Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

In a 64-page opinion dated July 16, 2007 (here), U.S. District Court Judge Lewis Kaplan granted the dismissal motions of thirteen of sixteen of the individual defendants in the KPMG tax shelter litigation, ruling that he had no choice but to dismiss the charges because prosecutors had violated the constitutional rights of defendants when they coerced KPMG to cut off the defendants' legal fees.

Judge Kaplan had previously ruled (see prior post, here) that the government's action in implementing the now-superseded Thompson Memorandum (which provides guidelines for corporate prosecution) violated individuals' constitutional rights. Since that time, Judge Kaplan and the Second Circuit had wrestled with the appropriate remedy for these constitutional violations. (The Second Circuit's opinion can be found here.) In his July 16 order, Judge Kaplan ruled that dismissal was the only appropriate remedy under the circumstances.

It is important to note that the government itself had urged, in light of the Court's prior finding of constitutional misconduct, that dismissal was the appropriate remedy for thirteen of the sixteen defendants. (The government's filing in connection with the dismissal motion can be found here.) The government's position was widely viewed as tactical, calculated to hasten the government's opportunity to appeal to the Second Circuit Judge Kaplan's prior finding of constitutional violation. News reports discussing the goverment's position can be found here.

But Judge Kaplan not only granted the dismissal, as the government itself had sought, and not only reconfirmed his prior findings of constitutional violation, he added additional findings that the government's conduct "shocks the conscience in the constitutional sense." Speaking of the prosecutors, Judge Kaplan said

Just as prosecutors used KPMG to coerce interviews with KPMG personnel that the government could not coerce directly, they used KPMG to strip any of its employees who were indicted of means of defending themselves that KPMG otherwise would have provided to them. Their actions were not justified by any legitimate governmental interest. Their deliberate interference with the defendants' rights was outrageous and shocking in the constitutional sense because it was fundamentally at odds with two of our most basic constitutional values - the right to counsel and the right to fair criminal proceedings. But the Court does not rest on this finding alone. It would reach the same conclusion even if the conduct reflected only deliberate indifference to the defendants' constitutional rights as opposed to an unjustified intention to injure them.

Judge Kaplan reviewed the impact of the government's conduct on each of the individual defendants, concluding that four of the defendants were deprived of counsel of their choice, and nine defendants were would be forced to mount less of a defense than they would have presented had KPMG paid their fees. Three of the defendants, a former KPMG partner and two former KPMG employees, would not have had their fees paid by KPMG and therefore their rights were not violated and their dismissals were denied.

In granting the individual defendants' motion, Judge Kaplan squarely put the blame on the government:

The Department of Justice, in promulgating the aspects of the Thompson Memorandum here at issue, and the [United States Attorney's Office] in the respects discussed above and in [Judge Kaplan's prior opinion], 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 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.

While Judge Kaplan's strongly worded ruling unquestionably represents a defense victory, the government will undoubtedly appeal Judge Kaplan's findings of unconstitutionality, so the battle for the dismissed defendants is far from over. (The White Collar Crime Prof Blog has an interesting commentary, here, on the possible impact of the government's tactical maneuvering on its appeal prospects.)

There are several noteworthy aspects of Judge Kaplan's dismissal ruling. The first relates to his observations about the defense expense associated with a case as massive as the KPMG tax shelter case. Although a few of the defendants are in straitened circumstances, most of them are millionaires. Yet even the wealthier individuals could not, Judge Kaplan found, afford to mount the defense their case required, given its magnitude. Or at a minimum they could not afford to mount the defense they would have mounted had KPMG paid for their defense. Judge Kaplan noted that while individual's defense expense estimates ranged from $7 million to $24 million, the estimates averaged $13 million, an amount clearly far beyond the reach of even many wealthy individuals.

The enormous potential costs of this type of criminal litigation - and the enormous power of the government to impose costs of this magnitude on individuals - absolutely requires that the government only exercise this power pursuant to strict constitutional guidelines. For the government to use its coercive power to compel employers to withhold funding for legal fees, particularly fees of this magnitude, imposes a form of severe punishment on individuals prior to a finding of guilt or even trial. The need for restraints around government behavior that could produce results of this type will clearly gain momentum from Judge Kaplan's opinions in the KPMG tax case.

The government, perhaps with its hand forced, had evinced its recognition of the circumstances; in December 2006, the Department of Justice , as noted in a prior post (here), issued modified guidelines in the form of the McNulty Memorandum. But in the meantime, Congress has stepped forward to address these issues.

