1. Describe the link between the tax culture at KPMG and leadership. Do you believe there is a direct correlation between dysfunctional tax decisions and culture?

2. How can tax positions taken reflect leadership style?

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

4. What's wrong with a CPA firm, such as KPMG, aggressively seeking to establish tax shelters for wealthy clients? Did KPMG's role in this regard reflect a failure of leadership or a failure of judgment? Explain.

In Chapter 4 we discussed the artificial tax shelter arrangements developed by KPMG LLP for wealthy clients that led to the settlement of a legal action with the Department of Treasury and the Internal Revenue Service. On August 29, 2005, KPMG admitted to criminal wrongdoing and agreed to pay $456 million in fines, restitution, and penalties as part of an agreement to defer prosecution of the firm. In addition, nine members of the firm were criminally indicted for their role in relation to the design, marketing, and implementation of fraudulent tax shelters.
In the largest criminal tax case ever filed, KPMG admitted it engaged in a fraud that generated at least $11 billion dollars in phony tax losses, which, according to court papers, cost the United States at least $2.5 billion dollars in evaded taxes. In addition to KPMG’s former deputy chairman, the individuals indicted included two former heads of KPMG’s tax practice and a former tax partner in the New York City office of a prominent national law firm.
The facts of the tax shelter arrangement are complicated, so we have condensed them for purposes of this case and present them in Exhibit 1.
Exhibit 1
Summary of Tax Shelter Transactions Developed by KPMG1
KPMG developed tax shelters to generate losses of $11.2 billion dollars for 601 wealthy clients that enabled them to avoid paying $2.5 billion in income taxes. KPMG mainly used four methods to help the wealthy clients avoid their tax liabilities or tax charges on capital gains. The shelters implemented were the Foreign Leveraged Investment Program (FLIP), Offshore Portfolio Investment Strategy (OPIS), Bond Linked Issue Premium Structure (BLIPS), and Short Option Strategy (SOS/SC 2). These shelters were designed to artificially create substantial phony capital losses through the use of an entity created in the Cayman Islands (a tax haven) for the purpose of the tax shelter transactions. The client purportedly entered into an investment transaction with the Cayman entity by purchasing purported warrants or entering into a purported swap. The Cayman entity then made a prearranged series of purported investments, including the purchase from either Bank A, which at the time was a KPMG audit client, Bank D, or both using money purportedly loaned by Bank A or Bank D, followed by redemptions of those stock purchases by the pertinent bank. The purported investments were devised to eliminate economic risk to the client beyond the cost to develop the tax shelters.
In the implementation of FLIP and OPIS, KPMG issued misleading opinion letters with assistance from its co-conspirators. The opinion letters were misleading because KPMG knew that the tax positions taken were more likely than not to prevail against the IRS, and the opinion letters and other documents used to implement FLIP and OPIS were false and fraudulent in a number of ways. For instance, the opinion letters began by falsely stating that the client requested KPMG’s opinion regarding the U.S. federal income tax consequences of certain investment portfolio transactions, while the real fact is that the conspirators targeted wealthy clients based on the clients’ large taxable gains and offered to generate phony tax losses to eliminate income tax on that gain as well as to provide a “more likely than not” opinion letter.
The “more likely than not” opinion letters provided an ambiguous and confusing view of the tax shelters to the users, but it brought an income of $50,000 to KPMG for each such opinion letter. In addition to that, the opinion letter continued by falsely stating that the investment strategy was based on the expectation that a leveraged position in the foreign bank securities would provide the investor with the opportunity for capital appreciation, when in fact the strategy was based on the expected tax benefits promised by certain conspirators in the tax frauds.