Tuesday a district judge finally weighed in on prosecutors’ practice of seemingly encouraging corporations and other entities to refuse to pay the legal fees of their employees accused of fraud or wrong-doing.  In a case involving tax fraud allegations against several former KPMG partners, U.S. District Judge Lewis Kaplan ruled that prosecutors unconstitutionally pressured KPMG into cutting off legal fees for its employees, apparently interfering with their right to a fair trial.  In a strongly worded opinion, Kaplan noted that the government had let “its zeal get in the way of its judgment.”

In sharply criticizing the legal fee policy, Judge Kaplan also calls into question the viability of the “Thompson memo.”  The memo sets forth a variety of factors that federal prosecutors must consider when determining whether to indict business entities, including the willingness of such entities to waive attorney-client privileges and whether the entities pay the legal bills of employees who are accused of misdeeds.   Prosecutors evaluate an entity’s cooperation based on its compliance with these factors.  In KPMG’s cases, it was able to avoid criminal prosecution in part because of its continued cooperation with the government.  And hence KPMG’s refusal to pay legal fees.  Prosecutors insisted that they applied no pressure on KPMG, but Judge Kaplan characterized their actions as holding the “proverbial gun” to the head of the company.

The decision may have a significant impact on the criminal prosecutions of corporate officials.   Post-Enron prosecutors apparently have utilized aggressively the tactics outlined in the Thompson memo, and those tactics seemed to have paid off because they essentially allow prosecutors to rely on the corporation to help build cases against various officers and directors within a corporation.  This appears to have resulted not only in the high profile guilty verdicts we have seen, but also in a host of guilty pleas from corporate actors.  Certainly cutting off legal fees to employees is just one of the techniques available to prosecutors outlined in the Thompson memo, but the tone of Judge Kaplan’s decision appears to raise concerns about government overreaching more generally—thereby casting a disapproving net over the entire Thompson memo.

It is not clear what kind of impact the decision will have on businesses and their employees embroiled in these suits.  Indeed, Judge Kaplan did not dismiss the suit against the KPMG employees.  Instead, the judge encouraged employees to file a lawsuit against KPMG for their legal fees.  As other commentators have noted, the decision appears to bind entities to pay the legal fees of its employees, even when there is no written agreement to that effect.  (KPMG apparently had an unwritten policy of paying such fees).  But this seems contrary to governing law, which of course does not require that corporations indemnify their employees.  At the very least the decision may encourage corporations and other entities to more affirmatively exclude particular employees from indemnification.  The decision also may make it more difficult for businesses to appear cooperative, forcing prosecutors to make good on their threat that such entities will be criminally indicted and suffer the fate of Arthur Andersen.  Given the Supreme Court’s ultimate resolution of the Arthur Andersen case, the realistic impact of that threat is not entirely clear.

Corporate Governance, Employees, White Collar Crime | Bookmark

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