There were two principal law firms involved in issuing the Egan opinions that would, the parties hoped, give the taxpayers risk-free access to the audit lottery for which they charged large premium fees (sort of like the driver of the get away car for a bank robbery charging a lot more than a tax driver would charge). These firms were Proskauer Rose, LLP ("Proskauer") and Sidley Austin Brown & Wood LLP ("Sidley Austin"). The principal partner at Proskauer was Ira Akselrad. The partner at Sidley was R.J. Ruble. The following portions of the opinion are Judge Saylors' focused factual conclusions (and are based on many detail fact findings earlier in the opinion)
UU. The Egans Did Not Receive Independent Legal Advice from Proskauer and Sidley Austin
1234. Both Proskauer and Sidley Austin had an inherent conflict of interest in purporting to render legal advice to the Egans.
1. Proskauer and Sidley Austin Did Not Provide Independent Legal Advice1235. As described above, R.J. Ruble of Sidley Austin and Ira Akselrad of Proskauer Rose actively assisted DGI/Helios in the design, development, marketing, and implementation of the tax shelter strategy and its variants. (Exs. 797, 798, 809, 814).
1236. Among other things, Ruble and Akselrad provided input on the strategies, commented on the marketing materials, and provided or commented on model legal opinions to use in the promoting tax shelter strategy.
1237. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios used the names and reputations of their law firms and their model opinions in marketing the strategy to prospective clients.
1238. As part of the strategy, Ruble and Akselrad agreed in advance to provide favorable legal opinions in order to induce taxpayer-investors to utilize the strategy.
1239. Ruble and Akselrad knew, or reasonably should have known, that the issuance of favorable legal opinions from prominent law firms was a central feature of the successful promotion of the strategy.
1240. As also described above, in the FDIS marketing materials, DGI/Helios had stated that one of its "most valuable" contributions to its clients was in "ability to firmly manage and control the process of getting . . . attorneys . . . to expeditiously reach the desired conclusions" (Ex. 809 (emphasis added)).
1241. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios was marketing the strategy in that fashion.
1242. Proskauer provided at least 28 favorable opinions, and Sidley Austin provided at least 30 favorable opinions, in support of the tax shelter strategy. (Ex. 1519).
1243. Proskauer and Sidley Austin provided legal advice both to DGI/Helios and to the individual taxpayer/investors who invested in the tax shelter strategy.
1244. Proskauer specifically acknowledged to the Egans, in a draft representation letter dated April 11, 2002, that it represented DGI/Helios and therefore had a conflict of interest if it also represented the Egans. (Ex. 1772).
1245. In addition, Ira Akselrad of Proskauer personally participated in a DGI tax shelter transaction in 2000. (Exs. 669, 2759). The favorable opinion letter concerning his personal transaction was issued by Brown & Wood on December 31, 2000. (Ex. 669).
1246. As described above, DGI/Helios played a substantial role in the drafting and delivery of the legal opinions by Proskauer and Sidley Austin.
1247. As described above, in nearly all instances, the legal fees of Proskauer and Sidley Austin were paid by DGI/Helios rather than the taxpayer/investors. Ruble and Akselrad were aware of that arrangement.
1248. DGI/Helios paid the fees of Proskauer and Sidley Austin in order to assert firmer management and greater control over the opinions rendered by the law firms. (Ex. 809).
1249. Proskauer and Sidley Austin derived substantial profit from the promotion and sale of the tax shelter strategy, and therefore had a financial interest in upholding the strategy.
1250. The Egans knew, or reasonably should have known, that the legal advice they received from Proskauer and Sidley Austin was not independent, and that the firms had an inherent conflict of interest.
2. The Egans Knew That the Legal Advice from Proskauer and Sidley Austin Was Not Independent
1251. The Egans were highly sophisticated taxpayers with considerable business experience,
1252. The Egans and their advisors knew that DGI/Helios marketed its ability to "manage and control the process" of getting attorneys "to expeditiously reach the desired conclusions." (Id.).
1253. The Egans and their advisors knew, or reasonably should have known, that DGI/Hellos had arranged in advance for four law firms, including Proskauer and Sidley Austin, to render favorable opinions to taxpayer/investors.
1254. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin had developed model opinions, and that they had rendered favorable opinions for other taxpayer/investors who had used the same or similar strategies.
