by Yvette Ostolaza and Natali Wyson
Once a corporation has decided to conduct an internal investigation, one of the first and most important decisions is who should lead that investigation. Investigations by independent outside counsel reporting to an independent committee of the board of directors are the most credible and defensible arrangements. However, that does not mean that every investigation must, or should be, conducted that way. In deciding who should conduct an investigation, companies should consider a number of factors, including:
· Whether allegations of wrongdoing implicate senior executives, the Board, or in-house counsel;
· The severity of the allegations;
· Whether allegations suggest criminal liability or require government involvement;
· Whether the alleged wrongdoing implicates a significant financial or accounting issue;
· The risk or threat of derivative litigation or other shareholder lawsuit; and
· Whether applicable laws require an independent investigation.
In situations where an allegation is not substantial, involves potential civil liability only, and does not implicate in-house counsel, the investigation may be conducted by in-house counsel or by outside counsel reporting to the company. An example might be an internal complaint about improper workplace behavior involving a non-executive employee. While unnecessary, in-house counsel may still benefit from hiring outside counsel to assist with the investigation or review the process and evidence afterwards. In such scenarios, in-house counsel might consider having outside counsel prepare findings to provide an extra layer of objectivity and privilege protection.
Issues involving senior executives may be more appropriate for outside counsel. One example might be a whistleblower claim against a senior executive or a member of the in-house legal team. Because of the positions of those involved and their relationships with in-house counsel, the investigation may run more smoothly and be more independent if handled by outside counsel.
In situations where senior executives or in-house counsel are implicated in wrongdoing that could lead to criminal liability and government review, the investigation should be conducted by independent outside counsel. Independent outside counsel can add increased objectivity and credibility to the investigation. Note, however, that the selection of counsel will be scrutinized to determine disinterestedness and independence as set forth under applicable law. Outside counsel that has been go-to counsel for the corporation’s business or that has a working relationship with the corporation often will not be considered independent, especially if the investigation’s scope covers transactions or other work handled by the law firm. As the Eleventh Circuit held in Stepak v. Addison, “directors must ensure that counsel is capable of independently evaluating the corporation’s interests.” 20 F.3d 398, 405 (11th Cir. 1994). Because outside counsel in Stepak had previously represented the alleged wrongdoers in related proceedings, the court held that its independence was tainted and the board’s resulting rejection of a shareholder demand was therefore not given the deference normally owed.
Even where senior executives and in-house counsel are not implicated, an independent investigation may nonetheless be important if the alleged wrongdoing is particularly severe and could lead to criminal liability, or if there is a real threat of derivative litigation. In such cases, independent investigations are not only more credible, they may also provide increased levels of deference by the government and courts. For example, under Section 101.458 of the Texas Business Organizations Code, a court “shall dismiss a derivate proceeding” if an “independent and disinterested” committee for a limited liability company determines “in good faith, after conducting a reasonable inquiry . . . that continuation of the derivative proceeding is not in the best interests” of the company. Additionally, such outside investigations have an increased likelihood of maintaining privilege because communications are less susceptible to claims that they involved a business purpose as opposed to legal advice.
Finally, it is important to note that an independent investigation may be legally required due to the nature of the alleged wrongdoing and the laws that are implicated. For example, Section 301 of the Sarbanes-Oxley Act (15 U.S.C. § 78j-1) requires that companies have independent audit committees with authority to engage independent counsel and to develop procedures for investigating complaints related to accounting, internal controls, or auditing matters. Thus, certain accounting and internal controls issues may require independent investigations. Companies and boards should evaluate these factors carefully in deciding whether independence is necessary.
Yvette Ostolaza is managing partner of Sidley Austin’s Dallas office. She can be reached at email@example.com. Natali Wyson is an associate at the firm. She can be reached at firstname.lastname@example.org.