Attorney Client Privilege Dispute Turns Aunt Into Uncle At The SEC

November 5, 2012

Seal of the U.S. Securities and Exchange Commi...

Reduced to basics, the attorney-client privilege is a client's privilege to refuse to disclose confidential communications with his or her attorney, and to prevent that disclosure by others. This privilege is a bedrock principle of American jurisprudence.  The core components of the privilege are

  • the existence of a communication;
  • that the communication be intended as confidential; and
  • that the purpose of the communication is to provide or obtain legal counsel.

The attorney-client privilege ensures that clients are able to fully explore potential and actual legal problems with their lawyers. On the other hand, if that privilege is frivolously asserted, it impedes the ability to investigate wrongful activity.

Turnaround Fair Play?

On May 1, 2012, the Securities and Exchange Commission ("SEC") issued an Order Instituting Administrative and Cease-and-Desist Proceedingsin In the Matter of Miguel A. Ferrer and Carlos J. Ortiz (Securities and Exchange Commission, Securities Act Of 1933 Release No. 9317; Securities Exchange Act Of 1934 Release No. 66892; Investment Company Act Of 1940 Release No. 30058; Administrative Proceeding File No. 3-14862 / May 1, 2012).

SIDE BAR:  In the Order, the Division of Enforcement (the "Division") alleged that during 2008 and 2009, Ferrer and Ortiz made fraudulent statements and omissions in connection with the offer, purchase and sale of 23 non-exchange-traded closed-end funds ("CEFs") in Puerto Rico; pointedly that the two respondents misrepresented that a competitive and liquid CEF secondary market existed in the face of declining investor demand, while concealing from investors that UBSFinancial Services Inc. of Puerto Rico (UBS PR) was propping up CEF market prices. Also, the Division alleged that Ferrer and Ortiz made these misrepresentations and omissions involving the sale of new primary market CEFs to customers.

Starting in March 2009, the Division alleged that after UBS PR's parent firm directed UBS PR to substantially reduce its growing inventory citing a significant financial risk, UBS PR and Ortiz executed a scheme to dump UBS PR's proprietary CEF shares by soliciting investors and undercutting sell orders from UBS PR's own customers trying to exit the market. The alleged result of the scheme was to produce significant market value losses for existing CEF customers. During this period, Ferrer also allegedly made misleading statements about CEF liquidity and market prices and assured that CEFs would always trade at high premiums to net asset value, even while UBS PR was substantially reducing its inventory, and according to Ferrer, causing "huge losses" to investors.

NOTE: The respondents are presumed innocent unless and until the Division proves its case at an administrative hearing.

At the hearing on October 11, 2012 (during nine days of October 2012 hearings) the Division  objected to a question posed to Ortiz by his counsel as to whether the document that Ortiz used in making a presentation, and the underlying policy described in the document, were reviewed by UBS Financial Services Inc. of Puerto Rico's Legal and Compliance Departments. UBS is Ortiz's employer and is providing him with legal counsel.

In making its evidentiary objection during the hearing, the Division asserted that during its investigation, it had been prevented on several occasions from inquiring into matters involving discussions with lawyers.  Accordingly, the Division argued that witnesses should not be allowed to testify about consulting with UBS' legal department. A classic what's-good-for-the-goose-is-good-for-the-gander position: If we can't ask you about it, then you can't discuss it.

Ortiz's counsel responded that:

  1. Ortiz has no power to assert or waive UBS's attorney-client privilege and has not asked UBS to do so; and
  2. the evidence is not being used to show that UBS's Legal counsel approved the documents, but rather to show that Ortiz checked with Legal and Compliance to refute the Division's expected claim that Ortiz was negligent.

ALJ Strikes Testimony

Chief Administrative Law Judge Murray ("ALJ")  sustained the Division's motion to strike Ortiz's answer and sustained several similar objections during Ortiz's and Ferrer's  testimony.  Thereafter, the parties presented their positions on those rulings.

Ortiz argued that the Division was not prevented from pursuing its line of questioning and, in fact, was properly allowed to ask questions about non-privileged communications. Overall, UBS properly objected to questions regarding the substance of witnesses' discussions with lawyers. Further, Ortiz denied that he was asserting a reliance-on-counsel defense; and, to the contrary, he asserted that he was merely demonstrating that before he made any kind of statement or presentation concerning the securities that are the subject of this proceeding, that he had the underlying information checked by the Legal Department.

Similarly, respondent Ferrer argued that  the Division was permitted to explore the circumstances surrounding consultations that Ferrer and Ortiz had with counsel. Ferrer requested that his answer at the hearing on October 16, 2012, be allowed to stand or, alternatively, that counsel's offer of be accepted as evidence in the proceeding

SIDE BAR:The hearings were scheduled to resume in Washington, DC on October 29th but were suspended because of Hurricane Sandy.

Rules Of Evidence

In adjudicating the parties' objections, Chief Administrative Law Judge Murray referenced the SEC's Rules of Practice:

SEC Rule of Practice 320. Evidence: Admissibility.