As a means to address these issues through legislative action, Senator Arlen Specter introduced a Senate bill (as discussed in a prior post, here) designed to address a variety of concerns with the government's corporate criminality guidelines, specifically to bar the government to use the threat of indictment to compel corporations to waive their attorney client privilege or cut off the payment of employees' attorneys' fees.

On July 12, 2007, Rep Bobby Scott (D. Va.) introduced a House Bill (H.R. 3013, "The Attorney-Client Privilege Protection Act of 2007," here) which is identical to the Senate bill. In his press release announcing the bill (here), Rep. Scott said that "when government agencies use tactics that violate Constitutional rights, it is time for Congress to act." The legislation enjoys the support of diverse groups, including the ACLU (here), the American Bar Association (here), and the National Association of Criminal Defense Lawyers (here).

The need for reinforced constraint and clarity in this area is compelling. Corporations faced with their own possible criminal prosecution must be certain that their payment of attorneys' fees to employees will not subject them to the possible corporate death sentence in the form of a criminal indictment. Individuals facing the possibility of defense fees so enormous they could exceed the ability of all but a very few individuals to pay would like the reassurance that their rights to indemnification from their employer will be honored. These individuals' ability to defend themselves - indeed, their ability to benefit from their constitutional rights - hangs in the balance.

The New York Times article discussing Judge Kaplan's dismissal opinion can be found here. A Bloomberg.com article discussing the opinion can be found here.

Hat tip to the WSJ.com Law Blog (here) for the links to Judge Kaplan's July 16 opinion, the government's dismissal memorandum and the Second Circuit opinion. The WSJ.com Law Blog has a helpful chronology of events leading up to Judge Kaplan's most recent opinion, here.

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When Deputy Attorney General Paul McNulty released the revised Department of Justice guidelines for federal prosecutors to use in determining whether or not to charge corporations criminally, it was the general perception that McNulty was responding to growing criticism of the Thompson Memo. (See my prior post on the topic, here.) It was also believed that McNulty was acting to avert legislation that had been introduced by Senator Arlen Specter. A December 16, 2006 New York Times article entitled "Judge's Rebuke Prompts New Rules for Prosecutors" examining the events, processes and discussions that led to McNulty's decision to release the revised guidelines may be found here (registration required).

However, while the changes embodied in the McNulty Memo (which may be found here) have generally been welcomed, there seems to be a consensus emerging in certain circles that the McNulty Memo did not go far enough and the Specter bill will still be needed.

For example, the American Bar Association President Karen J. Mathis issued a December 12, 2006 statement (here) saying that the McNulty Memo changes "do not go far enough...(and) fall far short of what is needed to prevent further erosion of fundamental attorney-client privilege, work product and employee protections during governmental investigations." In particular, Mathis criticized the memo because "instead of eliminating the improper department practice of requiring companies to waive their privilege in return for cooperation credit," the new policy "merely required high level department approval before waiver requests can be made." Mathis also said that "the new policy does not fully protect employees' legal rights in that it continues to allow prosecutors to force companies to take punitive actions against their employees in some cases in exchange for cooperation credit, long before any guilt is established." Mathis ended her statement with a plea on behalf of the ABA for Congress to take up the Specter bill when it reconvenes in January.

William Ide, the Chair of the ABA Task Force on Attorney-Client Privilege, said (here) that there is a "fundamental difference" between the Task Force's view that requiring a privilege waiver to avoid prosecution is never appropriate and the Justice Department's view that it sometime is. "We are going to need legislation," Ide said, unless the Justice Department goes one step further and recognizes that prosecutors are "not entitled to waiver, period, under any circumstances."

The bill that Senator Specter introduced on December 7, 2006, the "Attorney-Client Privilege Protection Act of 2006," may be found here. The bill is supported by a broad coalition, including the Association of Corporate Counsel, the National Association of Criminal Defense Lawyers, the American Civil Liberties Union and the U.S. Chamber of Commerce. The bill prohibits the forced disclosure of information protected by the attorney-client privilege. The bill also prohibits the government from conditioning a civil or criminal charging decision on whether or not an organization is providing legal fees for its employees, or on whether or not the organization has terminated an employee because of the "decision by that employee to exercise the constitutional right or other legal protections of that employee."

