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Rethinking Independence in Internal Investigations

11/8/2017 Articles

For a company under actual or potential government scrutiny, an independent internal investigation performed by outside counsel, sometimes coupled with cooperation with the government, can mean the difference between indictment and much more palatable result.  Often, outside counsel’s “independence” is conflated with “absolutely no prior work done for the subject company.”  Indeed, some companies and Boards categorically refuse to hire outside counsel to handle internal investigations if the firm has previously performed work for the company, out of concern that the government will assume that such counsel cannot conduct an “independent” investigation.

Although there are circumstances in which an entirely new firm should be hired for an internal investigation, imposing this sort of bright-line rule in every case may risk disqualifying a firm that is otherwise best equipped to handle a particular investigation, driving up costs and reducing efficiency while failing to increase credibility.  In many situations, investigative counsel can be diligent, objective, and independent despite having done some prior work for the client.  Investigative counsel that are familiar with the inner workings of a company from a prior relationship can bring enhanced efficiency and understanding to the investigation that can be extremely beneficial to the truth-finding process as well as to cost control efforts.  The point at which a prior counsel relationship may defeat independence must be considered on a spectrum.  While hiring a firm with no prior relationship may be useful or even necessary for some types of investigations, in other circumstances an existing or previous counsel relationship can enhance effectiveness with minimal if any threat to the investigation’s credibility.

As a threshold matter, while the government has stated that it favors “independent” investigations, it has offered little guidance on what that means.  For example, the Department of Justice’s recent checklist evaluating corporate compliance programs notes only that an investigation should be “properly scoped” and “independent, objective, appropriately conducted, and properly documented.” [1]  Notably, the guidance does not state that a firm’s prior work for a company disqualifies it as investigative counsel in all circumstances, nor does it state that some degree of prior work makes such counsel any less able to conduct an independent investigation.  The U.S. Attorney’s Manual focuses instead on the credibility of the investigation, noting that “[w]hichever process the corporation selects, the government’s key measure of cooperation must remain the same as it does for an individual: has the party timely disclosed the relevant facts about the putative misconduct?”[2] 

In the context of SEC investigations, Exchange Act Rule 10A-3(b)(4) requires that audit committees be authorized to engage “independent” counsel, but does not elaborate.[3]  The SEC’s 2001 Seaboard Report, listing criteria for evaluating corporate cooperation, only briefly mentions prior company work: “If outside persons [conducted the review], had they done other work for the company? Where the review was conducted by outside counsel, had management previously engaged such counsel?”[4]  However, the Report does not specify how the Commission is to evaluate such facts and does not characterize prior company work as impacting credibility.

Because most internal investigations, especially for public companies, will need to satisfy  auditors in addition to the government, it is helpful to consider the applicable audit standard regarding the level of independence required for a credible investigation result.  AU-C Section 500 (Audit Evidence) sets forth the audit standards that govern a public company audit that may rely on the findings of a “specialist” such as investigative counsel.[5]  Notably, the audit standards provide that such specialists may be relied upon as objective despite prior or current business relationships as long as other indicia of objectivity are present.  At least as far as the audit standards are concerned, the standard for credibility is “objectivity” rather than “independence,” a concept that also seems to better describe the government’s evaluation of credibility as a practical matter.

Although there are certainly situations when a company’s prior working relationship with outside counsel, especially if extensive, may impugn the credibility of an investigation, some amount of prior work by investigative counsel should not act as a de facto disqualifier.  First, taken to its logical extreme, this overly restrictive standard would potentially prevent companies from engaging counsel best-suited to address a particular issue.  Large companies regularly spread matters across a dozen or more law firms.  If a company could not then choose one of these familiar firms for an internal investigation – when criminal liability and/or millions of dollars in fines are at stake – companies may be foreclosed from choosing the best qualified counsel for a particular investigation.  Second, the risks of perceived lack of objectivity based on a prior working relationship can in some situations be cured through structural safeguards.  Depending on the type of investigation at issue, a company can establish lines of reporting and forms of supervision that allow outside counsel to bypass a prior or existing client contact.  For example, investigating counsel that reports directly to the Board or Audit Committee (or another special committee where appropriate) are less likely to be perceived as being improperly influenced by pre-existing in-house counsel relationships.  In an appropriate case, the lawyers within a firm who worked on prior matters can also be walled off from the investigation team.

