Shareholders can use whistleblower documents in fraud complaint: judge

By Alison Frankel
August 1, 2014

Here’s a new twist on an old story. A securities class action firm in the early stages of a fraud case tracks down a former employee of the defendant. The former employee dishes dirt about the company to an investigator, a boon for plaintiffs’ lawyers who have to draft a detailed complaint about corporate wrongdoing without the benefit of discovery from the defendant. The company protests, asserting that former employee was under a confidentiality agreement.

Often what happens next is that former employees recant their testimony, creating considerable awkwardness (or worse) for shareholder lawyers. But U.S. District Judge Edward Chen of San Francisco described a different scenario in an opinion Thursday in a securities fraud class action against the healthcare mobile communications company Vocera – which resulted in quite a different outcome for class counsel. In fact, securities lawyers who want to avoid controversy over confidential informants ought to consider adopting the strategy of Vocera class counsel from Labaton Sucharow.

As you know, under the Private Securities Litigation Reform Act of 1995, plaintiffs’ lawyers aren’t permitted access to discovery from defendants until after their complaints have withstood defense motions to dismiss. Yet to meet pleading standards, their complaints must provide detailed and specific allegations of fraud. So securities class action firms have little choice but to seek out corporate employees or former employees to flesh out their claims and push their cases beyond dismissal.

After Judge Chen appointed Labaton to lead the shareholder class action against Vocera, the firm’s chief investigator, Jerome Pontrelli, scored big when he found the company’s former audit director, who had only recently left Vocera’s employ. In addition to an interview, the former employee gave Pontrelli a binder of internal documents related to the fraud investigation.

Pontrelli, according to Labaton’s brief, was concerned that some of the documents might be privileged. Labaton partner Jonathan Plasse immediately recommended that the firm sequester the material before any lawyers at the firm even saw it. Labaton also hired ethics advisor Peter Jarvis, now at Holland & Knight. “We wanted to do everything appropriately,” Plasse told me. Labaton, he said, has never faced precisely the same circumstances as those in the Vocera case but was involved in a 2002 case in which plaintiffs’ lawyers obtained a ruling in San Francisco federal court that former JDS Uniphase employees were permitted to talk to shareholder investigators.

Labaton ethics counsel Jarvis contacted Vocera’s lawyers at Fenwick & West, according to Vocera’s brief, with a request that they review the documents and notify him whether they were privileged. Vocera instead informed Labaton that its confidential informant, the former audit director, had violated his severance agreement with the company and misappropriated internal documents. Vocera asked Judge Chen to block Labaton from using the material in an amended complaint against the company, arguing that the documents are precisely the sort of pre-dismissal internal discovery Congress disallowed in the 1995 law governing private securities class actions.

“If anything, lead plaintiffs’ motion underscores the need for more – not less – protection over internal company documents and information,” they wrote. “Without the procedural protections afforded by the formal discovery process, former employees and lead plaintiffs are left as the self-deputized, sole arbiters of what internal Vocera information may be disclosed, and when. It defies reason to suggest that Congress … meant to foreclose and protect against the impacts of early discovery on securities litigation, only to open the door to the plundering of internal documents or unrestrained inquiries into a party’s confidential information without the benefit of any protections at all.”

Judge Chen, however, said that Labaton could use not only the information its investigator obtained in his interview with the former Vocera audit director but also the documents (as long as they’re not privileged). The dispute, according to Chen, really boiled down to an issue of timing: Were shareholders permitted to use material they could obtain through post-dismissal discovery before they survived Vocera’s dismissal motion? The judge said yes.

“The documents were not provided by Vocera in response to a document production request; they were already in the possession of a third party who handed them to Labaton’s investigator,” Chen wrote. “While opposing this motion and negotiating a protective order imposes some cost on Vocera, that cost is different in quantity and quality from the burdensome discovery costs Congress had in mind in enacting the discovery stay provision. Vocera is not being subjected to a broad-based fishing expedition. Thus, the PSLRA’s discovery stay provision is not violated by plaintiffs’ acquisition and use of the documents in question.”

Chief among the factors Chen considered was Labaton’s handling of the disputed material. Even Vocera didn’t claim that the firm played any role in the purported misuse of the documents, Chen noted. Labaton lawyers didn’t solicit the supposed misappropriation and didn’t make use of the material before it asked the court to rule whether it could. “The way we responded … made a big difference,” Plasse told me. (Chen also analyzed the consequences for the Vocera former employee, the potential prejudice to Vocera and the public policy benefits of encouraging whistleblowers.)

The judge instructed Vocera to identify privileged documents. He also said the material would be covered by a protective order so that proprietary corporate information isn’t made public. But otherwise, Labaton partner Plasse said, the plaintiffs will be able to make use of the Vocera documents when Labaton drafts its amended complaint.

I emailed Vocera counsel Susan Muck and Jennifer Bretan of Fenwick, but they didn’t respond.

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