Another Perspective on KPMG and the Thompson Memo

It is always rewarding to The D & O Diary when a blog post provokes a thoughtful and interesting response. The D & O Diary's August 14, 2006 post about the Thompson Memo provoked a substantial response that is sufficiently interesting that we asked for and received the author's consent to reproduce the response in its entirety, as a guest post. The D & O Diary's first-ever guest blogger is John F. McCarrick, an attorney in the New York office of the Edwards Angell Palmer & Dodge law firm, and here is his guest post:

I enjoy reading your blog and wanted to comment on your post about the Thompson Memo. The reason this is of particular interest is because I have been working with several leading insurers for the past several months on a new legal expenses policy designed specifically to address this particular exposure. During the course of my research in connection with this project, here is what I concluded:

First, the employee legal expense advancement issue is not just a DOJ/Thompson Memo issue -- as would appear to be the case based on the American Bar Association and other advocacy groups' public statements about the evils of the Thompson Memo. The SEC employs similar strategies in its investigations based on the principles of the Seaboard report, and the NYAG applied this strategy in the Theodore Sihpol/Bank of America case to deny Sihpol legal expense advancement from BofA. Given the broader use of this strategy (note that the SEC initiates many more investigations each year than the DOJ does in this area), I find it interesting that no one is challenging the SEC or NYAG with the same intensity as in connection with the Thompson Memo criticisms.

One could look at the employee legal expense advancement issue as a balancing of two conflicting public policy concerns. The legitimate concern embodied in the Thompson Memo is that when a company under investigation employs a single counsel to represent its interests and those of all of its employees, such legal representation creates an opportunity for the company to improperly influence the cooperation of those of its employees being questioned in connection with the investigation. So, how can this be cured? Arguably, if the company hires separate counsel to represent its employees, the fact that the separate counsel has been retained by, and is being paid by, the company still creates an opportunity for improper influence of the employee's cooperation because the law firm and the employee recognize that the company is still paying the bills and therefore calling the strategic shots. Moreover, even if the employee goes out and hires his or her own counsel, the opportunity for improper influence remains because even though the company may no longer be calling the strategic shots, it still is paying the bills and
has some overt or subtle expectations about what it expects in terms of the employee's cooperation with the company in the investigation.

The counterweight public policy concern is that employees being questioned in connection with corporate white collar crime cases should have the benefit of competent counsel, given the personal implications involved if the government does not believe the employee is being fully truthful, regardless whether the employee has any culpability in connection with the underlying issues being investigated. Thus, even though 6th Amendment rights to counsel don't come into play until indictment, in practice, invocations of the Thompson Memo frequently occur at an early ( i.e., pre-indictment) stage of the investigation, and before an employee has a constitutional right to counsel.

With respect to your blog, I don't think it's correct to say that Judge Kaplan found portions of the Thompson Memo to be unconstitutional. To the extent there were right to counsel (post-indictment only) or due process (possibly pre- and post-indictment) violations, Judge Kaplan found that the actions of the government in furtherance of the Thompson Memo constituted unconstitutional conduct. Accordingly, I think one could reasonably argue (as the DOJ currently is arguing) that the Thompson Memo itself is not subject to challenge on constitutionality grounds, meaning that had the government acted in a less overt or threatening way in connection with a particular investigation, it nevertheless could have evaluated the company's cooperation (for indictment purposes) by looking at, among other things, whether the company was advancing legal expenses to employees.

Also, the invocation of the Thompson Memo in the KPMG case took place after the individuals were indicted. This is an important fact because there is no Sixth Amendment right to counsel prior to indictment. Thus, to the extent Judge Kaplan determined that a constitutional breach had occurred, such breach occurred with respect to the Sixth Amendment and therefore, constituted post-indictment conduct by the government. This is significant because the trigger for coverage under D&O policies (even the broader Side A DIC policies) is an indictment; meaning that if the Thompson Memo is invoked with respect to an employee pre-indictment, D&O coverage would not respond to pay for that employee's legal expenses.

Finally, D&O policies typically require that a "wrongful act" be alleged against a covered person in connection with a "claim" in order for coverage to be triggered. However, as a practical matter, invocations of the Thompson Memo occur most frequently pre-indictment (of the person or insured entity), and the government generally does not identify wrongful acts by the targeted employees when it insists that the company cease advancing legal expenses for that employee.

McCarrick is of course correct about Judge Kaplan's decision about the constitutionality of the Thompson memo; it was not the memo itself that was declared unconstitutional but the way the government had implemented it in the KPMG tax shelters case. He also makes a very good point about the policies of the SEC and the NYAG which also could have the effect of discouraging companies from funding employees' defense fees. His distinction between pre-indictment and post-indictment expenses (and constitutional rights) is important.

Option Backdating Litigation List Update: The D & O Diary updated its list of options backdating litigation on August 15, 2005, to add the new securities class action lawsuit that has been filed against Witness Systems. This brings the number of options timing securities fraud lawsuits to 13. The D & O Diary notes that the Witness Systems lawsuit, and the lawsuit filed most recently prior to that one, which was filed against Broadcom, were filed by firms that are best known for work in asbestos and tobacco class action litigation -- the Witness Systems case was filed by the Motley Rice law firm, and the Broadcom case was filed by the Kahn Gauthier and Swick firm. Perhaps the Milberg Weiss firm's misfortune is attracting opportunistic competition from other segments of the plaintiffs' bar.

You Tube Interlude: On the theory that anything that was the subject of a Wall Street Journal article (subscription required) is a suitable post topic for this blog, The D & O Diary offers this pop culture interlude. Readers who stay up later on Saturday nights than does The D & O Diary are probably already familiar with the "Lazy Sunday" video (also known as "The Chronicals of Narnia Rap"), mentioned in the Journal article. Here is a link for those for whom, like The D & O Diary, Saturday Night Live broadcasts occur two hours post-bedtime. The Lazy Sunday video spawned numerous spoofs. The D & O Diary's favorite spoof is the "Lazy Sunday UK" version (also known as "We Drink Tea Rap") which may be found here. Warning, turn the sound on your computer down before launching.