When federal prosecutors target a company for fraud, in-house counsel are increasingly facing a tough choice: voluntarily disclose sensitive internal information – at the risk ofwaiving the attorney-client and work product privileges – or stand firm against charges that can threaten the very survival of the company.

The dilemma has been compounded by dramatically stepped up enforcement efforts driven by the high-profile corporate scandals of the past couple of years, with the added twist that government investigators across the country are aggressively demanding full disclosure of records as a way to maybe get lenient treatment.

Prosecutors are also more willing to go after companies as a whole, rather than just charging individual wrongdoers. And a refusal to cooperate could lead to obstruction of justice charges, which the government is showing a greater willingness to pursue than in the past, such as in the Arthur Andersen and Martha Stewart cases.

These policies have been dictated by top management at the Department of Justice, the Securities and Exchange Commission and other federal agencies, all of which are closely tracking what field offices are doing in cracking down on corporate fraud, defense attorneys said.

The risks of turning over internal documents in the hope of getting a good deal with prosecutors are considerable.

Those risks include providing a “roadmap” for criminal charges if prosecutors are not satisfied the disclosure is “full and complete,” and opening the door to related civil suits from shareholders and others.

“The most serious problem for in-house counsel post-Enron is that federal prosecutors are turning corporate counsel into Elliot Ness,” said Boston criminal defense lawyer Thomas E. Dwyer Jr. “They want in-house counsel to do the investigations, and they want outside counsel to produce what in-house counsel did. This creates tension between in-house lawyers and their clients, and tension between in-house lawyers and their outside counsel. It’s fraught with difficulties.”

When To Disclose

No hard and fast rule applies to making the choice when to cooperate with the government, said veteran criminal defense attorney Nicholas C. Theodorou.

“Unfortunately, it’s an art, not a science, in determining when the benefits [of disclosure] outweigh the risks,” said Theodorou, a partner at Foley Hoag. “It really does depend on the facts and circumstances of each case. Some may feel everything must be disclosed, while others feel you can’t trust the government and you should defend. Sometimes the answer is somewhere in the middle.”

Miami criminal defense lawyer Rebekah J. Poston discourages her clients from making early voluntary disclosures.

“The government isn’t hanging a fat enough carrot at the end of the stick,” Poston said. “The government has said disclosure is a factor in deciding against an indictment, but nobody has said it’s a guarantee. A company may ultimately decide to disclose, but I wouldn’t advise doing so until a company has control over the situation and has accurate information. You damn well better know what you are disclosing and make sure you are in control of your own destiny to the best of your ability.”

Voluntary disclosure may enable a company to avoid any criminal penalties and significantly reduce civil penalties that may be imposed, and the government may even decide against taking any action against the company, he noted.

Chicago criminal defense attorney Thomas Durkin offered a bleak assessment of the current context.

“Ultimately, the company refuses to disclose information at its own risk,” Durkin said. “If it voluntarily discloses information as part of a deal with the government to avoid a lengthy and costly investigation, it still opens itself up to potential shareholder lawsuits, when the whole point of disclosure was to avoid long, drawn out investigations that can drain company resources. There’s no clear answer. It may come down to choosing the lesser of two evils.”

Durkin noted that a voluntary disclosure would very likely involve a waiver of attorney-client and work product privileges.

“There’s been a sea change in the attitude of enforcement agencies,” said Durkin, a partner at Mayer Brown and a former first assistant U.S. attorney. “They expect a waiver as part of any plea agreement. This could catch many companies unaware.”

Alan J. Glass, corporate counsel to CIRCOR International in Burlington, Mass., stressed that in-house lawyers have to keep in mind the “business” aspects of deciding on voluntary disclosure.

“Outside counsel is thinking in terms of what does the law provide and what is the government seeking to do,” Glass observed. “In-house lawyers add value by recognizing what is practical from the company’s perspective. You have to bring the business reality to the table.”

A critical consideration, Glass noted, is how competitors will potentially use public knowledge that your company is targeted for criminal prosecution or has engaged in criminal behavior.

“The negative publicity may have such a potent impact that it may weigh in favor of resolving the matter with the government,” Glass said. “You may think you have a solid case and may win, but at what cost? A competitor may run with it and that may cost you some business.”

But even a confidentiality agreement with the government may not protect a company from disclosure of the information in a civil lawsuit, noted Durkin.

“There is a conflicting law on confidentiality agreements with the government,” he said. “A plaintiff’s lawyer can subpoena the information, and a judge has to decide if the company waived the privileges by virtue of turning it over to the government. The prevailing view is that there is a waiver, but it depends on the jurisdiction and which judge rules on the matter.”

Former Massachusetts Attorney General Scott Harshbarger noted that in-house lawyers often have latitude in negotiating with prosecutors.

