The Lawyers For the Parties in the Egan Trial

I have previously discussed here Judge Saylor's epic opinion in Egan knocking down two tax shelters as fraudulent and offered here here excerpts from the opinion knocking the lawyers roles in the underlying fraudulent tax shelter transactions. I now provide the list of attorneys from LEXIS-NEXIS who appeared before Judge Saylor to represent the parties and certain nonparties (a movant, a third party witness, and 2 interested parties). It appears that all involved were well-represented.  The lawyers are:

For Fidelity International Currency Advisor A Fund, L.L.C., by the Tax Matters Partner, Plaintiff: David J. Curtin, James D. Bridgeman, Kiara Rankin, Sheri A. Dillon, William F. Nelson, LEAD ATTORNEYS, Bingham McCutchen LLP - DC, Washington, DC; John O. Mirick, LEAD ATTORNEY, Mirick, O'Connell, DeMallie & Lougee, Worcester, MA; Michelle Levin, LEAD ATTORNEY, PRO HAC VICE, Bingham McCutchen LLP - DC, Washington, DC; Ronald L. Buch, LEAD ATTORNEY, PRO HAC VICE, Bingham McCutchen LLP, Washington, DC; David K. McCay, Mirick, O'Connell, DeMallie & Louggee, LLP, Worcester, MA.

For United States of America, Defendant: Dennis M. Donohue, LEAD ATTORNEY, Washington, DC; Barry E. Reiferson, U.S. Department of Justice, Trial Attorney, Tax Division, Washington, DC; Heather L. Vann, U.S. Department of Justice, Washington, DC; John Lindquist, U.S. Department of Justice, Tax Division, Washington, DC.

For BDO Seidman LLP, Movant: Diana L. Erbsen, Ellis L. Reemer, LEAD ATTORNEYS, Frank J. Jackson, DLA Piper US LLP, New York, NY; Lisa S. Core, DLA Piper Rudnick Gray Cary US LLP, Boston, MA.

For Proskauer Rose LLP, Third Party Witness: Christopher L. DeMayo, LEAD ATTORNEY, Dewey & LeBoeuf LLP, Boston, MA; David M. Lederkramer, LEAD ATTORNEY, Proskauer Rose LLP, New York, NY; Lawrence M. Hill, Mark D. Allison, LEAD ATTORNEYS, Dewey & LeBoeuf LLP, New York, NY.

For KPMG LLP, Interested Party: Armando Gomez, LEAD ATTORNEY, Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC.

For RSM McGladrey, Inc., Interested Party: David E. Walters, Matthew M. Neumeier, LEAD ATTORNEYS, Howrey LLP, Chicago, IL; Peter J. Karol, Robert L. Kann, Sunstein Kann Murphy & Timbers LLP, Boston, MA.

Update on Prospects for Swiss Parliamentary Approval of the Deal

The NYT reports here that there are indications of a shift toward Parliamentary approval of the US / UBS / Swiss deal requiring UBS to turnover of 4,450 names of U.S. taxpayers hiding money -- and probably taxable income -- in UBS. Swiss Parliamentary action is expected in June.

Those U.S. taxpayers who expected / hoped the Swiss would hunker down to save them, may be disappointed. Their failure to join the voluntary disclosure program earlier may cost them significantly, at least in terms of penalties.  And, of course, I would expect that some will be criminally charged.

What the Egan Court (Judge Saylor) Said About the Lawyers

In the Egan case I discussed yesterday here, Judge Saylor was tough on the lawyers. I thought lawyers (who I presume are the principal readers of this blog) may find it at least interesting to read his detailed conclusions regarding the lawyers’ behavior.

There were two principal law firms involved in issuing the Egan opinions that would, the parties hoped, give the taxpayers risk-free access to the audit lottery for which they charged large premium fees (sort of like the driver of the get away car for a bank robbery charging a lot more than a tax driver would charge). These firms were Proskauer Rose, LLP ("Proskauer") and Sidley Austin Brown & Wood LLP ("Sidley Austin"). The principal partner at Proskauer was Ira Akselrad. The partner at Sidley was R.J. Ruble. The following portions of the opinion are Judge Saylors' focused factual conclusions (and are based on many detail fact findings earlier in the opinion)

UU. The Egans Did Not Receive Independent Legal Advice from Proskauer and Sidley Austin

1234. Both Proskauer and Sidley Austin had an inherent conflict of interest in purporting to render legal advice to the Egans.

1. Proskauer and Sidley Austin Did Not Provide Independent Legal Advice

1235. As described above, R.J. Ruble of Sidley Austin and Ira Akselrad of Proskauer Rose actively assisted DGI/Helios in the design, development, marketing, and implementation of the tax shelter strategy and its variants. (Exs. 797, 798, 809, 814).

1236. Among other things, Ruble and Akselrad provided input on the strategies, commented on the marketing materials, and provided or commented on model legal opinions to use in the promoting tax shelter strategy.

1237. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios used the names and reputations of their law firms and their model opinions in marketing the strategy to prospective clients.

1238. As part of the strategy, Ruble and Akselrad agreed in advance to provide favorable legal opinions in order to induce taxpayer-investors to utilize the strategy.

1239. Ruble and Akselrad knew, or reasonably should have known, that the issuance of favorable legal opinions from prominent law firms was a central feature of the successful promotion of the strategy.

1240. As also described above, in the FDIS marketing materials, DGI/Helios had stated that one of its "most valuable" contributions to its clients was in "ability to firmly manage and control the process of getting . . . attorneys . . . to expeditiously reach the desired conclusions" (Ex. 809 (emphasis added)).

1241. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios was marketing the strategy in that fashion.

1242. Proskauer provided at least 28 favorable opinions, and Sidley Austin provided at least 30 favorable opinions, in support of the tax shelter strategy. (Ex. 1519).

1243. Proskauer and Sidley Austin provided legal advice both to DGI/Helios and to the individual taxpayer/investors who invested in the tax shelter strategy.

1244. Proskauer specifically acknowledged to the Egans, in a draft representation letter dated April 11, 2002, that it represented DGI/Helios and therefore had a conflict of interest if it also represented the Egans. (Ex. 1772).

1245. In addition, Ira Akselrad of Proskauer personally participated in a DGI tax shelter transaction in 2000. (Exs. 669, 2759). The favorable opinion letter concerning his personal transaction was issued by Brown & Wood on December 31, 2000. (Ex. 669).

1246. As described above, DGI/Helios played a substantial role in the drafting and delivery of the legal opinions by Proskauer and Sidley Austin.

1247. As described above, in nearly all instances, the legal fees of Proskauer and Sidley Austin were paid by DGI/Helios rather than the taxpayer/investors. Ruble and Akselrad were aware of that arrangement.

1248. DGI/Helios paid the fees of Proskauer and Sidley Austin in order to assert firmer management and greater control over the opinions rendered by the law firms. (Ex. 809).

1249. Proskauer and Sidley Austin derived substantial profit from the promotion and sale of the tax shelter strategy, and therefore had a financial interest in upholding the strategy.
1250. The Egans knew, or reasonably should have known, that the legal advice they received from Proskauer and Sidley Austin was not independent, and that the firms had an inherent conflict of interest.

2. The Egans Knew That the Legal Advice from Proskauer and Sidley Austin Was Not Independent

1251. The Egans were highly sophisticated taxpayers with considerable business experience,

1252. The Egans and their advisors knew that DGI/Helios marketed its ability to "manage and control the process" of getting attorneys "to expeditiously reach the desired conclusions." (Id.).

1253. The Egans and their advisors knew, or reasonably should have known, that DGI/Hellos had arranged in advance for four law firms, including Proskauer and Sidley Austin, to render favorable opinions to taxpayer/investors.

