by John A.C. Keith 1998–99 VSB President

Your Virginia State Bar has a split personality. On the one hand, the VSB is an organization that is all about and for lawyers. At the same time, however, we have heavy responsibilities to the non-lawyer public. Most of us know this, but all of us forget it sometimes.

The primary mission of the Virginia State Bar is, as you know, to regulate the profession. The unstated, but clearly implied justification for this mission is to protect the public from the mischief that lawyers can cause when they are not properly monitored and controlled. We value self-regulation highly, but we must not lose sight of the public’s stake in it, lest we jeopardize this privilege.

Sometimes our dual constituency gives us difficulty. What is most comfortable for the bar is not always best for the public we serve. I hope you can think of some examples for yourself, but let me give your imagination a boost. Lawyers want to control access to the details of disciplinary records; potential consumers of legal services want to know all. Lawyers say that the public needs to be protected from nonlawyers who are now doing work once reserved to the legal profession; others are saying that we should let a free market decide who does the best work. Some lawyers insist on pushing the envelope of permissible advertising; the public is often appalled. You get the idea.

While our outstanding voluntary bar associations can be unabashed and effective cheerleaders for their members and for the profession generally, a mandatory bar organization cannot act that way. The Virginia State Bar is a state agency, operating under the Supreme Court of Virginia, and our threefold mission is (1) to regulate the profession (for the sake of the public); (2) to improve the public’s access to the legal system; and (3) to improve the legal and judicial systems (so the public is better served). Everything the VSB does has a public aspect to it, and it is critical that we never lose sight of that fact. The privilege of self-regulation lies in the balance.

Most of us accept on faith that self-regulation is an important asset to the profession, but how much thought have we given to the way in which the system benefits the public? In fact, the system of self-regulation of lawyers has worked well for generations and is still performing admirably. Several reasons for this somewhat surprising success emerge as one ponders the situation. First and foremost, we are part of a proud profession that recognizes the importance of adherence to a strict code of ethical conduct. Our tradition of excellence motivates us to rout out from our ranks those who bring us dishonor. Another fundamental aspect of our system is that it would be difficult, if not impossible, to operate it without lawyers. Our participation in any system that strives to provide just adjudication is almost a given. Lawyers and judges are integral to administration of the rule of law and protection of individual rights and societal values.

But just because we want to do the job and do it rather well by no means assures us that the system will automatically go on in perpetuity. Self-regulation is not a right, but a privilege, and we must never forget it.

How can we best preserve this crown jewel of the organized bar? We must guarantee that we are in a position to provide the resources it needs in order to flourish. The bedrock of our system is now, and always has been, a steady supply of talented and energetic volunteers. It is these generous men and women who fill the vast majority of front line jobs in our disciplinary system. Our volunteer force, some 213 strong, is comprised overwhelmingly of lawyers, but with a crucial leavening of lay persons who bring their indispensable perspective to every adjudication rendered by the Virginia State Bar. We owe a huge debt of gratitude to the lawyers of Virginia who have given selflessly to the operation of every aspect of our system.

The day when we could run the disciplinary process with few if any full time staff is long gone. Our staff is the backbone and pacemaker of lawyer discipline in Virginia. Our Bar Counsel, Barbara Williams, and her staff of dedicated lawyers not only represent the Bar in disciplinary matters, but also do scads of other jobs to keep the process moving along. Jim McCauley has earned a reputation as a guru of legal ethics and UPL, and the demands on him are on the rise. Patricia Rios, Clerk of the Disciplinary System, and her staff have a gigantic job in managing the mountain of records and other paperwork that the system generates. These are only a few of those on the VSB staff who are so important to the operation of the regulatory process. Here is my point—we cannot do the job without the staff; but in this cost-cutting era, staff size has not kept up with workload. Consequently, we are seriously understaffed and the workload is threatening to get the better of them. We must do what it takes to keep pace, or our ability to handle the important business entrusted to us will be impaired.

One final thing we, as a bar, must do in order to keep our system of self-regulation in good shape is to keep an open mind. We need constantly to be tinkering with our rules and processes in order to assure that they work right and are fair to all participants and to be willing to rethink completely any and all aspects of the way we have always done it. This responsibility rests to a large extent on elected and appointed bar leaders, but I hope that all Virginia lawyers will take a share of the load. Help those who are charged with deciding the shape that our cherished system takes in the future. Help them remember that the success of our self-regulatory efforts will be measured by how well we serve and protect the public.

by Alan D. Strasser

When your company learns that its own employee has stolen a lot of money, what should it do? Once it investigates to learn what happened, where should it go with the answer? Should the answer be written or oral?

Our recent experience illuminates some of the legal and practical problems that can arise during an internal investigation from the perspectives of inside counsel and outside counsel.1 Although many issues arose during this matter, this article focuses on three of them: 1) Discovery of the fraud occurs slowly, as company employees do not typically assume that irregular patterns mean that the company has been defrauded. 2) Having decided to investigate, the company must decide who will conduct the investigation and whether to create a written record of it. 3) The company must decide whether it will report the results to law enforcement and if so, to whom it should make the report.

We investigated a scheme that cost the Corporation more than a million dollars. A long-time Employee enlisted an Outside Vendor("Vendor") to cheat the Corporation concerning the provision of certain computer services. The Employee, who had the authority to order certain outside work, allowed the Vendor to submit invoices for the preparation of Computer-Assisted Drawings (CAD). Although the Vendor prepared none of the drawings, he would invoice the Corporation weekly for $7500 worth of phantom drawings. The Employee would approve payment and hand-carry the check to the Vendor. The Corporation eventually discovered the scheme and reported it to the FBI. Both men were indicted, pled guilty in federal court to fraud charges and eventually were sentenced to prison.

No Clear Signal About Bringing In Outside Help

No bell rang to announce that the Corporation had been defrauded. The slow unraveling of the fraud scheme came as a series of revelations to Corporate managers. A change in the accounting systems at the Corporation prompted one manager to ask questions about the size of his department’s annual costs from the Vendor. Those questions led to internal accounting inquiries that revealed that the Employee ordered the work, approved the work and approved payment for the work. No manager assumed that the Employee had done anything wrong, much less that he had concocted a fraudulent scheme, as he was a third generation employee of the Corporation and had worked there for twenty-eight years. The accounting inquiries led to the involvement of in-house counsel, who decided to bring in outside counsel with expertise in investigating frauds.

Close questioning of the Employee produced some inconsistencies and gaps in his explanation of the services that the Corporation was receiving. He also falsely denied having any financial relationship with the Vendor. Although the Employee insisted that the Corporation had received every single CAD drawing it had paid for, he was unable to produce any of them. During an interview with outside counsel, the Employee identified several locations in the Corporation’s computer system where the CAD drawings could be found. The Corporation looked there and found none the drawings. Without any warning to the Corporation or co-workers, the Employee resigned the next day.

Some Corporate managers were reluctant to believe that a long-time employee had stolen so much money. The managers believed that the Corporation had paid the Employee well and they had heard no major complaints from him. The Employee concealed most of the evidence of his new-found wealth for most of the duration of the scheme. The managers initially expressed skepticism about the need for investigating anything and wanted to gather as much information as possible before confronting the Employee. The Employee’s misleading answers during the interview and his precipitous resignation evaporated any doubt that the Corporation had been the victim of the crime.

As no one had been caught red-handed in the act of defrauding the Corporation, the proof of the scheme required the patient assembly of circumstantial evidence to rebut the denials by Employee and Vendor of any problems. Each new piece of evidence confirmed the conclusion that a fraud had been committed. When the internal audit was finally completed, the Corporation realized that it had been cheated on a broad scale.

Who Conducts the Investigation and Prepares the Report?

When faced with a potential fraud, the company should choose someone with experience in conducting internal investigations to direct an investigation. The company also should anticipate the possibility that the investigator may become a witness in a criminal prosecution or the subsequent civil case brought either by the insurance company or the company. In our case, the U.S. Attorney planned that both inside and outside counsel would testify at the trial of Employee and Vendor about statements each of those men had made during the internal investigation.

The investigation may require substantial accounting or technical expertise. In our case, the Corporation was able to call on an experienced internal auditor to conduct much of the internal accounting work. Use of company employees to conduct the investigation may reduce the cost of the investigation. Given the multiple demands on the time of employees, though, it is important to build an internal constituency for the investigation. It is not unusual to find that some managers resist conducting a thorough investigation in the belief that it is not worth the money to hire outside investigators and not worth the other foregone work to use internal investigators. The resistance by other managers can become most apparent when counsel insists that the investigator perform follow-up work or pursue another line of inquiry to nail down a point of proof.

It is possible to supplement the work of the internal auditor with outside experts where needed. Of course, the outside expert really must be an expert. In our case, the Corporation hired a partner in a national accounting firm who said he had experience in conducting investigations regarding computer files. The expert used a commercially available software product to search for the CAD drawing files that the outside vendor was supposed to provide. His search, he said, revealed that none of the files had been provided. Once the FBI interviewed him, though, he acknowledged that he could not say that the files had never been provided, but only that he was unable to find them at the time he searched. He explained to the FBI that he had only used the software on one previous investigation.

The experience with the accounting software "expert" illustrates one enduring problem in investigations: the level of proof necessary to convince internal managers of what has happened often will not suffice for purposes of a criminal prosecution, which requires proof beyond a reasonable doubt. The internal investigators may have to gather evidence for a report to the government that will go far beyond what is necessary to convince internal managers. Additional evidence gathering often confronts internal managers with additional demands on the time and attention of company employees.

Although the company can wait to make a decision whether to disclose the matter to law enforcement once the internal investigation is complete, the company must bear in mind the prospect of such disclosure from the beginning of the investigation. Once the company discloses the report of the internal investigation to the prosecutor, the company will have great difficulty preventing disclosure to third parties.

Will the company report the crime to a prosecutor?

Once the company has completed an internal investigation, it can decide whether to make a disclosure to law enforcement. Some companies do not as matters of policy inform law enforcement about internal thefts, because it is embarrassing. Some feel that it opens up the company to shareholder lawsuits because the loss suggests that the company lacked adequate internal controls. Many companies, though, realize that even the best systems cannot detect every possible fraud scheme, and so prefer to make an example of dishonest employees by referring the matter for prosecution.

