In re the Leslie Fay Companies, Inc. Securities Litigation

Citation: 161 F.R.D. 274Docket: Master File No. 92 Civ. 8036 (WCC)

Court: District Court, S.D. New York; May 26, 1995; Federal District Court

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The opinion and order issued by Senior District Judge William C. Conner addresses a discovery dispute in a class action lawsuit involving The Leslie Fay Companies, Inc., where plaintiffs allege securities law violations against former officers and directors, as well as the company's former auditor, BDO Seidman. BDO seeks the production of documents related to an Audit Committee Report (ACR) generated during an investigation into accounting irregularities. This investigation was prompted by the Board of Directors' awareness of financial discrepancies on January 31, 1993, which led to the Audit Committee hiring Weil, Gotshal & Manges for legal assistance and Arthur Andersen & Co. for accounting support.

The Court mandates that Weil produce documents unless it can demonstrate, on an individual basis, that any withheld documents contain legal analysis or advice not included in the ACR and pertain to different subject matters. The background includes the public announcement of the Audit Committee's investigation on February 1, 1993, which coincided with the filing of the first of multiple shareholder lawsuits and the initiation of investigations by the SEC and U.S. Attorneys. Following the completion of the ACR, Leslie Fay shared it with the SEC and U.S. Attorneys, which the Court previously ruled waived any associated legal protections.

Following the establishment of the Audit Committee Report (ACR) in the Leslie Fay chapter 11 bankruptcy case, the Creditors’ Committee raised concerns regarding Weil’s impartiality and the report's accuracy. In response, the bankruptcy court appointed Examiner Charles A. Stillman to investigate these claims. Stillman reviewed a significant amount of work product from Weil and AA related to the ACR and conducted depositions of several Weil attorneys. The court ensured that the confidentiality of the documents produced during the investigation was preserved, affirming that their production did not compromise any work-product or attorney-client privileges.

On May 27, 1994, Stillman submitted two reports to the bankruptcy court, evaluating potential claims for the bankruptcy estate and assessing Weil’s conflict of interest in representing the Audit Committee and preparing the ACR. These reports largely aligned with the ACR’s conclusions, indicating that senior management was not responsible for the accounting irregularities. Although initially sealed, the reports were made public in August 1994 following a motion from Bloomberg Business News. The ACR, initially confidential under a court order, was also declared non-confidential in a March 31, 1995 court order.

In the context of a U.S. Attorney's Office (USAO) investigation, Leslie Fay provided the ACR and additional materials prepared by AA at Weil's direction in response to grand jury subpoenas. A November 17, 1993 letter from the U.S. attorney stipulated that the ACR would remain confidential, with disclosures limited to law enforcement purposes. Similarly, a confidentiality agreement between the USAO and Weil dated May 19, 1994, ensured that the production of AA materials would not waive any attorney-client privilege or work-product protection.

On March 15, 1995, BDO issued a subpoena to Weil seeking four categories of documents, including memoranda from interviews conducted by Weil and AA regarding the ACR and related work products. BDO's attempts to secure compliance with the subpoena were unsuccessful, prompting them to request a pre-motion conference with the Court on April 18, 1995, to address Weil's non-compliance. Following a conference on April 19, the Court instructed the parties to submit their positions in writing. In its correspondence, BDO contended that the documents in question were not protected from discovery by the work-product doctrine or attorney-client privilege for three specified reasons.

BDO argues that the documents in question were created for business purposes rather than in anticipation of litigation, thus not protected by the work-product doctrine. Additionally, BDO claims that Weil has waived any protection or privilege by disclosing the documents and their contents to various parties, including Stillman, the Creditors’ Committee, the SEC, and the USAO/MDPA. BDO further asserts that Weil's public release of the Audit Committee Report (ACR) and the Court’s ruling deeming the ACR non-confidential necessitate the production of underlying Company financial statements and related documents. Lastly, BDO invokes the "crime-fraud" doctrine, arguing that Weil's potential involvement in fraudulent activities negates the work-product protection for these documents. BDO specifically points to the ACR’s conclusion that upper management was not involved in fraudulent activities, suggesting that Weil manipulated the report to clear management of wrongdoing, thereby implying Weil’s participation in the fraud. 

