More on the Daugerdas Case - The Role of Nonpromoter Enablers (6/5/11)

The Chicago Tribune reports on the consequences of BDO Seidman's love affair with the Daugerdas shelters. See Ameet Sachdev, Tax shelters put BDO Seidman in middle of firestorm with federal prosecutors, Chicago Tribune, Business (6/4/11). It is interesting to consider what additional retribution, if any, the Government may visit on BDO now that its former chief executive, Denis Field, has been convicted and others down the BDO food chain have pled. For all of the firms participating in this genre of shelters, one has to ask where the gatekeeper was or the gatekeepers were. Was anyone concerned about the well-being of the firm?

Someone has asked that question about Jenkens & Gilchrist, the Dallas based firm with national ambitions that drove it to expand, inter alia, into Chicago and pick up the now disgraced and convicted tax shelter promoter par excellence, Paul Daugerdas. I have written about Daugerdas before and want to discuss here a variation of the Jenkens & Gilchrist story recounted in a recent article, Milton C. Regan, Jr., Taxes and Death: The Rise and Demise of an American Law Firm, STUDIES IN LAW, POLITICS AND SOCIETY: LAW FIRMS, LEGAL CULTURE, AND LEGAL PRACTICE, Vol. 52, pp. 107-144, Austin Sarat, ed., JAI Press 2010; Georgetown Law and Economics Research Paper No. 11-08.

It is a fascinating read. I address here only a facet and expand upon it.  In bringing on Daugerdas with the understanding that he would bring with him one hell of a book of business (even underestimated at the time, but still significant), J&G recognized that the gross revenue and net profit it was buying carried significant risks. I don't think management in J&G recognized that the risks included criminal risks for any member of the firm (most significantly, of course, Daugerdas but the criminal risk could spread beyond Daugerdas to the firm or to others participating in some way, if there were a criminal risk).

J&G assigned a respected tax partner, Michael Cook, to oversee the opinions Daugerdas rendered. Cook had to give final approval to those opinions. Cook is a very good lawyer who I have known and respected since the late 1970s when he and I worked on a Frank Lyon type tax shelter for a bank. Frank Lyon is, of course, the Supreme Court case that blessed a well constructed but hokey tax shelter. As Charles Kingson has said regarding Frank Lyon and, its partner in crime (if that is the right word), Clay Brown, "Tax shelters have been blamed on shoddy promoters, but few shelters are shoddier than those approved by the Court in Lyon and Brown." Charles I. Kingson, How Tax Thinks, 37 Suffolk U. L. Rev. 1031, 1035 (2004). (Let me say in my own self defense that the Frank Lyon type shelter Cook and I worked on was a cookie cutter deal -- the Supreme Court itself created the cookie cutter -- based on the template of Frank Lyon with a few wrinkles that, we would like to think, made it more substantively and cosmetically real than Frank Lyon (cosmetically real,? Maybe just as cosmetically real?); at one point, I tongue in cheek said that it would help if the bank changed its name to Worthen Bank and moved to Arkansas.) Actually, to be fair, Kingson has identified other Supreme Court culprits (Charles Kingson, Economic Substance v. Supreme Court, 117 Tax Notes 269 (Oct. 15, 2007):

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;
no nontax motive; and
no shifting of risk.

Fast forward to the Daugerdas tax shelters over which Cook was charged by J&G with the responsibility to ride herd. The Government claimed in Daugerdas and the two predecessor cases (Larson and Coplan) that tax shelters of this genre (variations on Son-of-Boss based on Helmer) were not just hokey but criminal (there's a difference I suppose, because the cases cited by Kingson honor hokey but none of them were determined to be criminal; still, in today's environment and using cookie-cutter indictments, one could easily craft an indictment in Frank Lyon that would probably pass muster had the Supreme Court not blessed hokey in Frank Lyon). If those shelters were criminal one has to ask, why did the Government not charge J&G. Or why did not the Government prosecute Cook who was charged with the responsibility to vet the shelters? Or even, why did the Government not prosecute the other nonpromoter players such as independent tax lawyers advising the taxpayers.  Certainly, for tax shelters that are criminally illegal so that one can recognize that they violate a known legal duty, some smart people other than promoters, prosecutors or juries have to be capable of recognizing their illegality.

