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T H E

M A G A Z I N E

F O R

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G E N E R A L

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C F O

E-DISCOVERY

The 10,000 Document Rule Information Governance: a Market in Asia Cost-Shifting The In-House Option INTELLECTUAL PROPERT Y

State of the ISP Safe Harbor GOVERNANCE

Centralized IP Valuation HUMAN RESOURCES

Retiree Health Care Costs

Summary Jury Trials Cybersecurity Lame Duck Lobbying Arbitration Pitfalls Resolving Criminal Investigations Sustainability Push from Emerging Economies Alberto Gonzales on FCPA Overreach

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aug/ sept 2012 E X ECUTIV E COUNSEL

Editor’s Desk

Congressional gridlock is the sub-text of several articles in this issue of Executive Counsel. The matters being discussed might provoke some lively disagreement among readers, but few would dispute the need for legislative action. Maybe the best thing to do is keep that in mind when going to the polls in November. An article by former Attorney General Alberto Gonzales highlights ongoing tension between the DOJ’s enforcement of the Foreign Corrupt Practices Act and corporate reluctance to submit to investigations of their internal affairs. Gonzales points out that the FCPA gives prosecutors tremendous discretion. Thus, they hold all the cards when it comes to charging decisions. Faced with that situation most corporations elect to do whatever it takes to reach an agreement, because the alternative is a wide-ranging probe of business strategies. This dynamic means the DOJ is rarely forced to defend its increasingly aggressive interpretation of the Act. Gonzales hopes for reform, but doubts that it will come out of Congress. Policy changes at the agency level are possible, in his opinion. EC Editorial Advisory Board member Jamie Gorelick and her colleague Jonathan Cedarbaum discuss cybersecurity, another issue Congress should be addressing. The threat posed by cyber attackers is a national security priority, but legislators have failed to respond. The authors, optimists despite their extensive experience in Washington, expect renewed efforts after the national election. Ashley Davis and Malloy McDaniel, practitioners in the area of government relations, are optimists too. They think that the lame-duck session in December will be productive, and they advise interested parties to get their messages out well in

advance of what may be a frenzy of legislative activity. We’ll see how this all turns out. John Thacher writes about something that is often ignored in the e-discovery arena, the key role that human review plays in an increasingly technologized aspect of litigation. He posits “The 10,000 Document Rule,” which asserts that a review team doesn’t reach a reasonable understanding of a project until it has analyzed that number of documents. He says this is equally true in-house and at law firms, and that it’s crucial to integrate up to date technology into the methodology of a carefully selected and well-trained review team.

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

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aug/ sept 2012 E X ECUTIV E COUNSEL

Features

NEW THREATS, NEW LEGAL DEVELOPMENTS, IN CYBERSECURITY

Jamie Gorelick and Jonathan Cedarbaum SEC rules, but no legislation.

THE GLOBALIZATION OF CORPORATE RESPONSIBILITY

GOOD REASONS TO WEIGH IN FOR THE LAME DUCK SESSION

ENSURING A COST-EFFICIENT ARBITRATION

Dr. Paul Brooks Emerging economies are spawning sustainability initiatives.

Ashley Davis and Malloy McDaniel Develop relationships now for later impact.

Richard J. Holwell and Dorit Ungar Black It starts with the contract.

Page 4 4

RESOLVING CRIMINAL INVESTIGATIONS PRIOR TO INDICTMENT James Brady and Buck Oâ€™Leary Avoiding a corporate death sentence.

SUMMARY JURY TRIALS AS AN ALTERNATIVE TO LITIGATION

FCPA NEEDS FINE TUNING, SAYS FORMER AG

Patrick J. Arnold Jr. Abbreviated process, cost-efficient result.

Alberto R. Gonzales DOJ victories led to overreach.

aug/ sept 2012 E X ECUTIV E COUNSEL

Departments Editor’s Desk Executive Summaries

2 10

e-DIscovery

18 | Shifting E-Discovery Costs to the Losing Party Anthony Diana and Dan Regard A tax the one percent can live with.

20 | The 10,000 Document Rule: The Unspoken Beginning of E-Discovery Understanding John Thacher The human element still key to e-discovery.

Intellec tual ProPert y

29 | Online Copyright Protections After Viacom v. YouTube William D. Schultz How red is that flag? Governance

32 | Valuation Key to Managing IP Robert F. Reilly Be ready to answer questions about the value of your intellectual property. human resources

24 | Information Governance Creates Opportunities in Asia

34 | Reducing Corporate Retiree Health Care Costs

Allison Walton Asian clients need e-discovery expertise.

Nancy G. Ross and John A. Litwinski An unvested benefit may be terminated or changed.

27 | Bringing E-Discovery Processing Back In-House Brian Ingram For some companies, it could be a no-brainer.

canaDa / cross-BorDer

36 | BusinessMethod Patent Law in U.S., Canada, Seemingly in Synch Steven B. Garland and Colin B. Ingram Both reject a narrow definition of “process.”

Page 18

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Contributing Editors and WritErs

Patrick J. Arnold Jr. Dorit Ungar Black James Brady Paul Brooks Jonathan Cedarbaum Ashley Davis Anthony Diana Steven B. Garland Alberto Gonzales Jamie Gorelick Richard Holwell

Brian Ingram Colin B. Ingram John A. Litwinski Malloy McDaniel Howard “Buck” O’Leary Daniel L. Regard Robert Reilly Nancy G. Ross William D. Schultz John Thacher Allison Walton

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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.

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

Executive Summaries E-DISCOVERY PAGE 18

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Shifting E-Discovery Costs to the Losing Party

The 10,000 Document Rule: The Unspoken Beginning of E-Discovery Understanding

Information Governance Creates Opportunities in Asia

By Anthony Diana Mayer Brown and Dan Regard iDiscovery Solutions

The escalating costs of electronic discovery are a major factor in formulating litigation strategy, but state and federal courts are not uniform in the way they assess and allocate those costs after a party prevails. Recently there was a trend to allow more cost shifting to the losing party, but two recent court decisions appear to reverse that trend. In U.S. Bank National Association v. GreenPoint Mortgage Funding, Inc. in the New York State Supreme Court, Appellate Division, and in Race Tires America, Inc. v. Hoosier Racing Tire Corp (or “Race Tires III”) in the Third Circuit Court of Appeals, courts limited the scope of what costs may be “taxed” to a defeated litigant, while providing some guidance on the method of allocating electronic discovery costs between parties. These cases clarify the law in their respective jurisdictions, but the rules governing the allocation and taxation of discovery costs remain subject to judicial interpretation in the rest of the country. Thus, it remains essential for parties to plan electronic discovery strategy in advance in order to control costs. Keep in mind that the courts have not addressed the extent to which costs for non-copying preparatory work is recoverable. That would include costs for early case assessment, or sampling for the advanced development of keywords or the application of predictive coding – costs which are intended to circumscribe the scope of discovery and reduce the overall cost of copying.

By John Thacher TechLaw Solutions

Much attention has been devoted to e-discovery technology and its impact on document review. What is not being discussed, the author says, is the level of human review necessary to evaluate a document set, regardless of technology culling capabilities. Accordingly, he posits “The 10,000 Document Rule.” It states that a review team does not have a reasonable understanding of a project until after it has analyzed approximately 10,000 documents. One of the most often overlooked issues in the defensibility of document review systems is that they all depend on some level of early human interaction to set rules, write review protocols, train reviewers and automated systems, and perform other tasks. Applying the 10,000 document rule, the author observes that several of those steps often occur before anyone involved in the case has a meaningful understanding of the document collection. Since understanding – the people-heavy part of the process – cannot yet be automated effectively, the selection of people to run the technology and manage the process is critical. Technology to assist or supplant human-based classification holds great promise, but only when linked to understanding. The good news about integrating technology into human-based processes, the author says, is that it should realize immediate cost savings. Application of the 10,000 document rule will reduce and organize documents; time spent in the early stages to selecting the right team and technology will pay dividends as a project progresses.

By Allison Walton Symantec Corporation

As the amount of data and the number of content sources grow due to the globalization of business, lawyers proficient in e-discovery processes, information governance and their enabling technologies can look to the Asia Pacific region for business opportunities. Compliance is a main business driver for archiving data in Asia, but the technology that accomplishes compliance can also facilitate litigation readiness. This is evidenced by recent cases like E.I. du Pont de Nemours v. Kolon Industries, in the Eastern District of Virginia. The court ruled against Kolon, a South Korean manufacturer, for failure to issue a timely and proper litigation hold, which resulted in the spoliation of key evidence. The court found the destruction of relevant data to be the fault of company attorneys, reasoning that they could have prevented spoliation with an effective hold process. Asian companies in some respects approach information governance with a blank slate, the author suggests. Without the legacy technologies of U.S. companies, they have the opportunity to establish a broad information governance plan from the start, one that does not hinge exclusively on litigation. U.S. practitioners may be uniquely situated to help them do it. The author advises attorneys who want to acquire Asian clients to target heavily regulated companies such as banks and pharmaceutical houses that have large amounts of data and do business in the United States. She suggests teaming with local counsel, consulting organizations or vendors.

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AUG/ SEPT 2012 E X ECUTIV E COUNSEL

Executive Summaries INTELLEC TUAL PROPERT Y

GOVERNANCE

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Bringing E-Discovery Processing Back In-House

Online Copyright Protections after Viacom v. YouTube

Valuation Key to Managing IP

By Brian Ingram LexisNexis

By William D. Schultz Merchant & Gould

Cost control is a number one issue for most company and organization legal departments, and their litigation budgets – specifically data management and e-discovery – has become a primary focus for cost-savings. Bringing e-discovery processing in-house is one important option for reducing costs. Favorably priced data analysis and processing solutions now on the market can help organizations make the determination. Document review is often the costliest step in the pre-trial discovery process. If organizations can control the amount of data that needs to be reviewed during the initial stages of e-discovery, they will be positioned to realize major cost savings. Proper training and guidance from the software manufacturer are necessary to ensure proper integration with existing workflow and that best practices are documented and followed. Not all organizations should opt for an in-house solution. It’s important to determine if this approach will in fact result in lower costs and make overall business sense. If the number or size of cases is substantial, the in-house option should at least be explored. Even what seems like a relatively small matter can sometimes require sifting through hundreds of gigabytes of data. Creating an in-house processing capability with the appropriate tools and personnel can result in better control of e-discovery challenges and costs. The prospect for enormous cost savings can’t be ignored, but whether this is the right approach for any given organization can be answered only after thorough review, analysis and discussion.

The Digital Millennium Copyright Act gives service providers a safe harbor against copyright infringement claims unless they have notice of, or actual knowledge of, specific instances of infringement and do not act expeditiously to remove or disable the content. If the copyright holder does not provide notification, the safe harbor applies unless red flags are ignored. A service provider must show that it lacked the right and ability to control the infringing acts. A service provider is unprotected by the safe harbor if it receives financial benefit and has the right and ability to control the activity. Federal circuits are split on the interpretation of the safe harbor provision. The Ninth Circuit has held the “right and ability to control” provision “requires control over specific infringing activity that the provider knows about.” The Second Circuit rejected that interpretation on the grounds it was merely duplicative of the knowledge provisions. The Second Circuit also found that the mere ability to block an infringer’s access did not obviate the safe harbor provision for a service provider. It ruled that “something more than the ability to remove or block access to materials posted on a service provider’s website” is required. Based on the circuit split and unresolved ambiguities about key terms, copyright holders and service providers should continue to monitor legal developments in this area. The author has suggestions for both service providers and copyright holders until the issues are settled.

E-DISCOVERY

By Robert F. Reilly Willamette Management Associates

This article summarizes procedures to measure, control and exploit a company’s intellectual property. The author, a certified public accountant accredited in business valuation, says that inhouse counsel are in a unique position to recommend and implement these procedures. CPA/ABVs apply generally accepted approaches and procedures to conclude on the value, inter-company transfer price, license royalty rate or economic damages related to IP. An IP valuation helps centralize control of intellectual property assigned to different company operating units. Centralization allows management to effectively perform its internal control duties. While there are currently no requirements for CEOs or CFOs to vouch for IP valuations, the Sarbanes-Oxley Act as well as federal and state securities laws require that management be responsible for the internal control of all company assets. An IP valuation allows management to identify and pursue commercialization opportunities. It can be used by a corporate property owner to identify intangible assets that are excluded from state and local ad valorem property taxation. It also may be used to defend against third party infringement allegations. Valuations indicate reasonable royalty rates and enable damages measures that legal counsel may use to negotiate a settlement agreement. For most purposes, however, company management is not the primary audience for IP analysis. To achieve corporate objectives, management may have to make its case about IP value to a banker, auditor, taxing agency, regulatory authority, investor, judicial finder of fact or other third party.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

Executive Summaries

HUMAN RESOURCES

CANADA /CROSS-BORDER

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Reducing Corporate Retiree Health Care Costs

Business-Method Patent Law in U.S., Canada, Seemingly in Synch

New Threats, New Legal Developments, in Cybersecurity

By Nancy G. Ross and John A. Litwinski McDermott Will & Emery LLP

By Steven B. Garland and Colin B. Ingram Smart & Biggar

By Jamie Gorelick and Jonathan Cedarbaum WilmerHale

The cost of post-retirement health benefits must be set forth in a company’s filings with the Securities and Exchange Commission. Depending on the size of the company and the pool of covered workers and retirees, these costs can run well into the millions, and in some cases billions, of dollars. Many companies have changed or are in the process of changing these benefits. Today only 45 per cent of employers provide medical benefits to current retirees, and only 22 per cent of employers include retiree medical as one of the benefits offered to new hires. Moreover, according to a recent survey, approximately 43 per cent of companies that now offer retiree medical benefits are planning to reduce or eliminate them. Some companies have already eliminated them, and some have litigated successfully when changes they attempted to make were challenged. Goodyear Tire & Rubber achieved a settlement which reduced its retiree medical obligations by approximately $200 million. Whether a company can change its retiree medical benefits is largely a legal question. These benefits generally are not legally vested, meaning that often they can be reduced or terminated. If they are vested, a lifetime right to a certain level of retiree medical benefits is in effect, and they cannot be changed or eliminated without the retirees’ consent. Whether or not benefits are vested is a legal question that depends on the interpretation of relevant contracts and documents.

The decision of the Canadian Federal Court of Appeal in Amazon.com Inc. v. Canada provides the latest word on the patentability of computerimplemented inventions and business method patents in Canada. The recent development of Canadian law has paralleled that of the United States in cases such as Bilski v. Kappos and Mayo Collaborative Services v. Prometheus Laboratories, Inc., and the law in both countries may now be quite similar. The only statutory exemption from patentability in Canada is now in respect to “mere scientific principles or abstract theorems.” In the United States a similar prohibition with regard to “laws of nature, physical phenomena, and abstract ideas” has developed. The courts in both countries must assess whether the claimed invention avoids these specific prohibitions. Arguably, both the Supreme Court in Prometheus and the Canadian Federal Court of Appeal in Amazon placed important caveats with respect to the breadth of patentability. The Supreme Court appeared to endorse an analysis that focused on the “new” elements of a claimed invention. Similarly, the Court of Appeal in Amazon suggested that known computer hardware may not be sufficient to provide the “practical application” required for patentability of a novel algorithm. The impact of these decisions will only be known once the respective patent offices establish their practices and further case law is developed. The patent offices of both jurisdictions are currently working on final guidance documents to assist patent examiners.

Our economic activities, social lives and physical safety increasingly depend on computers and other devices linked through the Internet. Protecting those systems and the information they contain has become a national imperative. In the past decade, an increasingly sophisticated cybersecurity industry has grown up to contend with the growing array of threats posed by cyber attackers and cyber thieves. A recent PricewaterhouseCoopers study puts spending on cybersecurity in the United States at $30 billion a year, and growing at 10 to15 percent a year. The legal system has been slower to respond, but legislators and law enforcement, at both the federal and state levels, have begun to pay attention. Cybersecurity has become a top priority in the federal government’s national security agenda, both in the executive branch and on Capitol Hill, and we have seen increased regulatory and enforcement initiatives. In the fall of 2011, both President Obama and Senate Majority Leader Harry Reid (D-Nev.) identified cybersecurity as a top legislative priority, particularly in three areas: critical infrastructure protection, information-sharing and reorganization of the federal government’s own cyber defenses. House Republicans responded with their own proposals, but partisan divisions, business concerns about additional regulatory burdens, and public worries about enhanced threats to on-line privacy left the 112th Congress unable to adopt substantial new standards before recessing for the summer. We are certain to see re-invigorated efforts in 2013, once the presidential election is behind us.

