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Office of the Chief Accountant:
KPMG/KCI Initial Public Offering

October 16 Letter from KPMG LLP

KPMG

J. Terry Strange
Vice Chairman
345 Park Avenue
New York, NY 10154-0102
Telephone 212 909 5050
Fax 212 909 5048
jtstrange@kpmg.com

October 12, 2000

Mr. Lynn Turner
Chief Accountant
Office of the Chief Accountant
United States Securities
and Exchange Commission
450 Fifth Street, N. W.
Washington, D.C. 20549

Re: KPMG Consulting, Inc. Initial Public Offering (the "IPO")

Dear Mr. Turner:

We hereby request that the Staff of the United States Securities and Exchange Commission advise that, based upon and subject to the matters referred to herein, it will not recommend that the Securities and Exchange Commission take enforcement action against KPMG LLP ("KPMG"), or any other firms not owned by KPMG but conducting audit activities outside the United States for SEC registrants under the name "KPMG" or derivations thereof (collectively, "KPMG Non-US") asserting that KPMG or KPMG Non-U.S. is not "independent" based upon the attribution to KPMG or KPMG Non-U.S. of the activities of KPMG Consulting, Inc. ("KCI") following the completion of the transaction described below.

Legal Analysis

The federal securities laws require that financial statements filed with the Commission by public companies, investment companies, broker-dealers, public utilities, investment advisers and others be certified (audited) by independent public accountants.¹ The federal securities laws also authorize the Commission to define "accounting, technical and trade" terms used in the federal securities laws.²

The Commission has adopted Rule 2-01 of Regulation S-X, which provides, in part, that the "Commission will not recognize any certified public accountant or public accountant as independent who is not in fact independent."³ Rule 2-01 (b) provides that an accountant will not be considered independent of a registrant in which "he, his firm, or a member of his firm had...any direct financial interest or any material indirect financial interest." Rule 2-01 further provides that:

In determining whether an accountant may in fact be not independent with respect to a particular person, the Commission will give appropriate consideration to all relevant circumstances, including evidence bearing on all relationships between the accountant and that person or any affiliate thereof, and will not confine itself to the relationships existing in connection with the filing of reports with the Commission.⁴

The Commission's interpretations of Rule 2-01 are collected in Section 600 of the Codification of Financial Reporting Policies ("Codification"), entitled "Matters Relating to Independent Accountants."⁵ Section 602.01 of the Codification states that a materiality standard is used when assessing indirect financial interests because "some latitude for judgment is necessary in order to avoid undue hardship and expense to registrants and to accounting firms having a widespread accounting practice " In addition, Section 602.02.c of the Codification restricts the independent accountant from performing "bookkeeping and related professional services" that might cause a "mutuality of interest" to develop between the auditor and its client. Finally, Section 602.02.g of the Codification addresses business relationships - such as joint ventures, limited partnership agreements, and investments - that may impair an auditor's independence. That section provides, in part, that:

Direct and material indirect business relationships...with a client...will adversely affect the accountant's independence with respect to that client. Such a mutuality or identity of interests with the client would cause the accountant to lose the appearance of objectivity and impartiality in the performance of his audit because the advancement of his interest would, to some extent, be dependent upon the client.

KPMG desires to obtain assurance that, to the extent KCI provides certain consulting services for, enters into business relationships with, and/or makes investments in KPMG audit clients or to the extent that KPMG audit clients invest in KCI, KPMG's independence will not be deemed impaired pursuant to Rule 2-01 and Sections 602.01, 602.02.c, 602.02.g, or other provisions of the Commission's independence rules.

KPMG believes that, under the conditions detailed in this letter, it would not have a "mutuality of interest" or a "direct or material indirect business relationship" with, or a "direct financial interest or material indirect financial interest" in any of its audit clients that are also clients of or enter into business relationships with or invest in KCI, or in which KCI invests. This conclusion is based on the conditions detailed in this letter, which will, among other things: 1) limit at the outset and within five years end KPMG's equity interest in KCI; 2) impose limitations on KCI's use of the KPMG name; 3) require a strict separation of the corporate governance of KPMG and KCI; 4) forbid any revenue or profit sharing between KPMG and KCI; 5) forbid any joint marketing agreements between KPMG and KCI; and 6) limit any shared services between KPMG and KCI.

