Recent Government Scrutiny of In-house Counsel By David Fein and Robert Hoff Introduction When the financial news covers in-house counsel lately, the stories are increasingly about government enforcement actions against those lawyers. Following Enron, other corporate scandals, and the enactment of Sarbanes-Oxley earlier this decade, the Securities and Exchange Commission (“SEC”) and the Department of Justice (“DOJ”) height- ened their scrutiny of lawyers as “gatekeepers” for the public compa- nies they represent. In a speech two years ago, then SEC Enforcement Director Stephen Cutler announced increased enforcement attention on attorneys, whom he referred to as “sentries of the marketplace” whose job it was to “ensur[e] that our markets are clean.”1 An unprecedented number of SEC and DOJ actions have been brought against attorneys in the last five years. Based on a variety of securities law and other violations, the SEC or DOJ charged in-house counsel at Google, KPMG, Gen Re, Computer Associates, Warnaco, GemStar-TV Guide and Symbol Technologies, among others. The trend shows no signs of abating as many in-house counsel at public companies have found themselves caught up in the latest corpo- rate scandals. This article will explore two such matters—the SEC’s and DOJ’s industry-wide stock options backdating investigation and the Hewlett-Packard board leak controversy—and will describe the role of in-house counsel in these controversies. 16 Connecticut Lawyer February 2007 Visit www.ctbar.org The Stock Options cacies of the requirements are beyond the appropriate tone and culture to support rig- scope of this article, they generally require orous compliance with the laws. Of course, Backdating an attorney who becomes aware of evi- the chief legal officer is often in a better Investigation dence of a material violation of the securi- position than a junior lawyer to push back ties laws by a public company, or by any on management, and can be a bridge to the The SEC’s and DOJ’s far-reaching inves- officer, director, employee, or agent of the board on questionable or risky matters.7 tigations of improper backdating of stock company, to report the evidence to the com- Ultimately, any in-house lawyer who has options has ensnared over 130 public com- pany’s chief legal officer, the company’s knowledge of or plays any role in a transac- panies and resulted in the resignation or chief legal officer and its chief executive tion is vulnerable to an enforcement action dismissal of dozens of high-ranking offi- officer, or the audit committee of the com- if the transaction later faces government cers and directors. Among those who have pany’s board of directors, another independ- scrutiny. As a result, for self-survival, as resigned or been dismissed are the gener- ent committee of the board or the full board. well as the benefit of their client, it is al counsel of Boston Communications In a recent article, one of Enron’s former incumbent upon lawyers today to raise and Group, CNET, Comverse Technology, HCC in-house attorneys said business managers pursue concerns they have in matters on Insurance, IBasis, KB Home, KLA-Tencor, at Enron pressured them to wave through which they are working. McAfee, Mercury Interactive, Monster.com, and UnitedHealth.2 William Sorin, the former general coun- sel of Comverse Technology, pled guilty on November 2, 2006, to federal charges of conspiracy to commit mail fraud, securities fraud and wire fraud. Referring to the com- pany’s former CEO, Kobi Alexander (now a fugitive in Namibia), Mr. Sorin told a fed- eral judge: “I knew what [Mr. Alexander] was doing was wrong and did not challenge his conduct or share my knowledge with the board of directors and auditors of the com- pany.” Mr. Sorin said he was complicit in the scheme out of “the respect I had felt for Mr. Alexander” and “my belief in his importance to the success of the company.” Mr. Sorin added, “I failed as a lawyer and disserved our shareholders.”3 Mr. Sorin’s admission that he knew the CEO’s conduct was wrong at the time, but did not challenge it or expose it to the com- pany’s board or auditors, raises a significant question: what should in-house counsel do when she suspects that a senior executive or board member is engaged in wrongdoing? From the SEC’s perspective, the answer is deals, with little resistance from the gener- In the stock options investigations, only clear. The lawyer – as gatekeeper – must act al counsel. “The worst thing you could do one case—Comverse—has thus far resulted affirmatively to confirm or deny her suspi- at Enron was to be viewed as an obstruc- in charges against a company’s general cions and report and put a stop to any ille- tionist,” he said.5 Another former Enron counsel. Mr. Sorin signed annual and quar- gal conduct that has