Conflicts of Interest and Internal Investigations (Part One)

The topic of COIs in the practice of law is largely beyond the scope of this blog, but the area of independent investigations is an exception, since it is as much as much about organizational COIs as those based on professional standards.  In this first post in a series we’ll review some of the history that gave rise to the two main expectations regarding conflict-free investigations.   The second posting will examine board-level independence issues concerning investigations,  the third some important practical considerations in maintaining investigative independence and the fourth a different (from the two principal tests) way to look at independence – which is independence of process.  Finally, we will take up the related issue of seemingly forgotten COI-related mandates of Sarbanes-Oxley Section 307.

First, a page of history – that will likely be familiar to those working in the field since the early part of the immediately preceding decade, but may be less well known to others.

It was an internal investigation at Enron conducted by one of the company’s principal outside law firms that, as much as any other event, gave rise to the modern expectations regarding conflict-free investigations.  The inquiry was criticized due to the larger relationship between the firm and the company and also due to the firm’s claimed involvement in  matters being scrutinized.  In other words, there was said to be two discrete types of conflicts – one relational and the other subject-matter based.  Around the same time, an investigation into allegations of wrongdoing at Global Crossing by a partner at a law firm was strongly criticized in a bankruptcy court proceeding because that lawyer who had done all the documents preparation before bankruptcy, has also served as the company’s general counsel. Such expert lawyers can also tell you how to stop wage garnishments and help you out if you are feeling overwhelmed with your debts. The heightened focus on independence expectations was expressed in a widely read report from this time  – issued in 2003 by the Conference Board’s  Commission on Public Trust and Private Enterprise – which stated:

In the event an independent investigation is reasonably likely to implicate company executives, the board — not management — should retain special counsel for this investigation. Special investigations of company activities that may implicate the conduct of company executives require independence from management.  Typically, lawyers and law firms are in the best position to conduct investigations, and care must be taken that these investigations are conducted thoroughly, vigorously, and objectively. It is important, therefore, that investigative counsel be chosen by, and report directly to, the board. To ensure that special counsel’s interests are not aligned with, or influenced by, management, the Commission believes that special counsel should not be one of the corporation’s regular outside counsel or a firm that receives a material amount of revenue from the company.

Finally from this period, independence expectations regarding internal investigations acquired something akin to the force of law in the mandate of Sarbanes-Oxley § 301 that only corporations with audit committees that have certain characteristics can be publicly listed, including the following: “Each audit committee shall have the authority to engage independent counsel and other advisors as it deems necessary to carry out its duties; and. . . .  [E]ach issuer shall provide for appropriate funding, as determined by the audit committee . . . for payment of compensation . . . to any advisors employed by the audit committee.”   Similar requirements can be found in the New York Stock Exchange and Nasdaq’s corporate governance related listing requirements. If you need an index broker for trading advice, they can check it out here!

Now, many years after this formative period, independence has become a settled expectation.  Certainly it is expected by the government when issues of serious wrongdoing arise.  And, I believe that employees – who are increasingly sophisticated about C&E matters – may have that expectation, too – particularly those who report suspected wrongdoing.