To their great chagrin, and after waging losing battles through the federal district and appellate courts, they found that they had armed their adversaries with their own privileged legal analyses and results of their investigations. They are well-heeled and sophisticated corporations, institutions of higher learning, and huge health-care conglomerates. They had the benefit of the best legal minds -- such as Skadden Arps and Kirkland & Ellis -- carefully crafting contractual confidentiality protections against the very thing that the courts allowed to happen. Worst of all, they were merely trying to be good citizens, providing their government with the fruits of their own internal investigations to assist the worthy process of ferreting out wrongdoing. As it turned out for too many of them, they might as well have invited their adversaries to tag along as their lawyers questioned witnesses, analyzed facts and law, and wrote the story of what had occurred. Because they had shared the materials with the government, they were compelled to share them equally with their opponents.

Risk of Selective Waiver

McKesson Corporation is the most recent entity to learn the hard lesson that selective waiver to the United States can rapidly transform into an unintended across-the-board waiver, making highly sensitive and seemingly privileged materials available to any and all outsiders. After a public accounting irregularities, the audit committee of the McKesson board of directors hired the Skadden firm to conduct an internal investigation, which ultimately outlined the conduct of two high-level employees. The two later became criminal defendants in a federal securities fraud indictment alleging intentional misstatement of publicly reported financial results. Because McKesson had provided Skadden's internal investigation report to both the sec and the United States Attorney's Office, the court granted the motions of the individual criminal defendants to be provided a copy of the same material. That holding of the United States District Court for the Northern District of California, in United States v. Bergonzi, 2003 wl 21805228 (August 5, 2003), is now on appeal to the United States Court of Appeals for the 9th Circuit, with McKesson as an appellant intervenor, and the Securities Industry Association (SIA) as amicus curiae.

The McKesson case is the latest in a two-decade long battle by corporate America to gain federal circuit court approvals for the selective waiver doctrine, created in 1978 by the 8th Circuit in its en banc opinion in Diversified Industries, Inc. v Meredith, 572 F.2d 596. The battle is a losing one, failing more strongly and more rapidly now than ever before, as the circuits line up consistently against the likely ill-fated doctrine. As virtually all others had done before them, McKesson and the sia centered their reliance on what they call "the well-reasoned" and "seminal" decision in Diversified Industries.

In Diversified Industries, however, the bulk of the circuit's attention is spent on whether the control-group test or the modified Harper Row test1 should be adopted to define the extent of the attorney-client privilege in corporate settings. A single sentence sets forth what has come to be termed the selective waiver doctrine:

As Diversified disclosed these documents (an internal investigation report prepared by the Wilmer, Cutler firm) in a separate and nonpublic sec investigation, we conclude that only a limited waiver of the privilege occurred. 2

The judicial reasoning for the holding is confined as well to one sentence:

To hold otherwise may have the effect of thwarting the developing procedure of corporations to employ independent outside counsel to investigate and advise them in order to protect stockholders, potential stockholders and customers.3

The district court in Bergonzi seized upon the fact that McKesson, through its counsel at the Skadden firm, had agreed with the authorities to provide the internal investigation report even before the investigatory work was undertaken by Skadden, and before the report was prepared. It concluded, as a result, that there never was an intention for the internal investigation to be privileged, and distinguished Diversified Industries in a passing comment. The comment noted that the Wilmer Cutler report in Diversified Industries was indeed privileged from the start, with a subsequent selective waiver. The Bergonzi court also noted that although Skadden had prepared and obtained written confidentiality contracts with both the sec and the Justice Department, the terms of those agreements allowed the government to use its discretion in producing the materials in grand jury and criminal proceedings and where the sec deemed legally necessary. The disclosure delegations made by McKesson to the government were found to have swallowed the contractual provisions for continuation of the privilege and work product protections.4

The court was equally dismissive of the legal underpinning for the confidentiality agreement, which McKesson and the United States/sec had predicated on the common interest doctrine. In the common interest declarations, McKesson purported not to be making any waivers, and the government agreed not to make any waiver arguments. The declared common interest for the internal investigation report was a mutuality between the government and McKesson in determining what led to the accounting misstatements.

The concept of common interest proved an illusory basis for protection of McKesson's case because the district court found the government interest adverse to that of McKesson. Notably, it cited the fact that the sec had issued a Wells letter to McKesson before the internal investigation report was produced to the government, putting McKesson on notice that it faced sec proceedings. This led to the penultimate holding and rationale for the court's decision: "Once a party has disclosed work product to one adversary, it waives work product protection as to all other adversaries."

