Zukerman Case Raises Issues Regarding Crime Fraud Exception to Attorney Client Privilege

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We welcome back guest blogger Peter Hardy.  Peter is a partner at Ballard Spahr in Philadelphia and an adjunct professor at Villanova Law School.  Peter, a former Assistant United States Attorney in Philadelphia and a former trial attorney with the Tax Division of the Department of Justice in Washington, D.C., has a practice that focuses on white collar criminal issues and the civil fallout.  Today, he examines the indictment involving a tax fraud case in which the government sought to turn the target’s attorney into a witness and how the government’s actions here should inform your actions in working with clients.  Keith

A recent indictment returned against a high-profile investor for alleged tax fraud has highlighted the potential perils for counsel posed by the crime-fraud exception to the attorney-client privilege and the attorney work product doctrine.  In this case, the crime-fraud exception was invoked successfully by the government to obtain otherwise privileged communications between the defendant and his lawyers during an IRS audit.  This evidence had real-world consequences because the disclosed communications resulted in both additional allegations of criminality and an effort by the government to suggest that counsel might be conflicted out of defending their client during the criminal case filed in the wake of the audit.  This case reminds tax practitioners – and any lawyer representing a client before a government agency – that the real-world protections surrounding legal privilege may be more fragile than anticipated.

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The indictment against Morris Zukerman, unsealed on May 23, 2016, charges him with one count of tax evasion (26 U.S.C. § 7201), one count of wire fraud (18 U.S.C. § 1343), and one count of obstructing the IRS (26 U.S.C. § 7212(a)).  The indictment is lengthy and complex and will be summarized here only.  According to the press release issued by the Office of the U.S. Attorney’s Office for the Southern District of New York, Mr. Zukerman is a business person who owns companies involved in energy investments and who engaged in multi-year tax fraud schemes in which he evaded over $45 million in taxes. More specifically, the government has alleged in part that Mr. Zukerman “evaded tens of millions of dollars of corporate income taxes arising out of $130 million sale of an oil company; he prepared personal tax returns for himself and family members that claimed millions of false deductions; [and] he evaded employment taxes based on personal employees[.].  . . . [W]hen the IRS auditors examined his returns, Zukerman allegedly schemed to defraud and obstruct the IRS auditors who were examining his false tax returns.”

For the purposes of this discussion, we will concentrate only on the alleged obstruction of the audit. Again, the government’s press release asserts as follows:

In seeking to obstruct and defraud the IRS during an audit of one of ZUKERMAN’s companies, ZUKERMAN utilized two attorneys from a law firm in Washington, D.C., to convey a false factual narrative to an IRS Appeals officer, who was undertaking a review of ZUKERMAN’s challenge to an adverse determination made by an IRS auditor during the corporate audit.  Pursuant to a “crime-fraud” ruling by the United States District Court for the Southern District of New York, and affirmed by the Second Circuit Court of Appeals, ZUKERMAN’s companies were required to disclose to the grand jury all of the communications between ZUKERMAN and the two attorneys that led to the submission to the IRS of the false factual narrative.

 

It is somewhat remarkable that the government saw fit to include the last sentence in the press release. The first sentence quoted above would have sufficed to describe the offense alleged in the indictment. For whatever reason, the government also wanted to announce publically the process underlying the grand jury investigation – which was irrelevant to whether or not prior obstruction had occurred during the audit – and make clear that, through successful invocation of the “crime fraud” exception to the attorney-client privilege, the government had obtained records regarding the defendant’s communications with his lawyers. Perhaps this language was intended as a pointed message to defense counsel; perhaps it was intended to set the stage for the government’s effort to raise potential conflict issues involving the defendant’s counsel in the criminal case – who were the same lawyers who had represented him in the audit.

After the return of the indictment, the government filed a letter with the district court, requesting a hearing on whether or not the defendant’s counsel could remain in the case. To be clear, there has been no suggestion that counsel engaged in misconduct. Rather, the government stated that there was a potential conflict created by the Mr. Zukerman proceeding to trial with his defense counsel, who “are potential witnesses as a result of the defendant’s use of those attorneys to convey false information to the Internal Revenue Service during a civil audit – offense conduct that is . . . described at length in the Superseding Indictment[.]” Although the government indicated that it thought that potential conflicts could be waived by the defendant, a hearing was necessary to establish knowing and intelligent waiver by the defendant of those potential conflicts. Ultimately, the district court determined that defense counsel could remain in the case because Mr. Zukerman provided the required waiver and because it is anticipated that Mr. Zukerman will not go to trial, but rather may resolve the case through a guilty plea.

Scenarios like the above case highlight the fact that lawyers who represent clients in tax audits – or in any sort of administrative investigation or inquiry – can become potential witnesses if the government later decides that misrepresentations occurred during the audit or inquiry.  Further, the same lawyer can be perceived as a helpful witness by either the client or the government: as a witness in support of a reliance on counsel defense, or as a witness for the government to undermine such a defense or even provide affirmative evidence of criminal intent, if, for example, counsel received less than full and accurate information from the client when providing the advice at issue, or if the client received advice and then acted to the contrary.

Thus, the prosecutorial interest in the potential opportunities afforded by the crime-fraud exception – both tactical and evidentiary – is not surprising. However, there is also a real risk that the crime-fraud exception can be abused, intentionally or otherwise, as we will now discuss.

