[Senate Prints 108-34]
[From the U.S. Government Publishing Office]


108th Congress                                                  S. Prt.
                            COMMITTEE PRINT                     
 1st Session                                                     108-34
_______________________________________________________________________

                                     



                       U.S. TAX SHELTER INDUSTRY:

                   THE ROLE OF ACCOUNTANTS, LAWYERS,

                      AND FINANCIAL PROFESSIONALS

                        FOUR KPMG CASE STUDIES:

                       FLIP, OPIS, BLIPS, AND SC2

                               __________

                              R E P O R T

                            prepared by the

                             MINORITY STAFF
                                 of the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

         COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE


[GRAPHIC] [TIFF OMITTED] TONGRESS.#13


                    RELEASED IN CONJUNCTION WITH THE
         PERMANENT SUBCOMMITTEE ON INVESTIGATIONS' HEARINGS ON


                         NOVEMBER 18 & 20, 2003

      Printed for the use of the Committee on Governmental Affairs


90-655              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
     Joyce Rechtschaffen, Minority Staff Director and Chief Counsel
                      Amy B. Newhouse, Chief Clerk

                                 ------                                

                 PERMANENT COMMITTEE ON INVESTIGATIONS

                   NORM COLEMAN, Minnesota, Chairman
TED STEVENS, Alaska                  CARL LEVIN, Michigan
GEORGE V. VOINOVICH, Ohio            DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

       Raymond V. Shepherd, III, Staff Director and Chief Counsel
                        Leland Erickson, Counsel
        Elise J. Bean, Minority Staff Director and Chief Counsel
      Robert Roach, Counsel and Chief Investigator to the Minority
                     Laura Stuber, Minority Counsel
                    Brian Plesser, Minority Counsel
         Julie Zelman Davis, Minority Professional Staff Member
            Chris Kramer, Minority Professional Staff Member
                  Beth Merillat-Bianchi, IRS Detailee
                     James Pittrizzi, GAO Detailee
                       Frank Minore, GAO Detailee
                   Jessilyn Cameron, Brookings Fellow
                     Mary D. Robertson, Chief Clerk


                            C O N T E N T S

                                 ------                                
                                                                   Page
I. INTRODUCTION..................................................     1

II. FINDINGS.....................................................     3

III. EXECUTIVE SUMMARY...........................................     5

      A. Developing New Tax Products.............................     7
      B. Mass Marketing Tax Products.............................     8
      C. Implementing Tax Products...............................     9
      D. Avoiding Detection......................................    13
      E. Disregarding Professional Ethics........................    15

IV. RECOMMENDATIONS..............................................    16

V. OVERVIEW OF U.S. TAX SHELTER INDUSTRY.........................    18

      A. Summary of Current Law on Tax Shelters..................    18
      B. U.S. Tax Shelter Industry and Professional Organizations    20

VI. FOUR KPMG CASE HISTORIES.....................................    22

      A. KPMG In General.........................................    22
      B. KPMG's Tax Shelter Activities...........................    24
        (1) Developing New Tax Products..........................    28
        (2) Mass Marketing Tax Products..........................    44
        (3) Implementing Tax Products............................    62
           a. KPMG's Implementation Role.........................    62
           b. Role of Third Parties in Implementing KPMG Tax 
      Products...................................................    71
        (4) Avoiding Detection...................................    91
        (5) Disregarding Professional Ethics.....................   101

APPENDIX A
    CASE STUDY OF BOND LINKED ISSUE PREMIUM STRUCTURE (BLIPS)....   111

APPENDIX B
    CASE STUDY OF S-CORPORATION CHARITABLE CONTRIBUTION STRATEGY 
      (SC2)......................................................   122

APPENDIX C
    OTHER KPMG INVESTIGATIONS OR ENFORCEMENT ACTIONS.............   126

 
                       U.S. TAX SHELTER INDUSTRY:
                   THE ROLE OF ACCOUNTANTS, LAWYERS,
                      AND FINANCIAL PROFESSIONALS

                              ----------                              


       FOUR KPMG CASE STUDIES: FLIP, OPIS, BLIPS, AND SC2

I. Introduction

    In 2002, the U.S. Senate Permanent Subcommittee on 
Investigations of the Committee on Governmental Affairs, at the 
direction of Senator Carl Levin, then its Chairman, initiated 
an in-depth investigation into the development, marketing, and 
implementation of abusive tax shelters by professional 
organizations such as accounting firms, banks, investment 
advisors, and law firms. The information in this Report is 
based upon the ensuing bipartisan investigation conducted 
jointly by the Subcommittee's Democratic and Republican staffs, 
with the support of Subcommittee Chairman Norm Coleman.
    During the course of its investigation, the Subcommittee 
issued numerous subpoenas and document requests, and the 
Subcommittee staff reviewed over 235 boxes, and several 
electronic compact disks, containing hundreds of thousands of 
pages of documents, including tax product descriptions, 
marketing material, transactional documents, manuals, 
memoranda, correspondence, and electronic mail. The 
Subcommittee staff also conducted numerous, lengthy interviews 
with representatives of accounting firms, banks, investment 
advisory firms, and law firms. In addition, the Subcommittee 
staff reviewed numerous statutes, regulations, legal pleadings, 
reports, and legislation, dealing with federal tax shelter law. 
The staff consulted with federal and state agencies and various 
accounting, tax and financial experts, including the U.S. 
Department of the Treasury, U.S. Internal Revenue Service 
(IRS), Public Company Accounting Oversight Board (PCAOB), 
California Franchise Tax Board, tax experts on the staffs of 
the Joint Commission on Taxation, Senate Committee on Finance, 
and House Committee on Ways and Means, various tax 
professionals, and academic experts, and other persons with 
relevant information.
    The evidence reviewed by the Subcommittee establishes that 
the development and sale of potentially abusive and illegal tax 
shelters have become a lucrative business in the United States, 
and professional organizations like major accounting firms, 
banks, investment advisory firms, and law firms have become 
major developers and promoters. The evidence also shows that 
respected professional firms are spending substantial 
resources, forming alliances, and developing the internal and 
external infrastructure necessary to design, market, and 
implement hundreds of complex tax shelters, some of which are 
illegal and improperly deny the U.S. Treasury of billions of 
dollars in tax revenues.
    The term ``tax shelter'' has come to be used in a variety 
of ways depending upon the context. In the broadest sense, a 
tax shelter is a device used to reduce or eliminate the tax 
liability of the tax shelter user. Some tax shelters are 
specific tax benefits explicitly enacted by Congress to advance 
a legitimate endeavor, such as the low income housing tax 
credit. Those types of legitimate tax shelters are not the 
focus of this Report. The tax shelters under investigation by 
the Subcommittee are complex transactions used by corporations 
or individuals to obtain significant tax benefits in a manner 
never intended by the tax code. These transactions have no 
economic substance or business purpose other than to reduce or 
eliminate a person's tax liability. These abusive tax shelters 
can be custom-designed for a single user or prepared as a 
generic ``tax product'' available for sale to multiple clients. 
The Subcommittee investigation focuses on the abusive tax 
shelters sold as generic tax products available to multiple 
clients.
    Under current law, generic tax shelters are not illegal per 
se; they are potentially illegal depending upon how purchasers 
actually use them and calculate their tax liability on their 
tax returns. Over the last 5 years, the IRS has begun 
publishing notices identifying certain generic tax shelters as 
``potentially abusive'' and warning taxpayers that use of such 
``listed transactions'' may lead to an audit and assessment of 
back taxes, interest, and penalties for using an illegal tax 
shelter. As used in this Report, ``potentially abusive'' tax 
shelters are those that come within the scope of an IRS 
``listed transaction,'' while ``illegal'' tax shelters are 
those with respect to which the IRS has taken actual 
enforcement action against taxpayers for violating federal tax 
law.
    The Subcommittee investigation perceives an important 
difference between selling a potentially abusive or illegal tax 
shelter and providing routine tax planning services. None of 
the transactions examined by the Subcommittee derived from a 
request by a specific corporation or individual for tax 
planning advice on how to structure a specific business 
transaction in a tax-efficient way; rather all of the 
transactions examined by the Subcommittee involved generic tax 
products that had been affirmatively developed by a firm and 
then vigorously marketed to numerous, in some cases thousands, 
of potential buyers. There is a bright line difference between 
responding to a single client's tax inquiry and aggressively 
developing and marketing a generic tax shelter product. While 
the tax shelter industry of today may have sprung from the 
former, it is now clearly driven by the latter.
    In order to gain a deeper understanding of the issues, the 
Subcommittee conducted four in-depth case studies examining tax 
products sold by a leading accounting firm, KPMG, to 
individuals or corporations to help them reduce or eliminate 
their U.S. taxes. KPMG is one of the largest accounting firms 
in the world, and it had built a reputation as a respected 
auditor and expert tax advisor. KPMG vigorously denies being a 
tax shelter promoter, but the evidence obtained as a result of 
the Subcommittee investigation is overwhelming in demonstrating 
KPMG's active and, at times, aggressive role in promoting and 
profiting from generic tax products sold to individuals and 
corporations, including tax products later determined by the 
IRS to be potentially abusive or illegal tax shelters.
    Earlier this year, KPMG informed the Subcommittee that it 
maintained an inventory of over 500 ``active tax products'' 
designed to be offered to multiple clients for a fee. The four 
KPMG case studies featured in this Report are the Bond Linked 
Issue Premium Structure (BLIPS), Foreign Leveraged Investment 
Program (FLIP), Offshore Portfolio Investment Strategy (OPIS), 
and the S-Corporation Charitable Contribution Strategy (SC2). 
KPMG sold these four tax products to more than 350 individuals 
from 1997 to 2001. All four generated significant fees for the 
firm, producing total revenues in excess of $124 
million.1 The IRS later determined that three of the 
products, BLIPS, FLIP, and OPIS, were potentially abusive or 
illegal tax shelters, while the fourth, SC2, is still under 
review. As of June 2002, an IRS analysis of just some of the 
tax returns associated with BLIPS, FLIP, and OPIS had 
identified 186 people who had used BLIPS to claim losses on 
their tax returns totaling $4.4 billion, and 57 people who had 
used FLIP or OPIS to claim tax losses of $1.4 billion, for a 
grand total of $5.8 billion.2 Evidence made 
available to the Subcommittee suggests that lost tax revenues 
are also significant, including documents which show that, for 
169 out of 186 BLIPS participants for which information was 
recorded, federal tax revenues were reduced by $1.4 billion.
---------------------------------------------------------------------------
    \1\ Letter dated 9/12/03, from KPMG's legal counsel, Wilkie Farr & 
Gallagher, to the Subcommittee, at 2. According to KPMG information 
provided to the Subcommittee in this letter and a letter dated 8/8/03, 
FLIP was sold to 80 persons, in 63 transactions, and produced total 
gross revenues for the firm of about $17 million over a 4-year period, 
1996-1999. OPIS was sold to 111 persons in 79 transactions, and 
produced about $28 million over a 2-year period, 1998-1999. BLIPS, the 
largest revenue generator, was sold to 186 persons in 186 transactions, 
and produced about $53 million over a 1-year period from about October 
1999 to about October 2000. SC2 was sold to 58 S corporations in 58 
transactions, and produced about $26 million over an 18-month period 
from about March 2000 to about September 2001. Other information 
presented to the Subcommittee suggests these revenue figures may be 
understated and that, for example, BLIPS generated closer to $80 
million in fees for the firm, OPIS generated over $50 million, and SC2 
over $30 million.
    \2\ United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), 
``Declaration of Michael A. Halpert,'' Internal Revenue Agent, at para. 
37.
---------------------------------------------------------------------------
    Some members of the U.S. tax profession are apparently 
claiming that the worst tax shelter abuses are already over, so 
there is no need for investigations, reforms, or stronger laws. 
The Subcommittee investigation, however, indicates just the 
opposite: while a few tax shelter promoters have ended their 
activities, the tax shelter industry as a whole remains active, 
developing new products, marketing dubious tax shelters to 
numerous individuals and corporations, and continuing to 
wrongfully deny the U.S. Treasury billions of dollars in 
revenues, leaving average U.S. taxpayers to make up the 
difference.

II. Findings

    Based upon its investigation to date, the Subcommittee 
Minority staff recommends that the Subcommittee make the 
following findings of fact.

        (1)  The sale of potentially abusive and illegal tax 
        shelters has become a lucrative business in the United 
        States, and some professional firms such as accounting 
        firms, banks, investment advisory firms, and law firms 
        are major participants in the mass marketing of generic 
        ``tax products'' to multiple clients.

        (2)  Although KPMG denies being a tax shelter 
        promoter, the evidence establishes that KPMG has 
        devoted substantial resources to, and obtained 
        significant fees from, developing, marketing, and 
        implementing potentially abusive and illegal tax 
        shelters that U.S. taxpayers might otherwise have been 
        unable, unlikely or unwilling to employ, costing the 
        Treasury billions of dollars in lost tax revenues.

        (3)  KPMG devotes substantial resources and maintains 
        an extensive infrastructure to produce a continuing 
        supply of generic tax products to sell to multiple 
        clients, using a process which pressures its tax 
        professionals to generate new ideas, move them quickly 
        through the development process, and approve, at times, 
        potentially abusive or illegal tax shelters.

        (4)  KPMG uses aggressive marketing tactics to sell 
        its generic tax products, including by turning tax 
        professionals into tax product salespersons, pressuring 
        its tax professionals to meet revenue targets, using 
        telemarketing to find clients, using confidential 
        client tax data to identify potential buyers, targeting 
        its own audit clients for sales pitches, and using tax 
        opinion letters and insurance policies as marketing 
        tools.

        (5)  KPMG is actively involved in implementing the tax 
        shelters which it sells to its clients, including by 
        enlisting participation from banks, investment advisory 
        firms, and tax exempt organizations; preparing 
        transactional documents; arranging purported loans; 
        issuing and arranging opinion letters; providing 
        administrative services; and preparing tax returns.

        (6)  Some major banks and investment advisory firms 
        have provided critical lending or investment services 
        or participated as essential counter parties in 
        potentially abusive or illegal tax shelters sold by 
        KPMG, in return for substantial fees or profits.

        (7)  Some law firms have provided legal services that 
        facilitated KPMG's development and sale of potentially 
        abusive or illegal tax shelters, including by providing 
        design assistance or collaborating on allegedly 
        ``independent'' opinion letters representing to clients 
        that a tax product would withstand an IRS challenge, in 
        return for substantial fees.

        (8)  Some charitable organizations have participated 
        as essential counter parties in a highly questionable 
        tax shelter developed and sold by KPMG, in return for 
        donations or the promise of future donations.

        (9)  KPMG has taken steps to conceal its tax shelter 
        activities from tax authorities and the public, 
        including by refusing to register potentially abusive 
        tax shelters with the IRS, restricting file 
        documentation, and using improper tax return reporting 
        techniques.

III. Executive Summary

    The Subcommittee's investigation into the role of 
professional organizations in the tax shelter industry has 
identified two fundamental, relatively recent changes in how 
the industry operates.
    First, the investigation has found that the tax shelter 
industry is no longer focused primarily on providing 
individualized tax advice to persons who initiate contact with 
a tax advisor. Instead, the industry focus has expanded to 
developing a steady supply of generic ``tax products'' that can 
be aggressively marketed to multiple clients. In short, the tax 
shelter industry has moved from providing one-on-one tax advice 
in response to tax inquiries to also initiating, designing, and 
mass marketing tax shelter products.
    Secondly, the investigation has found that numerous 
respected members of the American business community are now 
heavily involved in the development, marketing, and 
implementation of generic tax products whose objective is not 
to achieve a business or economic purpose, but to reduce or 
eliminate a client's U.S. tax liability. Dubious tax shelter 
sales are no longer the province of shady, fly-by-night 
companies with limited resources. They are now big business, 
assigned to talented professionals at the top of their fields 
and able to draw upon the vast resources and reputations of the 
country's largest accounting firms, law firms, investment 
advisory firms, and banks.
    The four case studies featured in this Report examine tax 
products developed by KPMG, a respected auditor and tax expert 
and one of the top four accounting firms in the United States. 
In the latter half of the 1990's, according to KPMG employees 
interviewed by Subcommittee staff, KPMG's Tax Services Practice 
underwent a fundamental change in direction by embracing the 
development of generic tax products and pressing its tax 
professionals to sell them. KPMG now maintains an inventory of 
more than 500 active tax products and routinely presses its tax 
professionals to participate in tax product marketing 
campaigns.
    Three of the tax products examined by the Subcommittee, 
FLIP, OPIS, and BLIPS, are similar in nature. In fact, BLIPS 
was developed as a replacement for OPIS which was developed as 
a replacement for FLIP.3 All three tax products 
function as ``loss generators,'' meaning they generate large 
paper losses that the purchaser of the product then uses to 
offset other income, and shelter it from taxation.4 
All three products have generated hundreds of millions of 
dollars in phony paper losses for taxpayers, using a series of 
complex, orchestrated transactions involving shell 
corporations, structured finance, purported multi-million 
dollar loans, and deliberately obscure investments.5 
All three also generated substantial fees for KPMG, with BLIPS 
and OPIS winning slots among KPMG's top ten revenue producers 
in 1999 and 2000, before sales were discontinued. All three tax 
products are also covered by the ``listed transactions'' that 
the IRS has published and declared to be potentially abusive 
tax shelters.6 In all three cases, the IRS has 
already begun requiring taxpayers who used these products to 
pay back taxes, interest, and penalties. Over a dozen taxpayers 
penalized by the IRS for using these tax products have 
subsequently filed suit against KPMG for selling them an 
illegal tax shelter.7
---------------------------------------------------------------------------
    \3\ See, e.g., document dated 5/18/01, ``PFP Practice 
Reorganization Innovative Strategies Business Plan--DRAFT,'' authored 
by Jeffrey Eischeid, Bates KPMG 0050620-23, at 1.
    \4\ Id. See also document dated 7/21/99, entitled ``Action 
Required,'' authored by Jeffrey Eischeid, Bates KPMG 0006664 (In the 
case of BLIPS, ``a key objective is for the tax loss associated with 
the investment structure to offset/shelter the taxpayer's other, 
unrelated, economic profits.'').
    \5\ See Appendix A for a more detailed explanation of BLIPS.
    \6\ FLIP and OPIS are covered by IRS Notice 2001-45 (2001-33 IRB 
129) (8/13/01); while BLIPS is covered by IRS Notice 2000-44 (2000-36 
IRB 255) (9/5/00). See also United States v. KPMG, Case No. 1:02MS00295 
(D.D.C. 9/6/02).
    \7\ See, e.g., Jacoboni v. KPMG, Case No. 6:02-CV-510 (M.D. Fla. 4/
29/02) (OPIS); Swartz v. KPMG, Case No. C03-1252 (W.D. Wash. 6/6/03) 
(BLIPS); Thorpe v. KPMG, Case No. 5-030CV-68 (E.D.N.C. 1/27/03) (FLIP/
OPIS).
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    The fourth tax product, SC2, is described by KPMG as a 
``charitable contribution strategy.'' 8 It is 
directed at individuals who own profitable corporations 
organized under Chapter S of the tax code (hereinafter ``S 
corporations''), which means that the corporation's income is 
attributed directly to the corporate owners and taxable as 
personal income. SC2 is intended to generate a tax deductible 
charitable donation for the corporate owner and, more 
importantly, to defer and reduce taxation of a substantial 
portion of the income produced by the S corporation, 
essentially by ``allocating'' but not actually distributing 
that income to a tax exempt charity holding the corporation's 
stock. Like BLIPS, FLIP, and OPIS, SC2 requires a series of 
complex, orchestrated transactions to obtain the promised tax 
benefits. Among other measures, these transactions involve the 
issuance of non-voting stock and warrants, a corporate non-
distribution resolution, and a stock redemption agreement; a 
temporary donation of the non-voting stock to a charity; and 
various steps to ``allocate'' but not distribute corporate 
income to the tax exempt charity.9 Early in its 
development, KPMG tax professionals referred to SC2 as ``S-
CAEPS,'' pronounced ``escapes.'' The name was changed after a 
senior tax official pointed out: ``I think the last thing we or 
a client would want is a letter in the files regarding a tax 
planning strategy for which the acronym when pronounced sounds 
like we are saying `escapes.' '' 10 In 2000 and 
2001, SC2 was one of KPMG's top ten revenue producers. SC2 is 
not covered by one of the ``listed transactions'' issued by the 
IRS, but is currently undergoing IRS review.11
---------------------------------------------------------------------------
    \8\ The formal title of the tax product is the S-Corporation 
Charitable Contribution Strategy.
    \9\ See Appendix B for a more detailed explanation of SC2.
    \10\ Email dated 3/24/00, from Mark Springer to multiple KPMG tax 
professionals, ``RE: S-corp Product,'' Bates KPMG 0016515. See also 
email dated 3/24/00, from Mark Springer to multiple KPMG tax 
professionals, ``Re: S-corp Product,'' Bates 0016524 (suggesting 
replacing ``all S-CAEPS references with something much more benign'').
    \11\ See email dated 4/10/02, from US-Tax Innovation Center to 
multiple KPMG tax professionals, ``IRS Summons Information Request for 
SC2,'' Bates XX 001433 (``The IRS has requested certain information 
from the Firm related to SC2.''); undated KPMG document entitled, 
``April 18 IRS Summons Response.''
---------------------------------------------------------------------------
    Together, these four case histories, BLIPS, FLIP, OPIS, and 
SC2, provide an in-depth portrait of how a professional 
organization like KPMG, and the professional organizations it 
allies itself with, end up developing, marketing, and 
implementing highly questionable or illegal tax products. The 
evidence also sheds light on the critical roles played by other 
professional organizations to make suspect tax products work.

A. Developing New Tax Products

    The Subcommittee investigation has found that the tax 
product development and approval process used at KPMG was 
deeply flawed and led, at times, to the approval of tax 
products that the firm knew were potentially abusive or 
illegal. Among other problems, the evidence shows that the KPMG 
approval process has been driven by market considerations, such 
as consideration of a product's revenue potential and ``speed 
to market,'' as well as by intense pressure that KPMG 
supervisors have placed on subordinates to ``sign-off'' on the 
technical merits of a proposed product even in the face of 
serious questions about its compliance with the law.
    The case of BLIPS illustrates the problems. Evidence 
obtained by the Subcommittee discloses an extended, unresolved 
debate among KPMG tax professionals over whether BLIPS met the 
technical requirements of federal tax law. In 1999, the key 
KPMG technical reviewer resisted approving BLIPS for months, 
despite repeated expressions of dismay from superiors. He 
finally agreed to withdraw his objections to the product in 
this email sent to his supervisor: ``I don't like this product 
and would prefer not to be associated with it [but] I can 
reluctantly live with a more-likely-than-not opinion being 
issued for the product.'' This assessment is not exactly the 
solid endorsement that might be expected for a tax product sold 
by a major accounting firm.
    The most senior officials in KPMG's Tax Services Practice 
exchanged emails which frankly acknowledged the problems and 
reputational risks associated with BLIPS, but nevertheless 
supported putting it on the market for sale to clients. One 
senior tax professional summed up the pending issues with two 
questions:

        ``(1) Have we drafted the opinion with the appropriate 
        limiting bells and whistles . . . and (2) Are we being 
        paid enough to offset the risks of potential litigation 
        resulting from the transaction? . . . My own 
        recommendation is that we should be paid a lot of money 
        here for our opinion since the transaction is clearly 
        one that the IRS would view as falling squarely within 
        the tax shelter orbit.''

    No one challenged the analysis that the risky nature of the 
product justified the firm's charging ``a lot of money'' for a 
tax opinion letter predicting it was more likely than not that 
BLIPS would withstand an IRS challenge. When the same KPMG 
official observed, ``I do believe the time has come to shit and 
get off the pot,'' the second in command at the Tax Services 
Practice responded, ``I believe the expression is shit OR get 
off the pot, and I vote for shit.''
    BLIPS, like its predecessors OPIS and FLIP, was sold by 
KPMG to numerous clients before the IRS issued notices 
declaring them potentially abusive tax shelters that did not 
meet the requirements of federal tax law. Other professional 
firms have also sold potentially abusive or illegal tax 
products such as the Currency Options Brings Reward 
Alternatives (COBRA) and Contingent Deferred Swap (CDS) sold by 
Ernst & Young, the FLIP tax product and Bond and Option Sales 
Strategy (BOSS) sold by PricewaterhouseCoopers, the Customized 
Adjustable Rate Debt Facility (CARDS) sold by Deutsche Bank, 
the FLIP tax product sold by Wachovia Bank, and the Slapshot 
tax product sold by J.P. Morgan Chase.12 The sale of 
these abusive tax shelters by other firms clearly demonstrates 
that flawed approval procedures are not confined to a single 
firm or a single profession. Many other professional firms are 
also developing and selling dubious tax products.
---------------------------------------------------------------------------
    \12\ Slapshot is an abusive tax shelter that was examined in a 
Subcommittee hearing last year. See ``Fishtail, Bacchus, Sundance, and 
Slapshot: Four Enron Transactions Funded and Facilitated by U.S. 
Financial Institutions,'' S. Prt. 107-82 (107th Congress 1/2/03).
---------------------------------------------------------------------------

B. Mass Marketing Tax Products

    A second striking aspect of the Subcommittee investigation 
was the discovery of the substantial effort KPMG has expended 
to market its tax products to potential buyers. The 
investigation found that KPMG maintains an extensive marketing 
infrastructure to sell its tax products, including a market 
research department, a Sales Opportunity Center that works on 
tax product ``marketing strategies,'' and even a full-fledged 
telemarketing center staffed with people trained to make cold 
calls to find buyers for specific tax products. When 
investigating SC2, the Subcommittee discovered that KPMG used 
its telemarketing center in Fort Wayne, Indiana, to contact 
literally thousands of S corporations across the country and 
help elevate SC2 to one of KPMG's top ten revenue-producing tax 
products.
    The evidence also uncovered a corporate culture in KPMG's 
Tax Services Practice that condoned placing intense pressure on 
the firm's tax professionals--CPAs and lawyers included--to 
sell the firm's generic tax products. Numerous internal emails 
by senior KPMG tax professionals exhorted colleagues to 
increase their sales efforts. One email thanked KPMG tax 
professionals for a team effort in developing SC2 and then 
instructed these professionals to ``SELL, SELL, SELL!!'' 
Another email warned KPMG partners: ``Look at the last partner 
scorecard. Unlike golf, a low number is not a good thing. . . . 
A lot of us need to put more revenue on the board.'' A third 
email asked all partners in KPMG's premier technical tax group, 
Washington National Tax (WNT), to ``temporarily defer non-
revenue producing activities'' and concentrate for the ``next 5 
months'' on meeting WNT's revenue goals for the year. The email 
stated: ``Listed below are the tax products identified by the 
functional teams as having significant revenue potential over 
the next few months. . . . Thanks for help in this critically 
important matter. As [the Tax Services Practice second in 
command] said, `We are dealing with ruthless execution--hand to 
hand combat--blocking and tackling.' Whatever the mixed 
metaphor, let's just do it.''
    The four case studies featured in this Report provide 
detailed evidence of how KPMG pushed its tax professionals to 
meet revenue targets, closely monitored their sales efforts, 
and even, at times, advised them to use questionable sales 
techniques. For example, in the case of SC2, KPMG tax 
professionals were directed to contact existing clients about 
the product, including KPMG's own audit clients. In a written 
document offering sales advice on SC2, KPMG advised its 
employees, in some cases, to make misleading statements to 
potential buyers, such as claiming that SC2 was no longer 
available for sale, even though it was, apparently hoping that 
reverse psychology would then cause the client to want to buy 
the product. KPMG also utilized confidential and sensitive 
client data in an internal database containing information used 
by KPMG to prepare client tax returns in order to identify 
potential targets for its tax products.
    KPMG also used opinion letters and insurance policies as 
selling points to try to convince uncertain buyers to purchase 
a tax product. For example, KPMG tax professionals were 
instructed to tell potential buyers that opinion letters 
provided by KPMG and Sidley Austin Brown & Wood would protect 
the buyer from certain IRS penalties, if the IRS were later to 
invalidate the tax product. In the case of SC2, KPMG tax 
professionals were instructed to tell buyers that, ``for a 
small premium,'' they could buy an insurance policy from AIG, 
Hartford Insurance, or another firm that would reimburse the 
buyer for any back taxes or penalties actually assessed by the 
IRS for using the tax product. These selling points suggest 
KPMG was trying to present its tax products as a risk free 
gambit for its clients. They also suggest that KPMG was 
pitching its tax products to persons with limited interest in 
the products and who likely would not have used them to avoid 
paying their taxes, absent urging by KPMG to do so.

C. Implementing Tax Products

    Developing and selling a tax product to a client did not, 
in many cases, end KPMG's involvement with the product, since 
the product often required the purchaser to carry out complex 
financial and investment activities in order to realize the 
promised tax benefits. In the four cases examined by the 
Subcommittee, KPMG enlisted a bevy of other professionals, 
including lawyers, bankers, investment advisors and others, to 
carry out the required transactions. In the case of SC2, KPMG 
actively found and convinced various charitable organizations 
to participate. Charities told the Subcommittee staff that KPMG 
had contacted the organizations ``out of the blue,'' convinced 
them to participate in SC2, facilitated interactions with the 
SC2 ``donors,'' and supplied drafts of the transactional 
documents.
    The Subcommittee investigation found that BLIPS, OPIS, 
FLIP, and SC2 could not have been executed without the active 
and willing participation of the law firms, banks, investment 
advisory firms, and charitable organizations that made these 
products work. In the case of BLIPS, OPIS, and FLIP, law firms 
and investment advisory firms helped draft complex 
transactional documents. Major banks, such as Deutsche Bank, 
HVB, UBS, and NatWest, provided purported loans for tens of 
millions of dollars essential to the orchestrated transactions. 
Wachovia Bank initially provided client referrals to KPMG for 
FLIP sales, then later began its own efforts to sell FLIP to 
clients. Two investment advisory firms, Quellos Group LLC 
(``Quellos'') and Presidio Advisory Services (``Presidio''), 
participated directly in the FLIP, OPIS, or BLIPS transactions, 
even entering into partnerships with the clients. In the case 
of SC2, several pension funds agreed to accept corporate stock 
donations and sign redemption agreements to ``sell'' back the 
stock to the corporation after a specified period of time. In 
all four cases, Sidley Austin Brown & Wood agreed to provide a 
legal opinion letter attesting to the validity of the relevant 
tax product. Other law firms, such as Sherman and Sterling, 
prepared transactional documents and helped carry out specific 
transactions. In return, each of the professional firms was 
paid lucrative fees.
    In the case of BLIPS, documents and interviews showed that 
banks and investment advisory firms knew the BLIPS transactions 
and ``loans'' were structured in an unusual way, had no 
reasonable potential for profit, and were designed instead to 
achieve specific tax aims for KPMG clients. For example, the 
BLIPS transactions required the bank to lend, on a non-recourse 
basis, tens of millions of dollars to a shell corporation with 
few assets and no ongoing business, to give the same shell 
corporation an unusual ``loan premium'' providing additional 
tens of millions of dollars, and to enter into interest rate 
swaps that, in effect, reduced the ``loan's'' above-market 
interest rate to a much lower floating market rate.
    Documents and interviews also disclosed that the funds 
``loaned'' by the banks were never really put at risk. The so-
called loan proceeds were instead deemed ``collateral'' for the 
``loan'' itself under an ``overcollateralization'' provision 
that required the ``borrower'' to place 101% of the loan 
proceeds on deposit with the bank. The loan proceeds serving as 
cash collateral were then subject to severe investment 
restrictions and closely monitored by the bank. The end result 
was that only a small portion of the funds in each BLIPS 
transaction was ever placed at risk in true investments. 
Moreover, the banks were empowered to unilaterally terminate a 
BLIPS ``loan'' under a variety of circumstances including, for 
example, if the cash collateral were to fall below the 101% 
requirement. The banks and investment advisory firms knew that 
the BLIPS loan structure and investment restrictions made 
little economic sense apart from the client's tax objectives, 
which consisted primarily of generating huge paper losses for 
KPMG clients who then used those losses to offset other income 
and shelter it from taxation.
    Documents and interviews showed that the same circumstances 
existed for the FLIP and OPIS transactions--banks and 
investment advisory firms financed and participated in 
structured and tightly controlled financial transactions and 
``loans'' primarily designed to generate tax losses on paper 
for clients, while protecting bank assets.
    A professional organization that knowingly participates in 
an abusive tax shelter with no real economic substance violates 
the tax code's prohibition against aiding or abetting tax 
evasion.13 A related issue is whether and to what 
extent lawyers, bankers, investment advisors, tax exempt 
organizations, and others have an obligation to evaluate the 
transactions they are asked to carry out and refrain from 
participating in potentially abusive or illegal tax shelters. 
Another issue is whether professional organizations that 
participate in these types of transactions qualify as tax 
shelter promoters and, if so, are obliged under U.S. law to 
register the relevant transactions as tax shelters and maintain 
client lists.
---------------------------------------------------------------------------
    \13\ 26 U.S.C. 6701.
---------------------------------------------------------------------------
    These issues are particularly pressing for several 
professional firms involved in the KPMG transactions that may 
be tax shelter promoters in their own right. For example, 
Sidley Austin Brown & Wood is under investigation by the IRS 
for issuing more than 600 legal opinion letters supporting 13 
questionable tax products, including BLIPS, FLIP, and 
OPIS.14 Deutsche Bank has sponsored a Structured 
Transactions Group that, in 1999, offered an array of tax 
products to U.S. and European clients seeking to ``execute tax 
driven deals'' or ``gain mitigation'' strategies.15 
Internal bank documents indicate that Deutsche Bank was 
aggressively marketing its tax products to large U.S. 
corporations and individuals, and planned to close billions of 
dollars worth of transactions.16 At least two of the 
tax products being pushed by Deutsche Bank, BLIPS and the 
Customized Adjustable Rate Debt Facility (CARDS), were later 
determined by the IRS to be potentially abusive tax shelters.
---------------------------------------------------------------------------
    \14\ See ``Declaration of Richard E. Bosch,'' IRS Revenue Agent, In 
re John Doe Summons to Sidley Austin Brown & Wood (N.D. Ill. 10/16/03).
    \15\ Email dated 4/3/02, from Viktoria Antoniades to Brian McGuire 
and other Deutsche Bank personnel, ``US GROUP 1 Pres,'' DB BLIPS 6329-
52, attaching a presentation dated 11/15/99, entitled ``Structured 
Transactions Group North America,'' at 6336.
    \16\ Id. at 6345-46.
---------------------------------------------------------------------------
    Another set of issues arising from KPMG's enlistment of 
other professionals to implement its tax products involves the 
role played by tax opinion letters. A tax opinion letter, 
sometimes called a legal opinion letter when issued by a law 
firm, is intended to provide written advice to a client on 
whether a particular tax product is permissible under the law 
and, if challenged by the IRS, how likely it would be that the 
challenged product would survive court scrutiny. Traditionally, 
such opinion letters were supplied by an independent tax expert 
with no financial stake in the transaction being evaluated, and 
an individualized letter was sent to a single client. The mass 
marketing of tax products to multiple clients, however, has 
been followed by the mass production of opinion letters by a 
professional firm that, for each letter sent to a client, is 
paid a handsome fee. The attractive profits available from such 
an arrangement have placed new pressure on the independence of 
the tax opinion letter provider.
    In the four case histories featured in this Report, the 
Subcommittee investigation uncovered disturbing evidence 
related to how tax opinion letters were being developed and 
used in connection with KPMG's tax products. In each of the 
four case histories, the Subcommittee investigation found that 
KPMG had drafted its own prototype tax opinion letter 
supporting the product and used this prototype as a template 
for the letters it actually sent to its clients. In addition, 
in all four case histories, KPMG arranged for an outside law 
firm to provide a second favorable opinion letter. Sidley 
Austin Brown & Wood, for example, issued hundreds of opinion 
letters supporting BLIPS, FLIP, and OPIS.17 The 
evidence indicates that KPMG either directed its clients to 
Sidley Austin Brown & Wood to obtain the second opinion letter, 
or KPMG itself obtained the client's opinion letter from the 
law firm and delivered it to the client, apparently without the 
client's actually speaking to any of the lawyers at the firm.
---------------------------------------------------------------------------
    \17\ In the case of SC2, KPMG also arranged for Bryan Cave to issue 
a legal opinion supporting the tax product, but it is unclear whether 
Bryan Cave ever issued one.
---------------------------------------------------------------------------
    The evidence raises serious questions about the independent 
status of Sidley Austin Brown & Wood in issuing the legal 
opinion letters supporting the KPMG tax products. The evidence 
indicates, for example, that KPMG collaborated with the law 
firm ahead of time to ensure it would supply a favorable 
opinion letter. In the case of BLIPS, KPMG and Sidley Austin 
Brown & Wood actually exchanged copies of their drafts, 
eventually issuing two, allegedly independent opinion letters 
that contain numerous, virtually identical paragraphs. 
Moreover, Sidley Austin Brown & Wood provided FLIP, OPIS, and 
BLIPS clients with nearly identical opinion letters that 
included no individualized legal advice. In many cases, the law 
firm apparently issued its letter without ever speaking with 
the client to whom the tax advice was directed. By routinely 
directing its clients to Sidley Austin Brown & Wood to obtain a 
second opinion letter, KPMG produced a steady stream of income 
for the law firm, further undermining its independent status. 
One document even indicates that Sidley Austin Brown & Wood was 
paid a fee in every case in which a client was told during a 
FLIP sales pitch about the availability of a second opinion 
letter from an outside law firm, whether or not the client 
actually purchased the letter. This type of close, ongoing, and 
lucrative collaboration raises serious questions about the 
independence of both parties and the value of their opinion 
letters in light of the financial stake that both firms had in 
the sale of the tax product being analyzed.
    A second set of issues related to the tax opinion letters 
involves the accuracy and reliability of their factual 
representations. The tax opinion letters prepared by KPMG and 
Sidley Austin Brown & Wood in BLIPS, FLIP, and OPIS typically 
included a set of factual representations made by the client, 
KPMG, the participating investment advisory firm, and the 
participating bank. These representations were critical to the 
accounting firm's analysis upholding the validity of the tax 
product. In all three cases, the Subcommittee investigation 
discovered that KPMG had itself drafted the factual 
representations attributed to other parties. The evidence shows 
that prior to attributing factual representations to other 
professional firms involved in the transactions, KPMG presented 
draft statements to the parties beforehand and negotiated the 
wording. But in the case of the factual representations 
attributed to its client, the evidence indicates KPMG did not 
consult with the client beforehand and, in some cases, even 
refused, despite client objections, to allow the client to 
alter the KPMG-drafted representations.
    Equally disturbing is that some of the key factual 
representations that KPMG made or attributed to its clients 
appear to contain false or misleading statements. For example, 
KPMG wrote in the prototype BLIPS opinion letter that the 
client ``has represented to KPMG . . . [that the client] 
independently reviewed the economics underlying the [BLIPS] 
Investment Fund before entering into the program and believed 
there was a reasonable opportunity to earn a reasonable pre-tax 
profit from the transactions.'' In fact, it is doubtful that 
many BLIPS clients ``independently reviewed'' or understood the 
complicated BLIPS transactions or the ``economics'' underlying 
them. In addition, KPMG knew there was only a remote 
possibility--not a reasonable possibility--of a client's 
earning a pre-tax profit in BLIPS. Nevertheless, since the 
existence of a reasonable opportunity to earn a reasonable 
profit was central to BLIPS' having economic substance and 
complying with federal tax law, KPMG included the client 
representation in its BLIPS tax opinion letter.

D. Avoiding Detection

    In addition to the many development, marketing, and 
implementation problems just described, the Subcommittee 
investigation uncovered disturbing evidence of measures taken 
by KPMG to hide its tax product activities from the IRS and the 
public. Despite its 500 active tax product inventory, KPMG has 
never registered, and thereby disclosed to the IRS the 
existence of, a single one of its tax products. KPMG has 
explained this failure by claiming that it is not a tax 
promoter and does not sell any tax products that have to be 
registered under the law. The evidence suggests, however, that 
KPMG's failure to register may not be attributable to a good 
faith analysis of the technical merits of the tax products.
    Five years ago, in 1998, a senior KPMG tax professional 
advocated in very explicit terms that, for business reasons, 
KPMG ought to ignore federal tax shelter requirements and not 
register the OPIS tax product with the IRS, even if required by 
law. In an email sent to several senior colleagues, this KPMG 
tax professional explained his reasoning. In that email, he 
assumed that OPIS qualified as a tax shelter, and then 
explained why the firm should not, even in this case, register 
it with the IRS as required by law. Among other reasons, he 
observed that the IRS was not vigorously enforcing the 
registration requirement, the penalties for noncompliance were 
much less than the potential profits from selling the tax 
product, and ``industry norms'' were not to register any tax 
products at all. The KPMG tax professional coldly calculated 
the penalties for noncompliance compared to potential fees from 
selling OPIS: ``Based upon our analysis of the applicable 
penalty sections, we conclude that the penalties would be no 
greater than $14,000 per $100,000 in KPMG fees. . . . For 
example, our average [OPIS] deal would result in KPMG fees of 
$360,000 with a maximum penalty exposure of only $31,000.'' The 
senior tax professional also warned that if KPMG were to comply 
with the tax shelter registration requirement, this action 
would place the firm at such a competitive disadvantage in its 
sales that KPMG would ``not be able to compete in the tax 
advantaged products market.'' In short, he urged KPMG to 
knowingly, purposefully, and willfully violate the federal tax 
shelter law.
    The evidence obtained by the Subcommittee indicates that, 
over the following 5 years, KPMG rejected several internal 
recommendations by tax professionals to register a tax product 
as a tax shelter with the IRS. For example, the Subcommittee 
investigation learned that, on at least two occasions, the head 
of KPMG's Department of Professional Practice, a very senior 
tax official, had recommended that BLIPS and OPIS be registered 
as tax shelters, only to be overruled each time by the head of 
the entire Tax Services Practice.
    Instead of registering tax products with the IRS, KPMG 
instead apparently devoted resources to devising rationales for 
not registering them. For example, a fiscal year 2002 draft 
business plan for a KPMG tax group described two tax products 
that were under development, but not yet approved, in part due 
to tax shelter registration issues. With respect to the first 
product, POPS, the business plan stated: ``We have completed 
the solution's technical review and have almost finalized the 
rationale for not registering POPS as a tax shelter.'' With 
respect to the second product, described as a ``conversion 
transaction . . . that halves the taxpayer's effective tax rate 
by effectively converting ordinary income to long term capital 
gain,'' the business plan states: ``The most significant open 
issue is tax shelter registration and the impact registration 
will have on the solution.''
    KPMG's concealment efforts did not stop with its years-long 
refusal to register any tax shelter with the IRS. KPMG also 
appears to have used improper reporting techniques on client 
tax returns to minimize the return information that could alert 
the IRS to the existence of its tax products. For example, in 
the case of OPIS and BLIPS, some KPMG tax professionals advised 
their clients to participate in the transactions through 
``grantor trusts'' and then file tax returns in which all of 
the capital gains and losses from the transactions were 
``netted'' at the grantor trust level, instead of each gain or 
loss being reported individually on the return. The intended 
result was that only a single, small net capital gain or loss 
would appear on the client's personal income tax return.
    A key KPMG tax expert objected to this netting approach 
when it was first suggested within the firm in 1998, writing to 
his colleagues in one email: ``When you put the OPIS 
transaction together with this `stealth' reporting approach, 
the whole thing stinks.'' He wrote in a separate email: ``You 
should all know that I do not agree with the conclusion . . . 
that capital gains can be netted at the trust level. I believe 
we are filing misleading, and perhaps false, returns by taking 
this reporting position.'' Despite these strongly worded emails 
from the KPMG tax professional with authority over this tax 
return issue, several KPMG tax professionals apparently went 
ahead and prepared client tax returns using grantor trust 
netting. In September 2000, in the same notice that declared 
BLIPS to be a potentially abusive tax shelter, the IRS 
explicitly warned against grantor trust netting: ``In addition 
to other penalties, any person who willfully conceals the 
amount of capital gains and losses in this manner, or who 
willfully counsels or advises such concealment, may be guilty 
of a criminal offense.'' In response, KPMG apparently contacted 
some OPIS or BLIPS clients and advised them to re-file their 
returns.
    KPMG used a variety of tax return reporting techniques in 
addition to grantor trust netting to avoid detection of its 
activities by the IRS. In addition, in the four cases examined 
by the Subcommittee, KPMG required some potential purchasers of 
the tax products to sign ``nondisclosure agreements'' and 
severely limited the paperwork used to explain the tax 
products. Client presentations were done on chalkboards or 
erasable whiteboards, and written materials were retrieved from 
clients before leaving a meeting. Another measure taken by 
senior KPMG tax professionals was to counsel staff not to keep 
certain revealing documentation in their files or to clean out 
their files, again, to limit detection of firm activity. Still 
another tactic discussed in several KPMG documents was 
explicitly using attorney-client or other legal privileges to 
limit disclosure of KPMG documents. For example, one 
handwritten document by a KPMG tax professional discussing OPIS 
issues states under the heading, ``Brown & Wood'': ``Privilege 
B&W can play a big role at providing protection in this area.'' 
None of these actions to conceal its activities seems 
consistent with what should be the practices of a leading 
public accounting firm.

E. Disregarding Professional Ethics

    In addition to all the other problems identified in the 
Subcommittee investigation, troubling evidence emerged 
regarding how KPMG handled certain professional ethics issues, 
including issues related to fees and auditor independence. The 
fees charged to KPMG clients raise several concerns. Some 
appear to be ``contingency fees,'' meaning fees which are paid 
only if a client obtains specified results from the services 
offered, such as achieving specified tax savings. More than 20 
states prohibit the payment of contingency fees to accountants, 
and SEC, AICPA, and other rules constrain their use in various 
ways. Internal KPMG documents suggest that, in at least some 
cases, KPMG deliberately manipulated the way it handled certain 
tax products to circumvent contingency fee prohibitions. A 
document discussing OPIS fees, for instance, identifies the 
states that prohibit contingency fees and, then, rather than 
prohibit OPIS transactions in those states or require an 
alternative fee structure, directs KPMG tax professionals to 
make sure the OPIS engagement letter is signed, the engagement 
is managed, and the bulk of services is performed ``in a 
jurisdiction that does not prohibit contingency fees.''
    In the case of BLIPS, clients were charged a single fee 
equal to 7% of the ``tax losses'' to be generated by the BLIPS 
transactions. The client fee was typically paid to Presidio, an 
investment advisory firm, which then apportioned the fee amount 
among various firms according to certain factors. The fee 
recipients typically included KPMG, Presidio, a participating 
bank, and Sidley Austin Brown & Wood. This fee splitting 
arrangement may violate restrictions on contingency fees, 
client referral fees, and fees paid jointly to lawyers and non-
lawyers.
    KPMG's tax products also raise auditor independence issues. 
Three of the banks involved in BLIPS, FLIP, and OPIS (Deutsche 
Bank, HVB, and Wachovia Bank), employ KPMG to audit their 
financial statements. SEC rules state that auditor independence 
is impaired when an auditor has a direct or material indirect 
business relationship with an audit client. KPMG apparently 
attempted to address the auditor independence issue by giving 
its clients a choice of banks to use in the transactions, 
including at least one bank that was not a KPMG audit client. 
It is unclear, however, whether individuals actually could 
choose what bank to use. Moreover, it is unclear how providing 
clients with a choice of banks alleviated KPMG's conflict of 
interest, since it still had a direct or material, indirect 
business relationship with a bank whose financial statements 
were certified by KPMG auditors.
    A second set of auditor independence issues involves KPMG's 
decision to market tax products to its own audit clients. By 
engaging in this marketing tactic, KPMG not only took advantage 
of its auditor-client relationship, but also created a conflict 
of interest in those cases where it successfully sold a tax 
product to an audit client. The conflict of interest arises 
when the KPMG auditor reviewing the client's financial 
statements is required, as part of that review, to examine the 
client's tax return and its use of unusual tax strategies. In 
such situations, KPMG is, in effect, auditing its own work.
    A third set of professional ethics issues involves conflict 
of interest concerns related to the legal representation of 
clients who, after purchasing a tax product from KPMG, have 
come under IRS scrutiny. The issues include whether KPMG should 
be referring these clients to a law firm that represents KPMG 
itself on unrelated matters, and whether a law firm that has a 
longstanding, close, and ongoing relationship with KPMG, 
representing it on unrelated matters, should also represent 
KPMG clients. While KPMG and the client have an immediate joint 
interest in defending the tax product that KPMG sold and the 
client purchased, their interests could quickly diverge if the 
suspect tax product is found to be in violation of federal tax 
law. This divergence in interests has been demonstrated 
repeatedly since 2002, as growing numbers of KPMG clients have 
filed suit against KPMG seeking a refund of past fees they paid 
to the firm and additional damages for KPMG's selling them an 
illegal tax shelter.
    The following pages provide more detailed information about 
these and other problems uncovered during the Subcommittee 
investigation into the role of professional firms in the tax 
shelter industry.
    The tax products featured in this Report were developed, 
marketed, and executed by highly skilled professionals in the 
fields of accounting, law, and finance. Historically, such 
professionals have been distinguished by their obligation to 
meet a higher standard of conduct in business than ordinary 
occupations. When it came to decisions by these professionals 
on whether to approve a questionable tax product, employ 
telemarketers to sell tax services, or omit required 
information from a tax return, one might have expected a 
thoughtful discussion or analysis of the firm's fiduciary 
duties, its ethical and professional obligations, or what 
should be done to protect the firm's good name. Unfortunately, 
evidence of those thoughtful discussions was virtually non-
existent, and considerations of professionalism seem to have 
had little, if any, effect on KPMG's mass marketing of its tax 
products.

