On December 12, 2006, Deputy Attorney General Paul McNulty issued a memorandum titled "Principles of Federal Prosecution of Business Organizations." It represents the Department of Justice's (DOJ) attempt to deal with criticism from judges, Congress, and the private bar over what were perceived by many to be DOJ strong-arm tactics in conducting corporate criminal investigations.

While the "McNulty Memorandum" may be a step in the right direction, its guidance is fraught with ambiguity. Many questions linger regarding the nature and degree of pressure prosecutors may place on "cooperating" companies. The overriding issue for all concerned, be they in-house counsel, corporate boards, or criminal defense counsel, is how these guidelines will be implemented. The answer will determine whether the McNulty Memorandum reflects real change, or is merely the same package in more appealing wrapping.

Genesis of the McNulty Memorandum

The McNulty Memorandum superseded the controversial "Thompson Memorandum," issued in January 2003 by then Deputy Attorney General Larry D. Thompson (titled the "Principles of Federal Prosecution of Business Organizations"). The Thompson Memorandum engendered significant controversy by providing that whether a company agreed to waive its attorney-client privilege and work product protection, and whether it advanced counsel fees to its employees, were relevant to the assessment of corporate prosecution. The McNulty Memorandum also replaced the October 21, 2005, "McCallum Memorandum," or "Waiver of Corporate Attorney-Client Privilege and Work Product Protection," the DOJ's first effort to address the controversy caused by Thompson. While McNulty reiterates a great deal of existing policy, it contains significant refinements in the provisions regarding privilege waiver and advancement of fees.

The McNulty Memorandum was issued in the wake of two significant and recent reactions to DOJ's tactics, one from the courts and one from Congress. In the KPMG tax shelter prosecutions, District Court Judge Lewis Kaplan of the Southern District of New York issued two opinions finding portions of the Thompson Memorandum unconstitutional, including that Thompson's provisions discouraging a company's advancement of legal fees to its employees violated the Fifth and Sixth Amendments to the U.S. Constitution. See United States v. Stein, 435 F. Supp. 2d 330 (S.D.N.Y. 2006), and United States v. Stein, 440 F. Supp. 2d 315 (S.D.N.Y. 2006).

On January 4, 2007, Senator Arlen Specter reintroduced bipartisan legislation titled the Attorney-Client Privilege Protection Act of 2007. This legislation would amend the federal Criminal Code (Title 18, U.S.C.) to prohibit any federal agent or attorney from conditioning treatment of the company on waiver of privilege, payment of employees' legal fees, continued employment of a person under investigation, or entry into a joint defense agreement. With the issuance of the McNulty Memorandum, this bill remains in committee.

Factors Considered in Charging Business Entities

The McNulty Memorandum, like the Thompson Memorandum before it, directs federal prosecutors to consider nine factors in deciding whether to charge a business entity: (1) the nature and seriousness of the offense; (2) the pervasiveness of wrongdoing within the company; (3) the company's history of similar conduct; (4) the company's timely and voluntary disclosure of wrongdoing, and its willingness to cooperate in the investigation of its agents; (5) adequacy of its compliance program; (6) remedial actions, including any efforts to implement an effective compliance program or improve an existing one; (7) collateral consequences, including disproportionate harm to shareholders or other innocent parties; (8) adequacy of prosecution of responsible individuals; and (9) adequacy of alternative remedies, such as civil or regulatory enforcement.

The memorandum makes clear, however, that the scope of prosecutorial discretion remains exceedingly broad, still steeped in an individual prosecutor's judgment of the weight to be given the above factors. Indeed, in detailing those factors, McNulty makes clear that "prosecutors must exercise their judgment in applying and balancing" them, and advises that "the prosecutor generally has wide latitude in determining when, whom, how and even whether to prosecute . . ."

Assessment of Corporate "Cooperation"

McNulty made significant revisions to Thompson's fourth factor—willingness to cooperate. In particular, McNulty addresses (1) when federal prosecutors may demand that a company waive its attorney-client privilege or attorney work product confidentiality and (2) whether a company's advancing attorney fees and related expenses to its employees or agents may be considered inconsistent with a company's willingness to cooperate fully. In most other respects, including the use of joint defense agreements, even the cooperation provisions of McNulty leave Thompson largely unchanged.

In its privilege waiver provisions, the McNulty Memorandum purports to address the widespread perception that a pervasive culture of waiver requests had evolved within DOJ. The Thompson Memorandum had explicitly allowed prosecutors to consider the willingness to waive in their corporate charging decisions: "In gauging the extent of the corporation's cooperation, the prosecutor may consider the corporation's willingness to . . . waive attorney-client and work product protection."

McNulty, however, sets forth some limitations on the discretion of federal prosecutors in making waiver requests. Preliminarily, it provides: "Prosecutors may only request waiver of attorney-client or work product protections when there is a legitimate need for the privileged information to fulfill their law enforcement obligations." Whether a legitimate need exists depends on the application of four factors: (1) the likelihood and degree to which the privileged information will benefit the government's investigation; (2) whether the information sought can be obtained in a timely and complete fashion by using alternative means that do not require waiver; (3) the completeness of the voluntary disclosure already provided; and (4) the collateral consequences to a corporation of a waiver.

