Rarely are the tensions between the interests of a corporation and the interests of its management as problematic as when a suspicion of insider fraud or self-dealing arises. Paradoxically, as the potential conflict of interest grows starker, the pressures on corporate counsel to ignore the conflict grow stronger. It may be easy for law professors or bar advisory committees to describe the "right thing to do" and it may be easy for some of us to risk our jobs and careers by telling the CEO or COO who hired us that we represent the corporation, not management; but, in the real world, the pressures on all concerned to ignore or deny the conflict are immense.
All too often, the notion of bringing in outside counsel to investigate the allegations is seen as adding fuel to the fire. To whom does this "stranger" report? Who will control him or her? Will outside counsel understand the legitimate business interests of the corporation in handling the matter with discretion? Aren't we adding just one more wild card into the mix? But, if brought in at the proper time and given the proper mandate, outside counsel can and should be seen not as an intruder but as an effective tool for managing every corporate counsel's worst nightmare.
Before Turning to Outside Counsel, Do You Have Internal Safety Valves?
Though the appropriate use of outside counsel can help to insulate corporate counsel from the extraordinary pressures associated with the investigation of insider misconduct, typically you will not (and should not) turn to outside counsel until you have performed a preliminary investigation of your own and concluded that a serious problem may exist. When a suspicion of insider misconduct first surfaces, it usually doesn't announce itself as such. More often than not, the initial concern arises because an anomaly has been detected. It is not even clear that something is wrong, let alone that misconduct is afoot.
A footnote in a financial statement seems strange. An explanation given for a certain transaction doesn't quite make sense. A mid-level employee has been asked to document a transfer of funds but only knows what he's been told to do, not why. Surely, such anomalies and nothing more do not justify retention of outside counsel. Inside counsel will likely be dealing with the suspicion on his or her own, at least during the early stages.
If and when you face such a situation, it is crucial that corporate structures exist which will permit you to act on your concerns and that a corporate culture exists which makes it more likely that potential problems will be identified and brought to your attention.
Are there independent, outside directors to whom one can turn? Has an independent audit committee already been established and is it authorized to deal with issues beyond the annual audit?
If the answer to these questions is no, corporate counsel may find him or herself in an untenable situation. You are, after all, "just a lawyer." Without client authorization, you may be powerless to act and the corporate officers who would normally direct you to act may be conflicted. Suggest that independent safety valves--such as a committee of independent, outside directors -- be established before there is a formal investigation underway or, at least, before targets have been identified. The current trend toward requiring corporations to establish independent audit committees (The SEC now requires that SEC registered companies maintain an audit committee which is independent of inside directors) should give you ample support in pressing for such a structural precaution.
Though old-fashioned embezzlement is not unheard of, most serious defalcations are accomplished through the guise of complex, seemingly arms length transactions. It is not unusual for counsel (both inside and outside) to discover that he or she has unwittingly drafted the documents that effected or covered up the malfeasance. Make sure that the document drafters understand the entire transaction and its underlying business purpose. Be wary of complexity for complexity's sake. Don't be a scrivener.
Maintain your professional skepticism and independence.
As lawyers, we are trained to be skeptics and our skepticism is, in great measure, our stock and trade. Admittedly, in-house counsel face much greater threats to that skepticism than we on the "outside" do, but avoid the temptation to check your skepticism and independence at the door.
The Role of Outside Counsel
If your preliminary inquiries don't provide satisfactory answers and the unresolved concerns are material, you should turn to your board (see precautions, above) and discuss the advisability of retaining outside counsel to investigate the matter. Use of outside counsel to perform this function affords numerous advantages over an internal investigation.
Protection of corporate privilege. There are numerous ways a hostile party, be it a civil litigant or a government prosecutor, may be able to force discovery out of in-house counsel. Though not even outside counsel can guarantee protection of the privilege, they are in a much better position to defend it than in-house counsel. (See accompanying article.)
Insulation of insiders from the process. Even in the best of circumstances, it is simply unrealistic to expect that you or your staff will be able to avoid the pressures to divulge information to your fellow employees, particularly if the inquiring employees are officers to whom you ordinarily report. These pressures would also make it difficult for you to follow the investigation wherever it may lead you. And even if you could withstand the pressures, the psychic price you would pay would be enormous. Outside counsel, retained for the specific and limited purpose of conducting the investigation, will be relatively immune to these forces.
Ability to litigate if appropriate. If insider misconduct is discovered, outside counsel is in a far better position to advise the board on the possibility of seeking to remedy the defalcation through litigation. In addition, if outside counsel has conducted the investigation, they will have the benefit of the internal discovery conducted during the investigation and, if litigation does arise, the learning curve, which can be steep and expensive in these complex matters, can be avoided.
Defensible business judgments. The end result of the investigation may well exonerate the insiders or may conclude that the costs and uncertainties associated with any litigation to redress the wrong far outweigh the possible corporate benefit. In many jurisdictions, such a recommendation by outside counsel can act as a complete defense to shareholder derivative suits.
We are all inclined to think that it "can't happen here" but, unfortunately, the daily headlines in the financial press serve as a constant reminder that it can. Some corporate insiders will fail to resist the temptations their successes have laid before them. When they do, the appropriate corporate response is vital but corporate resources are often paralyzed or in denial. Thinking in advance about what may seem unthinkable and moving quickly and proactively when suspicions surface can serve to control and minimize the damage.