When a crisis hits, the arduous work of special investigation committees can pay great dividends for a company’s future.
No one wants to receive the call, yet many have: the chair, CEO or general counsel informing the board that a lawsuit, analyst report, news article or government inquiry has surfaced, alleging unethical or illegal activities involving the company or its officers, directors or employees.
In such cases, the general counsel or outside counsel often advises the board to promptly establish a special investigations committee (SIC) composed of disinterested directors. This committee is responsible for thoroughly reviewing the allegations and preparing a comprehensive report for the full board.
Having chaired and participated in many SICs, I have experienced both the privilege and the challenges of conducting these investigations. Some allegations have been baseless, while others have led to serious consequences, including dismissals, policy overhauls, and even criminal indictments and convictions.
SIC work is challenging, time-consuming and sometimes deeply sobering. Yet, it is always rewarding. When conducted effectively, these committees help companies navigate crises and emerge stronger, more resilient and better prepared for future challenges.
What Is a Special Investigations Committee?
An SIC is a temporary committee of disinterested directors established to investigate corporate wrongdoing. It dissolves upon completing its investigation and submitting a final report.
An SIC consists of directors who are not implicated in the allegations. If current directors are involved, the SIC typically comprises those who joined the board after the period in question. In some cases, new directors may be appointed to ensure complete independence.
Benefits of an SIC
Under corporate law, forming an SIC offers legal and strategic advantages, particularly when addressing allegations of malfeasance, fiduciary breaches, “noisy” resignations, shareholder demands or governmental inquiries.
The SIC demonstrates the board’s commitment to its fiduciary duties of care and loyalty by ensuring an independent investigation. One of its first tasks is determining whether an investigation is warranted. If shareholders issue a demand letter, the SIC evaluates the claims and decides if further action is necessary. If no action is warranted, the SIC must ensure its conclusion is well-supported, typically conducting some level of investigation to satisfy legal requirements.
If shareholders file a derivative lawsuit, an SIC’s work can help the board seek dismissal under the business judgment rule. The Delaware case Zapata Corp. v. Maldonado provides a framework for dismissing such lawsuits, evaluating:
- Independence and good faith. The SIC must act independently, conduct a thorough investigation and operate in good faith.
- Judicial business judgment. Even if the SIC meets the first standard, the court independently determines whether dismissing the lawsuit serves the company’s best interests.
A rigorous investigation by an SIC helps protect directors from personal liability while reinforcing the duty of loyalty — an ethical and legal obligation requiring executives and directors to prioritize the company’s interests over personal gain.
SIC Independence
For an SIC to conduct an impartial investigation, it must operate independently from the board and management, with unrestricted access to company records and employees. While it may provide updates at its discretion, it is not required to do so, and interim reports should avoid preliminary conclusions.
Confidentiality is critical. Prematurely sharing findings can compromise credibility and the integrity of the investigation. The SIC may face pressure from board members or management to disclose preliminary findings. However, it must firmly resist such attempts in order to maintain the integrity of the investigation. While this strict confidentiality can strain relationships, it is necessary to preserve the SIC’s independence.
Reporting the Formation of an SIC and Its Investigation
Neither forming an SIC nor commencing an investigation requires public disclosure. However, if the board deems the SIC’s formation material, an 8-K filing with the SEC is necessary. Companies may also issue a press release to inform investors.
Throughout the investigation, the company and SIC must continually assess whether disclosure is necessary. Disclosure is required if the investigation leads to the resignation, termination or departure of executives or board members or necessitates the restatement of financial statements. If a restatement is needed, the company must file an 8-K within four business days, specifying which financial statements are affected.
If regulatory agencies such as the SEC or DOJ become involved, disclosures may be required. A Wells notice or formal government subpoena also necessitates disclosure.
In addition to 8-K filings, disclosure may be required in regular annual or quarterly filings, particularly in financial statement notes or the management’s discussion & analysis (MD&A). If the company anticipates legal liability or regulatory action, it must consider an accounting reserve.
