You used the word "shocked." You're shocked by the way KPMG handles tax shelters in week one of joining it?
Yes. Shocked and thinking, "There must be some explanation for this. I must be missing something." So you go down the normal paths to investigate and find out what's a reasonable explanation for this; and was going through over a period of months, and I guess my first year, some enlightenment. There was no explanation. It was just bad intent in accepting those facts and representations. It was my belief then -- and it's my belief now -- that KPMG knew exactly what they were doing. …
They weren't playing it straight?
They were not playing it straight.
What's going on when you say, "They were accepting facts and representations"? … What's that mean?
That's a very, very complicated question. I think that's one of the reasons that this problem has persisted. You need a little bit of background to understand what goes along with a tax shelter.
The tax shelters are developed by the promoter -- KPMG, or otherwise -- and what's offered is an opinion letter to the taxpayer. In a nutshell, what that opinion letter does is it purports to provide the taxpayer with protection against penalties in the event that they're not correct and they do not prevail.
The law does not require that you're absolutely certain on every position that you take in order to take the position -- nor should it. You should be able to take a position. But what it does not allow for is playing of the audit lottery, that the only way we can win this is because the IRS will not discover it.
So what these opinion letters are intended to do is to provide that taxpayer with protection from those penalties, by saying, "I didn't play the audit lottery. I reasonably relied on a person who's qualified to know, and they gave me an opinion that said, 'It's not the audit lottery. I could very well win this. In fact, it's more likely than not that I win this.'"…
If I understand you correctly, what you're saying is that KPMG drafts a prototype explanation for the tax shelter user, which then KPMG says, "Based on what you've told us, we think you'll do all right."
But in effect, KPMG's faking the facts to start with.
I don't know if I'd use the term "faking the facts." They write up a prototype opinion. ...
What's the climate, what's the environment, what's the mindset that you'd run into when you were working at KPMG in those early days?
… What was going on was different when I started than shortly thereafter. There was a metamorphosis from that traditional client service support role that I mentioned to you, to this tax strategy, tax product, tax solution development mindset. What the whole drive became at the Washington National Tax and elsewhere at KPMG's tax practice was to produce tax shelters to be sold to investors or taxpayers.
Wholesale marketing, that's right. Develop strategies that can be widely marketed. For something to be categorized as a product, it had to have certain revenue potential.
Did they talk about these as tax products? Is that what you're saying?
That's an interesting question. These tax shelters were -- from 1998, I want to say, up until about 1999 -- they were called "tax products." It was a good thing. These firms -- and KPMG in particular -- viewed moving from this client service, answer on a case-by-case basis -- a one-off basis, if you will -- a question, put it in the file and put it away -- to "productizing."
That was the big term in that industry and other industries. "Productizing" the service into something that could be replicated and sold. So yes, they called them "tax products."
What does it mean to call it a tax product? …
A tax product is something that's really driven by the developer of the tax strategy, not driven by the transaction and giving tax advice, as compared to tax advice. A tax product -- the tax treatment drives the transaction.
What you're saying is normal tax planning is somebody's got a problem, and the come to the accountant and say, "How can I handle my taxes?" Tax products are in-house; you're generating a lot of stuff, and you're marketing to a lot of people.
The easiest distinction between traditional tax planning and tax advice is traditional tax planning is exactly that. A client comes to you and says, "I'm going to do a transaction," or, "I've done a transaction. Tell me how to do it or how to treat it, and give me the most favorable treatment possible of that transaction."
Versus a tax product, what came to be known as a "tax solution," where somebody comes up with, finds a purported loophole, finds a way to exploit the tax law. "If only I had that transaction." They go out and find the taxpayers and the clients to do the transaction that needs to be done to take advantage of that loophole.
So it's being generated within the accounting firm?
That's the difference?
That's the difference -- the impetus for the transaction, yes.
What's happening in the shelter practice inside KPMG in the late 1990s?
In the late 1990s when I joined, in 1998, what was happening is people were excited. The boom was starting to take hold or had substantially taken hold, and this sounded like a great idea for supercharging the tax practice. "Stop waiting for people to call you and give them an answer. Let's go out and sell a lot more product. Let's get out there and sell it proactively."
It sounded like a good marketing strategy. Where it went wrong was where the marketing took over the firm. So people were initially excited. I think as people started realizing some of the problems of a sales culture in this industry, they developed reservations, and realized some of the negatives that came along with it.