IV. Recommendations

    Based upon its investigation to date and the above 
findings, the Subcommittee Minority staff recommends that the 
Subcommittee make the following policy recommendations.

        (1) Congress should enact legislation to increase 
        penalties on promoters of potentially abusive and 
        illegal tax shelters, clarify and strengthen the 
        economic substance doctrine, and bar auditors from 
        providing tax shelter services to their audit clients.

        (2) Congress should increase funding of IRS 
        enforcement efforts to stop potentially abusive and 
        illegal tax shelters, and the IRS should dramatically 
        increase its enforcement efforts against tax shelter 
        promoters.

        (3) The IRS and PCAOB should conduct a joint review of 
        tax shelter activities by accounting firms, and take 
        steps to clarify and strengthen federal and private 
        sector procedures and prohibitions to prevent 
        accounting firms from aiding or abetting tax evasion, 
        promoting potentially abusive or illegal tax shelters, 
        or engaging in related unethical or illegal conduct. 
        The PCAOB should consider banning public accounting 
        firms from providing tax shelter services to their 
        audit clients and others.

        (4) The IRS and federal bank regulators should conduct 
        a joint review of tax shelter activities at major 
        banks, clarify and strengthen bank procedures and 
        prohibitions to prevent banks from aiding or abetting 
        tax evasion, promoting potentially abusive or illegal 
        tax shelters, or engaging in related unethical or 
        illegal conduct.

        (5) The U.S. Department of Justice and IRS should 
        conduct a joint review of tax shelter activities at 
        major law firms, and take steps to clarify and 
        strengthen federal and private sector rules to prevent 
        law firms from aiding or abetting tax evasion, 
        promoting potentially abusive or illegal tax shelters, 
        or engaging in related unethical or illegal conduct. 
        The U.S. Treasury Department should clarify and 
        strengthen professional standards of conduct and 
        opinion letter requirements in Circular 230 and 
        explicitly address tax shelter issues.

        (6) Federal and private sector regulators should 
        clarify and strengthen federal and private sector rules 
        related to opinion letters advising on tax products, 
        including setting standards for letters related to mass 
        marketed tax products, requiring fair and accurate 
        factual representations, and barring collaboration 
        between a tax product promoter and a firm preparing an 
        allegedly independent opinion letter.

        (7) The American Institute of Certified Public 
        Accountants (AICPA), American Bar Association, and 
        American Bankers Association should establish standards 
        of conduct and procedures to prevent members of their 
        professions from aiding or abetting tax evasion, 
        promoting abusive or illegal tax shelters, or engaging 
        in related unethical or illegal conduct, including by 
        requiring a due diligence review of any tax-related 
        transaction in which a member is asked to participate. 
        Tax exempt organizations should adopt similar standards 
        of conduct and procedures.

        (8) The AICPA, American Bar Association, and American 
        Bankers Association should strengthen professional 
        standards of conduct and ethics requirements to stop 
        the development and mass marketing of tax products 
        designed to reduce or eliminate a client's tax 
        liability, and should prohibit their members from using 
        aggressive sales tactics to market tax products, 
        including by prohibiting use of cold calls and 
        telemarketing, explicit revenue goals, and fees 
        contingent on projected tax savings.

        (9) The AICPA and American Bar Association should 
        strengthen professional standards of conduct and ethics 
        requirements to prohibit the issuance of an opinion 
        letter on a tax product when the independence of the 
        author has been compromised by providing accounting, 
        legal, design, sales, or implementation assistance 
        related to the product, by having a financial stake in 
        the tax product, or by having a financial stake in a 
        related or similar tax product.

V. Overview of U.S. Tax Shelter Industry

  A. Summary of Current Law on Tax Shelters

    The definition of an abusive tax shelter has changed and 
expanded over time to encompass a wide variety of illegal or 
potentially illegal tax evasion schemes. Existing legal 
definitions are complex and appear in multiple sections of the 
tax code.18 These tax shelter definitions refer to 
transactions, partnerships, entities, investments, plans, or 
arrangements which have been devised, in whole or significant 
part, to enable taxpayers to eliminate or understate their tax 
liability. The General Accounting Office (GAO) recently 
summarized these definitions by describing ``abusive shelters'' 
as ``very complicated transactions promoted to corporations and 
wealthy individuals to exploit tax loopholes and provide large, 
unintended tax benefits.'' 19
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    \18\ See, e.g., 26 U.S.C. Sec. Sec. 461(i)(3) (defining tax shelter 
for certain tax accounting rules); 6111(a), (c) and (d) (defining tax 
shelter for certain registration and disclosure requirements); and 
6662(d)(2)(C)(iii) (defining tax shelter for application of 
understatement penalty).
    \19\ ``Challenges Remain in Combating Abusive Tax Shelters,'' 
testimony by Michael Brostek, Director, Tax Issues, GAO, before the 
U.S. Senate Committee on Finance, No. GAO-04-104T (10/21/03) 
(hereinafter ``GAO Testimony'') at 1.
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    Over the past 10 years, Federal statutes and regulations 
prohibiting illegal tax shelters have undergone repeated 
revision to clarify and strengthen them. Today, key tax code 
provisions not only prohibit tax evasion by taxpayers, but also 
penalize persons who knowingly organize or promote illegal tax 
shelters 20 or who knowingly aid or abet the filing 
of tax return information that understates a taxpayer's tax 
liability.21 Additional tax code provisions now 
require taxpayers and promoters to disclose to the IRS 
information about certain potentially illegal tax 
shelters.22
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    \20\ 26 U.S.C. Sec. 6700.
    \21\ 26 U.S.C. Sec. 6701.
    \22\ See, e.g., 26 U.S.C. Sec. Sec. 6011 (taxpayer must disclose 
reportable transactions); 6111 (organizers and promoters must register 
potentially illegal tax shelters with IRS), 6112 (promoters must 
maintain lists of clients who purchase potentially illegal tax shelters 
and, upon request, disclose such client lists to the IRS).
---------------------------------------------------------------------------
    Recently, the IRS issued regulations to clarify and 
strengthen the law's definition of a tax shelter promoter and 
the law's requirements for tax shelter disclosure.23 
For example, these regulations now make it clear that tax 
shelter promoters include ``persons principally responsible for 
organizing a tax shelter as well as persons who participate in 
the organization, management or sale of a tax shelter'' and any 
person who is a ``material advisor'' on a tax shelter 
transaction.24 Disclosure obligations, which apply 
to both taxpayers and tax shelter promoters, require disclosure 
to the IRS, under certain circumstances, of information related 
to six categories of potentially illegal tax shelter 
transactions. Among others, these disclosures include any 
transaction that is the same or similar to a ``listed 
transaction,'' which is a transaction that the IRS has formally 
determined, through regulation, notice, or other published 
guidance, ``as having a potential for tax avoidance or 
evasion'' and is subject to the law's registration and client 
list maintenance requirements.25 The IRS has stated 
in court that it ``considers a `listed transaction' and all 
substantially similar transactions to have been structured for 
a significant tax avoidance purpose'' and refers to them as 
``potentially abusive tax shelters.'' 26 The IRS has 
also stated in court that ``the IRS has concluded that 
taxpayers who engaged in such [listed] transactions have failed 
or may fail to comply with the internal revenue laws.'' 
27 As of October 2003, the IRS had published 27 
listed transactions.
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    \23\ See, e.g., Treas. Reg. Sec. 301.6112-1 and Sec. 1.6011-4, 
which took effect on 2/28/03.
    \24\ Petition dated 10/14/03, ``United States' Ex Parte Petition 
for Leave to Serve IRS `John Doe' Summons on Sidley Austin Brown & 
Wood,'' (D.N.D. Ill.), at para. 8.
    \25\ Id. at para. 11. See also ``Background and Present Law 
Relating to Tax Shelters,'' Joint Committee on Taxation (JCX-19-02), 3/
19/02 (hereinafter ``Joint Committee on Taxation report''), at 33; GAO 
Testimony at 7. The other five categories of transactions subject to 
disclosure are transactions offered under conditions of 
confidentiality, including contractual protections to the ``investor'', 
resulting in specific amounts of tax losses, generating a tax benefit 
when the underlying asset is held only briefly, or generating 
differences between financial accounts and tax accounts greater than 
$10 million. GAO Testimony at 7.
    \26\ Petition dated 10/14/03, ``United States' Ex Parte Petition 
for Leave to Serve IRS `John Doe' Summons on Sidley Austin Brown & 
Wood,'' (D.N.D. Ill.), at para.para. 11-12.
    \27\ Id. at para. 16.
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    In addition to statutory and regulatory requirements and 
prohibitions, federal courts have developed over the years a 
number of common law doctrines to identify and invalidate 
illegal tax shelters, including the economic 
substance,28 business purpose,29 
substance-over-form,30 step 
transaction,31 and sham transaction 32 
doctrines. A study by the Joint Committee on Taxation concludes 
that ``[t]hese doctrines are not entirely distinguishable'' and 
have been applied by courts in inconsistent ways.33
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    \28\ See, e.g., Gregory v. Helvering, 293 U.S. 465 (1935); ACM 
Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), cert. denied 
526 U.S. 1017 (1999); Bail Bonds by Marvin Nelson, Inc. v. 
Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987) (``The economic 
substance factor involves a broader examination of . . . whether from 
an objective standpoint the transaction was likely to produce economic 
benefits aside from a tax deduction.'').
    \29\ See, e.g., Gregory v. Helvering, 293 U.S. 465 (1935); 
Commissioner v. Transport Trading & Terminal Corp., 176 F.2d 570, 572 
(2nd Cir. 1949), cert. denied 339 U.S. 916 (1949) (Judge Learned Hand) 
(``The doctrine of Gregory v. Helvering . . . means that in construing 
words of a tax statute which describe commercial or industrial 
transactions we are to understand them to refer to transactions entered 
upon for commercial or industrial purposes and not to include 
transactions entered upon for no other motive but to escape 
taxation.'')
    \30\ See, e.g., Weiss v. Stearn, 265 U.S. 242, 254 (1924) 
(``Questions of taxation must be determined by viewing what was 
actually done, rather than the declared purpose of the participants; 
and when applying the provisions of the Sixteenth Amendment and income 
laws . . . we must regard matters of substance and not mere form.'')
    \31\ See, e.g., Commissioner v. Court Holding Co., 324 U.S. 331, 
334 (1945) (``The transaction must be viewed as a whole, and each step, 
from the commencement of negotiations to the consummation of the sale, 
is relevant. A sale by one person cannot be transformed for tax 
purposes into a sale by another using the latter as a conduit through 
which to pass title.''); Palmer v. Commissioner, 62 T.C. 684, 692 
(1974).
    \32\ See, e.g., Gregory v. Helvering, 293 U.S. 465 (1935); Rice's 
Toyota World v. Commissioner, 752 F.2d 89, 91-92 (4th Cir. 1985); 
United Parcel Service of America, Inc. v. Commissioner, 78 T.C.M. 262 
at n. 29 (1999), rev'd 254 F.3d 1014 (11th Cir. 2001) (``Courts have 
recognized two basic types of sham transactions. Shams in fact are 
transactions that never occur. In such shams, taxpayers claim 
deductions for transactions that have been created on paper but which 
never took place. Shams in substance are transactions that actually 
occurred but which lack the substance their form represents.'').
    \33\ Joint Committee on Taxation report at 7.
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    Bipartisan legislation to clarify and strengthen the 
economic substance and business purpose doctrines, as well as 
other aspects of federal tax shelter law, has been developed by 
the Senate Finance Committee. This legislation has been twice 
approved by the Senate during the 108th Congress, but has yet 
to become law.34
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    \34\ See, e.g., S. 476, the CARE Act of 2003 (108th Congress, first 
session), section 701 et seq.
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  B. U.S. Tax Shelter Industry and Professional Organizations

          Finding: The sale of potentially abusive and illegal 
        tax shelters has become a lucrative business in the 
        United States, and some professional firms such as 
        accounting firms, banks, investment advisory firms, and 
        law firms are major participants in the mass marketing 
        of generic ``tax products'' to multiple clients.

    Illegal tax shelters sold to corporations and wealthy 
individuals drain the U.S. Treasury of billions of dollars in 
lost tax revenues each year. According to GAO, a recent IRS 
consultant estimated that for the 6-year period, 1993-1999, the 
IRS lost on average between $11 and $15 billion each year from 
abusive tax shelters.35 In actual cases closed 
between October 1, 2001, and May 6, 2003, involving just 42 
large corporations, GAO reports that the IRS proposed abusive 
shelter-related adjustments for tax years, 1992 to 2000, 
totaling more than $10.5 billion.36 GAO reports that 
an IRS database tracking unresolved, abusive tax shelter cases 
over a number of years estimates potential tax losses of about 
$33 billion from listed transactions and another $52 billion 
from nonlisted abusive transactions, for a combined total of 
$85 billion.37
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    \35\ GAO Testimony at 12.
    \36\ Id. at 11.
    \37\ Id. at 10.
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    GAO has also reported that IRS data provided in October 
2003, identified about 6,400 individuals and corporations that 
had bought abusive tax shelters and other abusive tax planning 
products, as well as almost 300 firms that appear to have 
promoted them.38 According to GAO, as of June 2003, 
the IRS had approved investigations of 98 tax shelter 
promoters, including some directed at accounting or law 
firms.39
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    \38\ Id. at 11.
    \39\ Id. at 16.
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    IRS Commissioner Mark Everson testified at a recent Senate 
Finance Committee hearing that: ``A significant priority in the 
Service's efforts to curb abusive transactions is our focus on 
promoters.'' 40 He stated, ``The IRS has focused its 
attention in the area of tax shelters on accounting and law 
firms, among others. The IRS has focused on these firms because 
it believes that, in the instances in which the IRS has acted, 
these firms were acting as promoters of tax shelters, and not 
simply as tax or legal advisers.''
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    \40\ Testimony of Mark Everson, IRS Commissioner, before the Senate 
Committee on Finance, ``Tax Shelters: Who's Buying, Who's Selling and 
What's the Government Doing About It?'' (10/21/03), at 7.
---------------------------------------------------------------------------
    Mr. Everson also described the latest generation of abusive 
tax shelters as complex, difficult-to-detect transactions 
developed by extremely sophisticated people:

        ``The latest generation of abusive tax transactions has 
        been facilitated by the growth of financial products 
        and structures whose own complexity and non-
        transparency have provided additional tools to allow 
        those willing to design transactions intended to 
        generate unwarranted tax benefits. . . . [A]busive 
        transactions that are used by corporations and 
        individuals present formidable administrative 
        challenges. The transactions themselves can be 
        creative, complex and difficult to detect. Their 
        creators are often extremely sophisticated, as are many 
        of their users, who are often financially prepared and 
        motivated to contest the Service's challenges.'' 
        41
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    \41\ Id. at 2.

    The Commissioner stated that due to the ``growth in the 
volume of abusive transactions'' and ``a disturbing decline in 
corporate conduct and governance,'' among other factors, the 
IRS has enhanced its response to abusive transactions in 
general, and abusive tax shelters in particular.42 
He said that the Office of Tax Shelter Analysis (OTSA), first 
established in February 2000 within the Large and Mid-Size 
Business Division, is continuing to lead IRS tax shelter 
efforts. He stated that, ``OTSA plans, centralizes and 
coordinates LMSB's tax shelter operations and collects, 
analyzes, and distributes within the IRS information about 
potentially abusive tax shelter activity.'' 43 Mr. 
Everson described a number of ongoing IRS tax shelter 
initiatives including efforts to increase enforcement 
resources, conduct promoter audits, enforce IRS document 
requests against accounting and law firms, implement global 
settlements for persons who used certain illegal tax shelters, 
develop proposed regulations to improve tax opinion letters and 
ethics rules for tax professionals appearing before the IRS, 
and issue additional notices to identify illegal tax shelters.
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    \42\ Id. at 3.
    \43\ Id. at 8.
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    The Commissioner warned:

        ``[A]busive transactions can and will continue to pose 
        a threat to the integrity of our tax administration 
        system. We cannot afford to tolerate those who 
        willfully promote or participate in abusive 
        transactions. The stakes are too high and the effects 
        of an insufficient response are too corrosive.'' 
        44
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    \44\ Id. at 16.

    Professional organizations like accounting firms, banks, 
investment advisers, and law firms are now key participants in 
the tax shelter industry. These firms specialize in producing 
tax shelters that utilize complex structured finance 
transactions, multi-million dollar loans, novel tax code 
interpretations, and expensive professional services requiring 
highly skilled professionals. These firms routinely enlist 
assistance from other respected professional firms and 
financial institutions to provide the accounting, investment, 
financing or legal services needed for the tax shelters to 
work.
    During the past 10 years, professional firms active in the 
tax shelter industry have expanded their role, moving from 
selling individualized tax shelters to specific clients, to 
developing generic tax products and mass marketing them to 
existing and potential clients. No longer content with 
responding to client inquiries, these firms are employing the 
same tactics employed by disreputable, tax shelter hucksters: 
churning out a continuing supply of new and abusive tax 
products, marketing them with hard sell techniques and cold 
calls; and taking deliberate measures to hide their activities 
from the IRS.

VI. Four KPMG Case Histories

  A. KPMG In General

    KPMG International is one of the largest public accounting 
firms in the world, with over 700 offices in 152 
countries.45 In 2002, it employed over 100,000 
people and had worldwide revenues of $10.7 billion. KPMG 
International is organized as a Swiss ``non-operating 
association,'' functions as a federation of partnerships around 
the globe, and maintains its headquarters in Amsterdam.
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    \45\ The general information about KPMG is drawn from KPMG 
documents produced in connection with the Subcommittee investigation; 
Internet websites maintained by KPMG LLP and KPMG International; and a 
legal complaint filed by the U.S. Securities and Exchange Commission 
(SEC) in SEC v. KPMG LLP, Civil Action No. 03-CV-0671 (D.S.D.N.Y. 1/29/
03), alleging fraudulent conduct by KPMG and certain KPMG audit 
partners in connection with audits of certain Xerox Corporation 
financial statements.
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    KPMG LLP (hereinafter ``KPMG'') is a U.S. limited liability 
partnership and a member of KPMG International. KPMG is the 
third largest accounting firm in the United States, and 
generates more than $4 billion in annual revenues. KPMG was 
formed in 1987, from the merger of two long-standing accounting 
firms, Peat Marwick and Klynveld Main Goerdeler, along with 
their individual member firms. KPMG maintains its headquarters 
in New York and numerous offices in the United States and other 
countries. KPMG is run by a ``Management Committee'' made up of 
15 individuals drawn from the firm's senior management and 
major divisions.46 KPMG's Chairman and CEO is Eugene 
O'Kelly, who joined KPMG in 1972, became partner in 1982, and 
was appointed Chairman in 2002. KPMG's Deputy Chairman is 
Jeffrey M. Stein, who was also appointed in 2002. From 2000 
until 2002, Mr. Stein was the Vice Chairman for Tax heading 
KPMG's Tax Services Practice, and prior to that he served as 
head of operations, or second in command, of the Tax Services 
Practice.
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    \46\ The 15 Management Committee members are the Chairman, Deputy 
Chairman, Chief Financial Officer, General Counsel, head of the 
Department of Professional Practice, head of the Department of 
Marketing and Communications, head of the Department of Human 
Resources, the two most senior officials in the Tax Services Practice, 
the two most senior officials in the Assurance Practice, and the most 
senior official in each of four industry-related ``lines of business,'' 
such as telecommunications and energy. Subcommittee interview of 
Jeffrey Stein (10/31/03).
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    KPMG's Tax Services Practice is a major division of KPMG. 
It provides tax compliance, tax planning, and tax return 
preparation services. The Tax Services Practice employs more 
than 10,300 tax professionals and generates approximately $1.2 
billion in annual revenues for the firm. These revenues have 
been increasing rapidly in recent years, including a 45% 
cumulative increase over 4 years, from 1998 to 
2001.47 The Tax Services Practice is headquartered 
in New York, has 122 U.S. offices, and maintains additional 
offices around the world. The current head of the Tax Service 
is Vice Chairman for Tax, Richard Smith.
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    \47\ Internal KPMG presentation dated 7/19/01, by Rick Rosenthal 
and Marsha Peters, entitled ``Innovative Tax Solutions,'' Bates XX 
001340-50. A chart included in this presentation tracks increases in 
the Tax Service's gross revenues from 1998 until 2001, showing a 
cumulative increase of more than 45% over the 4-year period, from 1998 
gross revenues of $830 million to 2001 gross revenues of $1.24 billion.
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    The Tax Services Practice has over two dozen subdivisions, 
offices, ``practices'' or ``groups'' which over the years have 
changed missions and personnel. Many have played key roles in 
developing, marketing, or implementing KPMG's generic tax 
products, including the four products featured in this Report. 
One key group is the Washington National Tax Practice (WNT) 
which provides technical tax expertise to the entire KPMG firm. 
A WNT subgroup, The Tax Innovation Center, leads KPMG's efforts 
to develop new generic tax products. Another key group is the 
Department of Professional Practice (DPP) for Tax, which, among 
other tasks, reviews and approves all new KPMG tax products for 
sale to clients. KPMG's Federal Tax Practice addresses federal 
tax compliance and planning issues. KPMG's Personal Financial 
Planning (PFP) Practice focuses on selling ``tax-advantaged'' 
products to high net worth individuals and large 
corporations.48 Through a subdivision known as the 
Capital Transaction Services (CaTS) Practice, later renamed the 
Innovative Strategies (IS) Practice, PFP led KPMG's efforts on 
FLIP, OPIS, and BLIPS.49 KPMG's Stratecon Practice, 
which focuses on ``business based'' tax planning and tax 
products, led the firm's efforts on SC2. Innovative Strategies 
and Stratecon were disbanded in 2002, and their tax 
professionals assigned to other groups.50
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    \48\ Minutes dated 11/30/00, Monetization Solutions Task Force 
Teleconference, Bates KPMG 0050624-29, at 50625.
    \49\ Document dated 5/18/01, ``PFP Practice Reorganization 
Innovative Strategies Business Plan--DRAFT,'' Bates KPMG 0050620-23, at 
1.
    \50\ Stratecon appears to have been very active until its 
dissolution. See, e.g., email dated 4/8/02, from Larry Manth to 
multiple KPMG tax professionals, ``Stratecon Final Results for March 
2002,'' Bates XX 001732 (depicting Stratecon's March 2002 revenues and 
operating expenses).
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    Several senior KPMG tax professionals interviewed by the 
Subcommittee staff, when asked to describe KPMG's overall 
approach to tax services, indicated that the firm made a 
significant change in direction in the late 1990's, when it 
made a formal decision to begin devoting substantial resources 
to developing and marketing tax products that could be sold to 
multiple clients. The Subcommittee staff was told that KPMG 
made this decision, in part, due to the success other 
accounting firms were experiencing in selling tax products; in 
part, due to the large revenues earned by the firm from selling 
a particular tax product to banks; 51 and, in part, 
due to new tax leadership that was enthusiastic about 
increasing tax product sales. Among other actions to carry out 
this decision, the firm established the Tax Innovation Center 
which was dedicated to generating new generic tax products. One 
senior KPMG tax professional told the Subcommittee staff that 
some KPMG partners considered it ``important'' for the firm to 
become an industry leader in producing generic tax products. He 
said that, of the many new products KPMG developed, some were 
``relatively plain vanilla,'' while others were ``aggressive.'' 
He said that the firm's policy was to offer only tax products 
which met a ``more likely than not'' standard, meaning the 
product had a greater than 50 percent probability of 
withstanding a challenge by the IRS, and that KPMG deliberately 
chose a higher standard than required by the AICPA, which 
permits firms to offer tax products with a ``realistic 
possibility of success,'' or a one-in-three chance of 
withstanding an IRS challenge.52
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    \51\ For information about this tax product, see Appendix C, ``Sham 
Mutual Fund Investigation.''
    \52\ KPMG's policy is included in the KPMG Tax Services Manual--
U.S., May 2002, KPMG Accounting & Reporting Publication, (hereinafter 
``KPMG Tax Services Manual''), Sec. 24.5.2, at 24-3.
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    In recent years, KPMG has become the subject of IRS, SEC, 
and state investigations and enforcement actions in the areas 
of tax, accounting fraud, and auditor 
independence.53 These enforcement actions include 
ongoing litigation by the IRS to enforce tax shelter related 
document requests and a tax promoter audit of the firm; SEC, 
California, and New York investigations into a potentially 
abusive tax shelter involving at least 10 banks that are 
allegedly using sham mutual funds established on KPMG's advice; 
SEC and Missouri investigations or enforcement actions related 
to alleged KPMG involvement in accounting fraud at Xerox 
Corporation or General American Mutual Holding Co.; and auditor 
independence concerns leading to an SEC censure of KPMG for 
investing in AIM mutual funds while AIM was an audit client, 
and to an ongoing SEC investigation of tax product client 
referrals from Wachovia Bank to KPMG while Wachovia was a KPMG 
audit client. In addition, a number of taxpayers have filed 
suit against KPMG for allegedly selling them an illegal tax 
shelter or improperly involving them in work on illegal tax 
shelters.
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    \53\ Brief summaries of some of these matters are included in 
Appendix C.
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  B. KPMG's Tax Shelter Activities

          Finding: Although KPMG denies being a tax shelter 
        promoter, the evidence establishes that KPMG has 
        devoted substantial resources to, and obtained 
        significant fees from, developing, marketing, and 
        implementing potentially abusive and illegal tax 
        shelters that U.S. taxpayers might otherwise have been 
        unable, unlikely or unwilling to employ, costing the 
        Treasury billions of dollars in lost tax revenues.

    KPMG has repeatedly denied being a tax shelter promoter. 
KPMG has denied it in court when opposing IRS document requests 
for information related to tax shelters,54 and 
denied it in response to Subcommittee questions. KPMG has never 
registered any tax product with the IRS as a potentially 
abusive tax shelter.
---------------------------------------------------------------------------
    \54\ See United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 9/6/
02), ``Answer to Petition to Enforce Internal Revenue Summonses,'' at 
para. 1 (``KPMG asserts that it is not a tax shelter organizer, but a 
professional firm whose tax professionals provide advice and counseling 
on a one-on-one basis to clients and prospective clients concerning the 
clients' tax situations.'')
---------------------------------------------------------------------------
    KPMG does not refer to any of its tax products as ``tax 
shelters'' and objects to using that term to describe its tax 
products. Instead, KPMG refers to its tax products as ``tax 
solutions'' or ``tax strategies.'' The KPMG Tax Services Manual 
defines a ``tax solution'' as ``a tax planning idea, structure, 
or service that potentially is applicable to more than one 
client situation and that is reasonable to believe will be the 
subject of leveraged deployment,'' meaning sales to multiple 
clients.55
---------------------------------------------------------------------------
    \55\ KPMG Tax Services Manual, Sec. 24.1.1, at 24-1.
---------------------------------------------------------------------------
    In response to a Subcommittee inquiry, KPMG provided the 
Subcommittee with a list of over 500 ``active tax products'' 
designed to be offered to multiple clients for a 
fee.56 When the Subcommittee asked KPMG to identify 
the ten tax products that produced the most revenue for the 
firm in 2000, 2001, and 2002, KPMG denied having the ability to 
reliably track revenues associated with individual tax products 
and thus to identify with certainty its top revenue 
producers.57 To respond to the Subcommittee's 
request, KPMG indicated that it had ``undertaken a good faith, 
reasonable effort to estimate the tax strategies that were 
likely among those generating the most revenues in the years 
requested.'' 58 KPMG identified a total of 19 tax 
products that were top revenue-producers for the firm over the 
3-year period.
---------------------------------------------------------------------------
    \56\ Untitled document, produced by KPMG on 2/10/03, Bates KPMG 
0000009-91.
    \57\ See chart entitled, ``Good Faith Estimate of Top Revenue-
Generating Strategies,'' attached to letter dated 4/22/03, from KPMG's 
legal counsel to the Subcommittee, Bates KPMG 0001801 (``[B]ecause each 
tax strategy is tailored to a client's particular circumstances, the 
firm does not maintain any systematic, reliable method of recording 
revenues by tax product on a national basis, and therefore is unable to 
provide any definitive list or quantification of revenues for a `top 
ten tax products', as requested by the Subcommittee.'').
    \58\ Id.
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    The Subcommittee staff's preliminary review of these 19 top 
revenue-producing tax products determined that six, OPIS, 
BLIPS, 401(k)ACCEL, CARDS, CLAS, and CAMPUS, are either within 
the scope of ``listed transactions'' already determined by the 
IRS to be potentially abusive tax shelters or within the scope 
of IRS document requests in an ongoing IRS review of KPMG's tax 
shelter activities.59 The Subcommittee determined 
that many, if not all, of the 19 tax products were designed to 
reduce the tax liability of corporations or individuals, and 
employed features such as structured transactions, complex 
accounting methods, and novel tax law interpretations, often 
found in illegal tax shelters. The Subcommittee staff briefly 
reviewed a number of other KPMG tax products as well 
60 and found that they, too, carried indicia of a 
potentially abusive tax shelter.
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    \59\ Compare 19 tax products listed in the chart produced by KPMG 
on 8/8/03, Bates KPMG 0001801, to the tax products identified in United 
States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), ``Petition to 
Enforce Internal Revenue Service Summonses.''
    \60\ These tax products included OTHELLO, TEMPEST, RIPSS, and 
California REIT.
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    KPMG insists that all of its tax products are the result of 
legitimate tax planning services. In legal pleadings seeking 
KPMG documents, however, the IRS has stated that a number of 
KPMG's tax products appear to be ``tax shelters'' and requested 
related documentation to determine whether the firm is 
complying with federal tax shelter laws.61 The IRS 
specifically identified as ``tax shelters'' FLIP, OPIS, BLIPS, 
TRACT, IDV, 401(k) ACCEL, Contested Liabilities, Economic 
Liability Transfer, CLAS, CAMPUS, MIDCO, certain ``Tax Treaty'' 
transactions, PICO, and FOCUS.62 The IRS also 
alleged that, according to information from a confidential 
source, ``KPMG continues to hide from the IRS information about 
tax shelters it is now developing and marketing'' and ``KPMG 
continues to develop and aggressively market dozens of possibly 
abusive tax shelters.'' 63
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    \61\ United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), 
``Petition to Enforce Internal Revenue Service Summonses.''
    \62\ Id.
    \63\ United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), 
``Declaration of Michael A. Halpert,'' Internal Revenue Agent, at para. 
38.
---------------------------------------------------------------------------
    The Subcommittee staff selected three of KPMG's 19 top 
revenue producing tax products for more intensive study, OPIS, 
BLIPS and SC2, as well as an earlier tax product, FLIP, which 
KPMG had stopped selling after 1999, but which was the 
precursor to OPIS and BLIPS, and the subject of lawsuits filed 
in 2002 and 2003, by persons claiming KPMG had sold them an 
illegal tax shelter. All four of these tax products were 
explicitly designed to reduce or eliminate the tax liability of 
corporations or individuals. Three, FLIP, OPIS, and BLIPS, have 
already been determined by the IRS to be illegal or potentially 
abusive tax shelters, and the IRS has penalized taxpayers for 
using them. A number of these taxpayers have, in turn, sued 
KPMG for selling them illegal tax shelters.64 It is 
these four products that are featured in this Report.
---------------------------------------------------------------------------
    \64\ See, e.g., Jacoboni v. KPMG, Case No. 6:02-CV-510 (M.D. Fla. 
4/29/02) (OPIS); Swartz v. KPMG, Case No. C03-1252 (W.D. Wash. 6/6/03) 
(BLIPS); Thorpe v. KPMG, Case No. 5-030CV-68 (E.D.N.C. 1/27/03) (FLIP/
OPIS). In addition, a KPMG tax professional has sued KPMG for 
defamation in ``retaliation for the Plaintiff's refusal to endorse or 
participate in [KPMG's] illegal activities and for his cooperation with 
government investigators.'' Hamersley v. KPMG, Case No. BC297905 (Los 
Angeles Superior Court 6/23/03).
---------------------------------------------------------------------------
    The dispute over whether KPMG sells benign ``tax 
solutions'' or illegal ``tax shelters'' is more than a 
linguistic difference; it goes to the heart of whether 
respected institutions like this one have crossed the line of 
acceptable conduct. Shedding light is a memorandum prepared 5 
years ago, in 1998, by a KPMG tax professional advising the 
firm not to register what was then a new tax product, OPIS, as 
a ``tax shelter'' with the IRS.65 Here is the advice 
this tax professional gave to the second most senior Tax 
Services Practice official at KPMG:
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    \65\ Memorandum dated 5/26/98, from Gregg Ritchie to Jeffrey Stein, 
then head of operations in the Tax Services Practice, ``OPIS Tax 
Shelter Registration,'' Bates KPMG 0012031-33. Emphasis in original.

        ``For purposes of this discussion, I will assume that 
        we will conclude that the OPIS product meets the 
---------------------------------------------------------------------------
        definition of a tax shelter under IRC section 6111(c).

        ``Based on this assumption, the following are my 
        conclusions and recommendations as to why KPMG should 
        make the business/strategic decision not to register 
        the OPIS product as a tax shelter. My conclusions and 
        resulting recommendation [are] based upon the immediate 
        negative impact on the Firm's strategic initiative to 
        develop a sustainable tax products practice and the 
        long-term implications of establishing . . . a 
        precedent in registering such a product.

        ``First, the financial exposure to the Firm is minimal. 
        Based upon our analysis of the applicable penalty 
        sections, we conclude that the penalties would be no 
        greater than $14,000 per $100,000 in KPMG fees. . . . 
        For example, our average deal would result in KPMG fees 
        of $360,000 with a maximum penalty exposure of only 
        $31,000.

        ``This further assumes that KPMG would bear 100 percent 
        of the penalty. In fact . . . the penalty is joint and 
        several with respect to anyone involved in the product 
        who was required to register. Given that, at a minimum, 
        Presidio would also be required to register, our share 
        of the penalties could be viewed as being only one-half 
        of the amounts noted above. If other OPIS participants 
        (e.g., Deut[s]che Bank, Brown & Wood, etc.) were also 
        found to be promoters subject to the registration 
        requirements, KPMG's exposure would be further 
        minimized. Finally, any ultimate exposure to the 
        penalties are abatable if it can be shown that we had 
        reasonable cause. . . .

        ``To my knowledge, the Firm has never registered a 
        product under section 6111. . . .

        ``Third, the tax community at large continues to avoid 
        registration of all products. Based upon my knowledge, 
        the representations made by Presidio and Quadra, and 
        Larry DeLap's discussions with his counterparts at 
        other Big 6 firms, there are no tax products marketed 
        to individuals by our competitors which are registered. 
        This includes income conversion strategies, loss 
        generation techniques, and other related strategies.

        ``Should KPMG decide to begin to register its tax 
        products, I believe that it will position us with a 
        severe competitive disadvantage in light of industry 
        norms to such degree that we will not be able to 
        compete in the tax advantaged products market.

        ``Fourth, there has been (and, apparently, continues to 
        be) a lack of enthusiasm on the part of the Service to 
        enforce section 6111. In speaking with KPMG individuals 
        who were at the Service . . . the Service has 
        apparently purposefully ignored enforcement efforts 
        related to section 6111. In informal discussions with 
        individuals currently at the Service, WNT has confirmed 
        that there are not many registration applications 
        submitted and they do not have the resources to 
        dedicate to this area.

        ``Finally, the guidance from Congress, the Treasury, 
        and the Service is minimal, unclear, and extremely 
        difficult to interpret when attempting to apply it to 
        `tax planning' products. . . .

        ``I believe the rewards of a successful marketing of 
        the OPIS product . . . far exceed the financial 
        exposure to penalties that may arise. Once you have had 
        an opportunity to review this information, I request 
        that we have a conference with the persons on the 
        distribution list . . . to come to a conclusion with 
        respect to my recommendation. As you know, we must 
        immediately deal with this issue in order to proceed 
        with the OPIS product.''

    This memorandum assumes that OPIS qualifies as a tax 
shelter under federal law and then advocates that KPMG not 
register it with the IRS as required by law. The memorandum 
advises KPMG to knowingly violate the law requiring tax shelter 
registration, because the IRS is not vigorously enforcing the 
registration requirement, the penalties for noncompliance are 
much less than the potential profits from the tax product, and 
``industry norms'' are not to register any tax products at all. 
The memorandum warns that if KPMG were to comply with the tax 
shelter registration requirement, this action would place the 
firm at such a competitive disadvantage that KPMG would ``not 
be able to compete in the tax advantaged products market.''
    The Subcommittee has learned that some KPMG tax 
professionals agreed with this analysis,66 while 
other senior KPMG tax professionals provided the opposite 
advice to the firm.67 but the head of the Tax 
Services Practice, the Vice Chairman for Tax, ultimately 
decided not to register the tax product as a tax shelter. KPMG 
authorized the sale of OPIS in the fall of 1998.68 
Over the next 2 years, KPMG sold OPIS to more than 111 
individuals. It earned fees in excess of $28 million, making 
OPIS one of KPMG's top ten tax revenue producers in 2000. KPMG 
never registered OPIS as a tax shelter with the IRS. In 2001, 
the IRS issued Notice 2001-45 declaring tax products like OPIS 
to be potentially abusive tax shelters.
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    \66\ See, e.g., email dated 5/26/98, from Mark Springer to multiple 
KPMG tax professionals, ``Re: OPIS Tax Shelter Registration,'' Bates 
KPMG 0034971 (``I would still concur with Gregg's recommendation. . . . 
I don't think we want to create a competitive DISADVANTAGE, nor do we 
want to lead with our chin.'' Emphasis in original.)
    \67\ Lawrence DeLap, then DPP head, told the Subcommittee he had 
advised the firm to register OPIS as a tax shelter. Subcommittee 
interview of Lawrence DeLap (10/30/03).
    \68\ See email dated 11/1/98, from Larry DeLap to William Albaugh 
and other KPMG tax professionals, ``OPIS,'' Bates KPMG 0035702.
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    The following sections of this Report describe the systems, 
procedures, and corporate culture behind KPMG's efforts to 
develop, market, and implement its tax products, as well as 
steps KPMG has taken to avoid detection of its activities by 
tax authorities and others. Each of these sections includes 
specific evidence drawn from the BLIPS, SC2, OPIS, and FLIP 
case histories. Appendices A and B provide more detailed 
descriptions of how BLIPS and SC2 worked.

  (1) Developing New Tax Products

          Finding: KPMG devotes substantial resources and 
        maintains an extensive infrastructure to produce a 
        continuing supply of generic tax products to sell to 
        multiple clients, using a process which pressures its 
        tax professionals to generate new ideas, move them 
        quickly through the development process, and approve, 
        at times, potentially abusive or illegal tax shelters.

    KPMG prefers to describe itself as a tax advisor that 
responds to client inquiries seeking tax planning services to 
structure legitimate business transactions in a tax efficient 
way. The Subcommittee investigation has determined, however, 
that KPMG has also developed and supports an extensive internal 
infrastructure of offices, programs, and procedures designed to 
churn out a continuing supply of new tax products unsolicited 
by a specific client and ready for mass marketing.
    Drive to Produce New Tax Products. In 1997, KPMG 
established the Tax Innovation Center, whose sole mission is to 
push the development of new KPMG tax products. Located within 
the Washington National Tax (WNT) Practice, the Center is 
staffed with about a dozen full-time employees and assisted by 
others who work for the Center on a rotating basis. A 2001 KPMG 
overview of the Center states that ``[t]ax [s]olution 
development is one of the four priority activities of WNT'' and 
``a significant percentage of WNT resources are dedicated to 
[t]ax [s]olution development at any given time.'' 69
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    \69\ ``Tax Innovation Center Overview,'' Solution Development 
Process Manual (4/7/01), prepared by the KPMG Tax Innovation Center 
(hereinafter ``TIC Manual''), at i.
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    Essentially, the Tax Innovation Center works to get KPMG 
tax professionals to propose new tax product ideas and then 
provides administrative support to develop the proposals into 
approved tax products and move them successfully into the 
marketing stage. As part of this effort, the Center maintains a 
``Tax Services Idea Bank'' which it uses to drive and track new 
tax product ideas. The Center asks KPMG tax professionals to 
submit new ideas for tax products on ``Idea Submission Forms'' 
or ``Tax Knowledge Sharing'' forms with specified information 
on how the proposed tax product would work and who would be 
interested in buying it.70 The Idea Submission Form 
asks the submitter to explain, for example, ``how client 
savings are achieved,'' ``the tax, business, and financial 
statement benefits of the idea,'' and ``the revenue potential 
of this idea,'' including ``key target markets,'' ``the typical 
buyer,'' and an estimated ``average tax fee per engagement.''
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    \70\ ``TIC Solution Development Process,'' TIC Manual at 6.
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    In recent years, the Center has established a firm-wide, 
numerical goal for new tax idea submissions and applied ongoing 
pressure on KPMG tax professionals to meet this goal. For 
example, in 2001, the Center established this overall 
objective: ``Goal: Deposit 150 New Ideas in Tax Services Idea 
Bank.'' 71 On May 30, 2001, the Center reported on 
the Tax Services' progress in meeting this goal as part of a 
larger power-point presentation on ``year-end results'' in new 
tax solutions and ideas development. For each of 12 KPMG 
``Functional Groups'' within the Tax Services Practice, a one-
page chart shows the precise number of ``Deposits,'' ``Expected 
Deposits,'' and ``In the Pipeline'' ideas which each group had 
contributed or were expected to contribute to the Tax Services 
Idea Bank. For example, the chart reports the total number of 
new ideas contributed by the e-Tax Group, Insurance Group, 
Passthrough Group, Personal Financial Planning Group, State and 
Local Tax (SALT) Group, Stratecon, and others. It shows that 
SALT had contributed the most ideas at 32, while e-Tax had 
contributed the least, having deposited only one new idea. It 
shows that, altogether, the groups had deposited 122 new ideas 
in the idea bank, with 38 more expected, and 171 ``in the 
pipeline.''
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    \71\ KPMG presentation dated 5/30/01, ``Tax Innovation Center 
Solution and Idea Development--Year-End Results,'' Bates XX 001755-56, 
at 4.
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    In addition to reporting on the number of new ideas 
generated during the year, the Center reported on its efforts 
to measure and improve the profitability of the tax product 
development process. The year-end presentation reported, for 
example, on the Tax Innovation Center's progress in meeting its 
goal to ``Measure Solution Profitability,'' noting that the 
Center had developed software systems that ``captured solution 
development costs and revenue'' and ``[p]repared quarterly 
Solution Profitability reports.'' It also discussed progress in 
meeting a goal to ``Increase Revenue from Tax Services Idea 
Bank.'' Among other measures, the Center proposed to ``[s]et 
deployment team revenue goals for all solutions.''
    Development and Approval Process. Once ideas are deposited 
into the Tax Services Idea Bank, KPMG has devoted substantial 
resources to transforming the more promising ideas into generic 
tax products that could be sold to multiple clients.
    KPMG's development and approval process for new tax 
products is described in its Tax Services Manual and Tax 
Innovations Center Manual.72 Essentially, the 
process consists of three stages, each of which may overlap 
with another. In the first stage, the new tax idea undergoes an 
initial screening ``for technical and revenue potential.'' 
73 This initial analysis is supposed to be provided 
by a ``Tax Lab'' which is a formal meeting, arranged by the Tax 
Innovations Center, of six or more KPMG tax experts 
specializing in the tax issues or industry affected by the 
proposed product.74 Promising proposals are also 
assigned one or more persons, sometimes referred to as 
``National Development Champions'' or ``Development Leaders,'' 
to assist in the proposal's initial analysis and, if warranted, 
shepherd the proposal through the full KPMG approval process. 
For example, the lead tax professional who moved BLIPS through 
the development and approval process was Jeffrey Eischeid, 
assisted by Randall Bickham, while for SC2, the lead tax 
professional was Lawrence Manth, assisted by and later 
succeeded by Andrew Atkin.
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    \72\ KPMG Tax Services Manual, Chapter 24, pages 24-1 to 24-7.
    \73\ TIC Manual at 5.
    \74\ The TIC Manual states that a Tax Lab is supposed to evaluate 
``the technical viability of the idea, the idea's revenue generation 
potential above the Solution Revenue threshold, and a business case for 
developing the solution, including initial target list, marketing 
considerations, and preliminary technical analysis.'' TIC Manual at 5.
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    If a proposal survives the initial screening, in the second 
stage, it must undergo a thorough review by the Washington 
National Tax Practice (``WNT review''), which is responsible 
for determining whether the product meets the technical 
requirements of existing tax law.75 WNT personnel 
often spend significant time identifying and searching for ways 
to resolve problems with how the proposed product is structured 
or is intended to be implemented. The WNT review must also 
include analysis of the product by the WNT Tax Controversy 
Services group ``to address tax shelter regulations issues.'' 
76 WNT must ``sign-off'' on the technical merits of 
the proposal for it to be approved for sale to clients.
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    \75\ In an earlier version of KPMG's tax product review and 
approval procedure, WNT did not have a formal role in the development 
and approval process, according to senior tax professionals interviewed 
by the Subcommittee. This prior version of the process, which was 
apparently the first, firm-wide procedure established to approve new 
generic tax products, was established in 1997, and operated until mid 
1998. In it, a three-person Tax Advantaged Product Review Board, whose 
members were appointed by and included the head of DPP-Tax, conducted 
the technical review of new proposals. In 1998, when this 
responsibility was assigned to the WNT, the Board was disbanded. The 
earlier process was used to approve the sale of FLIP and OPIS, while 
the existing procedure was used to approve the sale of BLIPS and SC2. 
Subcommittee interview of Lawrence DeLap (10/30/03).
    \76\ KPMG Tax Services Manual, Sec. 24.4.1, at 24-2.
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    In the third and final stage, the product must undergo 
review and approval by the Department of Practice and 
Professionalism (``DPP review''). The DPP review must determine 
that the product not only complies with the law, but also meets 
KPMG's standards for ``risk management and professional 
practice.'' 77 This latter review includes 
consideration of such matters as the substantive content of 
KPMG tax opinion and client engagement letters, disclosures to 
clients of risks associated with a tax product, the need for 
any confidentiality or marketing restrictions, how KPMG fees 
are to be structured, whether auditor independence issues need 
to be addressed, and the potential impact of a proposed tax 
product on the firm's reputation.78
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    \77\ Id., Sec. 24.5.2, at 24-3.
    \78\ Subcommittee interview of Lawrence DeLap (10/30/03). The 
Subcommittee staff was told that, since 1997, DPP-Tax has had very 
limited resources to conduct its new product reviews. Until 2002, for 
example, DPP-Tax had a total of less than ten employees; in 2003, the 
number increased to around or just above 20. In contrast, DPP-
Assurance, which oversees professional practice issues for KPMG audit 
activity, has well over 100 employees.
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    Each of the three stages takes time, and the entire 
development and approval process can consume 6 months or 
longer. The process is labor-intensive, since it requires tax 
professionals to examine the suggested product, which is often 
quite complex, identify various tax issues, and suggest 
solutions to problems. The process often includes consultations 
with outside professionals, not only on tax issues, but also on 
legal, investment, accounting, and finance issues, since many 
of the products require layers of corporations, trusts, and 
special purpose entities; complex financial and securities 
transactions using arcane financial instruments; and multi-
million-dollar lending transactions, all of which necessitate 
expert guidance, detailed paperwork, and logistical support.
    The KPMG development and approval process is intended to 
encourage vigorous analysis and debate by the firm's tax 
experts over the merits of a proposed tax product and to 
produce a determination that the product complies with current 
law and does not impose excessive financial or reputational 
risk for the firm. All KPMG personnel interviewed by the 
Subcommittee indicated that the final approval that permitted a 
new tax product to go to market was provided by the head of the 
DPP. KPMG's Tax Services Manual states that the DPP ``generally 
will not approve a solution unless the appropriate WNT 
partner(s)/principal(s) conclude that it is at least more 
likely than not that the desired tax consequences of the 
solution will be upheld if challenged by the appropriate taxing 
authority.'' 79 KPMG defines ``more likely than 
not'' as a ``greater than 50 percent probability of success if 
[a tax product is] challenged by the IRS.'' 80 KPMG 
personnel told the Subcommittee that the WNT's final sign-off 
on the technical issues had to come before the DPP would 
provide its final sign-off allowing a new tax product to go to 
market.
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    \79\ KPMG Tax Services Manual, Sec. 24.5.2, at 24-3.
    \80\ Id., Sec. 41.19.1, at 41-10.
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    Once approved, KPMG procedures required a new tax product 
to be accompanied by a number of documents before its release 
for sale to clients, including an abstract summarizing the 
product; a standard engagement letter for clients purchasing 
the product; an electronic powerpoint presentation to introduce 
the product to other KPMG tax professionals; and a 
``whitepaper'' summarizing the technical tax issues and their 
resolution.81 In addition, to ``launch'' the new 
product within KPMG, the Tax Innovation Center is supposed to 
prepare a ``Tax Solution Alert'' which serves ``as the official 
notification'' that the tax product is available for sale to 
clients.82 This Alert is supposed to include a 
``digest'' summarizing the product, a list of the KPMG 
``deployment team'' members responsible for ``delivering'' the 
product to market, pricing information, and marketing 
information such as a ``Solution Profile'' of clients who would 
benefit from the tax product and ``Optimal Target 
Characteristics'' and the expected ``Typical Buyer'' of the 
product. The four case histories demonstrated that KPMG 
personnel sometimes, but not always, complied with the 
paperwork required by its procedures. For example, while SC2 
was the subject of a ``Tax Solution Alert,'' BLIPS was not.
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    \81\ Id., Sec. 24.4.2, at 24-2. See also TIC Manual at 10.
    \82\ TIC Manual at 10.
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    In addition to or in lieu of the required ``whitepaper'' 
explaining KPMG's position on key technical issues, KPMG often 
prepared a ``prototype'' tax opinion letter laying out the 
firm's analysis and conclusions regarding the tax consequences 
of the new tax product.83 KPMG defines a ``tax 
opinion'' as ``any written advice on the tax consequences of a 
particular issue, transaction or series of transactions that is 
based upon specific facts and/or representations of the client 
and that is furnished to the client or another party in a 
letter, a whitepaper, a memorandum, an electronic or facsimile 
communication, or other form.'' 84 The tax opinion 
letter includes, at a minimum under KPMG policy, a statement of 
the firm's determination that, if challenged by the IRS, it was 
``more likely than not'' that the desired tax consequences of 
the new tax product would be upheld in court. The prototype tax 
opinion letter is intended to serve as a template for the tax 
opinion letters actually sent by KPMG to specific clients for a 
fee.
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    \83\ KPMG Tax Services Manual, Sec. 41.17.1, at 41-8.
    \84\ Id., Sec. 41.15.1, at 41-8. A KPMG tax opinion often addresses 
all of the legal issues related to a new tax product and provides an 
overall assessment of the tax consequences of the new product. See, 
e.g., KPMG tax opinion on BLIPS. Other KPMG tax opinions address only a 
limited number of issues related to a new tax product and may provide 
different levels of assurance on the tax consequences of various 
aspects of the same tax product. See, e.g., KPMG tax opinions related 
to SC2.
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    In addition to preparing its own tax opinion letter, in 
some cases KPMG seeks an opinion letter from an outside party, 
such as a law firm, to provide an ``independent'' second 
opinion on the validity of the tax product. KPMG made 
arrangements to obtain favorable legal opinion letters from an 
outside law firm in each of the case studies examined by the 
Subcommittee.
    The tax product development and approval process just 
described is the key internal procedure at KPMG today to 
determine whether the firm markets benign tax solutions that 
comply with the law or abusive tax shelters that do not. The 
investigation conducted by the Subcommittee found that, in the 
case of FLIP, OPIS, BLIPS, and SC2, KPMG tax professionals were 
under pressure not only to develop the new products quickly, 
but also to approve products that the firm's tax experts knew 
were potentially illegal tax shelters. In several of these 
cases, top KPMG tax experts participating in the review process 
expressed repeated concerns about the legitimacy of the 
relevant tax product. Despite these concerns, all four products 
were approved for sale to clients.
    BLIPS Development and Approval Process. The development and 
approval process resulting in the marketing of the BLIPS tax 
product to 186 individuals illustrates how the KPMG process 
works.85 BLIPS was first proposed as a KPMG tax idea 
in late 1998, and the generic tax product was initially 
approved for sale in May 1999. The product was finally approved 
for sale in August 1999, after the transactional documentation 
required by the BLIPS transactions was completed. One year 
later, in September 2000, the IRS issued Notice 2000-44, 
determining that BLIPS and other, similar tax products were 
potentially abusive tax shelters and taxpayers who used them 
would be subject to enforcement action.86 After this 
notice was issued, KPMG discontinued sales of the product.
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    \85\ See Appendix A for more information about BLIPS.
    \86\ IRS Notice 2000-44 (2000-36 IRB 255) (9/5/00).
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    Internal KPMG emails disclose an extended, unresolved 
debate among WNT and DPP tax professionals over whether BLIPS 
met the technical requirements of federal tax law, a debate 
which continued even after BLIPS was approved for sale. Several 
outside firms were also involved in BLIPS' development 
including Sidley Austin Brown & Wood, a law firm, and Presidio 
Advisory Services, an investment advisory firm run by two 
former KPMG tax partners. Key documents at the beginning and 
during a key 2-week period of the BLIPS approval process are 
instructive.
    BLIPS was first proposed in late 1998, as a replacement 
product for OPIS, which had earned KPMG substantial fees. From 
the beginning, senior tax leadership put pressure on KPMG tax 
professionals to quickly approve the new product for sale to 
clients. For example, after being told that a draft tax opinion 
on BLIPS had been sent to WNT for review and ``we can 
reasonably anticipate `approval' in another month or so,'' 
87 the head of the entire Tax Services Practice 
wrote:
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    \87\ Email dated 2/9/99, from Jeffrey Eischeid to John Lanning, 
Doug Ammerman, Mark Watson and Larry DeLap, ``BLIPS,'' Bates MTW 0001.

