As we reported in May 2006 (link), prosecutors in recent years have been pressuring corporations to “cooperate” with prosecutions and investigations by denying indemnification and ceasing payment of defense costs of targeted individual officers and directors. The Department of Justice was particularly proactive in pressing corporations to cease advancement of defense costs, citing a memorandum issued in 2003 to United States Attorneys by Deputy Attorney General Larry D. Thompson. In the Thompson Memorandum, the DoJ indicated that “the corporation’s . . . willingness to cooperate in the investigation of its agents” would hinge, at least in part, on “whether the corporation appears to be protecting its culpable employees and agents” by, inter alia, advancing attorney fees.
Since then, following a United States District Court decision critical of this policy, Deputy Attorney General Paul J. McNulty issued a revised memorandum superseding the Thompson Memorandum. The McNulty Memorandum set forth a more relaxed stance on a corporation’s willingness to advance defense costs on behalf of officers and directors targeted by prosecutors. The McNulty Memorandum, coupled with several court decisions criticizing the DoJ’s prior policy, provides a measure of certainty to corporations and some comfort to their targeted officers and directors.
While the McNulty Memorandum retains in the comments to its Factor VII the language about “protecting its culpable employees and agents,” it further states that:
Prosecutors generally should not take into account whether a corporation is advancing attorneys’ fees to employees or agents under investigation or indictment. Many state indemnification statutes grant corporations the power to advance legal fees of officers under investigation prior to a formal determination of guilt. As a consequence, many corporations enter into contractual obligations to advance attorneys’ fees through provisions contained in corporate charters, bylaws, or employment agreements. Therefore, a corporation’s compliance with governing state law and its contractual obligations cannot be considered a failure to cooperate.
Thus, at first blush, it would appear that the McNulty Memorandum backs away from the Thompson Memorandum’s stance on advancing attorney fees. In footnote 3, however, the Memorandum goes on to provide that “[i]n extremely rare cases, the advancement of attorneys’ fees may be taken into account when the totality of circumstances show that it was intended to impede a criminal investigation.” Thus, the McNulty Memorandum appears, at the very least, to have left the door open for further discussion about whether a corporation could face indictment for advancing legal fees to its employees.
The softening of the language from the Thompson Memorandum resulted from a decision out of the Southern District of New York, United States v. Stein, 435 F. Supp. 2d 330 (S.D.N.Y 2006) (Stein I). The case arose out of criminal action brought against certain KPMG employees for tax shelter schemes. Invoking the Thompson Memorandum, prosecutors demanded that KPMG cease advancing defense costs to the individual defendants or face criminal responsibility itself for the tax scheme. Not wishing to face the same fate as Arthur Andersen, KPMG acceded to the demand. Sixteen former partners and employees of KPMG argued in federal court in New York that prosecutors exceeded their authority and the court agreed. In a decision authored by Judge Kaplan, the district court found that the government had acted unconstitutionally, in violation of the Fifth Amendment right to substantive due process and Sixth Amendment right to counsel by promulgating Factor Four and essentially coercing KPMG into cutting off the advancement of legal fees.
The government subsequently petitioned the court for further review, resulting in a second published decision from Judge Kaplan criticizing the Thompson Memorandum. See United States v. Stein, 495 F. Supp. 2d 390 (S.D.N.Y. 2007) (Stein II). In Stein II, the government argued that there was no reason to believe that the defense bar read the Thompson Memorandum to convey a threat of prosecution and that “none of the prosecutors read the Thompson Memorandum in this way.” The court disagreed, noting that “[a]ny competent lawyer reading the document would regard a corporate client that was under investigation as being at greater risk of indictment if it advanced legal fees.” Further, the court pointed to the fact that “[t]he Justice Department itself undoubtedly recognized this when, following Stein I, it changed it in the McNulty Memorandum.” Ultimately, then, the court reaffirmed its decision dismissing charges against thirteen of the KPMG partners and employees on the grounds that the government’s conduct violated the Sixth Amendment right to counsel, noting:
The Department of Justice, in promulgating the aspects of the Thompson Memorandum here at issue . . . deliberately or callously prevented many of these defendants from obtaining funds for their defense that they lawfully would have had absent the government’s interference. They thereby foreclosed these defendants from presenting the defenses they wished to present and, in some cases, even deprived them of counsel of their choice. This is intolerable in a society that holds itself out to the world as a paragon of justice. The responsibility for the dismissal of this indictment as to thirteen defendants lies with the government.
Since Stein I, two other district courts have weighed in on the constitutionality of the government’s threat to indict companies that advance legal fees. In United States v. Stodder, 2006 WL 3066196, at *3 (C.D. Cal. 2006), the Court rejected the defendant’s motion to dismiss, post-verdict, on the grounds that he had produced no evidence that his employer ceased advancing legal fees because of the Thompson Memorandum. The court then went on to state that, in any event, it found “the Stein decision scholarly but ultimately unpersuasive” and would not follow it.
Subsequently, in United States v. Rosen, 487 F. Supp. 2d 721, 735 (E.D. Va. 2007), the court followed Stein analytically but denied defendants’ motion to dismiss based on the factual circumstances of the case. Initially, the court agreed with the defendants (and the court in Stein) that the Thompson Memorandum implicated the Sixth Amendment right to counsel because it prevented defendants from accessing funds that the employer company was contractually bound to advance to them. Still, the court refused to dismiss charges because it found that, since their attorneys were able to continue representation even after the company quit advancing legal fees, the defendants had experienced no prejudice. Despite its outcome though, Rosen cannot be read as an endorsement of the Thompson Memorandum or the policy it advocates towards legal fees. The court stated in closing:
It is worth reiterating that the result reached here is in no way an endorsement of the Thompson Memorandum policy directive with respect to an organization’s payment or advancement of attorney fees for employees who are targets or subjects of criminal investigations. Indeed, that policy is unquestionably obnoxious in general and is fraught with the risk of constitutional harm in specific cases. As Justice Blackmun noted in a different context, “it is unseemly and unjust for the government to beggar those it prosecutes in order to disable their defense at trial.” Caplin & Drysdale, Chartered v. United States, 491 U.S. at 635, 109 S.Ct. 2646 (Blackmun, J., dissenting).
Stein and Stodder have each been appealed to their respective Courts of Appeals, as Rosen likely will be once the district court case concludes.
While corporations can take some comfort from the fact that, regardless of the outcome on appeal, Stein I has resulted in a change to existing policy, the question of how far prosecutors will push under the McNulty Memorandum remains unresolved. Many are looking to the Courts of Appeals for guidance, with the understanding that decisions siding with Stein, or adopting the reasoning in Rosen, could prevent prosecutors from considering the advancement of legal fees in all except the most egregious cases. Further, while the same Sixth Amendment concerns do not apply in SEC proceedings, if the Courts of Appeals were to rule against the government on grounds relating to breach of contract, these decisions also could be applied to prevent the SEC from pressuring corporations to cease indemnification in cases where corporate bylaws require it.