As a result, the internal investigation report prepared by Skadden was ordered produced to the former company executives who are under indictment. Although the federal Rules of Criminal Procedure and the obligation of the United States under Brady v. Maryland, 373 U.S. 83 (1963), provided additional independent grounds for the order to produce the report, the McKesson circumstances are not narrowly confined to the situation where a criminal defendant obtains otherwise privileged materials which have been voluntarily provided to the prosecutor.

For example, McKesson was sued shortly after its public disclosure of accounting irregularities by shareholders. The Georgia court, where the civil shareholder action is venued, independently had ordered the internal investigation report produced in discovery based upon its own rejection of the selective waiver doctrine.5

Motivators for Disclosure

At the same time that the circuit courts are depicting in their holdings the clear risk of selective disclosure to the government, the governmental pressure for self-disclosure by corporations has reached a new peak. The motivators for such disclosure now exist in multiple forms, and can be viewed by corporations as tantamount to mandates.

• Sarbanes Oxley. The Sarbanes-Oxley legislation and its "up the ladder" reporting and "noisy withdrawal" provisions are only the most recent highlights to this phenomenon. Section 307 of Sarbanes-Oxley places affirmative reporting responsibilities on a corporation's attorney. In specified circumstances, the rules require lawyers to report to the highest levels of corporate authority material violations of the securities laws and other failures of legal compliance, as well as permit disclosure to third parties to prevent substantial injury to the corporation or investors. When these requirements are coupled with sec Rule 205, which was effective on August 5, 2003, the lawyer becomes a reporting instrument in the same venue where the lawyer has traditionally been deployed to carry on privileged and work-product investigations to determine what occurred and how to advise the company. The enlistment of the lawyer and the lawyer's role to detect and disclose wrongdoing presents tensions and uncertainty for practitioners in the securities field.6
• The Justice Department. The United States Sentencing Guidelines Relating to Corporations ("USSG"), which became effective in 1991, have promoted a program of corporate voluntary disclosure as a means of avoiding prosecution altogether or reducing the financial consequence of corporate fines and penalties. Computation of corporate fines and penalties with and without credits under the guidelines reveals startlingly sizeable spreads between the minimum and maximum consequences. From a financial point of view, the inducement to attempt to earn the benefits available under the guidelines is compelling.7

Additional incentives -- apart from the concrete difference in potential punishments -- for corporations to work directly with the Department of Justice can be found among the guideline provisions of the so-called "Holder Memorandum" and its successor of January 20, 2003, by Deputy Attorney General Larry D. Thompson.8

First published in 1999 by Attorney General Reno and her deputy, Eric Holder, the guidelines provide guidance to federal prosecutors deciding whether to seek indictment of corporate entities and other business organizations. The January, 2003 iteration of the guidelines announces a new focus on the "authenticity of a corporation's cooperation." It remarks that "too often" corporations take steps to impede and delay the full elucidation of facts involved in a criminal investigation.

The heart of the Justice Department's guidelines for corporations is a nine-item list of considerations for prosecution. Item 6 directly bears on the selective waiver issue presented in the McKesson litigation and the related efforts to gain judicial acceptance of its premise beyond the 8th Circuit. Item 6 provides that a federal prosecutor should consider, in determining whether to prosecute a corporation:

the corporation's timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigations of its agents, including, if necessary the waiver of corporate attorney-client and work-product protection." (emphasis added).9

The guidelines go on to explicate that such waivers are not required in order for a corporation to avoid prosecution, but that prosecutors are free to request them when deemed necessary to "provide timely and complete information." The paragraph immediately before provides that corporations are encouraged to conduct internal investigations and to disclose their findings.

The cumulative effects of the corporate sentencing guidelines, the Holder Memorandum and its successor in the Ashcroft administration, and the already entrenched practices of the government in seeking production of internal investigation reports institutionalize the role of the "corporate lawyer" as government agent far beyond the Sarbanes-Oxley subject matter of securities fraud.

• Regulatory Agencies. The government cooperation question is not confined to securities matters and criminal matters alone. Any corporation or business entity in a highly regulated industry is apt to be covered by either a voluntary or compulsory self-disclosure program promulgated by the oversight agency. For example, the Health and Human Services Department and the Defense Department have longstanding disclosure programs which have yielded substantial numbers of both civil and criminal cases. Each agency program has its own peculiarities and enforcement patterns; the extent to which a regulated business is dependent on government revenues can be determinative of the degree of incentive to provide disclosures under such programs. The experience of the Massachusetts Institute of Technology (mit) with the Defense Department is instructive in this regard.