Factual Background

Pursuant to the Separation Agreement, dated as of December 29, 1999 (the "Separation Agreement"), and other agreements specified therein (the "Ancillary Agreements" and, together with the Separation Agreement, the " Agreements"), KPMG agreed to contribute the Consulting Business, as defined in the Non-Competition Agreement,⁶ to KPMG Consulting, LLC in exchange for membership units, which were distributed to KPMG and many of its partners (the "Separation"). Units of KPMG Consulting, LLC were then exchanged for KCI common shares (the "Exchange"). At the completion of the Separation and Exchange, KPMG Consulting, LLC was 99.5% owned by KCI. Pursuant to certain separate agreements, Cisco Systems, Inc. ("Cisco") acquired convertible preferred stock of KCI, which Cisco subsequently agreed to convert into the common stock of KCI at the time of the IPO, and KCI is obligated to repurchase from Cisco any shares of preferred stock that would convert into more than 9.9% of the common stock of KCI. Upon completion of the IPO of KCI common shares, no more than 19.9% of the common shares of KCI will be held by KPMG and its assurance and tax partners, approximately 8% of the common shares will be held by the former KPMG partners or employees who became employees of KCI or its subsidiaries after the Separation and Exchange, 9.9% will be held by Cisco and the remaining approximately 62% or more will be held by the public. Other key terms of the transaction are:

For five years following the closing of the IPO, KPMG will not compete with KCI by engaging in or holding itself out as engaged in the Consulting Business (as defined in footnote 6 of this letter) transferred to KCI.
After the closing of the IPO, there will be no corporate governance, management or direct or indirect financial ties between KPMG and KCI (other than KPMG's ownership of KCI common stock and the transition services arrangements described below).
The shares of KCI common stock held by KPMG and its assurance and tax partners as a result of the transaction will represent less than 20% of KCI's issued and outstanding common stock as of the close of the IPO. KCI stock options are not held by KPMG or its assurance and tax partners. KCI stock options are held by employees and directors of KCI. As such options vest, the percentage ownership of KCI common shares held by KPMG will be reduced further.⁷

Conditions to No-Action Confirmation

We request that, subject to compliance with the following conditions, the SEC Staff not recommend enforcement action to the Commission based upon the attribution to KPMG or KPMG Non-U.S. of the activities of KCI following completion of the KCI transaction under the following conditions:

