S. Hrg. 108–473

U.S. TAX SHELTER INDUSTRY: THE ROLE OF

ACCOUNTANTS, LAWYERS, AND FINANCIAL

PROFESSIONALS

HEARINGS

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

OF THE

COMMITTEE ON 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

NOVEMBER 18 AND 20, 2003

VOLUME 1 OF 4

Printed for the use of the Committee on Governmental Affairs

(

U.S. TAX SHELTER INDUSTRY: THE ROLE OF ACCOUNTANTS, 

LAWYERS, AND FINANCIAL PROFESSIONALS 

U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

91–043 PDF 2004

S. Hrg. 108–473

U.S. TAX SHELTER INDUSTRY: THE ROLE OF

ACCOUNTANTS, LAWYERS, AND FINANCIAL

PROFESSIONALS

HEARINGS

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

OF THE

COMMITTEE ON 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

NOVEMBER 18 AND 20, 2003

VOLUME 1 OF 4

Printed for the use of the Committee on Governmental Affairs

(

(II)

COMMITTEE ON GOVERNMENTAL AFFAIRS 

SUSAN M. COLLINS, Maine, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

NORM COLEMAN, Minnesota 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

PETER G. FITZGERALD, Illinois 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

JOSEPH I. LIEBERMAN, Connecticut 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

RICHARD J. DURBIN, Illinois 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

MICHAEL D. BOPP, Staff Director and Chief Counsel 

JOYCE A. RECHTSCHAFFEN, Minority Staff Director and Counsel 

AMY B. NEWHOUSE, Chief Clerk

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

NORM COLEMAN, Minnesota, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

PETER G. FITZGERALD, Illinois 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

RICHARD J. DURBIN, Illinois 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

RAYMOND V. SHEPHERD, III, Staff Director and Chief Counsel 

ELISE J. BEAN, Minority Staff Director and Chief Counsel 

ROBERT L. ROACH, Minority Counsel and Chief Investigator 

MARY D. ROBERTSON, Chief Clerk 

(III)

C O N T E N T S 

Opening statements: Page 

Senator Coleman .............................................................................................. 1, 69

Senator Levin .................................................................................................... 4, 72

Senator Lautenberg .......................................................................................... 9

WITNESSES 

TUESDAY, NOVEMBER 18, 2003

Debra S. Petersen, Tax Counsel IV, California Franchise Tax Board, Rancho 

Cordova, California .............................................................................................. 11

Mark T. Watson, former Partner, Washington National Tax, KPMG LLP, 

Washington, DC ................................................................................................... 13

Calvin H. Johnson, Andrews & Kurth Centennial Professor, The University 

of Texas at Austin School of Law, Austin, Texas .............................................. 14

Philip Wiesner, Partner in Charge, Washington National Tax, Client Services, 

KPMG LLP, Washington, DC ............................................................................. 32

Jeffrey Eischeid, Partner, Personal Financial Planning, KPMG LLP, Atlanta, 

Georgia .................................................................................................................. 32

Richard Lawrence DeLap, Retired National Partner in Charge, Department 

of Professional Practice-Tax, KPMG LLP, Mountain View, California ........... 34

Larry Manth, former West Area Partner in Charge, Stratecon, KPMG LLP, 

Los Angeles, California ........................................................................................ 34

Richard J. Berry, Senior Tax Partner, Pricewaterhouse Coopers, New York, 

New York .............................................................................................................. 54

Mark A. Weinberger, Vice Chair, Tax Services, Ernst & Young LLP, Washington, DC ............................................................................................................. 55

Richard H. Smith, Jr., Vice Chair, Tax Services, KPMG LLP, New York, 

New York .............................................................................................................. 57

THURSDAY, NOVEMBER 20, 2003

Raymond J. Ruble, former Partner, Sidley Austin Brown and Wood, LLP, 

New York, New York, represented by Jack Hoffinger ...................................... 76

Thomas R. Smith, Jr., Partner, Sidley Austin Brown and Wood, New York, 

New York .............................................................................................................. 77

N. Jerold Cohen, Partner, Sutherland Asbill and Brennan, LLP, Atlanta, 

Georgia, accompanied by J.D. Fleming .............................................................. 79

William Boyle, former Vice President, Structured Finance Group, Deutsche 

Bank AG, New York, New York ......................................................................... 95

Domenick DeGiorgio, former Vice President, Structured Finance, HVB America, Inc., New York, New York, accompanied by Brian Skarlatos ................... 97

John Larson, Managing Director, Presidio Advisory Services, San Francisco, 

California .............................................................................................................. 114

Jeffrey Greenstein, Chief Executive Officer, Quellos Group, LLC, formerly 

known as Quadra Advisors, LLC, Seattle, Washington .................................... 115

Mark Everson, Commissioner, Internal Revenue Service, Washington, DC ...... 128

William J. McDonough, Chairman, Public Company Accounting Oversight 

Board, Washington, DC ....................................................................................... 130

Richard Spillenkothen, Director, Division of Banking Supervision and Regulation, The Federal Reserve, Washington, DC ...................................................... 131

Page

IV

ALPHABETICAL LIST OF WITNESSES

Berry, Richard J.: 

Testimony .......................................................................................................... 54

Prepared statement .......................................................................................... 303

Boyle, William: 

Testimony .......................................................................................................... 95

Prepared statement with an attachment ....................................................... 317

Cohen, N. Jerold: 

Testimony .......................................................................................................... 79

Letter dated November 18, 2003, submitted with answers to questions ..... 315

DeGiorgio, Domenick: 

Testimony .......................................................................................................... 97

Prepared statement .......................................................................................... 326

DeLap, Richard Lawrence: 

Testimony .......................................................................................................... 34

Eischeid, Jeffrey: 

Testimony .......................................................................................................... 32

Prepared statement .......................................................................................... 298

Everson, Mark: 

Testimony .......................................................................................................... 128

Prepared statement with an attached chart .................................................. 338

Greenstein, Jeffrey: 

Testimony .......................................................................................................... 115

Prepared statement .......................................................................................... 334

Johnson, Calvin H.: 

Testimony .......................................................................................................... 14

Prepared statement .......................................................................................... 286

Manth, Larry: 

Testimony .......................................................................................................... 34

Larson, John: 

Testimony .......................................................................................................... 114

McDonough, William J.: 

Testimony .......................................................................................................... 130

Prepared statement .......................................................................................... 349

Petersen, Debra S.: 

Testimony .......................................................................................................... 11

Prepared statement .......................................................................................... 275

Ruble, Raymond J.: 

Testimony .......................................................................................................... 76

Smith, Richard H., Jr.: 

Testimony .......................................................................................................... 57

Smith, Thomas R., Jr.: 

Testimony .......................................................................................................... 77

Prepared statement .......................................................................................... 312

Spillenkotchen, Richard: 

Testimony .......................................................................................................... 131

Prepared statement .......................................................................................... 361

Watson, Mark T.: 

Testimony .......................................................................................................... 13

Prepared statement .......................................................................................... 285

Weinberger, Mark A.: 

Testimony .......................................................................................................... 55

Prepared statement .......................................................................................... 309

Wiesner, Philip: 

Testimony .......................................................................................................... 32

Page

V

APPENDIX 

Minority Staff Report of the Permanent Subcommittee on Investigations entitled, ‘‘U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and 

Financial Professionals, Four KPMG Case Studies: FLIP, OPIS, BLIPS, 

and SC2,’’ released in conjunction with the Permanent Subcommittee on 

Investigations’ hearings on November 18 and 20, 2003, S. Prt. 108–34 ......... 145

I. INTRODUCTION ............................................................................................... 145

II. FINDINGS ......................................................................................................... 147

III. EXECUTIVE SUMMARY .............................................................................. 149

A. Developing New Tax Products ................................................................ 151

B. Mass Marketing Tax Products ................................................................ 152

C. Implementing Tax Products .................................................................... 153

D. Avoiding Detection ................................................................................... 157

E. Disregarding Professional Ethics ............................................................ 159

IV. RECOMMENDATIONS ................................................................................. 160

V. OVERVIEW OF U.S. TAX SHELTER INDUSTRY ..................................... 162

A. Summary of Current Law on Tax Shelters ............................................ 162

B. U.S. Tax Shelter Industry and Professional Organizations ................. 164

VI. FOUR KPMG CASE HISTORIES ................................................................ 166

A. KPMG In General .................................................................................... 166

B. KPMG’s Tax Shelter Activities ............................................................... 168

(1) Developing New Tax Products ............................................................ 172

(2) Mass Marketing Tax Products ............................................................ 188

(3) Implementing Tax Products ................................................................ 206

a. KPMG’s Implementation Role ........................................................ 206

b. Role of Third Parties in Implementing KPMG Tax Products ...... 215

(4) Avoiding Detection ............................................................................... 235

(5) Disregarding Professional Ethics ....................................................... 245

APPENDIX A 

CASE STUDY OF BOND LINKED ISSUE PREMIUM STRUCTURE 

(BLIPS) .......................................................................................................... 255

APPENDIX B 

CASE STUDY OF S-CORPORATION CHARITABLE CONTRIBUTION 

STRATEGY (SC2) ......................................................................................... 266

APPENDIX C 

OTHER KPMG INVESTIGATIONS OR ENFORCEMENT ACTIONS ....... 270

Page

VI

EXHIBIT LIST 

Volume 1

1. a. BLIPS: Bond Linked Issue Premium Structure, PowerPoint presentation with eight slides prepared by the Permanent Subcommittee 

on Investigations ...................................................................................... 371

b. SC2, PowerPoint presentation with five slides prepared by the Permanent Subcommittee on Investigations .............................................. 379

c. Mass Marketing of Tax Shelters, chart prepared by the Permanent 

Subcommittee on Investigations ............................................................. 384

d. Knowledge of Counter Parties, chart prepared by the Permanent 

Subcommittee on Investigations ............................................................ 385

2. KPMG Memorandum, February 1998, re: Summary and observations 

of OPIS ............................................................................................................ 386

3. KPMG Memorandum, May 1998, re: OPIS Tax Shelter Registration ........ 393

4. Gibson, Dunn & Crutcher LLP Memorandum to KPMG, March 2000, 

re: BLIPS Tax Opinion ................................................................................... 400

5. KPMG email, April 1999, re: BLIPS (‘‘The original intent of the parties 

was to participate in all three investment stages of the Investment Program.’’ It seems to me that this is a critical element of the entire analysis 

and should not be blithely assumed as a ‘‘fact’’. If it is true, I think 

it should be one of the investor’s representations. However, I would 

caution that if there were, say, 50 separate investors and all 50 bailed 

out of at the completion of Stage I, such a representation would not 

seem credible.) ................................................................................................. 408

6. KPMG email, February 2000, re: Product champions needed for S Corp 

strategy (I want to personally thank everyone for their effort during 

the approval process of this strategy. It was completed very quickly 

and everyone demonstrated true teamwork. Thank you! Now lets SELL, 

SELL, SELL!!) ................................................................................................ 412

7. KPMG email, February 2000, re: BLIPS/OPIS (. . . the sooner we get 

them out the door the better since the law—especially the primary profit 

motive test—is evolving daily and not in a taxpayer friendly manner. 

* * * As I understand the facts, all 66 closed out by year-end and 

triggered the tax loss.) .................................................................................... 415

8. KPMG email, February 2001, re: SC2 Solution—New Development 

(Quick Snapshot—We are now offering a modified SC2 solution. S Corp 

shareholders can use the structure of direct significant gift to 501(c)(3) 

tax exempts of their choice. Net tax benefit is less than original SC2 

. . . shareholder ‘‘feel good’’ factor is higher. We need targets and ICV’s. 

* * * 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.) .............................................................................. 423

9. KPMG email, June 2000, re: Revised SC2 Script, Rosenthal/Stein approval of SC2 calling script ............................................................................ 426

10. KPMG emails, September 1998, January 1999, and October 2000 re: 

Grantor Trust Issue and KPMG Memorandum of Telephone Call, May 

2000, re: Grantor Trust Issue (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.) .... 428

11. KPMG email, March 1998, re: Simon Says (. . . and yet in truth the 

option 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.) ...................................................................................................... 439

12. Email, May 1999, re: Who is the Borrower in the BLIPS transaction 

(Based on your analysis below, do you conclude that the tax results 

sought by the Investor are NOT ‘‘more likely than not’’ to be realized? 

* * * Yes.) ....................................................................................................... 448

Page

VII

13. Email, August 1999, re: BLIPS (However, before engagement letters are 

signed and revenue is collected, I feel it is important to again note 

that I and several other WNT [Washington National Tax] 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.) ........................................................................................................... 450

14. KPMG email, May 1998, re: OPIS Tax Shelter Registration (If for some 

reason the IRS decides to ‘‘get tough’’ with someone vis-a-vis the old 

rules, I suspect it could easily pick on ANY of the Big 6, or for that 

matter any number of law firms/promoters—I don’t think we want to 

create a competitive DISADVANTAGE, nor do we want to lead with 

our chin.) ......................................................................................................... 451

15. KPMG email, December 1998, re: OPIS (After December 31, 1998, there 

will be no marketing of OPIS in any circumstances.) .................................. 452

16. KPMG email, July 1999, re: National Accounts Database (VALUE 

PROPOSITION: . . . The all-in cost of the program, assuming a complete loss of investment principal, is 7% of the targeted tax loss (pretax). 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.) ............................................................................ 453

17. KPMG email, August 1999, re: BLIPs (Depicting the approval of BLIPS 

and views of some at KPMG about the strategy.) ....................................... 455

18. KPMG email, September 1999, re: BLIPS 2000 (A number of people 

are looking at doing BLIPS transactions to generate Y2K losses. We 

currently have bank capacity to have $1 billion of loans outstanding 

at 12/31/99. This translates into approximately $400 million of premium. This tranche will be implemented on a first-come, first-served 

basis until we fill capacity. Get your signed engagement letters in!!) ......... 459

19. KPMG email, February 2000, re: Hot Tax Products (5 Month Mission) 

(Thanks for help in this critically important matter. As Jeff [Stein] 

said, ‘‘We are dealing with ruthless execution—hand to hand combat—

blocking and tackling.’’ Whatever the mixed metaphor, let’s just do it.) ..... 460

20. KPMG email, April 2000, re: SC2 (There have been several successes—

the West and South Florida with many ICV’s in other parts of the 

country. We are behind. This is THE STRATEGY that they expect significant value added fees by June 30. The heat is on. . . .) .............................. 463

21. KPMG Document, SC2—Meeting Agenda June 19th, 2000 ......................... 464

22. KPMG email, July 2000, re: Attaching memorandum to Tax Partners 

and Tax Management Group. re: Selling with Confidence: Skills for 

Successful Selling—‘‘Positioning.’’ ................................................................. 486

23. KPMG email, August 2000, re: Solution Activity Reports—SC2 (Our 

team of telemarketers is particularly helpful in a number of respects: 

—to further qualify prospects; —to set up phone appointments for you 

and your deployment team.) ........................................................................... 488

24. KPMG email, November 2000, re: SW SC2 Channel Conflict (Attached 

is a list of SC2 targets in the Southwest that we are including in 

an upcoming telemarketing program.) .......................................................... 490

25. KPMG email, December 2000, re: STRATECON WEST—KICK OFF 

PLAN FOR ’01 (. . . we must aggressively pursue these high-end strategies.) ................................................................................................................. 492

26. KPMG email, March 2001, re: Friday’s Stratecon Call (Due to the significant push for year-end revenue, all West Regional Federal tax partners 

have been invited to join us on this call and we will discuss our ‘‘Quick 

Hit’’ strategies and targeting criteria.) .......................................................... 494

27. KPMG email, April 2001, re: Friday’s Stratecon Call (The [tax] strategies 

have a quick revenue hit for us, . . .) ............................................................ 495

Page

VIII

28. KPMG email, May 1999, re: Marketing BLIPS (One does not need to 

understand how the program is structured to determine whether someone 

has sufficient gain and has the tax risk appetite to do an OPIS/BLIPS 

type strategy.) .................................................................................................. 496

29. KPMG email, September 1999, re: BLIPS—managing deal flow (As you 

know, we have until 10/15 at the latest to close loans and 10/22 to 

activate the FX trading etc. (the 60 day countdown).) ................................. 499

30. KPMG email, October 1999, re: BLIPS (18 OPIS ‘‘slots’’ were reserved 

for the intended BLIPS participants noted in the third paragraph 

below.) .............................................................................................................. 500

31. KPMG email, November 1999, re: BLIPS (It occurs to me that it would 

be useful to know something about the investment performance as we 

call these clients to discuss their go forward strategy. . . . * * * As 

you may be aware, the 60-day anniversary of your client’s participation 

in the Strategic Investment Fund is November 22nd. As a reminder 

for you and your client, we have summarized certain procedures that 

may be of interest.) .......................................................................................... 503

32. Generating Capital Losses, A Presentation for ———, KPMG Peat 

Marwick LLP, ———, 1996 ........................................................................... 505

33. KPMG Memorandum, June 1998, re: June 11 OPIS Conference Call 

(Use of Nondisclosure Agreements and Outside Advisors) ........................... 517

34. Email, July 1999, re: BLIPS—Economic Substance Issue (Gentlemen, 

we have completed our review of the BLIPS loan documents. In general, 

these documents indicate that the loan proceeds will be invested in very 

safe investments (e.g., money market instruments). Thus it seems very 

unlikely that the rate of return on the investments purchased with the 

loan proceeds will equal or exceed the interest charged on the loan 

and the fees incurred by the borrower to secure the loan. * * * Before 

any fees are considered, the client would have to generate a 240% annual 

rate of return on the $2.5 million foreign currencies investment in order 

to break even. If fees are considered, the necessary rate of return to 

break even will be even greater.) .................................................................... 521

35. KPMG email, May 2000, re: Brown & Wood BLIPS Opinion letters 

(As we discussed, the B&W opinion letters touch all the necessary bases. 

The fact and representation sections are almost identical to the ones 

in our Opinion and many analysis sections are exact copies of our Opinion. Please let me know if you want further details about the ‘‘noncritical’’ typos.) ................................................................................................ 522

36. KPMG email, July 1999, re: brown&wood (If you have a KPMG opinion, 

you should also have a B&W opinion. We do ours and they use it 

as a factual template for their opinion, usually within 48 hours.) .............. 524

37. Internal Revenue Bulletin No. 2000–36, September 5, 2000, Notice 2000–

44, Tax avoidance using artificially high basis—describing a BLIPStype transaction .............................................................................................. 525

38. KPMG Document, PFP Practice Reorganization, Innovative Strategies 

Business Plan—DRAFT (May 18, 2001) ....................................................... 528

39. KPMG email, May 1999, re: BLIPS Update (Larry [DeLap], I don’t 

like this product and would prefer not to be associated with it.) ................ 532

40. KPMG email, December 2000, re: Weekly Tax Solutions Call (Larry 

[DeLap]—Are you suggesting that we stop marketing the solution, or 

that you just don’t want a public discussion of the solution in light 

of the IRS focus?) ............................................................................................ 533

41. KPMG’s Personal Financial Planning Presentation, BLIPS AND 

TRACT, Carol Warley, June 1999 (BLIPS Benefit: —Avoid All Of The 

Capital Gains And Ordinary Income Tax; —Net Benefit To Client —Effective Tax Rate Less After Tax Cost of Transaction of Approximately 

5%) ................................................................................................................... 536

42. KPMG email, April 1999, re: BLIPS (The underlying tax planning is 

such that the investor is likely to bail out after Stage 1; i.e., after 

about 60 days.) ................................................................................................ 543

Page

IX

43. KPMG email, March 2000, re: S-corp Product (No, we don’t disclose 

all risks in all engagement letters. * * * . . . I definately (sic) agree 

on disclosing the risks upfront and would prefer to have the separate 

memo that states the risks involved. . . . is there a way to make the 

risk memo be covered under 7525?) ............................................................... 545

44. Sutherland Asbill & Brennan LLP correspondence, July 2002, re: Representations of BLIPS client .......................................................................... 555

45. KPMG correspondence to Sutherland, Asbill & Brennan LLP, September 

2002, re: Contract with KPMG for tax assessment for BLIPS client ......... 557

46. KPMG email, November 2002, re: Script (Attached is a list of law 

firms that are handling FLIP/OPIS cases. * * * Attached is the script 

. . . waiver language and list of attorneys to follow.) .................................. 560

47. KPMG email, March 2002, re: SC2 (Given the current state of affairs 

relative to the IRS and accounting firms, I think we should not be 

discussing SC2 on the Monday night call at this time.) .............................. 563

48. KPMG email, August 1999, re: BLIPS Engagement Letter (Attached 

is the engagement letter approved by Larry [DeLap].) ................................. 566

49. KPMG email, March 2000, re: S-corp Product (1. This appears to be 

little more than a old give stock to charity and then redeem it play 

. . . * * * Our preference is that the client donate stock to a local 

401(a), . . .) ..................................................................................................... 574

50. KPMG email, April 2000, re: S-Corporation Charitable Contribution 

Strategy (SC2) (This is a relatively high risk strategy.) ............................... 584

51. KPMG email, August 2001, re: New Solutions-WNT [Washington National Tax] (Beginning in December . . . The shareholders will most 

likely want access to the cash (especially if we could get it to them 

tax-free).) .......................................................................................................... 585

52. KPMG email, October 2001, re: SC2 Client (His ownership is so minute, 

he is concerned about it being reduced any further by the charitable 

contribution. We know that this reduction is only temporary, . . .) ........... 587

53. KPMG Document, Tax Innovation Center, Product Idea Submission 

Form and KPMG Tax Solution Alert, April 24, 2000, S-Corporation 

Charitable Contribution Strategy .................................................................. 589

54. KPMG document, undated, Draft PDC Talk Points 6/19, S-Corporation 

Charitable Contribution Strategy (Cold call script.) .................................... 595

55. KPMG email, March 2001, re: Florida S corporation search (Request 

to utilize database on tax return information to identify potential SC2 

clients.) ............................................................................................................ 597

56. KPMG email, March 2001, re: South Florida SC2 Year End Push ........... 599

57. KPMG email, March 2001, re: SC2—Client Base Expansion ..................... 601

58. KPMG email, December 2001, re: SC2 (. . . working on a back-end 

solution to be approved by WNT [Washington National Tax] that will 

provide S-corp shareholders additional basis in their stock which will 

allow for the cash built-up inside of the S-corporation to be distributed 

tax-free to the shareholders.) .......................................................................... 602

59. KPMG email, January 2002, re: SC2 (Shelly Nance is in Fort Wayne, 

which is ‘‘cold call central’’. How can she (or he) be involved in sending 

out messages about SC2 if it is not being mass marketed.) ......................... 604

60. Permanent Subcommittee on Investigations correspondence to KPMG, 

LLP, November 2003, re: November hearing testimony ............................. 609 

61. KPMG Presentation excerpts: Tax Innovation Center Solution and Idea 

Development—Year-End Results, May 30, 2001; and Goal: Deposit 150 

New Ideas in Tax Service Idea Bank ............................................................ 612

62. KPMG Presentation excerpts: Innovative Tax Solutions, July 19, 2001; 

Tax Practice Update; and Tax Practice Growth Gross Revenue .................. 614

63. KPMG Presentation, S-Corporation Charitable Contribution Strategy 

(SC2 Update), June 18, 2001, showing SC2 Revenues ................................ 617

Page

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64. KPMG email, May 1999, re: BLIPS—More Likely Than Not? (. . . while 

I am comfortable that WNT [Washington National Tax] 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 wrt (sic) 

this product . . .) ............................................................................................ 621

65. KPMG email, May 1999, re: BLIPS (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. * * * 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 review as falling squarely within the tax shelter 

orbit.) ............................................................................................................... 623

66. KPMG email, August 1999, re: BLIPS involvement in the NE—BDMs 

(KPMG’s fee is 1.25% (125 basis points) of the gain to be mitigated. 

This fee is included as part of the 7% investment in strategy.) ................... 628

67. Deutsche Bank email, July 1999, re: Risk and Resources Committee 

Paper (BLIPS Summary—The 7.7% will cover market risks, transaction 

costs, and DBSI fees.) ..................................................................................... 632

68. Email, September 1999, re: West (Larry [DeLap], just to clarify, even 

if we have five or more investors in a single BLIPS transaction, you 

don’t think we need to register the transaction as a tax shelter. Is this 

correct? * * * No, that is not correct, Mark Ely has concluded there 

is a reasonable basis not to register.) ............................................................ 641

69. Deutsche Bank/Presidio Advisors, LLC Memorandum, April 1999, re:

BLIPS friction costs (On day 60, Investor exits partnership and unwinds 

all trades in partnership.) .............................................................................. 644

70. Deutsche Bank New Product Committee Overview Memo: BLIPS Transaction (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.) ................................................................ 646

71. First Union (Wachovia) Capital Management Group Enhanced Investment Strategy Release, February 2, 1999 ...................................................... 651

72. KPMG Foreign Leveraged Investment Program, Issue and Hazard Summary (Taxpayer not sufficiently ‘‘at risk’’ under section 465) (preliminary 

and final versions) .......................................................................................... 652

73. KPMG email, February 1999, re: BLIPS (. . . status of the BLIPS as 

an OPIS replacement strategy. . . . I would think we can reasonably 

anticipate ‘‘approval’’ in another month or so. * * * Given the marketplace potential of BLIPS, I think a month is far too long— . . .) .............. 654

74. Email, February 1999, re: BLIPS Progress Report (I don’t like this pressure . . .) ......................................................................................................... 655

75. KPMG MEETING SUMMARY, February 1999, re: Determine if BLIPS 

is viable ............................................................................................................ 656

76. Email, April 1999, re: BLIPS (I would not characterize my assessment 

of the economic substances of the ‘‘premium borrowing’’ in the BLIPS 

transaction as ‘‘positive.’’) ............................................................................... 660

77. Email, April 1999, re: BLIPS Analysis ......................................................... 661

78. Email, May 1999, re: Who is the Borrower in the BLIPS transaction ........ 662

79. Email, August 1999, re: BLIPS Documents—Acceptance of Recommended 

Language ......................................................................................................... 663

80. Email, May 1999, re: BLIPS (According to Presidio, the probability of 

making a profit from this strategy is remove (possible, but remote).) ......... 664

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XI

81. KPMG email, May 1999, re: BLIPS (. . . 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 [Washington 

National Tax] had not been given complete information about how the 

transaction would be structured . . .) ........................................................... 665

82. Email, August 1999, re: BLIPS (. . . before engagement letters are signed 

and revenue is collected, I feel it is important to again note that I 

and several other WNT [Washington National Tax] partners remain 

skeptical that the tax results . . . would actually be sustained by a 

court if challenged by the IRS.) ..................................................................... 666

83. Email, January 2000, re: BLIPS 2000 (The PFP guys really need your 

help on the BLIPS 2000 strategy. . . . so we can take this to market.) ...... 667

84. Email, March 2000, re: Blips I, Grandfathered Blips, and Blips 2000 

(. . . I do not believe KPMG can reasonably issue a more-likely-thannot opinion on the economic substance issues for the Blips . . .) ................ 668

85. KPMG Memoranda, February 1999, re: BLIPS ........................................... 669

86. KPMG Memoranda, March 2000, re: Talking points on significant tax 

issues for BLIPS 2000 .................................................................................... 670

87. KPMG Memoranda, S Corporation Charitable Contribution Strategy, 

Summary of Certain Risks (The opinion also much be based on all 

pertinent facts and the law as it relates to those facts; must not be 

based upon inaccurate legal or factual assumptions; and must not unreasonably rely upon the representations, statements, findings, or agreements of the taxpayer or any other person.) .................................................. 675

88. Email, May 1999, re: BLIPS (It was not until I heard conflicting information that I questioned the original facts. In the future, I will question 

everything Presidio and Randy Bickham represent to me.] ......................... 677

89. KPMG Tax Leadership, 2003; KPMG Tax Practice Organization, 2002, 

2001 and 2000 ................................................................................................. 680

90. a. KPMG Tax Opinion Letter (Signed Final), December 1999. [Redacted 

by the Permanent Subcommittee on Investigations] .............................. 684 

b. Brown & Wood Tax Opinion Letter (Signed Final), December 1999. 

[Redacted by the Permanent Subcommittee on Investigations] ............ 781

c. SEALED EXHIBIT: Unredacted copies of Exhibit No. 90a. and 90b 

(above) ......................................................................................................... *

91. KPMG Memoranda, August 1998, re: Tax Products Practice (I was responsible for KPMG’s position that we should not register OPIS as a 

tax shelter and insisted that we make the business case with DPP. 

This was of significant benefit in marketing the OPIS product and will 

establish the direction with respect to KPMG’s position on future tax 

products.) ......................................................................................................... 857

92. KPMG email, September 1998, re: OPIS (These fees relate to approximately $1.2 billion in notional losses for approximately 25 clients.) .......... 865

93. Email, June 1998, re: OPIS (Not only will this unduely (sic) harm 

our ability to keep the product confidential, it will DESTROY any chance 

the client may have to avoid the step transaction doctrine.) ........................ 866

Volume 2

94. a.–ggg. Documents relating to FLIP/OPIS ................................................... 869

95. a.–BBB. Documents relating to BLIPS ........................................................ 1240

96. a.–ll. Documents relating to SC2 .................................................................. 1692

Volume 3

97. a.–pp. Documents relating to development/marketing of tax products ..... 1951

98. a.–ppp. Documents relating to registering, reporting and filing with Internal Revenue Service .................................................................... 2225

Page

XII

99. Documents relating to investment advisory firms:

a.–f. Quadra/Quellos ...................................................................................... 2473 

g.–t. Presido .................................................................................................... 2485

100. Documents relating to law firms:

a.–u. Sidley Austin Brown & Wood .............................................................. 2540 

v.–gg. Sutherland Asbill & Brennan ............................................................ 2576

101. Quadra Capital Management, LP. facsimile, August 1996, attaching 

Memorandum on UBS’ involvement in U.S. Capital Loss Generation 

Scheme (the ‘‘CLG Scheme’’) (As I mentioned, KPMG approached us 

as to whether we could affect the security trades necessary to achieve 

the desired tax results.) ................................................................................... 2607

102. Deutsche Bank Memorandum, July 1999, re: GCI Risk and Resources 

Committee—BLIPS Transaction .................................................................... 2612

103. Deutsche Bank email, July 1999, re: Risk & Resources Committee 

Paper—BLIPS and Comments on Blips Collateral and Credit Terms 

(I would have thought you could still ensure that the issues are highlighted by ensuring that the papers are prepared, and all discussion 

held, in a way which makes them legally privileged.) ................................. 2615

104. Deutsche Bank email, July 1999, re: Risk & Resources Committee 

Paper—BLIPS (Our approach is as follows: STRUCTURE: . . . 

Priviledge (sic): This is not easy to achieve and therefore a more detailed 

description of the tax issues is not advisable. REPUTATION RISK: . . . 

we have been asked by the Tax Department not to create an audit 

trail in respect of the Bank’s tax affaires.) .................................................... 2618

105. Deutsche Bank email, February 2002, re: Updated Presidio/KPMG 

trades (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. * * * . . . we would 

like to lend an amount of money to Hypovereinsbank equal to the amount 

of money Hypovereinsbank lends to the client.) ............................................ 2619

106. Deutsche Bank email, April 2002, re: US GROUP 1 Pres, attaching 

Structured Transactions Group North America Presentation, November 

15, 1999 ........................................................................................................... 2622

107. HVB Document, undated, re: Presidio (7% –> fee (equity) paid by investor for tax sheltering) ...................................................................................... 2646

108. HVB email, September 1999, re: Presidio .................................................... 2647

109. Deutsche Bank email, April 1999, re: presidio—w. revisions (. . . The 

holding period/life of the LLC will typically be 45 to 60 days. At the 

end of this time period, the LLC will unwind all transactions, repay 

the loan par amount and premium amount. For tax and accounting 

purposes, repaying the premium amount will ‘‘count’’ like a loss for 

tax and accounting purposes.) ........................................................................ 2649

110. KPMG email, March 2000, re: Bank representation (The bank has 

pushed back the loan again and said they simply will not represent 

that the large premium loan is consistent with industry standards.) ......... 2657

111. HVB credit request for BLIPS transaction by Presidio personnel, September 1999. (HVB will earn a very attractive return if the deal runs 

to term. If, however, the advances are prepaid within 60 days (and 

there is a reasonable prospect that they will be), HVB will earn a return 

of 2.84% p.a. on the average balance of funds advanced.) ........................... 2660

112. KPMG Memoranda, March 1998, re: OPIS (The attached went to the 

entire working group. . . . I believe that the OPIS product (‘‘Son of 

Flip’’) is a stripped down version of the LLC (partnership) structure.) ...... 2678

Page

XIII

113. Deutsche Bank email, October 1999, re: BLIPS (PKS reports that a 

meeting with John Ross was held on August 3, 1999 in order to discuss 

the BLIPS product. PKS represented PB 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.) ..................................................... 2679

114. Deutsche Bank New Product Committee Overview Memo: BLIPS Transaction (11–DB will have the right to approve/disapprove all trading 

activity in the Company. This will allow DB to effectively force the 

closure of the company and repayment of its loan to DB.) [Note: An 

alternative version of this document was previously entered into the 

Permanent Subcommittee on Investigations’ hearing record as Exhibit 

No. 70.] ............................................................................................................ 2681

115. KPMG Minutes of Assurance/Tax Professional Practice Meeting, September 28, 1998 ............................................................................................... 2686

116. Brown & Wood email, December 1997, re: joint projects (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, as you and I have discussed.) ................................ 2691

117. KPMG email, September 1997, re: Flip Tax Opinion (ALSO, OUR DEAL 

WITH BROWN AND WOOD IS THAT IF THERE NAME IS USED 

IN SELLING THE STRATEGY, THEY WILL GET A FEE.) ..................... 2692

118. KPMG Memorandum, March 1998, re: B&W Meeting (What should be 

the profit-split between KPMG, B&W and the tax products group/

implementor for jointly-developed products?) ............................................... 2693

119. KPMG Memorandum, December 1997, re: Business Model—Brown & 

Wood Strategic Alliance .................................................................................. 2696

120. Brown & Wood email, December 1997, re: Confidential Matters (On 

another point, as I have been mentioning with you, I do work for a 

number of people who have potentially complementary tax advantaged 

products. Let me state up front, I am not trying to push any of these 

on KPMG, but it might be useful if you are trying to get a repitoire 

of products jump started to talk to some or all of them. In addition, 

each of them has a relationship with one or more financial institutions 

who provide credit, derivatives trades, etc. necessary to execute the product.) .................................................................................................................. 2699

121. KPMG email, May 2000, re: BLIPS—7 percent (The breakout for a 

typical deal is as follows: . . . Trading Loss 70 * * * Attached is Kerry’s 

breakout of the 7 percent. [Redacted] gets 30 bpts from the Mgt. Fee. 

Is this detailed enough?) ................................................................................. 2701

122. KPMG email, September 1999, re: BLIPS—managing deal flow (As you 

know, we have until 10/15 at the latest to close loans and 10/22 to 

activate the FX trading, etc. (the 60 day countdown).) ................................ 2702

123. HVB Memorandum, October 1999, re: Presidio Credit Request Dated 

September 14, 1999 (To summarize the above, the increased limits will 

now permit the full amount of our facility to be invested in EUR deposits 

and do related forwards.) ............................................................................... 2703

124. HVB Document, Back-End Process ............................................................... 2705

125. HVB Document, Transaction Timeline (Exchange USD Amount to EUR 

Amount * * * USD 181,300,000) .................................................................. 2711

126. PRESIDIO ADVISORY SERVICES, LLC Memorandum, April 2002, re:

Year 2000 Strategic Plan. (Over the past two years because of delays 

in obtaining the requisite approvals to market the OPIS and BLIPS 

products, we did not begin closing deals until September of 1998 and 

1999, respectively. * * * Both Deutsche Bank and KPMG have requested 

that we replace our existing BLIPS product with a new product in 

2000.) ............................................................................................................... 2712

Page

XIV

127. KPMG/Presidio Advisors email, October 1999, re: Couple of quick questions—Liquidating distributions (Upon distribution (at the end of the 

60 day period), can the client designate where the funds go?) ..................... 2719

128. Handwritten notes, March 1998, re: Brown & Wood (Confirm w/Presidio 

that they will register.) ................................................................................... 2720

129. PRESIDIO ADVISORY SERVICES, LLC Memorandum, September 

1999, re: BLIPS loan test case (Four special purpose, single member 

Delaware LLC, owned by four trusts: D. Amir Makov revocable trust 

(1/3), JL capital trust (1/3), RP capital trust (1/6), pointe du Hoc 

irrevocable trust (1/6)) ................................................................................... 2721

130. KPMG/Presidio Advisors email, December 1998, re: BLIPS meeting (Second, the tax analyses and opinion writing needs to go into high gear.) ..... 2722

131. KPMG/Presidio Advisors/Brown & Wood email, December 1998, re:

BLIPS meeting (I spoke with R.J. this morning about a ‘‘tax-focused’’ 

meeting next week. As a first step before scheduling a meeting, we 

thought that we should first draft the base of an opinion letter in an 

outline format which will be circulated for comment before getting everyone together for a ‘‘all-hands’’ meeting. We are currently working on 

the document and expect to circulate it next week.) ...................................... 2723

132. KPMG email, February 2000, re: Brown & Wood opinion letter—BLIPS 

(Jeff Eischeid has promised the Brown & Wood opinion template ready 

in two weeks and we need your analysis.) ..................................................... 2724

133. KPMG email, January 2001, re: blips (We’re still working with Moore 

& Van Allen. They’ve declined to write a concurring opinion—their firm 

doesn’t write such opinions as a matter of policy. They are considering, 

this week, whether they will write [redacted] a MLTN [More Likely 

than Not] penalty opinion.) ............................................................................ 2726

134. IRS Form 8264, Application for Registration of a Tax Shelter, QA Investments, LLC registration of FLIP ................................................................... 2727

135. KPMG/Quadra Fax and Memoranda, October 1997, re: Registration of 

FLIP ................................................................................................................. 2729

136. Deutsche Bank email, July 1999, re: hi bill..presidio (i informed him 

that you are point man on the deal and that all comments should 

go through you) ............................................................................................... 2734

137. KPMG email and Memorandum, July 1997, re: Revised Memorandum 

((I) KPMG’s Tax Advantaged Transaction Practice; (II) Presidio’s Relationship with KPMG; (III) Transition Issues.) .............................................. 2735

138. HVB Document, August 2000, Presidio—Plafond (Investors have, so far, 

chosen to liquidate before the second (180 day) phase. ie after 60 days.) ... 2745

139. a.–t. Documents relating to Ernst & Young ................................................ 2746 

140. a.–o. Documents relating to PriceWaterhouseCoopers ............................... 2803

141. a.–k. Documents relating to First Union ..................................................... 2848

142. a. WNT Solutions by Primary Functional Group—FYI 2001–2002, November 26, 2002, reprinting first three pages of document (other 

pages sealed, see Exhibit 139b.) ................................................................ 2871

b. SEALED EXHIBIT: WNT Solutions by Primary Functional Group—

FYI 2001–2002, dated November 26, 2002 .............................................. *

143. SEALED EXHIBIT: StrateconWest email, December 2001, re:

StrateconWest/FSG Solution (Please find attached the latest and greatest 

list of strategies for StrateconWest and FSG) ............................................... *

144. SEALED EXHIBIT: Correspondence between Brown & Wood LLP and 

Presidio Advisors LLC, dated October 1998 and February 1999, regarding billing and document preparation for tax opinion ................................. *

145. Organizational Chart, KPMG Tax Practice Organization, produced by 

KPMG LLP in response to request made by Senator Levin at the November 18, 2003, hearing ............................................................................... 2874

Page

XV

146. Statement for the Hearing Record of Reuven S. Avi-Yonah, Irwin I. 

Cohn Professor of Law and Director of the International Tax Master 

of Law Program at the University of Michigan Law School ....................... 2875

147. a.–b. Supplemental questions and answers for the record of KPMG. 

[Note: Exhibit 147a has been redacted, full document has been 

made a SEALED EXHIBIT.] ............................................................... 2878

148. Supplemental questions and answers for the record of Deutsche Bank .... 2939

149. Supplemental questions and answers for the record of HVB America, 

Inc. ................................................................................................................... 2949

150. Supplemental questions and answers for the record of Quellos Group, 

LLC .................................................................................................................. 2982

151. Supplemental questions and answers for the record of Sutherland Asbill 

& Brennan LLP [Note: Submission has been redacted, full document 

has been made a SEALED EXHIBIT.] ......................................................... 2984

152. Supplemental questions and answers for the record of Sidley Austin 

Brown & Wood ................................................................................................ 2999

153. Statement for the Record and supplemental questions and answers for 

the record of the Los Angeles Department of Fire & Police Pensions 

System ............................................................................................................. 3016

154. Supplemental questions and answers for the record of the Internal Revenue Service .................................................................................................... 3025

Volume 4

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry: 

The Role of Accountants, Lawyers, and Financial Professionals—Four 

KPMG Case Studies: FLIP, OPIS, BLIPS, and SC2, a Report prepared 

by the Minority Staff of the Permanent Subcommittee on Investigations 

in conjunction with the Subcommittee hearings held November 18 and 

20, 2003: [Note: Footnotes not listed are explanative, reference Subcommittee interviews for which records are not available to the public, 

or reference a widely available public document.]

Footnote No. 1, SEALED EXHIBIT ............................................................ *

Footnote No. 3, See Hearing Exhibit No. 38 (above) .................................. 528

Footnote No. 4, See Hearing Exhibit No. 16 (above) .................................. 453

Footnote No. 10, See Attachments (2) .................................................. 3027, 3036

Footnote No. 11, See Attachment ................................................................. 3045

Footnote Nos. 15–16, See Hearing Exhibit No. 106 (above) ...................... 2622

Footnote No. 47, See Hearing Exhibit No. 62 (above) ................................ 614

Footnote No. 48, See Attachment ................................................................. 3047

Footnote No. 49, See Hearing Exhibit No. 38 (above) ................................ 528

Footnote No. 50, See Attachment ................................................................. 3053

Footnote No. 52, See Attachment ................................................................. 3054

Footnote No. 55, See Footnote No. 52 (above) ............................................. 587

Footnote No. 56, SEALED EXHIBIT .......................................................... *

Footnote No. 57, See Attachment ................................................................. 3244

Footnote Nos. 58–59, See Footnote No. 57 (above) ..................................... 601

Footnote No. 65, See Attachment ................................................................. 3245

Footnote No. 66, See Hearing Exhibit No. 14 (above) ................................ 451

Footnote No. 68, See Attachment ................................................................. 3248

Footnote No. 69, See Attachment ................................................................. 3351

Footnote No. 70, See Footnote 69 (above) .................................................... 644

Footnote No. 71, See Hearing Exhibit No. 61 (above) ................................ 612

Footnote No. 72, See Footnote No. 52 (above) ............................................. 587

Page

XVI

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote Nos. 73–74, See Footnote No. 69 (above) ..................................... 644

Footnote Nos. 76–77, 79–81, See Footnote No. 52 (above) ......................... 587

Footnote No. 82, See Footnote No. 69 (above) ............................................. 644

Footnote No. 83, See Footnote No. 52 (above) ............................................. 587

Footnote No. 84, See Attachment, Footnote No. 52 and Hearing Exhibit 

Nos. 96ff, 96hh, and 96kk (above) ............................................ 3375, 587, 1692

Footnote No. 87, See Hearing Exhibit No. 73 (above) ................................ 654

Footnote No. 88, See Hearing Exhibit Nos. 73 and 85 (above).............. 654, 669

Footnote No. 89, See Hearing Exhibit No. 74 (above) ................................ 655

Footnote No. 90, See Hearing Exhibit No. 75 (above) ................................ 656

Footnote Nos. 92–93, See Hearing Exhibit No. 64 (above) ........................ 621

Footnote No. 94, See Hearing Exhibit Nos. 64, and 76–79 

(above)............................................................................................. 621, 660–663

Footnote Nos. 95–96, See Hearing Exhibit No. 65 (above) ........................ 623

Footnote No. 97, See Hearing Exhibit No. 12 (above) ................................ 448

Footnote No. 98, See Attachment ................................................................. 3468

Footnote No. 99, See Attachment and Hearing Exhibit No. 65 

(above)................................................................................................... 3469, 623

Footnote No. 100, See Hearing Exhibit No. 65 (above) .............................. 623

Footnote No. 101, See Hearing Exhibit No. 81 (above) .............................. 665

Footnote No. 102, See Hearing Exhibit No. 39 (above) .............................. 532

Footnote No. 103, See Attachment ............................................................... 3472

Footnote No. 107, See Attachment ............................................................... 3474

Footnote Nos. 108–109, See Hearing Exhibit No. 13 (above) .................... 450

Footnote No. 110, See Hearing Exhibit No. 83 (above) .............................. 667

Footnote No. 111, See Hearing Exhibit Nos. 84 and 86 (above)............ 668, 670

Footnote No. 113, See Hearing Exhibit No. 41 (above) .............................. 538

Footnote No. 115, See Hearing Exhibit No. 38 (above) .............................. 528

Footnote No. 116, See Hearing Exhibit No. 2 (above) ................................ 386

Footnote No. 117, See Attachment ............................................................... 3475

Footnote No. 121, See Attachment ............................................................... 3482

Footnote No. 122, See Attachment ............................................................... 3492

Footnote No. 123, See Hearing Exhibit No. 87 (above) .............................. 675

Footnote No. 124, See Hearing Exhibit No. 49 (above) .............................. 574

Footnote No. 125, See Attachments (2) and Hearing Exhibit No. 49 

(above)................................................................................................... 3495, 574

Footnote No. 126, See Attachments (3) and Hearing Exhibit No. 49 

(above)................................................................................................... 3506, 574

Footnote No. 127, See Hearing Exhibit No. 59 (above) .............................. 604

Footnote Nos. 128–129, See Footnote No. 52 (above) ................................. 587

Footnote No. 130, See Attachment and Hearing Exhibit No. 54 

(above)................................................................................................... 3517, 595

Footnote No. 131, See Hearing Exhibit No. 23 (above) .............................. 488

Footnote No. 132, See Attachment ............................................................... 3519

Footnote No. 133, See Hearing Exhibit No. 6 (above) ................................ 412

Footnote No. 134, See Hearing Exhibit No. 20 (above) .............................. 463

Page

XVII

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote No. 135, See Attachment ............................................................... 3520

Footnote No. 136, See Hearing Exhibit No. 25 (above) .............................. 492

Footnote No. 137, See Hearing Exhibit No. 8 (above) ................................ 423

Footnote No. 138, See Attachment ............................................................... 3522

Footnote No. 139, See Hearing Exhibit No. 27 (above) .............................. 495

Footnote No. 140, See Hearing Exhibit No. 19 (above) .............................. 460

Footnote No. 141, See Attachment ............................................................... 3523

Footnote Nos. 142–143, See Hearing Exhibit No. 55 (above) .................... 597

Footnote No. 144, See Attachment ............................................................... 3530

Footnote Nos. 145–148, See Footnote No. 144 (above) ............................... 3530

Footnote No. 149, See Attachment (Partial document reprinted, full 

document SEALED EXHIBIT) ................................................................. 3557

Footnote No. 150, See Attachment (Partial document reprinted, full 

document SEALED EXHIBIT) ................................................................. 3568

Footnote No. 151, See Attachment ............................................................... 3572

Footnote No. 152, See Attachment ............................................................... 3573

Footnote No. 154, See Attachments (2) ........................................................ 3575

Footnote No. 155, See Footnote No. 135 (above) ......................................... 2729

Footnote No. 156, See Attachment ............................................................... 3579

Footnote No. 157, See Attachments (3), Footnote No. 156 and Hearing 

Exhibit No. 56 (above) ............................................................... 3581, 3579, 599

Footnote No. 158, See Hearing Exhibit No. 55 (above) .............................. 597

Footnote No. 159, See Hearing Exhibit No. 24 (above) .............................. 490

Footnote No. 160, See Attachments (2) ........................................................ 3591

Footnote Nos. 161–162, See Footnote No. 157 (above) ............................... 3581

Footnote No. 163, See Attachment ............................................................... 3596

Footnote Nos. 166–167, See Hearing Exhibit No. 21 (above) .................... 464

Footnote No. 168, See Attachment, Footnote No. 156 and Hearing Exhibit Nos. 21 and 139m (above)...................................... 3606, 3579, 464, 2746

Footnote Nos. 169 and 171, See Hearing Exhibit No. 21 (above) .............. 464

Footnote No. 174, See Footnote No. 152 (above) ......................................... 3573

Footnote No. 176, See Hearing Exhibit No. 63 (above) .............................. 617

Footnote No. 177, See Hearing Exhibit No. 62 (above) .............................. 614

Footnote No. 178, See Hearing Exhibit No. 23 (above) .............................. 488

Footnote No. 179, See Attachment ............................................................... 3607

Footnote No. 180, See Footnote No. 57 (above) ........................................... 3244

Footnote No. 181, See Footnote No. 151 (above) ......................................... 3572

Footnote No. 183, See Attachment ............................................................... 3620

Footnote Nos. 184–185, See Footnote No. 57 (above) ................................. 3244

Footnote No. 186, See Attachment (Partial document reprinted, full 

document SEALED EXHIBIT) ................................................................. 3621

Footnote Nos. 187–188, See Footnote 186 (above) ...................................... 3621

Footnote No. 189, See Footnote No. 56 (above) SEALED EXHIBIT ......... *

Footnote Nos. 190–191, See Hearing Exhibit No. 38 (above) .................... 528

Footnote No. 192, See Attachment and Hearing Exhibit No. 38 

(above)................................................................................................... 3623, 528

Page

XVIII

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote Nos. 193–194, See Hearing Exhibit No. 38 (above) .................... 528

Footnote No. 200, See Hearing Exhibit No. 137 (above) ............................ 2735

Footnote No. 201, See Attachment (Partial document reprinted, full 

document SEALED EXHIBIT) ................................................................. 3929

Footnote No. 203, See Attachment and Hearing Exhibit No. 65 ......... 3632, 623

Footnote No. 204, See Hearing Exhibit No. 21 (above) .............................. 464

Footnote No. 205, See Hearing Exhibit No. 8 (above) ................................ 423

Footnote No. 208, See Hearing Exhibit No. 21 (above) .............................. 464

Footnote No. 211, See Hearing Exhibit Nos. 51 and 58 (above)............ 585, 602

Footnote No. 213, See Footnote No. 84 (above) ........................................... 3375

Footnote No. 214, See Hearing Exhibit No. 110 (above) ............................ 2657

Footnote No. 217, See Footnote No. 84 (above) ........................................... 3375

Footnote No. 218, See Hearing Exhibit No. 64 (above) .............................. 621

Footnote No. 220, See Hearing Exhibit No. 5 (above) ................................ 408

Footnote No. 221, See Hearing Exhibit No. 7 (above) ................................ 415

Footnote No. 222, See Hearing Exhibit Nos. 38 and 64 (above)............ 528, 621

Footnote No. 223, See Attachments (2) and Hearing Exhibit No. 15 

(above)................................................................................................... 3635, 452

Footnote No. 227, See Attachment ............................................................... 3641

Footnote No. 228, See Footnote No. 223 ...................................................... 3635

Footnote No. 230, See Hearing Exhibit No. 105 (above) ........................... 2619

Footnote No. 231, See Footnote Nos. 157 and 163 (above)................. 3581, 3596

Footnote No. 232, See Attachment ............................................................... 3643

Footnote No. 234, See Hearing Exhibit No. 105 (above) ............................ 2619

Footnote No. 235, See Attachments (4) ........................................................ 3644

Footnote No. 236, See Hearing Exhibit No. 105 (above) ............................ 2619

Footnote No. 238, See Footnote No. 117 ...................................................... 3475

Footnote No. 239, See Attachments (2) and Hearing Exhibit Nos. 111 

and 129 (above); two addition items for this footnote are SEALED 

EXHIBITS ................................................................................ 3660, 2660, 2721

Footnote No. 240, See Attachment and Hearing Exhibit No. 70 

(above)................................................................................................... 3665, 646

Footnote No. 241, See Footnote No. 235 and Hearing Exhibit No. 138 

(above)................................................................................................. 3644, 2745

Footnote No. 242, See Hearing Exhibit Nos. 103 and 104 

(above)................................................................................................. 2615, 2618

Footnote No. 243, See Hearing Exhibit No. 70 (above) .............................. 646

Footnote No. 244, See Attachment ............................................................... 3668

Footnote Nos. 245–246, See Hearing Exhibit No. 113 (above) .................. 2679

Footnote Nos. 248–250, See Hearing Exhibit No. 110 (above) .................. 2657

Footnote No. 251, See Footnote No. 84 ....................................................... 3375

Footnote No. 252, See Hearing Exhibit No. 105 (above) ............................ 2619

Footnote Nos. 253–255, See Hearing Exhibit No. 106 (above) .................. 2622

Footnote No. 256, See Attachment ............................................................... 3670

Footnote No. 257, See Attachment and Hearing Exhibit No. 106 

(above)................................................................................................. 3671, 2622

Page

XIX

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote No. 258, See Hearing Exhibit No. 106 (above) ............................ 2622

Footnote No. 261, See Footnote No. 201 (above) ......................................... 3929

Footnote No. 262, See Attachment ............................................................... 3672

Footnote No. 263, See Attachment ............................................................... 3678

Footnote No. 265, See Attachment, Footnote No. 244 and Hearing Exhibit Nos. 70 and 108 (above)......................................... 3679, 3668, 646, 2647

Footnote No. 266, See Attachments (2) (One document partially reprinted, full document is (SEALED EXHIBIT) ....................................... 3681

Footnote No. 267, See Footnote No. 266 (above) ......................................... 3681

Footnote No. 268, See Attachment ............................................................... 3687

Footnote No. 270, See Footnote No. 154 (above) ......................................... 3575

Footnote No. 271, See Footnote No. 237 (above) (Found in the files 

of the Subcommittee) ................................................................................ *

Footnote No. 272, See Attachment ............................................................... 3690

Footnote No. 273, See Footnote No. 272 (above) ......................................... 3690

Footnote No. 274, See Attachment ............................................................... 3697

Footnote No. 275, See Attachments (5) ........................................................ 3703

Footnote No. 276, See Footnote No. 275 (above) ......................................... 3703

Footnote No. 278, See Hearing Exhibit No. 101 (above) ............................ 2607

Footnote No. 279, See Attachment ............................................................... 3711

Footnote No. 280, See Attachment ............................................................... 3712

Footnote No. 281, See Footnote No. 117 and Hearing Exhibit No. 112 

(above)................................................................................................. 3475, 2678

Footnote No. 282, See Hearing Exhibit Nos. 64, 69 and 81 

(above)............................................................................................. 621, 644, 665

Footnote No. 283, See Hearing Exhibit No. 81 (above) .............................. 665

Footnote No. 284. See Attachment .............................................................. 3714

Footnote No. 285, See Attachment ............................................................... 3717

Footnote No. 286, See Attachment (Four additional items for this footnote are SEALED EXHIBITS) ................................................................. 3718

Footnote No. 293, See Hearing Exhibit No. 120 (above) ............................ 2699

Footnote No. 294, See Hearing Exhibit No. 119 (above) ............................ 2696

Footnote No. 295, See Attachment ............................................................... 3719

Footnote No. 296, See Footnote No. 117 and Hearing Exhibit Nos. 

