Wrongful Disclosure Counterclaim in FBAR Willful Penalty Suit Dismissed Because Decedent Taxpayer Did Not Assert the Wrongful Disclosure (5/30/16)

In United States v. Garrity, 2016 U.S. Dist. LEXIS 66372 (D. Conn. 2016), here, the United States filed a complaint, here, seeking judgement on a willful FBAR penalty assessment for the year 2005. Key background paragraphs of the complaint are:

7. In November 1989, Paul G. Garrity, Sr., established the Lion Rock Foundation, a Liechtenstein Shiftung. Paul G. Garrity, Sr., was the primary beneficiary of the Lion Rock Foundation from the time it was founded until his death in 2008. 

8. In November 1989, Paul G. Garrity, Sr., opened an account in the name of Lion Rock Foundation with LGT Bank, a bank located in Liechtenstein, having a number ending in 718 (“Account”). The Account continued in existence until after the death of Paul G. Garrity, Sr. After his death, in 2009, the funds held in the account were distributed equally to each of his three sons, Kevin S. Garrity, Paul G. Garrity, Jr., and Sean R. Garrity. 

9. On or about the time the Account was opened, Paul G. Garrity, Sr., entered into an Agency Agreement with BIL Treuhand AG (“BIL Treuhand”) to appoint members of the Lion Rock Foundation Board. The agreement required BIL Treuhand “as well as the person(s) appointed by [it] . . . to act in accordance with the Instructions imparted by [Paul G. Garrity, Sr.,] or persons empowered to act on behalf of [Paul G. Garrity, Sr.]” At all times relevant to this matter, Paul G. Garrity, Sr., exercised complete control over the Lion Rock Foundation.

[Money was shunted to the foundation through a related offshore  company which billed Garrity's U.S. taxable entity for "inspection services."  That offshore company never performed any services.]

14. At various times, an entity known as Tamino Trading, Ltd., and Grant Thornton International, Ltd., both also deposited monies into the Account.

16. Paul G. Garrity, Sr., did not report any income or loss from the Account, or otherwise disclose the existence of the Account to the IRS, on his 2005 federal income tax return, or at any other time. Moreover, Paul G. Garrity, Sr., did not advise the accountant who prepared his 2005 federal income tax return of the existence of the Account at any time. 

18. In May 2008, the IRS initiated an audit as to the tax liability of Paul G. Garrity,
Sr., for the 2005 taxable year. In connection with that audit, the IRS was investigating matters related to the Account. 

19. On October 14, 2009, Diane M. Garrity, a representative of the estate of Paul G. Garrity, Sr., deceased, filed Treasury Forms TD-F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”), for the 2003 through 2008 calendar years with the IRS. The FBAR filed for the 2005 calendar year indicates that the maximum amount held in the Account during that year was $1,873,382.00.

[There is no indication whether this was filed under the 2009 iteration of OVDP.  If it was, then the estate apparently opted out, which was necessary for the IRS to assert the FBAR penalty rather than the then applicable MOP of 20%; however, one would think that the IRS would have alleged that in the complaint; hence, the audit may have been a regular audit, perhaps generated by information from some source; moreover, readers should note that only one FBAR penalty apparently was asserted or, if asserted, only one is subject to the complaint, consistent with the position announced after the penalty was asserted.]

26. As of June 30, 2006, the balance of the Account was at least $1,873,382.00. 

27. On February 26, 2013, in accordance with 31 U.S.C. § 5321(a)(5)(C)(i), a delegate of  the Secretary of the Treasury assessed a civil penalty against the estate of Paul G. Garrity, Sr., deceased, in the amount of $936,691.00, due to the willful failure of Paul G. Garrity, Sr., to disclose the Account to the IRS (“FBAR Penalty”). 

30. In addition to the FBAR Penalty, the estate of Paul G. Garrity, Sr., deceased, owes a late-payment penalty pursuant to 31 U.S.C. § 3717(c)(2) and 31 C.F.R. § 5.5(a) in the amount of $106,705.79, as of February 20, 2015.  

31. In addition to the FBAR Penalty, and the late-payment penalty described in the previous paragraph, the estate of Paul G. Garrity, Sr., deceased, owes accrued interest in the amount of $17,784.30 as of February 20, 2015. 

32. The estate of Paul G. Garrity, Sr., deceased, is liable to the United States of America for the FBAR Penalty, as well as associated penalties and interest, in the total amount of $1,061,181.09 as of February 20, 2015, plus statutory accruals from that date until the liability is paid in full.

The defendants sought to amend the answer to assert a counterclaim under § 7431 for wrongful disclosures of § 6103 information.  The Court in its order dated May 20, 2016, here, describes the attempt to amend as follows:

After the July 24 deadline for amending the pleadings passed, Defendants' counsel discovered that certain publicly-available IRS training materials contained information about the IRS's investigation of Paul G. Garrity, Sr. (ECF No. 40 at 1-2.) Specifically, Defendants allege that Dennis Brager of the Brager Tax Law Group submitted a Freedom of Information Act ("FOIA") request to the IRS by letter dated April 3, 2014. (ECF No. 40-2 at 16.) On September 30, 2014, the IRS produced 6,601 pages of documents in response to the FOIA request, including "unredacted PowerPoint slides from an IRS training program" that "included a case study discussing the IRS investigation of Paul G. Garrity, Sr. that was the genesis of the Title 31 and 26 penalties and proposed income tax deficiencies against" Paul G. Garrity, Sr. (the "Case Study Materials"). (Id. at 16-17.) The Brager Tax Law Group posted the Case Study Materials on its website, where Defendants later found it and immediately recognized that it contained Paul G. Garrity, Sr.'s return information. (Id.) On June 29, 2015, Defendants served their First Request for Production of Documents on the Government in this action. (Id.) Defendants argue that the Case Study Materials are responsive to this request, but the Government disagrees, and did not produce the Case Study Materials. (ECF No. 44 at 3 n.1; ECF No. 40 at 3.) 

Defendants have now filed a motion to amend the scheduling order to extend the deadline to amend pleadings and allow them to file an amended answer and assert a counterclaim. (ECF No. 40 at 4.) In their proposed counterclaim, Defendants allege that the Government violated 26 U.S.C. § 6103(a) by disclosing the Case Study Materials to IRS agents not directly concerned with the investigation and the law firm, which disclosed the information to the public through its website. n1 (ECF No. 40-2 at 15-16.) Section 6103(a)(1) provides, in relevant part, that "no officer or employee of the United States . . . shall disclose any return or return information obtained by him in any manner in connection with his service as such an officer or an employee or otherwise or under the provisions of this section." Section 7431(a) provides a private right of action for damages against the Government for such unauthorized disclosures.
   n1  Defendants represent that they "do not seek damages for each of the untold number of third-parties who read, copied, or downloaded the disclosed information from the third-party law firm website or from websites or platforms to which the information may have been transferred or re-posted." (ECF No. 45 at 8-9.)

The Government opposed the attempt to amend on the grounds that the parties in the dispute attempting to assert the claim were not the taxpayer who allegedly suffered the injury.  The Court accepted the Government's argument, reasoning that

Given the clear text of the statute and the strict construction of waivers of sovereign immunity, this Court agrees that the private cause of action in Section 7431 is limited to claims brought by taxpayers whose return information has been disclosed. Here, the allegations in the counterclaim make clear that the "taxpayer" whose "return information" was disclosed was Paul G. Garrity, Sr., and not the Estate. Therefore, the plain reading and the one consistent with construing waivers of sovereign immunity narrowly is that the Estate is not "such taxpayer" and may not bring suit. 

Defendants contend that the Estate may sue under Section 7431 because the Estate "is a legal continuation of the deceased taxpayer" (ECF No. 45 at 5), but the plain language of the statute does not embrace such a broad class of plaintiffs, which would also sweep in assignees and all other manner of successors-in-interest. [10]  Nor does it matter if the right of action under Section 7431 is considered to be a property interest of the type that would ordinarily pass upon death, as the court found in Schachter v. United States, 847 F. Supp. 140 (N.D. Cal. 1993). Declining to follow Shapiro v. Smith, 652 F. Supp. 218, 218-19 (S.D. Ohio 1986)—which had held that an older version of Section 7431 was akin to a tort action protecting personal privacy rights and did not survive the taxpayer's death—the Schachter court held that Section 7431 creates "a property interest which should survive death," and allowed the substitution of the estate of a plaintiff who had died after bringing suit. Schachter, 847 F. Supp. at 141. Schachter reasoned that: (1) "all taxpayers, not just individuals, can sue under § 7431, while under tort law a corporation or association has no right to privacy," (2) Section 7431 "provides for 'actual' damages, an indication that property rights were to be taken into account," and (3) allowing a right of survival is consistent with the legislative aim of discouraging "governmental intimidation through disclosure." Id. Even if the Court accepts the reasoning in Schachter that Section 7431 creates a property right, the disclosure of Paul G. Garrity, Sr.'s return information occurred years after Paul G. Garrity, Sr.'s death, according to the allegations in the proposed counterclaim. n4 Thus, Paul G. Garrity, Sr., never had a property right in such a cause of action during his lifetime, and there was, at the time of his death, no such property right to pass to the Estate. n5
   n4 Paul G. Garrity, Sr. died on February 10, 2008. (ECF No. 40 at 1.)
   n5 It is worth noting that, at common law, no right of action for invasion of personal privacy, and thus no property right in such an action, could have accrued to Paul G. Garrity, Sr., after his death. A dead person has no cognizable right of action when his privacy is invaded. See Restatement (Second) of Torts § 652I, cmt. b. ("In the absence of statute, the action for the invasion of privacy cannot be maintained after the death of the individual whose privacy is invaded."). 

JAT Comments:

1.  It is interesting that the defendants' counsel learned of the possible disclosure by studying the FOIA materials posted by Dennis Brager.  I discussed those disclosures earlier at IRS Documents On OVDI/P From FOIA Request (Federal Tax Crimes Blog 11/17/14), here.  Thanks, Dennis.

