Government Motion in Kepke Case to Exclude Expert Testimony About the Law (8/10/22)

I picked up an argument in a Government Motion to Exclude Defendant’s Proffered Expert Witness in the Kepke prosecution, United States v. Kepke (N.D. Cal. Criminal No. 3:21-CR-00155-JD), Motion dated 8/5/22, here. In general, the Government claims that Kepke’s expert witness disclosures were too cryptic to understand the expert witness’s proffered testimony, but the Government inferred that the expert witness would improperly testify about the law. Here are the three key paragraphs I focus on (Motion pp, 7-9):

             Expert witnesses are not permitted to offer opinions consisting of their interpretation of the law. See Hangarter v. Provident Life and Acc. Ins. Co., 373 F.3d 998, 1018 (9th Cir. 2004) (quoting Mukhtar v. Cal. State Univ., Hayward, 299 F.3d 1053, 1066 n. 10 (9th Cir. 2002), overruled on other grounds by Barabin v. AstenJohnson, Inc., 740 F.3d 457, 467 (9th Cir. 2014)); see also Snap-Drape, Inc. v. Comm’r, 98 F.3d 194, 198 (5th Cir. 1996). “[I]instructing the jury as to the applicable law is the distinct and exclusive province of the court.” Nationwide Transp. Fin. V. Cass Info. Sys., Inc., 523, F.3d 1051, 1058-59 (9th Cir. 2008); see also United States v. Caputo, 517 F.3d 935, 942 (7th Cir. 2008) (“The only legal expert in a federal courtroom is the judge.”); United States v. Weitzenhoff, 35 F.3d 1275, 1287 (9th Cir. 1993); CZ Services, Inc. v. Express Scripts Holding Co., 3:18-cv-04217-JD, 2020 WL 4518978, at * 2 (N.D. Cal. Aug. 5, 2020) (“[L]egal opinions are not the proper subject of expert testimony. Reed v. Lieurance, 863 F.3d 1196, 1209 (9th Cir. 2017). An expert may not give opinions that are legal conclusions, United States v. Tamman, 782 F.3d 543, 552-53 (9th Cir. 2015), or attempt to advise the jury on the law, Strong v. Valdez Fine Foods, 724 F.3d 1042, 1046-47 (9th Cir. 2013).”).

            In at least one criminal tax case, the Ninth Circuit approved expert testimony about the law where “the theory of the defense [was] that there [was] a good faith dispute as to the interpretation of the tax laws.” See United States v. Clardy, 612 F.2d 1139, 1153 (9th Cir. 1980) (citing United States v. Garber, 607 F.2d 92 (5th Cir. 1979) (distinguished by United States v. Burton, 737 F.2d 439, 444 (5th Cir. 1984)). But that does not mean that legal evidence is automatically admissible in all criminal tax trials. To the contrary, courts regularly exclude legal experts in criminal tax cases. See, e.g., United States v. Boulware, 558 F.3d 971, 974-75 (9th Cir. 2009) (affirming exclusion of expert testimony that specific “corporate distributions were legally non-taxable” as an impermissible legal opinion); see also United States v. Curtis, 782 F.2d 593, 598-600 (6th Cir. 1996) (affirming exclusion of expert testimony and distinguishing Garber); United States v. Harris, 942 F.2d 1125, 1132 n.6 (7th Cir. 1991) (evidence “may include expert testimony about case law, to the extent that the defendant claims actual reliance on that case law. Case law on which the defendant did not in fact rely is irrelevant because only the defendant’s subjective belief is at issue.”); United States v. Ingredient Tech. Corp., 698 F.2d 88, 96-97 (2d Cir. 1983) (affirming exclusion of expert testimony and distinguishing Garber); United States v. Alessa, 3:19-cr-00010, 2021 WL 4498638, at *4 (D. Nev. Sept. 30, 2021) (evidence of a conflict in the law is irrelevant if Defendant was not aware of the conflict).

            Here, Mr. Read’s proposed testimony must be excluded because, reading between the lines (as we must because the disclosures do not reveal Mr. Read’s actual opinions), it seems likely that Mr. Read plans to testify about his understanding of the law. At best, Mr. Read’s opinion that certain offshore structures are permissible or even common is tantamount to testimony that, in his opinion, Defendant’s actions were legal. This is exactly the type of opinion that is prohibited under Ninth Circuit law because “‘[w]hen an expert undertakes to tell the jury what result to reach, this does not aid the jury in making a  decision, but rather attempts to substitute the expert’s judgment for the jury’s.’” United States v. Diaz, 876 F.3d 1194, 1197 (9th Cir. 2017) (quoting United States v. Duncan, 42 F.3d 97, 101 (2d Cir. 1994)). And any minor probative value the proffered testimony might have would be substantially outweighed by a danger of unfair prejudice, confusing the issues, and misleading the jury.

