INSIGHTS
Harvey Pitt, Senior Advisor & Managing Director at Kalorama Partners; Teresa Goody, Managing Director at Kalorama Partners
Intelligence
Corporate Internal
Investigations: When, Why,
Strategy
by Whom and How?
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It’s a sad fact of life that bad things happen to good companies.
And, when
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they do, many well run companies are confused about how to respond.
Many inappropriately rely on a concept of “reverse laissez faire”—that is,
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they wait for government prosecutors to tell them whether what
they’re
doing is wrong, why it’s wrong and how it must be fixed. And then, like
Captain Renault in the movie Casablanca, they’re “shocked, shocked to
discover” that they don’t like government’s answers.1
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But, law enforcers and regulators, like nature,
abhor a vacuum, ensuring that corporations
practicing reverse laissez faire in the face of
difficulties will pay a heavy price for their inertia.
Indeed, succumbing to inertia’s seduction, while
invariably costly for companies, is typically
catastrophic for the senior managers that adopt
(or acquiesce in) such a strategy.
Confronted with bad news, corporations—and
especially corporate boards—must be able to
answer at least the following ten questions:
• What happened?
• How did it happen?
• How did we learn about it—existing systems
of internal control, government subpoenas,
private lawsuits or a whistleblower?
• Is this a systemic or one-off problem?
• Who—If anyone—was harmed?
• What is the extent of any harm inflicted?
• Have we remediated those injured, and to
what extent?
• Does the government know about this?
• If the government doesn’t know, when (not
whether) should it be told?
• What assurances are there that this incident
is unlikely to recur?
Pragmatic Considerations
If a company learns that something untoward
has occurred, and the incident is not yet known
publicly or by the government, the company
has an opportunity to control events rather than
allowing events to control it. An opportunity the
company should avail itself of with alacrity. By
undertaking a prompt internal investigation, a
company in those circumstances demonstrates—
to internal and external constituencies—that
it is serious about preventing and redressing
inappropriate conduct, and that it cares about its
reputation for integrity and ethical behavior. More
importantly, when the government does learn
about the incident in question, the company has
a realistic chance of persuading the government
to desist from conducting its own investigation—
either entirely or, at a minimum, until the
company’s internal investigation has concluded.
This, of course, will require the company to
share the fruits of its internal investigation
with the government once the company’s
efforts are concluded, but that’s a small price to
pay if it makes a governmental investigation
unnecessary or limits the scope and duration
of any governmental investigation that may be
undertaken.
1 Asked why he just ordered the night club run by Humphrey Bogart’s character, Rick Blaine, to close, Major Renault, played by Claude
Raines, states—as he receives his gambling “winnings”—that he is “shocked, shocked to discover that gambling is going on in here!”
See IMDB’s write up of Casablanca, available at http://www.imdb.com/title/tt0034583/trivia?tab=qt&ref_=tt_trv_qu.
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Corporate Governance Considerations
Especially when a company learns about untoward
conduct after the government is already aware of
it, many boards assume—or are advised—that their
company should turn the matter over to defense
counsel, and everyone should get out of counsel’s
way. That’s a serious tactical error, and also may
reflect a failure by the board to fulfill its corporate
governance responsibilities. Since governmental
law enforcers rarely commence investigations
without cause, boards must view the onset of a
governmental investigation as a suggestion that
their company’s personnel may have engaged in
illegal, improper, inappropriate, unethical or bad
business conduct. Boards that do not inquire into
such conduct can be liable if they don’t ascertain
whether improper conduct occurred and, if it did,
whether safeguards have been put in place to
prevent its recurrence. For these reasons, internal
corporate investigations have been on the rise.
