KPMG Attorney's Fees Claims Kicked By the Second Circuit -- Is Dismissal of the Indictment Next?

The jury-rigged procedure created by U.S. District Judge Lewis Kaplan to address claims for attorney's fees by the former KPMG partners and employees charged with tax evasion for their role in selling tax shelters has been overturned by the Second Circuit (opinion available below).  Judge Kaplan found that the Department of Justice violated the Fifth and Sixth Amendment rights of the individual defendants in one of the largest tax prosecutions ever when prosecutors pressured KPMG to cut off paying attorney's fees as a condition of the deferred prosecution agreement it entered into to settle a criminal investigation of the firm's conduct in the creation and marketing of the tax shelters.  Rather than dismiss the indictment because of the constitutional violations, Judge Kaplan found that the court had ancillary jurisdiction to hear civil claims by the defendants for payment of the fees as the best remedy.  In a 25-page opinion that will please those with an affinity for federal appellate jurisdiction and the rules for mandamus actions, the court of appeals first decided that it would treat the claim by KPMG challenging the judge's decision as a petition for a writ of mandamus so it could sidestep the question of whether it had jurisdiction over the action or whether it was an unappealable interlocutory order -- remember the collateral order doctrine from your civil procedure course?

After cutting through the jurisdictional thicket, the Second Circuit addressed the appropriateness of the ancillary civil proceeding by which defendants could seek to have KPMG pay their attorney's fees.  In a concise, well-written rejection of Judge Kaplan's analysis of the need for such a remedy, the court of appeals found that Judge Kaplan's process would not address the core claim of a constitutional violation and the procedures for adjudicating the issues were quite unclear.  The opinion states:

[T]he assertion of ancillary jurisdiction over matters that are otherwise outside the jurisdiction conferred by the Constitution and the Congress can be justified only by compelling needs arising in the exercise of the jurisdiction that is conferred. While we do not exclude the possibility of a legitimate ancillary proceeding involving a non-party to the primary litigation, we believe that the requisite compelling circumstances will be rare, as the need for such a proceeding generally will be far less pressing than in cases involving parties already before the court.  In the present matter, the prejudice to KPMG is clear, and the need for the ancillary proceeding is entirely speculative.  The claims to be resolved in the ancillary proceeding sound in contract, i.e. appellees claim that KPMG impliedly -- in one case expressly -- promised to pay their expenses in defending the present criminal charges. The prejudice to KPMG in having these claims resolved in a proceeding ancillary to a criminal prosecution in the Southern District of New York is clear. At stake are garden variety state law claims, albeit for large sums.  KPMG believed that contractual disputes between it and the appellees would be resolved by arbitration. Instead, KPMG is faced with a federal trial of more than a dozen individuals’ multi-million dollar “implied-in-fact” contract claims.  Moreover, because such a proceeding is governed by no express statutory authority, the district court has indicated its intention to apply to this expedited undertaking an ad hoc mix of the criminal and civil rules of procedure determined on the fly, as it were. The resolution of the contract claims against KPMG is thus to occur in an entirely sui generis proceeding even though it may require the scrutinizing of decades of KPMG’s conduct, determining the states of mind of dozens of individuals, applying the findings from those inquiries to the particular circumstances of each appellee, and resolving multiple questions of the law of several states. Waiting to appeal from a final judgment in this sort of proceeding can hardly be described as an “adequate means” of relief eliminating the need for mandamus.

In discussing the appropriateness of the district court's remedy, the Second Circuit pointed to what may well be the next step in the litigation: dismissal of the indictment.  The court wrote:

Even if the holding that the government violated the Fifth and Sixth Amendments is correct -- an issue on which we express no opinion -- the ancillary proceeding will provide a "remedy" only if KPMG loses, hardly a foregone conclusion on the present record. But even if there are constitutional violations and even if KPMG was contractually obligated to pay appellees’ expenses, the ancillary proceeding is not an indispensable remedy and may not even constitute a full remedy. Dismissal of an indictment for Fifth and Sixth Amendment violations is always an available remedy. (Italics added)

Judge Kaplan eschewed the dismissal remedy because of the costs imposed on society when a criminal case cannot be prosecuted.  Faced with the Second Circuit's reversal of his mechanism for granting attorney's fees -- the likelihood of KPMG prevailing before him was slight, I think -- the only clear alternative for addressing the constitutional violations is to dismiss the indictment.  At that point, the government is almost guaranteed to file an appeal, which will place the constitutional question squarely before the court of appeals, and, perhaps down the road, the Supreme Court. 

Judge Kaplan's analysis of the constitutional violations in this case was an extension of existing caselaw, at best.  Whether his findings survive depends on the next step: Will the judge grant the remedy pointed to by the Second Circuit as the most direct means of addressing the prosecutorial violations found by the court and thereby open his constitutional analysis to appellate review?  If he does dismiss the indictment, an already slowed case will grind to a halt while appeals are pursued, and each side will have a strong incentive to seek Supreme Court review.  Not dismissing the indictment puts the court in the uncomfortable position of finding sustantial constitutional violations but granting no relief to the aggrieved parties. (ph)

Download us_v. Stein Opinion May 23 2007.pdf