Fourth Circuit Fuzzes the Issue as to Whether Legal Uncertainty Is an Issue for the Court (11/5/18)

In United States v. Burks, 2018 U.S. App. LEXIS 23804 (4th Cir. 2018) (unpublished), here, Burks was convicted of "conspiracy to commit mail and wire fraud, substantive mail and wire fraud, and conspiracy to defraud the United States by impairing the lawful functions of the Internal Revenue Service."  He was sentenced to "176 months incarceration concurrent on the counts involving mail and wire fraud, and 60 months concurrent on the conspiracy to defraud count, as well as being ordered to forfeit $244 million." This should tell you that the defraud / Klein conspiracy was not the principal driver in this case which involved the more serious mail and wire fraud charges for a Ponzi scheme.

I will get to the defraud / Klein conspiracy, but want first to mention that one of the banks involved filed "multiple suspicious activity reports with the United States Treasury."  I won't get further into that, but this is a good warning to the practitioner community that these reports are filed and the depositor is not notified.

The issue that I found particularly interesting was what I called the James issue.  James v. United States, 366 U.S. 213 (1961).  James held that legal uncertainty in the law's commands meant that a defendant could not be convicted of a crime as a matter of law.  I offer here the discussion on James from Michael Saltzman and Leslie Book, IRS Practice and Procedure, ¶ 12.05[2][b][iii] Complexity and uncertainty in the tax law (footnotes omitted; online edition viewed on 11/5/18) (Disclosure:  I am the principal draftsman of that Chapter):

¶ 12.05[2][b][iii] Complexity and uncertainty in the tax law. 

One defense to a tax crime is that the legal duty upon which the criminal charge is based is not sufficiently certain to put the defendant on notice that failure to honor the uncertain duty can be an intentional violation of a known legal duty.

The seminal decision is James v. United States. The issue was whether James could be prosecuted for evasion under Section 7201 for failing to report and pay tax on embezzled income. James had been convicted of failure to report and pay, meaning that the jury determined guilt, which further meant that the jury determined that he intentionally violated a legal duty he knew to report the income. The question was whether, because of legal uncertainty as to the duty, he could be convicted even if he had a subjective intent to violate a duty that he “knew” (at least thought he knew). The Supreme Court majority found that the substantive issue of taxability of embezzled funds was in doubt — a doubt of the Supreme Court's own making. In an earlier case, Wilcox, the Supreme Court held that embezzled funds were not income for federal tax purposes. The underlying premise was that embezzled funds gave rise to an offsetting obligation to pay back, so the defendant had no increase in wealth and thus no taxable income. After that holding and before James, the Supreme Court decided in Rutkin that extorted funds were income despite an obligation to repay, thus rejecting the theoretical underpinning of Wilcox. In Rutkin, the Court expressly declined to overrule Wilcox. That was the state of the law when James was convicted. So Wilcox's express holding that embezzled funds was not income stood un-reversed; James presented the issue of whether James could be criminally prosecuted for failure to report embezzled funds that the un-reversed Supreme Court authority squarely on point held was not income. 

The Supreme Court started its analysis in James by taking the step it had previously declined to take in the intervening case, holding that for civil tax purposes, embezzled funds are income, thus overruling the original holding. Under the Court's reasoning, the law prior to this reversal did not clearly impose a legal duty with respect to embezzled funds (although that might be an even strong inference, it was not a compulsory inference from Rutkin because in Rutkin the Court expressly declined to reverse Wilcox). So even though James subjectively “knew” embezzled funds were taxable and violated that duty known to him (remember the jury so determined), objectively, there was legal doubt as to his duty to report and pay tax on embezzled funds. The duty itself was unknowable in any objective legal sense because of the state of the Supreme Court authority. Emphasizing that it was dealing with a criminal penalty, the Court said the following: 

We believe that the element of willfulness could not be proven in a criminal prosecution for failing to include embezzled funds in gross income in the year of misappropriation so long as the statute contained the gloss placed upon it by Wilcox at the time the alleged crime was committed. Therefore, we feel that petitioner's conviction may not stand and that the indictment against him must be dismissed. 

