John Hasnas is a professor of ethics and law at Georgetown University’s McDonough School of Business and is the author of the new book, Trapped: When Acting Ethically is Against the Law (Cato 2006), which is an adaptation of Hasnas’ article Ethics and the Problem of White Collar Crime.
In this superb Cato Institute op-ed (first published in the Wall Street Journal), Professor Hasnas addresses a common topic on this blog — the perverse effect that implementation of the Department of Justice’s Thompson Memo has had on companies serving up their employees as sacrificial lambs to avoid an Arthur Andersen-like meltdown:
Say you run a financial services firm that markets tax shelters to wealthy clients. Although the shelters are aggressive, you firmly believe they’re legal. Indeed, you have sent one of your tax partners to testify before Congress to that effect. The IRS hasn’t challenged the shelters in court, and no court has declared them to be illegal. Nevertheless, the Department of Justice has opened an investigation of your firm for tax fraud and indicted the partner who testified before Congress.
As a responsible executive, what should you do? Instruct corporate counsel to conduct an internal investigation to ensure that no law has been broken? Have the legal department begin to work on the corporation’s defense? Enter into a joint defense agreement with the partner under indictment? Advance the partner’s legal fees in accordance with the company’s policy of supporting employees sued for employment related actions?
Or should you have the corporation accept responsibility for tax fraud, officially declare that several of your tax partners engaged in unlawful conduct, refuse to enter into a joint defense agreement or advance the legal fees of any of these partners, fire those who refuse to cooperate with the government, waive the firm’s attorney-client and work product privileges, disclose all information that may incriminate your employees to the government, and agree to pay a several hundred million dollar fine?
[The latter approach], surprisingly, is the answer. Under current federal law and Department of Justice policy, it would be irresponsible management to attempt to defend the corporation or its employees.
Incidentally, my . . . hypothetical is not a fanciful one. KPMG recently agreed to pay $456 million to avoid indictment for marketing tax shelters that have never been shown to be illegal. It also waived its attorney-client and work product privileges and is helping the government prosecute 17 of its former employees, including a tax partner it sent to testify before Congress. This help includes providing the government with all incriminating evidence in its possession and firing and refusing to advance the attorney’s fees of employees who defend themselves rather than cooperate with prosecutors. It also includes agreeing not to retain employees who say anything inconsistent with the indicted employees’ guilt, something that neatly precludes the accused from obtaining defense witnesses.
Legally, KPMG is on good grounds in taking these actions. Ethically, the case is considerably less clear.
Read the entire op-ed. The syndrome that Professor Hasnas addresses has resulted in enormous economic cost (see Arthur Andersen, Dynegy, Merrill Lynch, AIG, KPMG, etc.) and damage to lives, families and reputations, perhaps best reflected by the plight of the four Merrill Lynch executives in the Enron-related Nigerian Barge case and the sad case of Jamie Olis.
However, apart from those horrific costs, the most troubling aspect of the government’s criminalization of business is the damage to justice and societal respect for the rule of law. As noted earlier here, prosecution of business crimes has become a game of roulette for government prosecutors, who play on an ugly cauldron of public cynicism, resentment, and tolerance for abusive use of governmental power to prosecute the unpopular executive of the moment. When the frightening loss of thousands of jobs and the destruction of careers and families is rationalized as a tolerable cost of the use of the state’s awesome prosecutorial power for the better good of society, we are well on our way to a time when, as Sir Thomas warns us, we will not be able to “stand upright in the winds” of abusive state power that will blow then. What Ann Rynd reminded us about socialism applies equally well to the abusive exercise of the state’s prosecutorial power:
[T]he truth about their souls is worse than the obscene excuse you have allowed them, the excuse that the end justifies the means and that the horrors they practice are means to nobler ends. The truth is that those horrors are their ends.
Department of Coercion
One of the common subjects covered on my humble blog over the past couple of years has been the increasing regulation of business through criminalization of risk-taking. Accordingly, it’s appropriate that my first post on this more esteemed forum shoul…
By ignoring the rule of law, the Department of Justice has taken us back to the days of death by denunciation.
In the Andersen case, Andersen waived all attorney/client and work product privileges and fully cooperated with the government. However, the government (with the help of Judge Melissa Harmon) was successful in keeping this information from both the public and the jury, along with the fact that Enron CFO Andrew Fastow committed his crimes within Enron’s SPEs, none of which were ever Andersen clients.
