What Shareholder Proposals on Proxy Access Tell Us About its Value

* Bernard S. Sharfman is an associate fellow of the R Street Institute and a member of the Journal of Corporation Law’s editorial advisory board. Mr. Sharfman would like to thank Jonathan Cohn, Shane C. Goodwin, John G. Matsusaka, and Tara Bhandari for their helpful comments and suggestions. Mr. Sharfman is dedicating this article to his wife, Susan David, and his daughter, Amy Sharfman.


Proxy access is the ability of certain privileged shareholders to have their own slate of director nominees included in the company’s proxy materials whether or not the board of directors (“Board”) approves. These materials include a proxy statement used to solicit shareholder votes and a voting card allowing shareholders to vote without having to attend the annual meeting.1 For many years, the default rules of corporate and securities law have provided the Board with exclusive authority to decide whether shareholder proposals seeking to implement proxy access are to be included in a public company’s proxy solicitation materials. Five years ago the Securities and Exchange Commission (SEC) amended its rules to require these proposals be included.2

Because of the difficulty of crafting a binding proxy access bylaw within the confines of the SEC’s 500 word limit on shareholder proposals,3 proposals are usually non-binding, requesting, not requiring, the Board to implement proxy access by amending the company’s governing documents. These proposals can be understood as the first step in the process of implementing proxy access on a company-by-company basis.

Roughly 200 companies received proxy-access proposals in 2016.4 The proposals usually limit the availability of proxy access to large shareholders who have held at least three percent of company shares, individually or as an aggregation of 20 to 25 investors, for at least three years.

When voting on a proxy access proposal, shareholders need to be informed about the expected effect of proxy access on the market value of their shares. Boards also need to be informed about this expected change in value when considering if it should amend its governing documents to include proxy access, either for purposes of preempting a shareholder vote or considering its implementation subsequent to such a vote at the annual meeting. The SEC needs to be informed about the expected change in value on a market-wide basis prior to making any changes to its proxy access rules, including putting back on its agenda the idea of universal proxy access for all public companies (“universal proxy access”).5

One way to understand the value of proxy access is through empirical analysis of the shareholder proposals on proxy access that have already been submitted for inclusion in the proxy materials of public companies. Unfortunately, the empirical research on these proposals is limited to one empirical study. This study, even though well executed, leads to more questions than answers and thus cannot be relied upon as authority on a standalone basis. This is a critical point that shareholders, board members, and the SEC need to understand when such empirical evidence is used in support of or against proxy access.

I. The Bhandari Report

The available empirical study is a report prepared by Tara Bhandari, Peter Ilievy, and Jonathan Kalodimos.6 The report was initiated when all three were employees of the SEC’s Division of Economic and Risk Analysis.7 This report took the form of an “event study.” An event study investigates the impact of new information upon the expected stock returns of a targeted cross-section of firms.8 In the report, the event was the Office of the Comptroller of New York City’s (“Comptroller”), the custodian and investment adviser to the New York City Pension Funds, unexpected announcement to the public that it had simultaneously submitted non-binding proxy access proposals to 75 public companies.9

An event study is used to determine “whether there is an abnormal stock price effect associated with an unanticipated event”10 (the Comptroller’s announcement) on a sample of firms that may have been uniquely affected by the event (the 75 firms to which the Comptroller simultaneously submitted proposals). The null hypothesis to be tested is whether the mean abnormal return (abnormal stock price effect on the targeted sample of firms) at the time of the event is equal to zero. That is, if there was no effect from the announcement, then the mean abnormal return at the time of the event will equal zero.11 The event date was November 6, 2014. The authors found that the Comptroller’s announcement led to a positive, statistically significant, 0.53% abnormal return for the 70 firms12 used in their sample. In terms of hypothesis testing, the results meant that the null hypothesis had been rejected.13 Moreover, they interestingly found a strong correlation between the returns generated on this event date and the returns of the sample on the date, approximately four years earlier,14 when the SEC announced it was going to stay the implementation of its universal proxy access rule.15

II. Selection Bias and a Lack of Randomness

Even though the Bhandari report indicates that proxy access has value, this is far from the end of the story. The small sample size makes it very difficult to make inferences about why the Comptroller’s announcement had such a significant impact on the target firms. The sample cannot be further broken up to see if certain sub-groups are responsible for moving the numbers.

Moreover, the sample lacks randomness as a result of selection bias. Randomness means that each element of a population has an equal chance of being part of the sample. A random sample is required in order to make generalized claims about how the entire population of U.S. public firms would be affected by shareholder proposals on proxy access (i.e. external validity). The Comptroller’s selection process violated the requirement of randomness and, therefore, the results lack external validity.

