Identifying and Combatting Fraud and Other Misconduct in Transactions and Litigation A Case Study and Some Tactical Considerations
Michael Farhang, James Fogelman, Robert Klyman and Jay Srinivasan Thursday, March 16th 2017
“Forgery. Perjury. Willful destruction of evidence. Litigators might sometimes suspect the other side of such shenanigans, but rarely do you get an unequivocal win as a result. On Friday, a team from Gibson, Dunn & Crutcher led by James Fogelman and Jay Srinivasan pulled it off, arguing successfully that a key plaintiffs’ document in a $12 billion fight was fake.”
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Judge Suzanne Bruguera’s November 22, 2016 Order and December 2, 2016 Default Judgment Determined three of Plaintiffs’ key documents to be forgeries Found “ample evidence” of perjury by Plaintiffs, in particular Lead Plaintiff, to mislead the Court and cover up misconduct Dismissed Plaintiffs’ Third Amended Complaint with prejudice Enjoined Plaintiffs from continuing to breach the Joint Venture Agreement Granted over $6 million in fees and costs to Gibson Dunn’s client
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How did Gibson Dunn and its clients prove forgery, fabrication, manipulation, and spoliation of evidence?
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Plan A: Plaintiffs and Their Counsel Swore That “Version 2” Was The “Original” From September 2010
“. . . the original has remained in “This document, sir, is the document that [Plaintiff’s] possession until recently, was sent to our office, that is correct.” when he turned it over to [Plaintiffs’] counsel for handling and maintaining in accordance with the September 8, 2015 order of this Court.”
“. . . plaintiffs have assembled the original hard copies of the agreements for holding in escrow by a third party . . . They produced for copying “Since my receipt of the documentation . . . in by [Defendants] the original hard copies of JVA mid-September 2010, I have carefully maintained Version 2 and the La Cienega PMA.” the original hard copies of Version 2 and [the] September 14, 2010 cover letter for it.”
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Additional Perjury by Plaintiffs
VIDEOTAPED DEPOSITION TESTIMONY TUESDAY, SEPTEMBER 22, 2015
Q. Now, just to clarify, is it Q. Let me clarify. Do you still have your testimony that the the original of what you say you found document you brought with you in the basement in the last eight to 12 today [“Version 2”] is exactly months [the Cover Letter] ? what you claim to have received A. Yes, I do sir. in September of 2010? Q. And where do you have that document? THE WITNESS: Yes. A. I keep that document in my safe now.
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Plan B: Plaintiffs And Their Counsel Threaten To Blame Defendants’ Counsel for “Switching” The Documents
From: [Plaintiffs’ Counsel] Sent: Friday, October 16, 2015 1:13 PM To: [Gibson Dunn] Subject: Re: Lincoln Studios: Production of documents – Time Sensitive
“Please understand that it is our position that this letter and version 2 was received in 2010. Once again, if you take the only copy of the letter and subsequent testing demonstrates that the age of the paper is after 2010, it will be our position that there has been an alteration.”
“. . . If you take the letter, and it ends up being time dated at any other time in 2010, it will be our position that you have altered or substituted the document. My proposal guarantees that you will not have this exposure.”
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PNY USB Drive (Used N.S. Dell Desktop Dell OptiPlex 7010 N.S. 2012 Computer to transfer “NS clean 123 Computer (The A.S. NMS Dell (DELLNEIL2012-PC) PRINT.pdf”) Desktop)
Seagate BUP Slim BK Seagate 4 terabyte drive Seagate 4 terabyte 20 Other USB (Replaced Seagate drive (Original Seagate USB (used in backup of Devices Secondary Hard Drive) N.S. Dell Desktop) Secondary Hard Drive)
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Lead Plaintiff’s Computer Is Backdated 17 Times in 60 Days
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Plaintiffs’ employees downloaded Eraser Portable on 12/3/2015 and ran it on 12/4/2015:
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Even Plaintiffs’ Computer Forensics Expert Was Disturbed By Plaintiffs’ Misconduct
“It’s a horrendous idea.”
