The decision to conduct an internal investigation is frequently driven by an unexpected event that imposes risk to a company. A shareholder composes a demand letter alleging breaches of fiduciary duty by the board of directors. A whistleblower claims that senior management is overriding internal controls to prevent the disclosure of related-party transactions. An outside auditor uncovers a persistent pattern of prematurely recorded revenues seemingly designed to inflate earnings. A rogue employee engages in misconduct under the pretense of corporate authority. The government contacts the company with precisely crafted requests for information—or, the FBI shows up with a search warrant. Once confronted with these types of unwelcome events, companies need to promptly consider the credibility of the underlying accusations and prudently determine whether an internal investigation is warranted.
Internal investigations are traditionally favored when the activity in question may be prevalent or flagrant, or result in substantial financial harm to the company, especially if it raises the possibility of participation or acquiescence by senior officers or directors. This urgency becomes even greater when the conduct at issue is brought to a company’s attention by a governmental authority, such as the Federal Bureau of Investigation, Securities and Exchange Commission, Commodity Futures Trading Commission or Internal Revenue Service, whether via telephone inquiry or formal subpoena, thus placing it on notice of active and ongoing regulatory scrutiny. Here, a company finds itself at a significant informational disadvantage with no reasonable certainty what documents the government staff has reviewed, with whom they have spoken or what preliminary theories are being developed. It becomes critical under these formidable circumstances for a company to attempt to close the informational gap as quickly as possible.
Even when the immediacy and severity of the threat is less evident, there are numerous advantages in conducting an internal investigation. Most obviously, it provides a company with an opportunity to discover the relevant facts, determine whether misconduct occurred, identify possible wrongdoers and detect procedural deficiencies that potentially enabled the wrongdoing. Armed with this information, a company is able to develop and implement well-designed internal controls to prevent the misconduct from reoccurring and avoid the prospect of greater civil—or, even criminal—liability, had the misconduct continued.
An effective internal investigation may also position a company (after careful consideration of any collateral impact) to pursue various forms of credit available to those who self-report quickly and cooperate fully. Among the factors that regulatory agencies consider when granting cooperation credit are whether the company has voluntarily conducted an investigation, stopped the wrongdoing, taken remedial actions, disclosed the misconduct to the appropriate authorities and provided a comprehensive written report supported by relevant documents and witness testimony. In exchange, the regulatory authorities may be convinced to forego any enforcement proceedings or actions or otherwise agree to various forms of legal and financial relief, including reduced charges, waived or decreased penalties and disgorgement and softened factual findings.
Given the potential advantages from a well-conducted internal investigation, it is crucial for a company to avoid missteps at the outset that could undercut the investigation’s ultimate value. This article focuses on three fundamental questions pertaining to the structure of an investigation that a company must resolve before it commences.
Who Should Oversee an Internal Investigation?
It is essential that those tasked with supervising an internal investigation are able to objectively assess the relevant facts and appropriately remediate any significant deficiencies. If the conduct at issue exclusively involves lower level or nonexecutive personnel, senior management often fill this role. Otherwise, this type of oversight customarily falls within the fiduciary responsibilities of the company’s board of directors, subject to any conflicts of interest that may exist. Some conflicts are readily apparent from the start. Directors who are specifically named in the alleged wrongdoing or believed to have been actively involved in the conduct at issue should be excluded from the investigation. Other conflicts may be less obvious, such as pre-existing personal or business relationships between individual directors and persons potentially involved in the alleged misconduct. These relationships should also be vetted to gain assurance that the investigation is overseen only by directors who are disinterested in both fact and appearance.
There are additional practicalities that may limit director involvement. Internal investigations routinely require a significant investment of time and flexible availability, which can make it impossible for all directors to participate. There may also be certain directors whose professional backgrounds are better suited to serve in this capacity. As such, many boards— and especially larger ones—decide to create special committees, which are comprised exclusively of disinterested directors. Through formal resolution, these directors are delegated the authority to conduct the investigation (the purpose and scope of which is described in the resolution) and either report their findings and recommendations for board approval or make final determinations on the board’s behalf.
