Today's General Counsel (Formerly Executive Counsel), V9 N3, June/July 2012 by Today's General Counsel

JUNE/JULY 2012 VOLUME 9 / NUMBER 3 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 ,

INTELLECTUAL PROPERT Y

C E O

C F O

ENVIRONMENTAL

“Prioritized Examination” When Trade Secret Protection Rules

Avoiding Pitfalls in Energy Performance Contracting HUMAN RESOURCES

Witness Preparation

E-DISCOVERY

Audio, the Forgotten ESI Digital and Paper

GOVERNANCE

The GC-Finance Collaboration

CANADA/ CROSS-BORDER

A Merger Gone Awry: Key Role for Standstill Provisions Canadians Bought, U.S. Sold in First Quarter RFPs for Law Firms New Ways to Reduce Litigation Costs Accounting Issues in Securities Class Actions

CROSSBORDER DEALS Multi-Language Documentation M&A Trends to Watch for the Rest of 2012 Key Precautions in Multinational Agreements

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june/july 2012 E X ECUTIV E COUNSEL

Editor’s Desk

There is always pressure to lower the cost of legal services, but generally speaking it only succeeds in slowing the rate at which they rise. Litigation is the prime driver, and as Alan Rudlin writes in this issue of Executive Counsel, “it is unlikely that litigation will ever be inexpensive in America.” Nevertheless, his article discusses two relatively new methods that bite into the most costly component of the litigation process: expensive and timeconsuming pretrial tasks, such as e-discovery. Some corporations are pursuing a two-track process: instructing their litigators to go full speed ahead preparing for trial, but hiring separate counsel who concentrate solely on settlement. Rudlin explains the different skills required for each, and the advantages of using both. He suggests a fixed fee arrangement with settlement counsel. He also discusses the Delaware Court’s private arbitration fast-track option, in which Chancery Court judges sit as arbitrators. That option itself is being challenged in federal court, and litigation has already begun. Preparation for the inevitable is the theme of an article by Martin O’Hara and Jon Schuyler Brooks. Litigation costs rise considerably when they involve companies from multiple countries, but drawing up contracts that anticipate certain contingencies can minimize the problem. Along with determining the forum in which disputes will be heard, contracts should address what body of law will be applied to decide a potential dispute. David Williams and Tamika Tremaglio discuss the ever-changing role of the general counsel, as they cite a Deloitte survey that indicates GC-CFO collaboration is increasing but is still “occasional” in about one quarter of companies. They mention the old canard about GC’s being deal-breakers and hand-wringers, but sometimes that’s just what the doctor ordered. For

example, it would have been interesting to hear what the GC of HCP, a health care real estate investment trust, had to say about the strategy his company followed when it tried to acquire a Canadian company, SZR. Read about the $225 million mistake HCP made in an article by Terri L. Mascherin, Kyle A. Palazzolo and Gaurav Jetley. Look for us online at executivecounsel.info

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

june/july 2012 E X ECUTIV E COUNSEL

Features

M&A TRENDS TO WATCH FOR THE REST OF 2012

AvOiDiNg PiTFAllS iN ENERgy PERFORMANCE CONTRACTiNg

Kyle Krpata and Andrew Nelson Flush companies looking for deals.

Dale B. Tauke Define the technical issues carefully.

Page 40

RFPS ARE AN OvERlOOKED OPPORTUNiTy FOR lAW FiRM COST-SAviNgS Robert C. Mattern Support service RFPs can save money and improve contracts.

PRECAUTiONS ESSENTiAl iN MUlTiNATiONAl AgREEMENTS

NEW WAyS TO REDUCE liTigATiON COSTS

Martin J. Oâ&#x20AC;&#x2122;Hara and Jon Schuyler Brooks Consider where disputes will be heard.

Alan Rudlin Separate settlement counsel, and sitting judges as mediators.

MUlTiNATiONAl M&A REviEW OFTEN REQUiRES TRANSlATED DOCUMENTS Ty Cobb and Eric Elting Machine translation as part of the process.

SECURiTiES ClASS ACTiON SETTlEMENTS DECliNE, BUT ACCOUNTiNg iSSUES REMAiN Laura E. Simmons and Matt G. Armstrong Dodd-Frank and SOX keep the heat on.

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Departments Editor’s Desk Executive Summaries

2 10 E-DISCOVERY

18 | How to Handle Audio, the Forgotten Esi Michael Arkfeld Digital sound is electronic, discoverable.

21 | Digital and Paper Records in Law Firms, Legally Wed Carolyn Casey Time to formalize their relationship. HUMAN RESOURCES

22 | Coordinated Witness Preparation For Employment Litigation Roy Futterman Getting their story straight.

INTELLEC TUAL PROPERT Y

CANADA / CROSS-BORDER

26 | Prioritizing Your Patent Application

35 | Shut Up and Stand Still

Chinh H. Pham and Fang Xie New “Prioritized Examination” has a goal of 12 months.

29 | Reconsider the Way You Protect New Ideas Mark A. Klapow Every patent starts as a trade secret.

Terri L. Mascherin, Kyle A. Palazzolo and Gaurav Jetley Courts take standstill agreements seriously.

38 | Canadians Bought, U.S. Sold In First Quarter Divya Balji Strong dollar seeking safe haven.

GOVERNANCE

32 | The Evolving Role Of The General Counsel David Williams and Tamika Tremaglio Finance and legal teaming up.

Page 26

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Editor-in-ChiEf Robert Nienhouse

Publisher Julie Duffy

MaNagiNg eDiTOr David Rubenstein

execuTive eDiTOr Bruce Rubenstein

MaNagiNg DirecTOr, execuTive cOuNsel iNsTiTuTe Neil Signore

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Contributing Editors and WritErs

Michael R. Arkfeld Divya Balji Jon Schuyler Brooks Carolyn Casey Ty Cobb Eric Elting Roy Futterman Mark A. Klapow Kyle Krpata Terri L. Mascherin Robert C. Mattern

Andrew Nelson Martin J. O’Hara Kyle A. Palazzolo Chinh H. Pham Alan Rudlin Laura E. Simmons Dale B. Tauke Tamika Tremaglio David Williams Fang Xie

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All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information or retrieval system, with out the written permission of the publisher. Articles published in Executive Counsel are not to be construed as legal or professional advice, nor unless otherwise stated are they necessarily the views of a writer’s firm or its clients. Executive Counsel (ISSN 1932-9024) is published six times per year by Nienhouse Media, Inc., 640 Park Avenue, Hinsdale, IL 60521-4644 Image source: iStockphoto | Printed by Quad Graphics | Copyright © 2011 / 2012 Nienhouse Media, Inc. Email submissions to editor@executivecounsel.info or go to our website www.executivecounsel.info for more information. Postmaster: Send address changes to: Executive Counsel, 640 Park Avenue, Hinsdale, IL 60521-4644 Periodical postage paid at Hinsdale, Illinois and additional mailing offices.

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Executive Summaries HUMAN RESOURCES

E-DISCOVERY

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How to Handle Audio, the Forgotten ESI

Digital and Paper Records in Law Firms, Legally Wed

Coordinated Witness Preparation for Employment Litigation

By Michael Arkfeld Educator and author

By Carolyn Casey Iron Mountain

By Roy Futterman DOAR Litigation Consulting LLC

As early as the year 2000, federal courts acknowledged that discoverable electronically stored information (ESI) included audio. Audio stored in digital formats is now found in a variety of storage systems and locations, and courts are likely to impose sanctions based on failure to adequately identify, preserve and disclose “sound recordings.” Failure to identify and disclose responsive audio evidence can lead to sanctions, including an adverse inference instruction. The prudent course is to stay current on technology such as phonetic search software, which can enhance audio search capability, decrease its cost, and identify and disclose relevant and responsive audio. Attorneys who understand audio search issues, and the court mandates that pertain to them, can provide a valuable service to their clients. Phonetic search software efficiently and cost-effectively breaks down audio content to “phonemes,” the smallest components of human speech, and creates a time-aligned phonetic index of the content. This allows for key word searches similar to a text-based search platform. The difference is that the software is looking for phonetic patterns that match the search terms. Because phonetic search technology is not dictionary-based, there is no need to train the system for dialects or accents. This process not only creates the truest representation of spoken audio, but it enables the most accurate access to information contained within the audio files. Reviewers can listen to potentially relevant content to verify, annotate, and tag responsive and privileged recordings.

About one third of all law firms have a formal policy for managing paper records, but no policy for managing their digital records, according to survey taken by the author’s company. She suggests formulating a unified policy in preparation for the time when almost all records except for hard copy documents required by law will be digital. Formulation of this policy requires addressing issues like what to keep, what to destroy and which is the “official” record – the electronic or paper version. The author provides several tips for creating a policy. If you have a hard-copy policy, she suggests using it as a springboard to implement digital and paper records retention and destruction programs. Many aspects of a paper plan can be adapted to the demands of digital document management. Scanning, which is now likely part of any firm’s hybrid workflow, will be a critical part of the migration to a reduced-paper environment. A partner with records expertise, sophisticated imaging technology and “scale” to handle large projects can help to map out and implement an imaging strategy, whether it’s “on-demand,” on-going, or for specific large e-discovery projects. Once there is buy-in from senior leadership to unify the paper and electronic policy, the firm will be on its way to effectively managing a hybrid environment. That lays the groundwork for switching over to a purely digital system, which will be the norm in the not too distant future.

The defense of a labor and employment case that is headed toward trial is often based on the testimony of a variety of employees, most of whom are disinterested in the trial and appalled at the prospect of testifying. According to the author, counsel can create a strong defense out of this disadvantageous scenario through coordinated witness preparation, which he compares to making a wall out of individual bricks. He suggests gathering all the testifying witnesses in one place for a coordinated series of sessions, over a number of days. This technique exposes individual and group issues that can weaken or derail a defense strategy. Throughout this process, common individual behavioral and motivational issues emerge, and once identified they can be resolved before trial. Gathering witnesses and hearing their testimony often exposes a significant case problem that might be missed in individual witness preparation. It’s not uncommon for each supervisor and human resources worker to attempt to obscure his or her own responsibility for decisions made about workplace incidents, pointing toward other departments as being the proper place of decision-making. This may be useful for an individual witness, but it’s problematic for the company and the defense strategy. The problem is explicitly labeled as such to the group, without any one witness being blamed. Then the group cooperates in identifying the reasonableness of actions taken at each decision point until all are satisfied with the unified and accurate narrative.

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JUNE/JULY 2012 E X ECUTIV E COUNSEL

Executive Summaries GOVERNANCE

INTELLEC TUAL PROPERT Y

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Prioritizing Your Patent Application

Reconsider the Way You Protect New Ideas

The Evolving Role of the General Counsel

By Chinh H. Pham and Fang Xie Greenberg Traurig

By Mark A. Klapow Crowell & Moring LLP

By David Williams and Tamika Tremaglio Deloitte Financial Advisory Services LLP

An expedited procedure for examining U.S. patent applications, called Prioritized Examination, or “PE,” has been implemented by the America Invents Act, which was signed into law by President Obama in September 2011. The goal of PE is for qualified U.S. patent applications to reach final disposition within 12 months. This represents an inexpensive alternative to the regular patent prosecution route, which on average takes about three years to disposition. Those who are in industries where products have a short shelf life, who trade patent rights for investment or licensing opportunities, and/or regard patents as an important defensive tool, have a strong incentive to use this procedure. The PE procedure also may allow U.S. patentees to accelerate patent examination in certain foreign countries. A patent application filed on or after September 26, 2011, may be granted PE status subject to the following requirements: It must be a non-provisional application for an original U.S. utility or plant patent filed via the USPTO’s electronic filing system, and the application as filed must contain no more than four independent claims and no more than 30 total claims. In addition, it must not include any multiple dependent claims. An international application being entered into the United States as a “by-pass” continuation application also may be eligible. To maximize the benefits of PE, companies should review their patent portfolios as soon as possible to identify pending applications that call for expedited examination.

Most corporate legal departments have established processes to translate new ideas into patents. In many companies this approach is automatic, and trade secrets are not part of the conversation. Developments in both patent and trade secret law, however, suggest that it is time to revisit this approach. There is increasing appreciation for the flexibility of trade secret protection. A wide range of information that can qualify for trade secret protection cannot be patented – for example customer lists, pricing and cost data, business plans and software code. Unlike patents, trade secret protection is not limited by time. So long as its holder can maintain secrecy, a trade secret can last forever. Unlike patents, trade secret damages can include compensation for unjust enrichment, and preliminary and permanent injunctive relief is commonly granted in trade secret cases. The patenting process has also become very expensive. The average cost to obtain a relatively complex patent in the United States is over $10,000. This does not include the costs of protection outside the United States. The average annual budget for the intellectual property departments for large companies, which are typically the most dedicated to steering new ideas through the patent process, is over $6 million. The author suggests three scenarios in which trade secret protection may prove superior to patenting: When the commercial value is uncertain; when the new idea cannot be reverse engineered; and when the new idea may not qualify for a patent.

A recent Deloitte Financial Advisory Services LLP poll of 1,300 business professionals found that nearly two-thirds of respondents believe that market volatility has driven increased collaboration among C-suite executives. A significant percentage – 41 percent – reported that the collaboration between the GC and CFO at their companies is high, while 25 percent said the GC-CFO collaboration is occasional. Only three percent said it was non-existent. Respondents disagreed when asked in what situations this collaboration mattered most. Thirty-four percent said there should be strong teamwork regardless of market conditions, while 27 percent said teamwork is needed only during an economic downturn when organizations experience higher layoffs and need to manage debts or collections. Another 25 percent said periods of business growth and expansion – where there are likely more mergers, acquisitions, and hiring – require the most collaboration. The authors argue that companies that don’t foster collaboration between finance and legal are risking a competitive disadvantage, and they suggest practicing consistent inclusion. They say GCs should be involved and integrated in initial discussions on a transaction or issue. They also advise developing crossfunctional specialization. By knowing the business, GCs become specialists on what is most important, and this allows them to make cross-functional decisions. GCs should be brought in on discussions about tax matters, M&A and crossborder transactions. They will benefit from the information, and the organization will benefit from the breadth of their views. This teamwork is important through every kind of business cycle.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

Executive Summaries

CANADA /CROSS-BORDER PAGE 35

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Shut Up and Stand Still

Canadians Bought, U.S. Sold in First Quarter

M&A Trends to Watch for the Rest Of 2012

By Divya Balji mergermarket

By Kyle Krpata and Andrew Nelson Weil, Gotshal & Manges

Canadian companies are becoming the dominant bidders in U.S.-Canada cross-border M&A deals. A strong Canadian dollar, weaker valuations in the United States and the loosening of purse strings in the credit market help to create a buyers’ market, as do perceptions that the United States is still a safe haven (compared to Europe and emerging countries). Other factors are access to cheap deal capital that can be used to boost returns, a larger scale and broader scope of M&A opportunities and a desire to replace public market exposure with private market exposure. Three out of the four billion dollar-plus deals announced in Q1 2012 were in the energy and utilities sector. The U.S. $1.4 billion purchase of CH Energy Group by Fortis Inc in February of this year led the pack. Fortis, the largest investor-owned distribution utility in Canada, had said last year that it was looking to expand into the United States through acquisitions, and could have as many U.S. assets as Canadian over the next 10 years. Watchtell, Lipton, Rosen & Katz LLP acted as the legal advisor for CH Energy Group, and White & Case LLP acted as the legal advisor for Fortis. Canadian banks, which were making large buys in the United States in 2010 and 2011, have now shifted their focus to Asia, so there weren’t as many deals in the financial services sector between Canada and the United States in Q1 as there had been in the past.

