United States: Federal Prosecutors Violated The U.S. Constitution By Pressuring KPMG To Cut Off Payment Of Defense Costs To Indicted Former Employees

The U.S. District Court for the Southern District of New York recently held that the Department of Justice violated the Fifth and Sixth Amendment rights to due process and to legal representation when it pressured accounting giant KPMG to withhold payment of defense costs of current or former employees who were under investigation. The decision casts doubt on the provision in the DOJ’s Thompson Memorandum that considers the advancement of legal fees to so-called culpable employees and agents as evidence of a corporation’s non-cooperation with DOJ investigations.

U.S. v. Stein arose out of an investigation of certain KPMG tax shelters. At the outset of the investigation, DOJ prosecutors made clear that they "would look at any discretionary payment of [legal] fees by KPMG under a microscope." Despite KPMG’s longstanding practice of advancing legal fees in similar situations, the firm decided to cut off all such payments to anyone indicted, and to cap (at $400,000) and condition any payments before an indictment on satisfactory cooperation by the employee with the DOJ’s investigation.

In August 2005, KPMG entered into a $456 million deferred-prosecution agreement in which it admitted to criminal wrongdoing and agreed to cooperate in the investigation of its former partners and employees in exchange for avoiding indictment. Soon thereafter, the DOJ indicted 18 individuals, including 16 former KPMG partners. KPMG refused to advance payment of legal costs to these KPMG defendants, who then moved to dismiss the indictments, citing the DOJ’s interference.

The Court held that KPMG’s decision to cut off, or otherwise cap or condition, payment of defense costs was the direct consequence of the pressure applied on KPMG by the Thompson Memorandum and the DOJ. The Court further held that such pressure interfered with the KPMG defendants’ ability to present the defense they wished to present, and thus violated their Fifth Amendment due process rights. It also interfered with the defendants’ right to choose their lawyers and to use their own funds to mount their own defense, and so violated their Sixth Amendment right to counsel.

The Court refused to dismiss the indictments outright, but left the door open for future relief. The Court also invited the KPMG defendants to bring a civil action against KPMG for payment and future advancement of legal fees (which the KPMG defendants filed on July 11, 2006 and KPMG subsequently moved to dismiss on jurisdictional grounds). Noting that the DOJ has substantial influence over KPMG by virtue of the cooperation requirements in the deferred-prosecution agreement, the Court also observed that "[i]t may well be in [the DOJ’s] interest to use that influence or power to cause KPMG to advance the defense costs." The DOJ is expected to appeal the decision.

The decision is further evidence that Courts are increasingly willing to constrain measures to combat corporate fraud if they violate principles of fundamental fairness in the criminal process.