Independent or Internal Investigations
Many companies are learning the hard way the
difference between conducting an internal or
independent investigation, most notably when
dealing with a governmental enforcement
authority, such as the Securities and Exchange
Commission (“SEC”) and the Department of
Justice (“DOJ”). Each type of investigation is best
suited for different purposes; therefore before
structuring an investigation, its goals should
be ascertained and considered. An internal
investigation is one directed by management;
an independent investigation is one directed
by independent board members, typically a
subcommittee of the audit committee or a special
committee, with independent advisors. Internal
management-led investigations are best suited for
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routine issues not involving managerial personnel.
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The SEC and DOJ affirmatively encourage
companies to ferret out instances of their own
misconduct and then investigate them.3 But, both
agencies “reward” only those companies that
conduct independent investigations. Thus, if the
investigation is something for which the company
will want formal governmental “credit,” only an
independent investigation will suffice. Similarly,
if the corporate problem is one that’s likely to be
discussed in major media outlets, an independent
investigation is appropriate. For significant issues,
objective, disinterested, persons should conduct
the investigation. Factors militating in favor of an
independent review include:
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• Management involvement in, or knowledge
of, the misconduct;
• Company benefits, not solely individual selfinterest by bad actors;
• Possible restatement of company financials;
• Discovery by compliance/internal audit
functions; or
• Misconduct engendering potentially grave
sanctions.
Methodology
Internal corporate investigations should be
designed to elicit as much information as
possible about the events in question. Unlike
governmental interrogations, or litigation
depositions, the goal of the process should be
to develop a valid basis for corporate actions,
not amass an evidentiary record to support the
exercise of prosecutorial judgment. Internal
investigations should not be focused exclusively
on testing witness recollections or posing
questions designed to support a pre-conceived
2 See, e.g., In the Matter of Cooper Companies, Inc., Sec. Exch. Act Rel. No. 35082 (Dec. 12, 1994) (responsibility of corporate directors
to safeguard the integrity of a company’s public statements and the interests of investors when evidence of fraudulent conduct by
corporate management comes to their attention); In the Matter of John Gutfreund, Sec. Exch. Act Rel. No. 31554 (Dec. 3, 1992) (oversight
responsibilities require taking prompt action to address corporate misconduct); see also U.S. SENTENCING GUIDELINES MANUAL
§8C2.5(f)&(g) (Nov. 1, 2011) (organization’s “culpability score” decreases if organization has an effective program to prevent and detect
violations of law, and takes prompt and effective action demonstrating that it does not condone such conduct after becoming aware of
the offense).
3 The SEC’s framework for evaluating cooperation is commonly referred to as the “Seaboard Report.” See Sec. and Exch. Comm’n, Report
of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of
Cooperation to Agency Enforcement Decisions, SEC Rel. Nos. 34-44969 and AAER-1470 (Oct. 23, 2001), available at http://www.sec.gov/
litigation/investreport/34-44969.htm. The DOJ, likewise, has enumerated factors it considers to determine the credit, if any, awarded to
cooperators. Dep’t of Justice, Principles of Federal Prosecution of Business Organizations, Title 9, Ch. 9-28.000, available at http://www.
justice.gov/opa/documents/corp-charging-guidelines.pdf.
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point of view. As a matter of practice, we prefer
to conduct interviews informally—that is, without
a stenographic recording, but with copious
contemporaneous notes taken of the questions
and answers. Consistent with the view that these
interviews are not memory tests, we generally
provide advance access to documents about which
we will question a witness, and we favor multiple
interview sessions, as opposed to single sessions
of marathon length.
The directors overseeing the internal investigation
should attend all, or almost all, of the interview
sessions so they can observe the witnesses as
they are questioned and form judgments about
each witness’ credibility. While questioning can
be left, in the first instance, to the outside advisors
to the directors overseeing the investigation, the
involved directors should inject questions of their
own, as appropriate. Ultimately, these directors
should report to the full board on what they
believe occurred and make recommendations,
rather than accept a broad delegation of authority
to make final decisions about the matters under
review. While independent internal investigations
should have a clearly-defined focus and should
not be conducted as a roving commission, it is
important that the effort not be unduly restricted
solely to the precise events leading to the decision
to conduct the investigation.