The work-product doctrine, as established by case law, protects documents prepared in anticipation of litigation, particularly those reflecting an attorney's mental processes. Although factual materials may be discoverable if there is substantial need, attorney mental impressions are more rigorously protected. To invoke this protection, a party must demonstrate that the documents were prepared with litigation in mind, which requires establishing both causation (the documents were created because of impending litigation) and reasonableness (the anticipation of litigation was a primary purpose). Documents prepared for non-litigation purposes do not qualify for this immunity.

Reasonableness assesses the applicability of the work-product doctrine based on the specific circumstances of a case. Professors Wright and Miller highlight that prudent parties prepare for litigation before formal proceedings begin. The critical test is whether a document was created due to the prospect of litigation, rather than as part of routine business operations. Even if litigation is anticipated, documents generated in the normal course of business do not qualify for work-product immunity.

In the current case, the mere anticipation of securities fraud litigation or an SEC investigation does not automatically classify the Audit Committee's investigatory materials as work product. The Seventh Circuit's ruling in Binks Mfg. Co. reinforces that an investigation conducted as part of regular business practices is discoverable, regardless of potential litigation. Although litigation was foreseeable after the accounting irregularities were disclosed, the evidence indicates that the Audit Committee's investigation was primarily for business purposes, not solely in anticipation of litigation.

The Audit Committee's investigation aimed to make informed decisions regarding personnel changes, assess the scope of the fraud, and implement new organizational controls to reassure stakeholders. Statements from Leslie Fay's leadership indicated that the investigation was undertaken to address concerns from creditors and shareholders, further demonstrating its business-driven context rather than a purely litigious motive.

The New York Times reported on September 28, 1993, that a company's report was delayed to avoid implying senior executives were responsible for a scandal. The following day, the company announced that its Audit Committee found no evidence linking current Board members to accounting irregularities and had made recommendations for improving financial structure and controls. Consequently, the company terminated CFO Paul Polishan and midlevel corporate controller Donald Kenia for cause. It was argued that the Audit Committee's investigation was not primarily conducted in anticipation of litigation, aligning with precedents that state work-product protection applies only to documents created mainly for legal purposes. Although potential legal liability influenced the investigation, other significant factors were also present, which undermined the claim of work-product protection. Weil, who bears the burden of proof, argued that the investigation had no role in the official financial restatement, yet did not deny other non-litigation purposes for the investigation. Additionally, Weil contended that the Audit Committee Report (ACR) was work product because it was based on protected documents. However, the court clarified that it had never definitively ruled the ACR as work product, emphasizing that the Audit Committee waived any work product immunity by disclosing the Report to the SEC without confidentiality measures. The court ultimately agreed with BDO that the ACR and its underlying documents were not prepared primarily for litigation and therefore do not qualify as attorney work product.

The attorney-client privilege protects confidential communications between an attorney and a client made for obtaining legal advice. It requires that legal advice be sought from a professional legal advisor, with communications made in confidence by the client. Waiver of this privilege can occur if the client discloses privileged information, such as through testimony or voluntary production of documents to a third party. This waiver can extend to related communications, known as "subject matter waiver," particularly if the privilege-holder uses the privilege strategically in litigation. In this case, while the documents in question were not created primarily for litigation, they likely contain communications made in the context of legal advice provided by Weil to the Audit Committee. The documents, including interview notes and drafts, indicate legal advice regarding accounting irregularities. The inquiry now focuses on whether Weil has waived the privilege through prior disclosures to the SEC, Stillman, and the USAO/MDPA.

