September 18, 2014

Corporate Internal Investigations and the Fifth Amendment

James D. Wing

Many directors and officers of major corporations believe that if their corporation has procured directors and officers liability insurance for them in an amount they consider reasonable, they are not taking substantial personal risk by serving. This article is written not to frighten them or to impliedly criticize existing practices and beliefs. Rather, its purpose is to educate them and their corporate counsel about new issues and realities that accompany the increasing criminalization of actions of innocent executives that traditional corporate bylaws and executive protection programs do not address. 

Just as one insures one's home against a fire that one cannot imagine will occur, innocent executives should be sure that their corporation has insured their careers and personal lives against the statistically infrequent yet potentially catastrophic effect of becoming involved in a criminal or regulatory prosecution. A committee of the American Bar Association has published for the second year in a row its "Checklist for Corporate Counsel Supervising the Creation or Renewal of an Executive Protection Program." The Checklist expressly addresses this issue. (See 2013 Checklist in Business Law Today, September 2013.) The purpose of this article is to better sensitize executives and their counsel to the criminal risks that the checklist discusses and to motivate them to ameliorate these risks at little additional cost to their corporations. 

To do this, executives and their corporate counsel first need to better understand current criminal and regulatory enforcement practices. 

Corporate Internal Investigations and Executive Risks

A principal tool of U.S. federal law enforcement is to threaten to criminally prosecute a corporation. Corporations that have shares listed on a U.S. exchange or that do substantial business in the United States are exposed. Corporations domiciled anywhere in the world can fall within this definition. 

The threat, indeed the credible fear of a future threat, usually creates an immediate response. Corporations invariably wish to avoid the reputational damage, legal costs, and legal risk associated with the filing of criminal charges by U.S. authorities. They can greatly mitigate their exposures by agreeing to "cooperate" with prosecutors and other law enforcement authorities before they are criminally charged. This means that they promise enforcement authorities that they will assist in bringing to justice those of their individual officers, directors, and employees who may be guilty of criminal misconduct. Such a "cooperation" agreement is typically accompanied by an agreement by the corporation to pay fines or penalties and to adopt a stringent internal compliance program to minimize the occurrence of similar misconduct in the future. If such an agreement is reached, the corporation obtains a so-called "deferred prosecution" or "non-prosecution" agreement. 

The corporation "cooperates" by interviewing all potentially involved executive and non- executive personnel, including many who believe they are entirely innocent or uninvolved in any suspected wrongdoing. It does this through a so-called "corporate internal investigation." 

Enforcement agencies have a financial incentive to cause corporations to "cooperate" by conducting internal investigations. The costs of the investigation (and they are frequently very substantial) are borne by the corporation. This relieves the enforcement agency's budget of a substantial burden. At the same time, the corporate internal investigation has proven to be a potent law enforcement tool. 

To secure appropriate credit for conducting the investigation, the corporation must demonstrate to the enforcement agency that the investigation will be conducted by first-rate, independent legal counsel. It thus retains private attorneys (usually former prosecutors) from a respected law firm who, by definition, have resources beyond those normally available to the enforcing authority. These attorneys generally first assemble and review all corporate documents and electronic information relevant to the inquiry. They then set about to interview all involved in the suspected misconduct. 

Frequently, the parties interview senior officers and sometimes directors who may be the beneficiaries of mandatory advancement and indemnification charter provisions or bylaws and the corporation's directors and officers liability insurance program. The validity, scope, and effectiveness of these contracts in protecting executives vary depending on the law governing the corporation and government regulations. But whenever executives are promised advancement and indemnity, either through private contracts or insurance policies, the executives invariably believe that the corporation will defend and protect them from any liability that arises out of their good faith service to the corporation, including legal fees and costs they incur in the process of defending themselves in an internal investigation. 

They believe, for example, that the corporation will defend them if they are falsely accused of complicity in illegal conduct by staff wishing to divert attention away from their own misconduct. They believe they will be protected if they are involved in an accepted, long- standing corporate practice that suddenly comes under attack by enforcement authorities. They count on the corporation's protection if they have internally questioned a corporate practice but have dropped their concerns based on assurances that the practice is legal, which assurances are given by senior executives brandishing lengthy legal opinions from major law firms that purportedly approve the questioned conduct. 

