Another argument to defeat a claim of priority over a defective mortgage is constructive notice. The Arizona Court of Appeals recently held that two deeds of trust recorded without property descriptions took priority over a competing mortgage because the facts showed that the holder of the competing mortgage had constructive notice of the defective liens. The court looked to the contract that showed that the holder of the competing mortgage knew it was in “third lien” position.

Recent cases demonstrate numerous ways that a defective mortgage can regain at least some of its priority position.

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The government has been both aggressive and expansive in its enforcement of the Foreign Corrupt Practices Act. However, it has encountered challenges that demonstrate the difficulties presented by these complex cases. U.S. authorities have been able to expand the scope of the FCPA in settled cases involving corporations, but have suffered significant setbacks when trying to enforce it against individuals who prefer trial to settlement.

For non-U.S. defendants, the FCPA requires the government to establish territorial jurisdiction. Enforcement authorities have staked out an aggressive interpretation of this term by reaching out to capture wire transfers between foreign parties using foreign banks that “cleared” through those banks’ U.S. dollar correspondent accounts. In 2011, the DOJ relied on correspondent account liability as the basis of jurisdiction in several cases.

U.S. authorities recently posited a new area of jurisdictional basis: U.S.based e-mail accounts. In an action brought against Magyar Telekom, the DOJ’s sole claim to anti-bribery jurisdiction was based on a foreign official’s U.S.-based email address, whereby email was “passed through, stored on, and transmitted from servers located in the U.S.” In June 2011, the court found no territorial jurisdiction where a DHL package was sent from the U.K. to a government informant in the United States. Given the unique facts of the situation – a shipment solicited by the government and delivered to the government – it remains to be seen whether this ruling will establish a strong enough precedent to influence future cases.

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Executive Summaries

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Top Five Mistakes Companies Make When Confronted With a Search Warrant

Unconscionability Claims Still Breathing

By William Shepherd Holland & Knight

If your company is ever the subject of a search warrant, there are several mistakes that are certain to make a bad situation worse, according to the author, the Chair Elect of the ABA’s Criminal Justice Section.

The first thing to remember is that you are no longer in control of your office or factory. The court has seized your premises to allow law enforcement to search it. You cannot stop what is about to happen. A containment strategy handled by experienced criminal counsel may be possible, but a misstep could lead to arrest for interfering with the execution of a search warrant. That would be a major mistake.

The most common mistake a criminal defendant makes is engaging in conversation. Business-crime search warrants rarely result in a change in “custody status,” and if you are not in custody you will not be given a Miranda warning.

Without that reminder, people tend to make regrettable offhand comments and explanations, but gab is just a gift to the authorities.

Instead, note the agencies involved in the search, who is in charge, whether or not a prosecutor is on scene, and if the search is being filmed.

This kind of intelligence is often the one positive that can come from the search, but to acquire it you will need to keep quiet and observe carefully.

Remain composed. Screaming, weeping, arrogance and demeaning comments to investigators only confirm the stories of your accusers.

By David T. Biderman and Miriam D’Jaen Farhi Perkins Coie

Before the U.S. Supreme Court’s ruling in AT&T Mobility LLC v. Concepcion, states often overturned arbitration agreements with class action waivers based on the doctrine of unconscionability. After Concepcion, it is clear that a class action waiver alone will not invalidate arbitration requirements. But the business community should recognize that the courts are still invoking the doctrine of unconscionability, and other considerations, to invalidate arbitration provisions.

In a recent California court of appeal decision, Sanchez v. Valencia Holding Company, LLC, the court found that the contract was adhesive and contained terms it found to be harsh or one-sided, so the arbitration provision was “permeated by unconscionability” and, thus, unenforceable.

Several state courts have refused to enforce arbitration clauses that create cost barriers to consumer claims. The Ninth Circuit, applying California law, has also refused to enforce arbitration clauses that impose large costs relative to the size of the claim.

Forum selection clauses can also be challenged on the ground of substantive unconscionability. For example, courts in California have repeatedly held that an unreasonable venue provision may render an arbitration agreement substantively unconscionable if it interferes with the claimant’s due process rights or gives the defendant an advantage in the dispute resolution process.

The author provides a list of considerations to keep in mind when drafting arbitration clauses in consumer agreements. Among them: Require affirmative consent; avoid imposing prohibitive costs; and provide clear and conspicuous notice of the arbitration provision.

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“Your problems have a legal precedent.”

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APR/ MAY 2012 E X ECUTIVE COUNSEL

E-Discovery

Why Corporate Defendants Should Embrace E-discovery

By Jeffrey Lilly

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discovery is commonly viewed as dangerous, costly and unfair for corporate defendants.

But defendants that have prepared in advance for e-discovery requests – and

even those that haven’t – are well-positioned to not only respond responsibly to e-discovery requests, but also to use e-discovery to their advantage.

Despite the common perception, e-

discovery provides significant opportunities for corporate defendants.

Keep in mind that the Federal Rules do not have one set of rules for defendants and another for plaintiffs.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

E-Discovery

The burden of preserving electronic information applies equally to both.

Consider, for example, a personal injury lawsuit, and the distinct possibility that social media like Facebook and Twitter hold – indefinitely – a treasure trove of information that could be evidence for a corporate defendant.

While the costs of preserving, searching, collecting, and producing e-data almost always will be significantly more for a corporate defendant, there are multiple ways a defendant can use it to further a successful defense. Consider these points: • “I didn’t know I would sue you” is a poor defense to a spoliation claim. The preservation obligation arises when one reasonably anticipates litigation. The plaintiff, of course, is the first to know the lawsuit is on the horizon. Reasonable minds can disagree about when that is, and when a plaintiff should realize that it should be preserving electronic evidence, but arguably it’s when the potential plaintiff has consulted with an attorney whose advice should be to begin to do so.

Defendants should aggressively pursue e-discovery issues, including whether and when litigation-related information has been discarded or manipulated. If a plaintiff has destroyed potentially relevant information after the incident at issue, the defense has a strong argument for an adverse inference.

Plaintiffs typically do not expect or prepare ahead of time to be plaintiffs, so they likely will not have a system in place to preserve data. How many people have a retention policy at home?

How many think through the possibility of becoming involved in a lawsuit before deleting e-mails or throwing away old CD’s or thumb drives? How many people are prepared to protect the integrity of meta-data at home?

How many think they are protecting themselves by avoiding e-mail and using text messaging at home instead of work e-mail?

Nonetheless, a plaintiff that doesn’t take steps to preserve this data is at as much risk of suffering consequences for the loss of critical evidence as a

corporate defendant. As a defendant, do not be so focused on your own obligations that you forget to demand the same level of compliance from your opponent.

• “Overly broad and unduly burdensome” objections may have been cut and pasted into many a response to a discovery request, but with e-discovery this objection has teeth.

A court will limit discovery pursuant to the Federal Rules of Civil Procedure, if the “burden or expense of the proposed discovery outweighs its likely benefit, considering the needs of the case, the amount in controversy, the parties’ resources, the importance of the issues at stake in the action, and the importance of the discovery in resolving the issues.”

A court also may limit discovery of electronically stored information (ESI) that is “not reasonably accessible because of undue burden or cost.”

As a defendant, do not be so focused on your own obligations that you forget to demand the same level of compliance from your opponent.

Given the potentially exorbitant costs of e-discovery, defendants have a much stronger “burdensomeness” argument than ever before, particularly if the requested material is not easily accessible.

By contrast, plaintiff’s ESI is likely to be much simpler and easier to preserve and collect. Even if it isn’t, the relative ease and cost of complying with this mutual obligation is another bargaining chip that corporate defendants have when negotiating reasonable discovery agreements.

• Cooperation cuts costs. The way that

e-discovery law is developing, legal risks must be balanced against economic costs, primarily by encouraging early cooperation and providing safety nets for disclosure errors. As pressure on litigants to cooperate on e-discovery has increased, so have the benefits for a corporate defendant.

First, the risk of monetary sanctions diminishes if parties cooperate, early and often. Second, e-discovery agreements may allow for staging the discovery process, spreading out and perhaps limiting costs if later stages become unnecessary.

Third, while litigants are compelled to take zero risk that privileged information could be disclosed, the effect of the applicable rules should be to encourage cooperation and protection from inadvertent disclosure, such that the disproportionate costs of preventing inadvertent disclosure are tempered.

Federal Rule of Evidence 502 was established, in part, to address the cost issue. This rule, according to an explanatory note by the Judicial Conference Advisory Committee on Evidence Rules, responds to “the widespread complaint that litigation costs necessary to protect against waiver of attorney-client privilege or work product have become prohibitive due to the concern that any disclosure (however innocent or minimal) will operate as a subject matter waiver of all protected communications or information. This concern is especially troubling in cases involving electronic discovery.”

FRE 502 also states that a disclosure is not a waiver if the privilege holder “took reasonable steps to prevent disclosure.”

Reasonable steps can take several forms. The same Judicial Conference Advisory Committee explanatory note goes on to say that case law sets out “a multifactor test for determining whether inadvertent disclosure is a waiver. The stated factors (none of which is dispositive) are the reasonableness of precautions taken, the time taken to rectify the error, the scope of discovery, the extent of disclosure and the overriding issue of fairness. The rule does not explicitly

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codify that test, because it is really a set of non-determinative guidelines that vary from case to case. The rule is flexible enough to accommodate any of those listed factors ... The implementation of an efficient system of records management before litigation may also be relevant.”

The bottom line is that if reasonable steps can be taken to protect privileges, such that the inordinate amount of attorney review time is reduced, and discovery agreements are reached at the outset of a litigation, the resulting cost reduction will make the cooperation economically advisable. “Quick-peek” and “claw-back” agreements provide additional protection against inadvertent disclosures.

When plaintiffs use e-discovery requests as a weapon by making unreasonable requests, fire back immediately. Make clear that you are complying with your preservation obligations, that you expect plaintiff to do the same, and that you wel-

come an opportunity to sit down and discuss your mutual obligations.

The opposing attorney at that point may not be so eager to meet, and assuming you have been proactive in preparing for such a request, chances are you will be better prepared than the plaintiff.

It remains true that despite the mutual obligations to preserve electronic data, costs will almost always be higher for a corporate defendant. However, the concept of cost-shifting is gaining traction, and that is another factor that should be included in early negotiations on the scope of discovery. The framework for pursuing cost shifting is established in the Federal Rules of Civil Procedure as part of Rule 26.

Ultimately, the Federal Rules create an avenue for a party to argue under some circumstances that preservation involves undue cost, and that if the materials are required to be produced, some cost shifting should be ordered.

This is a significant tool to use in negotiating discovery at the outset of a lawsuit. Some courts have indeed assessed costs for electronic discovery against a losing party, and that prospect may rein in a plaintiff that is aggressively seeking voluminous discovery. ■

Jeffrey Lilly is a partner at Gordon & Rees, in the Austin, Texas, office. He is a member of the firm’s Drug & Medical Device and Tort & Product Liability practice groups, and co-chair of the firm’s E-Discovery Practice. He represents clients in product liability, toxic tort and commercial litigation matters in state and federal courts, and represents witnesses both nationally and internationally. jlilly@gordonrees.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

E-Discovery

E-discovery Data Subject to Export Control Laws

By Jayne Rothman

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efore electronically stored information is provided to other parties, numerous regulations need to be considered. Those regulations stem from, among other domestic sources, the Health Information Portability Accountability Act, the Gramm-Leach-Bliley Act and the Fair Credit Reporting Act. In addition, various international regulations (e.g., blocking statutes and data protection laws) complicate data transfers across national boundaries.

This article provides an overview of a lesser understood set of regulations, those aiming to protect the transfer of knowledge regarding military technology and related technical data. The Export Administration Regulations (EAR), enforced by the United States Department of Commerce, and the International Traffic in Arms Regulations

(ITAR), enforced by the United States Department of State, require that businesses in selected industries ensure the security of data or certain “dual use” commercial items that could assist in the development of military capability.

Together EAR and ITAR are referred to as the U.S. Export Control Laws and Regulations. Any corporation that conducts business in the aerospace, defense, automotive, chemical, engineering, construction and high-tech industries may be subject to these regulations. They must control their data sufficiently to avoid the “export” or “deemed export” of certain information and commercial items outside the United States without a license and to prevent access by “foreign persons,” whether such persons are inside or outside the United States.

Violations can result in substantial

penalties. Individual liabilities for the disclosure of controlled technical data to unauthorized foreign persons under ITAR include fines of up to $500,000 per civil violation and up to ten years of imprisonment, along with penalties of up to $1,000,000, per willful criminal violation. Liabilities under EAR may involve fines ranging from $10,000 to $120,000 for each civil violation and fines ranging from $50,000 to $1,000,000 for each criminal violation, with up to ten years of imprisonment.

A “foreign person” is a person who is “not a lawful permanent resident” of the United States (not a United States citizen or green card holder) or does not have refugee or asylum status. A foreign person can also be “any foreign corporation, business association, partnership, trust, society

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or any other entity or group that is not incorporated or organized to do business in the United States, as well as international organizations, foreign governments and any agency or subdivision of foreign governments (e.g., diplomatic missions).”

In general, “export controlled data” includes specific information needed to develop, produce, maintain, manufacture, assemble, test, repair, operate, modify, process or otherwise use equipment or technologies that are on the control lists of the EAR or the ITAR. Export controlled data can be, for example, a diagram, tables or formulae, a manual, or plans or designs contained in an email.

It is critical for any business that possesses data subject to the U.S. Export Control Laws and Regulations to maintain strict protocols for any and all receipts and transfers of technical data, as the definition of “export” is quite broad. This responsibility extends to any third party providing services to the data owner, including outside counsel and any e-discovery service provider.

Therefore, particular caution must be used when utilizing legal services such as data collection, litigation support, database hosting or document review to ensure that such service provider is “ITAR compliant.”

Once an e-discovery company has been contacted by a corporation or its outside counsel to provide legal services, certain key questions need to be asked to assess whether steps should be taken to ensure compliance with the Regulations. These questions include whether the client conducts business within the affected categories under the ITAR or EAR, and whether technical data may be included in the submitted data set for processing.

Data subject to the Regulations must not be exported, provided or made accessible to any foreign persons.

This would embrace the following activities: sending copies, providing access to the data, and sharing or disclosing the data in any form, including written, verbal and visual, and it would implicate document review projects.

