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Did federal prosecutors pressure KPMG L.L.P. to stop paying the legal fees of 16 indicted ex-employees? The defendants, who have been charged for their alleged roles in a tax shelter fraud at the accounting firm, say yes. And in a recent motion, they add that the coercion violated their constitutional right to counsel and their right to a fair trial. It’s the first time that the government has been challenged for asking corporations to stop fee payments. In hearings on the KPMG employees’ motion in May, prosecutors denied exerting any pressure, and maintained that it was the company’s decision to cut off the fees. KPMG’s deputy general counsel, who also testified at the hearing, said the same thing. But Judge Lewis Kaplan, who had yet to rule on the motion at press time, appeared skeptical of the government’s claim. However the issue is resolved, it will have a major impact on other corporate defendants. “These questions usually don’t get litigated, and usually don’t even see the light of day,” says William McLucas, a former enforcement director at the Securities and Exchange Commission. Now a partner at Wilmer Cutler Pickering Hale and Dorr, McLucas is representing four business groups (including the Association of Corporate Counsel) that filed an amicus brief in support of the KPMG defendants. The fee issue is also crucial for in-house lawyers. ACC president Frederick Krebs says that on the one hand, his members are expected by their company to cooperate with the government. On the other hand, Krebs says, “corporate counsel recognize that employees have a constitutional right to defend themselves.” Many companies have long covered the legal bills for workers who land in hot water for something they did as part of their job. According to the business groups’ amicus brief in the KPMG case, 48 of the nation’s 50 largest corporations cover fees for employees in trouble. (Many companies are required to do so by their bylaws.) But the business groups add in their brief that this practice has come under increasing attack from the government. The U.S. Department of Justice “coerces corporate counsel to withhold previously promised support for employees’ legal defense,” the groups maintain. The government exerts its alleged pressure through the so-called Thompson memo, which was written in 2003 by then � deputy attorney general Larry Thompson (now GC at PepsiCo, Inc.). This document outlines the factors that prosecutors can consider when deciding whether to file criminal charges against a company. One is whether the business has demonstrated its willingness to cooperate with the government in various ways, including by cutting off legal fees for “culpable” employees. Since the Thompson memo was issued, 23 companies have avoided criminal charges by striking a deferred prosecution or nonprosecution agreement with the Justice Department. It’s likely that the government pressed the fee issue with many, if not all, of those businesses, experts say. In the Justice Department’s view, the Thompson memo means only that a company may be rewarded if it stops footing its workers’ legal bills. Brian Roehrkasse, a spokesman at the department’s Washington headquarters, stresses that the memo doesn’t require legal fees to be cut off. However, the question of whether prosecutors merely appreciate a fee cutoff, or actually expect it, may be a moot point to businesses that feel they have to dodge prosecution at all costs. In the May hearings over the KPMG defendants’ motion, Judge Kaplan suggested that the firm couldn’t help but conclude from the Thompson memo that cutting off fees would help it avoid criminal charges. Assistant U.S. attorney Marc Weinstein said he disagreed “fundamentally” that the Thompson memo could have “in and of itself” dictated KPMG’s decision. “If that is true,” the judge shot back, “that is certainly not what [government lawyers] have said to the defense bar of America.” The KPMG case began unfolding in January 2004, when the giant New York � based accounting firm was told that it was under investigation for its promotion and sale of allegedly illegal tax shelters. Desperate to avoid an indictment, KPMG engaged in heated negotiations with the government, which resulted in a deferred prosecution agreement in August 2005. As part of the deal, KPMG agreed to “separate” wrongdoers from the company and to help prosecute them ["Mr. Clean," November 2005]. The U.S. attorney’s office in Manhattan subsequently indicted 16 company employees, as well as two outside tax lawyers and an investment adviser. All of the defendants, including former KPMG associate general counsel Steven Gremminger, have pled not guilty. The company has admitted in court that it always paid the legal fees of any employee or former employee involved in work-related litigation. KPMG also had a severance agreement with one defendant, ex � deputy chairman Jeffrey Stein, explicitly agreeing to cover his legal bills. Ultimately, however, the accounting firm stopped paying or capped the fees for all 16 indicted former employees. According to a defense brief citing prosecutors’ notes, the government first raised the fee issue during initial settlement talks with KPMG in February 2004. At that meeting, one prosecutor said that if the company had discretion about covering employees’ legal bills, “we’ll look at [what KPMG decides] under a microscope.” Another prosecutor added that under the Thompson memo, “misconduct cannot be rewarded” by paying legal fees. A few days after this meeting, KPMG deputy general counsel Joseph Loonan sent a memo to the company’s employees stating that it would pay fees only for those who “cooperated” with the government’s investigation, and that it would cap those fees at $400,000 per person. According to the defendants’ brief, the government approved KPMG’s plan as long as prosecutors could define what constituted cooperation. To illustrate how pressure was exerted on KPMG, the brief cites phone calls, letters, e-mails, and conversations among lawyers for the government, the company, and the defendants. The brief says that when one KPMG partner asserted his right to refuse an interview with prosecutors, he was labeled uncooperative. When another partner asserted her right to refuse to appear before a grand jury without her counsel, the government labeled her uncooperative too. In both cases, KPMG fired the employees and cut off their legal fees, the brief says. A KPMG spokesman declined comment for this story. At the May hearings on the defendants’ motion, however, deputy GC Loonan denied that prosecutors pressured KPMG to cut off the fees. But Loonan also admitted that “wanting to have the government believe we were cooperating with them” was one of the reasons the company stopped paying Stein’s legal fees. Erwin Chemerinsky, a Duke University professor and a noted author on constitutional law, says he believes that the Thompson memo does put pressure on companies like KPMG, and that it is unconstitutional. “The government may say that KPMG had a choice,” Chemerinsky says, “but that ignores the reality. The flaw in the government’s argument is that pressure can violate the Constitution just as much as an outright ban.” With additional reporting by Mark Hamblett

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