Corporate Counsel: Meeting Governance And Compliance Needs

Wednesday, September 1, 2004 - 00:00

Editor: What role do you see the corporate lawyer and particularly corporate counsel playing in the approach to corporate governance that has emerged in the wake of the scandals?

Ide: I believe that an essential element of that approach is rebuilding trust in the corporation as an institution and that corporate counsel plays an essential role in that approach. Each of the scandals was based on violations of law that had been developing over extended periods of time that might well have been uncovered if corporate counsel had been properly resourced and empowered by their corporate clients to undertake adequate legal compliance systems.

Editor: What is an adequate legal compliance system and what role do the lawyers play?

Ide: The essence of a compliance system in the new era of corporate governance is that it must be an information and reporting system that gives management and the board of directors information they need to assure that the necessary education, reporting, auditing and monitoring is taking place in a meaningful way. Lawyers are a critical part of any compliance system - irrespective of the size or structure of the company - because one of the functions of a compliance system is to detect, evaluate and resolve potential violations of law. Other company personnel may, and likely should, be involved in the compliance process, but it is axiomatic that a lawyer is the best skilled to address violations of law.

The new, post-Enron environment has placed added layers of complexity to compliance that necessitate the involvement of the legal department. To the point, a compliance system now must not only fit the business of the company, but also must meet increasingly demanding regulatory requirements. As discussed more extensively in my "Three Pillars" article (on pages 556-557 of vol. 2, no. 21 of BNA's Public Accountability Report), compliance systems must now respond to a complex regulatory environment created by Sarbanes-Oxley, state law and the Organizational Sentencing Guidelines (they or their equivalent will be in place regardless of how the US Supreme Court rules on them). It is critical that the compliance system be subject to sufficient involvement by the corporation's lawyers to make sure that the corporation is protected from violations of law and passes regulatory muster. It is the lawyers' responsibility to assure that the compliance system really works - because it is the foundation of the effort to restore trust in the corporation.

Editor: Why is the general counsel so important?

Ide: The law department's involvement in the compliance process is buttressed by the general counsel's status as the chief legal officer of the company. As such, the general counsel has the ultimate accountability for legal compliance within the company, and, as the Report of the ABA's Task Force on Corporate Responsibility (Cheek Report) makes clear, the general counsel's duties in this regard are to the shareholders and not individual officers or directors. Along these same lines, the general counsel must have direct access to the board of directors, particularly the audit committee, to make the board aware of any emerging compliance issues involving potential violations of law.

Editor: What is the general counsel's responsibility for assuring that she and the corporation have the tools to assure that trust will in fact be restored?

Ide: I have mentioned the importance of the general counsel's role. However, to properly discharge that function, she must have access to needed tools, which includes having a critical mass of properly organized in-house lawyers with a presence within the corporation sufficient to provide them with a reasonable likelihood of uncovering and identifying potential violations of law. In his interview in the November 2003 issue of The Metropolitan Corporate Counsel, Chief Justice E. Norman Veasey of the Delaware Supreme Court stated on page 76 that "I think the corporate lawyer should have the courage of a modern day Atticus Finch" and "just say no" when asked to serve as general counsel where management is unwilling to provide her with the tools necessary to discharge her responsibilities.

She must also have the status that provides her with the credibility and respect needed to get the attention of senior management and that of the board and audit committee where that is necessary. In a letter to The Metropolitan Corporate Counsel , published on page 56 of its Northeast edition, Tom Baxter, President of the Greater New York Chapter of ACC-A emphasized the importance of "being sufficiently trusted by senior management to be brought into all of the company's significant decisions but also being sufficiently independent in judgement to say "this cannot be done."

An effective compliance program must have elements that are inherently business or system driven - hence the need to call upon tools and personnel outside the law department. Internal control systems, employee compliance training and hotlines are essential. Access to outside counsel, investigative agencies, forensic accountants and other outside services are of great importance.