According to Thomson Reuters, the value of announced M&A transactions during the first quarter of 2012 was down 15 per cent from the fourth quarter of 2011. Despite the slow start, there are some encouraging signs as the uneasiness appears to be gradually waning and being replaced by modest confidence in the deal markets. The authors discuss some factors and trends they foresee during the remainder of 2012, assuming relatively stable macroeconomic and geopolitical climates. They expect that deal cycles may be longer due to intense negotiations on key transaction terms, because no deal participant can afford to be exposed in the current environment. While strategic M&A has been driving the market for the last several quarters, they say that private equity buyers are more than ready to get back in the game. Many funds are seeking to deploy uncommitted capital and take advantage of favorable debt financing. Buyers, particularly private equity sponsors, are mindful of the need for downside protection in the event they cannot close, and they continue to require reverse termination fee structures or damages caps. The intellectual property wars show no sign of abating. More than ever, companies need intellectual property assets for use as swords, shields and bargaining chips. As a result, companies with intellectual property that can be used defensively in other portfolios will have a seller’s market in which to monetize it. This is especially true of patents.

By Terri L. Mascherin and Kyle A. Palazzolo Jenner and Block and Gaurav Jetley Analysis Group

Parties contemplating an M&A transaction typically enter into a confidentiality agreement (CA) to facilitate the exchange of non-public information. The parties may include a standstill clause, which aims to protect the target from a hostile takeover attempt by an acquirer with access to the target’s confidential information. The risk of non-compliance can be severe, as Ventas v. HCP illustrates. SZR, a Canadian company, conducted a structured sales process to identify a buyer. Ventas, HCP, and other potential acquirers executed CAs with SZR. HCP’s included a standstill and a confidentiality undertaking. In January 2007, SZR and Ventas announced an agreement to acquire SZR for C$15 in cash per unit, and to assume SZR’s debt. Soon after, HCP publicly disclosed a purported offer to acquire SZR at C$18 per unit. SZR’s stock price shot up from under $C15 to over $C18. Litigation resulted in HCP withdrawing its “offer.” However, Ventas was forced to increase its offer from C$15 to C$16.50 to secure the votes necessary to complete the transaction from SZR’s holders. Ventas then commenced litigation against HCP. It sought to recover $101 million – the amount by which it had to enhance its offer in order to complete the deal – plus punitive damages. In the ensuing trial, a jury found HCP liable for tortious interference with Ventas’ C$15 deal and awarded $101 million in damages. The Sixth Circuit affirmed their verdict.

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Executive Summaries PAGE 44

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Avoiding Pitfalls in Energy Performance Contracting

RFPS Are an Overlooked Opportunity for Law Firm Cost-Savings

Precautions Essential in Multinational Agreements

By Dale B. Tauke Fox, Hefter, Swibel, Levin & Carroll

Performance contracting can be a way for facility owners or operators to “go green” and save money. What that means is that contractors include service and equipment packages which provide retrofits that increase efficiency by reducing energy consumption. Performance contracts are different from routine installation or construction contracts. They offer to the facility owner the guarantee of improved energy efficiency, and that guarantee is backed with the promise of monetary payments if it is not met. The engineering profession has developed standardized guidelines and best practices, and for federal projects the U.S. Department of Energy has created guidelines. To avoid contract problems, the author says it is important to understand the objective: Savings in this context are measured in units of energy, not dollars, and the guarantee is that the new installation will consume less energy to achieve a specified output. Make it a handson project for senior management. Get help from an outside consultant. Get your entire maintenance team on board. Remember contracting basics, and that all key terms of any construction project need to be addressed, and provide for efficient dispute resolution. Finally, it’s important to agree on the savings report form and get access to data and calculations. The complexity and volume of data involved in energy efficiency calculations create a risk that the post-project savings reports will be either an unhelpful avalanche of information or too little information to allow for an adequate review.

By Robert C. Mattern Mattern & Associates LLC

By Martin J. O’Hara Much Shelist and Jon Schuyler Brooks Phillips Nizer Llp

Law firms typically list their top four expenses (lowest to highest) as wages, rent, insurance and support services. With regard to support services contracts, most firms continue to sign them with little industry comparison. According to the author, this represents a lost opportunity for savings. He says that an open request for proposal (RFP) process in which a multitude of vendors is invited to participate will yield on average more than 14 percent in savings over engagements in which negotiations involve only the incumbent vendor. A firm can be pleased with its incumbent vendor and still engage in an open RFP. The Director of Administration for Thompson Coburn LLP recently completed an open RFP process for facility services. The five-year contract signed with Pitney Bowes Management Services in 2006 was set to expire. According to the Director, the firm had a good relationship with Pitney Bowes and was pleased with the services they’d been providing. However, he undertook an analysis of pricing models and service offerings. It took more than a year to complete, but significant potential efficiencies were discovered in labor, duplicating equipment and impression costs. The firm decided to sign a renewal contract with Pitney Bowes, but it was under more advantageous conditions, both for the short term of the contract period and for future negotiations. The author outlines an alternative knows as “the closed RFP process,” which also can result in savings.

General counsel and CFOs know about the high cost of litigation, including the cost of litigating such avoidable issues as choice of forum or law. But they should also be aware that such costs can be much higher when the contract involves parties from multiple countries, in which case it is important to consider carefully the potential issues and incorporate precautions into the contract that will save the company time and money if there is a breach. The first issue to consider is where a dispute will be heard. Absent a contract provision specifying the forum, courts may undertake an unpredictable selection process in which multiple factors are weighed. A well-drafted provision will designate or at least delimit the forum. Along with forum, any company entering into a multinational agreement should consider what body of law will be applied to decide a dispute. The choice of law will have an impact on other elements of the agreement, including a mandatory arbitration provision. There are many benefits to including an arbitration provision in any contract, but those benefits are magnified in a multinational scenario. Like a forum selection clause, an arbitration clause can dictate where the arbitration will proceed. Another issue is attorney’s fees, which are in many venues outside the United States paid by the losing party. The authors caution that selection of a law firm in multinational deals can be tricky and suggest various strategies for making the selection.

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Executive Summaries

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New Ways To Reduce Litigation Costs

Multinational M&A Review Often Requires Translated Documents

By Alan Rudlin Hunton & Williams LLP

By Ty Cobb Hogan Lovells and Eric Elting TransPerfect Legal Solutions

Securities Class Action Settlements Decline, but Accounting Issues Remain

The major cost driver in litigation is not the trial, but rather the many expensive and time consuming pretrial tasks. Those costs have ballooned in recent years, with e-discovery alone averaging millions of dollars in mediumsize cases. The author considers two recent developments that have the potential to significantly shorten the dispute process and reduce these costs: the Delaware Courtâ&#x20AC;&#x2122;s adoption of a private arbitration fast-track option for certain business disputes, and the growing use of separate settlement counsel in selected cases. In 2010, the Delaware Court of Chancery adopted a procedure that allows parties to have their dispute arbitrated privately by one of the regular judges of the court. This process is faster than courtroom litigation: The rules provide for an expedited arbitration hearing at the end of 90 days. There is a $12,000 initial filing fee and $6,000 per diem for each day of arbitration. The arbitrators are respected jurists with a sophisticated expertise in business disputes, more so than may be the case among general docket judges and private arbitrators. The process has been challenged in federal court. The practice of hiring separate counsel solely to negotiate a settlement is a relatively new development. The work of settlement counsel does not duplicate what trial counsel may be doing. It allows the company to send the message that it is serious about winning at trial, but is open to the possibility of settlement.

Until recently, according to the authors, the FTC viewed the matter of non-English-language documents during the discovery process with some flexibility. Today, the FTC often makes a second request, in which it requires translated documents. The prevalence of Foreign Corrupt Practices Act (FCPA) cases is another factor in the growing need for translation processes. Legal representatives are now tasked with proving their compliance efforts not only in their U.S. headquarters, but also in their foreign operations. The ability to do that hinges on access to translated documentation of business practices abroad. Machine translation is essential for managing the multilingual documents involved in discovery, M&A, patent litigation and other matters. Relying on machines for triage early in the translation process is one strategy. This can be coupled with various technologies to cull down the data set. Then human experts can carefully translate a smaller set of documents. The authors provide examples of how translation services factored into several cases. These include a second request from the FTC that involved 400 documents in 12 languages and came only three days before a critical government deadline, and a case involving an FCPA investigation that required the translation of relevant documents from Chinese into English. The authors note that international companies need attorneys that can practice law in the United States, so they value hiring U.S.-based counsel. With this practice, translation becomes important in collaborating between the company abroad and domestic counsel.

By Laura E. Simmons and Matt G. Armstrong Cornerstone Research

There was a decrease in the volume and value of securities class action settlements in 2011, but there is reason to expect that this is a temporary dip and that accounting issues will remain important in securities litigation. In 2011, there were 65 securities class action settlements, with a median settlement amount of approximately $6 million, compared with an average of almost 100 settlements, with a median settlement amount of just under $10 million for the prior five years. In addition, the number and percentage of settled cases involving violations of generally accepted accounting principles (GAAP), financial statement restatements, and/or accompanying SEC actions declined to the lowest levels in 10 years. Only one in four cases involved financial restatements. Each of these factors in 2011 was approximately 30 percent or more below the prior five-year average. While nearly 95 percent of the largest 50 securities class action settlements in history involved accounting cases, the majority of these settlements occurred prior to 2009. These findings suggest that the risks associated with accounting issues have decreased. However, there are factors that warrant further consideration. This yearâ&#x20AC;&#x2122;s 10-year anniversary of Sarbanes-Oxley is marked by continued regulatory activity, new regulatory developments, an increasing number of allegations related to SOX 404, new incentives created by Dodd-Frank whistleblower provisions and increased collaboration between regulatory agencies. The securities litigation environment remains volatile, and monitoring accounting issues in litigation continues to be important.

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JUNE/JULY 2012 E X ECUTIVE COUNSEL

E-Discovery

How to Handle Audio, the Forgotten ESI By Michael Arkfeld

udio evidence has become a hot-button issue for corporations and their law firms. Audio stored in digital formats is now found in a variety of storage systems and locations, including call-logging systems, voicemail servers, call center recording systems, unified messaging, and web conferencing. The harsh reality is that courts have become more likely to impose sanctions based on failure

to adequately identify, preserve and disclose â&#x20AC;&#x153;sound recordings.â&#x20AC;? Whether requesting or producing audio evidence, attorneys who understand audio search issues, and the court mandates that pertain to them, can provide a valuable service to their clients. A law firm that assumes it can effectively manage audio with manual review processes is taking a risk. Today the prudent course is to stay cur-

rent on technology such as phonetic search software, which can enhance audio search capability, decrease its cost, and identify and disclose relevant and responsive audio. AUDIO EVIDENCE IS DISCOVERABLE

As early as the year 2000, federal courts acknowledged that discoverable electronically stored information (ESI)

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

E-Discovery

included audio. In Kleiner v. Burns, the court stated that “‘computerized data and other electronically-recorded information’ includes, but is not limited to: voicemail messages and files, backup voicemail files ... [and] Web site information stored in textual, graphical or audio format ...” This mandate was applied in E*Trade Secs. LLC v. Deutsche Bank AG, where the court issued an adverse inference instruction against securities companies for failing to preserve voicemail and other ESI. In 2006, digital audio evidence was included when the federal and most state courts amended their procedural rules. Federal Rules of Civil Procedure Rule

party had “notice” of the anticipated or pending litigation. Thus, when faced with a potential lawsuit, attorneys on both sides have a responsibility to inform their clients of the duty to preserve and disclose relevant audio evidence. Failure to identify and disclose responsive audio evidence can lead to sanctions, including an adverse inference instruction. TYPES OF AUDIO EVIDENCE

Digital audio recordings created in the course of business are proliferating, with many businesses now recording and storing audio conversations by way of voicemail, web conferencing meetings or financial transactions. With

of thousands, in one case, a quarter million, voicemails showing up from various backups and computer platforms.” Many companies today provide voicemail service in-house, often storing voicemail on hard drives, backup tapes or optical disks, but fail to address this content during discovery. Because of its digital format, voicemail now can be stored, manipulated and treated like e-mail. Moreover, a voicemail file can be easily attached to an e-mail message. Generally, if you mention a “sound recording” most attorneys think of voicemail, and indeed voicemail remains an important location for audio information. However, it is only

When faced with a potential lawsuit, attorneys on both sides have a responsibility to inform their clients of the duty to preserve and disclose relevant audio evidence. 34(a), which sets forth the forms of ESI that a party can request, defines “documents” and “electronically stored information” to include “sound recordings, images, and other data or data compilations stored in any medium from which information can be obtained.” Rule 26(f), which addresses “meet and confer,” specifically requires the parties to address “any issues relating to disclosure or discovery of electronically stored information, including the form or forms in which it should be produced.” This means that parties must be knowledgeable about the client’s sound recording and storage systems, audio formats, preservation and production issues. In fact, in Kleiner the court stated that the rules provide that a party’s initial disclosures include audio evidence. The law is clear that litigants have a duty to preserve any evidence that may be relevant to reasonably anticipated litigation, and that the key issue in determining when a duty to preserve arises centers on when the

advanced digital technologies, the ability to record and store audio on digital storage media has resulted in volume growth comparable to that occurring with e-mails and text messaging. Audio evidence is unique and important because it can provide a person’s words in his or her own voice, preserving tone, inflection or sarcastic intent. In this way, audio recordings can be more effective than statements from a document. But traditionally audio has been more difficult to search than text. “It used to be voicemail wasn’t a big risk in discovery, because it resided on third-party proprietary platforms,” wrote John H. Jessen, in a law review article (“Special Issues Involving Electronic Discovery”) in The Kansas Journal of Law & Public Policy. “You couldn’t get to it, it got overwritten effectively, and it was hard to deal with. Today ... voicemail messages are digital files sitting on computers, which make all of the rules of discovery, of recoverability, of review, et cetera, fall right into place. We routinely find thousands, tens

one of many locations and sources of audio that may be relevant ESI. Others include the following: • Trading activities. The energy and financial sectors are among the industries that rely on telephone calls for business interactions. Both of these industries are highly regulated and required to record telephone conversations. Both federal and foreign regulatory agencies have intensified their investigative activity, and they often require the preservation and disclosure of audio recordings. U.S. agencies that may require disclosure include the SEC, the Federal Energy Regulatory Commission and the the Commodity Futures Trading Commission. • Call centers. Phone call recording is an important procedure for many businesses large and small for a variety of reasons, including quality control, training, compliance, regulations and more. Telephone call center repositories may receive, transmit and store large volumes

june/july 2012 E X ECUTIV E COUNSEL

E-Discovery

of audio in the course of answering product inquiries from consumers or during outgoing calls for business transactions, telemarketing, client services and debt collection services. Call centers may be required to preserve call information pursuant to the Payment Card Industry Act, Dodd-Frank, Sarbanes-Oxley, the Telemarketing Sales Rule, the Telephone Consumer Protection Act, the Truth in Lending Act, the Fair Debt Collection Practices Act, Health Insurance Portability and Accountability Act and the Privacy Rule and the Medicare Improvements for Patients and Providers Act. Be aware there are many additional sources and locations of sound recordings, including podcasts, YouTube videos, and training and iPhone recordings. REVIEWING AUDIO

Parties who reasonably anticipate litigation have an obligation to identify, preserve and disclose relevant, responsive sound recordings. At that point the critical questions become: How do you listen to or “review” audio to determine what is responsive and should be disclosed, and what is privileged and should not be disclosed? What methods are available for audio search and review? For voicemail, one option is to ask the custodian who controls it to manually review it – hours of it. However, this process may run afoul of the selfselection prohibition set forth in the Pension Committee case. But relevant, privileged or proprietary information must all be identified. Unintelligible voicemail will need to be handled, as well. Assigning these tasks to legal professionals, requiring them to listen to hours of voicemail and flag relevant passages, would be very costly and usually unreliable. It likely would then be necessary to transcribe the audio into text, another step that would add significant expense and would be likely to introduce errors. Re-searching, if it became necessary, would essentially require listening to the audio again. Another option is using voice recog-

nition software to convert audio files to text, and then using text search tools to identify relevant passages in the text. Unfortunately the conversion of audio to text is time-intensive, and because of dialects, varying speech patterns, misspellings and other issues, it often results in accuracy rates below forty percent. PHONETIC SEARCH

