(The opinions expressed here are those of the author, a columnist for Reuters.)

By Alison Frankel

Oct 30 (Reuters) - A federal judge in California has found law firm Latham & Watkins in civil contempt for “flagrant violations” of a protective order shielding discovery produced by short seller Muddy Waters in a securities class action against Banc of California.

U.S. District Judge Dolly Gee of Santa Ana ruled that Latham improperly disclosed to its client, California businessman Steven Sugarman, an expert witness report that incorporated highly confidential information from Muddy Waters. (Gee issued the sanctions opinion on Sept. 30, but it was only unsealed on Tuesday.) The judge also ruled that Sugarman improperly shared the expert witness report with an employee in an attempt to gin up negative news stories about Muddy Waters.

Gee ordered Latham and Sugarman to pay Muddy Waters’ fees and costs for investigating and litigating the short seller's motion for sanctions and civil contempt. Muddy Waters’ counsel from Harder Stonerock said in an Oct. 21 declaration that it has incurred more than $330,000 in fees and costs in connection with that motion. The firm also asked Gee to award additional fees and costs of more than $800,000 to recompense Muddy Waters for litigating Sugarman’s initial subpoena for documents and for defending a pair of related lawsuits by Sugarman against the short-seller.

A Latham spokesperson declined to comment. Sugarman’s counsel from Michelman & Robinson did not respond to a query. I also sent a query to Sugarman via his current business, The Change Company, but did not hear back.

The background on this dispute, which I first told you about last year, is quite convoluted, but here are the essential details. A class of investors sued Sugarman and Banc of California back in 2017 after Banc's share price plunged in response to an anonymous blog post asserting that it had ties to a known securities fraudster. The company settled with investors in 2020 for about $30 million. As part of the deal, investors agreed to dismiss claims against Sugarman.

In the midst of the class action, Sugarman and Latham subpoenaed documents from Muddy Waters, which was not a party in the case, to back defense arguments that the short seller published the anonymous blog post to profit from its short position in Banc shares. Muddy Waters produced trading records and internal emails under a protective order that designated the material as attorneys' eyes only.

An expert defense witness subsequently wrote a report to support the defense theory that Muddy Waters had engineered and profited from the precipitous drop in Banc’s share price. That report, according to Gee, incorporated the highly confidential information produced by Muddy Waters in response to the defense subpoena.

Sugarman escalated his feud with Muddy Waters after the class action settlement, suing the short seller in state and federal court. Muddy Waters won the dismissal of both suits.

Then in 2023, according to Muddy Waters founder Carson Block, the expert witness report resurfaced as a point of contention. A onetime Sugarman employee named Adam Levine told Block that Sugarman had instructed him “to leak complete, unredacted copies” of the expert witness report in order to “plant negative articles about Mr. Block and Muddy Waters.”

Sugarman’s ultimate goal, according to Levine, was to prompt the U.S. Justice Department and U.S. Securities and Exchange Commission to investigate Muddy Waters.

A caveat here: Sugarman and Levine are engaged in vicious litigation against one another, with Sugarman accusing Levine of stealing documents and threatening violence and Levine asserting that he was wrongly terminated.

Sugarman’s brief opposing sanctions for Muddy Waters asserts that Levine “fabricated” evidence to suggest that Sugarman improperly shared the expert witness report with journalists.

Levine’s counsel, Erica Gonzales of Brock & Gonzales, did not respond to an email query.

After Levine contacted him, Block moved for sanctions in the class action, asserting that Latham and Sugarman breached the protective order shielding Muddy Waters’ trading records and emails. Latham, he said, should not have shared the expert report with Sugarman because it contained material designated to be seen only by attorneys. And Sugarman, Block alleged, violated the protective order by telling journalists about the report.

Latham offered two arguments in its brief opposing sanctions. The firm told Gee that the expert report, which it labeled as confidential, was not actually based on attorneys’ eyes only discovery from Muddy Waters but was instead largely derived from trading records obtained from other sources. Latham also argued that even if the firm should have designated the expert report as for attorneys’ eyes only, the error was a good-faith glitch.

“A technical error during a years-long, incredibly complex litigation requiring near-daily application of the protective order does not preclude a finding of substantial compliance or warrant imposition of civil contempt,” the firm said. “Sanctions are particularly inappropriate here where there is no evidence of bad faith.”

Gee rejected those arguments, concluding that the expert report included copious information designated to be seen only by attorneys.

“The evidence is clear and convincing that Latham violated the order and that the violation was not based on a good faith and reasonable interpretation,” the judge said. “The court takes such flagrant violations of a protective order seriously.”

Gee did acknowledge “insufficient evidence” that Latham “acted in bad faith as opposed to in serious error,” citing the firm’s 2019 query to a magistrate judge about sharing Muddy Waters' discovery with Sugarman. The underlying class action settled, Gee noted, before the magistrate issued a ruling.

The judge also rejected Sugarman’s assertions that he did not realize the report contained highly confidential information and that he disclosed it only to his former employee, Levine, in the good-faith belief that he was entitled to share it.

Gee highlighted Levine’s evidence that Sugarman himself discussed the report with journalists.

“Sugarman’s claim that Levine did this independently, of his own initiative, and not at Sugarman’s behest is simply not credible,” she said.

In an email statement, Muddy Waters’ Block said Gee’s description of Latham’s conduct showed “pervasive rot in the American legal industrial complex.” Block also said the judge’s findings “make clear Steven Sugarman went way over the line in pursuing his misguided vendetta against Muddy Waters.”

Read more:

Muddy Waters LLC wants Latham sanctioned in escalating war with California businessman

(Reporting By Alison Frankel)

((alison.frankel@thomsonreuters.com; 646-223-6491 (o) 917-848-7493 (c);))