Opinion: Unethical conduct costs government in prosecutions

Federal prosecutors have been threatening corporations under investigation with criminal indictments unless the corporations pressure their employees to cooperate in the investigations. At prosecutors’ insistence, corporations threaten to stop indemnifying employees for legal expenses unless they cooperate.

The KPMG story

Prosecutors used those tactics against accounting firm KPMG. Recently, a federal judge dismissed charges against 13 former KPMG partners and employees because of the government’s coercive tactics.

In the late 1990s, KPMG created and sold aggressive tax shelters, some of which created paper losses on foreign currencies. Wealthy individuals bought the shelters to offset taxable gains without putting any money at risk.

The U.S. Department of Justice declared the tax shelters illegal and said they had cost the government $2.5 billion in unpaid taxes. KPMG denied any wrongdoing and vowed to vigorously defend the company, as well as current and past personnel who prepared the shelters. The company urged those under investigation to fight any charges of wrongdoing, and, as was KPMG’s practice, indemnified them for their legal expenses.

In 2005, prosecutors threatened to indict KPMG over the tax shelters. Knowing that a criminal indictment destroyed the Arthur Andersen accounting firm, KPMG sought to cut a deal with federal prosecutors.

In exchange for a deferred prosecution, KPMG agreed to take full responsibility for the illegal tax shelters and to pay a $456 million penalty. The company also agreed to change its practice of indemnifying current and former personnel for legal expenses. KPMG’s management released a memo stating the company would not pay the legal expenses of any person who refused to cooperate fully with government investigators. KPMG capped paying the legal expenses of any person under investigation at $400,000. Also, all indemnification for legal fees ended if a person was indicted.

Eventually, the government indicted some KPMG former partners and employees for conspiracy, fraud and tax evasion. Following its deferred prosecution agreement, KPMG immediately stopped paying the legal expenses of those persons indicted.

The defendants moved for dismissal of the charges against them, arguing that the government’s interference with KPMG’s indemnification policy violated the Fifth and Sixth amendments.

In a scathing opinion, Judge Lewis A. Kaplan of the district court in Manhattan ruled for the defendants. On the defendants’ Fifth Amendment rights, Kaplan found that some defendants gave statements to government investigators they would not have given except for the fear of not having their legal expenses paid. Some gave statements without the benefit of counsel. As a result, the government violated the defendants’ rights to substantive due process and a fair trial.

In ruling the government violated the defendants’ Sixth Amendment rights, the court noted that employers often reimburse employees for legal expenses incurred because of their jobs. Kaplan stated, “Persons in jobs big and small, private and public, rely on it (reimbursement) every day.” It is difficult to hire and keep good employees unless employers protect them against expensive legal actions arising out of doing their jobs.

The court commented on the high costs of defending complex criminal business cases and the need for access to substantial financial resources. KPMG defendants already had incurred legal expenses ranging from $500,000 to $3.6 million. The court estimated the expected defendants’ total legal costs would range between $7 million and $24 million.

‘Outrageous’ conduct

The court found that KPMG always paid its personnel’s legal expenses, regardless of the costs and regardless of indictments. The defendants had every reason to expect KPMG to indemnify them for all their legal expenses and the company would have done so, except for the government’s interference.

Under the Sixth Amendment, defendants have the right to obtain and use all available resources to select the counsel of their choice, free of knowing or reckless government interference. Selecting a particular attorney is critical to the type of defense a defendant makes and falls within the ambit of the Sixth Amendment.

In dismissing the charges against the 13 defendants, the court called the government’s conduct outrageous. The case reminds prosecutors to behave ethically. The government cannot both prosecute a defendant and seek to influence the manner in which she or he defends the case.

John D. Copeland, J.D., LL.M., Ed.D., is an executive in residence at The Soderquist Center for Leadership and Ethics and professor of business at John Brown University in Arkansas.