Crime-Fraud Exception Applied

The United States Court of Appeals for the Second Circuit affirmed a district court's application of the crime-fraud exception

On the merits, we see no abuse of discretion in the district court’s application of the crime-fraud exception to the attorney-client privilege. The district court did not clearly err in finding that one of the Company’s internal controls required that all significant contracts be submitted to its legal department for review – in fact, its finding was based on Sealed Appellant 1’s own statement to the Company’s auditor that such a control was in place. It also did not clearly err in finding that the agreements, which addressed allegations of serious workplace sexual misconduct by the Company’s CEO and involved millions of dollars in payments, were significant for purposes of that control. Finally, it did not clearly err in finding that Sealed Appellant 1 and Sealed Appellant 2’s communications about the agreements helped to shield them from the Company’s legal department, circumventing that control. As a result, the district court did not abuse its discretion in holding that the crime-fraud exception applied.

The case involves a public company traded on the New York Stock Exchange and, as such, was legally obligated to keep accurate books and records

During his tenure leading the Company, Sealed Appellant 1 relied for legal advice on Sealed Appellant 2, a partner at the law firm Sealed Appellant 3. Even as to the corporate client, the relationship between Sealed Appellant 1 and Sealed Appellant 2 was a close one: Sealed Appellant 2 noted that unlike the typical outside counsel, he maintained direct contact with Sealed Appellant 1, not just the Company’s general counsel. Sealed Appellant 2 represented both the Company and Sealed Appellant 1 personally throughout the relevant period.

Between 2018 and 2022, Sealed Appellant 2 helped Sealed Appellant 1 negotiate two non-disclosure agreements to which the Company was a party but which were not disclosed to the Company’s in-house legal department or its auditors. Both agreements were made with female former Company employees who had accused Sealed Appellant 1 of sexual misconduct.

The company appointed a special committee after an anonymous tip about one of the settlements.

On July 25, 2022, the Company announced that it would restate its financial statements for the years of 2019, 2020, 2021, and the first quarters of 2021 and 2022 to account for $14.6 million in settlement payments that Sealed Appellant 1 had made or committed to make on behalf of the Company between 2006 and 2022 – including the $10.3 million in payments to Victims 1 and 2. The Company explained that those payments previously “were not appropriately recorded as expenses in the Company’s Consolidated Financial Statements.” Id. at 482. However, the Company also concluded that “the quantitative and qualitative impact of these accounting errors” was such that the errors “were not material to its previously issued financial statements.” Id.

Proceedings

On September 13, 2023, the government served grand jury subpoenas on Sealed Appellant 2 and Sealed Appellant 3. Among other requests, the subpoenas sought all communications between and among Sealed Appellant 1 and lawyers or other personnel of Sealed Appellant 3 concerning Victims 1 and 2. On December 12, 2023, Sealed Appellants 2 and 3 substantially completed their initial production of materials responsive to the subpoena. The production included a privilege log indicating that Sealed Appellants 2 and 3 had withheld 208 documents based on assertions of attorney-client privilege raised by Sealed Appellant 1 and the Company.

Holding

we hold that the district court did not abuse its discretion in applying the crime-fraud exception to the disputed documents here.

Basis

In sum, the fact that it might be prudent for a company to ensure that all the controls on which it relies are recorded in a particular internal format does not necessarily mean that a control exists only if it is documented that way. That observation is especially salient where the control aligns with common sense (like, for example, a requirement that company lawyers review significant company-related contracts) and when the company represents externally that the control is indeed in place. Thus, Sealed Appellant 1’s counter-arguments do not undermine the district court’s finding that there was probable cause to believe that the Company had a legal contracts control in place during the relevant period.

Concealment

Those facts provide a sufficient basis for a prudent person to believe that the settlement negotiations and resulting attorney-client communications were structured and intended to conceal the resulting agreements from the Company. As the district court explained, “[e]very edit to the draft agreement and every discussion about the negotiations and how to structure the deals played a role in keeping the Victims quiet and the Company . . . in the dark.” Special App’x at 17. Intentional concealment of the settlement negotiations from the Company could support a finding that Sealed Appellant 1 and Sealed Appellant 2 circumvented the legal contracts control – a criminal violation of 15 U.S.C. § 78m(b)(5). As a result, the district court properly held that probable cause existed to believe that the relevant communications were (1) “in furtherance of [a] crime or fraud” and (2) “intended . . . to facilitate or to conceal the criminal activity.” In re Richard Roe, 168 F.3d at 71 (emphasis omitted). Thus, its application of the crime-fraud exception was not an abuse of discretion.

Because we hold that the district court did not err in deciding that these documents are subject to the crime-fraud exception based on the legal contracts control theory, we decline to address whether they are also subject to the exception on the other bases addressed by the district court.

(Mike Frisch)