The Case for Independent Counsel

Board members increasingly recognize the wisdom of seeking separate legal advice

Since passage of the Sarbanes-Oxley Act (SOX), two clear trends have emerged in corporate governance. First, most directors and CEOs have come to recognize the value of an independent board. In a recent survey, directors identified the two most significant attributes of a well-run board: regular executive sessions outside the presence of management and a high percentage of independent members. The second trend: Directors operating in an increasingly regulated and litigious environment are seeking legal advice more frequently as a regular feature of board diligence. More than three quarters of directors said they anticipated consulting with outside counsel in the coming year.

Most directors now recognize the significant intersection of those two trends. Since your company benefits from having independent directors and sound legal advice, you should ensure that directors are getting independent legal advice.

Some boards now retain counsel to attend all meetings and advise them on an ongoing basis, having concluded that the benefits of independent advice more than outweigh concerns about additional costs and potential inefficiencies. They believe that independent legal advice is unquestionably needed for the numerous ongoing tasks and that, when a crisis erupts, everyone benefits from having a second set of knowledgeable lawyers available immediately to advise the board. Even directors who have not retained regular separate counsel recognize that, under some circumstances, they need independent advice. In the survey of board members, 44 percent of respondents said they anticipate retaining counsel of their own choosing in 2008.

This increasing reliance on independent counsel reflects a trend in best practices and developing legal requirements. SOX requires that corporations authorize their audit committees to retain independent counsel, and various stock exchanges have established similar requirements for compensation committees. Legal experts, including one commissioner of the Securities and Exchange Commission, (SEC) have advised boards operating as a whole to consider independent counsel. And the former Chief Justice of the Delaware Supreme Court suggests that courts may begin looking to such regulatory rules in determining, for purposes of private litigation, whether directors have satisfied their duties. In other words, today's best practices will likely become tomorrow's legal requirements.

Rule of Thumb Directors of companies with complex operations and substantial assets should consider retaining their own attorney on an ongoing basis. Moreover, all directors confronting any issue that may significantly impact company counsel's personal interests or those of the executives who hire and fire them should consider seeking independent counsel. As a rule of thumb, if an issue merits both discussion in executive session and the advice of counsel, independent counsel is probably needed. Surveys and experience suggest the following examples:

• Allegations of serious improprieties by senior management

• External or internal investigations

• Senior executive compensation negotiations

• Mergers and acquisitions, especially where poison pills or other personal financial incentives exist

• Controversial accounting or disclosure issues

• SOX compliance

• Board evaluations

Most company counsel strive to recognize when their advice might be influenced by their relationship with senior management and when to advise the board or individual directors to seek independent counsel. But lawyers are only human (contrary to popular belief), and sometimes fail to recognize their limitations, so directors cannot rely entirely on company counsel to spot such situations. Similarly, directors cannot leave the choice of independent attorneys to company counsel, as they may lack independence. Sixty-three percent of directors responding to a recent survey said that directors should ask the general counsel for recommendations but make their own hiring decisions.

The Best Defense When a company faces significant lawsuits or governmental investigations, its directors must again consider whether their interests and those of the company are best served by retaining separate counsel. If you arenot named personally as a defendant, you will generally be concerned with protecting the interests of the corporation.

On the other hand, a lawsuit naming you as a defendant implicates your own personal interests, which may differ in key respects from those of the company's officers. In this case, you should seriously consider separate counsel.

On a substantive level, most lawsuits allege "primary" wrongdoing by senior officers and, because the company is generally bound by management's actions, the officers' and the company's interests in defending such suits are largely co-extensive.

In contrast, plaintiffs usually allege "secondary" wrongdoing by the directors for "failing to discover" certain facts or "failing to control" the officers. Directors thus have an additional defense unavailable to other defendants—even if plaintiffs could prove a "primary" violation, they may not be able to prove that the directors participated in or knew about the wrongdoing. Your position as an outsider can generally be most effectively explained to a judge or jury by lawyers who do not also represent the insider defendants.

