Business: KPMG Dodges a Big Bullet

By Jeff Lipsey

In what could have been another major catastrophe for the accounting industry, the accounting firm KPMG dodged an enormous bullet Monday by pleading guilty to a broad criminal conspiracy concerning tax shelters.

KPMG will not face criminal prosecution charges for obstruction of justice, but it agreed to pay $456 million in fines and restitution and will help in the prosecution of at least eight former KPMG executives as well as other outside individuals, according to the Wall Street Journal.

The reason KPMG is not facing criminal charges at first had me upset; I could not understand, after what happened to Arthur Andersen, how KPMG would not go down the same path. However, I had to reconsider after researching some more about what exactly the Department of Justice and the Internal Revenue Service considers illegal tax shelters.

The IRS allows tax shelters but only if they provide a “legitimate economic purpose.” Otherwise, the shelter’s sole purpose is to avoid a tax liability. An example of a legitimate tax shelter would be deducting the interest paid on a home mortgage or other methods approved by Congress. Illegal shelters are much more complicated and usually require a dozen transactions to avoid detection.

No matter how you look at it, KPMG committed an illegal action. They deliberately marketed illegal shelters to hundreds of their most wealthy clients, generating more than $11 billion of false tax losses from 1996 to 2002. The Department of Justice, however, did not indict KPMG for several reasons.

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First, KPMG is the smallest of the Big Four accounting firms but yet still large enough to efficiently manage the recent Sarbanes-Oxley Act of 2002. If the Department of Justice indicted them, then KPMG would lose its most profitable clients and literally be destroyed by the ruling.

The Department of Justice then must have learned a lesson after what happened with Arthur Andersen, especially after the Supreme Court overturned Andersen’s conviction back in June. The Department of Justice wants to get as much as it can without creating a large amount of publicity. Also, KPMG’s demise at such a crucial time in the accounting profession would be horrible planning for a department fiercely pushing the Sarbanes-Oxley Act.

I’m unsure of how KPMG’s guilty plea will affect the future of the profession. Andersen’s criminal actions were not alone among the then-Big 5. And, if the Department of Justice can decide whether or not to indict a firm based on market conditions, then that could give the Department of Justice unheralded power. I’m also worried that the precedent in this case will allow further criminal charges against large corporations to go relatively unpunished.

I feel good about KPMG’s recognition of the problem and that it is doing what it can to help solve it. They have promised the Department of Justice to cooperate with federal prosecutors in the indictment of former employees and others involved in the crime.

Finally, the lack of national media attention to this issue surprises me. I don’t know if I should attribute that to hurricane Katrina or the unwillingness of the public to go through another Andersen.

Stock Pick of the Week

With hurricane Katrina devastating a large section of the southeast, trying to find a company that isn’t affected by it is rather difficult. That is why I am recommending not a specific stock, but a sector. The Energy Select Sector SPDR (ticker symbol XLE) is currently trading at its 52 week high. Normally, I tend to stray away from stocks trading at the 52 week high, but since its start last year it has increased more than 100 percent and has increased over 30 percent this year alone. It has the low risk ability like a mutual fund but it encompasses the entire energy sector. A must-have for the long-term investor. Stock Price: $50.64.

Jeff Lipsey is a senior in Business. His columns appear on Thursdays. He can be reached at [email protected]