1254. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin had developed model opinions, and that they had rendered favorable opinions for other taxpayer/investors who had used the same or similar strategies.

1255. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin intended to render favorable opinions from the onset of the transactions.

1256. The Egans and their advisors knew that their communications with Proskauer and Sidley Austin were frequently shared with DGI/Helios and KPMG.

1257. The Egans and their advisors knew that none of their communications with Proskauer and Sidley Austin were privileged, or marked "privileged."

1258. The Egans and their advisors provided their comments on the draft opinions to James Haber or Tim Speiss, and not exclusively (or even always directly) to the law firms.

1259. The Egans received a draft engagement letter from Proskauer that specifically noted a conflict of interest based on the fact that Proskauer also represented DGI/Helios.

1260. The Egans and their advisors knew, or reasonably should have known, that Proskauer had a conflict of interest, because it also represented DGI one of the principal promoters of the tax shelter strategy.

1261. The Egans and their advisors knew that the fees of Proskauer and Sidley Austin (other than the fee for the non-disclosure letter by Proskauer) were paid by DGI/Helios.

1262. The Egans would not have paid Helios for the transactions until Helios provided satisfactory and favorable legal opinion letters.

VV. The Proskauer Opinion for Fidelity High Tech Was Based on Unreasonable Factual Assumptions

1263. The Proskauer opinion letter dated April 5, 2002, on the Fidelity High Tech transaction was based on unreasonable factual assumptions, including assumptions that the Egans knew, or reasonably should have known, were untrue.

1264. The Egans did not reasonably rely on the April 5, 2002, Proskauer opinion letter for tax reporting purposes.

1. The Opinion Contained False and Misleading Factual Assumptions

1265. The Proskauer opinion letter was purportedly based on factual representations that were false and misleading.

a. Investor Representation No. 1 Was False

1266. Paragraph I of the Investor Representations in the Proskauer opinion letter stated:

Investors entered into the options trades to hedge against market volatility in a large concentrated holding of technology stock so as to produce an overall economic profit. Investors believed that the options were correlated to this concentrated position so that the options would produce an effective hedge.

(Ex. 122 at 8-9). This representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).

1267. That representation was false from both a subjective and objective standpoint.

1268. From a subjective standpoint, the Egans did not enter into the option trades '"to hedge against market volatility." Moreover, the Egans did not believe that the options "would produce an effective hedge."

1269. From an objective standpoint, as described above, the transaction was not reasonably designed to create an effective hedge.

b. Investor Representation No. 2 Was False

1270. Paragraph 2 of the Investor Representations in the Proskauer opinion letter stated:

Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Option would be profitable and on Investors own independent evaluation, Investors believed they had a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits.

(Ex. 122 at 9 (emphasis added)). That representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).

1271. That paragraph is template language, and is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).

1272. That representation was false from both a subjective and objective standpoint.

1273. From a subjective standpoint, the Egans did not believe that they had "a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor [that is, Alpha] as to the probability of the referenced property reaching certain price levels at which the Option would be profitable," nor did they conduct an "independent evaluation."

1274. From an objective standpoint, as described above, there was no reasonable possibility of profit on the option trades in excess of all fees and transaction costs and without regard to tax benefits.

c. Investor Representation No. 3 Was False

1275. Paragraph 3 of the Investor Representations in the Proskauer opinion letter stated:

Each investor contributed his or her membership interest in [Index] or [Option] to [Fidelity High Tech] for substantial non-tax business reasons, including the short term risk management of concentrated stock positions.

(Ex. 122 at 9). That representation was also made almost verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).

1276. That paragraph is template language, and similar language is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).

1277. That representation was false from both a subjective and objective standpoint.

1278. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.

1279. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. There was no reasonable possibility of profit on the transaction, and the transactions did not provide "short term, risk management of concentrated stock positions."

d. Investor Representation No. 10 Was False or Misleading

1280. Paragraph 10 of the investor Representations in the Proskauer opinion letter stated:

There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that owner of the Options and Bank were contractually obligated to perform under the Options in accordance with their stated terms.

(Ex. 122 at 9). That representation was also made verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).

1281. That paragraph is template language, and is also found essentially verbatim in the Sidley Austin opinion letter. (Ex. 121 at 13).

1282. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.

1283. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 122 at 36).

1284. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity High Tech transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.

e. The Date of the Original Contribution of EMC Stock Was False

1285. The High Tech Certificate of Facts falsely stated that Richard and Maureen Egan had contributed shares of EMC stock to High Tech on February 7, 2001. Those shares were actually contributed on September 8, 2000.

1286. If the Proskauer opinion letter had correctly stated that Fidelity High Tech had been holding EMC stock since September 8, 2000, it would have been more obvious that there was no business purpose for the Egans to acquire options in Index A and Option A, and then within days thereafter transfer those options to High Tech.

2. The Opinion Omitted Essential Facts

1287. The Proskauer opinion letter did not include any facts concerning the true purpose of the Fidelity High Tech transaction, which was to create an artificial step-up in basis in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.

1288. The Proskauer opinion letter did not include any facts concerning the design and implementation of the Fidelity High Tech transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.

1289. The Proskauer opinion letter did not include any facts concerning the amounts of fees paid to Helios and KPMG on the transaction. The omission of those facts was unreasonable.

1290. The opinion omitted any reference to the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."

1291. The omission of the fees was deliberate, and was done at the instruction of Orrin Tilevitz to Michael Swiader at Proskauer. (Ex. 1621).

3. Proskauer Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts

1292. As described above, Ira Akselrad of Proskauer personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.

1293. As also described above, Akselrad was personally substantially familiar with the Fidelity High Tech transaction independent of the Certificate of Facts executed by the Egans, including the Egans' purposes in entering into the transaction.

1294. Among other things, Akselrad knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that the transaction was designed and intended to generate an artificial step-up in basis, and had no other purpose; (4) that the transaction served no genuine hedging or risk-reduction function; and (5) that there was no economic substance to the transaction.

1295. Ira Akselrad therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.

4. Richard Egan Did Not Read the Certificate of Facts or the Proskauer Opinion Letter

1296. Richard Egan did not read the Certificate of Facts relating to the High Tech transaction before signing it. (R. Egan, 3:100-01).

1297. Richard Egan did not read the legal opinion letter from Proskauer relating to the High Tech transaction at the time it was issued, and, in fact, did not read it until the IRS initiated an audit years after the opinion was issued. (Id. at 3:76-77).

WW. The Sidley Austin Opinion for Fidelity international Was Based on Unreasonable Factual Assumptions

1298. The Sidley Austin opinion letter dated March 8, 2002, on the Fidelity International transaction was based on unreasonable factual assumptions. Including assumptions that the Egans knew, or reasonably should have known, were untrue.

1299. The Egans did not reasonably rely on the March 8, 2002 Sidley Austin opinion letter for tax reporting purposes.

1. The Opinion Contained False and Misleading Factual Assumptions

1300. The Sidley Austin opinion letter was purportedly based on factual representations that were false and misleading.

a. Investor Representation No. 1 Was False

 1301. Paragraph 1 of the Investor Representations in the Sidley Austin opinion letter stated:

Investor entered into the Transaction for substantial non-tax business reasons, predominately related to offsetting various investment risks associated with a large single concentrated holding in a U.S. technology company, and to hedge against currency fluctuations in international markets in which this technology company has significant currency exposure due to sales. . . . Also investor has entered into certain Options to hedge against interest rate fluctuations. . . .

(Ex. 121 at 12) (emphasis added). That representation was also made verbatim in paragraph 1 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1302. That representation was false from both a subjective and objective standpoint.

1303. From a subjective standpoint, the Egans did not enter into the transactions for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid income taxes.

