Further Comments on the Briefing in the Larson, Pfaff and Ruble Cert Petitions (6/21/11)

I have just received the Government's Brief in Opposition to Certiorari in the Larson and Pfaff cases (Sup. Ct. Dkt No. 10-1049) and Brief in Opposition to Certiorar in the Ruble Case (Sup. Ct. Dkt No. 10-1061). I have previously blogged on the Petitions for Certiorai in those cases in the following blog entries: Petitions for Cert in US v. Pfaff, Ruble & Larson and The Conduct Too Remote Is Not Evasion Argument in the Larson & Pfaff Petition for Certiorari . I have just a few points that I wish to make on the documents documents I just received:

1. The issue that I think is worthy of certiorari is whether the economic substance doctrine draws a sufficiently knowable criminal line. (I have previously blogged on facets of this issue here.)  The problem, in my mind, is that the Supreme Court itself has botched the analysis and approved civilly transactions that lack economic substance relative to the taxpayer's participation in the shelters / arrangements. Charles Kingson, are respected observer in this area, has said pungently:

Four of the most important Supreme Court tax cases (Clay Brown, Frank Lyon, Consumer Life, and Cottage Savings) all held for the taxpayer despite:

no pretax profit; n1

no nontax motive;

and no shifting of risk.

Charles Kingson, Economic Substance v. Supreme Court, 117 Tax Notes 269 (Oct. 15, 2007). See also Charles I. Kingson, How Tax Thinks, 27 Suffolk U. L. Rev. 1031, 1035 (2004) ("Tax shelters have been blamed on shoddy promoters, but few shelters are shoddier than those approved by the Court in Lyon and Brown.").

In my mind the poster-child is Frank Lyon that many observers -- I would say most but I have not polled the universe -- think the Supreme Court reached the wrong result in an opinion that did nothing more than decide the case and provided no rational guidance for a flawed result or for resolving future cases. Actually, it did more than just decide the case and provide no guidance, it gave hope to tax shelter promoters, to taxpayers and to taxpayer advisers that shelters with little or no substance relative to the tax benefit the taxpayer claimed would be respected for tax purposes. Therein lies the tragedy in these tax shelter prosecutions.

If the Government wanted to center its prosecution on the lies told which, in my mind, should be the heart of criminal tax prosecutions (see blogs here), that is one thing. But the Government did not do that in Larson or the succeeding prosecutions; rather, it chose to make lack of economic substance the center piece of the prosecutions. (In Daugerdas, as in Enron, however, the lie was the front and center issue.)  Lawyers, commentators, trial courts and courts of appeals have machinated over that the definition and role of economic substance without coming to clear guidance on the issue.

The point  is that, if the Supreme Court had done its duty in Frank Lyon to give not only guidance but good guidance (neither of which it did), I doubt that the tax shelter proliferation could have occurred and I doubt that these defendants would have been in the dock on any criminal tax issue. I think there is a direct line that can be traced from Frank Lyon to these defendants actions -- one might say induced by a very bad Supreme Court decision. It will be tragic if the Supreme Court does not now at least consider the possibility of its own error as a cause and remove criminal liability under the James theory. Only the Supreme Court can correct its own errors and, in James, the Supreme Court did just that by relieving the defendant of criminal liability rather than punish him for the Supreme Court's failure to do its duty in an earlier case. A criminal case is perhaps not the place to resolve the civil issue of the precise warp and woof of the economic substance doctrine. Economic substance is not as easy an issue to resolve as was the embezzlement issue in James. But the Supreme Court is fully capable of recognizing the problem it created with Frank Lyon, reversing the conviction, and defer setting the full contours of the economic substance doctrine to another day. Citizens should not go to jail because of errors sown by the Supreme Court.

For further reading on the mess created by Frank Lyon, see my earlier posts: Justice Stevens Announces Retirement (4/9/10) and Altria # 1 - Frank Lyon and tax shelters (3/28/10).  Also, for scholarly works, see the seminal (if hyperbolic, but not much) discussion of Frank Lyon's deficiencies, Bernard Wolfman, The Supreme Court in the Lyon's Den: A Failure of Judicial Process, 66 Cornell L. Rev. 1075, 1098 (1981). Leandra Lederman also has a more recent discussion at Leandra Lederman, W(h)ither Economic Substance?, 95 Iowa L. Rev. 389, 409-416 (2010).

As a bit of an aside, I note that until this day the courts are still screwing around with the damage sown by Frank Lyon. See Merck & Co., Inc. v. United States, ___ F.3d ___ (3d Cir. 6/20/10).  Many, perhaps most courts get it right in the final analysis, but only after the most inordinate thrashing around for ways to work around the Supreme Court's most unfortunate Frank Lyon decision.