        ``Given the marketplace potential of BLIPS, I think a 
        month is far too long--especially in the spirit of 
        `first to market'. I'd like for all of you, within the 
        bounds of good professional judgement, to dramatically 
        accelerate this timeline. . . . I'd like to know how 
        quickly we can get this product to market.'' 
        88
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    \88\ Email dated 2/10/99, from John Lanning to multiple KPMG tax 
professionals, ``RE: BLIPS,'' Bates MTW 0001. See also memorandum dated 
2/11/99, from Jeffrey Zysik of TIC to ``Distribution List,'' Bates MTW 
0002 (``As each of you is by now aware, a product with a very high 
profile with the tax leadership recently was submitted to WNT/Tax 
Innovation Center. We are charged with shepherding this product through 
the WNT `productization' and review process as rapidly as possible.'')

    Five days later, the WNT technical expert in charge of 
Personal Financial Planning (PFP) tax products--who had been 
assigned responsibility for moving the BLIPS product through 
the WNT review process and was under instruction to keep the 
head of the Tax Services Practice informed of BLIPS' status--
wrote to several colleagues asking for a ``progress report.'' 
He added a postcript: ``P.S. I don't like this pressure any 
more than you do.'' 89
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    \89\ Email dated 2/15/99, from Mark Watson to multiple KPMG tax 
professionals, ``BLIPS Progress Report,'' Bates MTW 0004.
---------------------------------------------------------------------------
    A few days later, on February 19, 1999, almost a dozen WNT 
tax experts held an initial meeting to discuss the technical 
issues involved in BLIPS.90 Six major issues were 
identified, the first two of which posed such significant 
technical hurdles that, according to the WNT PFP technical 
reviewer, most participants, including himself, left the 
meeting thinking the product was ``dead.'' 91 Some 
of the most difficult technical questions, including whether 
the BLIPS transactions had economic substance, were assigned to 
two of WNT's most senior tax partners who, despite the 
difficulty, took just 2 weeks to determine, on March 5, that 
their technical concerns had been resolved. The WNT PFP 
technical reviewer continued to work on other technical issues 
related to the project. Almost 2 months later, on April 27, 
1999, he sent an email to the head of DPP stating that, with 
respect to the technical issues assigned to him, he would be 
comfortable with WNT's issuing a more-likely-than-not opinion 
on BLIPS.
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    \90\ ``Meeting Summary'' for meeting held on 2/19/99, Bates MTW 
0009.
    \91\ Subcommittee interview of Mark Watson (11/4/03).
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    Three days later, at meetings held on April 30 and May 1, a 
number of KPMG tax professionals working on BLIPS attended a 
meeting with Presidio to discuss how the investments called for 
by the product would actually be carried out. The WNT PFP 
technical reviewer told the Subcommittee staff that, at these 
meetings, the Presidio representative made a number of 
troubling comments that led him to conclude that the review 
team had not been provided all of the relevant information 
about how the BLIPS transactions would operate, and re-opened 
concerns about the technical merits of the product. For 
example, he told the Subcommittee staff that a Presidio 
representative had commented that ``the probability of actually 
making a profit from this transaction is remote'' and the bank 
would have a ``veto'' over how the loan proceeds used to 
finance the BLIPS deal would be invested. In his opinion, these 
statements, if true, meant the investment program at the heart 
of the BLIPS product lacked economic substance and business 
purpose as required by law.
    On May 4, 1999, the WNT PFP technical reviewer wrote to the 
head of the DPP expressing doubts about approving BLIPS:

        ``Larry, while I am comfortable that WNT did its job 
        reviewing and analyzing the technical issues associated 
        with BLIPS, based on the BLIPS meeting I attended on 
        April 30 and May 1, I am not comfortable issuing a 
        more-likely-than-not opinion letter [with respect to] 
        this product for the following reasons:

          ``. . . [T]he probability of actually making a 
        profit from this transaction is remote (possible, but 
        remote);

          ``The bank will control how the `loan' proceeds are 
        invested via a veto power over Presidio's investment 
        choices; and

          ``It appears that the bank wants the `loan' repaid 
        within approximately 60 days. . . .

        ``Thus, I think it is questionable whether a client's 
        representation [in a tax opinion letter] that he or she 
        believed there was a reasonable opportunity to make a 
        profit is a reasonable representation. Even more 
        concerning, however, is whether a loan was actually 
        made. If the bank controls how the loan proceeds are 
        used and when they are repaid, has the bank actually 
        made a bona fide loan?

        ``I will no doubt catch hell for sending you this 
        message. However, until the above issues are resolved 
        satisfactorily, I am not comfortable with this 
        product.'' 92
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    \92\ Email dated 5/4/99, from Mark Watson to Larry DeLap, Bates 
KPMG 0011916.

    The DPP head responded: ``It is not clear to me how this 
comports with your April 27 message [expressing comfort with 
BLIPS], but because this is a PFP product and you are the chief 
PFP technical resource, the product should not be approved if 
you are uncomfortable.'' 93 The WNT PFP technical 
reviewer responded that he had learned new information about 
how the BLIPS investments would occur, and it was this 
subsequent information that had caused him to reverse his 
position on issuing a tax opinion letter supporting the 
product.94
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    \93\ Email dated 5/5/99, from Larry DeLap to Mark Watson, Bates 
KPMG 0011916.
    \94\ Email dated 5/5/99, from Mark Watson to Larry DeLap, Bates 
KPMG 0011915-16. Mr. Watson was not the only KPMG tax professional 
expressing serious concerns about BLIPS. See, e.g., email dated 4/6/99, 
from Steven Rosenthal to Larry DeLap, ``RE: BLIPS,'' Bates MTW 0024; 
email dated 4/26/99, from Steven Rosenthal to Larry DeLap, ``RE: BLIPS 
Analysis,'' Bates MTW 0026; email dated 5/7/99, from Steven Rosenthal 
to multiple KPMG professionals, ``Who Is the Borrower in the BLIPS 
transaction,'' Bates MTW 0028; email dated 8/19/99, from Steven 
Rosenthal to Mark Watson, Bates SMR 0045.
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    On May 7, 1999 the head of DPP forwarded the WNT PFP 
technical expert's email to the leadership of the tax group and 
noted: ``I don't believe a PFP product should be approved when 
the top PFP technical partner in WNT believes it should not be 
approved.'' 95
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    \95\ Email dated 5/7/99, from Larry Delap to three KPMG tax 
professionals, with copies to John Lanning, Vice Chairman of the Tax 
Services Practice, and Jeffrey Stein, second in command of the Tax 
Services Practice, Bates KPMG 0011905. In the same email he noted that 
another technical expert, whom he had asked to review critical aspects 
of the project, had ``informed me on Tuesday afternoon that he had 
substantial concern with the `who is the borrower' issuer [sic].'' 
Later that same day, May 7, the two WNT technical reviewers expressing 
technical concerns about BLIPS met with the two senior WNT partners who 
had earlier signed off on the economic substance issue, to discuss the 
issues.
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    On May 8, 1999, the head of KPMG's Tax Services Practice 
wrote: ``I must say that I am amazed that at this late date 
(must now be six months into this process) our chief WNT PFP 
technical expert has reached this conclusion. I would have 
thought that Mark would have been involved in the ground floor 
of this process, especially on an issue as critical as profit 
motive. What gives? This appears to be the antithesis of `speed 
to market.' Is there any chance of ever getting this product 
off the launching pad, or should we simply give up???'' 
96
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    \96\ Email dated 5/8/99, from John Lanning to four KPMG tax 
professionals, Bates KPMG 0011905.
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    On May 9, one of the senior WNT partners supporting BLIPS 
sent an email to one of the WNT technical reviewers objecting 
to BLIPS and asked him: ``Based on your analysis . . . do you 
conclude that the tax results sought by the investor are NOT 
`more likely than not' to be realized?'' The technical reviewer 
responded: ``Yes.'' 97
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    \97\ Email exchange dated 5/9/99, between Richard Smith and Steven 
Rosenthal, Bates SMR 0025 and SMR 0027.
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    On May 10, the head of the WNT sent an email to five WNT 
tax professionals:

        ``Gentlemen: Please help me on this. Over the weekend 
        while thinking about WNT involvement in BLIPS I was 
        under the impression that we had sent the transaction 
        forward to DPP Tax on the basis that everyone had 
        signed off on their respective technical issues(s) and 
        that I had signed off on the overall more likely than 
        not opinion. If this impression is correct, why are we 
        revisiting the opinion other than to beef up the 
        technical discussion and further refine the 
        representations on which the conclusions are based. I 
        am very troubled that at this late date the issue is 
        apparently being revisited and if I understand 
        correctly, a prior decision changed on this technical 
        issue?! Richard, in particular, jog my memory on this 
        matter since I based my overall opinion on the fact 
        that everyone had signed off on their respective 
        areas.?'' 98
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    \98\ Email dated 5/10/99, from Philip Wiesner to multiple WNT tax 
professionals, Bates MTW 0031.

    A few hours later, the head of WNT sent eight senior KPMG 
tax professionals, including the Tax Services Practice head, 
DPP head, and the WNT PFP technical reviewer, a long email 
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message urging final approval of BLIPS. He wrote in part:

        ``Many people have worked long and hard to craft a tax 
        opinion in the BLIPS transaction that satisfies the 
        more likely than not standard. I believed that we in 
        WNT had completed our work a month ago when we 
        forwarded the [draft] opinion to Larry. . . .

        ``[T]his is a classic transaction where we can labor 
        over the technical concerns, but the ultimate 
        resolution--if challenged by the IRS--will be based on 
        the facts (or lack thereof). In short, our opinion is 
        only as good as the factual representations that it is 
        based upon. . . . The real `rubber meets the road' will 
        happen when the transaction is sold to investors, what 
        the investors' actual motive for investing the 
        transaction is and how the transaction actually 
        unfolds. . . . Third, our reputation will be used to 
        market the transaction. This is a given in these types 
        of deals. Thus, we need to be concerned about who we 
        are getting in bed with here. In particular, do we 
        believe that Presidio has the integrity to sell the 
        deal on the facts and representations that we have 
        written our opinion on?! . . .

        ``Having said all the above, I do believe the time has 
        come to shit and get off the pot. The business 
        decisions to me are primarily two: (1) Have we drafted 
        the opinion with the appropriate limiting bells and 
        whistles . . . and (2) Are we being paid enough to 
        offset the risks of potential litigation resulting from 
        the transaction? . . . My own recommendation is that we 
        should be paid a lot of money here for our opinion 
        since the transaction is clearly one that the IRS would 
        view as falling squarely within the tax shelter orbit. 
        . . .'' 99
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    \99\ Email dated 5/10/99, from Philip Wiesner to John Lanning and 
eight other KPMG tax professionals, ``RE: BLIPS,'' Bates KPMG 0011904. 
See also email response dated 5/10/99, from John Lanning to Philip 
Wiesner and other KPMG tax professionals, ``RE: BLIPS,'' Bates MTW 0036 
(``you've framed the issues well'').

    Later the same day, the Tax Services operations head wrote 
in response to the email from the WNT head: ``I think it's shit 
OR get off the pot. I vote for shit.'' 100
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    \100\ Email dated 5/10/99, from Jeffrey Stein to Philip Weisner and 
others, Bates KPMG 0011903.
---------------------------------------------------------------------------
    The same day, the WNT PFP technical reviewer wrote to the 
head of the Tax Services Practice: ``John, in my defense, my 
change in heart about BLIPS was based on information Presidio 
disclosed to me at a meeting on May 1. This information raised 
serious concerns in my mind about the viability of the 
transaction, and indicated that WNT had not been given complete 
information about how the transaction would be structured. . . 
. I want to make money as much as you do, but I cannot ignore 
information that raises questions as to whether the subject 
strategy even works. Nonetheless, I have sent Randy Bickham 
four representations that I think need to be added to our 
opinion letter. Assuming these representations are made, I am 
prepared to move forward with the strategy.'' 101
---------------------------------------------------------------------------
    \101\ Email dated 5/10/99, from Mark Watson to John Lanning and 
others, ``FW: BLIPS,'' Bates MTW 0039 (Emphasis in original.).
---------------------------------------------------------------------------
    A meeting was held on May 10, to determine how to proceed. 
The WNT head, the senior WNT partner, and the two WNT technical 
reviewers decided to move forward on BLIPS, and the WNT head 
asked the technical reviewers to draft some representations 
that, when relied upon, would enable the tax opinion writers to 
reach a more likely than not opinion. The WNT head reported the 
outcome of the meeting in an email:

        ``The group of Wiesner, R Smith, Watson and Rosenthal 
        met this afternoon to bring closure to the remaining 
        technical tax issues concerning the BLIPS transaction. 
        After a thorough discussion of the profit motive and 
        who is the borrower issue, recommendations for 
        additional representations were made (Mark Watson to 
        follow up on with Jeff Eischeid) and the decision by 
        WNT to proceed on a more likely than not basis 
        affirmed. Concern was again expressed that the critical 
        juncture will be at the time of the first real tax 
        opinion when the investor, bank and Presidio will be 
        asked to sign the appropriate representations. Finally, 
        it should be noted that Steve Rosenthal expressed his 
        dissent on the who is the investor issue, to wit, 
        `although reasonable people could reach an opposite 
        result, he could not reach a more likely than not 
        opinion on that issue'.'' 102
---------------------------------------------------------------------------
    \102\ Email dated 5/10/99, from Philip Wiesner to multiple KPMG tax 
professionals, Bates KPMG 0009344.

    After receiving this email, the DPP head sent an email to 
the WNT PFP technical reviewer asking whether he would be 
comfortable with KPMG's issuing a tax opinion supporting BLIPS. 
The WNT PFP technical reviewer wrote: ``Larry, I don't like 
this product and would prefer not to be associated with it. 
However, if the additional representations I sent to Randy on 
May 9 and 10 are in fact made, based on Phil Wiesner's and 
Richard Smith's input, I can reluctantly live with a more-
likely-than-not opinion being issued for the product.'' 
103
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    \103\ Email dated 5/11/99, from Mark Watson, WNT, to Lawrence 
DeLap, Bates KPMG 0011911.
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    The DPP head indicated to the Subcommittee staff that he 
did not consider this tepid endorsement sufficient for him to 
sign off on the product. He indicated that he then met in 
person with his superior, the head of the Tax Services 
Practice, and told the Tax Services Practice head that he was 
not prepared to approve BLIPS for sale. He told the 
Subcommittee staff that the Tax Services Practice head was 
``not pleased'' and instructed him to speak again with the 
technical reviewer.104
---------------------------------------------------------------------------
    \104\ Subcommittee interview of Lawrence DeLap (10/30/03).
---------------------------------------------------------------------------
    The DPP head told the Subcommittee staff that he then went 
back to the WNT PFP technical reviewer and telephoned him to 
discuss the product. The DPP head told the Subcommittee staff 
that, during this telephone conversation, the technical 
reviewer made a much clearer, oral statement of support for the 
product, and it was only after obtaining this statement from 
the technical reviewer that, on May 19, 1999, the DPP head 
approved BLIPS for sale to clients.105 The WNT PFP 
technical reviewer, however, told the Subcommittee staff that 
he did not remember receiving this telephone call from the DPP 
head. According to him, he never, at any time after the May 1 
meeting, expressed clear support for BLIPS' approval. He also 
stated that an oral sign-off on this product contradicted the 
DPP head's normal practice of requiring written product 
approvals.106
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    \105\ Id.
    \106\ Subcommittee interview of Mark Watson (11/4/03).
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    Over the course of the next year, KPMG sold BLIPS to 186 
individuals and obtained more than $50 million in fees, making 
BLIPS one of its highest revenue-producing tax products to 
date.
    The events and communications leading to BLIPS' approval 
for sale are troubling and revealing for a number of reasons. 
First, they show that senior KPMG tax professionals knew the 
proposed tax product, BLIPS, was ``clearly one that the IRS 
would view as falling squarely within the tax shelter orbit.'' 
Second, they show how important ``speed to market'' was as a 
factor in the review and approval process. Third, they show the 
interpersonal dynamics that, in this case, led KPMG's key 
technical tax expert to reluctantly agree to approve a tax 
product that he did not support or want to be associated with, 
in response to the pressure exerted by senior Tax Services 
professionals to approve the product for sale.
    The email exchange immediately preceding BLIPS' approval 
for sale also indicates a high level of impatience by KPMG tax 
professionals in dealing with new, troubling information about 
how the BLIPS investments would actually be implemented by the 
outside investment advisory firm, Presidio. Questions about 
this outside firm's ``integrity'' and how it would perform were 
characterized as questions of risk to KPMG that could be 
resolved with a pricing approach that provided sufficient funds 
``to offset the risks of potential litigation.'' Finally, the 
email exchange shows that the participants in the approval 
process--all senior KPMG tax professionals--knew they were 
voting for a dubious tax product that would be sold in part by 
relying on KPMG's ``reputation.'' No one challenged the 
analysis that the risky nature of the product justified the 
firm's charging ``a lot of money'' for a tax opinion letter 
predicting it was more likely than not that BLIPS would 
withstand an IRS challenge.
    Later documents show that key KPMG tax professionals 
continued to express serious concerns about the technical 
validity of BLIPS. For example, in July, 2 months after the DPP 
gave his approval to sell BLIPS, one of the WNT technical 
reviewers, objecting to the tax product, sent an email to his 
superiors in WNT noting that the loan documentation 
contemplated very conservative instruments for the loan 
proceeds and it seemed unlikely the rate of return on the 
investments would equal or exceed the loan and fees incurred by 
the borrower. He indicated that his calculations showed the 
planned foreign currency transactions would ``have to generate 
a 240% annual rate of return'' to break even. He also pointed 
out that, ``Although the loan is structured as a 7-year loan, 
the client has a tremendous economic incentive to get out of 
loan as soon as possible due to the large negative spread.'' He 
wrote: ``Before I submit our non-economic substance comments on 
the loan documents to Presidio, I want to confirm that you are 
still comfortable with the economic substance of this 
transaction.'' 107 His superiors indicated that they 
were.
---------------------------------------------------------------------------
    \107\ Email dated 7/22/99, from Mark Watson to Richard Smith and 
Phil Wiesner, Bates MTW 0078.
---------------------------------------------------------------------------
    A month later, in August, after completing a review of the 
BLIPS transactional documents, the WNT PFP technical reviewer 
again expressed concerns to his superiors in WNT:

        ``However before engagement letters are signed and 
        revenue is collected, I feel it is important to again 
        note that I and several other WNT partners remain 
        skeptical that the tax results purportedly generated by 
        a BLIPS transaction would actually be sustained by a 
        court if challenged by the IRS. We are particularly 
        concerned about the economic substance of the BLIPS 
        transaction, and our review of the BLIPS loan documents 
        has increased our level of concern.

        ``Nonetheless, since Richard Smith and Phil Wiesner--
        the WNT partners assigned with the responsibility of 
        addressing the economic substance issues associated 
        with BLIPS--have concluded they think BLIPS is a 
        ``more-likely-than-not'' strategy, I am prepared to 
        release the strategy once we complete our second review 
        of the loan documents and LLC agreement and our 
        comments thereon (if any) have been incorporated.'' 
        108
---------------------------------------------------------------------------
    \108\ Email dated 8/4/99, from Mark Watson to David Brockway, Mark 
Springer, and Doug Ammerman, Bates SMR 0039.

---------------------------------------------------------------------------
    The other technical reviewer objecting to BLIPS wrote:

        ``I share your concerns. We are almost finished with 
        our technical review of the documents that you gave us, 
        and we recommend some clarifications to address these 
        technical concerns. We are not, however, assessing the 
        economic substance of the transaction (ie., is there a 
        debt? Who is the borrower? What is the amount of the 
        liability? Is there a reasonable expectation of 
        profit?) I continue to be seriously troubled by these 
        issues, but I defer to Phil Wiesner and Richard Smith 
        to assess them.'' 109
---------------------------------------------------------------------------
    \109\ Email dated 8/4/99, from Steven Rosenthal to Mark Watson and 
others, Bates SMR 0039.

---------------------------------------------------------------------------
The senior partners in WNT chose to go forward with BLIPS.

    About 6 months after BLIPS tax products had begun to be 
sold to clients, an effort was begun within KPMG to design a 
modified ``BLIPS 2000.'' 110 One of the WNT 
technical reviewers who had objected to the original BLIPS 
again expressed his concerns:
---------------------------------------------------------------------------
    \110\ Senior KPMG tax professionals, again, put pressure on its tax 
experts to quickly approve the BLIPS 2000 product. See, e.g., email 
dated 1/17/00, from Jeff Stein to Steven Rosenthal and others, ``BLIPS 
2000,'' Bates SMR 0050 (technical expert is urged to analyze new 
product ``so we can take this to market. Your attention over the next 
few days would be most appreciated.'').

        ``I am writing to communicate my views on the economic 
        substance of the Blips, Grandfathered Blips, and Blips 
        2000 strategies. Throughout this process, I have been 
        troubled by the application of economic substance 
        doctrines . . . and have raised my concerns repeatedly 
        in internal meetings. The facts as I now know them and 
        the law that has developed, has not reduced my level of 
---------------------------------------------------------------------------
        concern.

        ``In short, in my view, I do not believe that KPMG can 
        reasonably issue a more-likely-than-not opinion on 
        these issues.'' 111
---------------------------------------------------------------------------
    \111\ Email dated 3/6/00, from Steven Rosenthal to David Brockway, 
``Blips I, Grandfathered Blips, and Blips 2000,'' Bates SMR 0056. See 
also memorandum dated 3/28/00, to David Brockway, ``Talking points on 
significant tax issues for BLIPS 2000,'' Bates SMR 0117-21 (identifying 
numerous problems with BLIPS).

    When asked by Subcommittee staff whether he had ever 
personally concluded that BLIPS met the technical requirements 
of the federal tax code, the DPP head declined to say that he 
had. Instead, he said that, in 1999, he approved BLIPS for sale 
after determining that WNT had ``completed'' the technical 
approval process.112 A BLIPS power point 
presentation produced by the Personal Financial Planning group 
in June, a few weeks after BLIPS' approval for sale, advised 
KPMG tax professionals to make sure that potential clients were 
``willing to take an aggressive position with a more likely 
than not opinion letter.'' The presentation characterized BLIPS 
as having ``about a 10 risk on [a] scale of 1-10.'' 
113
---------------------------------------------------------------------------
    \112\ Subcommittee interview of Lawrence DeLap (10/30/03).
    \113\ Power point presentation dated June 1999, by Carol Warley, 
Personal Financial Planning group, ``BLIPS AND TRACT,'' Bates KPMG 
0049639-45, at 496340. Repeated capitalizations in original text not 
included.
---------------------------------------------------------------------------
    In September 2000, the IRS identified BLIPS as a 
potentially abusive tax shelter. The IRS notice characterized 
BLIPS as a product that was ``being marketed to taxpayers for 
the purpose of generating artificial tax losses. . . . [A] loss 
is allowable as a deduction . . . only if it is bona fide and 
reflects actual economic consequences. An artificial loss 
lacking economic substance is not allowable.'' 114 
The IRS' disallowance of BLIPS has not yet been tested in 
court. Rather than defend BLIPS in court, KPMG and many BLIPS 
purchasers appear to be engaged in settlement negotiations with 
the IRS to reduce penalty assessments.
---------------------------------------------------------------------------
    \114\ IRS Notice 2000-44 (2000-36 IRB 255) (9/5/00) at 255.
---------------------------------------------------------------------------
    OPIS and FLIP Development and Approval Process. OPIS and 
FLIP were the predecessors to BLIPS. Like BLIPS, both of these 
products were ``loss generators'' intended to generate paper 
losses that taxpayers could use to offset and shelter other 
income from taxation,115 but both used different 
mechanisms than BLIPS to achieve this end. Because they were 
developed a number of years ago, the Subcommittee has more 
limited documentation on how OPIS and FLIP were developed. 
However, even this limited documentation establishes KPMG's 
awareness of serious technical flaws in both tax products.
---------------------------------------------------------------------------
    \115\ See document dated 5/18/01, ``PFP Practice Reorganization 
Innovative Strategies Business Plan--DRAFT,'' Bates KPMG 0050620-23, at 
1.
---------------------------------------------------------------------------
    For example, in the case of OPIS, which was developed 
during 1998, a senior KPMG tax professional wrote a 7-page 
memorandum filled with criticisms of the proposed tax 
product.116 The memorandum states: ``In OPIS, the 
use of debt has apparently been jettisoned. If we can not 
structure a deal without at least some debt, it strikes me that 
all the investment banker's economic justification for the deal 
is smoke and mirrors.'' At a later point, it states: ``The only 
thing that really distinguishes OPIS (from FLIPS) from a tax 
perspective is the use of an instrument that is purported to be 
a swap. . . . However, the instrument described in the opinion 
is not a swap under I.R.C. Sec. 446. . . . [A] fairly strong 
argument could be made that the U.S. investor has nothing more 
than a disguised partnership interest.''
---------------------------------------------------------------------------
    \116\ Memorandum dated 2/23/98, from Robert Simon to Gregg Ritchie, 
Randy Bickham, and John Harris, concerning OPIS, Bates KPMG 0010729.
---------------------------------------------------------------------------
    The memorandum goes on:

        ``If, upon audit, the IRS were to challenge the 
        transaction, the burden of proof will be on the 
        investor. The investor will have to demonstrate, among 
        other things, that the transaction was not consummated 
        pursuant to a firm and fixed plan. Think about the 
        prospect of having your client on the stand having to 
        defend against such an argument. The client would have 
        a difficult burden to overcome. . . . The failure to 
        use an independent 3rd party in any of the transactions 
        indicates that the deal is pre-wired.''

It also states: ``If the risk of loss concepts of Notice 98-5 
were applied to OPIS, I doubt that the investor's ownership 
interest would pass muster.'' And: ``As it stands now, the 
Cayman company remains extremely vulnerable to an argument that 
it is a sham.'' And: ``No further attempt has been made to 
quantify why I.R.C. Sec. 165 should not apply to deny the loss. 
Instead, the argument is again made that because the law is 
uncertain, we win.'' The memorandum observes: ``We are the firm 
writing the [tax] opinions. Ultimately, if these deals fail in 
a technical sense, it is KPMG which will shoulder the blame.''
    This memorandum was written in February 1998. OPIS was 
approved for sale to clients around September 1998. KPMG sold 
OPIS to 111 individuals, conducting 79 OPIS transactions on 
their behalf in 1998 and 1999.
    In the case of FLIP, an email written in March 1998, by the 
Tax Services Practice's second in command, identifies a host of 
significant technical flaws in FLIP, doing so in the course of 
discussing which of two tax offices in KPMG deserved credit for 
developing its replacement, OPIS.117 The email 
states that efforts to find a FLIP alternative ``took on an air 
of urgency when [DPP head] Larry DeLap determined that KPMG 
should discontinue marketing the existing product.'' The email 
indicates that, for about 6 weeks, a senior KPMG tax 
professional and a former KPMG tax professional employed at 
Presidio worked ``to tweak or redesign'' FLIP and ``determined 
that whatever the new product, it needed a greater economic 
risk attached to it'' to meet the requirements of federal tax 
law.
---------------------------------------------------------------------------
    \117\ Email dated 3/14/98, from Jeff Stein to Robert Wells, John 
Lanning, Larry DeLap, Gregg Ritchie, and others, ``Simon Says,'' 
concerning FLIP, Bates 638010, filed by the IRS on June 16, 2003, as an 
attachment to Respondent's Requests for Admission, Schneider Interests 
v. Commissioner, U.S. Tax Court, Docket No. 200-02.
---------------------------------------------------------------------------
    Among other criticisms of FLIP, the email states: ``Simon 
was the one who pointed out the weakness in having the U.S. 
investor purchase a warrant for a ridiculously high amount of 
money. . . . It was clear, we needed the option to be treated 
as an option for Section 302 purposes, and yet in truth the 
option [used in FLIP] was really illusory and stood out more 
like a sore thumb since no one in his right mind would pay such 
an exorbitant price for such a warrant.'' The email states: 
``In kicking the tires on FLIP (perhaps too hard for the likes 
of certain people) Simon discovered that there was a delayed 
settlement of the loan which then raised the issue of whether 
the shares could even be deemed to be issued to the Cayman 
company. Naturally, without the shares being issued, they could 
not later be redeemed.'' The email also observes: ``[I]t was 
Greg who stated in writing to I believe Bob Simon that the `the 
OPIS product was developed in response to your and DPP tax's 
concerns over the FLIP strategy. We listened to your input 
regarding technical concerns with respect to the FLIP product 
and attempt to work solutions into the new product. . . .' ''
    This email was written in March 1998, after the bulk of 
FLIP sales, but it shows that the firm had been aware for some 
time of the product's technical problems. After the email was 
written, KPMG sold FLIP to ten more customers in 1998 and 1999, 
earning more than $3 million in fees for doing so. In August 
2001, the IRS issued a notice finding both FLIP and OPIS to be 
potentially abusive tax shelters.118 The IRS has 
since audited and penalized numerous taxpayers for using these 
illegal tax shelters.119
---------------------------------------------------------------------------
    \118\ IRS Notice 2001-45 (2001-33 IRB 129) (8/13/01).
    \119\ See ``Settlement Initiative for Section 302/318 Basis-
Shifting Transactions,'' IRS Announcement 2002-97 (2002-43 IRB 757) 
(10/28/02).
---------------------------------------------------------------------------
    SC2 Development and Approval Process. The Subcommittee 
investigation also obtained documentation establishing KPMG's 
awareness of flaws in the technical merits of 
SC2.120
---------------------------------------------------------------------------
    \120\ See Appendix B for more detailed information on SC2.
---------------------------------------------------------------------------
    Documents proceeding the April 2000 decision by KPMG to 
approve SC2 for sale reflect vigorous analysis and discussion 
of the product's risks if challenged by the IRS. The documents 
also reflect, as in the BLIPS case, pressure to move the 
product to market quickly. For example, one month before SC2's 
final approval, an email from a KPMG professional in the Tax 
Innovation Center stated: ``As I was telling you, this Tax 
Solution is getting some very high level (Stein/Rosenthal) 
attention. Please review the whitepaper as soon as possible. . 
. .'' 121
---------------------------------------------------------------------------
    \121\ Email dated 3/13/00, from Phillip Galbreath to Richard 
Bailine, ``FW: S-CAEPS,'' Bates KPMG 0046889.
---------------------------------------------------------------------------
    On April 11, 2000, in the same email announcing SC2's 
approval for sale, the head of the DPP wrote:

        ``This is a relatively high risk strategy. You will 
        note that the heading to the preapproved engagement 
        letter states that limitation of liability and 
        indemnification provisions are not to be waived. . . . 
        You will also note that the engagement letter includes 
        the following statement: You acknowledge receipt of a 
        memorandum discussing certain risks associated with the 
        strategy. . . . It is essential that such risk 
        discussion memorandum (attached) be provided to each 
        client contemplating entering into an SC2 engagement.'' 
        122
---------------------------------------------------------------------------
    \122\ Email dated 4/11/00, from Larry DeLap to Tax Professional 
Practice Partners, ``S-Corporation Charitable Contribution Strategy 
(SC2),'' Bates KPMG 0052581-82. One of the KPMG tax partners to whom 
this email was forwarded wrote in response: ``Please do not forward 
this to anyone.'' Email dated 4/25/00, from Steven Messing to Lawrence 
Silver, ``S-Corporation Charitable Contribution Strategy (SC2),'' Bates 
KPMG 0052581.

    The referenced memorandum, required to be given to all SC2 
clients, identifies a number of risks associated with the tax 
product, most related to ways in which the IRS might 
successfully challenge the product's legal validity. The 
---------------------------------------------------------------------------
memorandum states in part:

        ``The [IRS] or a state taxing authority could assert 
        that some or all of the income allocated to the tax-
        exempt organization should be reallocated to the other 
        shareholders of the corporation. . . . The IRS or a 
        state taxing authority could assert that some or all of 
        the charitable contribution deduction should be 
        disallowed, on the basis that the tax-exempt 
        organization did not acquire equitable ownership of the 
        stock or that the valuation of the contributed stock 
        was overstated. . . . The IRS or a state taxing 
        authority could assert that the strategy creates a 
        second class of stock. Under the [tax code], subchapter 
        S corporations are not permitted to have a second class 
        of stock. . . . The IRS or a court might discount an 
        opinion provided by the promoter of a strategy. 
        Accordingly, it may be advisable to consider requesting 
        a concurring opinion from an independent tax advisor.'' 
        123
---------------------------------------------------------------------------
    \123\ Undated KPMG document entitled, ``S Corporation Charitable 
Contribution Strategy[:] Summary of Certain Risks,'' marked ``PRIVATE 
AND CONFIDENTIAL,'' Bates KPMG 0049987-88.

    Internally, KPMG tax professionals had identified even more 
technical problems with SC2 than were discussed in the 
memorandum given to clients. For example, KPMG tax 
professionals discussed problems with identifying a business 
purpose to explain the structure of the transaction--why a 
donor who wanted to make a cash donation to a charity would 
first donate stock to the charity and then buy it back, instead 
of simply providing a straightforward cash 
contribution.124 They also identified problems with 
establishing the charity's ``beneficial ownership'' of the 
donated stock, since the stock was provided on the clear 
understanding that the charity would sell the stock back to the 
donor within a specified period of time.125 KPMG tax 
professionals identified other technical problems as well 
involving assignment of income, reliance on tax indifferent 
parties, and valuation issues.126
---------------------------------------------------------------------------
    \124\ See, e.g., email dated 3/13/00, from Richard Bailene to 
Phillip Galbreath, ``S-CAEPS,'' Bates KPMG 0015744.
    \125\ See, e.g., email dated 3/13/00, from Richard Bailene to 
Phillip Galbreath, ``S-CAEPS,'' Bates KPMG 0015745; KPMG document dated 
3/13/00, ``S-Corporation Charitable Contribution Strategy--Variation 
#1,'' Bates KPMG 0047895 (beneficial ownership is ``probably our 
weakest link in the chain on SC2.''); memorandum dated 3/2/00, from 
William Kelliher to multiple KPMG tax professionals, ``Comments on S-
CAEPS `White Paper,' '' Bates KPMG 0016853-61.
    \126\ See, e.g., email dated 3/13/00, from Richard Bailene to 
Phillip Galbreath, ``S-CAEPS,'' Bates KPMG 0015746, and email from Mark 
Watson, ``S-CAEPS,'' Bates KPMG 0013790-93 (raising assignment of 
income concerns); emails dated 3/21/00 and 3/22/00, from Larry DeLap 
and Lawrence Manth, Bates KPMG 0015739-40 (raising tax indifferent 
party concerns); various emails between 7/28/00 and 10/25/00, among 
KPMG tax professionals, Bates KPMG 0015011-14 (raising tax indifferent 
party concerns); and memorandum dated 2/14/00, from William Kelliher to 
Richard Rosenthal, ``S-Corp Charitable and Estate Planning Strategy 
(`S-CAEPS'),'' Bates KPMG 0047693-95 (raising valuation concerns).
---------------------------------------------------------------------------
    More than a year later, in December 2001, another KPMG tax 
professional expressed concern about the widespread marketing 
of SC2 because, if the IRS ``gets wind of it,'' the agency 
would likely mount a vigorous and ``at least partially 
successful'' challenge to the product:

        ``Going way back to Feb. 2000, when SC2 first reared 
        its head, my recollection is that SC2 was intended to 
        be limited to a relatively small number of large S 
        corps. That plan made sense because, in my opinion, 
        there was (and is) a strong risk of a successful IRS 
        attack on SC2 if the IRS gets wind of it. . . . Call me 
        paranoid, but I think that such a widespread marketing 
        campaign is likely to bring KPMG and SC2 unwelcome 
        attention from the IRS. If so, I suspect a vigorous 
        (and at least partially successful) challenge would 
        result.'' 127
---------------------------------------------------------------------------
    \127\ Email dated 12/20/01, from William Kelliher to David 
Brockway, ``FW: SC2,'' Bates KPMG 0012723.

    Together, the BLIPS, OPIS, FLIP, and SC2 evidence 
demonstrates that the KPMG development process led to the 
approval of tax products that senior KPMG tax professionals 
knew had significant technical flaws and were potentially 
illegal tax shelters. Even when senior KPMG professionals 
expressed forceful objections to proposed products, highly 
questionable tax products received technical and reputational 
risk sign-offs and made their way to market.

  (2) Mass Marketing Tax Products

          LFinding: KPMG uses aggressive marketing tactics to 
        sell its generic tax products, including by turning tax 
        professionals into tax product salespersons, pressuring 
        its tax professionals to meet revenue targets, using 
        telemarketing to find clients, using confidential 
        client tax data to identify potential buyers, targeting 
        its own audit clients for sales pitches, and using tax 
        opinion letters and insurance policies as marketing 
        tools.

    Until recently, accounting firms were seen as traditional, 
professional firms that waited for clients to come to them with 
concerns, rather than affirmatively targeting potential clients 
for sales pitches on tax products. One of the more striking 
aspects of the Subcommittee investigation was discovery of the 
substantial efforts KPMG has expended to market its tax 
products, including extensive efforts to target clients and, at 
times, use high-pressure sales tactics. Evidence in the four 
case studies shows that KPMG compiled and scoured prospective 
client lists, pushed its personnel to meet sales targets, 
closely monitored their sales efforts, advised its 
professionals to use questionable sales techniques, and even 
used cold calls to drum up business. The evidence also shows 
that, at times, KPMG marketed tax shelters to persons who 
appeared to have little interest in them or did not understand 
what they were being sold, and likely would not have used them 
to reduce their taxes without being approached by KPMG.
    Extensive Marketing Infrastructure. As indicated in the 
prior section, KPMG's marketing efforts for new tax products 
normally began long before a product was approved for sale. 
Potential ``revenue analysis'' was part of the earliest 
screening efforts for new products. In addition, when a new tax 
product is launched within the firm, the ``Tax Solution Alert'' 
is supposed to include key marketing information such as 
potential client profiles, ``optimal target characteristics'' 
of buyers, and the expected ``typical buyer'' of the product.
    KPMG typically designates one or more persons to lead the 
marketing effort for a new tax product. These persons are 
referred to as the product's ``National Deployment Champions,'' 
``National Product Champions,'' or ``Deployment Leaders.'' In 
the four case studies investigated by the Subcommittee, the 
National Deployment Champion was the same person who served as 
the product's National Development Champion and shepherded the 
product through the KPMG approval process. For example, the tax 
professional who led the marketing effort for BLIPS was, again, 
Jeffrey Eischeid, assisted by Randall Bickham, while for SC2 it 
was, again, Larry Manth, assisted and succeeded by Andrew 
Atkin.
    National Deployment Champions have been given significant 
institutional support to market their assigned tax product. For 
example, KPMG maintains a national marketing office that 
includes marketing professionals and resources ``dedicated to 
tax.'' 128 Champions can draw on this resource for 
``market planning and execution assistance,'' and to assemble a 
marketing team with a ``National Marketing Director'' and 
designated ``area champions'' to lead marketing efforts in 
various regions of the United States.129 These 
individuals become members of the product's official 
``deployment team.''
---------------------------------------------------------------------------
    \128\ KPMG Tax Services Manual, Sec. 2.21.1, at 2-14.
    \129\ Id.
---------------------------------------------------------------------------
    Champions can also draw on a Tax Services group skilled in 
marketing research to identify prospective clients and develop 
target client lists. This group is known as the Tax Services 
Marketing and Research Support group. Champions can also make 
use of a KPMG ``cold call center'' in Indiana. This center is 
staffed with telemarketers trained to make cold calls to 
prospective clients and set up a phone call or meeting with 
specified KPMG tax or accounting professionals to discuss 
services or products offered by the firm. These telemarketers 
can and, at times, have made cold calls to sell specific tax 
shelters such as SC2.130
---------------------------------------------------------------------------
    \130\ See, e.g., SC2 script dated 6/19 (no year provided, but 
likely 2000) developed for telemarketer calls to identify individuals 
interested in obtaining more information, Bates KPMG 0050370-71. A 
telemarketing script was also developed for BLIPS, but it is possible 
that no BLIPS telemarketing calls were made. BLIPS script dated 7/8/99, 
Bates KPMG 0025670.
---------------------------------------------------------------------------
    In addition to a cadre of expert marketing support 
personnel, National Deployment Champions are supported by 
powerful software systems that help them identify prospective 
clients and track KPMG sales efforts across the country. The 
Opportunity Management System (OMS), for example, is a software 
system that KPMG tax professionals have used to monitor with 
precision who has been contacted about a particular tax 
product, who made the contact on behalf of KPMG, the potential 
sales revenue associated with the sales contact, and the 
current status of each sales effort.
    An email sent in 2000, by the Tax Services operations and 
Federal Tax Practice heads to 15 KPMG tax professionals paints 
a broad picture of what KPMG's National Deployment Champions 
were expected to accomplish:

        ``As National Deployment Champions we are counting on 
        you to drive significant market activity. We are 
        committed to providing you with the tools that you need 
        to support you in your efforts. A few reminders in this 
        regard.

        ``The Tax Services Marketing and Research Support is 
        prepared to help you refine your existing and/or create 
        additional [client] target lists. . . . Working closely 
        with your National Marketing Directors you should 
        develop the relevant prospect profile. Based on the 
        criteria you specify the marketing and research teams 
        can scour primary and secondary sources to compile a 
        target list. This will help you go to market more 
        effectively and efficiently.

