Chapter 13 - § 13.4 • INTERNAL INVESTIGATIONS AND THE ATTORNEY-CLIENT PRIVILEGE

• Jurisdiction: Colorado

§ 13.4 • INTERNAL INVESTIGATIONS AND THE ATTORNEY-CLIENT PRIVILEGE

§ 13.4.1—Internal Investigations

It is always advisable for a company, when it identifies the possibility that there has been a violation of the securities laws or other violations, to conduct an internal investigation to identify the actions and any risks of liability and responsibility. In many cases, internal investigations are conducted by a special committee of outside directors who retain independent counsel and experts to assist. So long as the confidentiality of internal investigations is maintained, the attorney-client privileges are maintained. In many cases, however, there are reasons to make some public disclosure. Investigative authorities also frequently seek access to the results of internal investigations.

The internal investigation serves as a necessary fact-gathering process, a vehicle to assist in developing corrective disclosure or other remedial action, and to assist counsel in obtaining information in anticipation of litigation. The report generally contains a wealth of information that would be valuable to government enforcement and civil action. The issuer faces a dilemma in determining whether to waive the privileges and protections in sharing the materials with the governmental investigating entity. By cooperating, the issuer may avoid an enforcement proceeding or minimize the consequences; on the other hand, those materials may become discoverable in subsequent civil litigation. The SEC supports companies turning over the results of their internal investigations. In a § 21(a) investigation,¹⁷⁹ the SEC said, "When businesses seek out, self report and rectify illegal conduct and otherwise cooperate with the Commission's staff, large expenditures of government and shareholder resources can be avoided and investors can benefit more promptly."

When confidentiality is maintained, the attorney-client privilege is protected. In In re Woolworth Corp. Securities Class Action Litigation,¹⁸⁰ the court held that attorney-client privilege and the work-product doctrine both protected information gathered in an internal investigation by Woolworth of public allegations made by Woolworth's treasurer of "serious deliberate, accounting irregularities."

A company cannot close its eyes to wrongdoing. In many cases, an independent investigation by the board of directors and counsel is mandated. There are, however, costs and benefits for any internal investigation.

Benefits

1) An investigation will help the board meet its fiduciary obligations to exercise due diligence.
2) An internal investigation can be an important tool in emphasizing a corporate culture intending to comply with the legal requirements.
3) An internal investigation can assist management and the board in identifying legal and other exposure early, giving the company an opportunity to remediate the problem and mitigate damages.
4) A thorough internal investigation can ease public and government concerns and allow the company to gain control of the situation.
5) An internal investigation will allow the company to obtain credit under the Seaboard Report (see § 13.4.5) and other civil and criminal guidelines for investigation and remediation.

Costs

1) The government may learn things from a company's internal investigation that it might not otherwise have uncovered.
2) If the investigation is not complete or remedial actions were not taken, the company may lose credibility with the government investigators.
3) An investigation that is given to the government investigators may prove to be a road map for private litigants who can gain access to the report since privilege will have been waived.
4) An internal investigation that identifies wrongdoing may result in adverse publicity.

Generally, when a criminal or civil SEC investigation starts, management and the company have different interests. The board of directors must, in the exercise of their fiduciary responsibilities, act in the best interests of the corporation — even if it means turning over evidence that may not be favorable to management.

§ 13.4.2—Attorney-Client Privilege

Issues of attorney-client privilege and work product are exceedingly complex. Work product is not entitled to absolute protection, and production of work product may be compelled when the party seeking discovery demonstrates a "substantial need" for the materials and an undue hardship — that is, an inability to obtain the information through other means.¹⁸¹ The attorney-client privilege affords confidentiality to communications among clients, their attorneys, and agents for both, for the purpose of seeking and rendering legal advice, so long as the communications were intended to be and were in fact kept confidential. The privilege does not, however, protect facts known by the client, even when the facts were learned from counsel, or learned by counsel from independent sources.¹⁸²

