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On June 27 a federal district court struck down the Department of Justice’s efforts to cut off the corporate advancement of attorney fees to former KPMG employees. But in-house lawyers, including those at private and nonprofit entities such as hospitals, should not relax quite yet. The Justice Department remains committed to its position, and as other cases show, in-house counsel still face the risk of paying their own legal fees in a government investigation. What can in-house counsel do? Traditional directors-and-officers liability policies may not cover in-house lawyers in these situations — something corporate counsel should know in advance — but employed-lawyers professional-liability insurance is also on the market. More important, certain best practices can help in-house lawyers minimize their risk of winding up in trouble. LAWYERS ON THE HOOK Although much has been written about the evolving role of in-house counsel for publicly traded companies, less attention has been directed to the changing role of in-house counsel for private companies or nonprofit organizations. Nevertheless, such lawyers face similar exposures to those confronted by their counterparts at public companies. Counsel at private companies or nonprofits also can face claims lodged by their corporate employer, other employees, third parties, and regulators. Cases against lawyers for private companies and nonprofit organizations are growing in number. In part, this is because of judicial recognition of in-house lawyers’ duties to nonclients. Such a finding is especially likely in situations in which the nonclient is a foreseeable beneficiary of the services performed by another entity’s lawyer or the courts conclude that the nonclient should be allowed to rely on another entity’s lawyer for equitable reasons. By way of example, a health care entity seeking to sell off certain assets provided the due diligence conducted by its general counsel to a potential purchaser, who ultimately consummated the deal. Later, the purchaser believed that it had bought a lemon and brought an action for negligence and legal malpractice against the seller’s general counsel. The matter settled to the benefit of the purchaser, because it had compelling arguments about detrimental reliance. A brief review of two cases illustrates the scope of exposure that in-house lawyers have confronted. In Pereira v. Cogan (2003), a case in the U.S. District Court for the Southern District of New York, the general counsel of Trace International Holdings was held liable for matters involving improprieties by others about which he knew nothing. Nonetheless, the court ruled that the general counsel of a corporation must advise the board of directors of its duties and assist the board in meeting its obligations. In essence, the general counsel must become the chief governance officer of the privately held company. On appeal, the decision of the lower court against the general counsel was vacated by the U.S. Court of Appeals for the 2nd Circuit, and the case was remanded for a jury trial, now scheduled for October 2006. Another eye-opening case, which reportedly involved a decision not to provide legal fees, arose after a 2004 deferred-prosecution agreement between the United States and the University of Medicine and Dentistry of New Jersey. The case resulted from a hospital’s failure to comply with certain billing rules. The United States alleged that in May 2001 a hospital employee discovered that the hospital was billing Medicaid incorrectly. The university’s legal department was promptly notified, and it retained outside counsel to address the billing problem. From July to December 2001 the outside law firm issued three drafts and a final opinion on the billing issue. In the first two drafts, the law firm concluded that the hospital had to disclose the billing problem to the government. In the final opinion, the law firm advised that the inappropriate billing should stop. The billing continued, and disclosure was not made to the government until 2004. The government thereupon alleged that the university knowingly and willfully submitted numerous false claims to Medicaid and received improper reimbursements of at least $4.9 million. The government deferred prosecution upon the university’s agreement to a federal monitor. Among the monitor’s many responsibilities is the hiring of a new general counsel. In addition, the university agreed to waive the attorney-client privilege and work-product privilege and to fully cooperate with the ongoing investigation. The investigation was focused on, among others, current and former university lawyers. It has been reported that the university refused to advance attorney fees to these lawyers. The reasons for refusing to do so have not been reported. It is unknown whether the university’s decision not to advance attorney fees would have been different had it been made after the KPMG case. This ruling, by Judge Lewis Kaplan on June 27 in United States v. Jeffrey Stein (2006), involves indicted ex-KPMG employees. Kaplan found that the Justice Department had violated the defendants’ substantive due process rights, their Sixth Amendment right to counsel, and their Fifth Amendment right to a fair trial by inducing KPMG to cut off the advancement of attorney fees — in violation of KPMG’s own indemnification policy. Kaplan focused on a Justice Department policy known as the Thompson memo, which requires prosecutors to consider whether KPMG was “protecting its culpable employees and agents . . . through advancement of attorneys fees.” The statements of government officials during negotiations reinforced KPMG’s view that it would substantially increase its risk of indictment if it followed its existing indemnification policy. Consequently, KPMG changed this policy to eliminate advancement