| | Law.com's In-House Counsel | |
Sue Reisinger
Corporate Counsel
November 9, 2005
©2005 In-House Counsel Online
It was a festive day for Sven Erik Holmes. Family, friends and colleagues
surrounded him in the Tulsa federal courthouse last March as his official
portrait was unveiled. It was the last day on the job for Holmes, who was
retiring as chief federal judge for the Northern District of Oklahoma, after 10
years on the bench.
Five months later, Holmes was back in a federal court, without his robes and
under drastically different circumstances. This time, the U.S. Attorney in
Manhattan looked on as Holmes, now the chief legal officer for KPMG, signed a
document to keep his company from being criminally prosecuted. Afterward Holmes
remembers someone quipping: "It used to be the full force of the U.S. government
behind your signature. Now it's on top of your signature."
The deal was a lifesaver for the New York-based auditing firm, which is caught
up in what the government calls "the largest ever tax shelter fraud." The
document allowed KPMG to enter a so-called deferred prosecution agreement: The
feds agreed to defer prosecuting KPMG on one count of conspiracy to defraud the
Internal Revenue Service until Dec. 31, 2006. If the accounting firm adheres to
the terms, the charge will be dropped. Holmes describes the deal as KPMG's last
resort, adding, "Society has a very real interest in [punishing] this kind of
wrongful conduct."
As part of the agreement, KPMG had to admit to a lengthy list of illegal actions
-- from creating and selling shady tax shelters that saved wealthy clients
millions in taxes, to trying to cover up the scheme by lying under oath. And it
had to pay $456 million in penalties. The tax shelters, with names like FLIP
(Foreign Leveraged Investment Program), OPIS (Offshore Portfolio Investment
Strategy), BLIPS (Bond Linked Issue Premium Structure) and SOS (Short Option
Strategy), funneled money through foreign accounts to create phony investment
losses. All told, the firm's clients dodged at least $2.5 billion in taxes,
according to court documents.
The auditing firm also agreed to curtail its tax business, including ceasing its
private client tax service. And it promised to institute an array of ethics and
compliance reforms, under the auspices of former Securities and Exchange
Commission chair and corporate cleanup monitor Richard Breeden. Among them:
setting up a hot line for whistleblowing employees to reach Holmes' office. With
the firm on probation, any hint that it is trying to hide something from the IRS
in the next year could make the government pursue the charge.
Holmes had nothing to do with the criminal behavior -- he wasn't around when
KPMG was selling the shelters from 1997 to 2002. But he has everything to do
with the company's hopes of changing its image as an arrogant and deceitful
rogue that raked in $128 million in ill-gotten profits while thumbing its nose
at the law. With his sterling reputation -- as a partner at Williams & Connolly
in Washington, D.C., he was known to "fire" corporate clients rather than defend
behavior he saw as unethical -- and his sober, judicial demeanor, he's exactly
the kind of top lawyer a firm like KPMG needs right now.
According to corporate law professor Deborah DeMott of Duke University, it's
especially important for companies to turn to someone with a reputation for
honesty and credibility when they're under the gun from regulators. Holmes'
appointment as chief legal officer over the company's general counsel Claudia
Taft, she says, "signals the market and the regulators" that the company is
ready to change its culture and practices. (Taft, who remains GC at KPMG,
according to a spokesperson, declined to comment for this story.)
So how did Holmes go from sitting in judgment on felons to seeking mercy for a
wayward corporation? For the 54-year-old, the summer of 2004 brought a midlife
yearning for something new after a "comfortable" decade as a federal judge. A
Clinton appointee, he knew there was little chance he'd be elevated to a higher
court during the Bush administration. "I wasn't bored or tired," Holmes says,
but he and his wife kept discussing "what-ifs" about the rest of their lives.
They had moved to Tulsa 10 years earlier from Washington, D.C., when their
children were 4 and 8, so the girls could grow up in Oklahoma near their
grandparents. But their daughters were now teenagers, and the grandparents had
passed away. Holmes and his wife thought the timing might be right to return to
the East Coast. So he began exploring if there might be "something unique and
challenging" for him beyond the bench.
