U.S. Disputes KPMG Ruling

Dismissal of Tax-Shelter Case May Be Only Path to Appeal

Federal prosecutors said a detrimental judicial ruling may force them to drop criminal charges against a dozen former KPMG partners, laying the groundwork for a bold appellate strategy in one of the largest tax-shelter investigations in history.

Government lawyers filed court papers late Friday saying they "respectfully disagree" with a judge's finding that they violated the constitutional rights of KPMG officials by pressuring the accounting firm not to pay the indicted employees' legal fees.

Yet, given the sharply worded 2006 ruling by U.S. District Judge Lewis A. Kaplan, prosecutors wrote that "it is difficult to understand how anything short of dismissal of the indictment would suffice."

Kaplan has scheduled a hearing in New York on Monday to help determine how the case, in which accountants and consultants allegedly helped wealthy clients avoid paying more than $2.5 billion in taxes, will proceed.

Prosecution tactics against former KPMG executives became the centerpiece of a broad national debate over the scope of government power to police financial crimes. Kaplan criticized government lawyers for leaning on the accounting firm to stop paying legal fees for workers who did not bend to prosecutors' demands.

In a ruling embraced by defense lawyers across the nation, the judge took the unusual step of declaring that prosecutors had violated the defendants' Fifth and Sixth amendment rights to a fair trial and legal counsel of their choice.

Later, Kaplan opened a separate civil case and encouraged KPMG to reimburse its former partners' legal bills. The judge's decision spurred the Justice Department to revamp its policy on which factors it would consider in deciding whether to file criminal charges against corporations.

Without addressing the propriety of prosecution tactics, an appeals court panel earlier this year said that Kaplan lacked authority to force KPMG to pay the legal fees. Instead, the appeals court said, Kaplan could devise another punishment for the government, including outright dismissal of the massive case.

Lawyers for the former KPMG executives recently urged the judge to toss out indictments because of government overreaching. Kaplan then directed the U.S. attorney's office in the Southern District of New York, which led the multi-year tax-shelter investigation, to suggest its own punishment.

Assistant U.S. Attorney John M. Hillebrecht responded late last week with a 45-page motion that experts say is designed to push an appeals court to overturn Kaplan's most volatile findings of government misconduct.

Legal analysts who read the court papers surmised that prosecutors are preparing to appeal the issue, and Kaplan's constitutional findings, to a higher court. But until the judge actually takes the step of dismissing the case, the government's hands are tied.

"The only way they really could get it reviewed is dismissal; that's the best way," said Wayne State University law professor Peter J. Henning, co-author of a Web log on white-collar crime. "It wouldn't surprise me if the judge came up with a different alternative. He's going to have to think long and hard about it."

Michael J. Madigan, a District lawyer for former KPMG partner John Lanning, said, "This is quite a high-wire act by the government, but we wholeheartedly agree with dismissal of this case, which has hung over the heads of our clients now for over three years."

KPMG, one of the nation's four largest accounting firms, agreed to pay $456 million and revamp its operations in a 2005 settlement with the government that helped the firm avoid a possible corporate death sentence.