Keys To A Successful Investigation

Wednesday, August 1, 2007 - 00:00

Editor: Please give our readers a snapshot of your background and experience.

Harkness: I am a litigator at Kramer Levin. Over the years I have represented individuals, companies, auditors and audit committees in complex financial fraud cases, typically ones involving accounting irregularities, ranging from Enron and, most recently, the Parmalat case, but also including cases under the radar where things have gone well, so no one has ever heard about them.

Editor: Has your former career in international public relations been useful in terms of assisting clients?

Harkness: Over the years I have found that my PR background has helped me assist clients in responding to press inquiries. Many of my cases have been of interest to the press, such as the Enron case where I represented Arthur Andersen. All too often, lawyers reflexively instruct clients not to speak to the press, but in many cases, particularly when there is a high degree of media scrutiny, it is impossible for a company to remain silent, and you have to balance the need to protect the public reputation of the enterprise with the legal risk of misspeaking. I don't personally subscribe to the precept that silence is the only option with regard to the media, particularly if there is some public reputational harm that the investigation alone confers.

Editor: Have you advised clients about conducting internal investigations or investigations of governmental bodies?

Harkness: I find that typically if an internal investigation is involved, a government body will often be involved shortly thereafter, or a governmental investigation may turn into an internal investigation. Most of my cases over the last several years have involved both.

Editor: At what stage in an internal investigation should outside counsel be brought in?

Harkness: It depends upon the specialization of the company's own staff. For instance, does the company have an in-house-counsel staff or internal-audit department whose people are trained in conducting internal investigations? There has certainly been enough public outcry about such instances as the Hewlett-Packard investigation, where those not normally accustomed to conducting an investigation were doing so.

I would offer a few guidelines: first of all, if the company does not have an internal staff that is trained and expert in conducting internal investigations, it should go almost automatically to outside counsel who are specialized in conducting investigations, even if the investigation is as simple as one involving discrimination or some human resources violation.

If you have a trained group adept in doing internal investigations, then I think there are different thresholds for seeking outside counsel. The first one is whether or not the facts that are coming out of the investigation look to implicate material parts of the business. For example, is this going to have or have the potential of being a material hit to the financial statement? If so, then bringing in outside counsel is a good idea. Another instance is where the integrity of senior management might come into question, even one senior manager at a high level. It is very difficult for general counsel or internal auditors to investigate people at a very senior level.

Editor: Do you subscribe to the notion that an outside firm with no prior strong allegiances to the company should be engaged?

Harkness: For the most part I do. However, I find that if the investigation is of prior behavior dating back some time that might have a litigation impact but would not likely raise disclosure issues, someone familiar with the company actually can be very useful. However, if current behavior or very recent past behavior is under investigation that could implicate current employees, the firm doing the investigation should typically be one that is not strongly wedded to the company. Often what will happen is that one law firm will conduct the investigation and another law firm will represent the company and play the more traditional defense-lawyer role. Companies can still have the counsel of trusted advisors, but the party who actually does the investigation should not have strong ties to the company.

Editor: Should the investigation be focused only on the facts related to the potential compliance failure or should it be focused more broadly on the whole ethos of the company?

Harkness: I think it's important for any investigation to have a very clear scope and that the scope only be broadened if the people in charge of that investigation have signed on to its being widened. I advise clients to focus on the company behavior at issue initially which often gives you a pretty clear sense of what the ethos of the company is. If the audit or special committee determines that the problems appear pervasive, the committee usually recommends to the full board a widening of the scope of the investigation. I typically start an investigation by focusing on very specific problems, keeping in mind that a wider range of inquiry may be necessary.

Editor: What should the role of the general counsel be once an external law firm is brought into the picture?

Harkness: If the general counsel or others in his or her office are implicated in the scope of the investigation, the general counsel's role may be a fairly limited one. If in-house counsel are not implicated, I personally like to have the general counsel involved in document collection and providing updates as the investigation progresses since he or she is someone with knowledge of the company who can be a guide to who's who, where documents are stored, who knows about particular transactions or company policies.

Editor: Should the general counsel also keep management informed as to the progress of the investigation?

Harkness: This depends on what the investigation is about. The key people to be kept apprised of the investigation are those who are charged by the board to oversee it. In many instances, it is appropriate to have senior management really in charge of and overseeing the mechanics of the investigation, but if senior management is implicated in potential malfeasance, it is usually a mistake to have them actively involved. What we often do is look at the scope of the investigation right up front and then decide who is going to be managing the process and facilitating the collection of documents, the interviewing of witnesses, who is going to get updates. Having very clear communication lines is important so that everyone knows who is entitled to what information. This helps to put people at ease.

