The Investigation And Prosecution Of Business Organizations

Wednesday, October 1, 2008 - 01:00

June 2006, New York federal judge Lewis A. Kaplan found unconstitutional the government's use of coercion to induce KPMG not to pay the legal fees of employees facing criminal charges.1In that case, the government used principles from the Thompson Memorandum, an already controversial Department of Justice (DOJ) policy that provided that such legal fee payments and a company's failure to waive attorney-client privilege and work product protection could be viewed as evidence of an organization's non-cooperation with a federal investigation. The decision was noteworthy because it was the first time that a court reviewed the constitutionality of the government's use of the Thompson Memorandum.

Two years later, the world looks a bit different - the Thompson Memorandum is no longer in force, but was replaced by two successive DOJ policies, the latest of which was issued on August 28, 2008; a federal appeals court upheld Judge Kaplan's decision on August 28, 2008; and both political parties are calling for the formal regulation of certain DOJ activities relating to the prosecution of business organizations. However, the risks for business organizations still exist, as an organization's cooperation remains a key element of any charging decision. Understanding what is and what is not deemed "cooperative" remains important for any business organization.

The Thompson Memorandum

The government's policy regarding an organization's cooperation and payment of legal fees was formally expanded and made mandatory in the 2003 Thompson Memorandum, drafted by then DAG Larry D. Thompson. The memorandum required federal prosecutors to consider nine additional factors in their any charging decision. An organization's willingness to cooperate2(factor 4) was specifically addressed at Section VI of the memorandum, which provided that prosecutors could consider the following:

• The timing and completeness of a company's disclosure, including a waiver of attorney-client and work product privileges;

• Whether a company appeared to be protecting its culpable employees and agents by advancing attorneys fees, retaining them without sanction for misconduct, or providing information to them about the government's investigation pursuant to a joint defense agreement;

• Whether a company, while purporting to cooperate, had engaged in conduct that "impeded" an investigation by overly broad assertions of corporate representation of employees, providing inappropriate directions to employees or their counsel, making misleading assertions or omissions, delaying production of records, or failing to promptly disclose illegal conduct.

The Thompson Memorandum received an enormous amount of criticism from the legal and business communities, who in turn put great deal of pressure on elected officials to take up the cause, and on the DOJ to amend its policy.

The first real blow against the Thompson Memorandum, however, came not from Congress, but in a courtroom. In the Stein case, thirteen defendants moved to dismiss an indictment, arguing that the government's coercive actions violated their constitutional rights.

The Stein Case

In 2004, the Manhattan United States Attorney's Office began investigating KPMG's promotion of certain tax shelters. KPMG approached the United States Attorney's Office to determine what it could do to cooperate, but learned over several meetings that its proposed plan to "clean house," fire certain partners, and encourage its employees to cooperate was not enough. The government made clear that KPMG's payment of legal fees for employees could count against KPMG in any charging decision, notwithstanding KPMG's long-standing voluntary practice of paying legal fees for employees. KPMG acquiesced to government demands, and made clear to individual employees that it would provide only limited legal fees, and only while the employee cooperated with the government. KPMG eventually received a non-prosecution agreement, but thirteen of its former employees were indicted. In January 2006, all thirteen moved to dismiss the indictment based on the government's interference with KPMG's advancement of fees.

In his June 2006 decision, Judge Kaplan concluded that the government deprived the employees of their right to fair criminal proceedings. In so doing, the government violated the employees' Fifth Amendment right to substantive due process, (the defendants had a fundamental right to use available resources free of government coercion), and Sixth Amendment right to a lawyer of one's choice, (the government improperly interfered with employees' expectation of receiving advancement of legal fees). The judge thereafter dismissed the indictment.

On the government's appeal, (decided August 28, 2008), the Second Circuit Court of Appeals upheld Judge Kaplan's decision. The appellate court disagreed with the government's argument that KPMG voluntarily suspended its legal fees payments: "KPMG faced ruin by indictment and reasonably believed it must do everything in its power to avoid it . . . . The government's threat of indictment was easily sufficient to convert its adversary into its agent. KPMG was not in a position to consider coolly the risk of indictment, weigh the potential significance of the other enumerated factors in the Thompson Memorandum, and decided for itself how to proceed."

Revocation Of The Thompson Memorandum

The initial Stein decision provided a chink in the government's armor and made clear that (at least in New York) a prosecutor's power was not unlimited. However, the actual holding is quite narrow - the Stein decision held that it was unconstitutional for the government to coerce an organization to withhold legal fees when an employee has a legitimate expectation interest to receive advancement of legal fees. Other defendants who have tried to argue a broader reading of the case have been denied. See, e.g., United States v. Olis , No. H-03-217-01, 2008 WL 620520 (S.D.Tex. March 3, 2008) (distinguishing Stein ).

Thus, even after the Stein case, the use of the Thompson Memorandum was still permitted, and prosecutors could still insist on waivers of attorney-client privilege and work product protection. These issues have been addressed, in part, by Congress and the DOJ.

