KPMG and the Government's "Prosecution of KPMG" - Can we learn any lessons from this investigation with the approach of FIN 48?

When I assisted large case examiners during the period of time that “tax solutions” were being marketed, I used to quip that I would love to know what was going on in those meetings wherein the accounting firm was making the tax department into a profit center. So I must admit, I have been fascinated with the ongoing investigation into KPMG. Unfortunately, I have a learned a bitter lesson: “be careful what you ask for you may get it”. It appears what we are all getting is a lesson in constitutional rights that is frankly alarming to those that follow/practice law let alone tax law.

I have heard various respected tax attorneys, both government and private practitioners, comment that those accountants/firms are getting what they deserve. I would be a hypocrite if I did not admit that I too shared those feelings. But now the cases are unfolding and no one can tell me this is how the government, our government, is supposed to govern, let alone, prosecute a case.

What we know as to the government’s prosecution emanates from the rulings in United States v. Stein, and it is as follows:

On August 26, 2005, KPMG and the government entered into the Deferred Prosecution Agreement (“DPA”), pursuant to which KPMG consented to the filing of a one-count Information charging it with conspiracy to defraud the United States and the Internal Revenue Service and to violate the tax laws of the United States. The DPA attached the 34-page Information to which KPMG consented. On August 29, 2005, the Information was filed. KPMG publicly waived its right to be indicted and consented to the filing of the Information. KPMG entered a plea of not guilty. The DPA was made a part of the record. Among other things, the DPA provided that the government would recommend to the Court that prosecution of KPMG on the Information would be deferred "for the period through December 31, 2006."

In return, KPMG provided/performed the following for the government:

In February of 2004, the attorneys for KPMG met with the United States Attorney’s Office, (“USAO”). KPMG’s attorneys were familiar with the Thompson Memorandum which in part provided that “[i]n gauging the extent of the corporation's cooperation [for purposes of determining whether it should be indicted], the prosecutor may consider the corporation's willingness to identify the culprits within the corporation, including senior executives, to make witnesses available, to disclose the complete results of its internal investigation, and to waive attorney-client and work-product privileges.” The commentary to the Thompson Memorandum further provided that as to the meaning of cooperation: “One factor the prosecutor may weigh in assessing the adequacy of a corporation's cooperation is the completeness of its disclosure including, if necessary, a waiver of the attorney-client and work product protections •••” Thus, the Thompson Memorandum made clear that the failure of a business organization facing possible indictment to induce its personnel to submit to interviews by the government and to disclose whatever they know may be a factor weighing in favor of indictment of the entity.

Keenly aware of what had happened to Arthur Anderson, the KPMG lawyers made clear to prosecutors that KPMG intended to cooperate in order to save the firm and that it would not protect individual employees. Although KPMG still was investigating its legal obligations to theses employees/partners, they said, it would not pay legal fees for employees who declined to cooperate with the government, or who took the Fifth Amendment, as long as it had discretion to take that position. On March 11, 2004, the lawyers for KPMG had a conference call with the USAO and the government was assured that KPMG would be “as cooperative as possible” so that the office would not exercise its discretion to indict the firm. On the same date, the attorneys for KPMG wrote to the USAO, enclosing among other things a form letter that the attorneys was sending to counsel for the KPMG Defendants then employed by KPMG who had received subject letters from the government or otherwise appeared to be under suspicion. The form letter stated that KPMG would pay an individual's legal fees and expenses, up to a maximum of $400,000, on the condition that the individual “cooperate with the government and ••• be prompt, complete, and truthful.”

Each of the KPMG Defendants subsequently made proffers to the government pursuant to the USAO's standard proffer agreement after receiving the letter or, in one case, after having been told its substance but before receiving it. Six of the nine left KPMG before they made their statements and do not claim that they made their statements under a threat of loss of their employment.

  • A proffer in this context means a statement by a subject of the investigation. Under the terms of the standard proffer agreement used in this district, the government may not use the statement in its case-in-chief, but it is free to use leads obtained from it and may use the statement on cross-examination and in a variety of other circumstances. Federal Bar Council, Proffer, Plea and Cooperation Agreements in the Second Circuit 3-13 (2003). See also Richard B. Zabel and James J. Benjamin, Jr., “Queen for a Day” or “Courtesan for a Day”: The Sixth Amendment Limits to Proffer Agreements, 15 No. 9 White-Collar Crime Rep. 1 (2001).