So you've got marketing driving the way everybody's thinking about it.
Yes. The push to sell, the revenue goals and the push to sell tax strategies was -- you really couldn't give no for an answer. "No" was not an acceptable answer. It's, "How are we going to sell more of these? Tell us how, and keep thinking until you come up with a way to do this, and then get out there and sell them."
This is big business?
This is huge business, yes. …
So there are internal memos at KPMG that have come to light in various investigations and so forth. I mean, they've set very ambitious targets for individual shelters.
Yes. On certain of the shelters, they've purported to be able to generate several million dollars -- double-digit, in some cases -- $100 million or more of revenue. That's right. …
What's happening inside KPMG as this tax shelter business takes off?
There are several levels of what's happening. Really the most abusive tax shelters were fairly clandestine.
Because the really ugly stuff -- there's restrictions on access.
They didn't want their own people to know?
They did not want their own people to know. In fact, some of the products, they would produce materials that went along with them -- typically, a white paper which described their product and how it works. Many of those very, very aggressive ones were listed as, quote, "restricted," which means it's on a need-to-know basis. Unless you need to know, you're not going to get access to that document.
Inside KPMG's tax practice.
What about the clients? Can the clients keep a copy and show them to their lawyers?
As you saw in one of the memos, that was strongly discouraged for a number of reasons. I think, if it ultimately would have killed the deal, yes, there would've been a progressive disclosure of how it worked to close the sale, but no more than was absolutely necessary. Yes.
So there was a culture of secrecy about the most aggressive [shelters]. Were you part of a special team if you were working on the most aggressive tax shelters?
Yes. As I said, there was a general sales culture. I and others -- everyone in the tax practice was required to attend mandatory sales training and things of that nature.
But in these particular, there were particular tax shelter groups, some that are mentioned in the materials: Stratecon, Personal Financial Planning or PFP -- those were the groups. They had their own meetings, and they discussed how to market. Generally, the ones outside those groups were not invited to those meetings. …
So Stratecon and Personal Financial Planning are two of the most aggressive marketing groups inside KPMG?
They were. At the time I was there, those were some of the names they went by. One of the things that makes it difficult to kind of follow the history of this is that the names of the groups and the organization of the groups changed very, very often. Stratecon, for instance, was formerly known as TTM, Total Tax Minimization.
Total Tax Minimization?
Yes. That's somewhat self-explanatory.
I was just going to say that makes it pretty clear what it's about.
Yes, that would be fairly difficult to argue that a transaction is driving the tax solution. Yes.
There's another group on the organizational chart that's called a "Tax Innovation Center."
What's a Tax Innovation Center?
Yes, the Tax Innovation Center, or the TIC, was what was developed right around 1998, I believe. That was what was seen as necessary to rapidly produce in a way that was timely to get these tax products to market.
Was this the incubator for tax schemes?
It's the incubator, and it's really the support for the marketing. There are really two components that go along with developing a tax product. It's developing the technical solution, the technical strategy.
This is very intricate, tightly worked out.
Yes, well, they're studied a lot. If you run into a problem … if you've invested too much and you discover in late stages that something has a technical glitch, very many of them got to market anyhow.
But just to stick with it, how did they get generated? There's a thing called Tax Innovation Center, Project Ideas Submission form. What's that?
There were several ways how strategies -- tax products or tax solutions -- got generated. Sometimes it came from another service provider who had a similar idea. But within KPMG, what that's about is these were people coming up with ideas and submitting them to the Tax Innovation Center for development into a full-fledged tax solution, or tax product.
So people all around the country from KPMG are encouraged to come up with ideas for tax shelters?
Encouraged and paid a bonus for doing so, yes. …
You said before Stratecon and Personal Financial Planning were two of the hothouse tax shelter promotion units within KPMG. What were partners making there, say, compared to ordinary partners?
Yes. Well, without having seen their pay stubs, I can tell you what was reported by many of the other partners. The partners who were not involved in tax shelters were pretty vocal about the disparity and the amount of money that the tax shelter promoters were making. …
If you were a tax partner at KPMG, [were you] expected to help sell these shelters to your clients?
Not only expected. I think some of the materials in the report and other materials would definitely show that "expected" is very kind. If you did not, you would be shown the door sooner or later.