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

Executive Summaries

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The Globalization of Corporate Responsibility

Good Reasons to Weigh in for the Lame Duck Session

Ensuring a Cost-Efficient Arbitration

By Dr. Paul Brooks Tata Steel

By Ashley Davis and Malloy McDaniel Blank Rome Government Relations LLC

By Richard J. Holwell and Dorit Ungar Black Holwell Shuster & Goldberg LLP

In today’s global marketplace, where ideas are as coveted as any other commodity, emerging market corporations are showing Europe and North American-based companies new approaches to sustainable business practices, the author writes. He suggests we pay close attention to how rivals from emerging economies tackle what has come to be known as Corporate Social Responsibility (CSR). He cites among other examples the Future Steel Vehicle project, led by WorldAutoSteel, a steelmaker consortium from established and emerging markets. It has produced a concept car with a battery electric platform that uses advanced steel technology and has a body that is 35 percent lighter than conventional steel, plus a five-star safety rating. This was achieved at no additional overall cost and with no increase in the environmental impact of production. The author’s company built lagoons to circulate clean factory water to a nearby river. The area is now designated by the UK as a Site of Special Scientific Interest and an important habitat for wildlife. Whether one considers CSR to be an afterthought for corporations that can “afford” to consider matters other than profit, or believes sustainable business is an integral part of creating value, entrepreneurs and corporations from emerging markets have something to offer that is unique and has impact, the author says. The question for the West is whether to respond or, at its own peril, ignore the next great wave of competition and innovation from upstart rivals.

The next several months represent an opportunity for advocates to disseminate their message on Capitol Hill, in advance of what may be the most productive months of the legislative year: the so-called lame duck session, from the November election through the end of December. There are five key initiatives that Congress needs to tackle by the end of 2012, and each will have a significant impact on a wide range of industries. The Bush tax cuts are set to expire on December 31, 2012. Unemployment insurance, the payroll tax cut and the sustainable growth rate, or medicare “doc fix,” are set to expire on December 31st. The research and development tax credit and other tax provisions are expiring, and it is likely that the President will need to request another debt ceiling increase before the end of the year, which will spark heated debate. Finally, the automatic, across-theboard budget cuts known as “sequestration” that were included in the Budget Control Act of 2011 will be triggered in 2013, resulting in $1.2 trillion in cuts to be split between security and other programs. As important as the next few months are for laying the groundwork for the lame duck session, they are equally important in terms of preparing for 2013. Exactly which issues get tabled until then will in part depend on who wins the election, but in any case lawmakers will want to tackle major initiatives early in the session. Advocates that did not make themselves part of the process in 2012 risk being left behind next year.

The cost of arbitration is one advantage it has over litigation, but with the encroachment of the U.S. litigation process into the arbitration process that’s becoming less of an advantage. Parties often spend significant time and resources fighting over issues that could have been addressed easily when they wrote the arbitration clause of their contract. The authors identify some pitfalls of arbitration clauses and how to address them. Most arbitration clauses are drafted to apply to any dispute “arising from or in connection with” the contract. This can result in one side dragging in unintended parties or making numerous claims in the hope that one will stick. Parties who wish to limit arbitration to contractual disputes should consider more restrictive language – for example, a clause covering disputes “arising out of” the contract but not “in connection with” the contract. A perceived advantage of non-administered arbitration is that parties do not pay administrative fees. However, more often than not the institution’s administrative fees are negligible compared to attorney and arbitrator fees. The potential cost savings from lower arbitrator rates generally outweighs the savings from non-payment of administrative expenses. Depositions are costly, and they take management time, but they can be avoided easily by a stipulation in the arbitration clause. This should be married with a requirement that direct testimony be presented beforehand, in writing, so the arbitrators can review and opposing counsel can prepare for cross-examination.

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Executive Summaries

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Resolving Criminal Investigations Prior to Indictment

Summary Jury Trials as an Alternative to Litigation

FCPA Needs Fine Tuning, Says Former AG

By James Brady and Buck O’Leary Dykema

By Patrick J. Arnold Jr. McAndrews Held & Malloy

By Alberto R. Gonzales Waller Lansden Dortch & Davis

The authors present a hypothetical in which a corporation has been served with a federal grand jury subpoena seeking documents and emails relating to the possible submission of false claims to the Government. As Arthur Andersen L.L.P. discovered, a conviction can be a corporate death sentence. However, since Andersen’s demise, the DOJ’s attitude toward criminal prosecutions of business organizations has changed. The Department is often willing to forego pursuing a conviction, provided certain conditions are met. To avoid indictment, the company must persuade DOJ: (1) that it is innocent, or (2) that even if it is not innocent, a criminal prosecution would be unwise because of the consequences for innocent employees and shareholders, or because of other special circumstances, or (3) that it should be permitted to resolve the matter with a Non-Prosecution Agreement (NPA) or Deferred Prosecution Agreement (DPA) with the Department. This pre-indictment exercise is like an informal trial in which the company bears the burden of persuasion, has no rights and DOJ attorneys serve as judge and jury. The company must cooperate with the government’s investigation, conduct its own investigation quickly, assess the facts realistically and maintain its credibility throughout the process. If wrongdoing occurred, the company must implement measures to prevent a recurrence. The authors provide a summary of how to proceed. They advise quick action to determine whether a violation has occurred, and if it has, that the company conform to as many factors that disincline toward prosecution as possible.

Trials have become so expensive that few clients choose to go through them. A modified version of so-called “summary jury trials” could provide an affordable solution to that problem, according to the author. In a summary jury trial, both parties participate in an abbreviated, mock trial before an advisory jury. The process is non-binding, and it is intended to be a flexible. The author proposes holding summary jury trials – with some binding effect – after initial discovery has been completed, but before the close of discovery. The advisory jury might hear only lawyers’ arguments, or they might hear some testimony from witnesses. If used as the author proposes, and at an early stage of a case, the summary jury trial would allow the parties to observe the perception of jurors on the main merits of their case. It also would be an efficient form of discovery, regardless of whether the case settles. Each side would see the other’s key documents and witnesses. This would help boil down the key evidence. Counsel for both sides would be in a better position to streamline any further discovery and prepare for trial. And, if the parties failed to reach settlement, they’d still have enough money left to try the case on the merits. The author analyzes an expedited trial program offered by a California court and says it compares unfavorably to a summary jury trial, if the case in question is complex.

Use of the Foreign Corrupt Practices Act to level the playing field among domestic companies doing business abroad has led to complaints that the statute places U.S. companies at a disadvantage with respect to their foreign competitors. The FCPA gives prosecutors tremendous discretion in defining its scope, and thus tremendous leverage in charging decisions. Corporations are averse to being investigated, especially for FCPA violations , and as a result these cases often settle. But, according to the author, a former U.S. Attorney General, the more that American companies elect to settle and not force the DOJ to defend its aggressive interpretation of the Act, the more aggressive the DOJ has become in its prosecution decisions. Prosecutions of individuals under the FCPA have been less successful than those targeting companies, but speculation that the DOJ will scale back its FCPA efforts based on such problems is unfounded, the author says. He notes that lessons learned in those cases become part of the Fraud Section’s institutional memory, and that cases such as the one pending against Wal-Mart for its activities in Mexico make the public keenly aware of the problems caused by corruption. The author suggests targeted reforms that add a compliance defense and a willfulness requirement for corporate criminal liability. He questions the fairness of going after a company for unknown violations by a foreign agent if it has complied with a list of conditions known as DOJ Principles of Prosecution.

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Aug/ Sept 2012 E X ECUTIVE COUNSEL

E-Discovery

Shifting E-Discovery Costs to the Losing Party By Anthony Diana and Dan Regard

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ Sept 2012

E-Discovery

s inside counsel are often painfully aware, the escalating costs of electronic discovery has to be a major factor in formulating a litigation strategy. Unfortunately, they must contend with the fact that state and federal courts are far from uniform in the way they assess and allocate the costs of electronic discovery after a party prevails. There was a recent trend to allow for more cost shifting to the losing party, but two recent court decisions appear to reverse that trend. In U.S. Bank National Association v. GreenPoint Mortgage Funding, Inc. in the New York State Supreme Court, Appellate Division, and in Race Tires America, Inc. v. Hoosier Racing Tire Corp (or “Race Tires III”) in the Third Circuit Court of Appeals, the courts limited the scope of what costs may be “taxed” to a defeated litigant, while providing some guidance on the method of allocating electronic discovery costs between parties. “making copies”

Federal law provides an important tool to control litigation costs through the “taxation of costs” available under the Federal Rules of Civil Procedure (FRCP). The rules governing taxation of costs permit federal courts to award certain expenses to the prevailing party. FRCP 54(d) provides that unless “a federal statute, these rules, or a court order provides otherwise, costs – other than attorney’s fees – should be allowed to the prevailing party.” This broad pronouncement is tailored by 28 U.S.C. §1920, which permits courts to allow only costs authorized under the statute. Of particular relevance to parties seeking to recover electronic discovery costs, §1920(4) authorizes recovery of fees “for exemplification and the costs of making copies of any materials where the copies are necessarily obtained for use in the case.” Lending additional credence to the applicability of cost taxation to electronic discovery costs, the Judicial Administrations and Technical Amendments Act of 2004 changed the language of §1920(4) to allow for recovery of “copies of any materials,” rather than

the previous phrase, “copies of paper.” Parties and courts seeking to apply cost taxation in today’s electronic discovery context may point to this amendment as evidence of intent to modernize the scope of recoverable costs. Prior to the Third Circuit’s decision in Race Tires III, district courts were gradually expanding the application of §1920(4) to include certain expenses associated with the collection, processing and production of ESI. Various district courts have permitted the taxation of electronic discovery costs, including electronic scanning and imaging of documents, and Bates numbering of documents. At least two district courts have taxed all electronic discovery

of VHS tapes to DVD fell under the definition of “making copies” and therefore were taxable to the losing party. Moreover, the court noted that not all tasks necessary for producing documents constitute “making copies,” and it rejected the notion that encouraging cost savings or other equitable concerns were valid factors in determining taxability under the statute. aLLocaTion in neW YoRk

Rules regarding allocation of e-discovery costs are even more varied in state courts. In New York state, the unique and often conflicting set of rules that have developed are viewed as potentially the most generous.

The potential shifting of significant costs to unsuccessful litigants has now been limited, at least in the Third Circuit. costs associated with creating litigation databases, in amounts of approximately $240,000 and $4.6 million. The potential shifting of significant costs to unsuccessful litigants now has been limited, at least in the Third Circuit, by Race Tires III, where the appeals court vacated a $365,000 award to the victorious defendants for a broad range of electronic discovery costs. Instead, the court awarded only $30,000 for transferring, scanning, and converting tasks that qualified as “making copies,” pursuant to the court’s analysis. The issue on appeal in Race Tires III was, in fact, whether costs charged by electronic discovery vendors for collecting, processing, and producing electronically stored information were indeed taxable against a losing party. The appeals court decision in Race Tires III rests heavily on interpretation of the intent of Congress in 28 U.S.C. §1920. The appeals court noted that “Section 1920 ... defines the full extent of a federal court’s power to shift litigation costs absent express statutory authority.” The court held that only the scanning of paper documents, the conversion of native files to TIFF images, and the transfer

Even when courts have asserted that the standard for cost allocation is “well-established” in New York, the prevailing “requester-pays” presumption has been frequently criticized as inefficient and problematic because it was not clear what costs were to be paid by the requesting party, and whether that presumption of paying also meant an allocation of the control of the discovery process to the requesting party. For example, under the presumption that requesting parties pay for ESI discovery costs, requesting parties may gain an advantage in dictating the scope and method of production because producing parties’ ability to argue that discovery requests pose an undue burden may be diminished. Contrary to the cost-control rationale underlying the requester-pays presumption, this may actually increase the producing parties’ costs in responding to discovery demands because only certain types of ESI discovery costs may be paid for by the requesting party, and other more significant costs, such as attorney review time, may still be the responsibility of the producing party. continued on page 23

Aug/ Sept 2012 E X ECUTIVE COUNSEL

E-Discovery

The 10,000 Document Rule

The Unspoken Beginning of E-Discovery Understanding By John Thacher

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ Sept 2012

E-Discovery

uch attention has been devoted to the subject of e-discovery technology and its impact on document review. What is not being discussed, however, is the level of human review that is necessary to successfully evaluate a document set, regardless of technology culling capabilities. Thus: “The 10,000 Document Rule.” Based on ten years experience, managing over 100 document reviews and involving well over fifty million documents, The 10,000 Document Rule asserts that a review team does not have a reasonable understanding of a review project until after it has analyzed approximately ten thousand documents. Why is this rule important? Because it tells us that it’s critical for law firms, their clients, and professional review teams to appreciate the minimum learning curve necessary to assess and develop appropriate workflow processes. The 10,000 Document Rule applies equally to inhouse, law firm, and managed review teams. There are simply no shortcuts. HOW IT WORKS

An experienced review team will

develop a methodology whereby the review team does the “grunt work” and the firm and client are presented with exemplars of unique document groups incorporating the knowledge gleaned from the initial 10,000 document review. On the first day of a document review project, no one including the client and the firm understands much about the document set. Typically the litigation team will have general ideas about creating a production set, identifying the hot documents, drawing the line for protecting privilege, and organizing the documents for later use. However, the very nature of the review process means that the facts of any case are learned one document at a time. Inevitably this means that reviews, workflow processes, and assumptions are developed before the initial investigation has begun. Generally speaking, after reviewing approximately 5,000 documents, a reviewer begins to understand the complexity of the issues. After 10,000 documents, across a sampling of custodians, the reviewer can conclude with a high degree of precision how the legal team will want to treat the document set and defend the rationale behind a classification scheme. A sophisticated and experienced review team with a well-defined workflow process can efficiently address the challenges of the learning curve. Reviewing 10,000 documents takes time and some willingness to suffer. At 100 documents per hour, approximately 100 reviewhours are required to develop an “educated” understanding of the document set and how the case strategy, as defined by the firm and the client, should be applied to the classification scheme. Rarely is this early learning curve issue discussed or built into the review timeline, a fact that should raise a red-flag regarding many of the workflows currently in play in the marketplace. INCREASING VOLUMES, DECREASING MANPOWER

In the current economy everyone is being asked to do more with less. For example, our firm now employs

teams of 15 to do the review work we used to do with 100 people, and it’s probable that in the near future we will do the same work with only five people. To be successful, these review teams will need to be highly specialized experts in the review process and capable of using a wide array of technologies. Replacing large teams of reviewers with more advanced technology and processes is inevitable. Anyone who has spent significant time trying to coax consistency out of a group of 100 attorneys will not shed many tears at the demise of large team reviews. While review teams are being reduced, document volumes continue to grow as an apparent corollary of Moore’s Law (which projects computer processing power to double every two years). Every time someone in corporate America hits “reply all,” a document population grows exponentially. Technology is critical to help manage the increasing volumes of ESI, and the more sophisticated the technology, the more training and expertise becomes necessary. CLASSIFICATION AND UNDERSTANDING

Generally, there are two primary reasons to review documents. The first is classification – the organization of documents into useful categories such as “Responsive,” “Not Responsive” and “Privileged.” The second is understanding – understanding the process whereby the legal team absorbs the facts in order to counsel the client on proper legal strategy. Understanding is necessary both before and after proper classification. Classification without understanding is not particularly helpful in the e-discovery process. When discovery was a much smaller, paper-based process, small case teams could read through every document and slowly assimilate all of the pertinent facts leading up to their trials. Case strategy evolved naturally with the absorption and availability of facts. This evolving case strategy informed and refined the system of classification. Classification and understanding were completely entwined and could be easily driven by a small

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team or single attorney performing both tasks in a single effort. With the exponentially expanding volume of documents associated with today’s matters, the scale of e-discovery has outgrown the simple, traditional approach that previously served both purposes. Case teams are faced with complex and scattered processes where the two primary functions are almost completely separated. Technology, in combination with a well-defined workflow process, and under the guidance of an experienced team, has become a necessary element to conduct an effective document review. TECHNOLOGY, HUMAN REVIEW AND DEFENSIBILITY

Review technologies are constantly being improved and expanded. A great deal of new technology has been introduced to assist with classification. But understanding remains technologically elusive. The effectiveness of these new systems at placing documents within a proper classification is measurable, and the task itself is highly repetitive, making it an excellent candidate for automation. Enough “science” has been developed to understand that human-based classification without multiple layers of quality control (QC) is extremely unreliable. Likewise, it seems a settled point that Boolean-search keyword approaches are inadequate and will not return all the documents that should be subjected to classification. The use of technology to assist or supplant human-based classification holds great promise, but only when linked to understanding. One of the most often overlooked issues in the defensibility of document review systems is that they all depend on some level of early human interaction to set rules, create seed sets, write review protocols, train reviewers/automated systems, and deliver the early QC. Applying The 10,000 Document Rule, it is easy to see that several of those steps often occur before anyone involved in the case has a meaningful understanding of the document collection. This disconnect necessitates mid-course corrections, as early case perceptions are superceded by the

realities of the document population. Understanding is a very different type of problem. How does one measure how much understanding went into the development of a review protocol, or how much understanding the case team was able to glean from the work done by the review team? Understanding does not follow from repetition, although repetition clearly reinforces the act of understanding.