A company may report the crime to law enforcement to improve its chances of collecting restitution. Although federal law always permitted a judge to order that a convicted defendant pay restitution, Federal law now requires the court to order restitution as part of the sentence for any defendant convicted of "an offense against property...including any offense committed by fraud or deceit." 18 U.S.C. §3663A(c)(1))A)(ii). Although many criminal defendants lack the resources to make substantial restitution, the court’s order makes it easier for the victim-even a corporate victim-to collect something from the wrongdoer. Of course, the company never can collect unless it reports the matter to law enforcement.

In our case, the Corporation decided to report the matter to law enforcement to publicize that the Corporation would not tolerate this kind of conduct from its employees or outside vendors. The Corporation also reported the loss to its insurance company and obtained reimbursement for the loss.

If the internal investigation results in a referral to law enforcement, the company’s investigative work probably will increase, rather than decrease. Often this will mean educating the managers, internal auditors and even senior management on the virtues of the referral and the potential benefits to the company. Counsel must explain to senior management that a referral may not bring a prompt resolution of the matter nor will it necessarily bring prompt restitution.

In our case, senior management fully supported the referral to law enforcement and understood the logistical support it required. They proved instrumental in insuring that adequate corporate resources were devoted to the internal audit, the referral, and support of the prosecution. Even with this level of support and resources, a year passed between the referral to the FBI and the entry of guilty pleas on the eve of trial. It took eight months from the referral to an indictment, even though the Corporation’s internal auditors had prepared a detailed audit report and the Corporation had amassed thousands of pages of supporting documentation

Should the company prepare a written report?

There is no simple automatic answer to the question whether a company should prepare a written report of its investigation. Preparation of a written report imposes a discipline of clarity and thoroughness not required by an oral report. A written report can explain more systematically a complicated fraud scheme or a large web of circumstantial evidence. A written report makes it easier for others, especially senior management, to review the investigation and the analysis that is part of any internal investigation. The preparation of a written report makes it easier to communicate a concise account of the fraud and its detection to a prosecutor or other outside party.

A written report, however, means there is greater risk of disclosure to people who should not read the report. Given the ubiquity of photocopiers, scanners, and e-mail, it is easy to copy and transmit any written report. Furthermore, a written report commits the writer of it to particular version of the facts that may be contradicted by later discoveries. If the writer then testifies at a trial, he can be impeached with the prior written report.

In our case, the Corporation chose to have internal auditors prepare a written report under the direction of counsel. The links among the pieces of circumstantial evidence in the scheme were too hard to follow without a systematic written description of the evidence and the various tests and searches that the auditors made. Furthermore, counsel wanted senior management to be able to review the report if necessary to understand the origin and scope of the scheme so that the Corporation could implement corrective measures. Finally, counsel wanted a compact summary of the scheme for communication to the prosecutor and insurance company.

Which law enforcement authority should receive the report?

If the company decides to send the case to a prosecutor, which one should it choose? Federal prosecutors typically have more substantial resources, including the FBI, available to them to investigate white-collar crimes.2 They also do not have to juggle the crushing caseloads that state or local prosecutors handle. Furthermore, the Federal Sentencing Guidelines require imprisonment in most cases for anyone who has stolen a substantial sum; state courts may not impose jail time for routine "white collar " crimes. On the other hand, state prosecutors almost always will have jurisdiction over the theft or embezzlement under state criminal laws. Despite the impression created by recent national events, federal prosecutors lack the authority to investigate every imaginable crime. Federal prosecutors typically insist on identifying a specific federal statute that was violated before they will proceed. Although the federal mail fraud and wire fraud statutes have broad reach, they do not cover everything.

In our case, the Corporation preferred to have a federal prosecutor handle the matter. However, the Employee and Vendor did not use the mails or any interstate wires as part of their schemes, so neither the federal mail nor wire fraud statutes applied. The Vendor delivered the invoices by hand, and the Employee delivered the checks by hand. Although we doubt that the Employee or Vendor planned to avoid the mail or wire fraud statutes, their conduct did so. Unfortunately for them, however, the Corporation’s checks were drawn on an out-of-state bank. The deposit of out-of-state bank checks, which traveled interstate as part of the check-clearing process, supported jurisdiction under 18 U.S.C. § 2314 (interstate transport of proceeds obtained by fraud) where the amount of the fraud exceeds $5,000. Pereira v United States, 347 U.S. 1,9 (1954); United States v Scarborough, 831 F. 2d 1244 (D.C. Cir. 1987);

Even after the company has decided to report the crime to a prosecutor, it may have to persuade the prosecutor to investigate and prosecute. Prosecutors may be reluctant to investigate what seems to be an ordinary commercial dispute, because they reason that for-profit entities can protect themselves against theft or other crimes through civil litigation. Furthermore, prosecutors often suspect the thoroughness of any internal investigation, believing that the company may be more interested to find a scapegoat for a problem than to be scrupulous about identifying the true culprit. The prosecutor may suspect that the internal investigation had an ulterior motive that has little to do with the prosecutor’s insistence on neutral and even-handed application of the criminal law. The company must convince the prosecutor that it actually seeks the truth rather than merely identifying a convenient target for blame because the ultimate decision to prosecute remains with the government. The company can advocate prosecution and supply evidence to support it, but it must be careful not to appear heavy-handed about its approach. It must allow the prosecutor to gather the evidence he needs, even if that means duplicating the investigative steps that the company already has taken.

In most jurisdictions, including the Fourth Circuit, the disclosure of an internal investigative report to the government will waive whatever attorney-client privilege would have protected the report from outside parties. In re Martin Marietta ,856 F. 2d 619 (4th Cir. 1988), the Fourth Circuit held that a company’s disclosure to the government of materials from an internal investigation waived the attorney-client and nonopinion work-product privileges when a third party (in that case, an employee) sought to compel disclosure of the items for use in his defense in a related criminal case.3 Disclosure of the company’s internal report may mean that other parties, including potentially adverse civil litigants or the company employee (or in our case, the Vendor) can compel disclosure of the report and its underlying data. In Martin Marietta, the Fourth Circuit exempted only opinion work product from disclosure.

Disclosure of the internal investigative report to the insurance company in support of the company’s claim often will have the same effect. As embezzlement and like schemes often are covered by a company’s insurance policy, the company must examine the question of whether to report the loss to the insurance company and try to recover under its policy. The insurance company typically will want to see evidence of the loss before it pays any money. Should the insurance company get the same report as the prosecutor?

Disclosure to the insurance company almost certainly will bring about a waiver of whatever privileges would have attached to an internal investigative report. Thus, if the company knows that it will submit a copy of the report to the prosecutor, it can submit a copy to the insurance company because the privilege would have been waived in any event. The company should provide the same version of the report to the insurance company as it did to the prosecutor to avoid the possibility of later impeachment with inconsistent statements between the two versions of the report or impeachment with omissions from one of the reports.

Counsel then faces a few choices, none of them ideal. Counsel can try to prepare a report for law enforcement and/or insurance purposes. That report, once disclosed, will not be privileged, but counsel may be able to preserve the privilege for underlying discussions with the company. Counsel must take steps to try to preserve the privilege about any advice he has given the company’s senior management and for discussion with management about strategic choices the company might make in pursuing the investigation, or in fitting the investigation into any other company purpose.

Summary

Internal investigations inevitably raise complicated issues of law and of internal management. We hope that this article has illustrated how these issues intersect generally and in the context of the Corporation’s particular case. We hope that this discussion and the illustration will help others avoid potential pitfalls in these internal investigations.

Endnotes

1 Even though the entire case appeared in court, the Corporation does not wish to be identified publicly. In-house counsel played a substantial role in the internal investigation and in the writing of this article but asked not to be identified to preserve the Corporation’s privacy.

2 The Washington Post published a revealing article showing that embezzlers seldom receive jail time in the state courts in northern Virginia. "A Crime with Little Punishment," Page A1, October 1, 1998.

3 In one recent case, a federal judge upheld enforcement of a subpoena to a company in a civil case for copies of all the materials it had provided to the government in support of a prosecution. The judge ruled that the disclosure to the government waived whatever privilege might have attached to the materials. Resources Inc v Dun & Bradstreet Co, 96 Civ. 5716 (S.D.N.Y. 1998) (Stanton, J.)

A litigation partner in the Washington, D.C. office of Kutak Rock since 1991, Mr. Strasser specializes in the defense of white-collar criminal cases, Congressional investigations, and associated regulatory and administrative investigations. In recent years, his criminal practice has focused on the defense of allegations of health care fraud and fraud against the government and on the implementation of corporate compliance programs.

Mr. Strasser graduated cum laude from Yale College (1974) and Harvard Law School (1977). From 1977 to 1991, he served as a Trial Attorney with the Civil Frauds Section of the Justice Department and as an Assistant U.S. Attorney for the District of Columbia.

by Catherine D. Mayes

We know you have a corporate compliance program. Following the adoption of the U.S. Sentencing Guidelines for Organizations and the decision of the Delaware Chancery Court in In re: Caremark, every company issued (or reissued) a code of conduct and conducted "ethics" training for its employees. Columbia/HCA did so, and then, if one is to believe the indictments and pleadings, people went right ahead and falsified cost reports. My own company adopted a code of conduct in 1993. Yet we have had a number of ethics violations since, none the scale of what happened at Columbia/HCA, but, nevertheless, things that put more gray hair on senior management heads. My guess is your company (or your clients) are not so very different. Does this prove corporate compliance programs are a big waste of time?

Not on your life. A corporate compliance program is effective if it instills among employees the ability to detect violations and the willingness to report them to you. You can not define "success" in ethics training as the elimination of violations. The root causes of unethical behavior are not addressed by ethics training.1 There may be cases where an employee stops doing something wrong as a result of learning that it is wrong, but in our experience, the employee who is engaged in prohibited activity knows it is prohibited and is doing it anyway. So we define "success" in ethics training as getting your ethical employees (which 99% are) to come forward when they see or think they see unethical activity by others.

In order for ethics training to be effective, you have to get past the cynicism ("No one really worries about ethics.") and the defensiveness ("You don’t trust me, do you?") and convince your good employees, especially managers, that ethics is good business. This article suggests how to go about that. It assumes you have a formal code of conduct for employees and formal training on what is required of them by law and by your company’s internal policies. It assumes as well that your company's training is a touch stale and that the formal code of conduct has gathered dust in your bookcase. The challenge is to keep your program healthy.

Step 1: Convince Yourself.