So there were quotas, in effect.
There were quotas. There were revenue goals that the partners had to reach. There aren't enough hours in the day for them to reach those goals selling hourly services. So they quickly realized, "If I want to meet that revenue goal and stay around here and be paid what I expect to make for my services, there's no other way to do it other than selling the tax shelters."
I get an impression when I look at the charts, even when I was at the hearings listening to the testimony, of an organization that's really geared up. … I mean, this looks like it's a main line of business for KPMG. Is that right?
Yes, that is right. Certainly by 1999 or so, when it was in full bloom, yes, that's right. From 1999 to 2001, for sure, the vast majority of resources in the tax practice were devoted towards developing, supporting, or in some way facilitating the development of tax shelters. Yes, that's absolutely correct. …
Who's driving this? Is this coming from a bunch of wildcat entrepreneurs, a special kind of the Stratecon group way over in the skunkworks, sort of generating special products? Or is this part of mainstream KPMG? Are there orders and blessings from on top?
It's mainstream KPMG, in my opinion. I think it's supported by those documents. … This tax shelter sales was driven from the top. It was coming from the top guy in the tax practice, Jeff Stein. There were people in the field that were overly aggressive in selling certain strategies and created problems.
There were plenty of procedures to limit KPMG's exposure, and many of the people in the field deviated from those procedures and increased their exposure. That's not to say that KPMG did not approve a very aggressive strategy. They just wanted it done in a way that didn't overexposure them to liability. I think the people in the field did not always follow those procedures, but the problem was not attributable to a lack of controls. …
Now did [Jeff Stein] personally get involved? [In a memo, Jeff Stein talks about "ruthless execution." You see these other memos -- sell, sell, sell -- with this drumbeat going. I mean, is Jeff Stein on the conference call phone with people? Is he sending out broadcast e-mails, faxes, that kind of stuff?
Yes. I had limited access to those things. Part of the secrecy issue at KPMG is many of the things were partner-only, although I was invited by many of the partners to attend certain things and was often advised what took place in some of those partner-only meetings.
But, yes, the ones that I attended and the observation made by the partners who conveyed what went on in those meetings to me was, yes, Jeff Stein was -- they would have conference calls, where he would demand an explanation of why you were not adequately selling the tax shelters. As I said, "No" was not acceptable. Having no reason or the inability to sell the tax shelters was not acceptable. You would have to find a way to do it.
You mentioned secrecy several times -- secrecy within KPMG. What about secrecy vis-a-vis the IRS? What about secrecy vis-a-vis the outside world? We see any number of communications that say, "Don't leave documents behind with your clients," "Don't let your clients show these documents to their traditional attorneys or accountants," and so forth. What's going on here? What's the practice here, and why is this happening?
A couple of things are happening there. One of the things -- which is discussed in some of those documents -- is there used to be confidentiality agreements that were given to the tax shelter buyers. One of the things that's going on is not wanting these strategies to leak out to another promoter.
The other thing is not wanting it to leak out to the IRS. As you see, the failure to register tax shelters and failure to keep a list of and give the IRS the list of transactions -- that's what's going on there. They did not want to give the facts, the detrimental facts, to the IRS, or even disclose that the transaction took place.
They're playing the audit lottery. They know if [the IRS] look[s] at the transaction, it's so weak technically, that the only way that you can sell this and get away with it is to put in procedures that minimize the chance that the IRS will detect it. It will not survive if it sees the light of day. No court would genuinely uphold one of the transactions at a more-likely-than-not level, if all facts were known.
So you conceal it?
You conceal it. There're a variety of mechanisms to conceal it -- delay giving those facts or advising the IRS. One of the big things that's come to play here is the statute of limitations. If the tax year runs and the statute of limitations runs, it may be too late. If you disclose after that, arguably, there's nothing the IRS can do about it. …
Do you have the sense of folks trying to stay one jump ahead of the IRS? There's a famous Jeff Stein e-mail, which carries the title "Simon Says," and there's this whole thing. They call these deals FLIP, and another one OPIS, and another one BLIPS. It turns out BLIPS is Son of OPIS, and OPIS is Son of FLIPS. What's going on? … The documents seem to suggest there's a progression.
Yes, there's a progression. The progression involves a few things. The amount of transactions out there is increasing the scrutiny, and it's time to shut it down, because--
Because the IRS may catch you?
