Before the Knock on the Door

November 9, 2015Articles New York Law Journal

Reprinted with permission from the April 6 issue of New York Law Journal. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Before the Knock on the Door

Explore the benefits and risks of voluntary disclosure to the government.

Daniel A. Schnapp, New York Law Journal

In the post-Enron era, the internal investigation has become a commonplace fact of life at most companies, regardless of the size of the company, whether the company is public or private, or even the nature of the company's business. In-house counsel, as well as business owners, principals, officers and directors, CFOs and auditors, now must consider the costs of performing such investigations as a cost of doing business, even when the costs appear extreme. Take, for example, the amount reportedly spent by Avon Products to investigate potential violations of the Foreign Corrupt Practices Act (FCPA) between 2009 and 2011—a cool $247 million.1 Further, legal fees alone in an internal investigation can cross the $100 million dollar mark, particularly where companies are required to indemnify their officers and directors for their legal fees.2 Such extreme costs often do not even include the actual costs and penalties associated with the efforts a company may take to fix the problems that gave rise to the investigation. Volkswagen, for example, has set aside approximately $7.2 billion to address the costs and penalties arising from the recently reported manipulation of diesel emissions tests.3

Beyond the costs associated with the internal investigation lie complex questions concerning the disclosure of the results of an internal investigation to the government, as well as the benefits and risks associated with such disclosure. Even while the government has attempted to incentivize such disclosure, and cooperation, questions remain as to the how, why, and when to disclose.

What Triggers an Internal Investigation?

Initially, there are numerous triggers for an internal investigation, including, without limitation, a subpoena, a search warrant, an anonymous tip to the media, an employee complaint, a letter or demand from a shareholder or a phone call from an investigator.

Of all of these triggers, perhaps the most chilling to in-house counsel is the notice of the commencement of a government investigation, or where the company, before or after the initiation of an investigation, learns that a U.S. government agency, or a local, state, or foreign government agency, is investigating the same or similar conduct that gave rise to the internal investigation. But a company can, and should, take methodical, strategic steps to plan for and ameliorate the initial concerns and risks that are associated with the onset of a government investigation of prosecution.

Fundamental Steps

Certainly a comprehensive and reliable internal investigation can improve the outcome of any government investigation, and perhaps even positively affect future civil litigation, such as the defense of class actions. The negative effects of a subpar investigation, on the other hand, can severely jeopardize the ability of a company to escape liability and can result in such adverse results such as including waiver of the attorney client privilege, adverse jury instructions, obstruction of justice charges, spoliation sanctions, and extensive damage to corporate and personal reputations.4

Therefore, any internal investigation, whether or not the government is conducting its own investigation into the same conduct at issue in the internal corporate investigation, requires appropriate actions and planning. For example, a crucial first step in carrying out an investigation is to ensure any potentially relevant documents are preserved by issuing a litigation hold to all necessary employees.5 Such a litigation hold should be designed to halt any routine document-destruction practices and to ensure that the relevant employees preserve documents or communications related to the conduct that gave rise to the investigation.

Similarly, understanding how to obtain and protect evidence in the face of potential government action, how to conduct interviews with employees, including senior management, and effectively staffing the investigation may directly influence the credibility of the investigation, particularly when shared with law enforcement. Where an investigation involves such serious matters as insider trading, bribery, misconduct by a senior executive, or other matters involving potential criminal liability, the staffing of the investigation may include outside counsel, inside counsel, an Audit Committee, a Special Committee of the Board, or even others.6

Inside and outside counsel should also ensure that the subject company has the appropriate pieces in play to meet regulatory requirements. The availability of information concerning how to conduct proper investigations is legion, and maintaining policies and coordinating with outside counsel to determine best practices in how to prepare for and anticipate conducting an appropriate investigation is almost always advisable.

Before the Government Comes Knocking

Both inside and outside counsel should know whether a company has certain obligations to conduct an independent investigation and to self-report its findings, even in the absence of an ongoing governmental investigation. Typically such obligations arise where prior public disclosures, such as in a SEC filing, conflict with the findings of an internal investigation.

Further, there exists a plethora of regulations that bear upon whether self-disclosure is necessary, thereby taking the need to even consider the issue of whether or not to disclose. For example, Sarbanes-Oxley regulations require, among other things, corporations to establish audit committees with responsibility for developing procedures to receive, retain and investigate complaints of financial fraud involving auditing, accounting or internal controls issues.7 Similarly, Sarbanes-Oxley requires CEOs and CFOs to certify both that the company's financials are truthful and accurate and that they are personally responsible for the company's internal controls, and imposes an obligation to report to the auditors and board of directors any significant deficiencies in the design or operation of internal controls. A willful failure to comply with these responsibilities can result in personal criminal exposure of up to 20 years' imprisonment.8

The courts have often dealt with the obligations to disclose illegal conduct, often in the securities context, and have found that not all illegal conduct requires disclosure. In the matter of Galati v. Commerce Bancorp., 2005 U.S. Dist. LEXIS 26851 (D. N.J.), for example, the U.S. District Court for the District of New Jersey ruled that "[e]ven if a corporation is engaging in illegal practices, predictions of future events such as criminal indictments are too speculative to be material" and therefore do not need to be disclosed.9

The U.S. Court of Appeals for the Third Circuit affirmed the district court's ruling and noted that "the illegality of [Commerce Bank's] conduct does not establish a Rule 10b-5 violation unless [the company] made a misleading statement in conjunction with the conduct," and held that the defendants did not have a duty under Rule 10b-5 to disclose the information.10

So what happens in a more opaque situation such as where the internal investigation has uncovered a serious, but non-material event, such as in the example recently posited by the current Chairwoman of the SEC, Mary Jo White, where a rogue employee in a small foreign subsidiary has been bribing a foreign official in violation of the FCPA?11

Under such a circumstance, counsel has to consider that even if the conduct was illegal, disclosure may not be absolutely necessary (unless, of course, the conduct was at odds with previous disclosures to investors). The inquiry does not necessarily end there; disclosure, even in the absence of a duty to do so, may still be in the company's best interests, and may set the stage for a more favorable outcome in the event of a subsequent government investigation.