The 75 companies were targeted for multiple reasons unrelated to enhancing shareholder value. Thirty-three were targeted because they were in industries directly related to climate change; 24 for a lack of board diversity; and 25 were cited for having received “significant opposition to their 2014 advisory vote on executive compensation.”16 This resulted in 20 of the 75 target firms being from the gas and oil industry, nine from the utilities industry and another six from the coal industry.17 Such a weighting of companies either producing or consuming huge quantities of carbon-based fuels is not representative of the current universe of U.S. public companies.18

It is also reasonable to assume that the selection process was a function of how successful the Comptroller expected to be in either getting firms to implement proxy access prior to a shareholder vote or at least getting a substantial percentage of votes if a shareholder vote took place. The Comptroller would not have wasted its time selecting a firm where the expected probability of success was zero or close to it. According to Nell Minow, a leader in the shareholder empowerment movement, the Comptroller has “been very smart about picking companies where shareholders are looking to make a change.”19

However, the selection bias discussed so far does not entirely explain how the Comptroller whittled down the number of targeted firms to 75 out of the over 3,000 public firms that it could choose from. It is reasonable to assume that it also targeted firms that had not been historically responsive to its engagement or the engagement of other like-minded shareholder activists on issues including board diversity, executive compensation, climate change, disclosure of political contributions, employee wages, etc. According to the Comptroller, “to effect true change, you need the ability to hold entrenched and unresponsive boards accountable and that is what we are seeking to do.”20 Therefore, an additional targeting criterion may have been firms that had not adequately cooperated on one or more of these other issues. For those firms that had been cooperative, it would be counterproductive for the Comptroller to target them for proxy access. This additional criterion would have created more bias in the sample.

One counterargument is that the Comptroller’s sample was random with respect to the expected value of proxy access. Ironically, as described above, this may be true to some extent given that the Comptroller was not targeting firms based solely on the criterion of enhancing shareholder value. However, the abnormal returns found in the Bhandari report did not measure the value of proxy access per se, but the expected returns of proxy access as a function of both the market’s estimation of its value at a target firm (positive or negative) and the probability that proxy access could actually be achieved at the firm. Selection bias with respect to the second variable may have resulted in a lack of external validity.

As argued above, the Comptroller would have targeted firms where it believed it would have success, i.e. firms with dissatisfied investor bases, making the probability of success higher than it would be if the target firms were selected in a random fashion. Moreover, it is possible that the two variables are not independent, but are positively correlated. In other words, the greater the level of investor dissatisfaction means not only the higher probability of success but also the greater the likelihood the market will find the value of proxy access to be positive. If so, then the Comptroller’s selection process will yield more companies that the market feels will benefit from proxy access versus a randomly selected sample.

In sum, the Comptroller’s selection process excluded a vast sector of the universe of public companies. This adversely affected the ability of the analysis to accurately represent the expected benefits or costs of proxy access to all public companies, making the results biased, most likely in the upward direction. The study thus lacks external validity outside the boundaries of the Comptroller’s selection criteria.21 The results of the Bhandari report may be able to inform us about how proxy access may have affected the firms in the small sample under study, but there is great uncertainty if it can be generalized to the three thousand plus other firms that also make up the universe of public companies.

III. Omitted Variable Bias

Even if the Bhandari report lacks external validity, one result that is still extremely interesting is the finding that the Comptroller’s announcement had such a large impact on the value of the target sample, a 0.53% average abnormal return. This result is puzzling given the proposals were non-binding and uncertainty existed over whether they would win approval by shareholders or be implemented by the Board even after shareholder approval. Moreover, there was uncertainty whether shareholders had the wherewithal or even desire to ever use their right to nominate if implemented, and if they did use their right to nominate, if any of their nominees would actually win election.

There are several other reasons why the result is perplexing. First, the proposals effectively excluded activist hedge funds from participating in proxy access because of the required three-year holding period.22 Second, the Bhandari report found that the Comptroller was not specifically targeting poor performing firms that could benefit the most from proxy access.23 Third, the study controlled for abnormal returns generated by the industries where the target firms belonged.24 But most importantly, proxy access does not exist in isolation from the markets for corporate control (friendly and hostile takeovers through mergers and acquisitions)25 and influence (shareholder activism including hedge fund activism),26 the primary means by which board members are replaced outside of board nominating committees.

In the market for corporate control, Doidge, Karolyi, and Stulz report that from 1997 to 2012, 4,957 firms were delisted from U.S. stock exchanges as a result of merger activity.27 This activity must have resulted in thousands of Board members losing their seats. In the market for corporate influence, shareholders are already getting significant board representation through engagement with the Board. From 2006 to 2013, a total of 1,128 dissident seats were granted to shareholders either through a proxy contest or private negotiation, with 179 in 2013 alone.28 Moreover, of those 1,128 seats granted, 702 seats were gained through hedge fund activism.29

Given the more powerful means by which to change the composition of a Board, this should put a significant cap on the value of proxy access as a means to reduce agency costs caused by the separation of share ownership from board management. In sum, the 0.53% average abnormal return found in the Bhandari report is counter-intuitive.

A possible explanation is that one or more independent variables, not specified in the event study’s regression equation, may be causing the abnormal return. If so, then there may be omitted variables that are correlated with both a company receiving a proxy access proposal from the Comptroller and the abnormal returns generated by the shares of the target firms on the event date.

So, what could these omitted or missing independent variables be if they indeed exist? For one, such a variable would describe the level of dissatisfaction the company’s shareholder investor base currently has with the Board and/or executive management. The identification of a dissatisfied shareholder base is critical to the workings of those who participate in the market for corporate control (takeovers) and hedge fund activism.<30

If correct, then we should interpret the appearance of a proxy access proposal as a new or confirming signal to the market that there is a high level of shareholder dissatisfaction with the Board. Proxy access, unlike other shareholder proposals, makes a compelling statement that large activist institutional investors are extremely dissatisfied with the Board and would be happy to see a change.