A third option is phonetic search software, starting with the first step: identifying the amount of audio content at issue. Like text-based ESI, audio and video contain large quantities of non-responsive information. But with this technology, non-responsive sound recordings can be eliminated easily without the need for human review. When the time comes to review the audio files, producing counsel then will have a realistic estimate of how many hours of audio must be searched and reviewed, the audio format or formats that need to be addressed, and the approximate review costs. Audio recordings such as trading-floor calls, call-center recordings and voicemail are stored in a variety of formats, including proprietary ones. If you are the requesting party, it is important to ensure that you receive the audio files in a “reasonably usable” format, as the time and cost of converting and searching audio files can be significant. Phonetic search breaks down audio content to the smallest components of human speech, known as phonemes (defined by Wikipedia as “cognitive units of speech sound ... which distinguish the words of a language.”) In phonetic search software, phonemes are indexed to analyze what is being said without being affected by such factors as dictionaries, background noise, languages, dialects or speaking styles. Rather than converting sound to text and then searching the text, phonetic search software creates a time-aligned phonetic representation of the content. This index allows for key word searches similar to a text-based search platform. The difference is that the software is looking for phonetic patterns that match the requested search terms. For example, the word “asbestos” is phoneti-

cally indexed and stored as “as-bes-tos.” When searching for “asbestos,” the software breaks it down phonetically and scans the index file phoneme-by-phoneme for a match, returning relevancyranked results with surprising accuracy. This process not only creates the truest representation of spoken audio, but it enables the fastest and most accurate access to information contained within the audio files. Reviewers can listen to potentially relevant content to quickly verify, annotate, and tag responsive and privileged recordings. Phonetic search eliminates the need to maintain complex speech-to-text dictionaries. New words, industry terms, blended words, proper names, slang, code words, brand names, and even the non-standard mixing of different languages can be processed using the phonetic approach. Because phonetic search technology is not dictionary-based, there is no need to train the system for dialects or accents. This method does not depend on subjective analysis of the sound recording, and it eliminates judgment errors due to fatigue, boredom or distractions. Regulatory officials and litigants are increasing their demands for audio ESI, and corporations and their counsel that do not comply risk significant sanctions and regulatory penalties. Audio ESI needs to be accurately analyzed and reviewed, and phonetic search software can do that efficiently and cost-effectively. ■

Michael Arkfeld is an attorney, educator and author in the field of electronic evidence and discovery. His published writings include Arkfeld on Electronic Discovery and Evidence, Arkfeld’s Best Practices Guides for Electronic Discovery and Evidence, ESI Pretrial Discovery – Strategy and Tactics, and Legal Hold and IT Primer for Legal Professionals. He is a former assistant United States Attorney for the District of Arizona. michael@arkfeld.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

E-Discovery

Digital and Paper Records in Law Firms, Legally Wed A Formal, Unified Information Management Policy By Carolyn Casey

houldn’t we welcome the union of digital and paper records in law firms with a formal, unified information management policy? You’d think so, but our company’s Law Firm Information Management Benchmark Report revealed that 31 percent of law firms surveyed have a paper records policy, but none for digital records. And many of the firms that do have epolicies struggle with adhering to them. Closing the gap between the two requires a good deal of preparation and, well, some counseling. Attorneys and staff will need to know how to manage digital records. This includes addressing issues like what to keep, what to destroy and which is the “official” record – the electronic or paper version. If a firm ultimately wants to go paperless – or, more accurately, severely reduce its reliance on paper (except for hard copy documents required by law) – how does it get there? When building a unified records

management policy, here are some tips to consider: • Leverage your best assets. If your firm lacks a digital policy, use your existing hard copy policy as a springboard to implement digital and paper records retention and destruction programs. You can adapt many aspects of a paper plan – such as required retention periods, establishing post-matter closing records procedures, and training attorneys and staff on the destruction process – to the demands of digital document management. • Develop your vision. Many of those self-help books tell you to visualize your future success. The same advice applies to achieving the sometimes elusive goal of a paper-free firm. If you have limited internal resources, consider partnering with experts familiar with law firms and digital conversion technology to help develop a vision for an optimal transition strategy and implementation plan.

• Be “image-conscious.” Scanning, which is now likely part of your hybrid workflow, will be a critical part of your migration to a reducedpaper environment. A partner with records expertise, sophisticated imaging technology and “scale” to handle large projects can help you map out and implement an imaging strategy, whether it’s “on-demand,” on-going or for specific large ediscovery projects. You can keep the scanned images in-house or securely store them with your provider for easy online access. • Once there is buy-in from senior leadership to unify your paper and electronic policy, you’ll be on your way to effectively managing a hybrid environment. With that kind of backing, you’ll be able to win over attorneys and staff on the benefits of applying a hybrid digital/paper records management policy – laying the groundwork for a possible, amicable digital-paper divorce down the line. ■

Carolyn Casey, is Senior Marketing Manager, Legal Vertical, at Iron Mountain, specializing in law firm information management and e-discovery. She has more than 20 years experience in law, technology and global marketing. Her resume includes attorney and legal assistant roles at Brobeck, Phleger & Harrison, Covington & Burling and Skadden Arps. Carolyn.casey@ironmountain.com

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Human Resources

Coordinated Witness Preparation for Employment Litigation By Roy Futterman

hen preparing for the defense of a labor and employment case that is headed toward trial, companies often are faced with a problem: The defense is based on the testimony of a variety of employees, most of whom are disinterested in the trial and appalled at the prospect of testifying. How can in-house and outside counsel create a strong defense out of this disadvantageous scenario?

The answer, â&#x20AC;&#x153;coordinated witness preparation,â&#x20AC;? can be compared to making a wall out of individual bricks. At the outset, gather all the testifying witnesses (e.g., executives, HR representatives, relevant supervisors) in one place for a coordinated series of sessions over the course of a weekend or a number of days. This technique exposes individual and group issues that can weaken or derail a defense strategy. Throughout

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

Human Resources this process, common individual behavioral and motivational issues emerge, and once identified they can be resolved before trial. This procedure can be used not only to prepare each witness, but also to coordinate their responses to attacks on their actions and the actions of others in the company; to clearly delineate standard corporate procedures; and to create coherent case narratives and trial themes. When the trial team hears the potential witnesses testify back-to-back, the strengths that emerge from consistent positions and the weaknesses that come from inconsistencies become obvious. At that point it’s relatively easy to imagine how the jurors will see the witnesses and evaluate the overall case.

outright. It was dizzying to watch them shift the blame. The consultant and the trial team explicitly labeled this as an issue and told the witnesses what they saw. It was presented to them as a systemic problem that they needed to resolve together rather than as an admonishment of any one of them individually. They all then worked together to trace the decisions that were made, and not made, in this sequence of events, and they jointly identified the reasonableness of the actions taken at each of these decision points. When each individual witness saw that he or she was not at risk of either getting in trouble at work or bringing down the case, each was visibly relieved. They were then able to cooperate in developing the day’s true narrative that satisfied each of them

As we had hoped, she took the opportunity to pass the responsibility for just about every human resources type decision to the legal department or management. Her testimony made her department seem ineffectual and useless to employees who had real issues. The plaintiffs were awarded $250 million in this case. It’s crucial: Seek out the hot potato problem and resolve it before going to trial. COORDINATING THE NARRATIVE

Another important reason to gather witnesses together for coordinated preparation is to develop a synchronized case narrative out of disparate testimony, developing talking points across witnesses. In one case, when working on the

HANDLING SELF-INTEREST

Gathering all witnesses together and hearing their testimony back-to-back often exposes a significant case problem that might otherwise be missed in individual witness preparation. We might call this “the hot potato problem.” In this scenario, each supervisor and human resources worker attempts to obscure his or her own responsibility for decisions made about workplace incidents (such as termination or responses to complaints), pointing toward other departments as being the proper place of decision-making. This may be useful for an individual witness, but it’s problematic for the company and the defense strategy. This routinely arises with HR department witnesses in particular. Human resources workers are trained to defer many decisions to other departments, such as legal or upper management. In one case, when working on the defense of a wrongful termination matter at an insurance company, our experts brought together the three human resources people involved in a chain of decisions that occurred over the course of one day, and that led to an employee’s firing. In the preparation session, each witnesses sheepishly hinted at the responsibility of the two others for failing to make proper decisions, without saying it

Gathering all witnesses together and hearing their testimony back-to-back often exposes a significant case problem that might otherwise be missed. individually and as a group. This is typical of how the common hot potato problem is resolved. First, it is exposed and identified by having the witnesses prepare together. Second, the problem is explicitly labeled as such to the group, without any one witness being blamed. Third, the group cooperates in identifying the reasonableness of actions taken at each decision point until all are satisfied in the unified and accurate narrative. Why is this problem so harmful if left unidentified? We saw an example when we worked on the plaintiff side of a class action discrimination case against Novartis Pharmaceuticals. After it became apparent that the defense was suffering from this problem, our trial team put the Novartis head of human resources on the stand and walked her through explaining those aspects of the business for which she had responsibility.

defense side of a racial discrimination matter related to hotel staff, we used focus groups to develop case themes. This research led us to believe that trial jurors would likely see the conflicts at issue as personality-based rather than race-based. The trial team then worked with witnesses to make more explicit references to the personality issues that were noted in the evidence, so that each witness hit similar, evidencesupported talking points. The reactions of supervisors and human resources personnel were shown to be coherent, coordinated and appropriate responses to workplace personality conflicts. In this way, the consultant and trial team act as conductors of an orchestra, bringing together the various melodic lines, keeping one rhythm, and emphasizing and de-emphasizing different players at different times to make one unified symphony out of many components.

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Human Resources COUNTER-STRATEGY

While it is important to gather one’s own witnesses to find the strengths and weaknesses of one’s own case, this technique can also be used in reverse to find the other side’s weaknesses as revealed in deposition testimony. In other words, turn their wall into individual bricks. To do this, the team watches the other side’s deposition videos in order to understand their witnesses’ strengths and weaknesses. This is especially useful in employment cases, because it can often shed light on particular behavioral issues of testifying workers in certain industries. We applied this technique when we were on the defense side of a wage-and-hour case in which relatively low-level travel agency workers sued for overtime pay. The written transcripts of their depositions made their case look quite powerful. When we watched many of the plaintiffs’ deposition videos in a row, however, we saw that their behavior told a different story. It was obvious that most

of them were not comfortable. They acted as if they had been cajoled or coerced into testifying. Seeing how they might appear on the stand, we changed our strategy for defending the case to take advantage of the plaintiffs’ weakness. Analysis of the deposition videos also revealed which parts of their testimonies the witnesses were most uncomfortable discussing. We have seen variations in how different types of workers testify on both sides of employment cases. When working on the plaintiff’s side, for instance, we saw our strong case become weak when we met with rural warehouse workers suing about racial discrimination. They were awkward and uncomfortable with our trial strategy team. On paper, their case was strong, but their hearts were not into standing up to opposing counsel. These techniques that are effective in labor and employment cases may also be applied in other areas, whenever nervous, self-interested witnesses are being prepared to testify, whether

for plaintiff or defense. The conclusion remains the same: An uncoordinated strategy that does not account for inconsistencies among witnesses, the role of self-interest, the hot potato problem, and behaviors that belie the witnesses’ confidence in their positions, can break a case. These problems can be addressed. The solutions discussed here are relatively simple fixes. Coordinated witness preparation strategies can save your case. ■

Roy Futterman, Ph.D., is a clinical psychologist and director at DOAR Litigation Consulting LLC, which consults on trial strategy, trial graphics, trial presentation and e-discovery/discovery in complex civil and criminal litigation. rfutterman@doar.com

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JUNE/JULY 2012 E X ECUTIV E COUNSEL

Intellectual Property

Prioritizing Your Patent Application By Chinh H. Pham and Fang Xie

n expedited procedure for examining U.S. patent applications, called Prioritized Examination, or “PE,” has been implemented by the Leahy-Smith America Invents Act, signed into law by President Obama in September of last year. The goal of PE is for qualified U.S. patent applications to reach final disposition within 12 months. This represents an inexpensive alternative to the regular patent prosecution route, which on average takes about three years to final disposition. Those who are in industries where products have a relatively short shelf life, who

trade patent rights for investment or licensing opportunities, and/or regard patent rights as an important defensive tool against infringers, will have a strong incentive to use this procedure. PE is part of an effort by the U.S. Patent and Trademark Office to “provide applicants with greater control over when their utility and plant applications are examined and to promote greater efficiency” in the patent examination process. According to the USPTO, a patent application, filed on or after September 26, 2011, may be granted PE status, subject to the following requirements:

It must be a non-provisional application for an original U.S. utility or plant patent filed via the USPTO’s electronic filing system. An international application being entered into the United States as a “by-pass” continuation application also may be eligible. The application must be complete with an oath or declaration and the official fees.

The application as filed must contain no more than four independent claims and no more than 30 total claims. In addition, it must

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

Intellectual Property not include any multiple dependent claims. If at any time during prosecution an amendment is filed and results in a non-conforming set of claims, the PE procedure will be automatically terminated.

The number of PE Requests is limited to a maximum of 10,000 in each fiscal year, subject to further evaluation and change by the USPTO. At the expense of a small fee ($4,800 for a large entity and $2,400 for a small entity), the PE program potentially provides many advantages, including significantly shortened examination time, reduced burden on the applicants, and a more efficient global patent strategy. SHORTENED EXAMINATION TIME

The USPTO’s goal is to provide, on average, a final disposition within 12 months of prioritized status being granted. Typically that could be the mailing of a Notice of Allowance; a Final Office action; filing of a Notice of Appeal; filing of a Request for Continued Examination; or abandonment of the application. Currently utility, plant and reissue (“UPR”) applications await on average 28.0 months before receiving a first Office action, and on average spend 33.7 months in examination before reaching a final disposition. Thus, PE promises a significant shortening of examination time and associated expenses. Interestingly, the wait time tends to be the longest for technology areas where the product shelf life tends to be shorter. This includes computer architecture, software & information security; networks, multiplexing, cable & security; communications; and mechanical engineering, manufacturing and products. Applicants in these technology areas, on average, must wait about 29.6 months, or more, to receive a first communication on the patent-

ability of their inventions. For computer, software, networks and communications industries, the total average pendency is about 40 months, the longest of all technology areas. Thus, those who would benefit the most from the significantly shortened examination time under PE are inventors and businesses in the computer, software and communications industries. PE offers a quick, inexpensive option for obtaining a patent, as opposed to the traditional route where the application must wait in queue for from two to four years before it is examined. Because issued patents enjoy a presumption of validity and have a more defined scope of claim coverage than pending applications, those patents that issue quickly will enable inventors and companies to more effectively market and protect those of their products that may be subject to improvements, redesigns and replacements. The same benefit also would be valuable to innovation-driven companies that are seeking to leverage patent rights to establish and maintain their competitive position in a fast-changing market. With an issued patent, a startup company will be better positioned for investment; a growth-stage company may be enabled to identify more partnership and cross-licensing opportunities; and an established company will be able to better defend itself against potential infringers. Again, because issued patents have less uncertainty than pending applications, they are viewed more favorably by investors and licensees, at the same time they are a more effective deterrent to potential infringers. REDUCED BURDEN

