Corporate Investigations: Their Hidden Traps ' and How to Avoid Them

This is the first in a two-part series on how to conduct corporate investigations for corporate counsel.

Corporate counsel face a myriad of challenges when conducting or overseeing an internal workplace investigation. From ethical issues to potential third-party liability, the pitfalls are everywhere. New responsibilities and risks under Sarbanes-Oxley make the job even more daunting for counsel in publicly held firms. However, with advanced planning, there are ways to conduct a workplace investigation that may prevent it from coming back to haunt you.

Public confidence in corporations and the people who manage them is diminishing. A company trying to maintain the confidence of the financial marketplace must exhibit a commitment to comply with the law, which requires a willingness and an ability to conduct an honest internal investigation to root out wrongdoers.

When it comes to investigating suspected incidents of employee misconduct, an employer can either significantly limit potential liability, or greatly expand it. It's all about the investigation ' who conducts it, when it is conducted, how it proceeds and what is done with the information. Corporate counsel need to decide how involved they can, or should, be in the process and develop clear guidelines to ensure its integrity.

Weighing Counsel's Involvement

There are both advantages and disadvantages for involving counsel in an investigation. It is wise to define, in advance, exactly what circumstances require counsel.

Because counsel has the experience to address many of the issues likely to arise, there is an advantage to including them on the investigation team. A corporation can also preserve confidentiality by using the attorney-client privilege and the work-product doctrine. Counsel's involvement can also serve as a buffer to protect senior corporate officials from governmental investigators. Attorneys also have the expertise to know when and how a successful resolution can be negotiated.

On the other hand, involving counsel can cost more and go against the corporate culture. In routine matters, the dispute simply may not warrant the expenditure. And once counsel is in the picture, the other side is more likely to retain an attorney. This could escalate a problem to a level in which resolution becomes more difficult and expensive. If the corporate philosophy is to resolve problems at the lowest level within the organization, then employers may want to allow the managers who created the problem to solve it without involving corporate counsel ' as long as undue risk is not created for the corporation. An important consideration is the type of liability nightmare that could arise if those given the responsibility mishandle investigations.

The $1.4 Million Bag of Potato Chips

The inadequate workplace investigation in the case Patricia Rue filed against K-Mart is a prime example of why fair and thorough workplace investigations are important. A K-Mart warehouse was experiencing a documented shrinkage of inventory, especially edible products. According to a security employee, a warehouse employee, Patricia Rue, was observed eating a bag of potato chips in the warehouse. Using a 'ready-fire-aim' approach, K-Mart fired Rue for misconduct. Since rumors among employees were impacting productivity, management held a meeting and explained that Rue had been fired for misappropriating company property.

Rue filed for unemployment compensation, and was awarded benefits. Rue later filed a lawsuit against K-Mart that alleged that the statements made in the post-discharge meeting with her former co-workers were defamatory. K-Mart planned to defend on the basis that the allegedly defamatory statement was true. However, the trial judge did not allow K-Mart to present evidence in support of this defense because the Unemployment Compensation Referee had already found this not to be the case and that decision was preclusive ' collateral estoppel is the legal term ' in the state court defamation lawsuit.

A jury awarded Rue $1.49 million ' $90,000 in compensatory damages, and $1.4 million in punitive damages. The trial court judge denied K-Mart's motion for post-trial relief as to the amount of punitive damages. The judge believed K-Mart's investigation was sloppy and incomplete, and that the award was appropriate. K-Mart appealed to the Superior Court of Pennsylvania, which affirmed the trial court decision. Eventually, K-Mart obtained a hearing before the entire court and persuaded it to overturn the trial judge's collateral estoppel ruling. The case was remanded for a new trial.

