Shearman & Sterling LLP
In recent years, government authorities have ever more rigorously pursued corruption. The number and magnitude of recent corruption investigations, particularly in Latin America, have raised questions about the implications for those doing business with entities ensnared in these investigations. The existence of a government investigation should not automatically halt a transaction. History shows that transactions can be executed successfully if the proper steps are taken to identify the risks, manage the impact of the investigation, and craft an effective mitigation plan to isolate the transaction from any prior misconduct. However, if the proper steps are not taken and the process is mismanaged, it can prove fatal to the transaction. Although each investigation is unique, the risks commonly associated with corruption investigations can be grouped into a few categories and each can be managed through a mitigation program. Companies considering a transaction with a subject of a corruption investigation, as well as subjects of such investigations, should consider how these risks apply to the proposed transaction. The risks include: (1) adverse effects on ongoing business and financial challenges; (2) investigations or actions by authorities of other jurisdictions, including additional inquiries into currently uninvolved business divisions and transaction parties; and (3) potential prosecution, penalties and adverse consequences for transaction parties and on certain of their assets. Unless the transaction can wait until the investigation is resolved, parties must address these risks regardless of whether the allegations are ultimately proven to be true or false. The fact that authorities have commenced an investigation means that the allegations must be addressed. The appropriate approach to each risk is driven by the particular facts.
Corporate counsel must also anticipate often unforeseen challenges of corruption investigations. One challenge relates to document management. Legal counsel should take steps to ensure that employees understand that all documents and records related to the allegations must be preserved to avoid liability under the doctrine of spoliation and under the Sarbanes Oxley “Anti-Shredding” provision. Relations with individual employees who are potential and actual witnesses in the investigation is a separate but equally important challenge. Corporate counsel must inform each individual that corporate counsel represents the company and that the individual must consider separate legal counsel. In light of the US Department of Justice’s (“DOJ”) recent focus in the so-called “Yates Memo” on individual accountability (see infra at IV(c)), managing the company’s obligations to and relationships with individual employees and the interests of authorities investigating allegations is increasingly important.
Adverse Effects on Business and Financial Difficulties Experienced by the Company Under Investigation
A corruption investigation usually adversely impacts ongoing business at the target, including disruption to daily operations. Throughout the investigation, company leadership and relevant employees have to devote significant attention to responding to investigative inquiries and developing the company’s defense, which diverts resources and detracts attention from day-to-day management of the business. Investigations that involve authorities from multiple countries often can stretch a company’s management and resources, because management must deal with varying demands and interests of multiple jurisdictions. In recent years, investigations have increasingly involved authorities from several countries. For example, the investigation into corruption at Alstom S.A., a French power and transportation company, which concluded in 2014, involved investigations by US, Swiss, and U.K. authorities. In recent anti-corruption prosecutions, notably the proceeding against Rolls Royce, VimpelCom and Odebrecht S.A., the enforcement authorities from several countries agreed on coordinated proceedings to resolve the investigation. The risks for a target may be exacerbated if the different jurisdictions do not coordinate their investigations, as is currently the case for Odebrecht.
A corruption investigation also impacts the morale of employees. Employees at all levels may become uncertain about their own futures at the company, as well as the future of the company itself, particularly where the investigation is public and there is intense media scrutiny of the company. Moreover, investigations—which inquire into employees’ work, emails and conduct, and often involve interviews of employees—have the potential to disclose not only corrupt conduct, but also non-corrupt but nevertheless problematic employee conduct. Thus, even employees who were not involved in corrupt conduct may be concerned and distracted by the investigation, particularly in jurisdictions where employees expect (and the law may provide) a level of confidentiality in their work communications. Thus, the data collection and interview process in and of itself can give rise to anxiety among the employees. As the findings are reported, employees may become increasingly uncertain about possible employment termination and even personal liability. Finally, corruption investigations can lead to Board level and senior management turnover, which can be especially disruptive to a company’s operations.
A corruption investigation also can disrupt business relationships and future opportunities. Because, under the laws of many jurisdictions, permits, licenses, concessions, and contracts obtained through fraud or corruption are either void per se or voidable, the value of any company is at risk if voided permits, concessions, licenses, or contracts are key to its business. In addition, payment and other performance under contractual arrangements implicated in the investigation may be disrupted. Counterparties also may be reluctant to enter into new business arrangements pending further clarity regarding the implications of the investigation. Financial institutions may curtail, suspend or retract financing support. Finally, the corruption investigation’s impact on the company’s business is further complicated if investigating authorities lack experience calculating fines in corruption investigations. Challenging business prospects and the threat of fines due to the investigation can create liquidity constraints and even lead companies to become unable to pay debts as they are due, obtain new credit when needed, or assure shareholders of the health of the business. In some cases, companies may file for bankruptcy. In 2016, several prominent Brazilian engineering and construction companies involved in the Lava Jato corruption scandal, such as OAS S.A. and Galvão Engenharia S.A., filed for bankruptcy due to a ban imposed by Petrobras on such companies from bidding on new projects.
