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The 2D U.S. Circuit Court of Appeals has ruled that a federal judge lacks the power to hear claims by indicted former KPMG executives that the accounting giant must pay for their defense in a massive criminal tax-shelter prosecution. Stein v. KPMG, No. 06-4358-cv. Judge Lewis A. Kaplan of the U.S. District Court for the Southern District of New York, who is handling the criminal case, last year ruled that the government had used the threat of prosecution of the company to pressure it into cutting off payment of the defendants’ legal fees, thereby violating their rights to a fair trial and effective assistance of counsel. Kaplan criticized the government’s reliance on the so-called Thompson Memorandum, which set out standards to be followed by federal prosecutors in deciding whether to bring prosecutions against companies. Kaplan invited the KPMG defendants to file civil actions, and denied KPMG’s motion to dismiss. KPMG ultimately was rewarded for its cooperation with the government in January when charges against the company were dropped pursuant to a nonprosecution agreement. Kaplan claimed ancillary jurisdiction over the fees issue, encouraging KPMG defendants to file civil claims to remedy what he regarded as constitutional violations. The 2d Circuit took the unusual step of granting a writ of mandamus to compel Kaplan to vacate his order. “The district judge is not a party and, by granting the writ, we avoid an unnecessary, potentially costly, and time-consuming procedure that would certainly be vacated on appeal,” Judge Ralph K. Winter wrote on behalf of the court. “The prejudice to KPMG in having these claims resolved in a proceeding ancillary to a criminal prosecution in the Southern District of New York is clear,” he wrote. The circuit also took issue with Kaplan’s interpretation of the defendants’ claims that KPMG had a history of paying the fees of employees facing criminal investigation and charges. The sole instance in which KPMG paid legal fees in the past was for two partners indicted and convicted in a 1974 case. Most of the employees in the criminal case before Kaplan “as a condition of having their pre-indictment legal fees paid by KPMG” signed letters “acknowledging that KPMG would not pay post-indictment fees and . . . waived any right to such fees.” The Thompson memo gave no “weight to payments required by contract. As a result the constitutional issues before the district court went solely to what pressure the government put on KPMG not to pay fees voluntarily and to what KPMG’s response was,” Winter said. Given that it was conceivable that the government could exert pressure on a firm to break even a contractual promise to pay fees, it was possible that an ancillary proceeding would not “render any constitutional violation harmless,” the court said. The remedies available to the district court in the circumstances here “did not include its novel exercise of ancillary jurisdiction.” The ruling means that the defendants must now file their claims for fees in state court or, as KPMG argues, pursue arbitration. But the decision leaves Kaplan free to consider other remedies for any misconduct by the government, including dismissal of the indictment.

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