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In the past year and a half, the confidence of investors has been shaken by a wave of corporate scandals that has engulfed some of the largest and best-known public companies in the United States. Congress passed the Sarbanes-Oxley Act of 2002 to restore investor trust by promulgating key corporate governance initiatives. The act has created a procedure for in-house and outside counsel to report allegations of internal corporate misconduct. It also has required that audit committees of boards of directors of public companies establish procedures for the receipt, retention and investigation of complaints regarding accounting, internal controls or auditing matters. It always has been important for companies to undertake internal investigations when faced with credible allegations of misconduct. In this post-Sarbanes-Oxley world, it is even more incumbent upon public companies and their audit committees to ensure that such investigations are conducted in a reasonable and accurate manner. If the allegations are found to be meritorious, the internal investigative team must make recommendations to the company about systemic changes to prevent future wrongdoing and terminations of those who engaged in the misconduct. The team also must develop a game plan to minimize the company’s exposure in the inevitable onslaught of civil/criminal/regulatory actions. An effective internal investigative team that uncovers misconduct must be proactive in approaching federal regulators to minimize or avoid altogether regulatory action against the company. In order to maximize the chances that regulatory action will not be filed against the company, the investigative process must inspire confidence that it was conducted in a good faith quest for the truth and reached the correct conclusions. The hallmarks of an effective internal investigation are objectivity, thoroughness and swiftness. This article seeks to provide some guidance to in-house and outside counsel and boards of directors about how best to realize those qualities in structuring, conducting and overseeing a successful corporate internal investigation. DO RETAIN INDEPENDENT OUTSIDE COUNSEL. In order to prepare for potential governmental cooperation, the internal investigation typically should be conducted by independent outside counsel without a previous relationship to the company. Federal regulators view retention of objective and independent counsel as a sign that the company is committed to engaging in a genuine internal investigation. For example, the Securities and Exchange Commission explicitly noted in SEC Release No. 44969 (Oct. 23, 2001) that retention of such counsel is one factor that tips in favor of the commission electing not to file an enforcement proceeding against a company or filing a proceeding with reduced charges. As recent press attention makes clear, the investing public also has more confidence in the results of internal investigations that are directed by outside counsel who do not have significant pre-existing ties to the company. DON’T PERMIT INTERESTED PARTIES TO TAINT THE INVESTIGATION. All parties interested in the subject matter of the investigation must be isolated from participating in the investigative process. For example, if the CEO likely could be implicated by the investigation, it is important that he or she be excluded from the team overseeing the investigation. Moreover, it is important that all interested parties be sufficiently isolated from the investigation in order to avoid subsequent allegations that he or she influenced its course or coerced its team members. DO TAKE STEPS TO PRESERVE ALL RELEVANT DOCUMENTS. The Enron fiasco serves as a powerful example of the increased scrutiny and harsher penalties that may ensue if relevant documents and potential evidence are destroyed while an investigation is pending. Therefore, it is critical that steps are taken at the very inception of the internal investigation to preserve all relevant hard copy and electronic documents. It equally is important that such steps be documented. DO CONDUCT A SPEEDY INVESTIGATION. In making charging decisions, federal regulators consider the speed with which the investigation is conducted and how quickly and appropriately the company metes out penalties to individual employees who were responsible for the wrongdoing. In addition, a company’s day-to-day business often is derailed during an internal investigation by the disruptions associated with employee interviews and document collections and the inevitable distraction of employees’ attention and focus away from business activities. To the extent that the company has disclosed that an internal investigation is ongoing, it also behooves the company to complete the investigation as quickly as possible to demonstrate to the investing public that it has resolved the issues at the heart of the investigation and is taking positive steps in moving forward with the company’s business. DON’T SACRIFICE THOROUGHNESS FOR SPEED. While speed is important, it also is crucial that the investigation be conducted in a thorough and accurate manner. The investigative process must include interviews of all present or former employees reasonably implicated during the course of the investigation and a review of all key documents. The investigative team also must have the freedom and financial wherewithal to hire expert consultants, as warranted, to assist counsel in analyzing data gathered during the course of the investigation. A delicate balance must be struck between internal investigations where every possible stone is turned over and conducting a reasonable and thorough investigation. As recent press attention has demonstrated, if a company cuts corners on the scope and extent of the investigation, the company may be forced to start the process all over again, resulting in the enormous expense of funding not one, but two, investigations. Significantly, the company likely would have lost its chance to demonstrate to the regulators that it be credited for such good behavior in conducting its own internal investigation when the agency considers whether to levy charges against the company. Last, but