X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
The need for corporations to conduct internal investigations has exploded in the post-Enron/Sarbanes-Oxley (SOX) era and shows no sign of slowing, particularly given the recent deluge of stock option backdating cases that have been reported in the press. Also prominent in the headlines has been the way in which investigations are conducted. From government inquiries into possible illegal conduct to lawsuits alleging whitewashed reports, the need for a carefully executed investigation is vital. Below are a few pointers for both counsel and their clients to consider to avoid some common pitfalls and help navigate through internal investigations. Be Prepared As with most anything, the best course of action to take with respect to internal investigations is to take a proactive approach and be prepared before the need for one arises. One step a company can take in this regard is to review its directors and officers liability insurance to see whether the cost of internal investigations is covered and if so, understanding what notice must be given to the insurer in the event that one is necessary. If there is no coverage, the company is well advised to shop around for some given the significant cost that often accompanies these investigations. Another step that companies can take before trouble rears its head is to screen outside law firms as potential investigators. As discussed in more detail below, a company may determine it needs independent counsel to head up the investigation, and having potential counsel lined up before will help simplify what can be a difficult and time-consuming process during a stressful period for the company. Companies should identify qualified firms that can perform internal investigations, and then have those firms run conflict checks to make sure they can immediately represent the company should the need arise. Investigation Oversight Typically, a company’s audit committee or some other independent board committee should oversee the investigation. It is important that the matter being investigated not involve the individuals supervising the inquiry. Otherwise, the integrity of the investigation may be called into question and its results rejected by interested parties such as government agencies, auditors and the investing public. Finding an Investigator While companies typically recognize the need for and importance of internal investigations, the question of who should conduct the investigation can be a murky one for the company, and even its counsel, to answer. There is no one clear answer to this question, as each case is different and what is required will necessarily depend upon the particular facts of the case. Generally speaking, it is prudent to use an attorney to conduct the investigation in order to best protect any privilege that might attach to the investigation’s work product and findings. Companies tend to prefer to look either in-house or to their usual outside counsel who they are familiar with, have confidence in, and because of counsel’s familiarity with the business operations, will likely save the company money, at least in the short run. And aside from the sizeable fees that are commonly associated with these investigations, outside counsel have an interest in continuing to serve and maintain their relationships with their clients, particularly during what can be a turbulent time for those clients. There are certain drawbacks, however, to using counsel already affiliated with the company. One disadvantage to using in-house counsel is that the attorney-client and work-product privileges are subject to attack on the ground that the in-house attorney was providing business advice instead of legal advice. Another potential problem with using in-house counsel, as well as the company’s regular outside counsel, is that the investigation’s findings are less likely to be found credible by government regulators or other interested parties given the close relationship and to some degree, financial dependence by those attorneys on the company. Moreover, in some instances, counsel may have had some involvement in the conduct being investigated. By engaging independent counsel, these risks are minimized. As mentioned above, the company’s audit committee is generally a good choice to supervise internal investigations, and SOX specifically authorizes audit committees “to engage independent counsel . . . to carry out its duties. According to the 1934 Exchange Act Release No. 44969, “Even prior to SOX, the SEC made clear in a release detailing the criteria it considers when deciding whether, and to what extent, it will bring an enforcement action against an issuer, that it prefers the use of an independent party to get to the bottom of potential wrongdoing. In its 2001 Seaboard 21(a) report, the SEC said that in considering the cooperation of an issuer, it considers: Did the company commit to learn the truth, fully and expeditiously? 