Preventing and Discouraging Corporate Misconduct
In a perfect world, a robust corporate ethics policy and regular ethics training would prevent all misconduct.
Unfortunately, headlines remind us that workplace pressures and old fashioned greed produce seemingly endless instances of unfair business practices, corner cutting, financial fudging, lying, cheating and other forms of corporate misconduct.
Perhaps the most brazen recent example was Volkswagen. The company paid $4.3 billion in criminal and civil penalties and six employees were indicted for conspiring to cheat U.S. emissions tests.
In-house counsel are on the front lines of preventing corporate misconduct and they are sometimes forced to take the extreme steps of withdrawing from the representation or reporting criminal misconduct to outside authorities.
This article is not about those complete breakdowns of the attorney-client relationship, but rather every day strategies in-house counsel can use to prevent and discourage misconduct at earlier stages.
Few aspects of in-house practice are more daunting than playing “gatekeeper” – preventing colleagues from violating laws, regulations or the rights of others. If you delay a product launch to resolve safety or regulatory concerns, you’ll almost certainly be unpopular with some of your colleagues for a while - at least until they get over not receiving their full year-end bonuses as a result of your gatekeeping.
In some organizations, you might even see a ding in your year-end evaluation – and your bonus. These opaque digs might read like “…needs to show greater business judgment,” or “… needs to be less dogmatic.”
But let the product launch go forward with unresolved concerns and the consequences could be much worse for you and the organization, as Volkswagen learned.
Gatekeeping challenges vary widely by organization size and complexity, counsel’s role and other factors, but they arise in every environment, including public agencies and non-profit organizations. Counsel must be prepared to respond effectively.
In-House Counsel as Gatekeeper – Why Prevent Misconduct?
RPC 1.13(b) and its Analogues in Other States
There are several sources for this responsibility. First and foremost for lawyers in Washington state is our version of ABA Model Rule of Professional Conduct 1.13(b) (underlining added). Most states have very similar legal ethics rules.
RPC 1.13 ORGANIZATION AS CLIENT
(b) If a lawyer for an organization knows that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law that reasonably might be imputed to the organization, and that is likely to result in substantial injury to the organization, then the lawyer shall proceed as is reasonably necessary in the best interest of the organization. Unless the lawyer reasonably believes that it is not necessary in the best interest of the organization to do so, the lawyer shall refer the matter to higher authority in the organization, including, if warranted by the circumstances, to the highest authority that can act on behalf of the organization as determined by applicable law.
Regulatory and Criminal Exposure for Failing as Gatekeeper
A wide range of statutes and regulations also create criminal and regulatory enforcement exposure for in-house counsel viewed in hindsight as having failed as gatekeepers. The SEC’s regulations under Section 307 of Sarbanes-Oxley, for example, impose “reporting up” obligations on in-house counsel at publicly traded companies (15 U.S.C. § 7245; 17 C.F.R. Part 205).
And prosecutors and regulators alike have targeted numerous in-house counsel in recent years, alleging both “aiding and abetting” and even direct involvement in criminal or regulatory violations.
Lastly, shareholders and other civil litigants, including former client organizations themselves, may also sue in-house attorneys for poor gatekeeping, often alleging malpractice (professional negligence) and fiduciary violations.
All in-house counsel are subject to potential malpractice claims for failing to prevent harms to the organization. And general counsels, as company officers, have heightened fiduciary duties under corporate law to protect company assets by preventing harmful misconduct.
Identifying Gatekeeping Risk Factors; Staying Out of Harm’s Way
Before taking any in-house position, candidates should consider gatekeeping risk factors.
Gatekeeping risks can be more frequent and more serious, for example, in highly regulated industries or where the products or services offered pose greater risks to consumers or the public. Where there are more rules and regulations to follow, there are also inherently more temptations to break those rules and regulations for cost reasons or for competitive advantages.
And risky products and services increase both the likelihood and potential severity of alleged gatekeeping failures, since complaints to regulators are more likely.
But the most significant organizational factors may be more subjective. The highest risk levels are probably found in organizations with poor ethical leadership at the top and hence weak internal ethics standards throughout.
If rumor has it that the CEO is a narcissistic bully, consider applying elsewhere.
Lastly, even highly ethical but equally highly siloed organizations can pose challenges if the segregation or dispersion of duties and authority allows projects or initiatives to get far along without adequate legal or regulatory input.
It is always harder to effectively guide or alter a project once substantial resources have been committed.