2.  Kudos to Defendants' Counsel for catching this.  Although the district court rejected the attempt, there might be an appeal and the issue might still have some gravitas in a settlement of the case.  Defendants' Counsel per Pacer are:

Daniel F. Brown
Andreozzi, Bluestein, Weber, Brown LLP - Clarence
9145 Main Street
Clarence, NY 14031  

Michael Menapace
Wiggin & Dana-Htfd
20 Church St.
Hartford, CT 06103  

Randall P. Andreozzi
Andreozzi, Bluestein, Weber, Brown LLP - Clarence
9145 Main Street
Clarence, NY 14031 

3.  I am reminded of a case I handled while with the DOJ Tax Division was back in Estate of John Morris v. Commissioner, 454 F.2d 208 (4th Cir. 1972), here, affirming 55 T.C. 636 (1971) (Tax Court Reviewed Decision).  In that case, the IRS asserted that a testamentary estate of the deceased taxpayer who had suffered the involuntary conversion could not replace the property and thereby qualify the deceased taxpayer for tax exemption under § 1033.  The taxpayer won in the Tax Court.  DOJ Tax appealed.  I was assigned to brief the appeal.  My argument was the same as the IRS asserted in the Tax Court.  In the Fourth Circuit, at oral argument, Judge Sobeloff (then very senior) asked me how many judges were in the Tax Court.  I said I was not sure, but my opposing counsel said that it was some number like 15 or 17 (I can't remember what exactly he said).  It was not clear from the opinion how many judges agreed with the majority holding but it was clear that only 4 judges dissented.  Thus, Judge Sobeloff silently made a quick math calculation and decided that, whatever the number, the Tax Court was overwhelmingly against the IRS's position which I was dutifully asserting.  His next comment was something to the effect, "Well, isn't that the end of it."  Of course he knew that merely affirming a majority in the Tax Court because the majority was the majority was not the role he served.  But he was signaling that I needed a powerful argument to win and that I had not made that argument.  And, as they say, the rest is history.

4.  But the equitable basis for the Morris decision does have overtones of the argument the defendants asserted in Garrity.  The decedent's death precluded him from pursuing the benefit clearly conferred by Congress - in Morris, exemption of the gain, and in Garrity, the wrongful disclosure suit.  Should there be a different result in Garrity?  There are many downsides to death, but should denial of the wrongful disclosure action be one of them?

The Defraud Conspiracy and It's Expansion; The First Circuit Speaks (5/28/16)

I have blogged before about the scope of the defraud conspiracy in 18 USC § 371, here, which, principally in a tax setting is referred to as a Klein conspiracy after United States v. Klein, 247 F.2d 908 (2d Cir. 1957), a tax case that over time has been very prominent in tax crimes prosecutions.  The other conspiracy in §371 is the offense conspiracy.  The offense conspiracy is a conspiracy to commit an offense defined in another criminal statute.  The offense itself must pass constitutional muster.  Assuming that it does, the conspiracy crime to commit the offense will almost assuredly pass muster. The defraud conspiracy, however, is loosey-goosey.  (That's a term of art that I use in this context, but I think it is descriptive for the defraud conspiracy.  The statutory text is:  "to defraud the United States, or any agency thereof in any manner or for any purpose."  As interpreted, however, it is variously formulated but a standard formulation is that it is a conspiracy to impair or impede the lawful function of a Government agency.  You will notice something curious about that formulation, for, although the statute textually requires a conspiracy to "defraud," that standard formulation says nothing about fraud or defraud.  Fraud or defraud normally requires unlawfully taking something of value (property, including money).  Generally, where fraud or defraud is a textual element of a federal criminal statute, that taking or intended taking of something of value is required.  See United States v. Coplan, 703 F.3d 46, 61-62 (2d Cir. 2012).  If a person behaves badly but does not take or intend to take something of value, the crime is not fraud or defraud (at least outside the defraud conspiracy statute).  But, that is not true in the defraud conspiracy, at least as interpreted.  (Like the Bible and Constitutional interpretation, it is all about interpretation; it does not really matter what the words mean or would have meant to the drafter or, in this case, the legislature; it is how the words are interpreted and that can be something else indeed.)

The Supreme Court has pronounced that the interpretation of the defraud element in the defraud conspiracy merely means a conspiracy to impair or impeded the lawful function of the IRS.  I have noted before that this Supreme Court expansion of the meaning of the textual element of defraud has been subject to question.  United States v. Coplan, 703 F.3d 46 (2d Cir. 2012), here, cert. denied 134 S.Ct. 71 (2013); See Coplan #1 - Panel Questions Validity of Klein Conspiracy (Federal Tax Crimes Blog 12/1/12), here.  Basically, the Second Circuit panel majority opinion questioned the Supreme Court's prior interpretations culminating in Hammerschmidt v. United States, 265 U.S. 182 (1924) that expanded the scope of the defraud conspiracy beyond the usual meaning of the word fraud or defraud.  The Second Circuit panel stated that, in view of the Supreme Court's holding in Hammerschmidt and its own holding in Klein, it could do no more than express the concern that the Supreme Court's interpretation went beyond the text of the statute.

In United States v. Morosco, ___ F.3d ___, 2016 U.S. App. LEXIS 8753 (1st Cir. 2016),  here, the First Circuit was asked to consider this issue and applied the Hammerschmidt interpretation in a case not involving tax or the IRS.  The Court did address several of the issues that swirl around that Hammerschmidt interpretation, so I offer here the portions of the opinion.  The background is that the defendants were convicted of the defraud conspiracy related to HUD property inspections.  I cut and paste the key portions of the opinion (all footnotes except one (because it is important) omitted):

Void-for-Vagueness Claim 

Fitzpatrick and Morosco complain that section 371's defraud clause — criminalizing any conspiracy "to defraud the United States, or any agency thereof in any manner or for any purpose" — is unconstitutionally vague as applied to them. For those not in the know, a law is unconstitutionally vague if it fails to give ordinary people fair notice of what is forbidden, or if it fails to give the designated enforcers (police, prosecutors, judges, and juries) explicit standards (thus creating a risk of arbitrary enforcement). See Welch v. United States, 136 S. Ct. 1257, 2016 WL 1551144, at *3 (2016). Of course the requisite fair warning can come from judicial decisions construing the law. See, e.g., United States v. Lanier, 520 U.S. 259, 266, 117 S. Ct. 1219, 137 L. Ed. 2d 432 (1997). And judges have no business junking a statute simply because we could have written it "with greater precision." Rose v. Locke, 423 U.S. 48, 49, 96 S. Ct. 243, 46 L. Ed. 2d 185 (1975). 

Helpfully, both sides agree — rightly — that Fitzpatrick and Morosco preserved their vagueness claim below (via a motion to dismiss the indictment) and that our review is de novo. See, e.g., United States v. Hussein, 351 F.3d 9, 14 (1st Cir. 2003). Also helpfully, both sides concede that binding precedent squarely forecloses this claim.1Link to the text of the note And we second that assessment. 

Start with Fitzpatrick's and Morosco's most loudly trumpeted point. As they tell it, section 371's "defraud" clause only bans conspiracies to deprive the government of property and money by dishonest schemes, a reading (they add) that jibes with the common-law understanding of "defraud." And such a reading would help them (they continue) because they never scammed the government out of property or money. Unhappily for them, years' worth of Supreme Court precedent holds that section 371 "is not confined to fraud as that term has been defined in the common law," see Dennis v. United States, 384 U.S. 855, 861, 86 S. Ct. 1840, 16 L. Ed. 2d 973 (1966); that defrauding the government under section 371 means obstructing the operation of any government agency by any "deceit, craft or trickery, or at least by means that are dishonest," see Hammerschmidt v. United States, 265 U.S. 182, 188, 44 S. Ct. 511, 68 L. Ed. 968 (1924); and that the conspiracies need not aim to deprive the government of property or money, see id., because the act is written "broad enough . . . to include any conspiracy for the purpose of impairing, obstructing, or defeating the lawful function of any" government "department," see Haas v. Henkel, 216 U.S. 462, 479, 30 S. Ct. 249, 54 L. Ed. 569 (1910). Ever faithful to high-Court holding, our caselaw rejects the idea that section 371 only bars conspiracies to defraud the government out of property or money. See United States v. Barker Steel Co., 985 F.2d 1123, 1136 (1st Cir. 1993) (relying on Supreme-Court cases interpreting section 371 and its basically "similar predecessors"); Curley v. United States, 130 F. 1, 6-10 (1st Cir. 1904) (explaining that "defraud" in section 371's forerunner has a broader meaning than the common-law definition — and justifiably so because the statute's aim is to protect the government, and deceit can impair the workings of government even if the conspiracy does not take the government's property or money). Obviously then, this facet of Fitzpatrick's and Morosco's vagueness thesis goes nowhere.

Undaunted, Fitzpatrick and Morosco also suggest that because no statute or regulation criminalizes receiving a list of sample units before any HUD inspection, the government could not prosecute them under section 371. But our cases take all the wind out of their sails, holding as they do "that lawful activity may furnish the basis for a" section-371 conspiracy conviction. See United States v. Hurley, 957 F.2d 1, 4 (1st Cir. 1992) (finding unconvincing "defendants' asserted lack of 'fair warning' that their 'legal' conduct could be the basis for a criminal prosecution," noting that "[t]he statutory prohibition against defrauding the government adequately put defendants on notice that a scheme designed to frustrate tax collection was prohibited"); accord Barker Steel Co., 985 F.2d at 1131 (emphasizing that section 371 bans both "(1) conspiracies to commit a specific offense against the United States, included elsewhere in the criminal code, and (2) conspiracies to defraud the United States," and rejecting defendants' argument "that if no other federal law or regulation proscribes alleged conduct, then [they] cannot be held criminally responsible pursuant to § 371" — "[i]f the second clause were interpreted to require commission of a specific offense, it would have the same meaning as the first clause thus rendering the second clause redundant"); United States v. Tarvers, 833 F.2d 1068, 1075 (1st Cir. 1987) (stressing that section 371 "does not require that the means used to achieve the unlawful goal of the conspiracy be unlawful"). So this aspect of Fitzpatrick's and Morosco's vagueness theory also goes nowhere. 