Should Counsel Assist in an Internal Investigation?
When investigations are board-driven, this formal resolution should also authorize the committee to select and retain legal counsel (along with other advisers and consultants), to perform services as it deems appropriate. While the committee may prefer to delay judgment on whether any subject matter experts are required until the investigation unfolds, it is most advisable to include counsel at the beginning. Counsel can offer the special committee valuable assistance in preserving potentially relevant materials and developing a strategy to realize the investigation’s objectives in a comprehensive and efficient manner. In addition, counsel is commonly tasked with performing, at the committee’s direction, many of the integral aspects of the internal investigation, including document reviews, witness interviews and report drafting.
The benefits of involving counsel are not limited to these assigned duties. A special committee is confronted with a variety of legal concerns that are inherent to any investigation, such as interpreting the accumulated evidence to determine whether any violations of law transpired, assisting in the development of an action plan to correct any violations, and assessing whether any corporate directors, officers or employees participating in the conduct may require separate legal representation. The inclusion of counsel when conducting the investigation (as opposed to utilizing internal auditors or compliance teams) also allows communications between the committee and counsel to be protectable under the attorney-client privilege. Likewise, the committee would be able to safeguard work generated by counsel throughout the investigation under the work product doctrine.
Should Independent Counsel Be Retained for an Internal Investigation?
Since investigations are typically expensive and time sensitive, there may be a natural inclination for a special committee to rely upon in-house attorneys, who already possess a widespread understanding of the company. And while it is true that internal counsel is a valuable resource to enhance efficiency and cost effectiveness during an investigation, there are practical disadvantages to their active involvement. In-house attorneys are employees of the company and may report to individuals who are (or later become) focal points of the investigation. This dynamic not only places in-house counsel in an awkward situation, but it could also hinder the fact finding mission since employees may be fearful of, and less forthcoming with, someone they view as an extension of management. Perhaps most importantly, government attorneys are pre-disposed to discount the meaningfulness of any conclusions reached.
The company’s customary outside counsel might also be viewed as an attractive option, as committee members often have confidence and comfort with these attorneys through previous interactions as well as their overall achievements on the company’s behalf. Unfortunately, this pre-existing relationship may damage outside counsel’s perceived objectivity, even when the advice they have provided the company is wholly unconnected to the alleged conduct under investigation. Although outside counsel does not work at the company, they still work for the company—and, integrity notwithstanding, may be viewed by regulators as a biased advocate motivated to preserve the client and the potential for future business. As with the selection of the special committee, the specter of a conflict of interest by counsel can undermine the potential benefits of an investigation as much as an actual one.
To avoid this potential drawback, it is often preferable to retain counsel that has no material prior relationship with the company, board, management or persons central to the investigation. This degree of independence signifies, in both fact and appearance, that counsel is beholden only to those persons directing the investigation—and is dedicated solely to an objective assessment of the accumulated facts. Another advantage is that it allows the special committee to retain independent counsel that is uniquely qualified to meet its specific needs. This includes not only vast expertise in conducting internal investigations, but also specialized knowledge of the pertinent area of law and unique skills needed to capably detect and decipher the relevant information. Further, attorneys who have worked for the government agency conducting the investigation (or the agency to which the company reports in the ordinary course of business) will have established credibility with these regulators and can provide an added dimension of insight.
In sum, the credibility of an internal investigation hinges on the diligence of the work and the objectivity of those who perform it. Investigations that are guided by senior management or disinterested directors with the learned assistance of independent outside counsel provide an optimal framework to demonstrate the importance a company places on compliance. Under this framework, a company is well positioned to perform a thorough investigation, provide reasoned corrective actions and obtain a more favorable regulatory outcome.
Reprinted with permission from the January 25, 2019 issue of Corporate Counsel.
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