On August 28, 2008, the Second Circuit Court of Appeals affirmed the dismissal of all criminal charges against 13 former partners and employees of the accounting firm KPMG on the grounds that their Sixth Amendment right to counsel had been violated when KPMG was pressured by Justice Department policies and prosecutors into limiting and then terminating its payment of the defendants’ legal fees. These proceedings have been closely watched by the corporate and white-collar communities.

When the U.S. Attorney’s Office in the Southern District of New York began investigating KPMG’s aggressive marketing of what the government later alleged were fraudulent tax shelters, the Justice Department’s “Principles of Federal Prosecution of Business Organizations” were codified in the Thompson Memorandum, named for then-Deputy Attorney General Larry D. Thompson and issued in 2003 in the wake of the Enron meltdown. A central theme of the Thompson Memorandum was that prosecutors should consider the extent and value of a corporation’s cooperation in deciding whether to indict a corporation and not just individual actors. In particular, in assessing a business’ cooperation, it directed prosecutors to consider “whether the corporation appears to be protecting its culpable employees and agents” through, among other things, the advancement of attorneys’ fees where such indemnification was not mandated by applicable law. While KPMG’s past practice had been to advance legal fees to employees facing investigation (and even those under indictment), in this instance, the company capped the payment of legal fees; conditioned their payment on an employee’s cooperation with the government; and terminated such payments if an individual was indicted.

In 2005, the government indicted the first of 16 individual defendants, while it entered into a deferred prosecution agreement with KPMG, based largely on the latter’s cooperation. In 2006, following evidentiary hearings, Judge ­Lewis­ Kaplan ruled that the Sixth Amendment rights of the individual defendants had been violated and dismissed the indictment against them.

The Court of Appeals found no basis for disturbing Judge Kaplan’s factual finding that, “but for the Thompson Memorandum and the prosecutors’ conduct, KPMG would have advanced legal fees without condition or cap.” The Court rejected a number of the government’s arguments as inconsistent with this key finding. It also attributed responsibility for KPMG’s indemnification decision to the government because the latter, through its policies and the conduct of its prosecutors, had “steered KPMG toward [the government’s] preferred fee advancement policy and then supervised its application in individual cases.” Effectively, in the Court’s view, KPMG had become the government’s agent.

On appeal, the government did not contest that four defendants could not retain counsel of their choosing once KPMG had stopped paying their legal fees post indictment. Nor did the government dispute that the termination of legal fees for the remaining nine defendants compelled them to restrict the activities of their legal counsel notwithstanding the “extremely complex” nature of the criminal case against them. The Second Circuit agreed with the district court that this constituted “unjustified governmental interference with the right to defend oneself using whatever assets one has or might reasonably and lawfully obtain.”

Interestingly, most of the government’s conduct (including the issuance of the Thompson Memorandum and the prosecutors’ meetings with KPMG during the course of the investigation) pre-dated the defendants’ indictment in 2005. Although a defendant’s constitutional right to counsel does not attach until he is charged, the Court ruled that, “[w]hen the government acts prior to indictment so as to impair the suspect’s relationship with counsel post-indictment, the pre-indictment actions ripen into cognizable Sixth Amendment deprivations upon indictment.” Finally, the Second Circuit also found that the government’s Sixth Amendment violation had not been cured by a prosecutor’s 2006 representation to Judge Kaplan that KPMG was free “to exercise [its] business judgment” on the advancement of legal fees to the individual defendants. In the absence of any other cure which could restore the defendants to the status quo ante, the Court found the dismissal of all criminal charges was required.

In closing, the Court of Appeals cautioned (without explaining why) that its holding might not apply to a defendant who had attempted unsuccessfully to get charges dismissed because of the same kind of interference with his right to counsel; who had gone to trial with counsel of his choosing but had been compelled to limit the scope of counsel’s efforts on his behalf due to financial constraints; and who then had been convicted based on overwhelming evidence which a more fully financed defense team might have been able to counter. Coincidentally, on the same day as the Court of Appeals issued Stein, the Justice Department issued revised guidelines for white-collar prosecutions prohibiting federal prosecutors from basing their evaluation of a corporation’s cooperation on the latter’s decision to pay legal fees for its officers or employees absent evidence of obstruction of justice. (See previous article.) The full text of the Second Circuit decision can be found at United States v. Stein, 2008 U.S. App. LEXIS 18524, No. 07-3042 (2d Cir. August 28, 2008).