        ``Many of you have also tapped into the Practice 
        Development Coordinator resource. Our team of 
        telemarketers is particularly helpful . . . to further 
        qualify prospects [redaction by KPMG] [and] to set up 
        phone appointments for you and your deployment team. . 
        . .

        ``Finally tracking reports generated from OMS are 
        critical to measuring your results. If you don't 
        analyze the outcome of your efforts you will not be in 
        a position to judge what is working and what is not. 
        Toward that end you must enter data in OMS. We will 
        generate reports once a month from OMS and share them 
        with you, your team, Service Line leaders and the [Area 
        Managing Partners]. These will be the focal point of 
        our discussion with you when we revisit your solution 
        on the Monday night call. You should also be using them 
        on your bi-weekly team calls. . . .

        ``Thanks again for assuming the responsibilities of a 
        National Deployment Champion. We are counting on you to 
        make the difference in achieving our financial goals.'' 
        131
---------------------------------------------------------------------------
    \131\ Email dated 8/6/00 from Jeff Stein and Rick Rosenthal to 15 
National Deployment Champions, Bates KPMG 050016.

    In 2002, KPMG opened a ``Sales Opportunity Center'' to make 
it easier for its personnel to make use of the firm's extensive 
marketing resources. An email announcing this Center stated the 
---------------------------------------------------------------------------
following:

        ``The current environment is changing at breakneck 
        speed, and we must be prepared to respond aggressively 
        to every opportunity.

        ``We have created a Sales Opportunity Center to be the 
        `eye of the needle'--a single place where you can get 
        access to the resources you need to move quickly, 
        knowledgeably, and effectively.

        ``This initiative reflects the efforts of Assurance 
        (Sales, Marketing, and the Assurance & Advisory 
        Services Center) and Tax (Marketing and the Tax 
        Innovation Center), and is intended to serve as our 
        `situation room' during these fast-moving times. . . .

        ``The Sales Opportunity Center is a powerful 
        demonstration of the Firm's commitment to giving you 
        what you need to meet the challenges of these momentous 
        times. We urge you to take advantage of this resource 
        as you pursue marketplace opportunities.'' 
        132
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    \132\ Email dated 3/14/02, from Rick Rosenthal and other KPMG 
professionals, to ``US Management Group,'' Bates XX 000141 (Emphasis in 
original.).

    Corporate Culture: Sell, Sell, Sell. After a new tax 
product has been ``launched'' within KPMG, one of the primary 
tasks of a National Deployment Champion is to educate KPMG tax 
professionals about the new product and motivate them to sell 
it.
    Champions use a wide variety of tools to make KPMG tax 
professionals aware of a new tax product. For example, they 
include product information in KPMG internal newsletters and 
email alerts, and organize conference calls and video 
conferences with KPMG tax offices across the country. Champions 
have also gone on ``road shows'' to KPMG field offices to make 
a personal presentation on a particular product. These 
presentations include how the product works, what clients to 
target, and how to respond to particular concerns. On some 
occasions, a presentation is videotaped and included in an 
office's ``video library'' to enable KPMG personnel to view the 
presentation at a later date.
    Documentation obtained by the Subcommittee shows that 
National Deployment Champions and senior KPMG tax officials 
expend significant effort to convince KPMG personnel to devote 
time and resources to selling new products. Senior tax 
professionals use general exhortations as well as specific 
instructions directed to specific field offices to increase 
their sales efforts. For example, after SC2 was launched, the 
head of KPMG's Federal Practice sent the following an email to 
the SC2 ``area champions'' around the country:

        ``I want to personally thank everyone for their efforts 
        during the approval process of this strategy. It was 
        completed very quickly and everyone demonstrated true 
        teamwork. Thank you! Now let[']s SELL, SELL, SELL!!'' 
        133
---------------------------------------------------------------------------
    \133\ Email dated 2/18/00, from Richard Rosenthal to multiple KPMG 
tax professionals, Bates KPMG 0049236.

    The Federal Tax head also called specific KPMG offices to 
urge them to increase their SC2 sales. This type of instruction 
from a senior KPMG tax official apparently sent a strong 
message to subordinates about the need to sell the identified 
tax product. For example, a tax professional in a KPMG field 
office in Houston wrote the following after participating in a 
conference call on SC2 in which the Federal Tax head and the 
SC2 National Deployment Champion urged the office to improve 
---------------------------------------------------------------------------
its SC2 sales record:

        ``I don't know if you were on Larry Manth's call today, 
        but Rosenthal led the initial discussion. There have 
        been several successes. . . . We are behind.

        ``This is THE STRATEGY that they expect significant 
        value added fees by June 30.

        ``The heat is on. . . .'' 134
---------------------------------------------------------------------------
    \134\ Email dated 4/21/00, from Michael Terracina, KPMG office in 
Houston, to Gary Choate, KPMG office in Dallas, Bates KPMG 0048191.

    In the SC2 case study examined by the Subcommittee, 
National Deployment Champions did not end their efforts with 
phone calls and visits urging KPMG tax professionals to sell 
their tax product, they also produced detailed marketing plans, 
implemented them with the assistance of the ``deployment 
team,'' and pressured their colleagues to increase SC2 sales. 
For example, one email circulated among two members of the SC2 
deployment team and two senior KPMG tax professionals 
---------------------------------------------------------------------------
demonstrates the measures used to push sales:

        ``To memorialize our discussion, we agreed the 
        following:

          ``*Over the next two weeks, Manth [SC2 National 
        Deployment Champion] will deploy [Andrew] Atkin [on the 
        SC2 deployment team] to call each of the SC2 area 
        solution champions.

          ``*Andrew will work with the champion to establish a 
        specific action plan for each opportunity. To be at all 
        effective, the plans should [be] very specific as to 
        who is going to do what when. . . . There should be 
        agreement as to when Andrew will next follow-up with 
        them to create a real sense of urgency and 
        accountability.

          ``*Andrew will involve Manth where he is not getting 
        a response within 24 hours or receiving inappropriate 
        `pushback.' Manth will enlist [David] Jones or Rick 
        [Rosenthal, senior KPMG tax officials,] to help 
        facilitate responsiveness where necessary given the 
        urgency of the opportunity. . . .

          ``*Manth believes inadequate resources are currently 
        deployed to exploit the Midwest SCorp client and target 
        population. Craig Pichette has not yet been able to 
        dedicate enough time to this solution. . . . John 
        Schrier (NE Stratecon) or Councill Leak (SE Stratecon) 
        could be effective. . . .

          ``*Resource[s] will be assigned to adequately 
        address the market opportunity in Florida. . . . Goals 
        must be explicit . . . including a percentage weighting 
        based on expected time commitment. . . .

        ``Manth will explore with Rick the opportunity to form 
        alliances with other accounting firms to drive 
        distribution.'' 135
---------------------------------------------------------------------------
    \135\ Email dated 1/30/01, from David Jones to Larry Manth, Richard 
Rosenthal, and Wendy Klein, ``SC2--Follow-up to 1/29 Revisit,'' Bates 
KPMG 0050389.

    Senior KPMG tax officials also set overall revenue goals 
for various tax groups and urged them to increase their sales 
of designated tax products to meet those goals. For example, in 
an email alerting nearly 40 tax professionals in the 
``Stratecon West'' group to a conference call on a ``Kick Off 
Plan For '01,'' a senior Stratecon professional, who was also 
---------------------------------------------------------------------------
the SC2 National Deployment Champion, wrote:

        ``Hello everyone. We will be having a conference call 
        to kick-off our Stratecon marketing efforts to 
        aggressively pursue closed deals by 6/30/01. The main 
        purpose of the call is to discuss our marketing and 
        targeting strategy and to get everyone acquainted with 
        a number of Stratecon's high-end solutions. If you have 
        clients, at least one of these strategies should be 
        applicable to your client base. As you all know, to 
        reach plan in the West, we must aggressively pursue 
        these high-end strategies.'' 136
---------------------------------------------------------------------------
    \136\ Email dated 12/2/00, from Lawrence Manth to multiple tax 
professionals, Bates XX 000021.

    Two months later, a member of the SC2 deployment team, who 
also worked for Stratecon, sent an email to an even larger 
group of 60 tax professionals, urging them to try a new, more 
appealing version of SC2. In a paragraph subtitled, ``Why 
---------------------------------------------------------------------------
Should You Care?'' he wrote:

        ``In the last 12 months the original SC2 structure has 
        produced $1.25 million in signed engagements for the SE 
        [Southeast]. . . . Look at the last partner scorecard. 
        Unlike golf, a low number is not a good thing. . . . A 
        lot of us need to put more revenue on the board before 
        June 30. SC2 can do it for you. Think about targets in 
        your area and call me.'' 137
---------------------------------------------------------------------------
    \137\ Email dated 2/22/01, from Councill Leak to multiple tax 
professionals, Bates KPMG 0050822-23.

    The steady push for tax product sales continued. For 
example, three weeks later, the Stratecon tax professional sent 
an email to his colleagues stating, ``Due to the significant 
push for year-end revenue, all West Region Federal tax partners 
have been invited to join us on this [conference] call and we 
will discuss our `Quick Hit' strategies and targeting 
criteria.'' 138 Six weeks after that, the same 
Stratecon official announced another conference call urging 
Stratecon professionals to discuss two ``tax minimization 
opportunities for individuals'' which will ``have a quick 
revenue hit for us.'' 139
---------------------------------------------------------------------------
    \138\ Email dated 3/13/01, from Larry Manth to multiple KPMG tax 
professionals, ``Friday's Stratecon Call,'' Bates XX 001439.
    \139\ Email dated 4/25/01, from Larry Manth to multiple KPMG tax 
professionals, ``Friday's Stratecon Call,'' Bates XX 001438.
---------------------------------------------------------------------------
    Stratecon was not alone in the push for sales. For example, 
in 2000, the former head of KPMG's Washington National Tax 
Practice sent an email to all ``US-WNT Tax Partners'' urging 
them to ``temporarily defer non-revenue producing activities'' 
and concentrate for the ``next 5 months'' on meeting WNT's 
revenue goals for the year.140 The email states in 
part:
---------------------------------------------------------------------------
    \140\ Email dated 2/3/00, from Philip Wiesner to US-WNT Tax 
Partners, Bates KPMG 0050888-90.

        ``Listed below are the tax products identified by the 
        functional teams as having significant revenue 
        potential over the next few months. . . . [T]he 
        functional teams will need . . . WNT champions to work 
        with the National Product champions to maximize the 
        revenue generated from the respective products. . . . 
        Thanks for help in this critically important matter. As 
        Jeff said, `We are dealing with ruthless execution--
        hand to hand combat--blocking and tackling.' Whatever 
---------------------------------------------------------------------------
        the mixed metaphor, let's just do it.''

    The evidence is clear that selling tax products was an 
important part of every tax professional's job at KPMG.
    Targeting Clients. KPMG's marketing efforts included 
substantial efforts to identify prospective purchasers for its 
tax products. KPMG developed prospective client lists by 
reviewing both its own client base and seeking new clients 
through referrals and cold calls.
    To review its own client base, KPMG has used software 
systems, including ones known as KMatch and RIA-GoSystem, to 
identify former or existing clients who might be interested in 
a particular tax product. KMatch is ``[a]n interactive software 
program that asks a user a series of questions about a client's 
business and tax situation,'' uses the information to construct 
a ``client profile,'' and then uses the profile to identify 
KPMG tax products that could assist the client to avoid 
taxation.141 KPMG's Tax Innovation Center conducted 
a specific campaign requiring KPMG tax professionals to enter 
client data into the KMatch database so that, when subsequent 
tax products were launched, the resulting client profiles could 
be searched electronically to identify which clients would be 
eligible for and interested in the new product. RIA-GoSystem is 
a separate internal KPMG database which contains confidential 
client data provided to KPMG to assist the firm in preparing 
client tax returns.142 This database of confidential 
client tax information can also be searched electronically to 
identify prospective clients for new tax products and was 
actually used for that purpose in the case of 
SC2.143
---------------------------------------------------------------------------
    \141\ Presentation entitled, ``KMatch Push Feature Campaign,'' 
undated, prepared by Marsha Peters of the Tax Innovation Center, Bates 
XX 001511.
    \142\ See, e.g., email dated 3/6/01, from US-GoSystem 
Administration to Andrew Atkin of KPMG, ``RE: Florida S corporation 
search,'' Bates KPMG 0050826; Subcommittee interview of Councill Leak 
(10/22/03).
    \143\ Id.
---------------------------------------------------------------------------
    The evidence indicates that KPMG also uses its assurance 
professionals--persons who provide auditing and related 
services to individuals and corporations--to identify existing 
KPMG audit clients who might be interested in new tax products. 
Among other documents evidencing the role of KPMG assurance 
professionals is the development and marketing of tax products 
that require the combined participation of both KPMG tax and 
assurance professionals. In 2000, for example, KPMG issued what 
it called its ``first joint solution'' requiring KPMG tax and 
assurance professionals to work together to sell and implement 
the product.144 The tax product is described as a 
``[c]ollection of assurance and tax services designed to assist 
companies in . . . realizing value from their intellectual 
property . . . [d]elivered by joint team of KPMG assurance and 
tax professionals.'' 145 Internal KPMG documentation 
states that the purpose of the new product is ``[t]o increase 
KPMG's market penetration of key clients and targets by 
enhancing the linkage between Assurance and Tax 
professionals.'' 146 Another KPMG document states: 
``Teaming with Assurance expands tax team's knowledge of client 
and industry[.] Demonstrates unified team approach that 
separates KPMG from competitors.'' 147 Another KPMG 
document shows that KPMG used both its internal tax and 
assurance client lists to target clients for a sales pitch on 
the new product:
---------------------------------------------------------------------------
    \144\ Presentation dated 7/17/00, ``Targeting Parameters: 
Intellectual Property--Assurance and Tax,'' with attachment dated 
September 2000, entitled ``Intellectual Property Services,'' at page 1 
of the presentation, Bates XX 001567-93.
    \145\ Presentation dated 10/30/00, ``Intellectual Property Services 
(IPS),'' by Dut LeBlanc of Shreveport and Joe Zier of Silicon Valley, 
Bates XX 001580-93.
    \146\ Presentation dated 7/17/00, ``Targeting Parameters: 
Intellectual Property--Assurance and Tax,'' with attachment dated 
September 2000, entitled ``Intellectual Property Services,'' at page 1 
of the attachment, Bates XX 001567-93.
    \147\ Presentation dated 10/30/00, ``Intellectual Property Services 
(IPS),'' by Dut LeBlanc of Shreveport and Joe Zier of Silicon Valley, 
Bates XX 001580-93.

        ``The second tab of this file contains the draft target 
        list [of companies]. This list was compiled from two 
        sources an assurance and tax list. . . . [W]e selected 
        the companies which are assurance or tax clients, which 
        resulted in the 45 companies on the next sheet. . . . 
        What should you do? Review the suspects with your 
        assurance or tax deployment counterpart. . . . 
        Prioritize your area targets, and plan how to approach 
        them.'' 148
---------------------------------------------------------------------------
    \148\ Presentation dated 7/17/00, ``Targeting Parameters: 
Intellectual Property--Assurance and Tax,'' with attachment dated 
September 2000, entitled ``Intellectual Property Services,'' at page 1 
of the attachment, Bates XX 001567-93.

    Additional tax products which relied in part on KPMG audit 
partners followed. In 2002, for example, KPMG launched a ``New 
Enterprises Tax Suite'' product 149 which it 
described internally as ``a cross-functional element of the Tax 
Practice that efficiently mines opportunities in the start-up 
and middle-market, high-growth, high-tech space.'' A 
presentation on this new product states that KPMG tax 
professionals are ``[t]eaming with Assurance . . . [and] 
fostering cross-selling among assurance and tax 
professionals.'' 150
---------------------------------------------------------------------------
    \149\ See WNT presentation dated 9/19/02, entitled ``Innovative Tax 
Solutions,'' which, at 18-26, includes a presentation by Tom Hopkins of 
Silicon Valley, ``New Enterprises Tax Suite,'' Tax Solution Alert 00-
31, Bates XX 001636-1706. The Hopkins presentation states that the new 
product is intended to be used to ``[l]everage existing client base 
(pull-through),'' ``[d]evelop and use client selection filters to 
refine our bets and reach higher market success,'' and ``[e]nhance 
relationships with client decisionmakers.'' As part of a ``Deployment 
Action Plan,'' the presentation states that KPMG ``[p]artners with 
revenue goals are given subscriptions to Venture Wire for daily lead 
generation'' and that ``[t]argeting is supplemented by daily lead 
generation from Fort Wayne'' where KPMG's telemarketing center is 
located.
    \150\ Presentation dated 3/6/00, ``Post-Transaction Integration 
Service (PTIS)--Tax,'' by Stan Wiseberg and Michele Zinn of Washington, 
D.C., Bates XX 001597-1611 (``Global collaborative service brought to 
market by tax and assurance . . . May be appropriate to initially 
unbundle the serves (`tax only,' or `assurance only') to capture an 
engagement'').
---------------------------------------------------------------------------
    Other tax products explicitly called on KPMG tax 
professionals to ask their audit counterparts for help in 
identifying potential clients. For example, a ``Middle Market 
Initiative'' launched in 2001, identified seven tax products to 
be marketed to mid-sized corporations, including SC2. It 
explicitly called upon KPMG tax professionals to contact KPMG 
audit partners to identify appropriate mid-sized corporations, 
and directed these tax professionals to pitch one or more of 
the seven KPMG tax products to KPMG audit clients. ``In order 
to maximize marketplace opportunities . . . national and area 
champions will coordinate with and involve assurance partners 
and managers in their respective areas.'' 151
---------------------------------------------------------------------------
    \151\ Email dated 8/14/01, from Jeff Stein and Walter Duer to 
``KPMG LLP Partners, Managers and Staff,'' ``Stratecon Middle Market 
Initiative,'' Bates KPMG 0050369.
---------------------------------------------------------------------------
    In addition to electronic searches, National Deployment 
Champions regularly exhorted KPMG field personnel to review 
their client lists personally to identify those that might be 
interested in a new product. In the case of SC2, deployment 
team members asked KPMG tax professionals to review their 
client lists, not once, but twice:

        ``Attached above is a listing of all potential SC2 
        engagements that did not fly over the past year. In an 
        effort to ensure we have not overlooked any potential 
        engagement during the revenue push for the last half of 
        [fiscal year] 2001, please review the list which is 
        sorted by estimated potential fees. I'd like to revisit 
        each of these potential engagements, and gather 
        comments from each of you regarding the following. . . 
        . Would further communication/dialogue with any listed 
        potential engagement be welcome? What were the reasons 
        for the potential client's declining the strategy?'' 
        152
---------------------------------------------------------------------------
    \152\ Email dated 2/9/01, from Ty Jordan to multiple KPMG tax 
professionals, ``SC2 revisit of stale leads,'' Bates KPMG 0050814.

    In addition to reviewing its own client base, KPMG worked 
with outside parties, such as banks, law firms, and other 
accounting firms, to identify outside client prospects. One 
example is the arrangement KPMG entered into with First Union 
National Bank, now part of Wachovia Bank, in which Wachovia 
referred clients to KPMG in connection with FLIP. In this case, 
Wachovia told wealthy clients about the existence of the tax 
product and allowed KPMG to set up appointments at the bank or 
elsewhere to make client presentations on FLIP.153 
KPMG apparently did not pay Wachovia a direct referral fee for 
these clients, but if a client eventually agreed to purchase 
FLIP, a portion of the fees paid by the client to Quellos, a 
investment advisory firm handling the FLIP transactions, was 
forwarded by Quellos to Wachovia. KPMG also made arrangements 
for Wachovia client referrals related to BLIPS and SC2, again 
using First Union National Bank, but it is unclear whether the 
bank actually made any referrals for these tax 
products.154 In the case of SC2, KPMG also worked 
with a variety of other outside parties, such as mid-sized 
accounting firms and automobile dealers, to locate and refer 
potential clients.155 A large law firm headquartered 
in St. Louis expressed willingness not only to issue a 
confirming tax opinion for the SC2 transaction, but also to 
introduce KPMG ``to some of their midwestern clients.'' 
156
---------------------------------------------------------------------------
    \153\ Subcommittee interview of Wachovia Bank representatives (3/
25/03).
    \154\ See, e.g., email dated 8/30/99, from Tom Newman to multiple 
First Union professionals, ``next strategy,'' Bates SEN 014622 (BLIPS 
``[f]ees to First Union will be 50 basis points if the investor is not 
a KPMG client, 25 bps if they are a KPMG client.''); email dated 11/30/
01, from Councill Leak to Larry Manth, ``FW: First Union Customer 
Services,'' Bates KPMG 0050842-44 (``I provide my comments on how we 
are bringing SC2 into certain First Union customers.''). Because KPMG 
is also Wachovia's auditor, questions have arisen as to whether their 
client referral arrangements violate SEC's auditor independence rules. 
See Section VI(B)(5) of this Report for more information on the auditor 
independence issue.
    \155\ See, e.g., email dated 1/30/01, from David Jones to Larry 
Manth, Richard Rosenthal, and Wendy Klein, ``SC2--Follow-up to 1/29 
Revisit,'' Bates KPMG 0050389 (working to form accounting firm 
alliances).
    \156\ Memorandum dated 2/16/01, from Andrew Atkin to SC2 Marketing 
Group, ``Agenda from Feb 16th call and goals for next two weeks,'' 
Bates KPMG 0051135.
---------------------------------------------------------------------------
    In addition to reviewing its own client base and seeking 
client referrals, KPMG used a variety of other means to 
identify prospective clients. In the case of SC2, for example, 
as part of its marketing efforts, KPMG obtained lists of S 
corporations in the states of Texas, North and South Carolina, 
New York, and Florida.157 It obtained these lists 
from either state government, commercial firms, or its own 
databases. The Florida list, for example, was compiled using 
KPMG's internal RIA-GoSystem containing confidential client 
data extracted from certain tax returns prepared by 
KPMG.158 Some of the lists had large blocks of S 
corporations associated with automobile or truck dealers, real 
estate firms, home builders, or architects.159 In 
some instances, KPMG tax professionals instructed KPMG 
telemarketers to contact the corporations to gauge interest in 
SC2.160 In other cases, KPMG tax professionals 
contacted the corporations personally.
---------------------------------------------------------------------------
    \157\ See, e.g., email dated 8/14/00, from Postmaster-US to unknown 
recipients, ``Action Required: Channel Conflict for SC2,'' Bates KPMG 
0049125 (S corporation list purchased from Dun & Bradstreet); 
memorandum dated 2/16/01, from Andrew Atkin to SC2 Marketing Group, 
``Agenda from Feb 16th call and goals for next two weeks,'' Bates KPMG 
0051135 (Texas S corporation list); email dated 3/7/01, from Councill 
Leak to multiple KPMG tax professionals, ``South Florida SC2 Year End 
Push,'' Bates KPMG 0050834 (Florida S corporation list); email dated 3/
26/01, from Leonard Ronnie III, to Gary Crew, ``RE: S-Corp Carolinas,'' 
Bates KPMG 0050818 (North and South Carolina S corporation list); email 
dated 4/22/01, from Thomas Crawford to John Schrier, ``RE: SC2 target 
list,'' Bates KPMG 0050029 (New York S corporation list).
    \158\ Email dated 3/6/01, from US-GoSystem Administration to Andrew 
Atkin of KPMG, ``RE: Florida S corporation search,'' Bates KPMG 
0050826. Subcommittee interview of Councill Leak (10/22/03).
    \159\ Email dated 11/17/00, from Jonathan Pullano to US-Southwest 
Tax Services Partners and others, ``FW: SW SC2 Channel Conflict,'' 
Bates KPMG 0048309.
    \160\ See, e.g., email dated 6/27/00, from Wendy Klein to Mark 
Springer and Larry Manth, ``SC2: Practice Development Coordinators 
Involvement,'' Bates KPMG 0049116; email dated 11/15/00, from Douglas 
Duncan to Michael Terracina and Gary Choat, ``FW: SW SC2 Progress,'' 
Bates KPMG 0048315-17.
---------------------------------------------------------------------------
    The lists compiled by KPMG produced literally thousands of 
potential SC2 clients, and through telemarketing and other 
calls, KPMG personnel made uncounted contacts across the 
country searching for buyers of SC2. In April 2001, the DPP 
apparently sent word to SC2 marketing teams to stop using 
telemarketing calls to find SC2 buyers,161 but 
almost as soon as the no-call policy was announced, some KPMG 
tax professionals were attempting to circumvent the ban asking, 
for example, if telemarketers could question S corporations 
about their eligibility and suitability to buy SC2, without 
scheduling future telephone contacts.162 In December 
2001, after being sent a list of over 3,100 S corporations 
targeted for telephone calls, a senior KPMG tax professional 
sent an email to the head of WNT complaining that the list 
appeared to indicate ``the firm is intent on marketing the SC2 
strategy to virtually every S corp with a pulse.'' 
163
---------------------------------------------------------------------------
    \161\ See email dated 4/22/01, from John Schrier to Thomas 
Crawford, ``RE: SC2 target list,'' Bates KPMG 0050029.
    \162\ Email dated 4/23/01, from John Schrier to Thomas Crawford, 
``RE: SC2 target list,'' Bates KPMG 0050029.
    \163\ Email dated 12/20/01, from William Kelliher to David 
Brockway, WNT head, Bates KPMG 0013311. A responsive email from Mr. 
Brockway on the same document states, ``It looks like they have already 
tried over 2/3rds of possible candidates already, if I am reading the 
spread sheet correctly.''
---------------------------------------------------------------------------
    When KPMG representatives were first asked about KPMG's use 
of telemarketers, they initially told the Subcommittee staff 
that telemarketing calls were against firm 
policy.164 When asked about the Indiana cold call 
center which KPMG has been operating for years, the KPMG 
representatives said that the center's telemarketers sought to 
introduce new clients to KPMG in a general way and did little 
more than arrange an appointment so that KPMG could explain to 
a potential client in person all of the services KPMG offers. 
When confronted with evidence of telemarketing calls for SC2, 
the KPMG representatives acknowledged that a few calls on tax 
products might have been made by telemarketers at the cold call 
center, but implied such calls were few in number and rarely 
led to sales. In a separate interview, when shown documents 
indicating that, in the case of SC2, KPMG telemarketers made 
calls to thousands of S corporations across the country, the 
KPMG tax professional being interviewed admitted these calls 
had taken place.165
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    \164\ Subcommittee briefing by Jeffrey Eischeid and Timothy Speiss 
(9/12/03).
    \165\ Subcommittee interview of Councill Leak (10/22/03).
---------------------------------------------------------------------------
    Sales Advice. To encourage sales, KPMG would, at times, 
provide written advice to its tax professionals on how to 
answer questions about a tax product, respond to objections, or 
convince a client to buy a product.
    For example, in the case of SC2, KPMG sponsored a meeting 
for KPMG ``SC2 Team Members'' across the country and emailed 
documents providing information about the tax product as well 
as ``Appropriate Answers for Frequently Asked Shareholder 
Questions'' and ``Suggested Solutions'' to ``Sticking Points 
and Problems.'' 166 The ``Sticking Points'' document 
provided the following advice to KPMG tax professionals trying 
to sell SC2 to prospective clients:
---------------------------------------------------------------------------
    \166\ ``SC2--Meeting Agenda'' and attachments, dated 6/19/00, Bates 
KPMG 0013375-96.

        ``1) `Too Good to be true.' Some people believe that if 
        it sounds too good to be true, it's a sham. Some 
---------------------------------------------------------------------------
        suggestions for this response are the following:

          ``a) This transaction has been through KPMG's WNT 
        practice and reviewed by at least 5 specialty groups. . 
        . . Many of the specialists are ex-IRS employees.

          ``b) Many sophisticated clients have implemented the 
        strategy in conjunction with their outside counsel.

          ``c) At least one outside law firm will give a co-
        opinion on the transactions. . . .

          ``e) Absolutely last resort--At least 3 insurance 
        companies have stated that they will insure the tax 
        benefits of the transaction for a small premium. This 
        should never be mentioned in an initial meeting and 
        Larry Manth should be consulted for all insurance 
        conversations to ensure consistency and independence on 
        the transaction.

        ``2) `I Need to Think About it.' . . . We obviously do 
        not want to seem too desperate but at the same time we 
        need to keep this moving along. Some suggestions:

          ``a) `Get Even' Approach. Perhaps a good time to 
        revisit the strategy is at or near estimated tax 
        payment time when the shareholder is making or has made 
        a large estimated tax payment and is extremely 
        irritated for having done so. . . .

          ``b) Beenie Baby Approach. . . . We call the client 
        and say that the firm has decided to cap the strategy . 
        . . and the cap is quickly filling up. `Should I put 
        you on the list as a potential?' This is obviously a 
        more aggressive approach, but will tell you if the 
        client is serious about the deal.

          ``c) `Break-up' Approach. This is a risky approach 
        and should only be used in a limited number of cases. 
        This approach entails us calling the client and 
        conveying to them that they should no longer consider 
        SC2 for a reason solely related to KPMG, such as the 
        cap has been reached with respect to our city or region 
        or . . . the demand has been so great that the firm is 
        shutting it down. This approach is used as a 
        psychological tool to elicit an immediate response from 
        the client. . . .

        ``5) John F. Brown Syndrome. This is named after an 
        infamous attorney who could not get comfortable with 
        anything about the strategy. We have had a number of 
        clients with stubborn outside counsel with respect to 
        the strategy itself, the engagement letter, or other 
        aspects of the transaction. Here are some approaches:

          ``a. If we . . . know he will not approve of the 
        transaction we should tell this to the client and 
        either walk or convince the client not to use the 
        attorney or law firm for this deal. . . .

          ``c. If the fee is substantial . . . the last resort 
        is to summarize a transaction with all the possible 
        bells and whistles to make the deal as risk-free as 
        possible. For example: The client does SC2 with the 
        following elements: 1) option to reacquire stock from 
        [tax exempt organization], 2) insurance covering the 
        tax benefits plus penalties . . ., and 3) outside 
        opinion from an independent law firm. If the attorney 
        is still uncomfortable, we need to convey this to the 
        client and they can decide.''

    This document is hardly the work product of a disinterested 
tax adviser. In fact, it goes so far as to recommend that KPMG 
tax professionals employ such hard-sell tactics as making 
misleading statements to their clients--claims that SC2 will be 
sold to only a limited number of people or that it is no longer 
being sold at all in order to ``elicit an immediate response 
from the client.'' The document also depicts attorneys raising 
technical concerns about SC2 as ``stubborn'' naysayers who need 
to be circumvented, rather than satisfied. In short, rather 
than present KPMG as a disinterested tax adviser, this type of 
sales advice is evidence of a company intent on convincing an 
uninterested or hesitant client to buy a product that the 
client would apparently be otherwise unlikely to purchase or 
use.
    Using Tax Opinions and Insurance as Marketing Tools. 
Several documents obtained during the investigation demonstrate 
that KPMG deliberately traded on its reputation as a respected 
accounting firm and tax expert in selling questionable tax 
products to corporations and individuals. As described in the 
prior section on designing new tax products, the former WNT 
head acknowledged that KPMG's ``reputation will be used to 
market the [BLIPS] transaction. This is a given in these types 
of deals.'' In the SC2 ``Sticking Points'' document, KPMG 
instructed its tax professionals to respond to client concerns 
about the product by pointing out that SC2 had been reviewed 
and approved by five KPMG tax specialty groups and by 
specialists who are former employees of the IRS.167
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    \167\ ``SC2--Meeting Agenda'' and attachments, dated June 19, 2000, 
at Bates KPMG 0013394.
---------------------------------------------------------------------------
    KPMG also used opinion letters as a marketing tool. Tax 
opinion letters are intended to provide written advice 
explaining whether a particular tax product is permissible 
under the law and, if challenged by the IRS, the likelihood 
that the tax product would survive court scrutiny. A tax 
opinion letter provided by a person with a financial stake in 
the tax product being analyzed has traditionally been accorded 
much less deference than an opinion letter supplied by a 
disinterested expert. As shown in the SC2 ``Sticking Points'' 
document just cited, if a client raised concerns about 
purchasing the product, KPMG instructed its tax professionals 
to respond that, ``At least one outside law firm will give a 
co-opinion on the transactions.'' 168 In another SC2 
document, KPMG advises its tax professionals to tell clients 
worried about IRS penalties: ``The opinion letters that we 
issue should get you out of any penalties. However, the Service 
could try to argue that KPMG is the promoter of the strategy 
and therefore the opinions are biased and try and assert 
penalties. We believe there is very low risk of this result. If 
you desire additional assurance, there is at least one outside 
law firm in NYC that will issue a co-opinion. The cost ranges 
between $25k-$40k.'' 169
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    \168\ Id. Another document identified Bryan Cave, a law firm with 
over 600 professionals and offices in St. Louis, New York, and 
elsewhere, as willing ``to issue a confirming tax opinion for the SC2 
transaction.'' Memorandum dated 2/16/01, from Andrew Atkin to SC2 
Marketing Group, ``Agenda from Feb 16th call and goals for the next two 
weeks,'' Bates KPMG 0051135. See also email dated 7/19/00, from Robert 
Coplan of Ernst & Young to ``[email protected],'' Bates 2003EY011939 
(``As you know, we go to great lengths to line up a law firm to issue 
an opinion pursuant to a separate engagement letter from the client 
that is meant to make the law firm independent from us.'')
    \169\ ``SC2--Appropriate Answers for Frequently Asked Shareholder 
Questions,'' included in an SC2 information packet dated 7/19/00, Bates 
KPMG 0013393.
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    KPMG was apparently so convinced that an outside legal 
opinion increased the marketability of its tax products, that 
in the case of FLIP, it agreed to pay Sidley Austin Brown & 
Wood a fee in any sale where a prospective buyer was told that 
the law firm would provide a favorable tax opinion letter, 
regardless of whether the opinion was actually provided. A KPMG 
tax professional explained in an email: ``Our deal with Brown 
and Wood is that if their name is used in selling the strategy 
they will get a fee. We have decided as a firm that B&W opinion 
should be given in all deals.'' 170 This guaranteed 
fee arrangement also provided an incentive for Sidley Austin 
Brown & Wood to refer clients to KPMG.
---------------------------------------------------------------------------
    \170\ ``Declaration of Richard E. Bosch,'' IRS Revenue Agent, In re 
John Doe Summons to Sidley Austin Brown & Wood (N.D. Ill. 10/16/03) at 
para. 18, citing an email dated 10/1/97, from Gregg Ritchie to Randall 
Hamilton. (Capitalizations in original omitted.)
---------------------------------------------------------------------------
    On occasion, KPMG also used insurance as a marketing tool 
to convince reluctant buyers to purchase a KPMG tax product. In 
the case of SC2, the ``Sticking Points'' document advised KPMG 
tax professionals to tell clients about the existence of an 
insurance policy that, for a ``small premium,'' could guarantee 
SC2's promised ``tax benefits'':

        ``At least 3 insurance companies have stated that they 
        will insure the tax benefits of the transaction for a 
        small premium. This should never be mentioned in an 
        initial meeting and Larry Manth should be consulted for 
        all insurance conversations to ensure consistency and 
        independence on the transaction.'' 171
---------------------------------------------------------------------------
    \171\ ``SC2--Meeting Agenda'' and attachments, dated June 19, 2000, 
Bates KPMG 0013375-96.

    According to KPMG tax professionals interviewed by 
Subcommittee staff, the insurance companies offering this 
insurance included AIG and Hartford.172 KPMG 
apparently possessed sample insurance policies that promised to 
reimburse the policy holder for a range of items, including 
penalties or fines assessed by the IRS for using SC2, 
essentially insuring the policy holder against being penalized 
for tax evasion.173 Once these policies were 
available, KPMG tax professionals were asked to re-visit 
potential clients who had declined the tax product and try 
again:
---------------------------------------------------------------------------
    \172\ See, e.g., Subcommittee interview of Lawrence Manth (11/6/
03).
    \173\ Id.

        ``Attached above is a listing of all potential SC2 
        engagements that did not fly over the past year. . . . 
        We now have a number of Insurance companies which would 
        like to underwrite the tax risk inherent in the 
        transaction. We may want to revisit those potential 
        clients that declined because of audit risk.'' 
        174
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    \174\ Email dated 2/9/01, from Ty Jordan to multiple KPMG tax 
professionals, ``SC2 revisit of stale leads,'' Bates KPMG 0050814.

Evidence obtained by the Subcommittee indicates that at least 
half a dozen SC2 purchasers also purchased SC2 insurance.
    Tracking Sales and Revenue. KPMG repeatedly told the 
Subcommittee staff that it did not have the technical 
capability to track the sales or revenues associated with 
particular tax products.175 However, evidence 
gathered by the Subcommittee indicates that KPMG could and did 
obtain specific revenue tracking information.
---------------------------------------------------------------------------
    \175\ Subcommittee briefing by Jeffrey Eischeid (9/12/03); 
Subcommittee interview of Jeffrey Stein (10/31/03).
---------------------------------------------------------------------------
    The Subcommittee learned, for example, that once a tax 
product was sold to a client and the client signed an 
engagement letter, KPMG assigned the transaction an 
``engagement number,'' and recorded in an electronic database 
all revenues resulting from that engagement. This engagement 
data could then be searched and manipulated to provide revenue 
information and totals for individual tax products.
    Specific evidence that revenue information was collected 
for tax products was obtained by the Subcommittee during the 
investigation from parties other than KPMG. For example, an SC2 
``update'' prepared in mid-2001, includes detailed revenue 
information, including total nationwide revenues produced by 
the tax product since it was launched, total nationwide 
revenues produced during the 2001 fiscal year, and FY01 
revenues broken down by each of six regions in the United 
States: 176
---------------------------------------------------------------------------
    \176\ Internal KPMG presentation, dated 6/18/01, by Andrew Atkin 
and Bob Huber, entitled ``S-Corporation Charitable Contribution 
Strategy (SC2) Update,'' Bates XX 001553.

        ``Revenue since solution was launched:
          $20,700,000

        ``Revenue this fiscal year only:
          $10,700,000

        ``Revenue by Region this Fiscal Year

          * West    $7,250,000
          * Southeast    $1,300,000
          * Southwest    $850,000
          * Mid-Atlantic    $550,000
          * Midwest    $425,000
          * Northeast    $300,000

KPMG never produced this document to the 
Subcommittee.177 However, one email related to SC2 
that KPMG did produce states that monthly OMS ``tracking 
reports'' were used to measure sales results for specific tax 
products, and these reports were regularly shared with National 
Deployment Champions, Tax Service Line leaders, and Area 
Managing Partners.178
---------------------------------------------------------------------------
    \177\ Another document provided to the Subcommittee by parties 
other than KPMG carefully traces the increase in the Tax Services 
Practice's ``gross revenue.'' It shows a ``45.5% Cumulative Growth'' in 
gross revenue over a 4-year period, with $829 million in FY98, $1.001 
million in FY99, $1.184 million in FY00, and $1.239 million in FY01. 
See chart entitled, ``Tax Practice Growth Gross Revenue,'' included in 
a presentation dated 7/19/01, entitled, ``Innovative Tax Solutions,'' 
by Marsha Peters of Washington National Tax, Bates XX 001340.
    \178\ Email dated 8/6/00 from Jeffrey Stein to15 National 
Deployment Champions, Bates KPMG 050016.
---------------------------------------------------------------------------
    Moreover, KPMG's Tax Innovation Center reported in 2001, 
that it had developed new software that ``captured solution 
development costs and revenue'' and that it had begun 
``[p]repar[ing] quarterly Solution Profitability reports.'' 
179 This information suggests that KPMG was refining 
its revenue tracking capabilities to be able to track not only 
gross revenues produced by a tax product, but also net 
revenues, and that it had begun collecting and monitoring this 
information on a regular basis. KPMG's statement, ``the firm 
does not maintain any systematic, reliable method of recording 
revenues by tax product on a national basis,'' 180 
was contradicted by the evidence.
---------------------------------------------------------------------------
    \179\ Internal KPMG presentation, dated 5/30/01, by the Tax 
Innovation Center, entitled ``Tax Innovation Center Solution and Idea 
Development--Year-End Results,'' Bates XX 001490-1502.
    \180\ Letter from KPMG to Subcommittee, dated 4/22/03, attached 
one-page chart entitled, ``Good Faith Estimate of Top Revenue-
Generating Strategies,'' n.1.
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    No Industry Slow-Down. Some members of the U.S. tax 
profession have asserted that professional firms are beginning 
to turn away from marketing illegal tax shelters, so there is 
no need for investigations, reforms, or stronger laws in this 
area. KPMG has claimed that it is no longer marketing 
aggressive tax products designed to be sold to multiple 
clients. The Subcommittee investigation, however, found that, 
while a few professional firms have reduced or stopped selling 
generic tax products in the last 2 years, KPMG and other 
professional firms appear to be committed to continuing and 
deepening their efforts to develop and market generic, 
potentially abusive, tax products to multiple clients.
    Evidence of KPMG's commitment to ongoing tax product sales 
appears throughout this Report. For example, KPMG provided the 
Subcommittee with a 2003 list of more than 500 ``active tax 
products'' it intends to offer to multiple clients for a fee. 
Just last year, in 2002, KPMG established a ``Sales Opportunity 
Center'' which the firm itself has characterized as ``a 
powerful demonstration of the Firm's commitment to giving'' 
KPMG professionals ready access to marketing tools to sell 
products and services to multiple clients. Also in 2002, the 
Tax Innovation Center helped develop new software to enable 
KPMG to track tax product development costs and net revenues, 
and issue quarterly tax product profitability reports. In 2003, 
KPMG's telemarketing center in Indiana continued to be staffed 
and ready for tax product marketing assistance.
    Evidence of marketing campaigns shows KPMG sought to expand 
its tax product sales by targeting new market segments. In 
August 2001, for example, KPMG launched a ``Middle Market 
Initiative'' to increase its tax product sales to mid-sized 
corporations:

        ``Consistent with several other firm initiatives . . . 
        we are launching a major initiative in Tax to focus 
        certain of our resources on the Middle Market. A major 
        step in this initiative is driving certain Stratecon 
        high-end solutions to these companies . . . through a 
        structured, proactive program. . . . National and area 
        champions of this initiative will meet with leadership 
        . . . to discuss solutions, agree on appropriate 
        targets, and develop an area strategy. . . . In order 
        to maximize marketplace opportunities . . . national 
        and area champions will coordinate with and involve 
        assurance partners and managers in their respective 
        areas. . . . [C]hampions will also coordinate with the 
        tax practice's proposed strategic alliance with mid-
        tier accounting firms. The goal for Stratecon is to 
        close and implement engagements totaling $15 M in 
        revenues over the next 15 month period (FY ending 9/
        02).'' 181
---------------------------------------------------------------------------
    \181\ Email dated 8/14/01, from Jeff Stein and Walter Duer to 
``KPMG LLP Partners, Managers and Staff,'' ``Stratecon Middle Market 
Initiative,'' Bates KPMG 0050369.

The Middle Market Initiative identified seven KPMG tax products 
to be marketed to mid-sized corporations, including SC2. It 
explicitly called upon KPMG tax professionals to contact KPMG 
audit partners to identify appropriate mid-sized corporations, 
and then to pitch one or more of the seven KPMG tax products to 
KPMG audit clients. It is the Subcommittee staff's 
understanding that this marketing campaign is ongoing and 
successfully increasing KPMG tax product sales to mid-sized 
corporations across the United States.182
---------------------------------------------------------------------------
    \182\ Subcommittee interview of Jeffrey Stein (10/31/03).
---------------------------------------------------------------------------
    In December 2001, KPMG held a ``FY02 Tax Strategy 
Meeting,'' to discuss ``taking market leadership'' in 2002. One 
email described the meeting as follows:

        ``Thank you for attending the FY02 Tax Strategy 
        Meeting. It's now time to take action. As you enter the 
        marketplace armed with the knowledge of `Taking Market 
        Leadership,' please remember to share your thoughts and 
        experiences with us so we can better leverage the three 
        key market pillars--Market Share, Client Centricity, 
        and Market-Driven Solutions. . . .

        ``[W]e want to hear more about:

          * Teaming with Assurance; . . .
          * How clients are responding to our services and 
        solutions;
          * Ideas for new services and solutions; and
          * Best practices.'' 183
---------------------------------------------------------------------------
    \183\ Email dated 12/12/01, from Dale Affonso to ``Tax Personnel--
LA & PSW,'' Bates XX 001733.

    Additional evidence of KPMG's continued involvement in the 
marketing of generic tax products comes from the chart prepared 
by KPMG, at the Subcommittee's request, listing its top ten 
revenue producing tax products in 2000, 2001, and 
2002.184 The list of ten tax products for 2002 
includes, among others, the ``Tax-Efficient Minority Preferred 
Equity Sale Transaction'' (TEMPEST) and the ``Optional Tax-
Deductible Hybrid Equity while Limiting Local Obligation'' 
(OTHELLO).185 Another KPMG chart, listing Strat 
econ's tax products as of January 1, 2002, describes TEMPEST as 
a product that ``creates capital loss,'' 186 while 
OTHELLO ``[c]reates a basis step-up in built-in gain asset and 
potential for double benefit of built-in losses.'' 
187 The minimum fee KPMG intends to charge clients 
for each of these products, TEMPEST and OTHELLO, is $1 
million.188 KPMG has also indicated that each of the 
tax products listed on the Stratecon chart remained an ``active 
tax product'' as of February 10, 2003.189
---------------------------------------------------------------------------
    \184\ KPMG chart entitled, ``Good Faith Estimate of Top Revenue-
Generating Strategies,'' attached to letter dated 4/22/03, from KPMG's 
legal counsel to the Subcommittee, Bates KPMG 0001801.
    \185\ Id.
    \186\ KPMG chart entitled ``StrateconWest/FSG Solutions and 
Solution WIP--As of January 1, 2002,'' Bates XX 001009-25.
    \187\ Id. at 2.
    \188\ Id. at 2 and 4.
    \189\ See undated document provided by KPMG to the Subcommittee on 
2/10/03, ``describing all active tax products included in Tax Products 
Alerts, Tax Solutions Alerts and Tax Service Ideas,'' Bates KPMG 
0000089-90.
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    A final example of evidence of KPMG's ongoing commitment to 
selling generic tax products is a draft business plan for 
fiscal year 2002, prepared for the Personal Financial Planning 
(PFP) tax practice's Innovative Strategies (IS) 
group.190 This business plan indicates that, while 
the IS group's marketing efforts had decreased after IRS 
issuance of new tax shelter notices, it had done all the 
preparatory work needed to resume vigorous marketing of new, 
potentially abusive tax shelters in 2002. The IS business plan 
first recounts the group's past work on FLIP, OPIS, and BLIPS, 
noting that the millions of dollars in revenue produced from 
sales of these tax products had enabled IS to exceed its annual 
revenue goals in each year from 1998 until 2000. The business 
plan then states:
---------------------------------------------------------------------------
    \190\ Document dated 5/18/01, ``PFP Practice Reorganization 
Innovative Strategies Business Plan--DRAFT,'' Bates KPMG 0050620-23, at 
1. This document was authored by Jeffrey Eischeid, according to Mr. 
Eischeid. Subcommittee interview of Jeffrey Eischeid (11/3/03).

        ``The fiscal [2001] IS revenue goal was $38 million and 
        the practice has delivered $16 million through period 
        10. The shortfall from plan is primarily attributable 
        to the August 2000 issuance [by the IRS] of Notice 
        2000-44. This Notice specifically described both the 
        retired BLIPS strategy and the then current 
        [replacement, the Short Option Strategy or] SOS 
        strategy. Accordingly, we made the business decisions 
        to stop the implementation of `sold' SOS transactions 
        and to stay out of the `loss generator' business for an 
---------------------------------------------------------------------------
        appropriate period of time.''

