Legal Hazard: Corporate Crime, Advancement of Executives' Defense Costs, and the Federal Courts (Part II)
Vol. 7
December 2006
Page
III. FEDERAL RESPONSES TO THE UNDERENFORCEMENT PROBLEM
The foregoing discussion demonstrates that corporate practices of indemnification and advancement of legal fees can exacerbate problems of corporate culture that promote overreaching by some executives. Signaling a decisive turn from the legacy of underenforcement, the Department of Justice has relatively recently begun to focus on the problems of corporate culture that give rise to criminal conduct. A core aspect of this Department of Justice effort is holding corporations accountable as culpable agents on an organizational level, through respondeat superior standards.
Respondeat superior liability developed to promote organizational accountability. Since a corporation was a collective entity that acted through agents, without special legal provisions a corporation could escape accountability by arguing that its agents were engaging in activity beyond the corporation's knowledge. Proving that the board of directors, the highest authority in the corporation, expressly approved of a corporate official's illegal acts would impose a virtually impossible burden on plaintiffs in civil suits or on the government in a criminal prosecution. To address this gap between corporate conduct and available remedies, respondeat superior liability evolved. To prevail on a respondeat superior theory, the government in a criminal case must demonstrate that agents of the corporation acted within the scope of their employment, and acted with the intent of benefiting the corporation.[127]
The virtue of this respondeat superior theory is that the corporation can no longer readily disavow the misconduct of its agents. Instead, the corporation has an incentive to more carefully monitor the conduct of all of its agents and to ensure that the agents' conduct conforms to law. Moreover, the corporation, through its senior managers, is in the best position to create internal organizational norms, both formal and informal, that achieve this result.[128] While vicarious liability - holding one person or entity responsible for the acts of another - may seem to leave a residue of unfairness in the context of criminal law,[129] at this late date in the development of the doctrine, executives who tolerate wrongdoing on their watch can hardly claim surprise. Nor can executives who, as recent juries found in cases such as Enron and WorldCom, engage in fraud. Indeed, the only party with a legitimate complaint is the hapless shareholder, who has little control over the entity, but bears the cost if the corporation is subject to prosecution. The externalities visited on shareholders, however, demonstrate most clearly the importance of aligning management's interests with shareholders' interests through reforms of corporate governance, greater transparency regarding executives' compensation and other factors that maximize agency costs. By encouraging this process, the prospect of respondeat superior liability can contribute to the reform of corporate culture.[130]
In the criminal context, the government has recognized that liability should hinge on the pervasiveness of violations within the entity.[131] The corporate rank of the officials committing misconduct should also be taken into account: more senior officials' misconduct will tend to prove that the inappropriate acts were more pervasive throughout the entity.[132] A corporate criminal case therefore turns on the nature of corporate culture: where factors such as agency costs and moral hazard create an organizational climate conducive to wrongdoing, it is appropriate for the government to consider criminal prosecution.
However, prosecutors may also take into account a range of factors, including the corporation's cooperation with the investigation,[133] its record of compliance with prior government enforcement actions,[134] and the sincerity of its commitment to institutional change.[135] The Thompson Memorandum suggests that prosecutors assessing cooperation and a commitment to change can consider, inter alia, the corporation's willingness to waive attorney-client privilege,[136] its subsidy of executives' legal fees,[137] and its overall treatment of managers who have engaged in wrongdoing.[138] Where these countervailing factors warrant, prosecutors should pursue alternatives to indictment, including entering into a Deferred Prosecution Agreement (DPA) with the company.
IV. UNDERENFORCEMENT'S REVENGE: THE KPMG CASE
Since efforts to shift the status quo often meet with resistance, it is not surprising that the government's effort to end the underenforcement paradigm has encountered serious obstacles. The organized bar and academic commentators have expressed concerns about the fairness of vicarious liability in criminal law,[139] the sometimes unpredictable expansion of coverage of white-collar conduct under federal criminal statutes,[140] and the efficacy of attempts to reform corporate culture through criminal law processes.[141] In United States v. Stein, one court has joined the critics, focusing on the Thompson Memorandum's consequences for individual defendants, in a case related to conceded criminal activity by KPMG, one of the nation's leading accounting firms.[142] Unfortunately, the Stein court got things seriously wrong.
In Stein III, the court held that the Department of Justice's inclusion of concern about payment of attorney's fees, as merely one component in the government's decision about whether to enter into a DPA with a corporation, violated the Fifth and Sixth Amendments.[143] Because of this holding, in Stein IV the court suppressed statements made by two individual defendants.[144] Moreover, the court exercised ancillary jurisdiction over the fee dispute between the individual defendants and the company despite the presence of distinct facts and difficult questions of state law that would usually counsel against supplemental federal jurisdiction.[145] While the decision received significant publicity, its failures of analysis make it a dangerous precedent that will increase agency costs and moral hazard for owners of business organizations, and reduce the government's ability to combat stonewalling of investigations that is disfavored under both the legal ethics rules and substantive law.
a. KPMG's Criminal Activity, the Government's Investigation, and the Court's Decisions
The facts underlying the KPMG case form a textbook example of organizational misconduct and its aftermath. KPMG and the United States Department of Justice entered into a DPA in 2005 in which KPMG acknowledged extensive criminal conduct concerning the marketing of tax shelters and the representations it made to the Internal Revenue Service (IRS) and others concerning the operation of those shelters.[146] In the DPA, which KPMG agreed to over three years after the IRS commenced an investigation of KPMG's tax shelter practices,[147] KPMG admitted that its criminal conduct was "deliberatively approved and perpetrated at the highest levels of KPMG's tax management, and involved dozens of KPMG partners and personnel."[148]
While the short-term focus on marketing tax shelter schemes landed KPMG in hot water, KPMG exacerbated its plight by stonewalling investigators. KPMG entered into the DPA after pursuing a course for an extended period during the investigation that involved "steps… designed to hide its tax shelter activities."[149] Prior to entry into the DPA, KPMG asked a number of senior managers to leave the firm, including Jeffrey Stein, the deputy chair and chief operating officer.[150] After a "very friendly"[151] negotiation with the chair of the company, Stein received a "very generous"[152] severance package that included a three-year consulting agreement that would pay Stein $100,000 per month. The agreement also provided a subsidy for Stein's defense costs.[153] Although this lucrative agreement was concluded by the middle of 2004, the judge noted that "only recently" did KPMG reveal its terms to the government or the court.[154].
Subsequently, Stein and a number of other KPMG executives, partners, and employees were indicted on charges of tax fraud. KPMG and the Justice Department had discussions which alluded to the question of severance packages and advancement of attorney's fees. During these discussions, prosecutors warned KPMG that "wrongdoers shouldn't be rewarded."[155] One prosecutor remarked that the government would carefully scrutinize any claim that KPMG had a legal obligation to advance legal fees to individual defendants.[156]
KPMG subsequently stated that it would cap attorney's fees advanced to all employees involved in the investigation, and cut off such fees for present and former employees who refused to cooperate. Although KPMG had agreed to cap its fees for all personnel at $400,000, KPMG paid Stein almost $650,000 to reimburse him for his lawyer's fees without informing the government.[157] Evidence in the record suggested that the remaining KPMG partners were disturbed that Stein had received a better severance deal than many other KPMG personnel, and that his deal might reflect a broader mishandling of the response to the government's investigation.[158] Other defendants did not have express severance agreements that covered attorney's fees and apparently did not have insurance that would reimburse these costs.[159] However, at least one of these defendants still retained substantial assets. The court found that this defendant was a flight risk who should be denied bail because he had $20 million in available assets, much of which he had concealed through a tangled web of financial transactions for the apparent purpose of thwarting plaintiffs in civil suits.[160]
Analyzing this situation, the court made two significant rulings. First, it found in June 2006, that the existence of the Thompson Memorandum and references to the Memorandum by prosecutors in the case had pressured KPMG to cap or deny fees to the individual defendants. The court held that this pressure violated the Fifth and Sixth Amendments. In its decision, which the media and some commentators asserted was a broad rebuke to the government's approach to corporate criminal prosecutions, the court also exercised ancillary jurisdiction over claims for the advancement of legal fees made by the individual defendants against KPMG and suggested, without deciding, that the defendants might prevail on this point with an implied contract theory. Second, in July 2006, the court held that KPMG had acted as the government's agent in conditioning advancement of attorney's fees and one defendant's continued employment on cooperation with prosecutors.[161] Accordingly, the court suppressed as involuntary under the Fifth Amendment the statements made by two individual defendants in proffer sessions with the government.
b. Stein and the Constitutionalization of Agency Costs
The Stein decisions dovetail neatly with the crescendo of indignation about the Thompson Memorandum expressed by commentators and defenders of the status quo. Unfortunately, the Stein court's reasoning does not withstand careful analysis of the problems posed by unlimited subsidy of legal fees for executives in criminal cases. Indeed, the facts in Stein amount to a cautionary tale about the intractability of those problems.
First, Stein amply illustrates the basis for the concern regarding "factor payments" that underlies RICO and legal ethics. KPMG had declined to cooperate with the government for an extended period, and indeed had resisted, in both its factual and legal positions, the investigation in a fashion that another federal court had found to be disingenuous. KPMG had also granted a lucrative severance package to the highest-ranking manager implicated in the tax shelter scandal and had concealed this agreement from prosecutors and from the court. KPMG's behavior thus had all the earmarks of a "circle the wagons"[162] approach to the government's investigation, in which the firm bought the good will of potential adverse witnesses. Such a strategy could also feature attorneys selected and funded by KPMG to stonewall the government's future efforts. While KPMG sought to change its tune once it became clear that this stonewalling strategy was untenable, it continued to hold out on the government, particularly regarding the generous terms of its severance agreement with former COO Stein.[163] On these facts, it was appropriate for the government to insist that KPMG definitively demonstrate its intent to abandon the stonewalling strategy by requiring employees to cooperate with the government's investigation, and limiting or eliminating the advancement of attorney's fees.
Second, both the Stein severance agreement and the unlimited subsidy of attorney's fees to individual defendants imposed substantial agency costs on KPMG. The Stein severance agreement, by suggesting that KPMG had been less than wholehearted in "cleaning house," potentially jeopardized the DPA. So did the intransigence of a number of KPMG employees, who resisted even scheduling interviews with prosecutors, yet expected that they would keep their jobs with a company that would have incurred enormous costs and possibly faced extinction if it continued to stonewall.[164] Moreover, the total exposure of KPMG for advancement of legal fees could have easily exceeded $20 million,[165] with little prospect that any of this money would have been repaid. In this setting, a company that sought to end its "consulting" arrangement with Stein[166] and limit subsidy of attorney's fees if it had the legal capacity to do so would merely be exercising sound business judgment.
In contrast to this view of what a prudent prosecutor and a business organization seeking to minimize agency costs would want, the court's legal holdings are difficult to support. While the court asserted that the defendants have a Sixth Amendment right to advancement of legal fees, precedent holds only that the defendant has a right to "spend his own money" to secure counsel.[167] When, as here, the defendants' legal claims to advancement from the company are questionable, the government does not violate the Sixth Amendment if it strongly recommends that an entity receiving such claims analyze them fully. This is especially the case when that entity is also seeking a favorable plea deal because of an acknowledged history of illegality and lack of cooperation. This is not a case where the government seeks to disqualify or otherwise remove a particular attorney without good cause.[168] Nor is it a case where the government has sought to deprive a defendant of a fair trial by declining to disclose exculpatory evidence, or by depriving the defendant of access to witnesses within the government's control.
The court also asserted that the government interfered with the fundamental fairness of a criminal proceeding, in violation of the Fifth Amendment. As a matter of substantive due process, however, courts have typically required a showing of far more intrusive behavior, such as physical coercion.[169] Any government pressure here, in contrast, focused merely on the company's declining to do what (with the possible exception of its agreement with defendant Stein) it had never bound itself to do in the first place.[170]
This point also disposes of the procedural due process issue. The government's conduct would have raised substantial issues if prosecutors had pressured KPMG to breach clear legal obligations to the individual defendants. Here, however, those obligations were (again with the possible exception of Stein) decidedly unclear.[171] The court argued that an organization's interest in recruiting qualified managers supports guarantees of advancement. However, a business organization could also decide that unlimited advancement increases agency costs and moral hazard, stems from a race to the bottom that hurts the owners of the company, and skews discourse in ways that unduly discount long-term perspectives. Absent clear law mandating advancement, no federal interest - constitutional or otherwise - requires that companies choose the former course over the latter. Indeed, important federal interests in transparency would counsel the latter, at least when an organizational defendant is also an issuer of securities.[172]
The same disregard for legitimate government and corporate prerogatives pervades the court's decision in Stein IV, which suppressed as involuntary proffer statements by managers whom KPMG had threatened with termination or cessation of fee subsidies. Here, the company's governance concerns interact with the government's legitimate concerns about cooperation to permit a wide range of company responses to the prospect of indictment. The Stein IV court ignored these neutral justifications and conflated two lines of cases. One line of cases concerns the kind of pressure that government can exert on a company to force its employees to cooperate.[173] The other line addresses the nexus between a government investigation and an investigation by a business self-regulatory group such as the National Association of Securities Dealers (NASD) or the New York Stock Exchange (NYSE).[174] The court mixes and matches these two lines of cases to arrive at a result that is appropriate under neither.
Under the Garrity v. New Jersey line of cases, a court considers whether the government's leverage against the employer is extrinsic to the potential indictment and compels the imposition of substantial lasting economic harm. While these cases invoke Fifth Amendment rights, they are best viewed as procedural due process cases regarding the imposition of sanctions without an opportunity for a hearing. In Garrity,[175] for example, which involved the investigation of police officers for allegedly fixing traffic tickets, a statute required that an individual holding any public office who refused to cooperate with an investigation forfeit his employment, including vested pension rights.[176] The Supreme Court focused on the statute's requirement of forfeiture, which occurred without any hearing on whether the officer had committed underlying acts that would merit such a drastic penalty.[177]
In Stein IV, the government did not threaten to impose sanctions that would compel direct economic harm to KPMG. This distinguishes the government's conduct from the conduct at issue in the Garrity line of cases, which hinged on the statutorily compelled forfeiture of pension rights, professional licenses, or valuable contracts. Of course, in Stein, prosecutors knew that an indictment would have consequences. However, an indictment does not legally compel such consequences, which flow instead from a crystallization of existing concerns about a company's reputation. Unless the Constitution is read to bar all indictments that have adverse collateral impacts on defendants, the prospect of an indictment for a business organization should have no greater significance under the Constitution than the indictment of any other person or entity. Nor is an indictment final and unreviewable,[178] as were the sanctions imposed in Garrity and its progeny. This distinction between economic harm that is foreseeable in the marketplace and harm that is legally required by the state places Stein outside the Garrity line of cases. Moreover, employers such as KPMG generally have the right to discipline employees for violating workplace rules, including rules that require compliance with investigative procedures.[179] A company like KPMG that delays conducting its own investigation, and awaits investigation by the government, should not lose that prerogative.[180]
The Stein IV decision is similarly inapposite in its citation of cases dealing with involuntariness caused by interaction between government and self-regulatory enforcement efforts. In these cases, courts balance two concerns. Courts strive to preserve the ability of self-regulatory bodies like the NASD, which can impose sanctions that threaten an investigatory target's livelihood, to perform their task of policing behavior within a regulated industry. However, courts do not allow government to circumvent Fifth Amendment constraints through a clear pattern of tactical collusion with such self-regulatory entities. Generally, to preserve robust industry self-regulation, courts have tolerated a significant degree of interaction between self-regulatory entities and the government, absent concrete proof that the entity and the government colluded on a specific tactical level, for example through collaboration in the entity-compelled questioning of a target.[181]
The collaboration between the prosecutors and KPMG in Stein IV does not meet this standard. The court points only to the publication of the Thompson Memorandum, the statement by a prosecutor that fee subsidies would be viewed "under a microscope,"[182] and the prosecutors' reporting to KPMG the names of employees who had refused to participate in proffer sessions.[183] Even if the prosecutors believed that KPMG would threaten termination or cessation of fee subsidies as a result, interactions of this kind do not rise to the level of close tactical collaboration required.[184]
V. SELF-GOVERNMENT, FEE SUBSIDIES, AND THE COURTS
The Stein court ultimately failed to realize that placing limits on fee subsidies for corporate executives facing criminal charges is a matter of self-government for both business organizations and the polity itself. Courts have a significant role to play in this ongoing process of self-governance, but - particularly for federal courts - a respect for the boundaries of that role is crucial. Dealing with the agency costs that wayward executives impose on shareholders requires recognition of the interdependence of government enforcement and corporate reform - an interdependence heralded by commentators and jurists of the New Deal era. In a climate of burgeoning agency costs, a shift toward government enforcement is necessary to promote sound corporate governance. Government enforcement also moderates the political distortions wrought by executive overreaching. Of course, enforcement has boundaries, too, which courts should police. However, a federal court that is too eager to reshape enforcement policy risks undermining sound governance for the business organization, states, and the public. Responding to these concerns, this section outlines appropriate roles for prosecutors, corporations, and the federal courts on the issue of legal fee subsidies in criminal cases.
a. Prosecutors' Interests in Limiting Fee Subsidies
Prosecutors and regulators deciding whether to indict need significant flexibility in defining what counts as cooperation. Flexibility at the charging stage is an essential tool for tempering the impact of broad language of penal statutes with equitable consideration for the "unique facts and circumstances of particular cases."[185] Moreover, prosecutors are in the best position to assess the nature and scope of information that their investigation requires, in light of the resources available.[186]
Although the complaint that prosecutors have too much discretion at the charging stage is probably as old as the discretion itself,[187] the alternatives are even more problematic. Ceding discretion to Congress to decide who to prosecute in a particular case would clash with the constitutional bar on bills of attainder, increasing the influences of politics and posturing in charging decisions.[188] While judges assess cooperation and other factors in sentencing, allowing the judge to oversee the charging process would move American justice from an adversarial to an inquisitorial model,[189] merging prosecutorial and judicial functions in a fashion at odds with the checks and balances that the Framers envisioned.[190] Conferring significant, although not unlimited, discretion on prosecutors at the charging stage best matches expertise and constitutional imperatives.
A prosecutor's opportunity to assess cooperation in the context of organizational crime is even more important than similar discretion in the context of an individual defendant. Collective entities such as corporations generate a massive paper trail, while attempts to reconstruct events are frustrated by multiple players telling different stories.[191] Selecting the wheat from the chaff requires cooperation from the entity.
Prosecutors also legitimately value cooperation in the organizational arena because it signals a lower risk of recidivism. In the corporate area, cooperation can amount to a new charter for doing business, bringing new emphases to transparency and strong internal controls.[192] The benefits of such organizational change accrue to all stakeholders in the corporation, including shareholders, employees, and customers. Reducing the likelihood of future wrongdoing also allows prosecutors and regulators to more efficiently allocate scarce enforcement resources.