Senator Spector is the outgoing Republican Chair of the Senate Judiciary Committee. The incoming Chair, Democratic Senator Patrick Leahy, has not yet indicated whether he will push to get the Specter bill passed. Senator Leahy did issue a statement (here) in which he said that "I remain concerned that, depending on how the new policies are implemented, prosectors may still be able to inappropriately consider a corporation's waiver of this important privilege." He also said that "I will continue to monitor the implementation of this new policy and to hold the Administration accountable so that the right to counsel is preserved for all Americans."

The White Collar Crime Prof blog has helpfully compiled (here) a list of links to a broad range of commentary on the McNulty Memo.

Special thanks for alert reader Jeremy Gilman for the links to the ABA sources.

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As The D & O Diary has previously noted (most recently here), the Thompson Memo, the Department of Justice's corporate criminality guidelines for prosecutors, has been the target of significant criticism. In the KMPG tax shelters prosecution, the judge found prosecutor's implementation of the Memo to be unconstitutional (here). Most recently, Sen. Arlen Specter proposed legislation that would have overridden the Thompson Memo's provision that compelled corporations seeking to avoid prosecution to waive their attorney client privilege and withhold payment of their employees' attorneys' fees.

On December 12, 2006, in apparent response to this criticism and possibly in an attempt to forestall the legislative efforts, the Department of Justice announced (here) that U. S. Deputy Attorney General Paul J. McNulty had released new guidelines revising the Thompson Memo. The new guidelines, entitled "Principles of Federal Prosecution of Business Organizations" may be found here. An Executive Summary of the new guidelines may be found here. The revised guidelines identify nine factors for prosecutors to use when deciding whether or not to charge a corporation with a criminal offense.

The most significant revisions in the McNulty Memo relate to the attorney-client privilege and the advancement of attorneys' fees. With respect to the attorney-client privilege, the guidelines adopt a "tiered approach," by which the prosecutor must now obtain advanced written approval from the Deputy Attorney General in order to request a corporation to waive its attorney client privilege. In order to obtain approval, the prosecutor must "establish a legitimate need" by showing the likely prosecutorial benefit, as well as the absence of alternative means to obtain the information and the extent of voluntary disclosure already provided. According to the Executive Summary, prosecutors should seek attorney-client communications only in "rare circumstances."

The revised guidelines also provide new standards for when prosecutors may request a waiver of privilege in order to obtain facts uncovered in a company's internal investigation. Before requesting these materials, prosecutors must seek the approval of their local United States Attorney, who must consult with the Assistant Attorney General for the Criminal Division.

Prosecutors are also directed in connection with their charging decision not to consider a corporation's decision not to provide attorney-client communication after the government makes the request. (However, the prosecutors may still favorably consider a corporation's voluntary provision of attorney-client privilege material or information.) The new memorandum also instructs prosecutors in connection with their charging decision that the cannot consider a corporation's advancement of attorneys' fees to employees, except in "rare exception" where the advancement of fees combined with other facts shows that the payment of fees was intended to impede the government's investigation. (Even in the exceptional circumstances, the advancement of fees may only be considered if authorized by the Deputy Attorney General.)

The new guidelines are effective immediately and apply to ongoing investigations.

The revisions have already been criticized for not going far enough. According to news reports (here), critics are concerned that the guidelines don't bar prosecutors from rewarding companies that waive their privilege; according to these critics, the ability to reward includes the reward to withhold the reward, which operates exactly like a punishment.

Hat tip to the White Collar Crime Prof blog (here) for the link to the McNulty Memo and the Executive Summary.

A Close Look at A Credit Rating Agency: Shareholders, creditors and even D & O underwriters who depend on the reports of credit rating agencies will want to read the December 12, 2006 New York Times article entitled "Objectivity of a Rating Questioned" (here, registration required). The article examines questions raised by 34 industrial customers of Portland General Electric in connection with a Standard & Poor's report the utility relied upon to support the utility's regulator petition for a rating increase.

The customers subpoenaed documents that had gone between the utility and S & P during the 21 months preceding the report's completion. The documents showed that S & P "solicited comment from the utility on a draft report and then made at least 48 changes that the utility sought before releasing the report." The utility then used the report as "independent corroboration" of its request to raise rates, increase its profit margin, and shift fuel-cost risks to its customers.

As reflected in a comment reported in the article, the "documents illustrate a fundamental problem with allowing companies that issue stocks and bonds to pay for evaluations by credit reporting agencies."