In what is basically a Hail Mary pass, Morosco argues that two fairly recent cases signal a new willingness on the high Court's part to entertain vagueness challenges — a willingness (the argument goes) that we must emulate. The two cases are (1) Skilling v. United States, 561 U.S. 358, 130 S. Ct. 2896, 177 L. Ed. 2d 619 (2010), limiting "honest services" fraud so that it only applies to defendants involved in either bribery or kickback schemes, and (2) Johnson v. United States, 135 S. Ct. 2551, 192 L. Ed. 2d 569 (2015), declaring the Armed Career Criminal Act's residual clause — a provision dealing with crimes that "involve[] conduct that presents a serious potential risk of physical injury" — too vague to be enforced. His pass falls incomplete, however, and for a simple reason. Neither Skilling nor Johnson overruled the Haas/Hammerschmidt line of section-371 cases. And because overruling Supreme Court precedent is the Court's job, not ours, we must follow Haas/Hammerschmidt, etc. until the Court specifically tells us not to — something that is true even if these long-on-the-books cases are in tension with Skilling and Johnson (and we do not suggest that they are). See Hohn v. United States, 524 U.S. 236, 252-53, 118 S. Ct. 1969, 141 L. Ed. 2d 242 (1998) (declaring that Supreme Court "decisions remain binding precedent until [the Court] see[s] fit to reconsider them, regardless of whether subsequent cases have raised doubts about their continuing vitality"); Rodriguez de Quijas v. Shearson/Am. Express, Inc., 490 U.S. 477, 484, 109 S. Ct. 1917, 104 L. Ed. 2d 526 (1989) (instructing that "[i]f a precedent of this Court has direct application in a case, yet appears to rest on reasons rejected in some other line of decisions, the Court of Appeals should follow the case which directly controls, leaving to this Court the prerogative of overruling its own decisions"); see also United States v. Coplan, 703 F.3d 46, 61-62 (2d Cir. 2012) (rejecting the idea that a circuit court should use Skilling to rework controlling section-371 precedent, noting that lower courts should leave any reworking to the Supreme Court); Spector Motor Serv. v. Walsh, 139 F.2d 809, 823 (2d Cir. 1943) (L. Hand, J., dissenting) (cautioning lower courts against "embrac[ing] the exhilarating opportunity of anticipating" the overruling of a Supreme Court decision), vacated sub nom. Spector Motor Serv. v. McLaughlin, 323 U.S. 101, 65 S. Ct. 152, 89 L. Ed. 101 (1944). 

With the vagueness issue out of the way, we press on. 

* * * * 

Mens-Rea Claim 

At oral argument before us, Morosco (through his lawyer) conceded that while what he did (giving CHA the list of to-be-inspected units before the inspection) "does not appear to be innocent," he "did not see it as criminal." That tees up his mens-rea argument, which is sort of a corollary to his void-for-vagueness claim: Morosco contends that section 371's defraud clause — which, to repeat, outlaws conspiracies "to defraud the United States, or any agency thereof in any manner or for any purpose" — lacks a mens-rea requirement. And, he intimates, to cure this problem, the judge should have told jurors (but did not) that they could only convict if they found that he knew his actions constituted a crime — an instruction, he says, that would have resulted in his acquittal, because, as he knew, no HUD regulation criminalized giving housing-authority officials a list of to-be-inspected units before the inspections. Color us unconvinced. 

Mens rea (for the uninitiated) is the mental state — "knowingly" or "willfully," for example — required to convict. The idea behind the mens-rea requirement "is that a defendant must be 'blameworthy in mind' before he can be found guilty" — an idea that "is 'as universal and persistent in mature systems of law as belief in freedom of the human will and a consequent ability and duty of the normal individual to choose between good and evil.'" See Elonis v. United States, 135 S. Ct. 2001, 2009, 192 L. Ed. 2d 1 (2015) (quoting Morissette v. United States, 342 U.S. 246, 250, 252, 72 S. Ct. 240, 96 L. Ed. 288 (1952)). So important is this concept that we will usually read criminal statutes as implicitly requiring proof of mens rea even when they do not have a mens-rea component explicitly written into them, id. — though in doing so we read into them "only that mens rea which is necessary to separate wrongful conduct from 'otherwise innocent conduct,'" id. at 2010 (quoting Carter v. United States, 530 U.S. 255, 269, 120 S. Ct. 2159, 147 L. Ed. 2d 203 (2000)). 

But "[t]his is not to say that a defendant must know that his conduct is illegal before he may be found guilty." Id. Far from it. Instead, he "generally must 'know the facts that make his conduct fit the definition of the offense.'" Id. (quoting Staples v. United States, 511 U.S. 600, 608 n.3, 114 S. Ct. 1793, 128 L. Ed. 2d 608 (1994)). We say "generally," however, because in certain situations — like where a statute presents a danger of criminalizing apparently innocent acts — we sometimes require proof that the defendant knew his conduct infracted a specific law. See, e.g., Cheek v. United States, 498 U.S. 192, 200-01, 111 S. Ct. 604, 112 L. Ed. 2d 617 (1991). 

Back to our case. Essentially parroting a pattern-jury instruction, the parties — Morosco included — asked the judge to tell the jury that a section-371 conviction requires proof that the defendant acted "willfully," i.e., with "bad purpose, either to disobey or to disregard the law." See Nancy Torresen, 2015 Revisions to Pattern Criminal Jury Instructions for the District Courts of the First Circuit 119 (2015), available at http://www.med.uscourts.gov/pdf/crpjilinks.pdf (instruction 4.18.371(3)); see generally United States v. Charlton, 502 F.3d 1, 3 n.2 (1st Cir. 2007) (noting that the pattern instructions, though often helpful, "have not been officially adopted by th[is] court"). And the judge agreed to do just that. First, though, he told the jurors that section 371 reaches conspiracies to defraud that "have been agreed upon willfully to impair, impede or defeat the proper operation of the federal government by . . . deceit, craft, trickery, or dishonest means." He also told them that the government had to prove "two types of intent": an intent to "willfully and knowingly join[] the conspiracy" and "an intent to violate, whether reasonable or not, . . . the underlying" section-371 offense. As for what "willfully" means, the judge said that

[t]o act willfully . . . means to act voluntarily and intelligently and with the specific intent that the underlying crime, that is, interfering with the proper operation of the [HUD] program, . . . be committed. That is, when we talk about acting "willfully," we talk about acting with bad purpose either to disobey or disregard the law, and not to act simply because of ignorance, or accident, or mistake. 

Defending the judge's charge, the government (to quote its brief) says that section 371 neither explicitly nor implicitly "require[s] 'willful' action" — a "knowing[]" mens rea suffices — so, the government asserts, the instruction here actually required prosecutors to prove "a level of mens rea" higher than what the statute demands. n6 Interesting as the government's thought may be, the only mens-rea issue relevant here is the one Morosco raises: i.e., his claim that the judge should have said more than he did, instructing them that to convict they had to find that he knew his actions were not just improper (he basically concedes that they were) but were "criminal." The problem for Morosco is that he never asked for such an instruction, meaning we review only for plain error — a hard-to-meet standard that requires a person in his shoes to show "error, plainness, prejudice to [him] and the threat of a miscarriage of justice." See United States v. Torres—Rosario, 658 F.3d 110, 116 (1st Cir. 2011); see also United States v. Frady, 456 U.S. 152, 163, 102 S. Ct. 1584, 71 L. Ed. 2d 816 (1982) (noting that plain error means an error so obvious that a judge is "derelict in countenancing it, even absent the defendant's timely assistance in detecting it"). But Morosco cites no authority — and we know of none — saying that the mens rea for a case like his is that the defendant knew his conduct constituted a crime. So the situation here is not within a country mile of plain error — i.e., an "'indisputable'" error by the judge, "given controlling precedent." See Correa-Osorio, 784 F.3d at 22 (quoting United States v. Jones, 748 F.3d 64, 70 (1st Cir. 2014), which in turn cited United States v. Marcus, 560 U.S. 258, 262, 130 S. Ct. 2159, 176 L. Ed. 2d 1012 (2010)).
   n6 For support, the government cites out-of-circuit cases holding that a section-371 prosecution does not require "willful" intent, see United States v. Khalife, 106 F.3d 1300, 1303 (6th Cir. 1997); United States v. Cyprian, 23 F.3d 1189, 1201-02 (7th Cir. 1994); United States v. Derezinski, 945 F.2d 1006, 1012 (8th Cir. 1991) — though the government acknowledges, at least implicitly, that the judge's "[t]o act willfully" instruction essentially tracks the one we approved in another conspiracy-to-defraud case involving section 371. See United States v. Monteiro, 871 F.2d 204, 208 (1st Cir. 1989). 

We are not done with "willfully," however. 

Supplemental-Instruction Claim 

After deliberating for about two hours, the jury sent the judge a note saying, "Can we have an expanded definition of what constitutes 'willfulness' in regards to this charge?" Admitting that he was "not exactly sure what 'expanded'" meant, the judge talked with the parties' attorneys and proposed "simply repeat[ing] what I said before here, to which no objection was made . . . ." Because the jury had sought an "expanded definition," lawyers for Fitzpatrick and Morosco asked the judge to say more. Fitzpatrick's attorney offered some language. n7 But the judge declined to take counsel's suggestion, concluding that the recommendation did not add usefully to what he proposed to say. Fitzpatrick's lawyer then asked the judge to caution the jurors that they should not regard the supplemental instruction "as a substitute for the earlier instruction . . . ." Calling counsel's request "silly" — because, the judge said, the earlier instruction and the supplemental instruction were "the same thing" — the judge then gave the jury a written supplemental instruction, which read (cross-outs omitted):
   n7 Here is what Fitzpatrick's lawyer proposed:
An act or failure to act is, quote, willful, unquote, if done voluntarily and intentionally, and with the specific intent to do something the law forbids, or with specific intent to fail to do something the law required to be done; that is to say, with bad purpose either to disobey or to disregard the law. The burden to prove intent, as well as all other elements of the crime, rests with the government.  

  To act "willfully" means to act voluntarily and intelligently and with specific intent that the underlying crime — conspiracy to impair, impede and defeat the proper operation of the physical condition assessment of federally-funded housing units of the Chelsea Housing Authority by the United States Department of Housing and Urban Development's Real Estate Assessment Center ("REAC") — be committed, that is to say with bad purpose, either to disobey or to disregard the law and not because of ignorance, accident or mistake.

