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In today’s post-Sarbanes-Oxley business environment, it would be hard to find a corporate officer who cannot easily identify his obligations to a company in a legal crisis: When allegations of criminal misconduct come to light, corporate officers must respond quickly to minimize damage to the company and its employees, usually by conducting an internal investigation. What many CEOs may fail to appreciate, however, is how much the selection of the investigator can influence an outcome. Increasingly, the more independent the investigator, the more regulators will assume that the investigation results are valid. That’s why I believe CEOs should hire independent outside counsel � that is, different counsel than the company uses for its general corporate securities advice � to conduct internal investigations when allegations of wrongdoing arise. It’s understandable that company officers instinctively want to turn to known, trusted legal advisers when, for example, a disgruntled ex-employee makes a serious accusation about accounting improprieties. Many officers would favor tapping the company’s general counsel or usual outside counsel to perform at least a preliminary inquiry. However, reliance on regular advisers often ignores the possibility � however remote or repugnant � that one or more of those advisers had some involvement with the subject of the investigation. In other words, they might have an interest in the outcome of the investigation. Regular outside counsel, though a step removed from the company, may also find it difficult to conduct a truly thorough investigation. After all, it knows that a long-standing (and usually lucrative) client relationship may be at stake. These biases, even if they don’t affect the integrity of the investigation, can taint the process with an appearance of impropriety. That undermines management’s ability to rely on the findings or to use them to the company’s benefit. THE ENRON EXAMPLE Enron’s experience is an obvious example. When an employee raised concerns about accounting treatment for the now-infamous Raptor partnerships and other transactions, Enron’s CEO and general counsel responded appropriately and began a preliminary investigation to determine the nature and scope of the problem. Yet the CEO’s decision to rely upon Enron’s traditional outside counsel, Vinson & Elkins, for that preliminary investigation turned out to be a disaster for the company. The selection of Vinson & Elkins may at the time have appeared to be reasonable because the law firm was familiar with Enron’s operations and the complex transactions in question. In addition, the complaining employee seemed to stand alone with her concerns. With perfect hindsight, however, we see that Vinson & Elkins failed to bring to management’s attention most of the serious problems that predicated the company’s collapse. Vinson & Elkins actually concluded that it didn’t see the need for a “further widespread investigation by independent counsel or auditors,” according to William Powers Jr.’s Report of Investigation by the Special Committee of the Board of Directors of Enron. Vinson & Elkins’ investigation was criticized both by the Powers report and by congressional investigators. Another recent glaring example of the conflicts that can arise when companies use their regular counsel to conduct an investigation is Simpson Thacher’s investigation of accounting practices at Global Crossing. Simpson had handled Global Crossing’s IPO, and one of its partners was serving as acting general counsel of the company. It had billed the company for tens of millions of dollars in fees for the vast amount of legal work the firm performed in the few years preceding Global Crossing’s collapse. Simpson concluded that no further action by the company was necessary. But Simpson’s work was later criticized as inadequate. (For example, the firm never interviewed the employee who had made the initial complaint.) Global Crossing filed for bankruptcy shortly thereafter. A spate of investigations into the company’s accounting improprieties was launched by the Securities and Exchange Commission, the Federal Bureau of Investigation, and a special committee of the board of directors, all of which made clear that Simpson had failed the company. In the wake of those investigations and Global Crossing’s collapse, Simpson has recently paid $19.5 million to company shareholders to settle a securities fraud class action and made another multimillion dollar payment to settle a malpractice claim. Both payments were the direct result of the damage caused by an allegedly inadequate investigation by Simpson into Global Crossing’s accounting practices. ALL ABOUT INDEPENDENCE We can learn from the mistakes of Enron and Global Crossing executives and their lawyers. Regulators have long made it clear that they presume greater validity in reviews conducted by independent counsel and will test the objectivity of internal investigations by conducting their own evaluations. Take, for example, the 2001 enforcement action against Gisela de Leon-Meredith, the controller of a public company with a division in Miami. She was found responsible for the company’s inaccurate books and records and for material misstatements made in its SEC filings. The SEC pursued an action against the controller but not against the company, because it had effectively and appropriately responded to the allegations of wrongdoing. In its news release about the matter, the SEC used the opportunity to set forth a list of criteria that it uses in determining how to credit “self-policing, self-reporting, remediation and cooperation” by companies seeking leniency: “Did the company commit to learn the truth, fully and expeditiously? Did it do a thorough review of the nature, extent, origins and consequences of the conduct and related behavior? Did management, the Board or committees consisting solely of outside directors oversee the review? Did company employees or outside persons perform the review? If outside persons, had they done other work for the company? Where the review was conducted by outside counsel, had management previously engaged such counsel? Were scope limitations placed on the review? If so, what were they?” The value of independent investigators was also recently made plain by the passage of Section 301 of the Sarbanes-Oxley Act. Among other things, Section 301 required that the audit committees of public companies have the “authority to engage independent counsel and other advisers, as it determines necessary to carry out its duties” as well as the means to compensate those advisers. When it promulgated the rules that implemented this section of the act, the SEC commented that: “The advice of outside advisors may be necessary to identify potential conflicts of interest and assess the company’s disclosure and other compliance obligations with an independent and critical eye. Often, outside advisors can draw on their experience and knowledge to identify best practices of other companies that might be appropriate for the issuer. The assistance of outside advisors also may be needed to independently investigate questions that may arise regarding financial reporting and compliance with the securities laws. Accordingly, as proposed, the final rule specifically requires an issuer’s audit committee to have the authority to engage outside advisors, including counsel, as it determines necessary to carry out its duties.” Surely, if the creators and enforcers of Sarbanes-Oxley are so publicly and audibly encouraging audit committees to use independent counsel in appropriate circumstances, company executives should pay attention. If those arguments are not enough, attorney-client relationship issues could further sway the debate. Section 307 of the Sarbanes-Oxley Act and subsequent SEC regulations require company counsel to report evidence of material violations of securities laws to the CEO and/or the audit committee if the problem is not satisfactorily addressed at lower levels. The SEC is considering enhancing these rules by requiring company counsel (both in-house and outside counsel who assist the company with its SEC reporting and filing obligations) to make a “noisy withdrawal” from the company � that is, notify the SEC that he is withdrawing and disaffirm any SEC filing he helped prepare � if the attorney does not receive an appropriate response to his report of a material violation. Although the SEC has not yet implemented these rules, they loom large, and would provide a strong incentive to bring in independent counsel. In short, CEOs must consider the best interests of the company and its shareholders when choosing counsel to conduct an investigation into allegations of wrongdoing. CEOs must resist the urge to turn to trusted, familiar counsel in difficult circumstances. The reward, however, will be well worth it: Enforcers will be more likely to trust the outcome of that investigation, more likely to credit the company for having done a thorough job of responding to the problem, and less likely to launch a costly and redundant investigation of its own to verify the first expensive review. Cecelia Kempler was co-chair of LeBoeuf, Lamb, Greene & MacRae’s insurance practice, chair of its life insurance practice, and served on its executive committee until her retirement from the partnership on Dec. 31, 2003. She serves on the board of a major life insurer and on its audit committee, and has written and spoken extensively on insurance industry issues.

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