In Internal Investigations, Cooperation Is Key

In the wake of well-publicized corporate failures and the heightened responsibilities imposed on corporations, their officers, directors, and professionals by the recently enacted Sarbanes-Oxley Act, internal investigations have been pushed to the forefront of corporate representation. Cooperation among corporate employees, in-house attorneys and outside counsel has never been more critical and can have a direct impact on the efficacy of internal investigations, the continued success of the business, and potential corporate and individual liability.

Issues arise involving the attorney/client and work product privilege, the "up the ladder" reporting rules promulgated by the Securities and Exchange Commission (SEC) pursuant to the Sarbanes-Oxley Act, and the SEC's proposed "noisy withdrawal" rules. This article discusses the potential benefits of timely and effective internal investigations and strategies for effective cooperation between in-house and outside counsel. It also highlights issues and recent developments relating to privilege and professional responsibility paramount to all who participate in internal investigations.

When a corporate manager or in-house lawyer learns of potential wrongdoing, whether identified by management or outside auditors, through an employee complaint, or through notice of a governmental investigation, the first thought that should come to mind is "let's investigate this ourselves so that we know what we're dealing with."

Early investigation provides important information, and prompt and effective investigation and redress of suspected wrongdoing can help minimize its impact, legally and from operational and investor and public relations standpoints. Demonstrable good faith efforts to identify and redress potential wrongdoing, and the provision of information obtained through internal investigations to governmental entities, may mitigate potential sanctions. Demonstration of these same good faith efforts to analysts and investors also can help minimize potential injury to the company's public image and standing in the markets.

Internal investigations can effectively uncover misconduct such as employee theft, corruption or misappropriation, or misallocation of corporate funds. They also can provide important advantages where individuals may have claims against the corporation, such as for discrimination¹ or personal injury. However timely and thorough, internal investigations present the greatest potential benefit where suspected conduct may give rise to governmental investigation and prosecution. Prompt, effective internal investigations may allow corporations to quickly identify and stop wrongful conduct, avoid future injury and eliminate potentially cumulative liability.

In addition, guidelines promulgated by the U.S. Department of Justice (DOJ), the SEC and the NASD state that prompt investigation and remediation of suspected wrongdoing, especially prior to a governmental investigation, should be considered when decisions regarding potential prosecutions and sanctions are made. Each entity specifically considers a company's willingness to share internal investigation results and waive privileges when making such decisions.²

Although certain investigations may properly be conducted by in-house counsel, investigations of serious or large scale wrongdoing - especially where the suspected conduct implicates systemic problems, could give rise to substantial liability, or involves issues requiring technical expertise beyond that possessed by in-house counsel - should be conducted at least with the assistance of outside counsel. Where investigations are overseen by an audit committee, it is critical that the committee engage independent counsel who, in turn, may retain forensic accountants and other independent professionals. Engagement of outside counsel brings additional expertise and resources, reduces the influence of management which might, in fact or appearance, compromise the investigation, and adds credibility and objectivity to its findings.

Early Stages

Engagement of outside counsel does not, however, mean that cooperation and coordination with in-house counsel, managers and other employees is not essential to the success of an investigation. In-house lawyers and management have institutional knowledge that is invaluable to investigators. Management and in-house attorneys must take essential first steps and ensure that outside investigators receive full cooperation from company employees and professionals.

Outside investigators must be sensitive to potential disruption of operations, must take all reasonable steps to minimize the impact of an investigation on productivity and employee morale, and must work closely with company personnel to understand the company's business, the nature of the suspected problem, and any legal and operational implications specific to an industry, firm or incident. Therefore, while it is important that outside investigators maintain both actual and apparent independence, their relationship with company officials, including attorneys, should not be adversarial.

It may be necessary to take emergency measures to halt improper conduct and/or prevent future harm to the company, its employees, clients/customers or investors. These steps may include implementation of new policies or procedures, discipline, public disclosure or legal action including injunctive actions. In-house attorneys and managers must quickly identify the need for such action and communicate it to outside counsel. Outside counsel must cooperate on a basis sufficient to put in place necessary protections without compromising, in fact or appearance, the independence of the subsequent investigation.

