Sparing itself from a potentially lethal criminal indictment, KPMG LLP, the nation’s fourth-largest accounting firm, admitted Monday to setting up fraudulent tax shelters for its wealthiest clients that cost the U.S. billions of dollars in revenue.
While the firm avoided prosecution, Justice Department officials in New York filed tax fraud charges against eight former employees of the accounting firm and one outside lawyer for allegedly conspiring to defraud the Internal Revenue Service through the scheme.
Appearing in a Lower Manhattan courtroom, KPMG lawyers admitted that “a number of KPMG tax partners engaged in conduct that was unlawful and fraudulent.”
In sidestepping prosecution, KPMG admitted guilt and agreed to pay $456 million in penalties.
But it may have avoided the same fate of its former competitor, Chicago-based Andersen. The once powerful firm crumbled after its 2002 conviction in the accounting scandal that engulfed its client Enron Corp. The conviction was overturned by the Supreme Court earlier this year, but not before the loss of all of its business and all but a handful of employees.
Citing a desire to avoid “collateral damage” to the public and KPMG employees, U.S. Atty. Gen. Alberto Gonzales, speaking in Washington, signaled that the government was looking to avoid an Andersen-like collapse.
If the Andersen case serves as a guide, KPMG’s roughly 1,000 corporate clients would likely have stopped doing business with a firm under federal indictment.
Gonzales said that “there are many factors that we weigh to determine the appropriate law enforcement action,” including “what are the consequences on the company and what are consequences on the industry?”
He added that “we are protecting the efforts of honest businesses as well as deterring future crimes.”
Yet some industry watchers Monday couldn’t help but speculate whether Andersen might have been spared had prosecutors known that a company employing some 28,000 people would be effectively put out of business after being charged with obstruction of justice.
“If Andersen had been second, it might have avoided the indictments and survived. Timing is everything,” said Lawrence Revsine, professor of accounting at Northwestern University’s Kellogg School of Management.
The Department of Justice called the KPMG scandal the largest criminal tax case ever filed and said the firm’s scam allowed clients to avoid paying $2.5 billion in taxes.
“Simply stated, if you had a multimillion-dollar tax liability, KPMG would find a way to wipe it out, even when the firm’s own experts thought the transactions would not survive IRS scrutiny,” said IRS Commissioner Mark Everson. “The only purpose of these abusive deals was to further enrich the already wealthy and to line the pockets of KPMG partners.”
In addition to admitting guilt and paying a fine, KPMG agreed that by early next year it would end its private client tax practice as well as its compensation and benefits tax practice, historically lucrative parts of its business. KPMG discontinued most of its private client tax practice in 2002.
To enforce the agreement, Richard Breeden, the former Securities and Exchange Commission chairman who also oversaw MCI Inc. after the WorldCom Inc. bankruptcy, will monitor KPMG for three years.
IRS officials said Monday that KPMG’s tax shelter scheme was driven by greed.
The executives allegedly sold fraudulent tax shelters between 1996 and 2002 that claimed $11 billion in bogus tax losses. Disguised as legitimate investments, the shelters were known by names such as FLIP, for foreign leveraged investment program; BLIPS, for bond linked issue premium structure; and SOS, for short option strategy.
According to the Justice Department, the shelters were targeted at individuals who needed a minimum of $10 million or $20 million in tax losses in order to offset gains that should have been taxed.
Rather than guarding clients against legitimate yet risky investments, the shelters sold by KPMG executives reported tax losses in order to offset profits made on stock market and other types of investments. KPMG admitted the shelters aided “high net worth” clients from paying capital gains and income taxes.
Such aggressive tax shelters were emblematic of the late-1990s “era of excess,” according to corporate governance experts.
“This was a time when accounting firms were under tremendous pressure to find ways other than filing tax forms to make money,” said Nell Minow, editor of The Corporate Library, a corporate governance database. “Just like those at Enron, Global Crossing and Hollinger, people lost any sense of perspective and the consequences of their actions.”
Had the government chosen to prosecute KPMG, it is unlikely the firm could have avoided the legal troubles that doomed Andersen.
“This was the most appropriate solution to this situation,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “A world with three major accounting firms instead of four would be very difficult on the whole architecture that was developed post-Sarbanes-Oxley.”
The Sarbanes-Oxley Act, passed in 2002 after financial scandals took down firms such as Enron and WorldCom, requires corporations to hire separate auditors for parts of businesses that may be in competition with each other. In merger and acquisition deals, the act forbids an auditor from taking on work that could be judged to be a conflict of interest.
Lawyers for some of the KPMG defendants publicly vowed to fight the charges. Robert S. Fink, the lawyer of Richard Smith, one of the KPMG partners indicted Monday, said in a statement that “the government is attempting to criminalize the type of tax planning that tax professionals engage in on a daily basis.”
“If the government wants to put an end to these types of transactions, the proper response is for Congress to change the law, not to scare professionals away with indictments,” the statement read.
Under the agreement, KPMG will make an initial payment of $256 million by Sept. 1, followed by a $100 million payment in mid-2006 and another $100 million at the end of next year.