Editor: You mentioned the need for general counsel to have a critical mass of properly organized in-house counsel reporting to her.

Ide: Unless there are sufficient in-house counsel, there is little likelihood that the complaints of a Sherron Watkins will be heard soon enough for timely remedial action to be taken. I am not suggesting that law departments simply hire more lawyers to perform a monitoring function, but rather that, if the legal staff is doing its job of advising employees with respect to legal issues and drafting or reviewing documents requiring legal input, the in-house lawyers will be sufficiently accessible so that an employee troubled by a possible legal issue or concerned about possible fraud by a supervisor has someone readily available in whom she is willing to confide. My experience is that while employee compliance training programs and effective hotlines are essential, they are no substitute for having a critical mass of lawyers available who have established a wide range of friendly and mutually supportive relationships with middle as well as senior management.

In recent years, budget pressures have led to cutbacks in legal department budgets. In many cases, all corporate departments have been asked to take a percentage reduction in overall budgets or in body count. Sometimes this is done without regard to effect on the functions that the department is called upon to perform. The legal department is a particularly vulnerable target because its functions frequently seem to some in management to have little relationship to the bottom line - at least until a "bet the company" scandal comes to light.

When I say properly organized, I mean that all lawyers should not only recognize their responsibilities under Sarbanes-Oxley and the ethical rules, but also should have a solid line reporting relationship to the general counsel. The same should be true of outside counsel.

Unlike other functions and mechanisms within a company, the legal function (assuming a critical mass of properly organized in-house counsel) is the only function capable of providing on-going counseling that will head off a legal problem before it becomes a scandal. Where corporate counsel are involved in corporate planning, they can identify legal issues and in many cases suggest solutions that will pass legal muster.

Editor: What accounts for the different approach taken by Sarbanes-Oxley to the roles of auditors and lawyers in the trust-rebuilding process?

Ide: The regulation of auditors of public companies is extensive as Bill McDonough, chair of the PCAOB, has explained in his interview on the cover of this issue of The Metropolitan Corporate Counsel and the role of the self-regulatory mechanisms has been greatly reduced. On the other hand, the treatment of lawyers in Section 307 of Sarbanes-Oxley is based to a large extent on Rule 1.13 of the Model Rules and the existing self-regulatory system seems to be largely intact.

The difference is probably attributable to the fact that the failure of the auditors and indeed of the self-regulatory system that had been established by the accounting profession was so visible. A number of the scandals would have been uncovered much earlier if the financial statements certified by the auditors had accurately depicted the true financial condition of the companies. The cross selling within accounting firms reached a point where the audit function was compromised.

Lawyers were not without blame in some of the scandals, but their role as counselors and advocates did not put them in the enabling position that the audit function did for accountants. While, this does not excuse the lawyers, it does make the trust-rebuilding process for the lawyers somewhat easier. However, that can occur only if the lawyers seize the opportunity to prove that they can play their legally and professionally mandated role without the more intensive regulation applicable to auditors.

Editor: You mentioned that corporate counsel is still largely governed by self-regulatory mechanisms. You were a member of the ABA's Task Force on Corporate Responsibility that articulated the role and responsibilities of the corporate counsel of public companies. Based on its Report (Cheek Report), what is the primary obligation of corporate counsel and what guidance does it provide with respect to the implementation of that responsibility?

Ide: At the beginning of this interview, I mentioned the importance of the role of corporate counsel in corporate governance and some ways in which that role should be implemented. I am pleased that the self-regulatory recommendations of the Cheek Report reinforce my observations. For example, it declares that the primary obligation of a lawyer serving a public corporation is to serve the interests of the entity, independent of the personal interests of any particular director, officer, employee or shareholder. It is essential that all corporate counsel view themselves as lawyers who happen to work for a company, not employees who happen to be lawyers.