In brief, the investigation must not only
be independent in fact, it must also appear
independent to a reasonable observer, aware
of all relevant facts. The ten questions set
forth at the outset of this article should all be
addressed, both in questioning of witnesses
and in specific recommendations ultimately
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made to the company’s board of directors. When
recommendations are made about significant
process and governance matters, it is appropriate
to discuss the preliminary conclusions with
members of senior management—not for the
purpose of giving them an opportunity to talk
the sub-committee out of specific conclusions,
but as a reality check, to make sure that any
recommendations that will ultimately be made can
actually be implemented. Furthermore, provisions
should be made for following up on management’s
responses to the recommendations to ensure that
no recommendation falls through the cracks.
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Conclusion
When untoward events appear to afflict an
otherwise well-run corporation’s existence, the
independent directors have an obligation to
satisfy themselves that they understand how the
conduct at issue occurred, how it can be redressed
and how the future recurrence of such conduct can
be minimized. Independent internal investigations
provide a recognized methodology for informing
boards and helping them fashion an appropriate
response to these kinds of problems. With care,
thoughtfulness and creativity, companies can
take an unfortunate event and demonstrate their
commitment to ethical and legal standards that
reflect best-in-class practices.
M O R E I N F O R M AT I O N
[email protected]
+1 (212) 886-1600
www.teneoholdings.com
H a r v e y P itt
Mr. Pitt is a Senior Advisor with Teneo and is Chief Executive Officer of the global business consulting firm, Kalorama
Partners, LLC, and its law firm affiliate, Kalorama Legal Services, PLLC. He served as the twenty-sixth Chairman of the
United States Securities and Exchange Commission. In that role, from 2001 until 2003, Mr. Pitt was responsible, among
other things, for overseeing the SEC’s response to the market disruptions resulting from the terrorist attacks of 9/11, for
creating the SEC’s “real time enforcement” program, and for leading the Commission’s adoption of dozens of rules in
response to the corporate and accounting crises generated by the excesses of the 1990s.
For nearly a quarter of a century before becoming the SEC’s Chairman, Mr. Pitt was a senior corporate partner in the
international law firm, Fried, Frank, Harris, Shriver & Jacobson. He was a founding trustee and the first President of the
SEC Historical Society, and participates in a wide variety of bar and continuing legal education activities to further
public consideration of significant corporate and securities law issues. Mr. Pitt served as an Adjunct Professor of Law
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at Georgetown University Law Center (1975-84), George Washington University Law School (1974-82), the University of
Pennsylvania School of Law (1983-84), and The Yale Law School (2007).
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Mr. Pitt served previously with the SEC, from 1968 until 1978, including three years as the Commission’s General Counsel
(1975-78). He received a J.D. degree from St. John’s University School of Law (1968), and his B.A. from the City University
of New York (Brooklyn College) (1965). He was awarded an honorary LL.D. by St. John’s University in June 2002, and was
given the Brooklyn College President’s Medal of Distinction in 2003.
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Mr. Pitt is currently a Director of GWU Medical Faculty Associates, Inc., a §501(c)(3) corporation that provides
comprehensive medical care to residents of the greater Washington, D.C. metropolitan area, and serves on its Audit
Committee. He is a member of the Global Advisory Forum of the CQS Hedge Fund, and a member of the Regulatory and
Compliance Advisory Council of Millennium Management LLC. He also serves on the Board of Directors to the offshore
funds of Paulson & Co., and its affiliates. He previously served for three years on the National Cathedral School’s Board
of Trustees, where he was at various times Board Vice-Chair, Co-Chair of the Board’s Governance Committee and Chair
of the Audit and Compensation Committees. Mr. Pitt previously served as a Director of Approva Corporation, and was a
member of its Audit Committee.
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