The Audit Committee's production of the Audit Committee Report (ACR) to the SEC has resulted in a waiver of work-product immunity, attorney-client privilege, and self-critical analysis privileges related to the report itself. While this waiver may not extend to all documents underlying the report, subsequent developments render efforts by Weil to prevent discovery of these documents inequitable. Upholding Weil's privilege claim would significantly prejudice BDO at trial, as the ACR's conclusions exonerate Leslie Fay’s senior management while implicating BDO in alleged fraudulent activities. BDO argues that the senior management orchestrated the fraud, complicating its defense as many executives may invoke the Fifth Amendment, making it nearly impossible to recreate the underlying work.

Since the Audit Committee has already waived privilege concerning the ACR's contents, they cannot justifiably withhold related documents from BDO, especially as the Company seeks to use the ACR's conclusions against BDO in ongoing litigation for professional negligence and breach of contract. The Audit Committee's selective assertion of privilege appears to exploit the system for tactical advantage, contrary to established legal principles against such conduct. The court recognizes that while the Audit Committee has waived privilege over the ACR's subject matter, this does not automatically eliminate all claims of privilege regarding the underlying documents. However, any privilege should be equitably pierced only to address potential prejudice to BDO.

Document portions reflecting Weil's legal analysis or advice are exempt from discovery, while interview notes and summarized financial data are discoverable. BDO is entitled to discovery unless Weil demonstrates that specific documents contain legal analysis or advice not addressed in the ACR. 

Regarding disclosures to the USAO/MDPA, Stillman, and the AA Audit Team, BDO claims that the Audit Committee waived privilege by sharing underlying documents. However, these disclosures were made under confidentiality agreements that preserved privilege. The bankruptcy court's order ensured that producing documents to Stillman did not breach attorney-client or work product privilege, and the intention was to facilitate cooperation and avoid duplication. The USAO/MDPA also agreed to maintain confidentiality, aligning with case law suggesting that such disclosures do not constitute waiver if confidentiality is preserved.

BDO further argues that the Audit Committee's sharing of investigatory documents with the AA Audit Team constituted waiver. Weil counters that no privileged documents were shared, and BDO lacks evidence to support its claims. Consequently, the Audit Committee has not waived its privilege regarding these documents.

Lastly, BDO contends that the ACR's alteration to protect upper management from liability negates any privilege on the underlying documents. The Second Circuit indicates that attorney-client privilege does not apply to communications that further ongoing or contemplated criminal fraud.

BDO has not provided adequate evidence to establish that the Audit Committee Report (ACR) was a sham intended to obscure management’s fraud. To meet its burden, BDO must show that the ACR was manipulated to misattribute responsibility for the fraud. However, the conclusions drawn by the Stillman reports, which BDO has not contested, align closely with those of the ACR. In the absence of further evidence of fraud, BDO is not entitled to access the documents underlying the ACR under the crime-fraud exception.

Weil, Gotshal & Manges is required to produce the documents underlying the ACR unless they can demonstrate, on a document-by-document basis, that these documents contain legal analysis or advice not reflected in the ACR. The document distinguishes between two groups of auditors: the AA team and the AA Audit Team, the latter having replaced BDO after its resignation in May 1994.

Leslie Fay filed for bankruptcy on April 5, 1993, leading to a stay of all litigation against the company, and Leslie Fay was subsequently removed as a defendant in this case. Following this, the Official Committee of Equity Security Holders of Leslie Fay Companies, Inc. initiated an adversary proceeding against BDO in bankruptcy court on April 4, 1995, alleging breach of contract and professional negligence.

BDO initially sought court orders for the production of communications with government agencies regarding the ACR but has since withdrawn that request. The text notes that some courts have interpreted the von Bulow case as endorsing subject matter waiver only in circumstances where confidential communications are selectively disclosed for tactical advantages in litigation. The ruling indicates that the ACR’s disclosure to the SEC, while occurring during bankruptcy proceedings, nonetheless falls under the subject matter waiver rule, as the Equity Committee intends to use the report's conclusions in its case against BDO.

Weil argues that disclosures to the USAO/MDPA were made in a common interest context, which may prevent waiver; however, the court finds that a confidential agreement suffices to avoid a waiver, rendering the common interest argument unnecessary for consideration.