It is well recognized that the ability of a corporation to attract and retain quality directors, officers and employees depends in large part on the corporation’s willingness to indemnify such individuals for personal losses suffered as a result of claims relating to actions taken in their corporate capacity. For example, Section 145 of the Delaware General Corporation Law specifically authorizes Delaware corporations to indemnify agents acting on behalf of the corporation. Included in these indemnification obligations is the requirement to advance or pay for the costs incurred in defending the individuals. These obligations ordinarily continue until entry of a final, nonappealable judgment against the individual finding that he or she engaged in intentional fraudulent or criminal conduct.
Much to the chagrin of prosecutors and regulators targeting corporations and their directors, officers and employees, those individuals can use the corporation’s resources (augmented by directors and officers insurance) to buy the strongest defense possible, as well as to eliminate (or at least ameliorate) the personal impact of any settlement or judgment. Over the past several years, prosecutors and regulators have sought to undercut this advantage by demanding that the corporations (which typically also are targets of the same investigations) “cooperate” with the investigation by denying indemnification and cease paying the defense costs of individual targets.
For many years the SEC has required that fines paid by individuals subject to enforcement proceedings, including in settlements, not be indemnified by the corporation. Thus far, though, the SEC generally has not taken the next step and demanded that corporations truly “cut loose” individuals by ceasing to pay defense costs.
The Department of Justice, however, has been more proactive in pressing corporations to cease advancement of defense costs. In a memorandum issued in 2003 to United States Attorneys by Deputy Attorney General Larry D. Thompson, the DoJ set forth nine factors to be considered by prosecutors in determining whether to bring charges against a corporate target of a criminal investigation. Factor 4 in the Thompson Memorandum is “the corporation’s . . . willingness to cooperate in the investigation of its agents.” The Thompson Memorandum comments that in determining whether a corporation is cooperating with the investigation, prosecutors should consider “whether the corporation appears to be protecting its culpable employees and agents.” As the Thompson Memorandum explains:
[W]hile cases will differ depending on the circumstances, a corporation’s promise of support to culpable employees and agents, either through the advancing of attorneys fees, through retaining the employees without sanction for their misconduct, or through providing information to the employees about the government’s investigation pursuant to a joint defense agreement, may be considered by the prosecutor in weighing the extent and value of a corporation’s cooperation.
A footnote to this discussion recognizes that “[s]ome 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.” Although the Thompson Memorandum calls this latter proposition “obvious,” many prosecutors are insensitive to the dilemma faced by corporations facing a choice between criminal prosecution and meritorious litigation to enforce entrenched, statutory indemnification rights.
A recent, high profile example of prosecutors demanding an organization cease advancing defense costs to individual targets involves the threat by prosecutors to charge KPMG with criminal responsibility for tax shelter schemes. Not wishing to face the same fate as Arthur Andersen, KPMG acceded to the demand. Twelve former partners and employees of KPMG argued in federal court in New York that prosecutors exceeded their authority:
By making clear that KPMG’s survival as an entity could depend, even in part, on abandoning its practice — grounded in [Delaware] state law and public policy — to advance legal fees to employees who had acted on its behalf, the Government has uncomfortably expanded its role. It has gone from an investigator/prosecutor to a bullying behemoth, who demands as tribute the sacrifice of individuals and uses any means at its disposal to stifle opposition to its awesome power to prosecute individuals. In doing so, the Government has violated law and policy. It has undermined the public policy and legal admonitions of the state of Delaware; it has improperly interfered with the contractual relationship between KPMG and its partners; and it has also unjustifiably and intentionally hampered the KPMG defendants’ ability to defend themselves in this case.
The court set a hearing on this issue for May 8, 2006. The court’s ruling will undoubtedly set the tone going forward as to whether prosecutors can use this tool to their advantage in future prosecutions.
For further information, please contact John Stigi at (213) 617-5589.