In a November 2, 2004 letter to the USAO, the attorneys for KPMG wrote:

“KPMG has repeatedly directed all current and former personnel to cooperate with the investigation and has conditioned payment of attorney's fees upon prompt, complete, and truthful cooperation with the government's inquiry. Whenever your Office has notified us that individuals have not rendered prompt, complete, and truthful cooperation, KPMG has promptly and without question encouraged them to cooperate and threatened to cease payment of their attorney fees and (if applicable) to take personnel action, including termination. In certain instances, KPMG's action has led previously non-cooperating individuals to meet with your Office. In other instances, KPMG has ceased payment of fees and expenses.”

At later meetings, and in a so-called “White Paper” that argued against indictment of the firm, it was “noted that KPMG had ‘hinged attorneys fees on whether people would talk to [the government]’ ” and “that KPMG had cut off fees for several individuals for non-cooperation and had terminated two partners for non-cooperation,” including for “asserting ••• [the] 5th Amendment right not to testify.” A memorandum of a June 13, 2005 meeting with the DOJ discloses that it was argued that “We [KPMG] said we'd pressure-although we didn't use that word-our employees to cooperate” and when employees did not cooperate, “Justin [AUSA Weddle] or Stan [AUSA Okula] would tell us,” and the firm then cut off fee payments and/or fired the individual. Indeed, KPMG's final submission to the DOJ argued that it had fully cooperated by, among other things, “pressuring current and former personnel to cooperate fully with the investigation.” See United States v. Stein, 440 F.Supp.2d 315 (S.D.N.Y. 2006) (“Stein II”).

In Stein II, the Court found two of the proffers to have been produced by coercion by KPMG acting on behalf of the government and therefore in violation of the 5th amendment. Garrity v. New Jersey, 385 U.S. 493, 496, (1967); D.L. Cromwell Invests., Inc. v. NASD Regulation, Inc., 279 F.3d 155, 161 (2d Cir.2002); accord, Lugar v. Edmondson Oil Co., Inc., 457 U.S. 922, 937 (1982); Corrigan v. Buckley, 271 U.S. 323, 330 (1926).

The proffers which were found to be in violation of the 5th amendment were those that had been obtained after the employee was threatened to be fired and/or cut off payment of his legal fees if he did not comply with their request. As the Court found:

[T]he government quite deliberately precipitated KPMG's use of economic threats to coerce the proffer statements in question. “KPMG's decision to cut off all payments of legal fees and expenses to anyone who was indicted and to limit and to condition such payments prior to indictment upon cooperation with the government was the direct consequence of the pressure applied by the Thompson Memorandum and the USAO.” The Thompson Memorandum, moreover, made it clear that a company's failure to ensure that its employees disclose whatever they knew, regardless of their individual rights and concerns, might weigh in favor of indicting the company. The USAO knew that KPMG would apply additional pressure, beyond the threatened cut-off of legal fees, to “uncooperative” employees. Indeed, it reported them to KPMG in circumstances in which there was no conceivable reason for doing so except to facilitate the firing threats that ensued.

The opinion is now being appealed and the trial has been adjourned sine die. See United States v. Stein, 461 F.Supp.2d 201 (S.D.N.Y. 2006). The lower Court has filed a memorandum of law amplifying its position in its rulings in United States v. Stein, 435 F.Supp.2d 330, 374 (S.D.N.Y.2006) (“Stein I”) and Stein II. See United States v. Stein, Slip Copy, 2007 WL 91350 (S.D.N.Y. 2007).

As to those KPMG Defendants whose proffers were not excluded, the matters have become dire. In United States v. Stein, 463 F.Supp.2d 459 (S.D.N.Y. 2006) the Court ruled that the conversations with one of the defendants and the attorneys from KPMG were not privileged and therefore the attorneys for KPMG can turnover their notes to the USAO.

In United States v. Stein, 463 F.Supp.2d 459 (S.D.N.Y. 2006) the Court acknowledged that KPMG’s attorneys were trying to curry favor with the Government and that the defendant as a fiduciary of the partnership was assisting in the firm’s investigation of the matter. The defendant was never informed that the attorney were in effect agents of the Government. Yet, the Court citing to In re Bevill, Bresler & Schulman Asset Management Corp., 805 F.2d 120, 123, 125 (3d Cir.1986); United States v. Int'l Bhd. of Teamsters, 119 F.3d 210, 217 (2d Cir.1997) found that there was no evidence that the defendant was deceived by KPMG or its attorneys about the nature of her relationship with counsel. Moreover, her subjective belief as to the attorneys for KPMG also being her attorney, without more, the Court found was insufficient to meet her burden of proving privilege.

