Information Management under

§802 of The Sarbanes-Oxley Act of 2002

A discussion of e-discovery and the simpler days of document discovery

Paper presented at:

CORPORATE GOVERNANCE & ACCOUNTING REFORM PANEL

December 12, 2002

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©2002 Perry Binder, J.D.
PerryBinder.com
Legal Commentator/Professional Speaker

The question posed for my discussion is how an auditor/company’s document retention program will be impacted by the rules of “workpaper retention” proposed by the SEC under §802 of The Sabanes-Oxley Act of 2002.  The SEC is taking comments on these proposed rules until December 27, 2002, and will complete Final Rules by January 26, 2003.

This discussion gains even greater relevance on the heels of $8.25 million in fines levied by the SEC and other regulatory agencies last week against eight investment banks for failure to preserve e-mail documents.  Many e-mails were "discarded" or "recycled" by some companies a few months after they were written.

In addition, some of these firms relied on employees to preserve copies of their e-mails on their computers' hard drives. But "there were inadequate systems or procedures to ensure that employees did so for the requisite record-keeping period," according to the SEC order.

I.  Discussion during Corporate Governance Panel – The World of

e-Discovery in an Investigation

A.  Does your company have a consistent document retention program, which continually monitors:

One centralized e-mail system

Hard drive data and Backup tapes

Employee floppy disks and home computers

Company Laptops

Powerpoint presentations

Cell phone and Palm Pilot logs

Cookie files and Personal history files

Instant Messaging (IM)

Coming soon:  Voice-activated e-mail

B.  How does The Sabanes-Oxley Act of 2002 impact your current document retention program?

II.  §802 of The Sabanes-Oxley Act of 2002 .

         CRIMINAL PENALTIES FOR ALTERING DOCUMENTS

         (text of statute is provided at the end of this paper)

Questions to which the SEC is seeking comment:

·         Are the "workpapers" and other documents that would be required to be retained under this proposed rule sufficiently described? If not, what changes should be made to provide for greater clarity? Are there alternative definitions that would better implement section 802?

The proposed SEC rule would require that the auditor retain workpapers and other documents that form the basis of the audit or review of an issuer's financial statements, and memoranda, correspondence, communications, other documents, and records (including electronic records) that meet two criteria.

The two criteria are that the materials (1) are created, sent or received in connection with the audit or review, and (2) contain conclusions, opinions, analyses, or financial data related to the audit or review.

The proposed rule, therefore, would require an auditor to retain any materials satisfying both criteria. Non-substantive materials that are not part of the workpapers, however, such as administrative records, and other documents that do not contain relevant financial data or the auditor's conclusions, opinions or analyses would not meet the second of these criteria and would not have to be retained. 

• Would auditors have to implement significant changes to their retention policies or internal control processes and procedures, as well as system upgrades, to ensure compliance with the proposed rule? If so, what types of changes most likely would be required? How can we minimize any required changes consistent with section 802?

The period for retention of these materials is five years after the end of the fiscal period in which an accountant audits or reviews an issuer's financial statements, which is the period prescribed by section 802. However, the SEC is asking for comments as to whether the period should be extended, in order to be consistent with Section 103 (“Auditing, Quality Control, and Independence Standards and Rules”) (directing the Public Company Accounting Oversight Board) to require auditors to retain certain material or supporting documents for seven years*).

*The SEC extended this time period to seven years; see the 2003 Update at the end of this paper.

III.  The Discovery Process of a Lawsuit in the Good Ol’ Days

DISCOVERY - in a civil case, anything that could LEAD TO reliable, relevant evidence (which is not privileged) is discoverable (that's very broad).

Common discovery methods:

- Depositions

- Interrogatories

- Requests for Documents

- Requests for Admissions

- Request to Examine (Mental and Physical, when those items are at issues -- such as in a personal injury case)

We may also discover what experts the other side may call, as well as that expert's opinion through discovery.

Your attorney and paralegals write discovery requests and go to opposing counsel's office to inspect relevant documents. How do they know what to photocopy?

They'll usually make 3 piles:

1. the yes pile, produce these documents

2. no, don't produce to us

3. the "I have no clue" pile, thus we'll take them (we'll figure out if we need them at a later date)

If your company is in the middle of litigation, your firm may be asked to comply with a document request. Give your attorney EVERYTHING relevant. S/he will sift through these documents, looking for items protected by the attorney-client privilege, as well as which items need to be produced.

S/he looks on the back of every document -- it may have some important notations contained thereon.  In addition, just because you have two copies of a document, you should still give the attorney both documents -- the other side is entitled to ALL copies of the same document.

For example, what if an important element of their case rests upon whether someone actually received notice of something and you come across an internal memo addressed to this person on the subject.  If you find a document with a little check mark next to his name, that might be evidence that the person actually received it. WE'RE THAT DETAIL ORIENTED!

If we're sending discovery requests to a corporation seeking documents, usually the "records custodian" is the person we'll direct the request to. Remember, when the other side is represented by an attorney, we send all requests to the attorney.

If we need something from a non-party (someone who isn’t a named plaintiff or defendant), we need to subpoena the item.  If we need to take a deposition and that person is outside our jurisdiction, we'll need to fly there to take the deposition. We might also ask that person to bring documents to the deposition -- that's called a subpoena duces tecum.

If your deposition is being taken, here are some possible objections to discovery that your attorney may raise:

- privilege (usually attorney-client)

- work product - research and strategies of your attorney are not discoverable by the other side

- overbroad question

- vague/ambiguous question

- irrelevant question

- harassing/burdensome question

- compound question

NOT A VALID OBJECTION - that such a request would be inadmissible at trial.

What if opposing counsel objects to our discovery or fails to respond to our discovery?

We'd file a Motion to Compel Discovery and leave it up to the judge.

