From PLI’s Course Handbook
Internal Investigations 2008: Legal, Ethical & Strategic Issues
#14541
6
internal corporate
investigations—anticipating
possible voluntary disclosure
Steven M. Kowal
Bell Boyd & Lloyd, LLP
STEVEN M. KOWAL is a partner in the Chicago office of Bell, Boyd & Lloyd, LLP. He chairs the White Collar Criminal Defense and Corporate Investigations Group, and is a member of the Antitrust and Trade Regulation Department. His practice is concentrated in complex criminal and civil litigation, particularly antitrust and trade regulation, investigations and enforcement proceedings by FDA, healthcare, securities, and business matters. He has successfully defended numerous companies and individuals in many grand jury investigations and criminal prosecutions, as well as civil regulatory proceedings. He also has conducted internal investigations for major corporations. Mr.Kowal is a Fellow of the American College of Trial Lawyers. He has extensive federal trial experience and has prepared criminal and civil appeals in five federal circuit courts of appeals and several state appellate courts. Mr.Kowal has been listed as one of The Best Lawyers in America, recognized as one of the nation’s leading lawyers in white collar criminal defense by Chambers USA, America’s Leading Lawyers for Business, included in the Guide to the World’s Leading Competition and Antitrust Lawyers and the Cross-Border Competition Handbook and listed in Illinois Super Lawyers in white collar criminal defense and antitrust law. Prior to entering private practice, Mr.Kowal was a senior trial attorney in the Antitrust Division of the U.S. Department of Justice where he prosecuted numerous criminal and civil antitrust cases. He received several awards for outstanding performance including the Attorney General’s Special Commendation. He was the chair of the Criminal Practice and Procedure Committee of the American Bar Association’s Section of Antitrust Law from 2001 through 2005. He received two awards from the ABA for Exceptional Leadership in Preparing Policy Comments on behalf of the Section of Antitrust Law relating to proposed amendments to the Federal Sentencing Guidelines for Organizations. He has authored numerous articles and is a frequent speaker around the country on criminal defense and regulatory enforcement issues. Mr.Kowal graduated magna cum laude from St. Procopius College where he was the valedictorian of his class, and cum laude from the Northwestern University School of Law.
INTERNAL CORPORATE INVESTIGATIONS – ANTICIPATING POSSIBLE VOLUNTARY DISCLOSURE
Steven M. Kowal*
Bell Boyd & Lloyd, LLP
Chicago, Illinois
I. INTRODUCTION
Companies conduct internal investigations for many reasons. In the run of the mill case, the investigation may be intended to get to the bottom of some form of employee misconduct in the work place. In more serious situations, the lawful management of the company may be called into question. Often, allegations of misconduct by officers and executives must be investigated to meet evolving standards of effective corporate governance.[1] The investigation will generate the factual information necessary to evaluate potential liability, gain control of problematic conduct and minimize injury. The investigation will allow the company to craft a strategy that will address civil liability, limit or avoid criminal and regulatory sanctions and implement remedial measures. In certain situations, a report that the company has conducted an investigation may buttress investor confidence and enhance market position.
Increasingly, internal reviews are conducted either in anticipation of a formal government investigation or immediately after a government investigation has commenced. In these situations, the government’s prosecutorial policies and practices will have a substantial effect on the design and implementation of the internal review. Unfortunately, the government’s policies strongly encourage disclosure of at least some aspects of the internal review for the company to receive favorable consideration in the government’s exercise of its prosecutorial discretion.
The prospect of such a “voluntary” disclosure places special emphasis on the manner in which the investigation is initiated, designed and conducted. This paper will consider those issues which require particular attention when disclosure to the government should be anticipated.
II. GOVERNMENT POLICIES REQUIRING DISCLOSURE
The United States Department of Justice has issued a series of guidelines delineating the factors to be considered by prosecutors in determining whether criminal charges should be brought against companies. Although the current version of these guidelines does not explicitly require disclosure of information gained through the company’s internal investigation to receive favorable credit, previous versions were very direct. The government stated it would place significant emphasis on whether the company waived its applicable privileges and disclosed information derived from the internal investigation. Many believe the government’s previous guidelines generated a “culture of waiver” which will result in disclosure of privileged information even under the current guidelines.