Data export is interpreted broadly,

so it’s critical to ensure that the regulated data is secured, with access provided only to authorized users who are not foreign persons. Any employee or contractor assigned to the project should be trained regarding compliance and required to sign a certificate affirming at least that he or she is familiar with the export control issues involved in the matter; has read and understands the certification; is aware of his or her personal liability upon a disclosure of export controlled technical data to foreign persons; agrees to take reasonable measures to prevent unauthorized foreign persons from having access to or using any export controlled technical data; and agrees to contact the company legal department immediately in connection with any potential or actual unlawful disclosure of export controlled technical data to any foreign person.

Key Recommendations foR handling technical data

• Properly identify the data. Implement measures to require that it is clearly marked and identified (typically by the client data owner) prior to transfer from the data owner.

• Isolate and secure the regulated data.

• Prevent electronic access by unauthorized persons. Separate physical access. Require enclosed, secure “authorized access only” areas for document review projects.

• Take all appropriate measures to ensure that the data will not be inadvertently viewed or accessed by a foreign person. This would include creating a secure, separate database to hold the data, with a separate user account creation process that requires the HR Department to verify non-foreign person status, and monitoring - and when appropriate disabling - remote access to the data.

• Identify the specific customer service group that will have access to the data. Clients that own export controlled data will need to communicate with the client services team regarding deliveries,

data processing and other document review related issues during the matter. Customer service team members must not be “foreign persons.” Therefore, identify U.S. nationals to serve as dedicated client service representatives.

• Communicate, educate and train.

E-discovery service providers that obtain, process and manage data subject to the Regulations should prepare and distribute memoranda and checklists describing business and legal requirements and regularly train and educate employees.

Hire outside counsel to assist in developing compliance protocols.

Make sure that each employee has passed a criminal background check. Require the client or its outside counsel to provide a list of client employees authorized to access the data. Require that work on the project be completed within a secured space with self-locking doors, and with authorized access only. Disable any feature on workstations that allows users to download and transmit information. Allow hard copy printing to be performed only in access-controlled areas, and require employees to shred printed documents.

There are substantial risks in handling data subject to the Regulations, but the risks can be mitigated by designing an appropriate infrastructure and implementing some of the recommended protocols. The investment of time, personnel and financial resources to ensure compliance with such protocols are well worth the effort. ■

Jayne Rothman is Corporate Counsel to Epiq Systems, Inc. and its subsidiary companies.

Prior to joining Epiq, she practiced at Dewey Ballantine LLP and Weil Gotshal & Manges LLP. jrothman@epiqsystems.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

E-Discovery

Digital Forensics and Discovery Management are Certified Specialties

By Brad Berkshire

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he way electronic evidence is acquired can vary widely depending on whether the case is a criminal investigation, government investigation or civil litigation, but in all cases the person managing the acquisition needs to be well trained in the process of electronic evidence handling. In each of these scenarios, there are now so many sources of digital information that insuring sound, defensible and repeatable data collection processes has become a formidable challenge. Every case is likely to have unique data sources and circumstances requiring unique solutions. There is no

“one size fits all” approach to acquiring and handling electronic evidence.

This is an especially important consideration in discovery management, where a large civil case can involve the “live,” non-forensic collection of thousands of gigabytes of data from several domestic and international corporate I.T. sources.

In this situation, a company or its outside counsel may decide to retain a discovery management or data collection expert to oversee the process, which can be very different from that in a criminal investigation where only a single hard drive forensic image may be required.

While it’s true that a forensic exami-

nation case likely will require a more thorough technical analysis of recovered files, including items from deleted space and slack space, both scenarios require similarly sound processes and fundamental precautions in acquiring and handling the recovered data.

These processes include industrystandard data acquisition technologies that protect the integrity of live, active file copies of original electronic documents, or the use of forensic tools that provide the “bit-by-bit” forensic image of a suspect hard drive. In either case, well-documented procedures are required. With the increasing likelihood of cross-border data

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sources, it becomes even more important to use a qualified resource.

With these demanding requirements, how is it possible to identify and retain a qualified expert in this field? And looking at it from the other side, how can a legal, technology, or investigative professional train to attain exceptional expert status in this field?

One answer is to look to the forensic and discovery management certification courses that teach best practices for electronic evidence collection and analysis. All the major forensic certifications involve significant prerequisite technology experience, in addition to lengthy hands-on instructor training and practical examination scenarios.

One of these certifications is the CCE (Certified Computer Examiner), established in 2003. The CCE is governed by the International Society of Forensic Computer Examiners (ISFCE) and favors a process-oriented curriculum – that is, one that doesn’t highlight the use of any single technology platform to perform acquisition or analysis work.

Instead, the CCE curriculum takes a “technology-agnostic” approach that focuses on teaching defensible techniques in all phases of the electronic evidence collection and analysis process. An underlying principle is that regardless of the technology or forensics toolkit used, the examiner must make certain that all evidence handling processes follow accepted and established techniques, and that the resulting evidence acquisition or evidence analysis is admissible and defensible in court.

To this end, the CCE curriculum can prepare the examiner for the complex technology issues that arise in capturing data from all of today’s wide range of sources, including PCs, servers, portable drives, tablets, mobile devices and cloud computing environments.

Regardless of the source or the scale of the evidence capture, the fundamental principles remain the same: proper evidence acquisition techniques; chain of custody documentation; complete, objective analysis and reporting; and thorough documentation of all these processes to insure they are defensible.

As testimony to the increasing

importance of expert-assisted evidence handling in civil disputes or investigations, the CCE and the other forensic certification programs are seeing more students from discovery management providers, corporations and law firms.

The certified experts are no longer providing just forensic imaging, analysis and expert testimony in criminal cases. They are also being tasked to provide consultative and process management oversight across a variety of corporate litigation and government investigation scenarios. Experience will always be a factor, but the basics of the CCE or other forensic certification are practical solutions, sound processes, and defensible workflows.

Traditionally, the ability to perform digital forensics may be the most well known skill possessed by certified examiners. While forensic imaging is not necessary in all civil litigation, an increasing number of cases are seeing forensic imaging as a combined, over-preservation and targeted collection technique.

The cost and time required for drive imaging is generally going down as acquisition technologies advance and become more efficient, even though hard drive sizes continue to increase. It has become common for a law firm or corporate litigant to capture a preservation drive image of a custodian’s PC and then target and extract individual email stores and e-doc folders containing material relevant to the litigation.

This process can be less expensive for the company and less invasive for the employee, as compared with a lengthy in-person custodian interview combined with a time-consuming, live, active-file data capture. Should the litigant have to perform supplemental collections from a custodian’s hard drive, the preservation image is accessed and these files are recovered quickly and defensibly without the need to return to the custodian’s original data source.

Imaging can also become the best acquisition option for companies with remote workers or teams. Advances in automated remote imaging and ‘over-theinternet’ secure tunneling technologies, e.g. “F-Response,” have provided forensic experts with low-cost options to use

standard forensic toolkits to capture hard drive images from remote workers.

Preservation imaging is also common practice when a company is under litigation-hold order and a snapshot of a terminated employee’s desktop data is required prior to the employee’s departure.

The preservation image is held in digital storage, and if the terminated employee’s data becomes relevant to litigation, his or her files can be recovered quickly and defensibly using forensic recovery toolkits.

Finally, in any case scenario where there is an accusation or suspicion of intentional records destruction, forensic imaging is the preferred acquisition method for full capture of an employee’s individually stored data.

In summary, supporting any of these efforts requires the same sound techniques and processes required for a criminal forensic examination, and for that reason law firms and corporate counsel should seek qualified experts to oversee, manage, and perform data acquisition and recovery work. There is no single process formula, as the work required can vary widely from one engagement to the next.

Understanding and communicating the right approach requires training, experience, and a solid foundation in best practices. Regardless of the matter’s scope or venue, data acquired in response to litigation or investigation is evidence, and it must be handled properly to ensure its integrity and admissibility in court, and that the methods employed to gather it are defensible. The CCE is a good example of a certification that can provide this foundation. ■

Brad Berkshire, Vice President of Consulting Services for Planet Data, consults with clients in the areas of litigation and discovery management. He is a Certified Computer Examiner (CCE), as awarded by the International Society for Computer Examiners (ISFCE). bberkshire@planetds.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

E-Discovery

In-house E-discovery Technology Invokes the Cloud

By Michele C.S. Lange

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orporations and law firms continue to sharpen their ediscovery capabilities to gain efficiencies and reduce costs across all stages of the Electronic Data Reference Model (EDRM): information management, identification, preservation, collection, processing, review, analysis, production and presentation.

In many cases this means bringing “do-it-yourself” (DIY) e-discovery technologies in-house, to be operated by skilled company IT and legal staff.

Eighty-six percent of Fortune 1000 corporations and medium-tolarge law firm respondents indicated that they in-source some aspect of e-discovery, according to a recent

Harris Interactive-Kroll Ontrack survey (“Nine Trends in the Evolution of E-discovery”).

Given current economic conditions and the maturation of the ediscovery industry, this comes as no surprise. In-sourcing of e-discovery both saves money and increases control over litigation projects.

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E-Discovery

This process often raises questions.

Specifically, many corporate legal teams and their law firms are asking:

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How can my organization better manage costs and increase control over discovery?

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Which aspects of e-discovery are best in-sourced and which are best outsourced?

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Can my organization hire the talent needed to manage insourced technology?

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Striking the right balance between in-house and outsourced providerbased services can be difficult, with potentially millions of dollars on the line. In an outsourced model, expert service providers add value and perform the heavy lifting, allowing your organization to concentrate on core business functions or the merits of the case. For in-house DIY solutions, the promise of more control comes at the expense of the organization’s staff being responsible for maintaining and operating the systems in a defensible manner.

There is no one-size-fits-all approach. Any organization considering in-house e-discovery technologies should consider carefully both its existing infrastructure and its likely litigation demands. E-discovery response teams should analyze their strengths and weaknesses before deciding whether a particular EDRM task should be in-sourced. Does in-house IT have the knowhow to manage information and ensure preservation?

Do in-house counsel have the labor resources to take on document review?

Is there adequate logistics and proficient attorney, litigation support, or paralegal teams to handle review and production of e-mail, loose files, server data, cell phone data, social media data and other types of ESI? Once a corporation or law firm has decided in principle to employ a DIY e-discovery solution, it must choose a specific technology. The top three factors to consider are ease of

use, data security and compatibility with existing investments. Keep in mind that it will be important to avoid downtime, and that organizations are ethically obligated to ensure that clients receive defensible and cost-effective results.

To that end, use of cloud-based technologies (also known as “software as a service” or SaaS platforms) is growing rapidly. Presently, according to the “Nine Trends” survey, approximately 46 percent of companies and 37 percent of law firms indicate that they are comfortable storing data or conducting e-discovery in the cloud. Companies of all sizes, public and private, that are seeking to reduce storage costs, improve overall efficiency and integration with partners, are increasingly turning to the cloud to house critical business information and run essential corporate functions remotely.

Accordingly, legal professionals are now obliged to consider how cloud-based platforms have affected the legal market and e-discovery practices, and how they are likely to do so in the future. The fact is that cloud and SaaS-based solutions have driven innovation in the e-discovery market since the introduction of SaaS-based document review tools in the 1990s. Today, e-discovery software and service providers are providing tools to help users manage, preserve, collect, process, review, analyze and produce documents on a single platform, harnessing the power of cloud-based technology.

Unlike e-discovery software installed within an organization’s physical building space, cloud discovery technologies are extremely flexible and put control of the EDRM into the hands of the organizations that use them without requiring IT installation, maintenance and general oversight.

The cloud relieves corporations and law firms of the burden of discovery data hosting, which is expensive and requires numerous trained personnel to implement and maintain a secure information infrastructure. For many corporations and law firms, hosting

data in-house is implausible, simply because they lack the required fiscal and human resources.

The most significant benefit of the cloud, however, is 24/7 global availability, a factor that can be critical in today’s competitive litigation environment. These systems are installed on remote servers and can be conveniently accessed on-demand, anywhere in the world, via web browser.

Still, two fundamental concerns about discovery in the cloud remain: data security and privacy. Legal and IT teams can mitigate these concerns by doing their homework before entering into any cloud-based service agreement. Inquire as to the provider’s storage capacity and the location of the data, the underlying technology infrastructure, data center physical security, user profiles and authentication methods, and - perhaps most important - monitoring and penetration testing protocols.

It will be important to work with a trusted provider, so that in the end the cloud-based solution meets the needs of the organization, at the same time it provides the level of security required by clients, ethics rules and IT managers.

There is no longer a universally accepted common approach to e-discovery.

Corporations and law firms need to monitor the evolution of these technologies – especially the increasingly prevalent cloud and SaaS-based solutions. ■

Michele C.S. Lange, a director with the Discovery product line at Kroll Ontrack, guides evolution of the company’s legal technology products and services.

She also counsels clients on integrating electronic discovery into their case strategy. An attorney, she is co-author of the American Bar Association book, Electronic Evidence and Discovery: What Every Lawyer Should Know. mlange@krollontrack.com

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apr/ May 2012 E X ECUTIV E COUNSEL

Intellectual Property

Rougher Litigation Terrain for Non-Practicing Entities

By Michael N. Rader

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S

everal recent trends in patent litigation have made lawsuits brought by non-practicing entities (NPEs) somewhat easier and cheaper to defend.

Historically, many of these cases have settled based not on their merits but as a function of defense costs.

While legal costs will continue to be a factor in settlement of NPE cases, these developments may shift the balance somewhat toward merits-based case valuations.

production – for example, limiting production requests to five custodians and five search terms per custodian.

In several cases, the Eastern District of Texas has adopted a version of Judge Rader’s Model Order, and the District of Delaware recently took similar steps when implementing its own default e-discovery rules. If routinely implemented in patent cases, such standards are likely to limit the ability of NPEs to use the threat of discovery as a settlement tactic.

E-DiscovEry rEforms

Limiting thE numbEr of cLaims

Discovery, in particular e-discovery, is one of the great pressure points that NPEs have when the go after a target.

Typically NPEs have only a modest number of documents to produce in connection with the patents they assert, while their targets must sift through, process and produce huge volumes of materials. Leveling the e-discovery playing field would have a profound

effect on NPE settlement dynamics.

Indeed, courts have increasingly sought to streamline the e-discovery process to control patent litigation expenses. For example, Federal Circuit Chief Judge Randall Rader and the Advisory Council of the Federal Circuit have developed a “Model Order” imposing significant limits on email

Courts also have taken steps to prevent patent cases from proceeding to summary judgment or trial with unreasonable numbers of asserted claims still pending.

