General Counsel Roundtable: Coping With Compliance Challenges In The Post-Scandal World

[Editors Note] We felt that our readers would be interested in the responses of the general counsel who will participate in the "Corporate Governance and Compliance Readiness Seminar: New Challenges for Corporations and Their Lawyers" on Thursday, October 14 (see page 52) to some of the questions to be discussed. The questions raised were formulated by Mr. Sims on the basis of his extensive legal and business experience (he participated in the formation of a number of banks and is a founder and chair of First Capital Bank, Atlanta). As you can see, there is broad agreement on the fundamentals, with some areas where the approaches differ. You are urged to consider attending the seminar where you will have the opportunity, during and after the breakout sessions, to benchmark on these and other issues.

Sims: How important to your company's compliance efforts is "tone at the top?"

Hendry: Very.

Patrikis: It should go without saying that the tone from compliance must flow top down. I would include in this both support for the compliance and the internal audit functions. There should be awareness throughout the organization that the chairman and the Audit Committee focus on these items.

Sabatino: Critical. At Schering-Plough, a new CEO was brought in during April 2003, and one of his priorities was inculcating a new culture concerning compliance and business integrity. In turn, he brought in a new leadership team, which includes the head of our pharmaceutical business, a new CFO, and a senior executive to head up a new, separate compliance function, among others. We work together on the Executive Management Team to make sure we are doing everything possible to establish the correct tone at the top.

Shepherd: "Tone at the top" is crucial to the success of all corporate initiatives, and is especially important in the case of compliance, where contributions to profitability are less obvious and immediate.

Sims: How has Sarbanes-Oxley affected the status, size, training and organization of the legal department, relationships with outside counsel and the use of legal service providers?

Hendry: Little.

Patrikis: Sarbanes-Oxley did give rise to a great deal of work after enactment. I would add to these the revised listing standards of the New York Stock Exchange, which also generated a lot of work. I think that we have returned to normalcy, but with a bit more work for both in-house and outside counsel. We still are educating our attorneys around the world about Sarbanes-Oxley, both in terms of what it does and what it does not do.

Sabatino: The size of the law department has not changed due to Sarbanes-Oxley, although there was substantial overtime, particularly during the period while initial implementing regulations were issued and processes were enhanced in order to comply. We also increased the use of outside experts to review and confirm our initial interpretations and compliance. This is now tapering off.

Shepherd: I'm not sure that Sarbanes-Oxley has done much for our status, but the attention given to corporate governance issues, including the regulations and listing standards following SOX, has been beneficial.

Sims: Do all in-house lawyers and outside counsel report on a solid line basis to the general counsel?

Hendry: No.

Patrikis: I do not see any change in our relationships with our myriad of outside counsel. Not all in-house attorneys report directly to me. However, for the most part, I see no difference in the relationship between those that do and those that do not.

Sabatino: Yes, all lawyers, in-house or outside, report to me as General Counsel. No outside counsel provide services to the business, except as coordinated through my office. And to date, when the Board or a Committee has asked for outside counsel, they have asked our Corporate Secretary's Office, which reports to me, to handle the selection and coordination. A recent example was that a Committee asked the Corporate Secretary's Office which reports to me to arrange for an outside counsel to provide an update on their fiduciary duties in connection with a recent case that received much publicity.

Shepherd: Everyone providing legal advice in our company reports on a solid line ultimately to the General Counsel.

Sims: How has Sarbanes-Oxley affected the reporting relationships of the general counsel, particularly with respect to the Audit Committee and the board? For example, does the general counsel meet with them without other members of management being present?

Hendry: It has not changed my reporting relationships. I was already meeting with the Audit Committee and board without other members of management being present; but the amount of time that I spend at such meetings has increased.

Patrikis: Both Sarbanes-Oxley and the NYSE listing standards have had an impact on the Audit Committee. Its meetings are longer. I typically do not meet separately with the Committee, but I do have frequent communications with the chairman of the Committee.

