Allegedly, a substantial portion of the Funds' investments were in subordinated tranches of various securitizations, including mortgage-backed securities, for which market quotations were not readily available between January 2007 and August 2007, thus requiring a large proportion of the Funds' portfolios to be periodically valued based on good faith valuation procedures established and overseen by the Directors.  The OIP alleged that the Directors did not determine a fair valuation method, nor did they continuously review any such method's appropriateness; but, to the contrary, delegated those duties to a fair valuation committee, without providing the committee any meaningful guidance, and did not even bother to learn how fair values were being determined. The SEC alleges that such failures resulted in the NAVs of the Funds being materially misstated from at least March 31, 2007 to August 9, 2007.

Oops!

On January 18, 2013, counsel for the Independent Directors involved in this matter notified the SEC Division of Enforcement ("Division") counsel, that the Division appeared to have produced privileged emails. In response to that advisory, the Division requested identification of the possibly privileged emails - counsel for the Independent Directors declined to do so.

On January 23, 2013, Division counsel notified Respondents' counsel that the Division "asserts privilege to internal emails among the staff, as well as any draft or final action memos."

In the hallowed tradition tit-for-tat and one-upmanship of litigation, on  January 30, 2013, the Independent Directors disclosed (but did not file under seal) one of the emails as an attachment to a "Supplemental Response" to the Division's Motion to Strike.

On February 1, 2013, the Independent Directors agreed to return two emails that contained attached action memos.

Submitted to the ALJ

Reduced to its essentials, the Division seems to have inadvertently produced documents to respondents, among the materials sent are 11 emails that the Division now argues are "privileged." All of which prompted motion practice among the parties concerning whether a protective order should be issued to preserve the confidences in the subject communications.  As part of it Motion on February 11, 2013, the Division has asked SEC Administrative Law Judge Cameron Elliot to find:

• that the eleven emails, identified in Div. Ex. A, are privileged,
• that the Division did not waive any privilege by their inadvertent production,
• that the emails are inadmissible, and

for the ALJ to order Respondents to return or destroy all copies of the emails. Respondents assert that any privilege associated with these eleven emails has been waived and state that they intend to use the emails in litigation of this proceeding.

Dissecting The Issue

In a somewhat ominous telegraphing of the ALJ's likely ruling, we have this pronouncement In the Matter of J. Kenneth Alderman, CPA et al. (Order on Motion For Protective Order, Securities And Exchange Commission, Admin Pro. Rulings Release No. 755, Admin. Proc. File #3-15127, March 5, 2013), on page 3 of the Order:

It is laudable that the Independent Directors notified the Division of a possible inadvertent production and agreed to return two obviously privileged emails; it is most definitely not laudable that they otherwise declined to specifically identify the suspect materials and eventually disclosed one of them in a publicly available filing. I am at a loss to understand why the Independent Directors have been so cavalier about the sensitivity of the materials at issue, particularly because they are almost entirely irrelevant in this proceeding.

The ALJ determined that the subject emails are irrelevant and generally of no probative value; and the communications fall into four categories:

1. emails between SEC staff forwarding information of potential use in the investigation leading to the present OIP
2. emails between Commission staff that evidence deliberations over whether to file the present OIP
3. an email between Commission staff about a possible separate administrative proceeding against an entirely different respondent
4. an email forwarding a complaint from the Commission's Tips, Complaints, and Referrals (‘TCR") system

Moreover, since the emails are replete with the opinions of SEC staff members, the ALJ notes that:

The opinions of the various staff members involved in deciding whether to bring this proceeding are of no concern to me. In fact, it would be illegal for me to consider such opinions. Commission Rule of Practice 121 states:

Any Commission officer, employee or agent engaged in the performance of investigative or prosecutorial functions for the Commission in a proceeding as defined in Rule 101(a) [of the Commission's Rules of Practice] may not, in that proceeding or one that is factually related, participate or advise in the decision, or in Commission review of the decision pursuant to Section 557 of the Administrative Procedure Act, 5 U.S.C. 557, except as a witness or counsel in the proceeding.

As to the issue of irrelevancy, the ALJ underscores that the emails will not be used in litigation, which is viewed as a circumstance that effectively deprives the Respondents of any legitimate interest in using or even keeping them.  Based upon considerations of both irrelevancy and work-product doctrine, the ALJ granted the Division's Motion and ordered that all copies of the eleven emails at issue, in whatever form, be returned to the Division or destroyed; and that all documents which refer to the contents of the eleven emails will be treated as confidential, including all filings in this proceeding designated by any party as "FILED UNDER SEAL"

Bill Singer's Comment

One troubling and disconcerting aspect of this matter is the revelation that one of the emails inadvertently forwarded by the Division to the respondents contained a complaint from the TCR system.  I and other Wall Street regulatory pundits have often wondered about the sanctity of the SEC Whistleblower protections of anonymity (as mandated under Dodd-Frank). Whether the substance of the TCR Complaint included the disclosure of the identity of a whistleblower or not is beside the point. The most pertinent question now is how did this leak occur and what steps, if any, have been implemented to prevent a recurrence.