By Prashant Dubey and Mary Mack, Esq.
In the United States home ownership is almost equivalent to freedom of speech, equality and the pursuit of happiness. The fact is that most people who “own” a home own only a small piece of it; the rest is financed through mortgages. And some of them have proven to be quite risky and costly for the economy.
Subprime loans and other adjustable-rate mortgages, which are made to higher-risk borrowers with lower income or shakier credit histories than prime borrowers (at higher interest rates to compensate for increased credit risks), came with hidden surprises and hidden costs. And as the housing bubble began to burst in 2006, the default rates on these risky loans began to increase.
Forward two years later, and the subprime mortgage crisis has evolved into a global financial crisis. While the subprime lending crisis was the first domino, other dominoes are beginning to teeter. Low-documentation loans, interest-only loans and pick-your-payment loans are now surfacing as problem loans. Loans secured by real estate with diminishing value have payment streams that are also diminishing as homeowners walk away from properties and payment obligations.
All those affected — homeowners, regulators, politicians and investors — are clamoring for someone to blame. Investigations have begun, and class-action lawsuits are being filed. What’s yet to be seen is how wide-ranging the current backlash will be for the institutions involved in funding these risky loans and purchasing them in the secondary market.
Lending based on housing has affected other credit markets as well. The crisis of confidence has hit municipal and corporate bond markets, underwriters, hedge funds, private equity, and IPO financing. It has affected business lines of credit for operating expenses. Major disruptions and realignments are beginning to occur as a result of the cash flow constraints, all of which will require due diligence (amassing data and analyzing it). Resulting legal actions and investigations will require production of data to regulatory and investigatory agencies, as well as third-party claimants.
The subprime mortgage crisis has evolved into a global financial crisis.
It’s not just the organizations making loans that are being (or will be) affected. Financially sophisticated enterprises routinely hedge their currency risks in transactions or engage in credit swaps to reduce that risk. Self-insured enterprises use sophisticated financial instruments in administering their health portfolio. Some organizations administer their own pension plans. A key point: The subprime crisis affects more than financial institutions.
Certainly, similar crises have occurred before. Take the savings-and-loan debacle of the late 1980s to early 1990s, when the federal government created a huge and unwieldy bureaucracy just to scoop up and repackage home loans that had faltered. S&L institutions were shuttered, and their assets were reallocated. This time around, however, those with potential liability face a new danger: the smoking guns and large volumes of electronic evidence that may exist somewhere in the e-universe.
Digital Data and the Subprime Market
In the last 10 years, e-mail, voice mail, instant messaging and text messaging have become integral pieces of business communications, particularly in the financial services industry. Digital information generated by business transactions is stored in a staggering number of structured databases, which are either transaction processing systems or electronic data warehouses.
When a lawsuit is filed and the call comes for e-discovery, those who have not proactively mapped, organized and studied their electronic content universe may be caught by surprise. In the current environment surrounding e-discovery, a lack of readiness can result in a costly fire drill fraught with risks (including sanctions). Most attorneys agree they would rather litigate on the merits than spend all their time fighting the e-discovery fire.
The subprime crisis is really just beginning to take shape and is going to spawn a wave of litigation, much of which will turn on evidence uncovered during discovery. Mortgage lenders will be sued by borrowers who claim misrepresentation or unsuitability. The larger cases, however, will involve businesses suing other businesses — those that sold and bought risky collateralized debt obligations and are now teetering on the brink of insolvency as a result of investment actions taken in the midst of the subprime lending euphoria.
Questions will be asked during the discovery process, such as:
- What did those involved know about the risk profile of the CDOs?
- When did they know it?
- How were they represented?
- What were the expectations? and
- What due diligence occurred?
All these questions comprise the issues, arguments, claims and defenses that are part and parcel of litigation. Inevitability, the answers to these questions will lead to the records, data repositories and custodians being implicated — the foundational elements of electronic discovery.
Pop, Pop, Pop!
