With its deferred prosecution agreement with the government finalized, the first criminal indictments were filed today against former KPMG partners in connection with the creation and promotion of tax shelters that still threatens the firm ability to survive as a going concern. Today’s indictment charges eight former KPMG executives — including former KPMG deputy chairman Jeffrey Stein and four other lawyers (including one former Sidley Austin partner) — with conspiracy for designing and marketing the fraudulent tax shelters. Here are the previous posts on KPMG’s tax shelter woes, and here is the indictment.
Although the criminal charges and probable future charges against other KPMG personnel ensure bad publicity for the firm for years, the government’s controversial decision to terminate former accounting giant Arthur Andersen by indicting that firm is ironically the reason that KPMG just may survive the fallout over the tax shelter indictmetns. With large public companies having so few other choices for auditors left, KPMG’s still stout audit practice may be able to generate enough business to makeup for the loss of KPMG’s once lucrative tax shelter practice.
The admissions that KPMG made today in connection with its deferred prosecution agreement will assist the government in prosecuting the indicted individuals and in future cases against other former KPMG partners, bankers, lawyers, and outside advisers who participated in creating and promoting the shelters. For example, KPMG admitted the tax shelter that it sold under the name “Bond Linked Issue Premium Structure” (“Blips”) was a fraudulent tax shelter and admitted that the firm engaged in fraudulent conduct in connection with two other shelters, known as “Flip” and “Opis.” Among the major banks that provided financing for the shelter transactions were Deutsche Bank AG, HVB Group and UBS AG, whose former executive — Domenick DeGiorgio — has already pled guilty to fraud and conspiracy charges in connection with the Blips transactions.
Here is the KPMG statement on the deferred prosecution agreement.

Regulation FD requires full disclosure of securities issuers’ communications with analysts for the supposed purpose of protecting the hypothetical ordinary investor. It’s one of those regulations that sounds good on the surface, but fails miserably in practice.
The truth is that Reg FD attempts to regulate statements that perpetuate a myth — i.e., that the securities markets are a level-playing field for the ordinary individual investor. In fact, securities markets are hopelessly rigged against the individual investors, who really have no business attempting to compete in those markets against the pros. Rather, study after study has shown that the individual investor would be much better off simply investing in index funds rather than operating under the myth that the securities markets are fairer for the ordinary investor than, say, playing the slots in Las Vegas.

Continue reading →

Martha Stewart — who was unjustly prosecuted and convicted for allegedly misleading the government about an supposed crime that the government could not prove — finishes the home confinement component of her sentence next week. Ellen Podgor (she of “Busted for Yoga” fame) wonders in this post which of the following will be the legacy of the Stewart case:

1. Tell the truth to the government when questioned.

OR

2. Don’t talk to the government when they seek information.

Given recent developments in other cases, the following alternative might also be added:

3. Waive the attorney-client privilege, offer up others as sacrificial lambs for the government to prosecute, and enter into a deferred prosecution agreement with the government to avoid criminal charges.

The anticipated settlement of criminal charges over KPMG, LLP‘s creation and promotion of allegedly illegal tax shelters has been finalized between the accounting firm and the Department of Justice and will be announced on Monday. Here are the previous posts on KPMG and its tax shelter saga.
Under the deal, KPMG will pay $456 million in fines, accept former chairman of the Securities and Exchange Commission Richard C. Breeden as an independent monitor of the firm’s operations through at least 2006. The firm will also agree to limits on the scope of its tax practice and continue to serve up to prosecutors for possible criminal charges former KPMG partners and other professionals who worked on the tax shelters, which the DOJ contends cost the U.S. Treasury at least $1.4 billion in unpaid taxes. KPMG allegedly earned fees of $124 million on creating and promoting the tax shelters to about 350 clients.
As noted in earlier posts, the settlement with the Justice Department does not mean that KPMG is out of the woods yet by any stretch. KPMG still faces potentially enormous civil liability as a result of its admission of wrongdoing in regard to the tax shelters. Even more importantly, KPMG’s serving up of its former partners on a platter to prosecutors has so damaged partner morale at the firm that key partners may leave the mess behind for greener pastures at competitor firms. Thus, even when it tries to do so, the federal government may not be capable of avoiding an Arthur Andersen-type meltdown of one of the few remaining big accounting firms available to handle the increased regulatory requirements that the government has imposed on public companies.
Update: This NY Sunday Times article — purportedly based on inside sources — tells the story on how KPMG’s management came to embrace, and then abandoned the defense of, the tax shelter promotion scheme.