The defendants in Daugerdas tried to bootstrap their innocence from the role of such non-promoter players who reviewed the transactions apparently without recognizing their criminality. Let's see what the defendants' claimed. I quote here from the closing argument of Daugerdas' lawyer:

He [Daugerdas] went to Jenkens. Jenkens had a number of highly regarded tax lawyers. Mike Cook was the head of the tax practice, one of the most highly regarded tax lawyers in Texas. Bryan Lee was there, a guy who graduated near the top of his class from the University of Texas Law School, was a good tax lawyer. Patrick O'Daniel, a Supreme Court clerk specializing at Jenkens in taxes. Andrius Kontrimas, the guy who talked to Mike Hammer about the HOMER strategy, a brilliant trust and estate and tax lawyer. None of them said you can't do this strategy, it doesn't have any reasonable probability of profit. None of them said that. They embraced the strategy. Not only did they embrace it, they worked on the opinions, they helped do the research to update the opinions, they reviewed the opinions and signed off on them.

What does all that mean to Paul Daugerdas? It means that I'm not a lone wolf out here, I'm not just someone out in the middle of the night saying, oh, the fees don't count on the profitability analysis. There were lots of people, educated, trained, experienced people who agreed with him and went forward with these transactions and helped him go forward with these transactions.

The clients, they had advisers. Jeff Lonsdale, remember he came in here? The government talked about him and doing a HOMER transaction. Former tax director for Comdisco, one of the largest computer leasing companies in America, went down to become the tax director for the Hunt family, for the Hunt family trusts. The Hunts are one of the richest families in America.

He did a HOMER strategy. He didn't do it on his own. He consulted with a lawyer for the trusts. And he consulted with Baker & McKenzie, one of the largest law firms in the country. In fact, he showed the Baker & McKenzie lawyers the opinion that Jenkens & Gilchrist had drafted, showed it to them in draft form, and they approved it. It didn't leap off the page at them that these representations can't be true. Nobody said that.

The Shumaker Loop lawyers were there for the Kasperzaks and Peter Barnhart and Larry Morgan. They didn't say you've got to count the fee. They didn't think it was so nuts. They went forward and advised their clients to go forward with these transactions. And other law firms were involved in these transactions or variations of them. DeCastro West, Curtis Mallet, Jackson Tufts, Brown & Wood, Ryan & Sudan.

That's just some we heard about during this trial. Were all of these people involved in criminal conduct, every one of them? It can't possibly be.

We heard with respect to the HOMER transaction that Deutsche Bank engaged White & Case, a huge firm right down the street here in midtown -- my geography is not that good about New York, but I think that's where it is -- to review the HOMER transaction, to take a look at it, to vet it. They did, and they went forward with it.

Accounting firms were involved: Arthur Andersen, Ernst & Young, KPMG, some of the biggest and best accounting firms at that time in the world. Investment banks were involved with the strategies. All of these banks were named from the witness stand: Goldman Sachs and Smith Barney.

And there were other strategies out there. Not just the Jenkens strategies. There was BOSS, son of BOSS, Bricolage, and Gramercy and Sentinel and COBRA. They were all being done by different people, not Jenkens. Aggressive strategies? Yes. Criminal? No way.

Variations on these arguments were made by others. The arguments did not work.  The jury convicted.

Perhaps one of the reasons that the arguments did not work is that the jury did not get to see and hear from the individuals involved. I can't explain why they did not testify, but it is not unusual for the Government to hold the threat of prosecution over witnesses whose testimony  might otherwise be favorable as a way -- so some defense lawyers assert -- of preventing them from testifying favorably to the defense. I have no idea if that happened in the Daugerdas case but I will say that, if a potential witness has even remote potential for criminal prosecution, that witness' attorney is going to counsel against that witness testifying at the invitation of the defense (or even the prosecution for that matter) without an immunity agreement or order. Only the prosecutors can give immunity and may be unlikely to exercise that discretion if the witness is potentially helpful to the defense.

If the Government and the jury in Daugerdas are correct, all of the other enablers (from the gatekeepers in J&G to the independent professionals for the taxpayers) failed to recognize shelters that were so bad that they not only did not work but were criminal. The Government has not charged them with criminal wrongdoing, however.

Note on 1/4/12 @ 4:12 AM :  I made some slight readability corrections to the penultimate paragraph.