These innocent executives soon find that their legal protection in a corporate internal investigation is highly doubtful or impractical for the following reasons: 

1. The protection offered by most bylaws and insurance policies comes too late. Most mandatory advancement and indemnification bylaws and insurance policies do not reimburse or fund an executive's legal expenses until the executive is formally charged by a third party or an enforcement authority for a discrete wrongful act or at least formally subpoenaed to participate in a court or administrative proceeding. That is frequently too late. A corporate internal investigation proceeds on the opposite assumption, i.e., that no discrete claim has been made against a discrete individual for any discrete wrongful act and that the executive's participation in the investigation is voluntary. 

This issue of timing is crucial. Most "white collar" criminal cases are made or broken at the investigative stage before any charges or complaints are filed. The highly publicized criminal trials of notorious executives are only the tip of an iceberg. They are a tiny fraction of the white collar criminal cases that are actively investigated. Many cases wash out at the investigative stage. Even in cases that are pursued, there is usually a sorting out of which individuals will and will not be charged. That is where the innocent director needs help. The director’s goal, and that of his or her counsel, is to avoid all charges. Even if an individual executive faces prosecution, it often is in that person’s interest to negotiate a plea bargain before formal charges are filed, because better terms can be arranged before a prosecutor "sets his or her feet in concrete" by filing an indictment that contains the most severe charges, and the maximum number of charges, that the prosecutor thinks may be proved. 

Given these realties, it is totally naïve and out-of-date to assume, as most insurance policies and bylaws do, that their purpose is fulfilled so long as the executive is protected after a formal case is commenced or formal claim made. 

2. The innocent executive believes that by asserting Fifth Amendment privileges in an internal investigation, he or she is admitting to wrongdoing; thus, the executive does not know how to properly defend him or herself. The common perception of the Fifth Amendment is that it protects only the guilty. An unrepresented and innocent executive generally shares that perception and thinks that by asserting the privilege, he or she is admitting to wrongdoing. That perception is totally wrong. 

The Fifth Amendment is the number one protection that U.S. criminal law affords the innocent. U.S. law only permits (but does not require) judges and juries in civil cases to infer that the testimony of a person who asserts the Fifth Amendment would be adverse to his or her interests. Even in a civil case, assertion of the privilege is not an admission of anything. One simply must not confuse civil and criminal rules. The distinction between procedures in civil and criminal cases is central to U.S. law and fundamentally misunderstood by laypeople, most officers and directors, and even by many lawyers. The privilege against being compelled to incriminate oneself is, as stated in Miranda v. Arizona, 384 U.S. 436, 460 (1966), ". . . the essential mainstay of our adversary system. . . ." 

Like most people, the usual executive knows nothing of the critical Fifth Amendment privilege in a criminal, much less investigatory, context and does not know that it can be asserted during an internal investigation without admitting wrongdoing. Whether the executive should or should not assert it in that context requires legal judgment. The usual executive rarely employs competent counsel when he or she should , and certainly does not know how to defend him or herself. 

3. The innocent executive does not know that he or she has Fifth Amendment rights or even what they are in the context of an internal investigation. To fully appreciate the above point (which most readers find counter-intuitive and startling) requires an understanding of the Fifth Amendment, the U.S. version of the privilege against compelled self-incrimination. It starts from the legal principle that the state (I use that somewhat loaded term on purpose) has the right to the testimony and information of all those under its jurisdiction. In colloquial terms, the state has the right, upon a proper showing of need, to get into everyone's head – to learn everything its citizens and those who come under its criminal jurisdiction know. The Fifth Amendment is a narrow exception to this principle. Its function is to protect individuals from being "compelled" by the state to incriminate, i.e., testify against, themselves. The key word is "compulsion." 

