AAA, Independent Fact-Finding And The Subprime Crisis

Tuesday, January 1, 2008 - 01:00

Editor: Bill, when did you first become aware of the power of Independent Fact-Finding (IFF)?

Ide: My interest was sparked back in the 1980s in connection with the E.F. Hutton debacle. Public trust needed to be restored in that company because doubts, media attacks and regulator involvement were dissipating stakeholder value by driving off customers.

This use of IFF accelerated in the nineties. Post-Enron it has become even more visible. When I was general counsel of Monsanto, I learned a lot about public trust and the impact it can have. IFF really revolves around public trust. With technologies being what they are, you have turbo-news where within seconds an allegation - a doubt - can be blasted throughout the world. If corporations, universities, governments or other entities don't have a quick response that restores confidence, then the benefit of the doubt goes against them and their stock can go down, suppliers can pull away and customers can be lost.

The court system is not conducive to moving rapidly. The IFFS approach restores confidence by using objective, independent fact-finding to quickly get to the bottom of a situation. This approach is a critical part of crisis management. With information traveling so rapidly via the Internet, taking quick and effective steps to restore reputation and public trust is critical.

Editor: I have often thought one of the great tragedies was what happened to Arthur Andersen. Paul Volker volunteered to come in and run Arthur Andersen. Do you think that organization could have been saved if Paul Volker had been brought in a little earlier and said I'm willing to conduct an investigation so that the public and the decision makers at the Department of Justice and in the Administration would have a better sense of the total picture.

Ide: I think it would have. If an entity will say to stakeholders, regulators and the public it will be totally transparent and let the chips fall where they may, the entity comes out fine. Back in the eighties, E.F. Hutton did not do that and stayed in denial too long, and ultimately that took the company down. They brought in Griffin Bell when it was way too late.

At the same time, Lee Iacocca at Chrysler had a situation where odometers were turned back on cars used by senior executives. He went on television and frankly confessed that it had happened without attempting to justify it, apologized to the American people and said all wrongdoers would be found and punished. That was the end of it. There is no question that if an entity moves quickly to deal with its problems and is totally transparent, it is not going to suffer nearly as much as when the public is left in a state of doubt and distrust.

Editor: Apple's response to its backdating problem is often used as an example of how a prompt independent investigation can be helpful.

Ide: Apple brought in an independent third party to do fact-finding and then told the SEC it would turn the facts over to them. The wrongdoers were found and punished and the SEC brought no regulatory action. That is a classic example of how effective IFF can be. That situation stands in stark contrast to the response of Hewlett-Packard to what was a legitimate concern about board members leaking confidential information. It did its own investigation with tragic consequences for the company and the company people who mishandled the investigation.

Editor: In response to the need for IFF services that involve carefully conducted investigations by neutrals with impeccable credentials, the American Arbitration Association has set up its IFFS service. As chair of its panel of distinguished investigators, please describe why the AAA IFFS service fills a unique need.

Ide: The AAA program sets up standards which are available to everyone. Those who conduct the investigation must operate under those standards. They are known to the boards of directors. They are also known to third parties when they become aware of the results. Those standards set guidelines that avoid the kind of investigative overreach that characterized the HP investigation. AAA standards contemplate that the investigator must be truly neutral - an independent third party who has had no relationships with the company or its people that in any way would detract from that neutrality.

Editor: How is the cost, scope and process involved in the investigation defined?

Ide: Before an AAA investigation is agreed to, the corporation enters into an engagement letter with AAA setting forth guidelines that will govern the investigation. They would cover such matters as its scope, cost, how the investigator will be selected and, importantly, the philosophy under which the investigation will be conducted; for example, it will be as nondisruptive to normal business operations as possible and will endeavor to the extent consistent with full disclosure to protect the attorney-client privilege and work product.

A most critical factor is to have people doing the investigation who understand the corporate world and how it works. If you've been inside corporations and understand how the structures work and how the cultures work, then you can be much more strategic and tactical, getting to the facts very quickly in the least disruptive fashion.

