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 SrinivasanThursday, March 16th 2017

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“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

“Since my receipt of the documentation . . . in mid-September 2010, I have carefully maintained the original hard copies of Version 2 and [the] September 14, 2010 cover letter for it.”

“. . . the original has remained in [Plaintiff’s] possession until recently, 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 by [Defendants] the original hard copies of JVA Version 2 and the La Cienega PMA.”

“This document, sir, is the document that was sent to our office, that is correct.”

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Additional Perjury by Plaintiffs

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Q. Now, just to clarify, is it

your testimony that the

document you brought with you

today [“Version 2”] is exactly

what you claim to have received

in September of 2010?

THE WITNESS: Yes.

Q. Let me clarify. Do you still have

the original of what you say you found

in the basement in the last eight to 12

months [the Cover Letter] ?

A. Yes, I do sir.

Q. And where do you have that document?

A. I keep that document in my safe now.

VIDEOTAPED DEPOSITION TESTIMONY

TUESDAY, SEPTEMBER 22, 2015

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Plan B: Plaintiffs And Their Counsel Threaten To Blame Defendants’ Counsel for “Switching” The Documents

“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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From: [Plaintiffs’ Counsel]Sent: Friday, October 16, 2015 1:13 PMTo: [Gibson Dunn]Subject: Re: Lincoln Studios: Production of documents –Time Sensitive

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Plan C: Destroy All The Electronic Evidence Despite The Court’s Orders And Commitments Made To The Court

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Plaintiffs Conspire To Destroy Lead Plaintiff’s Computer Before the Court-Ordered Forensic Inspection

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Plaintiffs’ Employees Conspire to Permanently Delete and Wipe DevicesPrior To The Court-Ordered Forensic Examination

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N.S. 2012 Computer (DELLNEIL2012-PC)

PNY USB Drive (Used to transfer “NS clean 123 PRINT.pdf”)

N.S. Dell Desktop Computer

Seagate 4 terabyte drive (Original Seagate Secondary Hard Drive)

Seagate BUP Slim BK USB (used in backup of N.S. Dell Desktop)

Seagate 4 terabyte drive (Replaced Seagate Secondary Hard Drive)

20 Other USB Devices

Dell OptiPlex 7010 (The A.S. NMS Dell Desktop)

Devices Destroyed, Manipulated, or Withheld by Plaintiffs

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Lead Plaintiff’s Computer Is Backdated 17 Times in 60 Days

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Plaintiffs Admit To Downloading And Using Powerful File Eraser Software And Deleting Incriminating Software And Data

Plaintiffs’ employees downloaded Eraser Portable on 12/3/2015 and ran it on12/4/2015:

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Even Plaintiffs’ Computer Forensics Expert Was DisturbedBy Plaintiffs’ Misconduct

“I think it was dumb. Bad idea.”

“It’s a horrendous idea.”

“All I can say it was a stupid thing for him to have done. I wouldn’t have recommended it . . . .”

“I would not advise somebody to do that.”

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Plaintiffs Stand Alone On Forged “Version 2”

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“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

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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

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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

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From: [Defendants]To: [Plaintiffs and Plaintiffs’ Deal Counsel]Sent: Wed 5/26/2010 3:32:12 PMSubject: [Joint Venture] Term Sheet

[Lead Plaintiff]

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The 5-Year Buy/Sell Provision Was Incorporated PerPlaintiffs’ Request

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Versions 1 and 3 of the LLC Agreement

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Plaintiffs’ In-House Counsel Confirms: No 3 Year Buy/Sell In “Actual LLC Agreement”

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From: [Plaintiffs’ In-House Counsel]Sent: Friday, July 19, 2013 12:04 PMTo: [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 AMTo: [Plaintiffs’ In-House Counsel]Subject: FW: [FWD: FW: Emailing: [JV] Term Sheet v6 redline.doc, [JV] Term Sheet v6.doc]

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Changing “five” to “three” Causes A Single Overhanging Letter

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Version 1 and 3 LLC Agreements Are Different Than Version 2LLC Agreement

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Version 1 and Version 3 LLC Agreements

Version 2 LLC Agreement

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The CPS Code Found On The Original “Version 2” Confirms It Was Printed July 15, 2013

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All Other Versions of the Q1 Version 2 LLC Agreement Were Made On Or After July 15, 2013

K61 Version 2 LLC Agreement

Q1 Version 2 LLC Agreement

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Versions of the JV Agreement Modified/EmailedOver Time on Plaintiffs’ Devices

September 2010

January 2011 July 2013

“Version 1”“Version 3”

“Version 2”

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<Presentation Title/Client Name>

Friday, July 19, 2013, at 12:04 p.m.