42 and 112 (above)..................................................................... 3475, 543, 2678

Footnote No. 299, See Footnote No. 156 (above) ......................................... 3579

Footnote No. 301, See Attachment ............................................................... 3722

Footnote No. 302, See Attachment ............................................................... 3754

Footnote No. 303, See Hearing Exhibit No. 21 (above) .............................. 464

Footnote No. 306, See Attachment ............................................................... 3756

Footnote No. 307, See Attachment ............................................................... 3757

Footnote No. 308, See Footnote No. 307 (above) ......................................... 3757

Footnote No. 310, See Hearing Exhibit No. 128 (above) ............................ 2720

Footnote No. 312, See Footnote No. 52 (above) ........................................... 3054

Footnote No. 313, See Attachments (3) ........................................................ 3767

Footnote No. 314, See Hearing Exhibit No. 38 (above) .............................. 528

Page

XX

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote No. 319, See Attachments (2) ........................................................ 3775

Footnote No. 320, See Attachment ............................................................... 3779

Footnote No. 321, See Attachments (2) ........................................................ 3795

Footnote Nos. 322–323, See Footnote No. 320 (above) ............................... 3779

Footnote No. 324, See Attachment and Footnote No. 320 .................. 3801, 3779

Footnote No. 327, See Attachment ............................................................... 3812

Footnote No. 328, See Attachment ............................................................. 3813

Footnote No. 329, See Attachments (2) ...................................................... 3814

Footnote No. 330, See Footnote No. 329 (above) ....................................... 3814

Footnote No. 331, See Attachments (3) ...................................................... 3816

Footnote No. 332, See Attachments (3) ...................................................... 3822

Footnote No. 333, See Hearing Exhibit No. 21 (above) ............................ 464

Footnote Nos. 335–336, See Hearing Exhibit No. 43 (above) .................. 545

Footnote No. 337, See Hearing Exhibit No. 128 (above) .......................... 2720

Footnote No. 338, See Hearing Exhibit No. 103 (above) .......................... 2615

Footnote No. 339, See Hearing Exhibit No. 104 (above) .......................... 2618

Footnote No. 340, See Footnote No. 154 (above) ....................................... 3575

Footnote No. 341, See Attachment ............................................................. 3830

Footnote No. 342, See Attachments (2) ...................................................... 3831

Footnote No. 343, See Footnote No. 203 (above) ....................................... 3632

Footnote Nos. 344 and 346, See Hearing Exhibit No. 28 (above) ............ 496

Footnote No. 347, See Footnote No. 122 (above) ....................................... 3492

Footnote No. 348, See Hearing Exhibit No. 28 (above) ............................ 496

Footnote Nos. 349–350, See Footnote No. 163 (above) ............................. 3596

Footnote No. 351, See Footnote No. 117 (above) ....................................... 3475

Footnote No. 352, See Footnote No. 52 (above) ......................................... 3054

Footnote No. 355, See Attachment ............................................................. 3835

Footnote No. 356, See Footnote No. 355 (above) ....................................... 3835

Footnote No. 359, See Attachment and Footnote No. 203 (above) ........... 3840

Footnote No. 360, See Hearing Exhibit No. 121 (above) .......................... 3482

Footnote No. 361, See Attachment and Hearing Exhibit No. 58 

(above)................................................................................................... 3842, 602

Footnote No. 362, See Footnote No. 361 (above) ....................................... 3842

Footnote No. 363, See Attachment ............................................................. 3847

Footnote No. 364, See Attachment ............................................................. 3848

Footnote No. 367, See Footnote No. 154 (above) ....................................... 3575

Footnote Nos. 368–369, See Footnote No. 52 (above) ............................... 3054

Footnote No. 370, See Hearing Exhibit No. 115 (above) .......................... 2686

Footnote No. 371, See Footnote No. 52 (above) ......................................... 3054

Footnote No. 372, See Hearing Exhibit No. 114 (above) .......................... 2681

Footnote No. 373, See Attachments (2) and Footnote Nos. 154 and 

203 (above) ............................................................................... 3850, 3575, 3632

Footnote No. 374, See Footnote No. 373 (above) ....................................... 3850

Footnote No. 375, See Footnote No. 144 (above) ....................................... 3530

Footnote No. 376, See Footnote No. 150 (above) ....................................... 3568

Footnote No. 377, See Footnote No. 151 (above) ....................................... 3572

Footnote No. 378, See Footnote No. 355 (above) ....................................... 3835

Footnote Nos. 379–382, See Hearing Exhibit No. 115 (above) ................ 2686

Page

XXI

155. Documents relating to Footnotes found in U.S. Tax Shelter Industry—

Continued

Footnote No. 383, See Attachment and Hearing Exhibit No. 46 

(above)................................................................................................... 3853, 560

Footnote No. 384, See Hearing Exhibit No. 44 (above) ............................ 555

Footnote No. 385, See Attachment ............................................................. 3854

Footnote No. 386, See Hearing Exhibit No. 38 (above) ............................ 528

(1)

U.S. TAX SHELTER INDUSTRY: THE ROLE OF 

ACCOUNTANTS, LAWYERS, AND FINANCIAL 

PROFESSIONALS 

TUESDAY, NOVEMBER 18, 2003

U.S. SENATE, 

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS,

OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 9:02 a.m., in room 

SH–216, Hart Senate Office Building, Hon. Norm Coleman, Chairman of the Subcommittee, presiding. 

Present: Senators Coleman, Levin, and Lautenberg. 

Staff Present: Raymond V. Shepherd, III, Staff Director and 

Chief Counsel; Joseph V. Kennedy, General Counsel; Mary D. Robertson, Chief Clerk; Leland Erickson, Counsel; Mark Greenblatt, 

Counsel; Steven Groves, Counsel; Frank J. Minore, Detailee, GAO; 

Kristin Meyer, Staff Assistant; Steve D’Ettorre, Staff Assistant; 

Bryan Nelson, Intern; Elise J. Bean, Staff Director/Chief Counsel 

to the Minority; Bob Roach, Counsel and Chief Investigator to the 

Minority; Laura Stuber, Counsel to the Minority; Brian Plesser, 

Counsel to the Minority; Julie Davis, Professional Staff Member; 

Christopher Kramer, Professional Staff Member to the Minority; 

Beth Merillat-Bianchi, Detailee, IRS; Jim Pittrizzi, Detailee, GAO; 

Rebecca Dirks, Intern; Ken Seifert, Intern; Jessilyn Cameron, 

Brookings Fellow; Grant Bosser (Senator Sununu); Nate Graham 

(Senator Bennett); Kevin Carpenter (Senator Specter); Mimi 

Braniff (Senator Stevens); David Berrick (Senator Lieberman); Gita 

Uppal (Senator Pryor); Rudy Broiche (Senator Lautenberg); and 

Mandana Parsazad (Senator Dayton). 

OPENING STATEMENT OF SENATOR COLEMAN 

Senator COLEMAN. This hearing of the Permanent Subcommittee 

on Investigations is called to order. 

I want to thank you for attending today’s hearing. Today and 

Thursday we will focus on a set of issues developed by this Subcommittee’s Ranking Member, Senator Levin. And, Senator Levin, 

I would like to commend you for your tireless efforts to prevent the 

abuse of our tax code by those willing to exploit loopholes and avoid 

paying legitimate taxes. You have done tremendous work in this 

area, and it is a pleasure for me to work with you. 

In a bipartisan fashion, PSI has developed a deeper understanding of the history of individual tax shelters. PSI has uncovered how those shelters work, how they were marketed to potential 

2

investors, and how they were structured in order to avoid scrutiny 

by the Internal Revenue Service. Due to the complexity of these 

schemes, our hearings will focus only on a few of the shelters, but 

there are many others like them. 

There is an old English proverb that says, ‘‘A clean glove often 

hides a dirty hand.’’ Today we will hear firsthand how the ethical 

standards of the legal and accounting profession have been pushed, 

prodded, bent, and in some cases broken for enormous monetary 

gain. The fact is abusive and potentially illegal tax shelters sold to 

corporations and wealthy individuals rob the U.S. Treasury of billions of dollars in lost tax revenues annually. 

Let me be clear: While some of the products we discuss today are 

not technically illegal, they are most certainly ethically questionable and demonstrate a deliberate effort on the part of the participants to fly underneath the regulatory radar of the IRS. This is not 

a victimless crime. It is not the government that loses money. It 

is the people of America, average working families who will bear 

the brunt of lost revenues so that a handful of rich lawyers, accountants, and their clients can manipulate legitimate business 

practices to make a profit. 

According to the GAO, a recent IRS consultant estimated that for 

the 6-year period 1993 to 1999, the IRS lost an average of between 

$11 and $15 billion each year from abuse of tax shelters. The 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 unlisted abusive transactions, for a total of $85 billion. 

As I said, this is not a victimless crime. To put this in context, 

if the IRS proactively shut down these abusive tax shelters and collected the diverted revenue, it would have helped to finance a substantial portion of our efforts in Iraq. Abusive tax shelters are fashioned in the likeness of legitimate transactions as permitted under 

the IRS Code. The transactions themselves are highly complex, involving accounting firms, major financial institutions, investment 

firms, and prestigious law firms. Not only are these participants 

necessary for the transaction, they provide the added benefit of 

making detection by the IRS difficult. Moreover, these entities provide a veneer of legitimacy, for abusive tax shelters are, in fact, illusory and sham transactions with little or no economic substance, 

driven primarily for favorable tax consequences. 

There are three ovearching issues that these hearings will address. The first is the Internal Revenue Service’s ability to enforce 

the Nation’s tax laws. There is no doubt that our tax laws are very 

complex and give rise to different interpretations. The Service’s interpretation is not legally controlling, and taxpayers have the right 

to ignore it if they think a court will uphold their reading of the 

statutes and regulations. But the IRS does have a right to challenge tax strategies it thinks are invalid. In order for the Service 

to challenge strategies and for the courts to rule, they must be 

aware of how taxpayers are applying the law. 

The Subcommittee’s investigation has uncovered evidence that 

the transactions studied here were deliberately designed to avoid 

detection by the IRS. Even an illegal strategy works if the government never finds out about it. Even more disturbing, the IRS has 

3

specific rules that require the promoters of certain tax products to 

notify the IRS whenever a taxpayer uses one of them. This gives 

the IRS the opportunity to review how the taxpayer has applied 

law to his or her specific situation. 

Evidence suggests that the accounting firms knowingly evaded 

this requirement and that the IRS has not been as forceful in its 

administration of this registration requirement as it could be. 

When transactions are hidden from the government, it loses its 

ability to enforce the law. The perception can quickly arise that fair 

application of revenue statutes is a sucker’s game, that those who 

are rich and powerful ignore it or interpret it to their own benefit, 

and that only the average guy gets stuck with his full share. The 

system that relies primarily on voluntary compliance cannot afford 

to allow this perception to seem real. 

Second, for a long time both the accounting and legal industries 

have been justifiably proud of their professions. Both have held 

themselves up to the public as practicing a high standard of professional ethics and giving the public honest access to a complex body 

of doctrine. Given the complexity of tax and accounting law, Americans with any wealth are increasingly dependent on professional 

advice in order to reconcile their personal interests with legal requirements. If clients cannot have absolute confidence in the accuracy of the advice they get, these professions no longer will merit 

the high standard we have previously given them. 

This leads naturally to the third major theme of these hearings. 

We all know that an institution, especially one as large as the accounting firms appearing here today, cannot be held strictly responsible for every action of all their employees. Individual workers 

often have motives and take actions that are directly contrary to 

the intentions of a company’s leaders. But because we foresee these 

conflicts, the existence of strong internal controls has become a key 

component of modern management practices. These controls are 

meant to ensure that no single employee or group of employees is 

allowed to subject the firm to a large amount of risk without the 

leadership’s approval. 

We will hear evidence that the internal controls that the accounting and law firms seem to have had in place did not work. The people responsible for ensuring firm quality often raise serious questions about the transactions we will discuss today. Yet it appears 

that their advice and recommendations were often disregarded in 

the effort to boost revenue. 

These three issues—the ability of the IRS to learn of aggressive 

tax strategies, the possibility of misleading advice to taxpayers, 

and the breakdown of internal controls—all raise serious issues 

about future policy toward the tax industry. I am hopeful that the 

information Senator Levin has helped us uncover will lead to positive reforms. 

I look forward to hearing from our panelists this morning, and 

I especially look forward to Senator Levin’s questioning of the panelists. I know we will all learn a great deal today. 

With that, I will turn it over to the distinguished Ranking Member, Senator Levin. 

4

1The Minority Staff Report appears in the Appendix on page 145. 

OPENING STATEMENT OF SENATOR LEVIN 

Senator LEVIN. Thank you, Mr. Chairman, for your comments 

and for your support of this investigation that began a year ago 

when I was Chairman here, but has continued with the support of 

Senator Coleman. We are grateful for that and for what this is 

going to lead to, hopefully, as he points out. What we must point 

toward are a series of significant reforms if we are going to change 

the practices which we are going to hear described this morning. 

My statement is something of a long statement because I do 

want to set forth what these shelters are in detail so that we can 

understand them. I know I have the understanding of our Chairman in proceeding this way. Normally I would try to limit an opening statement to 10 minutes, but this one could go 15 minutes or 

so, and I thank the Chairman for his understanding of that, even 

though we have a very difficult time schedule this morning. 

Unlike legitimate tax shelters, abusive tax shelters have no real 

economic substance. They are designed to provide tax benefits not 

intended by the tax code and are almost always convoluted and 

complex. Crimes like terrorism or murder or fraud or embezzlement produce instant recognition of the immorality involved. But 

abusive tax shelters are MEGOs—that means ‘‘my eyes glaze over.’’ 

Those who cook up these concoctions count on their complexity to 

escape scrutiny and public ire. 

The tax shelter industry is also fundamentally different than it 

was a few years ago. Instead of individuals and corporations going 

to their accountant or law firm and asking for tax planning advice, 

the engine driving the industry is now a horde of tax advisers cooking up one complex scheme after another, so-called tax products, 

generally unsolicited by clients, and then using elaborate marketing schemes to peddle these products across the country. 

In order to gain a deeper understanding of the issues involved 

in the marketing of these products, the Subcommittee conducted an 

in-depth case study examining four tax products designed, marketed, and sold by a leading accounting firm, KPMG, to individuals 

or corporations to help them reduce or eliminate their U.S. taxes. 

These four products are known to KPMG and its clients as BLIPS, 

FLIPS, OPIS, and SC2. 

We are releasing a 125-page Minority Staff Report today detailing what we found in these four case histories.1

The testimony today will disclose a tawdry tale: A highly compromised internal review and approval process at KPMG; highly 

aggressive marketing efforts to sell tax schemes aimed at producing paper tax losses; and schemes which attempt to disguise tax 

reduction scams as business activity, in the case of BLIPS, or a 

charitable donation, in the case of SC2. 

An excerpt from a long e-mail by a top KPMG tax professional 

on whether KPMG should approve BLIPS for sale to clients illustrates the skewed priorities. He said that the decision on BLIPS 

came down to this: ‘‘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.’’

5

1See Exhibit No. 1a. which appears in the Appendix on page 371. 

Being paid a lot of money for a dubious tax scheme—that is what 

it all comes down to. 

The testimony today will pull back the curtain on the pressurecooker environment within KPMG to mass market its tax products 

to multiple clients. Again, one detail illustrates the extent of the 

problem: The full-fledged telemarketing center that KPMG maintained in Fort Wayne, Indiana, and staffed with people trained to 

make cold calls to find buyers for specific tax products. The telemarketing scripts, the thousands of cold calls made to sell the tax 

product known as SC2, the revisits to potential buyers who said no 

the first time, all show KPMG pushing its so-called tax products. 

The testimony today will also show the lengths to which KPMG 

went to hide its tax products and its sales efforts from the IRS. Despite its 2003 inventory of 500 active tax products, KPMG has 

never registered and thereby disclosed to the IRS the existence of 

a single one of its tax products. It has claimed in court and to the 

Subcommittee staff that it is not a tax shelter promoter. 

Today’s testimony will disclose, however, that some tax professionals within the firm advised the firm, to no avail, to register 

some of its products as tax shelters. 

You will also hear about improper tax return reporting by 

KPMG, file clean-ups, and other efforts to hide their activities from 

the IRS and public scrutiny. 

Finally, you will hear today and in the hearing on Thursday that 

in ventures as large and profitable as the marketing of these tax 

shelters, there were many professionals ready to join forces with 

KPMG to carry out the complex financial structures required to 

camouflage the tax schemes behind a facade of economic substance. 

These professionals included banks, which financed the loans for 

sham transactions designed to create a veneer of economic substance; investment advisory firms, which cooked up phony financial 

transactions to create the appearance of a business purpose; and 

law firms, which wrote boilerplate legal opinions to justify dubious 

tax schemes and to shield taxpayers from penalties. 

With such a formidable array of talent and expertise, potential 

clients were persuaded to buy and use the deceptive shelters 

KPMG was peddling, and the U.S. Treasury was effectively defrauded of taxes owed as a result. 

We are going to focus on two shelters, BLIPS and SC2. Let’s first 

look at BLIPS. We have some charts here on the screens, and some 

of you have, hopefully, charts in front of you.1

BLIPS stands for Bond-Linked Issue Premium Structure. Inside 

KPMG, BLIPS was called a ‘‘loss generator’’ because the intent of 

the tax product was to generate a paper loss that the buyer could 

then use to offset other income and to shelter that other income 

from taxation. 

For this example, we will suppose the BLIPS buyer—let’s call 

him the taxpayer—has a taxable gain or taxable income of $20 million that the BLIPS transaction is intended to shelter by creating 

a $20 million paper loss. 

On the first slide, we will see the first step is the BLIPS taxpayer setting up a shell corporation called a limited liability comVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
6

pany, or LLC. The taxpayer gives this shell company out-of-pocket 

cash equal to 7 percent of the $20 million paper loss that he wants 

to create. In this case, that means the taxpayer provides $1.4 million. This money will be used for fees for the firms that are part 

of this scheme and for an investment program set up as the fig leaf 

of economic substance to hide what is really a tax scam. 

On the next slide, we will see what happens next, which is a bank makes a so-called 7-year loan of $50 million to the shell company, LLC. The BLIPS taxpayer agrees to pay an above-market interest rate on the loan, say 16 percent interest. Because he is willing to pay such a high interest rate, the bank also credits him with 

a so-called $20 million loan premium that is, not coincidentally, 

equal to the tax loss that the taxpayer is buying from KPMG. If 

the taxpayer later pays off the loan early, as planned, the bank will 

charge a prepayment penalty that, not coincidentally, will approximate the loan premium and make sure that it is repaid. The bank 

credits the taxpayer’s account, which stays at the bank, with the 

$50 million so-called loan and the $20 million premium, for a total 

of $70 million. 

There are more wrinkles. For instance, in order to get the $70 

million, the taxpayer and the shell company have to agree to severe 

restrictions on how the loan proceeds can be used. And they must 

maintain collateral in cash or liquid securities in an account at the 

same bank equal to at least 101 percent of the loan and premium 

amount, meaning about $70.8 million. 

Now, think about that for a moment, because this collateral requirement is one key to understanding why this loan is a sham. A 

cash collateral requirement of 101 percent means that none of the 

loan proceeds can really be put at risk. That money, more than the 

amount of the loan itself, has to be kept safe in an account at the 

bank which, on paper, loaned it. 

The next slide: Enter Presidio. They are the investment advisory 

firm that works hand in glove with KPMG and handles a lot of the 

legwork of the transaction. Presidio directs two companies it controls—Presidio Growth and Presidio Resources—to participate in 

the transaction. 

Next, Presidio and the taxpayer’s shell company form a partnership called a strategic investment fund or SIF. The taxpayer’s shell 

company, that LLC, contributes all of its assets to the partnership: 

The $1.4 million in cash from the taxpayer and the $70 million 

credit from the so-called loan and loan premium. The Presidio companies contribute about $140,000. Based on these contributions, the 

taxpayer has a 90-percent interest and Presidio collectively has a 

10-percent interest in the strategic investment fund. 

The next slide: Here is the switcheroo. The shell company decides 

with the consent of the bank to assign or transfer the so-called 

bank loan to the fund. 

Next slide: Here comes the fig leaf. The fund takes the money it 

has and supposedly engages in foreign currency transactions. The 

fund takes the so-called loan proceeds, the $70 million, and simply 

converts them into euros and puts the euros in what one bank calls 

a synthetic dollar account. The fund also signs a contract to guarantee that it can convert the euros back to the same number of dollars at no risk in 30 or 60 days. The fund also puts at risk a very 

7

1See Exhibit No. 1b. which appears in the Appendix on page 379. 

small amount of money, never more than what the taxpayer has 

contributed, by shorting foreign currencies pegged to the U.S. dollar. Not much of an investment program. 

While the BLIPS loan is supposed to last 7 years, every taxpayer 

that bought it, 186 out of 186, pulled out early, as planned. They 

quit. They pulled out because the point of BLIPS is not to invest 

money but to generate a paper loss for tax purposes before the end 

of the tax year. 

The last slide on BLIPS: Now we are at the unwind. At day 60, 

the taxpayer pulls out of the partnership. The partnership, the 

fund, repays the so-called loan to the bank, plus a prepayment penalty to cover the premium so that the whole $70 million is returned 

to the bank. The fund then distributes any remaining assets to its 

partners, which usually is little or nothing. The taxpayer’s $1.4 

million is usually gone, mostly in fees, but that is a price that he 

is more than willing to pay for the $20 million tax loss. 

Because of the way the loan was structured, KPMG told the taxpayer he can claim that his cost basis to participate in the partnership is equal to the $20 million loan premium and the $1.4 million 

in cash that he contributed to the partnership. That means he supposedly can claim a $21.4 million loss on his tax return. 

Now, if this does not make much sense to you, it is because the 

whole transaction is an elaborate concoction to create the impression of economic substance. The taxpayer did not use the $70 million loan proceeds at all due to the collateral requirement. He 

parked that $70 million in a synthetic dollar account at the bank 

and used his own money to make a few safe currency transactions. 

He could have made those without any loan at all. The point of the 

loan was simply to generate a tax loss to shelter the taxpayer’s 

other income. 

KPMG approved BLIPS for sale in October 1999 and sold it to 

186 people until, in September 2000, the IRS listed it as a potentially abusive tax shelter. In 1 year, KPMG obtained at least $53 

million in fees, making BLIPS one of KPMG’s top revenue-producing tax products. 

Now let’s look at the second shelter, SC2, which stands for S Corporation Charitable Contribution Strategy.1

An S corporation is organized under Subchapter S of the tax 

code, and its income is attributed to its shareholders and taxed as 

ordinary individual income instead of corporate income. Instead of 

generating a phony paper loss, this tax product generated a phony 

charitable donation. 

The first step is that KPMG approaches an existing S corporation, usually owned by one person, with a purported charitable donation strategy. The corporation takes several steps to prepare for 

the SC2 transaction. First, assuming that the S corporation had, 

let’s say, 100 shares of common stock, on KPMG’s advice, the S corporation issues and distributes to its sole shareholder an additional 

900 non-voting shares plus 7,000 warrants to buy 7,000 more 

shares of the company stock in the future. The corporation also 

issues a non-distribution resolution stating that the company will 

8

not distribute any of its income to its shareholders for a specified 

period of time, usually 2 or 3 years. 

Next, KPMG introduces the individual shareholder to a qualified 

tax-exempt charity, which KPMG has made a major effort to identify, and the individual donates the 900 non-voting shares to this 

charity. The charity signs a redemption agreement with the corporation, which allows the charity to require the corporation to buy 

back the donated stock after a specified period of time, usually the 

same amount of time specified in the corporation’s non-distribution 

resolution. 

The redemption agreement and non-distribution resolution are 

the keys to understanding why SC2 is a sham. Everyone participating in this situation knows from the outset that the stock donation is not intended to be permanent. It is intended to be temporary. The clear understanding of all the parties is that the charity will be selling the donated stock back to the donor in a few 

years. 

But the appearance for the moment is that the S corporation now 

has two shareholders: The charity owns 900 non-voting shares, and 

the individual owns 100 voting shares and 7,000 warrants. 

On the next slide, we will see that for the next 2 or 3 years, 

while the charity is a shareholder in the S corporation, due to the 

non-distribution resolution the corporation allocates but does not 

actually distribute 90 percent of its net income to the charity and 

10 percent to the individual shareholder. 

The difference between ‘‘allocation’’ and ‘‘distribution’’ is critical. 

Under Federal tax law, an S corporation shareholder, unless taxexempt, pays income tax on the net income ‘‘allocated’’ to it on the 

company books, not on the cash actually ‘‘distributed.’’ According to 

KPMG, that means that the 90 percent of company income allocated to the charity is tax-exempt, while the individual has to pay 

taxes on only the 10 percent allocated to him. That is true even 

though the charity often never sees a nickel of the money supposedly allocated to it and agrees, indeed, to forego that income. 

On the third slide, we will see the following: We are 2 or 3 years 

down the road after significant net income has been accumulating 

inside the company, when the charity’s redemption rights kick in. 

The charity sells back the 900 non-voting shares to the S corporation for cash. While this cash payment pales in comparison to the 

amount of sheltered corporate income, because of the way the 

shares are valued, it is, nonetheless, a significant amount for the 

charity. 

Now the payout, the fourth slide. This is where the individual 

shareholder makes out. 

The charity has sold back its shares and is no longer a shareholder in the S corporation. All of the income that has been built 

up in the corporation for the last 2 or 3 years is distributed to the 

individual shareholder. KPMG advises him that on the 90 percent 

of the income allocated to the charity previously, which is now his, 

he can claim the income is capital gains, taxable at the lower capital gains rate, rather than the higher ordinary income rate. 

KPMG approved SC2 for sale in March 2000, and over the next 

2 years sold it to about 58 corporations. This tax product became 

one of KPMG’s top tax products in the years 2000 and 2001, generVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
9

ating more than $28 million in fees for the firm. KPMG discontinued the sales in late 2001. In early 2002, the IRS asked KPMG 

to produce documents related to SC2 and is now reviewing the 

product. 

We may hear this morning that KPMG has seen the light, and 

that it and the other large accounting firms no longer develop and 

sell these types of aggressive shelters. Let’s hope that is the case. 

However, the report that we are releasing today depicts a powerful 

engine going at full speed, developing and selling 500 active tax 

products at KPMG as of February 2003. That was the response 

date for the subpoena of this Subcommittee. 

Having claimed all during this year to my staff that these tax 

products are legitimate, KPMG’s prepared testimony today is that 

the firm not only has turned off, but dismantled, that 500-cylinder 

engine. 

List me as skeptical. I am simply afraid we cannot trust the industry to police itself. 

We need to take strong and forceful action to stop the pilfering 

of our treasury and the damage to the credibility of our tax system. 

We need stronger penalties on tax shelter promoters, an end to 

auditor conflicts of interest, a better economic substance test, and 

more enforcement dollars for the IRS to go after tax shelter promoters and their abusive schemes. These and other actions are outlined in the report that my staff has released today. 

These reforms are, of course, only part of the answer. The firms 

involved in designing, hawking, and implementing these dubious 

tax products need to restore professional pride. KPMG now says it 

has stopped selling aggressive tax products. Pricewaterhouse Coopers has withdrawn from a number of transactions and refunded 

some client fees. Ernst & Young says it will no longer market certain transactions to its public company audit clients and will require those clients to obtain audit committee approval before Ernst 

& Young will sell tax shelter services to their executives. That is 

a start. 

The engine of deception and greed needs to be turned off, dismantled, and consigned to the junkyard where it belongs. That is 

what happened after the Enron collapse. Exposure helped put an 

end to some deceptive financial scams. If that is the result of this 

investigation, it will move the production and promotion of abusive 

tax shelters out of big business, although it may well be picked up 

by fly-by-night hucksters from whom such behavior is less surprising. 

Again, my thanks to you, Mr. Chairman, for your great support 

of this effort. 

Senator COLEMAN. Thank you, Senator Levin. Senator Lautenberg, would you like to make an opening statement. 

OPENING STATEMENT OF SENATOR LAUTENBERG 

Senator LAUTENBERG. Yes, thanks very much, Mr. Chairman, 

and I commend you for holding this hearing today and Thursday 

regarding the tax shelter industry. These are particularly timely 

subjects to review, and if Senator Levin had not so artfully described the way you do it—and maybe sent some people out of the 

room looking for a way to fulfill the pattern that you have deVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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scribed—I learned something this morning, and it is a very tough 

situation that we find ourselves in. 

Over the past few years, our economy has been racked by corporate and accounting scandals so big and previously unimaginable, and I come out of the corporate world and remember expressions like the Big Eight, diminished to certainly lesser status and 

prestige and respect that these large firms had. But in many cases, 

they turned out to be conspirators with companies like Enron that 

have gone belly up. People lost their jobs, their life savings, their 

retirement savings, and their faith in the fundamental fairness of 

our stock market. 

The situation worsens as we look at other organizations getting 

into places like the mutual fund industry, the New York Stock Exchange itself, all talking about concealing the truth from the public, 

hiding things. And that is where we are when we look at what has 

happened here with tax sheltering. 

The marketing, the use of questionable, even abusive tax shelters 

for individuals with very high incomes evolved, and many of the 

questionable tax shelters at issue today were created during the 

biggest, longest economic expansion in our Nation’s history. I will 

assume that the witnesses will confirm that the economic good 

times during the mid and late 1990’s created such wealth that 

there was enormous pressure to find new ways to shelter that 

wealth. So a veritable army of the best and the brightest accountants, lawyers, and investment bankers went to work on behalf of 

their high net worth clients. 

I was a corporate Chief Executive Officer for many years, and my 

company, ADP, did very well, but I am a bit old-fashioned because 

I believe that the better you do, the more taxes you should pay, not 

less. So much for progressivity. 

How much money are we talking about? According to the General Accounting Office and the Internal Revenue Service database, 

tracking unresolved abusive tax shelter cases over a number of 

years, estimates potential tax losses at about $33 billion from listed 

transactions, and another $52 billion from non-listed but questionable transactions. That is $85 billion. I want to put it in perspective. We just borrowed $87 billion from future generations to pay 

for the ongoing war and reconstruction in Iraq. It may be said that 

these tax shelters complied with tax laws and IRS regulations, but 

I think there is something inappropriate, to say the least, about 

how much time, energy and expertise is helping to save some of our 

very richest to hide more of their multimillion dollar income from 

taxation when we are notably short of funds to meet our national 

obligations, especially with young men and women in harm’s way 

who do what they do regardless of some of the economic loss that 

they experience as a result of being away from their jobs, away 

from their community, and away from their families. 

A few weeks ago I participated in a panel discussion in New 

York City hosted by Atlantic Monthly Magazine on the future of 

corporate America. There were two current CEOs also on the 

panel, and they complained about the burdens imposed upon them 

by the Sarbanes-Oxley Corporate Accountability Bill that Congress 

passed last year. My response was simply: If you tell the truth, 

then it would not have been necessary to develop the strict regime 

11

1The prepared statement of Ms. Petersen appears in the Appendix on page 275. 

that says everybody has to report along the way about what the results were. The fact of the matter is that if industry and the professionals associated with it outside of the companies, outside of the 

firms that are creating and marketing these tax shelters, if they 

will not police themselves, then the Congress is going to do it for 

them. They will not sit by while greed-fueled corporate malfeasance 

wipes out jobs, savings, and lives. 

Today’s hearing raises questions about the accounting industry’s 

role in devising and peddling tax shelters, and I hope that it is 

going to shed some light on the useful things that Congress might 

do with regard to definitions, disclosure requirements and increased penalties. Clearly though, the primary responsibility for 

cracking down on abusive tax shelters rests with the accounting 

profession itself, and I am heartened by the response of some firms, 

particularly Ernst & Young, to this scandal. But we have a long 

way to go to fix this mess. 

I thank you, Mr. Chairman, for holding the hearing. 

Senator COLEMAN. Thank you, Senator Lautenberg. 

I would now like to welcome our first panel to today’s important 

hearing. Debra Petersen, tax counsel with the California Franchise 

Tax Board; Mark Watson, a former partner with KPMG’s Washington National Tax Practice; and finally Calvin Johnson of the 

University of Texas at Austin’s School of Law. For the record, let 

me mention that Mr. Watson is appearing before the Subcommittee 

this morning under Subcommittee subpoena. 

I thank each of you for your attendance at today’s hearing and 

look forward to hearing your testimony. 

Before we begin, pursuant to Rule 6, all witnesses who testify before this Subcommittee are required to be sworn. At this time I 

would ask you to please stand and raise your right hand. 

Do you swear that the testimony you are about to give before the 

Subcommittee will be the truth, the whole truth, and nothing but 

the truth, so help you, God? 

Ms. PETERSEN. I do. 

Mr. WATSON. I do. 

Mr. JOHNSON. I do. 

Senator COLEMAN. I would note that we are using a timing system today. When you see the lights go from green to yellow, yellow 

means getting close to quitting and red means that it is time to 

quit. I would like to limit the testimony to 5 minutes, but your entire prepared testimony will become part of the official record. 

So with that, Ms. Petersen, we will have you go first this morning, followed by Mr. Watson, and finish up with Mr. Johnson. After 

we have heard all the testimony, we will turn to questions. 

Ms. Petersen, you may proceed. 

TESTIMONY OF DEBRA S. PETERSEN,1 TAX COUNSEL IV, CALIFORNIA FRANCHISE TAX BOARD, RANCHO CORDOVA, CALIFORNIA 

Ms. PETERSEN. Thank you, Mr. Chairman. I am testifying today 

on behalf of Controller Steve Westly and the California Franchise 

Tax Board. On their behalf, I would like to thank you for this opVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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portunity to give testimony on some of the most egregious tax 

scams that we have ever seen. 

In recent years the Franchise Tax Board has seen a gross proliferation of abusive tax schemes and tax shelters that have been 

aggressively marketed to taxpayers. We have been appalled at the 

positions taken to justify these transactions and schemes. These 

are designed and sold as tax-saving strategies and are veiled with 

a limited technical reading of the tax law and a flimsy excuse for 

a valid business purpose. The transactions are designed to create 

artificial losses and to make use of losses and deductions a second 

time. 

Based on the GAO’s report that you have mentioned, the $85 bil- lion report, we estimate that California’s share of that $85 billion 

is $3.5 billion. So California is very concerned about abusive tax 

shelters, and we are dedicated to cracking down on tax sheets and 

abusive tax shelters. 

In the words of Controller Steve Westly, ‘‘California loses hundreds of millions of State tax dollars each year as a result of these 

sophisticated tax schemes. This is legitimate tax money owed to 

the State of California that funds our schools, helps our elderly, 

and fuels our emergency and transportation services. With a record 

deficit currently plaguing our State, we are very motivated to pursue these cases.’’

We have already taken a number of steps to curb the promotion 

and use of these tax avoidance schemes. First of all, in 1998 we 

rolled out a computer program system that would help us to trace 

the flow-through of pass-through entity income to the ultimate person that should be reporting that income. 

Then on September 13, 2003, the State of California, along with 

33 other States, signed a memorandum of understanding with the 

Small Business Self-Employed Operating Division of the Internal 

Revenue Service. We have been, and will continue to cooperate 

with the Internal Revenue Service in the identification and audit 

of tax shelters. 

In October 2003, the Governor of California signed into legislation a bill that provides for reporting requirements, increases existing penalties, and imposes new penalties for tax shelters. Our new 

law provides for a voluntary compliance initiative, wherein taxpayers who voluntarily file amended returns and pay the full 

amount of the tax and interest related to tax shelter benefits 

claimed on their return can avoid the new and increased penalties. 

We are hoping that many taxpayers will be wise and take advantage of the voluntary compliance initiative, especially since we plan 

not to settle tax shelter issues. Our bill was modeled after the Tax 

Shelter Transparency Act, and we hope that Congress will pass 

this legislation at the Federal level in the near future. 

We also passed legislation that would shut down one of the most 

egregious tax avoidance scams that we have ever seen. We saw 

banks form solely-owned registered investment companies for the 

purpose of paying no State income tax on their earnings on their 

loan portfolios. Contrary to the spirit and the intent in the Investment Act of 1940, they have registered these companies solely to 

avoid State income tax. We worked in cooperation with the Securities and Exchange Commission on that issue. 

13

1The prepared statement of Mr. Watson appears in the Appendix on page 285. 

Our Executive Director, Gerald Goldberg, chairs the Corporate 

Income Tax Shelter Working Group of the Multistate Tax Commission. Some of the goals of the working group is to share information among the States regarding tax shelters and abusive tax 

transactions, and to develop anti-abuse legislative tools. Apart from 

the MTC, the State of California has been working directly with 

several States to coordinate information about State level tax shelters that we have encountered. 

While we are pleased with the progress that we have made to 

identify and close down tax shelters, we think that more needs to 

be done in order to prevent creative minds from formulating new 

shelters and schemes that circumvent tax laws. We need to focus 

more on promoters and tax return preparers who sign tax returns 

without proper disclosure, and in some cases attempt to bury transactions on tax returns. Imposing penalties, however stiff, is not 

good enough. The preparers count on the audit lottery. Even 

disgorgement of the profit made on the transaction is not enough 

to discourage these practices. If the preparer is caught 1 in 10 

times, then 9 out of 10 times they win. So even if they have to pay 

back $1 million out of $10 million that they earned on the promotion of a shelter, they still come out $9 million ahead. In addition, the firms very often have insurance to cover themselves on 

these transactions. 

Second, we would like to see the registration exemptions be examined to see whether they should be removed for these types of 

transactions. Requiring registration of the 1933 Act and other acts 

will provide disclosure of more information about the transactions 

and will cost the promoter more. The fact that the tax laws required registration under the Investment Act of 1940 in order to 

conduct the scam that they were trying to do with their loan portfolios enabled us to see that transaction at an early stage, and were 

able to shut it down. 

Senator COLEMAN. Ms. Petersen, I ask if you could summarize 

here. 

Ms. PETERSEN. Sure. We would also like to see some whistleblower statutes to encourage good and honest people to come forward with information that would help us to find these shelters. 

Finally, we need to beef up the enforcement agencies. We had 

one prominent California tax litigator note that the reason that we 

were seeing so many shelters is that ‘‘the enforcer had backed off.’’ 

Clearly we need to have enforcement activity in order to encourage 

self-compliance. 

Senator COLEMAN. Thank you, Ms. Petersen. Mr. Watson. 

TESTIMONY OF MARK T. WATSON,1 FORMER PARTNER, WASHINGTON NATIONAL TAX PRACTICE, KPMG, LLP, WASHINGTON, DC 

Mr. WATSON. Chairman Coleman, Senator Levin, and Members 

of the Subcommittee, good morning. 

My name is Mark Watson. I am here today to provide information to the Subcommittee regarding my experience working at 

KPMG. In particular, I understand that the Subcommittee wants 

14

1The prepared statement of Mr. Johnson appears in the Appendix on page 286. 

me to address certain tax strategies that were approved and implemented during my tenure at KPMG. 

Before answering the Subcommittee’s questions, please let me 

give a brief description of my background and my role at KPMG. 

I am a graduate of Texas A&M University, where I received a 

bachelor’s degree in finance and a master’s degree in tax. 

In 1992, I joined KPMG as a staff accountant in their personal 

financial planning practice, and I was located in the Houston, 

Texas office. In 1994, I came to Washington on a 2-year rotation 

in KPMG’s Washington National Tax Practice, which was the 

group responsible for providing technical tax support to KPMG’s 

field offices. In 1996, I moved to KPMG’s Dallas Field Office, where 

I continued to work in the personal financial planning practice. 

KPMG promoted me to partner in 1997. 

I returned to Washington in 1998 as the partner in charge of the 

Personal Financial Planning Group within the Washington National Tax Practice. I developed significant experience in the areas 

of individual income tax, fiduciary income tax, and estate and gift 

taxes, as these were the areas of focus for the Personal Financial 

Planning Group at that time, and that group provided technical tax 

support to KPMG’s field offices regarding those matters. 

Also at around this time, KPMG’s Washington National Tax 

Practice assumed the additional role of participating in the review 

and analysis of potential tax strategies that were to be sold and 

marketed to KPMG clients and others. 

When I was in the Washington National Tax Practice I reported 

to Phil Wiesner, who was the partner in charge of that practice at 

that time. I also reported to Doug Ammerman, who was the partner in charge of KPMG’s Personal Financial Planning Practice. 

During this time the Personal Financial Planning Group of the 

Washington National Tax Practice was comprised of approximately 

eight individuals, and I was responsible for supervising those individuals. 

In the summer of 2000, KPMG transferred me out of the Washington National Tax Practice on a 2-year overseas assignment. 

After I completed that overseas assignment, rather than return to 

a position in the Personal Financial Planning Practice, I decided to 

leave KPMG. Today, I continue to work in the tax area, focusing 

on estate planning. 

I would now be happy to address any questions that the Subcommittee may have. 

Senator COLEMAN. Thank you. Mr. Johnson. 

TESTIMONY OF CALVIN H. JOHNSON,1 ANDREWS & KURTH 

CENTENNIAL PROFESSOR, THE UNIVERSITY OF TEXAS AT 

AUSTIN SCHOOL OF LAW, AUSTIN, TEXAS 

Mr. JOHNSON. My name is Calvin Johnson, and I teach tax and 

accounting at the University of Texas in Austin. 

My general conclusion is that tax shelters have done real damage 

to the national tax system. Former IRS Commissioner Charles 

Rossotti, said that the IRS is losing the war on tax compliance. 

Some 80 percent of the most sophisticated taxpayers are avoiding 

15

their share of tax, he said. And I think that the figures support 

that assessment. Real or effective tax rates are running at a maximum of 10 percent for corporations and investors, and these are 

the people that Congress wants to and needs to tax at 35 percent. 

The tax system is not in healthy shape. 

Every day a cadre of well-trained, well-paid, highly-motivated tax 

professionals have been launching vicious attacks on the tax base, 

and they have done considerable damage. KPMG charged over $80 

million for its BLIPS and SC2 shelters. We can be confident that 

they destroyed many times that in terms of tax. Uncle Sam seems 

to be losing the war against tax shelters. 

I have two short comments on remedies. The first one is on retroactivity. KPMG sold a shelter called BLIP or Son of Boss, which 

depended upon the creation of artificial accounting losses by having 

real liabilities, real economic liabilities assumed, be ignored for tax 

purposes. The tax law was said to be blind to the assumption. Congress fixed the problem by retroactive amendment of the Internal 

Revenue Code, and then Treasury fixed the specific problems of 

BLIPS with a retroactive amendment to the regulations going back 

for 4 years. 

I applaud the retroactive cure. The statute that BLIPS attacked 

was drafted by the best minds in the country right before the Internal Revenue Code of 1954, spending a lot of time and deliberation 

on this system. Sometimes a vicious attack like BLIPS opens up a 

hacker’s windows in the best-designed system in the world. Sometimes it does not, but the litigation is required and the long war 

of litigation prevents full enforcement of the law. Congress has to 

react by fixing the hole retroactively. 

I hope that the Treasury and the Congress will also fix the socalled SC2 shelter retroactively to deny all of KPMG’s customers 

any tax benefits. SC2 creates a second class of stock which sub-S 

corporations are prohibited to have because it tries to separate the 

tax on the income from the ownership of the underlying capital. 

SC2 also separates the tax from the real economic ownership of the 

income. 

Going beyond the specific shelters, I would hope that the IRS 

and Congress would set up a joint institution to conduct legislative 

audits. The office would have the duty of fixing the tax law when 

the shelters have ripped it open. Litigation is a long and ugly process. Far better to cure the rips the shelters have caused by retroactive fixes. 

My second comment is on auditor independence. An auditor, a 

CPA, has to have an attitude of extraordinary skepticism, even 

hostility, to the firm that it is auditing. Nothing else will satisfy 

the zealous loyalty to investors and to the capital markets that 

CPAs must have. In this post-Enron world, CPAs cannot be offering tax shelters or business advice. The CPAs are trying to be both 

the cop, the FBI Task Force, and also the consigliore to the very 

same don, to the very family at the very same time, and it does 

not work. They are not helping the public investors in the capital 

market. 

The remedy is simple. Firms auditing SEC statements need to 

separate their auditing and advising functions into two unrelated 

companies by spinoff or sale. In fact, I believe that under current 

16

law, the Sarbanes-Oxley Act, accounting committees may not approve for the sale, the purchase of a tax shelter from their auditing 

CPA. It is a violation of their duty to ensure independence and 

none of them should ever be approved. I think the auditing committees are going to face personal liability every time they say yes 

to these under any circumstances. 

Thank you very much. 

Senator COLEMAN. Thank you very much, Professor Johnson. 

Professor Johnson, my first question will be to you. How would 

you grade Senator Levin’s description of BLIPS? [Laughter.] 

Mr. JOHNSON. I thought it was superb. This man can come down 

and teach my class, and bump me for a while. 

Senator COLEMAN. Thank you. 

Senator LEVIN. I was going to say thanks for asking, but I was 

not sure what the answer was. 

Mr. JOHNSON. I’m on your side. 

Senator COLEMAN. Ms. Petersen, in your prepared testimony you 

talked about BLIPS transactions lacking economic substance. Can 

you further explain that? What does it mean to lack economic substance? 

Ms. PETERSEN. Economic substance has a number of tests that 

you look at. One is that there are no economic advantages other 

than the tax savings. The tax benefits outweigh the economic risks 

and the potential profit, and third, that there’s no business purpose 

separate from the tax consequences. So usually there’s just no justifiable business purpose for the transaction other than to reduce 

taxes, and the transaction usually lacks the potential to generate 

a profit. 

Senator COLEMAN. We focused today on BLIPS and SC2. Clearly 

though there are a range of these schemes that are out there: 

COBRA, which was marketed by Ernst & Young; Son of Boss, 

which was marketed by Pricewaterhouse Coopers. Do they all bear 

the general characteristics that you testified to today? 

Ms. PETERSEN. Yes. In each of those cases you can see where 

they’re trying to create an artificial or non-economic loss, and very 

often they will use different mechanisms to be able to inflate, in 

those situations, the basis of a pass-through entity, so that the 

owner gets a higher basis than they should normally be entitled to 

without any risks, and then they go and claim that as a loss when 

they dispose of the——

Senator COLEMAN. So you have it within the industry—first, let 

us back it up. People made a lot of money in the 1990’s. 

Ms. PETERSEN. Yes. 

Senator COLEMAN. There is a lot of cash out there. And you have 

within the industry, either a loophole in the law or blinders on the 

law enforcers. A whole industry is saying, we can come up with 

ways in which there is very little risk, but an opportunity to write 

off massive loss. Would that be an accurate assessment? 

Ms. PETERSEN. That is correct. 

Senator COLEMAN. Aside from holding the tax preparers accountable, how do we prevent this? Many of these firms have come and 

said, we do not do this any more, they have acknowledged this as 

headed down the wrong path—but how do we stop this tomorrow? 

What is it that we need? You talked about a Taxpayer TransVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
17

parency Act. Would it be your testimony that a Taxpayer Transparency Act are things that we can do to prevent this in the future? 

Ms. PETERSEN. Yes, very definitely that would help, but we 

would also like to see—I think Mr. Johnson may have touched 

upon this—Sarbanes-Oxley Act, that same concept, extended to tax 

return preparers, to say, if you’re going to sell and market these 

shelters, then you cannot sign the tax return for the taxpayer investor that’s claiming those. You need to send them to another 

firm. Let another firm take an independent look at the transactions 

and make the adequate disclosures on there. 

We would like to see some sort of a licensing or registration of 

tax return preparers, because until you are able to take away their 

ability to do their profession, if you’re only looking at penalties, 

they’re going to continue to do what they do as long as economically it makes sense to do that. 

And we would like to see the ethical standards raised for tax preparers. Right now they have this idea that as long as it’s not illegal 

or there’s nothing that blatantly tells them you cannot do this particular thing, they’re going to go ahead and try and take those positions, and so we really need to have them come up on their standards and try to support the whole spirit and the purpose of the 

laws. 

Then we’d like to see publication of a list of opinion providers, 

whose opinions are really inadequate. Sometimes these opinions 

mislead the person that they’re giving the opinion to, to think that 

they’re going to be able to avoid penalties, when the reality, they’re 

kind of circular. They rely strictly on the taxpayer making representations. And that’s how the opinion is given. So we would like 

to see, as we find these firms that give faulty opinions, to publish 

that, let the public be put on alert that they can’t rely on those 

opinions issued by those firms. 

We also see great abuse with the fee structure. Some of the firms 

use contingency fees, meaning up front they’ll go in and sell the 

work that they’re going to do and say, we’ll take a percentage of 

the benefits that you get derived from that——

Senator COLEMAN. You have any problem with firms marketing 

SC2? I mean my sense is that with SC2 in particular, they are 

doing cold calling out there to Subchapter S corporations. You have 

a concern with that? 

Ms. PETERSEN. Yes. You’re talking about companies that probably wouldn’t otherwise be looking to get in these types of investments, now feeling the pressure that everybody’s doing this, that 

they ought to take advantage of this, and they might not have otherwise thought of this. 

Senator COLEMAN. Let me ask you one other question. What is 

the culpability to the taxpayer in these schemes? 

Ms. PETERSEN. Well, the taxpayer is going to have to pay back 

the amount of tax that they sheltered, that was incorrectly sheltered, and then they’re going to also be subject to potential penalties. Right now California probably has stiffer penalties than the 

Feds do because we enacted our legislation and you haven’t enacted 

that yet. 

18

Senator COLEMAN. But do you absolve them of culpability if they 

have an opinion from their accounting firm, they have a legal opinion, typically from a law firm in these cases—and we are going to 

examine that more on Thursday—in spite of that, do they still have 

culpability? 

Ms. PETERSEN. They may, because even though they might try 

to rely on the opinions, if the opinion is faulty or if it is issued by 

someone that has promoted that particular shelter, we’re going to 

look at it and say that your reliance is invalid and that you can’t 

do that. 

Senator COLEMAN. Mr. Watson, I want to focus a little bit on 

your knowledge of and involvement in dealing with BLIPS in particular. Did you have a chance to review the BLIPS transactions 

when this concept was being developed? 

Mr. WATSON. Yes, I did. 

Senator COLEMAN. Who was responsible? I presume there had to 

be some discussion, when you were establishing something like 

BLIPS, somebody had to be saying, well, is it legal? Is it not legal? 

Can you talk to me how that worked within the firm? 

Mr. WATSON. Sure. Perhaps I should just overview the process 

that we went through to review and approve BLIPS. BLIPS was 

one of the first tax strategies that was put through KPMG’s newlystructured review process, and that new review process was implemented probably in the fall of 1998. The review process involved 

KPMG’s Washington National Tax Office, the Tax Innovation Center, which was recently created, and KPMG’s Department of Professional Practice. 

The Washington National Tax Office’s role was to review, and if 

possible, approve a tax strategy based on the applicable tax law. 

So that’s where the legal analysis was made. 

The Tax Innovation Center was there to really facilitate the review process in the sense of making sure that adequate resources 

were available and then participating or helping with the development of marketing materials and the deployment of approved strategies. 

And finally, the Department of Professional Practice’s role was to 

determine that, if a tax strategy was approved by the Washington 

National Tax Office, whether the business risks associated with 

that strategy were appropriate for KPMG to be involved with, and 

they also made sure that the auditor independence rules were sufficiently addressed. 

So that’s how we went through the review process. We really had 

three different groups looking at the various issues, both from a tax 

standpoint and from a business risk standpoint. And to answer 

your question, yes, these issues were debated, they were examined 

at some length. And in fact, the review process with BLIPS officially started on February 11, and after numerous meetings, numerous e-mail messages and hundreds of hours of tax research, it 

was finally approved around May 10, 1999. 

Senator COLEMAN. According to judicial precedent, there must be 

reasonable opportunity to earn pre-tax profit. Do you believe that 

the BLIPS transaction allowed for this, and if not, why not? 

Mr. WATSON. That was my primary concern with the BLIPS 

transaction. I was never comfortable that BLIPS provided a reasonVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
19

1See Exhibit No. 80 which appears in the Appendix on page 664. 

able opportunity to make a reasonable pre-tax profit, and I didn’t 

believe that it could make a reasonable pre-tax profit primarily because of what Senator Levin disclosed in his opening statement, 

that very little of the proceeds were going to be invested in a manner that could generate a sufficient rate of return. 

Senator COLEMAN. And you in fact sent out an e-mail raising this 

issue; is that correct? 

Mr. WATSON. Yes, sir, that’s correct. 

Senator COLEMAN. I have a copy of it. It is Exhibit 80,1 and if 

staff could give Mr. Watson a copy. It is an e-mail dated Wednesday, May 5, 1999, 9:21 a.m. In that you say, ‘‘According to Presidio, 

the probability of making a profit from this strategy is remote, possible but remote. Thus, I don’t think a client’s representation that 

they thought there was a reasonable opportunity to make a profit 

is a reasonable representation. If it isn’t a reasonable representation, our opinion is worthless.’’

Can you talk to me about Presidio’s role? Did you have an opinion from Presidio as to what they thought of this transaction? 

Mr. WATSON. Yes. This e-mail message was the result of a meeting that I attended on April 30 and May 1, 1999, where Presidio, 

members of Presidio, were present to explain the investment strategy, in essence, to the partners who were going to be selling this 

transaction. 

Senator COLEMAN. Can you explain again Presidio’s involvement 

in the transaction? 

Mr. WATSON. Presidio was the investment adviser. They arranged for the investment side of this transaction to take place. 

Senator COLEMAN. In the KPMG tax opinion that I have had a 

chance to review, Presidio represents there is a reasonable opportunity for pre-tax profit. My question is, does this representation 

seem credible based on the May 5 e-mail? 

Mr. WATSON. It did not seem credible to me, no. 

Senator COLEMAN. Can you explain how they got there? 

Mr. WATSON. Senator, I don’t know how they go there on this 

issue. This was my primary concern and the reason I continually 

raised the issue with Mr. Wiesner and Mr. Smith, but they decided 

that this was a reasonable representation and that the opinion letter could be issued. 

Senator COLEMAN. I also understand that you were concerned 

about who was the borrower in the BLIPS transaction and the fact 

that the bank required the loan to be paid in 60 days. Can you explain the significance of these issues and why you feel they negatively impacted KPMG’s ability to issue an opinion to its clients? 

Mr. WATSON. Well, the who’s the borrower issue really related to 

whether you could get the basis with respect to the premium, in 

other words, the $20 million loss that Senator Levin described. We 

were concerned that the individual taxpayer would not be treated 

as the true borrower, but rather the investment fund itself would 

be treated as the true borrower, because the bank really had significant restrictions on the use of the money. It was just really 

transferred from one account at the bank to another account at the 

bank in a very short period of time. So we feared that an easy atVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
20

tack on this transaction was for the IRS to just argue that the taxpayer never really borrowed the money, and therefore there is no 

basis for which to claim a loss. 

Senator COLEMAN. Were these concerns ever resolved to your satisfaction? 

Mr. WATSON. Not to my satisfaction, no, and nor to Mr. Rosenthal’s satisfaction, who expressed some significant concerns specifically on who’s the borrower issue. 

Senator COLEMAN. Two other questions, three questions. Who is 

Larry DeLap? 

Mr. WATSON. Mr. DeLap was the partner in charge of KPMG’s 

Department of Professional Practice for the tax practice at that 

point in time. 

Senator COLEMAN. Do you recall a telephone conversation with 

Larry DeLap, during which you indicated to him that all of your 

concerns were resolved regarding the BLIPS transactions? 

Mr. WATSON. I don’t recall that conversation, Senator. It may 

very well have taken place, and in fact, I will assume that it took 

place, but I’m quite certain that I did not tell Mr. DeLap that I was 

comfortable with the BLIPS transactions or that all my concerns 

had been resolved, and in fact that’s completely inconsistent with 

the e-mail messages that I wrote both before and after the date of 

this purported conversation. 

Senator COLEMAN. The last question, and we will do another 

round. Do you consider it unusual for KPMG to go forward with 

the strategy despite the fact that several technical partners, yourself, apparently Mr. Rosenthal, had significant problems with it, 

and if so, why do you believe they went forward with it anyway? 

Mr. WATSON. Well, I was disappointed with the decision, but 

again, a lot of people were involved in this review process, a lot of 

smart partners with significant experience, including Mr. Wiesner, 

Mr. Smith, Mr. DeLap, and Mr. Eischeid. And so, when they decided that, despite our reservations, despite our concerns, to move 

forward, there was really nothing left for me to say. 

Senator COLEMAN. Senator Levin. 

Senator LEVIN. Let me go through some of those e-mails with 

you. On May 7 and May 10, you and Mr. Rosenthal, that is Steve 

Rosenthal, met with Mr. Wiesner and Mr. Smith to discuss your 

concerns. Mr. Wiesner announced apparently at that point that the 

decision was made to move forward with BLIPS. What took place 

at those meetings? Did you express your problems with this BLIPS 

deal? 

Mr. WATSON. I recall that we met to discuss my concerns and 

Mr. Rosenthal’s concerns regarding economic substance and who 

was the borrower. I wouldn’t describe the meeting as a substantive 

conversation, but we did lay out our concerns, and Mr. Smith and 

Mr. Wiesner did respond with why they thought it was not a problem, cited some cases, which Mr. Rosenthal later researched and 

replied that he was still not comfortable with the who’s the borrower issue. 

Senator LEVIN. There are two distinct problems that you had, is 

that correct? One was who was the borrower. 

Mr. WATSON. Correct. 

21

Senator LEVIN. It was your conclusion that there were grave 

doubts that the borrower here was the taxpayer; is that correct? 

Mr. WATSON. I was concerned about that, yes. 

Senator LEVIN. When you say you were concerned, you indicated 

in your e-mails and otherwise, as I understand it, that the borrower here was really effectively the partnership if there was any 

loan at all. Is that correct? 

Mr. WATSON. That’s what I was afraid of, yes, that the conclusion 

would be that the partnership borrowed the money and not the individual taxpayer. 

Senator LEVIN. That would be because? 

Mr. WATSON. That would be because the bank controlled the 

funds and the taxpayer actually never received the funds. 

Senator LEVIN. There was, in addition to that question—assuming there was a loan, who was the borrower—there was the underlying question of whether or not there was a loan at all. Is that correct? 

Mr. WATSON. Yes. That was a concern as well, whether this was 

truly a bona fide loan. 

Senator LEVIN. The reason that you had doubts about that was 

because? 

Mr. WATSON. Again, because of the significant restrictions placed 

on the loan proceeds. 

Senator LEVIN. Would you list those restrictions? 

Mr. WATSON. I think you adequately listed it. It was the collateral requirement that was contained in the loan documents that in 

essence prohibited those loan proceeds from being invested in any 

manner other than money market type instruments. 

Senator LEVIN. The collateral requirement was for how much? 

Mr. WATSON. At least 101 percent, if I recall correctly. 

Senator LEVIN. Ms. Petersen, let me ask you about both BLIPS 

and SC2. Before I do that, let me just go back. 

Is it fair to say, Mr. Watson, without going through all of the emails, that you expressed your problems with BLIPS on a number 

of occasions in a number of ways to Mr. Wiesner, Mr. Eischeid, and 

Mr. DeLap? 

Mr. WATSON. Yes, sir, it is, numerous times. 

Senator LEVIN. Now let me go to Ms. Petersen. 

I want to get yours and the other witness’s quick assessments of 

the two tax products that we are focusing on here today, BLIPS 

and SC2. In your opinion, do these two tax products comply with 

Federal tax law? 

Ms. PETERSEN. No. 

Senator LEVIN. Mr. Watson. 

Mr. WATSON. I think they comply with a technical reading of 

Federal tax law, yes. I did not think these were fraudulent transactions. But as to BLIPS I did not believe that it met the standard 

of more likely than not primarily because of the economic substance issue. 

Senator LEVIN. And more likely than not would mean that you 

did not believe it was more likely than not that they would be sustained in a court? 

22

1See Exhibit No. 1c. which appears in the Appendix on page 384. 

Mr. WATSON. Correct, that they would be—that the tax results 

would be sustained by a court of law if challenged by the Internal 

Revenue Service. 

Senator LEVIN. Mr. Johnson, in your judgment were these two 

tax products in compliance with Federal law? 

