Audit Committee/Board-led Independent Investigation
Where a company’s audit committee wishes to conduct an investigation into potential violations (this may happen before any government investigation starts), they should probably not use a law firm that regularly does work for the company. There are a few, related reasons for this.
First, any such investigation should be independent in order to be credible. It’s not independent if the firm conducting the investigation has other ongoing work for the company or frequently does work for the company and expects to continue doing work for the company.
Second, it may represent an actual conflict of interest for the law firm if issues the company consulted with the firm on in earlier periods become (or should become) subjects of the investigation.
Third, after the investigation concludes, the audit committee or the company may wish to present the results of the investigation to government regulators such as the SEC or DOJ; if the law firm that conducted the investigation is found to have a prior or ongoing relationship with the company, the government may worry that the investigation “pulled punches” as to the issues it covered or the involvement of company officers or directors in a position to award legal work to the firm.
Fourth, the audit committee and the Board have duties to the shareholders to ensure that any members of company management that were involved in directing or allowing violations to take place are properly dealt with, which might be more difficult to ascertain if the lawyer or firm making recommendations about company managers has had extensive, friendly relationships with the individuals being evaluated.
Finally, and we’ve seen this principle violated in the past with not-so-great results, the law firm that represents the company in the government investigation should not be the same firm that conducted the investigation. This is because the law firm would be put in the position of urging the government to rely on the firm’s own work (the “independent” investigation that the same firm just completed) at a time when the firm is charged with defending the company’s interests. This puts the law firm in the position of vouching for the integrity of its own investigation at a time when the government knows that the firm’s actual job is to minimize liability and protect the company’s interests—which could (and probably should) cause the government to question the impartiality and reliability of the investigation the law firm (and company) wants the government to take seriously.
Company Representation
When it comes to representing the company’s interests in an SEC or DOJ investigation, it may be entirely appropriate that the lawyer or law firm that has previously represented the company in other contexts also defend the company’s interests in what may be a protracted, years-long investigative process with potential litigation at the end.
Choosing a law firm that has done work for the company, is familiar with the business model, and has developed a solid rapport with the business executives and in-house counsel is often a very good idea and can cut down on the costs associated with bringing in lawyers who know nothing of the company or its industry. This must always be subject, however, to making sure that the law firm has the necessary expertise with the relevant agencies. It seldom makes sense to use the lawyer who regularly assists the company in its FDA labeling and advertising issues in an SEC enforcement investigation into whether the company’s financial statements were intentionally misstated. If the FDA lawyer doesn’t have colleagues at the firm with the SEC or DOJ backgrounds necessary to handle such an investigation, the company needs to find a new firm that does have such expertise; this is no time for on-the-job learning.
If a different law firm has completed an independent investigation, the law firm charged with the company’s defense will want to point to the findings and recommendations of the internal investigation and persuade the government that the company has figured out what went wrong, taken appropriate remedial action in reliance on the investigation conducted by an independent firm, and should therefore not be excessively penalized for problems that have already been exposed, investigated, and properly addressed.
Insurance—Directors & Officers (“D&O”) Insurance
Most companies of any size will have considered purchasing a D&O insurance policy and most corporate insurers will suggest such a policy as a prudent investment. As discussed further below, most corporate by-laws require the company to indemnify and advance to its directors and officers legal costs incurred in a lawsuit or investigation related to their service as corporate board members or executives. A D&O policy is one way for the company to offset or mitigate its liability for the costs of defense of these individuals if and when a lawsuit is filed or an investigation commenced.
General Counsel and those responsible with dealing with the company’s risks should consider retaining counsel with expertise in coverage issues in evaluating D&O policies and should also make sure the insurance company has the necessary depth and experience in D&O coverage to adequately address the company’s needs. In our experience, this is not an area in which it pays to have taken out “bare bones” coverage.
The costs of defending against a securities class action lawsuit or a government investigation into potential securities fraud at the company escalate very quickly. Adequate coverage can save tens of millions of dollars in the long run.
As with most insurance, a company with a D&O policy must pay careful attention to its notice obligations under the policy. Insurance companies are very happy to take premiums in on the front end, but each and every excuse to delay payment or to invoke an exclusion can and will be exercised. Accordingly, at the first indication of a potential issue where D&O coverage may be needed (for example, a subpoena received from a government agency), the company must notify its insurance carrier in accordance with the policy’s requirements.
Employee Representation
One fraught area can be the decision whether and when to secure separate counsel for individual company employees. Separate counsel is required when the company’s and the individual’s interests materially diverge and the firm representing the company cannot ethically represent the employee as well. Sometimes this is apparent right away and at other times this only becomes apparent later during the course of an investigation. In either event, the lawyer that ends up representing an employee (or, sometimes, a group of employees) must be as qualified and well-versed in the relevant legal issues and have experience with investigations of the same type, or there could be serious missteps, to the detriment of both the individual employee and the company. No one is well-served if the lawyer taking on the representation is not qualified to do it.
