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Governance Ethics Hot Topics – Counsel’s Responsibility for Getting the Board Involved


ALAN BELLER: Governance ethics, hot topics, council's responsibility for getting the board involved. Over the course of the day, we've talked about a lot of strategic and compliance and legal reasons for getting the board involved in a variety of things. But this panel is going to take a slightly different twist, which is, you're all lawyers somewhere, and what are your ethical obligations for getting the board of directors of your employer or your company or your client, I guess, as the case may be, involved?

To moderate this panel, we have Karl Groskaufmanis. Karl is a litigation partner in Fried Frank's Washington office, a member of the firm's securities enforcement and regulation practice. He's been at Fried Franks since 1988. And he became a partner in 1995. He is also, very importantly, I think, for this panel, the General Counsel of Fried Frank, and so the Fried Franks questions-- and more and more firms are getting general counsels-- for those of you who don't know. And one of the reasons is, so that there is someone at your law firm, if you're a partner in a law firm who can answer the kinds of questions that Karl is going to talk about this afternoon. Karl, it's yours.

KARL GROSKAUFMANIS: Thank you, Alan. Thank you for letting us join you today and congratulations for making it to the end of the day. Let me start off by introducing my colleagues on the panel. To my extreme right, your extreme left, is Jim Walker from Richards Kibbe and Orbe. Jim concentrates his practice in government investigations, complex litigation, professional liability, and legal ethics. Part of his practice is representing people like us lawyers in government investigations, litigations, and professional responsibility proceedings. He gets to see a lot of these issues firsthand. And we're kindred souls because Jim also serves as General Counsel of Richards Kibbe and Orbe. And once you get a bunch of law firm general counsels together and everyone gets talking, it's always-- I never leave and don't learn something along the way, and that's true with Jim as well.

Si Lorne, to my immediate right, is the Vice Chairman and Chief Legal Officer of Millennium Management, LLC, a large asset manager based here in New York. Prior to joining Millennium, Si was a partner in the Los Angeles office of Munger Tolles and Olson. He's also been the Global Head of Internal Audit at Solomon Brothers, and the Global Head of Compliance at Citigroup. Si also looks at these issues, obviously, as a fellow lawyer, but he also is a director. He serves on the board of directors and chairs the audit committee of Teledyne Technologies, which is listed on the New York Stock Exchange.

And I guess to start off, I know you've covered a lot of different aspects of the counseling relationship with directors and boards. And I think one of the things that, when we stepped back and thought about this, was the fact, one of the things that struck us, and this strikes me every time I'm in front of a board myself in some capacity, is that it is still very much a very personal relationship. As big as firms have gotten and the firm's represented here are various forms of large, for the most part. It is still, with all the artificial intelligence out there, with all the technology, it is still a very personal relationship. And then one of the things that strikes you when you talk to people, when I talk to other law firm general counsel, and who do you use, who do you use on this issue, it's striking how much, even today, part of the personal aspects of it are very central to that relationship. And that's true of boards.

Both boards and senior management often have lawyers, both external and internal, with whom they've shared not years, but decades. These are very longstanding relationships. But as an ethical matter, as a practical matter, the juxtaposition to that reality is that the relationship runs typically to the entity, not to the individual director, not to the individual management. So while it is critically important to have that personal connection, have that personal bond, to develop that relationship, the attorney-client relationship typically does not run to the person. And in many instances, that's not a particularly pressing or germane point. If you're addressing whether to complete an acquisition or to complete a spinoff, that may not be the single most pressing point. But there are instances where the interests of individual directors or individual members of management may not be fully aligned with the company. And that's where the tensions, that's where the tensions can pop up.

And in terms of addressing that today, we thought that we would work through a hypothetical situation, work through some fact patterns, and address some of the questions that arise along the way. Each of us will have a few thoughts, but others will pipe in and, of course, we welcome any thoughts from either individuals in the room or people who are connected through the web.

Our company is hearkening back to our Roadrunner days. Some of you are a certain vintage, remember watching the Roadrunner on a regular basis and wondering how he always got away, but Acme Telecom is a publicly traded global telecommunications company. Acme CFO, Fred Financier, collaborates daily with the company's general counsel, GC Loyal. They are good friends. And that's not atypical, there are many GCs that we know that are very good, both professional and personal colleagues, with their CFOs.

Acme's ethics hotline receives two emails, each from a different employee, both of whom report to Fred. By design, all hotline tips, including these two e-mails, are forwarded to the GC. The first e-mail's from Emily, who alleges that Fred sexually harassed her through various text messages, in which Fred persistently asks her to go on dates with him even though she consistently refuses to do so. The second is from Sarah, who states that Fred repeatedly insists that sleeping with him is the only way he would promote her and that she has told him repeatedly that she does not want to have sex with him. He just laughs, says he was joking, but he does it again.

Acme's corporate policy, as you might expect, prohibits sexual harassment, which Acme defines as, unwelcome conduct of a sexual nature, which makes a person feel offended, humiliated, and/or intimidated. Acme's policy confirms that sexual harassment can include, one or more incidents and actions constituting harassment maybe physical, verbal, and nonverbal. So GC calls Fred the CFO into his office to see what Fred knows about the allegations.

