Electronic Discovery for the Financial and Investment Services Industry

1. Electronic Discoveryfor the Financial and Investment Services Industry Harris L. Kay Henderson & Lyman

2. Discovery in the Electronic Age 99% of all information created by businesses is in electronic format. 60 billion emails sent daily in the US. In the event of litigation, this electronic material is discoverable. Electronic material must not only be preserved, but must also be available for production.

3. Discovery in the Electronic Age Nearly every civil case involves electronic discovery (e-discovery). Average cost of electronic discovery demands is $140,000 per case. 65% of corporations do not include electronic documents in their document retention schemes. 80% of corporate documents have never been printed.

4. Discovery in the Electronic Age • What materials may be included? • E-mail • Microsoft “Office” files • Software programs/code • Other data compilations • Instant messages • Records of internet use • Removable devices (CDs, DVDs, thumb drives) • Personal laptops and computers

5. The New Federal Rules Initial Disclosures must include information about electronic materials. (Rule 26(a)). Electronic discovery issues may be addressed in and covered by Scheduling Orders. (Rule 16 (b)). Electronic materials must be produced in response to subpoenas, interrogatories, document requests.

6. Safe Harbor A party need not provide discovery of electronically stored information from sources that the party identifies as not reasonably accessible because of undue burden or cost. (Rule 26(b)(2)(B)). Absent exceptional circumstances, a court may not impose sanctions for failing to provide electronically stored information lost as a result of the routine, good-faith operation of an electronic information system. (Rule 37(f)).

7. In Federal Court, All Civil Cases Will Include Electronic Discovery

8. Other Federal Statutes: Sarbanes-Oxley Section 802 • Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both. • Anyone who destroys audit work papers “shall be fined under this title, imprisoned not more than 10 years, or both.”

9. Other Federal Statutes:Exchange Act Rule 17a-4 Broker-dealers must “preserve for a period of not less than three years, the first two years in an accessible place . . . [o]riginals of all communications received and copies of all communications sent” related to their “business as such.” Electronic communications related to broker-dealers’ “business as such” fall within Rule 17a-4. The “content of the electronic communication is determinative” as to whether it must be retained. Reporting Requirements for Brokers and Dealers under the Securities Exchange Act of 1934.

10. Other Federal Statutes:Commodity Exchange Act Every CTA and CTO must keep books and records for a period of at least 3 years.(Section 4(n)). Every FCM, IB, floor broker, or floor trader must keep books and records for a period of at least 5 years, with the first two years being readily accessible. (Section 4(g); Reg. 1.31).

11. Other Federal Statutes:PSLRA Section 27(b) • Discovery is stayed pending resolution of any motion to dismiss. • However, during the pendency of the stay: Any party to the action with actual notice of the allegations contained in the Complaint shall treat all documents, data complications (including electronically recorded or stored data), and tangible objects that are in the custody or control of such person and that are relevant to the allegations, as if they were the subject of a continuing request for production of documents from an opposing party under the Federal Rules of Civil Procedure.

12. State Courts:Uniform Rules Adopted August 2 Brought to you by the Conference that created the UCC, right here in Chicago. The rules mirror “the spirit and direction of the recently adopted amendments to the Federal Rules of Civil Procedure. The Drafting Committee has freely adopted, often verbatim, language from . . . the Federal Rules.” “Up-to-date rules” for the “discovery of electronic documents.” Parties must confer and report to the Court on electronic materials, and details related to their preservation, review and production. Parties may serve on each other “a request for the production of electronically-stored information.” The requesting party may “specify a form in which each type of electronically-stored information is to be produced.”

13. Electronic Discovery and FINRA

14. Notice to Members 99-90 List 1 (All Customer Cases) • Correspondence between the customer and the Member. • Notes by the Member regarding the customer account. • Recordings and notes of telephone calls or conversations. • Records related to the customer account. List 7 (Misrepresentations) and 13 (Suitability) • Copies of all materials provided, reviewed, or used by the Member relating to the transactions or products at issue.

15. Notice to Members 03-33 Group e-mail is “sales literature.” Individual e-mails are “correspondence.” Web sites are “advertisements.” Chat-room discussions are “public appearances.” Instant messages present unique issues.

16. 2004 Industry Survey Says: • Fewer than half of the broker-dealers retained and archived e-mail. • Two-thirds of the broker-dealers did not know, or were unsure about, what constitutes an electronic business record that must be retained. • Only 11 percent retained and archived business-related instant messages. • Only 13 percent monitored or controlled instant message use. 2004 Survey, American Management and epolicy Institute

17. Consequences of E-Discovery Failures

18. Zubulake and the Dawn of E-Discovery

19. Who Bears the Cost? Zubulake I: UBS must pay the costs of producing readily-accessible documents. UBS must restore and produce a small percentage of archived materials, so that the Court may conduct a cost-shifting analysis. Zubulake III: UBS must bear 75% of the cost to restore backup tapes, and all costs related to review and production: “The parties should split the cost of breaking into the safe. . .once the safe is opened, the production of the documents found inside is the sole responsibility of the responding party.” Zubulake IV: UBS must bear costs of re-deposing certain individuals for the purpose of “inquiring into issues raised by the destruction of evidence and any newly-discovered email.”

20. UBS Pays the Price Zubulake V: The Court found that UBS had failed to take all necessary steps to ensure that relevant data was preserved and produced. The Court sanctioned UBS with an adverse inference instruction and costs. The Court sanctioned UBS for overwriting e-mail backup tapes—although they were overwritten before UBS was advised to retain them. The Court recognized that counsel has “repeatedly advised” UBS of its discovery obligations, and acknowledged that counsel “came very close to preventing the loss of evidence.”