The good news about integrating technology into good human-based processes is that you should realize cost savings on the very first case. Effective application of The 10,000 Document Rule will help reduce and better organize the document population, leading to a more streamlined and manageable document collection. There are plenty of competing technologies and pricing models available to create efficiencies

The 10,000 Document Rule applies equally to in-house, law firm, and managed review teams. There are no shortcuts. Understanding is integral to a good document review process, but it is not yet a technology priority that is focused primarily on reducing time and cost. The lack of emphasis in this area virtually guarantees that a majority of the defensibility issues will come from failures in the realm of understanding. Finally, it is important to remember that without a formal knowledge transfer process to the legal team, all of the accumulated knowledge, understanding and case development will suffer when the review team walks out the door at the end of the review. How can we create more streamlined work flows and higher quality results? While the answer is fairly simple, it is not always realistic in a real world of unknown scope, unrealistic deadlines, uncooperative custodians, collection delays and antagonistic opposing parties. Remember, The 10,000 Document Rule requires a reasonable beginning to the process. The best solution is to start with proven humanbased systems and integrate as much technology as possible. The bigger the project, the heavier the emphasis on the use of technology and the more attention needs to be placed up-front on understanding. Since understanding – the people-heavy part of the process – cannot yet be automated effectively, the selection of people to run the technology and manage the process is even more critical.

and savings right out of the box. Devoting time in the early stages to select the right team and technology will pay dividends as a project progresses. Getting started is a matter of being committed to saving the client money through the development of a defensible, repeatable workflow based on understanding. On your next project consider implementing The 10,000 Document Rule and measuring how this effort helps to improve understanding and workflow processes. Compare the total cost of this approach to the last similarly sized case. Look up and down the chain to see whether the understanding that comes from reviewing 10,000 documents before developing processes is paying dividends. Assess further to determine whether the benefits are being communicated to the teams that need the understanding to manage the case properly. ■

John Thacher, attorney and MBA, is Director of Managed Review services at TechLaw Solutions. He has more than 12 years experience in managed review and e-discovery and is a leading proponent of “Fixed Price Managed Review” for e-discovery teams. jthacher@techlawsolutions.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ Sept 2012

E-Discovery

Shifting E-Discovery Costs to the Losing Party continued from page 19 Furthermore, requesting parties may argue for expanded involvement in the ESI collection and production process because they are funding the process. The recent decision by the Appellate Division for the First Department in Greenpoint Mortgage

Zubulake for use in deciding whether to shift discovery costs. The court determined the seven-factor test was appropriate in applying the broad discretion afforded courts to shift discovery costs under New York Civil Practice Law and Rules Article 31.

The Third Circuit Court of Appeals court noted that not all tasks necessary for producing documents constitute “making copies.” should help resolve some of these issues, but ultimately may limit the ability to shift costs to the requesting party. At the outset of discovery at the trial level in this case, GreenPoint moved for a protective order requesting that “each party ... pay for its own discovery requests ... and that U.S. Bank ... pay for GreenPoint’s pre-production attorney review time for the purposes of privilege and confidentiality assertions.” Asserting that the requester-pays principle is “well established” in New York, the trial court granted GreenPoint’s request that U.S. Bank bear costs incurred in production, but rejected the request that U.S. Bank also bear the costs associated with attorney review time. On appeal, the Appellate Division vacated the trial court’s determination that the requesting party bears the costs of producing the documents it requests. The court instead embraced Judge Schiendlin’s decision in Zubulake v. UBS Warburg LLC, which requires that the producing party bear “the initial cost of searching for, retrieving and producing discovery, but permits the shifting of costs between the parties” if the motion court determines that the discovery request is unduly burdensome or expensive. In adopting this approach, the Appellate Division also embraced a seven-factor guideline outlined in

The Appellate Division’s decision in GreenPoint clarifies previously unsettled New York law regarding which party must initially bear the costs of production. By adopting the approach set forth by Judge Schiendlin in Zubulake, the First Department aligns with the benchmark in electronic discovery practice in federal courts. “NON-COPYING” COSTS REMAIN UNRESOLVED

While Race Tires III and Greenpoint Mortgage will significantly clarify the law in their respective jurisdictions, the rules governing the allocation and taxation of discovery costs remain subject to varied and unpredictable judicial interpretation in the rest of the country. Thus, in order to control costs, negotiate discovery issues aggressively and, potentially, recover certain electronic discovery costs upon prevailing in litigation, it remains essential for parties to plan and assess electronic discovery strategy upfront. Reference to the Sedona Conference Cooperation Proclamation, already endorsed by over 100 State and Federal judges, may help at that point, in that it could clarify if not reduce the scope and burden of overly broad electronic discovery. Another way to address potential taxation claims (as well as other proportionality or cost-shifting mechanisms) is by way of thoughtful categorization and

documentation of legal versus non-legal activities when preparing case invoices. Particular attention to the categories enumerated by the courts, especially in the Third Circuit, may make recovery easier once the case is decided. In the end litigants will need to keep in mind that the courts have not addressed the extent to which costs for non-copying preparatory work is recoverable. That would include costs for early case assessment, or sampling for the advanced development of keywords or the application of predictive coding – costs which are intended to circumscribe the scope of discovery and reduce the overall cost of copying. Without this direction, litigants anticipating victory will need to consider that money they invest upfront for these processes may or may not be recoverable. ■

Anthony Diana is a partner at Mayer Brown, in the New York office. He is co-leader of the firm’s Electronic Discovery and Records Management group, counseling large financial institutions, pharmaceutical companies and manufacturers on the discovery and management of electronic information. adiana@mayerbrown.com

Daniel L. Regard is a nationally recognized electronic evidence and case management expert with 20 years experience in consulting to legal and corporate entities. He is the founder and a managing director of iDiscovery Solutions, Inc. dregard@idiscoverysolutions.com

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

E-Discovery

Information Governance Creates Opportunities for U.S. Lawyers in Asia By Allison Walton

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

E-Discovery

s the amount of data and content sources grows due to the globalization of business, lawyers proficient in e-discovery processes, information governance solutions and their enabling technologies can look to the Asia Pacific region for business opportunities. Asia is still relatively new to this field because its countriesâ€™ various legal systems do not provide for pre-trial discovery in the same way the United States does. But considering how the economies of the Asia Pacific Region are growing and the likelihood of increasing commerce with the United States, it is reasonable to assume that many organizations based in Asia could face the same stringent information management and e-discovery requirements as U.S. organizations. The litigation, privacy and regulatory climates are different

for each country in Asia, but data management and information governance are becoming increasingly common. This article will focus on winning Asian clients by articulating and emphasizing the importance of information governance and litigation readiness. INFORMATION GOVERNANCE BEFORE E-DISCOVERY

Logic and historical data suggest that as businesses become less tied to geographic locales they will generate more data. The movement of data collection away from a solely custodial-based search, toward source and contentbased search (regardless of whether the purpose is compliance or litigation) is one byproduct of globalized business. This movement is accelerated by the desire to replace on-premises IT infrastructure with cloud-based services and to decrease capital expenditures. In Asia, the concept of information governance is taking hold but is still in its beginning stages. Unlike e-discovery, information governance is not driven solely by litigation. It is the umbrella that addresses all aspects of data: security, storage, de-duplication, classification, search, collection, processing and review. Responsibility belongs to the key stakeholders in various kinds of information within an organization. However, many U.S. organizations that are addressing their information management processes are doing so because e-discovery can be expensive and painful. In order to retrieve data pertinent to a matter they are often forced to use outside service providers. Many have responded to hefty price tags and spoliation risks associated with multiple matters by bringing e-discovery in-house. These in-house capa-

bilities are not commonly deployed in Asia, but they can be as part of a larger information governance platform.

Asian companies do not have the legacy technologies that exist within U.S. organizations, and therefore they have the opportunity to execute a broad information governance plan from the start. Whether Asia will repeat or leapfrog U.S. experience in this area largely depends on how American lawyers advise Asian clients. Purchasing decisions that streamline information management, and reduce risk and cost, are advisable from the perspective of both parties. Inhouse archiving and search capabilities makes the practice of law more efficient for lawyers while reducing risk and cost for their clients. Asian companies do not have the legacy technologies of U.S. organizations, and therefore they have the opportunity to execute a broad information governance plan from the start, one that does not hinge exclusively on litigation. That point is crucial, because technology today allows many outdated discovery and search practices to be bypassed. Asian organizations doing business here may be required to comply with our pre-trial discovery requirements; thus they can leverage these technologies to accomplish their local compliance and regulatory objectives. This shift

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will eventually be necessary from a storage and record-keeping perspective regardless of U.S. litigation. In Taiwan, for example, banks have been required to comply with the Personal Data Protection Act. Since 2010, this law not only applies to banks, but to all organizations in Taiwan.

and records relevant to DuPont’s trade secret claims. The court found the destruction of relevant data to be the fault of the company’s attorneys, reasoning that they could have prevented the spoliation through an effective litigation hold process. The three hold notices that

The U.S. court ruled against a South Korean manufacturer for failing to issue a timely and proper litigation hold.

To enable customers to comply, technology companies have presented organizations with the U.S. “EDRM” (Electronic Discovery Reference Model), in order to communicate the concept of a workflow. Thus, in this example, while using the EDRM model for litigation as a communication tool to enable compliance, organizations also benefit on multiple fronts by instituting archive and search capabilities. Some notable benefits include not only reporting functionality to ensure compliance but storage reduction through single instance storage, defined retention periods, and long-term savings. HUGE JUDGEMENT AGAINST KOREAN COMPANY

The fact that compliance is a main business driver for archiving data in Asia, and that the archiving and search technology that accomplishes compliance can also facilitate litigation readiness, is evidenced by recent U.S. cases like E.I. du Pont de Nemours v. Kolon Industries in the Eastern District of Virginia. This case highlights the breakdown that can occur across borders when there is a lack of knowledge about a client’s information system, and no effective workflow developed for U.S. litigation by an Asian company and their lawyers. In the DuPont case the court ruled against a South Korean manufacturer for failing to issue a timely and proper litigation hold, which resulted in the spoliation of key evidence. The spoliation occurred when Kolon executives and employees deleted emails

were circulated to the key custodians and data sources were all problematic at some level. They were either too limited in their distribution, ineffective since they were prepared in English for Korean-speaking employees, or too late to ensure that the destruction did not occur. The jury returned a $919 million verdict for DuPont. This case exemplifies the importance of issuing a timely and comprehensive written litigation hold notice. Organizations should identify the key players and data sources that may have relevant information and have systems in place to make sure spoliation does not occur. This cannot be accomplished without a data map and the ability to notify and track the custodians and/or sources of data that need to be preserved. Additionally, preservation typically cannot be effectively implemented without an archive. WINNING ASIAN BUSINESS

Here are some tips about how to get clients in Asia: • Meet with the global practice groups and target key Asia Pacific region clients that are heavily regulated (such as banks and pharmaceutical companies), do business in the United States and have large amounts of data. • If there is no resident e-discovery expert within the firm, team up with another law firm, a consulting organization and/or a technology vendor. • Familiarize yourself with the infor-

mation governance technology that is available today through product demos and by fostering relationships to stay abreast of innovation. Information governance requires a suite of connected products, not one product. There are work flows associated with each product and buying decisions usually require a committee of key stakeholders. • Locate local counsel that can be the face of the firm in the countries you are targeting for business. Get references and use them as a vehicle to meet more people in the country or region. • Set some meetings and take a trip to become familiar with local culture and legal/regulatory history. • Devise pricing models that are more innovative than hourly billing, and get smart about adapting your practice to be profitable while meeting the needs of Asian markets. There is now an opportunity for U.S. lawyers to assist Asian clients with respect to information governance issues, and thereby to deepen existing or potential client relationships. Many American law firms already have a good foundation to launch a practice in this area. The lawyer that knows how an organization is managing data has an important advantage. Information governance counseling by lawyers fosters trust, establishes expertise, and is key to repeat business. It leaves the client feeling it has been party to an exchange with measurable results. ■

Allison Walton is an e-discovery Attorney at Symantec Corporation. Prior to joining Symantec, she worked for Liquid Litigation Management, an online review platform, and served as a business development manager for CaseSight Inc., a visual case presentation firm. She is active in the Seventh Circuit Electronic Discovery Pilot Program. allison_walton@symantec.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ Sept 2012

E-Discovery

Bringing E-Discovery Processing Back In-house By Brian Ingram

ccording to the 2011 Chief Legal Officer Survey by management consulting firm Altman Weil, chief legal officers said that cost control is their number one priority. According to the survey, 56 percent of CLOs had increased their law department budgets from the previous year. One of the most costly areas for companies and organizations has long been their litigation budgets, and more recently the explosion of data volumes has made data management and e-discovery a primary focus for cost-savings. Another study, a 2012 Rand Corporation survey titled “Where the Money Goes,” finds that expenditures for outside counsel consumed about 70 percent of total e-discovery production costs. With the amount of ESI itself growing exponentially and driving up those e-discovery costs, organizations are now starting to bring more of their e-discovery processing tasks in-house. This is being done as a way to regain control over e-discovery, mitigate the inherent risks associated with outsourcing data processing and as a cost-savings measure. Most industry standards indicate that document review, specifically, is the costliest step in the pre-trial discovery process. If organizations can control the amount of data that needs to be reviewed during the initial stages of e-discovery, such as the ESI processing stage, they will be better positioned to realize substantial cost savings. How do you know if bringing ediscovery in-house is the right move for your company or organization? Favorably priced data analysis and processing solutions now on the market can help organizations assess their data and make the determination. Not all organizations should opt for

an in-house solution. It’s important to determine if this approach will actually result in cost savings and make overall business sense. Determine the approximate number, size and types of cases your organization

is involved with annually. If the number – or size – of cases is substantial, it makes sense to at least explore the in-house ESI processing option. Even what seems like a relatively small matter can sometimes require sifting through

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hundreds of gigabytes of data. According to “Bring E-discovery In-house,” by Deb Logan of Gartner Research, most companies with as few as ten cases a year, or one or two big cases a year with multiple custodians, should give serious thought to bringing the process in-house. The explosion of data often makes the decision to bring processing inhouse seem like a no-brainer, even

custodians and their document management practices than anyone; deciding what gets processed for review is best handled by the organization itself, rather than outside counsel. When you’re processing your own data, outside counsel will be less likely to revert to “casting a wide net” when requesting data, so you reduce the risk of over-collecting and processing non-responsive data.

aging expectations regarding the time it will take will alleviate some of the stress. Most potential problems can be headed off before they arise by understanding the software’s capabilities and delegating management of the systems to appropriate personnel. Make sure the technology fits into the organization’s IT infrastructure and works smoothly with other existing systems, and that there is buy-in from

If the decision is to go in-house, don’t wait for a major litigation to initiate the purchases or activate installations.

if only a few cases are litigated each year. Indeed, any significant reduction in the amount of document review hours by outside counsel will more than pay for investing in an in-house ESI processing capability. But regardless of the ultimate decision, the organization will benefit from the review and analysis exercise, which should involve personnel from several departments other than legal (notably IT and Records). If you decide to go in-house, don’t wait for a major litigation to initiate the purchases or activate installations. The time to buy is once the decision is made. Set up protocols and procedures before a massive litigation. The processing software and accompanying technology are usually secondary issues compared to the people, the processes and the adoption of a new business culture. What kind of return on investment can you expect? The first and most sought after benefit is cost savings. Because document review continues to be the most expensive part of discovery, by controlling your own data and determining what must be processed and reviewed by the attorneys, you will be able to reduce billable hours immediately. Simply put, the fewer unnecessary documents and custodians reviewed, the lower your costs. It’s your data, and you’re more familiar with the