1304. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. The transactions did not offset "various investment risks," nor was it reasonably designed to create an effective hedge against "currency fluctuations" or "interest rate fluctuations."

b. Investor Representation No. 2 Was False

1305. Paragraph 2 of the Investor Representations in the Sidley Austin opinion letter stated:

Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Options would be profitable and on Investor's own independent evaluation, Investor believed that he had a reasonable opportunity to earn a reasonable profit from the Transactions in excess of all fees and transaction costs and without regard to tax benefits.

(Ex. 121 (emphasis added)). That representation was also made verbatim in paragraph 2 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1306. That paragraph is template language, and is also contained in the Proskauer opinion letter. (Ex. 122 at 9).

1307. That representation was false from both a subjective and an objective standpoint.

1308. From a subjective standpoint, the Egans did not believe that they had a "reasonable opportunity to earn a reasonable profit from the transaction in excess of all fees and transaction costs and without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor" as to "the probability of the referenced property reaching certain price levels at which the Options would be profitable," nor did they conduct an "independent evaluation."

1309. From an objective standpoint, as described above, there was no reasonable possibility of profit from the transaction in excess of all fees and transaction cots and without regard to tax benefits.

c. Investor Representation No. 3 Was False

1310. Paragraph 3 of the Investor Representations in the Sidley Austin opinion letter stated:

Investor contributed the membership interest in World to [Fidelity] International for substantial non-tax business reasons. . . . .

(Ex. 121 at 12). That representation was also made verbatim in paragraph 3 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1311. That representation was false from both a subjective and an objective standpoint.

1312. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.

1313. From an objective standpoint, there were no substantial non-tax business reasons to contribute the membership interest in World to Fidelity International.

d. Investor Representation No. 9 Was False of Misleading

 1314. Paragraph 9 of the Investor Representations in the Sidley Austin opinion letter stated:

There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that Investor/World (and International as transferee of Investor) and Counterparty were contractually obligated to perform under the Options in accordance with their stated terms.

(Ex. 121 at 13). That representation was also made verbatim in paragraph 9 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1315. That paragraph is template language, and is also found verbatim in the Proskauer opinion letter. (Ex. 122 at 9).

1316. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.

1317. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 121).

1318. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity International transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.

2. The Opinion Omitted Essential Facts

1319. The Sidley Austin opinion letter did not include any facts concerning the true purpose of the Fidelity International transaction, which was to create an artificial loss in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.

1320. The Sidley Austin opinion letter did not include any facts concerning the design and implementation of the Fidelity International transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.

1321. The Sidley Austin opinion letter did not include any facts concerning the role of the foreign partner in the transaction, including the fact the fact that he invested no funds, bore no risk, added no value, and was separately compensated by the promoters for his role in the transaction.

1322. The Sidley Austin opinion letter did not include any facts concerning the amounts of fees to Helios and KPMG on the transaction. The omission of those facts was unreasonable.

1323. The opinion omitted the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."

3. Sidley Austin Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts

1324. As described above, R.J. Ruble of Sidley Austin personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.

1325. As also described above, Ruble was personally substantially familiar with the Fidelity International transaction independent of the representation letter executed by Richard Egan, including the Egans' purposes in entering into the transaction.

1326. Among other things, Ruble knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that Samuel Mahoney was not a true partner; (4) that the transaction was designed and intended to generate losses for tax purposes, and had no other purpose; (5) that the transaction served no genuine hedging or risk-reduction function; and (6) that there was no economic substance to the transaction.

1327. R.J. Ruble therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.

4. Richard Egan Did Not Read the Investor Representation Letter

1328. Paragraph 10 of the representation letter relating to the Fidelity International transaction states as follows: "Investor has reviewed the description of the Transactions attached hereto and such description is accurate and materially complete." (Ex. 78).

1329. Richard Egan did not read the representation letter relating to the Fidelity International transaction before signing it. (R. Egan, 3:100).

XX. Both the Proskauer Opinion Letter and the Sidley Austin Opinion Letter Were Based on Unreasonable Legal Assumptions

1330. The purported purpose of the Proskauer and Sidley Austin opinion letters was to advise the Egans of the potential tax consequences of the Fidelity transactions.

1331. The April 5, 2002, Proskauer opinion letter, among other things, contained the following conclusions:

(1) "that for federal income tax purposes it is more likely than not" that the claimed step-up in basis would be "used to compute gain on the sale of the [stock in Fidelity High Tech]";

(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of [the Egans and Alpha], the Transactions would have the requisite business purpose and economic substance";

(3) that "[t]he step transaction doctrine would not apply to recharacterize the Transactions";

(4) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and

(5) the IRS "should not be successful were it to assert a penalty against an Investor under Section 6662(b)(2) or (3)."

(Ex. 122 at 10-12).

1332. The March 8, 2002 Sidley Austin opinion letter, among other things, contained the following conclusions:

(1) that "for federal income tax purposes it is more likely than not" that the claimed step-up in basis, and the claimed allocations of gains and losses, would be respected;

(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of investor, the Transactions would have the requisite business purpose and economic substance";

(3) that "[although the matter cannot be entirely free from doubt because of the factual nature of the inquiry, on balance, the requisite profit motive exists to support the deduction of any loss from the Transactions under Code Section 165(c)(2) and Code Section 183";

(4) that "[The step transaction doctrine would not apply to the Transactions";

(5) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and

(6) that "the IRS should not be successful were it to assert a penalty against Investor Code Section 6662(b)(2) or (3) for positions taken on Investor's federal income tax return with respect to the Transactions."

(Ex. 121 at 16-18).

1333. A reasonable opinion letter would have laid out the likely positions that would be asserted by the IRS, and discussed the relevant authorities, whether favorable or unfavorable, in order to evaluate the likelihood that the courts would uphold the positions taken by the Egans.

1334. The opinion letters superficially purport to discuss the relevant authorities, but in reality their analysis is incomplete, incorrect, and misleading in multiple respects.

1335. Furthermore, the opinion letters were not written as a measured or reasoned analysis of a likely legal outcome, but rather as advocacy pieces intended to defend a previously determined conclusion.

1336. For example, any reasonable and experienced tax attorney would have recognized that the IRS would assert that the economic substance doctrine (or a variant) would apply to the Fidelity High Tech and the Fidelity International transactions. Both opinion letters recognize that fact, and both devote several pages to a purported analysis of that issue.

1337. The Proskauer opinion letter concluded that the Fidelity High Tech transaction would be upheld even if it had no economic substance, as long as the taxpayer was subjectively motivated by a business purpose other than obtaining tax benefits. (Ex. 122 at 29). It then stated in conclusory fashion that the Egans "contributed the Options and the Stock to [High Tech], and Maureen [Egan] contributed her interest in [High Tech] to [MEE Holdings], for substantial non-tax business reasons including investment management, risk control, and estate planning purposes which reasons would likely satisfy any business purpose requirement for engaging in the Transactions." (Id. at 31).

1338. The Proskauer opinion letter thus effectively assumed that the transaction would be upheld as long as the Egans represented that they subjectively believed the transaction had a business purpose.

1339. No reasonable tax attorney would assume that a transaction of that nature would be recognized and upheld by the courts simply because the taxpayer made a self-serving statement about his or her supposed business purpose.

1340. Because Richard Egan was a resident of Massachusetts, it should have been obvious that there was a substantial likelihood that the applicability of the economic substance doctrine would be litigated in the First Circuit. The opinion letter, however, contains no mention of any relevant First Circuit case law on the subject. Among other things, the opinion letter does not mention, much less analyze, the First Circuit's opinion in Dewees v. Comm'r, 870 F.2d 21 (1st Cir. 1989), a tax shelter case in which the court noted (in a discussion of Section 165(c)) that where the "objective features of the situation are sufficiently clear, self-serving statements from taxpayers could make no legal difference."