“I would not advise “I think it was dumb. Bad idea.” somebody to do that.”
“All I can say it was a stupid thing for him to have done. I wouldn’t have recommended it . . . .”
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Plaintiffs Stand Alone On Forged “Version 2”
“I thought it was a typo, a misunderstanding, it was fixed.”
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Plaintiffs’ Deal Counsel Confirmed That There Is No “Typo” In Section 11.1
Q. Sir, looking at the language “five years from the date hereof,” which is contained in the redline portion 11.1(a)(i), you’re not aware of any typos in that language; correct, sir? A. No. Q. There are no typos contained in section 11.1(a)(i) of Exhibit 3; correct? A. Correct.
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Ex-President of Plaintiffs Confirms: No Typo in Section 11.1
Ex-President’s Deposition Testimony
Q. And you are not aware of any typo in Section 11.1 A1, correct?
A. No, I’m unaware of that.
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Non-Binding Term Sheet: Three Years OR Stabilization
From: [Defendants] To: [Plaintiffs and Plaintiffs’ Deal Counsel] Sent: Wed 5/26/2010 3:32:12 PM Subject: [Joint Venture] Term Sheet
[Lead Plaintiff]
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The 5-Year Buy/Sell Provision Was Incorporated Per Plaintiffs’ Request
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From: [Plaintiffs’ In-House Counsel] Sent: Friday, July 19, 2013 12:04 PM To: [Lead Plaintiff] Subject: RE: [FWD: FW: Emailing: [JV] Term Sheet v6 redline.doc, [JV] Term Sheet v6.doc]
From: [Lead Plaintiff] Sent: Friday, July 19, 2013 11:47 AM To: [Plaintiffs’ In-House Counsel] Subject: FW: [FWD: FW: Emailing: [JV] Term Sheet v6 redline.doc, [JV] Term Sheet v6.doc]
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Version 1 and 3 LLC Agreements Are Different Than Version 2 LLC Agreement
Version 1 and Version 3 LLC Version 2 LLC Agreement Agreements
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All Other Versions of the Q1 Version 2 LLC Agreement Were Made On Or After July 15, 2013
Q1 Version 2 K61 Version 2 LLC LLC Agreement Agreement
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Versions of the JV Agreement Modified/Emailed Over Time on Plaintiffs’ Devices
“Version 2”
“Version 3” “Version 1”
September January July 2013 2010 2011
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Monday, July 15, 2013, at 3:51 p.m.
The file is opened on Lead P’s son’s company computer, a device that was originally withheld from forensic examination. Before 4:00 p.m., the file is Monday, July 15, 2013, at 1:24 p.m. printed on a P’s Xerox WorkCenter machine, in P’s offices, leaving the CPS The file was transferred to a thumb code. The produced “Version 2” contains one page that was not printed with drive from the unknown computer the rest of the document.
Monday, July 15, 2013, at 4:18 p.m. Sunday, July 14, 2013, at 9:46 p.m. The print-out of “Version 2” is scanned to Lead P’s son’s email An unknown computer opened and account from the Xerox WorkCenter. modified a file called “P6 LA MF Holding I LLC clean NS 123 Monday, July 15, 2013, at 9:43 p.m. PRINT.pdf.” This unknown “Version 2” pdf that was created earlier that day is “modified,” computer has never been produced. indicating a change to the document.