Compared with the USPTO’s existing programs for expediting examination (such as Petitions to Make Special, based on an applicant’s age or health; the Patent Prosecution Highway; the Patent Application Backlog Reduction Stimulus Program; and the Accelerated Examination Program), the PE procedure is advantageous in that it

significantly reduces the burden on the applicants. For example, unlike the Accelerated Examination program (implemented in 2006), the PE procedure does not require a pre-examination prior art search and does not require an Accelerated Examination Support Document, with its rigorous preparation requirements. PE also can lessen the financial burden on the applicant. The upfront Request fee of $4,800 ($2,400 for small entities) is likely to save costs for applicants in the long term. By comparison, the costs for pursuing Accelerated Examination can be $10,000 to $20,000, or more, independent of the costs for preparing the application itself. In exchange for the relatively modest cost associated with PE, applicants could potentially save one to three years of attorney fees for application upkeep. GLOBAL STRATEGY

The PE procedure also may allow U.S. patentees to accelerate patent examination in certain foreign countries. The USPTO has bilateral agreements with numerous patent offices overseas, including in Australia, Austria, Canada, Denmark, the European Patent Office, Finland, Germany, Hungary, Iceland, Israel, Japan, Korea, Mexico, Norway, Russia, Singapore, Spain, Sweden, Taiwan, and the United Kingdom. Under these agreements, an applicant receiving a favorable ruling from one office may request that a second office fast track the examination of corresponding applications pending in that office. Thus a potential strategy is to quickly obtain allowable claims in the USPTO under the PE procedure, and then proceed to fast-track examination in the other countries. This combined PE-PPH (Patent Prosecution Highway) strategy will allow applicants to obtain patents in both the USPTO and eligible foreign patent offices faster and more efficiently. Given the obvious benefits, it is no surprise that many savvy inventors and companies are rushing to file their PE applications. As noted above, there is an annual numerical cap – 10,000

JUNE/JULY 2012 E X ECUTIV E COUNSEL

Intellectual Property

applications – and that is a less than two percent of the 505,195 utility and plant applications filed in FY 2011. According to the most recent USPTO figures, from September 26, 2011 (when the program became available) to March 15, 2012, a total of 2,628 PE applications were filed. Among these, 153 applications were allowed in less than six months. To maximize the benefits of PE, companies should begin to review their patent portfolios as soon as possible to identify pending applications that call for expedited examination. This can be achieved by filing, for example, a continuing application that satisfies all the requirements under the program. Should companies decide to file new applications, care should be taken in view of the most relevant prior art; it is recommended that a set of claims that are most likely to be allowed should be presented. In many instances this may require a conservative approach, submitting and accepting a relatively narrow set of claims, while leaving broader

Chinh H. Pham is a shareholder at Greenberg Traurig, in the Intellectual Property Department, and co-chair of the firm’s Boston office Intellectual Property Practice Group. He is a registered patent attorney with particular experience in the strategic creation, implementation and protection of intellectual property rights for high technology clients. phamc@gtlaw.com

claims for pursuit in other applications that are not on the prioritized track. The combined PE-PPH strategy should be leveraged to more quickly obtain patents in both the USPTO and

Fang Xie, Ph.D., is a registered patent agent and technology specialist in the Intellectual Property Department at Greenberg Traurig. Her practice is focused on developing and maintaining clients’ intellectual property rights in the United States and abroad, in areas including nucleic acid synthesis and sequencing, antibodies and immunotherapy, cancer and chemotherapy, pharmaceuticals and synthetic organic chemistry, as well as medical devices and nanotechnology. xief@gtlaw.com eligible foreign patent offices. ■ Fang Xie contributed to this article under the supervision of Chinh H. Pham. Ms. Xie is a registered patent agent and not admitted to the practice of law.

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THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

Intellectual Property

Reconsider the Way You Protect New Ideas Trade Secret Protection Never Expires By Mark A. Klapow

june/july 2012 E X ECUTIV E COUNSEL

Intellectual Property

ew ideas are the lifeblood of most companies, and patents are the gold standard for protection. Most corporate legal departments have established processes to translate new ideas into patents. In many companies this approach is automatic, and trade secrets are not part of the conversation. Developments in both patent and trade secret law, however, suggest that it is now time to revisit this approach. Congress passed the first of many patent acts in 1790 and set up a patent board three years later, which soon become the Patent and Trademark Office (PTO). Thus, the process for granting and enforcing patents is well-defined and hierarchical. Congress establishes the law, the PTO issues patents, federal district courts

Also, unlike patent cases, in which an infringement claim is typically the only cause of action asserted by the plaintiff, trade secret cases are rarely as straightforward as a misappropriation claim. Other state law claims, like tortious interference and breach of employee covenants, very often accompany a misappropriation claim. Two federal causes of action, based on the Economic Espionage Act and the Computer Fraud and Abuse Act, are also pleaded in many trade secret cases. In summary – and in contrast to patent law – trade secret law has been a mix of federal and state judicial decisions interpreting a host of disparate laws. Thus it emerged that most companies and laws clearly preferred patents. So ingrained into the culture

It is widely believed that only a small percentage of patents issued generate more in revenue than the cost to obtain them in the first place. alone hear infringement disputes (in practice the cases are heavily concentrated in only a few districts), and the Federal Circuit hears appeals. By contrast, trade secret law is diffuse. Common law trade secret claims first appeared in England and the United States in the 1800s, and trade secret law then evolved through a hodgepodge of state laws. In 1979, the Uniform Trade Secrets Act (USTA) was drafted and has now been adopted in most states. However, important commercial hubs such as New York and Texas have not adopted the UTSA. Even among those states that have adopted some form of it, not all versions are identical. A decision in one state is not binding in other states, even if the statutory language is identical, and federal and state decisions may not be binding on each other.

of some companies is the primacy of obtaining patents, that even the scientists and engineers may measure achievements in numbers of patents hung on the wall. Many legal departments respond to a new idea reflexively, by starting the patent process. Unless a new idea clearly is not patentable, rarely does anyone consider trade secret protection. And even then, rarely is it pursued. Two factors that have come into clearer focus in the last decade are challenging this approach. First, there has been a steadily increasing appreciation for the flexibility of trade secret protection. Every patent starts as a trade secret; however there is a wide range of information that can qualify for trade secret protection but cannot be patented. For example, customer lists, pricing and cost data, business plans

and software code can all be trade secrets, but are not patentable. Unlike patents, trade secret protection is not limited by time. So long as its holder can maintain its secrecy, a trade secret can last forever. Unlike patents, trade secret damages can include compensation for unjust enrichment. Preliminary and permanent injunctive relief is commonly granted in trade secret cases. Patent litigants, by contrast, generally are limited to recovering damages based on a reasonable royalty or lost profits, and the bar for injunctive relief is now very high. Trade secret owners have other litigation advantages too. For example, trade secret holders can define the contours of their trade secrets after the misappropriation becomes known, and often they can further refine that definition well into the early part of the litigation, whereas patent litigants must deal with the patent as it was written – typically years before any infringement. Thus, what was once viewed as an advantage of patents over trade secrets – PTO preapproval – now often appears to be a weakness, particularly in a world of computerized prior art searches. Second, it is increasingly difficult and expensive to assert patent rights offensively. It is widely believed that there are too many patents being issued. Both the PTO and the courts thus have been clamping down on the process, making issuance and validation in court more challenging. Each year the patent process takes longer (it now averages over three years), and there are more rejections than ever. In litigation, courts are imposing special disclosure rules for patent cases, and cases such as KSR and Bilski have raised the bar for patentability. There is constant talk that Congress, the PTO or the courts are soon to make obtaining or enforcing patents even more difficult. The patenting process has also become very expensive. The average cost to obtain a relatively complex patent in the United States is over $10,000. This does not include the

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

Intellectual Property costs of protection outside the United States. The average annual budget for the intellectual property departments for large companies, which are typically the most dedicated to steering new ideas through the patent process, is over $6 million. The average cost to litigate a patent case that seeks damages of more than $25 million is over $5 million, and most technology companies have multiple patent cases going on simultaneously. Coupled with the rise of so-called “patent trolls” – entities that purchase patents for the purpose of extracting license royalties from companies – this is enough to sour any business leader on patents altogether. With these developments in mind, here are three scenarios in which companies should consider whether

plans through trade secret protection and avoid the expense of the patent process. Protecting trade secrets is not free, but unlike patents, the costs are mostly in infrastructure to set up physical and electronic security. Thus, the incremental cost of protecting an additional trade secret is typically modest. • When the new idea cannot be reverse engineered. The CocaCola formula has been protected as a trade secret for more than 100 years. This was possible because the formula has been kept secret and no one has been able to ascertain it from analysis of the finished product. Your company may not have a secret formula for its signature product, but it probably does have

Had it patented the secret formula, Coca-Cola would have lost exclusivity over 80 years ago.

opting for trade secret protection is more advantageous than obtaining and defending patent rights: • When the commercial value is uncertain. There are no reliable statistics on this, but it is widely believed that only a small percentage of patents issued generate more in revenue than the cost to obtain them in the first place, perhaps in part because some companies practice the “defensive” use of patents to fend off competitors. This is much like the military doctrine of mutually assured destruction. In any event, particularly in a down economy, companies should be comparing the revenues versus the costs of their patent portfolios over time and drawing some conclusions. In many instances, companies can protect new ideas that are not in their current commercialization

internal processes that can be effectively and economically secreted, rather than patented. Manufacturing processes are a good example. Companies invest time and money upgrading their manufacturing processes to improve quality, maximize output, and/or reduce costs. These are valuable improvements, but the process cannot be reverse engineered from the final product. Consider restricting access to that process through security and non-disclosure agreements, and protecting it as a trade secret. Had it patented the secret formula, Coca-Cola would have lost exclusivity over 80 years ago. Patenting the idea necessitates revealing sensitive technical information. The patent specification must be sufficiently detailed so that one of “ordinary skill in the art” can make and use the invention without

“undue experimentation.” This is called the enablement requirement. Furthermore, the patent specification must identify the “best mode” for practicing the invention. For some types of patents, these requirements are not hard to meet. For others, such as pharmaceuticals, these requirement can be onerous and may force the inventor to disclose more information about its internal processes than it would care to share, information that has value based on its secrecy. But if not properly disclosed in the specification, the patent may later be adjudged to be invalid. In such a situation, the company is forced to choose: Attempt to obtain a patent, but disclose to the world sensitive information in the process. Or, instead, consider protecting both as trade secrets. Trade secrets, of course, have no disclosure requirements at all. • When the idea cannot be patented. Patents are limited by subject matter in ways trade secrets are not. It is important to note that choosing to rely on trade secret protection is neither automatic nor free. The requirement of reasonable efforts to maintain secrecy applies in all cases. Judges and jurors will expect to see investments in security for new ideas. Counsel should be consulted to establish physical, cyber-security and contract protections – much of which should be done anyway. ■

Mark A. Klapow is a partner at Crowell & Moring LLP in Washington, D.C. He is a member of the Litigation Practice Group, specializing in complex commercial cases, including cases involving antitrust, intellectual property and business torts. He is a leader in handling cases involving trade secrets and has often written on the subject. mklapow@crowell.com

June/July 2012 E X ECUTIV E COUNSEL

Governance

The Evolving Role of the General Counsel Greater Collaboration with Finance By David Williams and Tamika Tremaglio

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

Governance

ot long ago, you would expect an organization’s general counsel and chief financial officer to discuss matters such as mergers and acquisitions, financial offerings, litigation and regulatory enforcement actions, but the collaboration

decisions. Companies became more conservative and deliberate in their decisions, and leaders were less likely to take steps without considering the legal ramifications. A recent Deloitte Financial Advisory Services webinar poll of 1,300 business professionals corroborates this trend. Among those polled were professionals from financial services; technology, media and telecommunications; consumer and industrial

products; and the energy and resources sectors. Nearly twothirds of respondents believe that market volatility has driven increased collaboration among C-suite executives. A significant percentage – 41 percent – reported that the collaboration between

mattered most. Thirty-four percent said there should be strong teamwork regardless of market conditions, while 27 percent said that teamwork is needed only during an economic downturn, when organizations experience higher layoffs and need to manage debts or collections. Another 25 percent said periods of business growth and expansion – where there likely are more mergers, acquisitions, and hiring – require the most collaboration. There is a natural overlap in the roles that GCs and CFOs play in their organizations. While their areas of expertise are different, their roles are complementary because each takes risk into account when making business decisions. GCs determine what is doable from a legal perspective. Consequently, they may put up a roadblock to a business plan or take actions that increase costs. Because their decisions slow down CFO’s ability to get things done quickly, CFOs sometimes view in-house counsel as more of a hindrance than an asset. However, more lawyers are broadening their business skills, and as they gain more business knowledge through education and increased opportunities

There is a natural overlap in the roles that GCs tended to be episodic. General counsel rarely sat at the table with Csuite executives on a regular basis to discuss financials, sales and marketing strategy. But as organizations faced increasingly complex problems brought on by the economy, anecdotal evidence suggests that top-level executives found that GC-CFO collaboration helped them make better business

and CFOs play in their organizations.

the GC and CFO at their companies is high. Twenty-five percent said the GC-CFO collaboration is occasional, while three percent said it was nonexistent. However, there was more variation when respondents were asked in what situations this collaboration

“at the table,” they enhance their positions. They act as advisors, strategists, and business partners in addition to their traditional stewardship role. In this way, they are following an evolutionary path similar to that of CFOs, who have long been seen as cross-functional players.

June/July 2012 E X ECUTIV E COUNSEL

Governance

These days, GCs are not only helping their companies identify and lessen risks, and facilitate regulatory compliance. They are also building value. By being included in the initial stages of any transaction, GCs can act as a filter to make an early determination about what is legal, ethical, and executable. They can help the finance team or sales and business units develop a proof-of-concept for a transaction, vet a plan for any flaws and then assist in structuring the transaction. There are other areas where GCs can provide vital advice. For instance, they can make an early determination about the risk of violating government regulations, or whether vendors

a tone for fostering and strengthening any working relationship. The keys to helping GCs and CFOs develop a stronger bond include communication, transparency, coordination and respect. Through communication, each department can educate the other regarding their particular objectives and priorities. GCs should also be invited early and often at the initial stages of a transaction or major financial event. Transparency should be a hallmark of the business team in order to promote effective decision-making. GCs also need to bring in the right people. This may mean hiring outside consultants, or counsel with

A collaborative GC-CFO relationship will bring 34

more strategic vision, improved efficiency, better results, lower costs, and reduced risks.

and third parties are not in compliance with contractual agreements and could potentially break a law. In such cases, GCs could help educate and arrange training, so the CFO’s office and other business units will know how to perform appropriate monitoring and avoid compliance violations. Some large companies with numerous facilities for different product lines place in-house counsel alongside business, sales, or engineering colleagues, thus facilitating greater interaction. Previously, in-house counsel often had its own department, perhaps even in a separate building, but lawyers who know the business can better understand the risks. Still, many organizations have a long way to go, as Deloitte’s poll findings have shown. Organizations need to set

specialties that address an issue. Mutual respect is essential, even if both sides may not like the answer they get. They should keep in mind that they are working toward the same goals: protecting the organization and building value. To improve collaboration and send a signal to the rest of the organization that its legal and financial goals are fully integrated, here are some practical steps that CFOs and GCs can take: • Practice consistent inclusion. CFOs and GCs can help foster communication by practicing inclusion. This will help each side understand the other’s priorities and the thought processes behind legal and financial decisions. It also will send a message across the organization

that there is a common finance and legal platform. • Make collaboration continuous. GCs should be involved and integrated in initial discussions on a transaction or issue. • Develop cross-functional specialization. By knowing the business, GCs can become specialists on what is most important – the organization. This allows them to make crossfunctional decisions. Bring them in on discussions about tax matters, M&A and cross-border transactions. They will benefit from the information, and the organization will benefit from the breadth of their views. A collaborative GC-CFO relationship will bring more strategic vision, improved efficiency, better results, lower costs, and reduced risks. Yet many companies don’t seem to understand what can be gained. As a result, they may be losing out on improving business performance. Keep in mind that this teamwork is important throughout every business cycle. While in-house legal and finance may not always agree, their common objectives are to protect the company, improve performance, and increase the company’s value. Organizations that understand this team dynamic will gain a competitive advantage. ■

