I assume most of you have been following the spectacular collapse of FTX, the cryptocurrency exchange that was once worth $34 billion and is now worth less than the coins in the cushions of your couch, with theft, fraud, and a host of other felonies thrown in for good measure. If you’re like me, you probably had this reaction: “What the f**k happened here?!” If you are a regulator or law enforcement, you might also be thinking (among many other things): “Where were the lawyers, and what did they do to stop this?” Sadly, these are now common questions as expectations regarding the responsibilities of in-house counsel to spot and stop corporate malfeasance have changed dramatically over the past two decades. These expectations (and new laws) are driving more in-house counsel to look for ways to beef up their role as the “watchdogs” of the company, on the prowl for trouble and wrongdoing – and one clear way to show the value of the legal function. It’s not an easy task, however. It’s can be fraught with risk and conflicting loyalties. And it often seems like the in-house lawyers are bringing a water gun to a knife fight, i.e., they need more help. Warren Zevon said it best way back in 1978:
“Send lawyers, guns, and money. The shit has hit the fan!”
The problem for lawyers is that guns and money may not be enough (though they certainly help, especially the money bit). They need a plan and a process for how best to identify problems and what to do if they uncover (or suspect they have uncovered) serious wrongdoing. This edition of “Ten Things” walks you through a plan for doing just that:
1. Why it matters. In-house lawyers face lots of demands on their time, from run-of-the-mill legal matters to spotting and managing risk to requests that they become more strategic in their work so as to advance the business goals of the company. The latter two can be tricky. It is certainly fun to be asked to play a strategic role, but it can cause problems when an in-house lawyer realizes that some of the goals and actions of the company may not comply with the law or with the company’s own policies. This plays into your role as one of the key managers of “risk” at the company, i.e., there will be times when your various roles collide. More and more, regulators are looking at the legal department and asking what it did to stop bad actors and, if the answer is nothing or not enough, the in-house lawyers may be culpable in whatever crime or violation was committed (or, depending on what happened, charged with obstruction of justice). Likewise, there are laws (e.g., Sarbanes Oxley) that clearly require in-house lawyers to surface issues of wrongdoing and take specific steps to report issues, protect whistleblowers, and – if necessary – make a noisy withdrawal from the company (i.e., quit). Lastly, the Rules of Professional Responsibility impose specific obligations on lawyers to withdraw and report “up the ladder” about clients looking to commit or who have committed a crime or fraud (see, e.g., ABA Model Rules 1.2 and 1.6). Bottom line? Failing to act may get you in serious legal trouble, so the role of watchdog is one to embrace, not shy away from.
2. Understand the business. It is difficult to be the company watchdog if you do not understand the business. I suspect one reason for the problems at FTX is the complicated nature of cryptocurrencies and blockchain. I have no knowledge one way or the other, but my gut is that many members of the FTX legal team did not truly understand how crypto works (I don’t either so not throwing any rocks). If you sign on to be in-house counsel, one of your first obligations is to spend whatever time is needed to understand the business model of the company you work for. This likely means asking a lot of questions, looking at demos, getting additional CLE training, and studying up on the business and the marketplace on your own. Part and parcel to understanding the business is having a basic understanding of business finance. You do not need to have an MBA but you need to be able to read a balance sheet, a cash flow statement, and an income statement (P&L). If you can do this, you’ll be able to follow along during most meetings where the company’s finances are being discussed and (hopefully) spot things that don’t look right and/or be able to ask intelligent questions about what you are seeing.
