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United States v. Stein

June 26, 2006

UNITED STATES OF AMERICA,
v.
JEFFREY STEIN, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Lewis A. Kaplan, District Judge.

OPINION

TABLE OF CONTENTS

Facts ........................................................................ 3

The Thompson Memorandum ..............................................3

KPMG Gets Into Trouble and "Cleans House" . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

KPMG's Policy on Payment of Legal Fees .................................... 9

The Initial

Discussion between the USAO and Skadden . . . . . . . . . . . . . . . . . . . . . . . . 10

KPMG Gets the Message................................................. 17

The Government Presses Its Advantage ..................................... 22

The Conclusion of the Investigation, KPMG's Stein Problem and the Deferred Prosecution Agreement ...................................................... 22

The Deferred Prosecution Agreement and the Indictment in This Case . . . . . . . . . . . . . 26

The Present Motion ..................................................... 28

The Government's Initial Response .................................. 28

Prehearing Proceedings ............................................ 30

The Hearing ..................................................... 31

Ultimate Factual Conclusions ............................................. 32

Discussion.................................................................. 34

I. The Relationship Between KPMG and its Personnel With Respect to Advancement of Legal Fees and Defense Costs ..................................... 34

A. Indemnification and Advancement Generally . . . . . . . . . . . . . . . . . . . . . 34

B. KPMG ................................................... 37

II. The Government Violated the Fifth and Sixth Amendments by Causing KPMG to Cut Off Payment of Legal Fees and Other Defense Costs Upon Indictment . . . 39

A. The Right to Fairness in the Criminal Process . . . . . . . . . . . . . . . . . . . . 39

1. Nature of the Right ................................... 39

2. The Right to Fairness in the Criminal Process Is a Fundamental Liberty Interest Entitled to Substantive Due Process Protection Where, As Here, the Government Coerces a Third Party to Withhold Funds Lawfully Available to a Criminal Defendant . . . . . . . . . . 45

3. The Government's Actions Violated the Substantive Due Process Right to Fairness in the Criminal Process . . . . . . . . . . . . . . . . . . 48

B. The Sixth Amendment Right to Counsel . . . . . . . . . . . . . . . . . . . . . . . . . 54

1. The Nature and Scope of the Right to Counsel . . . . . . . . . . . . . . 54

a. Attachment of Sixth Amendment Rights . . . . . . . . . . . . . 55

b. "Other People's Money" ......................... 56

2. The Thompson Memorandum and the Government's Implementation Violated the KPMG Defendants' Sixth Amendment Right to Counsel ................................................... 58

3. The KPMG Defendants Are Not Obliged to Establish Prejudice, Which in Any Case Would Be Presumed Here . . . . . . . . . . . . . . 60

III. It is Premature to Consider the Government's Actions With Respect to Payment of Legal Expenses Incurred Before Indictment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

IV. The Remedy ..................................................... 68

A. Monetary Relief Against the Government Is Precluded by Sovereign Immunity ................................................. 70

B. Monetary Relief May Be Available Against KPMG . . . . . . . . . . . . . . . . 73

1. This Court Has Subject Matter Jurisdiction . . . . . . . . . . . . . . . . . 74

2. Personal Jurisdiction, Even If It Does Not Already Exist, May Be Obtained Over KPMG ................................. 76

C. Possible Dismissal and Other Remedies . . . . . . . . . . . . . . . . . . . . . . . . . 79

V. Some of the Actions of the USAO in Response to the Motion Were Not Appropriate ............................................................... 80

Conclusion .................................................................. 81

The issue now before the Court arises at an intersection of three principles of American law.

The first principle is that everyone accused of a crime is entitled to a fundamentally fair trial.*fn1 This is a central meaning of the Due Process Clause of the Constitution

The second principle, a corollary of the first, is that everyone charged with a crime is entitled to the assistance of a lawyer.*fn2 A defendant with the financial means has the right to hire the best lawyers money can buy. A poor defendant is guaranteed competent counsel at government expense.*fn3 This is at the heart of the Sixth Amendment.

The third principle is not so easily stated, not of constitutional dimension, and not so universal. But it too plays an important role in this case. It is simply this: an employer often must reimburse an employee for legal expenses when the employee is sued, or even charged with a crime, as a result of doing his or her job. Indeed, the employer often must advance legal expenses to an employee up front, although the employee sometimes must pay the employer back if the employee has been guilty of wrongdoing.

