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Practicing White Collar Criminal Defense in the Post-Enron Era:
Some Changes in the System
By Robert J. Sussman
Introduction
In the past, white collar criminal defense was not much different from any other kind of criminal defense, except there was more paper and less violence. Today, the goal of white collar criminal defense practice is to make certain the government does not turn white (or gray) into black. The criminal defense lawyer’s job is more difficult than ever because of the criminalization of business conduct in the name of correcting society’s ills with the wave of a legislative hand; the pressure on prosecutors to rid our country of corporate fraud; the stretching of the breadth of conspiracy, money laundering, obstruction and securities law to the breaking point; and the use of the sentencing guidelines to try to bring targeted criminal defendants to their knees.
Sarbanes-Oxley provisions, Justice Department cooperation guidelines for corporations, and whistle-blower rewards have made new battalions of invisible deputies out of many corporate officers and civil (and some criminal) lawyers. Below we outline the obstacles the criminal defense lawyer needs to overcome in defending a white collar case today.
It used to be easier to distinguish civil cases from criminal ones. The civil cases were based on negligent acts, on misleading statements or securities filings, or violations of accounting protocols. Criminal cases were based on intentional misconduct, blatant lies tied to venal motives, and smoking gun memos and tapes that made grand juries blanch. That was before Enron. Now businesses and employees are being criminally investigated and charged for conduct formerly addressed in civil cases.
The difference between civil fraud and criminal fraud under the faithful service, mail fraud, wire fraud, or securities fraud statutes, has always been a question of line drawing. This moving line was originally drawn by prosecutors and validated by either judges (as our justice system intended) or, by corporate compliance that moves the ball further down the right-hand side of the field, often without judicial review.
Invisible Deputies
More and more often the “knock on the door” by the government now comes from a company’s general counsel. To understand why, we must look at the Sarbanes-Oxley statute and the Thompson Memo of the United States Department of Justice (DOJ). These two documents have changed the landscape significantly. Compliance is the corporate watchword and super-cooperation is the corporate mantra.
With the pursuit of that goal in mind, corporate budgets for compliance have increased exponentially. National law firms have created “corporate governance” divisions staffed with numerous former prosecutors and securities litigators. Out of a sense of caution, what would have been informal disputes have turned into Sarbanes-Oxley whistle-blower issues. The government in turn has rewarded this new conduct with deferred prosecution agreements, decreased fines, civil settlements and public “attaboys” that may soften the impact of the results of criminal investigation that the company often started in the first place. What federal regulatory agencies were doing during the savings and loan crisis is being done by corporate audit committees today.
Mr. Thompson’s Memo
How did we get here? On January 20, 2003, Deputy U.S. Attorney General Larry Thompson wrote a memo outlining the DOJ’s position on factors to be considered when deciding whether to criminally charge corporations.1 Nine factors are considered in making a decision whether to indict a company:
1. The nature and seriousness of the offense, including the risk of harm to the public, and applicable policies and priorities, if any, governing the prosecution of corporations for particular categories of crime;
2. The pervasiveness of wrongdoing within the corporation, including the complicity in, or condemnation of, the wrongdoing by corporate management;
3. The corporation’s history of similar conduct, including prior criminal, civil, and regulatory enforcement actions against it;
4. The corporation’s timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents, including, if necessary, the waiver of corporate attorney-client and work product protection;
5. The existence and adequacy of the corporation’s compliance program;
6. The corporation’s remedial actions, including any efforts to implement an effective corporate compliance program or to improve an existing one, to replace responsible management, to discipline or terminate wrongdoers, to pay restitution, and to cooperate with the relevant government agencies;
7. The collateral consequences, including disproportionate harm to shareholders, pension holders, and employees not proven personally culpable and the impact on the public arising from the prosecution;
8. The adequacy of the prosecution of individuals responsible for the corporation’s malfeasance; and
9. The adequacy of remedies such as civil or regulatory enforcement actions.2
After the release of the Thompson Memo, U. S. Attorney James B. Comey was questioned on his views on the DOJ’s policies of requesting corporations to waive attorney-client privilege. When asked whether corporations waiving their attorney-client privilege would let the government piggyback on the company’s investigation, Mr. Comey stated:
Yes, and there is nothing wrong with that. This is about the public’s interest in uncovering corporate crime in a timely fashion, not only to prosecute the wrongdoers, but also to minimize additional losses and maximize restitution. Some internal investigations cost millions of dollars and analyze hundreds of thousands of documents. Federal prosecutors don’t have funds for that, and would be unable to replicate that work. They can, however, work with a report of such an internal effort in order to conduct a thorough and complete Government investigation. Ultimately, however, we go back again to the core issue, which is whether a corporation wants to earn leniency in the charging decision and under the Guidelines.3
How does this affect employees suspected of misconduct? In an employment-at-will state like Texas, firings tied to compliance programs have undoubtedly increased significantly. Additionally, Texas is likely to see:
• More internal investigations;
• More internal investigations turned over to prosecutors;
• More corporate waivers of the attorney-client privilege;
• More requirements of Fifth Amendment waivers as a condition of employment;
• Less indemnification of officers and employees;
• More requirements of cooperation with investigators as a condition of advanced indemnification; and
• More voluntary disclosure of wrongdoing to authorities.
