This article was published in slightly different form in the November 26, 2007 issue of the National Law Journal.
Both companies and their boards today increasingly rely on internal investigations as a powerful strategic tool. These projects are used to identify relevant facts and develop legal analyses to assist in decision-making necessary to address suspected or alleged internal wrongdoing or malfeasance. Internal investigations also can help company leaders and directors demonstrate to shareholders, enforcement officials and the public that they are meeting exacting standards of corporate oversight and the legal responsibilities of their positions. But not all internal investigations are created equal. The credibility of the result of an investigation, and thus its utility, depends in large measure on the credibility of the process by which its conclusions are obtained.
The internal supervision of an investigation and the selection of resources to do it are crucial to its credibility. Therefore, many companies and boards turn today to the option of conducting an "independent investigation" as a means to enhance the value of the undertaking. In an independent investigation, the internal control over the project may be by a board, one of its committees or the company itself (typically through the general counsel personally), whichever might be seen as most attenuated from the conduct or activity subject to inquiry. The supervising entity, in turn, engages outside resources without significant ties to the company to do the work. This model helps to reassure shareholders that corporate decisions will be taken on unbiased sets of facts and independent legal analyses of the circumstances in question. In addition, regulators and enforcement officials typically perceive a fact-gathering process carried out by independent lawyers under the supervision of uninvolved management or independent directors as a more credible process than other alternatives.
However, the value of independence has to be weighed against the insight and efficiency that flows from having outside counsel familiar with the company conduct the investigation. A key to effective investigations is understanding the nature of the business underlying the questioned conduct. Without that understanding, it is too easy to miss the significance of particular facts and issues, especially when relatively esoteric commercial practices or imperatives may be the driving force behind the conduct. Counsel familiar with the business and what drives it are likely to have a significant head start on others who will have to climb a learning curve to get to the same place.
Use of outside counsel demonstrates independence
Since an investigation's value is based significantly upon its credibility, using experienced outside counsel can make the difference in helping a company and its board demonstrate the reliability of conclusions to regulators, enforcement officials, shareholders and the general public. Also, conducting effective and efficient investigations is a decided specialty. Companies typically turn, therefore, to outside lawyers who have both expertise and experience in conducting internal investigations and a reputation for credibility and skill with regulators and the general investing public. This factor is important simply because regulatory and enforcement officials evaluate investigations and their results based in part on their estimation of the investigators' reputation and skill. In particular, when an allegation can be shown to lack merit, that conclusion will be more believable if it comes from an independent investigation led by respected attorneys and conducted under the supervision of relatively independent internal company authority.
Another early issue that the investigating lawyers and the company should determine together is whether the investigation and its work product will be privileged. Frequently, one of the reasons an inquiry may be necessary is to support required or prudentially well-advised public disclosures and/or voluntary disclosures to enforcement authorities. At the same time, when such disclosures constitute a waiver, they can potentially expose to discovery by third parties all of the results of the investigative matter, not just the material selectively disclosed. Analysis of the best course will depend on the particular circumstances of each investigation, but the issue should be identified and addressed at the start. That way, the investigation can be undertaken in a manner consistent with how the board and company expect to treat the resulting information. The individual or group supervising the project for the company should maintain active liaison with the counsel conducting it in order to oversee it properly. Informed joint decision-making between the company and investigators requires open, clear lines of communication, since investigations seldom follow a predictable path. In addition, when a board committee supervises an investigation, communication with the entire board is well advised. Not doing so runs the risk that the nature, conduct and extent of the investigation may be questioned after the fact by uninvolved board members, and this can impair the board's collegiality and smooth functioning. An exception, of course, is when the issues involve the conduct of other board members or when senior management potentially involved in the investigation matter sit on the board as inside directors.
For most companies, addressing and controlling costs is an important aspect of directing an investigation. Most investigations are costly undertakings, necessarily involving document review, interviews and factual and legal analyses. A company should understand the reasons for using forensic accountants, information technology experts and other types of investigators, since the extent to which an investigation takes advantage of these types of resources can have a significant impact on its cost. Also, when disclosures are contemplated, the cost of communication consultants should be considered. Another key cost driver is whether investigators must perform an extensive factual and legal analysis and report it in a formal document. If third parties with an interest in the underlying circumstances can be expected to scrutinize these reports closely, the analysis will need to be particularly comprehensive, which increases its cost. Some costs may be avoided in situations in which it is appropriate to omit a formal written report and to rely instead on a briefing and oral discussion with management and/or the board.
It is the rare investigation that does not turn out factual surprises. These unanticipated twists and turns often move an inquiry in new directions. As a result, another key to a successful investigation is being prepared to deal with new developments while being committed to a disciplined focus on the original objective. Having an overall strategy and long-term objective for an investigation helps in assessing how best to deal with unanticipated "red flags" as they arise.
For public companies, managing disclosure obligations as an investigation uncovers new facts is a vital issue. Often, the investigation may raise significant disclosure issues that require careful consideration and treatment. Waiting until the investigation is over before addressing them can be problematic because the risks of untimely disclosure are considerable. At the same time, premature public disclosure of the partial results of an ongoing investigation could impede the process. To resolve public-disclosure questions, the board and the company in some cases may need to coordinate advice from separate disclosure counsel with that of counsel conducting the investigation.
For optimum results, a company should communicate early and clearly its expectation that officers and employees should render full cooperation and assistance to the investigation. This sends a strong message about the company's intent and can foster a more positive attitude about the investigation within the company.
Investigations involving overseas operations, particularly in the European Union, may implicate data privacy laws designed to protect employee personal information. If the investigation must expand beyond the United States, counsel should check whether there are any restrictions in the other jurisdictions on accessing, using and transferring records containing individually identifiable personal data, including basic information such as employees' names. Likewise, in many countries, local laws about labor rights and nongovernment investigations may substantially affect the conduct of an investigation and add to its costs.
The hard truth: remedial measures
Finally, companies and boards must be prepared to manage an investigation's results. One of the likely outcomes of an internal investigation, especially if the subject matter involves misconduct, is the need to identify remedial measures to improve corporate conduct in the future and to address the circumstances under which the misconduct arose. Various remedial measures can be designed, ranging from dismissing senior officers to enhancing financial systems and controls.
After that, the board will generally need to play a role in monitoring any remedial measures. The board might choose to receive regular reports from management or it might engage outside resources to monitor implementation of remedial measures and to test their effectiveness periodically. The mandatory use of outside monitors is becoming a common feature of settlements with enforcement authorities when the underlying conduct included alleged or acknowledged violations of law or regulatory standards.
A well-run internal investigation designed to produce credible results can turn a potential corporate crisis into a valuable opportunity to enhance a company's reputation. It can also position a company to achieve a far better result in regard to potential liabilities and penalties than might otherwise be the case. The key is to aggressively employ good judgment and proven resources.