Initially, the government will likely take into account, and look favorably upon, a corporation's voluntary disclosure of the negative (or positive) findings of a company's internal investigation. The benefits may include without limitation, a reduction in the payment of fines and penalties, and can lead to the deferment of prosecution, cooperation agreements, or a non-prosecution agreement.12 Multiple government agencies also have voluntary disclosure programs for such situations, such as the FCPA, the Foreign Account Tax Compliance Act and the IRS Offshore Voluntary Disclosure Program.13

On the other hand, the company may consider the possibility, however fleeting or remote in an era of increasingly disgruntled employees, whistleblowers, and social media that, by staying silent, the government never comes knocking.

Ultimately, inside and outside counsel must confer and determine all of the potential upsides and downsides to voluntary disclosure in the absence of a duty to disclose. But there is no guarantee that the decision to disclose will be met with the forgiveness of corporate wrongdoing, just as there is no guarantee that silence will not prove beneficial.

After the Government Comes Knocking

The DOJ itself has explicitly noted in its "Thompson memo" that, cooperation is a potential mitigating factor in a criminal prosecution by which a corporation—just like any other subject of a criminal investigation—can gain credit in a case that otherwise is appropriate for indictment and prosecution.14 The Thompson memo states that "[i]n determining whether to charge a corporation and how to resolve corporate criminal cases, the corporation's timely and voluntary disclosure of wrongdoing and its cooperation with the government's investigation may be relevant factors. In gauging the extent of the corporation's cooperation, the prosecutor may consider, among other things, whether the corporation made a voluntary and timely disclosure, and the corporation's willingness to provide relevant information and evidence and identify relevant actors within and outside the corporation, including senior executives."

The DOJ has also pointed out in the Thompson Memo, however, that the decision not to cooperate by a corporation (or individual) is not itself evidence of misconduct, at least where the lack of cooperation does not involve criminal misconduct or demonstrate consciousness of guilt (e.g., suborning perjury or false statements, or refusing to comply with lawful discovery requests), and so, failure to cooperate, in and of itself, does not support or require the filing of charges with respect to a corporation any more than with respect to an individual.15

The SEC, for its part, has attempted to signal its encouragement for companies to self-report evidence of wrongdoing and cooperate with the Commission. In its "Seaboard Report," the Commission noted that, "[w]hen businesses seek out, self-report and rectify illegal conduct, and otherwise cooperate with Commission staff, large expenditures of government and shareholder resources can be avoided and investors can benefit more promptly."16 Further, the Commission notes that "[c]ooperation by individuals and entities in SEC investigations and related enforcement actions can contribute significantly to the success of the agency's mission. Information obtained from cooperators helps detect violations of the federal securities laws, increase the effectiveness and efficiency of SEC investigations, and provide important evidence necessary to take enforcement actions. The program gives SEC investigators access to high-quality, firsthand evidence, resulting in stronger cases that can shut down fraudulent schemes earlier than otherwise would be possible."17

Further, the Federal Sentencing Guidelines, which sets the basis for sentences arising out of the violations of federal criminal statutes, are geared to encourage self-reporting and cooperation. In particular, the Guidelines use a "Culpability Score" to determine the level of fine to be imposed on a corporation. The Culpability Score begins with a 5 and includes a 5-point reduction for self-reporting, cooperation, and acceptance of responsibility under §8C2.5(g)(1).18 However a company will be penalizedwhere a company fails to take steps to self-report and cooperate "(A) prior to an imminent threat of disclosure or government investigation [] and (B) within a reasonably prompt time after becoming aware of the offense."19 Perhaps the explicit promises of leniency under the Federal Sentencing Guidelines remain one of the strongest incentives for a company to voluntarily disclose the offending conduct to the government and then follow through with cooperation.

As reflected in the Federal Sentencing Guidelines, another critical issue is the issue of when to disclose. Certainly, permissiveness exhibited by a company in not immediately taking steps to halt the offending activity and disclose will be considered negatively by the government, while, at the same time, the company requires time to circle the wagons and determine whether, and how, to document the offending conduct, to determine what information will likely be obtained by the government, evaluate potential defenses, plan and prepare for testimony, and to set aside the appropriate funds to pay any penalties.

The Thompson memo, for its part, notes that "the government's key measure of cooperation must remain the same as it does for an individual: Has the party timely disclosed the relevant facts about the putative misconduct? That is the operative question in assigning cooperation credit for the disclosure of information…"20


Perhaps one of the most difficult and potential existential issues facing a company will be whether or not to self-report potentially criminal conduct to the government, and then to resolve the issues of timing and methods of cooperation.

No question can seem more complex to a board of directors than whether, if the company voluntarily discloses potentially criminal conduct, will it nonetheless become the object of greater governmental scrutiny.

With little exception, there is no black and white rule, only a complex decision process that must be made following thorough examination of all the benefits and risks of disclosure and cooperation.



2. Id.





7. 15 U.S.C. §78j-1 (2006).

8. Id.

9. Id.






15. Id.


17. Id.


19. Id.


Reprinted with permission from the April 6 issue of New York Law Journal. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.