3. What’s the tone at the top? The importance of “tone at the top” has almost become cliché. Yet, it is one of the single most important indicators to in-house lawyers as to whether there will be trouble or not. Know the signs of a good culture versus a bad one. If the executive team plays by the rules, takes its responsibilities seriously, and holds themselves and others accountable to be good stewards of the company, there is a high likelihood that you will not be dealing with “FTX-like” issues. If the company has a robust compliance program, an ethics hotline, an internal audit team, and an established process to investigate compliance issues, you will be starting in a good place. But, if the opposite is true, and the senior management is running the business like a frat house, cutting corners, ignoring basic corporate governance and record keeping, looking to enrich themselves at the expense of investors, employees, and customers, well, you are almost certain to have issues. If the board is full of “buddies” of the CEO or only a handful of people have any true power, that’s a potential problem. Does the general counsel have a seat at the table or is she standing out in the hall? Is compliance the first thought or an afterthought? If there are no policies or training or consequences for violating policies, those are all big flashing red warning signs. Consequently, before you even take a job at a company you should be asking questions about tone at the top and, once on board, constantly be on the lookout for issues. To be fair, many start-ups have a “loose” culture because that is how they grew and all they know. If they are willing to bring on in-house lawyers and take advice – and action – to fix things and put in place the type of culture, policies, and processes that change things, then you have an opportunity to make a positive impact on the company and its culture and you can feel good about the direction of the company as well.
4. Ask a lot of questions. Most people become lawyers because they have a natural sense of curiosity. Hopefully, I am describing you. Harness that curiosity to ask a lot of questions, especially when things seem “off.” This can be a bit tough because you don’t want to be the person who questions everything to death (that person is very annoying and is not really accomplishing anything). For a watchdog, it all comes down to your access to information (whether provided to you in the normal course or what you dig out on your own). So, when events warrant and problems are brewing or the signs of trouble are there, that is the time to engage with some probing questions. What you ask depends on the circumstances, but here is a set of questions I kept in my back pocket for whenever things got weird (which, fortunately, has been very rare during my career):
- Does this sound right?
- Do the numbers add up/make sense?
- Is this an arms-length transaction/deal?
- How does this advance the interests of the company?
- Who benefits from this economically?
- What are the relationships of the parties involved?
- Does this comply with company policies?
- Does this comply with the law?
- Does this trigger any obligations under the Rules of Professional Responsibility?
- What happens if this goes public?
- Does the board know about this/do they need to know?
- Does internal audit know about this?
- Is someone lying/hiding something?
One of the best pieces of advice I received as a young in-house lawyer was never trust one person’s answers and always “triangulate” answers from different sources to make sure you are getting the full picture. Even if someone isn’t lying per se, asking others can get you more and better information in terms of deciding if there is an issue that needs further scrutiny.
5. Don’t ignore problems. I know this sounds almost too basic, but once you become aware of an issue (even a potential issue) don’t ignore it, don’t stick your head in the sand, and don’t think that it is “someone else’s” problem. It is most definitely your problem. Potential problems are, obviously, harder to deal with because nothing has happened yet, or you may not be sure if anything will happen. Regardless, pay attention to what is going on around you in meetings. Take note of every aside, joke, or comment. While likely nothing, sometimes these types of statements are the harbingers of an issue otherwise hidden away. Use your list of questions to help educate yourself as to whether something more needs to be done. If you become aware of an issue or potential issue, have a plan in place with how the legal department will take action to dig in. Start with following the company’s official processes as set out in the applicable policies, which may mean reporting to your supervisor, the compliance officer, internal audit, or whomever. If the responsibility to look into problems falls on legal or your shoulders, get going, i.e., don’t let things fester. However, as you move forward, be measured and calm. Until you know for sure that something is a real problem, your mission is to simply gather facts, not to see conspiracy and law-breaking at every turn. How you act, what you say, and what you write all matter, both in terms of getting to the bottom of any issues, but also in regard to your career. Going off half-cocked and treating everyone like a criminal will ultimately backfire on you and you’ll create a paper trail that likely does more harm than good (for the company and for you personally). After you have reported the issue or concluded your investigation, follow up regarding what is being done about your report or your findings. If the answer is “nothing,” ask why. If you feel that the issue is not getting the right attention or response, figure out where to go next with your concern. Again, do this in a calm and measured manner. There may be very good reasons why no action is being taken and do not assume it is a cover-up or whitewash. If, after following through, you are still convinced that more needs to be done, you need to figure out the “up the ladder” path to ensure that the most senior decision-makers at the company (including the board of directors) are aware that there may be (or is) a serious problem that needs their attention.
