Department of Justice Policies Held Unconstitutional
By: JOHN W. LUNDQUIST & RICHARD H. KYLE, JR.
July 2006
Businesses rely on the assumption that any communications they have with their lawyers will be maintained in confidence. That, after all, is what the attorney-client privilege is all about. Business executives also expect their employees to provide indemnity if they are sued. Yet, since 2003, when the Department of Justice issued its now notorious “Thompson Memorandum,” discussed below, businesses have been expected to waive the attorney-client privilege to be regarded as good, cooperative corporate citizens. In the same vein, the DOJ has made it clear that it will look askance at any business that provides indemnity for attorney’s fees to an employee found to be roughly within 10 miles of an investigation.
Criticism of the “Thompson Memorandum” has built steadily from quarters as diverse as the U.S. Chamber of Commerce to the A.C.L.U. The “Thompson Memorandum,” once touted as part of the post-Enron, Sarbanes-Oxley cure against corporate fraud, has now become a symbol of overreaching and overregulation by the government. As a result, the United States Sentencing Guidelines Commission took the highly unusual step of reversing field and striking the requirement that businesses waive privilege in order to be treated more favorably under the Guidelines. Even more dramatically, U.S. District Court Judge Lewis Kaplan ruled on June 26, 2006 that the government had unconstitutionally interfered with the defendants’ right to indemnity for attorney fees in the criminal prosecution of a number of former KPMG officers and employees.
The criticisms of the “Thompson Memorandum” will have significant implications for just about everyone in business.
ATTORNEY-CLIENT PRIVILEGE
Courts have long recognized that the attorney-client privilege is as essential for corporations as it is for individuals. The privilege is crucial to the success of internal investigations of corporate misconduct by outside and in-house counsel. Recently, however, the sanctity of the attorney-client privilege has been seriously challenged as federal prosecutors and government regulators routinely request that corporations disclose privileged information during criminal investigations.
The genesis of this shift was the “Thompson Memorandum,” which lays out standards that prosecutors can weigh when deciding whether to seek an indictment of a corporation—a virtual death penalty for many companies, as Arthur Anderson discovered. The standards include whether the firm has waived attorney-client privilege to give prosecutors access to confidential documents and other information.
The United States Sentencing Guidelines Commission soon followed suit, with amendments that enabled businesses to qualify for leniency by demonstrating “thorough” cooperation by waiving attorney-client privilege. The government has aggressively pushed the envelope of what it considers “thorough” cooperation by a corporation under investigation. For example, after federal prosecutors announced the indictment of securities class action giant Milberg, Weiss, Bershad & Schulman and two of its partners, the law firm claimed that prosecutors had demanded access to communications with its counsel in exchange for a deferred prosecution. According to the firm, Weiss’ refusal to waive the attorney-client privilege led to its indictment. In contrast, KPMG, under pressure from the government, concluded that “thorough” cooperation required the company to completely waive the attorney-client privilege protection.
The American Bar Association has strongly criticized the Thompson Memorandum and the Sentencing Commission amendment. Its primary concerns are that the amendment:
- forces companies to waive their attorney-client privilege in most cases (“companies will have no choice but to waive these privileges, as the government’s threat to label them as ‘uncooperative’ will have a profound effect not just on their sentencing, but on their public image, stock price, and credit worthiness as well”),
- undermines internal corporate compliance programs, and
- unfairly harms employees who are forced to make the Hobson’s choice between keeping their jobs or preserving their legal rights.
In the face of mounting criticism, the Commission recently announced that it was removing the privilege waiver language from the Guidelines. Unless Congress takes action to modify or disapprove of the Commission’s proposal, it will become law effective November 1, 2006.
While this is a welcome development, the Justice Department’s waiver policy, as spelled out in the “Thompson Memorandum,” continues to be problematic and needs to be addressed. The perception that corporate lawyers are being “deputized” by zealous government prosecutors to develop evidence against corporate officers undermines the trust and confidence in counsel that is so central to our adversarial system of justice.
INDEMNITY
Every business incorporated in Minnesota (as well as many other states) must indemnify employees who face investigation arising from their employment, unless it has opted out in its articles or bylaws. In order to receive such indemnity under Minnesota law, an employee must certify that he or she has not been indemnified by another organization, has acted in good faith, has received no improper personal benefit, and, in the case of a criminal proceeding, had no reasonable cause to believe the conduct was unlawful. Employees, directors, or officers of a business under investigation may request indemnity for their personal attorney’s fees, judgments, fines, and other costs. The company may be obligated to pay if legal prerequisites and other conditions set forth in the company’s articles or bylaws have been met. The obligation to provide indemnity may be funded, in part, through D&O insurance (which may specify other conditions).
The government is not fond of this sort of indemnity, state law notwithstanding. Many employees would not be able or willing to engage counsel, or afford counsel on their own. Things are a whole lot easier for the government if it can deal directly with officers, directors, and employees instead of lawyers. And, when skilled lawyers represent multiple employees in the same case, they commonly organize and share information under joint defense agreements, which shield their communications with each other.
This coordinated opposition can provide a formidable roadblock to the government. So it was no surprise when the Department of Justice noted in the “Thompson Memorandum” that one of the factors the government will consider in deciding whether to treat a business with kid or boxing gloves is whether it has advanced fees to employees.
In the KPMG case, the court convened a hearing to determine whether the government’s policies, as well as communications to KPMG executives suggesting that KPMG not indemnify certain employees, unconstitutionally intruded into the defendants’ right to defend themselves. The company itself avoided the fate of Arthur Andersen by working out a deferred prosecution agreement with the government in lieu of indictment. Its former employees were not so fortunate and claimed that KPMG was coerced by the government into turning off the legal fee spigot. The Court, in an 88-page opinion, agreed. Its decision to conduct a hearing reflects growing concern that policies such as those set forth in the “Thompson Memorandum” are improper.
CONCLUSION
Any business that is or may become the subject of a investigation needs to study how to best ensure the maintenance of privilege as well as whether to provide indemnity to its officers, directors, and employees and, if so, under what conditions.