This third principle is not the stuff of television and movie drama. It does not remotely approach Miranda warnings in popular culture. But it is very much a part of American life. Persons in jobs big and small, private and public, rely on it every day. Bus drivers sued for accidents, cops sued for allegedly wrongful arrests, nurses named in malpractice cases, news reporters sued in libel cases, and corporate chieftains embroiled in securities litigation generally have similar rights to have their employers pay their legal expenses if they are sued as a result of their doing their jobs. This right is as much a part of the bargain between employer and employee as salary or wages.*fn4

Most of the defendants in this case worked for KPMG, one of the world's largest accounting firms. KPMG long has paid for the legal defense of its personnel, regardless of the cost and regardless of whether its personnel were charged with crimes. The defendants who formerly worked for KPMG say that it is obligated to do so here. KPMG, however, has refused.

If that were all there were to the dispute, it would be a private matter between KPMG and its former personnel. But it is not all there is. These defendants*fn5 (the "KPMG Defendants") claim that KPMG has refused to advance defense costs to which the defendants are entitled because the government pressured KPMG to cut them off. The government, they say, thus violated their rights and threatens their right to a fair trial.

Having heard testimony from KPMG's general counsel, some of its outside lawyers, and government prosecutors, the Court concludes that the KPMG Defendants are right. KPMG refused to pay because the government held the proverbial gun to its head. Had that pressure not been brought to bear, KPMG would have paid these defendants' legal expenses.

Those who commit crimes -- regardless of whether they wear white or blue collars -- must be brought to justice. The government, however, has let its zeal get in the way of its judgment. It has violated the Constitution it is sworn to defend.

Facts

The Thompson Memorandum

In June 1999, then-U.S. Deputy Attorney General Eric Holder issued a document entitled Federal Prosecution of Corporations (the "Holder Memorandum") to provide "guidance as to what factors should generally inform a prosecutor in making the decision whether to charge a corporation in a given case."*fn6 He took pains to make clear that the factors articulated in the memorandum were not "outcome-determinative" and that "[f]ederal prosecutors [we]re not required to reference these factors in a particular case, nor [we]re they required to document the weight they accorded specific factors in reaching their decision." Nevertheless, the language that plays a central role in the present controversy first was found in the Holder Memorandum.

The Holder Memorandum set forth some common sense considerations. Prosecutors, in deciding whether to indict a company, should pay attention to things like the nature and seriousness of the offense, the pervasiveness of wrongdoing within the entity, the company's efforts to remedy past misconduct, the adequacy of other remedies, and the like. It mentioned also:

"the corporation's timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents, including, if necessary, the waiver of the corporate attorney-client and work product protection . . ."*fn7

Section VI elaborated on what was meant by cooperation. The general principle was that "[i]n gauging the extent of the corporation's cooperation, the prosecutor may consider the corporation's willingness to identify the culprits within the corporation, including senior executives, to make witnesses available, to disclose the complete results of its internal investigation, and to waive attorney-client and work-product privileges."*fn8 The memorandum then set out several paragraphs of commentary, the most relevant for present purposes being this:

"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 upon 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."*fn9 A footnote to the comment concerning the advancing of attorneys' fees read:

"Some states require corporations to pay the legal fees of officers under investigation prior to a formal determination of their guilt. Obviously, a corporation's compliance with governing law should not be considered a failure to cooperate."*fn10

Thus, the Holder Memorandum made clear that advancing of attorneys' fees to personnel of a business entity under investigation, except where such advances were required by law, might be viewed by the government as protection of culpable individuals and might contribute to a government decision to indict the entity.

The Court, with the consent of the parties, takes judicial notice of the Holder Memorandum.

As noted, the Holder Memorandum was not binding. Federal prosecutors were free to take it into account, or not, as they saw fit. But the corporate scandals of the earlier part of this decade changed that.

In late 2001, Enron, Global Crossing, Tyco International, Adelphia Communications and ImClone, among other companies, found themselves in worlds of trouble, much of it apparently of their own making. Bankruptcies and criminal prosecutions followed including, notably, the indictment of Enron's auditors, Arthur Andersen LLP -- an indictment that resulted in the collapse of the firm, well before the case was tried.*fn11 And on July 9, 2002, the President issued Executive Order 13271, which established a Corporate Fraud Task Force (the "Task Force") headed by United States Deputy Attorney General Larry D. Thompson.

On January 20, 2003, Mr. Thompson issued a document entitled Principles of Federal Prosecution of Business Organizations (the "Thompson Memorandum") which, in many respects, was a modest revision of the Holder Memorandum. Indeed, the language concerning cooperation and advancing of legal fees by business entities was carried forward without change.