6. Know when people are lying to you. People lie all the time. Mostly, they are innocent white lies designed to spare someone’s feelings or keep something minor from becoming a big deal. However, when you are wearing your watchdog hat, and are looking into whether there are serious problems at your company, you need to have some basic skills around detecting whether the people you are talking to are lying to you with the intention to deceive you and throw you off the trail. There is a large amount of science around detecting lies. See for example “How to Tell if Someone is Lying: The Ultimate Deception Guide.” Here are a few things that I look for to determine if someone is lying to me:
- They look me straight in the eye (most people look away when thinking about your question – liars, ironically, more often look you in the eye and try to hold your gaze).
- They are sweating (usually in the “T-Zone” – the forehead and upper lip).
- Their voice gets squeaky (liars tend to get dry mouth).
- They have a paler complexion.
- They fidget – a lot.
- They tell me they are “being completely honest with me” or “I swear to God I am telling you the truth.”
- They hide their hands or gesture with palms away from me (indicating they are holding something back)
- They use convoluted sentences, long pauses, avoid first-person pronouns, and use a lot of negative words when explaining “what happened.”
- My gut instinct (sometimes you just know).
None of these are a 100% guarantee that someone is lying, but taking them all together, and taking them together with what you know from other sources (or will find out) can help you zero in on who is being honest and who is not.
7. Who are your allies? Being an in-house lawyer can be a lonely job, even when you are part of a bigger legal department, but especially when you are the only lawyer at the company. This sense of isolation can make in-house lawyers reluctant to dig into wrongdoing as they may not feel empowered to move forward or lack confidence in their abilities or whether they are overreacting or not. All fair and reasonable concerns. The good news is that there is no company where everyone is engaged in bad acts and wrongdoing, there are always people like you who want to play by the rules and do what is best for the company. Your job is to find those people as your ability to be effective in the role is far stronger if you have cultivated allies than if you are the lone wolf. It may be easy, i.e., they are everywhere around you. Or, it may be a challenge, i.e., you are not sure about whom you can trust. My advice is to start with the most obvious people: the CFO (or her deputies), risk management, the head of compliance, internal audit, and other members of the legal department (starting with the general counsel if that is not already your role). Your goal is to develop a network of like-minded co-workers that you feel you can bring issues to and obtain their impartial advice as to what to do next. More importantly, if there actually is an issue, people who will join you in a united front to confront the issue at the right levels of the company, including the CEO and the board of directors.
8. Document everything. As you probably already know, I keep a detailed notebook filled with my notes of every meeting and call I participated in. I have these going back for years and years. I think this is a smart practice in general. On occasion, I have had to pull out a notebook to help answer questions or respond to convenient memory losses. If you find yourself in a situation where things look suspicious (or you have actually uncovered something untoward), it is even more important that you document a) what you found, b) what you did/whom you told, c) their response and actions, and d) what you did next. This can be something you write “to the file” or send in an email to outside counsel so there is a contemporaneous record of your actions. Or you can send it to your manager or the compliance office. Regardless of where it goes, keep things factual and free of hyperbole. If things are gray, note that. In other words, do not write a 5,000-word missive full of accusations and threats. That will be received very negatively, even by the most honest broker. You are writing things down for two reasons. The first is to set out the background and your concerns so that someone else knows what you know and can decide (or help decide) the next steps. The second is to protect yourself in the event something goes very wrong, and people start to ask, “where were the lawyers?!” While that question may or may not be fair, having a written record of the steps you took to investigate, what you did with that information, how you followed-up, etc., can be a life saver. If the situation is bad enough, it is also the basis for why you are quitting (see below). Keep the attorney-client privilege in mind when writing to others (notes to yourself are not privileged) but understand that the privilege is not foolproof (crime-fraud exception) and that the client (the company) can waive it. So, be smart about what you write down.