1255. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin intended to render favorable opinions from the onset of the transactions.
1256. The Egans and their advisors knew that their communications with Proskauer and Sidley Austin were frequently shared with DGI/Helios and KPMG.
1257. The Egans and their advisors knew that none of their communications with Proskauer and Sidley Austin were privileged, or marked "privileged."
1258. The Egans and their advisors provided their comments on the draft opinions to James Haber or Tim Speiss, and not exclusively (or even always directly) to the law firms.
1259. The Egans received a draft engagement letter from Proskauer that specifically noted a conflict of interest based on the fact that Proskauer also represented DGI/Helios.
1260. The Egans and their advisors knew, or reasonably should have known, that Proskauer had a conflict of interest, because it also represented DGI one of the principal promoters of the tax shelter strategy.
1261. The Egans and their advisors knew that the fees of Proskauer and Sidley Austin (other than the fee for the non-disclosure letter by Proskauer) were paid by DGI/Helios.
1262. The Egans would not have paid Helios for the transactions until Helios provided satisfactory and favorable legal opinion letters.
VV. The Proskauer Opinion for Fidelity High Tech Was Based on Unreasonable Factual Assumptions
1263. The Proskauer opinion letter dated April 5, 2002, on the Fidelity High Tech transaction was based on unreasonable factual assumptions, including assumptions that the Egans knew, or reasonably should have known, were untrue.
1264. The Egans did not reasonably rely on the April 5, 2002, Proskauer opinion letter for tax reporting purposes.
1. The Opinion Contained False and Misleading Factual Assumptions1265. The Proskauer opinion letter was purportedly based on factual representations that were false and misleading.
1266. Paragraph I of the Investor Representations in the Proskauer opinion letter stated:a. Investor Representation No. 1 Was False
Investors entered into the options trades to hedge against market volatility in a large concentrated holding of technology stock so as to produce an overall economic profit. Investors believed that the options were correlated to this concentrated position so that the options would produce an effective hedge.(Ex. 122 at 8-9). This representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).
1267. That representation was false from both a subjective and objective standpoint.
1268. From a subjective standpoint, the Egans did not enter into the option trades '"to hedge against market volatility." Moreover, the Egans did not believe that the options "would produce an effective hedge."
1269. From an objective standpoint, as described above, the transaction was not reasonably designed to create an effective hedge.
1270. Paragraph 2 of the Investor Representations in the Proskauer opinion letter stated:b. Investor Representation No. 2 Was False
Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Option would be profitable and on Investors own independent evaluation, Investors believed they had a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits.(Ex. 122 at 9 (emphasis added)). That representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).
1271. That paragraph is template language, and is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).
1272. That representation was false from both a subjective and objective standpoint.
1273. From a subjective standpoint, the Egans did not believe that they had "a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor [that is, Alpha] as to the probability of the referenced property reaching certain price levels at which the Option would be profitable," nor did they conduct an "independent evaluation."
1274. From an objective standpoint, as described above, there was no reasonable possibility of profit on the option trades in excess of all fees and transaction costs and without regard to tax benefits.
1275. Paragraph 3 of the Investor Representations in the Proskauer opinion letter stated:
c. Investor Representation No. 3 Was False
Each investor contributed his or her membership interest in [Index] or [Option] to [Fidelity High Tech] for substantial non-tax business reasons, including the short term risk management of concentrated stock positions.(Ex. 122 at 9). That representation was also made almost verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).
1276. That paragraph is template language, and similar language is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).
1277. That representation was false from both a subjective and objective standpoint.
1278. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.
1279. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. There was no reasonable possibility of profit on the transaction, and the transactions did not provide "short term, risk management of concentrated stock positions."
1280. Paragraph 10 of the investor Representations in the Proskauer opinion letter stated:d. Investor Representation No. 10 Was False or Misleading
There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that owner of the Options and Bank were contractually obligated to perform under the Options in accordance with their stated terms.(Ex. 122 at 9). That representation was also made verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).
1281. That paragraph is template language, and is also found essentially verbatim in the Sidley Austin opinion letter. (Ex. 121 at 13).
1282. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.
1283. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 122 at 36).
1284. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity High Tech transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.