The bottom line holding is that, given the confusion as to the objective legal duty, James could not be prosecuted. It did not matter that the jury had determined that James had willfully failed to report the income, a holding that logically meant that James had not placed any reliance on the confusing Supreme Court authority. It did not matter, as the jury found, that James had the darkest of motives vis-a-vis the federal tax system. All that mattered was that, as a matter of law regardless of the facts, the legal duty was uncertain and thus could not support a criminal prosecution.

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.

District Court Case on Brady Obligations and Uncertain Legal Duty (5/30/14)

The name of this case initially attracted me.  United States v. Townsend, 2014 U.S. Dist. LEXIS 70656 (ED WA 2014), here.  It  turns out the defendant is no relation to me.  But the case proved to have some interesting facets.  The first is just an interesting recitation of the Government's Brady obligations.  The second is a more interesting application of the James holding that uncertain legal obligation cannot form the basis for a criminal prosecution.

The defendant was indicted under Section 7202, here, for failing to withhold and pay over on employee's compensation.

Now the issues I report in this blog:

1.  Brady

Brady v. Maryland held "that the suppression by the prosecution of evidence favorable to an accused upon request violates due process where the evidence is material either to guilt or to punishment, irrespective of the good faith or bad faith of the prosecution." 373 U.S. at 87. In United States v. Bagley, 473 U.S. 667 (1985), the Supreme Court disavowed any difference between exculpatory and impeachment evidence for Brady purposes. Despite the Government's argument to the contrary, Bagley also held that regardless of request, favorable evidence is material, and constitutional error results from its suppression by the government, "if there is a reasonable probability that, had the evidence been disclosed to the defense, the result of the proceeding would have been different." 473 U.S. at 682 (it abandoned the distinction between the "specific-request" and "general — or no-request" situations). 

The Ninth Circuit summarized the obligation of the prosecutor concerning Brady material under Kyles v. Whitley, 514 U.S. 419 (1995): 

Moreover, as we have previously held: 

actual awareness (or lack thereof) of exculpatory evidence in the government's hands, ... is not determinative of the prosecution's disclosure obligations. Rather, the prosecution has a duty to learn of any exculpatory evidence known to others acting on the government's behalf. Because the prosecution is in a unique position to obtain information known to other agents of the government, it may not be excused from disclosing what it does not know but could have learned. 

United States v. Price, 566 F.3d 900, 909 (9th Cir. 2009) (citing Carriger v. Stewart, 132 F.3d 463, 479-80 (9th Cir. 1997) (en banc)). The Government correctly notes that Brady is not a discovery rule, but then incorrectly claims the materiality test of Rule 16 and Brady are interchangeable. ECF No. 46 at 5-9. They are not. Rule 16(a)(1)(E)(i) only requires demonstration that the "item is material to preparing the defense" not that it's materiality rise to the level of a reversible Constitutional violation for the failure to disclose it.

I don't know that any of this is new or bold, but it is useful refresher of the Brady obligation.

2.  The Uncertain Legal Duty Issue

Eighth Circuit Affirms Offshore Account Related Conviction (1/18/14)

In United States v. Picardi, ___ F.3d )___, 2014 U.S. App.LEXIS 502 (8th Cir. 2014), here, the Eight Circuit affirmed conviction on counts of tax evasion (5 counts), tax perjury (5 counts) and FBAR violations (3 counts).  The Court of Appeals states the background succinctly as follows:

Picardi was a surgeon in western South Dakota. In the mid-1990s, Picardi became a client of Anthony Kritt, an attorney and a certified public accountant. From 1997 until 2003, Picardi participated in an "employee leasing program" promoted and run by Kritt that required Picardi to enter a contract with Montrain Services, Ltd., an Irish corporation, to lease his services as a physician. Montrain Services contracted with Professional Leasing Services, Inc., a Nevada corporation that was operated by Kritt, to provide Picardi's services to Professional Leasing Services. In turn, Professional Leasing Services contracted with Picardi's medical group to "lease" Picardi's services to it. 

Picardi's income from this program was distributed in a manner designed to avoid taxes. Picardi's medical group paid Professional Leasing Services a "leasing fee" for Picardi's medical services. Professional Leasing Services then paid Picardi a small portion of this "leasing fee" as wages, which Picardi reported as income on his tax returns. In a series of complex transactions, the other, larger portion of the "leasing fee" was transferred into foreign financial accounts set up for Picardi. Picardi did not report this portion as income on his federal income tax returns from 1999 until 2003. On paper, the unreported portion of Picardi's income was "deferred compensation" inasmuch as he was supposed to be unable to access it until he retired or turned seventy years old. Picardi did, however, access and use the funds through another series of complex transactions made to look like loans. Picardi further reduced his taxes by categorizing the portion of his income sent overseas as "professional leasing services" expenses on his medical practice's corporate income tax returns. In April 2003, Picardi withdrew from the "employee leasing program," but he continued to maintain his interest in the foreign accounts containing his "deferred compensation." For the 2004 to 2008 tax years, Picardi failed to disclose to the Internal Revenue Service ("IRS") his financial interest in the foreign accounts. 

