Dispatch

• KPMG to be monitored
• Mayflower loses its bloom
• tax credits a “nightmare”
• “accountants putting insurers on the skids”

KPMG to be monitored

KPMG has reached a settlement with the US Justice Department and the Internal Revenue Service to end the legal action against the firm. KPMG has admitted to criminal wrongdoing and agreed to pay $456m in fines, restitution and penalties in return for the deferment of prosecution until the end of next year. Assuming KPMG fully complies with the terms of its agreement, the criminal prosecution will then be dropped.

“In the largest criminal tax case ever filed, KPMG has admitted that it engaged in a fraud that generated at least $11bn in phony tax losses which, according to court papers, cost the United States at least $2.5bn in evaded taxes,” said a statement from the US Department of Justice.

As well as the financial penalties, KPMG will be independently monitored for three years. Richard Breeden, former Securities and Exchange Commission chairman, is to serve as the independent monitor and, at the end of his term, the IRS will continue to monitor KPMG’s tax practice and “adherence to elevated standards” for two further years.

In a statement, Timothy P Flynn, KPMG chairman and chief executive, said: “KPMG LLP is pleased to have reached a resolution with the Department of Justice. We regret the past tax practices that were the subject of the investigation. KPMG is a better and stronger firm today, having learned much from this experience. The resolution of this matter allows KPMG to confidently face the future as we provide high quality audit, tax and advisory services to our large multi-national, middle market and government clients.”

KPMG added: “All of the individuals indicted are no longer with the firm. KPMG has put in place a process to ensure that individuals responsible for the wrongdoing related to past tax shelter activities are separated from the firm… With regard to claims by individual taxpayers, KPMG looks forward to resolving the civil litigation expeditiously and with full and fair accountability.”

But KPMG’s settlement marks another stage in the prosecution process, not its end. Nine individuals will now be prosecuted. These include Jeffrey Stein, former deputy chairman of KPMG; John Lanning and Richard Smith, former vice chairmen in charge of tax; Philip Wiesner, former partner in charge of the Washington tax office; Jeffrey Eischeid, Robert Pfaff and Mark Watson, all KPMG partners; and John Larson, a former senior tax manager at the firm. One non-KPMG defendant has been named: Raymond Ruble, a former tax lawyer at Sidley Austin Brown & Wood.

In addition, Domenick DeGiorgio - head of the financial group at bank HVB - has pleaded guilty to participation in the provision of fraudulent tax shelter schemes and the supply of false documents to support the transactions. Further prosecutions are expected, probably including executives at other banks.

Earlier this year, the US Senate Permanent Subcommittee on Investigations issued a report after investigating the sale of tax shelters. Senator Norm Coleman, chairman of the subcommittee, said when the report was published: “Abusive tax shelters hurt the American people, the honest hard working families that pay their fair share. This report details how accountants, lawyers, bankers, and investment advisers developed, implemented, and mass-marketed cookie-cutter tax shelters used to rip off the Treasury of billions of dollars in taxes.”

The report named several more accountancy firms, banks and legal firms as having sold what it described as “abusive tax shelters”, with charities also becoming involved in the transactions.

• KPMG’s former chairman and chief executive in the US, Eugene O’Kelly, has died at the age of 53. O’Kelly oversaw the initial stages of the action against the firm over tax shelters until resigning in June when he was diagnosed with cancer.

Mayflower loses its bloom

PricewaterhouseCoopers is to face disciplinary complaints over its audits of the Mayflower Group, following an investigation into the collapsed bus maker by the Accountancy Investigation and Discipline Board.

In its first investigation, the AIDB has bared its teeth and, as a result, PwC is in the dock. More than a year after beginning its consideration of events in the collapse of Mayflower and its Transbus subsidiary, AIDB has decided to file a complaint against PwC to be heard by an independent tribunal, convened by the AIDB.

