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In the wake of corporate scandals such as those at WorldCom, Adelphia, Enron and elsewhere, new attention has focused generally on standards of corporate governance and specifically on those applicable to corporate directors. Several initiatives involving corporate governance by both federal authorities and the two largest stock exchanges have only increased the pressure for substantial independent board oversight of corporate affairs. In this climate, directors must be vigilant in monitoring the operations and management of the corporation. In certain circumstances, this gives rise to the necessity to conduct an independent investigation into alleged malfeasance or other wrongdoing potentially damaging to the corporation. Coupled with effective compliance programs, internal investigations can substantially improve the position of corporations faced with issues of criminal prosecution or civil fraud litigation. Increased significance of compliance programs Effective corporate compliance programs have taken on increased significance in both the civil and criminal realms. In the criminal context, the existence of a well-designed and ordinarily effective program is taken into account in both charging and sentencing decisions. The Thompson Memorandum, which lays out U.S. Department of Justice (DOJ) policy regarding charging business organizations criminally, lists the existence of such a program among the factors to be considered. Federal Prosecutions of Business Organizations, Memorandum from Deputy Attorney General Larry Thompson to the U.S. attorneys’ offices (Jan. 20, 2003), www.usdoj.gov/usao/eousa/foia_reading_room/usam/title9/crm00162.htm. A program that is “adequately designed for maximum effectiveness in preventing and detecting wrongdoing by employees,” and that is enforced by management, will weigh against prosecution. The DOJ recognizes that “no compliance program can ever prevent all criminal activity by a corporation’s employees.” Among the characteristics of an effective compliance program listed specifically in the memorandum are that “the corporation’s directors exercise independent review over proposed corporate actions rather than unquestioningly ratifying officers’ recommendations,” that the directors are “provided with information sufficient to enable the exercise of independent judgment,” that “internal audit functions [are] conducted at a level sufficient to ensure their independence and accuracy,” and that the directors have “established an information and reporting system in the organization reasonabl[y] designed to provide management and the board of directors with timely and accurate information sufficient to allow them to reach an informed decision regarding the organization’s compliance with the law.” Id. (citing In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996)). Even if the corporation is indicted and pleads guilty or is convicted, the existence of an effective compliance program may substantially affect the sentence imposed under the U.S. Sentencing Guidelines. Under the guidelines, a corporation that can demonstrate an “effective program to prevent and detect violations of law” may receive a lower “culpability score,” and ultimately a lower fine, than it would otherwise. See U.S.S.G. �� 8A1.2 (D), (E), cmt. � (k), 8C2.5. Further, a court is not required to impose probation on a convicted corporation with an effective compliance program. Corporate compliance programs have great significance in civil litigation as well. Indeed, the Delaware Chancery Court has noted that implementing such a system-or ensuring that such a system is implemented-is a part of directors’ fiduciary duty to the corporation. See Caremark, 698 A.2d at 970. Failure to implement such a system reasonably sufficient to keep the directors informed of relevant information, particularly of violations of law or internal policies, may be a breach of this duty. Yet just implementing a compliance program does not satisfy directors’ fiduciary responsibility; the directors must also ensure that the system is adequately monitored. See Guttman v. Huang, 823 A.2d 492, 507 (Del. Ch. 2003). Directors’ “duty to monitor” the affairs of the corporation thus generally comprises a duty to ensure that an adequate compliance program of systems and controls is put in place to alert the directors to potential wrongdoing, and to monitor the adequacy and effectiveness of the program. In Caremark, the court held that “[o]nly a sustained and systematic failure of the board to exercise oversight-such as an utter failure to attempt to assure a reasonable information and reporting system exists” would establish liability on the part of the directors. 698 A.2d at 971. In Guttman, however, the court suggested that a board would violate this duty if it “lacked an audit committee, . . . had an audit committee that met only sporadically and devoted patently inadequate time to its work, or . . . [if] the audit committee had clear notice of serious accounting irregularities and simply chose to ignore them or, even worse, to encourage their continuation.” 823 A.2d at 507. At least under Delaware law, then, the existence of an active and competent audit committee, along with other factors such as a comprehensive compliance program and the use of an outside auditor to conduct annual audits and to review the corporation’s compliance program, is relevant to directors’ fulfillment of this duty. But how should a corporation respond when its compliance program or other information reveals evidence of possible wrongdoing? This may occur in a variety of situations-a shareholder derivative claim, a claim under the False Claims Act, allegations of antitrust violations, to cite only a few examples. Each situation may warrant an internal investigation assisted by outside counsel. For illustrative purposes, consider here the appropriate investigative response by a board of directors faced with a demand from a shareholder proposing to assert a derivative claim, assuming, as is commonly the case, the applicability of Delaware law. Pursuant to Delaware law, a shareholder is generally required to demand that the board of directors take action before the shareholder initiates litigation on behalf of the corporation. See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244, 253-54 (Del. 2000). Upon receipt of a shareholder’s demand that it initiate litigation, the board must investigate the bases for the claims asserted and determine whether commencing litigation is in the interests of the corporation. This investigative task is ordinarily delegated to a committee of the board-the demand committee-which investigates the claims and reports back to the board with its conclusions and recommendation. Once formed, the demand committee will ordinarily retain outside counsel to assist it in its investigation. The committee may also, depending on the issues in question, authorize counsel to retain experts. Experts in accounting, for example, might be retained to assess the performance of the corporation’s outside auditor or its own accounting practices. Next, the committee, assisted by counsel, must determine the scope of its investigation. Courts applying Delaware law have held that a demand made upon a board of directors “must identify the alleged wrongdoers, describe the factual basis of the wrongful acts and harm caused to the corporation, and request remedial relief.” Allison ex rel. G.M.C. v. General Motors Corp., 604 F. Supp. 1106, 1117 (D. Del. 1985), aff’d, 782 F.2d 1026 (3d Cir. 1985) (table). The demand received by the board, if it meets this standard (a question the committee should consider) will thus serve as a guide to the scope of the claims to be investigated. Nevertheless, the demand may be imprecise or conclusory as to the claims it asserts, or as to the bases for those claims, and may require the committee to make judgments about which investigative avenues to pursue. In making such judgments, the committee may wish to contact the demanding shareholder’s counsel to request clarification of ambiguous claims or assertions in the demand. Whether or not such clarification is forthcoming, this step may improve the corporation’s position in later litigation. Methodology is another important consideration In addition to the scope of the investigation, the committee must also determine the methodology to be employed. Generally, the committee, through counsel, will investigate by reviewing relevant documents and interviewing present and former employees, managers and directors with the aim of determining whether wrongdoing has in fact occurred. The committee, however, should also ultimately consider whether initiating litigation is in the corporation’s best interests. In this regard, the committee should consider any internal review of the issues in question already undertaken by the corporation. When such a review has occurred, it should itself be examined to determine whether its methodology was reasonable, and its conclusions reliable, under the circumstances. Finally, the committee should also consider whether the issues in question were raised through the corporation’s internal compliance program, whether the response by management or the board was reasonable in light of issues that were raised and, significantly, whether any necessary changes have been made to the program if there are issues that should have been raised but were not. In addition to being utilized to satisfy directors’ fiduciary responsibilities to monitor corporate affairs, internal investigations also provide facts crucial to informed decision-making on legal issues. Because many such decisions are the province of corporate management, at least in the first instance, the product of independent board investigations often has real value in resolving related management issues. George J. Terwilliger III is a partner in the Washington office of White & Case. He was deputy attorney general of the United States from 1991 to 1992. John C. Wells, an associate at the firm, assisted in preparing this article.

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