The Commission or the hearing officer may receive relevant evidence and shall exclude all evidence that is irrelevant, immaterial or unduly repetitious. 

The ALJ analyzed the threshold issue as follows:

Rule 320 of the Commission's Rules of Practice, which allows the admission of relevant, material, and not unduly repetitious evidence, does not prohibit unfairly prejudicial evidence. Other knowledgeable authorities take a different position. The Financial Industry Regulatory Authority (FINRA) provides for the exclusion of evidence that is "unduly prejudicial." FINRA Rule 9263(a). "Undue prejudice" is defined as "The harm resulting from a fact-trier's being exposed to evidence that is persuasive but inadmissible (such as evidence of prior criminal conduct) or that so arouses the emotions that calm and logical reasoning is abandoned." Black's Law Dictionary 1198 (7th ed. 1999). And, perhaps more significantly, Rule 401 of the Federal Rules of Evidence provides that:

The court may exclude relevant evidence if its probative value is substantially outweighed by a danger of one or more of the following: unfair prejudice, confusing the issues, misleading the jury, undue delay, wasting time, or needlessly presenting cumulative evidence. ¹

"Situations in this area call for balancing the probative value of and need for the evidence against the harm likely to result from its admission," and "‘Unfair prejudice' within its context means an undue tendency to suggest decision on an improper basis, commonly, though not necessarily, an emotional one." Fed. R. Evid. 403, Advisory Committee Notes 2012, Revised Edition, West. . .


footnote 1: The Commission's case law is that the Federal Rules of Evidence do not govern Commission proceedings, however, they are often used as a reference point.

Unfairly-Prejudiced Standard

In analyzing the issue, the ALJ first considered the  attorney-client privilege, which she framed as  the client's right to refuse to disclose and to prevent any other person from disclosing confidential communications between the client and the attorney. The ALJ noted that witnesses had answered some investigative and hearing questions about involvement with the Legal Department without objection; and that some exchanges on the issue were  the appropriate invocation of the privilege or  dialogue about it.  Nonetheless, although UBS expressly instructed Ortiz that he could testify to having conferred with the Legal department, when he conferred, and with which lawyers - such instructions only allowed Ortiz to describe what was discussed on a phone cal, for example,l if there were no lawyers involved.

In considering the range of UBS's objections, the ALJ believed that the attorney-client privilege had, in fact, occasionally been over-zealously invoked; and, as a consequence, the Division had been prevented from investigating the Legal Department's involvement in these issues. The ALJ deemed such a proscription as having unfairly prejudiced the Division by allowing the respondents to show that they had consulted UBS's Legal Department and it allowed or approved the use of the materials in dispute. Accordingly, the ALJ sustained the Division's objections to questions about clearance of material by UBS's Legal Department and declined to use that material in making a decision.  In the Matter of Miguel A. Ferrer and Carlos J. Ortiz (Order On Evidentiary Issue, Admin. Proc. Ruling Rel. No. 730; Admin. Proc. File No. 3-14862 / November 2, 2012).

Bill Singer‘s Comment

As a lawyer, I jealously guard the attorney-client privilege, which I view it as among the most important privileges embedded in our legal system.  That being said, it is also among the most abused.  I hardly imagine that I could present an more even-handed analysis than that.

What I don't understand about the ruling in this case is that nowhere in the SEC Rules of Practice is there an "unfairly prejudicial" standard. Go re-read the cited rule: it ain't there.  Consequently, the ALJ's decision isn't on the firmest of ground and may well prove shaky if appealed to the federal courts.

The ALJ's rationale comes off as an exercise in if my aunt were a man, she'd be my uncle.  Clearly, I find the justification for the ruling flawed - which is not to suggest that it is wrong but to underscore how shaky it may prove to be on any appeal.  Boiled down to its essence, the rationale is that the respondents' assertion of the attorney-client privilege at the times in dispute served to unfairly prejudice the Division.  From there it's a bumpy ride.

There is no "unfairly prejudicial" standard in the SEC's Rules of Practice that would permit the proffered evidence to be struck.  The ALJ then considers other evidentiary rules that do not apply to the SEC and concludes, sort of, that there is a unfair prejudice standard that she can apply at the SEC.  Except,you know, there really isn't - and note the cited footnote.

The better approach to untying this Gordian Knot would have been to find that the attorney-client privilege was not properly invoked and to order the testimony, if such a legal basis existed.  The other approach would have been to allow the testimony for the limited purpose of showing the prior consultation but to take it for what it's worth given the lack of substance (and that value would be limited).

The other solution - going forward - would be for the SEC to sense how its ALJ squirmed in trying to resolve this issue and to revise its Rules of Practice to cover this issue in the future.

Understand that I am not even remotely suggesting that it was not "unfair" for the respondents in this case to have asserted the attorney-client privilege as they chose.  That may well have been the case and, if such is correct, then the ALJ likely reached the right decision by a most unfortunate circuitous track.  I'm simply noting that seasoned lawyers will likely read this case with disapproval.  Of course, those same lawyers may feel some discomfort, when they see their own shenanigans all too clearly depicted.