The Cooperation Conundrum
by James J. Farrell and Jeremy G. Suiter*

Corporations accused of financial misconduct have a strong incentive to cooperate with federal investigators looking into those allegations: the SEC considers a company’s “cooperation in determining whether and how to charge violations of the federal securities laws.”¹ Similarly, the DOJ’s Corporate Fraud Task Force considers “the authenticity of a corporation’s cooperation” in deciding whether to file criminal charges.²

Prosecutors often define “cooperation” to include a waiver of all privilege claims (like the attorney-client privilege and the work product doctrine) and the tender of any information gained by the company’s counsel during an internal investigation. But the recent prosecution of three former executives for lying to their company’s counsel during an internal investigation may hinder such investigations in the future.

The Internal Investigation

In 2002, several federal agencies, including the FBI and the SEC, began investigating the accounting practices at Computer Associates, a large software company. In response, Computer Associates publicly promised to cooperate with the government, and hired a law firm to conduct an internal investigation.

As part of the investigation, the attorneys interviewed various Computer Associates executives. During the interviews, three executives allegedly lied by denying they had used improper accounting practices to meet analysts’ earnings estimates for the company. Computer Associates later waived all privileges and provided the results of the internal investigation to federal investigators. As a result, the executives’ allegedly false statements to their company’s attorneys were passed on to the government.

The Obstruction Charges

Although there was no allegation that the three executives lied directly to federal investigators or a grand jury, the United States Attorney’s Office for the Eastern District of New York charged them with obstruction of justice. Typically, obstruction charges punish conduct such as document destruction or witness tampering. In this case, the government accused the executives of trying to obstruct the investigation into Computer Associates by misleading the company’s lawyers. According to the charges, the executives knew their statements would be passed on to federal investigators, yet they repeatedly and intentionally lied about the improper accounting practices to the attorneys conducting the internal investigation.³

In April 2004, each of the three executives pleaded guilty to obstructing justice and to a second charge of securities fraud.⁴ Two of the executives face up to 10 years in prison. The third could be jailed as long as 20 years.

The Changing Role Of Corporate Counsel

One notable aspect of the Computer Associates case is that it essentially “deputized” the company’s counsel. Lying to a federal official is, of course, a federal crime. Martha Stewart, for example, was convicted of obstruction of justice for lying to investigators about her ImClone stock sale. But lying to corporate counsel was not previously considered obstruction of justice.

The Computer Associates case thus represents another example of the recent trend to enlist corporate counsel in the battle against corporate misconduct. For example, under new SEC rules enacted under Sarbanes-Oxley,⁵ if an attorney representing a public company obtains evidence that the company may have committed a material violation of law, the attorney must report the evidence to the company’s chief legal officer. If the legal officer does not provide an “appropriate response within a reasonable period of time,” the attorney must continue to report the evidence “up the ladder” to the company’s directors. The SEC is still considering additional “gatekeeper” obligations on counsel—often referred to as the “noisy withdrawal”—that would require the attorney to notify the SEC and withdraw if the company’s response seems inadequate.⁶

[L]ying to corporate counsel was not previously considered obstruction of justice.

The SEC also has begun imposing multimillion dollar penalties against companies under investigation for securities violations for the acts or omissions of their attorneys. In March, the SEC fined Banc of America Securities LLC $10 million because documents were not promptly produced, and because of other “dilatory tactics that delayed the investigation.”⁷ In May, despite tentatively agreeing to settle accounting fraud charges against Lucent Technologies Inc. without penalty, the SEC reversed course and fined Lucent $25 million because its outside counsel gave an interview downplaying the misconduct. The SEC also cited the fact that Lucent had agreed to indemnify individual employees who were fighting the fraud charges.⁸

Congress is also trying to reshape the legal rules familiar to corporate counsel. One bill currently pending before Congress, H.R. 2179,⁹ would make it easier for the SEC, in the name of deterring securities violations, to obtain personal financial records, privileged documents, and information provided to a grand jury.

The Implications

It is not uncommon for employees interviewed during an internal investigation to mistakenly believe that corporate counsel represents them. To avoid confusion on this point, the Supreme Court has held that corporate counsel must inform employees interviewed during an internal investigation of the nature and purpose of the inquiry, and explain that counsel represents the corporation, which retains the right to waive the privileged nature of the interview.¹⁰

In light of Computer Associates, counsel conducting an internal investigation should consider whether additional disclosures are necessary, like the possibility that the employee could face criminal prosecution for lying in the interview. Employees armed with this knowledge may be more forthcoming with the truth. But there is also a risk that employees—even those with nothing to hide—may simply clam up for fear of prosecution. Another risk is that giving employees such notice may bolster the scienter element that was apparently crucial to the Computer Associates prosecutions. Indeed, the charges against the three former executives were based in part on the fact that they knew their statements would be passed on to federal investigators. Absent such knowledge, it is not clear that an employee who lies to corporate counsel could be prosecuted for obstruction.

Conclusion

Companies under federal investigation, and their counsel, are facing a changing landscape. Prior to the Computer Associates case, companies already had numerous issues to consider in deciding whether to cooperate. If they did so, their counsel had to consider numerous issues in deciding how to conduct the internal investigation. The recent prosecutions of the Computer Associates executives add yet one more factor to consider in this cooperation conundrum.

Notes

1. SEC Release No. 2001-117 (Oct. 23, 2001), available at <www.sec.gov/news/headlines/prosdiscretion.htm>.
2. “Principles of Federal Prosecution of Business Organizations” (Jan. 20, 2003), available at <www.usdoj.gov/dag/cftf/corporate_guidelines.htm>.
3. Informations filed on April 8, 2004, in United States v. Rivard (E.D.N.Y. Cr. No. 04-329), United States v. Kaplan (E.D.N.Y. Cr. No. 04-330), and United States v. Zar (E.D.N.Y. Cr. No. 04-331).
4. Minute Entries filed on April 8, 2004, in United States v. Rivard (E.D.N.Y. Cr. No. 04-329), United States v. Kaplan (E.D.N.Y. Cr. No. 04-330), and United States v. Zar (E.D.N.Y. Cr. No. 04-331).
5. SEC Release No. 33-3185 (Jan. 29, 2003), available at <www.sec.gov/rules/final/33-8185.htm>.
6. SEC Release No. 33-8186 (Jan. 29, 2003), available at <www.sec.gov/rules/proposed/33-8186.htm>.
7. SEC Litigation Release No. 34-49386 (Mar. 10, 2004), available at <www.sec.gov/litigation/admin/34-49386.htm>.
8. SEC Press Release No. 2004-67 (May 17, 2004), available at <www.sec.gov/news/press/2004-67.htm>.
9. Bill summary and status is available at <http://thomas.loc.gov/ cgi-bin/bdquery/z?d108:h.r.02179:>.
10. Upjohn v. United States, 449 U.S. 383 (1981).

About the Authors

James Farrell (James.Farrell@lw.com) is a partner, and Jeremy Suiter (Jeremy.Suiter@lw.com) is an associate, in the Los Angeles office of Latham & Watkins LLP.