Corporate Internal Investigations

By Michael A. Collora
Send Email to: mcollora@dwyercollora.com     
   
  
Written for the MCLE Corporate compliance seminar, Given July 16, 1999, © MCLE, Inc. All Rights Reserved.

Because of increasing corporate liability for employee misconduct, it has become more common in recent years for corporations to conduct internal investigations. The purpose of these investigations is to allow a corporation to determine whether there has been employee misconduct which may implicate the corporation. Typically, an internal investigation is conducted by a lawyer, either in-house or outside counsel, to verify the accuracy of an allegation or a complaint of employee misconduct. This article summaries the issues raised by such an investigation.

An internal investigation is generally triggered in one of several ways: through an allegation from a company employee as to a violation of law (through a hotline or a direct complaint), an audit report which generates the demand for an investigation, the commencement of a civil action alleging fraud or a series of fraudulent acts, or a criminal charge from the United States Government.
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A. Whether to Conduct an Internal Investigation

When a corporation is facing a civil or criminal allegation by a governmental agency, there may be little choice in determining whether to conduct an investigation. Generally, a corporation will need to conduct this investigation in order to respond to the complaint.

If the corporation is facing any other type of complaint, there will be a decision whether to respond with an internal investigation. This initial decision should be made by in-house counsel in conjunction with the Board of Directors. It must first be determined if the complaint has a basis in fact, and how widespread the problem might be. Then it must be determined whether a formal internal investigation should ensue. When there are no formal charges against the corporation, there may be a desire to avoid making waves. However, when there has been potential serious misconduct, the corporation should proceed with an internal investigation. This will alleviate the risk of some outsider doing so, to far worse consequences.

As an initial goal, the investigation will allow the corporation to determine whether there has been wrongdoing within the corporation and will also allow the corporation to detect and punish the responsible parties. Secondly, the investigation will allow the corporation to be prepared should a formal civil or criminal complaint follow. Third, an internal investigation may permit the corporation to detect and report criminal wrongdoing before detection by the government. This could assist the corporation in avoiding prosecution, or under the Federal Sentencing Guidelines protect the corporation from fines and injunctions to which it might otherwise be subject. Top

B. Who Should Conduct An Internal Investigation

Once counsel and the Board of Directors have decided that an investigation should be conducted, it must be decided who will handle the investigation. The investigation will likely be conducted by either in-house counsel, or outside counsel.

Again, when the internal investigation is triggered by a formal criminal compliant from the United States government, there may be no choice - the action may require investigation by outside counsel. If this is not the case, the determination will be made by in-house counsel and the Board.

In conducting an internal investigation, in-house counsel are more cost and time efficient than outside counsel. Additionally, in-house counsel will already be familiar with the organization and functioning of the corporation, and may be able to obtain answers more quickly.

However, there are many disadvantages to using in-house counsel. Lack of objectivity, or the perception of lack of objectivity will be a great hurdle for in-house counsel. In-house counsel may face a conflict of interest between proper execution of the investigation and the protection of their employer. This conflict may flare up when the alleged wrongdoers are high level officials, or when the action has been brought by stockholders. When allegations have attracted much publicity, hiring outside counsel to investigate the claims may act to assure the public that the corporation is acting to rectify the problem, whereas in-house counsel may be seen as part of an attempt to cover up the misconduct.

If there is a shareholder demand letter or complaint, the Board of Directors may need to go outside of the corporate legal department, setting up an independent litigation committee to investigate such claims. In most cases, the decision of this committee may have a substantial influence over the outcome of the claim, where the findings of in-house counsel may not. See Harhen v. Brown, 46 Mass. App. Ct. 793 (1999) (judgment of internal investigatory committee convened after filing of derivative suit is not entitled to business judgment rule when decision to dismiss charges is found to be neither reasonable nor principled.)

