Conducting Internal Investigations

In the current regulatory environment, companies are increasingly conducting internal investigations focused on potential wrongdoing. U.S. laws and law enforcement agencies increasingly expect that companies will police their own conduct and report potential misconduct to the appropriate federal law enforcement agency. Many federal and state agencies have adopted a formal disclosure protocol under which potential misconduct or unlawful activity can be reported. Additionally, the Department of Justice has adopted Federal Guidelines on the Prosecution of Corporations that specifically require consideration of "[the] corporation's timely and voluntary disclosure of wrongdoing and its willingness to cooperate with the government's investigation . . . ." State Attorney General Offices, including the New York Attorney General Office, likewise provide far more lenient treatment to companies that make voluntary disclosures of potential wrongdoing and voluntarily take remedial action. This regulatory landscape highlights the critical importance of the issues that we will be covering today relating to internal corporate investigations and government disclosure.

There is no standard definition of the term "internal investigation." For purposes of this seminar, we mean to include the full range of information-gathering activities that a company engages in upon learning of possible wrongdoing. In some instances, the internal investigation may appropriately be limited to a few interviews and the gathering and review of a limited number of documents. In other instances, the internal investigation will require a far-reaching and comprehensive search for documents, the review of vast quantities of documents and other records, and extensive interviews of large numbers of witnesses.

For the most part, this outline focuses on internal investigations conducted as a result of concerns that a company may have violated U.S. law. Similar issues (as well as certain important differences) are involved in internal investigations where the company is the potential victim of misconduct (e.g., theft of company assets) and we will touch upon those distinctions throughout the day.

What follows is a thumbnail discussion of seven steps for conducting internal investigations from the initial stages, to document collection, to corrective action and government disclosure.

I. Deciding Whether To Initiate An Internal Investigation

The initial issue to be considered upon uncovering potential wrongdoing is whether an internal investigation is warranted. If it appears that the government has already initiated an investigation or that one is probable, then the case for undertaking an internal investigation is likely to be compelling. When faced with a government investigation, it is almost always in the best interests of the company to gather information to enable the company to respond effectively to the government's investigation.

There are several respects in which information gathered during an internal investigation can assist in forming an effective response to a government investigation. The internal investigation may uncover persuasive evidence from which the company can argue either that no violative conduct occurred or that the matter otherwise does not warrant prosecution. The results of the internal investigation can assist the company in deciding whether to attempt to settle the government investigation. The results of the internal investigation might assist the company in persuading the government to agree to a settlement that the company finds acceptable. Disclosing the results of the investigation can assist the company in persuading the government either that no government investigation is necessary or, more likely, that the government investigation need be far less extensive and disruptive than it might otherwise be. Evidence gathered in the internal investigation can also assist in preparing witness testimony. The internal investigation might uncover evidence that refreshes a witness's recollection so that the witness recalls exculpatory events or appears more credible than might otherwise be the case. In addition, an internal investigation might enable the company to develop themes that are helpful to the company and that place the alleged misconduct in an appropriate context.

In the context of a possible criminal prosecution, the federal sentencing guidelines for corporations provide for an increase in criminal fines to be imposed on corporations in connection with criminal violations of federal law if senior corporate personnel "participated in, condoned, or [were] willfully ignorant of the offense" or if "tolerance of the offense by substantial authority personnel was pervasive throughout the corporation." Guidelines Manual 8C2.5. Conversely, the federal sentencing guidelines for corporations provide for a reduction in the criminal fine to be imposed on a corporation, under certain circumstances, if the criminal offense occurred despite "an effective program to prevent and detect violations of law." Id. There is a presumption that the program was not effective if senior management participated in, condoned, or were willfully ignorant of the offensive conduct. 8C2.5(f). In addition, certain government agencies have formally implemented programs that are designed to encourage companies voluntarily to disclose misconduct to the government before the government begins an investigation.

The fact that, upon uncovering red flags, a company promptly undertook an internal investigation and implemented appropriate remedial action can also assist a company in arguing against the imposition of civil penalties. See United States v. Phelps Dodge Industries, Inc., 589 F. Supp. 1340 (S.D.N.Y. 1984). In Phelps Dodge, in considering the civil penalty to be imposed on Phelps Dodge in connection with an alleged violation of an FTC cease and desist order, the district court considered the company's failure to investigate indications of misconduct as one factor indicating the company's bad faith. Id. at 1364.

The case for an internal investigation is also likely to be compelling if private litigation has been commenced or is probable. An internal investigation can greatly assist a company in mounting an effective response to a private action. For example, in response to an allegation of discrimination, a prompt and effective investigation followed by appropriate remedial action can assist the company in successfully asserting an affirmative defense pursuant to Burlington Industries, Inc. v. Ellerth, 524 U.S. 742 (1998) and Faragher v. City of Boca Raton, 524 US. 775 (1998). Similarly, the extent, if any, to which the company may be exposed to punitive damages in a private action may be affected by whether a company conducted a prompt and effective investigation in response to indications that an employee or agent may have engaged in misconduct. The Restatement of Torts provides that punitive damages may properly be awarded against a company for the misconduct of the company's employee or agent if, among other things, the company "ratified or approved of the" misconduct. Restatement (Second) of Torts 909 (1979). Failure to conduct a prompt and effective internal investigation may be treated as a ratification for this purpose. See Davis v. Merrill Lynch Pierce Fenner & Smith, Inc., 906 F.2d 1206, 1224 (8th Cir. 1990) (Merrill Lynch "may have ratified [an employee's conduct] by failing to investigate the unusual increase in [trading] activity in [the account...