Additional Investigations by Authorities and Changing Scope of Investigations
Usually corruption investigations are drawn-out and evolve over time. Most investigations take at least a year to conclude and can continue for three to five years, or longer. Although typically the most relevant information is revealed relatively early in the process, new significant information may come to light over the entire course of the investigation. This can impact proposed transactions in several ways. First, new entities and individuals may become a target of the investigation. Being a “target of an investigation” means that authorities believe a business or individual should be charged with criminal wrongdoing. For example, with respect to the ongoing Lava Jato corruption investigation, Odebrecht S.A., a major Brazilian engineering and construction company that often conducted business with Petrobras, and its CEO, Marcelo Odebrecht, were initially the subject of the investigation by Brazilian and US authorities. Marcelo Odebrecht eventually became a target of the investigation, and in June 2015, Brazilian authorities brought criminal charges against him alleging he paid bribes to politicians.
Additionally, any company that has entered into a transaction with a party connected to a corruption investigation, or is planning to enter into a transaction with a party connected to a corruption investigation, should consider the possibility of itself being implicated in the corruption investigation. Even if the transaction party has no connection to the corruption, authorities may interpret any new transaction as aiding or furthering continuing wrongdoing by the original target of the investigation. In such a case, authorities may choose to investigate the transaction or bring charges of aiding and abetting or furthering the corruption. In the United States, a person charged with aiding and abetting, or furthering corruption faces the same penalties as someone who had engaged in corruption himself. Other criminal charges that US authorities bring against parties include fraud and money laundering claims, and charges under the Racketeer Influenced and Corrupt Organizations (“RICO”) Act. Although a conviction requires proof of intent, a company (or its officers) cannot escape liability simply because it (they) lacked subjective intent to violate laws. Intent is determined by the objective facts and circumstances surrounding the events. Therefore, a person can be found to have intended to aid and abet corruption if facts developed at trial establish such intent.
Finally, additional investigations may arise. Lava Jato may be the archetypal example. What began as a Brazilian investigation into a kickback scheme involving certain Petrobras employees has expanded internationally with reports of authorities from the United States, Switzerland and more than a dozen other countries investigating companies and individuals connected to the alleged bribery at Petrobras and beyond. For example, the Odebrecht Plea Agreement in the US Federal Court details bribery by Odebrecht in eleven countries in addition to Brazil, extending well beyond Odebrecht’s relationship with Petrobras. While not every corruption investigation will become as sweeping as the Lava Jato investigation, companies with international operations or relationships may be candidates for multi-jurisdictional corruption investigations.
Potential Prosecution and Penalties
At the outset of any investigation, it is too early to determine potential penalties or liabilities for the targets or other “connected” parties. However, companies may face large fines depending on the magnitude of the corruption, the culpability of the company, and the jurisdiction. In the past, US prosecuting authorities generally have attempted to impose penalties in a manner that allows companies to avoid bankruptcy or significant reorganization. However, prosecutors may have difficulty calculating the penalty that has such an impact.
The penalties that can arise from corruption convictions include fines, jail time, the invalidation of essential permits, licenses, or agreements entered into through corruption, and even the forced dissolution of the Company. If found guilty of violating the US anti-bribery law that prohibits bribing foreign officials to obtain business, the Foreign Corrupt Practices Act (“FCPA”), companies face penalties, including: (i) a US $2 million fine per violation; (ii) a $250,000 fine and five years of imprisonment for each individual officer or employee implicated; and (iii) alternative fines of twice the gross gain or loss in the transaction. In its 2014 Plea Agreement with the DOJ, Alstom pleaded guilty and paid $772 million to resolve charges of a widespread scheme involving tens of millions of dollars of bribes paid in various countries, including Indonesia, Saudi Arabia, Egypt, the Bahamas, and Taiwan. Authorities may also impose an independent monitor upon a company, which would subject it to further inquiry, not to mention administrative burden and expense, and burden to morale, something the DOJ and US Securities and Exchange Commission (“SEC”) required as part of a three-year deferred prosecution agreement and a settlement agreement, respectively, to resolve charges of books and records violations of the FCPA by Siemens in 2008. Non-US authorities may also impose their own penalties in conjunction with US authorities. In 2008, Siemens, in addition to pleading guilty to FCPA violations, agreed to pay $450 million in criminal fines to resolve charges with the DOJ, $350 million in disgorgement of ill-gotten gains to resolve charges with the SEC, and penalties of €395 million ($560 million) to German authorities. In an interesting development, the Odebrecht penalty in connection with a resolution in the US, Switzerland and Brazil was calculated on the basis of the US Sentencing Guidelines. The use of the US Sentencing Guidelines to calculate the penalties in non-US proceedings is a hopeful sign of increased coordination among jurisdictions as to penalties.
