Empowering Lawyers To Meet Governance, Compliance Challenges

Friday, October 1, 2004 - 01:00

The Editor interviews Thomas C. Baxter, President, Greater New York Chapter, Association of Corporate Counsel - America, and Executive Vice President and General Counsel, Federal Reserve Bank of New York.

Editor: What is general counsel's role in corporate governance?

Baxter: A general counsel's obvious role with regard to all laws and legal requirements is to advise the corporation about those standards and to help implement measures that comply with any applicable requirements. There are specific, but no less important, roles for a general counsel when it comes to corporate governance.

The first is as a visionary, a role that extends beyond advising about the minimum legally required standards of corporate governance to making the connections between good corporate governance and good business, keeping abreast of the latest thinking on corporate governance and helping senior management and the board of directors of a corporation fashion a healthy corporate culture that values a solid ethical environment, accountability and full and fair disclosure of financial condition.

The second is as a leader. The "tone at the top" is set by the highest constitutional body of the corporation - its board of directors. But the board cannot set the tone by itself. It needs the active aid of the CEO, the CFO and the general counsel. As the lawyer for the corporation, the general counsel is in a unique position to lead by example and to foster respect for, and adherence to, the highest ethical and legal standards.

Editor: What part have Sarbanes-Oxley, the Sentencing Guidelines, Caremark, the Model (ethics) Rules, the ABA's Task Force on Corporate Responsibility and recommendations in special litigation committee reports played in shaping that role?

Baxter: Some of the sources you've cited provide many very clear and specific mandatory rules for what is expected of a general counsel. For instance, Sarbanes-Oxley and its implementing regulations impose clear obligations on a general counsel in an up-the-ladder reporting policy. Sarbanes-Oxley and some of the corporate governance guidance also suggest a strong role for general counsel in helping management and the board develop specific corporate governance practices, such as development of corporate governance principles, a code of ethics, more detailed audit committee charters and the like.

More generally, however, many of the recent corporate governance initiatives have not really changed the broader role of general counsel. They have perhaps reminded lawyers that the client of general counsel and his or her office is the corporation and that the duty is to the corporation . They have also reminded corporations of the importance of developing a culture that encourages a strong general counsel.

Editor: Why is it important for corporate counsel to have the status required to play that role?

Baxter: Without access, authority and resources sufficient to undertake any of the obligations of his or her role, the effectiveness of even the most talented general counsel will be limited. A general counsel who is not brought into all of a company's significant decisions, who is not encouraged and expected to exercise his or her independent judgment and whose work and judgments are not afforded consequence is not going to be effective.

If a general counsel is reporting to a mid-level corporate officer, and not to the CEO, that lawyer's position speaks to the value the board and senior management places on the contribution of that general counsel. Such a position does send a powerful message to the rest of the corporation that the general counsel's office is, if not unimportant, less important. That lack of status inevitably hampers the effectiveness of the general counsel and lawyers in his or her office.

We see and hear anecdotal evidence to this effect. Richard Breeden, in his report on the failure of WorldCom, noted that the legal department was fragmented and dispersed and that the CEO appeared to have done everything possible to undermine the stature and authority of the legal department, expressing disdain for compliance and ethical concerns. That kind of culture opens the door to bad behavior. The importance of access, authority and resources, which are all indicia of a general counsel's status, simply cannot be overstated.

Editor: Please discuss the presence of the general counsel at board meetings and important board committees, membership on the highest level of corporate management and planning committees (including the risk management committee) and reporting relationships.

Baxter: The general counsel should be included in all senior management meetings (including any risk management committee meetings) and be consulted in all major decisions. Likewise, in my view, the general counsel should be a member of any senior management compliance function and meet independently with the board of directors and its committees regularly and as needed. Ideally, the general counsel should report directly to the CEO, and all lawyers for the corporation should ultimately report to the general counsel.