To invoke successfully the crime-fraud exception to obtain otherwise privileged attorney-client communications, the government must make a prima facie showing that (a) the client was committing or intending to commit a crime; and (b) the attorney-client communications were in furtherance of the alleged ongoing crime.  The government’s prima facie burden is relatively light, and it does not require the government to prove that a crime in fact occurred, or that the intended crime was accomplished.  Rather, courts generally hold that the standard is merely one of “reasonable cause”; that is, the government only has to make a showing of reasonable cause to believe that the attorney’s services were misused in furtherance of an ongoing criminal scheme.  The exception can apply even if the attorney is innocent and entirely unaware that the client is engaged in or planning a crime.  As a matter of process, the district court reviewing the government’s application – which will be filed under seal – may make its decision in camera, based upon information supplied ex parte by the government.  The court does not have to base its decision on evidence independent of the communications between the attorney and the client.

This evidentiary threshold is low.  Further, the usual procedure attendant to decisions regarding the crime-fraud exception, which almost always occur during grand jury investigations, virtually ensures that the details and merits underlying most decisions – sometimes based on ex parte government submissions – will never see the light of day.  Moreover, district courts overseeing grand jury investigations are, generally speaking, extremely reluctant to potentially interfere with the evidence gathering function of the grand jury, which historically has received very wide berth.  Of course, the course of almost every grand jury investigation is a function of the choices and subjective beliefs of the particular federal prosecutor directing the investigation, rather than the grand jurors themselves.  This confluence of factors means that, as a practical matter, it will be a very rare case indeed – perhaps no case – in which a district court or a magistrate court concludes on the basis of a limited and non-public hearing that it will put some brakes the grand jury’s fact-finding function because the government has failed to show (sometimes through an ex parte submission) that, after accepting its view of the case, there is at the very least “reasonable cause” to believe or suspect that legal advice was misused in the furtherance of some alleged ongoing offense, and that the most prudent course is to order otherwise privilege communications to be divulged.  In part, the reasoning for allowing privilege to be pierced may go:  if criminal charges are actually ever filed, it ultimately will be up to the jury to sort out whether or not an actual crime was committed.  Such reasoning may be explicit, or it may be an unconscious consideration rooted in the very human proclivity to perform an act when ultimate responsibility can be attributed to others.

Anecdotally, it appears to this writer that, over the years, federal prosecutors have become increasingly willing to pursue otherwise privileged evidence from counsel through the aggressive invocation of the crime-fraud exception.  Several years ago, the perils inherent in this possible trend were noted by the district judge who acquitted Lauren Stevens, a former in-house counsel charged with obstruction of justice during an investigation by the Food and Drug Administration, after finding that the government’s evidence during her trial was insufficient as a matter of law to prove criminal intent.  When explaining the granting of the defendant’s motion for judgment of acquittal, the district court observed that much of the evidence upon which the government relied had been obtained through the crime-fraud exception, and then noted:

There are, of course, profound implications for the free flow of communications between a lawyer and a client when the privilege is abrogated, as it was in this case.

. . . .

With the 20/20 vision of hindsight, and that’s always the place to be in terms of wisdom, the [order requiring the production of legal documents under the crime-fraud exception] was an unfortunate one, because I now have benefitted from a trial in which these documents that were ordered produced were paraded in front of me, and the prosecutors were permitted to forage through confidential files to support an argument for criminality of the conduct of the defendant.

What those records demonstrate to the Court is, first of all, that access should not have been granted to them in the first place. . . .

. . . .

[A] lawyer should never fear prosecution because of advice that he or she has given to a client who consults him or her, and a client should never fear that its confidences will be divulged unless its purpose in consulting the lawyer was for the purpose of committing a crime or a fraud.

United States v. Stevens, No. RWT 10cr0694 (D. Md. May 10, 2011).  These concerns regarding the potential for abuse in the use of the crime-fraud exception, although eloquent, do not appear to have been embraced often in practice since the issuance of the acquittal in the Stevens case.

The decision in the Zukerman case regarding the crime-fraud exception may have been entirely appropriate; this discussion does not purport to address that question on the merits.  Regardless of whether it was right or wrong, however, the case represents yet another cautionary tale about how the attorney-client privilege and work-product doctrine do not always provide the long-lasting protections that one might hope they provide, particularly if your client stumbles later into the cross-hairs of a creative and aggressive prosecutor. Even if counsel is not personally the subject or target of a criminal investigation, receiving a subpoena for records or to testify against one’s client is obviously a situation to be avoided.  Certainly, this cautionary tale applies to lawyers representing clients during tax audits.  However, it also applies more globally to any lawyer – whether acting as outside counsel or in-house counsel – handing an administrative inquiry by the government, including the Securities and Exchange Commission, the Food and Drug Administration, and many other agencies.  Although courts describe the reasonable cause standard as reasonably demanding, the practical realities suggest that whether or not the crime-fraud exception will overcome otherwise privileged communications turns not on a court’s application of the legal standard to the facts, but rather on the discretion and mindset of the particular government attorney and whether or not he or she sees fit to pursue the exception.

Comments

  1. Jim Malone says

    This was well-done. One of my concerns when I learned of the decision was collateral damage for the lawyers involved, both in terms of their reputations generally and their future credibility with prosecutors in other investigations.

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