Fred denies the allegations and says he and the whole finance team have been under tremendous pressure this month to close a quarter successfully. So Fred says he's not surprised that Emily and Sarah are lashing out at him. Fred admits he's been teasing people, including them in an effort to ease the pressure, and offers that perhaps he's been misunderstood. Fred assures GC that he will handle this and there will be no more complaints. GC advises Fred that he will not raise the allegations to the board level provided Fred agrees to stop participating in the improper conduct and no additional allegations arise.

And so, presented with this, we face a number of questions that, as counsel, we think about. And the first one is maybe in a sense, one of the more fundamental ones. Was who does GC represent? And, I think on this one, there is a simple answer and then there's a more complicated pragmatic answer. Simple answer is that the GC's client is Acme, the corporate entity. The company cannot speak so the model recognizes that a lawyer employed or retained by an organization represents the organization, acting through its duly authorized constituents. In this instance, including Fred.

So GC has an attorney-client relationship with the company. The more complicated pragmatic part of this is, though, that the CFO of any public company typically will have, as is the case here, an important working relationship with the general counsel. The CFO may not manage the general counsel directly, but typically, is an important constituency. You would imagine, in any type of evaluation process, the CFO is one of the senior managers who contributes to the evaluation and has input into his performance review. And so, as a practical matter, GC here, the general counsel, has to develop a working relationship and maintain a working relationship with Fred. He has to find a way to work productively with him on a day-to-day basis.

The challenge for any GC in this setting though, is how do you go about, in a real world sense, conveying and reminding Fred and other members of senior management that you are the company's lawyer and not that individual's lawyer? And that's hard because anytime there's a legal question, ranging from the neighbor's dog that keeps running into Fred's yard, to what's proper revenue recognition under the SEC's rules, to what has to be disclosed. These are questions that get brought to the GC on a normal basis. I think that one of the ways I've seen general counsels deal with this question is that they look for opportunities in the course of their dealing with their management constituencies to make that point.

One time to do it, when it's not awkward, it's just the simple reality is, in the normal course the general counsel has to advise, in a public company setting, has to counsel the senior management on how indemnification and advancement rights work within the company. If you join a public company at a senior level, you accept-- or you practically, whether you accept it or not, a practical reality is that from time to time, you will be on the wrong end of civil litigation of one type or another. And there'll be costs associated with representation in those civil litigations, and articles and bylaws address that in terms of circumstances, under which those expenses are advanced, and in which they're indemnified.

And that conversation is one in which you can have and say, "Because I, as a general counsel and not your personal lawyer, if there is a civil litigation, your named the defendant in a civil litigation, a securities class action, or any other type of claim, this is how it works." And that's a communication which, among other things, you're addressing the mechanics of who pays the bills and how they get paid, which is not a concept that people are uninterested in that capacity. But that communication conveys the fact, among other things, that you as general counsel are not their lawyer.

SIMON LORNE: Karl, quick question, though. As is typical in a hypothetical, we're sort of given a sparse set of facts. And in fact, we've got some relationship over the years that's developed between Fred and GC, and it's not unusual. I know it's not unusual for other executives to walk into the general counsel's office and say, "I'm buying a house and here is this complication on the title. Can you help me out?" Or maybe it's, "I'm thinking about getting a divorce. Can you help me out?" And some of those things, and quite often the general counsel will feel comfortable giving advice. Sometimes he'll say, "Well, you really ought to have your own lawyer but here's what I think."

You develop a relationship where Fred may well come to think of general counsel as representing him individually, as well as the company. How do you handle that?

KARL GROSKAUFMANIS: Well, yeah and you do. And part of being helpful with the-- whether it's a home sale or a divorce-- that's one of the ways in which, as a practical matter, that's one of the ways in which a lawyer develops a relationship. And I think that in each instance, saying, "I can't do that, I can't talk about that at all, I'm the company's lawyer," while that is a pristine from the ethical rules standpoint, is a pristine answer, it's not a real world answer in terms of someone that you spent the last two decades working with on a day-to-day basis.

But I think, Si, one way you can have that conversation is, you can say, "Well, divorce law's not what I do. It's not something that I have firsthand-- I have some incidental experience with it. I have colleagues, I have friends who do it, or in any number of settings, I've learned something about it. So here are the things that I think you should take to a lawyer to talk through these things." You can walk through the-- here are the five most important things in any divorce proceeding."

SIMON LORNE: But you handle allegations of sexual harassment law, apparently. That's what we've got here, isn't it?

KARL GROSKAUFMANIS: You do have to handle allegations of sexual harassment law, yes.

SIMON LORNE: And then that's getting close to divorce.

KARL GROSKAUFMANIS: No, no. Well, I think--

JAMES WALKER: It depends, I suppose.


KARL GROSKAUFMANIS: It can end up there, I suppose. But I think that you do get, as a public company general counsel, if one of your named executive officers is going through a divorce, in some form or another, you're going to be involved in that case. You'll be discovery associated with a divorce that you'll end up with. General Electric had an instance in which, according to published accounts, the discovery about the former CEO's divorce, led to more fulsome visibility into what the perks of being a former general counsel was like, and it led to an SEC proceeding, when those facts became known.

