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Charges Dropped Against 13 Ex-KPMG Officials
Prosecutors Violated Defendants' Rights by Pressuring Their Firm, Judge Rules

By Carrie Johnson
Washington Post Staff Writer
Tuesday, July 17, 2007

A federal judge tossed out indictments against 13 former KPMG executives yesterday in the government's largest criminal tax-fraud case ever, citing "intolerable" prosecutorial abuses that deprived the officials of their constitutional right to a defense.

The decision, by U.S. District Judge Lewis A. Kaplan, is a strong rebuke of federal prosecutors who exerted intense pressure on the giant accounting firm to stop paying legal bills for employees who refused to cooperate with the investigation.

The sanction, which Kaplan called "drastic," averts a trial focused on whether the former KPMG executives knowingly helped wealthy clients avoid $2.5 billion in tax liabilities by selling them unlawful tax shelters.

"There are limits on the permissible actions of even the best prosecutors," Kaplan wrote. "The responsibility for the dismissal of this indictment . . . lies with the government."

Michael J. Garcia, the U.S. attorney in Manhattan, whose office led the investigation, said he "respectfully disagrees" with the judge's findings. Prosecutors are reviewing their appellate options.

The sprawling tax-shelter investigation has ensnared law firms, accounting firms and investment banks. Over time, it also has come to symbolize a backlash against hard-nosed tactics the Justice Department adopted to police corporate crime after scandals at Enron and WorldCom five years ago. Today, federal officials plan to gather to mark the fifth anniversary of the presidentially created Corporate Fraud Task Force.

Yet the case involving KPMG was unusual from the start, in terms of the number of defendants targeted and the strategies prosecutors embraced to do so, legal analysts said.

Kaplan's ruling centered on KPMG's decision to stop what he said was its longtime practice of paying legal fees for employees caught up in federal investigations.

That decision resulted from a February 2004 meeting between prosecutors and representatives from KPMG, the judge said. KPMG was desperate to avoid criminal charges that could put it out of business.

At the meeting, KPMG agreed to do whatever it took to cooperate with the probe, according to notes taken by a lawyer who attended the session.

Under pressure, the firm urged its executives to meet with prosecutors and share information or risk being dismissed or forced to pay their own mounting legal bills -- as happened to some of them.

Ultimately, KPMG went so far as to walk away from a severance agreement it had signed a month before the government meeting with former deputy chairman Jeffrey Stein. The firm cut off payments to Stein because a KPMG lawyer "thought it would help [KPMG] with the government," the lawyer later told the judge.

The judge ruled yesterday that bullying by the government was so "outrageous and shocking" that it ran afoul of the Constitution. The facts of the case, he wrote, "demonstrate a willingness by the prosecutors to use their life and death power over KPMG to induce KPMG to coerce its personnel to bend to the government's wishes."

KPMG eventually averted criminal prosecution by agreeing to pay $456 million and discontinue parts of its tax business.

In his statement yesterday, Garcia, the U.S. attorney, signaled that he might contest the judge's finding that the government's conduct was so troubling that it violated the defendants' constitutional rights. Such a ruling is extremely rare and is likely to trigger intense scrutiny from an appeals court, said lawyers not involved in the case.

"The fact of the matter is the government overreached in just about every way," argued Cristina Arguedas, a lawyer for a former executive involved in yesterday's ruling.

"This is really an overwhelming victory, not only for the defendants but for the system of justice in this country," said Washington lawyer Michael J. Madigan, who represents John Lanning, a former KPMG partner. "These kinds of tactics shouldn't be used against anybody."

The head of a trade group for corporate lawyers yesterday called the ruling a "wake-up call." Lawyers who defend corporations and executives across the country said Kaplan's criticisms over the past year already have had a significant impact. Companies including AOL in Dulles have resumed paying defense costs for employees under government scrutiny.

Top Justice Department officials last year overhauled guidelines that help determine when companies are charged with breaking the law. A coalition including the American Civil Liberties Union, the National Association of Criminal Defense Lawyers and the U.S. Chamber of Commerce said prosecutors did not go far enough.

Congress is taking note of the heated debate. The judge's ruling came a few days after Rep. Robert C. Scott (D-Va.) introduced legislation with bipartisan support that would protect executives' communications with their lawyers and would bar prosecutors from using legal fees as a weapon against executives who assert their right against self-incrimination. Sen. Arlen Specter (R-Pa.) advanced a similar bill in the Senate.

"Enough is enough," said Stephanie A. Martz, director of the white-collar-crime project of the National Association of Criminal Defense Lawyers.

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