The jury returned guilty verdicts roughly an hour later. 

Fitzpatrick thinks that the judge's actions here constituted an abuse of discretion, the standard (the parties agree) that governs our oversight of preserved claims, see United States v. Rivera-Hernández, 497 F.3d 71, 83 (1st Cir. 2007), with unpreserved claims getting plain-error review. Ultimately, though, we see no reason to reverse. 

Fitzpatrick's lead argument is that the judge should have given an "expanded" definition of "willfully" since that is what the jury asked for. But he does not tell us what the judge should have said differently in defining that term — e.g., he does not argue that the judge should have given the supplemental instruction that counsel suggested. And given this situation, we can hardly say that his argument adds up to an abuse of discretion. Cf. generally Lussier v. Runyon, 50 F.3d 1103, 1111 (1st Cir. 1995) (saying that, "[i]n general, the abuse of discretion framework is not appellant-friendly"); Dopp v. Pritzker, 38 F.3d 1239, 1253 (1st Cir. 1994) (emphasizing that that most "appellants who consider themselves aggrieved by discretionary decisions of the district court . . . are destined to leave this court empty-handed"). 

Conceding that the judge "did not wrongly define 'willfully'" in the original charge, Fitzpatrick next blasts the judge for (supposedly) "omitt[ing] the thrust of the defense," first by not reminding the jury that conviction required "dual intent" — i.e., proof that he had "knowingly and willfully joined the conspiracy," plus had "the specific intent to commit the underlying crime"; and then by "omitting the earlier emphasis" that "'mere presence'" at the scene of a crime does not implicate the bystander in that offense (the judge had given a "mere presence" charge in his original instructions). Fitzpatrick preserved neither claim, however. And he makes no attempt to explain how he satisfies the requisites of plain error. We are under no obligation to do his work for him. See, e.g., United States v. Etienne, 772 F.3d 907, 918 n.7 (1st Cir. 2014); United States v. Calderón-Pacheco, 564 F.3d 55, 58 (1st Cir. 2009); accord Citizens Awareness Network, Inc. v. United States, 391 F.3d 338, 354 (1st Cir. 2004). 

Lastly, Fitzpatrick argues that the judge should have warned the jury that the supplemental instruction was not a substitute for the original instruction. Perhaps such an instruction might be called for when a judge "amplifie[s] or explain[s]" the original instruction. See United States v. Parent, 954 F.2d 23, 27 (1st Cir. 1992) (quoting Beardshall v. Minuteman Press Int'l, Inc., 664 F.2d 23, 29 (3d Cir. 1981)). But even Fitzpatrick admits that the judge's supplemental instruction essentially mimicked the original, unobjected-to "willfully" charge. And he cites no case — or any persuasive reason — requiring that a judge must give the pined-for warning in a situation like ours. 

What this all means is that Fitzpatrick's supplemental-instruction claim has no legs. But there is still work for us to do.

JAT Comment:  I don't know that this necessarily adds anything new, but it certainly presents the discussion in a different context.  But, even though the First Circuit does not plumb the depth that the Second Circuit did in Coplan, it says enough to say that the Hammerschmidt interpretation is loosey-goosey indeed.  I have raised related concerns about the defraud conspiracy, both whether the Hammerschmidt expansion is appropriate à la Coplan and whether the mens rea standard for conviction is parallel and the same as the Cheek definition of willfully.  At least in my mind, the First Circuit struggled to affirm by rejecting arguments that it should have thought more about; even if it affirmed as it probably felt constrained to do by Hammerschmidt, it could have gone farther with the permutations with respect to willfully and related issues.  (And, this is just me, I thought the drafter of the opinion was too cute in the way he wrote it.)

Update on the Zukerman Indictment - Potential Waivable Conflicts of Interest of Advocate as Witness (5/28/16; 6/21/16)

READERS SHOULD NOTE THE CLARIFICATION BELOW AS OF 6/6/16 AT 3:45 AM.

I recently posted on the Zukerman indictment: Prominent and Very Rich Investor Indicted in SDNY (Federal Tax Crimes Blog 5/24/16), here.  In that posting I have the following paragraph:

3. One of the obstructions charged relates to Zukerman passing false information to IRS Appeals through two attorneys at a Washington Law Firm.  That alone made me curious as to which firm and attorneys were used in the scheme, but I have not been able to find out that information.  And, the Government seems to have gotten access to the communications between Zukerman and the attorneys.  Since I assume that such information and documents were not given to the Government with Zukerman's consent, As the press release indicates, the attorney-client privilege was pierced by the Government pursuant to district court and Second Circuit opinions.  The Second Circuit opinion is  In re Grand Jury Subpoenas Dated March 2, 2015, 628 F. App'x 13 (2d Cir. 2015), here.  I discussed that Second Circuit opinion in a prior blog entry, Second Circuit Affirms Application of Crime-Fraud Exception to the Attorney-Client Privilege (Federal Tax Crimes Blog 10/10/15), here.

The prosecuting AUSA for SDNY, Stanley Okula, has written a letter, here, to the judge requesting a hearing, a so-called Curcio hearing (see United States v. Curcio, 680 F.2d 881 (2d Cir. 1982)).  The request is:

At that conference, the Government will request that the Court address potential conflicts issues relating to the defendant's current counsel, from the law firm of Williams & Connolly. More specifically, we will request that Your Honor conduct a Curcio proceeding, see United States v. Curcio, 680 F.2d 881 (2d Cir. 1982), which requires the Court to address with the defendant directly his desire to proceed with defense counsel who face potential waivable conflicts of interest - here, James Bruton and James Fuller, partners from Williams & Connolly, both of whom currently represent the defendant in this criminal case, and both of whom are potential witnesses against the defendant at any future trial or hearing. Mr. Bruton and Mr. Fuller are potential witnesses as a result of the defendant's use of those attorneys to convey false information to the Internal Revenue Service during a civil audit - offense conduct that is not only described at length in the Superseding Indictment (See Ind. ¶¶ 28-34) but was also the subject of a grand jury ''crime-fraud'' ruling by Judge Caproni that was affirmed by the Second Circuit Court of Appeals. See In re: Grand Jury Subpoenas, 2015 WL 5806060 (2d Cir. 2015) (upholding district court's crime/fraud ruling requiring attorneys for Zukerman to disclose attorney/client  communications that resulted in submission to IRS of tax protest letter that included false facts). 

In sum, we believe that the potential conflict can be waived by the defendant, but only after the Court conducts a proceeding pursuant to Curcio and its progeny. Consistent with the approach we have taken in prior proceedings of this sort, the Government expects to submit to Your Honor by early next week a set of questions that should be asked of the defendant at the Curcio hearing, in order to determine that the defendant understands the nature of the potential conflicts and that he knowingly desires to proceed with his counsel, notwithstanding the potential conflicts.

The letter is cc'd to the following:

James A. Bruton, III, Esq.
David Zinn, Esq.
(Counsel for the Defendant)
Henry Putzel, III, Esq.
(Conflicts Counsel for the Defendant)

Messrs. Bruton and Zinn are with the firm of Williams & Connolly ("W&C"), headquartered in Washington, DC.  I infer from the designation of Mr. Putzel, who is not with W&C, that he is an independent attorney advising Zukerman of the potential conflicts.

The letter has the following at the end, signed by the Judge (bold face in original):

GRANTED. The parties are directed to appear in Courtroom 15D of the United States
Courthouse, 500 Pearl Street, New York, New York, 10007, on June 8, 2016, at 4:45 p.m., for an initial conference and to address the potential conflict between Defendant and his counsel.
SO ORDERED.
Dated: May 24, 2016
New York, New York

The attorneys entering appearances for Zukerman, according to the docket entries viewed on 5/28/16 are:  Mr. Bruton, David Michael Horniack, and Mr. Zinn, all with W&C.  (All have requested admission pro hac vice to represent Zukerman in this case.)  I know Mr. Bruton, here, a prominent criminal tax defense attorney, and believe that he is competent, ethical and well-respected among his peers.  (So, I can understand why Zukerman would want him as his counsel in a criminal tax case; if I had that problem, Mr. Bruton would be on a list of perhaps 2 or 3 that I would want to consider representing me.)

The Second Circuit (which includes the SDNY in which Zukerman was indicted) has described the Curcio hearing as follows (United States v. Perez, 325 F.3d 115, 119 (2d Cir. 2003)):

At such a hearing, the trial court (1) advises the defendant of his right to representation by an attorney who has no conflict of interest, (2) instructs the defendant as to the dangers arising from particular conflicts, (3) permits the defendant to confer with his chosen counsel, (4) encourages the defendant to seek advice from independent counsel, (5) allows a reasonable time for the defendant to make a decision, and (6) determines, preferably by means of questions that are likely to be answered in narrative form, whether the defendant understands the risk of representation by his present counsel and freely chooses to run them. See id. at 888-90. The ultimate goal of these procedures is to permit the court to determine whether the defendant's waiver of his right to conflict-free counsel is knowing and intelligent.

It seems clear that the two attorneys through whom Zukerman allegedly passed allegedly fraudulent information to the IRS (a centerpiece of the tax obstruction charge in the indictment) were with W&C.  Mr. Okula identifies those attorneys as James Bruton and James Fuller.  Only Mr. Bruton has entered an appearance to represent Zukerman in the criminal case.

The conflict in issue identified by Mr. Okula is that Mr. Bruton and Mr. Fuller (Bruton's partner at W&C) apparently are necessary or appropriate witnesses in the criminal case.  Having an advocate testify in any case, civil or criminal, raises all sorts of red flags.  The red flag identified by Mr. Okula is the potential for conflict of interest with the party the advocate represents.  The advocate's role as a witness can potentially impair the effective representation of the party the advocate represents.  That is solely a conflict of interest issue that would require that the represented party be fully advised of the potential conflict and make a knowing waiver of the potential conflict, including the risks involved.  As stated by Mr. Okula, resolving that potential issue to insure a knowing waiver will be the purpose of the hearing.  I assume that the presence of conflicts counsel indicates that Zukerman is prepared to make a knowing waiver and that defense counsel and Zukerman think that the Court will so hold after the Curcio hearing.

