United States: The Growing Importance Of Independent Investigations Overseen By The Audit Committee

Last Updated: December 31 2012
Article by Bradley J. Bondi and Geoffrey Gettinger

Most Read Contributor in United States, May 2019
  • The current regulatory environment has increased the importance of conducting an independent, internal investigation of allegations.
  • Both DOJ and SEC credit independent investigations as an important part of cooperation, one of the key elements in reducing corporate and individual liability.
  • Regulators and investors will expect independent directors to oversee a robust, independent investigation in some circumstances and may fault the directors if they fail to do so.
  • An appropriate independent investigation can help rebuff shareholder claims that a company and its independent directors did not react quickly to root out misconduct.
  • Although considerable, the costs of an independent investigation often are outweighed by the tangible benefits to the company.

In the wake of the 2008 financial crisis, the discovery of the massive Madoff Ponzi scheme, and the enactment of the sweeping Dodd-Frank financial regulatory reform legislation, the Department of Justice (DOJ), Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and state attorneys general have all ramped up their oversight and enforcement of white-collar criminal and securities laws. The SEC, for example, brought 735 enforcement actions in FY2011—more than in any other single year—and obtained $2.8 billion in penalties and disgorgement.1 In addition to regulators, the plaintiffs' securities bar, often with the assistance of whistleblowers, has been eager to bring cases against banks, financial services companies, and large companies. This all comes at a time of economic turbulence when shareholders demand that companies cut their costs and do more with less.

In this environment of increased scrutiny from both regulators and shareholders, corporate management and directors are under greater pressure to react quickly and decisively at the first indication of malfeasance or fraud. Failure to be proactive in the face of allegations of corporate misconduct can be financially devastating to a company and may expose management and directors—even independent directors—to personal liability.

When faced with such allegations, the best defense is a mastery of the facts, which can only be gleaned from a full investigation of the problem. What happened? Who was involved?

Was management at fault, either directing the misconduct or willfully turning a blind eye to it? Are policies and procedures in place to keep this from happening again?

To answer these questions and many others, a company typically has two choices: (1) to conduct an internal investigation overseen by management and led by in-house or outside corporate counsel; or (2) to conduct an independent, internal investigation overseen by the audit committee or special committee of the board of directors, using outside counsel that has not previously represented the company. Although an investigation overseen by management may be appropriate in many situations, an independent investigation is the preferred, and often required, course to investigate suspected misconduct by management or potential violations of federal criminal or securities laws that could subject the company to a regulatory enforcement action.

With scarce resources and increasing demands placed on them, government agencies such as the DOJ and SEC are showing greater leniency for companies that conduct independent investigations overseen by the audit committee or a special committee of the board. Frequently, one of the first questions a DOJ or SEC Enforcement lawyer will pose to a company under investigation for serious misconduct is, "Does the company plan to conduct an independent investigation?" For government agencies, an independent investigation is viewed as more trustworthy than an investigation overseen by management, because the independent directors on an audit committee or special committee, who oversee an independent investigation, have fiduciary obligations to the shareholders to identify and remediate violations of laws, even if those violations occurred at senior levels in the company. Moreover, to be considered independent, the audit committee or special committee must retain counsel that has not previously done work at the direction of the management of the company. In other words, the counsel conducting the independent investigation has no perceived bias toward management that might be viewed as potentially interfering with their judgment.

There is no doubt that an investigation, whether internal or independent, can be costly, time consuming, and distracting in the near term. Any conduct warranting an independent investigation correspondingly requires a more expansive investigation. The ultimate cost is tied to the nature and pervasiveness of the misconduct and the requisite scope of the independent investigation. Beyond the financial costs to the company, in the form of fees for legal and other expert services, an independent investigation could prove distracting and uncomfortable for management, depending on the conduct being investigated.

In almost all situations where an independent investigation is warranted, however, such an investigation yields significant and tangible benefits that outweigh its costs and that are simply not available if the company proceeds with an in-house investigation. First, an independent investigation best enables the company to address any significant problems at the company (e.g., determine the extent of the suspected misconduct, remove culpable or incompetent employees from the company, improve internal controls and other policies to ensure that the identified misconduct cannot be repeated). Second, an independent investigation is usually carried out with the possibility that its results will be shared with regulators or law enforcement in order to impress upon the government that the company has acted quickly and appropriately when confronted with misconduct. Here, the value of an independent investigation comes into sharp focus; a competent and rigorous independent investigation gives the company credibility and persuasive currency with its regulators. Both the SEC and the DOJ place a premium on robust, independent, internal investigations overseen by audit committees, and reward such action through reduced sanctions or, in some notable cases, by not charging the company despite clear violations of the law.