Mr. JOHNSON. I think the IRS can beat them. 

Senator LEVIN. Should they beat them? 

Mr. JOHNSON. Oh, absolutely. 

Senator LEVIN. If we look at the chart with the three mass marketing quotes on them, I think this is Chart 3. I am sorry, it is 

Chart 1c.1 I gave the wrong number. 

The first line is from a KPMG e-mail: ‘‘Look at the last partner’s 

scorecard. Unlike golf, a low number is not a good thing. A lot of 

us need to put more revenue on the board.’’ This is talking about 

tax shelter sales. 

Another internal KPMG e-mail: ‘‘Sell, sell, sell.’’

A third KPMG e-mail: ‘‘We are dealing with ruthless execution, 

hand-to-hand combat, blocking and tackling. Whatever the mixed 

metaphor, let’s just do it.’’

Professor Johnson, what is your reaction to that kind of culture? 

Mr. JOHNSON. Certainly not surprise. KPMG’s assessment is 

they’re making a lot of fees and that the penalties that will be incurred on them are not high enough going to stop them. Oliver 

Wendell Holmes said that it’s a case of holding in the bad man. 

You simply can’t rely on an ethical role. The penalties of money or 

maybe a little bit of jail time are the only thing that are going to 

do it. 

Senator LEVIN. Ms. Petersen, what is your reaction to those kind 

of comments? 

Ms. PETERSEN. I think it is just reflective of the greed of the 

firms, the desire to make as much money at any cost that they possibly can. 

Senator LEVIN. I want to get a little more detail from you, Ms. 

Petersen, about the BLIPS shelter. You testify about it in your 

written testimony, but you did not get into it in any detail. You did 

in response to the Chairman’s question a bit, and I want to press 

you a little more on that. In your review of BLIPS, would you go 

into the question of whether or not there was economic substance 

in a little more detail than you did to the Chairman’s question? 

Ms. PETERSEN. I think you described in great detail of how the 

transaction is put together. 

Senator LEVIN. Would you describe it in your words though, 

whether or not you believe there was economic substance? 

Ms. PETERSEN. I don’t think there is economic substance to that 

transaction. Again, the only way that they are creating that loss 

is not because the investor or the taxpayer was out $20 million, because they borrowed everything. They only got there as a phony 

paper loss. So they inflated the basis of the partnership or passthrough entity’s based and then took that as a loss. It had nothing 

to do with the amount of money that was invested by the taxpayer. 

Senator LEVIN. You have done some examinations, I believe, of 

the BLIPS transactions; is that correct? 

23

Ms. PETERSEN. I’ve looked at the BLIPS transaction, yes. 

Senator LEVIN. Have you seen any taxpayers who made a profit 

as an investment? In other words, putting aside the tax benefit 

here, the tax loss, which was created by this shelter, did you see 

any taxpayers who made a profit on that small investment portion 

that they put in? 

Ms. PETERSEN. I don’t recall. I can tell you that these things 

were very short-lived and came and went over maybe a 60-day period of time. 

Senator LEVIN. Was the loan ever at risk here, the so-called loan 

ever at risk? 

Ms. PETERSEN. Looking at the terms of the loan and the restrictions on that loan, no, I don’t think so. 

Senator LEVIN. Also looking at the collateral requirement? 

Ms. PETERSEN. The collateral requirement, that’s right. 

Senator LEVIN. Where was that loan? Was that not retained in 

the bank? 

Ms. PETERSEN. I don’t know. 

Senator LEVIN. Was the loan needed for that small investment 

that was there? I know it was needed obviously to create the tax 

loss, but in terms of the small investment portion of this deal? 

Ms. PETERSEN. No. It was only there just to create the loss. 

Senator LEVIN. It was what? 

Ms. PETERSEN. Only there just to create the loss. 

Senator LEVIN. Did you have a chance to review the opinions 

that were issued by KPMG relative to this shelter? 

Ms. PETERSEN. Yes, I did. 

Senator LEVIN. Based on that review, do you think that the 

KPMG BLIPS opinion letter was one that a client could gain some 

assurance from? 

Ms. PETERSEN. The difficulty I found with that opinion letter is 

that it relied very heavily on representations, and in particular on 

a representation made by the taxpayer, that they had reviewed the 

economics of the transaction, and they made a statement that they 

were going to be able to make a profit. But you have to question 

whether the taxpayers themselves really understood the complexities of these transactions to be able to make that determination. 

In that opinion, there’s about 16 pages discussing economic substance, and the conclusion of it is strictly based on the representation that was made by the taxpayer. 

Senator LEVIN. On the SC2, you mentioned in your written testimony that the SC2 opinion letters that you reviewed were ‘‘grossly 

deficient.’’

Ms. PETERSEN. Yes. 

Senator LEVIN. Can you elaborate on that point, to be my final 

question for this round? 

Ms. PETERSEN. Well, the opinion letters that I saw dealt with 

some of the code sections, but failed to really address any of the 

tax doctrines that we look at in these cases. So they didn’t talk 

about step transaction. They didn’t talk about assignment of income. They didn’t talk about those doctrines which is what you 

have to look at to say, does this thing hang together or not? They 

didn’t address economic substance. They didn’t address any of 

those types of things, just went down through a series of code secVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
24

tions. Well, we can do this here. Here’s a case that we think we 

don’t meet the facts of those cases, and we think we’re clean on 

this transaction. 

Senator LEVIN. In your judgment were they grossly deficient? 

Ms. PETERSEN. Yes. 

Senator LEVIN. Thank you. My time is up. 

Senator COLEMAN. Thank you, Senator Levin. Senator Lautenberg. 

Senator LAUTENBERG. Thanks, Mr. Chairman. 

I am a little bit more interested in how we got to where we are 

because of the criticism I hear from my former colleagues in the 

corporate world, that the government is complicating life so much 

and interfering in many ways with their ability to make forecasts, 

etc., all of which I consider as part of an incredible conspiracy to 

deceive the public and the government. 

I am kind of curious about how were colleagues of yours in the 

accounting world seduced into cooperating with these deceptions 

we saw out there? What kind of devices were traditionally used to 

say, to exchange it for simply a pat on the back as it used to be 

for a good job? How much of this was affected as a result of the 

division of the firm into essentially two principal parts, one the auditing side and the other the consulting side? 

Mr. WATSON. First, with respect to your question about the auditing and consulting side, I had no involvement with the audit 

practice so I can’t answer what kind of activity was taking place 

in the audit practice. My experience was solely limited to the tax 

practice. 

With respect to your question about how professionals were seduced, I don’t know that professional were seduced, per se. There 

certainly was a tremendous amount of pressure being applied from 

the leadership at KPMG to review, and if possible, approve these 

transactions, because they had tremendous marketplace potential 

to generate revenue for KPMG. Nonetheless, I feel, at least based 

on my experience, that, with the exception of economic substance 

in the case of BLIPS, a thorough review was applied and the professionals did act in a professional manner to reach their conclusion. 

Senator LAUTENBERG. Mr. Johnson, do you have any knowledge 

or observation about what it is, what happened when the accounting firms split their business? Was that then a lead in to sharing 

the profits more directly, as opposed to simply the audit function 

which made sure the books were presented honestly? We saw a 

huge change in character during this period of time, and I am wondering where it went wrong. I did a lot of work for the accounting 

firms in my former corporate life. 

Mr. JOHNSON. I think the bottom is obviously money. There is an 

awful lot of money to be made by beating the IRS, and the IRS is 

perceived increasingly as being a paper tiger that doesn’t have 

enough smarts, doesn’t have enough ability to stop anything. If the 

IRS is going to leave millions of dollars hanging around on the 

table, then I think their perception is all they’re doing is going in 

and picking it up. 

There is no question that the accounting firms are now considerably compromised in their independence. They’re supposed to be 

25

very skeptical about the firms that they’re auditing. They are serving the investing public to ensure fair disclosure. I think the country was utterly shocked by Arthur Andersen, the one that had the 

best reputation of all, to find out that firm was teaching Enron how 

to make their financial statements absolutely meaningless by guiding them through the elaborate mine field set up by accounting 

standards to protect investors. 

I don’t think the accountants understand the degree of righteous 

anger that investors have against firms like Arthur Andersen. 

Enron went from the 7th largest company in the country to overnight being absolutely worthless, and all who touched Enron lost 

their nest eggs, lost their life savings. And Arthur Andersen helped 

them do it. They were supposed to be the cops. They were supposed 

to be somebody that you could depend on. They were supposed to 

be the sign of absolutely moral rectitude, and it turns out that they 

were co-conspirators. They had been co-opted and captured in full. 

There is no question that this making a lot of money, giving advice, 

selling sleazy tax shelters to the client is utterly inconsistent with 

their cop role, and I think the cop role has been utterly compromised. I think that accountants simply have no business having 

that business advisory function and the cop function within the 

same firm. They’ve got to split up, they’ve got to spin off or sell. 

We depend on the accountants’ credibly to ensure that we’re getting good financial statements, and those people are turning out to 

eat too many donuts. The cops are eating too many donuts. 

Senator LAUTENBERG. There is a lot of slippage here, and it is 

discouraging and demoralizing for the public. What do they do? 

They see their pension fund evaporating in front of their eyes, and 

much of that is caused by this incredible greed culture which has 

developed in the country, where a CEO comes in and signs a 5-year 

contract, and is forced emotionally and financially to say, if you do 

not join in you are kind of maybe stupid. Join in. Get your stock 

price up. Forget about what the company is going to look like 5 

years, 10 years from now, what you turn over to a successor when 

that happens, because inevitably it does, and the bonuses are in 

the so many millions that it is hard to conceive that that could be 

created without permanently damaging the companies, and it has 

in many instance. 

There was a comment made about board members. I predict that 

one day you will see a class of professional that works exclusively 

boards, because otherwise you cannot get someone to leave their 

regular business responsibilities, come over, join in, take a hit if 

one occurs by permitting something to sneak through, and I think 

that that cozy cooperation between a board and the CEO or the 

chairman or whomever makes these recommendations for board 

memberships is going to find that there are not people around who 

they can be so proud of to come along and join their boards unless 

the protections are so high that it alters the thinking function of 

the board member. 

What do we think about expanding, as Ms. Petersen said, the 

Sarbanes-Oxley Act requirements to the accounting function? Is it 

a good idea for government to get more involved at this juncture. 

How do we cure the problem that we have? This is not simply the 

tax shelters, and that is what I said initially, and that is to make 

26

sure that the public is getting a fair shake on the information on 

the data they receive. 

Mr. JOHNSON. I think separating the auditing function and business advising functions is a first step, an absolutely mandated first 

step, that you can’t be simultaneously trying to help and trying to 

be a cop against an audited firm. 

Senator LAUTENBERG. Ms. Petersen, do you have a view? 

Ms. PETERSEN. I think I gave my comments, but I think you need 

to remember that the firms have a tax preparer side, so there’s the 

tax side, there’s the auditing side. They may have business consulting. And what we’re missing is looking at the tax return preparers, and that’s the concern we have, is what are those preparers 

doing? What are their duties? What are the requirements on them? 

Senator LAUTENBERG. What are their opportunities? That is the 

question, you see. 

Ms. PETERSEN. Their opportunities are great. 

Senator LAUTENBERG. Yes. The opportunities for deception, there 

is almost a demand out there to see how clever you can be and 

avoid paying tax, and I find it irritating. Again, having spent 30 

years of my life in the corporate world gives me a little bit different 

insight, and I believe that if you make it, you pay, and that is the 

way it ought to be, fairly straightforward. I see the Center for 

Budget Policy Priorities, a research group, said preliminary tax for 

this year indicate corporate taxes account for just 7.4 percent of 

total tax receipts, down from in the 1960’s when it was 21 percent 

of total receipt. I do not say that 21 percent should be the mark 

we are trying to toe, but there has been far less required of wealth 

taxpayers now than there perhaps has ever been. It is not fair and 

deprives us of revenue opportunities. 

The fact is that my time has expired. [Laughter.] 

Thank you very much. 

Senator COLEMAN. Thank you, Senator Lautenberg. 

Mr. Watson, I think you indicated in response to Senator Levin’s 

question that you thought the BLIPS was thoroughly reviewed? 

Mr. WATSON. With the exception of the economic substance issue, 

yes. 

Senator COLEMAN. I am trying to understand how we get from 

a thorough review of very bright professionals, where there clearly—I am not an accountant. I did not do too well in math—and as 

I look at this, I ask where is the substance? Where is the risk? I 

am trying to understand how we got there. In fact, let me direct 

this question to Mr. Johnson. I will come back to you, Mr. Watson. 

Professor Johnson, is it your sense, Professor, that what you 

have here is kind of a risk versus benefit kind of analysis. The risk 

is a buck, the benefit, whether caught or not caught is 10 bucks. 

So why not do it? Is that your sense? 

Mr. JOHNSON. Absolutely. Phil Wiesner is not a rogue elephant. 

He’s not an unusual member of this community. He is core to management. This is a KPMG official decision by the core of management, and it’s really unfair to consider this to be an aberration. It’s 

not an aberration. It is a system, people reacting to the system in 

places in which the penalties are very low, trivial, nonexistent, and 

the rewards of not paying tax are very high. I’m not sure we should 

27

get moralistic. It’s just a matter of creating the right system incentives and throwing some people in jail. 

Senator COLEMAN. But is this because the law allows it? I mean, 

again, this is not just KPMG, it is all the firms. Ms. Petersen 

talked about a variation of these, opportunities for folks to wipe 

their loss off the books and avoid paying taxes. Is it because the 

law allows it or because the IRS does not catch it? 

Mr. JOHNSON. Well, it’s a combination of both. They’re finding—

they’re creating hacker’s windows. The tax law looked like it was 

beautiful and a good safety net, and worked and fully described, 

and then—these are very highly motivated, very well trained, very 

well paid professionals who are sitting there in a skunk works full 

time. The best minds of our generation are now spent in skunk 

works tax shelters. Sometimes they work, or at least they appear 

to work. 

Senator COLEMAN. What is a skunk works? I am sorry, I missed 

that. 

Mr. JOHNSON. A skunk works is——

Senator COLEMAN. We do not have those where I grew up in 

Brooklyn. 

Mr. JOHNSON. A skunk works is a factory that creates dirty 

tricks in the middle of war. It’s the creative people who figure out 

how to do nasty things to the Nazis or Commies or the IRS, one 

or the other its kind of the same view. They are the high-tech people that are going to do a whole bunch of dirty tricks. Sometimes 

those people win, even against a well-designed tax system. 

Sometimes we have to have extensive litigation to fix these. The 

only justification for litigation is that it’s a little bit better than the 

trial by combat that it replaced. After 10 years of litigation, sometimes the IRS wins. So a lot of it is that they’re very creative destroyers, and they succeed in destroying stuff. Then sometimes it’s 

just that the IRS doesn’t have as much talent, doesn’t have as 

many resources. Everybody kind of hates the IRS, so they sit there 

being held back, and they don’t compete as well. They don’t wake 

up in the morning with that same sense of viciousness that the 

skunk works people do. You’ve got to give the skunk works credit. 

There are times in which in this war over money the most talented 

lawyers win it. Is it compliance or is it illegal? The answer is, well, 

sometimes their schemes are so brilliant they in fact—work. They 

created a loophole. They really did create it. They won. And you 

can take it all the way to the Supreme Court and they’ve still created the loophole. 

Senator COLEMAN. One last question. One of your recommendations of action for the Federal Government, allow the government 

to turn over the suit for damages to aggressive plaintiff lawyers for 

a reasonable fraction of the return. Can you discuss that? 

Mr. JOHNSON. Yes. In fact, the plaintiffs’ lawyers are starting to 

get active in this stuff. They think that there is a breach of contract action. You know, you promised to save me $10 million worth 

of tax and the IRS caught me, and I want my $10 million from you. 

And that is kind of a regular contract. 

I will say if there is anybody who is as talented, vicious, harddriving, and smart as the skunk works tax shelter people are, it 

is the plaintiffs’ bar. The plaintiffs’ bar are very talented people, 

28

and in some sense, if we want our tax enforced, maybe we ought 

to put talent against talent. 

There is a lot of damage that has been done, just pure uncompensated damages to Uncle Sam, to our country, and it seems to 

me quite ordinary law to say if you have done damage, then you 

ought to be obligated in a civil court of law to make amends, pay 

compensation for the damage that you have done. The system 

works in other areas. I think it might work here. 

Senator COLEMAN. Thank you, Professor. Senator Levin. 

Senator LEVIN. Thank you. Sometimes these very creative 

schemes that the skunk works produce are found to be legal. Is 

that correct? They have created a loophole, as you put it. 

Mr. JOHNSON. Yes. 

Senator LEVIN. Is it also true that sometimes they are found to 

be illegal? 

Mr. JOHNSON. Yes. 

Senator LEVIN. So when you say it is a combination of both, 

there are some that turn out that will be found not to be illegal, 

and there are some that will be found to be illegal. Is that accurate? 

Mr. JOHNSON. Yes. Jerome Kurtz, who was Commissioner of Internal Revenue Service some years ago, had to define a tax shelter 

as those that did not comply with the law because the IRS function 

is to force compliance with the law. But a tax shelter goes way beyond that. 

There are a lot of cases in which you rip the fabric apart of a 

perfectly good system and make it into jelly, make it into Alzheimer’s networks or something completely dumb, completely paralyzed, completely open and unable to collect tax. That is why I 

think you need a legislative audit, a combination of Congress and 

IRS who can go back and say, no, maybe that was the interpretation, but it is a bad interpretation, that is not what we intended 

to do. We intended to write a beautiful tax system that worked. 

The Supreme Court often says the taxpayers should win on an interpretation that is outrageous, and those things need to be fixed 

retroactively very fast. You need to repair your tax base. 

The tax base is sacred. Countries decline and disappear when 

their taxpayers get in bad shape, and ours is in awful shape and 

it needs to be defended against this crap. 

Senator LEVIN. I could not agree with you more, but also, I think 

part of that is that some of the tax shelters which have been created are ‘‘abusive but found to be illegal.’’ Is that correct? 

Mr. JOHNSON. Absolutely. I hope all these get found to be, but, 

it is——

Senator LEVIN. Found to be illegal? 

Mr. JOHNSON. Yes, found to be illegal. But it is still——

Senator LEVIN. All right. Let me now go——

Mr. JOHNSON. It is still up in the air. You know, on some of these 

you have not decided. 

Senator LEVIN. I think they were, and I hope they are found to 

be. 

29

1See Exhibit No. 88 which appears in the Appendix on page 677. 

Now let me go back to Mr. Watson. If you would, would you turn 

to Exhibit 88? 1 I want to go through this with you. 

These are a series of e-mails, and if you look at the one from you 

to a bunch of folks, Eischeid, Ammerman, relative to BLIPS on 

May 5, and these two dots—do you see those two dots there? OK. 

Now, I want to read these to you because it seems to me these are 

very significant and come to the heart of the matter as to what 

your reaction was to BLIPS. 

‘‘According to Presidio, the probability of making a profit from 

this strategy is remote, possible but remote. Thus, I don’t think a 

client’s representation that they thought there was a reasonable 

opportunity to make a profit is a reasonable representation. If it 

isn’t a reasonable representation, our opinion letter is worthless.’’

Now, when you said that, ‘‘according to Presidio,’’ that is what 

Presidio told you at a meeting, which is where you got started really worrying about this BLIPS thing. Is that correct? 

Mr. WATSON. Yes, Senator, that’s correct. 

Senator LEVIN. Because what they told you at that meeting was 

different than what you had previously understood. Is that correct? 

Mr. WATSON. That’s correct. 

Senator LEVIN. All right. Now, the next dot: ‘‘The bank will control via a veto power over Presidio how the ‘loan’ proceeds are invested. Also, it appears that the bank will require this ‘loan’ to be 

repaid in a relatively short period of time, e.g., 60 days, even 

though it is structured as a 7-year loan. These factors make it difficult for me to conclude that a bona fide loan was ever made. If 

a bona fide loan was not made, the whole transaction falls apart.’’

Now, those were your words, right? 

Mr. WATSON. Yes, sir. 

Senator LEVIN. And in your judgment—you have given us your 

judgment already here this morning—you had doubts that a bona 

fide loan was made. 

Mr. WATSON. Yes. 

Senator LEVIN. And if it was not, this whole transaction, in your 

words, falls apart. Correct? 

Mr. WATSON. It would not produce the tax results desired. 

Senator LEVIN. All right. Now, if you were told by—it would not 

produce it. 

Mr. WATSON. It would not produce the desired tax results. 

Senator LEVIN. In other words, the IRS would not allow it because it was not consistent with the tax code. Is that another way 

to say that? 

Mr. WATSON. Well, if there was no bona fide loan, then there was 

never any basis to claim a loss for. 

Senator LEVIN. And, therefore, they could not properly claim the 

deduction. 

Mr. WATSON. That’s correct. 

Senator LEVIN. All right. Now, Presidio told you, as I understand 

your e-mail, that the probability of making a profit from this strategy is remote, possible but remote. Is that correct? 

Mr. WATSON. That’s correct. 

30

1See Exhibit No. 10 which appears in the Appendix on page 428. 

Senator LEVIN. And then when you stated your concerns to the 

folks that you talked to, they said we are going to get some additional representations from Presidio. Is that correct? 

Mr. WATSON. That’s correct. This problem was cured through 

representations. 

Senator LEVIN. Just representations, which they obtained from 

Presidio. Correct? 

Mr. WATSON. Correct. 

Senator LEVIN. And here is one of the representations that was 

made to ‘‘cure the problem.’’ Presidio has represented to KPMG the 

following—this is dated December 31, 1999. It is not in the exhibits. ‘‘Presidio believed there was a reasonable opportunity for an investor to earn a reasonable pre-tax profit, in excess of all associated 

fees and costs, and without regard to any tax benefits that may 

occur.’’ That was exactly the opposite of what Presidio acknowledged to you, wasn’t it? 

Mr. WATSON. It was, yes. 

Senator LEVIN. And yet after you told the folks at KPMG that 

Presidio told you that, in fact, there was little probability of making a profit, or to put it differently, it was remote, they made a representation that Presidio said the opposite, and this came after you 

told them what Presidio had told you. Is that correct? 

Mr. WATSON. That is correct, yes. 

Senator LEVIN. All right. My time is up. I had one more subject. 

Senator COLEMAN. Senator Levin, do you want to pursue one 

more subject? 

Senator LEVIN. Just one more quick subject, if I can, and that 

has to do with the issue of grantor trusts, and this is something 

of a separate issue. 

The Subcommittee has come across some material suggesting 

that with respect to OPIS and BLIPS, grantor trusts were used to 

net out gains and losses and to obscure reporting at the individual 

taxpayer level. Can you explain—well, let’s go to Exhibit 10 1 because I think time-wise we are going to have to cut through a little 

quicker. 

In Exhibit 10, you appear to be expressing your views that, with 

regard to your own analysis of the use of grantor trusts relative to 

the OPIS transaction, that those grantor trusts, in your words, 

‘‘Notwithstanding the conclusion reached in the ‘grantor trust 

memo,’ 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 return/statements only for certain clients? 

When you put the OPIS transaction together with this ‘stealth’ reporting approach, the whole thing stinks.’’

That is in Exhibit 10. Those are your words? 

Mr. WATSON. Yes, sir. 

Senator LEVIN. And is that what the firm was doing? 

Mr. WATSON. That was my understanding, yes, that the grantor 

trusts were being used to disguise the OPIS and perhaps the 

BLIPS transactions. 

31

Senator LEVIN. And then you also wrote in January 1999 a memo 

in which you said the following: ‘‘You should all know that I do not 

agree with the conclusion reached in the attached memo that the 

capital gains can be netted at the trust level. I believe we are filing 

misleading, and perhaps false, returns by taking this reporting position.’’

Was that your position then? 

Mr. WATSON. Yes, it was. 

Senator LEVIN. Is it your position now? 

Mr. WATSON. Yes, it is. 

Senator LEVIN. All right. And then, finally, in Mr. Eischeid’s 

memo, which appears at the top of the page, he writes, relative to 

a conference call, ‘‘We concluded that each partner must review the 

WNT memo’’—and WNT stands for Washington——

Mr. WATSON. Washington National Tax. 

Senator LEVIN. National Tax, which is part of KPMG, right? 

Mr. WATSON. Correct. 

Senator LEVIN. ‘‘. . . memo and decide for themselves what position to take on their returns—after discussing the various pros and 

cons with their clients.’’

Therefore, your conclusion was essentially ignored. Is that correct? It was left up to each of the partners? 

Mr. WATSON. Yes, Senator, it was. 

Senator LEVIN. Thank you. 

Senator COLEMAN. Senator Levin, I am going to follow up with 

one question just based on that last line of questioning that you 

had, the issue of grantor trusts here. IRS Notice 2000–44, according to that notice, using a grantor trust is criminal activity? 

Mr. WATSON. They threatened criminal penalties in that notice, 

yes, sir. 

Senator COLEMAN. Can you give me a sense of the time sequence 

of that memo versus your communications here? Did the memo 

come out before or after? 

Mr. WATSON. The notice came out in, I believe, August 2000. 

These e-mail messages were taking place in January 1999. So this 

actually related to the OPIS transaction, but the desire was to use 

that same reporting position with respect to the BLIPS transaction. 

Senator COLEMAN. Thank you, Mr. Watson. 

This panel is excused. We thank you very much. 

I would now like to welcome our second panel to today’s hearing: 

Philip Wiesner, Partner in Charge of KPMG’s Washington National 

Tax Client Services, Washington, DC; Jeffrey Eischeid, a partner 

in KPMG’s Personal Financial Planning Office, Atlanta, Georgia; 

Richard Lawrence DeLap, a retired National Partner in Charge of 

KPMG’s Department of Professional Practice-Tax, Mountain View, 

California; and, finally, Larry Manth, the former West Area Partner in Charge for KPMG’s Stratecon, Los Angeles, California. 

I want to thank you all for your attendance at today’s hearing, 

and I look forward to your testimony. Before we begin, pursuant 

to Rule VI, all witnesses who testify before the Subcommittee are 

required to be sworn. At this time, I would ask you to please stand 

and raise your right hand. Do you swear that the testimony you 

are about to give before the Subcommittee will be the truth, the 

whole truth, and nothing but the truth, so help you, God? 

32

1The prepared statement of Mr. Eischeid appears in the Appendix on page 298. 

Mr. WIESNER. I do. 

Mr. EISCHEID. I do. 

Mr. DELAP. I do. 

Mr. MANTH. I do. 

Senator COLEMAN. Again, as I noted with the other panel, we 

will be using a timing system. I would like you, if you are going 

to make prepared statements, to limit them to 5 minutes. We will 

enter your entire written testimony into the record. 

Again, I am going to give an opportunity for opening statements, 

starting with Mr. Wiesner, Mr. Eischeid, Mr. DeLap, and Mr. 

Manth. 

TESTIMONY OF PHILIP WIESNER, PARTNER IN CHARGE, 

WASHINGTON NATIONAL TAX, CLIENT SERVICES, KPMG, 

LLP, WASHINGTON, DC 

Senator COLEMAN. I understand, Mr. Wiesner, that you will not 

be making an opening statement? 

Mr. WIESNER. That is correct, Senator. 

Senator COLEMAN. Mr. Eischeid. 

TESTIMONY OF JEFFREY EISCHEID,1 PARTNER, PERSONAL 

FINANCIAL PLANNING, KPMG LLP, ATLANTA, GEORGIA 

Mr. EISCHEID. Mr. Chairman and Members of the Subcommittee, 

on behalf of KPMG there are four main points that I would like 

to call to your attention: 

One, the tax strategies being discussed today represent an earlier time at KPMG and a far different regulatory and marketplace 

environment. None of the strategies—nor anything like these tax 

strategies—is currently being presented to clients by KPMG. 

Today, KPMG advises our clients on the enormous range of potential outcomes under the tax laws and how to achieve the best 

outcomes in their individual cases. We have provided the Subcommittee with materials that describe hundreds of these approaches. None of these are aggressive tax strategies like FLIP, 

OPIS, BLIPS, and SC2. 

Two, the strategies presented to our clients in the past were complex and technical, but were also consistent with the laws in place 

at the time, which were also extremely complicated. 

Three, the strategies did undergo an intensive and thorough review, a process that resulted in vigorous, sometimes even heated, 

debate. 

Four, KPMG understands that the regulatory environment and 

marketplace conditions have changed. This has led to significant 

changes within KPMG over the past 3 years. 

We would like to elaborate on each of these points. 

First, the tax strategies under review were all presented under 

regulatory and marketplace conditions that do not now exist. 

Today, KPMG does not present any aggressive tax strategies specifically designed to be sold to multiple clients, like FLIP, OPIS, 

BLIPS, and SC2. 

These strategies were presented at a time when the U.S. economic boom was creating unprecedented individual wealth and a 

33

demand for tax advice aimed at achieving tax savings. All major 

accounting firms, including KPMG, as well as prominent law firms, 

investment advisers, and financial institutions gave tax advice, including presenting these types of tax strategies to clients. 

In KPMG’s case, other firms often provided investment advisory 

and other non-tax services in connection with these transactions. 

All of these relationships were consistent with KPMG’s legal and 

professional requirements. 

Second, it is true that these strategies were complicated and that 

the tax consequences turned on careful and detailed analyses of 

highly technical tax laws, regulations, rulings, and court opinions. 

But all of these tax strategies were consistent with the laws in 

place at the time. 

It is important to note that no court has found them to be inconsistent with the tax laws. In some cases, the IRS has agreed that 

taxpayers should be allowed to retain a portion of the tax benefits 

they claimed as a result of implementing a strategy. 

For all of the strategies being reviewed by the Subcommittee, 

KPMG provided our clients with a ‘‘more likely than not’’ opinion 

as to their tax consequences. In other words, we informed our clients that, based on the facts and actions they took, they would 

have a ‘‘more likely than not’’—or a greater than 50 percent—

chance of prevailing if the IRS challenged the transaction. 

The tax laws are complicated and often ambiguous and unsettled. As a result, KPMG’s opinions regarding these tax strategies 

were long, detailed, and technical. Our clients were told that, in addition to a possible tax benefit, the law required a transaction to 

have a business purpose, profit, charitable, or other non-tax motive. 

They were required to provide us with representations to that effect. Our clients were sophisticated and typically had their own attorneys, accountants, and investment advisers. Throughout the 

process, KPMG made it very clear to clients that they were undertaking complex transactions on which the law was ambiguous and 

often had not been clarified by either the IRS or the courts. 

Our third point is that because we understood that these tax 

strategies might be subject to an IRS challenge, KPMG put them 

through a rigorous review process before they were approved for 

presentation to multiple clients. The tax strategies also underwent 

very careful analysis of the IRS requirement for registering tax 

shelters in effect at the time. 

Many tax partners with different areas of expertise participated 

in the review process. That, combined with the fact that we were 

dealing with a ‘‘more likely than not’’ opinion, is the reason there 

was a lively and often lengthy debate among partners over the interpretation and application of tax laws, regulations, rulings, and 

opinions. Many of the materials provided to the Subcommittee document this internal debate. 

Finally, KPMG has changed. We learned a number of important 

lessons from our previous tax policies and practices. As a result, 

KPMG has made substantial improvements and changes in our 

practices, policies, and procedures over the past several years. My 

colleague, Richard Smith, will describe these in greater detail. 

In the practice I head, Personal Financial Planning, we have 

shifted our approach from one focused on taking solutions to clients 

34

to one that works with clients to address their individual situations. This is consistent with KPMG’s current leadership philosophy and more conservative approach to the tax service practice. 

We understand that simply being technically correct is not 

enough. We know we need to respond better to the continuing 

changes in the tax laws and regulations and the needs of our clients. We also need to ensure that no action taken will call into 

question the integrity, reliability, and credibility of KPMG. 

Thank you. 

Senator COLEMAN. Thank you, Mr. Eischeid. 

TESTIMONY OF RICHARD LAWRENCE DELAP, RETIRED NATIONAL PARTNER IN CHARGE, DEPARTMENT OF PROFESSIONAL PRACTICE-TAX, KPMG LLP, MOUNTAIN VIEW, CALIFORNIA 

Senator COLEMAN. Mr. DeLap, I understand that you will not be 

making a prepared statement. 

Mr. DELAP. That is correct. 

Senator COLEMAN. Thank you. Mr. Manth. 

TESTIMONY OF LARRY MANTH, FORMER WEST AREA PARTNER IN CHARGE, STRATECON, KPMG LLP, LOS ANGELES, 

CALIFORNIA 

Mr. MANTH. Mr. Chairman and Members of the Subcommittee, 

I had not planned to make a statement at today’s hearing, but simply to appear here to answer the Subcommittee’s questions regarding a tax strategy known as SC2, a tax strategy for which I was 

primarily responsible during a portion of my time as a partner 

there. But I have seen some press articles on today’s hearing, and 

I note that they contain some misstatements about SC2. I wanted 

to take this opportunity to set the record straight, and I appreciate 

the Subcommittee allowing me to do so. 

First and foremost, there is no question that there was a real donation of S corporation stock to a tax-exempt organization. The taxexempt organizations involved received real and quantifiable benefits from these donations. Tax-exempts that redeemed their S corporation stock have received literally millions of dollars in cash 

which have directly benefited thousands of police and fire fighters. 

Almost all the press reports state that under SC2, the charity sells 

back its shares to the S corporation for fair market value. This is 

true. But it doesn’t tell the whole story. 

One key element of SC2 is that the charity does not, in fact, have 

any obligation to sell the shares back to the S corporation. A number of tax-exempt organizations have not redeemed their shares 

after 2 years. Some are actually seeking a better valuation or waiting for a greater return from their stock at some future point. Basically, the charity controls the stock and does not have to sell it 

back to the S corporation. 

I have also read descriptions that say that should the charity decide not to sell its stock, other S corporation shareholders can exercise warrants for additional shares of stock, thereby making the 

charity’s shares much less valuable. Actually, just the opposite 

would happen. An S corporation shareholder who wanted to exercise the warrants would have to come up with a substantial 

35

amount of money to pay for the new stock. That money would be 

paid into the S corporation and raise its market value. This would 

reduce the charity’s percentage ownership share, but the charity 

would end up owning a smaller percentage of a much more valuable company. In other words, owning 10 percent of $1 million is 

a lot better than owning 90 percent of $100,000. 

Some articles reported that S corporations that implemented SC2 

passed resolutions to limit or suspend dividends or other distributions to shareholders, basically to keep the charity from getting any 

share of earnings. So far as I know, a resolution limiting or suspending distributions was not an element of SC2. In fact, KPMG 

recommended that S corporations make distributions during the 

period tax-exempts held their stock. Such payments made the S 

corporation stock even more attractive to the charity, while still allowing substantially more income to be reinvested in the S corporation than before the stock was donated to the charity. There are 

tax-exempt organizations that have received hundreds of thousands 

of dollars in distribution income while they were holding S corporation stock. 

Finally, some articles referred to pledges that individual S corporations made to guarantee that charities would receive at least 

the original value of their stock at the time it was redeemed. It was 

my experience that some SC2 transactions involved such a pledge, 

but that in most transactions, no pledge was offered or even requested. 

Essentially, SC2 was a strategy that involved a gift to a charity, 

a tax-free build-up of income, and a deferral of income so that it 

could be subject to capital gains tax in the future. This is virtually 

identical to another tax strategy that is still widely available to 

taxpayers. It is called the charitable remainder trust, and Congress 

wrote it into the tax laws many years ago so that it is not only 

legal but encouraged by law. 

I note this because, along with all the factors I have described, 

it further supports KPMG’s position that SC2 was consistent with 

the law and regulations governing charitable giving and S corporations. Thank you. 

Senator COLEMAN. Thank you, Mr. Manth. 

Mr. Manth, let me just follow up as I recall listening to Senator 

Levin’s testimony and talking about distribution of income. I believe his testimony was that there was not distribution of income. 

This was one of the concerns. And your testimony is to the contrary. 

Do you know—and I do not have the information in front of me. 

Is there a percentage of the times in which there was distribution 

versus non-distribution? 

Mr. MANTH. I don’t know. We recommended that the S corporations make dividend distributions. 

Senator COLEMAN. Do you have any information as to whether, 

in fact, that was practiced? 

Mr. MANTH. I know it was done, but I don’t have that in front 

of me. 

Senator COLEMAN. OK. Can I ask you about registration of this 

product with the IRS as a tax shelter? Do you know whether it was 

registered? 

36

Mr. MANTH. I do not believe it was registered. 

Senator COLEMAN. Can you help me understand that? I think 

that is one of the concerns here about not registering. It would appear to me obviously if you register something and the IRS knows 

it is there, they have got a better shot at taking a look. Here it is 

not registered. Can you talk to me, tell me the reason for that? 

Mr. MANTH. Well, I have been out of the business for a while, 

and my recollection in the registration there are two types of registrations. There was what we referred to as the old 6111(c) registration, which was really if there were significant deductions created in excess of an investment, then you would have to register. 

And then there were the new regulations that came out on registration, and I believe that a thorough review of registering SC2 

was done on both. And it was concluded that it was not a 

registerable transaction. 

Senator COLEMAN. And I would ask any of the individuals from 

KPMG about BLIPS. Was that registered? 

Mr. EISCHEID. No, sir, it was not. 

Senator COLEMAN. And as a result of not registering, I would 

take it, then, the IRS would not know if an individual taxpayer had 

gotten a certain amount of gain, if they had made a lot of money 

on some business transactions. 

My sense with BLIPS is that, in fact, by setting BLIPS up, the 

IRS would not know that information. 

Mr. EISCHEID. Senator, that is not my impression or understanding; that, in general, and specifically with respect to BLIPS, 

the taxpayers would report on their income tax returns their taxable income, including the income from sales of stock or the businesses that they owned as well as the tax effects of the BLIPS investment transaction that they entered into. 

Senator COLEMAN. Mr. Wiesner, were you in charge of resolving 

the issues associated with economic substance? 

Mr. WIESNER. Yes, Senator, I was. 

Senator COLEMAN. And then did you ultimately approve the 

BLIPS transaction despite the concerns raised by Mr. Watson and 

perhaps others? 

Mr. WIESNER. Yes, Senator, I did. It was after about a 5-month 

review process in which we very intensively reviewed every issue 

that our whole team of professionals would raise with respect to 

the transaction. 

Senator COLEMAN. One of the things, though, that concerns me 

here regards the exchanges between Watson and Presidio and then 

the ultimate opinion by Presidio, which seems to contradict an earlier representation. 

Did Mr. Watson ever inform you that he had met with Presidio 

and that they had indicated to him the chance of making a profit 

from a BLIPS transaction was—I think his words were ‘‘possible 

but remote’’? 

Mr. WIESNER. Yes, Senator, I believe—I don’t know if he sent me 

the e-mail or just informed me about it. But when he did, we would 

have looked further into the issue and examined it in greater detail 

in order to make ourselves comfortable that, in fact, there was an 

economic profit potential in the transaction. 

37

Senator COLEMAN. And then Presidio comes back—and Senator 

Levin went into this in a little more detail—with a representation 

saying that there was a reasonable opportunity to earn a pre-tax 

profit. Is that correct? 

Mr. WIESNER. Yes, sir, that’s correct. When they came—after we 

had met with Presidio and gotten comfortable with additional information that we could then rely upon their representation. 

Senator COLEMAN. What kind of additional information did they 

give you to reverse their sense about the possibility of pre-tax profit? 

Mr. WIESNER. Senator, at this point I do not have a specific recollection of it. I don’t know if Mr. Eischeid has a more specific recollection. 

Mr. EISCHEID. Senator, actually, in terms of the referenced meeting, I believe Mr. Watson spoke to April 30 and perhaps May 1, I 

was physically present at that meeting, and I came away with a 

distinctly different impression with respect to the investment program outlined by the Presidio investment advisory firm. And it was 

not that the possibility of obtaining a profit from entering into 

those transactions was remote. 

Senator COLEMAN. BLIPS was at least represented as a 7-year 

investment strategy, marketed as such. I understand that all 66 

deals in 1999 closed after the first phase of 60 days, and few of the 

other remaining deals actually transitioned to stage two. Can you 

help me understand how you market something as a 7-year strategy and yet all the transactions close out in the 60 days? 

Mr. EISCHEID. I think, Senator, as Presidio articulated the investment program, it was a multi-stage investment that took on 

varying degrees of risk as the strategy matured and progressed. 

And at any point in time, the investors had a choice as whether 

to contribute additional equity to the investment program and to 

continue their investments in these foreign currencies and the like. 

And certainly one of the considerations that those investors undertook was what was going to be the income tax consequences of 

their adoption of this investment strategy, and, importantly, as was 

discussed earlier, what would be the consequences that were anticipated when they terminated their investment in this strategic investment fund. 

Senator COLEMAN. We had a 15-minute vote posted. What I am 

going to do, Senator Levin, is I am going to finish my questioning 

in just a couple of minutes, and then we will adjourn the hearing 

and come back after the vote. The other possibility is I could finish 

my questioning quickly, go vote, you continue, and I will come 

back. Do you want to keep it going? 

Senator LEVIN. Are there two votes or one, do we know? 

Senator COLEMAN. Could we check to see whether there are two 

votes or one? 

We touched upon, Mr. Eischeid, the concept of netting at the 

grantor trust level, and it was just touched upon by Mr. Watson 

at the end. Has KPMG engaged in transactions with clients or provided the clients with the option of netting? 

Mr. EISCHEID. The netting issue was, I think, discussed at some 

length within KPMG, and there was, as you can tell from some of 

the documentation, a rigorous debate and disparate views exVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00061 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
38

1See Exhibit No. 38 which appears in the Appendix on page 528. 

pressed. And from that documentation, you can see that my primary objective was to make sure that our professionals were not 

doing something that I would term wrong, that proper reporting 

was occurring. 

When it comes to that type of tax return preparation issue, historically our firm has approached that with respect to relying on 

our partners, the individual tax return preparers, to analyze the 

law and to make the proper determination with respect to the returns that they are preparing to ensure that they are complete and 

accurate. 

Senator COLEMAN. Exhibit 38,1 Are you the author of a memo labeled ‘‘PFP Practice Reorganization, Innovative Strategies Business 

Plan’’? Can we show the witness a copy of the memos? I just want 

to know if you are the author. The piece that I have, it talks about 

history, and in the last paragraph, the fiscal 2001 IS revenue goal 

was $38 million, the practice is to have $16 million through period 

ten, the shortfall from plan is primarily attributed to the August 

2000 issuance of Notice 2000–44. This notice specifically described 

both the retired BLIPS strategy and the current SOS strategy. Accordingly, we made the business decision to stop implementation of 

SOS transactions and stay out of the loss generator business for an 

appropriate period of time. In addition, there is no word that the 

softening in the overall economy, e.g., the decline in new IPOs, the 

devaluation of technology stock valuations, adversely affected our 

ability to broadly sell our modernization tax advisory services suite 

of solutions. 

Do you recall whether you—is that your memo? 

Mr. EISCHEID. I believe that it was, Senator. It was a draft that 

I put together as I was contemplating what business plan that I 

would put forth for the innovative solutions practice. 

Senator COLEMAN. Let me see if I can kind of sum up the environment, because you talk about that in your statement. There was 

a lot of cash being generated and a lot of profit in the 1990’s, and 

I take it that you are out there, and Ernst & Young and Pricewaterhouse, and everybody is out there and coming up with, ‘‘creative solutions in which folks who are generating profits, it would 

mean they pay taxes on that, can minimize their tax liability.’’ A 

fair statement? 

Mr. EISCHEID. Yes, Senator, I think that our profession was actively engaged in reviewing and evaluating and creating what we 

termed solutions or strategies to help our clients minimize their tax 

liability. 

Senator COLEMAN. And there is nothing illegal about helping 

folks minimize their tax liability. 

Mr. EISCHEID. Correct. 

Senator COLEMAN. But help me understand. As I listened to Senator Levin’s description of BLIPS and listened to the witnesses, it 

does not seem to be economic substance in there. There does not 

seem to be much at risk. And so help me understand how, with all 

this rigorous review, you in effect have these transactions in which 

there is no real risk, there is very limited potential to make real 

profit, and folks have the capacity to write off $20 million, $30 milVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00062 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
39

lion, or $40 million. Help me understand how it got to that place 

and why folks think it is OK or thought it was OK. 

Mr. EISCHEID. Well, Senator, I think that, first of all, we are 

talking about a period that was several years ago, and we are talking about transactions that are admittedly, quite aggressive in 

terms of the application of the tax laws. I think that our firm, myself included, believed that those transactions were legal and that 

they met the literal requirement of the Internal Revenue Code and 

the regulations and so forth. 

I will tell you here today that our firm would not approve that 

type of transaction to be introduced to our clients, that we have 

made the determination that it is too close to the line, so to speak, 

as to what is more likely than not ultimately going to prevail once 

it is judicially determined. 

Senator COLEMAN. Thank you. 

We have a vote. What I am going to do is I am going to adjourn 

the hearing for approximately 10 minutes until the return of Senator Levin. He will then continue his questioning. There are two 

stacked votes. I will not be back for that since I will do the second 

vote, too, but then I will come back. 

The hearing then will stand adjourned for approximately 10 minutes until the return of Senator Levin. 

[Recess.] 

Senator LEVIN [presiding]. We are going to proceed now, and 

Senator Coleman will be back a little later. There is a second vote 

going on, and he is going to wait there for the second vote to begin. 

Let me start with you, Mr. Eischeid. Three of the four products 

that we are looking at—FLIP, OPIS, and BLIPS—operate in a 

similar way, and my question to you is this: Isn’t it the case that 

all of these are primarily tax-reduction strategies that have financial transactions tied to them to give them a colorable business 

purpose? 

Mr. EISCHEID. Senator, I am not sure that that would be how I 

would characterize those transactions. I certainly viewed them as 

investment strategies that certainly had a significant income tax 

component to them. 

Senator LEVIN. My question to you, though, is: Are these not primarily tax-reduction strategies? 

Mr. EISCHEID. I think you would have to speak to each individual 

taxpayer to ascertain their primary purpose for entering into the 

transaction, and I think you would get different answers, depending on which taxpayer that you spoke to. I suppose I would also 

just simply point out that, not to get overly technical, but primarily 

it tends to be a term of art in sort of the tax professional world 

that is very difficult, frankly, to pin down. 

Senator LEVIN. Is it not the case that these were designed and 

marketed primarily as tax-reduction strategies? 

Mr. EISCHEID. Senator, I would not agree with that characterization. 

Senator LEVIN. All right. Now, let’s look at what other parties involved in transactions said about that issue. If you look at Exhibit 

40

1See Exhibit No. 1d. which appears in the Appendix on page 385. 

1d.,1 this is a compendium of how other parties involved in these 

shelters characterized them, and it is pretty clear what the consensus is here. 

First is a UBS Bank memo regarding FLIP. ‘‘The principal design of this scheme is to generate significant capital losses for U.S. 

taxpayers which can then be used to offset capital gains which 

would otherwise be subject to tax.’’

Then there is the memo of one of the investment advisory firms 

involved in FLIP, which was Quadra: ‘‘KPMG approached us as to 

whether we could effect the security trades necessary to achieve 

the desired tax results. The tax opportunity created is extremely 

complex.’’

Then at First Union, now Wachovia, regarding FLIP: ‘‘Target 

customers. Who are the target customers? Capital gain of $20 million or more. Potential benefits: Individual capital gain elimination.’’ You do not see anything in there about investment, do 

you? 

And then you have got an HVB employee—HVB is a German 

bank—regarding BLIPS: ‘‘Seven percent is the fee equity paid by 

investors for tax sheltering.’’ That is the way that particular bank 

employee looked at it. 

And then you look at a Deutsche Bank internal memo: ‘‘It is imperative that the transaction be wound up due to the fact that the 

high-net-worth individual will not receive his or her capital loss or 

tax benefit until the transaction is wound up.’’

Now, do you still claim that these tax strategies were primarily 

investment strategies and not tax-reduction strategies? Is that your 

testimony under oath here that they were not designed primarily 

as tax-reduction strategies? 

Mr. EISCHEID. Senator, my testimony is that these were investment strategies that were presented to individual taxpayers that 

had tax attributes that those investors found attractive. 

Senator LEVIN. Well, let me ask my question again, then. Is it 

your testimony that these were not designed and marketed primarily as tax-reduction strategies? 

Mr. EISCHEID. Senator——

Senator LEVIN. I am talking now about designing and marketing. 

Were these designed and marketed primarily as tax-reduction 

strategies? 

Mr. EISCHEID. Senator, I can’t speak to any and all of the marketing activities. You know, for example, you read——

Senator LEVIN. Well, just speak to what you know. 

Mr. EISCHEID. Thank you——

Senator LEVIN. From what you know, were these designed and 

marketed primarily as tax-reduction strategies? 

Mr. EISCHEID. And what I know is that they were not, that I personally had a number of conversations with clients and prospective 

clients, and they were always characterized as investment transactions with a significant pre-tax economic purpose that was embedded in the overall transaction. 

41

1See Exhibit No. 32 which appears in the Appendix on page 505. 

1See Exhibit No. 41 which appears in the Appendix on page 536. 

Senator LEVIN. All right. Now, look at what the professionals at 

KPMG said about the purpose of the transactions. Take a look at 

Exhibit 32.1

When KPMG and the financial advisory firm Quadra pitched 

FLIP to that UBS Bank, this is how the product was presented. 

Here is the title: ‘‘Generating Capital Losses.’’ That is the title of 

the presentation. 

If this is an investment strategy, why does KPMG describe it and 

pitch it to potential partners as a product designed to generate capital losses? 

Mr. EISCHEID. Senator, I don’t believe I’ve ever seen this document before. 

Senator LEVIN. Well, now that you look at it, can you give me 

an explanation? 

Mr. EISCHEID. I don’t know what purpose this document might 

have been used for. 

Senator LEVIN. This was the pitch of FLIP to a potential partner 

bank, UBS. 

Mr. EISCHEID. OK. 

Senator LEVIN. That is the purpose. 

Mr. EISCHEID. I’ll accept your statement, sir. I have no——

Senator LEVIN. Now that you know, can you explain why it is 

characterized the way it is? 

Mr. EISCHEID. No, sir, I cannot explain why someone used that 

phrase, sir. 

Senator LEVIN. All right. Now let’s look at the strategy that you 

were involved with, Exhibit 41.1 This is the presentation of BLIPS 

prepared by Carol Warley. Do you know who she is? 

Mr. EISCHEID. Yes, Senator. 

Senator LEVIN. All right. She is the BLIPS regional deployment 

champion, is she not? Or was she not? 

Mr. EISCHEID. I don’t remember her being the regional deployment champion, but she may have been, yes. 

Senator LEVIN. She was intimately involved with BLIPS? 

Mr. EISCHEID. Yes, Senator. 

Senator LEVIN. Now, look at the chart on page 4 of that exhibit, 

if you would. 

‘‘BLIPS Benefit: Avoid all of the capital gains and ordinary income tax. Net benefit to client—effective tax rate less after tax cost 

of transaction of approximately 5 percent.’’

Are you familiar with that? 

Mr. EISCHEID. No, Senator, I’m not. 

Senator LEVIN. Well, this is BLIPS. You were intimately involved 

with BLIPS, weren’t you? 

Mr. EISCHEID. Yes. 

Senator LEVIN. Well, this is your document, isn’t it? This is a 

KPMG document. 

Mr. EISCHEID. It appears to be a document prepared by Carol 

Warley, yes, sir. 

Senator LEVIN. She works for KPMG? 

Mr. EISCHEID. Yes, she does. 

42

1See Exhibit No. 18 which appears in the Appendix on page 459. 

Senator LEVIN. Was she wrong? Was she wrong that was the 

purpose of BLIPS? That is the only purpose stated: Avoid all of the 

capital gains and ordinary income tax. Do you see anything there 

about this investment you made reference to? 

Mr. EISCHEID. Senator, I have no knowledge of what Carol 

Warley was trying to communicate——

Senator LEVIN. Have you ever seen that document before? 

Mr. EISCHEID. No, I have not. 

Senator LEVIN. Is this a KPMG document? Do you know that 

much? 

Mr. EISCHEID. It appears to be, yes, Senator. 

Senator LEVIN. All right. But you don’t—you think that is inaccurate, that statement? 

Mr. EISCHEID. If the statement is that that is the sole benefit of 

BLIPS, then, yes, Senator, I would say that is inaccurate. 

Senator LEVIN. Does BLIPS avoid all of the capital gains and ordinary income tax? Is that a benefit of BLIPS? 

Mr. EISCHEID. A potential benefit of BLIPS, sir, would be the reduction of one’s income tax liabilities, yes, Senator. 

Senator LEVIN. Well, is this accurately stated that a BLIPS benefit is to avoid all of the capital gains and ordinary income tax? Is 

that accurate or not? It is a KPMG document. Is it an accurate 

statement or not? 

Mr. EISCHEID. When you say a KPMG document, it certainly appears to be—to have been prepared by a KPMG professional——

Senator LEVIN. It says here KPMG 0049642, proprietary material, confidentiality requested. Are you denying this is a KPMG 

document? 

Mr. EISCHEID. Senator, at least in terms of your reference, I 

think that’s an indication that it is a document that KPMG produced, and as you indicated, the cover seems to indicate that it was 

prepared by Carol Warley. I have no indication as to what purpose 

she might have intended to use this document for. It does not appear to me, at least on cursory review, that it would have been prepared for use in a discussion with a client of KPMG. 

Senator LEVIN. Take a look at Exhibit 18.1

Now, this is a document that you signed, and this says, ‘‘A number of people are looking at doing BLIPS transactions to generate 

Y2K losses.’’ That refers to year 2000 losses. Are you familiar with 

that document? 

Mr. EISCHEID. Yes, Senator. 

Senator LEVIN. Is that accurate? 

Mr. EISCHEID. I believe it was. 

Senator LEVIN. ‘‘We currently have bank capacity to have $1 billion of loans outstanding at 12/31/99. This translates into approximately $400 million of premium. This tranche will be implemented 

on a first-come, first-served basis until we fill capacity. Get your 

signed engagement letters in!! ’’

Are those your words? 

Mr. EISCHEID. I believe they were, yes, sir. 

43

2See Exhibit No. 16 which appears in the Appendix on page 453. 

Senator LEVIN. And then take a look at Exhibit 16.2 This is from 

you to Michael Comer. It says here at the top, look at the last line 

in that first paragraph, ‘‘Innovative Strategies is a portfolio of 

value-added products that are designed to mitigate an individual’s 

income tax as well as estate and gift tax burdens. BLIPS is just 

one of the products in the innovative Strategies portfolio.’’

So BLIPS, according to your memo, was ‘‘designed to mitigate an 

individual’s income tax as well as estate and gift tax burdens.’’ Is 

that true? Was that true when you wrote it? 

Mr. EISCHEID. Yes, sir, I believe that one of the attributes of the 

BLIPS strategy was the income tax mitigation. 

Senator LEVIN. Well, I know you are trying to make it one of the 

attributes, but in your words, it was that this was a product ‘‘designed to mitigate.’’ Was BLIPS designed to mitigate an individual’s income tax and estate and gift tax burdens? Yes or no. 

Mr. EISCHEID. Senator, as I previously testified, I think that is 

one of the attributes that was designed into the strategy, both the 

income tax consequences as well as, as we’ve heard previous testimony on, the economic investment attribute. 

Senator LEVIN. Do you see anything about investment attributes 

in your memo here as to what it was designed to do? Now, you 

can’t blame this on Carol Warley. She wrote the other thing. You 

said, well, you are not familiar with that KPMG document, but this 

one you are familiar with. And here you are saying it was ‘‘designed to mitigate.’’ My question is: Do you see any reference here 

to investment strategy on that memo of yours? 

Mr. EISCHEID. No, Senator, I don’t. I think that you are somewhat reading ‘‘designed’’ out of context. 

Senator LEVIN. Give me the whole context. 

Mr. EISCHEID. Well, I think my intention here was to reference 

the innovative strategies in general as a portfolio of value-added 

products——

Senator LEVIN. Which are? Keep finishing the sentence. 

Mr. EISCHEID. In the aggregate, in general, are designed to help 

mitigate an individual’s income as well as estate and gift tax burdens. So that the——

Senator LEVIN. That is the purpose——

Mr. EISCHEID [continuing]. Entire portfolio and the purpose of 

that portfolio was to aggregate in a sense in a place a number of 

different strategies that taxpayers might be interested in discussing that have some significant income tax consequence associated with them. 

Senator LEVIN. When it says BLIPS is one of the products in that 

portfolio, now look at the context. Is there any doubt in your mind 

that it is, according to that previous sentence, therefore, a valueadded product designed to mitigate an individual’s income tax as 

well as estate and gift tax burden? 

Mr. EISCHEID. Senator, I don’t know how to change my answer 

to——

Senator LEVIN. Well, try an honest answer. Just give me a direct 

answer to this. You are making a reference here to a portfolio 

whose purpose is to mitigate on individual’s taxes. That is what 

44

1See Exhibit No. 16 which appears in the Appendix on page 453. 

your own memo says—the other ones you said you weren’t familiar 

with. They were all KPMG stuff, but you are not familiar with 

that. Now it is yours. You are Jeff. Now, how do you avoid looking 

that straight on and saying, I did say that, BLIPS is a product designed to mitigate an individual’s income tax because it is part of 

Innovative Strategies portfolio?’’ Why not just give us a straightforward answer? 

Mr. EISCHEID. I’m trying my best, sir. 

Senator LEVIN. Why isn’t that the straightforward answer? 

Mr. EISCHEID. I think the straightforward answer is that that 

was one of the attributes of the BLIPS products——

Senator LEVIN. One of the attributes. 

Mr. EISCHEID [continuing]. And that we certainly recognized that 

and that was one of the factors that our clients were quite interested in. 