A federal grand jury returned a superseding indictment charging Picardi with five counts of income tax evasion, in violation of 26 U.S.C. § 7201; five counts of filing a false return, in violation of 26 U.S.C. § 7606(1); and three counts of failing to file with the IRS a required form regarding his interests in foreign accounts, in violation of 31 U.S.C. §§ 5314 and 5322 and 31 C.F.R. §§ 103.24 and  [*4] 103.27(c). Picardi proceeded to a jury trial. At trial, Picardi claimed that he had a good faith belief that the "deferred compensation" component of the "employee leasing program" was legal and that he relied upon the expert and legal advice of Kritt. The jury found Picardi guilty of all thirteen counts, and he was sentenced to 60 months' imprisonment. Picardi then timely filed this appeal.

Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.

Petitions for Cert in US v. Pfaff, Ruble & Larson

Petitions for certiorari have been filed in the criminal convictions of John Larson, Robert Pfaff and R.J. Ruble in the massive KPMG-related criminal case which drew fame in an earlier iteration (United States v. Stein before 13 defendants were dismissed for prosecutorial abuse). The Second Circuit summary affirmance of the convictions of Larson, Pfaff and Ruble is here. The petition for John Larson and Robert Pfaff is here. The petition for R. J. Ruble is here..

Fourth Circuit says Factual Uncertainty Is Not Legal Uncertainty for James-Critzer-Mallas Defense (4/25/11)

I have written in other blogs about uncertainty in law and the legal principle, emanating from the seminal decision in James v. United States, 366 U.S. 213 (1961), here, that uncertainty as to the law's commands precludes criminal prosecution. (For my prior blog discussions, see here.)  There are two key Fourth Circuit cases on that issue -- United States v. Critzer, 498 F.2d 1160 (4th Cir. 1974) and United States v. Mallas, 762 F.2d 361 (4th Cir. 1985). The Fourth Circuit recently addressed the issue again in in United States v. Cole, 631 F.3d 146 (4th Cir. 2011). Unfortunately the facts were very bad for the defendant, so it was clear that the Court of Appeals was not inclined to want to help him.

The defendant, a real estate agent, received secret commissions by having the sellers pump up the sales price and remit the amount of the artificially inflated commissions to a corporation he owned. The defendant did not disclose these secret commissions to his partners, the buyers.  The corporation apparently did not report the "commissions" and neither did the defendant who was the actual earner of the commissions. Indeed the defendant did not even file tax returns until he learned that that he was being criminally investigated. He then filed tax returns for the years involved (2001-2003), reporting no taxable income for each year. He did this by characterizing the "commissions" as "assignment fees" which he treated as a sale of capital assets producing short term capital gains against which he applied carry forward losses. The Government did not agree with these shenanigans and indicted. As described by the Court:

A grand jury issued a superseding indictment in September 2008 charging Cole in six counts: three counts for willfully filing false tax returns for tax years 2001, 2002, and 2003, in violation of 26 U.S.C. § 7206(1), and three counts for evading income taxes in the same years in violation of 26 U.S.C. § 7201. The indictment charged that, inter alia, Cole falsely claimed $2 million of ordinary income as capital gains.

From the bare text, one might wonder why the Government was charging both 7206(1) and 7201 for the same three years. Rather than speculate at this time (maybe readers can provide the answer crisply), I just move on to address the issue of uncertainty in the law.

According to the Court, the jury convicted as follows:

In a special verdict form the jury largely adopted the Government's theory of the case, although it declined to find that Cole had fraudulently claimed charitable deductions and business expenses. Ultimately, the jury found Cole guilty on all six counts for willfully mischaracterizing the $2 million as capital gains each year and failing to report the $98,200 in income from the sale of the $1 million note.

Another Set Back for the Remaining Daugerdas Defendants - Economic Substance is Sufficiently Malleable to Establish a Line a Citizen Could Know (12/29/10)

Judge Pauley, USDC SDNY, served up a loss for the Daugerdas defendants just before Christmas. The opinion in United States v. Daugerdas, 759 F. Supp. 2d 461 (SD NY 2010) is here. The defendants made the now standard argument in complex tax shelters, particularly those based on extrapolations of Helmer, that, given Helmer, the law was not sufficiently clear to establish a legal duty that the defendants could know. I have previously blogged on facets of this issue before. See here.

