Free Motion to Stay - District Court of Federal Claims - federal

Case 1:05-cv-00999-MMS

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Statement of Facts

1. KPMG LLP ("KPMG") is a Delaware limited liability partership and is
one of

the "Big Four" public accountingfirms.

2. From 1996 until 2002, KPMG, though its ta parters, assisted high net worth United States citizens to evade United States individual income taxes on bilions of dollars in capital gain and ordinary income by developing,
promoting and implementing unregistered and fraudulent tax shelters. A

number of KPMG 'ta parters engaged in conduct that was unlawful and fraudulent, including: (i) preparing false and fraudulent tax retùrns for shelter clients; (ii) drafting false and fraudulent proposed factual recitations and representations as par of the documentation underlying the ~helters; (iii) issuing opinions that contained those false and fraudulent statements and that purported to rely upon those representations, although the KPMG
tax parters and the high net worth individual clients knew they were not
tre; (iv) actively taking steps to conceal from the IRS these shelters and the tre facts regarding them; and (v) impeding the IRS by knowingly failing to

locate and produce all docum~nts called for by IRS summonses and extent ofKPMG's roJe with misrepresenting to the IRS the nature and
respect to certain tax shelters.
3. This course of conduct was deliberately approved and perpetrated at the

highest levels ofKPMG's tax management, and involved dozens ofKPMG
parters and other personneL. Certain individuals involved were later

promoted to firm-wide leadership positions. Moreover, during the period

1996 through 2002, KPMG changed its policies and practices in a manner that encouraged the sale of tax "products" to multiple clients. In this
regard, KPMG changed its compensation strcture in a manner that

encouraged the sale of tax products, set policies and goals that demanded the creation and sale of tax products, and created within its tax departent
groups of

parters and other personnel who were specifically charged with

developing and seP~.ng tax shelters. .
4. Throughout the period in question, the firm's internal control systems failed to prevent the improper and ilegal conduct because of inherent weaknesses in the system of internal controls and because those controls that were in place were overrdden by certain individuals in tax management.KPMG has implemented changes and enhancements to its internal control systems and wil implement additional enhancements pursuant to the Deferred Prosecution Agreement with the Government, to ensure that such failures
cannot recur. Furher, KPMG has taken a humber of

personnel actions intended to ensure that all of the parers and employees responsible for the

ilegal conduct described herein have been separated from the firm. KPMG
intends not only to ensure that none of its parers wil in the future

partcipate with its clients and others in fraud, but indeed, KPMG wants in the future to ensure that the highest standards of ethics and compliance with
United States tax laws wil be met by the finn, its leadership, parers,

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EXHIBIT

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personnel and clients.

The Fraudulent Tax Shelter Activities

5. KPMG tax parters helped design or sell the following tax shelters (and them) to high net wort United States citizens during the variations of period in question: Foreign Leveraged Investment Progrm ("FLIP"'); Offshore Portfolio Investment Strategy ("OPIS"); Bond Linked Issue Premium Strcture ("BLIPS"); and Short Option Strategy ("SOS").
6. FLIP was marketed and sold by KPMG between 1996 and 1999 to at least

80 high net wort individual clients and generated at least $1.9 bilion in
bogus ta losses; KPMG's gross fees from FLIP transactions were at least

$17 milion. OPIS was marketed and sold by KPMG between 1998 and 2000 to at least 170 high net worth individual clients, and generated at least bilion in bogus tax losses; KPMG's gross fees from OPIS transactions
$2.3

were at least $28 milion. BLIPS was marketed and sold by KPMG

between 1999 and 2000 to at least 186 high net worth individual clients, and generated at least $S.i billon in bogus tax losses; KPMG's gross fees from BLIPS transactions were at least $53 milion. SOS was marketed and sold by KPMG tax parters between 1998 and 2002 to at least 165 high net worth individual clients, .and generated at least $1.9 bilion in bogus tax
losses; KPMG's estimated gross fees from 80S transactions were at least

$17 milion. In addition, at least 14 KPMG parters engaged in SOS
trnsactions for their own account.

