The Department of Justice’s controversial policy of pressuring companies to stop paying the legal fees of top executives and other employees as a condition of getting lenient treatment in some criminal investigations was dealt a serious blow recently when a federal judge ruled the practice was unconstitutional.
And while lawyers say the decision will enable corporations and their employees to stand taller against the government in white-collar criminal cases, they warn of potentially troubling details in the decision.
In U.S. v. Stein, U.S. District Court Judge Lewis A. Kaplan of the Southern District of New York ruled the U.S. government violated the 5th and 6th Amendments (entitlement to a fair trial and to the effective assistance of counsel) by pressuring accounting firm KPMG into avoiding paying the legal fees of individual employees and into breaching a fee agreement with one person.
The judge decried the Justice Department’s well-known Thompson Memorandum, saying it “obliged [prosecutors] to consider the advancing of legal fees by [corporations], except as required by law, as at least possibly indicative of an attempt to protect culpable employees and as a factor weighing in favor of indictment.”
(The decision can be viewed at http://www.acc.com/public/attyclientpriv/kpmg_decision.pdf and the Thompson Memorandum is available at www.usdoj.gov/dag/cftf/corporate_guidelines.htm.)
Michael A. Collora of Boston’s Dwyer & Collora said the ruling “provides a big chip for corporate counsel to use in bargaining with the Justice Department,” adding that “contractual subsidies of legal fees should not be a factor if this holds up.”
While Collora and other attorneys said the government does not use “pressure tactics” against legal fee advancements in most cases, they stressed that failure to finance a good legal defense in any case puts unfair pressure on companies and individuals.
“It’s an unthinkable Hobson’s choice for a company to suffer the penalty of indictment or seek exoneration at the cost of throwing senior executives under the bus,” argued Thomas Cranmer of Michigan-based Miller Canfield.
Stanley A. Twardy Jr., who often practices in New York City for Connecticut-based Day Berry & Howard, agreed, adding that Big Apple prosecutors are “more aggressive in using prosecutorial tools because they are in the forefront of the biggest white-collar cases with more at stake in each case.” Twardy said legal fees for each executive in a case like KPMG tax shelter case “could easily run into millions of dollars.”
Frederick J. Krebs, president of the Association of Corporate Counsel, said the decision is “a substantial, encouraging decision in a significant and symbolic case.” Kaplan’s ruling is “a shot across the bow of the Justice Department,” Krebs said, as the DOJ launches mounting numbers of white-collar indictments.
But the restrictions on government interference with legal fee advancements may come with a price tag for corporations, warned William D. Johnston of Young, Conaway Stargatt & Taylor in Delaware.
“This well-backed and scholarly decision goes astray by suggesting a right to legal fee advancement,” he argued. “Footnote 119 [of the opinion] suggests that uniform past practices in paying legal fees can create an implied-in-fact contract.”
Experts predicted the Kaplan ruling will go under the microscope of other judges and practicing lawyers in months to come, and other aspects of the 88-page opinion may loom larger in the future.
Legitimate expectations of payment
In 1999, then-U.S. Deputy Attorney General Eric Holder issued a Justice Department memo regarding prosecution of corporations, telling prosecutors they should consider a company’s “willingness to cooperate in the investigation of its agents” in deciding how to charge in a case.
Kaplan said this memo “made clear that advancing of attorney’s fees to personnel of a business entity under investigation… might be viewed by the government as protection of culpable individuals.” But the judge also stressed that prosecutors were “free to take it into account or not.”
Holder’s successor, Larry D. Thompson began work on an updated version of the memorandum in late 2002, just as the IRS was investigating fraudulent abuses of corporate tax shelters, some of which were allegedly connected to KPMG.
At the same time, executives of KPMG were called to testify before Congress and admonished by Senators from both sides of the aisle. That led KPMG to clean house, firing several ultimate targets in 2003, the same year that Thompson bolstered the Holder memo by making it “binding on all federal prosecutors,” according to Kaplan.
Shortly after the government issued summonses to KPMG, prosecutors intimated to the firm’s counsel that payment of individuals’ legal fees had to be considered under the Thompson memo and “rewarding” of any “misconduct” could be punished under federal sentencing guidelines.
When KPMG told Stein and other partners that it would not pay their legal fees, they challenged the action as a governmental deprivation of due process. Kaplan then invited briefing on whether there was an “implied-in-fact” agreement to advance fees and whether the sending of target letters triggered the individuals’ constitutional right to have adequate counsel.
The judge noted there was no bylaw or statute requiring KPMG to pay the legal fees of its executives, but found a legitimate expectation of indemnification and advancement based on past practices.
Kaplan also wrote that “bus drivers, news reporters… and corporate chieftains” generally have similar expectations and rights to indemnity. He added that this right “is as much a part of the bargain between employer and employee as …wages.”