Many judges have adopted casespecific procedures, under which patent owners must settle on a limited number of “representative” claims to be tried.

Chief Judge Rader himself has imposed

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Intellectual Property such requirements when sitting by designation on district courts.

The Federal Circuit’s February 2011 In re Katz Interactive Call Processing Patent Litigation decision implicitly endorsed such claim selection procedures.

The Katz litigation arose out of efforts by an NPE to leverage a portfolio of interactive voice-response patents, including almost 2,000 claims, against a group of 165 defendants. The presiding judge limited the plaintiff to 100 claims, with the option to add more if it could demonstrate that they raised unique issues. The plaintiff appealed these limits, but the Federal Circuit endorsed the judge’s procedure, opening the door for more district courts to pare down NPE cases.

Deterring Strike SuitS

Surprising as it may seem, the Eastern District of Texas has emerged as a leader in innovative approaches designed to prevent NPEs from using traditional litigation requirements and

more than the settlement range on discovery, or settle for what amounts to cost of defense, regardless of whether a defendant believes it has a legitimate defense.”

More widespread adoption of procedures like these would have a profound effect on the dynamics of NPE patent litigation across the country.

JoinDer reStrictionS

Traditionally, many NPEs have named dozens of defendants in the same case to minimize filing fees and subsequent litigation costs. The America Invents Act effectively ended this practice by permitting joinder only when all defendants are making, using, selling, offering to sell or importing “the same accused product or process.”

The need to pay dozens, or even hundreds, of $350 filing fees instead of just one will inevitably impact the economics of NPE litigation, at least at the margins. While some NPEs may be tempted to send letters rather than file

Gone are the days when NPEs could sue 50 defendants almost as easily as they could sue one. schedules to coerce settlements based on legal expense rather than the merits.

Judge Leonard Davis, in particular, has emerged as a leader in evaluating such initiatives, by way of: • Holding “mini-Markman” and summary judgment hearings early in a case on key claim terms that may be case-dispositive.

• Requiring expedited discovery of earlier settlements and/or existing licenses.

• Encouraging early summary judgment motions on damages theories.

• Staged trials, starting with validity issues.

Judge Davis has commented that NPE cases can present accused infringers “with a Hobson’s choice: spend

suit, doing so would risk inviting declaratory judgment actions. Presumably at some point certain NPEs will elect to bypass claims against some potential targets altogether. Gone are the days when NPEs could sue 50 defendants almost as easily as they could sue one.

It is unclear whether the restrictions on joinder will have more significant effects on NPE litigation. One critical question is whether courts will be receptive to the routine use of Rule 42 to consolidate cases involving the same patent or patents for pre-trial purposes.

Nothing in the America Invents Act prohibits such an approach. tranSfer MotionS

Following a trend that started in 2008 with the In re TS Tech case, the Federal Circuit has continued to scru-

tinize district court decisions denying defendant motions to transfer cases out of districts that have only tenuous connections to the dispute in question.

Most of these cases involve NPEs that brought suit in the Eastern District of Texas, although the December 2011 In re Link_A_Media decision ordered transfer out of Delaware.

Responding to earlier transfer decisions, many NPEs have taken steps to “anchor” themselves in Eastern Texas or other preferred districts. For example, they sometimes incorporate and/or set up purported offices (including by transferring patent-related documents) in the desired forums prior to filing suit. They may also include one or two Texasbased defendants, along with others.

NPEs also can file multiple rounds of litigation, beginning with defendants rooted in the forum and later moving on to those with little or no connection.

When later defendants complain, NPEs stress the judicial economy of handling all of the litigation in the same district.

The Federal Circuit has increasingly rebuffed these tactics, however, even ordering cases transferred when the Texas judges had previous experience with the asserted patents. In the future, more NPE cases will be defended in the accused infringer’s home court, which is cheaper (and more advantageous) to defendants and more costly to NPEs. awarDing attorneyS’ feeS

Patent law requires unsuccessful patent owners to pay the attorneys’ fees of prevailing defendants in “exceptional” cases. Two recent Federal Circuit decisions have affirmed such awards, while two others have reversed them. Collectively speaking, these cases suggest that the threat of a fee award is something NPEs need to take seriously, but not something which defendants should count on.

In Eon-Net v. Flagstar Bancorp, the Federal Circuit affirmed the district court’s decision to award more than $600,000 in attorneys fees and sanctions against an NPE that filed suit against a defendant based on a frivolous infringement theory. The suit was continued on page 33

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APR/ MAY 2012 E X ECUTIV E COUNSEL

Intellectual Property

What to Patent is a Strategic Question

By John G. Rauch

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Intellectual Property

M

ajor patent transactions are in the news, and the financial and strategic importance of a well-managed patent portfolio has the attention of many C-suite executives. In 2011, for example, Google Inc. offered $12.5 billion for a portfolio of 17,000 patents and 7,000 pending patent applications from Motorola Mobility.

It was a clear indication of Google’s intent to expand and defend strategic growth in the smartphone market.

Google had previously bid on bankrupt Nortel Networks’ patent portfolio, which was sold at auction to a consortium that included Apple, EMC, Ericsson, Microsoft, Research In Motion and Sony, for $4.5 billion.

Even smaller portfolios can yield significant value. Tegal Corporation, for instance, sold a portfolio of patents related to nanolayer deposition technology for $4 million.

As these and other transactions suggest, developing or acquiring a patent portfolio can be a source of significant competitive and financial advantage for an innovative company, especially in the life sciences, chemicals or information technology sectors.

But companies don’t need thousands of patents to achieve strategic advantage.

Given the time and resources required to pursue and maintain a patent – and the cost of litigation to enforce patent rights – many would be better served with a right-sized patent portfolio that supports specific business goals.

Now, some companies are beginning to ask their corporate counsel and technology

managers whether their patent portfolios are being actively managed.

Typical questions include: Why do we own these patents? What other inventions should we patent?

What patents should we license or sell? How much will this cost? The answers are all part of developing a patent portfolio strategy.

DEFENSE

As most general counsel are aware, a U.S. patent can be a powerful defense of a new invention, giving its owner the right to exclude others in the United States from making, using or selling the covered product or technology. Patent rights may be enforced in the federal courts or, if a domestic

OFFENSE

Less well appreciated in the C-suite is that patents also can be used as an offensive weapon. Offensive actions include asserting a patent against an infringer in a lawsuit or licensing the patent to another company with an interest in the technology. Licensing is especially useful for patents on technology that is no longer of interest to your company but is still valued by others, because it can create revenue stream in the form of royalties.

Patents also can be transferred for cash or other compensation when the purchaser values ownership more than the seller does. Identifying a licensee or purchaser requires effort, but these transactions can add value from assets

Deciding what to patent requires focusing on business goals and gauging available resources. patent is infringed by imported products, before the U.S. International Trade Commission.

Clearly, patents help companies defend a key technology, component, or feature of a product that gives them a competitive advantage and sets them apart in the market. For a small company or one focused on particular technology, a patent on a core feature is the most important component of a patent portfolio.

A related defensive strategy is acquiring patents of other companies that are related to your key technology or core feature. Research and competitive analysis may disclose other companys’ patents that complement that technology or its market, in a situation where your patent has left openings for design-arounds that could be implemented with the complementary patents. But if you own the patent on the design-around as well as on the core product, you have stronger rights to keep others out of the market – in effect, by way of a picket fence around your core feature.

that were not generating value before.

Another offensive strategy, now more frequently employed in the technology and research sectors, is to patent an element of a competitor’s technology before the final product is actually invented. In some industries, marketers and technologists keep close watch on competitors and their products to see what next-generation competitor products will look like. A patent application filed on an innovation that a competitor will require in the near future can block that competitor or force it to spend time and money on a design-around.

DEVELOPING THE PORTFOLIO

These considerations lead to the next set of questions for the corporate counsel, about how best to develop a patent portfolio that allows for both defensive and offensive strategies: • Can we patent our company’s technologies?

• What should we patent, and when?

• How should we prioritize our patenting?

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apr/ May 2012 E X ECUTIV E COUNSEL

Intellectual Property Business managers, marketers and technologists all should be involved in answering these questions.

Patentability of your technology requires that it be new, useful and not an obvious innovation by the standards of patent law. Novelty generally requires that an invention has not been publicly disclosed, although current U.S. law provides for a one-year grace period after publicizing an invention.

Meeting the requirement for usefulness is usually easy, although some business method and biotechnology inventions recently have received close scrutiny by U.S. Patent and Trademark Office (USPTO) examiners. Your patent

maintain confidentiality through nondisclosure agreements. At some point, however, a product or service must be publicized and that will require action to protect the invention. Events such as new product launches and trade shows are occasions to contact a patent attorney to review what can and should be patented.

Patenting early in the development process, once you have identified a solution to the problem, but possibly before solving implementation details, leads to a simpler application than one for later development stages. You are not obligated to update the written description later. However, if important

exist before the patent is issued.

Fortunately, the USPTO recently has begun a new program of prioritized patent application examination, colloquially called Track I, or Fast Track. For an additional fee (now $4,800), USPTO promises to process the application within 12 months.

The first patent through the Track I process was issued to Google on January 10, 2012, just over three months from the date the application was filed in the USPTO. In many companies, heightened awareness of the value of a welldesigned patent portfolio has renewed interest in patenting. At the same

Upcoming events such as new product launches and trade shows are occasions to contact a patent attorney to review what can and should be patented.

32 attorney can help craft the application to best cover permitted subject matter.

Deciding what to patent requires focusing on business goals and gauging available resources. Core features if possible should be protected, especially those that required the most research and development and solved particularly difficult problems. Companies should consider patenting manufacturing techniques, software, or online tools developed in executing a business strategy, any and all of which can create a business advantage.

A strong published patent application teaches competitors how to solve the problems your invention addresses, but it keeps them from duplicating your invention. A patent attorney can help prepare your patent application in a way that provides sufficient detail for the patent examiners, at the same time that it anticipates future challenges to your claims.

Ideally, your patent application will be filed before any event publicizes the invention. Companies working with others outside the company, such as suppliers or customers, should

inventions continue to occur during development, those innovations can be captured in subsequent applications that build on the first to further protect your investment.

Planning is critical. A company must allow sufficient time to develop the invention and to draft and revise the patent application. Ninety days is typical. After filing, there can be a long wait for USPTO examination results. The USPTO’s goal is to issue an examination report within 14 months, but the delay is typically two years and can be as many as four. The usual examination report is a rejection of the invention, but the routine is to amend the application and request reconsideration. The majority of patent applications are eventually allowed, although the current average pendency is about 34 months.

The delay that occurs while a patent is pending can be frustrating when the proposed patent is essential to your business. Obtaining financing or being able to block a competitor, for example, can hinge on having the issued patent in hand, since no rights

time, increasing budget pressures have required many companies to reduce their patenting expenditures, so it has become increasingly important to be strategic and cost-effective in designing and developing a portfolio.

A business doesn’t need thousands of patents to build significant portfolio value, but the inventions of most value to the company and others can produce substantial value. â–

John G. Rauch is a shareholder at Brinks Hofer Gilson & Lione. A former patent attorney at Motorola, he specializes in patent prosecution and counseling, licensing, and preparing opinions, with extensive experience in computer technology, business methods, online commerce, networked search systems and business-to-business systems, telecommunications and electronics. jrauch@brinkshofer.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Intellectual Property

Rougher Litigation Terrain for Non-Practicing Entities continued from page 29 one out of more than a hundred that the plaintiff and related entities had filed. The patentee had a history of making formulaic offers proposing to drop cases in return for lump sum payments of between $25,000 and $75,000. The Federal Circuit took this pattern as indicative of extortion.

In another recent case, Marctec, LLC v. Johnson & Johnson, the Federal Circuit affirmed a $4.68 million attorney fee award in favor of a stent manufacturer that had obtained summary judgment of non-infringement as to an NPE’s medical device patent --again, where the NPE’s infringement theory was exceptionally weak.

By contrast, in two other recent cases, iLOR, LLC v. Google, Inc. and Old Reliable Wholesale, Inc. v. Cornell Corporation, the Federal Circuit reversed attorneys’ fee awards. In iLOR, the court found that the plaintiff’s erroneous claim construction proposal was at least “reasonable” given the facts of the case. In Old Reliable, the court concluded that a key concession by an

important plaintiff’s witness about the prior art was not dispositive of the patent’s validity, and thus proceeding with the case did not amount to bad faith.

Reconciling the results in these cases is difficult. It bears note that the plaintiffs in Eon-Net and Marctec were NPEs, whereas Old Reliable and iLOR had made bona fide efforts to practice their own inventions. While not specifically acknowledging it, courts may in practice be more inclined to give the benefit of the doubt to patent owners that bring suit in the face of potential business disruptions, crippling discovery costs, and the risk of infringement counterclaims.

By contrast, NPEs generally can file suit without worrying about such issues.

While still an infrequent occurrence, attorneys fee awards against NPEs may have some impact on their willingness to bring particularly weak claims to extract cost-of-litigation settlements.

Collectively, the above trends suggest that the legal environment for NPE patent litigation is shifting in ways that

will make it harder for NPEs to extract settlements based on expected legal expense rather than the merits of a case.

How far the pendulum swings will depend on how far district court judges and the Federal Circuit are willing to extend these trends. ■

Michael N. Rader is a shareholder at Wolf, Greenfield & Sacks and co-chair of the firm’s Litigation Practice Group.

He represents the firm’s clients as lead counsel in patent, trademark and copyright litigation matters in courts nationwide and before the International Trade Commission. His experience spans a variety of technologies, including medical devices, semiconductors, sporting goods, coffee brewing equipment and transgenic mice. mrader@wolfgreenfield.com

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APR/ MAY 2012 E X ECUTIV E COUNSEL

Intellectual Property

Protecting IP in Government Contracts

By Scott A. Felder

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Intellectual Property

T

he laws and regulations that dictate the rights the federal government receives in a contractor’s intellectual property make up a complicated web, reflected in the wide variety of contract clauses that allocate rights in contractors’ patents, technical data, and computer software. Indeed, a contractor will encounter substantially different rules regarding its technical data and computer software depending upon whether the contract is with a defense agency or a civilian agency.