The hearing will also hear charges laid by the AIDB against Mayflower’s former finance director, David Donnelly. However, no charges will be heard against Arthur Andersen, which audited Mayflower’s accounts until 2002. The investigation against a former Transbus employee, John Shelton, is still being finalised.

PwC is accused regarding its audit of the 2002 Transbus accounts, specifically relating to the treatment of an invoice discounting facility. The tribunal will consider whether the impact of the discount facility should have raised questions about the company’s ability to continue as a going concern beyond the end of 2003. Donnelly faces charges both regarding these matters, but also about the refinancing of the group’s banking facilities at the end of 2003 and the failure of the company to disclose the discovery of accounting irregularities.

Mayflower failed to make payments in full under its invoice discounting arrangements to HSBC, but it appears this debt was not recorded in the accounts. The accounting failures produced a £20m error in the company’s books, increasing the group’s total liabilities to around £250m. Parts of the Mayflower Group have been in administration since March last year, with Deloitte appointed as administrator. Several parts of the group, including Transbus, have since been sold.

A spokeswoman for PwC said: “We are surprised that the AIDB has chosen to file disciplinary complaints against this firm. In July 2004 the AIDB announced an enquiry into the events surrounding the collapse of the Mayflower Group. Since then, we have examined the conduct of the relevant audits carefully and we are very confident that they were planned and conducted with due skill and care. We consider the complaints to be misconceived and we look forward to explaining why that is the case to the tribunal.”

Shareholders of Mayflower have considered taking legal action for losses arising from a £63m rights issue in 2002. Law firm Edwin Coe represented a shareholders’ action group, but it is unclear whether the legal action - claiming that the rights issue was made on a false prospectus - will proceed. Edwin Coe did not respond to our requests for a comment.

The collapse of Mayflower sparked concerns about corporate governance in mid-sized companies, as the group did not conform with the Higgs recommendations. It had two non-executive directors, one of whom had been former UK prime minister, Sir John Major, but he was not replaced when he resigned in 2002.

The AIDB can seek to impose unlimited fines on firms or individuals, or to have them expelled from the profession’s representative bodies. Reference to the AIDB was made by ACCA and ICAEW.

PwC is still defending its auditing practices regarding both the collapsed bank BCCI and another engineering company TransTec, which has a confusingly similar name to that of Mayflower’s subsidiary. TransTec’s chairman was Geoffrey Robinson, a former Labour Government minister.

tax credits a "nightmare"

The UK Government’s tax credit system has been described as “a nightmare” by MPs who monitor public spending. Criticisms have been endorsed by ACCA, which has called for an immediate review of the system.

Edward Leigh, chairman of the House of Commons Public Accounts Committee, said that despite changes to tax credit administration, it appeared that the system was not working any better. “The introduction and operation of the Inland Revenue’s new tax credits system have been a nightmare. The Revenue has yet to produce reliable evidence that the flood of public money being wasted under the previous tax credits scheme through fraud and error has been stemmed to any degree. And hundreds of thousands of genuine claimants, many of them vulnerable people in very difficult circumstances, have been seriously mistreated.”

Leigh added that although the new tax credits system was supposed to be simpler to administer and simpler for claimants to understand, in practice the system routinely overpays large numbers of claimants. He said that 1.8m claimants were overpaid for the 2003–04 tax year. “This is no kindness to people in desperate financial circumstances, for many have subsequently to cope with repayment demands by the department,” argued Leigh. After the introduction of new tax credits, hundreds of thousands of claimants were not paid on time.

The committee said that it was important to recognise that worthy but ambitious schemes could be undone by excessive complexity. In an attempt to try to fix the tax credits problems, Revenue & Customs staff were moved from tax work to assist with tax credits administration, creating a continuing backlog in the handling of tax cases and enquiries.

Chas Roy-Chowdhury, ACCA’s head of taxation, welcomed the intervention of the MPs. “The PAC report shows that the Revenue’s so-called ‘new tax credits system’, introduced in 2003, has not improved over two years as it uses outdated earnings figures to calculate awards,” he said. “This resulted in 1.8m (33%) of claimants being overpaid in 2003-04. For it to work fairly and effectively, the Revenue needs to ensure that it is proactive and not rely so heavily on individuals to give the information necessary to receive the correct tax credits.

