Articles of Interest

"INDEPENDENT DIRECTORS NEED INDEPENDENT COUNSEL"

Edward R. Gallion, Esq.

Some years ago, while involved in structuring internal corporate investigations arising from some rather widely reported corporate calamities, I somewhat jokingly suggested that the ultimate shareholder derivative suit might challenge the massive diversion of corporate assets thrown seemingly indiscriminately at every outside law firm that could be found with no substantive prior relationship with the corporation to assist in some discrete aspect of the investigation. Many is the time I found myself in courtroom galleries in the company of any number of the senior-most partners of the most highly regarded (read, costly) law firms in the nation, all awaiting the opportunity to report to the court on the status of the still ongoing internal investigation, pursuant to which the corporation in question had managed to keep angry shareholders and their unwelcome derivative suits at bay pending the conclusion of the investigation at some yet-to-be determined date far off in the future. As the company's legal fee meter whirled at a brutally rapid rate given the large assemblage of such highly paid attorneys cooling their heels for extended periods of time, the long-awaited interim report almost invariably was solemnly delivered by a single attorney in the space of just a few moments. The esteemed gathering would disband immediately thereafter, with most of the attendees scrambling to the airport for their first-class flight returns to their far-flung offices around the country.

Unassailable integrity and impartiality of the investigative process at any cost was then the sine qua non directive unanimously insisted upon by the entire board of directors.

Unquestionably, much has changed in the intervening years; the proverbial pendulum has swung decisively in the opposite direction. True independence, objectivity, impartiality and thoroughness -- all of which once were revered as the talismanic requirements of any internal investigation that was to be accepted and blessed by a court to foreclose shareholder litigation -- have all but disappeared entirely.

By many recent accounts, corporate investigations now regularly are carried out by in-house attorney employees, whose "conclusions" are then presented to the company's corporate counsel and then in turn to the board for ratification. Plainly, no semblance of objectivity or impartiality possibly can attach to such procedures, yet they appear to gain in popularity as the favored means of addressing all manner of corporate irregularities.

Similarly bewildering and frustrating to shareholder adherents to principles of corporate integrity and accountability are those situations in which the company professes to "go the extra mile" by retaining "outside counsel" to conduct the internal inquiry into allegations of improprieties. In practice, however, this is more likely than not to play out as follows: (1) the company's general counsel contacts the company's most favored outside law firm; (2) the (most frequently, corporate/transactional) partner of the outside firm with primary responsibility for the client speaks with his (typically, underengaged) counterpart in the firm's litigation department to formulate a response to the internal problem; (3) the litigation partner rounds up every available associate attorney at the firm to descend upon the company and disrupt its daily operations by reviewing every available email and document and "interviewing" every available employee over an implausibly extended time period; (4) summaries of these far-flung disorganized activities are amassed for repeated summarization and ultimate preparation as a "final report;" and (5) the report is presented to the board of directors for immediate ratification.

Such a process is designed to suggest thoroughness -- not to mention a staggeringly high price tag for the shareholders -- but can it seriously be argued that its findings and recommendations have resulted from any objective analysis by attorneys who are truly independent from the company? Merely assigning the investigatory efforts to the litigation department within the company's regular outside law firm should be viewed just as skeptically by shareholders and the courts as if only company lawyers had been involved, and the reasons for such skepticism are manifest. While company management may never before have dealt personally with members of the litigation group, the company's relationship with that firm's corporate/transactional department is well developed, and it defies business realities to suggest that such an investigation will not be monitored closely, if not influenced outright, by the corporate partner whose primary objective, of course, is to protect and perpetuate his law firm's relationship with the company.

Where then, one might justifiably ask, are the non-management directors as such events unfold? I choose the word "non-management" purposefully to reflect the well-nigh universally held presumption that many of today's outside directors' objectivity and impartiality are dangerously compromised to some degree by, among other things, close personal relationships to management and their cross-memberships on overlapping and interlocking boards of directors. In common situations such as described above, the directors are expected merely passively to await the presentation of a "final report" and then to ratify its findings and recommendations. In the unlikely event that any concerns are raised as to the integrity or objectivity of the investigation, they can be adroitly deflected by pointing to the sheer number of attorneys involved, the fact that the outside litigation attorneys were largely unknown to the company and, of course, the staggeringly high bill for legal fees generated in connection therewith. The steps along the path of convenience and least resistance have thus been carefully choreographed for the convenience of the outside directors, whose acquiescence is only too common.

