By Mark Hamblett
06-28-2006
Southern District of New York Judge Lewis Kaplan delivered a harsh rebuke to prosecutors Tuesday for pressuring KPMG to cut off legal fees for employees unwilling to cooperate in the largest tax fraud investigation in the nation's history.
Saying the government "let its zeal get in the way of its judgment" and "violated the Constitution it is sworn to defend," Kaplan in United States v. Stein, S1 05 Crim. 0888, found that prosecutors had violated the Fifth and Sixth amendments by "causing KPMG to cut off legal fees and other defense costs upon indictment."
The decision has been eagerly anticipated by defense groups and business organizations such as the U.S. Chamber of Commerce and the Association of Corporate Counsel, who have become increasingly concerned at prosecutorial tactics they believe are eroding defendants' rights to counsel and a fair trial.
Kaplan said KPMG should consider paying the fees of 16 former employees now under indictment. He invited the former partners and employees of the accounting company to sue for fees if need be. And he urged the government to use its influence with the company to persuade it to pay the fees.
For the moment, Kaplan declined defense requests to dismiss the indictments although he held open that possibility.
KPMG had long made it a practice to pay the fees of its employees, the judge found, but it changed its policies in the hopes of obtaining the deferred prosecution agreement it ultimately signed in August 2004.
In an 83-page opinion that was unsparing in its criticism of the government, Kaplan said KPMG was so intent on staving off indictment and surviving as an entity that it told its employees it would no longer pay their fees if they refused to cooperate with the government and that it would cut off fees for those who were indicted.
"KPMG refused to pay because the government held the proverbial gun to its head," the judge said.
David Spears of Richards Spears Kibbe & Orbe, one of the attorneys for lead defendant Jeffrey Stein, said he was "floating on air" after reading the judge's opinion.
"This decision will change the way the government does business in the investigation and prosecution of entities," Spears said.
Southern District U.S. Attorney Michael Garcia issued a statement saying, "We are disappointed in Judge Kaplan's opinion today ... which we respectfully believe is unsupported by the factual record and the applicable law. The actions of the government were entirely consistent with appropriate Department of Justice policy, and we believe that the prosecutors acted ethically and properly throughout this case."
While the judge said that monetary relief against the government for the violations is precluded by sovereign immunity, and KPMG is technically not a party to the case, he said he had ancillary jurisdiction to resolve the issue of whether KPMG can be forced to pay the legal fees and costs of those under indictment. He directed the clerk to open a civil docket number for the claims of defendants against KPMG and gave them 14 days to do so.
But the judge also said dismissal of the indictment ("or other unpalatable relief") is still a possibility if the legal fees of those under indictment are not paid.
"The government has substantial influence and almost certainly, power over KPMG by virtue of the cooperation clauses in the [deferred prosecution agreement]," the judge said. "It may well be in its interest to use that influence or power to cause KPMG to advance the defense costs."
Charles Stillman of Stillman Friedman & Schechtman, who represents KPMG, said the company was reviewing its options.
"If the defendants are going to consider any possibility of action against [KPMG], they will have to pay attention to their contractual relationship with the firm, including whether or not they have the right to go to court or arbitration," Stillman said.
GOVERNMENT PRESSURE
The judge's opinion comes on the heels of a May hearing he held to explore improper government influence over KPMG fee policy and its impact on the due process rights and the right to counsel of the defendants.
The hearing focused on meetings and communications between prosecutors and KPMG attorneys in early 2004, shortly after it was blistered by a Senate subcommittee investigating tax shelters for the wealthy. The shelters, prosecutors ultimately contended, were nothing but paper transactions that cost the government more than $2 billion in tax revenue.
With the heat on KPMG, the company hired Robert Bennett of Skadden, Arps, Slate, Meagher & Flom to try a fresh approach to dealing with the government. It also dismissed Stein, the firm's deputy chairman, who left with a generous severance agreement that included the advancement of legal fees.
KPMG, Stein's lawyers said, later reneged on the fee obligation because it feared the government would discover the arrangement and indict the firm.
At a Feb. 25 meeting, prosecutors asked Bennett and other representatives of KPMG about the firm's policy on fees for employees under investigation and whether or not the firm had "discretion" to pay the fees.
The question was an important one, given the Thompson Memorandum, a 2003 Justice Department policy statement on measuring the cooperation of entities as a factor in determining whether the government would offer a deferred prosecution agreement.
The Thompson Memo instructs prosecutors to consider several factors in deciding whether to charge a company criminally, including whether it waives the attorney-client privilege, whether it protects culpable employees by letting them keep their jobs and whether it advances them legal fees, and whether they share information about the investigation.
According to the government, the payment, or withholding, of legal fees was not the determining factor in its decision to ultimately reach a deferred prosecution agreement with KPMG. The firm avoided indictment, otherwise known as the corporate death penalty, by pledging cooperation with the government and agreeing to pay $456 million.
But defense lawyers for the 17 former KPMG employees (one pleaded guilty) cried foul, saying that two prosecutors essentially threatened the company to use its fee policy to force employees to cooperate.
At closing argument in May, Assistant U.S. Attorney Marc A. Weinstein insisted that the Thompson Memo could not, "in and of itself," have dictated KPMG's decision to change its fee policy. The issue of fees, Weinstein insisted, is only explored by the government when it suspects a company of "circling the wagons" and offering sham cooperation -- pretending to cooperate in an investigation while shielding individual wrongdoers and offering them support, sometimes through the advancement of legal expenses.
