Thompson Memorandum on Fees Found Unconstitutional

The Thompson Memo

The Thompson Memo ' officially, the Memorandum from Deputy Attorney General Larry D. Thompson to Heads of Department Components and United States Attorneys Re: Principles of Federal Prosecution of Business Organizations (available at:www.usdoj.gov/usao/eousa/foia_reading_room/usam/title9/crm00161.htm) ' has this to say about entities under investigation that advance their employees' legal fees:

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 ' through the advancing of attorneys fees ' may be considered by the prosecutor in weighing the extent and value of a corporation's cooperation.

A footnote adds this gloss: '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.'

When the footnote is read together with the text, the Thompson Memo's import is clear: An entity under investigation hoping to demonstrate 'genuine' cooperation to the government should not advance legal fees to employees whom the government deems 'culpable' unless it is legally required to do so. Judge Kaplan found that 'few if any competent defense lawyers would advise a corporate client at risk of indictment that it should feel free to advance legal fees to individuals in the face of the Thompson Memorandum itself.'

The KMPG Case

It was not the text of the Thompson Memo alone that was at issue in the KPMG case. Judge Kaplan's factual findings, made after a 2-day evidentiary hearing, show prosecutorial conduct specifically intended to coerce KPMG to cut off fees. Before the criminal tax shelter investigation, KPMG's longstanding practice always was to advance fees to its partners and employees to defend any civil or criminal case. Indeed, in the 1970s, KPMG advanced fees for the defense of two partners through investigation, trial, and appeal of a criminal conviction. More recently, in the 2002 enforcement action brought by the SEC relating to KPMG's audit of Xerox, KPMG conceded that it paid over $20 million to defend four partners both in that case and in a related criminal investigation.

Against this backdrop of KPMG's previously unbroken support for its employees came prosecutors wielding the Thompson Memo. The government raised the fee issue at its first meeting with KPMG's counsel at the very start of the investigation. In the middle of that discussion, after KPMG's counsel said that the firm had not reached any decision on fees, a senior prosecutor said 'misconduct' could not be 'rewarded' under 'federal guidelines.' Another line prosecutor echoed this sentiment, telling KPMG's counsel that if KPMG had 'discretion' on fees, the government would 'look at that under a microscope.'

Shortly after that meeting, KPMG broke from its prior practice by capping fees, conditioning fees on cooperation with the government, and cutting off fees altogether upon indictment even though it never conducted an internal investigation to determine for itself if anyone had engaged in wrongdoing. Moreover, KPMG's fear of indictment, and, in the words of its chief legal officer, its need 'to be able to say at the right time with the right audience' that it was in full compliance with the Thompson Memo, caused it to breach a clear contractual obligation in Stein's severance agreement to pay his legal fees. Judge Kaplan appeared to have no difficulty finding that, but for the Thompson Memo and its use by the prosecutors, KPMG would have advanced fees.

Judge Kaplan's Findings

The government's interference in KPMG's decision whether to advance fees violated defendants' rights to due process and assistance of counsel. Judge Kaplan recognized the 'fundamental' due process right of a criminal defendant 'to obtain and use in order to prepare a defense resources lawfully available to him or her, free of knowing or reckless government interference.' Particularly here, where the government has produced millions of documents in discovery, the need for resources to mount a defense is paramount. Subjecting the government's attempt to deprive defendants of resources to 'strict scrutiny,' Judge Kaplan found its conduct not to have been 'narrowly tailored to achieve a compelling government interest.'

The government's first rationale ' that the Thompson Memo punishes those whom prosecutors deem culpable ' was rejected out-of-hand. 'The imposition of economic punishment by prosecutors, before anyone has been found guilty of anything, is not a legitimate government interest ' it is an abuse of power.' The government's other justifications ' that its policy helps gauge the sincerity of corporate cooperation and encourages companies to pressure employees to cooperate as well ' both were found wanting. The Thompson Memo is not limited to corporations that 'circle the wagons,' but applies to all companies (however sincere their cooperation) to coerce them to refuse to advance fees. There is no language in the Memo limiting it to companies that engage in obstructive conduct or whose cooperation is otherwise lacking. The Memo also flies in the face of corporate public policy in virtually all states, including Delaware, which encourages companies to advance fees to officers and employees as an incentive to corporate service, so that employees can be free from the fear that they might later be 'left out to dry' in the event of a lawsuit or investigation.

As for the right to counsel, the fact that the challenged government conduct occurred before indictment did not prevent a successful Sixth Amendment claim. Judge Kaplan found that the government's pre-indictment coercion of KMPG was calculated to deprive the defendants of resources after they were indicted. The Supreme Court previously has found in the Sixth Amendment context that defendants have the right to use their personal resources to defend themselves, and the KPMG case is a necessary corollary of that right. Further support for Judge Kaplan came from the Supreme Court's decision this Term in United States v. Gonzalez-Lopez, 2006 WL 1725573 (U.S. June 26, 2006), where the Court found that wrongful deprivation of retained counsel-of-choice was a structural error requiring automatic reversal of a conviction without any need to show prejudice. It is no leap of logic to apply that principle here ' that the government's wrongful interference with a defendant's ability to fund his retained attorney through resources that would otherwise be available is a constitutional wrong.

