A New Era Of Whistleblower-Triggered Investigations

Thursday, June 21, 2012 - 11:23

The Editor interviews Steven S. Sparling, Partner, Kramer Levin Naftalis & Frankel LLP.

Editor: Please tell us about your background and professional experience.

Sparling: I graduated from Cardozo Law School in 1998 and joined Cleary Gottlieb’s New York office as a litigation associate. I then clerked for Judge Robert Chatigny in the U.S. District of Connecticut. Following my clerkship, I returned to Cleary Gottlieb, but I liked clerking so much that I left again to clerk for Judge Maryanne Trump Barry of the Third Circuit Court of Appeals. Following that clerkship, I joined Kramer Levin in September 2002, and I’ve been here ever since.

My practice principally involves a broad range of white collar criminal and regulatory issues at both the federal and state level, including allegations of securities and accounting fraud, Foreign Corrupt Practices Act violations, insider trading, the running of Ponzi schemes, money laundering, obstruction of justice and tax offenses.

I also have extensive experience conducting corporate internal investigations for large companies, and I have represented both officers and directors in connection with such investigations. I also teach a class on corporate internal investigations at Cardozo Law School. In addition, I represent individuals, companies and funds in connection with complex securities and commercial civil litigation.

Editor: Our readers are interested in your insights into the efforts by the government to gain information about corporate wrongdoing. Describe its efforts to obtain waivers of the attorney-client privilege.

Sparling: Around the time of the passage of Sarbanes-Oxley (SOX) in 2002, the Department of Justice and the SEC were enforcing a policy to aggressively pursue privileged documents from corporations in exchange for a cooperation credit, as reflected in the Thompson, Holder and McNulty memos, all of which were highly controversial.

This represented an effort by the government to get corporations to root out and report wrongdoing on their own through SOX, while at the same time the government was trying to see behind the corporate curtain by obtaining a waiver of the privilege. In some ways, this dual policy approach was a statement by government regulators that they needed help from corporations and from their privileged files to effectively investigate corporate wrongdoing.

Fundamentally, there was an assumption that privileged materials would reveal where the corporate wrongdoing was buried. This placed corporations in a precarious position, as the attorney-client privilege and work product doctrine are essential components of our adversary system and tools that enable lawyers to effectively investigate potential wrongdoing. In certain respects, this left corporations defenseless.

Ultimately the courts intervened and found aspects of DOJ cooperation credit policy unconstitutional, and the pendulum started to swing in the direction of preserving the privilege.

Editor: Does the Dodd-Frank Act represent an even greater effort on the part of the government to uncover what is going on inside corporations?

Sparling: Although the Dodd-Frank Act is relatively new, it reflects in some respects a renewed effort to intrude into the corporate investigative process. To understand the potential impact of Dodd-Frank, you have to go back to SOX and consider the two acts together.

The regulatory regime imposed by SOX requires companies to have internal compliance programs and mechanisms for internal reporting of compliance issues, which included the potential obligation to investigate wrongdoing. This often led to the hiring of outside counsel to get the benefit of an independent investigation rather than an interested investigation conducted by the company’s in-house lawyers.

Dodd-Frank’s bounty program, which gives whistleblowers the chance to win a significant bounty if the information provided qualifies under the implementing regulations the SEC has adopted, incentivized corporate insiders and even outsiders with knowledge of what was happening within a corporation to race to regulators and blow the whistle. Under Dodd-Frank, to qualify for a reward, it is important that the whistleblower provide “original information,” which, among other things, means that the putative whistleblower be early in line in providing the information. As such, Dodd-Frank incentivized whistleblowers to report early, which increased the pressure on companies to investigate quickly and threatened to undermine the internal reporting mechanisms established by SOX.

Note that Dodd-Frank reflects a governmental belief that special access to inside corporate information is important for regulators to have to effectively root out potential corporate wrongdoing. This time, the emphasis shifted from privileged materials to tips an insider might only know.

Editor: Describe the connection between the whistleblower provisions of Dodd-Frank and internal investigations.   

Sparling: In addition to making sure that the company does not inappropriately retaliate against whistleblowers and thereby violate the provisions of Dodd-Frank, there are a number of factors in-house and investigative counsel must consider in the wake of Dodd-Frank.

