Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_06-cv-04435/USCOURTS-cand-3_06-cv-04435-17/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:78m(a) Securities Exchange Act

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United States District Court

For the Northern District of California

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United States District Court

For the Northern District of California

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SECURITIES AND EXCHANGE

COMMISSION,

Plaintiff,

 v.

GREGORY L. REYES, et al.,

Defendants. /

No. C 06-04435 CRB

MEMORANDUM AND ORDER

RE: SEC’S MOTION TO COMPEL

In this civil enforcement action, the Securities and Exchange Commission (“SEC”)

alleges that three executives of Brocade Communications Systems, Inc. (“Brocade”),

participated in a conspiracy to backdate stock options. One of these executives, Gregory

Reyes (“Reyes”), has filed a motion for partial summary judgment. He argues that investors

consider non-cash expenses such as employee stock option (“ESO”) compensation

“immaterial” to their investment decisions, and that any deception about the amount or nature

of such expenses, at least in the circumstances presented by this case, does not constitute a

“material misrepresentation” under the securities laws. See Def.’s Mot. for Partial Summ. J.

on the Issue of Materiality at 19-32 (Docket No. 119) (hereinafter “Materiality Motion”).

In support of the motion, Reyes submitted reports from three experts, two of whom

were retained not only for the purpose of providing expert testimony, but also as litigation

consultants. Reyes has disclosed all of the documents reviewed by these experts strictly in

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 Prior to 1993, courts were split on the question of whether communications between an

attorney and a testifying expert were discoverable. See Intermedics, Inc. v. Ventritex, Inc., 139

F.R.D. 384, 387 n.3 (N.D. Cal. 1991) (collecting cases). In 1993, however, the discovery rules

were amended to require the disclosure of “the data or other information considered by [expert

witnesses] in forming [their] opinions.” Fed. R. Civ. P. 26(a)(2)(B). Since the amendment,

courts have overwhelmingly, though not uniformly, imposed a “bright-line rule” that all

materials considered by a testifying expert, including attorney work product, must be disclosed.

Regional Airport Authority of Louisville, 460 F.3d at 715; In re Pioneer Hi-Bred International, 238 F.3d at 1375; Karn v. Ingersoll-Rand, 168 F.R.D. 633, 637-41 (N.D. Ind. 1996). But see

Haworth, Inc. v. Herman Miller, Inc., 162 F.R.D. 289, 292-96 (W.D. Mich. 1995). This Court

concurs in the “majority view” that Rule 26(a)(2)(B) requires the disclosure of all materials

considered by, presented to, or relied upon by a testifying expert in forming his or her opinions,

regardless of whether they might otherwise be protected by the work-product privilege.

Regional Airport Authority of Louisville, 460 F.3d at 715. Accord Fed. R. Civ. P. 26 Advisory

Comm. Note to 1993 Amendments (“Given this obligation of disclosure, litigants should no

longer be able to argue that materials furnished to their experts to be used in forming their

opinions--whether or not ultimately relied upon by the expert--are privileged or otherwise

protected from disclosure when such persons are testifying or being deposed.”).

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their capacity as “witnesses.” See Fed. R. Civ. P. 26(a)(2)(B) (requiring disclosure of “the

data or other information considered by the witness in forming the opinions”). But he has

refused to disclose documents ostensibly reviewed in their capacity as “consultants,” arguing

that such materials constitute privileged work product. The SEC, which disputes this claim

of privilege, filed a motion to compel production of the documents withheld. As explained

below, the motion is hereby GRANTED in part and DEFERRED in part.

BACKGROUND

When experts serve as litigation consultants, the work-product privilege generally

applies to materials reviewed or generated by them in that capacity. Fed. R. Civ. P. 26(b)(3);

United States v. Nobles, 422 U.S. 225, 238-39 (1975); In re Cendant Corp. Sec. Litig., 343

F.3d 658, 662-65 (3d Cir. 2004). When experts serve as testifying witnesses, the discovery

rules generally require the materials reviewed or generated by them to be disclosed,

regardless of whether the experts actually rely on those materials as a basis for their opinions. 