9. Have someone you trust available to speak with. Regardless of whether you are part of a large legal department or a solo general counsel, you need someone you trust to confide in. My preference is experienced outside counsel. But, it may be someone in the legal department or the business generally. In some circumstances, it could even be a member of the board of directors. Assuming it is outside counsel, spend time developing the relationship and ensuring that they know how the business functions, the personalities at play, the strategy of the company, and so forth. I often used a SWOT analysis when meeting with my trusted advisor to help them see what I saw when it came to my thoughts about the strengths, weaknesses, opportunities and threats facing the legal department or even a specific issue. They also need to know that if things get weird they are the first call you are making (and be sure they are willing to accept that role). You will likely never need to call them in this capacity, but knowing you have someone to help you think through issues, see through your blind spots, and help ensure you are making the right moves at the right time is a godsend.
10. Be prepared to quit. No one likes this one, but sometimes your conscience, the law, or your ethical obligations as a lawyer will require that you quit if you become aware of material wrongdoing and an executive team that is refusing (or even hostile) to cleaning up the problems. They may even make it easier for you to decide by firing you for asking too many questions. See this story about one of my heroes, Ravinder Passi, who showed unbelievable courage in doing the right thing during an internal investigation into the Nissan/Ghosn scandal – and it ultimately cost him his job. While having to make such a decision is rare, quitting a job because of company misconduct is an occupational hazard tied to being an in-house lawyer. If all of the things above have failed, if the company leadership is hell-bent on unethical or illegal activity, or if you simply don’t want to be part of a slimy organization, be prepared to walk.
In-house lawyers may not welcome the role of watchdog, but it comes with the job. When they abdicate the role or are not fully prepared to serve in it, bad things can happen. Fortunately, the situation with FTX is like a 100-year flood – a lot of unusual things that don’t normally happen must happen for it to become an issue. For most in-house lawyers, these conditions rarely, if ever, arise. But, pretending as if it could never happen or sticking your head in the sand and ignoring warning signs will only lead to trouble. In-house counsel must be constantly vigilant and have tools and plans in place to spot problems, deal with problems (or potential problems) immediately, and – if necessary – pull the ripcord and parachute out of the burning plane – squawking loudly all the way down to the landing. If you want to go deeper, here are a few resources I think are incredibly valuable:
- Staying Ethical in an In-House Legal Environment (Locke Lord)
- Ethical Challenges in the Role of In-House Counsel (Hugh Gunz & Sally Gunz)
- When Compliance Officers and In-House Counsel Are at Risk (Sarah Coyne & Robert Stern)
- Drawing the Line as In-House Counsel (Paul Swegle)
- General Counsel and In-House Legal as Corporate Conscience (Eric Sigurdson)
And finally, know the rules of professional responsibility that apply to you and if you are by yourself, get some help (from inside and outside the company). If you are part of a legal team, work together to create a process to spot and deal with issues together. The watchdog is so much better if it runs with a pack.
November 30, 2022
My fifth book, Showing the Value of the Legal Department: More Than Just a Cost Center is available now, including as an eBook! As the ABA says, “Reading this book can prevent corporate crime and most common maladies.” The ABA knows what it’s talking about. Buy a copy today and keep corporations honest and cure the common cold at the same time! You can buy it HERE.
Two of my books, Ten Things You Need to Know as In-House Counsel – Practical Advice and Successful Strategies and Ten (More) Things You Need to Know as In-House Counsel – Practical Advice and Successful Strategies Volume 2, are on sale now at the ABA website (including as e-books).
“Ten Things” is not legal advice nor legal opinion and represents my views only. It is intended to provide practical tips and references to the busy in-house practitioner and other readers. If you have questions or comments, or ideas for a post, please contact me at email@example.com, or if you would like a CLE for your in-house legal team on this or any topic in the blog, contact me at firstname.lastname@example.org.