Another key distinction is whether the procurement is commercial or non-commercial in nature. Historically, the government has received the same rights as the general public when purchasing commercial items.

(Commercial items are items that are offered to the general public in the standard commercial marketplace for use for non-governmental purposes.)

Coupled with the statutory preference for commercial item contracting, contractors could assume that their IP rights would be well protected if they were furnishing commercial items or software to the government.

Although the distinction between commercial and non-commercial acquisitions remains important, recent changes in the rules applicable to Department of Defense (DoD) contracts have begun to blur the line between them. These changes reflect a trend towards expanded government rights in contractor IP and increased administrative burdens on contractors, without disturbing the statutory preference for commercial item contracting.

Contractors – particularly those less familiar with public contracts – must be wary of the risks presented by these changes and know how to mitigate them. Otherwise they may surrender rights unnecessarily.

Subcontractors that provide slightly modified commercial components as contributions to a larger whole are most vulnerable.

This article discusses some implications of the recent changes and provides recommendations contrac-

tors can adopt to safeguard their IP when dealing with the DoD. In the discussion that follows, “IP” refers to technical data and computer software, but not to patent rights, which are allocated separately via clauses that are beyond the scope of this article.

PRESUMPTION REVERSED

DoD contracts allocate IP rights between the contractor and the government based on who paid to develop the item to which the IP relates. The greater a party’s financial contribution, the greater that party’s rights.

Thus, if the government pays 100 percent of the cost to develop a new computer program, it typically will

If the government pays 100 percent of the cost to develop a new computer program, it will typically receive a license to use that software for any purpose and share it with anyone, even the developer’s competitors. receive a license to use that software for any purpose and to share it with anyone, even the developer’s competitors.

If, on the other hand, the contractor had developed that same program at private expense, the government’s rights would be considerably restricted. A middle ground, called Government Purpose Rights, exists for mixed funding situations.

The longstanding statutory presumption has been that commercial

items are developed exclusively at private expense. By default, therefore, the government would receive only narrow rights in commercial computer software and commercial item technical data. Typically, these rights would be commensurate with those obtained by ordinary purchasers of the same items. The government would bear the burden of proving that federal funds were used to develop the commercial item in any challenge to the contractor’s commercial licensing terms.

As a result, a commercial contractor could preserve its IP without undertaking the administrative and financial expense of maintaining detailed records to demonstrate that its items were developed without government funding.

This presumption was partially reversed by the 2007 and 2008 National Defense Authorization Acts and recent regulatory implementation. A commercial item is no longer presumed to have been developed at private expense if it is a major system, or a subsystem or component of a major system, unless it is a commercial-off-the-shelf (COTS) item offered to the government without modification in the same form in which it is sold in the commercial marketplace. The contractor now has the burden of demonstrating development at private expense.

The recent regulatory changes further provide that the allocation of rights in technical data pertaining to a commercial item developed in any part at government expense will be governed by two distinct contract clauses: The privately-funded portion of the item will be governed by the clause for commercial item technical data, and the governmentfunded portion will be governed by the clause for non-commercial item technical data.

The latter change highlights the importance of the doctrine of segregability, which allows funding determinations and rights allocations to be made at the lowest practical sub-item or sub-component level. Of

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course, segregating components from the whole may be technically impracticable (you can’t unscramble an egg) or present problems of proof for the contractor. These evidentiary difficulties are exacerbated by the fact that commercial contractors have long been operating under a regime that did not require detailed records for commercial items.

If a contractor cannot technically and financially distinguish the government and privately-funded portions of an item, the government may be able to assert Government Purpose Rights or Unlimited Rights in the technical data pertaining to the whole item.

The consequences of these changes are illustrated by the following hypothetical. Consider a contractor that utilizes its privately-developed proprietary technology to customize shock absorbers for commercial auto manufacturers. Suppose that this contractor enters into a subcontract to supply similar, but not identical, customized shock absorbers for a new Army truck that qualifies as a major system. Although the Army’s shock absorbers undoubtedly remain commercial items, they are no longer COTS items once they are customized to the Army’s needs.

As a result, the contractor is no longer entitled to the presumption that any aspect of the customized shock absorber – even the underlying platform – was developed exclusively at private expense. Unless the contractor maintains records to establish both that the customizations can be technically separated from the underlying platform, and that the underlying platform was entirely privately funded, the contractor runs the risk of losing its ability to restrict the government’s use and disclosure of all technical data pertaining to the shock absorbers, not just those portions that relate to the government funded customization.

BEST PRACTICES

Contractors can minimize the risks discussed above by adopting a number

of best practices: • Keep close tabs on your development life cycle. An item is “developed” when it exists and is workable. Try to reach this point prior to accepting any government funds.

• Offer items on a COTS basis. The use of COTS items preserves the presumption of development at private expense, even where those items are destined for inclusion in a major system, subsystem or component of a major system.

• Keep detailed technical and financial records of your development.

licenses on an ad hoc basis. Contractors can use these specifically negotiated licenses to overcome difficulties that may otherwise exist in establishing segregability or funding, limiting the government to only the rights it needs rather than the broader rights it might otherwise receive by default.

The DoD is moving towards taking greater rights in contractor IP by default, shifting the burden to the contractor to establish that broader rights are unwarranted. Future changes, including a proposal to unify treatment of technical data and computer software and the

DoD contracts allocate IP rights between the contractor and the government based on who paid to develop the item to which the IP relates.

They will maximize your ability to segregate your products into discrete pieces and enable you to prove the funding source for each piece.

Combined, the records will allow you to assert and enforce maximum restrictions over the broadest possible range of IP. • Consider a software-as-a-service (“SaaS”) model. Although future changes to the procurement regulations may minimize its prophylactic value, for the time being a SaaS model allows the government to benefit from your product without your surrendering IP rights.

• Follow the marking requirements set forth in the contract. The importance of this step cannot be overstated. Even before the changes discussed above, contractors that failed to use prescribed legends were at substantial risk of losing their ability to restrict the government’s use and disclosure of their IP. • Negotiate procurement-specific licenses. Unlike civilian agencies, the DoD allows contractors to negotiate IP

amendments made by the 2012 National Defense Authorization Act, will likely continue this trend.

Nonetheless, by being conscious of the pitfalls these changes introduce and by being vigilant in meeting the demands that they entail, contractors can maximize protection of their IP. ■

Scott A. Felder is a partner at Wiley Rein LLP, in the Intellectual Property and Government Contracts practices. He counsels clients in the acquisition, protection, management and enforcement of intellectual property rights, with a particular emphasis on patent law.

He also advises clients concerning intellectual property in relation to government contracts, including patent rights, rights in technical data and computer software, and in IP disputes with the government. sfelder@wileyrein.com.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Intellectual Property

Combating Trade Secret Theft Abroad through Legal Action at Home

By Michael Strapp

37

T

heft of corporate trade secrets abroad is on the rise. Security experts and government officials are increasingly concerned about breaches of corporate networks. In January, the director of national intelligence warned the Senate Intelligence Committee of overseas actors that are targeting the intellectual property of U.S. companies in an effort to “save themselves the time and expense of doing R&D.” U.S. companies, aware of the risks involved in conducting business

abroad, are taking extraordinary measures. As the New York Times reported in February, at AirPatrol, a Maryland-based company that specializes in wireless security systems, employees take only loaner devices to China and Russia, never enable Bluetooth and always switch off the microphone and camera.

What happens when such measures are not enough? Can corporations seek redress in U.S. courts for the theft of trade secrets, even when those trade secrets are stolen abroad?

Addressing these very questions, a federal appeals court recently determined that the International Trade Commission, a quasi-judicial federal agency, does have authority to bar the importation of products made abroad using misappropriated trade secrets that were developed in the United States. The appeals court relied on a statute that prohibits “unfair methods of competition and unfair acts in the importation of articles . . . into the United States.”

The case decided by the appeals

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court involved Amsted Industries, a domestic manufacturer of cast steel railway wheels. Amsted owned a secret process for manufacturing such wheels but no longer used that process in the United States. It licensed it instead to several firms with foundries in China.

The TianRui Group, a Chinese manufacturer of railway wheels, also sought to license Amsted’s technology, but the parties could not agree on terms. Then, after the failed negotiations, TianRui hired employees away from one of Amsted’s Chinese licensees, Datong.

In proceedings before the ITC, Amsted proved that the Datong employees hired by TianRui had been trained in the secret Amsted process, knew that the process was proprietary and confidential, but nonetheless disclosed it to TianRui. Amsted also proved that TianRui, after misappropriating the Amsted trade secret, imported into the United States the wheels it had manufactured using the trade secret.

At the appeals court, TianRui argued that the jurisdiction of the ITC cannot reach trade secret misappropriation that occurs outside the United States. Although the court agreed that Congressional legislation typi-

court ruled that the ITC’s authority to address misappropriation of trade secrets abroad is limited to those situations where the act of misappropriation abroad results in the importation of goods into the United States. As

The ITC’s authority to address misappropriation of trade secrets abroad is limited to those situations where the act of misappropriation abroad results in the importation of goods into the United States. cally applies only within the territorial jurisdiction of the United States, it rejected the argument advanced by TianRui. The statute at issue focused on the inherently international transaction of importation, the appeals court explained, and so the presumption against extraterritoriality did not govern the case.

While the appeals court agreed that ITC jurisdiction could reach trade secret theft abroad, it placed an important limitation on that jurisdiction.

The

the appeals court explained, “the Commission has no authority to regulate conduct that is purely extraterritorial. The Commission does not purport to enforce principles of trade secret law in other countries generally, but only as that conduct affects the U.S. market.”

The TianRui decision is important for U.S. corporations that do substantial business in countries where the theft of corporate trade secrets is widespread. Domestic corporations that learn of trade secret theft abroad can now obtain an order from the ITC excluding from importation goods that are made using stolen trade secrets. An exclusion order may not deter trade secret theft by entities abroad that have no intention of selling their goods in the United States, but it will be a powerful weapon against those that are selling, marketing, or intend to sell and market, products made with stolen trade secrets in the United States.

An ITC exclusion order is not the only U.S. legal tool to combat the theft of trade secrets abroad. The Economic Espionage Act, passed by Congress in 1996, makes theft of trade secrets a federal crime. In particular, the EEA prohibits espionage on behalf of foreign governments for purposes of obtaining trade secrets from

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Intellectual Property U.S. businesses. More generally, the EEA also outlaws the theft of trade secrets when it is undertaken for the economic benefit of someone other than the rightful owners.

Under the EEA, information is a trade secret if (1) the owner took reasonable measures to keep it secret and (2) the information has independent economic value because of its secrecy.

The wide scope of the EEA is consistent with the purpose behind it. Legislative history indicates that in the wake of the Cold War, Congress recognized that espionage had evolved to focus on secrets that lead to a commercial and economic advantage. Congress also acknowledged that corporate trade secrets are an important national economic resource. In this context the EEA was passed, to directly and systematically address economic espionage.

The EEA not only criminalizes trade secret theft in the United States, it also explicitly prohibits the theft of trade secrets abroad if the offender is a U.S. citizen or corporation, or if any act in furtherance of the offense was committed in the United States. While prosecutions under the provision of the EEA criminalizing trade secret theft abroad have not been common, that may change soon with the rise in international corporate espionage.

Thus, businesses seeking legal redress in the United States for the theft of trade secrets abroad face an important choice: Should they try to initiate criminal proceedings under the Economic Espionage Act, or should they petition the International Trade Commission for an exclusion order?

In certain circumstances the answer is clear. If the trade secret theft abroad has not and will not lead to the importation into the United States of products made using the purloined secrets, the ITC is not an option. Conversely, if the theft was carried out abroad by a foreign national acting on behalf of a foreign entity, and no act in furtherance of the theft occurred in the United States, the conduct would not fall within the ambit of the EEA.

If criminal and civil options to combat trade secret theft abroad are both available – for example, where a U.S. citizen stole trade secrets abroad on behalf of a foreign company, and the foreign company then imported goods made with the stolen secrets

fined up to $10,000,000.

Complementing the penalty provision, the EEA authorizes both mandatory and discretionary forfeiture that targets proceeds of the crime and any personal property used in the commission of the crime.

The Economic Espionage Act, passed by Congress in 1996, will under some circumstances make theft of trade secrets a federal crime. into the United States – companies must weigh the risks and benefits associated with pursuing an exclusion order at the ITC versus a criminal indictment under the EEA. One important benefit of an ITC action is the swift pace of ITC litigation. The entire discovery period is typically about six months, and a trial usually occurs in less than a year. The entire investigative process is only 15-16 months from institution of the investigation.

Another important benefit to an ITC action, especially in comparison to seeking criminal charges, is that the bar to instituting an investigation by the ITC is quite low. Indeed, investigation by the ITC is mandatory upon the filing of a complaint under oath, alleging a violation.

The benefits of initiating a criminal proceeding under the EEA instead of pursuing an investigation before the ITC are first, as Congress noted when passing the Act, a criminal prosecution does not tax the resources of smaller businesses that can’t afford the legal fees and costs of an ITC investigation.

Additionally, the deterrent effect of a successful criminal prosecution may outweigh the punitive aspects of an exclusion order. Under the EEA, individuals may be fined up to $500,000 and face up to 15 years in prison, and organizations may be

U.S. companies considering what steps to take to combat trade secret misappropriation abroad should be aware of both options. If the primary goal is to swiftly shut down the importation of infringing products, the ITC is the logical venue. Because there is no need for personal jurisdiction and service need not be made pursuant to the Hague Convention, a lawsuit can be commenced without delay. Time to trial is very short, and injunctive relief, in the form of an exclusion order, is awarded as a matter of right.

If on the other hand a company does not have the resources to pursue an ITC action, or it wishes to send a powerful deterrent message to the entity that has misappropriated the trade secret, initiating a criminal prosecution may be a viable and more attractive option. ■

Michael Strapp is a partner in the Litigation Department at Goodwin Procter LLP, in the Boston office. He practices in patent and trade secret litigation, with a particular focus on cross-border intellectual property disputes. mstrapp@goodwinprocter.com

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APR/ MAY 2012 E X ECUTIVE COUNSEL

Governance

Can Internal Investigations be Kept from Shareholders?

By Jonathan S. Sack

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S

enior management often face sensitive issues, such as allegations of misconduct by executives or improper relationships with vendors. In those situations, management typically calls for an investigation to understand the facts before deciding how to respond. Such

investigations are usually conducted by in-house or outside counsel so that the information gathered is protected by the attorney-client privilege and the work product doctrine.