As occurs frequently, Judge Pauley conflates two distinct -- albeit related -- concepts. The threshold issue is whether the duty was knowable -- a legal inquiry that is separate from what the defendants might have known or intended. James and its progeny establish that the duty must be sufficiently clear that a citizen (not necessarily the actual defendant in the dock) could know the duty. Only if that question is answered in the affirmative is the Cheek issue reached -- did the defendant know the knowable legal duty? That is an issue for the jury to determine after trial so long as the prosecutors have enough evidence to survive a motion for acquittal.

Without citing James or its progeny, Judge Pauley does address the James threshold issue. Bottom line, he holds that the economic interest concept as a bar to claimed benefits and as interpreted by the courts (it is a judicial doctrine, after all) was sufficiently certain to give the hypothetical citizen a line that could be crossed (aka was knowable), leaving the issue for trial of whether these particular defendants knew the line they allegedly crossed. Could have known is not sufficient for a criminal conviction. The Government will have to prove that the did know. But that is another chapter.

Larson, Pfaff, Ruble Convictions In KPMG Tax Shelters Case Affirmed (8/27/10)

The Second Circuit issued a Summary Order today affirming the convictions of Larson, Pfaff and Ruble the remnants of the larger KPMG criminal tax prosecution previously gutted in United States v. Stein, 541 F.3d 130 (2d Cir. 2008)(dismissal of 13 defendants because prosecutors improperly forced KPMG to stop paying their attorneys fees). The summary order for the affirmance of the convictions (I call this the Substantive Order) is here and the companion decision regarding Pfaff's bail (I call this the Bail Order), a precedential full opinion, is here.

At the outset, I am surprised, given the public interest in the convictions, that the Court relegated its substantive disposition to a Summary Order. Moreover, the case was the Government's first major initiative in the abusive tax shelter context and there are other similar tax shelter prosecutions and investigations in the pipe line that could be informed by some of the issues presented in the case.  The Second Circuit's Internal Operating Procedure Rule 32.1.1 says:

More on Legal Uncertainty and, More Importantly, the Subjective Prong of the Economic Substance Test (1/19/10)

I have previously discussed here the economic substance instruction that Judge Kaplan gave in the skinnied down KPMG trial that resulted convicted three defendants of multiple tax evasion crimes and is currently on appeal to the Second Circuit. I blogged about the Government’s outsized brief filed last Friday (see the brief here). My topic of focus was the effect of legal uncertainty in the law.

Today, I carry that discussion further in the context of the Government’s claims about the role of the economic substance doctrine in a criminal tax case. To set the stage, there clearly is some uncertainty in the civil cases about the economic substance doctrine. Two tests have been developed, which the Government calls (Br. 55) and most practitioners call a subjective prong and an objective prong. The subjective prong is whether the taxpayer engaging in the transaction had a nontax profit or business objective. Under this test, tax can be a consideration but the taxpayer must have an actual business or profit object or intent; further, there is no requirement that the taxpayer's objective be reasonable. The objective prong is whether the transaction has some – perhaps limited to some reasonable – possibility of profit. The major uncertainty from the civil cases is whether the tests are in the conjunctive or disjunctive. That is, whether a taxpayer desiring to sustain his claim of tax benefits must prove (i) both that he had the profit objective (however unreasonable) and that it was a reasonable profit or business objective or (ii) either of those prongs. (For tax coneheads (among whom I number myself), this objective / subjective inquiry, if indeed conjunctive, may be analogized to the relief from the substantial understatement penalty for tax shelter transactions if the taxpayer had a belief that the transaction will more likely prevail and the belief is objectively reasonable.) The courts in the civil cases are split on that conjunctive / disjunctive issue for the economic substance test.

To state the obvious, criminal cases are not civil cases and different policies are implicated that requires some role reversal. The criminal case asks whether the Government has proved beyond a reasonable doubt that the civil tax result is certain and was willfully violated. Accordingly, in instructing the jury, as he should in a criminal case, Judge Kaplan adopted the most defendant friendly version of the split – that is, he advised the jury that the Government had to both that there was no taxpayer profit or business objective and no reasonable profit or business objective. I have doubts about turning over the economic substance test under either formulation to a jury in a criminal case, but if it must be turned over (and Second Circuit authority says it must), I think Judge Kaplan made the right choice by requiring the conjunctive application of the test. (It is important at this stage to note that the Government argued to Judge Kaplan that the jury should be instructed in the disjunctive – i.e., the jury can convict if either (i) under the subjective prong, the Government proved beyond a reasonable doubt that the taxpayers involved had no profit or business motive, or (ii) under the objective prong, the Government proved beyond a reasonable doubt that there was no possibility – or, in the Government’s mind reasonable possibility -- of profit; that notion is just goofy in a criminal case, but I won't digress further here.)

