In light of a recent federal court decision and existing policies of federal regulatory agencies, a company undertaking an internal investigation of potential misconduct should consider retaining experienced outside counsel who does not have extensive prior relationships to the company or its officers, directors and employees. By retaining such special counsel, companies avoid, among other things, potential claims by their officers, directors, and employees that the counsel conducting the internal investigation had a personal attorney-client relationship with the employee which may result in unforeseen conflicts of interest.
Recent cases suggest that if such a claim is made, the company may be precluded from sharing the results of the investigation with the government in circumstances where cooperation may benefit the company. The use of special counsel also may be required in certain circumstances to avoid a breach of the duty of loyalty owed to all clients by outside counsel.
In United States v. Nicholas, ___ F. Supp.2d ___, 2009 WL 890633, No. Cr. 08-00139 (C.D. Cal. April 1, 2009), a criminal securities fraud case, Broadcom engaged its regular outside counsel to investigate the circumstances relating to its grants of certain stock options. Broadcom had a longstanding attorney-client relationship with the counsel who it retained to conduct this internal investigation.
At the time of the internal investigation, counsel concurrently represented Broadcom and its CFO in a related derivative action. During the internal investigation, counsel interviewed the CFO on behalf of the corporation. It was a disputed issue of fact whether counsel sufficiently explained to the CFO that counsel was representing solely the company and that any privilege associated with the interview was only the company’s to assert. See Upjohn Co. v. United States, 449 U.S. 383 (1981) (holding that employees’ communications to corporate counsel conducting an internal investigation are covered by the corporation’s attorney-client privilege; warnings explaining the nature of the attorney’s relationship to the company and not the employee are commonly referred to as Upjohn warnings).
Ultimately, Broadcom unilaterally decided that its counsel’s interview with its CFO should be disclosed to its outside auditors, the SEC and the U.S. Attorney’s Office. Neither the company nor counsel sought the CFO’s consent to this disclosure.
In Nicholas, the court suppressed the statements made by the CFO to the company’s counsel, finding that the company’s counsel failed to provide the CFO with adequate Upjohn warnings. The court went further by holding that since an individual attorney-client relationship existed between counsel and the CFO in the derivative action, even if the company’s counsel had provided the CFO with more complete warnings about the nature and circumstances of the internal investigation interview, counsel could not unilaterally impose a change in the nature of the CFO’s relationship with counsel merely by providing Upjohn warnings, and the CFO’s acquiescence in answering counsel’s ensuing questions. The court found that, among other things, the disclosure of the interview by the company and counsel breached the duty of loyalty owed by the attorney to the CFO and breached the CFO’s attorney-client privilege, rendering the CFO’s statements inadmissible in the criminal case, while also subjecting counsel to possible civil liability and professional disciplinary action. See also Pendergest-Holt v. Sjoblom and Proskauer Rose, LLP, Civil No. 09-00578 (N.D. TX) (malpractice complaint filed on March 27, 2009 — and voluntarily withdrawn on April 10, 2009 — against attorneys for the Stanford Group by its former Chief Information Officer alleging, among other things, that the attorneys did not advise the CIO that they were not representing her personal interests, that the CIO had the option of not appearing at the SEC proceeding, and that the interests of the Stanford Group may be adverse to the CIO’s interests).
The cautionary lesson of Nicholas is that, in certain circumstances, businesses should consider using experienced outside special counsel, other than their regular counsel, to investigate alleged misconduct, especially where it is likely that regular counsel would be presented with potential conflicts of interest based on prior joint representations of the company and individuals whose activities may become the subject of the investigation. In addition to the conflict of interest issues identified in Nicholas, some federal agencies have expressed their preference that internal investigations may be viewed with more credibility in cases where companies retain experienced special counsel.
In its Seaboard report, the SEC stated that it would consider whether a company presented with allegations of potential wrong doing used outside counsel who did not have extensive prior relationships with the company and its officers and directors to ensure greater independence of the inquiry. See Securities Exchange Act Release No. 44969, Oct. 23, 2001 (available at http://www.sec.gov/litigation/investreport/34-44969.htm). For the SEC, selection of such special counsel is considered favorably in assessing the reliability of counsel’s investigation and the credibility of any resulting report. Similarly, but less formally, "best practices" of some other federal agencies, such as the Office of the Comptroller of Currency, encourage selection of special counsel to investigate possible misconduct.
As a result, a company facing possible government scrutiny from alleged misconduct should consider retaining counsel who does not have a substantial prior relationship with the company to avoid problems arising from possible conflicts of interest. Retaining such special counsel also supports the credibility of the inquiry in the event the company decides to disclose the results of its investigation to governmental agencies.
Michael A. Schwartz and John L. Schweder, II