David Williams is the chief executive officer of Deloitte Financial Advisory Services LLP. davidswilliams@deloitte.com

Tamika Tremaglio is a principal in the Forensic & Dispute Services practice of Deloitte Financial Advisory Services LLP. ttremaglio@deloitte.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

Canada/Crossâ&#x20AC;&#x201C;Border

Shut Up and Stand Still Understanding the Role of Standstill Provisions in M&A Disputes By Terri L. Mascherin, Kyle A. Palazzolo and Gaurav Jetley

june/july 2012 E X ECUTIV E COUNSEL

Canada/Cross–Border

hen HCP, a health care real board ... to establish rules of the game play increases the risk that the target estate investment trust, anthat promote an orderly auction ... [A] will be sold for a relatively low price. nounced a topping bid for board striving in good faith to extract Sunrise Senior Living REIT (SZR) in Feb- the last dollar they could for their KEEP QUIET ruary 2007, it probably did not expect to stockholders might promise ... [that the As noted above, CAs, with or without a lose the bidding and ultimately shell out standstill, restrict the ability of potentop bidder] will get very strong deal more than $225 million to the successful tial acquirers to make public discloprotections including a promise from bidder. One of the reasons for the unhap- the target not to waive the Standstill as sures. The risk of non-compliance with py outcome for HCP: Under the terms these terms can be severe, as Ventas v. to the losers.” of a confidentiality agreement, HCP was HCP illustrates. Recently, the Chancery Court prohibited from bidding outside of the By way of background, SZR , a reiterated the enforceability of standsale process and from making any public Canadian REIT listed on the Toronto stills in Celera Corporation Sharedisclosures regarding its interest in acstock exchange, conducted a structured holder Litigation. quiring SZR – let alone disclosures that, sales process to identify a buyer. Ventas, From the target’s perspective, standit turned out, were inaccurate. HCP, and several other potential acquirstills help maintain control over the sale As corporate attorneys know, in the ers negotiated and executed CAs with process, ideally ensuring that the target’s M&A context parties contemplating a SZR. HCP’s included both a standstill board will be the decision maker in negotiated transaction typically enter and a confidentiality undertaking. By determining when and how to disclose into a confidentiality or non-disclosure early 2007, Ventas and HCP were the a potential transaction to the market. As agreement (CA) to facilitate the exonly two buyers still in the process. a rule, companies do not want to be put change of non-public information. Ultimately, only Ventas put forth an unin play by another firm, as this creates Those CAs may conditional binding include a standfinal offer. On still clause, which January 15, 2007, aims to protect SZR and Ventas Courts have recognized that a corporation may the target from a announced that hostile takeover Ventas had entered properly impose restrictions on bidders in order attempt by an into an agreement acquirer armed to acquire SZR for to run an effective process. C$15 in cash per with access to the unit, and to assume target’s confidenSZR’s debt. tial information. On February 14, after the market A standstill may prohibit a suitor from uncertainty among the targets’ employees closed, HCP publicly disclosed a purmaking an unsolicited offer, whether and customers, and that can lead to a ported offer to acquire SZR at C$18 public or private, and may limit the decline in revenues and profitability and per unit. Overnight, SZR’s stock price suitor’s ability to sponsor a proxy conweaken the target’s negotiating ability. shot from under $C15 to over $C18. test or take other steps to attempt to Moreover, public disclosure of a Over the next few weeks, litigation in pressure the target into a deal, enabling bid attracts arbitrageurs to the target’s Canada resulted in HCP withdrawing the target to exercise some control over stock. They seek to profit by realizing its “offer.” However, as to Ventas’ deal, public disclosures. On May 4, 2012, the difference between the target’s the Delaware Chancery Court found the die was cast. Ventas was forced stock price and the ultimate deal price. to increase its offer from C$15 to that hostile bidder Martin Marietta To get the deal done, arbitrageurs will C$16.50 to secure the votes necessary had breached confidentiality agreepressure the target to negotiate with a ments with target Vulcan Materials, hostile bidder, even if the target’s board to complete the transaction from SZR’s and blocked the transaction. The Wall unit holders. Ventas then commenced is against the deal. The impact of their litigation against HCP in the U.S. It Street Journal called it a “strong mespresence on deal-related disputes can sage for the deals community: Confibe significant as well. In Air Products v. sought to recover $101 million – the dentiality agreements count.” amount by which it had to enhance its Airgas, a highly publicized case in the offer in order to complete the deal – Courts have recognized that a Delaware Chancery Court, Chancelcorporation may properly impose plus punitive damages. lor Chandler pointed to the extent to In the trial that followed, a jury restrictions on bidders in order to run which the common stock of Airgas was found HCP liable for tortious interan effective process. In the Topps Co. held by arbitrageurs as one of the facference with Ventas’ C$15 deal and Shareholder Litigation, the Delaware tors in his ruling upholding the Airgas awarded $101 million in damages. Chancery Court recognized “[w]hen a poison pill defense. Given that acquircorporation is running a sale process, it ers try to buy a target for the lowest The jury found that HCP engaged in “significantly wrongful conduct” is responsible, if not mandated, for the possible price, having a company in

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

Canada/Cross–Border

because HCP’s press release misrepresented that HCP had made a binding offer to acquire SZR, and HCP did not disclose that it was unable to reach an agreement with the firm that managed

by other potential acquirers. After HCP issued its press release, SZR and Ventas both went to the Canadian courts seeking adjudication of the parties’ rights and obligations. SZR’s ability to

Litigation in Canada resulted in HCP withdrawing its “offer,” but the die was cast. SZR’s properties and that its board was unwilling to make an unconditional bid without that agreement in hand. The Sixth Circuit affirmed, finding that HCP made several statements to SZR and to the market that were “contaminated by fraud, misrepresentations, and concealment.” The court held that “HCP’s alleged fraud in this case was the direct cause of Ventas’s injury.” Following that appeal, HCP agreed to pay an additional $125 million to settle Ventas’ punitive damages claim. The Ventas case shows how markets react to disclosures relating to a transaction, and the critical importance of controlling the flow of information. The market’s reaction to HCP’s February 14, 2007 release was swift. Not only did the price jump to over C$18, but an unusually large number (over 25 times the normal volume) of shares were traded. The fact that new unit holders had paid significantly more than C$15 doomed Ventas’ ability to generate enough votes to close the transaction at C$15. HCP’s subsequent withdrawal of its offer did not change that dynamic, as HCP’s conduct gave unit holders enough leverage to make Ventas increase its offer to C$16.50. HCP ran afoul of the law because Ventas and SZR had negotiated careful deal protections, and because HCP sought to take its case to the public markets with inaccurate information. The standstill in HCP’s CA factored heavily in that outcome. Ventas’ Purchase Agreement with SZR gave Ventas the legal means to protect its deal in the Canadian courts and require SZR to enforce the standstills entered into

consider HCP’s purported offer was litigated under Canadian law, which governed the deal documents. The Ontario Superior Court, and later the Court of Appeal, found for Ventas. The courts held: (1) HCP’s standstill precluded HCP from submitting a subsequent bid, and the Purchase Agreement required SZR to enforce that standstill; (2) the requirement that SZR enforce the standstill was balanced and objectively reasonable; and (3) SZR acted reasonably in designing and conducting the auction process to maximize value. The Canadian courts’ rulings led HCP to announce that it was withdrawing its purported offer to acquire SZR. The damages awarded Ventas in the U.S. courts resulted from HCP’s unusual strategy of taking its case to the public markets and doing so with less than completely accurate and truthful information. Those damages might have been avoided had HCP complied with its CA. But the courts did not have to rely upon the CA, because the jury found HCP’s statements to the market were fraudulent. As the Sixth Circuit recognized in upholding the jury’s verdict, “[t]he public interest in full and fair competition is furthered by imposing liability on a market player, such as HCP, for fraudulently leveraging a public market to sabotage a competitor, as liability for such conduct will deter similar future conduct and promote economic certainty in the marketplace.” Inaccurate disclosures can distort market prices and, hence, are not sanctioned by the courts. In the context of M&A, inaccurate information can be and usually is harmful. Consider that HCP’s disclosures increased the risk that

SZR’s deal with Ventas would not close. Had that risk materialized, the loss to Ventas and to SZR would potentially have been even greater than the damages awarded to Ventas. Enforcing CAs and standstills, and preventing inaccurate disclosures, will facilitate transactions, as both targets and bidders will have reason to be confident that deals will not be derailed by unauthorized or inaccurate information. Corporate counsel for the target and bidders in a sales process are well advised to understand how standstills can benefit parties on both sides of the transaction, and to assess the risks inherent in the loss of control over the deal process. ■

Terri L. Mascherin is a partner in Jenner and Block’s Litigation Department, based in Chicago. She has extensive experience in disputes over corporate transactions, partnerships, joint ventures, licenses, and contracts. tmascherin@jenner.com

Kyle A. Palazzolo is an associate based in Jenner’s Chicago office. He concentrates on complex civil litigation. kpalazzolo@jenner.com

Gaurav Jetley is a vice president in the New York office of Analysis Group, an economic consulting firm. He has worked on numerous merger-related litigations and authored research on M&A issues. gjetley@analysisgroup.com

june/july 2012 E X ECUTIV E COUNSEL

Canada/Cross–Border

Canadians Bought, U.S. Sold in First Quarter By Divya Balji

espite economic uncertainty south of the border, Canadian companies still see the U.S. economy as robust and are now becoming the dominant bidders in U.S./Canada cross border M&A deals. A strong Canadian dollar, weaker valuations in the United States and the loosening of purse strings in the credit market certainly help create a buyers’ market, as well. In addition to the relative strength of the Canadian dollar, Canadian M&A buyers continue to flock to the United States for a number of reasons, including a perception that it is still a safe haven (compared to Europe and emerging countries), access to cheap deal capital that can be used to boost returns, a larger scale and broader scope of M&A opportunities and a desire to replace public market exposure with private market exposure – this according to Kristian Knibutat, the Canadian leader of the PricewaterhouseCoopers LLP Deals practice, working in the Toronto office. For Q1 2012, there were 48 announced deals between Canada and the United States, excluding lapsed and withdrawn bids, with a value of more than U.S. $10 billion, according to Mergermarket data. Out of these 48 deals, 27 had Canadian firms as the dominant bidder. Three out of the four billion-dollarplus deals announced in Q1 2012 were in the energy and utilities sector. The U.S. $1.4 billion purchase of CH Energy Group by Fortis Inc in February of this year led the pack. Fortis, the largest investor-owned distribution utility in Canada, had said last year that it was looking to expand into the United States through acquisitions, and could have as many U.S. assets as Canadian over the next 10 years. Watchtell, Lipton, Rosen & Katz LLP acted as the legal advisor for CH Energy Group and

White & Case LLP acted as the legal advisor for Fortis. Canadian companies that have saturated their growth domestically could look towards their southern neighbor for more robust growth through acquisitions, and vice versa, said an industry analyst covering the energy sector. Other larger cross-border energy deals were the purchase of Flint Energy Services by URS Corporation for U.S. $1.3 billion, and the sale of SEMCO Holding by Continental Energy Systems LLC to AltaGas for U.S. $1.1 billion. Flint Energy Services worked with Bennett Jones LLP and Hall, Estill, Hardwick, Gable, Golden & Nelson P.C. and URS worked with Latham & Watkins LLP and Osler, Hoskin & Harcourt LLP for this transaction. AltaGas worked with Dykema Gossett PLLC and Stikeman Elliott LLC, and Continental worked with Cravath Swaine & Moore LLP. Other sectors that stood out in Q1 2012 include industrials, consumers, technology and healthcare. Some notable deals in these sectors include the sale of Drug Trading Company and Medicine Shoppe Canada by Katz Group to McKesson Corporation for U.S. $919 million, JMC Steel Group’s U.S. $108 million purchase of Lakeside Steel Corporation from Jaguar Financial and Mood Media’s U.S. $86 million acquisition of DMX Holdings. McKesson worked with Blake, Cassels & Graydon LLP for its purchase. JMC worked with Stikeman Elliott LLP. Lakeside worked with Fasken Martineau DuMoulin LLP and Osler, Hoskin & Harcourt LLP. Mood Media worked with Stikeman Elliott, and DMX worked with Fulbright and Jaworski LLP. Canadian banks, which were making

large buys in the United States in 2010 and 2011, have now shifted their focus to Asia. Therefore, we did not see as many deals in the financial services sector between Canada and the United States in Q1 as there has been in the past. With continued uncertainty in Europe and a possible slowdown in growth in China, the United States will remain the investment destination for Canadian firms looking to expand, several industry experts said. ■

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. Mergermarket is now on twitter and can be followed @mergermarket. Divya.Balji@mergermarket.com

by Ne th w a Se e Pr s t le A of m odu he cted La eri ct 20 w can of 11 Li A th br s e ar so Ye ie cia ar s. t io n

“ THE BEST TECHNOLOGY MEANS FEWER ATTORNEYS NEEDED ON EACH CASE.” RICHARD ROSENSWEIG DIRECTOR, LITIGATION GROUP GOULSTON & STORRS BOSTON

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M&A Trends to Watch for the Rest of 2012 By Kyle Krpata and Andrew Nelson

WHILE STRATEGIC M&A HAS BEEN DRIVING THE MARKET FOR THE LAST SEVERAL QUARTERS, PRIVATE EQUITY BUYERS ARE MORE THAN READY TO GET BACK IN THE GAME.

HAT DOES THE REMAINDER OF 2012 HOLD FOR THE M&A MARKET? It can only get better from here, at least we hope. In

2011, M&A activity started off with a bang and ended in a whimper, with the overarching theme of global uncertainty dominating the landscape for much of the year. The general inactivity and lack of new deal processes at the end of 2011 carried over to the beginning of 2012. According to Thomson Reuters, the value of announced M&A transactions during the first quarter of 2012 was down 15 per cent from the fourth quarter of 2011 (with the number of deals falling 21 per cent compared to 2011). Despite the slow start to the year, there are some encouraging signs as the uneasiness appears to be gradually waning and is being replaced by modest confidence in the deal markets. The strengthening of the U.S. economy and greater availability of cash, among other things, have set the stage for an uptick in M&A activity over the remainder of the year.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

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Following are some of the more interesting and important factors and trends to consider for the remainder of 2012. All of them assume relatively stable macroeconomic and geopolitical climates.

These perspectives will also impact private companies as they look to their comparable public companies to help guide valuation. This disconnect between buyers and sellers will result in longer deal cycles, but buyers and sellers willing to make the effort to bridge this gap will find creative ways to get deals done, including by using earnouts, contingent value rights or other performance-based deferred compensation in private deals.

Private equity sellers, driven by looming uncertainty around the u.s. election and the Potential for regulatory changes resulting therefrom, will take advantage of imProved market conditions to exit investments.

Kyle Krpata is a partner at Weil, Gotshal & Manges in the Silicon Valley office, where he specializes in private equity and mergers & acquisitions. He has a broad corporate practice with emphasis on private equity transactions, public and private mergers and acquisitions, distressed and bankruptcy acquisitions and venture capital and growth equity transactions. kyle.krpata@weil.com

Focus on Key Terms; Gap in expecTaTions While both buyers and sellers are anxious to get deals done again, deal cycles may be longer due to intense negotiations on key transaction terms. No deal participant can afford to be exposed in the current environment. As a result – and based on lessons learned from past transactions – sellers are laser-focused on deal certainty and are insisting on buttoned up financing commitments, specific performance and full recourse against buyers. Buyers, particularly private equity sponsors, are mindful of the need for downside protection in the event they cannot close, and continue to require reverse termination fee structures or damages caps. Also, increased antitrust enforcement activity by the government has compelled buyers and sellers to spend more time allocating antitrust risk between the seller’s need for certainty and the buyer’s desire to avoid remedies such as divestitures. The most important term, price, obviously is a key factor affecting deal timing and success. Buyers may be expecting valuations based more in line with historical performance, while sellers are seeking higher valuations based on current and projected market conditions. In the first part of 2012, the markets pushed public stock prices higher than they have been in years, and public companies engaged in sale processes will seek to capitalize on these prices. Gun-shy buyers, on the other hand, will cite historical performance and an uncertain future as reasons to avoid paying at the top of the market.