Epic Tales - the Government Brief in KPMG Criminal Case and Uncertainty in the Law

The Government's long awaited epic (209 pages to conclusion) brief to the Second Circuit in the KPMG criminal case is now out. Readers of the blog may review and download it here.

There is a lot in the brief. I quickly spotted length and healthy doses of what appears to be both wheat and chaff. I also found many rhetorical flourishes (probably chaff, but making for a good read to grab interest).  I am not yet certain whether the rhetorical flourishes have much substance, but that is beyond my pay grade anyway.

I did find one Government claim in the brief with hyperbole and error. The claim is (pp. 103-104):

Larson concedes that the trial evidence sufficed to demonstrate that he “subjectively did not believe that the BLIPS transaction had a ‘reasonable possibility of profit.’” (Larson Br. 16). He contends, however, that this concession is of no moment — that the jury, instructed as it was on “willfulness,” was nonetheless not entitled to find that he intentionally evaded taxes because his subjective intent to intentionally violate the tax laws was irrelevant. Larson asks this Court to hold that “as a matter of law. . . a defendant cannot intentionally violate a known legal duty if the substance of that duty would have been objectively unclear to a fully informed lawyer or judge at the time.” (Larson Br. 16, 38 emphasis added); see also Pfaff Br. 29-30; Ruble Br. 25-26). According to the defendants, the economic substance doctrine was sufficiently murky at the time of their conduct, objectively speaking, to foreclose willfulness.

Put simply, the defendants argue that the fact that they intentionally broke the law and knew that they were intentionally breaking the law — facts that the jury found beyond a reasonable doubt — are irrelevant, because in 1999 other people might not have known that their conduct was against the law. This breathtaking argument confounds law and common sense. This precise claim has been rejected by this Court and is hence foreclosed.

 I think that Government's claim is just flat out wrong. I have previously discussed this issue both in my book (pertinent portions here) and in some blogs here, so will not repeat the details. I just summarize my claim of hyperbole and error.

In James v. United States, 366 U.S. 213 (1961), here, the Supreme Court held that legal uncertainty -- i.e., actual uncertainty in the state of the law -- is a bar to prosecution for a tax crime which requires willfulness. In James, the defendant had been prosecuted and convicted, meaning that the jury had determined that he had intended to violate a known legal duty. The problem was that he only thought he knew the law he intended to violate. The Supreme Court held that, regardless of his intent to violate the law, the law in question was legal sufficiently uncertain that James could not be convicted regardless of his intent. 

That is pretty much it.  (The summary is heavily dependent upon understanding the intramural dispute among the Justices evidenced in the various opinions in James, so that is the best place to start.)

The Government's only reference to James is on page 109 to the fact that defendants cite the case and some notion that it is "nothing like this case" because it involved ambiguity "from dueling Supreme Court opinions, which were directly in conflict on the specific tax question at issue in that case."  The Government does not explain and I cannot fathom how the principle of James that uncertainty in the law is a legal barrier to prosecution and conviction is a special rule requiring uncertainty caused by the Supreme Court.  The issue is one of certainty in the law such that a citizen can be criminally prosecuted and proper notice to all citizens; that not dependent upon the Supreme Court's failings or timidity.

Unthinking Criminality - Where is the Line? (11/7/09)

Thanks to the Tax Prof Blog, I picked up this article written by prolific tax lawyer and author, Robert W. Wood. The Article is "Ten Ways to Audit Proof Your Return" (published online by Forbes)

The strategies offered by Mr. Wood are variations on a theme I discuss in a recent article, John A. Townsend, Tax Obstruction Crimes: Is Making the IRS's Job Harder Enough, 9 Hous. Bus. & Tax. L.J. 255 (2009). Some of these strategies I present in more detail in the online appendix to the article.

