New York Law Review

Tag: Corporate Fraud

  • Kirschner v. KPMG LLP, 15 N.Y.3d 446 (2010): In Pari Delicto and the Adverse Interest Exception

    15 N.Y.3d 446 (2010)

    Under New York law, the doctrine of in pari delicto prevents a corporation from recovering against a third party for damages resulting from the corporation’s own wrongdoing, unless the adverse interest exception applies, requiring that the agent has totally abandoned the corporation’s interests, acting entirely for their own purposes.

    Summary

    In the wake of the Refco and AIG scandals, the Court of Appeals addressed whether corporations could sue their auditors for failing to detect internal fraud. The court reaffirmed the in pari delicto doctrine, which prevents wrongdoers from seeking relief in court. The court explained imputation, where an agent’s actions are attributed to the principal, and the adverse interest exception, where the agent acts entirely against the principal’s interest. The court held that absent total abandonment by the agent to the principal’s interest, the corporation is barred from suing third parties for wrongs that the corporation itself participated in, furthering the policy that corporations should monitor their agents.

    Facts

    Refco, a brokerage firm, collapsed after revealing fraudulent loans orchestrated by its CEO, which had hidden massive debt. A Litigation Trust was created to pursue claims on behalf of Refco’s creditors. AIG was found to have defrauded investors into thinking they were more secure and prosperous than they really were.

    The Litigation Trustee sued Refco’s executives, investment banks, law firms, accounting firms, and customers, alleging they aided and abetted the fraud or were negligent in not discovering it. Shareholders of AIG brought a derivative action accusing AIG officers of misstating AIG’s financial performance.

    Procedural History

    The District Court dismissed the Litigation Trustee’s claims, citing the Second Circuit’s Wagoner rule, finding the trustee lacked standing due to Refco’s participation in the fraud and that the adverse interest exception didn’t apply. The Delaware Court of Chancery dismissed the AIG derivative action on similar grounds. The Second Circuit and the Delaware Supreme Court certified questions to the New York Court of Appeals regarding the scope of the adverse interest exception and the applicability of in pari delicto.

    Issue(s)

    1. Whether the adverse interest exception to imputation is satisfied by showing that the insiders intended to benefit themselves by their misconduct?

    2. Whether the adverse interest exception is available only where the insiders’ misconduct has harmed the corporation?

    3. Would the doctrine of in pari delicto bar a derivative claim under New York law where a corporation sues its outside auditor for professional malpractice or negligence based on the auditor’s failure to detect fraud committed by the corporation; and, the outside auditor did not knowingly participate in the corporation’s fraud, but instead, failed to satisfy professional standards in its audits of the corporation’s financial statements?

    Holding

    1. No, because the agent must totally abandon the principal’s interest and act entirely for their own purposes.

    2. Yes, because the fraud must be committed against the corporation, not on its behalf.

    3. Yes, because in pari delicto applies when a corporation, through its agents, is equally culpable with the defendant.

    Court’s Reasoning

    The court reasoned that the in pari delicto doctrine prevents courts from resolving disputes between wrongdoers. Agency principles dictate that an agent’s actions are imputed to the principal. The adverse interest exception is narrow and applies only when the agent has “totally abandoned” the principal’s interest. The court rejected the argument that intent alone is sufficient; the fraud must be against the corporation, not merely for its benefit. The court emphasized that principals are best suited to monitor their agents and that any harm from the discovery of the fraud does not bear on whether the adverse interest exception applies.

    The court stated, “To come within the exception, the agent must have totally abandoned his principal’s interests and be acting entirely for his own or another’s purposes. It cannot be invoked merely because he has a conflict of interest or because he is not acting primarily for his principal”.

    The court declined to broaden the adverse interest exception, noting the potential for a double standard where stakeholders of corporations are absolved while stakeholders of third-party professionals are held responsible. The court was not convinced that expanding remedies would meaningfully deter professional misconduct and found that existing legal and regulatory frameworks already provide disincentives. The court concluded that maintaining stability in the law outweighed the speculative benefits of altering precedent.