Wednesday Thursday Friday Saturday Sunday Monday Tuesday Wednesday Thursday Friday Saturday July 10 July 11 July 12 July 13 July 14 July 15 July 16 July 17 July 18 July 19 July 20
Friday, July 12, 2013, at 4:52 p.m. P’s In-House Counsel emails two July 15, 2013, 3:51 p.m. Tuesday, July 16, 2013, at Friday, July 19, 2013, at 12:04 p.m. versions of the JV Agreement, 9:44 p.m. Email announces resignation P’s In-House emails Lead P: “This attaching two live emails from 2010 USB drive containing the of then-President of [3-year] concept didn’t make it into and 2011 containing the original and document entitled “P6 LA Plaintiffs, who negotiated the the actual LLC Agreement.” the operative JV Agreement. MF Holdings I LLC NS JV Agreement for Plaintiffs. clean 123 PRINT.pdf” is Friday, July 12, 2013, at 4:57 p.m. plugged into Lead P’s Friday, July 19, 2013, at 4:59 p.m. son’s computer. Plaintiffs Lead P forwards In-House Counsel’s email never produced this P’s In-House Counsel emails containing both “Version 1” and “Version 3” to device. Defendants a copy of “Version 2” his son without explanation. for the first time. 27
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The “Cover Letter” Is Another Forgery
In an attempt to conceal his forgeries, Lead Plaintiff reached out to his employees to ask about metadata on different versions of the cover letter that he created.
Lead Plaintiff to Employee on Lead Plaintiff to another September 9, 2015, attaching cover Employee on September 18, letter v2: “I have a question on this 2015, attaching cover letters letter . . . I wanted to know if you v2 and v3: “Please take a can tell when the original was look at metadata. I’ll call you taken or scanned.” in 15.”
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The La Cienega PMA Was Clearly Altered
All Other PMA Documents
Q2 MARCH 2012 PMA
LaPorte Decl., ¶ 99 30
From: [Defendants’ Counsel] Sent: Wednesday, January 25, 2012 4:45 PM To: [Plaintiffs, Plaintiffs’ Counsel and Defendants] Subject: Luxe La Cienega, LLC – Management Agreement
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From: [Plaintiffs’ Director of Development] Sent: Thursday, January 26, 2012 10:40 AM To: [Defendants’ Counsel, Defendants, and Plaintiffs] Subject: RE: Luxe La Cienega, LLC – Management Agreement
“This looks okay to me.”
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Draft La Cienega PMA Circulated And Approved In January 2012
From: [Defendants’ Counsel] Sent: Friday, January 27, 2012 10:45 AM To: [Third Party Lenders] Cc: [Plaintiffs and Plaintiffs’ Counsel] Subject: [Lender] – Luxe La Cienega
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Q2 La Cienega PMA Contains The Uncorrected Typo
Q2 LA CIENEGA PMA (March 01, 2012)
K55 PMA K54 PMA K 70 (Draft K27 PMA K58 PMA K57 PMA La Cienega PMA)
UNCORRECTED “WRITTING” “WRITTING” CORRECTED TO “WRITING” TYPO (2010-2011) (2011-2013)
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The Typo Was Later Fixed, Including in the Draft La Cienega PMA
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Takeaways and Lessons
Thoroughly review disputed documents for defects Be quick to seek court intervention for the preservation and production of evidence Hire the right experts Don’t cut corners Repeatedly present consistent narrative to the Court
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Robert Klyman Michael Farhang Partner Partner Corporate Department Litigation Department
Post-Acquisition Fraud Investigations
• Fraud Investigations – When Should a Client Invest in a Post-Acquisition Investigation? – Questions about whether transaction was for fair value • Complete financial information will only be available after the sale • Former management may depart or have few incentives to question pre-deal representations • Former management may have financially incentivized remaining managers to obscure critical problems – Concerns from Investors, Auditors, Lenders, or Regulators • Sudden financial downturns or loss of asset value may spark questions about deal • Change in target company value may affect parent’s share value (e.g., goodwill impairments, etc.) • Undisclosed liabilities or regulatory problems may devalue investment and create successor liability – Need to Strengthen and Maintain Adequate Internal Controls and Compliance • Accountants can’t advise on legal avenues • Many fraud cases are based on non-GAAP issues • Legal counsel can orient fact-finding toward legal theories of eventual recovery • Legal counsel can help client evaluate cost-benefit analysis of investigation vs. potential recovery • Legal counsel can help client defend or initiate government investigations • Investigation by counsel can be used to explain issues to investors, lenders, auditors, regulators, and other third parties – Initial Post-Acquisition Investigation Can Be Small and Targeted • Initial investment in potential recovery can be limited • Eventual recovery can be large
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Buyer Claims for Fraud and Investigations
Financial Fraud Connected to Sale Process • Caterpillar’s Acquisition of ERA Mining Machinery/Siwei (2012) • Abry Partners’ Acquisition of F&W Publications (2005) • McKesson Corp.’s Acquisition of HBOC (1998) • Echo Global Logistics Inc.’s Acquisition of ShipperDirect Logistics Inc. (2013)
Undisclosed Liabilities (e.g., FCPA) Affecting Sale Value • Elandia’s acquisition of Latin Node (2007) • Halliburton’s acquisition of KBR (1998)
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Post-Acquisition Fraud Investigations
Where is Fraud Typically Found? • Financial Statements – GAAP violations • Inflated Projections • Vendor Contracts • Inflated Revenues • Concealment of Customer Departures or Other Problems • MAC events • Working Capital • FCPA, Export Compliance, etc. • Other areas?
