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Sarbanes-Oxley Presents Interesting Dilemmas for Corporate Counsels
Frank Kumpuris, Class of 2007
October 27, 2005

Internal investigations have become increasingly important since the passage of Sarbanes Oxley. Proof of this can be seen in the staggering increase in the amount of fines imposed by the Securities and Exchange Commission since 2001. In that year, the SEC imposed $44 million in fines. The amount of fines charged in 2002 and 2003 has been over $1 billion. Also, the number of individuals that have been barred from serving as officers and directors rose from thirty-eight in 2000 to one hundred sixty-one in 2004. Everyone from corporate officers and directors to compliance personal must keep these possible consequences in mind in this new regulatory environment.

Sarbanes Oxley is the latest attempt by Congress to, once again, restore public confidence in the American business system. Company officers and directors would do well to accept it as fact regardless of the increases in cost and reporting requirements. This is true despite the fact that most Americans do not have a great deal of confidence in big business. According to the graph below, only 15% of the public polled had either a “great deal” or “quite a lot” of confidence in large business corporations as of July 2002.

Potential probes can be damaging for corporate reputations and stock prices regardless of the financial amount in question, the seriousness of the allegations or the prominence of the company that is under investigation.

Corporate counsel and compliance personnel play a central role in SEC investigations and often have the ability to minimize the chance that their company will be surrounded in a cloud of negative publicity. Once an investigation has been initiated, the SEC emphasizes the criteria set forth in the “Seaboard Doctrine”. The Seaboard Doctrine was introduced in 2001 as a flexible system of guidelines governing investigations, but it has since developed into compulsory guidelines in evaluating a company’s self-reporting and policing policies and its level of cooperation. Although the list below is not an exhaustive list, the Seaboard Doctrine asks the following:

1. Did the misconduct result from inadvertence, honest mistake, simple negligence, reckless or deliberate indifference to indicia of wrongful conduct, willful misconduct or unadorned venality?

2. How did the misconduct arise?

3. How high up in the chain of command was knowledge of, or participation in, the misconduct?

4. How long did the misconduct last?

5. How much harm has the misconduct inflicted upon investors and other corporate constituencies?

6. How was the misconduct detected and who uncovered it?

7. How long after discovery of the misconduct did it take to implement an effective response?

8. What steps did the company take upon learning of the misconduct? Did the company immediately stop the misconduct? Are persons responsible for any misconduct still with the company?

9. What processes did the company follow to resolve many of these issues and ferret out necessary information?

10. Did the company commit to learn the truth, fully and expeditiously?

11. Did company employees or outside persons perform the review? If outside persons, had they done other work for the company?

12. What assurances are there that the conduct is unlikely to recur?

13. Is the company the same company in which the misconduct occurred, or has it changed through a merger or bankruptcy reorganization?

The implications of this development means that the government now expects companies to do more than fulfill a minimal legal obligation and turn over requested information. Cooperation is critical to minimize the impact on an investigation.

   An interesting perspective can bee seen in evaluating just the first twelve hours that a company is under investigation. Investigations frequently begin either with the SEC sending investigators directly to the offices of a company or with the General Counsel receiving a letter advising him or her that the company is under investigation. Obviously, the letter reminds the company that it is important to maintain any and all relevant documents. A situation such as this emphasizes the importance of not only a comprehensive document retention policy but also the importance of a “safety provision” that allows a company to quickly notify critical personal including information technology that regular destruction of documents must be suspended. Both the general counsel and internal audit and compliance personnel must be familiar with the Seaboard Doctrine to effectively determine what credit that the company may receive for working together with investigators. After a company learns it is under investigation, it is critical that the company respond candidly in order to cause minimal business interruption. Understanding the Seaboard Doctrine is essential because of the number of examples of companies that have “admitted to certain wrongdoing [and] received no punishment based upon their internal investigations, self-reporting and cooperation with the commission.”

The remainder of the first critical day should be devoted to information gathering and processing by compliance personnel, the general counsel and, possibly outside counsel. During this time, it is important to assess whether or not corrective action needs to be taken to prevent any ongoing or future violation. The company will also need to assess any reporting obligations that might be created by an investigation. Special challenges relate to the post-Sarbanes Oxley era because the chief executive officer, chief financial officer and chief operating officer may have problems with the fact that they certified previously released financial reports. The overall goal of these new reporting requirements is greater disclosure regarding the certification process. This goal is achieved by exposing relevant parties to the potential of increased exposure to liability with the hope that it will translate into additional involvement. The day should ideally conclude with a meeting of the board of directors of the company and/or the audit committee. The board must be fully informed of the SEC’s inquiry and of the results of any preliminary investigation. Using this information, the board must make a determination regarding whether it needs to conduct its own separate investigation and whether it needs to retain independent counsel. Given the fact that regulators will evaluate the level of cooperation and responsiveness of the company in determining potential penalties, the importance of a well informed general counsel and compliance personnel cannot be underestimated.

From the view point of the corporate counsel, the Seaboard Doctrine implies that companies must proactively cooperate if they hope to avoid a formal investigation, penalties or an enforcement proceeding “including affirmative steps to uncover, halt and remediate potential wrongdoing.” The most significant implication of this doctrine is that cooperation can potentially include waiving certain privileges that have come to be expected by attorneys including the work product doctrine. The issue that arises out of this requirement is whether a firm should conduct an internal investigation given the fact that the reports, notes and other materials related to that investigation may not be protected by the work product doctrine. The reason that this is a prospective problem for corporate counsel and regulatory personnel is that the ending statement and all of the supporting documentation which is turned over to the SEC could end up with private plaintiffs, giving attorneys a litigation roadmap of what went wrong and why.

When considering this possible dilemma, companies that are mindful of the role of corporate integrity are also likely to remember the fact that some accounts suggest that “the case against Arthur Andersen was built on a single document authored by an in-house lawyer.” In preparation of a report related to a potential violation, corporate counsels must walk a fine line whereby they facilitate understanding of potential risks and possible solutions for decision-makers. At the same time, they want to ensure that the results are not discoverable in civil suits or generally used to the detriment of the company.

This is true because of the increased importance that the government and prosecutors along with the market as a whole is putting on the role of corporate integrity. An example of this can be seen in the fact that Sears was able to have its fine reduced from $100 million to $60 million after being convicted of an ethical violation because the prosecutor in the case evaluated the ethics program at Sears and determined that the program was more than simply an abstract concept. A minimal investment that the company had made in an ethics program had resulted in a major payoff. This is a lesson for companies that are currently in the process of internal investigations either because of a voluntary request for information or a subpoena that making an investment in a corporate ethics program can have a tangible payoff in the investigation process.