Originally published on Forbes.com June 10th, 2014
Did you miss that period when the most prestigious accounting firms in the country, PWC, EY, KPMG and BDO among them, were running criminal enterprises? Janet Novack, my esteemed editor, and Laura Saunders broke the story in Forbes in 1998 in an article titled The Hustling Of X Rated Shelters while it was still ongoing. I have been writing about the aftermath for most of my tax blogging career. My first post on the drama concerned the travails of the estate of Richard Egan (founder of EMC and American Ambassador to the Republic of Ireland – not bad for a kid from Dorchester).
Now thanks to Tanina Rostain and Milton C. Regan, Jr. you can read all about it in “Confidence Games – Lawyers, Accountants, and the Tax Shelter Industry”. It is a sad story with no heroes and only one villain, who is colorful enough to be engaging – Paul Daugerdas, who is still awaiting sentencing on his second conviction (He got a do-over on his trial due to juror misconduct). The book is a must-read for all tax professionals and others may enjoy it too. More importantly, the authors analyze the institutional flaws that created this scandal – the deprofessionalization of the practice of law and accounting and Congressional neglect of the IRS.
The Lawyers
The story about how Big Law tax practice evolved is one that I can’t attest to it, but it certainly seems plausible. Corporate law firms used to be much more club-like with little client turnover and seniority-based compensation systems. Clients were largely firm clients, not vulnerable to following individual attorneys. The attorneys were drawn for the most part from a small portion of the population – white, male, and Protestants – what some would call the Waspocracy.
The passing of the Waspocracy is reflected in many things among them that best-selling novelist James Gould Cozzens, their best chronicler, is little remembered today. Most dramatic perhaps is the fact that the Supreme Court has not a single Protestant. Even the African American is a graduate of the College Holy Cross (Choo, choo, rah, rah). Of course, they would not have put it this way, but apparently, their style of tax practice was to advise their clients “Don’t be a chazzer!” or as we also put it at Joseph B Cohan and Associates “Pigs get fed, hogs get slaughtered”. There was a sense that the tax bar had a responsibility not only to their clients but also to the system.
Although it was hardly alone, the law firm most singled out by the authors was Jenkens and Gilchrist. JG wanted to vault into the national scene and in order to make that leap, it needed to increase “profits per partner”, once a closely guarded secret, but now a metric of surpassing importance. Profits per partner would attract winning rainmakers to the firm allowing it to expand.
Opinions on tax shelters were a great way to boost profits per partner, since they were valued billed, based on the client’s tax savings. One firm estimated that its hourly rate worked out to $9,000 on tax shelter opinions.
The Accountants
Many would think that it was greed that led accountants to this debacle, but I think that it was another of the seven capital sins that was at the root of it, something which the authors remark on:
In the late 1990s and 2000s, professionals at these firms compared their lot to that of professionals at financial institutions. They longed for a “Goldman-Sachs type practice” that would generate substantially more income.
The greatest hazard that most CPAs face is envy. The hard reality of professional practice is that you either have to do some actual work yourself or pay somebody, probably pretty well, to do some work. Tax practices try to get around this by having a “leverage model” that “pushes work down” to the lowest paid person possible. Then there is that vast pool of highly educated South Asians that the internet makes available for compliance work. Neither of those courses is the road to great profitability.
Regional firms were starting to get involved in directly providing other financial services. The schemes were usually presented as essentially free money. You refer your clients to the most genius money managers that ever walked the earth, who would then by some slightly twisted path kick you back 25 basis points or so. There are numerous reasons why this is not a good idea and I think most such arrangements were ultimately unwound. That bad idea was not available to the Big 6 or 5 or 4 (Maybe we should call them the Big Countdown). They had an even worse idea, a variation on the concept of “value billing”.
Design a cookie-cutter tax shelter that actually has only one transaction (two if you want to be generous) and that by a hypertechnical interpretation of partnership tax provisions creates basis out of thin air. Have your audit partners tell clients who are about to experience “liquidity events” that instead of paying the federal government 20%, they can pay KPMG 3%.
Only first they have to sign a non-disclosure and they can’t have somebody independently vet the deal. There are already law firms lined up who have “experience” with the deals that will provide you with an opinion letter that constitutes a “get out of jail free card”. Deutsche Bank has the transaction all teed up for you. Just remember that if anybody asks that you were hoping to score big on it and the tax benefits were incidental.
Putting it in biblical terms, the venerable accounting firms were selling their birthright for a mess of pottage. Within the firms, people who thought it was a bad idea found that resistance was futile.
…..those who declined to work on shelters or raised issues about their propriety were sidelined and suffered negative career repercussions.
At KPMG, email functioned to rally the converted and to isolate and weaken those who had reservations or counseled a more cautious approach.
Congress
The other part of the story was the way that the IRS was crippled by investigations into supposed abuses in the collections area. Combined with persistent underfunding, that leg of the next shelter crisis remains with us.
Aftermath
Jenkens and Gilchrist was put under by the unraveling of the shelters, but after taking down Arthur Andersen, the Government decided that the Big 4 were too few to fail. Few people went to prison.
Because of the government’s overreaching, the biggest tax prosecution in United States history was reduced to a case against five individuals who had not been the driving force behind the firm’s tax shelter activities.
It’s A Great Book
I highly recommend Confidence Games. It weaves together the pieces of a complex story giving a great deal of historic context. The Big 4 is probably chastened enough that the next great assault on the tax system will not be coming from there, but Congress is still playing the abusive step-parent to the IRS and is setting us up for the next one.
You can follow me on twitter @peterreillycpa.
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