These factors, however, beg many questions that will likely only be answered with the experience of implementation. For example, the first factor, benefit to the investigation, would appear difficult to assess without some inquiry into the nature of what is being withheld. However, DOJ insistence on counsel proffers, even hypothetical, as to the substance of privileged communications could quickly vitiate the fundamental purpose of the privilege "to encourage full and frank communication between attorneys and their clients . . .," Upjohn v. United States, 449 U.S. 383 (1981). The second factor, the availability of alternate means, would appear to provide a basis for counsel to resist production of interview memoranda so long as the identity of knowledgeable witnesses is made known to the government. As described below, however, access to counsel interview memoranda is hardly addressed with clarity by McNulty. The third factor, completeness of voluntary disclosure, appears to leave a great deal of judgment in the hands of a prosecutor to pressure for details obtained through privileged investigations. On the other hand, the fourth factor, collateral consequences, does appear to provide defense counsel with a basis to argue that the ever-present danger of private civil suits—and the risk that waiver as to one party is waiver as to all (the issue of "selective waiver")—provides good grounds to resist a government request.

If the "legitimate need" standard is met, McNulty then sets forth a "step-by-step approach" that federal prosecutors must follow in pursuing waiver. Prosecutors must first seek "purely factual information," which may or may not be privileged. This is described as "Category I" information. It includes, but is not limited to, "witness statements, or purely factual interview memoranda regarding the misconduct, organization charts created by company counsel, factual chronologies, factual summaries, or reports (or portions thereof) containing investigative facts documented by counsel." Before requesting Category I information, federal prosecutors must request and receive written authorization from the U.S. Attorney. The U.S. Attorney, in turn, must provide a copy of this request to, and consult with, the Assistant Attorney General for the Criminal Division in Washington. Notably, a company's response to the government's request for Category I information "may be considered in determining whether a corporation has cooperated in the government's investigation." Thus, failure to waive even the most well-founded privilege for such materials can still be held against the corporation.

The breadth of Category I, however, appears to continue to make fair game the very work of counsel that has caused the most concern to date—the result of counsel's internal investigation. The phrases "purely factual interview memoranda," "factual chronologies," "factual summaries," and "reports containing investigative facts" can be read to encompass the typical manner in which the results of internal investigations are documented. Further, what constitutes "purely factual" interview memoranda is difficult to discern. It certainly could be interpreted to include Upjohn protected interviews by corporate counsel of their employees. Category I thus appears in many ways to ignore the practical reality that rendering "pure" legal advice is but a small part of what counsel do in response to a government investigation. Rather, it is the distillation of fact, and the selection and identification of what is relevant, that more than anything embodies the essence of counsel's work. If prosecutors read Category I to capture typical investigative work product, the very chilling effect that the McNulty Memorandum purports to address may remain largely unremedied.

Only if the Category I information "provides an incomplete basis to conduct a thorough investigation" can federal prosecutors request "Category II" information. Category II is comprised of "attorney-client communications or non-factual attorney work product" such as "legal advice given to the corporation before, during, and after the underlying misconduct occurred." To obtain Category II information, the U.S. Attorney must obtain written authorization from the Deputy Attorney General, setting forth the "legitimate need" for the information and identifying the scope of the waiver sought.

Unlike Category I information, where a refusal to waive "may be considered in assessing cooperation," if the corporation does not waive as to Category II, the government "must not consider this declination against the corporation in making a charging decision." With what could be viewed as deft sleight of hand, however, the memorandum goes on to provide: "Prosecutors may always favorably consider a corporation's acquiescence to the government's waiver request in determining whether a corporation has cooperated." For a company facing the Armageddon of federal criminal prosecution, "not considering" a refusal versus "favorable consideration" of acquiescence looks all too much like a distinction without practical difference.

The second controversial provision of the Thompson Memorandum dealt with advancement of legal fees to employees. Thompson explicitly stated that this factor could be considered by prosecutors as a strike against the corporation: "Thus, while cases will differ depending on the circumstances, 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."

In a section titled "Shielding Culpable Employees and Agents,"the McNulty Memorandum addresses this issue of advancement. It provides, contrary to Thompson, that "prosecutors generally should not take into account whether a corporation is advancing attorneys' fees to employees or agents under investigation and indictment." [Emphasis added]. This is because "a corporation's compliance with governing state law and its contractual obligations cannot be considered a failure to cooperate." McNulty does not explicitly address the distinction between mandatory and permissive indemnification, and appears to leave open the possibility that prosecutors could continue to press against indemnification in cases where it is optional. The use of the term "generally" also adds an amorphous quality to the fee issue. Broadly written bylaws, however, that require indemnification to the full extent permitted by applicable state law should help companies avoid such controversy.