7. KPMG tax parters tyically marketed the shelters to financially sophisticated, high net worth individuals who had at least $20 milion in taxable gain, and who therefore would be interested in a shelter that would generate bogus losses that could be used to offset that gain, usually in the same tax year. For each ofthese tax shelters, the high net worth individual client selected the amount ofthe loss he or she wanted to generate, and the promoters would then calibrate the size of transaction to generate that loss. KPMG and the other promoters and partcipants charged the high net worth individual clients a 5 and 7%, to implement the transaction, an amount that included the fees of the promoters and other participants, as well as a small portion that would be used to execute the purported "investment" transactions. KPMG's share was usually i to the purported tax losses mirrored the practice of competing tax shelter promoters, including other major accounting and law firms that developed and sold similar shelters.
KPMG tax parters and the other all aspects of the percentage of the selected tax loss, usually between. 1.25% oftbe tax loss. KPMG's practice of charging a percentage of

8. FLIP and OPIS were designed by KPMG tax parters, a New York lawyer

law firm (the "New York Lawyer"), other individuals, and two KPMG tax professionals who
who at the time was a parer in a prominent national

left KPMG in i 997 to form a purported "investment advisory firm located
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in San Francisco, which in trth and in fact was in the business of promoting tax shelters (the "purported investment advisory firm"). FLIP, OPIS, and variations sold by another major accounting firm were substantially similar. These shelters were intended to generate substantial losses through the use of a pre-arranged series of purchases of and options on stock of one of two prominent international bank followed by
capital

redemptions of those investments by the ban.
9. The FLIP and OPIS opinions signed by KPMG tax parters, and the

representations drafted by KPMG tax parers and knowingly adopted by
the high net worth individual clients, falsely stated that: (a) the client

requested KPMG's opinion "regarding the U.S. federal income tax consequences of certin investment portfolio transactions," when-in trth and in fact these were tax shelter transactions designed to generate bogu tax losses; (b) the "investment strategy" was based on the expectation that a leveraged position in the foreign bank securities would provide the "investor" with the opportnity for capital appreciation, when in trth and in fact the strategy was based on the expected bogus ta benefits to be generated; and ( c) certin money was paid as part of an investment (i.e., for
a warrant or a swap), when in trth and in fact the money constituted fees

due to promoters and other faciltators of the transaction. An of these opinion letters were substantially identical, save for the names of the clients and entities involved, the dates, and the dollar amounts involved in the transactions.
10. Senior KPM G tax professionals criticized the viabilty of these transactions and specifically questioned whether the transaction 'had economic substance or risk and whether the non-resident alien, whose parcipation as an equity holder of the foreign corporation was critical to the expected ta treatment
of the redemption, would be respected. by the IRS as a tre equity holder or

would instead be treated as a service provider or debt holder being paid a fee to accommodate the "investor."
11. KPMG tax parters were instrcted not to permit potential OPIS "investors" to retain a copy ofKPMG's PowerPoint presentation describing the transaction because to do so would "DESTROY any chance the client may have to avoid the step transaction doctrne." In some cases KPMG tax
parers took steps described below in paragraph 25 to assist high net wort

individual clients to report the transactions in a fraudulent manner with the intent to evade federal income taxes.
12. BLIPS was designed by KPMG tax parters, the purported investment advisory firm, the New York Lawyer, and others. The BLIPS transaction

was intended to generate a substantial ordinary or capital loss though the use of a loan issued at an above-market interest rate and with a substantial "loan premium" which was not in fact a tre loan. KPMG tax parters and the purported investment advisory firm enlisted three prominent
international banks - including one bank that also partcipated in FLIP,

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OPIS, and SOS - to provide the purported "loans" used by the high net

worth individual clients who participated in this shelter.
13. The BLIPS tax opinions signed by the KPMG tax parters purported to rely upon certn factual representations made by the high net wort individual clients. These representations, which were devised by KPMG tax parters and others involved in designing BLIPS and were knowingly'adoptëd by the high net worth individual clients, were false and misleading. The New York Lawyer issued substantially identical opinions reaching the same conclusion and purportng to rely upon the same false representations.
14. Among the false representations in the BLIPS opinion letter was the

representation that the high net worth individual client as well as:the purported investment advisory firm "believed there was a reasonäble opportnity to earn a reasonable pre-tax profit from the (BLIPS) transactions," when there was no such opportnity. As the KPMG tax
parers and the high net worth individual clients well knew, there was no