Sabatino: I attend all Audit Committee and board meetings, and Sarbanes-Oxley has not changed this. From time to time, I am asked to meet in executive session with the Audit Committee or board. Our Audit Committee has a practice, which I think is a good one, to ask at the conclusion of each meeting whether anyone attending desires a private session. This is an addition to regularly scheduled private sessions with the independent and inside auditors. Our committee that oversees non-financial compliance issues also follows this practice.

Shepherd: I've been fortunate to have a strong relationship with the Board. A general counsel is typically well positioned to have a close relationship with the Board in most companies - particularly when he or she also serves as corporate secretary. The Board is accustomed to looking to him or her for advice. SOX may have added greater structure or formality to the relationship in some companies. For example, I already had regular access to the Board, but we made an executive session with the General Counsel a routine agenda item for each meeting of the Audit Committee.

Sims: What procedures are used within the legal department to assure the CEO and CFO that they can sign the certifications required by Sarbanes-Oxley? Do lawyers within the legal department provide sign-offs with respect to their practice areas?

Hendry: A disclosure committee of legal and finance supervises an up-the-chain certification system.

Patrikis: At AIG, both the Comptroller and I receive "Mini-certs" from various members of senior management. I receive them from the most senior officials and those that do not have responsibility for a profit center. I also ask the most senior attorneys for their comments.

Sabatino: We have a multi-phase process within the entire company, not just the law department. For the litigation updates, our senior securities counsel sends the actual requirements out with a request for updates each quarter to all managing lawyers, and other lawyers handle important issues for the company. We recently enhanced this process by adding a final review of the filing by the head of our litigation group. Key financial and business unit leaders provide subcertifications indicating that the data they provide is accurate and correct in all material respects.

We have a management disclosure committee that includes key business persons, investor relations, the controller, treasurer, tax counsel, internal audit and our senior securities lawyer. Their function is to consider materiality of issues from multiple perspectives and to help eliminate any inadvertent gaps in the data provided for the 10Qs, 10Ks and 8Ks. Our controller's office has its own quality process, followed each quarter.

At the Audit Committee's instruction, the independent auditor issues a review letter each quarter. Close to the filing date, we have a due diligence roundtable which the CEO and CFO attend. We discuss the processes followed during the quarter and highlight the special diligence on particular issues. At the conclusion of the meeting they request discussion of any item that might impact the integrity of the reporting or the certifications.

Shepherd: Lawyers participate actively in our various infrastructure groups and disclosure committees and provide reports that support my advice in connection with the certifications.

Sims: Is the general counsel (or outside counsel reporting to the general counsel) involved in determining whether the internal control system relating to financial reporting meets legal requirements? Does the legal department have lawyers (or outside counsel) versed in law and accounting issues?

Hendry: Internal counsel determine whether the internal control system relating to financial reporting meets legal requirements. The legal department has lawyers (or outside counsel) versed in law and accounting issues.

Patrikis: The role of the Legal Department in the Section 404 quest is not a major one. First, there is our own involvement in the internal control process. Second, we assist our clients in that process. We do not have an attorney/accounting expert on our staff or rely on outside counsel for this service. Of course, in a public company, such as AIG, both in-house and outside counsel have a fair degree of familiarity with accounting matters.

Sabatino: Our corporate secretary, who is also our senior securities counsel, is very well versed in law and accounting issues relating to SEC reporting and compliance, including internal controls relating to financial reporting. She is part of the law department.

She sits on our 404 steering committee, which meets periodically to consider our internal controls over financial reporting. That committee receives regular updates from the team implementing the process for documentation and testing of internal controls over financial reporting as required by the PCAOB rules implementing Sarbarnes-Oxley Section 404. They also receive regular updates from internal teams and the independent auditors about testing such controls.

She informs me of any interpretive issue regarding the legal and regulatory requirements for the internal control system relating to financial reporting that arise in the steering committee meetings. She and I also work closely with our senior vice president - global compliance and business practices and his staff regarding any issues that may impact such controls that are identified in the regular course of compliance activities.

