Procedures for the Effective Handling of an Internal Corporate Investigation

in the Post-Sarbanes-Oxley World

by
Jay G. Martin
Baker Hughes Incorporated

I. Introduction

The internal corporate investigation is more common today than ever. Enron, Arthur
Andersen and other examples of alleged corporate misconduct fill the news. Even an
unsubstantiated allegation of corporate misconduct or fraud will cause companies to investigate
themselves, their officers and their employees. Internal corporate investigations have become an
established response to allegations of improprieties on the part of the corporation, its officers, or
its employees. Corporations initiate internal investigations in response to an ongoing government
investigation or agency subpoena, or pursuant to a consent decree with a government agency.
Such investigations may be prompted internally because of a complaint or grievance from an
employee or group of employees.

Management should notify the board of directors promptly of any improprieties so that
qualified and experienced counsel can be engaged from the outset of the investigation.
Preliminary investigation conducted by management, and without the involvement of counsel,
will likely not receive the benefits of the attorney-client privilege or work product doctrine. The
corporation should seriously consider engaging outside counsel from the outset of an
investigation to underscore the legal nature of the investigation.

As explained more fully below, senior officers of the corporation should make explicit
their request for counsel to provide legal, rather than business, advice. Specifically, the request
should refer to a legal examination -- an investigation intended to culminate in legal advice --
rather than a purely factual inquiry. If outside counsel is hired, such a request should be included
in the retention letter; if in-house counsel is involved, a memorandum to the same effect should
be sent.

II. Key Factors in Conducting an Internal Corporate Investigation

In structuring any internal corporate investigation, the following issues should be

addressed by the General Counsel of the corporation with appropriate assistance from outside
counsel.

A. Decide Who Should Conduct the Investigation. The first decision in the planning
of any internal corporate investigation, the choice of investigator, requires careful
analysis of the issues raised by the complaint or allegation of corporate
misconduct giving rise to the need for the investigation, careful consideration of
the corporation’s objectives in the investigation, and evaluation of the available
alternatives for conducting the investigation. Independent counsel representing
the board of directors of a corporation or a committee of the board have become a
favored choice in the corporate crisis scenario, but most complaints or situations
that arise requiring an internal corporate investigation may reasonably be
reviewed by a corporation’s in-house counsel, regular outside counsel, the
 internal audit manager or the corporation’s chief compliance officer (if it has one
and such person is an attorney).

B. Determine the Initial Scope of the Investigation. An initial step that should always
be taken when planning for the review of allegations in a complaint or allegation
of corporate misconduct is a determination and documentation of the initial scope
of the review. The scope should be broad enough to yield a comprehensive
understanding of the facts at issue and to allow the corporation, its audit
committee, its board of directors and management to reach reasonable
conclusions on an appropriate response. At the outset, the scope of any internal
corporate investigation should always be considered an initial scope to avoid later
questions about artificial limitations on the ability of the investigation to
effectively understand and address the matters raised in the complaint. In its
October 23, 2001 Report of Investigation Pursuant to Section 21(a) of the
Securities-Exchange Act of 1934 and Commission Statement on the Relationship
of Cooperation to Agency Enforcement Decisions, SEC Release No. 34-44969
(generally known as the “Seaboard Report”), the SEC notes that one factor it will
consider when assessing the cooperation of entities in connection with potential
enforcement proceedings is whether there were scope limitations placed on any
internal corporate investigation

C. Promptly Notify Employees of the Investigation. At the beginning of an internal

corporate investigation, or in conjunction with service of a grand jury subpoena,
government agents will often attempt to contact and interview a corporation’s
employees without prior authorization from their corporate employer. Such
contacts routinely occur at the employees’ homes where they are most vulnerable
(i.e., in the presence of a spouse or family). It is an unpleasant fact that
government agents often resort to aggressive, improper and threatening
statements to employees to induce them to cooperate against the corporation and
its management.

General Counsel often take the position with the government at the initial stages
of an internal corporate investigation that they represent all corporate employees.
Thus, the General Counsel may request the government to refrain from contacting
any employee without prior notice to, and approval of, the General Counsel.
Traditionally, the government has taken a different view on its ethical obligations
with regard to contacts with “represented persons.” In 1999, however, Congress
passed the McDade Amendment, 28 U.S.C. § 530B, which requires government
lawyers to abide by the laws and ethics rules in states where they carry out their
prosecutorial duties.1 Thus, government lawyers must generally follow the ethics
rules and case authority regarding ex parte contact with corporate employees that
are in effect in the relevant states.