For these reasons, prosecutors act appropriately when they set conditions of cooperation for collective entities that are reasonably related to the goals of promoting thorough investigations and preventing recidivism. While a complete ban on subsidy of legal fees in criminal cases might not be adequately tailored to these goals, prosecutors should not be burdened with a requirement that they adduce specific, concrete proof of an ongoing conspiracy of silence. A history of noncooperation, like that concededly exhibited by KPMG, warrants prophylactic efforts to limit legal fee subsidies,[193] particularly since such limits also serve the interests of shareholders by reducing agency costs.[194] Moreover, such limits are neutral; they do not allow the government to veto a defendant's particular choice of defense counsel.[195] Similarly, prosecutors should be free to seek clear evidence of organizational change, including changes in corporate personnel. The replacement of executives who have a stake in the status quo with executives committed to reform is a crucial signal of organizational commitment. In cases of pervasive and egregious collective wrongdoing, of the kind that KPMG acknowledged in its DPA with the government, a prudent prosecutor would rarely settle for less.[196]
b. Corporate Governance Aided by Government Action
Cooperation, including limits on fee subsidies, can also re-frame the relationship between government and the corporation. For the Stein IV court, the relationship is purely instrumental: a corporation cooperates to save itself. However, as theorists of cooperation have observed, cooperation is also a constitutive endeavor, premised on a transformation in organizational habit, perspective, and self-definition.[197]. If the agency costs and moral hazard encouraged by fee subsidies and underenforcement corrupt corporate governance, cooperation with the government in rooting out these risks restores governance focused on shareholder interests.
Limiting legal fee subsidies in criminal cases promotes sound organizational governance both ex ante and ex post. Ex ante, limiting fee subsidies sends a sobering message that executives should avoid conduct that violates legal norms. Managers facing the possibility of contributing to their own legal defense will be more likely to deliberate about long-term costs and consequences, as well as the propriety, of their actions. As a result, corporate discourse may shift from an Enron-like riff on the obsolescence of conventional metrics such as price-earnings ratios to a more measured conversation.[198] This deliberative shift will reduce agency costs to shareholders, who typically bear the consequences when executives opt for short-term results.[199]
Moreover, ex post, avoiding further diminution of shareholder value is an important and neutral policy. Further waste only adds insult to injury, as shareholders typically see the value of their shares plummet in corporate crisis. Legal fees can multiply in corporate prosecutions, with total corporate exposure (absent D & O insurance, which has its own externalities for shareholders) ranging readily into millions of dollars. Some might persist in regarding such amounts as mere "pocket change." However, this cavalier attitude toward costs echoes the moral hazard combatted by limits on fee subsidies.[200]
Viewed in this light, the corporate housecleaning catalyzed by government investigations is not merely an instrumental activity, but a return to first principles. This is surely the premise of William O. Douglas's comment, while Chair of the SEC, that private entities like the stock exchanges (and by implication, corporations themselves) should "take the leadership with Government playing a residual role… keep[ing] the shotgun, so to speak, behind the door, loaded, well-oiled, cleaned, ready for use but with the hope it would never have to be used."[201] As Judge Friendly noted in an opinion holding that the use of sanctions by the New York Stock Exchange to compel cooperation did not violate the Fifth Amendment even when those statements were subsequently used in a criminal prosecution, government authority is a necessary adjunct of corporate self-governance.[202] For Judge Friendly, government was given authority by Congress[203] to make sure that private entities "diligently and effectively used… the 'traditional process of self-regulation'" to promote enforcement and avoid threats to corporate integrity.[204] In other words, government holds out the carrot and stick to remind the company that its first obligation is to its owners.
A corporation that wished to avoid the agency costs and moral hazard associated with unlimited fee subsidies could impose a cap tied to the income of its employees. For example, a company could advance up to $250,000 in legal fees to employees whose salary was equal to or less than that amount. The corporation would pay a descending fraction of legal costs for other employees, up to a salary of $1 million. Such a strategy could limit the corporation's maximum exposure for any employee to $500,000, a manageable ex post loss prevention strategy.[205] It would also reduce hardship for lower- and mid-level employees, and defray some costs for senior executives.[206] Moreover, senior executives would be free to rely on past compensation from the corporation to fund the bulk of their own defense.[207]
c. Fee Subsidies and the Jurisdiction of Federal Courts
To further self-government, not only at the level of the separation of powers and the corporation, but also with regard to federalism concerns, federal courts should hold that they lack ancillary jurisdiction over fee disputes between lawyers and third parties. The "ill-defined concept of ancillary jurisdiction" should be carefully cabined, to avoid trenching on federalism values.[208] Failing to curtail ancillary jurisdiction in fee advancement matters creates serious tensions with the limited grant of authority conferred on federal courts under Article III, and potentially with state primacy in the regulation of insurance.[209] Moreover, the heedless exercise of ancillary jurisdiction can also frustrate important federal policies, such as the policy favoring transparency under the securities laws and the policy favoring arbitration. Most seriously, as the Stein III opinion demonstrates, the manifest interest of federal courts in keeping lawyers in the criminal case subtly sways judges to depart from accepted interpretations of state law to reach this result, covertly creating a distinct body of federal common law in tension with Erie.
The best way to cabin ancillary jurisdiction in the area of fee disputes is for courts to insist on the venerable standard of a "common nucleus of operative facts."[210] Generally, claims meet this standard if they "would ordinarily be expected to be tried in one judicial proceeding."[211] When the standard is met, concerns of judicial economy would justify the exercise of ancillary jurisdiction. When factual connections are more attenuated, however, the exercise of ancillary jurisdiction in fee disputes risks misinterpretation of state law and disruptions in the expectations of parties who should be allowed to order their affairs without federal court intervention.[212]
In criminal cases, courts have traditionally exercised ancillary jurisdiction to decide matters that emerge out of the same nucleus of facts and concern property controlled by the court. For example, courts will entertain a defendant's post-trial petition for return of property seized by the government.[213] However, federal courts will usually decline to decide disputes about additional agreements between defendants and third parties, because such disputes are not directly related to the underlying case, and are also more likely to involve difficult questions of state law in which the court has limited expertise.[214] For example, a court will order a bail bondsman to restore collateral for the bond to the defendant.[215] However, a court will decline to decide the merits of a contractual dispute between the bail bondsman and the defendant about the premium paid to obtain the bond.[216]
A court also appropriately exercises ancillary jurisdiction over matters, including fee disputes, concerning the obligations of a party toward the attorney appearing on the party's behalf. Such disputes ultimately involve the integrity of judicial proceedings, and the "court['s]… responsibility to protect its own officers."[217] Consider a case in which an attorney seeks reimbursement from the client for work done in proceedings presided over by the court. A court has seen the attorney's work, and is well situated to judge its value. Moreover, the court cannot allow a party to the case to unjustly enrich herself by benefiting from an attorney's advocacy before the tribunal, and then refusing to pay an agreed-upon amount. Without this authority, the court would in essence become complicit in the party's stiffing of the attorney, since the party's incentive to pay vanishes upon the trial's completion and an ingenious party can also use the time elapsed during the trial to conceal assets.[218]
Disputes involving the amount of payments by third parties to lawyers lack this unjust enrichment rationale, and frequently involve difficult questions of state law that a federal court should leave to state tribunals.[219] To decide a fee advancement issue, the court must make sense of a "patchwork"[220] that includes state law, corporate by-laws, and contractual arrangements - none of which would ordinarily fall within the subject matter jurisdiction of the federal courts.[221] The court may easily miss the nuances of this situation. Moreover, the costs of error in such cases are large: fee subsidies can involve substantial obligations imposed on corporations or partnerships, running into the tens of millions of dollars. Expending these funds on advancement has opportunity costs, hindering corporations that are already expending substantial resources to pay a federal fine from undertaking other activities that their managers believe are important for shareholders.[222]
The court's decision in Stein III shows that federal courts are hardly immune to erroneous interpretations of state law on issues such as fee advancement. A federal court has a built-in bias in favor of finding a right to advancement in such cases, because of the court's stake in avoiding any uncertainty about the availability of current counsel, its concerns about equality in defendants' treatment, and its reluctance to appear insensitive to the financial needs of members of the defense bar who regularly appear before it.[223] No court wants to precipitate substitution of counsel, even when limiting fee advancement will not necessarily lead to that result.[224] Moreover, the court, faced with a situation where one defendant, possibly a senior manager such as Jeffrey Stein, may have a contract that requires advancement, but other, more junior defendants lack this recourse, will be tempted to treat all defendants equally. Finally, vivid anecdotal evidence suggests that courts are willing to take steps such as continuing proceedings to ensure that counsel gets paid, even when a continuance may prejudice a defendant's interests.[225] A court is surely even more willing to take such steps when a defendant's and counsel's interests are aligned.
This tendency resulted in the Stein III court's misguided foray into the law of implied-in-fact contracts. The court suggested that junior managers might have an implied contract claim for fee subsidies,[226] even though the implied contract cases the court cited hinged on clear evidence of intent derived from a course of dealing between the parties that was not present in the instant case.[227] The court also ignored the caution from cases finding implied-in-fact contract terms in the employment setting that courts should not invoke the doctrine to "create rights and duties not otherwise provided for in the existing contractual relationship."[228] State courts have limited the reach of the doctrine to preserve stability in individual employment contracts.[229] Federal courts that expand the doctrine disrupt a balance of interests painstakingly calibrated under state law.[230]
When institutional biases in the federal courts drive misinterpretation of state court precedent, ancillary jurisdiction poses a challenge to Erie itself.[231] Any court can make mistakes, but a systemic tendency in federal court to misconstrue state sources of authority resembles a clandestine turn toward federal common law. As Brandeis noted in Erie, the subtleties and variations of state law are part of the fabric of American self-government.[232] Federal courts seeking to exercise their authority within the parameters set by Article III may make common law where it is consistent with their role, but should steer well clear of temptation where state law supplies a constitutionally mandated rule of decision. Here respecting the interests of prosecutors and corporations in the substantive ramifications of fee subsidies suggests the need for judicial self-restraint.
VI. CONCLUSION
Sometimes the march of time creates an illusion of consensus around certain legal arrangements. However, this consensus can be more fragile than it initially appears. In times of scandal, such as the corporate scandals surrounding Enron and WorldCom, earlier questions about such practices regain currency. The debate about corporate advancement of attorney's fees, insurance, and indemnification in criminal cases is a pointed example.
Advancement of fees and related practices, while necessary in some contexts, engender agency costs and moral hazard. Senior executives who succumb to the lure of enrichment at shareholders' expense rely on advancement and related practices as devices that will shield them from accountability. For such executives, advancement and related practices are elements of compensation, often negotiated at less than arm's length, with virtually no transparency for shareholders or government regulators acting on shareholders' behalf. Errant executives can also use fee subsidies to subordinates to encourage stonewalling government investigations. Boards that are beholden to management eagerly accept such provisions, despite their costs for corporations, in a race to the bottom for executive talent. Fee subsidies also create tension with both legal ethics and substantive law. Nevertheless, over time, cognitive biases and input from segments of the ABA shaping the perceived attributes of the "modern" corporation have accorded fee subsidies the dignity of conventional wisdom.
Such assumptions did not lack for critics decades ago. New Dealers like William O. Douglas, while agreeing that corporate executives needed protection from frivolous suits, wrote about the need for greater structural protections against executive self-dealing and coziness with corporate boards. For the New Dealers, exposing errant executives to some of the risks posed by their own conduct was a bracing antidote to the agency costs and moral hazard described above. These commentators recognized that sound corporate governance, like constitutionalism itself, depended on precommitment to a long-term perspective sufficiently robust to withstand the lure of short-term gain.
After a disheartening period of underenforcement by government helped pave the way for Enron and related scandals, prosecutors and regulators have recently exhibited a more robust approach to executive misconduct. This approach, articulated in the Thompson Memorandum, uses the powerful weapon of criminal law enforcement to encourage corporations to police themselves. Particularly where a business organization has a track record of resisting investigations, prosecutors appropriately regard changing corporate personnel and limiting fee subsidies as signals that the company wishes to cooperate fully and prevent recurrences of misconduct.
Critics of the government's robust turn in enforcement policy argue that the threat of indictment in such cases constitutes government overreaching. The Stein court, for example, asserted that the mere publication of the Thompson Memorandum, together with a handful of follow-up statements by prosecutors, amounted to government coercion in violation of the Fifth and Sixth Amendments. However, the Stein court and other critics of the government's enforcement policy ignore the agency costs and moral hazard triggered by fee subsidies. In ignoring these problems, critics also miss the most fundamental issues of governance - both private and public - posed by executive misconduct, and misperceive the appropriate role for federal courts presiding over such cases.
While critics charge that business organizations like KPMG that change personnel and limit fee subsidies to head off an indictment are merely acting instrumentally, this claim misapprehends the interaction of government and business organizations since the New Deal, and proves too much. The New Deal understanding of the interaction of business and government suggested that the power of the government was a necessary adjunct to vigorous business self-regulation. Companies that reduce the agency costs and moral hazard induced by fee subsidies are returning to the first principles of corporate governance that overreaching executives abandoned. The need for a wake-up call to the company, in the form of an imminent indictment, may be a sad commentary on the fragility of sound governance. However, it does not vitiate the promise of genuine reforms undertaken by the organization. Of course, it is possible that the organization is acting purely instrumentally, to placate the government and avoid the full consequences of past misconduct. To this extent, however, the government is more than justified in seeking personnel change and limits to fee subsidies as a guarantee of cooperation and a hedge against future backsliding by the corporation.
Federal court decisions like Stein III and IV that stifle this process ignore principles of sound corporate governance, as well as the federal interest in transparency for business organizations. A decision like Stein III, with its creeping expansion of ancillary jurisdiction, also immerses the federal courts in contractual disputes that are best left to arbitration and to state courts. Moreover, by interpreting state contract law through the lens of the court's interest in uninterrupted funding of the defendant's chosen counsel, the court risks creating a body of federal common law on fee disputes that exists in subtle but unmistakable tension with Erie.
Corporations that are serious about reducing agency costs need not eliminate all fee subsidies. In the modern corporation, such a step would radically thin the talent pool for managerial positions, and unduly bias executives toward risk-averse behavior. However, a corporation should cap its fee subsidies in criminal proceedings. In addition, regulators should require full disclosure of the terms of the corporation's D & O insurance, and the record of premiums paid. State courts should construe ambiguous contracts for indemnification and fee subsidies in favor of the owners of the corporation, viewing such agreements as elements of a compensation package in which the executive is well-situated to bargain with a friendly board, not insurance in the arm's length sense of the term.
Ultimately, combating the agency costs and moral hazard posed by fee subsidies demonstrates the complementary relationship of self-governance in the polity and the boardroom. When government ignores risks to shareholders posed by underenforcement, it also becomes a tacit accomplice in financial harm to investors, imposing a covert tax through underenforcement. Underenforcement is also a signal that overreaching business executives have attained too much power over the terms of public discourse. However, when underenforcement damages the integrity of business organizations, it also in the long-term undermines the ability of business to act as a counterweight to an overreaching government. Eventually, as Enron demonstrated, the evidence of corporate insider excess becomes impossible to ignore. The result may be over-regulation, such as the glut of paper plaguing small corporations that a broad range of commentators have criticized as a consequence of the Sarbanes-Oxley Act. In contrast, when corporations hold themselves in check, the polity avoids the convulsions of blame directed at the privileged that the Framers warned can distort democracy. On this view, curbing the agency costs caused by excessive fee subsidies contributes to the stability of both business organizations and the polity itself.
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[127] See United States v. Automated Medical Laboratories, 770 F.2d 399 (4th Cir. 1985). See generally Samuel A. Buell, The Blaming Function of Entity Criminal Liability, 81 Ind. L.J. 473, 488-90 (2006) (discussing theory of vicarious criminal liability in corporate setting).
[129] Cf. id. at 404 (arguing that corporate punishments, such as exorbitant fines, can also create negative externalities, such as layoffs, plant closings, and hardship to the corporation's shareholders, creditors, and suppliers).
[130] It is especially useful at highlighting the risks to the corporation of encouraging corporate agents to act only in their short-term best interests, and in the short-term interests of the company. The conduct of corporate officials, such as Enron's, who, see Regan, supra note 15, at 1147-49, promote short-term gains at the expense of long-term business integrity, and cut legal corners as a result, can give rise to respondeat superior liability. In such cases, the fact that corporate officials also may have promoted their own interests does not rebut the argument that these officials also intended to benefit the corporation.
[133] Id. at 5. Cf. Christopher A. Wray & Robert K. Hur, Corporate Criminal Prosecutions in a Post-Enron World: The Thompson Memorandum in Theory and Practice, 43 Am. Crim. L. Rev. 1095, 1135-37 (2006) (discussing positive effect of new enforcement policy on cooperation by corporations).
[135] Id. at 6-9. But see John S. Baker, Jr., Reforming Corporations Through Threats of Federal Prosecution, 89 Cornell L. Rev. 310, 316-20 (2004) (expressing skepticism about appropriateness and efficacy of "good corporate citizen" goal of prosecutors).
[136] See Thompson Memorandum, supra note 2, at 5. Cf. Lonnie T. Brown, Jr., Reconsidering the Corporate Attorney-Client Privilege: A Response to the Compelled-Voluntary Waiver Paradox, 34 Hof. L. Rev. 897, 935-46 (2006) (discussing implementation and effects of DOJ policy). Of course, to prevail on any substantive charge, such as obstruction, prosecutors must prove all of the elements of the charge, including intent to impede an investigation. See Arthur Andersen, LLP v. United States, 544 U.S. 696 (2005); United States v. Quattrone, 441 F.3d 153 (2d Cir. 2006).
[139] See John Hasnas, Ethics and the Problem of White Collar Crime, 54 Am. U.L. Rev. 579 (2005); Brief of Sec. Indus. Ass'n as Amici Curiae, supra note 70.
[140] Id. Cf. Lawrence M. Solan, Statutory Inflation and Institutional Choice, 44 Wm. & Mary L. Rev. 2209, 2236-60 (2003) (discussing factors that broaden the scope of federal criminal liability).
[142] See United States v. Stein (Stein III), 435 F. Supp. 2d 330 (S.D.N.Y. 2006), United States v. Stein (Stein IV), S1 05 Crim. 0888 (LAK), 2006 U.S. Dist. Lexis 49435 (S.D.N.Y. July 20, 2006).
[146] Id. at 349. See also United States v. Stein (Stein I), S1 05 Crim. 0888 (LAK) 2005 U.S. Dist. LEXIS 27812 (S.D.N.Y. Nov. 14, 2005), Government's Post-Hearing Memorandum on Issues Concerning the Defendants' Right to Counsel (submitted May 22, 2006) [hereinafter Government's May 22, 2006 Brief] at 14 n. 10 (quoting from DPA) (copy on file with the author). See generally Rostain, supra note 51, at 84-92 (discussing abuses in the marketing of tax shelters).