Other significant investment returns include the enhanced ability to mount a cogent defense of the procedures used, and a consequent reduction of exposure to e-discoveryrelated risk and possible sanctions. When a third party controls the process, it’s much more difficult to enforce your e-discovery policies. By “owning” the process, so it becomes consistent, repeatable and transparent, you control the risk. Like any technology initiative, implementation of an in-house ESI processing capability comes with challenges. It’s not just a matter of installing some software and pushing a button. Skilled personnel are needed. Even so, there are many opportunities for making mistakes along the way. Understanding that e-discovery is a constantly evolving process, as opposed to simply a piece of software, is a key to successful implementation. Proper training and guidance from the software manufacturer are needed to ensure proper integration with existing workflow, and that best practices are documented and followed. Partner with your chosen software provider and make sure you can be confident they will be there for assistance in the future. Be aware that the sheer volume of data involved in litigation can make internal processing burdensome. Laying the groundwork and realistically man-

the entire organization. Involving personnel from IT and Records will help maintain the integrity and capability of the system. The question of whether or not to bring ESI processing in-house is being considered by organizations in several industries. Creating your own processing capability with the appropriate tools and personnel will definitely enable you to take better control of your e-discovery challenges and costs. The prospect for enormous cost savings can’t be ignored, but whether this is the right approach for your organization can only be answered after thorough review, analysis and discussion. ■

Brian Ingram is head of the Litigation Technology Consulting division at LexisNexis. During more than 20 years in the profession, he has worked in e-discovery at CSX corporation and has managed litigation support departments at a number of law firms, including King & Spalding, Alston & Bird, and Paul Hastings & Troutman Sanders. He is a frequent speaker at industry trade shows and conferences. brian.ingram@lexisnexis.com

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ sept 2012

Intellectual Property

Online Copyright Protections after Viacom v. YouTube By William D. Schultz under the new definition, it had the right and ability to control the infringing acts. The Viacom decision prompted the Ninth Circuit to re-examine its December, 2011, decision in UMG vs. Veoh. In that case, the Court upheld the district court’s grant of summary judgment because the defendants were protected under the DMCA safe harbor provisions. However, in June of 2012 the Ninth Circuit requested that the parties submit supplemental briefs related to the Second Circuit’s interpretation of the safe harbor provision. Briefs were submitted. No decision had yet been issued as of this writing. This article outlines the basic parameters of the DMCA, its safe harbor provisions, the courts’ analyses of those provisions, and the impact of the courts’ decisions on copyright holders and service providers. SAFE HARBOR BASED ON USER CONTENT

opyright holders and online service providers take note. A recent Second Circuit decision and pending re-hearing in the Ninth Circuit will impact any business that owns a copyright or that allows others to post content on its websites. In Viacom v. YouTube, the Second Circuit confirmed that a service provider may avoid copyright infringement under the safe harbor provision of the Digital Millennium Copyright Act (DMCA) unless the provider is provided notice of or has actual knowledge or awareness of specific instances of infringement and does not act expeditiously to remove or

disable the content. The ruling clarified that general awareness of infringing acts is insufficient to be disqualified from safe harbor protection. For the safe harbor to apply, however, a service provider must show that it lacked the right and ability to control the infringing acts. The Viacom court held that right and ability to control “requires something more than the ability to remove or block access to materials posted on a service provider’s website.” The Second Circuit remanded the case to determine whether YouTube had knowledge or awareness of any specific instances of infringement and whether,

The DMCA was designed to provide protection to copyright owners in a digital world. Effective October 28, 1998, it clarified and extended copyright protection to the Internet. It also provided for a limitation of liability (safe harbor) against online service providers when users post infringing content on their websites. In order to qualify for protection based on user-generated content, service providers must designate an agent to receive notification of claimed infringement and provide the agent’s contact information on the website and to the Copyright Office. After receiving a copyright holder’s notification, the service provider must respond expeditiously to remove the content or risk losing the safe harbor protection. In situations where the copyright holder does not provide notification, the service provider may receive the benefits

Aug/ Sept 2012 E X ECUTIV E COUNSEL

Intellectual Property

of the safe harbor provision so long as the service provider does not have actual knowledge that its system contains infringing materials, nor an awareness of facts or circumstances (“red flags”) from which infringement is apparent. If the service provider has actual knowledge or an awareness of facts or circumstances from which infringement is apparent, it must expeditiously remove or disable access to infringing material. Additionally, a service provider may not take advantage of the safe harbor benefits if it receives a financial benefit directly attributable to the infringing activity where the service provider has the right and ability to control the activity. The interpretations of “red flag” awareness and “right and ability to control” are the central issues in the cases before the Second and Ninth Circuits. In Viacom v. YouTube, Viacom sued YouTube for copyright infringement for thousands of instances of copyright infringement based on copyrighted videos users placed on YouTube’s online service. The district court dismissed the claims, holding YouTube was insulated from infringement based on the safe harbor provision of the DMCA. In April 2012, the Second Circuit affirmed the district court’s statutory interpretation that general awareness of infringement was insufficient to lose the safe harbor benefits. Rather, a defendant will only lose the safe harbor protection if it actually knew of the infringing acts or was aware of the facts and circumstances that indicate specific and identifiable instances of infringement. While the court affirmed the statutory interpretation, it reversed the district court’s grant of summary judgment because it found “a reasonable juror could conclude that YouTube had actual knowledge of specific infringing activity, or was at least aware of facts or circumstances from which specific infringing activity was apparent.” In June 2012, the Ninth Circuit requested the parties in UGM v. Veoh to submit briefs related to the knowledge and awareness requirements, based on the Second Circuit decision. That court

had previously ruled that disqualification of the safe harbor protection occurs when the service provider has specific knowledge of particular infringing activity. As it stands, both the Second and Ninth Circuits require actual knowledge or awareness of specific infringing activity. If these decisions stand, services providers who have only a general awareness of infringing content on their site will not lose safe harbor protection. For copyright holders, the holdings support sending actual notice to the service providers rather than relying on whether the service providers have actual knowledge or an awareness of specific instances of infringement. RIGHT AND ABILITY TO CONTROL

A service provider is disqualified from the safe harbor if it receives financial benefit and has the right and ability to control the activity. Circuits, however, are split on the interpretation of the provision.

trolled the infringing activity based on its statutory interpretation. The Ninth Circuit has requested that the parties in the Veoh case submit briefing to discuss the statutory definition of “right and ability to control.” If the Ninth Circuit upholds its prior decision, there will be a split of authority over whether a service provider must be aware of specific infringing material to have the right and ability to control. Further, the “something more” has yet to be interpreted. Based on the circuit split and ambiguity, copyright holders and service providers should monitor the status of the Viacom and Veoh cases. SUGGESTIONS FOR SERVICE PROVIDERS

• Follow the requirements for setting up DMCA notices. The DMCA provides specific guidelines, including designating an agent to receive notifications of

If these decisions stand, services providers who have only a general awareness of infringing content on their site will not lose safe harbor protection.

The Ninth Circuit held the “right and ability to control” provision “requires control over specific infringing activity that the provider knows about.” The Second Circuit rejected that interpretation because it was merely duplicative of the knowledge provisions. The Second Circuit also found that the mere ability to block an infringer’s access was insufficient to disqualify a service provider from benefitting from the safe harbor. Instead, the Court ruled that it “requires something more than the ability to remove or block access to materials posted on a service provider’s website.” The Second Circuit remanded the case to the district court to determine if YouTube benefited from and con-

claimed infringement, providing the Copyright Office proper contact information, and posting the proper information on the website in question. Service providers that have more than one website should follow the procedures for each website. • Refrain from modifying content. The DMCA safe harbor provision is designed to remove liability from service providers who allow for user-generated content, not content generated by the service provider. Service providers that modify the user content may lose protection. The Viacom court cited a single case where the right and ability to control was found. In that case,

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ sept 2012

Intellectual Property

control was found where the service provider issued detailed instructions regarding layout, appearance, and content. The service provider prohibited certain types of content and refused access to those who did not abide by the instructions. Service providers should limit influence over the specific types of content posted. • Act quickly. The DMCA requires that service providers remove or disable infringing content expeditiously when the safe harbor provisions are triggered. • Avoid “conscious avoidance.” The Second Circuit instructed that willful blindness, or conscious avoidance, may be applied in appropriate circumstances to demonstrate knowledge or awareness of specific instances of infringement under the DMCA. Service providers who take deliberate efforts to avoid knowledge of specific instances of infringement may lose safe harbor protection.

SUGGESTIONS FOR COPYRIGHT HOLDERS

When claiming an infringement, provide written notice that complies with the DMCA. To avoid any doubt on what constitutes actual knowledge or awareness, owners should provide notice pursuant to the DMCA’s notification provision. Review the policies on the service provider’s site to confirm proper notification. • Identify the specific location of infringing content. Copyright owners who are aware of their content on a particular site should inform the site owner of the particular URL or online location where the material is located. General notifications may not be sufficient, depending on the circumstances. At a minimum, provide the URL of search results that can be replicated by the service provider. • Monitor and enforce copyrighted works. Copyright holders should monitor their works through

online searches. If a DMCA notice is posted on the site, copyright holders may provide notice, which prompts the website owner to remove or disable the content or face liability. • Secure copyright registrations. Providing notification of your copyrighted work can be simplified by securing a registration of the work and providing the registration information to the service provider. ■

William D. Schultz is a partner with Merchant & Gould. He is an intellectual property attorney specializing in online and software trademark, copyright, and patent litigation matters. wschultz@merchantgould.com

aug/ sept 2012 E X ECUTIV E COUNSEL

Governance

Valuation Key to Managing IP By Robert F. Reilly

ost companies make serious efforts to manage their working capital assets, as well as their tangible assets, like land, buildings and equipment. However, many companies assign less importance to the management of their intangible assets, despite the fact that in many industries intangible assets, including intellectual property, account for a large percentage of the typical companyâ€™s total value. This article summarizes some ways that a company can more effectively control and exploit IP. Legal counsel are in a unique position to recommend and implement these procedures. In particular, this article explains how

a certified public accountant who is accredited in business valuation (CPA/ ABV) can work with legal counsel to inventory, control, appraise and maximize the value of intellectual property. vALUATION APPROACHES

CPA/ABVs are CPAs who have pursued specialized training, testing, and credentialing in the valuation of businesses and intangible assets, including intellectual property. They apply generally accepted approaches, methods and procedures to conclude the value, intercompany transfer price, license royalty rate or economic damages related to IP. In addition to valuations performed

for financial accounting purposes, CPA/ ABVs perform IP valuation analyses for transaction, financing, litigation, taxation and corporate planning, among other purposes. They routinely work with general counsel, and they often work with IT, marketing and corporate development executives to maximize the value of IP. To value a particular property, the CPA/ABV may apply income approach methods, such as the capitalized excess earnings method; market approach methods, such as the relief from royalty method; or cost approach methods, such as the replacement cost new less depreciation method. For other IP analyses (e.g., intercompany transfer price, license royalty rate, or lost profits/economic damages), the CPA/ABV will apply correspondingly specialized approaches and methods. In addition to the quantitative analyses, the CPA/ABV will perform due

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Governance

diligence procedures and apply qualitative analyses. For example, this may include inventorying, documenting, and organizing all of the company’s IP, or doing a competitive strategic analysis that assesses the strengths, weaknesses and opportunities of the company’s IP as compared to industry competitors. These due diligence procedures provide both quantitative and qualitative assessments that can be used in the management and exploitation of IP. To manage any type of asset, tangible or intangible, a company first has to identify, measure and control that asset. Through the IP inventory, valuation, and centralization procedures, the CPA/ ABV can help company management understand and increase IP value. benefits

The following summarizes some economic benefits from IP inventory and valuation: Corporate Governance and Internal Control Benefits • At many companies, IP management is decentralized to the operating business unit level. An IP valuation can identify, inventory and centralize control of IP. Centralization allows management to effectively perform its internal control duties. While currently there are no requirements for CEOs or CFOs to vouch for IP valuations, the Sarbanes-Oxley Act as well as federal and state securities laws require that management be responsible for the internal control of all company assets. • An IP valuation may inform management regarding a need for IP insurance, including IP-related business interruption insurance and property insurance. • An IP valuation may prepare the company for the expected nearterm implementation of fair value accounting principles. After the convergence of GAAP (Generally Accepted Accounting Principles) and the IFRS (International Financial Reporting Standards), and the associated adoption of fair value

accounting principles, a reporting entity may elect to report the fair value of its intangible assets, including IP. Those entities that choose to do so will be better prepared by virtue of an IP valuation. Transactions and Financings Benefits • An IP valuation allows management to identify and pursue commercialization opportunities. These may include debt and equity financing, inbound and outbound IP licenses, and income tax reduction strategies. The company can use its IP value as the collateral for asset-based debt financing or to support its proposed stock valuation in the negotiation of an equity private placement. • An IP valuation may allow the company to generate incremental income from an outbound IP license to non-competitive licensees. Legal Protection Benefits • Data from the IP inventory allows corporate counsel to better protect all of the IP, including properties that are inactive or for defensive use. • The IP valuation can be used by corporate counsel to prosecute a third party IP infringement. It should provide relevant information that may be used to claim a reasonable royalty rate, lost profits or other economic damages from the infringing party. • The valuation may also be used by corporate counsel to defend against third party infringement allegations. The analysis should document the IP development and ownership, legal registrations and type of use. IP valuations indicate reasonable royalty rates or other damages measures that the legal counsel use to negotiate a settlement agreement. Taxation Benefits • After the IP inventory and valuation process, companies may create an IP holding company and assign all current and future IP to that company. The holding company structure can allow the company to enter into inter-company IP license agreements with its operating business units.

Depending on the taxing jurisdiction in which the holding company is created, such IP transfers and intercompany licenses may reduce state and federal income tax expense. • An IP valuation can be used by a corporate property owner to identify intangible assets that are excluded from state and local ad valorem property taxation. The company can then ensure that its property tax assessment does not include the value of IP. The IP valuation can also be used to support federal income tax deductions, such as a charitable contribution of inactive IP to a university or other not-for-profit entity. • Inventory and valuation of IP gives companies the benefit of improved internal control and legal protection. It allows them to realize economic benefits from IP-related transactions, financing, licenses, litigation and tax deduction opportunities. For most purposes, however, company management is not the primary audience for IP analysis. To achieve the intended corporate objectives, management may have to convince a banker, auditor, taxing agency, regulatory authority, investor, judicial finder of fact or other third party about the IP value. In such instances, the CPA/ABVs objectivity and credibility are important to achieving the IP-related objectives. ■

Robert Reilly is managing director of Willamette Management Associates, a business valuation consulting, forensic accounting and financial opinion firm. He is a member of the American Institute of Certified Public Accountants, serving on the forensic and valuation services executive committee. He is a Certified Public Accountant, Certified Management Accountant and Chartered Financial Analyst, accredited in business valuation and certified in financial forensics. rfreilly@willamette.com

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

Human Resources

Reducing Corporate Retiree Health Care Costs By Nancy G. Ross and John A. Litwinski