1341. Furthermore, and in any event, Proskauer knew, or reasonably should have known, that the Egans subjectively had no non-tax business reasons or purposes for entering into the transaction.

1342. The Sidley Austin opinion letter indicated that different circuits took different approaches to the economic substance doctrine, but that the "correct" approach was to uphold the transaction if it had either a business purpose (a subjective inquiry) or economic substance (an objective inquiry). (Ex. 121 at 62). The opinion later, and inconsistently, stated that it is "well-established that a transaction . . . will not be respected for tax purposes unless the transaction . . . [has] economic substance separate and distinct from the economic benefit derived from the tax reduction." (Id. at 70).

1343. Like the Proskauer opinion letter, the Sidley Austin opinion letter addressed the Egans' purported "business purpose" in conclusory fashion:

Investor believed that he had a reasonable opportunity to earn a reasonable profit, in excess of all fees and transaction costs, from the Transaction, without regard to tax benefits. Also as stated above, Investor contributed the Options to International for substantial non-tax business reasons, including hedging of risk in a highly concentrated stock, hedging currency risk as foreign markets made up an increasingly large component of the business in their concentrated holdings, and hedging currency risk with respect to a line of credit, the professional management provided by [Alpha], and the desire to create a larger pool of capital through the involvement of other investors such as [Samuel Mahoney].

(Id. at 62).

1344. Like the Proskauer opinion letter, the Sidley Austin opinion letter did not mention the Dewees case, or otherwise address the issue of whether the courts were likely to accept self-serving statements from taxpayers at face value.

1345. Like Proskauer, Sidley Austin knew, or reasonably should have known, that the Egans subjectively had no such business reasons or purposes for entering into the transaction.

1346. The discussion in the Proskauer opinion letter concerning the "economic substance" of the Fidelity High Tech transaction contained virtually no analysis of the actual facts of the transaction. (Ex. 122 at 32-34).

1347. The discussion in the Sidley Austin opinion letter concerning the "economic substance" of the Fidelity International transaction contained some factual analysis. (Ex. 121 at 70-77). That opinion letter, however, ignored several critical issues, such as whether the Fidelity International transaction actually served a reasonable hedging function, or whether the Egans had a reasonable possibility of profit in excess of fees and costs associated with the transaction.

1348. The discussion in both opinion letters as to whether the transactions described in IRS Notice 2000-44 are the "same as" or "substantially similar to" the High Tech transaction was incomplete and misleading. (Exs. 122 at 35; 121 at 93-98). Indeed, the opinion letters disposed of the issue summarily, with virtually no analysis.

1349. The Proskauer opinion letter stated that in the Notice 2000-44 transaction, the contribution of the option spread "directly results in a tax loss," whereas in the High Tech transaction, "the increased outside basis resulting from the contribution of the option spread simply permits investors to avoid a taxable gain." (Ex. 122 at 35). No explanation was given as to why the creation of an artificial basis step-up through the contribution of an option spread is not "substantially similar" to the creation of an artificial loss through the contribution of an option spread. Likewise, the opinion letter stated that in Notice 2000-44, the taxpayer's net economic outlay was described as "zero or nominal," whereas in the High Tech transaction it was "far greater than 'nominal.'" (Id.). Again, no explanation was given as to why a net economic outlay that was a small fraction of the claimed tax benefit is not "substantially similar" to an outlay that was "nominal."

1350. The Sidley Austin opinion letter contained the same language verbatim. (Ex. 121 at 97-98).

1351. In summary, the neither opinion letter provided a meaningful or coherent analysis as to several critical issues, including the applicability of the economic substance doctrine.

1352. The lack of a meaningful or coherent analysis as to those issues was deliberate. The authors of the opinion letters knew that it was not likely that the Fidelity High Tech or Fidelity International transaction would survive a legal challenge in which all the underlying facts were made known.

1353. The purpose of the opinion letters was not to provide legal guidance, but to provide a potential defense against the imposition of penalties, and thus to induce the taxpayer/Investor to enter into the transaction.

1354. The Egans were highly sophisticated and experienced taxpayers and knew, or reasonably should have known, that the legal analysis in the opinion letters was not reasonable.


[END OF EXCERPTS]
--------------------------------

Although not making similar findings and conclusions for other law firms, Judge Saylor does note (par. 123) that two other law firms were involved in "worked with DGI/Helios and KPMG to develop and market the strategy and to issue favorable opinions": Bryan Cave; and Lord, Bissell & Brook. Among other findings about their participation at the various steps in developing and marketing, Judge Saylors also finds (par. 476) that

476. As with the earlier marketing presentations, the September 17 PowerPoint presentation indicated that the Egans could obtain a "more likely than not" tax opinion from one of four law firms: Sidley Austin (the successor by merger to Brown & Wood), Proskauer, Bryan Cave, or Lord Bissell. (Id.).

Now, if one wanted to extrapolate or speculate, then ...

Judge Finds Ambassador's Tax Shelter Transactions Bullshit (Actually Worse Than That)

I have previously noted here that a Claims Court judge, in effect, held that a tax shelter transaction was bullshit. Another case does the same thing, although it does not exactly use the BS word. Judge F. Dennis Saylor, District Judge for Massachusetts, has handed down a whopping – both in length and effect on the taxpayers – opinion in Fidelity International Currency Advisor A Fund, LLC v. United States (4:05-cv-40151), a TEFRA proceeding involving Son-of-Boss tax shelters. The taxpayers involved (when the drill down on the partnerships is made) were Richard and Maureen Egan. Richard Egan was former Ambassador to Ireland. He and his wife made too much money. He and his wife did not like to pay tax. They entered phony transactions to shelter large gains.  They did not pay the tax. They tried to hide their activity from the IRS.  They were caught.  His estate and his wife will have to pay the tax, interest on the tax, apparently the accuracy related penalties, and interest on the accuracy related penalties. (I would think that, given the strength of the judge's view of the taxpayers' misbehavior, the Government / IRS might be sorely tempted to assert the civil fraud penalty when the action moves to the taxpayer level; note that if fraud was involved as the court held and the partnership is a sham, everything could drill down to the taxpayers' returns and the civil statute would be open indefinitely (see prior posts here and here); I haven't thought this through yet, so maybe someone will comment on it.)

The opinion is 357 pages long as issued by the court. The only copy of the opinion that I have is a whopping scanned pdf the original which is large, not easy to read and is not searchable. Hence, I offer up here an OCR'd version that I hope has been reasonably OCR'd (I have not tried to proof read it; note that when you click, the document will come up in google docs which I find difficult to work with; I recommend that you download the document (click on top of screen in Google Docs) and view it in regular pdf format which is both bookmarked and searchable.).

I won't try to summarize the opinion, because the Court does that for us as follows:

I. INTRODUCTION

A. Summary of Facts

Richard J. Egan was one of the founders of EMC Corporation, a large, publicly-traded manufacturer of computer storage devices. By the year 2000. Richard Egan and his wife Maureen had amassed enormous personal wealth, the great majority of which was in the form of EMC stock.

The Egans were highly sophisticated taxpayers; Richard Egan was one of the most successful businessmen in the history of the United States. His personal and family financial affairs, including the management of his wealth and the payment of his taxes, occupied an entire organization of twenty or so employees, which included his three sons, at least two certified public accountants, and a variety of other business and financial specialists. Richard and Maureen Egan expressly delegated power over their tax affairs to their son Michael, and explicitly and implicitly delegated authority for those matters throughout the family organization.