[147] See Stein III 435 F. Supp. 2d at 338. Shortly after the IRS began its investigation, the United States Senate held hearings about the tax shelter industry, during which a bi-partisan group of senators criticized tax shelter practices generally, and KPMG in particular. Id. For example, Senator Coleman, Republican of Minnesota, observed that "the ethical standards of the legal and accounting profession have been pushed, prodded, bent and, in some cases, broken, for enormous monetary gain." Id. (citing U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and Financial Professionals, Hearings Before the Permanent Subcomm. On Investigation of the S. Comm on Governmental Affairs, 108th Cong. 2 (2003) [hereinafter Subcomm. Hearings]). Senator Levin, Democrat of Michigan, advised a KPMG witness to "try an honest answer." Id., (citing Subcomm. Hearings at 43).
[148] Government's May 22, 2006 Brief, supra note 146, at 14 n. 10, (quoting KPMG-DOJ DPA, Statement of Facts, Para. 3).
[149] See United States v. KPMG, LLP, 316 F. Supp. 2d 30, 37-38 (D.D.C. 2004). These steps included making spurious claims of privilege with respect to documents that KPMG argued constituted advice to particular clients, but that the court found were presumptively unrelated to individual clients, and instead were "nothing more than an orchestrated extension of KPMG's marketing machine" for tax shelter products.
[153] KPMG also agreed to indemnify Stein, except as to "willful or intentional unlawful acts." Id. In addition, the agreement provided for arbitration of any dispute concerning its terms. See Government's May 22, 2006 Brief, supra note 146, at 31.
[156] Id. at 344 (finding that prosecutor warned that his office would examine KPMG's duty to advance fees "under a microscope").
[157] Id. at 347-48. KPMG, according to the court, came to view the Stein severance agreement as "something of a ticking bomb," that might sour the government on the DPA. Id. KPMG also attempted to characterize some of the $650,000 advanced to Stein in legal fees as defense of civil litigation, although it was later forced to stipulate that the entire amount reflected advancement of legal fees in the criminal case against Stein. Id. at 348 n. 74.
[160] See Stein I, 2005 U.S. Dist. Lexis 27812 at *22 (discussing bail request of defendant David Greenberg).
[163] The government would also have acted reasonably in entertaining suspicions that David Greenberg, whom the court specifically found had concealed a large array of assets to protect them from private plaintiffs and from criminal penalties or forfeiture efforts, had used the instrumentalities of the firm to accomplish this goal.
[164] As it was, KPMG paid a fine of almost $500 million, as well as agreeing to a corporate monitor and a range of other reforms, as part of the DPA. See Stein III, 435 F. Supp. 2d at 349.
[165] This figure is derived from defendant David Greenberg's payment of a $2 million retainer to his counsel, as well as the presence of more than ten individual defendants in the case.
[166] See supra notes 151-152 and accompanying text (discussing camouflage of essentially gratuitous payments as consulting agreements).
[167] Caplin & Drysdale, Chartered v. United States, 491 U.S. 617, 626 (1989) (emphasis added) (upholding federal attorney's fee forfeiture provisions, where fee was fruit of illegal activity).
[168] This distinguishes the Stein case from the case of United States v. Gonzalez-Lopez, 126 S. Ct. 2557 (2006), that the court cites. Stein III, 435 F. Supp. 2d at 369 n. 190. In Gonzalez-Lopez, the Supreme Court actually addressed a very different issue - the showing required of a defendant to vacate a conviction when the trial court had improperly disqualified defense counsel. The Gonzalez-Lopez Court ruled that the defendant did not have to show prejudice in such a case. The Stein court rightly denied the government's motion to disqualify a law firm that had previously represented a KPMG employee now cooperating with the government. See United States v. Stein, 410 F. Supp. 2d 316 (S.D.N.Y. 2006) (Stein II) (holding that client could waive conflict, if he retained standby counsel to cross-examine any of firm's former clients, when former clients did not object, there were a small number of attorneys who did criminal tax work, and other attorneys would also be potentially conflicted out by their representation of other defendants in the case).
[169] Indeed, the Court has recently minimized the coercive effect of more extreme government conduct, such as temporarily withholding treatment for a suspect undergoing emergency medical care, and emphasized the government's legitimate need to obtain information in exigent circumstances. See Chavez v. Martinez, 538 U.S. 760 (2003). Cf. John T. Parry, Escalation and Necessity: Defining Torture at Home and Abroad, in Torture: A Collection 145, 151-52 (Sanford Levinson ed., 2004) (critiquing Chavez). For examples of egregious conduct by the government that violated the physical integrity of a defendant, see Rochin v. California, 342 U.S. 165 (1952) (holding that police violated substantive due process through conduct that "shocked the conscience," including pumping suspect's stomach without his consent).
[170] Defendant Stein may have been in a somewhat different position, because of the terms of his severance agreement. However, the court did not find that the government was aware of this agreement; indeed, it acknowledges that KPMG took steps to conceal the agreement's terms from prosecutors, the courts, and the public.
[171] Indeed, the court implicitly recognized the lack of clarity regarding KPMG's obligation to advance fees by resorting to a theory of implied contract in its analysis of KPMG's obligation to advance legal fees. Stein III, 435 F. Supp. 2d at 356 n. 119. As the cases cited by the court indicate, implied contract rests on clear evidence of the parties' intent manifested through a consistent course of conduct. See Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue Shield of New Jersey, 448 F.3d 573, 582 (2d Cir. 2006) (holding that doctors who had received reimbursement from an HMO for an extended period for performing various medical procedures were entitled to receive reimbursement at the same rate for procedures recently performed); Manchester Equip. Co., Inc. v. Am. Way Moving & Storage Co., Inc., 176 F. Supp. 2d 239, 245 (D. Del. 2001) (finding that evidence of parties' intent was insufficient). KPMG's modest experience with criminal matters, encompassing its apparent subsidy of legal fees in a 1970's prosecution and a recent SEC investigation, does not demonstrate the clarity courts require. A court could find the existence of an implied contract in a setting involving a fee dispute between a lawyer and client where, for example, the lawyer had worked for the client in the past for a set fee, and had just performed additional work. However, KPMG did not have this kind of special "repeat-player" relationship with any of the attorneys that the individual defendants retained in Stein. Indeed, KPMG's express capping of attorney's fees to defense lawyers would trump any evidence of prior contrary intent.
[174] See, e.g., D.L. Cromwell Investments, Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162-63 (2d Cir. 2002).
[177] See also Lefkowitz v. Turley, 414 U.S. 70 (1973) (holding that statements were coerced when the state invoked a state law canceling contracts and imposing a five year bar on future business with a contractor who refused to cooperate or order his employees to do so); Spevack v. Klein, 385 U.S. 511 (1967) (holding that statement by attorney was involuntary under the Fifth Amendment when state extracted it pursuant to a statute that authorized disbarment of an attorney who failed to cooperate in an investigation)
[178] See Gerard E. Lynch, Our Administrative System of Criminal Justice, 66 Fordham L. Rev. 2117 (1998) (arguing, in light of the concerns of many targets of investigations about the consequences of indictment, that proffer sessions with federal prosecutors cast prosecutors as an informal administrative agency, subject to the "judicial review" provided by a trial on the merits, the prospect of which ideally keeps prosecutors honest).
[179] See Matima v. Celli, 228 F.3d 68, 79 (2d Cir. 2000) (holding that private employer does not violate fair employment laws by taking adverse action against employee who violates neutral workplace rules); Tullo v. City of Mount Vernon, 237 F. Supp. 2d 493, 504 (S.D.N.Y. 2002) (holding that fair employment laws do not prohibit discipline of employee for impeding an investigation). Cf. EEOC v. Total System Serv., Inc., 221 F.3d 1171, 1175-76 (11th Cir. 2001) (employer may discipline employee upon good faith finding that employee lied in course of internal investigation). But see Anne Lawton, The Bad Apple in Sexual Harassment Law, 13 Geo. Mason L. Rev. 817, 848-49 (2005) (arguing that Total Systems decision gives employers too much power in sexual harassment cases).
[180] A company could also conduct its own investigation, secure statements from employees, and then turn over those statements to law enforcement. While the corporation can assert lawyer-client privilege regarding such statements, the corporation can also elect to waive the privilege. See Upjohn Co. v. United States, 449 U.S. 383, 389-90 (1981); Brown, Corporate Attorney-Client Privilege, supra note 136, at 922-35. As long as a lawyer conducting an investigation for the corporation informs employees that the lawyer represents the company, not the employee, the employee has no legitimate expectation that the communication will remain confidential. See Simon, After Confidentiality, supra note 8.
[181] See D.L. Cromwell Inv., Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162-63 (2d Cir. 2002) (holding that evidence of coordination in timing between NASD investigation and grand jury proceedings, together with statements by federal investigators that they were "working with" NASD, along with other facts suggesting collaboration, did not compel inference that NASD was an agent of the state for Fifth Amendment purposes).
[182] This statement was denied by the prosecutor and not specifically recollected by any witness, but was referred to in notes of a meeting by one of KPMG's lawyers. The court's factual findings here are subject to a clearly erroneous standard.
[183] Stein IV, 2006 U.S. Dist. Lexis 49435 at *62. Cf. Stein III , 435 F. Supp. 2d at 346 (quoting another prosecutor as making the generic statement, in response to a query from lawyers from KPMG about whether they should advance legal fees to executives, that under federal guidelines "misconduct" should not be "rewarded").
[184] One decision, United States v. Montanye, 500 F.2d 411 (2d Cir. 1974), lends some superficial comfort to the Stein defendants, but only if one reads it very selectively. In Montanye, a company collaborated closely with the government in conducting a polygraph examination of a day employee, who had admitted during a previous polygraph session that he may have committed a homicide. According to the court, the employer was "admittedly acting as an agent for the police." Id. at 415. However, the court ruled that the employer's threat of termination to the employee, who had had his job for only a couple of days, was not an economic sanction serious enough to render the employee's statement involuntary. Id.
The court asserted that the Garrity line of cases involved more substantial and lasting economic harm, including the forfeiture of pension rights or a professional license. The Montanye court also indicated that mere termination of any employee, including a "pampered professional or high-paid businessman," would similarly not constitute sufficient harm. Id. at n. 3. This statement, while dicta, would seem to require classifying the threatened termination and loss of fee subsidies in Stein as insufficient, as well. However, the better view of the Montanye decision's relevance to Stein may be that in Montanye the employer was concededly acting as the government's agent by collaborating on the terms of a specific examination of the target, while such close tactical collaboration is not present in Stein.
In addition, Stein clearly does not involve a sham investigation of an employer pursued for the sole purpose of exerting leverage on another party or entity. Implementation of a scheme of this kind in which the government and the employer colluded to extract admissions from individual defendants would almost certainly render the admissions involuntary, and could also be problematic for prosecutors under rules of professional responsibility. Cf. United States v. Hammad, 858 F.2d 834 (2d Cir. 1988) (holding that court could exercise supervisory power to suppress evidence yielded by sham grand jury subpoena); Bruce A. Green & Fred C. Zacharias, Regulating Federal Prosecutors' Ethics, 55 Vand. L. Rev. 381, 439-43 (2002) (discussing rationales for prosecutors' independence) (discussing supervisory power). But see John Gleeson, Supervising Criminal Investigations: The Proper Scope of the Supervisory Power of Federal Judges, 5 J.L. & Pol'y 423 (1997) (criticizing cases such as Hammad as unjustified intervention into prosecutorial decisions). Prosecutors, in their efforts to secure cooperation, can also be insensitive to special factors beyond a defendant's complete control that make cooperation difficult. See Peter Margulies, Battered Bargaining: Domestic Violence and Plea Negotiation in the Criminal Justice System, 11 S. Calif. Rev. L. & Women's Stud. 153, 170-71 (2001) (arguing for checks on prosecutorial practice regarding defendants such as some couriers or "mules" in drug transactions whose fear of domestic violence contributed to underlying offense). However, Stein clearly does not involve issues of this sort. The Stein IV court hints that the government might have threatened to indict KPMG, regardless of whether KPMG was "guilty of anything." See Stein IV, 2006 U.S. Dist. Lexis 50723, at *3. However, nowhere in this opinion or in Stein III does the court dispute the statements made by KPMG as part of the DPA that its senior executives had engaged in a pervasive pattern of tax fraud. Nor does the court question the bona fide nature of the nearly $500 million fine KPMG agreed to pay to avoid indictment.
[185] See Kenneth Culp Davis, Discretionary Justice: A Preliminary Inquiry 17 (1969). Cf. Green & Zacharias, supra note 184, at 439-43.
[186] Id. at 442 ("Prosecutors… can judge prosecutorial and other law enforcement resources in a way that may inform the decision, for example, of which suspects to pursue and which suspects should receive lenient treatment").
[188] See U.S. Const., art. I, § 9, cl. 3. Cf. Lovett v. United States, 66 F. Supp. 142 (Ct. Cl. 1945), aff'd on other grounds, 328 U.S. 303 (1946) (discussing Bill of Attainder clause problems with legislation that conditioned appropriations on Congressional approval of reappointment of 39 federal employees whom Chairman of House Committee on Un-American activities termed, "irresponsible, unrepresentative, crackpot, radical bureaucrats" and associates of "Communist front organizations"); Stephen Dycus, et al., National Security Law 134-45 (3d ed. 2002) (discussing Bill of Attainder issues in national security context).
Government has some avenues for limiting prosecutorial discretion. For example, legislatures may mandate prosecution of certain offenses because of concern that prosecutors and law enforcement have been excessively lenient or indifferent in the past. See Emily J. Sack, Battered Women and the State: The Struggle for the Future of Domestic Violence Policy, 2004 Wis. L. Rev. 1657, 1696 (discussing mandatory prosecution in domestic violence cases). However, this remedy for prosecutorial discretion, anchored by strong justifications in some contexts, aims to protect victims and deter future wrongdoing, not assist defendants.
[189] Cf. Jay Sterling Silver, Truth, Justice, and the American Way: The Case Against the Client Perjury Rules, 47 Vand. L. Rev. 339, 403-09 (1994) (arguing that some legal ethics rules undermine adversary system and foster inquisitorial stance by courts that threatens fundamental process values).
[190] See United States v. Williams, 504 U.S. 36 (1992) (holding that a court acting under its supervisory power lacks authority to regulate grand jury investigations that should have a substantial degree of independence in a constitutional system). Cf. Sara Sun Beale, Reconsidering Supervisory Power in Criminal Cases: Constitutional and Statutory Limits on the Authority of the Federal Courts, 84 Colum. L. Rev. 1433 (1984) (arguing for limits on federal courts' supervisory authority); Fred C. Zacharias & Bruce A. Green, Federal Court Authority to Regulate Lawyers: A Practice in Search of a Theory, 56 Vand. L. Rev. 1303, 1314-36 (2003) (discussing possible readings of Williams). But see Niki Kuckes, The Democratic Prosecutor: Explaining the Constitutional Function of the Federal Grand Jury, 94 Geo. L.J. 1265, 1272-73 (2006) (arguing that the notion of grand jury independence is a fiction masking prosecutorial authority).
[191] See Brown, Corporate Crime Enforcement, supra note 55, at 527-28 (discussing difficulty of detecting corporate crime).
[193] Moreover, efforts to end or limit participant subsidies through negotiations with corporations do not give the government an unfair advantage in bargaining with individual defendants. The case most frequently cited by critics of government efforts is the example of the corporate middle manager, who may not be able to afford the resources necessary to retain an upper-echelon defense attorney through trial. However, prosecutors negotiating with middle-level managers will, given the Thompson Memo's focus on corporate wrongdoing, have one central inquiry: does the mid-level manager have useful information about higher-ups in the company or corporate food-chain? If the individual defendant has such information, most lawyers will advise the client to trade the information for a favorable plea deal. Counsel paid by the corporation may be more likely to stress the down side of cooperation when cooperation would injure the corporation's interests; however, that tendency undercuts the argument that corporate legal fee subsidies adversely affect individual defendants. In such situations, the corporation may be adversely affected, but the individual defendant is better off by providing information.
Contrast this example with the scenario in which the individual defendant has no information to trade. Here, on the surface, restricting or ending fee subsidies obliges the defendant to go to trial with inferior counsel. Here, too, however, surface appearances obscure the details of actual practice. If a middle-manager who is facing indictment has no information to trade about higher-ups, the government will have that much less leverage against the corporation. In this situation, the corporation will face far less pressure to eliminate the subsidy. While the corporation may still limit or end the subsidy, its calculation is likely to be an honest assessment of whether the individual defendant has damaged the corporation by engaging in inappropriate behavior.
This discussion of the two middle-manager scenarios takes care of the two strongest examples invoked by critics of the government. It leaves one further case - the case of the top-level manager. In this case, prosecutors will be less willing to trade concessions on a plea for information, particularly when the manager is at the very top of the corporate food-chain. Limiting or ending corporate participant subsidies may leave the top-level manager to her own resources in financing a lengthy trial. However, a senior executive will likely have been compensated in the past at a level that allows her to retain high-quality counsel on her own, thus diminishing the need for corporate subsidy. See Stein I, 2005 U.S. Dist. Lexis 27812 at *22 (discussing bail request of defendant David Greenberg, whom the court found had $20 million in assets and had already given his lawyer a $2 million retainer). An executive with salary, stock options, and other assets in the tens or hundreds of millions of dollars may wish that her former employer would help out with lawyers' bills, but can hardly cry poverty. While a white-collar case like the KPMG matter may involve substantial numbers of documents, thus adding to the time that a defense lawyer must bill, the key documents in this case are relatively modest in number, in part due to the "cookie-cutter" nature of the tax "advice" that KPMG furnished to support its marketing scheme. See Stein III, 435 F. Supp. 2d at 371; United States v. KPMG, LLP, 316 F. Supp. 2d 30, 37-38 (D.D.C. 2004).
[195] A defendant who wishes to retain particular counsel has other options, including paying for counsel with his own resources, and asking the lawyer to accommodate the defendant's finite resources with a finite bill. To be sure, a limit on fee subsidies may constrain the defendant's selection of counsel. However, assuming again that the defendant does not have a legally binding contract for advancement of fees, asking the defendant to fund most or all of his defense puts him in exactly the same position as all other criminal defendants, apart from indigent defendants for whom the government provides a lawyer. Because limits on fee subsidies are neutral with respect to particular attorneys, and serve the significant government interests of reducing stonewalling and corporate agency costs, such limits constitute merely incidental burdens on the right - which the courts have always recognized as contingent in a variety of respects - to select one's own counsel. See United States v. O'Brien 391 U.S. 367 (1968) (holding that statute prohibiting burning of draft card imposed merely incidental burden on free speech). But see Kent Greenwalt, Speech, Crime, And The Uses Of LanguagE328-31 (1989) (arguing that Court engaged in inappropriately deferential review of statute); Michael C. Dorf, Incidental Burdens on Fundamental Rights, 109 Harv. L. Rev. 1175, 1202-05 (1996) (same). Cf. Humanitarian Law Project v. Reno, 205 F.3d 1130, 1135 (9th Cir. 2000), cert. den. sub nom Humanitarian Law Project v. Ashcroft, 532 U.S. 904 (2001) (holding that provisions of Antiterrorism and Effective Death Penalty Act (AEDPA), 18 U.S.C. 2339A(b) (2002), that prohibited financial assistance to designated foreign terrorist organizations such as Al Qaeda imposed merely incidental burden and therefore did not violate First Amendment); Margulies, The Virtues and Vices of Solidarity, supra note 87, at 200-07 (discussing appropriate scope of AEDPA provisions).