Once a General Counsel is aware of a government investigation that has any

potential to become serious, prompt and effective communication with the

1
See United States v. Talao, 222 F.3d 1133, 1139 (9th Cir. 2000).

2
 corporation’s employees is essential: (1) to advise of the existence of the
investigation; (2) to advise that the corporation’s employees may be contacted
directly by government or other investigators; (3) to provide legitimate
information on their options in responding to those contacts; and (4) to ask the
employees to promptly inform counsel when contacts have been attempted or
made and what, if anything, was said. There is nothing inherently improper with
such a communication to employees. A General Counsel must be aware, however,
that some types of communication with represented and unrepresented
individuals or employees are improper and may constitute obstruction of justice.2
This is a potentially dangerous area where the involvement of experienced
counsel is strongly advisable.

D. Interview Employees as Soon as Possible in Connection with an Internal

Corporate Investigation. For the reasons outlined above, early in an internal
corporate investigation, in-house or outside counsel will want to interview
employees who may have knowledge of the relevant facts. While these interviews
are essential to adequately represent the corporation, it is equally important to
consider whether an attorney-client relationship will be created with the
individual employee, and the potential consequences of such a relationship. Most
states have adopted a version of American Bar Association (“ABA”) Model Rule
1.13(d), which mandates that corporate counsel “explain the identity of the client
when it is apparent that the organization’s interests are adverse to those of the
constituents with whom the lawyer is dealing.” Even in states that have not
adopted such a rule, counsel should clearly identify the client during the
investigatory process.

ABA Model Rule 4.3 also provides that the attorney must make every reasonable
effort to correct an unrepresented person’s possible misunderstanding of the
attorney’s role. Should such individuals reasonably believe that an attorney-client
relationship exists between them and corporate counsel, the privilege may apply.
As a result, counsel for the company may be later prevented from disclosing
information learned during such interviews without the interviewee’s consent,
even though such disclosure is in the corporate client’s interests.3 Moreover, if an
attorney-client relationship is created, in the event the employee later becomes a
government or adverse witness, counsel may be barred from further representing
the corporation because of the difficulty of cross-examining the witness (who is
arguably the prior client).

Additionally, counsel must be careful not to give legal advice to lower level
employees unless representation is intended. In the event an employee asks
whether he or she needs counsel, corporate counsel should indicate that, if the
individual desires an attorney, counsel will make a list of competent counsel

2
For an egregious example, see United States v. Cintola, 818 F2d 980, 989-90 (1st. Cir. 1987) (an attorney
who counseled immunized client in grand jury investigation to refuse to testify to protect interests of non-
client target, was guilty of conspiracy to violate 18 U.S.C. § 1503).
3
See, e.g.. Diversified Ind. Inc. v. Meredith, 572 F.2d 596, 611 n.5 (8th Cir. 1977).

3
 available to him or her. As noted above, a statement by corporate counsel that the
individual needs or does not need counsel could be interpreted as providing legal
advice. Further, it may be in the interests of the corporation not to have that
individual have counsel, as it may preclude the company from being able to deal
directly with that individual in the future. This is particularly true in the early
stages of an internal corporate investigation.

E. Maximizing the Protection of the Attorney-Client Privilege. For the attorney-

client privilege to apply to an internal corporate investigation, the corporation
must consult with an investigating attorney in his or her professional, legal
capacity. Hence, having an attorney attend a meeting is not enough. Rather, the
attorney must be explicitly authorized by management or the board of directors or
a committee of the board to inquire into the subject under investigation, and must
seek information to assist in: (l) evaluating whether an employee’s conduct has
bound or would bind the corporation; (2) assessing the legal consequences, if any,
of an employee’s conduct; or (3) formulating appropriate responses to actions that
have been or may be taken by others with regard to that conduct. A company can
maximize its attorney-client privilege during an internal corporate investigation
by taking the steps described below:

— First, the corporation must assign an attorney rather than a member of

management to conduct the investigation. Investigative materials
generated by persons other than attorneys and their agents will not qualify
as privileged. Accordingly, senior management should not be permitted to
interfere with an attorney’s investigation by interviewing employees. In
addition, prior to the beginning of any investigation, the corporation
should obtain an internal authorization or external engagement letter
broadly setting forth the terms of the investigating attorney’s
representation, the scope of his or her investigation, and the fact that the
corporation seeks legal advice in connection with the investigation. The
corporation should also maintain tight control over all communications in
order to prevent inadvertent waiver of the privilege.