With the Egans' wealth and income came potentially large tax liabilities. As of 2000, the Egans beneficially owned approximately 25 million shares of EMC stock. At its peak in September 2000, EMC shares traded at more than $100 per share. Because the Egans' basis in those shares was extremely small -- approximately two cents per share -- the sale of any substantial portion of that stock would have produced huge capital gains, subject to a long-term capital gains tax at a rate of 20%.

In addition, the Egans owned non-qualified options to purchase more than 8 million shares of EMC stock at very low strike prices. The exercise of those options would generate large amounts of ordinary income, subject to taxes at a marginal rate that approached 40%.

In early 2000, Richard Egan and his son Michael became interested in investing in tax shelters to avoid taxes on the capital gains and ordinary income that was likely to result from the sale of EMC stock and the exercise of the options. With the assistance of an attorney from Chicago named Stephanie Denby, the Egans interviewed several tax shelter promoters in May 2000. They eventually selected the large international accounting firm KPMG. Through KPMG, the Egans were introduced to a small firm called Helios, which (with a related company called Diversified Group International, or DGI) had designed a highly complex tax shelter transaction that it was marketing to wealthy individuals.

The original tax shelter scheme involved the contribution of both paired offsetting options (in large notional amounts) and appreciated assets (such as EMC stock) to an entity taxed as a partnership. In simplified terms, the promoters claimed that the purchased option was an asset, but that the sold option was not a liability; the taxpayer thus supposedly contributed assets to the partnership entity, but not liabilities, creating a grossly inflated basis in his interest in the entity. The taxpayer's interest would then be sold, and the taxpayer would claim that the inflated basis (from the contribution of the options) "eliminated" any gain from the disposition of the stock or other assets. Variations of the scheme were designed to create artificial losses to offset ordinary income.

A significant feature of the scheme was the fact that four major law firms -- including Proskauer Rose and Brown & Wood, eventually Sidley Austin Brown & Wood -- had been recruited by the promoters to provide favorable opinion letters. The taxpayers were told in advance that they could choose one of the four firms for their favorable opinion. The opinion letters were in essence intended to serve as insurance against tax penalties should the IRS ever discover the transactions, and thus to induce investors to invest in the tax shelters.

By early August 2000, the Egans were on the brink of engaging in a transaction with KPMG and DGI/Helios that was designed to eliminate up to $200 million in capital gains by artificially inflating basis, and were considering a follow-up transaction designed to create up to $200 million in artificial losses to offset ordinary income.

In August 2000, the IRS issued Notice 2000-44. That notice directly attacked the types of tax shelter schemes that the Egans were about to enter into, and stated that the IRS would not recognize transactions of the type described in the Notice.

In the wake of Notice 2000-44, the promoters and their law firms concluded that it was too risky to proceed with the ordinary income portion of the scheme in its present form. The promoters and the Egans nonetheless pressed forward with the capital gains strategy, with a transaction designed to create $160 million in artificial basis. The strategy involved an orchestrated series of steps that were principally conducted through Fidelity High Tech Advisor A Fund, LLC. The essential steps of the transaction, other than the sale of the stock, were completed by early 2001. Unfortunately for the Egans, however, the price of EMC stock declined, to the point where they had created a purported "basis" of $160 million without sufficient offsetting assets to take advantage of it. The Egans accordingly decided to "stuff" additional low-basis stock into Fidelity High Tech in an effort to use the artificial basis they had created.

In the meantime, the Egans continued to speak with the promoters about a possible tax shelter strategy for ordinary income from the exercise of the options. By early 2001, the promoters had devised a new variation of the strategy that they called the "Financial Derivatives Investment Strategy," or FDIS. The FDIS strategy, among other things, generated paper "losses" for taxpayers by assigning any offsetting "gains" offshore -- to one of two Irish confederates of the tax promoters (neither of whom, of course, filed U.S. tax returns).

The Egans exercised their stock options at various points in 2001, resulting in a gain of $162.9 million. By early October 2001, the Egans had decided to use the FDIS strategy to shelter that income from taxes. Like the prior transaction, the strategy involved an orchestrated series of steps, this time through Fidelity International Currency Advisor A Fund, LLC. The various steps of the transaction were completed by the end of 2001.

The IRS, however, continued its efforts to crack down on tax shelters. In June 2002 -- before the Egans had filed their individual tax return for the year 2001 -- the IRS adopted a temporary regulation that required the filing of a disclosure statement if a taxpayer had participated in certain tax shelter transactions. KPMG, which was preparing the Egans' return, concluded that such a disclosure statement was required with the Egans' return. Rather than make the disclosure, however, the Egans fired KPMG and hired an accountant at another law firm -- who was also a confederate of the promoters -- to sign their return.

Around the same time, and as promised by the promoters, the Egans received opinion letters from Proskauer Rose (as to the Fidelity High Tech transaction) and Sidley Austin (as to the Fidelity International transaction) purporting to opine that it was "more likely than not" that the proposed tax treatment would be upheld. The Egans also received a separate letter from Proskauer Rose opining that the disclosure insisted upon by KPMG was not required.

The Fidelity International transaction resulted in the creation of artificial "losses" of $158.6 million in 2001, which the Egans used to offset the ordinary income of $162.9 million from the option exercise on their 2001 income tax return that year. The disclosure statement that was prepared by KPMG, and never filed, stated that "expected reduction in federal income tax liability" from the Fidelity International transaction was $65.5 million. The Egans also claimed a loss of $1.7 million from Fidelity International on their 2002 tax return.

The Egans sold all of the stock in Fidelity High Tech in 2002, for $76.2 million in proceeds. The real basis for that stock was $8.7 million; the inflated claimed basis was more than $163 million. Instead of reporting a capital gain of $67.4 million from the sale of that stock for 2002, the Egans reported a huge loss.

The IRS eventually learned of the scheme, and disallowed the treatment of the transaction on the various partnership returns on multiple grounds.

B. Summary of Legal Conclusions

In substance, plaintiffs Fidelity High Tech and Fidelity International seek to overturn the various adjustments made by the IRS to items on the partnership tax returns. The principal argument advanced by the government in response is premised on the economic substance doctrine, sometimes referred to as the sham transaction doctrine.

A fundamental principle of tax law is that transactions without economic substance, or sham transactions, will not be recognized. The precise contours of the economic substance doctrine have not been set, and vary from circuit to circuit. Nonetheless, it is clear that courts are required to consider the substance of a transaction, rather than its mere form, in considering the tax effect to be given to it. In making that determination, courts normally are required to consider two aspects of a transaction: the subjective purpose of the taxpayer (that is, whether the taxpayer actually had a non-tax business purpose for entering into the transaction) and the objective purpose of the transaction (that is, whether the transaction, objectively viewed, had a reasonable possibility of profit or other business benefit).

Here, the Egans claim that the principal purpose of the transactions, viewed objectively, was to serve as a hedge: to mitigate the risk of a decline in the price of EMC stock (in the case of the Fidelity High Tech transaction) or to mitigate the risk of fluctuating interest rates or foreign currency values (in the case of the Fidelity International transaction). From an objective standpoint, however, the transactions were entirely irrational; they were unnecessarily and extravagantly expensive, and did not hedge the purported risks effectively (or at all). The Egans also appear to claim that the transactions were entered into for profit. If so, they were also irrational for that purpose; the transactions were designed and intended to lose money, and in fact did so.

The objective features of the transactions were irrational because, of course, the Egans subjectively had no actual business purpose for entering into them. None of the participants in these complex transactions believed that they were real business transactions, with any purpose other than tax avoidance. Indeed, it is highly doubtful that any participant believed, even for a minute, that the transactions would withstand legal scrutiny if discovered. No one with the slightest understanding of the tax laws could reasonably believe that $160 million in basis could be created cut of thin air, or that $160 million in income could be made to vanish in a puff of smoke. In accordance with that belief, the Egans and their advisors went to great lengths to try to ensure that the IRS would never find out about the transactions -- including, among other things, the filing of partnership and individual tax returns with multiple false and misleading entries.

