Penalties and Corporate America's Shenanigans (10/1/14)

Michael Lewis continues to amaze.  See Michael Lewis, The Secret Goldman Sachs Tapes (BloombergView 9/16/14), here.  He is not the story.  He is the story-teller.  One who hears stories from others and says something meaningful about their story.  The story here is from a bureaucrat, Carmen Segarra, the hero of the piece.  The big issue here could be characterized as capture of the regulators, but that may be a bit too facile as the articles cite.  See also Nolan McCarthy, Five things the Goldman tapes teach us about financial regulation (Washington Post Monkey Cage 9/03/14), here.

The story here is about how Goldman Sachs, the larger than life financial institution, works its will with the regulators who are supposed to restrain its will.  It is probably not a story about the evil giant, GS.  GS is not evil (in my opinion).  It is big, it is powerful, it has friends in the right places.  The regulators know that.  That is the evil.  But that is life.  The job of Government is to mitigate that evil by diligence of the type that, allegedly, did not happen with GS.

I won't try to summarize the story.  I can't do that as well as Michael Lewis or Carmen Sagarra in the This American Life episode.  536: The Secret Recordings of Carmen Segarra (This American Life 9/26/14), here.  (For those who prefer reading, the transcript is here.)

The story is about regulators with the Federal Reserve regulating GS.  In reading this story, I could not help but think about this episode in the context of IRS audits.  I have spoken often about bullshit tax shelters.  Basically, fraudulent shelters playing on complexity to discourage regulators (IRS agents) from having the will to get to the bottom of the bullshit.  Many of those shelters were implemented by the titans and exemplars of corporate America.  Those who knew better.  Some of the bullshit shelters were caught and splayed before the public when the taxpayers were so brazen as to litigate in a public forum.  But the GS episode makes me wonder how many were not caught or may have received a pass for some of the reasons laid out in the saga of the Federal Reserve and GS.

In this regard, here are some excerpts from the WP Monkey Cage article summarizing the PRI Sagarra episode.

Tax Shelter Penalties -- Other Costs of Being a Player

Practitioners tend to focus principally on civil and criminal tax penalties when trying to discourage clients (taxpayers or promoters) from aggressive tax shelter activity. For the well counseled and level headed client, these penalties are often sufficient. These penalties have sometimes not been decisive in discouraging the activity, particularly when as imagined in KPMG, the civil penalties are factored in as just a cost of doing business.

There are other discouragers, though. Jay Soled, Professor at Rutgers, has published an article on a topic that should be dear to our tax shelter and tax shelter promoter clients hearts. The article is titled, Tax Shelter Malpractice Cases and Their Implications for Tax Compliance, published at 58 Am. U. L. Rev. 267 (2009). Professor Soled makes the case that these malpractice cases serve to punish professional promoters' (lawyers, accountants, etc.) inappropriate tax shelter behavior and, as a result, discourage future inappropriate tax shelter behavior. He thus argues for more, not less, malpractice claims and suits, as a key part of the overall system to discourage this activity so clearly damaging to a civilized socity.

In the article, Professor Soled also discusses (p. 305) the new whistleblower regime offering substantial rewards that should have a discouraging effect on abusive tax shelters, because outliers will have a financial incentive to disclose to the IRS. In the latter regard, decision makers in corporations with significant tax departments need to be wary of incentivizing an employee to go to the IRS. While whistleblowers will not necessarily increase the cost to taxpayers upon whom the whistle is blown, they will increase the likelihood of being caught and, possibly, even the bottom-line cost if the whistleblowers deliver up more solid information upon which the IRS can assert the accuracy related or even civil fraud penalty.