Internal investigations can arise in a number of different ways and can concern a number of different subjects. Allegations of financial misconduct, employment-related missteps, and breaches of fiduciary duty, among others, can all lead a company in that direction. Grand jury subpoenas, search warrants, target letters, media reports, whistleblower claims, audit reports, and routine risk assessments can often require senior management, the board of directors, or a board’s audit committee to begin an internal review. If the concerns are serious enough, an internal investigation may be necessary to determine: (1) what happened, (2) if wrongdoing occurred, and (3) what the company’s potential exposure may be.

If conducted intelligently, a strong internal investigation can minimize damage from an ethical breakdown and convince regulators or prosecutors that corporate misconduct is under control. But to make that happen, it is critical that conflicts of interest not undermine the work a bulletproof investigative report can do. Two matters in 2013 have made the point plainly.

Le-Nature’s, Inc.

In March, the U.S. Court of Appeals for the Third Circuit affirmed the conviction of Le-Nature’s, Inc.’s former executive vice president, who had participated in a $660 million accounting fraud scheme. The scheme was missed by an internal investigation that was hopelessly conflicted and had no real chance of identifying the financial irregularities that ultimately sank the company.

Here’s how the investigation played out, according to the Superior Court of Pennsylvania. As part of standard quarterly audit procedures, the engagement partner at Le-Nature’s auditor solicited the concerns of three senior managers regarding the company’s financial activities, and asked whether they suspected fraudulent activity.  The CFO, chief administrative officer, and vice president of administration all expressed concerns about the accuracy of Le-Nature’s sales figures, and resigned shortly thereafter. In their resignation letters, the officers said they suspected CEO Greg Podlucky’s potential misconduct with the company’s vendors, suppliers, and customers. The CFO, John Higbee, noted in particular that Podlucky had denied him access to documentation supporting Le-Nature’s general ledger details. Higbee explained that by conducting business transactions “without any normal review by others, such as the CFO,” Podlucky had rendered it impossible for Higbee to discharge his responsibilities to Le-Nature’s.

The auditor soon requested that Le-Nature’s hire “competent independent legal counsel to conduct a thorough and complete investigation of the allegation made by the” senior managers. The company’s board of directors then appointed a special committee to do just that. The special committee hired an outside law firm, which in turn hired a forensic accounting firm to assist in the investigation.

Three months later, the law firm provided a draft of its report to Podlucky, who was not a member of the special committee and whose conduct was the subject of the investigation. The special committee had not received a copy of the draft report, but Podlucky immediately called a meeting of the board of directors to discuss it. Podlucky also provided comments to the law firm on the draft report. About ten days later, the law firm provided the draft report to the special committee.

The accounting firm and the law firm approved the report. Unsurprisingly after the filter put on it by Podlucky, the report “found no evidence of fraud or malfeasance with respect to any of the transactions” subject to the investigation. As the Pennsylvania Superior Court said, Podlucky and his senior managers used this stamp of approval to retain their positions at Le-Nature’s and to continue to “loot” the company, “incurring further corporate debt and wasting corporate funds on avoidable transactions.”

The internal investigation, ostensibly designed to root out an ongoing fraud, instead became a tool of the fraud. Compromising the investigation’s independence led to hundreds of millions in losses at Le-Nature’s and criminal convictions of seven company executives and consultants. The defendants were convicted in the U.S. District Court for the Western District of Pennsylvania for mail fraud and money laundering violations.

Chesapeake Energy Corp.

For now, the second instance is less dramatic. In February, the audit committee of the board of directors of Chesapeake Energy Corporation concluded an internal investigation into (1) whether CEO Aubrey McClendon had engaged in misconduct by privately borrowing hundreds of millions of dollars from some of the company’s biggest financiers; and (2) potential antitrust violations during Chesapeake’s acquisition of drilling rights in a Michigan shale formation. The investigation by the committee and another outside law firm lasted ten months and involved more than 50 interviews with executives from Chesapeake and other companies. The probe found no intentional misconduct by McClendon.

Unfortunately for McClendon and Chesapeake, government regulators were not placated. Michigan Attorney General Bill Schuette, who had begun an antitrust inquiry into Chesapeake, was especially unimpressed with the supposed independence of the internal investigation that had cleared McClendon. Shortly after Chesapeake announced the results of its internal probe, his spokeswoman said: “The importance of independent – rather than internal – investigations cannot be emphasized enough in a case involving antitrust bid-rigging allegations. Our thorough, independent investigation into these serious allegations will continue.”

Chesapeake’s internal investigation also did not deter the SEC. Nine days after the supposed all-clear, the SEC escalated its investigation into the company, converting its informal inquiry into a formal investigation, complete with subpoena power.

“I’m now confused because the board just said everything was fine,” said Fadel Gheit, an oil analyst at Oppenheimer. “I really thought the board had an iron-clad, air-tight grip on the situation. Unfortunately, the saga continues.”

It is unclear exactly what factors led the SEC to disregard the results of Chesapeake’s internal probe. But the independence of the investigation certainly seemed compromised to the Michigan Attorney General’s Office.

The lessons from these two episodes should be clear. When conducting internal investigations, outside counsel should bear in mind who is being represented. In most instances, the client is the company and not the CEO or any particular member of senior management. Remembering that should keep investigators’ eyes on the ball and lead to a result that will optimize results and minimize costs for the company.