Question

KPMG admitted that its personnel took specific, deliberate steps to conceal the existence of the shelters from the IRS by, among other things, failing to register the shelters with the IRS as required by law, fraudulently concealing the shelter losses and income on tax returns, and attempting to hide the shelters using sham attorney-client privilege claims.

The information and indictment alleged that top leadership at KPMG made the decision to approve and participate in shelters; issue KPMG opinion letters despite significant warnings from KPMG tax experts and others throughout the development of the shelters; and, at critical junctures, that the shelters were close to frivolous and would not withstand IRS scrutiny, that the representations required to be made by the wealthy individuals were not credible, and the consequences of going forward with the shelters—as well as failing to register them—could include criminal investigation, among other things.

As we noted in Chapter 4, an unusual aspect to the case is the culture that apparently existed in KPMG's tax practice during the time the shelters were sold, which was to aggressively market tax shelter arrangements targeting wealthy clients by approaching them with the deals rather than the clients coming to KPMG. Back in the late 1990s, the stock market was booming, and the firm sought to take advantage of the increasing number of wealthy clients by accelerating its tax-services business. The head of KPMG's tax department at the time, Jeffrey M. Stein, and its CFO, Richard Rosenthal, created an environment that treated those who didn't support the "growth at all costs" effort as not being team players.

Once it became clear that the firm faced imminent criminal indictment over its tax shelters, KPMG turned to its head of human resources, Timothy Flynn, to somehow persuade the government not to indict. He knew that criminal charges against the firm would probably kill it, as they did Arthur Andersen after the Enron scandal.

For years, KPMG had stoutly denied any impropriety, calling its tax advice legal. But Flynn took a gamble and met with Justice Department officials to acknowledge that KPMG had engaged in wrongdoing. He got no promises in return, and the admission could have sunk the firm. Instead, it provided flexibility to the prosecutors, who were aware that the collapse of one of only four remaining accounting giants could harm the financial markets. Two months later, the government gave KPMG a deferred-prosecution deal, holding off indicting if KPMG paid a $456 million penalty and met other conditions.

The agreement between KPMG and the IRS required permanent restrictions on KPMG's tax practice, including the termination of two practice areas, one of which provided tax advice to wealthy individuals, and permanent adherence to higher tax practice standards regarding the issuance of certain tax opinions and the preparation of tax returns. In addition, the agreement banned KPMG's involvement with any prepackaged tax products and restricted KPMG's acceptance of fees not based on hourly rates. The agreement also required KPMG to implement and maintain an effective compliance and ethics program; to install an independent, government-appointed monitor to oversee KPMG's compliance with the deferred prosecution agreement for a three-year period; and its full and truthful cooperation in the pending criminal investigation, including the voluntary provision of information and documents.

Questions

Describe the relationship between the tax shelters developed by KPMG and management of the tax practice at the firm.

Answer 1

KPMG's tax shelters were closely tied to a corporate culture focused on aggressive growth, leading to unethical practices. Following a crackdown, a management shift occurred, acknowledging wrongdoing and resulting in a deferred-prosecution agreement with significant reforms to KPMG's tax practice.

Step-by-step explanation:

KPMG Tax Shelters Management :

The tax shelters developed by KPMG were inextricably linked to the management philosophy of the tax practice at the firm. This relationship was characterized by aggressive marketing strategies targeting wealthy clients with complex tax shelter products, despite warnings from within about their questionable legality. The leadership, including Jeffrey M. Stein and Richard Rosenthal, fostered a culture of 'growth at all costs', discouraging dissent and prioritizing the expansion of their tax services business over compliance with tax laws and ethical standards.

When faced with potential criminal indictment, KPMG altered its strategy and under the leadership of Timothy Flynn, pursued negotiations with the Justice Department, leading to a deferred-prosecution agreement. This agreement imposed a $456 million penalty on KPMG, required the termination of certain practice areas, the adherence to stricter tax practice standards, the implementation of a robust compliance and ethics program, and the installation of an independent monitor, thereby fundamentally altering the management and operation of KPMG's tax practice.