Project: Corporate Counsel - Law Firms Avoiding Surprises In Today's Post-Enron Climate

Sunday, May 1, 2005 - 01:00

Editor's Note: The purpose of this series of interviews is to explore how law firms partner with corporate counsel to assist them in their efforts to meet the challenges of the New Legal Environment (including Sarbanes-Oxley, the revised Organizational Sentencing Guidelines and other requirements that grew out of the scandals as well as the corporate governance requirements of state law and the securities exchange rules). "Partnering" means going the extra mile for clients by anticipating their needs. It also includes keeping clients informed of issues that might take them by surprise. It involves helping corporate counsel in situations where his or her duty to the corporation creates difficulties with management.

Editor: How is your firm helping your clients to avoid surprises as regulations continue to evolve in response to the Enron and other corporate scandals?

Sheehan: Our SOX committee serves as a spearhead for the firm's self analysis of its own legal opinions in a variety of transactions and provides a sounding board for our clients on such matters as the certifications that SOX requires from the companies' chief officers. The team vigilantly keeps current with every new regulation and iteration of decisional law.

Because of the obvious tie between SOX requirements and the sentencing guidelines revisions, our committee is comprised of not only corporate lawyers steeped in securities law, but also those who have a strong white collar criminal law background. The experience of our lawyers in litigating real-world issues enables them to give companies guidance on how to avoid similar problems in the future. One committee member with a combined accounting and legal background is particularly helpful given the financial derivation of many of these problems. For example, special purpose corporations are arcane creations requiring an expert to understand their accounting nuances. Accounting expertise is also helpful on the many corporate governance matters with an ERISA element.

Editor: How are you helping clients with the SOX certification requirements?

Sheehan: When certification requirements first arose, the procedures were not in place to fully inform the corporation's chief officers. We have helped corporate clients develop standardized techniques that give them trust and confidence in what they are signing because they have done their due diligence by asking the right questions and not overlooking any accounting irregularity. If someone in an untoward way has frustrated the company's accounting practices to keep the officers and directors from seeing a true picture of what is going on financially, liability will fall on the person who has engaged in the cover up, and the officers and directors cannot be held personally responsible.

Editor: Does this mean that the safe harbor from liability is not dead if the directors acted in good faith and made a sound business judgment (even if it proved to have been wrong)?

Sheehan: Yes. Liability will not be imposed merely because someone disagrees with a judgment with respect to a particular acquisition, divestiture, investment or other matter as long as sound business judgment was exercised.SOX adds procedures that give directors and officers the substantive ability to say "We looked at that, we evaluated it and we exercised sound business judgment."

Editor: What can be some of the negative results if directors are too independent?

Sheehan:Assessing a director's independence is a fact-sensitive inquiry. Some pundits complain that true independence would require directors to become so attenuated from the corporation that they would not know its name. It does not make sense to appoint someone with no experience to serve in this capacity. You certainly would not choose a doctor or lawyer who had no experience. Why would you want directors so independent and so removed that they have no experience of having served on significant boards?

Editor: How is your firm staffed to help your corporate clients with internal investigations?

Sheehan: We have 10 former assistant U.S. attorneys with diverse backgrounds in fraud and abuse in arenas ranging from healthcare to financial institutions. Each has a specialty that has been of tremendous assistance to a variety of clients. Based on our legal advice regarding internal investigations, the corporations have taken action with respect to employees, and in some cases have made changes to their bylaws or structure.

This is a busy area for us, which I expect will continue to grow. More and more boards recognize the need for outside counsel to scrutinize the allegations of a particular instance. Acting on outside legal advice frees board members from charges of cronyism or favoritism that might be made if they were not to solicit independent investigation and analysis.

Editor: Are you helping companies to develop effective compliance training programs?

Sheehan: Working with our corporate counterparts, we develop compliance programs attuned to the key areas of the corporation. Nobody knows how to target legal advice to their company's business better than the corporate counsel. The problems they encounter every day provide the best historical background for developing compliance guidelines. We team with them when they do not have the time or background for addressing these areas.