of legal fees to anyone who did not fully cooperate with the government’s investigation and to anyone who had been indicted. Kaplan found that KPMG refused to advance legal fees for the defendants “because the government held the proverbial gun to its head.” On the day the ruling was issued, a Justice Department spokesman observed that no other court had rendered such a decision and confirmed that “the department remains committed to the principles set out in the Thompson memorandum.” D&O MAY NOT SAVE YOU Thus lawyers face increased exposure at a time when their employers or former employers may be unwilling or unable to advance legal fees. Can insurance policies fill the gaps? The intent of directors-and-officers liability insurance (commonly known as D&O insurance) is to provide insurance coverage to directors and officers for their negligent acts, errors, or omissions in the running of the corporation or nonprofit organization. If in-house counsel is acting within his capacity as an officer of the entity, therefore, D&O insurance should provide coverage for any claims that arise. If coverage is expanded under the D&O policy to include all employees, as is the case for many health care and nonprofit D&O policies, even those in-house counsel who are neither directors nor officers are eligible for coverage. Leading D&O insurers, however, warn that claims containing allegations of legal malpractice or negligence in rendering legal advice do not fall within the coverage provided. Further, many D&O policies contain professional-services exclusions that preclude coverage for legal services. In addition, certain insurers advise that they will provide coverage only to the general counsel of the named parent corporation for all work, legal or otherwise, performed on behalf of the corporation or nonprofit organization. No other attorneys, including general counsels of subsidiaries, are entitled to this scope of coverage. Other insurers say they will review the totality of circumstances surrounding the allegations in determining coverage. D&O insurers specifically advise that it is not their intent to provide coverage for claims arising from a wide variety of activities performed by lawyers. These legal activities include rendering formal or casual legal opinions, managing litigation (including exhibiting “bad faith” when litigating), reviewing or drafting legal documents upon which a third party relies, providing legal services to employees in connection with employment termination or corporate restructuring, approving contracts with vendors or clients, reviewing literature published by the company, and creating press releases or giving interviews in the lawyers’ capacity as in-house counsel. In short, a D&O policy might not cover claims arising from much, if not most, of what in-house lawyers typically do. LEGAL INSURANCE If D&O insurance won’t cover many in-house lawyers, another form of insurance might. Employed-lawyers professional-liability insurance is designed to provide insurance coverage for claims of legal malpractice that arise from the legal work performed on behalf of the corporation or nonprofit organization by in-house lawyers and their support staff. This once-sleepy product line has gained momentum following the passage of Section 307 of the Sarbanes-Oxley Act of 2002 and inquiries and investigations into nonprofits by the House Ways and Means Committee, the Senate Finance Committee, and the Internal Revenue Service. Employed-lawyers insurance typically covers defense costs for claims brought by the employer. It may also cover claims by regulators, including investigations, depending upon the terms of the policy. It also covers third-party claims alleging legal malpractice, claims arising out of “moonlighting” activities or pro bono work performed at the direction of the corporate employer, and claims brought by employees whom in-house counsel have represented. Claims or expenses that are not covered by this insurance generally include fines and penalties; the return of fees, expenses, costs, or other disgorgement; the costs of complying with injunctive or nonmonetary relief; and the costs associated with fraudulent acts, dishonest or criminal acts, and the intentional violation of laws. AVOIDING TROUBLE To stay on the right side of the road, in-house lawyers in all industry sectors need to remember that the duty owed is to the entity and not to any one individual. Further, in-house counsel should not ignore possible wrongdoing by the entity or any of its employees. Accept responsibility for ensuring that the entity makes meaningful financial disclosures regarding material transactions. Scrutinize transactions that potentially expose the entity to increased liability, especially those with insiders or those that may involve a conflict of interest. Make certain that material transactions are reviewed and approved in accordance with established procedures. Alert management and the board of directors to all relevant factors underlying a decision to proceed with a certain course of action that may pose heightened risks. Advise management and the board where appropriate of the possible consequences of a mistake in judgment. These steps can help keep in-house lawyers out of trouble. But in case trouble ever comes, in-house lawyers also would be well advised to learn about their insurance. Know the employer’s indemnification policies, the laws that govern such policies, and the insurance coverage that the employer has, lacks, or may be willing to purchase.
Susan F. Friedman is a senior vice president at Marsh, an insurance broker, where she heads the practice group of employed-lawyers-insurance products. Hope S. Foster is a partner in the D.C. office of Mintz Levin Cohn Ferris Glovsky and Popeo, where she specializes in health care services.

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