Because Andersen was never the auditor of the entities where the crimes took place, the DOJ could not charge Andersen with any wrong-doing in the audit. Because there, had never been a subpoena or even any discussion of a subpoena, Andersen’s “document destruction” (David Duncan admitted shredding ‘duplicate copies of old memos, old magazines & requests for charitable contributions’) was entirely legal. Therefore, the DOJ charged Andersen with “witness tampering” on the novel theory that politely asking employees to follow a legal procedure was somehow a criminal act.
The “witness tampering” statute states that the prosecution must prove the defendant “knowingly corruptly persuaded” someone to withhold evidence from an “official proceeding”. The DOJ prosecuted Andersen on the theory that the law required neither “knowing” nor “corrupt” persuasion nor any connection to an “official proceeding”. The trial court and the 5th Circuit condoned the DOJ’s misstatement of the law. By a 9 – 0 decision, the U.S. Supreme Court stood up for the rule of law & reversed the conviction.
The DOJ’s bald misstatement of the law left Andersen partners with a stark choice. Lie under oath by pleading guilty to an act that was entirely legal or face certain destruction for telling the truth. Andersen partners chose to tell the truth.
KPMG’s tax shelters were aggressive but as Professor Hasnas pointed out, no court has found them to be “abusive” or illegal. Even if they are at some point judged to be “abusive”, it does not follow that KPMG possessed criminal intent to defraud the government, which is the basis for KPMG’s plea.
The real crime is that an unethical government forces ethical people into a situation where honesty means certain death.
When we laugh at Helmsley’s and Martha’s problems, we make the next persecution easier.
I agree that the Andersen case was and that the KPMG case is being handled improperly. That said, I can offer only some sympathy. I have worked in the tax practices of both firms. When first employed, I believed I was going to learn how to deliver prudent tax advice to my clients. Soon I realized that what mattered most was revenue generation. The firms encourage us to push the limits often at the clients expense. The leadership, while not encouraging us to break the letter of the law, definitely encouraged violating the sprit. The recipients of our services were more than happy to oblige (especially after dinner at Brennan’s and visit to Treasures). I hope that in the future the firms and the businesses utilizing their services exercise better judgment.
Mike says, “When first employed, I believed I was going to learn how to deliver prudent tax advice to my clients. Soon I realized that what mattered most was revenue generation.”
Mike, this is a scheme to defraud, the knowing, wilful, deliberate use of a half-truth. Go to the website for Hasnas. He has a short paper that explains that half-truths are schemes to defraud.
As your post makes plain, this kind of dishonesty is a crime of violence. It has left you hurt just as much as a robber pulling a knife across your face. It did such to every other honest employee, every customer, every investor who relied on either and as a result lost their life savings.
Tax law & accounting is about 5% black, 5% white and 90% gray. My experience is that tax accountants, who are advocates for the taxpayer, don’t want to get anywhere close to fraud.
My understanding was that Andersen partners refused to sign any tax returns containing the KPMG shelters. Still, that doesn’t necessarily mean the shelters are “abusive” and it certainly doesn’t mean that KPMG intended to commit fraud.
According to the WSJ, the KPMG partner who was asked to explain the shelters to Congress, testified that although he did not design the shelters, he believed they were legal. And they may in fact be. However, the DOJ has indicted him for lying to Congress merely for giving his legal opinion. (The fact that lying to Congress is illegal is laughable given the dishonesty of our politicians. Just consider the number of laws passed by Congress that exempt themselves –ADA, civil rights laws, social security, to name just a few.)
One Andersen retired partner, on reading about the indictment of the KPMG partner, commented that if the government had not destroyed our retirement income, he would cheerfully donate funds to help this KPMG partner (unknown to him) who has to defend himself because KPMG threw him to the wolves.
Two quotes give food for thought.
“In Germany they came first for the Communists, and I didn’t speak up because I wasn’t a Communist. Then they came for the Jews, and I didn’t speak up because I wasn’t a Jew. Then they came for the trade unionists, and I didn’t speak up because I wasn’t a trade unionist. Then they came for the Catholics, and I didn’t speak up because I was a Protestant. Then they came for me, and by that time no one was left to speak up.” — Martin Niemoeller
“Freedom is a fragile thing and is never more than one generation away from extinction. It is not ours by inheritance; it must be fought for and defended constantly by each generation; for it comes only once to a people.”
