Thursday, October 13, 2005

Is the KPMG Tax Partner Indictment That Bad?

The Wall Street Journal's has already come out against the prosecution of eight former KPMG partners and a former law firm partner for their involvement in the creation and sales of questionable tax shelters, and it has published a lengthy op-ed (here) by Stanford law professors Robert Weisberg and David Mills, entitled "A Very Strange Indictment."  The issue raised by Profs. Weisberg (one of the leading criminal law scholars in the nation) and Mills is, "While the accountants and their clients may have done some bad things, the notion that their behavior is criminal, and even sufficiently criminal to threaten the very existence of this major firm and its thousands of jobs, casts doubt on the fairness and judgment with which the federal prosecutors have exercised their discretion."  They assert that the prosecutors, frustrated with the failure of Congress to outlaw tax shelters, are "venting their frustration over this failure to act by fashioning felony charges out of ethereal legal material."

There are certainly questions that can be raised about the prosecution, and the principle one in my mind is that these shelters have never been found to be improper, an issue that will be raised by the defense, no doubt.  Moreover, as the op-ed notes, the indictment hints at possible "obstruction of justice" in the testimony of one of the indicted KPMG partners, but that is not an object of the conspiracy nor even cited as integral to the sales of the tax shelters -- it took place well after the transactions at issue. 

Profs. Weisberg and Mills make a number of good points, but I do quibble with two issues that they raise as calling into doubt the legal viability of the indictment.  First, they argue that "there has never been a prosecution under the general 'defraud' clause in a tax case where the alleged conspiratorial objective is reducing one's taxes without substantial legal basis for doing so."  I'm not sure whether they are trying to distinguish this conspiracy prosecution from any number of tax conspiracy cases in which the defendant did not pay federal taxes on a claim that the tax laws do not apply.  Many of the tax protester cases involve a charge of conspiracy to defraud the United States under Sec. 371, that a claim that the tax laws do not apply (or that income earned in the United States is not subject to tax) is a conspiracy to deprive the government of lawfully owed taxes.  A recent decision discussing such a charge is U.S. v. Ambort, 405 F.3d 1109 (10th Cir. 2005).  The government's charge that the KPMG tax shelters were improper is similar to the prosecution of tax protesters who assert the tax laws do not apply to them: each defendant is seeking to reduce (or avoid) taxes without a substantial basis for doing so.  The key assumption in the KPMG case, of course, is that the shelters were illegal, a claim that will be more difficult to establish than showing the validity of the tax laws and Sixteenth Amendment (leaving aside the whole admission of Ohio to the Union question).

A second point made in the op-ed is "the very idea of punishing the accountants in a kind of test case of this theory of the criminal tax law is self-refuting. That is, even if the accountants knew the transaction would be deemed to lack a business purpose, they had no reason whatsoever to think that under these circumstances they could face anything worse than the usual civil penalties. And without that knowledge, they cannot be guilty of tax fraud." I'm not sure I agree with the reading of Cheek v. United States, 498 U.S. 192 (1991), that Profs. Weisberg and Mills advance.  The key passage in Cheek about the intent required to prove a "willful" criminal violation of the tax law is: "Willfulness, as construed by our prior decisions in criminal tax cases, requires the Government to prove that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty."  This intent element permits a defendant to argue that a mistake regarding the applicability of the law is a valid defense because it negates the requisite intent, but Cheek does not require the government to prove that the defendant knew the conduct was in fact a crime, or would be prosecuted by the government.  Cheek requires a voluntary and intentional breach of a known legal duty, but knowledge that a violation of that duty could be prosecuted criminally is not an element.  The fact that the government has not prosecuted a particular theory of liability before, or imposed civil penalties in prior situations, does not mean the defendants did not know that they had a duty to properly report (or assist clients of the firm in reporting) their taxes.  Indeed, I think it would be quite difficult for accountants and lawyers (including five defendants who were both) in this case to assert the type of ignorance of the law defense that was sanctioned in Cheek.  Ignorance of the law does not equate to ignorance of what could be prosecuted as a criminal violation, if the person knows that there is an obligation to comply with a legal duty.

The prosecution of the KPMG partners is certainly aggressive, and it will be a very difficult case for the government to win without the cooperation of one or more individual partners who participated in the creation and selling of the shelters.  The more the government allows the case to become a battle over the technical aspects of the shelters, the worse off it will be.  Profs. Weisberg and Mills are right that it is difficult to understand what the government's theory of prosecution is at this point, and whether the shelters were illegal, which does indeed make the indictment strange.  Whether it is an improper application of the conspiracy statute is a much closer issue. (ph)

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