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Full Disclosure

By Megan Kinneyn | Feb. 2, 2007

Law Office Management

Feb. 2, 2007

Full Disclosure

In the latest round of options-backdating investigations, who represents the best interests of the company—general counsel, special committee counsel, or independent directors' counsel? It all depends. By Thomas Brom

By Thomas Brom
      Too Many Cooks?
      The first rule for surviving as general counsel is to avoid being thrown under the bus. Yet in the option-backdating mess, a dozen general counsel?and about as many CEOs?have taken one for the team. Most resigned after an internal investigation conducted by counsel for a special committee of the board of directors. Those committee engagements, repeated in more than 130 backdating investigations, indicate an enormous change in the governance of public corporations.
      The second rule for surviving as general counsel is to control the flow of legal advice. But the ability to do that changed dramatically with passage of the Sarbanes-Oxley Act in 2002. Congress gave a board's audit committee, composed solely of independent directors, express authority to hire separate counsel. Other committees of independent directors, including compensation and governance, can do likewise. Today, special committees commonly conduct internal investigations and review derivative suits, parent-subsidiary mergers, and management buyouts. A committee may hire separate counsel for itself, or to represent all independent directors.
      The third rule of surviving as general counsel is to beware of committees that can hire a better lawyer. After that, there are no bright-line rules.
      The complications seem limitless. Who is the client? Is it the corporate entity, a committee of the board, the officers and directors, or all of the above? Is representation of the entity's constituent parts separate or joint? If separate counsel provide conflicting advice, who is acting in the best interests of the company?
      "The attorney-client relationship is contractual," says Pamela Phillips, a partner at Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco who specializes in attorney liability and legal ethics. "It's a matter of agreement that can be constructed in any way. You could represent the entity, just the special committee, or both, according to the common interest doctrine." The basic considerations are addressed in rule 3-600 of the Rules of Professional Conduct and ABA Model Rule 1.13.
      "Regardless of the engaging entity, you always represent the best interests of the company," adds David G. Keyko, a partner in the New York office of Pillsbury Winthrop Shaw Pittman who has conducted internal investigations and is a member of his office's professional responsibility committee. "There is a pass-through from the constituent entity to the corporation as a whole."
      In the backdating cases, representation issues arise in a particular context: the assumption that the substance of an internal report will be passed on, either orally or in writing, to government authorities. So investigating counsel's duty of confidentiality under California Business & Professions Code section 6068(e) as well as the attorney-client and work-product privileges have immediate relevance. Who owns the privilege, and who may waive it?
      "The special committee holds the privilege," says John Potter, a partner in the San Francisco office of Quinn Emanuel who also has conducted internal investigations. "The committee can waive the privilege and make its intentions known to the full board. Separate counsel for officers and directors may object, but you do it anyway."
      Four years ago the ABA's so-called Cheek Report saw the problems of separate representation coming. (Report of the American Bar Association Task Force on Corporate Responsibility; March 31, 2003.) In a footnote, the authors found that retention of outside counsel to advise the board, or one or more of its committees, "generally would not be desirable." (Final Report, at 24 n. 54.) The note continued, "Apart from the cost of additional counsel, the division of management and the board of directors into two separately counseled factions may result in less open communication, less constructive collaboration ... and, ultimately, less effective oversight by the board of directors."
      But just a year later ethics experts at the University of Pennsylvania Law School found that separate representation of independent directors was spreading, and irreversible. "We make a prediction," wrote Geoffrey C. Hazard Jr. and Edward B. Rock in "A New Player in the Boardroom: The Emergence of the Independent Directors' Counsel." (ABA, The Business Lawyer, August 2004.) "Some independent directors, especially those who serve on an Audit Committee, will conclude that they are better off with independent counsel appointed on a standing basis ... Once an independent lawyer is hired for the Audit Committee, that lawyer will, over time, become the counsel for the independent directors more generally; he will guide them through their obligations on the Compensation Committee, the Nomination Committee, and in their SOX mandated separate meetings."
      Hazard and Rock predicted further that audit committee members would have to choose "whether to be counseled by the company's in-house general counsel (when there is one), the company's main outside law firm, or ... an independent lawyer." The professors concluded that independent directors' hiring of counsel signals a shift in corporate governance from a "team" concept to "judgmental monitoring"?with its inherent tension between officers and directors.
      That shift, however, isn't assured. Pressure on target companies to cooperate with the government by waiving the privilege-or throwing someone under the bus-has drawn squeals of protest, rousing everyone from the business lobby to the American Civil Liberties Union. In December, Senator Arlen Specter (R-Penn.) introduced a bill that would prohibit federal attorneys from demanding, requesting, or conditioning treatment on waiver of the privilege, withdrawal of legal defense fees, or participation in joint defense agreements. A week later U.S. Deputy Attorney General Paul J. McNulty amended terms of the infamous January 2003 Thompson memo, a move viewed as a peace offering that the Association of Corporate Counsel in Washington, D.C., immediately rejected as too little, too late.
      But there may be no going back to "team" governance. "For better or worse, we're in the era of judgmental monitoring," says Patrick McGurn, executive vice president and special counsel for Institutional Shareholder Services in Rockville, Maryland. "Independent directors of public corporations are expected to exercise oversight."
      Adds Quinn Emanuel's Potter, "There's been unparalleled growth in the use of special committees to conduct investigations, and they've never before been used systematically in that way. But it's tilting at windmills to object to the process now."

Megan Kinneyn

Daily Journal Staff Writer

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