"reasonable likelihood of earning a reasonable pre-tax profit" from BLIPS, BLIPS was negligible, unrelated to the large "loans" that were the key elements ofthe purported tax benefits BLIPS, and was simply window dressing for the BLIPS tax shelter.
and instead the "investment" component of of

15. The opinion letters and other documents implementing BLIPS also

contained the false and fraudulent representation (among others) that the BLIPS "investment" was "highly leveraged." In trth and in fact, and as the KPMG tax parers and the high net worth individual clients well knew,
there was no "leverage" in the BLIPS transaction - the negligible

"investment" component was carred out and secured using only cash
contrbuted by the high net worth individual client.

16. Another false representation contained in the opinion letters was that the duration of the individual's partcipation in the thee-phase, seven-year . investment progrm was dependent upon the performance of the program
relative to alternative investments. The KPMG tax parers and the high

net worth individual clients well knew thoughout the development and BLIPS, and at the time the high net worth individual clients made this representation and the KPMG opinions were issued, that this representation was false and fraudulent. The principal purpose of the BLIPS transaction was to generate a ta loss to offset substantial income or
implementation of

gains,and in order to generate this purported tax benefit, the individuals
had to and would withdraw from the

BLIPS program by year end. Therefore, the KPMG tax parters and the high net wort individual clients knew and expected that the transactions would terminate by year end and indeed in approximately 60 days, the earliest time at which the high net worth individual client could trgger the promised tax loss, not at some
investment-related point i~ any purported "seven-year" program.

Throughout 1999, and as expected by the BLIPS paricipants, each of the high net wort individual clients who engaged in a BLIPS transaction
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exited the transaction before year end (i.e., upon completion ofthe first 60 those individuals remained for three phases or seven years, and none eared a direct profi on their investment.
day "phase"). None of

I 7. The "investment program" created by the purported investment investments advisory
was described as a program of firm for the BLIPS transactions

in foreign currencies intended to take advantage of volatility in foreign
currencies though investments in foreign currency contracts, options and foreign curency denominated debt securities. However, when the high net-

worth individual clients who engaged in BLIPS transactions exited the transaction, the purported investment advisory firm tyically acquired publicly traded equity securities to distrbute to those clients, and to which the bogus tax basis generated through BLIPS would be "attachea-." In at least one case, a KPMG tax parter worked with the purported irilvestment advisory finn and a high net worth individual client to identify publicly traded stocks that had already suffered large losses during the calendar year and used those stocks for "attaching" the bogus tax basis, for the purpose of creating the impression that the tax losses arose from the poor performance ofthe stocks and not from the BLIPS tax shelter.
i 8. Notwithstanding serious and valid concerns expressed by certain KPMG tax

parters and other professionals throughout the development of BLIPS

about the honesty of the proposed opinion letter and the credibility of the proposed factual representations (as well as other defects in the tax analysis . contained in the opinions), Washington National Tax ("WNT"), the Professional Practice - Tax ("DPP-Tax"), and other members Departent of of tax leadership approved BLIPS.
19. In March 2000, KPMG's tax leadership was advised by two ofKPMG's top

technical tax experts that BLIPS was "frvolous" and would "lose" in court, and was advised by professional and legal' compliance personnel of the risks associated with tax shelter transactions like BLIPS, including the risk of liability and penalties, action by the IRS's Director of Practice, and action by State Boards of Accountancy. , Nevertheless, and despite the obvious facts about BLIPS and the warnings conveyed during that time frame, KPMG's tax leadership decided to authorize the issuance of favorable opinions on all of the 1999 trnsactions, BLIPS
criminal investigation, civil and proceeded with the implementation of another series of

transactions in 2000.