On a tactical level, company counsel will inevitably have more frequent contact with senior management than with the directors, who will therefore have less control over defense decisions. Even the most diligent company counsel may find it difficult to pay as much attention to the interests of the directors (whom they see once a month at most) as they do to management's interest (whom they interact with on a daily basis). A separate attorney whose sole job is to safeguard the director's interests will ensure that these interests are considered in all defense decisions.

Not every lawsuit will require separate counsel. In assessing the need, consider these factors:

Size and complexity. Larger, more complex, and more public disputes generally merit greater consideration of separate counsel. Governmental investigations usually increase the threat of personal exposure and heighten the need for separate counsel. So-called derivative actions—where plaintiff purports to sue in the name of the corporation—require directors to demonstrate their independence from the alleged wrongdoers in senior management.

• Allegations against a director. Non-trivial allegations of insider trading or other self-dealing by the director virtually compel retention of separate counsel. If you face such allegations, pay particular attention, and make sure to understand the attorneyclient privilege.

• Allegations against management. Allegations of serious wrongdoing by senior management increase the likelihood that the directors' and the company's interests will eventually diverge from management's. In such cases, you should consider retaining your own attorney and discuss with company counsel how they plan to ensure that the company's defense will not be influenced by potentially inconsistent interests of management.

Assets AvailableWhere insurance coverage and company assets may be insufficient to cover defense costs, settlements, or judgments, individual exposure and the need for separate counsel increase significantly. Likewise, directors with substantial personal assets make attractive targets and should give greater consideration to separate counsel. Directors should gain a full understanding of the D&O coverage available; for example, most policies now cover the company's own defense costs and you should ensure that the company does not use up the entire policy in its defense, leaving no protection for you.

Some questions to consider: Would separate counsel cost too much or make defense efforts less efficient? Virtually all indemnification provisions obligate the company to pay for your separate counsel, and D&O carriers routinely agree to pay such costs.

If you retain experienced attorneys, they will minimize costs by relying on the work of company counsel for most purposes, focusing their own efforts on points where your interests may differ. When all attorneys understand their respective responsibilities, company counsel's role is enhanced by havingother attorneys who can focus on the directors' unique interests and lend perspective to joint decisions.

What role should separate counsel play? You can hire counsel to represent you for all purposes, including appearing in court. Alternatively, you can hire "shadow counsel," who will not make their presence known to the outside world, but will monitor the proceedings, advise you behind the scenes, and offer input to company counsel who will continue to represent you publicly. Directors sometimes retain shadow counsel early in the case, then decide to have them appear publicly at a later stage. In either role, the same attorney may effectively represent more than one similarly situated directors.

At what stage of the case should I retain separate counsel? Key strategic decisions are made during the early stages of most cases, so take steps as early as possible to ensure that your unique interests are considered. Additionally, retaining separate counsel at the outset will send no negative signals to your co-defendants or your opponents. On the other hand, it is generally the case that when an individual who is initially represented by company counsel decides midway through the case to retain separate counsel, the inference inevitably arises that something has gone wrong. For that reason, we recommend resolving uncertainty in favor of separate counsel at the outset. Finally, as in the non-litigation context, you should seek advice from company counsel, but decide for yourself whom you want to represent you.

Lost PrivilegeSome directors worry that hiring separate counsel will send the wrong message to management or opposing counsel. But the decision to hire separate counsel reflects the simple reality that an outside director's position differs, by definition, from management's. The decision to seek separate counsel does not by itself demonstrate any lack of faith in management or in company counsel. In fact, retention of independent board counsel is no longer remarkable in any context; it is the developing norm. In complex litigation, it is a virtual requirement: For example, in all but one of the 23 securities class-action cases that our firm is currently defending, some or all director defendants have retained separate counsel.

There is no substitute for developing your own relationships with company counsel, both inside and outside. By doing so, you remind counsel that their duties run to directors as well as to management. Building rapport also increases your ability to spot potential independence issues and helps avoid misunderstandings on those occasions when you do decide to retain separate counsel.

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