Portland General Electric is now an independent company, but it was owned by Enron from 1997 to April 2005.

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It is always rewarding to The D & O Diary when a blog post provokes a thoughtful and interesting response. The D & O Diary's August 14, 2006 post about the Thompson Memo provoked a substantial response that is sufficiently interesting that we asked for and received the author's consent to reproduce the response in its entirety, as a guest post. The D & O Diary's first-ever guest blogger is John F. McCarrick, an attorney in the New York office of the Edwards Angell Palmer & Dodge law firm, and here is his guest post:

I enjoy reading your blog and wanted to comment on your post about the Thompson Memo. The reason this is of particular interest is because I have been working with several leading insurers for the past several months on a new legal expenses policy designed specifically to address this particular exposure. During the course of my research in connection with this project, here is what I concluded:

First, the employee legal expense advancement issue is not just a DOJ/Thompson Memo issue -- as would appear to be the case based on the American Bar Association and other advocacy groups' public statements about the evils of the Thompson Memo. The SEC employs similar strategies in its investigations based on the principles of the Seaboard report, and the NYAG applied this strategy in the Theodore Sihpol/Bank of America case to deny Sihpol legal expense advancement from BofA. Given the broader use of this strategy (note that the SEC initiates many more investigations each year than the DOJ does in this area), I find it interesting that no one is challenging the SEC or NYAG with the same intensity as in connection with the Thompson Memo criticisms.

One could look at the employee legal expense advancement issue as a balancing of two conflicting public policy concerns. The legitimate concern embodied in the Thompson Memo is that when a company under investigation employs a single counsel to represent its interests and those of all of its employees, such legal representation creates an opportunity for the company to improperly influence the cooperation of those of its employees being questioned in connection with the investigation. So, how can this be cured? Arguably, if the company hires separate counsel to represent its employees, the fact that the separate counsel has been retained by, and is being paid by, the company still creates an opportunity for improper influence of the employee's cooperation because the law firm and the employee recognize that the company is still paying the bills and therefore calling the strategic shots. Moreover, even if the employee goes out and hires his or her own counsel, the opportunity for improper influence remains because even though the company may no longer be calling the strategic shots, it still is paying the bills and
has some overt or subtle expectations about what it expects in terms of the employee's cooperation with the company in the investigation.

The counterweight public policy concern is that employees being questioned in connection with corporate white collar crime cases should have the benefit of competent counsel, given the personal implications involved if the government does not believe the employee is being fully truthful, regardless whether the employee has any culpability in connection with the underlying issues being investigated. Thus, even though 6th Amendment rights to counsel don't come into play until indictment, in practice, invocations of the Thompson Memo frequently occur at an early ( i.e., pre-indictment) stage of the investigation, and before an employee has a constitutional right to counsel.

With respect to your blog, I don't think it's correct to say that Judge Kaplan found portions of the Thompson Memo to be unconstitutional. To the extent there were right to counsel (post-indictment only) or due process (possibly pre- and post-indictment) violations, Judge Kaplan found that the actions of the government in furtherance of the Thompson Memo constituted unconstitutional conduct. Accordingly, I think one could reasonably argue (as the DOJ currently is arguing) that the Thompson Memo itself is not subject to challenge on constitutionality grounds, meaning that had the government acted in a less overt or threatening way in connection with a particular investigation, it nevertheless could have evaluated the company's cooperation (for indictment purposes) by looking at, among other things, whether the company was advancing legal expenses to employees.

Also, the invocation of the Thompson Memo in the KPMG case took place after the individuals were indicted. This is an important fact because there is no Sixth Amendment right to counsel prior to indictment. Thus, to the extent Judge Kaplan determined that a constitutional breach had occurred, such breach occurred with respect to the Sixth Amendment and therefore, constituted post-indictment conduct by the government. This is significant because the trigger for coverage under D&O policies (even the broader Side A DIC policies) is an indictment; meaning that if the Thompson Memo is invoked with respect to an employee pre-indictment, D&O coverage would not respond to pay for that employee's legal expenses.

Finally, D&O policies typically require that a "wrongful act" be alleged against a covered person in connection with a "claim" in order for coverage to be triggered. However, as a practical matter, invocations of the Thompson Memo occur most frequently pre-indictment (of the person or insured entity), and the government generally does not identify wrongful acts by the targeted employees when it insists that the company cease advancing legal expenses for that employee.