Such a proposal is a clear signal to the market that the Board may be vulnerable to hedge fund activism or a takeover (friendly or hostile), especially when the stock price has been under pressure.31 In essence, the company has been put “in play.” This is valuable information for the market in its process of continually reevaluating the price of a company’s shares. We know from recent research on hedge fund activism that the up-front gains in a company’s stock price from such activism can be extremely rewarding to shareholders.32 Therefore, the increased potential for hedge fund activism or acquisition activity may be the true drivers of the abnormal returns found in the Bhandari report, not the market’s estimation of the value of proxy access as a stand-alone tool for enhancing corporate governance.

A counterargument is that the report’s finding of a strong correlation between the returns of the target firms on the date that the Comptroller announced its proxy access initiative and the returns that the target firms yielded on the date the SEC stayed its universal proxy access rule confirms the primary role of proxy access as being the cause in the change in value. Yet, this interesting finding does not negate the potential for omitted variables as an explanation for the counter-intuitive results. The potential for omitted variables still needs to be researched. If such a variable is found, then the strong correlation discussed above is just that: a correlation between two events, and only two events, that occurred four years apart, and no more.

In sum, the mean abnormal returns are much too high to be explained simply by the disclosure of the Comptroller’s proxy access proposals. Proxy access is just a very small part of the story of how Board composition is influenced by market forces. The potential for omitted variables is great and needs to be explored in future empirical studies.

IV. Non-Stationarity

The Bhandari report, which focused on one event at one point in time, must also be understood in the context of non-stationarity: the potential for the stock market to react differently to the same events at different points in time.33 If non-stationarity exists, then the stock market may provide “one result for a period and a diverse outcome for another period” as the perception of investors change over time.34 This is consistent with an efficient market where the market price is an unbiased estimate of the true value of the investment, but is not necessarily a correct one at any point in time.35

It is easy to see how non-stationarity may play a role in the results of future event studies on proxy access. At this time, the stock market has zero practical experience with proxy access. Investors have yet to use proxy access to nominate candidates for the Board. Therefore, there is no data to evaluate how the performances of those nominees who have been elected to the Board have affected shareholder value. As a result, it is possible that as the market becomes more informed about the real value of proxy access, future event studies, including studies on the value of shareholder proposals on proxy access, may provide different results based on changed perceptions.36

To overcome the perception that the Bhandari report may be tainted by the potential for non-stationarity, a number of event studies would need to be conducted on various event dates over a number of years. Hopefully, they will generate results that are consistent. Until then, the issue of non-stationarity will need to be acknowledged by those who utilize the Bhandari report.

V. Conclusion

The Bhandari report is an important first step in the process of trying to understand the value of proxy access based on shareholder proposals. However, even though the authors appear to have done the best job possible with a limited data set, it is not possible to use the report as support for the proposition that proxy access is an enhancement to the corporate governance of a public company, either generally or at a targeted company. More specifically, the results of the report lack external validity resulting from a sample that is not randomly generated; there is the strong possibility of omitted error bias; and the issue of non-stationarity limits the significance of the results.