    The business plan then identified six tax products which 
had been approved for sale or were awaiting approval, and which 
were ``expected to generate $27 million of revenue in fiscal 
'02.'' 191 Two of these strategies, called 
``Leveraged Private Split Dollar'' and ``Monetization Tax 
Advisory Services,'' were not explained, but were projected to 
generate $5 million in 2002 fees each.192 Another 
tax product, under development and projected to generate $12 
million in 2002 fees, is described as:
---------------------------------------------------------------------------
    \191\ Id. at 3.
    \192\ Id. But see minutes dated 11/30/00, Monetization Solutions 
Task Force Teleconference, Bates KPMG 0050624-29, at 50627 (advocating 
KPMG design and implementation of ``sophisticated entity structures 
that have elements of both financial product technology and tax 
technology,'' including ``monetization solutions that have been 
traditionally offered by the investment banks'' such as ``prepaid 
forwards, puts and calls, short sales, synthetic OID conveyances, and 
other derivative structures.'')

        ``a gain mitigation solution, POPS. Judging from the 
        Firm's historic success in generating revenue from this 
        type of solution, a significant market opportunity 
        obviously exists. We have completed the solution's 
        technical review and have almost finalized the 
        rationale for not registering POPS as a tax shelter.'' 
        193
---------------------------------------------------------------------------
    \193\ Document dated 5/18/01, ``PFP Practice Reorganization 
Innovative Strategies Business Plan--DRAFT,'' Bates KPMG 0050620-23, at 
2.

Still another tax product, under development and projected to 
generate $5 million in 2002 fees, is described as a 
``conversion transaction . . . that halves the taxpayer's 
effective tax rate by effectively converting ordinary income to 
long term capital gain. . . . The most significant open issue 
is tax shelter registration and the impact registration will 
have on the solution.'' The business plan estimates that, if 
the projected sales occur, ``the planned revenue per [IS] 
partner would be $3 million and the planned contribution per 
partner would equal or exceed $1.5 million.''
    The business plan provides this analysis:


        ``[T]here has been a significant increase in the 
        regulation of `tax shelters.' Not only is this 
        regulatory activity dampening market appetite, it is 
        changing the structural nature of the underlying 
        strategies. Specifically, taxpayers are having to put 
        more money at risk for a longer period of time in order 
        to improve the business purpose economic substance 
        arguments. All things considered, it is more difficult 
        today to close tax advantaged transactions. 
        Nevertheless, we believe that the Innovative Strategies 
        practice is a sustainable business opportunity with 
        significant growth opportunity.'' 194
---------------------------------------------------------------------------
    \194\ Id. at 2.

This and other evidence obtained by the Subcommittee during the 
past year indicate an ongoing, internal effort within KPMG to 
continue the development and sale of generic tax products to 
multiple clients.

  (3) Implementing Tax Products

    (a) KPMG's Implementation Role

          LFinding: KPMG is actively involved in implementing 
        the tax shelters which it sells to its clients, 
        including by enlisting participation from banks, 
        investment advisory firms, and tax exempt 
        organizations; preparing transactional documents; 
        arranging purported loans; issuing and arranging 
        opinion letters; providing administrative services; and 
        preparing tax returns.

    In many cases, KPMG's involvement with a tax product sold 
to a client does not end with the sale itself. Many KPMG tax 
products, including the four examined by the Subcommittee, 
require the purchaser to carry out complex financial and 
investment activities in order to realize promised tax 
benefits. KPMG typically provided such clients with significant 
implementation assistance to ensure they realized the promised 
tax benefits on their tax returns. KPMG was also interested in 
successful implementation of its tax products, because the 
track record that built up over time for a particular product 
affected how KPMG could, in good faith, characterize that 
product to new clients. Implementation problems have also, at 
times, caused KPMG to adjust how a tax product is structured 
and even spurred development of a new product.
    Executing FLIP, OPIS, and BLIPS. FLIP, OPIS, and BLIPS 
required the purchaser to establish a shell corporation, join a 
partnership, obtain a multi-million dollar loan, and engage in 
a series of complex financial and investment transactions that 
had to be carried out in a certain order and in a certain way 
to realize tax benefits. The evidence collected by the 
Subcommittee shows that KPMG was heavily involved in making 
sure the client transactions were completed properly.
    As a first step, KPMG enlisted the participation of 
professional organizations to help design its products and 
carry them out. In the case of FLIP, which was the first of the 
four tax products to be developed, KPMG sought the assistance 
of investment experts at a small firm called Quellos to design 
the complex series of financial transactions called for by the 
product.195 Quellos, using contacts it had 
established in other business dealings, helped KPMG convince a 
major bank, UBS AG, to provide financing and participate in the 
FLIP transactions. Quellos worked with UBS to fine-tune the 
financial transactions, helped KPMG make client presentations 
about FLIP and, for those who purchased the product, helped 
complete the paperwork and transactions, using Quellos 
securities brokers. KPMG also enlisted help from Wachovia Bank, 
convincing the bank to refer bank clients who might be 
interested in the FLIP tax product.196 In some 
cases, the bank permitted KPMG and Quellos to make FLIP 
presentations to its clients in the bank's 
offices.197 KPMG also enlisted Sidley Austin Brown & 
Wood to issue a favorable legal opinion letter on the FLIP tax 
product.198
---------------------------------------------------------------------------
    \195\ Quellos was then known and doing business as Quadra Capital 
Management LLP or QA Investments, LLC.
    \196\ KPMG actually did business with First Union National Bank, 
which subsequently merged with Wachovia Bank.
    \197\ Subcommittee interview of First Union National Bank 
representatives (3/25/03).
    \198\ KPMG actually worked with Brown & Wood, a large New York law 
firm which subsequently merged with Sidley & Austin.
---------------------------------------------------------------------------
    In the case of OPIS and BLIPS, KPMG, again, enlisted the 
help of Sidley Austin Brown & Wood, but used a different 
investment advisory firm. Instead of Quellos, KPMG obtained 
investment advice from Presidio Advisory Services. Presidio was 
formed in 1997, by two former KPMG tax professionals, one of 
whom was a key participant in the development and marketing of 
FLIP.199 These two tax professionals left the 
accounting firm, because they wanted to focus on the investment 
side of the generic tax products being developed by 
KPMG.200 Unlike Quellos, which had substantial 
investment projects aside from FLIP, virtually all of 
Presidio's work over the following 5 years derived from KPMG 
tax products. Presidio's principals worked closely with KPMG 
tax professionals to design OPIS and BLIPS. Presidio's 
principals also helped KPMG obtain lending and securities 
services from three major banks, Deutsche Bank, HVB, and 
NatWest, to complete OPIS and BLIPS transactions.
---------------------------------------------------------------------------
    \199\ The two former KPMG tax professionals are John Larson and 
Robert Pfaff. They also formed numerous other companies, many of them 
shells, to participate in business dealings including, in some cases, 
OPIS and BLIPS transactions. These related companies include Presidio 
Advisors, Presidio Growth, Presidio Resources, Presidio Volatility 
Management, Presidio Financial Group, Hayes Street Management, Holland 
Park, Prevad, Inc., and Norwood Holdings (collectively referred to as 
``Presidio'').
    \200\ Subcommittee interview of John Larson (10/21/03); email dated 
7/29/97, from Larry DeLap to multiple KPMG tax professionals, ``Revised 
Memorandum,'' Bates KPMG JAC 331160, forwarding memorandum dated 7/29/
97, from Bob Pfaff to John Lanning, Jeff Stein and others, ``My 
Thoughts Concerning KPMG's Tax Advantaged Transaction Practice, 
Presidio's Relationship with KPMG, Transition Issues.''
---------------------------------------------------------------------------
    In addition to enlisting the participation of legal, 
investment, and financial professionals, KPMG provided 
significant administrative support for the FLIP, OPIS, and 
BLIPS transactions, using KPMG personnel to help draft and 
prepare transactional documents, and assist the investment 
advisory firms and the banks with paperwork. For example, when 
a number of loans were due to be closed in certain BLIPS 
transactions, two KPMG staffers were stationed at HVB to assist 
the bank with closing and booking issues.201 Other 
KPMG employees were assigned to Presidio to assist in 
expediting BLIPS transactions and paperwork. KPMG also worked 
with Quellos, Presidio, and the relevant banks to ensure that 
the banks established large enough credit lines, with hundreds 
of millions of dollars, to allow a substantial number of 
individuals to carry out FLIP, OPIS, and BLIPS transactions.
---------------------------------------------------------------------------
    \201\ Credit Request dated 9/26/99, Bates HVB 001166; Subcommittee 
interview of HVB representatives (10/29/03).
---------------------------------------------------------------------------
    When asked about KPMG's communications with the banks, the 
OPIS and BLIPS National Deployment Champion initially denied 
ever contacting bank personnel directly, claiming instead to 
have relied on Quellos and Presidio personnel to work directly 
with the bank personnel.202 When confronted with 
documentary evidence of direct contacts, however, the 
Deployment Champion reluctantly admitted communicating on rare 
occasions with bank personnel. Evidence obtained by the 
Subcommittee, however, shows that KPMG communications with bank 
personnel were not rare. KPMG negotiated intensively with the 
banks over the factual representations that would be attributed 
to the banks in the KPMG opinion letters. On occasion, KPMG 
stationed its personnel at the banks to facilitate transactions 
and paperwork. The BLIPS National Deployment Champion met with 
NatWest personnel regarding the BLIPS transactions. In one 
instance in 2000, documents indicate that, when clients had 
exhausted the available credit at Deutsche Bank to conduct OPIS 
transactions, the Deployment Champion planned to meet with 
senior Deutsche Bank officials about increasing the credit 
lines so that more OPIS products could be sold.203
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    \202\ Subcommittee interview of Jeffrey Eischeid (10/8/03).
    \203\ See, e.g., memorandum dated 8/5/98, from Doug Ammerman to 
``PFP Partners,'' ``OPIS and Other Innovative Strategies,'' Bates KPMG 
0026141-43 at 2; email dated 5/13/99, sent by Barbara Mcconnachie but 
attributed to Doug Ammerman, to John Lanning and other KPMG tax 
professionals, ``FW: BLIPS,'' Bates KPMG 0011903 (``Jeff Eischeid will 
be attending a meeting . . . to address the issue of expanding capacity 
at Deutsche Bank given our expectation regarding the substantial volume 
expected from this product.'') It is unclear whether this meeting 
actually took place.
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    Executing SC2. In the case of SC2, the tax product could 
not be executed at all without a charitable organization 
willing to participate in the required transactions. KPMG took 
on the task of locating and convincing appropriate charities to 
participate in SC2 transactions. The difficulty of this task 
was evident in several KPMG documents. For example, one SC2 
document warned KPMG personnel not to look for a specific 
charity to participate in a specific SC2 transaction until 
after an engagement letter was signed with a client because: 
``It is difficult to find qualifying tax exempts. . . . [O]f 
those that qualify only a few end up being interested and only 
a few of those will accept donations. . . . We need to be able 
to go to the tax-exempt with what we are going to give them to 
get them interested.'' 204 In another email, the SC2 
National Deployment Champion wrote:
---------------------------------------------------------------------------
    \204\ Attachment entitled, ``Tax Exempt Organizations,'' included 
in an SC2 information packet dated 7/19/00, ``SC2--Meeting Agenda,'' 
Bates KPMG 0013387.

        ``Currently we have five or six tax exempts that have 
        reviewed the transaction, are comfortable they are not 
        subject to UBIT [unrelated business income tax] and are 
        eager to receive gifts of S Corp stock. These 
        organizations are well established, solid 
        organizations, but generally aren't organizations our 
        clients and targets have made gifts to in the past. 
        This point hit painfully home when, just before signing 
        our engagement letter for an SC2 transaction with a $3 
        million fee, an Atlanta target got cold feet.'' 
        205
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    \205\ Email dated 2/22/01, from Councill Leak to multiple KPMG tax 
professionals, ``SC2 Solution--New Development,'' Bates KPMG 0050822.

    KPMG refused to identify to the Subcommittee any of the 
charities it contacted about SC2 or any of the handful of 
charities that actually participated in SC2 stock donations, 
claiming this was ``tax return information'' that it could not 
disclose. The Subcommittee was nevertheless able to identify 
and interview two charitable organizations which, between them, 
participated in more than half of the 58 SC2 transactions KPMG 
arranged.206
---------------------------------------------------------------------------
    \206\ Subcommittee interviews with Los Angeles Department of Fire & 
Police Pension System (10/22/03) and the Austin Fire Relief and 
Retirement Fund (10/14/03).
---------------------------------------------------------------------------
    Both charities interviewed by Subcommittee staff indicated 
that they first learned of SC2 when contacted by KPMG 
personnel. Both used the same phrase, that KPMG had contacted 
them ``out of the blue.'' 207 Both charities 
indicated that KPMG personnel explained SC2 to them, convinced 
them to participate, introduced the potential SC2 donors to the 
charity, and supplied draft transactional documents. Both 
charities indicated that, with KPMG acting as a liaison, they 
then accepted S corporation stock donations from out-of-state 
residents whom they never met and with whom they had never had 
any prior contact.
---------------------------------------------------------------------------
    \207\ Id.
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    KPMG also distributed to its personnel a document entitled, 
``SC2 Implementation Process,'' listing a host of 
implementation tasks they should complete in each transaction. 
These tasks included technical, administrative, and logistical 
chores. For example, KPMG personnel were told they should 
evaluate the S corporation's ownership structure and 
incorporation documentation; work with an outside valuation 
firm to determine the corporation's enterprise value and the 
value of the corporate stock and warrants; and physically 
deliver the appropriate stock certificates to the charity 
accepting the client's stock donation.208
---------------------------------------------------------------------------
    \208\ ``SC2 Implementation Process,'' included in an SC2 
information packet dated 7/19/00, Bates KPMG 0013385-86.
---------------------------------------------------------------------------
    Both charities said that KPMG often acted as a go-between 
for the charity and the corporate donor, shuttling documents 
back and forth and answering inquiries on both sides. KPMG 
apparently also drafted and supplied draft transactional 
documents to the S corporations and corporate 
owners.209 One of the pension funds informed the 
Subcommittee staff that, when one corporate donor needed to re-
take possession of the corporate stock due to an unrelated 
business opportunity that required use of the stock, KPMG 
assisted in the mechanics of selling the stock back to the 
donor.210
---------------------------------------------------------------------------
    \209\ Subcommittee interview of Lawrence Manth (11/6/03).
    \210\ Subcommittee interview of William Stefka, Austin Fire Relief 
and Retirement Fund (10/14/03).
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    The documentation shows that KPMG tax professionals also 
expended significant effort developing a ``back-end deal'' for 
SC2 donors, meaning a tax transaction that could be used by the 
S corporation owner to further reduce or eliminate their tax 
liability when they retake control of the S corporation and 
distribute some or all of the income that built up within the 
company while the charity was a shareholder. The SC2 National 
Deployment Champion wrote to more than 20 of his colleagues 
working on SC2 the following:

        ``Our estimate is that by 12/31/02, there will be 
        approximately $1 billion of income generated by S-corps 
        that have implemented this strategy, and our goal is to 
        maintain the confidentiality of the strategy for as 
        long as possible to protect these clients (and new 
        clients). . . .

        ``We have had our first redemption from the LAPD. 
        Particular thanks to [a KPMG tax professional] and his 
        outstanding relationship with the LAPD fund 
        administrators, the redemption went smooth. [Three KPMG 
        tax professionals] all worked together on structuring 
        the back-end deal allowing for the shareholder to 
        recognize a significant benefit, as well as getting 
        KPMG a fee of approx. $1 million, double the original 
        SC2 fee!!

        ``[Another KPMG tax professional] is in the process of 
        working on a back-end solution to be approved by WNT 
        that will provide S-corp shareholders additional basis 
        in their stock which will allow for the cash build-up 
        inside of the S-corporation to be distributed tax-free 
        to the shareholders. This should provide us with an 
        additional revenue stream and a captive audience. Our 
        estimate is that if 50% of the SC2 clients implement 
        the back-end solution, potential fees will approximate 
        $25 million.'' 211
---------------------------------------------------------------------------
    \211\ Email dated 12/27/01, from Larry Manth to Andrew Atkin and 
other KPMG tax professionals, ``SC2,'' Bates KPMG 0048773. See also 
email dated 8/18/01, from Larry Manth to multiple KPMG tax 
professionals, ``RE: New Solutions--WNT,'' Bates KPMG 0026894.

This email communication shows that the key KPMG tax 
professionals involved with SC2 viewed the strategy as a way to 
defer and reduce taxes on substantial corporate income that was 
always intended to be returned to the control of the stock 
donor. It also shows that KPMG's implementation efforts on SC2 
continued long past the sale of the tax product to a client.
    Preparing KPMG Opinion Letters. In addition to helping 
clients complete the transactions called for in FLIP, OPIS, 
BLIPS, and SC2, when it came time for clients to submit tax 
returns at the end of the year or in subsequent years, KPMG was 
available to help its clients prepare their returns. In 
addition, whether a client's tax return was prepared by KPMG or 
someone else, KPMG supplied the client with a tax opinion 
letter explaining the tax benefits that the product provided 
and could be reflected in the client's tax return. In three of 
the cases examined by the Subcommittee, KPMG also arranged for 
its clients to obtain a second favorable opinion letter from an 
outside law firm. In the fourth case, SC2, KPMG knew of law 
firms willing to issue a second opinion letter, but it is 
unclear whether any were actually issued.
    A tax opinion letter, sometimes called a legal opinion 
letter when issued by a law firm, is intended to provide 
written advice to a client on whether a particular tax product 
is permissible under the law and, if challenged by the IRS, how 
likely it would be that the challenged product would survive 
court scrutiny. The Subcommittee investigation uncovered 
disturbing evidence related to how opinion letters were being 
developed and used in connection with KPMG's tax products.
    The first issue involves the accuracy and reliability of 
the factual representations that were included in the opinion 
letters supporting KPMG's tax products. In the four case 
histories, KPMG tax professionals expended extensive effort 
drafting a prototype tax opinion letter to serve as a template 
for the opinion letters actually sent by KPMG to its clients. 
One key step in the drafting process was the drafting of 
factual representations attributed to parties participating in 
the relevant transactions. Such factual representations play a 
critical role in the opinion letter by laying a factual 
foundation for its analysis and conclusions. Treasury 
regulations state:

        ``The advice [in an opinion letter] must not be based 
        on unreasonable factual or legal assumptions (including 
        assumptions as to future events) and must not 
        unreasonably rely on the representations, statements, 
        findings, or agreements of the taxpayer or any other 
        person. For example, the advice must not be based upon 
        a representation or assumption which the taxpayer 
        knows, or has reason to know, is unlikely to be true, 
        such as an inaccurate representation or assumption as 
        to the taxpayer's purposes for entering into a 
        transaction or for structuring a transaction in a 
        particular manner.'' 212
---------------------------------------------------------------------------
    \212\ Treas. Reg. Sec. 1.6664-4(c)(1)(ii).

    KPMG stated in its opinion letters that its analysis relied 
on the factual representations provided by the client and other 
key parties. In the BLIPS prototype tax opinion, for example, 
KPMG stated that its ``opinion and supporting analysis are 
based upon the following description of the facts and 
representations associated with the investment transactions 
undertaken by Investor.'' 213 The Subcommittee was 
told that Sidley Austin Brown & Wood relied on the same factual 
representations to compose the legal opinion letters that it 
drafted.
---------------------------------------------------------------------------
    \213\ Prototype BLIPS tax opinion letter prepared by KPMG, (12/31/
99), Bates KPMG 0000405-417, at 1.
---------------------------------------------------------------------------
    Virtually all of the FLIP, OPIS, and BLIPS opinion letters 
contained boilerplate repetitions of the factual 
representations attributed to the participating parties. For 
example, virtually all the KPMG FLIP clients made the same 
factual representations, worded in the same way. The same was 
true for KPMG's OPIS clients and for KPMG's BLIPS clients. Each 
of the banks that participated in BLIPS made factual 
representations that varied slightly from bank to bank, but did 
not vary at all for a particular bank. In other words, Deutsche 
Bank and HVB attested to slightly different versions of the 
factual representations attributed to the bank participating in 
the BLIPS transactions, but every BLIPS opinion letter that, 
for example, referred to Deutsche Bank, contained the exact 
same boilerplate language to which Deutsche Bank had agreed to 
attest.
    The evidence is clear that KPMG took the lead in drafting 
the factual representations attributed to other parties, 
including the client or ``investor'' who purchased the tax 
product, the investment advisory firm that participated in the 
transactions, and the bank that provided the financing. In the 
case of the factual representations attributed to the 
investment advisory firm or bank, the evidence indicates that 
KPMG presented its draft language to the relevant party and 
then engaged in detailed negotiations over the final 
wording.214 In the case of the factual 
representations attributed to a client, however, the evidence 
indicates KPMG did not consult with its client beforehand, even 
for representations purporting to describe, in a factual way, 
the client's intentions, motivations, or understanding of the 
tax product. KPMG alone, apparently without any client input, 
wrote the client's representations and then demanded that each 
client attest to them by returning a signed letter to the 
accounting firm.
---------------------------------------------------------------------------
    \214\ See, e.g., email dated 3/27/00, from Jeffrey Eischeid to 
Richard Smith, ``Bank representation,'' and email dated 3/28/00, from 
Jeffrey Eischeid to Mark Watson, ``Bank representation,'' Bates KPMG 
0025753 (depicting negotiations between KPMG and Deutsche Bank over 
factual representations to be included in opinion letter).
---------------------------------------------------------------------------
    The evidence indicates that KPMG not only failed to consult 
with its clients before attributing factual representations to 
them, it also refused to allow its clients to deviate from the 
KPMG-drafted representations, even when clients disagreed with 
the statements being attributed to them. For example, according 
to a court complaint filed by one KPMG client, Joseph Jacoboni, 
he initially refused to attest to the factual representations 
sent to him by KPMG about a FLIP transaction, because he had no 
first hand knowledge of the ``facts'' and did not understand 
the FLIP transaction.215 According to Mr. Jacoboni, 
KPMG would not alter the client representations in any way and 
would not supply him with any opinion letter until he attested 
to the specific factual representations attributed to him by 
KPMG. After a standoff lasting nearly 2 months, with the 
deadline for his tax return fast approaching, Mr. Jacoboni 
finally signed the representation letter attesting to the 
statements KPMG had drafted.216
---------------------------------------------------------------------------
    \215\ Jacoboni v. KPMG, Case No. 6:02-CV-510 (M.D. Fla. 4/29/02) 
Complaint at para.para. 16-17 (``[I]t seemed ridiculous to ask Mr. 
Jacoboni to sign the Representation Letter, which neither he [Mr. 
Jacoboni's legal counsel] nor Mr. Jacoboni understood. Moreover, Mr. 
Jacoboni had no personal knowledge of the factual representations in 
the letter and could not verify the facts as KPMG requested.'' Emphasis 
in original.); Subcommittee interview of Mr. Jacoboni's legal counsel 
(4/4/03).
    \216\ Id. at para.para. 18-19. Mr. Jacaboni also alleges that, 
despite finally signing the letter, he never received the promised tax 
opinion letter from KPMG.
---------------------------------------------------------------------------
    Equally disturbing is that some of the key factual 
representations KPMG attributed to its clients appear to 
contain false or misleading statements. For example, in the 
BLIPS prototype letter, KPMG wrote: ``Investor has represented 
to KPMG . . . [that the] Investor independently reviewed the 
economics underlying the [BLIPS] Investment Fund before 
entering into the program and believed there was a reasonable 
opportunity to earn a reasonable pre-tax profit from the 
transactions.'' 217 The existence of a client profit 
motive and the existence of a reasonable opportunity to earn a 
reasonable pre-tax profit are central factors in determining 
whether a tax product like BLIPS has a business purpose and 
economic substance apart from its tax benefits. It is the 
Subcommittee's understanding that this client representation 
was repeated substantially verbatim in every BLIPS tax opinion 
letter KPMG issued.
---------------------------------------------------------------------------
    \217\ Prototype BLIPS tax opinion letter prepared by KPMG, (12/31/
99), Bates KPMG 0000405-417, at 9.
---------------------------------------------------------------------------
    The first stumbling block is the notion that every client 
who purchased BLIPS ``independently'' reviewed its 
``economics'' beforehand, and ``believed'' there was a 
reasonable opportunity to make a reasonable profit. BLIPS was 
an enormously complicated transaction, with layers of 
structured finance, a complex loan, and intricate foreign 
currency trades. A technical analysis of its ``economics'' was 
likely beyond the capability of most of the BLIPS purchasers. 
In addition, KPMG knew there was only a remote possibility--not 
a reasonable possibility--of a client's earning a profit in 
BLIPS.218 Nevertheless, since the existence of a 
reasonable opportunity to earn a reasonable profit was critical 
to BLIPS' having economic substance, KPMG included that 
questionable client representation in its BLIPS tax opinion 
letter.219
---------------------------------------------------------------------------
    \218\ See email dated 5/4/99, from Mark Watson, WNT, to Larry 
DeLap, DPP, Bates KPMG 0011916 (Quoting Presidio investment experts who 
set up the BLIPS transactions, KPMG tax expert states: ``the 
probability of actually making a profit from this transaction is remote 
(possible, but remote).'').
    \219\ KPMG required the investment advisory firm, Presidio, to make 
this same factual representation, even though Presidio had informed 
KPMG personnel that ``the probability of actually making a profit from 
this transaction is remote (possible, but remote).'' The evidence 
indicates that both KPMG and Presidio knew there was only a remote 
possibility--not a reasonable possibility--of a client's earning a 
profit in the BLIPS transaction, yet both continued to issue and stand 
behind an opinion letter attesting to what both knew was an inaccurate 
factual representation.
---------------------------------------------------------------------------
    BLIPS was constructed so that the potential for client 
profit from the BLIPS transactions increased significantly if 
the client participated in all three phases of the BLIPS loan, 
which required a full 7 years to finish. The head of DPP-Tax 
observed that KPMG had drafted a factual representation for 
inclusion in the prototype BLIPS tax opinion letter stating 
that, ``The original intent of the parties was to participate 
in all three investment stages of the Investment Program.'' He 
cautioned against including this factual representation in the 
opinion letter: ``It seems to me that this [is] a critical 
element of the entire analysis and should not be blithely 
assumed as a `fact.' . . . I would caution that if there were, 
say, 50 separate investors and all 50 bailed out at the 
completion of Stage I, such a representation would not seem 
credible.'' 220
---------------------------------------------------------------------------
    \220\ Email dated 4/14/99, from Larry DeLap to multiple KPMG tax 
professionals, ``RE: BLIPS,'' Bates KPMG 0017578-79.
---------------------------------------------------------------------------
    The proposed representation was not included in the final 
version of the BLIPS prototype opinion letter, and the actual 
BLIPS track record supported the cautionary words of the DPP 
head. In 2000, the KPMG tax partner in charge of WNT wrote:

        ``Lastly, an issue that I am somewhat reluctant to 
        raise but I believe is very important going forward 
        concerns the representations that we are relying on in 
        order to render our tax opinion in BLIPS I. In each of 
        the 66 or more deals that were done at last year, our 
        clients represented that they `independently' reviewed 
        the economics of the transaction and had a reasonable 
        opportunity to earn a pretax profit. . . . As I 
        understand the facts, all 66 closed out by year-end and 
        triggered the tax loss. Thus, while I continue to 
        believe that we can issue the tax opinions on the BLIPS 
        I deals, the issue going forward is can we continue to 
        rely on the representations in any subsequent deals if 
        we go down that road? . . . My recommendation is that 
        we deliver the tax opinions in BLIPS I and close the 
        book on BLIPS and spend our best efforts on alternative 
        transactions.'' 221
---------------------------------------------------------------------------
    \221\ Email dated 2/24/00, from Philip Wiesner to multiple KPMG tax 
professionals, ``RE: BLIPS/OPIS,'' Bates KPMG 0011789.

    This email and other documentation indicate that KPMG was 
well aware that the BLIPS transactions were of limited duration 
and uniformly produced substantial tax losses that 
``investors'' used to offset and shelter other income from 
taxation.222 This growing factual record, showing 
that BLIPS investors invariably lost money, made it 
increasingly difficult for KPMG to rely on an alleged client 
representation about BLIPS' having a reasonable profit 
potential. KPMG nevertheless continued to sell the product and 
to issue tax opinion letters relying on a critical client 
representation that KPMG had drafted without client input and 
attributed to its clients, but which KPMG knew or had reason to 
know, was unsupported by the facts.
---------------------------------------------------------------------------
    \222\ Email dated 5/4/99, from Mark Watson, WNT, to Larry DeLap, 
DPP, Bates KPMG 0011916. See also document dated 5/18/01, ``PFP 
Practice Reorganization Innovative Strategies Business Plan--DRAFT,'' 
authored by Jeffrey Eischeid, Bates KPMG 0050620-23, at 1-2 (referring 
to BLIPS and its predecessors, FLIP and OPIS, as a ``capital loss 
strategy,'' ``loss generator'' or ``gain mitigation solution'').
---------------------------------------------------------------------------
    Discontinuing Sales. Still another KPMG implementation 
issue involves decisions by KPMG to stop selling particular tax 
products. In all four of the case studies examined by the 
Subcommittee, KPMG stopped marketing the tax product within 1 
or 2 years of its first sale.223 The decision was 
made in each case by the head of DPP-Tax, after consultation 
with the product's Deployment Champion and other senior tax 
professionals.
---------------------------------------------------------------------------
    \223\ See, e.g., email dated 12/29/01, from Larry DeLap to multiple 
KPMG tax professionals, ``FW: SC2,'' Bates KPMG 0050562 (discontinuing 
SC2); email dated 10/1/99, from Larry DeLap to multiple KPMG tax 
professionals, ``BLIPS,'' Bates KPMG 0011716 (discontinuing BLIPS); 
email dated 12/7/98, from Larry DeLap to multiple KPMG tax 
professionals, ``OPIS,'' Bates KPMG 0025730 (discontinuing OPIS).
---------------------------------------------------------------------------
    When asked to explain why sales were discontinued, the DPP 
head offered several reasons for pulling a tax product off the 
market.224 The DPP head stated that he sometimes 
ended the marketing of a tax product out of concern that a 
judge would invalidate the tax product ``as a step 
transaction,'' using evidence that a number of persons who 
purchased the product engaged in a series of similar 
transactions.225 Limiting the number of tax products 
sold limited the evidence that each resulted in a similar set 
of transactions orchestrated by KPMG. Limiting the number of 
tax products sold also limited information about them to a 
small circle and made it more difficult for the IRS to detect 
the activity.226
---------------------------------------------------------------------------
    \224\ Subcommittee interview of Lawrence DeLap (10/30/03).
    \225\ Id.
    \226\ See Section VI(B)(4) of this Report on ``Avoiding 
Detection.''
---------------------------------------------------------------------------
    Evidence in the four case studies shows that internal KPMG 
directives to stop sales of a particular tax product were, at 
times, ignored or circumvented by KPMG tax professionals 
marketing the products. For example, the DPP head announced an 
end to BLIPS sales in the fall of 1999, but allowed KPMG tax 
professionals to complete numerous BLIPS sales in 1999 and 
2000, to persons who had been approached before the marketing 
ban was announced.227 These purchasers were referred 
to internally at KPMG as ``grandfathered BLIPS'' 
clients.228 A handful of additional sales took place 
in 2000, over the objection of the DPP head, after his 
objection was overruled by head of the Tax Services 
Practice.229 Also in 2000, some KPMG tax 
professionals attempted to restart BLIPS sales by developing a 
modified BLIPS product that would be sold to only extremely 
wealthy individuals.230 This effort was ultimately 
unsuccessful in restarting BLIPS sales.
---------------------------------------------------------------------------
    \227\ See, e.g., email dated 10/13/99, from Carl Hasting to Dale 
Baumann, ``RE: Year 2000 Blips Transactions,'' Bates KPMG 0006485 (``I 
thought we were told to quit marketing 200[0] BLIPS transactions.''); 
email dated 10/13/99, from Dale Baumann to Carl Hasting and others, 
``RE: Year 2000 Blips Transactions,'' Bates KPMG 0006485 (``No 
marketing to clients who were not on the BLIPS 2000 list. The BLIPS 
2000 list were for those individuals who we approached before Larry 
told us to stop marketing the strategy. . . .'').
    \228\ See, e.g., two emails dated 10/1/99, from Larry DeLap to 
multiple KPMG tax professionals, ``BLIPS,'' Bates KPMG 0011714.
    \229\ Subcommittee interview of Lawrence DeLap (10/30/03).
    \230\ See, e.g., email dated 6/20/00, from William Boyle of 
Deutsche Bank to other Deutsche Bank personnel, ``Updated Presidio/KPMG 
trades,'' Bates DB BLIPS 03280 (``Presidio and KPMG are developing an 
expanded version of BLIP's which it will execute on a limited basis for 
its wealthy clientele. They anticipate executing approximately 10-15 
deals of significant size (i.e. in the $100-300m. Range).'').
---------------------------------------------------------------------------
    In the case of SC2, KPMG tax professionals simply did not 
comply with announced limits on the total number of SC2 
products that could be sold or limits on the use of 
telemarketing calls to market the product.231 In the 
case of FLIP and OPIS, additional sales, again, took place 
after the DPP head had announced an end to the marketing of the 
products.232 The DPP head told Subcommittee staff 
that when he discontinued BLIPS sales in 1999, he was pressed 
by the BLIPS National Deployment Champion and others for an 
alternative product.233 The DPP head indicated that, 
because of this pressure, he relented and allowed KPMG tax 
professionals to resume sales of OPIS, which he had halted a 
year earlier.
---------------------------------------------------------------------------
    \231\ See Section VI(B)(2) of this Report on ``Mass Marketing Tax 
Products.'' See also, e.g., email dated 4/23/01, from John Schrier to 
Thomas Crawford, ``RE: SC2 target list,'' Bates KPMG 0050029; email 
dated 12/20/01, from William Kelliher to David Brockway, ``FW: SC2,'' 
Bates KPMG 0013311; and email response dated 12/29/01, from Larry DeLap 
to William Kelliher, David Brockway, and others, ``FW: SC2,'' Bates 
KPMG 0013311.
    \232\ See, e.g., email dated 9/30/99, from Jeffrey Eischeid to 
Wolfgang Stolz and others, ``OPIS,'' Bates QL S004593.
    \233\ Subcommittee interview of Lawrence DeLap (10/30/03).
---------------------------------------------------------------------------

    (b) Role of Third Parties in Implementing KPMG Tax Products

    FLIP, OPIS, BLIPS, and SC2 could not have been executed 
without the active and willing participation of the banks, 
investment advisors, lawyers, and charitable organizations that 
made these products work. The roll call of respected 
professional firms with direct and extensive involvement in the 
four KPMG case studies includes Deutsche Bank, HVB, NatWest, 
UBS, Wachovia Bank, and Sidley Austin, Brown & Wood. Smaller 
professional firms such as Quellos, and charitable 
organizations such as the Los Angeles Department of Fire & 
Police Pensions and the Austin Fire Fighters Relief and 
Retirement Fund, while less well known nationally, are 
nevertheless respected institutions who played critical roles 
in the execution of at least one of the four tax products.

          LFinding: Some major banks and investment advisory 
        firms have provided critical lending or investment 
        services or participated as essential counter parties 
        in potentially abusive or illegal tax shelters sold by 
        KPMG, in return for substantial fees or profits.

    The Role of the Banks. Five major banks participated in 
BLIPS, FLIP, and OPIS. Deutsche Bank participated in more than 
50 BLIPS transactions in 1999 and 2000, providing credit lines 
that totaled as much as $2.8 billion.234 Deutsche 
Bank also participated in about 60 OPIS transactions in 1998 
and 1999. HVB participated in more than 30 BLIPS transactions 
in 1999 and 2000, providing BLIPS credit lines that apparently 
totaled nearly $2.5 billion.235 NatWest apparently 
also participated in a significant number of BLIPS transactions 
in 1999 and 2000, providing credit lines totaling more than $1 
billion.236 UBS AG participated in 100-150 FLIP and 
OPIS transactions in 1997 and 1998, providing credit lines 
which, in the aggregate, were in the range of several billion 
Swiss francs.237
---------------------------------------------------------------------------
    \234\ See, e.g., email dated 6/20/00, from William Boyle of 
Deutsche Bank to other Deutsche Bank personnel, ``Updated Presidio/KPMG 
trades,'' Bates DB BLIPS 03280; chart entitled, ``Presidio Advisory 
Services. Deal List 1999,'' Bates HVB000875 (BLIPS transactions for 
1999); chart entitled, ``Presidio Advisory Services. Deal List 2000,'' 
Bates HVCD00018-19 (BLIPS transactions for 2000).
    \235\ See, e.g., memorandum dated 8/19/03 (this date is likely in 
error), from Ted Wolf and Sylvie DeMetrio to Christopher Thorpe and 
others, ``Presidio,'' Bates HVCD 00001; chart entitled, ``Presidio 
Advisory Services. Deal List 1999,'' Bates HVB000875 (BLIPS 
transactions for 1999); chart entitled, ``Presidio Advisory Services. 
Deal List 2000,'' Bates HVCD00018-19 (BLIPS transactions for 2000). See 
also credit request dated 1/6/00, Bates HVB 003320-30 (seeking approval 
of $1.5 billion credit line for 2000, and noting that, in 1999, the 
bank ``booked USD 950 million (out of USD 1.03 billion approved) . . . 
all cash collateralized.'')
    \236\ See, e.g., email dated 6/20/00, from William Boyle of 
Deutsche Bank to other Deutsche Bank personnel, ``Updated Presidio/KPMG 
trades,'' Bates DB BLIPS 03280.
    \237\ See, e.g., UBS memorandum dated 12/21/99, from Teri Kemmerer 
Sallwasser to Gail Fagan, ``Boss Strategy Meetings . . .,'' Bates SEN-
018253-57; Subcommittee interview of UBS representatives (4/4/03).
---------------------------------------------------------------------------
    Two investment advisory firms also participated in the 
development, marketing and implementation of BLIPS, FLIP, and 
OPIS. Quellos participated in the development, marketing, and 
execution of FLIP. It participated in over 80 FLIP transactions 
with KPMG, as well as similar number of these transactions with 
PricewaterhouseCoopers and Wachovia Bank. It also executed some 
OPIS transactions for KPMG. Presidio participated in the 
development, marketing, and implementation of OPIS and BLIPS 
transactions, including the 186 BLIPS transactions related to 
186 KPMG clients.238 The Presidio principals even 
conducted a BLIPS transaction on their own 
behalf.239
---------------------------------------------------------------------------
    \238\ See, e.g., email dated 3/14/98, from Jeff Stein to Robert 
Wells, John Lanning, Larry DeLap, Gregg Ritchie, and others, ``Simon 
Says,'' Bates 638010, filed by the IRS on June 16, 2003, as an 
attachment to Respondent's Requests for Admission, Schneider Interests 
v. Commissioner, U.S. Tax Court, Docket No. 200-02, (describing the 
role of Presidio principal, Robert Pfaff, in the development of OPIS); 
Subcommittee interviews of John Larson (10/3/03 and 10/21/03).
    \239\ Subcommittee interviews of John Larson (10/3/03 and 10/21/
03). Presidio discussed completing a BLIPS transaction on its own 
behalf with the assistance of HVB, but ultimately completed the 
transaction elsewhere. See, e.g., ``Corporate Banking Division--Credit 
Request'' dated 9/14/99, Bates HVB 000147-64; ``Corporate Banking 
Division--Credit Request'' dated 4/28/00, Bates HVB 004148-51; 
memorandum dated 9/14/99, from Robert Pfaff of Presidio to Dom 
DiGiorgio of HVB, ``BLIPS loan test case,'' Bates HVB 000202; chart 
dated 9/14/99 entitled, ``Presidio Ownership Structure,'' Bates HVB 
000215; undated document entitled, ``Structural Differences in the 
Transaction for Presidio Principals,'' Bates HVCD 00007; undated 
diagrams depicting BLIPS loans to Presidio principals, Bates HVB 
004272-75.
---------------------------------------------------------------------------
    The banks and investment advisory firms interviewed by the 
Subcommittee staff acknowledged obtaining lucrative fees for 
their participation in FLIP, OPIS, or BLIPS. Deutsche Bank 
internal documents state that the bank earned more than $33 
million from OPIS and expected to earn more than $30 million 
for BLIPS.240 HVB earned over $5.45 million for the 
BLIPS transactions it completed in less than 3 months in 1999, 
and won approval of increased BLIPS transactions throughout 
2000, ``based on successful execution of previous transactions, 
low credit risk and excellent profitability.'' 241
---------------------------------------------------------------------------
    \240\ See undated document entitled, ``New Product Committee 
Overview Memo: BLIPS Transaction,'' Bates DB BLIPS 01959; email dated 
4/28/99, from Francesco Piovanetti to Nancy Donohue, ``presidio--w. 
revisions, I will call u in 1 min.,'' Bates DB BLIPS 6911.
    \241\ See HVB credit request dated 1/6/00, Bates HVB 003320-30 (HVB 
``earned USD 4.45 million'' from BLIPS loan fees and ``approximately 
USD 1 million'' from related foreign exchange activities for BLIPS 
transactions completed from October to December 1999); HVB document 
dated 8/6/00, from Thorpe, marked ``DRAFT,'' Bates HVB 001805.
---------------------------------------------------------------------------
    The Subcommittee interviewed four of the five banks, most 
of which cooperated with the inquiry and were generally open 
and candid about their interactions with KPMG, their 
understanding of FLIP, OPIS, and BLIPS, and their respective 
roles in these tax products. Evidence obtained by the 
Subcommittee shows that the banks knew they were participating 
in transactions whose primary purpose was to provide tax 
benefits to persons who had purchased tax products from KPMG. 
Some of the documentation also make it plain that the bank was 
aware that the tax product was potentially abusive and carried 
a risk to the reputation of any bank choosing to participate in 
it.
    For example, a number of Deutsche Bank documents make it 
clear that the bank knew BLIPS was a tax related transaction 
and posed a reputational risk to the bank if the bank chose to 
participate in it. One Deutsche Bank official working to obtain 
bank approval to participate in BLIPS wrote:

        ``In this transaction, reputation risk is tax related 
        and we have been asked by the Tax Department not to 
        create an audit trail in respect of the Bank's tax 
        affaires. The Tax department assumes prime 
        responsibility for controlling tax related risks 
        (including reputation risk) and will brief senior 
        management accordingly. We are therefore not asking R&R 
        [Reputation & Risk] Committee to approve reputation 
        risk on BLIPS. This will be dealt with directly by the 
        Tax Department and [Deutsche Bank Chief Executive 
        Officer] John Ross.'' 242
---------------------------------------------------------------------------
    \242\ Email dated 7/30/99, from Ivor Dunbar of Deustche Bank, DMG 
UK, to multiple Deutsche Bank professionals, ``Re: Risk & Resources 
Committee Paper--BLIPS,'' unreadable Bates number. See also email dated 
7/29/99 from Mick Wood to Francesco Piovanetti and other Deutsche bank 
personnel, ``Re: Risk & Resources Committee Paper--BLIPS,'' Bates DB 
BLIPS 6556 (paper prepared for the Risk & Resources Committee ``skirts 
around the basic issue rather than addressing it head on (the tax 
reputational risk).'').

    Another Deutsche Bank memorandum, prepared for the ``New 
Product Committee'' to use in reviewing BLIPS, included the 
---------------------------------------------------------------------------
following statements explaining the transaction:

        ``BLIPS will be marketed to High Net Worth Individual 
        Clients of KPMG. . . . Loan conditions will be such as 
        to enable DB to, in effect, force (p)repayment after 60 
        days at its option. . . . For tax and accounting 
        purposes, repaying the [loan] premium amount will 
        `count' '' like a loss for tax and accounting purposes. 
        . . . At all times, the loan will maintain collateral 
        of at least 101% to the loan + premium amount. . . . It 
        is imperative that the transaction be wound up after 
        45-60 days and the loan repaid due to the fact that the 
        HNW individual will not receive his/her capital loss 
        (or tax benefit) until the transaction is wound up and 
        the loan repaid. . . . At no time will DB Private Bank 
        provide any tax advice to any individuals involved in 
        the transactions. This will be further buttressed by 
        signed disclaimers designed to protect and `hold 
        harmless' DB. . . . DB has received a legal opinion 
        from Shearman & Sterling which validates our envisaged 
        role in the transaction and sees little or no risk to 
        DB in the trade. Furthermore opinions have been issued 
        from KPMG Central Tax department and Brown & Wood 
        attesting to the soundness of the transactions from a 
        tax perspective.'' 243
---------------------------------------------------------------------------
    \243\ Undated document entitled, ``New Product Committee Overview 
Memo: BLIPS Transaction,'' Bates DB BLIPS 01959-63.

Still another Deutsche Bank document states: ``For tax and 
accounting purposes, the [loan] premium amount will be treated 
as a loss for tax purposes.'' 244
---------------------------------------------------------------------------
    \244\ Email dated 7/1/99 from Francesco Piovanetti to Ivor Dunbar, 
`` `Hugo' BLIPS Paper,'' with attachment entitled, ``Bond Linked 
Indexed Premium Strategy `BLIPS,' '' Bates DB BLIPS 6585-87 at 6587.
---------------------------------------------------------------------------
    Bank documentation indicates that a number of internal bank 
departments, including the tax, accounting, and legal 
departments, were asked to and did approve the bank's 
participation in BLIPS. BLIPS was also brought to the attention 
of the bank's Chief Executive Officer John Ross who made the 
final decision on the bank's participation.245 
Minutes describing the meeting in which Mr. Ross approved the 
bank's participation in BLIPS state:
---------------------------------------------------------------------------
    \245\ See email dated 10/13/99, from Peter Sturzinger to Ken Tarr 
and other Deutsche Bank personnel, ``Re: BLIPS,'' attaching minutes 
dated 8/4/99, from a ``Deutsche Bank Private Banking, Management 
Committee Meeting'' that discussed BLIPS, Bates DB BLIPS 6520-6521.

        ``[A] meeting with John Ross was held on August 3, 1999 
        in order to discuss the BLIPS product. [A bank 
        representative] represented [Private Banking] 
        Management's views on reputational risk and client 
        suitability. John Ross approved the product, however 
        insisted that any customer found to be in litigation be 
        excluded from the product, the product be limited to 25 
        customers and that a low profile be kept on these 
        transactions. . . . John Ross also requested to be kept 
        informed of future transactions of a similar nature.'' 
        246
---------------------------------------------------------------------------
    \246\ Id. at 6520.

Given the extensive and high level attention provided by the 
Bank regarding its participation in BLIPS, it seems clear that 
the bank had evaluated BLIPS carefully and knew what it was 
getting into.
    Other evidence shows that Deutsche Bank was aware that the 
BLIPS loans were not run-of-the-mill commercial loans, but had 
unusual features. Deutsche Bank refused, for example, to sign a 
letter representing that the BLIPS loan structure, which 
included an unusual multi-million dollar ``loan premium'' 
credited to a borrower's account at the start of the 
loan,247 was consistent with ``industry standards.'' 
The BLIPS National Deployment Champion had asked the bank to 
make this representation to provide ``comfort that the loan was 
being made in line with conventional lending practices.'' 
248 When the bank declined to make the requested 
representation, the BLIPS National Deployment Champion tried a 
second time, only to report to his colleagues: ``The bank has 
pushed back again and said they simply will not represent that 
the large premium loan is consistent with industry standards.'' 
249 He tried a third time and reported: ``I've 
pushed really hard for our original language. To say they are 
resisting is an understatement.'' 250 The final tax 
opinion letter issued by KPMG contained compromise language 
which said little more than the loan complied with the bank's 
own procedures: ``The loan . . . was approved by the competent 
authorities within [the Bank] as consistent, in the light of 
all the circumstances such authorities consider relevant, with 
[the Bank's] credit and documentation standards.'' 
251
---------------------------------------------------------------------------
    \247\ See Appendix A.
    \248\ Email dated 3/20/00, from Jeffrey Eischeid to Mark Watson, 
``Bank representation,'' Bates KPMG 0025754.
    \249\ Email dated 3/27/00, from Jeffrey Eischeid to Richard Smith, 
``Bank representation,'' Bates KPMG 0025753.
    \250\ Email dated 3/28/00, from Jeffrey Eischeid to Mark Watson, 
``Bank representation,'' Bates KPMG 0025753.
    \251\ KPMG prototype tax opinion letter on BLIPS, dated 12/31/99, 
at 11.
---------------------------------------------------------------------------
    A year after Deutsche Bank began executing BLIPS 
transactions, a key bank official handling these transactions 
wrote an email which acknowledged the ``tax benefits'' 
associated with BLIPS and noted, again, the reputational risk 
these transactions posed to the bank:

        ``During 1999, we executed $2.8b. of loan premium deals 
        as part of the BLIP's approval process. At that time, 
        NatWest and [HVB] had executed approximately $0.5 b. of 
        loan premium deals. I understand that we based our 
        limitations on concerns regarding reputational risk 
        which were heightened, in part, on the proportion of 
        deals we have executed relative to the other banks. 
        Since that time, [HVB], and to a certain extent 
        NatWest, have participated in approximately an 
        additional $1.0-1.5 b. of grandfathered BLIP's deals. . 
        . . [HVB] does not have the same sensitivity to and 
        market exposure as DB does with respect to the 
        reputational risk from making the high-coupon loan to 
        the client. . . . As you are aware, the tax benefits 
        from the transaction potentially arise from a 
        contribution to the partnership subject to the high-
        coupon note and not from the execution of FX positions 
        in the partnership, activities which we perform in the 
        ordinary course of our business.'' 252
---------------------------------------------------------------------------
    \252\ Email dated 6/20/00, from William Boyle to multiple Deutsche 
Bank professionals, ``Updated Presidio/KPMG trades,'' Bates DB BLIPS 
03280.