The Egans contend that their subjective intentions are irrelevant. In substance, they contend that as long as the transactions were not fictitious -- that is, as long as the entities existed, the money was transferred, and the options were purchased and sold -- the economic substance doctrine does not apply. But the transactions at issue were "real" only in the sense that a performance by actors on stage is "real." The actors are real human beings, and the stage sets are made of real wood and real paint. But the actors are reading from a script. No one watching "Macbeth" believes that they are witnessing the murder of a Scottish king, and the actors do not believe it either. Here, too, the participants were simply following a script -- a script that had little or no connection to any underlying business or economic reality.

The Egans also make a number of technical arguments, all of which assume that the transactions were real and should be respected. The linchpin of the scheme from a technical standpoint was a potential anomaly in the tax code: under a line of cases interpreting Section 752, a purchased option is an asset, but a sold option is only a contingent liability. The Egans thus take the position that a taxpayer can purchase offsetting options and contribute them to a partnership entity, and thereby contribute an asset but not a liability. From there, it is but a few steps to use the "asset" to inflate the basis of the partner's interest in the entity. If the tax system depended entirely on form over substance, the argument might well pass muster.

But tax liabilities are not so easy to dodge. It would be absurd to consider offsetting options -- purchased and sold at the same time, and with the same counterparties -- as separate items, and to act as if the one item existed and the other did not. That is particularly true where (as here) the individual option positions were gigantic, and might bankrupt the taxpayer or the options dealer if no offset were in place.

The Egans also point to the longstanding principle that it is perfectly legitimate to arrange one's affairs so as to pay as low a tax bill as possible. That assertion is true, as far as it goes. It is entirely appropriate, for example, for a taxpayer to decide to buy a house rather than to rent, in order to take advantage of the many tax advantages of home ownership. A taxpayer may buy a house with a mortgage in order to take advantage of the deductibility of mortgage interest. But a taxpayer cannot undertake phony or meaningless transactions and claim a tax advantage; he cannot, for example, lend money to himself, pay "interest" on the loan, and claim the interest deduction. If the tax laws permitted such a result, they would be nonsensical, and anyone who paid taxes would be a fool. The tax laws are neither so simple nor so easily evaded.

Finally, the Egans claim that they relied in good faith on formal legal opinions issued by Proskauer Rose and Sidley Austin, two highly prominent law firms. It is true that both firms issued opinions to the Egans. And it is true that both firms opined that it was more likely than not that their tax treatment of the transactions would be upheld.

But those opinions, too, were just additional acts of stagecraft. The lawyers were not in the slightest rendering independent advice; the promoters of the tax shelters had arranged favorable opinions from those firms well in advance, and as part of their marketing strategy. Indeed, the promoters (not the Egans) paid the law firms' fees. More fundamentally, the opinions were themselves fraudulent: they were premised on purported "facts" that the Egans and the law firms knew were false, and reached conclusions that everyone involved knew could not possibly be correct. The opinions had but one purpose: to serve as a form of insurance against the imposition of penalties if the transactions were ever to come to light.

The claim of good faith reliance on counsel is thus wholly without merit. The Egans knew that the opinion letters were simply part of the tax shelter scheme, and did not for a moment believe that they were receiving independent legal advice after a full disclosure of all underlying facts.

In short, the Fidelity High Tech and Fidelity International transactions were complete shams, without any economic substance of any kind. For that reason, and for the other reasons set forth below, the transactions should not be recognized, and the adjustments made by the IRS will be upheld.

Fascinating WaPo Story on the Birkenfeld Saga

The May 16 edition of the Washington Post has a fascinating article on the Birkenfeld saga. David S. Hilzenrath, Swiss banker turned whistleblower ended up with a prison sentence. Birkenfeld strived to get the holy grail of whistleblower rewards under Code Section 7623 (statute here and IRS discussion here) and immunity from prosecution.  That was a delicate dance, and he tried out several partners for the dance (DOJ Tax, SEC, IRS).  Birkenfield stepped on some toes and ended up being prosecuted.  It remains to be seen whether he will be rewarded.  If so, the amount could be huge.

I have previously blogged various aspects of the Birkenfeld saga (see here for all posts), including being named Tax Analysts Person of the year (see here).

The takeaway from Birkenfeld's experience is that, if you are going to do this dance, you must come clean and not protect either your self or others (including clients).

Some good quotes from the article:

[Karen E.] Kelly [of DOJ Tax and Walter Anderson prosecution fame] also put Birkenfeld's lawyers on notice: The Justice Department was not part of the IRS whistleblower program, "and you should act accordingly."

* * * * *

[After giving DOJ Tax criminal attorneys some tantalizing information] Prosecutor Kevin M. Downing "looked at me and said, 'Oh, you watch too much TV. That's Hollywood,' " Birkenfeld recounted in an interview. Birkenfeld said he felt he was treated with "hostility and aggression."

* * * * *

Meanwhile, Downing had been leading the landmark prosecution of former employees of the big accounting firm KPMG on charges of promoting fraudulent tax shelters. In that case, a court dismissed charges against 13 of the defendants after finding that the government "violated the Constitution it is sworn to defend" by in effect denying them access to counsel. The court said the prosecution's overzealousness was consistent with policies established at Justice headquarters.

* * * * *

At Birkenfeld's sentencing last year, Downing said the banker's assistance had been indispensable. "I will say that without Mr. Birkenfeld walking into the door of the Department of Justice in the summer of 2007, I doubt as of today that this massive fraud scheme would have been discovered by the United States government," Downing said.

But Downing faulted him for "failing to disclose his involvement with the fraud and the U.S. clients that he aided." If Birkenfeld had been more forthcoming about one of his own clients before the government reached a financial settlement with that client, the California real estate billionaire would have been sent to prison, Downing said.

"We cannot have people, U.S. citizens, engage in that kinds [sic] of fraud scheme, come back here, and put half the leg in the door," Downing told the court, according to a transcript.

Birkenfeld argued that if he divulged client names without a subpoena, he could have been jailed in Switzerland.

[Why do I put this last item from the article in this blog? Principally because I had an analogous experience with the esteemed Mr. Dowing while he was serving as one of the prosecutors in the KPMG individual defendant prosecution (the one noted above where the juggernaut of the prosecution fizzled because of even more egregious prosecutorial abuse).  The team, including principally Downing, insisted that my client violate U.S. federal and state law to give the prosecutors information without issuing a grand jury subpoena required by federal and state law for that type of information disclosure. (For my prior discussion of this issue, see here.)  My client refused to be bullied by the prosecution team, consistent with my client's and my understanding of the law. Dowing et al. prosecuted my client too, but fortunately the prosecution team got their come-uppance for other prosecutorial abuse, of which this relatively minor incident was a fair harbinger.]

* * * * *

The head of the IRS Whistleblower Office, Stephen A. Whitlock, declined to discuss the Birkenfeld matter, citing confidentiality law. Speaking generally, he said that the whistleblower program "is not an immunity program."

"And if the person who is bringing us the information has some criminal exposure themselves," Whitlock said, "then they need to think about that."

En Banc Rehearing in Rigas - Scope of Conspiracy, Totality, and Double Jeopardy

Eearlier this week, the Third Circuit decided the Rigas case en banc. United State v. Rigas, 605 F.3d 194 (3d Cr. 2010).  I have previously discussed the panel decision (United States v. Rigas, 584 F.3d 594 (3d Cir. 2009)) here. The Third Circuit took the case en banc

on the sole issue of whether the two clauses in 18 U.S.C. § 371 -- the "offense" clause and the "defraud" clause -- constitute separate offenses under the Double Jeopardy Clause of the United States Constitution.

