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LEGO v. STRATOS LIGHTWAVE

November 4, 2004.

CATHERINE LEGO, as representative of the shareholders of Tsunami Optics, Inc., et al., Plaintiffs,
v.
STRATOS LIGHTWAVE, INC., Defendant.



The opinion of the court was delivered by: LEWIS KAPLAN, District Judge

MEMORANDUM OPINION

The plaintiffs in this action, which is pending in the Northern District of California, move to compel non-party Ernst & Young LLP ("E&Y") to comply with a subpoena seeking discovery concerning defendant Stratos Lightwave, Inc. ("Stratos"),*fn1 a client of E&Y's accounting business. The matter turns on whether and to what extent the Illinois accountant's privilege applies here.

  Facts

  A. The Parties' Claims

  The plaintiffs were founders of and investors in Tsunami Optics, Inc. ("Tsunami"), a California-based enterprise in the fiber optics industry. In 2002, Tsunami merged with a Stratos subsidiary in a transaction in which the securities of Tsunami were converted into a right to receive securities of Stratos as well as post-merger payments in Stratos securities in amounts that were to be a function of the average trading price of Stratos common stock during a defined period following the merger. Plaintiffs subsequently commenced this action, claiming that Stratos has mismanaged the Tsunami subsidiary, and thereby interfered with the Tsunami shareholders' rights under the merger agreement, and that Stratos induced plaintiffs to enter into the transaction by misrepresenting its financial condition.

  Stratos in turn counterclaimed. It contends, among other things, that plaintiffs fraudulently induced it to enter into the transaction by misrepresenting Tsunami's current and anticipated financial condition as well as its product development schedules. The parties rely exclusively on state law for the rules of decision governing their claims save that one of Stratos' five claims for relief on its counterclaim is based on Section 10(b) of the Securities Exchange Act of 1934*fn2 and Rule 10b-5 thereunder.*fn3

  B. The Disputed Discovery

  E&Y was Stratos' outside auditor. In June 2003, plaintiffs served on E&Y's New York headquarters a subpoena issued by this Court which seeks to compel deposition testimony and the production of a broad variety of documents relating generally to the parties' agreement, E&Y's activities on behalf of Stratos such as due diligence on the Tsunami transaction, Stratos' financial condition, analyses of Tsunami's financial condition, and other matters.

  E&Y objects to the subpoena on the ground that the requested information is protected from disclosure by the Illinois accountant's privilege. The plaintiffs counter that privilege with respect to the subject matter of this subpoena should be determined in accordance with federal, not state, law and that even if state law does apply, the Court should apply California or New York law, neither of which recognizes a privilege for accountants. They seek an order compelling compliance with the subpoena.

  Discussion

  A. Overview

  Federal Rule of Evidence 501 provides that privileges in federal courts are governed by federal common law except that in civil cases, "with respect to an element of a claim or defense as to which State law supplies the rule of decision, the privilege of a witness [or] person . . . shall be determined in accordance with State law." In a diversity case, this rule "requires the application of the state law of privileges, except where the proof is directed to an issue that is governed by federal law."*fn4

  To the extent that the discovery requested in this case is relevant to the federal counterclaim (or to a defense based on federal law), or to both federal and state claims, privileges are determined in accordance with federal law. This rule is consistent with the established principle that when federal jurisdiction is based on the existence of a federal question, but the case includes pendent state law claims arising out of the same events, federal law governs privileges.*fn5 To the extent, however, that the ...


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