Read (or reread) the cases involving noncompliance in your industry. Read the recent Supreme Court cases involving sexual harassment.2 The message is clear: violations do not go unpunished just because company policy prohibits the illegal act, but the punishment for companies that have conscientiously tried to avoid violations is nearly always less onerous than for companies that have no such track record. More importantly, notice that the violations that end up in the courts are ones that went on a long time, not the ones that were detected and dealt with timely by the company. The longer illegal activity goes undetected, the more likely a major liability will result, with all the attendant bad publicity, loss of management focus, legal costs and other headaches.

Step 2: Convince Your Senior Management.

You’re the lawyer, so the law moves you. Your superiors are businessmen. They need to be convinced that corporate compliance programs work. Ethics is good business. Together with sound business decisions and corporate citizenship, ethics is an essential component of a positive public image—that illusive, but vital good will. In addition, ethics is a risk and cost management tool. This is true for many reasons, all (unfortunately) hard to quantify.

Ethical companies retain good employees. If your employees, all the way up the ranks to middle and senior managers, see unethical behavior in the management layer above them, what do they do? Quit, at best; lose their commitment; or at worst, copy the behavior in the misguided notion that dishonesty is the key to success in your company.

Ethical companies retain good customers. Customers, like employees, are overwhelmingly ethical people. Even when they might suggest or imply they want you to bend a rule on their behalf, they are not likely to leave you for refusing. But when they conclude a company is bending rules routinely, they flee.

It is always cheaper to investigate one false act than to investigate many. It is always cheaper to pay a fine for a single violation than for many. At the risk of being redundant, the realistic objective of the compliance program is early detection, not prevention.

Senior management tends to think all you need to do to get compliance is to tell people if they don’t follow the rules they’ll be fired. Managers with this mindset are not particularly interested in the idea of "selling" ethics. But once a violation occurs, they are engaged. That’s the time to be ready with your message: ethics is good business.

Step 3: Convince Your Employees.

Above all else, employees need to be convinced that senior management is serious about conducting business honestly and within the law, and about punishing wrongdoers.

• Ethics (or something akin to it) needs to be mentioned in every all-hands meeting.

• Ethics needs to be a stated goal of the organization.

• Ethics needs to be enforced in detail: take care of the small stuff and the big stuff doesn’t happen. If an employee is found to have committed a minor violation of law or policy, treat him with dignity but resist the temptation to be "merciful." In most cases the employee who is terminated will find comparable work and will have learned a valuable lesson. More importantly, the employees who remain will have learned a valuable lesson.

• Invite business units to do an updated risk assessment of the ethical and legal issues in their unit. A lively dialogue about where controls are needed or where they may be excessive refocuses attention on the legal and ethical obligations of the group.

• Ethics can be woven into presentations on new products, new tools and new developments in the industry. Besides touting all the bells and whistles, show employees and customers that you know what your moral obligations are by pointing out the edits and audit trails built into the system.

• Respond to every question and report of suspicious activity with great interest and earnestness. For many people, mustering the courage to blow the whistle is a hurdle. It will immediately put them at ease to know you share their concern and will take charge of an investigation or research their issue. This person will find it easier to call you again and will encourage his or her coworkers to call you when they have a question or suspicion.

Endnotes

1 In 1997, the Ethics Officer Association and the American Society for Chartered Life Underwriters and Chartered Financial Consultants sponsored a survey of diverse organizations. More than one-third of the employees admitted committing an ethics violation. The most common violation was cutting corners on quality control. Ethical Management 8:5 (November 1998). Most unethical behavior can be attributed to workplace pressure to perform or personal gain (money, ambition or romance). Ibid at 5.

2 Faragher v. City of Boca Raton, 188 S.Ct. 2275; Burlington Industries, Inc. v. Ellerth, 118 S.Ct. 2257.

Catherine Dunlap Mayes is the Corporate Compliance Officer of Sallie Mae, Inc. Based in Reston, Sallie Mae provides funds for education by purchasing loans, primarily federally guaranteed student loans originated under the Federal Family Education Loan Program, from lenders. The company currently owns or manages student loans for 5.3 million people. The company, including subsidiaries, has approximately 4,000 employees in 13 states. In addition to her compliance duties, Catherine is Legislative Counsel and an expert in title IV of the Higher Education Act of 1965. She graduated in 1977 from the University of Virginia School of Law and practiced 6 years with the D.C. firm of Beveridge and Diamond, P.C., before joining Sallie Mae.

By Janean S. Johnston

It has taken awhile getting used to being treated like Hester Prynne. You remember her—the one with the scarlet letter "A". It is not that my private life is so titillating; it instead reflects what I have chosen to do since leaving law school. My "A" stands for "Auditor", although sometimes in my career of auditing law firms since 1987, I have felt like Hester--misunderstood and condemned to be separated from polite society.

That is why I was caught totally off guard while attending a 1993 conference dealing with Corporate Compliance issues arising out of the 1991 Federal Sentencing Guidelines when I was approached by two people and asked if I would consider auditing the internal law departments of their two respective companies. One request was made by the CEO of a large insurance company and the other was from the general counsel of a well-known food company.

I respectfully declined. I assumed both companies probably had well-run law departments as evidence by their attendance at the seminar. There was also very little time in my busy schedule, so I rationalized that private law firms needed my services much more than in-house law departments, since they were exposed to law suits by their clients when things went wrong, and no one could ever imagine those kinds of problems in an internal law department at that time. So I did not even give a second thought to saying no.

Several years later, the general counsel of a defense firm asked if I would conduct a review/audit of his law department. I said yes this time because I was beginning to understand some of the increasing pressures that internal law departments were starting to experience. After assenting, three questions came to mind: (1) Why would an in-house law department need or want an outside auditor? (2) What would I be reviewing? (3) How could I benefit the general counsel and the company through the audit process and final report?

At our first preliminary strategy session, the general counsel graphically laid out the situation that his Office of General Counsel ("OGC") was operating under at the time. Try and imagine the scenario he described. His corporation had been caught up in the "buy-or-be-bought" frenzy among defense firms after the end of the Cold War and ensuing reductions in defense spending. As a result, his firm acquired an aerospace firm and several unexpected situations arose due to the consolidation. The first was a proxy fight and as a result, five "young Turks" were added to the board, shifting the balance of power and bringing in a new CEO, with a different corporate philosophy, to run the newly merged company. The new company now had many thousands more employees, but only two lawyers were brought from the acquired company’s law department to assist an already down-sized OGC, thereby doubling the already onerous workload. (Remember, "lean and mean" was the mantra of the times.) The entire company was struggling through a major reorganization, and the resulting turmoil. (The day I started my audit, two vice presidents were "let go" and one week prior, another vice president had resigned.) Not only did the general counsel have a new CEO and a different corporate culture, but his law department was responsible for providing the information, materials, and necessary supervision for training and assimilating thousands of new employees and bringing them up to speed on corporate compliance issues (since their old firm had provided no training about such areas as anti-trust concerns, insider trading or the importance of confidentiality, etc.), in addition to the considerable task of coordinating and consolidating all the benefits packages for the new members of the company. Also included on the "to do" list for the OGC was handling a "qui tam" lawsuit which came along with the acquired company, free of charge.

The general counsel had to try and mesh the two different corporate cultures among his own staff (he had a "hands-off" style and the new attorneys were used to a "hands-on" style), and develop systems and procedures that were consistent with everyone’s values and needs and that would be followed by all. Additionally, several of the existing policies created internal turf wars between various divisions in the law department over separate budgets, compensation issues, sharing of support staff, etc. Overriding all of these issues was a general feeling among the OGC members of confusion, mistrust, insecurity, and low morale.

No wonder I was approached to help. The general counsel then gave me the following tasks to accomplish as part of my audit: (1) Review internal departmental procedures, (2) Review their outside counsel management process, (3) Review the intra-department communication process, (4) Analyze the OGC’s organizational fit, and (5) Serve as an ad hoc check on the current health of the department. The purpose of the audit was to prevent "surprises" later for the general counsel.

The procedure I use for conducting an internal audit/review is fairly simple. Every member of the OGC (not just the lawyers, but law clerks, secretaries, etc.) participates in confidential interviews and responds to a set of questions relating to each of the five general areas being reviewed. This approach works best with an outside, objective party conducting the questioning and the review. It should also be noted that every audit is unique, and the questions developed are dependent upon the type of corporation and the scope of the review, as selected and determined in cooperation with the general counsel, and can vary greatly from one audit to another.

For example, in this particular audit, under the first category, Internal Departmental Procedures, questions were asked about calendaring and mail-opening procedures, filing procedures and records management (including document retrieval and security issues), knowledge of current business operating policies, computer usage and procedures, and performance review protocols, etc.

Questions relating to the second category, Outside Counsel Management Process, mainly revolved around the OGC’s current software program and determining its capability to track all of the necessary information. Since the legal department’s workload had doubled with the acquisition of the new entity, more legal work was being given to outside counsel. Therefore, it was extremely important that the work was being assigned to competent, cost-effective attorneys, who were being managed efficiently and paid promptly for their work.

Since the company had facilities all over the country, and lawyers in several locations, questions concerning the third area, Intradepartmental Communications, involved determining what mechanisms the OGC used to foster good communication with the legal department, and if they were sufficient. In addition to reviewing the various handbooks and manuals, the frequency of general staff and departmental meetings, who was required to attend (or who was excluded), questions were asked concerning job descriptions and performance evaluations and whether communication was facilitated in both directions through these processes. Members of the OGC were also queried whether satisfaction surveys were used with their client/business groups, and about the process for the orientation and training of new employees and temporary workers in their department. Final questions were asked about general communication within the company and whether they were kept informed as to the future goals and objectives of their company by the CEO or another senior executive, in order to learn whether they felt information flowed downwards as well as upwards.

The fourth category, Analyzing the Organizational Fit, disclosed a number of problems that were occurring because the OGC had recently been decentralized. Separate departmental budgets had created turf wars over support staff usage, as well as some conflicts over management roles. For example: Does one division/business group manager "manage" another division/business group manager and his or her decisions and expenditures when the costs for those expenditures comes out of the first manager’s budget? (Under the current system, when there is a lawsuit in the defense division involving a human resources problem, the HR attorney manages the outside counsel working on the case, but the money spent to handle the matter comes out of the defense group’s budget.) Also, the incentive plan that was part of the department heads’ compensation package set up conflict-of-interest situations because the attorneys were sometimes more concerned about meeting their individual goals and staying within or under budget than in doing what might be in the best interests of the entire company, e.g., settling a questionable case early in order to stay under budget rather than taking the time and money to reach a more desirable conclusion, especially when the litigation expenses would have been taken out of their individual budget.

