Internal Investigation What To Expect


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  • Shareholder Derivative claims. Self-dealing and breach of fiduciary duty by corporate officers. “Special Litigation Committees.” Bankruptcy. Assess fraudulent conveyance claims. Search for preference payments. Assess other possible claims.
  • Fair. Conducted with the benefit of 20/20 hindsight and conducted outside the normal adversary process. Exonerate innocent as well as implicate the guilty. You are not an advocate of one side or another—your goal is to be objective finder of facts. Facts will then then dictate.
  • “Client” interface will be the Audit Committee Chairman Any issues that impacts the financial reporting system—is of concern
  • Want a law firm that is not beholden to management Perception: VE and Enron. Whistleblower comes to senior management. Sent to VE.
  • “Forensic” independentce.
  • Need to make sure that everyone is not trying to dump all its responsibility on the Audit Committee. Everyone needs to remember their responsibilites.
  • No artificial limits.
  • SEC definitely wants to see the appropriate “tone at the top” at this stage of the investigation.
  • Document review. Search terms. Should not be so broad as to be ridiculously expensive Tension with regulators over “relevant.” Preservation is not as expensive as review.
  • Right to lawyer
  • When company accountants need to be present. Someone in the representation chain. Independent judgment of credibility. Freezing up.
  • Who, what, where, when.
  • Pros and cons. Detailed report with cross references. Con. Detailed report with cross references. Speed and cost.
  • The Company and its outside counsel.
  • Seaboard Doctrine.
  • SEC may begin taking actions against law firms for inadequate investigations. “Appearance before commission.” Ability to discipline the lawyers and firm involved if it wants to.
  • Internal Investigation What To Expect

    1. 1. Internal Corporate Investigations What to Expect What is Expected
    2. 2. Investigation Triggers <ul><li>Regulatory Inquiries </li></ul><ul><li>Whistleblowers </li></ul><ul><li>Internal Audit </li></ul><ul><li>Independent Auditors </li></ul><ul><li>Shareholder Derivative Claims </li></ul><ul><li>Bankruptcy Investigations </li></ul>
    3. 3. Investigative Goals <ul><li>Discover the facts. </li></ul><ul><li>Gather the facts in a systematic fashion so that those who review the investigation and its results are comfortable that the process of fact-gathering was independent, competent, and thorough; i.e., a credible investigation. </li></ul><ul><li>A fair and balanced assessment of facts. </li></ul><ul><li>Recommend remedial action. </li></ul>
    4. 4. Key Participations in Process
    5. 5. Independent Oversight <ul><li>Audit Committee IS responsible for investigation. </li></ul><ul><li>Each Audit Committee must establish procedures for the receipt, retention, and treatment of complaints regarding accounting, internal accounting controls, or auditing matters, including procedures for the confidential, anonymous submission by employees of the issuer of concerns regarding financial reporting systems, </li></ul>
    6. 6. Independent Oversight <ul><li>No SEC mandate for specific procedures that Audit Committees must follow to resolve complaints. </li></ul><ul><li>Audit Committees have flexibility to develop and utilize procedures appropriate for the circumstances. </li></ul><ul><li>Ultimately, the Audit Committee must make the decision as to which resources to use and processes to follow. </li></ul>
    7. 7. Independent Law Firm <ul><li>Investigation undertaken by substantial law firm. </li></ul><ul><li>Good reputation. </li></ul><ul><li>Experienced. </li></ul><ul><li>Good working relationship with SEC and DOJ. </li></ul><ul><li>Can work with Company auditors. Auditors find lawyers credible. </li></ul><ul><li>Want to avoid perception that law firm is in any way beholden to Company or senior management. </li></ul>
    8. 8. Independent Forensic Accountants <ul><li>Generally necessary to engage, especially if complicated accounting issues exists. </li></ul><ul><li>Also should be independent of Company and management, although not required. Generally the forensic group must be independent. </li></ul><ul><li>Accountants should be retained by counsel, not the Audit Committee, to maintain privilege. </li></ul>