The issue is whehter a tax obstruction crime exists when a taxpayer performs an otherwise legal act (illustrated by the strategies in Mr. Woods' article and in my article and appendix) with the intent to impair or impede the IRS's administration of the tax laws? Are Mr. Woods' and my examples which are specifically intended to lower the audit profile examples of conduct that should be subject to criminal punishment? Can readers discern a line between such conduct that is criminal and not criminal? Keep in mind that a bedrock principle of the tax law and other types of related crimes is that a hypothetical reasonable actor should be able to discern the line with clarity, otherwise there can be crime. If there is no discernable line, is there only prosecutorial discretion that keeps practitioners (including Mr. Wood and myself) who have engaged in variations on this theme over the years from prosecution? And, finally, would the courts cry foul as did Judge Kozinski in the Caldwell case?

I'll let my readers chew on those questions. I have already spoken ad nausuem. I would appreciate the readers' responses.

Have a great weekend!

Uncertainty in the Law and Willfulness (10/13/09)

In an article in today's New York Times here, Adam Liptak discusses Justice Scalia's dissent from denial of certiorari in Sorich v. United States, 129 S.Ct. 1308 (2009). Justice Scalia's lament is that the "honest services" crime does not provide an intelligible standard for criminal conduct. This theme is presented in the tax cases from James forward requiring a knowable law for tax crimes. Since the tax law requires willfulness, defined as the intentional violation of a known legal duty, then the legal standard must be knowable so that the defendant -- any defendant, even the hypothetical reasonable defendant -- charged with the crime must be able to ascertain the legal standard in order to intend to violate the standard.

Mr. Liptak notes with respect to "honest services" that "If you can make sense of that phrase, you have achieved something that has so far eluded the nation’s appeals courts." As a result, it is fair to say that citizens cannot ascertain the legal standard with any certainty and, correspondingly, judges and juries cannot predictably hold them to that uncertain standard. This phenomenon, Justice Scalia notes, violates fundamental constitutional principles, and gives the prosecutors too much unchecked power to pick and choose their defendants in a wide swath of conduct. Liptak notes:

Certainty of the Law's Command and Willfulness (9/10/09)

In my last blog here, I concluded as follows:

In this proposed instruction, the court pre-empts the issue of uncertainty in the law. Once the court finds the uncertainty in the law, then, as in James, any conviction based on the defendant’s intent to violate the law is irrelevant. (I will discuss this aspect of James in my next blog.)

The James point is that, if the law is uncertain in some objective sense, the defendant can have the blackest, darkest, most evil specific subject intent to violate the law, and that will be irrelevant. Anglo-American jurisprudence simply does not permit convictions for evil intent alone. The following is from my recent article (John A. Townsend, Is Making the IRS's Job Harder Enough?, 9 Hous. & Bus. Tax L.J. 260, 263-4 (2009), here):

In its third meaning - i.e., in the Cheek meaning applicable to substantive tax crimes generally [that the defendant know the law and intend to violate it] - the requirement of willfulness has both objective and subjective components. 47 Objectively, as a matter of law, the law's command must be knowable - the law's command is sufficiently certain that it is capable of being known by a citizen. 48 Subjectively, the defendant must have actually known the rule and have intended to violate it. 49

The objective component invokes the court's function to determine whether the law is sufficiently certain that it sets an appropriate standard to guide and judge conduct where the law requires that the defendant know that he or she is violating the law. If it does not, then even if the defendant clearly intended to violate some law that he mistakenly thought was certain, he cannot be tried for it. 50

n47. See supra note 46 and accompanying text.
n48. See, e.g., United States v. Pirro, 212 F.3d 86, 91 (2000) ("Because only willful conduct is criminal under § 7206 and because willfulness requires a voluntary intentional violation of a known duty, the duty involved must be knowable.") (internal quotations omitted); see also James v. United States, 366 U.S. 213, 224, 82 S. Ct. 1052, 1058 (1961) [here] (describing what a "knowable" legal duty is); United States v. Critzer, 498 F.2d 1160, 1162-63 (4th Cir. 1974); Garber v. United States, 607 F.2d 92, 97-98 (5th Cir. 1979) (en banc); United States v. Dahlstrom, 713 F.2d 1423, 1428 (9th Cir. 1983), cert. denied, 466 U.S. 980 (1984); United States v. Mallas, 762 F.2d 361, 363 (4th Cir. 1985); United States v. Harris, 942 F.2d 1125, 1131 (7th Cir. 1991). Uncertainty of the law's requirements, often the by-product of tax law complexity and ambiguity, can defeat willfulness as a matter of law. See, e.g., Harris, 942 F.2d at 1131. The civil penalty regime of the tax law includes concepts for analysis in dealing with uncertainty in the law. The tax world deals daily with concepts such as frivolous, non-frivolous but not reasonable, reasonable basis, substantial authority, more likely than not, should, will or what have you. See infra note 75. By analogy to the willfulness requirement of the criminal tax laws, only the frivolous position would seem to support an environment where, as a matter of law, the taxpayer or the practitioner could be willful. This knowability standard is closely related to the rule of lenity, discussed below. See infra Part VII.
n49. See Cheek, 498 U.S. at 201; Bryan, 524 U.S. at 193-94.
n50. This point is established by the majority, concurring, and dissenting opinions in James v. United States, 366 U.S. 213, 221-22, 224-25, 246 (1961), a tax evasion case. After trial, the jury found the defendant guilty, which necessarily meant that the jury found he intended to violate the tax law. Id. The Supreme Court said that the law was sufficiently uncertain that a defendant could not be held to the standard even if he may have intended to violate the law. Id.