CLARIFICATION ON 6/616 AT 3:45 AM:

In the balance of the original posting (which I keep below), I addressed potential issues that could arise should these counsel have to testify in the case in chief.  As it turns out, in a letter to the Court on May 31, 2016, here, AUSA Okula advised the Court (the content is short so, I quote it all but the bold-face has been supplied by me):

Enclosed please find a set of questions we respectfully propose that the Court utilize at the June 8, 2016 Curcio proceeding in the above-referenced case. As we noted in our letter of May 23, 2016, we believe the Curcio hearing is necessary in order for the Court to explore (1) the nature of the potential conflict of interest faced by the defendant’s current counsel, James A. Bruton, III, and James T. Fuller, III, from the law firm of Williams & Connolly; (2) the defendant’s awareness and understanding of the potential conflict; and (3) the defendant’s desire,after consulting with independent counsel, Henry Putzel, III, to knowingly waive any conflict or potential claim arising therefrom. 

As our proposed questions make clear, the potential conflict stems from the fact that both Mr. Bruton and Mr. Fuller were required, pursuant to a “crime fraud” ruling made by Judge Caproni, to disclose to the grand jury their written and oral communications with the defendant concerning a tax Protest Letter prepared by Bruton and Fuller and submitted to the civil branch of the Internal Revenue Service. That letter endeavored to challenge certain audit determinations previously made by an IRS auditor with respect to one of the defendant’s corporate entities. Both Mr. Fuller and Mr. Bruton were also required to testify as witnesses before the grand jury that voted the charges against the defendant. 

Based on our discussions with defense counsel, we understand that the defendant wishes to sign a plea agreement and schedule a plea proceeding. Before taking either step with current counsel, however, we respectfully submit that the potential conflict issue must be addressed and successfully navigated.

Although I am not an expert in this area, although the concerns I originally expressed seemed to be raised, it now appears that, if Zukerman pleads guilty as indicated in the letter, the only issue is the conflict issue which, as AUSA Okula originally noted can be waived.  I should have anticipated that result since most tax crimes cases result in a plea which has often been negotiated by the time the indictment is filed or, if sealed, unsealed.  Still, if AUSA Okula had a concern about these attorneys even representing Zukerman in the plea proceeding, it would seem to me that he should have had that concern in the negotiations.  Perhaps he did and felt the presence of conflict counsel was sufficient for him to do that, with the intention of presenting the issue to the Court when the indictment was unsealed.

AUSA Okula's  proposed Curcio hearing questions are here.

Update on 6/9/16 2:30pm:

The Curcio hearing was held on 6/8/16. The New York Times has this article on the hearing:  Matthew Goldstein & Alexandra Stevenson, Lawyers Ordered to Testify on Client’s Tax Evasion Case (NYT 6/8/16), here.  The article is a good one.  Basically, it appears that the conflict was waived and the client will plead guilty to  one or more of the charged crimes with what appears will be a very large tax loss.  The article does give some of the detail, principally from the indictment, about the defendant's use of the lawyers to communicate false information to the IRS.  I may post further information on this latter after I have time to pull any additional filings from Pacer.

Update on 6/21/16 9:30am:

Peter Hardy has an excellent discussion of the crime-fraud exception at Zukerman Case Raises Issues Regarding Crime Fraud Exception to Attorney Client Privilege (Procedurally Taxing Blog 7/17/16), here.

NOTE THE FOLLOWING DISCUSSION IS NOT RELEVANT IN LIGHT OF ZUKERMAN'S APPARENT INTENT TO ENTER A GUILTY PLEA.  I KEEP IT ONLY FOR POTENTIAL FUTURE REFERENCE IN OTHER CASES.

But, the advocate as witness in a case raises other issues than the potential for conflict.  ABA Model Rule 3.7, Lawyer as Witness, here, address those other issues as follows:

Rule 3.7 Lawyer As Witness 

(a) A lawyer shall not act as advocate at a trial in which the lawyer is likely to be a necessary witness unless:

(1) the testimony relates to an uncontested issue;
(2) the testimony relates to the nature and value of legal services rendered in the case; or
(3) disqualification of the lawyer would work substantial hardship on the client.

(b) A lawyer may act as advocate in a trial in which another lawyer in the lawyer's firm is likely to be called as a witness unless precluded from doing so by Rule 1.7 or Rule 1.9.

The Model Rules do not control the appearances in the Zukerman case, but seem to parallel the rules that are applicable (noted below).  Accordingly, the Commentary to the Model Rule, here, might be useful reading.

The Second Circuit has this discussion of the applicable rules and their concerns (Murray v. Metro. Life Ins. Co., 583 F.3d 173, 177-79 (2d Cir. 2009), here):

IV 

Plaintiffs make the separate argument that disqualification of Debevoise is proper by virtue of the witness-advocate rule set  out in Rule 3.7 of the New York Rules of Professional Conduct. Subsection (a) of the Rule provides, with certain exceptions, that "[a] lawyer shall not act as an advocate before a tribunal in a matter in which the lawyer is likely to be a witness on a significant issue of fact." N.Y. R. Prof'l Conduct § 3.7(a). Subsection (b) is broader, as it addresses imputation: "A lawyer may not act as an advocate before a tribunal in a matter if . . . another lawyer in the lawyer's firm is likely to be called as a witness on a significant issue other than on behalf of the client, and it is apparent that the testimony may be prejudicial to the client." See N.Y. R. Prof'l Conduct § 3.7(b)(1).  

Rule 3.7 lends itself to opportunistic abuse.  "Because courts must guard against the tactical use of motions to disqualify counsel, they are subject to fairly strict scrutiny, particularly motions" under the witness-advocate rule. Lamborn v. Dittmer, 873 F.2d 522, 531 (2d Cir. 1989). The movant, therefore, "bears the burden of demonstrating specifically how and as to what issues in the case the prejudice may occur and that the likelihood of prejudice occurring [to the witness-advocate's client] is substantial." Id. "Prejudice" in this context means testimony that is "sufficiently adverse to the factual assertions or account of events offered on behalf of the client, such that the bar or the client might have an interest in the lawyer's independence in discrediting that testimony." Id. 

As this definition suggests, the showing of prejudice is required as a means of proving the ultimate reason for disqualification: harm to the integrity of the judicial system. We have identified four risks that Rule 3.7(a) is designed to alleviate: (1) the lawyer might appear to vouch for his own credibility; (2) the lawyer's testimony might place opposing counsel in a difficult position when she has to cross-examine her lawyer-adversary and attempt to impeach his credibility; (3) some may fear that the testifying attorney is distorting the truth as a result of bias in favor of his client; and (4) when an individual assumes the role of advocate and witness both, the line between argument and evidence may be blurred, and the jury confused. Ramey v. Dist. 141, Int'l Ass'n of Machinists & Aerospace Workers, 378 F.3d 269, 282-83 (2d Cir. 2004) (internal citations and alterations omitted). These concerns matter because, if they materialize, they could undermine the integrity of the judicial process. See Hempstead Video, Inc. v. Inc. Vill. of Valley Stream, 409 F.3d 127, 132 (2d Cir. 2005) ("The authority of federal courts to disqualify attorneys derives from their inherent power to preserve the integrity of the adversary process.") (internal quotation marks omitted); see also id. (emphasizing "the need to maintain the highest standards of the profession") (internal quotation marks omitted). 

In imputation cases (Rule 3.7(b)), the witness is not acting as trial counsel; these concerns are therefore "absent or, at least, greatly reduced." Ramey, 378 F.3d at 283 (internal quotation marks omitted); see also A.B.A. Model Rules of Prof'l Conduct § 3.7 cmt. 5 ("Because the tribunal is not likely to be misled when a lawyer acts as advocate in a trial in which another lawyer in the lawyer's firm will testify as a necessary witness, [Model Rule 3.7(b)] permits the lawyer to do so except in situations involving a conflict of interest."). Accordingly, disqualification by imputation should be ordered sparingly, see Kubin v. Miller, 801 F. Supp. 1101, 1114 (S.D.N.Y. 1992), and only when the concerns motivating the rule are at their most acute. 

Therefore, we now hold that a law firm can be disqualified by imputation only if the movant proves by clear and convincing  evidence that [A] the witness will provide testimony prejudicial to the client, and [B] the integrity of the judicial system will suffer as a result. This new formulation is consistent with our prior efforts to limit the tactical misuse of the witness-advocate rule. See, e.g., Lamborn, 873 F.2d at 531.

It is important for readers to make the key distinction between the advocate acting as witness (addressed in the Rule subsection (a)) and the advocate's partner acting as witness (addressed in subparagraph (b), referred to as imputation).  The Court says that motions to disqualify under under Rule 3.7 potentially lend themselves to "opportunistic abuse," particularly focusing on subsection (b), where the advocate's partner is a witness).  For subsection (b) cases, the Court creates a substantial burden of proof (clear and convincing evidence) of prejudice to the client and damage to the integrity of the judicial system. It is not clear what the burden might be under subsection (a) which is the more sensitive of the situations addressed.  

As I read Mr. Okula's letter, two W&C attorneys may have to testify -- Mr. Bruton and Mr. Fuller.  Mr. Bruton is counsel in the case, thus subject to subsection (a).  Mr. Fuller is not counsel in the case, thus subject to subsection (b).  Of course, Mr. Okula raises only the potential conflict issue.  He does not raise at all the other issues/problems to which subsections (a) and (b) are directed involving the integrity of the judicial process.  The Court can raise those issues on its own.  Perhaps that is why Okula is pressing the conflicts issue with the notion that the Court itself may raise the issue.  But that is nothing more than my speculation, for I have no way to read Mr. Okula's mind.  I can only read what he said in his letter, and he said nothing beyond the issue of conflicts which, he assures the Court, are waivable.

Another speculative possibility is that Mr. Okula believes Zukerman will clear the conflicts hurdle and permit Mr. Okula to take extra advantage of the W&C attorneys.  I presume, for example, that when the two are called in the case in chief, the Court will likely treat the two as sufficiently close to hostile witnesses that it will permit Mr. Okula to lead them.  (My experience, though, is that attorneys, particularly smart attorneys, are not easily led.)  And, I can imagine other things that might happen, but I won't burden readers with my imaginings, which nobody is willing to pay me for.

I look forward to the results of the hearing on June 8.