— President Ronald Reagan
I would bet most in public accounting and corporate tax departments would agree with Ms. Morrison’s opinion. Its a funny how where we work determines how we think. I cant help but wonder how the 90% gray area would be viewed by the same individuals if they worked for the IRS or a state revenue agency. (Especially if those agencies paid their employees $55K right out of school, fed them fancy meals daily, gave them tickets to every ball game in town and had a partner track so that in 12-15years one could make $3-400K per annum.
I worked in public over 8 years and didnt find the tax code quite as grey. I now work for the government and believe it would do all tax accountants good to work a short while for “the other side”. Perhaps the gray would shrink a bit.
P.S. The bit about the retired Andersen partner not having funds to help the KPMG partner is a bit far fetched.
Mike’s comment (March 12) is obviously made from the viewpoint of not being an Andersen partner. Most retired partners lost a minimum of $1 million in retirement through no fault of there own. Perhaps he is working for the government because he was not on a partner track.
Nice jab Andy. I wonder where you work. Believe it or not, not everyone wants to be a partner in a Big 4 firm. I wonder if we would agree that the whole firm (Andersen) should not have suffered, if, hypothetically, the actions of the few rouge individuals had caused a physical injury rather than a financial one. And, we were the plaintiff’s attorneys.
Great post; the original WSJ column has been reposted (without co$t) on the Cato Institute website:
http://www.cato.org/pub_display.php?pub_id=5974
Mike,
I would like to live in a world where the government could be prosecuted for the kinds of things for which it pursues private companies and individuals. But to answer your questions, I would not wish to see your retirement disappear because of what a group of agents did in Waco. To suggest otherwise about the Andersen partners I think suggests a perverted sense of justice. Few government officials even believe any longer that it was the right thing to do.
Mike,
It is true that some of tax law is settled. However, obviously a large portion is unsettled or as I termed it, “gray.” Otherwise, why would the IRS Code, regs, Rev Procs & Rev Rulings be increasing at an exponential rate?
Many of the problems facing accounting over the last decade is that businesses have been changing at an ever-increasing rate. Just consider the effect of the internet. This leads to new issues in accounting disclosure, tax accounting and auditing. Everybody – the FASB, the SEC, IRS or the accounting firms — has struggled to keep up, with mixed success.
As to your blase attitude about the fate of partners & retired partners, let me give you a few thoughts. First, while there may or may not have been mistakes on various audits, the Enron frauds were committed, with collusion of major banks, within Enron’s SPEs, none of which were ever Andersen clients.
Second, being stripped of capital and retirement funds hit different individuals in different ways. To note the obvious, a partnership is capitalized solely by partners and retired partners and for them to finance a worldwide organization requires a lot of cash and reinvestment.
Many active partners chose to join other large firms and were basically made whole. But not all did, either by choice or circumstance. Some very young partners who had borrowed for their capital investment did not. Therefore, they are left paying Citigroup, the bank that financed Andersen’s capital account loans & who helped frame Andersen in the Enron fraud, for their capital account loans.
Some partners just approaching retirement age were not picked up by other firms because their expected work life did not justify the long-term payment of retirement benefits.
As to retired partners, their financial problems vary with age cohort, with those in their 80s and 90s, as well as the widows, being most vulnerable. Unlike most pensions, which are either funded by shareholders or taxpayers, retired partners’ pensions are their own money, reinvested in Andersen over decades of working long hours to finance expansion and provide opportunity for those coming behind.
Partners made good money in the late 90s but that wasn’t always the case. For years the tremendous investment to build AC, expand training (I believe training cost 10% of gross fees in the 1980s) and open new offices in response to globalization kept partner draws relatively modest. We, like other partners, gave approximately 10% of our gross partner earnings to charity.
Further, partners in their 70s, 80s & 90s did not have access to the before-tax savings of 401(k)s and maximum tax rates were 50%.
Finally, the more elderly the individual and spouse, the more likelihood of devastating illness, the need for long-term care, etc.
Discussion of these general factors does not take into account individual challenges. Many retired partners have children in college (I know one with a child in high school) whose educations need to be paid for. At least 2 retired partners have severely handicapped children who will never be financially or emotionally independent. The carefully laid plans to protect these children have been destroyed by the DOj’s fraudulent actions.