The final category which needed to be analyzed was the "Current health (mental and attitudinal) of the OGC". Questions were asked about the interaction of staff members, and whether the two cultures and different styles were blending, also about stress levels due to the increased workload and members’ perceptions of the change to a decentralized law department and whether problems which had arisen within the OGC were being handled to their satisfaction. The information gathered would help give the general counsel a clearer picture of the overall morale level of his law department and enable him to address any concerns in a timely and effective way.

At the end of all the information-gathering through personal, confidential interviews and collection and review of written policies, procedures, employee handbooks, etc., the data was analyzed and organized for my oral presentation to the general counsel. It had been initially stipulated that the majority of the reporting phase would be conducted verbally, especially for any sensitive information, and only a broad overview of the five principal categories and the ensuing recommendations would be captured in a written report.

The general counsel was gratified to find that both reports generally verified his assessment of how his law department was functioning. However, there were selected areas in which the audit/review provided new and quite valuable information, a different perspective, and some creative suggestions for improved policies and procedures that would greatly benefit operations within the OGC.

Some of the following issues from the five general categories were discussed during the reporting phase. Recommendations under the first category included: (1) Adding an office administrator (at least part-time) to assist the general counsel in managing and overseeing all the departmental procedures and systems; (2) Revising the calendaring procedures to achieve more conformity; and (3) Developing uniform filing procedures as well as a more efficient document retrieval system.

Category two comments addressed the fact that the training provided with the software program to manage the outside counsel data base was inadequate. Among other consequences, invoices were not being issued in a timely manner. Staff members clearly needed additional training and technical support to manage that area.

Under the third category, members of the OGC appreciated the "hands-off" but still accessible style of the general counsel, but generally wanted more information about the company and what was happening within the other divisions/business groups of the OGC. Suggestions from this category were: (1) Develop a communication procedure to facilitate the sharing of support staff back and forth from one business group to another; (2) Revise the job descriptions and make them specific to the individual; (3) Implement regular, annual performance evaluations in order to communicate expectations (on both sides) about what constituted a job well done and to motivate continued high performance; (4) Update the resource manual (which should contain all the primary procedures and processes used by the OGC) and provide a copy to every member of the OGC; and (5) Increase the orientation and training of new employees and temps, a function that had suffered due to a staff downsizing and the absence of an office administrator.

The recent decentralization of the legal department had created some tension. Category four recommendations included new procedures in order to reduce the possibility of turf wars, a phenomenon that was taking place with depressing regularity.

Reduced staffing levels and increased workload had created stress and debate over issues of "fairness" that were noted in the fifth category. The general counsel and I collaborated on solutions involving the use of part-time help in some areas and increasing communication and adding procedures in others to alleviate tension. It was also necessary to build a "team" mentality between attorneys and support staff. Tight budgets and a downsized staff made it even more important to provide adequate technology and training to maintain morale and general effectiveness.

At the conclusion of the report phase, at the request of the general counsel, I developed a proposal to help assist him and the OGC in implementing a number of the recommendations listed in the report. Due to budgetary limitations, I was able to provide hands-on assistance in creating, revising and implementing new procedures on a consulting basis which was more cost-effective than adding additional staff to manage changing the systems and procedures.

I always learn something new during every audit, and this was no exception. The general counsel suggested to me that other corporate law departments might need auditing services as much as his did, and told me that the defense industry was not the only one being targeted for corporate compliance issues by the government. Obviously, manufacturing companies were being closely scrutinized due to environmental concerns, but it was his perception that the healthcare industry would soon become the number one target for corporate compliance review, because of the increasingly large fraction of federal budget allocations to such expenditures, and the corresponding need for much greater oversight. Current events appear to corroborate his perceptions. Any readers involved in these industries should give serious consideration to whether your companies and respective in-house law departments might benefit from such a review/audit.

As Peter Drucker has intimated, it is fairly easy to be a good auditor, all you have to do is ask the right questions. You don’t need to know all of the answers! The collaborative part of the process is the most rewarding for me. I enjoy being used as a conduit by staff to voice their views and concerns while still maintaining confidentiality, and working as a team with the general counsel to solve creatively the problems that have emerged.

My job is especially fulfilling when I can work with a conscientious general counsel (such as this one), who has the drive and integrity to achieve the corporate goals set forth by his or her CEO, who at the same time is able to remain sensitive to the personal and professional needs of fellow OGC members.

My own follow-up to an audit involves sending the general counsel a "Client Satisfaction" survey form to complete. This provides me the input I need to revise and improve my own approach. While the general counsel gratefully acknowledged I had helped him sleep better at night, and assisted him in reaching his goal of "No surprises", the best feedback I received was from the managing partner at my firm. He told me the general counsel related to him that his company would have been happy to pay three times what they had been charged for my services because of the value of the information they had received–to both the pleasure and chagrin of my managing partner.

As I said at the beginning, I am starting to get used to my own "A". Hopefully, you can see that it stands not only for "Auditor", but also for a valued "Assistant" (or Angel of mercy!) who can help you learn what is really going on within your own law department and provide you an early opportunity to change any deficient procedures and also to receive a vote of confidence with respect to those parts of your system that are working well.

DISCLAIMER: While this article is based on an actual audit/review performed by the author, all names, dates, and locations, etc. have been protected to preserve the confidentiality of the process.

Janean S. Johnston, J.D. has a national law practice management consulting business. In addition to auditing and teaching on behalf of private firms, state bar organizations, and insurance companies, she has most recently been an ethics/LOMA auditor for the State Bar of California. She resides in Alexandria, Va.

by Andrea L. Bridgeman

Giving back is a professional

responsibility not only for pri-

vate practitioners, but for corporate counsel as well. Although financial contributions to pro bono providers and securing pro bono commitments from outside counsel may indirectly achieve the goals of Canon 2*/, corporate counsel can do so directly by practicing law. Having an in-house pro bono program can enrich your workplace, career, and the futures of those who need your help.

The Federal Home Loan Mortgage Corporation ("Freddie Mac") is a shareholder-owned, government-sponsored enterprise established by Congress in 1970 to provide a continuous flow of funds for residential mortgages, which is done primarily by purchasing mortgages from mortgage lenders. At Freddie Mac, we help make housing safe and affordable for millions of Americans, and through our philanthropic efforts, we strive to make these happy, healthy homes for at-risk children and their families. Freddie Mac’s 70+ attorney Legal Division has run an award-winning pro bono program in conjunction with Legal Services of Northern Virginia, Inc. (LSNV) since 1991. This program fits neatly with the corporate mission and the emphasis on giving back to our community.

Here’s how Freddie Mac’s program works: The Legal Division provides LSNV with attorneys on a weekly basis to perform intake interviews (screening applicants and evaluating the legal merits of their problems), staff for clinics, representation for clients in negotiations, court cases and administrative proceedings. The program enjoys tremendous corporate support--the Freddie Mac Foundation has augmented our efforts with:

• funds for printing LSNV brochures and for minority law student summer interns

• meeting facilities

• computer equipment and reference materials, and

• seed money to establish a child advocacy center

In return, LSNV provides Freddie Mac’s Legal Division with a variety of pro bono activities (and malpractice insurance), educational support, including training that qualifies for CLE credit, supervision and administrative support, opportunities to develop our staff’s legal, managerial and communications skills, and positive public relations, community goodwill and recognition at local, state and national levels.

Considerations in establishing a corporate pro bono program:

Pro bono work does require a commitment of employee time and resources. For this reason, support from corporate management is crucial to a program’s success. Once this support is in place, consider these matters for building an in-house pro bono program:

1. Legal Competence. Clients are entitled to a competent attorney, regardless of whether they are paying for the representation. Canon 6 requires that a lawyer undertake representation only in those matters in which he has specific knowledge, skill and efficiency. The competence requirement, which applies to court and administrative procedures as well as to substantive practice areas, can be met by:

• prior practice experience,

• association with another lawyer (or a pro bono organization) competent in the matter (DR 6-101), or

• specialized training

2. Malpractice Insurance Coverage. While pro bono clients are considered to be public clients for all purposes, few corporations carry malpractice insurance for their in-house counsel. Malpractice coverage can be acquired directly or through an associated pro bono organization (many carry policies for attorney volunteers).

3. Conflicts of Interest. Corporate counsel are no less at risk of encountering conflicts of interest than are private practitioners. Potential conflicts can limit:

• substantive issues to those areas of business or operations in which the corporate employer is not engaged,

• representation in matters in which corporate customers, competitors and/or suppliers may be adverse parties, and

• the ability to represent certain clients zealously by restricting positions that favor a client but may be at odds with corporate interests

As in law firms, there should be a conflicts committee or coordinator to manage this aspect of the corporate pro bono initiative.

4. Client Confidentiality. To insure client confidentiality, all pro bono client files should be maintained separately from those relating to the corporation, and each legal department employee, whether or not involved in the pro bono initiative, should be cautioned to exercise care to preserve client information and confidences. (See EC 4-2)

5. Insulating the Corporate Employer. To avoid the appearance that the corporate employer is engaged in the unauthorized practice of law or is otherwise responsible for the attorneys’ pro bono legal work, the best practice is not to use corporate letterhead, business cards or meeting rooms for pro bono clients.

In addition, there should be a formal "policy and procedure" setting out the corporation’s pro bono program parameters, including those discussed above. It should include a liaison/contact list for all internal and external parties, and should address, at a minimum, the following issues:

• will time spent on pro bono activities be credited toward the volunteer’s workweek goal, or in addition to that goal?

• will pro bono activities occurring during regular business hours be tolerated, encouraged or discouraged?

• what mechanisms exist for pro bono work product quality control, and for tracking volunteer’s time, cases and files?

Many of the perceived impediments to performing pro bono work in-house are, upon closer inspection, red herrings. The greatest of these is a fear of the unknown and a reluctance, particularly on the part of ‘seasoned’ attorneys, to venture into unfamiliar settings or substantive areas of the law. Targeted training and/or pro bono work that uses existing skills can minimize this concern.

Your community’s poorest and most disadvantaged have a variety of legal needs. In addition to counseling and representing individuals, there are non-profit organizations that could use corporate counsel’s expertise with incorporations and tax-exempt status, corporate governance, employee management, commercial matters, insurance coverage, real estate and leases, navigating through government and administrative red tape, and so on.

Pro bono legal work gives your organization a chance to build stronger communities, enhance the skills of your legal staff, and improve your work environment by attracting quality employees and increasing job satisfaction and morale for existing employees. With a pro bono program, you can give back, and everybody wins.