The general counsel must be understood to have the full confidence of the CEO and the board of directors and to have a mandate from the board to protect the company against violations of law and internal policies.

Editor: Is there a conflict between corporate counsel's role as an advisor to management and corporate counsel's responsibility to the corporate entity? How can corporate counsel continue to have the confidence of management under these circumstances?

Baxter: There is always the potential for conflict, and counsel needs to be ready for it. When it occurs, the corporate officer needs to get other counsel, because the corporate counsel's client is the corporation. If a corporate officer decides to undertake illegal action, the lawyer has a duty to the corporation to inform other senior management or the board of directors. The general counsel who does not perform this control function role is failing the corporate client.

The potential for conflict should not impair management's confidence in the general counsel. One way for general counsel to continue to have the confidence of management is to ensure that management understands that the client is the corporation, not management.

Editor: When CEOs and CFOs sign the certificate required by Sarbanes-Oxley, they may seek written assurance from the general counsel that she is unaware of any disclosable event that should be disclosed, that the company is in compliance with material legal requirements and that she is not aware of any material defect in internal controls. What are the implications of providing such written assurance?

Baxter: "Subcertification" is a practice that has grown out of the Sarbanes-Oxley Act's CEO and CFO certification requirements. General counsel, other executive officers and junior officers, particularly in finance or tax areas, may each be asked to sign subcertifications or provide other written information that the CEO/CFO will rely upon in making their legally required certifications. I am asked to provide a yearly certification to our President relating to controls in the legal group that I head at the Federal Reserve Bank of New York.

Whether a particular company decides to take this approach or not, the important thing to remember about any certification is that it is only as meaningful and reliable as the process supporting it. A general counsel should provide a certification only to the extent that he or she is able to articulate a basis for his/her belief as to the accuracy and completeness of each statement he or she is certifying. So, for instance, before certifying that the company is in compliance with material legal requirements, the general counsel should be able to point to a process and procedures - e.g., a compliance program - designed to ensure that this is the case.

Subcertifications can reinforce a corporate culture that promotes good disclosure controls and procedures and values transparency in the form of complete and accurate public disclosure. Each individual who signs a subcertification is more likely to reflect carefully on the accuracy and completeness of the information he or she is asked to provide. This practice can be valuable in reminding more junior staff that they have "ownership" of controls within their purview. The CEO/CFO should always remember, however, that the signing of subcertifications by general counsel, or any other officers or anyone else, is not a substitute for diligence and knowledge on the part of the CEO/CFO.

Editor: Can't the internal auditors do everything that corporate counsel can in terms of uncovering disclosable issues? Can't management simply rely on employee compliance training and hotlines?

Baxter: In a word, "no." Internal auditors can uncover questionable accounting and control practices under standards applicable to those important areas. But no individual acting as an auditor can or should make legal judgments. Likewise, compliance functions are crucial to most, if not all, sizable businesses today. But a compliance function should be relying on the judgment and skill of attorneys who are capable of making legal judgments that form the basis for compliance work. In fact, the close linkage of compliance and legal work is probably the reason that so many compliance functions operate under the general counsel - which I think is preferable as an organizational model.

Editor: How important is corporate counsel's role in advising management about the legal considerations applicable to planning major business initiatives, being involved in reviewing the legal aspects of its press releases, annual reports and other documents and generally advising management on the legal aspects of their proposed actions? Does this give corporate counsel the ability to head off problems before they become significant? How important is an understanding of the legal implications of planned actions?

Baxter: The importance of corporate counsel's role in managing legal and reputational risks that are embedded within public documents and new products is a key part of life as a general counsel in the 21st century. It is also a demand that in many respects is both new and challenging. General counsel should work closely with the heads of human resources and corporate communications and should be represented on any new product or business line committee. In addition, the general counsel should be involved in crisis management planning and any efforts toward crisis prevention.