  1. For a legal history of proxy access, see Bernard S. Sharfman, What Theory and the Empirical Evidence Tell Us about Proxy Access, 12 J.L. Econ. & Pol’y (forthcoming 2016). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2757761.
  2. 17 C.F.R. §240.14a-8(i)(8) (2011).
  3. 17 C.F.R. §240.14a-8(d) (2011).
  4. Sidley Austin LLP, Proxy Access Update – Momentum Continues to Build in 2016 4 (2016), http://www.sidley.com/~/media/update-pdfs/2016/09/proxy-access-momentum-in-2016–september-22-2016.pdf.
  5. Universal proxy access would automatically allow certain privileged shareholders to place their Board nominees into the proxy solicitation materials of almost all public companies without the need for a charter amendment or bylaw. The SEC adopted a universal proxy access rule that was to become effective on November 15, 2010. Prior to it being implemented, the D.C. Circuit Court of Appeals unanimously decided to vacate the rule after determining that the SEC had promulgated the rule in violation of the Administrative Procedure Act’s “arbitrary and capricious” standard of review. See Sharfman, supra note 1, at 18.
  6. Tara Bhandari, et al., Public versus Private Provision of Governance: The Case of Proxy Access, (SEC Staff Working Paper, 2015), http://www.sec.gov/dera/staff-papers/working-papers/public-vs-private-provision-of-governance.pdf. For a review of empirical studies on universal proxy access, see Sharfman, supra note 1.
  7. Illievy and Kalodimos are no longer with the SEC.
  8. Roberta Romano, Less is More: Making Shareholder Activism a Valuable Mechanism of Corporate Governance, 18 Yale J. on Reg. 174, 187 n.37 (2001).
  9. Press Release, Office of the New York City Comptroller, Comptroller Stringer, NYC Pension Funds Launch National Campaign to Give Shareowners a True Voice in How Corporate Boards Are Elected (Nov. 6, 2014), http://comptroller.nyc.gov/newsroom/comptroller-stringer-nyc-pension-funds-launch-national-campaign-to-give-shareowners-a-true-voice-in-how-corporate-boards-are-elected/.
  10. S.V.D. Nageswara Rao and Sreejith U, Event Study Methodology: A Critical Review, 3(1)A The Macrotheme Rev. 40, 44 (Spring 2014).
  11. S. P Khotari & Jerold B. Warner, Chapter 1 – Econometrics of Event Studies, in Handbook of Empirical Corporate Finance 3 (B. Espen Eckbo ed., 2007).
  12. Five firms were removed from the sample because they had made earnings announcements on that day.
  13. The Bhandari report was not exclusively focused on the Comptroller’s announcement. In total, it evaluated 158 proxy access proposals, including the Comptroller’s 75 proposals, at 133 firms over four proxy seasons. Bhandari, supra note 6, at 14.
  14. The stay date was October 4, 2010. See Bhandari, supra note 6, at 11.
  15. Bhandari, supra note 6, at 19.
  16. Sumberg, supra note 9.
  17. Bhandari, supra note 6, at 43, tbl. 3.
  18. Sharfman, supra note 1, at 15.
  19. Jena McGregor, ExxonMobil Shareholders Just Approved a Powerful New Measure That Could Reshape investors’ Influence on Company Boards, Wash. Post, May 25, 2016, https://www.washingtonpost.com/news/on-leadership/wp/2016/05/25/big-investors-are-getting-a-powerful-new-right-in-record-numbers-if-they-ever-use-it/.
  20. Sumberg, supra note 9.
  21. Aswath Damodaran, Investment Valuation: Tools and Techniques for Determining the Value of Any Asset 121 (3d ed. 2012) (When a sample is “random, this does limited damage to the results of the study. If the choice is biased, it can provide results which are not true in the larger universe.”).
  22. Bernard S. Sharfman, Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value?, 2015 Colum. Bus. L. Rev. 813, 825 (2015).
  23. Bhandari, supra note 6, at 28.
  24. Id. at 15 (“We control for industry in all of our tests.”).
  25. Henry G. Manne, Mergers and the Market for Corporate Control, 73 J. Pol. Econ. 110 (1965).
  26. See generally Brian R. Cheffins & John Armour, The Past, Present, and Future of Shareholder Activism by Hedge Funds, 37 J. Corp. L. 51, 58 (2011); Paul Rose & Bernard S. Sharfman, Shareholder Activism as a Corrective Mechanism in Corporate Governance, 2014 BYU L. Rev. 1014 (2015).
  27. Craig Doidge et al., The U.S. Listing Gap 5 (Nat’l Bureau of Econ. Research, Working Paper No. 21181, 2015).
  28. Shane Goodwin, Myopic Investor Myth Debunked: The Long-Term Efficacy of Shareholder Advocacy in the Boardroom 51, tbl. 1 (Harvard Bus. Sch., Working Paper, 2014), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2450214.
  29. Id. at 52.
  30. See Damien Park, How Activist Investors Identify Their Targets, Director Notes (Conference Bd., N.Y.), June 2016, at 3, fig. 3.
  31. See generally Bernard S. Sharfman, A Theory of Shareholder Activism and its Place in Corporate Law, 82 Tenn. L. Rev. 791 (2015); Bernard S. Sharfman, The Tension Between Hedge Fund Activism and Corporate Law, J.L. Econ. & Pol’y (forthcoming 2016), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2722124 (exploring the connections between proxy access proposals and market perception).
  32. See, e.g., Lucian A. Bebchuk et al., The Long-Term Effects of Hedge Fund Activism, 115 Colum. L. Rev. 1085 (2015); Nicole M. Boyson & Robert M. Mooradian, Corporate Governance and Hedge Fund Activism, 14 Rev. Derivatives Res. 169, 175–78, 201 (2011); Alon Brav et al., Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. Fin. 1729, 1731 (2008); Christopher P. Clifford, Value Creation or Destruction? Hedge Funds as Shareholder Activists, 14 J. Corp. Fin. 323, 324 (2008); Robin M. Greenwood & Michael Schor, Investor Activism and Takeovers, 92 J. Fin. Econ. 362, 374 (2009); April Klein & Emanuel Zur, Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors, 64 J. Fin. 187, 217–18 (2009).
  33. See Rao & Sreejith U, supra note 10.
  34. Id.
  35. See Damodaran, supra note 21, at 112.
  36. See Yaniv Konchitchki & Daniel E. O’Leary, Event Study Methodologies in Information Systems Research, 12 Int’l J. of Acct. Info. Systems 99, 108 (2011).

Navigating Conflicting Roles: The Ethical Obligations of an Organization’s Lawyers Post-Wells Fargo

* J.D. Yale Law School (2016); J.D. candidate, Yale Law School (2017 expected); J.D. candidate, Yale Law School (2017 expected), respectively. The authors are student members of the Ethics Bureau at Yale, a legal clinic at Yale Law School supervised by Professor Lawrence J. Fox, the George W. and Sadella D. Crawford Visiting Lecturer in Law at Yale Law School. For their time, insight, and meticulous guidance, we are indebted to Professor Larry Fox, Christine Michelle Duffy, Irwin Warren, and the student members of The Ethics Bureau at Yale. All errors are our own.


Government-initiated enforcement actions aimed at exposing white-collar crime have proliferated considerably following the recent financial crisis. To get ahead of these investigations, many organizations hire in-house or external counsel to conduct their own preliminary investigations. These internal investigations create significant issues for lawyers who must provide to employees they interview an “Upjohn warning”—a disclosure that the lawyer represents only the organization and its interests. Lawyers must caution employees that while their communications are protected by the attorney-client privilege, the privilege belongs to the organization, and the corporation may elect to waive the privilege and disclose otherwise protected information to third parties.1 To date, lawyers have largely confined Upjohn warnings to the context of internal investigations. But a recent case, decided by the District Court for the Southern District of New York, raises the possibility that the ethical lawyer should give Upjohn-like warnings in a wider variety of day-to-day conversations and consultations.

