Introduction

In In Re: Grand Jury Subpoenas Dated September 13, 2023, a Second Circuit panel (Lynch, Robinson, Merriam) provided guidance on a variety of complex issues related to grand jury subpoenas, attorney-client privilege, and the provisions of federal securities law prohibiting the willful circumvention of a company’s internal accounting controls.  The panel’s opinion addressed both jurisdictional and substantive issues in affirming the district court’s order that the crime-fraud exception applied to a particular set of documents sought by the government from three pseudonymous witnesses in the course of a grand jury investigation.

On the jurisdictional issue, the panel held that district court orders requiring attorneys to produce potentially privileged documents in response to grand jury subpoenas may be immediately appealed by current or former clients who hold the privilege.  On the merits, the panel broadly construed the definition of an internal accounting control that can give rise to criminal liability under the statute and provided additional guidance on the crime-fraud exception to the attorney-client privilege.  The Court’s thorough and careful opinion will be a useful resource for attorneys and district courts.

Background

Appellant 1 was the CEO of a publicly traded company (the “Company”).  The Company, like all publicly traded companies, was required by federal law to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that” significant transactions are “recorded as necessary” to “permit preparation of financial statements in conformity with generally accepted accounting principles” and “to maintain accountability for assets.”  15 U.S.C. § 78m(b)(2)(B).  Additionally, officers of the Company, like all officers of publicly traded companies, were required to make an annual certification that the Company’s financial records were accurate, that they had established and maintained internal controls, and that the internal controls were sufficient to “ensure that material information relating to [the Company] is made known to such officers by others within those entities.”  15 U.S.C. § 7241(a).  Consistent with the latter requirement, Appellant 1 certified to the Company’s auditors that he had established and maintained internal controls for the Company.  One such internal control addressed in Appellant 1’s certification was that, under company policy, the Company’s legal department reviewed all significant contracts.  However, the Company did not maintain a written policy document confirming that this legal department review process was one of the Company’s internal controls.

In 2018 and 2022, two women who had worked at the Company privately accused Appellant 1 of sexual misconduct.  Appellant 1 did not bring these allegations to the attention of the Company.  Instead, he worked with Appellant 2—a partner at Appellant 3, a law firm representing both Appellant 1 and the Company—to negotiate secret settlement and non-disclosure agreements (the “Agreements”) with the two women.  The Agreements required Appellant 1 to make payments to his accusers in exchange for their silence and release of claims against both Appellant 1 and the Company.  Appellant 1 executed the Agreements on behalf of the Company without notifying the Company’s legal department, and all three Appellants worked in concert to ensure that the Company’s legal department did not learn of the Agreements.  However, Appellant 1 made the required payments to the two women using his personal funds.

The Company’s board learned of the Agreements in 2022 and opened an investigation.  During the investigation, Appellant 1 resigned from the Company and disclosed the Agreements to the company’s legal department for the first time.  After learning of the Agreements, the Company concluded that the payments under the Agreements should have been treated as Company expenses.  Accordingly, the Company restated its financial statements for the 2019-2022 period to account for the settlement payments that Appellant 1 had made on behalf of the Company during the period, but reported that the payments were not material to the Company’s financial statements.

In the wake of these events, the government opened an investigation.  The government served grand jury subpoenas on Appellant 2 (the law firm partner) and Appellant 3 (the law firm) in September 2023, seeking their communications with Appellant 1 concerning the two women.  In December 2023, Appellants 2 and 3 made a production of documents, but withheld 208 documents based on assertions of attorney-client privilege raised by Appellant 1 and the Company.  The government then moved to compel production of many of the remaining documents, which Appellants 1, 2, and 3 opposed.

The district court granted the government’s motion to compel, holding that Appellant 1 could not claim privilege over many of the documents pursuant to the crime-fraud exception.  It held that the government had established probable cause to believe that the Appellants had violated several provisions of federal law by circumventing the Company’s internal controls around legal department review of significant contracts, creating false books and records, and making false statements to the Company’s auditors in the service of concealing the settlement agreements.  The appeal followed.

Jurisdiction

The Second Circuit first addressed whether it had jurisdiction to hear the Appellants’ appeal of the district court’s order granting the government’s motion to compel production of documents from Appellant 2 and his law firm, Appellant 3.  It concluded that it had jurisdiction.

