Fraud is ancient," writes Mark A. Olson, who is of counsel at Archer Norris in Walnut Creek and does internal corporate investigations. "It is the child of ingenuity, desire, and transgression, and its forms are without number."
Olson's article on boardroom crime-scene investigations appears in the 2006 Practising Law Institute handbook on accounting and finance. But if larceny is endemic, fraud detection is just good business. Firms with internal-investigation practices are thriving. So are the forensics divisions of the Big Four accounting firms and a growing number of forensic boutiques, including Kroll Inc.
"I'd estimate our annual forensics revenue at about $200 million to $300 million," says Christian Tregillis, Kroll's western U.S. regional leader in Los Angeles. "The Big Four and the other boutiques have about equivalent revenue from forensics. There's a big demand for service providers."
But conducting internal corporate investigations has never been more complicated. Not least of the hazards is maintaining the attorney-client and work product privileges in the face of government investigators and parties inside the company who might have their own lawyers. "In a large public corporation under investigation, it would not be unusual for the corporation, the board, the audit committee, the officers, and affected employees to be represented by separate counsel," says Jan L. Handzlik, a partner in the Los Angeles office of Howrey.
Privilege waivers can be calculated, but they may also be inadvertent or the result of court challenges. "There are potholes to avoid and minefields to walk through on a daily basis," says David P. Bloch, a principal with Deloitte Financial Advisory Services in Washington, D.C. "Not every lawyer should be doing these investigations."
An investigating attorney usually is hired by either the audit committee or a special committee of the board. That attorney may hire a forensic accountant, who reports to the attorney and will not testify in subsequent litigation. "There is no air between the investigating attorney and the forensic accountant," says Pamela S. Palmer, a litigation partner in the Los Angeles office of Latham & Watkins.
However, some of the separately represented parties may seek access to the investigation's findings. "All constituencies want to know what's in that internal report," Handzlik says. "But access to the report should be limited to those who fall within the attorney-client privilege, have a need to know, and are not conflicted."
Whether the work product privilege protects the release of an internal report to third parties, including outside auditors, is unsettled law. In 2002, for instance, a judge in the Southern District of New York-citing the Sarbanes-Oxley Act-held that a company waived the work product privilege when it shared minutes of the investigating attorney's report with its outside auditor. "[A]s has become crystal clear in the face of the many accounting scandals that have arisen as of late, in order for auditors to properly do their job, they must not share common interest with the company they audit," wrote district Judge Alvin K. Hellerstein (Medinol, Ltd. v. Boston Scientific Corp., 214 F.R.D. 113 (2002)).
Two years later, a different judge in the Southern District disagreed, finding that the work product protection applied to notes released to an outside auditor because in the underlying trial, the company and the auditor had aligned interests in ferreting out corporate fraud. (Merrill Lynch & Co. Inc. v. Allegheny Energy Inc., 229 F.R.D. 441 (2004); rev'd on other grounds, 500 F.3d 171 (2007).)
Similarly, the attorney-client privilege is in play. Last November, the Delaware Chancery Court granted a plaintiff's motion in a derivative action to compel Maxim Integrated Products; its special committee; counsel Orrick, Herrington & Sutcliffe; and the forensic accountants to produce all material withheld on grounds of the attorney-client privilege.
Maxim had asserted the privilege for its communications with Orrick relating to the special committee's findings, reports, presentations, and other communications under the joint-privilege doctrine. But its special committee-a single director-had been given only limited authority and presented a final oral report in the presence of directors individually named as defendants, who attended with their separate counsel. Chancellor William B. Chandler III found that the third parties lacked common interests with the client, "precluding application of the common interest exception to protect the disclosed communications." In addition, he concluded that the plaintiffs' showing of good cause vitiated the privilege. (Ryan v. Gifford (2007 Del. Ch. LEXIS 168).)
The ruling put the defense bar in a tizzy. "The courts are looking at adversity, or lack of common interest, among individuals," says Douglas R. Young, a partner at the San Francisco office of Farella Braun & Martel who does internal investigations. "There is a concern now about how you can do an investigation, report it to the board, and how the board can then act without a waiver."
In early January, Chandler issued a second opinion in an interlocutory appeal that seemed to soften the blow. (Ryan v. Gifford (2008 Del. Ch. LEXIS 2).) He specifically denied Maxim's assertion that he had established a new legal right of access to internal corporate information. "The decision would not apply to a situation (unlike that presented in this case) in which board members are found to be acting in their fiduciary capacity, where their personal lawyers are not present, and where the board members do not use the privileged information to exculpate themselves," Chandler wrote. "Maxim's 'Chicken Little' argument that the Court's November 30 decision changes the law of privilege, therefore, is vastly overstated. The sky is not falling. Maxim has merely been struck by an acorn that it brought upon itself."
With so much in flux, outside auditors-required by law to express an opinion that a company's books and records were prepared in accordance with accounting principles and fairly reflect its condition-can only watch and wait. They want to know what's going on, but often can't get access to an investigator's report.
"The outside auditor wants comfort," says Sarah A. Good, a partner at Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco who conducts internal investigations. "It wants an exchange of information, which commonly is done verbally, by PowerPoint presentation, or in writing. But plaintiffs counsel could challenge such an exchange as constituting a waiver, and some courts might agree with them."