occurred. As Steve lawyer observed that the value attorneys terly reports that were allegedly misstated Cutler said, the SEC has “seen too many add “boils down to the questions they ask. because they said “all options have been examples of lawyers who twisted them- Lawyers have to push beyond superficial granted at exercise prices equal to fair mar- selves into pretzels to accommodate the explanations or a simple reliance on the ket value on the date of grant.”8 Contrary to wishes of company management, and failed work of others.... Though they can’t review that statement, Mr. Sorin helped backdate in their responsibility to insist that the com- every business decision, they should care- the company’s stock option grants to the pany comply with the law.”4 fully examine important ones. And they CEO, other executives, other employees The requirement that in-house counsel shouldn’t be ‘cowed by their clients.’”6 and himself (resulting in a personal profit report illegal activity is not just embodied Former SEC General Counsel Giovanni of $1 million). in SEC speeches. Sarbanes-Oxley and the Prezioso said that the SEC expects the chief Mr. Sorin also allegedly lied to a SEC regulations promulgated thereunder legal officer of a public company to play an Comverse in-house lawyer and the compa- articulate the “up-the-ladder” reporting essential leadership role in assuring the requirements for attorneys. While the intri- (Please see next page) Connecticut Lawyer February 2007 17 ny’s outside auditors once the alleged fraud into, legally ambiguous—or worse—areas. came to light in 2006.9 Presumably, he The criminal action against Mr. Hunsaker escaped an obstruction of justice charge and others is in its early stages. Regardless because the government could not show that of the outcome, there are already important he intended or knew his statements would be questions to ask and lessons to learn from provided to the government. In some recent the Hewlett-Packard matter. First, how far cases, federal prosecutors have charged does an in-house lawyer have to go to satis- obstruction of justice based simply on false fy herself that her client’s conduct is legal? statements made to a company’s outside Despite assurances and reassurances by counsel as part of an internal investigation. A many at and outside Hewlett-Packard that necessary nexus for the government’s charge the company’s investigative technique of is that the interviewee believed and intended pretexting was lawful, it is unclear how far that his statements to counsel were going to the company’s counsel went to satisfy be shared with the government. themselves that agents for Hewlett-Packard Computer Associates’ former general were employing lawful procedures in carry- counsel, Steven Woghin, faced such a charge ing out a Board-initiated investigation. as a result of the prosecution arising out of A now infamous e-mail exchange between that company’s revenue recognition scheme. Mr. Hunsaker and a Hewlett-Packard inves- Computer Associates retained a law firm to tigator, Anthony Gentilucci, is demonstra- conduct an internal investigation and made tive. Mr. Hunsaker asked Mr. Gentilucci clear to the government and the public that how the company’s outside investigator, it was committed to cooperating fully with Ronald DeLia, obtained cellular and home the government. In interviews with the telephone records of the investigation’s tar- company’s law firm, Computer Associates gets. The following e-mail exchange ensued: executives lied to and misled the lawyers GENTILUCCI:The methodology uti- about the revenue recognition practice. lized is social engineering, he has Lies in these private interviews formed the investigators call operators under some basis for a string of indictments and convic- ruse, to obtain the call record over the tions for obstruction of justice, including phone, its [sic] verbally communicated Mr. Woghin’s plea in September 2004 to to the investigator, who has to write it conspiracy to commit securities fraud and down. In essence the Operator should- obstruction of justice. A similar scenario n’t give it out, and that person is liable could arise in the stock options investiga- in some sense. Ron [DeLia] can tions, since it has been reported that the describe the operation better, as well as government is relying heavily on outside the fact that this technique since he, and private law firms and internal investiga- others have been using it, has not been tions to identify fraud and bring it to the challenged. I think it is on the edge, but 10 government’s attention. above board. HUNSAKER: I shouldn’t have asked...11 The Hewlett-Packard Following that e-mail exchange, Mr. Board Leak Hunsaker allegedly forwarded telephone Investigation numbers of targets of the investigation to enable Mr.