At that same time, KPMG was fighting for its life against then-U.S. Attorney
David Kelley in New York. Kelley had convened a grand jury and seemed determined
to indict the company as much for its cover-up tactics as for its tax shelters.
The government had easily settled previous tax shelter cases with other auditing
firms for much smaller fines. In 2003, for instance, Ernst & Young paid a paltry
$15 million to settle. But KPMG had infuriated officials by hiding documents,
defying federal investigators and lying to the IRS, U.S. senators and a federal
court.
The Justice Department action wasn't the only case dogging KPMG that summer. It
was fighting civil charges filed in 2003 by the SEC, accusing the firm of
helping Xerox Corp. cook its books to cover up a $3 billion gap between its
finances and its reported income. The SEC was also investigating whether KPMG
audit failures allowed Gemstar-TV Guide International Inc., to misstate and
inflate its revenue. And in California, in a civil suit that's still pending,
KPMG compounded its troubles by angering the trial judge. That case involved a
$50 million accounting malpractice allegation by a client, Targus Group
International Inc., an Anaheim, Calif.-based supplier of laptop computer cases
and accessories. When KPMG hid documents and misled the court, the state judge
imposed sanctions on the company. KPMG denies the malpractice allegations.
Targus lawyer Michael Avenatti, an associate at Greene Broillet & Wheeler in
Santa Monica, Calif., says KPMG's abuse of discovery was so bad that the judge
allowed him to depose GC Taft. Her deposition is sealed, but Avenatti describes
her answers as "evasive."
In fact, discovery abuse in the Justice Department's case probably riled federal
prosecutors even more than the illegal tax shelters. When the IRS tried
repeatedly in early 2004 to shake loose material on the shelters, KPMG lawyers
claimed that many of the records were protected by attorney-client privilege --
a claim the U.S. attorney later called a "sham." So the IRS went to court to
force KPMG to submit its documents.
In May 2004, D.C. federal district court Chief Judge Thomas Hogan agreed with
the IRS. He ordered KPMG to turn over the documents. In a footnote, Hogan wrote:
"The court hesitates to consider the judicial resources that have been wasted as
a result of these improper claims." KPMG's senior managers knew they were in
trouble. They had begun to clean house by firing three employees involved in the
tax shelters, but they needed something more: a white knight to face the feds --
and burnish the company's image. They sent the headhunters on a quest.
Late that summer, Holmes was contacted by one of his former law partners at
Williams & Connolly. A KPMG headhunter, who was nervous about approaching a
sitting judge, asked the colleague to contact Holmes. The judge was intrigued.
So was KPMG Chairman and CEO Eugene O'Kelly when he heard of Holmes' interest.
KPMG wanted to bring in someone with Holmes' reputation for legal rigor and
unimpeachable ethics. One former law clerk, Jeffrey Faucette, recalls that his
boss was detail-oriented and "absolutely dedicated to getting it right."
Faucette now directs the litigation department at Howard Rice Nemerovski Canady
Falk & Rabkin in San Francisco. (KPMG is not a client.)
The judge had other attractive qualities. Holmes is politically connected. He
worked for David Boren, a Democrat, when Boren was governor of Oklahoma and
later a U.S. senator. And he's used to dealing with sensitive public matters.
Holmes also served as general counsel and staff director for the U.S. Senate
Select Committee on Intelligence, and on a congressional committee investigating
the Iran-Contra links in the 1980s.
He's media-savvy, too. It runs in the family -- his wife is Lois Romano, a
veteran reporter for The Washington Post, and their older daughter just
entered journalism school at Northwestern University. In Tulsa, Holmes was known
for taking the press on site visits during trials, such as to a toxic waste
dump. KPMG courted Holmes through the fall of 2004. The first-generation
American son of Norwegian immigrants, Holmes hit it off with KPMG's O'Kelly, a
first-generation Irish-American. (O'Kelly stepped down in ill health in June
2005 and died three months later of cancer at 53.)