[196] Prosecutors operate within limits. For example, the government could not ask the corporation to select or reject a particular lawyer or firm. This would not be a "content-neutral" measure, and could also make the corporation into an agent of the government for Sixth Amendment purposes. Moreover, the government should not require a corporation to withhold documents or access to personnel who have information relevant to individual defendants. See ABA Task Force, supra notes 38-43 and accompanying text. However, the government could require that a corporation that entered into a plea disavow the statements of current or former corporate officials that conflicted with representations that the corporation made in its plea. Given these limits, government efforts to restrict fee subsidies are a tailored strategy for dealing with a difficult problem.
[198] Cf. Cfa Centre For Financial Marketing INtegrity and Business Roundtable Inst. Corp. Ethics, Breaking the Short Term Cycle: Discussion and Recommendations On How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus On Long-Term Value 3 (July 2006) ("excessive focus of some corporate leaders, investors, and analysts on short-term… earnings and a lack of attention to the strategy [and] fundamentals… of long-term value creation… can tip the balance in value-destructive ways for market participants"). This commitment to a long-term perspective is central to constitutionalism, as well. See Jon Elster, Social Institutions, in Nuts and Bolts For the Social Sciences, 147, 150 (1989) (observing that "[t]he parts of a constitution that make it more difficult to change the constitution than to enact ordinary legislation... force people to think twice before they change it"); Ruti G. Teitel, Transitional Justice 193 (2000) (noting that the notion of a founding moment for republics "reconciles the dilemma of political change with constitutional permanence"); Frank Michelman, Law's Republic, 97 Yale L.J. 1493 (1988) (arguing that judicial review helps ensure that sober second thoughts can counter the tendency of political leaders to cater to the exigencies of the moment through scapegoating subordinated groups).
[199] Of course, short-term holders of stock may also benefit from the volatility generated by short-term executive perspectives; however, hedge funds and other short-term traders have a range of investment opportunities and resources that ordinary investors lack.
[200] Indeed, limiting advancement will also reduce agency costs - including agency costs imposed on managers by their own lawyers -- and moral hazard ex post, by encouraging individual defendants to more carefully monitor their own legal costs. Managers who retain counsel at least partially on their own dime will be less likely to spring for eleven law firm associates working on their case, or to blithely accept a law firm's healthy mark-up for photocopying. See Lerman & Schrag, supra note 82. The result may just be a "leaner, meaner" defense effort. In this fashion, limiting fee subsidies may serve defendants' interests in the long-term.
[201] See Silver v. N.Y. Stock Exch., 373 U.S. 341, 350-53 (1963), citing Douglas, The Forces of Disorder, supra note 126, at 82. Douglas' view that the threat of government action encourages industry self-governance and deters managers from imposing agency costs on shareholders contrasts with the Stein IV court's more vivid but less nuanced description of the same phenomenon as the "corporate equivalent of capital punishment." See Stein IV, 2006 U.S. Dist. Lexis 49435, at *5.
[203] See H.R. Rep. No. 1383, 73d Cong., 2d Sess. 15 (1934); S. Rep. No. 792, 73d Cong., 2d Sess. 13 (1934) (stressing broad responsibility of exchanges for self-governance).
[205] Alternatively, the corporation could appoint an independent subcommittee of the board of directors to determine if the charges against the executive involved, 1) genuinely disputed issues of fact, such as intent, see United States v. Quattrone, 441 F.3d 153 (2d Cir. 2006), or materiality, or, 2) novel issues of law. See Alex Berenson, Case Expands Types of Lies Prosecutors Will Pursue, N.Y. Times, May 17, 2004, at C 1 (reporting on guilty please in obstruction of justice case involving executives' misstatements to an outside law firm retained by the corporation to investigate possible managerial misconduct). Cf. ABA Task Force, supra note 2, at n. 15 (discussing new theories of obstruction of justice). A corporation could also ask an executive receiving advancement to post a bond, in order to facilitate repayment of legal fees if executive was convicted of crime that injured corporation. See Radin, supra note 1, at 290.
[206] One could argue that limiting subsidy of legal fees will adversely affect the defense bar as a whole, thus weakening a bulwark against government overreaching. See Margulies, Lawyers' Independence, supra note 73 (discussing importance of criminal defense). Cf. Sam A. Schmidt & Joshua L. Dratel, Turning the Tables: Using the Government's Secrecy and Security Arsenal for the Benefit of the Client in Terrorism Prosecutions, 48 N.Y.L. Sch. L. Rev. 69, 70-71 (2003-04) (discussing systemic obstacles to representation in terrorism cases); Teri Dobbins, Protecting the Unpopular from the Unreasonable: Warrantless Monitoring of Attorney Client Communications in Federal Prisons, 53 Cath. U.L. Rev. 295 (2004) (discussing chilling effect of attorney-client monitoring); Margulies, Virtues and Vices of Solidarity, supra note 87 (discussing chilling effect of attorney-client monitoring); Ellen S. Podgor & John Wesley Hall, Government Surveillance of Attorney-Client Communications: Invoked in the Name of Fighting Terrorism, 17 Geo. J. Legal Ethics 145 (2004) (same). However, it is far from clear that capping executives' legal defense fees in criminal cases will yield this result. Corporations will still reimburse managers for a portion of their legal fees. Senior executives will still be able to use their own resources to pay their lawyers. See infra note 207 (discussing resources available to senior executives). Indeed, the turn toward vigorous federal enforcement may well make white-collar defense a growth industry. Cf. Coffee, supra note 18, at 367 (noting that provisions of Sarbanes-Oxley Act have "proven to be an unexpected blessing and major source of new revenue" for accountants).
[207] Cf. Stein I, 2005 U.S. Dist. Lexis 27812 (S.D.N.Y. Nov. 14, 2005), at *22 (denying bail application for defendant David Greenberg because he had secreted approximately $20 million in assets). See also Radin, supra note 1, at 289-90 (noting extensive financial resources of many executives who seek advancement of legal fees, and mentioning alternative approach under which executives could be required to post secured bond with the corporation to guarantee repayment of advance upon a final adjudication of guilt). Where companies continued to opt for broader D & O insurance or indemnification, state courts could prospectively construe such contracts for the benefit of the shareholders. The SEC should also require that corporations disclose details of their D & O insurance, including the pricing history for the premiums paid. See Griffith, supra note 1. See also SEC Guidelines On Disclosure of Executive Compensation, http://www.sec.gov/news/press/2006/2006-123.htm (Aug. 2006 rules set more rigorous standards for disclosure of compensation, including perquisites).
A corporation could legitimately reimburse executives at a higher level in cases involving an absence of willful misconduct or an unforeseen expansion in legal liability. For an example of the latter scenario, see United States v. Socony-Vacuum Co., 310 U.S. 150 (1940). In Socony-Vacuum, the Court rejected a claim by an oil company accused of price-fixing that an agreement with federal regulators purporting to authorize the setting of prices immunized the company from liability under the antitrust laws. Cf. Waller, supra note 67, at 96-98 (discussing Justice Douglas' opinion for the Court). In such a case, a corporation could find that executives appropriately relied on their understanding with federal administrative officials. However, a corporation should seek independent advice on this question, to avoid excess influence by corporate insiders.
[209] See Ambromovage v. UMW, 726 F.2d 972, 989 (3d Cir. 1984). See generally Jeffrey A. Parness & Daniel J. Sennott, Expanded Recognition in Written Laws of Ancillary Federal Court Powers: Supplementing the Supplemental Jurisdiction Statute, 64 U. Pitt. L. Rev. 303 (2003).
[210] Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 379-80 (1994); UMW v. Gibbs, 383 U.S. 715, 725 (1966) (discussing pendent jurisdiction); Polishan, 19 F. Supp. 2d at 330 n. 4 (M.D. Pa. 1998).
[212] Cf. G. Heileman Brewing Co. v. Joseph Oat Corp., 871 F.2d 648, 657 (7th Cir. 1989) (Posner, J., dissenting) (arguing that court should strictly interpret Fed. R. Civ. P. 16(f), which grants federal courts power to compel appearance of "attorneys" at settlement conferences, to exclude power to compel appearance of party with settlement authority, since party is free to make choice not to settle dispute and compelled appearance may waste time and resources).
[214] Cf. Cluett, Peabody & Co., Inc. v. CPC Acquisition Co., Inc., 863 F.2d 251, 256 (2d Cir. 1988) (discussing standards for ancillary jurisdiction).
[216] Id. at 221-22. Cf. Polishan, 19 F. Supp. 2d at 330 (M.D. Pa. 1998) (holding that court lacked ancillary jurisdiction in fee subsidy case to adjudicate dispute about bond that insurance carrier required defendant to post).
[217] See CPC Acquisition Co., 863 F.2d at 256 (2d Cir. 1988); Nat'l Equip. Rental Ltd. v. Mercury Typesetting Co., 323 F.2d 784 (2d Cir. 1963); Petition of Rosenman, Colin, Freund, Lewis & Cohen, 600 F. Supp. 527, 531 (S.D.N.Y. 1984) (ancillary jurisdiction over fee dispute between party and attorney).
[218] Ironically, despite this concern, courts exerting ancillary jurisdiction over fee advancement disputes display indifference to the problem of vanishing assets that arises when a corporation lacks effective remedies against a defendant who has received an adverse final judgment. See United States v. Weissman, 1997 U.S. Dist. Lexis 8540 at *32(S.D.N.Y. June 13, 1997).
When the lawyer has received a fee from the client but has not done the work, the court may act to ensure that the lawyer is not unjustly enriched at the client's expense. This is particularly true when the attorney is no longer involved in the case because of the court's exercise of its supervisory power over disqualification. Cf. Garcia v. Teitler, 443 F.3d 202, 209 (2d Cir. 2006) (affirming exercise of ancillary jurisdiction to assure that disqualified attorney returned unused portion of his retainer to his client, so that the client could retain another lawyer). Indeed, in the latter case, exercise of ancillary jurisdiction might not be necessary at all, since the court's supervisory power over ethical conduct by attorneys appearing before it would likely suffice to sanction the attorney and cause the attorney to release the disputed amount to the client. See Lonnie T. Brown, Jr., "May It Please the Camera ... I Mean the Court" - An Intrajudicial Solution to an Extrajudicial Problem, 39 Ga. L. Rev. 83 (2004) (arguing for more robust judicial sanctions to curb extrajudicial remarks by prosecutors and defense attorneys); Green & Zacharias, supra note 184; Peter Margulies, Above Contempt?: Regulating Government Overreaching in Terrorism Cases, 34 Sw. U. L. Rev. 449 (2005) (arguing that courts should use supervisory power vigorously to deter prosecutorial excesses, such as prejudicial public statements and material omissions in warrant applications).
[219] This is particularly true where federal courts seek to construe D & O insurance policies. Cf. Jeffrey A. Parness & Tait J. Lundgren, Nonparty Insurers in Federal Civil Actions: The Need for New Written Civil Procedure Laws, 36 Creighton L. Rev. 191, 208 (2003) (noting concern about disruption of clear state interest in regulating insurance when federal court adjudicating tort claim seeks to resolve coverage dispute between insured and insurer).
[221] A federal court may occasionally encounter a fee subsidy case that apparently presents no difficult state law issues. See United States v. Weissman, S2 94 Cr. 760 (CSH), 1997 U.S. Dist. Lexis 8540 (S.D.N.Y. June 13, 1997) (construing by-laws and agreement with defendant providing for advancement). However, this ease of decision may be illusory. In Weissman, for example, the court considered whether a defendant who had been convicted of a crime could require the corporation, pursuant to advancement provisions, to pay the defendant's attorney for work done before the conviction. The court held that the corporation had to pay for the work, asserting that any other result would give the corporation an incentive to delay reimbursement in the hope that a guilty verdict would terminate its obligation to pay. Id. at *28-29. In reaching this conclusion, however, the court relied in part on commentary to the Model Business Corporation Act that alluded to the need for the corporation to have authority to advance fees, but said nothing about the corporation's duty to do so. Id. (citing Model Business Corporation Act § 8.53 official cmt. at 252 ("It is often critically important to a director… that the corporation he served have power to make advances at the beginning of and during the proceeding") (emphasis added)). Moreover, the court, while acknowledging the corporation's concern that the defendant would be unable to repay the almost $3 million in legal fees he was receiving, dismissed this concern as irrelevant. See id. at *32. The court could have considered whether state law would require or permit ordering the defendant to post a secured bond under such circumstances. These points demonstrate the risk that a court's determination of the difficulty of state law will be skewed by the felt need to compensate the defendant's lawyer, even in situations where advancement clearly disserves corporate interests, and where the defendant's lawyer could have foreseen uncertainties in her prospects for obtaining a fee.
[222] A federal court may also assert supplemental jurisdiction to "enable [the] court to function successfully… to manage its proceedings, vindicate its authority, and effectuate its decrees." See Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 379-80 (1994), (citing Chambers v. NASCO, 501 U.S. 32 (1991)) (power to compel payment of opponent's attorney's fees as sanction). However, this authority generally extends only to issues intrinsic to a judicial proceeding, such preventing contumacious behavior in court, sanctioning attorneys, and deterring defiance of the court's orders. See Green & Zacharias, supra note 184. Ensuring that a third party pays a party's legal fees does not fit within these constraints.
[223] Cf. Lynn M. Lopucki, Courting Failure: How Competition For Big Cases Is Corrupting The Bankruptcy Courts 19-24 (2005) (describing how bankruptcy judges' concern about maintaining their reputation among high-profile members of the bankruptcy bar skews allocation of bankruptcy matters). Of course, federal district judges, as opposed to bankruptcy judges, are appointed for life. See U.S. Const., art. III. However, even if federal district judges lack the clear instrumental reasons that other judges possess for pleasing members of the bar, cognitive biases may skew district judges' perceptions if they view practicing lawyers as part of their professional community, value interaction with lawyers at bar conferences, and so on. See supra notes 38, 53 and accompanying text (discussing cognitive biases). The subtlety of these influences does not justify exercising jurisdiction where other tribunals lacking such biases, such as state courts and arbitrators, are available. Cf. United States v. Buhler, 278 F. Supp. 2d 1297, 1299-300 (M.D. Fla. 2003) (declining to assert jurisdiction over fee dispute).
[224] In another scenario, counsel might agree to shave off part of their fee, as distressing as such an outcome would be for them. See Baker & Griffith, supra note 12 (discussing how corporations with high deductibles for their D & O coverage are able to extract savings from providers of legal services).
[225] See Morgan & Rotunda, supra note 75, at 123-24, (citing Martin Mayer, The Lawyers 161-62 (1967)) (recounting that veteran lawyers who have not yet been paid routinely obtain continuances by notifying the court that they are waiting for "Mr. Green"). The Stein III court focused on analogous issues by seeking to "ensure" that the Stein defendants, unlike other defendants of limited means in criminal cases, could "afford to pay… counsel to do what they think appropriate." Stein III, 435 F. Supp. 2d at 377-78.
[227] See Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue Shield of New Jersey, 448 F.3d 573, 582 (2d Cir. 2006) (finding that doctors were entitled to reimbursement at customary rate for services rendered to HMO); Manchester Equip. Co., Inc. v. Am. Way Moving & Storage Co., Inc., 176 F. Supp. 2d 239, 245 (D. Del. 2001) (insufficient evidence of parties' intent). See also supra notes 226-228 and accompanying text (discussing Stein III's mischaracterization of state law precedents on implied contract).
[228] See Ayash v. Dana-Farber Cancer Inst., 822 N.E.2d 667, 684 (Mass. 2005), (citing Uno Rest., Inc. v. Boston Kenmore Realty Corp., 805 N.E.2d 957, 964 (Mass. 2004)) (declining to find implied covenant for right of first refusal in real estate transaction, since party could have bargained expressly for this right). Courts have generally limited implied-in-fact contracts in employment to contexts where an employer had terminated an employee in breach of a duty of good faith fairly inferable from the employer's own stated procedures, see Ayash, 822 N.E.2d at 684 , or where the employer had deprived the employee of payment for services that the employee had "fairly earned and legitimately expected," and the employer would otherwise be unjustly enriched. See Maddaloni v. Western Mass. Bus Lines, Inc., 438 N.E.2d 351, 356-57 (Mass. 1982). See also Guz v. Bechtel Nat'l, Inc., 8 P.3d 1089, 1100-12 (Calif. 2000) (limiting doctrine of implied-in-fact contract and implied covenant of good faith in employment setting). Courts have pointedly declined to find that a contract or a contract term to be implied-in-fact creates a "general duty on the part of an employer to act 'nicely.'" See Ayash, 822 N.E.2d at 684. See generally Peter Linzer, Rough Justice: A Theory of Restitution and Reliance, Contracts and Torts, 2001 Wis. L. Rev. 695, 704-08 (discussing relationship between contracts implied-in-fact and unjust enrichment); J. Wilson Parker, At-Will Employment and the Common Law: A Modest Proposal to De-Marginalize Employment Law, 81 Iowa L. Rev. 347, 364-66 (1995) (discussing connection between implied covenant of good faith in employment contracts and creation of implied-in-fact contracts); Stewart J. Schwab, Studying Labor Law and Human Resources in Rhode Island: Remarks on the Occasion of the Creation of a Joint-Degree Program in Law and Labor Relations/Human Resources, 7 Roger Williams U.L. Rev. 383, 388-89 (2002) (analyzing doctrine). Cf. Murphy, supra note 46 (discussing scope of restitution remedy).
[230] In addition, the Stein III court dismissed the arbitration requirement in defendant Stein's severance agreement, despite strong state and federal policies favoring enforcement of arbitration clauses. See Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002); Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983) [Need citation to Stein itself].
[231] See Erie Ry. v. Tompkins, 340 U.S. 64 (1938) (requiring that federal courts defer to state law in diversity cases).
[232] Id. at 75-76. Brandeis, quoting an earlier distinguished jurist, aptly diagnosed the danger, in noting that the "general law" that pre-Erie federal courts invoked to displace state law was often little more than "what the judge… thinks at the time should be the general law on a particular subject… judges have fallen into the habit of [invoking the general law]… as a convenient mode of brushing aside the law of a state in conflict with their views." Id. at 78, (citing Baltimore & Ohio R. Co. v. Baugh, 149 U.S. 368, 401 (1893) (Field, J., dissenting) (criticizing majority's invocation of "general law" to apply fellow servant rule to bar recovery of railroad employee for work-related injuries which would have been compensable under state law)). Cf. New State Ice Co. v. Liebmann, 285 U.S. 262, 280, 310-11 (1932) (Brandeis, J., dissenting) (discussing states as "laboratories" of federalism, entitled to some deference in efforts to regulate business).
Citation
7 U.C. Davis Bus. L.J. 2 (2006)
Copyright
Copr. © Peter Margulies, 2006. All Rights Reserved.