“As many of those eligible to claim are taxed under PAYE, their payroll details are already within the Revenue’s system. The Revenue should be made to co-ordinate its systems so that information already held on thousands of people is kept up to date. This would dramatically help improve the overpayments situation, which is currently causing distress among many families who are being chased to repay monies to the Revenue.” Roy-Chowdhury urged the Government to write-off overpayments and conduct a “root and branch review” of the system.

John Whiting, tax partner at PwC, added: “Inevitably a lot of people who claim them do not have advisers and probably have not dealt with tax offices before, and here lies some of the problem. But you can’t get away from the fact that tax credits have paid a lot of people a lot of money and done a lot of good. But it has messed a lot of people around. It does need to be improved.”

The Child Poverty Action Group, a charity, is now taking a legal test case against the Inland Revenue, arguing it has broken its own rules for recovery of overpaid benefits. CPAG says that although these state that claimant circumstances must be taken into account when overpayments are recovered, in practice benefits are automatically reduced after an overpayment comes to light.

The “new” tax credits - Child and Working Tax Credits replaced the “old” Working Families’ and Children’s Tax Credits in April 2003. But, in some circumstances, even people earning over £50,000 can be eligible to receive payments under the new system. “A lot of accountants, especially small ones, will have some clients and their families for whom they will have to deal with tax credits,” said Roy-Chowdhury. “Many accountants will deal with all the family’s financial affairs, including their children’s, and this is something they need to know about.”

"accountants putting insurers on the skids"

Accountants, standards setters, regulators and actuaries are to blame for restricting the capacity of insurers to build up their necessary long term reserves, according to a report from the Centre for the Study of Financial Innovation.

CSFI’s report criticises action taken against insurers over “finite reinsurance” contracts - regarded by many regulators as debt disguised as reinsurance and under which no risk is transferred. The use of finite reinsurance has been at the heart of both the New York attorney-general’s investigation into the American Insurance Group (AIG) and the criminal proceedings in Australia following the collapse of HIH.

Finite reinsurance “is a rational response to the exigencies of an irrational accounting and regulatory environment”, says CSFI. “In other words, because accountants and regulators fail to understand that insurance needs special treatment to allow (indeed, to encourage) accumulation of substantial long term reserves, the insurers have been driven to develop finite re contracts (and other derivatives) as a way to build up the provisions they need without being held to ransom by the taxman.”

AIG is described as “one of the best managed firms in the industry, driven to finite re in order to protect its stakeholders”. But the insurance sector is being undermined by “the perverse rules that accountants impose and the madness of the plaintiffs’ bar”, says CSFI. Now the insurance sector is itself at risk, it is argued, by the cumulative pressures of asbestos and pharmaceutical litigation and the treatment of finite reinsurance contracts.

Andrew Hilton, director of CSFI, says: “The short termism of the current accounting rules and the failure of accountants and regulators to acknowledge where insurance is special may end up driving a stake through the heart of the insurance industry.”

The paper is sponsored by the Worshipful Company of Insurances, whose David Bland argued that insurers were having to cope with “absurd regulation and stiflingly inept accounting standards and practices”.

CSFI is a financial services think-tank, chaired by Sir Brian Pearse, former chief executive of Midland Bank and finance director of Barclays Bank, who is now a non-executive director of Britannic Assurance. Other CSFI governing council members include: Peter Cooke, former chairman of the worldwide regulatory practice of PwC in London; Robert Bench, former vice chairman of PwC’s regulatory practice and managing partner in Washington; Richard Lambert, former editor of the Financial Times; Charles Goodhart, professor of finance at the London School of Economics and a former member of the Bank of England’s monetary policy committee; and Angela Knight, a former Conservative Government minister and now director-general of the Association of Private Client Investment Managers and Stockbrokers.