Therefore, the same firm that was found to be working for the benefit of the United States, can we say agent, can have turn over their attorney's notes to the prosecutors in this case. A simple observation – If this is what the government calls a victory, i.e. constitutional rights being ignored for the good of the fisc, then I hate to see what it calls a defeat.

Now KPMG, the alleged original target of the investigation, is seeking to have its agreement enforced. The United Stated Government is trying to enforce the agreement. So were would this leave KPMG? A black eye no doubt but its reputation will and has rebounded. The United States government gets another “victory” in its “war against tax-shelters”. The KPMG Defendant’s are fighting for the respective lives although their firm profited in the hundred’s of millions of dollars. Yes, these individual did profit and don’t get me wrong their actions need to be investigated, both civilly and criminally, but they are entitled to due process which is the cornerstone of our judicial system and not subject, to a dare I say, a witch hunt.

Finally we are left with the attorney-client privilege and right against self-incrimination being left in tatters. That is not just my opinion but it is also the opinion of some very prestigious lawyers. See Brief Of Amici Curiae The New York Council Of Defense Lawyers, The New York State Bar Association, And The National Association Of Criminal Defense Lawyers In Support Of Affirmance Of The District Court's Rulings In Favor Of Defendants-Appellees, filed United States Court Of Appeals For The Second Circuit, See 2007 TNT 26-54. As stated therein:

Two fundamental constitutional principles are at stake in this case. First, under the Fifth Amendment, an individual may not be required to serve as a witness against himself in any criminal proceeding, and therefore is entitled to rely, unburdened, upon this privilege and refuse requests for his evidence. Second, under the Sixth Amendment, an accused has the right to subject the prosecution's proof to adversarial testing by skilled counsel. These principles provide the essential safeguard that permits the Government to zealously prosecute cases secure in the knowledge that any verdict obtained is both procedurally and substantively fair.


The actions of the prosecution in this case upset that balance and violated the Constitution. It seems clear that the Government may not condition employment and payment of attorneys' fees to its own employees on the waiver by those employees of Fifth Amendment protections. Such conduct would eviscerate the Fifth Amendment right. The prosecution's conduct is no less egregious when it enlists a private employer to condition adequate legal representation and employment on a proffer to the Government, on pain of the "corporate death penalty" (i.e., indictment) if the corporation does not succumb. In our modem economy, virtually every employee works for some form of corporate employer. If the Government could, willy- nilly, threaten to indict a target corporation if it does not condition previously promised attorneys' fees or employment on the employee's agreement to give up his or her Fifth Amendment rights, there would be little left of that right indeed.

Amici recognize that potential defendants, that is, subjects of criminal investigation, can be forced to make difficult choices. However, the Constitution does not, and must not, tolerate the prosecution, either directly or indirectly, putting a subject or target in the position where he must waive one constitutional right in order to protect another. Here, the Government's threat to indict KPMG if it did not cut off promised attorneys' fees and, for one individual, employment, rises to the level of a constitutional violation as the prosecution's actions wholly invaded the ability of the defendants to choose how to exercise their constitutional rights absent Government coercion. In so doing, the prosecution's presentation of a Hobson's choice, sanctioned by the Thompson Memorandum, calls into question the fairness of a criminal process that intentionally seeks to weaken the ability of an accused to mount a defense.

With FIN 48, there will be plenty of times were counsel desires to ascertain the facts necessitating the “more likely than not opinion”. See Long Term Capital Holdings, Ltd. v. United States, 330 F.Supp.2d 122 (D.Conn.2004). At times, employees of the business will need to be interviewed. One could submit that corporate/partnership employees bring their own counsel into these maters/interviews. Is that really a practicalidea but are we heading there? At a minimum, receive assurance from the corporate lawyer that the lawyer is also representing the employee in the matter, i.e. either giving personal legal advice or the employee is part of the scope of representation. After all, the IRS is now reconsidering its position as to seeking tax accrual workpapers in light of FIN 48. See Stratton, FIN 48 Leading IRS to Reconsider Restraint Policy for Workpapers, 2007 TNT 28-3. We know the IRS will ask for the attorney’s notes as they will claim waiver and if not waiver well - If the IRS doesn’t agree with the position taken by the business well look what has happened in KPMG, need I say more.

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