After A $1.45 Billion Adverse Inference Ruling, Morgan Stanley Wished It Complained Less And Worked More

May 2005

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Electronic discovery needs to be taken more seriously by many litigants. A recent big-dollar case provides a striking example from a (presumably) sophisticated litigant. The defendant is already accusing its legal counsel of malpractice.

In mid-May 2005, a Florida jury awarded billionaire investor Ronald Perelman a total of $1.45 billion, consisting of $604.3 million in compensatory damages and $850 million in punitive damages from Morgan Stanley. Morgan Stanley said it would appeal the verdict.

Based on an adverse inference ruling for electronic discovery abuse, the Court instructed the jury in part that:

"Morgan Stanley participated in a scheme to mislead [plaintiff] and others and cover up the massive fraud at Sunbeam until Morgan Stanley and Sunbeam could close the purchase."

Perelman then only had to prove that that he relied on misstatements and related analysis by Morgan Stanley.

The victory is based on Perelman's allegation that Morgan Stanley defrauded him as part of the 1998 sale of his 82 percent stake in Coleman (maker of camping gear) to Sunbeam for $160 million cash and 14.1 million Sunbeam shares. Four days after the acquisition, Sunbeam announced a revenue shortfall and the stock promptly lost 25 percent of its prior market value. In June 1998, Sunbeam's board fired its CEO after the SEC accused the CEO of accounting misstatements. Perelman then installed his own management team at Sunbeam, but the company filed for bankruptcy protection after the new management team was unable to make the company profitable. Perelman's Sunbeam stock became worthless.

Court's Summary of Morgan Stanley's Botched Discovery

Perelman's case was based on the notion that Morgan Stanley knew that Sunbeam was in financial difficulty, and hid this information to allow it to get a reported $30 million in investment banking fees. Based on these allegations, emails in 1997 and early 1998 were important.

The Court granted a motion for an adverse inference based on discovery missteps, which the Court summarized as follows:

Morgan Stanley instructed that emails be retained in February 1999, but failed to implement this instruction and continued to overwrite emails for another 12 months.
On April 16, 2004, the Court ordered Morgan Stanley to:

search the oldest backup tape for each of 36 employees involved in the Sunbeam transaction for emails from February 15, 1998 through April 15, 1998

review emails for 29 specified search terms including "Sunbeam", "Coleman", "Perelman" and two likely misspellings of his name, "camper" and "grill", regardless of the email date

certify its full compliance with the Order

On May 14, 2004, Morgan Stanley produced around 1300 pages of emails, but failed to provide the required certification. After inquiry by the plaintiff, Morgan Stanley produced the certification on June 23, 2004.
Prior to May 6, 2004 (i.e., before both the email production and the subsequent certification), the person supervising the email production and providing the certification became aware that 1,423 additional email tapes had been found at a Brooklyn NY Morgan Stanley facility. The tapes included dates that were relevant to the production.
The May 14, 2004 productions also failed to consider an additional 738 8-mm backup tapes that were not timely given to the outside processor being used by Morgan Stanley for a conversion process. When the outside processor received the tapes, the vendor notified Morgan Stanley of the date-relevance of the tapes to the Perelman production, but Morgan Stanley failed to withdraw the certification or otherwise inform the plaintiff of the potential for additional production.
On November 18, 2004, Morgan Stanley produced an additional 8,000 pages of emails and attachments (over 6 times more than what was originally certified to). With this production, Morgan Stanley said that the additional production came from "newly discovered" tapes. However, the Court found that this was false. The Brooklyn NY tapes being referred to were not technologically ready to be produced until January 2005, seven months after their discovery.
In January 2005, Morgan Stanley found another 169 relevant backup tapes. On February 11 and 12, Morgan Stanley found more than 200 additional date-relevant backup tapes.
On February 13, Morgan Stanley learned that the date-based searches that had already occurred were flawed, so there were at least 7,000 additional emails that were within the scope of the ordered production.
In a February 2005 hearing over the questioned electronic discovery, Morgan Stanley represented to the Court that late October is the first time that anyone knew that there was discoverable email that had not been produced. The Court then ordered additional discovery, including (i) additional Morgan Stanley depositions and (ii) the plaintiff's employment of an outside technical investigator. Based on this additional discovery, the Court found that this representation during the February 2005 hearing was false.