In upholding the punitive damages, the trial judge was obviously moved by what he considered to be a shoddy investigation. He focused his wrath on the following factors:

• The security officer who allegedly observed Rue didn't make a positive identification.
• K-Mart violated its own procedures concerning investigations.
• K-Mart failed to undertake any sort of investigation that might have exonerated Rue.
• The time from when the incident was first reported until K-Mart management made a decision to discharge Rue, was less than two hours.
• Rue had alibi witnesses, who were never questioned.

This case offers a valuable lesson in conducting workplace investigations: People expect that before an employer discharges anyone for alleged misconduct, it will conduct a full and fair investigation.

Is Discharge Based on a Flawed Investigation a Developing Claim?

There are numerous examples of improper investigations leading to lawsuits against previous employers. In California, the courts have created an employer duty to conduct a proper investigation before terminating an employee. In Cotran v. Rollins Hudig Hall Int'l., Inc., 17 Cal.4th 93 (1998), the California Supreme Court held that the proper inquiry in adjudicating a breach of contract claim is not whether 'the employee in fact commit[ted] the act leading to dismissal.' Rather, it is whether 'the factual basis on which the employer concluded a dischargeable act had been committed [was] reached honestly, after an appropriate investigation and for reasons that are not arbitrary or pretextual.' An 'adequate investigation,' the Court held, 'includes notice of the claimed misconduct and a chance for the employee to respond.' Id. at 108.

Other states have been mixed in their view of this issue. The Texas Supreme Court ruled that employers do not owe a common law duty of ordinary care in investigating alleged misconduct by at-will employees. Texas Farm Bureau Mut. Ins. Cos. v. Sears, (Tx. 2002). In support of its holding, the Texas Supreme Court cited decisions rejecting claims based on a negligent investigation theory under the laws of Alaska, Colorado, Connecticut, Indiana, Iowa, Louisiana, Maryland, Michigan, Montana, Oklahoma, Washington and Wyoming.

Nevertheless, on the day of the Texas Supreme Court decision, the New Jersey Superior Court ruled that an employee accused of sexual harassment could seek action against his former employer alleging an improper investigation. Grasser v. United Healthcare Corp., No. Mid-L-12026-99 (N.J. Super. Ct. Law Div. Aug. 30, 2002) (Ciccone J.S.C.) That court reasoned that New Jersey's Law Against Discrimination embodies a public policy requiring 'fair and thorough' investigations of allegations of workplace harassment. The court held that if such an investigation had not been undertaken and the plaintiff had been terminated as a result of a faulty investigation, he could claim wrongful termination.

A company may be tempted to defend its conduct by pointing to the results of an internal investigation. Remember that juries often side with the employee who has been fired if they feel that a fair investigation was not conducted. Companies should understand that there is a general expectation that they conduct good investigations, a lesson learned in the K-Mart case. What is a good investigation? The answer depends on the situation, but even though the law is not specific, an investigation must be prompt, fair and thorough.

Choosing an Investigator

The first step is selecting a neutral investigator, someone who may be called as a witness. There are various people you could choose internally (HR professionals, corporate counsel, managers, audit, ethics or security personnel) or externally (private investigator, regular or special outside counsel). If a company wants the confidentiality that comes with the attorney-client privilege or the attorney work-product doctrine, choose an attorney.

The investigator should have:

• an understanding of the purpose of the investigation and its legal issues
• knowledge of company policies, procedures, practices and rules
• effective interviewing skills (to be able to develop rapport, press for admissions, understand interviewees)
• credibility if later needed as a witness in court (eg, no record of convictions, revocation of a license, history of termination for misconduct or incompetence, or history of moral turpitude, etc.)
• take thorough, accurate notes
• maintain confidentiality
• instill confidence in the quality and fairness of the investigation.
• be able to testify clearly at a jury trial legal proceeding and convey an impression of being knowledgeable, impartial, thorough and honest.

Sometimes it may be necessary to have a team of investigators to meet these requirements, but a leader and principal witness should be established immediately.

Ethical Issues for Corporate and Outside Counsel

Ethical and evidentiary issues come into play during every workplace investigation.