In United States v. Wells Fargo Bank, N.A.,2 the court held that an employee could not disclose the privileged information necessary to raise an advice-of-counsel defense because the corporation owned the privilege.3 As a result, Wells Fargo poses a corollary question to the one addressed in Upjohn. Under Upjohn, organizational lawyers must warn employees that the organization may disclose privileged information over an employee’s objection. After Wells Fargo, the question becomes whether organizational lawyers warn employees that the organization may refuse to disclose privileged information in response to an employee’s legitimate request to do so. This white paper explores the professional ethical repercussions of the Wells Fargo decision and proposes several steps that organizations and their lawyers can take to reckon with the case’s implications.

I. Wells Fargo, Upjohn, and the Obligation to Warn

In Wells Fargo, the government brought fraud charges against both Wells Fargo Bank and Kurt Lofrano, one of the bank’s vice presidents. Lofrano stated that he relied on the advice of company counsel, but Wells Fargo objected to the disclosure of privileged attorney-client communications.4 The court issued two important holdings. First, it held that an employee otherwise lacking authority to waive the attorney-client privilege on the corporation’s behalf could not do so for the purpose of raising a personal advice-of-counsel defense, stating that “the privilege is not waived by the employee’s mere invocation of an advice-of-counsel defense during discovery.”5 Having refused to find an implied waiver, the court then had to decide whether “Lofrano’s right to present an advice-of-counsel defense . . . override[s] Wells Fargo’s privilege.”6 The court concluded that it did not, explaining that “to hold that Lofrano can pursue his defense over the Bank’s objection would ‘render[ ] the privilege intolerably uncertain.’”7

Wells Fargo holding affirms the longstanding principle that only the party who holds the privilege may waive it through either an explicit or implied waiver.8 Indeed, this principle appears to hold true despite the tremendous costs it may place on employees’ abilities to put forth their best defense.9 As such, an employee who receives and acts on the advice of organizational counsel would likely be barred from raising an advice-of-counsel defense if the organization refuses to waive attorney-client privilege, even when that defense is the backbone of the employee’s case.

Wells Fargo belongs to a long line of cases wherein organizations and their employees diverge on the issue of waiving attorney-client privilege.10 The most important of these cases is Upjohn Co. v. United States. In Upjohn, the Court held that organizational counsel’s conversations with employees fell under the attorney-client privilege, but the privilege belonged solely to the corporation, and not the employee. There, “[m]anagers were instructed to treat the investigation as ‘highly confidential’ and not to discuss it with anyone other than Upjohn employees who might be helpful in providing the requested information.”11 The Court found this disclaimer to constitute sufficient notice to inform the employees that their communications with counsel were privileged and that the employees did not control that privilege. In reaching its decision, the Court explained: “[T]he privilege exists to protect not only the giving of professional advice to those who can act on it but also the giving of information to the lawyer to enable him to give sound and informed advice.”12

The purpose of the Upjohn warning is to inform employees that the advice they receive is for the organization and not themselves. The warnings have no statutory basis, and so companies may formulate them in multiple ways. Standard Upjohn warnings inform the employee of the following: (a) the lawyer represents the employer; (b) any advice given during the conversation is for the organization and not the employee; (c) the communication is protected by the attorney-client privilege, but that privilege belongs to the organization and not the employee; (d) the organization may choose to waive the privilege and disclose the employee’s statements to a third party, including government authorities; and (e) the employee has an obligation to keep the contents of the communication confidential.13 However, even seemingly watered-down Upjohn warnings have been held acceptable so long as employees do not reasonably believe that they have an attorney-client relationship with the organizational counsel. For example, the Ninth Circuit found a warning that the employee was being interviewed “on behalf of” a company sufficient, at least where subsequent conduct by the employees indicated that they were aware that the privilege belonged to the company.14

In addition to allowing less formal versions of the Upjohn warning in the internal investigation context, Wells Fargo and other federal court opinions suggest that Upjohn warnings may also be required outside the context of internal investigations. For example, in In re Kellogg, Brown & Root, Inc., the court held that the distinction between talking with counsel for the sake of gaining legal advice and for purposes of complying with a routine regulatory or company policy rested on a “false dichotomy.”15 The court also noted that “a variety of other federal laws require similar internal controls or compliance programs.”16 Indeed, courts may hesitate to draw lines between investigative and non-investigative communications because, as a practical matter, the potential for conflicts of interest will exist in both situations.

II. The Dual Nature of Lawyers’ Ethical Obligations

Wells Fargo made clear that employees who act in reliance on the advice of organizational counsel may be prevented from raising an advice-of-counsel defense in litigation. Lawyers now have notice that courts may honor an organization’s refusal to waive privilege, meaning that reliance on the lawyer’s advice might put the employee in legal peril. This raises a series of Upjohn­-like questions: After Wells Fargo, when does an organizational lawyer have an ethical duty to warn? Must organizational lawyers always inform employees that they do not represent them and that all succeeding conversations are protected by organizational privilege, or do lawyers have flexibility to decide when such warnings are necessary? What information should the warning contain, and should lawyers advise employees to retain their own counsel?