not least, the company would have a public relations fiasco on its hands. DO TAKE STEPS TO PRESERVE THE ATTORNEY-CLIENT PRIVILEGE AND ATTORNEY WORK PRODUCT IN INTERVIEWS. The investigative team should send a minimum of two attorneys to interview each witness. That way, there will be two witnesses to statements made during the interview should any disputes arise subsequently over what the witness said during the interview. The witness should be informed at the outset that the attorneys represent the company, not the witness; that the communication should be kept confidential and not disclosed to other persons; that the communication is protected by the company’s attorney-client privilege and that the company could elect to waive the privilege at its sole discretion at some future point to share information gathered during the investigation with federal regulators. If a current employee witness refuses to be interviewed by the team, the witness should be informed that he or she has an obligation to cooperate with the company’s internal investigations as part of the witness’s employment relationship with the company. If the witness still balks at meeting with the investigative team, the matter should be referred to the group inside the company that has directed the investigation for appropriate personnel action. The witness’s statements should not be tape-recorded or transcribed verbatim because such recordings or transcriptions potentially may be discoverable by governmental entities or private litigants. Instead, one of the attorneys participating in the interview should take notes and prepare a memorandum regarding the interview that indicates that it was prepared in anticipation of litigation or regulatory action and incorporates that attorney’s mental impressions, opinions and analysis. DO TAKE A “BOTTOM-UP” APPROACH TO WITNESS INTERVIEWS. At the very beginning of an investigation, the team’s knowledge and information about a company’s internal systems and processes and the allegations themselves is quite limited. It is helpful to begin the investigation with the lowest-level employees with knowledge of the alleged misconduct and work up to the executives at the top. By the time that the interviews with the highest-ranking officers and directors occur, the investigative team will have knowledge built upon by many prior interviews and review of key documents. As a result, those interviews will be more productive and the team will be able to ask the tough questions that might not have been so obvious at the very beginning of the investigation. DON’T ENTER INTO A JOINT DEFENSE AGREEMENT. A company should not enter into a joint defense arrangement with its employees who allegedly engaged in wrongdoing. Such an arrangement may prohibit the company from sharing information provided by its employees to regulators at a later date. Not being able to cooperate with regulators by fully disclosing all key facts uncovered in the investigation may prevent the regulators from crediting the company with cooperation and either bringing reduced charges against the company or not pursuing an action against the company at all. In addition, earlier this year, the Department of Justice issued a policy statement discouraging joint defense arrangements under such circumstances. (DOJ Jan. 20, 2003 Internal Policy Memorandum, “Principles of Federal Prosecution of Business Organizations,” by Deputy Attorney General Larry Thompson.) DO ASSUME THAT THE COMPANY MAY DISCLOSE PRIVILEGED MATERIALS TO REGULATORS AND THAT SUCH DISCLOSURE MAY WAIVE THE PRIVILEGE IN SUBSEQUENT LITIGATION. In order to avoid charges against the company, the company may elect to waive the attorney-client and work-product privileges and disclose to federal regulators the fruits of its internal investigation. The law governing attorney-client and work-product privileges with regard to documents created during the internal investigation is in a state of flux. The question at issue is whether a company’s decision to disclose to regulators the paperwork created by an internal investigation constitutes a waiver of privilege such that private litigants can discover those documents in a subsequent civil suit. Of course, these documents would offer civil plaintiffs a massive windfall in civil litigation. While the uncertain state of the law makes it difficult to generate a clear strategy with respect to this issue, a few protective steps should be taken. First, when creating documents during the course of the investigation, assume that private litigants ultimately will have access to the documents produced. Second, should a company elect to waive the attorney-client and work-product privileges with respect to the SEC or DOJ, the company should attempt to enter into a confidentiality agreement that will, to the extent possible, preserve the company’s future claim of privilege. Courts have held that such agreements are effective to ensure that the privilege has not been waived with respect to private litigants. See, e.g., Saito v. McKesson HBOC, 2002 WL 31657622 (Nov. 13, 2002); Diversified Indus., Inc. v. Meredith, 572 F.2d 596 (8th Cir., 1977). Unfortunately, some courts have held to the contrary that even an airtight confidentiality agreement with federal regulators will waive privilege as to subsequent litigants. See, e.g., Westinghouse Elec. Corp. v. Philippines, 951 F.2d 1414, 1431 (3d Cir. 1992); United States v. Bergonzi, CR-00-0505 MJJ (Jan. 10, 2003, N.D. Cal.) (appeal pending); In re Columbia/HCA Healthcare Corp., 192 F.R.D. 575 (D. Tenn. 2000). In order to be in the best position to protect disclosure of documents to civil litigants, a company should wait until the internal investigation is concluded, and any reports and memoranda already prepared, before entering into a confidentiality agreement and agreeing to turn such documents over to the SEC or DOJ. Sarah A. Good is head of the securities practice group and vice chair of the litigation department at San Francisco’s Howard, Rice, Nemerovski, Canady, Falk & Rabkin. Ajay Krishnan was an associate at Howard, Rice, and is now clerking at the Ninth Circuit U.S. Court of Appeals.

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