So yeah, you're right. You do get exposed, but I think that, to the heart of your question is, how do you answer that question in a way that maintains the relationship, but at the same time, doesn't make you that person's lawyer. I think that you can convey information that is-- On some level, you probably have some-- you start at a better place in terms of just the substance of the law and how to deal with it than most people do. You can convey some of that, but you do that in the terms of a referral.

And the other thing I think that can convey the concept is, let me help you find somebody who is-- because you'll be better, as a general counsel or anyone in this room, anyone in this room will be better positioned to find a good divorce counsel than someone who has contact with the bar, who does-- people do their transactions in there, as they eat. By hook or by crook, all of us can do it better than the CEO can. And so again, you can be helpful, but being helpful in those terms. And you are being helpful. You're conveying, I can't do this because, well, because I don't practice divorce law, but also, I can't do this because I'm not your lawyer. And you are in an adverse relationship with another party. There's going to be real assets here. It's complicated, and someone else has to do it, but I can tell you what I think are the things to take that person, and I can tell you here are the three people I would call if I unfortunately found myself in that situation.

JAMES WALKER: So let's complicate this a little bit more. One can imagine that there may have been instances where GC may have represented the CFO. I'm going to give you an example. It's going to be a variation on the US versus Rule case, or maybe US versus Nicholas, from 2009, where let's say the GC accepted service of a subpoena or a complaint on behalf of the CFO and other members of management at the start of the litigation. So in that instance, GC represented the CFO, or at least made that representation.

Now, let's say that that happened with respect to probably some-- not necessarily as huge as the stock option backdating complaint. That was at issue there, but let's say, some smaller level litigation where the various officers were named and that happens contemporaneous with this conversation. Who does GC represent? GC seems to represent the CFO, at least for now, in connection with that, but how about with respect to this complaint?

KARL GROSKAUFMANIS: Right. No, I think that's fair. It's going to be a rare relationship when we talk about the depth of the relationship we have where from time to time there won't be incidental-- and maybe more than incidental, which may be part of what you're saying is that, there may be instances in which you have a lawyer who's provided assistance that goes beyond just nominal, or it goes beyond the referral that I've talked about, and has actually taken affirmative steps. And look, I think some of that can happen.

But I think one of the ways to think about it is-- it's hard to think about when you're in that role, is you have the picture a circumstance in which Fred-- you reached the end of this sexual harassment process, review process, and the company's ultimate decision is that he will no longer be in his position, he'll be terminated. And under those circumstances, Fred could become, himself, a litigant against the company. And people in those positions often have done so. So I think that one of the things-- Jim, to the point you're making, is when you find yourself going down that path, think about a day when you are not working next to each other, but the relationship has gone the other way. And having made a referral, having accepted service, I think there are places where the amount of effort, the amount of representation is quite nominal and limited.

But if you went beyond accepting the service and represent-- you would say it's a small claims matter or something that took the matter through small-- then I agree. It becomes harder at that point. And Fred is better positioned to say, hey, when I brought this issue, I thought, I brought this issue, I realized the person was the company's lawyer, but I thought this person was my lawyer as well.

I brought my small claims court matter to my divorcee. He represented me. He went and attended hearing. That becomes a lot harder than to say, oh, I was not your lawyer. And then the claim against you as a lawyer is not just that you were my lawyer, but the way you handled the matter amounted to malpractice. You're essentially defending a malpractice case. So I guess, Jim, maybe that would segue to our second question.

ALAN BELLER: Karl? Karl, I actually thought maybe you were heading in a different direction. Does the conversation that the GC and Fred have make the GC his lawyer?

KARL GROSKAUFMANIS: Does that conversation make-- No, I don't think that that conversation-- I don't think that conversation alone makes him the lawyer, because we can have a discussion about how fulsome that was. But the GC is acting in his general counsel capacity.

ALAN BELLER: The last sentence is what was making me think about this. Don't worry. It won't go any further if--

KARL GROSKAUFMANIS: Yeah, I think GC says he won't--

ALAN BELLER: I don't disagree with your conclusion. I did think that was going to be one of your questions.

KARL GROSKAUFMANIS: I think one of the challenges with dealing with these situations is that you-- In the normal course, a board, particularly in a hotline-type setting, any-- My anecdotal experience, and I don't know how you'd measure this truly empirically, but there's a lot of craziness in any hotline, the sort of pool of things that come in and [INAUDIBLE]. Some of them are just pure HR, just personal disputes. But part of the problem is you never know which one is the one or whatever the subset of ones for which there's something really going on.

