Federal prosecutors have notified as many as 20 former partners at the accounting firm KPMG LLP, including some who were members of its senior management team, that they could face criminal charges for their role in selling tax shelters in the 1990s, according to people familiar with the case.
Government lawyers have not yet decided whether to bring criminal charges against the firm, but they are asking for tough concessions from KPMG as the price of any potential settlement. At the same time they also are focusing on individual executives involved in the tax shelters, according to sources, who spoke on condition of anonymity because of the delicate stage of the investigation.
Earlier this year, federal prosecutors in New York had recommended that KPMG face criminal charges, but senior Justice Department officials in Washington expressed concerns about the prospect of another accounting firm collapse after the 2002 demise of Arthur Andersen LLP and the Supreme Court's reversal in May of Andersen's criminal conviction, according to the sources. Instead, both prosecutors and the firm continue to negotiate.
The KPMG probe, which dates back several years, could be the next major case in a string of business fraud prosecutions that surfaced after the collapses of Enron Corp. and WorldCom Inc. KPMG was one of several firms that sold questionable tax shelters to wealthy clients, creating lucrative sources of revenue.
After reports of possible criminal charges against KPMG appeared in June, the firm issued a statement apologizing for "unlawful" activity by former partners and pledged to cooperate with investigators. The firm turned over batches of documents, pressured dozens of tax executives to resign, and imposed caps on their attorney fees.
Analysts say those moves could help persuade regulators to forgo an indictment and instead impose lesser sanctions, such as requiring the firm to pay millions of dollars in financial penalties and admitting facts that could implicate former employees. Negotiations between prosecutors and the firm continue and a resolution could be weeks away. The talks are taking place as several key Justice Department figures are in transition, including the U.S. attorney in the Southern District of New York and the head of Justice's criminal division. The assistant attorney general for tax issues has recused herself from the case, sources said.
The final agreement could be similar to Merrill Lynch & Co.'s pact with the Justice Department over its dealings with Enron, in which the firm agreed to increased monitoring and other business changes.
That gives little solace to the former partners, several of whom testified at a 2003 Senate hearing -- which cited internal KPMG correspondence about whether the shelters would pass muster with the Internal Revenue Service. Some of the officials speculated in memos released at the Senate hearing that the firm should roll the dice and approve the deals, since it was likely to make more in fees than any penalties the government would impose.
KPMG sold the shelters to 350 people and reaped about $124 million in fees between 1997 and 2001, the report said.
"The only possible way to have made these people behave -- they were so far below professional standards -- is in fact that some people have to go to jail," said Calvin H. Johnson, a tax law professor at the University of Texas at Austin who has written about the KPMG case.
Unlike in the Andersen investigation, in which only one mid-level audit partner pleaded guilty to obstruction of justice, prosecutors are scrutinizing senior people at KPMG, one of the four big remaining audit firms in the nation.
Among those at KPMG who are facing government scrutiny are such high-ranking officials as its former deputy chairman, the onetime head of the firm's tax services unit and the former leader of the District-based national tax practice.
The shelters, called names such as OPIS, FLIPS and BLIPS, generally helped wealthy clients to create large paper losses, offsetting big gains that otherwise would have produced steep tax bills. Senate investigators estimated the shelters reduced federal tax revenue by $1.4 billion.
Many of the KPMG partners denied they had engaged in a conspiracy to break the law, arguing instead that they had exploited long-standing loopholes in the arcane tax code. Lawyers and tax experts analyze shelters to determine whether they will pass IRS review on a "more likely than not" basis -- a standard that amounts to a slightly more than 50 percent chance.
There are ongoing questions about whether the shelters themselves were lawful. A civil case filed in San Francisco by an investment firm that devised one of the structures is challenging the IRS interpretation that the tax shelter lacks economic justification.
Separately, individual taxpayers who used some of the structures have been able to settle their claims with the IRS through an amnesty program.
Moreover, many of the shelters were vetted by lawyers and other tax advisers, giving former KPMG officials another possible defense if they can show they relied on those professional experts and thus lacked the intent to break the law.
The KPMG investigation is intensifying at the same time federal authorities are vowing to take enforcement of tax cases more seriously. In recent years, the IRS has struggled with such efforts as the agency has experienced repeated staffing cuts. But Commissioner Mark W. Everson has made enforcement a renewed priority, referring 3,000 cases to the Justice Department last year for possible criminal prosecution.
"Our system of tax administration depends upon the integrity of practitioners," Everson said in a March speech at the National Press Club.
KPMG first drew the ire of regulators by refusing to turn over documents related to the shelters. It also took a hard-nosed approach to dealing with the IRS, while rivals at Ernst & Young LLP and PricewaterhouseCoopers LLP settled and paid multimillion-dollar fines over their tax marketing efforts. Ernst has said that it, too, faces a criminal investigation into its tax shelter dealings.