By Jett Hanna
When an organization has a potential problem, lawyers are often employed to investigate the extent of the problem, the likelihood of liability, and the need for early action to mitigate any legal consequences. Companies subject to Sarbanes Oxley are required to initiate internal investigations under many circumstances. Sarbanes-Oxley Act of 2002, Pub.L. No. 107-204, 116 stat. 745 (2002), Sections 301, 304, 404. Sarbanes Oxley and ethical rules both require lawyers to report matters “up the corporate ladder” when an organization constituent acts in a way that will violate the law or a legal obligation of the organization, or that will result in substantial injury to the organization. See Texas Disciplinary Rules of Professional Conduct Rule (TDRPC) 1.12(b), ABA Model Rule 1.13(b). These requirements have increased the frequency with which lawyers have recommended internal investigations.
Internal investigations pose dangers for the lawyers who conduct them. Claims have arisen from failure to conduct investigations with sufficient independence from company management. The malpractice risks identified at the ABA conference were:
• Conflicts of interest arising out of representation of both organization constituents and the organization
• Conflicts of interest arising out of the relationship of prior work by the lawyers for the organization
• Mistakes made in the course of the investigation.
Conflicts with Constituents
The first conflict can arise from failure to clarify the role of the lawyer in the investigation. As a general rule, a lawyer conducting an internal investigation should tell organization constituents who are interviewed in the course of an internal investigation that they are not the client. See TDRPC Rule 1.12(e), ABA Model Rule 1.13(f). This communication, known as an Upjohn warning, then treats the interview as a communication between the lawyer and the company, and the company controls the confidentiality privilege. See Upjohn Company v. United States, 449 U.S. 383, 386-396 (1981). Without this warning, the individual interviewed can claim attorney client privilege for discussions, potentially to the detriment of the company. Note that the comments to ABA Model Rule 1.13 states that the lawyer should advise the constituent that they may wish to obtain independent counsel.
Prior to or during the course of an interview, an organization constituent may ask the lawyer questions, such as whether the constituent “has a problem” or needs a lawyer. A lively discussion over the proper response took place at the conference. One presenter felt that if the person interviewed was not the subject of the investigation who might face personal liability or responsibility in the matter being investigated, then giving reassurance to them that they could talk freely was permitted. This may constitute legal advice, however, and create an attorney client relationship. TDRPC 4.03 and ABA Model Rule 4.3 both restrict the advice that can be given to non-clients to the advice to seek other counsel. Advice can lead to malpractice liability. After discussion, another panelist suggested that a lawyer could state truthfully, without providing any advice, that the constituent is not the target of the investigation. If an interview subject requests legal counsel, the interview should be terminated immediately. It may be appropriate to put any warnings or statements as to the nature of the investigation in writing so that the nature of the communication will be clear in later proceedings.
A number of malpractice claims have been made by constituents who were targets of an internal investigation. In Texas, an appellate court permitted a malpractice claim by a constituent to proceed against an investigating law firm. The law firm conducted an interview of a company truck driver. The law firm then provided information obtained in the interview to the prosecutor, and the driver was indicted. The driver’s assertion that the lawyers said they represented both the company and the driver was sufficient to create a fact issue as to whether the firm represented the driver. Perez v. Kirk & Carrigan, 822 S.W.2d 261, 265-66 (Tex. App.Corpus Christi 1991, writ denied)
Conflicts from Prior Services to the Client
If the subject of the investigation involves matters related to prior legal services, the law firm may face a claim that they had a conflict in conducting the internal investigation. Suppose, for example, that a law firm has assisted a company with issuing securities, and a claim is made that important information was not disclosed in offering documents. If the allegedly important information was disclosed to the lawyer and the lawyer opined that the information did not need to be disclosed, the company or its officers may have an advice of counsel defense against securities fraud allegations.
Any time a transaction in which a lawyer of law firm provided legal services is questioned in some respect, the lawyer or firm should consider whether it has a conflict of interest and should leave the matter for other counsel. This applies whether the questioning is implied by the nature of the new legal services requested, comes directly from the client, or is alleged by a third party. Certainly, some situations will involve questioning so unlikely to result in a conflict that the lawyer can proceed. For example, if a third party questions a provision in a contract and the lawyer believes, properly, that the question is frivolous, the lawyer need not withdraw.
When do you go up the ladder?
Failure of a lawyer to go “up the ladder” in accordance with the rules of ethics and Sarbanes Oxley can lead to lawyer liability. It should be understood that Sarbanes Oxley subtly expands the circumstances when a lawyer must go up the ladder and discuss matters uncovered with higher authorities within the client. The differences between Sarbanes Oxley and the ethics rules are as follows:
• Credible evidence triggers the need to go up the ladder under Sarbanes, while actual knowledge is required by both TDRPC 1.12(b) and ABA Model Rule 1.13(b).
• Substantial injury to the organization is not required by Sarbanes, but is required for ethical rules to be triggered.
• The disciplinary rules arguably provide the lawyer more flexibility in deciding when to go up the ladder, while Sarbanes states the requirement as mandatory.
It should be noted that the TDRPC 1.12 does not provide a lawyer with a window to report matters that can harm the organization outside of the organization. ABA Model Rule 1.13 provides such a window only if the information has been passed up the ladder and is not in connection with either investigation or defense of a matter for the organization. Initially, the SEC proposed “noisy withdrawal” requirements for regulations under Sarbanes Oxley in certain situation, but those have not be finally enacted.
From a malpractice avoidance standpoint, lawyers should utilize the Sarbanes Oxley “up the ladder” requirements, even if Sarbanes Oxley doesn’t apply. Withholding evidence of a violation of law or of a legal obligation from higher authorities within a client seems to invite legal malpractice claims. Going over the head of the person with whom a lawyer communicates in an organization is not the best way to keep a good relationship with that person, but may be necessary to assure the best service to the true client-the organization.
Recent Investigation Malpractice Related Cases
United States v. Nicholas, 606 F.Supp. 2d 1109 (C.D. Cal. 2009) (“Ruehle I”), rev’d
sub. nom., United States v. Ruehle, 583 F.3d 600 (9th Cir. 2009) (“Ruehle II”).
Criminal case against company CFO. Evidence was not suppressed in criminal prosecution of the CFO because the Upjohn warning was inadequate and the CFO was aware that company had intended to share results of the investigation with regulators.
Pendergest-Holt v. Sjoblom, United States District Court for the Northern District of
Texas, Case no. 3:09-cv-00578-L (Complaint).
Arising out of the Stanford Financial investigation, a company officer sued the corporation’s lawyer after she was indicted based on questions under oath asked while lawyer was present.
C. Cohen, as Trustee of the Friedman’s Creditor Trust v. Morgan Schift & Co., Inc., 394
B.R. 623 (S.D. Ga. 2008).
A malpractice claim was allowed to proceed based on an allegation of conflict of interest when an investigation expanded into areas in which the law firm had been involved.