Vol. 7
December 2006
Page
III. FEDERAL RESPONSES TO THE UNDERENFORCEMENT PROBLEM
The foregoing discussion demonstrates that corporate practices of indemnification and advancement of legal fees can exacerbate problems of corporate culture that promote overreaching by some executives. Signaling a decisive turn from the legacy of underenforcement, the Department of Justice has relatively recently begun to focus on the problems of corporate culture that give rise to criminal conduct. A core aspect of this Department of Justice effort is holding corporations accountable as culpable agents on an organizational level, through respondeat superior standards.
Respondeat superior liability developed to promote organizational accountability. Since a corporation was a collective entity that acted through agents, without special legal provisions a corporation could escape accountability by arguing that its agents were engaging in activity beyond the corporation's knowledge. Proving that the board of directors, the highest authority in the corporation, expressly approved of a corporate official's illegal acts would impose a virtually impossible burden on plaintiffs in civil suits or on the government in a criminal prosecution. To address this gap between corporate conduct and available remedies, respondeat superior liability evolved. To prevail on a respondeat superior theory, the government in a criminal case must demonstrate that agents of the corporation acted within the scope of their employment, and acted with the intent of benefiting the corporation.[127]
The virtue of this respondeat superior theory is that the corporation can no longer readily disavow the misconduct of its agents. Instead, the corporation has an incentive to more carefully monitor the conduct of all of its agents and to ensure that the agents' conduct conforms to law. Moreover, the corporation, through its senior managers, is in the best position to create internal organizational norms, both formal and informal, that achieve this result.[128] While vicarious liability - holding one person or entity responsible for the acts of another - may seem to leave a residue of unfairness in the context of criminal law,[129] at this late date in the development of the doctrine, executives who tolerate wrongdoing on their watch can hardly claim surprise. Nor can executives who, as recent juries found in cases such as Enron and WorldCom, engage in fraud. Indeed, the only party with a legitimate complaint is the hapless shareholder, who has little control over the entity, but bears the cost if the corporation is subject to prosecution. The externalities visited on shareholders, however, demonstrate most clearly the importance of aligning management's interests with shareholders' interests through reforms of corporate governance, greater transparency regarding executives' compensation and other factors that maximize agency costs. By encouraging this process, the prospect of respondeat superior liability can contribute to the reform of corporate culture.[130]
In the criminal context, the government has recognized that liability should hinge on the pervasiveness of violations within the entity.[131] The corporate rank of the officials committing misconduct should also be taken into account: more senior officials' misconduct will tend to prove that the inappropriate acts were more pervasive throughout the entity.[132] A corporate criminal case therefore turns on the nature of corporate culture: where factors such as agency costs and moral hazard create an organizational climate conducive to wrongdoing, it is appropriate for the government to consider criminal prosecution.
However, prosecutors may also take into account a range of factors, including the corporation's cooperation with the investigation,[133] its record of compliance with prior government enforcement actions,[134] and the sincerity of its commitment to institutional change.[135] The Thompson Memorandum suggests that prosecutors assessing cooperation and a commitment to change can consider, inter alia, the corporation's willingness to waive attorney-client privilege,[136] its subsidy of executives' legal fees,[137] and its overall treatment of managers who have engaged in wrongdoing.[138] Where these countervailing factors warrant, prosecutors should pursue alternatives to indictment, including entering into a Deferred Prosecution Agreement (DPA) with the company.
IV. UNDERENFORCEMENT'S REVENGE: THE KPMG CASE
Since efforts to shift the status quo often meet with resistance, it is not surprising that the government's effort to end the underenforcement paradigm has encountered serious obstacles. The organized bar and academic commentators have expressed concerns about the fairness of vicarious liability in criminal law,[139] the sometimes unpredictable expansion of coverage of white-collar conduct under federal criminal statutes,[140] and the efficacy of attempts to reform corporate culture through criminal law processes.[141] In United States v. Stein, one court has joined the critics, focusing on the Thompson Memorandum's consequences for individual defendants, in a case related to conceded criminal activity by KPMG, one of the nation's leading accounting firms.[142] Unfortunately, the Stein court got things seriously wrong.
In Stein III, the court held that the Department of Justice's inclusion of concern about payment of attorney's fees, as merely one component in the government's decision about whether to enter into a DPA with a corporation, violated the Fifth and Sixth Amendments.[143] Because of this holding, in Stein IV the court suppressed statements made by two individual defendants.[144] Moreover, the court exercised ancillary jurisdiction over the fee dispute between the individual defendants and the company despite the presence of distinct facts and difficult questions of state law that would usually counsel against supplemental federal jurisdiction.[145] While the decision received significant publicity, its failures of analysis make it a dangerous precedent that will increase agency costs and moral hazard for owners of business organizations, and reduce the government's ability to combat stonewalling of investigations that is disfavored under both the legal ethics rules and substantive law.
a. KPMG's Criminal Activity, the Government's Investigation, and the Court's Decisions
The facts underlying the KPMG case form a textbook example of organizational misconduct and its aftermath. KPMG and the United States Department of Justice entered into a DPA in 2005 in which KPMG acknowledged extensive criminal conduct concerning the marketing of tax shelters and the representations it made to the Internal Revenue Service (IRS) and others concerning the operation of those shelters.[146] In the DPA, which KPMG agreed to over three years after the IRS commenced an investigation of KPMG's tax shelter practices,[147] KPMG admitted that its criminal conduct was "deliberatively approved and perpetrated at the highest levels of KPMG's tax management, and involved dozens of KPMG partners and personnel."[148]
While the short-term focus on marketing tax shelter schemes landed KPMG in hot water, KPMG exacerbated its plight by stonewalling investigators. KPMG entered into the DPA after pursuing a course for an extended period during the investigation that involved "steps… designed to hide its tax shelter activities."[149] Prior to entry into the DPA, KPMG asked a number of senior managers to leave the firm, including Jeffrey Stein, the deputy chair and chief operating officer.[150] After a "very friendly"[151] negotiation with the chair of the company, Stein received a "very generous"[152] severance package that included a three-year consulting agreement that would pay Stein $100,000 per month. The agreement also provided a subsidy for Stein's defense costs.[153] Although this lucrative agreement was concluded by the middle of 2004, the judge noted that "only recently" did KPMG reveal its terms to the government or the court.[154].
Subsequently, Stein and a number of other KPMG executives, partners, and employees were indicted on charges of tax fraud. KPMG and the Justice Department had discussions which alluded to the question of severance packages and advancement of attorney's fees. During these discussions, prosecutors warned KPMG that "wrongdoers shouldn't be rewarded."[155] One prosecutor remarked that the government would carefully scrutinize any claim that KPMG had a legal obligation to advance legal fees to individual defendants.[156]
KPMG subsequently stated that it would cap attorney's fees advanced to all employees involved in the investigation, and cut off such fees for present and former employees who refused to cooperate. Although KPMG had agreed to cap its fees for all personnel at $400,000, KPMG paid Stein almost $650,000 to reimburse him for his lawyer's fees without informing the government.[157] Evidence in the record suggested that the remaining KPMG partners were disturbed that Stein had received a better severance deal than many other KPMG personnel, and that his deal might reflect a broader mishandling of the response to the government's investigation.[158] Other defendants did not have express severance agreements that covered attorney's fees and apparently did not have insurance that would reimburse these costs.[159] However, at least one of these defendants still retained substantial assets. The court found that this defendant was a flight risk who should be denied bail because he had $20 million in available assets, much of which he had concealed through a tangled web of financial transactions for the apparent purpose of thwarting plaintiffs in civil suits.[160]
Analyzing this situation, the court made two significant rulings. First, it found in June 2006, that the existence of the Thompson Memorandum and references to the Memorandum by prosecutors in the case had pressured KPMG to cap or deny fees to the individual defendants. The court held that this pressure violated the Fifth and Sixth Amendments. In its decision, which the media and some commentators asserted was a broad rebuke to the government's approach to corporate criminal prosecutions, the court also exercised ancillary jurisdiction over claims for the advancement of legal fees made by the individual defendants against KPMG and suggested, without deciding, that the defendants might prevail on this point with an implied contract theory. Second, in July 2006, the court held that KPMG had acted as the government's agent in conditioning advancement of attorney's fees and one defendant's continued employment on cooperation with prosecutors.[161] Accordingly, the court suppressed as involuntary under the Fifth Amendment the statements made by two individual defendants in proffer sessions with the government.
b. Stein and the Constitutionalization of Agency Costs
The Stein decisions dovetail neatly with the crescendo of indignation about the Thompson Memorandum expressed by commentators and defenders of the status quo. Unfortunately, the Stein court's reasoning does not withstand careful analysis of the problems posed by unlimited subsidy of legal fees for executives in criminal cases. Indeed, the facts in Stein amount to a cautionary tale about the intractability of those problems.
First, Stein amply illustrates the basis for the concern regarding "factor payments" that underlies RICO and legal ethics. KPMG had declined to cooperate with the government for an extended period, and indeed had resisted, in both its factual and legal positions, the investigation in a fashion that another federal court had found to be disingenuous. KPMG had also granted a lucrative severance package to the highest-ranking manager implicated in the tax shelter scandal and had concealed this agreement from prosecutors and from the court. KPMG's behavior thus had all the earmarks of a "circle the wagons"[162] approach to the government's investigation, in which the firm bought the good will of potential adverse witnesses. Such a strategy could also feature attorneys selected and funded by KPMG to stonewall the government's future efforts. While KPMG sought to change its tune once it became clear that this stonewalling strategy was untenable, it continued to hold out on the government, particularly regarding the generous terms of its severance agreement with former COO Stein.[163] On these facts, it was appropriate for the government to insist that KPMG definitively demonstrate its intent to abandon the stonewalling strategy by requiring employees to cooperate with the government's investigation, and limiting or eliminating the advancement of attorney's fees.
Second, both the Stein severance agreement and the unlimited subsidy of attorney's fees to individual defendants imposed substantial agency costs on KPMG. The Stein severance agreement, by suggesting that KPMG had been less than wholehearted in "cleaning house," potentially jeopardized the DPA. So did the intransigence of a number of KPMG employees, who resisted even scheduling interviews with prosecutors, yet expected that they would keep their jobs with a company that would have incurred enormous costs and possibly faced extinction if it continued to stonewall.[164] Moreover, the total exposure of KPMG for advancement of legal fees could have easily exceeded $20 million,[165] with little prospect that any of this money would have been repaid. In this setting, a company that sought to end its "consulting" arrangement with Stein[166] and limit subsidy of attorney's fees if it had the legal capacity to do so would merely be exercising sound business judgment.
In contrast to this view of what a prudent prosecutor and a business organization seeking to minimize agency costs would want, the court's legal holdings are difficult to support. While the court asserted that the defendants have a Sixth Amendment right to advancement of legal fees, precedent holds only that the defendant has a right to "spend his own money" to secure counsel.[167] When, as here, the defendants' legal claims to advancement from the company are questionable, the government does not violate the Sixth Amendment if it strongly recommends that an entity receiving such claims analyze them fully. This is especially the case when that entity is also seeking a favorable plea deal because of an acknowledged history of illegality and lack of cooperation. This is not a case where the government seeks to disqualify or otherwise remove a particular attorney without good cause.[168] Nor is it a case where the government has sought to deprive a defendant of a fair trial by declining to disclose exculpatory evidence, or by depriving the defendant of access to witnesses within the government's control.
The court also asserted that the government interfered with the fundamental fairness of a criminal proceeding, in violation of the Fifth Amendment. As a matter of substantive due process, however, courts have typically required a showing of far more intrusive behavior, such as physical coercion.[169] Any government pressure here, in contrast, focused merely on the company's declining to do what (with the possible exception of its agreement with defendant Stein) it had never bound itself to do in the first place.[170]
This point also disposes of the procedural due process issue. The government's conduct would have raised substantial issues if prosecutors had pressured KPMG to breach clear legal obligations to the individual defendants. Here, however, those obligations were (again with the possible exception of Stein) decidedly unclear.[171] The court argued that an organization's interest in recruiting qualified managers supports guarantees of advancement. However, a business organization could also decide that unlimited advancement increases agency costs and moral hazard, stems from a race to the bottom that hurts the owners of the company, and skews discourse in ways that unduly discount long-term perspectives. Absent clear law mandating advancement, no federal interest - constitutional or otherwise - requires that companies choose the former course over the latter. Indeed, important federal interests in transparency would counsel the latter, at least when an organizational defendant is also an issuer of securities.[172]
The same disregard for legitimate government and corporate prerogatives pervades the court's decision in Stein IV, which suppressed as involuntary proffer statements by managers whom KPMG had threatened with termination or cessation of fee subsidies. Here, the company's governance concerns interact with the government's legitimate concerns about cooperation to permit a wide range of company responses to the prospect of indictment. The Stein IV court ignored these neutral justifications and conflated two lines of cases. One line of cases concerns the kind of pressure that government can exert on a company to force its employees to cooperate.[173] The other line addresses the nexus between a government investigation and an investigation by a business self-regulatory group such as the National Association of Securities Dealers (NASD) or the New York Stock Exchange (NYSE).[174] The court mixes and matches these two lines of cases to arrive at a result that is appropriate under neither.
Under the Garrity v. New Jersey line of cases, a court considers whether the government's leverage against the employer is extrinsic to the potential indictment and compels the imposition of substantial lasting economic harm. While these cases invoke Fifth Amendment rights, they are best viewed as procedural due process cases regarding the imposition of sanctions without an opportunity for a hearing. In Garrity,[175] for example, which involved the investigation of police officers for allegedly fixing traffic tickets, a statute required that an individual holding any public office who refused to cooperate with an investigation forfeit his employment, including vested pension rights.[176] The Supreme Court focused on the statute's requirement of forfeiture, which occurred without any hearing on whether the officer had committed underlying acts that would merit such a drastic penalty.[177]
In Stein IV, the government did not threaten to impose sanctions that would compel direct economic harm to KPMG. This distinguishes the government's conduct from the conduct at issue in the Garrity line of cases, which hinged on the statutorily compelled forfeiture of pension rights, professional licenses, or valuable contracts. Of course, in Stein, prosecutors knew that an indictment would have consequences. However, an indictment does not legally compel such consequences, which flow instead from a crystallization of existing concerns about a company's reputation. Unless the Constitution is read to bar all indictments that have adverse collateral impacts on defendants, the prospect of an indictment for a business organization should have no greater significance under the Constitution than the indictment of any other person or entity. Nor is an indictment final and unreviewable,[178] as were the sanctions imposed in Garrity and its progeny. This distinction between economic harm that is foreseeable in the marketplace and harm that is legally required by the state places Stein outside the Garrity line of cases. Moreover, employers such as KPMG generally have the right to discipline employees for violating workplace rules, including rules that require compliance with investigative procedures.[179] A company like KPMG that delays conducting its own investigation, and awaits investigation by the government, should not lose that prerogative.[180]
The Stein IV decision is similarly inapposite in its citation of cases dealing with involuntariness caused by interaction between government and self-regulatory enforcement efforts. In these cases, courts balance two concerns. Courts strive to preserve the ability of self-regulatory bodies like the NASD, which can impose sanctions that threaten an investigatory target's livelihood, to perform their task of policing behavior within a regulated industry. However, courts do not allow government to circumvent Fifth Amendment constraints through a clear pattern of tactical collusion with such self-regulatory entities. Generally, to preserve robust industry self-regulation, courts have tolerated a significant degree of interaction between self-regulatory entities and the government, absent concrete proof that the entity and the government colluded on a specific tactical level, for example through collaboration in the entity-compelled questioning of a target.[181]
The collaboration between the prosecutors and KPMG in Stein IV does not meet this standard. The court points only to the publication of the Thompson Memorandum, the statement by a prosecutor that fee subsidies would be viewed "under a microscope,"[182] and the prosecutors' reporting to KPMG the names of employees who had refused to participate in proffer sessions.[183] Even if the prosecutors believed that KPMG would threaten termination or cessation of fee subsidies as a result, interactions of this kind do not rise to the level of close tactical collaboration required.[184]
V. SELF-GOVERNMENT, FEE SUBSIDIES, AND THE COURTS
The Stein court ultimately failed to realize that placing limits on fee subsidies for corporate executives facing criminal charges is a matter of self-government for both business organizations and the polity itself. Courts have a significant role to play in this ongoing process of self-governance, but - particularly for federal courts - a respect for the boundaries of that role is crucial. Dealing with the agency costs that wayward executives impose on shareholders requires recognition of the interdependence of government enforcement and corporate reform - an interdependence heralded by commentators and jurists of the New Deal era. In a climate of burgeoning agency costs, a shift toward government enforcement is necessary to promote sound corporate governance. Government enforcement also moderates the political distortions wrought by executive overreaching. Of course, enforcement has boundaries, too, which courts should police. However, a federal court that is too eager to reshape enforcement policy risks undermining sound governance for the business organization, states, and the public. Responding to these concerns, this section outlines appropriate roles for prosecutors, corporations, and the federal courts on the issue of legal fee subsidies in criminal cases.
a. Prosecutors' Interests in Limiting Fee Subsidies
Prosecutors and regulators deciding whether to indict need significant flexibility in defining what counts as cooperation. Flexibility at the charging stage is an essential tool for tempering the impact of broad language of penal statutes with equitable consideration for the "unique facts and circumstances of particular cases."[185] Moreover, prosecutors are in the best position to assess the nature and scope of information that their investigation requires, in light of the resources available.[186]
Although the complaint that prosecutors have too much discretion at the charging stage is probably as old as the discretion itself,[187] the alternatives are even more problematic. Ceding discretion to Congress to decide who to prosecute in a particular case would clash with the constitutional bar on bills of attainder, increasing the influences of politics and posturing in charging decisions.[188] While judges assess cooperation and other factors in sentencing, allowing the judge to oversee the charging process would move American justice from an adversarial to an inquisitorial model,[189] merging prosecutorial and judicial functions in a fashion at odds with the checks and balances that the Framers envisioned.[190] Conferring significant, although not unlimited, discretion on prosecutors at the charging stage best matches expertise and constitutional imperatives.
A prosecutor's opportunity to assess cooperation in the context of organizational crime is even more important than similar discretion in the context of an individual defendant. Collective entities such as corporations generate a massive paper trail, while attempts to reconstruct events are frustrated by multiple players telling different stories.[191] Selecting the wheat from the chaff requires cooperation from the entity.
Prosecutors also legitimately value cooperation in the organizational arena because it signals a lower risk of recidivism. In the corporate area, cooperation can amount to a new charter for doing business, bringing new emphases to transparency and strong internal controls.[192] The benefits of such organizational change accrue to all stakeholders in the corporation, including shareholders, employees, and customers. Reducing the likelihood of future wrongdoing also allows prosecutors and regulators to more efficiently allocate scarce enforcement resources.