2. Now, I discuss what the parties in the Larson and Pfaff briefing say about James. The Larson and Pfaff petition asserted that, if the law is objectively uncertain, the defendants could not be guilty of violating the law regardless of whether they had "intended" to violate the law (as the jury apparently so found because the instructions required them to find willfulness, defined as intent to violate a known legal duty). Larson and Pfaff cite James for that proposition. The Government rebuts with the allegation that James was a plurality decision; even though that was what the plurality decision held, the Government asserts, the proposition did not command a majority of the court. In reply, Larson and Pfaff note that the Government is just wrong. The proposition had commanded a majority, citing Justices Black and Douglas joining the plurality on this issue. (See Larson & Pfaff Reply Brief, pp. 1 & 2 at n. 1.) And, how else could it be? Willfulness has two key elements -- the defendant must intend to violate a known legal duty and that legal duty must be knowable (i.e., certain enough that it can set a perceivable line that can then be known). Otherwise criminal conviction would violate due process because the legal duty is not knowable. We do not send citizens to jail for evil hearts but for criminal acts which require a knowable legal duty at least in the context of crimes requiring willfulness.

3. The Government seems to fall back on an argument that, even if the judge instructed the jury as to the wrong economic substance test, there must be some minimum economic substance test that can set the criminal line and defendants surely crossed that line. (See Government Brief in Opposition in Larson and Pfaff, pp. 17 and 18.) The problem with that argument is that It does not tell anyone what the particular jury that heard this evidence would have decided had it been properly instructed on that minimum economic substance test. I hope the Supreme Court will not be lulled into thinking that, well, justice was done even though the jury did not speak to the issue.  (I should point out that it is not uncommon to affirm verdicts where it is uncertain that the jury convicted on a theory of conviction based on an appropriate instruction or an alternative theory based on an improper instruction.  See e.g., my subsequent blog on Conscious Avoidance / Deliberate Ignorance -- Assuming the Jury Acted Properly (6/23/11).

4. By the way, even by making the argument in paragraph 3, the Government is in effect conceding ambiguity in the line, if any, set by the economic substance test.

5. The Government makes an astounding argument to support tax evasion convictions. Larson and Pfaff argued that they could not be guilty directly as actual principals in the crime of tax evasion. To which the Government responded:

Finally, petitioners fail to address the alternative theory submitted to the jury that they aided and abetted in the preparation of the clients' false returns under 18 U.S.C. 2. See Gov't C.A. Br. 146. The district court instructed the jury that it could find petitioners guilty as aiders and abbetors if it found that (i) the taxpayer at issue had committed at least one act of evasion if he [the taxpayer] had acted with the willful intent to evade taxes and (ii) petitioners were a cause in fact in bringing about or causing the taxpayer to file a false return. Id. At 155-156. Petitioners do not challenge those instructions before this Court.

The Government speaks most sloppily here. This paragraph claims aiding and abetting under 18 USC 2(a), although it does seem to incorporate obliquely elements of causer liability under 18 USC 2(b). But the principal claim is the defendants were or could have been convicted as aiders and abettors of the taxpayers if it found that the taxpayers committed at least one action of evasion. That claim is false. At the trial, the Government conceded that the taxpayers were not guilty of evasion (hence they certainly could not for purposes of this case commit one act of evasion). Here is the actual instruction the Court gave on that point: “You, therefore, are instructed that no defendant can be found guilty of tax evasion on the theory that he aided and abetted any taxpayer who is not a defendant in this case in committing a crime of tax evasion. Off the table.” (Transcript p. 5244.) I have written on this point before and for those sufficiently interested to delve into the issue further, but (i) I do link here to a draft of an article that I have written on this subject (note that this draft was written before Judge Pauley blew the Government's 18 USC 2 theories out of the water, and needs to be update for that, but Judge Pauley's actions confirm that the article is basically right) and (ii) link here to my earlier blog where I discuss Judge Pauley's deconstruction of these fuzzy notions in the third major tax shelter trial.

6. Of course, the Government does blunder, apparently unintentionally, into a real issue in raising the specter of causer liability under 18 USC 2(b) in its discussion of the separate concept of aider and abettor liability. I discuss causer liability in my draft article and conclude that causer liability applies where the defendants could not themselves be guilty of the crime because they lack a status required by the substantive criminal statute for direct guilt of the crime. The courts have held that the enablers other than the taxpayers can be directly guilty of the crime of tax evasion by their own actions regardless of the guilt of the taxpayers. The judges in the three major tax shelter trials accepted that proposition as a given. If that is true, causer liability cannot apply period. Judge Pauley got that right as well and refused to give a causer liability instruction. But Judge Kaplan gave the causer liability instruction without realizing its inapplicability. More to the point, however, if Larson and Pfaff are correct in their argument that persons other than taxpayers cannot be guilty of the crime of tax evasion, then causer liability could apply. But, if you accept the Government's argument that persons other than taxpayers can be guilty of evasion, then causer liability is not applicable.  There was mass confusion in the instructions that Judge Kaplan gave and that Judge Pauley avoided.  Even if one could say that the jury instructions could be read as finding "cause" which should establish either direct principal liability for evasion (if nontaxpayers can be guilty of evasion) or causer liability (if they cannot), there is still the problem of the erroneous aiding and abetting instruction which the Government apparently believes justifies the verdict.  Confusion reigns.