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?” Since that release, the SEC routinely points to the issuer’s cooperation and examines whether or not an independent investigation was conducted as a basis for its decisions. On the other hand, the SEC has imposed stiff sanctions against companies where there was no independent investigation. In SEC v. Del Global Technologies Corp., et al., Del Global Technologies agreed to pay a $400,000 penalty as part of a settlement in an accounting fraud case. The “penalty was imposed, in part, because the company, upon the discovery of the fraudulent accounting scheme by the firm’s auditors, commissioned an internal investigation that sought to shield the [wrongdoer] of the fraud . . . from liability. For example, Del’s audit committee hired [the wrongdoer's] close personal friend to conduct the investigation.” The SEC has also rejected the results of investigations, which can make a $400,000 penalty look modest compared with the cost of having to conduct a second investigation, not to mention the potential exposure to the investigator whose report was rejected. According to a complaint that was filed by the city of San Diego against Vinson & Elkins in July, San Diego expects it will have to pay more than $20 million for a second investigation after having already paid V&E more than $6 million to investigate the same issues. San Diego alleged it hired V&E to defend it before the SEC and the U.S. Attorney’s Office, who are investigating a massive funding deficit in San Diego’s pension system. According to the complaint, V&E said it was going to conduct an “objective warts and all” investigation, but its report was viewed as a piece of advocacy and rejected by both the SEC and KPMG. San Diego’s suit seeks more than $10 million in damages. This case comes hot on the heels of yet another lawsuit facing V&E alleging a whitewashed internal investigation arising out of the Enron debacle. In the Enron case, V&E conducted an internal investigation on behalf of Enron, its largest client at the time, with respect to transactions in which V&E was intimately involved, and which ultimately led, at least in part, to Enron’s demise. V&E’s investigation of Enron found no evidence of wrongdoing. Even where the investigation does not obviously create a conflict and preclude regular outside counsel from conducting the investigation, caution must be exercised. Frequently, investigations into one particular area can often lead into others as the document review and interview process proceeds. In addition, it is not uncommon for company employees found to have taken part in the wrongdoing to claim that they acted on the advice of counsel. If this happens, and the investigation was conducted by such counsel, a new investigator may need to be brought in. Given the potential exposure that can result from failing to conduct an independent, thorough and objective investigation, a company’s regular outside counsel should carefully consider whether to recommend to its client to engage independent counsel at the outset of the investigation. Conducting the Investigation Once the investigator is hired and the scope of the investigation is determined, there are certain practices that will facilitate a successful investigation. One such practice is to make clear early on, either in the engagement letter or otherwise, that the purpose of counsel’s investigation is to provide legal advice. A large part of the investigative process is fact gathering, and counsel should be cognizant of making every effort to protect the attorney-client privilege and its work product. Also early on, a plan should be established for collecting and preserving the facts of the case. Most, if not all of the information gathered in the investigation will come from documents and witness interviews. Similar to a litigation hold, the investigator should instruct the company not to discard hard copies of documents or purge any electronic data. Once the “investigation hold” is issued, computer forensic experts should immediately be retained to capture, preserve and make available for review the electronic data. Another important point is that investigators generally should not represent both the company and its employees, including senior management, because they frequently become adverse to the company during the investigation. When interviewing employees, counsel should make clear it represents the company, not the employee, that the interview should be kept confidential, and that while the interview is privileged, the privilege belongs to and can be waived by the company. After the interview, counsel should prepare memoranda summarizing its thoughts and impressions of the witness and what was said during the interview. Although it may sound obvious given the recent headlines concerning the California attorney general’s criminal investigation of Hewlett-Packard, the investigator needs to make sure it is familiar with and follows the law, in all applicable jurisdictions. For example, while it may be legal to retrieve and review the data from an employee’s laptop in Pennsylvania without the employee’s consent, it may not be in France. There are an endless number of other issues that can come up and decisions that will need to be made as the investigation unfolds, including whether or not to prepare a written report and with whom to share the results of the investigation. It is impossible to address every contingency here, and what will need to be done during any given investigation will depend upon the particular facts of that case. But by following these general guidelines and exercising good judgment, counsel and their clients involved in an internal investigation will be well served. JAY A. DUBOW is a partner in the litigation department of Wolf Block Schorr & Solis-Cohen. Prior to joining the firm, he was a branch chief in the division of enforcement of the SEC in Washington, D.C. His practice concentrates on securities litigation including defending SEC and other regulatory investigations and securities class actions. He can be contacted by calling 215-977- 2058. MYLES A. SEIDENFRAU is an attorney in the business litigation department of Wolf BlockSchorr & Solis-Cohen’s Cherry Hill office. Priorto law school, he worked in the Equity ResearchDepartment of a major investment bank.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.