Ways to Mitigate Risk
Given these and other related risks, the prospect of executing a transaction in the midst of a corruption investigation can be daunting. However, often these risks can be managed through a well-planned mitigation program. The common goals of a mitigation program include: (1) obtaining as much information as possible about the corruption allegations and investigation, particularly whether the corruption is ongoing; (2) implementing or revising the compliance program at the target (and, potentially, their contractors) so that it is in line with international best practices; (3) assessing the impact on business and isolating the transaction from liabilities arising from the investigation; and (4) cooperating and maintaining a dialogue with authorities to avoid the appearance of aiding an ongoing corruption scandal. While any mitigation program should be tailored to the needs of each transaction, the methods discussed below are designed to avoid pitfalls experienced by parties in past transactions, and to help parties move forward with transactions involving parties ensnared in corruption investigations.
Investigation Into the Allegations of Corruption
The principal goals of any mitigation program include determining the extent of the corruption, minimizing the impact of past or ongoing corruption on the transaction, and evaluating the potential impact of the alleged corruption on the value of the business. Such information is typically collected and identified through an independent, internal investigation. A thorough and independent investigation is critical to sound and predictive decision-making, because government investigations are unlikely to provide much substantive insight into the alleged corruption until they are complete, often years after they began. Because transactions cannot be delayed for years, and to reduce the risk of unknown disclosures years in the future, transaction parties should use due diligence and, as necessary, independent investigations to learn as much about the corruption as possible. Therefore, parties should begin planning an independent, internal investigation as early as practicable. While targets may have the urge to withhold information from transaction parties about the allegations of corruption and delay commencement of an independent investigation, it is generally better in the long run to disclose allegations of corrupt activity and to commence addressing the resulting counterparty concerns sooner rather than later, even if the target questions the merit of the allegations.
The case of Latin Node Inc. (“Latinode”), a Florida telecommunications company, and eLandia International Inc., a Miami-based information and communications technology company, illustrates how the impact of a lack of thorough due diligence and investigation can cause a company to overpay in a transaction. In 2007, eLandia acquired Latinode, but discovered post-closing that from March 2004 to June 2007, Latinode made over $1 million in payments to third-party intermediaries who passed funds to Honduran officials in exchange for an essential interconnection contract with Hondutel, a state-owned telecommunications company. eLandia voluntarily disclosed the illicit payments to the DOJ and cooperated with the government’s investigation. However, as the parent company, eLandia was ultimately responsible for Latinode’s $2 million criminal fine. Of more significance than the fine, however, was Latinode’s drop in value and subsequent bankruptcy proceedings. As explained earlier, contracts obtained through corruption are often void per se or voidable under applicable law and that was the case for key Latinode contracts. In its second quarter 10-Q filing, eLandia estimated that, as a result of Latinode’s corruption, the $26.8 million purchase price was approximately $20.6 million in excess of the fair value of the assets acquired from Latinode.
eLandia’s reliance on Latinode’s representations during the acquisition demonstrates the importance of learning in detail how the corruption was conducted and by whom. Such details include the payment mechanisms used by the company, such as payroll or invoices, as well as any other sources of information about the corruption. To do so, parties must request access to original transaction documents and informal communications like emails, as well as documents relating to ancillary transactions, such as the fake consulting agreement used by Latinode, and then assess the effects of the potentially corrupt transaction. This includes any related permits, licenses, and contracts that may be obtained through corrupt payments. Generally speaking, the procedure is to “follow the money.” Once there is a detailed understanding of the corrupt activity and of the people involved in or knowledgeable about that activity, investigators (either with other transaction party investigators or separately) should interview as many of those people as possible. At times, employees can be reluctant to speak to investigators, but employee interviews often provide context and information that is simply unavailable in documents and records. For obvious reasons, it is typical for there to be very limited direct documentary evidence of corrupt transactions, and interview testimony is thus often crucial in understanding the transactions and events at issue.
Coordinated investigations by transaction parties may help to avoid the pitfalls experienced by eLandia. In 2007, Siemens AG, the German engineering and manufacturing conglomerate, and Nokia Corporation, the Finnish communications and information technology company, successfully closed a joint venture after several jurisdictions launched independent investigations into Siemens and some of its subsidiaries for allegations that Siemens had permitted corrupt payments to occur. For example, the DOJ found that Siemens used off-book accounts to make corrupt payments, entered into purported business consulting agreements with no basis, hired former Siemens employees as purported business consultants to make corrupt payments, used false invoices to justify payments to business consultants, mischaracterized corrupt payments as legitimate expenses, and limited the quality and scope of audits of payments to business consultants. Additionally, the DOJ found that Siemens lacked sufficient anti-corruption compliance controls and its senior management failed to take action even after they were informed of significant control weaknesses.