The panel first noted Circuit precedent that, in most cases, orders denying motions to quash grand jury subpoenas (or granting motions to compel production in response to grand jury subpoenas) are not immediately appealable.  That is because they are not final orders appealable under 28 U.S.C. § 1291.  The Second Circuit had previously rationalized that general rule by explaining that an order granting a motion to compel (or denying a motion to quash) is not the end of the proceeding—the party subject to the subpoena may still choose whether to comply or risk contempt, and if the party chooses the latter, the district court has discretion in how to handle contempt proceedings.  Because final orders are those that leave nothing for the court to do but execute the judgment, and orders granting motions to compel production (or denying motions to quash) in response to grand jury subpoenas must be enforced through further contempt proceedings, such orders are not final and therefore not appealable.

However, the panel also explained that there are exceptions to the general rule.  One such exception arose in Perlman v. United States, 247 U.S. 7 (1918).  Perlman was a non-party witness in a patent case who introduced certain documents at trial.  After the underlying patent case was dismissed, lawyers for the parties in the underlying patent case were informed that the Government sought Perlman’s documents as part of a grand jury investigation, and the parties’ lawyers did not object to turning over the documents.  Perlman moved to quash on Fourth and Fifth Amendment grounds, and the district court denied the motion.  The Supreme Court held that Perlman could immediately appeal the district court’s order because Perlman could not force the parties’ lawyers to be held in contempt in order to trigger an appealable order, and accordingly, he would be “powerless to avert the mischief of the order” without an immediate appeal.  Id. at 13. 

The panel further noted that, in subsequent cases, the Second Circuit and other Courts of Appeal had extended the logic of Perlman to instances in which parties objected to grand jury subpoenas on non-Constitutional grounds, such as cases in which parties opposed, on attorney-client privilege grounds, grand jury subpoenas directed to their counsel.  That is because, as in Perlman, the client would be powerless to avert the effects of the order without an immediate appeal.  Lawyers are not bound to maintain client confidentiality in the face of a court order; it would be unreasonable to expect a lawyer to be held in contempt to protect a client’s privilege; and the client cannot force his lawyers to be held in contempt to trigger an appealable order. Accordingly, the panel held that in cases where district courts grant motions to compel production of documents from lawyers in response to grand jury subpoenas (or deny motions to quash grand jury subpoenas), their clients are entitled to immediately appeal under the Perlman exception.[1]

Merits of the District Court’s Crime-Fraud Exception Ruling

Having concluded that it had jurisdiction to hear the appeal, the panel turned to the merits of the district court’s crime-fraud exception ruling.  It held that the district court had not abused its discretion in finding that the exception applied and ordering the Appellants to produce certain documents.

The panel first laid out the standard for applying the crime-fraud exception: a party seeking to invoke the exception must demonstrate that there is probable cause (1) that the client communication or attorney work product in question was itself in furtherance of the crime or fraud and (2) to believe that the particular communication with counsel or attorney work product was intended in some way to facilitate or to conceal the criminal activity.

With this in mind, the Court summarized the potential federal crime at issue—a violation of 15 U.S.C. §§ 78m(b)(5) and 78ff(a), which prohibit willfully circumventing a company’s internal accounting controls.  Citing several out-of-circuit cases and Appellant 1’s own certifications to the Company’s auditors, it explained that the Company’s requirement that its legal department review “all significant contracts” qualified as an “internal accounting control” under the statute.  The panel identified several types of internal controls, such as the review of records for completeness, accuracy and authenticity, or a method to record transactions completely and accurately.  The panel was particularly focused on the fact that Appellant 1 told the Company’s auditors in a formal interview that the review of significant contracts was aimed at mitigating fraud risk, and that the auditors based their corruption risk assessment in part on this claim.

In doing so, the panel rejected an argument that an internal control must be documented in a written policy to qualify as an internal accounting control under the statute.  It explained that when a senior corporate executive like Appellant 1 describes a control to company auditors, willful circumvention of that control may be a crime, even if the control is not formally documented in writing.  The panel also pointed out that there is no express requirement in the relevant statute or any regulation that limits internal controls to those written in a formal policy document.

