The U.S. arm of Big Four firm KPMG has agreed to pay $456 million in penalties in three installments over the next 16 months, to admit to a single count of conspiracy to commit tax fraud, and to accept an outside monitor of its operations as part of a deal with the government to avoid potentially fatal criminal charges in connection with its past sales of questionable tax shelters. Under terms of the agreement, KPMG will also implement elevated standards for its tax business.
The deal, which will remain in force through Dec. 31, 2006, ends a year-and-a-half long investigation, and makes the Big Four accounting firm the latest addition to a growing list of entities that have cut deferred prosecution deals with federal prosecutors.
"KPMG LLP is pleased to have reached a resolution with the Department of Justice. 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," KPMG Chairman and CEO Timothy Flynn said in a statement issued Monday. "The resolution of this matter allows KPMG to confidently face the future as we provide high quality audit, tax and advisory services to our large multinational, middle market and government clients."
The firm had been under criminal investigation by the DoJ since February 2004 in connection with certain tax services it sold from 1996 until 2002. The probe was part of a larger tax shelter investigation into the role of accounting firms, law firms, large banks and taxpayers who participated in the development, promotion and implementation of tax shelters.
Meanwhile, an indictment unsealed in U.S. District Court in Manhattan charged nine former KPMG executives—including former deputy chairman Jeffrey Stein—with conspiracy for designing and marketing fraudulent tax shelters to help wealthy individuals avoid paying taxes, the Associated Press reported.
The KPMG investigation has been of particular interest to the business community because of a widely held view that a criminal indictment would have been a death sentence for the audit firm. The case also highlights a recent trend toward deferred prosecution agreements, which have become increasingly common post Arthur Andersen.
Under such agreements, corporations avoid prosecution by agreeing to terms that vary widely, but which often include a public acknowledgement of responsibility, payment of a hefty fine and/or restitution, cooperation with the government in ongoing investigations, and governance reforms. If a company complies with the conditions of a deferred agreement for a specified period, the indictment is dismissed; however, if the government feels a company failed to comply, prosecution is a given.
In recent years, a number of high-profile companies have accepted deferred prosecution agreements, including Merrill Lynch, Computer Associates, and most recently, Bristol-Myers Squibb Co.
In June, BMS resolved an investigation by the U.S. Attorney's Office in New Jersey relating to wholesaler inventory and various accounting matters and avoided indictment by agreeing to terms that included paying $300 million to a shareholder compensation fund—on top of $389 million already agreed to in order to settle shareholder litigation. Other terms of the agreement included the resignation of the chief executive, and the appointment of a non-executive chairman of the board. In exchange, the government agreed to defer pursuing a criminal complaint filed against BMS, and to drop the criminal matter entirely in two years if the company cooperates fully.
No Chips At The Bargaining Table
Tween
In an interview prior to the announcement of the deal, Douglas Tween, a partner at Coudert Brothers who until recently served as a trial attorney with the Department of Justice Antitrust Division, told Compliance Week that a deferred prosecution agreement was “KPMG’s only hope to survive as a viable business.”
In the aftermath of Arthur Andersen’s rapid implosion following its indictment in the Enron case, public companies and regulators expressed concerns that a criminal indictment would have been a death sentence for KPMG, further narrowing the already slim number of choices corporations have for their audit and attest work.
“The government is sensitive to the collateral consequences of the indictment and prosecution of a company, particularly after the Arthur Andersen case—that case changed the landscape,” said Tween. “Deferred prosecution is one way the government can achieve a lot of reforms without destroying the business.”
“For a firm like KPMG, an indictment would be a death penalty,” added Tween. “What public company can rely on audits by a company that’s been indicted? And how would the PCOAB view an indictment? It would make it impossible for them to do business.”
Koltin
Allan Koltin, a consultant to the accounting profession and chief executive of Chicago-based PDI Global, agreed with Tween’s assessment. “The pressure is so severe not to bring down the firm, that there’s a question of whether the public markets could hold stable if companies only had three choices [for their audit and consulting work],” Koltin told Compliance Week. “The government has no choice but to keep four firms in business.”
Aquila
“I think that the government realized that what it did to Andersen was too draconian and is trying to make sure they don't put KPMG under,” agreed August Aquila, director of practice management consulting for The Growth Partnership.
Lee
Still, observers note that, the firm is lucky to have reached a deal. That’s partially because news reports have portrayed KPMG's initial conduct as extremely uncooperative. “Once this [uncooperative] stance is taken, KPMG lost whatever credit the firm could have accrued for cooperating—which is something that the DoJ has acknowledged as an important consideration in these types of investigations,” said Jason Lee, co-chair of the securities enforcement defense group at Shartsis Friese and former senior counsel in the SEC's Division of Enforcement for six years. “Coming from what appears to be the brink of indictment, which was the worst-case-scenario for the firm, to a delayed prosecution is truly a remarkable feat.”
“KPMG had no chip left at the bargaining table,” agreed Koltin.
Internal Hemorrhaging
Koltin, who had expected a fine in excess of $500 million prior to the announcement of the deal, said that even at $456 million, “that’s a big number, and a future drain on profits that will cause some additional bleeding.”
With a deferred prosecution agreement in place, the firm faces the immediate issue of deciding how that fine would be split among the firm’s partners. Koltin, who spoke to several KPMG partners late last week, told Compliance Week on Friday that could lead to “internal hemorrhaging,” since the money will come out of partners’ pockets.
As part of the deal, former SEC Chairman Richard Breeden has been tapped to serve as an outside monitor at the accounting firm for a three-year period. Breeden didn't respond to a request for comment, but observers say he’s the right person for the job. “If this deal is completed and the DoJ and KPMG agree to install former Chairman Breeden, who has only added to his tremendous credibility through his work in WorldCom, the DoJ can rest assured that KPMG will be held accountable to the terms of the deal,” Lee told Compliance Week prior to the official announcement.
“Breeden certainly has the credentials to help KPMG though this crisis,” agreed Aquila.
While an agreement with the DoJ staved off criminal charges, KPMG still faces civil charges related to its past tax shelter sales.
Tween noted that the public statement of responsibility, which is required as part of a deferred prosecution agreement, could make it tough to for KPMG to defend its position in civil lawsuits.
“Making a public statement [such as the one KPMG made] has consequences, it’s not just symbolic,” said Tween. “It’s difficult to defend any class action civil lawsuits because the company has made a public admission.”
In a June statement, KPMG publicly acknowledged “full responsibility for the unlawful conduct by former KPMG partners” during the period in question and noted, “we deeply regret that it occurred.” The firm also said it stopped providing the services in question, put in place a process to ensure that “those responsible for wrongdoing” were separated from the firm, instituted firm-wide structural, cultural and governance reforms, and undertook “significant change” in its business practices.
Meanwhile, the charges against the former KPMG partners signify how the landscape has changed over the last few years, said Tween. “Traditionally, companies and employees would stick very close together. Companies would pay the legal fees and look for joint resolutions, the companies would plead guilty.” Today, however, Tween said it’s far more common for the government to charge the culpable individuals, and for the companies “to cut those individuals loose.”
In addition, Tween said companies are increasingly being required to waive attorney-client and attorney work-product privileges as part of their agreement to cooperate with efforts to go after individual employees. “The government is requiring companies more and more to waive those privileges and to disclose internal investigation results and reports as a way of making companies show good faith,” says Tween.
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