In its Order on granting an adverse inference, the Court included the following about Morgan's Stanley's conduct:

25. Throughout this entire process, MS &Co. and its counsels' lack of candor has frustrated the Court and opposing counsel's ability to be fully and timely informed.

26. MS &Co.'s failure during the summer and fall of 2004 to timely process a substantial amount of data that was languishing in the 'staging area', rather than being put into a searchable form and then searched, was willful and gross abuse of its discovery obligations.

27. MS &Co.'s failure to timely notify [plaintiff] of the existence of the DLT and 8-mm tapes, which it had located as early as 2002, and certainly prior to the June 23, 2004 certification, and its failure to timely process those raw backup tapes was willful and a gross abuse of its discovery obligations.

28. MS &Co.'s failure to produce all email attachments was negligent, and it was discovered and revealed only as a result of [plaintiff's] hiring a third-party vendor pursuant to the Court's February 4, 2005 Order, to double-check MS &Co.'s compliance with the April 16, 2004 Agreed Order."

As a result, the Court ordered that:

Morgan Stanley "shall bear the burden of proving to the jury, by the greater weight of the evidence, that it lacked knowledge of the Sunbeam fraud, and did not aid and abet or conspire with Sunbeam to defraud [the plaintiff]" and

[Plaintiff] "will be allowed to 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. (See e.g., General Motors Corp. vs. McGee, 837 So 2d 10120)

Lessons to be Learned

Besides the obvious comment that one should not (i) lie to the Court, and (ii) promise what you can not deliver, there are some more subtle mistakes that Morgan Stanley could have avoided:

Although Morgan Stanley did use an outside vendor for data conversion of older tape formats, the outside assistance was generally limited. The Court criticized Morgan Stanley's continued use of insufficient internal resources dedicated to the effort. According to the Court, Morgan Stanley:

"did not move as expeditiously as possible. For example, [Morgan Stanley] gave no thought to using an outside contractor to expedite the process of completing discovery, though it had certified completion months earlier; it lacked the technological capability to upload and search the data at that time, and would not attain that capacity for months."

Although Morgan Stanley consistently cited the unfair scope of discovery, the amount of electronic documents that ultimately needed to be produced was quite modest (a couple of boxes of paper, which could easily also be produced on a single disk) when compared to the size of the case and the scope of the allegations. This occurred because the Court fashioned a practical and narrow scope of what was relevant, using key word searches.
Ultimately, the plaintiff succeeded because it (i) won the opportunity to employ its own expert to investigate what Morgan Stanley had done, and (ii) continued to press for more information. We often see litigants fail to get all that is reasonably expected because the technology is scary to the lawyers involved, and/or because the other side is being obstinate.
Morgan Stanley faces regulatory constraints in terms of how quickly data can be discarded. Most businesses do not face these limitations. Our article, Reducing the Cost of Electronic Storage, provides useful suggestions. However, if data must be maintained, do it right. Morgan Stanley's near-continuous finding of more backup tapes demonstrates that they had no idea where all their data resided. There is no way to implement any policy without first having a clear inventory of what exists.

Fulcrum Inquiry assists lawyers and their clients with electronic discovery and computer forensics. Here are some related articles:

California Case Clarifies Cost Shifting in Electronic Discovery Disputes

Practical Advice for Electronic Discovery

Electronic Discovery Can No Longer Be Ignored

Four Big Myths of Electronic Discovery

New Lawyer Standard for Electronic Discovery

Reducing the Cost of Electronic Storage

Proposed Electronic Discovery Rules are a Mix of Good and Bad Ideas
Computer Forensics Deserve a Place in Your Human Resource Toolkit