State Auditor Troy Kelley was named in a 10-count federal indictment alleging tax evasion and lying to investigators.

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TACOMA — State Auditor Troy X. Kelley was defiant Thursday in the face of a 10-count indictment returned by a federal grand jury in Seattle, vowing he was innocent of charges that he illegally kept more than $2 million in fees from prospective homeowners and tried to hide the money from the IRS.

Less than an hour after he stood before a U.S. magistrate judge and pleaded not guilty to felony charges that could send him to prison for up to 20 years, Kelley appeared before reporters at a downtown Tacoma hotel and said he was the victim of a federal witch hunt.

The FBI and IRS, he said, have picked through his life for years, questioning friends and former employees, weaving together what he called an “ill-constructed narrative” to support the indictment.

“They are a long way from proving any wrongdoing,” he said. “I am confident, very confident, I will be able to prove my innocence.

“I did not break the law,” said Kelley, 50, a Democrat and former state legislator who was elected state auditor in 2012. “I want to be extremely clear here, I never ever thought I was breaking the law.”

What could happen next

Although some officials are calling on Troy Kelley to resign as auditor, he says he will take a leave of absence.

If he were convicted of a felony, under state law, Kelley would have to quit.

If he were to resign, the governor can appoint a temporary successor. If Kelley were to leave before May 11, an election would be held this fall to fill out the remainder of his term through 2016. If Kelley were to quit after that, the governor’s appointee would serve until the regular 2016 election.

In addition to the criminal charges, federal prosecutors are seeking a forfeiture of more than $1.4 million in cash.

Kelley left the news conference out a back door, leaving his attorneys to take questions.

The indictment alleges the crimes occurred mostly between 2003 and 2008 and involved Kelley’s former real estate reconveyance business, Post Closing Department. Kelley is alleged to have taken fees he was supposed to refund to prospective homebuyers.

The indictment also claims that, in 2011 and 2012, Kelley paid himself $245,000 a year through a shell company, then illegally wrote off more than $60,000 each of those years for tax purposes for personal and campaign expenses.

Other charges allege he tried to hide the fees from the IRS. The most serious count, which carries a 20-year maximum, involves allegations that Kelley lied during depositions and in declarations filed in a 2010 federal lawsuit against him and his company over the kept fees.

That lawsuit, brought by Old Republic Title, was settled the next year, with Kelley paying more than $1 million.

One of Kelley’s attorneys, Robert McCallum, is a former criminal-tax prosecutor. He acknowledged Thursday, “There is clearly a disagreement as to exactly how Mr. Kelley should have filed his tax returns.”

“I believe this is a civil-tax-timing issue that is very complex and should not be litigated in a criminal forum,” he said.

The investigation has been going on for several years, and Kelley’s attorneys were asked why he would run for elective office knowing about it.

His other attorney, Mark Bartlett, a former senior prosecutor in the U.S. Attorney’s Office in Seattle, said the very fact that Kelley did seek office proves the defense’s proposition that Kelley believed everything he had done was above board.

Troy Kelley gives a statement following his 10-count federal arraignment alleging tax evasion and lying to investigators. (Katie G. Cotterill / The Seattle Times)

“Because if he thought he had done something wrong,” Bartlett said, “the last thing he would have done is run for public office.”

McCallum said Kelley recently paid the IRS more than $400,000, which he hoped would have resolved some of the issues now charged as crimes.

Federal authorities say Kelley was anything but honest in his business dealings.

Kelley “spun a web of lies in an effort to avoid paying his taxes and keep more than a million dollars that he knew did not belong to him, but instead should have been returned to thousands of homeowners across this state,” Acting U.S. Attorney Annette Hayes said in a statement.

With the indictment, pressure built quickly on Kelley to resign. Gov. Jay Inslee, state Attorney General Bob Ferguson, state Treasurer Jim McIntire, several state Democratic lawmakers and both the state Democratic and state Republican parties were among those calling on Kelley to step down.

“This indictment today makes it clear to me that Troy Kelley cannot continue as state auditor,” Inslee said. “He should resign immediately.”

