Corporate Compliance - Law Firms Watching Your Step: Avoiding The Pitfalls And Perils Of Corporate Internal Investigations - Part I

Since the creation of the Corporate Fraud Task Force in July 2002, the United States Department of Justice and the other member agencies have worked feverishly to ferret out corporate crime and punish wrongdoers. The Task Force, in the three years following the announcement of its formation by President Bush, has instituted hundreds of investigations, secured over five hundred corporate fraud convictions or guilty pleas, and charged over nine hundred defendants. Not to be outdone by federal law enforcement authorities, some state attorneys general have followed suit, pursuing their own well-publicized probes of corporate practices. The stakes in these investigations are enormously high, not just for the individuals whose conduct comes under review, but also for the corporations themselves. Corporations risk substantial criminal fines and civil penalties, and they often must endure a host of investigation-related side effects such as a disruption of business and a diminution of market capitalization. The severity of these consequences, and the ease with which criminal liability can attach to an organization for the acts of employees within the scope of their authority, means that no responsible company can afford to ignore suspected wrongdoing within its ranks.

The government's new focus on corporate America, in turn, has generated a sharp increase in the number of internal investigations. Today, perhaps more than ever, internal investigations are an integral part of the business landscape. In general, a corporation will undertake an internal investigation for one of two reasons. First, an internal investigation may be launched in response to a government inquiry, such as a grand jury subpoena or a letter of informal inquiry by the Securities and Exchange Commission ("SEC"). Second, a corporation may initiate an investigation to address an issue brought to its attention through internal means, such as an allegation of wrongdoing by an employee of the company or an issue identified by the company's external auditor. As a result of the Sarbanes-Oxley Act of 2002 and the obligations that it imposes on public corporations, these internally-sparked investigations have increased dramatically in the post-Enron business climate, so much so that "internal investigation attorneys are becoming a dreaded necessity for a growing number of public companies."1

Regardless of the event that triggers an internal investigation, attorneys engaged to handle this kind of matter for a corporation often confront complex issues unique to this practice area. To navigate these issues successfully requires a basic understanding of the ways in which missteps by counsel can compound the client's problems and potentially undermine the engagement. This article offers certain key points to keep in mind when conducting an internal investigation, the consideration of which will better prepare counsel for the challenges that may surface and the pitfalls and perils that could lead to problems for both client and attorney.

Identifying The Client

In an internal investigation, counsel typically is engaged either by management or the company's board of directors or some subset thereof, most often the audit committee. Regardless of the source of the engagement, counsel must keep in mind that he represents the interests of the corporate entity, not any individual employee, officer, or board member. The distinction between the corporation and its constituents perhaps finds no greater importance than in the area of corporate internal investigations, where counsel's charge is to examine alleged wrongdoing by company personnel. Indeed, the very nature of the representation means that counsel at times can find himself at odds with company executives whose interests may differ in significant ways from those of the company. Counsel should be careful always to fulfill his duty of loyalty to the company and not become conflicted by a false sense of duty to others, such as the general counsel or other members of management. Subordinating the company's interests to those of its constituents could undermine the credibility of the investigation, worsen the company's problems, and give rise to professional liability issues for investigating counsel.

Not only must counsel remember that his duty of loyalty rests with the corporation, he also should take steps, when necessary, to make this point clear to company employees. The need to disclose that the company is the attorney's client will come up most often in the context of employee interviews, a critical component of every corporate internal investigation. Experienced investigation attorneys make this disclosure, which has come to be known as the " Upjohn warning" or "corporate Miranda warning," at the outset of any employee interview. The warning typically includes the following elements: the attorney represents the corporation and not the individual employee; the interview is covered by the attorney-client privilege, which belongs to and is controlled by the company, not the individual employee; the company may decide, in its sole discretion, whether to waive the privilege and disclose information from the interview to third parties, including the government. Although some attorneys provide additional interview warnings to employees, counsel must be mindful of the delicate balance between providing sufficient cautions and obtaining information necessary to further the company's investigation. Excessive warnings can chill an employee's willingness to cooperate.

