The new SEC bounty-hunter regime, the explosion in whistleblower claims, and the increasing severity and complexity of those claims raises the specter of government investigations and criminal sanctions. Our readers have requested our insight and lessons learned, so we offer the following.

When a whistleblower alleges wrongdoing, companies must make an initial judgment of what the likelihood is that the government will commence a criminal investigation against the organization or its directors, officers or employees. Formulation of a cost-effective, legally sufficient internal investigative plan depends upon it. If the allegations are made internally rather than to a government agency, the pace with which the investigation proceeds may be more reasonable. The pressure to learn the truth is constant. But no external factors influence the timing of the inquiry. If, however, the allegations are made internally and to a government agency, the need for more prompt attention heightens. Prompt reasonable action oftentimes will alleviate the government’s fear that whistleblower allegations may be covered up. Recognizing when a whistleblower report may result in possible criminal action naturally depends upon the nature of the information. Sometimes the allegations pertain to alleged violations of the law that are obvious even to an untrained person. Other times the whistleblower information is less definite, incomplete, or contradictory. Then the decision as to how serious an issue the allegations pose is harder to make.

The U.S. Department of Justice has published the Principles of Federal Prosecution of Business Organizations (U.S. Attorney’s Manual §§ 9-28.000 to 9-28.1300). Identifying whether these factors exist in a particular situation will aid in assessing federal law enforcement, and possibly state and local official, interest in the matter. Factors the business entity must assess to determine if a criminal investigation is likely are identified in it.

Factors that Can Turn a Regulatory or Civil Inquiry into a Criminal One

  1. Senior Management Involvement – The more serious the involvement of high-level senior management or board members in the alleged wrongdoing, the greater the likelihood the government will seek criminal sanctions. Prosecutors generally target the highest culpable officials in pursuing criminal charges based upon a belief that prosecution of those officials has a greater deterrent impact. There is a significant law enforcement focus on “Tone at the Top.”
  2. Extensive Management Involvement – The greater the number of officers or employees within the organization who are inculpated, the greater the likelihood the investigation will ultimately lead to criminal sanctions. Extensive management involvement is viewed as evidence of an organizational atmosphere of non-compliance.
  3. Number of Victims – The greater the number of victims of the alleged wrongdoing the more likely the matter will result in a criminal investigation. The amount or type of each victim’s loss is important as well. Political or public pressure on law enforcement officials will influence this factor.
  4. Aggregate Loss – The larger the financial impact on all victims, the more likely the government will utilize the criminal law. Assessment of the financial impact includes not only the actual loss to all the victims but also the financial gain by the culpable persons or organization.
  5. Prior History – The prior history of the organization is critical. If the organization has had previous difficulties in the same or related areas and such difficulties resulted in civil or regulatory actions, the government is more likely to seek criminal sanctions to increase the penalty to the organization.
  6. Enforcement Priorities – Agencies cannot investigate and prosecute all wrongdoing. If the wrongdoing does not fit in an enforcement priority, it may not be ignored, but it will not likely receive heightened attention. Priorities are set for policy and budgetary reasons. For example, fraud involving financial institutions, health care fraud, and the bribery of foreign officials are major priorities of the federal government.
  7. Response to Investigation – Where allegations of destruction of documents or falsification of evidence exist, the government tends to resort to criminal sanctions. Mostly it is easier to prove criminal the obstructive behavior than the substantive regulatory violations or other offending conduct. Obstructive conduct during the investigatory stages also undermines any attempt by the organization to characterize the conduct that started the inquiry as not sufficiently consequential for treatment under the criminal law.

Factors Influencing the Decision of When to Retain Outside Counsel

In determining whether to retain outside counsel to conduct an investigation, several factors are relevant. Each should be evaluated accordingly because the importance of each factor varies in the context of each matter. 

  1. Focus/Scope of the Inquiry — Determine the number of management employees involved and whether the alleged impropriety involves persons at or above the organizational level of the General Counsel. If one of the persons implicated ranks at or higher in the organization than the General Counsel, use of outside counsel protects the organization from allegations that the investigation conducted by the subordinate employee was influenced by the fact that a superior was the focus of the inquiry. Moreover, where the scope of the inquiry involves a number of senior executives, use of outside counsel can shield the organization from claims that the General Counsel was “outvoted.”
  2. Consequences of Adverse Result — The more serious the allegations or risk of exposure if wrongdoing is found, the more advisable it may be to employ outside counsel. This is especially true if the need for an internal investigation was created by the visit of law enforcement personnel, receipt of a grand jury subpoena or execution of a search warrant and the organization, its officers or employees are identified as the “subject” or “target” of the investigation. Estimate the financial cost to the organization should the investigation result in an adverse action against it. For example, if the financial penalty is not material and it is the only anticipated consequence other than internal employee discipline, then incurring the cost of an outside attorney to conduct the investigation may not be prudent. Conversely, if the financial penalty is material or the collateral consequences to the organization, e.g. debarment, exclusion, etc., are significant, retention of outside counsel may be more desirable.
  3. Potential Conflicts Between the Organization and Individuals — Where an organization to protect itself may have to distance itself from individual directors, officers or employees who are the focus of the investigation, it may be better to accomplish that through the use of outside counsel.
  4. Size and Expertise of Legal Staff — Conducting internal investigations is time consuming. In-house legal departments may not have appropriately trained or experienced staff to conduct the investigation. In the latter case, use of outside counsel is necessary. Clearly defined procedures have to be developed to ensure that the use of such personnel does not adversely impact preservation of the attorney-client privilege.
  5. Location of Investigation — Where the investigation involves activities in non-U.S. entities, use of outside counsel may be critical to preserving the attorney-client privilege. In many countries, the protection of the attorney-client privilege does not extend to communications with in-house counsel or personnel working under them as it does in the U.S.