Holmes says he did not negotiate specific hiring points with O'Kelly, but sought
broad assurances about putting the necessary legal and ethical changes in place.
O'Kelly assured Holmes that KPMG already was cooperating with the federal
investigation and was following the tenets of the so-called Thompson memo. The
memo was written in 2003 by then-Deputy Attorney General Larry Thompson (now GC
of Pepsi Co. Inc.) to spell out what a corporation must do to win a deferred
prosecution agreement. If KPMG could not completely avoid being prosecuted, then
it wanted a deferred prosecution agreement -- the trend in dozens of recent
corporate cases, including those involving American International Group Inc.,
Monsanto Co., Computer Associates International Inc., Merrill Lynch & Co. Inc.
and Bristol-Myers Squibb Co.
Holmes knew accepting the job would mean putting his reputation on the line, as
well as giving up a secure, lifetime appointment to the bench. It didn't hurt
that KPMG offered him many times his $160,000-plus salary as a judge, but those
who know Holmes insist that he wasn't motivated by the lure of a big paycheck.
What was important to Holmes was O'Kelly's promise that the new chief legal
officer would have the "standing and authority" to clean up KPMG and make it an
ethical model for corporate America. Holmes believed O'Kelly was sincere.
Touching his chest for emphasis, Holmes says, "In the end, you go with what you
believe, and with the people you believe in."
So KPMG announced Holmes' hiring in January 2005. His duties include overseeing
ethics and compliance, directing the office of general counsel and its 25
lawyers and acting as counsel to the chairman, the management committee and the
board of directors. Holmes says, "It doesn't get more challenging than this.
Everything interesting in law, public policy and business whirls around these
issues."
By the time Holmes came on board in March, KPMG had already begun to resolve its
legal problems. It settled the Gemstar case with the SEC by paying $10 million
to shareholders and accepting a censure. And in April it reached a settlement
with the SEC on the Xerox case; KPMG agreed to pay $22.5 million and accept a
censure.
The accounting firm was cooperating with the Justice Department as well. O'Kelly
had hired a new team of outside lawyers, headed by Robert Bennett, the
Washington superlawyer. Bennett, a partner at Skadden, Arps, Slate, Meagher &
Flom, had served as special counsel to the U.S. Senate Select Committee on
Ethics in several major investigations.
Yet, all KPMG's efforts came too little and too late to placate the U.S.
Attorney. Observers say Kelley was determined to indict the company and send a
message to corporate America: Don't fool with the feds. KPMG feared that an
indictment would kill the company and its 18,000 jobs, much as the Enron-related
criminal charges had mortally wounded accounting giant Arthur Andersen.
Just four days after starting his new job in March, Holmes sat down with the
prosecutor. Kelley says that while Holmes came in the midst of negotiations, "he
was a quick study." Kelley was also impressed with how Holmes worked with
Bennett. "Judge Holmes is not afraid to have a strong outside counsel, [and] he
wants your honest opinion," Kelley explains. "I think KPMG is fortunate to have
him there."
Holmes struck an easy rapport with Kelley because they shared the same views
about the wrongdoing and the wrongdoers. Holmes agreed with the prosecutor that
indictments were necessary. The only question was of whom. Holmes, trying to
dissuade Kelley from indicting the firm itself, told the prosecutor that
companies hold a special place in society, and that you harm innocent people
when you indict a business rather than individual wrongdoers. Holmes jokes that
he and the U.S. Attorney agreed on almost everything -- "except indicting the
company."
By June, however, KPMG's efforts seemed doomed. Kelley was ready to indict. But
Holmes and his legal team had one more chance. Holmes recalls, "In my last
meeting with David Kelley, I talked about meeting with the Department of Justice
in Washington," and Kelley agreed to set up a meeting with his boss, Deputy
Attorney General James Comey. Holmes says he appreciates that Kelley "availed us
that opportunity ... and didn't take the final resolution -- indictment -- upon
himself."