Kaplan shot back on the Thompson Memo.
"If that is true," he said, then the people at the Justice Department were "lousy drafters" and they should "start all over again."
And if that was true, he said, then "that is certainly not what they have said to the defense bar of America."
INTERSECTION OF PRINCIPLES
In Tuesday's opinion, Kaplan said the Stein case and the Thompson Memo presented an intersection of three principles -- the due process guarantee of a fair trial, the Sixth Amendment right to the assistance of competent counsel and a third principle, "not of constitutional dimension" but important nonetheless, "an employer often must reimburse an employee for legal expenses when the employee is sued, or even charged with a crime, as a result of doing his or her job."
The judge explored the 1999 Holder Memorandum, a Justice Department policy statement that said the government might view the advancement of fees to personnel of a business entity under investigation as "protection of culpable individuals."
The Thompson Memo took the fee statement in the Holder Memo one step further by making it mandatory for all federal prosecutors to consider an entity's legal fee policy.
Shirah Neiman, chief counsel to Garcia, was asked at the May hearing whether her reference to "federal guidelines" on corporation cooperation agreements at the February 2004 meeting specifically concerned the fee issue. Neiman pointedly told the KPMG legal team that "misconduct" would not be "rewarded."
She testified that her statement was not a reference to fees but was instead addressed to any severance arrangements between KPMG and other top executives during its attempt to clean house.
But defense lawyers argued that the reference to the Thompson Memo in tandem with a discussion on KPMG's fee policy proved their point -- that the government was trying to muscle the company on fees.
FIRM 'GOT THE MESSAGE'
Kaplan said he found it "unnecessary to decide Neiman's subjective purpose in making the remark because what is more important is how her comment was understood."
KPMG's actions in the aftermath of the February 2004 meeting, he said, made it clear that the company got "the message."
After reviewing the facts, Kaplan found that the government "conducted itself in a manner that evidenced a desire to minimize the involvement of defense attorneys."
In March 2004, the firm sent out a form letter to employees who might become subjects of the investigation or might otherwise be considered under suspicion. The letter said the firm would pay fees up to $400,000 as long as the individuals cooperated with the government promptly, completely and truthfully and that monies for fees and expenses would cease if the person was charged with criminal wrongdoing.
The firm then drafted an advisory memorandum that urged employees to cooperate but also said they had the right to be represented by counsel, referred to some of the advantages of having counsel, and said KPMG had arranged for independent counsel for employees who wanted to consult with them.
After two government prosecutors expressed disappointment with the "tone" of the letter, Kaplan said, KPMG "capitulated" to their "demand" that new language be added, including one line that advises employees "you may deal directly with government representatives without counsel."
Kaplan said "it is entirely plain that the government's purpose in demanding the supplement was to increase the chances that KPMG employees would agree to interviews without consulting or being represented by counsel."
"From that point forward," he said, "the government took full advantage."
In the end, the judge found that "[a]bsent the Thompson Memorandum and the actions of the U.S. Attorney's Office, KPMG would have paid the legal fees and expenses of all of its partners and employees both prior to and after indictment, without regard to cost."
FUNDAMENTAL RIGHT
The judge said those actions diminished the fairness of a criminal proceeding, a principle that "not only prevents the prosecution from interfering actively with the defense, but also from passively hampering the defendant's efforts."
He said the right to fairness in the criminal process is a "fundamental liberty interest entitled to substantive due process protection."
Kaplan said that a defendant's "right to prepare defense resources lawfully available to him or her, free of knowing or reckless government interference" was "basic to our concepts of justice and fair play. It is fundamental."
He concluded that the Thompson Memorandum "is not narrowly tailored to achieve a compelling" governmental objective and therefore fails examination under the strict scrutiny standard.
The government's argument on the Sixth Amendment, that the right to counsel could not have been implicated in many of its actions because the right does not attach until indictment, did not convince the judge.
The KPMG defendants were also not obliged to show that they were prejudiced by the violation, the judge found, because, under the circumstances, "prejudice must be presumed."
He said it was premature to consider the remedy sought by the defendants, dismissal of the indictment, "prior to the exhaustion of all possible courses that could lead to that outcome."
The defendants had argued that, despite sovereign immunity, the judge still had the power to award attorney fees in the form of monetary sanctions for prosecutorial misconduct. The judge rejected the argument, as he did an argument that the Federal Tort Claims Act and the Administrative Procedure Act waived sovereign immunity.
The defendants' complaints against KPMG for fees, he said, may contain a prayer for declaratory relief. The judge promised to grant a speedy hearing on such a request.
The ruling came just three days after the New York State Bar Association passed a resolution condemning what it views as pervasive interference by the federal government into the right to counsel.
"The resolution that we passed states, as a matter of policy, that the government should not, must not, pressure corporations to breach their obligation to indemnify employees and thereby prevent their employees from having counsel," said state bar President Mark H. Alcott of Paul Weiss Rifkind Wharton & Garrison, who welcomed Kaplan's ruling. "It's really a pretty simple concept, but these days the government doesn't seem to get it. People have a right to an attorney, and the government has no business interfering with that."