What if the other side objects and refuses to produce a document based on a privilege?

We can ask the judge to conduct an IN CAMERA (in chambers, outside our view) proceeding, where s/he looks at the document and decides if we can see the document. If we can see only a portion, s/he will instruct opposing counsel to REDACT the document -- take out the privileged part and show us the rest.

What if opposing counsel feels that we asked for something unreasonable in discovery (such as scheduling our out-of-town plaintiff/client for a deposition in Atlanta on one day notice)?

We'd file a Motion for Protective Order, to ask the judge for protection from complying with an unreasonable discovery request.

What if opposing counsel never responds to our discovery?

Aside from compelling discovery, we could ask the court for sanctions (especially if a party doesn't comply with a court order), which could range from the cost of filing and arguing the motion to the most drastic sanction -- striking the pleadings (Complaint/Answer) of the offending party (thus that party would lose the case).

In federal court, Rule 11 of the federal rules of civil procedure details the sanctions in federal court.  Note that in Georgia Statute §9-11-37, the court can impose fines against an attorney who abuses the discovery process.

IV.  Introduction of Documents at Trial in the Good Ol’ Days

In order for an exhibit to be used at trial, it must be AUTHENTIC and RELEVANT.

Some exhibits are actual evidence (the "smoking gun memo") and some are to demonstrate something (demonstrative evidence -- such as a chart for an expert).

To show that a document is authentic, we must introduce it at trial through the use of a witness. That person must answer certain questions to ascertain the document’s authenticity.  If it's a memo, then putting the person on the stand who wrote it would be an easy way to authenticate the document.  All we would need to ask is:

Did you write this memo?

Is that your signature?, etc.

But what if that person is longer at the company? Oftentimes we'll call to the stand a company's RECORDS CUSTODIAN - someone who can testify that:

- this is a document written in the regular course of business

- that this document has been kept in corporate files and a chain of custody has been maintained to ensure that the document has not been tampered with.

Why is this important?? Because of the HEARSAY RULE -- if someone else is testifying about the truthfulness of a document, the court needs to be careful that the document has some safeguards.

Many statements are "hearsay," but there are several exceptions to the hearsay doctrine.  Let’s examine the BUSINESS RECORDS EXCEPTION.  The line of direct examination goes like this:

Q.  What are your duties at XYZ, Inc.?

A.  One of my duties is to maintain the files of the company.

Q.  Do you recognize this document?

A.  Yes, it was written by a former employee of the company.

Q.  Is it a document kept in the regular course of business?

A.  Yes, it is a memo from one executive to another.

Q.  What is the chain of custody of this document?

A.  A photocopy of the document is kept in a monthly file folder; it was found after your discovery request was made in a folder marked “Feb 2002.”

Q.  And what is the date of the memo I am showing you?

A.  Feb 15, 2002

Q.  Do you know where the original memo is?

A.  No.

Q.  Have you made a diligent effort to locate this document?

A.  Yes.

This line of questioning is important because of the BEST EVIDENCE DOCTRINE, which says that the court prefers the original of a document.  If we can show, though, that a photocopy is reliable in the absence of an original, we’ll usually be able to introduce the copy into evidence. 

These questions LAY THE FOUNDATION to introduce a document:

Your honor, at this time I'd like to label the document as Plaintiff's exhibit 15.

How the process works:

1- the clerk of the court marks it

2- the lawyer shows it to opposing counsel and asks questions about the document to the witness

3- the attorney asks the court to "move it into evidence (opposing counsel can object to all or a portion of the document*)

4- if there are no objections, the document becomes part of the evidence and can be used by the jury as evidence.

*If the judge feels that a portion of the document is prejudicial or not relevant, the other portion can still come into evidence, by blocking out the bad part -- this is called REDACTING or EXPUNGING evidence (mentioned above).

V.  To Send Comments to the SEC on §802 of The Sabanes-Oxley Act:

You should send three copies of your comments to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. You also may submit your comments electronically to the following address: rule-comments@sec.gov. Please use only one method of delivery. All comment letters should refer to File No. S7-46-02; this file number should be included in the subject line if you use electronic mail. Comment letters will be available for public inspection and copying at the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549-0102. We will post electronically-submitted comment letters on the Commission's Internet Web site (http://www.sec.gov). We do not edit personal identifying information, such as names or electronic mail addresses, from electronic submissions. Submit only information you wish to make publicly available.

To view the SEC proposals on §802, see www.sec.gov/rules/proposed/33-8151.htm . Comments should be received on or before December 27, 2002 on the following statute:

SEC. 802. CRIMINAL PENALTIES FOR ALTERING DOCUMENTS.

(a) IN GENERAL- Chapter 73 of title 18, United States Code, is amended by adding at the end the following:

`Sec. 1519. Destruction, alteration, or falsification of records in Federal investigations and bankruptcy

`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.

`Sec. 1520. Destruction of corporate audit records

`(a)(1) Any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1(a)) applies, shall maintain all audit or review workpapers for a period of 5 years from the end of the fiscal period in which the audit or review was concluded.

`(a)(2) The Securities and Exchange Commission shall promulgate, within 180 days, after adequate notice and an opportunity for comment, such rules and regulations, as are reasonably necessary, relating to the retention of relevant records such as workpapers, documents that form the basis of an audit or review, memoranda, correspondence, communications, other documents, and records (including electronic records) which are created, sent, or received in connection with an audit or review and contain conclusions, opinions, analyses, or financial data relating to such an audit or review, which is conducted by any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1(a)) applies

2003 Update -- After the Comments were received, the SEC put forth the following amendment:

Note: The information is provided for educational purposes only and is not offered as legal advice. Consult an attorney in your state for legal questions on this information.

©2002 Perry Binder, J.D.