Focus on core Business Whether under pressure from shareholders or as part of a regular review of alternatives, boards of directors and companies will continue to review and reevaluate their strategies to look for ways to unlock value and improve earnings. Many will decide to refocus on their core businesses, which will lead to opportunities for both strategic and private equity buyers to purchase unwanted businesses or divisions of larger enterprises. Already in 2012 we have seen eBay’s sale of Rent. com to PRIMEDIA, Kraft Foods’ spinoff of its North American grocery unit (which should be completed later this year), ConocoPhillips spinoff of its refinery business and Yahoo’s sale of half of its 40 per cent stake in Alibaba Group Holding. Private equity buyers specializing in carve-out transactions should see plenty of opportunities to put capital to work by acquiring such non-core businesses. resurGence oF privaTe equiTy Buyers (and sellers) While strategic M&A has been driving the market for the last several quarters, private equity buyers are more than ready to get back in the game. Many funds are seeking to deploy uncommitted capital and take advantage of favorable debt financing markets, and are eying both public and private targets. More importantly, private equity sellers, driven by looming uncertainty around the U.S. election and the potential for regulatory changes resulting therefrom, will take advantage of the improved market conditions to exit investments. Many funds are also facing end of life issues.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

These factors will create opportunities for both strategic buyers and other private equity funds. In 2011 private equity sponsors exited $170.4 billion through sales to strategic buyers and an additional $49.3 billion in secondary buyouts, and in the first quarter of 2012 private equity sponsors either sold (90 per cent of exits) or took public (10 per cent of exits) 112 companies (with approximately $21 billion in proceeds) – which represented the highest number of first quarter exits since 2007. While the initial public offering market has improved and has been enticing to some sponsors, sales will remain the preferred exit for sponsors and will drive increased M&A activity over the rest of the year.

Nortel transaction, Google announced its agreement to acquire Motorola Mobility for $12.5 billion, and most agree that Google’s real target was Motorola Mobility’s 17,500 patents and 7,000 patent applications. By the first four months into 2012, we had already seen Intel’s acquisition of approximately 190 patents and 170 patent applications from RealNetworks for $120 million, Facebook’s acquisition of 750 patents from IBM for an undisclosed amount and Microsoft’s acquisition of more than 800 patents from AOL for $1.1 billion. The success of these transactions for both buyers and sellers and the need to accumulate intellectual property assets will create a robust market for these transactions through the rest of 2012.

CASH IS KING Many large enterprises are sitting on hoards of cash. For example, Apple has approximately $100 billion – prior to the payment of the dividend it plans to pay to its shareholders – Microsoft has approximately $50 billion, Cisco has approximately $45 billion, Google has approximately $45 billion and Oracle has approximately $30. Companies flush with cash are looking for opportunities to use that cash through acquisitions. Also, on the private equity side, despite a fundraising slowdown in 2011, private equity sponsors still have considerable dry powder to put to use. According to Bloomberg, as of October 2011 private equity sponsors had over $937 billion in capital at their disposal. Both public companies and private equity sponsors will be under some pressure to put their cash to use. Companies with significant cash will be able to move quickly to take advantage of increased inventory in the market, and in some cases may be more attractive than private equity buyers that need to rely on debt financing to pay a portion of the purchase price.

HOSTILE ACTIVITY Hostile transactions have increased significantly over the last few years. They comprised 29.3 per cent of the market in 2011 (by deal value), which is up from 10.3 per cent in 2010 and 10.2 per cent in 2009, according to Thomson Financial. Private equity buyers, who historically have not engaged in much hostile activity, also have jumped into the fray in recent years. We believe that hostile transactions will continue to make up a meaningful portion of deal activity in 2012 especially in light of market conditions favorable for hostile M&A activity, including significant company cash reserves, the increased availability of financing, the general decline in target company takeover defenses and the continued rise of shareholder activism. Prior to dropping its takeover attempt, Roche Holdings had been campaigning for Illumina’s shareholders to support its hostile bid to purchase the company for $6 billion (a bid that had been rejected by Illumina’s board), and Coty had made an unsolicited offer to acquire Avon Products, a bid likewise rejected by Avon’s board (and ultimately withdrawn by Coty). Recently, Carl Icahn succeeded in his hostile bid for CVR Energy, when 55 per cent of the outstanding shares agreed to tender them, giving the Icahn group control of more than 69 per cent of the outstanding shares. Hostile transactions are a challenge to complete. Their twists and turns can lead to a variety of outcomes, such as the target remaining independent, a hostile bid turning friendly (as was the case with Sanofi-Aventis’ recent acquisition of Genzyme) or a hostile approach starting a process by which the target company ultimately is sold to a third party. ■

MONETIZATION OF INTELLECTUAL PROPERTY The intellectual property wars show no sign of abating. More than ever, companies need intellectual property assets for use as swords, shields and bargaining chips. As a result, companies with significant intellectual property portfolios will continue to seek to monetize all or a portion of their intellectual property, specifically patents. Nortel Networks’ recent sale of more than 6,000 patents and patent applications covering a broad range of wired, wireless and digital communications technologies for $4.5 billion made headlines and sparked a number of similar transactions. Soon after the closing of the

Andrew Nelson is an associate in the Corporate Department at Weil, Gotshal & Manges, in the Silicon Valley office. His practice is primarily focused on mergers and acquisitions and private equity transactions, including public and private company mergers and going private transactions. andrew.nelson@ weil.com

Avoiding Pitfalls in ENERGY PERFORMANCE CONTRACTING

By Dale B. Tauke

erformance contracting can be a way for owners or operators of buildings and other facilities to “go green” and save money. What it means is that contractors include service and equipment packages which provide retrofits that increase efficiency by reducing costly energy consumption. These retrofits may include a variety of measures, with the expectation that energy savings will partially or entirely pay for the equipment and other costs over time. The common terms “energy savings” or “energy efficiency” embrace more than just direct electricity or natural gas costs. They may, for example, also reference water usage savings or savings in operating costs from reduced maintenance or other efficiencies. Performance contracts are different from routine installation or construction project contracts. Providers of performance contracts offer a valuable financial and operational incentive to the facility owner – the guarantee of improved energy efficiency – and that guarantee is backed with the promise of monetary payments if it is not met. However, in projects large or small, given the inherently technical issue of energy-efficiency measurement, performance contracting is subject to complications and pitfalls. What follows is a brief overview of performance contracting and a roadmap to help avoid these problems and generally to assist in the process of negotiating the contract.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

MEASUREMENT AND VERIFICATION The engineering profession has developed standardized guidelines and best practices. The International Performance Measurement and Verification Protocol, or IPMVP (which comes from the Efficiency Valuation Organization, a private nonprofit organization that focuses on best practices in this area) is one key set of principles for improving energy efficiency. For federal projects, the U.S. Department of Energy sponsored the creation of M&V Guidelines: Measurement and Verification for Federal Energy Projects Version 3.0. Standards for particular applications also may be found in Guideline 14-2002, Measurement of Energy and Demand Savings, from the American Society of Heating, Refrigeration and Air Conditioning Engineers. And, from the International Standards Organization, there is ISO 50001, Energy Management Systems – Requirements with Guidance for Use. The IPMVP is applied in many non-governmental performance contracts, and any facility owner entering into such contracts should become familiar with it. The IPMVP sets out basic principles to help ensure that the measurement and verification (M&V) of energy savings

A FEASIBILITY STUDY SHOULD PROVIDE FOR COLLECTING BASELINE DATA AND ESTABLISHING A MEASUREMENT AND VERIFICATION PLAN FOR EVALUATING PRE AND POST-PROJECT ENERGY USE.

is accurate, complete, conservative, consistent, relevant and transparent. STARTING THE PROCESS Like the contract for any major infrastructure or construction project, a performance contract will require an exacting feasibility study or plan. The plan should estimate achievable efficiency improvements and their expected costs, and it should develop the specifications and timetable for the proposed work.

Often the facility owner will need to retain and compensate the project contractor to do the study. For a large project, the preliminary study may be expensive, but usually there is no way around it. The collected data and the analysis of potential energy savings performed will provide the basis for determining whether or not to go ahead, and if it does go ahead it will provide the basis for the contractor’s efficiency guaranty in the final contract. The cost of the preliminary study is commonly waived or subsumed into the final project pricing if the project is implemented. The feasibility study will also need to address two key areas necessary, per the IPMVP, for determining the energy savings to be achieved. First, it will need to provide for collecting baseline data – essentially the pre-project energy usage of the facility – over a suitable period of time. This study will form the starting point for determining how much energy the project saves. The process will involve “mapping” the institution’s HVAC (heating, ventilation, and air conditioning) points and other key data, recommending steps to improve energy efficiency and developing the key database that becomes the baseline. The quantity of data to be collected, the method of collection and the period of time to be subject to analysis will need to be determined, based on the projected value of the energy-saving measures under contemplation and the projected data collection costs. Second, the study will need to specify a measurement and verification (M&V) plan. The M&V plan identifies the methods and formulae to be used to evaluate the quantity and cost of the energy consumed in the specified post-project measurement periods, compared to the pre-project period. While the IPVMP specifies four broad options of M&V methodology, the option selected will need to be further rendered into something more detailed and workable. The preliminary analysis will also generate a financial model, showing the expected savings from the new systems and equipment. The financial model will help the owner decide whether or not to purchase the retrofit by showing its expected return on investment, and pay-back time. The financial model will also be important for projects that entail some shared risk-taking by a financing institution. The financing party will need to be assured that the projected savings will cover all debt service and administrative cost. THE CONTRACT Given this background, how can owners and operators avoid potential pitfalls in a performance contract and minimize the chance for future disputes and litigation? Here are some guidelines: • Understand the objective. Guaranteed savings in a performance contract should not be construed as a promise that utility bills will be lowered, because savings in this context are measured in units of energy, not dollars. Factors not within control of the contractor, such as utility costs per unit and increased usage (e.g. by opening up a new floor or wing of a building), will affect energy costs. The efficiency guarantee

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•

is that the new installation will consume less energy to achieve a specified output or result. In effect, the guarantee is that energy cost will be less than what it would have been under the old system, given no increase in per-unit energy costs and no increased facility usage. Make it a hands-on project. Required efficiency measurement expertise typically will be new terrain for most owners. A sharp focus on the project is important. For any significant performance contract, it’s important to have a senior official take ownership of project development, contracting, implementation and review. Get help. It’s tempting to look at a performance contract as a conventional construction or installation project contract, but it’s more complicated than that due to the need for the M&V plan. Unless the facility owner has in-house engineering experts who are experienced in energy efficiency issues, retaining an outside consultant for help with M&V plan development and the contracting phase, as well as for review of the postproject savings reports from the contractor for at least the first full-year cycle after project completion, is highly recommended. While the IPMVP covers the basics, its application in any specific situation remains a matter for professional review. Get your entire team on board. The maintenance staff for any building or campus often has a strong proprietary interest in the facilities’ equipment and systems. However, sometimes that interest can turn to skepticism, and even hostility, toward the new and at times complicated methodology that a performance contract may entail. This kind of discord can be a serious threat to the project. Providing the opportunity for appropriate staff to have meaningful input from the project’s earliest stages will go a long way toward promoting harmony. Remember contracting basics. Because a performance contract has some unusual features, a facility owner may forget that it is also, basically, a construction or installation contract. All the key contract terms

that should go into a good construction or installation contract need to be addressed in a performance contract. • Try to provide for efficient resolution of disputes. The technical data-driven nature of energy savings measurement in performance contracts makes it worthwhile to give serious thought to using arbitration to resolve disputes. One approach that may achieve a faster and possibly less adversarial result is to provide for retaining a qualified independent engineer as an arbitrator, to review both parties’ positions and calculations and then make a binding decision. • Watch the assumptions and adjustments language. The IPMVP does allow for the M&V plan to specify assumptions as well as a method for making calculation adjustments or data extrapolations in the event that facility or other conditions have changed in such a way that pre and postproject measurements no longer show an “apples-to-apples” comparison. These are typically reasonable provisions, but any contract wording about when assumptions, adjustments and extrapolations may be made needs to be reviewed carefully. These provisions should not be so broad as to render the M&V process meaningless or untrustworthy, or leave the facility owner with no assurance that demonstrable and reliable savings have actually been achieved. • Agree on the savings report form and get access to data and calculations. The complexity and volume of data involved in energy efficiency calculations create a risk that the post-project savings reports will be either an unhelpful avalanche of information or too little information to allow for an adequate review. The solution is for the parties to establish what the report should include during the contracting process, and then make the agreed-upon details part of the performance contract. As a fallback, the facility owner should have the contractual right to the underlying data and calculations for the purpose of verifying conclusions in the savings report. ■

Dale B. Tauke is a partner at Fox, Hefter, Swibel, Levin & Carroll in Chicago, working in the firm’s Corporate and Securities and Corporate Finance groups. He practices in the areas of structured finance and complex contracting matters, including plant and facility engineering and construction. DTauke@fhslc.com

ABA International members come from more than 90 countries, and include private practitioners from across the globe as well as in-house counsel, academics and lawyers in the public sector.

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WHAT WILL ATTENDANCE AT THE 2012 FALL MEETING OFFER YOU? • Over 60 substantive concurrent continuing legal education sessions (an entire year’s worth of CLE credits) and showcases with world-class speakers, focused on the latest international legal and ethics issues; • Program tracks including: Business/Transactional, Compliance/Regulatory, Corporate Counsel, Corruption, Dispute Resolution/Litigation, Latin American/Caribbean, Law Practice Management, Public International Law/Rule of Law, and Young Lawyers; • Networking opportunities with counterparts, decision makers and potential clients from around the world who are active in international practice areas; • Outstanding social events including daily luncheons with keynote speakers and evening receptions at Fontainebleau Miami Beach; the Moore Building in Miami’s fabulous Design District; and the New World Symphony just off Lincoln Road in Miami Beach; • An exhibition hall with dynamic products and services for the legal profession; • Specialized meetings with colleagues who share your areas of interest at committee working business meetings, division breakfasts and committee dinners; • Special programming for Corporate Counsel.

For more information or to register, please visit

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RFPS ARE AN OVERLOOKED OPPORTUNITY FOR LAW FIRM COST-SAVINGS By Robert C. Mattern

aw firms are regaining their footing following the 2008 economic crisis and the recession that followed. But now the paradigm has shifted, and there’s no turning back. Per-attorney billing rates alone can no longer be relied upon to drive a firm’s profitability. The traditional legal model has become more client-centric, and in this model client pressure for more decision power about costs has changed the game permanently. Alternative fee arrangements and an empowered client are driving the need to capture cost-efficiencies at every level. The Altman Weil Law Firms in Transition Survey 2011 listed among its top trends more price competition (90 per cent) and fewer support staff (88 per cent). This combination can be challenging, considering that firms

must also avoid sacrificing the quality of their work product – i.e. their attorneys’ time. Finding creative alternative methodologies to capture cost-efficiencies in the face of these pressures can seem like looking for a needle in a haystack. From lowest to highest, law firms typically list their top four expenses as wages, rent, insurances, and support services contracts. As a standard practice, firms compare starting wages, publish their earnings per partner and hire brokers to assist them with insurance and procuring their office space. However, firms still in most cases handle support services contracts with no outside expertise and with little industry comparison. Herein lays the opportunity in the haystack. It’s become an imperative for law firms to get optimum pricing for the services and products they procure. Yet many

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO JUNE/JULY 2012

firms handcuff themselves and fail to accomplish this goal with three common counterproductive practices:

1 2 3

They operate in a vacuum without benchmark/target pricing information and market knowledge. They allow existing relationships to either determine or hinder the strategic procurement of these services or products.