Prominent and Very Rich Investor Indicted in SDNY (5/24/16)

Most readers will already know of the indictment of Morrris E. Zukerman, an affluent alleged tax cheat.  The indictment is here and the Press Release from the USAO SDNY is here.  One of the news items about this indictment is:  Jesse Drucker, Oil Investor Zukerman Dodged $45 Million in Taxes, U.S. Says (Bloomberg News 5/23/16), here.

I think the USAO SDNY provides a good summary of the criminal mischief.  The key excerpts from the press release are:

MORRIS E. ZUKERMAN, a Manhattan businessman who owns companies involved in energy investments, was charged today in a three-count Indictment with engaging in multi-year tax fraud schemes pursuant to which he evaded over $45 million in income and other taxes.   

* * * * 

U.S. Attorney Preet Bharara said: “As alleged in the indictment, Morris Zukerman cheated on virtually all of his various tax obligations: he evaded tens of millions of dollars of corporate income taxes arising out of $130 million sale of an oil company; he prepared personal tax returns for himself and family members that claimed millions of false deductions; he evaded employment taxes based on personal employees; and he evaded New York sales and use taxes.  To top it off, when the IRS auditors examined his returns, Zukerman allegedly schemed to defraud and obstruct the IRS auditors who were examining his false tax returns.” 

* * * * 

According to the Indictment unsealed today in Manhattan federal court and other court filings related to this matter: 

ZUKERMAN, the principal of M.E. Zukerman & Co. (“MEZCO”), an investment firm located in Manhattan, schemed to evade taxes based on income received from the January 2008 sale of a petroleum products company (the “Oil Company”) he co-owned (through a MEZCO subsidiary) with a public company.  ZUKERMAN schemed to evade the reporting of the sale – which resulted in the receipt by the MEZCO subsidiary of $130 million in gross sales proceeds – by falsely telling his accountants in mid-2008 that he had transferred ownership of the MEZCO subsidiary to a family trust in early 2007.  In support of the story he gave to the accountants, ZUKERMAN created backdated documents such as promissory notes and a board resolution purporting to show the transfer of the subsidiary to his family trust in 2007.  The false documents allowed ZUKERMAN to remove the MEZCO subsidiary from the consolidated tax reporting being handled by the accountants for MEZCO and thereby evade the reporting to the IRS of the sale of the Oil Company, as well as the payment of over $35 million in corporate income taxes. 

Following the sale of the Oil Company, ZUKERMAN transferred the proceeds of the sale from the MEZCO subsidiary to his family trust and various corporations he controlled, including a company called Zukerman Investments.  Between 2008 and 2013, ZUKERMAN directed that over $50 million of the funds transferred to Zukerman Investments be used to purchase paintings by European artists from the 15th through the 19th centuries (the “Old Master paintings”), which ZUKERMAN used to decorate his Upper East Side apartment and the apartments of two family members – Family Member-1 and Family Member-2.

In connection with the purchase of the Old Master paintings, ZUKERMAN schemed to defraud New York State of over $4.5 million of sales and use taxes by directing that the paintings, which were frequently purchased from galleries located blocks from ZUKERMAN’s Manhattan residence, be shipped by the galleries to ZUKERMAN’s corporate addresses located in Delaware and New Jersey, and transported immediately thereafter (sometimes within minutes), by ZUKERMAN and others, back to ZUKERMAN’s residence in New York – all without the payment to New York State of sales or use taxes.  ZUKERMAN further schemed to defraud New York State of sales and use taxes by using his corporate address in New Jersey to be falsely listed on a sales invoice for a $645,000 pair of diamond earrings he purchased in Europe from a jeweler who turned over possession of the earrings to a member of ZUKERMAN’s family in Manhattan but charged no sales tax, based on the out-of-state address provided by ZUKERMAN.   

ZUKERMAN also schemed to evade personal income taxes and to obstruct the IRS by (i) causing various tax return preparers to prepare U.S. Individual Income Tax Returns, Forms 1040, for ZUKERMAN and his wife, and for Family Member-1, Family Member-2, and Family Member-3, that claimed, in the aggregate, millions of dollars of false and fraudulent deductions and expenses, such as phony charitable contributions and investment interest expenses; (ii) diverting, for personal use, corporate assets from MEZCO and other corporate entities ZUKERMAN controlled by directing that hundreds of thousands of dollars of fees be paid between 2007 and 2013 to Family Member-1, Family Member-2, and Family Member-3, for which the family members performed little or no work; (iii) directing that corporate funds be used to pay compensation to, and health care insurance for, a household employee of ZUKERMAN, whom ZUKERMAN also caused to be falsely identified as a MEZCO employee to ZUKERMAN’s corporate health care provider when, in truth and fact, the household employee worked exclusively out of ZUKERMAN’s homes in New York City and in Maine as a domestic employee; (iv) falsely under-reporting employment taxes through the payment of hundreds of thousands of dollars of cash and other wages to ZUKERMAN’s domestic employees; and (v) providing false information to the IRS during audits in an attempt to fraudulently convince IRS auditors and other IRS employees that the fraudulent claims made on his previously filed tax returns were accurate when, in truth, they were not.      

The False Charitable Contribution Deductions for the 2009 & 2011 Tax Years 

ZUKERMAN’s fraudulent charitable contribution deductions – totaling $1 million – arose out of a real estate transaction in 2009 and 2010, pursuant to which ZUKERMAN purchased approximately 240 acres of property on Black Island, a small island located off the coast of Maine, close to ZUKERMAN’s home on a nearby island.  ZUKERMAN was enlisted to purchase the Black Island property by a Maine-based land conservation entity (“the Conservation Entity”) that was seeking to orchestrate the purchase, for conservation purposes.  After considering making a charitable contribution to the Conservation Entity intended to be used to purchase the property, ZUKERMAN decided instead to purchase the land as the outright owner for the benefit of himself and his family for $1 million through a newly formed limited liability company he solely owned.  ZUKERMAN, however, falsely told his tax return preparer that the $1 million he paid for the property should be declared on his personal income tax returns as a charitable contribution to the Conservation Entity during the 2008 and 2010 tax years. 

 ZUKERMAN subsequently signed the false 2008 and 2010 tax returns and caused them to be filed with the IRS. 

The False Investment Interest Expense Deductions Relating to the Corporate Loans 

ZUKERMAN orchestrated the creation of hundreds of thousands of dollars of fraudulent “investment interest expense” deductions on his own tax returns and those of three family members.  ZUKERMAN accomplished this by falsely telling his tax preparers that payments made from the personal bank accounts of ZUKERMAN and his family members to a California bank were made to legitimately satisfy loan interest payments owed by one of his California companies.  In fact, although the interest payments were initially made from the bank accounts of ZUKERMAN and those of his family members (whose accounts ZUKERMAN controlled), ZUKERMAN secretly took funds from the bank account of the California corporation that owed the interest payments and reimbursed himself and his family members.  In addition, because the corporation that owed the interest payments had claimed the interest indebtedness as an expense on its corporate tax returns, ZUKERMAN’s claiming of the same expenses on his own tax returns and those of his family members constituted fraudulent double deductions.    

The Audit Fraud 

In seeking to obstruct and defraud the IRS during an audit of one of ZUKERMAN’s companies, ZUKERMAN utilized two attorneys from a law firm in Washington, D.C., to convey a false factual narrative to an IRS Appeals officer, who was undertaking a review of ZUKERMAN’s challenge to an adverse determination made by an IRS auditor during the corporate audit.  Pursuant to a “crime-fraud” ruling by the United States District Court for the Southern District of New York, and affirmed by the Second Circuit Court of Appeals, ZUKERMAN’s companies were required to disclose to the grand jury all of the communications between ZUKERMAN and the two attorneys that led to the submission to the IRS of the false factual narrative.                        

*                      *                      * 

ZUKERMAN, 71, of New York, New York, is charged with: one count of tax evasion, which carries a maximum sentence of five years in prison; one count of wire fraud, which carries a maximum sentence of 20 years in prison; and one count of obstructing the IRS, which carries a maximum sentence of three years in prison.  The three charges each also carry a maximum fine of $250,000, or twice the gross gain or loss from the offense. 

The press release does remind its audience that these are just the criminal allegations in the case.  The Government will have to prove beyond a reasonable doubt the allegations and the elements of each crime charged.

JAT Comments:

1. Except for the large numbers and some complexity in the evasion schemes, this is more or less standard stuff in tax crimes cases – tax obstruction under 7212 and tax evasion under 7201 (although the tax evasion allegations are in one count -- Count Two -- for multiple year individual and entity tax evasion which, I think, usually are charged in separate counts).  There is a wire fraud count -- Count Three -- for evading state sales and use taxes with the standard dodge of round-tripping valuable personal property purchase out of NY (no sales tax) and then back into NY for personal enjoyment.  The latter state tax dodge occurs frequently and is not usually the subject of a federal indictment (at least I don’t think so).  Certainly, as indicated, more counts could have been coaxed from the pattern of conduct alleged, but given the operation the Sentencing Guidelines, there are enough counts alleged that conviction of even just the tax evasion and/or wire fraud counts will probably permit the maximum sentence a judge might impose.  The tax obstruction count is a 3 year felony, so the Guidelines Range on the allegations made will substantially exceed 3 years and, perhaps, even 5 years, but I doubt that a judge would sentence in excess of 5 years.

2. The schemes were apparently uncovered as a result of random tax audits of a related entity and Zukerman personally.

3. [Note this paragraph was substantially revised later on 5/24/16] One of the obstructions charged relates to Zukerman passing false information to IRS Appeals through two attorneys at a Washington Law Firm.  That alone made me curious as to which firm and attorneys were used in the scheme, but I have not been able to find out that information.  And, the Government seems to have gotten access to the communications between Zukerman and the attorneys.  Since I assume that such information and documents were not given to the Government with Zukerman's consent, As the press release indicates, the attorney-client privilege was pierced by the Government pursuant to district court and Second Circuit opinions.  The Second Circuit opinion is  In re Grand Jury Subpoenas Dated March 2, 2015, 628 F. App'x 13 (2d Cir. 2015), here.  I discussed that Second Circuit opinion in a prior blog entry, Second Circuit Affirms Application of Crime-Fraud Exception to the Attorney-Client Privilege (Federal Tax Crimes Blog 10/10/15), here.