    9. 9. Tone and Substance <ul><li>Audit Committee, as a matter of substance and tone , must express a willingness to actively oversee the investigation and assume responsibility for its results </li></ul><ul><li>Investigators report directly to the Audit Committee, usually through its Chair or a designee. </li></ul><ul><li>Detailed updates to Audit Committee as facts are developed. </li></ul><ul><li>Audit Committee will continuously be pressed by Company management and audit firm on conduct of investigation. </li></ul>
    10. 10. Scope <ul><li>Audit Committee defines the scope. </li></ul><ul><li>Initial focus may be narrow. May increase. </li></ul><ul><li>Insure that proposed scope is sufficient to be relied upon for audit purposes. </li></ul><ul><li>Audit firm should be consulted in scope definition but Audit Committee is sole authority. </li></ul><ul><li>Update auditor periodically. </li></ul>
    11. 11. Scope and Work Plan <ul><li>Scope should change if investigation uncovers facts that should be investigated. </li></ul><ul><li>Should be clear trail of how scope was defined and, if changed later, why it was changed. Also document why certain leads not followed. </li></ul><ul><li>Investigators must have authority to pursue all evidence of wrongdoing, no matter where it may lead, with no artificial limitations. But professional judgment needs to be exercised. </li></ul><ul><li>SAB 99 guidance on materiality. </li></ul><ul><li>Detailed Work Plan should be developed </li></ul><ul><ul><li>Audit Committee should approve </li></ul></ul><ul><ul><li>Audit firm should approve </li></ul></ul>
    12. 12. Company Cooperation <ul><li>Audit Committee must ensure that all Company employees, including senior management, are encouraged to cooperate with investigation. </li></ul><ul><li>Board and senior management directive to employees to: </li></ul><ul><ul><li>Cooperate with investigation; </li></ul></ul><ul><ul><li>Make themselves available on request; </li></ul></ul><ul><ul><li>Make available documents; </li></ul></ul><ul><ul><li>Be truthful and candid. </li></ul></ul>
    13. 13. Document Preservation and Review <ul><li>Suspend document retention (destruction) process until scope of investigation is defined. </li></ul><ul><li>Once scope is defined, preserve forensically the relevant electronic data. Usually need outside help. </li></ul><ul><li>Document review must be broad enough to capture all relevant documents, but narrow enough to meet realistic scope. </li></ul><ul><li>Hard copy documents must also be collected and reviewed. </li></ul><ul><li>Document the process for later review by others. </li></ul><ul><li>Ideally should precede the witness interviews. </li></ul>
    14. 14. Witness Interviews <ul><li>Identify key witnesses in work plan, making reasoned decisions on whom to interview, when and where. </li></ul><ul><li>Witnesses must be advised: </li></ul><ul><ul><li>Investigators represent the Audit Committee, not the witness, the Company, or its management. </li></ul></ul><ul><ul><li>Rights under Sarbanes-Oxley. </li></ul></ul><ul><ul><li>Notice that interview is not privileged and that investigators are free to disclose information learned to the Audit Committee, the Company, and any regulators. </li></ul></ul>
    15. 15. Witness Interviews <ul><li>Process </li></ul><ul><ul><li>All interviews should have more than one person present to conduct the interview. </li></ul></ul><ul><ul><li>If financial reporting or internal controls are implicated, forensic accountants should be present. </li></ul></ul><ul><ul><li>Company auditor may be present and in some circumstances should be present to help judge credibility. Especially true of witnesses in representation chain. </li></ul></ul><ul><ul><li>Interviewers should keep detailed notes of interviews. </li></ul></ul><ul><ul><li>Notes v. transcripts. </li></ul></ul>
    16. 16. Weight of the Evidence <ul><li>May find evidence going both ways; goal is to determine what probably happened based on the credible evidence </li></ul><ul><li>Auditors will consider incriminating evidence: </li></ul><ul><ul><li>In assessing remedial action </li></ul></ul><ul><ul><li>Willingness to accept representations from particular individuals </li></ul></ul>
    17. 17. Confidentiality of Ongoing Investigation <ul><li>Institute procedures to insure that executives or employees potentially involved are not updated as to investigation progress. </li></ul><ul><li>Management should not interfere with investigation or demand to be updated on its progress. Management will be updated on the Audit Committee’s schedule. </li></ul><ul><li>Management should not have any prior substantive contact with interviewees or targets. </li></ul>
