A court in the Southern District of New York recently issued a noteworthy opinion in addressing a discovery dispute concerning communications between a non-party witness at the center of the SEC’s allegations and her attorneys, to whom she provided false information expecting they would pass it along to the SEC. In denying defendants’ request to examine the witness’s attorneys on these issues, the court held that although certain communications were no longer privileged because the witness waived the privilege and the crime-fraud exception applied, it would limit the extent to which the defendant could examine the attorneys on those communications on the basis of the proportionality requirement under Rule 26. The opinion serves as an apt reminder to defense counsel seeking exculpatory information being withheld as privileged that Rule 26’s proportionality requirement may pose an additional hoop through which to jump, even where arguments regarding the crime-fraud exception and waiver are successful.

The SEC’s Charges Against Defendants

On May 14, 2019, SEC filed fraud charges against Collector’s Coffee Inc. (d.b.a. Collectors Café)—a memorabilia auction business—and its CEO, Mykalai Kontilai, for misappropriating over $6 million of investor funds in a $23 million offering fraud that included false statements to investors. In the complaint the Commission also alleged that “Kontilai knowingly created and presented the SEC staff with fabricated documents (an employment agreement, loan agreement, and bank statement) in an effort to mislead the SEC and further conceal his misappropriation of investor funds.”[1]

Chief Operating Officer’s Deposition Testimony

During discovery, the defendants deposed the Company’s Chief Operating Officer, Gail Holt, in relation to certain documents produced to the SEC. During her deposition, Holt acknowledged lying to her attorneys regarding the authenticity of documents at the core of the SEC’s claims against the defendant, knowing full well her attorneys would convey those false statements to the SEC during the course of the investigation that led to the lawsuit.[2] Specifically, Holt intended to cause two of her attorneys to inform the SEC that she had created an employment agreement, when in fact she sent Kontilai her signature so he could create the employment agreement. Additionally, Holt testified that she lied to one of the two attorneys about the role of the other in producing the agreement to the SEC, knowing that such statement was also false.[3] Holt further testified that during a proffer with the SEC she admitted to making the false statements to her attorneys about the employment agreement knowing they would communicate that information to the SEC.[4]

Holt also testified that she lied to her two attorneys about the authenticity of the bank statement and a corresponding loan agreement.[5] In this case, however, according to her testimony, she did not know the statement and loan agreement would be produced to the SEC.

Defendants Seek to Redepose Holt’s Attorneys

After deposing Holt’s attorneys, who refused to answer certain questions based on the attorney-client privilege, the defendants sought to compel the attorneys to respond to questions regarding their communications with Holt concerning the subject documents on the grounds that Holt waived the attorney-client privilege, or alternatively, that the privilege does not apply under the crime-fraud exception. Defendants’ stated aim in seeking this testimony was to obtain impeachment material to use against Holt at trial.

In response, Holt argued that neither the crime-fraud exception nor the waiver doctrine applied, and that in any event the discovery sought was neither relevant nor proportional to the needs of the case under Rule 26 of the Federal Rules of Civil Procedure. The SEC also argued separately that the court should not permit additional discovery under Rule 26.

The Court’s Rulings

Crime-Fraud Exception

The court found that the crime-fraud exception applied, finding that Holt had instructed one of her attorneys to convey statements she knew were false to the SEC and had made false statements to another of her attorneys that she knew would be conveyed to the SEC.[6] In so ruling, the court rejected Holt’s arguments that the crime-fraud exception did not apply because Kontilai had manipulated her into lying to counsel. Even if that were true, the court reasoned, the manipulative conduct “would not vitiate probable cause to believe that she in fact made false statements to her counsel that she intended to be communicated to the SEC.”[7] The court also rejected Holt’s argument that no false statements were actually made to the SEC in connection with the employment agreement, holding that the false statements need not actually be made to the SEC because the “crime-fraud exception applies even to an ‘attempted perpetration of a crime or fraud.’” The court therefore concluded the crime-fraud exception removed the protections for attorney-client communications related to the employment agreement.

Waiver

In response to the defendants’ claims of broad privilege waiver, the court concluded that the waiver of the attorney-client communication privilege was limited in scope, confining it to communications with the two attorneys regarding the bank statement and loan agreement, and only the particular communications discussed during her deposition. The court explained that any subsequent questioning of her counsel is limited to the particular conversations in Holt’s testimony and not conversations on the same subject matter because Holt’s deposition testimony did not amount to a subject matter waiver. In rejecting the defendants’ argument that Holt was using privilege both as a sword and a shield, the court noted Holt is not a party to the litigation and therefore was in no position to use the privilege as both a sword and shield. It further held that the “at issue” doctrine was inapplicable because her mere descriptions of conversations with her attorney during her deposition did not place them “at issue.”