When an attorney is hired to conduct a workplace investigation regarding employee misconduct for a corporate entity and provide advice to the corporation, the attorney represents the organization, and not the individual shareholders, members, directors, officers or employees. American Bar Association Model Rules of Professional Conduct, Rule 1.13 specifically addresses this issue:

(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.
(d) In dealing with an organization's directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization's interests are adverse to those of the constituents with whom the lawyer is dealing.

Thus, it's important that the employees to be interviewed understand that the attorney represents only the company, and not the individual being interviewed. Best practices dictate that the attorney explains prior to beginning the interview that the attorney represents the company, and while the information that the employee provides may be confidential, the attorney does not represent the individual nor can the attorney provide the employee with any legal advice. The attorney should also state that communication with counsel may not be privileged, but if it is, the privilege belongs to the corporation. Therefore, the employee should be advised to protect the confidentiality of what is discussed in the interview. Moreover, the attorney may wish to explain to the employee that he or she has the right to retain separate counsel of his/her own choice. By stating this disclaimer up front, the attorney ensures that no ambiguity remains. If the individual asks if he or she needs a personal attorney, the investigating attorney should never discourage the individual from hiring personal counsel.

In many cases, counsel may be called upon to represent both the corporation and one or more of its employees. In an employment context, there is always some potential for future conflict if this arises. The possibility of conflict will be better known once the investigation has been completed. It is therefore the better practice to withhold making a determination until after the investigation on whether counsel may also represent individuals besides the corporation.

Corporate attorneys need to remember that they do not represent individual employees. All information must be kept confidential from employees or supervisors, unless the corporate client specifically consents. Model Rule 1.6 states in part:

(a) a lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation or the disclosure is permitted by paragraph (b).

If a corporation requests its lawyer to investigate allegations of wrongdoing, interviews made in the course of that investigation between the lawyer and the client's employees or other constituents are covered by Rule 1.6. This does not mean, however, that these constituents are clients. The lawyer may not disclose information relating to the representation except for disclosures explicitly or impliedly authorized by the organizational client in order to carry out the representation or as otherwise permitted by Rule 1.6.

Therefore, attorneys should not share the results of the investigation with any employees, except those designated by the corporation on a need-to-know basis. If anyone makes inquiries, the standard reply should be that all information is confidential.

This ethical duty of confidentiality is broader than the evidentiary attorney-client privilege in two ways. First, the evidentiary privilege protects only information from the client, whereas the duty of confidentiality applies to all information 'relating to representation.' Therefore, information received from others may not be privileged but is confidential to the extent that it relates to the representation. Second, the duty of confidentiality applies in all contexts, not just when the attorney is a witness to the proceedings.

It often happens during an investigation that the attorney will be tempted to disclose information to a witness to prompt a memory or encourage cooperation. Depending on the information, it may be advisable to clear this in advance with the client. Alternatively, it may be appropriate to set up a protocol so that permission can be granted quickly when warranted.

If the facts of an investigation are placed at issue in ensuing litigation, the attorney may be conflicted out of representing the client in that particular litigation, under the language of Rule 3.7.

• A lawyer shall not act as an advocate at a trial in which the lawyer is likely to be a necessary witness unless:
• the testimony relates to an uncontested issue;
• the testimony relates to the nature and value of legal services rendered in the case; or
• disqualification of the lawyer would work substantial hardship on the client.

This rule may impact the selection of outside counsel to conduct a workplace investigation. Because the disqualification runs only to the lawyer and not the law firm, this often results in having the main outside lawyer act to supervise an investigation rather than conduct it. In this way, the corporation can get the benefit of its counsel's judgment and insight without disqualifying counsel at the time of trial.

In the second part of this series, we will discuss how to protect critical attorney-client privilege during an investigation.

Jeffrey I. Pasek is a Senior Member of Cozen O'Connor, where he chairs the firm's national labor and employment practice group. telephone 215-665-2072.