1285. The High Tech Certificate of Facts falsely stated that Richard and Maureen Egan had contributed shares of EMC stock to High Tech on February 7, 2001. Those shares were actually contributed on September 8, 2000.e. The Date of the Original Contribution of EMC Stock Was False
1286. If the Proskauer opinion letter had correctly stated that Fidelity High Tech had been holding EMC stock since September 8, 2000, it would have been more obvious that there was no business purpose for the Egans to acquire options in Index A and Option A, and then within days thereafter transfer those options to High Tech.
2. The Opinion Omitted Essential Facts1287. The Proskauer opinion letter did not include any facts concerning the true purpose of the Fidelity High Tech transaction, which was to create an artificial step-up in basis in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.
1288. The Proskauer opinion letter did not include any facts concerning the design and implementation of the Fidelity High Tech transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.
1289. The Proskauer opinion letter did not include any facts concerning the amounts of fees paid to Helios and KPMG on the transaction. The omission of those facts was unreasonable.
1290. The opinion omitted any reference to the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."
1291. The omission of the fees was deliberate, and was done at the instruction of Orrin Tilevitz to Michael Swiader at Proskauer. (Ex. 1621).
3. Proskauer Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts1292. As described above, Ira Akselrad of Proskauer personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.
1293. As also described above, Akselrad was personally substantially familiar with the Fidelity High Tech transaction independent of the Certificate of Facts executed by the Egans, including the Egans' purposes in entering into the transaction.
1294. Among other things, Akselrad knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that the transaction was designed and intended to generate an artificial step-up in basis, and had no other purpose; (4) that the transaction served no genuine hedging or risk-reduction function; and (5) that there was no economic substance to the transaction.
1295. Ira Akselrad therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.
4. Richard Egan Did Not Read the Certificate of Facts or the Proskauer Opinion Letter1296. Richard Egan did not read the Certificate of Facts relating to the High Tech transaction before signing it. (R. Egan, 3:100-01).
1297. Richard Egan did not read the legal opinion letter from Proskauer relating to the High Tech transaction at the time it was issued, and, in fact, did not read it until the IRS initiated an audit years after the opinion was issued. (Id. at 3:76-77).
WW. The Sidley Austin Opinion for Fidelity international Was Based on Unreasonable Factual Assumptions
1298. The Sidley Austin opinion letter dated March 8, 2002, on the Fidelity International transaction was based on unreasonable factual assumptions. Including assumptions that the Egans knew, or reasonably should have known, were untrue.
1299. The Egans did not reasonably rely on the March 8, 2002 Sidley Austin opinion letter for tax reporting purposes.
1. The Opinion Contained False and Misleading Factual Assumptions1300. The Sidley Austin opinion letter was purportedly based on factual representations that were false and misleading.
1301. Paragraph 1 of the Investor Representations in the Sidley Austin opinion letter stated:a. Investor Representation No. 1 Was False
Investor entered into the Transaction for substantial non-tax business reasons, predominately related to offsetting various investment risks associated with a large single concentrated holding in a U.S. technology company, and to hedge against currency fluctuations in international markets in which this technology company has significant currency exposure due to sales. . . . Also investor has entered into certain Options to hedge against interest rate fluctuations. . . .(Ex. 121 at 12) (emphasis added). That representation was also made verbatim in paragraph 1 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).
1302. That representation was false from both a subjective and objective standpoint.
1303. From a subjective standpoint, the Egans did not enter into the transactions for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid income taxes.
1304. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. The transactions did not offset "various investment risks," nor was it reasonably designed to create an effective hedge against "currency fluctuations" or "interest rate fluctuations."
1305. Paragraph 2 of the Investor Representations in the Sidley Austin opinion letter stated:b. Investor Representation No. 2 Was False
Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Options would be profitable and on Investor's own independent evaluation, Investor believed that he had a reasonable opportunity to earn a reasonable profit from the Transactions in excess of all fees and transaction costs and without regard to tax benefits.(Ex. 121 (emphasis added)). That representation was also made verbatim in paragraph 2 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).
