Neither A Whitewash Nor A Witch-Hunt Be: Reclaiming The Independence Of Internal Investigations
By Michael Levy, Amy Carpenter-Holmes & Michael Spafford
What is the purpose of an internal investigation? An observer who has been listening to recent discussions of the practical requirements of internal investigations in today’s regulatory climate might conclude that the sole purposes of an internal investigation are (1) to demonstrate absolute and uncompromised cooperation with the government and (2) to uncover “the fraud.” Unfortunately, somewhere between the government’s rush to punish perceived rampant corporate wrongdoing and corporate America’s understandable desire to avoid becoming another Arthur Andersen, the very simple purpose of an internal investigation—to investigate with true independence—has been lost.
The ultimate purpose of an internal investigation is to uncover the facts, whatever they may be. To realize this objective, a neutral investigator must conduct a thorough, thoughtful inquiry, considering all relevant factors and following all valid leads, to come to an independent assessment. Fraud must be identified without hesitation even when it reaches to the highest levels of a company. On the other hand, if accusations of wrongdoing are not well-founded, they must be rejected no matter how much pressure to find wrongdoing may exist.
The current enforcement environment should not be allowed to distort the fundamental purpose and independence of an internal investigation. An experienced investigator, however, also will recognize that, now more than ever, internal investigations are not one-size-fits-all. Internal investigations must be carefully tailored to the unique circumstances of each matter, and internal investigators must remain flexible enough to respond to changes in those circumstances. When all is said and done, law firms conducting internal investigations must be committed to wading through all the increasing pressures and competing interests in order to come to a truly independent assessment of the facts at issue.
On Fraud, Culprits, and Cooperation
In the wake of an internal investigation at Enron in August and September of 2001 that many viewed as overly narrow, prosecutors throughout the country became increasingly skeptical not only of narrowly constrained internal investigations performed by lawyers too closely aligned with the matters being investigated, but also of any investigation—whether truly independent or not—that did not root out purported wrongdoing. Responding to Enron’s collapse, the President of the United States proclaimed a pandemic of fraud in corporate America and swiftly committed significant resources to the eradication of corporate corruption, creating the Corporate Fraud Task Force (“Task Force”).
On January 20, 2003, in the midst of this declared war on corporate corruption, Deputy Attorney General Larry D. Thompson issued his “Principles of Federal Prosecution of Business Organizations” (the “Thompson Memorandum”) setting forth the factors federal prosecutors must weigh when deciding whether to seek an indictment against a company. “The main focus of [the principles set forth in the memorandum] is increased emphasis on and scrutiny of the authenticity of a corporation’s cooperation” with prosecutors.
Less often discussed, but in many respects even more significant, is the fact that the Thompson Memorandum presumes fraud. This presumption is reflected in, among other things, the memorandum’s numerous references to “the culprits” and its reminder that a corporation’s willingness to “support culpable employees and agents” by paying their attorney’s fees, retaining them as employees, or entering into joint defense agreements with them, weighs against receiving credit for cooperation. Thus, notwithstanding the fact that companies cannot function if their employees are too intimidated to focus on their jobs, the Department of Justice (“DOJ”) provides a powerful incentive for a company at the outset to treat any employee involved in an internal investigation just as the Thompson Memorandum does—as a “culprit.”
The impact of this aggressive new posture has been dramatic and widespread, and the impact on internal investigations has been particularly noticeable. Once fraud by “culpable” employees is presumed, any cooperation by the company that does not result in uncovering that fraud and identifying those guilty parties becomes suspect. The pressure to uncover fraud becomes almost unavoidable. When meeting the government’s expectations of cooperation becomes paramount to the survival of the company, satisfying the government can easily threaten to take precedence over the fundamental independence of the investigation.
Identifying an Investigatory Approach
The essential goal of an internal investigation is to evaluate allegations of corporate wrongdoing effectively, efficiently, and independently. Returning to this purpose does not ignore the reality of the current regulatory environment or diminish the importance of reasonable cooperation with the government; it simply shifts the focus back to the task at hand. Neither a desire to deliver a clean bill of health to a profitable, long-time law firm client nor the desire of regulators to find fraud should drive an internal investigation. Regulatory pressures and the current environment are but two factors amid the multiple considerations that must go into appropriately staffing, structuring, and conducting an internal investigation.
