Compliance Readiness Dealing With Your Company's Employees In Connection With An External Investigation : Effective Strategies For Maximizing Success And Cooperation-Part II

Corporations can act only through people; as corporate counsel, you know only too well how true this familiar axiom is and how it can play out in the life of your company. Your company relies every day on people to be its public face and its public voice, and by far the largest segment of the people through whom your company can act is its employees, from top management to the mail room staff. When you are faced with an SEC investigation or proceeding, the actions and motivations of some of these individuals, most of whom will be unknown to you, come under the regulatory microscope. Ensuring that the company deals effectively with its employees can make an enormous difference in achieving a successful outcome.

Counsel For Employees: Determining When the Company Should Provide Representation And Strategies For Doing It Efficiently

It is widely accepted that the company benefits when its employees have representation in connection with an external investigation. The anxiety and stress associated with being interviewed by or testifying before regulators can be reduced significantly if employees have competent counsel to prepare them, to listen to their concerns, and to provide them with an understanding of their role in what is for them a completely foreign process. Providing employees with this level of comfort, in turn, helps to minimize the distraction caused by an investigation and helps employees expeditiously return to contributing to the company's productivity. Ensuring that employees have counsel also makes it more likely that information or testimony they provide is clear and consistent, and is based on facts rather than speculation.

Assuming the company has decided that it is in its interest for its employees to have counsel in connection with an investigation, two preliminary questions arise: whether the employee needs counsel separate and apart from the company's counsel and, if so, who should bear the cost.

Who Should Represent The Employee: Full Cooperation Has Its Cost

Whether the company's attorneys should also represent employees in an external investigation is a complicated issue that can only be resolved by taking into account the specific facts and circumstances presented. Despite its fact specific nature, there are several guiding principles to bear in mind in making this assessment. First, even though the ABA's Model Rules of Professional Conduct permit company counsel to represent all employees (assuming a continuity of interests), the government generally views such representation as something less than "full cooperation." Representation solely by company counsel may be interpreted at best as an impediment to full and independent disclosure by employees and, at worst, an effort by the company to shape employees' testimony. Depending on the significance of the investigation, the regulator's perception may be enough to drive the decision to enlist separate counsel for your employees.

Another key consideration is the extent to which the interests of the employee and the company are aligned and the potential that they may diverge. Ordinarily an attorney may represent a company's employees so long as their interests are aligned and the representation of one client will not adversely affect the representation of the other client. However, experience teaches us that at the outset of an investigation or proceeding, it is difficult to assess the full scope of any particular employee's involvement or knowledge, and thus difficult to predict how positions may change and become adversarial. The risk in such a situation is not merely that, at some point along the way, the company's counsel may need to stop representing the employee; rather, the far more significant risk is that company counsel could be disqualified from the representation altogether. Although most law firms retainer agreements attempt to minimize this result by having the employee waive in advance any future conflict and explicitly give permission to the law firm to continue representing the company in the event of a conflict, it is far from clear that such prohibitions will be enforced.

Once a determination is made that employees need separate counsel, an important objective is to do so in an efficient and cost-effective manner. In a large investigation, dozens of employees may be interviewed or deposed; having dozens of separate law firms review the relevant documents, educate themselves on the status and scope of the investigation, and send your company the bill for all this time is neither efficient nor cost-effective. Moreover, having a large number of attorneys involved increases the risk of a disconnect in communications with and approach to the regulators. Building familiarity and trust with your audience is a key goal of your response to an investigation, and a "musical chairs" scenario in the interview or deposition room can detract from that goal.

One strategy for maximizing efficiencies and promoting uniformity in dealings with regulators is to use one outside firm for all employees. The obvious advantage is that only one team of lawyers needs to be briefed, educated, and brought up to speed on the investigation, saving the company time and money and streamlining the process of communicating important developments. In the typical case in which various employees are not targets or subjects of the investigation, but merely witnesses, a single firm's representation of multiple employees makes sense and is usually very effective. When a particular employee is known to be or appears likely to become a subject or target, or otherwise may face potential liability arising out of his or her actions, it is best to employ separate counsel for that employee.