1306. That paragraph is template language, and is also contained in the Proskauer opinion letter. (Ex. 122 at 9).
1307. That representation was false from both a subjective and an objective standpoint.
1308. From a subjective standpoint, the Egans did not believe that they had a "reasonable opportunity to earn a reasonable profit from the transaction in excess of all fees and transaction costs and without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor" as to "the probability of the referenced property reaching certain price levels at which the Options would be profitable," nor did they conduct an "independent evaluation."
1309. From an objective standpoint, as described above, there was no reasonable possibility of profit from the transaction in excess of all fees and transaction cots and without regard to tax benefits.
1310. Paragraph 3 of the Investor Representations in the Sidley Austin opinion letter stated:c. Investor Representation No. 3 Was False
Investor contributed the membership interest in World to [Fidelity] International for substantial non-tax business reasons. . . . .(Ex. 121 at 12). That representation was also made verbatim in paragraph 3 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).
1311. That representation was false from both a subjective and an objective standpoint.
1312. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.
1313. From an objective standpoint, there were no substantial non-tax business reasons to contribute the membership interest in World to Fidelity International.
1314. Paragraph 9 of the Investor Representations in the Sidley Austin opinion letter stated:d. Investor Representation No. 9 Was False of Misleading
There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that Investor/World (and International as transferee of Investor) and Counterparty were contractually obligated to perform under the Options in accordance with their stated terms.(Ex. 121 at 13). That representation was also made verbatim in paragraph 9 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).
1315. That paragraph is template language, and is also found verbatim in the Proskauer opinion letter. (Ex. 122 at 9).
1316. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.
1317. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 121).
1318. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity International transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.
2. The Opinion Omitted Essential Facts1319. The Sidley Austin opinion letter did not include any facts concerning the true purpose of the Fidelity International transaction, which was to create an artificial loss in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.
1320. The Sidley Austin opinion letter did not include any facts concerning the design and implementation of the Fidelity International transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.
1321. The Sidley Austin opinion letter did not include any facts concerning the role of the foreign partner in the transaction, including the fact the fact that he invested no funds, bore no risk, added no value, and was separately compensated by the promoters for his role in the transaction.
1322. The Sidley Austin opinion letter did not include any facts concerning the amounts of fees to Helios and KPMG on the transaction. The omission of those facts was unreasonable.
1323. The opinion omitted the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."
3. Sidley Austin Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts1324. As described above, R.J. Ruble of Sidley Austin personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.
1325. As also described above, Ruble was personally substantially familiar with the Fidelity International transaction independent of the representation letter executed by Richard Egan, including the Egans' purposes in entering into the transaction.
1326. Among other things, Ruble knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that Samuel Mahoney was not a true partner; (4) that the transaction was designed and intended to generate losses for tax purposes, and had no other purpose; (5) that the transaction served no genuine hedging or risk-reduction function; and (6) that there was no economic substance to the transaction.
1327. R.J. Ruble therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.
4. Richard Egan Did Not Read the Investor Representation Letter1328. Paragraph 10 of the representation letter relating to the Fidelity International transaction states as follows: "Investor has reviewed the description of the Transactions attached hereto and such description is accurate and materially complete." (Ex. 78).
1329. Richard Egan did not read the representation letter relating to the Fidelity International transaction before signing it. (R. Egan, 3:100).
XX. Both the Proskauer Opinion Letter and the Sidley Austin Opinion Letter Were Based on Unreasonable Legal Assumptions
1330. The purported purpose of the Proskauer and Sidley Austin opinion letters was to advise the Egans of the potential tax consequences of the Fidelity transactions.
1331. The April 5, 2002, Proskauer opinion letter, among other things, contained the following conclusions:
(1) "that for federal income tax purposes it is more likely than not" that the claimed step-up in basis would be "used to compute gain on the sale of the [stock in Fidelity High Tech]";(Ex. 122 at 10-12).
(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of [the Egans and Alpha], the Transactions would have the requisite business purpose and economic substance";
(3) that "[t]he step transaction doctrine would not apply to recharacterize the Transactions";
(4) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and
(5) the IRS "should not be successful were it to assert a penalty against an Investor under Section 6662(b)(2) or (3)."
1332. The March 8, 2002 Sidley Austin opinion letter, among other things, contained the following conclusions:
(1) that "for federal income tax purposes it is more likely than not" that the claimed step-up in basis, and the claimed allocations of gains and losses, would be respected;(Ex. 121 at 16-18).
