United States v. Stein, a U.S. District Court for the Southern District Court opinion (July 17, 2007) by District Judge Lewis Kaplan, is fascinating reading, and may have significant implications for a number of firms.
The opinion opens with “The government threatened to indict, and thus to destroy, the giant accounting firm, KPMG LLP (“KPMG”). It coerced KPMG to limit and then cut off its payment of the legal fees of KPMG employees. KPMG avoided indictment by yielding to government pressure. Many of its personnel did not.”

Citing its earlier decision that held that the government's interference with KPMG's payment of the legal fees of its employees and former employees violated the employees’ constitutional rights, the court dismissed the indictment for conspiracy and tax evasion as a result of promoting tax shelters for 13 of the 16 KPMG defendants.

The opinion provided a remarkable window into the negotiations between the U.S. Attorney’s office and KPMG, as well as the substantial defense costs being incurred. In pressuring KPMG, the government’s so-called “Thompson Memorandum” was cited. That memorandum made cooperation with a government investigation a consideration in deciding whether to indict a corporation or other business entity. A number of factors were specifically cited that indicate cooperation.

In that regard, the memo stated the following: “Another factor to be weighed by the prosecutor is whether the corporation appears to be protecting its culpable employees and agents. Thus, while cases will differ depending on the circumstances, a corporation's promise of support to culpable employees and agents, either through the advancing of attorneys’ fees, through retaining the employees without sanction for their misconduct, or through providing information to the employees about the government's investigation pursuant to a joint defense agreement, may be considered by the prosecutor in weighing the extent and value of a corporation's cooperation.” 

The district court indicated that as a result negotiations with the government over the Thomson Memorandum, KPMG changed its past long-standing policy to advance and pay legal fees, without a preset cap or condition of cooperation with the government, for counsel for partners, principals, and employees of the firm in those situations where separate counsel was appropriate to represent the individual in any civil, criminal or regulatory proceeding involving activities arising within the scope of the individual's duties and responsibilities as a KPMG partner, principal, or employee. The court held that with regard to the dismissals the defendants had been either deprived of counsel of their choice or their ability to defend against the indictment.

To get an idea of the costs, begin with the fact that to date and without yet going to trial there are over 23 million pages of material in electronic or hard-copy form that have to be examined, and the defendants experienced difficulties in searching multiple databases and accessing some documents. And without even going to trial, the defendants on an average incurred $1.7 million in legal expenses. Interestingly, the opinion indicated that under its past policy, KPMG paid for a $20 million defense for four of its personnel in the Xerox case.

The government is appealing the decision that found that it violated the defendants’ constitution rights.

So what are the ramifications of this decision for firms, their partners and staff? For one, I believe there will be greater negotiations between firm and both  partners and potential incoming partners with regard to payment of legal expenses, both as to caps and other limiting conditions. This will apply to possible criminal and civil actions. Also, past policy will give little comfort, and the firms will be pressed to reduce the policy to a binding contract.

As a result, firms will have to closely scrutinize their malpractice insurance protection and might find the payment of legal expenses might be a deal breaker when negotiating with a potential incoming partner or deter a partner from developing a particular client strategy or niche. Firms will also be paying closer attention to possible legal exposure, both criminal and civil. A good example might be with regard to members of firms or firm affiliates that act in some kind of fiduciary capacity.

Another possible ramification is that although the government won’t likely use payment of legal fees as an indication of lack of cooperation by a professional entity, it will continue to use possible prosecution of the entity as leverage for the firm to give-up the “culpable” individuals for government prosecution.
What do you think?

 Please e-mail me at Howard,Wolosky@sourcemedia.com with your reactions to this decision.

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