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Executive Summary #19 on Legal Issues

November 6, 2006

What We Have Here Is Failure to Cooperate: The Thompson Memorandumand Federal Prosecution of White-Collar Crime

By

A federal court in Manhattan issued two impor­tant rulings this summer that shed light on highly questionable and apparently unconstitutional poli­cies and practices that federal prosecutors have been using in their offensive against "white-collar" financial crime. In United States v. Stein, the De­partment of Justice is prosecuting former employ­ees of international accounting firm KPMG for their alleged wrongdoing in the firm's tax-shelter practice. Judge Lewis Kaplan of the U.S. District Court for the Southern District of New York con­cluded in two rulings this past June and July that federal prosecutors violated the Stein defendants' Fifth and Sixth Amendment rights by exerting un­due pressure upon KPMG to encourage its em­ployees to forgo their rights.

When KPMG first learned that the IRS had referred its investigation of KPMG to the Justice Department for possible prosecution, the firm essentially threw itself on the mercy of the prose­cutors, offering to do anything necessary to avoid indictment. KPMG had quickly concluded that a federal criminal indictment probably would destroy the firm-before a trial even started or a guilty verdict was returned-much as federal indictment alone had destroyed its powerful former competitor Arthur Andersen.

In accordance with Justice Department policies, a business organization might persuade federal prose­cutors not to indict if it scores well on a set of nine factors enumerated in Principles of Federal Prosecution of Business Organizations, a January 2003 memoran­dum by then-Deputy Attorney General Larry Thompson. Prominent among them is the business's willingness"to cooperate in the investigation" of its employees and other agents. Most of what is deemed cooperation is non-controversial. What has caused widespread concern, however, is the Thompson Memorandum's direction to prosecutors to consider (1) whether a business organization has declined to pay attorney fees for its "culpable employees and agents" and (2) whether the organization has waived its attorney‑client privilege and similar protections for confidential attorney work product.

It has become common practice for prosecutors, while avoiding express demands, to encourage a business to waive privilege and deny payment of attorney fees. Justice Department officials deny that practices like this exist, but Judge Kaplan's rulings tell a different story.

At its first meeting with prosecutors, KPMG's out­side counsel revealed that the firm would cooperate fully with the government in order to avoid indict­ment. Judge Kaplan determined that, from there, the federal prosecutors pressed their advantage with KPMG to so great an extent that they violated the defendants' constitutional rights. During the meet­ing, prosecutors repeatedly raised questions regard­ing whether KPMG intended to pay employees' legal fees. Prosecutors referred to the Thompson Memorandum and to "federal guidelines."

The message that KPMG understandably took away from this meeting is that it would be risking the prosecutors' displeasure and, more important, indict­ment if it adhered to its unbroken tradition of paying the full amount of its employees' legal fees. KPMG thus promised to cap payments for all employees and cut off payments altogether for employees the gov­ernment deemed to be uncooperative.

To put this proposal into effect, KPMG asked the federal prosecutors to notify the firm immediately whenever they found one of the firm's employees to be uncooperative. When KPMG received such notices, it would promptly send the employee a let­ter. The letter threatened to cut off all legal fees and strongly implied that the employee would be fired unless he began providing full cooperation to the government investigators.

As Judge Kaplan noted, it has become an impor­tant principle of American working life that "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." The cost and complexity of defending against most white-collar criminal charges is far greater than the cost of defending the typical traffic acci­dent or even medical malpractice case. An innocent employee who cannot pay for his own defense has almost no viable options other than pleading guilty in order to negotiate a less onerous sentence.

Similarly, the attorney-client privilege and attor­ney work-product protections are essential to maintaining the safeguards provided to Americans by the attorney-client relationship. Anglo‑Ameri­can law and society have for centuries believed that the privilege encourages and facilitates law-abiding conduct.

The KPMG investigation Judge Kaplan exam­ined in the Stein case provides compelling evi­dence that our federal justice system needs reform. The Justice Department has neither repudiated nor distanced itself from the prosecutors' conduct in the KPMG investigation.

Five specific reforms to the Department of Jus­tice's prosecutorial policies and practices stand out. The Justice Department should:

Eliminate consideration of whether a business organization waived its rights to maintain the confidentiality of privileged attorney-client communications and attorney work product when determining whether the business should be indicted;

Accept, but never request, privileged materials;

Not seek production of materials and informa­tion for which a business has asserted a privi­lege objection in response to a valid subpoena or other request unless the materials and infor­mation are not in fact privileged because they are being used to perpetrate a crime or fraud;

Collect and regularly publish, at least until the above recommendations are implemented, sta­tistics showing how often federal prosecutors request waivers, how often individuals and businesses agree to such requests, and how they waive privilege apart from any overt request; and

Eliminate any consideration of whether a busi­ness is paying employees' legal fees when deter­mining whether the organization will be indicted.

No one should doubt the dedication to profes­sional excellence and integrity of Justice Depart­ment prosecutors. Nor should anyone doubt the enormous pressure from the media, Congress, and the public to secure convictions in high-profile white-collar criminal cases. Nevertheless, prosecutors must withstand the temptation to eliminate or bypass impediments to successful prosecutions, including the attorney-client privi­lege and employer-funded legal defenses. To take the easier course is to exalt efficiency over jus­tice-to the ultimate detriment of all those whom the Department seeks to serve.

Brian W. Walsh is Senior Legal Research Fellow in the Center for Legal and Judicial Studies at The Heritage Foundation.

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