By Gene Johnson and Derrick Nunnally

The Associated Press

TACOMA — State Auditor Troy Kelley, the elected official charged with rooting out government fraud and waste, pleaded not guilty Thursday after a federal grand jury indictment charged him with filing false tax returns, attempted obstruction of a civil lawsuit and possession of more than $1 million in stolen property related to his former business.

The 41-page indictment, unsealed earlier in the day, alleged various misdeeds by Kelley in connection with mortgage title services companies he previously ran. Federal prosecutors said he kept more than $1 million that should have been refunded to customers and that he unlawfully avoided paying taxes by claiming personal or campaign expenses were business-related.

“Mr. 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 L. Hayes said.

Kelley was flanked by his attorneys as he appeared Thursday afternoon for his arraignment at U.S. District Court in Tacoma. He pleaded not guilty to 10 felony counts and a magistrate judge set trial for June 8.

The most serious charge carries up to 20 years in prison. A felony conviction would automatically force him from office, and some lawmakers spoke about the possibility of impeaching him in light of the charges alone.

In a statement, Kelley said he was disappointed by the indictment and that he would take a temporary leave of absence beginning May 1, but that he was “determined to fight back.”

“For the past few years, I have been the subject of an intense investigation by the federal government about my private business practices going back more than 10 years,” he said. “I am very confident that I will be able to prove my innocence.”

Gov. Jay Inslee called on Kelley to resign, as did Attorney General Bob Ferguson.

“This indictment today makes it clear to me that Troy Kelley cannot continue as state auditor,” Inslee said in a statement.

At his court appearance, Kelley appeared calm and said “Yes, your honor,” in a clear voice when U.S. Magistrate Judge J. Richard Creatura asked if he understood the charges.

With no objection from prosecutors, Creatura allowed Kelley to go free on bond. He cannot travel outside Washington without notifying federal authorities.

At a news conference after his court hearing Kelley read aloud the statement he had distributed before and took no questions.

“I did not break the law,” he said.

He then left while his criminal attorney, Mark N. Bartlett, a former top federal prosecutor in Seattle, spoke about the allegations. Bartlett and Kelley’s tax attorney, Robert N. McCallum, said the indictment charged Kelley with ducking taxes he was in the process of paying.

“This is a prosecution that is flawed both in execution and in conception,” Bartlett said.

Speculation has been swirling around Kelley, a Democrat elected in 2012, since last month, when federal agents searched his home and subpoenaed the auditor’s office for records concerning a longtime business associate who subsequently went to work for him at the state agency.

Days after the search, Kelley wrote a $447,000 check to the U.S. Treasury Department, noting in the subject line that it would cover future tax debts, the indictment said.

Kelley’s company, Post Closing Department, worked with escrow and mortgage title companies to track real estate transactions. According to the indictment, it was supposed to collect up to $150 in advance as a fee for each transaction; keep $15 to $20 for its services; pay any government fees required; and then refund whatever portion remained. Instead, Kelley kept the money, the indictment said — an amount that totaled at least $3 million from 2006 to 2008.

“Contrary to his representations, Troy X. Kelley did not refund unused portions of reconveyance fees to borrowers, but instead fraudulently retained, stole, and converted them to his own use,” the indictment said.

One of the escrow companies Kelley worked with, Old Republic Title, sued him in 2009. He eventually paid more than $1 million to settle the case.

Attempted obstruction of a civil lawsuit carries a maximum sentence of up to 20 years. Possession and concealment of stolen property carries up to 10 years. Kelley is also charged with corrupt interference with internal revenue laws.

The government is also seeking an order that Kelley forfeit nearly $1.5 million.

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Johnson reported from Seattle. Rachel La Corte contributed from Olympia.