To understand the extent of the corruption at Siemens, Nokia closely monitored Siemens’s investigation into corruption, bribery, and internal controls. Ultimately, Siemens pleaded guilty to a lack of sufficient anti-corruption compliance controls. The company was fined $450 million by the DOJ. As part of a settlement in a parallel SEC suit, Siemens was required to disgorge $350 million dollars in ill-gotten profits. On the same day, the company announced that it had entered into a second settlement with the German authorities, agreeing to pay penalties of €395 million ($560 million) in addition to the €201 million ($287 million) in penalties that it previously paid in an earlier settlement. In all, Siemens paid more than $1.6 billion in penalties as a result of its corrupt activities, which remains the largest amount in FCPA history to date. Although these penalties were unprecedented, the results of the investigation and mitigation procedures were favorable for both Siemens and Nokia. The joint venture was preserved, and Nokia eventually fully acquired Siemens’s stake in 2013 without any allegation that the joint venture participated in the corrupt conduct.
Review and Enhance Compliance Program
When allegations of corruption arise, parties should look to put in place an anti-corruption compliance and monitoring program that meets international best practice standards before any transaction is completed. The successful institution of such a compliance program can save a company millions in fines and lawyers’ fees, whereas an inadequate (or no) policy could result in years of further inquiry by authorities, additional costs associated with prolonged monitorship, such as attorneys’ fees, and even selling off businesses due to continued involvement in corruption. To do so, transaction parties should put in place document retention policies that create a formal procedure for retaining documents with any connection to the transaction. Document retention policies carry a special risk in the context of investigations, which will be discussed in detail in a subsequent section. See infra at IV(a). Following implementation of a document retention policy, an independent team should review the compliance policy of the entity under investigation and should recommend enhancements designed to prevent future similar issues based on international best practice standards. An enhanced policy should then be adopted and rigorously implemented.
The realities of the risks of additional costs due to an inadequate compliance program were demonstrated in the case of Vetco Gray. On June 22, 2004, the DOJ charged ABB Vetco Gray, Inc. and ABB Vetco Gray UK Ltd., two subsidiaries of ABB Ltd. that developed oil exploration technology, with violations of the FCPA for their role in bribing Nigerian officials in an effort to facilitate the procurement of oil contracts. The companies allegedly had made corrupt payments of over $1 million to a Nigerian agency that approved bidders for oil exploration contracts. As part of their plea agreement with the DOJ, the companies were each fined $5.25 million and were required to disclose all information related to an ongoing internal investigation into other instances of corruption and to implement an effective compliance program.
Around the time of the plea agreement in 2004, a consortium of investors was in the process of acquiring Vetco Gray. The investors asked the DOJ to issue an Opinion Release outlining their responsibilities in implementing the compliance system required by the DOJ. The DOJ required effective internal controls, training, and other procedures designed to deter and detect future violations of the FCPA. It did not take action against the investors for violations of the FCPA committed prior to their acquisition of Vetco Gray. Despite Vetco Gray’s 2004 commitment to implement an effective compliance program, the corrupt payments to Nigerian officials continued until about April of 2005, which the company voluntarily disclosed to authorities.
As part of a 2007 deferred prosecution agreement between Vetco Gray and the DOJ, the company agreed to several commitments: (1) to pay $26 million in criminal fines, (2) the appointment of an independent compliance monitor to oversee and maintain a robust compliance program, (3) to undertake a complete investigation of companies originally identified in the DOJ’s Opinion Release, and (4) that any future purchaser would be bound to these commitments. Around this time, GE Oil and Gas was in talks to purchase many of Vetco Gray’s assets for $1.9 billion; however, GE Oil and Gas required the case to be settled and all fines paid before the purchase took place.
In the case of Vetco Gray, the failure to actually implement an effective compliance program, internal controls, and training programs resulted in continued FCPA violations and significant additional criminal fines and sanctions imposed by the DOJ. Although Vetco Gray did voluntarily disclose the corrupt payments in both instances, neither Vetco Gray nor its original acquirers implemented sufficient controls necessary to stop the corrupt activity. The result of the acquirers’ inability to implement an effective compliance program was a cost of $26 million.
Alternatively, substantive, effective improvements in a company’s compliance program may result in more favorable treatment by authorities and a certain level of insulation against further fines. In October 2007, the DOJ agreed to defer prosecution against York International Corporation (“York”), a Pennsylvania heating, cooling, and refrigeration manufacturing company, for conspiracy to commit wire fraud and to violate the books and records provision of the FCPA. From November 2000 to March 2003, a York subsidiary allegedly used a Jordanian company as an intermediary to make a series of indirect kickback payments to the Iraqi government in exchange for receiving contracts to supply its products to various Iraqi ministries and governmental departments. From 1999 through 2005, York subsidiaries allegedly authorized hundreds of kickbacks to employees of government customers and contracts of government customers to obtain government projects in various countries, including Bahrain, Egypt, India, Turkey, and the United Arab Emirates.
