Today, when a board or an audit committee becomes aware of a so-called “red flag” of misfeasance, legal wrongdoing or other significant deficiency in corporate performance, the director’s longstanding duty to act on the information known takes on greater urgency than in times past. This is especially true of public companies where directors are potentially liable to shareholders for failing to exercise their fiduciary duties, but also applies to private companies and non-profits. To address these duties, boards and committees are increasingly using independent investigations—investigations managed directly by a board or designated committee and conducted without the supervision of corporate management by using outside legal and other resources without existing ties to the company.
Board and board committee members are finding increased value in being able to obtain facts and legal advice independently on a particular issue. The objective of independence is to provide a superior level of credibility and reliability of the board action in the eyes of regulators, enforcement officials, shareholders and the general public. This credibility, in turn, becomes a substantial asset to board members intent on meeting their individual fiduciary duties.
When an Independent Investigation Can Be an Asset to the Board
In the absence of taking independent action where it is arguably appropriate, board members can be subject to criticism and exposed to liability for failing to aggressively and independently undertake steps reasonably necessary to the exercise of their fiduciary duties. In short, process counts. Management may be perfectly capable of retaining the necessary resources to perform and supervise an internal investigation, including through the use of reputable independent investigative resources. There are clearly circumstances where doing so is appropriate. Where an independent investigation is called for, though, the board can properly consider whether achievement of its objectives can be enhanced significantly by the board supervising and directing such an investigation itself. This highlights the importance of directors examining a given circumstance to determine, first, is an internal investigation necessary? Second, if so, should it be conducted under the auspices of management or of the board Third, under the authority of either, should the investigation be structured so as to be “independent,” that is, supervised by independent board members and/or utilizing resources not significantly tied to the company’s existing business?
A prime indicator of the need for an independent investigation by a board or a committee is where the subject matter involves conduct by or under the close supervision of senior management of the company. The conflict in having senior management commission or direct an investigation is obvious. Even undertaken with the best of intentions, the results of such an inquiry are likely to be considered compromised in the eyes of third parties with a potential interest in the matter. Moreover, because information indicating possible misfeasance or malfeasance of senior management is decidedly a red flag for board attention, simply turning the issue back to management is likely to invite allegations of director liability. Conversely, where the allegation may lack merit, that determination will be a far more credible conclusion if it is the product of an independent investigation. The same rationale applies to issues involving sustained or systemic weaknesses in corporate performance or conduct. While such underperformance, misconduct or other matters at issue may originate from operations far below the level of senior management, the board’s duty to oversee corporate affairs and to supervise the conduct of management is more than arguably indicated by such systemic failures.
Whether potential remedial action or other follow-up may require board direction or approval is also a factor to consider. There is significant value to the board and to individual directors in proactively and aggressively addressing a situation from investigation through analysis to remedial measures.
The need and justification for an independent investigation conducted by the board or a committee may or may not be clear in a given circumstance. The hard cases, of course, are those where neither element is clear. The use of independent counsel to assist in evaluating whether an independent inquiry is needed can help to validate whatever decision is eventually made. More substantively, an organized analysis of the reasons for and against undertaking such an independent inquiry can be of substantial assistance to a meaningful board or committee discussion and resolution of the merits of the question.
Considerations for Effective Independent Internal Investigations
Given that one of the prime objectives of doing such an independent investigation is to establish a credible process, and results, obtaining the services of counsel with the requisite expertise, experience and credibility to help meet that objective is a critical step. Conducting internal investigations is far different from fact-gathering in civil litigation or due diligence in a transaction, because the subject matter may threaten careers and often presents issues of potential individual criminal or civil liability. The work includes managing the sequence of efficiently examining what is often a large volume of paper and electronic documents and records for relevant data, obtaining information from people of various backgrounds and stations in a company and addressing when enough information has been obtained that the investigation may be curtailed. These tasks require substantial experience and expertise in order to obtain a credible and productive result. Regulators and enforcement officials also will measure the investigation by evaluating the investigator in terms of individual reputation and skill.
An important issue to consider is whether the investigation itself and its work product will be deemed privileged. Investigation results may require public disclosures or suggest prudential disclosure to regulatory and enforcement authorities. It may be advantageous not to have the fact-gathering process be privileged so that disclosure does not invite suggestion of broad privilege waiver as to the entire subject matter. Conversely, disclosure to third parties of the results of the investigation may render all of the investigative work subject to discovery by litigants against individual directors and/or the company, including in shareholder derivative actions. While it is beyond the scope of this article to suggest all of the factors appropriate to resolution of the privilege issue, it is important that this issue be recognized and considered when undertaking an independent investigation.
Also critical is being prepared to address unforeseen developments that may radically alter not just the course of the investigation, but even the matters in issue. It is not at all unusual to face loss or destruction of relevant records and the unavailability or non-cooperation of key individuals. People whose conduct is subject to scrutiny may rightly wish to maximize the protection of their personal rights and request that the company pay for counsel to be engaged to advise them in connection with the investigation. Dealing with these circumstances in a responsible manner requires close communication and informed joint decision-making between counsel and those supervising and directing the investigation. For this reason, it is often advantageous for the board or committee to designate one or two of its members, as the prime contacts for the investigation, with the discretion and responsibility to bring decisional matters to the entire committee or board, as appropriate.
Because such investigations can be costly, it is important to address with counsel at the outset the steps necessary to conduct the matter efficiently and to control costs. The principal cost– control factors are the size and scope of document review, the number of interviews to be conducted, the nature and extent of specialized resources (forensic accountants, forensic information technology and other experts) to be utilized in the investigation and the extent to which factual and legal analysis of the results will be undertaken and reported. When conducting an investigation in countries with data privacy laws is necessary, cost and efficiency may be significantly impacted by the need to comply with these laws, which tightly regulate accessing, using and removing records that contain personal data, even data as common as a person’s name.
The Bottom Line
It is more likely now that directors will face issues of whether to authorize independent internal investigations. Despite the increased frequency of such investigations, conducting one is not an everyday occurrence and may well be beyond the experience of most board members. The resources, both human and capital, required to successfully manage such an independent investigation—and the stakes attached to the need to undertake one—suggest that preparation, forethought and dedication to task are necessary prerequisites to a successful undertaking.