Like their auditors will, companies should weigh on an individual basis the question of whether outside counsel can conduct a thorough, objective investigation that will be viewed as credible  – realizing that there are instances in which a prior working relationship will be acceptable or even beneficial.  For example, outside counsel with prior experience will often bring an in-depth understanding of the company’s business operations and relevant personnel – which can be crucial in time or dollar-constrained investigations.  Likewise, if outside counsel previously worked as a company’s employment counsel, it will be well-acquainted with company policies regarding termination and thus able to quickly analyze employment repercussions – common issues in any internal investigation.  Despite investigative counsel’s prior work, the government is still very likely to grant such findings considerable weight where objectivity is otherwise present.  For General Motors’ internal investigation on defective ignition switches, G.M. hired two law firms (King & Spalding and Jenner & Block) that had previously done legal work for the company.  G.M. reached a favorable settlement with the Department of Justice more quickly and for far less than other car companies involved in similar defective ignition switch investigations.  Preet Bharara, the former U.S. Attorney for the Southern District of New York, specifically cited G.M.’s internal investigation and cooperation as a reason for the favorable settlement.[6] 

Choosing outside counsel with prior experience with the company may be especially appropriate where counsel has worked only on a limited number of unrelated cases.  For example, in both the Yahoo! data breach and the Wells Fargo fraudulent account investigations, both investigating firms (Sidley Austin LLP and Shearman & Sterling, respectively) had previously been engaged for unrelated work. [7] On the other hand, there are clear instances where a company’s prior relationship with outside counsel should disqualify that counsel from conducting a subsequent internal investigation.  For example, the government may view outside counsel as too self-interested to conduct an objective investigation if counsel was involved directly or even indirectly in the events under investigation.  The seminal example is Vinson & Elkins’ investigation into the Enron fraud allegations.  Vinson was hired as investigative counsel despite the firm’s role in helping to create several off-the-books investment partnerships that were a focus of the government’s investigations.[8]  The internal investigation concluded that the partnerships were legally appropriate, a result that did little to deter government scrutiny. 

A similar situation exists when the company’s in-house or general counsel’s advice is itself under investigation, or where the actions of a non-lawyer client contact are under scrutiny.  Because of the risk that investigating counsel may be perceived as reticent to make findings that might result in discipline of their prior or current client contacts, a fully independent firm should be hired.  The perceived  lack of credibility may also require completely “new” counsel to investigate some whistleblower complaints.  Depending on the severity of the conduct alleged, a whistleblower’s own perception of bias or fear of his or her identity being uncovered by longstanding counsel may make completely new counsel a safer choice.[9]

In summary, outside counsel’s independence should not be viewed as a strict binary determined solely by whether counsel had a previous working relationship with the company.  The degree of independence required in a given situation should instead be considered on a spectrum, informed by the specifics of each case, with an overall eye toward counsel’s objectivity under the particular circumstances. 


 

[1] U.S. Department of Justice, Evaluation of Corporate Compliance Programs, available at https://www.justice.gov/criminal-fraud/page/file/937501/download.

[2] U.S. Department of Justice, U.S. Attorney’s Manual 9-28:720; see also id. (“The extent of the cooperation credit earned will depend on all the various factors that have traditionally applied in making this assessment [e.g., the timeliness of the cooperation, the diligence, thoroughness and speed of the internal investigation, and the proactive nature of the cooperation.])”

[3] Exchange Act Rule 10A-3(b)(4) (“Each audit committee must have the authority to engage independent counsel and other advisers, as it determines necessary to carry out its duties.”)

[4] U.S. Securities and Exchange Commission, Seaboard Report (Oct. 23, 2001), available at https://www.sec.gov/litigation/investreport/34-44969.htm.

[5] AU-C §500.A38.A39 et. seq.

[6] Ivory and Vlasic, $900 Million Penalty for G.M.’s Deadly Defect Leaves Many Cold (Sept.17, 2015), available at https://www.nytimes.com/2015/09/18/business/gm-to-pay-us-900-million-over-ignition-switch-flaw.html (“Mr. Bharara cited an internal investigation conducted for G.M. as favorable in determining the penalties paid by the automaker.  The two law firms hired for that inquiry, King & Spalding and Jenner & Block, had previously done legal work for G.M.  And court papers show that Anton R. Valukas, the chairman of Jenner & Block, who headed the G.M. investigation, helped represent the automaker in its talks with the Justice Department.”)

[7] Sidley had previously represented a group of technology companies, including Yahoo!, in an amicus brief that it wrote in In re Seagate Litigation in 2007.  See 2007 WL 1032685 (C.A. Fed.).  Shearman had previously represented Wells Fargo Securities LLC, a subsidiary of Wells Fargo & Co., in a debt offering in 2015.  See http://www.shearman.com/en/newsinsights/news/2015/06/wells-fargo-in-fts-international-notes-offering.

[8] James Grimaldo and Peter Behr, Houston Law Firm Helped Craft Enron Deals (Jan. 27, 2002) available at https://www.washingtonpost.com/archive/politics/2002/01/27/houston-law-firm-helped-craft-enron-deals/a4011343-6a7e-432b-a526-697849e9bf1d/?utm_term=.e8eea215d9c9Hou

[9] Dan Dunne, Compliance & Ethics Professional, Foxes and Henhouses (Aug. 2011).

 

 

 

 

 

 

 

 

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