In 2003, Deputy Attorney General Larry D. Thompson issued a revised set of guidelines for corporate prosecutions.[2] These guidelines identified several factors that prosecutors were to consider in evaluating “the proper treatment of a corporate target” including the nature of the offense, the corporation’s history of similar conduct, the existence or adequacy of a corporation’s compliance program and a corporation’s timely and voluntary disclosure of wrongdoing.
In particular, the Thompson version stressed that a corporation’s “timely and voluntary disclosure of wrongdoing” and its willingness to cooperate in the investigation of its agents including, if necessary, the waiver of corporate attorney-client and work product protections, were factors that influenced the prosecutorial decision. In determining whether the corporation was in fact cooperative, prosecutors were authorized to consider whether the company had waived the attorney-client privilege and work product protections “both with respect to its internal investigation and with respect to communications between specific officers, directors and employees and counsel.”
The issuance and implementation of the Thompson Memorandum caused great consternation. In effect, the government had explicitly stated that the quality of a company’s cooperation was an important factor in determining whether criminal charges would be brought, and the assessment of that cooperation would be influenced by, if not depend on, the decision to waive attorney-client and work product protections and disclose information that had been gained through the company’s internal investigation. This policy raised concerns not only among the defense bar and eventually the United States Sentencing Commission, but also attracted heightened congressional scrutiny.
In response to these concerns, Deputy Attorney General Paul J. McNulty issued revised guidelines in December 2006.[3] The McNulty Memorandum stressed the value of corporate cooperation and advised that, in determining whether to charge an organization, prosecutors should favorably consider the organization’s willingness to disclose information requested by the government including that protected by attorney-client or work product protections. The McNulty Memorandum, however, backed away from the virtual requirement of disclosure that was imposed by the Thompson version. Rather, the McNulty Memorandum states that the government can seek an explicit waiver only in certain limited situations, and even then only with the approval of superiors within the Department of Justice. Nevertheless, the McNulty Memorandum does recognize that companies that “voluntarily” waive the applicable privileges should receive favorable consideration for that decision. Many believe the “culture of waiver” that was generated by the implementation of the Thompson Memorandum will affect decisions under the McNulty policy, and that companies will understand that to receive full credit for cooperation with the government, they will be expected to waive applicable privileges and disclose the internal investigation information.
Policies favoring the waiver of privileges and the disclosure of information are not confined to the Department of Justice. In 2001, the Securities & Exchange Commission used the report of an investigation of wrongdoing at the Seaboard Corporation to set out 13 nonexclusive factors that it would review in determining whether a company deserved reduced penalties for violations.[4] The significance of cooperation was made explicit. One of the factors in the policy focused on whether “the company promptly, completely and effectively disclose[d] the existence of the misconduct to the public, to regulators and to self-regulators. Did the company cooperate completely with appropriate regulatory and law enforcement bodies?”
The SEC Seaboard policy also focuses on whether the company identified the “possible violative conduct with sufficient precision to facilitate prompt enforcement actions against those who violated the law,” and “did the company voluntarily disclose information [the SEC staff] did not directly request and otherwise might not have uncovered?” In effect, the SEC has stated that the company’s decision to uncover evidence of misconduct and present it to the Commission would be a substantial factor in determining whether an enforcement action would be initiated against the company and the amount of the penalty that would be sought.
In this context, a company’s internal review of misconduct that may generate a government investigation, or which already is the focus of such an investigation, must be conducted with the expectation of disclosure to a government agency. This realization will substantially affect the manner in which the investigation is designed and implemented. Without consideration for the potential for disclosure, the company and its counsel may find that they have generated substantial additional problems for the company, its officers and employees and the investigating legal counsel.