Because their role is strictly defined, outside counsel may also be better able to utilize the attorney-client privilege. For example, a Delaware court found that because in-house counsel served many roles in an internal investigation (including chairing the Board of Directors), many of his communications with the client were non privileged. See Grimes v. LCC International Inc., Del.Ch.No. 16957, 4/23/99. Additionally, if non attorney personnel are hired by outside counsel, they may also be protected by the privileges afforded to the attorney. See In re Grand Jury Proceedings, 786 F.2d 3 (1st Cir. 1986). Finally, if formal actions against the corporation have not yet been filed, an investigation by outside counsel may hold off any formal action by the government (i.e. the issuing of subpoenas), especially if outside counsel has a good relationship with the government prosecutors. Top

C. Scope of the Investigation

Whether in-house or outside counsel is hired, this counsel must initially decide what the scope of the investigation is, and how the investigation should be conducted. Again, if the investigation is not entirely voluntary, the scope may already be defined by a formal process from the government, and will most likely parallel the government investigation.

An initial meeting should be held where counsel finds out pertinent information about the corporation and the investigation. Counsel (particularly if outside counsel) should determine the structure of the corporation, the politics within the corporation, and the chain of command, including to whom counsel must report. When the decision of scope is left to the corporation, this must also be discussed.

These issues should be outlined in a resolution from the Board of Directors and/or a letter from an executive officer to counsel. This document should indicate that the Board is seeking legal advice exclusively, and also indicate that the investigation is being pursued in anticipation of litigation. Such a resolution or instruction may later assist in preserving privileges.

Whether the scope should be limited or broad will depend upon the area of concern, as well as the nature of the tip or charge. For example, a charge of discrimination by a specific employee would be more limited then an antitrust allegation. The anticipated scope of the investigation should be spelled out in the initial resolution.

The resolution and instructional letter should also outline the parties, and their roles in the investigation. Important issues to resolve include for whom counsel is serving, to whom counsel must report, who is to receive the ultimate report, who will be the attorney-corporation liaison, who will be in charge of document control, and other such matters.

While this initial resolution will be helpful to outline these matters, counsel should not feel proscribed by the limits set. Counsel should follow all leads until satisfied that all information has been gathered, or that no violation has occurred. The broadening of such an investigation will probably be met with opposition from the corporation that wishes to avoid disclosing problems which are not yet known either to the government, or indeed even high level board members. It should be explained by counsel that prosecutors will follow these same leads, and that it is better for the corporation to become aware of them first. Top

D. Investigative Process

The principle goal of the investigation is to determine what happened, who was involved, for how long, and whether such events constitute violations of the law. Achieving these goals will generally require the gathering and analysis of documents, and interview of employees.

Before attempting a review of documents, counsel should understand the organizational structure of the corporation. This will help counsel determine what documents exist, the location of these documents, the flow of these documents, and under whose care these documents have been. This may all require some initial interview of employees who have this information. In addition, counsel should be aware of how and where duplicates are maintained. In a corporation where emails substitute for paper documents, it should also be determined how access to these messages may be obtained. Counsel should also attempt to note which documents are missing. In the gathering of documents, it may be necessary for counsel to have upper level management instruct all employees to cooperate with the production of documents. A clear letter should be addressed to all appropriate employees explaining the documents needed, as well as the obligation to hand over such documents.

A document organization plan that works is essential to the completeness and accuracy of any investigation and a structure should be created that fulfills this need. For example, there should be a log which notes when documents are received, and when they are reviewed. All original documents received should be numbered, as well as properly labeled as to source. In organizing documents, a room on site should be designated for their location and should be locked at night. If the documents are needed by employees, a copy person should be assigned to make these copies, returning the original to the document room and the copy to the requesting individual. Working copies may be prepared for attorneys for use in interviewing, and for use in creation of a chronology.

Personal documents of employees can be extremely useful for counsel, and should be gathered. This includes items such as calendars, expense accounts, and correspondence. When gathering documents for review, counsel should separate these personal documents from corporate documents. Unlike corporate documents, personal documents will in some ways be sheltered under 5th Amendment protections afforded to individuals. See US v. Feldman, 83 F.3d 9,14 (1st Cir. 1996) (while 5th Amendment does not protect the destruction of incriminating documents voluntarily prepared, it does protect against involuntary preparation and production of incriminating documents). An employee has the right to refuse to produce personal items which may incriminate her. The employee will also have the right not to testify as to the nature or description of the documents. But see In Re Grand Jury Subpoena Duces Tecum, 1 F.3d 87,93 (2nd Cir. 1993) (production cannot be refused "if the government can demonstrate with reasonable particularity that it knows of the existence and location of subpoenaed documents."). This protection probably does not extend to the contents of the documents. See id. at 92.