An investigation should provide the information necessary for the company to make well-informed judgments and, when appropriate, engage criminal or regulatory authorities with a complete, objective view of the facts. This starts, of course, with determining what happened and why and, depending on the nature and scope of the investigation, may further include determining whether, in the opinion of the independent investigator, any laws, regulations, or internal corporate policies were violated. If there were violations, the internal investigator almost certainly will want to address who is responsible and how similar issues can be prevented in the future, including, when appropriate, making recommendations for changes in corporate governance, controls, and the compliance function.
Achieving these goals will require an independent investigator to consider at the outset a number of issues, including:
1. Who Should Serve As Counsel For the Investigation and Who Is the Client?
One of the first decisions in conducting an internal investigation is whether the investigation should be handled by in-house attorneys or outside counsel. While truly self-regulatory investigations traditionally can be and have been handled by in-house counsel, in the current environment it is generally the wisest course of action to engage outside counsel for any investigation that has even the potential to garner interest from government enforcement agencies. If outside counsel is desired, the question becomes whether to rely on a company’s regular outside counsel or a law firm unrelated to the activities at issue. Using counsel familiar with the company’s structure and the matters at hand allows the investigation to move more quickly and economically because the investigator does not need to spend time getting up to speed. This may be particularly tempting when the subject of the investigation is highly technical or specialized.
Considerations of expense and efficiency may prevail when the company is confident that the scope of the investigation is unlikely to expand to areas of interest to government enforcement agencies. In the current enforcement environment, however, choosing an outside law firm with no prior involvement with the transactions or matters at issue is almost always the preferred course of action for any investigation involving an area of potential governmental scrutiny. The need for truly objective, unaffiliated, independent investigators is particularly strong for investigations involving significant financial concerns or the actions of senior management.
The investigator, whether in-house counsel or outside counsel, then must understand who the client is. Because in most circumstances any investigation involving potential legal or regulatory violations should be independent of company management, the client generally should be an independent committee of the board of directors, a role often fulfilled by the audit committee of the board. Of course, if the allegations are significant or have the potential to implicate the audit committee or the board, the company would be well advised to establish a special committee of the board consisting solely of newly-appointed independent directors who can act without any suggestion of a conflict of interest.
2. What Is the Nature and Scope of the Investigation?
It is critical that the scope of the investigation be determined by neither a client nor an investigator who was involved in any way with the subject matter of the investigation. Rather, an independent investigator and an autonomous client must consider the nature of the allegations and work together to establish the initial scope of the investigation. Are the allegations of a self-regulatory nature or do they indicate potential fraud or violation of some other law or government regulation? The nature and subject matter of the allegations usually will define the scope of the investigation, as well as who the investigator will interview and what documents the investigator will review first. While it is essential to define the scope of any internal investigation at the outset, any independent investigator must be encouraged to seek expansion of that scope whenever he deems it necessary—particularly in matters involving potential fraud or other legal or regulatory violations.
3. How Can Counsel Best Obtain the Facts?
An investigator gets facts from two primary sources: documents and employees. In order to review and analyze all relevant documents, an investigator first needs to freeze the company’s document retention policy and communicate this change in policy to all relevant employees. An investigator then needs to establish a protocol for the collection and review of documents, as well as decide whether it is necessary to hire outside experts, such as forensic accountants, to help analyze these materials. With the explosion of electronic mail and other electronic records, the task of gathering all relevant materials, and then reviewing and analyzing them, requires significant technological and organizational skills in addition to the traditional skills of legal analysis and judgment.
Even if an investigator has easy access to all relevant documents, however, a complete investigation is only possible when employees are candid and forthcoming with information. The challenge for the investigator is how best to encourage such cooperation. An investigator needs to communicate forthrightly with employees regarding the investigation, including how it will impact their work, what is expected from them, and whether and how the company plans to provide counsel for its employees.
