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. Back in Chapter 4 we discussed the "realistic possibility of success" standard in taking tax positions under the Statements on Standards for Tax Services of the AICPA. This is a high standard to meet. Generally, there would need to be a 70-80% of prevailing if a tax position were challenged by the IRS. The "more likely than not" standardappears in Treasury Circular 230, which covers rules of conduct for those who practice before the IRS, including CPAs, attorneys, and enrolled agents. A tax preparer who fails to comply with Circular 230 will likely be subject to penalties and possibly other sanctions if she advises a client to take a position on a tax return or a document that does not meet the applicable tax reporting standard. The three standards for tax positions in Treasury Circular 230, ranked from lowest to highest, are reasonable basis, substantial authority, and more likely than not. 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 sheltersas well as failing to register themcould 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

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.