Resources for corporate counsel interested in performing pro bono legal work are available from the Virginia State Bar Pro Bono office (804/775-0522), the American Bar Association Center for Pro Bono (312/988-5769), the American Corporate Counsel Association’s ACCA Foundation (202/293-4103; Web site www.acca.com/foundation) and from your local legal services corporation. Malpractice insurance coverage is available from the National Legal Aid Defenders Association Service Corporation (202/452-9870 or 800/725-4513).

*/ References are to the Virginia Code of Professional Responsibility.

Andrea L. Bridgeman is a real estate/contracts attorney at Freddie Mac in McLean, Virginia, where she is co-chair of the Pro Bono Steering Committee. Freddie Mac’s Legal Division was recognized for its pro bono efforts in 1995 with the American Corporate Counsel Association’s Pro Bono Award and in 1998 with the American Bar Association’s Pro Bono Publico Award. Ms. Bridgeman is a past chair of the Corporate Counsel Section and is currently co-chair of the Fairfax Bar Association’s Business Law/Corporate Counsel Section.

By Jon Grossman

A. Introduction

The Internet has become one of the foremost tools for disseminating, researching, and accessing information. No communication medium or consumer electronics technology has ever grown so quickly. As of January 1997, over 56 million people had access to Internet worldwide. By the year 2000, Internet use is expected to grow to 450 million worldwide. The relatively low investment required for information dissemination has permitted businesses, government agencies, associations, libraries, museums, and countless ordinary people to communicate with literally tens of millions of people around the world virtually instantaneously and at low cost.

Most commercial entities, realizing the vast commercial possibilities available, and wishing to appear technologically current, have created their own websites. The potential for quick, easy, and global dissemination of information fostered a tremendous growth in the number of growth websites. Numerous corporate websites have been created. For example, in 1995 the number of law firm websites was so small that they all could be visited within less than one hour. By 1997, well over 2000 law firm websites had been created, with more websites being added weekly. The market penetration for companies with in house legal department is likely to be higher. With this fast paced development, it is no surprise that changes in the law have lagged somewhat behind. But changes in the law relating to the Internet are occurring. This article explores one area of law as it relates to the Internet – these legal issues relating to the creation and maintenance of an Internet website.

B. What Is A Website?

A "Website" is an electronic location on the world wide web that may contain text, sound, and graphical information. The website has an address that starts with "http" and ends with a suffix indicating the type of organization sponsoring the website.1 A major difference between the Web and the Internet in general is the presence of "hypertext" links in most websites. A hyperlink is an underlined portion of text on a website that allows a user, by clicking on the highlighted text, to be connected to a different site. As opposed to linear text, which requires a user to read from left to right, top to bottom, beginning to end, in hypertext, the user follows links that take him or her to various different places in the document, or even to other websites without scanning through the entire text. Thus, hypertext links allow a user to move from one web page to another almost instantaneously.

In addition to hyperlinks, which will be referred to as "out links," newer websites may also contain divided screens or "frames" that may help a user to "point" to another Web location. In other words, "frame" technology is a page display capability which enables the display of multiple and independently scrollable panels on a single screen. including text, hypertext, graphics, and other frames. Used on the Web a frame acts as a pointer to a document, image, or clip on the Web contained in another Web page that pulls the document, image, or clip from the other Web page into the current document for display.

Websites are comprised of multiple "pages" that may be actually shorter or longer than the actual paper pages of information. As explained by one court, a web page is a computer data file on a host operating a web server within a given domain name. When the web server receives an inquiry from the Internet, it returns the web page data in the file to the computer making the inquiry. The web page may comprise a single line or multiple pages of information and may include any message, name, word, sound or picture, or combination of such elements.

Intermatic Inc. v. Toeppen, 947 F. Supp. 1227 (N.D. Ill. 1996).

C. Getting Started: Naming Your Website

In order to have a website, you need to first apply for a domain name. The domain name is both an identification and an address. All Internet computers address each other in terms of numbers and use a common protocol (TCP/IP protocol) to communicate with each other. Each server hooked up to this interconnected computer network has a unique designation number, composed of four parts, each less than 256 characters. Because people found remembering the numbers assigned to each computer too difficult, the server’s designation number was replaced by domain names that people could remember. Domain names take on a hierarchical format, where the final word (e.g. "com" ) after the last dot (e.g. in "http: //www.dsmo.com") is the top-level domain. Originally, six top-level domains were established ("com" = commercial; "edu" = educational; "org" = organizational; "mil" = military; "net" = network; and "gov" = governmental). Later, additional top-level domains were added based on unique two-letter domain names representing different countries (e.g. "uk" for United Kingdom, "jp" for Japan, and "se" for Sweden). At present, more top-level domains are sought to be added.

Domain names are assigned by a single entity known as Internic. Internic is run by Network Solutions, Inc., a company located in Northern Virginia. In order to obtain the domain name, Internic searches its records to see if the chosen name is taken. Domain names are generally issued by Internic on a first-come first-served basis. If the company’s natural domain name is taken, the company may consider a multitude of options: including misspellings, unusual punctuation, using a specialty or geographic domain name such as "patent.com" or "virginiabroker.com." For companies with international offices multiple domain names are recommended particularly when the company maintains a website in more than one language.

Trademarks may be used as companies’ domain names. Because trademark rights are recognized in a narrow class of goods or services, different companies could have similar marks in different industries. For example, "Delta" is the trade mark for both an airline and a faucet manufacturer. If Delta Airlines selects delta.com as its domain name, Delta Airlines would not commit trademark infringement, but the faucet manufacturer would be blocked from using its trade name as its domain name.

Similarly, domain names may be used as trademarks. As more people communicate online and more companies use e-mail for marketing and advertising, more companies will advertise their domain names and claim trademark protection in those names. The U.S. Patent and Trademark Office has already taken the position that Internet domain names may be registered when used as trademarks. See Intermatic Inc. v. Toeppen, 947 F. Supp. 1227 (N.D. Ill. 1996); Panavision Int’l v. Toeppen,945 F. Supp. 1296 (C.D. Cal. 1996).

After determining that the domain name that your company wants has not been taken you must either (1) set up a server and get an Internet connection (about $20-40,000 first year cost) or (2) contract with an Internet service provider to host your top level domain name (roughly $600-4,000 first year cost). In the latter case, the service provider will handle registering your new domain name with Internic. In turn, Internic will electronically survey the server to ensure that it responds to your domain name; thus, application for a domain name is impossible without having an Internet service provider or your own server set up to respond to Internic’s query.

It should be noted that a whole industry around domain names has developed. Some individuals have attempted to take well known brand names and add ".com" after the name. These individuals are known as cyber-squatters. Presently, cyber-squatter domain names are being challenged in various courts, and appear to be of doubtful validity. As with any important business decision with legal implications, consult specialized counsel.

D. Consideration in Building The Website

The next step is to build your website. Usually companies firms will either rely on someone in their MIS department, or an outside contractor, to build the site. Each approach has distinct legal advantages and disadvantages. If your company is going to build a website, it must do it well. Obviously, your company cannot get an indemnification when using an employee, and this is a reason to get an outsider. On the other hand, your company may want someone who is technically competent and able to update the website regularly. This aspect is important in the securities industry, because your company may have an opportunity to update. Failing to provide a timely update may have securities law implications.

Of course, some companies offer website maintenance services. For example, many large Internet providers have website divisions that will gladly assist a company in creating a website for a price. Small companies should expect to pay anywhere between $750 and up for a well-designed website; mid-size companies between $1,500 and $3,000; and large companies from $3,000 and up. If your company decides to use an outside service, your company should shop around and check the outsider’s references, i.e. their client’s websites.

Whether your company uses an insider or outsider, there are some critical copyright law ramifications. If MIS employees are used, it is likely that the firm will own the copyright in its websites (excluding third party material). That is because when the work was created by an employee working within the scope of his/her duty, the resulting product, absent an agreement otherwise, is considered "work-made-for-hire". A work-made-for-hire makes your company the author, and thus the owner, of the copyright. By contrast, the independent contractor would need to assign the copyright to you or your company. Sometimes it is hard to obtain or negotiate an assignment. Indeed, many web builders do not assign copyright ownership to the software because they want to re-use portions of the website’s software for other customers. A way to avoid such a logjam is to receive an assignment on the format, graphics and overall look and feel of the web pages and home page of the website with a license to the developer’s software.

A common misconception when using an outside developer is that you can obtain copyright ownership by executing an agreement deeming the website as a "work-made-for-hire". However, this will not usually work. Only certain works can be made pursuant to a work-made-for-hire contract, and websites are not often one of them.2 An assignment is always the safest route.

Another disadvantage to having the employee build the website relates to liability. To the extent you can negotiate a license from the independent contractor, the more likely you can add protective language in the form of warranties, indemnifications, maintenance obligations, consequential damages and even in some cases insurance protection. Also, by licensing the website, the licensor has the obligation to enforce its rights, such as copyrights, in order to preserve the underlying value of your license. One issue/liability that cannot be delegated, however, is ethical obligations. Thus, reliance on an outsider must be tempered by close supervision and care to ensure that an attorney’s ethical obligations to his or her clients are not compromised by the website.

E. Legal Issues Regarding Framing And Linking

As previously noted "Framing" refers to the use of HTML (Hypertext Markup Language) code that allows Web page creators and users to divide the browser window into separate windows on the same page called "frames." In attempting to keep the user’s attention focused on the current Web page, some page builders have framed around other company’s websites to create more content. Some recent court cases have erupted around this practice, alleging that it amounts to an impermissible passing off or misappropriation of the framed website’s content. Care therefore must be taken when framing the content of other websites to provide some form of attribution. Also, in the event that advertising on the framed website is removed, be forewarned that this practice will likely trigger problems.

Once the website is built, you may then want to link it to other sites. Linking facilitates meeting new people whom you otherwise would never meet. As mentioned in part A, hyperlinks are commonly placed on existing web pages, allowing Internet users to move rapidly from one web page to another by just clicking on one button. The process is simple: someone with a related site may have a hypertext link from their site to yours. Potential customers looking for information on that site can click on the hypertext and jump directly to your company’s site. A common type of link involves an exchange of links from and to each site. Law firms can also buy banner advertising on popular sites such as Yahoo. Thus, providing good and readily available contact information will likely have more people linking to your site, without their requesting a link back.