For these reasons, prosecutors act appropriately when they set conditions of cooperation for collective entities that are reasonably related to the goals of promoting thorough investigations and preventing recidivism. While a complete ban on subsidy of legal fees in criminal cases might not be adequately tailored to these goals, prosecutors should not be burdened with a requirement that they adduce specific, concrete proof of an ongoing conspiracy of silence. A history of noncooperation, like that concededly exhibited by KPMG, warrants prophylactic efforts to limit legal fee subsidies,[193] particularly since such limits also serve the interests of shareholders by reducing agency costs.[194] Moreover, such limits are neutral; they do not allow the government to veto a defendant's particular choice of defense counsel.[195] Similarly, prosecutors should be free to seek clear evidence of organizational change, including changes in corporate personnel. The replacement of executives who have a stake in the status quo with executives committed to reform is a crucial signal of organizational commitment. In cases of pervasive and egregious collective wrongdoing, of the kind that KPMG acknowledged in its DPA with the government, a prudent prosecutor would rarely settle for less.[196]
b. Corporate Governance Aided by Government Action
Cooperation, including limits on fee subsidies, can also re-frame the relationship between government and the corporation. For the Stein IV court, the relationship is purely instrumental: a corporation cooperates to save itself. However, as theorists of cooperation have observed, cooperation is also a constitutive endeavor, premised on a transformation in organizational habit, perspective, and self-definition.[197]. If the agency costs and moral hazard encouraged by fee subsidies and underenforcement corrupt corporate governance, cooperation with the government in rooting out these risks restores governance focused on shareholder interests.
Limiting legal fee subsidies in criminal cases promotes sound organizational governance both ex ante and ex post. Ex ante, limiting fee subsidies sends a sobering message that executives should avoid conduct that violates legal norms. Managers facing the possibility of contributing to their own legal defense will be more likely to deliberate about long-term costs and consequences, as well as the propriety, of their actions. As a result, corporate discourse may shift from an Enron-like riff on the obsolescence of conventional metrics such as price-earnings ratios to a more measured conversation.[198] This deliberative shift will reduce agency costs to shareholders, who typically bear the consequences when executives opt for short-term results.[199]
Moreover, ex post, avoiding further diminution of shareholder value is an important and neutral policy. Further waste only adds insult to injury, as shareholders typically see the value of their shares plummet in corporate crisis. Legal fees can multiply in corporate prosecutions, with total corporate exposure (absent D & O insurance, which has its own externalities for shareholders) ranging readily into millions of dollars. Some might persist in regarding such amounts as mere "pocket change." However, this cavalier attitude toward costs echoes the moral hazard combatted by limits on fee subsidies.[200]
Viewed in this light, the corporate housecleaning catalyzed by government investigations is not merely an instrumental activity, but a return to first principles. This is surely the premise of William O. Douglas's comment, while Chair of the SEC, that private entities like the stock exchanges (and by implication, corporations themselves) should "take the leadership with Government playing a residual role… keep[ing] the shotgun, so to speak, behind the door, loaded, well-oiled, cleaned, ready for use but with the hope it would never have to be used."[201] As Judge Friendly noted in an opinion holding that the use of sanctions by the New York Stock Exchange to compel cooperation did not violate the Fifth Amendment even when those statements were subsequently used in a criminal prosecution, government authority is a necessary adjunct of corporate self-governance.[202] For Judge Friendly, government was given authority by Congress[203] to make sure that private entities "diligently and effectively used… the 'traditional process of self-regulation'" to promote enforcement and avoid threats to corporate integrity.[204] In other words, government holds out the carrot and stick to remind the company that its first obligation is to its owners.
A corporation that wished to avoid the agency costs and moral hazard associated with unlimited fee subsidies could impose a cap tied to the income of its employees. For example, a company could advance up to $250,000 in legal fees to employees whose salary was equal to or less than that amount. The corporation would pay a descending fraction of legal costs for other employees, up to a salary of $1 million. Such a strategy could limit the corporation's maximum exposure for any employee to $500,000, a manageable ex post loss prevention strategy.[205] It would also reduce hardship for lower- and mid-level employees, and defray some costs for senior executives.[206] Moreover, senior executives would be free to rely on past compensation from the corporation to fund the bulk of their own defense.[207]
c. Fee Subsidies and the Jurisdiction of Federal Courts
To further self-government, not only at the level of the separation of powers and the corporation, but also with regard to federalism concerns, federal courts should hold that they lack ancillary jurisdiction over fee disputes between lawyers and third parties. The "ill-defined concept of ancillary jurisdiction" should be carefully cabined, to avoid trenching on federalism values.[208] Failing to curtail ancillary jurisdiction in fee advancement matters creates serious tensions with the limited grant of authority conferred on federal courts under Article III, and potentially with state primacy in the regulation of insurance.[209] Moreover, the heedless exercise of ancillary jurisdiction can also frustrate important federal policies, such as the policy favoring transparency under the securities laws and the policy favoring arbitration. Most seriously, as the Stein III opinion demonstrates, the manifest interest of federal courts in keeping lawyers in the criminal case subtly sways judges to depart from accepted interpretations of state law to reach this result, covertly creating a distinct body of federal common law in tension with Erie.
The best way to cabin ancillary jurisdiction in the area of fee disputes is for courts to insist on the venerable standard of a "common nucleus of operative facts."[210] Generally, claims meet this standard if they "would ordinarily be expected to be tried in one judicial proceeding."[211] When the standard is met, concerns of judicial economy would justify the exercise of ancillary jurisdiction. When factual connections are more attenuated, however, the exercise of ancillary jurisdiction in fee disputes risks misinterpretation of state law and disruptions in the expectations of parties who should be allowed to order their affairs without federal court intervention.[212]
In criminal cases, courts have traditionally exercised ancillary jurisdiction to decide matters that emerge out of the same nucleus of facts and concern property controlled by the court. For example, courts will entertain a defendant's post-trial petition for return of property seized by the government.[213] However, federal courts will usually decline to decide disputes about additional agreements between defendants and third parties, because such disputes are not directly related to the underlying case, and are also more likely to involve difficult questions of state law in which the court has limited expertise.[214] For example, a court will order a bail bondsman to restore collateral for the bond to the defendant.[215] However, a court will decline to decide the merits of a contractual dispute between the bail bondsman and the defendant about the premium paid to obtain the bond.[216]
A court also appropriately exercises ancillary jurisdiction over matters, including fee disputes, concerning the obligations of a party toward the attorney appearing on the party's behalf. Such disputes ultimately involve the integrity of judicial proceedings, and the "court['s]… responsibility to protect its own officers."[217] Consider a case in which an attorney seeks reimbursement from the client for work done in proceedings presided over by the court. A court has seen the attorney's work, and is well situated to judge its value. Moreover, the court cannot allow a party to the case to unjustly enrich herself by benefiting from an attorney's advocacy before the tribunal, and then refusing to pay an agreed-upon amount. Without this authority, the court would in essence become complicit in the party's stiffing of the attorney, since the party's incentive to pay vanishes upon the trial's completion and an ingenious party can also use the time elapsed during the trial to conceal assets.[218]
Disputes involving the amount of payments by third parties to lawyers lack this unjust enrichment rationale, and frequently involve difficult questions of state law that a federal court should leave to state tribunals.[219] To decide a fee advancement issue, the court must make sense of a "patchwork"[220] that includes state law, corporate by-laws, and contractual arrangements - none of which would ordinarily fall within the subject matter jurisdiction of the federal courts.[221] The court may easily miss the nuances of this situation. Moreover, the costs of error in such cases are large: fee subsidies can involve substantial obligations imposed on corporations or partnerships, running into the tens of millions of dollars. Expending these funds on advancement has opportunity costs, hindering corporations that are already expending substantial resources to pay a federal fine from undertaking other activities that their managers believe are important for shareholders.[222]
The court's decision in Stein III shows that federal courts are hardly immune to erroneous interpretations of state law on issues such as fee advancement. A federal court has a built-in bias in favor of finding a right to advancement in such cases, because of the court's stake in avoiding any uncertainty about the availability of current counsel, its concerns about equality in defendants' treatment, and its reluctance to appear insensitive to the financial needs of members of the defense bar who regularly appear before it.[223] No court wants to precipitate substitution of counsel, even when limiting fee advancement will not necessarily lead to that result.[224] Moreover, the court, faced with a situation where one defendant, possibly a senior manager such as Jeffrey Stein, may have a contract that requires advancement, but other, more junior defendants lack this recourse, will be tempted to treat all defendants equally. Finally, vivid anecdotal evidence suggests that courts are willing to take steps such as continuing proceedings to ensure that counsel gets paid, even when a continuance may prejudice a defendant's interests.[225] A court is surely even more willing to take such steps when a defendant's and counsel's interests are aligned.
This tendency resulted in the Stein III court's misguided foray into the law of implied-in-fact contracts. The court suggested that junior managers might have an implied contract claim for fee subsidies,[226] even though the implied contract cases the court cited hinged on clear evidence of intent derived from a course of dealing between the parties that was not present in the instant case.[227] The court also ignored the caution from cases finding implied-in-fact contract terms in the employment setting that courts should not invoke the doctrine to "create rights and duties not otherwise provided for in the existing contractual relationship."[228] State courts have limited the reach of the doctrine to preserve stability in individual employment contracts.[229] Federal courts that expand the doctrine disrupt a balance of interests painstakingly calibrated under state law.[230]
When institutional biases in the federal courts drive misinterpretation of state court precedent, ancillary jurisdiction poses a challenge to Erie itself.[231] Any court can make mistakes, but a systemic tendency in federal court to misconstrue state sources of authority resembles a clandestine turn toward federal common law. As Brandeis noted in Erie, the subtleties and variations of state law are part of the fabric of American self-government.[232] Federal courts seeking to exercise their authority within the parameters set by Article III may make common law where it is consistent with their role, but should steer well clear of temptation where state law supplies a constitutionally mandated rule of decision. Here respecting the interests of prosecutors and corporations in the substantive ramifications of fee subsidies suggests the need for judicial self-restraint.
VI. CONCLUSION
Sometimes the march of time creates an illusion of consensus around certain legal arrangements. However, this consensus can be more fragile than it initially appears. In times of scandal, such as the corporate scandals surrounding Enron and WorldCom, earlier questions about such practices regain currency. The debate about corporate advancement of attorney's fees, insurance, and indemnification in criminal cases is a pointed example.
Advancement of fees and related practices, while necessary in some contexts, engender agency costs and moral hazard. Senior executives who succumb to the lure of enrichment at shareholders' expense rely on advancement and related practices as devices that will shield them from accountability. For such executives, advancement and related practices are elements of compensation, often negotiated at less than arm's length, with virtually no transparency for shareholders or government regulators acting on shareholders' behalf. Errant executives can also use fee subsidies to subordinates to encourage stonewalling government investigations. Boards that are beholden to management eagerly accept such provisions, despite their costs for corporations, in a race to the bottom for executive talent. Fee subsidies also create tension with both legal ethics and substantive law. Nevertheless, over time, cognitive biases and input from segments of the ABA shaping the perceived attributes of the "modern" corporation have accorded fee subsidies the dignity of conventional wisdom.
Such assumptions did not lack for critics decades ago. New Dealers like William O. Douglas, while agreeing that corporate executives needed protection from frivolous suits, wrote about the need for greater structural protections against executive self-dealing and coziness with corporate boards. For the New Dealers, exposing errant executives to some of the risks posed by their own conduct was a bracing antidote to the agency costs and moral hazard described above. These commentators recognized that sound corporate governance, like constitutionalism itself, depended on precommitment to a long-term perspective sufficiently robust to withstand the lure of short-term gain.
After a disheartening period of underenforcement by government helped pave the way for Enron and related scandals, prosecutors and regulators have recently exhibited a more robust approach to executive misconduct. This approach, articulated in the Thompson Memorandum, uses the powerful weapon of criminal law enforcement to encourage corporations to police themselves. Particularly where a business organization has a track record of resisting investigations, prosecutors appropriately regard changing corporate personnel and limiting fee subsidies as signals that the company wishes to cooperate fully and prevent recurrences of misconduct.
Critics of the government's robust turn in enforcement policy argue that the threat of indictment in such cases constitutes government overreaching. The Stein court, for example, asserted that the mere publication of the Thompson Memorandum, together with a handful of follow-up statements by prosecutors, amounted to government coercion in violation of the Fifth and Sixth Amendments. However, the Stein court and other critics of the government's enforcement policy ignore the agency costs and moral hazard triggered by fee subsidies. In ignoring these problems, critics also miss the most fundamental issues of governance - both private and public - posed by executive misconduct, and misperceive the appropriate role for federal courts presiding over such cases.
While critics charge that business organizations like KPMG that change personnel and limit fee subsidies to head off an indictment are merely acting instrumentally, this claim misapprehends the interaction of government and business organizations since the New Deal, and proves too much. The New Deal understanding of the interaction of business and government suggested that the power of the government was a necessary adjunct to vigorous business self-regulation. Companies that reduce the agency costs and moral hazard induced by fee subsidies are returning to the first principles of corporate governance that overreaching executives abandoned. The need for a wake-up call to the company, in the form of an imminent indictment, may be a sad commentary on the fragility of sound governance. However, it does not vitiate the promise of genuine reforms undertaken by the organization. Of course, it is possible that the organization is acting purely instrumentally, to placate the government and avoid the full consequences of past misconduct. To this extent, however, the government is more than justified in seeking personnel change and limits to fee subsidies as a guarantee of cooperation and a hedge against future backsliding by the corporation.
Federal court decisions like Stein III and IV that stifle this process ignore principles of sound corporate governance, as well as the federal interest in transparency for business organizations. A decision like Stein III, with its creeping expansion of ancillary jurisdiction, also immerses the federal courts in contractual disputes that are best left to arbitration and to state courts. Moreover, by interpreting state contract law through the lens of the court's interest in uninterrupted funding of the defendant's chosen counsel, the court risks creating a body of federal common law on fee disputes that exists in subtle but unmistakable tension with Erie.
Corporations that are serious about reducing agency costs need not eliminate all fee subsidies. In the modern corporation, such a step would radically thin the talent pool for managerial positions, and unduly bias executives toward risk-averse behavior. However, a corporation should cap its fee subsidies in criminal proceedings. In addition, regulators should require full disclosure of the terms of the corporation's D & O insurance, and the record of premiums paid. State courts should construe ambiguous contracts for indemnification and fee subsidies in favor of the owners of the corporation, viewing such agreements as elements of a compensation package in which the executive is well-situated to bargain with a friendly board, not insurance in the arm's length sense of the term.
Ultimately, combating the agency costs and moral hazard posed by fee subsidies demonstrates the complementary relationship of self-governance in the polity and the boardroom. When government ignores risks to shareholders posed by underenforcement, it also becomes a tacit accomplice in financial harm to investors, imposing a covert tax through underenforcement. Underenforcement is also a signal that overreaching business executives have attained too much power over the terms of public discourse. However, when underenforcement damages the integrity of business organizations, it also in the long-term undermines the ability of business to act as a counterweight to an overreaching government. Eventually, as Enron demonstrated, the evidence of corporate insider excess becomes impossible to ignore. The result may be over-regulation, such as the glut of paper plaguing small corporations that a broad range of commentators have criticized as a consequence of the Sarbanes-Oxley Act. In contrast, when corporations hold themselves in check, the polity avoids the convulsions of blame directed at the privileged that the Framers warned can distort democracy. On this view, curbing the agency costs caused by excessive fee subsidies contributes to the stability of both business organizations and the polity itself.
For Part I of this article, click here
[127] See United States v. Automated Medical Laboratories, 770 F.2d 399 (4th Cir. 1985). See generally Samuel A. Buell, The Blaming Function of Entity Criminal Liability, 81 Ind. L.J. 473, 488-90 (2006) (discussing theory of vicarious criminal liability in corporate setting).
[129] Cf. id. at 404 (arguing that corporate punishments, such as exorbitant fines, can also create negative externalities, such as layoffs, plant closings, and hardship to the corporation's shareholders, creditors, and suppliers).
[130] It is especially useful at highlighting the risks to the corporation of encouraging corporate agents to act only in their short-term best interests, and in the short-term interests of the company. The conduct of corporate officials, such as Enron's, who, see Regan, supra note 15, at 1147-49, promote short-term gains at the expense of long-term business integrity, and cut legal corners as a result, can give rise to respondeat superior liability. In such cases, the fact that corporate officials also may have promoted their own interests does not rebut the argument that these officials also intended to benefit the corporation.
[133] Id. at 5. Cf. Christopher A. Wray & Robert K. Hur, Corporate Criminal Prosecutions in a Post-Enron World: The Thompson Memorandum in Theory and Practice, 43 Am. Crim. L. Rev. 1095, 1135-37 (2006) (discussing positive effect of new enforcement policy on cooperation by corporations).
[135] Id. at 6-9. But see John S. Baker, Jr., Reforming Corporations Through Threats of Federal Prosecution, 89 Cornell L. Rev. 310, 316-20 (2004) (expressing skepticism about appropriateness and efficacy of "good corporate citizen" goal of prosecutors).
[136] See Thompson Memorandum, supra note 2, at 5. Cf. Lonnie T. Brown, Jr., Reconsidering the Corporate Attorney-Client Privilege: A Response to the Compelled-Voluntary Waiver Paradox, 34 Hof. L. Rev. 897, 935-46 (2006) (discussing implementation and effects of DOJ policy). Of course, to prevail on any substantive charge, such as obstruction, prosecutors must prove all of the elements of the charge, including intent to impede an investigation. See Arthur Andersen, LLP v. United States, 544 U.S. 696 (2005); United States v. Quattrone, 441 F.3d 153 (2d Cir. 2006).
[139] See John Hasnas, Ethics and the Problem of White Collar Crime, 54 Am. U.L. Rev. 579 (2005); Brief of Sec. Indus. Ass'n as Amici Curiae, supra note 70.
[140] Id. Cf. Lawrence M. Solan, Statutory Inflation and Institutional Choice, 44 Wm. & Mary L. Rev. 2209, 2236-60 (2003) (discussing factors that broaden the scope of federal criminal liability).
[142] See United States v. Stein (Stein III), 435 F. Supp. 2d 330 (S.D.N.Y. 2006), United States v. Stein (Stein IV), S1 05 Crim. 0888 (LAK), 2006 U.S. Dist. Lexis 49435 (S.D.N.Y. July 20, 2006).
[146] Id. at 349. See also United States v. Stein (Stein I), S1 05 Crim. 0888 (LAK) 2005 U.S. Dist. LEXIS 27812 (S.D.N.Y. Nov. 14, 2005), Government's Post-Hearing Memorandum on Issues Concerning the Defendants' Right to Counsel (submitted May 22, 2006) [hereinafter Government's May 22, 2006 Brief] at 14 n. 10 (quoting from DPA) (copy on file with the author). See generally Rostain, supra note 51, at 84-92 (discussing abuses in the marketing of tax shelters).
