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Jonathan J. Lerner
Partner
Corporate, Securities and Commercial Litigation
Skadden, Arps, Slate, Meagher & Flom LLP

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

We have been hearing a lot lately about investigations in the political, business and board contexts that have backfired due to alleged illegal conduct by the investigators retained. Are there any general lessons to be learned from these situations, or are they so isolated and unique that there is little value in focusing on how to conduct a corporate investigation?

These situations are not isolated or unique. Retained investigators are used often to help gather information for perfectly legitimate reasons in perfectly appropriate corporate investigations. And, there are lessons to be learned -- both to ensure the legal and ethical integrity of corporate conduct, and to avoid the media spotlight which shines so much brighter today than ever before on these issues. I hasten to add a disclaimer, however, that in today's world of journalistic feeding frenzies, we should be extremely careful in attempting to draw lessons from any particular incident no matter how much publicity it has drawn because they all involve critical unproven allegations of illegality, intent or irresponsibility. I am reluctant to contribute to the instinct for prejudgment, which regrettably is all too prevalent today. I do think, however, that is productive, especially in the current environment, to focus on what I will call the maximum protective effort -- without in any way suggesting that a lesser effort would violate any legal or ethical standard.

What types of investigative methods have been used which have raised questions?

According to one pending federal indictment of an investigator, and a lawyer who hired him, the investigator used illegal wiretaps to obtain information about a third person, who was a client of the lawyer. The information obtained by the wiretaps allegedly provided to the lawyer included attorney-client privileged communications.

In another situation, according to public reports, investigators used "pretexting", which involved attempts to obtain telephone records and personal information about a number of persons by the investigators using false pretenses -- or "pretexts" to acquire the information. Unlike the use of secret wiretaps, which are generally illegal, the legality of pretexting is subject to debate.

Is the possibility that illegal or unethical conduct will occur during the course of a corporate investigation enough to rule out using outside investigators?

By no means. However, the fact that a company has a legitimate interest in developing information in furtherance of detecting and either preventing or terminating improper conduct does not justify ignoring the methods used to obtain information.

What should a company do where it needs to obtain information to conduct an investigation to determine if wrongdoing has occurred and, if so, by whom?

Once management or the Board decides that an investigation is required, it must be recognized, especially if it does not involve a routine matter, that the manner in which the investigation is to be performed may be affected by the gravity of the threat posed and the status of the subjects of the inquiry. If the matter under investigation is significant, or involves members of senior management or the Board, independent outside counsel, unaffected by emotion or pre-existing relationships, should be called in at the inception to oversee the manner in which the inquiry is handled and should be specifically engaged to address all questions of legality and ethics. This single salutary action, in all likelihood, will provide the highest level of assurance of investigative propriety, as well as, a buffer between the investigative methods used and the company.

Is the retention of outside counsel always effective in preventing an investigation from backfiring?

If outside counsel is experienced in conducting investigations of the type required, and satisfactory inquiry has been made regarding counsel's integrity and competency in conducting such investigations, it should be effective to protect the company and its officers and directors who have every right to expect -- and rely on -- outside counsel, reasonably believed to be qualified, to conduct itself within the boundaries of the law. Of course, every rule has an exception, and no matter how many independent lawyers are engaged, the company and its officers and directors cannot be insulated from obviously illegal conduct -- like the use of illegal wiretaps -- if they know about it.

What should be done if a director is suspected of engaging in unethical or illegal conduct, such as insider trading?

Companies have an obligation to obey the law and a right to investigate potential unlawful or unethical conduct involving the company no matter who is involved. And, of course, directors have fiduciary obligations to the company, which include the duty of loyalty that would be violated by knowingly exploiting the company's confidential information for personal gain. As with any other significant challenge to the company's welfare, senior management, aided by counsel, should apprise the board of the threat to the company from the use of its confidential information and the options available to the company to protect itself. They may include requesting the appropriate office of the United States Attorney or District Attorney to investigate or the company conducting its own internal investigation. Since internal corporate investigations do not have subpoena power, the consent of the directors and all other persons to be questioned would be needed to allow the company to obtain and review documents, including their telephone records, to permit the company to administer lie detector tests, if appropriate and necessary, and permit them to be interviewed by company counsel. Of course, other factors, such as the consequence of violating a company policy of cooperation in connection with such investigations or the specter of a possible criminal investigation, may facilitate the consent requested.

Beyond relying on outside counsel to retain and supervise an investigative firm, how can a company gain further comfort that the firm will act legally and ethically in conducting its part of the investigation?

The retention agreement for any investigative firm should spell out very clearly that only legal methods may be utilized, that the investigator warrants it will adhere scrupulously to that instruction and that it, not the client, is responsible for the manner in which the investigation is conducted. Outside investigators also should be given a copy of, and acknowledge in their retention agreements, that they are required to adhere to the company's code of ethics and standards of business conduct.

Will this language fully protect a company from any responsibility if illegal methods are used?

No. If the investigator uses illegal methods and the company knows it, then the language in the retention agreement may be regarded as mere "window dressing" as a recent situation involving International Truck and Empire Corp. illustrates. In the face of a class action lawsuit accusing the Company of hostility toward and harassment of black employees, the Company's general counsel retained an investigative firm to investigate the racial environment at one of the Company's facilities. As part of the investigation, the investigative firm inserted agents posing as employees into the plant and recorded conversations, including conversations with the class action plaintiffs. The judge levied monetary sanctions against the corporation's lawyers -- both inside and outside counsel -- because, among other things, they were involved in all aspects of the investigation. On the other hand, the language will come in very handy if the investigator engages in illegal or questionable conduct and the client is not aware of it.

Are there any other important lessons to be learned from these recent incidents?

It is important to not react emotionally to a threat to the organization -- no matter how injurious it appears to be. Good governance should not go out of the window at the first sign of trouble. On the contrary, a potential crisis -- whether a potential restatement, insider trading by an officer or director, or a leak -- is the time when adherence to good corporate governance is most important. What begins as an investigation can, with the best intentions, quickly turn in a direction that no one within the company anticipates and lines easily can be crossed, particularly where outside consultants feel the pressure to produce results and do it quickly. To be sure, no company is going to hire an investigator for the purpose of going through the motions and failing. But, there cannot be any confusion allowed on the issues of legality, or for that matter any other investigative technique -- legal or not -- that could harm the company's reputation. The decision about whether to employ any tactic that is even marginal should be made by, and under the direct supervision of, its outside counsel. If an error in judgment is made, the ability to point to a decision by an independent outside counsel will be "priceless".

Jonathan J. Lerner is a partner with Skadden, Arps, Slate, Meagher & Flom LLP. His practice emphasizes federal court litigation, including securities, corporate and commercial litigation, as well as matters involving legal ethics and commercial arbitration. He has played a leading role in many of Skadden, Arps’s most significant cases in these areas. He is ranked by Chambers Global and Chambers USA as one of New York City’s top lawyers in both general and securities litigation, and
is listed in Best Lawyers in America.