20. SOS and variations on that shelter were designedto generate a substantial
ordinary or capital

loss through the creation of an artficially high basis in

an interest in a parership or other entity through a series of purchases and offsettng options on foreign currency. KPMG's top technical
sales of

expert concluded that the losses' claimed from SOS transactions were not

more likely than not to be upheld in court if challenged by the IRS. Nonetheless, KPMG's tax leadership permitted its tax professionals to
market and implement the

trnsactions, all of which were substantially
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similar, and to prepare tax returns incorporating these bogus tax losses.
21. One KPMG tax parter from the Stratecon group (the "Stratecon Parter") even issued KPMG ta opinions stating that the bogus tax losses generated
by the sas tax shelter transactions were more likely than not to withstand

challenge by the IRS, notwithstanding the conclusion ofKPMG's top technical experts to the contrary. These opinion letters, and other aSsociated documents, were false and fraudulent in many ways, including the
following: they misrepresented SOS as an investment, when in trth and in

fact, as the Strtecon Parter ~d the high net worth individual clients well
knew, it was a tax shelter designed to generate ta losses; they falsely

claimed that the "investor" would have entered into the option positions independe.nt of the other steps that made up SOS, when in trth and in fact, as the Stratecon Parter and the high net wort individual clIentswell knew, the "investors" would not; and they falsely claimed that the option positions were contrbuted to a parership to "diversify" the client's "investment"

when in trth and in fact, as the Stratecon Parter and the high net wort individual clients well1aew, the contrbution was simply a necessary step
in the tax shelter and was executed for the purpose of generating the tax loss. Although the Stratecon Parter took several steps to conceal his activity from both the IRS and some members ofKPMG leadership, several this activity. Ultimately, KPMG's Office of senior tax parters 1aew of General Counsel determined that the Stratecon Parter had violated firm policies and recommended that the firm terminate him, but that recommendation was rejected in late 2002 by the former Deputy Chairman and tax leadership.
22. In addition to the SOS transactions implemented by the Stratecon Parter, a

number of other KPMG tax parers assisted high net wort individual
clients with SOS transactions for a fee generally equal to 1 % of the tax

losses to be generated. In these transactions, KPMG qid not issue an
opinion as to the legitimacy of c1ainung the losses purortedly generated by

the shelter but those transactions were supported by opinions issued by
other firms. When a senior KPMG tax parter at WNT reviewed a draft

SOS opinion letter to be issued by the New York Lawyer to several high net worth individual clients ofKPMG, the tax parter suggested that the representations upon which the draft opinion letter was based were not credible and questioned whether the high net wort individual client would be able to swear under oath in a court of law that the representations were

tre. Nonetheless, another KPMG tax parer continued to assist in the
implementation of this SOS transaction and prepared and signed the tax returns of these clients incorporating the bogus tax losses, as did other KPMG tax parters in other SOS trsactions.
Steps Taken to Avoid IRS Scrutiny o/the Tax Shelters

23. KPMG tax parters actively took steps to conceal these shelters from the IRS. These actions included: (i) deciding not to register the tax shelters
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with the IRS, as required by law; (ii) preparing tax returns for some high net wort individual clients that fraudulently attempted to make it less likely that the individuals would be audited or, if audited, less likely that the IRS would learn through the audit of the clients' participation in the tax shelter; and (ii) improperly seekig to conceal the transactions under the veil of sham attorney-client privilege claims.

24. As part of their effort to conceal the tax shelters from the IRS, KPMG tax
leaders decided not to register

those tax shelters as KPMG was required by law to do. Specifically, the decisions not to register the tax shelters were made in the face of advice from its professional and legal compliance personnel that the shelters should have been registered. On at least one
occasion, those professional and legal compliance personnel wared that a

wilful failure to register the shelters could be criminal conduct. 't

25. KPMG tax professionals prepared tax returns for some high net worth individual clients that fraudulently attempted to conceal the shelters from
IRS scrutiny. Specifically, some KPMG tax parters worked with high net

wort individual clients to use a grantor trst and net the short-tenn capital losses generated by these tax shelters with the long-term capital gains that the shelters were designed to offset. By this improper and fraudulent conduct, the high net wort individual clients reported on their tax returns only a small net gain or loss created by subtracting the large bogus shelter loss from the large long-term capital gain rather than reporting both large figures on their individuá. income tax returns. Thè purpose of making use nettng" was to conceal the bogus ta shelter losses from the IRS and thus reduce the risk of an audit of the high net worth individual clients, thereby reducing as well the risk that the IRS would scrutinize the shelters. Despite stark warnings by the parer.:in-charge of the personal financial plalming group within WNT that to engage in
of this "grantor-trst