Senator LEVIN. Take a look at Exhibit 16—well, let me just ask 

you about the fees. How were the fees priced for BLIPS? What fee 

did you charge your customers? 

Mr. EISCHEID. Our fees would vary depending on the circumstances. We would negotiate a fee with our clients, determine 

an amount, and put that in——

Senator LEVIN. Wasn’t it based on the tax loss? 

Mr. EISCHEID. I don’t believe that we looked at our fee in that 

way, no, Senator. 

Senator LEVIN. Take a look at Exhibit 16,1 near the bottom. 

BLIPS contact, you are the contact here, too. Here is the fee. 

‘‘BLIPS is priced on a fixed-fee basis which should approximate 

1.25 percent of the tax loss.’’ Are those your words? 

Mr. EISCHEID. Well, my only hesitation is really to try and refresh my recollection with respect to this e-mail. It very well may 

have been my words. I don’t recall writing that. 

Senator LEVIN. Is it true? 

Mr. EISCHEID. That would not be my view or my testimony, sir. 

Senator LEVIN. It is not your testimony. That is the whole point. 

Was it true or not? Was BLIPS priced on a fixed-fee basis approximating 1.25 percent of the net tax loss? 

Mr. EISCHEID. In a very indirect way, yes, sir. The fee that we 

would typically use as the starting point of our negotiation we developed a shorthand around, which we used as 1.25 percent of what 

we referred to as the loan premium amount. And as you indicated 

earlier, that loan premium amount translated into tax basis for the 

investor. 

Senator LEVIN. And that was the intent, was it not, of that premium? 

Mr. EISCHEID. I’m sorry. I don’t understand the question, sir. 

Senator LEVIN. Was that the intent of the premium, to be approximately the net tax loss that the investor would gain from this 

whole transaction? 

Mr. EISCHEID. We believed that that was the appropriate tax 

treatment of that loan premium, yes, sir. 

Senator LEVIN. Was that the tax loss which you told taxpayers 

that they could expect, approximately, from this transaction? 

45

Mr. EISCHEID. We generally told taxpayers, I believe, that the 

tax treatment of that loan premium, whatever that amount would 

be, should translate into tax basis for them, yes, sir. 

Senator LEVIN. Tax basis which would be then deducted from 

any capital gain or income that they had? 

Mr. EISCHEID. Depending on what ultimately happened with that 

tax basis, yes. 

Senator LEVIN. Was it the intent to be something which would 

be a deduction from their income? 

Mr. EISCHEID. I think the answer would generally be yes, that 

the taxpayers would anticipate using that tax basis at some point 

in time and reflecting that on their income tax. 

Senator LEVIN. They were so informed of that, were they not? 

Mr. EISCHEID. Yes, sir. I mean I believe they were informed as 

to the tax consequences of their participation in the BLIPS investment program. 

Senator LEVIN. My time is up. Thank you. 

Senator COLEMAN. Mr. DeLap, because you did not give an opening statement, I just want to do a little background here. Can you 

tell us what position you held at KPMG during the period that 

FLIPS, BLIPS, OPIS and SC2 strategies were being developed and 

marketed? 

Mr. DELAP. In February 1997, I became a partner in charge of 

a newly-created Department of Professional Practice Tax, and I 

held that position until June 30, 2002, at which time I turned it 

over to my successor, and then I retired from the firm on September 15, 2002. 

Senator COLEMAN. Could you tell us what your responsibilities 

entailed? 

Mr. DELAP. The responsibilities generally related to seeing that 

firm personnel complied with various regulatory rules, Internal 

Revenue Service, SEC, AICPA, and State accountancy boards. It 

entailed helping set policy, recommending policy changes to leadership, involved making revisions as necessary to the firm’s tax services manual, involved an annual quality performance review of the 

tax personnel in the various operating offices relative to compliance 

with firm policies and procedures. It included review of all contingent fee engagement letters to determine whether they complied 

with rules of the SEC, AICPA, and State boards accountancy. 

Senator COLEMAN. Did you have any role in the approval of the 

aforementioned strategies, the FLIPS, the OPIS, or the BLIPS? 

Mr. DELAP. With respect to tax strategies intended to be discussed with multiple clients, the rule was to review those strategies from a policy standpoint, to determine that the manner in 

which they were taken to clients, complied with the various regulatory rules and firm policy. 

Senator COLEMAN. So you were involved then in the process, had 

a chance to raise concerns prior to approval? 

Mr. DELAP. That is correct. 

Senator COLEMAN. In regard to BLIPS strategy, during your review is it correct that you raised over 20 points that needed to be 

resolved prior to your approval? 

Mr. DELAP. As I recall, I received a proposed pro forma—proposed model tax opinion regarding BLIPS that set forth the facts, 

46

discussion and technical analysis, I think, sometime in April 1999. 

I read that proposed opinion, and as I recall I had a list of 29 concerns that I sent back to Washington National Tax for further development. 

Senator COLEMAN. Did you also share the concern about the couple mentioned before, the client ability to make a profit, and also 

I think the question of who is the borrower? Did you have concerns 

about those issues? 

Mr. DELAP. Yes. 

Senator COLEMAN. Do you recall whether those concerns were 

ever satisfied, were ever resolved to your satisfaction? 

Mr. DELAP. Ultimately I determined that the analysis prepared 

by Washington National Tax, the final analysis, I thought addressed those concerns. 

Senator COLEMAN. Help me understand, how do you get an opinion issued, a more likely than not opinion issued when—and it is 

easy in hindsight, we are looking back at this now, and I presume 

it is tough sitting down there, but we are looking back at this and 

we are seeing stuff that did seem to be substance, did not seem to 

be risk, did not seem to be profit, seemed to be transactions that 

you can lay out on a chart, but nothing you can put your hands 

around. How do you get to a more likely than not analysis based 

on that? I learned in law school not to ask more than one question, 

but I am asking more than one question. See if you can pull them 

together. Did you get to that more likely than not because folks 

simply thought the IRS would not know or did not have the resources or would not pursue it, or was there a valid intellectual 

basis for that more likely than not opinion? 

Mr. DELAP. I believe, Senator, that it was based on a rigorous 

analysis of the technical rules. The analysis and the conclusion, 

from a technical standpoint was reached by Washington National 

Tax, so I might need to deflect that particular question to Mr. 

Wiesner. 

Senator COLEMAN. Mr. Wiesner. 

Mr. WIESNER. If I can supplement Mr. DeLap’s answer. We came 

to the conclusion—we started in February 1999, and had intensive 

meetings with the Presidio people and their economic people. They 

laid out the transaction for us. At the end of the first meeting we 

had everybody around a table. We had the Presidio people leave, 

and put on a white board all the issues that we saw that were 

raised in the discussion, assigned those issues out to an appropriate technical resource within Washington National Tax, and 

then over a series of the next 2 months, 3 months, tried as best 

we could to resolve the issues that had been raised. And it was 

only after spending probably about 1,000 hours of time that we 

were able to arrive at our more likely than not conclusion. 

Senator COLEMAN. From a lay person sitting here, the sense is 

that there is a lot of money to be made here, and revenues are 

driving outcome. How much of a factor did revenues play in these 

decisions? 

Mr. WIESNER. Senator, from my point of view, money was not a 

consideration. We certainly were aware at Washington National 

Tax that this was an item of priority for the PFP practice, but the 

practice that we keep the resources assigned to the project and deal 

47

with the issues, and tell us sooner rather than later whether you 

can or cannot get to the more likely than not level of comfort. 

Senator COLEMAN. You did on BLIPS though, $53.2 million in 

fees? 

Mr. WIESNER. Being in Washington National Tax, which we are 

not in the operating office, I’m not familiar with the exact amount 

of fees, Senator. 

Senator COLEMAN. I will go back to Mr. DeLap. This issue of registration, I need to understand that. We initially understand that 

you took the position that the BLIPS products should be registered 

as a tax shelter with the IRS, and I heard today and understand 

that BLIPS was never registered. Did you agree with the decision 

not to register? 

Mr. DELAP. The registration statute left the implementation interpretation of the statutory words to regulations which were originally prepared in the 1980’s in response to the syndicated tax shelters marketed generally by investment banks back in the early 

1980’s, and it was difficult to—or close to impossible in some cases 

to interpret those regulations as they might apply to the type of 

strategy like BLIPS. My view at the time was that it would have 

been—it would be preferable for Presidio to register the strategy, 

as I viewed Presidio as the organizer. I was told that Presidio declined to register. The Vice Chairman of Tax discussed the registration issue with the partner in charge of the Practice and Procedures Group in Washington National Tax, who is the firm’s expert 

on procedural matters including registration. His conclusion was, 

at that time, that there was a reasonable basis not to register. 

Based on that technical conclusion by the partner in the Practice 

and Procedures Group, I agreed to permit the strategy to go forward without registration. 

Senator COLEMAN. What is the hierarchy here? What is your relationship with the partner in the PFP, Practice and Procedures? 

Do you have any authority over that person? Are you on an equal 

plane? 

Mr. DELAP. I guess it would be parallel. Washington National 

Tax reported ultimately—I don’t remember the exact layers, but ultimately to the Vice Chairman Tax. I reported to the Vice Chairman Tax. 

Senator COLEMAN. There was a little discussion—I came in at 

the tail end of it—of confidentiality, having BLIPS clients sign a 

confidentiality agreement. Did you have any problem with that? 

Mr. DELAP. At the time a nondisclosure agreement relative to 

tax strategies was common in the profession, so at the time I did 

not have a problem with that as such. 

Senator COLEMAN. Let me just get to the termination of the marketing of BLIPS, which I believe was at the end of 1999? 

Mr. DELAP. Yes, it was, I think in the fall of 1999. 

Senator COLEMAN. Did you have any involvement with KPMG’s 

decision to terminate the marketing of BLIPS? 

Mr. DELAP. When I approved BLIPS from a policy standpoint, I 

set forth a list of conditions under which it would need to be offered. One of those conditions was that it would be offered to a limited number of individuals who were individuals who understood 

the investment and tax risk involved, and that Doug Ammerman 

48

1See Exhibit No. 10 which appears in the Appendix on page 428. 

and I would discuss at which point the marketing should be terminated. I believe that we had that discussion, I think in October 

1999, maybe November 1999, and determined at that time there 

should be no further approaches to potential clients regarding 

BLIPS. 

Senator COLEMAN. A cynic might say that the more transactions, 

the greater chance of being on the IRS’s radar. Any substance to 

that cynicism? 

Mr. DELAP. The way—I viewed it somewhat differently. I expected that the transactions, being large transactions, would be 

picked up on audit. My concern was that if there were an unlimited 

number of taxpayers entering into similar transactions, that the 

likelihood that a court would invoke the Step Transaction Doctrine, 

would go way up. So I thought it was important relative to the 

overall analysis that there be a limited number. 

Senator COLEMAN. Thank you. Senator Levin, a short follow-up 

round. 

Senator LEVIN. Thank you, Mr. Chairman. 

I want to go back to the way KPMG’s fees were tied to the targeted loss, Mr. Eischeid. Those fees were not tied, as I understand 

it, to the total amount of money managed or the amount of profit, 

if any, made by those investments. Is that correct? 

Mr. EISCHEID. I suppose, Senator, in the same sense that it’s referenced to the loan premium. You could use as an alternative reference the total amount invested in the strategic investment fund. 

You just really adopt a differing percentage to derive sort of the 

shorthand starting point for those fee negotiations. 

But to the second point, there was no contingency around our 

fees. Once we had negotiated an amount with the client, it was a 

fixed amount that the client then agreed to pay us. 

Senator LEVIN. Typically 1.25 percent of the targeted loss; is that 

correct? 

Mr. EISCHEID. Generally, yes, sir. 

Senator LEVIN. Now let us talk about the comments regarding 

netting and the grantor trust. Mr. Watson, who was one of the 

chief technical persons there, testified that netting gains and losses 

in a grantor trust would then allow individual gains and losses to 

be hidden, and that was not proper. 

If you will look at Exhibit 10,1 contains some internal KPMG emails on this matter. At this point KPMG was discussing whether 

its clients should use that method of netting, and Mr. Watson reacted strongly to it. If you look at the two comments that Watson 

made, ‘‘When you put the OPIS transaction together with this 

‘stealth’ reporting approach, the whole thing stinks.’’ And the last 

sentence of the second quote of this e-mail of Mr. Watson, ‘‘I believe 

we are filing misleading, and perhaps false, returns by taking this 

reporting position.’’

Do you agree with Mr. Watson’s position, Mr. Eischeid? 

Mr. EISCHEID. Senator, before I answer your question, I would 

like to, if I could, clarify the record. In your previous question I had 

agreed to your statement before you had I think completed it, and 

49

so I just wanted to clarify that my affirmative response is with respect to our fee calculation and the loan premium amount. 

With respect to this question, no, I don’t agree with Mr. Watson’s 

characterization. 

Senator LEVIN. Here is what you wrote in that Exhibit 10. ‘‘We 

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.’’

What I do not understand is why is the leader of the group, on 

an issue of this magnitude that is raised by the top technical professional on the issue, you tell your colleagues that they can do as 

they see fit. Should not a firm adopt a standard position on an 

issue as controversial as this one, and particularly one that results 

in potentially fraudulent returns? Why not a standard position in 

your firm? 

Mr. EISCHEID. Senator, first of all, the reference memorandum, 

which I don’t necessarily see here, was prepared by the head of the 

Personal Financial Planning Practice within National Tax at the 

time. And so sometime later Mr. Watson expressed his view with 

respect to the issues addressed in that opinion. So what you are 

witnessing here is really that spirited debate that I referenced in 

my initial comments about what is simply the right answer? What 

is the proper interpretation of the law? I don’t think that any of 

the professionals viewed it as anything more than that, and that 

my partners are tax professionals, and I trusted their judgment to 

analyze the law and arrive at a correct determination. 

Senator LEVIN. Did any KPMG clients who utilized BLIPS use 

grantor trusts to net out the losses that were received from those 

strategies? 

Mr. EISCHEID. Senator, no, not to my knowledge. 

Senator LEVIN. Did KPMG ever suggest this to them as a strategy? Did you ever sell BLIPS or OPIS on the basis of netting gains 

or losses in a grantor trust? 

Mr. EISCHEID. Senator, as I indicated, I don’t believe that any of 

our BLIPS clients prepared or had tax returns prepared that reflected any type of grantor trust netting. 

I must also point out that when—the IRS’s position with respect 

to grantor trust netting—emerged, as we discussed earlier, in August 2000, we endeavored to approach all of our clients to ascertain 

whether or not this type of netting might have occurred on one of 

their tax returns, and if so, we recommended to those clients, given 

the articulated position of the IRS, that they amend those returns. 

Senator LEVIN. If you take a look at Exhibit 10 at the second 

from the last page, where it says ‘‘up in the Northeast,’’ the third 

line there. ‘‘The short answer to your inquiry is,’’ see that? ‘‘Up in 

the Northeast, at least, there is quite a bit of activity in the trust 

area where they used to not audit many of these kinds of trusts. 

They are now auditing quite a number of them because they have 

figured out that trusts are a common element in some of these 

shelter deals.’’ Do you see that, ‘‘trusts are a common element?’’ 

Was that true in the case of BLIPS? 

Mr. EISCHEID. Senator, I have no basis to answer that question. 

Senator LEVIN. You are not familiar with this KPMG document? 

Mr. EISCHEID. I have seen this KPMG document, yes, sir. 

50

1See Exhibit No. 65 which appears in the Appendix on page 623. 

Senator LEVIN. Is it true that trusts are a common element in 

some of these shelter deals? 

Mr. EISCHEID. That would not be my understanding, no, Senator. 

Senator LEVIN. This was a call that you made, as I understand, 

asking a colleague if that colleague had spoken with a client whose 

name is redacted here; is that right? 

Mr. EISCHEID. No, Senator, I don’t think I had anything to do 

with this particular document. 

Senator LEVIN. Take a look at the next page. It is a memo from 

you. ‘‘Did you have your ‘netting’ discussions with’’ blank and 

blank, redacted because they are clients, ‘‘I need copies of the 

memos of oral advice.’’ That is your memo. 

Mr. EISCHEID. Yes, Senator. 

Senator LEVIN. This is the answer to it. So how can you say you 

are unaware of it? 

Mr. EISCHEID. My impression, Senator, is that these are two totally unrelated documents, separated by 6 months or more. 

Senator LEVIN. The memorandum here of May 24 is not a response to your October document; they are not related? 

Mr. EISCHEID. No, Senator. I think the second memorandum that 

you are referring to——

Senator LEVIN. Which is the second one, the one on top of——

Mr. EISCHEID. October 20 is really referencing those kinds of client discussions that I just testified to. After Notice 2044 came out, 

and we went back to our clients to ascertain whether or not some 

type of netting activity had been undertaken. 

Senator LEVIN. So whether or not the top document was a response to the earlier one or not, you were interested in knowing 

whether there were netting discussions; is that correct? And it related to FLIP; is that correct? 

Mr. EISCHEID. This particular, the dialogue between myself and 

another of our partners related to a FLIP transaction, yes, Senator. 

Senator LEVIN. The short answer is yes. My question is, that that 

document asking your colleague whether you had netting discussions, related to FLIP; is that correct? And the answer is yes, is 

it not? 

Mr. EISCHEID. Yes, this related to FLIP, correct. 

Senator LEVIN. Mr. Manth—well, let me ask Mr. Wiesner. I have 

a little time left. You are the partner in charge of the Washington 

National Tax Office during the BLIPS review. Exhibit 65 1 is a May 

7, 1999 e-mail from Mr. DeLap. He forwards an e-mail from Mark 

Watson, who reports that based on new information he had just 

learned at a meeting with Presidio on BLIPS that he is no longer 

comfortable with the BLIPS product because there is only a remote 

possibility of making a profit, and the bank controls the loan proceeds, so it is doubtful it is not even a real loan. He also reports 

that another technical reviewer at WNT is concerned about who is 

the borrower, and Mr. DeLap recommends not moving forward 

until these issues are resolved. 

Then, Mr. Wiesner, on May 7 and May 10 you meet with Mr. 

Rosenthal and Mr. Watson to discuss their concerns. You announce 

51

2See Exhibit No. 7 which appears in the Appendix on page 415. 

that the decision was made to move forward. You overruled your 

technical people on this, did you not? 

Mr. WIESNER. Senator, what was reflected here was on—when 

we started our discussions of whether or not we could arrive at a 

more likely than not opinion in January. After 2 months of deliberation, I had believed, because I thought I had received everyone’s 

sign-off, that we had arrived at a more likely than not conclusion. 

Mr. DeLap then began his review of the transaction, and there 

were some follow up e-mails and memorandums such as this 

memorandum on Friday, May 14. 

To the extent that there were issues raised that were new issues 

raised concerning the transaction, yes, we took those very seriously. 

Senator LEVIN. One of the issues is whether or not the representations which are material to your firm’s tax opinion are credible; 

is that correct? 

Mr. WIESNER. Yes, sir, that is correct. 

Senator LEVIN. Whether those representations are credible. If 

you take a look at Exhibit 7,2 you wrote this memo on February 

7. 

‘‘Last, 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 on BLIPS 

I. In each of the 66 or more deals that were done last year, our clients represented that they ‘independently’ reviewed the economics 

and had a reasonable opportunity to earn a pre-tax profit. Also, 

they had no ‘agreement’ to complete the transaction in any predetermined manner, i.e., close out the deal on 12/31 and trigger the 

embedded tax loss.’’

Now your writing. ‘‘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 BLIPS I, the issue 

going forward is can we continue to rely on the representations in 

any subsequent deals if we go down that road?’’

Now, when you were confronted with that evidence—66 out of 66, 

that is not a coincidence—what did you do? Did you evaluate 

whether KPMG should rely on the client’s representations for these 

BLIPS deals? 

Mr. WIESNER. Senator, in the memorandum we are referring to, 

the e-mail which was February 24, the first paragraph of the email was my conclusion that we still could issue a more likely than 

not tax opinion. We had considered——

Senator LEVIN. Is this for the ones that existed, or for a new one? 

Mr. WIESNER. This was for the 66 transactions that we were 

talking about for 1999. 

Senator LEVIN. Let us separate those out for the moment. You 

said later on in that memo, going forward, the issue is whether we 

can continue to rely on the representations made. 

Mr. WIESNER. Yes, I did, Senator, because after I made my conclusion based on an evaluation of the law, and that is that the fact 

that the 66 people got in and got out, that does not, per se, result 

in the transactions of each individual not meeting the economic 

52

substance doctrine. But then, looking forward and worrying as a 

professional about the sort of—the types of representations we are 

looking for here and the reasonableness of the representations, I 

had a concern from a business point of view of whether we could 

continue to rely on the representations. 

Senator LEVIN. But you did continue, did you not? 

Mr. WIESNER. I am not sure on that, Senator, but if in fact we 

did, a determination was—my——

Senator LEVIN. You are not sure whether you continued to sell 

BLIPS deals? 

Mr. WIESNER. Senator, this memorandum really was my last involvement in the BLIPS transaction. 

Senator LEVIN. Well, let me tell you, you did continue to sell 

BLIPS deals. Now, does that trouble you? 

Mr. WIESNER. Well, Senator, I would have to look and examine 

the issue as we did for the 1999 deals and determine, again, whether there was a reasonable basis for each of the individuals to make 

their representation. And that was an issue for 1999 as well as 

going forward that I and Washington National Tax wasn’t in a position to make. 

What I did to follow up was talk to Mr. Eischeid and to make 

sure that Mr. Eischeid and the people in the field who were dealing 

with the clients would explore the issues. 

Senator LEVIN. I don’t see how in heaven’s name as a tax professional you raise an issue, 66 out of 66 representations turn out not 

to be accurate. And you raise first the question as to whether you 

ought to issue the opinions that you subsequently issued. But then 

you say going forward. Going forward. Now you raise an issue. 

What about future deals? Should we continue to sell this? Should 

we continue to rely on these representations that are unanimously 

disproved by the facts? 

These are not credible representations. You put them in your client’s mouth. You folks write the representations. There is no prospect of a profit on the investment. Sixty-six times out of 66 that 

turns out to be the case. You raise the question, and then you continue to go forward as a firm anyway. You continue to sell this tax 

deal. 

Mr. EISCHEID. Senator, I am certain that I don’t agree with your 

characterization. We don’t believe that the representations that our 

clients made to us were false and that it is——

Senator LEVIN. It turned out not to be true 66 out of 66 times. 

Would you agree with that? 

Mr. EISCHEID. No, Senator, I would not. I think the representation that we’re speaking to is that the client at the time that they 

entered into the transaction believed that they had a reasonable 

opportunity to make a profit from their investment transaction. I 

think that’s the representation and——

Senator LEVIN. Mr. Wiesner, you said, ‘‘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.’’ The 

firm did not do that. They did not follow your advice. Should they 

have? 

Mr. WIESNER. Senator, my responsibility was, again, as a technical reviewer of the transaction and coming to my conclusion with 

53

respect to the transaction and what we should do. I made the recommendation from my own personal view and in my own judgment, and—but I was not the person who would ultimately make 

the decision. 

Senator LEVIN. Does it trouble you the firm went forward and 

continued to sell BLIPS? You were troubled when you wrote the 

memo. Are you troubled now when I tell you the firm went ahead 

and sold BLIPS, more BLIPS? Does that bother you? 

Does anything bother you? Now I am asking you a direct question. You made a recommendation, Mr. Wiesner. You are a professional. You recommended to your firm that they stop selling 

BLIPS. They didn’t. My question: Does that bother you? 

Mr. WIESNER. Senator, I was—again, in the context of the situation, I was making my own personal recommendation in terms of 

what I thought was a course of action. This is an area of very complex, difficult interpretation of the law, application of the facts to 

the law, and I made my best determination and made my recommendation. 

Mr. EISCHEID. And, Senator, I might point out——

Senator LEVIN. Could you answer my question? 

Mr. EISCHEID. I am sorry. 

Senator LEVIN. Are you going to answer my question? I know it 

was a personal recommendation of yours. That is my question. Are 

you personally bothered by the fact that your recommendation was 

not followed? 

Mr. WIESNER. Would I have preferred that my recommendation 

were followed? 

Senator LEVIN. Yes. 

Mr. WIESNER. Yes. 

Senator LEVIN. Thank you, Mr. Chairman. 

Senator COLEMAN. Thank you. We will excuse the panel and now 

call our next panel. 

Senator LEVIN. Mr. Chairman, I do have questions for the record 

for the witnesses that I did not get to, and I am wondering if the 

record can be kept open for those witnesses. 

Senator COLEMAN. Without objection. 

Senator LEVIN. Thank you. 

Senator COLEMAN. I would now like to welcome our third panel 

to today’s hearing: Richard Berry, Jr., Senior Partner with 

Pricewaterhouse Coopers, New York City; Mark Weinberger, Vice 

Chair of Tax Services for Ernst & Young, Washington, DC; and, finally, Richard H. Smith, Jr., Vice Chair of Tax Services for KPMG 

LLP, New York City. 

Again, I want to thank you for your attendance at today’s hearing, and I look forward to hearing your testimony. 

Before we begin, pursuant to Rule VI, all witnesses who testify 

before the Subcommittee are required to be sworn. At this time I 

would ask you to please stand and raise your right hand. Do you 

swear that the testimony you are about to give before this Subcommittee is the truth, the whole truth, and nothing but the truth, 

so help you, God? 

Mr. BERRY. I do. 

Mr. WEINBERGER. I do. 

Mr. SMITH. I do. 

54

1The prepared statement of Mr. Berry appears in the Appendix on page 303. 

Senator COLEMAN. As I have indicated to witnesses before in the 

other panels, I would like you to confine your testimony to 5 minutes in a statement but that your entire written testimony will be 

entered into the record. 

We will start with Mr. Berry, who will go first, followed by Mr. 

Weinberger and finish up with Mr. Smith. And after we have heard 

all the testimony, we will turn to questions. 

Mr. Berry, you may proceed. 

TESTIMONY OF RICHARD J. BERRY, JR.,1 SENIOR TAX PARTNER, PRICEWATERHOUSE COOPERS LLP, NEW YORK, NEW 

YORK 

Mr. BERRY. Thank you. Good afternoon, Chairman Coleman and 

Senator Levin. I am Rick Berry, and I serve as the national leader 

of Pricewaterhouse Coopers tax practice. I am pleased to be here 

today to discuss the important topic of abusive tax shelters. 

Let me say right at the outset that we share the Subcommittee’s 

concerns about the impact that abusive shelters have on our tax 

system. I welcome the opportunity to discuss our own experience 

with the Subcommittee. I know you have had a long day so far, so 

I will briefly summarize my written testimony. 

From 1997 to 1999, we had a small group of less than 10 people 

who worked on three tax shelters known as FLIP, CDS, and BOSS. 

The BOSS transaction triggered widespread public attention and 

controversy in the fall of 1999. As a result, we decided that we had 

made a regrettable mistake being in this business. Our reputation 

was hurt, our clients and people were embarrassed, and it was incompatible with our core business. 

We got out of this business immediately. We established an independent and centralized quality control group. We strengthened 

our procedures to ensure that we would never again engage in this 

type of activity. We decided the appropriate course of action was 

to shut down the BOSS transactions and refund all the fees we had 

received. 

Not one of the BOSS transactions was ever completed. We also 

never, I repeat, never did any of the so-called Son of BOSS transactions. We stopped doing FLIP and CDS as well. We have now 

been out of this business for almost 4 years. 

Not long after this, the IRS contacted our firm to review our compliance with the registration and list maintenance requirements of 

the tax law. The next step to putting this behind us was to work 

with the IRS to resolve any issues relating to our registration and 

list maintenance obligations. We fully cooperated with the Service. 

We reached a closing agreement in June 2002 and made a settlement payment. We agreed to provide the IRS with over 130 tax 

planning strategies for their review. They are in the final stages of 

this review, and no issues have been raised. 

The IRS also reviewed our quality control procedures and told us 

they were comprehensive, thorough, and effective. We continue to 

cooperate with the Service and fully abide by the terms of our 

agreement. 

55

1The prepared statement of Mr. Weinberger appears in the Appendix on page 309. 

Our experience almost 4 years ago served as a wake-up call to 

our tax practice. Our partners were adamant that we get out of 

this business immediately. We took the unusual step of shutting 

down the largest transaction and returning all of our fees. We settled with the IRS. We implemented comprehensive quality control 

procedures to ensure that the firm would never again be involved 

with potentially abusive tax products. We take responsibility for 

our actions, and we have learned from our mistakes. As a result, 

our tax practice is once again dedicated to the core values on which 

our firm was founded. 

Thank you for the opportunity to testify before you today. I look 

forward to your questions. 

Senator COLEMAN. Thank you, Mr. Berry. Mr. Weinberger. 

TESTIMONY OF MARK A. WEINBERGER,1 VICE CHAIR, TAX 

SERVICES, ERNST & YOUNG LLP, WASHINGTON, DC 

Mr. WEINBERGER. Good afternoon, Chairman Coleman and Senator Levin. My name is Mark Weinberger, and I am representing 

Ernst & Young. I appreciate the opportunity to participate in addressing the important matters being considered by your Subcommittee. 

The subject of tax shelters is complex, and the complexity begins 

with the definition of tax shelters. When I discuss tax shelters, I 

am referring to products that have been widely marketed that are 

intended to generate tax benefits substantially in excess of any anticipated economic and business benefits, generally to shelter income from other sources. Beginning in the mid-1990’s, these products were marketed with increasing frequency by investment 

banks, law firms, financial service firms, accounting firms, and 

other professional service firms, including ours. 

The stock market boom and the proliferation of the stock awards 

in the 1990’s created an unprecedented number of individual taxpayers with large gains and significant potential tax liabilities. Initially, in an effort to be responsive to client needs, we and other 

firms looked for legitimate tax planning to try and meet their 

needs. Perhaps reflecting the tenor of the times, these efforts rapidly evolved into competitive and widespread marketing of those 

ideas. 

Selling and marketing are essential parts of any business, but we 

should not allow any part of our tax practice to be dominated by 

a sales mentality. Our past involvement in the type of activities 

that are the focus of this Subcommittee’s attention is not reflective 

of our—and we believe your—expectations of our role as professionals. Ernst & Young has more than 23,000 employees in the 

United States. That number includes more than 6,000 professionals 

in the tax practice who provide a wide range of tax services to more 

than 22,000 tax clients. The revenues derived from the work under 

scrutiny by this Subcommittee never accounted for more than onehalf of 1 percent of our firm’s revenues. Our core tax practice was 

and is assisting our clients in their efforts to comply with the tax 

laws and reduce their tax liability in a manner that is appropriate 

56

and consistent with the tax law. We are committed to doing business in ways that embody the highest professional standards. 

To make sure that we stay true to who we are as a firm, since 

I have assumed responsibilities, we have implemented a host of 

policy, procedural, and organizational reforms designed to create 

the highest quality professional environment. In addition, we have 

entered into a settlement agreement with the IRS regarding tax 

shelter registration and list maintenance requirements. And we 

have disbanded the group that had been involved in developing and 

marketing of tax products of the type at issue. This has nothing to 

do with the merits of the transactions; it has to do with who we 

want to be as a firm. 

We have made a number of organizational changes that are relevant in the context of this hearing. Ernst & Young has established 

a new full-time position called Americas Director for Tax Quality, 

who is a senior serving client representative who now has full-time 

responsibility just to look over all of our quality initiatives; established a Tax Technical Review Committee for each of our key functional areas in tax to provide detailed technical reviews of significant issues and help assure consistency in interpretation of the tax 

law; established a new tax review board, with members that include senior executives from outside the tax practice from our general counsel’s office and our quality department, to provide a firmlevel view with respect to tax practices, services, and relationships; 

and established a new tax practice hotline to allow employees to 

provide anonymous input on any matter about which they may 

have concerns. 

In addition to our most recent initiatives, we continue to adhere 

to our policies under which we do not recommend transactions that 

have been listed by the IRS as potentially abusive or substantially 

similar; and, furthermore, we do not enter into confidentiality 

agreements with our clients for tax services. 

Finally, as part of our efforts to move forward, earlier this year 

Ernst & Young executed a closing agreement with the Internal 

Revenue Service resolving all issues regarding tax shelter rules 

and regulations. A key aspect of that agreement is our commitment 

to implement a quality and integrity program to promote the highest standards of practice and ongoing compliance with laws and 

regulations. 

The agreement includes a significant investment by our firm in 

education, data collection, national review, and annual audits of 

our practices across the country. This will ensure consistent quality 

for our firm and our clients. 

In closing, we believe these initiatives, individually and collectively, will foster the highest standards of professionalism within 

Ernst & Young. We believe these policies are the right course for 

our firm and our clients. 

That said, in the years ahead, there surely will be disagreements 

between the IRS and taxpayers. Our tax laws are enormously complex, and there is more than ample room for disagreement on any 

number of issues. Where the Service and the taxpayers disagree, 

those differences should reflect well-reasoned and good-faith interpretations of the rules as applied to a particular taxpayer’s facts 

and circumstances. 

57

Let me assure you that we know who we are and who we want 

to be. We have taken, and are taking, numerous steps to ensure 

that quality and professionalism are the touchstones for everything 

we do. 

Thank you again for the opportunity to discuss our positive 

changes with you, Mr. Chairman and Senator Levin, and I will answer the Subcommittee’s questions at the appropriate time. 

Senator COLEMAN. Thank you, Mr. Weinberger. Mr. Smith. 

TESTIMONY OF RICHARD H. SMITH, JR., VICE CHAIR, TAX 

SERVICES, KPMG LLP, NEW YORK, NEW YORK 

Mr. SMITH. Thank you, Mr. Chairman. 

Mr. Chairman, Senator Levin, my name is Richard Smith. I am 

the Vice Chair of Tax Services for KPMG. While today’s hearing is 

focused on certain tax strategies KPMG presented to clients in the 

past, I would like to describe how KPMG’s policies and practices 

have changed since then. 

The business and regulatory environment are markedly different 

today than at the time KPMG and its competitors presented such 

strategies, and KPMG has moved forward as well. KPMG has no 

higher priority than restoring public trust in the accounting profession. It is no longer enough to say that a strategy complies with 

the law or meets technical standards. Today, the standard by 

which we judge our conduct is whether any action could in any way 

risk the reputations of KPMG or our clients. If it could, we will not 

do it. Our reputation, our integrity, and our credibility are simply 

too important to put at risk. 

Some of the more significant changes and new procedures in 

place at KPMG include: 

One, we have substantially changed KPMG’s tax services and offerings. Today, KPMG offers our clients tax services that are tailored to address their distinct business objectives and tax planning 

needs. We no longer offer or implement aggressive look-alike tax 

strategies. In particular, we no longer offer or implement FLIP, 

OPIS, BLIPS, or SC2, or any similar transactions. Additionally, 

KPMG does not and will not accept any new engagements for advice and opinions on tax shelters that have been listed and deemed 

abusive by the Internal Revenue Service. 

Two, over the past 3 years, KPMG has developed an increasingly 

more rigorous and formal review and oversight procedure within 

our tax practice. All tax strategies must undergo three levels of review and approval. 

First, we have created the new position of Partner in Charge of 

Tax Risk and Regulatory Affairs. This partner analyzes each tax 

strategy proposed by the firm to determine if it could in any way 

put KPMG or our clients at risk. 

Second, the partner in charge of our Washington National Tax 

Practice must sign off on the technical merits of all significant tax 

strategies. 

Finally, the Department of Professional Practice-Tax reviews all 

tax strategies to ensure that they are in compliance with the firm’s 

policies and procedures. Each of these partners has veto power over 

any tax strategy proposed and operate independently from our operations and business development functions. If any tax strategy 

58

puts KPMG or our clients at risk, is not technically correct and defensible, or is inconsistent with our policies or procedures, it will 

not be approved. 

Three, we have also revised our procedures with respect to list 

maintenance and registration obligations under the Internal Revenue Code. In early 2000, KPMG established a practice, procedure, 

and administration group in Washington National Tax as the contact point for analysis of disclosure, list maintenance, and registration issues. KPMG’s procedures and training programs have been 

updated continuously since that time, tracking developments in the 

law and fine-tuning our compliance processes. 

Four, practices and positions focused on look-alike strategies are 

no longer part of this firm. In 2002, two practices in particular, 

Stratecon and Innovative Solutions, were eliminated. Many of the 

partners who were part of these practices are no longer with the 

firm. We have abolished positions such as national deployment 

champions and area deployment champions, which were charged 

with marketing these strategies to our clients. We also eliminated 

the Tax Innovation Center, which was responsible for supporting 

the marketing of look-alike tax strategies. 

Five, our tax training program now focuses on technical developments rather than marketing strategies. We have discontinued 

weekly tax partner calls, training programs, and other activities 

that primarily focus on marketing. Tax partners calls and training 

now concentrate on changes in the law and technical tax developments. 

Six, in 2002, KPMG implemented a firm-wide compliance and 

ethics hotline. This hotline is designed to encourage anyone within 

KPMG to report their concerns about any potentially unethical, improper, or illegal conduct within the firm, and is in addition to 

long-standing channels for employee communication. 

Seven, we have put in place more stringent rules about offering 

tax services to executives at our SEC audit clients. Under the Sarbanes-Oxley Act, the audit committees of our SEC audit clients 

must preapprove all services provided by KPMG, including tax 

services. We have applied this disclosure and approval discipline to 

tax advice offered to executives of SEC audit clients. 

Eight, we are constantly looking at additional steps we can take 

to improve and enforce compliance with these policies and practices. 

Senator COLEMAN. If you would just summarize? 

Mr. SMITH. I will just sum up and move forward. Thank you, 

Senator. 

Senator COLEMAN. Thank you. 

Mr. SMITH. We encourage anyone at KPMG to bring to our attention immediately any actions that are inconsistent with these guiding principles and procedures and to suggest additional policies or 

procedures that would help ensure that we are providing the highest quality tax services and advice to our clients. 

KPMG looks forward to being part of the solution and wants to 

work with Congress as well as the IRS and other policymakers as 

you consider sound and responsible approaches to better define 

what tax strategies are allowable under the law and to further 

strengthen the enforcement of the tax code. 

59

Thank you, and I look forward to your questions. 

Senator COLEMAN. Thank you, Mr. Smith. 

First, let me say that I applaud the efforts that you have taken 

and the commitment that you have made to apply the highest 

standards, the sensitivity that we are hearing today regarding the 

impact this has on the reputation of firms and the industry. So I 

want to put on the record my appreciation for that. 

At the same time, obviously, as we look back, the past is not a 

pretty past, and part of the concern, as we sit here, our job is to 

figure out where we go from here. Was the past just simply a product of the booming 1990’s and being awash in cash? And the sense 

I get, gentlemen, is that—and, by the way, not just PWC and Ernst 

& Young and KPMG. We could have had the table lined up with 

everybody in the business, it seems, looking for ways to figure out 

how to wash out profit and to limit liability. I mean, that is the 

reality. 

So the question is: How do we make sure it does not happen 

again? How do we make sure that these statements today that you 

make saying, hey, we have changed our process, we have cleaned 

up our act, will be the reality should this economic engine start 

booming again? And that is a concern. 

I do not think we need to have an IRS agent sitting there next 

to you as you make your policy decisions. But as we look at the 

past, clearly, there is a very sorrowful record, I think. 

Mr. Berry, I would take it that you would agree that these FLIP, 

BOSS, CDS things, as you look back, lacked economic substance. 

Mr. BERRY. Mr. Chairman, with respect to the BOSS transaction, 

which we did not do, that in my judgment is an abusive shelter, 

or would have been. 

With respect to FLIP and CDS, if not abusive, they come very 

close to that line. They do not meet our quality standards. We regret that we ever got involved in those transactions, and we would 

not do them today. 

Senator COLEMAN. Would you have an opinion on BLIPS? 

Mr. BERRY. I am not familiar with those transactions. We never 

did them. 

Senator COLEMAN. We talked about registering a little bit, and 

perhaps, Mr. Weinberger, on that issue. My concern is the lack of 

registration service as the way to keep things under the radar. 

Would you agree with that? 

Mr. WEINBERGER. Senator, I agree that transparency and the 

ability for the IRS to be able to identify transactions quickly and 

respond is absolutely a cornerstone to being able to deal with this 

process going forward. And that involves registration on the part 

of promoters. It involves disclosure by taxpayers. And it involves 

the list maintenance rules that the IRS also passed. 

Senator COLEMAN. How do we ensure that there is transparency 

on a regular basis? Is it going to require more legislation? 

Mr. WEINBERGER. Well, Senator, since the original transactions 

that were discussed today and others that are out there have occurred, there have been significant regulatory changes, and there 

are legislative changes before the Senate Finance Committee. The 

environment has changed in many ways, not the least of which is 

the disclosure rules are now more aligned with the registration and 

60

list maintenance rules, which creates a web so that not only will 

individuals have to disclose transactions, but the promoters are 

supposed to register them and maintain lists as a mechanism to be 

able to give the IRS the information to be able to actually know 

when those transactions occur and to respond appropriately. 

Senator COLEMAN. Mr. Smith, does KPMG have internal controls 

regarding to ensure that IRS registration requirements are met? 

Mr. SMITH. Yes. Certainly over the years, we have improved our 

policies and procedures to reflect not only the changes that have 

taken place in the law and regulations, as Mr. Weinberger described, the changes in the disclosure rules as well as the listing 

requirements. But we have put in policies and procedures that go 

beyond those particular rules that I think are helpful in addressing 

the concerns that you are talking about today. 

For example, for us we think transparency is so important that 

we are going to err on the side of registration beyond what might 

be required in the law and regulations. 

Senator COLEMAN. One of the areas of questioning that was generated by my distinguished Ranking Member, Senator Levin, had 

to do with the fee structure. To me, why not base fees on profits 

that would be generated by a transaction, if you really believe that, 

versus fees that are being generated due to the amount of loss you 

are going to take? I mean, it is clear that that was the standard. 

Is that something that needs to be dealt with legislatively? 

Mr. SMITH. I think that there are a number of different ways 

that fees could be structured, and I think there have been some 

significant changes that have occurred over the past couple of 

years. 

Mr. DeLap talked about the changes with regard to contingent 

fees. We think that those were good changes and certainly have focused on how do we bring transparency to our fees as well as bring 

transparency for the government into the transactions in which we 

are involved. 

Senator COLEMAN. And, again, to note from an industry-wide 

perspective, I take it, Mr. Weinberger, that Ernst & Young also 

used a fee system based on taxes avoided under the shelters in the 

past. Is that correct? 

Mr. WEINBERGER. Senator, we had fixed fees that were based on 

investments which were attributable to the losses. 

Senator COLEMAN. Has that process been changed today? 

Mr. WEINBERGER. Yes, the AICPA and the SEC have rules on 

contingent fees, and obviously we need as an industry to comply 

with all of those. The vast majority of work that our firm does is 

hourly based. There are certain circumstances where they are specifically allowed to have value-billing based on the complexities of 

different transactions or the investment involved. 

Senator COLEMAN. And my last question, because I am trying to 

figure out where we go from here, and I could spend a lot of time 

getting very angry, as my colleague, I think justifiably, from Michigan has been as he has looked at the amounts of tax avoidance as 

a result of these schemes and the impact that it has. 

Gentlemen, I would like you all to respond. Talk to me about the 

lessons you have learned what the industry as a whole should take 

from what we have discussed today, and where does the tax adVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00084 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
61

viser industry go from here? Where do we go from a legislative perspective as well as from an internal perspective? And I take it your 

statements of the controls you set in place perhaps have answered 

that, but I would like your sense. Is there more legislation that we 

are going to have to enact in order to keep the reins on this thing 

and ensure that people meet the highest quality ethical standards? 

Mr. Berry. 

Mr. BERRY. Yes, my firm is very supportive of additional legislation, particularly in the areas of increased disclosure, both on the 

part of the taxpayer and the tax preparer, and definitely increased 

penalties. 

Senator COLEMAN. Mr. Weinberger. 

Mr. WEINBERGER. Senator, I think that legislation will never 

solely prevent individuals, if they do not step up to the plate and 

do the right thing. So I think it takes our part as a professional 

service firm. I think it does take the IRS following up on the transactions they identify. I think the transparency and disclosure rules 

are crucial. We have an incredibly complex tax code. I am not Pollyanna-ish enough to think that we are going to simplify it, but 

that would certainly be a huge benefit to dealing with those who 

want to aggressively use the tax code in ways that take advantage 

of the complexity. And like Mr. Berry, I do think the cost/benefit 

analysis of looking at whether or not when you give advice you are 

following the rules, it should be further analyzed, absolutely. 

Senator COLEMAN. Mr. Smith. 

Mr. SMITH. Yes, I think all of the component pieces of the system 

are important to improving compliance with the tax code. The IRS, 

clients, tax advisers, Congress—I think all of those are important 

in terms of the policies that they set. 

At the end of the day, it is how a professional feels about themselves and how they feel that they should conduct themselves, and 

that is part of setting the tone at the top within each of those organizations and institutions. And it is about executing on setting the 

highest professional standards and making sure that we live up to 

those. 

So I think the internal controls and changes that have been 

made by certainly the three firms before you right now, as well as 

the changes with regard to listing and disclosure that apply to the 

firms and apply to the taxpayers, are important developments in 

the entire system. 

We certainly support anything that relates to further transparency and enforcement of that transparency. 

Senator COLEMAN. Thank you, Mr. Smith. Senator Levin. 

Senator LEVIN. Thank you, Mr. Chairman. 

I am glad one of you mentioned the need to increase penalties. 

The current penalty for promoting an abusive tax shelter is $1,000. 

Now, there is no way that that is anything other than a parking 

ticket. And when professionals promote abusive tax shelters, it 

seems to me that the penalty has got to be similar to what the penalty is paid by the taxpayer that they are advising and putting documents into the hands of. And so one of the provisions of the bill 

which we will be introducing will be increased penalties, but they 

are going to be significant because the current penalties of $1,000, 

62

1See Exhibit No. 89 which appears in the Appendix on page 680. 

I think a maximum of $10,000 for a similar violation, is a joke. And 

it is a pitiful joke. 

Mr. Smith, your prepared statement says on page 4 at the top 

that in 2002, KPMG eliminated two tax groups that ‘‘were responsible for developing tax strategies specifically designed to be presented to multiple clients, Stratecon and Innovative Solutions.’’ 

And when did that happen in 2002? 

Mr. SMITH. That happened as I came on as the Vice Chair of 

Tax, Senator, which would have been in April. 

Senator LEVIN. Of last year? 

Mr. SMITH. Yes. 

Senator LEVIN. Well, when you look at Exhibit 89,1 if you would 

take a look at your exhibits, this is the organizational chart for 

KPMG for 2003 that your firm supplied to the Subcommittee in 

February of this year in response to the subpoena. 

Now, we asked for organizational charts for each of several years 

so we could understand the way your firm is organized. The 2003 

chart still lists Stratecon. How do you explain that? 

Mr. SMITH. This organizational chart is inaccurate. 

Senator LEVIN. Your own organizational chart is inaccurate? 

Mr. SMITH. This particular version——

Senator LEVIN. Your own organizational chart is inaccurate? Is 

that what your testimony is? 

Mr. SMITH. This version that you have is not accurate in terms 

of——

Senator LEVIN. This is your document, KPMG 000001. I mean, 

this is what you supplied to us. This is the first document you supplied to us in response to a subpoena. Are you testifying that the 

document you supplied us showing your organizational makeup for 

2003 was inaccurate? 

Mr. SMITH. I think it reflects a change in one box in this particular organizational chart which has me as the Vice Chair of Tax. 

There are numerous—as I just perused over this particular organizational chart before me, there are numerous errors in terms of the 

organization. 

Senator LEVIN. All right. I just want to make it clear. This is the 

chart that your firm supplied to us. Is that correct? 

Mr. SMITH. I suspect it is, Senator. 

Senator LEVIN. Can you get us an accurate chart? 

Mr. SMITH. Yes. 

Senator LEVIN. Because I think the Subcommittee has a right to 

expect when we subpoena documents that you will give us accurate 

documents. Is that a fair expectation, would you say? 

Mr. SMITH. I would have expected that you would have received 

something other than a draft organizational chart. 

Senator LEVIN. Was this a draft that you submitted to us? 

Mr. SMITH. Let me restate that, sir. This document that you have 

does not reflect our organization. 

Senator LEVIN. OK. Now, it also refers to a PFP, Personal Financial Planning, as I understand it. 

Mr. SMITH. Yes. 

Senator LEVIN. Innovative Strategies, do you see that? 

63

Mr. SMITH. I don’t see——

Senator LEVIN. Do you see where it says PFP Inno Strat, J. 

Eischeid? Do you see that, the third column? 

Mr. SMITH. I’m sorry. I don’t. 

Senator LEVIN. Excuse me, J. Eischeid. 

Mr. SMITH. Oh, I do see it, yes. 

Senator LEVIN. OK. It doesn’t refer to Innovative Solutions, 

which your statement refers to. 

Mr. SMITH. Innovative Strategies or Innovative Solutions——

Senator LEVIN. They are the same? 

Mr. SMITH [continuing]. Was a practice that we no longer had 

after I became Vice Chairman, notwithstanding what is reflected 

on this organizational chart. 

Senator LEVIN. We can’t find Innovative Solutions, which your 

testimony referred to, in any of your charts. It is always Innovative 

Strategies. 

Mr. SMITH. Well, the two practices, Senator, that I focused on 

when I became Vice Chair in terms of making some changes to our 

focus and to our business were Stratecon and Innovative Strategies 

or Innovative Solutions. 

Senator LEVIN. To either name, is when you——

Mr. SMITH. Either name from my perspective. 

Senator LEVIN. I have got you. 

Mr. SMITH. It is the practice that was represented by this prior 

organizational chart. 

Senator LEVIN. OK. I want to ask about another document. This 

is a proprietary document which we are going to put in front of 

you. We did not put it in our documents because it is proprietary. 

It is a long one. 

Mr. SMITH. Thank you. 

Senator LEVIN. It is dated November 26. Do you see that? 

Mr. SMITH. Yes, Senator, I do. 

Senator LEVIN. OK. Now, if you take a look at about the eighth 

line on the left, it still shows Stratecon there. You said that you 

eliminated it in April 2002. 

Mr. SMITH. Yes. 

Senator LEVIN. We have a date, November 26, 2002, which still 

shows Stratecon, and it still shows Solutions in Development. How 

do you explain that? 

Mr. SMITH. Yes. As I came in to serve as the Vice Chair of Tax, 

I made very clear that we were going to make changes to our structure in terms of the organization and focused on these two in particular, and others. 

This document reflects the fact that the systems that we had had 

not yet been changed at the particular point in time when this document was produced. 

Senator LEVIN. I thought you said you terminated—it is just very 

unclear to me. I thought you said you terminated Stratecon when 

you came in in April 2002. And my question is: Why does Stratecon 

still show as having Solutions in Development on November 26, 

2002? It is a straightforward question. 

Mr. SMITH. Yes, and——

Senator LEVIN. I don’t understand your answer. 

64

1See Exhibit No. 34 which appears in the Appendix on page 521. 

2See Exhibit No. 13 which appears in the Appendix on page 450. 

Mr. SMITH. Let me try to elaborate on it, Senator, and that is, 

we have a number of systems, accounting systems throughout our 

business, and stand-alone databases in various parts of our business, and I believe that this particular document reflects a database that was not updated based on the changes that we made in 

our practice. 

Senator LEVIN. So this document is wrong, too. It wasn’t updated 

as of November 26? It was incorrect? 

Mr. SMITH. Systems changes in terms of databases do take some 

time to implement, so it is reflective that we had had a Stratecon 

practice and that certain things had been worked on, yes. 

Senator LEVIN. There is an e-mail from Mark Watson, Exhibit 

34,1 Mr. Smith, on July 22, 1999. 

Mr. SMITH. That was Exhibit 34, Senator? 

Senator LEVIN. Yes, Exhibit 34, to you and Mr. Wiesner. This is 

about the BLIPS economic substance issue. It raises questions. It 

says, ‘‘It seems very unlikely that the rate of return on the investments purchased with the loan proceeds will equal or exceed the 

interest charged on the loan and the fees incurred by the borrower 

to secure the loan. . . . Before any fees are considered, the client 

would have to generate a 240-percent annual rate of return on the 

$2.5 million foreign currencies investment in order to break even. 

If fees are considered, the necessary rate of return to break even 

would be even greater.’’

Mr. Watson also noted that the BLIPS client ‘‘has a tremendous 

economic incentive to get out of the loan as soon as possible due 

to the large negative spread.’’

And then he asked you, ‘‘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.’’ He had told our staff that he never heard from 

you following that memo. Is that correct? 

Mr. SMITH. Well, my recollection doesn’t serve me back to 1999, 

Senator, but let me provide you some insights that might be helpful. 

Senator LEVIN. I just want to know, because in terms of time we 

are running out. Do you remember responding to this memo? 

Mr. SMITH. I have no particular recollection of responding to this 

memo, but I know what I would do having read this memo right 

now, and that would have been—he talks about a commitment that 

he has, I think for the following day, and so I either would have 

called him or I would have known that that deadline was not something that we needed to meet, and I would have gotten back to him 

either in a general meeting about this matter or specifically. 

Senator LEVIN. All right. Now, turn to Exhibit 13,2 if you would. 

This is an August 1999 Mark Watson memo. It says before BLIPS 

‘‘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 chalVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00088 Fmt 6633 Sfmt 6633 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
65

lenged by the IRS. We are particularly concerned about the economic substance of the BLIPS transaction.’’

And then if you look at the top of the page, you will see that Steven Rosenthal responded to Mark Watson that very day as follows: 

‘‘I share your concerns.’’ And then a few lines later, ‘‘I continue to 

be seriously troubled by these issues, but I defer to Phil Wiesner 

and Richard Smith to assess them.’’

So now your two professionals seriously question the economic 

substance of BLIPS, and they appear to be identifying you as well 

as Mr. Wiesner as individuals who ignored their concern and 

pushed through the approval of BLIPS. You have heard Mr. Watson’s testimony. How did BLIPS get approved when there are such 

serious questions about its economic substance? 

Mr. SMITH. Well, I certainly don’t agree with the characterization 

that we ignored their concerns. If we go back and look at the entire 

time line here, you go back to January or February 1999, and there 

was in-depth consideration of all of the issues that were implicated 

within BLIPS. These are a couple among those which where the 

debate continued. Certainly it was encouraged that everybody have 

the opportunity to raise concerns that they had throughout the 

process at any point in the process so that those could be concerned—be considered, excuse me. 

Senator LEVIN. If the professionals in their positions today had 

the same problems with the tax product, would you proceed with 

it? 

Mr. SMITH. I would say that if people have technical concerns 

with regard to any matters that we have, that we would consider 

them seriously in our discussion. The difference——

Senator LEVIN. I am sure that is what your position is, that you 

would seriously consider them. But given what you know now—and 

I think then from these memos—of their concerns, lack of economic 

substance, no real loan. Over and over again they were told. This 

came to you anyway. Would you override their concerns today? 

Mr. SMITH. I think our process has evolved in terms of how we 

might address this today. One of the things that we have learned 

in terms of how to deal with these types of issues is that we put 

out as our standard that we got to ‘‘more likely than not.’’ And we 

believe that we reached that standard. 

The issue with that standard is that it is close to the edge of the 

cliff. You are up to and—you are not to cross that edge. But certainly once you go up there, it is often the cautious and the right 

thing to do to back away and not approach these types of issues 

in the same manner. 

So the change in the way that we would go about this would be 

to consider that and assure ourselves that we are not conducting 

ourselves in a way that would have this same level of risk associated with it. 

Senator LEVIN. Over the last 5 years, Mr. Smith, did KPMG encourage the sale of its tax products to potential clients? 

Mr. SMITH. We are in a business, Senator, and we do talk to our 

clients about tax advice, and we encourage and talk to our professionals about making sure that they represent our clients and that 

they think about their industry and the issues that face them and 

work to represent them fully. 

66

Senator LEVIN. Well, it is not a response to the question, and I 

want to ask it—I am going to try it again. 

Mr. SMITH. Sure. 

Senator LEVIN. It is a very significant question. It goes to the 

heart of all of the promoting that you did. You have given us a list 

of all the tax products which you developed, which were offered for 

sale. We have seen the marketing plans, the telemarketing, the 

profiles of likely clients for your tax products, the internal databases that were used to develop potential client lists for some of 

your tax products; again, your telemarketing center in Fort Wayne, 

Indiana; the unsolicited contacts with clients to tell them of KPMG 

tax products and services; the revenue goals that you set for your 

tax groups; your sales opportunity center that was intended to help 

its personnel sell your tax products. 

I just want to talk now about tax products, and my question to 

you, again, is: Have you over the last 5 years encouraged the sale 

or acceptance of tax products to potential clients? 

Mr. SMITH. Certainly our encouragement of our professionals to 

serve their clients has extended over the past 5 years as well as 

before that. 

Senator LEVIN. I have just got to keep asking it. It is my last 

question. I may have to ask it two or three more times. Have you 

encouraged the sale or acceptance of your tax products to potential 

clients? 

Mr. SMITH. We have encouraged our tax professionals to advise 

our clients, and we do that, have contact with——

Senator LEVIN. Did that include—look, I have got to just keep 

asking this. Did that include encouraging the sale or acceptance of 

your tax products by those clients? 

Mr. SMITH. Well, Senator, I think that——

Senator LEVIN. It is a straightforward question. 

Mr. SMITH. In a number of different components of our business, 

we talk to our clients in many different ways, over the telephone 

and in writing, in meetings face-to-face, and we do encourage our 

tax professionals to meet with our clients and talk to them about 

the complexities of the tax code and to talk about their business 

and the things that they ought to be thinking about from a tax perspective, yes. [Laughter.] 

Senator LEVIN. Is ‘‘yes’’ the answer to my question? 

