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June 22, 2005

Victor Fleisher, a UCLA Tax prof and blogger, writes in A Taxing Blog:

KPMG is getting its arm twisted over some tax shelters. Larry Ribstein thinks the government, or at least the criminal division, should back off. Christine Hurt also thinks the government is being a little harsh. I disagree.

One problem with both criminal indictments/staggeringly high civil penalties is that they may punish the whole firm for the misdeeds of a few. But this threat is necessary to encourage internal monitoring among law firm and accounting firm partners. Law firms will invest a lot more resources in reviewing tax opinions if their future livelihoods depend on it.

A conviction would destroy KPMG and leave only three firms in the business of auditing the largest companies. A Wall Street Journal piece yesterday (subscribers only) indicates that even with the existing four firms, it can be impossible to get an acceptable competing bid for a big company audit:

Intel Corp. is one of the many big companies now bumping up against the limitations. After using Ernst & Young LLP as its auditor for more than three decades, the semiconductor maker considered switching recently for a fresh look at its financials. But it stuck with Ernst after receiving proposals from the other Big Four firms: Deloitte & Touche LLP, KPMG and PricewaterhouseCoopers LLP. That is because federal regulations bar the three other firms from serving as Intel's independent auditor unless they give up valuation, computer-software and other work they do for Intel

While certainly KPMG partners should go to jail for crimes that KPMG seems to admit took place, and KPMG should be sanctioned, it's hard to see where anybody benefits from destroying the firm.

UPDATE: Today the Wall Street Journal reports:

Securities and Exchange Commission officials are privately discussing steps to take in the event of a collapse of one of the Big Four accounting firms, including temporarily relaxing some rules they put in place two years ago to try to improve the quality of audits.

It would be morbidly funny if the effort to punish KPMG for tax crimes led to weaker audits.

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