Despite this limitation on consideration of advancement of fees, prosecutors are still free to ask questions about how, and by whom, an individual's attorney fees are being paid. Further, in "extremely rare cases," where a prosecutor determines that the "totality of the circumstances" shows that the advancement of fees was intended to impede a criminal investigation, advancement may be taken into account in the charging decision. Prior approval from the Deputy Attorney General, however, must be obtained before prosecutors may consider this factor.

The McNulty Memorandum does nothing to address the Thompson Memorandum's provisions on joint defense agreements. Both McNulty and Thompson provide: "A corporation's promise of support to culpable employees and agents, . . . through providing information to the employees about the government's investigation pursuant to a joint defense agreement, may be considered by the prosecutor in weighing the extent and value of a corporation's cooperation."

This continues to be troubling for several reasons. Who is to judge "culpability" in the advance of any judicial due process? Is the mere identification by the prosecutor of an employee as a "subject" of the investigation sufficient? The breadth of the definition of a "subject" in the Justice Department manual—which, in white collar cases, encompasses virtually anyone whose conduct touched upon the transactions at issue—thus could sweep within it almost any employee with relevant knowledge. Broadly read, this provision of the McNulty Memorandum thus could be read by prosecutors to justify a routine assault on joint defense agreements.

Such disfavor of joint defense agreements, however, would be inconsistent with both law and good policy. Joint defense agreements have long been sanctioned by the courts as an important tool in effective representation. It is simply unjustified for the DOJ to presume without evidence that such agreements are being used other than in the ethical manner sanctioned by law. Further, veteran prosecutors in complex white collar cases must recognize that experienced and well-informed defense counsel often enhance rather than hinder the investigative process. A meaningful dialogue between defense and prosecution more often than not contributes greatly to avoiding unwarranted and ill-conceived prosecutions. Viewing joint defense agreements as nothing more than a cloak for obstructive conduct simply does not reflect the reality of the vast majority of white collar cases. In the context of the McNulty Memorandum's implicit recognition of the importance of effective legal representation, one hopes that this reference to joint defense agreements will be read narrowly and used with caution.

Compliance Programs

Although the McNulty Memorandum raises a plethora of questions that will undoubtedly be argued for some time, proactive measures to avoid misconduct, in the form of an effective compliance program, remain a significant theme in the DOJ's assessment of corporate criminal liability. The McNulty Memorandum thus reiterates the department's view on the importance of compliance programs. It recognizes that "federal prosecutors and corporate leaders share a common goal. Directors and officers owe a fiduciary duty to a corporation's shareholders, the corporation's true owners, and they owe duties of honest dealing to the investing public in connection with the corporation's regulatory filings and public statements. The faithful execution of these duties by corporate leadership serves the same values in promoting public trust and confidence that our criminal prosecutions are designed to serve."

The memorandum stresses that the existence of a compliance program, while not dispositive, continues to be a substantial factor favoring declination of corporate prosecution—but only if the program is "designed and implemented in an effective manner," and not "merely a paper program." In so doing, McNulty places significant emphasis on the important role of corporate directors: "[D]o the corporation's directors exercise independent review over proposed corporate actions rather than unquestioningly ratifying officers' recommendations; are the directors provided with information sufficient to enable the exercise of independent judgment; are internal audit functions conducted at a level sufficient to ensure their independence and accuracy; and have the directors established an information and reporting system in the organization reasonably designed to provide management and the board of directors with timely and accurate information sufficient to allow them to reach an informed decision regarding the organization's compliance with the law. In re: Caremark, 698 A.2d 959 (Del. Ct. Chan. 1996)." This restated emphasis on the need to prove the effectiveness of compliance programs—and the important role of corporate directors in that process—serves as an important reminder to corporate boards and executives alike that they must regularly assess whether their compliance efforts are as strong in implementation as they are on paper.

Among the factors prosecutors will continue to assess in determining whether a compliance program has the requisite "teeth" are (1) detailed policies keyed to the particular business in question (e.g., policies specifically addressing regulatory requirements for billing government programs, the Truth in Negotiations Act, the Medicare/Medicaid Anti-Kickback Act); (2) policies in areas that typically create compliance risks (e.g., Foreign Corrupt Practices Act, antitrust, financial controls); (3) training and proactive auditing; (4) a code of ethics and constant communication from management on the primacy of ethical behavior (i.e., "tone at the top"); (5) vehicles for anonymous reporting; (6) a compliance officer/compliance committee with direct access to the board; (7) appropriate discipline for violations; and (8) voluntary disclosure of issues uncovered by the program.

Conclusion

Whether the McNulty Memorandum represents true substantive change will have to await the record of its implementation. Hopefully, in the end, the message of the department will be that effective representation, and the appropriate application of meaningful advocacy, will not be discouraged in the name of corporate "cooperation." In the meantime, one message to business entities remains clear: the most important thing that company counsel can do now to minimize risk in the future is to have a compliance program as effective in practice as it is complete on paper.