Yes, it's getting too much exposure, and the IRS may catch you. Yes. Another thing that you see in FLIP in particular is that it had a serious technical glitch. Technically, it did not work, despite some of the other problems. …
You say technically it would not work. It sounds like you got a bad cylinder or something like that. That's not what you mean.
The way these things work is that you find a loophole. You have to build a transaction around it to get that loophole, and you have to say why somebody would've done that for non-tax reasons.
Well, in that particular transaction, they need a couple of things. They needed the taxpayer who wanted to offset his gain to be a co-shareholder in a corporation with a foreign party, and would throw the gain off of a transaction to the foreign party and inherit a large tax basis that would generate a loss.
What they had to convince the IRS of is that those two shareholders, the U.S. party and the foreign party, had a relationship that would cause that tax basis to shift, but not enough of a relationship that would cause the U.S. taxpayer to inherit the foreign taxpayer's tax.
The way they did that in FLIP was with warrants. What Jeff Stein's talking about in that "Simon Says" e-mail is that nobody in their right mind would buy that warrant under those circumstances. It doesn't make any business sense, and it sticks out like a sore thumb. …
What's interesting is the judgments. You said Jeff Stein's the number one guy. He's hot for marketing these tax transactions. But FLIP has been marketed -- 160-odd people, or something like that, have bought it, according to the IRS. Fifteen of them, or 20 of them, have sued KPMG. So here's a guy -- the number one guy -- saying, "The stuff we sold was garbage."
Right. The most troubling thing to me was not the ripping off of the IRS, or the Treasury. It was the misleading the clients, that's exactly right. When there was a problem after implementation, after a fee was collected -- particularly in the case of an audit client -- that the strategy had been sold, and a serious glitch or problem -- really, a fatal flaw in the tax shelter was discovered.
In my experience, that was never conveyed to the purchaser to let them know that they had that exposure. …
[They would] produce an opinion that said it was OK, that more likely than not it would be bought by the courts, when according to these e-mails they, themselves, knew that it wouldn't fly?
That's correct. It produced the opinion after they realized there was a critical flaw and, quote, "The train had left the station. It's too late. Get onboard. We have to produce this opinion and provide it to the client. There's no practical solution to do otherwise. It would be highly detrimental. We'd get sued and all kinds of ramifications."…
What's the thinking going on here? The IRS is slowly catching on to what's going on in the late 1990s, and gradually, it's issuing tax notices. Then, gradually, it's issuing regulations that say, "You've got to register these listed transactions. These are questionable, if not bogus, transactions. You've got to tell us about them." And KPMG's not doing that -- is it?
No, it's not. It did not comply with the regulations, and it knowingly did not comply with the regulations.
What happened in 1999 was the government realized that, "Look, you're not going to play the audit lottery. We're going to produce regs. We're going to enhance the existing regulations that will require that all facts are on the table. You have to tell us the transactions, and we know what happened. Then we'll debate, and we'll fight in court over what the proper tax treatment is."
As I said, given KPMG's feelings on what would happen when the light of day hit the tax shelter, they didn't want that to happen. So they depended upon those facts not being known by the IRS. They did not comply with the registration or the listing requirements. I think with respect to the registration, you can see that some of the analysis that took place -- it was a pure financial business decision…
The cost and the penalties associated with not registering paled in comparison to the revenues that would be generated by those tax shelters that had to be registered. If they were registered, KPMG decided they couldn't sell them. So they made a business decision not to register them.
So there was no deterrent. Financially, it was so lucrative to sell them, that even if they got caught, they weren't going to get hurt?
Yes. I think Sen. Levin in the hearing went into some of the penalties, and that's right. …
So in your experience, when you're sitting there inside KPMG, what was their thinking about whether or not to register the shelters as the IRS required?
Well, somewhat from an outsider's perspective -- I certainly wasn't privy to those conversations -- but based on the reading of some of the documents that were released by the permanent subcommittee, their thinking was very much like the thinking on every other matter. It was a practical decision based on the associated risks, and really disregarded the legal analysis that goes into making that decision.
With respect to the registration, as is shown in the documents, it's not a genuine objective analysis of whether the law really applies and it's required to be registered. It's a practical analysis of, "What will this do to our ability to sell the tax shelters, and how much can we make from selling them?" That's the analysis that took place.
