“You know if you blow the whistle then you’re going to be blackballed out of an industry, you’re going to face financial hardships and you have to deal with that,” says Mike Hamersley, a corporate tax law specialist with the Californian state government.
Three years ago Hamersley was heading for partnership at KPMG. On the surface everything appeared to be going well, but the lawyer was becoming increasingly troubled about his firm’s sale of tax shelters.
Finally Hamersley felt he had no choice but to blow the whistle and report his concerns to the federal authorities. His contribution played a major part in KPMG’s candid admission of wrongdoing last month, which led to a $456m (£258.2m) settlement with the US government.
“In the end you have to make a decision not to care what people think of you and take on the risk of being ruined financially, but it wasn’t easy,” Hamersley reflects. “I had the support of my family and friends. I also had a child who was born around the time it was happening. That enabled me to see the kind of industry I was in and I wanted to set an example.”
Hamersley’s crucial evidence helped the US Department of Justice to nail KPMG. Under the deal, KPMG “admits and accepts” that, through the conduct of “certain KPMG tax leaders, partners and employees”, it assisted “high-net-worth US citizens to evade US individual income taxes on billions of dollars in capital gain and ordinary income by developing, promoting and implementing… fraudulent tax shelters”.
“It’s nearly always impossible, certainly with a jury, to convict tax practitioners, because they have to understand tax; and then you have to prove what’s inside their heads, and you’re never going to do that,” Hamersley says. Unless, that is, someone from the inside speaks out.
The US authorities have been mindful of how the accounting profession’s big five was reduced to a big four after Arthur Andersen was decimated when prosecutors charged it with obstruction of justice over the Enron affair in 2002. Hence the Department of Justice came up with its ‘deferred prosecution’. The firm will be made subject to an overseer, Richard Breeden, a former chairman of the Securities and Exchange Commission (SEC). The corporate troubleshooter will make sure that for the next three years the firm does not reoffend.
In a separate action, eight former KPMG executives and an outside lawyer associated with four tax avoidance schemes, which took place between 1996 and 2002 and earned the firm $124m (£70.2m), have been indicted.
The idea of a deferred prosecution is a “new concept which would have been unheard of five years ago”, comments Robert Fink, a defence lawyer at New York firm Kostelanetz & Fink, who is acting for Richard Smith, one of the indicted former partners. “The government’s trying to get some middle ground where they’re punishing a corporation and putting in monitors and yet not destroying innocent stockholders and innocent employees,” he says.
So where does the agreement leave his client? “He believes that they’ve made a submission in order to avoid prosecution,” he says. “They basically made this deal with the government and agreed to things that aren’t true and that they have no first-hand knowledge of. If you read their admission, it reads almost verbatim to the indictment.”
When to blow
During the late 1990s, KPMG’s tax products in the US became an increasingly important part of the firm’s practice. By 2001, the tax practice employed some 10,000 tax professionals and brought in approximately $1bn (£570m) in revenue, which represented a 45 per cent increase on the previous four years. In late 1998, KPMG began to develop a new product for wealthy individuals with large capital gains, called bond-linked issue premium structures (Blips).
Around that time Hamersley was a junior in KPMG’s national tax practice and had not been exposed to the discussions surrounding Blips and the other tax shelters. In an interview on the US television programme Frontline, he later said the partners involved in developing these products held the information “pretty close to the vest” and that access was limited to a “need-to-know” basis. The unofficial reason, Hamersley reckoned, was that “this was some pretty ugly stuff”.
However, Hamersley was promoted and moved to the Los Angeles office in 2000. The firm assured him that, everything being equal, he would be made a partner within a couple of years. But while the lawyer worked on client service matters, he began to learn more about the tax shelters. According to Tanina Rostain, professor of law at New York Law School, Hamersley attributed the aggressive salesmanship to the “Wild West” atmosphere of the office, adding that “over time he began to realise that the push to market tax shelters came directly from the firm’s senior tax leadership”.
“I was in a practice where you could stay isolated because we were paid for technical advice, although the firm was moving away from that towards tax shelters,” says Hamersley. “My decision for a year and a half was that I was going to disclose this stuff silently, but I was going to be careful about exposing myself to a career-ending event.” Nor did Hamersley intend to expose himself to criminal liability. He was able to “extract” himself from dubious transactions, he says.
Hamersley’s objective was “to make partner and get the hell out of there”, he reveals. But he felt that making partner was “like an initiation test” and that it depended on his becoming increasingly complicit with the tax shelter practice.
There was no ducking the issue in the summer of 2002 when KPMG won the audit of a major company which had engaged in aggressive tax shelters (including some that had been listed as potentially abusive by the Internal Revenue Service (IRS)) and to which KPMG tax partners were keen to sell additional products. Then, in July 2002, the Sarbanes-Oxley Act came into force, providing for a 10-year prison term for destroying corporate audit papers. Under pressure to do just that, Hamersley knew what he had to do and blew the whistle.
When the firm discovered that Hamersley was cooperating with the government, it put him on administrative leave, where he remained for one and a half years. A rumour began to circulate in the firm that Hamersley was not working because he was mentally unstable. In June 2003, Hamersley sued KPMG in the California state court for defamation and retaliating against his whistleblowing. In January the following year, the suit settled for an undisclosed amount.
Hamersley now works for the California Franchise Tax Board investigating the kinds of schemes that he exposed. He takes issue with the notion that tax fraud is a victimless crime. “It’s incredibly destructive to society because the numbers are so enormous, especially when you look at the deficits in every state and on the federal side,” he says.
One thing that facilitates tax shelter promotion, he says, is “the vilification of the IRS – making people believe that they’re the bad guys.” He believes “getting it out of the average citizen’s mind that it’s their money and the Revenue’s just collecting it” is the way forward, adding: “Nobody likes paying tax, but somebody has to pay for the roads.”