Every cloud has a silver lining. So it was for the Department of Justice and the Big Four accounting firm KPMG when Hurricane Katrina obscured a storm of Orwellian doublespeak accompanying their Aug. 29 settlement: a settlement of one of the most massive tax frauds ever perpetrated against the United States.

The Justice Department's press release announced KPMG's admissions that:

• "It engaged in a fraud that generated at least $11 billion in phony tax losses, which cost the United States at least $2.5 billion."
• "Its personnel took specific deliberate steps to conceal the existence of the shelters, by failing to register the shelters with the IRS, as required by law, fraudulently concealing the shelter losses and income on tax returns, and using sham attorney-client-privilege claims."
• "Opinion letters issued for shelters were false and fraudulent in numerous respects."
• "KPMG officials approved shelters' sales despite warnings from KPMG tax experts and others that they risked criminal prosecution."

The Justice Department's press release was equally remarkable for its omissions:

• Another KPMG tax shelter deemed abusive by the Internal Revenue Service cost the United States at least $1.7 billion in 2003.
• While evading several hundred million dollars in federal taxes through KPMG, WorldCom employed a fraudulent KPMG shelter establishing the "foresight of top management" as an asset on which royalties were charged to evade $2 billion in taxes owed to 14 states and Washington, D.C. That foresight most notably yielded WorldCom's $11 billion fraud and bankruptcy.
• KPMG's sale of fraudulent shelters to hundreds of wealthy citizens and corporations from 1996 to 2003 allowed at least $4.2 billion in federal and $2 billion in state tax evasion.
• KPMG documents established that legality mattered little to the some 30 partners creating these shelters or the 1,500 others profiting in silence as KPMG officials argued that "rolling the dice" would generate fees outweighing risks of government penalties.

Rolling the dice paid off handsomely when Attorney Gen. Alberto Gonzales announced: "If you engage in fraud, if you participate in providing false statements, you're going to be prosecuted. We want to be very, very clear: There is no company that is too big or too important an industry that will escape prosecution if they (sic) in fact engage in wrongdoing."

Nothing was less clear or more disingenuous. Gonzales and Justice Department officials in fact rejected the recommendation of the U.S. attorney for the Southern District of New York that KPMG be indicted. In return for KPMG's admissions and $456 million fine (10 cents on every federal tax dollar evaded), the Justice Department's "deferred prosecution" treated KPMG like a wayward juvenile: Charges will be dismissed on Dec. 31, 2006, if KPMG pays and plays nice.

Clearly, huge influence was brought to bear - or bought - when the U.S. attorney's recommendation to indict KPMG was overruled. The Justice Department answered KPMG's decade-long pursuit of criminal tax fraud, conspiracy, and obstruction with the $456 million "E-Z Pass" fine as KPMG flew through federal toll gates. The IRS sweetened the deal, forgoing penalties on shelters addressed by the Justice Department and others under investigation.

"Today's actions demonstrate our resolve to hold accountable those who play fast and loose with the tax code," averred IRS Commissioner Mark Everson. "We simply can't tolerate flagrant abuse of the law and of professional obligations by tax practitioners, particularly those associated with so-called blue-chip firms, like KPMG."

That the IRS and the Justice Department, in their sweetheart deals with KPMG, demonstrated all the "resolve" of sand in a tsunami is undeniable.

Gonzales credited to "collateral damage" the Justice Department's solicitude toward a firm so corrupt that eight former senior partners face prosecution. Indicting KPMG for massive tax fraud, conspiracy, and obstruction might put it out of business! But had KPMG ever concerned itself with risks of prosecution, its 1,500-plus partners could have eschewed implicating themselves and hundreds if not thousands of employees in criminal activities.

Others argued that deferred prosecution lets KPMG preserve "its viability as an auditor" - conveniently ignoring KPMG's myriad failures in that capacity:

• Investigations of former KPMG audit client Fannie Mae's financial statements are likely to result in an $11 billion earnings restatement.
• Last April, KPMG paid $22.5 million to settle Securities and Exchange Commission charges that KPMG had "willfully aided and abetted Xerox's violations of the anti-fraud, reporting, record-keeping, and internal-controls provisions of the federal securities laws," letting Xerox overstate revenues by $3 billion and earnings by $1.5 billion from 1997 to 2000.
• Last October, KPMG paid investors $10 million following an SEC censure for "improper professional conduct" in 1999-2002 Gemstar-TV Guide audits and another $115 million to settle accounting-malpractice claims following Lernout & Hauspie's massive corporate fraud and bankruptcy in 2000.
• In March 2003, KPMG paid Rite-Aid $125 million to settle lawsuits arising from failed audits, resulting in $1.6 billion in overstated 1990s profits and another $75 million to settle a suit arising from failed Oxford Health Plans audits.
• In January 2004, Royal Dutch/Shell admitted overstating oil reserves by 23 percent, and KPMG, its auditor for overseas operations when the overstatements occurred, is found to have ignored corporate memoranda advising it that reserve bookings might be compromised by a bonus system that rewarded inflated reporting.

Coupled with its complicity in scores, if not hundreds, of some 1,250 corporate financial restatements in 1999-2003, KPMG's blatant failures as an auditor visited incalculable financial harm on millions of unsuspecting investors, who had depended on its integrity and independence, while KPMG chose, instead, to roll the dice in favor of crooked corporate executives, who cooked the books and paid its lavish fees.

A book co-written by KPMG chief executive officer Timothy Flynn warns: "Damage to a company's integrity can fell an organization if enough blows are sustained."

In spite of these innumerable self-inflicted blows to KPMG's integrity, the Justice Department, in a "vote of confidence," will retain KPMG as its auditor.

The department as good as said: If you can find an accounting firm capable of demonstrating so sustained a contempt for federal, state, local, and securities laws; professional accounting standards; the integrity of our capital markets; and law-abiding taxpayers and investors everywhere - hire it.

The Justice Department rolled the dice. You lose.

Joe Loughran, a career consultant and a former investment banker for Goldman Sachs, is writing a book about Wall Street's complicity in the Internet bubble.

© 2005 Providence Journal

Related features:
Law-abiding companies need corporate criminal prosecuted

Corporate Crime Reporter on the KPMG settlement

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