The Cheek Report states that the SEC and state attorney disciplinary authorities should cooperate in sharing information in order to promote effective and appropriate enforcement of rules of conduct applicable to counsel to public corporations and that the courts, law schools and lawyer professional organizations such as the ABA should promote awareness of, and adherence to, the professional responsibilities of lawyers in their representation of public corporations. It also states that law firms and corporate law departments should adopt procedures to facilitate and promote compliance with rules of professional conduct governing representation of public corporations.

Editor: How does the Cheek Report characterize the relationship of the general counsel to the corporation's legal compliance system?

Ide: It states that the general counsel should have primary responsibility for assuring the implementation of such a system under the oversight of the board of directors. This means that the general counsel should have the responsibility for assuring compliance with laws, but others can be responsible for assuring the proper operational issues involved with a compliance system.

Editor: In many of the corporations involved in the scandals, the general counsel seemed to lack the authority, contacts with the directors or access to information that would enable the general counsel to effectively implement the responsibilities described in the Cheek Report. These might be described as "status issues." Are these issues also addressed in the Report?

Ide: Your point is well taken. In the Cheek Report, we sought to put the general counsels' role of assuring compliance with laws front and center in the minds of directors and audit committees, given their concern that their companies avoid scandals and their knowledge that the recent scandals all involved allegations of massive violations of law. Thus, the Cheek Report provides that the selection, retention, and compensation of the corporation's general counsel should be approved by the board of directors. It states that general counsel should meet regularly and in executive session with a committee of independent directors to communicate concerns regarding legal compliance matters, including potential or ongoing material violations of law by, and breaches of fiduciary duty to, the corporation. It also provides that all reporting relationships of internal and outside lawyers for a public corporation should establish at the outset a direct line of communication with general counsel through which these lawyers are to inform the general counsel of material potential or ongoing violations of law by, and breaches of fiduciary duty to, the corporation.

Editor: The concept of "trust rebuilding" seems to be at the heart of your emphasis on the importance of corporate counsel's role in corporate governance. What can be done when an event may be of sufficient magnitude to trigger a social legitimacy crisis where the company and the lawyers who represent it may not be sufficiently credible in the eyes of the public to determine the true facts?

Ide: Public trust is the essential ingredient lost by corporate America and currently by the market system as a whole. Policymakers have been wrestling with the appropriate restructuring of the regulatory institutions designed to generate trust in publicly traded corporations, and groups such as the American Bar Association and the New York Stock Exchange have examined how to reestablish trust in "corporate governance," a term previously foreign to the common vocabulary.

Although the problem of public trust is particularly salient today for publicly traded business corporations, all organizations, both public and private, may face social legitimacy crises. The voracious appetite of the news media for possible wrongdoing, its role in forming public opinion, and its technological capacity to disseminate information widely and instantaneously can cause an immediate and irreparable loss of trust if the organization is not prepared to respond quickly and decisively to end the social legitimacy crisis and to regain the public's trust.

Rebuilding the trust lost in the wake of a social legitimacy crisis is essential. Going hand in glove with the "trust-rebuilding" function of corporate counsel is the need reflected in the Cheek Report for engagements of counsel by the board of directors, or by a committee of the board, for special investigations or independent advice to be structured to assure independence and direct reporting to the board of directors or the committee.

Where there is a severe social legitimacy crisis, it may be necessary for a corporation to reach out to well-known public figures with reputations for integrity to conduct internal investigations and report their findings to the public - a process referred to as "public independent fact-finding" (PIFF).

PIFF is not a panacea for this age of corporate illegitimacy and public mistrust and by no means is it a replacement for other trust-generating institutions, many of which are undergoing restructuring in the face of the current crisis; however, PIFF holds some interesting promise. To the extent that PIFF can help falsely accused organizations clear their names, can help otherwise good companies restore their names after the wrongdoing of a few of their constituents, and can aid in the reformation of good companies gone bad, it should be used and supported. However, some degree of institutionalization, with an emphasis on procedures and standards that preserve the integrity of the process, will best serve its continued use and development. The American Arbitration Association's effort through its Independent Fact-Finding Service to institutionalize PIFF is to be commended.