    This document shows that Deutsche Bank was fully aware of 
and had a sophisticated understanding of the tax aspects of 
BLIPS. To address the issue of reputational risk, the email 
went on to propose that, because HVB had a limited capacity to 
issue more BLIPS loans, and Deutsche Bank did not want to 
expose itself to increased reputational risk by making 
additional direct loans to BLIPS clients, ``we would like to 
lend an amount of money to [HVB] equal to the amount of money 
[HVB] lends to the client. . . . We would like tax department 
approval to participate in the aforementioned more complex 
trades by executing the underlying transactions and making 
loans to [HVB].'' In other words, Deutsche Bank wanted to be 
the bank behind HVB, financing more BLIPS loans in exchange for 
fees and other profits.
    Other Deutsche Bank documents suggest that the bank may 
have been helping KPMG find clients or otherwise marketing the 
BLIPS tax products. A November 1999 presentation by the bank's 
``Structured Finance Group,'' for example, listed BLIPS as one 
of several tax products the group was offering to U.S. and 
European clients seeking ``gain mitigation.'' 253 
The presentation listed as the bank's ``strengths'' its ability 
to lend funds in connection with BLIPS and its ``relationships 
with [the] `promoters' '' 254 later named as 
Presidio and KPMG.255 An internal bank email a few 
months earlier asked: ``What is the status of the BLIPS. Are 
you still actively marketing this product[?]'' 256
---------------------------------------------------------------------------
    \253\ Email dated 4/3/02, from Viktoria Antoniades to Brian McGuire 
and other Deutsche Bank personnel, ``US GROUP 1 Pres,'' DB BLIPS 6329-
52, attaching a presentation dated 11/15/99, entitled ``Structured 
Transactions Group North America,'' at 6336, 6346.
    \254\ Id. at 6337.
    \255\ Id. at 6346.
    \256\ Email dated 7/19/99, involving multiple Deutsche Bank 
employees, ``Update NY Issues,'' Bates DB BLIPS 6775.
---------------------------------------------------------------------------
    The same document suggests that Deutsche Bank may have been 
a tax shelter promoter in its own right. For example, the 
document indicates that, in 1999, the Structured Transactions 
Group was offering over a dozen sophisticated tax products to 
U.S. and European clients seeking to ``execute tax driven 
deals'' or ``gain mitigation'' strategies.257 The 
document indicates that Deutsche Bank was aggressively 
marketing these tax products to large U.S. corporations and 
individuals, and planning to close billions of dollars worth of 
transactions.258 At least two of the tax products 
listed by Deutsche Bank, BLIPS and the Customized Adjustable 
Rate Debt Facility (CARDS), were later determined by the IRS to 
be potentially abusive tax shelters. During the late 1990's and 
early 2000, Deutsche Bank was also involved, either directly or 
through Bankers Trust (which Deutsche Bank acquired in June 
1999), in a number of tax-driven transactions with Enron 
Corporation, including Project Steele, Project Cochise, Project 
Tomas, and Project Valhalla.259
---------------------------------------------------------------------------
    \257\ Email dated 4/3/02, from Viktoria Antoniades to Brian McGuire 
and other Deutsche Bank personnel, ``US GROUP 1 Pres,'' DB BLIPS 6329-
52, attaching a presentation dated 11/15/99, entitled ``Structured 
Transactions Group North America,'' at 6336. See also undated document 
entitled, ``Update on the Private Exchange Fund,'' Bates DB BLIPS 6433 
(describing the packaging of another tax product offered by the 
Structured Transactions Group).
    \258\ Id. at 6345-46.
    \259\ See ``Report of Investigation of Enron Corporation and 
Related Entities Regarding Federal Tax and Compensation Issues, and 
Policy Recommendations,'' Joint Committee on Taxation Staff (Report No. 
JCS-3-03, February 2003).
---------------------------------------------------------------------------
    Despite the bank's involvement in and sophisticated 
knowledge of generic tax products, when asked about BLIPS 
during a Subcommittee interview, the Deutsche Bank 
representative insisted that BLIPS was an investment strategy 
which, like all investment products, had tax implications. The 
bank representative also indicated that, despite handling BLIPS 
transactions for the bank, he did not understand the details of 
the BLIPS transactions, and downplayed any reputational risk 
that BLIPS might have posed to the bank.260
---------------------------------------------------------------------------
    \260\ Subcommittee interview of Deutsche Bank, (11/10/03).
---------------------------------------------------------------------------
    In contrast to Deutsche Bank's stance, in which its 
representative's oral information repeatedly contradicted its 
internal documentation, HVB representatives provided oral 
information that was fully consistent with the bank's internal 
documentation. HVB's representative acknowledged, for example, 
that HVB knew BLIPS had been designed and was intended to 
provide tax benefits to KPMG clients. The bank indicated that, 
at the time it became involved, it felt it had no obligation to 
refrain from participating in BLIPS, since KPMG had provided 
the bank with an opinion stating that BLIPS complied with 
federal tax law. For example, in one document seeking approval 
to provide a significant line of credit to finance BLIPS loans, 
HVB wrote this about the tax risks associated with BLIPS: 
``Disallowance of tax attributes. A review by the IRS could 
potentially result in a ruling that would disallow the [BLIPS] 
structure. . . . We are confident that none of the foregoing 
would affect the bank or its position in any meaningful way for 
the following reasons. . . . KPMG has issued an opinion that 
the structure will most likely be upheld, even if challenged by 
the IRS.'' 261 A handwritten document prepared by 
HVB personnel is even more direct. It characterizes the 7% fee 
charged to KPMG clients for BLIPS as ``paid by investor for tax 
sheltering.'' 262 This document also states that the 
bank ``amortizes premium over the life of loan for tax 
purposes.''
---------------------------------------------------------------------------
    \261\ Credit request dated 9/26/99, Bates HVB 001166.
    \262\ Undated one-page, handwritten document outlining BLIPS 
structure entitled, ``Presidio,'' which Alex Nouvakhov of HVB 
acknowledged during his Subcommittee interview had been written by him, 
Bates HVB 000204.
---------------------------------------------------------------------------
    When it became clear that the IRS would list BLIPS as an 
abusive tax shelter, an internal HVB memorandum again 
acknowledged that BLIPS was a tax transaction and ordered a 
halt to financing the product, while disavowing any liability 
for the bank's role in carrying out the BLIPS transactions:

        ``[I]t is clear that the tax benefits for individuals 
        who have participated in the [BLIPS] transaction will 
        not be grandfathered because Treasury believe that 
        their actions were contrary to current law. . . . It is 
        not likely that KPMG/Presidio will go forward with 
        additional transactions. . . . As we have stated 
        previously, we anticipate no adverse consequences for 
        the HVB since we have not promoted the transaction. We 
        have simply been a lender and nothing in the notice 
        implies a threat to our position.

        ``In view of the tone of the notice we will not book 
        any new transactions and will cancel our existing 
        unused [credit] lines prior to the end of this month.'' 
        263
---------------------------------------------------------------------------
    \263\ Memorandum dated 8/16/00, from Dom DeGiorgio and Richard 
Pankuch to Christopher Thorpe and others, ``Presidio BLIPS 
Transactions,'' Bates HVB 003346.

    HVB's representative explained to the Subcommittee staff 
that the apparent bank risk in lending substantial sums to a 
shell corporation had been mitigated by the terms of the BLIPS 
loan which gave the bank virtually total control over the BLIPS 
loan proceeds and enabled the bank to ensure the loan and loan 
premium would be repaid.264 The bank explained, for 
example, that from the start of the loan, the borrower was 
required to maintain collateral equal to 101% of the loan 
proceeds and loan premium and could place these funds only in a 
narrow range of bank-approved investments.265 That 
meant the bank treated not only all of the loan proceeds and 
loan premium as collateral, but also additional funds supplied 
by the KPMG client to meet the 101% collateral requirement. HVB 
wrote: ``We are protected in our documentation through a 
minimum overcollateralization ratio of 1.0125 to 1 at all 
times. Violation of this ratio triggers immediate acceleration 
under the loan agreements without notice.'' 266 HVB 
also wrote: ``The Permitted Investments . . . are either 
extremely conservative in nature . . . or have no collateral 
value for margin purposes.'' 267 KPMG put it this 
way: ``Lender holds all cash as collateral in addition to being 
custodian and clearing agent for Partnership. . . . All 
Partnership trades can only be executed through Lender or an 
affiliate. . . . Lender must authorize trades before 
execution.'' 268
---------------------------------------------------------------------------
    \264\ Subcommittee interview of HVB representative (10/29/03).
    \265\ See, e.g., email dated 10/29/99, from Richard Pankuch to 
Erwin Volt, ``KWG I capital treatment for our Presidio Transaction,'' 
Bates HVB 000352 (``Our structure calls for all collateral to be placed 
in a collateral account pledged to the bank.''); email dated 9/24/99, 
from Richard Pankuch to Christopher Thorpe and other HVB professionals, 
``Re: Presidio,'' Bates HVB 000682 (``all collateral is in our own 
hands and subject to the Permitted Investment requirement''). Compare 
undated Deutsche Bank document, likely prepared in 1999, ``New Product 
Committee Overview Memo: BLIPS Transaction,'' Bates DB BLIPS 01959-63, 
at 1961 (``At all times, the loan will maintain collateral of at least 
101% to the loan + loan premium amount. If the amount goes below this 
limit, the loan will be unwound and the principal + premium repaid.''); 
email dated 7/1/99, from Francesco Piovanetti to Ivor Dunbar, `` `Hugo' 
BLIPS Paper,'' with attachment entitled, ``Bond Linked Indexed Premium 
Strategy `BLIPS','' Bates HVB DB BLIPS 6885-87 (``The loan proceeds 
(par and premium) will be held in custody at DB in cash or money market 
deposits. . . . Loan conditions will be such as to enable DB to, in 
effect, force prepayment after sixty days at its option.'').
    \266\ BLIPS credit request dated 9/14/99, Bates HVB 000155. See 
also Memorandum dated 7/29/99, from William Boyle to Mick Wood and 
other Deutsche Bank personnel, ``GCI Risk and Resources Committee--
BLIPS Transaction,'' Bates DB BLIPS 06566, at 3 (The BLIPS loan ``will 
be overcollateralized and should the value of the collateral drop below 
a 1.0125:1.0 ratio, DB may liquidate the collateral immediately and 
apply the proceeds to repay amounts due under the Note and swap 
agreements.'')
    \267\ BLIPS credit request dated 9/14/99, Bates HVB 000155.
    \268\ Document dated 3/4/99, ``BLIPS--transaction description and 
checklist,'' Bates KPMG 0003933-35.
---------------------------------------------------------------------------
    Deutsche Bank and HVB were not the only banks involved in 
executing KPMG tax products. Another was Wachovia Bank, acting 
through First Union National Bank, which not only referred bank 
clients to KPMG to purchase FLIP, but also directly sold FLIP 
to many of its clients, and considered becoming involved with 
BLIPS and SC2 as well.269 A 1999 Wachovia internal 
email demonstrates that the bank was fully aware that it was 
being asked to facilitate transactions designed to reduce or 
eliminate tax liability for KPMG clients:
---------------------------------------------------------------------------
    \269\ See Section VI(2) of this Report for discussion of Wachovia's 
client referral activities.

        ``[A] KPMG investment/tax strategy . . . was voted and 
        approved by the due diligence subcommittee last week. 
        This means that the Risk Oversight Committee will have 
        this particular strategy on its agenda at its Wednesday 
        meeting. . . . The strategy will service to offset 
        either ordinary income or capital gains ($20 million 
---------------------------------------------------------------------------
        minimum).

        ``There are several critical points that should be 
        noted with respect to this strategy if we get it 
        approved. Many of these points related to Sandy Spitz' 
        concern (and KPMG's concern) that First Union has a 
        very high profile across our franchise for being 
        associated with `tax' strategies: namely, FLIP and 
        BOSS. Sandy does not want this kind of high profile to 
        be associated with this new strategy.

        ``In order to address some of Sandy's concerns and 
        lower our profile . . .

          ``* The strategy has an KPMG acronym which will not 
        be shared with the general First Union community. We 
        will probably assign a generic name. . . .

          ``* No one-pager will be distributed to our referral 
        sources describing the strategy. . . .

          ``* Fees to First Union will be 50 basis points if 
        the investor is not a KPMG client, 25 bps if they are a 
        KPMG client. . . .

        ``I have written up a technical summary of the tax 
        opinion since Sandy will only allow us to read a draft 
        copy of the opinion in his office without making a 
        copy.'' 270
---------------------------------------------------------------------------
    \270\ Email dated 8/30/99, from Tom Newman to multiple First Union 
professionals, ``next strategy,'' Bates SEN-014622.

Clearly, First Union was well aware that it was handling 
products intended to help clients reduce or eliminate their 
taxes and was worried about its own high profile from being 
``associated with `tax' strategies'' like FLIP.
    In addition to its participation in KPMG-developed tax 
products, First Union helped develop and market the BOSS tax 
product sold by PricewaterhouseCoopers (``PWC''), which was 
later determined by the IRS to be a potentially abusive tax 
shelter. First Union had in its files the following document 
advocating the bank's involvement with BOSS:

        ``The proposed transaction takes advantage of an 
        anomaly in current tax law which we expect will be 
        closed down by legislation as soon as Congress finds 
        out about it. We make this investment available only to 
        select clients in order to limit the number of people 
        who know about it. We hope that will delay the time 
        Congress finds out about it, but at some point, it is 
        likely that they will find out and enact legislation to 
        shut it down. First Union acts as sales agent for PwC 
        with respect to this transaction, since the bankers are 
        in a very good position to know when a client has 
        entered into a significant transaction which might have 
        generated significant taxable income. 
        PricewaterhouseCoopers would provide a Tax Opinion 
        Letter which would say that if the entity were examined 
        by the IRS, the transaction would `more likely than 
        not' be successfully upheld.'' 271
---------------------------------------------------------------------------
    \271\ Memorandum dated 12/21/99, from Teri Kemmerer Sallwasser to 
Gail Fagan, ``Boss Strategy Meetings . . .'' Bates SEN-018253-57.

This document provides additional, unmistakable evidence that 
First Union knew it was participating in transactions whose 
primary purpose was to reduce or eliminate clients' taxes.
    Still another bank that handled KPMG tax products is UBS 
AG, now one of the largest banks in the world. UBS was 
convinced by Quellos and KPMG to participate in numerous FLIP 
and OPIS transactions in 1997 and 1998, referred to 
collectively by UBS as ``redemption transactions.''
    UBS documentation clearly and repeatedly describes these 
transactions as tax-related. For example, one UBS document 
explaining the transactions is entitled: ``U.S. Capital Loss 
Scheme--UBS `redemption trades.' '' It states:

        ``The essence of the UBS redemption trade is the 
        creation of a capital loss for U.S. tax purposes which 
        may be used by a U.S. tax resident to off-set any 
        capital gains tax liability to which it would otherwise 
        be subject. The tax structure was originally devised by 
        KPMG. . . . In October 1996, UBS was approached jointly 
        by Quadra . . . and KPMG with a view to it seeking UBS' 
        participation in a scheme that implemented the tax loss 
        structure developed by KPMG. The role sought of UBS was 
        one purely of execution counterparty. . . . It was 
        clear from the outset--and has been continually 
        emphasised since--that UBS made no endorsement of the 
        scheme and that its connection with the structure 
        should not imply any implicit confirmation by UBS that 
        the desired tax consequences will be recognized by the 
        U.S. tax authorities. . . . UBS undertook a thorough 
        investigation into the propriety of its proposed 
        involvement in these transactions. The following steps 
        were undertaken: [redacted by UBS as `privileged 
        material'].'' 272
---------------------------------------------------------------------------
    \272\ UBS internal document dated 3/1/99, ``Equities Large/Heavily 
Structured Transaction Approval,'' with attachment entitled, ``U.S. 
Capital Loss Scheme--UBS `redemption trades,' '' Bates UBS 000009-15.

At another point, the UBS document explains the ``Economic 
Rationale'' for redemption transactions to be: ``Tax benefit 
for client,'' 273 while still another UBS document 
states: ``The motivation for this structure is tax optimisation 
for U.S. tax residents who are enjoying capital gains that are 
subject to U.S. tax. The structure creates a capital loss from 
a U.S. tax point of view (but not from an economic point of 
view) which may be offset against existing capital gains.'' 
274
---------------------------------------------------------------------------
    \273\ Id. at UBS 000010.
    \274\ UBS internal document dated 11/13/97, ``Description of the 
UBS `Redemption' Structure,'' Bates UBS 000031.
---------------------------------------------------------------------------
    In February 1998, an unidentified UBS ``insider'' sent a 
letter to UBS management in London ``to let you know that [UBS 
unit] Global Equity [D]erivatives is currently offering an 
illegal capital gains tax evasion scheme to US tax payers,'' 
meaning the redemption transactions. The letter continued:

        ``This scheme is costing the US Internal Revenue 
        [S]ervice several hundred million dollars a year. I am 
        concerned that once IRS comes to know about this scheme 
        they will levy huge financial/criminal penalties on UBS 
        for offering tax evasion schemes. . . . In 1997 several 
        billion dollars of this scheme was sold to high 
        networth US tax payers, I am told that in 1998 the plan 
        is continu[ing] to market this scheme and to offer 
        several new US tax avoidance schemes involving swaps.

        ``My sole objective is to let you know about this 
        scheme, so that you can take some concrete steps to 
        minimise the financial and reputational damage to UBS. 
        . . .

        ``P.S. I am sorry I cannot disclose my identity at this 
        time because I don't know whether this action of mine 
        will be rewarded or punished.'' 275
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    \275\ Letter dated 2/12/98, addressed to SBC Warburg Dillon Read in 
London, Bates UBS 000038.

In response to the letter, UBS halted all redemption trades for 
several months.276 UBS apparently examined the 
nature of the transactions as well as whether they should be 
registered in the United States as tax shelters. UBS later 
resumed selling the products, stopping only after KPMG 
discontinued the sales.277
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    \276\ See email dated 3/27/98, from Chris Donegan of UBS to Norm 
Bontje of Quadra and others, ``Re: Redemption Trade,'' UBS 000039 
(``Wolfgang and I are presently unable to execute any redemption 
transactions on UBS stock. The main reason for this seems to be a 
concern within UBS that this trade should be registered as a tax 
shelter with the IRS.'').
    \277\ Subcommittee interview with UBS representative (10/28/03).
---------------------------------------------------------------------------
    The UBS documents show that the bank was well aware that 
FLIP and OPIS were designed and sold to KPMG clients as ways to 
reduce or eliminate their U.S. tax liability. The bank 
apparently justified its participation in the transactions by 
reasoning that its participation did not signify its 
endorsement of the transactions and did not constitute aiding 
or abetting tax evasion. The bank then proceeded to provide the 
financing that made these tax products possible.
    The Role of the Investment Advisors. Bank personnel were 
not the only financial professionals assisting KPMG with BLIPS, 
FLIP, and OPIS. Investment experts also played key roles in 
designing, marketing, and implementing the three tax products, 
working closely with KPMG tax professionals throughout the 
process. For example, the investment experts involved with 
BLIPS, FLIP, and OPIS helped KPMG with designing the specific 
financial transactions, making client presentations, obtaining 
financing from the banks, preparing the transactional 
documents, establishing the required shell corporations and 
partnerships, and facilitating the completion of individual 
client transactions. In the case of FLIP, investment experts at 
Quellos, then known as Quadra, provided these services. In the 
case of OPIS, both Quellos and Presidio provided these 
services. In the case of BLIPS, these services were generally 
provided by Presidio.
    A memorandum sent by a Quellos investment expert to a 
banker at UBS explained the investment company's role in FLIP 
and the nature of the tax product itself as follows:

        ``KPMG approached us as to whether we could affect the 
        security trades necessary to achieve the desired tax 
        results. I indicated that I felt we could and they are 
        currently not looking elsewhere for assistance in 
        executing the transaction.

        ``The tax opportunity created is extremely complex, and 
        is really based more on the structuring of the entities 
        involved in the securities transactions rather than the 
        securities transactions themselves. KPMG has assured me 
        that prior to spending much time, beyond just 
        conceptually seeing if we can do it, they would provide 
        Quadra and any counterparty (UBS) with the necessary 
        legal opinions and representatives letters as to why 
        they are recommending this transaction to their 
        clients. Assuming their tax analysis is complete, our 
        challenge is to design a series of securities/
        derivatives trades that meet the required objectives.

        ``In summary, this tax motivated transaction is 
        designed for U.S. companies requiring a tax loss. The 
        way this loss is generated is through the U.S. company 
        exercising a series of options to acquire majority 
        ownership in a Foreign investment (Fund). The tax 
        benefits are created for U.S. Co. based on the types of 
        securities transactions done in the foreign investment 
        Fund and shifting the cost basis to the parent U.S. 
        Company. . . .

        ``If a U.S. company/individual has a $100 million 
        dollar capital gain they owe taxes, depending on their 
        tax position, ranging from $28 million to $35 million. 
        As a result, they are more than willing to pay $2 to $4 
        million to generate a tax loss to offset the capital 
        gain and corresponding taxes. . . .

        ``I have told KPMG that we should be able to execute 
        the transaction once they have a commitment from a 
        potential client. KPMG has already had a number of 
        preliminary meetings with potential clients and one of 
        their challenges was to identify a party that can 
        manage the Fund level and facilitate the transactions 
        with Foreign Co. Given your ability to act as Foreign 
        Co., and facilitate the securities trades, I have told 
        them to stop looking. Once they have a firm client, 
        then we can map out the various details to execute the 
        transaction.'' 278
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    \278\ Memorandum dated 8/12/96, from Jeff Greenstein of Quellos to 
Wolfgang Stolz of UBS, Bates UBS 000002.

This document leaves no doubt that Quellos was fully aware that 
FLIP was a ``tax motivated transaction'' designed for companies 
or individuals ``requiring a tax loss.''
    Quellos was successful in convincing UBS to participate in 
not only FLIP, but also OPIS transactions throughout 1997 and 
1998, as described earlier. Quellos may also have been a tax 
shelter promoter in its own right. For example, in addition to 
its dealings with KPMG on FLIP and OPIS, Quellos teamed up with 
First Union National Bank and PWC to execute about 80 FLIP 
transactions for them. In addition, Quellos held discussions 
with KPMG regarding at least two tax products that Quellos 
itself had developed, but it is unclear whether sales of these 
products actually took place.279 A UBS document 
states that Quellos' ``specialty is providing tax efficient 
investment schemes for high net worth U.S. individuals and 
their investment vehicles.'' 280
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    \279\ See, e.g., email dated 12/10/99, from Douglas Ammerman to 
multiple KPMG tax professionals, ``Innovative Strategy Development,'' 
Bates KPMG 0036736 (discusses KPMG working with Quellos on two products 
that Quellos had developed, called FORTS, a ``loss generating 
strategy,'' and WEST, a ``conversion strategy.'').
    \280\ Undated UBS internal document, ``Memorandum on USB' 
involvement in U.S. Capital Loss Generation Scheme (the `CLG 
Scheme'),'' Bates UBS 000006.
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    Presidio played a similar role in the design, marketing, 
and implementation of OPIS and BLIPS. Two of Presidio's 
principals are former KPMG tax professionals who knew the KPMG 
tax professionals working on OPIS and BLIPS. These Presidio 
principals were repeatedly identified by KPMG as members of 
``the working group'' developing OPIS and were described as 
having contributed to the design and implementation of 
OPIS.281 Moreover, Presidio initially brought the 
idea for BLIPS to KPMG, and was thoroughly involved in the 
development, marketing, and implementation of the product. On 
May 1, 1999, prior to the final approval of BLIPS, Presidio 
representatives made a detailed presentation to KPMG tax 
professionals on how the company was planning to implement the 
BLIPS transactions.282 During the presentation, 
among other points, Presidio representatives disclosed that 
there was only a ``remote'' possibility that any investor would 
actually profit from the contemplated foreign currency 
transactions, and that the banks providing the financing 
planned to retain, under the terms of the contemplated BLIPS 
``loans,'' an effective ``veto'' over how the ``loan proceeds'' 
could be invested. These statements, among others, caused 
KPMG's key technical reviewer in the Washington National Tax 
group to reconsider his approval of the BLIPS product, in part 
because he felt he had ``not been given complete information 
about how the transaction would be structured.'' 283
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    \281\ See , e.g., memorandum dated 3/13/98, from Robert Simon to 
Jeff Stein and Sandy Smith, all of KPMG, ``OPIS,'' Bates KPMG 0010262 
(``The attached went to the entire working group (Pfaff, Ritchie, R.J. 
Ruble of Brown & Wood, Bickham, and Larson).''); email dated 3/14/98 
from Jeff Stein to multiple KPMG tax professionals, ``Simon Says,'' 
Bates 638010, filed by the IRS on June 16, 2003, as an attachment to 
Respondent's Requests for Admission, Schneider Interests v. 
Commissioner, U.S. Tax Court, Docket No. 200-02 (``By the way--anybody 
who does not have a copy of the Pfaff letter, let me know and I will 
fax it over to you. In addition in case you want a copy of the November 
6, 1997 memo detailing the proposed LLC structure written by Simon to 
`The Working Group' which included Ritchie, Pfaff, Larson, Bickahm 
[sic] and R.J. Ruble of the law firm of Brown & Wood let me know and I 
will fax it over to you as well.''). Robert Pfaff and John Larson are 
the former KPMG tax professionals who left the firm to open Presidio.
    \282\ See, e.g., email dated 5/10/99, from Mark Watson to John 
Lanning and others, ``FW: BLIPS,'' Bates MTW 0039; email dated 5/5/99, 
from Mark Watson to Larry DeLap, Bates KPMG 0011915-16. See also, e.g., 
memorandum dated 4/20/99, from Amir Makov of Presidio to John Rolfes of 
Deutsche Bank, ``BLIPS friction costs,'' Bates DB BLIPS 01977 (showing 
Presidio's role in planning the BLIPS transactions; includes statement: 
``On day 60, Investor exits partnership and unwinds all trades in 
partnership.'')
    \283\ See Section VI(B)(1) of this Report discussing the BLIPS 
development and approval process; email dated 5/10/99, from Mark Watson 
to John Lanning and others, ``FW: BLIPS,'' Bates MTW 0039.
---------------------------------------------------------------------------
    When BLIPS was eventually approved over the objections of 
the WNT technical reviewer, Presidio played a key role in 
making client presentations to sell the product and in 
executing the actual BLIPS transactions. One of the most 
important roles Presidio played in BLIPS was, in each BLIPS 
transaction, to direct two of the companies it controlled, 
Presidio Growth and Presidio Resources, to enter into a 
``Strategic Investment Fund'' partnership with the relevant 
BLIPS client. This partnership was central to the entire BLIPS 
transaction, since it was this partnership that assumed and 
repaid the purported ``loan'' that gave rise to the BLIPS 
client's ``tax loss.'' In each BLIPS transaction, a Presidio 
company acted as the managing partner for the partnership and 
contributed a small portion of the funds used in the BLIPS 
transactions. Presidio also performed administrative tasks 
that, while more mundane, were critical to the success of the 
the tax product. For example, when BLIPS was just starting to 
get underway, Presidio took several steps to facilitate the 
transactions, including stationing personnel at one of the law 
firms preparing the transactional documents.284
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    \284\ Email dated 5/13/99, from Barbara Mcconnachie to multiple 
KPMG tax professionals, ``FW: BLIPS,'' Bates MTW 0045 (``Presidio has 2 
individuals permanently housed at Sherman & Sterling to assist in the 
necessary documentation.''). Sherman & Sterling prepared many of the 
key transactional documents for BLIPS transactions involving Deutsche 
Bank.
---------------------------------------------------------------------------
    When a problem arose indicating that currency conversions 
in two BLIPS transactions had been timed in such a way that 
they would create negative tax consequences for the BLIPS 
clients, Presidio apparently took the lead in correcting the 
``errors.'' An email sent by Presidio to HVB states:

        ``I know that Steven has talked to you regarding the 
        error for Roanoke Ventures. I have also noted an error 
        for Mobil Ventures. None of the Euro's should have been 
        converted to [U.S. dollars] in 1999. Due to the tax 
        consequences that result from these sales, it is 
        critical that these transactions be reversed and made 
        to look as though they did not occur at all.'' 
        285
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    \285\ Email dated 12/28/99, from Kerry Bratton of Presidio to 
Alexandre Nouvakhov and Amy McCarthy of HVB, ``FX Confirmations,'' 
Bates HVB 002035.

Other documents suggest that, as Presidio requested, the 
referenced 1999 currency trades were somehow ``reversed'' and 
then executed the next month in early 2000.286 HVB 
told Subcommittee staffers that they had been unaware of this 
matter and would have to research the transactions to determine 
whether, in fact, trades or paperwork had been 
altered.287
---------------------------------------------------------------------------
    \286\ See, e.g., memorandum dated 12/23/99, from Kerry Bratton of 
Presidio to Amy McCarthy of HVB, ``Transfer Instructions,'' Bates HVB 
001699; memorandum dated 1/19/00, from Steven Buss at Presidio to Alex 
Nouvakhov at HVB, ``FX Instructions--Mobile Ventures LLC,'' Bates HVB 
001603; email dated 1/19/00, from Alex Nouvakhov at HVB to Matt Dunn at 
HVB, ``Presidio,'' Bates HVB 001601 (``We need to sell Euros for 
another Presidio account and credit their [U.S. dollar] DDA account. It 
is the same deal as the one for Roanoke you did earlier today.''); 
email dated 1/19/00, from Alex Nouvakhov at HVB to Steven Buss at 
Presidio, ``Re: mobile,'' Bates HVB 001602; memorandum dated 1/19/00, 
from Steven Buss at Presidio to Timothy Schifter at KPMG, ``Sale 
Confirmation,'' Bates HVB 001600.
    \287\ Subcommittee interview of HVB bank representatives (10/29/
03).
---------------------------------------------------------------------------
    Presidio has worked with KPMG on a number of tax products 
in addition to the four examined in this Report. A Presidio 
representative told the Subcommittee staff that 95% of the 
company's revenue came from its work with KPMG.288
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    \288\ Subcommittee interview of John Larson (6/20/03).

          Finding: Some law firms have provided legal services 
        that facilitated KPMG's development and sale of 
        potentially abusive or illegal tax shelters, including 
        by providing design assistance or collaborating on 
        allegedly ``independent'' opinion letters representing 
        to clients that a tax product would withstand an IRS 
---------------------------------------------------------------------------
        challenge, in return for substantial fees.

    The Role of the Law Firms. The evidence obtained by the 
Subcommittee during the course of the investigation determined 
that one law firm, Sidley Austin Brown & Wood, played a 
significant and ongoing role in the development, marketing, and 
implementation of the four KPMG tax products featured in this 
Report.
    Sidley Austin Brown & Wood is currently being audited by 
the IRS to evaluate the firm's ``role . . . in the organization 
and sale of tax shelters'' and compliance with federal tax 
shelter requirements.289 In court pleadings, the IRS 
has alleged the following:
---------------------------------------------------------------------------
    \289\ ``Declaration of Richard E. Bosch,'' IRS Revenue Agent, In re 
John Doe Summons to Sidley Austin Brown & Wood (N.D. Ill. 10/16/03) at 
para. 5.

        ``[I]t appears that [Sidley Austin Brown & Wood] was 
        involved in the organization and sale of transactions 
        which were or later became `listed transactions,' or 
        that may be other `potentially abusive tax shelters.' 
        The organization and sale of these transactions appears 
        to have been coordinated by [primarily] . . . Raymond 
        J. Ruble. . . . During the investigation, I learned 
        that [Sidley Austin Brown & Wood] issued approximately 
        600 opinions with respect to certain listed 
        transactions promoted (or co-promoted) by, among 
        others, KPMG, Arthur Andersen, BDO Seidman, Diversified 
        Group, Inc., and Ernst & Young. . . . The IRS has 
        identified transactions for which [Sidley Austin Brown 
        & Wood] provided opinions, . . . FLIPS, OPIS, COBRA, 
        BLIPS and CARDS, as `listed transactions.' 
        ''290
---------------------------------------------------------------------------
    \290\ Id. para.para. 9, 10, 12.

The IRS also alleges that, in response to a December 2001 
disclosure initiative in which taxpayers obtained penalty 
waivers in exchange for identifying their tax shelter 
promoters, 80 disclosure statements named Sidley Austin Brown & 
Wood as ``promoting, soliciting, or recommending their 
participation in certain tax shelters.'' 291 The IRS 
also alleges that the law firm provided approximately 600 
opinions for at least 13 tax products, including FLIP, OPIS, 
and BLIPS.292
---------------------------------------------------------------------------
    \291\ Id. at para. 14.
    \292\ Id. at para. 27(a).
---------------------------------------------------------------------------
    Information obtained by the Subcommittee indicates that 
Sidley Austin Brown & Wood, through the efforts of Mr. Ruble, 
did more than simply draft opinion letters supporting KPMG tax 
products; the law firm formed an alliance with KPMG to develop 
and market these tax products. IRS court pleadings, for 
example, quote a December 1997 email in which Mr. Ruble states: 
``This morning my managing partner, Tom Smith, approved Brown & 
Wood LLP working with the newly conformed tax products group at 
KPMG on a joint basis in which we would jointly develop and 
market tax products and jointly share in the fees.'' 
293 An internal KPMG memorandum around the same time 
states: ``[W]e need to consummate a formal strategic allicance 
with Brown & Wood.'' 294
---------------------------------------------------------------------------
    \293\ Id. at para. 15, citing an email dated 12/15/97, from R.J. 
Ruble. This email also references a meeting to be set up between KPMG 
and two partners at Sidley Austin Brown & Wood, Paul Pringle and Eric 
Haueter. See also email dated 12/24/97, from R.J. Ruble to Randall 
Brickham at KPMG, ``Confidential Matters,'' Bates KPMG 0047356 
(``Thanks again . . . for spending time with Paul and Eric. Their 
meeting you all helps me immensely with the politics here.'').
    \294\ Memorandum dated 12/19/97, from Randall Bickham to Gregg 
Ritchie, ``Business Model--Brown & Wood Strategic Alliance,'' Bates 
KPMG 0047228.
---------------------------------------------------------------------------
    Three months later, an internal KPMG memorandum discussing 
an upcoming meeting between KPMG and Brown & Wood states that 
KPMG tax professionals intended to discuss ``how to 
institutionalize the KPMG/B&W relationship.'' 295 
Among other items, KPMG planned to discuss ``the key profit-
drivers for our joint practice,'' citing in particular KPMG's 
``Customer list'' and ``Financial commitment'' and Brown & 
Wood's ``Institutional relationships within the investment 
banking community.'' The memorandum states that KPMG also 
planned to discuss ``[w]hat should be the profit-split between 
KPMG, B&W and the tax products group/implementor for jointly-
developed products,'' and suggesting that in ``a 7% deal'' 
KPMG, B&W and the ``Implementor'' should split the net profits 
evenly, after awarding a ``finder's allocation'' to the party 
who found the tax product purchaser. Still other documents 
indicate that Sidley Austin Brown & Wood, through Mr. Ruble, 
became a member of a working group that jointly developed 
OPIS.296 Evidence obtained by the Subcommittee also 
indicates that Sidley Austin Brown & Wood, through Mr. Ruble, 
was an active participant in the development of BLIPS, 
expending significant time working with KPMG tax professionals 
to author their respective opinion letters.
---------------------------------------------------------------------------
    \295\ Memorandum dated 3/2/98, from Randall Bickham to Gregg 
Ritchie, ``B&W Meeting,'' Bates KPMG 0047225-27.
    \296\ See , e.g., memorandum dated 3/13/98, from Robert Simon to 
Jeff Stein and Sandy Smith, all of KPMG, ``OPIS,'' Bates KPMG 0010262 
(``The attached went to the entire working group (Pfaff, Ritchie, R.J. 
Ruble of Brown & Wood, Bickham, and Larson).''); email dated 3/14/98 
from Jeff Stein to multiple KPMG tax professionals, ``Simon Says,'' 
Bates 638010, filed by the IRS on June 16, 2003, as an attachment to 
Respondent's Requests for Admission, Schneider Interests v. 
Commissioner, U.S. Tax Court, Docket No. 200-02 (``By the way--anybody 
who does not have a copy of the Pfaff letter, let me know and I will 
fax it over to you. In addition in case you want a copy of the November 
6, 1997 memo detailing the proposed LLC structure written by Simon to 
``The Working Group'' which included Ritchie, Pfaff, Larson, Bickahm 
[sic] and R.J. Ruble of the law firm of Brown & Wood let me know and I 
will fax it over to you as well.'').
---------------------------------------------------------------------------
    In the case histories examined by the Subcommittee, once 
the design of a KPMG tax product was complete and KPMG began 
selling the product to clients, Sidley Austin Brown & Wood's 
primary implementation role became one of issuing legal opinion 
letters to the persons who had purchased the products. Sidley 
Austin Brown & Wood, through Mr. Ruble, wrote literally 
hundreds of legal opinions supporting FLIP, OPIS, and 
BLIPS.297 In the case of SC2, KPMG had apparently 
made arrangements for clients to obtain a second opinion from 
either Sidley Austin Brown & Wood 298 or Bryan Cave, 
another major law firm,299 but it is unclear how 
many SC2 buyers, if any, took advantage of these arrangements 
and bought a second opinion.
---------------------------------------------------------------------------
    \297\ See ``Declaration of Richard E. Bosch,'' IRS Revenue Agent, 
In re John Doe Summons to Sidley Austin Brown & Wood (N.D. Ill. 10/16/
03) at para. 18, citing an email by KPMG tax professional Gregg 
Ritchie.
    \298\ Subcommittee interview of Lawrence Manth (11/6/03).
    \299\ See memorandum dated 2/16/01, from Andrew Atkin to SC2 
Marketing Group, ``Agenda from Feb 16th call and goals for next two 
weeks,'' Bates KPMG 0051135.
---------------------------------------------------------------------------
    Traditionally, second opinion letters are supplied by a 
disinterested tax expert with no financial stake in the 
transaction being evaluated, and this expert sends an 
individualized letter to a single client. Certain IRS 
penalties, in fact, can be waived if a taxpayer relies ``in 
good faith'' on expert tax advice.300 The mass 
marketing of tax products to multiple clients, however, has 
been followed by the mass production of opinion letters that, 
for each letter sent to a client, earns its author a handsome 
fee. Since there are few costs associated with producing new 
opinion letters, once a prototype opinion letter has been 
completed for the generic tax product, the mass production of 
largely boilerplate opinion letters has become a lucrative 
business for firms like Sidley Austin Brown & Wood. The 
attractive profits available from these letters have also 
created new incentives for law firms to team up with tax 
product promoters to become the preferred source for a second 
opinion letter. This profit motive undermines an arms-length 
relationship between the two opinion writers.
---------------------------------------------------------------------------
    \300\ See 26 U.S.C. Sec. 6662(d)(2)(C)(i); Treas.Reg. 
Sec. Sec. 1.6662-4(g)(4)(ii) and 1.6664-4(c)(1).
---------------------------------------------------------------------------
    Actions taken by Sidley Austin Brown & Wood and KPMG to 
collaborate on their respective opinion letters raises 
additional questions about the law firm's independent status. 
The evidence indicates that the law firm collaborated 
extensively with KPMG in the drafting of the BLIPS, FLIP, and 
OPIS opinion letters. This collaboration included joint 
identification, research, and analysis of key legal and tax 
issues; discussions about the best way to organize and present 
the reasoning used in their respective letters; and joint 
efforts to identify necessary factual representations by the 
participating parties in the transactions being analyzed. In 
the case of FLIP, Mr. Ruble faxed a copy of his draft opinion 
letter to KPMG before issuing it.301 In the case of 
BLIPS, Sidley Austin Brown & Wood and KPMG actually exchanged 
copies of their respective draft opinion letters and conducted 
a detailed ``side-by-side'' review ``to make sure we each cover 
everything the other has.'' 302 The result was two, 
allegedly independent opinion letters containing numerous, 
virtually identical paragraphs.
---------------------------------------------------------------------------
    \301\ Facsimile cover sheet dated 2/26/97, from R.J. Ruble to David 
Lippman and John Larson at KPMG, Bates XX 001440.
    \302\ Email dated 9/24/99, from R.J. Ruble of Brown & Wood, to 
Jeffrey Eischeid and Rick Bickham of KPMG, Bates KPMG 0033497; followed 
by other emails exchanged between Brown & Wood and KPMG personnel, from 
9/25/99 to 10/29/99, Bates KPMG 0033496-97.
---------------------------------------------------------------------------
    KPMG used the availability of a second opinion letter from 
Sidley Austin Brown & Wood as a marketing tool to increase 
sales of its tax products, telling clients that having this 
second letter would help protect them from accuracy-related 
penalties if the IRS were to later invalidate a tax 
product.303 Many clients were apparently swayed by 
this advice and sought an opinion letter from the law firm. 
Evidence obtained by the Subcommittee indicates that the 
opinion letters provided by the law firm were, like KPMG's 
opinion letters, virtually identical in content and reflected 
little, if any, individualized client interaction or legal 
advice. In some cases, KPMG arranged to obtain a client's 
opinion letter directly from the law firm and delivered it to 
the client, apparently without the client's ever speaking to 
any Sidley Austin Brown & Wood lawyer. One individual told the 
Subcommittee staff that after KPMG sold him FLIP, KPMG arranged 
for him to obtain a favorable opinion letter from Sidley Austin 
Brown & Wood without his ever contacting the law firm or 
directly speaking with a lawyer.304 An individual 
testifying at a recent Senate Finance Committee hearing 
testified that he had received a Sidley Austin Brown & Wood 
opinion letter for COBRA, a tax product he had purchased from 
Ernst & Young, by picking up the letter from the accounting 
firm's office. He testified that he never communicated with 
anyone at the law firm.305 This type of evidence 
suggests that the law firm's focus was not on providing 
individualized legal advice to clients, but on churning out 
boilerplate opinion letters for a fee.
---------------------------------------------------------------------------
    \303\ See, e.g., KPMG document dated 6/19/00, entitled ``SC2--
Meeting Agenda,'' Bates KPMG 0013375-96, at 13393; see also Section 
VI(B)(2) of this Report on using tax opinion letters as a marketing 
tool.
    \304\ Jacoboni v. KPMG, Case No. 02-CV-510 (D.M.D. Fla. 4/29/02), 
at para. 19 (``Mr. Jacoboni later received a copy of a `concurring 
opinion' dated August 31, 1998, from the law firm Brown & Wood, LLP, 
which was requested by Dale Baumann of KPMG. The Brown & Wood 
concurring opinion was mailed from New York to Mr. Jacoboni in 
Florida.''); Subcommittee interview of legal counsel to Joseph Jacoboni 
(4/4/03).
    \305\ See testimony of Henry Camferdam regarding his purchase of 
COBRA, Senate Finance Committee hearing, ``Tax Shelters: Who's Buying, 
Who's Selling, and What's the Government Doing About It?'' (10/21/03) 
(Camferdam: ``I never talked to anyone at Brown & Wood. In fact, all of 
their documents were sent to us via [Ernst & Young]--not directly to 
us.'').
---------------------------------------------------------------------------
    By routinely directing clients to Sidley Austin Brown & 
Wood to obtain a second opinion letter, KPMG produced a steady 
stream of income for the law firm. In the case of BLIPS, FLIP, 
and OPIS, Sidley Austin Brown & Wood was apparently paid at 
least $50,000 per opinion. One document indicates that Sidley 
Austin Brown & Wood was paid this fee in every case where its 
name was mentioned during a sales pitch for BLIPS, whether or 
not the client actually purchased the law firm's opinion 
letter. Other evidence indicates that in some BLIPS 
transactions expected to produce a very large ``tax loss'' for 
the client, Sidley Austin Brown & Wood was paid more than 
$50,000 for its opinion letter.
    Sidley Austin Brown & Wood provided opinion letters not 
only to KPMG, but also to other firms selling similar tax 
products. For example, the law firm also issued favorable 
opinion letters for COBRA, a tax product similar to OPIS, but 
sold by Ernst & Young. An email seems to suggest that when a 
client sought a tax opinion letter for a product from Ernst & 
Young and was turned down, Sidley Austin Brown & Wood may have 
advised the client to try KPMG instead. The internal Ernst & 
Young email states:

        ``[Redacted name] told me that during the January 
        meeting, Richard Shapiro gave him the name of R.J. 
        Rubell [sic] at Brown and Wood and said that they could 
        contact him directly regarding the tax opinion and 
        other issues. He did that. Rubell said that Brown and 
        Wood stands by the deal and is willing to issue the 
        same opinion letter as before. They and others do not 
        see the risk that E&Y sees. Apparently, B&W is also 
        working with Diversified and KPMG and Rubell steered 
        them in that direction.'' 306
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    \306\ Email dated 2/11/00, from Alexander Eckman to David G. 
Johnson and others, subject line redacted, Bates 2003EY011640.

It is unclear exactly what problem is being addressed, but this 
email raises concerns about opinion letter shopping and about 
the propriety of the law firm's steering clients away from 
Ernst & Young, apparently because that firm refused to issue a 
requested letter, and toward KPMG.
    In short, in exchange for substantial fees, Sidley Austin 
Brown & Wood provided legal services that facilitated KPMG's 
development and sale of potentially abusive or illegal tax 
shelters such as FLIP, OPIS, and BLIPS, including by providing 
design assistance and collaborating on allegedly 
``independent'' opinion letters representing to clients that 
the KPMG tax products would withstand an IRS challenge.

          Finding: Some charitable organizations have 
        participated as essential counter parties in a highly 
        questionable tax shelter developed and sold by KPMG, in 
        return for donations or the promise of future 
        donations.