Appropriate Remedy

In considering the appropriate remedy for the government's improper conduct depriving defendants of legal fees, Judge Kaplan ultimately found that he could not compel the government to pay defendants' fees because of sovereign immunity. KPMG, however, is another matter, as the court may exercise ancillary jurisdiction over a third party in a criminal case relating to a fee dispute. See Garcia v. Teitler, 443 F.3d 202 (2d Cir. 2006); United States v. Weissman, 1997 WL 334966 (S.D.N.Y. June 16, 1997). Judge Kaplan gave defendants 14 days to file an ancillary complaint against KPMG seeking advancement of fees in a summary proceeding, similar to the remedy provided under Delaware corporate law. 8 Del. C. ' 145. In the meantime, Judge Kaplan strongly importuned the government to use its influence with KPMG, which remains subject to a deferred prosecution agreement, to induce KPMG to advance fees voluntarily. The ultimate sanction for prosecutorial misconduct ' dismissal of the indictment ' remains open should KPMG fail to provide a remedy.

Conclusion

Judge Kaplan's ruling is certain to be groundbreaking. It may deeply affect DOJ policy and restore the ability of individuals to mount a meaningful defense to the burdens and challenges presented by complex corporate criminal prosecutions. As of this writing, the government has not appealed, and there is some question whether the DOJ would do so and risk a court of appeals decision affirming this important ruling. One can only hope that, in the future, corporations will be free to make fee advancement decisions without the government's thumb on the scale.

Craig D. Margolis ([email protected] ) is a former federal prosecutor and counsel in the Washington, DC, office of Vinson & Elkins LLP, specializing in government investigations and white-collar criminal defense. He is co-counsel with David Spears of Richards, Spears, Kibbe & Orbe LLP for Jeffrey Stein.

Strong words: KPMG refused to pay its employees' legal fees because prosecutors held a 'gun to its head,' and the government thus 'violated the Constitution it is sworn to defend.'

This statement from U.S District Judge Lewis A. Kaplan in the KPMG tax shelter case has shaken the foundations of corporate prosecutorial policy. United States v. Stein et al., 2006 WL 1735260, (S.D.N.Y. June 26, 2006).

Since Jan. 20, 2003, when the Department of Justice (DOJ) released the so-called Thompson Memorandum, federal prosecutors have attempted to coerce companies and other entities under investigation to refuse to advance legal fees and expenses to employees deemed 'culpable' for the government. The KPMG case itself is a poignant example, as the firm, to save itself from indictment, cut off legal fees to its former partners and employees, including my client Jeffrey Stein. KMPG did this despite its at least 35-year prior practice of paying the legal fees of its employees in investigations. The challenge brought by counsel for the KPMG defendants, including this author and Stein's co-counsel David Spears, led to Judge Kaplan's watershed ruling that the Thompson Memo's fee provisions violate both the Fifth Amendment right to due process and the Sixth Amendment right to assistance of counsel.

The Thompson Memo

The Thompson Memo ' officially, the Memorandum from Deputy Attorney General Larry D. Thompson to Heads of Department Components and United States Attorneys Re: Principles of Federal Prosecution of Business Organizations (available at:www.usdoj.gov/usao/eousa/foia_reading_room/usam/title9/crm00161.htm) ' has this to say about entities under investigation that advance their employees' legal fees:

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 ' through the advancing of attorneys fees ' may be considered by the prosecutor in weighing the extent and value of a corporation's cooperation.

A footnote adds this gloss: '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.'

When the footnote is read together with the text, the Thompson Memo's import is clear: An entity under investigation hoping to demonstrate 'genuine' cooperation to the government should not advance legal fees to employees whom the government deems 'culpable' unless it is legally required to do so. Judge Kaplan found that 'few if any competent defense lawyers would advise a corporate client at risk of indictment that it should feel free to advance legal fees to individuals in the face of the Thompson Memorandum itself.'

The KMPG Case

It was not the text of the Thompson Memo alone that was at issue in the KPMG case. Judge Kaplan's factual findings, made after a 2-day evidentiary hearing, show prosecutorial conduct specifically intended to coerce KPMG to cut off fees. Before the criminal tax shelter investigation, KPMG's longstanding practice always was to advance fees to its partners and employees to defend any civil or criminal case. Indeed, in the 1970s, KPMG advanced fees for the defense of two partners through investigation, trial, and appeal of a criminal conviction. More recently, in the 2002 enforcement action brought by the SEC relating to KPMG's audit of Xerox, KPMG conceded that it paid over $20 million to defend four partners both in that case and in a related criminal investigation.