"grntor trst netting" might be criminal, a leader ofthe PFP group decided

that each individual KPMG tax parter should decide for himself or herself

whether he or she rilt comfortable advising high net worth individual clients to engage in "grantor trst netting" or to partcipate in this practice.
26. The Stratecon Parter took additional fraudulent steps to conceal shelter

transactions from the IRS by purportng to have the high net worth individual clients engage a law firm to provide legal advice, which law firm would then purport to engage KPMG to work under the direction of the law firm. Although under United States v. Kovel, communications by nonlawyer professionals such as accountants are

protected under the attorney-

client privilege when the accountant is in fact working under the direction of an attorney, numerous Kovel arrangements established by this former
parer were sham arrangements because the individuals did not directly

engage the law firm, in many instances never even spoke to the lawyers whom they had purportedly engaged, and the Stratecon Parer's work was done outside of the purported lawyer-client privilege. The purpose of this improper conduct was to enable the high net worth individual client, with
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the assistance of

the Stratecon Parer, to conceal the fraudulent tax shelter

from the IRS by attempti,g to cloak an of the work for the shelter in the
attorney-client privilege. The Stratecon Parter's conduct was well known

to his supervisors who were later promoted to the positions of Vice Financial Officer. This abuse ofthe attorney-client privilege was used by the Stratecon Parter (with the his supervisors) to circumvent the finn's internal controls, and to prevent others at KPMG from having full access to documents relating to the Stratecon Parter's fraudulent activities.
Chainnan in charge of Tax and Chief knowledge and approval of

27. Some KPMG tax parters and tax leaders also routinely attempted to cloak in the attorney-client privilege communication~ that revealed the tre nature
of

their conduct even though those communications were not priyileged-

i.e., they were not conveying confidential information to attorneýs for the purpose of receiving legal advice - by routinely copying an Associate General Counsel on email communications and memoranda in an effort to conceal information contained in those communications and memoranda from the IRS and others.
KPMG's Responses to IRS and Senate Investigations

o/its Fraudulent Tax Shelter Activities
28. Despite the effo$ described above by the tax pàrters to prevent IRS

scrutiny of these ta shelters, the IRS became aware of certain of these tax shelters and in September 2001 it initiated an examination ofKPMG for its this examination, in early 2002 the IRS issued 25 summonses to KPM G calling information relating to numerous tax strategies with
failure to register the transactions with the IRS. As part of for the provision of

which KPMG may have been involved. In response to these 25 ,

summonses, KPMG provided the IRS with several hundred boxes of documents responsive to the sumonses. However, hundreds of documents privilege that were later rejected by a United States Distrct Court based on the Court's determination, which KPMG did not appeal, that KPMG had "misrepresent( ed) its unprivileged tax shelter marketing actjvities as privileged communications."
were witheld on claims of 29. In addition, the IRS summonses

knowledgeable person to testify

required KPMG to designate a under oath at the IRS. KPMG's tax leadership designated the parter in charge of the PFP group (the "PFP Leader") to testify. A KPMG representative who attended the first of the testimony expressed the view to several KPMG tax leaders that the PFP Leader's testimony was, in many respects, misleading and evasive. This testimony was not supplemented or corrected.
PFP Leader's four days of

30. One of the 25 summonses to which KPMG responded called for production

of documents relating to transactions described in an IRS administrative notice designated as Notice 2000-44. KPMG tax parters understood that documents relating to BLIPS and SOS were called for in response to this
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summons and others. KPMG produced certain documents relating to BLIPS. but did not produce any documents relating to SOS. Despite the involvement of a number of its ta parters in the marketing and sale of

SOS transactions, which was well known to several members ofKPMG's
tax leadership and certain parers responsible for responding to the

summonses, no documents relating to SOS were collected as part of the initial summons response process, and on several occasions prior to 'early 2003, the IRS was falsely advised that KPMG had largely complied with the IRS summonses.
31. In addition, as several members of KPMG' s ta leadership and certain '

parters responsible for responding to the summonses well knew,

information and documents relating to the Stratecon Parter's activities by summonses issued by the IRS to KPMG. Indeed, the
were called for