Some retired partners/spouses have huge health problems such as cancer, need for organ transplants,MS, etc. but do not yet qualify for Medicare. Such pre-existing conditions render them nearly uninsurable.
Several retired patners have faced death, frantic with worry about how their widows would survive. Some of our dear friends are in their 80s. The husband’s mother was widowed when he was 18 and so for much of their married life, they supported his mother. Now her mother, living in a nursing home, has run out of money. The retired partner & his wife support her.
These are real people and these are just the ones that I happen to know of.
Consider this. The U.S. government routinely understates both the deficit and the national debt because, unlike public companies, the government does not book any liabilities for pension costs. Should the public ever wake up to this fraud, taxpayers might refuse to pay for your pension. If this should happen when you are near retirement or, worse yet, after retirement when you have no employment options, perhaps you would have at least a limited grasp of the problem.
Mary,
A partner should be in a better spot than many of the others who worked for Anderson many years and lost everything (i.e., mail room personnel, admins, etc.) Many people with less resources have similar plights (parents to care for, children in college, cancer).
I was also trying to point out that we talk out of both sides of our mouths depending on the situation we are in. If you husband had worked for Enron (rather than Andersen), was 59, and lost everything he had saved for retirement, would you feel the same about Andersen? The Government didnt crush Andersen by surprise – there were many fiascos prior to Enron. The tax partners could have split from the firm (like AC) after seeing the audit issues time and time again.
Last point, we would like to think that these firms are most concerned with doing the right thing when in reality it is just risk vs reward (revenue vs no revenue) and most times revenue wins. I have sat in many meetings with partners concerning themselves about what may happen if strategies the they sold were discovered (all before they changed “strategies” to “solutions”, stopped using contingency fees and got rid of the BDMs “salespeople”) Perhaps I should post some whitepapers on this blog and we can discuss the gray.
Mike,
You are absolutely correct that there are always people worse off.
That is why when the firm was being destroyed, retired partners immediately contacted the elderly and widows to see what help could be given. That is why retired partners set up a mentoring network to assist employees looking for jobs, an effort joined by employees at all levels who contributed skills, contacts and moral support. That is why on the opening day of the congressional “fact-finding hearing”, my husband & I called our friends who have spent most of their lives supporting one parent or another, told them that AA could not survive the smear campaign and told them we would stand by them financially. That is why we were contacted by a couple with pre-schoolers and told the very same thing.
Thankfully, non-partner retirees are covered by Erisa, but I believe at a reduced level.
This discussion started because you found it difficult to believe that AA retired partners might have financial difficulties such that they couldn’t take care of a KPMG partner left dangling in the wind. We have our plates full looking after our own.
As to what you say you saw in partner meetings, if I were there, I might agree with you 100%. But I wasn’t there and whoever you are referring to is not in this discussion to give his/her side of the story. Therefore, I am not in a position to comment.
I will always give the benefit of the doubt to those who are willing to sign & date a transaction, bearing responsibility for their decisions. And I will always disagree with any kind of a blanket smear.
I can tell you that I saw a partner resign on the spot from a major tax client because that client verbally abused a tax senior. I can also tell you that a tax manager told me that when he called the partner to tell him that another very large tax client may be back-dating documents, the partner without hesitation told the manager to get everybody packed up & back to the office because he was on his way out to resign. I would hope that all partners would act similarly in the same situation.
You ask how I would feel about Andersen if my husband & I had been Enron employees who lost everything due to the Enron fraud. I would hope that I would have the intelligence and integrity to blame Fastow and those who aided & abetted his fraud, rather than those who were not in a position to discover the fraud. (Fastow ought to be glad that AA people don’t decide his sentence.)
How are Enron people helped by destroying innocent people? How does deliberately misstating the problem prevent the next train wreck?
You point out that tax partners could have split off from audit, thereby isolating ourselves from fallout from a potential audit failure. That is true, but we were under the illusion that Americans were still governed by the rule of law. Speaking for my husband & myself, we are appalled at the level of dishonesty in business, financial institutions and the media, but the sanctimonious dishonesty of our government is worse.
The reason I have chosen to speak out is to warn other CPAs so that they can correctly assess the risk of staying in public accounting in a country that no longer values the presumption of innocence or due process. Every thinking person should be chilled by the Andersen case.