These protections enable the company to collect and weigh the facts without fearing disclosure. Indeed, in

most cases, a company can reasonably expect that the results of the internal investigation will remain privileged, unless the company chooses to disclose them by, for example, informing a government agency or filing a lawsuit.

However, in some cases, senior management does not have full

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Governance

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control over the privileged information. For example, the company may decide that the information learned during the investigation is “material” under the securities laws and requires public disclosure.

This article discusses another limitation on the privilege, one that

arises under principles of corporate governance. Litigious shareholders have been permitted to obtain privileged materials under a “fiduciary exception” to the attorney-client privilege. This doctrine, stemming from the seminal Garner v. Wolfinbarger case (1970) in the Fifth Circuit, permits shareholders

to obtain privileged materials upon a showing of “good cause” for setting the attorney-client privilege aside. The rule has been applied by both federal and state courts to permit disclosure of privileged materials in shareholder suits.

The tension between a company’s need for confidentiality and shareholders’

apr/ may 2012 E X ECUTIVE COUNSEL

Governance

right of access recently played out in the context of sexual harassment allegations against Mark Hurd, the chairman, president and CEO of Hewlett-Packard Company, and the litigation that followed. What happened can be seen as a cautionary tale for senior executives and directors who may be faced with similar matters.

Jodi Fisher, an actress, reportedly was hired by HP to host executive events after Mark Hurd saw her on a

of Business Conduct,” including that Hurd has a close personal relationship with an HP contractor, which was not disclosed to the board, and that Fisher had received compensation or expense reimbursements without a legitimate business purpose.

The HP board also announced that Hurd had entered into a separation agreement, which granted him severance payments reportedly worth over $35 million.

Espinoza then filed an action in the Delaware Court of Chancery, seeking a court-ordered inspection of the report.

Shareholders of a Delaware corporation have the right to inspect the books and records of the corporation if they demonstrate a “proper purpose,” and the Delaware courts have recognized as proper Espinoza’s stated purpose: to investigate potential corporate mismanagement, wrongdoing and waste.

In a ruling from the bench, the Dela-

Since the 1970 Garner v. Wolinbarger case, litigious shareholders have been permitted to obtain privileged materials under a “fiduciary exception” to the attorney-client privilege.

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televison show. Over a period of two years, Fisher traveled to HP events, and according to a letter from her attorney, Gloria Allred, Hurd repeatedly solicited sex from Fisher and pressed her to meet him for dinners and drinks, paid for by HP, despite the fact that Fisher rejected his advances. The Allred letter, which was sent to Hurd in June 2010, detailed Fisher’s sexual harassment allegations against Hurd as well as her claim that Hurd had disclosed inside information regarding HP’s impending purchase of EDS. When HP’s board of directors learned of the sexual harassment allegations, it retained Covington & Burling LLP to investigate. A month later Covington presented an “interim” report to the board, including findings of possible violations by Hurd of HP’s Standards of Business Conduct. The board discussed the situation at several meetings, and then it requested Hurd’s resignation.

HP announced to investors on August 6, 2010 that the investigation “determined there was no violation of HP’s sexual harassment policy, but did find violations of HP’s Standards

Those announcements immediately prompted a flurry of shareholder “books and records” demands, and shareholder litigation. One demand was made by HP shareholder Ernest Espinoza, who requested records of the investigation into the sexual harassment allegations.

He sought to justify the demand on the grounds that he needed the records to investigate corporate mismanagement, wrongdoing and waste by the HP board, and to investigate Hurd in connection with the board’s decision not to fire him for cause, but instead to grant him a lucrative severance package.

In response HP provided extensive non-privileged records, including board minutes relating to the investigation, to consideration of whether to terminate Hurd, and to the negotiation of the separation agreement; records of the contractor’s compensation; a letter from the attorney (Allred) who had leveled the sexual harassment allegations; and various HP guidelines and policies that Hurd was found to have violated.

The company refused to produce the Covington Report, arguing that it was protected from disclosure by the attorney-client privilege and the work product doctrine.

ware Chancery Court acknowledged that under normal circumstances the report would be privileged because it was prepared by counsel to the HP board for the purpose of (1) communicating to the client (the HP board) information concerning an investigation conducted by lawyers and (2) providing legal advice to the board.

However, the court recognized that the privilege may be “restricted or denied entirely” because the Covington Report related to a matter which had become the subject of a shareholder suit against a corporation.

To determine whether “good cause” existed to deny protection of the privilege over the Covington Report, the Chancery Court looked to Garner v. Wolfinbarger.

There, the court had listed the factors to be considered in determining whether a shareholder had established “good cause” for obtaining the documents being sought. Those factors are: • The number of shareholders and the percentage of stock that their shares represent.

• The nature of the shareholder’s claim and whether it is “colorable,” meaning a claim that presents enough evidence

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Governance

• • • • •

on its face to warrant further investigation and inquiry.

Whether the information is “necessary” and unavailable from other sources.

The risk of revealing trade secrets or other confidential information.

Whether the shareholder has identified the information sought and is not merely fishing for information.

Whether the shareholder has alleged criminal conduct.

Whether the communication is advice concerning the litigation itself.

Analyzing the Garner factors, the Chancery Court accepted HP’s assertion of the attorney-client privilege and held that the privilege was not outweighed by other considerations.

Although Espinoza had identified a single document and was not merely “fishing,” he did not demonstrate a “need” to inspect the report or that the information in the report “was unavailable from other sources.”

The court relied primarily on HP’s voluminous production of non-privileged records, from which Espinoza could draw his own conclusions, and on HP’s representation that the Covington Report did “not address the board’s decision-making process and does not discuss the for-cause issue at all.”

The Chancery Court also held that the Covington Report was protected from disclosure by the work product doctrine for many of the same reasons. The work product doctrine, which is separate but related to the attorney-client privilege, shields from disclosure material developed or prepared by or on behalf of attorneys in anticipation of litigation. Work product protection is not absolute and can be overcome through an adversary’s showing of “substantial need” or “undue hardship” with respect to factual materials. Mental impressions and analyses remain protected from disclosure unless the analyses are disclosed.

Espinoza appealed the Chancery Court’s ruling to the Delaware Supreme Court, which agreed that Espinoza was not entitled to the Covington Report.

But it reached that conclusion on different grounds, namely that he did not show that accessing it was “essential” to accomplishing the purpose of his inspection of HP’s books and records.

The Delaware Supreme Court held that in a books and records action, the issue of whether the records sought are “essential” is a predicate issue. According to the Court, the privilege issue, a separate and distinct analysis, was purely “academic” because the records sought were not essential.

To be “essential” for the purpose of a books and records demand, the

The litigation over the Mark Hurd allegations makes clear the protections are not absolute. information contained in a document must be unavailable from another source. The Supreme Court held that Espinoza failed to show “essentiality” for three reasons.

First, the Covington Report did not discuss the “for cause” issue. The Supreme Court acknowledged that if the report had discussed the “for cause” issue, Espinoza’s claim would have stood on a “significantly different footing.” Second, Espinoza failed to establish that the report played any role in the board’s decision to enter into the separation agreement rather than to terminate Hurd for cause. Third, HP already disclosed the “essential” aspects of the report.

The court acknowledged that Espinoza was given the Allred letter, which informed him of the details of Fisher’s claims, and records documenting the internal investigation process and the misconduct that

was uncovered by the investigation.

Espinoza also was informed of the Covington Report’s “critical findings” – namely Hurd’s violation of HP’s business conduct rules but not its sexual harassment policy – and he was informed of the board’s decision to permit Hurd to resign without being terminated for cause.

Thus, without reaching the privilege issue addressed by the Chancery Court, the Delaware Supreme Court held that HP was not required to produce the Covington Report.

Companies must conduct internal investigations under many different circumstances. Often the results must be reported in writing, so that the findings are given complete and proper consideration by the board or other governing body. Under most circumstances these reports will be shielded from disclosure by the attorney-client privilege and the work product doctrine, but litigation over the allegations against Mark Hurd makes clear that these protections are not absolute.

The Delaware courts’ handling of HP’s investigation and the Covington Report should give companies comfort – but only limited comfort – that internal investigations will remain confidential. ■

Jonathan S. Sack is a principal of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C. in New York City. His practice focuses on the representation of companies and individuals in criminal and civil matters and in internal investigations. He formerly was the chief of the Criminal Division of the U.S. Attorney’s Office for the Eastern District of New York. He is a member of the Executive Counsel Editorial Advisory Board. jsack@maglaw.com Attorney Kefira R. Wilderman assisted in the preparation of this article.

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APR/ MAY 2012 E X ECUTIV E COUNSEL

Human Resources

Carrots, Not Sticks, to Fend off Unions Countering the New Election Rule

By A. John Harper III

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F

or company leadership, a lot can happen in two weeks. A product liability crisis could erupt, an environmental blunder could make headlines, or a natural disaster could sever supply chains without warning.

Now, another worry is emerging: New federal labor law could mean an entire company workforce could unionize virtually overnight.

Beginning April 30, National Labor Relations Board rules allows unions to hold what the U.S. Chamber of Commerce lambasts as “ambush elections.�

If unions are able to take hold through these abbreviated elections, there could be enduring consequences for the ability of companies to effectively manage operations.

Currently, NLRB data shows the

average time between the filing of an election petition with the Board and the holding of a secret ballot election is about 31 days. A recent Bloomberg Government Study has found that unions win 58 percent of elections held 36 to 40 days after a request, while that rate rises sharply to 87 percent when the vote takes place within 11 to 15 days.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Human Resources Assuming legal challenges to the new rules are unsuccessful, the rules could shorten the petition-to-election time gap to as little as 10 days, by restricting an employer’s ability to challenge the makeup of the employee voting unit and other aspects of the

election process until after the election.

The most important rules alter the current election regime by: • Strictly limiting pre-election hearings – and evidence allowed at the hearings – to determining whether there is a “question concerning representation.” A question concerning representation exists

when a union files, with the NLRB, an election petition supported by evidence that a requisite number of employees support the union, and the employer has refused to recognize the union. If the Board’s regional director concludes there is such a question, he or she directs an election to resolve it.

• Prior to April 30, an employer could challenge issues such as the eligibility of individual employees to be included in, or excluded from, a proposed bargaining unit before the election was held.

Elections are often won or lost by slim margins, so not being able to challenge the makeup of the “electorate” before the election is a significant change.

• Eliminating the recommendation that election dates be set no sooner than 25 days after direction of an election. The 25-day period was in place to allow more time for the Board to rule on requests for review.

• Eliminating the parties’ right to file a pre-election request for review of a regional director’s decision to order an election, and instead deferring all requests for Board review until after the election. Any pre-election requests can then be combined with a request for review of any post-election rulings.

These new rules are not a positive development for employers. Unions will be emboldened by the assumption that they will be operating in a friendlier legal environment and will aggressively pursue opportunities to organize employees. And employees, feeling uncertain in this economy, may be even more receptive to union promises of greener pastures.

With a future-minded approach, however, this could be a prime opportunity for management to tell the full story of why there is little value in joining a union before one comes calling. The right plan can boost employee morale for the longterm, increase productivity and avoid legal missteps if a petition is filed.

IDENTIFYING EMPLOYEE MOTIVATIONS

Voting for union representation can seem attractive to employees for a variety of reasons, but never when they are happy with their work life. Before thinking about how unionization might affect your company, ask yourself why employees would consider voting for a union in the first place.

Are you showing favoritism, or do employees perceive that you are? If employees are excelling in their duties, they want to be rewarded at the same level as the person next to them. They expect that their job performance and conduct will be managed consistently and in good faith.

Does your company place high value on working conditions? To compete in a global market, employees are spending an increasing amount of time at work and away from home. That means employees need adequate accommodations, including breaks, flexible schedules and vacation time.

How do your benefits packages stack up to those of competitors? No matter the industry, employees want to know that they’re not getting a raw deal. While it’s easy to slash costs

New rules could shorten the petition-toelection time gap to as little as 10 days. here, you should carefully weigh the consequences of doing so. Informed employees pay attention to 401K contributions, health care plans and flex accounts, and they might start to question management’s commitment to their well-being when faced with below-standard benefits or cuts to their existing benefits.

Are you paying your employees what they are worth? Higher wages alone

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apr/ May 2012 E X ECUTIV E COUNSEL

Human Resources

won’t fend off union ploys, but they are surely one of your biggest bargaining chips. Food prices, transportation costs, and similar cost-of-living expenses are rising in many parts of the country, and employee compensation should duly reflect that.

EmployEE RElations pRogRams

After identifying employee motivations, capitalize on that knowledge.

Building a strong employee relations program is the best way to apply what you’ve learned and affect the

hardest goal to achieve, but it’s the most important. From front-line employees to upper management, the more connected employees feel to the ultimate performance of the company, the more productive and cohesive the entire operation will be. It’s about galvanizing hearts and minds around common goals.

Monitor sentiment. No program can improve unless you know how it’s performing. Involve your employees in a feedback process, and be forthright about the measures you

The right plan can boost employee morale for the long-term, increase productivity and avoid legal missteps if a petition is filed.

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mood of your organization. The key is to develop a program that aligns with your company’s culture, values and mission. Because those guidelines can vary widely, focusing on overarching themes can help you develop tactics that will make a difference.

Create an atmosphere that inspires. This can mean adopting an environment of mutual motivation – managers motivating employees, employees motivating managers, and employees motivating one another.

Instill the notion that what your company is accomplishing every day is changing lives, inside your four walls and beyond.

Expect and reward high performance and efficiency. It’s less about nurturing egos and emotions than about setting a high bar and being vocal and visible when a measure of success is met. In every sector, but certainly in professional services, employees want to be challenged, pushed to their potential and experience a real sense of accomplishment.

Make each staff member feel important to the overall success of the operation. This is probably the

are implementing and the results you expect to achieve. post-pEtition stRatEgy

Despite employee relations programs and intense focus on morale, unions will always be in campaign mode. AFL-CIO President Richard Trumka is famously attributed as saying, “Corporate [unionization] campaigns swarm the target employer from every angle, great and small, with an eye toward inflicting upon the employer the death of a thousand cuts rather than a single blow.”

With an aggressive union posture and the new rules allowing even less time to make your case once a petition is filed, you must have a plan in place.

Consider the following: • Do you have a cohesive message?

• Can you disseminate your message quickly and effectively?