Proceeding in the Best Interest of the Organization – Seven Best Practices
So what does it look like to “proceed as is reasonably necessary in the best interest of the organization” without getting sued, prosecuted, harangued by regulators or, alternatively, getting fired for being a chronic, curmudgeonly naysayer?
No. 1 – Cultural and Structural Foundations
An ounce of prevention is worth a pound of cure, and in-house counsel at all levels of an organization can play a role in establishing an environment where misconduct is less likely.
First, every general counsel should ensure that his or her organization has a top-down, ethics-driven culture where “doing the right thing” is the paramount priority.
Second, every general counsel should insist on having routine meetings with the board and key board committees. A general counsel’s high degree of authority and visible channels of communication up the chain send a powerful deterrent message throughout an organization that malfeasance has no place to hide.
Be wary of general counsel roles that would report to the chief financial officer and have only limited (and possibly highly choreographed) access to the CEO and board. That structure may communicate to the entire organization (and you) that the general counsel is a second tier functionary with limited influence over business ethics.
No. 2 – Learn the Business and Earn Your Colleagues’ Confidence
In-house counsel at all levels should aspire to be so competent, trusted and admired that colleagues at all levels naturally accept and follow their lead.
To earn this trust, colleagues must know that you understand and embrace the organization’s goals. Quietly and effectively demonstrate that you understand where the organization is headed and that you are passionately committed to pushing initiatives forward, efficiently addressing legal and regulatory challenges and solving problems.
Always resist the urge to make yourself feel useful by simply finding fault with what others in the organization are trying to do without offering solutions first.
Being business savvy and demonstrating excellent business judgement are key to earning a level of trust and respect that will help ensure colleagues include you early in projects and take your concerns seriously.
No. 3 – Don’t Confuse Judgment Calls with Gatekeeping
There is nothing wrong with in-house counsel engaging in those discussions and diplomatically expressing personal opinions. But there is a fine line between something that is illegal or improper and just stupid. Blocking stupid projects or initiatives is usually somebody else’s job. In-house counsel should avoid burning goodwill on matters outside their responsibility or authority.
More challenging yet, team members in highly entrepreneurial organizations often want to push legal and regulatory boundaries and operate in slightly grey areas. Inexperienced counsel often rush to judgement in such circumstances and take unnecessarily rigid positions.
Resist drawing lines where none exist – “uncertain” doesn’t always equal “illegal.” Be willing to accept appropriate risks if superiors up the chain are willing to do so also. Strive to be a creative “thought leader” in grey areas, not a timid follower of the status quo. The “easy answer” is not always the correct answer.
Demonstrating this level of risk tolerance and creativity will lead your colleagues to accept your judgment when legal or regulatory difficulties can’t be avoided.
No. 4 - Don’t Just Say “No” – Look for a Better Solution
Even where proposed conduct would be illegal or otherwise improper, avoid the temptation to immediately just say “no” and walk away.
Always assume that there is some other way to do something another team member wants to do and explore those possibilities with your colleague until and beyond the point at which he or she wants to concede that there is not a better solution.
In such instances, in-house counsel must have the humility and insight to realize that their non-attorney colleagues probably know best about how to achieve the organization’s objectives and that it is in-house counsel’s job to help guide their colleagues through creative problem solving to tease out the very best solutions to legal and regulatory challenges.
No. 5. – Using Emotional Intelligence and Psychology 101
Even after you go through something like the process discussed in No. 4 above, a team member may still become agitated and even angry if they perceive you as unreasonably blocking or slowing a potentially valuable course of action.
Gatekeeping can be a stressful and high risk activity, especially early in a career. Keeping your cool is often hard, but it’s almost always helpful.
Anticipate gatekeeping stresses and how to respond. Be ready to suppress the desire to angrily correct a colleague. Focus on trying to understand and appreciate his or her perspective. Listening and asking questions is the best formula for preventing conflict. Colleagues will often talk themselves right to your position when the facts and law are on your side.
And don’t be afraid to try a little psychology. Most of us understand cognitive dissonance theory - the idea that a person trying to hold onto and reconcile two inconsistent ideas will seek to resolve that internal conflict.
Consider asking questions that lead your colleague to the conclusion that breaking the law, triggering a violation, or causing some other legal trouble conflicts with their self-image as a smart, honest, law abiding person.
“Would this be worth risking the company’s reputation or yours?”
“Can you imagine explaining a regulatory violation to future potential employers?”
No. 6. – The “Good Cop, Bad Cop” Role of Outside Counsel
Another tool for killing bad ideas early is to suggest a call with outside counsel, especially when gatekeeping risks to the organization and to in-house counsel are high.