The SEC's Seaboard Report, which is the Commission's policy statement outlining the circumstances upon which the SEC will charge a company, provides that the SEC will exercise leniency where an audit committee or special committee of the board has conducted an independent, internal investigation. In evaluating whether and how much to credit a company's cooperation (in other words, whether to be lenient in terms of charges and sanctions) the Seaboard Report specifically asks: "Did the company commit to learn the truth, fully and expeditiously? Did it do a thorough review of the nature, extent, origins, and consequences of the conduct and related behavior? Did management, the board, or committees consisting solely of outside directors oversee the review? Did company employees or outside persons perform the review?2 If the answer to most of these questions is "yes," the company is in line to receive cooperation credit from the Commission, which may temper or forestall an SEC-led investigation and positively influence charging decisions. For example, in enforcement investigations involving ArthroCare,3 Navistar,4 and infoUSA,5 the SEC credited the cooperation of those companies in commencing independent, internal investigations overseen by the audit committees by deciding not to issue a monetary penalty against the companies.

Likewise, the Federal Sentencing Guidelines provide for reduced criminal sanctions for comparable forms of cooperation. Chapter 8 of the Guidelines provides for reduced sanctions where a company "self-reported the offense to the appropriate government authorities, fully cooperated in the investigation, and clearly demonstrated recognition and affirmative acceptance of responsibility for its conduct." The benefit to cooperation with the DOJ was on display in the March 2012 prosecution of BizJet International for violations of the Foreign Corrupt Practices Act. BizJet received a deferred prosecution agreement, a fine of $11.8 million (significantly less than recommended by the Federal Sentencing Guidelines), and was not required to submit to a monitor. In justifying its lenient treatment of BizJet, DOJ credited the company's robust independent, internal investigation, explaining that, "BizJet's cooperation has been extraordinary, including conducting an extensive internal investigation, voluntarily making U.S. and foreign employees available for interviews, and collecting, analyzing, and organizing voluminous evidence and information for the Department."6

On the flip side, there can be serious consequences for failing to conduct an independent, internal investigation when appropriate: that failure will generate significant skepticism on the part of regulators and law enforcement.

Since the enactment of the Sarbanes-Oxley Act in 2002, audit committees have been required to include within their charters the right to hire counsel and conduct investigations. The DOJ and SEC will expect audit committees to use that power when appropriate and may draw negative inferences from any other course of action. Further, although currently in its infancy, it is likely that the SEC whistleblower bounty program authorized by the recently enacted Dodd-Frank Act will result in more corporate whistleblower complaints coming directly to the SEC. In this environment of increased whistleblowers, the prospect of addressing allegations of any serious misconduct without the knowledge of regulators is remote. If regulators are likely to be involved, it is imperative that the company conduct an investigation that the DOJ and SEC will credit— and that means one that is independent of management.

Finally, and of no small significance, a well-conducted independent, internal investigation can help to rebuff the inevitable shareholder claims against a board for allegedly failing to respond adequately to allegations of internal misconduct.

Not every allegation of misconduct requires the commencement of independent investigation. When allegations of a significant problem are brought to the attention of the board, the audit committee should consult with their own outside counsel concerning whether to conduct an independent investigation and the scope of that investigation. In consultation with their counsel, the audit committee should weigh the benefits and costs of the conducting such an independent investigation. With the growing insistence of regulators on independent investigations, the audit committee should not hesitate to commence an independent investigation where the circumstances warrant one.


1. Testimony on Examining the Settlement Practices of U.S. Financial Regulators, U.S. House of Representatives, Committee on Financial Services; May 17, 2012. Available at http://www.sec.gov/news/testimony/2012/ts051712rk.htm .

2. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Release No. 44969, Accounting and Auditing Enforcement Release No. 1470 (October 23, 2001). Available at http://www.sec.gov/litigation/investreport/34-44969.htm .

3. In the Matter of Arthrocare Corp., Exchange Act Release No. 63,883 (Feb. 9, 2011). Available at http://www.sec.gov/litigation/admin/2011/34-63883.pdf

4. In the Matter of Navistar International Corp., Exchange Act Release No. 62,653 (Aug. 5, 2010). Available at http://www.sec.gov/litigation/admin/2010/33-9132.pdf

5. In the Matter of infoUSA, Inc., k/n/a infoGroup, Inc., Exchange Act Release No. 61,708 (Mar. 15, 2010). Available at http://www.sec.gov/litigation/admin/2010/34-61708.pdf

6. Press Release, Department of Justice, Bizjet International Sales and Support, Inc., Resolves Foreign Corrupt Practices Act Investigation and Agrees to Pay $11.8 Million Criminal Penalty (Mar. 14, 2012). Available at http://www.justice.gov/opa/pr/2012/March/12-crm-321.html

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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