Messrs. Sarbanes and Oxley
Around the time of the Thompson Memo, Sarbanes-Oxley was enacted.4 It allowed for:
1) CEO’s and CFO’s to personally attest to the accuracy of corporate financial statements and filings and established penalties for false certifications;5
2) Whistleblowers to be protected; and6
3) The definition of “obstruction of justice” to be significantly broadened.7
1) Executives’ Duty and False Certification
The CEO and CFO must certify (in Form 906) under oath both the accuracy and the completeness of the issuer’s financial results, including specific representations regarding both the internal controls and the disclosure controls of the company (i.e. in an SEC filing such as a 10K).8 Sarbanes-Oxley requires CEOs and CFOs to certify that each periodic report “fairly represents, in all material respects, the financial condition and results of operations of the issuer.”9 Sarbanes-Oxley provides for criminal penalties ranging from up to $1 million in fines and up to 10 years in prison for filing a 906 Certificate “knowing” that the subject report does not comport with all the requirements of section 906, to up to $5 million and up to 20 years if the officer “willfully certifies” a report “knowing” that the subject report does not comport with all the requirements of the section.10
2) Whistleblower Retaliation
Sarbanes-Oxley prohibits U.S companies and their officers, employees, contractors, subcontractors, and agents from taking retaliatory action of any kind against an employee for reporting acts of fraud to federal officials or supervisors in the company.11 It also creates a new whistleblower cause of action for employees who report fraud.12 This protection extends not only to whistleblowers who report an actual fraud but also to conduct that he/she “reasonably believes” is a violation.13 Additionally, the Act creates criminal penalties, including fines and up to ten years in prison for employers who take harmful retaliatory actions against whistleblowers.14
3) Obstruction of Justice
Sarbanes-Oxley significantly expands the punishment for the improper destruction of corporate communications and documents.15 The Act creates two new criminal statutes regarding document destruction – sections 1519 - 1520 of Chapter 73 of Title 18 of the United States Criminal Code – and expands the scope of 18 U.S.C. §1512. The Act also increases the potential punishment for a violation of section 1512 to up to 20 years per violation. Section 1519 provides in pertinent part:
Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under Title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years or both.16
What “in relation to or contemplation of” means is not defined. Arguably, it is punishing the previously non-criminal conduct of “knowingly” (not willfully) destroying or altering records before a governmental investigation begins. This provision will no doubt get some companies to spend more on record storage facility rentals and less on shareholders.
Indemnification
Corporate employers usually agree to indemnify an employee where the employee has successfully defended himself against civil and/or criminal litigation arising from work-related conduct. Mandatory indemnifications apply, in many instances, only to directors and officers.17 Corporate employers are also allowed, by statute, to permissively indemnify employees. Permissive indemnification does not require successful defense, but many jurisdictions, including Texas, require that the employee “acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.”18
Some corporate employers will agree to advance the costs of the employee’s defense, provided that the employee acknowledges that he has to repay the advance if need be. Some jurisdictions, including Texas, require the employee to state that he has a good faith belief that he has met the standards necessary for indemnification. For a criminal matter, this statement would have to include the employee’s affirmation that he did not have reasonable cause to believe his conduct was unlawful.19
In addition to the indemnification statutes, some jurisdictions also allow the corporation to authorize greater indemnification rights through their corporate bylaws and/or articles of incorporation.20 The corporation may choose to use its bylaws to limit the range of indemnification it offers to its employees so as to avoid large litigation expenses.
The DOJ issued its opinion on the topic of permissive indemnification in the Thompson Memorandum on January 20, 2003.21 The DOJ provides that “a corporation’s promise of support to culpable employees and agents, . . . through the advancing of attorney’s fees, . . . may be considered by the prosecutor in weighing the extent and value of a corporation’s cooperation.” While it is not entirely clear how the DOJ will weigh the issue of permissive indemnification, it would appear that corporations that choose to provide too much protection, such as permitting the employee to return to work without sanction, may find themselves in a much weaker position when attempting to curry favor with the government.
Insurance
The majority of Director & Officer (D&O) insurance policies require the insurer to cover the costs of defense rather than imposing the duty to defend on the insurer. These defense costs usually are included in the liability limit for loss under the D&O policy, and are not an addition to the policy. In effect, one can deplete the entire policy by using it for defense expenses. An insured must often cooperate with the insurer’s investigation and handling of the claim. Many D&O policies require an insured party to select its counsel from an approved list for securities claims. As with many other types of claims, the insurer’s consent is required for the insured’s choice of defense counsel.22
Because of recent corporate scandals, many insurers have sought to rescind insurance policies on the basis of false information or failure to disclose information in the application for insurance.23 The law generally allows an insurer to rescind a policy as to all insureds on the basis of a material or fraudulent misrepresentation in the application, unless the application of policy contains an application severability clause. One Alabama court interpreted a full severability clause as limiting an insurer to rescission only as to the individual who made a knowing misrepresentation on the application and any other insured who had personal knowledge of the fraud.24 This suggests that at least one court will interpret the law as narrowly as possible when an insurer seeks to rescind.
