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Across the country, company lawyers watched, wincing, as a tidal wave of scandal overtook Enron Corp. general counsel James Derrick Jr. The accounting fiasco flushed him out of his job at the beginning of March and perhaps out of his career as a lawyer, when all is said and done. Derrick, a 20-year veteran of Houston powerhouse Vinson & Elkins, had been the energy giant’s top lawyer for 10 years when he was confronted with an employee letter warning that a “wave of accounting scandals” could destroy the company. Did he handle those allegations properly? The three experts to whom we turned for guidance said that not enough behind-the-scenes information had been revealed to reach a verdict. But the attorney-client privilege that cloaks Derrick’s doings may get stripped away in the government’s investigation, and the GC’s role may become better known. For even when a lawyer does everything right, if his work has aided a fraud, all confidentiality bets are off. It may take years, indictments and a lot of civil suits before the full story of Enron’s in-house lawyering is told. In the meantime, top legal officers across the country need advice on how to keep their companies, and careers, from getting “Enroned.” So, Corporate Counsel executive editor Rorie Sherman asked legal ethics guru Stephen Gillers, corporate governance expert Nell Minow, and white-collar defense lawyer Benito Romano (a former U.S. Attorney for the Southern District of New York) for direction on the right way for GCs to handle an Enron-like disaster. INITIAL REACTION What is a general counsel ethically bound to do after receiving a letter from an employee accusing the company of accounting fraud?

Stephen Gillers, vice dean and professor, New York University School of Law: That depends: How serious is the purported wrong; how detailed is the accusation? What does the general counsel know about the employee making the accusation? Depending on the answers to these questions, a GC should begin by talking directly with the employee, if identified. If the allegation is anonymous and the charge serious and sufficiently specific, then the GC should begin an informal inquiry. Talk to others who may know what is going on. Look at records. Depending on what is uncovered, the GC either should continue looking into the matter or close the file. The GC’s duty is to protect the client, that is to say the company, no matter whose toes are stepped on.

Nell Minow, editor, The Corporate Library: The GC should show that letter to the inside auditor, the outside auditor, the CEO and the audit committee. He should warn the audit committee’s members that they have the authority to retain their own counsel and their own auditors, if they feel that is necessary. It [also] matters how credible the allegation is. The anonymous letter Enron vice president Sherron Watkins sent to president Kenneth Lay in August warning of a “wave of accounting scandals” had a great deal of credibility. It sounded well informed and important. I would err on the side of following up. Later, Watkins made herself known. And I would not be willing to dismiss any allegations from someone at her level — even if the GC’s first inclination is to think the claims are not legitimate. Also, even if a GC believes the allegations will not be supported, he needs to make the fact of the allegation known to the relevant parties, and he must let them know that he’s following up.

