KPMG Tax Shelter Case Could Be Dropped

An appeals court gives a federal judge the go-ahead to dismiss the tax-shelter case against former KPMG employees.

The federal case against former KPMG employees accused of using fraudulent tax shelters may be weakening. The judge overseeing the case has questioned the constitutionality of the federal prosecutors’ behavior, particularly their use last year of techniques outlined in the so-called Thompson Memorandum. The Department of Justice memo, issued in 2003, says that companies accused of wrongdoing will receive more lenient treatment if they cooperate with government prosecutors.

In an opinion issued on Wednesday, the Second U.S. Circuit Court of Appeals said that U.S. District Court Judge Lewis Kaplan could throw out the KPMG case if he believes prosecutors denied 16 of the audit firm’s former employees their constitutional rights by compelling the firm to stop paying their legal fees. The appeals court refrained from opining on whether that action is constitutional. Last year, Kaplan accused investigators in the KPMG case of using the DoJ guideline to justify pressuring the audit firm to cut off legal support for employees.

In the KPMG case — which has been called the largest criminal tax case in American history — former and current employees are charged with conspiracy and tax evasion. They are alleged to have used fraudulent tax shelters that bilked the government out of more than $2 billion in taxes.

At first, KPMG promised to pay the employees’ legal defense fees, according to their attorneys. But the audit firm allegedly dropped the promise when it was indicted, and much to the consternation of employee-right activists, KPMG agreed to a deferred prosecution agreement and paid $456 million in fines and penalties. By doing so, KPMG can avoid prosecution by agreeing to cooperate fully with the government.

Kaplan has not ruled out dismissing the case based on what he considers a constitutional violation by prosecutors. He “explicitly left that possibility open as an incentive for the government to strong-arm KPMG to advance … defense costs,” stated the higher court’s opinion. In other words, Kaplan implied he would let the case move forward if the audit firm agreed to pay the legal fees of the former employees.

Kaplan’s dissatisfaction with the criminal investigation has been a roadblock to the case moving forward. He lobbed his complaint against prosecutors nearly a year ago and postponed the case. In the meantime, the DoJ revised the Thompson Memo (written by former Department of Justice Deputy Attorney General Larry Thompson) to restrict how prosecutors glean cooperation from corporations. Critics say the original memo gave the government too much leeway in plea agreements with corporations, and some contend the memo is still too onerous in the way it allows federal prosecutors to trade potential leniency for cutting off legal fees and waiving attorney-client privilege rights.

The new memorandum instructs prosecutors to not consider whether a company has paid for its employees’ attorneys fees when determining charges, and requires the deputy attorney general’s approval of all attorney-client communication requests. DoJ deputy AG Paul McNulty, who is retiring this summer, introduced the new memo last December.

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