"What's the [calculated] risk-reward?"
I don't know if that's accurate, but what's described in the documents ... the penalties are approximately 10 percent of the fees we could generate.
So make $300,000, pay $30,000 in penalties, even if you get caught; and if you don't get caught, zero.
No. If you can go to the bank and exchange a $10 bill for a $100 bill, I think you'd do that every day of the week. …
What's wrong with [the opinion letters]? …
The heart of the problem is really twofold. One, the underlying law that they're analyzing -- it's not an objective analysis. It's a disingenuous and weak technical argument.
The bigger problem is, yes, in almost all of the transactions, there needs to be a business purpose -- a non-tax purpose for why you would do that transaction -- that provides those tax benefits. KPMG has provided what the facts would be, and the business purpose would be to facilitate that tax benefit. It very often does not exist in reality. ...
What are you doing inside KPMG, back in 1999, 2000, 2001, 2002, about this kind of problem? What are saying about this to partners?
As I said, on the first transaction I was on and thereafter, I'm expressing that transaction involved one where the person who sold it in the field originally told me, "You don't need a business purpose for the transaction." When I convinced him that wasn't true, he gave me a list of purported business transactions, each of which had serious problems. Ultimately, the person who signed the opinion went with one of those business purposes, although he knew it was false.
So I am expressing problems with the procedures that are going on in writing the opinions, and it's falling on deaf ears.
Were you told at some point to keep your mouth shut?
Yes. When I was at National Tax, I was not told specifically to keep my mouth shut, and I was less vocal in my concerns. When I got to the Los Angeles office, I got more vocal and raised more serious concerns, and was specifically told to keep my mouth shut, and if I did not, there would be serious ramifications to my career.
And were there?
There were ultimately ramifications, I believe, both from that and then from a matter that was not directly related to the tax shelters that were sold by KPMG, but audit issues that involved tax shelters. …
Can a KPMG auditor be independent and objective in looking at the tax returns of a corporate or wealthy individual client, when KPMG has sold a tax shelter to that client?
Well, the answer is no. When they audit the financial statements of a publicly traded corporation, in that audit there's a tax provision. There are tax matters that give rise to financial statement benefit. KPMG uses its tax partners to perform the tax provision review.
If that tax partner who's doing the tax provision review was a tax shelter promoter, or certainly if he was the tax shelter promoter who sold the strategy to that audit client, how on earth is he going to be objective in the analysis? He can't be. He'd have to say the very thing that he sold to clients and made a substantial amount of income from was not legitimate, should not have been benefited on the financial statements, although the clients that he may have sold the shelters to were, in fact, benefited.
So the answer is no. In that circumstance, it's nearly impossible for KPMG to be objective.
You're talking about either a direct or an indirect conflict of interest.
It's a pretty direct conflict of interest, yes. …
Is there a tension [in the accounting industry] between being a [professional] and focusing on the bottom line?
There's absolutely a tension between being a professional and focusing on the bottom line. A professional should advocate for his client, and should advocate as strongly as he can to reach a position for his client. But there are certain thresholds that he should not cross over, and [he] certainly should be intellectually honest in doing that, and should put himself in place. "If we get to court on this matter, how will a court that's objective look at this?"
To do otherwise is to do your client a serious disservice. You're giving a client an expectation of a result that is not objective. As a client, I would not want such advice. I'd want to know the associated risk, and I would make the business decision on what to do. But I wouldn't want to be misled that I was in a better position than I really was. And that was going on. That was a byproduct of the sales culture.
So what happened to the ethics of the accounting industry?
I think, like many other industries, the ethics were put aside for the money. Ethics are nice, but if I can get rich and ethics are standing in the way, then I'm going to find some way to rationalize away any ethical constraints. …
Were there people around you and others who had a feeling, "We're getting into [areas] we ought not to be getting into. We've gone off the track. We've lost our way>"
Yes. There were people in the profession that expressed a real concern with the direction the firm was taking in this sales culture. As time went on, those became less and less, because anyone with half a brain quickly realized that it wasn't going to do them any good. They realized that it was too late to change that direction. They, for the most part, kept their mouths' shut. It was futile to raise such objections. Certainly at 1999 or 2000, it would've done no good to raise those kind[s] of objections.
Because the firm was making so much money?