One issue regarding linking, is whether their creation constitutes copyright infringement. Although case law on this point is sparse, it is worth noting a couple of recent cases.

In Shetland Times Ltd. v. Wills, a Scottish case, the defendants used the headlines of the plaintiffs' stories as links to the plaintiffs' newspaper articles published on the Internet. The question was whether headlines were copyrightable subject matter. A preliminary injunction was granted, and the case settled on November 11, 1997. In The Washington Post Co. v. Total News, Inc., a case regarding linking and framing discussed below, paragraph 4 of the settlement allows the defendants to link to the plaintiffs' Web site, but only by using the full URL. Both settlements show that the companies involved agree that the use of the plain URL in a link should be allowed; however, the use of another structure to represent the URL in a link may pose a copyright problem.

Because it is the user who retrieves and views the Web page, the creator of a link to that page is only liable for direct infringement if linking violates the copyright of the owner of the linked page. This is hardly conceivable, because the link only provides the user with an address, and its only purpose is to facilitate the access to a document by providing the user with an alternative to typing the URL of the page. Moreover, if typing a URL does not constitute copyright infringement because it is a necessary part of viewing a Web page, then neither does providing a link. In fact, instead of activating a certain link by clicking on it, the user could also simply type the URL into the browser with the same result. Obviously, by creating a link, the content of the linked page is not reproduced, distributed, publicly performed, or displayed.

One could argue, however, that a link itself prepares a derivative work because it virtually incorporates the content of the linked page into the linking page. However, since the link itself does not reveal any part of the linked page, the user cannot possibly know the content of the linked page, and the supposedly underlying work (the linked page) is not recast, transformed or adapted in the sense of 17 U.S.C. § 101. The mere virtual presence ("one click away") of the linked page does not change this fact. Indeed, a link simply appears to be an electronic version of a reference to another work, like a citation in a law book, for instance. No one has ever reasonably argued that a citation "incorporates" the cited work. The technologically-improved accessibility of the cited work does not change the nature of the citing work and, therefore, linking does not involve the adaptation right. For the same reasons, deep linking (which is linking into an embedded page in a web site) does not constitute copyright infringement, even though it might be actionable on other grounds such as unfair competition and trademark law. Since linking does not involve any of the rights exclusively assigned to the copyright owner and therefore does not constitute copying, it is irrelevant whether or not the linked page contains infringing material. Therefore, a plain HREF3 link does not appear to directly infringe any of the exclusive rights assigned to the copyright owner.

F. Use Of Disclaimers And Online Contracts

The legal significance of the disclaimer is that it is relevant to determining whether those entities with a legal duty to protect against harms from the Site have in fact exercised reasonable care in preventing such harms. Courts determine whether a disclaimer or warning is adequate by applying a "reasonableness standard." In applying this standard, courts often use as a benchmark the standard warning language used by other members of the industry at issue.

The efficacy of a disclaimer is governed by state law and state laws differ as does the extent to which the courts in particular jurisdictions view such disclaimers with favor. This uncertainty is compounded by the fact that we are dealing in the context of new technologies, i.e., online use and the Internet, where the courts have only begun to grapple with the responsibilities of website operations.

Another way to propose limiting liability is through a website contract. The legal protection afforded by the contract language is less certain. The purpose of the language is, in essence, to form a contract between the individual accessing the website and the site’s sponsor, which contract provides for example that, in exchange for allowing an individual access to the website, the individual acknowledges that the information is being provided without warranty, agrees not to infringe on copyrights associated with the website, and waives his or her right to recover damages for injuries caused by reliance on the Site.

The courts are divided over whether such a contract -- that is not the subject of bargaining, but is agreed upon simply by clicking an "accept" button -- is enforceable. Furthermore, while courts do enforce contractual waivers of liability, they do not do so in all cases, particularly when the liability results from recklessness or intentional tortious acts. For example, if your company knowingly allowed incorrect harmful information to remain on the website for an extended time, there is a substantial possibility that the liability waiver in the contract language would not be enforced with respect to harms resulting from such information. Thus, contract language may not be reliable protection against liability arising from the website. It should be remembered, however, that this issue only becomes relevant to if your company is somehow found to have a legal duty to the injured party.

Obviously, your company should try, if possible, to avoid assuming any responsibility for, or control over, the operation of the website. This includes giving the website maintenance responsibilities to a third party vendor and then making sure that what appears on the website has been carefully reviewed. If practical from a business standpoint, your company should enter into an agreement with such third party on-line provider that contains (a) a statement setting forth that your company has no responsibilities concerning the content of the Site; and (b) indemnification provisions in which a third party provider agrees to indemnify your company for all liabilities, costs and expenses incurred in connection with claims made against your company that are related to the Site. While, ideally, your company may want to avoid any liability altogether, it cannot rely only on indemnity. That is because the indemnifier must ultimately have a deep pocket to cover court costs and attorneys fees. Often, particularly with small developers, the price tag is too high. The company may be better off with someone in the company making sure that the company’s content is represented accurately.

For example, in In Re Presstek, the Securities and Exchange Commission ("SEC") held Presstek, Inc., a company that distributed a research analyst’s report, liable for materially overstating Presstek’s sales and earnings outlook. In its order dated December 1997, the SEC clearly stated that "[A]n issuer may also be liable for false statements contained in a third-party report if it adopts, expressly or impliedly, the statements after they are published, even if management had no role in preparing the reports." In re Presstek, 1997 SEC Lexis 2645. In the Commission’s view, an issuer who knows, or is reckless in not knowing, that the distributed information is false or misleading, cannot be insulated from liability because management was not actively involved in the preparation of that information. To limit this kind of liability in Presstek-like circumstances, a company should have inside counsel review website content on a routine basis.

Most importantly, your website should include an appropriate disclaimer. Examples of appropriate disclaimers abound. Here are just a few examples:

PLEASE READ THIS DISCLAIMER AND AGREEMENT CAREFULLY BEFORE ACCESSING OR USING THIS SITE. BY ACCESSING OR USING THIS WEBSITE, YOU CERTIFY THAT YOU UNDERSTAND THE DISCLAIMER AND AGREE TO BE BOUND BY THE TERMS AND CONDITIONS SET FORTH BELOW. IF YOU HAVE QUESTIONS, CONTACT _____HELP BEFORE PROCEEDING.

The Company its agents or representatives do not make any representations as to the accuracy, completeness or correctness, timeliness or usefulness of any information contained herein. All information contained herein is provided "AS IS" and the company expressly disclaims making any express or implied warranties with respect to the fitness of the information contained herein for any particular usage, its merchantability, its application or purpose or its non-infringement. Solely for the purpose of providing access to information of potential utility to [website] users, [hyper]links appear on this Site to allow direct access to such information. The Company does not monitor or review the content of such independently operated Sites. The inclusion of such [hyper]links is neither intended nor understood to constitute any implied or express approval or acceptance of the validity of the information contained in such independent Sites and is not intended nor should it be understood by the user as an endorsement or recommendation of any of the information, products, or manufacturers identified in those independently operated Sites.

By accessing this forum, you agree that in no event will the company, the sponsor of this forum and any of the business entities mentioned herein (including entities for which a hyper-link is provided) be liable to you or anyone else for any decision made or action taken by you or anyone else based upon or in reliance upon the information provided through this forum. You further agree to hold the Company, the sponsor of this forum and any business entity mentioned herein (including entities for which a hyper-link is provided) harmless against liability for any loss, claim, or damage arising from your use of any of the information and ideas contained herein.

The materials provided in this forum are copyrighted and may be downloaded and/or reprinted for PERSONAL USE ONLY. Permission to reprint or electronically reproduce any copyrighted material, document, tradename, logo or other graphic, in whole or in part, for any other reason is expressly prohibited, unless prior written consent is obtained from the Company or from the owner of such material.

I have read and understand the above terms and conditions and agree to all of them.(hit return button)

Some considerations for specific disclaimer language for attorney includes using the term "general information," so that the disclaimer helps avoid problems regarding the creation of an attorney-client privilege not to mention the unauthorized practice of law. The request that no information be sent until the on-line reader talks with a lawyer may also prevent a disqualifying disclosure from a potentially adverse party. In other words, one of your client’s adverse party may e-mail to you a material admission.

As an alternative, or in addition, to the disclaimer, a company may consider using a click wrap or shrink wrap license. As Internet use has grown dramatically in recent years, so too has the use of click wrap licensing. A click wrap or web wrap license refers to a contract created by requiring the would-be purchaser of a digital work to accept various usage restrictions, via a series of mouse "clicks," before granting access to the work, or before the information products or other products are transferred. Specifically, click wrap contracting involves the text of an offer presented on a computer screen along with the license terms. The license terms "pop up" on a screen when a program is first opened and are not physically written down on paper. The user looks at the terms of the agreement on his/her computer and then manifests "unambiguous consent" by clicking a box which signals consent to be bound by the agreement that has just passed on the screen. For example, a term of the agreement may be that the customer-user explicitly agrees not to use the sender’s services to transmit unsolicited commercial e mail to others (also known as "spamming") or to send pornographic messages. Recurring provisions in click wrap license agreements include proprietary rights, limitations on warranties and damages, limitations on user’s rights, and broad disclaimers of liability.

Until recently, the enforceability of click wrap agreements was uncertain. Departing from the traditional contractual style, the licensor in a click wrap agreement does not receive a signed agreement from the user, and instead relies on the consumer's assent via the Internet, by clicking "accept." As a consequence, the issue that arises is whether the purchaser agreed to the terms of the click wrap agreement, or whether these agreements are unenforceable as a contracts of adhesion or whether such agreements are otherwise unconscionable. More recently, however, courts have expressly recognized the enforceability of the click wrap agreements. See ProCD, Inc. v. Zeidenberg, 86 F.3d 1447 (7th Cir. 1996); Hotmail Corp. v. Van$ Money Pie, Inc., 47 U.S.P.Q.2d 1020 (N.D. Cal. 1998).

G. E-mail And Associated Risks

E-mail is the most basic and the most useful Internet-based client relation tool. All major online services include e-mail functions as a standard feature. E-mail sent over the Internet from one computer to another is encoded in a common communications protocol (TCP/IP). The protocol allows communication between the transmitting and receiving computer, even where the two computers are not identical. As a consequence, lawyers can send messages to any client connected to the Internet through an e-mail address.