The organizational lawyers’ obligation to warn can be gleaned from the Model Rules of Professional Conduct (Model Rules), which imposes duties on lawyers with respect to both their organizational clients and the individual employees within the organization. The Model Rules set the following standard: An organization’s lawyer must warn employees that they are not the lawyer’s clients, and that the organization owns the privilege for any succeeding conversations, in situations wherein the lawyer reasonably believes that the employee’s interests may be or become adverse to the organization’s interests. This standard derives from a combined reading of Model Rules 1.13, 4.3, and 1.7.17

First, Model Rule 1.13 sets out lawyers’ ethical obligations when representing an organizational client. Because an organization cannot act except through its directors, officers, and other employees, counsel’s client is “the organization acting through its duly authorized constituents.”18 Lawyers do not, however, represent individual employees in their personal capacity.19 Thus, “[i]n dealing with an organization’s directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization’s interests are adverse to those of the constituents with whom the lawyer is dealing.”20 The comment to Rule 1.13(f) further explains that this warning should include reminders that “lawyer[s] cannot represent such constituent,” “that such person may wish to obtain independent representation,” and that lawyers’ discussions with “the individual may not be privileged.”21

The Wells Fargo decision sheds light on when organizational lawyers should perceive potential adversity between the organization and employees’ interests. Because lawyers must maintain confidentiality of client information, employees may become adverse to the organization whenever employees face personal liability for which they would like to raise an advice-of-counsel defense. In such a situation, the organization may refuse to waive the attorney-client privilege. When lawyers reasonably foresee that such a conflict may arise, they have a duty to remind the employee of the identity of their organizational client and their client’s right to prohibit the employee from disclosing any legal advice the organization’s lawyers provide.

This interpretation is further bolstered by Model Rule 4.3, which governs lawyers’ interactions with unrepresented persons. It states:

In dealing on behalf of a client with a person who is not represented by counsel, a lawyer shall not state or imply that the lawyer is disinterested. When the lawyer knows or reasonably should know that the unrepresented person misunderstands the lawyer’s role in the matter, the lawyer shall make reasonable efforts to correct the misunderstanding. The lawyer shall not give legal advice to an unrepresented person, other than the advice to secure counsel, if the lawyer knows or reasonably should know that the interests of such a person are or have a reasonable possibility of being in conflict with the interests of the client.22

This rule clearly requires that, in situations wherein the interests of the organization and an individual employee may potentially conflict, organizational counsel must refrain from giving any indication that would lead such employees to believe that they are represented by counsel. The burden is on lawyers to unambiguously communicate that they represent the interests of the organization and not the employees. This communication should include a reminder that, in any correspondence between the lawyer and the employee, the organization owns the privilege and is the sole entity that may waive it.

Failure to clarify the identity of an organizational counsel’s client not only violates a lawyer’s duties to unrepresented employees, but also may violate a lawyer’s obligations to their organizational clients. Of course, employees’ interests will not always clash with organizational interests; oftentimes, interests will align.23 However, when organizational counsel can reasonably foresee a potential conflict, they must adequately dispel an employee’s perception that a lawyer-client relationship has been formed. Otherwise, they risk unwittingly creating an “accidental client” based on the employee’s detrimental reliance.24 Taking on an accidental client can violate a lawyer’s ethical obligations to their organizational clients if the new employee-client’s interests are adverse to the interests of the organization. Indeed, the Model Rules prohibit a lawyer from taking on a representation that involves a concurrent conflict of interest—a situation in which “the representation of one client will be directly adverse to another client” or “there is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client.”25

In sum, the discussed Model Rules converge to impose an obligation on organizational lawyers to warn employees that the lawyers represent the organization, not the employee, whenever lawyers reasonably believe the employee’s interests may be or become adverse to the organization’s. This adversity arises because the organization may refuse to waive attorney-client privilege despite the employee wishing to waive it for the purpose of raising an advice-of-counsel defense.

III. Recommendations for Organizations and their Lawyers

The failure to give an adequate warning could have serious consequences for both lawyers and her organizational clients. Lawyers may face state bar disciplinary proceedings and/or malpractice liability, and employers may suffer the attendant reputational (and potentially financial) costs of their lawyers’ professional misconduct. Importantly, disciplinary and civil malpractice proceedings would progress separately from the original litigation, and the failure to warn does not necessarily affect the organization’s ability to control disclosure of the privileged communication.26 However, if the failure to warn creates an accidental client, then the employee can assert her own attorney-client privilege. Furthermore, if corporate counsel accidentally forms a lawyer-client relationship with the un-warned employee, then counsel would need to withdraw from both representations in order to avoid concurrent representation of adverse clients.27

That said, identifying the existence of an ethical obligation to warn in theory leaves many questions open in practice. Organizational lawyers provide advice to employees in a variety of contexts, and it would not be practical or advisable for lawyers to begin each and every interaction with a warning. At least in certain contexts, requiring a warning before every consultation might deter employees from sharing information with organizational counsel. As the Supreme Court has recognized, these consultations are essential because they allow “the advocate and counselor to know all that relates to the client’s reasons for seeking representation [so that] the professional mission [can] be carried out.28 Furthermore, “full and frank communication between attorneys and their clients . . . promote[s] broader public interests in the observance of law and administration of justice.”29 Thus, Wells Fargo exposes a central irony that plagues the attorney-client privilege in the organizational context—the very privilege that is supposed to encourage employees to talk with counsel also threatens to chill such interactions.