Yes, the firm was making a ton of money doing it, and the people who were selling the shelters were lauded for doing so. They were rapidly rising to the top positions in the firm. You got a sense that if you raised concerns, you're going to have a big problem.
In particular, with one of the partners in Los Angeles, I had continually questioned certain shelters that were sold and asked them, don't they realize this is technically deficient? Don't they realize these implementation procedures are not legal?
He finally got to a point in 2001 where he said, "Mike, you just don't get it. They don't care. They don't care that it's illegal. They're going to keep doing this. It's driving the revenues, and they're not going to stop."
He turned out to be right, in my opinion. It was a futile effort. Had I known that, I probably should have left the firm shortly after coming.
KPMG has insisted publicly that it was not, in fact, selling and marketing tax products; it was selling investment strategies.
Yes, I think it said a couple things. It was selling investment strategies. It also said it's not a promoter. Well, you can be the judge from the hearings and the materials. In my opinion, that's just completely not credible.
I mean, the whole culture was driven by sales, and the transactions were not investment strategies. The impetus for the transaction was a tax loophole, if you will, a tax benefit that they were seeking. It was not the purported possible profits from the transaction -- the business profits. So those statements, in my opinion, are not credible. …
I need to go back to this question of the climate, the world, the mindset inside KPMG, which we discussed at the beginning. … You've blown the whistle, and you've stepped away from it. When you look back and say, "My God. What were we doing? What were all my colleagues doing?" How do you explain it to those of us who aren't in there?
I think what explains it is some of the same things you've seen with regard to the non-tax things, like the Enrons. You have a number of parties, and Enron and these accounting scandals. You have facilitators, you have bankers, you have lawyers, you have accountants. They're all making money, and they get together. Each one views their job as a very specific task. If they have reservations with someone else's task, it's not their job, and they don't raise it.
So I think from the people at KPMG are these very smart, and in many cases -- these aren't evil people. These are people who are able to rationalize what they're doing and somehow find a way to view it as OK.
So is it a game to get around the law?
Yes, that's one of the biggest issues. It was viewed as a game. It's all a big game, and if we can twist the law -- "Look at this cute thing I can do with the law." You see that that's reflected in some of the names of some of these strategies, viewing this as kind of a cutsie "Look what I can do with the tax law." …
Several people have said to us that the lawyers and the accountants in particular got jealous of the kind of money the investment bankers were making in the late 1990s, and they wanted a piece of the action. Was there a kind of a competitive envy that began to infect the ethics of the accounting profession?
I think that's right. I was with Ernst & Young at the time. … But a top partner in that firm reflected just that to a number of people, that this is an attempt, yes. "The investment bankers get paid on this on this non-hourly basis. They get a percentage of their deals. How do we do that? How do we get a cut on our deals?" Because the amount of revenues and the revenue goals we want to reach are not obtainable on an hourly basis with hourly billing.
The only way we'll be able to do it is to develop these, quote, "value-added" services -- getting what really, in most cases, amounts to a contingency fee, in terms of a percentage of the tax savings.
You see in the documents here that KPMG fees are set up as a percentage of what the tax benefit is going to be to the client. … When you look in the documents, it's clear. There're even numbers in some of these memos. Seven percent is used in one, 1 percent are used in others. You said people were working on commission. They were getting a percentage. Isn't that right?
What amounts to a commission, yes. Both the amount that was paid to KPMG from the tax shelter purchasers and the determination of the salaries and the bonuses of the promoters that worked for KPMG -- yes, it was determined based on the amount of fees that were generated. The amount of compensation was determined on the amount of fees. The fees that KPMG got was determined specifically and exclusively on the amount of tax savings that they generated for the tax shelter purchaser. …
What do you make of the argument that KPMG says they weren't selling tax products, when they were charging people on the basis of how much tax savings they were getting?
It's disingenuous, and not credible.
Do you buy it in any way? Is there something here we're missing?
I don't think so. I don't buy it at all. It's an attempt to get out of the registration -- the harsh results of the registration rules and failing to register tax shelters.
Was there any sufficient deterrent? Did you ever detect that KPMG felt that there was any sufficient deterrent against their doing these kinds of tax shelters?
No, and not just with the tax shelters. I observed several actions which the firm would take that were pure practical cost-benefit, risk-reward analysis: "How much is in it for us if we do it? How much do we have to lose?"