21. UBS Pays the Price Zubulake V, cont’d: Counsel “must take affirmative steps to monitor compliance so that all sources of discoverable information are identified and searched.” The jury awarded Zubulake $9.1 million in compensatory damages and $20.1 million in punitive damages.

22. Electronic Discovery on Trial

23. Morgan Stanley:Electronic Discovery on Trial • The Coleman – Sunbeam litigation • Morgan Stanley, Sunbeam’s investment banker and sole underwriter, allegedly prepared false financial information regarding Sunbeam. • Ronald Perelman sold Coleman to Sunbeam, and accepted Sunbeam stock as a major part of the purchase price. • Electronic discovery abuses in the case resulted in an adverse inference instruction and punitive damages of $850 million; later reversed on appeal.

24. Morgan Stanley:Electronic Discovery on Trial • Wrongful termination litigation • Morgan Stanley placed the technology expert for the Coleman case on administrative leave, accusing him of snooping in others’ email accounts. • He then turned whistle-blower, and told regulators about the “Brooklyn tapes,” and that Morgan Stanley was improperly deleting emails.

25. Morgan Stanley:Electronic Discovery on Trial • The SEC investigation and civil action • Morgan Stanley agreed to settle with SEC for a $15 million civil penalty for alleged failure to produce thousands of emails during the SEC’s investigations. • The NASD & NYSE • $5 million settlement. • Class action by arbitration claimants.

26. Morgan Stanley:Electronic Discovery on Trial • Fines and penalties. • Morgan Stanley agreed to adopt and implement policies, procedures and training focused on the preservation and production of email communications. • Morgan Stanley also agreed to hire an independent consult to review its reforms.

27. Morgan Stanley:Electronic Discovery on Trial Moral of Story: Allegations of failure to comply with electronic discovery responsibilities overshadow the substantive allegations of the case. Consequences, including damages, sanctions, civil penalties, may exceed the amount in dispute.

28. Qualcomm Patent Litigation On October 14, 2005, Qualcomm filed suit against Broadcom for infringement of two of its patents. On January 26, 2007, a jury unanimously returned a verdict in favor of Broadcom, finding no infringement.

29. Qualcomm Patent Litigation After trial, Qualcomm turned up over 300,000 pages of evidence it didn’t produce. A Qualcomm employee testified about 21 key emails that that had not been produced and were found on her laptop. A federal judge called Qualcomm’s conduct an “organized pattern of litigation misconduct.” Qualcomm was ordered to pay Broadcom’s legal fees – totaling approximately $8.5 million.

30. Electronic Discovery and the Regulators

31. Banc of America • SEC fined Banc of America Securities $10 Million for “dilatory tactics that delayed the investigation,” including: • Failing to meet document production deadlines. • Claiming that certain documents were “missing,” when they were later found. • Asserting that the production of archived e-mails was burdensome, when they were able to recover some for their own defense. • Deleting certain e-mails from the firm’s computer system.

32. Banc of America:The SEC Comments • “We view this as serious misconduct.” • “This case should tell those who are responding to government subpoenas and document requests that there are severe consequences when the integrity of the process isn’t respected. This is in many ways a textbook example of how not to deal with the government in an investigation.” Stephen Cutler, SEC Director of Enforcement March 10, 2004

33. 2006 Enforcement Action Against Merrill Lynch During the period from October 2003 through February 2005, Merrill Lynch repeatedly failed to promptly furnish to the SEC staff certain e-mails related generally to its business as a broker-dealer and exchange member. SEC sought enforcement action based upon Merrill Lynch’s “systemic failure” to furnish e-mails to the SEC in connection with its investigations.

34. 2006 Enforcement Action Against Merrill Lynch • The SEC found: • “Merrill Lynch’s systems, policies, and procedures designed for the prompt production and retention of e-mails were deficient and Merrill Lynch failed to ensure that it complied with its obligations as a regulated entity.” • “Merrill Lynch’s inability to promptly produce e-mails contradicts statements made by Merrill Lynch that its e-mail retention systems were in compliance with Section 17(a) of the Exchange Act.”

35. 2006 Enforcement Action Against Merrill Lynch • Specifically, the SEC cited Merrill Lynch for: • Taking nearly seven months to produce e-mails for six employees in connection with an SEC investigation. • Taking between two and six months to produce e-mails for five employees in connection with another SEC investigation. • Taking “between two and fifteen months to produce requested e-mails” to claimants in arbitration proceedings. • Falsely asserting that e-mails generated through its retail branch offices were readily retrievable.

36. The Merrill Lynch Settlement Merrill Lynch agreed to: • Revise its systems, policies and procedures to ensure compliance with federal securities laws and rules governing the prompt production of e-mails; • Retain a qualified independent consultant to analyze and report on the sufficiency of the revised system; and • Adopt and implement all recommendations of the consultant. • Merrill Lynch also paid a $2.5 million fine.

37. Miscellaneous Issues and Recommendations • Documentation of litigation hold orders. • Agreed-upon search terms. • IT ownership at the outset. • Downside of tape backup. • Degradation of backup tapes. • Obsolete, non-transferable technology. • One study found greater than 70% failure rate for attempted restorations. • In the event of catastrophe, best-case scenario is last backup day. • WORM compliance.

38. Best Practices Don’t Stop at Retention • You wish you could make some emails disappear: • “Don’t put this in writing, but . . .” • “We may be in breach of contract, and here’s why . . .” • “I can’t believe she’s pregnant at such an inconvenient time . . .” • “We need to get rid of the dead wood.”

39. Harris L. Kay Henderson & Lyman 175 West Jackson Boulevard, Suite 240 Chicago, Illinois 60604 (312) 986-6960