They allow procurement to be carried out by a sourcing or procurement department that makes its decisions largely on the basis of price, without taking into account other critical factors. All three of these traps can be avoided. DUE DILIGENCE, POTENTIAL SAVINGS In a typical firm scenario, where there may be upwards of 100 engagements for both equipment and outsourcing RFPs, an open RFP process (where a multitude of vendors are invited to participate) will yield on average more than 14 per cent in savings over similar sized engagements where negotiations involved only the incumbent vendor or vendors.

The cost savings is crucial in the new legal model. Some executive directors have also described the open RFP process as part of their due diligence and their representation of that due diligence to their superiors. In other law firms, leaders have recognized innovations that have taken place in the market since their last contract negotiation and have taken the open RFP as an opportunity to investigate those innovations. On the down side, an open RFP requires a great deal of additional work during the process, and if a new vendor is selected, additional work at the end of the process. There is also the opportunity cost of the time involved. It can be said that an open RFP may be a daunting process. The Director of Facilities and Operations at Dow Lohnes, for instance, remarked that heâ&#x20AC;&#x2122;d wanted to commence an open RFP on office supplies for over three years, but the daunting nature of the process dissuaded him. A firm can be pleased with its incumbent vendor and still engage in an open RFP. The Director of Administration for Thompson Coburn LLP, Larry Schulte, recently completed an open RFP process for facility services. The five-year contract signed with Pitney Bowes Management Services in 2006 was set to expire in April 2011. Consistent with best practices in the fiscal and operational management of the firm,

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Thompson Coburn decided to engage in the open RFP process. Schulte notes that the firm indeed had a good relationship with the vendor and was pleased with the services Pitney had been providing. However, he adds, “We felt we could improve our due diligence by doing a full-scale analysis of current pricing models and service offerings.” Thompson Coburn began the open RFP process in June of 2010, and the process took more than a year to complete, but it paid off. Significant efficiencies were found in labor, duplicating equipment and total impression costs. At the end of the open RFP, Thompson Coburn decided to sign a renewal contract with Pitney, but they were able to do so under far more advantageous conditions for both the short contract period and for future negotiations. With all the benefits of an open RFP process, it would seem a foregone conclusion that firms would always opt to use it, but that’s not the case. Here are some of the informally gathered reasons for not using the open RFP process:

• My staff and I don’t have the time. • I am afraid I will make my current vendor angry, or they will reassign the people who staff my account. • I am so happy with the services I am getting that I won’t make a change. Why go through the process? THE VENDOR’S RENEWAL OFFER Chances are your firm’s incumbent vendor will approach the firm about extending the term of the contract at some point prior to the expiration of the current contract. Equipment vendors for financial reasons will usually time this for approximately halfway through your current term, while outsourcing vendors will typically approach you within the last 12 to18 months of your contract. Results by way of this method can vary wildly. The cost may actually increase in a market that is highly competitive, or a firm may be pitched a projected savings of 20 per cent. A variety of factors will play into this process, including whether the contract was competitive at its inception, the length of time the vendor has been servicing the account, current market conditions and what the vendor perceives as the firm’s understanding of the marketplace. The upside of contract renewal through the vendor offer is that your firm may get better pricing and terms, with the added benefit of not losing staff hours that would have had to be dedicated to an RFP. The downside, of course, is that pricing

and terms may not be improved. Vendor contracts and services have a tendency to become outdated if they are not challenged through a competitive process, with long term negative effects. THE CLOSED RFP Firms that are satisfied with their vendor sometimes choose the process known as a closed RFP. This occurs when analysis and benchmarks of the operation are scrutinized along with the contracts, and there are recommendations on workflow, contract terms and pricing. The client approves recommendations and then the closed RFP is submitted to the preferred vendor as a basis of negotiation. If agreement on pricing and terms is not possible, a closed RFP can become an open RFP. In 2007, Shook, Hardy & Bacon signed a 5-year contract with Pitney Bowes Management Services. The contract encompassed end-to-end solutions for mail and document management services (copy, mail, fax, scan and litigation support services) for the firm’s seven domestic locations. With the contract coming up for renewal, the firm wanted to identify areas where they felt there was room to optimize their document processes. By approaching Pitney with the client’s requests – along with benchmark pricing and terms – it was possible to work together in creating a plan to address the law firm’s needs. They were able to procure a solid contract with strong financial and operational savings – actually adding additional services, including audio visual assistance, hospitality services, reception assistance and trial support. The closed RFP process is not ideal, but as exemplified in the case of Shook Hardy, it can result in better pricing and terms and enable the firm to have an unbiased view of the operation in a way that’s less time-consuming than an open RFP. There is little question that a competitive process will deliver the optimum savings and improvement in terms. However, a well-managed “closed RFP” with realistic benchmarks can also deliver impressive savings. Clearly, the least desirable course is to renew without any competitive pressure applied to your current vendor. In the new legal climate, it is imperative that law firms get optimum pricing for the services and products they procure. The key is to recognize when a competitive process is required to deliver the type of savings that the client-driven marketplace is mandating. Support services contracts should be like other major law firm expenses: They should be addressed with either closed or open RFP’s.

Rob Mattern is president and founder of Mattern & Associates LLC, a consultancy that helps law firms with RFP development, cost-recovery and other aspects of in-house operations and outsourcing management. rmattern@ matternassoc.com

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Precautions Essential in MULTINATIONAL AGREEMENTS By Martin J. Oâ&#x20AC;&#x2122;Hara and Jon Schuyler Brooks

ertain areas of law – notably taxes, trusts and estates – force practitioners to anticipate future events and plan for them. For business transaction lawyers, the future extends only as far as closing. They carefully articulate the post-closing business obligations of the respective parties in contract documents, but driven by the need to facilitate the deal, many satisfy their concerns about post-closing legal obligations by simply including a reciprocal indemnity clause. General counsel and their CFOs are very familiar with the inherent cost of litigation, including the added costs of litigating avoidable issues, such as choice of forum or law. But they should also be aware that such costs can be much higher when the contract involves companies from multiple countries. In such scenarios, it is important to consider the many issues that can surface and incorporate precautions into the contract that will save the company time and money if there is a breach. The first issue to consider is where a potential dispute will be heard. Reflexively, the answer might be the company’s location. However, there are other questions to consider. Absent a contract provision specifying the forum, courts may undertake an unpredictable process in which they weigh multiple factors, including where the contract was negotiated, executed, performed and breached. Other questions might include whether the company has only one office from which it expects to perform under this contract; where the company’s likely witnesses are located; and the company’s stature in that community. Companies should also take into account whether the law firm drafting the contract has meaningful affiliations in the locale under consideration. Addressing all these issues can cause affidavits and legal memoranda to pile up and billable hours to soar. But a welldrafted provision will designate or at least delimit the forum. Careful thought should also be given to the procedural differences between state and federal courts, and whether any tactical or strategic advantages derive from those differences. It is often valuable to consider whether one or the other is preferable in an appeal. A forum selection clause should be very specific. For example, woe to the out-of-towner who agrees to a provision specifying “any court in the city of New York,” assuming any dispute will be heard in Manhattan, and later is served with a summons issuing from

Staten Island, which happens to be where the adverse party is based. If a specific court is not identified, make sure the language sufficiently limits the possibilities. If a state court is chosen, it is best to get the matter before a Commercial Part judge. They are familiar with complex business issues. It is advisable to identify the court by name in the contract. If a federal court is chosen, the agreement should state the district and division. These same issues will also surface if the decision is made to arbitrate disputes arising under the contract. For example, the arbitral forum selection clause can specify not only the physical location of the hearing, but the arbitration organization to be used and the rules that will apply. Finally, care must be taken that a forum selection clause is permitted by the law of another jurisdiction. In an effort to protect their citizens, some jurisdictions mandate by statute which courts will hear certain types of disputes and stipulate that such a mandate cannot be waived.

CHOICE OF LAW Along with determining the forum, any company entering into a multinational agreement should also consider what body of law will be applied to decide a potential

It is far easier for all to agree on the applicable body of law during the courtship rather than during the divorce.

dispute. Once again, the automatic answer might be “where the company does business.” However, one must consider whether it might be more advantageous to

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Martin J. O’Hara is a principal and vice chair in the Litigation & Dispute Resolution group at Chicago-based Much Shelist. He has extensive experience in representing clients on commercial litigation and the defense of professionals in malpractice actions. mohara@ muchshelist.com

select the law of the country where the contract will be executed or largely performed. Alternatively, the law of the state in which the company is headquartered and/or incorporated might be better. One factor too rarely considered in choosing the law is whether the company is more likely to be a plaintiff or a defendant. If the company will be a plaintiff (for example, when it is the licensor of intellectual property), consider choosing a body of law that allows for pre-judgment interest at a high statutory rate, such as New York at nine percent per annum. However, if the company has a greater chance of being a defendant (such as when it is manufacturing goods to a third party’s specifications), the company should select a body of law that either does not grant the plaintiff an entitlement to prejudgment interest, or one that sets a comparatively low statutory rate. Absent a contractual choice-of-law provision, a court will be thrown into a legal abyss known

There are three primary avenues a general counsel can take when retaining counsel outside of the United States

as Conflict of Laws, for which the company will pay additional litigation costs and suffer even greater uncertainty of outcome. So, after choosing the body of law that will apply, make sure the contract provision also incorporates the

terms “without giving any regard to its Conflict of Laws provisions.” Otherwise, the contract will incorporate the principles used by the selected body of law to dictate whether a completely different body of law can be applied. In most instances, all parties to a contract benefit from knowing in advance the specific body of law that will apply. It is far easier for all to agree on that body of law during the courtship rather than during the divorce.

MANDATORY ARBITRATION PROVISIONS The choice of law for an international contract will have an impact on other elements of the agreement, including a mandatory arbitration provision. There are many benefits to including an arbitration provision in any contract, but those benefits are magnified in a multinational scenario. For example, arbitration can help a company avoid unpredictable courts as well as possible political issues that might exist in a country where the company seeks to do business. By requiring arbitration of disputes under a contract, the company has some degree of certainty regarding how the dispute will be decided. As in a forum selection clause, an arbitration clause can dictate where the arbitration will proceed. Similarly, the arbitration provision allows the parties to dictate the number of arbitrators that will decide the matter and the language that will be used. Having these issues predetermined through an arbitration provision leads to a quicker, more efficient and cost-effective process than that offered through traditional litigation in courts. There are potential downsides to an arbitration provision. First, there are very limited appellate or review rights after an arbitration award is entered. In virtually all circumstances the decision is final. While this is favorable if your company prevails, it obviously has a significant negative impact to the losing party. This differs from litigation where the decision by the trial court can be followed by years of appeals. However, the small potential pitfalls associated with arbitration are generally outweighed by the benefits in a multinational dispute.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

The laws concerning recovery of attorneys’ fees by a prevailing party differ between the United States and most other countries. In the United States, the general rule is that each party is responsible for its own attorneys’ fees unless a contract or statute provides otherwise. Under the English rule, the party that loses the litigation pays for the opposing party’s legal fees. The English rule predominates outside of the United States, but the way in which it is applied can vary from country to country. Therefore, if the contract does not specify whether attorneys’ fees may be recovered, the issue will be decided based on the specific location where the dispute is litigated. Whether to allow a prevailing party to recover its attorneys’ fees or to require each party to pay its own attorneys’ fees is a strategic decision that a company needs to make while drafting the contract. Regardless of the decision, this provision should be included in the contract in order to provide the company with certainty on this matter in the event a dispute arises.

RETAINING COUNSEL OUTSIDE THE U.S. Contract provisions aside, another critical issue in any multinational litigation or arbitration brought outside the United States is the retention of counsel to represent the company in the matter. There are three primary avenues a general counsel can take when retaining counsel outside the United States: (1) Directly retain a law firm that practices in the locale of the litigation or arbitration. This can provide excellent results, assuming that the client performs a proper due diligence investigation and is able to identify the right firm or attorney for the matter. The downside is that the due diligence process can be time-consuming. (2) Retain a large U.S. firm with an international presence, including an office in the locale where the matter is pending. This allows the client to coordinate with counsel in the United States and know that the lawyers handling the matter are affiliated with an excellent law firm. However, retaining such a firm comes with high billable rates typically

Any company entering into a multinational agreement should consider what body of law will be applied to decide a potential dispute.

charged by large, international firms. The size of the matter may not justify the payment of the higher fees charged by such firms. (3) Use a U.S. firm that belongs to an international network. One example is the International Alliance of Law Firms (IALF). The IALF has 60 member firms in 43 countries, and the firms are primarily Englishspeaking. The benefit of using a U.S. firm belonging to such an alliance is that the client initially can coordinate with counsel in the United States, while at the same time tapping into the firm’s network of proven counsel in the foreign country. The potential downside is that the client must rely to some extent on the U.S. firm’s knowledge of its foreign alliance members. However, member firms of many such alliances have proven track records working with each other, which reduces the risks substantially. Many important issues must be considered when litigation outside the United States is a possibility. Some issues need to be weighed during transaction negotiations and while the contract is being drafted. Others arise when the litigation or arbitration begins. In either circumstance, planning for and properly addressing the issues can save substantial time and money in the long run. ■

Jon Schuyler Brooks is a litigation partner and co-chair of the Environmental Practice Group at New York-based Phillips Nizer LLP. He represents clients in complex commercial and environmental litigation matters, and environmental aspects of real estate, corporate and financial transactions. jbrooks@ phillipsnizer.com

New Ways to Reduce

LITIGATION COSTS By Alan Rudlin educing outside litigation costs, which have grown precipitously in the last decade, is a key goal for inside counsel. Various changes to the billable hour model have been tried, but these appear to be having only incremental impacts. The major cost driver in litigation is not the trial, but expensive and time- consuming pretrial tasks like electronic and other forms of discovery, which can go on for years. These pretrial costs have ballooned recently, with

e-discovery alone averaging millions of dollars in mediumsize cases. Two recent and little-noticed solutions have developed to shorten the process and reduce these costs: Delawareâ&#x20AC;&#x2122;s adoption of a private arbitration fast-track option for certain business disputes, and the growing use of separate settlement counsel in selected cases. PRIVATE JUDICIAL ARBITRATION

A majority of U.S. corporations are incorporated in Delaware, in part to take advantage of the body of commercial and corporate law that the stateâ&#x20AC;&#x2122;s Court of Chancery has

The Delaware Court’s attempt to offer the private arbitration alternative to litigation has itself been challenged in a lawsuit in federal court.