    18. 18. Deadlines <ul><li>The investigation should proceed quickly, although getting it right is more important than speed. </li></ul><ul><li>But, the investigation should not be compromised by inordinate management pressure, upcoming deadlines for the filing of a 10-K, or other artificial restraints. </li></ul><ul><li>Most audit firms will not permit the scope, quality, or depth of an investigation to be compromised by unreasonable deadlines. </li></ul>
    19. 19. Transparency <ul><li>Auditor will expect complete access to information. </li></ul><ul><li>Auditor will want to make its own judgment and will review the investigation materials. </li></ul><ul><li>Failure to provide results may result in scope limitation. </li></ul><ul><li>Sharing with auditor impairs confidentiality of investigation because only 15 states, not including Texas, have auditor—client privilege. </li></ul>
    20. 20. Privilege Issues <ul><li>Interview notes and any report may be protected by attorney-client privilege and/or work-product privileges. </li></ul><ul><li>“Facts” not protected by either privilege. </li></ul><ul><li>SEC will request access to any written report. </li></ul><ul><ul><li>SEC’s position is that disclosure does not waive privilege. </li></ul></ul><ul><ul><li>Court decisions do not agree that there is no waiver. </li></ul></ul><ul><ul><li>Best practice is to obtain non-waiver agreement. </li></ul></ul>
    21. 21. Report Contents <ul><li>Circumstances leading to investigation. </li></ul><ul><li>Investigation’s scope. </li></ul><ul><li>Persons interviewed. </li></ul><ul><li>Sources of documents reviewed. </li></ul><ul><li>Underlying facts discovered. </li></ul><ul><li>Conclusions on culpability and intent. </li></ul><ul><li>Explanation of accounting adjustments. </li></ul><ul><li>Proposed remedial action. </li></ul>
    22. 22. Report Form <ul><li>Oral or written. </li></ul><ul><li>Needs and desires of: </li></ul><ul><ul><li>Audit Committee </li></ul></ul><ul><ul><li>Regulators </li></ul></ul><ul><ul><li>Auditors </li></ul></ul><ul><li>should be considered. </li></ul><ul><li>Auditor will document conclusions in work papers. </li></ul>
    23. 23. Company Response <ul><li>The Company will be required to provide representations with regard to the investigation and any financial statements affected by its conclusions. </li></ul><ul><li>Auditors may not accept audit-related representations from management when evidence of wrongdoing exists. </li></ul>
    24. 24. Public Disclosures <ul><li>Audit Committee, in consultation with Company, should consider the extent to which disclosure regarding the investigation should be made. </li></ul><ul><li>Review draft press releases. </li></ul><ul><li>But disclosure is ultimately the responsibility of the Company, not Audit Committee. </li></ul><ul><li>Company should make available to auditor draft press releases. </li></ul><ul><li>Continue to assess the need for disclosure. </li></ul>
    25. 25. Reporting to Government <ul><li>Audit Committee should consider benefits of cooperation and self-reporting if evidence of wrongdoing found. </li></ul><ul><li>Full cooperation is not a guarantee of non-enforcement. </li></ul><ul><li>Full and reasoned evaluation should be made before making a decision to self-report. </li></ul><ul><li>Consider whether Company auditors should attend meetings with government. </li></ul>
    26. 26. Auditor’s Response <ul><li>Auditor will assess the reasonableness of scope, findings, independence and conclusions of investigation. </li></ul><ul><li>Assess the extent to which the investigation can be relied upon for purposes of issuing audit report. </li></ul><ul><li>Assess whether the Company has taken “timely and appropriate remedial actions” per §10A. </li></ul><ul><li>Assess the extent to which Company personnel have cooperated with investigators and been candid and truthful. </li></ul>
    27. 27. Conclusions <ul><li>Objective: get investigation behind you; not make it worse. </li></ul><ul><li>Inadequate investigations can: </li></ul><ul><ul><li>Lead to adverse regulatory results; </li></ul></ul><ul><ul><li>Prevent audited financial statements; </li></ul></ul><ul><ul><li>Increase the appearance of guilt; </li></ul></ul><ul><ul><li>Result in sanctions against law firm conducting the regulations under the SEC Rules of Practice and Standards of Conduct. </li></ul></ul><ul><li>A thorough independent investigation: </li></ul><ul><ul><li>Safeguards the integrity of the outcome; </li></ul></ul><ul><ul><li>Serves the interest of a public company, its board, its regulators, its auditors, and its shareholders. </li></ul></ul>