Uncertain About Subprime And CDO Exposures - An Internal Investigation May Be In Order

Saturday, December 1, 2007 - 00:00

Editor: Please discuss your experience with internal investigations and related civil litigation.

Kaufhold: The focus of my practice is securities litigation and investigations. Approximately half of the securities cases that I've handled have involved some form of internal investigation, whether conducted by independent counsel or company counsel. My roles in different matters have included representing companies, independent directors or other board committees and, of course, individual corporate directors and officers.

Editor: What are the most common circumstances when companies decide it is appropriate to undertake an independent investigation?

Kaufhold: By far the most common issues for investigation at public companies are accounting and disclosure issues followed by insider trading allegations. The decision to bring in independent counsel is usually triggered when the issues relate to the conduct of senior management or board members. This has been true most recently in the stock options backdating investigations and cases that have kept us very busy.

Editor: What are the steps that a company should take at the outset of an independent investigation to maximize its value?

Kaufhold: The most important first step is to ensure the independence of both the folks overseeing the investigation and the counsel conducting it. The second key step is to define, and adjust as necessary, the scope of the investigation. On one hand, these investigations are very costly in terms of both management's time and fees and costs. On the other hand, it's very difficult to predict in advance every key issue that may arise during the course of an investigation and the bottom line is that a company and its counsel really need to maintain the flexibility to address and follow up appropriately on all significant issues that are discovered.

Editor: There is a prediction that companies with subprime and CDO exposures may face multiple types of litigation exposure. This will undoubtedly trigger a multitude of internal investigations. Directors may be concerned about personal liability in securities class actions and derivative litigation if the company has not fully disclosed its potential liability and may want an investigation to determine whether full disclosure has in fact been made by management. What are the benefits and pitfalls of such an investigation?

Kaufhold: There are at least two potentially key benefits to such an investigation. First, the results of a thoughtful and efficient investigation can provide directors with the information necessary to guide business decisions regarding subprime and CDO exposure. Second, from a legal perspective, such an investigation will help directors demonstrate that they have discharged their fiduciary duties to the Company. Potential pitfalls include diversion of management's time and attention from the business of the Company, fees and costs associated with the investigation and, depending on the circumstances, potential waiver of attorney-client privilege.

Editor: Many of the cases will involve business vs. business litigation. How will internal investigations affect these cases?

Kaufhold: Internal investigations should be helpful in follow-on litigation to the extent the Company has gathered the relevant facts and documents. The factual and legal analysis performed in the course of the investigation can be leveraged in later litigation. However, it is important for the Company and its counsel to remain cognizant of potential privilege issues.

Editor: Internal investigations may also be triggered by civil and criminal actions brought by attorneys general and regulatory bodies. What cautions do you have?

Kaufhold: The potential privilege issues mentioned above are even more pronounced during the pendency of civil and criminal investigations by regulators and prosecutors due to the possibility that the government will ask the Company to waive privilege with respect to the conduct and result of the investigation. While the matter is not entirely settled, the majority view is that such a waiver with respect to the government has that practical effect of providing private litigants with access to the same information in follow-on litigation. As a result, companies and their counsel need to consider carefully the actions taken during the course of an investigation and the form in which findings and conclusions are documented.

Editor: The internal investigations may be accompanied by e-discovery? Given the proclivity of some in the financial services industry to use flip phrases, do you have any thoughts about the extent and nature of any e-discovery that may be employed in such investigations? Given that the results of such investigations may affect litigation outcomes, what cautions do you suggest?

Kaufhold: E-discovery has caused a real shift in the scope and expense of investigations over the past 5-10 years. Historically, investigations focused on analysis of a limited universe of hard-copy documents maintained by a company followed by interviews with key employees and third-parties. More recently, electronically stored documents have greatly expanded the expected scope of such investigations. Now, common practice is to seek and review relevant e-mail messages from office computers, home computers, company servers and archives. This is an expensive and time-consuming process.

Unfortunately, the proclivity of some executives to use flip phrases in e-mails is not limited to the financial services industry. It is important for business of all sizes and in all industries to recognize that scrutiny of e-mail messages is now a fact of life in investigations and civil litigation. During the course of investigations, companies should complete a thorough analysis of potentially relevant e-discovery. Regulators and private plaintiffs are sure to do so and it is always better for a company and its directors and officers to understand the scope of potential problems in a timely manner.

Editor: Does Akin Gump have the expertise in the financial services industry required to fully understand the issues involved in these cases? How will it cope with conflicts issues?

Kaufhold: Absolutely. Our firm has an internationally recognized funds practice and regularly represents leading financial institutions in a wide variety of litigation and regulatory actions. With respect to conflicts, the key imperative is to resolve potential conflicts at the outset of the representation. This is particularly important in the context of independent investigations because conflict issues can severely compromise the value of such an investigation and, in extreme cases, could force a company to literally re-do an investigation with conflict-free independent counsel.

Editor: While the financial services industry is currently addressing subprime and CDO issues, do you have any predictions regarding what issues regulators and plaintiff's attorneys will target next?

Kaufhold: I believe there will be increased focus on retirement products and funds due to the enormous amounts of money set aside in such funds and accounts and the fees and commissions earned by the industry. Also, the current subprime and CDO investigations underscore the difficulty and uncertainty of valuing and accounting for assets in the absence of an established and active market for that asset, and this issue cuts across a number of industries.

Editor: Do you have any final comments?

Kaufhold: Investigations - whether handled internally or by independent counsel - are among the most challenging issues that in-house counsel and their clients will face. In addition to the legal issues involved, it is crucial that in-house counsel successfully address the practical, personality and relationship issues that often arise when an investigation impacts senior management and board members. Often, trusted legal counsel can be as helpful with these issues as with the strictly legal issues that must be handled.

Please email the interviewee at skaufhold@akingump.com with questions about this interview