McCarrick is of course correct about Judge Kaplan's decision about the constitutionality of the Thompson memo; it was not the memo itself that was declared unconstitutional but the way the government had implemented it in the KPMG tax shelters case. He also makes a very good point about the policies of the SEC and the NYAG which also could have the effect of discouraging companies from funding employees' defense fees. His distinction between pre-indictment and post-indictment expenses (and constitutional rights) is important.

Option Backdating Litigation List Update: The D & O Diary updated its list of options backdating litigation on August 15, 2005, to add the new securities class action lawsuit that has been filed against Witness Systems. This brings the number of options timing securities fraud lawsuits to 13. The D & O Diary notes that the Witness Systems lawsuit, and the lawsuit filed most recently prior to that one, which was filed against Broadcom, were filed by firms that are best known for work in asbestos and tobacco class action litigation -- the Witness Systems case was filed by the Motley Rice law firm, and the Broadcom case was filed by the Kahn Gauthier and Swick firm. Perhaps the Milberg Weiss firm's misfortune is attracting opportunistic competition from other segments of the plaintiffs' bar.

You Tube Interlude: On the theory that anything that was the subject of a Wall Street Journal article (subscription required) is a suitable post topic for this blog, The D & O Diary offers this pop culture interlude. Readers who stay up later on Saturday nights than does The D & O Diary are probably already familiar with the "Lazy Sunday" video (also known as "The Chronicals of Narnia Rap"), mentioned in the Journal article. Here is a link for those for whom, like The D & O Diary, Saturday Night Live broadcasts occur two hours post-bedtime. The Lazy Sunday video spawned numerous spoofs. The D & O Diary's favorite spoof is the "Lazy Sunday UK" version (also known as "We Drink Tea Rap") which may be found here. Warning, turn the sound on your computer down before launching.

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As noted in this prior D & O Diary post, at least one U.S. District Court has found the Thompson Memo unconstitutional. At its recent annual convention, the American Bar Association adopted a Report issued by its Task Force on Attorney-Client Privilege. The Report urges the Department of Justice to withdraw or revise a number of provisions in the Thompson Memo, including in particular the provisions encouraging corporations seeking to avoid criminal prosecution to withhold the payment its employees' criminal defense fees. Among other things, the report states that this provision of the Thompson Memo is "inconsistent with ABA principles, good corporate governance, the role of lawyers in our adversarial system of justice and individual Constitutional rights." The Task Force presented four specific recommendations for the revision of the Thompson Memo, which may be found here.

Professor Ellen Podgor, in a post on the White Collar Crime Prof blog, presents a more practical argument for the Department of Justice to revise or abandon the Thompson Memo - that is, as long as prosecutors act upon the Thompson Memo's requirements, they run the risk that future prosecutions will be in jeopardy, as companies could escape prosecution or individuals walk free if additional courts find the prosecutors' reliance on the Thompson Memo to be unlawful. She notes "as a taxpayer, I am not sure this benefits our pocketbooks."

And in an article in the August 14, 2006 issue of the National Law Journal, two defense attorneys present their view that Judge Kaplan's opinion in the KPMG tax shelters case was correct in declaring the Thompson Memo unconstitutional, but flawed by its failure to throw out the criminal cases against the individual defendants altogether. Their argument is that Judge Kaplan's solomonic effort to compel KPMG to pay the individual defendants' attorneys' fees failed to recognize that the "government's conduct prejudiced the defendants' ability to make critical pretrial decisions, including what lawyer to hire; whether and on what terms the defendants' might cooperate with the government or plea bargain; or other lawyering that might prevent an indictment." Their argument is that denial of legal fees at the early stages "cannot be atoned for after the fact" because the "full panoply of pretrial lawyering [is] forever lost when the government interferes with the attorney-client relationship."

Options Backdating Litigation Update: The D & O Diary's options backdating litigation list, which may be found here, has been updated to add the new securities fraud class action lawsuit that has been been filed Broadcom Corp. The number of securities fraud lawsuits based on options timing allegations now stands at 12. Note: The list was updated again on August 15, 2006, to add the new securites fraud lawsuit that has been filed against Witness Systems.

Calvin's Dad Explains the Universe: Calvin's Dad (of Calvin and Hobbes fame) was a patent attorney, and that is close enough to a good reason to include a link to this site containing a distillation of Calvin's father's pronouncements on the mysterious workings of the universe.