As a result, he concluded the Thompson Memo “often prevents companies from providing employees and former employees with the financial means to exercise their constitutional rights to defend themselves.”
The judge rejected government arguments that individual defendants have “no right to spend other people’s money,” asserting there was legitimate expectation of advancement of fees. Kaplan also rejected the argument that “right to counsel” only attaches at arraignment or indictment where pre-indictment events affect the defense.
Defense lawyers applaud
White-collar defenders agreed the decision brought welcome legal assistance to an area of serious contention between the government and defendants.
Johnston said “advancement of legal fees is a hot topic and it is getting a lot hotter.” He noted that “many companies in the post-Enron environment have added fee advancement provisions to their [corporate governance documents].”
Krebs affirmed that the topic is of major concern to corporate counsel, noting that “we received more notes of support [at the ACC] for this effort [filing amicus briefs and lobbying Congress] than for anything we have ever done.”
He added that the ACC would not hesitate to jump into another case on this subject or the issue of waiver of attorney-client privilege, if necessary. “We hope this effort will be a springboard to more success in the future,” Krebs said.
Noting that the KPMG case is the largest tax fraud case in history, and perhaps the most closely watched among criminal defense lawyers, Cranmer said the ruling provided enormous benefits to corporate counsel.
“The decision gives general counsel some degree of comfort that an individual won’t have to make a decision to turn on the corporation because they have no other alternative to stay out of jail,” he said.
Cranmer noted that few individuals could begin to pay for their defense in a case of this magnitude because it involves literally millions of documents and dozens of investigatory agents.
Twardy agreed, adding that prosecutors outside of the Southern District of New York would be wary of this ruling even if it is not binding on them. “For corporations, this decision provides an opportunity to push back at the government, and for individuals this will provide an opportunity for a better defense with better lawyers,” he argued.
In Collora’s eyes, the most important benefit to come from the decision may be “the ability to keep current employees happy by showing that you will defend them and adhere to any contractual obligations to provide a defense. This decision gives the company the right to make the call on any decision to advance legal fees.”
Concerns about the ruling
But Johnston contended that corporate counsel “should be very concerned about the decision interfering with the corporate right to decide on advancement. An officer employee may have a right to expect advancement [under the ruling].”
He added that Delaware law – partly at issue in the case – is “clearly permissive in nature and not mandatory” as to executive entitlements to legal fee indemnification and advancement, despite published press reports to the contrary.
Johnston said the judge acknowledged the permissive nature of the law, but created a novel kind of “implied promissory estoppel” argument to force KPMG to pay for the legal costs of those individual defendants not protected by contract or corporate bylaws and documents.
The veteran trial lawyer also called attention to judicial suggestions in footnote 119 concerning California law. “All of the [KPMG] partners might have an argument that they have a right to be protected because of [interpretation of] a California statute that affects anyone ‘doing business’ in California,” he asserted.
“The real problem is that the company should retain the right to decide when advancement is appropriate and the company must retain the right to cut off payments as well,” Johnston argued.
Lawyers also expressed concerns about where the Justice Department goes after this ruling.
“They could toss the Thompson Memorandum out altogether, and that would be bad,” said Twardy.
He noted that lawyers benefit from the mitigating considerations in the memorandum that prosecutors must consider, such as “the seriousness of the offense” or “the history of similar conduct” or “the collateral consequences” of a serious charge.
“We learned from Arthur Andersen that an indictment for an accounting firm can be the corporate death penalty, and throw thousands of people out of work,” Twardy said, noting that the government can now give consideration to such “collateral consequences.”
Johnston said it was more likely the government would simply pare back the application of the Thompson Memorandum so its enumerated charging factors are not required considerations, essentially returning to the Holder Memorandum position that Kaplan seemed to endorse.
But Krebs maintained that such a position would still be objectionable. “The Holder Memo is a problem because it is just never appropriate to interfere with the right to counsel, even if prosecutors are not required to take legal fee [advancement] into consideration,” he said.
Lawyers generally agreed that Kaplan would not be the only judge to interpret the rights of defendants as pitted against the Thompson Memorandum.
Twardy pointed to a pending New Hampshire case, U.S. v. Gagalis, in which the issue of attorney fee advancement is also in question. “It is not a given that the Kaplan decision will stand,” he added, noting that it could be appealed or not followed in other districts.
“This is not the last word on the subject,” Cranmer predicted. “There will likely be future clashes in court and a legislative fix may ultimately be needed,” he said. “If Judge Kaplan becomes a lone voice in the wilderness, something else will need to be done.”
That is one reason the ACC has been pushing for legislative attention to this matter as well.
Krebs, a former lobbyist, said the ACC is pushing for hearings in the House of Representatives and the Senate Judiciary Committee on the subjects of the Thompson Memorandum and the pressure to waive attorney-client privilege.