Judge Maass Grants Adverse Inference Instruction in Coleman v. Morgan Stanley

Coleman (Parent) Holdings, Inc. v. Morgan Stanley & Co., Inc., 2005 WL 679071 (Fla. Cir. Ct. Mar. 1, 2005)

Coleman (Parent) Holdings, Inc. (“CPH”) sued Morgan Stanley & Co., Inc. (“MS & Co.”) for fraud in connection with CPH’s sale of its stock in Coleman, Inc. to Sunbeam Corporation. Establishing whether MS & Co. had knowledge of Sunbeam’s fraudulent scheme was central to the case, and CPH sought access to MS & Co. documents, including email.

This cause came before the Court on CPH’s motion for adverse jury instruction due to MS & Co.’s destruction of email and MS & Co.’s noncompliance with the Court’s Agreed Order as modified by CPH’s ore tenus motion for additional relief, and on CPH’s motion to compel further discovery regarding MS & Co.’s destruction and non-production of email.

Destruction of Email

While MS & Co. did order the preservation of related paper documents, it continued to overwrite email after 12 months despite an SEC regulation requiring that they be preserved for two years. See 17 C.F.R �� 240.17a-4 (1997).

Noncompliance with Agreed Order

On April 16, 2004, the Court entered an Agreed Order requiring MS & Co. to search the oldest full backup tape for MS & Co. employees involved in the transaction, review email dated during a specified period and those containing certain search terms, produce non-privileged responsive email by May 14, 2004, provide a privilege log, and certify complete compliance. MS & Co. produced 1,300 pages of email on time. The manager in charge of the project, Mr. Riel, did not certify compliance until June 23, 2004.

Sometime before May 6, 2004, Mr. Riel and his team learned of 1,423 backup tapes in Brooklyn, New York. These were never processed in accordance with the Agreed Order, making Mr. Riel’s certification false. Mr. Riel knew by July 14, 2004 that these tapes covered the responsive time period, but never withdrew the certification nor informed CPH. Other tapes found in Manhattan were also handled in violation of the Agreed Order.

Mr. Riel was replaced with Ms. Gorman, who did nothing regarding the production for five months. The Court was not informed until November 17, 2004 that the certificate of compliance was incorrect due to the discovery of more material. An additional 8,000 pages of email was produced the next day from what were said to be “newly discovered” tapes (Ms. Gorman and her team apparently had not learned how to process materials into searchable form until January 2005.)

CPH made inquiries regarding the status of backup tape restoration and discoveries of additional tapes. MS & Co. did not provide complete responses and failed to provide a time for completion.

Hearings on Adverse Jury Instruction

During hearings on CPH’s motion for an adverse jury instruction held February 2, 2005, Thomas Clare of Kirkland & Ellis, LLP (“Kirkland”) misrepresented the date when it was learned that the Brooklyn tapes might contain recoverable data, failed to specify when production would be complete, failed to notify the Court regarding found tapes, and also apparently misrepresented the time period when tapes were found.

MS & Co. subsequently revealed that it had discovered more additional tapes, its software was not locating all responsive email attachments, and the date-range search for users of Lotus Notes was flawed such that some email had not been fully reviewed.

The Court’s Ruling

MS & Co. and its counsel’s lack of candor “frustrated the Court and opposing counsel’s ability to be fully and timely informed.” MS and Co.’s failure to process material in the staging area where it was to be uploaded and processed into searchable form “…was a willful and a gross abuse of its discovery obligations,” as was its failure to timely notify CPH regarding found tapes and timely process such tapes. Its failure to produce all email attachments and Lotus Notes email was negligent and only discovered via CPH hiring a third-party vendor to check compliance with the Agreed Order. Its failure to locate potential backup tapes until February 12 was grossly negligent. Many of MS & Co.’s failings “were done knowingly, deliberately, and in bad faith.” Its acts “have severely hindered CPH’s ability to proceed.”

MS & Co. spoiled evidence justifying sanctions based on its failure to maintain email in readily accessible form as required by SEC regulations and with knowledge that legal action was threatened. Sanctions are also justified based on willful disobedience of the Agreed Order.

The Court granted Plaintiff’s motion for an adverse inference instruction. MS & Co. was ordered to continue to use best efforts to comply with the Agreed Order and the February 4, 2005 order to comply with CPH’s ore tenus motion to participate in the search of additional tapes or appoint a third party to conduct the search.

The Court decided to read a statement of facts to the jury which details MS & Co.’s behavior in whatever evidentiary phase requested by CPH. CPH may argue that MS & Co.’s concealment of its role in the Sunbeam transaction “is evidence of its malice or evil intent, going to the issue of punitive damages.”

MS & Co. shall bear the burden of proving that it lacked knowledge of the Sunbeam fraud and did not aid and abet or conspire with Sunbeam. It shall compensate CPH for costs and fees associated with the motion. Plaintiff’s motion to compel further discovery regarding MS & Co.’s destruction and non-production of email was denied.

Full text of the order can be found here.

Our thanks to Matt McCarrick, The Litigation Support Guy, for providing us with a copy of the order.