New Tax Shelter Enabler Indictments - More About the Lie (6/8/09)

On June 4, 2009, the Federal District Court in Seattle unsealed a previously sealed indictment of certain Quellos-related individuals. A Wall Street Law Blog article is here, and the indictment is here. Quellos was a bona fide investment company that got in the tax shelter business. The indictment contains the same pattern as the KPMG related indictment -- (1) conspiracy as the ubiquitous Count One and 8 Counts of Tax Evasion. But the indictment and goes beyond that pattern to add 3 counts of wire fraud and one count of money laundering conspiracy. Wire fraud and money laundering conspiracy often accompany traditional tax crimes (including the general defraud conspiracy), but are not often charged together in the same indictment. See Tax Division Directive No. 128. And, such piling on of charges addresses a concern that Congress recently stated in FERA (see the prior discussion here)).

I focus in this blog not on the charging decisions (how many crimes can a creative prosecutor imagine and charge), but rather upon the basic pattern of conduct that is reported to be behind the indictment. I have previously discussed here the common feature -- the lie -- of tax shelter crimes. See prior blogs here and here. If tax shelter crimes are really about the lie, who is the target of the lie? It is not a lie unless it is told to someone who might rely upon the lie. Let's take the quintessential lie that the Government claims in tax shelters -- that the taxpayer has a business or profit motive independent of the tax benefits. The lie is intended for IRS consumption to distract the IRS from the truth -- no profit motive and no right to the tax benefits claimed. In all events, it is imagined, the lie might avoid penalty relief if all else fails. The lie is also intended for persons in the tax shelter chain who might not know the truth otherwise and relies upon the lie as truth as a condition to their participation in the chain.

The WSJ Law Blog today asks the question of whether attorneys for the taxpayers entering Quellos shelters were also the intended targets of such lies in order to give them the comfort they needed to, in turn, give the taxpayers whatever comfort they needed. In other words, in the simple example posited above, the lie about the intended business or profit motive might be required for the taxpayers' lawyers to bless the deal. That is the focus of the WSJ Law Blog discussion.

But in the simple example I posit, what lie is being told? It is true that in these deals, the promoters require the taxpayer to make the independent business or profit motive representation. But who is making the representation? It is the taxpayer. The taxpayer has the relationship with his own counsel -- i.e., the taxpayer's lawyer is not in bed with the tax shelter promoters but truly an independent lawyer representing only one person, the taxpayer. The taxpayer's lawyer is supposed to understand the overall structure including any of its components relevant to the taxpayer's representation as to independent business or profit motive. If the taxpayer believes the representation and his lawyer believes that, properly counseled by that lawyer, the taxpayer believes the representation, there should be no criminal conduct on behalf of either the taxpayer or the lawyer. Of course, even if the taxpayer's lawyer believes that the taxpayer believes the representation and nevertheless, based on the lawyer'sw independent review of the structure, believes that the taxpayer is misguided as to the belief, the lawyer's job is to counsel the client that the facts do not support the belief, however sincerely held, and the taxpayer should reconsider. But, if the taxpayer persists in his belief after proper counseling, however misguided that belief may be, it is not the taxpayer's lawyer's job to call his client a lier. It is, after all, a subjective belief, and there is no litmus test of a subjective belief. (Of course, the lawyer will surely advise the taxpayer that the risk is that, if the belief is not credible, the lawyer and the taxpayer take the risk that no one -- specifically the IRS, a prosecutor or a juror -- will believe that the taxpayer really believed he had an independent business or profit motive or that the lawyer really believed that the taxpayer had that belief, and the Government may convict the taxpayer and the lawyer for hiding behind the known lie to particpate.)