Key Victory For Execs On Legal Bills; Thompson Memo Hit

In a first-of-its-kind decision sure to please executives under investigation everywhere, a federal judge has slapped down prosecutors for pressuring KPMG to cut off legal support to 16 employees indicted for selling illegal tax shelters.

In a New York federal court, Judge Lewis Kaplan said that KPMG refused to pay its employees’ legal bills “because the government held the proverbial gun to its head.” Kaplan went on to say that the Justice Department’s policy of considering whether a company pays the legal fees of employees accused of wrongdoing as a factor in whether to indict the company itself is unconstitutional.

Kaplan then ordered the government not to consider KPMG’s payment of counsel fees for indicted employees, and told the defendants they could file a claim against the accounting firm to have their legal fees reimbursed.

The judge’s 88-page decision—in United States v. Stein et al—was cheered by defense lawyers who have long questioned the government’s ability to pressure companies to abandon their usual practice of subsidizing the legal defense of employees. The subject has been raised in other recent cases, but Kaplan is the first judge to come down squarely against prosecutors.

Although Kaplan’s decision is not binding on judges elsewhere, experts say the ruling could be extremely influential in other cases and will be aggressively cited by defense lawyers, who now have ammunition in the form of a stinging rebuke by a respected judge in a high-profile case to buttress claims of government overreaching.

Rose

“I’ve been waiting for a judge to say something like this one did for a long time,” says Robert Rose, a partner with Sheppard, Mullin, Richter & Hampton. “We’ve entered this world where the DoJ is going beyond simply guilt or innocence; they are meting out economic punishment … This is a very big issue. [Companies] get all kinds of opinions from lawyers about how quickly and how much they need to do to cooperate to satisfy the people doing the investigation.”

Powers

Marc Powers, a partner with Baker & Hostetler in New York and a former Securities and Exchange Commission branch chief, tells Compliance Week that he has worried about “the erosion of the attorney-client privilege as well as things which affect people’s basic constitutional rights … Thank goodness for the judiciary.”

Garcia

Michael Garcia, U.S. attorney for the Southern District of New York, unsurprisingly saw the decision in a less charitable light. “We are disappointed in Judge Kaplan’s opinion … which we respectfully believe is unsupported by the factual record and the applicable law,” Garcia said in a brief written statement. “The actions of the government were entirely consistent with appropriate Department of Justice policy and we believe that the prosecutors acted ethically and properly throughout this case.”

Message Received

The case involving the KPMG employees arose from an Internal Revenue Service investigation into certain tax shelters offered by the accounting giant. When a Senate subcommittee began its own investigation into abusive tax shelters by accountants, financial advisers and others, three senior KPMG partners testified before the committee. After a stormy hearing, the three partners left KPMG as part of a house cleaning, but that didn’t stave off a referral to the DoJ, which passed the investigation on to Garcia’s office in Manhattan.

THE THOMPSON MEMO

The excerpt below is from The Thompson Memo,"

which was a January 20, 2003, memo from Department of Justice Deputy Attorney General Larry D. Thompson to the "Heads of Department Components, United States Attorneys." The memo was titled, "Principles of Federal Prosecution of Business Organizations," and the excerpt below was from Section VI, "Charging a Corporation: Cooperation and Voluntary Disclosure." Relevant provision has been highlighted in red:

A. General Principle: In determining whether to charge a corporation, that corporation's timely and voluntary disclosure of wrongdoing and its willingness to cooperate with the government's investigation may be relevant factors. In gauging the extent of the corporation's cooperation, the prosecutor may consider the corporation's willingness to identify the culprits within the corporation, including senior executives; to make witnesses available; to disclose the complete results of its internal investigation; and to waive attorney-client and work product protection.

B. Comment: In investigating wrongdoing by or within a corporation, a prosecutor is likely to encounter several obstacles resulting from the nature of the corporation itself. It will often be difficult to determine which individual took which action on behalf of the corporation. Lines of authority and responsibility may be shared among operating divisions or departments, and records and personnel may be spread throughout the United States or even among several countries. Where the criminal conduct continued over an extended period of time, the culpable or knowledgeable personnel may have been promoted, transferred, or fired, or they may have quit or retired. Accordingly, a corporation's cooperation may be critical in identifying the culprits and locating relevant evidence.

