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Ernst & Young Says It Faces Criminal Inquiry on Shelters

Ernst & Young, the big accounting firm, said yesterday that federal prosecutors were investigating tax shelters it had promoted and that it was cooperating with the inquiry.

Disclosure of the Justice Department inquiry, which the firm said it had learned about last week, comes after several statements by the commissioner of the Internal Revenue Service, Mark W. Everson, praising the firm for shutting down its tax shelter unit and for cooperating with I.R.S. auditors.

“As we have done in other inquiries regarding tax shelters, we are cooperating fully with this investigation,” an Ernst & Young spokesman, Charles Perkins, said.

The aggressive tax avoidance techniques sold by Ernst were not limited to the United States. The firm is being sued by some clients in Britain over a device to escape value-added taxes.

The British arm of the firm has said there was nothing improper about any of its tax products.

British tax officials told The Financial Times three weeks ago that Ernst & Young was “probably the most aggressive, creative, abusive provider of schemes and arrangements among the major accountancy firms.”

The criminal investigation in New York, reported yesterday by The Wall Street Journal, comes nearly a year after the Internal Revenue Service announced a settlement with Ernst & Young of civil liability for its tax shelters.

Ernst paid $15 million last July to settle its civil liability for the shelters, and agreed to identify clients and turn over all documents. The firm said that in the first half of 2002 it had stopped selling shelters that the I.R.S. considered abusive.

Mr. Everson, the I.R.S. commissioner, who has emphasized enforcement of the tax laws, said at the time that the settlement “represents a real breakthrough and is a good working model for agreements with practitioners.” He said Ernst & Young had agreed to establish a “quality and integrity program to ensure the highest standards of practice and ongoing compliance with the law and regulations.”

An I.R.S. spokesman, Terry L. Lemons, said the repeated praise from Mr. Everson and the fact that the firm now says it is under criminal investigation did not suggest any split between the I.R.S. and the Justice Department.

“There is absolutely no daylight between the I.R.S. and the Justice Department in our combined efforts to combat abusive tax shelters,” Mr. Lemons said.

Indeed, it could be that Ernst & Young's cooperation with the I.R.S. is behind the impaneling of a grand jury, several former tax and prosecution experts said.

In pledging full cooperation, Ernst & Young may have turned over documents that caught the attention of I.R.S. auditors, who in turn referred the matter to prosecutors. Or the firm may have become aware of conduct by some of its executives, partners, employees or outside advisers that it then brought to the attention of the I.R.S. in hopes of insulating itself from prosecution.

Zachary W. Carter, who leads the white-collar crime department at Dorsey & Whitney and who was the United States attorney in Brooklyn for six years, said the “firm itself may not be in jeopardy, but there may be conduct by individuals that prosecutors think is worth taking a look at.”

“I can't imagine that the Justice Department could be anything but more cautious in exercise of its discretion” to prosecute individuals, rather than firms, “in the aftermath of the process that resulted in the prosecution of Arthur Andersen,” he said.

That prosecution, which diverted public attention from Enron to the conduct of its accounting firm, effectively destroyed Andersen.

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