Monday, November 5, 2018

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 LEXIS 23804 (4th Cir. 2018) (unpublished), here, Burks was convicted of "conspiracy to commit mail and wire fraud, substantive mail and wire fraud, and conspiracy to defraud the United States by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.Let's address some conceptual issues inherent in James that may be easily and erroneously conflated. James itself held that uncertainty in the law can preclude prosecution regardless of a defendant's intention to violate what he or she may have thought was a known legal duty. In this inquiry, the defendant's actual intent is irrelevant, and conceptually therefore it is not a jury issue but a judge issue that the judge pre-empts without the existence of actual intent being relevant. This issue turns upon the legal conclusion as to whether the law is “knowable” — meaning that it sets a discernible legal duty. Knowability is a legal issue for the court, as the Supreme Court held in James. The issue for the jury is whether the defendant knew the knowable legal duty and intended to violate it. This is a factual issue for the jury that is only addressed after the court first determines that the legal duty is knowable. (Actually, as in James, the determination that the law is unknowable can be made after the defendant has been found guilty by reversing the conviction.)
James is still viable on this issue. James spawned other cases in which convictions were reversed, but reversals are not common.
I sometimes state this issue by saying that, for tax willfulness crimes under the Cheek willfulness standard, the taxpayer can be convicted only if the duty is actually known to the defendant and if the law is sufficiently certain that it is knowable.  Whether it is known to the defendant is a jury issue; whether it is legally knowable under James is a judge issue.

Now, in Burks, the James issue was raised, although through the Fourth Circuit's iteration of the James issue in United States v. Mallas, 762 F.2d 361 (4th Cir. 1985).  The Burks opinion tucks it discussion of the issue in a footnote as follows (bold face supplied by JAT):
   n4 In spite of the indictment properly alleging each element of a Klein conspiracy, Burks argues, based on United States v. Mallas, 762 F.2d 361 (4th Cir. 1985), that the indictment should have been dismissed before trial because as a matter of law, whether to report both cashed-out and reinvested awards as income on the Forms 1099 raised a sufficiently vague question of tax law that Burks could not have acted with the required intent to defraud. Burks supported this argument with citations to Treasury regulations, case law from the United States Tax Court, and an opinion letter drafted by an experienced tax lawyer. This argument is unpersuasive. 
   First, as is evidenced by Burks' attempt to submit evidence that went far beyond the four corners of the indictment, his argument was not raised in the appropriate context. The resolution of such a question about the application of the tax laws to the specific facts of the case is a quintessential role of the jury. The problematic nature of Burks' argument is only highlighted by Mallas itself. In that case, the court determined that the appropriate application of the tax laws to the defendants' conduct was highly debatable and therefore that their convictions could not be sustained; however, this determination only occurred after a full jury trial. Therefore, Mallas does not indicate that it is appropriate for the district court to conduct a mini-trial to determine how clearly the tax laws apply to the facts of the case when evaluating a pretrial motion to dismiss. 
   Second, even on the merits, Burks' argument about the Forms 1099 is unpersuasive. In essence, Burks argues it was correct to include as income on the Forms 1099 both awards received in cash and those reinvested because the reinvested awards counted as income that the affiliates had "constructively received." Under the tax regulations, income is constructively received by a taxpayer when it is "credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given." 26 C.F.R. § 1.451-2(a). The Forms 1099 that RVG issued to its affiliates indicated that the affiliates together constructively or actually received more than $108 million of income in 2011; however, RVG's revenues in 2011 were only $37 million. Based on this revenue stream, it would have been impossible to conclude that more than $108 million was "made available [to affiliates] so that [they] may draw upon it at any time" and, therefore, it was not vague or highly debatable whether the affiliates had constructively received all of the income that the Forms 1099 reported. Accordingly, even on the merits, Burks' argument is unavailing.
As I read this, in the First paragraph, the Court does not seem to recognize that the James issue is a purely legal issue.  It is not a jury issue.  For that reason, although James itself succeeded after the jury trial, what the Court held in essence was that the vagueness issue (thus not setting the proper standard) was an objective legal determination made by the judge rather than by the jury.  That can be done pretrial, and does not require any trial, mini or otherwise.  All it requires is briefing on the issue whether, as a matter of law, the legal duty is sufficient vague that it cannot be knowable and thus cannot be the subject of a crime requiring willfulness, a specific intent to violate a known legal duty.  Stated otherwise, as a matter of law, an unknowable legal duty because of vagueness or uncertainty cannot be a legal duty which the defendant can know (even if he thinks he knows the law).   I do think, though, that in the Second paragraph on the merits, the Court is correct in saying that there was no vagueness or uncertainty in the law, thus mooting its discussion of whether resolution of that issue should await the trial.

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