Once necessary steps have been taken to prevent ongoing or future harm, the first and often most important step in any investigation is the preservation of information. This includes paper and electronic documents and voicemail messages, and may include physical objects such as product samples. Many companies have document retention policies providing clear rules for the retention and destruction of documents.

It is more important than ever that every company implement such a policy and that employees be reminded of it at regular intervals. Attempts to inform employees of these policies after concerns arise are less effective, and may be misinterpreted by plaintiffs' attorneys and government investigators. Policies should be reviewed and, if necessary, revised periodically, and periodic reminders should be sent to employees concerning their contents and any changes.

As soon as a complaint is received or a questionable practice is suspected or discovered, in-house attorneys should take steps to preserve relevant information. This often requires a decision (immediately communicated to employees) to suspend destruction/deletion pursuant to the company's document retention policy. Hard copies of documents must be collected and information technology professionals must be enlisted to identify, collect and preserve relevant electronic documents and information contained on the company's voice mail system and computer networks, and to suspend destruction of computer network backup tapes.³ In addition, the computers of all persons connected in any way with the suspected wrongdoing should be secured until their hard drives can be analyzed and/or replicated.

Proper handling of this step can determine the efficacy of the investigation and the manner in which it is perceived by outsiders. Therefore, it is advisable that in-house attorneys identify persons, departments and physical locations that may contain or have access to critical information, then arrange for outside counsel to oversee its collection, organization and review. The necessity and value of cooperation between in-house and outside counsel at this early stage cannot be overstated, and mistakes made at this stage are extremely difficult to overcome.

The second, and often most important and productive element of an internal investigation is the interview process. Corporate employees, outside professionals and sometimes customers and vendors can provide investigators with invaluable information. By speaking face-to-face with individuals, investigators often are able to obtain information unavailable from a review of documents or other sources, and to assess credibility. This information allows investigators to streamline the review of documents and other evidence, and can help focus the investigation. In-house attorneys and management should take all steps necessary to ensure that firm employees provide full cooperation to investigators and that investigators have full access to all necessary business records, facilities, professionals and outside vendors. It is important that employees, who often are suspicious of outside investigators, be instructed by management to cooperate with investigators, be directed not to discuss the substance of their interviews with others, and be assured that they will not be retaliated against for cooperating with the investigation.

Maintaining Privileges

The decision whether to share the results of an internal investigation with governmental investigators or to waive applicable privileges is a decision with legal and business implications that must be considered jointly by in-house and outside counsel in close consultation with management or the audit committee. Of course, to obtain the benefits potentially available through a waiver of privileges, information first must be privileged. In-house and outside counsel must work together to minimize the risk that privileges are inadvertently waived during the investigation process.

Most obviously, attorneys should not discuss the substance of the engagement or the investigation with third parties, and should label substantive communications as attorney/client communications and/or attorney work product. Caution should be taken to ensure that conversations are not overheard by third parties, and documents relating to investigations should be maintained in secure, restricted-access areas of corporate and outside counsel's offices.

The conduct of interviews is one of the first areas in which complicated issues of privilege arise. The Upjohn⁴ case outlined important criteria by which the applicability of privileges is gauged in connection with interviews of corporate employees. There is no "bright line" test. However, in-house and outside counsel involved in such interviews should follow certain guidelines. First, the interviews should be conducted by attorneys. Second, the information gathered during the interviews must be for the purpose of rendering legal (as opposed to business) advice.⁵

The retention of outside counsel will go a long way to establish that this is the aim of the investigation and the interviews. Third, the information must be kept confidential. It is important that information be distributed within the company on a "need-to-know" basis, that all conversations relating to the interviews be prefaced by a warning that the information is privileged, and that anyone with access to the information be instructed to maintain its confidentiality. All documents embodying information obtained during the interview process should be clearly marked as attorney/client communications and attorney work product, and steps to ensure that the materials are not inadvertently disclosed to third parties must be taken.