Mr. SMITH. I believe that my entire response was the answer to 

your question. 

Senator LEVIN. But is the ‘‘yes’’ at the end of it intended to respond to my question? Did KPMG——

Mr. SMITH. I’m trying to——

Senator LEVIN. No, I am sorry. See, you come here and you are 

asking us to believe that you have basically changed your ways, 

things are done differently there now for various reasons. And, 

frankly, I am skeptical. And one of the reasons which makes me 

skeptical is I cannot get a straight answer out of you to a very direct question, whether or not KPMG encouraged the sale or acceptance of its tax products to potential clients. There is a mass of evidence that you did, but I cannot get you to say, ‘‘Yes, one of the 

things we did was encourage the sale or acceptance of our tax products to potential clients.’’ I cannot get you to say that. 

67

Mr. SMITH. Well——

Senator LEVIN. Even though it is obviously true. It is as clear as 

the nose on your face that it is true. 

Mr. SMITH. I think we are in agreement, Senator, because what 

you just said was one of the things that we do is to encourage our 

professionals, yes, to——

Senator LEVIN. No. You just say encourage professionals. Look, 

Mr. Smith, I don’t want to play a game with you. I want to try to 

get a direct answer, and I will try one more time. But you understand the reluctance to give a direct answer to me raises questions 

about what you are saying that you are trying to change your ways 

or you have changed your ways or you are going to through a lot 

of procedures. 

Now, unless I can get a straight answer to a question that has 

overwhelming evidence in support of a yes answer, I cannot—I am 

skeptical about what you are telling us otherwise. So let me ask 

it one last time. 

Over the last 5 years, is one of the things that KPMG did was 

encourage the sale or acceptance of its tax products to potential clients? Can you give me a yes or no answer to that? 

Mr. SMITH. I can, Senator. 

Senator LEVIN. And what is it? 

Mr. SMITH. Yes. 

Senator LEVIN. Thank you. Thank you, Mr. Chairman. 

Senator COLEMAN. Thank you, Senator Levin. 

With that, the hearing record will be kept open for 3 weeks. The 

witnesses are reminded that when answering supplemental written 

questions from the Subcommittee, they will still be under oath. 

I want to thank the witnesses for appearing before us today. This 

hearing is adjourned. 

[Whereupon, at 1:10 p.m., the Subcommittee was adjourned.] 

(69)

U.S. TAX SHELTER INDUSTRY: THE ROLE OF 

ACCOUNTANTS, LAWYERS, AND FINANCIAL 

PROFESSIONALS 

THURSDAY, NOVEMBER 20, 2003

U.S. SENATE, 

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS,

OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 9:05 a.m., in room 

216, Hart Senate Office Building, Hon. Norm Coleman, Chairman 

of the Subcommittee, presiding. 

Present: Senators Coleman and Levin. 

Staff Present: Raymond V. Shepherd, III, Staff Director and 

Chief Counsel; Joseph V. Kennedy, General Counsel; Mary D. Robertson, Chief Clerk; Leland Erickson, Counsel; Mark Greenblatt, 

Counsel; Steven Groves, Counsel; Frank J. Minore, Detailee, General Accounting Office; Kristin Meyer, Staff Assistant; Steve 

D’Ettorre, Staff Assistant; Kevin Carpenter (Senator Specter); Elise 

J. Bean, Staff Director/Chief Counsel to the Minority; Bob Roach, 

Counsel and Chief Investigator to the Minority; Julie Davis, Professional Staff Member to the Minority; Laura Stuber, Counsel to the 

Minority; Brian Plesser, Counsel to the Minority; Christopher Kramer, Professional Staff Member to the Minority; Beth MerillatBianchi, Detailee, Internal Revenue Service; Jim Pittrizzi, Detailee, 

General Accounting Office; Ken Seifert, Intern; Jessilyn Cameron, 

Brookings Fellow; David Berrick (Senator Lieberman); and Rudy 

Broiche (Senator Lautenberg). 

OPENING STATEMENT OF SENATOR COLEMAN 

Chairman COLEMAN. This hearing of the Permanent Subcommittee on Investigations is called to order. 

I want to begin by thanking my distinguished Ranking Member, 

Senator Levin, again for his work in this area and his deep concern 

for taxpayers, his concern for just kind of a fundamental sense of 

right and wrong in business practices. I think when we address 

those concerns, when we clear up things that are very problematic, 

such as we examined last Tuesday and which we will address 

today, I think we all benefit. 

Senator LEVIN. Thank you, Senator Coleman. 

Chairman COLEMAN. On Tuesday, this Subcommittee heard testimony under oath concerning the role of major accounting firms in 

the development, marketing, and implementation of generic tax 

products with no substantial economic purpose other than to reVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00093 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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duce tax burdens, the result being to rob the U.S. Treasury of billions of dollars annually. 

Let me begin by saying I am troubled by what I heard on Tuesday and troubled by what I did not hear. We had accounting firm 

after accounting firm come forward and tell us, ‘‘Mr. Chairman, 

what we did was wrong.’’ Yet, I remain troubled that it wasn’t 

some revelation that came to them after the fact that what they 

did was wrong. Common sense would dictate that they knew what 

they were doing was wrong when they were doing it. 

Although the various firms gave tortured explanations of multiple levels of review and hours of deliberation they engaged in before reaching their decisions of more probable than not legality, I 

think the answer is much simpler. It was the 1990’s. The surge in 

the market made many awash in cash. There were millions of dollars to be made and everybody else was doing it. But the bottom 

line itsthat it was wrong, it was unethical, and in some cases was 

illegal. 

These sham transactions clearly lacked economic substance. 

Some may have believed there was a loophole that supported these 

transactions, but the lure of millions of dollars in fees clearly 

played a role in the decision on the part of tax professionals to 

drive a Brink’s truck through any purported loophole. 

Last Tuesday shined a light on a dark and shameful period for 

the accounting industry. That was the past and it must remain the 

past. The future is much brighter. I was bolstered by the fact that 

all the firms said these abusive tax shelters are a thing of the past. 

Some admitted their mistakes. All said they would sin no more. 

We heard that many of the people involved in these abusive tax 

shelters are no longer working for these companies, that they have 

put in place policies and procedures that will deter such practices 

in the future, and that they have recommitted themselves to the 

highest ethical and business standards. 

It was obvious last Tuesday and it will be demonstrated today 

that accounting firms did not act alone. Others, including otherwise 

reputable investment advisors, banks, and law firms were part and 

parcel of these fraudulent schemes. Moreover, they also provided 

the added benefit of making detection by the IRS difficult. These 

entities provided a veneer of legitimacy for abusive tax shelters 

that were, in fact, illusory or sham transactions with little or no 

economic substance driven primarily for favorable tax consequence. 

Based on PSI’s investigation, investment advisors were essential 

for developing and implementing the financial transactions for 

these shelters. In fact, investment advisors have been deemed to be 

promoters of tax shelters bought by the IRS for certain sheltered 

transactions, triggering registration obligations. 

However, the Permanent Subcommittee has determined that Presidio, an investment firm that clearly promoted at least two abusive tax shelters, BLIPS and OPIS, did not register these shelters 

with the IRS. By refusing to register these abusive tax shelters, it 

is obvious that KPMG and Presidio attempted to conceal their existence from the IRS. There are others who are also complicit—lawyers and bankers who made money, lots of money, and had to know 

what they were doing was wrong. 

71

This Subcommittee was not playing Monday morning quarterback when it focused on these transactions. The players in these 

abusive tax shelters had to know there was no economic substance 

to these transactions and that their efforts to avoid IRS detection 

by failing to register them was part of a deliberate cover-up. It 

seems clear to this Senator that ethical concerns were gagged and 

blindfolded by the lure of big dollars. 

Major law firms are essential to the tax shelter business. They 

were routinely utilized by the accounting firms to provide tax opinions in order to protect taxpayers from penalties if challenged by 

the IRS. Some firms provided hundreds of cookie cutter opinions of 

various tax schemes. The other firms took on the additional role of 

soliciting, developing, and marketing tax schemes. In fact, the IRS 

has targeted at least two prominent law firms as promoters of tax 

shelters. 

As someone who practiced law for 17 years in the Minnesota Attorney General’s Office, former Solicitor General of the State of 

Minnesota, I am well aware of the ethical standard that requires 

attorneys to avoid even the appearance of impropriety. Based on 

our investigation, it is difficult for me to understand how that 

standard was not violated in these cases. 

In addition, the existence of a closed business relationship with 

KPMG also raises concerns about whether any independent analysis and advice was provided. I look forward to hearing the testimony of the attorneys involved in these transactions. 

And the bankers, I know, take great pride in what they do and 

the code of conduct they insist upon for their employees and themselves. Most Americans may not think of bankers as their friend 

next door, but for generations, Americans have come to expect that 

banks are a bastion of fiscal responsibility in possession of their 

money, their savings, their hopes, and their dreams. In this case, 

it appears that bankers helped facilitate these transactions for the 

price of admission into a tax shelter business that allowed everyone 

involved to profit. 

Prominent banks provided the necessary loans for tax shelters. 

While the banks have traditionally concerned themselves primarily 

with credit risks, these loans were critical for generating the artificial paper losses in the tax shelter industry. For the banks involved, these schemes were merely a vehicle to generate substantial profits. 

Given the evidence that PSI has uncovered in the sworn testimony the Subcommittee has heard, it is imperative to ensure that 

the proper regulatory and oversight framework exists to address 

the myriad of participants involved in the tax shelter industry. 

On the last panel, we will hear from the agencies charged with 

enforcing the laws. The Internal Revenue Service is primarily responsible for interpreting and enforcing the tax laws. High rates 

automatically create a large incentive to find loopholes or tax strategies. The complexity of the tax code also reduces the transparency 

of returns, making it very difficult for the regulators to follow what 

is going on in the private sector. 

On Tuesday, the Subcommittee heard testimony that accounting 

and investment firms structured deals to intentionally conceal their 

efforts from the IRS. It is imperative that Congress not allow the 

72

IRS to become the toothless paper tiger that is ignored by those involved in the tax shelter industry. We must give them the tools, 

the resources, and the direction necessary for the proper enforcement of our Nation’s tax laws. Congress must not allow the IRS to 

be an irrelevancy. 

After today’s hearing, I intend to discuss with Senator Levin 

what follow-up action we need to take in order to address the problems exposed by this investigation. A number of potential reforms 

were discussed at Tuesday’s hearings. These include more expansive and explicit reporting requirements, tougher penalties for noncompliance, and more effective internal review procedures within 

the professional firms involved in these transactions. The scope of 

my response will depend very much on the behavior of the professional firms and the willingness and ability of the regulators to address these issues. 

If Congress needs to act in order to provide more resources or to 

simplify tax laws and close loopholes that are being upheld by the 

courts, then we will do so. Let me be very clear, however. I am 

against additional regulation just for the sake of more regulation. 

The preferable way is professionals who self-impose a high ethical 

standard and to consistently act in accordance with those standards without requiring Congressional review to highlight transgressions. 

But sometimes, regulations such as the Sarbanes-Oxley Act are 

the only way to restore the public trust without which our tax and 

financial systems cannot work. I do intend to see public trust in the 

application of tax laws restored. Congress will take the necessary 

steps to prevent a recurrence or the proliferation of abusive tax 

shelters. 

With that, the distinguished Ranking Member, Senator Levin. 

OPENING STATEMENT OF SENATOR LEVIN 

Senator LEVIN. Thank you very much, Mr. Chairman. First, let 

me thank you for these hearings, thank you and your staff for all 

the support that you have given to this investigation. It has been 

critical and the country is very much in your debt for doing this. 

Today, as you point out, is the second of 2 days of hearings on 

our year-long investigation into the role of professional firms, such 

as accounting firms, banks, investment advisors, and law firms, in 

the development, marketing, and implementation of abusive tax 

shelters. 

The purpose of the transactions that we have been looking at and 

the transactions creating those shelters wasn’t to make a profit, 

but it was to produce a tax loss to offset or to shelter income. These 

transactions were a sham, a deception, an abuse of honest taxpayers. 

The first day of hearings focused on KPMG, a leading accounting 

firm that for the past 5 years has been heavily involved in the development and marketing of generic tax products to multiple clients, including some potentially abusive or illegal tax shelters. It 

took some time at the last hearing before KPMG would admit that 

it has been promoting tax products, but in the end, they finally did. 

Today’s hearing will examine some of the professional firms that 

have joined forces and worked hand-in-glove with KPMG in the tax 

73

1See Exhibit No. 137 which appears in the Appendix on page 2735. 

shelter business—banks, investment advisors, and lawyers, without 

which those abusive tax shelters would never have polluted so 

many tax returns and robbed Uncle Sam and average taxpayers of 

billions of dollars of revenues. 

The Subcommittee’s investigation is focused on four KPMG tax 

shelters known by their acronyms, BLIPS, FLIP, OPIS, and SC2. 

The first three have already been identified by the Internal Revenue Service as potentially abusive or illegal tax shelters. The 

fourth, SC2, is under IRS review. BLIPS, FLIP, and OPIS required 

the participation of a bank, investment advisory firm, and law firm 

to work. Each of the professional firms here today had a role in one 

or more of these tax products and helped provide the legal or financial facade of economic substance for transactions whose only real 

purpose was to reduce or eliminate the buyer’s taxes. 

KPMG sold BLIPS, FLIP, and OPIS to about 300 people. It is no 

accident that the same banks, investment advisors, and law firms 

appear over and over again in connection with the transactions 

needed to implement these tax shelters. In fact, KPMG courted and 

built up relations with each of these professional firms because it 

couldn’t implement its tax products without them. KPMG also 

wanted to form business alliances with other respected professionals to increase its stature in client contacts. 

An internal KPMG memorandum that we just received this 

week, which is Exhibit 137,1 lays it all out. In 1997, a month before 

he left the firm to form his own investment advisory firm called 

Presidio, a senior KPMG partner, Robert Pfaff, sent a memo to the 

two top officials in the KPMG tax services practice with a number 

of suggestions for, ‘‘KPMG’s Tax Advantaged Transaction Practice.’’ 

Among other suggestions, the memo argues for the development of 

‘‘turnkey’’ tax products, tax shelters that KPMG clients could use 

without any changes to reduce their taxes. 

The memo also stated that, in most cases, it will be ‘‘difficult or 

impossible for KPMG to be the sole provider of a tax advantaged 

product,’’ in other words, a tax shelter, ‘‘due to restrictions placed 

on the firm’s scope of activities by authorities.’’

The memo described KPMG’s ‘‘dilemma’’ in its words, as follows: 

‘‘To avoid IRS scrutiny, KPMG had to market its tax products as 

investment strategies, but if it characterized its services as providing investment advice to clients, it could attract SEC scrutiny 

and have to comply with Federal securities regulations.’’ 

And this memo, again, which we just received this week, explains 

it as follows: ‘‘It is clear we cannot openly market tax results of an 

investment. Rather, our clients should be made aware of investment opportunities that are imbued with both commercial reality 

and favorable tax results. Conversely, we cannot offer investments 

without running afoul of a myriad of firm and securities rules. Ultimately, it was this dilemma that led me to the conclusion that 

KPMG needs to align with the likes of a Presidio.’’

In other words, KPMG recognized that to make its tax products 

work, KPMG itself could not provide ‘‘investment advice.’’ It also 

knew it could not issue loans or provide financing. It had no authority to practice law. It needed assistance from other profesVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00097 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
74

sionals with those capabilities to carry out its tax schemes and it 

found them. 

Law firms like Brown and Wood, which later became Sidley Austin Brown and Wood, issued favorable, boilerplate legal opinion letters for BLIPS, FLIP, and OPIS, issuing more than 250 opinion letters in all. 

Investment advisory firms like Quellos doing business as 

Quadra, and Presidio helped set up hundreds of BLIPS, FLIP, and 

OPIS transactions. 

Banks like Deutsche Bank, HVB Bank, and others financed hundreds of BLIPS, FLIP, and OPIS transactions. Deutsche Bank and 

HVB together provided more than $5 billion in financing for these 

transactions. 

Everyone, of course, got paid lots of fees. For example, in BLIPS, 

clients paid a set fee at 7 percent of the planned tax loss. Now 

think about that. If anything demonstrates that the goal of these 

schemes was to produce paper tax losses, it is that the fee was 

based on the size of the planned tax loss. The higher the planned 

tax loss, the higher the fee. 

In the case of the BLIPS fee, after certain expenses were subtracted, the remaining money was divvied up among the firms that 

carried out the client’s BLIPS transaction. KPMG and the banks 

each got 1.25 percent, what they called 125 basis points. The investment advisor got 2.75 percent, or 275 basis points. The law 

firm generally got $50,000 for each opinion, possibly more in cases 

where the expected tax loss was large. 

Looking at just the four tax products examined by this Sub- committee, KPMG brought in fees totalling at least $124 million. 

Sidley Austin Brown and Wood, with more than 250 opinion letters, raked in at least $50,000 per boilerplate letter and made more 

than $12 million. Deutsche Bank hauled in about $33 million from 

its OPIS transactions and expected to make the same again from 

BLIPS. HVB made over $5 million in less than 3 months doing 

BLIPS deals in 1999 and decided on doing more in the year 2000, 

due in part, in its own words, to ‘‘excellent profitability.’’

Now, what exactly were these fees for? The law firm Sidley Austin Brown and Wood provided a so-called independent legal opinion 

letter finding that the tax products complied with the law. In fact, 

the law firm collaborated heavily with KPMG to develop the products and write the opinion letters. The banks provided financing 

and nominal currency transactions that acted as an investment fig 

leaf to disguise transactions that were really tax driven. The investment advisors provided the design and the rhetoric to recast 

the tax dodges as investment strategies. 

The facts echo what this Subcommittee uncovered during its 

Enron investigation: Respected professional organizations offering 

their services and making a lot of money by assisting other parties 

to complete highly structured and deceptive transactions. In this 

case, the transactions were intended to help KPMG’s clients reduce 

or eliminate paying their fair share of taxes owed to Uncle Sam. 

By facilitating these tax schemes, these organizations also opened 

themselves up to possible violations of the laws against the promoting of abusive tax shelters and against aiding or abetting tax 

evasion. 

75

Now, relative specifically to the SC2 tax product, we had planned 

to have at today’s hearing one of the pension funds that KPMG approached and convinced to participate in SC2 transactions. None of 

the SC2 tax products could have been sold absent a charity willing 

to accept S Corporation stock donations under unusual circumstances. To save time, we asked the pension fund to submit a 

written statement instead of appearing here today. 

That statement sets forth these key facts. KPMG initiated the 

contact with the charity. The charity did not know its 28 benefactors beforehand, and the charity was asked and expected to hold 

the stock it was given ‘‘for several years’’ and would then ‘‘be able 

to sell the stock back to the owner and receive cash.’’ In short, it 

is clear that SC2 was intended to provide only temporary stock donations. 

Also relative to SC2, we did not have time at the last hearing 

to address a number of very troubling statements made by the 

former KPMG tax partner Lawrence Manth, who headed up the 

SC2’s sales effort and who claimed that KPMG was selling SC2 to 

benefit police and firefighters. The documents are overwhelming in 

demonstrating the opposite. KPMG was not acting altruistically in 

selling SC2, but again, it was helping its clients reduce or eliminate their taxes. If the sole objective was to make a charitable donation, SC2 donors could have simply donated cash instead of 

going through the exercise of first donating stock, then buying it 

back for cash, and we plan to follow up on those statements with 

Mr. Manth and others. 

The industry which promotes abusive tax shelters should have no 

place in the business plans of respected legal and financial professionals. It is time to put an end to banks, investment advisors, and 

law firms using their talent to promote, aid, or abet dubious and 

abusive tax shelter schemes. 

Finally, we will hear today from three key regulators: The IRS, 

the Federal Reserve, and the newly formed Public Company Accounting Oversight Board. Each has a role to play in convincing, 

or if necessary forcing, accounting firms, banks, investment advisors, and law firms to get out of the abusive tax shelter promotion 

business. To help those efforts, Congress needs to enact stronger 

penalties for promoting, aiding, or abetting abusive tax shelters. 

The current fines of $1,000 for individuals and $10,000 for corporations are useless as deterrents. 

We also need more enforcement dollars for the IRS to go after 

tax shelter promoters. We also need to put an end to auditor conflicts of interest that arise when accounting firms sell tax shelter 

services to their audit clients and then turn around and audit their 

own handiwork. We need to clarify and strengthen the economic 

substance doctrine. 

We need a coordinated regulators’ review to identify abusive tax 

shelter products some accounting firms, banks, investment advisors, and law firms are selling, and to stop them from assisting the 

purveyors of abusive tax shelters. 

And, as our Chairman, I think very eloquently pointed out, we 

need the professions themselves to adhere to higher standards of 

conduct. 

76

1See Exhibit No. 116 which appears in the Appendix on page 2691. 

Again, my thanks to you, Mr. Chairman, and to your staff for all 

the help you have given me. 

Chairman COLEMAN. Thank you, Senator Levin. 

I would now like to welcome our first panel to today’s important 

hearing: Raymond J. Ruble, a former partner for the law firm of 

Sidley Austin Brown and Wood; Thomas R. Smith, a current partner with Sidley Austin Brown and Wood; and finally N. Jerold 

Cohen, a partner with the law firm of Sutherland Asbill and Brennan. I thank each of you for your attendance at today’s hearing and 

look forward to hearing your testimony. 

Before we begin, pursuant to Rule 6, all witnesses who testify before this Subcommittee are required to be sworn. I would ask you 

to each rise and raise your right hand. 

Do you swear that the testimony you are about to give will be 

the truth, the whole truth, and nothing but the truth, so help you, 

God? 

Mr. RUBLE. I do. 

Mr. SMITH. I do. 

Mr. COHEN. I do. 

Chairman COLEMAN. Thank you, gentlemen. 

Gentlemen, we do have a timing system. I would ask that you 

keep your statements to 5 minutes. Your fully prepared statements 

will be entered into the official record. 

Mr. Ruble, we will have you go first this morning, followed by 

Mr. Smith and finish up with Mr. Cohen. After we have heard all 

of your testimony, we will turn to questions. Mr. Ruble, I understand that you are accompanied by counsel. Counsel, please identify yourself for the record. 

Mr. HOFFINGER. Jack Hoffinger. 

Chairman COLEMAN. Thank you. Mr. Ruble, you may begin. 

TESTIMONY OF RAYMOND J. RUBLE, FORMER PARTNER, 

SIDLEY AUSTIN BROWN AND WOOD, LLP, NEW YORK, NEW 

YORK, REPRESENTED BY JACK HOFFINGER 

Mr. RUBLE. Thank you, sir. Senator Coleman and Senator Levin, 

my name is R.J. Ruble. I would very much like to respond to your 

questions on the matters that are being discussed today and I appreciate your endeavors in this regard. However, I have been instructed by my counsel not to testify based on my Fifth Amendment constitutional rights. 

Chairman COLEMAN. Mr. Ruble, I would like to see if I could just 

explore two matters with you. One, if you could just turn to Exhibit 

116 1 in the exhibit book, it appears to be an e-mail from R.J. Ruble 

that reads as follows: ‘‘This morning, my managing partner, Tom 

Smith, approved Brown and Wood, LLP, working with the newly 

conformed tax products group at KPMG on a joint basis in which 

we would jointly develop tax products and jointly share in the fees, 

as you and I have discussed.’’ Is this, in fact, an e-mail that you 

prepared? 

Mr. RUBLE. I must respectfully decline to answer on the grounds 

asserted. 

77

1See Exhibit No. 90a. and 90b. which appear in the Appendix on pages 684 and 781. 

2The prepared statement of Mr. Smith appears in the Appendix on page 312. 

Chairman COLEMAN. I would just ask one other question, again, 

for my foundational purposes. You have in the exhibit book Exhibits 90a. and 90b.1 Exhibit 90a. purports to be an opinion by KPMG 

regarding some of the tax shelters that we talked about. Exhibit 

90b. purports to be a Brown and Wood legal opinion. I would note 

that both opinions appear to have substantially the same language, 

in fact, almost the exact language. I would ask you again if that 

is a correct assertion. 

Mr. RUBLE. I have been instructed to decline to answer on the 

grounds asserted. 

Chairman COLEMAN. Given the fact that you are asserting your 

Fifth Amendment right against self-incrimination to all questions 

asked of you by the Subcommittee, you are excused, Mr. Ruble. 

Mr. RUBLE. Thank you very much, sir. 

Chairman COLEMAN. Mr. Smith. 

TESTIMONY OF THOMAS R. SMITH, JR.,2 PARTNER, SIDLEY 

AUSTIN BROWN AND WOOD, NEW YORK, NEW YORK, LLP 

Mr. SMITH. Thank you, Mr. Chairman and Senator Levin. My 

name is Tom Smith. I am a partner in the law firm of Sidley Austin Brown and Wood and I am pleased to answer your questions 

to the extent that I can. 

I joined Brown and Wood in 1963 and have spent my career 

there as a securities lawyer. I am not a tax lawyer. But from 1996 

to May 1, 2001, at the time of our merger with Sidley and Austin, 

I was the managing partner of Brown and Wood. 

Mr. Chairman, our firm wants to cooperate with the Subcommittee to the maximum extent it can. The area of tax work that 

brings us here today is an area that our firm no longer participates 

in. Unfortunately, my personal files on these matters were lost in 

the destruction of our office in the World Trade Center on September 11, and Mr. Ruble, the person in our firm most knowledgeable about these matters, is not available to you or to us. Thus, we 

are limited in the information we can provide. 

Mr. Ruble is no longer a partner of the firm. He was expelled 

from the partnership on October 24, 2003, for activities in violation 

of the partnership agreement, that is, accepting undisclosed compensation and for refusing to explain his conduct to the firm. 

As a result, we are not confident that the information Mr. Ruble 

has given us in the past and upon which we have relied is accurate, and we have so advised the Subcommittee staff, the Internal 

Revenue Service, and other interested parties. 

That said, let me tell you a bit about the tax practice at Brown 

and Wood. Of the approximately ten tax partners at Brown and 

Wood before the merger, Mr. Ruble was virtually the only one who 

engaged in this practice, although he consulted with others on discrete issues. At the time Mr. Ruble began providing concurring 

opinions to individual taxpayers, Brown and Wood had an opinion 

committee and expected partners to seek the advice of that committee or of the other colleagues at the firm of novel and unsettled 

legal issues. In addition, Brown and Wood required approval of tax 

78

opinions by a second tax partner, and as a matter of fact, during 

the period in 1999, we expanded that second opinion requirement 

to all lawyers. 

After the merger, the firm maintained and expanded the size of 

the opinion committee and further enhanced its policies in this 

area. The purpose of this policy was to help ensure the quality and 

consistency of tax advice provided by the firm and to provide an 

electronically maintained library of tax opinions that all tax lawyers could access. 

No set of procedures will stop an individual from acting improperly if he or she is unwilling to abide by the rules of our profession 

and to engage in blatant acts of deceit and concealment. Nevertheless, we have hired a tax attorney whose principal responsibility is 

to monitor our internal procedures and our compliance with the 

evolving requirements of the Internal Revenue Service. 

Prior to the merger of Brown and Wood and Sidley and Austin 

and as part of our transition planning, it was decided that the combined firm would stop providing individual tax opinions that this 

Subcommittee is considering and we would reorient the tax practice to the corporate transactional work that is central to both 

firms’ practices. This action reflected the decision of Brown and 

Wood and the combined firm to redirect the efforts of the firm to 

our core tax work and did not and does not reflect on the quality 

of the work performed earlier. I understand that no court has decided that Mr. Ruble’s tax opinions are wrong, much less rendered 

in bad faith. 

Although Mr. Ruble had confirmed that he had stopped issuing 

opinions of this type, the firm discovered that additional opinions 

had been issued after the merger. When confronted with this, Mr. 

Ruble said that the opinions were the last in the typewriter and 

were being rendered because he had pre-merger commitments to 

provide them to clients. He was told to stop issuing such opinions. 

He assured the firm that he had stopped, but in fact, he lied to us. 

He evaded our controls we had in place and he breached the trust 

we reposed in him. 

We had and have procedures in place designed to ensure that all 

of our lawyers, partners, associates, and others act in compliance 

with applicable laws and the highest ethical standards. In a law 

partnership, the effectiveness of procedures of this sort is highly 

dependent upon the trustworthiness of our partners. 

Both Sidley Austin Brown and Wood and I personally want to 

thank you for the open, cooperative, and professional treatment we 

have received from both the Majority and Minority staff. 

Chairman COLEMAN. Thank you, Mr. Smith. 

Mr. Cohen, before we proceed, I note that you have a gentleman 

with you. For the record, would you please identify him. 

Mr. COHEN. A partner, J.D. Fleming, who has come with me. 

79

1Letter to Senators Coleman and Levin, dated November 18, 2003, with responses to questions appears in the Appendix on page 315. 

TESTIMONY OF N. JEROLD COHEN,1 PARTNER, SUTHERLAND 

ASBILL AND BRENNAN, LLP, ATLANTA, GEORGIA, ACCOMPANIED BY J.D. FLEMING 

Mr. COHEN. Mr. Chairman, Senator Levin, thank you very much 

for inviting me to these hearings. I commend you on the hearings. 

I think they are very important. I think if they lead to the passage 

of some of the provisions that were passed in the Senate CARE Act 

or to some of the provisions that are now in the JOBS Act, I think 

that will be very good. 

I am especially pleased to hear both Senators acknowledging that 

the Service needs more resources. Over the last 7 years, its workload has gone up over 11 percent and its workforce down by over 

11 percent. You just can’t keep that up and it is showing, and it 

is showing in some of these things. 

First of all, let me say that my firm, Sutherland Asbill and Brennan, has not been involved in the development, marketing, or implementation, or the promotion, aid, or abetment of the tax shelters 

that you have asked us about. In fact, the fourth of the shelters, 

SC2, I know nothing at all about. 

We have been engaged by clients who were under audit by the 

Internal Revenue Service long after they participated in these 

transactions to represent them, and we have been representing 

them in that regard. 

Every time we discuss with a client potential representation, we 

inform them that we cannot—cannot—participate in any suit 

against any promoter, whether it is the promoter or a firm that has 

been involved with the transaction, that we represent, and we have 

a litigation group that represents all of the major accounting firms, 

five back then, four now, in totally unrelated litigation. We tell 

them because of that, we cannot represent them in any action 

against anyone connected with this, these transactions, and we 

suggest to them that they obtain other counsel to represent them 

in that regard. We tell them that several times and we tell them 

to engage other counsel sooner rather than later because there is 

a statute of limitations problem in any actions that they might 

want to consider. 

Now, having said that, let me also commend the staff for the Minority Report. I haven’t read the whole thing, it is awfully long, but 

I thought it was very good. I know they worked long and hard at 

that. In fact, I called some of the staffers a couple of times and 

found them working late at night on that. 

But after my letter responding to your questions and reading the 

Minority Report, I found that I could make further responses to 

some of your questions. I respect the pressure the staff was under 

and I know that our firm is only discussed in three pages of the 

large report. But I wish they had had time, and I know they didn’t, 

to consult with me because there are a lot of misstatements in 

those three pages about my firm’s activities. 

First of all, it states that KPMG referred over two dozen clients 

to us. That is not true. I am not saying that I would not have liked 

to have had more clients, because we shared the costs of our repVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00103 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
80

resentation among all the clients, and I am sure all of the clients 

would have liked to have had more, but we never had two dozen 

clients referred to us by KPMG to my knowledge. I have no idea 

what KPMG told you. We had clients coming in from other clients, 

from financial advisors, and from law firms. In fact, the first clients 

we had with regard to the three transactions, the three products, 

if you will, that I knew about came from law firms. 

Let me also say that I can tell you now that we have in the three 

transactions that we have worked on approximately 40 such clients. That is, reading the numbers you have in your report, it is 

not an inconsiderable number to me, but it is a small part of the 

landscape. 

Now, the report suggests that our only disclosure to the client 

was in the engagement letter, which is quite clear. Your report 

does cite the engagement letter stating to the clients that we cannot represent them before the accounting firms. It suggests that 

that is all we did, and there is an opinion that came out that cannot be correct—because it did not represent the facts. 

The facts are that is not all we did. Before undertaking any engagement, we spoke to the client or to their financial advisor or 

whoever their advisor was. Some of these clients are so wealthy 

that you don’t speak to the clients. They always contact the lawyers either through their own in-house lawyer or through their financial advisors, and all were advised, clients, financial advisors, 

in-house people, that they needed to get another lawyer to—if they 

contemplated any action against anyone in connection with the 

products. They were told to do that right away because there was 

a statute of limitations problem. 

Now, the report also suggests that representing clients when another group in my firm represents KPMG is a conflict of interest. 

I will have to tell you, that goes way beyond any ethical responsibility I have been aware of in my 42 years of practice, way beyond 

that. And even though there is not a conflict there, we, as I said, 

took care to tell—KPMG knew we could not defend them against 

any of these clients and the clients knew we also could not represent them. If there is a conflict, I would suggest that there may 

be a conflict in both representing the clients before the IRS and 

against KPMG. It gives you a pretty tight rope to walk in making 

your arguments. 

Finally, I would like to mention the fact that the report suggests 

that we entered into agreements hiring KPMG. We entered into 

one such so-called Covell agreement. It was entered into because 

the client was already being advised by KPMG. We thought we 

might need to have some advice from KPMG. We did not want to 

waive the client’s attorney-client privilege, the privilege with respect to our advice, and so we entered into the one Covell letter. 

We never entered into another one with connection with these 

transactions because we never used that one, so it was never, ever 

used. 

Chairman COLEMAN. I would ask you to summarize the rest of 

your testimony, Mr. Cohen. 

Mr. COHEN. Well, the summary is—I think that I will go back 

to the start. I wish the staff had talked to me a little—had time 

to talk to me. I know I am not a big piece of this action, and I 

81

think I could have corrected these things. Having read the rest of 

the report, I am sure they would have corrected the record on that 

score. 

And once again, I would say the one thing you didn’t mention, 

you or Senator Levin, you mentioned that you want more disclosure. I think that is badly needed. You mentioned that you want 

more resources for the IRS. I think that is badly needed. The one 

thing you haven’t mentioned is the one that I think is the most important, and that is an extension of the statute of limitations where 

there is no disclosure. I think that will go a lot further. In my experience, penalties have not done the job. Back when I was Chief 

Counsel of the Internal Revenue Service, we fought tax shelters on 

a much broader scale, much lower dollars, and the penalties didn’t 

seem to stem that tide. Thank you. 

Chairman COLEMAN. Thank you, Mr. Cohen, and I do want to 

thank you for your testimony. It has been very clarifying. I will tell 

you up front that on first blush, our concerns had to do with potential conflicts of interest with KPMG and you have gone a long way 

to explaining that and helping us understand it better, so I do 

thank you for that. 

Let me just make sure that I do understand. First, did KPMG 

refer tax audit cases to you? 

Mr. COHEN. I think they did, but not in the——

Chairman COLEMAN. You said you never had two dozen. Do you 

know what the number was? 

Mr. COHEN. No, I do not at this time. I can try to find that out 

and submit that number to your staff. But I would say I have no 

idea whether KPMG thought that they referred more clients to us 

than they actually referred, but the references—frequently, clients 

come in from a number of sources. Most of our references came 

from law firms, from financial advisors, from the clients themselves 

who had talked to other clients. 

Chairman COLEMAN. And I take it KPMG has an ongoing relationship with Sutherland Asbill and Brennan? 

Mr. COHEN. The firm continues to defend in malpractice cases, 

other than cases involving tax shelters, KPMG and the other three 

of the remaining large accounting firms. 

Chairman COLEMAN. Could you tell us the approximate amount 

of attorney fees that KPMG generated? 

Mr. COHEN. I haven’t the slightest idea. 

Chairman COLEMAN. Could you provide that to us after——

Mr. COHEN. If under our professional responsibility we are allowed to and we can go to KPMG and get that authorization, that 

waiver, we would be more than happy to do so. 

Chairman COLEMAN. I would appreciate that. 

Did KPMG ever tell you they would knowingly refer clients to 

your firm when the subject matter was a tax scheme/shelter that 

they were deeply involved in? 

Mr. COHEN. Never. 

Chairman COLEMAN. In referring the cases that they did refer to 

you, my question has to do with whether you then turned around 

and retained KPMG to serve as consultants in the case? You indicated in your testimony that happened one time. 

Mr. COHEN. One Covell letter, that’s right. 

82

1See Exhibit No. 116 which appears in the Appendix on page 2691. 

Chairman COLEMAN. And then you——

Mr. COHEN. That’s it. 

Chairman COLEMAN [continuing]. Indicated that not again? 

Mr. COHEN. Not again, and let me mention this. I never—I don’t 

recall a client that came in just—KPMG said, go to me. My understanding was that they gave the clients a choice of firms. 

Chairman COLEMAN. Thank you, Mr. Cohen. 

Mr. Smith, according to IRS pleadings filed against Brown and 

Wood, Brown and Wood issued approximately 600 opinion letters 

regarding these 13 different tax avoidance products during Mr. Ruble’s tenure. Can you give me a sense of kind of the knowledge, 

how it worked in Brown and Wood, whether folks would know 

about what Mr. Ruble was doing, whether they would know kind 

of the volume of what he was doing, the type of things that he was 

doing? How did that work? How did that supervision oversight 

work? 

Mr. SMITH. Senator Coleman, I will, but let me just caution, I am 

sure you can tell, and I am very outraged, I can tell you what we 

were told and what our understanding was and I can go through 

that with you. 

Mr. Ruble’s practice in this area, I think, to the best of my understanding, really started in 1997. You referred to an e-mail in 

which there was a discussion—it said that there was a discussion 

with me. The first I knew about that e-mail was when I read it in 

the Wall Street Journal several weeks ago. I knew nothing about 

that. We had never been told that there was any sort of an alliance 

or proposed alliance with KPMG or anyone else. Had he had that 

conversation with me, I would have immediately talked to our executive committee about it, that I was basically the chairman of that, 

and this has never happened and we never approved any sort of 

an alliance with KPMG. That would have required a lot of analysis 

on our part and it just never happened. 

Chairman COLEMAN. That e-mail is Exhibit 116,1 I think, in the 

books in front of you, if you turn to Tab 116, the large black book 

right there. 

Mr. SMITH. Yes. 

Chairman COLEMAN. And as I indicated before, the bottom of 

that e-mail, ‘‘Subject, Joint Projects; Author, R.J. Ruble; Date, 12/

15/97, 11:08 a.m. This morning, my managing partner Tom 

Smith—’’

Mr. SMITH. Yes. 

Chairman COLEMAN. ‘‘—approved Brown and 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 as you and I have discussed.’’ You 

indicate that that e-mail is not true, not accurate? 

Mr. SMITH. We never—I never saw this and it is totally untrue. 

Chairman COLEMAN. Are you aware of any agreement or effort 

to market tax products with KPMG? 

Mr. SMITH. No. 

Chairman COLEMAN. Can you help me understand? Is that something that would be unusual for a law firm to do? 

83

Mr. SMITH. It would be unusual for Sidley Austin Brown and 

Wood to do, and at that time Brown and Wood. I would be happy 

to tell you what our understanding was that we were doing. When 

you asked——

Chairman COLEMAN. Please. I would appreciate that. 

Mr. SMITH. Yes. You asked how we handled this at the firm. In 

1998, the revenues increased materially in this area and as the 

chairman, as the managing partner, I undertook and the executive 

committee undertook to see if we could get a better handle on what 

these opinions were, was this a business we should be in, what sort 

of exposure to risks that we had because of these opinions, and exactly what our role was in supplying these opinions. And I called 

the practice group head, Tom Humphries, and asked him, who was 

aware of what was happening here but really had not been involved with these opinions. Some of the partners had been involved 

with certain discrete issues, but not with the total product. That 

was a total opinion. 

I looked at those opinions and read them. They were more likely 

than not based on factual representation opinions. Quite frankly, 

sir, I was really not in a position to pass on the validity of those 

opinions. I think we had four or five of our tax partners read those 

opinions and advise us, and the advice we got was that they were 

valid opinions under the then law. 

We discussed with Mr. Ruble and with our tax partners exactly 

what our role was in this and we were told that our role was to 

provide concurring opinions to taxpayers, and a lot of times to their 

financial advisors, and Mr. Cohen testified that you do this, and 

that KPMG wanted an outside law firm to do this, that KPMG 

would designate to help the financial advisors understood this. 

We understood his role to be not involved in the design of these 

products, but that KPMG would come to him with the product and 

ask him if he could render the concurring opinion. Now, to do that, 

Mr. Ruble had to do a thorough analysis of what was in there. It 

was my understanding we inquired about this, that he would perhaps make suggestions so that he could render his opinion and perhaps he might—I guess if he saw something there to improve the 

product, he might have passed that on. That is just an assumption 

on my part. We thought he was being given the product and just 

saying if—rendering his opinion on them, more likely than not 

based on the factual assumptions. 

Chairman COLEMAN. My concern is, first, he issued approximately 600 opinions, so I take it he is generating a substantial 

amount of fees which I would then suspect is not under the radar 

screen of Brown and Wood? 

Mr. SMITH. Absolutely not. 

Chairman COLEMAN. He is generating volume here? 

Mr. SMITH. Absolutely not. 

Chairman COLEMAN. If he is generating that volume, I am just 

again trying to understand the internal mechanism. He was generating a lot of money in a tax area? 

Mr. SMITH. Right. 

Chairman COLEMAN. I take it he is not operating solely by himself? 

84

Mr. SMITH. Well, that is a good question. We have all of this 

under review. I think in large measure, what we most fear in a law 

firm, he was a lone wolf, and this is——

Senator LEVIN. What? 

Mr. SMITH. A lone wolf, Senator Levin, not to mention a rogue 

partner, which is your greatest fear. 

Chairman COLEMAN. And you understand, though, again, having 

been in the profession for a number of decades and understanding 

there are lone wolves but understanding the structure of law firms, 

you have a guy generating a lot of fees——

Mr. SMITH. Correct. 

Chairman COLEMAN [continuing]. And complex issues that when 

looked at are pretty clear. You look at these issues and you have 

on the BLIPS cases, I believe there were 66 investors. These are 

supposed to be 7-year investment schemes. Every one of them gets 

out after 60 days. You look at this thing and you can see it is being 

created for generating tax loss. That is what it is about. I am still 

troubled by the sense that it is just Mr. Ruble. 

Mr. SMITH. Well, it was Mr. Ruble who was rendering the opinions and dealing with the clients. I know of no instance in my understanding where any other tax lawyer at Brown and Wood were 

involved in the dealings with the clients. 

We had the other tax partners in the group, in a highly esteemed 

group, I think we had four or five of them review these opinions 

and advise us as to whether or not they were appropriate. And as 

I say, I am a securities lawyer and I have to rely on their advice 

in this regard. 

Chairman COLEMAN. Senator Levin. 

Senator LEVIN. The IRS has alleged in court that Sidley Austin 

Brown and Wood issued about 600 opinion letters on 13 potentially 

abusive or illegal tax shelters, and it is our understanding that 

about half of those letters, perhaps 250 to 300, were issued in connection with BLIPS, FLIP, and OPIS. Would that be about right? 

Mr. SMITH. Yes, we did render approximately 600, and I think 

it was 13 different transactions. I just don’t know the answer as 

to how many applied to which. 

Senator LEVIN. You don’t have any idea about how many were 

issued in conjunction with BLIPS, FLIP, and OPIS? 

Mr. SMITH. No, sir. I can get you that——

Senator LEVIN. Well, we will tell you. Let us assume that our information is correct, and if you would——

Mr. SMITH. I would assume, yes. 

Senator LEVIN [continuing]. For the purpose of discussion say 

about 300. Now, we understand that your firm charged substantially the same fee, $50,000, for each letter provided to BLIPS, 

FLIP, and OPIS clients. 

Mr. SMITH. It was a fixed fee. I think it started at $50,000. There 

may have been different amounts in different instances. 

Senator LEVIN. Possibly a little more——

Mr. SMITH. Yes. 

Senator LEVIN [continuing]. If the tax loss was more? 

Mr. SMITH. No, I don’t think it was—it was my understanding 

it was never based on the size of the transaction. 

85

Senator LEVIN. Well, we will get to that later in terms of the 

fees. 

Mr. SMITH. Yes. 

Senator LEVIN. So you got $50,000 for each letter, approximately? 

Mr. SMITH. Approximately, that is my understanding in this. 

Senator LEVIN. Now, these letters were drafted after the initial 

prototype, is that correct? In other words, there was an initial letter on each of these and then the following letters, follow-up letters, were virtually identical to the prototype letter, is that not correct? 

Mr. SMITH. Could you help me with what you mean by prototype? 

Senator LEVIN. The first letter that you wrote approving BLIPS, 

for instance, was followed by dozens and dozens of other letters——

Mr. SMITH. That is correct. 

Senator LEVIN [continuing]. And so the first letter was the prototype. 

Mr. SMITH. OK. I understand. 

Senator LEVIN. And then all the successive letters, 50 or 100 on 

each, BLIPS, FLIP, and OPIS, were then basically cookie cutter 

opinions following that prototype opinion, is that correct? 

Mr. SMITH. Yes. To my understanding, yes. I could not tell you 

to what extent they varied based on the facts. It could have been. 

Senator LEVIN. All right. It could have been——

Mr. SMITH. But that was my basic understanding of it. 

Senator LEVIN. All right. 

Mr. SMITH. Pretty similar, basically similar, Senator, to——

Senator LEVIN. Virtually identical? Basically the same, but use 

your words. Now, the clients’ names were changed. In how many 

cases were there client consultations? 

Mr. SMITH. I couldn’t answer that question, Senator. 

Senator LEVIN. Is it possible that in most cases, there were no 

client consultations, you simply submitted the letter? 

Mr. SMITH. I couldn’t answer that question. 

Senator LEVIN. All right. 

Mr. SMITH. That is a question we would be interested in. We 

would be interested in the answer to that question. 

Senator LEVIN. I would hope so. 

Mr. SMITH. Yes. 

Senator LEVIN. Who was your client? 

Mr. SMITH. Well, we were rendering these opinions to the taxpayer. I don’t think we—and that was—hopefully, we had engagement letters with respect to this which explain this and explain our 

role. But these opinions were being rendered—I don’t think we rendered more than one opinion to any taxpayer, and that was the 

sole piece of legal work we did for those taxpayers, these concurring opinions. 

Senator LEVIN. Right. 

Mr. SMITH. KPMG as a national tax group were also rendering 

an opinion, to my understanding. 

Senator LEVIN. The taxpayer was supposed to be your client. You 

don’t know whether there was any personal contact with those taxVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00109 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
86

payers in most cases or not, do you, for instance, in the BLIPS 

transactions? Do you have any idea? 

Mr. SMITH. It was my understanding that Mr. Ruble was available to consult, primarily with the financial advisors of these taxpayers. I have no idea. 

Senator LEVIN. You have no idea. Did you ever ask Mr. Ruble, 

in all your conversations with Mr. Ruble, about this matter, as to 

whether he ever met with your clients? 

Mr. SMITH. The tax partners would have. 

Senator LEVIN. Did you ask your tax partners whether there was 

ever any connection? 

Mr. SMITH. I did not, sir. 

Senator LEVIN. Is that not an important question for a law firm, 

as to whether you have any contact with your client or not? 

Mr. SMITH. I think it is an important question. 

Senator LEVIN. But you didn’t ask that of these tax partners of 

yours? 

Mr. SMITH. I don’t recall asking that, yes. 

Senator LEVIN. On the question of fees, according to the American Bar Association Model Rule 1.5, a lawyer ‘‘shall not make an 

agreement for, charge, or collect an unreasonable fee,’’ and then 

cites the factors to be considered in setting a fee amount as the 

time and labor required, the novelty and difficulty of the questions 

involved, and the skill requisite to perform the legal service properly. 

It used to be that legal opinions were written for one client on 

a particular set of facts, but mass marketed tax products are accompanied by mass production of legal opinion letters with 

boilerplate language, and this is what happened here, according to 

your own testimony, and as a matter of fact, that is what happened 

with these tax shelters, BLIPS, FLIP, and OPIS. Virtually all the 

costs associated with the letters are attached, therefore, to drafting 

the first prototype opinion, which would be labor intensive. But 

after that, with the cookie cutter follow-ups by the hundreds, the 

firm has very limited costs since it used that boilerplate language 

to produce the later letters and rarely even consulted with the client, or you don’t even know whether the clients were consulted. 

Now, my question has to do with the fees that were charged on 

these letters. Did your firm estimate in advance about how many 

opinion letters would be issued for a shelter? 

Mr. SMITH. It is my understanding that we had no idea how 

many taxpayers would be investing in these structured products. 

Senator LEVIN. And would be referred to your firm? 

Mr. SMITH. That would be referred to our firm. 

Senator LEVIN. So now how would you decide on the fee? How 

can you charge $50,000 for a cookie cutter opinion letter when you 

don’t know if you are going to issue 1, 5, 50, 100, or 200 of those 

letters, same fee, $50,000? How do you decide on that fee? What 

is it based on? 

Mr. SMITH. We would have to ask Mr. Ruble how he——

Senator LEVIN. Well, you asked Mr. Ruble. I am sure you had 

these conversations. You ended up firing him. What did he say 

when you asked him, how do you base a fee? 

Mr. SMITH. I never asked him how he would base the fee or——

87

1See Exhibit No. 117 which appears in the Appendix on page 2692. 

Senator LEVIN. But you knew you were getting $50,000 for each 

piece of paper that your firm was issuing? 

Mr. SMITH. That would be part of his——

Senator LEVIN. And you have an ethical obligation to charge your 

clients, who you probably never even saw, a reasonable fee. How 

do you base a $50,000 fee? 

Mr. SMITH. That would be part of the arrangement that he would 

have made in the first instance, what the fees would cost, and we 

had no idea whether or not we were going to make money on this 

or not. If we were going to get $50,000 a transaction and we only 

had two or three, we are clearly going to lose a lot of money. 

Senator LEVIN. So you did figure out that if there were only two 

or three of these, you would lose money. 

Mr. SMITH. Well, obviously we would. The time would be greater 

than that. 

Senator LEVIN. So what was your break-even point? 

Mr. SMITH. I have no idea, Senator. 

Senator LEVIN. Does your firm have any idea? 

Mr. SMITH. I can sort of do an analysis of that. I doubt if we had 

much of an idea as to what the break-even point would be, because 

going into this, you wouldn’t know how much research was going 

to be involved. You wouldn’t know—I assume that there was—Mr. 

Ruble was conferring with his clients or the advisors of his clients 

to a certain extent. I can’t tell you to what extent. 

Senator LEVIN. Do you know how many hours? Was there a billing kept for this kind of——

Mr. SMITH. Yes. 

Senator LEVIN. About how many——

Mr. SMITH. I do not have that with me. I would be happy to provide you with that. 

Senator LEVIN. So you did keep track of about how many hours 

went into the preparation of that opinion? 

Mr. SMITH. Yes. 

Senator LEVIN. All right. You will submit that to the Subcommittee? 

Mr. SMITH. Yes. 

Senator LEVIN. But you decided—were you involved in this decision that no matter how many opinions were issued, they were all 

going to be about $50,000 a crack? 

Mr. SMITH. I was not involved in that decision. 

Senator LEVIN. Who was, besides Mr. Ruble? 

Mr. SMITH. Well, at this point, I am just perplexed as to answer 

any of these questions. I will see what I can find out on that. 

Senator LEVIN. Let me turn now to Exhibit 117.1 This is a 

KPMG employee stating that, ‘‘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 opinions,’’ that is your 

law firm, ‘‘should be given in all deals.’’ They are deciding that 

your opinion is going to be given to presumably your client. Isn’t 

that astounding, that some outside company is going to decide that 

your opinion is going to be given to folks who are supposed to receive independent advice and be your clients? 

88

1See Exhibits No. 90a. and 90b. which appear in the Appendix on pages 684 and 781. 

Mr. SMITH. Senator Levin, this was not our understanding. It 

was our understanding on these transactions that the taxpayer was 

going to be given a choice of two or three firms. 

Senator LEVIN. So this comes as a surprise to you? 

Mr. SMITH. Oh, absolutely. 

Senator LEVIN. There was no deal with Brown and Wood, right? 

Mr. SMITH. Well, certainly not to my knowledge, or the knowledge of the executive committee. 

Senator LEVIN. And did you ask Mr. Ruble whether he had made 

a deal on your behalf with KPMG? 

Mr. SMITH. Well, I don’t know that we asked him if he had made 

a deal, having had—but we inquired heavily throughout this as to 

exactly what his role was. 

Senator LEVIN. Did you ask him whether he had made a deal 

with KPMG? 

Mr. SMITH. I didn’t. 

Senator LEVIN. Did anybody ask, as far as you know, on behalf 

of your firm? Did we have some kind of an arrangement with 

KPMG? Did anybody ask him that question? 

Mr. SMITH. Well, the arrangement——

Senator LEVIN. Since you got hundreds of referrals at $50,000 a 

crack, did anybody ask Ruble in your presence or otherwise whether there was an arrangement with KPMG and your firm? 

Mr. SMITH. Well, as——

Senator LEVIN. As far as you know, did anybody——

Mr. SMITH. There is an arrangement implicit in what I described. 

Senator LEVIN. Did anyone ask Mr. Ruble explicitly whether or 

not there was a deal between your firm and KPMG that the users 

of these tax shelters would be given your letter? 

Mr. SMITH. I have no knowledge of anyone asking him if there 

was a deal. 

Senator LEVIN. Or an agreement? 

Mr. SMITH. Agreement. 

Senator LEVIN. My time is up, thank you. 

Chairman COLEMAN. Thank you, Mr. Levin. 

Let me continue and make sure I understand. The client is the 

taxpayer, is that correct? 

Mr. SMITH. That is correct, Senator Coleman. 

Chairman COLEMAN. Not KPMG. So how did the client come to 

your attention or to Mr. Ruble’s attention? 

Mr. SMITH. They would—it was our understanding, in connection 

with KPMG marketing these investment products that they would 

give the taxpayer the choice of two or three firms and that is how 

we would be approached thereafter. 

Chairman COLEMAN. So KPMG is supposed to give the taxpayer 

a number of firms and it is your testimony you are not aware of 

any arrangement, marketing arrangements or the other type of 

interconnecting relationships that the Ruble e-mails reflect? 

Mr. SMITH. It was our understanding that there was absolutely 

no efforts on our part to market or promote these products. 

Chairman COLEMAN. In Exhibits 90a. and 90b.1—I think really 

have the first pages, but there are many page——

89

Mr. SMITH. This would be in the other book? 

Chairman COLEMAN [continuing]. Opinions. Yes. If you look at 

Exhibit 90a., it would be just the first page, 90a. is on the stationery of KPMG. I believe Exhibit 90b. would be—you have just 

the first page of the opinion from Brown and Wood. So KPMG, as 

I would understand it, is providing an opinion to the taxpayer, 

right, and then Brown and Wood is supposed to provide an independent analysis, is that correct? 

Mr. SMITH. That is correct. 

Chairman COLEMAN. And if one looks at these opinions, the language is in substantial portion exactly the same. Do you work with 

the tax firms in developing your opinions? 

Mr. SMITH. It was our understanding that he—his role was to review the product and determine whether he could give a concurring 

opinion, and really the only input that he would have would be 

whether or not there needed to be modifications so that he could 

opine. 

Chairman COLEMAN. Again, these opinions are being reviewed by 

others in the firm? 

Mr. SMITH. There was a second signer requirement throughout 

this provision. 

Chairman COLEMAN. And so if the others in the firm are seeing 

kind of the exact duplications of opinions and opinion after opinion 

after opinion, would that shine a light or would that raise a concern to anybody? 

Mr. SMITH. That, with respect to a product, the opinions are 

going to be basically the same. I don’t know that that would shine 

a light. I must add that in terms of this second opinion requirement, among the many things that we are looking at is to what extent that was observed. 

Chairman COLEMAN. I am concerned about the relationship with 

KPMG, whether——

Mr. SMITH. Right. 

Chairman COLEMAN. Where is the independence in this? I can 

tell you from where we are sitting, Mr. Smith, there doesn’t seem 

to be a heck of a lot of independence. From where we are sitting, 

as a matter of fact, there isn’t. Let us lay that out. Now, the question is, is it Mr. Ruble or did it go beyond Mr. Ruble and that is 

what we are trying to understand. 

Mr. SMITH. That what went beyond? I am sorry, Senator. 

Chairman COLEMAN. The intertwining of relationships between a 

law firm and an accounting firm, the marketing of tax products between a law firm and an accounting firm. That is what we are trying to understand, and we are looking at stuff that says that it has 

been approved, it has been discussed. We are looking at substantial 

legal opinions that are almost exact between the accounting firm 

and the law firm. 

Mr. SMITH. With respect to these products, they would be almost 

exact. I can’t really tell you to what extent there might be differences, but here again, it is something I can find out for you. 

Chairman COLEMAN. How do you avoid this in the future? What 

is Sidley Austin Brown and Wood doing today to make sure that 

rogue partners don’t have the capacity to get involved in sham relationships with accounting firms or tax products like this? 

90

1See Exhibit No. 116 which appears in the Appendix on page 2691. 

2See Exhibit No. 120 which appears in the Appendix on page 2699. 

Mr. SMITH. Well, I testified that we have strengthened our opinion policy. We have been coming up with more of a structured opinion policy. Throughout the time that we were rendering these opinions, one specific thing that we have done is put in—is have a tax 

attorney whose job is to monitor opinions being given in the department. We have an electronic library of these opinions, who the second opinion writer is, and this is to avoid any tax opinions being 

rendered that hasn’t been reviewed. 

But I must caution that law firms operate on a degree of trust. 

As you know, 25 years ago, when I first joined Brown and Wood, 

it was just pretty much a general partnership. We trusted each 

other. Unfortunately, this has been very much eroded in this instance. 

