Recommended practices for companies and their counsel in conducting internal investigations.


Since 2001, over 2,500 public companies have retained outside counsel to conduct internal investigations into suspected wrong-doing by corporate executives and employees. These investigations have included inquiries into suspected violations of the Foreign Corrupt Practices Act; alleged options backdating activities; alleged violations of the antitrust, environmental, import/export, and other laws; and financial statement improprieties. (1) The Federal Criminal Procedure Committee of the American College of Trial Lawyers ("the Committee") has observed counsel implementing a wide variety of procedures and protocols in conducting corporate internal investigations for issuers and public companies in particular. The result has been variances, both in treatment of officers and employees and in outcomes of the investigations for such officers and employees and the corporations themselves. The Committee has sought to determine, and now recommends, what it believes to be the fairest and most effective practices for conducting internal investigations of possible corporate wrongdoing. (2) Although the principles articulated in this paper are tailored to internal investigations by issuers and public companies where significant allegations of malfeasance are alleged or suspected, many of these principles may be applied in the context of other entities and smaller investigations.

In Part I, we examine the internal and external factors to consider when deciding whether to conduct an internal investigation, including what conditions usually provoke the need to do so and what policies of federal or state prosecutors or regulators or of external auditors might influence the manner of conducting an internal investigation. Part I also examines the role of the Board and management in conducting the investigation, including the roles of internal counsel, regular outside counsel, and independent outside counsel. Part I concludes by analyzing the Board's and Special Counsel's role in putting together the basic building blocks of an internal investigation, from determining the appropriate scope of the inquiry, to creating an accurate factual record, including the preservation, collection, and examination of the company's records, to communicating with and examining witnesses, including issues of indemnification and warnings.

In Parts II and III, we analyze whether and how the attorney-client privilege and attorney's work product are impacted in the course of conducting and finalizing an effective investigation. In Part IV, we turn to the external investigation and the roles of special and regular counsel in such investigation. Finally, in the Appendix, we summarize our recommendations.


    1. Factors to Consider When Evaluating Whether to Commence an Internal Investigation When Allegations Have Been Lodged of Significant Corporate Malfeasance or Where an Outside Auditor Suspects Illegality

      Internal investigations typically result from discovery--by the Company, the media, an external auditor, or a whistleblower--of circumstances that raise a serious concern of potential liability or financial misconduct. The investigations are thus meant to determine the validity and seriousness of the circumstances alleged or disclosed and what action, if any, the Company should take consistent with the best interests of the shareholders. Among the possible responsive actions are remediation, market disclosure, and preparation for, and defense of, potential prosecutorial and regulatory actions or civil lawsuits. Depending on whose conduct is the focus of the investigation, senior management, the Board of Directors, an audit committee, or a special committee of disinterested directors may decide to commence an investigation. There are some respected corporate lawyers who counsel that Boards should resist the trend of having audit committees or special committees of independent directors routinely investigating whistleblower complaints and the like. (3)

      Whether to commence an internal investigation may be a discretionary decision, supra, or, in limited circumstances, may be prescribed by statute. In the latter case, [section] 10A of the Securities Exchange Act requires external auditors, who detect or otherwise become aware that an illegal act has or may have occurred, to determine whether it is likely such an illegal act has occurred and the effect of any illegal act on the Company's financial statements. (4) Auditors look to the Company to investigate and evaluate such possible illegalities and then assess whether the Company and the Board of Directors have taken "timely and appropriate remedial actions" regarding such possible illegalities. In this regard, the methodology used in "10A investigations" is not materially different from an internal investigation commenced on the Company's own initiative, and therefore, for the purposes of this paper they will be treated collectively.

      Outside of the Section 10A context, there are several circumstances that have traditionally triggered the initiation of internal investigations by senior management, a Board, audit committee, or special committee:

      * Receipt of a whistleblower letter or communication that raises allegations of misconduct by senior or significant members of management;

      * Shareholder demand in the nature of an actual or threatened derivative action against directors and officers, possibly leading to formation of a Special Litigation Committee;

      * Allegations of misconduct raised by external auditor, internal auditor, or compliance;

      * Board member suspicion of misconduct by officers or employees;

      * Receipt of subpoena or informal request for information by a government or self-regulatory organization ("SRO"), or an announcement by a government agency or SRO of suspicions of misconduct by the Company or industry; or

      * Allegations of misconduct by the media, watchdog groups, or academics.

      In addition, although there have been no reported enforcement actions under the section yet, the "reporting up" provisions of the Sarbanes-Oxley Act of 2002, set forth in section 307 and subsequently amplified by Rule 205 adopted by the SEC, require in-house counsel to ensure that the Company takes appropriate steps in response to allegations of wrongdoing. (5)

    2. External Factors, Such as the Existence or Anticipated Existence of a Parallel Government Investigation or Shareholder Lawsuit, Should Be Considered When Making Decisions About How To Conduct and Document an Internal Investigation

      There is a reasonable likelihood that any major internal investigation will be followed by, or conducted parallel to, an actual (or anticipated) external investigation by (one or more of): the Department of Justice ("DOJ"), the Securities and Exchange Commission ("SEC"), the New York Stock Exchange ("NYSE") (or other SRO), a state attorney general or local district attorney, or other enforcement or regulatory authority. The Company and the Board may also be facing civil lawsuits, including shareholder class actions and derivative suits, pertaining to the alleged misconduct, and in certain instances, may be dealing with criminal investigations initiated by federal and, more recently, state prosecutors. (6)

      The existence or threatened existence of any of these external events necessarily affects how the Company, Board, audit or independent committee, and outside counsel conduct and document an internal investigation. As discussed more fully below, counsel and the Company should anticipate that all documents created, facts uncovered, and witness statements made to them, may be disclosed to the government or regulator, and also may be discoverable by a private plaintiff. This assumption should be a factor in all major decisions about the procedure and protocol for any major internal investigation. In particular, the Company, the Board or its independent committees, and counsel may want, or may be forced, to make an early determination about whether and how they will "cooperate" with government or regulatory investigations. During approximately the last decade, driven by regulatory policies promulgated by the DOJ, (7) the SEC and other regulators, (8) as well as the U.S. Sentencing Commission; the passage of federal legislation mandating certain activities by independent auditors and audit committees; and civil litigation, there has been a renewed emphasis on companies' expanding the scope of their cooperation with governmental and initiating their own investigations. The purpose of these extensive internal investigations into perceived corporate misconduct is to achieve longer-term benefits at the hands of such regulators and avoid what could be punitive reactions by regulators and auditors.

      Since the mid-1990s, the principal focus of law enforcement and regulatory authorities in the United States has been to develop policies and guidelines designed to induce corporations and other business entities to waive, or not assert, applicable attorney-client and work-product privileges and protections. (9) In 1999, after several years of informal policies at various United States Attorney's Offices (principally the Southern District of New York), the DOJ formally adopted what came to be known as the "Holder Memorandum," named for Eric Holder, then Deputy Attorney General, and now Attorney General, of the United States. The Holder Memorandum, although advisory, set forth standards by which a corporation would be judged cooperative in a federal criminal investigation. (10) One factor was whether the corporation waived or did not assert privileges protecting the confidentiality of communications. (11)

      In 2002, then Deputy Attorney General Larry Thompson promulgated a revision of the Holder Memorandum, this time making mandatory the use of the factors in judging whether a corporation was sufficiently cooperative, including whether applicable...

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