Wednesday, November 25, 2009

A Lesson on the Crime-Fraud Exception to Attorney-Client Privilege

On November 20, the Fourth Circuit entered an unpublished decision in United States v. Under Seal & John Doe, 2009 U.S. App. LEXIS 25523 (4th Cir. 2009). The issue was whether the district court properly applied the crime fraud exception to the attorney client privilege, thus permitting the Government to subpoena an attorney's files. The attorney is referred to in the opinion as Counsel.

Such holdings are fact driven, and these facts quoted succincntly by the Fourth Circuit suggest the conclusion:
In 1997, the president of the Corporation established another entity in the Isle of Man ("the Isle of Man Entity"). Two of the Corporation's three directors, one of which is the Corporation's president, were directors of a corporation also established in the Isle of Man ("the Isle of Man Corporation"), which is the trustee of the Isle of Man Entity. Between 1997 and 2000, the Corporation transferred $ 22,523,478 of its assets to the Isle of Man Entity. In 2000, the Corporation dissolved after filing Articles of Termination and Articles of Dissolution with the proper state authorities.

Prior to the Corporation's dissolution and continuing thereafter, the Internal Revenue Service (IRS) conducted an audit of the Corporation. During the audit, the Corporation's president [*3] told the IRS that the transfers from the Corporation to the Isle of Man Entity were made pursuant to opinion letters from several law firms that these transfers were legal. One such letter, which was written by Counsel, was provided to the IRS. Counsel's letter stated that a qualified United States charitable corporation can legally make a grant to a charitable organization in another country so long as the funds are used for charitable purposes. The IRS audit of the Corporation concluded with a finding of "no issue raised."
[I hope you see from just the quoted cryptic summary that something is rotten.]

Back to the case, a grand jury investigation started, and a grand jury subpoena issued. After some sparring and an earlier appeal and remand, the district court held that the Government had established the applicability of the crime fraud exception. The district court based its holding on the ground that the U.S. charitable corporation's return was incorrect, thus potentially violating § 7206(1), in showing no relationship between the U.S. charitable corporation and the Isle of Man charitable corporation.

Counsel appealed, asserting that the statement on the U.S. corporation's return was technically correct, thus, a la Pirro, avoiding the shoals of § 7206(1), because the question only asked about relationship between the U.S. corporation and an individual. (There was of course an individual or individuals behind the lifeless and breathless, wholly fictional (from a legal perspective) Isle of Man corporation, but let's not get hung up on such technicalities.)

The Fourth Circuit summarized the exception and the showings required to invoke it:
The invocation of the crime-fraud exception requires a prima facie showing that "(1) the client was engaged in or planning a criminal or fraudulent scheme when he sought the advice of counsel to further the scheme, and (2) the documents containing the privileged materials bear a close relationship to the client's existing or future scheme to commit a crime or fraud." In re Grand Jury Proceedings # 5, 401 F.3d at 251 (citations omitted). A party invoking the crime-fraud exception can satisfy the first prong of this test by making a prima facie showing of evidence, which, if accepted by the trier of fact, establishes the elements of an ongoing or prospective violation of the law. Id. The second prong of this test is satisfied with a showing of a close relationship between the withheld communications and the alleged violation. Id. Once a sufficient showing has been made, the attorney-client privilege ceases to protect any of the communications related to the alleged violation. In re Grand Jury Subpoena, 419 F.3d 329, 345 (5th Cir. 2005) (citing In re Sealed Case, 676 F.2d 793, 812 n.74, 219 U.S. App. D.C. 195 (D.C. Cir. 1982)).
The Fourth Circuit then reviewed the district court's application of the exception, gliding past the district court's invocation of the potential for violating § 7206(1) and moving to what it perceived was more solid ground in a potential defraud / Klein conspiracy violation under 18 U.S.C. § 371. The court said:
In its ex parte submission, the Government has provided the court with prima facie evidence that the Corporation, its principals and the Isle of Man Entity had an agreement to defraud the United States Government in contravention of § 371. The Government's submission provides prima facie evidence that the Corporation and the Isle of Man Entity entered an agreement to defraud the United States both by concealing the ultimate disposition of the Corporation's funds through the transfer of assets overseas and by using the Corporation's tax-exempt status to circumvent the collection of taxes on the profits of individuals. Such a purpose falls directly within the confines of § 371. The transfer of $ 22,523,478 to the Isle of Man Entity would be an overt act in furtherance of this purpose.
The Fourth Circuit then closed or tightened the noose by holding that the close relationship to that potential violation had been shown.

Things do not look good for the attorney.

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