I 34

n 1960, health care spending in the United States was only 4.7 percent of GDP. By 2009, it had increased to 17 percent, for a total of $2.5 trillion – an average of more than $8,000 per person. U.S. spending on health care is expected to continue its increase, and by 2019 to reach $4.5 trillion, or 19.3 percent of GDP. Medical care for retirees is even more expensive than health care for workers and children. According to the U.S. Department of Health and Human Services, in 2004 per person spending on health care for those age 65 and older was $14,797, which was 5.6 times higher than spending per child ($2,650) and 3.3 times higher than spending per working-age person ($4,511). Those numbers have continued to increase in the past few years. The Financial Accounting Standards Board, in FAS 106, requires public companies to disclose their future retiree medical obligations. The cost of post-retirement health benefits must be set forth in a company’s filings with the Securities and Exchange Commission. Depending on the size of the company and the pool of covered workers and retirees, these costs can run well into the millions, and in some cases billions of dollars. Given the dollar amounts involved, there are often significant financial advantages to reducing or eliminating such benefits, and many companies have done that or are in the process of doing it. Today only 45 per cent of employers provide medical benefits to current retirees, and only 22 per cent of employers include retiree medical as one of the benefits offered to new hires. Moreover,

according to a recent survey, approximately 43 per cent of companies currently offering retiree medical benefits are planning to reduce or eliminate them. Companies in a wide range of industries have eliminated retiree medical coverage and upheld those changes in subsequent litigation. These include manufacturing (United Dominion Industries, Inc., now a part of SPX Corporation), insurance (AXA Equitable Life Insurance Company, formerly the Equitable Life Assurance Society of the United States), and consumer products (Pabst Brewing Co.). Equally common is cost savings to the company through a favorable litigation settlement. A highly-publicized case involved Goodyear Tire & Rubber Company. For decades, Goodyear had provided generous health care benefits to tens of thousands of union retirees and their beneficiaries. But faced with significant pressures from competitors with more favorable cost structures, Goodyear announced in 2006 that it would shift a large part of the cost of health care to retirees. Goodyear was then sued in a class action lawsuit. Unlike the other cases referred to above, the Goodyear law-

suit was heard within the federal Sixth Circuit Court of Appeals, which has historically issued pro-retiree decisions in such cases. In spite of this hurdle, Goodyear achieved a settlement which reduced its retiree medical obligations by approximately $200 million. The true value of that settlement for Goodyear may end up being even higher. This is because the risks going forward, such as the risk that actual medical expenses will outpace projections, are now borne by the retirees. They now receive benefits from an independent voluntary employees’ beneficiary association trust (VEBA) that was funded as part of the settlement, rather than by the company. In addition, by shifting these liabilities off its books, the company removed a significant cloud of uncertainty over its business prospects. Other examples include Dana Corporation, which agreed to a settlement which reduced its retiree health care obligations by approximately $300 million, and Navistar, which sharply reduced its retiree health care obligations from $2.6 billion to $1 billion. In 2009, through negotiation, litigation, and the use of a VEBA structure, Ford reduced its retiree

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO aug/ sept 2012

Human Resources medical obligations from $23.7 billion to $13.2 billion. Using a similar approach, Chrysler reduced its retiree medical obligations by more than $7 billion prior to its bankruptcy. Whether a company can change its retiree medical benefits is largely a legal question. Retiree medical benefit plans are generally governed by a federal law called the Employee Retirement Income Security Act (ERISA). Retiree medical benefits are generally “unfunded,” meaning that companies have not set aside money to pay future benefits. And retiree medical benefits differ from traditional pension or 401(k) benefits in that generally they are not legally vested, meaning that they can often be reduced or terminated. The key legal issue is whether the benefits have vested under the terms of the applicable plan. If the benefits are vested, that creates a lifetime right to a certain level of retiree medical benefits, and the benefits cannot be changed or eliminated without the retirees’ consent. Whether benefits are vested is a legal question that depends on the interpretation of the relevant contracts and documents. The law on retiree medical vesting varies dramatically among courts nationwide. United Dominion Industries, Equitable Life, and Pabst Brewing Co. each litigated in the Seventh Circuit Court of Appeals, based in Chicago. The Seventh Circuit is considered to have more employer-favorable law on retiree medical benefits than most other federal circuit courts. By contrast, Goodyear was litigated in the Sixth Circuit, based in Cincinnati, which is considered to be a pro-retiree court in this area of the law. If it becomes necessary to litigate, the company will naturally want to litigate in a court which has historically favored its position. But the lawsuit must have a sufficient connection to the court where it is filed to prevent transfer or dismissal of the case. Note also that, even if the company initiates litigation to ratify a change in benefits in a favorable court, affected retirees often will file a separate lawsuit in another, more pro-retiree jurisdiction. The resolution of those competing lawsuits is often one of the key issues in retiree medical benefits litigation.

It should be noted, however, that changes to retiree medical benefits do not always result in litigation. Depending on the scope of the changes, and the jurisdiction in which the case is likely to be heard, retirees and their potential counsel may conclude that the risks of litigation outweigh the benefit. Alternatively, if there are relevant stakeholders (such as a union), the company can in some cases negotiate a settlement in advance without the need for litigation. Due diligence, with significant legal and business analysis, should precede any decision to change or terminate retiree medical benefits. The company should gather the relevant documents, including collective bargaining agreements, health plan documents and disclosures, and communications regarding retiree medical benefits. Counsel experienced in this area should carefully analyze these documents in light of the governing law. It is also important to analyze the relevant plan delegations and amendment procedures, to ensure that the formalities of any change to retiree medical benefits comply with terms of the plan documents and ERISA. It is critical to identify which officer(s) have authority to make changes, as well as which executives and board members should be involved in the decision-making process. Another important step is to retain the appropriate outside consultants to provide a valuation of the effect of the changes. They should be hired through counsel, so as to increase the likelihood that their findings will be shielded from later disclosure in the event of litigation. There are various ways that retiree medical benefits can be changed. Common approaches include instituting a cap on employer contributions, instituting or increasing co-pays and deductibles, or establishing an independent VEBA which the company funds initially but which eliminates the company’s obligation to provide retiree medical benefits going forward. Particularly in the union setting, the option of a VEBA has received growing attention because it provides stability for retirees while allowing companies to eliminate the FAS 106 liability from

their books. Companies following this approach include AK Steel, Goodyear, Ford, Chrysler, and General Motors. The company should also develop a game plan for announcing the changes. This should include a careful plan for announcing them (including whether to give any representative union courtesy notice); monitoring the reaction of employees and retirees (including in online retiree forums); setting up a hotline number for questions and responses, with careful logs to monitor calls; and having a litigation plan in place. In sum: Reducing or eliminating retiree medical benefits is complicated because of the myriad of legal and business issues involved, but the positive effect on a company’s bottom line can be substantial. ■

Nancy G. Ross is a partner in the Chicago office of McDermott Will & Emery. She practices in the area of employee benefits class action litigation and counseling under ERISA. She has extensive experience counseling employers seeking to reduce their retiree health benefits exposure, and she has successfully represented numerous companies in litigation challenging the reduction of such benefits. nross@mwe.com

John A. Litwinski is a partner in the Chicago office of McDermott Will & Emery LLP. He practices in the area of employee benefits class action litigation and counseling under ERISA. He has extensive experience counseling employers seeking to reduce their retiree health benefits exposure and has successfully represented numerous companies in litigation challenging the reduction of such benefits. jlitwinski@mwe.com

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

Canada/Cross–Border

Business-Method Patent Law in U.S., Canada, Seemingly in Synch By Steven B. Garland and Colin B. Ingram

he decision of the Federal Court of Appeal (Canada) in Amazon. com Inc. v. Canada provides the latest word on the patentability of computer-implemented inventions and so-called business method patents in Canada. The recent development of Canadian law has paralleled that of the United States in cases such as Bilski v. Kappos and Mayo Collaborative Services v. Prometheus Laboratories, Inc., and the law in both countries may now be quite similar. The Canadian Patent Act defines an invention as “any new and useful art, process, machine, manufacture or composition of matter,”or any new and useful improvement to any of these. A nearly identical definition is found in U.S. patent legislation. The only statutory exemption from patentability in Canada is in respect to “mere scientific principles or abstract theorems.” In the United States a similar prohibition with regard to “laws of nature, physical phenomena, and abstract ideas” has developed by way of the jurisprudence. Thus, in deciding whether a particular invention is patentable, the patent office and the courts in both countries must assess whether the claimed invention avoids these specific prohibitions and fits in one of the aforementioned independent categories. This task has become increasingly difficult in the case of inventions relating to modern and arguably less traditional technologies. Methods of doing business, often consisting of steps implemented by computers, have presented a particular challenge. THE AMAZON DECISION IN CANADA

The decision in Amazon.com Inc. v. Canada arose out of a Canadian patent

application filed in 1998. It described a method and computer system for ordering items over the internet by way of a single action – for example, a single click of a computer mouse – and is often referred to as Amazon.com’s “one-click” patent. The application was first rejected by the Commissioner of Patents, the head of Canada’s Patent Office. While concluding that what Amazon.com described and claimed was novel and “inventive” (i.e. not obvious), the Commissioner also concluded that the application was not directed to patentable subject matter. In the ruling, the Commissioner applied a novel, four-step approach to assessing patentable subject matter: • Assess both form and substance of the claims. The latter requires an assessment of what is new or “actually invented.” This manner of construing a Canadian patent was novel and contrary to established decisions of the Supreme Court of Canada. • Once assessed in terms of both form and substance, the subject matter must fit within one of the categories in the definition of invention. For the purposes of Amazon.com’s application, the Commissioner found the “substance” to be a “business method” and that Amazon.com’s application failed to meet a narrow test of “art”: that it be “an act or series of acts performed by some physical agent upon some physical object and producing in such object some change either of character or of condition.” • Consider whether subject matter is excluded. In this case, for the first time in Canada, the Commissioner specifically found that business methods were unpatentable per se. • Consider whether the subject matter

is “technological.” Again, the Commissioner found that the “substance” of the invention (the new use for a computer “cookie”) was not technological. In the appeal to the Federal Court, Justice Phelan held that all four elements of the Commissioner’s approach were wrong in law. Notably, the court concluded that there was no per se prohibition against business methods. Also, based on a Supreme Court of Canada decision, the court applied a much broader test for patentable “art”:

that it must not be a disembodied idea, but rather have a method of practical application.

that it must be a new and inventive method of applying skill and knowledge.

that it must have a commercially useful result.

Justice Phelan found Amazon.com’s claims to a computer system and a method to be patentable, the former falling within the category of “machine” and the latter falling within the category of “art,” per the test described above. In particular, he found that the method achieved practical application by being activated through the use of cookies, computers, the internet and the customer’s own action. On further appeal, the Federal Court of Appeal largely affirmed Justice Phelan’s decision, again rejecting the Commissioner’s approach. It agreed there is no per se prohibition on business methods, and “a novel business method may be an essential element of a valid patent claim.”

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

Canada/Cross–Border

Moreover, the Court affirmed that there is no technological requirement. However, the Court of Appeal also indicated that in its view the fact that an abstract idea may be given a “practical application,” e.g. by implementing it on a computer, was not necessarily sufficient to render it patentable. Thus, this decision creates some lingering uncertainty with respect to the patentability of computer-implemented inventions. The Court of Appeal ordered the Commissioner to re-examine the application on an expedited basis in

accordance with the Court of Appeals’s statement of the relevant legal principles, and in particular to assess whether “the only inventive aspect of the claimed invention is the algorithm – a mathematical formula – that is programmed into the computer to cause it to take the necessary steps to accomplish a one-click online purchase.” In that case, Amazon. com would not be entitled to a patent. Shortly after the release of the decision, the Commissioner issued a patent to Amazon.com, including all the claims originally in dispute before the courts.

BILSKI AND PROMETHEUS

Similar issues have arisen recently in the United States, culminating in two major Supreme Court decisions. Bilski was decided in 2010. In that case, Bilski’s patent application claimed a method for hedging and protecting against the risk of price fluctuations in commodity markets. The application had been rejected by the Patent Office and the Court of Appeals for the Federal Circuit. The appeals court held the method was not patentable because it was an abstract

aug/ sept 2012 E X ECUTIV E COUNSEL

Canada/Cross–Border idea that was not tied to a particular machine or apparatus and did not transform a particular article into a different state or thing. This so-called “machine or transformation test” was held by the appeals court to be the sole test to determine if a claimed method would fall into the “process” category of invention. However, on appeal, the Supreme Court rejected this position. Like the Canadian Federal Court in Amazon, it cautioned against unnecessarily narrowing the scope of patent protection for innovative technologies. Furthermore, the Court affirmed that there is no outright ban on business method patents – that while abstract ideas, natural phenomena and laws are not patentable, the application of those ideas, phenomena and laws may be. Ultimately, Bilski’s application was rejected by the Court for being nothing more than an abstract idea.

tion was, according to the Court, a law of nature. The Court therefore focused on whether the claims added “enough” to the natural laws, emphasizing what was new in the claim beyond the mere correlation. It found the claims added nothing more than either what was necessary to perform the steps or already known by the medical community. Thus the recent jurisprudence on patentable subject matter in Canada and the United States has developed in parallel. The U.S. Supreme Court in Bilski and the Canadian Federal Court in Amazon rejected a narrow test for patentable art or process, one which emphasized the presence of a “machine” or “industrial age” type physical steps. Rather, both decisions focused on whether the claims were “abstract” or had a practical application.

The U.S. Supreme Court in Bilski and the Canadian Federal Court in Amazon.com Inc. v. Canada rejected a narrow test for patentable art or process, one which emphasized the presence of a “machine” or “industrial age” type physical steps.

The issue of the scope of patentable processes arose again in the Prometheus case, where the U.S. Supreme Court considered claims regarding a method of optimizing therapeutic efficacy for treatment of certain auto-immune disorders. The method instructed physicians to administer a drug, determine blood levels of a certain chemical related to the drug, and increase or decrease the drug dosage depending on a given threshold of the chemical’s blood level. The Court viewed the claims as being directed towards the correlation between the blood level of the chemical and the appropriate dose. This correla-

Arguably, both the Supreme Court in Prometheus and the Canadian Federal Court of Appeal in Amazon placed important caveats with respect to the breadth of patentability. In Prometheus, the Supreme Court appeared to endorse an analysis that focused on the “new” elements of a claimed invention. Similarly, the Court of Appeal in Amazon suggested that known computer hardware may not be sufficient to provide the “practical application” required for patentability of a novel algorithm (which may encompass a business method). The impact of both these decisions will only be known once the respective

patent offices establish their practices in response to them and further case law is developed in their wake. The patent offices of both jurisdictions are currently developing final guidance documents to assist patent examiners. In Canada, the appeals in Amazon have confirmed that the Commissioner utilized a flawed, overly-restrictive approach to patentability by adopting, inter alia, an excessively narrow test for patentable “art” and an unsupportable per se prohibition for business methods. However, the full breadth of patentability of computer-implemented “business methods” remains an open question. ■

Steven Garland is a partner in the Ottawa office of Smart & Biggar. He has 20 years of experience in all types of intellectual property litigation in numerous industries. He has appeared as counsel at both the trial and appellate levels of the Federal Court of Canada, in the Ontario Superior Court and Court of Appeal, and before the Supreme Court of Canada, and he regularly appears before the Patent Appeal Board and the Trademarks Opposition Board. He has also been retained as a mediator. sbgarland@smart-biggar.ca

Colin Ingram is a partner in the Ottawa office of Smart & Biggar. He practices in the areas of patent prosecution in the electrical/electronics field, and in all areas of intellectual property and IP litigation. He also has been heavily involved in leading Canadian cases on the scope of anti-trust claims relating to patent rights. He has appeared before the Ontario Superior Court of Justice, the Federal Court of Canada and the Supreme Court of Canada. cbingram@smart-biggar.ca

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New Threats, New Legal Developments, in Cybersecurity By Jamie Gorelick and Jonathan Cedarbaum 40

ur economic activities, social lives, and even our physical safety increasingly depend on computers and other devices linked through the Internet. Protecting those systems and the information they contain has thus become a national imperative. As President Obama said near the outset of his Administration, “America’s economic prosperity in the 21st century will depend on cybersecurity.” In the past decade, an increasingly sophisticated cybersecurity industry has grown up to help companies, individuals, and government agencies contend with the growing array of threats posed by cyber attackers and cyber thieves. A recent PricewaterhouseCoopers study puts spending on cybersecurity in the United States at $30 billion a year, and growing at 10 to15 percent a year. The legal system has been slower to respond. But legislators and law enforcement, at both the federal and state levels, have begun to pay attention, and 2012 and 2013 may well see major developments in the legal regime governing cybersecurity. At this point, cybersecurity has become a top priority in the federal government’s national security agenda, both in the executive branch and on Capitol Hill. At the same time, we have seen increased regulatory and enforcement initiatives. In 2011 and 2012, the number of regula-

tory and enforcement initiatives designed to strengthen cyber defenses – prosecutions, interagency collaborations, public-private partnerships – has increased significantly. That trend is likely to accelerate, particularly in critical infrastructure sectors like energy, telecommunications, finance, defense and internet infrastructure. Regulators not normally associated with data security, such as the SEC and state insurance commissioners, are getting into the act. We’ve also seen increased litigation. Many of the relevant existing statutes – such as the Electronic Communications Privacy Act (ECPA) and the Computer Fraud and Abuse Act (CFAA) – were written in the pre-Internet era, indeed even before personal computers and email had become pervasive in the workplace. A similar time line applies with respect to the commonlaw causes of action that plaintiffs are relying on to pursue data security breach claims. Thus, courts are still hashing out basic issues of defining who can sue and for what. This year may see a number of these issues – who has standing to sue, what kinds of damages are cognizable, and what kinds of contractual arrangements give rise to implicit guarantees of data security protection – reach state supreme courts and the U.S. Supreme Court.