On October 1, 2007, York entered into a three-year deferred prosecution agreement with the DOJ, under which York agreed to pay $10 million as a penalty and to improve compliance policies and procedures. In a related matter with the SEC, York agreed to pay over $10 million in disgorgement and prejudgment interest, a $2 million dollar civil penalty, and to improve its compliance policies and procedures. Under both agreements, York was also required to submit to the appointment of an independent monitor for its compliance program. Despite multiple instances of corrupt payments across decades in several countries, the DOJ and SEC cited York’s enhanced compliance policies and procedures and its willingness to have the compliance program reviewed by an independent monitor among the reasons why it did not pursue criminal charges against the company. Subsequently, that compliance program helped reduce the resulting impact when bribery and embezzlement at another part of York was discovered and reported to the SEC and DOJ. The DOJ declined to prosecute the company citing its cooperation, voluntary disclosure and extensive compliance efforts, while the SEC, citing similar factors, brought an administrative proceeding resulting in a small civil penalty and disgorgement for improperly obtained business.
Given the impact that enhanced compliance policies and internal controls can have on the potential for deferred prosecution agreements and fines imposed by regulators, parties should focus on gathering information and developing compliance programs early in the investigation process. Acquirers of entities under investigation can be held responsible for the acquiree’s subsequent compliance with the FCPA. In light of the DOJ’s recent retention of a full time Compliance Counsel Expert, the DOJ is likely to continue to make compliance a priority.
Structuring the Transaction Accordingly
Transaction parties may also structure the transaction to address risks of potentially negative consequences of an investigation. Such measures include structuring around any potential impairment of creditworthiness of the investigated party to the extent relevant to the transaction. Parties may also manage cash flows from the proposed transaction to minimize any implication that the transaction is being used to further any alleged corrupt conduct in business unrelated to the transaction. Finally, transaction parties may also include a set of conditions to closing, such as satisfaction of the counterparty with the investigative process and its conclusion. These conditions may allow one party to build a right to terminate the agreement in the event the other party did not meet certain conditions. Through such conditions, principals of transactions, and by extension their lenders, would not be liable for terminating an agreement in light of the negative effects of a corruption investigation and would thus manage their risk exposure.
For example, Lockheed Martin Corporation, an American aerospace company, was able to terminate a merger agreement with Titan Corporation, an American information and communications company—without paying a hefty termination fee—in light of Titan’s inability to resolve a pending DOJ investigation into alleged corruption at Titan. In 2003, Lockheed entered into an agreement with Titan under which Lockheed would acquire Titan. During that time, the DOJ and SEC were pursuing parallel investigations over alleged violations of the FCPA relating to the provision of wireless telecommunications projects in Benin by certain Titan subsidiaries. According to the SEC, Titan paid more than $3.5 million to an agent in Benin to secure the re-election of Benin’s incumbent president and thereby enable the company to develop telecommunications projects there with his support. The SEC alleged that Titan failed to devise or maintain an effective system of internal controls to prevent or detect FCPA violations, and that Titan had falsified documents filed with the United States government and underreported commission payments in its business dealings in France, Japan, Nepal, Bangladesh, and Sri Lanka.
Aware of these ongoing investigations, Lockheed built into the merger agreement a right to terminate in the event that (1) Titan failed to obtain written confirmation from the DOJ that the investigation had been resolved and that the DOJ did not intend to pursue charges against Titan; or (2) Titan had not entered into a plea agreement on or prior to June 25, 2004. As of June 26, 2004, Titan had not satisfied either requirement, so Lockheed terminated the merger agreement despite the fact that Titan had lowered the acquisition price by $200 million. Titan eventually pleaded guilty to anti-bribery violations and subsequently was acquired by L-3 Communications. While not all parties will be able to agree upon as favorable terms as Lockheed, parties will be able to mitigate the impact of contingencies, such as delayed resolution of investigations conducted by authorities, and move forward (or not) with transactions accordingly.
An example of the consequences of delaying the modification of the contemplated transaction’s structure in light of a pending corruption investigation was observed in connection with the Gasoducto Sur Peruano pipeline project in Peru. In that project, Odebrecht was the lead sponsor and EPC contractor when its involvement in the Lavo Jato investigation in Brazil became public. For more than a year, while Odebrecht’s activities in Peru were the subject of media speculation, the structure of the transaction remained unchanged. Ultimately, while the structure was changed, given the uncertainties which then existed, the parties were unable to implement mitigating measures before the Government of Peru determined not to extend a key deadline for the project and, as a consequence, permanent financing for the project could not be obtained and resulted in the project’s collapse.
Dialogue With the Government Authorities
Throughout the process, it will be important to establish an open and transparent dialogue with the regulators undertaking the governmental investigations. Typically, government investigators do not provide substantial input to the transaction parties’ efforts to mitigate risks from the corruption investigation. However, transparency and open conversation with the authorities will benefit parties so that the authorities do not misunderstand the goals or activities of the transaction. In doing so, at least to some degree, government investigators may provide limited guidance about any issues they observe. In the case of Vetco Gray, the acquirers were able to obtain an Opinion Release from the DOJ, which provided guidance on the acquirers’ responsibilities. In addition, past cases demonstrate that US authorities take into consideration early disclosure and candidness with the government. In 2007, the DOJ highlighted York’s “early discovery and reporting of the kickback payments, its thorough review of those payments, as well as its discovery and review of improper payments made in other countries,” in its agreement to defer prosecution. Similarly, the SEC took into consideration the fact that York self-reported kickback payments to the United Nations Oil-for-Food Program in its settlement with York.