Parallel Proceedings – Stays
Many criminal defendants involved in corporate litigation are now faced with civil proceedings at the same time as their criminal proceedings. A criminal defendant may be able to gain an advantage in his criminal case through the wider discovery in the parallel civil case. While this may be helpful, a criminal defendant may choose to stay the civil proceedings to avoid having to face the decision between self-incrimination through deposition or having an adverse inference drawn against him in the civil proceeding because he invoked his Fifth Amendment right not to testify.25 These stays contemplate the “special circumstances and the need to avoid substantial and irreparable prejudice.”26 Until recently, courts have been more likely to stay civil proceedings when requested by the prosecutor. Some courts have begun to more heavily scrutinize prosecutors’ requests for stays when the civil defendants are likely to be prejudiced by the delay. Further, a defendant who is under only criminal investigation is unlikely to receive a stay prior to indictment.27
Defendants can also use the protection of the Private Securities Litigation Reform Act (PSLRA) that provides in securities actions, all discovery and other proceedings are automatically stayed while a motion to dismiss is pending unless there is certain discovery necessary to preserve evidence or prevent undue prejudice.28 The courts are now looking for a more detailed display of actual prejudice to inform their balancing of the competing interests at stake when ruling on whether to stay proceedings.29
Summary
In the end, the goal of the criminal defense lawyer practicing white collar crime never really changed. It is to vigorously defend the client and make sure that the government prosecutor is stopped or side-stepped. As long as there is business, there will likely be business crimes. The government’s approach transitions over time, and the criminal defense lawyer must be ever vigilant of the ways in which the government seeks to change the rules to ensure the judicial system allows for a fair fight.
Endnotes
1. http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm 2. Id. 3. Interview with United States Attorney James B. Coney Regarding Department of Justice’s Policy on Requesting Corporations under Criminal Investigation to Waive the Attorney Client Privilege and Work Product Protection, United States Attorneys’ Bulletin, Nov. 2003, Vol. 51, No. 6. 4. http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm ; Sarbanes-Oxley Act of 2002 Pub.L. 107-204, 116 Stat. 745. 5. See 15 U.S.C. § 7241 (Supp. 2004). 6. See 18 U.S.C. § 1415A (Supp. 2004). 7. Sarbanes-Oxley Act of 2002, §805, Pub.L. 107-204, 116 Stat. 745. 8. See 17 C.F.R. § 240.13a-14 (2003); 17 C.F.R. § 240.15d-14 (2003). 9. See 17 C.F.R. § 240.13a-14 (2003); 17 C.F.R. § 240.15d-14 (2003). 10. 18 U.S.C. § 1350 (Supp. 2004). 11. Id. 12. 18 U.S.C. § 1514A(a) (Supp. 2004). 13. 148 Congressional Record 57418-01 (Daily Ed., July 26, 2002, Statement of Sen. Leahy). 14. 18 U.S.C. § 1514A(c) (Supp. 2004). 15. 18 U.S.C. § 1513 (Supp. 2004). 16. See 18 U.S.C. § 1519-1520 (Supp. 2004). 17. 18 U.S.C. § 1519 (Supp. 2004). 18. Tex. Bus. Corp. Act Ann. art. 2.02-1(H), (O). 19. Tex. Bus. Corp. Act Ann. art. 2.02-1(B). 20. Tex. Bus. Corp Act Ann. art 2.02-1(B), (K). 21. Tex. Bus. Corp. Act Ann. art. 2.02-1(G). 22. Billa, William P. & Saltzman-Jones, Tiffany S., Walker, Wilcox, Matousek LLP, “D&O Policy Basics: What You Should Know”, ABA - August 4-9, 2005. 23. See In re WorldCom, Inc., Sec. Litig., 354 F.Supp.2d 455 (S.D.N.Y. 2005). 24. In re HealthSouth Corp., 308 F.Supp.2d 1253 (N.D. Ala. 2004). 25. See Wehling v. Columbia Broadcasting Sys., 608 F.3d 1084, 1089 (5th Cir. 1978). 26. See United States v. Little Al, 712 F.2d 133, 136 (5th Cir. 1983); Frierson v. City of Terrell, 2003 WL 22479217 (N.D. Tex 2003). 27. See United States v. Little Al, 712 F.2d 133, 136 (5th Cir. 1983); Frierson v. City of Terrell, 2003 WL 22479217 (N.D. Tex 2003). 28. 15 U.S.C. §77z-1(b)(1) & 78u-4(b)(3)(B), See also, In re WorldCom Sec. Litig., 234 F.Supp.2d 301 (S.D.N.Y. 2002). 29. Spiro, Edward M., “To Stay or Not to Stay,” New York Law Journal, Oct. 5, 2005.
Robert J. Sussman is a partner in the firm of Hinton Sussman Bailey & Davidson, L.L.P. A graduate of the University of Houston Law Center, Sussman is board certified in Criminal Law.
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