In a criminal case alleging multimillion-dollar securities and accounting fraud brought against the former Executive Vice President of Sales of Carter’s Inc., a Georgia federal court is poised to determine whether allegedly incriminating statements given in the course of interviews that were part of an internal investigation conducted by the Audit Committee of the Board of Directors with the assistance of outside counsel and forensic accountants should be admitted as evidence against him in his upcoming trial. The former officer, Joseph Elles, is charged with executing a scheme to defraud Carter’s and its shareholders by concealing and lying about an accounting fraud, causing false SEC filings and falsifying company records. Elles consented to be interviewed by Carter’s outside lawyers as part of an internal investigation launched by the company into accounting irregularities and relationships with wholesale customers that ultimately resulted in the company restating earnings. The Government alleges that Elles made significant admissions during the interview, and Elles has asked the court to bar the use of his statements on grounds that they were coerced, and that the company was effectively acting as an agent of the government in forcing him to waive his Fifth Amendment constitutional right against compelled self-incrimination.
The government has opposed Elles’ attempt to suppress his statements, and indeed has most recently taken the further step of affirmatively asking the court to admit his interview statements into evidence at trial as “incriminating admissions.” To this, Elles has mounted a further attack articulated on October 31, 2012, that doing so could, among other things, pervert the jury’s perception of events out of which the charges against him arise. The ruling by the court on all issues raised by Elles may significantly impact internal investigations conducted by public companies into potential wrongdoing or issues raised in government investigations.
Although companies undertaking internal investigations involving interviews of current and former employees take steps to address procedural fairness and the potential consequences of voluntary participation, in this case Elles makes a fundamental constitutional attack on the process. Corporate internal investigations, and the voluntary disclosure of their results, have grown to be important proactive and cooperative undertakings by companies when dealing with wrongdoing that exposes the company itself to potential enforcement action. Constraints now being addressed by the Georgia federal court, if imposed, could not only significantly reshape the process, but also impact the effectiveness of internal investigations generally.
Internal corporate investigations
Public companies such as Carter’s are incentivized to investigate and self-report corporate wrongdoing, and to cooperate with law enforcement authorities when wrongdoing is uncovered. Their incentive emanates from a series of pronouncements, policies and guidelines beginning with “charging guidelines” originally published in 1999 by the U.S. Department of Justice regarding federal prosecution of corporations. The charging guidelines set the stage for gauging a corporation’s timely and voluntary disclosure of wrongdoing, and its level of cooperation in any government investigation. The original charging guidelines have been revised and superseded several times, but the controlling principle remains in force. As stated in the United States Attorneys Manual, for example:
In determining whether to charge a corporation and how to resolve corporate criminal cases, the corporation’s timely and voluntary disclosure of wrongdoing and its cooperation with the government’s investigation may be relevant factors. In gauging the extent of the corporation’s cooperation, the prosecutor may consider, among other things, whether the corporation made a voluntary and timely disclosure, and the corporation’s willingness to provide relevant information and evidence and identify relevant actors within and outside the corporation, including senior executives.
Guidelines emerged as well from the U.S. Securities and Exchange Commission (SEC) through the Seaboard Report in 2001, and now as carried into the SEC Enforcement Manual. The corporate internal investigation is today the common and single most effective mechanism in meeting the criteria impacting the commencement of civil or criminal actions set out in the array of published government reports, guidelines and manuals. The simple practical result of a company’s compliance with guidelines is the avoidance of any enforcement action directed at the company itself.
Internal investigations dealing with accounting irregularities or other aspects of financial fraud in a public company most often fall to the company’s audit committee, which typically engages the assistance of outside counsel and forensic accountants. Commonly, legal counsel engaged by the audit committee are not the company’s regular outside counsel. Law firms engaged to carry out the investigation develop a protocol and execute the investigation with the assistance of independent forensic accountants. As is commonly the case, the protocol for internal investigations includes interviewing employees and former employees who voluntarily agree to appear and cooperate.