You know, there's no deterrent. As Sen. Levin went through in the hearing, the amount of penalties are a joke. They don't care if they're breaking the law. "What's the penalty associated with breaking the law, and how much can we make from doing it?"
Mike, you blew the whistle inside KPMG. Why?
Well, in my particular case … [I] was asked and demanded to participate directly in what I believed to be an illegal act. I had no choice. I had to blow the whistle, and the consequences that result were expected.
Was it worth it?
In hindsight, yes, I have to say it was worth it. I mean, what was the choice? To commit the act and lose sleep over potentially going to jail, or in that case, really causing harm to the shareholders of this particular company.
How were you penalized?
My career at KPMG and, likely, in the industry is over. In October 2002, I was placed on leave of absence. The firm couldn't figure out what to do with me. I've had no contact, have not been allowed in the office since. My career has, at the very best, been put on hold, and as I said, in the industry, is likely over.
Who do we hold accountable?
I think you definitely hold the accounting firms -- in this case, KPMG -- accountable for going out and peddling things that they knew had serious problems. In many cases, you might also hold the tax shelter purchaser themselves accountable.
There's a variety of knowledge amongst those purchasers. Some are well informed. They know exactly what they're getting; they're more sophisticated. Some don't. They rely upon the promoter to advise them of exposure, and they really believe that those shelters will prevail and objectively are valid.
Can we count on the accounting industry to clean up its own act?
I don't think so. From my observation, they haven't changed from the cost-benefit approach, and only to the extent that they thought it wasn't good for their business to continue doing it would this really put an end to the tax shelters. So without that kind of a deterrent, no, I don't think you can count on them to clean up their own act.
What needs to be done?
A number of things need to be done. I think the most important issue is, from the IRS perspective, from Treasury's perspective, increasing the penalties and increasing the mechanisms to provide adequate disclosure -- to prevent people from playing the audit lottery, to prevent them from counting on their transaction, or the real facts of their transaction -- from being discovered to get the result they want. That definitely needs to happen.
There need to be serious penalties on the promoters that go out and entice people to do those kinds of transactions. It's a supply-side, demand-side situation. I think the supply side, the tax promoters, is the real problem. If you cut that off, there are very few of the shelter buyers who would have the ability to consummate those transactions on their own.
How do you stop the attempts? How do you stop the promoters? As soon as you declare one shelter, or two shelters, or 10 or 20 shelters illegal or improper, they go create new ones.
Yes. One thing that's clear is what will not work. You do not address it on a shelter-by-shelter basis. In order to shut down existing shelters, I think the government's efforts to identify them and educate taxpayers about them serves a valid function to shut down existing shelters. But you have to educate them about shelters that are similar and ones that will likely come right in their footsteps.
You have to address the behavioral misconduct, not the specific shelters. The thing that facilitates these shelters -- you'll always find a loophole in the law. These are very clever, very creative people. You cannot fill all the gaps in the tax code.
What you need to fix is the incentives and the disincentives for a person knowingly manipulating those provisions by providing false facts. That behavior needs to be regulated.
How do you do that? How do you regulate behavior like that? Put a fine on it? Have people got to go to jail? Have responsible accounting officials got to go to jail? Have criminal penalties got to be invoked?
There's a varying degree of misconduct. In some cases, I think, yes, the answer is people do have to go to jail. There are some people -- and this was discussed pretty widely with partners at KPMG -- that there are people, in their opinion and in mine, that jail time is the only deterrent. …
[KPMG] said they shut down the units that were mostly engaged in their shelter promotion or creation: Stratecon, Personal Financial Planning, Tax Innovation Center. Is that significant?
No, that's not significant. That's really modus operandi. They've done that in the past, as well. Many of those same units had been renamed or reorganized several times in the past.
A better question to ask would be, the activities that those groups have been engaged in, the problematic activities that were referred to in the hearing -- are they no longer doing those activities? Who cares what the group is called?
You can change the label on an organizational chart without changing what you're doing.
Yes, that's a fairly common practice for KPMG. It goes right along those lines of trying to put in place a facade or put forward something to make people believe something that does not exist.
Knowing KPMG from the inside, what would it take to persuade you that KPMG has really changed on the issue of tax shelters?