“There’s a huge amount you can negotiate about,” said Harshbarger, who is now a partner at Murphy Hesse Toomey & Lehane in Quincy, Mass. “Make sure you are not obstructing justice or covering up anything. But at the same time, you don’t have to waive everything. There are good and effective techniques to negotiate what the waiver will entail. You should really try to focus it on what’s really at stake.”

And that means you must get a complete handle on the facts as soon as possible after receiving notice of a government investigation, said former federal prosecutor H. Lowell Brown now practicing in Falmouth, Maine.

“It’s absolutely crucial that you understand as fully as possible what the facts are and what the implication of those facts are,” said Brown, “You have to become smarter, quicker about the case than the government. Once you decide to disclose or not, that completely affects what you do from that point forward.”

Internal Investigations

When investigating alleged criminal activities by employees, in-house lawyers should play a prominent role with the help of outside counsel, according to experts.

Small legal departments in particular should seek assistance from outside lawyers accustomed to working with prosecutors, Glass said. “You just don’t have the time to lead the charge yourself,” he noted.

Poston added: “You never want the fox in the henhouse. In-house counsel should not conduct the investigation, but should definitely be part of the team because they know how the company works and who internally should also be part of the team.”

To avoid internal conflicts and tension, outside counsel can conduct interviews with the key personnel in-house lawyers have been cultivating internally. At the same time, in-house lawyers can inform outside counsel on corporate culture and personalities.

Speed is of the essence, Brown stressed.

“In-house counsel must analyze the subpoena to determine what the investigation is about” he said. The next step is to meet with the prosecutor handling the case to help discern what the government’s concerns are, he advised.

George G. Hardiman, an enforcement attorney with the Massachusetts Secretary of State’s Office, agreed.

“In-house counsel should open up communications with the prosecutor right away to set up a reasonable understanding of what documents are being sought and when they need to be produced,” Hardiman said. “The government always wants more documents sooner than a company wants. Deal with those issues early on and stick to the agreement. It’s helpful in building trust between the attorneys as they work through the problem.”

A company’s document retention policy must be immediately suspended to avoid inadvertent destruction of potentially relevant documents to the investigation, Brown explained.

“You must get control over the documents,” he warned. “You should instruct those departments that may be the custodian of documents directly relevant to the subject matter of an investigation that they cannot destroy those documents in the regular course of business.”

This step helps a company avoid any appearance of obstructing justice and also avoids any negative evidentiary inference that the destroyed documents contained information contrary to the interests of the company, he said.

When conducting interviews of employees, in-house attorneys have to carefully explain that they represent the company, not the employee.

“When I interviewed employees as in-house counsel,” Brown explained, “I would say to them that I was the lawyer for the company, not them, and that the information was subject to the attorney-client privilege for the company, but that it could be waived.”

The fallout if that distinction is blurred, he said, is that the in-house lawyer may have to withdraw from the investigation because of potential conflicts of interest.

Miami defense attorney Dan Small suggested that companies should consider hiring an attorney to represent employee witnesses.

“The problem with the standard language about how the company’s attorney doesn’t represent the employee is that 99 percent of employees don’t have a clue what that means. They just assume their statements are confidential, and they may say things in a loose, casual way,” Small said.

A major benefit of having an attorney represent employee witnesses is that the lawyer can effectively filter out rumors, gossip and exaggerations, Small asserted.

“Lawyers who represent the company are pleased to have that buffer,” he said. “You can get a more accurate and complete statement the first time.”

In some instances, having an outside law firm conduct the entire investigation is preferred because it creates the appearance of objectivity and legitimacy, said Hardiman of the Massachusetts Secretary of State’s office, which is leading one of the investigations of Putnam Mutual Funds.

“An internal investigation conducted by outside counsel that is then reviewed by the government has the perception of being independent,” Hardiman said. “If I was ‘Monday morning quarterbacking’ for the government, I’d look to see if the outside lawyer was allowed to make independent decisions on how to conduct the investigation. The bottom line is that in-house counsel want their outside lawyers to be independent enough so that the government doesn’t view the report as a rubber stamp of a decision by management.”

The need to get a firm grasp on the facts right away was demonstrated in the government investigation of Putnam Mutual Funds, Harshbarger noted.

“Putnam is a good example of how not to respond to an investigation,” Harshbarger said. “For the first two weeks it was just flat out denial. Then the next two weeks they fired the CEO and other key officers. Then after a month, they came to realize if they had just led the way, it might have been determined that the alleged wrongdoing was an isolated circumstance and not reflective of the company as a whole.”

Indeed, it’s often the fear of the unknown that compels a company to acquiesce to government demands, according to Harshbarger.

