UPDATE 1-Appeals court upholds KPMG tax shelter convictions

* Convictions upheld of two ex-KPMG officials, one lawyer

* Larson’s $6 million fine found twice as much as allowed (Adds background, details from ruling, byline)

NEW YORK, Aug 27 (Reuters) - A federal appeals court in New York upheld on Friday the convictions of two former KPMG LLP[KPMG.UL] officials and a lawyer over illegal tax shelters, but threw out a $6 million fine against one of the defendants.

A Manhattan jury had in December 2008 convicted former KPMG tax partner Robert Pfaff and former KPMG senior tax manager John Larson on 12 counts each of tax evasion, and former Sidley Austin LLP partner Raymond Ruble on 10 counts of tax evasion.

Prosecutors said the men represented a tax shelter known as BLIPS as a means for clients who earned more than $20 million to eliminate capital gains or regular income for tax purposes.

Larson was sentenced to 10 years, one month in prison and fined $6 million. Pfaff got an eight year, one month prison term and was fined $3 million. Ruble got a 6-1/2 year prison term. The jury acquitted another former KPMG tax partner.

In Friday’s ruling, the U.S. Second Circuit Court of Appeals upheld the convictions and Larson’s prison sentence. But it found Larson’s fine too high, citing a lack of jury findings to support a fine above $3 million. It returned that part of the case to the lower court to recalculate any fine.

The convictions are part of a broader probe into whether KPMG helped wealthy clients set up questionable tax shelters to evade billions of dollars of taxes.

KPMG in August 2005 reached a $456 million accord with the government to avoid possible prosecution.

U.S. prosecutors once called the case their largest ever criminal tax prosecution, but it shrank after charges were dismissed against most of the individual KPMG defendants because the government interfered with their right to counsel.

In Friday’s unsigned ruling, a three-judge Second Circuit panel rejected challenges to the sufficiency of the evidence, including for a jury finding that the transactions “were entirely motivated by tax purposes.”

It also found no errors in U.S. District Judge Lewis Kaplan’s jury instructions and rejected Larson’s argument that his sentence was too long relative to the other defendants.

“We’re deeply disappointed with the court’s decision affirming the conviction and are considering our options for further review,” said J. Scott Ballenger, a lawyer representing Larson. “Of course, we’re gratified by the court’s recognition that the fine imposed was unconstitutional.”

Jack Hoffinger, a lawyer for Ruble, declined immediate comment, saying he had yet to review Friday’s ruling. Lawyers for Pfaff did not immediately return calls seeking comment.

The case is U.S. v. Pfaff et al, U.S. Second Circuit Court of Appeals, Nos. 09-1702, 09-1707 and 09-1790. (Reporting by Jonathan Stempel; editing by John Wallace and Gerald E. McCormick)