Fed. R. Civ. P. 26(a)(2)(B); Reg. Airport Auth. of Louisville v. LFG, LLC, 460 F.3d 697,

715 (6th Cir. 2006); In re Pioneer Hi-Bred Int’l, 238 F.3d 1370, 1375 (Fed. Cir. 2001);

United States v. City of Torrance, 163 F.R.D. 590, 593-94 (C.D. Cal. 1995).1

A question thus arises about whether, and to what extent, the work-product privilege

applies when an expert alternately dons and doffs the “privileged hat” of a litigation

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 As a conceptual matter, courts addressing the “hats” problem have often failed to

distinguish between two distinct ideas: the character of the documents reviewed, on the one

hand, and the particular role ostensibly played by the expert when reviewing them, on the other.

Compare B.C.F. Oil Refining, 171 F.R.D. at 62 (stating that “any ambiguity as to the role played

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consultant and the “non-privileged hat” of the testifying witness. In other words, does a

litigant forfeit the privilege that would otherwise attach to a litigation consultant’s work

when he offers that expert as a testifying witness? Every court to address this “multiple hats”

problem has concluded that an expert’s proponent still may assert a privilege over such

materials, but only over those materials generated or considered uniquely in the expert’s role

as consultant. B.C.F. Oil Refining, Inc. v. Consol. Edison Co. of New York, 171 F.R.D. 57,

61-62 (S.D.N.Y. 1997); Grace A. Detwiler Trust v. Offenbecher, 124 F.R.D. 545, 546

(S.D.N.Y. 1989); Beverage Mktg. Corp. v. Ogilvy & Mather Direct Response, Inc., 563 F.

Supp. 1013, 1015 (S.D.N.Y. 1983); see also Messier v. Southbury Training Sch., No. 3:94-

CV-1706, 1998 WL 422858, at *1-2 (D. Conn. June 29, 1988) (unpublished opinion).

These courts have further concluded that the scope of the privilege must be narrowly

construed against the expert’s proponent, lest the privilege interfere with the goal of the

disclosure requirements, which is to allow an adversary “to expose whatever weaknesses,

unreliabilities, or biases might infect the opinions of testifying experts called by [an] adverse

party.” City of Torrance, 163 F.R.D. at 593. Thus, “documents having no relation to the

expert’s role as [a witness] need not be produced but . . . any ambiguity as to the role played

by the expert when reviewing or generating documents should be resolved in favor of the

party seeking discovery.” B.C.F. Oil Refining, Inc., 171 F.R.D. at 62; see also Offenbacher,

124 F.R.D. at 546 (noting that documents “would become discoverable” to the extent that

“the delineation between [the expert’s] roles . . . become[s] blurred”); Beverage Marketing,

563 F. Supp. at 1014 (noting that the privileged and non-privileged status of “consultant” and

“witness” materials can be maintained only “if this delineation [is] clearly made”). Here, this

Court concludes, in accord with every other court that has considered the issue squarely, that

Reyes may assert the work-product privilege, but only as to materials that do not pertain to

the subject matter on which his experts have submitted testimony.2

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by the expert . . . should be resolved in favor of the party seeking discovery” (emphasis added));

with id. (stating that an expert’s proponent need not produce “documents having no relation to

the expert’s role as [witness]” (emphasis added)). This Court finds that the appropriate test for

disclosure is not what function the expert was ostensibly serving when he reviewed or generated

the particular documents in question. Rather, the test must be whether the documents reviewed

or generated by the expert could reasonably be viewed as germane to the subject matter on which

the expert has offered an opinion. First, this focus on the nature of the materials is more

consistent with Rule 26(a)(2)(B), which identifies the formation of the expert’s “opinions” as

the touchstone for disclosure. Second, this rule is in accord with other decisions concerning the

scope of waiver regarding the work-product privilege. See United States v. Nobles, 422 U.S.

225, 239 (holding that an attorney “waived the [work-product] privilege with respect to matters

covered in his [investigator’s] testimony” by presenting the investigator as a witness). Third,

this standard for disclosure is preferable because it emphasizes the concrete subject matter

contained within the documents, rather than the artificial and illusory distinction of the “hat”

worn by the expert at any particular time. Cf. United States v. Martinez, 514 F.2d 334, 343 (9th

Cir. 1975) (noting, in the context of jury instructions, that it is impossible to “unring the bell”

once certain thoughts or theories have been offered for consideration).