The litigation wave probably will not stop there. Actions will continue to be brought by prosecutors and by regulatory agencies. There will be shareholders lawsuits. There will be deals that cannot be consummated because of this credit crunch, whether directly related or not.
Initial cases are already surfacing and are somewhat like popcorn when it starts popping. There is always a first pop, and then it might be a little while before the second pop occurs. The next thing you know, all you can hear is pop, pop, pop, pop.
For those who have not proactively planned for large-scale e-discovery and mapped and organized their electronic content universe, a discovery request that accompanies a lawsuit or investigation could put the institution at a tremendous disadvantage.
That’s why the smart lawyers are getting friendly with the folks in IT, learning where the electronic content lives and refining the process for how they will respond to e-discovery demands when they happen. With knowledge comes thoughtful litigating. Having a structure in place to defensibly and predictably respond to discovery allows a company to demonstrate good faith during meet-and-confer negotiations and put in place repeatable processes that can be improved from case to case. Most importantly, it allows a company to infuse a sense of proportionality (regarding scope of discovery) in the midst of frenzy.
Emotions will run high. The judiciary may be more lenient in allowing discovery to be subject to increased scopes (more data). Costs will skyrocket. Being prepared will enable a company to ensure it is focused on taking actions that are reasonable and to make a case for same. But where do parties who suspect they may be targets of investigation or litigation begin?
Assemble Your Team
Inside counsel needs to look very closely at the composition of the discovery response team. How prepared are they to respond to the demands of e-discovery? Is there someone on staff who understands and can manage the intersection of law and technology? Is this person, whether an attorney, litigation support member or IT expert, able to articulate both the technical and legal requirements of the discovery obligations and ensure the actions taken are defensible, timely and cost-efficient?
Second, counsel may be well advised to seek outside, independent guidance from external e-discovery experts. Such experts have a deep understanding of all phases of the e-discovery process and can help legal and IT under stand the risks associated with each phase of discovery. Such expertise includes facilitating critical, open communication with other departments vital to defensible response, such as IT and records management.
It is highly likely that even smaller organizations will need to turn to multiple outside counsel for representation on varied subject matters and geographic jurisdictional needs. Partnering with an experienced e-discovery provider, with capabilities ranging from business consulting to data management services, will enable these organizations to have flexibility to move from outside counsel to outside counsel as their needs or conflicts demand.
Map the E-Universe
With a team in place, management needs to perform a digital storage reality check. A critical assessment of current business practices will uncover the gaps between belief and reality — the gaps that counsel must understand. This will help identify where employees, contractors, customers, vendors — everyone involved in transactions — have digital information stored. It’s often impossible, especially in large corporations, to have a one-size-fits-all digital communications and storage policy. Instead, counsel needs to find out how people are doing business and map it.
Remember, lack of full disclosure, even when due to ignorance, may lead to significant sanctions.
People may use multiple e-mail accounts. Find out what they are. They also may use Web mail, voice mail, PDAs, instant messaging, electronic calendars and other online and offline storage folders. Remember, lack of full disclosure, even when due to ignorance, may lead to significant sanctions.
People will do work whenever and wherever they are. It’s imperative to map the data and issues to the business process so that all potentially relevant data can be properly preserved and collected in preparation for discovery.
Understand Your Digital Storage System
Work with IT to identify how electronically stored information is retained and stored. Learn what type of files and information is stored in each repository and how the content is governed. An ESI content mapping process can start by analyzing the issues you anticipate, and the ESI that will be relevant to those issues.
From there, IT and legal can work together to identify where such ESI might reside. This exercise will help counsel better understand how the potentially relevant ESI is being captured, retained and ultimately disposed of in the normal course of business, as well as weigh what will happen if no action to preserve ESI is taken. In the course of mapping process, be prepared to ask a series of questions to key stakeholders throughout the organization, such as:
- Where does the relevant ESI reside among possibly hundreds of potential repositories?