Unlike its predecessor, however, the Thompson Memorandum is binding on all federal prosecutors.*fn12 Thus, all United States Attorneys now are obliged to consider the advancing of legal fees by business entities, except such advances as are required by law, as at least possibly indicative of an attempt to protect culpable employees and as a factor weighing in favor of indictment of the entity.*fn13

KPMG Gets Into Trouble and "Cleans House"

While all of this was going on, the Internal Revenue Service ("IRS") began investigating tax shelters, including a number that are subjects of the indictment in this case. In early 2002, it issued nine summonses to KPMG, which was less than fully compliant. Accordingly, on July 9, 2002, the government filed a petition in the United States District Court for the District of Columbia to enforce them.*fn14

A few months later, the Permanent Subcommittee on Investigations of the Senate Committee on Governmental Affairs "began an investigation into the development, marketing and implementation of abusive tax shelters by accountants, lawyers, financial advisors, and bankers."*fn15

This led to public hearings in November 2003 at which several senior KPMG partners or former partners -- three of them now defendants here -- testified.*fn16

The firm's reception at the hearing was not favorable. Senator Coleman, the subcommittee chair, for example, opened the hearing by saying that "the ethical standards of the legal and accounting profession have been pushed, prodded, bent and, in some cases, broken, for enormous monetary gain."*fn17 At another point, Senator Levin, the ranking minority member, in obvious exasperation at a KPMG witness, suggested that the witness "try an honest answer."*fn18

Eugene O'Kelly, then KPMG chair,*fn19 was concerned about the Senate hearing and the IRS proceedings.*fn20 He retained Skadden Arps Slate Meagher & Flom ("Skadden"), and particularly Robert S. Bennett, "to come up with a new cooperative approach."*fn21 One aspect of that new approach was a decision to "clean house" -- a determination to ask Jeffrey Stein, Richard Smith, and Jeffrey Eischeid, all senior KPMG partners who had testified before the Senate and all now defendants here -- to leave their positions as deputy chair and chief operating officer of the firm, vice chair -- tax services, and a partner in personal financial planning, respectively.*fn22

Given Mr. Stein's senior position and his relationship with Mr. O'Kelly,*fn23 his departure was cushioned substantially, although many of the facts have come to light only recently. He "retired" from the firm with a $100,000 per month, three-year consulting agreement. He agreed to release the firm and all of its partners, principals, and employees from all claims.*fn24 He and KPMG agreed also that Mr. Stein would be represented, at KPMG's expense, in any suits brought against KPMG or its personnel and himself, by counsel acceptable to both him and the firm or, if joint representation were inappropriate or if Mr. Stein were the only party to a proceeding, by counsel reasonably acceptable to Stein.*fn25

Despite KPMG's effort to stave off trouble by "cleaning house," much damage already had been done. In the early part of 2004, the IRS made a criminal referral to the Department of Justice ("DOJ"), which in turn passed it on to the United States Attorney's Office for this district ("USAO").*fn26

KPMG's Policy on Payment of Legal Fees

KPMG's policy prior to this matter concerning the payment of legal fees of its partners and employees is clear. While KPMG's partnership agreement and by-laws are silent on the subject, the parties have stipulated as follows:

"1. Prior to February 2004, . . . it had been the longstanding voluntary practice of KPMG 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.

"2. This practice was followed without regard to economic costs or considerations with respect to individuals or the firm.

"3. With the exception of the instant matter, KPMG is not aware of any current or former partner, principal or employee who has been indicted for conduct arising within the scope of the individual's duties and responsibilities as a KPMG partner, principal, or employee since [two partners] were indicted and convicted of violation of federal criminal law in 1974. Although KPMG has located no documents regarding payment of legal fees in that case, KPMG believes that it did pay pre- and post-indictment legal fees for the individuals in that case."

The Court infers and finds that KPMG in fact paid the pre- and post-indictment legal fees for the individuals in the 1974 criminal case. Moreover, the extent to which KPMG has gone is quite remarkable. In one recent situation involving KPMG's relationship with Xerox Corporation, it paid over $20 million to defend four partners in a criminal investigation and related civil litigation brought by the Securities and Exchange Commission.*fn27

The Initial Discussion between the USAO and Skadden

When the referral reached the USAO on February 5, 2004, it came under the supervision of Shirah Neiman, who was chief counsel to the United States Attorney, the USAO's liaison to the IRS, a participant in the drafting of the Holder Memorandum, and a very experienced prosecutor.*fn28 The USAO notified Skadden of the referral, and a meeting was scheduled for February 25, 2004.