4. Should the Company Pay for Counsel for Employees?
An investigator’s access to employees will be influenced materially by the company’s decision whether to provide counsel to its employees at the company’s expense. In making this decision, the company will necessarily face a number of considerations in addition to the Thompson Memorandum, including the company’s own bylaws, indemnification agreements it has with its employees, and any applicable laws—all of which may require the company to indemnify and advance the payment of employees’ attorneys fees.
Even in the absence of such requirements, and even with the Thompson Memorandum, it may still be in the best interests of the corporation to advance the payment of legal fees for counsel to represent certain employees. The decision whether to advance employees’ legal fees depends on many factors, including the nature of the allegations, the likelihood of government interest in the matter, and, if the government is already involved, whether the company reasonably expects that it will waive its privilege and provide information gathered from interviews of company employees directly to the government. Contrary to what some might assume, providing counsel for employees usually increases the efficiency and completeness of an investigation. An internal investigation is a stressful and anxious time for employees. Talking to an investigator can seem intimidating, and even the most well-intentioned employees do not always know how to be most helpful. Providing counsel to represent the interests of employees often makes employees more comfortable speaking with investigators and allows them to focus on their work while their lawyers focus on the investigation. Providing counsel also may be an important incentive for employees to stay with the company during a critical time.
5. What, If Anything, Should the Company Disclose and When?
Once the investigator has made a truly independent assessment of the facts, the company may face difficult decisions surrounding disclosure. Of course, these decisions may have been pre-empted if the government already knows of the investigation and real-time disclosure is the price of the government delaying the commencement of a full-scale government investigation. Assuming the government is not yet involved, however, disclosure decisions can be made only after the investigator has had a full and fair opportunity to assess the facts and advise the client about their implications. Furthermore, the company must reassess disclosure decisions as additional facts are learned. It is important for the company to disclose to its regulator what it knows as soon as practicable, but only if there is actually something to disclose. The company, advised by its counsel, must engage in a very delicate balancing act between disclosing as early as possible and taking the time necessary to learn what really happened. Even once a decision to disclose has been made, the company must consider the thorny questions of how to communicate the disclosure and whether it is possible to disclose without waiving the attorney-client privilege or attorney work product immunity.
Every internal investigation is different. Each poses unique challenges. An experienced investigator will recognize that not all begin the same way or progress the same way. Nor should every internal investigation—even in today’s environment of cooperation—be expected to come to any one particular conclusion.
The last four years have seen dramatic changes in how the government addresses alleged corporate fraud. Yet the fundamental purpose of an internal investigation cannot be sublimated to any external factors, whether they be a desire to placate a desirable law firm client or a desire to satisfy the DOJ by starting an investigation with the Thompson Memorandum’s presumption of fraud.
The purpose of an internal investigation is best served if the facts are uncovered and the process respected, no matter what the conclusion. It is the independence and thoroughness of an internal investigation that will allow a company to be confident it has uncovered and addressed fraud when it exists and, likewise, to set aside baseless complaints when fraud does not exist.
To accomplish that end, an independent investigator must conduct a thorough, well-planned investigation that is sensitive to, and respectful of, the needs and limitations of the company as well as any expected demands from regulators. It is incumbent upon the law firms conducting internal investigations to balance these pressures and competing interests in order to conduct a thorough, thoughtful, efficient, and, most importantly, independent investigation. An investigation must be committed to finding the facts, and internal investigators must jealously guard their independence. An internal investigation best serves the interests of the company, its employees, its shareholders, and the government when it neither presumes fraud nor gullibly declares innocence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
The piece was originally published in a 2006 McKee Nelson newsletter.
The innocent need able legal representation in criminal matters perhaps even more than the guilty. In addition, defense costs in investigations and prosecutions arising out of complex business environments often are far greater than in less complex criminal matters. Counsel with the skills, business sophistication, and resources that are important to able representation in such matters often are more expensive than those in less complex criminal matters. Moreover, the need to review and analyze frequently voluminous documentary evidence increases the amount of attorney time required for, and thus the cost of, a competent defense. Thus, even the innocent need substantial resources to minimize the chance of an unjust indictment and conviction.
United States v. Stein, No. S1 05 Crim. 888 (LAK), slip op. at n. 13 (S.D.N.Y. June 26, 2006).