It is hard to overestimate the value of the legal department within a contemporary business organization. In addition to executing litigation procedures, legal departments manage contracts, mergers and acquisitions, while ensuring regulatory compliance and protecting the organization from risks such as fraud, bribery and insider trading.

But despite all of the responsibilities of in-house counsel, there are scenarios in which a corporation is best served by quality outside counsel. In an environment of increased regulatory scrutiny, corporate management and boards may turn to outside counsel to help address issues of risk and liability. The most common reasons to engage outside counsel include audit committee investigations, shareholder derivative lawsuits and corporate risk analyses. In addition to the specialized knowledge that outside counsel brings to these subjects, its independent position in relation to the corporation is a valuable legal asset.

Outside Counsel and Audit Investigations

Audit investigations become necessary whenever a corporation is suspected of fraud, accounting irregularities or other forms of corporate misconduct. Audit investigations differ from a general internal audit in that they focus on a specific set of events or allegations. The nature of these allegations can be wide-ranging, and do not always include financial misconduct. Examples of scenarios that may require an audit investigation include:

  • Conflicts of interest among directors
  • Illegal payments or bribery
  • Senior management theft or fraud
  • Employee harassment
  • Leaks of confidential information to competitors
  • Improper accounting of business activities

These scenarios typically share a number of common characteristics, such as:

  • Potential for corporate or reputational damage
  • Allegations of misconduct by senior management or directors
  • Financial reporting irregularities
  • Possibility of major financial damage
  • Potential involvement of regulatory or law enforcement agencies

While it is possible for in-house counsel to conduct audit investigations, it is important to weigh the presumed benefits of their involvement against the impression of transparency and independence. Some may argue that the in-house legal staff comes to the case with a deeper understanding of the corporate culture and structure, its policies and procedures, and its record-keeping systems. However, this familiarity may come at the cost of operational independence.

Because the vast majority of audit investigations involve members of the senior management, it is possible that in-house legal representatives will be asked to pass judgment on their own supervisors. This conflict of interest may place restraints on their ability to render objective opinions, or, just as important, may create the impression of partiality.

This impression of partiality may be one of the strongest arguments for retaining the services of outside counsel. A perceived lack of investigative independence can cause damage among shareholders, regulators and even the public at large. The looming possibility of a conflict of interest may endanger the credibility of the investigation’s findings.

Outside counsel ensures a higher degree of investigative independence. This credibility is especially important when law enforcement and regulatory agencies are involved. Policies articulated by both the Securities and Exchange Commission and the Department of Justice highlight factors that may lead to a no-charge decision. Among these are the corporation’s full cooperation with the investigation, complete and voluntary disclosure of all violations, and remediation of violations. Taking on outside counsel in these cases helps to assure regulators and the general public that the investigation will be thorough and unbiased.

Outside Counsel in Shareholder Derivative Lawsuits

Another situation in which outside counsel is invaluable is in relation to a shareholder derivative lawsuit. In a shareholder derivative lawsuit, a plaintiff sues the board on behalf of the corporation for an alleged wrongdoing. Potential shareholder lawsuits may arise from allegations of self-dealing, massive business losses, misconduct of officers or board members, or the waste of corporate assets, among other violations.

In its defense, the corporation can appoint a special litigation committee (SLC) of independent and disinterested directors whose job it is to investigate the specifics of the allegations in order to determine whether litigation is in the best interests of the company. If, after a thorough investigation, the committee finds grounds to dismiss the complaint, the committee may move to dismiss the derivative suit. If the court agrees, this move may save the corporation a great deal of time and expense.

In determining whether to grant the dismissal, judges carefully review the SLC’s findings and interrogate the level of independence of its members. Frequently, a decision to dismiss can rest upon whether or not the corporation has retained truly independent counsel. For example, if the lawyers in question have worked with the corporation on previous matters, this may invalidate their findings.

Judges may also examine what percentage of the outside counsel’s revenue has come from the corporation. They may even take into account personal connections between members of the outside counsel and the management and directors. This level of increased scrutiny should serve as a caution to corporations when selecting outside counsel in SLC cases. True independence is of utmost importance; without it, the case is almost guaranteed to fail.

Outside Counsel’s Role in Risk Management and Analysis

Many companies in the financial services sector have begun establishing independent risk committees made up of outside counsel especially trained to evaluate and analyze corporate risk. Each of these committees is customized to suit the needs of the corporation and communicate the corporation’s place in relation to risk management and regulatory compliance. As part of this service, these committees typically:

  • Review and assess the effectiveness of established risk management systems
  • Establish the role and responsibilities of the chief risk officer
  • Monitor the risk-taking behavior of management and suggest appropriate actions
  • Assess the corporation’s level of regulatory compliance and suggest improvements

The independent nature of outside counsel assures corporations neutral, objective opinions on these matters. The fact that it comes from a third party can also protect against potential director liability.

Effective use of outside counsel may make the difference in protecting your corporation from litigation or costly compliance oversights. An outside counsel’s ability to operate independently allows them to offer unbiased advice to further your corporation’s mission.