KPMG and its assurance and tax partners will dispose of their KCI common stock within five years of the closing date of the IPO (subject to the limited exception specified below in this paragraph). KPMG and its assurance and tax partners will own less than 20 percent of KCI stock immediately following the closing of the IPO. The calculation of the percentage of KCI common stock owned by KPMG and its assurance and tax partners will be based on the percentage of outstanding KCI common stock owned by KPMG and its assurance and tax partners and pension funds for active partners at that time. Shares owned by former consulting partners or retired partners with no continuing role or financial interest (other than through a self-directed or fully funded retirement plan) in KPMG and shares which are acquired by partners or employees of KPMG and KPMG Non-U.S. after the IPO and which are subject to no transfer restrictions will be deemed not to be owned by KPMG and its assurance and tax partners for the purposes of this condition.
KCI will be entitled to use a variant of the "KPMG" name and logo (e.g., "KPMG Consulting, Inc.") for a transitional period of four years beginning at the closing of the IPO, as long as:
(i) All publications, letterhead and stationery, name plates, office signage, business cards and similar materials clearly designate KCI as not owned by KPMG (e.g. "an independent consulting firm"); and
(ii) KPMG does not represent in any publication, advertisement, press release, name plates, office signage, business cards or other similar material that it is the same firm, or controls, manages, governs or is affiliated with KCI, KCI's consulting business or any other affiliate, subsidiary or division of KCI; and
(iii) KCI does not represent in any publication, advertisement, press release, name plates, office signage, business cards or other similar material that it is the same firm, or controls, manages, governs or is affiliated with KPMG or any affiliate, subsidiary or division of KPMG.
KCI and KPMG will maintain separate corporate governance, management and financial structures and interests including: separate boards of directors (including no contractual right by KPMG to representation on KCI's Board of Directors and no service on the KCI Board of Directors by any then-active KPMG partner or employee or former partner or employee with continuing financial ties to KPMG other than under retirement benefit plans available to broad categories of former personnel), executives, employees, capital, credit lines or facilities, client bases, governing documents, operating policies, financial operations and financial and accounting policies. KCI and KPMG will not exert financial or other influence over the other party's corporate governance, management and financial structures or interests (except that KPMG may exercise its voting rights in respect of its KCI common stock).
After the closing of the IPO, KPMG will not accrue, pay to or receive from KCI any royalty, interest, dividend or other payment, whether or not tied to the performance of what was, before the Separation, the Consulting Business, except for dividends payable to all KCI shareholders and payments required to be made under the Agreements (e.g., indemnity, transition services etc.), which payments are described in the Addendum A attached hereto. Accordingly, KPMG and KCI will not share profits or revenue from consulting or any other engagements or agreements. Subsequent to the IPO and prior to the disposition of KCI shares by KPMG described in paragraph 11 below, when providing professional services to the same client, KPMG and KCI will do so only pursuant to separate individual agreements with that client. During this period, KPMG and KCI will not enter into prime/subcontractor relationships to provide professional services to the same client.
KPMG and KCI may, but will be under no obligation to, refer clients to one another; KPMG will not designate KCI as a preferred provider of services. KPMG and KCI may not pay referral fees or other compensation for such referrals to each other nor to any subsidiary, affiliate, employee or agent of the other entity. KPMG and KCI may not enter into any co- or joint marketing, advertising or similar agreements or arrangements which are inconsistent with the foregoing conditions or which do not clearly state that KPMG and KCI are separate firms.
KPMG Non-US and KCI may, but will be under no obligation, to, refer clients to one another; KPMG Non-US will not designate KCI as a preferred provider of services. KPMG Non-US and KCI may not pay referral fees or other compensation for such referrals to each other nor to any subsidiary, affiliate, employee or agent of the other entity. KPMG Non-US and KCI may not enter into any co- or joint marketing, advertising or similar agreements or arrangements which are inconsistent with the foregoing conditions or which do not clearly state that KPMG Non-US and KCI are separate firms.
KPMG and KCI will enter into a Transition Services Agreement for internal accounting and information services, office facilities and other services specified in Schedule A to the Transition Services Agreement. The services provided under this arrangement will have varying terms. Services and facilities identified in the definitive documents and certain other assets will be provided in accordance with the Transition Services Agreement so long as (i) KCI is physically separate from KPMG's other businesses and (ii) charges for such use are determined at arm's length (defined as cost, the basis historically used by KPMG to allocate expenses to its Consulting Business) and appropriate provision is made so that confidential information is not communicated between KPMG and KCI. Under the Transition Services Agreement, KPMG will not receive services from KCI and KPMG will not generate a profit on the services it provides KCI. The term for the provision of the services pursuant to the Transition Services Agreement will in no event be longer than three years after the closing of the IPO, except the term for provision of information technology and software and processing services, as specified in Schedule A to the Transition Services Agreement, may be four years. Only after the completion of the disposal of KCI shares by KPMG and its assurance and tax partners described in paragraph 11 below, KCI may, without obligation, if it determines that it is in KCI's economic best interest, choose to contract with KPMG to provide some of the services specified on Schedule A to the Transition Services Agreement. KCI and KPMG have entered into or will enter into sublease arrangements for all office space that KCI currently shares with other KPMG businesses. Under these arrangements, KCI will pay the cost of such space, including related services and capital costs, based on the total square footage of each facility used by KCI. The sublease arrangements with KPMG for each space will extend for the same term as the term of the lease currently held by KPMG. With respect to new leases for office space, KCI and KPMG individually will enter directly into such leases with the landlord and will not enter into new subleases with each other for office space after the expiration of the leases currently held by KPMG. Until such relocations are made, KPMG and KCI will have separate and distinct office signage and their offices will be clearly distinguishable from one another although they may share certain common facilities.
KPMG will not enter into any separate licensing agreements with KCI with respect to the intellectual property owned by KCI.
KPMG will consent to periodic reviews by Commission Staff or an independent party designated by the Commission or its Staff to ascertain that KPMG is complying with the conditions herein provided.
In accordance with the Agreements, at the closing of the IPO, KPMG will cease engaging in the Consulting Business (as defined in footnote 6 of this letter). Notwithstanding the previous sentence, KPMG may, after five years, provide the services that make up the Consulting Business and may provide such services to audit clients that file reports with the Commission to the extent permitted by Commission independence requirements or professional standards.
Immediately after the closing of the IPO, KPMG and its assurance and tax partners will hold less than 20% of the common shares of KCI. The shares will be subject to restrictions on sale pursuant to a standard lock-up arrangement with the underwriters of the IPO. The shares held by the assurance and tax partners will be disposed of on a pro rata basis over the five years following the closing of the IPO. KPMG will retain a portion of its shares for general firm purposes. The remaining shares held by KPMG, if any, will be set aside for distribution to the assurance and tax partners (the "Additional Partners' Shares") over a period of time. As soon as possible after the IPO date, 10% of the Additional Partners' Shares will be distributed to the assurance and tax partners and, subject to any required registration of such shares under the Securities Act of 1933, will become freely tradable upon expiration of the lock-up arrangement. The remaining Additional Partners' Shares will be distributed to the assurance and tax partners in up to five annual installments and, subject to any required registration of such shares under the Securities Act of 1933, will be free from restrictions on sale upon distribution. KPMG has registration rights to require KCI to file a registration statement for disposition or transfer of shares held by KPMG as soon as practicable after the IPO. The Additional Partners' Shares will be disposed of or retained at the discretion of the partners based on their individual investment and tax requirements. In any event, the KCI shares held by KPMG will be disposed of by the fifth anniversary date of the IPO.

