Under the settlement, KPMG agreed that the $456 million in penalties won't be tax-deductible and cannot be paid with insurance proceeds.

Also charged in the indictment was attorney Raymond J. Ruble, a former New York partner at law firm Sidley Austin Brown & Wood LLP, who wrote legal opinions supporting some of the shelters in question. All nine defendants are expected to plead not guilty. Their arraignments are scheduled for next week.

At a news conference in Washington, Attorney General Alberto Gonzales said the Justice Department weighed "collateral consequences" in deciding not to indict KPMG, three years after the 2002 indictment of former Enron Corp. auditor Arthur Andersen LLP triggered the accounting firm's collapse. He said the decision to settle for a deferred-prosecution agreement with KPMG "reflects the reality that the conviction of an organization can affect innocent workers and others associated with the organization, and can even have an impact on the national economy," Indeed, the Justice Department will continue using KPMG as its own outside auditor, in a vote of confidence for the firm.

In a statement, KPMG Chairman Timothy Flynn said the firm "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."

Prosecutors said the four shelters cited in the indictments -- known by the names Blips, Flip, Opis and a previously unpublicized shelter similar to Blips, called "Short Option Strategy" -- generated more than $11.2 billion of false tax losses from 1996 through 2002 for the hundreds of wealthy Americans who bought them.

The indictment accused the defendants of using various means to fraudulently conceal the shelters from the government, including failing to register them with the IRS, preparing tax returns that disguised the shelters' effects, and using sham attorney-client privilege claims. It also accused some of the defendants of lying to the IRS and to a Senate investigative panel during public hearings in November 2003.

Some defendants' lawyers blasted the government's charges, along with KPMG for cooperating with prosecutors' investigation. Stanley Arkin said the indictment of his client, Jeffrey Eischeid, "and certain of his partners represents a serious abuse of federal prosecutorial discretion and, as well, a profound betrayal by KPMG of its partners." Mr. Eischeid formerly was in charge of the KPMG unit that designed and sold the four shelters in question.

"By bringing these indictments, the government is attempting to criminalize the type of tax planning that tax professionals engage in on a daily basis," said Robert Fink, an attorney for Mr. Smith. "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."

Michael Madigan, an attorney for Mr. Lanning, said his client "does not have a criminal bone in his body. Today's indictment is a miscarriage of justice, and we look forward to our day in court. It's a tragedy to see what the government and KPMG have done today."

David Spears, an attorney for Mr. Stein, said his client "intends to vigorously contest the charges," but declined to comment further. An attorney for Mr. Ruble declined to comment. Others charged include two former KPMG accountants, John Larson and Robert Pfaff, who left the firm to form an outside advisory company that participated in KPMG shelter sales. Mr. Larson's lawyer, Steven Bauer, said "these defendants are good people, and if there's justice they'll win the case." An attorney for Mr. Pfaff declined to comment.

Also charged were former KPMG partners Philip Wiesner and Mark Watson, who once held top positions in the firm's Washington tax office. Mr. Watson's indictment comes as a surprise. During November 2003 hearings before the Senate Permanent Subcommittee on Investigations, he testified about his attempts to dissuade senior partners from approving one of the four shelters in question, Blips, which stands for Bond Linked Issue Premium Structure. Emails showed he cautioned other KPMG partners that the strategy wasn't legitimate.

In its indictment yesterday, the government used those statements against him. As part of its deferred-prosecution agreement, KPMG admitted that Blips was a fraudulent tax shelter. The strategy depended in part on securing loans from banks to finance the loss-generating transactions. Prosecutors say the loans were bogus because the money never left the banks.

An attorney for Mr. Watson declined to comment. Martha Rogers, an attorney for Mr. Wiesner, who also was involved in developing Blips, said his department's review of Blips "was performed in good faith" by people "who believed then and believe now that they were following KPMG policies and procedures with respect of a review of a tax opinion and applicable tax laws." She said Mr. Wiesner "categorically denies the allegations against him in the indictment."

Write to Jonathan Weil at jonathan.weil@wsj.com⁴