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Disclosure of Personally Identifiable Information. Banks and payment service companies have been frequent targets because they possess individuals’ financial information, but no sector has been immune. As many financial institutions have hardened their defenses, cyber-criminals have increasingly set their sights on other sectors, including retail, hospitality, enRegulators not normally associated with data security, such as the tertainment, health care, educaSEC and state insurance commissioners, are getting into the act. tion and social media. Breaches may result not only from cyber about enhanced threats to on-line privacy. intrusions, but also from inadequate physical However, we are likely to see a renewed push security that results in stolen or lost computers or back up media. for federal legislation in 2013, once the presidential election is behind us. Insurance. The increasing frequency and severity of data security breaches are leading to increased interest in insurance products designed VARIETY OF THREATS More than two billion people use the Internet, to help companies cope with attendant remediawhich contains roughly 300 million websites. tion and litigation costs – and to more disputes over whether existing policies cover these costs. The number of devices other than personal computers – including cell phones, BlackBerries, In the meantime, the SEC has begun to address the cybersecurity issue. On October and tablets – linked into the Internet is growing rapidly and creating new openings for malicious 13, 2011, its Division of Corporation Finance cyber activities. issued guidance on disclosure obligations relating to cybersecurity risks and incidents. Attack and Espionage. The military and intelThe guidance notes negative consequences ligence agencies have turned greater attention to Jamie Gorelick is a public companies may encounter after a cyber preventing and responding to attacks by foreign partner at WilmerHale. incident. They include costs of remediation, adversaries, whether hostile nations, terrorist She has represented groups, or politically motivated “hacktivists,” costs of increased cybersecurity protection diverse interests in such as Anonymous. May 2010 saw the creation measures, lost revenues, damage to reputation complex civil and crimiof a distinct military Cyber Command, headed and litigation costs. nal litigation, internal by a four-star general and dedicated both to proIn light of the damage a cyber incident can corporate investigatecting military computer systems and carrying cause and existing obligations to disclose infortions and counseling on issues at the interout military activities in cyberspace. mation that a “reasonable investor would considsection of law, policy Theft of Intellectual Property. Cyber theft of er important to an investment decision,” comand governance. She intellectual property, particularly by individupanies may be required to provide information has been on numerous als and organizations in China, Russia, and that allows investors to understand a company’s government comformer Warsaw Pact countries, has skyrockcybersecurity risks. The SEC has begun sending missions and panels, eted, with the value of stolen IP estimated in out inquiry letters probing whether issuer’s pubincluding the 9/11 the billions of dollars. lic statements are consistent with their filings. Commission, and is a Theft of Money. Cybercriminals are devising former Deputy Attormore sophisticated ways of manipulating comSECTOR-SPECIFIC INITIATIVES ney General of the U.S. puter users for illicit profit. One example: In Many federal efforts targeting particular and former general November 2011, the FBI and the U.S Attorney’s economic sectors are being initiated, and more counsel of the Defense Office for the Southern District of New York are forthcoming. One example is the Defense Department. She is a announced the indictment of seven individuals Industrial Base (DIB) Pilot Program, announced member of the Execuconnected to an Estonian company called Rove in June 2011. This voluntary trial enables DIB tive Counsel Editorial Digital, which had legitimate operations but companies or their Internet service providers Advisory Board. (ISPs) to get access to information, including also was accused of developing a botnet comjamie.gorelick@ classified information, about cyber threats and puter worm that had infected more than four wilmerhale.com responses from the government. Advocates million computers world-wide, and more than for the program see it as a model that may be 100 U.S. servers. The botnet is alleged to have expanded to other industrial sectors. enabled Rove Digital to reap millions of dollars Another initiative addresses the electric grid. in illicit revenue by diverting users, without their knowledge, from legitimate advertisements In 2010, the National Institute of Standards and Technology (NIST) issued a report on to fake sites. New federal legislation remains a possibility. In the fall of 2011, many observers thought substantial cybersecurity legislation had a good chance of being enacted in the 2012 congressional session. Then congressional efforts were derailed by partisan divisions, business concerns about new regulations, and public anxiety

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

cybersecurity strategy and requirements for the grid. In 2011, the Federal Energy Regulatory Commission (FERC) began, but put on hold, an effort to issue a rule on grid interoperability standards. In September 2011, the Department of Energy (DOE) issued a “Roadmap to Achieve Energy Delivery Systems Cybersecurity.” Then, in January of 2012, the White House and DOE announced an Electric Sector Cybersecurity Risk Maturity Pilot, a public-private collaboration to develop a model to help secure the electric grid against cyber threats and test that model with participating utilities. In health care, the Office of Civil Rights at the Department of Health and Human Services, in November 2011, announced a pilot program of security and privacy audits of 150 entities covered by the privacy and security rules under the Health Care Portability and Accountability Act. In the area of telecommunications and ISPs, in March, 2012, the Federal Communications Commission issued three voluntary codes of conduct designed to help combat botnet attacks, assaults on DNS servers and internet route hijacking.

THE LITIGATION LANDSCAPE

As data breaches have become more common and more significant, related litigation has proliferated. Many of the common-law and statutory causes of action being relied on were developed for other circumstances, so parties and courts are struggling to fit them to data breach matters. Among the questions being hashed out: Who has standing? Does disclosure of personal information, and the attendant heightened risk of identity theft, constitute sufficient injury to give a plaintiff standing to sue in federal court, or does there need to be more concrete economic harm? Federal courts of appeals have split on the issue. The Supreme Court has so far ducked the question, but it is likely to reach the high court soon. What suffices to create an implied contractual guarantee of security? When a customer or affected third party has no contractual agreement with the company suffering the breach, when can they nonetheless sue based on an implied contractual guarantee that the company would have adequate cybsersecurity protections in place? Many of these claims turn on the particular state’s contract-law doctrines. However, a number of courts have found such a contract implied, reasoning that a customer using a credit

card does not expect the merchant to allow unauthorized third-parties to access that data. May failure to provide adequate security violate consumer protection statutes? Again, the answer will turn on the particulars of a state’s consumer protection laws, but at least some courts are letting such claims proceed. What constitutes cognizable damage? This issue is arising in a number of contexts, including state common law claims, state statutory claims, the federal Computer Fraud and Abuse Act, and the federal Privacy Act, under which the Supreme Court held (in March of this year) that mental and emotional distress from disclosure of personal medical information does not constitute “actual damages.” Theft by former employees. During the second week in April, 2012, two federal courts of appeal restricted the use of several federal statutes as tools to target those who steal data or computer code. In United States v. Nosal, the en banc Ninth Circuit, by a vote of 9-2, limited the reach of the CFAA by holding that gaining authorized access to information on a computer system and then using the information for a purpose prohibited by a computer-use agreement, even for a fraudulent purpose, does not constitute “exceed[ing] authorized access.” In United States v. Aleynikov, the Second Circuit held that theft of computer source code itself could not be prosecuted under the Economic Espionage Act or the National Stolen Property Act.

FEDERAL LEGISLATIVE EFFORTS

In the fall of 2011, both President Obama and Senate Majority Leader Harry Reid (D-Nev.) identified cybersecurity as a top legislative priority, particularly in three areas: critical infrastructure protection, information-sharing and reorganization of the federal government’s own cyber defenses. House Republicans responded with their own proposals. National security experts of both parties argued that new federal laws were needed. But partisan divisions, business concerns about additional regulatory burdens, and public worries about enhanced threats to online privacy left the 112th Congress unable to adopt substantial new standards before recessing for the summer. The depth and variety of cyber threats facing U.S. companies will only increase. In the legislative arena, as in regulatory and enforcement action and litigation, we are certain to see re-invigorated efforts in 2013, once the presidential election is behind us. ■

Jonathan Cedarbaum is a partner at Wilmer Hale He has a diverse litigation practice, focusing especially on antitrust, False Claims Act (FCA), Federal Arbitration Act, and international cases. He also counsels on administrative law and constitutional issues, particularly in transnational matters, and has particular expertise representing clients before the Committee on Foreign Investment in the United States (CFIUS). He rejoined the firm in 2011 after two years in DOJ’s Office of Legal Counsel, ultimately serving as Acting Assistant Attorney General in charge of the office. jonathan.cedarbaum@ wilmerhale.com

The Globalization of Corporate Responsibility By Dr. Paul Brooks

n todayâ€™s globalized marketplace, which relies on no single engine for growth and where ideas are as coveted as any other commodity, corporations and entrepreneurs from the worldâ€™s emerging economies are reshaping the way that business gets done. In key sectors like manufacturing, telecommunications, IT services, mining, shipping, defense, aerospace and finance, emerging market players are beginning to rival, and in some cases surpass, their peers who are headquartered in more developed markets.

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Today, emerging market corporations bring to Europe and the United States a dizzying combination of investment, competition, ideas and innovation, but are also delivering new approaches to sustainable business. Free market competition being what it is, and with the hearts and minds of consumers up for grabs, established corporations would be wise to pay close attention to how rivals from China, India, Brazil or wherever else, tackle what has come to be known as Corporate Social Responsibility (CSR), and whether emerging entrepreneurs are giving birth to fresh approaches to sustainable business that deserve to be studied and even copied. The pattern of emerging market innovation disrupting established market haughtiness is well documented. Japanese automakers changed America and changed the world of manufacturing in the 1980s, through what is now called “lean manufacturing.” Today, low-cost cell phones, computers and automobiles have clear ramifications for the West, while the application of mass production principles to sophisticated business services has reshaped entire industries. Similarly, microfinance, as both a business

brought by emerging corporations and entrepreneurs can be equally applied to CSR. Indeed, we should expect that the reordering of the global economy in light of the boom in developing markets will change not just the balance of power in global industries, but the way that sustainable business is carried out. Today, the examples of this transition are compelling and include initiatives like the Future Steel Vehicle project, led by WorldAutoSteel, a consortium of steelmakers from established and emerging markets such as India, Brazil, China and Taiwan. This is a concept car, based on a battery electric vehicle platform, which uses the latest steel technology and has a body that is 35 percent lighter than conventional steel grades, plus a five-star safety rating. These results were achieved at no additional overall cost and with no increase in the environmental impact of production, compared to using materials other than steel to achieve the same standards. Similarly, at my own company, Tata Steel, we have built a series of man-made lagoons used for circulating clean factory water from the operations at Shotton, UK to the River Dee. Regular clearance and maintenance has enhanced the lagoons’ potential as a habitat for flora and fauna, attracting a variety of bird and other species. The area is now designated by the UK as a Site of Special Scientific Interest (SSSI), recognizing it as not merely compliant with local environment laws, but also as an important, albeit manmade , habitat for wildlife. In June 2011, we opened a nature reserve within the conservation area as well as a new nature trail and indoor classroom. Whether you consider CSR to be an afterthought for corporations that can “afford” to consider matters other than profit (not a view we hold) or you believe that sustainable business is an integral part of creating value and long term returns, it is undeniable that entrepreneurs and corporations from emerging markets have something to offer that is both unique and impactful. The question for the West is whether to respond or, at their own peril, ignore the next great wave of competition and innovation from upstart rivals. n

Some emerging market corporations are delivering new approaches to sustainable business that deserve to be studied, and even copied. model and source of profits, is spreading, and these examples are only the tip of the iceberg. Indeed the very concepts of “Asian Capitalism” or “Latin American Capitalism” have come to be recognized as new and highly successful variants of the approach to business that has dominated global business for a century. Great entrepreneurs who succeed in the face of overwhelming odds have built dozens of rapidly expanding companies throughout the Southern Hemisphere and Asia. These fast growth companies tend to have an amazing multiplier effect, and can create seismic changes that extend beyond their traditional home markets. It is not a fantasy to believe that the changes to industry

Dr. Paul Brooks is Group Director, Environment, for Tata Steel and a member of the Tata Sons Climate Change Steering Committee.

Good Reasons to Weigh in for the Lame Duck Session By Ashley Davis and Malloy McDaniel While conventional wisdom in Washington maintains that little will be accomplished in this Congress, the next several months represent a key opportunity for advocates to position themselves, develop key relationships and disseminate their messages on Capitol Hill, in advance of what may prove to be the most productive months of the legislative year: the so-called lame duck session.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO Aug/ Sept 2012

The lame duck session extends from the day after Election Day through the end of December. With legislators tackling issues ranging from the expiration of the Bush tax cuts to the triggering of sequestration, Congressional action at the end of this year will impact virtually every industry. With only two months to address a wide range of issues, members and their staffs will rely on the information they’ve gathered in the preceding months to inform their efforts, and those companies and interests that have engaged in the process early on stand to have the most meaningful impact. There are five key initiatives that Congress will need to tackle by the end of 2012, and each is set to have a significant impact on a wide range of industries. First, the Bush tax cuts, which were most recently extended during the lame duck session in late 2010, are set to expire on December 31, 2012. The 2010 deal extended the current income tax rates for two years to prevent an annual tax increase of more than $2,000 for the average American family. Second, unemployment insurance, the payroll tax cut and the sustainable growth rate, or medicare “doc fix,” are set to expire on December 31st. Congress passed a short-term extension of these programs in February, delaying the debate over their future until after the 2012 elections. If Congress does not extend these programs, unemployment benefits will be limited to 63 weeks, rather than the current 73; the payroll tax cut, which amounts to about $1000 dollars per year for the average American worker, will be eliminated; and Medicare doctors will face a 27 percent pay cut. Third are the “tax extenders,” which include the research and development tax credit and other expired or expiring tax provisions. And fourth, while no specific date has been identified, it is likely that the President will need to request another debt ceiling increase before the end of the year, which will almost certainly spark heated debate in Congress. Finally, the automatic, across-the-board budget cuts known as “sequestration” that were included in the Budget Control Act of 2011 will be triggered in 2013, resulting in $1.2 trillion in cuts to be split between security and non-security programs.

In addition to these necessary initiatives, during the lame duck session a number of more ambitious legislative proposals may emerge that could touch every sector in the American economy. Business leaders, members of Congress and presidential candidates alike have called for comprehensive tax reforms, including overhauls to the corporate and personal tax rates, as well as longer-term unemployment insurance, payroll tax cut, and “doc fix” initiatives. A number of legislators have also called for a new initiative to prevent sequestration, citing what they have called its “devastating impact” on defense programs. While a number of options have been proposed to prevent sequestration, including repealing it outright, it remains to be seen whether Congress will act to prevent the automatic budget cuts during the lame duck session or in early 2013, if at all. The heft of the lame-duck work load for Congress suggests that certain initiatives will not be considered until the 113th Congress convenes in January, and the decision as to which issues to table will rest, at least in part, on the outcome of the election. If former Massachusetts Governor Mitt Romney wins the presidency in November, it is likely that the Republicans will gain a few seats in the Senate, perhaps even achieving a narrow majority. In the event that the Republicans control all three branches of government, short term extensions are expected, as the new leadership will likely wait and pursue more comprehensive reforms in 113th Congress. In this case, both Congress and the President can be expected to hit the ground running in January, tackling major reforms to healthcare and the tax code, in addition to budgetary and deficitreduction efforts. If President Obama is re-elected, and the makeup of the Senate remains the same, the two parties will need to come together to address a number of major issues in a short period of time. While many have questioned the ability of this Congress to compromise, there is historical precedent for bipartisan compromise on major initiatives. In 1983, President Ronald Reagan and former House Speaker Tip O’Neill (D-MA) reformed Social Security, and then went on to pass comprehensive tax reform on a bipartisan basis three years later. continued on page 51

Ensuring a Cost-Efficient Arbitration By Richard J. Holwell and Dorit Ungar Black

The cost of arbitration has traditionally been considered one of its many advantages over litigation. Other perceived benefits are neutrality of the forum, speedier resolution (with no appeal), confidentiality, limits on discovery, informality of proceedings, and arbitrators that can be chosen based on their expertise in specific subject matters. But with the encroachment of the U.S. litigation process into the arbitration arena, these advantages are slowly starting to wane, and arbitration has grown increasingly expensive and timeconsuming, much to the frustration of both in-house and outside counsel.