Kelley, however, appears willing to fight to clear his name. He has declared he will take a leave of absence from the Auditor’s Office starting May 1, just more than a month ahead of a scheduled June 8 trial date before U.S. District Judge Ronald Leighton.

Prosecutors didn’t ask that Kelley be detained, and the court gave him permission to travel to Eastern Washington with his son’s soccer team.

As word of the indictment spread Thursday, Doug Cochran, chief of staff for the Auditor’s Office, summed up the revelations: “I think everybody’s sort of shellshocked.”

Federal agents searched Kelley’s Tacoma home in March while he and his family were on vacation. Since then, it has been revealed that authorities requested records relating to Kelley from several state agencies, and that the Auditor’s Office received a federal grand jury subpoena seeking records relating to Jason JeRue.

JeRue formerly worked with Kelley at Post Closing Department. After being elected auditor, Kelley helped create a position in the office for Jerue.

JeRue, who had been working from California and is now on leave, is not named in the indictment.

Federal prosecutors allege Kelley and Post Closing engaged in a drawn-out scheme to placate the concerns of his business partners while keeping fees he had promised to refund. The 41-page indictment alleges that between 2003 and 2008, Post Closing stole up to $2 million by not refunding money due its customers.

According to the indictment, it worked like this: Post Closing was paid by real estate companies to track and file mortgage and refinancing documents. Real estate companies would withhold up to $150 from a borrower’s transaction and turn it over to Post Closing to use for fees. If the fees turned out not to be necessary, Post Closing was to keep a $20 transaction charge but refund the remainder to individual borrowers.

Instead, Kelley kept the entire fee for the vast majority of transactions, according to the indictment, and later moved that money through various accounts.

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At one point, Kelley directed employees to create fake spreadsheets to show that fees were being properly tracked and occasionally issued refunds when someone complained “or to create a defense in the event that he subsequently was questioned about Post Closing Department’s actions,” according to the indictment.

Kelley is also charged with a single count of possession and concealment of stolen property for those allegations.

In a statement Thursday, Kelley claims the indictment criminalizes dealings he had with Old Republic that were resolved in the settlement of a civil lawsuit.

What he was doing, Kelley said, was “squarely in line with standard industry practices.”

It was that lawsuit, brought by Old Republic in 2010, where many of the allegations first surfaced. At the time, Kelley was serving as a state representative from the Tacoma area, which he had represented since 2006.

The lawsuit, brought in federal court, alleged that Kelley, his wife and others at Post Closing had stolen nearly $1.2 million from its customers.

Kelley and Old Republic ended the case in May 2011 with a confidential settlement. While running for auditor a year later, Kelley downplayed the lawsuit as an overblown business dispute, but repeatedly refused to divulge the amount of the settlement.

The indictment revealed Kelley had paid Old Republic $1.15 million — nearly the entire amount in dispute.

Even after that payment, Kelley “maintained approximately $2,581,653 of the funds he had concealed” from the IRS, according to the indictment.

Both Old Republic and another company, Fidelity Title, are named in the indictment as having been victims of the scheme.

Kelley is also charged with corrupt interference of IRS laws, two counts of filing false income-tax returns, and a single count of lying to IRS agents who questioned him in April 2013, a few months after his election as state auditor.

Under state law, Kelley would have to resign if convicted of a felony; if he resigned, Inslee could appoint a temporary successor.

Leave of absence

In the meantime, workers at the Auditor’s Office are trying to determine what a leave of absence for a state official looks like.

Since elected officials don’t earn sick or vacation days, Cochran, chief of staff for the Auditor’s Office, said he thinks that as long as Kelley remains in office, “he gets a paycheck.”

Kelley’s annual auditor’s salary is $116,950.

“It’s sort of unprecedented territory,” Cochran said.

The Auditor’s Office has “asked the Attorney General’s Office to assess the legal issues surrounding this situation,” according to Cochran.

“When we get their analysis we will know how to proceed,” Cochran wrote in an email Thursday evening.

In the meantime, Cochran says he sent a note Thursday morning telling auditor employees to “keep your head down and keep doing the good work you do.”

“It doesn’t really relate to the Auditor’s Office,” he said. “It relates to the state auditor.”