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On June 27, 2006, U.S. District Judge Lewis Kaplan held, in the KPMG tax shelter prosecution, that portions of the Thompson memo violate the constitutional rights of 16 former KMPG partners who are accused of participating in a fraudulent tax scheme. Judge Kaplan found that KPMG, seeking to show full compliance with the Thompson memo to avoid its own criminal prosecution, withheld advancement of attorneys' fees from the individual defendants. The Judge said in his 83-page opinion that "KMPG refused to pay because the government held the proverbial gun at its head." Judge Kaplan found that the government, through the Thompson memo and its own actions, violdated the defendants' right to due process guaranteed under the Fifth Amendment and their right to counsel guaranteed by the Sixth Amendment. The Judge declined to dismiss the indictments, holding rather that the individual defendants can pursue a civil action against KPMG seeking legal fees or that KPMG can decide on its own to advance the individuals' defense fees.

The Judge's lengthy opinion is thoughtful and scholarly, and full of the language of liberty and individual rights. Among other things, the Judge's opinion states that "[t]he imposition of economic punishment by prosecutors, before anyone has been found guilty of anything, is not a legitimate governmental interest - it is an abuse of power."

While Judge Kaplan's ruling is unquestionably a significant event that will impact pending prosecutions across the country, the specific practical consequences outside the KPMG tax shelters case will remain to be seen. His ruling is based on a detailed record of the particular facts and circumstances of that specific case. In addition, as the opinion of a U.S. District Court Judge, the decision has persuasive but not precedential authority. Nevertheless, Judge Kaplan's opinion is important and will have ramifications, and raises a host of potentially interesting questions in connection with the indictment of the Milberg Weiss law firm, among many other pending cases.

The wsj.com law blog's comments on Judge Kaplan's opinion can be found here. The wsj.com law blog's links to several major newspaper's stories and editorials about Judge Kaplan's opinion may be found here.

An interesting comment in the White Collar Crime Prof blog focusing on the legal duties of corporation's to advance defense costs and on the possible implications of Judge Kaplan's opinion for the D & O insurance industry can be found here.


The D & O Diary's prior posts on the Thompson Memo may be found here. The Wall Street Journal's (subscription required) article on the Milberg Weiss indictment may be found here.

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On May 30, 2006, American Tower Corporation became the fourth company to be named in a securities class action lawsuit connected with the options backdating probe. (As noted in this prior post on The D & O Diary, the three companies previously named in securities class action lawsuits related to options backdating are Vitesse Semiconductor, Comverse Technology, and United Health Group.) American Tower also reported that it had been named in a shareholders' derivative lawsuit in Massachusetts state court.

In an even more ominous development on the options backdating litigation front, on May 30, 2006, the plaintiffs' firm of Kahn Gauthier Swick LLC issued a press release announcing "the creation of the nation's first privately funded Independent Options Pricing Investigations Division," which reportedly was formed to invesitgate options backdating at U.S. companies. The press release names five companies the firm is currently investigating (Altera Corp., Brocade Communications, Broadcom Corp., Brooks Automation and CNet Networks), and urges shareholders of these companies to contact the firm "to discuss your legal rights." According to Kahn Gauthier's website, the firm was founded by tobacco litigation plaintiffs' attorney Wendall Gauthier.

Thompson Memo Update: In a prior post, the D & O Diary commented on the enormous burden the so-called Thompson Memo places on business organizations facing criminal investigations. Among other things, the firms can find themselves forced to withhold payment of their individual employees' attorneys' fees, or even to waive the attorney client privilege, in a bid for leniency in a criminal prosecution. The May 31, 2006 issue of USA Today carries a lengthy story discussing these issues in greater detail. Accompanying the article is a spiffy chart listing the 21 companies that have been forced to waive their attorney client privilege in connection with criminal investigations. The chart lists the wide variety of types of criminal matters in which the issue has arisen. According the WSJ.com law blog, the government's decision to indict the Milberg Weiss law firm has drawn together a variety of different organizations who object to the prosecutorial action of forcing firms to waive the privilege or cut off employees' attorneys' fees or face the death penalty of corporate criminal indictment. Among the groups joining together to voice their concern are the US Chamber of Commerce, corporate counsel groups and corporate defense lawyers.