The critical and heretofore indispensable element wholly absent from these all-too-frequent self-serving corporate exercises in internal fact-finding is, of course, any evidence of the involvement in at any time by truly independent counsel. It simply defies day-to-day business realities to suggest that the outside corporate partner, whose primary objective necessarily must be to protect and perpetuate his firm's relationship with the company, has not been carefully monitoring or even directly influencing the course of the investigation.

Given the recent confluence of reports that procedures similar to those described above are being deployed with alarming frequency in the aftermath of all manner of corporate misdeeds, the time has arrived for a thoughtful re-examination of the most basic tenet of corporate governance and the primary fiduciary responsibility of outside directors -- i.e., ensuring internal financial and operational integrity and accountability -- and how it is swept aside all too frequently in the context of internal corporate investigations.

Such disregard for this cornerstone of corporate governance appears to be occurring at a particularly perilous juncture for management. Enhanced reporting requirements, vastly more vigorous enforcement activity, heightened expectations of the fiduciary obligations of outside directors, and intensified judicial scrutiny and skepticism of the conclusions reached by such internal investigations have converged to underscore the need for the involvement of truly independent outside counsel. Moreover, the shareholder activists demanding greater management accountability today are more likely to emerge from highly sophisticated and well-financed hedge funds and investment banks' equity groups (rather than from the dog-eared Rolodexes of the plaintiffs' securities bar), who possess both the market savvy and resources aggressively to challenge the integrity and bona fides of the "recommendations" or "conclusions" that result from such internal corporate exercises so lacking in evidence of actual independence or impartiality.

It is axiomatic that outside directors are to be the shareholders' ultimate arbiters of management's stewardship of the corporation. Yet in recent instances of company misdeeds, irregularities and even outright scandals, outside directors appear only too willing to rubber-stamp the (perhaps pre-ordained) findings of internal investigations conducted entirely without any involvement of truly independent counsel. Speaking topically in this regard, it seems inconceivable that any experienced attorney not otherwise entangled with a company's ongoing operations would think it anything other than insanely inappropriate to place board members under aggressive electronic surveillance measures. It is worthy of note, if many press accounts are to be believed about this unfortunate incident, that it was not until an outside director sought counsel from his own independent attorney that this situation was properly brought to light and addressed.

Given the increasingly frequency with which outside directors' oversight of companies where corporate misdeeds have occurred is being examined with heightened scrutiny (and, in some instances, well-deserved outright skepticism) by the courts, as well as by the investing public at large, it would appear appropriate at this moment for non-management board members to engage in some thoughtful reflection as to whether their fiduciary obligations to the shareholders can fully be satisfied in the absence of legal advice from a truly independent source.

As a prophylactic measure, outside directors should consider retaining counsel with no prior ties to the corporation to provide advice on an ongoing basis, perhaps through the formation of a litigation committee composed of outside directors, which then is formally authorized to retain such independent outside counsel.

At a bare minimum, non-management directors should insist that independent counsel with no prior affiliation with the company be engaged immediately upon the mere suggestion that any significant corporate irregularities may have taken place. In this manner, independent attorneys can survey the situation and perform an initial inquiry as to the existence of impropriety and, if found, assume primary responsibility for structuring the procedures pursuant to which whatever necessary internal employee interviews and document review are to be conducted. It is respectfully suggested that, in light of recent judicial developments, outside directors may no longer expect to enjoy the deferential insulation and protections that heretofore have been routinely afforded them unless they are able to demonstrate active supervision of and involvement in a truly independent internal investigation. The mere reflexive ratification of neatly pre-packaged, pre-ordained "final reports" prepared by attorneys affiliated with the company should no longer suffice as evidence of effective corporate oversight or adequate satisfaction of bedrock fiduciary obligations to shareholders.

The procedures prescribed above by no means should be taken to suggest uncontrolled "witch hunts" on massive scales; quite to the contrary, counsel experienced in such internal investigations easily should be able to craft an internal inquiry that is narrowly tailored to meet, and carefully circumscribed to address, the discreet area of concern swiftly and with surgical precision.

Virtually any diversion of company assets from productive applications to the investigation and correction of corporate misdeeds should otherwise be unnecessary and is, therefore, wasteful by definition. The perpetrator(s) and origins of such misdeeds and the scope of their impact on company operations can be identified and remedied much more efficiently and cost-effectively through the engagement of experienced attorneys who are truly independent of the company. Of perhaps even greater importance to the corporate finances, additional substantial economies can be realized by minimizing (and, in many cases, eliminating outright) the otherwise attendant costs of litigating the issues of the impartiality and objectivity of the investigating attorneys, the overall integrity of the investigative process, and the unimpeachably appropriate conduct of the outside directors if, of course, such prudent measures are employed.