This is the first in a two-part series on how to conduct corporate investigations for corporate counsel.

Corporate counsel face a myriad of challenges when conducting or overseeing an internal workplace investigation. From ethical issues to potential third-party liability, the pitfalls are everywhere. New responsibilities and risks under Sarbanes-Oxley make the job even more daunting for counsel in publicly held firms. However, with advanced planning, there are ways to conduct a workplace investigation that may prevent it from coming back to haunt you.

Public confidence in corporations and the people who manage them is diminishing. A company trying to maintain the confidence of the financial marketplace must exhibit a commitment to comply with the law, which requires a willingness and an ability to conduct an honest internal investigation to root out wrongdoers.

When it comes to investigating suspected incidents of employee misconduct, an employer can either significantly limit potential liability, or greatly expand it. It's all about the investigation ' who conducts it, when it is conducted, how it proceeds and what is done with the information. Corporate counsel need to decide how involved they can, or should, be in the process and develop clear guidelines to ensure its integrity.

Weighing Counsel's Involvement

There are both advantages and disadvantages for involving counsel in an investigation. It is wise to define, in advance, exactly what circumstances require counsel.

Because counsel has the experience to address many of the issues likely to arise, there is an advantage to including them on the investigation team. A corporation can also preserve confidentiality by using the attorney-client privilege and the work-product doctrine. Counsel's involvement can also serve as a buffer to protect senior corporate officials from governmental investigators. Attorneys also have the expertise to know when and how a successful resolution can be negotiated.

On the other hand, involving counsel can cost more and go against the corporate culture. In routine matters, the dispute simply may not warrant the expenditure. And once counsel is in the picture, the other side is more likely to retain an attorney. This could escalate a problem to a level in which resolution becomes more difficult and expensive. If the corporate philosophy is to resolve problems at the lowest level within the organization, then employers may want to allow the managers who created the problem to solve it without involving corporate counsel ' as long as undue risk is not created for the corporation. An important consideration is the type of liability nightmare that could arise if those given the responsibility mishandle investigations.

The $1.4 Million Bag of Potato Chips

The inadequate workplace investigation in the case Patricia Rue filed against K-Mart is a prime example of why fair and thorough workplace investigations are important. A K-Mart warehouse was experiencing a documented shrinkage of inventory, especially edible products. According to a security employee, a warehouse employee, Patricia Rue, was observed eating a bag of potato chips in the warehouse. Using a 'ready-fire-aim' approach, K-Mart fired Rue for misconduct. Since rumors among employees were impacting productivity, management held a meeting and explained that Rue had been fired for misappropriating company property.

Rue filed for unemployment compensation, and was awarded benefits. Rue later filed a lawsuit against K-Mart that alleged that the statements made in the post-discharge meeting with her former co-workers were defamatory. K-Mart planned to defend on the basis that the allegedly defamatory statement was true. However, the trial judge did not allow K-Mart to present evidence in support of this defense because the Unemployment Compensation Referee had already found this not to be the case and that decision was preclusive ' collateral estoppel is the legal term ' in the state court defamation lawsuit.

A jury awarded Rue $1.49 million ' $90,000 in compensatory damages, and $1.4 million in punitive damages. The trial court judge denied K-Mart's motion for post-trial relief as to the amount of punitive damages. The judge believed K-Mart's investigation was sloppy and incomplete, and that the award was appropriate. K-Mart appealed to the Superior Court of Pennsylvania, which affirmed the trial court decision. Eventually, K-Mart obtained a hearing before the entire court and persuaded it to overturn the trial judge's collateral estoppel ruling. The case was remanded for a new trial.

In upholding the punitive damages, the trial judge was obviously moved by what he considered to be a shoddy investigation. He focused his wrath on the following factors:

• The security officer who allegedly observed Rue didn't make a positive identification.
• K-Mart violated its own procedures concerning investigations.
• K-Mart failed to undertake any sort of investigation that might have exonerated Rue.
• The time from when the incident was first reported until K-Mart management made a decision to discharge Rue, was less than two hours.
• Rue had alibi witnesses, who were never questioned.