Companies using e-mail have a significant competitive advantage over those that do not use e-mail. The message reaches the client’s computer within minutes and, unlike phone messages, the e-mail provides the client with an instant reply. Furthermore, sending an e-mail may mean eliminating human intermediaries such as secretaries and postal workers, ultimately cutting down on the company’s expenses. Because e-mail is so cost effective, it can justify, by itself, a company’s investment in Internet connections.

As concerns regarding the privacy of electronic communications diminish, e-mail will be used more aggressively by attorneys to schedule depositions, exchange interrogatories, propose and revise contracts or agreements, and communicate within and outside the company. Nevertheless, downloading business files received by e-mail and communicating with clients may be risky. On the Internet, hate mail needs no envelopes and stamps, and pornography needs no screen or projector. In addition, employees can transfer records to a personal e-mail address so that stolen data can be further redistributed or illegally used. Employees can also transmit e-mail to others, whether or not they use the same online service or regardless of their location within or outside the United States. Because most e-mail services allow the user to "attach" computer files, including text, sound, video, graphics, or entire computer programs, virtually any form of intellectual property may be endangered by e-mail. Finally, to get of e-mail takes more than erasing it from your inbox. Your company’s server may have a backup of the message. Another copy of the message may also exist at the internet service provider’s computer. Finally copies of the message may remain on the other party’s computer.

Moreover, the attorney’s duty to protect confidential information is a major concern among most attorneys who communicate with clients through e-mail. The duty of confidentiality arises from Disciplinary Rule DR 4-101 of the Virginia Code of Professional Responsibility, which imposes the obligation that an attorney "not reveal a confidence or secret of his client" unless the client consents after consultation. At present, attorneys are concerned that e-mail messages may not be protected by the attorney-client privilege because e-mail may not be considered to fall in the category of communications made in confidence, rendering them unprivileged. These privacy concerns are unsupported, however. E-mail is more difficult to intercept than a phone conversation from an office phone, the use of which is not considered to be violating the duty of confidentiality. Furthermore, the Electronic Communications Privacy Act of 1986 (ECPA) makes intercepting e-mail messages a criminal offense and expressly provides that any intercepted e-mail message retains its character as a privileged communication. Finally, encryption programs are available to improve the security of private transmission because they prevent a message from being read by those who do not have decoding capabilities.

Although concerns for protecting e-mail messages from hackers and service providers are significant, the issue of employers’ monitoring employees’ e-mail has stirred more debate. Employers are interested in regulating employees’ e-mail to ensure that employees are not using email to divulge proprietary information, harass other employees, create a hostile work environment, or expose the employers for liability for libel, slander, defamation, or copyright infringement. To improve their ability to access employees’ e-mail, employers may implement comprehensive policies governing e-mail use. Informing employees that the employer may monitor e-mail messages may create an implicit consent by the employee to this action. Under the ECPA, the communicator’s consent acquits a party of liability. Knowledge of the employer’s intent to monitor messages also decreases an employee’s expectation of privacy.

H. If You End Up In Court – Where Is Electronic Jurisdiction

The Internet lacks geographical boundaries. Not surprisingly, the speed of adoption of the Internet by its users has far outpaced most states’ attempts to adapt their substantive laws to the new medium. Because traditional legal principles are not always applicable in cyberspace, substantive issues such as personal and subject matter jurisdiction in Internet e-mail cases and websites have already arisen in Internet-related disputes.

Attorneys’ practicing in another state without a license will become a very debated Internet topic. Law firms that take advantage of Internet technology and websites will be able to deliver legal services anywhere in the United States at a cheaper cost than local firms. Additionally, e-mail, video-conferencing and other new technologies suggest that a local physical presence will be less of a factor in favoring local counsel. State ethical legislators have power to regulate only the attorneys licensed in that particular state. An interesting issue is whether rules applying to websites that have been created in particularly restrictive states such as Texas, California, and Florida apply to all law firm websites, since these websites are available in these states as well as the rest of the United States. Finally, attorneys in large firms licensed in one state may be also licensed to practice in the state where the firm’s office is located, for example Virginia. In this scenario, is the entire Virginia firm subject to the other state’s laws because of that attorney? Should California regulate the non-resident firm’s website only if the firm has significant and continuing representation of California citizens? These are just a few questions without answers.

A general theme to building your website on the Internet is that to a certain extent your company may be entering uncharted legal waters. While the purpose of this article is not to raise concerns, it is also worthwhile to raise awareness that many legal questions remain to be resolved. Thus, minimizing your risks in some of the ways noted above, may be the only practical answer available as this new technology continues to unfold.

Endnotes

1 The suffix "com" is used for commercial entities. "Edu" is used for educational institutions and "gov" for governmental organizations. "Org" is used for organizations, usually nonprofit, "mil" for military and "net" for networks.

2 Under 17 U.S.C. §101 a work made for hire is either a contribution to a collective work, a part of a motion picture or other audio visual work, a translation, a supplementary work, a compiliation, an instructional text, a test, answer material for a test or an atlas.

3 "HREF," or Hypertext Reference, link is a specific code that includes the URL of the Web page to be retrieved upon activation of the link. An HREF link to the home page of another Web site is known as "surface link," while an HREF link below the home page level is known as a "deep link."

Jon Grossman practices in the area of Computer Law with a focus on Intellectual Property issues including the acquisition of Patents and Copyrights. Other areas of work include computer-related licensing, export control and business counseling with respect to intellectual property. Mr. Grossman is also an Adjunct Professor at the Johns Hopkins University where he has taught for several years in the area of high technology law. Mr. Grossman has lectured extensively on issues pertaining to intellectual property law.

He received his BA from the University of Chicago (1977), his MS in Computer Science from the Johns Hopkins University (1982) and his JD from the American University (1986). Mr. Grossman is a member of the Bar of Pennsylvania, the District of Columbia, and is registered to practice before the U.S. Patent and Trademark Office.

By Scott Dondershine

I. Introduction.

Congress adopted the Fair Labor Standards Act (the "FLSA") in the late 1930s as part of President Roosevelt’s New Deal to produce higher levels of employment among the adult work force. Today, disgruntled employees often use the protections provided by the FLSA as a linchpin to turn a marginal case for wrongful discharge or some other adverse employment action into a successful action for severance pay or other financial redress. Corporate counsel needs to assist employers in complying with the FLSA to eliminate its use in claims alleging inappropriate employment decisions.

The scope of this article is limited to a general discussion of the overtime pay requirements under the FLSA and should not be relied upon for legal advice. First, the employees exempt from the overtime pay requirements are described, then the methods for computation of overtime pay, the record-keeping requirements and the remedies. Finally, some common pitfalls in applying the overtime pay requirements are explained.

II. Employees Exempt from the

FLSA Overtime Pay

Requirements.

The overtime pay requirements apply to all employees employed in an enterprise engaged in commerce or in the production of goods for commerce, unless an employer proves by clear and convincing evidence that an employee is exempt. Clark v. J.M. Benson Co., 789 F.2d 282, 286 (4th Cir. 1986). While there are several categories of exempt employees, most exemptions are narrow, applying only to certain specified special interest groups. The more commonly used exemptions are the white-collar and outside salesman exemptions discussed below.

A. White-Collar Exemptions.

Any employee meeting the applicable "short test" and employed in a bona-fide executive, administrative or professional capacity is exempt from the overtime pay requirements under the so-called "white-collar" exemptions. Although an employee can alternately meet a "long test," the long test is generally obsolete since virtually all employees meeting the short test will also pass the long test.

The short test for an executive is generally met if the employee is paid a weekly salary of $250 or more and meets the primary duties test by managing or supervising two or more employees. 29 C.F.R. § 541.1 (1998). It usually is not difficult to determine whether employees are performing managerial or supervisory functions -- they direct, control and evaluate the work of subordinates and can at least make suggestions and recommendations that will be given particular weight in determining whether a person should be hired, fired or promoted.

Two errors are commonly made in misclassifying persons as executives. First, a manager has to spend at least fifty percent (50%) of his or her time supervising employees. 29 C.F.R. § 541.103 (1998). This eliminates a lot of persons who perform substantial regular duties in addition to supervising employees. Secondly, an executive has to supervise two or more employees and, therefore, the head of a one-person department cannot be an executive.

Administrators generally are exempt under the short test if they are paid at least the same salary threshold as executives ($250 per week – usually, not a problem in today’s economy) and satisfy a primary duties test by performing office or non-manual work directly related to management policies or general business operations. Such work has to also involve the exercise of discretion and independent judgment. 29 C.F.R. § 541.2 (1998). Work that simply requires a skill without the use of discretion and independent judgment like that of inspectors, lumber graders, receptionists and clerical workers does not satisfy this requirement. Examples of typical administrators include: (1) executive secretaries who assist executives or administrative officials in the performance of their duties, exercising discretion and independent judgment in the process, (2) persons who act in a staff or functional capacity like an advisory tax expert or a personnel director, and (3) persons who perform special assignments, often away from the employer’s premises, such as buyers and traveling auditors.

Finally, professionals are exempt if they are paid at least the same $250 weekly salary as executives or administrators and also meet the primary duties test. A professional generally meets the primary duties test by performing work requiring knowledge of an advance type in a field of science or learning, by teaching, or by rendering services that require application of knowledge in the computer software field. 29 C.F.R. § 541.3 (1998). Professionals include teachers, computer programmers, software engineers, attorneys and doctors.

Although as discussed above the white-collar exemptions generally only apply to employees paid a salary, there are two important exceptions for professionals. The first exception is that attorneys, doctors, medical interns or residents or teachers do not have to be paid a salary. 29 C.F.R. § 541.3(e) (1998). Secondly, computer software professionals, do not have to be paid a salary provided that they are paid at least $27.63 per hour. 29 U.S.C.A. § 213(a)(17) (1998).

An employee paid a salary has to receive his full salary for any week in which work is performed without regard to the work's quality or quantity. As discussed below, an employer may not reduce the salary of an employee for absences of less than a day, a practice called "docking." Deductions are also not permitted if an employee is "ready, willing and able to work," but the employer cannot utilize the services of the employee due to the operating requirements of the business. 29 C.F.R. § 541.118 (1998).

Deductions may, however, be made if the employee is absent from work for a day or more for personal reasons (not including sickness or disability). Deductions for sickness or disability are permitted if made pursuant to a plan of providing paid sick or disability leave but the employee has exhausted his or her paid sick or disability leave or has not yet qualified for leave under the plan. Deductions can also be made if an employee qualifies for separate benefits under an employer-provided disability plan and the employee receives such benefits in lieu of salary. Several other exceptions apply and it is important to carefully read the rules to prevent converting an otherwise exempt white-collar employee into a non-exempt employee. 29 U.S.C.A. § 541.118 (1998).