This issue of discernment between personal and corporate documents is likely moot in the context of some self-regulatory organizations, such as the New York Stock Exchange. Such organizations may require individuals to comply with document requests in order to maintain their license, even documents which might otherwise be protected under the 5th Amendment. See US v. Solomon, 509 F.2d 863 (2nd Cir. 1975).

Written work done by counsel in the analysis of documents will be privileged as work-product, so long as it contains counsel’s mental impressions, opinions, or legal theories. See Hickman v. Taylor, 329 US 495 (1947); Whitehouse v. US District Court for the District of Rhode Island, 53 F.3d 1349 (1st Cir.1994); Savoy v. Richard A. Carrier Trucking, Inc., 178 F.R.D. 346 (D.Mass. 1998). Such documents might consist of charts, chronologies, and the like. These privileges may be waived if counsel discloses this work to a third party. All documents which may be subject to this privilege should be clearly marked privileged so as to avoid confusion and potential inadvertent disclosure. Top

E. Interview of Witness

Which employees will be interviewed depends upon the type of investigation being conducted. Counsel should begin by interviewing those who have been named in the allegation, as well as those who have indicated that they have pertinent information. The document review might also indicate other persons who should be interviewed. Counsel should utilize documents previously gathered in creating a file for each key individual to be interviewed. This file may contain such items as personnel records and calendars.

It will generally be beneficial to have two people conduct the interview. One might actually conduct the interview, while the other takes notes and prepares the record of the interview. It may be better to begin initial interviews with lower level employees, who have less to hide, and may be more willing to tell the whole story. If one starts with upper level management, counsel may find that the interviewees are stonewalling, and following up with lower level employees may be more difficult.

Who counsel represents in an internal investigation may be unclear to employees. Investigative counsel represents only the corporation. ABA Mode Rules of Professional Conduct, Rule 1.13; ABA Model Code of Professional Responsibility, EC 5-18. This information, along with the fact that employee need not speak to counsel, and that employee has the option of obtaining separate counsel should be made clear at the start of the interview. Because the attorney- client privilege is held by the corporation and not the individual employee, counsel should also advise the employee that any information gathered in the interview may be disclosed at the discretion of the corporation. See Upjohn v. US, 449 US 383 (1981). In fact, in some specific instances, counsel may be required to disclose information gathered from the employee, and the employee should be notified as such. For example, the Department of Defense requires that information regarding kickbacks be disclosed to them. U.S.C.A. Title 41 Sec. 57 (1996). While these warnings may make the gathering of information more difficult for the attorney, a failure to give these advisories can cause later problems in the investigation. For example, if the employee believes that counsel is representing her, she may attempt to invoke the attorney-client privilege to protect information she may have already divulged to corporate counsel.

Often counsel is requested to represent present and former employees, in addition to acting as counsel for the corporation. This does not create a problem in and of itself; however, it must be considered carefully before being taken on. See U.S. v. Coneo-Gurrero, 148 F.3d 44,46 (1st Cir. 1998) (no ineffective assistance of counsel where counsel jointly represented co defendants, where each defendant knowingly and voluntarily assumed the risk of potential conflicts). Normally, only low level employees, or those clearly outside the target area, should be represented. If there is any question at all, alternative counsel should be obtained. If joint representation is chosen, a full disclosure of potential problems must be given to both corporation and employee.

Another concern in the interviewing of witnesses is the preservation of privilege for such communications. The corporation holds a privilege as to communications between counsel and certain employees. Under Upjohn v. US, when the interview is held to render legal advice to the corporation, the corporation should be able to claim a broad privilege for all communications between counsel and employees. 449 US 383 (1981); see also US v. Reeder, 1999 WL 118050 (1st Cir. 1999); U.S. v. United Shoe Machine Corp., 89 F.Supp. 375 (D.Mass. 1950). This privilege, of course, protects the communication only, and not disclosure of the facts underlying the communication.

Written work-product of counsel in relation to the interview will be protected under the work-product privilege. See Hickman v. Taylor, 329 US 495 (1947). Verbatim notes taken during the interview will not be privileged, and should not be taken. See U.S. v. Marrero-Ortiz, 160 F.3d 768,775 (1st Cir. 1998) (rough notes taken during a witness interview not considered a ‘statement’, and therefore not subject to production). Notes from the interview that integrate counsel’s impressions, opinions or legal theories will be privileged, and counsel will want to record the interview in this manner.