- Who is the identified owner for each data repository?
- What types of ESI reside in those repositories?
- Are there third-party or off-site locations that may contain relevant ESI?
- Do you have a documented process for ensuring fulfillment of your preservation obligations?
- How are legal holds to preserve potential evidence enforced?
- Is there a written policy for document retention/destruction?
- Are the retention/destruction policies and procedures easily understandable by all employees? and
- Are your systems able to automatically retain/destroy electronic documents pursuant to compliance/hold schedules?
The tricky part for those with subprime exposure will be tracking down all the loan originators, repackagers, resellers and purchasers of the bundled loans and those who marketed the packages. Their digital warehouses may contain information vital to the defense.
As an example, counsel may need to learn as much as possible about where the subprime loans came from and how they were marketed when constructing a defense. During this process, they will need to determine which repositories, and from what organizations, contain relevant, responsive documents. From there, they will need to understand which repositories are in the “control of the company,” thus making them automatically subject to consideration for discovery.
Counsel and IT will both need to account for ESI that resides in the databases of all the partners related to the loan transactions. The most damning or vindicating information may be contained at a considerable digital distance from the home office.
Preserve the Evidence
Now that you know where the information is and more or less what it is, take steps to preserve the evidence for when action is required. This may involve collecting the information and storing it in a third-party location, preserving its place on the server or personal computer, or taking other forensically sound action that will preserve the metadata and chain of custody of the potentially relevant evidence.
Make sure you do the following:
- Designate a person as the collection owner;
- Establish a documented process for active file collection; and
- Secure a technology that allows you to implement your collection protocol when required to collect ESI.
An experienced e-discovery provider can guide IT in defensible strategies for preserving evidence by either conducting the preservation collection on behalf of the corporation or empowering IT with defensible processes for self-collection and preservation. Furthermore, these processes can be evaluated and determined as part of a formal discovery response planning process well ahead of litigation.
Because there may be investigations or criminal fraud actions, it is critically important that the e-discovery partner work with the organization and the key outside counsel to make sure the collection protocol will stand up to scrutiny.
Prepare, Don’t Panic
Having a structure in place to defensibly and predictably respond to discovery allows a company to reduce the risks and costs inherent in e-discovery as well as demonstrate good faith during meet-and-confer negotiations. It also helps counsel and IT put in place repeatable processes that can be improved over time. This sort of preparation allows counsel to do what they do best: Prepare a defense or, if a review of the data suggests liability, prepare for settlement.
Companies defending themselves in subprime-related litigation or investigations will be pressed to demonstrate what they knew, when they knew it, and how and to whom they communicated. If it appears that they are holding back relevant electronic evidence, even if it is just due to communication errors or newness to the process, it could be perceived negatively by the courts and result in costly sanctions and fines.
It would be prudent to plan from the beginning for reuse of reviewed and produced material. Privilege review is one of the most expensive elements of a case. Reuse of privilege calls and redaction, with oversight by trial counsel, is a key element of cost and risk reduction for an organization. Setting aside “junk,” like grocery lists, will pay dividends over and over. Early case assessment can assist in defensible strategies to limit the amount of information needed to be collected, reviewed and produced, saving even more time and money.
Putting a defensible process in place, soup to nuts, will protect both inside counsel and outside counsel from the dangers exposed in cases where potentially relevant evidence was missed, and at the same time reduce cost and time when both are at a very high premium.
It is always better to litigate on the merits of the case rather than on perceived e-discovery misbehavior.
Prashant Dubey is senior vice president and general manager of Fios Consulting in Portland. He has been instrumental in shaping the e-discovery market and is a frequent speaker and author on electronic discovery issues. Mary Mack, the company’s corporate technology counsel, has more than 20 years’ experience delivering enterprise-wide e-discovery, managed services and software projects with legal and IT departments in publicly held companies.
This article was previously published in the May 2008 edition of the Andrews Litigation Reporter