Unforeseen Challenges for Corporate Counsel in Corruption Investigations
Corporate counsel faces two major pitfalls during corruption investigations; one related to documents and the other related to witnesses. Both issues present distinct challenges. First, a notice to preserve all documents related to allegations should be put into place as soon as an investigation is on the horizon to avoid altering and destroying evidence. Second, corporate counsel involved in the investigation must keep counsel’s obligation to represent the company balanced with often longstanding personal relationships with individual employees or members of management.
Preservation of Documents and the Sarbanes-Oxley “Anti-Shredding” Provision
A crucial component of any corruption investigation is the collection and preservation of documents, given the importance of obtaining as much information as possible about the corruption and the impact of the corruption on the entity. Document preservation, of course, cannot be discussed without mentioning the now infamous case of Arthur Andersen. In Arthur Andersen, the government charged and convicted Arthur Andersen LLP, Enron’s accounting firm, with obstruction of justice by encouraging employees to shred two tons of documents. In 2005, the Supreme Court reversed the conviction in a unanimous opinion, reasoning that the destruction of documents was not “corrupt” within the meaning of the federal obstruction statute in place at the time. However, by the time the Supreme Court had made its ruling, the firm had already failed. The collapse of Arthur Andersen continues to serve as an example of the dramatic consequences of failure to properly preserve documents.
Despite the ultimate decision reached in the Arthur Andersen case, document retention policies should be tailored with the “anti-shredding” provision of the Sarbanes-Oxley Act of 2002 in mind. The Sarbanes-Oxley Act[67 ] prohibits the knowing tampering of records or documents with the intent to impact a federal investigation. The provision imposes criminal liability for anyone who “knowingly alters, destroys, mutilates, conceals [or] covers up . . . any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States. . . .” Any person found guilty of violating the statute faces fines and up to 20 years in prison.
Document retention policies need to be carefully crafted and followed because the statute has broad application. The inclusion of the word “knowingly” provides that a person needs only to know that he is destroying or changing a document with the intent to interfere with an investigation to be found liable. A person does not need to have a malicious intent to violate the statute. Additionally, the statute requires only that the person contemplate an “investigation or proper administration of any matter” within the jurisdiction of the federal government. Therefore, a person who tampers with evidence with the purpose of impacting a possible investigation in the future—even if one has not formally commenced—may have violated the statute.
As an example of the practical application of the “anti-shredding” provision, a CFO might be found liable under the statute for sending out an email reminder to employees to follow the company’s standard document retention policy, which calls for the routine destruction of documents, and attaching the policy with the purpose of avoiding disclosure to the DOJ of financial documents that suggest unauthorized payments to a foreign official. While in our example the CFO has not heard that the DOJ was looking to investigate the company, he expects that these documents would be problematic if the DOJ were to commence an investigation. The CFO likely has met the requirements for knowingly causing documents to be destroyed under the statute, because he (1) knowingly (without mistake or by accident) has likely caused the destruction or alteration of documents; and (2) sent out the email intending to impact a federal investigation. Although he does not know of an actual DOJ investigation, he likely falls under the statute, because he intended to influence one that he can reasonably expect to occur.
While some may feel tempted to allow a smoking gun or problematic documents to “disappear” in the absence of a pending or imminent investigation, one should fight the urge to do so. If problematic documents have been identified or an investigation is reasonably suspected to commence in the near future, a “freeze order” memorandum should be sent to relevant employees, the information and technology department of the company, and any person who may alter the records, such as third party storage providers, in order to preserve the documents and electronic records—simply sending the company’s standard document retention policy does not suffice. Moreover, the “freeze order” should not generally instruct employees to “save all information.” Rather, the notice should inform recipients of the types of documents and data to be preserved (e.g., emails, documents, chats, text messages, etc.), the areas of storage of concern (e.g., laptops, shared drives, databases, etc.), steps to properly preserve the information, and persons who control the relevant information. Once the notice is sent, the relevant personnel should follow up to confirm that the documents and records are being preserved in accordance with the “freeze order.” In light of the minimal level of knowledge required under the statute, red flags of problematic documents or efforts to tamper with documents should not be ignored, especially when an investigation is looming.