You will recall that that statute defines a criminal conspiracy as a conspiracy to commit an offense and a conspiracy to defraud the United States -- "the 'offense' clause and the 'defraud' clause, as stated by the Court in granting the petition for rehearing en banc.

The en banc majority opinion was written by Judge Fuentes who wrote the panel majority opinion. The en banc minority opinion was written by Judge Rendell who wrote the panel minority opinion. Needless to say, the result does not change. And, I am not sure much new was added by the en banc opinions; the battle lines were staked out in the predicate panel opinions. I have not tried to compare the en banc and panel opinions to pick up sublte nuances, but will offer her the gist of the en banc opinions.
Read more »

IRS Noises About Attacking Kovel Arrangements

Tax controversy attorneys often engage accountants to assist them in providing legal services to a client of the attorney facings civil or criminal tax investigation. This arrangement is called a Kovel agreement, named after the leading case recognizing it -- United States v. Kovel, 296 F.2d 918 (2d Cir. 1961). The IRS is now noising about testing the limits of the Kovel arrangement. An article in today's Tax Notes Today (Sam Young, Government Will Subpoena Accountants in Criminal Tax Prosecutions, Official Warns, 2010 TNT 91-4), although somewhat cryptic, seems to be consistent with the rumors we have heard in this regard. I should note, however, that, since this initiative -- if that is the right word for it -- is so fresh, there does not appear to be a definitive statement of the IRS's concern or its theories for avoiding a properly implemented Kovel arrangement. I suspect that the IRS will not be able to pierce a properly implemented Kovel arrangement, but I do suspect that there are arrangements under the guise of Kovel that exceed the limits of the construct on which Kovel is based. Readers wanting to pursue this matter further may click here for a more detailed discussion from the current update draft of my Tax Procedure book. Readers may also want to visit Phil Hodgen's excellent blog discussion of this same issue here.

Civil Statutes of Limitation for Abusive Tax Shelters

The statute of limitations rules for civil cases rules are:

a. In non-TEFRA cases, the general rule is 3 years with two key exceptions in the case of tax shelters: (i) 6 years if a 25% omission of gross income is involved and (ii) no statute if fraud is involved. See Section 6501(c)(1) & 2 and (e)(1)(A) (prior to amendment by the HIRE Act).

b. In TEFRA cases, the special statute of limitations (which may extend the limitations periods discussed in paragraph a.) a general 3 year rule with extended periods paralleling the general rules in paragraph a. in the case of: (i) false or fraudulent partnership returns (6 years except that partners "signing or participating in the preparation of" a false or fraudulent return) may be assessed at any time,” (ii) 6 years for 25% gross income omissions, (iii) unlimited if no return, and (iv) Service prepared returns. § 6229(a) &.(c).

Many abusive tax shelters attempted to make sure the general 3 year statute of limitations would apply by (i) offering a packaged (Government would call "cookie-cutter") legal opinion so as (the promoters and taxpayers hoped) to avoid fraud and (ii) creating the shelter through a mechanism other than omission of gross income. One of the so-called loss generator strategies was to create artificial basis. The Son-of-Boss transactions were typical of this type of abusive tax shelter. I won't get into the details of that genre of shelter, but I will illustrate in a highly simplified example. Suppose a taxpayer had $50,000,000 of capital gain and his or her only other income was $1,000,000 in compensation. If the taxpayer omitted the capital gain from his or her return, he or she would easily have a 25% omission of income and the six year statute would apply. If, however, the taxpayer can generate artificial basis to offset the capital gain (say making the gain net of the artificial basis $50,000 rather than $50,000,000), the taxpayer has set the stage for an argument that the three year statute applies. The argument is based on the Supreme Court's holding in Colony Inc. v. Commissioner, 357 U.S. 28 (1958), which interpreted the 1939 Code equivalent of the Section 6501(e) 25% omission 6 year statute. The IRS has argued that Colony did not require that holding, but the courts have generally disagreed. As a result, the IRS promulgated regulations that, if valid, would sustain the IRS position and overrule the cases holding otherwise.

The IRS hoped that the regulations would be the law, regardless of prior precedent, including even the Supreme Court precedent in Colony.  The IRS based its hope on the line of cases beginning with Chevron U.S.A. Inc. v. Natural Res. Def. Council, 467 U.S. 837 (1984) which gives the IRS broad authority to promulgate the law by regulation so long as the statute does not foreclose the interpretation adopted in the regulation -- i.e., the IRS may choose among reasonable interpretations of the statutory text. In National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005) ("Brand X") held that the IRS could by regulation overturn prior judicial precedent.  Justice Thomas for the majority synthesized the holding of Chevron as follows:

In Chevron, this Court held that ambiguities in statutes within an agency's jurisdiction to administer are delegations of authority to the agency to fill the statutory gap in reasonable fashion. Filling these gaps, the Court explained, involves difficult policy choices that agencies are better equipped to make than courts. If a statute is ambiguous, and if the implementing agency's construction is reasonable, Chevron requires a federal court to accept the agency's construction of the statute, even if the agency's reading differs from what the court believes is the best statutory interpretation. (Citations omitted.)

Then moving to whether an agency interpretation can trump an earlier court decision, Justice Thomas said:

A contrary rule would produce anomalous results. It would mean that whether an agency's interpretation of an ambiguous statute is entitled to Chevron deference would turn on the order in which the interpretations issue: If the court's construction came first, its construction would prevail, whereas if the agency's came first, the agency's construction would command Chevron deference.

Justice Thomas then concluded: “A court's prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.” Further emphasizing the point, Justice Thomas states: “Only a judicial precedent holding that the statute unambiguously forecloses the agency's interpretation, and therefore contains no gap for the agency to fill, displaces a conflicting agency construction.”

Brand X thus grants (or recognizes) the IRS’s (or any agency’s) authority to change the prior judicial interpretation so long as the agency interpretation is not foreclosed as a reasonable interpretation of an otherwise ambiguous statute. In other words, if in order to resolve the case at hand, the prior judicial opinion applies an interpretation that it thinks best resolves the case but is not necessarily commanded as the only reasonable interpretation of the statute, the prior judicial opinion does not foreclose an agency from adopting an interpretation otherwise that is a different reasonable interpretation and qualify that interpretation for Chevron deference.

Of course everything turns upon whether the prior judicial opinion effectively forecloses other reasonable interpretations of the statute. This then can become a tough call, and drawing this line will be where the play comes in the application of Brand X’s vision of Chevron deference. This was the setting as to the new IRS regulations interpreting the 25% omission rule which could be read as overturning Colony.

In Intermountain Insurance Service of Vail LLC v. Commissioner, 134 T.C. No. 11 (5/6/10), the Tax Court tackled that issue and held that Colony lived despite the regulation.  The Tax Court held that the Colony interpretation of the statutory text foreclosed there being reasonable alternatives that the IRS could choose among by regulation. The concurring opinion by Judge Halpern ably contests that notion.