(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of investor, the Transactions would have the requisite business purpose and economic substance";
(3) that "[although the matter cannot be entirely free from doubt because of the factual nature of the inquiry, on balance, the requisite profit motive exists to support the deduction of any loss from the Transactions under Code Section 165(c)(2) and Code Section 183";
(4) that "[The step transaction doctrine would not apply to the Transactions";
(5) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and
(6) that "the IRS should not be successful were it to assert a penalty against Investor Code Section 6662(b)(2) or (3) for positions taken on Investor's federal income tax return with respect to the Transactions."
1333. A reasonable opinion letter would have laid out the likely positions that would be asserted by the IRS, and discussed the relevant authorities, whether favorable or unfavorable, in order to evaluate the likelihood that the courts would uphold the positions taken by the Egans.
1334. The opinion letters superficially purport to discuss the relevant authorities, but in reality their analysis is incomplete, incorrect, and misleading in multiple respects.
1335. Furthermore, the opinion letters were not written as a measured or reasoned analysis of a likely legal outcome, but rather as advocacy pieces intended to defend a previously determined conclusion.
1336. For example, any reasonable and experienced tax attorney would have recognized that the IRS would assert that the economic substance doctrine (or a variant) would apply to the Fidelity High Tech and the Fidelity International transactions. Both opinion letters recognize that fact, and both devote several pages to a purported analysis of that issue.
1337. The Proskauer opinion letter concluded that the Fidelity High Tech transaction would be upheld even if it had no economic substance, as long as the taxpayer was subjectively motivated by a business purpose other than obtaining tax benefits. (Ex. 122 at 29). It then stated in conclusory fashion that the Egans "contributed the Options and the Stock to [High Tech], and Maureen [Egan] contributed her interest in [High Tech] to [MEE Holdings], for substantial non-tax business reasons including investment management, risk control, and estate planning purposes which reasons would likely satisfy any business purpose requirement for engaging in the Transactions." (Id. at 31).
1338. The Proskauer opinion letter thus effectively assumed that the transaction would be upheld as long as the Egans represented that they subjectively believed the transaction had a business purpose.
1339. No reasonable tax attorney would assume that a transaction of that nature would be recognized and upheld by the courts simply because the taxpayer made a self-serving statement about his or her supposed business purpose.
1340. Because Richard Egan was a resident of Massachusetts, it should have been obvious that there was a substantial likelihood that the applicability of the economic substance doctrine would be litigated in the First Circuit. The opinion letter, however, contains no mention of any relevant First Circuit case law on the subject. Among other things, the opinion letter does not mention, much less analyze, the First Circuit's opinion in Dewees v. Comm'r, 870 F.2d 21 (1st Cir. 1989), a tax shelter case in which the court noted (in a discussion of Section 165(c)) that where the "objective features of the situation are sufficiently clear, self-serving statements from taxpayers could make no legal difference."
1341. Furthermore, and in any event, Proskauer knew, or reasonably should have known, that the Egans subjectively had no non-tax business reasons or purposes for entering into the transaction.
1342. The Sidley Austin opinion letter indicated that different circuits took different approaches to the economic substance doctrine, but that the "correct" approach was to uphold the transaction if it had either a business purpose (a subjective inquiry) or economic substance (an objective inquiry). (Ex. 121 at 62). The opinion later, and inconsistently, stated that it is "well-established that a transaction . . . will not be respected for tax purposes unless the transaction . . . [has] economic substance separate and distinct from the economic benefit derived from the tax reduction." (Id. at 70).
1343. Like the Proskauer opinion letter, the Sidley Austin opinion letter addressed the Egans' purported "business purpose" in conclusory fashion:
Investor believed that he had a reasonable opportunity to earn a reasonable profit, in excess of all fees and transaction costs, from the Transaction, without regard to tax benefits. Also as stated above, Investor contributed the Options to International for substantial non-tax business reasons, including hedging of risk in a highly concentrated stock, hedging currency risk as foreign markets made up an increasingly large component of the business in their concentrated holdings, and hedging currency risk with respect to a line of credit, the professional management provided by [Alpha], and the desire to create a larger pool of capital through the involvement of other investors such as [Samuel Mahoney].(Id. at 62).