— Second, the corporation should exercise caution when engaging in any

oral communications relating to the internal corporate investigation. All
such communications should occur in private, outside the presence of third
parties who are not agents of counsel necessary for gathering facts, and
outside the presence of persons who are not on a “need-to-know” basis.
Furthermore, the corporation should inform all employees interviewed that
their communications are privileged and, as such, must be kept
confidential. These employees should also be instructed that the
corporation not the employees hold the privilege. Also, corporate
- -

management must bear in mind that communications made to an attorney

during a corporate meeting will be deemed privileged only when they
relate to the attorney’s eventual rendition of legal advice.

— Third, Counsel should demonstrate intended confidentiality of

communications by restricting dissemination within the corporation,
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 delivering reports from non-lawyers directly to counsel rather than using
intermediaries, and maintaining files and documentation apart from
general corporate files.

— Fourth, information should be obtained from the highest possible

management source from which it is available. This is advisable in light of
the limited reach of the Upjohn case.4 In other words, although Upjohn
rejected the notion that only upper management received the protections
of the attorney-client privilege, (i.e., the “control group”) it did not (nor
could it) govern state court decisions, many of which continue to apply
the control group principles when deciding attorney-client issues. Some
state courts will only extend the protections of the attorney-client
privilege to upper-echelon, “control group” management, and any
confidential communications from lower-level employees will not be
protected. Thus, counsel should seek to obtain information from the
highest possible sources within the organization, and follow up with
lower-level employees only if absolutely necessary.

— Fifth, where information relating to an internal investigation is gathered

by third parties, counsel should clearly and explicitly (by requests,
acknowledgement of receipt, etc.) indicate that the material is being
gathered for the purposes of rendering legal advice “in anticipation of
litigation.” It is to be noted that excessive marking of documents may
weaken the privilege for the sensitive documents that need the protection
most. In other words to, the extent possible, counsel should only mark as
confidential, privileged, or legal in nature, those documents that actually
deserve such a designation.

— Sixth, counsel should strive to include mental impressions, legal theories

or potential strategies in all notes or memoranda of interviews with others
in order to afford those documents the extensive protection of opinion
work product.

— Seventh, when communicating with former employees, counsel should

maintain his/her notes in a manner designed to maximize the protections
of the work product doctrine and advise the former employee of the
confidential nature of the investigation in order to discourage disclosure
of the information to others.

— Eighth, the corporation should also take care to safeguard all written
communications by labeling memorializations of interviews in the
following manner: “privileged and confidential, attorney-client
communication and/or attorney-work product; do not duplicate, do not
disseminate.” In addition, the corporation should limit the number of
copies made of any report, number those copies, and keep a log of persons
to whom these communications are disseminated. If written drafts

4
Enter citation of Upjohn case.
5
 circulate, they should be retrieved whether or not the recipient elects to
make comments.

— Ninth, if subpoenaed by a governmental agency, the corporation should

seek the government’s signature of a confidentiality agreement under
which the subpoenaing agency can review privileged materials only in
exchange for its agreement to not disclose these materials. Such an
agreement should further provide that disclosure of the relevant
documents does not constitute a waiver of the attorney-client privilege. By
using this language, a corporation can make it more difficult for private
litigants to secure copies of privileged documents.

F. Take Steps to Preserve Relevant Documents and Information. In the wake of the
issues surrounding Arthur Andersen’s destruction of Enron-related materials,
document preservation has become even more of a focus in all types of
government investigations and civil litigation. Even in circumstances where the
corporation has not been notified or does not suspect that a government
investigation or civil litigation is imminent, the procedures in place for the
handling of internal corporate investigations should include a requirement for
carefully preserving documents and information necessary for the corporate audit
committee’s and compliance committee’s review and action. Of course, when
such investigations or civil litigation are present, the complaint-handling
procedures and internal corporate investigation procedures (as well as the
company’s regular document-retention policies) should require an immediate
preservation of all relevant documents, including the suspension of automatic
delete features for electronic records and e-mail.

G. Deciding Disclosure Issues with Respect to Auditors, Regulatory Agencies and

the Public. A final consideration when planning an internal corporate
investigation should be the extent to which audit committees and companies
should or must disclose to their auditors, regulators or the public the existence of
any internal corporate investigation. The actual disclosure decisions will be
driven by the unique issues and circumstances surrounding each situation.
Caution, however, dictates that auditors be apprised of any internal investigation
that raises material questions about companies’ financial statements. Disclosure
to the SEC or other regulatory agencies and the public will depend significantly
on the specific nature and perceived validity of any complaint or allegations of
corporate misconduct, and should be decided in consultation with experienced
SEC and disclosure counsel.