And watching through some of the sequence-- we've ended up in situations-- this fact pattern addresses an issue for which we've had situations where there have been some people on the wrong end of allegations where you could say you weren't surprised, but there are some of which some of us had to be picked up off the floor when we heard who was involved. You're just completely stunned. So you don't know. And I think, to the point, is there may have been a history that shaped that response. We'll talk about whether that was the right response and the level to which--

SIMON LORNE: Let me also interject that this is the kind of situation, at least in my experience when I'm calling somebody into my office to talk about it, it's pretty clear I'm not representing him individually, and I'm the authority that might cause him to be fired. And if there were any doubt about that, then I think, in this kind of situation, again, then you do take the extra step and say, you've got to understand I'm not representing you here, and you're in deep trouble sort of thing, or potentially in deep trouble, or this is troublesome. You communicate the idea that you-- even if Fred thinks you represent him on a general basis, he doesn't think you represent him in this instance.

KARL GROSKAUFMANIS: Right, now, I think you would want-- And in the fact pattern, Fred does not do a perfect job of conveying that. But yes, you would want that clear.

AUDIENCE: And also, the conversation, you want to tell them, is not privileged.

KARL GROSKAUFMANIS: The point made was that the-- we should make the point that the conversation is not privileged.

SIMON LORNE: Or at least that the privilege belongs-- any privilege belongs to the company, and the company can waive the privilege, and because he's not the client, he has no control over it.

KARL GROSKAUFMANIS: So Jim, our second question, does GC face--

SIMON LORNE: [INAUDIBLE]. I think you could argue.

And you, Jim and Karl, would have a better feel for it. I think you can argue in that situation go downstream and assume a lawsuit is brought against the company, and Fred and everybody else. I think you may be able to argue that in that context, this was a communication with the control group and was privileged as to her.


SIMON LORNE: Control group of the company that you are figuring out, you're defending the work product. I mean, you could--

JAMES WALKER: Yeah, right. As the company's privilege.


SIMON LORNE: Situation in which the communication between Fred and the lawyer is not available to her as plaintiff.


KARL GROSKAUFMANIS: So Jim, does GC face a conflict of interest in addressing this situation and can Fred allege that GC is his lawyer in this matter?

JAMES WALKER: So there are a couple of things to consider with those two questions. The first one, does GC face a conflict of interest in addressing the situation? Well, what is the conflict there? First, we've already had a discussion about how GC's role is not to represent Fred. Although, there may have been instances in the past. But certainly, that's not his role in this conversation.

He's representing the company, starting potentially an inquiry-- although, it doesn't quite happen-- into the allegation that's been made. There may also be consideration of the fact that they are beyond collaborators. They're friends. Is there a personal interest conflict that needs to be considered here? Well, the friends-- I don't know that that necessarily means that GC's relationship with the CFO is such that he's not able to separate that in order to be able to represent the company in deciding what to do next.

However, the fact that Fred may believe that the GC represents him and GC may not have said anything to disabuse him of that thought, if there had not been a prior course of conduct or other conversations or something where Fred knew the difference between going in and talking to his buddy GC versus going in and talking to the GC of the company, maybe there's some room for Fred to make the argument that he believed that the GC was representing him in that conversation. Particularly, if there have been instances where GC has served in that personal role with respect to Fred.

Now, what would help here-- obviously, in the best case scenario, a couple of things might have happened. When this conversation occurred, GC may have said, need to talk to you about the situation, obviously I'm acting in my role as the general counsel of Acme, which just makes it crystal clear. Another thing is maybe there's been a course of conduct where Fred himself has recognized that there's a difference about talking about some incident that may have happened at the firm that may involve him or people that he works with versus them just chatting as friends or otherwise.

There may have been instances where the GC had an opportunity to remind other officers of the firm of his role in the firm as general counsel versus representing any of them-- the constituents-- through which he executes that role. We talked about D&O insurance or other times that they're talking about company business where there's an opportunity to remind Fred and others that as a lawyer he serves in the role as the general counsel of the company, not as a personal lawyer. If the facts are such that there have been those instances, that there was an understanding, those are facts that are helpful against any claim by Fred that GC represented him in this conversation.

KARL GROSKAUFMANIS: Right. But I think one of the things we've talked about in just the real life back and forth of these long-term relationships is that in a long-running close working relationship-- and I'm going to say it's inevitable-- but you could easily see instances in which there are parts of the record that Fred can now point to and say, you accepted service for me, you helped me with my divorce, I had every reason to think that you were a lawyer. And I think to your point, the real question then becomes, or part of the real question becomes, what do you have to offset that?

Because part of the building-- those some of those events or some of the things that you did were just part of the process of building or were an ancillary to the process of building a relationship, which is to go back where I started, is really central to having clients and having a practice. And in a client's mind, oftentimes-- we as lawyers have to have this boundary formed-- but in Fred's mind, that boundary is pretty theoretical at best. And if you're a lawyer for purposes of the 10-K, you're a lawyer for purposes of the dog next door that keeps barking, and you can deal with both.

So as to Emily, is GC required to report the information to anyone? And also, as to Sarah, should he be advising the board of directors? One director or the CEO? And does it matter if the conduct is ongoing or has stopped?

