2007 Issue 1 - New York City Bar Association

L A W Y E R ’ S R O L E I N C O R P O R A T E G O V E R N A N C E
part of their fiduciary obligations, directors have the specific duty to investigate
“red flags” indicative of wrongdoing by corporate agents. 193
Finally, corporate charters, bylaws and other internal policies and
procedures can impose additional obligations on directors. They may require
directors to receive reports of wrongdoing 194 and, where appropriate, to
conduct investigations. They may also assign certain investigative obligations
to committees of the Board of Directors such as the Audit Committee. Where
a designated committee or director fails to fulfill its oversight responsibilities,
it is possible that a violation of the duty of care has occurred. 195
B. Recommendations
We now address several questions counsel typically confronts with
respect to internal investigations.
1. Who should conduct the investigation and to whom does that counsel report
After determining that an internal investigation is required, the first
issue presented is who should direct the investigation. Typically, there are
three alternatives: the Audit Committee or other committee of the Board
composed of independent directors, the full Board of Directors, or management
of the corporation (often the General Counsel or a lawyer in the
office of the General Counsel). Various regulatory bodies have expressed
their preferences with respect to how this issue is resolved. The Thompson
58 (S.D. Tex. 2003) (finding that plaintiffs had stated a claim as to breach of fiduciary duty for
directors’ failure to act given their access to material information about the actual financial
condition of Enron).
193. See In re Caremark Int’l, Inc Derivative Litig., 698 A.2d 959, 970 (Del. Ch. 1996) (“[A]
director’s obligation includes a duty to attempt in good faith to assure that a corporate
information and reporting system, which the board concludes is adequate, exists, and that
failure to do so under some circumstances may, in theory at least, render a director liable for
losses caused by non-compliance with applicable legal standards.”); see also In re Citigroup,
Inc. S’holders Litig., Civ. A. No. 19827, 2003 Del. Ch. LEXIS 61, at *6-7 (June 5, 2003)
(describing a failure to provide oversight claim under Caremark); In re Worldcom, Inc. Secs.
Litig., No. 02 Civ 3288 (DLC), 2005 WL 638268, at *8 (S.D.N.Y. Mar. 21, 2005) (“[D]irectors
. . . may not fend off liability by claiming reliance where ‘red flags’ regarding the reliability of
an audited financial statement, or any other expertised statement, emerge.”); cf. WorldCom,
346 F. Supp. 2d at 684 (“If red flags arise from a reasonable investigation, underwriters will
have to make sufficient inquiry to satisfy themselves as to the accuracy of the financial statements,
and if unsatisfied, they must demand disclosure, withdraw from the underwriting
process, or bear the risk of liability.”)
194. SOX §307 and various listing standards currently require audit committees of public
companies regularly to receive reports of wrongdoing.
195. Cf. Walt Disney Derivative Litig., 2005 WL 1875804, at *35 (describing violation of
fiduciary duty claim where directors fail to act in the face of a legal obligation to act).
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