During interviews, attorneys must take steps designed to ensure that communications will be privileged. First, employees should be instructed by in-house counsel or management that they are required to participate in the interview process for the benefit of the company. Second, where possible, interviewees should be questioned only regarding areas within the scope of their corporate duties.

Finally, interviewees should be informed at the start of each interview session that: (i) the interview is being conducted by attorneys; (ii) the attorneys represent the company, and do not represent the interviewee; (iii) the interview is being conducted to obtain information necessary to provide legal advice to the company and will be subject to the attorney/client privilege; (iv) the privilege belongs to the company; (v) the employee should not discuss the contents of the interview with anyone unless authorized by company management or attorneys; and (vi) the company may decide at some point to waive the privilege, in which case the information obtained during the interview might be disclosed to management, governmental investigators or others. Observing these precautions cannot ensure that all interview communications will be privileged, but strictly complying with these guidelines will increase the likelihood that they will.

Privilege considerations also arise when investigators deal with outside professionals or employ independent professionals to assist in the investigation process. Sharing information and attorney work product with persons engaged to assist an attorney in providing legal representation generally does not result in waiver of privileges. However, at least one recent decision in the U.S. District Court for the Southern District of New York raises questions in this area. Medinol, Ltd. v. Boston Scientific⁶ held that because an auditor, "in order to be effective, must have interests that are independent of and not always aligned with those of the company," disclosure of internal investigation materials to the auditor constituted a waiver of the attorney work product privilege.

Although attorneys conducting internal investigations, especially if engaged by an audit committee, are unlikely to utilize the company's auditors for forensic work, they may communicate with them during the investigation. Medinol serves as just one reminder that both in-house and outside counsel must carefully consider privilege issues before sharing investigation information with third parties. Confidentiality agreements should be executed prior to disclosure, though they cannot guarantee that privileges will be preserved.

Professional Responsibility

SEC rules recently enacted or proposed pursuant to the Sarbanes-Oxley Act raise new issues for attorneys who become aware of wrongdoing during the course of an internal investigation.

The SEC's so-called "up-the-ladder" reporting rules require both in-house and outside attorneys to report "material violations" of state or federal securities laws or of fiduciary duties to the company's chief legal officer (CLO) or both the CLO and CEO. If attorneys believe reporting to the CLO or CEO would be futile, or do not reasonably believe that an appropriate response has been provided by the CLO, they are required to report "up-the-ladder" to the company's audit committee.

Outside counsel retained by an audit committee generally will report their findings directly to the audit committee under the terms of the engagement. Similarly, in-house counsel and outside attorneys employed by a company likely will report to the CLO. They will only be required to report "up the ladder" to the audit committee if they feel that reporting to the CLO would be futile or that the CLO or CEO has not adequately responded within a reasonable time. However, given the mandatory nature of the new rules, they appear to require that both in-house and outside counsel be diligent in following through on the results of investigations.

More controversial are the SEC's proposed "noisy withdrawal" rules that would require outside counsel who do not feel that an adequate response has been taken in response to an "up-the-ladder" report to immediately withdraw from representation, notify the SEC that the withdrawal was "based on professional considerations" and promptly disaffirm any document or representation filed with or submitted to the SEC that the attorney feels is materially false or misleading. The proposed rule imposes a similar obligation on in-house lawyers to disaffirm documents and representations to the SEC, but does not require them to resign. Where an attorney becomes aware of a prior material violation but no ongoing wrongdoing, withdrawal and disaffirmance would be permitted, but not required.

The SEC delayed implementation of these "noisy withdrawal" rules and is seeking additional comment on the proposed rule and an alternative that would require outside counsel to withdraw and inform the company that the withdrawal was based on "professional considerations." The alternative would require in-house counsel to cease any participation or assistance in any matter concerning the violation and notify the company that he or she believes that the company has not provided an appropriate response in a reasonable time. The alternative rule would also require the company to notify subsequently retained or hired attorneys of the reason for the withdrawal.

FootNotes:

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