E-Discovery Rule Changes May be Windfall for Tech Providers

New rules governing electronic communications will be painful for the unprepared, experts say.

By: Philippa Maister
Daily Report
Dec. 04, 2006

http://www.dailyreportonline.com/Editorial/News/new_singleEdit.asp?individual_SQL=12%2F4%2F2006%4012606%5FPublic%5F%2Ehtm

NEW LITIGATION DISCOVERY RULES dealing with a wide range of electronic communications are causing headaches for lawyers and their corporate clients. But the amendments to the Federal Rules of Civil Procedure, which took effect Dec. 1, have also opened opportunities for companies such as Nexidia Inc., an Atlanta business that uses advanced phonetic-based technology to search audio recordings.

The new rules require litigants to tell opponents about the existence of electronic information-under definitions that go far beyond e-mails, word processing and databases to include information stored in any electronic medium.

The new rules clearly cover sound recordings, according to Nexidia's technology counsel Dave Fishel, including voice mails, recorded conference calls, recordings made at corporate call centers and corporate governance discussions with investors or board members.

As the business community has become aware of the new e-discovery rules, Nexidia has seen a sharp jump in requests for its services from litigation-support and other companies in recent weeks, said Jeff Schlueter, senior director for business development.

Founded in 2000 by Georgia Tech professor Mark A. Clements, Nexidia grew out of Georgia Tech's business incubator program. Its technology converts audio files into phonetic audio tracks through which one can search for relevant information.

The company received initial funding from venture capital firms H.I.G. Ventures, Boston Millennia Partners, Paladin Capital Group, Cordova Ventures and SAIC Venture Capital Corp. In August, the company raised $13 million from Morgan Stanley-bringing the total funding received from investors to $37 million.

When it was founded, Nexidia focused on licensing its software to government agencies responsible for homeland security, law enforcement and intelligence gathering both in the U.S. and overseas, Schlueter said. The company provides support in 29 languages. Its software is also used by the Federal Energy Regulatory

Commission for e-discovery purposes in investigations.

But at the beginning of 2006, sensing an opportunity, Nexidia launched an on-demand service to serve the litigation needs of companies and law firms involved in e-discovery. In October, Nexidia announced a partnership with Fios Inc., a Portland, Ore., e-discovery services provider, to help clients manage complex litigation and regulatory compliance issues. Although the business is new, Schlueter said it has the potential to bring in millions of dollars a year.

Competition in the industry has certainly increased, with more than 200 new firms added in recent months, according to Phil Shelhaas, managing partner in the Atlanta office of OnSite E-Discovery. Its technology identifies key search terms in electronic information and databases. The firm has been providing e-discovery services, primarily to law firms, for eight years.

The new definition of electronically stored information covers anything created on the computer, including iPods, MP3 players, cell phones, personal digital assistants, digital phone systems, information on servers and even devices like Xboxes and PlayStations, Shelhaas said.

While Nexidia and other companies try to cash in on the new rules, the rest of the business community is preparing to deal with the changes' effects on a wide range of business practices. For companies large and small, litigation costs may go up, and the new rules pose risks even to nonlitigated matters such as mergers and acquisitions.

The stakes of e-discovery rules were demonstrated in 2005 in a case involving, coincidentally, Nexidia's investor, Morgan Stanley.

In Coleman v. Morgan Stanley, No. CA 03-5045 AI, the investment bank was fined a total of $1.5 billion in compensatory and punitive damages for failing to disclose the existence of thousands of e-mail back-up tapes in a case in which it served as financial adviser to Sunbeam Corp. In May, Morgan Stanley took another financial hit when the Securities and Exchange Commission slapped on a $15 million civil fine for the problem.

"The new rules don't change any obligations that a company already had to preserve electronically stored information," said King & Spalding associate Matthew S. Harman. "The new rules really lay out the disclosure requirements. It is not so much what you have to preserve, but what you have to tell the other side."

The amendments to federal rules 16, 26, 33, 34, 37 and 45 are so broad that every company should at a minimum be reviewing its information retention and storage policies, experts said.

This is especially true because state courts are also moving to adopt electronic discovery rules based on the federal court model, said Harman. In August, the Conference of Chief Justices released "Guidelines for State Trial Courts Regarding Discovery of Electronically Stored Information," which are largely consistent with the new federal rules.

Nevertheless, many organizations are unprepared for the far-reaching impact of the rules change, according to a November survey by Computerworld Inc. About 32 percent of the 170 information technology personnel surveyed said their company won't be able to meet its requirements; 11 percent said they are somewhat prepared; and 42 percent said they didn't know what their companies were doing to get ready.

According to the survey, 27 percent of IT managers said no one in the company was in charge of implementing processes to adjust to the new rules, and 35 percent couldn't identify the point person. In 20 percent of companies the IT department was spearheading the effort, in 8 percent in-house counsel, and in 5 percent the compliance department.

Companies involved in or facing lawsuits are now required at the onset of a case-typically even before the discovery period has opened-to disclose and describe all electronic information they may use in argument, as well as any such data that they will not be producing, according to Maureen E. O'Neill, a partner in the Atlanta office of Paul, Hastings, Janofsky & Walker.

Litigants do have a partial "out" against demands for more data if the information requested is "not reasonably accessible because of undue burden or cost." O'Neill predicts that disputes over what is "not reasonably accessible" are certain to occur. She said the rules allow opposing parties to challenge the claim and compel production of the information.

King & Spalding partner Richard A. "Doc" Schneider said it is a company's responsibility to know its electronic information storage systems and have its house in order to preserve information. Outside counsel would need to get involved and become familiar with the company's systems when litigation arises.

Essentially, Schneider said, companies have to know "what information you have, whether you are preserving the right stuff, and whether you have turned off systems you need to turn off in particular cases."

He predicts it will take three or four years for courts to wrap their arms around the new rules and decide what their expectations are.

Both O'Neill and Schneider say some companies may be tempted to settle certain cases instead of incurring the costs of e-discovery. Industry sources say it can cost $1,000 to $3,000 to process one gigabyte of information.

According to Nexidia's Shelhaas, almost 99 percent of documents today are created electronically. A single employee usually uses one to five gigabytes in e-mail alone.

"A small start-up technology company might have to process 100 gigabytes," he said. "The costs of e-discovery can easily amount to millions of dollars in big cases."