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Securities and Exchange Commission v. Stephen M. Kovzan

February 21, 2013

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
STEPHEN M. KOVZAN, DEFENDANT.



The opinion of the court was delivered by: K. Gary Sebelius U.S. Magistrate Judge

MEMORANDUM AND ORDER

This matter comes before the court upon Steven M. Kovzan's Third Motion to Compel (ECF No. 137). This is a civil enforcement action brought by the SEC against Mr. Kovzan under the Securities Act of 1933, 15 U.S.C. § 77a, et seq., and the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq. Highly summarized, the SEC alleges that Mr. Kovzan was involved with the preparation and signing of public SEC filings for his employer, NIC, Inc., from 2002 to 2006 that were materially false and misleading because they failed to disclose as income the NIC chief executive officer's perquisites. Among the alleged perquisites are commuting expenses from the CEO's home in Wyoming to NIC's headquarters in Kansas.

Mr. Kovzan seeks an order compelling the SEC to respond to his Second Set of Requests for Admission and his Third Set of Requests for Production of Documents and Things. The requests for admission and requests for production concern what Mr. Kovzan contends is the SEC's analogous practice of allowing high-level officials to reside in locations of their choice while the SEC reimburses these individuals for their travel. The SEC has objected to the Requests for Admission and Requests for Production on the grounds of relevance, the deliberative-process privilege, and on the basis of the Privacy Act, each of which is addressed below. For the reasons stated below, Mr. Kovzan's motion to compel is granted.

I.Relevance

Fed. R. Civ. P. 26(b)(1) outlines the scope of discovery. It provides that parties "may obtain discovery regarding any non-privileged matter that is relevant to any party's claim or defense-including the existence, description, nature, custody, condition, and location of any documents or other tangible things and the identity and location of persons who know of any discoverable matter." The court broadly construes relevance at the discovery stage, and "a request for discovery should be considered relevant if there is 'any possibility' that the information sought may be relevant to the claim or defense of any party."*fn1 "There is no presumption in the Federal Rules of Civil Procedure that a discovery request is relevant."*fn2

Relevance, however, is often apparent on the face of the request.*fn3 When it is not, the proponent of the discovery has the burden to show the relevance of the discovery sought.*fn4 If a discovery request seeks facially relevant information, or if the proponent has demonstrated relevance, the party resisting discovery must establish the lack of relevance by demonstrating that the requested discovery either: (1) is outside the scope of relevance as defined by Rule 26(b), or (2) is of such marginal relevance that the potential harm occasioned by discovery would outweigh the ordinary presumption in favor of broad discovery.*fn5

Mr. Kovzan argues this discovery is relevant to the issue of scienter and to the definition of commuting expenses. Scienter is an element of the securities fraud claims the SEC asserts. "Scienter requires a showing of an intent to defraud or recklessness."*fn6 Relying on the Tenth Circuit opinion City of Philadelphia v. Fleming Companies, the district judge presiding over this case made clear that scienter includes an objective component that may take into account industry practice or standard,

In Fleming, the Tenth Circuit defined recklessness as "conduct that is an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Thus, defendant argues that scienter may include an objective component, such that the standard of care in the industry is relevant. . . . The Court agrees with defendant that, under the Tenth Circuit's definition of recklessness to include an extreme departure from the standard of ordinary care, evidence of the practice within the industry may be relevant to the issue of scienter. Of course, the SEC could attempt to prove scienter in this case solely by showing an intent to defraud, thereby removing the issue recklessness from the case. The SEC has not limited its case in that manner, however. Accordingly, the Court concludes that defendant is entitled to seek evidence relating to the industry standard, whether or not such evidence was previously known to him or the public. The Court notes in this regard that that evidence need not be ultimately admissible to be discoverable, and the Court concludes that these requests are reasonably calculated to lead to the discovery of admissible evidence relevant to the issue of scienter.*fn7

Mr. Kovzan contends that in this respect, the SEC's similar practices would provide insight into whether it would be reckless to treat these types of expenses as ordinary business expenses rather than as personal communing expenses. He also argues this information is relevant to the meaning of "commuting" expenses versus ordinary business expenses because the SEC has stated in the course of discovery that its proxy rules and regulations do not contain any specialized definition of commuting or any guidance for distinguishing commuting expenses from business travel expenses. In response to discovery requests, the SEC has informed Mr. Kovzan that it is according the term "commuting" its "plain and ordinary meaning." Therefore, the SEC's arguably analogous practices could shed light on what is a proper commuting expense versus a business travel expense. Based on Mr. Kovzan's explanation, the court finds this information may be relevant.

The SEC's arguments in support of its relevance objection do not alter this conclusion. The SEC argues this information is not relevant for several reasons. First, the SEC contends Mr. Kovzan was not aware of and did not rely upon the SEC's judgments in making his decision regarding the reporting of the CEO's alleged commuting expenses. This argument fails to take into account Judge Lungstrum's most recent opinion in this case, in which he makes clear that the standard for reasonableness encompasses an objective component. In other words, discovery regarding the reasonableness of Mr. Kovzan's actions does not require Mr. Kovzan to have known about or relied upon the SEC's own practices regarding its high-level officials.

The SEC also argues the situation involving its officials is not factually similar to the situation involving NIC's CEO. More specifically, the SEC says it reimbursed its officials for travel from their permanent duty stations, whereas the NIC CEO's travel was not necessary or related to the business of NIC. These are contested factual issues, however, that the court is not prepared or equipped to resolve on the briefing for a motion to compel.

This argument is also intertwined with the SEC's position that the discovery Mr. Kovzan seeks is not relevant because the SEC's travel policy is not the "industry standard" with regard to a public company's reporting obligations of executive perquisites under Item 402 of Regulation S-K. Judge Lungstrum's most recent opinion confirms that industry practice could be relevant to the issue of scienter, but the opinion does not limit relevant evidence on this issue to industry practice. In other words, just because the SEC and NIC are not in the same industry and are not subject to the same requirements does not mean that information about how the SEC classified or treated its high-level officials' travel or commuting expenses could not be relevant to whether Mr. Kovzan's conduct constitutes an extreme departure from the standards of ordinary care. As Mr. Kovzan points out, the SEC's approval of certain expense reimbursements for tax and other purposes could conceivably shed light on when similar expenses may be considered ordinary travel costs and not commuting costs.

The SEC also makes conclusory statements that this discovery is burdensome and expensive, but the SEC has failed to provide specific details regarding the expense or time it would take to comply with what Mr. Kovzan has requested. Because of this, the SEC has not made a sufficient showing that the discovery is of such marginal relevance that the potential harm occasioned by this discovery would outweigh the presumption in favor of broad discovery. And the SEC has not shown that the information Mr. Kovzan seeks is outside the scope of relevance. That is not to say that the information Mr. Kovzan seeks will ultimately be admissible or that the district judge or the jury will find that this information does indeed bear upon the issues for which ...


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