    The Role of the Charitable Organizations. SC2 transactions 
could not have taken place at all without the willing 
participation of a charitable organization. To participate in 
SC2 transactions, a charity had to undertake a number of non-
routine and potentially expensive, time-consuming tasks. For 
example, the charity had to agree to accept an S corporation 
stock donation, which for many charities is, in itself, 
unusual; make sure it is exempt from the unrelated business 
income tax (hereinafter ``UBIT'') and would not be taxed for 
any corporate income earned during the time when the charity 
was a shareholder; sign a redemption agreement; determine how 
to treat the stock donation on its financial statements; and 
then hold the stock for several years before receiving any cash 
donation for its efforts. Moreover, relatively few charities 
are exempt from the UBIT, and those that are--like pension 
funds--do not normally receive large contributions from private 
donors.
    KPMG approved SC2 for sale to clients in March 2000, and 
discontinued all sales 18 months later, around September 2001, 
after selling the tax product to about 58 S corporations. The 
SC2 sales produced fees exceeding $26 million for KPMG, making 
SC2 one of KPMG's top ten revenue producers in 2000 and 2001. 
Although KPMG refused to identify the charities that 
participated in the SC2 transactions, the Subcommittee was able 
to identify and interview two which, between them, participated 
in more than half of the SC2 transactions KPMG arranged.
    The two charities interviewed by the Subcommittee staff 
indicated that they would not have participated in the SC2 
transactions absent being approached, convinced, and assisted 
by KPMG. The Los Angeles Department of Fire & Police Pensions 
System is a $10 billion pension fund that serves the police and 
fire departments in the city of Los Angeles in California. The 
Austin Fire Fighters Relief and Retirement Fund is a much 
smaller pension fund serving the fire departments in Austin, 
Texas.
    Based upon information provided to the Subcommittee, it 
appears that, out of the about 58 SC2 tax products sold by KPMG 
in 2000 and 2001, the Los Angeles pension fund participated in 
29 of the SC2 transactions, while the Austin pension fund 
participated in five. The Los Angeles pension fund indicated 
that, as a result of the SC2 transactions, it is currently 
holding stock valued at about $7.3 million from 16 S 
corporations, and has sold back donated stock to 13 
corporations in exchange for cash payments totaling about $5.5 
million. Both pension funds told the Subcommittee that the SC2 
stock donors and their corporations had generally been from 
out-of-state. The Los Angeles pension fund indicated that it 
had received stock from S corporations in Arizona, Georgia, 
Hawaii, Missouri, and North Carolina. The Austin pension fund 
indicated that it had received stock from S corporations in 
California, Mississippi, New Jersey, and New York. Both pension 
funds indicated that they had not met any of the SC2 donors 
until KPMG introduced them to the charities.
    Both charities indicated to the Subcommittee staff that, in 
determining whether to participate in the SC2 transactions, 
they relied on KPMG's representation that the transactions 
complied with federal tax law. The Los Angeles pension fund 
also obtained from an outside law firm a legal opinion letter 
on the narrow issue of whether the charity had the legal 
authority to accept a donation of S corporation stock. In 
analyzing this issue, the law firm notes first in the legal 
opinion letter that all of the facts recited about the 
transaction had been provided to the law firm by a KPMG tax 
professional.307 The letter concludes that the 
pension fund may accept an S corporation stock donation from an 
unrelated third party: ``Although this is a very unusual 
transaction, and there is almost no statutory, regulatory or 
other authority addressing the issue, we believe the Plan is 
permitted to accept a contribution.'' The letter also states, 
however, that the law firm had not been asked to provide any 
legal advice about the substance of the SC2 transaction itself, 
that it had not been given any documentation to review, and 
that it was not offering any opinion on ``the impact of the 
transaction on the `donor' from a tax or other standpoint.'' 
308
---------------------------------------------------------------------------
    \307\ Letter dated 12/30/99, from Seyfarth, Shaw, Fairweather & 
Geraldson to the Los Angeles pension fund, at 3.
    \308\ Id. The letter states: ``You have asked us to advise you 
concerning the ability of the L.A. Fire & Police Pension System (the 
`Plan') to accept a contribution from an unrelated third party in the 
form of nonvoting stock of a closely held California S corporation. . . 
. It should be noted that, from a procedural and due-diligence 
standpoint, (1) we have not been asked to conduct, and we have not 
conducted, any investigation into the company and/or the individual 
involved, (2) we have not yet reviewed any of the underlying 
documentation in connection with the donation or the possible future 
redemption of the stock, and offer no opinion on such agreements or 
their impact on any of the views expressed in this letter, (3) we have 
not examined, or opined in any way about, the impact of the transaction 
on the `donor' from a tax or other standpoint, and (4) we have not 
checked the investment against any investment policy guidelines that 
may have been adopted by the Board.''
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    Apparently, neither charity obtained a legal or tax opinion 
letter or other written legal advice, from KPMG or any other 
firm, on whether the SC2 tax product and related transactions 
complied with federal tax law or whether the charity's 
participation in SC2 transactions could be viewed as aiding or 
abetting tax evasion. The two pension funds told the 
Subcommittee that they simply relied on KPMG's reputation as a 
reputable firm in assuming the donation strategy was within the 
law.
    Both pension funds told the Subcommittee that, in every SC2 
transaction, it was their expectation that they would not 
retain ownership of the donated stock, but would sell it back 
to the stock donor after the expiration of the period of time 
indicated in the redemption agreement. They also indicated that 
they did not expect to obtain significant amounts of money from 
the S corporation during the period in which the charity was a 
stockholder but expected, instead, to obtain a large cash 
payment at the time the charity sold the stock back to the 
donor. Moreover, the charities told the Subcommittee staff that 
their expectations have, in fact, been met, and the SC2 
transactions have been carried out as planned by KPMG, the 
donors, and the charities. These facts and expectations raise 
serious questions about whether the SC2 transactions ever truly 
passed ownership of the stock to the charity or acted merely as 
an assignment of income for a specified period time to the 
charitable organization.
    In the case of BLIPS, FLIP, OPIS, and SC2, major banks, 
investment advisory firms, law firms, and charitable 
organizations provided critical services or acted as essential 
counterparties in the transactions called for by the tax 
products. Each obtained lucrative fees, often totaling in the 
millions of dollars, for their participation. Despite the 
complexity, frequency, and size of the transactions and their 
clear connection to tax avoidance schemes, none of the 
participating organizations presented to the Subcommittee a 
reasoned, contemporaneous analysis of the tax shelter, 
reputational risk, ethical, or professional issues justifying 
the organization's role in facilitating these highly 
questionable and abusive tax transactions.

  (4) Avoiding Detection

          Finding: KPMG has taken steps to conceal its tax 
        shelter activities from tax authorities and the public, 
        including by refusing to register potentially abusive 
        tax shelters with the IRS, restricting file 
        documentation, and using improper tax return reporting 
        techniques.

    Evidence obtained by the Subcommittee in the four KPMG case 
studies shows that KPMG has taken a number of steps to conceal 
its tax shelter activities from IRS, law enforcement, and the 
public. In the first instance, it has simply denied being a tax 
shelter promoter and claimed that tax shelter information 
requests do not apply to its products. Second, evidence in the 
FLIP, OPIS, BLIPS, and SC2 case histories indicate that KPMG 
took a number of precautions in the way it designed, marketed, 
and implemented these tax products to avoid or minimize 
detection of its activities.
    No Tax Shelter Disclosure. KPMG's public position is that 
it does not develop, sell or promote tax shelters, as explained 
earlier in this Report. As a consequence, KPMG has not 
voluntarily registered, and thereby disclosed to the IRS, a 
single one of its tax products. A memorandum quoted at length 
earlier in this Report 309 establishes that, in 
1998, a KPMG tax professional advised the firm not to register 
the OPIS tax product with the IRS, even if OPIS qualified as a 
tax shelter under the law, citing competitive pressures and a 
perceived lack of enforcement or effective penalties for 
noncompliance with the registration requirement. Another 
document discussing registration of OPIS had this to say: 
``Must register the product. B&W concerns--risk is too high. 
Confirm w/Presidio that they will register.'' 310 
The head of DPP-Tax told the Subcommittee staff that he had 
recommended registering not only OPIS, but also BLIPS, but was 
overruled in each instance by the top official in charge of the 
Tax Services Practice.311
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    \309\ See Section VI(B) of this Report.
    \310\ Handwritten notes dated 3/4/98, author not indicated, 
regarding ``Brown & Wood'' and ``OPIS,'' Bates KPMG 0047317. Emphasis 
in original. ``B&W'' refers to Brown & Wood, the law firm that worked 
with KPMG on OPIS. Presidio is an investment firm that worked with KPMG 
on OPIS.
    \311\ Subcommittee interview of Lawrence DeLap (10/30/03).
---------------------------------------------------------------------------
    Other documents show that consideration of tax shelter 
registration issues was a required step in the tax product 
approval process, but rather than resulting in IRS 
registrations, KPMG appears to have devoted resources to 
devising rationales for not registering a product with the IRS. 
KPMG's Tax Services Manual states that every new tax product 
must be analyzed by the WNT Tax Controversy Services group ``to 
address tax shelter regulations issues.'' 312 For 
example, one internal document analyzing tax shelter 
registration issues discusses the ``policy argument'' that 
KPMG's tax ``advice . . . does not meet the paradigm of 6111(c) 
registration'' and identifies other flaws with the legal 
definition of ``tax shelter'' that may excuse registration. The 
email also suggests possibly creating a separate entity to act 
as the registrant for KPMG tax products:
---------------------------------------------------------------------------
    \312\ KPMG Tax Services Manual, Sec. 24.4.1, at 24-2.

        ``If we decide we will be registering in the future, 
        thought should be given to establishing a separate 
        entity that meets the definition of an organizer for 
        all of our products with registration potential. This 
        entity, rather than KPMG, would then be available 
        through agreement to act as the registering organizer. 
        . . . If such an entity is established, KPMG can avoid 
        submitting its name as the organizer of a tax shelter 
        on Form(s) 8264 to be filed in the future.'' 
        313
---------------------------------------------------------------------------
    \313\ Email dated 5/11/98, from Jeffrey Zysik to multiple KPMG tax 
professionals, ``Registration,'' Bates KPMG 0034805-06. See also email 
dated 5/12/98, from Jeffrey Zysik to multiple KPMG tax professionals, 
``Registration requirements.,'' Bates KPMG 0034807-11 (reasonable cause 
exception, tax shelter definitions, number of registrations required); 
email dated 5/20/98, from Jeffrey Zysik to multiple KPMG tax 
professionals, ``Misc. Tax Reg. issues,'' Bates KPMG 0034832-33 
(``reasonable cause exception for not registering''; application of 
regulatory ``tax shelter ratio'' to identify tax shelters; 
``establishing a separate entity to act as the entity registering ALL 
tax products. . . . Otherwise we must submit our name as the tax 
shelter organizer.'').

    Another KPMG document, a fiscal year 2002 draft business 
plan for the Personal Financial Planning Practice, describes 
two tax products under development, but not yet approved, due 
in part to pending tax shelter registration 
issues.314 The first, referred to as POPS, is 
described as ``a gain mitigation solution.'' The business plan 
states: ``We have completed the solution's technical review and 
have almost finalized the rationale for not registering POPS as 
a tax shelter.'' The second product is described as a 
``conversion transaction . . . that halves the taxpayer's 
effective tax rate by effectively converting ordinary income to 
long term capital gain.'' The business plan notes: ``The most 
significant open issue is tax shelter registration and the 
impact registration will have on the solution.''
---------------------------------------------------------------------------
    \314\ Document dated 5/18/01, ``PFP Practice Reorganization 
Innovative Strategies Business Plan--DRAFT,'' Bates KPMG 0050620-23, at 
2.
---------------------------------------------------------------------------
    The IRS has issued ``listed transactions'' that explicitly 
identify FLIP, OPIS, and BLIPS as potentially abusive tax 
shelters. Due to these tax products and others, the IRS is 
investigating KPMG to determine whether it is a tax shelter 
promoter and is complying with the tax shelter requirements in 
Federal law.315 KPMG continues flatly to deny that 
it is a tax shelter promoter and has continued to resist 
registering any of its tax products with the IRS.
---------------------------------------------------------------------------
    \315\ See United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 9/6/
02).
---------------------------------------------------------------------------
    A second consequence of KPMG's public denial that it is a 
tax shelter promoter has been its refusal fully to comply with 
the document requests made by the IRS for lists of clients who 
purchased tax shelters from the firm. In a recent hearing 
before the Senate Finance Committee, the U.S. Department of 
Justice stated that, although the client-list maintenance 
requirement enacted by Congress ``clearly precludes any claim 
of identity privilege for tax shelter customers regardless of 
whether the promoters happen to be accountants or lawyers, the 
issue continues to be the subject of vigorous litigation.'' 
316 The Department pointed out that one circuit 
court of appeals and four district courts had already ruled 
that accounting firms, law firms, and a bank must divulge 
client information requested by the IRS under the tax shelter 
laws, but certain accounting firms were continuing to contest 
IRS document requests. At the same hearing, the former IRS 
chief counsel characterized the refusal to disclose client 
names by invoking either attorney-client privilege or Section 
7525 of the tax code as ``frivolous,'' while also noting that 
one effect of the ensuing litigation battles ``was to delay 
[promoter] audits to the point of losing one or more tax years 
to the statute of limitations.'' 317
---------------------------------------------------------------------------
    \316\ Testimony of Eileen J. O'Connor, Assistant Attorney General 
for the Tax Division, U.S. Department of Justice, before the Senate 
Committee on Finance, ``Tax Shelters: Who's Buying, Who's Selling and 
What's the Government Doing About It?'' (10/21/03), at 3.
    \317\ Testimony of B. John Williams, Jr. former IRS chief counsel, 
before the Senate Committee on Finance, ``Tax Shelters: Who's Buying, 
Who's Selling and What's the Government Doing About It?'' (10/21/03), 
at 4-5.
---------------------------------------------------------------------------
    IRS Commissioner, Mark Everson, testified at the same 
hearing that the IRS had filed suit against KPMG in July 2002, 
``to compel the public accounting firm to disclose information 
to the IRS about all tax shelters it has marketed since 1998.'' 
318 He stated, ``Although KPMG has produced many 
documents to the IRS, it has also withheld a substantial 
number.''
---------------------------------------------------------------------------
    \318\ Testimony of Mark W. Everson, IRS Commissioner, before the 
Senate Committee on Finance, ``Tax Shelters: Who's Buying, Who's 
Selling and What's the Government Doing About It?'' (10/21/03), at 11.
---------------------------------------------------------------------------
    Some of the documents obtained by the Subcommittee during 
its investigation illustrate the debate within KPMG over 
responding to the IRS requests for client names and other 
information. In April 2002, one KPMG tax professional wrote:

        ``I have two clients who are about to file [tax 
        returns] for 2001. We have discussed with each of them 
        what is happening between KPMG and IRS and both do not 
        plan to disclose at this time. Since Larry's message 
        indicated the information requested was to respond to 
        an IRS summons, I am concerned we are about to turn 
        over a new list of names for transactions I believe IRS 
        has no prior knowledge of. I need to know immediately 
        if that is what is happening. It will obviously have a 
        material effect on their evaluation of whether they 
        wish to disclose and what positions they wish to take 
        on their 2001 returns. Since April 15th is Monday, I 
        need a response. . . . [I]f we are responding to what 
        appears to be an IRS fishing expedition, it is going to 
        reflect very badly on KPMG. Several clients have 
        seriously questioned whether we are doing everything we 
        can to protect their interests.'' 319
---------------------------------------------------------------------------
    \319\ Email dated 4/9/02, from Deke Carbo to Jeffrey Eischeid, 
``Larry's Message,'' Bates KPMG 0024467. See also email dated 4/19/02, 
from Ken JOnes to multiple KPMG tax professionals, ``TCS Weekly 
Update,'' Bates KPMG 0050430-31 (``We have just hand-carried the lists 
of investors over to the IRS, for the following deals: . . . SC2. . . . 
Note that not all cilents names were turned over for each of these 
Solutions . . . so if you need to find out if a company or individual 
was on the list . . . call or email me.'').

    Tax Return Reporting. KPMG also took a number of 
questionable steps to minimize the amount of information 
reported in tax returns about the transactions involved in its 
tax products in order to limit IRS detection.
    Perhaps the most disturbing of these actions was first 
taken in tax returns reporting transactions related to OPIS. To 
minimize information on the relevant tax returns and avoid 
alerting the IRS to the OPIS tax product, some KPMG tax 
professionals advised their OPIS clients to participate in the 
transactions through ``grantor trusts.'' These KPMG tax 
professionals also advised their clients to file tax returns in 
which all of the losses from the OPIS transactions were 
``netted'' with the capital gains realized by the taxpayer at 
the grantor trust level, instead of reporting each individual 
gain or loss, so that only a single, small net capital gain or 
loss would appear on the client's personal income tax return. 
This netting approach, advocated in an internally-distributed 
KPMG memorandum,320 elicited intense debate within 
the firm. KPMG's top WNT technical tax expert on the issue of 
grantor trusts wrote the following in two emails over the span 
of 4 months:
---------------------------------------------------------------------------
    \320\ ``Grantor Trust Reporting Requirements for Capital 
Transactions,'' KPMG WNT internal memorandum (2/98).

        ``I don't think netting at the grantor trust level is a 
        proper reporting position. Further, we have never 
        prepared grantor trust returns in this manner. What 
        will our explanation be when the Service and/or courts 
        ask why we suddenly changed the way we prepared grantor 
        trust returns/statements only for certain clients? When 
        you put the OPIS transaction together with this 
        `stealth' reporting approach, the whole thing stinks.'' 
        321
---------------------------------------------------------------------------
    \321\ Email dated 9/2/98, from Mark Watson to John Gardner, Jeffrey 
Eischeid, and others; ``RE:FW: Grantor trust memo,'' Bates KPMG 
0035807. See also email dated 9/3/98, from Mark Watson to Jeffrey 
Eischeid and John Gardner, ``RE:FW: Grantor trust memo,'' Bates KPMG 
0023331-32 (explaining objections to netting at the grantor trust 
level).

        ``You should all know that I do not agree with the 
        conclusion reached in the attached memo that capital 
        gains can be netted at the trust level. I believe we 
        are filing misleading, and perhaps false, returns by 
        taking this reporting position.'' 322
---------------------------------------------------------------------------
    \322\ Email dated 1/21/99, from Mark Watson to multiple KPMG tax 
professionals, ``RE: Grantor trust reporting,'' Bates KPMG 0010066.

---------------------------------------------------------------------------
    One of the tax professionals selling OPIS wrote:

        ``This `debate' . . . [over grantor trust netting] 
        affects me in a significant way in that a number of my 
        deals were sold giving the client the option of 
        netting. . . . Therefore, if they ask me to net, I feel 
        obligated to do so. These sales were before Watson went 
        on record with his position and after the memo had been 
        outstanding for some time.

        ``What is our position as a group? Watson told me he 
        believes it is a hazardous professional practice issue. 
        Given that none of us wants to face such an issue, I 
        need some guidance.'' 323
---------------------------------------------------------------------------
    \323\ Email dated 1/21/99, from Carl Hasting to Jeffrey Eischeid, 
``FW: Grantor trust reporting,'' Bates KPMG 0010066.

The OPIS National Deployment Champion responded: ``[W]e 
concluded that each partner must review the WNT memo and decide 
for themselves what position to take on their returns--after 
discussing the various pros and cons with their clients.'' 
324
---------------------------------------------------------------------------
    \324\ Email dated 1/22/99, from Jeffrey Eischeid to Carl Hasting, 
``FW: Grantor trust reporting,'' Bates KPMG 0010066. Other OPIS tax 
return reporting issues are discussed in other KPMG documentation 
including, for example, memorandum dated 12/21/98, from Bob Simon/
Margaret Lukes to Robin Paule, ``Certain U.S. International Tax 
Reporting Requirements re: OPIS,'' Bates KPMG 0050630-40.
---------------------------------------------------------------------------
    The technical reviewer who opposed grantor trust netting 
told the Subcommittee staff that it was his understanding that, 
as the top WNT technical expert, his technical judgment on the 
matter should have stopped KPMG tax professionals from using or 
advocating the use of this technique and thought he had done 
so, before leaving for a KPMG post outside the United States. 
He told the Subcommittee staff he learned later, however, that 
the OPIS National Deployment Champion had convened a conference 
call without informing him and told the participating KPMG tax 
professionals that they could use the netting technique if they 
wished. He indicated that he also learned that some KPMG tax 
professionals were apparently advising BLIPS clients to use 
grantor trust netting to avoid alerting the IRS to their BLIPS 
transactions.325
---------------------------------------------------------------------------
    \325\ Subcommittee interview of Mark Watson (11/4/03).
---------------------------------------------------------------------------
    In September 2000, the IRS issued Notice 2000-44, 
invalidating the BLIPS tax product. This Notice included a 
strong warning against grantor trust netting:

        ``[T]he Service and the Treasury have learned that 
        certain persons who have promoted participation in 
        transactions described in this notice have encouraged 
        individual taxpayers to participate in such 
        transactions in a manner designed to avoid the 
        reporting of large capital gains from unrelated 
        transactions on their individual income tax returns 
        (Form 1040). Certain promoters have recommended that 
        taxpayers participate in these transactions through 
        grantor trusts and . . . advised that the capital gains 
        and losses from these transactions may be netted, so 
        that only a small net capital gain or loss is reported 
        on the taxpayer's individual income tax return. In 
        addition to other penalties, any person who willfully 
        conceals the amount of capital gains and losses in this 
        manner, or who willfully counsels or advises such 
        concealment, may be guilty of a criminal offense. . . 
        .'' 326
---------------------------------------------------------------------------
    \326\ IRS Notice 2000-44 (2000-36 IRB 255) (9/5/00) at 256.

The technical reviewer who had opposed using grantor trust 
netting told the Subcommittee that, soon after this Notice was 
published, he had received a telephone call from his WNT 
replacement informing him of the development and seeking his 
advice. He indicated that it was his understanding that a 
number of client calls were later made by KPMG tax 
professionals.327
---------------------------------------------------------------------------
    \327\ Subcommittee interview of Mark Watson (11/4/03). See also 
Memorandum of Telephone Call, dated 5/24/00, from Kevin Pace regarding 
a telephone conversation with Carl Hastings, Bates KPMG 0036353 
(``[T]here is quite a bit of activity in the trust area . . . because 
they have figured out that trusts are a common element in some of these 
shelter deals. So our best intelligence is that you are increasing your 
odds of being audited, not decreasing your odds by filing that Grantor 
Trust return. So we have discontinued doing that.'')
---------------------------------------------------------------------------
    Other tax return reporting concerns also arose in 
connection with BLIPS. In an email with the subject line, ``Tax 
reporting for BLIPS,'' a KPMG tax professional sent the 
following message to the BLIPS National Deployment Champion: 
``I don't know if I missed this on a conference call or if 
there's a memo floating around somewhere, but could we get 
specific guidance on the reporting of the BLIPS transaction. . 
. . I have `IRS matching' concerns.'' The email later 
continues:

        ``One concern I have is the IRS trying to match the 
        Deutsche dividend income which contains the Borrower 
        LLC's FEIN [Federal Employer Identification Number][.] 
        (I understand they're not too efficient on matching K-
        1's but the dividends come through on a 1099 which they 
        do attempt to match). I wouldn't like to draw any 
        scrutiny from the Service whatsoever. If we don't file 
        anything for Borrower LLC we could get a notice which 
        would force us to explain where the dividends 
        ultimately were reported. Not fatal but it is scrutiny 
        nonetheless.'' 328
---------------------------------------------------------------------------
    \328\ Email dated 2/15/00, from Robert Jordan to Jeffrey Eischeid, 
``Tax reporting for BLIPS,'' Bates KPMG 0006537.

    About a month later, another KPMG tax professional wrote to 
---------------------------------------------------------------------------
the BLIPS National Deployment Champion:

        ``We spoke to Steven Buss about the possibility of re-
        issuing the Presidio K-1s in the EIN of the member of 
        the single member [limited liability corporations used 
        in BLIPS].  He  said  that  you  guys  hashed  it  out  
        on  Friday 3/24  and  in  a  nutshell,  Presidio  is  
        not  going  to  re-issue  K-1s.

        ``David was wondering what the rationale was since the 
        instructions and PPC say that single member LLCs are 
        disregarded entities so 1099s, K-1s should use the EIN 
        of the single member.'' 329
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    \329\ Email dated 3/28/00, from Jean Monahan to Jeffrey Eischeid 
and other KPMG tax professionals, ``presidio K-1s,'' Bates KPMG 
0024451. See also email dated 3/22/00, unidentified sender and 
recipients, ``Nondisclosure,'' Bates KPMG 0025704.

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She received the following response:

        ``It was discussed on the national conference call 
        today. Tracey Stone has been working with Mark Ely on 
        the issue. Ely has indicated that while the IRS may 
        have the capability to match ID numbers for 
        partnerships, they probably lack the resources to do 
        so. While technically the K-1's should have the social 
        security number of the owner on them, it is my 
        understanding that Mark has suggested that we not file 
        a partnership for the single member LLC and that 
        Presidio not file amended K-1s. . . . Tracey indicated 
        that Mark did not like the idea of having us prepare 
        partnership returns this year because then the IRS 
        would be looking for them in future years.'' 
        330
---------------------------------------------------------------------------
    \330\ Email dated 3/27/00, unidentified sender and recipients, 
``presidio K-1s,'' Bates KPMG 0024451.

Additional emails sent among various KPMG tax professionals 
discuss whether BLIPS participants should extend or amend their 
tax returns, or file certain other tax forms, again with 
repeated references to minimizing IRS scrutiny of client return 
information.331
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    \331\ See, e.g., emails dated 4/1/00-4/3/00 among Mark Ely, David 
Rivkin and other KPMG tax professionals, ``RE: Blips and tax filing 
issues,'' Bates KPMG 0006481-82; emails dated 3/23/00, between Mark 
Watson, Jeffrey Eischeid, David Rivkin and other KPMG tax 
professionals, ``RE: Blips and tax filing issues,'' Bates KPMG 0006480. 
See also email dated 7/27/99, from Deke Carbo to Randall Bickham, 
Jeffrey Eischeid, and Shannon Liston, ``Grouping BLIPS Investors,'' 
KPMG Bates 0023350 (suggests ``grouping'' multiple, unrelated BLIPS 
investors in a single Deutsche Bank account, possibly styled as a joint 
venture account, which might not qualify as a partnership required to 
file a K-1 tax return); email response dated 7/27/99, unidentified 
sender and recipients, ``Grouping BLIPS Investors,'' KPMG Bates 0023350 
(promises followup on suggestion which may ``[solve] our grouping 
problem'').
---------------------------------------------------------------------------
    In the case of FLIP, KPMG tax professionals devised a 
different approach to avoiding IRS detection.332 
Again, the focus was on tax return reporting. The idea was to 
arrange for the offshore corporation involved in FLIP 
transactions to designate a fiscal year that ended in some 
month other than December in order to extend the year in which 
the corporation would have to report FLIP gains or losses on 
its tax return. For example, if the offshore corporation were 
to use a fiscal year ending in June, FLIP transactions which 
took place in August 1997, would not have to be reported on the 
corporation's tax return until after June 1998. Meanwhile, the 
individual taxpayer involved with the same FLIP transactions 
would have reported the gains or losses in his or her tax 
return for 1997. The point of arranging matters so that the 
FLIP transactions would be reported by the corporation and 
individual in tax returns for different years was simply to 
make it more difficult for the IRS to detect a link between the 
two participants in the FLIP transactions.
---------------------------------------------------------------------------
    \332\ See email dated 3/11/98 from Gregg Ritchie to multiple KPMG 
tax professionals, ``Potential FLIP Reporting Strategy,'' Bates KPMG 
0034372-75. See also internal KPMG memorandum dated 3/31/98, by Robin 
Paule, Los Angeles/Warner Center, ``Form 5471 Filing Issues,'' Bates 
KPMG 0011952-53; and internal KPMG memorandum dated 3/6/98, by Bob 
Simon and Margaret Lukes, ``Potential FLIP Reporting Strategy,'' Bates 
KPMG 0050644-45.
---------------------------------------------------------------------------
    In the case of SC2, KPMG advised its tax professionals to 
tell potential buyers worried about being audited:

        ``[T]his transaction is very stealth. We are not 
        generating losses or other highly visible items on the 
        S-corp return. All income of the S-corp is allocated to 
        the shareholders, it just so happens that one 
        shareholder [the charity] will not pay tax.'' 
        333
---------------------------------------------------------------------------
    \333\ ``SC2--Meeting Agenda'' and attachments, dated 6/19/00, Bates 
KPMG 0013375-96, at 13394.

    No Roadmaps. A Subcommittee hearing held in December 2002, 
on an abusive tax shelter sold by J.P. Morgan Chase & Co. to 
Enron presented evidence that the bank and the company 
explicitly designed that tax shelter to avoid providing a 
``roadmap'' to tax authorities.334 KPMG appears to 
have taken similar precautions in FLIP, OPIS, BLIPS, and SC2.
---------------------------------------------------------------------------
    \334\ ``Fishtail, Bacchus, Sundance, and Slapshot: Four Enron 
Transactions Funded and Facilitated by U.S. Financial Institutions,'' 
Report prepared by the U.S. Senate Permanent Subcommittee on 
Investigations of the Committee on Governmental Affairs, S. Prt. 107-82 
(1/2/03), at 32.
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    In the case of SC2, in an exchange of emails among senior 
KPMG tax professionals discussing whether to send clients a 
letter explicitly identifying SC2 as a high-risk strategy and 
outlining certain specific risks, the SC2 National Deployment 
Champion wrote:

        ``[D]o we need to disclose the risk in the engagement 
        letter? . . . Could we have an addendum that discloses 
        the risks? If so, could the Service have access to 
        that? Obviously the last thing we want to do is provide 
        the Service with a road map.'' 335
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    \335\ Email dated 3/25/00, from Larry Manth to Larry DeLap, Phillip 
Galbreath, Mark Springer, and Richard Smith, ``RE: S-corp Product,'' 
Bates KPMG 0016986-87.

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The DPP head responded:

        ``. . . If the risk has been disclosed and the IRS is 
        successful in a challenge, the client can't maintain he 
        was bushwhacked because he wasn't informed of the risk. 
        . . . We could have a statement in the engagement 
        letter that the client acknowledges receipt of a 
        memorandum concerning risks associated with the 
        strategy, then cover the double taxation risk and 
        penalty risks (and other relevant risks) in that 
        separate memorandum. Depending on how one interprets 
        section 7525(b), such a memorandum arguably qualifies 
        for the federal confidential communications privilege 
        under section 7525(a).'' 336
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    \336\ Email dated 3/27/00, from Larry DeLap to Larry Manth, Phillip 
Galbreath, Mark Springer and Richard Smith, ``RE: S-Corp Product,'' 
Bates KPMG 0016986.

    This was not the only KPMG document that discussed using 
attorney-client or other legal privileges to limit disclosure 
of KPMG documents and activities related to its tax products. 
For example, a 1998 document containing handwritten notes from 
a KPMG tax professional about a number of issues related to 
OPIS states, under the heading ``Brown & Wood'': ``Privilege[:] 
B&W can play a big role at providing protection in this area.'' 
337
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    \337\ Handwritten notes dated 3/4/98, author not indicated, 
regarding ``Brown & Wood'' and ``OPIS,'' Bates KPMG 0047317.
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    Other parties who participated in the KPMG tax products 
also discussed using attorney-client privilege to conceal their 
activities. One was Deutsche Bank, which participated in both 
OPIS and BLIPS. In an internal email, one Deutsche Bank 
employee wrote to another regarding BLIPS: ``I would have 
thought you could still ensure that . . . the papers are 
prepared, and all discussion held, in a way which makes them 
legally privileged. (. . . you may remember that was one of my 
original suggestions).'' 338 Earlier, when 
considering whether to participate in BLIPS initially, the bank 
decided to limit its discussion of BLIPS on paper and not to 
obtain the approval of the bank committee that normally 
evaluates the risk that a transaction poses to the reputation 
of the bank, in order not to leave ``an audit trail'':
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    \338\ Email dated 7/29/99, from Mick Wood to Francesco Piovanetti 
and other Deutsche Bank professionals, ``Re: Risk & Resources Committee 
Paper--BLIPS,'' Bates DB BLIPS 6556.

        ``1. STRUCTURE: A diagramatic representation of the 
        deal may help the Committee's understanding--we can 
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        prepare this.

        ``2. PRIVILEDGE [sic]: This is not easy to achieve and 
        therefore a more detailed description of the tax issues 
        is not advisable.

        ``3. REPUTATION RISK: In this transaction, reputation 
        risk is tax related and we have been asked by the Tax 
        Department not to create an audit trail in respect of 
        the Bank's tax affaires. The Tax department assumes 
        prime responsibility for controlling tax related risks 
        (including reputation risk) and will brief senior 
        management accordingly. We are therefore not asking R&R 
        Committee to approve reputation risk on BLIPS. This 
        will be dealt with directly by the Tax Department and 
        John Ross.'' 339
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    \339\ Email dated 7/30/99, from Ivor Dunbar to multiple Deutsche 
Bank professionals, ``Re: Risk & Resources Committee Paper--BLIPS,'' 
unreadable Bates DB BLIPS number.

    Another bank that took precautions against placing tax 
product information on paper was Wachovia Bank's First Union 
National Bank. A First Union employee sent the following 
instructions to a number of his colleagues apparently in 
connection with the bank's approving sales of a new KPMG tax 
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product:

        ``In order to . . . lower our profile on this 
        particular strategy, the following points should be 
        noted: The strategy has an KPMG acronym which will not 
        be shared with the general First Union community. . . . 
        Our traditional sources of client referrals inside 
        First Union should not be informed of which Big 5 
        accounting firm we will choose to bring in on a 
        strategy meeting with a client. . . . No one-pager will 
        be distributed to our referral sources describing the 
        strategy.'' 340
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    \340\ Email dated 8/30/99, from Tom Newman to multiple First Union 
professionals, ``next strategy,'' Bates SEN-014622.

    Other documents obtained by the Subcommittee include 
instructions by senior KPMG tax professionals to their staff 
not to keep certain revealing documentation in their files or 
to clean out their files, again to avoid or limit detection of 
firm activity. For example, in the case of BLIPS, a KPMG tax 
professional sent an email to multiple colleagues stating: 
``You may want to remind everyone on Monday NOT to put a copy 
of Angie's email on the 988 elections in their BLIPS file. It 
is a road map for the taxing authorities to all the other 
listed transactions. I continue to find faxes from Quadra in 
the files . . . in the two 1996 deals here which are under CA 
audit which reference multiple transactions--not good if we 
would have to turn them over to California.'' 341 In 
the case of OPIS, a KPMG tax professional wrote: ``I have quite 
a few documents/papers/notes related to the OPIS transaction. . 
. . Purging unnecessary information now pursuant to an 
established standard is probably ok. If the Service asks for 
information down the road (and we have it) we'll have to give 
it to them I suspect. Input from (gulp) DPP may be 
appropriate.'' 342
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    \341\ Email dated 1/3/00, from Dale Baumann to ``Jeff,'' ``988 
election memo,'' Bates KPMG 0026345.
    \342\ Email dated 9/16/98, from Bob to unknown recipients, 
``Documentation,'' Bates KPMG 0025729. Documents related to other KPMG 
tax products, such as TEMPEST and OTHELLO, contain similar information. 
See, e.g., message from Bob McCahill and Ken Jones, attached to an 
email dated 3/1/02, from Walter Duer to multiple KPMG tax 
professionals, ``RE: TCS Review of TEMPEST and OTHELLO,'' Bates KPMG 
0032378-80 (``There is current IRS audit activity with respect to two 
early TEMPEST engagements. One situation is under fairly intense 
scrutiny by IRS Financial Institutions and Products specialists. . . . 
Although KPMG has yet to receive a subpoena or any other request for 
documents, client lists, etc. we believe it is likely that such a 
request(s) is inevitable. Since TEMPEST is a National Stratecon 
solution for which Bob McCahill and Bill Reilly were the Co-Champions . 
. . it is most efficient to have all file reviews and ``clean-ups'' 
(electronic or hard copy) performed in one location, namely the FS NYC 
office. This effort will be performed by selected NE Stratecon 
professionals . . . with ultimate review and final decision making by 
Ken Jones. . . . [W]e want the same approach to be followed for OTHELLO 
as outlined above for TEMPEST. Senior tax leadership, Jeff Stein and 
Rick Rosenthal concur with this approach.'')
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    Marketing Restrictions. KPMG also took precautions against 
detection of its activities during the marketing of the four 
products studied by the Subcommittee. FLIP and OPIS were 
explained only after potential clients signed a confidentiality 
agreement promising not to disclose the information to anyone 
else.343 In the case of BLIPS, KMPG tax 
professionals were instructed to obtain ``[s]igned 
nondisclosure agreements . . . before any meetings can be 
scheduled.'' 344 KPMG also limited the paperwork 
used to explain the products to clients. Client presentations 
were done on chalkboards or erasable whiteboards, and written 
materials were retrieved from clients before leaving a 
meeting.345 KPMG determined as well that 
``[p]roviding a copy of a draft opinion letter will no longer 
be done to assist clients in their due diligence.'' 
346 In SC2, the DPP head instructed KPMG tax 
professionals not to provide any ``sample documents'' directly 
to a client.347
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    \343\ See, e.g., memorandum dated 8/5/98, from Doug Ammerman to PFP 
Partners, ``OPIS and Other Innovative Strategies,'' Bates KPMG 0026141-
43, at 2-3 (``subject to their signing a confidentiality agreement''); 
Jacoboni v. KPMG, Case No. 6:02-CV-510 (District Court for the Middle 
District of Florida) Complaint (filed 4/29/02), at para. 9 (``KPMG 
executives told [Mr. Jacoboni] he could not involve any other 
professionals because the investment `strategy' [FLIP] was 
`confidential.' '' Emphasis in original.); Subcommittee interview of 
legal counsel of Mr. Jacoboni (4/4/03).
    \344\ Email dated 5/5/99, from Jeffrey Eischeid to multiple KPMG 
tax professionals, ``Marketing BLIPS,'' Bates KPMG 0006106.
    \345\ Subcommittee interview of Wachovia Bank representatives (3/
25/03); Subcommittee interview of legal counsel of Theodore C. Swartz 
(9/16/03).
    \346\ Email dated 5/5/99, from Jeffrey Eischeid to multiple KPMG 
tax professionals, ``Marketing BLIPS,'' Bates KPMG 0006106.
    \347\ Email dated 4/11/00, from Larry DeLap to Tax Professional 
Practice Partners, ``S-Corporation Charitable Contribution Strategy 
(SC2),'' Bates KPMG 0052582.
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    KPMG also attempted to place marketing restrictions on the 
number of products sold so that word of them would be 
restricted to a small circle. In the case of BLIPS, the DPP 
initially authorized only 50 to be sold.348 In the 
case of SC2, a senior tax professional warned against mass 
marketing the product to prevent the IRS from getting ``wind of 
it'':
---------------------------------------------------------------------------
    \348\ Email dated 5/5/99, from Jeffrey Eischeid to multiple KPMG 
tax professionals, ``Marketing BLIPS,'' Bates KPMG 0006106.

        ``I was copied on the message below, which appears to 
        indicate that the firm is intent on marketing the SC2 
        strategy to virtually every S corp with a pulse (if S 
        corps had pulses). Going way back to Feb. 2000, when 
        SC2 first reared its head, my recollection is that SC2 
        was intended to be limited to a relatively small number 
        of large S corps. That plan made sense because, in my 
        opinion, there was (and is) a strong risk of a 
        successful IRS attack on SC2 if the IRS gets wind of 
        it. . . . [T]he intimate group of S corps potentially 
        targeted for SC2 marketing has now expanded to 3,184 
        corporations. Call me paranoid, but I think that such a 
        widespread marketing campaign is likely to bring KPMG 
        and SC2 unwelcome attention from the IRS. . . . I 
        realize the fees are attractive, but does the firm's 
        tax leadership really think that his is an appropriate 
        strategy to mass market?'' 349
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    \349\ Email dated 12/20/01, from William Kelliher to WNT head David 
Brockway, ``FW: SC2,'' Bates KPMG 0013311.

The DPP head responded: ``We had a verbal agreement following a 
conference call with Rick Rosenthal earlier this year that SC2 
would not be mass marketed. In any case, the time has come to 
formally cease all marketing of SC2. Please so notify your 
deployment team and the marketing directors.'' 350
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    \350\ Email dated 12/29/01, from Larry DeLap to Larry Manth, David 
Brockway, William Kelliher and others, ``FW: SC2,'' Bates KPMG 0013311.
---------------------------------------------------------------------------

  (5) Disregarding Professional Ethics

    In addition to all the other problems identified in the 
Subcommittee investigation, troubling evidence emerged 
regarding how KPMG handled certain professional ethics issues, 
including issues related to fees, auditor independence, and 
conflicts of interest in legal representation.
    Contingent, Excessive, and Joint Fees. The fees charged by 
KPMG in connection with its tax products raise several 
concerns. It is clear that the lucrative nature of the fees 
drove the marketing efforts and helped convince other parties 
to participate.351 KPMG made more than $124 million 
from just the four tax products featured in this Report. Sidley 
Austin Brown & Wood made millions from issuing concurring legal 
opinions on the validity of the four tax products. Deutsche 
Bank made more than $30 million in fees and other profits from 
BLIPS.
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    \351\ See, e.g., email dated 3/14/98, from Jeff Stein to multiple 
KPMG tax professionals, ``Simon Says,'' Bates 638010, filed by the IRS 
on June 16, 2003, as an attachment to Respondent's Requests for 
Admission, Schneider Interests v. Commissioner, U.S. Tax Court, Docket 
No. 200-02 (addressing a dispute over which of two tax groups, Personal 
Financial Planning and International, should get credit for revenues 
generated by OPIS).
---------------------------------------------------------------------------
    Traditionally, accounting firms charged flat fees or hourly 
fees for tax services. In the 1990's, however, accounting firms 
began charging ``value added'' fees based on ``the value of the 
services provided, as opposed to the time required to perform 
the services.'' 352 In addition, some firms began 
charging ``contingent fees'' that were paid only if a client 
obtained specified results from the services offered, such as 
achieving specified tax savings.353 Many states 
prohibit accounting firms from charging contingent fees due to 
the improper incentives they create, and a number of SEC, IRS, 
state, and AICPA rules allow their use in only limited 
circumstances.354
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    \352\ KPMG Tax Services Manual, Sec. 31.11.1 at 31-6.
    \353\ See AICPA Code of Professional Conduct, Rule 302 (``[A] 
contingent fee is a fee established for the performance of any service 
pursuant to an arrangement in which no fee will be charged unless a 
specified finding or result is attained, or in which the amount of the 
fee is otherwise dependent upon the finding or result of such 
service.'')
    \354\ See, e.g., AICPA Rule 302; 17 C.F.R. Sec. 210.2-01(c)(5) (SEC 
contingent fee prohibition: ``An accountant is not independent if, any 
point during the audit and professional engagement period, the 
accountant provides any service or product to an audit client for a 
contingent fee.''); KPMG Tax Services Manual, Sec. 32.4 on contingent 
fees in general and Sec. 31.10.3 at 31-5 (DPP head determines whether 
specific KPMG fees comply with various rules on contingent fees.)
---------------------------------------------------------------------------
    Within KPMG, the head of DPP-Tax took the position that 
fees based on projected client tax savings were contingent fees 
prohibited by AICPA Rule 302.355 Other KPMG tax 
professionals disagreed, complained about the DPP 
interpretation, and pushed hard for fees based on projected tax 
savings. For example, one memorandum objecting to the DPP 
interpretation of Rule 302 warned that it ``threatens the value 
to KPMG of a number of product development efforts,'' ``hampers 
our ability to price the solution on a value added basis,'' and 
will cost the firm millions of dollars.356 The 
memorandum also objected strongly to applying the contingent 
fee prohibition to, not only the firm's audit clients, but also 
to any individual who ``exerts significant influence over'' an 
audit client, such as a company director or officer, as 
required by the DPP. The memorandum stated this expansive 
reading of the prohibition was problematic, because ``many, if 
not most, of our CaTS targets are officers/directors/
shareholders of our assurance clients.'' 357 The 
memorandum states: ``At the present time, we do not know if 
DPP's interpretation of Rule 302 has been adopted with the full 
awareness of the firm's leadership. . . . However, it is our 
impression that no one other than DPP has fully considered the 
issue and its impact on the tax practice.''
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    \355\ Subcommittee interview of Lawrence DeLap (10/30/03); 
memorandum dated 7/14/98, from Gregg Ritchie to multiple KPMG tax 
professionals, ``Rule 302 and Contingency Fees--CONFIDENTIAL,'' Bates 
KPMG 0026557-58.
    \356\ Memorandum dated 7/14/98, from Gregg Ritchie to multiple KPMG 
tax professionals, ``Rule 302 and Contingency Fees--CONFIDENTIAL,'' 
Bates KPMG 0026555-59.
    \357\ ``CaTS'' stands for KPMG's Capital Transaction Services Group 
which was then in existence and charged with selling tax products to 
high net worth individuals.
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    In the four case studies examined by the Subcommittee, the 
fees charged by KPMG for BLIPS, OPIS, and FLIP were clearly 
based upon the client's projected tax savings.358 In 
the case of BLIPS, for example, the BLIPS National Deployment 
Champion wrote the following description of the tax product and 
recommended that fees be set at 7% of the generated ``tax 
loss'' that clients would achieve on paper from the BLIPS 
transactions and could use to offset and shelter other income 
from taxation:
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    \358\ If a client objected to the requested fee, KPMG would, on 
occasion, negotiate a lower, final amount.

        ``BLIPS . . . [A] key objective is for the tax loss 
        associated with the investment structure to offset/
        shelter the taxpayer's other, unrelated, economic 
        profits. . . . The all-in cost of the program, assuming 
        a complete loss of investment principal, is 7% of the 
        targeted tax loss (pre-tax). The tax benefit of the 
        investment program, which ranges from 20% to 45% of the 
        targeted tax loss, will depend on the taxpayer's 
---------------------------------------------------------------------------
        effective tax rates.

        ``FEE: BLIPS is priced on a fixed fee basis which 
        should approximate 1.25% of the tax loss. Note that 
        this fee is included in the 7% described above.'' 
        359
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    \359\ Document dated 7/21/99, entitled ``Action Required,'' 
authored by Jeffrey Eischeid, Bates KPMG 0040502. See also, e.g., 
memorandum dated 8/5/98, from Doug Ammerman to ``PFP Partners,'' ``OPIS 
and Other Innovative Strategies,'' Bates KPMG 0026141-43 at 2 (``In the 
past KPMG's fee related to OPIS has been paid by Presidio. According to 
DPP-Assurance, this fee structure may constitute a contingent fee and, 
as a result, may be a prohibited arrangement. . . . KPMG's fee must be 
a fixed amount and be paid directly by the client/target.'' Emphasis in 
original.)

    Another document, an email sent from Presidio to KPMG, 
provides additional detail on the 7% fee charged to BLIPS 
clients, ascribing ``basis points'' or portions of the 7% fee 
to be paid to various participants for various expenses. All of 
these basis points, in turn, depended upon the size of the 
client's expected tax loss to determine their amount. The email 
---------------------------------------------------------------------------
states:

        ``The breakout for a typical deal is as follows:
            Bank Fees    125
            Mgmt Fees    275
            Gu[aran]teed Pymt.    8
            Net Int. Exp.    6
            Trading Loss    70
            KPMG    125
            Net return to Class A 91'' 360
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    \360\ Email dated 5/24/00, from Kerry Bratton of Presidio to Angie 
Napier of KPMG, ``RE: BLIPS--7 percent,'' Bates KPMG 0002557.

Virtually all BLIPS clients were charged this 7% fee.
    In the case of SC2, which was constructed to shelter 
certain S corporation income otherwise attributable and taxable 
to the corporate owner, KPMG described SC2 fees as ``fixed'' at 
the beginning of the engagement at an amount that ``generally . 
. . approximated 10 percent of the expected average taxable 
income of the S Corporation for the 2 years following 
implementation.'' 361 SC2 fees were set at a minimum 
of $500,000, and went as high as $2 million per 
client.362
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    \361\ Tax Solution Alert for S-Corporation Charitable Contribution 
Strategy, FY00-28, revised as of 12/7/01, at 2. See also email dated 
12/27/01, from Larry Manth to Andrew Atkin and other KPMG tax 
professionals, ``SC2,'' Bates KPMG 0048773 (describing SC2 fees as 
dependent upon client tax savings).
    \362\ Id.
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    The documents suggest that, at least in some cases, KPMG 
deliberately manipulated the way it handled certain tax 
products to circumvent state prohibitions on contingent fees. 
For example, a document related to OPIS identifies the states 
that prohibit contingent fees. Then, rather than prohibit OPIS 
transactions in those states or require an alternative fee 
structure, the memorandum directs KPMG tax professionals to 
make sure the OPIS engagement letter is signed, the engagement 
is managed, and the bulk of services is performed ``in a 
jurisdiction that does not prohibit contingency fees.'' 
363
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    \363\ Memorandum dated 7/1/98, from Gregg Ritchie and Jeffrey Zysik 
to ``CaTS Team Members,'' ``OPIS Engagements--Prohibited States,'' 
Bates KPMG 0011954.
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    Another set of fee issues related to the fees paid to the 
key law firm that issued concurring legal opinions supporting 
the four KPMG tax products, Sidley Austin Brown & Wood. This 
law firm was paid $50,000 for each legal opinion it provided in 
connection with BLIPS, FLIP, and OPIS. Documents and interview 
evidence obtained by the Subcommittee indicate that the law 
firm was paid even more in transactions intended to provide 
clients with large tax losses, and that the amount paid to the 
law firm may have been linked directly to the size of the 
client's expected tax loss. For example, one email describing 
the fee amounts to be paid to Sidley Austin Brown & Wood in 
BLIPS and OPIS deals appears to assign to the law firm ``basis 
points'' or percentages of the client's expected tax loss:

        ``Brown & Wood fees:
            Quadra OPIS98--30 bpts
            Quadra OPIS99--30 bpts
            Presidio OPIS98--25 bpts
            Presidio OPIS99--25 bpts
            BLIPS--30 bpts'' 364
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    \364\ Email dated 5/15/00, from Angie Napier to Jeffrey Eischied 
and others, ``B&W fees and generic FLIP rep letter,'' Bates KPMG 
0036342.