The panel went on to explain that there was probable cause to believe that the settlement agreements between Appellant 1, the Company, and the alleged victims were “significant contracts” for purposes of the Company’s internal controls.  It concluded that these contracts could qualify as significant because of the potential reputational risk to the Company, and because there was ambiguity in the contracts as to whether the Company or Appellant 1 would be liable for the payments.  The panel relied on the fact that the contracts themselves stated that Appellant 1 and the Company would sustain “substantial damages” if the contracts were not treated confidentially.  In addition, Appellant 1 told others that the allegations made against him, if publicized, would cause damage both to him and “to the [C]ompany for sure[.]”  The two victims were paid a total of $10.5 million to keep their allegations confidential.

Having concluded that the significant contract review provision described by Appellant 1 was an internal control under federal law, and that the settlement agreements were significant, the panel finally concluded that there was probable cause to believe Appellant 1 committed a crime by working with Appellants 2 and 3 to willfully circumvent the legal contracts control.  It cited evidence that Appellant 1 was aware of the control; that Appellant 1 worked with outside counsel to ensure that the Company’s legal department did not learn of the contracts during the negotiation phase; that the contracts were not provided to the Company for record-keeping; and that Appellants 1 and 2 used text messages rather than email to communicate regarding the contracts in order to prevent the Company from learning of them.  Accordingly, the panel reasoned that the District Court had properly concluded that the disputed documents were not entitled to attorney-client privilege because there was probable cause for the district court to conclude that they were made in furtherance of a crime and were intended to facilitate the crime.

Commentary

The panel’s opinion presents useful guidance for practitioners on several issues.  In particular, the panel’s reaffirmation of the Perlman doctrine, and its clarification of the circumstances in which orders on grand jury subpoenas are appealable, gives practitioners a road map for helping to protect their clients’ privilege when a grand jury subpoena is issued to counsel for those clients.  In those instances, the parties ought to be able to challenge the subpoena to their attorneys and should not have their appeal rights limited to situations in which their attorneys take on the risk of contempt sanctions.  The panel’s discussion of the crime-fraud exception and its application of the legal standard are valuable contributions to the jurisprudence in this area, giving a roadmap in future cases not only to the government but to private parties that seek to compel the production of documents under this infrequently invoked exception notwithstanding a claim of privilege.

The panel’s holding on the internal control issue raises some interesting questions, apparently of first impression in the Circuit.  The opinion defines the statutory phrase “internal accounting control” very broadly, encompassing both formal written policies and less formal unwritten policies that may have been relayed orally to a company’s auditors.  By doing so, the panel suggests that an individual may violate the law by failing to honor unwritten internal controls.  It is understandable why the panel would broadly construe this term here, given the facts of this case.  As the panel held, it “aligns with common sense” to define the contract review requirement in this case as an internal accounting control.  Moreover, Appellant 1 himself certified to the Company’s auditors that the contract review requirement was an internal accounting control.

That said, the panel’s decision to define “internal accounting control” in a manner that can encompass even informal or unwritten company policies has the potential in future cases to significantly expand the scope of criminal liability under the relevant statutes.  This aspect of the ruling has the potential to criminalize a host of instances in which an employee violates a company’s informal or unwritten policies that the employee does not understand to qualify as an “internal accounting control.” Such an outcome would not be consistent with certain recent Supreme Court decisions that have narrowly construed federal criminal statutes in light of principles of fair notice, due process, and federalism.  See, e.g. Ciminelli v. United States, 598 U.S. 306 (2023) (rejecting wire fraud liability where a defendant did not deprive anyone of their property and only provided incorrect information to his or her counterparty, thereby denying the counterparty the “right to control” their property); Van Buren v. United States, 593 U.S. 374, 378, 394 (2021) (limiting the reach of the Computer Fraud and Abuse Act to only those “who obtain information from particular areas in the computer . . . to which their computer access does not extend,” lest we “criminalize everything from embellishing an online dating profile to using a pseudonym on Facebook”).

It is also worth noting that this aspect of the ruling may not bind future courts looking at the underlying statutory interpretation issue.  The panel’s lengthy footnote on the penultimate page of the opinion stresses that its ruling is a limited one, arising in the context of what is effectively an interlocutory appeal over a privilege claim.  The decision is not meant to suggest that Appellant 1 is guilty of any crime, only that the “evidence presented justifies intrusion into a legally-protected zone of privacy in the interest of permitting authorities to obtain evidence bearing on whether criminal charges should be brought.”  Future defendants should try to challenge any arguments by the government that the violation of unwritten, informal policies should give rise to criminal liability.