This case offers a valuable lesson in conducting workplace investigations: People expect that before an employer discharges anyone for alleged misconduct, it will conduct a full and fair investigation.

Is Discharge Based on a Flawed Investigation a Developing Claim?

There are numerous examples of improper investigations leading to lawsuits against previous employers. In California, the courts have created an employer duty to conduct a proper investigation before terminating an employee. In Cotran v. Rollins Hudig Hall Int'l., Inc., 17 Cal.4th 93 (1998), the California Supreme Court held that the proper inquiry in adjudicating a breach of contract claim is not whether 'the employee in fact commit[ted] the act leading to dismissal.' Rather, it is whether 'the factual basis on which the employer concluded a dischargeable act had been committed [was] reached honestly, after an appropriate investigation and for reasons that are not arbitrary or pretextual.' An 'adequate investigation,' the Court held, 'includes notice of the claimed misconduct and a chance for the employee to respond.' Id. at 108.

Other states have been mixed in their view of this issue. The Texas Supreme Court ruled that employers do not owe a common law duty of ordinary care in investigating alleged misconduct by at-will employees. Texas Farm Bureau Mut. Ins. Cos. v. Sears, (Tx. 2002). In support of its holding, the Texas Supreme Court cited decisions rejecting claims based on a negligent investigation theory under the laws of Alaska, Colorado, Connecticut, Indiana, Iowa, Louisiana, Maryland, Michigan, Montana, Oklahoma, Washington and Wyoming.

Nevertheless, on the day of the Texas Supreme Court decision, the New Jersey Superior Court ruled that an employee accused of sexual harassment could seek action against his former employer alleging an improper investigation. Grasser v. United Healthcare Corp., No. Mid-L-12026-99 (N.J. Super. Ct. Law Div. Aug. 30, 2002) (Ciccone J.S.C.) That court reasoned that New Jersey's Law Against Discrimination embodies a public policy requiring 'fair and thorough' investigations of allegations of workplace harassment. The court held that if such an investigation had not been undertaken and the plaintiff had been terminated as a result of a faulty investigation, he could claim wrongful termination.

A company may be tempted to defend its conduct by pointing to the results of an internal investigation. Remember that juries often side with the employee who has been fired if they feel that a fair investigation was not conducted. Companies should understand that there is a general expectation that they conduct good investigations, a lesson learned in the K-Mart case. What is a good investigation? The answer depends on the situation, but even though the law is not specific, an investigation must be prompt, fair and thorough.

Choosing an Investigator

The first step is selecting a neutral investigator, someone who may be called as a witness. There are various people you could choose internally (HR professionals, corporate counsel, managers, audit, ethics or security personnel) or externally (private investigator, regular or special outside counsel). If a company wants the confidentiality that comes with the attorney-client privilege or the attorney work-product doctrine, choose an attorney.

The investigator should have:

• an understanding of the purpose of the investigation and its legal issues
• knowledge of company policies, procedures, practices and rules
• effective interviewing skills (to be able to develop rapport, press for admissions, understand interviewees)
• credibility if later needed as a witness in court (eg, no record of convictions, revocation of a license, history of termination for misconduct or incompetence, or history of moral turpitude, etc.)
• take thorough, accurate notes
• maintain confidentiality
• instill confidence in the quality and fairness of the investigation.
• be able to testify clearly at a jury trial legal proceeding and convey an impression of being knowledgeable, impartial, thorough and honest.

Sometimes it may be necessary to have a team of investigators to meet these requirements, but a leader and principal witness should be established immediately.

Ethical Issues for Corporate and Outside Counsel

Ethical and evidentiary issues come into play during every workplace investigation.

