Welcome back for another week of What’s Next, where we report on the intersection of law and technology. This past week, a Muddy Waters report hurling accusations at Burford Capital gave us a peek into the somewhat enigmatic litigation funding industry. Plus, we continue to unravel the potential issues facing facial recognition. And Michael Dreeben declares that the Fourth Amendment is not dead yet. Let’s chat: Email me at [email protected] and follow me on Twitter at @a_lancaster3.

Chris Bogart, CEO of Burford Capital (courtesy photo)

Litigation Funding’s Muddied Waters

If you hear members of the legal community complaining about a crick in their necks, it might be from attempting to keep up with the accusations ping ponging between Burford Capital and due diligence-based investment firm Muddy Waters.

Last week, Muddy Waters published a report calling Burford “arguably insolvent,” and accused the litigation funder of manipulating its metrics for gauging financial returns. The next day, Burford issued a scathing rebuttal and hosted a lengthy shareholder call, slamming the report as false and misleading. On Sunday, Burford officially accused Muddy Waters of market manipulation, which The Rosen Law Firm in New York is investigating on behalf of shareholders. Freshfields Bruckhaus Deringer, Quinn Emanuel Urquhart & Sullivan and Morrison & Foerster are advising Burford.

Then, in the wee hours of the morning Tuesday, Muddy Waters ripped into Burford’s response.

“Leave it to former trial lawyers to talk so much, and yet say so little,” Muddy Waters said in a statement. “BUR’s written response and numbing two-hour call did nothing to dispel our view that BUR a) aggressively marks its cases up to generate non-cash profits, b) manipulates its … metrics in order to justify its fair value gains, c) deliberately confuses investors about the extent of its fair value gains in each period, and d) has a fragile balance sheet with too much leverage, particularly given the excessive costs the business runs (of which a significant portion could be management compensation).”

Muddy Waters did not stop there. The company also likened Burford to disgraced commodity traders Enron and Noble Group.

“Moreover, we believe BUR is effectively sprinting on a treadmill whereby it is growing its portfolio aggressively not because there are so many great opportunities; but, rather because it has so aggressively taken fair value gains that sap the business of future earnings power, and it therefore needs to add litigation assets to the balance sheet in order to take more fair value gains. In this way, we also see BUR as possessing the same illness that, in our view, brought Enron and Noble Group down: Addiction to mark-to-model gains financed by debt. BUR exhibits another characteristic of Enron and Noble Group—baselessly attacking critics in an attempt to distract investors from their own shortcomings.”

The company said the Financial Conduct Authority, a financial regulator in the United Kingdom, could have grounds to sanction Burford, and Muddy Waters is standing by to work with the regulator.

Although legal experts are divided about what exactly this exchange demonstrates, some argue the litigation funding industry might not be the same in the aftermath.

Teddy Baldwin of Steptoe & Johnson in Washington, D.C., said the report reflects some misunderstandings of third party funding. “As an example, I would not necessarily consider a case concluded after a judgment or an award when the claimant has a right to appeal,” Baldwin said. “This is especially true with certain investor-state arbitration cases where the claimant can seek an annulment of the award.”

Additionally, Baldwin said that funders do not need to win every case to be profitable—or even half of them. “The business model is such that only a portion of the cases need to be won and judgments collected to be profitable,” he said. “The growth of third party funders is evidence of the potential profitability of third party funding.”

However, the industry’s growth could be one reason why Burford has had to rely on on about four cases for the bulk of its net realized returns over the last seven years, according to the Muddy Waters report.

In one of his previous papers, Jeremy Kidd associate professor of law at Mercer University in Macon, Georgia, concluded that it was incorrect to think of litigation funding as leading to waves of new litigation. With likely a small increase in litigation, that would mean funders are moving in to an industry already dominated by lawyers and their contingency fees, Kidd said. “Competition between funders and lawyers would drive profits down, so I guess I’m not too surprised that profits aren’t what were expected.”

Luke Harrison of Debenhams Ottaway agrees that the litigation market has been devalued. “The Muddy Waters reports and the wide ranging press coverage subsequent to it has probably poured some water on the litigation funding fire that has been raging, which has been attracting large numbers of investors,” he said. “I think all its done is cool down the hype around the litigation funding industry.”

Harrison said lit funding is still a profitable asset class, but the issue highlights something that litigation funders have been well aware of: It’s a risky business.

Facial Recognition Fails

The law and public are continuing to grapple with the potential privacy concerns from facial recognition.