Editor: What first steps need to be undertaken once it is decided to proceed with an investigation?

Harkness: The very first and most critical step is setting up clear lines of responsibility and reporting. Investigations go off track when there is ambiguity as to who is in charge - who has access to facts before they're fully developed, who gets interim reports, who gets final reports and how those reporting lines are going to work.

The second step is to get a clear idea of what the deadlines are. Is this a government investigation with subpoenas that need responses? Are there upcoming filing deadlines? Does the company have a 10-K due? Will the investigation make the filing of the 10-K impractical or impossible? Are there debt covenants that need to be considered? Those are the sorts of questions we ask. Once the deadlines are established, it is important to coordinate with the appropriate management officials if the timing is going to make parts of running the business difficult.

The third matter of importance is to preserve the documents. Once you start an investigation, it's important to act quickly to make sure that all the relevant evidence is collected and a hold is placed on destruction of documents.

Editor: When should a company go public with news of the investigation?

Harkness: SEC guidance is not clear. If an investigation is material to the company which raises serious questions that might threaten its operation, then there is a need to disclose. One grey area is the situation where a company has just gotten a subpoena. Do you disclose the subpoena? In this day and age, unfortunately if a company discloses that it has gotten a subpoena, most people immediately believe this is another Enron. The stock takes a hit that really has no bearing on reality. One small company reported it received a subpoena - its stock took a 26 percent decline - but its only infraction was a need to restate the last quarter of earnings. In other words, the market's response was disproportionate to the problem and disclosure really hurt shareholders. Large cap companies may get subpoenas every day; disclosing subpoenas in those instances doesn't really make any sense. The main question really needs to be: does the subpoena implicate a material part of the business or pose a real legal threat to any part of the business? Another reason to disclose is if the company knows of imminent charges or material litigation. In those instances disclosure by way of an 8-K is probably necessary. Some clients put some of their litigation or subpoena-type disclosure into their quarterly or annual disclosures because they decide it is not material enough to really warrant a special announcement but important enough to avoid future civil litigation.

Editor: A Wells Notice - is that normally disclosed?

Harkness: Typically, companies do announce Wells Notices. Failure to disclose a Wells Notice would not be the basis of a criminal charge of stock fraud, only the filing of the actual charge would require disclosure. In a civil context, I think that most courts would find that failing to disclose a Wells Notice could be the basis of a 10(b) claim.

Editor: How does the attorney-client privilege and work-product doctrine need to be handled during an investigation?

Harkness: Very carefully. The landscape is changing quite dramatically right now. You have the Department of Justice issuing new guidelines on how it is going to treat the privilege and a variety of courts are wrestling with this issue. Courts are becoming more receptive in civil litigation to the argument that work product shared with government investigators should stay work product and not be disclosed to civil plaintiffs. The protection one gets from confidentiality agreements with the SEC, for instance, plays out differently depending upon the court where this is contested. This underscores the importance for any significant investigation to be run by people who have experience dealing with inverstigations who are current with the privilege issues.

Editor: What measures should a company take when confronted with a government investigation? Does the role of outside counsel assume an added importance in preparing the company for testimony and in trying to limit the scope of the inquiry?

Harkness: Getting involved with a government investigation is like getting a long-term serious disease: it takes a long time to go through the process and the consequences might be grave. The measures the company should take when confronted with a government investigation, particularly one that is focusing on a material part of its business, is to set up management structures very quickly in coordination with outside counsel to make sure that the process is one that is handled properly and doesn't unnecessarily disrupt the functioning of the business.

Outside counsel's role takes on added importance in that many companies that are under investigation today have not been investigated before. This is very much terra incognita for management and for the board, and certainly for the employees of the company. It is important for the company to have outside counsel who can provide not only legal counsel but also practical advice as to how to get through the investigation.

Trying to limit the scope is important. Beginning with a meaningful dialogue with the investigators from the government to find out what the scope of the investigation is and then developing a measure of trust between the investigators and the company representatives is foremost. If the investigator is starting to go down a road that is one that is not going to be fruitful, using outside lawyers who have reputations at the SEC or the Department of Justice as being straight shooters, a company can often avoid unnecessary delays in the investigation. Another step is getting people prepared who may be witnesses, making sure there is rapport with management so that open lines of communication can exist throughout the investigation.

Editor: Would you summarize your suggestions for our readers?

Harkness: There is a human component to investigations that is often underestimated by companies. Outside counsel can be very instrumental in helping companies manage the relationships that are impacted by investigations - with board members, with auditors, with lenders and major equity holders. The companies that are sensitive to the human relationship dynamic of the investigation and are proactive and upfront about managing those relationships end up having better results long term, particularly in a serious investigation that threatens the company's ability to do business.

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