    American Bar Association (ABA) Model Rule 1.5 states that 
``[a] lawyer shall not make an agreement for, charge, or 
collect an unreasonable fee,'' and cites as the factors to 
consider when setting a fee amount ``the time and labor 
required, the novelty and difficulty of the questions involved, 
and the skill requisite to perform the legal service 
properly.'' Sidley Austin Brown & Wood charged substantially 
the same fee for each legal opinion it issued to a FLIPS, OPIS, 
or BLIPS client, even when opinions drafted after the initial 
prototype opinion contained no new facts or legal analysis, 
were virtually identical to the prototype except for client 
names, and in many cases required no client consultation. As 
mentioned earlier, in BLIPS, Sidley Austin Brown & Wood was 
also paid a fee in any sale where a prospective buyer was told 
that the law firm would provide a favorable tax opinion letter 
if asked, regardless of whether the opinion was later requested 
or provided.365 These fees, with few costs after the 
prototype opinion was drafted, raise questions about the firm's 
compliance with ABA Model Rule 1.5.
---------------------------------------------------------------------------
    \365\ See ``Declaration of Richard E. Bosch,'' IRS Revenue Agent, 
In re John Doe Summons to Sidley Austin Brown & Wood (N.D. Ill. 10/16/
03) at para. 18, citing an email dated 10/1/97, from Gregg Ritchie to 
Randall Hamilton, ``Flip Tax Opinion.''
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    Still another issue involves joint fees. In the case of 
BLIPS, clients were charged a single fee equal to 7% of the tax 
losses to be generated by the BLIPS transactions. The client 
typically paid this fee to Presidio, an investment advisory 
firm, which then apportioned the fee amount among various firms 
according to certain factors. The fee recipients typically 
included KPMG, Presidio, participating banks, and Sidley Austin 
Brown & Wood, and one of the factors determining the fee 
apportionment was who had brought the client to the table. This 
fee splitting arrangement may violate restrictions on 
contingency and client referral fees, as well as an American 
Bar Association prohibition against law firms sharing legal 
fees with non-lawyers.366
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    \366\ See ABA Model Rule 5.4, ``A lawyer or law firm shall not 
share legal fees with a non-lawyer.'' Reasons provided for this rule 
include ``protect[ing] the lawyer's professional independence of 
judgment.''
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    Auditor Independence. Another professional ethics issue 
involves auditor independence. Deutsche Bank, HVB, and Wachovia 
Bank are all audit clients of KPMG, and at various times all 
three have played roles in marketing or implementing KPMG tax 
products. Deutsche Bank and HVB provided literally billions of 
dollars in financing to make OPIS and BLIPS transactions 
possible. Wachovia, through First Union National Bank, referred 
clients to KPMG and was paid or promised a fee for each client 
who actually purchased a tax product. For example, one internal 
First Union email on fees stated: ``Fees to First Union will be 
50 basis points if the investor is not a KPMG client, and 25 
bps if they are a KPMG client.'' 367
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    \367\ Email dated 8/30/99, from Tom Newman to multiple First Union 
employees, ``next strategy,'' Bates SEN-014622.
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    KPMG Tax Services Manual states: ``Due to independence 
considerations, the firm does not enter into alliances with SEC 
audit clients.'' 368 KPMG defines an ``alliance'' as 
``a business relationship between KPMG and an outside firm in 
which the parties intend to work together for more than a 
single transaction.'' 369 KPMG policy is that ``[a]n 
oral business relationship that has the effect of creating an 
alliance should be treated as an alliance.'' 370 
Another provision in KPMG's Tax Services Manual states: ``The 
SEC considers independence to be impaired when the firm has a 
direct or material indirect business relationship with an SEC 
audit client.'' 371
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    \368\ KPMG Tax Services Manual, Sec. 52.1.3 at 52-1.
    \369\ Id., Sec. 52.1.1 at 52-1.
    \370\ Minutes dated 9/28/98, of KPMG ``Assurance/Tax Professional 
Practice Meeting'' in New York, ``Summary of Conclusions and Action 
Steps,'' Bates XX 001369-74, at 1373.
    \371\ KPMG Tax Services Manual, Sec. 52.5.2 at 52-6 (Emphasis in 
original.). The SEC ``Business Relationships'' regulation states: ``An 
accountant is not independent if, at any point during the audit and 
professional engagement period, the accounting firm or any covered 
person in the firm has any direct or material indirect business 
relationship with an audit client, or with persons associated with the 
audit client in a decision-making capacity, such as an audit client's 
officers, directors, or substantial stockholders.'' 17 C.F.R. 
Sec. 210.2-01(c)(3).
---------------------------------------------------------------------------
    Despite the SEC prohibition and the prohibitions and 
warnings in its own Tax Services Manual, KPMG worked with audit 
clients, Deutsche Bank, HVB, and Wachovia, on multiple BLIPS, 
FLIP, and OPIS transactions. In fact, at Deutsche Bank, the 
KPMG partner in charge of Deutsche Bank audits in the United 
States expressly approved the bank's accounting of the loans 
for the BLIPS transactions.372 KPMG tax 
professionals were aware that doing business with an audit 
client raised auditor independence concerns.373 KPMG 
apparently attempted to resolve the auditor independence issue 
by giving clients a choice of banks to use in the OPIS and 
BLIPS transactions, including at least one bank that was not a 
KPMG audit client.374 It is unclear, however, 
whether individuals actually could choose what bank to use. It 
is also unclear how providing clients with a choice of banks 
alleviated KPMG's conflict of interest, since it still had a 
direct or material, indirect business relationship with banks 
whose financial statements were certified by KPMG auditors.
---------------------------------------------------------------------------
    \372\ Undated document prepared by Deutsche Bank in 1999, ``New 
Product Committee Overview Memo: BLIPS Transaction,'' Bates DB BLIPS 
6906-10, at 6909-10.
    \373\ See, e.g., memorandum dated 8/5/98, from Doug Ammerman to 
``PFP Partners,'' ``OPIS and Other Innovative Strategies,'' Bates KPMG 
0026141-43 (``Currently, the only institution participating in the 
transaction is a KPMG audit client. . . . As a result, DPP-Assurance 
feels there may be an independence problem associated with our 
participation in OPIS . . .''); email dated 2/11/99, from Larry DeLap 
to multiple KPMG tax professionals, ``RE: BLIPS,'' Bates KPMG 0037992 
(``The opinion letter refers to transactions with Deutsche Bank. If the 
transactions will always involve Deutsche Bank, we could have an 
independence issue.''); email dated 4/20/99, from Larry DeLap to 
multiple KPMG tax professionals, ``BLIPS,'' Bates KPMG 0011737-38 
(Deutsche Bank, a KPMG audit client, is conducting BLIPS transactions); 
email dated 11/30/01, from Councill Leak to Larry Manth, ``FW: First 
Union Customer Services,'' Bates KPMG 0050842 (lengthy discussion of 
auditor independence concerns and First Union).
    \374\ See, e.g., email dated 4/20/99, from Larry DeLap to multiple 
KPMG tax professionals, ``BLIPS,'' Bates KPMG 0011737-38 (discussing 
using Deutsche Bank, a KPMG audit client, in BLIPS transactions).
---------------------------------------------------------------------------
    In 2003, the SEC opened an informal inquiry into whether 
the client referral arrangements between KPMG and Wachovia 
violated the SEC's auditor independence rules. In its second 
quarter filing with the SEC in August 2003, Wachovia provides 
the following description of the ongoing SEC inquiry:

        ``On June 19, 2003, the Securities and Exchange 
        Commission informally requested Wachovia to produce 
        certain documents concerning any agreements or 
        understandings by which Wachovia referred clients to 
        KPMG LLP during the period January 1, 1997 to the 
        present. Wachovia is cooperating with the SEC in its 
        inquiry. Wachovia believes the SEC's inquiry relates to 
        certain tax services offered to Wachovia customers by 
        KPMG LLP during the period from 1997 to early 2002, and 
        whether these activities might have caused KPMG LLP not 
        to be `independent' from Wachovia, as defined by 
        applicable accounting and SEC regulations requiring 
        auditors of an SEC-reporting company to be independent 
        of the company. Wachovia and/or KPMG LLP received fees 
        in connection with a small number of personal financial 
        consulting transactions related to these services. 
        During all periods covered by the SEC's inquiry, 
        including the present, KPMG LLP has confirmed to 
        Wachovia that KPMG LLP was and is `independent' from 
        Wachovia under applicable accounting and SEC 
        regulations.''

In its third quarter filing with the SEC, Wachovia stated that, 
on October 21, 2003, the SEC issued a ``formal order of 
investigation'' into this matter, and the bank is continuing to 
cooperate with the inquiry.
    A second set of auditor independence issues involves KPMG's 
decision to market tax products to its own audit clients. 
Evidence appears throughout this Report of KPMG's efforts to 
sell tax products to its audit clients or the officers, 
directors, or shareholders of its audit clients. This evidence 
includes instances in which KPMG mined its audit client data to 
develop a list of potential clients for a particular tax 
product; 375 tax products that were designed and 
explicitly called for ``fostering cross-selling among assurance 
and tax professionals''; 376 and marketing 
initiatives that explicitly called upon KPMG tax professionals 
to contact their audit partner counterparts and work with them 
to identify appropriate clients and pitch KPMG tax products to 
those audit clients.377 A KPMG memorandum cited 
earlier in this Report observed that ``many, if not most, of 
our CaTS targets are officers/directors/shareholders of our 
assurance clients.'' 378
---------------------------------------------------------------------------
    \375\ See, e.g., Presentation dated 7/17/00, ``Targeting 
Parameters: Intellectual Property--Assurance and Tax,'' with attachment 
dated September 2000, entitled ``Intellectual Property Services,'' at 
page 1 of the attachment, Bates XX 001567-93.
    \376\ Presentation dated 3/6/00, ``Post-Transaction Integration 
Service (PTIS)--Tax,'' by Stan Wiseberg and Michele Zinn of Washington, 
D.C., Bates XX 001597-1611.
    \377\ Email dated 8/14/01, from Jeff Stein and Walter Duer to 
``KPMG LLP Partners, Managers and Staff,'' ``Stratecon Middle Market 
Initiative,'' Bates KPMG 0050369.
    \378\ Memorandum dated 7/14/98, from Gregg Ritchie to multiple KPMG 
tax professionals, ``Rule 302 and Contingency Fees--CONFIDENTIAL,'' 
Bates KPMG 0026555-59. CaTS stands for the Capital Transaction Services 
Group which was then in existence and charged with selling tax products 
to high net worth individuals.
---------------------------------------------------------------------------
    By using its audit partners to identify potential clients 
and targeting its audit clients for tax product sales pitches, 
KPMG not only took advantage of its auditor-client 
relationship, but also created a conflict of interest in those 
cases where it successfully sold a tax product to an audit 
client. This conflict of interest arises when the KPMG auditor 
reviewing the client's financial statements is required, as 
part of that review, to examine the client's tax return and its 
use of the tax product to reduce its tax liability and increase 
its income. In such situations, KPMG is, in effect, auditing 
its own work.
    The inherent conflict of interest is apparent in the 
minutes of a 1998 meeting held in New York between KPMG top tax 
and assurance professionals to address topics of concern to 
both divisions of KPMG.379 A written summary of this 
meeting includes as its first topic: ``Accounting 
Considerations of New Tax Products.'' The section makes a 
single point: ``Some tax products have pre-tax accounting 
implications. DPP-Assurance's role should be to review the 
accounting treatment, not to determine it.'' 380 
This characterization of the issue implies not only a tension 
between KPMG's top auditing and tax professionals, but also an 
effort to diminish the authority of the top assurance 
professionals and make it clear that they may not ``determine'' 
the accounting treatment for new tax products.
---------------------------------------------------------------------------
    \379\ Minutes dated 9/28/98, of KPMG ``Assurance/Tax Professional 
Practice Meeting'' in New York, ``Summary of Conclusions and Action 
Steps,'' Bates XX 001369-74. (Capitalization in original omitted.)
    \380\ Id. at Bates XX 001369. (Emphasis in original.)
---------------------------------------------------------------------------
    The next topic in the meeting summary is: ``Financial 
Statement Treatment of Aggressive Tax Positions.'' 
381 Again, the section discloses an ongoing tension 
between KPMG's top auditing and tax professionals on how to 
account for aggressive tax products in an audit client's 
financial statements. The section notes that discussions had 
taken place and further discussions were planned ``to determine 
whether modifications may be made'' to KPMG's policies on how 
``aggressive tax positions'' should be treated in an audit 
client's financial statements. An accompanying issue list 
implies that the focus of the discussions will be on weakening 
rather than strengthening the existing policies. For example, 
among the policies to be re-examined were KPMG's policies that, 
``[n]o financial statement tax benefit should be provided 
unless it is probable the position will be allowed,'' 
382 and that the ``probable of allowance'' test had 
to be based solely on technical merits and could not consider 
the ``probability'' that a client might win a negotiated 
settlement with the IRS. The list also asked, in effect, 
whether the standard for including a financial statement tax 
benefit in a financial statement could be lowered to include, 
not only tax products that ``should'' survive an IRS challenge, 
which KPMG interprets as having a 70% or higher probability, 
but also tax products that are ``more-likely-than-not'' to 
withstand an IRS challenge, meaning a better than 50% 
probability.
---------------------------------------------------------------------------
    \381\ Minutes dated 9/28/98, of KPMG ``Assurance/Tax Professional 
Practice Meeting'' in New York, ``Summary of Conclusions and Action 
Steps,'' Bates XX 001369-74.
    \382\ Id. at Bates XX 001370. (Emphasis in original.)
---------------------------------------------------------------------------
    Conflicts of Interest in Legal Representation. A third set 
of professional ethics issues involves legal representation of 
clients who, after purchasing a tax product from KPMG, have 
come under the scrutiny of the IRS for buying an illegal tax 
shelter and understating their tax liability on their tax 
returns. The mass marketing of tax products has led to mass 
enforcement efforts by the IRS after a tax product has been 
found to be abusive and the IRS obtains the lists of clients 
who purchased the product. In response, certain law firms have 
begun representing multiple clients undergoing IRS audit for 
purchasing similar tax shelters.
    One key issue involves KPMG's role in referring its tax 
shelter clients to specific law firms. In 2002, KPMG assembled 
a list of ``friendly'' attorneys and began steering its clients 
to them for legal representation. For example, an internal KPMG 
email providing guidance on ``FLIPS/OPIS/BLIPS Attorney 
Referrals'' states: ``This is a list that our group put 
together. All of the attorneys are part of the coalition and 
friendly to the firm. Feel free to forward to a client if they 
would like a referral.'' 383 The ``coalition'' 
referred to in the email is a group of attorneys who had begun 
working together to address IRS enforcement actions taken 
against taxpayers who had used the FLIP, OPIS, or BLIPS tax 
products.
---------------------------------------------------------------------------
    \383\ Email dated 4/9/02, from Erin Collins to multiple KPMG tax 
professionals, ``FLIPS/OPIS/BLIPS Attorney Referrals,'' Bates KPMG 
0050113. See also email dated 11/4/02, from Ken Jones to multiple KPMG 
tax professionals, ``RE: Script,'' Bates KPMG 0050130 (``Attached is a 
list of law firms that are handling FLIP/OPIS cases. Note that there 
are easily another 15 or so law firms . . . but these are firms that we 
have dealt with in the past. Note that we are not making a 
recommendation, although if someone wants to talk about the various 
strengths/weaknesses of one firm vs. another . . . we can do that.'').
---------------------------------------------------------------------------
    One concern with the KPMG referral list is that at least 
some of the clients being steered to ``friendly'' law firms 
might want to sue KPMG itself for selling them an illegal tax 
shelter. In one instance examined by the Subcommittee, for 
example, a KPMG client under audit by the IRS for using BLIPS 
was referred by KPMG to a law firm, Sutherland, Asbill & 
Brennan, with which KPMG had a longstanding relationship but 
with which the client had no prior contact. In this particular 
instance, the law firm did not even have offices in the 
client's state. The client was also one of more than two dozen 
clients that KPMG had steered to this law firm. While KPMG did 
not obtain a fee for making those client referrals, the firm 
likely gained favorable attention from the law firm for sending 
it multiple clients with similar cases. These facts suggest 
that Sutherland Asbill would owe a duty of loyalty to KPMG, not 
only as a longstanding and important client, but also as a 
welcome source of client referrals.
    The engagement letter signed by the KPMG client, in which 
he agreed to pay Sutherland Asbill to represent him before the 
IRS in connection with BLIPS, contained this disclosure:

        ``In the event you desire to pursue claims against the 
        parties who advised you to enter into the transaction, 
        we would not be able to represent you in any such 
        claims because of the broad malpractice defense 
        practice of our litigation team (representing all of 
        the Big Five accounting firms, for example).'' 
        384
---------------------------------------------------------------------------
    \384\ Engagement letter between Sutherland Asbill & Brennan LLP and 
the client, dated 7/23/02, at 1, Bates SA 001964.

The KPMG client told the Subcommittee that he had not 
understood at the time that this disclosure meant that 
Sutherland Asbill was already representing KPMG in other 
``malpractice defense'' matters and therefore could not 
represent him if he decided to sue KPMG for selling him an 
illegal shelter. The client signed the engagement letter on 
July 24, 2002.
    On September 8, 2002, Sutherland Asbill ``engaged KPMG'' 
itself to assist the law firm in its representation of KPMG's 
former client, including with respect to ``investigation of 
facts, review of tax issues, and other such matters as Counsel 
may direct.'' This engagement meant that KPMG, as Sutherland 
Asbill's agent, would have access to confidential information 
related to its client's legal representation, and that KPMG 
itself would be providing key information and analysis in the 
case. It also meant that the KPMG client would be paying for 
the services provided by the same accounting firm that had sold 
him the tax shelter. When a short while later, the client asked 
Sutherland Asbill about the merits of suing KPMG, he was told 
that the firm could not represent him in such a legal action, 
and he switched to new legal counsel.
    The conflict of interest issues here involve, not only 
whether KPMG should be referring its clients to a ``friendly'' 
law firm, but also whether the law firm itself should be 
accepting these clients, in light of the firm's longstanding 
and close relationship with KPMG. While both KPMG and the 
client have an immediate joint interest in defending the 
validity of the tax product that KPMG sold and the client 
purchased, their interests could quickly diverge if the suspect 
tax product is found to be in violation of federal tax law. 
This divergence in interests has been demonstrated repeatedly 
since 2002, as growing numbers of KPMG clients have filed suit 
against KPMG seeking a refund of past fees paid to the firm and 
additional damages for KPMG's selling them an illegal tax 
shelter.
    The preamble to the American Bar Association (ABA) Model 
Rules states that ``a lawyer, as a member of the legal 
profession, is a representative of clients, an officer of the 
legal system and a public citizen having special responsibility 
for the quality of justice. . . . As (an) advocate, a lawyer 
zealously asserts the client's position under the rules of the 
adversary system.'' The problem here is the conflict of 
interest that arises when a law firm attempts to represent an 
accounting firm's client at the same time it is representing 
the accounting firm itself, and the issue in controversy is a 
tax product that the accounting firm sold and the client 
purchased. In such a case, the attorney cannot zealously 
represent the interests of both clients due to conflicting 
loyalties. A related issue is whether the law firm can 
ethically use the accounting firm as the tax expert in the 
client's case, given the accounting firm's self interest in the 
case outcome.
    At the request of the Subcommittee, the Congressional 
Research Service's American Law Division analyzed the possible 
conflict of interest issues.385 The CRS analysis 
concluded that, under American Bar Association Model Rule 1.7, 
a law firm should decline to represent an accounting firm 
client in a tax shelter case if the law firm already represents 
the accounting firm itself on other matters. The CRS analysis 
identified ``two possible, and interconnected, conflicts of 
interest'' that should lead the law firm to decline the 
engagement. The first is a ``current conflict of interest'' at 
the time of engagement, which arises from ``a `substantial 
risk' that the attorney . . . would be `materially limited' by 
his responsibilities to another client'' in ``pursuing certain 
relevant and proper courses of action on behalf of the new 
client'' such as filing suit against the firm's existing 
client, the accounting firm. The second is a ``potential 
conflict of interest whereby the attorney may not represent the 
new client in litigation . . . against an existing, current 
client. That particular, potential conflict of interest could 
not be waived.''
---------------------------------------------------------------------------
    \385\ Memorandum dated 11/14/03, by Jack Maskell, Legislative 
Attorney, American Law Division, Congressional Research Service, 
``Attorneys and Potential Conflicts of Interest Between New Clients and 
Existing Clients.''
---------------------------------------------------------------------------
    The CRS analysis also recommends that the law firm fully 
inform a potential client about the two conflicts of interest 
prior to any engagement, so that the client can make a 
meaningful decision on whether he or she is willing to be 
represented by a law firm that already represents the 
accounting firm that sold the client the tax product at issue. 
According to ABA Model Rule 1.7, informed consent must be in 
writing, but ``[t]he requirement of a writing does not supplant 
the need in most cases for the lawyer to talk with the client, 
to explain the risks and advantages, if any, of representation 
burdened with a conflict of interest, as well as reasonably 
available alternatives, and to afford the client a reasonable 
opportunity to consider the risks and alternatives and to raise 
questions and concerns.'' The CRS analysis opines that a 
``blanket disclosure'' provided by a law firm in an engagement 
letter is insufficient, without additional information, to 
ensure the client fully understands and consents to the 
conflicts of interest inherent in the law firm's dual 
representation of the client and the accounting firm.


                               APPENDICES

                              ----------                              
                               APPENDIX A



       CASE STUDY OF BOND LINKED ISSUE PREMIUM STRUCTURE (BLIPS)

    KPMG approved the Bond Linked Issue Premium Structure 
(BLIPS) for sale to multiple clients in 1999. KPMG marketed 
BLIPS for about 1 year, from about October 1999 to about 
October 2000. KPMG sold BLIPS to 186 individuals, in 186 
transactions, and obtained more than $53 million in revenues, 
making BLIPS one of KPMG's top revenue producers in the years 
it was sold and the highest revenue-producer of the four case 
studies examined by the Subcommittee.
    BLIPS was developed by KPMG primarily as a replacement for 
earlier KPMG tax products, FLIP and OPIS, each of which KPMG 
has characterized as a ``loss generator'' or ``gain mitigation 
strategy.'' 386 In 2000, the IRS issued a notice 
declaring transactions like BLIPS to be potentially abusive tax 
shelters.387
---------------------------------------------------------------------------
    \386\ See, e.g., document dated 5/18/01, ``PFP Practice 
Reorganization Innovative Strategies Business Plan--DRAFT,'' authored 
by Jeffrey Eischeid, Bates KPMG 0050620-23, at 1.
    \387\ BLIPS is covered by IRS Notice 2000-44 (2000-36 IRB 255) (9/
5/00).
---------------------------------------------------------------------------
    BLIPS is so complex that a full explanation of it would 
take more space that this Report allows, but it can be 
summarized as follows. Charts depicting a typical BLIPS 
transaction are also provided.388
---------------------------------------------------------------------------
    \388\ A detailed explanation of these charts is included in the 
opening statement of Senator Carl Levin at the hearing before the 
Senate Permanent Subcommittee on Investigations, ``U.S. Tax Shelter 
Industry: The Role of Accountants, Lawyers, and Financial 
Professionals'' (11/18/03).

    1) The Gain. Individual has ordinary or capital gains 
---------------------------------------------------------------------------
income (e.g., $20 million).

    2) The Sales Pitch. Individual is approached with a ``tax 
advantaged investment strategy'' by KPMG and Presidio, an 
investment advisory firm, to generate an artificial ``loss'' 
sufficient to offset the income and shelter it from taxation. 
Individual is told that, for a fee, Presidio will arrange the 
required investments and bank financing, and KPMG and a law 
firm will provide separate opinion letters stating it is ``more 
likely than not'' the tax loss generated by the investments 
will withstand an IRS challenge.

    3) The Shell Corporation. Pursuant to the strategy, 
Individual forms a single-member limited liability corporation 
(``LLC'') and contributes cash equal to 7% ($1.4 million) of 
the tax loss ($20 million) to be generated by the strategy.

    4) The ``Loan.'' LLC obtains from a bank, for a fee, a non-
recourse ``loan'' (e.g., $50 million) with an ostensible 7-year 
term at an above-market interest rate, such as 16%. Because of 
the above-market interest rate, LLC also obtains from the bank 
a large cash amount up-front (e.g., $20 million) referred to as 
a ``loan premium.'' The ``premium'' equals the net present 
value of the portion of the ``loan'' interest payments that 
exceed the market rate and that LLC is required to pay during 
the full 7-year ``loan.'' The ``loan premium'' also equals the 
tax loss to be generated by the strategy. LLC thus receives two 
cash amounts from the bank ($50 million plus $20 million 
totaling $70 million).

    5) The ``Loan'' Restrictions. LLC agrees to severe 
restrictions on the ``loan'' to make it a very low credit risk. 
Most importantly, LLC agrees to maintain ``collateral'' in cash 
or liquid securities equal to 101% of the ``loan'' amount, 
including the ``loan premium'' (e.g., $70.8 million). LLC also 
agrees to severe limits on how the ``loan proceeds'' may be 
invested and gives the bank unilateral authority to terminate 
the ``loan'' if the ``collateral'' amount drops below 101% of 
the ``loan'' amount.

    6) The Partnership. LLC and two Presidio affiliates form a 
partnership called a Strategic Investment Fund (``Fund'') in 
which LLC has a 90% partnership interest, one Presidio 
affiliate holds a 9% interest, and the second Presidio 
affiliate has a 1% interest. The 1% Presidio affiliate is the 
managing partner.

    7) The Assets. The Fund is capitalized with the following 
assets. The LLC contributes all of its assets, consisting of 
the ``loan'' ($50 million), ``loan premium'' ($20 million), and 
the Individual's cash contribution ($1.4 million). Presidio's 
two affiliates contribute cash equal to 10% of the LLC's total 
assets ($155,000). The Fund's capital is a total of these 
contributions ($71.6 million).

    8) The Loan Transfer. LLC assigns the ``loan'' to the Fund 
which assumes LLC's obligation to repay it. This obligation 
includes repayment of the ``loan'' and ``loan premium,'' since 
the ``premium'' consists of a portion of the interest payments 
owed on the ``loan'' principal.

    9) The Swap. At the same time, the Fund enters into a swap 
transaction with the bank on the ``loan'' interest rate. In 
effect, the Fund agrees to pay a floating market rate on an 
amount equal to the ``loan'' and ``loan premium'' (about 8% on 
$70 million), while the bank agrees to pay the 16% fixed rate 
on the face amount of the ``loan'' (16% on $50 million). The 
effect of this swap is to reduce the ``loan'' interest rate to 
a market-based rate.

    10) The Foreign Currency Investment ``Program.'' The Fund 
converts most of its U.S. dollars into euros with a contract to 
convert the funds back into U.S. dollars in 30-60 days. This 
amount includes most or all of the loan and loan premium 
amount. Any funds not converted into euros remain in the Fund 
account. The euros are placed in an account at the bank. The 
Fund engages in limited transactions which involve the 
``shorting'' of certain low-risk foreign currencies and which 
are monitored by the bank to ensure that only a limited amount 
of funds are ever placed at risk and that the funds deemed as 
101% ``collateral'' for the bank ``loan'' are protected.

    11) The Unwind. After 60 to 180 days, LLC withdraws from 
the partnership. The partnership unwinds, converts all cash 
into U.S. dollars, and uses that cash to repay the ``loan'' 
plus a ``prepayment penalty'' equal to the unamortized amount 
of the ``loan premium,'' so that the ``loan'' and ``loan 
premium'' are paid in full. Any remaining partnership assets 
are apportioned and distributed to the LLC and Presidio 
partners, either in cash or securities. LLC sells any 
securities at fair market value.

    12) Tax Claim for Cost Basis. For tax purposes, the LLC's 
income or loss passes to its owner, the Individual. According 
to the opinion letters, the Individual can attempt to claim, 
for tax purposes, that he or she retained a cost basis in the 
partnership equal to the LLC's contributions of cash ($1.4 
million) and the ``loan premium'' ($20 million), even though 
the partnership later assumed the LLC's ``loan'' obligation and 
repaid the ``loan'' in full, including the ``premium amount.'' 
According to the opinion letters, the individual can attempt to 
claim a tax loss equal to the cost basis ($21.4 million), 
adjusted for any gain or loss from the currency trades, and use 
that tax loss to offset ordinary or capital gains income.

    13) IRS Action. In 2000, the IRS issued a notice declaring 
that the ``purported losses'' arising from these types of 
transactions, which use an ``artificially high basis,'' ``do 
not represent bona fide losses reflecting actual economic 
consequences'' and ``are not allowable as deductions for 
federal income tax purposes.'' IRS Notice 2000-44 listed this 
transaction as a potentially abusive tax shelter.

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                               APPENDIX B



   CASE STUDY OF S-CORPORATION CHARITABLE CONTRIBUTION STRATEGY (SC2)

    KPMG approved the S-Corporation Charitable Contribution 
Strategy (SC2) for sale to multiple clients in 2000. KPMG 
marketed SC2 for about 18 months, from about March 2000 to 
about September 2001. KPMG sold SC2 to 58 S-corporations, in 58 
transactions, and obtained more than $26 million in revenues, 
making SC2 one of KPMG's top ten revenue producers in 2000 and 
2001. SC2 is not covered by a ``listed transaction'' issued by 
the IRS, but is currently under IRS review.
    SC2 can be summarized as follows. A chart depicting a 
typical SC2 transaction is also provided.389
---------------------------------------------------------------------------
    \389\ A detailed explanation of this chart is included in the 
opening statement of Senator Carl Levin at the hearing before the 
Senate Permanent Subcommittee on Investigations, ``U.S. Tax Shelter 
Industry: The Role of Accountants, Lawyers, and Financial 
Professionals'' (11/18/03).

    1) The Income. Individual owns 100% of S-corporation which 
---------------------------------------------------------------------------
earns net income (e.g., $3 million annually).

    2) The Sales Pitch. Individual is approached by KPMG with a 
``charitable donation strategy'' to shelter a significant 
portion (often 90%) of the S-corporation's income from taxation 
by ``allocating,'' with little or no distribution, the income 
to a charitable organization. Individual is told that, for a 
fee, KPMG will arrange a temporary ``donation'' of corporate 
non-voting stock to the charity and will provide an opinion 
letter stating it is ``more likely than not'' that nonpayment 
of tax on the income ``allocated'' to the charity while it 
``owns'' the stock will withstand an IRS challenge, even if the 
allocated income is not actually distributed to the charity and 
the individual regains control of the income. The individual is 
told he can also take a personal tax deduction for the 
``donation.''

    3) Setting Up The Transaction. The S-corporation issues 
non-voting shares of stock that, typically, equal 9 times the 
total number of outstanding shares (e.g., corporation with 100 
voting shares issues 900 non-voting shares). Corporation gives 
the non-voting shares to the existing individual-shareholder. 
Corporation also issues to the individual-shareholder warrants 
to purchase a substantial number of company shares (e.g., 7,000 
warrants). Corporation issues a resolution limiting or 
suspending income distributions to all shareholders for a 
specified period of time (e.g., generally the period of time in 
which the charity is intended to be a shareholder, typically 2 
or 3 years). Prior to issuing this resolution, corporation may 
distribute cash to the existing individual-shareholder.

    4) The Charity. A ``qualifying'' charity (one which is 
exempt from federal tax on unrelated business income) agrees to 
accept S-corporation stock donation. KPMG actively seeks out 
qualified charities and identifies them for the individual.

    5) The ``Donation.'' S-corporation employs an independent 
valuation firm to analyze and provide a valuation of its non-
voting shares. Due to the non-voting character of the shares 
and the existence of a large number of warrants, the non-voting 
shares have a very low fair market value (e.g., $100,000). 
Individual ``donates'' non-voting shares to the selected 
charity, making the charity the temporary owner of 90% of the 
corporation's shares. Individual claims a charitable deduction 
for this ``donation.'' At the same time, the corporation and 
charity enter into a redemption agreement allowing the charity, 
after a specified period of time (generally 2 or 3 years), to 
require the corporation to buy back the shares at fair market 
value. The individual also pledges to donate an additional 
amount to the charity to ensure it obtains the shares' original 
fair market value in the event that the shares' value 
decreases. The charity does not receive any cash payment at 
this time.

    6) The ``Allocation.'' During the period in which the 
charity owns the non-voting shares, the S-corporation 
``allocates'' its annual net income to the charity and original 
individual-shareholder in proportion to the percentage of 
overall shares each holds (e.g., 90:10 ratio). However, 
pursuant to the corporate resolution adopted before the non-
voting shares were issued and donated to the charity, little or 
no income ``allocated'' to the charity is actually distributed. 
The corporation retains or reinvests the non-distributed 
income.

    7) The Redemption. After the specified period in the 
redemption agreement, the charity sells back the non-voting 
shares to the S-corporation for fair market value (e.g., 
$100,000). The charity obtains a cash payment from the 
corporation for the shares at this time. Should the charity not 
resell the stock, the individual-shareholder can exercise the 
warrants, obtain additional corporate shares, and substantially 
dilute the value of the charity's shares. Once the non-voting 
shares are repurchased by the corporation, the corporation 
distributes to the individual-shareholder, who now owns 100% of 
the corporation's outstanding shares, all of the undistributed 
cash from previously earned income.

    8) Taxpayer's Claim. Due to its tax exempt status, the 
charity pays no tax on the corporate income ``allocated'' or 
distributed to it. According to the KPMG opinion letter, for 
tax purposes, the individual can claim a charitable deduction 
for the ``donated'' shares in the year in which the 
``donation'' took place. During the years in which the charity 
``owned'' most of the corporate shares, individual will pay 
taxes on only that portion of the corporate income that was 
``allocated'' to him or her. KPMG also advised that all income 
``allocated'' to the charity is then treated as previously 
taxed, even after the corporation buys back the non-voting 
stock and the individual regains control of the corporation. 
KPMG also advised the individual that, when the previously 
``allocated'' income was later distributed to the individual, 
the individual could treat some or all as long-term capital 
gains rather than ordinary income, taxable at the lower capital 
gains rate. The end result is that the individual owner of the 
S-corporation was told by KPMG that he or she could defer and 
reduce the rate of the taxes paid on income earned by the S-
corporation.

    9) IRS Action. This transaction is under review by the IRS.

    [GRAPHIC] [TIFF OMITTED] T0655.009
    
    [GRAPHIC] [TIFF OMITTED] T0655.010
    


                               APPENDIX C



            OTHER KPMG INVESTIGATIONS OR ENFORCEMENT ACTIONS

    In recent years, KPMG has become the subject of IRS, SEC, 
and state investigations and enforcement actions in the areas 
of tax, accounting fraud, and auditor independence. These 
enforcement actions include ongoing litigation by the IRS to 
enforce tax shelter related document requests and a tax 
promoter audit of the firm, which are described in the text of 
the Report. They also include SEC, California, and New York 
investigations examining a potentially abusive tax shelter 
involving at least ten banks that are allegedly using sham 
mutual funds established on KPMG's advice; SEC and Missouri 
enforcement actions related to alleged KPMG involvement in 
accounting fraud at Xerox and General American Mutual Holding 
Co.; an SEC censure of KPMG for violating auditor independence 
restrictions by investing in AIM mutual funds while AIM was a 
KPMG audit client; and a bankruptcy examiner report on 
misleading accounting at Polaroid while KPMG was Polaroid's 
auditor.

SHAM MUTUAL FUND INVESTIGATION

    KPMG is currently under investigation by the SEC and tax 
authorities in California and New York for advising at least 
ten banks to shift as much as $17 billion of bank assets into 
shell regulated investment companies, allegedly to shelter more 
than $750 million in income from taxation.
    A regulated investment company (RIC), popularly known as a 
mutual fund, is designed to pool funds from at least 100 
investors to purchase securities. RIC investors, also known as 
mutual fund shareholders, are normally taxed on the income they 
receive as dividends from their shares, while the RIC itself is 
tax exempt. In this instance, KPMG allegedly advised each bank 
to set up one or more RICs as a bank subsidiary, to transfer 
some portfolio of bank assets to the RIC, and then to declare 
any income as dividends payable to the bank. Citing KPMG tax 
advice, the banks allegedly claimed that they did not have to 
pay taxes on the dividend income due to state laws exempting 
from taxation money transferred between a subsidiary and its 
corporate parent. Zions Bancorp., for example, has stated to 
the press: ``These registered investment companies were 
established upon our receiving tax and accounting guidance from 
KPMG and the securities law counsel from the Washington, D.C. 
firm of Ropes & Grey.'' 390
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    \390\ ``Zions Among Banks Accused of Scheme,'' Desert News (8/8/
03).
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    The RICs established by the banks are allegedly sham mutual 
funds whose primary purpose was not to establish an investment 
pool, but to shelter bank income from taxation. The evidence 
allegedly suggests that the funds really had one investor--the 
parent bank--rather than 100 investors as required by the SEC. 
Press reports state, for example, that some of the RICs had 
apparently sold all 100 shares to the employees of the parent 
bank. Also according to press reports, the existence of this 
tax avoidance scheme was discovered after a bank was approached 
by KPMG, declined to participate, and asked its legal counsel 
to alert California officials to what the bank saw as an 
improper tax shelter. When asked about this matter, California 
Controller Steve Westly has been quoted as saying, ``We do not 
believe this is appropriate.'' 391 RICs established 
by the ten banks participating in this tax shelter have since 
been voluntarily de-registered, according to press reports, 
with the last removed from SEC records in 2002.
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    \391\ ``Banks Shifted Billions Into Funds Sheltering Income From 
Taxes,'' Wall Street Journal (8/7/03).
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KPMG ACCOUNTING FRAUD AT XEROX

    On January 29, 2003, the SEC filed suit in federal district 
court charging KPMG and four KPMG partners with accounting 
fraud for knowingly allowing Xerox to file 4 years of false 
financial statements which distorted Xerox's filings by 
billions of dollars.392 The prior year, in 2002, 
without admitting or denying guilt, Xerox paid the SEC a $10 
million civil penalty, then the highest penalty ever paid to 
the SEC for accounting fraud, and agreed to restate its 
financial results for the years 1997 through 2000. In July 
2003, six former Xerox senior executives paid the SEC civil 
penalties totaling over $22 million in connection with the 
false financial statements.
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    \392\ SEC v. KPMG, Case No. 03-CV-0671 (D.S.D.N.Y. 1/29/03).
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    KPMG is contesting the SEC civil suit and denies any 
liability for the accounting fraud. Two of the named KPMG 
partners remain employed by the firm. The SEC complaint 
includes the following statements:

        ``KPMG and certain KPMG partners permitted Xerox to 
        manipulate its accounting practices and fill a $3-
        billion `gap' between actual operating results and 
        results reported to the investing public from 1997 
        through 2000. The fraudulent scheme allowed Xerox to 
        claim it met performance expectations of Wall Street 
        analysts, to mislead investors and, consequently, to 
        boost the company's stock price. The KPMG defendants 
        were not the watch dogs on behalf of shareholders and 
        the public that the securities laws and the rules of 
        the auditing profession required them to be. Instead of 
        putting a stop to Xerox's fraudulent conduct, the KPMG 
        defendants themselves engaged in fraud by falsely 
        representing to the public that they had applied 
        professional auditing standards to their review of 
        Xerox's accounting, that Xerox's financial reporting 
        was consistent with Generally Accepted Accounting 
        Principles and that Xerox's reported results fairly 
        represented the financial condition of the company. . . 
        .

        ``In the course of auditing Xerox for the years 1997 
        through 2000, defendants KPMG [and the four KPMG 
        partners] knew, or were reckless in not knowing, for 
        each year in which they were responsible for the Xerox 
        audit, that Xerox was preparing and filing quarterly 
        and annual financial statements and other reports which 
        likely contained material misrepresentations and 
        omissions in violation of the antifraud provisions of 
        the federal securities laws. . . .

        ``In the summer or early fall of 1999, Xerox complained 
        to KPMG's chairman, Stephen Butler, about the 
        performance of [one of the defendant KPMG audit 
        partners], who questioned Xerox management about 
        several of the topside accounting devices that formed 
        the fraudulent scheme. Although KPMG policy was to 
        review assignments of an engagement partner after five 
        years, and [the KPMG partner] had been assigned to 
        Xerox less than two years, Butler responded to Xerox's 
        complaints by offering [the KPMG partner] a new 
        assignment in Finland. After [the KPMG partner] 
        declined the new assignment, KPMG replaced [him] as the 
        worldwide lead engagement partner with [another of the 
        defendant KPMG partners] for the 2000 audit. This was 
        the second time in six years in which KPMG removed the 
        senior engagement partner early in his tenure at 
        Xerox's request.''

    KPMG was Xerox's auditor for approximately 40 years, 
through the 2000 audit. KPMG was paid $26 million for auditing 
Xerox's financial results for fiscal years 1997 through 2000. 
It was paid $56 million for non-audit services during that 
period. When Xerox finally restated its financial results for 
1997-2000, it restated $6.1 billion in equipment revenues and 
$1.9 billion in pre-tax earnings--the largest restatement in 
U.S. history to that time.

MISSOURI DEPARTMENT OF INSURANCE V. KPMG

    On December 10, 2002, the Director of the Missouri 
Department of Insurance, acting as the liquidator for an 
insurance firm, General American Mutual Holding Company 
(``General American''), sued KPMG alleging that: (1) KPMG, 
acting in conflicting roles as consultant and auditor, 
misrepresented the financial statements of its client, General 
American, and (2) KPMG failed to disclose substantial risks 
associated with an investment product called Stable Value 
which, with KPMG's knowledge and assistance, was sold by 
General American during the 1990's.393
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    \393\ Lakin v. KPMG, (MO Cir. 12/10/02).
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    Stable Value was an investment product that, in essence, 
allowed General American to borrow money from investors and 
reinvest it in high-risk securities to obtain a greater return. 
In the event General American was downgraded by a ratings 
agency, however, the terms of the Stable Value product allowed 
investors to withdraw their funds. In 1999, General American, 
in fact, suffered a ratings downgrade, and hundreds of Stable 
Value holders redeemed their shares, forcing General American 
to go into receivership and subjecting its investors to huge 
losses. KPMG is alleged to have never disclosed the risks of 
the Stable Value product to General American and, according to 
the Missouri Department of Insurance, actively attempted to 
conceal this risk.
    The following excerpts are taken from a complaint filed by 
the Director of the Missouri Department of Insurance against 
KPMG in the Jackson County Circuit Court:

        ``In the 1990's, with KPMG knowledge, and assistance, 
        General American management developed and grew to 
        obscene proportions a high-risk product known as Stable 
        Value. In essence, certain General American management, 
        with KPMG's help, bet the very existence of General 
        American on its Stable Value business segment and lost. 
        . . . With KPMG's knowledge, General American 
        management forced an otherwise conservative company to 
        engage in an ever-increasing extremely volatile 
        product. When this scheme failed, it was General 
        American's innocent members who were harmed. . . .

        ``KPMG consciously chose to: (a) misrepresent General 
        American's financial position; (b) not require the 
        mandated disclosures regarding the magnitude and risks 
        associated with the Stable Value product; and (c) 
        conceal from and misrepresent to the Missouri 
        Department of Insurance and General American's members 
        and outside Board of Directors, the true nature of the 
        Stable Value product. And during this same time, when 
        KPMG was setting up General American's innocent members 
        for huge financial losses, KPMG kept scooping up as 
        much money in fees as possible. . . . KPMG abandoned 
        and breached its professional obligations owed to 
        General American, General American's members and the 
        Missouri Department of Insurance. KPMG's failures 
        include a lack of independence, conflicts of interest, 
        breaches of ethical standards, and other gross 
        departures from the most basic of auditing and other 
        professional obligations. . . .

        ``To further the cover-up of its wrongful acts, KPMG 
        engaged in a continued pattern of deceit during the 
        Missouri Department of Insurance's investigation into 
        General American's liquidity crisis. The record is 
        replete with KPMG witnesses giving false testimony, 
        evasive answers and just `playing dumb' in an apparent 
        hope to avoid State of Missouri regulatory scrutiny and 
        the filing of this Petition. What KPMG wanted to hide 
        from the regulators was its misrepresentations, gross 
        breaches of its professional obligations and numerous 
        failures regarding full and fair financial reporting 
        for General American.''

SEC CENSURES KPMG

    On January 14, 2002, the SEC censured KPMG for engaging in 
improper professional conduct in violation of the SEC's rules 
on auditor independence and in violation of Generally Accepted 
Auditing Standards. KPMG consented to the SEC's order but did 
not admit or deny the SEC's findings.
    The following is taken from the SEC's press release 
announcing the censure of KPMG: 394
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    \394\ Press Release by the SEC, ``SEC Censures KPMG for Auditor 
Independence Violation,'' (No. 2002-4 1/14/02), available at 
www.sec.gov/news/press/2002-4.txt.

        ``The SEC found that, from May through December 2000, 
        KPMG held a substantial investment in the Short-Term 
        Investments Trust (STIT), a money market fund within 
        the AIM family of funds. According to the SEC's order, 
        KPMG opened the money market account with an initial 
        deposit of $25 million on May 5, 2000, and at one point 
        the account balance constituted approximately 15% of 
        the fund's net assets. In the order, the SEC found that 
        KPMG audited the financial statements of STIT at a time 
        when the firm's independence was impaired, and that 
        STIT included KPMG's audit report in 16 separate 
        filings it made with the SEC on November 9, 2000. The 
        SEC further found that KPMG repeatedly confirmed its 
        putative independence from the AIM funds it audited, 
        including STIT, during the period in which KPMG was 
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        invested in STIT.

        `` `This case illustrates the dangers that flow from a 
        failure to implement adequate polices and procedures 
        designed to detect and prevent auditor independence 
        violations,' said Paul R. Berger, Associate Director of 
        Enforcement.''

    In addition to censuring the firm, the SEC ordered KPMG to 
undertake certain remedies designed to prevent and detect 
future independence violations caused by financial 
relationships with, and investments in, the firm's audit 
clients.

POLAROID AND KPMG

    Polaroid Corporation filed for bankruptcy protection in 
October 2001. In February 2003, a federal bankruptcy court 
named Perry Mandarino, a tax expert, as an independent examiner 
for Polaroid. In August 2003, the bankruptcy examiner issued a 
report stating that Polaroid and its accounting firm, KPMG, had 
engaged in improper accounting procedures and failed to warn 
investors of Polaroid's impending bankruptcy. KPMG attempted to 
keep the report sealed, but the court made the report available 
to the public. Since the issuance of the examiner's report, 
shareholders have filed a class action lawsuit against Polaroid 
and KPMG alleging violations of the Securities and Exchange Act 
for filing false financial statements.
    Both the report and the lawsuit allege that KPMG and 
Polaroid engaged in a series of fraudulent accounting 
transactions, including overstating the value of assets and 
issuing financial statements that made the company appear 
healthier than it was. The examiner determined that KPMG should 
have provided a qualified opinion on the corporation's 
financial statements and included a warning about its status as 
a ``going concern.'' The examiner found that KPMG had been 
considering such a warning, but decided against issuing it 
after a telephone call was made by Polaroid's chief executive 
to KPMG's chairman.395 KPMG has charged that the 
report is ``unfounded'' and ``incorrect.'' 396
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    \395\ See, e.g., ``KPMG Defends Audit Work for Polaroid,'' Wall 
Street Journal (8/25/03).
    \396\ ``Polaroid Hit with Lawsuit After Report,'' Boston Globe (8/
27/03).
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