We have this situation with Mr. Ruble under review, and as part 

of that review, we are going to consider what additional controls we 

have to have. I am just absolutely apoplectic that this happened 

and embarrassed that this happened. 

Chairman COLEMAN. Senator Levin. 

Senator LEVIN. I want you to look again, Mr. Smith, at Exhibit 

116.1 This is a Ruble e-mail. It is dated December 15, 1997. ‘‘This 

morning, my managing partner, Tom Smith, approved Brown and 

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 as you and I have 

discussed. To the extent it is possible, it would be very beneficial 

from our perspective to involve our San Francisco office and I have 

given Paul Pringle and Eric Haueter of that office your name and 

telephone number. Please call me when you have a chance.’’ Mr. 

Smith, did you, in fact, approve Brown and Wood working with the 

newly conformed tax products group at KPMG as that e-mail stated? 

Mr. SMITH. Absolutely not. 

Senator LEVIN. Now, there were two other persons from the law 

firm’s San Francisco office, Mr. Pringle and Mr. Haueter—it is a 

little hard to read, but any rate, Eric Haueter. So KPMG writes—

Mr. Bickham at KPMG writes Mr. Ritchie at KPMG that the B&W 

initiative is moving ahead, as you can see from the attached. Now, 

if you will look at Exhibit 120.2—got it? 

Mr. SMITH. Yes. 

Senator LEVIN. All right. A meeting actually took place between 

KPMG and your two tax professionals. 

Mr. SMITH. They were not tax lawyers. Paul Pringle and Eric 

Haueter are securities lawyers, corporate securities. 

Senator LEVIN. All right. 

Mr. SMITH. Corporate securities. 

Senator LEVIN. Your two lawyers. 

Mr. SMITH. Yes. 

Senator LEVIN. Two lawyers for the B&W law firm. What took 

place at that meeting? 

Mr. SMITH. I have no knowledge of that, Senator. 

Senator LEVIN. Are they still with your firm? 

91

1See Exhibit No. 112 which appears in the Appendix on page 2678. 

Mr. SMITH. Absolutely. 

Senator LEVIN. Have you asked them? 

Mr. SMITH. No, I haven’t, sir. 

Senator LEVIN. You might do that. 

Mr. SMITH. I will. 

Senator LEVIN. Now, if you will take a look at Exhibit 112,1 it 

is a memo dated 3 months later. By the way, before I go to that 

exhibit, you say you have not talked to those two lawyers——

Mr. SMITH. About that matter. 

Senator LEVIN. About that matter. Is this the first time you 

learned that those two lawyers were named as having been at that 

meeting with KPMG? 

Mr. SMITH. The first time I have learned of that, yes. 

Senator LEVIN. Right now? 

Mr. SMITH. Right now. 

Senator LEVIN. All right. So now look at Exhibit 112, and this 

is March 13, 1998, and this is from—it is a KPMG memo saying 

that a working group has been formed to work on OPIS, and this 

working group includes R.J. Ruble of Brown and Wood. Is that unusual? 

Mr. SMITH. Well, I had——

Senator LEVIN. That he is part of a working group at KPMG? 

Mr. SMITH. I had heard that term working group, and it was my 

understanding that—working group can mean any number of 

things. It was my understanding that his role, as I have testified, 

was to provide these concurring opinions, and to the extent that he 

felt that a modification would be required for him to do that, perhaps that was it. When I read working group, I just had assumed 

that it would be something like a mailing list or something like 

that. I have scratched my head as to what working group means, 

but my understanding, I have said over and over again what his 

role was. 

Senator LEVIN. Now Mr. Cohen——

Mr. COHEN. Yes, sir? 

Senator LEVIN. Is it not true that the PSI staff invited you to 

come here to Washington to talk with them, you indicated you preferred not to travel here, and that you instead would want to talk 

to the staff by telephone? 

Mr. COHEN. I spoke with the staff about not attending this because I had some client conflicts. 

Senator LEVIN. Right, that you wanted to talk to them by phone? 

Mr. COHEN. Yes. 

Senator LEVIN. OK. 

Mr. COHEN. With respect to this hearing, Senator Levin. 

Senator LEVIN. And you spoke with our staff by phone on several 

occasions, is that true? 

Mr. COHEN. I did. 

Senator LEVIN. And is it true that you told the staff that your 

firm was then representing 24 KPMG clients? 

Mr. COHEN. I don’t believe—that we were representing 24? Not 

to my recollection, but I will try to get that number for you when 

I return and give that to Ms. Bean. 

92

Senator LEVIN. Is it possible you told our staff, as their notes indicate, that you were representing 24 KPMG clients? 

Mr. COHEN. Well, of course, anything is possible. To my recollection, I did not. 

Senator LEVIN. Did you say that you were sure that KPMG was 

giving your firm’s name to KPMG clients that you got? 

Mr. COHEN. I don’t recollect that, but let me say that having read 

the staff’s review where Mr. Jones, who heads up their controversy 

practice, was giving out the list of a coalition which, by the way, 

had about 50 lawyers in it, and we certainly would have been in 

that group. 

Senator LEVIN. But in terms of your stating to our staff that you 

were sure that KPMG was giving your firm’s name to KPMG clients that you got, you don’t remember that? 

Mr. COHEN. I don’t recall stating that, but I will tell you that I 

suspect that is true. 

Senator LEVIN. All right. Now, we interviewed a KPMG client 

that was referred to your firm and he told the Subcommittee that 

he was not repeatedly counseled that your firm represented KPMG 

and that he only understood that for the first time when he asked 

your firm for advice on whether he should sue KPMG. 

Mr. COHEN. Well, he did not ask the firm. He always spoke 

through his financial advisor, Mr. Thornette. Mr. Thornette was, in 

fact, told before the engagement that we represented—that our litigation team represented KPMG and that his client, Mr. Schwartz, 

should obtain other counsel if he intended to pursue any cause 

with respect to the transaction he went into and that he should do 

that sooner rather than later. And that was repeated when Mr. 

Thornette called us later to say that he had now decided to pursue 

that course. 

Senator LEVIN. Now, I want you to think about this scenario 

with me. 

Mr. COHEN. Certainly. 

Senator LEVIN. A client is sold a tax shelter by KPMG that turns 

out to be illegal, or allegedly illegal, and he wants to sue KPMG 

because the IRS is after him. Now, how do you undertake that representation to begin with? 

Mr. COHEN. How do we undertake that? 

Senator LEVIN. Yes. In other words, you had a long relationship, 

did you not, with KPMG? You had defended KPMG against malpractice claims. In addition to the malpractice claims, you had also 

represented KPMG against claims that they had given bad accounting advice, is that correct? 

Mr. COHEN. In business transactions, yes, that is correct. 

Senator LEVIN. So now you have a question of whether or not a 

client of yours with whom you had a longstanding relationship had 

sold an illegal tax shelter. When that comes to your attention, isn’t 

that something where you would immediately say, I can’t get involved in that matter because——

Mr. COHEN. No, that I cannot defend the taxpayer——

Senator LEVIN. Yes. 

Mr. COHEN. What comes to my mind—no, I don’t see a conflict 

there. 

Senator LEVIN. In representing a taxpayer? 

93

1See Exhibit No. 45 which appears in the Appendix on page 557. 

Mr. COHEN. No, in a tax proceeding. I could not represent that 

taxpayer in a proceeding against KPMG and I so informed the taxpayer and I advised the taxpayer, going beyond my ethical responsibilities, to obtain other counsel and to do that sooner rather than 

later. 

Senator LEVIN. OK. Now take a look at Exhibit 45.1

Mr. COHEN. I don’t have a copy of the exhibits. Are these the exhibits? 

Chairman COLEMAN. The white volume has Exhibit 45. 

Senator LEVIN. This is a letter sent in September 2002 by KPMG 

to your firm agreeing to assist the law firm in its representation 

of a KPMG client who had bought BLIPS. 

Mr. COHEN. All right. 

Senator LEVIN. So you hired KPMG as an expert in this case that 

was brought against him, is that correct? 

Mr. COHEN. We hired—this is a typical Covell letter that is used 

by attorneys to protect their clients’ confidential communications 

with them from disclosure and thereby waiver of the attorney-client privilege. At the time, as I said, this is the only one of these 

we entered into at the time we thought that we would be conferring with the KPMG. They had been previously the client’s accounting firm. They were providing the documents in response to 

some things called Information Document Requests, or IDRs, furnished by the IRS, and we thought we might need their advice. We 

never used their advice in this connection and we therefore—we 

just never entered into another Covell arrangement, in connection 

with these transactions. But this is quite common in connection 

with securities, antitrust, business litigation, etc. 

Senator LEVIN. This was in a firm, however, is that not correct, 

where a client of KPMG was also a client of yours? 

Mr. COHEN. That is correct. 

Senator LEVIN. And you used KPMG as the expert in the case 

which was brought against your client? 

Mr. COHEN. That is not correct. As I said——

Senator LEVIN. That is not correct? This was not a case that was 

brought against your client, the taxpayer? 

Mr. COHEN. We did not use KPMG as an expert. That is the part 

that is not correct. 

Senator LEVIN. That is the part that——

Mr. COHEN. That is correct. There is no——

Senator LEVIN. You used their services in a case. 

Mr. COHEN. Well, that is actually——

Senator LEVIN. Is that accurate? 

Mr. COHEN. Actually, the services that they provided were primarily in response to the Information Document Requests of the 

IRS, which they had already started providing to their client. It 

turned out that there was no exchange of information that needed 

protection via the Covell letter. Is that—have I explained that 

enough? 

Senator LEVIN. Was that the limit of any advice that you got, of 

any assistance that you got from KPMG in that case? 

Mr. COHEN. The limit was——

94

Senator LEVIN. Do you see the problem here? Do you see 

what——

Mr. COHEN. The limit was the furnishing of documents that had 

to be turned over to the IRS, yes. 

Senator LEVIN. And you could not get those documents except to 

hire them in that case and to pay them a fee? You could not get 

the documents otherwise, is that what you are telling me? 

Mr. COHEN. Well, we could not get the documents unless KPMG 

was willing—except through one of two sources, the client or the 

client’s financial advisor—I guess three sources, or through KPMG. 

Senator LEVIN. Did you have to pay KPMG to get those documents? 

Mr. COHEN. No. All——

Senator LEVIN. You could have gotten them without hiring them 

to provide services in that case. 

Mr. COHEN. The fees that KPMG received with respect to its 

services to the client were billed to the client. 

Senator LEVIN. Well, they were also, were they not, going to bill 

you? 

Mr. COHEN. No. 

Senator LEVIN. Well, what is this engagement letter which says 

our fees for this engagement will be based on the complexity of the 

issues? This is Exhibit 45. 

Mr. COHEN. Our fees in this engagement will be based on the 

complexity——

Senator LEVIN. It says here, we are pleased to engage KPMG to 

assist Sutherland—that we are pleased you have engaged KPMG. 

Mr. COHEN. Well, since the client was being billed for this, this 

was run by the client’s advisor as to whether this was the arrangement the client had with KPMG for fees. 

Senator LEVIN. And so the fees on page 2 that they are talking 

about are fees that they were charging to your joint client, is that 

correct? 

Mr. COHEN. These are fees that they were charging the client for 

their services in responding to Information Document Requests and 

the next paragraph makes it clear that our firm, since we are not 

being—we are not remitting anything to KPMG, we will only remit 

something to KPMG after the client sends a check to us. 

Senator LEVIN. And so the only funds that went to KPMG were 

from your joint client? Is that correct? 

Mr. COHEN. The only funds that went to KPMG were from 

KPMG’s client. 

Senator LEVIN. Who was also your client? 

Mr. COHEN. My client, I was representing this client in connection with the audit and the potential settlement of his tax matter. 

Senator LEVIN. So joint client? 

Mr. COHEN. Well, I don’t——

Senator LEVIN. It was a client of both of yours? 

Mr. COHEN. Yes. 

Senator LEVIN. OK. 

Mr. COHEN. But that is—in my—normally, Senator, I would 

think of a joint client as someone you are jointly representing before the IRS. That is not the case. 

Senator LEVIN. I understand. 

95

1The prepared statement of Mr. Smith appears in the Appendix on page 312. 

2The prepared statement of Mr. Boyle with an attachment appears in the Appendix on page 

317. 

Mr. COHEN. That is not the case. 

Senator LEVIN. It was a client of both of yours——

Mr. COHEN. Well——

Senator LEVIN. In different matters? 

Mr. COHEN. That is true, Senator, and I will tell you that I have 

a lot of——

Senator LEVIN. I am just asking you if that is accurate. 

Mr. COHEN. That is absolutely accurate. I have a lot of clients 

that are joint clients in that sense. 

Senator LEVIN. I understand. 

Mr. COHEN. In fact a number of major corporations in the country are clients of mine for tax matters and are joint clients in that 

they are clients of KPMG. 

Senator LEVIN. Thank you. 

Mr. COHEN. Certainly. 

Chairman COLEMAN. Gentlemen, thank you for your testimony. 

Mr. Smith, I know that you were reading a statement that has not 

been submitted to the Subcommittee. Would you make that available to the Subcommittee? 

Mr. SMITH. Yes.1

Chairman COLEMAN. Thank you. Your testimony has been very 

helpful. Thank you very much. 

I would now like to welcome our second panel to today’s important hearing: William Boyle, former Vice President of the Structured Finance Group of Deutsche Bank; and Domenick DeGiorgio, 

former Vice President of Structured Finance at HVB America. I 

thank each of you for your attendance at today’s hearing and look 

forward to hearing your testimony. 

Before we begin, pursuant to Rule 6, all witnesses who testify before the Subcommittee are required to be sworn. I would ask at 

this time that you please stand and raise your right hand. 

Do you swear that the testimony you are about to give before the 

Subcommittee will be the truth, the whole truth, and nothing but 

the truth, so help you, God? 

Mr. BOYLE. I do. 

Mr. DEGIORGIO. I do. 

Chairman COLEMAN. As I indicated, gentlemen, before the previous panel, we use a timing system here. Statements should be 

five minutes. If you have a more complete statement, your entire 

statement will be entered into the record. 

Mr. Boyle, we will have you go first, followed by Mr. DeGiorgio. 

After we have heard all the testimony, we will turn to questions. 

Mr. Boyle, you may proceed. 

TESTIMONY OF WILLIAM BOYLE,2 FORMER VICE PRESIDENT, 

STRUCTURED FINANCE GROUP, DEUTSCHE BANK AG, NEW 

YORK, NEW YORK 

Mr. BOYLE. Chairman Coleman, Ranking Member Senator Levin, 

and members of the Subcommittee, thank you for inviting me 

today. My name is William Boyle. I am a former employee of Bankers Trust. I joined Deutsche Bank when it acquired Bankers Trust. 

96

I left Deutsche Bank 2 years ago and am now an independent consultant. 

I welcome the opportunity to speak today about a transaction 

called BLIPS. The Subcommittee requested that I appear for an 

interview, which I was pleased to do so last week. The Subcommittee also requested that I appear today to testify, and I am 

pleased to do so voluntarily. 

Mr. Chairman, I was not involved in BLIPS at its inception. The 

BLIPS transaction was first proposed to Deutsche Bank in early 

1999. Deutsche Bank played a banking role in the BLIPS transactions. My personal involvement in BLIPS began around June 

1999, when I became a Vice President in the Structured Transactions Group of Deutsche Bank. 

BLIPS was developed for clients of KPMG. I understand it was 

designed for KPMG—I am sorry. I understand it was designed by 

KPMG or Presidio Advisors or both. BLIPS involved interest rate 

swaps and investments in foreign currency option contracts and 

foreign and domestic fixed-income securities. 

As part of BLIPS, Deutsche Bank issued to investors approximately 56 loans from September 1999 through October 1999. The 

stated principal amount plus premium of these loans was approximately $7.8 billion. The average size of the loan issued to the 

BLIPS investor by the bank was approximately $139 million. 

The bank lent money to investors and it executed transactions as 

directed by investors’ investment advisors. As a major global bank, 

Deutsche Bank was able to provide financial services for such 

transactions. These services included providing large loans, custody 

services, foreign exchange option trading, and interest rate derivatives. 

The transactions were not designed by Deutsche Bank. The bank 

did not present BLIPS to investors or in any other way market, 

sell, or promote it. Deutsche Bank did not provide any tax advice 

to any of the investors, nor did the bank discuss with any investor 

any potential tax benefits of the investment. 

Deutsche Bank took several risk management steps to assure 

that its actions in the BLIPS transactions were limited to its role 

as the executor of the financial transactions. Let me summarize 

those actions. 

First, before making the loans, Deutsche Bank conducted an internal review process. The internal groups that reviewed the bank’s 

provision of services were Deutsche Bank Private Banking, Global 

Markets, Tax, Legal, Credit Risk Management, Treasury, and Compliance. 

Second, each of the BLIPS investors agreed in writing that Deutsche Bank had not provided them with any tax, legal, investment, 

or other advice, and that they had, in fact, received such advice 

from expert professionals. One paragraph of that agreement read, 

‘‘You have been independently advised by your legal counsel and 

will comply with all Internal Revenue laws of the United States.’’

Third, the bank received written representation letters from 

KPMG, Presidio, and each investor that described the limited scope 

of Deutsche Bank’s involvement in the BLIPS transactions. This 

was done so that there would be no misunderstanding. 

97

1The prepared statement of Mr. DeGiorgio appears in the Appendix on page 326. 

Fourth, Deutsche Bank consulted with a prominent outside independent law firm for its counsel. The law firm drafted and reviewed the transactional documents pertaining to the bank. It also 

provided Deutsche Bank with a legal opinion, which has been provided to the committee. This opinion concluded, among other 

things, that Deutsche Bank is not a promoter or organizer of the 

BLIPS transactions and that Deutsche Bank had no responsibility 

to register the transaction as tax shelters. 

Regarding the tax treatment, Deutsche Bank understood that the 

BLIPS transactions involved potentially favorable income tax benefits that could be claimed by investors. In discussing the tax issues, 

it is important to describe the role of the bank. Deutsche Bank provides banking services for a transaction. As such, it is not customary or appropriate to provide legal or tax advice to its clients, 

nor is it customary or appropriate to determine in advance whether 

a client’s tax position will later be sustained. Historically, that is 

not a role that banks are authorized to play. 

Deutsche Bank’s role as the executor of financial transactions 

meant that the determination of whether the investor’s tax position 

would be sustained was outside of its banking role. Such a determination was the appropriate responsibility of the investor’s lawyers and accountants. However, Deutsche Bank carefully considered its involvement in BLIPS and sought independent legal advice 

that it was complying with its responsibilities. 

Mr. Chairman, that concludes my oral statement and I would be 

pleased to answer questions. 

Chairman COLEMAN. Thank you very much, Mr. Boyle. 

Mr. DeGiorgio, I notice you have a gentleman with you. Would 

he please identify himself for the record? 

Mr. SKARLATOS. Yes, sir. My name is Brian Skarlatos. 

Chairman COLEMAN. You may proceed, Mr. DeGiorgio. 

TESTIMONY OF DOMENICK DeGIORGIO,1 FORMER VICE PRESIDENT, STRUCTURED FINANCE, HVB AMERICA, INC., NEW 

YORK, NEW YORK, ACCOMPANIED BY BRIAN SKARLATOS 

Mr. DEGIORGIO. Thank you, Mr. Chairman. Chairman Coleman, 

Ranking Member Senator Levin, and members of the Subcommittee, my name is Domenick DeGiorgio and I am a Managing 

Director in the New York City office of Bayerische Hypo-und 

Vereinsbank, otherwise known as HVB. I appreciate the Subcommittee’s invitation to come before you to discuss HVB’s limited 

involvement with tax-oriented transactions in the late 1990’s. 

We agree with the Subcommittee that there are important public 

policy issues raised by the tax shelter phenomenon and we support 

the Subcommittee’s investigation into it. We look forward to discussing with you in the future the issues it raises. 

My written testimony addresses the specific questions asked by 

the staff about HVB’s role in any tax-oriented transactions. As I 

point out in that submission, we were only involved in one particular series of transactions that the Subcommittee is investigating, the so-called BLIPS transactions, and our role there was 

98

limited to providing traditional banking services, such as lending, 

foreign currency trading, and some interest rate derivative trading. 

We did not organize, promote, or market any tax shelter transactions and we certainly did not offer tax advice or tax opinions or 

any other kind of financial or investment advice to any of the customers. We did not refer any customers to KPMG or Presidio and 

we did not accept, or, for that matter, were offered any referral 

fees. To reiterate, our role was strictly as bankers in these transactions. 

The Subcommittee staff has assured us that they agree HVB’s 

activities in connection with the BLIPS transactions were legal and 

appropriate. We complied with applicable statutory and regulatory 

obligations. We followed our own cautious and conservative internal lending policies and the ‘‘know your customer’’ requirements. 

However, we recognize that the mass marketing of abusive tax 

shelters is a serious problem and we agree that financial institutions should not facilitate these types of products. Indeed, we discontinued our participation in the BLIPS transactions as soon as 

the IRS announced its position that they were improper. Since 

then, we have addressed our concerns about tax structured transactions by exiting the business entirely. We have concluded that 

tax structured transactions require extensive outside expert advice 

and go beyond our expertise as banking professionals. 

The staff has also told us that they appreciate HVB’s candor and 

openness in providing information during the Subcommittee’s investigation. Senator Levin’s Minority Report released Tuesday 

makes a note of that fact. 

We have fully cooperated with your inquiries. We have produced 

thousands of pages of documents and have given several hours of 

interviews with the staff, even before my appearance here today. 

We even requested a friendly subpoena before my appearance here 

today so that I would be able under the financial privacy laws to 

discuss any questions or respond to any questions you may have. 

As I said, my written testimony addresses the specific issues you 

have asked me to discuss and I will be happy to discuss them now. 

Chairman COLEMAN. Thank you, Mr. DeGiorgio. I apologize. 

Having lived in Brooklyn, New York, and my neighbors were 

Keratanuito, Kalavido, and Camparelli, I should have been able to 

handle DeGiorgio, so—— [Laughter.] 

Mr. DEGIORGIO. Mr. Chairman, it happens all the time. 

Chairman COLEMAN. I apologize for that, and thank you for your 

cooperation. 

Did KPMG, in your discussions with KPMG—first of all, how 

many of these BLIPS transactions was HVB involved in? 

Mr. DEGIORGIO. Over the 2-year period, approximately 30 transactions. 

Chairman COLEMAN. Did KPMG ever indicate to you this was a 

tax mitigation strategy versus an investment strategy? 

Mr. DEGIORGIO. We certainly were aware, as opposed to being ignorant, regarding the inherent tax benefits associated with the investment strategy. 

Chairman COLEMAN. Did it ever become clear to you that this 

was not going to be a 7-year collateral premium loan as originally 

laid out, that this was going to be a 60-day deal? 

99

1See Exhibit No. 111 which appears in the Appendix on page 2660. 

Mr. DEGIORGIO. We certainly recognized soon after the funding 

date that the likelihood of going beyond a 60-day period was less 

probable than the probability of this transaction remaining through 

maturity. 

Chairman COLEMAN. If I can direct your attention to Exhibit 

111.1 This, I believe, is a Presidio credit request, and if you look 

at the second page, I think it is, under background, counterparty 

purpose of transaction, it reads as follows. ‘‘HVB will earn a 

very’’—again, let me just back up. If you go to page 1, under comments, it says, ‘‘We are seeking an approval to fund four 7-year 

collateralized premium loans.’’ That is in the box labeled comment. 

That is on the No. 1 relationship. 

If you then go to box three, it notes that ‘‘HVB will earn a very 

attractive return if the deals run to term. If, however, the advances 

are prepaid within 60 days, and there is a reasonable prospect they 

will be, HVB will earn a return of two-point’’—I can’t read that—

a certain percent ‘‘on the average balance of the funds advanced, 

and given the fact that our collateral will most likely be cash deposits, at least for the early stage of the transaction, we enjoy the 

possibility of earning an infinite ROE,’’ presumably return on investment, ‘‘on these loans.’’

So at what point did somebody tell you these things are going to 

be 60-day deals and not 7-year premium high-risk loans? 

Mr. DEGIORGIO. The communication regarding the likelihood of 

these transactions or the investors terminating their positions prior 

to the 7-year maturity rate came to the bank through the Presidio 

investment firm. I don’t recall the exact verbiage used, but it went 

along the lines of it is likely that if the investors do not earn a substantial return on their investment during phase one of the investment strategy, they are likely to terminate their positions before 

the end of the year. 

Chairman COLEMAN. I have trouble with—well, let me back it 

up. Out of the 30 BLIPS transactions, how many got out after 60 

days? 

Mr. DEGIORGIO. Eleven were funded in 1999 and all 11 terminated their positions in 1999. 

Chairman COLEMAN. In 60 days? 

Mr. DEGIORGIO. Yes. 

Chairman COLEMAN. Did that raise any question in your mind 

about whether these were 7-year premium deals or 60-day deals? 

Mr. DEGIORGIO. Well, it certainly turned out to be 60-day transactions, but I still believe that there was some rational explanation 

and basis for entering into a 7-year facility. 

Chairman COLEMAN. How did you come to the interest rates on 

these? Do you recall what the interest rate was for these loans? 

Mr. DEGIORGIO. I thought I would have that information on the 

front page of this exhibit, but I don’t seem to see it there. 

Chairman COLEMAN. Well, how do you arrive at something generating a premium? What is the basis for that? 

Mr. DEGIORGIO. I am sorry, generating a premium? 

100

Chairman COLEMAN. Yes. In these loans, you have a base loan, 

right, then you have a premium, how does that happen? What kind 

of conditions do you need for that to happen? 

Mr. DEGIORGIO. The rate on the premium, is that what you are 

asking me? 

Chairman COLEMAN. Yes. 

Mr. DEGIORGIO. That is——

Chairman COLEMAN. I was told, I believe, by staff that it was 

right around 17 percent. 

Mr. DEGIORGIO. Correct. 

Chairman COLEMAN. Is that a high rate? 

Mr. DEGIORGIO. I think it was closer to 18 percent, and that is 

strictly a function of the net present value derived between the difference of the loans or the funds advanced and—over a 7-year 

term—and the stated or face amount of the loan. 

Chairman COLEMAN. But again, based on a 7-year term? 

Mr. DEGIORGIO. Correct. 

Chairman COLEMAN. But early on, you are noting that the reasonable prospects that this is going to be 60 days. 

Mr. DEGIORGIO. Well, we certainly had some questions as to 

whether or not the investors could make a substantial return on 

their investment. 

Chairman COLEMAN. What kind of credit risk was there with 

these loans? 

Mr. DEGIORGIO. The credit risk was nominal. 

Chairman COLEMAN. And that is——

Mr. DEGIORGIO. As I am sure you see, most of the transactions 

were over-collateralized. 

Chairman COLEMAN. Is that unusual? 

Mr. DEGIORGIO. Not necessarily. In many situations where trading activities or underlying investments are the motives or basis 

for taking down a loan, the collateral coverage is rather high. 

Chairman COLEMAN. Did you have any knowledge whatsoever 

that by getting out after 60 days, with the premiums that these 

generated, that you were generating a tax loss for an investor? 

Mr. DEGIORGIO. Again, we certainly were not ignorant of the resultant tax benefits. It is part of our due diligence. 

Chairman COLEMAN. And you realize our concern that these resulting tax benefits couldn’t have come about unless you participate in this. 

Mr. DEGIORGIO. Well, we certainly also recognized that a loan 

needed to be funded and you needed banks to fund those loans. But 

I think with permission, I would like to just elaborate on that for 

a moment and make it clear to the Subcommittee that for the tax 

advice and the tax analysis and the tax aspects of this transaction, 

our due diligence included understanding what support or level of 

support firms such as KPMG could and was willing to provide to 

its client base. And having received a copy of the draft of the opinion that was authored by KPMG, we certainly felt comfortable that 

based on the letter of the law and the analysis, that the opinion 

was well reasoned and it was supported by case study and we had 

no expertise or ability to challenge the conclusions reached in that 

opinion. 

101

1See Exhibit No. 69 which appears in the Appendix on page 644. 

Chairman COLEMAN. Mr. Boyle, let me get back to this issue 

about getting out in 60 days. Did Deutsche Bank expect that the 

taxpayers would likely terminate the BLIPS after only 60 days, 

even though the stated term of the loan was 7 years? 

Mr. BOYLE. I think that Deutsche Bank understood there was a 

strong likelihood of that happening, and, in fact, it did happen. 

Chairman COLEMAN. I think strong likelihood may be an understatement. Will you turn to Exhibit 69,1 please. By the way, how 

many BLIPS transactions did Deutsche Bank process? 

Mr. BOYLE. I believe approximately 56. 

Chairman COLEMAN. How many is that? 

Mr. BOYLE. I believe 56. 

Chairman COLEMAN. Fifty-six. Exhibit 69 is from Presidio Advisors. 

Mr. BOYLE. OK. 

Chairman COLEMAN. And it is to John Rolfes at Deutsche Bank. 

Can you identify who John Rolfes is? 

Mr. BOYLE. John Rolfes, I believe, is a Managing Director in the 

Private Bank. 

Chairman COLEMAN. And this says, ‘‘John, further to our Friday 

phone conversation, I would like to describe the necessary financing steps the BLIPS program will require,’’ and it lays it out. Day 

one, investor borrows a certain amount for 7 years, 16 percent annual rate. On day two, and I’m going to go now to the fourth paragraph, excuse me, day 7. On day 60, investor exits partnership and 

unwinds all trades in partnership. So Deutsche Bank up front 

knew that even though you were issuing what was a 7-year loan 

with an interest rate predicated on that, in fact, this was a 60-day 

deal. 

Mr. BOYLE. Well, clearly, the credit agreement was 7 years, but 

you can see everyone got out of the loans we were involved in in 

a 60-day period, yes. 

Chairman COLEMAN. And again with Deutsche Bank, as with 

HVB, collateral here was more than the amount of the loan and 

the premium combined, is that correct? 

Mr. BOYLE. Yes. 

Chairman COLEMAN. Deutsche Bank didn’t have much risk in 

this. 

Mr. BOYLE. Deutsche Bank had risk depending upon what the 

underlying assets were. I believe in the first stage, as you had 

seen, they elected to invest them in kind of short-term money market fund-type investments, so those were fairly very low risk, yes. 

Chairman COLEMAN. And didn’t Deutsche Bank insist that if collateral ever dipped below the 100 percent—101 percent figure, 

Deutsche Bank would be entitled to get its money back immediately? 

Mr. BOYLE. Yes. Well, I think that is a normal provision. I don’t 

think that provision itself is unusual because your recourse is to 

the assets that are there, so you want to ensure that you can dispose of the assets and repay the loan, yes. 

Chairman COLEMAN. So tell me again the reason for the 16 percent interest. How do you arrive at that figure? 

102

Mr. BOYLE. My understanding is the client requested a premium 

loan, and once again, you determine the 16 percent rate would—

you would basically discount that back and ensure that you received all the payments——

Chairman COLEMAN. So the client requests a premium loan and 

it is a premium loan that feeds into the tax consequences, the opportunity to get a tax loss, is that correct? 

Mr. BOYLE. That is my understanding, yes. 

Chairman COLEMAN. And that is what happened in all of these 

situations? 

Mr. BOYLE. Yes. 

Chairman COLEMAN. Senator Levin. 

Senator LEVIN. Mr. DeGiorgio, looking at this straight, would you 

not agree that this was basically intended to be a tax deal for the 

taxpayer? Just to cut through all this stuff before—I am going to 

go through all of it with you anyway——

Mr. DEGIORGIO. OK. 

Senator LEVIN [continuing]. To prove it, but—— [Laughter.] 

In your heart of hearts, is this not clearly intended to be a tax 

deal? 

Mr. DEGIORGIO. I think to dispute the notion that there were inherent and significant tax benefits is ridiculous. However, the investment strategy was described to us as a significant motive for 

these investors to enter into this transaction. 

Senator LEVIN. Could there be any profit in this transaction? I 

mean, is there any way? Just take a look at it. The only thing 

which was at risk was 7 percent of the premium, correct? 

Mr. DEGIORGIO. During phase one, which is the first 60-day period? 

Senator LEVIN. Right. 

Mr. DEGIORGIO. Correct. 

Senator LEVIN. The only thing that was at risk, and they all 

bailed out after 60 days——

Mr. DEGIORGIO. Right. 

Senator LEVIN [continuing]. And we will go through that just to 

show that is what the intention was. That is what the plan was, 

to finish at 60 days and then collect your tax loss. So assuming 

that is what happened, the only possible money that had any risk 

attached to it was that 7 percent that the taxpayer put up to pay 

all the fees, is that correct? 

Mr. DEGIORGIO. Again, at least initially during phase one——

Senator LEVIN. During the 60 days. 

Mr. DEGIORGIO. Yes. 

Senator LEVIN. OK. Is that correct? 

Mr. DEGIORGIO. Yes. 

Senator LEVIN. All right. Now, within 1 week after this loan was 

taken out by the taxpayer, the loan was assigned to an investment 

fund, right? 

Mr. DEGIORGIO. Correct. 

Senator LEVIN. And you were aware of that fact? 

Mr. DEGIORGIO. Yes. 

Senator LEVIN. Why wasn’t the loan just made to the investment 

fund? 

103

1See Exhibit No. 107 which appears in the Appendix on page 2646. 

Mr. DEGIORGIO. That, I don’t know. I am not sure why there was 

a two-tiered fund. 

Senator LEVIN. Why there was an assignment? 

Mr. DEGIORGIO. Correct. 

Senator LEVIN. You don’t know why these loans were just not 

made to the investment fund? Would there have been a tax advantage if it had been made to the investment fund? 

Mr. DEGIORGIO. There probably was, if I recall some of the aspects of the KPMG opinion, it did refer to a shifting of liability 

from one entity to another. 

Senator LEVIN. Assignment of——

Mr. DEGIORGIO. Being correlated with the tax benefit. 

Senator LEVIN. Of course. From what you now know, would you 

agree the only way that the tax benefit, the tax loss, would be created is if the loan originally went to the taxpayer and then was almost immediately assigned to that so-called investment fund? Is 

that what you now are aware of? 

Mr. DEGIORGIO. I am—the only way is a strong statement and 

I probably couldn’t make that. But I can certainly ascertain that 

it is one way of creating a tax loss. 

Senator LEVIN. All right. If you could think of the other reason 

for doing that, let the Subcommittee know, will you, for the record? 

Mr. DEGIORGIO. Sure. 

Senator LEVIN. We haven’t been able to find one yet, but if you 

can find one, let us know. 

Now, did you eventually come to understand, at least, that 

BLIPS was primarily a tax avoidance scheme? 

Mr. DEGIORGIO. No, I did not. 

Senator LEVIN. Let us go to Exhibit 107.1 Is it Alex Nouvakhov—

am I pronouncing his name correctly? 

Mr. DEGIORGIO. Very close. 

Senator LEVIN. All right. He is with your bank? 

Mr. DEGIORGIO. Yes, he is. 

Senator LEVIN. Now, he acknowledged to us that he knew that 

BLIPS was a tax shelter and here is what his notes read, if you 

could take a look at his notes. They are a little bit hard to read, 

but you will see on the right-hand side, right in the middle where 

there is a 7 percent and then there is an arrow up. Do you see 

that? 

Mr. DEGIORGIO. I am with you. 

Senator LEVIN. OK. It says, ‘‘Seven percent fee equity paid by the 

investor for tax sheltering.’’ Do you see that? 

Mr. DEGIORGIO. Yes, I do. 

Senator LEVIN. Well, he was aware of it, then, right? 

Mr. DEGIORGIO. Well, certainly—I certainly was present at the 

meeting where this presentation was made. 

Senator LEVIN. Is that an accurate note? 

Mr. DEGIORGIO. The note reflects the cost and how Presidio had 

intended on charging its investors for participating in the investment structure. 

Senator LEVIN. He didn’t say investment structure. He says tax 

sheltering. Was that an accurate note or wasn’t it? 

104

1See Exhibit No. 124 which appears in the Appendix on page 2705. 

Mr. DEGIORGIO. Actually, what Alex Nouvakhov thought at the 

point in time, I don’t recall Presidio mentioning or referring to this 

as a tax shelter, but they certainly described to us how the calculation of the cost to the investor was being made. 

Senator LEVIN. Did you understand it basically to be a tax sheltering effort? 

Mr. DEGIORGIO. I am sorry, can you repeat that, Senator? 

Senator LEVIN. Did you understand this at that point, then, to 

be basically a tax sheltering effort? 

Mr. DEGIORGIO. No. I still referred to this——

Senator LEVIN. I know you referred to it. I am talking about 

what you understand as a knowledgeable business person. Mr. 

Nouvakhov referred to it as a tax shelter and that the 7 percent 

fee was for that purpose. Now I am asking you, under oath, did you 

understand this to be and believe it to be basically a tax sheltering 

effort? 

Mr. DEGIORGIO. No, I did not. I still viewed it as an investment 

strategy with inherent tax benefits. 

Senator LEVIN. Now take a look at Exhibit 124.1 This is an HVB 

document. This begins on day 48. And then if you look at the second line on page one, it says, ‘‘Day 48, ten business days prior to 

the withdrawal date.’’ That is your document, right? 

Mr. DEGIORGIO. Yes, it is. 

Senator LEVIN. So it was obvious to you when you prepared this 

document that the withdrawal was going to occur on day 60, was 

it not? 

Mr. DEGIORGIO. Not exactly. 

Senator LEVIN. What does it mean, ten business days prior to 

withdrawal date? It doesn’t say possible withdrawal date. It says 

withdrawal date, right? Are you familiar with this document? 

Mr. DEGIORGIO. Absolutely. 

Senator LEVIN. Does it say prior to withdrawal date? Am I reading it right, or is this something subject to interpretation like Mr. 

Nouvakhov’s notes? 

Mr. DEGIORGIO. No, not at all. I can explain it fully. 

Senator LEVIN. All right. 

Mr. DEGIORGIO. Given the time of year, obviously it was fourth 

quarter 1999 going into a Y2K event, we as an institution—since 

we had reasonable expectations that the transactions would terminate within a 60-day period—prepared our back office and operations teams for the reasonable expectation of an unwind. 

Senator LEVIN. Within 60 days? 

Mr. DEGIORGIO. Within 60 days. But I have to say, Senator, if 

this were a different time of the year, in other words, if these 

transactions were funded in January and the 60-day period occurred within the first quarter of that year, this process would 

never have been put in place. It was simply a function of year-end 

constraints in addition to the Y2K events. 

Senator LEVIN. To summarize your testimony, you had the reasonable expectation that the withdrawal would occur by day 60 and 

then that happened in every case? 

Mr. DEGIORGIO. Correct. 

105

1See Exhibit No. 125 which appears in the Appendix on page 2711. 

Senator LEVIN. There was a theoretical possibility that it 

wouldn’t occur within 60 days, is that correct? 

Mr. DEGIORGIO. Theoretical possibility. 

Senator LEVIN. And your bank could force it to end at 60 days, 

couldn’t it? 

Mr. DEGIORGIO. No. 

Senator LEVIN. You didn’t have the power to end it at 60 days? 

Mr. DEGIORGIO. No, unless there were violations in the collateral 

ratio. 

Senator LEVIN. And the collateral ratio was 100 percent-plus, 

right? 

Mr. DEGIORGIO. Hundred-and-one-point-two-five. 

Senator LEVIN. Pretty solid collateral there? 

Mr. DEGIORGIO. Absolutely. 

Senator LEVIN. No risk for the bank? 

Mr. DEGIORGIO. No credit risk. Plenty of execution and operational and administrative risks. 

Senator LEVIN. There were operational risks. Didn’t you control 

the fund? Wasn’t it in your custody? 

Mr. DEGIORGIO. The funds were not necessarily at risk because 

you are absolutely correct. The funds remained in an account under 

the customer’s name at the bank. 

Senator LEVIN. At your bank? 

Mr. DEGIORGIO. Correct. The risks I am referring to, again, are 

operational regarding the trading activities——

Senator LEVIN. Which was limited to the 7 percent that the customer put up, right? 

Mr. DEGIORGIO. During the first 60 days, correct. 

Senator LEVIN. And you had the reasonable expectation when it 

would end, right? 

Mr. DEGIORGIO. Yes. I said that. 

Senator LEVIN. I now want you to say it, though, in connection 

with this point, which is that since there was an expectation that 

it would end within 60 days and there was no risk to the bank of 

its funds at all within that 60 days, because you were more than 

fully collateralized, that therefore the reasonable expectation was 

there would never be a risk to the bank. 

Mr. DEGIORGIO. Certainly the likelihood of there being credit 

risk to the bank was low, as we have ensured to protect ourselves 

with the over-collateralization measures. 

Senator LEVIN. And if you look at Exhibit 125,1 you have a chart 

showing that all the loan proceeds—not the equity, not that 7 percent, the taxpayer’s equity—is converted into Euros and will be 

converted back 30 days later. So this is a Euro account. This is not 

the loan, the premium loan or the basic loan. This is just the 7 percent, is that correct, or is this the whole loan? 

Mr. DEGIORGIO. This is the whole loan proceeds. 

Senator LEVIN. This is the loan proceeds? 

Mr. DEGIORGIO. Right. 

Senator LEVIN. So the so-called loan, and there is a great question as to whether there was a loan here at all since, for all the 

reasons that have been given the other day, but basically it was in 

106

1See Exhibit No. 113 which appears in the Appendix on page 2679. 

your control, fully collateralized, and expected to be terminated at 

60 days during which there was no risk, but in any event, during 

that period, there was a deposit into a Euro account, is that basically correct? 

Mr. DEGIORGIO. That is correct. 

Senator LEVIN. Were any of the loan proceeds during that period 

put at risk during the investment scheme, as part of the investment scheme? 

Mr. DEGIORGIO. Not during the first 60-day period. 

Senator LEVIN. That is the period we are talking about, right? 

Mr. DEGIORGIO. Yes. 

Senator LEVIN. My time is up. Thank you. 

Chairman COLEMAN. We will come back to a second round, Senator Levin. 

Senator LEVIN. Thank you. 

Chairman COLEMAN. Mr. Boyle, on the issue about whether the 

loan was at risk in terms of the Deutsche Bank transactions, did 

Deutsche Bank lay out some requirement that the loan had to be 

invested in certain types of securities? 

Mr. BOYLE. There was a list of permitted investments, yes. 

Chairman COLEMAN. And these, it is my understanding, they 

generate a lower rate of return than the interest that the Deutsche 

Bank was charging? 

Mr. BOYLE. I believe that the investment that they chose for the 

first days was an investment that——

Chairman COLEMAN. So Deutsche Bank knew up front there was 

going to be no profit generated within this 60-day period. 

Mr. BOYLE. To the—you mean with—after——

Chairman COLEMAN. Investor. 

Mr. BOYLE. After he made the investment, yes. 

Chairman COLEMAN. And again, at least the Deutsche Bank 

clearly got from Presidio a memo saying this is a 60-day deal. 

Mr. BOYLE. Like I said before, there was an expectation that it 

may very well wind up at 60 days, and in fact, did unwind. 

Chairman COLEMAN. I mean, again, expectation. On day 60, investor exits partnership and unwinds all trades in partnership. 

That is Exhibit 69. That is not an equivocal expectation, is it? 

Mr. BOYLE. That language is clearly not, no, sir. 

Chairman COLEMAN. Exhibit 113.1 This is a memo, Deutsche 

Bank Private Bank management committee meeting talking about 

the BLIPS product, is that correct? 

Mr. BOYLE. Yes. 

Chairman COLEMAN. And on page two, it indicates that KGT 

suggests that 25 customers be selected from different geographic 

areas. PKS will ensure that written agreements be prepared. Can 

you help me understand why you would want to select 25 customers from different geographic areas? 

Mr. BOYLE. I don’t know precisely. That was a Private Bank recommendation, I guess, to John Rolfes. I don’t believe that applied 

to us per se in the Structured Transactions Group. 

Chairman COLEMAN. Is that unusual, to put those kinds of geographic limitations on this? 

107

Mr. BOYLE. I don’t know, to be honest with you, sir. No. 

Chairman COLEMAN. Our concern here, is this an effort to keep 

this under the radar screen? 

Mr. BOYLE. I don’t know. 

Chairman COLEMAN. Have you heard of any other similar restrictions being placed in any other Deutsche Bank transactions? 

Mr. BOYLE. Not that I am aware of, no. 

Chairman COLEMAN. And Deutsche Bank ultimately engaged in 

56 of these deals. Senior management said 25. What is the reason 

for the difference? 

Mr. BOYLE. The reason for the difference. A different—originally, 

we were focusing on the amount that we may potentially loan and 

we wanted to do things in different stages to make sure we were 

comfortable executing the transactions, and I believe the initial 

stage, we were approached with the idea of doing up to 25 investors. 

Chairman COLEMAN. Again, I go back to this question that Senator Levin asked of Mr. DeGiorgio. Looking at this, is there any 

question in your mind that these were tax shelters that were going 

to be used to provide opportunities for taxpayers to generate loss 

and write it off? 

Mr. BOYLE. Well, it is very clear from the opinions and everything that there were significant tax benefits that the investor may 

report on its return, yes. 

Chairman COLEMAN. Were you concerned? Is Deutsche Bank concerned at all about the reputational risk for being involved in this 

stuff? 

Mr. BOYLE. You know, like all investments, we are very concerned in terms of reviewing, going through a very thorough internal review. 

Chairman COLEMAN. Have you changed your practices today? 

Mr. BOYLE. I am no longer an employee, so—I am certain they 

adjusted everything accordingly, but I am not there anymore. 

Chairman COLEMAN. And Mr. DeGiorgio, you have indicated that 

HVB has, in fact, changed its practices? 

Mr. DEGIORGIO. That is correct, and it is DeGiorgio. [Laughter.] 

Chairman COLEMAN. And it changed its practices because these 

are abusive tax shelters? 

Mr. DEGIORGIO. Well, when it became abundantly clear to the 

bank that the IRS had issues with the strategy, as was reflected, 

I believe, in a notice in August 2000, we immediately discontinued 

our participation in the transaction. 

Chairman COLEMAN. And again, it is your testimony here today 

that in spite of the fact that you had—how many BLIPS accounts 

did you have? 

Mr. DEGIORGIO. Approximately 30. 

Chairman COLEMAN. Thirty, that you had 30 BLIPS accounts, 

that all of these were purported to be 7-year loans at 16 percent 

interest rate, even though it was clear they were going to be 

exiting in 60 days and they were all exited on 60 days, and at the 

time, you weren’t aware that these were abusive tax shelters? 

Mr. DEGIORGIO. That is correct. 

Chairman COLEMAN. Senator Levin. 

108

1See Exhibit No. 70 which appears in the Appendix on page 646. 

2See Exhibit No. 106 which appears in the Appendix on page 2622. 

Senator LEVIN. Mr. Boyle, take a look at Exhibit 70,1 if you 

would. This is a bank document relative to BLIPS. It is called a 

new product committee overview memo. Take a look at page three, 

if you would, and it is point 12. ‘‘It is imperative that the transaction be wound up after 45 to 60 days and the loan repaid due 

to the fact that the HNW individual will not receive his or her capital loss or tax benefit until the transaction is wound up and the 

loan repaid.’’ Is that correct? 

Mr. BOYLE. Excuse me? 

Senator LEVIN. Is that—did I read that correctly? 

Mr. BOYLE. Well, you read it correctly, yes. 

Senator LEVIN. So it was imperative that this be wound up in 45 

to 60 days in order that the person get their tax benefit? Am I 

reading it right? 

Mr. BOYLE. Well, like I said before, the loan itself was a 7-year 

loan that people had the option of repaying at any time within that 

particular 7 years. And based upon the tax opinion, if they wanted 

to potentially take that tax benefit in the current year——

Senator LEVIN. Not potentially. Forget the potentially. 

Mr. BOYLE. OK. 

Senator LEVIN. If they wanted to get the tax benefit. 

Mr. BOYLE. If they wanted to get the tax benefit, they would 

have had to unwind it in the current year, yes. 

Senator LEVIN. And that was 60 days? 

Mr. BOYLE. Yes, sir. 

Senator LEVIN. OK. Now, in Exhibit 106,2 this is your 

PowerPoint presentation about this transaction. This is your Structured Transaction Group. That is the group that implemented 

BLIPS. You were part of that group, were you not? 

Mr. BOYLE. Yes, sir. 

Senator LEVIN. Page 7 of the exhibit describes the client environment for the group. It says that your group was doing ‘‘tax driven 

deals.’’

Mr. BOYLE. Those are the words, yes. 

Senator LEVIN. Is that a lie? Is your own PowerPoint presentation a lie? 

Mr. BOYLE. No. I mean, the group was involved in complex financial transactions in which there were significant tax benefits, yes. 

Senator LEVIN. No. Not significant tax benefits. Let us put that 

aside. We have heard that rhetoric two or three times. We are talking about your own PowerPoint that says these were ‘‘tax driven 

deals.’’ Were those words a lie? 

Mr. BOYLE. I did not prepare the document. 

Senator LEVIN. Were they accurate? 

Mr. BOYLE. That there were significant tax benefits? 

Senator LEVIN. No, that they were tax driven. 

Mr. BOYLE. I don’t know the precise context that they are using 

tax driven, but clearly, if you believe that——

Senator LEVIN. Give me a context for that. These are three 

words, tax driven deals. 

Mr. BOYLE. Yes. If you——

109

Senator LEVIN. That doesn’t mean some tax benefits. That means 

these were tax driven deals. That is your document. That is your 

bank’s document. 

Mr. BOYLE. Yes. 

Senator LEVIN. Was that accurate or not, that these were tax 

driven deals? 

Mr. BOYLE. If they are referring to the fact that there were significant tax benefits, yes. 

Senator LEVIN. Otherwise, if they were driven by those benefits—driven? 

Mr. BOYLE. Well, you have to look at——

Senator LEVIN. Driven means that is the principal point. That is 

the driver. You know what the word means. 

Mr. BOYLE. Yes, sir. 

Senator LEVIN. Let us not fiddle around with words. Were these 

tax driven deals? 

Mr. BOYLE. I don’t know which ones—I don’t know which deals 

they were referring to in that——

Senator LEVIN. BLIPS. 

Mr. BOYLE. BLIPS? 

Senator LEVIN. Was BLIPS a tax driven deal? 

Mr. BOYLE. I am not sure they are referring to BLIPS in that 

transaction. 

Senator LEVIN. Well, was BLIPS a tax driven deal? 

Mr. BOYLE. BLIPS had a very significant tax benefit, yes, sir. 

Senator LEVIN. Yes. And so you are denying it was a tax driven 

deal? 

Mr. BOYLE. No, I am saying if tax driven means significant tax 

benefits, yes. 

Senator LEVIN. And if it means that the principal purpose of it 

was tax benefits, it was not? 

Mr. BOYLE. That is something we weren’t involved in deciding or 

reviewing. 

Senator LEVIN. You weren’t involved in reviewing? I am asking 

you, you are saying that there were tax benefits. You knew that 

much. 

Mr. BOYLE. Yes. We understood that——

Senator LEVIN. But you can’t say that it was driven by tax benefits, is that correct? 

Mr. BOYLE. Yes. 

Senator LEVIN. You are not saying that? 

Mr. BOYLE. No. I mean, you are asking me what the investors’ 

intentions were. We did not talk to the investors, no, sir. 

Senator LEVIN. I am talking about your chart at your bank, your 

PowerPoint presentation. 

Mr. BOYLE. Right. 

Senator LEVIN. You were part of the committee that prepared it. 

I am asking you, are those words accurate, that you were looking 

at tax driven deals. You are not going to—you are going to basically tell me today that if it means something that it doesn’t mean, 

then yes. Now I am asking you, if it means what it says, is the answer yes or no? Was your bank engaged in tax driven deals? 

Mr. BOYLE. Like I said before, if it means transactions that may 

have significant tax benefits, yes. And I did not prepare this——

110

1See Exhibit No. 103 which appears in the Appendix on page 2615. 

Senator LEVIN. If it means that the principal purpose was tax 

benefits, then yes or no? 

Mr. BOYLE. I don’t—I am not aware of that. 

Senator LEVIN. The other word is ‘‘gain mitigation strategies,’’ by 

the way. Take a look now at page 17 of that same exhibit. You will 

see that BLIPS is listed as one of the deals implemented by the 

group. 

Mr. BOYLE. Yes. 

Senator LEVIN. Were you aware of the fact, Mr. Boyle, that the 

premium part of the so-called loan when it was repaid would generate a tax loss for the taxpayer? 

Mr. BOYLE. I was aware that may be the position they took, yes, 

I was. 

Senator LEVIN. Thank you. Now, it was designed as a 7-year investment program, but I think you indicated that the reasonable 

likelihood was that the taxpayer would get out after 60 days. Is it 

not true that it was anticipated that taxpayers would get out at 60 

days? 

Mr. BOYLE. We understood that they made that choice, yes. 

Senator LEVIN. Was it anticipated the taxpayers would get out, 

not possibly get out, but was it anticipated that they would get out 

at 60 days? 

Mr. BOYLE. I would say it was anticipated that they would get 

out, yes. 

Senator LEVIN. Thank you. You said anticipated they get out, 

yes, you meant, I assume, that they would get out in 60 days? 

Mr. BOYLE. In 60 days, yes, sir. 

Senator LEVIN. Thank you. Now, was the amount of funds that 

were at risk limited to the funds contributed by the taxpayer, that 

7 percent? 

Mr. BOYLE. No. They had a series of permitted investments that 

they could choose from. In the first stage, my understanding is they 

all invested in what you would refer to as low-risk investments. 

Senator LEVIN. So that if the 60-day period was the limit of the 

loan, then the risk in the foreign currency transactions would be 

limited to the funds contributed by the taxpayer, that 7 percent? 

Mr. BOYLE. I believe so, yes. 

Senator LEVIN. Was the 7 percent approximately that was contributed by the taxpayer in Presidio that was held in your bank 

until the investment fund was closed, is that also true? 

Mr. BOYLE. I am sorry? 

Senator LEVIN. Your bank held the funds? 

Mr. BOYLE. I believe so, yes. Well, yes. It went into a custody account in the Private Bank. 

Senator LEVIN. So the funds were held in your custody? 

Mr. BOYLE. For the benefit of the client, yes. 

Senator LEVIN. Yes. And the 7.7 percent was intended to cover 

market risks, transaction costs, and Deutsche Bank fees, is that 

correct? 

Mr. BOYLE. Yes. 

Senator LEVIN. Now, there was an Exhibit 103,1 if you take a 

look at that. It is from Mick Wood. He worked at the bank? 

111

1See Exhibit No. 104 which appears in the Appendix on page 2618. 

Mr. BOYLE. Yes. 

Senator LEVIN. In response to a memo that you wrote to him 

about BLIPS, this is, I think, similar to the question that our 

Chairman raised, and if I am duplicating it exactly, then forgive 

me. I may have missed your exhibit reference here, Mr. Chairman. 

But Exhibit 103 is a reply to a memo that you wrote about BLIPS, 

and he said, ‘‘I would have thought you could still ensure that the 

issues are highlighted by ensuring that the papers are prepared 

and all discussion held in a way which makes them legally privileged.’’ It sounds like he is suggesting that Deutsche Bank should 

hide the program behind the claim of privilege, is that correct? 

Mr. BOYLE. You may possibly interpret it that way. My understanding—I don’t know—I don’t recall much of what was hidden. 

I think the only things I recall was trying to limit the tax discussion with our attorneys to the appropriate professionals in the 

bank to review that. I think everything else is fairly well laid out, 

including any potential tax benefits that the investor may receive 

from the transaction. 

Senator LEVIN. You are saying that the purpose for the privilege 

was not to hide this program behind such a claim? 

Mr. BOYLE. I think the purpose—I don’t remember precisely, but 

I think generally my recollection is that the reference to privilege 

was more to—as you recall, we were advised—not advised, but we 

were counseled by an outside law firm and they were preparing a 

tax opinion with respect to our role in the transaction and it was, 

I believe, to limit the access people had internally to that document 

to the appropriate professionals that should be reviewing it. 

Senator LEVIN. And the purpose of limiting access to the document? 

Mr. BOYLE. To the tax opinion, yes. 

Senator LEVIN. The tax opinion? 

Mr. BOYLE. Yes. 

Senator LEVIN. Take a look at Exhibit 104.1 This is an e-mail 

from Ivor Dunbar——

Mr. BOYLE. Yes. 

Senator LEVIN. Co-head of your Structured Transaction Group 

who implemented BLIPS, and that again was your group, I gather, 

and here is what he says under point two, privilege. 

Mr. BOYLE. Yes. 

Senator LEVIN. ‘‘This is not easy to achieve, and therefore a more 

detailed description of the tax issues is not advisable.’’ Don’t describe the tax issues. 

Mr. BOYLE. Yes. 

Senator LEVIN. Keep those out of any paper trail. 

Mr. BOYLE. Right. 

Senator LEVIN. Is that right? 

Mr. BOYLE. That is clearly what he said there, yes. 

Senator LEVIN. Yes. Now look at point three in that same e-mail, 

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.’’ The tax department, don’t create an audit trail in respect to the bank’s tax affairs. ‘‘The tax department assumes priVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00135 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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mary responsibility for controlling tax related risks, including reputation risk, and will brief senior management accordingly. We are 

therefore not asking risk and resources committee to approve the 

reputation risk.’’ Boy, isn’t that unusual? 

Mr. BOYLE. I don’t——

Senator LEVIN. Not to approve a reputation risk because we want 

to do this orally? 

Mr. BOYLE. I don’t believe that is what he was getting at. I think 

what they were doing is in terms of reviewing the tax—the transaction, they were restricting that to the tax professionals, the attorneys, and senior management. I don’t believe that—when you go 

through the internal documents in terms of the approvals and that, 

I mean, it was always clear that there were tax benefits that may 

arise to the investor in the transaction. I don’t believe that was 

hidden or kept low profile at any point in time. 

