Circuit Upholds End of Cases Against Ex-KPMG Employees

But the government’s conduct in such negotiations came under sharp attack in the KPMG case. Southern District Judge Lewis Kaplan ruled that prosecutors had violated former KPMG employees’ Sixth Amendment right to counsel (NYLJ, June 28, 2006). He initially invited the 13 individual KPMG defendants to file civil suits against the company for their legal fees. However, the Second Circuit ruled that he lacked jurisdiction to hear such actions (NYLJ, May 24, 2007). Judge Kaplan then concluded that the only way to cure the constitutional violation was to dismiss the indictments entirely (NYLJ, July 17, 2007).

Yesterday, a Second Circuit panel of Judges Jacobs, Wilfred Feinberg and Peter Hall agreed, affirming Judge Kaplan’s dismissal in a 68-page decision.

The government “unjustifiably interfered with defendants’ relationship with counsel and their ability to mount a defense, in violation of the Sixth Amendment,” Judge Jacobs wrote for the unanimous panel in United States v. Stein, 07 cr. 3042.

The decision will be published Tuesday.

Prosecutors had argued on appeal that KPMG’s actions in suspending its legal-fees assistance to the indicted ex-employees were voluntary on KPMG’s part, but the circuit said the government’s stance rendered as state action the company’s decision.

“KPMG faced ruin by indictment and reasonably believed it must do everything in its power to avoid it,” the court said. “The government’s threat of indictment was easily sufficient to convert its adversary into its agent. KPMG was not in a position to consider coolly the risk of indictment, weigh the potential significance of the other enumerated factors in the Thompson Memorandum, and decided for itself how to proceed.”

The panel also rejected the government’s argument that the Sixth Amendment does not apply to third-party assistance with legal expenses. The court pointed out that it was well established that the Sixth Amendment bars the government from interfering in cases where a lawyer elects to represent a defendant for free.

“And if the Sixth Amendment prohibits the government from interfering with such arrangements, then surely it also prohibits the government from interfering with financial donations by others, such as family members and neighbors – and employers,” Judge Jacobs wrote.

Nor did a March 30, 2006 in-court government statement that KPMG was free to “exercise [its] business judgment” on payment of legal fees cure the violation, the circuit concluded. The court said that it was “unrealistic” to expect the company, which had assumed “a supine position” in its negotiations with the government, to reverse course and exercise judgment “as if it had never experienced the government’s pressure in the first place.”

The Thompson memo, circulated in January 2003 by then-Deputy Attorney General Larry D. Thompson, was replaced in December 2006 by a memo from Mr. Thompson’s successor, Paul J. McNulty.

The McNulty memo stated that federal prosecutors “generally should not” consider a company’s advancement of legal fees to employees in deciding whether or not the company is being cooperative. But the government reserved the right to consider such actions “when the totality of the circumstances show that [the advancement of legal fees] was intended to impede a criminal investigation.”

Most Qualifiers Dropped

The revisions announced yesterday by Deputy Attorney General Mark R. Filip at the New York Stock Exchange drop most qualifiers and simply state that prosecutors should not consider a company’s payment of employees’ legal fees. The new guidelines also said a company’s participation in a joint defense with employees should not be considered in deciding whether the company deserves credit for cooperation.

And, the revised guidelines are designed to address concerns about intrusions on attorney-client privilege in white-collar prosecutions. One major change is that the government will no longer give corporations credit for cooperation based on their waiver of attorney-client or work-product privilege. The disclosure of information will be the only factor considered, Mr. Filip said.

“[C]orporations will receive the same credit for disclosing facts that are contained in unprotected materials as they would for disclosing the identical facts contained in protected materials,” he said. “The government will assess neither a credit nor a penalty based on whether the disclosed materials are protected by the attorney-client privilege or attorney work product.”

Prosecutors also will now be barred from requesting the disclosure of internal communications covered by the attorney-client privilege. Mr. Filip used the example of a pharmaceutical sales representative asking in-house counsel whether her marketing practices were lawful.

“Permitting and respecting the need for such attorney-client communications is particularly important, because such dialogue is often a necessary, a typically salutary, part of a company’s efforts to obey the law on an ongoing basis,” Mr. Filip said.

In addition, prosecutors will be barred from awarding companies points for cooperation for firing or disciplining employees.

The changes will not likely salvage the government’s KPMG prosecution, which had been touted as one of the largest tax shelter prosecutions ever. Mr. Filip yesterday said it is too soon to discuss the circuit’s decision, but Stanley S. Arkin of Arkin Kaplan Rice, the lawyer for defendant Jeffrey Eischeid, the former head of KPMG’s personal financial planning group, said a push for review by the full Second Circuit or U.S. Supreme Court would send the wrong message.

“A good prosecutor has to be decent in addition to being tough,” said Mr. Arkin. He described the prosecutors’ conduct in the KPMG case as “just vicious” and said the new guidelines suggest the Justice Department had taken the right lessons from the court.

The tax shelter case is continuing against four other individual defendants, including lawyer R.J. Ruble, a former tax partner at Sidley Austin who provide opinion letters stating the tax shelters at issue were legal. Sidley Austin last year agreed to pay $39.4 million as part of a non-prosecution deal in the case.

The government was represented on appeal by assistant U.S. attorney Karl Metzner.

The former KPMG employees were represented by several leading white-collar and appellate lawyers, including Mr. Arkin, Seth Waxman of Wilmer Cutler Pickering Hale and Dorr and John S. Martin of Martin & Obermaier.

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