III. THE INVESTIGATION SHOULD BE CONDUCTED BY OUTSIDE COUNSEL
An important issue is who should conduct the investigation. A review by in-house counsel would appear to afford certain advantages. The in-house counsel will be familiar with the structure and operation of the company, and may have personal relationships with important executives that will facilitate the flow of information. Unquestionably, such an investigation will control cost.
There are, however, important countervailing considerations. If the government is investigating potential misconduct by senior management, then the credibility of the company’s internal review may be questioned if conducted by in-house counsel. Moreover, the participation of in-house counsel may raise a question of whether the investigation was conducted for business purposes in addition to the legal issues, and create another potential vehicle for compelled disclosure in either criminal or civil proceedings.
If the internal investigation is being conducted to try to persuade the government not to pursue enforcement proceedings, then almost certainly it should be done by outside counsel. The government will be more willing to accept that the investigation was conducted thoroughly and that disclosures are complete.
If the investigation focuses on conduct by senior management, the company may also consider whether special outside counsel should be retained. Such an arrangement will enhance the government’s perception of a credible investigation, and perhaps increase the likelihood that enforcement proceedings can be avoided. The use of special outside counsel will help to eliminate the concern that the company’s regular law firm did not want to ask difficult questions or criticize the management officials who are otherwise responsible for its retention. The use of special outside counsel will raise the cost of the investigation, and may create an unfortunate perception among management and employees that these new lawyers were engaged to find a problem, not merely to investigate whether a problem exists. Nevertheless, if the goal is to place the company in the best position possible to deal with prosecutors and regulators, then the use of such special counsel must be seriously considered.
IV. THE CLIENT MUST BE CAREFULLY DEFINED
At first blush, this would seem to be a relatively straightforward determination. The client is the corporation, and the attorneys conducting the internal investigation owe a duty of loyalty only to the corporation. The American Bar Association’s Model Rules of Professional Conduct Rule 1.13(a) states “A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.”
In practice, however, this becomes a more nuanced question. Counsel conducting the investigation must report to some individual or committee of the company, and the designation of that group is important. If the investigation is focused on possible misconduct by officers or senior executives, the lawyers conducting the internal review cannot be responsive to those officers or executives.
If the investigation is focused on middle or lower level employees, then the investigating counsel can report to the Board of Directors. In those situations where the accounting and financial practices of the company have been called into question, then it would be most appropriate to report to the audit committee of the board. This committee has special expertise to review and assess the accounting and financial practices of the company. Of course, a report to the audit committee assumes that members of that committee are not involved in the subject area of the investigation. If, however, the investigation is focused on senior officers or executives, then it is particularly important for the investigation to be conducted with complete independence and objectivity and to be able to convey that perception to the government. In most instances, this will suggest that a special committee of the board should be formed consisting of independent directors. This structure will enhance the prospect that the investigation will be viewed as credible, and that any recommendations will be implemented effectively.
A recent case has demonstrated the importance of defining exactly who represents the client, and to whom investigating counsel should report. In Ryan v. Gifford,[5] the court reviewed whether the report of investigating counsel resulted in a waiver of privileges. In Gifford, counsel was retained by a “special committee” of outside directors to investigate the possible backdating of stock options. Some of the members of the Board of Directors were a focus of the investigation. Nevertheless, investigating counsel delivered its report to the full Board of Directors, rather than just to the special committee. In addition, the individual lawyers for the suspect directors were present for the investigating law firm’s presentation.
The court focused on this disclosure as one basis to conclude that the attorney-client and work product protections related to the investigation had been waived, and that all of the information obtained during the investigation must be disclosed in related civil litigation. Basically, the court held that the disclosure to members of the Board of Directors, rather than just to the special committee, included individuals who did not have a common interest with the special committee. Accordingly, the requisite confidentiality had been waived.
If a special committee is appointed, then its authority should be established by a resolution from the board. In addition, the special committee should be authorized by the board to retain counsel and any additional professionals that may be necessary to conduct the investigation efficiently and effectively. This could include, for example, forensic accountants and electronic discovery consultants.