When an attorney is hired to conduct a workplace investigation regarding employee misconduct for a corporate entity and provide advice to the corporation, the attorney represents the organization, and not the individual shareholders, members, directors, officers or employees. American Bar Association Model Rules of Professional Conduct, Rule 1.13 specifically addresses this issue:

(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.
(d) In dealing with an organization's directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization's interests are adverse to those of the constituents with whom the lawyer is dealing.

Thus, it's important that the employees to be interviewed understand that the attorney represents only the company, and not the individual being interviewed. Best practices dictate that the attorney explains prior to beginning the interview that the attorney represents the company, and while the information that the employee provides may be confidential, the attorney does not represent the individual nor can the attorney provide the employee with any legal advice. The attorney should also state that communication with counsel may not be privileged, but if it is, the privilege belongs to the corporation. Therefore, the employee should be advised to protect the confidentiality of what is discussed in the interview. Moreover, the attorney may wish to explain to the employee that he or she has the right to retain separate counsel of his/her own choice. By stating this disclaimer up front, the attorney ensures that no ambiguity remains. If the individual asks if he or she needs a personal attorney, the investigating attorney should never discourage the individual from hiring personal counsel.

In many cases, counsel may be called upon to represent both the corporation and one or more of its employees. In an employment context, there is always some potential for future conflict if this arises. The possibility of conflict will be better known once the investigation has been completed. It is therefore the better practice to withhold making a determination until after the investigation on whether counsel may also represent individuals besides the corporation.

Corporate attorneys need to remember that they do not represent individual employees. All information must be kept confidential from employees or supervisors, unless the corporate client specifically consents. Model Rule 1.6 states in part:

(a) a lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation or the disclosure is permitted by paragraph (b).

If a corporation requests its lawyer to investigate allegations of wrongdoing, interviews made in the course of that investigation between the lawyer and the client's employees or other constituents are covered by Rule 1.6. This does not mean, however, that these constituents are clients. The lawyer may not disclose information relating to the representation except for disclosures explicitly or impliedly authorized by the organizational client in order to carry out the representation or as otherwise permitted by Rule 1.6.

Therefore, attorneys should not share the results of the investigation with any employees, except those designated by the corporation on a need-to-know basis. If anyone makes inquiries, the standard reply should be that all information is confidential.

This ethical duty of confidentiality is broader than the evidentiary attorney-client privilege in two ways. First, the evidentiary privilege protects only information from the client, whereas the duty of confidentiality applies to all information 'relating to representation.' Therefore, information received from others may not be privileged but is confidential to the extent that it relates to the representation. Second, the duty of confidentiality applies in all contexts, not just when the attorney is a witness to the proceedings.

It often happens during an investigation that the attorney will be tempted to disclose information to a witness to prompt a memory or encourage cooperation. Depending on the information, it may be advisable to clear this in advance with the client. Alternatively, it may be appropriate to set up a protocol so that permission can be granted quickly when warranted.

If the facts of an investigation are placed at issue in ensuing litigation, the attorney may be conflicted out of representing the client in that particular litigation, under the language of Rule 3.7.

• A lawyer shall not act as an advocate at a trial in which the lawyer is likely to be a necessary witness unless:
• the testimony relates to an uncontested issue;
• the testimony relates to the nature and value of legal services rendered in the case; or
• disqualification of the lawyer would work substantial hardship on the client.

This rule may impact the selection of outside counsel to conduct a workplace investigation. Because the disqualification runs only to the lawyer and not the law firm, this often results in having the main outside lawyer act to supervise an investigation rather than conduct it. In this way, the corporation can get the benefit of its counsel's judgment and insight without disqualifying counsel at the time of trial.

In the second part of this series, we will discuss how to protect critical attorney-client privilege during an investigation.

Jeffrey I. Pasek is a Senior Member of Cozen O'Connor, where he chairs the firm's national labor and employment practice group. telephone 215-665-2072.