Obviously, the particular phenomenon that has the IRS so exercised is the fact that it views the extended 6 year statute of limitations to be important to its collection of the taxes avoided by the abusive shelter because the parties involved well-hid their perfidy. Intermountain arose in the context of the TEFRA iteration of the 25% omission rule, but as noted above there is another TEFRA 6 year statute -- for returns that are false or fraudulent. The IRS has noised for years that Son-of-Boss transactions were false or fraudulent and have indicted and convicted some of the enablers in these transactions. Although no taxpayers have been indicted or convicted, the prosecutors in the cases certainly felt that the taxpayers were complicit. So, the IRS could get a 6 year TEFRA statute if it could prove by clear and convincing evidence that the partnership return was false or fraudulent. It is unclear why the IRS has not taken that approach. Morever, if indeed the prosecutors could prove that the taxpayer partners were complicit in the fraud, then an unlimited statute would apply (whether by virtue of the TEFRA rule or, perhaps even, by the regular § 6501(c)(1) and (2) rule). And, to trace this even further, the IRS might argue that the fraud which infects the individual return is sufficient to invoke the holding of Allen v. Commissioner, 128 T.C. 37 (2007).  (See my prior discussion of Allen here.)  I have not traced such a line of argument out to the end, but simply suggest that I see no clear reason why it might not be available.

Willfulness - What Does It Really Mean in Tax Cases?

The major tax crimes in the Internal Revenue Code require that the defendant act willfully. The standard for acting willfully is usually stated as intentional violation of a known legal duty, a statement drawn from the Supreme Court's cases culminating in Cheek v. United States, 498 U.S. 192 (1991) (and for this reason sometimes referred to as Cheek willfulness). In a later case, Bryan v. United States, 524 U.S. 184 (1998) dealing with a requirement in federal firearm licensing statute that the defendant act willfully, the Supreme Court said:

In certain cases [including Cheek] involving willful violations of the tax laws, we have concluded that the jury must find that the defendant was aware of the specific provision of the tax code that he was charged with violating.

Really?

The Ninth Circuit recently concluded that, well, that's not exactly what the Supreme Court meant. United States v. Mousawi, ____ F.3d ___ (9th Cir. 2010). Mousawi involved another criminal statute with a willfulness requirement, but the Ninth Circuit had to deal with this notion of willfulness from Bryan.  Here's the Ninth Circuit's analysis In discussing the cases upon which Bryan relied for the statement (Cheek and Ratzlaf v. United States, 510 U.S. 135 (1994), involving the structuring act then having a tax-like willfulness requirement) (case citations omitted):

Neither of these cases [Cheek and Ratzlaf], however, required the government to prove the defendant's knowledge of a specific provision of law. In Cheek, the Supreme Court held that “willfulness,” as used in the criminal provisions of the tax code, required the government to prove that the defendant knew of the legal duty to file an income tax return and to treat his wages as income. But the Court noted that the “jury would be free to consider any admissible evidence from any source” showing that the defendant was aware of this duty. While Cheek listed “awareness of the relevant provisions of the Code or regulations” as one source of such evidence, it did not identify it as the exclusive source. Similarly, Ratzlaff held that the government could not carry its burden to prove the "willfulness" requirement in a prosecution for illegal structuring of financial transactions merely by proving that the defendant knew of the bank's duty to report cash transactions of more than $ 10,000. Nevertheless, the government did not have to prove that the defendant was aware of the provision of the federal statute that made it illegal to structure his cash deposits to avoid triggering the bank's reporting obligation. It was sufficient if a jury could reasonably conclude that the “defendant knew of his duty to refrain from structuring," a conclusion which could be based on "reasonable inferences from the evidence of defendant's conduct.” Similarly, prior to Cheek and Ratzlaff, we indicated that "willfulness" under a complex anti-exportation statute required proof of "a voluntary, intentional violation of a known legal duty," but we considered this standard satisfied where the government proved “that the defendant [knew] that his conduct . . . is violative of the law.” These cases make clear that even in the context of “highly technical statutes that presented the danger of ensnaring individuals engaged in apparently innocent conduct,” the term “willfulness” requires the government to prove that the defendant was aware of the legal duty at issue, but not that the defendant was aware of a specific statutory or regulatory provision.

Tax Practitioners Complain About Too Rigid Application of Voluntary Disclosure Program for Offshore Accounts

The tax news media is abuzz yesterday and today about a letter from a group of tax attorneys significantly involved in advising and representing clients with offshore accounts (i) who made what they thought were voluntary disclosures under the pre-10/15/09 special program and (ii) are considering a voluntary disclosure after 10/15/09 under the general voluntary disclosure program. The attorneys' concern is that the IRS is interpreting the conditions for voluntary disclosure too rigidly so as to disqualify persons who were truly voluntary in their disclosures in every meaningful sense of the word voluntary but who had the misfortune to have turned up on the IRS's radar screen (perhaps through UBS disclosures) before they could implement the voluntary disclosure. The following is a good sound bite from the letter:

Our immediate concern is the prospect that the government may bring criminal tax charges against persons who attempted voluntary disclosures but were later advised that pursuant to the VDP they were not timely. Such action would effectively destroy the VDP.

A copy of the letter is here. Articles appear in this morning's Tax Notes and in the popular press (WSJ article is here and the Tax Prof Blog article is here).

Foreign Financial Information - New Provisions

The Foreign Account Tax Compliance Act ("FATCA") provisions of the recently enacted Hiring Incentives to Restore Employment Act ("HIRE Act") contains several provisions related to foreign financial asset disclosures to be made on income tax returns. New § 6038D) imposes a tax return disclosure requirement for an interest in a "specified foreign financial asset." Reportable “specified foreign financial assets” are depository or custodial accounts at foreign financial institutions and, to the extent not held in an account at a financial institution, (1) stocks or securities issued by foreign persons, (2) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (3) any interest in a foreign entity.

Key related provisions are:

1. Failure to comply with this provision can subject the entire return to an open statute of limitations until 3 years from the date the information is provided to the IRS.  § 6501(c)(8), as amended.  Moreover, failure to report income in excess of $5,000 attributable to foreign financial assets subjects the return to a 6 year statute of limitations.  § 6501(e)(1)(A)(ii).  Note in applying these two special statute of limitations rules, it is important to distinguish between the reporting of the information about the foreign financial assets and including the income attributable to the foreign financial assets in gross income.

2. Failure to comply can subject the taxpayer to significant penalties just for the failure to comply, regardless of whether additional tax is due. The penalty is $10,000, with an escalating penalty of $10,000 for each 30 days that the information is not provided after notice from the IRS.  § 6038D(d).

3. If the failure to comply results in an understatement of tax, there is a new 40-percent penalty on any understatement attributable to an undisclosed foreign financial asset. (This penalty applies not only to the new foreign financial assets disclosures under § 6038D, but also disclosures required under §§ 6038, 6038A, new 6038D, 6046A, and 6048.)  § 6662(b)(7) and (j).

For more information, I link to the pertinent portions of my Tax Procedure text. For a good discussion of the open statute of limitations issue, KPMG has a good discussion here.

Proposed Modifications to the Sentencing Guidelines -- More Latitude

New more lenient Sentencing Guidelines, effective 11/1/2010. The new / proposed guidelines permit a judge more leeway to consider factors not previously considered considered in the mainstream: criminal defendants’ military service, age, and mental and emotional conditions. Congress could still modify or even rejcect the proposals, but I don't think that is likely.

I think most of the phenomena that led to the change are not prominent in federal tax cases, but there is still some room for skillful and creative lawyering the sentencing phase in these cases.

Some links to further explore the proposals:

Sentencing Commission Proposals

Wall Street Journal Article

Wall Street Journal Law Blog

Sentencing Law Blog

DOJ Tax International Roadshow on Foreign Financial Accounts

The international press report that the DOJ Tax Team -- Kevin Downing et al. -- are on the road to keep the press coverage rolling on the need for U.S. taxpayers with foreign financial accounts to come forward before the Government knocks on the door (or catches them bringing cash into the country).

So the press reports go, the U.S. will have thousands of new cases involving banks other than UBS from banks and other governments.  And, the voluntary disclosure program has provided leads to many other potential targets, including enablers.


For coverage see:
The Business Times
China Daily