Senator LEVIN. No, but it was hidden. Not the tax benefits. What 

was hidden is what you are so unwilling to say but which is so obviously true, which is that was the principal purpose of the transaction. That is what the effort was. Obviously, there are tax impacts of every transaction. But this, the fact that this was intended 

to be a tax shelter, and that was its principal purpose, which is obvious from everything, is what they didn’t want to say there, because there would be a reputational risk at that point. 

And let me go on to that reputational risk. By the way, would 

there not be a reputational risk if, in fact, your papers—every time 

your papers say that the principal purpose of this was a tax deal, 

does that not create a reputational risk? 

Mr. BOYLE. If that is, in fact, true. I don’t recall anything——

Senator LEVIN. Yes, it would create a reputational risk every 

time you would say, this is a tax deal primarily, right? You would 

agree that creates a reputational risk? 

Mr. BOYLE. Yes, I would—yes, but I don’t recall those words out 

there anywhere in terms of——

Senator LEVIN. Well, we have gone through a lot of documents 

which quite clearly talk about this being a tax deal. 

Mr. BOYLE. Yes, sir. 

Senator LEVIN. Having to be wound up in a certain number of 

days and so forth. So what we see here is the tax department at 

Deutsche Bank saying that the reputational risk here was so great 

that it pulled the review of the BLIPS program out of your risk and 

resources committee because there would have been a paper trail, 

as you just indicated, and it instead personally briefed Mr. John 

Ross, who is the CEO of Deutsche Bank Americas. 

Now, how many times do you think that that would have happened, where there were these kind of tax deals that were pulled 

away from that committee and orally discussed with the CEO instead because of a statement that there is a reputational risk in 

having this reviewed by your committee? Do you think that happened frequently or would this be unusual? 

Mr. BOYLE. No. My understanding is that it was not pulled away 

from that committee because of BLIPS. I think that was a general 

policy that the bank was going through, that the tax aspects would 

be reviewed by the tax professionals and senior management. 

113

1See Exhibit No. 113 which appears in the Appendix on page 2679. 

2See Exhibit No. 105 which appears in the Appendix on page 2619. 

Senator LEVIN. But it says here, though, in Exhibit 104 again 

that we are, therefore, not asking risk and resources committee to 

approve reputational risk on BLIPS. This will be dealt with directly by the tax department and John Ross. I am asking you, was 

that common? 

Mr. BOYLE. With respect to any tax related transaction, yes. 

Senator LEVIN. It was? 

Mr. BOYLE. I believe so. 

Senator LEVIN. OK. I believe that the chairman is covered in Exhibit 113,1 where that same type of issue was raised—where it 

says, 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. Again, try me on this one. Why a low profile? Why limit it to 25? 

Mr. BOYLE. My recollection of the conversations, we were sitting 

down and taking Mr. Ross through the transaction, particularly our 

role in the transaction, and because it involved a more likely than 

not opinion for the potential tax benefit to the investor, we wanted 

to make very clear what our role was just in terms of banking, that 

we are not out there marketing or providing tax advice and that 

type of thing. So I am—my guess is he was referring to that conversation. 

Senator LEVIN. My final line of questions, if I ask the indulgence 

of the Chair, who has been very generous in many ways. Exhibit 

105,2 if you take a look at that, is an e-mail from you, Mr. Boyle, 

to John Wadsworth, and this is going to take a couple of minutes 

to work through this. 

Mr. BOYLE. Actually, I don’t have Exhibit 105. Oh, here it is. 

Senator LEVIN. You have it? OK. Here is what you wrote. ‘‘During 1999, we executed $2.8 billion of loan premium deals as part 

of BLIPS approval process. At that time, NetWest and HVB Bank 

had executed approximately a half-billion dollars 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.’’ 

You had done a lot of this, compared to the other banks, and here 

is what you proposed. 

‘‘In addition to the execution of the underlying FX transactions, 

we would like to lend an amount of money to HVB Bank equal to 

the amount of money HVB Bank lends to the client. We could potentially make a market interest rate loan secured by HVB high 

coupon loan to the client which would be secured by the underlying 

FX transactions. The loan we fund HVB Bank with could be differentiated from the underlying loan to the client because of the 

market coupon versus high coupon, the date the loans are made, 

and the fact that we do not face the client as HVB Bank does.’’

So in other words, Mr. Boyle, the reputational risk to Deutsche 

Bank for doing additional BLIPS deals was so great that the bank 

is not permitting any additional transactions, and in response to 

that situation, your solution is not to halt BLIPS transactions. 

114

Rather, you propose to fund and execute additional BLIPS transactions through the front of another bank, HVB. 

Now, if the reputational risk is that great, shouldn’t Deutsche 

Bank stop its participation rather than try to hide its involvement 

in more of these transactions? 

Mr. BOYLE. I think we have to put this note in context from what 

I remember. The bank itself had reached the conclusion back in 

November or October 1999 they didn’t want to participate anymore 

with these particular transactions. My understanding is that there 

may have been other opportunities to do some more. We approached Mr. Wadsworth with respect to revisiting this, and he 

clearly was not interested in doing any more of these deals, and it 

stopped at that point. 

Senator LEVIN. Mr. DeGiorgio, did Deutsche Bank approach HVB 

about this idea? 

Mr. DEGIORGIO. Yes, it did. 

Senator LEVIN. And did you or HVB accept the idea? 

Mr. DEGIORGIO. No, we did not. 

Senator LEVIN. You rejected it? 

Mr. DEGIORGIO. Yes, we did. 

Senator LEVIN. And why? 

Mr. DEGIORGIO. Because we were concerned with the operational 

and execution risks associated with the transaction that would not 

have been alleviated in the structure that had been proposed, as 

you see in this e-mail. 

Senator LEVIN. Thank you. Thank you, Mr. Chairman. 

Chairman COLEMAN. Thank you. Mr. DeGiorgio and Mr. Boyle, 

you are excused. 

I would now like to welcome our third panel to today’s hearing: 

John Larson, Managing Director of Presidio Advisory Services; and 

Jeffrey Greenstein, Chief Executive Officer of Quellos Group, formerly known as Quadra Advisors. I thank each of you for your attendance at today’s hearing and look forward to your testimony. 

Before we begin, pursuant to Rule 6, all witnesses who testify before the Subcommittee are required to be sworn. At this time, I 

would ask you to please stand and raise your right hand. 

Do you swear that the testimony you are about to give before 

this Subcommittee is the truth, the whole truth, and nothing but 

the truth, so help you, God? 

Mr. LARSON. I do. 

Mr. GREENSTEIN. I do. 

Chairman COLEMAN. Again, as you have seen with the earlier 

panels, I would like testimony to be 5 minutes. Your written testimony will be entered into the record in its entirety. 

Mr. Larson, we will have you go first this morning, followed by 

Mr. Greenstein. After we have heard all the testimony, we will 

then turn to questions. Mr. Larson. 

TESTIMONY OF JOHN LARSON, MANAGING DIRECTOR, 

PRESIDIO ADVISORY SERVICES, SAN FRANCISCO, CALIFORNIA 

Mr. LARSON. I have no advance statement. 

Chairman COLEMAN. Mr. Greenstein. 

115

1The prepared statement of Mr. Greenstein appears in the Appendix on page 334. 

TESTIMONY OF JEFFREY GREENSTEIN,1 CHIEF EXECUTIVE 

OFFICER, QUELLOS GROUP, LLC, FORMERLY KNOWN AS 

QUADRA ADVISORS, LLC, SEATTLE, WASHINGTON 

Mr. GREENSTEIN. Mr. Chairman, Senator Levin, my name is Jeff 

Greenstein and I appreciate the opportunity to be here today. I am 

the Chief Executive Officer of Quellos Group, based in Seattle, and 

since our founding in 1994, we have focused on providing both 

asset management services to institutional and private clients 

worldwide. 

We understand and very much respect the Subcommittee’s responsibility in this area and its interest in ascertaining whether 

there is a need to change public policy. 

You have asked me to address tax advantaged investments or 

strategies with names like BLIPS, SC2, FLIP, and OPIS. With respect to BLIPS and SC2, we have no experience in these areas 

whatsoever and, therefore, I cannot comment. With respect to the 

latter two strategies, I am able to discuss the investment and 

structural aspects with the Subcommittee today, although let me 

emphasize that I do not have any tax expertise and thus am not 

able to provide meaningful input on the tax aspects of either strategy. 

As you have heard, prior to our involvement, the international 

accounting firm of KPMG developed FLIP in the mid-1990’s to provide its clients with a tax savings investment strategy. In the 

course of many conversations and meetings, KPMG advised us that 

its senior tax experts, many of whom had direct Treasury or IRS 

experience, had carefully researched the existing statutes and regulations and that KPMG’s national tax office had concluded that 

these transactions would likely yield favorable tax treatment for its 

investors under the Internal Revenue Code. 

By way of history, our introduction to KPMG occurred in 1995 

in a matter completely unrelated to what we are here today to discuss. We were working with one of our clients to restructure a portion of their portfolio to meet their investment objectives. Given the 

importance of analyzing any investment portfolio on an after-tax 

basis, our client asked to review our portfolio recommendations 

with its tax advisor, KPMG, and therefore, at the client’s request, 

we did. 

As a result of this prior interaction, KPMG later contacted us to 

see if we would apply our investment expertise to help with the security transactions related to one of its strategies. This strategy 

later became known as FLIP. KPMG presented us with a set of 

predefined criteria that it had designed for FLIP and told us that 

transactions meeting these criteria would likely result in favorable 

tax consequences. Our role as investment advisor was to identify, 

analyze, implement, and manage the specific stock and option 

transactions that were required to execute FLIP. 

These transactions gave investors a reasonable prospect of earning an economic profit which, in fact, was very real as a number 

of FLIP and OPIS investors did indeed realize an overall profit. 

The profit potential was directly linked to the gradual appreciation 

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116

tions. KPMG specifically approved all of the stock and option transactions after it had determined that the transactions met the criteria for obtaining favorable tax consequences. 

Our role as investment advisor was formalized in 1997 with an 

agreement between KPMG and Quadra that defined our different 

roles. In the agreement, KPMG confirmed its responsibility for the 

tax aspects of the strategy while agreeing that Quadra had responsibility for only providing investment advice. KPMG was and remains an international accounting firm with an excellent reputation and deep resources and we relied on its tax analysis, conclusions and advice. Additionally, a prominent national law firm concurred with their opinion. 

KPMG began introducing FLIP to potential investors during 

1996, and subsequently, Pricewaterhouse Coopers, PWC, developed 

a similar strategy with similar tax attributes. They sought and received our assistance in providing investment-related advice and 

execution services. PWC also provided a detailed opinion of this 

strategy which was consistent with KPMG’s earlier conclusion that 

the Internal Revenue Code likely afforded favorable tax treatment. 

In 1998, we were approached again by KPMG with respect to a 

variation of the FLIP transaction known as OPIS. It was our understanding that KPMG had been offering this strategy to its clients through another investment advisor, the Presidio Group, but 

that the Presidio Group had exhausted its capacity. At that time, 

KPMG requested our assistance with executing OPIS. For OPIS, 

all of the investment and structural aspects of the strategy were 

fully developed, the nature of the financial instruments and security transaction had been fully specified, and our role was simply 

to implement the trades and execute the documents required as 

prescribed by KPMG. 

Chairman COLEMAN. I would ask you to summarize the rest of 

your testimony, Mr. Greenstein. 

Mr. GREENSTEIN. Thank you. I want to reiterate that our focus 

has been on meeting the financial and investment objectives of our 

clients through thoughtful, sophisticated, disciplined, and well-researched portfolio management. This presented us with the opportunity to work with some of the most respected groups in the industry, and I think it is important to note that we have not been 

working with the accounting firms in strategies along these lines 

for years. 

And with that, that is an abridged version of my prepared remarks and I would be happy to address any questions you might 

have. 

Chairman COLEMAN. Thank you, Mr. Greenstein. Your complete 

remarks will be entered into the record, without objection. 

Mr. Larson, you were originally—at one point, you were Senior 

Manager at KPMG, is that correct? 

Mr. LARSON. That is correct, yes. 

Chairman COLEMAN. And when did you move over to Presidio? 

Mr. LARSON. In the summer of 1997. 

Chairman COLEMAN. And, in fact, were you involved in forming 

Presidio Advisory Services? 

Mr. LARSON. I was. 

117

1See Exhibit No. 69 which appears in the Appendix on page 644. 

Chairman COLEMAN. And was that with another member of 

KPMG? 

Mr. LARSON. Yes, Robert Pfaff. 

Chairman COLEMAN. So would it be fair to say that you knew the 

ins and outs of these kinds of transactions, you had experience and 

history? 

Mr. LARSON. Yes, that would be fair. 

Chairman COLEMAN. And, in fact, I believe you were involved in 

developing FLIP’s transactions? 

Mr. LARSON. I was one of the team of developers, yes. 

Chairman COLEMAN. Now, it is fair to state, Mr. Larson, that 

Presidio knew the BLIPS transaction was specifically designed so 

that investors would exit on day 60 of the transaction, regardless 

of the fact that BLIPS was a financing structure as a 7-year loan, 

is that correct? 

Mr. LARSON. I would—I do not agree with that. 

Chairman COLEMAN. Would you turn to Exhibit 69,1 please. 

Mr. LARSON. The black one or the white one? 

Chairman COLEMAN. Sixty-nine is in the white one. It is a memo, 

Presidio Advisors Group. It is from Amir Makov. Do you know who 

that is? 

Mr. LARSON. Yes. He is my other business partner. 

Chairman COLEMAN. He is a partner? He has certain authority 

and can speak for Presidio with authority? 

Mr. LARSON. Yes, correct. 

Chairman COLEMAN. And this is a memo to John Rolfes, CEO at 

Deutsche Bank? 

Mr. LARSON. John was the Managing Director. 

Chairman COLEMAN. Managing Director, I am sorry. And in the 

memo, it lays out, ‘‘John, further to our Friday conversation, I 

would like to describe the necessary financing steps the BLIPS program will require,’’ and it lays out—it starts with the day one, investor LLC borrows $100,000, and then principal amount for 7 

years at 16 percent annual. So 7 years at 16 percent annual. And 

then you go down, day 7 and the last paragraph, beginning of the 

last paragraph on that page, ‘‘On day 60, investor exits partnership 

and unwinds all trades in partnership.’’ Is that what the document 

states? 

Mr. LARSON. That is what it states, yes, sir. 

Chairman COLEMAN. And is there anything equivocal about saying that the investor exits the partnership and unwinds all trades 

in partnership? 

Mr. LARSON. No, that is what it says. 

Chairman COLEMAN. So Presidio understood this was a 60-day, 

get out in 60-day deal? 

Mr. LARSON. What Presidio understood, even as the two previous 

speakers said, that there was a significant likelihood that investors 

would want to exit after 60 days, but in no way did we understand 

that this was unequivocally a 60-day investment. 

Chairman COLEMAN. In this document, there is no indication of 

significant likelihood. It says, ‘‘on day 60, investor exits partnership 

and unwinds all trades in partnership,’’ not significant possibility. 

118

1See Exhibit No. 80 which appears in the Appendix on page 664. 

Mr. LARSON. I agree that that is what it says. 

Chairman COLEMAN. Can you tell me what step transactions are? 

Mr. LARSON. Well, there is a tax doctrine which you might be referring to called the step transaction doctrine. 

Chairman COLEMAN. Is there a prohibition in the tax code 

against step transactions designed to produce artificial losses? 

Mr. LARSON. I am not quite sure what you are referring to. 

Chairman COLEMAN. In testimony on Tuesday, we heard that 

there was a remote chance—remote chance—that BLIPS investors 

would make a profit of a transaction because they were structuring 

it, and I believe if you turn to Exhibit 80,1 that testimony came 

from Mark Watson, who appeared under subpoena before this Subcommittee. He says, ‘‘According to Presidio, the probability of making a profit from this strategy is remote.’’ Was that a fair representation of Presidio’s conversations with Mr. Watson? 

Mr. LARSON. No, it is not. 

Chairman COLEMAN. So did Mr. Watson make this up? 

Mr. LARSON. I think Mr. Watson may have misunderstood the 

presentation and information that was provided to him. 

Chairman COLEMAN. Can you tell me how many BLIPS transactions Presidio was involved in? 

Mr. LARSON. My recollection is 65 to 70. 

Chairman COLEMAN. Do you know if anyone made a profit? 

Mr. LARSON. No, the trades were not profitable. 

Chairman COLEMAN. So Mr. Watson is saying Presidio says there 

is a remote possibility. You are saying zero. Of all you were involved in, zero transactions made a profit. 

Mr. LARSON. That is correct, although I am also saying that it 

was our view at the time when we were planning the program and 

executing it that, in fact, there was a significant possibility of profit. That did not come to pass, but I think we had a well-reasoned 

view that our strategies could be highly profitable. 

Chairman COLEMAN. Was the market in trouble at that time? 

Mr. LARSON. We were—under our—the trading strategies that 

we were implementing were foreign currency transactions, so I 

guess I am not sure what market you are referring to. 

Chairman COLEMAN. I am just trying to understand how you 

have every transaction in which you are involved, none makes a 

profit, but you are saying there was a reasonable possibility for 

profit. 

Mr. LARSON. The trading strategies, the primary ones that we 

were implementing were, I guess, based on our expectation that a 

specific event would take place in the market, and by that, what 

I mean is the largest positions that we took in the BLIPS trades, 

we were shorting the Argentina peso and we were shorting the 

Hong Kong dollar and we were taking positions of very significant 

size. By taking those positions, what we were speculating was that 

one or both of those currencies would be forced to break its trading 

peg and devalue, and if that took place, then we had an expectation 

that, in particular that with Argentina, that Argentina was likely—

in fact, we thought very nearly certain—to devalue its currency. 

119

Had that happened while our trades were open, the profits would 

have been extremely significant. 

Chairman COLEMAN. And what percentage of the loans were at 

risk, of the loans that were involved in these transactions? 

Mr. LARSON. The expected risk, but not the certain risk, was approximately equal to the equity invested by the investors. However, 

there was always a possibility of a catastrophic loss in any of the 

partnerships. 

Chairman COLEMAN. Let me ask the question this way. An inves- tor took out a $15 million loan—a $20 million loan from Deutsche 

Bank, or a $50 million loan from Deutsche Bank. How much of that 

was at risk? How much of that was involved in the risk of loss? 

Mr. LARSON. The most likely scenarios and the ones that came 

to pass was that amount would not be at significant risk during the 

initial part of the trade. 

Chairman COLEMAN. Sixty days? 

Mr. LARSON. Yes. That was the most likely. 

Chairman COLEMAN. The period in which they got out. 

Mr. LARSON. Yes. However, what I would go on to say is that 

there was also a possibility, not a likelihood by any means, but a 

possibility that if our foreign currency trades had moved against 

us, and in particular if the value of the either Hong Kong or Argentina currencies had gone up, then there could have been very significant losses which would have hit the collateral. 

Chairman COLEMAN. So the standard now is not a likelihood. 

Mr. LARSON. Standard—I am sorry. 

Chairman COLEMAN. You were saying that there was not a likelihood of profit being made. 

Mr. LARSON. I am sorry, could you repeat the question? 

Chairman COLEMAN. I am trying to use the phrase there. I was 

trying to understand what the expectation was during 60 days. In 

other words, how much of a $50 million loan, how much was at 

risk? A very minimal amount. What was then the likelihood of the 

investor suffering any loss? 

Mr. LARSON. Using your example, during the initial 60-day period of our trading program, it was unlikely that there would be 

any loss that would affect the $50 million of collateral. 

Chairman COLEMAN. Let me ask you one other question. I will 

pursue this line of questioning afterwards. According to the testimony of KPMG’s Lawrence DeLap on Tuesday, he was of the view 

that BLIPS transactions should be registered and Presidio should 

have registered the transactions. Did Presidio register their BLIPS 

transactions? 

Mr. LARSON. We did not. 

Chairman COLEMAN. Mr. Greenstein, did Quadra—at that time, 

you were Quadra—did you register the FLIP transactions with 

Pricewaterhouse Coopers? 

Mr. GREENSTEIN. Yes, we did. We took registration very seriously 

and followed the advice of the tax advisor. 

Chairman COLEMAN. Mr. Larson, did Presidio do some FLIP 

transactions? 

Mr. LARSON. Yes, we did. 

Chairman COLEMAN. Did you register those? 

Mr. LARSON. We did not. 

120

1See Exhibit No. 137 which appears in the Appendix on page 2735. 

Chairman COLEMAN. I will turn the questioning over to Senator 

Levin at this time, but there will be a second round. 

Senator LEVIN. Thank you. If you take a look at Exhibit 137,1

Mr. Larson, this is the memo that was written by Mr. Pfaff shortly 

before he left KPMG. When he wrote that memo, he went, as you 

have indicated, to join you at Presidio. You were partners with 

him. This is the road map that KPMG followed in its efforts to 

mass market tax shelters, or as Mr. Pfaff notes, develop a turnkey 

package tax product business and that Presidio was the instrument 

to do that. 

Now, Mr. Larson, was there a ‘‘Tax Advantaged Transaction 

Practice’’ at KPMG at the time that this memo was written, in July 

1997? Do you see that? There was a ‘‘Tax Advantaged Transaction 

Practice’’? 

Mr. LARSON. I do. There may have been an informal group that 

used that acronym, but I am not certain. 

Senator LEVIN. Well, you were there, weren’t you? 

Mr. LARSON. Yes, but I think this was written 6 or 7 years ago. 

Senator LEVIN. So you are saying that—was it called TAT? 

Mr. LARSON. KPMG loved acronyms and——

Senator LEVIN. Was it called TAT? 

Mr. LARSON. I am not sure whether I remember a TAT group, 

although I see it referred to here. 

Senator LEVIN. All right. Were you part of a Tax Advantaged 

Transaction Practice, formal or informal, at KPMG? 

Mr. LARSON. I was certainly part of a tax products—some informal groups, yes. 

Senator LEVIN. But you are not familiar with the term Tax Advantaged Transaction Practice? That is not something you remember participating in at KPMG? 

Mr. LARSON. I was personally assigned to the international tax 

services group during virtually my entire career. 

Senator LEVIN. Was there also this informal or formal group 

called Tax Advantaged Transaction Practice that you were part of? 

Mr. LARSON. I may have seen this acronym or name before or 

not. I don’t really recall. 

Senator LEVIN. All right. Were you part of the effort to complete 

the FLIP tax opinion before you left KPMG to go with Presidio? 

Mr. LARSON. I was one of the people that worked on the initial 

opinion, yes. 

Senator LEVIN. Was FLIP designed primarily for tax reduction? 

Mr. LARSON. I would say the FLIP was designed with two purposes in mind, one for the significant expected tax benefits, and 

second, to make money, for the investment possibility. 

Senator LEVIN. And was that true with other products, including 

BLIPS? 

Mr. LARSON. Yes, that was. 

Senator LEVIN. The question then becomes as to whether the primary purpose was the tax loss that was created or the possibility, 

which was indicated as remote, of making a profit, and that becomes, of course, the whole issue. 

121

1See Exhibit No. 1a. which appears in the Appendix on page 371. 

Now, take a look at page three of that Exhibit 137. ‘‘Logically,’’ 

Mr. Pfaff wrote, ‘‘we would simply issue an edict that any client 

with an imminent gain of a threshold amount,’’ large enough, in 

other words, ‘‘should contact the Tax Advantaged Transaction Practice. However,’’ he wrote, ‘‘after reading this case called Colgate 

Palmolive, it appears that we cannot openly market tax results of 

an investment. Rather, our clients should be made aware of investment opportunities that are imbued with both commercial reality 

and favorable tax results. Conversely, we cannot offer investments 

without running afoul of a myriad of firm and security rules. Ultimately, it was this dilemma that led me to the conclusion that I 

was in the wrong industry to play the role I enjoy the most, and 

hence, the firm’s need to align with the likes of a Presidio.’’

Now, this clearly shows that Mr. Pfaff and others at KPMG knew 

they were marketing tax advantaged products, that key court cases 

said that you can’t market tax shelters as such, so KPMG had to 

create a facade of investment around the tax advantaged products. 

And the investments that were part of these products were backfitted, then, into the transactions after the tax schemes were 

worked out, simply to try to make it look like there was an investment purpose to them. 

Now, if you take a look at Exhibit 137 from Mr. Pfaff, again, your 

partner, which you received a copy of, he talked about approaching 

only clients who had an ‘‘imminent gain.’’ Now, if this is an investment strategy, why would you limit it to approaching clients that 

were confronting a gain? If its purpose, any significant purpose, 

was to make a profit, why wouldn’t you approach folks who would 

want to make a profit? 

Mr. LARSON. I would say that that is consistent with the dual 

purpose of the transaction in that since we understood that one of 

the valuable aspects of this product was the hoped-for tax benefits, 

it would make sense that logical people to talk to about the combined package would be those who might be receptive to tax planning. 

Senator LEVIN. But making a profit would run the other direction. Then they would have to be sold another tax product to create 

a tax loss. 

Mr. LARSON. I think that the two can certainly be reconciled, but 

you are correct that to the extent that you make a profit on one 

of these transactions, then your tax benefit shrinks, so I agree with 

that. 

Senator LEVIN. You had two cross-purposes here. 

Mr. LARSON. To a degree. 

Senator LEVIN. Now, let us look at the financing of the BLIPS 

deals. This is Exhibit 1Aa.,1 but there is a chart which I think we 

can put on here, page 7, that contains a typical BLIPS deal. You 

were the principal marketer of BLIPS, is that not correct? 

Mr. LARSON. I am sorry, which exhibit? 

Senator LEVIN. That is Exhibit 1a., page 7. 

Mr. LARSON. Excuse me. 

Senator LEVIN. Do I have that right? Is that the right number? 

Chairman COLEMAN. It is in the white book. 

122

1See Exhibit No. 67 which appears in the Appendix on page 632. 

Senator LEVIN. I am sorry, yes, in the white book. 

Mr. LARSON. I don’t think the pages are numbered, so I am not 

sure what page you are on. 

Senator LEVIN. Well, just go through them and——

Mr. LARSON. Yes. I see. 

Senator LEVIN. Now, you were a principal marketer of BLIPS, is 

that not correct? 

Mr. LARSON. I was. 

Senator LEVIN. Now, why was it that the loan was initially taken 

out by the taxpayer? This so-called loan, this purported loan was 

initially taken out by the taxpayer and almost immediately assigned to this other entity. Why was the loan just not made to the 

investment group directly? 

Mr. LARSON. I think it could have been. 

Senator LEVIN. Well, the tax advantages would have been lost, 

wouldn’t they? 

Mr. LARSON. Certainly one way of structuring this for the tax advantage was to have the loan drawn down the way it was outside 

the partnership. 

Senator LEVIN. But if the loan were made directly to the partnership instead of to the taxpayer, there wouldn’t have been the tax 

benefit, right? There wouldn’t have been that premium. 

Mr. LARSON. That is correct. 

Senator LEVIN. OK. So it had to go that way. Now, that is for 

tax reasons. The taxpayer’s capital contribution was 7 percent of 

the loss that was planned to be generated by the BLIPS transaction, is that correct? 

Mr. LARSON. That was normally the case. 

Senator LEVIN. And if you look at Exhibit 67,1 this is a page from 

the Deutsche Bank PowerPoint presentation on the BLIPS program. If you look at the last three lines on that page, it reads as 

follows. ‘‘Seven-point-seven percent of the premium amount will be 

held in full by Deutsche Bank until the LLC account is closed and 

the Deutsche Bank has a legal claim on that amount in the credit 

agreement.’’ Then it says the following. ‘‘The 7.7 percent will cover 

market risks, transaction costs, and DBSI fees.’’

I think that is fairly clear. So the 7.7 percent put in by the taxpayer in Presidio was the amount set aside and held by Deutsche 

Bank to cover the risks associated with any currency trades, transaction costs, and Deutsche Bank fees. Now, would you not agree 

that within that 60-day period that the risk was limited to the capital funds put up by the investor? 

Mr. LARSON. Not exactly, no. 

Senator LEVIN. Was it true what you told our staff on October 

3, that the intent was that the maximum amount put at risk was 

the cash that the investor had contributed? Was that the intent? 

Mr. LARSON. That was the expectation, but what I also told the 

staff, and I would say here now, is that there was always the possibility which we in the banks were aware of that something could 

go wrong and that there could be a catastrophic trading loss on the 

FX positions in excess of that amount. 

123

Senator LEVIN. In the absence of a catastrophe, that was the intention. Did that ever happen, that catastrophe? 

Mr. LARSON. It did not. 

Senator LEVIN. And in the case of every BLIPS transaction, the 

loss was no more than the amount that was put up by the taxpayer, is that correct? 

Mr. LARSON. That is correct. 

Senator LEVIN. My time is up. Are we going to have another 

round? 

Chairman COLEMAN. Thank you, Senator Levin. 

Mr. Greenstein, according to your statement, Quadra is an investment advisor in clients referred to you by KPMG? 

Mr. GREENSTEIN. Pardon me? 

Chairman COLEMAN. Clients referred to you by KPMG in connection with the transactions known as FLIP and OPIS, is that correct? 

Mr. GREENSTEIN. They were referred, and in many cases, KPMG 

was their financial advisor based on a power of attorney that the 

client had executed. 

Chairman COLEMAN. It is very clear that advisors cannot be involved in abusive tax shelters, you understood that? There is no 

question about that? 

Mr. GREENSTEIN. Yes. 

Chairman COLEMAN. You have KPMG advising a client, issuing 

opinions, and you are relying on those. Did Quadra ever take any 

steps to have an independent, uninterested account review the 

transactions to ensure that you were not engaging in anything that 

ran afoul of the tax laws? 

Mr. GREENSTEIN. At that point, we knew of multiple unrelated 

premier tax advisory groups, both two accountants and two nationally recognized law firms, that had concluded the same tax issue, 

and at that point in time, KPMG and Pricewaterhouse Coopers, 

had tens—potentially tens of thousands of tax professionals and we 

respected the opinion and the work that they did, and there was 

no need for us to look elsewhere. 

Chairman COLEMAN. What is your understanding of the requirement that a promoter of a tax shelter register such transactions 

with the IRS? 

Mr. GREENSTEIN. My understanding is very limited, and on that 

issue, we deferred aggressively to the tax advisor, be it KPMG or 

Pricewaterhouse, for their conclusion on the matter. 

Chairman COLEMAN. Did you consider yourself to be a promoter 

of FLIP and OPIS under your understanding of the term? 

Mr. GREENSTEIN. I don’t understand the legal definition of the 

term, and I know there is one. We were certainly involved on certain marketing aspects, but I would say we were not the primary 

promoter. 

Chairman COLEMAN. You were involved in marketing? 

Mr. GREENSTEIN. We were involved in describing the investment 

and structural aspects, yes. 

Chairman COLEMAN. Now, for some or all of the FLIP and OPIS 

transactions that you engaged in with Pricewaterhouse Coopers, I 

think you indicated that you registered those transactions, is that 

correct? 

124

Mr. GREENSTEIN. I believe that to be the case, yes. 

Chairman COLEMAN. But it is my understanding that for the 

same transactions that Quadra engaged in with KPMG, Quadra 

did not register those transactions. 

Mr. GREENSTEIN. That is correct, under the guidance of KPMG. 

Chairman COLEMAN. Did you ever talk to KPMG and say, hey, 

we are doing it for Pricewaterhouse, why not you? 

Mr. GREENSTEIN. We did, yes. 

Chairman COLEMAN. And the response? 

Mr. GREENSTEIN. We have done our analysis and it is our opinion 

that it does not need to be registered and we will not be registering 

it, they told us. 

Chairman COLEMAN. You weren’t uncomfortable with that? 

Mr. GREENSTEIN. We weren’t uncomfortable because it was common certainly in the investment world for two well-respected organizations to reach different conclusions on the same matter, and we 

had respect for the work that they did in this regard. 

Chairman COLEMAN. You know by not registering them, you are 

not bringing it to the attention of the IRS, right? 

Mr. GREENSTEIN. I was aware of that, and again, I would stress 

how seriously we took the issue, because when PWC told us to register, we did register immediately. 

Chairman COLEMAN. But felt you didn’t have to do it with KPMG 

because they told you that they didn’t want to do it? 

Mr. GREENSTEIN. They told us that they concluded it did not 

need to be registered as a tax shelter. 

Chairman COLEMAN. Are you still involved in tax shelter transactions now, and that would be under, what is it, Quellos, because 

Quadra is no longer in existence? 

Mr. GREENSTEIN. We always focus on maximizing a client’s aftertax investment objectives, so in some cases, a simple shelter could 

be using municipal bonds. So that term, broadly defined, we are always trying to do that. But in terms of the types of strategies that 

we are talking about here today, no, we are not involved. 

Chairman COLEMAN. Help me understand. I have to say, with 

Presidio, it is very clear. They knew BLIPS was a 60-day transaction. It was very clear what the purpose was. I don’t have the 

paper trail, I must say, Mr. Greenstein, with you, but I have got 

to believe at the time you were doing this, was there any red light 

that went on? Pricewaterhouse says register and KPMG says don’t 

register. Isn’t there any red light that went on and said, hey, we 

may be involved in something here that is just not right? 

Mr. GREENSTEIN. Again, from our perspective, it was not uncommon for two well-respected firms, after thorough research, to come 

to different conclusions and we would see that all the time in the 

investment world where one well-respected group might say a stock 

is going up and someone else is saying it is going down, looking at 

the same facts. So no, it was not unusual to receive different opinions. 

Chairman COLEMAN. Senator Levin. 

Senator LEVIN. Mr. Larson, I think you have already testified 

that none of the BLIPS taxpayers, the folks who bought BLIPS, 

made a profit, is that correct? 

Mr. LARSON. That is correct. 

125

1See Exhibit No. 121 which appears in the Appendix on page 2701. 

Senator LEVIN. Is it then true that it was unlikely, based on that 

experience, that investors would earn a pre-tax profit? 

Mr. LARSON. Based on our expectation and observation of the foreign currency markets, and in particular the situation in 1999 with 

Argentina, we were expecting a devaluation of the Argentina peso 

at any time and, hence, it was our expectation that very significant 

profits would be forthcoming. Did we know exactly when Argentina 

was going to devalue? No, we did not, although within about 12 

months, after additional support by the International Monetary 

Fund eventually failed, Argentina did, in fact, devalue. But we 

were a little ahead of ourselves. 

Senator LEVIN. So that taxpayers who bought BLIPS—taxpayer 

after taxpayer after taxpayer—how many were there? 

Mr. LARSON. I believe we did about 65——

Senator LEVIN. Sixty-five——

Mr. LARSON [continuing]. Or 70. 

Senator LEVIN. And every single one of them did not get a profit 

on the investment. They all made out as they should not have 

made out in terms of the tax loss, that they made huge gains in 

terms of their tax losses. But in terms of that investment of that 

7 percent, over 60 in a row did not make a profit, right? 

Mr. LARSON. Many of those were going on simultaneously. 

Senator LEVIN. But 60 of them did not make a profit? 

Mr. LARSON. That is correct. 

Senator LEVIN. And yet you represented that there was still the 

reasonable opportunity to make a profit? 

Mr. LARSON. Yes, we did. 

Senator LEVIN. Now finally, in terms of your fee, Exhibit 121 1

has at the bottom an e-mail from Kerry Bratton at Presidio. The 

title of the e-mail message here is, ‘‘Regarding BLIPS, seven percent.’’ And as her message states—is Kerry Bratton a man or a 

woman? 

Mr. LARSON. She is a she. 

Senator LEVIN. As her message states, the e-mail shows how in 

a typical BLIPS deal the 7 percent put in by the taxpayer gets divided up, and here is what the typical deal does. Ten percent of the 

taxpayer’s money, 0.7 percent, in other words, went to currency 

trading losses. Most of the 7 percent, as a matter of fact, 5.5 percent of the 7 percent, went to the fees—your fees, the bank’s fees, 

KPMG’s fees. So only a small part of the taxpayer’s funds went to 

the currency transactions, is that correct, went to pay the losses on 

the currency transactions? Most of that 7 percent went for fees? 

Mr. LARSON. In her example, yes. 

Senator LEVIN. Not in her example, typically. They were typical. 

Mr. LARSON. Yes. 

Senator LEVIN. OK. So that was the typical breakdown of the 7 

percent? Was she right? 

Mr. LARSON. Actually, I think she left out the financing cost on 

the loan. 

Senator LEVIN. Well, it says here the breakout for a typical deal 

is as follows. Do you see that in the middle of that page——

Mr. LARSON. I do. 

126

Senator LEVIN. OK. Was this a typical breakout? 

Mr. LARSON. I would say yes. 

Senator LEVIN. OK. Now, the bottom line, then, is this, that the 

greater the loss, the greater the fees that you would receive, is that 

true? 

Mr. LARSON. Correct. 

Senator LEVIN. Your fee wasn’t part of the profit. It wasn’t based 

on profit. 

Mr. LARSON. Actually, excuse me. Greater—which loss, the tax 

loss or——

Senator LEVIN. Yes. Is that right? The greater the loss that this 

taxpayer had in this deal, this paper loss, the greater your fee, is 

that correct? 

Mr. LARSON. I think our—the advisory fee, I believe was charged 

as a percentage of the assets under management inside the strategic investment funds. 

Senator LEVIN. And that typically was the premium? 

Mr. LARSON. Yes, correct. 

Senator LEVIN. All right. And that premium was the same as the 

loss, is that correct, to the taxpayer? 

Mr. LARSON. It would be close——

Senator LEVIN. Close enough? 

Mr. LARSON. Yes. 

Senator LEVIN. And the greater that loss would be, the greater 

your premium would be, the greater your fee would be, is that not 

correct? 

Mr. LARSON. That is correct. 

Senator LEVIN. Your fee was not based on profit from an investment, is that correct? 

Mr. LARSON. That is correct. 

Senator LEVIN. Your fee was based on what that loss would be 

to the taxpayer, is that correct? 

Mr. LARSON. Correct. 

Senator LEVIN. And the greater the loss, the greater your fee? 

Mr. LARSON. I agree. 

Senator LEVIN. If anything demonstrates the purpose of this 

whole transaction simply—I think all these other documents prove 

it as well—but it is that the whole structure of the fees that went 

to the folks who cooked up this tax transaction was that the tax 

loss which the taxpayer achieved would determine the fee, and the 

greater the loss, the greater your fee. That, it seems to me, dramatizes what this is all about. 

I am not going to ask you to respond because I think you would 

probably give me some rhetoric about profit was possible and there 

was always a possibility that something would happen. But just 

strip away all of the gobbledy-gook and just take a look at how the 

fees of the folks who designed this tax shelter were achieved, and 

the fees were based on the loss to the taxpayer and the fees increased as the losses increased. They weren’t related to the profit 

for obvious reasons. There were no profits. None were expected. In 

fact, if it were based on profits, there wouldn’t have been any fees. 

I just have one more question of Mr. Greenstein, Mr. Chairman. 

I don’t know if you want to——

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1See Exhibit No. 135 which appears in the Appendix on page 2729. 

Chairman COLEMAN. No, we are not going to have another 

round. I was going to make a comment, and I would give you an 

opportunity to make the last comment, the last question, Senator. 

I just wanted to make sure—I never did too well in math and I just 

want to make sure we understand this, because we have talked a 

lot about the taxpayer didn’t make a profit and generated a loss, 

and so if you are short-selling Argentine pesos and there isn’t a catastrophe, in fact, none of these taxpayers made a profit. They 

made a loss. 

But the loss we are talking about here is not the loss in the 

transactions about pesos. The loss is when you set this deal up, if 

you got a $50 million loan, you got a $20 million premium. The loss 

is the loss you are going to write off when you cash out after 60 

days of $20 million. So I don’t want to be confused then, right. The 

loss is not the loss that the transaction—your fee is not a percentage of what was lost in the Argentina peso transaction. Your fee 

is a percentage of what the taxpayer was able to write off, is that 

correct? 

Senator LEVIN. Is that a yes? 

Chairman COLEMAN. Is that a yes? 

Mr. LARSON. Yes. 

Chairman COLEMAN. Senator Levin. 

Senator LEVIN. Just one question, Mr. Greenstein. I don’t have 

the exhibit handy. Perhaps my staff can get it. But you basically 

were told, were you not, by KPMG that whether or not you registered the FLIP was your decision? 

Mr. GREENSTEIN. They did mention that to us and we deferred 

again to their decision, viewing them as the primary promoter, that 

if they decided that it did not need to be registered for themselves 

that we would go with that assessment. 

Senator LEVIN. And then you wrote them in Exhibit 135,1 I believe, on the last page—excuse me, they wrote you. Gregg Ritchie 

wrote you that the analysis of the tax shelter registration requirements which may be applicable to Quadra must be made by your 

firm in conjunction with your own tax counsel. You didn’t do that, 

did you? 

Mr. GREENSTEIN. We did not, and I think this letter was—they 

had communicated other things to us different than what this letter said and I think this was to absolve them of any liability that 

they may have for our decision. 

Senator LEVIN. Do you know what CYA means? 

Mr. GREENSTEIN. Yes, sir. [Laughter.] 

Senator LEVIN. Was this a CYA letter, in your judgment? 

Mr. GREENSTEIN. I believe it was. 

Senator LEVIN. Thank you, Mr. Chairman. 

Chairman COLEMAN. Thank you. The witnesses are excused. 

I would now like to welcome our last panel to today’s important 

hearing: The Honorable Mark Everson, Commissioner at the Internal Revenue Service; William McDonough, Chairman of the Public 

Company Accounting Oversight Board; and Richard Spillenkothen, 

Director of Banking Supervision and Regulation of the Federal ReVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00151 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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1The prepared statement of Mr. Everson with an attached chart appears in the Appendix on 

page 338. 2 Chart entitled ‘‘Son of Boss Promoter Relationships’’ attached to Commissioner Everson’s 

prepared statement which appears in the Appendix on page 348. 

serve. I thank each of you for your attendance at today’s hearing 

and look forward to hearing your testimony. 

Before we begin, pursuant to Rule 6, all witnesses who testify before the Subcommittee are required to be sworn. At this time, I 

would ask you to please stand and raise your right hand. 

Do you swear that the testimony you give before the Subcommittee will be the truth, the whole truth, and nothing but the 

truth, so help you, God? 

Mr. EVERSON. I do. 

Mr. MCDONOUGH. I do. 

Mr. SPILLENKOTHEN. I do. 

Chairman COLEMAN. As you would have heard from the earlier 

panels, we would like all statements to be 5 minutes. Your entire 

written statement will be entered as part of the permanent record. 

Mr. Everson, we will have you go first this morning, followed by 

Mr. McDonough, and finish up with Mr. Spillenkothen. After we 

have heard all your testimony, we will proceed to questions. You 

may proceed, Mr. Everson. 

TESTIMONY OF MARK EVERSON,1 COMMISSIONER, INTERNAL 

REVENUE SERVICE, WASHINGTON, DC 

Mr. EVERSON. Thank you. Good morning, Mr. Chairman and 

Senator Levin. I commend you for your interest in this important 

subject of abusive tax shelters. 

Abusive tax avoidance transactions have a corrosive influence on 

our tax administration system and the very rule of law itself. Senator Grassley recently noted, ‘‘The IRS should be able to enforce 

the tax code and respect taxpayer rights at the same time. We can’t 

have people abusing the tax code and we can’t have the IRS abusing taxpayers. It is as simple as that.’’

I agree. The IRS must demonstrate and execute a balanced 

approach of service and enforcement if taxpayers are to remain 

faithful to our system of self-assessment, and we can’t allow manipulation of the tax system through abusive shelters to undermine 

taxpayers’ faith that if they pay their share of taxes, others will, 

as well. 

I would like to mention four factors which I believe have contributed to the proliferation of abusive tax shelters and are depicted 

on that chart.2

First, the complexity of the tax code. Abusive tax avoidance 

transactions are designed to take advantage of the complexity of 

the tax code to obtain benefits that Congress never intended. Complexity becomes the shelter promoters’ camouflage. Promoters hope 

that both the taxpayer and the IRS will be confused by a shelter’s 

complexity, while the transaction’s apparent viability is bolstered 

by legal opinions secured from reputable law firms. 

To address this complexity, the Treasury Department and the 

IRS have significantly increased and accelerated the issuance of 

published guidance concerning potentially abusive transactions and 

the IRS has vigorously pursued compliance with the promoter regVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00152 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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istration, list maintenance, and disclosure rules. These measures 

complement our increased examinations of tax shelters in taxpayer 

returns. 

Second, the cozy relationship among sophisticated promoters. 

You have identified the relationships that exist among the various 

promoters and facilitators who peddle abusive tax transactions. I 

would like to draw your attention to this chart, which depicts promoter relationships for just one type of transaction, in this case, 

the Son of Boss. 

The chart shows the reinforcing network of commercial interests 

that design, develop, and market these sophisticated products, including investment advisors, CPA firms, law firms, banks, and brokers. At the bottom, the chart indicates the linkages of these players to other tax shelter products of concern to the IRS. 

The IRS is currently investigating over 100 promoters, including 

accounting firms, law firms, and financial institutions. Most have 

complied with our request for documents, but some have not, so in 

the last 6 months, the Department of Justice has filed summons 

enforcement actions against six of these promoters, including accounting firms and, for the first time, law firms. In addition, we 

are auditing thousands of individuals and corporations who have 

entered into questionable transactions. 

Third, the erosion in professional ethics. At my confirmation 

hearing last March, I stated that attorneys and accountants should 

be the pillars of our system of taxation, not the architects of its circumvention. Based on what I have seen while on the job since May 

and what you have uncovered in your own investigation, I believe 

as strongly as ever in that statement. 

As you have learned some organizations have decided to turn 

away from the promotion of abusive tax shelters, have reached 

agreements with the IRS, and are moving on. That is good news. 

I believe it reflects a reassessment by these firms and an improvement in their professional ethics. Others, such as KPMG and Jenkens and Gilchrist, remain in litigation with the IRS and have not 

yet complied with our legitimate document requests. 

Fourth, nominal penalties undermine the regulation of abusive 

transactions. The penalties that are currently on the books with respect to the promotion of abusive tax transactions constitute a 

nominal cost of doing business to organizations determined to generate large fees by promoting abusive tax avoidance transactions. 

De minimis penalties are no more than a speed bump on a singleminded road to professional riches. 

Legislative proposals were announced in March 2002 to establish 

meaningful penalties for failure to comply with the promoter registration, disclosure, and list maintenance requirements of the 

code. We need significantly increased penalties to hit the promoters 

who don’t get the message where it counts, in their wallets. 

Mr. Chairman, I want to assure you and Senator Levin that the 

problem of abusive tax transactions is and will remain a high priority for the IRS. Thank you. 

Chairman COLEMAN. Thank you very much, Commissioner. 

Chairman McDonough. 

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1The prepared statement of Mr. McDonough appears in the Appendix on page 349. 

TESTIMONY OF WILLIAM J. McDONOUGH,1 CHAIRMAN, PUBLIC 

COMPANY ACCOUNTING OVERSIGHT BOARD, WASHINGTON, 

DC 

Mr. MCDONOUGH. Chairman Coleman, Ranking Member Senator 

Levin, and Members of the Subcommittee, I am pleased to appear 

before you today on behalf of the Public Company Accounting Oversight Board, and I would like to begin by commending the Subcommittee’s investigation of the role of professional firms, including 

accounting firms, in the development and marketing of abusive tax 

shelters. Indeed, the evidence you have accumulated has served as 

a wake-up call that we all, whether corporate leader, legislator, or 

regulator, must heed. 

The financial scandals at Enron, Adelphia, WorldCom, HealthSouth, and elsewhere left the impression that public company financial reporting is not to be trusted and that professional advisors, including investment bankers, lawyers, and even a company’s 

independent auditors, will help unscrupulous executives cook the 

books. 

Congress responded to that breach of trust by enacting the Sarbanes-Oxley Act of 2002. That Act established the PCAOB and 

charged it with ‘‘oversee[ing] the audit of public companies that are 

subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interest in the 

preparation of informative, accurate, and independent audit reports.’’

To carry out that charge, the Act gives the Board significant 

powers over the practice of auditing the financial statements of 

public companies, including: To register public accounting firms 

that audit public companies; to inspect the audits and quality controls of such firms; to conduct investigations and disciplinary proceedings; and to establish auditing quality control, ethics, independence, and other standards relating to the preparation of audit 

reports or issuers. 

Now, of course, much of the tax work done by accounting firms 

falls outside of the audit-oriented focus that Congress has assigned 

to the PCAOB. Nevertheless, the PCAOB has a variety of tools that 

may help address some of the problems caused by those abusive 

tax shelters that are designed to make financial statements look 

better. 

First, the Board will be conducting a program of annual inspections of the largest registered firms’ audits of public companies’ financial statements and triennial inspections of smaller registered 

firms. In those inspections, we will conduct reviews of engagement 

work papers, which will put us in a position to identify and examine how firms audit questionable, tax-oriented transactions that 

are reflected in public companies’ financial statements. We will also 

look for auditors’ involvement in structuring such transactions for 

public company audit clients. 

Because we are only beginning our inspections program, we cannot today assess the current extent of promotion and use of corporate tax shelters and products to public company audit clients. 

We will, however, scrutinize the accounting and presentation of the 

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1The prepared statement of Mr. Spillenkothen appears in the Appendix on page 361. 

transactions that we discover through our inspections program, 

specifically through our reviews of selected audit engagements. 

In addition, by looking at auditor compensation, promotion, and 

retention, our inspections will identify a firm’s policies and practices that create incentives for firm audit personnel to promote 

such transactions to their public company clients. 

Therefore, while existing laws and regulations may not ban auditors from promoting and giving tax opinions on such transactions 

to their audit clients, both auditors and public companies should 

expect heightened scrutiny of such transactions. The prospect of 

that scrutiny may give pause to corporate management, audit committees, and auditors that may consider such transactions. 

Second, through our authority to discipline registered firms and 

associated persons, we may impose stiff penalties for failing to adequately and impartially audit such transactions undertaken by 

public companies. 

Finally, the Board has the authority to commence a standard-setting project to address at least a part of the problem. Specifically, 

the Board has authority to add to the statutory list of non-audit 

services that a registered firm may not provide to audit clients. 

Such regulation, of course, would not prohibit a registered firm 

from selling tax shelters to non-audit clients. 

The Board also has the authority to develop and impose additional auditing procedures. While ferreting out tax avoidance is not 

directly within our purview, auditors ought to follow appropriate 

standards for identifying and auditing transactions whose main 

purpose is to create the impression of enhanced earnings in the financial statements. 

Congress gave the PCAOB the responsibility and the tools to 

build a new future for auditing through independent standard setting, registration inspection, investigations, and discipline. As we 

move forward to employ those tools in the public interest, my fellow Board members and I look forward to a long and constructive 

relationship with this Subcommittee. Thank you. 

Chairman COLEMAN. Thank you, Chairman McDonough. Mr. 

Spillenkothen. 

TESTIMONY OF RICHARD SPILLENKOTHEN,1 DIRECTOR, DIVISION OF BANKING SUPERVISION AND REGULATION, THE 

FEDERAL RESERVE, WASHINGTON, DC 

Mr. SPILLENKOTHEN. I, too, thank you, Mr. Chairman, for the opportunity to testify today on the Federal Reserve’s continuing efforts to advance corporate governance, risk management, and internal controls at banking organizations. 

Numerous corporate governance and legal compliance failings 

over the last 2 years, including those delineated by this Subcommittee, highlight once again the critical need for effective risk 

management and internal controls to guide firms’, both banks’ and 

commercial firms’, business practices and activities. 

Federal Reserve staff have not reviewed the specific tax structures that I understand to be the focus of today’s hearings, and as 

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sponsible for the oversight of tax compliance by banking organizations or their customers. 

However, I appreciate the opportunity to talk to you today about 

our supervisory requirements and expectations for banks involved 

in complex transactions and about some of the steps we have taken 

to address banks’ risk management and internal control infrastructures. 

At the outset, I should point out that the primary focus of the 

Federal Reserve’s supervision is promoting an institution’s safety 

and soundness, as well as compliance with banking and consumer 

laws and regulations in a way that protects depositors, the FDIC 

insurance fund, and the rights of consumers. 

Some basic principles and expectations for banking organizations 

guide our work in assessing business activities and risks, including 

banks’ involvement in complex structured transactions. 

First, and obviously most important, banking organizations must 

obey the law. They must have policies and procedures in place to 

ensure compliance with all laws and regulations and that they are 

not knowingly facilitating illegal activities by their customers or 

business associates. Banks should not engage in borderline transactions that are likely to result in significant reputational or operational risk to the organization. 

Second, banks should perform thorough due diligence on the 

transactions or business activities that they are involved in and 

check with key legal, accounting, and tax authorities within their 

organizations, as well as independent third party experts, when appropriate. Banking organizations ordinarily should not be held legally responsible for the judgments, actions, or malfeasance of their 

customers or third party professional advisors. Such an expectation 

would require banks to assume management responsibilities outside their span of control, create potential legal liabilities that 

would compromise their ability to perform as financial intermediaries, or threaten their safety and soundness, and place additional significant cost on banking organizations. 

Finally, banking organizations must recognize that although they 

are not directly accountable for the actions of their customers or 

third party legal and accounting professionals, to the extent that 

their names or products are implicitly associated with misconduct 

by those parties, additional legal and reputational risks may arise. 

With these principles in mind and in light of recent events of the 

last couple of years, the Federal Reserve has taken steps to enhance the supervision of complex structured transactions and refine its supervisory programs. 

During the past year, we have conducted special reviews of banking organizations engaged in complex structured transactions. 

Where we have found deficiencies, we have been clear on the need 

for banks to develop effective internal controls that comprehensively assess the risks associated with legal compliance. Formal 

Enron-related supervisory enforcement actions taken publicly by 

the Federal Reserve last summer underscore the expectations of 

bank supervisors on the need for banks to address internal weaknesses relating to complex structured transactions. 

In addition to these efforts, we are working with our colleagues 

at the other bank agencies and the SEC to develop supervisory 

133

guidance on appropriate controls and risk management systems 

pertaining to complex structured transactions, including those that 

may have a tax component or dimension. During this period, we 

have increased our supervisory emphasis on the management of 

legal and reputational risks. 

We are focusing increased attention on the adequacy of new 

product approval processes, the management of large or highly 

profitable customer relationships, and controls over the use of special purpose entities. Examiners are also stepping up efforts to review corporate governance and internal control infrastructures, including board and management oversight, corporate-wide compliance activities, and internal audit functions. 

Banks appear to be responding to the lessons of recent years and 

the actions of supervisors. They are implementing better processes 

for subjecting transactions with heightened risk profiles to additional levels of scrutiny. This includes more thorough written policies and procedures, as well as processes for due diligence reviews 

by appropriate internal control functions, including accounting, 

legal, tax, prior to the execution of more complex or risky transactions. Most organizations have established new or reconstituted 

senior-level review committees and have fortified their new product 

approval processes. 

Firms have also increased staff training around the identification 

and control of legal and reputational risks. Where necessary, banks 

should continue to strengthen these systems and bank management must work to ensure that the new processes are effective over 

time. 

In closing, supervisors will continue to focus on risk management 

and control processes in order to foster safety and soundness, financial stability, and compliance with applicable laws and regulations. Supervisory activities will reinforce recent actions taken by 

banks to address weaknesses, and where necessary, supervisors 

will take appropriate corrective and enforcement action. 

Of course, no system of official oversight is failsafe and supervisors cannot detect and prevent all control or management failures. However, strong and effective supervision, including the use 

of supervisory enforcement tools, management steps to strengthen 

corporate governance, risk management, and internal control infrastructures, and the incentives provided by marketplace discipline 

can contribute to better compliance and continued improvements in 

management of legal and reputational risks. 

Chairman COLEMAN. I would ask you to summarize. 

Mr. SPILLENKOTHEN. Thank you. I am finished, Mr. Chairman, 

and I would be happy to attempt to answer any questions you 

have. 

Chairman COLEMAN. Thank you very much, Mr. Spillenkothen. 

Let me just kind of go in reverse order here. Did you have a 

chance, Mr. Spillenkothen, to listen to the testimony today? 

Mr. SPILLENKOTHEN. I did not have a chance to listen to all of 

it, Mr. Chairman. I tried to stay involved in some of it, but not all 

of it. 

Chairman COLEMAN. If I can do a very brief summary, basically 

we have a situation where banks are issuing loans for these BLIPS, 

FLIP, and OPIS transactions, issuing loans ostensibly for 7-year 

134

periods but clearly being informed that these folks are getting out 

in 60 days. There is a premium piece in the loan structure, that 

when it is then part of an investment package, of which, by the 

way, very little is at risk, when it is pulled out, the investor claims 

loss. So you have folks, in effect, putting in very little. And, by the 

way, all these bank loans are collateralized at 101 percent. 

So these are clearly tax shelters. There is no question about 

them. These are not 7-year high-interest loans, they are 60-day 

deals, in and out. And yet the banks’ basic assertion is, well, we 

are not tax experts. We relied upon the KPMGs of the world. 

Do you see any problems with that kind of operation? 

Mr. SPILLENKOTHEN. Mr. Chairman, I have not had a chance to 

look at the specifics of these transactions and so I would be reluctant to try to opine on them. 

Chairman COLEMAN. I am not asking you to opine on the transaction. I am asking you to opine on the actions of the bank. I mean, 

how much more do they have to know? 

Mr. SPILLENKOTHEN. I think banks, as I tried to say, need to 

have internal systems to make sure that they are in compliance 

with all laws, including tax laws. I think the lesson of the last couple of years, which I think many banks have learned in part 

through the assistance of this Subcommittee and other market 

events, is that banks should avoid borderline transactions or transactions that have a high probability of resulting in legal problems 

or significant reputational risk. Banks need to ensure that they 

have systems in place to comply with the law, and ensure that they 

are not facilitating illegal activities by outside third parties. 