B. Outside Salesmen.

Outside salesmen are also exempt. Outside salesmen are persons employed for the purpose of making sales or obtaining orders or contracts for services if the employee is customarily and regularly away from the employer’s place of business. 29 C.F.R. § 541.5 (1998). Employees who work at the employer's place of business making sales either in person or by telephone generally do not qualify for this or any of the white-collar exemptions discussed above.

III. Computation of Required

Overtime Pay.

As discussed above, if an employee is not exempt, then he or she has to receive overtime pay of at least one and one-half times his or her regular hourly rate of pay for any hours worked in a workweek in excess of forty hours. The regular hourly rate of pay for a particular workweek is equal to the total compensation paid for such week divided by the number of hours actually worked in such week. 29 C.F.R. § 778.109 (1998). It is important in determining total compensation to include all remuneration paid to or on behalf of an employee, other than certain gifts and bonuses and compensation for overtime, holiday or sick leave. 29 U.S.C.A. § 207(e) (1998). For a bonus to be excluded from total compensation, the employer has to have the sole discretion as to its payment and amount. In addition, payment of the bonus has to be made at or near the end of the period covered by the bonus since the employee can not have any contractual expectation as to its payment. Examples of such bonuses include holiday and profit-sharing bonuses.

The next step in the overtime pay computation is to convert total compensation into a "regular hourly rate." The conversion method depends upon whether the employee is paid on a piece-rate, salary, commission, or other basis. The Code of Federal Regulations provide the following examples for making the conversion:

A. The regular rate of an hourly paid employee is relatively simple to compute. If Peter, a non-exempt employee, earns $6 per hour and works 46 hours in a particular workweek, then his pay for such week has to be at least $294 ($6 x 46; plus $3 x 6). If for the same week Peter also receives a production bonus of $9.20, then his total remuneration for the week based upon his regular rate of pay would equal $285.20 ($6 x 46 + $9.20) and his regular hourly rate would be $6.2 ($285.20 / 46 = $6.20). Peter would have to receive at least $18.60 ($6.20 / 2 = $3.10 x 6 hours = $18.60) in addition to receiving his $285.20 of regular compensation. 29 C.F.R. § 778.110 (1998).

B. The regular hourly rate for a pieceworker is computed by dividing the worker’s total earnings for the workweek from piece rates and other sources (such as production bonuses) by the total number of hours worked. If Samantha, a non-exempt worker, works 50 hours and earns $245.50 at piece rates for 46 hours and $5 an hour for 4 hours of waiting time, then her total compensation of $265.50 is divided by 50 hours to determine her regular hourly rate of pay of $5.31. Samantha also has to receive at least $26.55 ($2.655 x 10) of overtime pay. 29 C.F.R. § 778.111 (1998),

C. The regular hourly rate for an employee paid a salary for a set number of hours that the employee is expected to work is computed by dividing the salary by the number of hours which the salary is intended to compensate. For instance, if George receives a salary of $182.70 for 35 hours per week, then his regular hourly rate of pay equals $5.22. If George works 45 hours in a particular week, then he has to receive at least $182.70 for the first 35 hours, $5.22 per hour for the next five hours, and $7.83 per hour for the hours worked in excess of forty hours. Salary covering periods longer than a workweek, e.g. a month, has to be reduced to its workweek equivalent. For instance, a monthly salary is first multiplied by 12 to obtain the annual salary and is then divided by 52 to obtain the weekly salary. 29 C.F.R. § 778.113 (1998).

D. The regular hourly rate for a salaried employee paid a fixed salary regardless of the number of hours worked in a workweek equals the fixed salary divided by the number of hours actually worked in a particular workweek. The regular hourly rate will, consequently, vary depending upon the number of hours worked in a particular week. 29 C.F.R. § 778.114 (1998).

I. Commissions are also included in an employee's regular rate of pay. However, since payment of commissions is often deferred until the commissions can be ascertained the employer may disregard the amount of commissions until they are actually paid. When the amount of commissions are determined, they are apportioned over the period during which they were earned. Additional overtime compensation may be due as a result of inclusion of the commissions in an employee’s regular rate of pay during such period. 29 C.F.R. § 778.119 (1998). For example, assume that Tom, a non-exempt employee, earns $6 per hour and works 46 hours in a particular week. He also earns $92 in commissions that are not computed until the following month. Tom must be paid $294, excluding commissions, based upon working the 46 hours ($6 x 46; plus $3 x 6). When the amount of his commissions are computed, he must be paid additional overtime pay based upon an increase in his regular hourly rate of $2 ($92 / 46 = $2). Multiplying one-half of $2 times the six overtime hours results in additional compensation due of $6.

IV. Record-Keeping

Requirements.

Any employer subject to the FLSA provisions has to make, keep and preserve certain records relating to its employees. 29 U.S.C.A. § 211(c) (1998); 29 C.F.R. 516 (1998). While the specific records that need to be maintained depend upon the circumstances involved, an employer should maintain the records needed to prove compliance with the FLSA, including the records necessary to support that a particular employee is exempt and has been paid for all time worked. Basic records such as payroll records and employment agreements have to be preserved for at least three years. Supplemental records such as time and earning cards or sheets have to be preserved for only two years. 29 C.F.R. 779.514 (1998).

V. Remedies.

An employer failing to comply with the FLSA can be held liable for the unpaid overtime pay, attorney fees, costs, and liquidated damages. The amount of liquidated damages can be equal to the amount of unpaid overtime compensation so that liable employers have to pay double the amount of unpaid compensation. 29 U.S.C.A. § 216(b) (1998). Civil penalties also can be assessed, and any person willfully violating any of the provisions of the FLSA can be imprisoned for not more than 6 months and be fined not more than $10,000. 29 U.S.C.A. § 216(a) (1998).

Individual employees, a group of employees or the United States Department of Labor on behalf of an individual or a group of employees can file a lawsuit seeking to recover unpaid wages or damages. A lawsuit can be filed in Federal or state court. The Department of Labor also can audit payroll records either as a result of a complaint or a random audit. A lawsuit based upon a violation of the FLSA must be bought within two years of the date of the alleged violation, except in cases of willful violations in which case the statute of limitations is three years. 29 U.S.C.A. § 255 (1998).

VI . Common Pitfalls.

Counsel must be aware of the following pitfalls that could inadvertently cause an otherwise exempt employee to be non-exempt.

A. Docking.

As discussed above, the white-collar exemptions generally only apply if an employee is paid on a salary basis. An employee paid a salary may still be considered an "hourly" employee and thereby non-exempt if there is either an actual practice of making deductions for partial day absences against the weekly salary or an employment policy that creates a ‘significant likelihood’ of such deductions. Auer v. Robbins, 117 S.Ct. 905, 911 (1997). This is called "docking." Until the United States Supreme Court’s decision in Auer there was a great deal of uncertainty as to the circumstances under which deductions from salary for absences of less than a day converted an otherwise exempt employee into a non-exempt employee. Some jurisdictions held that an employment policy that merely permitted deductions for partial day absences converted an exempt employee into a non-exempt employee. Other courts required that actual deductions be made to warrant conversion. The Auer court adopted a compromise position specifying that a clear and particularized policy that effectively communicates that deductions will be made in specified circumstances is sufficient to convert an otherwise exempt employee into a non-exempt employee. Id.

Even if an employer is found to have wrongfully docked an employee’s pay, the "window of corrections" provides the employer with a means to avoid liability. "[W]here a deduction not permitted by these interpretations is inadvertent, or is made for reasons other than lack of work, the exemption will not be considered to have been lost if the employer reimburses the employee for such deductions and promises to comply in the future." 29 C.F.R. § 541.118(a)(6) (1998). A very recent case applied the "window of corrections" in holding that improper payroll deductions occurred with enough frequency and regularity that they cannot be characterized as inadvertent. See Belton v.

Sigmon, No. 97-0053-D, VLW 098-3-313 (W.D. Va. 1998).

B. Compensatory Time.

Related to the issue of docking, is the improper use of compensatory time. Under the FLSA, private employers are forbidden from granting "compensatory time" to their non-exempt employees in lieu of required overtime compensation. Although an employer can provide its non-exempt staff with compensatory time, the total number of hours worked in a week cannot exceed 40. The improper use of compensatory time for exempt employees can also convert an otherwise exempt employee into a non-exempt employee.

C. Averaging.

Since an employee’s regular hourly rate of pay is determined on a weekly basis, an employer can not average the hours worked in multiple weeks in computing the number of hours for which overtime compensation has to be provided. 29 C.F.R. § 778.104 (1998). For instance, assume that an employee is paid every two weeks and works 80 hours. At first glance, no overtime compensation would be due. However, if the employee works 32 of the 80 hours in one week and the remaining 48 hours in the following week, the employee would be due overtime compensation for the eight hours worked in excess of 40 in the second week.

D. Unrecorded Overtime.

In some organizations, employees are prohibited from working more than 40 hours per week without prior authorization. Even though employees are expected to complete projects in a timely fashion, employees are often reluctant to go through the process of having overtime authorized since the need for overtime is sometimes viewed as an indication of mismanagement or inefficiency. Employees who want to timely complete projects can, therefore, be induced into working the overtime without recording the hours worked, a habit referred to as "ghosting." Even though the number of "ghosted" hours in a week may be minimal, the aggregate number of ghosted hours in an employee’s career may be significant. Supervisors should carefully monitor the hours worked by their non-exempt employees to make sure that all hours are recorded and compensated.

VII. A Final Word.

Compliance with the FLSA overtime provisions requires knowledge of who is an exempt employee, who has to be paid overtime pay, and how to compute any earned overtime. Corporate counsel needs to be aware of the issues discussed in this article in order to assist employers in complying with the FLSA. Failure to comply with the FLSA will only decrease the leverage of employers addressing complaints of wrongful discharge or some other adverse employment action and result in an increase in claims for unpaid wages, liquidated damages, attorney fees, and potentially, civil and criminal penalties.

Scott A. Dondershine focuses on business and tax law issues for the law firm of McMahon, David and Brody located in Vienna, Virginia. He has significant experience structuring complex transactions and drafting contracts for businesses and individuals. Scott is licensed to practice law in Virginia, Maryland and the District of Columbia and is also a Certified Public Accountant. McMahon, David and Brody provides government contracting, business and tax law services for clients located throughout the Washington Metropolitan Area.