The warning serves two important purposes. First, it enables the attorney to fulfill her ethical obligation not to mislead an employee with interests adverse to those of the corporation. Under ABA Model Rule of Professional Conduct 1.13(f), "[i]n dealing with an organization's directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization's interests are adverse to those of the constituents with whom the lawyer is dealing." Although Rule 1.13(f) requires such an explanation only when the interests of the employee and the corporation are adverse, in the context of an internal investigation, the task of determining whether an employee's interests may eventually become adverse can be extremely difficult, if not impossible. Similarly, if an attorney believes that a person is unsure about the attorney's role, the attorney has an ethical obligation to correct this misunderstanding. When interviewing company employees about company matters, counsel for the company runs the very real risk of encountering individuals who fail to grasp that the attorney represents only the entity's interests and that those interests may not be aligned squarely with their own.

Most importantly, however, the warning enables counsel to cloak the interview with the attorney-client privilege and protect the company's control of the privilege. A failure to give the warning may result in the privilege being held jointly by the employee and the company, divesting the company of its ability to exercise exclusive control over the communications between company counsel and the employee. The general rule is that an attorney-client relationship can arise between the company's counsel and an employee if the employee has a reasonable belief that the attorney represents him. As one court stated, "[a] party establishes an implied attorney-client relationship if it shows (1) that it submitted confidential information to a lawyer, and (2) that it did so with the reasonable belief that the lawyer was acting as the party's attorney."2 In the context of an internal investigation, an implied attorney-client relationship between company counsel and an employee can pose significant problems for the company, preventing it, for example, from waiving the privilege with regard to communications between company counsel and the employee without the employee's consent. A joint privilege, in effect, gives the employee a veto power over the corporation's ability to disclose the communications to government authorities in the future should it be in the best interests of the company to do so.

Conducting The Investigation

Counsel also should bear in mind the importance of conducting a thorough and credible internal investigation. An investigation that overlooks relevant facts or results in inaccurate disclosures to the government can quickly compound the client's problems and subject counsel to claims that he attempted to conceal or gloss over corporate wrongdoing. Even if government authorities have not emerged to begin their own inquiry, counsel should assume in most cases that the matter they are investigating will eventually come under government scrutiny. As a result, attorneys should familiarize themselves with the federal obstruction of justice statutes and the broad reach of these laws. By doing so, counsel can protect the integrity of their internal investigations and go about their work in a way that minimizes the risks to them and their clients.

The risks to attorneys who proceed carelessly in this area are real. In November 2004, before leaving the SEC, Stephen Cutler revealed that the agency is looking closely at attorneys who conduct corporate internal investigations. Mr. Cutler stated:

"One area of particular focus for us is the role of lawyers in internal investigations of their clients or companies. We are concerned that, in some instances, lawyers may have conducted investigations in such a manner as to help hide ongoing fraud, or may have taken actions to actively obstruct such investigations."3

A mere month later, according to media accounts, the SEC informed an attorney that he may face civil sanctions for his role in an internal investigation at Endocare that found "no intentional wrongdoing by management."4 Not long after these results were released, the company disclosed that it was under investigation by the Department of Justice and the SEC. The dangers are plain: an attorney who is perceived by the government as whitewashing or covering up inappropriate corporate conduct faces the distinct possibility that the SEC, or some other government agency, will investigate not only the client's activities, but also the attorney's.

1Leigh Jones, Call for Internal Probes Growing, The National Law Journal, November 22, 2004, at 1.

2 Nelson v. Green Builders, Inc., 823 F. Supp. 1439, 1445 (E.D. Wis. 1993).

3The Themes of Sarbanes-Oxley as Reflected in the Commission's Enforcement Program, 18 Insights 18 (2004).

4 Stephen Taub, A Threatened SEC Lawsuit Would be the First Against a Lawyer Hired to Help a Company Conduct an Internal Investigation,, Dec. 7, 2004.

Published December 1, 2005.