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DISCUSSION

Reyes has identified the materials withheld as pertaining to “one of five discrete

projects” that the two experts, Steve Stanton and David Gulley, undertook in their role as

litigation consultants. See In Camera Submission Regarding Docs. Withheld on Att’y WorkProduct Grounds at 4 (Docket No. 208) (hereinafter “In Camera Submission”). Reyes argues

that each of these five projects has nothing to do with the experts’ opinions on the materiality

of stock-option expenses, but rather with “specific allegations about . . . alleged conduct and

intent.” Id. at 1. He argues that “the analyses and documentation relating to these projects

properly may be withheld” because the summary judgment motion “is directed solely to the

essential element of materiality and assumes arguendo the truth of the Commission’s

allegations regarding . . . conduct and intent.” Id. at 5.

The Court disagrees. While it may be true, as Reyes contends, that his motion

assumes arguendo the existence of some backdating, the motion does not stop at the

theoretical argument non-cash stock-option expenses are never material to reasonable

investors. Instead, it advances arguments about why the particular circumstances of the

alleged backdating scheme at Brocade did not rise to the level of material misrepresentations. 

For instance, the motion rests in part upon the observation that Brocade disclosed certain

aspects of the challenged stock option grants, id. at 4, 11-12, 22-24; that Brocade’s

restatement of stock-option expenses did not have a statistically significant effect on the

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actual price of Brocade’s stock, id. at 4-5, 14-16, 28-30; that the backdating of stock options

contributed to only a marginally to Brocade’s financial restatements, id. at 6-7, 30-32; and

that many of the stock options allegedly backdated in this case were never actually exercised,

id. at 3, 32.

Likewise, the reports authored by Stanton and Gulley rest upon a detailed factual

analysis about the accounting and valuation of the stock options actually issued by Brocade. 

See Decl. of Steven F. Stanton ¶ 6 (Docket No. 116) (hereinafter “Stanton Report”)

(discussing the “total number of stock options awarded, canceled, and exercised in the fiscal

years 1999, 2000, 2001, 2002, 2003, and 2004 as disclosed in Brocade’s annual filings”); id.

¶ 8 (discussing the “options at issue” based upon “the total number of options issued” and

“the percentage of options that were exercised”); id. ¶ 11 (discussing “the amount of stockbased compensation expense for the entire period affected by the restatement”); id. ¶ 17

(discussing how a “reading of Brocade’s financial statements” would have permitted an

investor to “locate all of the disclosures” related to the allegedly backdated stock options);

see also Decl. of David A. Gulley ¶ 7 (Docket No. 121) (hereinafter “Gulley Report”)

(concluding that “investors did not care about [Brocade’s] ESO grant expenses” based on

“all evidence considered”); id. ¶ 9 (discussing “Brocade’s share price history, financial

reporting, ESO grants and data related to Brocade and the equity markets”); id. ¶ 16

(indicating an awareness “that Brocade’s ESO grant expenses were small in relation to other

expenses”); id. ¶ 16 (indicating that “Brocade also disclosed in its footnotes much larger ESO

grant expenses”); id. ¶ 23 (“In summary, taken as a whole, the body of evidence I considered

strongly supports my opinion that investors in Brocade and its peers did not care about ESO

grant expenses.” (emphasis added)).

It is thus clear that neither the motion nor the experts’ reports are confined to the

theoretical or hypothetical realm. Rather, they are based on a detailed consideration of the

proper valuation of Brocade’s stock options grants, as well as judgments about the degree to

which allegedly backdated options actually affected Brocade’s earnings restatements. It is

also clear that many, though perhaps not all, of the materials withheld by Reyes on grounds

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of work-product privilege are relevant to these very same issues.3 For this reason, Reyes is

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hereby ORDERED to hand over to the SEC all withheld materials, save and except for the

materials that pertain exclusively to the “Grant-Date Probability Project” and the “MoneyLeft-on-the-Table Project.” As to those documents, Reyes is further ORDERED to submit

the documents for in camera inspection by Wednesday, April 4, 2007, so that the Court can

determine whether these materials should be disclosed, too. Accordingly, the SEC’s motion

to compel is hereby GRANTED in part, and consideration of the motion is hereby

DEFERRED in part, pending further review in camera.

IT IS SO ORDERED.

Dated: March 30, 2007 

CHARLES R. BREYER

UNITED STATES DISTRICT JUDGE

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