• Are your messengers credible?

Are they well-liked?

• Have you consulted legal counsel?

• Can your company adequately respond in 10 to 21 days?

• Do you have room in your budget to fend off a union campaign?

With these considerations in mind, develop a strategic team. This should include C-level executives, outside legal counsel, communications specialists, business unit heads and management trainers. The best teams involve all strategic stakeholders to form a unified front.

Next develop your communications plan with a fully integrated message delivery system. Any communications plan should have a keen understanding of the employee audience, with specific consideration given to work experience, rates of pay, education levels and any language barriers that might exist.

Identify and develop your supervisors. While you may have given someone the “supervisor” label, the NLRB will look beyond titles to the supervisor’s actual job responsibilities. You must ensure your supervisors match the definition in the National Labor Relations Act. That’s crucial because supervisors are not allowed to participate in the bargaining unit that union representatives will approach.

Consider supervisors as your boots on the ground against union organizing. They must be properly trained to identify signs of possible organizing activity and the legal limits of communicating company messages. This is the group that can win or lose most unionization campaigns for your company.

Being proactive is essential. Prepare for challenge in advance with a substantial and recognizable investment in your people. ■

A. John Harper III is of counsel at Haynes and Boone, in the Houston office. He represents clients in a wide range of labor relations and employment matters. john.harper@haynesboone.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Canada/Cross–Border

Canadian Pension Plans are Private Equity Heavyweights

By Jamie S. Koumanakos and Jeremy Forgie investment entity of the CAD $152 billion Canada Pension Plan; OMERS Private Equity, the private equity investment arm of the CAD $53 billion Ontario municipal employees pension plan; Alberta Investment Management Corporation (AIMCo), the CAD $71 billion investment manager of a number of Alberta public sector funds and other Alberta government entities; Public Sector Pension Investment Board (PSP), the CAD $58 billion investment entity for Canadian federal government employee pension plans and Caisse de Depot et Placement du Quebec (CDP), the CAD $143 billion investing entity for a number of Quebec depositors, including the Quebec Government and Employee Retirement Plan.

CO-INVESTMENT RELATIONSHIPS

D

espite the recent economic uncertainty, Canada’s public pension plans continue to be involved in high profile mergers and acquisitions across the globe. Driven in part by a desire to diversify asset classes to optimize returns in a low interest rate environment, and by the re-structuring of governance models to provide greater investment flexibility and independence, Canada’s public pension plans have proven themselves to be top tier international private equity dealmakers.

Worldwide mergers and acquisitions volume, including in Canada, has been moderate over the past year. In 2011,

there were 2307 deals announced in Canada with an aggregate value of CAD $178 billion (compared to 2117 deals with a value of CAD $199.5 billion in 2010). On the private equity side, there were 53 Canadian buyouts in 2011, with a value of CAD$14.8 billion (increased from 45 deals with a value of CAD$13.7 billion in 2010).

A number of Canadian pension plans have been active in the mergers and acquisitions marketplace, most notably Teachers Private Capital, the private equity investing entity of the CAD $107 billion Ontario Teachers Pension Plan (“Teachers”); Canada Pension Plan Investment Board (CPPIB), the

The private equity investments of Canada’s pension plans include passive limited partner investments in private equity funds, investments in fund-of-funds structures (particularly smaller to mid-size pension funds), direct investments either alone or as a co-investor alongside a private equity fund and, increasingly, active direct and co-sponsored buyouts.

Some of Canada’s public sector pension funds also invest in venture capital funds and in various mezzanine finance structures. Limited partner fund investments with private equity sponsors have created excellent partnering opportunities for the plans, acting as a springboard for long term co-investment deal relationships that can be attractive due to reduced management and transaction fees and, depending on the deal structure, more control over investments. These arrangements are also beneficial for sponsors as a way to further cement investor relationships

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apr/ may 2012 E X ECUTIVE COUNSEL

Canada/Cross–Border and provide needed sources of capital for larger transactions.

Several of the larger Canadian public sector pension funds have established long term relationships internationally with private equity firms. A pension fund may want to establish strategic relationships with a private equity firm where, for example, the pension fund wants access to specialized industries and markets where it does not have the resources or experience to invest directly, or where there is a high probability of co-investment opportunities and

to limit their private equity and other investments to Canadian companies.

However, the large public sector pension funds (like most other Canadian pension funds) are subject to certain investment limitations under either their own legislation, or under pension benefits legislation. In the area of private equity (particularly direct investments), of note are the restrictions against a pension fund owning more than 30 percent of the voting shares of a corporation and restrictions relating to transactions with related parties.

Some Canadian public sector pension funds are investing in venture capital funds and in various mezzanine finance structures.

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the manager or equity firm has a good record in the application of consistent management strategies.

The large Canadian public sector pension funds noted above have developed substantial internal resources to handle, for example, reporting, cash calls and distributions and the greater degree of monitoring required in private equity investments, including fund investments. They have developed a strong reputation as committed, patient investors who understand and can deal with the “J-curve” path of returns associated with many private equity investments.

In Canada, there is broad consensus that large pension funds acting in the interests of their pensioners and other plan members have the scope to become important representatives of minority shareholder interests, with the ability to elect independent board members, and in many cases because they have established reputations with regulators. This approach differs significantly from many U.S. pension funds, which typically do not play an active role in investments and have tended to rely more on traditional investment strategies, such as bonds and equities.

For a number of years, Canadian pension funds have not been required

Pension funds will of course be concerned about appropriate monitoring of investments made on behalf of the pension fund. Therefore board representation in a portfolio or investee company can be very important. In structuring a transaction, consideration often will need to be given to creating appropriate classes of voting and nonvoting participating shares in the investee company (or acquisition vehicle), and in the negotiation of appropriate terms in a shareholders agreement.

INFRASTRUCTURE INVESTMENTS

While the investments of Canada’s pension plans continue to cover a wide spectrum of industries, two areas in which they have been increasingly involved are infrastructure investments (including utilities, roads, bridges and ports) and real estate. These assets can be attractive investments for pension plans, due to their long term investment horizon, the possibility of stable returns and in some cases relatively high internal rate of return.

The investment prowess of Canada’s public pension plans has recently been demonstrated in a number of Canadian and international mergers and acquisitions transactions, including the U.S. $8.5 billion sale of Skype Global

S.a.r.l. by CPPIB, Silver Lake Capital and other shareholders to Microsoft Inc.; the U.S. $5.2 billion acquisition

by CPPIB, PSP and Apax Partners of Kinetic Concepts Inc.; the CAD $3.6 billion bid by Maple Group Acquisition Corp. (which consists of AIMCO, CDP, Teachers, Fonds de solidarite’s du Quebec and three Canadian banks) for the TMX Group Inc.; the U.S. $3.2 billion acquisition of Gassled Transportation System by CPPIB; OMERS’ CAD $2.1 billion co-sponsored acquisition of Husky Injection Moldings Systems with Berkshire Partners LLC; and Teachers’ U.S. $1.8 billion acquisition of Brussels Airport Co SA. Canada’s public pension plans have proven to be world class private equity investors and private equity fund partners. With the increased independence of pension plans as well as greater allocations of plan assets to private equity, it appears that this trend will continue, as Canadian plans look beyond their borders for attractive acquisition and investment opportunities. ■

Jamie Koumanakos is a partner at the New York office of Blake Cassells & Graydon LLP. He practices corporate and commercial law with a focus on domestic and cross-border mergers and acquisitions and private equity fund investments and co-investments. jamie.koumanakos@blakes.com

Jeremy Forgie is a partner in the Toronto office of Blake Cassells & Graydon LLP. He practices in the pension and employee benefits and tax groups, and he is involved in all aspects of employee benefits, pensions and executive compensation. jeremy.forgie@blakes.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Canada/Cross–Border

Private Equity Looks South

By Divya Balji

L

ast year proved to be trying for the global economy.

Uncertainty about the U.S. debt ceiling, the European financial crisis and talk about a slowdown in the Chinese economy created volatility in the capital and credit markets. Yet, Canada and its southern neighbour continued M&A activity in several sectors, including financial services.

“Canadian financial institutions are doing comparatively well, and so they are net buyers,” says Frank Arnone, Partner at Blake, Cassels & Graydon LLP. “They are buying where the deals are, and that’s outside of Canada.”

TD Bank Group made several acquisitions in order to expand its business in the United States. Its most recent purchase was last August, when it bought MBNA’s USD $8.5 billion Canadian credit card portfolio from Bank of America. TD worked with Torys LLP on the deal, and MBNA worked with Blake, Cassels & Graydon LLP. Before that, in April of 2011, TD spent USD $6.3 billion to acquire Chrysler Financial Services from Cerberus Capital Management. TD worked with Torys LLP and Simpson Thacher & Bartlett LLP on this acquisition, and Cerberus worked with Schulte Roth & Zabel LLP. Canadian utilities also looked south for deals. Two Canadian companies, Fortis Inc and Gaz Metro, sought to acquire Central Vermont Public Service (CVPS) last year. Gaz Metro won the battle and acquired Central Vermont for $USD 666 million. Gaz Metro worked with Osler, Hoskin & Harcourt LLP, and CVPS worked with Downs Rachlin Martin PLLC, Hogan Lovells, Loeb & Loeb and Sidley Austin LLP.

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Fortis came back in 2012, and recently announced the acquisition of CH Energy for about USD $1.5 billion. With very few targets left in Canada, Fortis has said that it will look to the United States to grow, because of the abundance of takeover targets there. Fortis worked with White & Case LLP, and CH Energy worked with Latham & Watkins LLP and Watchtell, Lipton, Rosen & Katz LLP. Deal activity in the middle market continues strong, with private equity firms seeking reliable, cash producing businesses. Companies that are at a stage where they are ready to grow but might need additional capital or expertise will likely be targets, said Michael Gans, of Blake, Cassels & Graydon LLP. A recent example is CI Capital’s purchase of IntraPac for an undisclosed sum. CI Capital worked with Blake,

Cassels & Graydon LLP, LexCounsel and Paul Weiss Rifkin Wharton & Garrison LLP. IntraPac worked with Gowling Lafleur Henderson LLP, Pacheco Coto and Sidley Austin LLP. ■

Divya Balji joined mergermarket, an independent mergers and acquisitions intelligence service, in June 2007 as a financial reporter and became Canada bureau chief in August 2009. She oversees the company’s M&A coverage in Canada, with a specific focus on energy and mining. Prior to working with mergermarket, she completed her degree in Economics & Mathematics at the University of Toronto.

Divya.Balji@mergermarket.com

Aggressive FCPA Enforcement

Getting Mixed Results

By Philip Urofsky, Marina Moon and Jennifer Rimm

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

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n 2011, and so far this year, the government has been both aggressive and expansive in its enforcement of the FCPA. In some cases, however, it has encountered challenges that demonstrate the difficulty of prevailing at trial in these complex cases.

For non-U.S. defendants, the FCPA requires the government to establish territorial jurisdiction, and over the past few years enforcement authorities have staked out an aggressive interpretation of this jurisdiction, for example by reaching out to capture wire transfers between foreign parties using foreign banks that “cleared” through those banks’ U.S. dollar correspondent accounts.

In 2011, the DOJ relied on correspondent account liability as the basis of jurisdiction over JGC Corporation, alleging that the Japanese company participated in a joint venture that authorized U.S. dollar wire transfers from the Netherlands to accounts in Japan and Switzerland. Correspondent account liability was also arguably the basis of jurisdiction in actions brought by the DOJ and SEC against Tenaris S.A. The Luxembourg company allegedly “made use of the means and instrumentalities of interstate commerce” in making a “same day transfer of approximately $32,140.67 through an intermediary bank” in New York to an agent acting on Tenaris’s behalf.

EMAIL-BASED JURISDICTION

U.S. authorities recently reached into an entirely new area of jurisdictional basis: U.S.-based email accounts. In an action brought against Magyar Telekom, the DOJ’s sole claim to anti-bribery jurisdiction was based on a foreign official’s U.S.based email address, whereby email was “passed through, stored on, and transmitted from servers located in the U.S.” This particularly weak jurisdictional basis resulted in a sentencing guidelines calculation of eight times what the company would have had to pay otherwise.

On the other hand, in June 2011, in the first of the socalled SHOT Show trials, the court found no territorial jurisdiction where a DHL package was sent from the U.K. to a government informant in the United States. Given the unique facts of the situation – a shipment solicited by the government and delivered to the government – it remains to be seen whether this ruling will establish a strong enough precedent to influence future cases.

To be liable under the FCPA, the benefit to the foreign official must have been given in order to “assist in obtaining or retaining business.” The government continues to expand the scope of this element and in the past year alleged the following satisfied the so-called “business nexus”: • Reduction of operating costs, such as preferred telecommunications rates (Juan Pablo Vasquez/Latin Node, Inc.); • Influencing inspectors responsible for certifying products for export (Tyson Foods, Inc.); • Allowing the importation of prohibited items (Ball Corporation);

• Sabotaging competitor’s tests (Paul Jennings/Innospec).

The FCPA defines “foreign official” to include employees of “instrumentalities” of foreign governments. What constitutes an “instrumentality” is a hotly debated topic, especially in the context of state-owned enterprises (SOEs).

Although in most cases, the government control of an entity should be self-evident and sufficient, there are instances

THE BENEFIT MUST HAVE BEEN GIVEN TO “ASSIST IN OBTAINING OR RETAINING BUSINESS,” BUT THE SCOPE OF THIS SO—CALLED BUSINESS NEXUS KEEPS EXPANDING. where the nature of the entity is less than obvious. The FCPA cases involving Chinese “design institutes” provide a notable case study. Foreign companies are bound by Chinese regulations that effectively compel foreign companies to partner with “design institutes,” which make product recommendations to SOEs. In two recent FCPA actions, companies were alleged to have made improper payments to employees of such institutes. In Watts Water Technologies, the SEC expressly stated that payments were made to “state-owned” design institutes, and in Rockwell Automation, Inc., the SEC said that design institutes are “typically state-owned.” Previously, in ITT Corporation (2009), the SEC alleged payments to employees of design institutes, “some of which were SOEs.” This progression appears to be a step towards clarity and may indicate the SEC’s increasing wariness of public scrutiny towards what constitutes an instrumentality of a foreign government.