As a federal government contractor, mit had contractually agreed to be subject to agency audits of its expenditure of contract funds. Under its Department of Defense contract, the federal dcaa conducted such a routine audit. During the course of the audit, mit provided the dcaa with materials it later sought to protect under work product and privilege protections. When the irs sought to obtain the materials which had been provided to the dcaa, as part of a separate investigation of mit's nonprofit exemption under 26 U.S.C. 501(c)(3), mit resisted. mit claimed to have a common interest (similar to that alleged by McKesson) with the Defense Department in the proper execution and performance of its contracts, and therefor concluded that it could preserve its work product and privilege protections under the common interest doctrine.

The 1st Circuit, in United States v. Massachusetts Institute of Technology, 129 F.3d 681(1997), disagreed with the common interest assertion, finding that mit merely hoped to have an inconsequential outcome to its dcaa audit. The possibility that the dcaa could be adverse to mit should misconduct be discovered should have been apparent to mit, according to the court. The court found that mit took "a calculated gamble" in disclosing its legally privileged and work product materials to the audit agency. In reasoning decidedly similar to that of the district court in McKesson, the 1st Circuit refused to accept the notion of a common interest between mit and the federal regulatory agency which oversaw it. characterizing the asserted common interest between mit and the agency as "abstract" and outside the interests legitimized in the case law, where "allied lawyers and clients ... who are working together in prosecuting or defending a lawsuit ... can exchange information among themselves without loss of privilege."10.

The repeated rejection of common interest assertions between governmental entities and the private business organizations which they oversee has occurred in spite of able legal analysis and confidentiality agreements. The likelihood that such legal measures and self-declarations in support of selective waiver will ultimately fail is increasingly high.

Dwindling Clout

In M.I.T., the court observed that as of 1997, six circuits had addressed the selective waiver issue that had emerged in the wake of Diversified Industries. Making itself the seventh to do so, the 1st Circuit aligned itself with the 2nd, 3rd, 4th, Federal and D.C. circuits in refusing to accept the doctrine.

In each case that presents the issue, the proponent of selective waiver places heavy reliance on the holding in Diversified Industries. With equal regularity, the deciding court gives short shrift to the 8th Circuit opinion, which is now 25 years old. The 1st Circuit in M.I.T. dispatched selective waiver summarily, describing the 8th Circuit opinion as an en banc decision "without more than a paragraph of analysis."11

Although the district court in McKesson distinguished Diversified Industries on the facts, other courts have been less kind. The 6th Circuit in In re: Columbia/HCA Healthcare Corporation Billing Practices Litigation, after accepting the matter on interlocutory appeal, ruled:

[W]e reject the concept of selective waiver in any of its various forms. ... [T]he uninhibited approach adopted out of whole cloth by the Diversified Court has little, if any relation to fostering frank communication between a client and his or her attorney. ... The attorney-client privilege was never designed to protect conversations between a client and the Government -- i.e., an adverse party -- ... . 12

The 6th Circuit opined that the Government has its own sufficient means, and powerful ones at that, to gather evidence in its investigations, finding that "[i]t is not necessary for the courts to create a new method."

In less pejorative language, but with the same rationale, the 2nd Circuit in 1993 rejected the 8th Circuit's selective waiver doctrine in In Re Steinhardt Partners LP Solomon Brothers Treasury Litigation,, 9 F.3d 230. The case involved a civil class action suit and a discovery request for production of all materials that had been previously provided by the defendant to the government, over the objection of the selective waiver doctrine. Voicing no sympathy for the Hobson's choice argument that counsel are caught between failing to cooperate with the authorities and revealing privileged materials to civil adversaries, the court stated that the necessity of making difficult choices in a litigation context is an insufficient basis for "carving a substantial exception to the waiver doctrine." In Westinghouse Electric Corp. v. Republic of Philippines, 951 F.2d 1414( 1991), the 3rd Circuit characterized the case as one which tested the "validity of the celebrated and controversial selective waiver theory fashioned by the 8th Circuit"; it concluded that upholding the theory is "unnecessary to encourage voluntary cooperation."

The growing consensus of decisions contrary to Diversified Industries adhere to the basic tenets of attorney-client privilege and the work product doctrine. The opinions in general carefully explicate the different rationales underlying the doctrine of waiver as it is applied first to the privilege, and next to the work product doctrine. The distinctions are well-framed by the 1st Circuit's concept of a "magic circle" outside which attorney-client privileged communications cannot extend. Those that are client-related, as defined by the parameters of the facts and case law, are properly within that magic circle. For the work-product doctrine, confidentiality within a "magic circle" is not the earmark that signals waiver. Instead, the conceptual driver in the waiver caselaw is the litigation-related concept of "adversary." The string of cases rejecting the 8th Circuit's selective waiver doctrine provides a clear message that governmental interests will be treated as naturally adverse to those of any corporate entity that finds itself conducting an internal investigation of possible wrongdoing.

