A Firm Problem: Claims and Privilege Risks When Long-Term Outside Corporate Counsel Investigates the C-Suite
I. The Reflex and Its Cost
When a credible allegation of misconduct is asserted against a chief executive, a Board's first instinct is to call trusted outside counsel it knows. This instinct is natural. Regular outside corporate counsel already understands the business, the personalities of the Board and C-Suite, the claims history, and the regulatory posture of the company. Such an investigation can be operational within hours rather than days or even weeks and will not require the investigators to get up to speed. And, in the compressed hours after a story breaks or a whistleblower letter arrives, this familiarity is comforting and seems cost effective.
Although outside corporate counsel should be notified of the claim and provide initial advice concerning it, it is often a mistake to allow the firm to conduct the investigation. The problem is not that long-standing counsel will do poor work. Firms in this position often do excellent work. The problem is that the choice of counsel converts what should be a company's defense — i.e., we investigated promptly and thoroughly and took effective remedial action — into a contested fact, and simultaneously enlarges the universe of material the company may be forced to surrender if it relies on the investigation and its findings.
II. Wynn Resorts: When the Choice of Counsel Becomes a Claim
On January 26, 2018, The Wall Street Journal published allegations of sexual misconduct by Steve Wynn, the founder, chairman, and chief executive of Wynn Resorts, Ltd. The Board of Directors announced the formation of a special committee to oversee the investigation that same day. Wynn resigned as chairman and CEO on February 6, 2018. A week later, the board engaged Gibson, Dunn & Crutcher LLP, the company’s long-term outside corporate counsel, to conduct the inquiry. Gibson Dunn had represented Wynn Resorts in its litigation with Kazuo Okada and in the dispute with Elaine Wynn, had appeared for the company in SEC and DOJ matters, and its own general counsel, Kimmarie Sinatra, was a former partner of the firm.
That one decision by the special committee of the Board exposed the company to substantial liability on multiple fronts. Derivative complaints filed on behalf of the New York State Common Retirement Fund and the New York City pension funds used the choice of Gibson Dunn to investigate as evidence that the board was still oriented toward protecting the founder rather than the corporation, excusing the shareholders from making a demand on the board. On September 6, 2018, a court denied Wynn Resorts’ motion to dismiss, finding the allegations sufficient to plead that the board had actual knowledge of serious allegations and faced a substantial likelihood of liability for conscious inaction. This decision is widely regarded as the first derivative suit to survive demand futility on a theory of board oversight failure in the face of executive sexual misconduct.
The aftermath was significant. The consolidated derivative action settled in November 2019 for $41 million to the company — $20 million from Steve Wynn personally and $21 million from insurers — plus roughly $49 million in credited governance enhancements, including his separation of the chair and CEO roles. A parallel federal securities class action in the District of Nevada settled for $70 million. The Nevada Gaming Commission imposed a $20 million fine in February 2019. And, in April 2019, the Massachusetts Gaming Commission fined the company $35 million and CEO Matthew Maddox $500,000, imposed an independent monitor, and described what it found as systemic failures and a pervasive culture of non-disclosure.
As the Wynn Resorts’ investigation demonstrates, a board facing a C-suite allegation is going to be judged on process, and the identity of the investigator is the most visible single element of that process. Retaining the firm that has advised the company — and, by extension, the subject executive — for years hands the plaintiffs' bar, regulators and proxy advisors a ready-made narrative that the investigation was not legitimate or not undertaken in good faith. That narrative is cheap to plead, but expensive to rebut.
II. Unintended Consequences: Expanding the Scope of Waiver
The retention of long-term corporate counsel to conduct an internal investigation may also result in a broader finding of waiver of privilege. If a company offers the results of an investigation as a defense or to mitigate liability, the scope of waiver generally includes the investigation report and all documents relating to the subject matter of the report. When an investigation is conducted by counsel with no other relationship to the company, the “same subject matter” is a bounded universe, including documents such as the engagement letter, the investigation plan, interview memoranda, the documents and data considered in the investigation and often an investigation report.