It would be a pretty thorough examination. First of all, it would be owning up to some of the things they've done. Unlike many of the other firms that I think genuinely have taken steps to turn the corner and have recognized -- you saw representatives from PricewaterhouseCoopers in particular came forward and said, "Look, we recognize--" I think his words were, "We never should have been in this business. We recognize we made a mistake." …
The change [at KPMG] appears to be a facade. The change appears to be, "Look at all the structural changes, group changes that we've made." But has there been real change? …
Are you saying you don't trust KPMG on its claim of reforming, because they haven't adequately confessed what they did wrong?
I think that's right. I do stay in contact with several of my colleagues from the firm, and they've conveyed exactly the same thing. If [there is] any glimmer of hope that there may be some real change, it's immediately met with their cynicism and their response that, "Mike, not a thing has changed here." So it's not my opinion alone. Several of the people I keep in touch with are equally as cynical about that "change." …
Talk to me a little bit about the sales training you got. You said everybody had to go through sales training. What was that all about?
The sales training, on a general basis for people who were not in any specific tax shelter groups, was just they've been referred to in the press and some of the documents as -- one was "Selling with Confidence," for instance. They were about how to position KPMG, how to position these tax shelters to your clients and how to sell them and how to address objections or concerns and things like that.
I think part of Jeff Stein's objective was to change the mindframe of tax professionals from finding problems with transactions and trying to address them objectively, to going out and proactively selling tax shelters and trying to close sales, trying to convince people that the tax strategies were worth buying. I think there was a view amongst the leadership that, kind of inherently, tax professionals lacked those kinds of abilities.
So the sales course was either totally or significantly devoted to selling shelters. It wasn't just sales, in general.
Yes, shelters of a varying degree of aggressiveness. They weren't all what would be referred to as "gain mitigation strategies," to completely or almost totally offset your tax obligation from a transaction. Some of them were deferral strategies or deferring the recognition of your income. They weren't as aggressive.
But we're not talking about selling auditing services.
No. We're talking about selling tax services and, principally, tax strategies -- tax shelters. …
So what is the moment [that you knew you would have to blow the whistle]? … What was it that happened? What one or two moments were just particularly acute for you?
I think the defining moment was the activities got more and more aggressive. The elements with a particular promoter in the Los Angeles office -- the elements of hiding the facts were really just blatant. That's when it really finally hit home, "Wow, some of the stuff that these guys are doing may very well be criminal." That was kind of a whole another kettle of fish.
I discussed that with an associate -- one that worked for this tax shelter promoter, who summarily went and told him and raised all kinds of issues. But at that point, I really realized, "This is not going to end well for this firm."
They had reached a point where they really thought, "Nobody can do anything to us," and for a variety of reasons. "The government's not smart enough. The laws don't penalize us enough." I realized that this was a very, very ugly situation, and it devolved pretty rapidly from there.
And you went home?
When I went home, I went home thinking, "How did I get here?" You get out of law school. It wasn't that long ago -- 1995. This was happening about six years later, and thinking to myself, one, "How did the industry get here? This was an industry that survived in the past, prior generations, on its ethics and integrity. How did the industry get here, and how did I get here? This was just not what I bargained for when I got out of law school." [I] agonized.
Then, finally, the decision was made for me in this audit matter that resulted in my lawsuit. I realized just that they put me in a position where I could no longer just stay silent. I was forced to make a decision and not participate, and that had dire consequences to my career. …
What's happened to you as a whistleblower? Has KPMG come after you?
Well, yes. Without getting into any level of detail, KPMG has come after me. As I said, my career in the industry is over. …
KPMG says you don't know what you're talking about; you didn't have anything to do with the tax shelter business. What's your response?
They made a statement after my testimony before the Senate Finance Committee, and they said a number of things which were just appalling. They attempted to very carefully craft a statement about who I am and what I did. They mischaracterized the statement that I made to put it into context.
Although I wasn't directly involved in the marketing and the tax shelters, I was very often given the opinion letters and asked by the tax partners and audit partners -- who those shelters were being promoted by -- to take a look at the strategies. So I got a close look at many of the strategies, and I was surrounded by the people who were directly involved in the shelters. That's the basis of my information.
You don't have to be a bank robber to understand and observe a bank robbery. …
Editor's Note: KPMG declined FRONTLINE's request for an interview. Here is a press release the firm released in response to Mike Hamersley's testimony before the Senate Finance Committee.