4. It is alleged that Zukerman spread the compliance (tax return reporting) work among various professional firms to prevent any one of them seeing enough of the big picture to identify or suspect the fraud.  Those firms are not identified except by pseudonyms.  I am not so much interested in the names of the firms and the professionals involved.  But I would like to know whether any of the professionals were considered for prosecution and/or discipline?  It seems to me that, even with only pieces of the bigger puzzle, the allegations suggest that some of the professionals may have asked more questions and insisted on answers.

5. In the latter regard, the indictment (par. 29, p. 20) alleges that, in an audit of a related entity, the IRS decided to disallow a claimed purchase of an interest in a deal by a related Zukerman entity.  The indictment alleges:  “In connection with this determination [by the IRS], the IRS noted, in an explanation of its decision dated May 24, 2012, that the CPA had acknowledged to the IRS that the CPA did not believe that Bodley had even owned an interest in the Oil Company.”  Got to be some kind of story there.

Whack a Mole - Fifth Circuit Confirms that the Stench of a Bullshit Shelter Does Not Smell Better with Time (5/18/16)

In Chemtech Royalty Associates, L.P. as Tax Matters Ptnr v. United States, ___ F.3d ___, 2016 U.S. App. LEXIS 9037 (5th Cir. 5/17/16), here, the Fifth Circuit rejected odorific (Urban Dictionary here) arguments in support of the bona fides of the partnership's investment bullshit tax shelter.  The Fifth Circuit had previously called the shelter itself foul indeed.  See Chemtech Royalty Assocs., L.P. v. United States, 766 F.3d 453 (5th Cir. 2014); see my blog on the prior Fifth Circuit opinion in Another Bullshit Tax Shelter Bites the Dust on Appeal Also (Federal Tax Crimes Blog 9/12/14; 9/20/14), here.  This time on appeal the issue was whether the partnership could avoid a penalty after the Fifth Circuit had previously called the shelter foul indeed.

In the first appeal, the district court had rejected the merits of the shelter (a holding affirmed on appeal) and held that two 20% accuracy related penalties applied -- the negligence and the substantial understatement.  Each of those penalties could apply, although only one 20% accuracy related penalty would apply (2 reasons for the one penalty).  The taxpayer appealed.  In the first opinion calling the merits of the shelter foul indeed, the Fifth Circuit vacated the penalties to remand for the district court to determine whether the penalties remained applicable in light of the Fifth Circuit opinion on the merits and the Supreme Court's opinion in United States v. Woods, 134 S. Ct. 557 (2013) (which actually involved the substantial and gross valuation misstatement penalties but which effectively, according to the Fifth Circuit, overruled two Fifth Circuit precedents).  On the remand, the district court re-affirmed the application of the negligence and substantial understatement penalties, and the partnership again appealed.

In this iteration, the Fifth Circuit held the negligence penalty applicable but deferred opining on the substantial understatement penalty.  It seems to me that the Court's opinion is a bit confusing (at least to me), so I will try to summarize my understanding of how the Court got there.

1.  The substantial understatement penalty.  Because the transaction in question was a tax shelter, the substantial understatement penalty applied unless, under the law applicable at the time, the taxpayer established that it reasonably believed that the tax benefits were more likely than not to prevail.  The Court essentially ducked that issue for now, by holding that the defense based on reasonable belief did not have to be litigated in the partnership proceeding, thus perhaps deferring it to another day when the taxpayer might pursue it.

2. The negligence penalty.  After rejecting the Government's procedural arguments to consideration of the taxpayer's defense to the negligence penalty, the Court rejected the partnership's claim that it had substantial authority, a traditional defense to the negligence penalty.  Basically, there was no substantial authority that the a taxpayer can hide a lending arrangement as a partnership.

Readers of this blog will recall that the Second Circuit said basically the same thing in GE's tax shelter misadventure in TIFD-III-E Inc. v. United States, 604 Fed. Appx. 69 (2d Cir. 2015), which, like the instant case, bounced from trial court to appellate court with the only difference that there was an obstinate trial judge in TIFD trying to help GE; the Second Circuit had to call the matter to a halt in a way that did not appear favorable to either GE or the trial judge; in the instant case, of course, the trial judge got it right and was affirmed by the Fifth Circuit.  See on the TIFD saga, my discussion of the final Second Circuit holding GE Gets Slapped Down Again for its BullShit Tax Shelter (Federal Tax Crimes Blog 5/20/15), here.

Sam Wyly's Continuing Travails -- the Bankruptcy Edition (5/15/16; 5/21/16)

I have previously written about the travails, visited upon themselves, by the Wyly brothers, Sam and Charles, very wealthy men who decided that they did not have to play by the rules.  All blog entries on the Wyly's are here.  The Wyly brothers lost a previous round on disgorgement by the SEC.  See Wylys Ordered to Disgorge Hundreds of Millions of Tax Benefits With Interest (Federal Tax Crimes Blog 9/27/14), here.

The latest chapter is a bankruptcy decision involving Sam Wyly, Charles Wyly and Charles' wife, Dee Wyly.  In re Samuel Evans Wyly, et. al. (Bkr No. 14-35043-BJH 5/10/16), here (because of the length of the opinion, I have used the Adobe bookmarking feature to bookmark in outline format because of its length; readers can download and use the bookmarks to more easily move around the lengthy document).  [JAT Note I just discovered on 5/21/16 that I had the wrong link to the opinion; I have corrected that and apologize to readers.]  The opinion is 459 pages (including Exhibits).  Without exhibits and excluding the table of contents, the opinion is 427 pages long.  This is a substantial read, depending on the level the reader chooses to drill down into the opinion.  For those merely wanting the judge's own summary, see the Conclusion which is 9 pages, beginning on p.418 and ending on page 427.  The bottom line (my summary of the judge's summary as to the key holdings):

1.  The issues (p. 418, footnote omitted):  "First, did Sam and Charles commit tax fraud? Second, if they did, what role, if any, did Dee have in that fraud?"

2. The conclusion as to Sam and Charles (p. 419):  "the Court is convinced — by clear and convincing evidence — that Sam and Charles committed tax fraud."

3.  The linchpin for the offshore structure was that a key trust created in 1992 was a nongrantor trust as to Sam and Charles.  Although Sam and Charles, through their advisor, received a number of opinions as to various facets of the structure, he never received an opinion that this key nongrantor trust linchpin was met until 2003.  Actually in 1993, Sam's and Charles' advisor had been told by a lawyer that an expert on this subject had concluded that there was a "significant risk" that the trust would be characterized as a grantor trust, which would defeat the planning.  At that point, the lawyer advised that the Wylys needed a real nongrantor trust settled by someone other than Wylys so that the Wylys were not grantors.  The characteristics of such a nongrantor trust were:

(i) the grantor of the trust has known the Wylys “for a considerable period of time,” (ii) the trust is being established as “an entirely gratuitous act,” and (iii) the grantor has not received and will not receive any “consideration, reimbursement or other benefit” for settling the trust, “directly or indirectly.”

4.  Then, pursuant to the advice, "an individual residing in the IOM [Isle of Man] who Sam barely knew, King, settled a trust in February 1994 naming Sam and his family members as beneficiaries."  The factual predicates stated in the documents for the new trust were false.  But, Sam began acting as if the façade was real.

Sam starts transacting business through it offshore by undertaking two more complicated private annuity transactions in 19961672 and a myriad of extremely complicated real estate transactions involving, among other things, homes, an art gallery, and an office for himself and other family members in Texas and Colorado in the late 1990s and early 2000s1673—all tax and reporting free.

5.  Sam then causes to be settled a similar supposed nongrantor trust through the façade of a stranger, again with false statements in the documents.  The Court takes the trouble to quote the key lies in its Conclusion, so here it is with the nominal nongrantor making the statement:

I wanted to take this opportunity to let you know what a pleasure it has been knowing you over the past years and dealing with you on both business and social matters. I appreciate your many courtesies. As you know, I have established a trust with Wychwood Trust Limited, called The La Fourche Trust, for the benefit of you and your family, and have provided this trust with the sum of $25,000.00. This is to show my gratitude for your loyalty to our mutual ventures and your personal support and friendship. I hope that, wisely managed, this trust fund can grow for many years and inure to the benefit of many generations of your family.

The Court says "All of this is a lie, except that the La Fourche IOM Trust was established with Wychwood Trust Limited."  [Those who have watched bullshit offshore planning will easily recognize this type of façade built on lies.]  Based on the lies and the façade of a nongrantor trust, a legal opinion was then forthcoming that the structure depending on the façade would work tax magic.  Of course, Sam claimed not to know about the lies (meaning, if believed, Sam's own lawyer had kept him in the dark), but the Court notes:

did Sam not wonder why King and Cairns, one individual he barely knew and the other who he did not know at all, each settled a trust with $25,000 in the IOM and named him and his wife and children as beneficiaries? Perhaps that happens all the time in Sam’s life, but if it happened in mine, I would be asking questions—lots of them.

6.  Another feature of these bullshit offshore trust is that the trust may -- but, supposedly, not must -- act pursuant to the orchestrator's (Sam's) statement of "wishes."  The Court said:

Let me be clear, that Sam’s directions to the offshore trustees was usually done through the formality of Sam making his “wishes” known to them—directly or through the trust protectors he appointed—is of little consequence. The IOM trustees never refused to follow Sam’s “wishes”—even when that made little sense—as they understood that their jobs depended upon it. If a Sam “wish” was not granted, they would be removed—plain and simple.

7.  As to Sam's claim that he did not know, "The Court does not believe that the law permits Sam to hide behind others and claim not to have known what was going on around him."

8.  But, as to Dee,

At the same time, the Court is equally convinced that Dee is innocent of any wrongdoing. That she did not know the details of what Sam and Charles had done offshore is clear. And, there was nothing that should have “tipped her off” that something was amiss. She did not commit fraud, she did not participate in any fraud, she was not willfully blind, and she is entitled to the benefit of the innocent spouse defense.

I suspect that, given the SDNY court's order on disgorgement, the decision as to Sam and Charles was entirely predictable, particularly because the bankruptcy court treated a number of facts as established under the doctrine of collateral estoppel. (See opinion, pp. 3 - 6 and Exhibit A to the opinion.)

