Growing numbers of in-house lawyers have reason to fret they might find themselves in the crosshairs of a criminal or civil fraud case. Over this past year, 11 general counsel (a record number) have been charged with civil or criminal fraud by the Department of Justice and the Securities and Exchange Commission.
Some targets were caught in the options backdating dragnet, and others came under scrutiny for failing to report accounting irregularities. Some counsel for financial service companies may yet be trapped in predatory lending investigations.
The exposure is particularly grave for lawyers wearing compliance hats – as shown by the recent multi-million dollar False Claims Act charges against Christi Sulzbach, the former GC and compliance chief of Tenet Healthcare, who “blessed” certain contracts with referring physicians that allegedly violated highly complex anti-kickback regulations.
Many experts say the trend will continue.
“These actions are not warning shots – it’s open season on in-house counsel,” said Charles A. Ross, a former prosecutor who defends white-collar criminal cases for Ross & Associates in New York City. “The regulatory and prosecutorial scrutiny of lawyers is higher than ever… [and] I see no sign of this abating.”
Sarah R. Wolf of Chicago, who heads up securities litigation and enforcement practice at Reed Smith, said lawyers are “in the hot box” because Sarbanes-Oxley essentially turned them into “gatekeepers” for corporate governance and public reporting.
“Speeches from the SEC Enforcement Division have made it clear that in-house lawyers, directors and auditors are targets [because] they’re particularly responsible for public disclosures now,” she said.
Lawyers have been hit by “a pendulum swing in corporate criminal thinking after the demise of Arthur Andersen,” according to Kelly B. Kramer, of Nixon Peabody’s government investigations and white-collar crime group in Washington D.C.
Prosecutors, Kramer said, don’t want to “kill” another company and put thousands of employees on the street. Instead, “The attitude now is: ‘We are not here to get the company; we’re here to get the bad guys, and the lawyers better not be helping the bad guys.’”
Because of the “gatekeeper effect,” lawyers now face potential exposure, not only for participating in a fraud or cover-up, but for failing to diligently detect one, prevent it or take steps to report it to shareholders and the SEC.
“The company and its lawyers are in an awkward relationship once a government investigation begins [so] it pays to have a robust compliance function and an ethics ‘hot line’ to detect problems quickly,” said Joseph Papelian, deputy general counsel of litigation for Delphi Corp., which in 2004 disclosed and corrected improper accounting for credits from suppliers, various warranty claims and certain post-retirement obligations.
Experts agree effective compliance programs can help to keep both companies and their lawyers out of trouble, but they warn that prosecutors take a dim view of “paper programs” full of platitudes and that lack meaningful detection and enforcement mechanisms.
“The government knows the difference between an ethics and compliance program that is a Potemkin village and one that is the real thing,” said John P. Hansen, a director for the Ethics & Compliance Officer Association.
In-house attorneys facing a government probe now must be wary of personal exposure “traps” related to document retention issues, witness interview procedures and various reporting obligations, defense attorneys said.

