Nine people, including six former KPMG LLP partners and the former deputy chairman of the firm, face criminal charges in the largest criminal tax case ever filed in the United States. In addition, the company has admitted wrongdoing and has reached a deal to pay US$456 million in fines, restitution and penalties to defer prosecution in the multi-billion-dollar tax fraud case.

Details of the settlement were released today by the U.S. Department of Justice and the U.S. Internal Revenue Service. According to a series of charging documents unsealed today, the fraud relates to the design, marketing, and implementation of fraudulent tax shelters.

KPMG admitted it engaged in a fraud that generated at least US$11 billion dollars in phony tax losses which, according to court papers, cost the U.S. at least US$2.5 billion dollars in evaded taxes. In addition to KPMG’s former deputy chairman, the individuals indicted include two former heads of KPMG’s tax practice and a former tax partner in the New York, N.Y., office of a prominent national law firm.

The criminal information and indictment together allege that from 1996 through 2003, KPMG, the nine indicted defendants and others conspired to defraud the IRS by designing, marketing and implementing illegal tax shelters.

According to the charges, KPMG, the indicted individuals, and their co-conspirators concocted tax shelter transactions, together with false and fraudulent factual scenarios to support them. These were targeted to wealthy individuals who needed a minimum of $10 million or $20 million in tax losses so they would pay fees that were a percentage of the desired tax loss to KPMG, certain law firms and others instead of paying billions of dollars in taxes owed to the government. To further the scheme, KPMG, the individual defendants, and their co-conspirators allegedly filed and caused to be filed false and fraudulent tax returns that claimed phony tax losses. KPMG also admitted that its personnel took specific deliberate steps to conceal the existence of the shelters from the IRS by, among other things, failing to register the shelters with the IRS as required by law; fraudulently concealing the shelter losses and income on tax returns; and attempting to hide the shelters using sham attorney-client privilege claims.

The information and indictment allege top leadership at KPMG made the decision to approve and participate in shelters and issue KPMG opinion letters despite significant warnings from KPMG tax experts and others throughout the development of the shelters and at critical junctures that the shelters were close to frivolous and would not withstand IRS scrutiny; that the representations required to made by the wealthy individuals were not credible; and the consequences of going forward with the shelters-as well as failing to register them-could include criminal investigation, among other things.

The agreement provides that prosecution of the criminal charge against KPMG will be deferred until Dec. 31, 2006, if specified conditions — including payment of the $456 million in fines, restitution, and penalties — are met. The $456 million penalty includes: $100 million in civil fines for failure to register the tax shelters with the IRS; $128 million in criminal fines representing disgorgement of fees earned by KPMG on the four shelters; and $228 million in criminal restitution representing lost taxes to the IRS as a result of KPMG’s intransigence in turning over documents and information to the IRS that caused the statute of limitations to run. If KPMG has fully complied with all the terms of the deferred prosecution agreement at the end of the deferral period, the government will dismiss the criminal information.

The agreement also requires permanent restrictions on KPMG’s tax practice, including the termination of two practice areas, one of which provides tax advice to wealthy individuals; and permanent adherence to higher tax practice standards regarding the issuance of certain tax opinions and the preparation of tax returns. In addition, the agreement bans KPMG’s involvement with any pre-packaged tax products and restricts KPMG’s acceptance of fees not based on hourly rates. The agreement also requires KPMG to implement and maintain an effective compliance and ethics program; to install an independent, government-appointed monitor who will oversee KPMG’s compliance with the deferred prosecution agreement for a three-year period; and its full and truthful co-operation in the pending criminal investigation, including the voluntary provision of information and documents.

@page_break@Richard Breeden, former Securities and Exchange Commission chairman, has been appointed to serve as the independent monitor. After his duties end, the IRS will monitor KPMG’s tax practice and adherence to elevated standards for two years.

Should KPMG violate the agreement, it may be prosecuted for the charged conspiracy, or the government may extend the period of deferral and/or the monitorship.

The indictment against the individuals alleges that as part of the conspiracy to defraud, they prepared false and fraudulent documents, and that several of them caused KPMG to provide false, misleading and incomplete documents and testimony in response to a Senate subpoena. The individual defendants are scheduled to be arraigned by Judge Lewis Kaplan. The charges contained in the indictment are merely accusations, and the defendants are presumed innocent unless and until proven guilty.

KPMG said in a statement that it is pleased to have reached a resolution in the case. “We regret the past tax practices that were the subject of the investigation. KPMG is a better and stronger firm today, having learned much from this experience,” said KPMG LLP chairman and CEO Timothy Flynn. “The resolution of this matter allows KPMG to confidently face the future as we provide high-quality audit, tax and advisory services to our large multinational, middle market and government clients.”

The company also noted it looks forward to resolving “expeditiously and with full and fair accountability” the civil litigation claims by individual taxpayers. It says the resolution of the investigation into the U.S. firm’s past tax shelter activities has no effect on KPMG International member firms outside the US.

“The agreement by KPMG provides a comprehensive and forward-looking framework for addressing the violations identified by DOJ, which do not arise under the federal securities laws,” noted Donald Nicolaisen, chief accountant for the SEC. “The PCAOB has advised me that it is issuing a statement on KPMG’s ongoing ability to perform audits of public companies based on its annual inspections of KPMG’s auditing work.”

“I am pleased that DOJ and KPMG have reached an agreement to resolve the issues under investigation by DOJ. I believe that the past conduct described in the agreement was unacceptable and the resulting penalties are appropriately significant,” Nicolaisen said. “The agreement addresses tax shelter activities outside KPMG’s audit practice and does not require or call for commission action. Commission staff will, of course, monitor the situation in view of the commission’s responsibilities to investors and markets.”

“Corporate fraud has far-reaching consequences, both to the marketplace and those whose livelihoods depend on companies that maintain honest business practices,” said U.S. attorney general Alberto Gonzales. “Today’s agreement requires KPMG to accept responsibility and make amends for its criminal conduct while protecting innocent workers and others from the consequences of a conviction. The stiff financial penalty announced today means that the firm is paying for its conduct, while the guarantees of co-operation, oversight and meaningful reform will help to ensure that its future business is conducted with honesty and integrity.”