The need to balance counsel’s obligations to both the organization and individual employees prevents the mechanical application of cookie-cutter rules. Rather, the proper approach is structural, involving effort along two dimensions. First, by drawing on institutional memory and building organizational capacity, counsel should proactively identify situations that require warnings and clearly communicate those warnings when appropriate. Second, to protect both the organization and its employees in situations where the need for a specific warning was not anticipated, organizational lawyers must foster a culture of notice through the organization’s daily business practices and employee training.

A. Giving Specific Warnings to Employees

The organizational lawyer’s first task is to determine when a warning is appropriate. On one hand, lawyers understand that there is an ethical obligation to clarify the existence and scope of representation unambiguously. On the other hand, lawyers should also be aware that excessive warnings could damage rapport and have a chilling effect on employees, making them less willing to seek or accept counsel’s advice. As the analysis above has indicated, ethical rules require that lawyers clearly warn an employee when they reasonably believe that the interests of the employee and the organization may be or become adverse to one another in the matter consulted upon. However, consultations with organizational counsel may lead to both organizational and individual liability in many situations. As such, the important task is to determine when the interests of the organization and the individual would not align in cases wherein both are sued for an alleged wrongdoing. To make this complex determination reliably, companies must engage in capacity-building efforts involving dialogue among employees, information gathering, and extensive record keeping.

Based on their professional experiences, lawyers have a general sense of the types of issues that are more likely to result in adversity between the organization and the individual employees. Some examples of these issues include individual acts of corruption or managerial employment discrimination against specific groups of employees. By collecting this information from practicing lawyers, looking into the organization’s specific history and institutional practice, and examining relevant case law and government investigation histories, organizations and their lawyers should work together to build a repertoire of potentially risky scenarios that are more likely to lead to conflicts. Furthermore, lawyers should dutifully record this information to aid institutional memory and serve as a reference for other organizational lawyers faced with similar dilemmas.

Once an organizational lawyer determines that a warning is necessary, she must clearly issue the warning before the employee reveals any information or receives any advice. The warning should include the following components:

  1. Counsel represents the organization and not the employee.
  2. The employee’s communications with the lawyer are protected by the attorney-client privilege.
  3. The privilege belongs solely to the organization and not to the employee.
  4. Only the organization may waive the privilege in order to disclose the contents of the communication to third parties in any subsequent proceeding.
  5. The employee will not be notified if the privilege is waived.
  6. The employee must keep confidential the information discussed, even if the employee later wants to say it relied on counsel’s advice.
  7. The employee should consider securing separate, individual representation.

Organizational lawyers should memorialize the giving of the warning, for example, by requiring the employee being interviewed to date and sign a form before proceeding with the communication.30 This memorialization serves two purposes. First, it provides the organization and employee with written evidence of notice, which is useful in future investigations and hearings. Second, the formality of the approach gives employees the opportunity to read the warning carefully and weigh the benefits and risks of continuing the communication.

B. Developing an Organizational Culture of Notice

Legal discretion is, of course, imperfect. Situations will inevitably arise, especially in the capacity-building stage, wherein lawyers reasonably believe that an organization and its employees will not develop interests adverse to one another but unexpected events later create an unforeseen conflict. It is very hard for lawyers to remedy this type of situation satisfactorily after-the-fact. As such, it is critical that lawyers cooperate with organizations to prospectively equip employees with knowledge of Wells Fargo’s implications through educational structural and policy adjustments. Giving employees a degree of control over how they choose to communicate with lawyers is the best safeguard to maintaining the delicate balance between their interests and the organization’s.

The first step towards establishing an ethical culture of notice is to provide information and training to every employee as part of the onboarding process. This is especially necessary for key employees who will be heavily involved in organizational decision-making. First, employees must be made aware of a relevant section on legal representation in their employee handbook and should also be provided with a memorandum on the scope of legal representation in their onboarding packets. Furthermore, employees could be required to attend introductory training sessions that mirror routine orientation lectures already provided by many organizations. These sessions should emphasize the implications of Wells Fargo and may employ a variety of learning tools such as simulations, lectures, videos, and hands-on exercises. Of course, current employees hired before the onboarding program’s launch should retroactively receive the same training and resources so that information is freely, fully, and continuously disseminated.

The efforts should not end, of course, at the beginning of an employee’s tenure at the organization. Organizations and their lawyers should collaborate to periodically remind employees of the nature and scope of organizational counsel’s representation. Such a reminder can be accomplished through the circulation of internal memoranda or company-wide e-mails. Organizational counsel may also arrange short seminars and workshops wherein employees are allowed to speak candidly with the organization’s lawyers about representational issues in a variety of legal scenarios. The benefits of such seminars would be two-fold. First, they would foster more open discussions about organizational lawyers’ roles and relationship with individual employees. Second, the seminars would also serve as a forum for lawyers to build rapport and trust with the organization’s employees.

It is imperative that the aforementioned seminars, trainings, and informational materials be tailored to specific employees’ functions, seniority levels, and decision-making roles within the organization. Indeed, the legal issues facing a manager are far more numerous than and fundamentally different from the issues facing entry-level employees. As such, managers would likely need additional and extended sessions. Similarly, training should increase in the wake of major changes in the law, such as Wells Fargo and Upjohn, as well as major events in the organization, such as a government investigation or enforcement action. Finally, employees, especially managers and officers, should be constantly alerted to the option of seeking individual representation in areas of high legal complexity and risk.