Ethical Obligations of Corporate Counsel
The ethical rules clearly provide that company counsel identify any potential conflict of interests between the company and its officers and employees, and clarify corporate counsel’s role in an investigation. ABA Model Rule of Professional Conduct 1.13 requires that corporate counsel “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.” ABA Model Rule of Professional Conduct 4.3 requires that:
In dealing on behalf of a client with a person who is not represented by counsel, a lawyer shall not state or imply that the lawyer is disinterested. When the lawyer knows or reasonably should know that the unrepresented person misunderstands the lawyer’s role in the matter, the lawyer shall make reasonable efforts to correct the misunderstanding. The lawyer shall not give legal advice to an unrepresented person, other than the advice to secure counsel, if the lawyer knows or reasonably should know that the interests of such a person are or have a reasonable possibility of being in conflict with the interests of the client.
In other words, the Model Rules require corporate counsel to be crystal clear that he or she represents only the company, not the individual, in the event a conflict of interests arises in the course of an investigation. Company counsel must also refrain from giving legal advice to the individual other than to obtain separate counsel. As an example, the CEO may have authorized illicit payments to government officials in exchange for business contracts, which may subject the CEO to individual prosecution. Any confidences shared between the CEO and the general counsel may give rise to future conflict issues that could force counsel to resign from the company and/or face a bar ethics review board. As a result, the moment that an employee, particularly a senior executive, is implicated in wrongdoing, company counsel must make clear his or her role as legal counsel for the company, not the individual. This problem may be particularly acute in a closely held company where the managers are also substantial owners. Counsel should also unmistakably advise the individual to secure separate legal counsel.
While not a case involving allegations of corruption, a 2009 criminal case against the former chief financial officer (“CFO”) of Broadcom Corporation, a US semiconductor company, is illustrative of the consequences of failure to clarify the role of corporate counsel to witnesses and potential targets in investigations. In this case, a judge admonished Broadcom’s law firm for failure to properly inform the former CFO, William Ruehle, that the law firm represented the company, not the CFO. In 2006, Broadcom retained the law firm in connection with an internal investigation of stock option granting practices. Civil lawsuits were also filed against the company and the CFO in connection with these practices. The law firm met with the CFO to discuss the company’s stock option practices, but the lawyers failed to clarify that they did not represent the CFO in his individual capacity. Eventually, the law firm did advise the CFO to hire separate counsel with respect to the investigation and civil suits. However, in light of the law firm’s failure to inform the CFO at the initial meeting discussing the stock option practices, the judge suppressed the CFO’s statements from the initial meeting.  The judge found that the law firm engaged in ethical misconduct that compromised the rights of the CFO and referred the law firm for discipline by the state bar. 
An appellate court eventually reversed the judgment but did not address misconduct by the law firm or the failure to provide adequate warning of the role of the law firm in the investigation. Rather, the appeals court found that the CFO’s statements to the attorneys were not made in confidence, because the CFO knew or should have known that the information provided would eventually be disclosed to third parties. Nevertheless, the appellate court described the lawyers’ actions as “troubling” and acknowledged the “treacherous path” that counsel faces when conducting investigations.
Providing an Adequate Upjohn Warning
When treading the treacherous path of internal investigations, several steps can be taken to avoid complications, such as those seen in the Broadcom case. First, those managing an investigation should evaluate very early on whether any party will require separate counsel, even before an investigation formally begins. Second, the opportunity to obtain separate counsel should be provided, ideally before any substantive information is learned from the party. The Upjohn warning, also known as the corporate Miranda warning, is usually used to do so. The typical Upjohn warning consists of advising the witness of the following:
- That counsel represents the company, not the individual, and that the individual may choose to obtain separate counsel prior to speaking with the company’s lawyers;
- That the purpose of the conversation or interview is to provide legal advice to the company, not the individual, in relation to the investigation;
- That the conversation is therefore covered by attorney-client privilege and is confidential; and
- The privilege belongs to the company, so the company—but not the individual—may share information from the conversation to third parties, including the government, without permission or notice to the individual.
While not explicitly required by the Model Rules, it is prudent practice to memorialize in writing when and how the Upjohn warning is given to employees and their acknowledgement thereof, as well as to standardize the Upjohn warning that is used. Corporate counsel likewise should provide the Upjohn warning to involved individuals as soon as an investigation can be anticipated in the foreseeable future. Such measures may avoid any uncertainty about the use and sufficiency of the Upjohn warning seen in the case of Broadcom.
Finally, it is important to note that the Upjohn warning is not a substitute for a waiver of conflict of interest. The Upjohn warning ensures that the individual understands that the corporate attorneys do not represent the individual, and the acknowledgement of the Upjohn warning allows corporate counsel to speak with the individual about the investigation subject matter. The acknowledgement of the Upjohn warning does not constitute a waiver of conflict of interest or permission for corporate counsel to represent the company and the individual.
The Yates Memo and the Evolving Focus on Corporate Cooperation and Individual Accountability
Clarifying and memorializing the scope of corporate representation and employees’ roles in investigations is increasingly important in light of the DOJ’s focus on individual accountability. In September 2015, the Department of Justice announced policy initiatives to facilitate prosecutions of individuals in corporate cases, which have been outlined in the Yates Memo. While the Yates Memo is not binding law, in November 2015, these changes to DOJ policy were incorporated into the Principles of Federal Prosecution of Business Organization of the US Attorneys’ Manual, which serves as practical guidance for DOJ attorneys investigating corruption.