While the facts are complex, the holdings summarized above are, in my opinion, straight-forward once the court found the facts.  Accordingly, I don't feel it necessary or appropriate to write further on them.

But, there was one facet of the Court's opinion that I found particularly interesting.  This involved the court's treatment of expert opinion proffered by the Wylys.  That discussion is p. 6 - 17 of the pdf opinion.

First, I offer some background.  In James v. United States, 366 US 213 (1961), the Supreme Court held that uncertainty as to the tax law's command precludes criminal prosecution for violating that uncertain command for a tax crime, such as evasion, requiring willfulness.  The willfulness element of most tax crimes requires that the person intend to violate a known legal duty.  In order for a person to have that intent the duty must be objectively knowable.  (As I have sometimes said, the willfulness element requires both a known legal duty (known as to the defendant) and a knowable legal duty (objectively knowable so that any defendant can be held to the standard.)  Hence, the cases are clear that uncertainty as to the law's command precludes willfulness and, necessarily, any crime that has willfulness as an element.  See e.g., E.g., United States v. Garber, 607 F2d 92 (5th Cir. 1979) (en banc); United States v. Critzer, 498 F2d 1160 (4th Cir. 1974) ; United States v. Dahlstrom, 713 F2d 1423, 1427 (9th Cir. 1983); and United States v. Harris, 942 F2d 1125 (7th Cir. 1991).  As in the cited cases, one of the "defenses" to tax crimes requiring willfulness is to show that the law's command is uncertain.  For more discussion of this issue, see Saltzman & Book, IRS Practice and Procedure, ¶ 12.05[2][b][iii] Complexity and uncertainty in the tax law (Thomson Reuters/Tax & Accounting, Rev. 2nd ed. 2002 & Supp. 2015-3).

There are some civil analogs imposing punishment on a taxpayer for conduct that would be deemed evasion.  The two most frequently encountered are the civil fraud penalty in § 6663, here, and the unlimited statute of limitations in case of a false return with intent to evade in § 6501(c)(1), here.  See Anderson v. Commissioner, 698 F.3d 160, 164 (3d Cir. 2012), cert. denied ___ U.S. ___, 133 S. Ct. 2797 (2013) (“the elements of evasion under 26 U.S.C. § 7201 and fraud under 26 U.S.C. § 6663 are identical.”); and cf. BASR Partnership v. United States, 795 F.3d 1338 (2015) (§ 6501(c)(1) and 6663 interpreted in pari materia).  Hence, one can infer -- correctly, I think -- that uncertainty as to the law's command will negate those civil "penalties" turning on fraud.

In whichever context the issue of uncertainty arises with respect to fraud, the issue becomes how the uncertainty may be shown.  In James, the Supreme Court's own earlier opinion established the uncertainty, so the Court did not have to delve deeply into how uncertainty is shown as to the law's commands.  Of course, it follows that all of the tools of statutory interpretation are available to show uncertainty in the law within the meaning of James and its progeny.  But, the issue has arisen in several cases and in the bankruptcy opinion in Wyly as to whether there might be other sources that might be used to show uncertainty.  Specifically, in other cases and in Wyly, the issue was presented whether expert testimony can be admitted to show practitioner and, by inference, taxpayer uncertainty as to the law's command, thereby showing uncertainty at to the law's command.

In Wyly, the Wylys proffered the expert testimony of Joshua S. Rubinstein, an experienced and respected lawyer.  This expert and his opinion were (footnotes omitted):

Rubenstein is a lawyer and partner at the firm of Katten Muchin Rosenman, LLP. The Debtors offered Rubenstein as an expert in “trust and estate law and taxation of trusts, with specific experience and knowledge regarding these areas during the 1990s, and also as an expert regarding practices concerning the establishment and administration of foreign trusts during the 1990s.” Rubenstein was to provide “an opinion as to how practitioners advised clients with respect to the application of the grantor trust rules to foreign trusts during the 1990’s (the ‘relevant time period’) and how foreign trusts, as opposed to domestic trusts were drafted and administered at the time.” The purported purpose of Rubenstein’s opinion is to assist the Court in the evaluation of the Debtors’ reasonable cause defense to their failure to file Forms 3520, 3520-A, and 5471, as well as to assist the Court in its evaluation of the Debtors’ alleged fraudulent intent for purposes of the IRS’ recovery of fraud penalties under 26 U.S.C. § 6663.

The court held:

1. The court is the sole decider of the law.  Rubinstein's legal opinion is not relevant to the Court's determination of what the law is or was.

Testimony such as this—which explained black letter law as it stands today or as it stood in years past—consisted of legal conclusions and was therefore inadmissible. This Court is capable of determining the law applicable to the Cases on its own, without Rubenstein’s assistance. All of Rubenstein’s testimony that simply told the Court what the law was or is will be stricken.

2.  But, some of Rubinstein's opinions were more nuanced as to the issues presented (footnotes omitted):

However, not all of Rubenstein’s testimony consisted of statements that were simply impermissible legal analysis, opinions, and conclusions. In addition to giving general statements of both past and present law, Rubenstein also made statements that the law that governed offshore trusts and the tax treatment of such trusts during the relevant time period was, in the eyes of many practitioners, including him, uncertain. The purported purpose of this testimony was, again, to assist the Court in assessing the Debtors’ reasonable cause defense and the presence or absence of fraudulent intent1 — i.e., according to the Debtors, given the fact of uncertainty among experienced tax professionals, how could the Debtors possibly have acted with fraudulent intent here? More specifically, the Debtors argue that if lawyers practicing in the area of cross-border trust and estate taxation felt that the law governing the taxation of offshore trusts like the ones at issue here was uncertain, then this in turn would tend to corroborate that the Debtors were uncertain about the state of the law, and any missteps that the Debtors made in following that law would be more reasonable and less likely to be fraudulent.

3.  In addressing this nuance, the court said:

The admissibility of this testimony regarding the fact of alleged uncertainty among members of the cross border trust and estate and tax bars as to how to interpret and apply the law during the relevant time period was a close call.

4.  The Court said that, on the evidence, Wyly may have had some knowledge of the uncertainty.  So, the legal uncertainty may have affected his conduct and therefore the expert opinion is relevant and admissible, although the Court gave it little weight.

5.  The key paragraphs are (footnotes omitted):

In closing out the analysis of the IRS’ first argument—that Rubenstein’s testimony consisted of impermissible legal conclusions—the Court will identify other testimony that Rubenstein gave that did not consist of impermissible legal conclusions. Although Rubenstein is a lawyer, this does not automatically mean that all of his testimony must therefore consist of statements of the law or legal conclusions. Rubenstein is permitted to “testify as to legal matters when those matters involve questions of fact.” Here, Rubenstein offered testimony as to whether certain practices—such as the settlement of trusts with nominal amounts of money, the use of protectors with expansive powers, or the use of “accommodation grantors”—were viewed as normal or proper by the cross-border trust and estate and tax bars during the relevant time period. The question of what members of the bar thought, as opposed to what the actual state of the law was, is a factual one. Although counsel for the Debtors or the IRS can explain what the true state of the law during the relevant time period was or is today via briefing or oral argument, proving what the cross-border trust and estate and tax bars thought the law was or how they viewed the law is a factual inquiry that requires resort to expert testimony as opposed to argument. Rubenstein’s testimony regarding the views of the bar during the relevant time period—like his testimony regarding the fact of uncertainty in the law during the relevant time period—is admissible. 

* * * * 

Despite these concerns, Rubenstein’s testimony that, during the relevant time periods: (i) the use of protectors in the context of foreign trusts was permissible and even common, (ii) de facto control of trustees by grantors was not out of the ordinary, and (iii) the use of “accommodation grantors” was thought to be legitimate is admittedly of some relevance here. It is helpful for the Court to understand that these practices—in and of themselves—were not considered to be inappropriate by the cross-border trust and estate and tax bars during the relevant time period. However, without any opinion as to whether the manner in which the Wylys themselves implemented their offshore system falls within the scope of the “usual” practices that Rubenstein describes, the Court can draw few useful conclusions from Rubenstein’s testimony.  While the Court can conclude that, in at least some situations, the use of protectors, accommodation grantors, and other devices that Rubenstein described was seen by the trust and estate and tax bars during the relevant time period as appropriate, the Court has no way of knowing how these same bars would have viewed the Wylys’ particular uses of these same devices. Though there is admittedly some relevance to Rubenstein’s testimony, it is limited.

JAT Comment: I think the Court got close to the right place, but I do suggest that, based on James, the Court could have admitted the expert testimony to address the issue of whether the law was sufficiently clear to proscribe -- and thus penalize -- Sam's conduct, regardless of whether Sam was aware of the uncertainty or not.  I have addressed various facets of this issue in prior blog entries dealing with uncertainty of the law.  Also, although not directly relevant, I offer this from my discussion the Saltzman Treatise, supra,  ¶ 12.05[2][b][iii] Complexity and uncertainty in the tax law (footnotes also omitted):

A tougher issue is whether, if by the time the district court addresses the James issue in a criminal proceeding, the law has developed in the interim between the conduct in issue and the criminal case. Conceivably, there could have been uncertainty in the law at the time of the conduct, but such uncertainty could have been resolved later, before prosecution. The proper testing point as to uncertainty in the law should, logically, be the time when the conduct occurred, not the time the court addresses the issue in the criminal case or even in a civil case decided after the conduct in question. 

If there was some uncertainty in the law and the judge does not dismiss the indictment, can the jury be apprised of that uncertainty in order to permit it to assess whether the defendants as tax professionals would have known about the uncertainty and therefore could not have factually had the intent to violate a known and certain legal duty? Phrased this way, the issue is not what the law is or even what the state of law was in any objective sense (properly determined by the judge), but whether practitioners, in good faith, could have not known the law's command and therefore did not intend to violate the law. From this standpoint, expert testimony as to the state of law reasonably perceived by practitioners at the time would seem to be helpful to the jury in assessing the defendant's willfulness. Still, that is academic reasoning; most courts will find some way to avoid trial testimony from experts about arcane tax rules that may likely be more confusing than enlightening to the jury.