What is "compulsion"? Again, the Fifth Amendment is a narrow exception to the basic principle that the state is entitled, upon a proper showing of need, to the knowledge of everyone within its jurisdiction. Nevertheless, once it applies, it is broadly and liberally interpreted. It covers compelled testimony that might be relevant to any existing or future criminal proceeding. But, as you will see from the decisions cited in the below footnotes, the definition of what constitutes "compulsion" has been vigorously debated in the U.S. Supreme Court and, amazingly, only recently defined with precision. So, what exactly constitutes "compulsion"?

  • Courts and judges cannot physically torture people to confess in court, a la the Inquisition, the Star Chamber, or witch trials. But it was not until 1965 that this principle was extended to bar prosecutors and judges from commenting to the jury in a criminal case on an accused's courtroom silence, or instructing a jury that it may infer facts against the accused simply because of his or her courtroom silence. Griffin v. California, 380 U.S. 609, 620 (1965). That ruling proceeded from the judicial realization that if judges and prosecutors can tell a jury that an accused who remains silent at trial can have facts resolved against him or her because of remaining silent, the accused is effectively being compelled to take the witness stand and testify against him or herself within the broad definition of incriminatory testimony.
  • By extension, police (agents of the state) cannot torture people to confess or give incriminating information while in police custody. Torture by police is, regrettably, not a medieval, "Star Chamber" practice or something left over from witch trials. The City of Chicago, in the celebrated case of police commander Jon Burge, recently paid its 100 millionth dollar to victims who were imprisoned after confessing to crimes, which confessions were the result of police station torture committed during the 1980s.
  • U.S. law further views as the product of compulsion all confessions or incriminating information given or ambiguous silence or body language exhibited by people in police custody unless the person has knowingly and voluntarily waived the Fifth Amendment privilege against self-incrimination. Such a waiver can be found only if the person has first been given a so-called Miranda warning that advises the person of the right to remain silent, to have counsel, and that everything he or she may say or do after the warning can be used against him or her in court. This is because U.S. law deems police custody so inherently intimidating that no reliable and knowing waiver of the Fifth Amendment privilege can be assumed without Miranda warnings.
  • Unconstitutional compulsion also exists if the state threatens to terminate or terminates the positions or contracts of state employees, government contractors and political office holders to force a confession or otherwise obtain incriminatory information. If the state, however, first offers the person immunity from having the statement or information (and facts derived from the information) used against the person in a later criminal prosecution, then the state can terminate the person if he or she still refuses to talk. In other words, the obtaining of confessions of those doing business with or representing the state through threat of termination and job loss is "compulsion" for Fifth Amendment purposes. The state, however, can eliminate the element of compulsion by offering the person immunity. Only if the offer of immunity is refused and the person still withholds information can the state constitutionally terminate that person or contractor. This rule, however, applies only to the state because only a state can offer immunity. The ability to obtain immunity and thereby remove the element of compulsion by job termination is not possessed by innocent directors and officers of private corporations. 

4. Innocent executives of private companies can be compelled to waive their Fifth Amendment privileges through threat of termination. As displayed above, the Fifth Amendment protections given those subject to the jurisdiction of U.S. courts apply only to action by the state. Thus, innocent executives of private for- and non-profit entities involved in corporate internal investigations can be threatened with termination and loss of valuable employment benefits for asserting their Fifth Amendment privileges. They can be (and generally are) terminated in any corporate internal investigation if they assert Fifth Amendment rights and decline to furnish facts that are links in a chain that might constitute a crime. They can be compelled to waive their rights to avoid termination without any offer of immunity. 

Thus, when called to give an interview in a corporate internal investigation, innocent executives' body language, refusal or disinclination to submit to the interview, and even silence in the face of questions or accusations can be used against them by prosecutors in later criminal proceedings. The only way such information can be kept from a later jury is if the executives expressly assert their Fifth Amendment privilege. They are not entitled to offers of immunity because they are not state employees; their only means of obtaining immunity is to retain counsel and bargain for it directly with prosecutors. 