SIMON LORNE: Well, first off, you've got to look at the totality. I don't think anybody's going to form pigeon holes in his or her mind and say, well, I don't have to report Emily, I don't have to report Sarah, so I'm OK. I mean, you've got to look at the totality. And the totality says, you've got two complaints. Both of them are relatively soft complaints, if you will. But they are serious complaints. And it's not a surprise to anybody that we're in a hypersensitive environment these days and these are issues that you have to take seriously.

If you decide that you need to go further-- and that will depend on the materiality-- if GC loyal talks to Fred-- and we know the discussion was a little bit deeper than the factual setting suggested-- and if he's really convinced that these are not valid complaints, maybe he doesn't have to go anywhere. That's not what I'm going to end up recommending. But if you decide they're not valid, and if in your own mind you're satisfied, then the right thing for you to do is not to take it any further. I don't think we see that in the facts, certainly as developed in the hypothetical. But that's where you go with it.

And you've got to go back and look at Model Rule 1.13 as it's adopted in your state. If it's a public company, you need to pay attention to the Part 205 rules. I don't think we're going to get into that today, but that gets into disclosure and those sorts of things. And I don't think we're in a disclosure area, but keep an eye on that one, if you will. But 1.13 envisions going up higher within the corporate ranks.

First to the CEO. And if the CEO doesn't respond in some appropriate way and you think it's a more serious problem than that, then going to the board of directors. Model Rule 1.13 stops there. As originally proposed at one point it opened the door to reporting to external authorities, but it didn't get there.

AUDIENCE: At what point, sir, do you think asking for copies of the text from Emily, the first employee? At what point would you ask to see those?

SIMON LORNE: Her question was, at what point do you ask to see the text of the emails from Fred to Sarah? I think you've probably done that before you sat down with Fred. I think. I want to see those pretty early in the game. And apparently, Sarah has made a complaint that wasn't made anonymously. So I know who it was that was complaining and I've got access to her. And I'm going to do the same thing with Emily. Thanks for your contact, Emily. What more information can you give me?

Among other things, if you're in that situation, you want, you need the employee to understand you're taking her complaint seriously and you're giving it the attention it deserves wherever you end up. You need to have Emily and Sarah satisfied that you'd-- well, whether either of them is satisfied is beyond your control, but you need to do what you can to have them satisfied that you're taking it seriously, that you're talking to Fred, and that you will do what you determine is appropriate.

JAMES WALKER: So one serious flaw in the hypothetical as set up is that it's not clear-- in fact, it doesn't appear-- that the GC has done any investigation beyond having read the email complaints. So not clear that he's actually requested the text messages, spoken to Emily, spoken to Sarah-- any of those things. And obviously, that would be part of an investigation that should happen.

SIMON LORNE: Even the initial rudimentary investigation.


SIMON LORNE: Yeah, I agree with that completely. And in fact, I don't want to have that conversation with Fred unless I've got all the information or as much of it as I can reasonably get, because I know that when I raise it, Fred's going to come back with something and I'm just going to be unarmed if I haven't done at least as much homework as I can do with a quick review.

So what I'm going to do at the very least-- you talk to the CEO first. You don't talk to the CEO before you talk to any of the directors. Among other things, if I were the CEO and you went to talk to the directors without telling me about it, I would be furious. And I need to put this carefully. It's important to bear in mind, the board of directors doesn't want to get this information unless it really should.

And my rule of thumb is as a director I want the GC to err by 5% or 10% on the side of giving me notice before I really need it. But I don't want her-- the board I'm on, the GC is a her-- I don't want her to err by 30%. Because once I'm told about it, I've got responsibilities and I've got to make sure I discharge them. And she isn't doing me a favor by giving me the phone call that says, gee, just for interest you should know this is going on, we don't think much of it. Wait a minute, no thank you. You get into why you don't think much of it, and I've got to question you and make sure I'm satisfied, et cetera.

So you absolutely go to the CEO first. And again, it's pretty easy to go to the CEO. And if, in fact, you've had your-- little bit more than the hypothetical suggests-- an initial inquiry, you go to the CEO and you say-- whatever CEO's name is-- I got these two reports. I've looked into them. Here's what I think we ought to do. I do or don't think there's anything material. I do or don't think we need to go to the board about it. And you discuss it with the CEO.

And maybe the CEO says, I'm sorry, I think we've got to let Fred go. I haven't liked his performance for the last couple of years anyway. Well, that's one easy resolution of the case. We don't need to worry about it any more. I don't think. I don't think we have any reporting obligations outside here. On the other hand, the CEO-- and you're always suspicious in a hypothetical-- the CEO more likely in the hypothetical says, I think you're right, let's not worry about it anymore.

And then it's back on your table to think about whether it reaches the level of potential harm to the organization that you do need to go to the board. I'm worried about it frankly, if I'm GC loyal in this situation, just because of the sensitivity around these issues right now. We read every couple of days in the paper about one CEO or another forced to resign over such allegations. CFO isn't quite as important as CEO in that context, but it's significant. And I am inclined to go toward the board.

The last part of the question-- does the answer depend on whether the conduct is ongoing or has stopped? Not much to my mind, because if I think it's real conduct, I'm worried about it even if it stopped. Because these things, in my experience, they tend not to stay stopped. You need to look further, because assuming-- if I say, oh, it stopped now and I'm satisfied it stopped, when it turns out not to have stopped, somebody is going to say, you what? You just decided to forget about it, because he told you it had stopped or whatever? I don't want to be in that position.