Chairman COLEMAN. One of the kind of common denominators of 

all these transactions is that they are not registered. In some cases, 

they are limiting the scope of them. They are geographically distributing them, keeping everything below the radar. Talk to me 

about expanding reporting requirements in a way that would allow 

IRS to identify loans that are being used for questionable tax shelters. Can you talk to me about that imposing burdensome additional costs? How would you evaluate the efficacy and cost impact 

of such requirements? Mr. Spillenkothen. 

Mr. SPILLENKOTHEN. Well, I think whenever you impose additional reporting requirements, there is potential burden, but one of 

the things that you have to do when you are developing reporting 

requirements is to be able to define what you are trying to collect 

information on. You have to be able to define the activity or transactions that you are trying to collect information on. I would leave 

it to my colleagues at other agencies, the IRS, to describe and deal 

with how you would define some of these things, but a clearly important element of getting reporting is to be able to define what activities one is trying to collect information on. 

Chairman COLEMAN. Commissioner Everson, how do you react to 

the IRS being described as a toothless paper tiger? 

Mr. EVERSON. I am sure that everyone who has come before this 

Subcommittee or before the Finance Committee in the hearing several weeks ago would not agree with that characterization, given 

their current problems. But I think what you are perhaps suggesting is that there has been concern that we need to have increased tools to do our job and perhaps more resources. 

135

I will comment on both of these areas, I have mentioned the penalties. I think the penalties are central to assuring that we learn 

what is going on in this whole arena. The question you just asked 

to my colleague gets to getting information from yet another 

source. If we can just get the information from the practitioners 

and from the taxpayers themselves, I think that will be very helpful. 

In terms of the resource question, I would point out both you and 

Senator Levin have spoken to this question most recently in your 

speech in New York. We are not an agency that gets topped up in 

the appropriations process. Yet again, we are sitting with a mark 

before the Senate right now that is $245 million below the President’s request, and this is something that has happened under Republican Presidents, Democratic Presidents, Republican Congresses, and Democratic Congresses. We tend to fall short. 

This is compounded in this case, because some 70 percent of our 

costs are personnel related and the pay raise is 2 percent greater 

than was budgeted. So we are more squeezed. And if there is an 

across-the-board non-defense, non-homeland recision of a percent or 

two on discretionary spending, that will cause further problems 

that are very significant for us. 

So in this area, the first thing I would like to see is for the funding request to be honored. 

Chairman COLEMAN. I think one of the concerns in dealing with 

the IRS is always about focus. I know you have the server, the wait 

person who worried about getting audited for her tips. You have 

the small business person worried about getting audited for whatever. And we are sitting at this hearing here and we are hearing 

about, over 6 years, $80-something billion potentially lost to taxpayers and the IRS being a toothless paper tiger in regard to these 

kinds of transactions. So I would say the issue is focus and what 

the policy makers would want to say is, yes, we are going to focus 

on those things that generate maximum return for the people who 

are massively committing tax fraud. 

Mr. EVERSON. I agree with that 100 percent, and in fact, if you 

look at the request that the President made for the 2004 budget, 

he did provide for additional funds particularly in this area. The 

first priority of the budget request was to devote more enforcement 

resources to high-end taxpayers and to address these corporate 

shelters, and we are prioritizing. 

We have shifted over a lot of our resources into this area, as the 

GAO and others have noted, in tracking all of our efforts, which include, as I mentioned, accelerating guidance. It includes enhancement of audits. We have got thousands of audits working right now 

for the taxpayers, businesses, and individuals alike in this area, including criminal investigations. 

We are also extending our leverage and our reach. We have 

reached an agreement with 42 States around the country. I think 

you heard testimony from the State of California about this agreement. We are sharing information, jointly managing the caseload. 

Already, California has given us information, for instance, that 

gave us new participants in one of the shelters we are investigating. So we are really trying to provide the focus to this subject 

that you have suggested is appropriate. 

136

Chairman COLEMAN. Just for me to try to get a sense of the 

scope of this, from your perspective, there was an article, I believe, 

in American Lawyer entitled ‘‘Still in the Shadows,’’ October 1, 

2003. It says, ‘‘as of June 2002, according to the IRS, 186 people 

had avoided $4.4 billion in taxes from BLIPS transactions. Another 

57 people had avoided $1.4 billion from FLIP and OPIS.’’ Are these 

numbers accurate, to the best of your knowledge? 

Mr. EVERSON. I won’t comment on particular numbers because 

the way some of these transactions are tracked by the originator 

of the transaction are a little bit different from the way we track 

them, sir. But overall, clearly, this problem runs into the billions 

of dollars. 

The difficulty here, if you will, is that there are potentially abusive transactions, families of transactions that we have identified. 

We have already listed over two dozen of them. There are general 

criteria based on the amount of tax avoided vis-a-vis the investment, the same kinds of questions you have been asking, that also 

compel disclosure. And clearly, some of those disclosure requirements are now just coming into effect for the tax year, calendar 

year 2003. We will see a lot of that information next year. But this 

problem runs into the billions of dollars. 

Chairman COLEMAN. And there are a range of these, COBRA, 

BOSS, Son of Boss, and other things that you laid out. 

Mr. EVERSON. Yes, sir. 

Chairman COLEMAN. One other question and then I will turn it 

over to my colleague, and there will be a second round. I have 

other questions I want to get to. 

I am concerned about the finger pointing that we saw here in regard to reporting, almost as if there was some lack of clear, common definition. Ernst & Young says, or PWC says we should report 

FLIP, but KPMG doesn’t. And then the advisors say, well, we are 

advised by these big accounting firms. It just seems obvious that 

the purpose of reporting—the ethical thing, the right thing to do 

is to give you notice and then people can make judgments about 

that. But there appears to be some legal basis or question, however 

questionable, that says you don’t have to report. How do you clarify 

that to make sure it is very clear that these kind of transactions 

have to be reported? 

Mr. EVERSON. I am not sure we need to clarify it. I do believe 

we need to increase the penalties so that the guidance which is already out there and in law is taken seriously. 

Chairman COLEMAN. Switch, being the switch that you may use 

to hit somebody, that kind of switch. 

Mr. EVERSON. I hate to say it, but not everybody has approached 

this from a point of view of the first objective which is to comply 

with the law. 

Chairman COLEMAN. I appreciate that. Senator Levin. 

Senator LEVIN. Let me first join you in welcoming our witnesses, 

thanking you for your work. It is critically important, and that is 

dramatized every day, but in 2 days of hearings here by what has 

been presented, pretty shocking, disturbing, sorry testimony. 

I also would urge you, if you haven’t had a chance, to read our 

staff report. It is an extraordinary report. I think perhaps your 

staffs have already had a chance to look at it, but in any event, 

137

we would be interested in your comments on the factual material 

which is set forth in that report. Perhaps for the record, Mr. Chairman, if it is appropriate, I would ask that they give us a comment 

about what they read in that report after they or their staffs have 

had a chance to do so. 

Chairman COLEMAN. That request will be made and the answers 

will become part of the official record. 

Senator LEVIN. I thank you. 

First, Mr. Everson, the fines that you made reference to, I 

couldn’t agree with you more. The current fine structure is really 

absurd, a $1,000 fine. It is not even a slap on the wrist. It is a slap 

on the finger or a slap on a nail on the finger. It is nothing. It is 

not even a cost of doing business. It is nothing compared to the ripoff that is going on and the amount of money that is made by those 

rip-offs. 

So just looking here at Section 6700, a person who organizes or 

assists in the organization of a partnership, any investment plan, 

causes to make another person to make or furnish an arrangement 

which the person knows or has reason to know is false or fraudulent shall pay a penalty equal to $1,000. It might as well not be 

here. In fact, I would prefer it not be there. 

Mr. EVERSON. It is chump change. 

Senator LEVIN. Yes. What we have got to do is find a way to 

move in the direction that you have talked about, and I will be introducing a bill to do exactly that which will even go beyond what 

Senator Grassley and others have done, because what they do is 

take away part or all of the rip-off amount, but they don’t penalize 

people. 

So if somebody makes money they should not have made, a fee of $50 million, to say that you have to give back part of what you 

improperly got, or even all as the maximum penalty, which is what 

is in the other bill, seems to me isn’t truly a penalty. It just says, 

give part of your ill-begotten gain back to us, or pay it to the government. It seems to me there has got to be a real penalty above 

and beyond what that person got improperly if we are going to 

really have a deterrent. 

But in any event, I welcome the comment that you made, because we are going to need support to go at least as far as the 

Grassley bill and, I hope, beyond that. I happen to believe that, for 

instance, the promoter of these illegal schemes should pay the 

same as the taxpayer to whom they sold the illegal scheme, and if 

the taxpayer has to pay Uncle Sam $40 million because that is 

what they cheated Uncle Sam of, that the promoter of that tax 

scheme that resulted in that cheating pay the same amount. That 

will be a deterrent if we can go that far. That is a real deterrent. 

Again, I won’t ask you to comment on specific penalties, but I do 

hope you will take a look at these various approaches to penalties. 

Now, Commissioner Everson, let me ask you this question relative to the enforcement problems that exist. Let us assume that 

the IRS gets wind of an illegal tax shelter, one that does not comply with Federal law, and it finds out that it is being promoted by 

a certain bank, a certain accounting firm, a certain investment advisory firm. Can the IRS tell the Federal Reserve about the bank’s 

involvement? 

138

Mr. EVERSON. Senator, one of the very important premises of the 

tax code is the confidentiality of taxpayer information. We respect 

that and we think that is very important. One of the results of that 

standard is that we are precluded from sharing information with 

others unless it reaches a point where we take it over, say, to the 

Justice Department because it becomes a full-fledged criminal matter. 

Senator LEVIN. If it is a crime that there is evidence of, you can 

take it to the FBI or the Justice Department, is that correct? 

Mr. EVERSON. We have a Criminal Investigations Division. If you 

may remember, they took care of Al Capone some decades ago. 

Senator LEVIN. Right. 

Mr. EVERSON. They would do the work and then they would 

bring it over. After it is ready, it goes over to the Tax Division at 

Justice and they look at it and they make the determination, and 

we do work with other agencies, yes, exactly as we did in the 

Scruchie indictment last week in corporate governance. 

Senator LEVIN. But you cannot, for instance, share information 

about civil violations——

Mr. EVERSON. That is correct. 

Senator LEVIN [continuing]. With, for instance, the SEC relative 

to an investment advisor. You can’t do it with the Public Company 

Accounting Oversight Board relative to an accounting firm’s involvement, and you can’t do it with the Federal Reserve relative to 

a bank’s involvement, even though you think the law has been violated, is that correct? 

Mr. EVERSON. That is correct. To use one of your examples, if my 

fellow panelist, Chairman of the Public Company Accounting Oversight Board, if we are working on one of the firms, the accounting 

firms, and we have discovered or we believe that there is a pattern 

of abuse in this area, I can’t turn to Bill and say, you ought to consider this in your risk assessment and your approach as to how you 

are governing the agency. 

Likewise, we audit thousands of companies every year, and if we 

determine that 10 or 20 or whatever, some small percentage, are 

operating at the edge from a corporate governance point of view in 

the tax arena, we cannot originate a discussion with the SEC. 

I do believe that what you are putting your finger on is an important subject that merits discussion because it is a gap in the governance structure. I want to make clear, however, that I do not believe in the routine sharing of individual tax return information. 

But in the case of some of these large corporations or the firms 

that you are discussing, I believe that there is a gap there that 

should be considered to be addressed. 

Senator LEVIN. I think we would welcome any thoughts, further 

comments that you have on that subject, and the same from our 

other witnesses. It is a very important subject. I agree with you. 

You don’t want any routine sharing here or else we are going to 

lose the great benefit, it seems to me, of our tax system, which is 

that we have got the confidence of taxpayers that they can pay 

their taxes and not worry about being turned over to the SEC, generally, unless they are committing a crime, in which case they will 

be turned over to the FBI. But short of that, there is an understanding among our taxpayers that is important to maintain. On 

139

the other hand, you point out there is a gap here, which perhaps 

can be addressed in an appropriate way. 

The Federal Reserve has done a review of financial products and 

I just am wondering, who should be doing the same kind of review 

here of these tax shelters that you did of the financial products? 

It requires a review here, and I think if you have any of your staff 

that were here during this hearing or the Finance Committee hearings, I think you probably got more than a drift as to how deep and 

significant a problem that we have. 

I am just wondering, who would be the appropriate agency to do 

the same kind of review of these kind of tax shelters, the ones that 

do not have a business purpose but whose primary purpose is to 

create a tax deduction? Would that be the Federal Reserve, would 

it be the Oversight Board, or would it be the IRS, or all three of 

you, or the SEC? 

Mr. MCDONOUGH. Senator, we at the PCAOB would certainly 

think that we have a piece of the action. Anything that an accounting firm is doing vis-a-vis its audit clients, we feel would fall within 

our purview and we would be, through our inspection process, pursuing it very aggressively. 

Even in the area which is not our direct responsibility, that is, 

the activities of accounting firms with their non-audit clients, what 

we are saying to them is that their real task is to restore the faith 

of the American people in their profession, and if you are running 

a firm, well, the place to start is in restoring public confidence in 

your firm. 

What we are saying as a Board, and what I am saying as a rather outspoken Chairman of the Board, is if you really want the 

American people to restore their confidence in your profession, you 

should be very thoughtful about what kinds of products you are offering, and if it is likely to hurt the reputation of your firm or not 

rebuild the reputation of your firm, you shouldn’t be doing it, even 

if it is legal. 

Senator LEVIN. OK. Mr. Spillenkothen, can you make a commitment to us that you would work with the Accounting Board and 

with the IRS to make a thorough review of these kinds of transactions which spawn these abusive tax shelters? Could you give us 

that kind of commitment? 

Mr. SPILLENKOTHEN. Senator Levin, we have, as you indicated, 

in the last year looked at bank involvement in complex structured 

transactions, a subset of which is transactions that have a tax component. We have, in doing that, focused on the banks’ internal controls and systems for identifying risky or suspect transactions; for 

having internal checks and balances that involve review by independent tax accounting, and legal people; for escalating questionable transactions to appropriate decisionmakers, and for ensuring 

adequate documentation and controls. As I indicated in my statement, where we found some deficiencies, we have given feedback 

to organizations. We have also taken some formal enforcement actions. 

So we have endeavored to focus on the risk management and internal controls of these organizations and I think we have already 

reviewed these transactions and we have worked into our ongoing 

supervisory processes procedures to focus on complex structured 

140

transactions. So I think we have tried to do that. We are working, 

as I indicated, on additional guidance that would provide risk management guidance on structured transactions, including those that 

have a tax dimension to them. 

So we have focused on complex structured transactions. Obviously, our expertise is not taxes and our focus is on safety and 

soundness and internal controls for compliance with all laws and 

regulations. 

Chairman COLEMAN. Thank you, Mr. Spillenkothen. 

Mr. McDonough, just a few things I would like to focus on. First, 

I totally agree in this post-Enron world, restoring confidence is absolutely critical. It is critical for the economy, critical obviously just 

on a personal level, you would think, for the firms involved. The 

question is, how do we do that and how do we ensure it and what 

role? 

My question, in part, is for you. The Public Company Accounting 

Oversight Board gets set up. Principally, you are looking at the 

quality of company audits, and the issues here that affect the reputation of these companies go beyond the audits. 

Mr. MCDONOUGH. Sure. 

Chairman COLEMAN. And I think we need more hands on deck 

in order to deal with this. I would hope that you would give some 

thought to how you can play a greater role in this. You have the 

bully pulpit, and that is important. You can remind people again 

and again. But beyond that, I just think the non-audit role of accounting firms today has certainly been called into great question, 

and though we have received a number—and I was certainly 

pleased to hear the companies come forth and say, we have 

changed our practice and changed our standards and changed personnel, but is that enough? So I would just hope that you would 

give that thought. 

The other question, and I think you addressed it somewhat in 

your testimony but I would like to kind of go back over it, Senator 

Levin raised questions about the degree to which accounting firms 

should be allowed to offer tax advice to the offices and the directors 

of the companies they audit. We have got this whole issue of you 

are auditing and you are offering tax advice. Could you describe 

the Board’s current views on that subject? 

Mr. MCDONOUGH. Right. Well, as you are aware and as you have 

just said, Mr. Chairman, the accounting firms have long provided 

tax advice to their audit clients and both the Sarbanes-Oxley Act 

and what the SEC had to say in January in a rule continue to 

make that possible. 

But having said that, we will use our inspections to do as much 

as we conceivably can. We will watch for whenever firms put pressure on auditors to sell non-audit services, including tax services, 

to executives. We will get at this issue through our examination of 

auditor compensation and promotion practices, and when we find 

inappropriate influences that may have an effect on audit quality, 

we will call the firm to bear on it. 

Essentially, what we are trying to say is we want audit firms to 

reward really good, tough auditors for being good tough auditors, 

not for other stuff. If we see that they are rewarding auditors or 

141

getting a little tax advice work or anything else, we will be very 

heavy-handed in our discussions with them. 

Chairman COLEMAN. Getting back to one other of the kind of the 

non-audit functions that came into question here, and that is fee 

generated by the percentage of loss that could be written off, is 

there anything inherently questionable about that? Perhaps, Commissioner, you might want to address this. Clearly, it raised red 

flags, it should have for the banks, it should have for the advisors, 

and certainly for the accounting firms. But is there anything inherently questionable about that and how would you deal with that 

issue in the future? 

Mr. EVERSON. One of the things that the Subcommittee report, 

and I have had a chance to read at least the summary of it, correctly highlights is the revision in fee structures over time at the 

accounting firms, which I think has very much contributed to this 

decline in ethics. That is to say that instead of billing for time, they 

bill for value added. That is a change in the professional construct. 

When I started out in accounting, you had the investment banks. 

They took fees and they had a stake in the action and they took, 

in many of these transactions, commercial risk, whereas the lawyers and the accountants were compensated based on time. That 

has drifted and changed over the decades so that the incentive, if 

you will, to gain riches as a professional is to change the value creation for the client. The last witness you had, the discussion you 

were having, in this case, it is not really value creation, it is value 

destruction from the government’s interest. That is a different construct for lawyers and accountants than what it once was and I 

don’t think it is a healthy one. 

Chairman COLEMAN. Chairman McDonough, would you respond 

to that? 

Mr. MCDONOUGH. Yes. I think it is clearly completely inappropriate for such arrangements to exist between an accounting firm 

and its audit clients. You mentioned earlier that we have the bully 

pulpit to deal with the accounting firms in areas which do not involve audit clients. That is being used, if I may say so, Mr. Chairman, very broadly and very effectively. 

I was down in Atlanta, Georgia, last night talking to the Georgia 

State Society of CPAs. I am spending a lot of my time out and I 

can tell you the message is very direct and it is not very subtle. 

It is, ‘‘we will have to have the accounting profession reach a new 

standard of culture, ethics, responsibility so they regain the confidence of the American people, and they can either do it voluntarily, which is the best way, or if they don’t do it voluntarily, we 

will make them do it.’’ That is pretty direct. 

Chairman COLEMAN. I appreciate those efforts, Mr. McDonough. 

Senator Levin. 

Senator LEVIN. Thank you. Mr. McDonough, you have indicated 

you are looking at adopting a national rule prohibiting the contingent fee. Is that where you are at? 

Mr. MCDONOUGH. I believe that all of the rules necessary to prohibit contingent fees for audit clients already exist. I will do a double-check and if they don’t, you can be very sure that we will be 

looking at any new audit standard setting or rulemaking we will 

need in the area, but I think it is already there. 

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Senator LEVIN. I think most States have it, but I don’t know that 

there is a national rule. But in any event, if you could double-check 

that——

Mr. MCDONOUGH. We will do that. 

Senator LEVIN [continuing]. And your commitment that it should 

be a national prohibition is helpful. 

Mr. MCDONOUGH. Yes. 

Senator LEVIN. Now, Senators Baucus, McCain, and I have introduced S. 1767, which would ban auditors from providing tax shelter 

services to clients that they audit. I am wondering whether you 

have had a chance to examine that legislation, and if so, what your 

reaction is to it. 

Mr. MCDONOUGH. Senator, I haven’t had an opportunity to review the legislation, but based on just the brief description you 

gave of it, it seems to me that it is highly unlikely that an accounting firm could be giving an audit client tax shelter advice and not 

flunk the independence test. Independence, as you know, is an absolute requirement for an auditor to maintain in order to carry out 

his or her professional responsibilities. 

But even if permitted by the audit committee, which all tax work 

really has to be and should be, if it came into the area of actually 

recommending and advising tax shelters, I think it would be quite 

clear. We would have to look at it in the individual case, but generically, that auditor would be evaluating his or her own work 

and that would flunk the independence test. 

Senator LEVIN. That is what we are trying to get at and trying 

to prohibit—that exact activity, where the accountant is auditing 

his own product, his own work product. If you could take a look at 

that bill and give us a response to it, that would be very helpful. 

The only thing I really want to say in conclusion, if I could just 

take a minute here, Mr. Chairman, is that basically, Uncle Sam is 

getting ripped off by the promoters of sham transactions which 

produce tax deductions and tax losses as their principal goal. These 

are abusive. They are costing us perhaps $10 or $15 billion a year. 

We have had really an extraordinary staff report, and I want to 

thank my staff, and your staff has been very supportive, Mr. Chairman, and I want to thank them for that support. 

The report that we have issued is probably the most detailed report on these sham transactions that we are aware of. In any 

event, it is a very disturbing picture. I think if the average taxpayer out there could somehow or other get through these complicated machinations, that the level of disgust and abhorrence 

would be so high that you as regulators and we as legislators 

would be forced to take very strong, very urgent action against the 

people who promote these shelters. 

They are aided and abetted in that process by professionals. It 

is similar to what happened with Enron. Enron was the engine, but 

professionals, including banks, stockbrokers, and lawyers, aided 

and abetted Enron. It could not have happened without them. 

In this case, we have the aiders and abetters. We also have the 

engine here being the designers of the tax shelters who are professional people. 

So we are going to do, I hope, everything that we can do legislatively to tighten up the law on economic substance, if necessary—

143

there is a bill which does that which has passed the Senate—to 

adopt penalties, I won’t say stricter penalties because I consider 

the ones that are in existence a joke and, for all intents and purposes, nonexistent, so adopt really tough penalties and real penalties for people who aid and abet these sham transactions which 

produce these tax shelters. 

The regulatory agencies that you represent are playing a critical 

role and we need you to work together to coordinate better, to use 

your resources in a targeted way, as I think our Chairman pointed 

out. 

But we also, frankly, need the professions to help clean up their 

own act. This is a pretty shameful exposition that we have witnessed here of professional failure. If it is a true profession, the immorality that we have seen, the shocking testimony of purposeful 

deceptive transactions which have no real purpose other than to 

create a tax deduction should really shake up our professions. But 

I don’t think we can count on that, unhappily. Even if the top-level 

folks who run these professions adopt good codes of ethics and enforce them, there are still going to be those folks who will try to 

evade those codes of ethics, and for that we need regulators, and 

for that, we need tough penalties. 

I am determined to do whatever I can, and I know our Chairman 

joins me in this, to do whatever we can to put an end to the kind 

of abuses that we have seen dramatized this week. 

Thank you, Mr. Chairman. 

Chairman COLEMAN. Thank you, Senator Levin. Senator Levin, 

I want to also reiterate my commitment to doing what we need to 

do to make sure that these sham abusive transactions are a thing 

of the past. 

I do want to thank our staffs, and thank my staff for all the work 

they have done to catch up with all the work that your staff did. 

They did an extraordinary job. These are complex transactions and 

that is one of the challenges certainly the IRS has in dealing with 

them. But they are also pretty simple. I mean, you don’t need to 

be a rocket scientist to figure out if somebody made $20 million 

and somebody comes up to you and says, hey, we will get that as 

a loss and then you will not have to pay taxes, limit tax liability 

on it. The complexity is how you get from A to Z, but the concept 

is very simple. 

What struck me, Senator Levin, as I listened, where otherwise 

very bright, smart people, not just in the accounting firms but all 

the others involved who just turned a blind eye to what was so obvious, and to me, it was obvious. I think everybody knew what they 

were doing and what they did was wrong, and it is not just Uncle 

Sam that gets ripped off. It is the little guy. The fact that there 

is $85 billion less being paid into the government coffers over 6 

years means that those folks who are paying the taxes, doing the 

right thing, working hard, they are the ones who are really suffering and we have got to make sure that doesn’t happen. 

You have a lot of responsibility. You have a lot of challenges. We 

will certainly work with you and support your efforts. Clearly, I 

look forward to working with you, Senator Levin, on your legislation and some of the recommendations proposed by the Commissioner. 

144

1The prepared statement of Mr. Lopez appears in the Appendix as Exhibit No. 153 on page 

3016. 

Hopefully, what we saw was a thing of the past. I think we have 

a responsibility to make sure it doesn’t happen again. I fear that, 

in part, we are nowhere out of the high-flying 1990’s. We are not 

generating just barrels of cash anymore from all these transactions, 

and in part, that may be why the activity has slowed up. I do accept the statements from the firms involved they have changed 

their ways, but the climate is different. 

I just want to make sure that—and I hope we get back to the 

economy rolling. I don’t want to get back to the ethical standards 

or the lack thereof, but when we get back to the economy rolling, 

I just want to make sure that if that should happen, that we don’t 

face the same problems. That is our challenge and we will do everything we can to make sure it doesn’t happen and still do the 

things we can to promote growth and promote economy and promote opportunity in this country. 

Before adjourning, I would like to add for the record a written 

statement submitted by Tom Lopez, the Chief Investment Officer 

with the Fire and Police Pension System of Los Angeles.1

With that, this hearing is adjourned. 

[Whereupon, at 1:10 p.m., the Subcommittee was adjourned.] 

(145)

A P P E N D I X

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, 

146

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 

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1Letter 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 ¶ 37. 

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. 

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 

148

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 

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3See, 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.’’). 5See Appendix A for a more detailed explanation of BLIPS. 

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 

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6FLIP 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). 7See, 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). 8The formal title of the tax product is the S-Corporation Charitable Contribution Strategy. 

9See 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 SCAEPS references with something much more benign’’). 11See 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.’’

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

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

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. 

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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 

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12Slapshot 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). 

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. 

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 

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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 docuVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00177 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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13 26 U.S.C. 6701. 

ments 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’’ abovemarket 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. 

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, inVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00178 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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14See ‘‘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. 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. 

cluding 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. 

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. 

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 

156

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 pretax 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. 

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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, deVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00181 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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scribed 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 

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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 

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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 secVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00184 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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tor 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 

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18See, e.g., 26 U.S.C. §§ 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. 20 26 U.S.C. § 6700. 21 26 U.S.C. § 6701. 22See, e.g., 26 U.S.C. §§ 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). 23See, e.g., Treas. Reg. Sec. 301.6112–1 and Sec. 1.6011–4, which took effect on 2/28/03. 

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

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

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 

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24Petition 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 ¶ 8. 25 Id. at ¶ 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. 26Petition 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 ¶¶ 11–12. 27 Id. at ¶ 16. 28See, 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.’’). 29See, 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.’’) 30See, 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.’’) 31See, 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). 32See, 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.’’). 

ter 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. 

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 

164

33 Joint Committee on Taxation report at 7. 34See, e.g., S. 476, the CARE Act of 2003 (108th Congress, first session), section 701 et seq. 35GAO Testimony at 12. 36 Id. at 11. 37 Id. at 10. 38 Id. at 11. 39 Id. at 16. 40Testimony 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. 

‘‘[t]hese doctrines are not entirely distinguishable’’ and have been 

applied by courts in inconsistent ways.33

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

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

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

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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41 Id. at 2. 42 Id. at 3. 43 Id. at 8. 44 Id. at 16.

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

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. 

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

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 

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45The 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. 46The 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). 

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. 

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. 

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 

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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. 48Minutes dated 11/30/00, Monetization Solutions Task Force Teleconference, Bates KPMG 

0050624–29, at 50625. 49Document dated 5/18/01, ‘‘PFP Practice Reorganization Innovative Strategies Business 

Plan—DRAFT,’’ Bates KPMG 0050620–23, at 1. 50Stratecon 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). 51For information about this tax product, see Appendix C, ‘‘Sham Mutual Fund Investigation.’’

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. 

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

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 vaVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00191 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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52KPMG’s policy is included in the KPMG Tax Services Manual—U.S., May 2002, KPMG 

Accounting & Reporting Publication, (hereinafter ‘‘KPMG Tax Services Manual’’), § 24.5.2, at 24–

3. 53 Brief summaries of some of these matters are included in Appendix C. 54See United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 9/6/02), ‘‘Answer to Petition to 

Enforce Internal Revenue Summonses,’’ at ¶ 1 (‘‘KPMG asserts that it is not a tax shelter organizer, but a professional firm whose tax professionals provide advice and counseling on a oneon-one basis to clients and prospective clients concerning the clients’ tax situations.’’) 

nilla,’’ 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

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. 

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. 

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 appliVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00192 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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55KPMG Tax Services Manual, § 24.1.1, at 24–1. 56 Untitled document, produced by KPMG on 2/10/03, Bates KPMG 0000009–91. 57See 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. 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.’’ 60These tax products included OTHELLO, TEMPEST, RIPSS, and California REIT. 61 United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), ‘‘Petition to Enforce Internal 

Revenue Service Summonses.’’ 62 Id.

cable 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

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. 

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. 

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 conVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00193 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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63 United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 7/9/02), ‘‘Declaration of Michael A. 

Halpert,’’ Internal Revenue Agent, at ¶ 38. 64See, 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). 65Memorandum 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. 

tinues to develop and aggressively market dozens of possibly abusive tax shelters.’’ 63

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. 

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: 

‘‘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

171

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 reVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00195 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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66See, 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.) 67Lawrence 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). 68See email dated 11/1/98, from Larry DeLap to William Albaugh and other KPMG tax professionals, ‘‘OPIS,’’ Bates KPMG 0035702. 

quirement, 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. 

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 

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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. 70 ‘‘TIC Solution Development Process,’’ TIC Manual at 6. 71KPMG presentation dated 5/30/01, ‘‘Tax Innovation Center Solution and Idea Development—Year-End Results,’’ Bates XX 001755–56, at 4. 

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

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.’’ 

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.’’ 

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 sysVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00197 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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72KPMG Tax Services Manual, Chapter 24, pages 24–1 to 24–7. 73TIC Manual at 5. 74The 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. 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). 76KPMG Tax Services Manual, § 24.4.1, at 24–2. 

tems 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. 

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. 

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 

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77 Id., § 24.5.2, at 24–3. 78Subcommittee 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. 79KPMG Tax Services Manual, § 24.5.2, at 24–3. 80 Id., § 41.19.1, at 41–10. 81 Id., § 24.4.2, at 24–2. See also TIC Manual at 10. 

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

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 multimillion-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. 

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’’ 

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82TIC Manual at 10. 83KPMG Tax Services Manual, § 41.17.1, at 41–8. 84 Id., § 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. 

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. 

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. 

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. 

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85See Appendix A for more information about BLIPS. 86 IRS Notice 2000–44 (2000–36 IRB 255) (9/5/00). 87 Email dated 2/9/99, from Jeffrey Eischeid to John Lanning, Doug Ammerman, Mark Watson 

and Larry DeLap, ‘‘BLIPS,’’ Bates MTW 0001. 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.’’) 89 Email dated 2/15/99, from Mark Watson to multiple KPMG tax professionals, ‘‘BLIPS 

Progress Report,’’ Bates MTW 0004. 

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. 

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: 

‘‘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

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

178

90 ‘‘Meeting Summary’’ for meeting held on 2/19/99, Bates MTW 0009. 91Subcommittee interview of Mark Watson (11/4/03). 

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-likelythan-not opinion on BLIPS. 

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-likelythan-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. . . . 

179

92 Email dated 5/4/99, from Mark Watson to Larry DeLap, Bates KPMG 0011916. 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. 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. 96 Email dated 5/8/99, from John Lanning to four KPMG tax professionals, Bates KPMG 

0011905. 

‘‘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

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

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

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

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 

180

97 Email exchange dated 5/9/99, between Richard Smith and Steven Rosenthal, Bates SMR 

0025 and SMR 0027. 98 Email dated 5/10/99, from Philip Wiesner to multiple WNT tax professionals, Bates MTW 

0031.

likely than not’ to be realized?’’ The technical reviewer responded: 

‘‘Yes.’’ 97

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

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 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 recVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00204 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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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’’). 100 Email dated 5/10/99, from Jeffrey Stein to Philip Weisner and others, Bates KPMG 

0011903. 101 Email dated 5/10/99, from Mark Watson to John Lanning and others, ‘‘FW: BLIPS,’’ Bates 

MTW 0039 (Emphasis in original.). 102 Email dated 5/10/99, from Philip Wiesner to multiple KPMG tax professionals, Bates 

KPMG 0009344.

ommendation 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

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

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

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

After receiving this email, the DPP head sent an email to the 

WNT PFP technical reviewer asking whether he would be comVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00205 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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103 Email dated 5/11/99, from Mark Watson, WNT, to Lawrence DeLap, Bates KPMG 0011911. 104Subcommittee interview of Lawrence DeLap (10/30/03). 105 Id. 106Subcommittee interview of Mark Watson (11/4/03). 

fortable 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

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

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

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 apVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00206 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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107 Email dated 7/22/99, from Mark Watson to Richard Smith and Phil Wiesner, Bates MTW 

0078. 108 Email dated 8/4/99, from Mark Watson to David Brockway, Mark Springer, and Doug 

Ammerman, Bates SMR 0039.

proach 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. 

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

The other technical reviewer objecting to BLIPS wrote:

184

109 Email dated 8/4/99, from Steven Rosenthal to Mark Watson and others, Bates SMR 0039. 110Senior 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.’’). 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). 112Subcommittee interview of Lawrence DeLap (10/30/03). 113Power 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. 

‘‘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

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: 

‘‘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

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

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 alVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00208 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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114 IRS Notice 2000–44 (2000–36 IRB 255) (9/5/00) at 255. 115See document dated 5/18/01, ‘‘PFP Practice Reorganization Innovative Strategies Business 

Plan—DRAFT,’’ Bates KPMG 0050620–23, at 1. 116Memorandum dated 2/23/98, from Robert Simon to Gregg Ritchie, Randy Bickham, and 

John Harris, concerning OPIS, Bates KPMG 0010729. 

lowable.’’ 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. 

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. 

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. § 446. . . . [A] fairly strong argument could be 

made that the U.S. investor has nothing more than a disguised 

partnership interest.’’ 

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. 

§ 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 

186

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. 118 IRS Notice 2001–45 (2001–33 IRB 129) (8/13/01). 119See ‘‘Settlement Initiative for Section 302/318 Basis-Shifting Transactions,’’ IRS Announcement 2002–97 (2002–43 IRB 757) (10/28/02). 120See Appendix B for more detailed information on SC2. 

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. 

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

SC2 Development and Approval Process. The Subcommittee 

investigation also obtained documentation establishing KPMG’s 

awareness of flaws in the technical merits of SC2.120

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 reVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00210 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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121 Email dated 3/13/00, from Phillip Galbreath to Richard Bailine, ‘‘FW: S-CAEPS,’’ Bates 

KPMG 0046889. 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. 123 Undated KPMG document entitled, ‘‘S Corporation Charitable Contribution Strategy[:] 

Summary of Certain Risks,’’ marked ‘‘PRIVATE AND CONFIDENTIAL,’’ Bates KPMG 0049987–

88.

flect, 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

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

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 taxexempt 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

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 

188

124See, e.g., email dated 3/13/00, from Richard Bailene to Phillip Galbreath, ‘‘S-CAEPS,’’ Bates 

KPMG 0015744. 125See, 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. 126See, 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). 127 Email dated 12/20/01, from William Kelliher to David Brockway, ‘‘FW: SC2,’’ Bates KPMG 

0012723.

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

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

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 

Finding: 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 

189

128KPMG Tax Services Manual, § 2.21.1, at 2–14. 129 Id.

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.’’

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 

190

130See, 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. 

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

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. . . . 

191

131 Email dated 8/6/00 from Jeff Stein and Rick Rosenthal to 15 National Deployment Champions, Bates KPMG 050016. 132 Email dated 3/14/02, from Rick Rosenthal and other KPMG professionals, to ‘‘US Management Group,’’ Bates XX 000141 (Emphasis in original.). 

‘‘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

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

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:

192

133 Email dated 2/18/00, from Richard Rosenthal to multiple KPMG tax professionals, Bates 

KPMG 0049236. 134 Email dated 4/21/00, from Michael Terracina, KPMG office in Houston, to Gary Choate, 

KPMG office in Dallas, Bates KPMG 0048191.

‘‘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

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

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 

193

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. 136 Email dated 12/2/00, from Lawrence Manth to multiple tax professionals, Bates XX 000021. 137 Email dated 2/22/01, from Councill Leak to multiple tax professionals, Bates KPMG 

0050822–23. 138 Email dated 3/13/01, from Larry Manth to multiple KPMG tax professionals, ‘‘Friday’s 

Stratecon Call,’’ Bates XX 001439. 

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

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

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

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 

194

139 Email dated 4/25/01, from Larry Manth to multiple KPMG tax professionals, ‘‘Friday’s 

Stratecon Call,’’ Bates XX 001438. 140 Email dated 2/3/00, from Philip Wiesner to US-WNT Tax Partners, Bates KPMG 0050888–

90.141Presentation entitled, ‘‘KMatch Push Feature Campaign,’’ undated, prepared by Marsha 

Peters of the Tax Innovation Center, Bates XX 001511. 142See, 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.

Stratecon professionals to discuss two ‘‘tax minimization opportunities for individuals’’ which will ‘‘have a quick revenue hit for us.’’ 139

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: 

‘‘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

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 cliVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00218 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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144Presentation 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. 145Presentation dated 10/30/00, ‘‘Intellectual Property Services (IPS),’’ by Dut LeBlanc of 

Shreveport and Joe Zier of Silicon Valley, Bates XX 001580–93. 146Presentation 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. 147Presentation dated 10/30/00, ‘‘Intellectual Property Services (IPS),’’ by Dut LeBlanc of 

Shreveport and Joe Zier of Silicon Valley, Bates XX 001580–93. 148Presentation 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. 149See 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. 

ents 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: 

‘‘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

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, highgrowth, high-tech space.’’ A presentation on this new product states 

that KPMG tax professionals are ‘‘[t]eaming with Assurance . . . 

196

150Presentation 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’’). 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. 152 Email dated 2/9/01, from Ty Jordan to multiple KPMG tax professionals, ‘‘SC2 revisit of 

stale leads,’’ Bates KPMG 0050814. 153Subcommittee interview of Wachovia Bank representatives (3/25/03). 

[and] fostering cross-selling among assurance and tax professionals.’’ 150

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

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

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 prodVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00220 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
197

154See, 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. 155See, 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). 156Memorandum 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. 157See, 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. 160See, 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. 161See email dated 4/22/01, from John Schrier to Thomas Crawford, ‘‘RE: SC2 target list,’’ 

Bates KPMG 0050029. 

ucts.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

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. 

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 

198

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.’’ 164Subcommittee briefing by Jeffrey Eischeid and Timothy Speiss (9/12/03). 165Subcommittee interview of Councill Leak (10/22/03). 166 ‘‘SC2—Meeting Agenda’’ and attachments, dated 6/19/00, Bates KPMG 0013375–96.

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

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

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: 

‘‘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. . . .

199

‘‘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 proVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00223 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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167 ‘‘SC2—Meeting Agenda’’ and attachments, dated June 19, 2000, at Bates KPMG 0013394. 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 ‘‘Dickensg@aol.com,’’ 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. 

fessionals 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

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

KPMG was apparently so convinced that an outside legal opinion 

increased the marketability of its tax products, that in the case of 

201

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 ¶ 18, citing an email dated 10/1/97, from Gregg 

Ritchie to Randall Hamilton. (Capitalizations in original omitted.) 171 ‘‘SC2—Meeting Agenda’’ and attachments, dated June 19, 2000, Bates KPMG 0013375–96. 172See, e.g., Subcommittee interview of Lawrence Manth (11/6/03). 173 Id. 174 Email dated 2/9/01, from Ty Jordan to multiple KPMG tax professionals, ‘‘SC2 revisit of 

stale leads,’’ Bates KPMG 0050814. 175Subcommittee briefing by Jeffrey Eischeid (9/12/03); Subcommittee interview of Jeffrey 

Stein (10/31/03). 

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. 

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

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: 

‘‘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

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. 

202

176 Internal KPMG presentation, dated 6/18/01, by Andrew Atkin and Bob Huber, entitled ‘‘SCorporation Charitable Contribution Strategy (SC2) Update,’’ Bates XX 001553. 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. 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. 

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

‘‘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

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 

203

180Letter from KPMG to Subcommittee, dated 4/22/03, attached one-page chart entitled, ‘‘Good 

Faith Estimate of Top Revenue-Generating Strategies,’’ n.1. 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.

by tax product on a national basis,’’ 180 was contradicted by the evidence. 

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

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 

204

182Subcommittee interview of Jeffrey Stein (10/31/03). 183 Email dated 12/12/01, from Dale Affonso to ‘‘Tax Personnel—LA & PSW,’’ Bates XX 001733. 184KPMG 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. 186KPMG 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. 189See 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. 

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

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

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

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 pracVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00228 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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190Document 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). 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.’’) 193Document dated 5/18/01, ‘‘PFP Practice Reorganization Innovative Strategies Business 

Plan—DRAFT,’’ Bates KPMG 0050620–23, at 2.

tice’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: 

‘‘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: 

‘‘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

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:

206

194 Id. at 2.

‘‘[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

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 

Finding: 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 

207

195Quellos was then known and doing business as Quadra Capital Management LLP or QA 

Investments, LLC. 196KPMG actually did business with First Union National Bank, which subsequently merged 

with Wachovia Bank. 197Subcommittee interview of First Union National Bank representatives (3/25/03). 198KPMG actually worked with Brown & Wood, a large New York law firm which subsequently merged with Sidley & Austin. 199The 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’’). 200Subcommittee 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.’’

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 finetune 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

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. 

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 

208

201 Credit Request dated 9/26/99, Bates HVB 001166; Subcommittee interview of HVB representatives (10/29/03). 202Subcommittee interview of Jeffrey Eischeid (10/8/03). 203See, 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. 204 Attachment entitled, ‘‘Tax Exempt Organizations,’’ included in an SC2 information packet 

dated 7/19/00, ‘‘SC2—Meeting Agenda,’’ Bates KPMG 0013387.

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. 

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

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: 

‘‘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 

209

205 Email dated 2/22/01, from Councill Leak to multiple KPMG tax professionals, ‘‘SC2 Solution—New Development,’’ Bates KPMG 0050822. 206Subcommittee interviews with Los Angeles Department of Fire & Police Pension System 

(10/22/03) and the Austin Fire Relief and Retirement Fund (10/14/03). 207 Id. 208 ‘‘SC2 Implementation Process,’’ included in an SC2 information packet dated 7/19/00, Bates 

KPMG 0013385–86. 209Subcommittee interview of Lawrence Manth (11/6/03). 210Subcommittee interview of William Stefka, Austin Fire Relief and Retirement Fund (10/

14/03). 

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

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

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-ofstate residents whom they never met and with whom they had 

never had any prior contact. 

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

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

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 

210

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.

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

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 

211

212Treas. Reg. § 1.6664–4(c)(1)(ii). 213Prototype BLIPS tax opinion letter prepared by KPMG, (12/31/99), Bates KPMG 0000405–

417, at 1. 

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

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. 

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. 

212

214See, 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). 215Jacoboni v. KPMG, Case No. 6:02–CV–510 (M.D. Fla. 4/29/02) Complaint at ¶¶ 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 ¶¶ 18–19. Mr. Jacaboni also alleges that, despite finally signing the letter, he never 

received the promised tax opinion letter from KPMG. 217Prototype BLIPS tax opinion letter prepared by KPMG, (12/31/99), Bates KPMG 0000405–

417, at 9. 

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. 

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

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 pretax 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 subVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00236 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
213

218See 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).’’). 219KPMG 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. 220 Email dated 4/14/99, from Larry DeLap to multiple KPMG tax professionals, ‘‘RE: BLIPS,’’ 

Bates KPMG 0017578–79. 

stance 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. 

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

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

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 

214

221 Email dated 2/24/00, from Philip Wiesner to multiple KPMG tax professionals, ‘‘RE: BLIPS/

OPIS,’’ Bates KPMG 0011789. 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’’). 223See, 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). 224Subcommittee interview of Lawrence DeLap (10/30/03). 225 Id. 226See Section VI(B)(4) of this Report on ‘‘Avoiding Detection.’’

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

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. 

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. 

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

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 

215

227See, 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. . . .’’). 228See, e.g., two emails dated 10/1/99, from Larry DeLap to multiple KPMG tax professionals, 

‘‘BLIPS,’’ Bates KPMG 0011714. 229Subcommittee interview of Lawrence DeLap (10/30/03). 230See, 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).’’). 231See 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. 232See, e.g., email dated 9/30/99, from Jeffrey Eischeid to Wolfgang Stolz and others, ‘‘OPIS,’’ 

Bates QL S004593. 233Subcommittee interview of Lawrence DeLap (10/30/03). 

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. 

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. 

(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. 

216

234See, 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). 235See, 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.’’) 236See, 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. 237See, 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). 238See, 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). 239Subcommittee 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. 

Finding: 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

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

217

240See 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. 241See 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. 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).’’).

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

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

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 

218

243 Undated document entitled, ‘‘New Product Committee Overview Memo: BLIPS Transaction,’’ Bates DB BLIPS 01959–63. 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. 245See 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. 246 Id. at 6520.

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

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

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: 

‘‘[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

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 borVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00242 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
219

247See 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. 251KPMG prototype tax opinion letter on BLIPS, dated 12/31/99, at 11. 252 Email dated 6/20/00, from William Boyle to multiple Deutsche Bank professionals, ‘‘Updated Presidio/KPMG trades,’’ Bates DB BLIPS 03280.

rower’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

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

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 

220

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. 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. 259See ‘‘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). 

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

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

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 

221

260Subcommittee interview of Deutsche Bank, (11/10/03). 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. 263Memorandum dated 8/16/00, from Dom DeGiorgio and Richard Pankuch to Christopher 

Thorpe and others, ‘‘Presidio BLIPS Transactions,’’ Bates HVB 003346. 

did not understand the details of the BLIPS transactions, and 

downplayed any reputational risk that BLIPS might have posed to 

the bank.260

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.’’ 

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

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 

222

264Subcommittee interview of HVB representative (10/29/03). 265See, 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. 268Document dated 3/4/99, ‘‘BLIPS—transaction description and checklist,’’ Bates KPMG 

0003933–35. 269See Section VI(2) of this Report for discussion of Wachovia’s client referral activities.

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

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: 

‘‘[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 

223

270 Email dated 8/30/99, from Tom Newman to multiple First Union professionals, ‘‘next strategy,’’ Bates SEN–014622. 271Memorandum dated 12/21/99, from Teri Kemmerer Sallwasser to Gail Fagan, ‘‘Boss Strategy Meetings . . .’’ Bates SEN–018253–57.

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

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

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. 

224

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. 273 Id. at UBS 000010. 274 UBS internal document dated 11/13/97, ‘‘Description of the UBS ‘Redemption’ Structure,’’ 

Bates UBS 000031. 

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

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

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 

225

275Letter dated 2/12/98, addressed to SBC Warburg Dillon Read in London, Bates UBS 

000038. 276See 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.’’). 277Subcommittee interview with UBS representative (10/28/03). 

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

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

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.

226

278Memorandum dated 8/12/96, from Jeff Greenstein of Quellos to Wolfgang Stolz of UBS, 

Bates UBS 000002. 279See, 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.’’). 

‘‘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

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 

227

280 Undated UBS internal document, ‘‘Memorandum on USB’ involvement in U.S. Capital Loss 

Generation Scheme (the ‘CLG Scheme’),’’ Bates UBS 000006. 281See , 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. 282See, 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.’’) 283See 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. 

UBS document states that Quellos’ ‘‘specialty is providing tax efficient investment schemes for high net worth U.S. individuals and 

their investment vehicles.’’ 280

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

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 

228

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. 285 Email dated 12/28/99, from Kerry Bratton of Presidio to Alexandre Nouvakhov and Amy 

McCarthy of HVB, ‘‘FX Confirmations,’’ Bates HVB 002035. 286See, 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. 287Subcommittee interview of HVB bank representatives (10/29/03). 288Subcommittee interview of John Larson (6/20/03).

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

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

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

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

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. 

229

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 ¶ 5. 290 Id. ¶¶ 9, 10, 12. 291 Id. at ¶ 14. 292 Id. at ¶ 27(a). 293 Id. at ¶ 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.’’). 294Memorandum dated 12/19/97, from Randall Bickham to Gregg Ritchie, ‘‘Business Model—

Brown & Wood Strategic Alliance,’’ Bates KPMG 0047228. 

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: 

‘‘[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

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

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

230

295Memorandum dated 3/2/98, from Randall Bickham to Gregg Ritchie, ‘‘B&W Meeting,’’ Bates 

KPMG 0047225–27. 296See , 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.’’). 297See ‘‘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 ¶ 18, citing an email by KPMG tax professional Gregg Ritchie. 298Subcommittee interview of Lawrence Manth (11/6/03). 299See 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. 300See 26 U.S.C. § 6662(d)(2)(C)(i); Treas.Reg. §§ 1.6662–4(g)(4)(ii) and 1.6664–4(c)(1). 

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. 

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. 

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 

231

301Facsimile 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. 303See, 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. 304Jacoboni v. KPMG, Case No. 02–CV–510 (D.M.D. Fla. 4/29/02), at ¶ 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 

Continued

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. 

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. 

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 indiVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00255 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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opinion was mailed from New York to Mr. Jacoboni in Florida.’’); Subcommittee interview of 

legal counsel to Joseph Jacoboni (4/4/03). 305See 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.’’). 306 Email dated 2/11/00, from Alexander Eckman to David G. Johnson and others, subject line 

redacted, Bates 2003EY011640.

vidual 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. 

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

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 repVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00256 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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resenting 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, 

234

307Letter 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.’’

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

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 

235

309See 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. 311Subcommittee interview of Lawrence DeLap (10/30/03). 

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

Other documents show that consideration of tax shelter registration issues was a required step in the tax product approval process, 

236

312KPMG Tax Services Manual, § 24.4.1, at 24–2. 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.’’). 314Document dated 5/18/01, ‘‘PFP Practice Reorganization Innovative Strategies Business 

Plan—DRAFT,’’ Bates KPMG 0050620–23, at 2. 315See United States v. KPMG, Case No. 1:02MS00295 (D.D.C. 9/6/02). 

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: 

‘‘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

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.’’

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. 

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 

237

316Testimony 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. 317Testimony 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. 318Testimony 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. 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 

Continued

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

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.’’ 

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

238

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.’’). 320 ‘‘Grantor Trust Reporting Requirements for Capital Transactions,’’ KPMG WNT internal 

memorandum (2/98). 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). 322 Email dated 1/21/99, from Mark Watson to multiple KPMG tax professionals, ‘‘RE: Grantor 

trust reporting,’’ Bates KPMG 0010066. 

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: 

‘‘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

‘‘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

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 

239

323 Email dated 1/21/99, from Carl Hasting to Jeffrey Eischeid, ‘‘FW: Grantor trust reporting,’’ 

Bates KPMG 0010066. 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. 325Subcommittee interview of Mark Watson (11/4/03). 326 IRS Notice 2000–44 (2000–36 IRB 255) (9/5/00) at 256.

that none of us wants to face such an issue, I need some 

guidance.’’ 323

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

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

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

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 indiVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00263 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
240

327Subcommittee 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.’’) 328 Email dated 2/15/00, from Robert Jordan to Jeffrey Eischeid, ‘‘Tax reporting for BLIPS,’’ 

Bates KPMG 0006537. 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.

cated that it was his understanding that a number of client calls 

were later made by KPMG tax professionals.327

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

About a month later, another KPMG tax professional wrote to 

the BLIPS National Deployment Champion:

‘‘We spoke to Steven Buss about the possibility of reissuing 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

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 

241

330 Email dated 3/27/00, unidentified sender and recipients, ‘‘presidio K–1s,’’ Bates KPMG 

0024451. 331See, 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’’). 332See 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. 333 ‘‘SC2—Meeting Agenda’’ and attachments, dated 6/19/00, Bates KPMG 0013375–96, at 

13394. 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 SubContinued

partnership returns this year because then the IRS would 

be looking for them in future years.’’ 330

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

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. 

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

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. 

242

committee on Investigations of the Committee on Governmental Affairs, S. Prt. 107–82 (1/2/03), 

at 32. 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. 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. 337 Handwritten notes dated 3/4/98, author not indicated, regarding ‘‘Brown & Wood’’ and 

‘‘OPIS,’’ Bates KPMG 0047317. 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.

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

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

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

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’’: 

‘‘1. STRUCTURE: A diagramatic representation of the deal 

may help the Committee’s understanding—we can prepare 

this.

243

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. 340 Email dated 8/30/99, from Tom Newman to multiple First Union professionals, ‘‘next strategy,’’ Bates SEN–014622. 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 

Continued

‘‘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

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 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 onepager will be distributed to our referral sources describing 

the strategy.’’ 340

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

244

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.’’) 343See, 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 ¶ 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. 345Subcommittee 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. 348 Email dated 5/5/99, from Jeffrey Eischeid to multiple KPMG tax professionals, ‘‘Marketing 

BLIPS,’’ Bates KPMG 0006106.

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

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’’: 

‘‘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 

245

349 Email dated 12/20/01, from William Kelliher to WNT head David Brockway, ‘‘FW: SC2,’’ 

Bates KPMG 0013311. 350 Email dated 12/29/01, from Larry DeLap to Larry Manth, David Brockway, William 

Kelliher and others, ‘‘FW: SC2,’’ Bates KPMG 0013311. 351See, 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). 352KPMG Tax Services Manual, § 31.11.1 at 31–6. 353See 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.’’) 354See, e.g., AICPA Rule 302; 17 C.F.R. § 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, § 32.4 on contingent fees in general and § 31.10.3 at 31–5 (DPP 

head determines whether specific KPMG fees comply with various rules on contingent fees.) 

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

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

(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. 

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

Within KPMG, the head of DPP-Tax took the position that fees 

based on projected client tax savings were contingent fees prohibVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00269 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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355Subcommittee 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. 356Memorandum 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. 358 If a client objected to the requested fee, KPMG would, on occasion, negotiate a lower, final 

amount. 359Document 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.)

ited 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.’’ 

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: 

‘‘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

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 

247

360 Email dated 5/24/00, from Kerry Bratton of Presidio to Angie Napier of KPMG, ‘‘RE: 

BLIPS—7 percent,’’ Bates KPMG 0002557. 361Tax 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. 363Memorandum dated 7/1/98, from Gregg Ritchie and Jeffrey Zysik to ‘‘CaTS Team Members,’’ ‘‘OPIS Engagements—Prohibited States,’’ Bates KPMG 0011954. 

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

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

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

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 

248

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. 365See ‘‘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 ¶ 18, citing an email dated 10/1/97, from 

Gregg Ritchie to Randall Hamilton, ‘‘Flip Tax Opinion.’’ 366See 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.’’ 

Quadra OPIS99—30 bpts 

Presidio OPIS98—25 bpts 

Presidio OPIS99—25 bpts 

BLIPS—30 bpts’’ 364

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. 

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

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 

249

367 Email dated 8/30/99, from Tom Newman to multiple First Union employees, ‘‘next strategy,’’ Bates SEN–014622. 368KPMG Tax Services Manual, § 52.1.3 at 52–1. 369 Id., § 52.1.1 at 52–1. 370Minutes 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. 371KPMG Tax Services Manual, § 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. § 210.2–01(c)(3). 372 Undated document prepared by Deutsche Bank in 1999, ‘‘New Product Committee Overview Memo: BLIPS Transaction,’’ Bates DB BLIPS 6906–10, at 6909–10. 373See, 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). 374See, 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). 

if the investor is not a KPMG client, and 25 bps if they are a 

KPMG client.’’ 367

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

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. 

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 

250

375See, 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. 376Presentation 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. 378Memorandum 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. 

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

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 creVerDate 0ct 09 2002 11:29 Jul 12, 2004 Jkt 091043 PO 00000 Frm 00274 Fmt 6601 Sfmt 6601 C:\DOCS\91043.TXT SAFFAIRS PsN: PHOGAN
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379Minutes 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.) 381Minutes 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.) 

ated 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. 

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. 

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 

252

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.’’). 384 Engagement letter between Sutherland Asbill & Brennan LLP and the client, dated 7/23/

02, at 1, Bates SA 001964.

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. 

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

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 

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385Memorandum 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.’’

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 

254

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.’’ 

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. 

(255)

386See, 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). 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).

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

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

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 

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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 lowrisk 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.

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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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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).

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

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 nonvoting 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 Scorporation 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 

267

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.

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390 ‘‘Zions Among Banks Accused of Scheme,’’ Desert News (8/8/03). 

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

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 

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391 ‘‘Banks Shifted Billions Into Funds Sheltering Income From Taxes,’’ Wall Street Journal

(8/7/03). 392SEC v. KPMG, Case No. 03–CV–0671 (D.S.D.N.Y. 1/29/03). 

ticipate, 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. 

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. 

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. . . .

272

393Lakin v. KPMG, (MO Cir. 12/10/02). 

‘‘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

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:

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273

394Press 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.

scene 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

‘‘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, 

274

395See, 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). 

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 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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