Deferred prosecution agreements raise concerns.

In late August, the Justice Department won a landmark case against KPMG LLP. A "deferred prosecution agreement" was entered into, whereby prosecution will be delayed until Dec. 31, 2006, and if KPMG stays out of the tax shelter business and cooperates with officials in related cases, the case will be dropped. KPMG admitted to criminal tax fraud and agreed to pay a $456 million penalty. At the same time, the government announced an indictment of eight former KPMG partners and an outside attorney, with more indictments likely (as reported in the press).

While deferred prosecution agreements have been around for some time, the KPMG case continues a trend by the Justice Department that began in early January 2003. Earlier, when Arthur Andersen's indictment put the firm out of business and 28,000 employees out of work, there was an understandable outcry: Why should the actions of a few individuals put an entire firm out of business?

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In January 2003, then-Deputy Attorney General (and head of President Bush's Corporate Fraud Task Force) Larry Thompson issued what is now widely known as the "Thompson Memo." After Arthur Andersen's demise, the government was understandably skittish about putting another company (particularly another large accounting firm) out of business. The memo sets forth the view that if a company cooperates, prosecutors should consider dropping charges against the company itself. However, it leaves the door open for indictments of company executives and employees.

A typical deferred prosecution agreement might include an indictment of the company, a requirement that it admit guilt, a large fine and/or restitution to victims (usually shareholders), some form of external monitoring and agree to cooperate in the prosecution of responsible individuals. In exchange, the government will "defer" prosecution for a certain period (usually 18 months to two years) and, if the conditions of the agreement are met, drop the indictment altogether. Alternatively, if the company fails to comply, the government can prosecute on the indictment.

Deferred prosecution agreements enable the government to get everything it might have gotten through a trial (fines, admission of guilt, changes to the company's governance) except a conviction itself. Statements made in the deferred prosecution agreement can be used against the company in related suits, such as civil suits and securities suits.

A few observations here. First, I am not a lawyer, and these are simply observations based on my (very!) limited knowledge of these agreements and their potential implications. The most glaring difference between these agreements and the typical company settlement with the Securities and Exchange Commission (SEC) is that the company admits guilt. Most settlements with the SEC are made without admitting or denying guilt.

Cooperation may be defined very broadly, and seems to have some inherent issues. In many cases, the company reportedly waives attorney-client and work-product privilege. In some jurisdictions, however, by providing privileged information, you may be effectively waiving that privilege to other third parties. I have also heard that some companies have successfully limited an agreement to requiring only specified documents and testimony.

Cooperation in the prosecution of responsible individuals requires a company to offer up some culpable individuals. MCI, for instance, entered into a deferred prosecution agreement and cooperated as prosecutors went after former CEO Bernard Ebbers (who was convicted). It is hard not to hold the CEO accountable for the egregious fraud in this instance.

While I am all for holding culpable individuals accountable, the message to employees in the KPMG case seems clear: even if what you are doing has the company's blessing, if the company gets into trouble, you are on your own. Indeed, the company may cooperate to prosecute you. How does this impact morale inside that company? Does the culture and behavior change in a positive way?

Waiving attorney-client privilege for documents that the prosecution can use against the individual employees puts these individuals at a significant disadvantage. While many companies pay employees' legal fees, by doing so for an individual who has effectively been offered up in exchange for a deferred prosecution, it may be perceived that the company is not cooperating. Therefore, the employee may be forced to pay his or her legal fees.

I am also wary about conditions apparently put in to some of these agreements. For example, when Bristol-Myers Squibb entered into a deferred prosecution agreement several months ago, one provision was to fund a chair at the U.S. Attorney's alma mater, Seton Hall Law School. One has to question whether that is helpful to the victims (shareholders).

What does all this mean for corporate executives? Obviously, your personal ethics should take top priority. Recognize that attorney-client privilege may not protect you as an individual, and that your professional decisions need to stand the test of your personal convictions.