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Expanded use of discovery is driving some but not all of the cost increase. Parties often spend significant time and resources fighting over issues that could easily have been addressed when they negotiated their commercial contract. But at that point the parties typically focus almost exclusively on substantive subject matter. The arbitration clause is often an afterthought, using boilerplate language lifted from some other contract. This is a mistake. An arbitration clause should be drafted carefully, because it provides a roadmap for future disputes and can have a dramatic impact on the cost of the arbitration. This article identifies some of the pitfalls of arbitration clauses and suggests some strategies for determining what in-house counsel should include and exclude in order to keep the pending arbitration streamlined and focused on the actual dispute. • The All-Inclusive Clause. Pitfall: Most arbitration clauses are broadly drafted to apply to any dispute “arising from or in connection with” the contract. They are designed to bring any conceivable dispute relating to the transaction under their umbrella. They seek to avoid litigating some claims in court, while others involving the same transaction are being arbitrated. This broad drafting causes duplication of effort and potentially inconsistent outcomes, and it can result in one party dragging unintended parties (e.g., affiliated entities or officers and directors of the other side) into the arbitration to gain leverage, or throwing in any conceivable claim, including tort or statutory claims, in hopes that one will stick. This in turn often results in significant resources being spent on motion practice concerning whether non-signatories are proper parties to the arbitration, or whether non-contractual claims are arbitrable. Solution: Parties that wish to limit arbitration to contractual disputes should consider more restrictive language – for example, a clause covering only disputes “arising out of” the contract, and not those “in connection with” the contract, or language expressly excluding any type of non-contractual claim. If the parties wish to avoid binding affiliated entities or officers and directors to the arbitration agreement, they

may include language providing that the arbitration agreement binds only contract signatories. • Non-Administered vs. Institutional Arbitration. Pitfall: A perceived advantage of non-administered arbitration is that parties do not pay administrative fees. However, more often than not the institution’s administrative fees are negligible compared to attorney and arbitrator fees. What is often overlooked is that in ad hoc arbitration, arbitrator fees are not regulated. By contrast, many institutional rules regulate arbitrator fees and provide for fee schedules that tie arbitrator compensation to the amount at stake, and/or cap the hourly fee that an arbitrator may charge. The potential cost savings from lower arbitrator rates generally outweighs the savings from non-payment of administrative expenses. Solution: Choose an arbitration institution, and do so with purpose. • Choose the Institution Wisely Pitfall: Selecting institutional arbitration and a set of rules provides administrative support, a framework of procedural rules and limitations on arbitrator costs. But the most significant advantage is that the leading arbitral institutions are well respected, including by national courts that tend to enforce awards rendered under their auspices in the absence of voluntary compliance. Some institutions have a more liberal regime than others on subjects such as the scope of discovery and time frame for issuance of an award. Some provide little guidance on any of these issues, leaving the arbitrators stranded and the parties fighting over the appropriate parameters. Solution: Except when the institution is chosen because it specializes in certain types of disputes (e.g., the International Centre for Settlement of Investment Disputes), the choice of institution often is guided by the nationality, geographic location and legal tradition of the parties. To make an informed choice, in-house counsel should be familiar with and comfortable with the rules of the selected institution. If the applicable rules are silent, for instance, on the time frame in which the arbitration must be completed, the parties can specify one. However, they should be cautious about including overly restrictive provisions. The benefit of those restrictions

An arbitration clause provides a roadmap for future disputes, and can have a dramatic impact on the cost of the arbitration.

Aug/ Sept 2012 E X ECUTIV E COUNSEL

Richard J. Holwell

served as a federal judge in the Southern District of New York, 2003-2012, before stepping down to found Holwell Shuster & Goldberg LLP in New York, where he is now a partner. During his tenure on the bench, Judge Holwell presided over two of the most significant fraud matters to reach trial in recent decades: the Raj Rajaratnam insider trading trial and a securities class action brought against Vivendi. rholwell@hsgllp.com

Dorit Ungar Black, a founding partner of Holwell Shuster & Goldberg LLP, has expertise in international arbitration and has practiced in both civil and common law jurisdictions. She focuses her practice on commercial contracts, complicated financial instruments, business torts, commercial leases and international construction projects. dblack@hsgllp.com

may be undercut by the impossibility of predicting whether such time limitations ultimately are feasible. This can be balanced out by including a caveat that specified time frames may be modified by the parties’ stipulation, or at the arbitrator’s discretion. • Number of Arbitrators, Method of Selection. Pitfall: If the parties don’t choose the arbitrators they want, the institution will do it for them. An arbitration clause that does not address the issue of choosing arbitrators can lead to disputes and delays. Solution: The contract should specify the number of arbitrators. Using a sole arbitrator not only results in significant cost savings, but simplifies every stage, from appointment to award-writing. Whether a sole arbitrator or a panel of three is used, spelling out the method of selection in the arbitration clause saves headaches later. For instance, with a panel of three, parties should choose whether the chairman will be appointed in the first instance by the parties, the party appointees or the institution. • Document Discovery Pitfall: The availability of document discovery will be seen as an advantage by some parties and a disadvantage by others, depending on their legal traditions. Most parties, however, are impartial to the subject at the contract drafting stage because they cannot forecast whether discovery will serve their interests or not. Absent a specific agreement, the arbitrator retains wide discretion in determining the scope of discovery, subject only to the institution’s guidelines. This often results in parties wasting significant ink fighting over the appropriate scope. Solution: The appropriate scope of discovery is largely a function of the nature of the dispute. Parties to an international contract that wish to avoid U.S.-style fishing expeditions can, for instance, stipulate to be governed by the 2010 IBA Rules on the Taking of Evidence in International Arbitration. They require that documents not only be relevant but also material to the outcome. Parties to a domestic contract can agree to be guided by the CPR’s Protocol on Document Disclosure & Presentation of Witnesses in Commercial Arbitration, which offers various modes of disclosure and presentation of witnesses, ranging from minimal to extensive.

Direct testimony should be limited to affirming the truthfulness of the written witness statement. Another way to discourage parties from exercising unnecessary discovery demands is to provide that the prevailing party can recover its attorney fees. • Witness Testimony. Pitfall: Depositions are another money pit. Not only are they costly, they take a toll on a client’s management time. While rarer than document discovery, depositions are not uncommon, especially when the arbitration involves U.S. counsel. Solution: Depositions can be easily avoided by way of a stipulation in the arbitration clause. This should be married with a requirement that direct testimony at any hearing be presented beforehand in written form so the arbitrators can review it, and opposing counsel can prepare for cross-examination. Direct testimony should be limited to affirming the truthfulness of the written witness statement. This in theory shortens the hearing, and certainly shortens pre-hearing procedure. In the current economy, finding cost-saving methods of resolving disputes is a major concern of corporate clients. There are several tactics to reduce costs after an arbitration has commenced – agreeing to limits on discovery, considering dispositive motions, imposing restrictions on the length of evidentiary hearings – but a well-drafted arbitration clause is a must for parties who wish to maintain the inherently attractive qualities of arbitration and protect themselves from escalating costs. ■

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Good Reasons to Weigh in for the Lame Duck Session continued from page 47

Similarly, President Bill Clinton worked with the Republican-controlled Congress in 1996 to reform welfare. There are already small, bipartisan groups within Congress that are working to develop such compromises, though it remains to be seen which proposals will be considered in the limited time the lame duck session allows. In either scenario, Congress will need to address several major issues in December, and it will need to work quickly, which means members need to be studying the issues and developing their positions long before they are asked to vote in December. Any successful lobbying strategy relies on developing relationships with key congress members and staff, and then educating those crucial players on the potential impacts of the legislation they consider. These two efforts are essential to making an organization part

number of major legislative issues to address in a very short period of time. Congressional staff will simply lack the time for such information gathering. Leadership will no longer fill fleeting legislative days with hearings, and membersâ€™ minds will for the most part be made up. This will not be the time to seek out new perspectives or begin forming ideas about these issues. Rather, at that point members and their staffs will be relying on the information they have gathered and the relationships theyâ€™ve already formed in the preceding months to inform their decisions. The timing of these initiatives will largely be determined by House and Senate leaders, highlighting the crucial role leadership plays during these critical months. While their agenda-setting powers are important all year long, the role of leadership is especially pronounced during this kind of condensed time frame. With so much to do and only two months to do it, committee chairs and House and Senate leadership have a key role to play in determining everything from which issues get hearings, to the length of debate, to which amendments will be considered on the floor. Leadership will carry the burden of determining which issues are taken up in the final months of the year, as well as which issues take the highest priority moving into 2013. As important as the next two months are for laying the groundwork for the lame duck session, they are equally important in terms of preparing for 2013. Come January, new and returning lawmakers will want to hit the ground running by tackling major initiatives early in the session. Key legislative priorities, conceived in 2012, will be pursued right out of the gate. Those who did not take the time to make themselves part of the process in 2012 risk being left behind. â–

Congress will need to address several major issues in December, but members will need to study the issues and develop their positions long before they vote. of the process, and there is no better time to lay this groundwork than during the months leading up to the lame duck session. This is when committees are focused on holding hearings and gathering information, when staffers are more available to meet with stakeholders, and when members have ample time to carefully consider various points of view before developing policy positions. Organizations that take the time to come to the Hill now, to make introductions, to participate in hearings and to share their views with committees, members and staff, will have the ability to play a key role in shaping the dialogue later this year. But once members return to Washington in November, they will have a

Ashley Davis is a principal at Blank Rome Government Relations LLC and leads the practice group. She represents Fortune 500 companies and trade associations in a wide range of industries on government relations matters related to education, transportation, international trade, homeland security, healthcare and other issues. Davis@ BlankRome.com

Malloy McDaniel, a principal at Blank Rome Government Relations LLC, brings more than 13 years experience working in Senate Leadership to the firm. Prior to joining Blank Rome, he served as both a policy advisor and whip liaison to Senate Republican Leader Mitch McConnell (R-KY). McDaniel@ BlankRome.com

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

RESOLVING

Criminal Investigations PRIOR TO INDICTMENT By James Brady and Buck O’Leary 52

ou are the CEO of a corporation that has been served with a federal grand jury subpoena seeking documents and emails relating to the possible submission of false claims to the government. The subpoena suggests that the company is a target of a U.S. Department of Justice investigation. The goal is to avoid criminal prosecution. As Arthur Andersen, L.L.P. discovered, a conviction can be a corporate death sentence. Andersen was convicted in 2002 of obstruction of justice for shredding documents relating to its Enron audit. Because the SEC does not allow convicted felons to audit public companies, Andersen lost its CPA licenses. Three years later, the Supreme Court reversed the conviction, but by that time Andersen was no longer in business. Since Andersen’s demise, DOJ’s attitude toward criminal prosecutions of legitimate business organizations has changed. It is often willing to forego pursuing a conviction, provided certain conditions are met. To avoid indictment, the company must persuade the DOJ: (1) that it is innocent, or (2) that even if it is not innocent, a criminal prosecution would be unwise because of the consequences for innocent employees, shareholders or other special

circumstances, or (3) that it should be permitted to resolve the matter with a Non-Prosecution Agreement (NPA) or Deferred Prosecution Agreement (DPA) with the Department. While the terms of an NPA or DPA can vary, the agreement is typically for two or three years. It requires the company to admit wrongdoing, make restitution, pay a fine, strengthen its compliance program and perhaps live under the eye of a DOJ selected monitor. In the event of a material breach, the DOJ is free to rescind the agreement and seek a conviction. This pre-indictment exercise is like an informal trial in which the company bears the burden of persuasion, has no rights and DOJ attorneys serve as judge and jury. To win, the company must cooperate with the government’s investigation, quickly conduct its own investigation, assess the facts realistically and maintain its credibility throughout the process. If wrongdoing occurred, the company must implement measures to prevent a recurrence. Once the company learns it is under investigation, it should suspend its regular document/information destruction program and take steps to preserve all relevant documentation and electronically stored information (ESI).

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

aug/ sept 2012 E X ECUTIV E COUNSEL

James Brady is Managing Member of Dykema’s Grand Rapids, MI, office and leader of the firm’s national White Collar Criminal Defense and Internal Investigations practice area. jbrady@dykema.com

The obligation to preserve may arise even prior to service of a subpoena or formal notice of an investigation. Since the enactment of a new obstruction of justice statute, the safe course of action is to preserve relevant documents and emails whenever the company anticipates that it may be the subject of an investigation. Counsel should send a letter to DOJ stating that he or she represents the company and that the company’s policy is to cooperate fully with all investigations, and request that the government refrain from attempting to interview its employees without prior notice. Once notified, government representatives theoretically should refrain from contacting current company employees. The 1998 McDadeMurtha Amendment made federal government attorneys and their investigative agents subject to state codes of professional conduct, and most prohibit contacting a person known to be represented by counsel. Nonetheless, government agents and cooperating witnesses periodically attempt to interview employees who are represented by counsel. Employees should be warned about this possibility. In our hypothetical, the company should issue a memorandum to its relevant employees stating that it is under investigation, has been served with a grand jury subpoena and that its policy is to cooperate fully. The memorandum should: • Describe the nature of the investigation. • Describe what is sought and instruct employees not to destroy relevant documentation and ESI. • Identify counsel representing the company and direct the employees to provide counsel with any relevant information. • Inform the employees that federal agents may contact them and offer to provide counsel at no expense to them. • Warn the employees that if they consent to be interviewed, they should tell the truth because knowingly making a false statement to a federal agent is a felony punishable by up to five years imprisonment. • Further warn the employees that communications among themselves without a company lawyer present do not fall under the company’s attorney-client privilege. • Advise the employees not to create nonprivileged documents or emails, relating to the investigation. (E.g., “I warned them years ago that this was fraud.”)

Because this memorandum may fall into government hands, it should avoid saying things which are inconsistent with the company’s policy of full cooperation. The memorandum should not “instruct” employees to refuse to be interviewed, but instead leave the choice up to them. Cooperation does not preclude the company from asserting its innocence. Even if the government concludes otherwise, the company may still be able to avoid criminal prosecution. The DOJ’s “Principles of Federal Prosecution of Business Organizations” directs prosecutors to consider a number of factors before deciding whether to proceed criminally. The factors favoring criminal prosecution are: the nature and seriousness of the offense, including the risk of harm to the public and DOJ’s priorities regarding certain violations; the pervasiveness of wrongdoing, including complicity in or condoning of criminal conduct by management; and any history of similar misconduct, including prior criminal, civil and regulatory enforcement actions against the company. The factors favoring a non-criminal resolution of the matter are: timely and voluntary disclosure of wrongdoing and willingness to cooperate; the existence and effectiveness of the corporation’s compliance program; remedial actions (including efforts to implement an effective compliance program or improve an existing one, to replace responsible management, to discipline or terminate wrongdoers, to pay restitution and to cooperate with the relevant government agencies); the collateral consequences of a prosecution and conviction, including whether there is disproportionate harm to shareholders, pension holders, employees, and others not personally culpable, as well as impact on the public arising from the prosecution; the adequacy of the prosecution of individuals responsible for the corporation’s malfeasance; and the adequacy of remedies such as civil or regulatory enforcement actions. In certain instances, possible public harm may trump “bad“ factors favoring prosecution. In 2005, the University of Medicine and Dentistry of New Jersey (UMDNJ) entered into a DPA because of a $4.9 million Medicaid double billing scheme. As part of its DPA, UMDNJ agreed to live under a court appointed monitor with extensive investigative powers. Subsequently, the monitor discovered a different, unrelated fraudulent scheme, namely,

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO aug/ sept 2012

that UMDNJ had been paying kickbacks for patient referrals. Moreover, high level UMDNJ officials were complicit in this scheme. Despite the pervasiveness of wrongdoing and UMDNJ’s recidivist history, DOJ declined to prosecute. UMDNJ was permitted instead to pay $8.3 million to settle its civil liability, probably because a criminal conviction would have resulted in a five year exclusion from participation in Medicare and Medicaid, and put the state’s largest teaching hospital out of business. Two of the physicians who received UMDNJ kickbacks, however, were prosecuted criminally, convicted and excluded. Once the company’s lawyers and DOJ attorneys agree on the scope of the subpoena, the company must do a diligent search and fully comply. The Civil False Claims and Dodd-Frank acts both provide significant

responsible to determine whether a violation occurred. Ascertaining the truth is often difficult. Courts have held that prior to interviewing an employee, the lawyer must inform the employee that: He or she (the lawyer) represents the company and not the employee; what the employee says during the interview is protected by the company’s attorney-client privilege and should be kept confidential; and that because the privilege belongs to the company and not the employee, the company is free to waive privilege and disclose what the employee said to third parties, including the government. Fairness may require such a warning, but it does motivate the culpable employee to clam up and may frustrate the company’s ability to learn the truth. Representation of the company and its employees by the same lawyer can cost credibility when the employee refuses to be interviewed without use immunity. The term use immunity means the government agrees not to use what the individual says against him in any criminal proceeding unless the person lies. As counsel for the employee, the lawyer must advise that individual about use immunity. It is then up to the employee to either consent to be interviewed, or refuse until granted use immunity. When the same lawyer represents both the company and its employees, and employees insist on use immunity, the government may find the company’s claims of full cooperation suspect. In contrast, when the employee is separately represented, the government understands that decisions about immunity are up to the individual and their counsel and beyond the company’s control. In the wake of the Andersen debacle, the DOJ has turned to NPAs and DPAs as a means of resolving corporate criminal violations. To obtain such a resolution, the company must act quickly to determine whether a violation has occurred and, if it has, conform to as many factors that favor declining prosecution as possible, while maintaining credibility throughout the process. ■