Editor: The subprime issue is on everyone's mind. It is becoming almost a daily event for some respected corporation to make an announcement about additional writedowns attributable to the subprime crisis. It's a crisis that affects a vast range of interests within our economic system. It is a situation where you have diverse interests involved in efforts to shift risk and liability to others. In the midst of this mutual finger pointing there are profound corporate governance issues involving the relationship between the directors and management. How can an IFFS investigation help?

Ide: In most situations that need investigation, the issues are complex. Clearly the directors need to know the facts so that they can lead the entity in determining if a problem exists and, if so, how to solve it. Unfortunately, all too often senior management is defensive and in denial. Thoughtful general counsel welcome the investigation because they themselves don't know what the facts are. Senior management or general counsel really need a third-party, objective view because they are somewhat compromised by being too close to the situations and knowing too well colleagues who may be under suspicion. In doing these investigations, senior management can be your biggest allies, encouraging the investigation and trying to guide you to where the facts are. If there is a cancer in the organization, they want to get it removed surgically without harming the whole body.

Editor: What role do you see the general counsel playing in this, given the expanded role of general counsel under Sarbanes-Oxley?

Ide: My experience has been that when these matters come up, today's boards want to know what's the right thing to do. Management tends to be in denial and status quo oriented. Therefore you can have tension between boards and management on how to proceed.

The directors' exposure to liability differs from that of management. The directors' risk centers on the steps they take today to assure that investors are kept informed. The liability of management also lies with what they did or failed to do in the past (of which the directors may not have been informed), such as the creation of the subprime-related products. Given the protection of the business judgment rule, a director's exposure to personal liability may start only after disclosure of the facts to investors is delayed for too long after the director should have known about the problem and its effects on investors. Clearly, red flags are flying today that signal to directors the need for their companies to fully inform investors of the impact of the subprime crisis on their businesses.

With management often reluctant to move quickly, general counsel are quite often the facilitators for the board. Their obligation is to the entity. I've seen good general counsel help the board seek an independent fact-finder and facilitate the process. When the board is uncomfortable, I think it is critical for the general counsel to assist in getting independent fact-finding going.

Editor: If the directors persistently ignore the red flags and fail to take appropriate action, might they not only expose themselves to personal liability but also void both the company's obligation to indemnify them and their D&O coverage? Does the general counsel have an obligation to advise the directors of these risks?

Ide: Yes to both questions. The Abbott case involved an allegation that its directors were acting in bad faith because they were aware of FDA concerns over the years as well as the lack of responsiveness on the part of the company to those concerns - with the result that Abbott incurred a huge fine. The court rejected the directors' motion for summary judgment and the case was permitted to proceed. A finding of bad faith could void the protection afforded by D&O policies and corporate indemnity agreements. The situation with respect to D&O coverage is further complicated by the obligation to inform the insurer once you are on notice of a possible exposure to litigation. Insurers are looking for reasons to deny coverage and the general counsel must be diligent to protect the insureds.

General counsel whose companies may be faced with claims arising from the subprime crisis and who have reason to believe that full disclosure of material information has not been made to investors should encourage their boards and senior managements to consider initiating an IFFS or other independent investigation without delay. It is imperative to gather facts and then to take prompt remedial action since in potential crisis situations such as the subprime scenario the passage of time works against the interests of both the directors and senior management.

Editor: If senior management and the board resist the general counsel's suggestion of an independent investigation and the general counsel is not completely convinced that full disclosure to investors has been made, what should the general counsel do?

Ide: General counsel in this situation are faced with a serious ethical and legal dilemma that is similar, but not identical, to being party to a cover-up of a serious compliance violation. He or she should retain counsel who would advise whether one may opt to believe management's assurances that adequate disclosures to investors have been made if there is a reasonable basis for such belief or may feel compelled to resign.

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