Benito Romano, partner, Willkie Farr & Gallagher: It is not a simple matter of marching off and doing an investigation. A GC has to make an evaluation of the claim before taking the first step. He must balance the inquiry that has to be made against the possible disruption to the operation of the company if such an investigation is launched, and people are brought in to be interviewed, et cetera. Having said that, though, the GC’s primary duty is to make a reasonable inquiry to determine whether there is a credible basis for the allegation. FOLLOW-UP Enron’s GC asked longtime outside counsel Vinson & Elkins to investigate the allegations of wrongdoing — but he told the firm not to second-guess the accountants. Did that constraint violate his duty to the company? Gillers: Maybe, maybe not. It’s not possible to say without getting a whole lot closer to the facts, not all of which are known. But lawyers accept general limitations on the scope of work all the time. They can limit their advice by assuming the accuracy of an outside expert’s conclusion. Lawyers are not experts in other fields, whether it’s accountancy or structural engineering. If the experts are reputable and there is no apparent reason to suspect the accuracy of their conclusion, the lawyer can run with that, and give a legal opinion based on it. A separate question is whether V&E’s lawyering was nevertheless competent. Perhaps there were signals that something was awry, which the firm failed to detect. I don’t know. We may find out, however, if the firm is sued. Minow: There is no clear answer without knowing more about the situation. It is fair and ethical for a client to impose boundaries on an assignment. But when anyone inside or outside the company raises concerns about a possible ethical or criminal violation, the GC is obligated to make sure that those claims are thoroughly investigated. Romano: Sometimes it is very important to get to the bottom of an allegation quickly. If you undertake a review of auditing judgments, inevitably you’ll add a substantial amount of time to an investigation, delaying any kind of conclusion. It’s not necessarily a violation of a GC’s duty to limit the scope of the investigation so that it avoids second-guessing or reviewing the accounting judgments made. A naked allegation that the judgments were wrong may not necessarily be enough to justify, in the absence of anything else, a thorough review of the auditing. You do have to question, though, whether V&E was in an impossible position. There is a always a question when a company has a long-standing relationship with a principal outside firm, as Enron had with V&E, whether the outside counsel are able to give thoroughly independent advice, because of their familiarity with the client and with the client’s representatives involved in transactions. If what we are reading is correct, in the Enron situation, V&E may have had a problem with their independence because of their involvement in the transactions that were the subject of the allegations. But that would depend on the exact nature of V&E’s involvement, which is not yet entirely clear. SPREAD THE WORD When allegations of company wrongdoing surface, what are the GC’s ethical obligations to the CEO? To the board of directors? The shareholders? The feds? Gillers: Under the American Bar Association Model Rules and the attorney ethics rules in U.S. jurisdictions, the GC’s obligations are to the company, acting through its officers and directors. The directors have final authority. The shareholders benefit from the lawyer’s work, but the lawyer does not take instruction from, nor does he report to, the shareholders. This may vary somewhat in small, closely held companies, but it’s the standard rule for large ones. If a problem is serious and threatening to the company and the GC cannot get an acceptable response from officers, his duty is to speak to the board — or at least to its independent members. If they are unresponsive, the rules tell the lawyer that he can resign. But under no circumstances should the GC ever assist in the illegal conduct. Nor should the GC reveal the wrongdoing outside the company — absent an exception to the confidentiality rules. If the wrongdoing is merely fraudulent, the ABA rules do not recognize an exception to confidentiality. Some believe that, in order to protect a client, the GC should have the power, if not the obligation, to go outside the company if the directors are unresponsive and the danger to the company is great. But the majority of U.S. jurisdictions do not allow this. Minow: The GC’s primary duty should be to the company, and I believe the company is best served when the GC sees that duty as being to the long-term shareholders. Therefore, the GC should support the board members in their investigation of any problems. That includes guiding the board through a self-examination that may result in replacement of some directors. Disclosure to the shareholders is handled through filings with the Securities and Exchange Commission. In a corporate meltdown, it may come up very quickly that the GC will have to advise the CEO to retain his own lawyer. CEOs are used to thinking of GCs as their lawyers. But in a situation like Enron’s, the interests of the CEO may be adverse to interests that have to come first for the GC. That’s clear when a CEO is embezzling funds. But it’s also true in a case like Enron’s, when you are talking about potential liability, securities fraud — some kind of civil or criminal violations. The GC has to be absolutely clear that he cannot provide the kind of advocacy that the CEO is entitled to expect from his own counsel. Of course, if a GC thinks he may have a very serious problem, then he absolutely wants to be the person to call the SEC and say, “We’ve identified a problem. We will be happy to invite you in with us as we investigate it; we want to work with you.” You always want to do that. Romano: The GC’s primary responsibility is to the company, its board and shareholders. He is obligated to make sure the client understands that there must be an immediate stop to any ongoing activity that may violate the law. If the client, in the form of the board, does not respond, the GC is not free to disclose confidential information. He may have no alternative but to resign. The GC has no ethical obligation to the government directly. In fact, the privilege restrains him from going to the government without his client’s permission. But, like any lawyer, he does have an obligation to disassociate himself from any ongoing improper activity — he certainly must not do anything to further it. PUT IT IN WRITING Once allegations of wrongdoing have been made, what should the GC be documenting? And what should he avoid putting in writing? Minow: You should be documenting everything and taking every step imaginable to privilege all of that documentation. Romano: Most careful lawyers will want to make sure — so there is no confusion about their advice — that that advice is given in writing. This is especially true when a lawyer is concerned that his client may be refusing to fairly consider his legal advice, perhaps because of the client’s personal interests. Once you create a document like that, though, you’ve put the ambivalent or timid or indecisive corporate executive in a tough spot. This document is going to exist in a number of different forms, in files and on hard drives. It will be there for investigators to find. And it will record, probably for eternity, that the executive had been informed and probably had an opportunity to take some action. In practical terms, though, to save your own career, once you are convinced that there is a crime or serious regulatory offense going on at your company — and the information is accurate and reliable — it would be prudent to tell everybody whom you are in a position to tell, and to document it, so there is no question later about your efforts. At the same time, though, there is no lawyer with any experience who isn’t aware of the dangers of reducing things to writing. The risk, of course, is that that writing will someday be subpoenaed or turn up in the midst of a government investigation or civil litigation. Many lawyers are careful about what they record — not only because they don’t want to create evidence that is usable against their clients — but also because, so often in situations like Enron’s, events are occurring so quickly that the lawyers’ writings sometimes do not accurately reflect what is actually transpiring. That said, most lawyers take notes and have a difficult time functioning without them. Good lawyers understand that their notes represent a contemporaneous record, which may ultimately be discoverable — particularly if there is a question of whether there was ongoing improper activity. KEEP IT CONFIDENTIAL What kinds of in-house legal communications about an Enron-like disaster are covered by the attorney-client privilege? Gillers: All information the GC receives in order to render legal services is privileged to the company, and the privilege can be asserted by the individuals in control of the company, which eventually may mean the trustee in bankruptcy. If an opponent can show that the allegedly privileged communication was probably a part of a criminal or fraudulent scheme, or in some places an intentional tort, the privilege is lost. This is true even if the lawyer is unaware of the scheme — and even if the immediate service the lawyer was asked to perform is a legitimate one, but, unknown to the lawyer, a part of the broader improper scheme. Minow: There are things you can do that will risk losing the attorney-client privilege. To keep it, you have to be acting as counsel the whole time. You can’t be counsel one day, and acting as a corporate secretary or other adviser to management, playing some kind of substantive role in determining business strategy, because then your memos may lose privilege. So you want to assert privilege on everything that you keep, and make sure that your role is so clearly defined that that is not going to be an issue. Romano: There is no lawyer who has done this kind of work — investigating events about which there are questions of legality — who doesn’t understand that there is a high risk that the material created in the course of the inquiry will be subpoenaed. In many cases, litigants and the government have been able to obtain that material. Sometimes it is anticipated that at the conclusion of the investigation the material will be made available to the government, because the company wants very much to make a clean breast of it. But I don’t think you can do an adequate job of investigating without running the risk of having your material become available to the government or a litigant.

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