Akin to cognitive dissonance, hopefully your colleague(s) will be too embarrassed or ashamed to describe and defend a highly questionable idea to a sophisticated stranger. And if you have the call and it goes as expected, the added support for your position will serve as yet another deterrent.
Calling counsel may seem wasteful when you already know the answer. But minimizing harm to your internal relationships is important for continued effectiveness, so allowing outside counsel to play “bad cop” once in a while is a wise use of resources.
The best outside counsel also frequently suggest completely different solutions to tricky problems and you should push them to do so in every call. Outside counsel might even take a completely different view of the matter. If that happens, strongly consider letting outside counsel’s opinion rule the day, demonstrating your flexibility and reasonable risk tolerance.
No. 7 – Standing Your Ground
The toughest and riskiest situations arise when, despite your most emotionally intelligent cajoling, creative alternative seeking, and strategic use of outside counsel, a peer or superior insists on an improper and dangerous path.
What strategies are likely to work best to stop or prevent the conduct without unnecessary relationship damage?
When stakes are high and in-house counsel or other gatekeepers such as internal auditors or compliance personnel have to draw a line, tensions can escalate badly, especially if colleagues perceive a threat to their authority, career success or financial well-being.
Sometimes, after discussions have dragged out and you’ve reached a true stalemate, brute force or power of position is all you have left to protect the organization. This can involve reporting up or simply exercising “power of position” if you have it.
On occasion, for example, a general counsel simply has to say to a head of marketing, “Fix that ad, I’m done talking about it,” or to a product person, “Do I really have to write a memo to the board about this?” And once in a great while, repeat offenders need to be fired. The author once had a high level colleague fired immediately after a problematic ad was run in violation of his clear order not to run it.
Using brute force or power of position may be expedient at the moment, but it is rarely the best course for long term success. Long term success depends on building and maintaining credibility, respect and confidence, and hopefully even some level of personal affinity, among one’s colleagues.
Again, it usually comes back to guiding difficult discussions to help colleagues fully appreciate consequences that may be less obvious to them, all without provoking further tensions.
Consider asking pointed questions along these lines, with hints that the issues may soon need to be taken further up the chain:
“So if you agree that the advertising campaign stretches the truth a bit, Kathy, how would you feel if there’s a regulatory action and you come under scrutiny as the one who drove it? Do you know what it’s like to be at the center of a regulatory action?”
“Diane, if I am correct, and the auditors do later determine that those revenues should not have been recognized this year, what would be the magnitude of the income restatement and what action might the SEC take? Will you or other officers be trading in our stock at all during that period when revenues might later be viewed as inflated?”
“Steven, I think we need to talk with Jeff (CEO) about this. I can’t allow you to take regulatory risks on behalf of the company without him understanding my concerns. Do you want to set that up or should I?”
“Jeff, I know you want to stick to the launch schedule; we all do. But how much would a recall cost the company? As CEO of the company, I think you have an obligation to bring this question to the Board. If you don’t, as general counsel I will be obligated to do so, and I’d rather not be put in that position.”
If the organization has a strong CEO that isn’t directly involved in the issue, or even an experienced board member, consider seeking their advice. Alternatively, without violating client confidences, consult with a more experienced in-house counsel whose judgment you trust.
Lastly, in-house counsel are frequently advised to document the advice they give in difficult situations for their own protection. Confidential memos to the file are fine, and any “reporting up” probably also warrants a memo, but the temptation to route stern memos or emails to colleagues should probably be resisted where possible.
Conversations are generally less off-putting to colleagues. Memos are intended to draw a line and that line may inadvertently extend beyond the issue in question to counsel’s ongoing relationship with one or more colleagues. Also consider carefully any risks to attorney-client privilege or similar unnecessary risks to the organization that a memo might create.
Gatekeeping is a hazardous duty that calls on in-house counsel’s best judgment, discretion and communication skills.
The risks to organization and self can never be completely eliminated, but by choosing one’s environment carefully, helping to shape that environment, picking battles wisely, and communicating timely and thoughtfully, gatekeeping can actually be one of in-house counsel’s most important and professionally rewarding roles.
Paul Swegle is general counsel of Newyu, Observa, XeePay, *Every and Breathometer. Paul is also a governor of the Washington State Bar Association and author of a best seller, "Contract Drafting and Negotiation for Entrepreneurs and Business Professionals."
Paul Swegle's second book, "Startup Law and Fundraising for Entrepreneurs and Startup Advisors" will be published in early 2019.