“The reason these requests from the government are so intimidating is that companies are afraid that the government might be right and they have no way of proving or disproving the allegations,” he explained. “This is where the defensiveness comes in and they cave in right away, just to avoid being in the papers.”

A thorough and speedy internal investigation allows a company to assess its strategy from a position of strength, he said.

Corporate Governance

In light of government prosecutorial priorities, Harshbarger stressed that in-house lawyers can elevate their importance to companies by leading the way in developing and enforcing an effective internal policy on corporate governance and ethics.

“Good governance is good business,” he said. “This is an opportunity to show your company has a comprehensive system of internal governance controls and that you believe in openness, accountability and transparency. The external reality is that your client needs you to play an active strategic role in determining how to deal with these situations and in making decisions before a crisis arises.”

An effective code of internal ethics that encourages compliance and internal reporting can help establish that criminal activities are isolated, rather than a pattern of fraud and criminal behavior, and can also protect against government coercion. “You can say to the prosecutor, ‘come and look at our system. Yes, there was a mistake. Yes, it might be fraud, but not because we ignored it,’” Harshbarger observed.

Michael J. Sullivan, the U.S. Attorney for Massachusetts, indicated his office does look carefully at corporate compliance procedures.

“Good controls in place to prevent fraud from occurring can go a long way from our perspective in exercising our range of discretion,” Sullivan said. “A code of ethics encouraging early detection and reporting throughout the entire corporation is a good starting point. But actions speak a lot louder than words. If you have a good code of ethics but do nothing to audit conduct, that’s likely not to be looked on favorably by our office.

Sullivan also indicated that his office pays particular attention to how a company treats whistleblowers who report a crime.

“We look at how corporations handle internal investigations of whistleblowers,” he said. “Is there a system in place to protect them? Or are whistleblowers ignored, reassigned, demoted or fired as a result of the allegations? How whistleblowers are treated is very important to us.”

* * *

U.S. Attorney’s Message To In-House Lawyers: Come Clean And Get A Better Deal

The Bush Administration has made corporate fraud a top enforcement priority nationwide – and prosecutors in New England have been leading the charge.

The U.S. Attorney’s office in Massachusetts, for example, has been one of the most aggressive districts in the nation when it comes to prosecuting white collar crime, particularly in health care fraud, and is now taking a close look at the market timing and late trading scandal in the mutual fund industry.

“No question investigating corporate crime is a new focus for us and is more intense that in the past,” U.S. Attorney Michael J. Sullivan told New England In-House. “It is a top priority of this office.”

Sullivan is undeterred by criticism by the defense bar that demanding full disclosure of records, including privileged material, is heavy-handed and overbearing.

“We do this case-by-case to get a full appreciation of the defenses available to a company,” Sullivan said. “President Bush has made clear that the Department of Justice should be focused on this area and that allegations of corporate fraud should be appropriately investigated and charges brought where evidence supports that. The willingness to waive privileges rests with target companies. Ultimately, it’s their decision.”

He acknowledged that full disclosure likely means a waiver of privileges: “In order for a corporation to get the benefit of cooperating, some waiver of privilege is going to be required. Complete disclosure provides us sufficient information to make a fully informed decision on evidence of crime by employees.”

Sullivan’s message to in-house lawyers in the region: Come clean and a favorable deal can be had.

“Corporations can benefit from our wide range of discretion [in bringing charges] by uncovering and reporting wrongdoing,” Sullivan said. “My message to in-house counsel is that I encourage them to report wrongdoings. That would go a long way toward their representation of their clients and shareholders and minimizing potential exposure to clients.”

Sullivan warned, however, that once a company decides to disclose information, it must be completely forthcoming.

Falmouth, Maine attorney H. Lowell Brown, a former in-house attorney with Northrop Grumman Corp and also a former assistant U.S. attorney, echoed that point.

“If your company discloses, you must be 100 percent accurate or close to it,” Brown said. “Otherwise, you lose credibility with the prosecution in negotiations. And it could expose the company to prosecution for fraud and obstruction of justice. That’s what you’re in for once you decide to disclose. You’re in for a penny, in for a pound. It’s very difficult to close that door.”

Sullivan has beefed up his white-collar crime unit over the past couple of years by hiring three additional assistant U.S. attorneys and also hiring staff accountants to strengthen his office’s ability to analyze financial data.

Federal investigators in the region have expanded their investigatory powers, according to Boston white-collar criminal defense attorney Nicholas C. Theodorou.

“In-house counsel should be aware that the government has new and expanded tools,” Theodorou said, “such as increased sharing of information among agencies, including the DOJ and [Securities and Exchange Commission], increased expertise in dealing with complex financial and accounting issues, and enhanced computer expertise in tracking and extracting information.”

Questions or comments can be directed to the writer at: [email protected].