Internal Investigations

You are the Chief Executive Officer, General Counsel, Chief Compliance Officer or a branch office manager at a large/medium/small brokerage firm. Your assistant walks in your office and hands you

  • a subpoena/document request from a federal or state prosecutor, a federal or state agency or an industry self-regulatory organization (“SRO”) seeking emails, trading records, personnel files and expense reports regarding one of the firm’s trading desks; or
  • a FINRA customer arbitration claim filed by three different clients alleging that one of your largest producers improperly sold shares of a microcap company to them and other clients which recently declared bankruptcy; or
  • an email from a female employee alleging that her direct superior continually sexually harasses her and other females in her department; or
  • a phone message from an elderly client saying she recently reviewed six months of account statements for the first time and did not recognize several of the checks written on her account.

What is your response? What are your obligations as an executive of the firm receiving these types of requests/allegations? What are the possible repercussions if any of these scenarios are not handled properly?

There are any number of events that occur in the day-to-day operations of a brokerage firm that might require the initiation of an internal investigation. Certainly, the receipt of a customer complaint or arbitration claim alleging a single unauthorized trade results in an internal investigation of sorts, albeit on a small scale. But in any of the scenarios described above, the financial and regulatory exposure, coupled with the negative publicity, could be significant. These might be isolated incidents. Or they could be indicative of systemic problems in the firm.

Most firms would want to “get in front” of any potentially significant exposure in an effort to limit their financial, regulatory and reputational liability.

How does a firm conduct an internal investigation?

The first question to ask is who will conduct the investigation? In the instance of sexual harassment claims, an experienced human resources manager might be the appropriate person to review the matter. A compliance manager with knowledge of the internal workings of the trading desk receiving regulatory scrutiny might be the one to examine the trading desk activity for the relevant time period.

However, many firms would most likely use an attorney to conduct the internal review of a significant matter. If an attorney is the lead investigator, the attorney and the firm will be able to utilize the attorney client privilege during the course of the investigation to protect interview notes, investigative findings, etc. (whether the firm chooses to waive the privilege at some point will be discussed later).

If it is a large brokerage firm, the firm presumably has in-house attorneys who have experience in conducting internal investigations. Small or medium firms, with smaller or non-existent legal departments, may have to immediately retain outside counsel (such as Lubiner, Schmidt & Palumbo) to conduct the investigation.

One of the first steps (if not the first) for the attorney leading the investigation is to order a litigation hold. That is a notice to all employees who might in any way be involved or connected to the underlying activity being investigated that all documents, emails, phone records, etc., relating to the activity must be retained. This is a very important initial action. Sometime in the future the firm may have to demonstrate to a regulator, prosecutor or arbitration panel that once the firm knew there was a problem and intended to investigate it, the firm made reasonable efforts to insure that all relevant evidence was preserved.

Next, the lead investigator must gather and analyze all relevant documents. In the case of the arbitration claim referenced earlier, a review of the named broker’s customer account holdings might show that the claim was inaccurate and no other clients of the broker owned shares of the microcap company. Or, to the contrary, multiple other customers owned the stock, including several executives of the company, one of whom happened to be a college roommate of the broker.

The next step in the process is for the attorney conducting the inquiry to interview witnesses (ideally, all relevant documents have been analyzed prior to initiating interviews. However, there may be situations that are time sensitive and may preclude the complete review of all documents prior to interviewing witnesses).

Are employees obligated to cooperate in the investigation? Is the attorney leading the investigation also representing any of the employees? What if an employee asks that the firm provide an attorney? What if an employee refuses to submit to an interview?

These are questions that frequently arise in the course of an internal investigation. That is why it is important for a firm that is conducting an internal investigation to have an experienced lead attorney who can plot out the course of the investigation beforehand and anticipate questions like the above.

(Generally speaking, employees are obligated to cooperate in the investigation. They can refuse to answer questions but could be terminated for doing so. The lead attorney is representing the firm, not the individual employees, and must make that clear to the employee-witnesses before any questioning (referred to as Upjohn warnings). The firm’s by-laws may obligate the firm to retain counsel to represent certain employees and should be reviewed).

At the conclusion of the investigation, the firm has several decisions to make. Should the firm disclose the results of its investigation? In the case of the subpoena, the documents are being turned over anyway to a regulator. In the case of the customer arbitration, the firm is obligated to report the arbitration claim on the broker’s U-4 within 30 days of receipt; additionally, all FINRA customer arbitrations are sent to the FINRA enforcement staff for their review.

In the case of the elderly client, the receipt of a verbal complaint is not a reportable event. If the internal review reveals that the elderly client simply misread her account statements, presumably the matter ends there. If, however, funds were stolen from the client, the firm will most likely settle with the elderly client. That settlement will then become reportable. In this instance, the firm and the lead attorney may decide that a phone call to the FINRA enforcement staff to give them a “heads up” may garner some goodwill in the future as FINRA examines the matter.

Another question, alluded to earlier, often arises regarding waiver of the attorney client privilege. At or near the conclusion of the internal investigation, the firm and its investigator have to analyze the firm’s regulatory exposure. If there was clear wrongdoing on the part of one or more employees performing their duties at the firm, in addition to imposing sanctions on the individuals, the regulator/prosecutor may consider seeking separate sanctions against the firm. Would the firm be in a better position to negotiate a lower or minimal sanction if the firm waives its attorney client privilege and turns over notes of witness interviews, any report prepared by the lead investigating attorney, etc., to the regulator investigating the matter?

This issue has evolved over time, primarily with investigations conducted by the Department of Justice and the Securities Exchange Commission. As in the case of disclosing the existence of the internal investigation to a regulator, the waiver of the privilege may gain the firm some goodwill from the examining authority. However, if a firm determines to waive the attorney client privilege in the immediate investigation, that decision may have repercussions in the future. Namely, waiver of the privilege in the immediate investigation will most likely result in the firm having to waive the privilege in any future related inquiries by other regulators. It may also operate as a waiver regarding any private litigation later filed against the firm.

Therefore, the decision whether to waive the attorney client privilege or not should only be made after consultation with counsel experienced in conducting internal investigations.

For an employee of a firm, being told that you are going to be interviewed by the firm’s lawyer in your office at 10 am the next day can be, to say the least, a disconcerting event. You may know (or not) the reason you are to be interviewed. You may have questions as to why you are being interviewed. How does this affect your job, what if you don’t cooperate? Is this attorney representing you too? If not, do you need an attorney?

Attorneys at Lubiner, Schmidt & Palumbo have worked in the in-house legal departments of major broker-dealers and as criminal prosecutors. We are experienced litigators and investigators who stand ready to assist any firms or individuals who find themselves involved a situation that may involve or require the conduct of an internal investigation.