To ensure fairness, disclosure should not be selective and made through an 8-K, press release and/or investor call. The information must be complete and truthful.
Conducting the Investigation
The SIC must promptly engage independent legal counsel, separate from the company’s existing counsel and maintain attorney-client privilege.
The first step is defining the investigation’s scope in coordination with the board and legal counsel. A scope that is too broad wastes resources, while one that is too narrow may not satisfy stakeholders or regulatory authorities.
Once the scope is defined, the SIC and its counsel determine the investigation approach. A critical early step is instructing all employees and directors to retain all communications and documents. Since many employees use personal devices for business, SIC counsel may require access to these devices. These requirements are often met with resistance.
Beyond emails and texts, SIC counsel typically reviews financial statements, board minutes, press releases and marketing materials. The company must provide all relevant documents, though negotiations on redactions may occur.
SIC counsel reviews these materials electronically, using keyword searches. It is surprising how often individuals write potentially incriminating messages without considering their implications.
After document review, SIC counsel identifies individuals for interviews. These are not depositions but information-gathering sessions. Most individuals comply, though some may request an attorney. The company typically covers legal fees, provided it approves the attorney. In rare cases, I have seen employees resign rather than participate.
If necessary, the SIC, through its counsel, will hire external experts, such as forensic accountants. SIC counsel should hire the experts to maintain privilege. The experts should be hired by outside counsel to maintain attorney-client privilege.
The SIC must control its timeline and budget without board interference. Investigations can delay SEC filings and strain finances, particularly for smaller companies. In some of my experiences, capital raises were necessary to fund the SIC’s work.
An effective SIC does not simply delegate work to attorneys. SIC counsel may include former prosecutors who may see wrongdoing in every document. Without oversight, investigations can become excessively broad, consuming time and resources.
A skilled SIC balances conducting a thorough investigation with maintaining focus on specific allegations. This balance is the hallmark of an effective SIC and its chair.
Management or the board may pressure the SIC to limit the investigation to control costs or restore investor confidence. However, the SIC must resist cutting corners. A well-executed investigation benefits the company and its leadership by restoring credibility and ensuring compliance with legal obligations.
Frequent communication between the SIC and its counsel is critical. Often, the SIC chair serves as the primary liaison, ensuring ongoing updates. Daily communication is not unusual during the investigative process.
An investigation can be extremely time-consuming, especially for the chair. The board often compensates SIC members for their work beyond standard board fees. In complex cases, compensation can exceed $100,000. Many attorneys recommend cash payments to avoid conflicts of interest associated with stock or options.
Findings
After document review, interviews and expert analysis, SIC counsel presents findings to the SIC. At this stage, there should be no surprises due to continuous communication.
The first priority is determining whether laws were violated and whether to report violations to authorities. If regulatory agencies have already contacted the company, SIC counsel manages communications.
The SIC also assesses regulatory violations, policy breaches and fiduciary duty breaches.
Reporting
Upon completing the investigation, the SIC provides a report to the full board, typically prepared by SIC counsel and reviewed by the SIC. In some cases, an extensive oral report may be deemed more appropriate.
The report details legal and policy issues, breaches of internal control and weaknesses in company policies. It includes well-documented facts, timelines and responsible parties. Recommendations may include corrective actions, policy changes or disciplinary measures.
While the SIC cannot enforce actions, it advises the board on whether internal controls should be strengthened, reporting lines altered, personnel changes made or training implemented. The report also advises on necessary public disclosures and legal settlements.
Once the SIC completes its investigation and reports its findings, the board should act to dissolve the SIC.
Tough, but Worth It
An SIC plays a crucial role in corporate governance by ensuring allegations of misconduct are addressed impartially and thoroughly. While the work is arduous and politically sensitive, a well-structured SIC strengthens the company’s integrity, accountability and resilience. In the long run, a properly managed investigation positions the company for a stronger future.