KPMG Settlement Sends Shockwaves through Accounting Industry

“Big Four” accounting firm KPMG LLP has acknowledged criminal tax fraud in providing sham tax shelter to wealthy clients between 1996 and 2002, the US Justice Department announced in an August 29 press release. The Justice Department levied a US$456 million fine: – US$100 million for failing to disclose tax shelters on tax filings, as required by law, which cost the US at least US$2.5 billion in tax revenues, according to court papers; – US$128 million for illegally earning US$115 million in fees; and – US$228 million to be paid to the US Internal Revenue Service (IRS) for US$2.5 billion in loss of taxes due to illegal activities.

The Justice Department in turn agreed to shelve the criminal charges by December 31, 2006, provided that KPMG pay all fines by that date and cease to provide fraudulent tax shelters to its clients.

Nine former employees are facing criminal prosecution for intentionally defrauding the IRS, concealing the nature of those tax shelters, and lying under oath during Senate testimony. They are former deputy chairman Jeffrey Stein; partners John Lanning, Richard Smith, Jeffrey Eischeid, Philip Wiesner, Robert Pfaff, Raymond Ruble, and Mark Watson; and former senior tax manager John Larson. They pleaded not guilty on Tuesday.

“Corporate fraud had far-reaching consequences,” said Attorney General Alberto R. Gonzales in the press release. “The stiff financial penalty announced today means that the firm is paying for its conduct, while the guarantees of cooperation, oversight, and meaningful reform will help to ensure that its future business is conducted with honesty and integrity.”

The Justice Department qualified its press release, “The charges contained in the indictment are merely accusations, and the defendants are presumed innocent unless and until proven guilty.”

Richard Breeden, a former Securities and Exchange Commission Chairman, had agreed to oversee KPMG’s compliance with the settlement and its ongoing practices until December 31, 2006. The IRS will then keep a close eye on KPMG’s tax practices for an additional two years.

“KPMG LLP is pleased to have reached a resolution with the Department of Justice,” said KPMG Chairman Timothy P. Flynn in a prepared statement. “We regret the past tax practices that were the subject of the investigation. KPMG is a better and stronger firm today, having learned much from this experience.”

“The actions of the IRS and DOJ in this case send a powerful message to the promoters, aiders, and abettors of abusive tax shelters that they can no longer expect to be let off the hook. They are as culpable as the taxpayers who take advantage of the scams, and should be treated no better,” said Senator Carl Levin in a specially prepared press release.

The Subcommittee on Investigations on US Tax Shelter Industry released a thorough explanation of the “BLIPS” (Bond-Linked Issue Premium Structures) tax shelters sold by KPMG in 2003. The Senate has for years promoted laws to make illegal certain tax shelters that have the sole purpose of reducing taxes, but has not been successful.

Four specific illegal tax shelters were named in the indictment: FLIP, OPIS, BLIPS, and SOS. These tax shelters, once part of KPMG’s lucrative tax practice, allegedly allow investors to reduce taxes through non-existent losses.

Class action lawsuits are being filed on behalf of those investors who paid large fees to KPMG for those tax shelters between 1998 and 2003.

KPMG had been defending itself for several years against former clients—including the McNair brothers of Houston, Texas (sons of oil tycoon Robert McNair)—who felt betrayed by a reputable accounting firm. The McNair brothers paid the IRS close to US$4 billion in back taxes they had previously withheld under tax shelter schemes.

KPMG in turn filed several lawsuits recently in a Texas state court against an investment advisor and two Texas law firms, alleging that they were educated investors, understanding full well what they were getting into.

KPMG International, a private professional services firm that operates in 148 countries and provides audit, tax, and advisory services through its member firms, is the fourth-largest accounting firm in the world.