U.S. v. Stein: Rewriting The Rules Of Corporate Cooperation With Government Investigations

Tuesday, August 1, 2006 - 01:00

The government "let its zeal get in the way of its judgment" and "violated the Constitution it is sworn to defend."

These are the words of District Court Judge Lewis A. Kaplan who declared on June 26, 2006 in U.S. v. Stein that KPMG's decision to stop advancing legal fees for its indicted or "uncooperative" employees was the direct result of unconstitutional government pressure. In so doing, Judge Kaplan may have done much more than pave the way for a handful of defendants to get their lawyers paid.

Judge Kaplan called into question the constitutionality of more than just actions of the prosecutors litigating Stein. He effectively struck down official Department of Justice policy, and may have initiated the rewriting of the rules of corporate cooperation in government investigations. This is no small thing. Because of the high price of indictment, "cooperation" has been the watch word for corporations under government scrutiny. One need only look at Arthur Andersen to see that an indictment can kill a company long before a jury decides whether a crime has actually been committed. Cooperation with prosecutors is the surest path to avoid corporate indictment.

Until now, however, the government has unilaterally defined what it means to be a "cooperating" corporation. The so-called Thompson Memorandum, circulated on January 20, 2003 by then-Deputy Attorney General Larry Thompson and officially entitled Principles of Federal Prosecution of Business Organizations, requires prosecutors to consider a number of factors when making the decision of whether to indict a corporation. Congress did not legislate these rules, nor were they the product of an administrative rule making. Furthermore, few courts have had occasion to subject the principles of the Thompson Memorandum to constitutional scrutiny. Yet for corporations under investigation, the Thompson Memorandum has been the law. That may now be changing.

In the Stein case, Judge Kaplan focused on the government's requirement to consider as uncooperative behavior a company's advancement of legal fees for its "culpable employees or agents." He declared that at least a portion of the Thompson Memorandum was unconstitutional. While his decision was focused on the issue of advancement of legal fees, his analysis supports various arguments that other portions of the Thompson Memorandum, including demands for privilege waivers, are similarly unconstitutional.

U.S. v. Stein: Facts And Conclusions

In February 2004, the United States Attorney's Office (USAO) began investigating KPMG for possible fraud related to the planning of tax shelters. From its first discussions with KPMG's outside counsel, the government strongly suggested that, to the extent that individuals within the company needed attorneys, outside counsel should recommend attorneys who understood that cooperation was the "best way to go." The USAO further pressured KPMG's counsel not to "reward misconduct" by, for example, paying attorneys' fees of those employees who refused to speak with the government. The government told KPMG's attorneys that if the company had discretion not to advance legal fees, it would look at KPMG's decision to pay fees "under a microscope." KPMG responded that it did in fact have discretion to refuse to advance legal fees and could cut off fees to employees who refused to cooperate. Judge Kaplan criticized the government for apparently not verifying KPMG's claim that it could stop advancing attorneys' fees, nor questioning the "obvious conflict of interest" in recommending attorneys that would most likely oblige the government.

Judge Kaplan also criticized the USAO for taking no issue with KPMG's written statement to its employees that they did not need separate counsel, and that even with separate counsel they were expected to cooperate fully with the government. Judge Kaplan found that KPMG circulated this statement in "capitulation" to the government's "demand," and that the government's purpose in compelling KPMG to tell its employees that they would not need separate counsel was to increase the chances that employees would agree to interviews without obtaining representation.

For several weeks after circulating the statement, the government notified KPMG's outside counsel every time a KPMG employee refused to participate in an interview with the government. In response, outside counsel advised that particular employees' attorneys' legal fees would be cut off unless the employee changed his or her mind within ten business days. Judge Kaplan called KPMG's actions "threats" and "pressure" on the government's behalf.

Following these and other concessions by KPMG, the government entered into a deferred prosecution agreement (DPA) with KPMG, whereby KPMG made many additional concessions, including invasive monitoring, paying a $456 million fine, handing over as much information as possible and urging its employees to do the same, and never contradicting the government's "statement of facts" - even in subsequent civil lawsuits against the company. KPMG also agreed to prospectively waive the protection of grand jury secrecy and the attorney-client privilege and work product protection as against the government, while being permitted to keep these privileges against individual "culpable" employees. It did this despite the practically settled law against selective waivers. And, the government reserved the right to unilaterally decide that a provision of the DPA had been violated, resulting in the indictment "that KPMG has labored so mightily to avoid," and used all information obtained against KPMG in a criminal proceeding. After signing the DPA, the government indicted nine individuals based on the DPA's agreed-upon "statement of facts."

In his conclusion, Judge Kaplan attacked the Thompson Memorandum as being inherently threatening and designed to minimize the involvement of defense attorneys in corporate investigations. He added that KPMG's decision to cut off legal fees for anyone indicted, and to limit pre-indictment fees to only those employees who agreed to cooperate, was "the direct consequence of the pressure applied by the Thompson Memorandum and the USAO."

The court found that the government's actions and policies violated the defendants' Fifth and Sixth Amendment rights under the Constitution.