The Southern District of New York found that privilege protected notes and work papers when a board committee had hired attorneys to investigate improprieties that were alleged by the corporate treasurer. The attorneys, Paul, Weiss, Rifkind, Wharton & Garrison, LLP, hired accountants, KPMG Peat Marwick, to investigate. In May 1994, the attorneys and accountants prepared and presented a report that was critical of senior management and the company's financial reporting practices. The company published the report. Shareholders, in class-action securities litigation, moved to compel production of internal notes and memoranda created by the attorneys and accountants, but the court denied the motion, saying that the privilege as to the underlying notes was not waived when the company published the report. Furthermore, materials produced and information possessed by an agent working for an attorney may be protected as work product, particularly when disclosure of such information would reveal the attorney's thinking and strategy.¹⁸³

On the other hand, in In re Subpoena Duces Tecum served on Wilkie Farr & Gallagher,¹⁸⁴ the court found that neither the attorney-client privilege nor the work-product doctrine applied when the results of an internal investigation were disclosed to the company's auditors to enable them to issue an unqualified opinion. Following the disclosure, the plaintiffs in a class action sought not only the report, but also the underlying documents. In finding for the plaintiffs, the court said, "Where primary motivation for the creation of work product is other than litigation, the work-product doctrine does not apply."

In disclosing the report to the auditors, the company had waived the privilege. The extent of the waiver:

depends on the "fairness doctrine," and what "prejudice to a party and distortion of the judicial process . . . may be caused by the privilege-holder's selective disclosure during litigation of otherwise privileged information." . . . The waiver of underlying materials or a complete subject matter waiver applies when a party seeks to use the privilege selectively, as both a sword and shield in litigation.¹⁸⁵

The court found that the company was seeking to use the privilege as both a sword (in using the unqualified opinion as evidence that the accounting irregularities were not material) and as a shield (protecting the underlying information from disclosure for judicial determination as to materiality).

Claus von Bulow was accused of attempted murder of his wife, but was acquitted after a famous trial in which Alan Dershowitz represented him. Dershowitz, with von Bulow's consent and assistance, wrote a book regarding the details of the prior representation and disclosed previously confidential information. Thereafter, the conservator for his (still unconscious) wife sued von Bulow for assault, negligence, fraud, and RICO violations, and she sought to use the information in the book and other confidential communications. The court said that the published information could be used since the privilege had been waived by von Bulow's consent to the book, but undisclosed portions of the communications were still privileged.¹⁸⁶

In other cases, the rule appears that when disclosure of privileged communications occurs in the context of litigation, subject matter waiver results.¹⁸⁷ When the privileged communications are disclosed outside of the litigation context and when they occur without prejudice to the opposing party, the waiver does not extend beyond the information disclosed.¹⁸⁸ When the disclosure occurs outside of litigation, however, subject matter waiver may still result when the party seeking discovery can show that a selective waiver has occurred (such as only disclosing supportive information), and this selective waiver has prejudiced it in trial preparation. Subject matter waiver can also result when the party uses a privileged communication in litigation.¹⁸⁹

Employees of an issuer cooperating in an investigation need to be cautious about their own situation. When counsel interviews an employee, the relationship between the company and the employee may not establish an attorney-client relationship with the employee. Without that relationship, there is no attorney-client privilege between the attorney and the employee being interviewed. In In re Grand Jury Subpoena,¹⁹⁰ an employee attempted to claim attorney-client privilege in resisting the production of an interview — even when the employee signed a "common interest agreement" with the employer. Unfortunately for the employee, the common interest agreement had been signed after the interview and the court held that it was not sufficient to establish the privilege for a prior interview.

§ 13.4.3—Waiver Of The Attorney-Client Privilege¹⁹¹

The SEC will cooperate with companies seeking to protect the attorney-client privilege, but such cooperation is frequently ineffective to protect attorney-client confidences that are disclosed to the SEC. In McKesson HBOC, Inc. v. Superior Court,¹⁹...