Lawyers caught in the middle

Many in-house lawyers have been caught in a cross-fire between senior managers who accuse them of being “roadblocks” and government prosecutors and regulators who are holding lawyers accountable for corporate legal compliance.
“Now more than ever, you must realize you are a lawyer for the corporation first, and you are not supposed to cater to individuals,” said Nicholas C. Theodorou, chair of the business crimes and government investigations group at Boston’s Foley Hoag.
“The lessons from the cases we’ve seen are that you can’t wander beyond the bounds of rendering legal advice [and] lawyers have to learn to say ‘no’ again,” Theodorou said.
Recent public pronouncements by the SEC’s Director of Corporate Finance, John White, amplify Theodorou’s perspective.
Commenting on the inadequacy of recent executive level disclosures, White said some in-house lawyers “have lost sight of their role,” warning them that “your client… is not the CEO, not the CFO, not any other member of management and not the board either.”
Thomas Cranmer, who handles white collar criminal defense and complex litigation for Michigan-based Miller Canfield, said in-house counsel’s new “watchdog role puts them in a much more difficult position than ever before.” He added that counsel must also understand “they have become targets [in part] because they’re the pressure points for erasing attorney-client privilege when the government wants someone to give up the bodies.”
In-house lawyers face just as much exposure from internal pressure to “sign off” on matters of questionable propriety, said Kramer, pointing to the KPMG case. KPMG’s management showered its tax lawyer-accountants with internal e-mails pushing them to approve of tax shelters that proved to be illegal, Kramer noted.
“The pressure to say ‘yes’ can push lawyers too far,” he observed, “but they can’t let themselves be pushed into saying, ‘This might be viewed as illegal or fraudulent, but it presents a relatively low risk for getting caught or prosecuted.’”
Theodorou noted that some lawyers got caught in options backdating scandals because company managers pushed too hard to avoid accounting charges for executive compensation resulting from beneficially priced options tied to shares priced retroactively.
“There were senior executives who said, ‘Make sure the auditors don’t know about this,’” Theodorou said, adding that failures to make disclosure to board members, audit committees and shareholders can all get counsel in hot water.
Cranmer pointed to the federal law (18 U.S.C. §1001), which prohibits misleading federal agents, as one of the major “trip wires” for in-house lawyers now. “In-house lawyers can be charged as aiders or abettors if they assisted in misleading actions, [and] they are high on the ‘hit list’ now, along with directors and auditors,” he said.
“Recent cases have shown that some lawyers just don’t understand that there is no ‘good soldier’ defense for acting under orders,” added Wolf, who also noted that SEC Chairman Christopher Cox has explicitly warned lawyers that they may have to “walk the plank” to fulfill their professional responsibility.
“The days of cozy relationships with management may be over for business lawyers,” added Ross.
He pointed to the “noisy withdrawal” rules proposed by the SEC – which would have required lawyers to withdraw from representation rather than remain silent about a fraud – as affirmation of this view. “This is a factor in targeting counsel [and] that makes it more dangerous than ever to walk the line between company executive and independent adviser,” he said.

Staying out of trouble

Experts made several suggestions for avoiding the widening prosecutorial dragnet – focusing on the need for independent and objective judgment in matters of compliance and disclosure.
“Sometimes it’s hard to predict how a prosecutor will view a corporate decision that is arguably in the ‘grey’ area of complex accounting or regulatory rules,” Ross said, “but it is much easier to convince [the prosecutor] that the decision was made in good faith if you sought the opinion of truly independent counsel.”
Kramer advised that in-house counsel should especially seek independent review of any option backdating or compensation decision that could affect them personally.
“It is now a matter of self-preservation to get independent substantiation that you have a good faith argument for what you are doing, especially in the grey areas,” he asserted.
Others noted that in-house compliance efforts and codes of business conduct could help demonstrate the good faith of responsible individuals, in addition to helping their corporate clients in the charging or sentencing phase of a criminal action.
Papelian said an “ethics hot line” is critically important, noting a number of companies that have failed to act on internal reports of whistleblowers on fraudulent or criminal activities, such as Enron, WorldCom and HealthSouth.
He added that hot lines should be staffed or at least monitored by outside professionals “who will not be swayed by management,” and warned that investigations should never be handled or influenced by a department subject to an investigation.
“If you do find something serious, like a possible FCPA [Foreign Corrupt Practices Act] violation, then you should go directly to the CEO and ask him to command an independent legal investigation and review,” said Papelian.
Kramer said hot lines, self-investigation and self-reporting are important for establishing “effective” compliance programs, as defined by the U.S. Sentencing Commission. “There has been much litigation over cases where people made noises and there was no vetting of their claims,” Kramer said. A “mere ‘paper’ compliance program with no real resources and no mechanisms for reporting or investigation should be avoided because it simply compounds a fraud,” he added.
Cranmer suggested that compliance programs be kept separate from the legal department “because lawyers have enough difficulty being viewed as ‘cops’ already.”
While companies handle legal and compliance overlays in different ways, Hansen said “the independence of the ethics [and compliance] officer is critical. When the general counsel wears both [legal and compliance] hats, there is the potential for a conflict between the roles.”
(Tips on ethics and compliance can be found at www.theecoa.org.)
Ross said many public companies are hiring former prosecutors and judges as vice presidents in charge of separate compliance functions for this reason. He added that a compliance program can be done cost-effectively “with a simple communications plan and leadership focus.”
In-house lawyers should follow Sarbanes rules and so-called “Seaboard” rules issued by the SEC to guarantee proper “up-the-ladder” reporting of compliance issues to the board of directors and audit committee, according to Wolf.
She added that “soft-pedaling” to the board and audit committee about the dangers of any financial discrepancy or regulatory transgression could mean trouble for lawyers.
“You can expect some shareholder actions as well after a criminal charge because plaintiffs will argue they were harmed by a breach of fiduciary duty,” Wolf said.