Shepherd: The accounting and finance executives take the lead on financial reporting matters, but they are advised by lawyers specializing in corporate finance and securities. In part because financial services businesses are so highly regulated, both the business people and in-house and regular outside counsel have developed great familiarity with financial reporting matters. Internal and external auditors also play an important role in accounting issues.

Sims: What is the general counsel's role in overseeing your company's legal compliance system, including putting in place an employee compliance and ethics training system that meets the requirements of the revised sentencing guidelines?

Hendry: Our legal compliance system reports to the general counsel.

Patrikis: I make reports to senior management on compliance matters. I also report to the Audit Committee on compliance matters and hotline calls and other significant investigations. The head compliance attorney is a direct report. She then has a matrix relationship with the compliance staff in our profit centers. The corporate compliance staff drafts all necessary policies and procedures. Periodically, compliance staff is gathered in New York to address current issues. And our corporate level compliance staff travels within and without the United States to meet with compliance staff and others on broad issues and particular matters. The corporate compliance staff maintains the code of conduct and addresses issues arising from the code. At least once a year, I send an e-mail broadcast to each employee reminding them of their obligation to report to me any problematic activity. We have a hotline that functions in a large number of languages. I do receive a number of e-mails, some anonymous from staff around the world raising questions on various matters. Profit center compliance staff engages in the training of staff within profit centers; our corporate staff participates in those efforts.

Sabatino: I am responsible for the legal compliance system. I work as a team with the senior vice president - global compliance and business practices (who has a direct reporting line to the CEO) regarding employee compliance and ethics training. Our work is directed not only in making sure our systems meet the requirements of the revised sentencing guidelines, but also in fostering a culture of compliance and business integrity throughout all work processes.

Shepherd: The Compliance Division reports to the general counsel in our company. The requirements of the Sentencing Guidelines are certainly useful references as we develop the curriculum and attendance expectations for training programs.

Sims: Does the mission of the legal department include being sufficiently involved in management decision-making processes to enable it to head off possible violations of law or other circumstances which could become disclosable issues?

Hendry: The mission of the legal department includes being sufficiently involved in management decision-making processes to enable it to head off possible violations of law or other circumstances which could become disclosable issues.

Patrikis: I do not think that we devote a lot of time to heading off violations of law, which are, and I hope will continue to be, few and far between. On the other hand, a great deal of our operations are in supervised and regulated financial businesses. The profit center attorneys must work with their clients to help ensure that our operations are consistent with law and regulation.

Sabatino: I sit on the Executive Management Team. This is our most senior executive management decision-making body. That gives me an avenue for pro-active input early in the process, and helps avoid another executive inadvertently overlooking a possible legal or disclosure issue.

I also stress to all my lawyers the importance of working as a team with the business executives and the other staff functions, so that they will be included in the planning and early implementation phases of the work. This allows them to work proactively rather than reactively in order to identify possible legal and disclosure issues early on.

Shepherd: It is certainly part of our mission to provide proactive advice - whether it be in structuring transactions or in offering other financial services - that accomplishes business objectives and complies with legal requirements.

Sims: How important is it to have a critical mass of in-house lawyers sufficient to pick up complaints by middle management with respect to fraud and illegality?

Hendry: The legal department should be of the right size to pick up such complaints.

Patrikis: Your question makes it seem like there is a substantial volume of middle managers complaining about fraud and illegality. I find that middle managers appreciate the services of an in-house attorney if they have not had one before. As to fraud, I have a "fraud squad" that deals with individuals outside of AIG who may have committed fraud. Other areas of AIG, such as internal audit, deal with internal fraud and other improper activity. Our corporate compliance staff will assist the internal auditors in their work.

Sabatino: It is important to have such a critical mass, not only to "pick up" complaints, but to help key business, accounting, and other functions learn to spot flags for possible trouble.

Shepherd: I trust none of our companies needs a large staff to handle complaints with respect to fraud and illegality.

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