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Bar News - January 5, 2007

NH Court Possible Catalyst for USDOJ Reversal on Fee Advancements


Major changes to US Department of Justice guidelines regarding the prosecution of business organizations demonstrate once again the far-reaching influence of the Federal District of New Hampshire on matters of public policy. On Dec. 12, 2006, Deputy Attorney General Paul J. McNulty announced a sea-change in the USDOJ’s approach to the prosecution of white-collar crime. “Prosecutors,” he stated in a memorandum addressed to all US Attorneys, “should not take into account whether a corporation is advancing attorneys’ fees to employees or agents under investigation and indictment” when determining whether to charge a corporation with a federal crime [emphasis added]. (Find Web link to the McNulty Memorandum in sidebar.)


McNulty’s announcement constitutes a reversal of the USDOJ’s much-criticized prior policy, set forth in the now infamous Thompson Memorandum of Jan. 20, 2003, which required prosecutors to consider a corporation’s decision to advance legal fees to “culpable” employees in making charging decisions (see sidebar). Among the first to express concern with this policy was federal District Judge Paul Barbadoro, who suggested in the course of the government’s prosecution of the technology firm Enterasys that its fee advancement policy could violate a criminal defendant’s Sixth Amendment right to counsel. As this paper seeks to demonstrate, his statements have proven prophetic and presaged the policy’s ultimate demise.


The Thompson Memorandum and Corporate Cooperation


The Thompson Memorandum, formally titled “Principles of Federal Prosecution of Business Organizations,” was issued by Deputy Attorney General Larry Thompson in the wake of Enron and other financial institution scandals. Its purpose was to provide federal prosecutors with updated guidelines regarding when and whether to seek charges against business organizations suspected of violating federal criminal law.


Generally speaking, it required the government to use many of the aggressive tactics commonly associated with its prosecution of drug dealers and organized crime against individual white-collar defendants and their corporate employers.


One of the chief features of the Thompson Memorandum is that it required prosecutors to deem a suspected company’s failure to cooperate with a government investigation as a strike against the company when determining whether to seek an indictment. Companies that waived the attorney-client privilege and the work product doctrine, and who further made their employees available to the government for interviews, were thus more likely to be granted a coveted non-prosecution agreement than those who did not. Companies who advanced fees to an otherwise undefined set of “culpable employees,” however, would be deemed “uncooperative” unless they were required to do so by governing state law.


Arrangements regarding the advancement of legal defense fees are not uncommon among corporations and their employees. Many companies promise to pay their employees’ legal fees as bills accrue over the course of a government investigation as part of an effort to attract employees to higher-risk positions. Such agreements are made out of recognition that employees could not otherwise afford the often crushing costs of legal representation themselves, even where an employer has promised to reimburse the employee once the investigation has terminated. Under the Thompson Memorandum, a company that opted to advance fees to employees in this manner jeopardized its chances of obtaining prosecutorial clemency and the attendant reprieve from corporate-death that some indictments entailed for large companies in the past. This often left employees with little or no ability to fund their own defense.


The early effects of this policy were starkly displayed in a number of high-profile federal prosecutions. During the government’s investigation of HealthSouth Corporation for accounting fraud in 2004, prosecutors informed HealthSouth that payment of fees to indicted executives would be viewed as uncooperative under the Thompson Memorandum. HealthSouth subsequently cut off fees to its former CEO Richard Scrushy who was also under investigation.


The government used the same tactic to similar effect in its investigation of Symbol Technologies, Inc., pressuring the company to withhold fees to indicted executives so as not to appear uncooperative. It was only after Symbol Technologies convinced the government that it was required to advance fees under its corporate bylaws that the government relented.


NH Judge Expresses Concern


In a March 7, 2006 hearing, Barbadoro, became the first judge to publicly express concern over the government’s practices in these cases. Before him were motions in the government’s prosecution of former employees of the New Hampshire technology firm, Enterasys. The former Enterasys employees argued that the government had interfered with their Sixth Amendment right to counsel by pressuring the corporation to discontinue advancing legal defense fees—fees which they claimed they were entitled to under Delaware law. When called to testify, the Assistant US Attorney in the case confirmed that he had told Enterasys that “the payment of attorneys’ fees for defendants was something the Department of Justice had instructed its line prosecutors to consider” when determining whether a corporation should be prosecuted or not (See United States v. Gagalis, 04-CR-126-01/06-PB, Mar. 7, 2006).