If a company fails to produce a

“bad” document that is already in the government’s possession, it

may lose credibility and prompt an obstruction of justice investigation.

financial incentives to current and former employees to report fraudulent conduct. These whistleblowers often purloin copies of the worst company documents and provide them to the government. If a company fails to produce a “bad” document that is already in the government’s possession, it may lose credibility and prompt an obstruction of justice investigation. If the company wishes to avoid criminal prosecution, any representations it makes to the government must be accurate and truthful. The company cannot be sure its representations are accurate unless its lawyers are armed with all the facts. Once the company has identified key documents, its lawyers must interview the employees

Howard “Buck” O’Leary is Senior Counsel in Dykema’s national litigation practice and counsels clients in criminal, civil and administrative investigations in a variety of areas, including antitrust, defense procurement fraud and health care fraud. He is based in the firm’s Washington DC office. holeary@dykema.com

AUG/ SEPT 2012 E X ECUTIV E COUNSEL

s l a i r T y r u J y r a m m Su ernative to Litigation t l A n a as d Jr. l o n r A . J k c i r By Pat

I will never forget what I heard a federal judge declare during a routine motion call a couple of years ago. The judge was in the process of setting a date several months in the future for an evidentiary hearing. Counsel for one of the parties stated that the date would not work because he had a trial scheduled in another case around the same time. “No, you don’t,” the judge responded, quickly but courteously. d

aug/ sept 2012 E X ECUTIV E COUNSEL

Courts have found their power to hold summary jury trials under Rule 16 of the Federal Rules of Civil Procedure. 58 The counsel, along with all the other lawyers waiting for their motions to be called, looked up with heightened attention. “No, you don’t,” the judge repeated, “and I will tell you why. Lawyers have become so expensive that nobody can afford to go to trial anymore. So we are going to set the matter for the date I suggested, and I’ll bet dimes to doughnuts that you will not have a conflict.” The whole courtroom laughed, with the possible exception of the presenting lawyer. For most of us it was nervous laughter. A slightly modified version of so-called “summary jury trials” could provide an affordable solution to the problem the judge identified. In a summary jury trial, both parties participate in a mock trial before an advisory jury. A summary jury trial is non-binding and is intended to be a flexible process. An abbreviated procedure is used. The advisory jury may hear only lawyers’ arguments, or they may hear some testimony from witnesses for both sides. The courts have found their power to hold summary jury trials under Rule 16 of the Federal Rules of Civil Procedure and under the

court’s inherent power to manage its cases. While summary jury trials were designed to facilitate pretrial settlement of the litigation, much like a standard settlement conference, I propose that a summary jury trial could also be used as a sort of “mini-trial” – with some binding effect -- after initial discovery has been completed, but well before the close of discovery. The parties could agree, perhaps with the court’s encouragement, that witnesses, subject to crossexamination, will provide evidence on only the main issues, or on some of the main issues. In addition, the parties could agree that such evidence would be accorded the same evidentiary status that it would have if taken during a deposition. If used in this way at an early stage of a case, the summary jury trial would allow each party to observe the perception of jurors on the main merits of its case. The parties then could make an early assessment of settlement potential. This also would be an efficient and cost-saving form of discovery, regardless of whether the case settles. Each side would be able to see the other’s key documents and witnesses, as actually used to present a case.

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO aug/ sept 2012

This would allow them to strip away much of the clutter that clogs the discovery process, and it would help boil down the key evidence. Counsel for both sides would likely be in a better position to streamline any further discovery and prepare for trial. And, if the parties failed to reach settlement, they’d still have enough money left to try the case on the merits. I believe that this proposed solution will gain traction, because there clearly has been a movement afoot to find ways to reduce costs for litigants. The Federal Civil Practice Section Council of the Illinois State Bar Association, for example, has been working on several proposals to cut trial costs down, such as reducing the need for and complexity of certain filings and procedures, and the United States District Court for the Northern District of California has adopted an expedited trial program. Some of the details of the California program are worth exploring, to both understand the program itself and to compare it to the proposed modified summary jury trial. It offers parties the option of consenting to a binding one-day trial to occur six months after the parties agree to the process. The stated purpose is to “offer litigants access to justice in a more efficient and economical fashion.” The nuts and bolts of the California program demonstrate a concentrated effort to reduce costs at all phases of a case: • The program is consensual and binding. • A case may be tried to a judge or jury. • To participate, the parties execute an “Agreement for Expedited Trial and Request for Approval.” • Expedited time schedules and rules of procedure begin when the court approves the Agreement. • The goal is to try the case in six months. • Discovery is limited to 10 interrogatories, requests for production and requests for admission by each party, and 15 hours of deposition time to be used at their discretion. • Experts are limited to one per side, absent agreement of the parties or leave of the court. • Pretrial motions require leave of court and may not exceed three pages. • Neither the terms of the Agreement nor its existence may be revealed to the jury.

• Juries will consist of six jurors. That may be reduced to five should a juror become unable to serve. • The judge conducts jury voir dire and sets time limits for openings and closings. • Each side is allowed three hours for presentation of its case, including cross-examination. • Post-trial motions are limited to recovery of costs and attorneys’ fees. • Grounds for new-trial motions and appeals are limited. While this program appears to have some real merit, a review of many of its provisions – specifically, for example, the 10-document request limit, the goal to try the case in six months, and the time limits for opening and closing statements – suggests that it will mainly serve cases with little or no complexity. My proposed modified summary jury trial procedure, however, is designed to be useful for all cases, and perhaps especially for complex ones. The trick in complex cases is to evaluate all of the facts and issues and boil them down to a comprehensive and understandable theory of the case. Complex cases may require more than 10 document requests and 15 hours of deposition. But, after enough discovery is completed to formulate a theory of the case, a chance to then proceed quickly to a truer evaluation of those theories would prove invaluable for settlement, trial evaluation, and ultimately for reduction in costs. By way of example, this could work extremely well in patent cases, which by their very nature are complex. Counsel for both the patent owner and the accused infringer in patent cases spend a great deal of time analyzing the meaning of specific words in the asserted patent claims and the application of those words to the accused product. This evaluation is done early in the case, yet two or more years of discovery will often elapse before there is any real opportunity for each party to legitimately “put on a case.” The fact gathering and surmising process that takes place during discovery is different than the actual presentation of those facts by a witness as part of an established theory of a case, but the sooner both parties can participate in and evaluate the latter, the better. A summary jury trial serves to accelerate the process in a cost-efficient way. ■

Patrick J. Arnold Jr. is a shareholder at McAndrews Held & Malloy in Chicago. His practice involves diverse areas of technology, focusing on patent, trademark and copyright litigation. He also assists clients in procurement, counseling and licensing. parnold@ mcandrews-ip.com

FCPA NEEDS FINE TUNING, SAYS FORMER

Congress Unlikely to Act

BY ALBERTO R. GONZALES 60

THE MAGA ZINE FOR THE GENER AL COUNSEL, CEO & CFO AUG/ SEPT 2012

uring my tenure as Attorney General, the Justice Department increased investigations under the Foreign Corrupt Practices Act (FCPA), which was enacted to outlaw payment by U.S. companies of foreign bribes to obtain and retain business. President George W. Bush supported the FCPA work of the Justice Department and the SEC. He supported less government regulation of businesses, but he also understood the importance of enforcing the rule of law in order to raise confidence in the business community that the federal government understood the necessity of consistency and predictability in law enforcement decisions. There has been a recent explosion of American investment and business in foreign countries in which corruption and bribes are a routine part of doing business. Ironically, using the FCPA to level the playing field among domestic companies doing business abroad has led to the complaint that the statute places U.S. companies at a disadvantage with respect to their foreign competitors. Because of increased American business activity overseas, the Bush administration made a conscious decision to allocate more resources to FCPA enforcement. We quickly discovered two things: The FCPA gives prosecutors tremendous discretion in defining its scope, and, thus, tremendous leverage in charging decisions; and corporations do not like to be investigated for any reason, but particularly for violations of the FCPA. As a result, these cases often settled. Charges were dropped in exchange for either non-prosecution or deferred prosecution agreements. But the more that American companies elect to settle and not force the DOJ to defend its aggressive interpretation of the Act, the more aggressive the DOJ has become in its interpretation of the law and its prosecution decisions. Because there are provisions in the Act that are either undefined or not well defined, there is great uncertainty and risk to a company that elects to fight charges. In 2008, DOJ began to string together a series of FCPA triumphs against companies like Siemens ($450 million), KRB/Halliburton ($579 million), and BAE Systems ($400 million). It is no secret that the Department began to target individuals, in addition to targeting parent companies and their subsidiaries, believing that these type of prosecutions would be most effective to discourage violations of the FCPA. Evidence of the new strategy was quickly apparent. Individual indictments rose from six in 2006 to 48 in 2010. However, because individual defendants are less likely than corporate defendants to settle or plead if it means jail time, the Department found itself going to trial in these cases. The prosecutions encountered trouble.

AUG/ SEPT 2012 E X ECUTIVE COUNSEL

Here are two examples: Based on the testimony of a cooperating witness, twenty-two individuals were indicted in 2010 in a government sting operation known as the Las Vegas “Shot Show” case. The trials were a disaster for DOJ. The first resulted in a hung jury, the second resulted in the dismissal of a conspiracy charge and outright acquittal of one defendant at the close of the government’s case,

THE FCPA GIVES PROSECUTORS TREMENDOUS DISCRETION IN DEFINING ITS SCOPE.

followed by two more acquittals by jury and another hung jury for the remaining defendants. In the end, the government not only dismissed pending indictments against those who had not yet gone to trial, but shortly thereafter also agreed to vacate the convictions of those who had already pled guilty in the case. Losses at trial are uncommon, but not rare. What is virtually unheard of is for the government to abandon a case in such a comprehensive fashion. During the same period, the Department suffered another blow in a Los Angeles case, in which DOJ charged Lindsey Manufacturing and two of its senior officers with violating the FCPA in connection with efforts to secure contracts from a Mexican state-owned utility. The government obtained convictions for all three defendants in May 2011. However, the defendants filed post-trial motions seeking to vacate their convictions, claiming the government had engaged in a pattern of misconduct. The court agreed to vacate the convictions and dismissed the indictment with prejudice. These and other unfavorable outcomes fueled speculation the government may either abandon its new strategy of targeting individuals and refocus on corporate targets, or scale back its FCPA efforts altogether. That has not happened for three reasons. First, the law enforcement priorities of DOJ reflect those of the President and the Attorney General. If they want to highlight corporate wrongdoing, the Department will continue to push these prosecutions. This Administration has not been shy about taking on big business in areas such as antitrust, tax and environmental enforcement. I am not commenting on the wisdom of these policies, just opining that this Administration is not likely to

give corporations the benefit of the doubt when it comes to FCPA investigations. Second, the FCPA prosecution strategy is not likely to change because the problems that plagued some of these cases are problems that either have been or can be corrected. While every setback is painful, they can also be a learning experience. The prosecution of FCPA cases are centralized in the Fraud Section of the Criminal Division to maximize resources and develop special expertise. Mistakes and lessons learned from one case are institutionalized in the prosecution play book for the next FCPA case. Third, I believe that FCPA prosecutions will continue because of cases like Wal-Mart. A few weeks ago the New York Times published an article detailing Wal-Mart’s apparent systematic plan to aid its expansion efforts in Mexico in the mid-2000s by making approximately $24 million in payments to local officials in order to obtain necessary construction licenses and permits. Because the FCPA contains an exception for payments which merely speed government action, as opposed to influencing the exercise of discretionary authority, there remains some question about whether the payments themselves actually violated the statute. Nevertheless, the surrounding circumstances – including alleged efforts to conceal the payments and to stymie a subsequent internal investigation – suggest that knowing violations occurred, and many experts expect government-imposed sanctions. At this point, Wal-Mart has a significant credibility problem in the eyes of government FCPA enforcers. The government’s perception is that the company not only failed to take adequate measures to prevent violations of the FCPA by its employees, but also allowed for an investigative whitewash once those apparent violations came to the attention of senior management. Together, those factors suggest a deliberate and concerted effort to violate the law. While it is likely too late for Wal-Mart to avoid government sanctions, the company maintains the ability to limit those penalties by demonstrating a genuine commitment to FCPA compliance. This means determining what happened in Mexico, finding out who authorized the conduct in question, taking appropriate disciplinary actions against those individuals, and installing measures to minimize the risk of future violations. Not surprisingly, Wal-Mart stock was down the first trading day after the New York Times article. The decrease reflects not simply the potential continued on page 64

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FCPA Needs Fine Tuning continued from page 62

Alberto R. Gonzales

is Of Counsel at the law firm of Waller Lansden Dortch & Davis, LLP, and the Doyle Rogers Distinguished Chair of Law at Belmont University. He is the former U.S. Attorney General and former Counsel to President George W. Bush. His speech on the FCPA, given to the Lawyers for Civil Justice on May 4, 2012, in Washington, D.C., can be found online at http://ow.ly/bsuSb. argonzales@ wallerlaw.com

cost of the investigation, possible sanctions, shareholder litigation and the public relations hit, but also the market’s recognition that some members of senior management may be terminated, thus hurting the company’s future prospects. The government will expect the company to undertake to determine whether and to what extent similar conduct has occurred in other parts of the world. The rationale underlying this obligation is that if this conduct occurred as a result of failures of internal controls, a similar lack of controls elsewhere in the world makes them equally susceptible. No one knows, of course, what the DOJ, SEC or Wal-Mart ultimately will do. However, I will share for you my perspective as Attorney General. A significant part of the job was to develop relationships with my foreign counterparts in order to develop better coordination, communication and consultation on law enforcement issues. I spoke often about the poison of public corruption and the need for other countries to address their internal corruption. It appears that Wal-Mart may have contributed to that corruption, raising questions whether competitors were forced to do the same in Mexico and around the world. If the reported facts are true, much of this activity occurred while I was in office. Candidly, when I read the New York Times story I was angry. The payments by Wal-Mart may be lawful as facilitating payments, although I do not

factors have altered the calculus by increasing the chances that the conduct will come to light if not disclosed. These include more resources, as discussed earlier, and a bounty incentive for whistleblowers now available under Dodd Frank. The FCPA was amended in 1988 during a tough economic climate to help American companies compete worldwide. We are in a tough economic environment again, but further amendments are unlikely given the Wal-Mart allegations. I believe companies have an obligation of due diligence and should have in place a strong compliance program, particularly when doing business in countries where corruption is routine and expected. Companies cannot purposefully remain ignorant. But how much do they have to do? I question the fairness of going after the company for the unknown violations by a foreign agent under the following conditions, based on DOJ Principles of Prosecution: • If the company makes a voluntary disclosure of wrongdoing. • If there was no participation in the illegal conduct by senior management. • If there is full cooperation with the government. • If the company implements remedial measures to prevent future violations. • If the company has a strong compliance program in place before the alleged behavior happened.

WAL-MART HIGHLIGHTS THE RISKS FOR COMPANIES WHEN THEY ELECT NOT TO REPORT FCPA PROBLEMS. believe the Department has ever agreed to facilitating payments in this amount, and the 2004 Fifth Circuit decision in U.S. v. Kay provides a window for prosecutors to attack the payments as falling within the context of foreign government procurement. Wal-Mart highlights the risks for companies when they elect not to report FCPA problems. The limited amount of government resources dedicated to FCPA issues in the past served to reduce the risk of detection and often tipped the scales in the decision by companies not to self disclose. In recent years, however, several

I do not support bribery, but I support targeted reforms to the FCPA that add a compliance defense and a willfulness requirement for corporate criminal liability. The United States should continue its efforts to get other countries to stop corruption, and I favor this approach of leveling the playing field over allowing U.S. companies to bribe foreign officials without consequences. However, there is clearly more that can be done to help American companies be competitive. Reforms are unlikely at the congressional level, but relief is possible and should be pursued at the agency level. ■

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