Rule 26’s Proportionality Requirement

Despite the court’s recognition regarding the applicability of the crime-fraud exception and its finding of limited waiver, it nonetheless further restricted the scope of deposition testimony defendants could take from Holt’s attorneys based on the proportionality limitations of Rule 26. The court analyzed the proportionality requirement by considering the importance of the issues at stake, the ability of discovery to resolve those issues, and the balance of the costs and benefits of the discovery, before concluding that only discovery directly related to the allegations in the complaint is significant enough to be proportional under Rule 26. Furthermore, the court found the proportionality concern is “particularly acute” here because the defendants are seeking discovery from non-party witnesses who lack firsthand knowledge of the issues underlying the facts at issue. Furthermore, the court explained that the discovery sought is to impeach the credibility of a witness and is not from the witness herself. The court also took issue with the tardiness of defendants’ requests and the defendants’ repeated discovery abuses, including in its initial depositions of the attorneys. Taken together, the court concluded that while it could exercise its discretion to bar any further discovery because such discovery is not proportionate under Rule 26, it declined to allow further questioning of one of the two attorneys at the center of its crime-fraud and waiver rulings, and limited further questioning of the other attorney to non-protected communications with Holt directly relating to allegations in the complaint that were no longer protected in light of the court’s ruling.

Conclusion

The SEC’s action against Collector’s Coffee and Kontilai was brought shortly before a criminal indictment was filed in Nevada against Kontilai and another of Collector’s Coffee’s officers. The indictment sets forth many of the same allegations brought in the SEC action, including Kontilai’s alleged fabrication, in coordination with “Employee A,” of the same documents at issue in Judge Gorenstein’s opinion. Assuming that “Employee A” is Holt, it is highly likely that Holt is a cooperating witness, and gave her deposition testimony without risk of criminal jeopardy (this would explain her lawyer allowing her to give such clearly self-incriminating testimony). Although the extent to which Judge Gorenstein considered the broader context in which the defendants’ discovery requests were made is unknown, it is hard to deny the possibility that the court was sensitive to Kontilai’s using the more liberal third-party civil discovery process to obtain discovery that would likely not have been permitted (or that would have been produced later during trial as Jencks material) under the Federal Rules of Criminal Procedure in the Nevada action.

Against this contextual backdrop, there are a number of takeaways from Judge Gorenstein’s opinion that should be heeded by defense counsel representing defendants in civil actions brought by the SEC:

• In such cases where defense counsel seeks civil discovery to obtain documents and testimony from third parties that may also have evidentiary value in the parallel criminal proceeding, defense counsel should make efforts to avoid the pitfalls that befell the defendants in Collector’s Coffee. These include (1) conducting such discovery in a timely manner, (2) refraining from engaging in overly-aggressive discovery tactics that may undercut requests for discovery later that lie within the court’s discretion, and (3) laying a strong foundation to argue that the third-party discovery sought is proportional to the needs of the case, which in this case the court, in its discretion, required a showing that the discovery “relate[d] directly to the allegations [in] the [SEC] complaint.”
• Judge Gorenstein’s refusal to apply the sword/shield doctrine to Holt’s selective assertions of privilege during her deposition seemed to ignore Holt’s likely status as a likely cooperating witness for the SEC, and for the DOJ in the parallel criminal proceeding. In situations like this, defense counsel would do well to characterize the cooperating witness’s selective assertion of privilege as effectively doing the bidding of the enforcement agencies with whom she is cooperating, and as offering the potential reward of leniency from the Government in the resolution of her own criminal or civil matters.[8]
• Finally, Judge Gorenstein’s heavy reliance upon Rule 26’s proportionality requirements in limiting the scope of permissible examination of Holt’s lawyers, even after finding that the sought-after attorney-client communications were subject to the crime-fraud exception and waiver, highlights the additional hurdle of proportionality that counsel must be prepared to overcome in order to obtain privileged information through third-party discovery.

[1] Amended Complaint at ¶ 38, SEC v. Collector’s Coffee Inc., No. 19CIV4355VMGWG, 2021 WL 1436664, at *1 (S.D.N.Y. Apr. 16, 2021).

[2] Holt Depo. at 31-33.

[3] Holt Depo. at 31-32.

[4] Holt Depo. at 30, 33. Holt denied causing a third attorney to tell the SEC that she had created the employment agreement, and Holt asserted privilege when asked if she instructed that attorney to provide false information to the SEC. Holt Depo. at 66-67. Separately, Holt confirmed that she made inaccurate or false statements to the third attorney during a December 2018 meeting with the third attorney and several other attorneys. See Holt Depo. at 149-58, 165-84.

[5] Holt Depo. at 187-189, 192, 194.

[6] Collector’s Coffee Inc., 2021 WL 1436664 at *8 (“These false statements were that the employment agreement sent to them was not false but rather was “recreated” by Holt, and that [the second attorney] had inadvertently produced the recreated version to the SEC.”).

[7] Collector’s Coffee Inc., 2021 WL 1436664 at *9.

[8] See, e.g., FTC v. American Tax Relief LLC, 2012 WL 8281722, at *2 (C.D. Cal. Aug. 8, 2012) (declining to admit declarations by non-party witnesses who previously invoked the Fifth Amendment based on sword/shield analogy, and noting that “while the declarants are not parties to this case, it is not accurate to view them as neutral, unaffiliated parties”); cf. In re Grand Jury Proceedings, 2001 WL 237377, *7 (Mar. 2, 2001) (noting that sword/shield analogy “does not neatly apply” to selective privilege assertion of witness during grand jury testimony because “even if the grand jury were to vote a ‘no true bill,’ that would afford only temporary relief [to witness], since the government can always empanel another grand jury”) (citing In re Grand Jury Proceedings, 219 F.3d 175, 189 (2d Cir. 2000)). But see United States v. Treacy, 2009 WL 812033, at *2 (Mar. 24, 2009) (sword/shield use of privilege “not implicated where, as here, the holder is not a party to the action and seeks no advantage against its adversary”).