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Buyer Claims for Fraud
M&A Strategies – How to Best Position Your Clients To React to Pre-Acquisition Fraud or Other Problems • Representations and Warranties – Projections or Earnouts • MAC Clauses (Osram Sylvania v. Townsend Ventures and sale-related fraud) • Privilege Issues – Who Retains Privilege Over Pre-Acquisition Communications • Indemnity Clauses - Exceptions for fraud, rescissions • Arbitration Clauses – Third party discovery, appealability, number of arbitrators, etc. • Choice of Law and Venue Clauses - California law favors buyers • Disclaimers in Confidentiality Agreements and Promotional Materials
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Post-Acquisition Fraud Investigations
Investigation Strategies – How to Best Position Your Clients To React to Pre-Acquisition Fraud or Other Problems • Board or Special Committee Involvement • Witness Interviews • Hold Notices – e.g., notices to former owners and management • Email Collection – Server data, hard drive data, and backup tape data – Data privacy in foreign jurisdictions • Protecting Privilege and Work Product Over Investigation • Accounting Reviews and Audits – Forensic Accounting Capabilities • Law Enforcement Strategy – Considering criminal or civil referrals • Litigation Strategy – Considering shareholder demands or civil litigation
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Buyer Claims for Fraud
Litigation Strategies – How to Best Position Your Clients To React to Pre-Acquisition Fraud or Other Problems • Common Law Fraud Claims – Rescission vs. Fraud Damages • Securities Fraud Claims – State and Federal • RICO Claims – Treble Damages • Breach of Contract – Damages Caps • Disclaimers • Due Diligence and Buyer’s Failure to Ask • Damages and Valuation – EBITDA multiple vs. DCF Approach – Choosing the right experts • Arbitration vs. Court – Confidentiality and Scope of Discovery – Selecting an arbitrator
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Buyer Claims for Fraud
• Some Considerations Regarding SPA and APA Provisions – Transfer of Pre-Existing Claims – Acquisition of an entire business via SPA will generally result in successor entity inheriting claims relating to assets and ongoing operations of the business owned by the pre-acquisition entity. In an asset purchase, unless claim owned by pre-acquisition entity relates to a transferred asset, it may or may not exist with successor entity. – Privilege – Privilege relating to legal issues concerning ongoing operations of business is generally transferred. But check the choice of law provision. Under Delaware law, privilege over sale-related communications may transfer without specific contract language (Great Hill) while under New York law, privilege over sale-related communications may not transfer absent specific language (Tekni-Plex). – Choice of Law – California law is very buyer-friendly, while Delaware and New York impose greater obligations on buyers (e.g., impact of disclaimers and diligence). Keep in mind that choice of law “arising under” provisions regarding disputes may not always govern extracontractual tort claims (e.g., New York). – Transfers of Data and Documents – Importance of ensuring that buyer has full title and access to all business and financial records (including email data) of the company (e.g., “books and records” may or may not be specific enough, include specifications regarding electronic data and other information stored on discs, tapes, servers, other media).
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