Trial, Pared in Scope, Nears After Stormy Prologue
By Paul Daviess and Chad Bray
The Wall Street Journal
Friday, October 12, 2007
NEW YORK -- It was once billed as the biggest tax-fraud case in
U.S. history. Then a federal judge devastated prosecutors by
dismissing charges against 13 out of 19 targets.
But as the landmark case against former executives of accounting
giant KPMG heads for trial Oct. 23, more than two years after
the initial indictments, the stakes are still high for the
government's broad fight against abusive tax shelters.
Three former lower-level KPMG executives and an attorney are all
that remain of a case that once included the accounting firm's
former vice chairman, Jeffrey Stein. A federal judge dismissed
the charges against 13 individuals in July after finding that
federal prosecutors violated their constitutional rights by
pressuring KPMG to cut off their legal fees. Two others have
Though the case has been whittled down, the outcome will be
closely watched in legal circles, executive suites and
A victory for the government could bolster its broad probe into
abusive tax shelters. An acquittal may cause the government to
re-think its strategy in future tax-shelter cases.
Prosecutors initially accused the 19 individuals of selling
bogus tax shelters to about 600 wealthy individuals from 1996 to
2002, generating about $2.5 billion of tax savings. The case
got bogged down for more than a year in a widely watched dispute
over the legal fees.
The federal judge overseeing the case, Lewis A. Kaplan,
challenged the government over pressure tactics that defense
attorneys say have been on the rise as part of a broader
crackdown on white-collar crime in wake of the Enron collapse.
Judge Kaplan concluded that KPMG refused to pay the legal fees
"because the government held the proverbial gun to its head."
The judge accused the prosecutors of being "economical with the
truth" in responses regarding the pressure tactics.
After throwing out the charges against the 13 individuals Judge
Kaplan said "the responsibility for the dismissal" of the
indictment "lies with the government."
A spokeswoman in the U.S. attorney's office for the Southern
District of New York, which is handling the case, declined to
comment. Prosecutors previously have denied placing an undue
pressure on KPMG and on Oct. 10 filed an appeal of the judge's
While many legal experts say there is a strong chance the judge
may get reversed, the fallout from his landmark ruling
continues: The Justice Department repudiated its guidelines for
white-collar prosecutors after Judge Kaplan singled out the
government's pressure tactics. Defense attorneys say federal
prosecutors have largely stopped asking companies if they are
paying legal fees, avoiding a topic that has become
"radioactive," as one lawyer put it.
Defense attorneys for Jamie Olis, who was convicted of fraud and
conspiracy in 2003, filed an appeal last week, alleging that
federal prosecutors in Houston pressured his former employer,
Dynegy Inc., to withhold his legal fees, a move that could lead
to similar appeals by others citing the KPMG case.
"With all the backstory going on, a complex tax-shelter case got
a lot more complex," said Peter Henning, a professor at Wayne
State University Law School in Michigan, who has been following
The Four to Be Tried
Opening arguments are scheduled for Oct. 23 in a trial expected
to last three to five months. The four on trial include former
KPMG tax partners Robert Pfaff, John Larson and David Greenberg,
and Raymond J. Ruble, a former partner at Sidley Austin LLP.
The government has turned over more than 22 million pages of
documents to defense attorneys. Much of the testimony is
expected to be complex and tedious information related to the
sale of tax shelters.
Convictions would energize the government's wide-ranging,
years-long probe into allegedly abusive tax shelters that has
ensnared others, including five current and former executives
from Ernst & Young; led to the closing of Jenkens & Gilchrist, a
large Dallas law firm, and HVB Group, which reached a
deferred-prosecution agreement with prosecutors last year.
Deutsche Bank AG also has come under scrutiny for its role in
the sale of the tax shelters. The bank hasn't been charged but
could reach a settlement with the government, according to a
person familiar with the matter.
The hurdle for prosecutors is that this is the first attempt to
criminalize the tax shelters. The Internal Revenue Service has
long contended that the shelters were improper. A federal judge
overseeing a separate civil case in Texas found that one of the
shelters at issue in the KPMG case was a sham that "lacked
"The question in the trial is whether or not the government can
prove beyond a reasonable doubt that these defendants knew that,
in reality, these transactions had no economic substance and
were never going to have any economic substance, not
withstanding whatever the theoretical potential of the
transactions might have been," said Michael N. Levy, a former
federal prosecutor and now a white-collar defense attorney at
McKee Nelson LLP in Washington.
Prosecutors contend the underlying tax-shelter transactions were
bogus investments designed to generate phony capital losses. In
order to conceal the true nature of the tax shelters from the
IRS, KPMG or a law firm provided clients with opinion letters
containing false and fraudulent representations about the
transactions, the government has alleged.
The four shelters at issue were known as Blips, or bond linked
issue premium structure; Flips, or foreign leveraged investment
program; OPIS, or offshore portfolio investment strategy; and
SOS, or short option strategies. The transactions allegedly
generated millions of dollars in fees and income for KPMG and
others, the government said.
Messrs. Larson, Pfaff, Greenberg and Ruble have been charged
with conspiracy and multiple counts of tax evasion. They have
denied wrongdoing. Attorneys for Messrs. Larson and Pfaff
didn't return calls for comment. Mr. Greenberg's attorney,
Richard Strassberg of Goodwin Procter LLP, said: "We'll be
vigorously defending the case." Mr. Ruble's attorney, Jack
Hoffinger, said, "We're proceeding to trial."
The government's case is expected to be bolstered by the guilty
plea last month of David Amir Makov, a one-time currency and
fixed-income derivatives trader, who said the "sole purpose" of
the Blips shelter was to generate "paper losses" and fees.
Mr. Makov, who pleaded guilty to a single count of conspiracy,
worked as an investment adviser at Presidio Resources Inc., an
investment-advisory firm formed by Messrs. Larson and Pfaff in
1997 after they left KPMG.
Keeping the Jury Awake
The other challenge for the government is to keep its case
simple and easy to understand for jurors. The tax-shelter
transactions are complex and difficult to follow. Look for
prosecutors to emphasize the millions of dollars in fees the
defendants pocketed in an effort to paint them as greedy,
defense attorneys say.
The government removed Justin Weddle, the lead prosecutor on the
case, after running into trouble over the legal-fee issue.
Assistant U.S. Attorney John Hillebrecht was added to the trial
team last year, but veteran prosecutor Shirah Neiman remains
firmly in charge of the legal strategy.
KPMG avoided a criminal indictment that could have put the firm
out of business. Instead, the firm signed a deferred
prosecution agreement in which it admitted to the fraudulent
sale and marketing of the bogus tax shelters and agreed to pay a
$456 million penalty.
Write to Paul Davies at
firstname.lastname@example.org and Chad Bray at