If there is an external, parallel investigation, counsel should advise employees as to the existence of that investigation, as well as their rights and responsibilities. Government investigators may create situations in which the employee feels pressured to talk (i.e. visits at home), and counsel should inform all employees that they have the right not to talk with government investigators. Employees must also be informed that if they do choose to talk with government investigators, they must be entirely truthful. A general list of Dos and Don’ts should be created for relevant employees detailing these points. Further, if government investigators begin gathering information from employees, the corporation may want to provide counsel to employees to offer advice before they are interviewed by government investigators. At all times, counsel must take care not to give advice which may be construed as coaching, for which they may risk an obstruction of justice charge. 18 U.S.C. Sec. 1512 (criminalizes tampering with a witness, victim or an informant through engaging in "misleading conduct"). Top

F. Reporting Conclusions

When the investigation process is complete, counsel will present the results to the client. If the investigation was mandated, there will probably be a proscribed form in which to present to findings, most likely via written report. If the investigation was voluntary, there are more choices for counsel to consider.

If there has been no violation found, a written report is an acceptable method to transmit the findings of counsel. If counsel needs to report violations to the Board, it is best, at least initially, to issue an oral report. An oral report provides the best protection against waiver of privileges, and can be more difficult for outside parties to obtain. A written summary can always be provided later.

In some situations, even when a violation exists, counsel may opt for a written report. If the corporation is considering self-reporting criminal misconduct to the government, a written report may be the only way to do so. Additionally, a corporation may feel that a written report is necessary for effectively addressing problems that have been uncovered. While an oral report provides the best protection against waiver of privileges, a written report can likely be maintained as confidential under the attorney-client privilege. Any distribution of a written report increases the possibility that available privileges will be waived, so care should be taken that the report is given only to the Board. The report should be marked as confidential and the copies should be numbered. A written report also raises the possibility of libel suits by employees mentioned in the report, and counsel should draft the report with this in mind.

If opted for, a written report should address all critical facts related to the investigation. The written report should also deal with likely government reactions and concerns to the uncovered conduct. Attached to the report may also be documents exculpatory for the corporation, or discussion of an exculpatory theory. There is no proscription against a joint report with an individual potential defendant.

The report, whether written or oral, may contain the following information: recommendation for the firing or censure of an individual, suggested or implemented changes in practice at the corporation, the filing of findings on forms prescribed by the government, settlement of a pending civil action, instigation of legal proceedings, or a decision against action. Top

G. Notification of Officials

At the completion of the investigation, the corporation will need to decide what to do with the information gathered. When the investigation has been voluntary, and counsel has concluded that there has been misconduct, the corporation must decide whether to self-report to the government. This presumes that there is no legal requirement to report to the government.

If criminal conduct is discovered, and the corporation wishes to voluntarily disclose this information, there are specific disclosure procedures required by different agencies. When a disclosure is to be made to the SEC, it can be done through the company’s registration statements, periodic financial filings, or proxy materials. If none of these forms are due for filing, the company can make a specific disclosure on SEC Form 8-K. For corporations involved in banking, violations are reported by the filing of a "suspicious activity report". Corporations which deal with the Department of Defense must contact the Department’s Assistant Inspector General for Criminal Investigative Policy and Oversight to report misconduct.

There are many benefits to self reporting which should be explained to the Board of Directors. The first is that of leniency under the Federal Sentencing Guidelines for Organizations. Corporations convicted of violation of federal law may face heavy fines, criminal liability for corporate officers, and corporate probation. Three recent cases serve as an example of the penalties faced by corporations which covered-up misconduct. Daiwa Bank was indicted on charges involving the cover-up of known unauthorized trades of US Treasury obligations by an employee, and was criminally prosecuted and fined $340,000,000. U.S. v. Daiwa Bank, S.D.N.Y., Docket No. 95 Crim. 947. Salomon Brothers escaped criminal charges involving a similar cover-up; however, the corporation was fined $290,000,000., was required to fully cooperate with prosecutors, and was required to institute strict compliance procedures within the corporation. See In re Gutfreund, et. al., 1992 WL 362753 (S.E.C.) (Dec. 3, 1992). Recent alleged criminal activity within Bankers Trust Corporation may result in the appointment of an outside examiner to counter claims that senior executives mishandled the investigation into criminal misconduct within the bank. The alleged mishandling of the original investigation could lead to disciplinary action against Bankers Trust, including dismissal of top executives in the corporation. Paul Beckett, Bankers Trust Senior Executive’s Role Over Fund Transfers May Be Examined, The Wall Street Journal, June 14,1999 at B11.

