Return to Spring 2007 Acredula Index
Responding to a Government
Investigation-
As a Director What Should I “Direct”?
Kevin M. Kinross
Reprinted from Acredula -- Spring 2007
If you or your organization become the subject of
government inquiry, hopefully it will be the first
and last time you have to navigate these waters.
As the second installment in our series on how
an organization should respond to a government
investigation, we turn the focus to the role of
directors. The big question you will face as a
director: “What should I direct?” Specifically,
directors should know what steps to take to cooperate
with the government agency conducting the investigation, and how to accomplish these steps
in order to position your organization for the best
resolution to the matter.
Create a special committee and
hire independent counsel
One of the first steps that a board of directors should
do is create a special committee of outside and,
if possible, disinterested directors to oversee and
direct the organization’s response to the government
inquiry.
This special committee will decide whether or not to
engage independent counsel to assist in the process.
If it appears that the government’s allegations rise
to senior officers and the risk of exposure to the
organization is significant, independent counsel
should be retained. As noted in the first article in
this series, independent counsel will add credibility
and will help plan the organization’s efforts to
respond to the government’s inquest. This includes
the decision of whether to conduct
an internal investigation, as well as
the procedure for doing so.
Aside from any unusual situation
or financial hardship, it is highly
recommended that independent
counsel be engaged early on in this
process. A government agency is
less likely to trust an assessment or
investigation performed by chief
legal counsel or a company’s current
outside counsel—both of which may appear to
have conflicts of objectivity.
After engaging independent counsel, the special
committee, with counsel’s assistance, can determine
whether or not the company should engage in its
own internal investigation of the matter. This decision
needs to consider:
The nature of the allegations;
The severity of the allegations;
The effect on the financial statements of the
company;
Whether the allegations involve a systematic or
limited occurrence; and
The number of high-level individuals involved.
Further, the committee needs to assess and recognize
the benefits and risks associated with conducting an
internal investigation.
A director’s fiduciary duty to an organization
includes the obligation to self-police, establish
detection programs, and help create and impose a
culture that will not foster illegal conduct by anyone
involved with the organization. When there are
suspicions of misconduct, a director’s duty may
require the initiation of an internal investigation to
identify the wrongdoers in order to mitigate damages
to the shareholders and the corporation. This
is especially true when there are actual allegations
of potential misconduct.
In today’s corporate climate, it is unlikely that
an organization will be able to avoid conducting
an internal investigation. At some point, the organization
will have to defend each step of their
response to the government, and every decision
will be looked at in a rear view mirror. Therefore,
it is important to provide independent counsel with
the authority necessary to gather and review key
information and to interview key witnesses soon
after the engagement.
Start an internal investigation
The role and frequency of internal investigations
has increased over the past five years, even before
the Sarbanes-Oxley Act of 2002 (“SOX”) was
signed into law. However, not every organization
has experienced or is familiar with what
internal investigations actually are and how they
are conducted.
An internal investigation is an examination typically
performed by outside counsel, which is retained by a
committee of outside directors. The counsel examines
the conduct of the corporation, its employees,
executives and sometimes directors.
When retaining independent counsel, the engagement
letter should specifically define counsel’s note
by doing the following:
Develop factual information related to the
allegations;
Provide advice concerning the organization’s
exposure and potential liabilities;
Provide advice for potential claims the organization
may have against third parties or its own
employees;
Defend the organization in litigation related to
the allegations; and
Recommend other actions to prevent non-compliance
in the future.
The letter should also expressly indicate the existence
of the government’s investigation.
Manage an internal investigation
As a director, you need to ensure the investigation
answers the necessary questions. Thus, the scope
and breadth of the internal investigation should
closely parallel the government’s investigation
and should be managed by the special committee.
To satisfy the fiduciary duty of care, the investigation
needs to be thorough. Any investigation that
chooses to ignore relevant facts and is too limited
in scope displays a lack of integrity and isn’t likely
to satisfy the investigating authorities
Of primary importance, the investigation should
start with the three main questions that we discussed
in our initial article for this series:
What is the nature of the misconduct involved;
How did the misconduct arise; and
Where in the organization did the misconduct
arise, including how high up in the chain of
command was there knowledge or participation
of the misconduct?
The investigation should also address:
How long the misconduct lasted;
How much harm the misconduct inflicted upon
investors or affiliated organizations;
How the misconduct was detected and who
found it; and
Factual support for each of the items above.
Analyze the results of an
investigation
After independent counsel has completed its investigation,
it should prepare a detailed report [addressed
to the special committee] that describes:
Allegations made;
Facts discovered during the investigation; and
Conclusions regarding whether the alleged
misconduct violated the law, company policies
or other obligations.
This report should not contain any surprises if, as a
director, you maintained contact with independent
counsel by overseeing its actions during the course
of the investigation. Further, this report should
be made orally, but independent counsel should
provide copies of its supporting documentation,
as a written report may be discoverable. A more
detailed review of the government’s current stance
on seeking waiver of privilege in light
of the McNulty memorandum will be
discussed in our next issue.
As a director, you should be prepared
to conduct internal investigations in
response to a government investigation,
even before any allegations
of misconduct arise. If you are a
director who, as member of the
special committee, is given the responsibility
to manage the internal
investigation, you need to be aware
of your responsibilities and be able
to actively control the investigation. Directors
should ask questions to and oversee the actions
of the independent counsel, assess their findings
both during and after the investigation is completed,
and be able to direct all necessary decisions to
remedy any illegal actions and ensure compliance
in the future.
Our next two articles in this series will focus on the
individual responsibilities of an organization’s chief
legal officer and its executives in responding to
government investigations. If you have questions or
wish to discuss those steps in advance or any of the
steps outlined above, please contact John P. Beavers
(614) 227-2361, Jeffery E. Smith (614) 227-2352
or Kevin M. Kinross (614) 227-8824.