Stratecon Parter had arranged for at least 14 KPMG parters to engage in

SOS transactions for their own account. Nevertheless, KPMG did not produce to the IRS in response to summonses any documents or information 2004, and on
relating to the Stratecon Parter's tax shelter activities until

several occasions prior to early 2003, the IRS was falsely advised that KPMG had largely complied with the IRS summonses.
32. In early 2003, the IRS became aware that KPMG tax parters had helped

some high net worth individual clients partcipate in SOS tax shelters. In

May 2003, IRS agents directly asked KPMG, through its outside counsel,
what role KPMG had played in the SOS shelters. A KPMG tax parter

seeking information in response to that inquiry conveyed the IRS' inquiry to the PFP Leader, who falsely advised that the only role that KPMG had high net worth
played with respect to SOS was to assist a couple of

individual clients in preparing arid fiing tax return that reflected the tax

losses from SOS transactions. ¡his false representation was then relayed to the firm's counsel, and then made to the IRS. In fact, KPMG was in
possession of numerous responsive documents and the existence of those documents was known to senior taX leaders :ind legal compliance personnel the SOS transactions
directing the slimmons-response process. Yet, none of

marketed and sold by KPMG tax parters were provided to the IRS until
late 2003 and early 2004.

the
33. In January 2003, the Permanent Subcommittee on Investigations of

United States Senate's Committee on Governental Affairs (the "Subcommittee") commenced an investigation into efforts of several major accounting firm, including KPMG, to mass market abusive tax shelters. As part of that investigation, the Subcommittee issued a subpoena to KPMG callng for the production of certain documents, including information relating to tax shelters used by certain KPMG parters to avoid their own taxes. KPMG was in possession of numerous documents responsive to that General
request and several senior tax parters and KPMG's Office of

Counsel were well aware of those tax shelters and documents and the Subcommittee's request for tnem. In February 2003, KPMG stated that "to
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the best of its knowledge and belief, after reasonable inquiry to date, the firm has not yet identified any documents that are responsive to this request," and the firm subsequently negotiated with the Subcommttee as to

the scope of the subpoena. None of the documents relating to SOS '
transactions, including tax shelters used by certain KPMG parers 9n their

own account, was produced to the Senate.

. .

34. In November 2003, several KPMG tax parters testified in a public hearng before the Subcommittee. The PFP Leader delivered KPMG's official statement to the Subcommittee, and then falsely denied in response to one the tax loss to be generated question that KPMG's fee was a percentage of

by the shelters. In addition, when asked by a Senator whether FLIP, OPIS
and BLIPS were "designed and marketed pnmarly as tax reductin

strategies," the PFP Leader falsely stated "Senator, 1 would not agree with that characterization." The testimony ofKPMG's representatives before the Subcommittee was misleading and evasive in other ways, at one point
prompting a Senator to admonish the PFP Leader to "tr an honest answer"

and at another point prompting a Senator to state to KPMG's Vice you to a
Chairman in charge of Tax that "1 can't get a straight answer out of

very direct question."

KPMG's Cooperation
35. At the outset of

the criminal investigation, KPMG made the decision to cooperate with the Governent. To that end, KPMG, on its own initiative,
determned to condition employment and payment of legal fees for its current and former parers on their cooperation in the investigation, and

took disciplinary action, including by refusing to pay attorneys' fees and by those who chose not to cooperate with the terminating the employment of defense
criminal investigation. KPMG also declined to enter into any joint

agreements with any current or former personnel or any other organizations the Governent's
or individuals whose conduct has been the subject of

investigation. KPMG responded to grand jury subpoenas by providing the Governent with documents reflecting the improper and ilegal conduct of its tax parters and others, and responded to numerous specific requests for information on particular issues. As the Governent's investigation progressed, the firm penodically authorized waivers of attorney-client and work product pnvileges in order to provide the Governent with documents containing factual information of material interest to the Governent's investigation. The firm also agreed to limited requests made by the Government to refrain from conducting certain internal inquiries that
might have interfered with the Governent's own investigation.

36. KPMG has also agreed to fully cooperate with the Governent's investigation into criminal wrongdoing associated with thè development, promotion, and implementation oftax shelters.

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