Tend E-files to Avoid Sticky Legal Issues

High-tech searches of e-files are a rapidly growing business—and can make firms easy prey for savvy lawyers and litigious clients.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

March 8, 2006

Businesses small and large need to act now to get their electronic files, databases and e-mail archives in order. Missteps could be costly—to the point of bankruptcy—if a firm finds itself the target of lawsuits filed by other companies, employees, unhappy customers, partners or government agencies.

With 90% of all businesses now involved in some type of legal action, according to a study by the law firm of Fulbright & Jaworski, chances are that your business will be sued at some point. Ratcheting up the risk in recent years is the swift emergence of electronic discovery. After precedent-setting cases in the early part of the decade made clear that computer files are fair game in legal discovery, e-discovery has zoomed to a $2-billion-a-year business. And that figure will quintuple within five years.

Lawyers can win the legal right to use e-discovery companies and their sophisticated software to search every computerized document—from annual budgets down to instant messaging notes between employees. Laptops, personal digital assistants, pocket-size USB flash devices and digital voice mail are as vulnerable as your primary computer network and server.

Although you may feel vulnerable, you shouldn't overreact. It's illegal to pitch or destroy electronic records, and doing so could mean jail time, not just losing a lawsuit. In fact, what makes many companies vulnerable is their inability to locate key electronic documents sought in a case. That could complicate a case against them and even expose the business to contempt of court charges. Prudent action means meticulously managing your files: Know what is in them. Know when and how to make them available. And have a clear policy for employees to follow for all electronically written materials.

Because of the Sarbanes-Oxley Act, which makes companies responsible for ferreting out illegal activities, proper tending of archives is crucial. There are strict rules for preserving electronic trails so questionable activities by an employee can be tracked. Firms involved in financial services, securities, banking, insurance and accounting are particularly at risk of running afoul of Sarbanes-Oxley requirements.

The cybersearch technique got a lot of ink last year when it helped financier Ronald Perelman win a $1.6-billion judgment against Morgan Stanley & Co., but it's being deployed in thousands of less-prominent cases. "We're seeing businesses with two employees to 200,000 being called upon to make available their digital files," says Michele Lange, staff attorney for legal technologies at Kroll Ontrack, a firm that does e-discovery for companies.

E-discovery has become an invaluable tool in a broad variety of cases—business files have even been used in nasty divorce battles. Given the rise in intellectual property cases, medical, pharmaceutical and technology companies are especially vulnerable.

"We're seeing digital file [searches] at very small companies involving employee disputes, alleged wrongful dismissal and discrimination suits," says Lange. Small businesses are especially vulnerable since they often don't have the accounting controls and forensics that large companies have.

In fact, the e-discovery process itself could pose too great a financial burden for many small firms to bear. Costs often run into the thousands of dollars—far more than the old discovery method of rummaging through file cabinets. However, companies' complaints that e-discovery costs are too burdensome rarely win sympathy from judges, who have the final say in deciding how big a share of such costs a defendant must pay. Even a relatively lenient 50-50 split may break a small company.

The best way to be prepared is to form an e-discovery "SWAT team" composed of company executives, legal, compliance and information technology officials. They need to set firm policies to ensure that no digital or paper documents are altered, removed or destroyed if the company is sued and must develop a plan for making copies of everything available for e-discovery teams.

Smaller firms without that depth of experience may want to turn to e-discovery companies themselves, which often help firms tidy up their electronic archives and comply with current laws, as well as execute searches for clients. Kroll Ontrack, Fios, Merrill Corp. and LexisNexis Applied Discovery are the leaders.

When confronted with an actual search, it's best to seek outside legal counsel with expertise in the e-discovery process. About 120 law firms nationwide claim to be experts in the field, but don't pick one from the telephone directory. Michael Clark, managing director of EDDix LLC, a research firm specializing in e-discovery litigation and compliance, says, "With so much at stake, it's important to inquire how long a law firm has handled e-discovery cases for businesses, if their attorneys specialize in it, whether they've spoken at legal forums about it and which specialized vendors they use for their own e-discovery software."