In some circumstances, therefore, granting a corporation immunity or amnesty or pretrial diversion may be considered in the course of the government's investigation. In such circumstances, prosecutors should refer to the principles governing non-prosecution agreements generally. See USAM § 9-27.600-650. These principles permit a non prosecution agreement in exchange for cooperation when a corporation's "timely cooperation appears to be necessary to the public interest and other means of obtaining the desired cooperation are unavailable or would not be effective." Prosecutors should note that in the case of national or multi-national corporations, multi-district or global agreements may be necessary. Such agreements may only be entered into with the approval of each affected district or the appropriate Department official. See USAM §9-27.641.

In addition, the Department, in conjunction with regulatory agencies and other executive branch departments, encourages corporations, as part of their compliance programs, to conduct internal investigations and to disclose their findings to the appropriate authorities. Some agencies, such as the SEC and the EPA, as well as the Department's Environmental and Natural Resources Division, have formal voluntary disclosure programs in which self-reporting, coupled with remediation and additional criteria, may qualify the corporation for amnesty or reduced sanctions. Even in the absence of a formal program, prosecutors may consider a corporation's timely and voluntary disclosure in evaluating the adequacy of the corporation's compliance program and its management's commitment to the compliance program. However, prosecution and economic policies specific to the industry or statute may require prosecution notwithstanding a corporation's willingness to cooperate. For example, the Antitrust Division offers amnesty only to the first corporation to agree to cooperate. This creates a strong incentive for corporations participating in anti-competitive conduct to be the first to cooperate. In addition, amnesty, immunity, or reduced sanctions may not be appropriate where the corporation's business is permeated with fraud or other crimes.

One factor the prosecutor may weigh in assessing the adequacy of a corporation's cooperation is the completeness of its disclosure including, if necessary, a waiver of the attorney-client and work product protections, both with respect to its internal investigation and with respect to communications between specific officers, directors and employees and counsel. Such waivers permit the government to obtain statements of possible witnesses, subjects, and targets, without having to negotiate individual cooperation or immunity agreements. In addition, they are often critical in enabling the government to evaluate the completeness of a corporation's voluntary disclosure and cooperation. Prosecutors may, therefore, request a waiver in appropriate circumstances. The Department does not, however, consider waiver of a corporation's attorney-client and work product protection an absolute requirement, and prosecutors should consider the willingness of a corporation to waive such protection when necessary to provide timely and complete information as one factor in evaluating the corporation's cooperation.

Another factor to be weighed by the prosecutor is whether the corporation appears to be protecting its culpable employees and agents. Thus, while cases will differ depending on the circumstances, a corporation's promise of support to culpable employees and agents, either through the advancing of attorneys fees*, through retaining the employees without sanction for their misconduct, or through providing information to the employees about the government's investigation pursuant to a joint defense agreement, may be considered by the prosecutor in weighing the extent and value of a corporation's cooperation. By the same token, the prosecutor should be wary of attempts to shield corporate officers and employees from liability by a willingness of the corporation to plead guilty.

Another factor to be weighed by the prosecutor is whether the corporation, while purporting to cooperate, has engaged in conduct that impedes the investigation (whether or not rising to the level of criminal obstruction). Examples of such conduct include: overly broad assertions of corporate representation of employees or former employees; inappropriate directions to employees or their counsel, such as directions not to cooperate openly and fully with the investigation including, for example, the direction to decline to be interviewed; making presentations or submissions that contain misleading assertions or omissions; incomplete or delayed production of records; and failure to promptly disclose illegal conduct known to the corporation.

Finally, a corporation's offer of cooperation does not automatically entitle it to immunity from prosecution. A corporation should not be able to escape liability merely by offering up its directors, officers, employees, or agents as in lieu of its own prosecution. Thus, a corporation's willingness to cooperate is merely one relevant factor, that needs to be considered in conjunction with the other factors, particularly those relating to the corporation's past history and the role of management in the wrongdoing.

