When Facing Options Backdating Investigations, Taking Early Strategic Steps Can Prevent Problems Later
Every public company can or should be considering the implications of the government’s rapidly expanding investigation into allegations that executives received back-dated options at favorable strike prices. The investigations began when the Wall Street Journal published a statistical study suggesting that it was extremely improbable for some executives to have consistently received their options when their company’s stock was at the lowest ebb. Since that time, more than 30 public companies have been associated with the investigation, many of them technology companies based in Silicon Valley.
The magnitude of these investigations is unprecedented in the history of the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ). While in the past there have been fertile periods of major corporate and white-collar prosecutions, including the recent accounting manipulation cases, the current spate of investigations is unusual because it potentially implicates dozens of public companies at one time.
Every general counsel needs to consider the implications of these investigations for its company. Along with potential criminal and civil (SEC) exposure, individual executives, directors and officers could face criminal liability based on potential mail and wire fraud, securities fraud and tax theories. Even if the governmental investigations can be successfully managed, plaintiffs’ class action derivative suits are inevitable. Nor would it be surprising for Congress to undertake a legislative investigation and to issue subpoenas to key witnesses. The disclosure issues and media considerations are particularly tricky in this setting.
The first 30 days are critical in responding to such an investigation. Frequently companies and counsel make early, critical strategic mistakes that lead to major problems later. Following are some of the key things that a company should consider immediately.
Form a Special Committee of the Board
The critical first step is for the board of directors to appoint a special committee composed of a few key directors of high stature and impeccable integrity. A special committee is necessary because other board members and key executives may be implicated, and the final report generated by the internal investigation will be more credible if it comes from the special committee. These individuals must be prepared to actively direct the investigation.
Choose Good Counsel
The special committee needs to oversee the hiring of counsel. This choice should not be taken lightly, and it is perhaps the most critical decision to be made. The committee members should resist the temptation to hire a firm or a particular lawyer because they have a prior close relationship. While many firms purport to do internal investigations, there are only a few who do them well.
The special committee should seek counsel with the following attributes:
- Good judgment
The goal of the internal investigation is to:
- Analyze whether there is civil or criminal exposure
- Recommend appropriate steps
- Save the company from prosecution
It is critical to have counsel who have successfully handled such investigations before, who regularly practice before the SEC and the U.S. Attorney’s Office, who have good relationships and generate respect with the governmental bodies, who have sufficiently deep resources at the firm to do a thorough and fast investigation, and who the government will see as both credible and independent. Thus, it is critical that counsel not be regular corporate counsel or the government will suspect a whitewash. Counsel should also be able to advise on press issues, securities issues and tax questions. The special committee should closely question prospective counsel about these areas of knowledge.
The most immediate step after hiring counsel is to give them the authority to collect information. Information is power in this situation, whether good or bad. Information does two things:
- It enables the special committee to make key decisions without being in the dark.
- It encourages the government to turn to the special committee’s lawyers as a source of information, so that the company is viewed as a positive rather than an obstructionist force.
Counsel will need to quickly gather and review key documents and interview critical witnesses. It is pointless to interview witnesses without having the documents to question assertions and jog memories, yet time is of the essence in capturing witness statements.
Establish Contact with the Government
Counsel will need to make contact with the critical decision-makers in the government, whether in the SEC or the U.S. Attorney’s Office, or both. It is critical to establish these lines of communication early to establish good relationships and to discover what the government knows, or thinks it knows, about the conduct in question. It is also important in these early meetings to establish that counsel is well prepared and willing, if necessary, to push back. The government must view counsel as a potentially powerful adversary and choose instead to use counsel as a resource.
Prevent Further Disasters
The old adage about the cover-up being worse than the crime could not be more true than in corporate investigations. The government has aggressively prosecuted individuals and companies for things that happen after the events originally investigated. The government prefers these prosecutions because they are easier to prove, easier for a jury to understand and less complicated than unraveling a complicated fraud. The prosecutions of Martha Stewart and others were based on a theory regarding behavior that occurred after the original matter was investigated. These prosecutions also show that even the most sophisticated companies and individuals can find themselves accused of obstruction, perjury or false statements. It is essential in the earliest stages of an investigation to prevent these issues from arising.
Other Key Concerns
These cases raise a host of other concerns, including media issues. Counsel should be familiar with handling high profile investigations. The press strategy should be considered as part of an overall legal strategy. In addition, counsel needs to consider disclosure issues from a securities standpoint. Obviously, the plaintiffs’ lawyers are looking for the opportunity to file cases, and any strategy must consider the effects of the governmental investigation on the civil lawsuits and vice versa.
There are significant privilege and Fifth Amendment issues. For example, the government will frequently ask counsel to waive the attorney-client privilege, although the DOJ policies that include the discussion of waiver have recently come under assault. The internal investigation must consider how and what the government may seek by waiver. Moreover, the production of privileged materials to the government could result in a waiver as to the same materials for plaintiffs’ counsel. By the same token, the witnesses who testify in proceedings may bind the company by their statements, yet their invocation of the Fifth Amendment may, in some circumstances, be held against them in civil cases.
In short, the company must stand ready to act quickly and decisively. At the same time, early mistakes can be fatal. Given the stakes are so high on so many fronts (criminal liability for the company, criminal liability for individuals, securities issues with the SEC, possible debarment from federal work, tax issues, derivative lawsuits and congressional inquiries), general counsel needs to treat this matter as if the future of the company were at stake—because it is.