P’s In-House emails Lead P: “This [3-year] concept didn’t make it into

the actual LLC Agreement.”

FridayJuly 19

ThursdayJuly 18

WednesdayJuly 17

TuesdayJuly 16

MondayJuly 15

SundayJuly 14

SaturdayJuly 13

FridayJuly 12

ThursdayJuly 11

WednesdayJuly 10

SaturdayJuly 20

P’s In-House Counsel emails two versions of the JV Agreement,

attaching two live emails from 2010 and 2011 containing the original and

the operative JV Agreement.

Friday, July 12, 2013, at 4:52 p.m.

The print-out of “Version 2” is scanned to Lead P’s son’s email account from the Xerox WorkCenter.

Monday, July 15, 2013, at 4:18 p.m.

“Version 2” pdf that was created earlier that day is “modified,” indicating a change to the document.

Monday, July 15, 2013, at 9:43 p.m.

Email announces resignation of then-President of

Plaintiffs, who negotiated the JV Agreement for Plaintiffs.

Tuesday, July 16, 2013, at 9:44 p.m.

P’s In-House Counsel emails Defendants a copy of “Version 2”

for the first time.

Friday, July 19, 2013, at 4:59 p.m.

Timeline Clearly Indicates “Version 2” Is A Forgery

Lead P forwards In-House Counsel’s email containing both “Version 1” and “Version 3” to

his son without explanation.

Friday, July 12, 2013, at 4:57 p.m.

An unknown computer opened and modified a file called “P6 LA MF

Holding I LLC clean NS 123 PRINT.pdf.” This unknown

computer has never been produced.

Sunday, July 14, 2013, at 9:46 p.m.

The file was transferred to a thumb drive from the unknown computer

Monday, July 15, 2013, at 1:24 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 printed on a P’s Xerox WorkCenter machine, in P’s offices, leaving the CPS code. The produced “Version 2” contains one page that was not printed with

the rest of the document.

Monday, July 15, 2013, at 3:51 p.m.

USB drive containing the document entitled “P6 LA MF Holdings I LLC NS clean 123 PRINT.pdf” is

plugged into Lead P’s son’s computer. Plaintiffs

never produced this device.

July 15, 2013, 3:51 p.m.

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Purported “Cover Letter” Is A Forgery

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The “Cover Letter” Is Another Forgery

In an attempt to conceal his forgeries, Lead Plaintiff reached out to his employees toask about metadata on different versions of the cover letter that he created.

Lead Plaintiff to Employee on September 9, 2015, attaching cover letter v2: “I have a question on this letter . . . I wanted to know if you can tell when the original was taken or scanned.”

Lead Plaintiff to another Employee on September 18, 2015, attaching cover letters v2 and v3: “Please take a look at metadata. I’ll call you in 15.”

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The La Cienega PMA Was Clearly Altered

Q2 MARCH 2012 PMA

All Other PMA Documents

LaPorte Decl., ¶ 9930

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Draft La Cienega PMA Circulated And Approved In January 2012

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From: [Defendants’ Counsel]Sent: Wednesday, January 25, 2012 4:45 PMTo: [Plaintiffs, Plaintiffs’ Counsel and Defendants]Subject: Luxe La Cienega, LLC – Management Agreement

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Draft La Cienega PMA Circulated And Approved In January 2012

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From: [Plaintiffs’ Director of Development]Sent: Thursday, January 26, 2012 10:40 AMTo: [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

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From: [Defendants’ Counsel]Sent: Friday, January 27, 2012 10:45 AMTo: [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

K58 PMA K27 PMAK57 PMA K54 PMAK55 PMA

Q2 LA CIENEGA PMA (March 01, 2012)

UNCORRECTED “WRITTING” TYPO (2010-2011)

“WRITTING” CORRECTED TO “WRITING” (2011-2013)

K 70 (Draft La Cienega

PMA)

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The Typo Was Later Fixed, Including in the Draft La Cienega PMA

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Only the Forged La Cienega PMA Contains Incorrect Page Number Listings

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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

Takeaways and Lessons

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Robert KlymanPartner

Corporate Department

Michael FarhangPartner

Litigation Department

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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).