The Yates Memo lists six key steps that federal prosecutors should take to pursue individual corporate wrongdoing. In brief, the six steps consist of:
- To qualify for any cooperation credit, corporations must disclose all relevant facts relating to individuals responsible for misconduct;
- Criminal and civil investigations should focus on individuals from the outset;
- Criminal and civil attorneys handling investigations should routinely communicate;
- Absent extraordinary circumstances or prior approved policy, culpable individuals will not be released from liability;
- Matters will not be resolved with a corporation without a clear, memorialized plan to resolve related individual cases; and
- Civil attorneys should focus on individuals and evaluate bringing a suit seeking penalties beyond the individual’s ability to pay.
The Yates Memo is only the latest iteration of DOJ policy focusing on corporate liability, and is consistent with recent DOJ practice focusing on individual culpability. In June 1999, the DOJ issued the Holder Memo that laid out “non-mandatory” factors that DOJ attorneys were to consider when deciding to bring charges against a corporate entity. In subsequent years, the Holder Memo was superseded by a succession of various memoranda, including the current Yates Memo. In a September 2014 speech, Principal Deputy Assistant Attorney General Marshal Miller spoke about how the lack of timely and complete cooperation effectively frustrates the pursuit of individual prosecutions and that companies facing government investigations should focus on evidence of individual culpability in order to obtain full cooperation credit. However, the Yates Memo departs from previous policy by requiring companies to disclose all information about individuals involved in or responsible for misconduct to receive any cooperation credit.
The changes to DOJ policy outlined in the Yates Memo affects considerations for corporate counsel facing corruption investigations in several ways. First, the policy gives greater importance to identifying all individuals, including senior management, who may be involved in or responsible for the corruption. Because a company must disclose all relevant facts related to all individuals who may be involved, counsel will not be able to selectively provide information about lower level employees—while not disclosing facts regarding management level employees—involved in or responsible for the misconduct for the purpose of obtaining cooperation credit. Second, because the DOJ’s civil and criminal investigations will “focus on individuals from the inception of the investigation,” employees may want to obtain separate counsel earlier in the investigation process than previously seen. Therefore, corporate counsel should carefully craft and monitor the use of the Upjohn warning as previously discussed.
However, the Yates Memo, in requiring disclosure of all information about individuals involved in or responsible for misconduct to receive any cooperation credit, leaves open whether a company waives attorney-client privilege when disclosing such information. Under any earlier version of the DOJ memos, a critical question was whether a company was required to waive attorney-client privilege when disclosing information to the DOJ as part of cooperation efforts. In 2007, the DOJ attempted to clarify its policy through the McNulty memo, which stated that companies were not expected to waive attorney-client privilege for attorney work product created during an investigation, but that disclosure of “purely factual information” could be considered in determining whether the company has cooperated with the government. Yet, if a company discloses information about individuals that the company has determined to be involved in or responsible for misconduct, it raises the question of whether the DOJ has reverted back to a de facto policy of requiring waiver of privilege to obtain cooperation credit.
The Yates Memo also brings to light a recurring question about separate counsel for individual employees when cooperating with regulators during investigations. In 2006, United States v. Stein, also known as “the KPMG case,” clarified that DOJ pressure on companies to cease paying attorneys’ fees for employees as a sign of corporate cooperation—which was in accordance with the Thompson Memo in place at the time—violated the Fifth and Sixth Amendment of the US Constitution by denying those individuals due process and the right to counsel. The judge in the KPMG case found that initially KPMG had agreed to pay for legal representation for KPMG officers facing potential criminal allegations in accordance with longstanding corporate policy; however, meetings with prosecutors made clear that payments of legal fees for employees would not be viewed favorably by prosecutors when considering whether KPMG would be indicted for creating fraudulent tax shelters.
Given the DOJ’s and the SEC’s increased interest in individual accountability and compliance, as well as other jurisdictions’ focus on anti-corruption efforts, more investigations and enforcement actions related to corruption are likely on the horizon for 2017 and beyond. Because investigations continue on for years, often without a clear end date, it would be impractical for companies and interested business partners to consider waiting for them to conclude. There are undeniable risks in and challenges to executing business transactions with a company that is subject to a corruption investigation. Despite these risks and challenges, a number of precedents demonstrate that such transactions can be completed effectively if proper measures are taken to perform due diligence on any potential adverse impact on the transaction due to past conduct, to isolate the alleged misconduct from the proposed transaction, and to implement effective policies and controls to ensure that future misconduct does not occur.
This paper was originally published by the Rocky Mountain Mineral Law Foundation in the manual of the Special Institute on International Mining and Oil & Gas Law, Development, & Investment (2017).
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