Against this backdrop of KPMG's previously unbroken support for its employees came prosecutors wielding the Thompson Memo. The government raised the fee issue at its first meeting with KPMG's counsel at the very start of the investigation. In the middle of that discussion, after KPMG's counsel said that the firm had not reached any decision on fees, a senior prosecutor said 'misconduct' could not be 'rewarded' under 'federal guidelines.' Another line prosecutor echoed this sentiment, telling KPMG's counsel that if KPMG had 'discretion' on fees, the government would 'look at that under a microscope.'

Shortly after that meeting, KPMG broke from its prior practice by capping fees, conditioning fees on cooperation with the government, and cutting off fees altogether upon indictment even though it never conducted an internal investigation to determine for itself if anyone had engaged in wrongdoing. Moreover, KPMG's fear of indictment, and, in the words of its chief legal officer, its need 'to be able to say at the right time with the right audience' that it was in full compliance with the Thompson Memo, caused it to breach a clear contractual obligation in Stein's severance agreement to pay his legal fees. Judge Kaplan appeared to have no difficulty finding that, but for the Thompson Memo and its use by the prosecutors, KPMG would have advanced fees.

Judge Kaplan's Findings

The government's interference in KPMG's decision whether to advance fees violated defendants' rights to due process and assistance of counsel. Judge Kaplan recognized the 'fundamental' due process right of a criminal defendant 'to obtain and use in order to prepare a defense resources lawfully available to him or her, free of knowing or reckless government interference.' Particularly here, where the government has produced millions of documents in discovery, the need for resources to mount a defense is paramount. Subjecting the government's attempt to deprive defendants of resources to 'strict scrutiny,' Judge Kaplan found its conduct not to have been 'narrowly tailored to achieve a compelling government interest.'

The government's first rationale ' that the Thompson Memo punishes those whom prosecutors deem culpable ' was rejected out-of-hand. 'The imposition of economic punishment by prosecutors, before anyone has been found guilty of anything, is not a legitimate government interest ' it is an abuse of power.' The government's other justifications ' that its policy helps gauge the sincerity of corporate cooperation and encourages companies to pressure employees to cooperate as well ' both were found wanting. The Thompson Memo is not limited to corporations that 'circle the wagons,' but applies to all companies (however sincere their cooperation) to coerce them to refuse to advance fees. There is no language in the Memo limiting it to companies that engage in obstructive conduct or whose cooperation is otherwise lacking. The Memo also flies in the face of corporate public policy in virtually all states, including Delaware, which encourages companies to advance fees to officers and employees as an incentive to corporate service, so that employees can be free from the fear that they might later be 'left out to dry' in the event of a lawsuit or investigation.

As for the right to counsel, the fact that the challenged government conduct occurred before indictment did not prevent a successful Sixth Amendment claim. Judge Kaplan found that the government's pre-indictment coercion of KMPG was calculated to deprive the defendants of resources after they were indicted. The Supreme Court previously has found in the Sixth Amendment context that defendants have the right to use their personal resources to defend themselves, and the KPMG case is a necessary corollary of that right. Further support for Judge Kaplan came from the Supreme Court's decision this Term in United States v. Gonzalez-Lopez, 2006 WL 1725573 (U.S. June 26, 2006), where the Court found that wrongful deprivation of retained counsel-of-choice was a structural error requiring automatic reversal of a conviction without any need to show prejudice. It is no leap of logic to apply that principle here ' that the government's wrongful interference with a defendant's ability to fund his retained attorney through resources that would otherwise be available is a constitutional wrong.

Appropriate Remedy

In considering the appropriate remedy for the government's improper conduct depriving defendants of legal fees, Judge Kaplan ultimately found that he could not compel the government to pay defendants' fees because of sovereign immunity. KPMG, however, is another matter, as the court may exercise ancillary jurisdiction over a third party in a criminal case relating to a fee dispute. See Garcia v. Teitler , 443 F.3d 202 (2d Cir. 2006); United States v. Weissman, 1997 WL 334966 (S.D.N.Y. June 16, 1997). Judge Kaplan gave defendants 14 days to file an ancillary complaint against KPMG seeking advancement of fees in a summary proceeding, similar to the remedy provided under Delaware corporate law. 8 Del. C. ' 145. In the meantime, Judge Kaplan strongly importuned the government to use its influence with KPMG, which remains subject to a deferred prosecution agreement, to induce KPMG to advance fees voluntarily. The ultimate sanction for prosecutorial misconduct ' dismissal of the indictment ' remains open should KPMG fail to provide a remedy.

Conclusion

Judge Kaplan's ruling is certain to be groundbreaking. It may deeply affect DOJ policy and restore the ability of individuals to mount a meaningful defense to the burdens and challenges presented by complex corporate criminal prosecutions. As of this writing, the government has not appealed, and there is some question whether the DOJ would do so and risk a court of appeals decision affirming this important ruling. One can only hope that, in the future, corporations will be free to make fee advancement decisions without the government's thumb on the scale.

Craig D. Margolis ([email protected] ) is a former federal prosecutor and counsel in the Washington, DC, office of Vinson & Elkins LLP, specializing in government investigations and white-collar criminal defense. He is co-counsel with David Spears of Richards, Spears, Kibbe & Orbe LLP for Jeffrey Stein.