Note, Source

* The original document included the following footnote: "Some states require corporations to pay the legal fees of officers under investigation prior to a formal determination of their guilt. Obviously, a corporation's compliance with governing law should not be considered a failure to cooperate."

The Thompson Memo: Principles Of Federal Prosecution Of Business Organizations

Before this case, KPMG had always paid the legal counsel of executives and other employees who encountered legal trouble because of things done during the course of their work duties. Prosecutors, however, met with KPMG as part of the tax shelter inquiry and made clear that paying for employees’ lawyers would be deemed non-cooperation under the U.S. Sentencing Guidelines and the so-called Thompson Memo. The memo, issued in January 2003 by Deputy Attorney General Larry Thompson, detailed revised principles for federal prosecution of business organizations (see box above, right, for related coverage and a copy of the memo). It was this DoJ directive on indicting corporations that Judge Kaplan ruled unconstitutional.

After agreeing to stop paying the legal fees of its employees, KPMG avoided indictment for the company. But 16 former KPMG executives, now forced to pay for their own attorneys, faced criminal charges. They then argued that the government had improperly interfered with KPMG’s willingness to advance legal fees, and violated their rights to fair trial under the Fifth and Sixth Amendments. Kaplan agreed.

“Justice is not done when the government uses the threat of indictment—a matter of life and death to many companies and therefore a matter that threatens the jobs and security of blameless employees—to coerce companies into depriving their present and even former employees of the means of defending themselves against criminal charges in a court of law,” Kaplan wrote. “If those whom the government suspects are culpable in fact are guilty, they should pay the price. But the determination of guilt or innocence must be made fairly—not in a proceeding in which the government has obtained an unfair advantage long before the trial even has begun.”

What Happens Next

Hermann

The implications of overturning parts of the Thompson Memo could be profound and widespread, since so many corporate corruption cases are filed in the Southern District of New York where Kaplan made his ruling. Although the Justice Department has not yet announced whether it will appeal the ruling, Robert Hermann, a partner with Thacher Proffitt & Wood, says he expects the DoJ to contest the decision.

“This is a Justice Department that fights everything,” says Hermann, himself a former prosecutor. “This is a nationwide policy. Judge Kaplan is only one judge, though a well-respected one. If they don’t appeal, they might try to get [the policy] sustained in other jurisdictions. Chances are good that some judge somewhere will go the other way. Then it will be set up for appellate review and possibly Supreme Court review.”

Deem

Debra Healy Deem, a partner with Buchalter, Nemer, Fields & Younger, says she hopes that Kaplan’s decision “brings about a reverberation about what the government is doing in these prosecutions, primarily because the potential for abuse appears at last to come to fruition … But I don’t have any expectation that the DoJ is going to change its ways. They’ll have to get spanked more than once, and not just at the trial level.”

But Roma Theus, vice chair of the Defense Research Institute’s White Collar and Corporate Governance Committee, says he “firmly believe[s] the DoJ will take the sentiments expressed by Judge Kaplan seriously.”

The Thompson Memo—which says that payment of individual employees’ legal fees is one of a number of factors to be considered in deciding whether a company will face indictment—“is a tremendous deterrent to corporations to provide any kind of support to their employees,” Theus says. And without a company subsidizing an employee’s legal defense, “a typical individual is virtually unable to defend him or herself against the DoJ, which has almost unlimited resources in terms of attorney power, investigative power and financial power.”

Kilduff

Kevin Kilduff, however, a partner with Burns & Levinson and a former IRS attorney, argues that well-funded corporations “willing to throw hundreds of thousands if not millions of dollars behind employees” only encourage employees to push the boundaries of legal behavior. “If employees felt as though their illegal recommendations could have a personal impact on their own personal well-being, that may [convince] them to live within the rules of the law,” Kilduff says.

Powers, of Baker Hostetler, says Kaplan’s ruling suggests that a coalition of voices, including civil libertarians, corporate counsel and criminal defense lawyers, may be having an effect on government policy. “Now you have the judiciary speaking out and causing real harm to the prosecutors,” he says. “Despite early statements of resistance [from the government], I think there will be changes.”

Related resources—including Judge Kaplan's decision, The Thompson Memo, and prior Compliance Week coverage—can be found in the box above, right.