After the whistle blows

Experts suggested ways to avoid the prosecutorial line of fire once a material legal violation has been discovered or the government has initiated a case against your company.
They especially stressed that relevant and material evidence should never be withheld from the audit committee, the board of directors, or a government investigator, regardless of a boss’s orders.
“You should not take any action that could be construed as facilitating a cover-up, and you need to keep all relevant documents preserved,” said Theodorou, adding that “you risk a charge of anticipatory obstruction if you start playing cute with your document retention policy.”
Papelian added: “You need to send out a search-and-hold memo, and you need to take the correct procedural steps to back up computer data and metadata to avoid any spoliation claims under the new electronic rules of evidence.”
Ross said that “in gathering the company’s story, it is particularly important to be wary of potential employee allegations that they were ‘pushed’ to say something, as that could be suborning perjury. For that reason, it may be necessary to interview witnesses one at a time, away from management, and to have another [independent professional] there as a witness.”
Wolf said in-house lawyers are often in the gravest period of danger once the investigation process begins because “prosecutors may view lawyers as actors and not advisers if it looks like a whitewash or cover-up has taken place.”
She added that because in-house lawyers have other exposures associated with witness interviews, they should also warn witnesses that they do not represent them and cannot invoke attorney-client privilege on their behalf.
Papelian suggested that in-house counsel periodically supply interview summaries and updates to the audit committee.
He also advised that the committee should take over investigations involving senior management. Papelian cautioned that the committee should not take “the easy solution” of firing people who appear to be responsible without providing for some due process to hear their side of the story.
“There are potential attacks by the government, the shareholders and by lawyers for the accused employees,” said Wolf. “Audit committees and even in-house lawyers are hiring their own counsel to get third-party opinions because the need for objectivity and independence has become so paramount.”

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Insurance may protect in-house lawyers in criminal actions

Criminal and regulatory actions can present tricky coverage issues affecting in-house lawyers, according to Donald Glazier, coverage and claims counsel for Integro Insurance Brokers.
“It is prudent to have an independent opinion of counsel to show [a lawyer’s] good faith in actions taken in the grey areas,” Glazier said. Such an opinion can possibly help a lawyer, or other individual, who is defending a government criminal charge that requires proof of the actor’s intent.
Glazier said three main protections are available to in-house lawyers to help them sleep at night: company indemnifications; director and officer (D&O) insurance policies; and employed lawyers coverage.
“The D&O policy only covers a lawyer if they are an officer, and only when they are acting as an officer, unless you can obtain specific schedules of coverage for your unique role as in-house general counsel,” said Glazier, who is based in Chicago.
Because general counsel now face many of the same exposures as directors under Sarbanes-Oxley rules, it is important for the company to cover its in-house lawyers to the same extent it does other executives under any indemnity or insurance policy, Glazier added.
“It is a good idea to ask about A-side coverage too, [which is] non-indemnifiable coverage that is commonly given to directors and which survives company bankruptcy and is renewable for the individuals,” he said.
Glazier suggested that separate-employed-lawyer coverage is important to have because “the limits of coverage from D&O could be depleted by multiple claims of other officers.”
Glazier also pointed out that coverage issues may arise on whether a lawyer was acting as a lawyer or an executive when accused of any misconduct by the government or by private plaintiffs riding the heels of a government case.
“You also have to be careful about exclusions for fraud or criminal acts, and possible exclusions as to payment of fines or penalties, which may be required by state law,” he cautioned.
“These are tough times for lawyers, and the primary goal of any coverage they obtain should be to pay for a successful defense of the actions they take, and that alone can cost millions of dollars,” Glazier said.