How Big a Cloud Is KPMG Under?

It probably won't face an Andersen-style indictment for dodgy tax shelters, but a big fine is likely, and former partners may be targeted

By Joseph Weber

Will KPMG be the next Arthur Andersen? Probably not. But the Big Four accounting titan, under attack in Washington for problematic tax shelters that cost the IRS hundreds of millions of dollars in lost revenues in the late 1990s, may be preparing itself, its clients, and former and current staffers for stiff penalties stemming from a longstanding Justice Dept. probe.

In a stinging condemnation of former but unnamed KPMG insiders, the nation's fourth-largest accounting firm on June 16 issued a statement that faulted unidentified former partners for "unlawful conduct" in marketing certain tax shelters from 1996-2002. While it took "full responsibility" for their actions, it argued that it has remedied problems that led to what it repeatedly called "wrongdoing" and said it expects a resolution that will involve "appropriately sanctioning" the firm.


  KPMG, seeking to distance itself from those former partners' actions, said it had instituted reforms to "ensure the highest ethical standards" and "undertaken significant changes in its business practices." A firm spokesman declined to detail the reforms or to discuss any element of the case beyond the statement. KPMG issued the statement after reports were published about Justice's internal debates on how to handle the case. Justice said it has no comments on it.

Outsiders expect that KMPG, once the go-to firm for tax shelters for wealthy individuals and corporations, can avoid becoming the target of an indictment of the kind that put Andersen out of business. But former partners of the global powerhouse could face individual indictments for devising and marketing dubious tax shelters, the observers say.

The accounting firm, instead, could face a deferred prosecution, a prosecutorial practice that would spare KMPG of being charged with a crime so long as it agreed to pay a hefty fine, accepted a series of remedies, and cooperated in Justice's cases against individuals. "KMPG is letting these people fend for themselves," says Lehman Bros. tax and accounting analyst Robert Willens, a former KPMG partner.


  It's not clear just how extensive the penalties will be. Also uncertain is the extent of the vulnerability of an estimated 30 former KPMG partners and staff who were involved in the firm's now-discontinued shelter business, which was once fabulously lucrative. Sanctions could involve a stiff fine against the firm, may even lead to a temporary KPMG suspension from the tax business, and could leave it operating under some type of outside supervision, some observers say.

Some outsiders argue that the firm and Justice officials are likely wrestling over what disciplinary actions the outfit will face. KPMG is believed to have earned as much as $124 million in fees from its tax shelters, and the government may well want a multiple of that figure in a fine, speculates Allan D. Koltin, chief executive officer of PDI Global, a Chicago-based consulting concern for the accounting profession.

"What's going on is a classic game of volleyball between the Department of Justice and KPMG," Koltin says. "The government is looking for a much bigger and fatter check than what KPMG has volleyed."


  The government is bargaining without using its heaviest club, a criminal indictment. Indeed, after Andersen collapsed in the wake of its indictment for obstruction of justice, Justice set up a formal policy encouraging the pursuit of individuals rather than companies -- so long as the companies lent a hand in the individual actions.

"You don't indict the company because it assists in your prosecution by cooperating fully," says John C. Coffee, a Columbia University law professor and director of the school's corporate-governance center. "We have seen deferred prosecution agreements becoming very popular in the last two years."

After Andersen, Coffee says, prosecutors don't want to risk putting another giant company out of business, depriving thousands of innocent employees of jobs, disrupting client relationships with thousands of other outfits, and shrinking the Big Four field of accounting titans by yet another firm. What's more, Justice suffered a humiliating reversal recently when the Supreme Court threw out the Andersen conviction, albeit on technical grounds involving a judge's jury instructions.

Still, KPMG clearly won't emerge untarnished from the problems. Its reputation will likely be damaged, and partners may have to dig deeply into their pockets to pay for the misconduct of their former colleagues.

With contributions from Howard Gleckman and Lorraine Woellert

Weber is BusinessWeek's Chicago bureau chief. Gleckman is a senior correspondent, and Woellert a correspondent in BusinessWeek's Washington bureau

Edited by Beth Belton

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