Why the Board of Directors Need an Investigation Protocol

Thomas Fox
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Compliance Evangelist

Many companies have an investigation protocol in place when a potential compliance or other legal issue arises. However, many Boards of Directors do not have the same rigor when it comes to an investigation, which should be conducted or led by the Board itself. The consequences of this lack of foresight can be problematic, because if a Board does not get an investigation which it handles right, the consequences to the company, its reputation and value can all be quite severe.

This last point was vividly driven home by the imbroglio involving McDonald’s and its former Chief Executive Officer (CEO), Steven Easterbrook. In late 2019, Easterbrook was terminated by the company’s Board of Directors for having a consensual, sexting relationship with a subordinate. He was not terminated “For Cause” and this decision allowed him to walk away with some $40 million in benefits. The Board investigation was cursory at best, taking Easterbrook’s word that this was his only transgression with an underling. The investigation confirmed the sexting issue but Easterbrook said that was his only liaison. Dieter Waizenegger, quoted in the Financial Times (FT), said, “The board really didn’t do its job.”

However, it turned out that Easterbrook had at least three other affairs with McDonald’s employees, one of which he awarded stock options. Easterbrook had deleted files and pictures off his phone and otherwise destroyed evidence of the affairs. According to the New York Times (NYT), an internal whistleblower brought forward evidence of the additional affairs. After (presumably) a more thorough investigation, McDonald’s filed suit to recoup the settlement package Easterbrook left the company with at his termination. The lawsuit alleged, “that Mr. Easterbrook actually carried on sexual relationships with three McDonald’s employees in the year before his ouster and that he awarded a lucrative batch of shares to one of those employees.”

In a The Corporate Board article, entitled “Successful Board Investigations”, David Bayless, partner, and Tammy Albarrán, former partner, Covington & Burling LLP, wrote about five key goals that any investigation led by a Board of Directors must meet.

Thoroughness. One of the key questions any regulator might pose is just how thorough an investigation is; to test whether they can rely on the facts discovered without having to repeat the investigation themselves. Regulators tend to be skeptical of investigations where limits are placed (expressly or otherwise) on the investigators, in terms of what is investigated, or how the investigation is conducted. This question can initially be a deal-killer, particularly if the regulator involved views an investigation insufficiently thorough, as its credibility is undermined.

Objectivity. An insufficiently objective investigation will be viewed by outsiders as inadequate or deficient. The same must be had with the investigators themselves. If a company uses its regular outside counsel, it may be viewed with some askance, particularly if the client is a high-volume client of the law firm involved, either in dollar amounts or in number of matters handled by the firm.

Accuracy. In any part of a best practices compliance program, the three most important things are “Document, Document and Document”. This means that the factual findings of an investigation must be well supported. Otherwise, the investigation opens itself up to skeptical prosecutors and regulators, and the government will just go ahead and conduct its own investigation. This is never good, and your company may well lose what little credibility and goodwill that it may have engendered by self-reporting or self-investigating.

Timeliness. Certainly, in the world of Foreign Corrupt Practices Act (FCPA) enforcement, an internal investigation should be done quickly. This has become even more necessary with the tight deadlines set under the Dodd-Frank Act Whistleblower provisions and the new mandate for whistleblowers to report to the SEC to receive protection from retaliation. But there are other considerations for a public company such as an impending Securities and Exchange Commission (SEC) quarterly or annual report that may need to be deferred absent as a timely resolution of the matter. Lastly, the Department of Justice (DOJ) or SEC may view delaying an investigation as simply a part of document spoliation.

Credibility. One of the realities of any investigation is that a Board of Directors led investigation is reviewed after the fact by not only skeptical third parties, but also sometimes years after the initial events and investigation. So not only is there the opportunity for “Monday morning quarterbacking,” but quite a bit of post event analysis.

How can a Board evaluate an investigation? Bayless and Albarrán offered seven considerations to facilitate a successful Board investigation.

Consider whether you need independent outside counsel. The appearance of partiality undermines the objectivity and credibility of an investigation. That means you should not use your regular counsel. The authors cite the SEC analysis of how independent Board members truly are to explain the need for independent counsel, which includes the following factors:

  • Did management, the Board or committees consisting solely of outside directors oversee the review?
  • Did company employees or outside persons perform the review?
  • If outside persons, have they done other work for the company?
  • If the review was conducted by outside counsel, had management previously engaged such counsel?
  • How long ago was the firm’s last representation of the company?
  • How often has the law firm represented the company?
  • How much in legal fees has the company paid the firm?

Consider hiring an experienced investigator to lead the internal investigation. Jim McGrath wrote and spoke about the need to utilize specialized counsel in any serious investigation. If a Board is leading an investigation, it is by definition, serious. Your investigation needs to be led by a lawyer with significant experience in conducting internal investigations; a strong background in criminal or SEC enforcement; and has substantive experience in the area of law at issue.

Consider the need to retain outside experts. In any investigation, there will be the need for a wider variety of subject matter experts (SMEs) than a compliance professional. If there are accounting issues, forensic accountants might be needed. In this day and age, an electronic discovery consultant is often required, and can be a cost-effective option for gathering and processing electronic data for review; an IT expert will be mandatory.

Analyze potential conflicts of interest at the outset and during the investigation. There are two types of conflicts of interest that may come to light during an investigation. First is the one which comes up when the law firm or lawyers conducting the inves­tigation are those whose prior legal advice has some bearing on the matters being investigated. During an internal investigation, however, the lawyers may be hired by, and represent, the Board or its committee. The second occurs when a lawyer or law firm jointly represents the Board and employees at the company as regulators have become increasingly concerned with joint representations. The trickier question is what to do when there simply is a risk that representing one client could limit the lawyers’ duties to the other. So, in these situations, joint representation may not be appropriate.

Carefully evaluate whistleblower allegations. Whistleblowers have become more important and taking their allegations seriously is paramount. This does not mean trying to find out who the whistleblowers might be to punish or stifle them, even if they are located outside the United States and therefore do not have protections under these laws. They can still get hefty bounties. Regulators are very wary of Boards that do not satisfactorily evaluate a whistleblower’s complaint based on a perception of the whistleblower himself, as opposed to the substance of the complaint. After Dodd-Frank, this can also cause additional problems for a company.

Request regular updates from outside counsel, without limiting the investigation. These types of investigations are long and very costly and can easily spin out of control. But, by trying to manage these costs, a Board might be perceived as placing improper limits on the investigation. The “goal is to strike the right balance between the cost of the investigation and its thoroughness and credibility.” To do so, flexibility is an important ingredient. The scope of what to investigate is not a static, one-time decision. Every investigation can, and usually does, evolve.

Consider whether an oral report at the conclusion of the investigation is sufficient. While there may be instances in which, due to complexity and the nature of allegations involved, a written report is necessary, there may be times when an oral report delivered to a Board is better as “a written report may be easier to follow and appear to be the logical conclusion to an investigation, it is an expensive and time-consuming endeavor, and it comes with great risk.”

The authors concluded their piece by stating, “By keeping in mind the issues addressed above, the Board will be better prepared for the investigation and readily able to exercise good judgment throughout the review. A well-conducted investigation by the Board may spare the company further disruption and costs associated with follow-on investigations by the regulators, or at the very least minimize the company’s exposure.” McDonald’s might wish it had done so about now.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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