In the meantime, on February 9, 2004, the USAO prepared "subject" letters -- letters advising the recipient that he or she "is a person whose conduct is within the scope of [a] grand jury's investigation"*fn29 -- to between 20 and 30KPMG partners and employees, including all but five of the defendants in this case.*fn30

In preparation for the meeting, Ms. Neiman, Assistant United States Attorneys ("AUSA") Weddle and Okula, and other members of the prosecution team conferred. They decided to ask Skadden whether KPMG was paying the legal fees of individuals under investigation.*fn31

Accordingly, the government prepared a document headed "Skadden Meeting Points" setting forth matters that the government intended to discuss at the meeting.*fn32 The first page of the three-page list contained an item that read:

"! Is KPMG paying/going to pay the legal fees of employees? Current or former?

What about taxpayers?

Who? ‡ Any agreements or other obligations to do so? What are they?"*fn33

The meeting was attended by Mr. Bennett, Ms. Neiman, and many others on both sides. Mr. Weddle began by telling Skadden that the government was there to hear what Skadden had to say and that it had a few questions. Mr. Bennett explained that Skadden had been hired in view of Mr. O'Kelly's concern about the controversy with the IRS and the Senate hearings and that KPMG had decided to clean house and change the atmosphere at the firm. He reported that the firm had taken high-level personnel action already, that it would cooperate fully with the government's investigation, and that the object was to save KPMG, not to protect any individuals. In an obvious reference to the fate of Arthur Andersen, he said that an indictment of KPMG would result in the firm going out of business.*fn34

After a discussion of the structure of KPMG and of potential conflicts of interest, Mr. Weddle "got to the subject of legal fees and asked whether KPMG was obligated to pay fees and what their plans were."*fn35 Mr. Bennett tested the waters to see whether KPMG could adhere to its practice of paying its employees'*fn36 legal expenses when litigation loomed. He asked for government's view on the subject.*fn37 Ms. Neiman said that the government would take into account KPMG's legal obligations, if any, to advance legal expenses, but referred specifically to the Thompson Memorandum as a point that had to be considered.*fn38

At or about that point, Messrs. Bennett and Bialkin told the USAO that KPMG's "common practice" had been to pay legal fees. They added that the partnership agreement was vague and that Delaware law gave the company the right to do whatever it wished, but said that KPMG still was checking on its legal obligations. It would not, however, pay legal fees for employees who declined to cooperate with the government, or who took the Fifth Amendment, as long as it had discretion to take that position.*fn39

The conversation then shifted briefly to a discussion of the personnel changes that KPMG had made.*fn40 Mr. Bennett reported that Messrs. Stein, Eischeid, and Smith had been asked to leave, but explained that neither KPMG nor Skadden had done an internal investigation to determine who were "bad guys" or whether any crime had been committed.*fn41 Almost immediately, Mr. Weddle reverted to the subject of attorneys' fees, asking Mr. Bennett to determine KPMG's obligations in that regard.*fn42 Ms. Neiman then said that "misconduct" should not or cannot "be rewarded" and referred to federal guidelines.*fn43

There is no dispute, and the Court finds, that this comment came immediately on the heels of a statement by Mr. Bennett relating to lawyers for KPMG partners.*fn44 There are disputes, however, about precisely what Ms. Neiman said about "guidelines" and what she meant by it.*fn45 The parties have focused in particular on whether Ms. Neiman intended her remark to be directed to the legal fee issue -- i.e., to be a statement to the effect that payment by KPMG of employee legal fees could be viewed as rewarding misconduct -- or to be directed instead at any severance arrangements between KPMG and Messrs. Stein, Eischeid, and Smith. Ms. Neiman testified that her intent was the latter.*fn46 But the Court finds it unnecessary to decide Ms. Neiman's subjective purpose in making the remark because what is more important is how her comment was understood.

As Ms. Neiman's remark came immediately after a statement concerning whether KPMG would be paying for lawyers for its personnel, it would have been quite natural to understand 15 the comment as having been directed at payment of legal fees. And that is exactly what happened:

* The IRS agent's handwritten notes, taken at the meeting, state: "BB - [illegible] Skadden may recommend lawyers for this. Wants lawyers who understand cooperation is the best way to go in this type of case.

He feels it is in the best interests of KPMG for its people to get attorneys that will cooperate with Go[vt]. Want to save the firm.

"Per SN

Fees -- under Federal ...


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