New England Biz Law Update
Phew! It appears the wave has crested on those pesky (and expensive) options backdating investigations.
But before we bid farewell to the government investigation de jour, it is worth spending a few minutes to reflect on what can be learned from these investigations so that in-house counsel will be prepared when the next wave of investigations comes along. In representing upper level managers at six companies involved in backdating investigations over the past year, I have observed some common issues and lessons emerge from these matters.
In-house counsel at the many New England companies caught up in backdating probes were concerned with at least three separate issues relevant to most governmental inquiries.
First, in-house counsel will almost always be involved in retaining outside counsel to conduct an “independent” investigation. How is this firm selected? Should the company’s corporate outside counsel be chosen? Or should a separate firm be hired? To whom does the firm report?
Second, general counsel has to be concerned with how the company will deal with the representation of present and former employees who are involved with the investigation. Should they have their own counsel? Can one attorney represent several employees? Should the company advance legal fees to the employees?
Third, what is the role of general counsel throughout the internal investigation in advising the CEO, the board of directors and the audit committee and coordinating with outside counsel?
Each of these issues is address below.
Hiring outside counsel
Your company’s CEO, board of directors and regular outside counsel must all be notified if your company receives a subpoena from the government, or has been listed in a statistical analysis of companies suspected of backdating, or an employee has raised concerns.
If the board decides an internal “independent” investigation is needed to learn more about what happened and assess potential liability, the company (by way of an independent committee of the board) will need to hire outside counsel to conduct the investigation. Often, the independent committee will look to in-house counsel to recommend the counsel to lead the investigation. You, in turn, will look to outside counsel for advice. our outside company counsel (the relationship partner who often has little experience in dealing with government investigations) will usually bring in one of the firm’s partners (typically a former federal prosecutor) to help advise the company on dealing with the government investigation (e.g., responding to subpoenas, and representing the company in negotiations with the government).
They will also usually provide advice on who should conduct the independent investigation on behalf of the independent committee of the board. Typically, they will recommend a former prosecutor at another law firm to conduct the investigation on behalf of the independent committee.
Recently, however, there has been a trend for the company’s outside law firm to also take on the role of conducting the internal investigation (sometimes in conjunction with another outside law firm acting as so-called “shadow counsel.”).
Who conducts the independent investigation is an important decision for the company. The paramount consideration is to hire a lawyer who can conduct a truly independent investigation. Otherwise, governmental authorities and investors may be skeptical of the committee’s findings. While it may be tempting to use your company’s longstanding outside law firm because of familiarity and trust, this may not be the wisest choice.
For example, in options backdating investigations, outside counsel was often the company’s counsel at the time of the conduct in question. This means the firm may have drafted the stock option plan, advised on options issues, and may even have responded to questions about the dating of options.
If the company’s outside law firm also represents the independent committee in conducting the internal investigation, the potential for an actual or perceived conflict of interest is substantial.
It is certainly not improbable that someone at the company consulted with outside counsel regarding the dating of stock options. The attorney for the independent committee may very well need to investigate what legal advice was given to the company.
Obviously, investigating one’s own partners is problematic. Even if outside counsel did not give legal advice and there is not an actual conflict, using the company’s main outside counsel can create the appearance of a conflict, as well as the appearance of circling the wagons to protect the relationship partner.
In addition, a government regulator or the shareholders may find it hard to believe an attorney from the company’s longstanding law firm will ask tough questions of upper level management. The relationship partner is the trusted advisor of the company and presumably has a close relationship with upper level management. Can a partner of the relationship partner confront the CEO, CFO, or general counsel about their knowledge of option backdating? Is it reasonable for a regulator to presume that the investigating partner pulled punches and did not want to uncover problematic conduct on the part of the CEO?
In dealing with the SEC and shareholders, purity is important – the company will not want anyone to question the independence of the investigation.
Dealing with employees
You may have to make some difficult decisions relating to upper level management, both past and present. Should you recommend that upper level managers retain their own counsel? What should general counsel do when an upper level manager asks if they need their own counsel? Do you recommend an attorney to represent the manager? Do you want one attorney to represent a group of similarly situated managers? Does the company advance legal fees for the managers?
For example, outside counsel who has commenced the independent investigation may want to interview the CFO. The CFO wants to know if he should have his own counsel and comes to you for advice as you have worked together for a long time and are friends.
Unfortunately, your friendship cannot be part of the equation. Your duties lie with the company and you should be taking direction from counsel for the independent committee. You must tell the CFO he needs to make that decision on his own, and that he should be speaking with counsel for the independent committee for guidance.
A tricky question is whether you want a group of employees to be represented by the same counsel. The answer largely depends on the facts and the comparable roles of the employees. It is no doubt in the company’s financial interest to have as few attorneys as possible get up to speed on the case. However, if there is a conflict between two employees, a new attorney will have to be brought in for one or both of the employees.
Usually, the company agrees to advance to the employee the cost of reasonable attorney’s fees, provided the employee signs an undertaking to repay the costs if it is later determined the employee was not entitled to indemnification. Although the company often has some discretion as to whether it will advance fees, the conventional wisdom is that advancement of fees is in the company’s best interest since it wants its employees to get the best possible counsel without the financial pressure of having to pay for it themselves.
The company often has the ability to recommend attorneys to represent its employees, who will look to you for a recommendation. In making this recommendation, you should consult with the attorneys from your outside law firm, who will be dealing with the attorneys for the employees on a host of issues. It is in the company’s best interest to be dealing with attorneys for its employees and managers who have experience with these types of cases.
Role of general counsel in investigation
The role of general counsel in these situations will vary depending on the circumstances. You will usually not be an active participant in the internal investigation. Counsel for the independent committee reports to the committee, and does not work for you or any member of management.
Your role with respect to the internal investigation is more logistical than substantive. This puts you in a somewhat difficult position. As the company’s counsel, you will be involved with strategic decisions as to how to deal with the governmental investigation and with employees who were involved in questionable conduct.
Yet, you may not have direct access to the source of information that will be necessary for the management team to make its decisions. Your lifeline is the company’s outside counsel (most likely the former federal prosecutor who is working with the relationship partner) who will be the point of contact and conduit for both counsel for the independent committee as well as the government attorneys.
Jonathan L. Kotlier is a partner at Nutter, McClennen & Fish and is a member of its government investigations and white collar crime practice group. Many of his current clients are companies and individuals who are being investigated by the SEC. Prior to joining Nutter, he was a federal prosecutor in the U.S. Attorney’s Office in Boston for 12 years, the last eight of which he served as Chief of the Economic Crimes Unit. He can be reached at [email protected]