This kind of involvement serves several purposes. Yes, as your question indicates, it should give corporate counsel an opportunity to head off problems before they become significant. It does this by providing a forum for corporate counsel to become aware of new activities that may require legal counsel, related deadlines for the provision of that counsel and any related legal staffing, resource or outside counsel issues. It also does this by providing general counsel an opportunity to explain the implications of new activities to the appropriate level of company management.

This involvement should also help corporate counsel develop a thorough understanding of any new activities, which will facilitate the provision of legal counsel in the future. It should also help corporate counsel establish appropriate preventive law programs and documentation to help employees understand legal issues and requirements related to the new activities.

Editor: Does a general counsel have an obligation to have the staff and other tools required to do his or her job? What should general counsel do if her requests for additional staffing and other tools are denied by management and, in her judgement she lacks the tools to do her job?

Baxter: These issues relate to my earlier statement about the importance of resources and the status of general counsel and the legal function. If the general counsel's office is not appropriately funded, the effectiveness of that office will be limited. Inadequate resources can impair the efforts of the office and will send a message to the rest of the corporation that the office's work is not a priority. The general counsel can make the case for additional resources directly to senior management or the board. Given today's focus on corporate governance, the importance of legal and compliance functions and the highly visible consequences of breakdowns in those areas, the CEO, Chairman and board should not be oblivious to the importance of a strong general counsel's office. If critical resources are denied, notwithstanding persuasive arguments for support, the general counsel should resign or risk becoming the designated scapegoat for what might happen.

Editor: The scandals focused principally on weaknesses in the accounting function. Should legal departments have lawyers on their staffs who are sufficiently skilled in law and accounting to identify a possible problem with authority to go to outside counsel for advice from professionals in that field? What about other functions within a company where antitrust, environmental, marketing, intellectual property, etc, disclosable issues might arise?

Baxter: Developing financial accounting standards are exposing lawyers to accounting practices, whether we like it or not. I believe that, depending on their practices, in-house lawyers may have to acquire very specialized knowledge about their clients' businesses and accounting practices, especially with respect to internal controls for financial reporting in public companies. At the same time, in-house counsel cannot become blind to more general legal or appearance problems and the larger context in which specialized issues arise. This is not necessarily a new issue, as in-house counsel have always had to balance the benefits of being a specialist versus those of being a generalist. Rather than becoming experts in specialized areas of the law unrelated to the core function of the companies they represent, in-house counsel can continue to serve their client best by knowing when to ask questions and solicit outside advice.

I would also add that, although many of the recent scandals have involved abuses in companies' accounting functions, the genesis of the scandals would seem to be weaknesses in the culture and governance structures of those companies, not the accounting function per se. For instance, we have all seen the reports of Enron's ultra-competitive, "anything goes," push-the-envelope culture Ñ and, as I mentioned earlier, a culture at Worldcom that, from public reports, disdained legal compliance and lawyers. One would think that similar accounting scandals would be less likely to arise at companies that have cultures that foster respect for, and adherence to, high ethical and legal standards and strong governance structures that encourage transparency, integrity and accountability.

Editor: Should all lawyers in a company have a direct reporting relationship to the general counsel?

Baxter: General counsel should foster open lines of communication, and because the general counsel is responsible for the corporation's legal affairs, the general counsel should receive reports on significant matters. A corporate culture that values transparency, integrity and accountability will encourage such reporting. All legal departments, whether required or not, should consider implementation of an up-the-ladder reporting policy of the type required by Sarbanes-Oxley: one that explicitly authorizes lawyers to bring concerns about suspected material violations of law to the general counsel or the board. Lawyers should understand that they will not suffer retaliation for following this policy. The policy should be applicable to any outside counsel retained by the corporation.

As for structure, I believe that there is no one-size-fits-all answer to the question whether all lawyers need to report to the general counsel. In some decentralized companies, lawyers are situated throughout the business areas, and there is no more than a dotted line reporting to the general counsel. In this decentralized legal environment, communication becomes even more significant.