From the bench, Barbadoro responded that this type of pressure could “violate the defendant’s [sic] Sixth Amendment right to have counsel of their choice because it could be deemed an attempt to prevent a defendant from using money to which it has a property right.” (See Gagalis.) He distinguished two drug-related cases in which the Supreme Court had upheld federal forfeiture statutes on the ground that those cases involved property to which the criminal defendants in the case had no rights. He pointed out that in the Enterasys case the property right to fee advancements arguably existed under Delaware law.


Seeing the writing on the wall, the US Attorney’s office promptly notified Enterasys that it would not view the advancement of fees as a sign of non-cooperation, and Enterasys, in turn, promised on the record that it would begin advancing fees to its indicted employees once again. The constitutional challenge raised by the Enterasys employees was therefore mooted, but not before Barbadoro instructed the government “to focus [on] building its case against the defendants” rather than “on the defendant’s [sic] preparing their defense.”


NYJudge Takes Next Step


The warning was not heeded by prosecutors in the Southern District of New York, who invoked the Thompson Memorandum to pressure the accounting firm KPMG to cap legal defense fees at $400,000 for individual employees charged with defrauding the government through abusive tax-shelters. Defendants in the case argued that by interfering with the their ability to receive legal fees, the government violated their Fifth Amendment right to due process, and their Sixth Amendment right to counsel.


In a lengthy opinion, Federal District Judge Lewis A. Kaplan, Southern District of New York, agreed (United States v. Stein, 2006 U.S. Dist. LEXIS 42915, *146 (S.D.N.Y. June 26, 2006)). The judge ruled that the Fifth and Sixth Amendments protect a defendant’s right “to obtain and use in order to prepare a defense resources lawfully available to [the defendant], free of knowing and reckless government interference.” He also ruled that fee advancements are often “as much a part of the bargain between employer and employee as a salary or wages,” and that the payment of such fees are particularly crucial in the context of a white collar criminal prosecution, where the costs of effective representation can be financially crushing.


Others Chime In


In the wake of Judge Kaplan’s decision, multiple voices called for the policy’s outright repeal. The American Bar Association House of Delegates and the New York State Bar Association passed a joint resolution seeking to prohibit the government from holding the advancement of fees against companies under investigation, and in mid-September, Karen J. Mathis, the president of the ABA, testified before the Senate Judiciary Committee that the policy “[stood] the presumption of innocence on its head” and “overturns well-established corporate governance practices.”


Senators Arlen Specter (R-PA) and Patrick Leahy (D-Vt.) issued statements agreeing with this position, as did former Attorney General Edwin Meese, and on Dec. 7, 2006, Specter introduced the Attorney-Client Privilege Protect Act, which states that “[i]n any Federal investigation . . . the United States shall not . . condition a civil or criminal charging decision relating to an organization . . . on . . .the provision of counsel to, or contribution to the legal defense or expense of, an employee of that organization.” (See 152 Cong. Rec. S11438, 39).


Five days later, the USDOJ issued a new policy forbidding federal prosecutors from considering the decision to advance fees to employees under investigation except in the “extremely rare case” where the “totality of the circumstances show that it was intended to impede a criminal investigation.” (See McNulty Memorandum.) Even under those circumstances, however, permission to consider this factor must be sought from the Deputy Attorney General himself.




While on the surface the USDOJ’s recent change in policy signals a positive shift in favor of maintaining some balance between the resources available to the government and those available to individuals, it remains to be seen whether the change will have a substantive effect on federal investigations, or whether prosecutors will continue to negatively view legal fee advancements sub rosa. There is little question, however, that in identifying the policy problems arising from prior government practice, Judge Barbadoro was out in front of the rest of the legal community. Indeed, that his concerns were embraced by many others, and that those concerns ultimately led to a change in policy, suggest that the judge may be properly credited as a catalyst for the change. Even if this is an overstatement, civil libertarians and the defense bar owe him a debt of gratitude.


Michael S. Lewis has been a member of the NH Bar since 2004. He is a former law clerk to Federal District Judge Paul Barbadoro and is currently a litigator at Arnold & Porter in Washington, DC. He is also the co-author, with Irvin B. Nathan, of “The Thompson Memo Ruling:  Recent Decisions May Have Little Effect on Other Cases,” Business Crimes Bulletin (October 2006).



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