[JURIST] The US Court of Appeals for the Second Circuit ruled [PDF text] Wednesday that a federal judge presiding over the criminal tax fraud prosecution of accounting firm KPMG [corporate website; JURIST news archive] improperly exercised ancillary jurisdiction over a state law contract claim brought against KPMG by 16 former partners and employees of KPMG and vacated the district judge's order "as beyond the district court's power" and dismissed the complaint. The 16 were all defendants in the criminal tax fraud prosecution and had sought to force KPMG to pay for their legal expenses. The dispute arose largely as a result of policies outlined in the Department of Justice's "Thompson Memorandum" [PDF text], which deemed that a "firm's voluntary payment of wrongdoing agents' legal expenses [is] a factor favoring prosecution of the firm." KPMG initially negotiated with the 16 defendants and paid the legal fees of some defendants, but ceased payments after indictments were issued due to pressure from the government. The district court found that there was a violation of the defendant's Fifth and Sixth Amendment rights [JURIST report] to fair trial and effective counsel, and sought to rectify the problem by accepting a contract claim against KPMG by the defendants.

The 16 defendants are accused of setting up tax shelters, costing the US government an estimated $2.5 billion in revenue. KPMG has admitted the tax shelters were illegal and has taken full responsibly for the unlawful conduct [JURIST report]. In August 2005, KPMG agreed to pay the IRS a $456 million fine [JURIST report] to avoid criminal prosecution for the tax shelters, and agreed to be supervised for three years by a former SEC chairman. Dow Jones Newswires has more.