Accounting firm KPMG LLP on Monday agreed to pay $456 million to settle a federal probe of its sales of fraudulent tax shelters, avoiding a criminal indictment that might have crippled the firm.

While KPMG (search), the smallest of the major U.S. accounting houses, itself escaped an indictment of the kind that destroyed Arthur Andersen (search) when it was convicted of destroying documents, eight former partners, including its former deputy chairman, and a KPMG lawyer, were indicted for selling the tax shelters to wealthy clients.

An outside monitor, Richard Breeden (search), a former Securities and Exchange Commission chairman, was appointed to oversee the firm's compliance with the settlement, which includes an agreement to shut down its tax practice for high net worth individuals within six months.

"That is a big blow, it was one of their flagship businesses that was quite profitable," said Robert Willens, accounting and taxation analyst with Lehman Brothers.

Auditor watchdog Public Company Accounting oversight Board said it remained confident in KPMG's ability to perform "high quality" audits. Legal experts said the firm's problems are not yet over, since it still has to deal with civil lawsuits from tax shelter clients.

"It's a big victory for KPMG, but they have only resolved the criminal matters," said Jonathan Feld, attorney with Chicago firm Katten Muchin Rosenman LLP.

GOVERNMENT LOSSES

In a press conference in Washington, U.S. Attorney General Alberto Gonzales said the settlement was designed to avoid hitting employees and others with "collateral consequences.

"With these actions we are protecting the efforts of honest businesses as well as deterring future crimes," Gonzales said.

The government said KPMG made $115 million in fees in a fraudulent conspiracy that stretched from 1996 to 2003.

The accounting firm generated at least $11 billion in phony tax losses for wealthy individuals and prevented the government from collecting $2.5 billion in tax receipts, the department said.

Those charged include the firm's former deputy chairman, Jeffrey Stein, and others who were involved in its tax practice.

Federal agents for more than three years have been investigating tax shelters that were sold by KPMG mostly to wealthy individuals.

"KPMG 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," said the firm's chairman and chief executive, Timothy P. Flynn, in a statement.

The shelters at issue are no longer sold by KPMG. The accounting industry generally has scaled back its shelter business amid a surge of official probes and bad publicity.

According to federal government documents on the probe, KPMG sold three "abusive" tax products: Bond-Linked Issue Premium Structure, or BLIPS, Foreign Leveraged Investment Program and Offshore Portfolio Investment Strategy.

A lawyer for Richard Smith, one of the indicted former partners, criticized Monday's settlement, saying it was an attempt to "criminalize" the type of tax planning that tax professionals engage in on a daily basis.

"There is nothing hidden, fraudulent or criminal about the BLIPS transaction. It was fully and openly reviewed and approved by many KPMG professionals and independent law firms who believed that BLIPS complied with the tax law. No court has ever held that the BLIPS transaction does not work," said Robert Fink of law firm Kostelantez & Fink, LLP.

"If the government wants to put an end to these types of transactions, the proper response is for Congress to change the law, not to scare professionals away with indictments. It is a misuse of prosecutorial discretion to use criminal prosecutions to change accepted and legitimate standards of conduct," Fink added.