First, even before there is an issue to investigate, corporate counsel should at least consider educating the company’s employees about the relevant bounty program provisions of Dodd-Frank. This may seem counterintuitive at first, but there are strong incentives for a company to learn information first so it can be understood and a strategy can be formed for dealing with it before regulators and the press take control of the process. Dodd-Frank includes, for example, rules that allow 120 days for a whistleblower to secure his place in line with the SEC for purposes of providing “original” information on the date he reports an issue internally, provided that the whistleblower reports the information to a regulator within 120 days of the internal report. Another incentive for employees to report internally first is that, under Dodd-Frank, if a whistleblower first makes a report to the company and the company subsequently provides the SEC with the results of an investigation based on that tip, and if the information provided to the SEC leads to a successful enforcement action, the SEC can give the whistleblower credit for all of the information investigative counsel found - even information the whistleblower didn’t originally provide.

Second, investigative counsel must identify early on any potential whistleblowers and quickly grasp the issues that may find their way into the hands of regulators. Among other things, the effect of the 120-day rule is to pressure the company to accelerate its investigation, as a whistleblower might go to the SEC at any time within that period and need not even wait at all to go to the SEC.

Third, Dodd-Frank has added an additional wrinkle to interacting with regulators. When considering what information to share with regulators and when to share it, investigative counsel must consider that a whistleblower may have already contacted regulators or may do so soon. To maintain the company’s credibility with regulators and secure cooperation credit where appropriate, counsel must carefully consider the pitfalls of tardy disclosures. But rushed decisions often lead to faulty findings, which may have a significant impact on the company before regulators and in subsequent proceedings. The specter of a whistleblower also impacts a decision of how hard to push back on regulators during an investigation. In many instances, it may be appropriate for a company to stand its ground against a regulatory investigation instead of trying to simply appease regulators. But will a whistleblower end up undermining an aggressive posture?

What every company should realize is that it may have employees who have any number of reasons to go outside and assert allegations of corporate wrongdoing in order to get anti-retaliation protection while possibly receiving a big bounty. The SEC does have certain gatekeeper responsibilities to vet information they receive, but companies cannot rely on the SEC in this regard. Outside counsel must be prepared to help corporations navigate these new waters.

Editor: There are many possible technological tools that may be used by a company in an investigation to ferret out wrongdoing that might serve as a basis for whistleblowing. These include accessing a suspect’s or witness’s stored emails, monitoring in real time incoming or outgoing emails, reviewing social media entries, listening to telephone calls or tracking travel. What issues are raised by conducting an investigation that deploys the panoply of technological tools that are available or by using such tools on an ongoing basis to nip potential wrongdoing in the bud rather than waiting for someone to blow the whistle?

Sparling: How far to proceed down the seemingly bottomless rabbit hole that opens up when investigating a company is a very delicate question. It depends to a large extent on the context and the nature of the wrongdoing.

Most companies do have repositories where information is stored for a long period of time. Accessing all of this information may be important to obtain a full understanding of what happened. In addition, employees now communicate in a variety of ways, including through on-line chats and text messaging. Oftentimes, this is done through corporate computers or mobile devices.

What’s helpful about technology is that after you identify a problem, it’s much easier to investigate it. It’s also more expensive to do so because of the volume and storage techniques.

In terms of monitoring in real time, that is a possibility. Perhaps doing so could help prevent potential violations or even save someone’s career before he or she makes a bad decision. But whether to monitor is more than just a legal decision. Companies need to be careful about the environment they are creating. Do they want employees to become paranoid that their emails are being searched and monitored? Is this going to kill camaraderie at the company in some way? Those are really issues for management to decide.

With respect to waiting for whistleblowers to identify problems, public companies have an incentive to have internal compliance mechanisms in place to protect them against accusations of being asleep at the wheel. And the consequences of not conducting an investigation could be dramatic in terms of shareholder lawsuits, criminal or civil sanctions, and a turnover of management. It could undermine confidence of a company’s stakeholders in the credibility and integrity of management. The effect would be even worse if the company started to investigate and then suppressed information about wrongdoing.

However, conducting an investigation is not a foregone conclusion. A report of an investigation will often become public and is more likely to be so in a whistleblower context, since it is designed to counter those allegations or to show that the company investigated them in good faith and, to the extent corroborated by investigation, took appropriate steps to remedy any compliance failures.

Obviously, you lose control of the report of the investigation once you disclose it outside the company. Companies are still struggling with how far to go.

Please email the interviewee at ssparling@kramerlevin.com with questions about this interview.