New England Biz Law Update
The recent falls of Enron, Arthur Andersen, and WorldCom highlight the increasing corporate liability for employee misconduct. This liability, in turn, emphasizes the importance of internal investigations of possible corporate misdeeds.
If properly executed, an internal investigation allows a corporation to determine whether there has been employee misconduct that may implicate the corporation and gives it the opportunity to limit the potential damage.
Internal investigations are triggered in one of several ways: an allegation from a company employee, an audit report, the filing of a civil lawsuit, or the commencement of a civil or criminal investigation by a government agency. When a government investigation raises a problem, there is often little choice but to begin an internal investigation. Similarly, if an allegation concerns the possible violation of securities laws, counsel may be obligated to institute an investigation under the requirements of the Sarbanes-Oxley Act of 2002.
In other contexts though, the corporate leadership must decide whether to respond with an internal investigation. Generally speaking, any credible indication of a violation of an important company policy or law should prompt an investigation.
Initial Steps
Once the determination is made to conduct an internal investigation, the next issue to resolve is who should conduct it. In-house counsel, outside counsel, or both, may conduct an investigation. When a government investigation or criminal complaint is the trigger, outside counsel normally should be in charge of the internal investigation. Under other scenarios, the board of directors and in-house counsel can decide who is best suited to lead the investigation.
The primary consideration is the seriousness of the alleged wrongdoing — the more serious it is, the more advisable it is to retain outside counsel. Outside counsel experienced in handling government investigations may be able to prevent the government from taking any formal action.
Furthermore, outside counsel will usually have more litigation experience and greater resources to direct at the investigation.
Importantly, because outside counsel’s role is strictly defined by the scope of the investigation, communications with outside counsel remain protected by the attorney-client privilege.
Another consideration, of course, is cost. Unless the corporation has a longstanding relationship with a law firm, in-house counsel may be more cost and time efficient due to greater familiarity with the organization. There are, however, a number of disadvantages in using in-house counsel. Lack of objectivity, or the perception thereof, can be a problem, as the very familiarity that allows for greater insight may also create bias or a perception of bias.
Once the company determines who will conduct the investigation, the scope of the investigation should be outlined in a resolution from the board of directors and/or a letter from an executive officer to counsel. While the initial resolution will be a helpful guide, counsel should not be confined by its limits, and instead should follow all leads until all relevant information has been gathered.
Conducting An Investigation
The principal goal of an investigation is to determine what happened, who was involved, for how long, and whether the events in question constitute a violation of law. Achieving this goal will require the gathering and analysis of documents and employee interviews.
Documents
If the company has a document retention plan, that is, a systematic plan for the destruction of paper and/or electronic files, counsel should consider whether to halt it immediately. If the impetus for the investigation is a lawsuit or an external investigation, particularly by the government, counsel should normally suspend the document retention plan. In other contexts, the decision will depend on the allegation and whether the document retention plan will destroy any relevant information.
A document organization plan is essential to the completeness and accuracy of any investigation. In most cases, a chronology should be created from key documents and all original documents should be stamped with sequential numbers and labeled as to source. A room for document storage should be set aside. Often the best way to ensure the effectiveness of these procedures is to designate a document custodian.
Finally, counsel should not overlook employees’ personal documents, such as calendars and correspondence, which can be extremely useful. These documents should be kept separate from corporate documents because the Fifth Amendment may shelter certain personal documents.
Witnesses
Counsel should begin by interviewing those employees implicated in the allegation as well as those believed to have pertinent information. A caveat is that it may be better to begin with lower level employees who have less to hide and may be more willing to tell the whole story.
Regardless of the order of the interviews, there are a number of thorny issues regarding witnesses that must be kept in mind. To begin, a number of issues should be made clear to employees at the beginning of every interview. Employees often confuse who counsel represents in an internal investigation, and therefore they should be told that, absent the waiver of any potential conflict, investigative counsel represents only the corporation.
Additionally, counsel should inform employees that they need not speak to counsel, they have the option of obtaining separate counsel, and, because the corporation and not the individual employee holds the attorney-client privilege, any information gathered may be disclosed at the discretion of the corporation.
Counsel must also be mindful of preserving confidentiality during an internal investigation. The corporation holds a privilege as to communications between counsel and employees, provided several criteria are met. This privilege protects the communication only, not disclosure of the underlying facts. Counsel also holds a work product privilege with respect to written work product. Verbatim notes are not privileged and therefore should not be taken.
Finally, if an external investigation is underway, counsel should advise employees of the existence of that investigation, as well as their rights and responsibilities. Government investigators may create situations in which employees feel pressured to talk (for example, visits at home), and counsel should inform all employees that they have the right not to speak with government investigators, but if they choose to do so, they must be truthful.
Employees should also be told that they are entitled to counsel, that the company will provide counsel if they wish, and that they should inform an investigator who contacts them that they are represented by counsel (if that is the case).
Reporting Conclusions
At the conclusion of the investigation, counsel will present the results to the company. If no violation has been found, there is usually no downside to a written report. Even when a violation is found, counsel may opt for a written report. If the corporation wishes to self-report criminal misconduct to the government, a written report gives counsel the most control over how the information is conveyed and prevents misunderstandings of what may be complex facts.
Counsel should draft the report keeping in mind the possibility of libel suits by employees mentioned in the report. Accordingly, a written report distributed outside the corporation should not quote or attribute statements made during employee interviews, but simply state the facts.
Once a report has been generated, the corporation must decide what to do. In some circumstances, if misconduct has been found, disclosure may be required. For example, sections 302, 409, and 906 of the Sarbanes-Oxley Act and implementing Securities and Exchange Commission regulations may require registered companies to disclose misconduct that implicates the companies’ financial condition or operations.
But the most challenging decision for a company occurs when a voluntary investigation reveals misconduct and the corporation must then determine whether to self-report to the government. In that situation, a number of issues must be considered.
First, counsel must contemplate the possibility that the government may never become aware of the misconduct uncovered in an investigation. Voluntary disclosure will alert the government to the wrongdoing and may invite punitive consequences for the corporation where there would have been none.
Second, many corporations fear the adverse publicity that may come with disclosure. The importance of adverse publicity depends on the corporation’s reliance on public goodwill in its business.
Third, Counsel should also be aware that self-reporting constitutes a disclosure to an outside party, and thus will undermine the corporation’s ability to protect that information from other parties. Upon notice that the corporation has admitted misconduct, groups that may have civil claims (for example, shareholders) will have a roadmap to bring suit.
Nonetheless, self-reporting has benefits. The first is leniency under the Federal Sentencing Guidelines for Organizations. Corporations convicted of violating federal law face heavy fines and corporate probation. Under the Guidelines for Organizations, a corporation that has an acceptable corporate compliance program in place, self-reports to the government, cooperates with the ensuing prosecution, and has no high-level involvement in the misconduct, may be eligible for a reduction in its fine. It is possible, although rare, that self-reporting will stave off sanctions entirely.
In the end, no corporation relishes the idea of commencing an internal investigation. In circumstances in which a corporation has no choice but to institute an investigation, the decision of what to do is easy.
It is in the gray areas where an investigation is not mandatory, but a failure to investigate could be dangerous, that the choice is difficult. In those situations, counsel should remember that, if done appropriately, an internal investigation could avoid far more costly repercussions down the road.