JAMES WALKER: You know actually-- something you said when you talked about the CEO responding-- well, I don't think it's anything, so no need to do anything more. What struck me about that is that there's another piece of a possible investigation and it depends on where this goes, which is has the GC reached out to HR, I suppose, to find out have there been prior complaints. Is there any history here? Is that something that-- and what does that mean with respect to what we're hearing now?

SIMON LORNE: Sure. And a good CEO-- if the GC doesn't and should have, a good CEO is going to ask that question. What's the history here? Have we had any other complaints? While you can be sure, at least in the hypothetical, because copies of all such complaints go to the GC, so he would have seen actual complaints. But you still want to talk to HR to find out what background there is.

KARL GROSKAUFMANIS: Right. So I think a high level one takeaway is that in the instances in which the rules mandate certain action-- and Si mentioned the Part 205 rules that the SEC adopted after Sarbanes-Oxley-- there's a pretty high bar in those rules as there is in 1.13 to actually having to take the steps. And I think in real life, in real practice, if you're having a discussion about whether it's material, you're probably going to those steps anyway, regardless of where you land on that.

And look, materiality-- even on this fact pattern, materiality is not-- so from a securities law standpoint, where a number of us live, today it's not even necessarily an easy question. The claims themselves empirically as a statistical matter are probably not material to many public companies. But we've seen public companies where prominent members of management have ended up in these problems. And the problems themselves when they've been aired publicly-- in some instances first in the press before they've gotten to members of the board, at least reportedly-- you've seen material moves in the stock price.

So it's not solely the fact, well, a $7 million settlement for this company is not a material event, because in some instances, it turned out to be so. So continuing with our story, because Fred is the CFO and this is very sensitive, GCB thinks better of keeping this to himself and oversees an internal investigation, which does not conclusively find that Fred did or did not violate--

SIMON LORNE: Does not inconclusively-- whatever that means.

KARL GROSKAUFMANIS: Does not inconclusively find that Fred did or did not violate the law or company policy. Acme, as a regular whistle-blowing process, reports quarterly to the audit committee of the board. Although, usually he said, she said situations are not included. Because Fred is CFO and this is a very sensitive, GC determines to present his findings only to the audit committee chair, Betty Boring.


GC thinks-- I don't take credit for all the names, just so we're clear here. GC thinks Fred will be comfortable with that, because Fred and Betty have always gotten along very well. And in fact, Fred's family and Betty's family co-own a private plane.


Is Betty the wrong board member to report these findings to? I guess from my perspective, Betty is the wrong sole board member to report these findings to. I think that one of the things-- over the course of the day, there's been a lot of talk in this program about how to guide boards to be effectively, how to guide them to act impartially and independently. And the one question-- if all you know is that this audit committee chair co-owns an airplane with Fred, that alone suggests to you that that's not--

ALAN BELLER: Perfect answer.

KARL GROSKAUFMANIS: --it's not the perfect answer. It's not like just sharing drinks once in a while after a board meeting. This actually manifested itself in a Delaware derivative action involving a stock-- a derivative action over a stock sale in which certain members of management were released from a lock-up. And the question was whether the board members who granted the waiver could be deemed independent?

And in the majority opinion in the Delaware Supreme Court, this fact alone raised significant questions in Judge Strine's mind as to whether this particular director could, in fact, impartially assess. And the analysis was this is-- first of all, it's a big deal. There's just not that many really small planes out there. There are some that are bigger than others, but it's not like a Toyota. It's a big ticket item. And one of the points the opinion made was just the mechanics and logistics of sharing an aircraft-- it's a different type of relationship.

So in this instance, if you step back from this, in the normal course in many companies-- Si talked about going to the CEO first and talking about where is he. In instances in which you as a general counsel were taking something to the board, oftentimes the chair of the audit committee would be one place you would start potentially. It's someone who is a logical person. To the committee to which a lot of these issues get addressed-- the committee made up of independent directors.

So absent this fact, she might be a good place to start. With this fact, I think that if you're taking to this board, at the very least you'd want the rest of the audit committee involved. Because she alone-- the shared airplane is going to-- it's the fact that clouds over everything else. The shared airplane is going to become the fact that obliterates everything else and will call into question anything that follows.

Conversely, though, if you do involve the rest of the audit committee and the rest of the audit committee weighs in, it's still not a great fact. But if you have three other independent directors who said, well, we're aware of the airplane-- you posit more investigation than our fact pattern, at least on its face, presents-- but if the GC was able to go and say, we did talk to both, we checked the records, we looked at-- we haven't had this come up-- you could have a set of circumstances where you would say that would not be an unreasonable judgment on the management's part, on their lawyer's part, in terms of the judgment they were making. But simply to bring it solely to Betty, I think that that exposes-- that just invites second-guessing of the process and the judgment.