Protocols for internal investigations invariably assure that persons interviewed by outside counsel are given the so-called Upjohn warning, meaning that they are informed whom the attorney conducting the interview represents (e.g., the corporation, and not the employee individually), that the attorney-client privilege belongs to the corporation, and that the corporation may waive the attorney-privilege and disclose the substance of the interview to third parties. The latter element is critically important in that the results of internal investigations are commonly shared with law enforcement authorities. Participation in interviews carried out as part of the internal investigation is voluntary, and interviewees may be represented by their own counsel. These interviews are not the equivalent of custodial interrogations in the law enforcement setting. In what has now been put before the court by Elles in regard to the Carter’s internal investigation, however, that is effectively one of the claims by which he seeks to suppress statements he made in the course of an interview from being used against him in his criminal trial. At that trial the government will claim that in the course of being interviewed as part of the company’s internal investigation, Elles admitted to several elements of the charges against him, and will seek to offer those statements as evidence.
Elles and the Carter’s internal investigation
Elles was employed by Carter’s from 1996 until March 2009, when he resigned his position and entered into a severance agreement. The severance agreement called for Carter’s to pay Elles some $900,000 over a 24-month period following his resignation in exchange for his agreement to cooperate with the company in facilitating a smooth transition of his responsibilities, and to provide reasonable assistance to the company regarding matters that were under his care and control during his employment. Several months after Elles’ resignation, Carter’s learned of a claim by a large wholesale customer for money allegedly owed in accordance with an undisclosed accommodation arrangement. Upon learning of the claim and the asserted arrangement that was inconsistent with representations by Elles to the company, Carter’s suspended Elles’ severance payments pending resolution of an inquiry into the claim.
The Audit Committee of Carter’s’ Board of Directors initiated an internal investigation and retained outside counsel to conduct it. The law firm set about to conduct witness interviews in connection with its investigation, including current and former Carter’s employees. The company delayed its scheduled earnings report for the third quarter of 2009 in order to complete a review of its accounting and accommodations to wholesale customers. Contact between Carter’s and the SEC ensued. At the same time, Carter’s publicly reported that it had self-reported information concerning its review to the SEC, and that outside counsel was assisting the audit committee in an investigation. Outside counsel agreed to provide information to the SEC about the impact of any accounting irregularities and the company’s net income for the periods involved.
As part of the Carter’s internal investigation, outside counsel contacted Elles requesting an interview. Elles requested that Carter’s indemnify him for any costs or fees incurred in any investigation or litigation, and also requested that the company advance his attorneys’ fees. The Carter’s Board of Directors rejected his request. Elles subsequently agreed to be interviewed by Carter’s’ outside counsel, but maintains that he did so in fear that his severance payments would be terminated. At his interview, Elles was represented by counsel, paid for by Carter’s.
Soon after the Elles interview Carter’s announced the completion of its investigation, and disclosed that it had incorrectly reported various customer accommodations in certain periods, and as a result had overstated net sales and net income during those periods. Carter’s also reported that it had been informed of a Justice Department investigation as well as that of the SEC. Subsequently, a federal grand jury indicted Elles (and later another individual) charging multiple securities fraud-related crimes.
Coercion and functional “deputization”of the company to deny constitutional rights?
Seeking to prevent the use of alleged admissions he made to Carter’s outside counsel, Elles argues that he was coerced into appearing at the interview, in violation of his constitutional right against self-incrimination, and further, that in executing the internal investigation Carter’s was effectively acting as an agent of the government, thus further implicating his constitutional right against self-incrimination. Coercion, according to
Elles, resulted from his belief that if he did not submit to the interview, Carter’s would terminate his severance payments, which would have devastating personal financial consequences. The potential loss, he argues, was “economic coercion,” leaving him with no choice but to cooperate, and removing his free choice to remain silent, all in violation of his Fifth Amendment right against compelled self-incrimination.