On December 7, 2006, U.S. Senator Arlen Specter, R-Pa., introduced the Attorney-Client Privilege Protection Act of 2006. That legislation would have prohibited federal prosecutors from making a "non-cooperation" determination because of a valid privilege assertion. On January 4, 2007, Senator Specter reintroduced the legislation as the Attorney-Client Privilege Protection Act of 2007. While the Senate has not yet passed its version (S. 3217) of the bill, the House of Representatives passed an analogue of the bill (H.R. 3013) in 2007.

The DOJ's first response to Senator Specter's legislation was the McNulty Memorandum, drafted by then DAG Paul J. McNulty as an update to the Thompson Memorandum, and issued on December 12, 2006. The memorandum addressed the waiver issue, not by eliminating a prosecutor's power to seek a privilege waiver, but by requiring prosecutors to obtain senior-level approval before seeking them. Although many acknowledged that the McNulty Memorandum was a step in the right direction, the memorandum had many critics who insisted that it still did not go far enough in prohibiting line prosecutors from potentially coercing business organizations into waiving privilege.

After significant pressure, and a renewed call for federal legislation, the DOJ revoked the McNulty Memorandum, and, on August 28, 2008, issued the Filip Memorandum, drafted by DAG Mark Filip. This new policy prohibits prosecutors from considering a business organization's decision not to waive privilege protection as a factor in assessing the organization's cooperation. Instead, prosecutors must measure a organization's cooperation by the extent to which the organization voluntarily discloses "relevant facts and evidence."

Recommendations

It is important for corporate counsel to understand the impact and scope of the Stein decision and Filip Memorandum. As stated above, the Stein decision is limited by its particular facts - a situation in which the government actually coerced an organization, and the organization's employees had a legitimate property interest in the item withheld (advancement of legal fees).

On the other hand, the introduction of the Filip Memorandum appears to be a step in the right direction. The memorandum instructs prosecutors not to treat the attorney-client privilege and work product protection or payment of corporate employees' attorneys' fees as indicia of alleged obstruction of justice. The memorandum also discourages prosecutors from coercing privilege waivers as positive criteria of cooperating and compliance with official investigations. The memorandum does not, however, do away with the idea of cooperation credit, and the necessity for organizations to show cooperation. Individuals typically demonstrate cooperation with government investigations by disclosing their knowledge of facts relating to the alleged wrongdoing. So too, business organizations must disclose their "knowledge" of the underlying facts to gain entitlement to cooperation credit. Of course, disclosure of an individual's knowledge does not raise the same concerns as the "knowledge" of a business organization. Not only does this standard make it potentially difficult to understand the form and quantity of knowledge that will sufficient to allow a business organization to receive this credit, but raises privilege issues separate and apart from waiver.

The new policy states that a business organization's disclosure to the government of the relevant facts is the test of its cooperation, and not a waiver of privilege. However, once a business organization faces a government inquiry, it typically retains attorneys to gather and assemble facts through an internal investigation. Even if there is no government inquiry, several laws, like for example Sarbanes-Oxley, require attorneys to conduct investigations or audits of business organizations. In view of this, it is unclear how a business organization could practically cooperate with the government under the Filip Memorandum without waiving at least the protection for "fact" attorney work product.

How aggressive prosecutors will be in seeking "fact" work product remains a question mark. A too aggressive or too lenient stance would raise waiver concerns or make the standards for cooperation credits meaningless, respectively. It will take some time for the effects of the Filip Memorandum to play out fully. One thing that is clear, however, is that the DOJ's policy has changed, and this change could impact the manner by which business organizations weigh the risks of indictment, pleas, deferred prosecution agreements, and trial. Corporate counsel would be well advised to obtain competent legal counsel at the start of any government inquiry to assist their business organizations in understanding the current landscape, and their options in determining the right manner and level of cooperation with the government. 1United States v. Jeffrey Stein, et al . , 435 F. Supp. 2d 330 (S.D.N.Y. 2006).

2 There is a great incentive for organizations to avoid the "non-cooperative" label. Such a label almost guarantees an indictment, which in turn almost guarantees its certain death, or, at least, major problems including loss of customers, personnel, and numerous lawsuits. One notable example, of course, was the 2002 case of Arthur Andersen, which lost nearly all of its clients, and its ability to finance its operations and conduct business in the public markets after being indicted. After the Andersen case, the lesson for corporate counsel was clear: to survive, an organization must avoid indictment, must comply with the government's demands, and make sure that they are labeled "cooperative."

Robert J. Kipnees is a Member of the firm's Litigation Department and White Collar Criminal Defense Practice Group. Khizar A. Sheikh is an Associate in the Litigation Department and White Collar Criminal Defense Practice Group.

Please email the authors at rkipnees@lowenstein.com or ksheikh@lowenstein.com with questions about this article.