Well, the government’s seemingly relentless campaign to criminalize business in the post-Enron era has finally reached the one industry — the movie business — that relishes such matters when they happen to somebody else.
The Wall Street Journal ($) is reporting today (free article here) that an ongoing investigation into DreamWorks Animation SKG Inc has been broadened by an SEC informal inquiry into Pixar Animation Studios after Pixar had over-estimated the number of sales upon its release of The Incredibles DVD.
This particular saga began when DreamWorks cut its earnings forecasts twice after heavy returns of its Shrek 2 DVD. In the case of DreamWorks, the SEC is apparently focusing on whether the studio should have informed investors earlier of the problems with Shrek 2 given the studio’s knowledge that DVDs were having an increasingly short shelf life than previous DVD issues. DreamWorks shares fell about 5% in May ahead of the release of its first-quarter results after an online report predicted that the results would be worse than expected, and then the company subsequently warned of lower earnings forecasts because Shrek 2 DVD sales had fallen short of expectations. Similarly, on June 30, Pixar announced that it would miss its second-quarter earnings because it had underestimated the rate of returns by retailers of The Incredibles DVD and that sales of the movie’s DVD had fallen about 7% short of estimates.
The studios are probably already working on a documentary similar to this one. As for what such a film would look like, Professor Ribstein — the expert on how business is portrayed in films — presents his case.

The Justice Department announced Thursday that it has filed a superseding indictment alleging additional counts of wire fraud and reporting fake trades against former El Paso Corp. trader Donald Burwell. The superseding indictment is the latest development in a series of criminal cases that the U.S. Attorney’s office for the Southern District of Texas has been pursuing against former traders of natural gas who worked for various Houston-based companies. Previous posts on the trader cases are here, here, here, here, here, here, here and here.

Continue reading →

Professor Ribstein notes an interesting development in the entertainment business, where creative financial types are securitizing revenue streams from artists’ work into financial instruments such as “Bowie Bonds,” which are then sold to investors to provide an income source for the artists and their recording studios. Given the revenue loss that some artists and record companies have incurred as a result of illegal downloads, Larry notes the sweet irony of capitalists rescuing “the artists from the non-respecters of property rights.”
Unfortunately, this creativity will only last until the government figures out what is really going on and puts a stop to it.

Peter Henning comes up with that apt description of Bruce Carton’s analysis of the black hole that is developing in the securities litigation arena, where litigation seemingly begets litigation about the original litigation. The latest example is speculation over Milberg Weiss becoming a class action target as a result of the criminal investigation into the firm’s handling of dozens of class actions over the years. Cracks Bruce, “Presumably the lawyers bringing any shareholder lawsuit against Milberg would be . . . lawyers who only file non-frivolous lawsuits seeking non-outrageous punitive damages.”
In discussing all of this, Bruce refers to this hilarious Toronto Globe and Mail commentary on the imminent securities class action against CIBC that will claim damages caused by CIBC’s recent generous settlement of claims against it in the Enron securities class action lawsuit:

While CIBC’s shareholders may indeed have the right to feel like they’re stuck in the intensive care unit without health coverage, the logic in taking this to court would seem distinctly fuzzy. If they blame the Enron settlement for hitting the value of their shares, what happens when their lawsuit is launched? Won’t the share price drop even further? And when that happens, shouldn’t they sue themselves? And eventually, won’t they have to end up paying billions to themselves to have their own lawsuit go away?
In the end, CIBC’s share price would be sucked in on itself and go into negative territory, a kind of financial black hole that only Stephen Hawking would understand.

At the start of the recent Merck/Vioxx trial, this post noted the dearth of clinical evidence that Vioxx was a particularly risky drug.
In light of last week’s big verdict in the case, long-time Clear Thinkers favorite James D. Hamilton (prior posts here) evaluates one of the recent clinical studies on Vioxx and explains the study’s statistical basis for the conclusion that there is a slightly elevated risk of heart attack for certain Vioxx users. Professor Hamilton then juxtaposes the following question against one of plaintiff’s lawyer Mark Lanier’s more disingenuous questions during the trial:

How did we arrive at a system in which 12 random Texans are assigned responsibility for evaluating the scientific merits of statistical evidence of this type, weighing the costs and benefits, and potentially sending a productive blue-chip American company into bankruptcy protection?

This BBC article indicates that none other than Steve Jobs may be the next executive to be on the receiving end of the tort liability merry-go-round:

The surge in sales of iPods and other portable music players in recent years could mean many more people will develop hearing loss, experts fear.

Mark Lanier is licking his chops.