According to Holmes, the turning point came at a June 13 summit in Washington
with Kelley and Comey. (Comey has since become general counsel at Lockheed
Martin Corp.) Representing KPMG were Holmes and Bennett, along with KPMG's new
chairman and CEO, Timothy Flynn, and deputy chairman, John Veihmeyer.
At the meeting, Bennett defended KPMG and emphasized its months-long efforts to
cooperate with the government. CEO Flynn described the dire results of any
criminal indictment -- clients fleeing, the firm folding, thousands of employees
laid off. He stressed that the Big Five accounting firms had already shrunk to
four with Andersen's closing, and now could go to three. Holmes assured Comey of
the company's plans for an overhauled ethics and compliance program.
Shortly afterward, Kelley relented and agreed to work with KPMG on the deferred
prosecution agreement. Kelley won't discuss his change of heart except to say,
"I was part of the discussions that came up with that decision." Sources believe
that Comey, who did not return calls for comment, ordered him to do it.
With great relief, KPMG's legal team began negotiating the settlement. Kelley
made tough demands, insisting that KPMG admit to all aspects of the wrongdoing.
The negotiations ran all summer, with Bennett doing most of the direct haggling
with Kelley. However, "We couldn't have gotten the result we got," Bennett says,
if it weren't for Flynn's and Holmes' leadership pushing the negotiations along
and reassuring Kelley of KPMG's commitment to cultural change.
Finally, on Aug. 26, the KPMG board accepted the agreement, and Sven Erik Holmes
signed his name to a waiver of indictment and the deferred prosecution
agreement. At the same time, eight former KPMG employees were indicted, along
with an outside lawyer, R.J. Ruble, formerly a tax partner at Sidley Austin
Brown & Wood's New York office. The government said more indictments will
follow.
Remarking on the agreement, U.S. Attorney General Alberto Gonzales appeared to
echo KPMG's argument. Gonzales cited "the reality that the conviction of an
organization can affect innocent workers and others associated with the
organization, and can even have an impact on the national economy."
Shortly after the settlement, Kelley, as previously planned, left the Justice
Department to become a senior litigation partner at Cahill Gordon & Reindel in
New York. He says he's satisfied with the accord: "At the end of the day, I
think the agreement was a very just outcome."
Part two of Holmes' job has just begun. Already promoted to executive
vice-chairman, Holmes now reports directly to CEO Flynn. Engaging, witty and
openly idealistic, the former judge talks about his plans for the firm as he
eats lunch informally with his staff. He peppers his conversation with asides
about family, baseball (he's a devoted Boston Red Sox fan) and the law.
Holmes inherited a problem-plagued legal department, as well as a slew of civil
suits filed by tax shelter clients who are seeking hundreds of millions of
dollars in damages. (Some of those suits were settled for $195 million in
September.) But his main challenge now is overseeing the changes promised in the
agreement. They include implementing a permanent compliance and ethics program
that will identify high-risk practice areas as well as reportable incidents.
Specifically, the agreement requires that the program punish employees who
violate laws and standards and reward those who report the violators. The
program must also include a hot line to Holmes' office to report any
noncompliance. Holmes has hired Williams & Connolly to do a risk-assessment
study to pinpoint the areas with the most potential for violations. He is also
working closely with Breeden, who started as a court-appointed monitor in
September, according to the terms of the settlement.
Equally important as the policies and procedures, Holmes says, is trying to
bring better communications to KPMG. He wants to make sure that when partners
have legal questions, as some did during the tax shelter days, that they are
addressed by an in-house lawyer who has the authority to give an answer. He also
wants to make sure that when the company asserts attorney-client privilege in
the future, it will be for a good cause and not a "sham," as it was against the
IRS.
Holmes sums up his expectations: "What you want is a system that aspires to get
it right. That's the test of a firm -- do they live in the aspiration? That's
all you can ask."