Coming Soon to a Courtroom Near You?: You may have missed it over the long holiday weekend, but on Saturday, May 27, 2006, the Wall Street Journal carried an article (subscription required) entitled "Scandals Seem Bad Now? Just Wait," speculating on the corporate scandals to come now that the grandaddy of them all from the last wave of corporate scandals -- the Enron criminal prosecution -- has been to the jury. The article conjectures that the credit boom of the last few years will generate several waves of scandals, including issues arising from: "proprietary trading at investment banks"; "scandalously incompetent lending" -- the prediction is that future blow ups will "expose those in the hedge fund world and elsewhere who've taken on excessive risk in pursuit of quick returns"; securitized loans, such as collateralized debt obligations, which the article comments is "an area rich in conflicts of interests, hazy pricing, excessive leverage and opportunities for self-dealing." Other fruitful areas for "tomorrow's accounting outrages" include excessive executive compensation, hedge funds' excessive management fees, and dual-share stock structures that enable founders or insiders to maintain corporate control to the detriment of other shareholders.

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The so-called "Thompson Memo," is an internal Department of Justice memorandum specifying the circumstances under which business organizations will be criminally prosecuted. The document places a great deal of emphasis on an organization's level of cooperation in the prosecutor's decision whether or not to prosecute the firm. The memo's onerous cooperation standards have been the highly criticized, most recently in the editorial (via wsj.com, subscription required) in the May 22, 2006 issue of the Wall Street Journal. The Journal condemns the government's decision to prosecute the Milberg Weiss law firm, saying the government "essentially held a gun to Milberg Weiss's head and threatened to indict unless the firm waived the attorney-client privilege and agreed to label its own partners criminals." The editorial asserts (with an ironic acknowledgement of the fact that it is downright odd for the Journal to be defending Milberg Weiss) that this is "a dangerous precedent that can -- and surely will-- be used against more honest business enterprises."

Just as insidious as government attempts to compel business organizations to waive the attorney-client privilege is the attempt to force companies to cut off their employees' attorneys fees. There is an extensive debate whether or not the government improperly pressured KPMG -- in connection with the allegations that KPMG sold fraudulent tax shelters -- to withhold individual employees' and partners' defense fees. (KPMG itself, seeking to avoid the death sentence of a criminal indictment, agreed to a $456 million deferred prosecution agreement). A May 19, 2006 post of the Corporate Crime Reporter attibutes the following to the Judge who heard argument in a pretrial hearing in the KPMG matter:

Isn't it just perfectly obvious from a reading of the Thompson memorandum that it is the position of the United States Department of Justice that a company facing possible prosecution hurts its case for a favorable outcome by advancing defense costs to present and former employees, except where they are legally obligated to do so, and that the natural consequence of that is that some corporations in that position, in furtherance of their enlightened self-interest, will cut off defense costs for individuals, who in the fullness of time will be indicted, and thus be deprived to one degree or another of the means of mounting a defense against the indictment?

Other cases have presented this same question. In March 2006, a federal judge granted a three-month postponement of the criminal trial of five former executives of Enterasys Networks. According to defense lawyers' filings, government lawyers pressured the company to cut off legal fees to the defendants to weaken the employees' ability to fight the charges. A March 28, 2006 Wall Street Journal article (via wsj.com, subscription required) discussing the Enterasys Networks case also states that in their investigation of accounting fraud at HealthSouth, federal prosecutors informed the company that payment of fees to indicted executives would be viewed as a sign of noncooperation, according to defense lawyers. The article also reports that prosecutors encouraged Symbol Technologies to withhold fees from exectives charged in an alleged accounting fraud. (Symbol apparently was able to pay the fees after it convinced prosecutors that the company bylaws required it to do so.) An article in the Spring 2006 issue of The John Liner Review (subscription required) details the government's largely successful efforts in connection with the prosecution of two executives from Westar Energy to prevent the utility from advancing defense costs to the officers despite the company's bylaws clearly mandating advancement

An extensive April 17, 2006 New York Times article discussing the issue of individuals' attorneys' fees and corporate cooperation under the Thompson Memo can be found here. (Registration required.)

The cover page of the Thompson memo states that "[f]urther experience with these guidelines may lead to additional adjustments." The time for the additional adjustments is overdue.

Update: The options backdating story has grown beyond The D & O Diary's ability to keep up with it. Fortunately, wsj.com has set up a separate page devoted to options backdating, which it updating on a daily basis. The WSJ Law Blog has an interesting post examining the apparent turf battle between the EDNY and the SDNY in issuing subpoenas in the options backdating probe (current score: EDNY 7 subpoenas, SDNY 6).

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