FCPA books and records enforcement actions typically focus on a company’s financial records. In Magyar Telekom, however, the government’s case centered on a secret agreement between Magyar Telekom and Macedonian government officials. The SEC alleged that the agreement was placed in the hands of a Greek intermediary and thus kept out of Magyar Telekom’s books and records.

This is notable because the company’s books and records were deemed to have been falsified because they did not contain the contract, rather than because they contained a specific inaccurate invoice or payment record.

MIXED RESULTS

While U.S. authorities have successfully expanded the scope of the statute in settled cases involving corporations, they have also come up against significant setbacks in their efforts

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Philip Urofsky is a partner and leader of the FCPA practice at Shearman & Sterling LLP, based in the Washington DC office. A former federal prosecutor, he served as Assistant Chief of the Fraud Section in the Department of Justice. philip.urofsky@ shearman.com

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Hee Won (Marina) Moon is a Shearman & Sterling associate in New York. marina.moon@ shearman.com

Jennifer Rimm is a Shearman & Sterling associate in New York. jennifer.rimm@ shearman.com

to enforce the FCPA against individuals.

For example, in January 2010 the DOJ staged a dramatic “take down” at the Las Vegas SHOT Show Conference (a shooting, hunting and outdoor trade show), following the sealed indictment of twenty-two individuals that followed an extensive undercover sting operation. Despite the fanfare, however, the government’s case came to an ignominious end two years later. In February 2012, the DOJ moved to dismiss all of the remaining indictments and defendants, after two trials in which the juries hung or acquitted the defendants, and the court dismissed critical counts and excluded allegedly critical evidence.

The government’s failure to convict the Shot Show defendants likely reflects two significant obstacles to the government’s novel approach. First, juries in sting trials may perceive the government as having entrapped the defendants, thus making trials difficult to prosecute. In the case of the Shot Show, after the first trial’s hung jury, one jury member reportedly said that the jurors distrusted the FBI’s methods, arguing that the defendants “wouldn’t be there unless it were a sting.”

Second, the government charged the Shot Show defendants with a single overarching conspiracy, although almost the only evidence in support was a meeting orchestrated by the government itself. The court, having from the beginning expressed skepticism concerning this approach, threw out the conspiracy count in the second trial.

In the end, the government might have had more success had it proceeded to trial based on its original approach, in which it charged the defendants in 16 separate indictments, grouping them based on more apparent and closer relationships.

Similar evidentiary problems befell the government’s case in last year’s trial of John O’Shea, a former ABB LTD manager who was charged with bribing officials at Mexico’s stateowned electric utility company. After a threeday trial, the court dismissed all substantive FCPA counts against O’Shea, finding that the prosecution’s chief witness knew almost nothing about the case, that the government failed to produce important witnesses and evidence, and that the prosecution’s evidence was insufficient to establish that the alleged intermediaries actually paid bribes for O’Shea.

The O’Shea decision underscores the difficulties inherent in FCPA prosecutions, which often rely on foreign witnesses and foreign documents that may be out of reach of U.S. enforcement agencies.

In Lindsey Manufacturing – the first ever jury verdict against a corporation on FCPA violations after trial – the court dismissed the indictment after the trial, citing multiple instances of prosecutorial misconduct by the government. From a FCPA perspective, however, a footnote to that court’s opinion may be even more significant, in that the court appeared to require the prosecution to trace funds paid to an intermediary to specific bribes or officials.

On the other hand, the judge in the O’Shea case, which involved payments to the same intermediary by a different company, expressly rejected this approach, holding that “the Government does not have to trace a particular dollar to a particular pocket of a particular official,” although it must “connect the payment to a particular official . . . who can be identified in some reasonable way. . . .”

Thus, it remains an open question just what the government is required to prove with respect to the flow of funds to make its case.

The government itself introduced a similar uncertainty when in the Control Components case it stipulated to jury instructions that will require it to prove that defendants knew that the bribe recipients were government officials.

Thus, in theory, the defendants could argue that they knew they were making payments to a customer’s employees, but did not realize the employer was a government instrumentality and its employees thus were foreign officials.

This stipulation may have a spillover effect in other cases. Already, one defendant has cited the stipulation as evidence that the government failed to establish that he knew that government officials were bribed.

The past year of FCPA enforcement vividly illustrates the tug and pull between aggressive interpretation and enforcement of the statute on the one hand and the difficulties of proving foreign bribery on the other. It is no accident that the expansive interpretations of the statute’s terms most often take place in uncontested settlements with corporations, while the government’s setbacks, which often turn on evidentiary rather than statutory grounds, take place in the adversary context of a trial.

If, as we expect, the government despite its recent problems continues to focus its attention on individuals, and those individuals continue to test the government’s case at trial, then we should also expect more development and definition of some of the FCPA’s provisions, particularly where the government may have pushed the envelope. ■

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Law Departments Leverage Analytics

By Keith Okano

100 Dashboards – user interfaces that organize and present information so it is easy to analyze – can provide valuable insights into a law department’s business processes. The metrics gleaned from analyzing that data can improve services, control costs, minimize risks and help the law department emerge as a strategic partner in the business.

Outside counsel fees represent a significant portion of overall spending in many departments, and e-billing can provide the insight necessary to control those costs. However, to optimize performance, gain greater efficiency and make more informed decisions, legal departments need to analyze all costs, internal and external. Understanding and leveraging metrics can

unlock the hidden value of an organization’s legal data; exposing metrics is changing the way some legal departments work.

Metrics gleaned from matter management/ebilling systems supporting key performance indicators are enabling legal staff to go beyond tracking spending, and provide multiple strategic benefits. These metrics can:

• Demonstrate the value of the legal service being delivered.

• Provide the insight needed to make critical decisions, such as what matters can be insourced – and for those that are outsourced, determine if a particular offer to handle certain litigation is beneficial.

• Identify risk and cost drivers and address those issues in real time.

• Identify key trends, such as types of litigation and performance related to specific types of litigation.

• Identify when it is beneficial to spend more to protect intellectual property.

• Predict annual spending.

• Provide specific data for compliance reporting, 10K reporting, and financial planning.

There are some law departments that have mastered harvesting and analysis of legal data to make better business decisions. Dow Chemical Company, with a large legal department with personnel located in numerous cities worldwide, is one example. “By generating

automatically flags the issue and calls for more review. As a result, our quarterly closing process has become painless. The depth of reporting and the high reliability of the data result in more accurate and available financial intelligence.”

Another case in point is the legal department at Rockwell Automation Inc. Five years ago, it set out to be information-enabled. Today, it manages data from more than 200 law firms, processing approximately twenty thousand invoices from almost three thousand active matters a year.

When they know where and why they spend money on outside counsel, they are able to “identify areas of risk, and take appropriate measures,” says Lisa Girmscheid, Legal Project Manager for Rockwell.

“We can spot trends and use that data to benchmark,” she says. “Timekeeper rates can be compared across individuals and firms. We also track timekeeper diversity. When a firm approaches us with a bid to take over a grouping of work or a practice area, it’s not always the case that high timekeeper rates equal

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more precise intelligence and reporting from legal activities, we are able to see exactly what’s happening at any given time, what the ramifications might be, and how to react and correct any issues,” says Chad Andrews, Dow’s Legal Systems Services Leader.

Dow’s legal team knows that whenever a new legal matter is spawned, the information and resources for controlling its cost are in place as well. This includes a detailed financial assessment, and scheduled matter review dates. Because of the matter management system, the in-house team has become better at rejecting invoices that do not adhere to approved billing rates. Analytics measure the team’s invoice review effectiveness, showing for example “number of exceptions approved and denied. “ “We have also implemented a liability change approval process,” says Andrews. “If it changes by a certain amount, the system

higher costs. Our data shows us case age and case cost per firm.”

Rockwell’s law firm selection is based on comparisons by venue, practice area and firm performance. Costs can be charged to the appropriate center. The quarterly accrual process can be streamlined because of the high level of data accuracy. One of Girmscheid’s key reports is an in depth year-to-year analysis of matters and firms. Last year Rockwell was able to ascertain that 27 percent of the department’s total spending was tied to its top 10 matters, and their top 10 firms were tied to 57 percent of total spending.

To be effective, a law department must deliver results that measure up against strategy.

Metrics can change a law department from a cost/liability to a strategic asset. With rigorous use of analytics, general counsel are better prepared to demonstrate the value of the services which their department provides. ■

Keith Okano is President of Bridgeway Software, a provider of legal enterprise resource planning (ERP) solutions. He focuses on identifying and creating infrastructure for products and services for corporate legal departments. keith.okano@ bridge-way.com

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

Many Defective Mortgages are Salvageable

By Robert A. Scott and Glenn A. Cline

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ny defect in a mortgage can create headaches for lenders, property owners, title insurers, and their lawyers. In this article, we survey recent cases that illustrate how the courts have applied equitable doctrines to tackle problems related to defective mortgages, and how justice and fairness are the driving forces in the solutions the courts have crafted.

A mortgage may be legally defective for a variety of reasons. The property description may be flawed, or even missing. It may lack an essential affidavit, or it may lack a signature from a spouse.

Such seemingly minor defects can throw a wrench in the system when a bank seeks to foreclose and discovers it faces adverse claims from judgment creditors, competing mortgagees and tax authorities, who insist that their liens should take priority over the bank’s prior recorded, but legally defective, instrument.

A bankruptcy trustee also may move for the mortgage to be declared invalid, allowing the estate to avoid the lien entirely.

In some cases, courts turn to equitable doctrines that can salvage the situation for the holder of the defective lien. One option is to ask the court to declare an “equitable mortgage” that may replace the defective mortgage.

This theory was successfully used in a recent Maryland case to salvage a deed of trust recorded without a property description. In Taylor Electric v. First Mariner Bank, a creditor claimed that its mechanic’s lien took priority over the bank’s defective mortgage. The Maryland court disagreed. Even though the recorded mortgage did not contain any legal description of the

property – not even the street address – the court ruled that a companion loan agreement between the borrower showed that the borrower intended to give the bank a mortgage on the property.

The court explained that the theory underlying the equitable mortgage doctrine is that an instrument that is intended to “charge certain lands,” even though defectively executed, is nevertheless considered to be evidence of an agreement to convey, and a court of equity should enforce the obligation despite the technical defects.

For the court to declare such an equitable mortgage is not surprising. But it also held that the equitable mortgage was effective against the third-party creditor with a perfected mechanic’s lien. In doing so, the court relied on the doctrine of equitable conversion, and treated the bank like a purchaser with an enforceable contract of sale.

Since the borrower had signed a loan agreement and defective deed of trust, the court concluded that equitable title passed to the bank. As a result, the subsequent mechanic’s lien did not attach.

Similar rulings were handed down by a New York state court judge and a bankruptcy judge in the Northern District of Ohio.

EQUITABLE SUBROGATION Under the doctrine of “equitable subrogation,” courts at times impose an equitable lien in cases where the proceeds of a loan were used to pay off a pre-existing lien. Lenders may still suffer a loss, however, because the lien amount is often limited to the amount paid to satisfy the prior lien.

In OneWest Bank v. Marshall, the lender’s deed of trust lacked a signature from one of the

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apr/ may 2012 E X ECUTIVE COUNSEL

Robert A. Scott

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is a partner in the Baltimore office of Ballard Spahr. He practices general commercial litigation, with an emphasis on real estate, title insurance, and consumer finance litigation. scottr@ ballardspahr.com

Glenn A. Cline is an associate in Ballard Spahr’s Baltimore office. He focuses his practice on real estate litigation, with an emphasis on title insurance defense and commercial landlord-tenant disputes. He regularly represents mortgage lenders in consumer finance claims. clineg@ ballardspahr.com

property owners. The lender brought a declaratory judgment, arguing that the doctrine of equitable subrogation entitled it to an equitable lien. A lower court rejected the claim, but the District of Columbia Court of Appeals reversed and found a valid claim for equitable subrogation. In such instances, the appellate court said, “the lender steps into the shoes of the mortgagee whom it has paid off and receives that mortgagee’s priority over subsequent liens.”

The doctrine has also been applied in the context of forged mortgages and deeds. In two similar cases, the Court of Special Appeals of Maryland and a federal bankruptcy judge in Mississippi held that even where a mortgage was forged by one spouse and unenforceable against the other, the lender was nonetheless entitled to an equitable lien equal to the couple’s prior mortgage, which both the husband and wife had indisputably signed.

Similarly, in Tribeca Lending Corp. v. Real Estate Depot Inc., a homeowner facing foreclosure from his original mortgage lender conveyed the property to a foreclosure consulting company and later tried to re-obtain title by forging a deed.

The homeowner also refinanced the original mortgage loan with a new mortgage loan. On appeal of a quiet title action, the court held that the new lender should be equitably subrogated to the rights of the original lender to the extent that the new loan paid amounts due on the original loan.

Equitable subrogation does not exist in all jurisdictions, however. And even in states where the doctrine is followed, some don’t apply it as liberally as others. The Supreme Court of Missouri, for example, held that equitable subrogation did not apply to an ineffective deed of trust. No valid lien was created against property owned jointly by husband and wife, the court held, because it named only the husband as the borrower – even though the proceeds of the loan were used to pay off a prior mortgage on which both spouses were indisputably obligated.

CONSTRUCTIVE NOTICE

Another argument to defeat a claim of priority over a defective mortgage is constructive notice.

The Court of Appeals of Arizona recently held that two deeds of trust recorded without property descriptions took priority over a competing mortgage because the facts showed that the holder of the competing mortgage had constructive notice of the defective liens. The court looked to the contract that showed that the

holder of the competing mortgage knew it was in “third lien” position.

Another court ruled that a bankruptcy trustee had constructive notice of a defective mortgage because it was properly indexed under the name of the borrower, and because a separate subordination agreement recorded in the land records, also under the borrower’s name, contained the correct property description. Similarly, a federal appeals court said a bankruptcy trustee could not avoid a mortgage recorded without a property description because the inclusion of the street address provided constructive notice to the trustee.

Other courts have rejected constructive notice arguments. For example, the IRS prevailed in a case where the recorded mortgage described only one of two tracts intended to be encumbered.

The court held that the IRS liens took priority over the mortgage on the tract that was omitted from the property description.

Some lenders have successfully invoked the doctrine of “substantial compliance” to salvage defective mortgages. A dispute between Ameriquest and Paramount, a competing lender, hinged on a Maryland law requiring an affidavit of consideration and disbursement signed by the lender, attesting to the timing and amount of funds advanced. Paramount, which held a mortgage secured by the same property but recorded two days after Ameriquest’s, challenged the affidavit because the funds were transferred two years later than described. Nevertheless, the Court of Appeals of Maryland held that Ameriquest’s mortgage was valid because it attached a new affidavit to the mortgage before recording it, an affidavit that was true as of the date of recording, and therefore “substantially complied” with the statute.