When an investigation is conducted by a law firm that has advised the company for fifteen years, the same subject matter may sweep in the firm's advice on other topics, such as the negotiation of the executive's employment agreement, a prior complaint that was quietly resolved, or prior advice to the executive concerning personnel issues or the topic of a whistleblower report. Those files sit in the same matter numbers, in the same email threads, and often under the same lead partner at the firm. When a board or special committee chooses a law firm, it also may be determining the scope of any future waiver.
III. Private Companies: Different Laws, But Similar Results
Although private companies are not required to make Exchange Act disclosures or face securities class action claims, there are numerous sources of potential liability. Minority stockholders and LLC members may assert direct and derivative fiduciary claims against executives and board members. Also, private equity sponsors, preferred holders, and board observers have contractual information rights that function like Section 220. In an acquisition situation, the adequacy of an internal investigation becomes a diligence item, a disclosure schedule entry, and/or a potential representation-and-warranty insurance claim. Or, an internal investigation may be offered as a defense in litigation, such as a sexual harassment claim, or to mitigate liability in a criminal or regulatory investigation.
Three structural features intensify the risks for private companies. First, entanglements with outside counsel are often deeper. The company's regular outside counsel frequently formed the entity, drafted the founder's employment and equity agreements, and counseled prior employment and corporate decisions relevant to the investigation. Second, there is often no independent mechanism to oversee the investigation — no audit committee, few or no unaffiliated directors, and no Rule 10A-3 authority to retain independent advisors. Third, the subject of the investigation is frequently the firm's originating client and the company's controlling holder, which makes the abstract question of “who is the client” more challenging.
The practical consequence is that a private company usually has more reason to bring in a firm with no prior relationship, not less. The absence of public scrutiny is not the absence of a record; it simply defers the reckoning to a transaction, a bank workout, a buyout dispute, or litigation.
VI. A Working Framework
- Let independent directors make the retention decision, and paper it. The minutes should reflect who selected counsel and the factors they considered in making the selection decision, including the lack of actual or perceived conflicts, experience in the industry and/or the expertise of selected counsel.
- Apply a conflicts test tied to subject matter, not just to formal representation. Ask whether the firm has advised the underlying conduct, the executive's compensation or employment terms, any prior complaint about the same executive or key witnesses, the disclosure decisions now in question, or the design of the compliance program at issue. An affirmative answer to any of these should be disqualifying because the firm would be investigating its own work and legal advice.
- Use a two-firm structure. Although the board or committee should retain truly independent investigative counsel, it should rely on corporate counsel or another well-known trusted counsel to provide advice to plan the investigation and address issues that arise during the investigation, including the defense of threatened claims, disclosure advice, document retention, regulatory interface, and advice concerning remedial and employment actions, ideally, with a separate document repository.
- Decide at the front end whether the company intends to rely on the investigation. If the board expects to use the findings to terminate for cause, satisfy an auditor, brief a regulator, support a disclosure, or assert a defense in litigation, waiver should be planned in advance. The investigation report should be drafted with the assumption it will be read by an adversary and by a judge and/or jury. If the board does not intend to rely on it, keep the report oral or tightly scoped and control distribution of the findings in it.
- Give real Upjohn warnings and document them. If it could be argued that the executive has a personal relationship with the firm or has received advice from the firm previously in his corporate role, those concerns should be addressed in writing before the first interview and separate counsel should be retained to represent the executive.
VII. Conclusion
Boards rarely choose their regular outside firm in bad faith. They choose it because it is fast, informed, and trusted. But in a C-suite investigation, the qualities that make the familiar firm attractive are the same qualities that make its work and conclusions subject to challenge. The marginal cost of retaining separate counsel is measured in fees and a few days or weeks of onboarding. The cost of the alternative has repeatedly been measured in nine figures.