The allegations in the criminal indictment of two former and two current Ernst & Young partners for tax fraud conspiracy and related crimes arising out of tax shelters promoted by E&Y makes for some very interesting reading. All four worked in a E&Y group first named VIPER (Value Ideas Produce Extraordinary Results), and later renamed SISG (Strategic Individual Solutions Group). One was the former national director of E&Y’s Center for Wealth Planning, another the national director of E&Y's Personal Income Tax and Retirement Planning practice. The basic premise of the U.S. attorney, as stated in the press release, is: “In order to maximize the appearance that the tax shelters were investments undertaken to generate profits, and to minimize the likelihood that the IRS would learn the transactions were actually designed to create tax losses and deductions, the defendants and their co-conspirators created and assisted in creating transactional documents and other materials containing false and fraudulent descriptions of the clients' motivations for entering into the transactions, and their motivations for taking the various steps that would yield the tax benefits.” The tax shelters are described as “cookie-cutter products that would eliminate, reduce or defer large tax liabilities.” One of the allegations is that the defendants worked with law firms to provide E&Y's clients with opinion letters that claimed the tax shelter losses or deductions would "more likely than not" or "should" survive IRS challenge, and the defendants knew those opinions were based upon false and fraudulent statements that omitted material facts. The indictment also alleges that the defendants and their co-conspirators undertook these actions so E&Y could participate in the highly lucrative tax shelter market in which other accounting firms were already participating. In response to the indictment, E&Y issued a press release stating those indicted are two former partners and two partners who have been on administrative leave, that they were part of a small group within the firm that disbanded years ago, and that E&Y voluntarily made many changes and enhancements to their tax practice. It also mentioned that some changes were made pursuant to a 2003 agreement with the IRS, which E&Y proudly proclaimed the IRS Commissioner called a "model for agreements with practitioners.” The indictment explains in detail how the shelters worked and were marketed, contains numerous quotes attributed to the defendants, and has an allegation the fees charged were based on a percentage of the tax savings obtained. Interestingly, there is a claim that three defendants utilized a fraudulent tax shelter with regard to the proceeds they received when E&Y sold its consulting business to Cap Gemini. The more I read, the more it reminded me of Enron’s downfall. As with Enron, there is an accounting firm involved, law firms certifying the validity of very complicated transactions, and financing from a third party. What is different is, unlike in Enron, the originator of the transactions is the accounting firm. I consider this difference to be very significant. But it is obvious, after the demise of Andersen, the government has decided to go after individuals criminally, rather than the firm, so as not to put the future of a Big Four firm in jeopardy. If it goes to a jury trial, how will the government simplify the transactions? What are the perceived smoking guns that it will present? With regard to the defense, will they claim the tax shelters weren’t criminal but very aggressive attempts at tax savings, similar to 1031 exchanges? If successful, the government will probably feel those in accounting firms, because of fear of criminal prosecution, will reign in a firm from engaging in fraudulent activities. I wonder if the government has successfully made that point already simply by indicting four former or current partners of a Big Four firm. A copy of the indictment is at http://online.wsj.com/public/resources/documents/EYIndictment20070530.pdf. The government’s press release is at usdoj.gov/usao/nys/pressreleases/May07/eyindictmentpr.pdf.  

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