Federal Court Considers SEC Subpoena of Outside Consultant Records

December 27, 2018

Today, there are few industries where consultants are not active. In some situations, a consultant is brought in to find problems. In other situations, consultants are engaged to fix problems. In some circumstances, consultants are hired in anticipation of litigation. In other circumstances they are hired to assist in litigation. Consequently, there is often a ton of information provided to and developed by an industry consultant that you may want to keep confidential. But according to what legal theory? When these outside third-parties were finding or fixing problems or helping you deal with the impact of a lawsuit or regulatory investigation, they frequently interacted with in-house and outside counsel. Perhaps the attorney-client privilege or attorney work product would cover any negative findings? On the other hand, the outside consultants were not lawyers and you did speak with them before your firm was named in any Complaint and before you actually hired your lawyer  . . .  uh oh. Consider how these issues just played out in a motion to quash an SEC subpoena directed at a consultant.

FINRA ETF Action

Upon learning that the Financial Industry Regulatory Authority, Inc. ("FINRA") had initiated an enforcement action against a brokerage firm for marketing exchange traded funds ("ETF"), Louis Navellier, the founder and principal of Navellier & Associates Inc. ("NAI") became concerned that the Securities and Exchange Commission would investigate NAI and other investment advisor firms that advertised ETF-based strategies. 

2013 ACA Review and Retention

On January 29, 2013, NAI's President forwarded various marketing materials directly to ACA Compliance Group partmer Ted Eichenlaub for review; and in his response, Eichenlaub invited NAI's President to follow up with him or his associate to gain clarity on the issues without any mention of counsel. Thereafter, ACA performed a mock audit of NAI that confirmed that NAI "looked pretty good." Accordingly, around February 2013, NAI retained outside consultant ACA Compliance Group to conduct a compliance review of NAI's marketing materials regarding Vireo AlphaSector strategies, which NAI licensed from F-Squared Investments, Inc. At the time when Navellier had engaged the services of ACA, he did not anticipate being sued and did not anticipate NAI being sued; notwithstanding that Naveliier's and NAI's counsel would subsequently state that ACA was retained to assist him in providing legal advice to his client in anticipation of possible SEC litigation. 

2013 SEC F-Squared Investigation

In September 2013, the SEC's Division of Enforcement opened an investigation into F-Squared, including its representations concerning F-Squared's AlphaSector strategies. Sometime in October 2013, Enforcement subpoenaed NAI for documents relating to the F-Squared investigation.

2016 SEC Investigation of NAI

In "Advisory Firm and Founder Charged for False Performance Claims in Advertising Materials" (SEC Lit. Rel. No. 23925 / August 31, 2017)
https://www.sec.gov/litigation/litreleases/2017/lr23925.htm, the SEC announced that it had filed a Complaint in the United States District Court for the District of Massachusetts alleging that Navellier & Associates violated Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-1(a)(5) and that Louis Navellier violated and, in the alternative, aided and abetted Navellier & Associates' violations of Sections 206(1) and 206(2) of the Advisers Act. READ the Complaint. https://www.sec.gov/litigation/complaints/2017/comp23925.pdf
As set forth in part in the SEC Litigation Release, the Complaint alleged that:

[F]rom 2010 to 2013, Mr. Navellier and his firm defrauded their clients and prospective clients, misleading them about the performance track record of the "Vireo AlphaSector" investment strategies that the firm offered under the "Vireo" brand name. First, Mr. Navellier and his firm allegedly breached their fiduciary duty to clients and prospective clients by ignoring and concealing red flags that should have alerted them that the investment strategies had not performed as advertised. Second, Navellier & Associates allegedly distributed materially false advertisements and client communications about the performance track record of the investment strategies. Third, as Mr. Navellier and his firm realized their misrepresentations could get them in legal trouble, they allegedly sold the Vireo line of business in August 2013 for $14 million, rather than correcting their prior misrepresentations to their clients or informing their clients about their conflicts of interest in selling the Vireo business.

Navellier & Associates' advertisements claimed that client assets had been invested in the investment strategies from April 2001 to September 2008 and that the strategies had significantly outperformed the S&P 500 Index from April 2001 to September 2008. In fact, no client assets had tracked the strategy from April 2001 through September 2008, and even as a back-test the claimed performance was substantially overstated.

SEC Subpoena

Defendants NAI and Navellier moved to quash an SEC subpoena seeking documents in the hands of  third-party consultant ACA pertaining to NAI for the January 2012 to September 2013 time period on the basis of the attorney-client privilege and the work-product doctrine. SEC argues that the 
  • attorney-client privilege does not apply to third-party communications;
  • ACA does not fall under a limited exception to this rule; and
  • litigation with the SEC was not anticipated. 
Magistrate Judge Mariann B. Bowler denied the Motion to Quash. In Securities and Exchange Commission, Plaintiff, v. Navellier & Associates, Inc. and Louis Nellier, Defendants (Memorandum and Order RE: Defendants' Motion to Quash Plaintiff's Subpoena to Non-Party ACA Compliance Group and for Protective Order; United States District Court for the District of Massachusetts, 17-11633 / December 21, 2018)
http://brokeandbroker.com/PDF/NavellierDMAOrder181221.pdf

Attorney-Client Privilege

In addressing the issue of attorney-client privilege, Magistrate Bowler reiterates the "well-honed" holding that said privilege protects "only those communications that are confidential and are made for the purpose of seeking or receiving legal advice," and does not immunize facts available from other source merely because a client had disclosed such facts to an attorney. As to the specific contentions at issue, the Memorandum and Order explains:

Defendants insist that the privilege extends to an outside consultant such as ACA because NAI hired ACA as part of an internal company review to assist NAI's counsel in advising his clients, NAI and Navellier (Docket Entry # 68-1, ¶ 4), regarding possible future litigation with the SEC. (Docket Entry ## 68, 74). The SEC disagrees and maintains that disclosure to an outside party such as ACA does not fall within the narrow exception to the waiver rule that applies when confidential communications are disclosed to the outside party. (Docket Entry # 69).

Magistrate Bowler concedes that documents created by an outside, third-party at an attorney's request for the purpose of advising and defending the client could fall under the exception pertaining to waiver of the privilege; however, such disclosure generally must be necessary to the lawyer in providing legal advice to the client. Necessary means more than just useful and may well be narrowed to something akin to a nearly indispensable. Accordingly, the Memorandum and Order holds that:

Here, the ACA was not serving an interpretive role and was not "'necessary, or at least highly useful'" to defendants' counsel in providing legal advice to defendants. Accordingly, the documents sought by the subpoena are not subject to attorney-client protection. 

Work Product Doctrine

As to the issue of whether the subpoenaed materials fall within the work-product doctrine, the Magistrate stated that the Defendants bear the burden of establishing such and that:

[H]ere, the SEC did not commence an investigation into NAI until more than two years after the end date of the time period for documents sought in the subpoena, September 2013. Navellier's concern about possible future litigation with the SEC in 2013 does not make the prospect of litigation with the SEC anticipated. Accordingly, the work-product doctrine does not provide protection for the withheld material. 

Overbroad

Notwithstanding the apparent SEC victory found in the Magistrate's denial of Respondents' Motion to Quash, she determined that:

Although the subpoenaed material is not privileged, the time period (January 2012 to September 2013) appears overbroad inasmuch as ACA's engagement began in or around January 2013. The parties are therefore instructed to confer with each other in an effort to narrow the time frame.