SIMON LORNE: Karl, minor-- maybe it's an amendment, maybe it's just a qualification or something-- it seems to me that if I'm in that situation, I probably call Betty because she's chair of the audit committee and see what she does with it. And if she handles it the right way, I'm comfortable. If she handles it in a way that doesn't leave me comfortable, I say you know Betty, I really think we've got to bring in the rest of the audit committee. I know you've got-- the hypothetical doesn't tell me whether I know that they co-own a private plane, by the way. I mean, it could turn out I don't know about it and that's a bad fact that shows up in the litigation.

KARL GROSKAUFMANIS: Yeah, that's true.

SIMON LORNE: But if I do know about it, I say if there is a complaint in here, it's going to allege that you were in cahoots with Fred because you co-own that plane. I really think we got to bring in the rest of the audit committee and there's no way in the world Betty says no, I'm going to handle it myself.

KARL GROSKAUFMANIS: I think that's right. I think if you know about the plane, then I can see where you have the first conversation with Betty. But I'm guessing the first conversation is, Betty, this can't be just you. It's got to be the rest of the-- on this one, it's got to be the rest of the audit committee.

JAMES WALKER: The only other thing I was thinking of is let's say we didn't have the issue with the co-ownership of the airplane. Betty would be an appropriate person to speak to, certainly initially. Now, if it turned out that there was a much bigger issue afoot, this becomes something where you want to at some point-- and maybe this would happen anyway-- you might be having a discussion with the entire audit committee to say, here is the issue that we've looked into and uncovered. But certainly, Betty in this instance, if she didn't have the airplane issue, would be the place to start normally.

KARL GROSKAUFMANIS: Right. And I think one of the things you're weighing is the thing that Si mentioned earlier, is you can't be in a position of taking every single thing, because your audit committee's time or all your directors' time is a limited precious commodity. And you have to be selective in how you use it and with whom you use it. I think what makes this one different is that first we have two employees and it's the CFO.

I mean, it'd be one thing if it was someone five or six levels down in the food chain, but this is one of your named executive officers. This is different. And in some respects, the members of the audit committee may be among the limited pool of people who really can deal with this. And a lot of other things-- if you had someone much, much more junior in the organization, the CEO may be the right reporting person, and ultimately, gets amalgamated with other information that goes to the board. I did that wrong, sorry.

Betty has known Fred for many years and does not believe these allegations. At the same time, she's troubled by the lack of a clear resolution in GC's work and decides to expand GC's internal investigation. Who is best suited to direct the expanded investigation? The general counsel, management, the board, or a board committee? Jim, who would you enlist in that?

JAMES WALKER: So in this instance, I would probably enlist an independent board committee. But that turns on what this expanded investigation is supposed to do, and also, the fact that I have this specific instance that I need to address. So let me back up a little bit and talk about this. If Betty said, you know what, I think that it would be good-- we didn't have this particular instance to deal with involving the CFO, but there have been issues in the past or whatever-- and Betty were to say, I'm thinking we should make sure that we feel confident about the way that we're addressing sexual harassment issues at the company and there needs to be an investigation, then that's something where I could see the GC overseeing it. And using internal staff and he and they, or she and they, will know the players, and the people to talk to, and that sort of thing, and can look at process.

And I think that that would be appropriate. And certainly, you want to think about what kind of resources are you dedicating, what's an efficient way in that instance to do this, and also, one that should have credibility in the absence of the particular facts we have here. Here, it looks like the idea is we should expand this investigation because we have this incidence, we're not comfortable with the resolution. We need to feel comfortable about the process. We need to be comfortable about what's happening in the organization.

And that's suggesting that you want an investigation that will have certain gravitas in terms of the results of that investigation, something that you can if you either want to affirmatively report about the fact that you've conducted this sort of investigation or want to be able to defend the company in terms of the process that it instituted to look into this matter. That's when you want to look to an independent committee and likely hiring outside counsel to provide that additional level of independence. But you need to look at the specifics of the situation that sparks the expanded investigation and what the scope of that investigation is going to be.

KARL GROSKAUFMANIS: Right. And I think Si that may lead us to our last set of questions, which is Acme engages its regular outside counsel, IC law firm, to conduct the investigation for the company under the direction of the audit committee. IC is familiar with this issue, because IC previously advised GC, the general counsel, not to disclose the allegations relating to Fred. And the question is, does IC's initial advice to GC make IC unsuitable to represent the audit committee and to conduct the internal investigation?

SIMON LORNE: I don't usually like to change the facts in a hypothetical. But back when we were Betty-- two points-- one is I don't think Betty gets to decide to expand the investigation. I think Betty needs to involve at least the entire audit committee. And that's going to involve a discussion among the audit committee members. And depending on the board, it may go to the board. Some boards comfortably delegate this kind of thing to the audit committee. Some don't. And that's a question of fact. But I don't think Betty does it by herself.

And when the board gets into that, you're going to dig a lot more, I think, into the facts. And you're going to explore how important and valuable Fred is. I mean, there are CFOs and there are CFOs. And is Fred two years away from retiring anyway, so that it's easy to suggest we accelerate that a little bit? Or is Fred a 35-year-old star that we really don't want to lose if we don't have to. All of those questions you'll get into.