The Costs Of Separate Counsel: Determining When And When Not To Pay

The question of when and under what circumstances the company must pay for the costs of counsel for employees in the context of a regulatory investigation or proceeding is driven primarily by the law of the state of incorporation and by the company's certificate of incorporation and by-laws, as well as, in certain instances, any employment agreement in effect. Although they vary, most state corporate laws permit companies to indemnify employees and advance counsel fees, but mandatory advancement is traditionally reserved only for directors and officers. As a practical matter, this means that the company typically has a choice as to whether to pay for the costs of counsel for its employees.

Regardless of whether the company has such a legal obligation, the reality is that most employees do not have the resources to engage sophisticated counsel experienced in such matters; as a result, for the reasons discussed above, it is usually in the company's interest to retain counsel on the employees' behalf. However, the company should be sure to have the employee sign an undertaking to repay the fees should the employee later be found to be disqualified from indemnification. Conduct that would render an employee disqualified from indemnification generally includes violations of law, violations of company policy, and actions adverse to the company's interests; again, both the relevant standard of conduct and the mechanism for evaluating that conduct are established by the operative state laws, the certificate of incorporation, by-laws, and any other agreement between the employee and the company.

While the company may feel obligated to pay for counsel for employees, there is a risk of "over-indemnification" that can lead to adverse consequences. In 2004, a large telecommunications company agreed to pay the SEC $25 million to settle an enforcement action resulting from the company's alleged "lack of cooperation" with an investigation into its accounting practices. According to the SEC, the company acted "contrary to the public interest" when it agreed to indemnify a number of employees for the consequences of the SEC's enforcement action. The SEC's view was that the company, by indemnifying employees in circumstances where neither state law nor the company's charter required indemnification, effectively gave its employees a "blank check to litigate" with the SEC.

Dealing With Whistleblowers: Sarbanes-Oxley Raises The Stakes

The image of the corporate whistleblower as a white knight motivated solely by conscience is often a fiction. As likely as not, so-called whistleblowers have some involvement in or responsibility for the wrongdoing being reported; in many cases, these individuals at a minimum may have looked the other way for a period of time, and the decision to blow the whistle was based as much on self-preservation as on conscience. The popular image of the whistleblower, coupled with the corporate scandals of the last several years, has wrought significant and serious changes in the law which must be taken into account when dealing with all employees in the context of an investigation.

The Sarbanes-Oxley Act not only created a cause of action for whistleblowers who were subjected to adverse employment action as a result of engaging in "protected activity" under the statute, i.e., providing information which an employee reasonably believes constitutes a violation of certain provisions of federal law, but also criminalized retaliation against so-called whistleblowers. Specifically, the Act imposes criminal penalties, including fines and a maximum term of imprisonment of ten years, on any person or entity who knowingly retaliates against an employee based on the employee's provision of truthful information to a law enforcement officer in connection with the commission or possible commission of a federal crime.

The existence of federal civil and criminal penalties for retaliation against purported whistleblowers has the potential to put a company in a tight predicament. On the one hand, the government, including the SEC, expects that a company will take prompt action when it learns of misconduct, including disciplining and/or terminating employees responsible for violations of law. As noted above, however, these same employees involved in misconduct may be whistleblowers, providing information to prosecutors, regulators or class action lawyers. The company thus may find itself caught between a rock and a hard place, needing to take disciplinary action in order to satisfy regulators but at the same time facing the potential for civil and/or criminal liability as a result. This is but one more area, similar to the debate about regulators demanding waiver of the attorney-client privilege, in which the demands of cooperation are in tension with the exercise by the company of its legal rights.


Dealing effectively and efficiently with employees in the context of a regulatory investigation or proceeding has become increasingly challenging in the age of "full cooperation." In order to best protect your company's interests, you may be required to take actions that only a few years ago would have seemed overly cautious. Now the stakes are higher than ever, and ensuring that your employees are represented by competent and independent counsel can be an investment that not only reaps rewards for the company in terms of the outcome of the investigation but, if approached properly, does not have to break the bank either.

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