[147] See Stein III 435 F. Supp. 2d at 338. Shortly after the IRS began its investigation, the United States Senate held hearings about the tax shelter industry, during which a bi-partisan group of senators criticized tax shelter practices generally, and KPMG in particular. Id. For example, Senator Coleman, Republican of Minnesota, observed that "the ethical standards of the legal and accounting profession have been pushed, prodded, bent and, in some cases, broken, for enormous monetary gain." Id. (citing U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and Financial Professionals, Hearings Before the Permanent Subcomm. On Investigation of the S. Comm on Governmental Affairs, 108th Cong. 2 (2003) [hereinafter Subcomm. Hearings]). Senator Levin, Democrat of Michigan, advised a KPMG witness to "try an honest answer." Id., (citing Subcomm. Hearings at 43).
[148] Government's May 22, 2006 Brief, supra note 146, at 14 n. 10, (quoting KPMG-DOJ DPA, Statement of Facts, Para. 3).
[149] See United States v. KPMG, LLP, 316 F. Supp. 2d 30, 37-38 (D.D.C. 2004). These steps included making spurious claims of privilege with respect to documents that KPMG argued constituted advice to particular clients, but that the court found were presumptively unrelated to individual clients, and instead were "nothing more than an orchestrated extension of KPMG's marketing machine" for tax shelter products.
[153] KPMG also agreed to indemnify Stein, except as to "willful or intentional unlawful acts." Id. In addition, the agreement provided for arbitration of any dispute concerning its terms. See Government's May 22, 2006 Brief, supra note 146, at 31.
[156] Id. at 344 (finding that prosecutor warned that his office would examine KPMG's duty to advance fees "under a microscope").
[157] Id. at 347-48. KPMG, according to the court, came to view the Stein severance agreement as "something of a ticking bomb," that might sour the government on the DPA. Id. KPMG also attempted to characterize some of the $650,000 advanced to Stein in legal fees as defense of civil litigation, although it was later forced to stipulate that the entire amount reflected advancement of legal fees in the criminal case against Stein. Id. at 348 n. 74.
[160] See Stein I, 2005 U.S. Dist. Lexis 27812 at *22 (discussing bail request of defendant David Greenberg).
[163] The government would also have acted reasonably in entertaining suspicions that David Greenberg, whom the court specifically found had concealed a large array of assets to protect them from private plaintiffs and from criminal penalties or forfeiture efforts, had used the instrumentalities of the firm to accomplish this goal.
[164] As it was, KPMG paid a fine of almost $500 million, as well as agreeing to a corporate monitor and a range of other reforms, as part of the DPA. See Stein III, 435 F. Supp. 2d at 349.
[165] This figure is derived from defendant David Greenberg's payment of a $2 million retainer to his counsel, as well as the presence of more than ten individual defendants in the case.
[166] See supra notes 151-152 and accompanying text (discussing camouflage of essentially gratuitous payments as consulting agreements).
[167] Caplin & Drysdale, Chartered v. United States, 491 U.S. 617, 626 (1989) (emphasis added) (upholding federal attorney's fee forfeiture provisions, where fee was fruit of illegal activity).
[168] This distinguishes the Stein case from the case of United States v. Gonzalez-Lopez, 126 S. Ct. 2557 (2006), that the court cites. Stein III, 435 F. Supp. 2d at 369 n. 190. In Gonzalez-Lopez, the Supreme Court actually addressed a very different issue - the showing required of a defendant to vacate a conviction when the trial court had improperly disqualified defense counsel. The Gonzalez-Lopez Court ruled that the defendant did not have to show prejudice in such a case. The Stein court rightly denied the government's motion to disqualify a law firm that had previously represented a KPMG employee now cooperating with the government. See United States v. Stein, 410 F. Supp. 2d 316 (S.D.N.Y. 2006) (Stein II) (holding that client could waive conflict, if he retained standby counsel to cross-examine any of firm's former clients, when former clients did not object, there were a small number of attorneys who did criminal tax work, and other attorneys would also be potentially conflicted out by their representation of other defendants in the case).
[169] Indeed, the Court has recently minimized the coercive effect of more extreme government conduct, such as temporarily withholding treatment for a suspect undergoing emergency medical care, and emphasized the government's legitimate need to obtain information in exigent circumstances. See Chavez v. Martinez, 538 U.S. 760 (2003). Cf. John T. Parry, Escalation and Necessity: Defining Torture at Home and Abroad, in Torture: A Collection 145, 151-52 (Sanford Levinson ed., 2004) (critiquing Chavez). For examples of egregious conduct by the government that violated the physical integrity of a defendant, see Rochin v. California, 342 U.S. 165 (1952) (holding that police violated substantive due process through conduct that "shocked the conscience," including pumping suspect's stomach without his consent).
[170] Defendant Stein may have been in a somewhat different position, because of the terms of his severance agreement. However, the court did not find that the government was aware of this agreement; indeed, it acknowledges that KPMG took steps to conceal the agreement's terms from prosecutors, the courts, and the public.
[171] Indeed, the court implicitly recognized the lack of clarity regarding KPMG's obligation to advance fees by resorting to a theory of implied contract in its analysis of KPMG's obligation to advance legal fees. Stein III, 435 F. Supp. 2d at 356 n. 119. As the cases cited by the court indicate, implied contract rests on clear evidence of the parties' intent manifested through a consistent course of conduct. See Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue Shield of New Jersey, 448 F.3d 573, 582 (2d Cir. 2006) (holding that doctors who had received reimbursement from an HMO for an extended period for performing various medical procedures were entitled to receive reimbursement at the same rate for procedures recently performed); Manchester Equip. Co., Inc. v. Am. Way Moving & Storage Co., Inc., 176 F. Supp. 2d 239, 245 (D. Del. 2001) (finding that evidence of parties' intent was insufficient). KPMG's modest experience with criminal matters, encompassing its apparent subsidy of legal fees in a 1970's prosecution and a recent SEC investigation, does not demonstrate the clarity courts require. A court could find the existence of an implied contract in a setting involving a fee dispute between a lawyer and client where, for example, the lawyer had worked for the client in the past for a set fee, and had just performed additional work. However, KPMG did not have this kind of special "repeat-player" relationship with any of the attorneys that the individual defendants retained in Stein. Indeed, KPMG's express capping of attorney's fees to defense lawyers would trump any evidence of prior contrary intent.
[174] See, e.g., D.L. Cromwell Investments, Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162-63 (2d Cir. 2002).
[177] See also Lefkowitz v. Turley, 414 U.S. 70 (1973) (holding that statements were coerced when the state invoked a state law canceling contracts and imposing a five year bar on future business with a contractor who refused to cooperate or order his employees to do so); Spevack v. Klein, 385 U.S. 511 (1967) (holding that statement by attorney was involuntary under the Fifth Amendment when state extracted it pursuant to a statute that authorized disbarment of an attorney who failed to cooperate in an investigation)
[178] See Gerard E. Lynch, Our Administrative System of Criminal Justice, 66 Fordham L. Rev. 2117 (1998) (arguing, in light of the concerns of many targets of investigations about the consequences of indictment, that proffer sessions with federal prosecutors cast prosecutors as an informal administrative agency, subject to the "judicial review" provided by a trial on the merits, the prospect of which ideally keeps prosecutors honest).
[179] See Matima v. Celli, 228 F.3d 68, 79 (2d Cir. 2000) (holding that private employer does not violate fair employment laws by taking adverse action against employee who violates neutral workplace rules); Tullo v. City of Mount Vernon, 237 F. Supp. 2d 493, 504 (S.D.N.Y. 2002) (holding that fair employment laws do not prohibit discipline of employee for impeding an investigation). Cf. EEOC v. Total System Serv., Inc., 221 F.3d 1171, 1175-76 (11th Cir. 2001) (employer may discipline employee upon good faith finding that employee lied in course of internal investigation). But see Anne Lawton, The Bad Apple in Sexual Harassment Law, 13 Geo. Mason L. Rev. 817, 848-49 (2005) (arguing that Total Systems decision gives employers too much power in sexual harassment cases).
[180] A company could also conduct its own investigation, secure statements from employees, and then turn over those statements to law enforcement. While the corporation can assert lawyer-client privilege regarding such statements, the corporation can also elect to waive the privilege. See Upjohn Co. v. United States, 449 U.S. 383, 389-90 (1981); Brown, Corporate Attorney-Client Privilege, supra note 136, at 922-35. As long as a lawyer conducting an investigation for the corporation informs employees that the lawyer represents the company, not the employee, the employee has no legitimate expectation that the communication will remain confidential. See Simon, After Confidentiality, supra note 8.
[181] See D.L. Cromwell Inv., Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162-63 (2d Cir. 2002) (holding that evidence of coordination in timing between NASD investigation and grand jury proceedings, together with statements by federal investigators that they were "working with" NASD, along with other facts suggesting collaboration, did not compel inference that NASD was an agent of the state for Fifth Amendment purposes).
[182] This statement was denied by the prosecutor and not specifically recollected by any witness, but was referred to in notes of a meeting by one of KPMG's lawyers. The court's factual findings here are subject to a clearly erroneous standard.
[183] Stein IV, 2006 U.S. Dist. Lexis 49435 at *62. Cf. Stein III , 435 F. Supp. 2d at 346 (quoting another prosecutor as making the generic statement, in response to a query from lawyers from KPMG about whether they should advance legal fees to executives, that under federal guidelines "misconduct" should not be "rewarded").
[184] One decision, United States v. Montanye, 500 F.2d 411 (2d Cir. 1974), lends some superficial comfort to the Stein defendants, but only if one reads it very selectively. In Montanye, a company collaborated closely with the government in conducting a polygraph examination of a day employee, who had admitted during a previous polygraph session that he may have committed a homicide. According to the court, the employer was "admittedly acting as an agent for the police." Id. at 415. However, the court ruled that the employer's threat of termination to the employee, who had had his job for only a couple of days, was not an economic sanction serious enough to render the employee's statement involuntary. Id.
The court asserted that the Garrity line of cases involved more substantial and lasting economic harm, including the forfeiture of pension rights or a professional license. The Montanye court also indicated that mere termination of any employee, including a "pampered professional or high-paid businessman," would similarly not constitute sufficient harm. Id. at n. 3. This statement, while dicta, would seem to require classifying the threatened termination and loss of fee subsidies in Stein as insufficient, as well. However, the better view of the Montanye decision's relevance to Stein may be that in Montanye the employer was concededly acting as the government's agent by collaborating on the terms of a specific examination of the target, while such close tactical collaboration is not present in Stein.
In addition, Stein clearly does not involve a sham investigation of an employer pursued for the sole purpose of exerting leverage on another party or entity. Implementation of a scheme of this kind in which the government and the employer colluded to extract admissions from individual defendants would almost certainly render the admissions involuntary, and could also be problematic for prosecutors under rules of professional responsibility. Cf. United States v. Hammad, 858 F.2d 834 (2d Cir. 1988) (holding that court could exercise supervisory power to suppress evidence yielded by sham grand jury subpoena); Bruce A. Green & Fred C. Zacharias, Regulating Federal Prosecutors' Ethics, 55 Vand. L. Rev. 381, 439-43 (2002) (discussing rationales for prosecutors' independence) (discussing supervisory power). But see John Gleeson, Supervising Criminal Investigations: The Proper Scope of the Supervisory Power of Federal Judges, 5 J.L. & Pol'y 423 (1997) (criticizing cases such as Hammad as unjustified intervention into prosecutorial decisions). Prosecutors, in their efforts to secure cooperation, can also be insensitive to special factors beyond a defendant's complete control that make cooperation difficult. See Peter Margulies, Battered Bargaining: Domestic Violence and Plea Negotiation in the Criminal Justice System, 11 S. Calif. Rev. L. & Women's Stud. 153, 170-71 (2001) (arguing for checks on prosecutorial practice regarding defendants such as some couriers or "mules" in drug transactions whose fear of domestic violence contributed to underlying offense). However, Stein clearly does not involve issues of this sort. The Stein IV court hints that the government might have threatened to indict KPMG, regardless of whether KPMG was "guilty of anything." See Stein IV, 2006 U.S. Dist. Lexis 50723, at *3. However, nowhere in this opinion or in Stein III does the court dispute the statements made by KPMG as part of the DPA that its senior executives had engaged in a pervasive pattern of tax fraud. Nor does the court question the bona fide nature of the nearly $500 million fine KPMG agreed to pay to avoid indictment.
[185] See Kenneth Culp Davis, Discretionary Justice: A Preliminary Inquiry 17 (1969). Cf. Green & Zacharias, supra note 184, at 439-43.
[186] Id. at 442 ("Prosecutors… can judge prosecutorial and other law enforcement resources in a way that may inform the decision, for example, of which suspects to pursue and which suspects should receive lenient treatment").
[188] See U.S. Const., art. I, § 9, cl. 3. Cf. Lovett v. United States, 66 F. Supp. 142 (Ct. Cl. 1945), aff'd on other grounds, 328 U.S. 303 (1946) (discussing Bill of Attainder clause problems with legislation that conditioned appropriations on Congressional approval of reappointment of 39 federal employees whom Chairman of House Committee on Un-American activities termed, "irresponsible, unrepresentative, crackpot, radical bureaucrats" and associates of "Communist front organizations"); Stephen Dycus, et al., National Security Law 134-45 (3d ed. 2002) (discussing Bill of Attainder issues in national security context).
Government has some avenues for limiting prosecutorial discretion. For example, legislatures may mandate prosecution of certain offenses because of concern that prosecutors and law enforcement have been excessively lenient or indifferent in the past. See Emily J. Sack, Battered Women and the State: The Struggle for the Future of Domestic Violence Policy, 2004 Wis. L. Rev. 1657, 1696 (discussing mandatory prosecution in domestic violence cases). However, this remedy for prosecutorial discretion, anchored by strong justifications in some contexts, aims to protect victims and deter future wrongdoing, not assist defendants.
[189] Cf. Jay Sterling Silver, Truth, Justice, and the American Way: The Case Against the Client Perjury Rules, 47 Vand. L. Rev. 339, 403-09 (1994) (arguing that some legal ethics rules undermine adversary system and foster inquisitorial stance by courts that threatens fundamental process values).
[190] See United States v. Williams, 504 U.S. 36 (1992) (holding that a court acting under its supervisory power lacks authority to regulate grand jury investigations that should have a substantial degree of independence in a constitutional system). Cf. Sara Sun Beale, Reconsidering Supervisory Power in Criminal Cases: Constitutional and Statutory Limits on the Authority of the Federal Courts, 84 Colum. L. Rev. 1433 (1984) (arguing for limits on federal courts' supervisory authority); Fred C. Zacharias & Bruce A. Green, Federal Court Authority to Regulate Lawyers: A Practice in Search of a Theory, 56 Vand. L. Rev. 1303, 1314-36 (2003) (discussing possible readings of Williams). But see Niki Kuckes, The Democratic Prosecutor: Explaining the Constitutional Function of the Federal Grand Jury, 94 Geo. L.J. 1265, 1272-73 (2006) (arguing that the notion of grand jury independence is a fiction masking prosecutorial authority).
[191] See Brown, Corporate Crime Enforcement, supra note 55, at 527-28 (discussing difficulty of detecting corporate crime).
[193] Moreover, efforts to end or limit participant subsidies through negotiations with corporations do not give the government an unfair advantage in bargaining with individual defendants. The case most frequently cited by critics of government efforts is the example of the corporate middle manager, who may not be able to afford the resources necessary to retain an upper-echelon defense attorney through trial. However, prosecutors negotiating with middle-level managers will, given the Thompson Memo's focus on corporate wrongdoing, have one central inquiry: does the mid-level manager have useful information about higher-ups in the company or corporate food-chain? If the individual defendant has such information, most lawyers will advise the client to trade the information for a favorable plea deal. Counsel paid by the corporation may be more likely to stress the down side of cooperation when cooperation would injure the corporation's interests; however, that tendency undercuts the argument that corporate legal fee subsidies adversely affect individual defendants. In such situations, the corporation may be adversely affected, but the individual defendant is better off by providing information.
Contrast this example with the scenario in which the individual defendant has no information to trade. Here, on the surface, restricting or ending fee subsidies obliges the defendant to go to trial with inferior counsel. Here, too, however, surface appearances obscure the details of actual practice. If a middle-manager who is facing indictment has no information to trade about higher-ups, the government will have that much less leverage against the corporation. In this situation, the corporation will face far less pressure to eliminate the subsidy. While the corporation may still limit or end the subsidy, its calculation is likely to be an honest assessment of whether the individual defendant has damaged the corporation by engaging in inappropriate behavior.
This discussion of the two middle-manager scenarios takes care of the two strongest examples invoked by critics of the government. It leaves one further case - the case of the top-level manager. In this case, prosecutors will be less willing to trade concessions on a plea for information, particularly when the manager is at the very top of the corporate food-chain. Limiting or ending corporate participant subsidies may leave the top-level manager to her own resources in financing a lengthy trial. However, a senior executive will likely have been compensated in the past at a level that allows her to retain high-quality counsel on her own, thus diminishing the need for corporate subsidy. See Stein I, 2005 U.S. Dist. Lexis 27812 at *22 (discussing bail request of defendant David Greenberg, whom the court found had $20 million in assets and had already given his lawyer a $2 million retainer). An executive with salary, stock options, and other assets in the tens or hundreds of millions of dollars may wish that her former employer would help out with lawyers' bills, but can hardly cry poverty. While a white-collar case like the KPMG matter may involve substantial numbers of documents, thus adding to the time that a defense lawyer must bill, the key documents in this case are relatively modest in number, in part due to the "cookie-cutter" nature of the tax "advice" that KPMG furnished to support its marketing scheme. See Stein III, 435 F. Supp. 2d at 371; United States v. KPMG, LLP, 316 F. Supp. 2d 30, 37-38 (D.D.C. 2004).
[195] A defendant who wishes to retain particular counsel has other options, including paying for counsel with his own resources, and asking the lawyer to accommodate the defendant's finite resources with a finite bill. To be sure, a limit on fee subsidies may constrain the defendant's selection of counsel. However, assuming again that the defendant does not have a legally binding contract for advancement of fees, asking the defendant to fund most or all of his defense puts him in exactly the same position as all other criminal defendants, apart from indigent defendants for whom the government provides a lawyer. Because limits on fee subsidies are neutral with respect to particular attorneys, and serve the significant government interests of reducing stonewalling and corporate agency costs, such limits constitute merely incidental burdens on the right - which the courts have always recognized as contingent in a variety of respects - to select one's own counsel. See United States v. O'Brien 391 U.S. 367 (1968) (holding that statute prohibiting burning of draft card imposed merely incidental burden on free speech). But see Kent Greenwalt, Speech, Crime, And The Uses Of LanguagE328-31 (1989) (arguing that Court engaged in inappropriately deferential review of statute); Michael C. Dorf, Incidental Burdens on Fundamental Rights, 109 Harv. L. Rev. 1175, 1202-05 (1996) (same). Cf. Humanitarian Law Project v. Reno, 205 F.3d 1130, 1135 (9th Cir. 2000), cert. den. sub nom Humanitarian Law Project v. Ashcroft, 532 U.S. 904 (2001) (holding that provisions of Antiterrorism and Effective Death Penalty Act (AEDPA), 18 U.S.C. 2339A(b) (2002), that prohibited financial assistance to designated foreign terrorist organizations such as Al Qaeda imposed merely incidental burden and therefore did not violate First Amendment); Margulies, The Virtues and Vices of Solidarity, supra note 87, at 200-07 (discussing appropriate scope of AEDPA provisions).