Put differently, it is unconstitutional compulsion where the state asks questions of public employees and contractors without granting them immunity from being prosecuted based on what they say. It is, however, not unconstitutional compulsion for private for- or non-profit companies to do the same, even when the questions are asked by a corporation that is itself being incented by the state to conduct the investigation to avoid criminal charges against itself. In an internal investigation, executives' private employers can order them to "talk or walk." The corporation can discharge them for asserting Fifth Amendment protections because the corporation is viewed as not acting "under color of state law" and thus cannot be sued for violating the executive's constitutional rights. By terminating the executive, the corporation is viewed as merely asserting its right to all information known by an employee or other fiduciary relevant to his or her employment or exercise of fiduciary duty. There are no Fifth Amendment implications to such a termination, a result diametrically opposite to that which would result if the innocent executive worked for the state. 

5. Again, most executives are totally ignorant of their rights and need assistance. The common perception among non-lawyers, including most innocent executives, is that the Fifth Amendment is important only to persons who have committed a crime. It does not occur to them that the Fifth Amendment may be important to them if they get caught up in an internal investigation of alleged wrongdoing. They do not understand that their truthful answers to questions may implicate them in unlawful conduct committed by others, nor do they appreciate the nature and extent of the risks they create for themselves should they convey incorrect information – even through inadvertence or as a result of a faulty recollection. Most innocent executives do not know that, if they sit down for an interview, they risk their silence and body language later being used against them unless and until they expressly assert their Fifth Amendment privilege. Most are unaware of the legal strategies astute counsel can employ to protect them, and do not even know that their situation raises issues of “obstruction of justice,” “immunity,” and “plea bargaining,” much less what those terms really mean. Executives absolutely require counsel incident to a corporate internal investigation before it commences. 

6. The innocent executive's position is not ameliorated by "Upjohn warnings." At the very beginning of an interview incident to a corporate internal investigation, the innocent executive is invariably given a so-called "Upjohn warning," advises the executive that although the interview is legally privileged, the privilege is controlled by the corporation and that anything the executive says can be used by the corporation for its own purposes. Unlike a person under arrest or otherwise in police custody, an executive who receives an Upjohn warning is in comfortable surroundings and is not charged with anything. Often the executive assumes that his or her personal interests and those of the company are aligned, even after being advised that this may not be the case. Indeed, the executive wants his or her interests to be aligned with those of the employer. Most executives are very reluctant to appear uncooperative in an internal investigation for fear that it may harm their career – as indeed it can. 

So an Upjohn warning is not the equivalent of a Miranda warning. It is not at all given for the benefit of the innocent executive as an advisement of rights. The Upjohn decision itself does not even mention warnings. Rather, the warning is given by corporate counsel as a matter of legal ethics to protect the lawyer and the lawyer’s corporate client so that the corporation can use the executive's statements for its own benefit, such as by turning them over to prosecutors to allow the company to escape criminal charges or to bargain for reduced penalties to the possible detriment of the executive. This is not to imply that an Upjohn warning is an inherently devious mechanism necessarily designed to pit the corporation against the innocent executive. The point is merely that it is not designed to aid the executive. 

Rather, the sole goal of an Upjohn warning is to make sure that the executive cannot claim that he or she thought counsel was offering personal representation as well as representation for the company, so that the executive’s interview (not only what was said, but also silence or body language) is subject to an attorney-client privilege that he or she controls. Yes, an Upjohn warning may motivate an innocent executive to employ personal counsel before deciding whether to proceed with the interview, but it is not designed to do so. 

7. The executive's position is not ameliorated by the maxim "innocent until proven guilty." The presumption that one is "innocent until proven guilty" applies only at trial and has no application in a corporate internal investigation. In the real world, some experienced white collar criminal defense counsel refer to the principle as really one where a person is only “innocent until charged,” or even “innocent until investigated.” That is because the adverse consequences that flow from being charged or investigated – bad publicity, potential loss of employment, familial break-up, damage to one's health, loss of personal relationships with colleagues, and the substantial personal and financial cost of mounting a defense at trial – are daunting. And some of the taint and adverse effects may remain even if an executive is ultimately acquitted at trial. 

