It is no secret that, in the last few years, the United States government has made corporate misconduct one of its top prosecutorial priorities. The government has not shied away from investigating and, at times, indicting business organizations for fraud and other wrongdoing. Companies are facing ever-increasing pressure from the Securities and Exchange Commission, Department of Justice, U.S. Attorneys Offices, and other agencies to cooperate with investigators in order to avoid the potentially fatal consequences of a criminal case.
Many companies understand that full cooperation with the government is the best, and perhaps only, way to avoid an indictment of the company. In this context, a company’s advancement of legal defense fees for employees and directors charged or investigated as a result of doing their jobs—a regular practice among many corporations—has come under close government scrutiny. Fearful that any advancement of legal fees would be construed by the government as evidencing a lack of cooperation, companies may bow to prosecutorial pressure and stop advancing legal fees to their employees. As a result, officers, directors, and rank-and-file employees are increasingly left to pay their often substantial legal bills on their own or, more likely, forego a full defense or plead guilty because the defense costs are beyond their means.
The Thompson Memorandum
This predicament is a recent phenomenon. Many states permit a corporation to obligate itself to advance its officers’ and directors’ legal defense costs during a government investigation. Recent decisions in Delaware, for example, have strictly enforced a corporation’s duty to advance legal fees to executives as provided by Section 145 of the Delaware General Corporation Law. These legal obligations and longstanding corporate practices, however, are at odds with a memorandum issued by then-Deputy Attorney General Larry D. Thompson on January 20, 2003 (known as the “Thompson Memorandum,” available at http://www.usdoj.gov/dag/cftf/ corporate_guidelines.htm). In the memorandum, the U.S. Department of Justice sets guidelines for the prosecution of business organizations. Notably, the Department advises that “a corporation’s promise of support to culpable employees and agents … through the advancing of attorneys fees … may be considered by the prosecutor in weighing the extent and value of a corporation’s cooperation.” The term “culpable” is not defined, thereby affording government attorneys broad discretion in determining when a corporation is cooperating and when, in the government’s view, it is not.
The Thompson Memorandum creates perverse incentives that pit a corporation against its own executives and directors suspected of wrongdoing. Officers and directors are learning the hard way that, at least when it comes to government investigations, they may not have their employer’s reasonably anticipated legal and financial support. Companies have been told by government attorneys that prosecutorial leniency for the company can hinge upon the government’s assessment of the payment of legal fees for their own management and directors.
The KPMG Decision
The perils and predicaments that companies and their executives face as a result of the Thompson Memorandum have been highlighted in the U.S. government’s ongoing prosecution of former KPMG LLP employees accused of selling fraudulent tax shelters. In that case, currently awaiting trial in a federal court in New York, the defendants contend that the government strong-armed KPMG to limit, or threaten to withhold, legal fees from partners or employees who were subjects during the investigation and defendants in the pending criminal action. The defendants allege that KPMG bowed to government pressure because the accounting giant wanted to obtain a deferred prosecution agreement and the relief it affords to avoid a criminal trial.
In a stinging rebuke to federal prosecutors and the Thompson Memorandum, Judge Lewis Kaplan concluded that the Thompson Memorandum was unconstitutional and violated the KPMG defendants’ substantive due process rights and their constitutional right to counsel. United States of America v. Stein, 435 F. Supp. 2d 230 (S.D.N.Y. 2006). “The government,” the Court stated, “has let its zeal get in the way of its judgment. It has violated the Constitution it is sworn to defend.” Concluding that “KPMG refused to pay [its employees’ defense fees] because the government held the proverbial gun to its head,” the Court offered two remedies for the defendants: either KPMG could advance defense costs, or the defendants could obtain, in a separate proceeding, a court order mandating advancement. In so doing, Judge Kaplan rejected— at least for now—a dismissal of the indictment against the KPMG defendants.
The KPMG decision may influence prosecutors to back off from implementation of the Thompson Memorandum, at least temporarily, which is good news for criminal defendants and investigative targets. Until there is greater clarity and finality on the limits of governmental actions in these investigations and prosecutions, however, corporations and their employees and directors should:
- Review their state’s laws on the obligations of corporations to pay legal fees for employees who are the subject of prosecutions and government investigations.
- Review and reevaluate the company’s bylaws, articles of incorporation, and any employment contracts and agreements regarding the terms and scope of the company’s obligations to pay an executive or director’s legal defense costs.
- Discuss the implications of funding executives’ or directors’ defense costs with counsel and, if possible, secure the assurance of government attorneys that such actions would not be deemed a failure to cooperate with the government.
- Review the company’s D&O policies to assess their applicability and investigate other insurance products that offer coverage for employees’ legal expenses incurred in connection with investigations by prosecutors and regulators, not just those legal expenses incurred after the onset of adversarial proceedings.
Many government investigations do not result in an indictment or a formal proceeding, but an individual officer or director can nevertheless incur substantial legal fees without being charged civilly or criminally.