[196] Prosecutors operate within limits. For example, the government could not ask the corporation to select or reject a particular lawyer or firm. This would not be a "content-neutral" measure, and could also make the corporation into an agent of the government for Sixth Amendment purposes. Moreover, the government should not require a corporation to withhold documents or access to personnel who have information relevant to individual defendants. See ABA Task Force, supra notes 38-43 and accompanying text. However, the government could require that a corporation that entered into a plea disavow the statements of current or former corporate officials that conflicted with representations that the corporation made in its plea. Given these limits, government efforts to restrict fee subsidies are a tailored strategy for dealing with a difficult problem.
[198] Cf. Cfa Centre For Financial Marketing INtegrity and Business Roundtable Inst. Corp. Ethics, Breaking the Short Term Cycle: Discussion and Recommendations On How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus On Long-Term Value 3 (July 2006) ("excessive focus of some corporate leaders, investors, and analysts on short-term… earnings and a lack of attention to the strategy [and] fundamentals… of long-term value creation… can tip the balance in value-destructive ways for market participants"). This commitment to a long-term perspective is central to constitutionalism, as well. See Jon Elster, Social Institutions, in Nuts and Bolts For the Social Sciences, 147, 150 (1989) (observing that "[t]he parts of a constitution that make it more difficult to change the constitution than to enact ordinary legislation... force people to think twice before they change it"); Ruti G. Teitel, Transitional Justice 193 (2000) (noting that the notion of a founding moment for republics "reconciles the dilemma of political change with constitutional permanence"); Frank Michelman, Law's Republic, 97 Yale L.J. 1493 (1988) (arguing that judicial review helps ensure that sober second thoughts can counter the tendency of political leaders to cater to the exigencies of the moment through scapegoating subordinated groups).
[199] Of course, short-term holders of stock may also benefit from the volatility generated by short-term executive perspectives; however, hedge funds and other short-term traders have a range of investment opportunities and resources that ordinary investors lack.
[200] Indeed, limiting advancement will also reduce agency costs - including agency costs imposed on managers by their own lawyers -- and moral hazard ex post, by encouraging individual defendants to more carefully monitor their own legal costs. Managers who retain counsel at least partially on their own dime will be less likely to spring for eleven law firm associates working on their case, or to blithely accept a law firm's healthy mark-up for photocopying. See Lerman & Schrag, supra note 82. The result may just be a "leaner, meaner" defense effort. In this fashion, limiting fee subsidies may serve defendants' interests in the long-term.
[201] See Silver v. N.Y. Stock Exch., 373 U.S. 341, 350-53 (1963), citing Douglas, The Forces of Disorder, supra note 126, at 82. Douglas' view that the threat of government action encourages industry self-governance and deters managers from imposing agency costs on shareholders contrasts with the Stein IV court's more vivid but less nuanced description of the same phenomenon as the "corporate equivalent of capital punishment." See Stein IV, 2006 U.S. Dist. Lexis 49435, at *5.
[203] See H.R. Rep. No. 1383, 73d Cong., 2d Sess. 15 (1934); S. Rep. No. 792, 73d Cong., 2d Sess. 13 (1934) (stressing broad responsibility of exchanges for self-governance).
[205] Alternatively, the corporation could appoint an independent subcommittee of the board of directors to determine if the charges against the executive involved, 1) genuinely disputed issues of fact, such as intent, see United States v. Quattrone, 441 F.3d 153 (2d Cir. 2006), or materiality, or, 2) novel issues of law. See Alex Berenson, Case Expands Types of Lies Prosecutors Will Pursue, N.Y. Times, May 17, 2004, at C 1 (reporting on guilty please in obstruction of justice case involving executives' misstatements to an outside law firm retained by the corporation to investigate possible managerial misconduct). Cf. ABA Task Force, supra note 2, at n. 15 (discussing new theories of obstruction of justice). A corporation could also ask an executive receiving advancement to post a bond, in order to facilitate repayment of legal fees if executive was convicted of crime that injured corporation. See Radin, supra note 1, at 290.
[206] One could argue that limiting subsidy of legal fees will adversely affect the defense bar as a whole, thus weakening a bulwark against government overreaching. See Margulies, Lawyers' Independence, supra note 73 (discussing importance of criminal defense). Cf. Sam A. Schmidt & Joshua L. Dratel, Turning the Tables: Using the Government's Secrecy and Security Arsenal for the Benefit of the Client in Terrorism Prosecutions, 48 N.Y.L. Sch. L. Rev. 69, 70-71 (2003-04) (discussing systemic obstacles to representation in terrorism cases); Teri Dobbins, Protecting the Unpopular from the Unreasonable: Warrantless Monitoring of Attorney Client Communications in Federal Prisons, 53 Cath. U.L. Rev. 295 (2004) (discussing chilling effect of attorney-client monitoring); Margulies, Virtues and Vices of Solidarity, supra note 87 (discussing chilling effect of attorney-client monitoring); Ellen S. Podgor & John Wesley Hall, Government Surveillance of Attorney-Client Communications: Invoked in the Name of Fighting Terrorism, 17 Geo. J. Legal Ethics 145 (2004) (same). However, it is far from clear that capping executives' legal defense fees in criminal cases will yield this result. Corporations will still reimburse managers for a portion of their legal fees. Senior executives will still be able to use their own resources to pay their lawyers. See infra note 207 (discussing resources available to senior executives). Indeed, the turn toward vigorous federal enforcement may well make white-collar defense a growth industry. Cf. Coffee, supra note 18, at 367 (noting that provisions of Sarbanes-Oxley Act have "proven to be an unexpected blessing and major source of new revenue" for accountants).
[207] Cf. Stein I, 2005 U.S. Dist. Lexis 27812 (S.D.N.Y. Nov. 14, 2005), at *22 (denying bail application for defendant David Greenberg because he had secreted approximately $20 million in assets). See also Radin, supra note 1, at 289-90 (noting extensive financial resources of many executives who seek advancement of legal fees, and mentioning alternative approach under which executives could be required to post secured bond with the corporation to guarantee repayment of advance upon a final adjudication of guilt). Where companies continued to opt for broader D & O insurance or indemnification, state courts could prospectively construe such contracts for the benefit of the shareholders. The SEC should also require that corporations disclose details of their D & O insurance, including the pricing history for the premiums paid. See Griffith, supra note 1. See also SEC Guidelines On Disclosure of Executive Compensation, http://www.sec.gov/news/press/2006/2006-123.htm (Aug. 2006 rules set more rigorous standards for disclosure of compensation, including perquisites).
A corporation could legitimately reimburse executives at a higher level in cases involving an absence of willful misconduct or an unforeseen expansion in legal liability. For an example of the latter scenario, see United States v. Socony-Vacuum Co., 310 U.S. 150 (1940). In Socony-Vacuum, the Court rejected a claim by an oil company accused of price-fixing that an agreement with federal regulators purporting to authorize the setting of prices immunized the company from liability under the antitrust laws. Cf. Waller, supra note 67, at 96-98 (discussing Justice Douglas' opinion for the Court). In such a case, a corporation could find that executives appropriately relied on their understanding with federal administrative officials. However, a corporation should seek independent advice on this question, to avoid excess influence by corporate insiders.
[209] See Ambromovage v. UMW, 726 F.2d 972, 989 (3d Cir. 1984). See generally Jeffrey A. Parness & Daniel J. Sennott, Expanded Recognition in Written Laws of Ancillary Federal Court Powers: Supplementing the Supplemental Jurisdiction Statute, 64 U. Pitt. L. Rev. 303 (2003).
[210] Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 379-80 (1994); UMW v. Gibbs, 383 U.S. 715, 725 (1966) (discussing pendent jurisdiction); Polishan, 19 F. Supp. 2d at 330 n. 4 (M.D. Pa. 1998).
[212] Cf. G. Heileman Brewing Co. v. Joseph Oat Corp., 871 F.2d 648, 657 (7th Cir. 1989) (Posner, J., dissenting) (arguing that court should strictly interpret Fed. R. Civ. P. 16(f), which grants federal courts power to compel appearance of "attorneys" at settlement conferences, to exclude power to compel appearance of party with settlement authority, since party is free to make choice not to settle dispute and compelled appearance may waste time and resources).
[214] Cf. Cluett, Peabody & Co., Inc. v. CPC Acquisition Co., Inc., 863 F.2d 251, 256 (2d Cir. 1988) (discussing standards for ancillary jurisdiction).
[216] Id. at 221-22. Cf. Polishan, 19 F. Supp. 2d at 330 (M.D. Pa. 1998) (holding that court lacked ancillary jurisdiction in fee subsidy case to adjudicate dispute about bond that insurance carrier required defendant to post).
[217] See CPC Acquisition Co., 863 F.2d at 256 (2d Cir. 1988); Nat'l Equip. Rental Ltd. v. Mercury Typesetting Co., 323 F.2d 784 (2d Cir. 1963); Petition of Rosenman, Colin, Freund, Lewis & Cohen, 600 F. Supp. 527, 531 (S.D.N.Y. 1984) (ancillary jurisdiction over fee dispute between party and attorney).
[218] Ironically, despite this concern, courts exerting ancillary jurisdiction over fee advancement disputes display indifference to the problem of vanishing assets that arises when a corporation lacks effective remedies against a defendant who has received an adverse final judgment. See United States v. Weissman, 1997 U.S. Dist. Lexis 8540 at *32(S.D.N.Y. June 13, 1997).
When the lawyer has received a fee from the client but has not done the work, the court may act to ensure that the lawyer is not unjustly enriched at the client's expense. This is particularly true when the attorney is no longer involved in the case because of the court's exercise of its supervisory power over disqualification. Cf. Garcia v. Teitler, 443 F.3d 202, 209 (2d Cir. 2006) (affirming exercise of ancillary jurisdiction to assure that disqualified attorney returned unused portion of his retainer to his client, so that the client could retain another lawyer). Indeed, in the latter case, exercise of ancillary jurisdiction might not be necessary at all, since the court's supervisory power over ethical conduct by attorneys appearing before it would likely suffice to sanction the attorney and cause the attorney to release the disputed amount to the client. See Lonnie T. Brown, Jr., "May It Please the Camera ... I Mean the Court" - An Intrajudicial Solution to an Extrajudicial Problem, 39 Ga. L. Rev. 83 (2004) (arguing for more robust judicial sanctions to curb extrajudicial remarks by prosecutors and defense attorneys); Green & Zacharias, supra note 184; Peter Margulies, Above Contempt?: Regulating Government Overreaching in Terrorism Cases, 34 Sw. U. L. Rev. 449 (2005) (arguing that courts should use supervisory power vigorously to deter prosecutorial excesses, such as prejudicial public statements and material omissions in warrant applications).
[219] This is particularly true where federal courts seek to construe D & O insurance policies. Cf. Jeffrey A. Parness & Tait J. Lundgren, Nonparty Insurers in Federal Civil Actions: The Need for New Written Civil Procedure Laws, 36 Creighton L. Rev. 191, 208 (2003) (noting concern about disruption of clear state interest in regulating insurance when federal court adjudicating tort claim seeks to resolve coverage dispute between insured and insurer).
[221] A federal court may occasionally encounter a fee subsidy case that apparently presents no difficult state law issues. See United States v. Weissman, S2 94 Cr. 760 (CSH), 1997 U.S. Dist. Lexis 8540 (S.D.N.Y. June 13, 1997) (construing by-laws and agreement with defendant providing for advancement). However, this ease of decision may be illusory. In Weissman, for example, the court considered whether a defendant who had been convicted of a crime could require the corporation, pursuant to advancement provisions, to pay the defendant's attorney for work done before the conviction. The court held that the corporation had to pay for the work, asserting that any other result would give the corporation an incentive to delay reimbursement in the hope that a guilty verdict would terminate its obligation to pay. Id. at *28-29. In reaching this conclusion, however, the court relied in part on commentary to the Model Business Corporation Act that alluded to the need for the corporation to have authority to advance fees, but said nothing about the corporation's duty to do so. Id. (citing Model Business Corporation Act § 8.53 official cmt. at 252 ("It is often critically important to a director… that the corporation he served have power to make advances at the beginning of and during the proceeding") (emphasis added)). Moreover, the court, while acknowledging the corporation's concern that the defendant would be unable to repay the almost $3 million in legal fees he was receiving, dismissed this concern as irrelevant. See id. at *32. The court could have considered whether state law would require or permit ordering the defendant to post a secured bond under such circumstances. These points demonstrate the risk that a court's determination of the difficulty of state law will be skewed by the felt need to compensate the defendant's lawyer, even in situations where advancement clearly disserves corporate interests, and where the defendant's lawyer could have foreseen uncertainties in her prospects for obtaining a fee.
[222] A federal court may also assert supplemental jurisdiction to "enable [the] court to function successfully… to manage its proceedings, vindicate its authority, and effectuate its decrees." See Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 379-80 (1994), (citing Chambers v. NASCO, 501 U.S. 32 (1991)) (power to compel payment of opponent's attorney's fees as sanction). However, this authority generally extends only to issues intrinsic to a judicial proceeding, such preventing contumacious behavior in court, sanctioning attorneys, and deterring defiance of the court's orders. See Green & Zacharias, supra note 184. Ensuring that a third party pays a party's legal fees does not fit within these constraints.
[223] Cf. Lynn M. Lopucki, Courting Failure: How Competition For Big Cases Is Corrupting The Bankruptcy Courts 19-24 (2005) (describing how bankruptcy judges' concern about maintaining their reputation among high-profile members of the bankruptcy bar skews allocation of bankruptcy matters). Of course, federal district judges, as opposed to bankruptcy judges, are appointed for life. See U.S. Const., art. III. However, even if federal district judges lack the clear instrumental reasons that other judges possess for pleasing members of the bar, cognitive biases may skew district judges' perceptions if they view practicing lawyers as part of their professional community, value interaction with lawyers at bar conferences, and so on. See supra notes 38, 53 and accompanying text (discussing cognitive biases). The subtlety of these influences does not justify exercising jurisdiction where other tribunals lacking such biases, such as state courts and arbitrators, are available. Cf. United States v. Buhler, 278 F. Supp. 2d 1297, 1299-300 (M.D. Fla. 2003) (declining to assert jurisdiction over fee dispute).
[224] In another scenario, counsel might agree to shave off part of their fee, as distressing as such an outcome would be for them. See Baker & Griffith, supra note 12 (discussing how corporations with high deductibles for their D & O coverage are able to extract savings from providers of legal services).
[225] See Morgan & Rotunda, supra note 75, at 123-24, (citing Martin Mayer, The Lawyers 161-62 (1967)) (recounting that veteran lawyers who have not yet been paid routinely obtain continuances by notifying the court that they are waiting for "Mr. Green"). The Stein III court focused on analogous issues by seeking to "ensure" that the Stein defendants, unlike other defendants of limited means in criminal cases, could "afford to pay… counsel to do what they think appropriate." Stein III, 435 F. Supp. 2d at 377-78.
[227] See Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue Shield of New Jersey, 448 F.3d 573, 582 (2d Cir. 2006) (finding that doctors were entitled to reimbursement at customary rate for services rendered to HMO); Manchester Equip. Co., Inc. v. Am. Way Moving & Storage Co., Inc., 176 F. Supp. 2d 239, 245 (D. Del. 2001) (insufficient evidence of parties' intent). See also supra notes 226-228 and accompanying text (discussing Stein III's mischaracterization of state law precedents on implied contract).
[228] See Ayash v. Dana-Farber Cancer Inst., 822 N.E.2d 667, 684 (Mass. 2005), (citing Uno Rest., Inc. v. Boston Kenmore Realty Corp., 805 N.E.2d 957, 964 (Mass. 2004)) (declining to find implied covenant for right of first refusal in real estate transaction, since party could have bargained expressly for this right). Courts have generally limited implied-in-fact contracts in employment to contexts where an employer had terminated an employee in breach of a duty of good faith fairly inferable from the employer's own stated procedures, see Ayash, 822 N.E.2d at 684 , or where the employer had deprived the employee of payment for services that the employee had "fairly earned and legitimately expected," and the employer would otherwise be unjustly enriched. See Maddaloni v. Western Mass. Bus Lines, Inc., 438 N.E.2d 351, 356-57 (Mass. 1982). See also Guz v. Bechtel Nat'l, Inc., 8 P.3d 1089, 1100-12 (Calif. 2000) (limiting doctrine of implied-in-fact contract and implied covenant of good faith in employment setting). Courts have pointedly declined to find that a contract or a contract term to be implied-in-fact creates a "general duty on the part of an employer to act 'nicely.'" See Ayash, 822 N.E.2d at 684. See generally Peter Linzer, Rough Justice: A Theory of Restitution and Reliance, Contracts and Torts, 2001 Wis. L. Rev. 695, 704-08 (discussing relationship between contracts implied-in-fact and unjust enrichment); J. Wilson Parker, At-Will Employment and the Common Law: A Modest Proposal to De-Marginalize Employment Law, 81 Iowa L. Rev. 347, 364-66 (1995) (discussing connection between implied covenant of good faith in employment contracts and creation of implied-in-fact contracts); Stewart J. Schwab, Studying Labor Law and Human Resources in Rhode Island: Remarks on the Occasion of the Creation of a Joint-Degree Program in Law and Labor Relations/Human Resources, 7 Roger Williams U.L. Rev. 383, 388-89 (2002) (analyzing doctrine). Cf. Murphy, supra note 46 (discussing scope of restitution remedy).
[230] In addition, the Stein III court dismissed the arbitration requirement in defendant Stein's severance agreement, despite strong state and federal policies favoring enforcement of arbitration clauses. See Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002); Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983) [Need citation to Stein itself].
[231] See Erie Ry. v. Tompkins, 340 U.S. 64 (1938) (requiring that federal courts defer to state law in diversity cases).
[232] Id. at 75-76. Brandeis, quoting an earlier distinguished jurist, aptly diagnosed the danger, in noting that the "general law" that pre-Erie federal courts invoked to displace state law was often little more than "what the judge… thinks at the time should be the general law on a particular subject… judges have fallen into the habit of [invoking the general law]… as a convenient mode of brushing aside the law of a state in conflict with their views." Id. at 78, (citing Baltimore & Ohio R. Co. v. Baugh, 149 U.S. 368, 401 (1893) (Field, J., dissenting) (criticizing majority's invocation of "general law" to apply fellow servant rule to bar recovery of railroad employee for work-related injuries which would have been compensable under state law)). Cf. New State Ice Co. v. Liebmann, 285 U.S. 262, 280, 310-11 (1932) (Brandeis, J., dissenting) (discussing states as "laboratories" of federalism, entitled to some deference in efforts to regulate business).
Citation
7 U.C. Davis Bus. L.J. 2 (2006)
Copyright
Copr. © Peter Margulies, 2006. All Rights Reserved.