To be sure, creating an organizational culture of notice will require an investment of institutional resources—but the benefit is worth the cost. Most importantly, all lawyers have an obligation to comply with applicable rules of professional conduct, even when compliance costs time and money. Second, and more directly relevant to an organization’s bottom line, building a culture of notice will help prevent the creation of accidental clients and insulate the organization against litigation concerning a former employee’s putative advice-of-counsel defense. Lastly, clearly communicating the organizational counsel’s role will help build trust between employees and an organization’s lawyers, ensuring that both groups can more effectively and efficiently support each other’s work.

IV. Conclusion

Wells Fargo clearly exposes the challenges facing lawyers in the context of organizational representation. Specifically, lawyers must serve as effective and zealous advocates for their organization while simultaneously honoring their ethical duties to unrepresented employees. As this white paper has discussed, lawyers must craft creative solutions to prevent the negative consequences of a Wells Fargo dilemma. Specifically, they should strive to institute small structural changes that (1) aid in the prediction of potential adversity between organizational and individual interests and (2) foster a culture of notice and information regarding the scope of legal representation.

  1. See Upjohn Co. v. United States, 449 U.S. 383 (1981).
  2. 132 F. Supp. 3d. 558 (S.D.N.Y. 2015) [hereinafter Wells Fargo I]. In fact, the court issued two opinions on the advice-of-counsel issue. See also United States v. Wells Fargo Bank N.A., No. 12-CV-7527 (JMF), 2015 WL 3999074, at *1 (S.D.N.Y. June 30, 2015) ]hereinafter Wells Fargo II]. In the body text, this paper will collectively refer to both opinions as the Wells Fargo case.
  3. Wells Fargo I, 132 F. Supp. 3d at 563.
  4. Wells Fargo I, 132 F. Supp. 3d at 560.
  5. Wells Fargo II, No. 12-CV-7527 (JMF), 2015 WL 3999074, at *2.
  6. Wells Fargo I, 132 F. Supp. 3d at 563.
  7. Id. at 564 (quoting Ross v. City of Memphis, 423 F.3d 596, 604 (6th Cir. 2005) (alteration in original)).
  8. Note, however, that because managers are fiduciaries acting on behalf of stockholders, courts may in some cases permit shareholders to discover attorney-client communications between corporate counsel and corporate managers. See Garner v. Wolfinbarger, 430 F.2d 1093, 1103–04 (5th Cir. 1970) (“The corporation is not barred from asserting [attorney-client privilege] merely because those demanding information enjoy the status of stockholders. But where the corporation is in suit against its stockholders on charges of acting inimically to stockholder interests, protection of those interests as well as those of the corporation and of the public require that the availability of the privilege be subject to the right of the stockholders to show cause why it should not be invoked in the particular instance.”); see also 1 John K. Villa, Corporate Counsel Guidelines § 1:27 (2015) (stating that “Garner has become the accepted law” and collecting cases).
  9. Acknowledging that “the Supreme Court did leave open the possibility that ‘exceptional circumstances implicating a criminal defendant’s constitutional rights might warrant breaching the privilege,’” the Wells Fargo Court emphasized that “this case is civil, not criminal, and therefore would not fall within such an exception even if it did exist.” Wells Fargo I, 132 F. Supp. 3d at 562.
  10. Furthermore, although Wells Fargo imagines a for-profit context, its implications extend to non-profit organizations as well.
  11. Upjohn Co. v. United States, 449 U.S. 383, 387 (1981).
  12. Id. at 390.
  13. See Robert R. Calo et al., Upjohn Warnings: Recommended Best Practices When Corporate Counsel Interacts with Corporate Individuals, Am. B. Ass’n (2009), https://www.crowell.com/PDF/ABAUpjohnTaskForceReport.pdf.
  14. United States v. Ruehle, 583 F.3d 600, 609 (9th Cir. 2009).
  15. 756 F.3d 754, 758 (D.C. Cir. 2014).
  16. Id. at 762.
  17. The New York Rules of Professional Conduct have an even more expansive conflict of interest standard that bars lawyers from representing clients with “differing,” and not necessarily adverse, interests. N.Y. Rules of Prof’l Conduct r. 1.7(a)(1).
  18. Id. r. 1.13.
  19. Id. r. 1.13 cmt. 2.
  20. Id. r. 1.13(f).
  21. Id. r. 1.13 cmt. 10.
  22. Id. r. 4.3.
  23. See Susan R. Martyn, Accidental Clients, 33 Hofstra L. Rev. 913, 939 (2005).
  24. See id. at 938.
  25. N.Y. Rules of Prof’l Conduct r. 1.7.
  26. United States v. Ruehle, 583 F.3d 600, 612-13 (9th Cir. 2009).
  27. See Brandon L. Garrett, Corporate Confessions, 30 Cardozo L. Rev. 917, 944-45 (2008).
  28. Trammel v. United States, 445 U.S. 40, 51 (1980).
  29. Upjohn Co. v. United States, 449 U.S. 383, 389 (1981).
  30. See, e.g., United States v. Nicholas, 606 F. Supp. 2d 1109 (C.D. Cal. 2009).