1344. Like the Proskauer opinion letter, the Sidley Austin opinion letter did not mention the Dewees case, or otherwise address the issue of whether the courts were likely to accept self-serving statements from taxpayers at face value.
1345. Like Proskauer, Sidley Austin knew, or reasonably should have known, that the Egans subjectively had no such business reasons or purposes for entering into the transaction.
1346. The discussion in the Proskauer opinion letter concerning the "economic substance" of the Fidelity High Tech transaction contained virtually no analysis of the actual facts of the transaction. (Ex. 122 at 32-34).
1347. The discussion in the Sidley Austin opinion letter concerning the "economic substance" of the Fidelity International transaction contained some factual analysis. (Ex. 121 at 70-77). That opinion letter, however, ignored several critical issues, such as whether the Fidelity International transaction actually served a reasonable hedging function, or whether the Egans had a reasonable possibility of profit in excess of fees and costs associated with the transaction.
1348. The discussion in both opinion letters as to whether the transactions described in IRS Notice 2000-44 are the "same as" or "substantially similar to" the High Tech transaction was incomplete and misleading. (Exs. 122 at 35; 121 at 93-98). Indeed, the opinion letters disposed of the issue summarily, with virtually no analysis.
1349. The Proskauer opinion letter stated that in the Notice 2000-44 transaction, the contribution of the option spread "directly results in a tax loss," whereas in the High Tech transaction, "the increased outside basis resulting from the contribution of the option spread simply permits investors to avoid a taxable gain." (Ex. 122 at 35). No explanation was given as to why the creation of an artificial basis step-up through the contribution of an option spread is not "substantially similar" to the creation of an artificial loss through the contribution of an option spread. Likewise, the opinion letter stated that in Notice 2000-44, the taxpayer's net economic outlay was described as "zero or nominal," whereas in the High Tech transaction it was "far greater than 'nominal.'" (Id.). Again, no explanation was given as to why a net economic outlay that was a small fraction of the claimed tax benefit is not "substantially similar" to an outlay that was "nominal."
1350. The Sidley Austin opinion letter contained the same language verbatim. (Ex. 121 at 97-98).
1351. In summary, the neither opinion letter provided a meaningful or coherent analysis as to several critical issues, including the applicability of the economic substance doctrine.
1352. The lack of a meaningful or coherent analysis as to those issues was deliberate. The authors of the opinion letters knew that it was not likely that the Fidelity High Tech or Fidelity International transaction would survive a legal challenge in which all the underlying facts were made known.
1353. The purpose of the opinion letters was not to provide legal guidance, but to provide a potential defense against the imposition of penalties, and thus to induce the taxpayer/Investor to enter into the transaction.
1354. The Egans were highly sophisticated and experienced taxpayers and knew, or reasonably should have known, that the legal analysis in the opinion letters was not reasonable.
[END OF EXCERPTS]
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Although not making similar findings and conclusions for other law firms, Judge Saylor does note (par. 123) that two other law firms were involved in "worked with DGI/Helios and KPMG to develop and market the strategy and to issue favorable opinions": Bryan Cave; and Lord, Bissell & Brook. Among other findings about their participation at the various steps in developing and marketing, Judge Saylors also finds (par. 476) that
476. As with the earlier marketing presentations, the September 17 PowerPoint presentation indicated that the Egans could obtain a "more likely than not" tax opinion from one of four law firms: Sidley Austin (the successor by merger to Brown & Wood), Proskauer, Bryan Cave, or Lord Bissell. (Id.).Now, if one wanted to extrapolate or speculate, then ...
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ReplyDeleteAnonymous,
ReplyDeleteYou just posted two comments that I initially approved, but have decided to take down because they are not consistent with my vision for this blog. I want to encourage reasoned discussion, but in your comments you let your rhetoric and hyperbole exceed your judgment.
How can you expect people to spend any time trying to figure out whether you have some worthy comments buried in such a diatribe -- as you described your comments? You may have some persuasive points buried in your comments but you have obscured them and thus made your arguments unpersuasive.
You may have some points that should be aired; I therefore encourage you to think about how you may state them in a reasoned way that has some chance of being considered on their merits and possibly even persuasive to the readers of this blog.