But if I as an audit committee chair decide we need an independent investigation, I want an independent investigation. And that doesn't mean our regular law firm-- period. And I know people will disagree with me. Both of you or all four of you may disagree with me.



SIMON LORNE: But I want a new look at it. And I want a look that isn't going to be subject to the challenge that I see that I as general counsel used to be a partner at IC before I came in, that I know they advised me not to disclose the allegations, and I went ahead and disclosed them anyway. I just don't want those complications. If I'm going to have an independent investigation, I want a real independent investigation that will stand up under scrutiny. I know that whoever looks at it is going to be skeptical anyway-- pardon me-- if the result of the independent investigation is that we keep Fred, which I'm assuming Fred is important to the company, and as GC I want that result and I don't want it to be true that these allegations have substance behind them.

I need an independent counsel to conduct that investigation-- period. Now, I want to be careful. I mean, there are some independent counsel that I've seen who will automatically go to must fire Fred. And I don't want to hire a must fire Fred independent counsel. But I want counsel with an open mind who I am comfortable cannot be challenged and will give me the best possible advice, blind to the fact of the various factors that can influence it. Now, you can go ahead and disagree, because you told me before you would.

KARL GROSKAUFMANIS: Well, no, not that I disagree, but I think that's always going to be the perfect answer or the better answer.

SIMON LORNE: I like to give perfect answers.

KARL GROSKAUFMANIS: And yet again, we have it here.


But there will be instances-- there's the economics because bringing an independent firm that's never worked-- there are instances where that won't be-- there will be an imperfect answer, which will be the answer that the company has to work with. The company may not have budget for outside counsel and has to have it done internally. And as many of us are external counsel, we don't favor that result. We don't mind matters that lead to large internal investigations. There's no constitutional objection to that.

ALAN BELLER: Now, Karl, if you're going-- to Si's point, if you're going to do an independent investigation, then there shouldn't be any obvious evidence that it's not independent. And using your internal lawyer or using your regular outside law-- I mean, if I were IC, if I were the engagement partner at IC and they came to me and said, would you investigate this? I'd say, of course, I would, but that's the wrong answer. Go find yourself independent counsel.

KARL GROSKAUFMANIS: Right. No, no, I get that. And I did say that's always the right answer. But there are circumstances where lawyers can't give that answer just because the economics don't allow it. And what I'm talking about is there are times where you have to work with imperfect set of--

SIMON LORNE: Karl, when you say the economics won't allow it, I assume you mean the economics of expense to the company not the economics of revenues to the law firm?

KARL GROSKAUFMANIS: Yes, that is correct.


I'm not opposed to the latter, but the form-- when we have this question, the answer is all-- and I get that you're both completely right. The answer here is it really should be a law firm that has had no prior associates. I think the harder question, though, for a practicing lawyer is there are instances-- you've got a nonprofit-- there are instances where that can't always be the default answer, so the question is what do you do then? You can't go out and hire the firm that's going to-- you don't have a seven figure-- you don't have a seven figure bubble in your budget.

MEREDITH B. CROSS: I'm at a loss, because it doesn't seem like-- if an investigation is going to be done, any law firm is going to charge money for it.


MEREDITH B. CROSS: And if it involves allegations of wrongdoing by management at that senior of a level, this one doesn't seem debatable to me. But I'm--

SIMON LORNE: I'm going to go a step further, I think. I'm assuming I really think Fred's important to the company and I don't really believe the allegations. It's much harder for me to keep Fred, if I get a report from somebody who is subject to attack.


SIMON LORNE: If I really want to keep Fred, I need a completely independent report that says, Fred is clean.

ALAN BELLER: And how much more expensive am I going to be than you, even though we were friends regular outside counsel.

MEREDITH B. CROSS: Assuming you don't hire the firm that always fires everybody and charges a lot.


Whoever that is.

KARL GROSKAUFMANIS: We won't refer people to there.


I'm making a different point, which I'm not disputing-- you're right, if Fred remains the CFO-- and we'll wrap up in just a second-- but if Fred remains the CFO--

ALAN BELLER: We're out of time.

KARL GROSKAUFMANIS: We're out of time. If Fred remains CFO, then you want that position to be as defensible as possible. It's just sometimes the perfect answer we're talking about is not one that's available and you have to work around that.

MEREDITH B. CROSS: That's fair.

ALAN BELLER: Are we done or do you have another slide?

KARL GROSKAUFMANIS: No, we are done, and I think we're at the appointed hour. And thank you very much for letting us--

ALAN BELLER: We've had a great day. And thank you all for hanging in there with us. Thank you for those of you in the ether for hanging in there with us. And thank you to the panel. This was great.


MEREDITH B. CROSS: And thank you, Alan.

ALAN BELLER: All right.

MEREDITH B. CROSS: And thank you, Alan, for doing this.

ALAN BELLER: And thank you, Meredith.

MEREDITH B. CROSS: It was fun. And Grace.

ALAN BELLER: Especially, Grace.

MEREDITH B. CROSS: Especially Grace.


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