8. Advancement and indemnity bylaw rights are of little help to an innocent executive who becomes involved in an investigation with criminal overtones. Thirty-five U.S. jurisdictions have adopted at least portions of the American Bar Association's Model Business Corporation Act that relate to the advancement and indemnity of directors and officers of for- profit corporations. Thirty-one of those jurisdictions have adopted the act's requirement that every executive seeking advancement of defense costs in a criminal case assert in writing innocence of breach of fiduciary duty in respect of the underlying events as a condition to obtaining advancement. Five other states also include the requirement. With the exception of one state, once such an assertion is made, it may be contested by the corporation and the executive's assertion cross-examined. 

By testifying, the executive will necessarily be giving what the law broadly defines as self-incriminatory testimony. If instead, the executive asserts Fifth Amendment rights and refuses cross examination, that silence can be used against him or her to deny advancement, in part because the executive is seeking affirmative relief in a civil case while simultaneously refusing to testify on his or her behalf. Even if the court declines to rule against the innocent executive for asserting the privilege against compelled self-incrimination, the court can still treat him or as "unavailable" and employ hearsay and other collateral evidence to defeat the right to advancement. 

A third alternative is for the court to refuse any ruling until the executive agrees to testify. An arbitration panel applying the law of New York did precisely that. 

The statutes of 13 jurisdictions contain no express requirement that an executive furnish a written assertion of innocence of breach of fiduciary duty as a condition to receiving advancement. This group includes Delaware, the leading U.S. corporate law jurisdiction. Research suggests, however, that none of these states omitted the requirement to preserve the privilege against self-incrimination of the executive seeking advancement. This leaves the issue undecided in those jurisdictions. (See sidebar.)

It is true that an assertion of innocence does not "waive" an innocent executive's Fifth Amendment rights absolutely. But it can undercut the executive's credibility and prejudice his or her position in subsequent negotiations with the state if the profession of innocence turns out to be at odds with other facts to which the prosecution wishes him or her to testify to support charges against higher value targets of prosecution. 

9. An executive involved in a corporate internal investigation faces a legal minefield. By now it should be obvious that an innocent executive faces a legal minefield whenever asked to participate in a corporate internal investigation that inquires into the possible violation of a U.S. criminal law (as most do). Innocent executives are generally ignorant of their rights and certainly ignorant of the risks they face and the strategies counsel can employ to better protect them. No corporate advancement and indemnity bylaw known to the authors protects executives' rights against compelled self-incrimination. Executives' protection generally attaches too late, and, like most commercially available director and officer liability policies, proceeds under the outdated assumption that an executive's interest and those of both his or her corporation and insurance company are aligned in the defense against a common third party claimant. 

The reality is that the interests of the executive and the corporation after an investigation commences (but not before) are adverse. This adversity of interest extends beyond the executive's desire to be left alone and the corporation's fundamental desire to secure an agreement insulating it from prosecution. Their legal interests are also adverse, for example, on the issues of whether defense costs are required to be advanced at all under the corporation's bylaws and insurance policies, whether the executive is entitled to access relevant corporate documents for use in the interview or for defense, whether the executive can assert Fifth Amendment protections against the corporation and the insurer to avoid incriminating information falling into the hands of the prosecuting authorities, how to resolve disputes over that issue in a manner that preserves privileges, the nature and cost of the defense, whether the corporation or insurance company has the right to determine or influence the identity of the lawyer to represent the innocent executive in a potentially catastrophic personal matter, whether a duty to cooperate with the corporation or insurer remains when such adversity of interest exists, and whether the corporation and the insurer are entitled to learn from the attorneys' billings information important to the defense, disclosure of which by the insured can render it amenable to subpoena by enforcement authorities. 

10. Only improved specialty insurance policies can cover these gaps; they currently do not exist. Most corporations that have D&O insurance have what is known as ABC cover. Some, in addition, have what is known as "Side-A-Only-Difference-in-Conditions" cover. The purpose of DIC ("difference-in-conditions") cover is twofold: 

First, it attempts to provide a coverage limit dedicated to those executives to whom it is given, free of the possibility that others, including the corporation itself, can successfully pursue claims against the policy that effectively reduce the executives' personal cover. It also partially serves to protect the executive from the consequences of the insolvency of the corporation or other insurers. 