  • People v. Kozlowski, 11 N.Y.3d 223 (2008): Admissibility of Factual Testimony and Subpoena of Internal Investigation Materials

    11 N.Y.3d 223 (2008)

    An attorney’s factual testimony regarding an internal investigation is admissible if it doesn’t express a personal opinion on the defendant’s guilt, and internal investigation materials are protected by qualified privilege unless a substantial need and undue hardship in obtaining equivalent information are demonstrated, or a waiver of privilege occurred.

    Summary

    This case concerns the convictions of former Tyco executives, Kozlowski and Swartz, for crimes related to corporate wrongdoing. The court addresses whether an attorney’s testimony during an internal investigation improperly conveyed an opinion on the defendants’ guilt, and whether the defendants’ subpoena seeking interview notes from the investigation was properly quashed. The court finds the testimony was factual and didn’t express an opinion and that the subpoenaed materials were protected by a qualified privilege, as the defendants failed to show a substantial need or inability to obtain the information elsewhere. The court also addresses the constitutionality of the fines imposed but finds that the fines were harmless if erroneous.

    Facts

    Kozlowski and Swartz, former executives at Tyco, were convicted of multiple counts of grand larceny and falsifying business records related to the misuse of company loan programs. They used the Key Employee Loan Program (KELP) and relocation loan program for personal expenses, such as artwork and residences. To cover these debts, they arranged for unauthorized bonus payments from Tyco’s Incentive Compensation Plan. The Compensation Committee, typically responsible for approving bonuses, was bypassed. After Kozlowski’s resignation, Tyco hired Boies Schiller to conduct an internal investigation into potential executive misconduct.

    Procedural History

    Kozlowski and Swartz were convicted after a nearly six-month trial. They appealed, arguing that the admission of Boies’s testimony and the quashing of their subpoena were erroneous. The Appellate Division affirmed the convictions. The defendants then appealed to the New York Court of Appeals.

    Issue(s)

    1. Whether the admission of David Boies’s testimony regarding the internal investigation, and the prosecutor’s summation comments thereon, improperly conveyed an opinion regarding defendants’ guilt.

    2. Whether the trial court abused its discretion in quashing the defendants’ subpoena duces tecum seeking factual portions of interview notes and memoranda prepared during the internal investigation.

    3. Whether the fines imposed under Penal Law § 80.00 violated Apprendi v New Jersey.

    Holding

    1. No, because the testimony was factual and didn’t express an opinion on the defendants’ guilt.

    2. No, because the subpoenaed materials were protected by a qualified privilege, and the defendants failed to demonstrate a substantial need or an inability to obtain the information through other means.

    3. The Court does not reach the question. Assuming without deciding that an Apprendi violation occurred, any error was harmless because the defendants’ trial testimony established gains that corresponded to or exceeded the fine amounts.

    Court’s Reasoning

    The Court reasoned that Boies’s testimony was limited to firsthand factual accounts of his investigation and conversations with Swartz and Tyco’s management. The testimony provided relevant facts for the jury to consider without expressing a personal opinion about the defendants’ guilt. The court distinguished this case from People v. Ciaccio, where a detective offered an opinion on the victim’s credibility. The court also found that the subpoena was properly quashed because the defendants failed to show a substantial need for the materials or an inability to obtain equivalent information elsewhere. The requested materials were deemed trial preparation materials protected by qualified privilege. The court emphasized that the defendants had access to the same witnesses and failed to demonstrate an attempt to secure independent interviews. Regarding the fines, the court assumed an Apprendi violation, which holds that any fact increasing the penalty for a crime beyond the statutory maximum must be submitted to a jury and proven beyond a reasonable doubt, but it found it harmless, as the defendant testified to the amount they gained in the crime, which was equal to, or exceeded, the fines.