Upon completion of the disposition of the KCI shares by KPMG and its assurance and tax partners as described in paragraph 11, KPMG and KCI will be free to contract and enter into business relationships with one another as would any other two independent entities.

Certain Confirmations

In connection with its request herein, KPMG hereby confirms to the Staff that:

After closing, KPMG and KPMG Non-U.S. will continue to be subject to the independence requirements of the securities laws and the SEC's independence rules and interpretations issued thereunder to the same extent as they were so subject prior to the closing.
KPMG agrees to the above conditions and has furnished a copy of this letter (and will furnish any final agreement on this subject) to KCI. KCI will expressly acknowledge that it has been furnished a copy of this letter. KPMG further represents to the Staff that it is not aware of any provisions of the Agreements or any agreement or instrument referred to therein that is inconsistent with this no-action letter in any material respect.
KPMG has furnished the Staff a copy of the penultimate draft of the Separation Agreement and Ancillary Agreements (including without limitation the schedules, exhibits and annexes thereto) and hereby represents to the Staff that the final executed versions of such documents will not differ in any respect material to the matters referred to in this letter from the drafts so furnished.⁸

Confirmation Requested

Based upon the foregoing representations and subject to compliance with the conditions set forth above, we hereby request that the Staff of the Securities and Exchange Commission advise that if an audit client of KPMG or KPMG Non-U.S. is also a client of, enters into a business relationship with, invests in, or is invested in by KCI, the Office of the Chief Accountant will not assert, on any of those grounds, that KPMG's or KPMG Non-U.S.'s independence from that audit client has been impaired. KPMG acknowledges that the relief requested by this letter will become effective if the IPO closing occurs within 90 days of the date of the issuance by the Staff of the confirmation requested above. In the event the IPO does not take place within 90 days of the receipt of such confirmation, KPMG may reapply for the relief requested in this letter.

****

Thank you for your attention to this matter. We look forward to receipt of the above mentioned confirmation letter.

Sincerely,

J. Terry Strange
Vice Chairman

Attachment

Footnotes

¹	See e.g., 15 U.S.C. 77aa(25), (26), 15 U.S.C. 78l, 78q, and 78m, 15 U.S.C. 79e(b), 79j, 79n, 15 U.S.C. 80a-8, 80a-29, 15 U.S.C. 80b-3(c)(1).
²	See 15 U.S.C. 77a(a), 15 U.S.C. 78c(b), 15 U.S~C. 79n(a), and 15 U.S.C. 80a-37(a).
³	17 C.F.R. 210.2-01 (1996).
⁴	Id.
⁵	Financial Reporting Codification, Section 600 - Matters Relating to Independent Accountants, reprinted in SEC Accounting Rules (CCH) ¶ 3,851. At 3, 781.
⁶	The Non-Competition Agreement defines "Consulting Business" as the provision of "Consulting Services" and "Consulting Supporting Services." The Consulting Services are enumerated in Appendix A to the Non-Competition Agreement.
⁷	In the event of a subsequent acquisition by KCI of one or more of the consulting businesses of KPMG Non-US using stock of KCI, the aggregate holdings of KPMG and KPMG Non-U.S. and their assurance and tax partners will be reduced such that the total ownership collectively held by KPMG and its assurance and tax partners and by KPMG Non-US and its assurance and tax partners will be less than 20% of the total issued and outstanding common stock of KCI, subject to the exceptions set forth in paragraph no. 1 of the conditions set forth below.
⁸	In the event of a subsequent acquisition by KCI of one or more of the consulting businesses of KPMG Non-U.S. using stock of KCI, KPMG acknowledges that the independence of KPMG Non-U.S. will be deemed to be impaired unless the terms and conditions of the agreements effecting such a transaction do not differ in any material respects from the terms and conditions described in this letter.