Under the Federal Sentencing Guidelines for Organizations, a corporation, which has an acceptable corporate compliance program in place, and which self reports to the government upon uncovering an infraction, cooperates with the ensuing prosecution, and has no high level involvement in the misconduct may be eligible for great reduction in sentencing, or possibly lack of prosecution altogether. As can be seen by these factors, the seriousness of the misconduct impacts the immunity offered to the corporation. Actual practices for prosecution of self reporting companies vary within the Justice Department. For example, the Antitrust Division offers immunity to any corporation which reports criminal misconduct before it is discovered by the government. Most divisions state that if a company self reports, the corporation will probably not be charged. It should be made clear to the corporation ahead of time that there are generally no guarantees.

While there are great benefits in deciding to self report, there are several issues that counsel must consider when advising. Many corporations fear the adverse publicity that may come along with voluntary disclosure. The importance of this consideration will vary depending upon the corporation’s reliance on public goodwill. Counsel must also confront the possibility that misconduct uncovered in the investigation may not be uncovered by the government. In this situation, voluntary disclosure will alert the government to the wrongdoing, and may invite punitive consequences for the corporation where there would have been none. When weighing this factor, counsel must consider the severity of the misconduct and the risk of discovery by the government.

Another major consideration is the potential destruction of privileges. Self-reporting to the government is a disclosure to an outside party, and may be considered as a waiver of applicable privileges. The waiver of these privileges may undermine the corporation’s ability to protect the information from other parties bringing suit. A few courts have adopted the principle of limited waiver. See Westinghouse v. Republic of the Philippines, 951 F.2d 1414 (3rd Cir. 1991) (rejecting per se limited waiver in favor of case by case determination); But see In re Steinhardt, 9 F.3d 230 (2nd Cir. 1993) (rejecting limited waiver). Under limited waiver, information given confidentially to the government may be protected from disclosure to third parties seeking the information. The First Circuit has not ruled on limited waiver, although there is favorable dicta. See U.S. v. Billmyer, 57 F.3d 31 (1st Cir. 1995).

There has been an increase in literature suggesting solutions to this disincentive to disclose. One is a broader recognition of the self-evaluative privilege. See Bredice v. Doctors Hospital, 50 F.R.D. 249 (DDC 1970), aff’d., 479 F.2d 920 (DC Cir. 1973); O’Connor v. Chrysler Corp. 86 F.R.D. 217 (D. Mass. 1980). This privilege protects information gathered in "critical self-analysis", where the gathering of this information advances some public interest. This privilege has been acknowledged at the District Court Level in Massachusetts, but has not been recognized by Massachusetts state courts, nor has it been recognized in the First Circuit. O’Connor, 86 F.R.D. 217. Another solution involves Federal agency support for continued privilege during compliance activities such as audits and investigations. Despite all of this, counsel should assume that information disclosed to the government will be waived as to other parties.

Disclosure to a third party will not be considered a waiver when made under a joint defense agreement. See US v. Schwimmer, 892 F.2d 237 (2ND Cir. 1989). A joint defense agreement may be used when information is transferred between parties which have a common legal interest. This agreement need not be in writing, however, counsel should get the agreement in writing in order to be cautious. A sample joint defense agreement is attached.

A third consideration in making a voluntary disclosure is exposure to a civil suit. Upon notice that the corporation is admitting criminal misconduct, other groups that may have civil claims (i.e., shareholders, vendors, other third parties) may bring suit. Because investigative material has been disclosed, these parties will have a roadmap with which to develop their case against the corporation.

Conclusion

Beginning an internal investigation can be costly, both in terms of time, money and morale. The corporation may have no choice, and, if done quickly, with notification to the authorities if criminal activity is uncovered, can avoid far more costly repercussions later.