Second, DIC insurance exists to cover as primary insurance known gaps in common law advancement, indemnity and ABC insurance protection. Its function is also to cover insured executives where no coverage gap exists, but where the corporation and/or the underlying ABC carrier refuse, or are financially unable, to cover the innocent executive. This aspect of DIC cover should be supported by advancement and indemnity bylaws that put flesh on the bones of corporations' typically vague promise to both its executives and its DIC carrier to indemnify innocent directors and officers "to the fullest extent permitted by law." Improved advancement and indemnity bylaws not only better protect the executive; they also serve to guarantee that the DIC carrier will recover in subrogation when it steps up to support the innocent executive if he or she is illegitimately denied advancement by the corporation and the underlying director and officer liability insurer. 

Efforts to provide such cover in unambiguous terms are underway. In the Checklist for Corporate Counsel, the American Bar Association committee attempts to exhaustively catalog the drafting issues known as of its date of publication. It then gives guidance on how to coordinate insurance cover and mandatory bylaw protections with available statutory exculpations so as to create a coherent package of executive protection. It does this to coordinate and harmonize the three sources of executive protection. For balance, it also suggests ways to limit a corporation's uninsured exposure to truly miscreant executives. In this process, the gap in existing insurance cover becomes obvious. 

The Issue is International in Application

These issues are not limited to U.S. domestic corporations. They affect every corporation in the world that lists its securities on U.S. exchanges or that does business in the United States in a substantial way. Most jurisdictions permit corporations formed under their laws to advance, indemnify and insure executives in the realization that if they do not, corporations will be deprived of the services of the best and most qualified. The law, practice and current insurance cover does not currently meet the test in this area. Executives who are compelled to testify against themselves and their colleagues to avoid being terminated are subjected to a practice that the U.S. Supreme Court has ruled constitutes unconstitutional compulsion when engaged in by the state. When the compulsion is inflicted on executives by private corporations at the behest of the state to further legitimate law enforcement objectives, unconstitutional compulsion has been held to be absent. Executives, thus, are in the front lines of U.S. criminal law enforcement against corporations. The executive involved in an investigation is walking in a legal minefield. Innocent executives should at least be supplied with astute counsel to navigate it. 

The Consequences of Inattention are Severe

The consequences that can be visited on an innocent executive involved in an internal or external investigation can be catastrophic. Executives become subject to the risk of massive financial, familial and personal loss. No insurance policy can insure for all the consequences of being involved in a criminal investigation, much less a criminal conviction. But insurance and advancement bylaws that coordinate with the insurance cover can be greatly improved to cover investigations. Only with such improvements can executives be guaranteed protection "to the fullest extent permitted by law" – the protection that they are generally promised and believe they have.

Additional Resources

For other materials on this topic, please refer to the following.

Business Law Today

2013 Checklist for Corporate Counsel Supervising the Creation or Renewal of an Executive Protection Program
By James D. Wing
September 2013

Corporate Counsel Checklist for a D&O Protection Program
By James D. Wing
August 2012 

BLS Program Materials Library 

Directors, Officers, and In-House Counsel: You Think You’re Covered But You’re Probably Not (And What to Do About It) (PDF)
2014 Spring Meeting
Presented by Director and Officer Liability, Business and Corporate Litigation, Corporate Governance, Private Equity and Venture Capital 

ABA Web Store 

Annotated Model D&O Indemnification Agreement (PDF)
2013, 30 pages
Director and Officer Liability Committee of the Business Law Section 

This product provides guidance to counsel developing a D&O indemnification agreement and includes a .zip file containing a PDF of the model agreement with annotations, and a Word file of the model agreement without annotations.

James D. Wing

Chair, D&O Insurance Subcommittee

James D. Wing is chair, D&O Insurance Subcommittee of the Director and Officer Liability Committee of the Business Law Section. An earlier version of this material appeared in the 2014 BLS Spring Meeting Program, “Directors, Officers, and In-House Counsel: You Think You’re Covered But You’re Probably Not (And What to Do About It).”