The Daugerdas Indictment - Part #4 - The Lie (6/16/09)

I have blogged before that tax shelter prosecutions are about the lie. Often, the claim is that the tax shelters lack economic substance, but in these prosecutions the real complaint is the lie that is designed to give an appearance of economic substance. The jury will not understand the complex, convoluted tax structure and byzantine legal analysis, but the jury will understand the lie. In this blog, I will look principally at the indictment's claims as to the big lie. I caution readers that I address here only my understanding of the Government's unilateral claims about the lie in the indictment. I make no attempt here to develop nuance or present defenses to those claims that the defendants may have.

The Big Lie

The big lie is the taxpayers' representations that they had a nontax business reason for participating in the shelter. "In truth and fact," the indictment asserts repeatedly, the taxpayers participated in order to achieve the touted artificial tax benefit and not for a nontax business reason (sometimes the indictment alleges "substantial" nontax business reason). And, in truth and fact, the promoters knew the taxpayers' real tax motivation, despite their formalistic reliance on the taxpayers' "representations" of business reason.

I think it helps to look at a sample allegation of the big lie. Paragraphs 44 & 45 of the indictment claims that the Helmer genre of shelter (SOS, Short Sale and Swaps) contained the. following lies (specifically false and fraudulent representations):"

a. The opinion stated:

You entered into the purchase and sale of the Options for substantial nontax business reasons, including (i) to produce overall economic profits because of your belief that the [foreign currency]/U.S. Dollar exchange rate and the [second foreign currency]/U.S. Dollar exchange rate relationships would change; and (ii) your belief that the most direct way, with the most leverage, to realize gain from expected changes in currency prices was the purchase and sale of the Options.

In truth and fact, the clients entered into the purchase and sale of the options in order to obtain the desired tax benefits, and had no substantial nontax business reasons for entering into them.
b. The opinion stated, "You contributed the Options to the Partnership for substantial nontax business reasons, including, but not limited to, potential diversification of the risks of certain investments, the desire to co-invest as partners with the other co-partners and for your convenience." In truth and fact, the clients had no substantial nontax business reasons for that step, and the clients took that step because the conspirators directed them to do so in order to achieve the tax
losses or benefits they purchased.
c. The opinion stated, "Your contribution of your interest in the Partnership to [the S corporation] was made for substantial nontax business reasons including, but not imited to, consolidation of investment activities, bookkeeping, accounting and tax functions and elimination of duplicate work and expenses in administration. " In truth [*25] and fact, the clients made the contribution in order to achieve the tax benefits and for no nontax business reason whatsoever.

Similarly, the indictment alleges (¶ 46) analogous lies as to the reason for entering the HOMER tax shelter. The alleged lie relates to the claimed purpose to create the trust for purposes of gifting and protecting assets and to the underlying investment strategy to leverage for potential gain.

The shelters are designed with some investment aspect that had some "lottery-type" possibility of paying off some amount, perhaps at the farthest reaches of theoretical possibility of covering the costs of the shelter (including the promoters' substantial fees). The indictment alleges, for example, that with respect to the SOS shelter, the promoters claimed that the underlying investment had a "sweet spot" that, if the stars lined up right, would produce a profit that was sweet indeed. The taxpayer's and promoters' notion was that this theoretical possibility would be sufficient nontax business reason for the shelter and its component steps. The indictment alleges that the possibility of the "sweet spot" if it existed at all was, like a lottery, "essentially nil" and thus was not sufficient to imbue the transaction with business purpose. Indeed, the indictment suggests that the financial institution at risk if the sweet spot were to hit would did not even hedge the risk (because it was nil) and, indeed, because they controlled the market in the transactions "would not permit it [sweet spot] to be hit." Of course the promoters other than the financial institution and the taxpayers might not have been aware that the financial institution would behave to eliminate the key sweet spot potential so essential to the nontax business reason claim, so I would think the test would be whether the sweet spot phenomenon, properly implemented as claimed, imbued the transaction with sufficient nontax business reason.

In order to support the claims of nontax business purposes, the defendants participated in the preparation of supporting documents, essentially repeating the lie, all for the purpose of misleading the IRS upon audit and then, consistently with the lie (tangled web once woven), the promoters lied to the IRS during audits, giving "misleading testimony [about] the clients motivations for engaging in the fraudulent tax shelters." (I guess the promoters subscribe to the concept attributed to Louis Howe (campaign manager for Franklin D. Roosevelt): "If you say a thing often enough, it has a good chance of becoming a fact." Jonathan Alter, The Defining Moment: FDR's Hundred Days and the Triumph of Hope, p. 36 (Simon & Schuster: 2007).

Other Lies

The indictment alleges a host of other conduct akin to lies (including failure to tell the whole truth). The indictment implies that defendants scamming the Government for taxes would hardly have qualms about scamming others with either lies or incomplete or misleading truth, and there is plenty of that and the lies or at least misleading truth that permitted that to happen. The presence of these other lies and the conduct promoted by the lies will probably make the jury much more inclined to believe that the Government has proved the big lie which sweeps across all tax shelters and all of the counts of the indictment.

Let's look at one instance alleged in the indictment (¶ 82). When Daugerdas negotiated his move from A&G to J&G in December 1998, he already had a book of business that would produce large fees in 1998. If he those fees came into A&G, Daugerdas would have to share more of the fees than he was willing to share with his partners at A&G. So, he negotiated his deal with J&G and received a sliding scale share of the fees without advising J&G how much. (I discussed this in the Daugerdas #2 blog.) He arranged for the fees to come to J&G rather than A&G. He then tried to get A&G to give mutual general releases without telling A&G that A&G would thereby walk away from the substantial fees then known to Daugerdas that his A&G partners might otherwise be entitled to share in. When A&G inquired about the need for mutual releases, Daugerdas "falsely stated that he had a religious discrimination claim against A&G, which he would be willing to release in the event he received a general release from A&G."

There is more but they merely add flavor to the big lie. Suffice it to say that the center of gravity of the overall indictment is the big lie discussed above.