As for his argument that Carter’s was acting as an agent of the government when it coerced him into waiving his constitutional right, Elles maintains that government enforcement policies, particularly those of the SEC in its Seaboard Report and now in the SEC Enforcement Manual, operate to compel a company such as Carter’s to fully cooperate with government investigations and get their current and former employees to do the same, for fear of civil and criminal charges that could result in the demise of a company. He maintains that companies are compelled to perform investigations that would otherwise be conducted by the government. Some commentators on the internal investigation process generally have suggested that the compulsion of companies now raised as part of Elles’ challenge amounts to de facto “deputization” of companies. In support of his position, Elles maintains that Carter’s was rewarded with the first-ever “Non-Prosecution Agreement” entered into with the SEC -- all at the expense of his constitutional right against self-incrimination. The government strongly disagrees, and the court must now decide whether the circumstances of the interview process in a corporate internal investigation amount to coercive “government action.”
Internal investigations as government action?
A key element in Elle’s challenge to the government’s use of his statements made in the interview is that Carter’s outside counsel in the investigation was effectively acting as the government. Indeed, he has specifically argued to the court that the lawyers “were working hand in glove with the prosecutors,” and that his statement was “set up” by the lawyers and designed to constitute “testimony.” His assertions to this effect are important, in that the court must determine whether there was in fact a close nexus between the government and the internal investigation, such that Carter’s in this case can be fairly considered as acting akin to the government itself. Legal principles have developed in the courts such that in the right circumstances a private actor, such as Carter’s here, could have sufficient nexus to the government. Courts consider the following:
- Did the government coerce or encourage the private actor to engage in the challenged conduct?
- Did the challenged conduct take place while the private actor was a willful participant in joint activity with the government?
- Did the challenged activity take place while the private actor was controlled by an agency of the government?
- Did the challenged activity take place after the government had delegated powers to the private actor that were traditionally the exclusive prerogative of the government?
- Was the government entwined in the management or control of the private actor when the challenged conduct took place?
- Was the private actor so entwined with government policies or so impregnated with a government character that it became a government actor?
- Did a government regulation compel the otherwise private actor to make the challenged decision?
Courts considering these questions have recognized that mere approval or acquiescence in the initiatives of a private party is not sufficient to make the government responsible for those initiatives. Thus, in assessing Elles’ challenge to the Carter internal investigation interview, the Georgia federal court must consider whether internal investigations are, in practical terms, themselves coerced, such that the government effectively acts through them. Elles relies principally on extant government policies and pronouncements, coupled with the pendency of criminal and civil investigations, in support of his contention that this is the case. His claim that Carter’s forced his interview under the perceived pain of terminating severance payments is relevant in the assessment to the extent that the alleged coercion was actually the product of government coercion of the company. But here again, the court will have to determine whether the incentives to engage in thorough internal investigations, to self report and to cooperate with the government equate with government action.
One way or another, the decision on Elles’ constitutional challenge to the use of his interview statements obtained in Carter’s internal investigation will further shape the process. The government aggressively contends that there is nothing in published policies, guidelines, reports or manuals to support the notion that a company like Carter’s, exercising its own business judgment and engaging in efforts to fulfill its duty to shareholders, and the obligations imposed by auditors regarding financial statements transforms itself into an agent of the government, and takes on the obligation to assure that its interviews are conducted in a manner consistent with an interviewee’s Fifth Amendment right against compelled self-incrimination. Elles counters that his statements were, by reason of the company’s economic coercion, not voluntary, and were not the product of a free and deliberate choice. If he is right, and if the court concludes that Carter’s, in carrying out its internal investigation, was sufficiently linked to the government in forcing Elles’ interview, and denying his Fifth Amendment right in the process, the manner of conducting internal investigations would undoubtedly change.
With arguments made to the court on October 1, 2012, the government has ratcheted up the controversy by affirmatively seeking from the court an order that would permit Elles’ interview statements to be admitted into evidence against him as incriminating admissions. In his own arguments submitted October 31, 2012, Elles challenges that attempt not only on the constitutional grounds already before the court, but also on evidentiary and fundamental fairness grounds. Whatever decision is made on any of the issues now before the court, the federal judicial appeals process may ultimately determine if, and to what extent, the corporate internal investigation process will be altered. The pending case is United States v. Elles, Case No. 1:11:-CR-445, United States District Court for the Northern District of Georgia.