Jack Townsend
Okay Mr. Townsend I will, thanks. I would like to point out that my statements regarding incontestable facts were far less inflammatory, less colorful and far far less derogatory than anything asserted by the Government or the Judge in this case regarding the taxpayers and purveyors.
ReplyDeleteThe Judge in this case rules that objectively several of the reps were false. Of course anyone in the tax world knows the reps are irrelevant in determining economic substance since in effect it always boils down to a test of objectivity, how much substance does a structured transaction need to work from a tax perspective. When these transactions were devised, no one knew the answer to that question as the case law was unclear and conflicting. Thus, the need for the tax opinion which concluded there was only a 50.1% chance of success even with all the purported fraudulent reps. In effect the opinions were an acknowledgement that the IRS would likely challenge and disallow these transactions not to mention many of the opinions specifically stated the IRS would treat these types of transactions as tax shelters under Section 6662 which defines a tax shelter as any transaction with little or no economic substance entered into for the avoidance of taxes.
ReplyDeleteIn short, none of the purveyors and/or participants ever claimed they would have entered into these transactions absent the tax benefits (in fact, it was quite the opposite) but rather took the position that there was enough “substance” to have a 50.1% chance of success in the event of likely IRS disallowance if the case were pursued all the way to the SCT. The Government seems to assert the taxpayers claim they would have engaged in these types of transactions without the tax benefits and the Government seems to assert the purveyors claimed the IRS would approve such transactions, this of course has never been the case regarding these types of transactions. In fact, if it were true, there would be no need for the tax opinion.
Then the Government like the Judge attacked the reps as false. This Judge goes so far to say that the reps were objectively false, a lie or series of lies.
“From an objective standpoint, as described above, the transaction was not reasonably designed to create an effective hedge.”
First off the rep doesn’t even say this and secondly, any purchase of any asset that protects or profits from the downward movement in the markets is a hedge, my goodness even the purchase of gold serves as a hedge, where is the objective lie?
“From an objective standpoint, as described above, there was no reasonable possibility of profit on the option trades in excess of all fees and transaction costs and without regard to tax benefits.”
How can something be objectively false when there is no definition of the very thing being decried, “reasonable possibility of profit”, there is no definition. ACM says reasonable possibility of profit didn’t exist because interest rates in the last 10 years had never moved enough to render that transaction profitable, does that mean if one time rates had moved enough the tax laws rules would be satisfied? How about option pricing under Black/Scholes, a 10% chance of profiting off an option is deemed more than reasonable by definition in such pricing model (if I can be so bold as to render a definition of reasonable possibility). Further as a general rule, several studies show options trade at a 20% to 30% premium to the price determined under Black/Scholes. In effect if one posits that options do not have a reasonable possibility of profit, anyone who deducts losses from options is a criminal. continued
“From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. There was no reasonable possibility of profit on the transaction, and the transactions did not provide "short term, risk management of concentrated stock positions."”
ReplyDeleteI have never been exactly sure what a substantial non tax business purpose was but case law most certainly provides that asset protection, estate planning and minimization of state taxes are appropriate non tax business purposes. In fact, in 2004 the Senate issued a report that confirmed the creation of phantom book earnings which allowed for the recognition of deferred tax assets was a business purpose. At a minimum, objectively speaking, regardless of the Egans’ intent, utilization of the structure created asset protection and estate planning opportunities. Further, risk minimization (which turned out to be a very real issue in this case), aptly applies as Refco was one of the counter parties in this case, anyone who sold an option to Refco and bought a partially offsetting position bore the risk if Refco went bankrupt (which it did), that the taxpayer would be liable for payment on the short position but Refco would not have to pay on the long under the bankruptcy law.
“If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity High Tech transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.”
This is my favorite by the Judge, he says this rep is false even though that is not what the rep says and the Judge goes so far as to say in order for the rep to be objectively false it must be construed in a particular manner, huh, I can construe anything anyone says to be objectively false. The rep in pertinent part says “committed to undertake all or any of the transactions described herein upon the happening of any other transaction”. Though this rep may be meaningless, it certainly is not false, no one was committed to do anything (at least in a legal sense) and most certainly no one was committed to do anything based upon other events happening (what ever that means). In fact, I am certain if the Egans purchased the options and decided to not go through with the rest of the transaction not only were they not committed to do so, they had no legal or otherwise, obligation to do so.