The compulsions and incentives of the Justice Department and the pressures of Sarbanes Oxley can be seen as nothing other than motivators, which creates a gambling mentality for the corporate community. Cooperate by disclosure in an effort to avoid corporate legal consequences, but if you do so, do not expect to keep the substance of your communications with the government confidential.

Conclusion

A close friend attended mit as a college student. His roommate had a pet boa constrictor in a terrarium in the fraternity house. It ate white mice for its meals. One day when the white mouse was dropped into the terrarium, the snake struck, but missed, and banged its head on the glass wall. It repeated its misfires, and finally gave up on getting the mouse. For days, the white mouse remained alive and well in the terrarium, to the great wonder of the mit college guys. In fact, the white mouse got so comfortable with the snake that it took to sleeping in the snake's coils. One day, of course, my friend saw the snake strike and swallow its friend, the mouse, in a flash.

The selective waiver cases grasp and announce the nature and function of the government in investigating and prosecuting wrongdoing. Just as it is the job of the boa to eat the mouse, it is the job of the government to pick and choose when it will prosecute, and it must be free to keep open its options. It remains an adversary throughout, and the fundamental nature of the relationship cannot change.

The choice to share privileged or work-product information with the government must be seen within this context, and decisions carefully counseled and made accordingly. The selective waiver doctrine as conceptualized 25 years ago should not be relied upon to provide continuing confidentiality after a corporation discloses internal investigation reports to the government. The potential for the reports to become discoverable by adverse litigants is clearly real and present.

Notes
1 Under the "control group test," only those conversations between in-house counsel and the corporation's controlling executives and managers are eligible for protection. See City of Philadelphia v. Westinghouse Elec. Corp., 210 F. Supp. 483 (E.D. Pa. 1962); Reed v. Baxter, 134 F.3d 351, 359 (6th Cir. 1978) (control group test); see also Harper & Row Publisher, Inc. v. Decker, 423 F.2d 487 (7th Cir. 1970) (Harper Row test).

2 Diversified Industries, Inc. v Meredith, 572 F.2d 596, 611 (8th Cir. 1978) (emphasis added). The term selective waiver has been used in the case law and literature to describe situations where disclosure of privilege is made to a selected party and resisted as to other parties; the term limited waiver, by contrast, is typically reserved for situations where a portion of a privileged matter is disclosed while trying to retain another portion as confidential.

3 Id. at 611.

4 The fact that the confidentiality agreement was struck with the government before the investigation was undertaken -- and in clear anticipation of providing the report to the government -- is less significant than it appears. Such confidentiality agreements, made with the government after the internal investigation report has been prepared, and without pre-investigation intentions to share it with the government, have been equally ill-fated in terms of protecting the selective waiver to the government. See e.g. In re Columbia Healthcare Corp. Billing Practices Litigation, 293 F.3d 289, 302 (6th Cir. 2002): "Privilege is not a creature of contract arranged between parties to suit the whim of the moment."

5 United States v. Bergonzi, 2003 wl 21805228 (08/05/03) n. 5.

6 . See Robert A DelGiorno, "Corporate Counsel as Government's Agent: The Holder Memorandum and Sarbanes-Oxley Section 307," The Champion, August 2003.

7 See United States Sentencing Guidelines §8C2.5(g).

8 These memoranda and other Justice Department policies pertaining to white-collar matters are readily accessible through the department's website. www.usdoj.gov/dag/cftf/corporate_guidelines.htm.

9 Memorandum of Larry D. Thompson, Deputy U.S. Attorney General, "Principles of Federal Prosecution of Business Organizations," item VI(A), January 20, 2003. http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm

10 United States v. Massachusetts Institute of Technology, 129 F.3d 681, 685 (1997).

11 Id. at 685.

12 In re: Columbia/HCA Healthcare Corporation Billing Practices Litigation, No. 00-6059, 2002 Fed. App. 0201P (6th Cir. 06/10/02).

The author acknowledges with thanks the research assistance of Christine Mennen, an associate attorney in the litigation group with Halleland Lewis Nilan Sipkins & Johnson.

JANICE M. SYMCHYCH is a shareholder with Halleland Lewis Nilan Sipkins & Johnson. A former United States magistrate judge, she concentrates her practice in white collar and civil fraud defense.