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Judge Questions Clarity of Prosecution's Tax-Shelter Case
By Lynnley Browning New York Times
Friday, March 31, 2006

A federal judge raised questions yesterday about the prosecution of 16 former KPMG employees over aggressive tax shelters, criticizing prosecutors for what he called murky definitions of fraud and evasion.

The judge, Lewis A. Kaplan of Federal District Court in Manhattan, said he was confused by what prosecutors said was a conspiracy by the defendants to make and sell aggressive shelters that allowed hundreds of wealthy investors to evade $2.5 billion in taxes from 1996 to 2002.

"Was the fraud and evasion in the execution or the design" of the shelters, Judge Kaplan asked during a hearing held to consider defense motions to drop or alter some charges.

Judge Kaplan made no ruling yesterday; he is expected to issue orders on the motions in coming weeks.

The case with 16 former employees of the accounting firm KPMG, an outside lawyer and an investment adviser as defendants is unusually large and dauntingly complex.  The defendants are scheduled to stand trial in September.  Their lawyers say their clients acted lawfully and appropriately.

Yesterday, Judge Kaplan asked prosecutors if they would consider dropping some of the 39 counts of tax evasion and limiting the evidence to be introduced during the trial, "in the interest of getting this thing tried in a single human life span."

Prosecutors say the defendants made, sold and in some cases used for themselves certain tax shelters that they knew would not pass muster with the Internal Revenue Service.  They are also charged with cheating on their own and others' tax returns and with lying to government investigators.  Not all defendants face the same charges.

One of the original defendants, David Rivkin, a former partner in KPMG's office in San Diego, pleaded guilty last week and agreed to cooperate with prosecutors against the remaining defendants.

Judge Kaplan also questioned aspects of an influential Justice Department memorandum that lays out guidelines on prosecutions of corporations.  That document, known as the Thompson memorandum, drafted in 2003 by a deputy attorney general, Larry Thompson, advises prosecutors to grant more lenient treatment to firms facing indictment if they forgo paying the legal fees of potentially culpable employees.

"Frankly, I'm very bothered by it," the judge said, saying the document "puts the government's thumb on the scales" and raises questions about the Sixth Amendment constitutional right to legal representation.

KPMG narrowly avoided indictment and instead reached a $456 million deferred-prosecution agreement in August, in the process admitting criminal wrongdoing and agreeing to cooperate with investigators.  But around the same time, KPMG, aware that some of its employees were about to be indicted, ended its longstanding practice of advancing legal fees of as much as $400,000 an employee.

"I find it shameful that the fees haven't been advanced," Judge Kaplan said.  "The reality is that you are depriving people of counsel, or at least interfering or impairing."

Some lawyers for the defendants argued yesterday that their clients would go bankrupt financing their defense.  One of the defendants, David Greenberg, a former senior tax partner at KPMG, has been unable to come up with the $25 million in bail needed to get out of jail, and appeared at the hearing in prison garb.

In court papers and oral arguments, prosecutors have repeatedly described the complex shelters as consisting of sham and fraudulent transactions, like phantom loans and investments, that generated artificial losses. Investors then cited these to claim tax losses against legitimate income.  Lawyers for the defendants argue that they had thought the shelters were legitimate.

To Judge Kaplan's question of whether fraud and evasion occurred in the design or in the carrying out of the shelters, Justin Weddle, an assistant United States attorney, answered, "Both."

No court has ruled the shelters illegal, but the I.R.S. has never considered them valid for deductions.

Nonetheless, Steven Bauer, a lawyer who represents John Larson, a former KPMG partner who is one of the 18 defendants, said prosecutors had withheld important information detailing, among other things, debate inside the I.R.S. over whether the shelters were legitimate.

Judge Kaplan ordered the prosecution to turn over any withheld information.
http://www.nytimes.com/2006/03/31/business/31shelter.html