Fifth Amendment Right To Due Process: No Back-Seat Driving

Judge Kaplan took the government to task for both its active and passive interference with the defense, resulting in a lack of fairness in the defendants' cases. "In short, fairness in criminal proceedings requires that the defendant be firmly in the driver's seat, and that the prosecution not be a backseat driver." According to Judge Kaplan, the Due Process Clause requires a standard of fundamental fairness that gives criminal defendants the opportunity to present a complete defense, and control the manner and substance of their defenses - including having counsel of their own choosing. In effect, the government was "obstructing" defendants' access to counsel. Judge Kaplan implicated other examples of "fairness," including not obstructing defendants from contacting witnesses necessary for their cases.

Furthermore, criminal defendants have a fundamental right to obtain and use resources lawfully available to them to prepare their defenses free of knowing or reckless government interference. The government's policies and actions were therefore subject to strict scrutiny, and neither the language in the Thompson Memorandum nor the USAO's actions exploiting the uncertainty of the Thompson Memorandum were narrowly tailored to achieve the government's interest in investigating and prosecuting crime.

Sixth Amendment Right To Counsel: Attached And Violated

Judge Kaplan rejected the government's argument that the Sixth Amendment, protecting an individual's right to counsel, had not yet attached at the time KPMG announced its policy of cutting off legal fees since no adversarial proceeding had yet been initiated. The court found that the Thompson Memorandum and the USAO's pre-indictment actions would have an effect on employees once indicted, and therefore the Sixth Amendment was implicated.

Judge Kaplan accused the government of acting with the purpose of minimizing potential defendants' access to resources necessary to mount their defenses, or at least with reckless disregard of this result. He added that the government was unable to bring forth adequate justification for its actions, rejecting as sufficient the government's argument that advancement of legal fees "occasionally might be part of an obstruction scheme or indicate a lack of full cooperation by a prospective defendant."

Furthermore, KPMG defendants were not required to show prejudice as a result of the government's misconduct, because Strickland did not call for a showing of prejudice where defendants are erroneously prevented from being represented by the lawyer of their choosing, regardless of the quality of the representation. Furthermore, prejudice to the KPMG defendants would be presumed because being denied counsel at a critical stage is a structural error, making a case-by-case inquiry unnecessary. The government's conduct, Judge Kaplan found, threatened to contaminate the entire proceeding, and it would be all but impossible to show prejudice after the fact.

Judge Kaplan's Opinion Could Open Some Doors For Defendants, If Other Courts Will Follow Suit

Every white collar defense lawyer knows that, for many companies, indictment means corporate death. No major financial services firm has ever survived a criminal indictment. By the time Arthur Andersen LLP was convicted in June 2002 on a single count of obstruction of justice, the firm had long since faced near dissolution. In an effort to avoid Andersen's fate, companies have made incredible concessions to the government in the face of potential indictment. Judge Kaplan's assertion that the threat of indictment amounted to coercion suggests that the threatened indictment of business organizations can lead to unconstitutional results. Indeed, Judge Kaplan's opinion should be persuasive in preventing prosecutors from demanding that legal fees not be advanced to employees during a corporate investigation.

The Stein decision also supports defense arguments that other aspects of the Thompson Memorandum are constitutionally suspect. For instance, government application of Thompson Memorandum principles may result in the suppression of statements in Stein. During the government's investigation of KPMG, some of the defendants were induced to make proffers to the government because they were told that failure to make a proffer would be seen as "uncooperative." Judge Kaplan acknowledged that at least some of the defendants' proffers to the government "conceivably would not have [been] made had they not [been] induced to do so by the threat of having payment of their legal fees cut off." While this issue was not directly addressed because it was before the court on another motion, Judge Kaplan raised the possibility of suppressing defendants' statements as a result of the government's interference with the defendants' abilities to mount defenses.

Stein also suggests that the Sixth Amendment may be violated where the prosecution, in an attempt to gain an unfair advantage at trial, interferes with the attorney-client relationship. Judge Kaplan's acknowledgment that the Sixth Amendment right can attach before judicial proceedings, specifically at the start of internal investigations, buttresses the arguments that coercing a waiver of the attorney-client privilege, or obtaining statements during investigations in the face of glaring conflicts of interest within the company, can amount to Sixth Amendment violations.

While it is unlikely that the Department of Justice will withdraw the Thompson Memorandum (at least right now), and similarly unlikely that corporations will blithely accept indictments so that they can have their day in court, it is possible that the Stein decision will help initiate a constructive discussion among corporate counsel, the defense bar, regulators and prosecutors so that the rules of corporation cooperation can be better - and more fairly - defined. With companies and private attorneys effectively becoming surrogates for the government during internal investigations, such a dialogue is overdue. This is particularly true because the judiciary, the traditional guardians of fairness, is rarely presented with cases such as Stein to decide because the price of getting a case to court is simply too high for most. Hopefully, the Stein decision will help initiate such a discussion.

Timothy P. Harkness is a Partner and Carmel E. Gabbay is an Associate in the litigation department of Kramer Levin Naftalis & Frankel LLP. For footnotes, please see this article on our Website, www.metrocorpcounsel.com.

Please email the authors at tharkness@kramerlevin.com or cgabbay@kramerlevin.com with questions about this article.