Running an internal investigation? Here’s what not to do

In today’s intense regulatory world, it is becoming increasingly common for private equity firms or their portfolio companies to encounter the need to investigate allegations of wrongdoing, whether from internal whistleblowers or from one of the growing list of interested enforcement agencies. The realization that your firm will need to conduct an internal investigation is always an unwelcome development: a serious issue has come to light that not only implicates potentially significant liability to regulators and/or investors, but will require time, money, and effort to first assess and understand. With strategic planning at the starting line, however, this unfortunate episode in your firm’s life can be contained and short-lived.  

The simple mission in an internal investigation is to learn about the problem in question, solve it, and move past it. Anything beyond is a needless waste of important resources. While it is imperative for private equity firms to contain any damage by understanding and assessing possibilities of impropriety quickly, a rush to investigate, without calibrating the investigative scope will lead to an overbroad, distracting, and expensive examination into areas unconnected to the potential wrongdoing at issue.  Large-scale investigations might be warranted in certain situations, but a common error made by many clients is to give their outside counsel free rein to initiate an open ended investigative mandate without first engaging in a detailed assessment of the risks, costs, and potential benefits of the investigation as a whole and its component parts. In many cases, a failure to carefully tailor the scope of an investigation at the outset may transform a manageable problem into something far more difficult to contain and conclude. The inherent disruption of an unrestrained investigation will magnify the distraction on your firm’s operations, may exacerbate underlying problems, or even potentially expose the firm to fresh liabilities.  

It is critical, therefore, that firm managers when alerted to potential wrongdoing remain cognizant of their power and responsibility to control the scope of an ensuing investigation. To help ensure that internal investigations remain appropriately circumscribed, private equity firms need to clearly define the mandate of the investigation before it begins and closely monitor their investigators to prevent the inquiry from spiraling into a costly and unnecessary expedition. 

To that end, the development of a governing “scope document” that clearly defines the investigative mandate – with the precise issues enumerated – will create fair boundaries for your investigative counsel. Obtaining sign-off on the scope from all the relevant stakeholders of the investigation (for example, firm owners, outside auditors, or the government depending on status of investigation) will confirm that everyone enters the investigative stage with identical expectations. Developing and pursuing an investigation in close adherence to this governing document will ensure that there is a full, but tight, investigation.  Proper use of a scope document will not limit the investigation of issues that require attention, but rather properly delineate the review that such issues will receive and curtail investigators from pushing beyond the scoped borders.  

In determining the scope of investigation for a given case, firm managers must engage in a conscious assessment of various competing factors. The foremost concern for many managers is the incremental costs and distraction levels associated with each additional responsibility delegated to the investigatory team. The competing questions are: how much is an additional project going to add to accomplishing the goal of understanding the problem?; and, how much is it going to cost in terms of both firm resources and distraction? Obviously, the answer depends on the facts in hand, but the critical point is that you must address these questions before your investigative counsel is let loose on your business. 

Balanced into these questions is the firm’s risk tolerance for potentially being later faulted for not doing a comprehensive enough inquiry. This is where getting early sign-off from all stakeholders on the scope of the investigation will serve you well. Another protective step is to consistently revisit and potentially retailor the scope as the fact pattern evolves.  

Regardless of how the scope document develops, it is vital that the investigation is clearly framed before investigators set about their task in earnest. Failure to focus risk-averse counsel – prone to exploring every possible hazard – at the outset will lead to unnecessary impediments to the firm’s business, ballooning costs, and the possibility that the initial issue of concern may get blurred in an expanding mix of confusion.

Sean Casey is a New York based partner with Kobre & Kim, a boutique law firm focused on litigation and investigations. Joshua Ray, also based in New York, is an associate with the firm.