A recent Federal Court decision highlights the potential conflicts that can arise when a corporation requests an outside law firm to conduct an internal investigation regarding prior corporate activities. Such conflicts can arise between the corporation and its executives. Handling these conflicts upfront can avoid a lot of pain down the road for the corporation, its executives and the outside law firm.

Earlier this month, in United States v. Nicholas, the Federal District Court in Central California reviewed the activities of an outside law firm that had been hired by Broadcom Corp. in connection with concerns regarding stock option grants to members of Broadcom's management. Broadcom retained a prominent California law firm, Irell & Manella, to handle an internal investigation regarding stock option grants. The Irell law firm was already defending Broadcom and its Chief Financial Officer against two other actions brought by shareholders of Broadcom.

As part of the stock option investigation, Irell lawyers interviewed Broadcom's CFO. The CFO believed that he was talking to his personal lawyers who were representing him in the shareholder actions but the CFO's interview was actually in connection with the internal investigation. The Irell lawyers who were interviewing the CFO never advised the CFO of the lawyers' dual roles or dual responsibilities. Comments made by the CFO to Irell's lawyers during the interview were eventually relayed by Irell lawyers to the US Securities and Exchange Commission.

As a result of the failure of the Irell lawyers to give notice of the dual representation to the CFO, the comments made by the CFO were deemed to be privileged and protected statements that could not be used by third parties. In addition, the Federal Court ruled that the Irell law firm failed to meet its duties, as lawyers, to their clients, as required under the California Bar Rules of Professional Conduct. Indeed the federal court went so far as to refer the Irell law firm to the California state bar for review and possible disciplining.

The Nicholas decision makes clear that corporations must handle internal investigations very carefully and that the outside lawyers brought in to conduct any such internal investigation must disclose up front to the corporation's executives the role being played by the lawyers, the specific representation being handled by such lawyers and the potential conflicts that may arise.

Failure by the outside investigating lawyers to give notice to the corporation's executives regarding the role of the outside law firm can make the results of the internal investigation more likely to be challenged and may expose the corporation and the law firm to additional problems.