We are helping clients interweave SOX and the sentencing guidelines together with whatever regulatory climate they are dealing with - be it healthcare, finance, environmental compliance or other areas. Frequently daunted by the maze of regulations confronting them, executives and in-house legal teams welcome our help in developing a compliance manual.

The advent of the extranet has enhanced our ability to partner closely with our clients. Instead of waiting for clients to call and suggest an issue, we are sharing on an extranet, tutorial basis insights into SOX and related statutes. The extranet gives them ready access to information needed on a daily basis without incurring the costs associated with a "hurry up" exercise every time there might be a problem. Our clients appreciate this kind of partnering.

Most of our work has been by department, division or product line. Major pharmaceutical companies have global compliance officers who are very valuable and very good at their jobs. More and more companies are following this model and staffing compliance functions to address every element of the corporation.

Editor: Isn't complying with SOX expensive?

Sheehan: Costs are related to the services needed. If outside counsel is called upon to conduct independent investigations, prepare compliance manuals, develop an extranet training program or deliver a tutorial addressed to a particular business area, an in-house legal department should be prepared to increase its budget to pay for these services. At the same time, the corporation needs to increase its budget for internal controls and compliance officers that before now have not been part of the corporate infrastructure. Such investments are critical for avoiding larger costs that would be incurred down the road without that kind of institutional backbone.

The problem with legal services is that they have never been a profit center, they have always been a cost. Lawyers, as a tradition, are risk adverse, and are characterized as having a negative influence on the otherwise entrepreneurial activities of the American corporation. That is certainly not how we view ourselves. We view ourselves as making sound judgments consistent with good business practices that ultimately benefit the corporation.

Editor: Do conflicts often arise between general counsel and their outside counsel when directors ask questions about their exposure to liability?

Sheehan:Questions from outside directors are usually asked in context. If outside counsel and the general counsel enjoy a good relationship, they have discussed that context and the various permutations that might flow from it. They can answer the question honestly and comfortably. In the rare circumstance when a good, honest exchange of ideas has not resulted in a uniform point of view, the conflict has been exposed before the director asks the question and a consensus has been reached that good judgment can yield different conclusions.

We have been very fortunate in this regard. We have never been in a situation where we have disagreed with general counsel after independently arriving at a conclusion. Corporate lawyers today have superb backgrounds. They have been trained at top law firms or have tremendous experience from government service.I have not encountered a rogue GC making decisions that are ill-advised and looking for consensus from outside counsel after the fact.

Editor: In what practice area are you seeing the most compliance issues arising?

Sheehan: The healthcare arena is fraught with compliance issues because it is so highly regulated at every level. Virtually all doctors, nurses and other healthcare providers, as well as the drug companies, device companies and other third parties that provide services to them, are regulated. In Philadelphia and Boston you are seeing a great deal of U.S. attorney activity in the healthcare field. More enforcement actions in other jurisdictions can be anticipated because the multiple layers of regulation create such a morass.

It is easy to get caught up in issues that appear innocent because they are common business practices that have been engaged in for years and accepted by the industry. With the benefit of 20:20 hindsight, the regulatory bodies say that they are not appropriate; the practices get litigated and often - but not always - the industry loses those battles. It is a continuing phenomenon in the healthcare arena.

Editor: How do you see SOX impacting privately held companies?

Sheehan: One of our specialties is advising closely held corporations, which is not unusual for a firm headquartered in New Jersey. Every day our excellent corporate department helps them address finance, corporate governance and other issues. As a result, many of our compliance programs have been directed to small, closely held companies. Most are looking eventually to go public with what is euphemistically called the "liquidity event." They want to be ready now with what will be necessary in the public arena.

Most companies want to run their business in a way that will withstand scrutiny at any level. Rather than running the risk of not managing it the right way, they are looking to comply with SOX and other regulatory requirements even when these regulations may not apply to them. We have an ongoing program that is directed to closely held corporations to meet this need.

Please email the author at dsheehan@gibbonslaw.com with questions about this article.