On Thursday, the U.S. Court of Appeals for the Ninth Circuit unanimously affirmeda district court ruling granting certification of a class made up of Facebook users who allege the social media giant’s facial recognition feature violates their privacy rights.

The feature, called Tag Suggestions, violates the Illinois’ Biometric Information Privacy Act, according to the Facebook users.

Facebook and the U.S. Chamber of Commerce said the feature doesn’t harm the site’s users, and therefore they lack standing under Spokeo, Inc. v. Robins. But the Ninth Circuit panel was not buying it.

“The plaintiffs allege that a violation of these requirements allows Facebook to create and use a face template and to retain this template for all time,” wrote Judge Sandra Ikuta. “Because the privacy right protected by BIPA is the right not to be subject to the collection and use of such biometric data, Facebook’s alleged violation of these statutory requirements would necessarily violate the plaintiffs’ substantive privacy interests.”

A spokesperson said Facebook plans to seek further review of the decision, according to my colleague Amanda Bronstad.

Yesterday, the Los Angeles Time covered an American Civil Liberties Union experiment exposing the potential problems that could arise from using current facial recognition technology in the criminal justice system. The ACLU ran head shots of state legislators against a database of 25,000 mugshots. About 1 in 5 legislators were mistakenly identified as an individual in the booking images.

“The software clearly is not ready for use in a law enforcement capacity,” said California lawmaker Phil Ting, who was matched with one of the arrest photos in the experiment. “These mistakes, we can kind of chuckle at it, but if you get arrested and it’s on your record, it can be hard to get housing, get a job. It has real impacts.”

Ting has authored a state bill barring law enforcement from using facial recognition with body camera footage.

Matt Cagle, an attorney with the Northern California chapter of the ACLU, told the publication that the legislation could potentially have a “ripple” effect as the largest state to propose a ban to the software.

Michael Dreeben, former U.S. deputy solicitor general and former counselor to special counsel Robert S. Mueller III (Photo: Jason Doiy/ALM)

A Reanimated Fourth Amendment

At points, a session at the American Bar Association’s Annual Meeting in San Francisco sounded a bit like a eulogy for the Fourth Amendment. However, Michael Dreeben, former U.S. deputy solicitor general and newly appointed Georgetown University Law Center lecturer, predicts fresh, high-tech applications for the constitutional clause.

Mary McNamara of Swanson & McNamara in San Francisco said the provision, which protects against unreasonable search and seizure, is “limping along on one toe, or perhaps an atom at this point.” McNamara pointed to the U.S. Supreme Court’s decision in Mitchell v. Wisconsin as a harbinger of the continued hostility on the court toward the Fourth Amendment when it comes to individual rights.

Dreeben regards the Fourth Amendment as an incremental piece of law. “This one was more of a continuing battle not so much a trend line that has any salience outside of this corner of the law,” he said.

In the future, Dreeben expects to see the Fourth Amendment invoked again insearches of data gathered online and from electronic devices. “Justices that are more on the liberal side of trying to carve out some domain of individual life protected from state use of technology to surveil,” he said. “I was on the losing side of about four of those cases. From my perspective the Fourth Amendment was coming out on top.”

On The Radar

Help Wanted California Attorney General Xavier Becerra has kicked off a hiring spree for privacy enforcers. In anticipation of the California Consumer Privacy Act going into effect in January, Becerra has started adding midlevel deputy attorneys general for the consumer law section in the Los Angeles, San Diego and San Francisco offices. Read more from Cheryl Miller here.

Brick and Mortar, and E-Commerce’s Blurring Line The California Supreme Court ruled that “visiting a website with intent to use its services is, for purposes of standing, equivalent to presenting oneself for services at a brick-and-mortar store” under the state’s Unruh Civil Rights Act. The opinion revived a bankruptcy lawyer’s proposed class action against Square Inc., alleging the mobile payment company discriminated against bankruptcy professionals. Read more from Ross Todd here.

Tech GC’s on Regulating Regulation At this year’s American Bar Association Annual Meeting in San Francisco, general counsel from some of Silicon Valley’s biggest tech companies shared their trade secrets for working with technology that’s often outpacing regulation. Some general counsel try to head off issues by embedding lawyers on the product teams, while others focus on increasing diversity in-house and in the firms they hire to avoid blind spots. Read more from Caroline Spiezio here.

Thanks for reading. We will be back next week with more What’s Next.