developed for handling commercial and corporate disputes. In 2010, that court adopted a new procedure that allows parties to have their dispute arbitrated privately by one of the regular judges of the court, and to get a ruling within 90 days. This private use of public judges is reminiscent of the high-occupancy vehicle, or “HOV,” freeway lanes in densely populated cities, where vehicles can elect to pay more to move faster. The Delaware Court imposes a $12,000 initial filing fee and a $6,000 per diem for each day of arbitration. This procedure is faster than litigation because the rules provide for an expedited arbitration hearing at the end of 90 days. In addition, the process is not bound by time-consuming traditional procedural, evidentiary and discovery rules. The arbitrators are highly respected jurists, sophisticated in resolving business disputes. Those qualities can vary among general docket judges, as well as among private arbitrators. Litigants can research the published decisions of the Delaware Court of Chancery to get a sense of the jurisprudential record of their prospective judicial arbitrator. This solves one of the biggest challenges in the world of private arbitration – how to efficiently assess information about the caliber of prospective arbitrators. Private arbitration rulings aren’t publicly available, and the sense of what a particular arbitrator is like normally is garnered largely by word-of-mouth. In fact, the world of alternative dispute resolution and

private arbitrators has boomed in recent years, and some unevenness in quality has been a result. While many forprofit arbitrators are affiliated with private groups that offer a measure of quality control, their assessments can be spotty. Furthermore, both inside counsel and outside trial counsel have had the experience of sometimes finding arbitration as time-consuming and expensive as litigation, especially where the arbitrators, like the lawyers, are being paid by the hour. There are other benefits to the Delaware judges being arbitrators. The rules according to which private arbitrators resolve disputes are highly discretionary. Virtually no reviewing court will consider a challenge or appeal alleging that the arbitrator failed to follow the law when rendering a decision. This can lead to rulings some find illogical, or decisions that seem at odds with established law. While the Delaware judges sitting as private arbitrators have that same breadth of discretion, they are accustomed to rendering decisions in accordance with the applicable law that they themselves have developed. As judges they are accountable for rational decision-making by appellate review, and this intellectual rigor likely continues when they serve as arbitrators. The risk of an aberrant ruling is considerably less before a Delaware judge whose day job is that of a jurist committed to following the rule of law. Thus, beyond the attraction of confidentiality in any purely private arbitration – which is shielded from public access to either the hearing or the filings – the Delaware procedure gives corporate litigants a strong assurance of the quality of the arbitrators’ decision process. In addition, this procedure gives corporations an option to arbitrate resolution of business disputes when one of the parties is from a foreign country. The enforceability of a judgment in a U.S. court against such foreign parties is uncertain, because the United States isn’t a signatory to any international treaty for reciprocal enforcement. By contrast, arbitration awards are readily enforceable in other countries pursuant to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. This is particularly helpful in mergers and acquisitions. Hence the Delaware process not only assures a speedy resolution at the trial level, but a much smoother and reliable post-judgment enforcement mechanism. Will the Delaware option flourish? Well, this being America, as de Tocqueville observed 200 years ago, every dispute ends up in litigation. Therefore, it is not surprising that the Delaware court’s attempt to offer the private arbitration alternative to litigation has itself been challenged in a lawsuit in federal court. The challenge is over the use of taxpayer supported judges and institutions to provide a private dispute resolution process, as well as the Constitutional issues raised by lack of public access to such matters. The counter arguments, offered by the defendant judges of the Delaware Court, as well as amici curiae, include the observation that if the United States doesn’t offer a high quality forum for quickly and efficiently resolving corporate and commercial disputes, global companies may turn

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Retaining separate settlement counsel allows the company to send the message that it is serious about winning at trial, while at the same time it is open to the possibility of settlement.

away from U.S. courts for such resolution, and indeed choose to locate their facilities or invest their capital elsewhere. A decision, expected soon, will likely be appealed. But regardless of the outcome in Delaware, an interesting example has been set that other states may choose to emulate, if for no other reason than to offer competitively attractive legal systems to draw companies to their states. States compete in a variety of ways to have companies locate operations or headquarters within their borders. Why shouldn’t states consider the obvious attraction of a private arbitration option by a sophisticated group of judges in commercial matters? SEPARATE SETTLEMENT COUNSEL

Hiring separate counsel solely to negotiate a settlement is a new development that actually revives an alternative that a few corporations have used in the past. At its heart is a compelling statistical reality: Upwards of 95 percent of all civil cases will settle before trial.

By that point, the company will have invested significant sums in the outside legal costs of discovery, depositions, expert witnesses and other tasks that accompany any corporate litigation. Beyond the large out-of-pocket costs, the company’s executives and employees will have endured the distractions of litigation. Focusing on the opportunities for an early settlement through the retention of separate settlement counsel is pragmatic and does not duplicate what trial counsel is doing. There are a number of reasons for this. First, settlement counsel looks at the litigation in terms of the strategic opportunities that resolution may bring, rather than the myriad microscopic legal issues that are required for trial preparation. Retaining separate settlement counsel actually frees up outside trial counsel to focus more efficiently on trial preparation. It allows the company to send the message that it is serious about winning at trial, while at the same time it is open to the possibility of settlement. The skills for successful negotiation in a settlement mediation are very different than the courtroom skills of a trial lawyer. While some trial lawyers recognize that fact and can shift accordingly, others cannot. In any case, it can be disruptive to shift in and out of both roles. Outside trial counsel support the client’s wish to minimize unnecessary litigation costs where possible. But the reality is that trial counsel has to focus on doing everything necessary to win. That can produce incentives that are different from those of settlement counsel. Particularly if done on a fixed fee basis, settlement counsel’s interest and incentives directly align with the client’s. It is unlikely that litigation will ever be inexpensive in America. But these two developments, if utilized more broadly by corporate counsel, can provide innovative ways to expedite resolutions and bring the cost of litigation down to manageable levels quickly and predictably. ■

Alan Rudlin is a litigation partner in the Richmond office of Hunton & Williams LLP. He has been lead trial counsel in complex litigation matters throughout the country. He has chaired the firm’s ADR practice group and has headed his state’s Joint Committee on Alternative Dispute Resolution. arudlin@hunton.com

Multinational M&A Review Often Requires Translated Documents By Ty Cobb and Eric Elting

The demand for multilingual translation in legal departments and law firms is increasing. Multilingual support is often required in such areas as court reporting, e-discovery for litigation, and virtual data rooms for mergers and acquisitions and bankruptcy cases. In these situations, fast turnaround times with error-free results is extremely important to firms and clients. Until recently, the Federal Trade Commission (FTC) viewed the matter of non-English-language documents during the discovery process with a certain amount of flexibility. If, for example, a company embarking on a merger had 500 documents in 12 different languages that the company claimed were likely not relevant

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

to the deal, the FTC often was willing to take their word for it. Today, the FTC is more likely to make a “second request” for translated documents – adding another layer of complexity for legal departments and law firms working with multinational companies and clients. The Foreign Corrupt Practices Act (FCPA) is another factor in the growing need for translation processes. To curtail international bribery, legal representatives must now prove their compliance efforts not only in their U.S. headquarters, but also in their foreign operations. The ability to do that hinges on access to translated documentation of business practices abroad. In a field that demands precision, the idea of machine translation (MT) can seem like an anathema. However, MT may be essential for managing the deluge of multilingual documents involved in discovery, mergers and other legal processes. Relying on MT for triage early in the translation process is one option. When a legal department or firm is faced with tens of thousands of documents in foreign languages and must determine which warrant careful translation and which are irrelevant, MT is very helpful. One option is to use MT early in the discovery process to give case teams a degree of English operability within the foreign language documents. The work product can be coupled with various technologies to cull the data set to manageable size, including early case assessment platforms. Then human experts can carefully translate a smaller set of documents. Another solution combines MT for a quick initial translation, followed by attorney-assisted document review to further narrow the universe of relevant documents and determine whether the document is responsive to the particular subject matter. Only then is human translation used to review and correct basic spelling and grammar issues. By integrating multiple forms of translation, firms can reduce costs without affecting accuracy. Faced with any case involving foreign language issues, lawyers should be aware of the main options for translation and when to employ each of them. A translation solutions partner can design an appropriate workflow that starts with machine translation for rapid review of astronomical amounts of data. The same partner can then provide a team of experienced, human experts or document reviewers for more thorough

Machine translation may be essential for managing the deluge of multilingual documents involved in discovery, mergers, and other legal processes.

and accurate translation and review of the most critical documents involved in discovery. Here, for example, is a closer look at how Hogan Lovells works with a translation service: The law firm often requires workflow development to determine the best document translation process for each individual case. Recently, it faced a case that tested its ability to work across and beyond language barriers. The firm had a second request from the FTC that involved 400 documents in 12 languages, and only three days before a critical government deadline. The firm worked with TransPerfect Legal Solutions to manage resources for this task, culling through the less important documents with MT and calling on human experts to carefully translate the information that was vital to the case. International companies need attorneys that can practice law in the United States, so they see the value of hiring U.S.-based counsel. Because this is a common practice, translation becomes important in collaborating between the company abroad and domestic counsel. For example, a current case involving an FCPA investigation requires the translation of relevant documents from Chinese into English, so the U.S. attorneys can read and assess documents. In this case, translation adds significant value when counsel analyzes whether the company is in violation of the U.S. law. Translation factors into much of the Hogan Lovells’ pro bono work, as well. Translation services enable the firm to take on Spanishspeaking clients and partner with organizations that assist refugees overseas. If cases require translation of birth certificates, verbal testimony or other documentation, there is a process to do that. Translation has also become an integral part of the firm’s intellectual property practice, where multilingual patent litigation is becoming more prevalent. With machine translation technology, law firms can quickly translate material to get the gist of the content and determine whether or not documents merit more accurate human translation. ■

Ty Cobb is a partner at Hogan Lovells. He practices primarily in the areas of white collar criminal litigation, SEC enforcement, Congressional investigations and hearings, and related complex civil litigation. ty.cobb@ hoganlovells.com

Eric Elting is the director of global legal and patent business development for TransPerfect Legal Solutions. eelting@ transperfect.com

jun/jul 2012 E X ECUTIV E COUNSEL

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO june/july 2012

Securities Class Action Settlements Decline, but Accounting Issues Remain By Laura E. Simmons and Matt G. Armstrong

The current environment for securities class actions, and for cases involving accounting issues in particular, is dynamic. There was a decrease in the volume and value of securities class action settlements in 2011, but there is reason to expect this is a temporary dip and that accounting issues will remain important in securities litigation.

ornerstone Research has found that securities class action settlements were down in 2011 to their lowest level in some years. In 2011, there were 65 securities class action settlements, with a median settlement amount of approximately $6 million, compared with an average of almost 100 settlements, with a median settlement amount of just under $10 million for the prior five years. In addition, the number and percentage of settled cases involving violations of generally accepted accounting principles (GAAP), financial statement restatements, and/or accompanying SEC actions declined to the lowest levels in the past 10 years. Only one in four cases involved financial statement restatements. That was the lowest level since 2003. Each of these factors in 2011 was approximately 30 percent or more below the prior five-year average. While nearly 95 percent of the largest 50 securities class action settlements in history involved accounting cases, the majority of these settlements occurred prior to 2009. These findings might suggest that the risks associated with accounting issues in litigation have decreased recently. However, there are a number of factors that warrant further consideration. There has been widespread commentary that the Sarbanes-

Oxley Act has led to improved corporate governance and a decline in financial restatements in recent years. Nevertheless, Audit Analyticsâ&#x20AC;&#x2122; report, 2010 Financial Restatements, A Ten Year Comparison, indicates that the number of restatements by publicly traded firms increased in 2010, reversing the trend from the prior five years. Consistent with this, the percentage of securities class actions filed in 2011 that involved financial statement restatements was higher than in each of the prior three years. Overall, the number of initial case filings including accounting allegations increased to 70 in 2011 from 46 in 2010. They represented nearly 40 percent of all 2011 filings. Moreover, amendments to initial case filings tend to add accounting allegations, so the proportion of cases involving accounting allegations ultimately is higher. Accounting allegations related to asset write-downs (e.g., declines in the value of loan portfolios) have risen due to more credit-crisis cases involving financial institutions. These allegations typically involve a change in estimate that is accounted for prospectively and do not result in a financial restatement. Cases involving write-downs typically settle for higher amounts than cases not involving accounting allegations. For example, from 2006 to 2011, the median settlement for cases involving asset write-downs was

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almost $14 million, compared with $5 million for cases not involving accounting allegations. Much of this difference results from the fact investor losses in cases involving asset writedowns tend to be larger than in other kinds of cases. The “seriousness” of accounting allegations also continues to be an important factor affecting settlements of securities class actions. We have not observed any systematic declines in securities cases accompanied by acknowledgments of intentional misstatements or omissions in financial statements (i.e., fraud) since the passage of SOX. Such acknowledgments are associated with higher settlement amounts. In fact, all else equal, settlement amounts will tend to be about 25 percent higher for cases involving company disclosures acknowledging the presence of intentional misstatements or omissions. Thus, more serious accounting issues still lead to increased settlement costs. We also continue to see derivative actions accompanying class actions, frequently in cases involving accounting allegations. Often these cases are resolved with changes in corporate governance practices and little or no cash payment (except to plaintiff counsel). Whatever the motivation for these cases, settlements for securities class actions accompanied by derivative actions tend to be higher. Not only do accounting cases typically settle for greater amounts, but they also tend to take longer to resolve. The average time to resolve a case not involving accounting allegations is less than six months, compared with almost 1.25 years for accounting cases. This difference is largely attributable to the fact that accounting cases are less likely to be dismissed, particularly in the early stages of litigation. Costs generally increase the longer these cases go on, in the form of a drain on management as well as attorneys’ fees. In fact indirect lawsuit costs are often greater than the direct litigation expenses. Looking at regulatory activity, the SEC’s 2011 Performance and Accountability Report indicates that the SEC filed 735 enforcement actions in 2011, more than in any previous fiscal year. Eightyfive of these enforcement actions were what the report calls “National Priority Cases – cases with the greatest significance and highest impact – an increase of 80 percent from 2010.” Some of these enforcement actions may lead to private litigation that likely will include accounting allegations. The SEC is not the only regulatory entity that is ramping up its enforcement activity. The budget for inspections by the Public Company

Accounting Oversight Board (PCAOB) increased by 17 percent from 2010 to 2011 and by 24 percent from 2011 to 2012. The PCAOB’s budget for investigations and enforcement also increased, by 27 percent from 2010 to 2011, and by 15 percent from 2011 to 2012. Increased inspection and enforcement planned for auditors of publicly traded firms will have implications for issuers, as well. Specifically, the PCAOB continues to increase its coordination with the SEC. When the PCAOB becomes aware of a GAAP violation during the course of an investigation, it is likely to communicate this finding to the SEC. Thus, PCAOB findings may be another factor leading to increased SEC actions in the future, which may in turn lead to a greater number of accountingrelated securities class actions. A major aspect of SOX that has affected private securities litigation is the Section 404 requirement for management and auditors to assess and certify the adequacy of a company’s internal controls over financial reporting. In recent years, plaintiffs have frequently alleged internal control weaknesses. In 2011, almost 65 percent of case filings involving accounting allegations made such allegations. Whether or not the company formally acknowledges internal control weaknesses has an impact on settlement amounts. Settlements are higher for cases in which plaintiffs allege internal control weaknesses and also are able to note a company announcement that acknowledges the weaknesses. Thus, SOX may have given plaintiffs a means to bolster their claims and obtain higher settlements in securities class actions. We also believe that the whistleblower provisions of the Dodd-Frank Act may bring an increase in accounting-related allegations in securities class actions. Given these trends, it is not surprising that public companies have been increasing their D&O insurance coverage. According to a recent Towers Watson survey (Directors and Officers Liability Survey 2011), management’s greatest concerns currently are private securities litigation, regulatory actions, and shareholder derivative actions. With the 10-year anniversary of SOX, we see continuing regulatory activity, new regulatory developments, an increasing number of SOX 404 allegations related to new incentives created by Dodd-Frank whistleblower provisions, and increased collaboration between regulatory agencies. Monitoring accounting issues in litigation continues to be important, as the securities litigation environment remains volatile. ■

Laura Simmons is senior advisor at Cornerstone Research, in the Washington D.C. office. She is a certified public accountant and a Ph.D, with experience in economic and financial consulting, including damages and liability issues in litigation involving securities and the Employee Retirement Income Security Act, as well as accounting issues in complex commercial litigation matters. lsimmons@ cornerstone.com

Matt G. Armstrong is a manager at Cornerstone Research, in the Washington DC office. He does economic consulting, with an emphasis on securities litigation, including loss causation analysis, class certification, and damages in accounting cases. marmstrong@ cornerstone.com

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