ADDENDUM

POSSIBLE PAYMENTS UNDER THE AGREEMENTS¹

Separation Agreement (Article 6)	Customary covenants arising from the separation of KPMG's and KCI's respective businesses.
Separation Agreement (Section 12.2)	Customary cross-indemnification provisions for damages arising from the operation of KPMG's and KCI's respective businesses or from breaches of representations and warranties in the Separation Agreement
Non-Competition Agreement (Section 2.3)	Termination provision providing for the payment of damages by either KPMG or KCI in the event of an early termination of the agreement caused by the merger of either KPMG or KCI with a competitor of the other
Transition Services Agreement (Section 2.01 )	KCI will make payments to KPMG for the provision of certain services and pursuant to certain subleases during the transition period.
Transition Services Agreement (Section 5.01)	Customary indemnification provision for Losses suffered by KCI as a result of the breach of the Transition Services Agreement by KPMG
Transition Services Agreement (Section 7.02)	KCI shall pay KPMG the excess termination costs incurred by KPMG in the event KCI terminates the agreement to provide shared services prior to the end of the specified term without KPMG's consent.
Registration Rights Agreement (Section 7)	Customary cross-indemnification provision for losses suffered pursuant , to the registration statement or under : the securities laws.
____________________ ¹ Not included on the Addendum are payments to be made with the proceeds of the IPO.

Reply

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON. D.C. 20549

OFFICE OF THE CHIEF ACCOUNTANT

October 16, 2000

Mr .J. Terry Strange KPMG LLP
280 Park Avenue
New York, New York 10017

Dear Mr. Strange:

The staff has reviewed your letter of October 12,2000 concerning the planned initial public offering of KPMG Consulting, Inc. ("KCI"). In your letter, you detail key terms of the transaction and conditions that KPMG LLP ("KPMG") will comply with following completion of the transaction. Your letter concludes that, following completion of the transaction and under the specified conditions, KPMG would not have a "mutuality of interest" or a "direct or material indirect business relationship" with, or a "direct financial interest or material indirect financial interest" in any of its audit clients that are also clients of or enter into business relationships with or invest in KCI, or in which KCI invests.

Assuming that the representations set forth in your letter are and continue to be accurate, and further assuming that KPMG continues to comply with each of the conditions set forth in your letter, the Office of the Chief Accountant ("OCA" or the "staff") will not assert that KPMG's independence from an audit client has been impaired solely because that audit client is also a client of, enters into a business relationship with, invests in KCI, or is invested in by KCI. Of course, KPMG otherwise remains fully subject to the Commission's independence requirements. OCA has taken this no-action position based on its evaluation of the relevant legal and policy considerations and does not hereby adopt or endorse the analysis or conclusions set forth in your letter.

As noted, the staff's position is contingent upon the accuracy of KPMG's representations as well as KPMG's continued compliance with the conditions set forth in your letter. In addition to your letter's representations, the staff notes oral representations that: 1) the term "assurance and tax partners" used in your letter includes all of KPMG's partners; 2) any termination costs payable to KPMG at the conclusion of the transition services agreements will be made solely for the acquisition of assets; and 3) KPMG's disposition of its KCI shares will not be part of any plan or arrangement that would allow KPMG to reacquire the KCI shares. In addition, the conditions detailed in your letter will, among other things: 1) limit at the outset and within five years end KPMG's equity interest in KCI; 2) impose limitations on KCI's use of the KPMG name; 3) require a strict separation of KPMG and KCI's corporate governance; 4) forbid any revenue sharing between KPMG and KCI; 5) forbid any joint marketing agreements between KPMG and KCI; and 6) restrict any shared services between KPMG and KCI. OCA emphasizes the importance of strict compliance with the conditions detailed in your letter. Failure to comply with any of these conditions will vitiate this no-action position. Further, this response expresses OCA's position only on these particular facts and circumstances and does not purport to express any legal conclusions on this or any other matter.

Sincerely,

Lynn E. Turner
Chief Accountant

cc: Gary G. Lynch, Esq.

http://www.sec.gov/info.accountants/noaction/kmpgnoac.htm

Office of the Chief Accountant: KPMG/KCI Initial Public Offering