By contrast, a bankruptcy judge rejected the lender’s claim that a mortgage “substantially complied” with an Ohio statute mandating identification of all names of persons acknowledging the mortgage. The bankruptcy trustee could avoid the mortgage, the court held, because the notary left blank the place where the borrowers should have been identified.

Although a legally defective mortgage can pose problems, recent cases demonstrate that there are a wide variety of theories that can enable the defective mortgage to regain at least some of its expected priority position. By relying on legal theories such as the equitable mortgage, equitable subrogation, constructive notice, and substantial compliance, the artful practitioner can often convince a court to uphold a mortgage’s validity. ■

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We invite you to explore our website, contact us with questions, and get involved in the eDiscovery community today.

CONTACT Chris La Cour (949) 887-3786 clacour@cvedr.com

APR/ MAY 2012 E X ECUTIV E COUNSEL

Top Five Mistakes Confronted with

By William Shepherd

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s the courtroom door closes and you head into a dazzle of cameras and microphones, you wonder where it all went wrong. Sure, there were things that could have been handled differently over the years, but you were focused on producing value for your shareholders, and as industry standards changed, you needed to stay ahead.

Things began to unravel 24 months before your sentencing, the day agents came in wearing those cliché windbreakers with block leaders spelling dread. You now realize your bravado and bluster on that day may have been the worst strategic move of your life, and the fact that none of the agents read you your Miranda Warnings had absolutely no bearing on your case, because as you stormed through the offices that day “explaining yourself” you were not in custody, and so Miranda didn’t apply.

How could you have handled that day differently? Would it have had a material impact, or was it a fait accompli when you made the earlier choices that constituted the crime?

Certainly the best course is to comply with the law and regulations of your industry, but if you are ever the subject of a search warrant, there are five mistakes that are certain to make a bad situation worse.

INTERFERING WITH THE SEARCH

The first thing to remember is that you are no longer in control of your office or factory. The court has seized your premises to allow law enforcement to search for certain property.

Premises and property are the key words. Law enforcement has gone to a judge with a written affidavit that lays out two things: (1) facts relating to a possible crime and (2) probable cause to believe evidence of that crime, the “property,” is located at your premises.

Before it ever got to the judge, the agents spent time investigating the case to the point of a search warrant.

They have done surveillance, talked to whistleblowers, maybe even done some undercover work posing as customers or staff. Then they drafted and redrafted the warrant,

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO APR/ MAY 2012

Companies Make when a Search Warrant submitted it for supervisor review, agency legal review, prosecutor review and ultimately for final review by the court.

Then, as a practical matter pertaining to the execution of the warrant, they briefed the search team, coordinated with local uniform officers so that there will be marked police units on scene in case any mishaps occur – and they have rolled out of bed early on search day to hit the office as it opens. Their momentum and enthusiasm have brought them to your office that morning and the court supports it. You cannot stop what is about to happen.

At best, a containment strategy handled by experienced criminal counsel may be possible, but a misstep could lead to arrest. Both state and federal law enforcement have arrest powers for separate crimes should a person try to interfere with the execution of a search warrant. Your first mistake would be to do that and then get arrested at the search.

FOREGOING THE RIGHT TO REMAIN SILENT

The most common mistake a criminal defendant makes is engaging in conversation with the search team. With rare exceptions, business-crime search warrants do not result in a change in “custody status” for people at the office, and if you’re not in custody, no one will remind you of those words you have heard so many times in your favorite police drama.

Without that reminder, people tend to make regrettable offhand comments, or even detailed explanations. Salesman try to sell themselves out of trouble. Elected officials try to politic themselves out of trouble. But no matter a person’s station in life, the gift of gab is just a gift to the police.

Agents who ask open-ended questions about operations seeking to “understand” your business are setting a baseline and making a note for their report. A customer’s offhand comment about the situation may turn into a key data point. Without full context, search-day comments can be fitted into

continued on page 64

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Unconscionability Claims Still Breathing Drafting Arbitration Clauses After Concepcion

By David T. Biderman and Miriam D’Jaen Farhi basis, substantive unconscionability focuses on the one-sidedness of a contract’s terms. The prevailing view is that both components must be present in order for a court to invalidate a contract or clause.

However, the majority approach in Concepcion is to weigh the two components on a sliding scale, such that the more significant one component is, the less significant the other need be to invalidate the agreement.

INCONSPICUOUS TERMS

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egal observers have called the U.S. Supreme Court’s ruling in AT&T Mobility LLC v. Concepcion a death knell for consumer class actions, and businesses are taking note. The controversial 5-4 decision upheld the validity of arbitration agreements that include class action waivers. In doing so, the decision effectively encouraged companies to revise their consumer agreements to ban class actions and require consumers to arbitrate disputes on an individual basis.

Before Concepcion, states often overturned arbitration agreements that had class action waivers based on the doctrine of unconscionability. After Concepcion, it is clear that a class action waiver alone will not serve as a basis for invalidating arbitration requirements. But, as the contours of the Concepcion decision take shape, the business community should recognize that the courts are still invoking the doctrine of unconscionability and other policy-based considerations to invalidate or undercut arbitration provisions.

In a recent California court of appeal decision, Sanchez v. Valencia Holding Company, LLC, the court stated that unconscionability can be used to overturn an arbitration provision even though the class waiver is deemed to be enforceable. The court found that because the contract was adhesive and contained terms it found to be harsh or one-sided, the arbitration provision was “permeated by unconscionability” and, thus, unenforceable.

The doctrine of unconscionability is based on both a procedural and a substantive component. Whereas procedural unconscionability refers to contracts that contain hidden terms or are offered on a “take it or leave it”

Procedural unconscionability focuses on two factors: oppression and surprise. Oppression arises from an inequality of bargaining power and the inability to negotiate terms in a meaningful way.

Surprise, on the other hand, involves the extent to which the supposedly agreed-upon terms of the agreement are hidden in a document drafted by the party seeking to enforce the disputed terms.

In Sanchez, for example, the court emphasized the following factors as evidence of procedural unconscionability: (1) the agreement was a pre-printed form with provisions on both sides of the page; (2) the arbitration provision was the last section of the agreement and appeared at the bottom of the last page; (3) no signatures or initials were required on any of the back pages of the agreement; (4) the plaintiff’s final signature appeared on the frontside of the last page of the agreement; (5) the arbitration provision’s typeface, font size, and line spacing was small and hard to read in comparison to the rest of the agreement; and (6) the plaintiff was not given an opportunity to read the agreement or negotiate any of the pre-printed terms.

Courts typically find substantive unconscionability when arbitration agreements force the weaker party to arbitrate claims while permitting a choice of forums or remedies for the stronger party. Unless there are reasonable commercial needs or “business realities” that warrant such terms, courts are likely to overturn clauses that are so one-sided as to appear unconscionable.

Arbitration agreements often allocate the

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO apr/ may 2012

costs of arbitration proceedings up front. In many cases, companies require the consumer to bear a certain percentage (fee-splitting) or all (fee-shifting) of the arbitration costs. While the U.S. Supreme Court does not invalidate feesplitting or fee-shifting arrangements, it acknowledges a “prohibitive costs” defense and evaluates fee arrangements on a case-by-case basis.

Following the Supreme Court’s lead, several state courts have refused to enforce arbitration clauses that create cost barriers to consumer claims. For example, in Brower v. Gateway 2000, Inc., the Supreme Court of New York found that a $4,000 arbitration fee, $2,000 of which was not refundable regardless of whether the plaintiffs prevailed, was unreasonable and prohibitive compared to the estimated $1,000 each plaintiff claimed in damages.

The Ninth Circuit, applying California law, has also refused to enforce arbitration clauses that impose large costs relative to the size of the claim. California law has often been applied to declare arbitration fee-sharing schemes unenforceable where they impose costs on consumers that exceed those a complainant would bear if he or she filed the complaint in court.

At the same time, courts across jurisdictions, including the U.S. Supreme Court, have held that this right to reimbursement is a two-way street. In Green Tree Financial, the Supreme Court stated that an arbitration clause that requires the consumer to reimburse the company for arbitration costs if the company prevails should also be enforced. Subsequent decisions indicate that courts have interpreted Green Tree Financial as validating arrangements in which the company advances the arbitration costs but reserves the right to be reimbursed.

As a general rule, while courts assess the allocation of costs on a case-by-case basis, the more arbitration costs are borne by the company, the more likely courts are to compel the arbitration.

CHOICE OF LAW AND VENUE

Generally, courts will enforce a choice of law provision where the state has some reasonable connection to the parties or the dispute, so long as enforcement does not undermine the public policy of the forum state.

Forum selection clauses can also be challenged on the ground of substantive unconscionability.

For example, courts in California have repeatedly held that an unreasonable venue provision may render an arbitration agreement substantively unconscionable if it interferes with the claimant’s due

process rights or gives the defendant an advantage in the dispute resolution process.

Depending on the jurisdiction, the inclusion of a confidentiality provision could threaten the enforceability of the arbitration clause.

For example, in California, courts often conclude that imposing a gag order on the proceedings may place the company in a superior position, ensuring that none of its potential opponents have access to precedent, or the ability to obtain information needed to build a case of intentional misconduct against a company.

In 2008, the Washington State Supreme Court held in McKee v. AT&T Corp that a confidentiality clause in a contract of adhesion was a one-sided provision “designed to disadvantage claimants and ... help conceal consumer fraud.”

It is important to understand that the enforceability of arbitration agreements depends on a variety of factors, not just the enforceability of class waivers. As companies review their consumer agreement and elect to resolve disputes via binding arbitration, they should consider the following recommendations: • Provide clear and conspicuous notice of the arbitration provision (e.g., with clear headings, capitalized letters and line breaks, etc.).

• Require affirmative consent, such as an “I accept” button or signature page.

• Make arbitration clauses as mutual as possible, unless there is a business reality that warrants unequal obligations.

• Avoid imposing “prohibitive costs.”

• Consider allocating cost by reference to the rules of an arbitration institution and/or including a statement that says in the event costs are excessive, the company will pay the difference between the stated cost and what is determined to be a reasonable cost.

• Select a venue that is reasonable given the respective circumstances of the parties (e.g., the state where the service is provided or where the consumer resides). Alternatively, specify that the venue will be selected in accordance with the standard rules of an arbitration institution.

• Select the governing law of a state that is more likely to enforce the arbitration agreement and its terms.

• Avoid including a confidentiality provision in the arbitration clause, unless there is a legitimate business need to do so.

• Finally, include a severability provision to help ensure that any unconscionable terms will not affect the validity of the remainder of the agreement. ■

David T. Biderman is a partner in the litigation group at Perkins Coie, in the firm’s Los Angeles and San Francisco offices.

He focuses his practice on class actions and mass tort litigation, representing a wide variety of companies in state and federal courts.

Dbiderman@ perkinscoie.com

Miriam D’Jaen Farhi is an associate in Perkins Coie’s Seattle office.

MFarhi@ perkinscoie.com

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Top Five Mistakes Companies Make when Confronted with a Search Warrant continued from page 61

a story that supports the theme of the investigation, and they are difficult to turn around later.

The better practice is to excuse the employees not directly involved in supervising the search and then, after thanking customers for coming, ask them to come back tomorrow, after you reopen. Criminal defense counsel can best advise on this practice to avoid additional charges of obstruction, but having an existing policy for outside counsel and reminding employees that although you are not instructing

the regulatory issues related to your business.

Some of that material might not be clearly labeled as attorney-client material, and it may not be segregated from other documents.

Agents know they must handle privileged material separately and seek prior court order to access it, but you should take the first step by making sure the agents know there may be privileged documents in the office.

In-house counsel may assist with this process. If you don’t assert privilege – or even

The most common mistake is engaging in conversation with the search team.

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William Shepherd is a partner with Holland & Knight in West Palm Beach, Florida. As a member of the firm’s White Collar Defense team, he defends individuals and corporations in state and federal government investigations, and in grand jury investigations. He is a former Florida Statewide Prosecutor and is Chair Elect of the ABA’s Criminal Justice Section. william.shepherd@ hklaw.com

them not to speak to police (obstruction), they do have a right to remain silent and may consult with an attorney provided for them at the company’s expense should they choose to speak to agents at some later date.

worse, if you consent to the review – you have put your legal team at a significant disadvantage. Bold statements like “take whatever you want, we have nothing to hide” are likely to come back to haunt you in the courtroom.

FAILING TO GATHER YOUR OWN INTELLIGENCE

BEING UNPROFESSIONAL

By exercising your right to remain silent, you leave quite a bit of room for the silence to be filled by agents discussing the search. They will be guarded in their comments, but it will be clear from their conduct how they prioritize “property” and if they have prior knowledge of where certain items might be located on the premises.

Insight about both these matters will open a window of understanding into their investigation. In the rush of events it may be difficult to focus on this, but if you miss this opportunity it will never be back. The information you gather and later share with criminal defense counsel may prove invaluable to your case. Note the various agencies involved in the search, the hierarchy of who is in charge, whether or not a prosecutor is on scene, and whether or not law enforcement is filming the search.

This kind of intelligence is often the one positive that can come from the search, but to acquire it you will need to be observing carefully.

WAIVING PRIVILEGE

You have spent time and money working with counsel to make sure you follow regulations. As part of that process, you may have been given memos and letters that detail your analysis of

Competitors, whistleblowers, or informants seeking the favor with their own sentencing judge have told the agents and prosecutors things about you that don’t put you in a good light. But in most cases, law enforcement hasn’t yet had a chance to see for themselves what your organization is really about. The time to show your professionalism and make them question the veracity of your accusers begins with the first interaction your company has with the search team.

Is there screaming and weeping? Is there arrogance and demeaning comments to investigators? If so, you have only confirmed the stories of your accusers.

This can be a very costly mistake, because during the closed door meetings between prosecutors and agents, you want someone to recall you as a professional and question whether or not you should be charged and how serious that charge should be. This is a mistake that is hard to quantify, but if the episode goes poorly, it is difficult to overcome that first impression.

If you handle the search day well, you’re still going to have challenges ahead, but you will not have made your situation worse. Make the most of the opportunity. ■

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