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The U.S. Court of Appeals for the Second Circuit has upheld the dismissal of criminal tax-shelter-fraud charges against 13 former employees of accounting firm KPMG on the grounds that prosecutors interfered with their constitutional rights to counsel. Yesterday’s ruling came shortly before a U.S. Department of Justice announcement that it has revised its guidelines for the investigation and prosecution of corporate crimes. Among the changes, which are effective immediately, is an explicit statement that prosecutors evaluating a company’s cooperativeness are not to consider whether a company has advanced legal fees to employees. KPMG had advanced such fees to individual employees targeted by the government in its probe of the promotion of illegal tax shelters. Acting under the earlier guidelines set forth by the Justice Department’s 2003 Thompson Memorandum, prosecutors informed KPMG that its assisting employees with legal fees would be taken into account in determining whether or not to prosecute the company itself. According to the decision written by Judge Dennis Jacobs, the government’s “overwhelming influence” prompted KPMG to impose conditions, then cap the fees and finally terminate them. Arthur Andersen, KPMG’s onetime rival, collapsed in the face of government charges that it participated in accounting fraud at Enron Corp. and companies’ fears of a similar fate have given prosecutors enormous leverage in negotiating nonprosecution agreements. KPMG signed such a deal in August 2005, agreeing to pay $456 million in fines and restitution to former tax shelter clients. Key Developments

February 2004: Prosecutors meet with KPMG in connection with an investigation into the company’s alleged devising and marketing of fraudulent tax shelters. August 2005: KPMG enters a deferred prosecution agreement, agreeing to pay $456 million and to cooperate in the prosecution of individuals. October 2005: The government indicts 19 people in connection with the probe, including 17 ex-employees of KPMG. January 2006: The defendants file a motion accusing prosecutors of improperly infringing on “their constitutional rights to counsel and a fair trial” by pressuring KPMG to stop paying their legal fees. March 2006: Ex-KPMG employee David Rivkin pleads guilty to conspiracy and tax evasion. June 26, 2006: Southern District Judge Lewis Kaplan rules that the U.S. Attorney’s Office coerced KPMG into refusing to advance legal fees for its ex-employees. He declines to dismiss the indictment, but says the ex-employees can pursue a civil lawsuit against the accounting firm for payment of their legal bills. United States v. Stein, 435 F. Supp. 2d 330. July 2006: The 16 ex-employees file a civil lawsuit against KPMG to recoup legal fees. January 2007: The case against KPMG is dismissed. May 2007: The U.S. Court of Appeals for the Second Circuit rules that Judge Kaplan cannot exercise ancillary jurisdiction over the civil case, although it suggests he could dismiss the indictment if he believes the defendants’ rights had been violated, Stein v. KPMP, 486 F.3d 753. June 2007: The 16 ex-employees file a motion to dismiss the indictment in light of Judge Kaplan’s June 2006 decision. Prosecutors later in the month ask the judge to dismiss charges against 12 of the 16 KPMG defendants, saying it is his only option due to his earlier ruling. July 16, 2007: Judge Kaplan dismisses indictments against 13 ex-KPMG employees. The case proceeds against the other three, as well as against the two non-employees, one of whom is R.J. Ruble, a former Sidley Austin tax lawyer, United States v. Stein, 495 F. Supp. 2d 390. September 2007: A second defendant, former investment advisor David Makov, pleads guilty. Yesterday: The Second Circuit upholds the dismissals.

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