Professor Ribstein posts this interesting analysis of the Fifth Circuit’s recent decision in Kimbell v. U.S.A., Case no. 03-10529 (May 20, 2004) that is welcome relief to estate planning attorneys who utilize the popular technique of family limited partnerships to help wealthy families escape taxes.
Family partnerships — although largely untested legally — have become increasingly popular over the past decade because they allow wealthy people to transfer large amounts of money and other property virtually tax-free to their heirs. In the typical family partnership, a wealthy person transfers assets into a partnership that is usually formed with the children. In most cases, a parent serves as general partner with the children holding limited partner shares. Less often, one of the children serves as the general partner.
For the wealthy, such tax planning can save an enormous amount for heirs that would otherwise be used to pay estate and gift taxes. For example, the top federal estate-tax rate is 48%, although the first $1.5 million of a taxable estate is usually exempt from federal estate tax.
Concern about the level of protection that family limited partnerships afford increased last year when the IRS won a case involving the late Texas businessman Albert Strangi on the grounds that Mr. Strangi retained excessive control over his family partnership. That decision is currently on appeal to the Fifth Circuit.
The new decision involves the estate of Ruth A. Kimbell, who died in 1998 at the age of 96. At the time Mrs. Kimbell died, the value of the assets in her family limited partnership — which was created only a few months before her death — was about $2.4 million. When the federal estate-tax return was filed, the estate claimed a big discount on the value of Mrs. Kimbell’s interest in the partnership, to which the IRS objected.
The dispute landed in federal district court, and the Fifth Circuit reversed the district court’s ruling that had denied the estate’s request for a refund of the estate taxes and interest paid. The Fifth Circuit panel noted that the assets contributed to the partnership included working interests in oil and gas properties, that Mrs. Kimbell retained sufficient assets outside the partnership for her own support, and that there was no commingling of partnership and Mrs. Kimbell’s personal assets.
Professor Ribstein observes the following:

There remain serious potential debtor-creditor issues in these firms aside from any estate planning problems, as I discuss in Reverse Limited Liability and the Design of Business Associations. Notably, in this case the partnership was set up to insulate the owners from potential environmental liability generated by the transferred assets. But in many of these cases, as I discuss in my article, the conveyance is intended to put the assets out of the reach of a debtor’s creditors on claims that have nothing to do with the transferred assets themselves. This might stand for estate tax purposes after this case, but even if it does raises problems in the debtor-creditor context.
The case illustrates the potentially devastating impact of the death tax, here a million without the FLP discount, on an estate that is not so enormous by modern standards.

In this NY Times op-ed, novelist Scott Turow takes the position that Martha Stewart got exactly what she deserved and that Martha’s defenders are way off base:

They have repeatedly noted that Ms. Stewart was charged only with lying after the fact about the stock sale, but not with securities fraud for the transaction itself. The Wall Street Journal editorial page, for example, said there “was something strange about prosecuting someone for obstructing justice over a crime that the government doesn’t claim happened.” And some feminists have suggested that Ms. Stewart was being penalized for being a powerful woman.

I don’t buy any of it. What the jury felt Martha Stewart did — lying about having received inside information before she traded — is wrong, really wrong. And the fact that so many on Wall Street have unashamedly risen to her defense is galling — galling because what she did actually harms the market. Wall Street leaders should be expressing chagrin that a corporate tycoon, who was also a member of the New York Stock Exchange board, could feel free to fleece an unwitting buyer.

H’mm, let’s think clearly about Mr. Turow’s analysis.

I agree that it was wrong for Martha to lie, although it should be pointed out that Martha’s lie was her contention to government investigators that she was innocent of the crime of insider trading, for which the government did not charge her.

But then, after noting Martha’s lie, Turow criticizes Martha because she engaged in illegal insider trading, the charge for which she was not prosecuted. Martha’s defenders — notably Professors Bainbridge and Ribstein — have defended Martha because the government elected not to charge her with the real crime (i.e., insider trading) and instead prosecuted her for merely claiming her innocence of that charge.

Consequently, Turow jumps from the premise that Martha’s lie was wrong to the proposition that she was guilty of insider trading. Maybe so, but the government did not prove that. Turow then asserts the following:

It’s true that Martha Stewart was not accused of securities fraud for selling her ImClone stock, because, the prosecutors said, historically no one else had been charged criminally with insider trading in similar circumstances.

Well, then that should apply also to prosecuting someone for proclaiming their innocence of a charge, which “historically no one else had been charged . . . in similar circumstances.”

Finally, Turow plays the class warfare card, reasoning that Martha’s defenders suggest different treatment for her because she is rich and famous:

Perhaps the most troubling aspect of the whole case, to me anyway, is how the arguments in defense of Ms. Stewart show a widespread mentality that is all too comfortable with unwarranted privilege. It is yet another example of how justice is very different for the rich and poor.

Consider: While it’s not insider trading for Martha Stewart to make some $50,000 using stolen information because she did not have the duty not to steal it, something very different would happen to you if you were caught with, say, a stolen watch in your hand. In that circumstance, the law virtually presumes you are guilty. For decades, American juries have been instructed that when a person is found in unexplained possession of recently stolen property, it is proper to infer that the person knows it is stolen, and thus almost certainly is guilty of receiving stolen property.

Likewise, while it’s technically not insider trading for someone to sell shares of stock for more than what he knows, through inside information, to be their true market value, the converse, your buying or selling that hot watch at a steep discount, will almost inevitably get you convicted for trading in stolen property. When we’re talking about these petty kinds of crimes, most often committed by the poor, the law does not bother with airy discussions of fiduciary duty. I can’t take seriously those who want to believe that the starkly differing contours of the law in these roughly parallel circumstances are unrelated to the economic circumstances, and social standing, of the typical violators.

Turow’s reasoning here is utterly muddled.

“Roughly parallel circumstances” between selling stock on inside information and stealing a watch and then hawking it? These circumstances are completely different — Martha bought her stock and then sold it; the thief stole the watch and sold it. Martha’s profit is the difference between the sale price of the stock and her purchase price, net of taxes. The thief’s profit is the gross sales price.

For these circumstances to be “roughly parallel,” either Martha would have had to steal proceeds from the sale of stolen stock (for which I’m sure she would have been prosecuted) or the thief would have had to buy the watch and then sell it to an unsuspecting buyer for a higher price even though the thief knew information about the watch that made it less valuable.

Despite Turow’s self-righteousness, there are not many prosecutions over the allegedly fraudulent sale of a watch.

Even on the one correct point that he makes, Turow has it turned around. Yes, justice is very different for the rich and poor. In this particular case, someone without Martha’s fame would have had her wrist slapped, been required to disgorge her profits (as Martha did), and that would have been the end of it.

However, that was not the end of it in this case because Martha is a high profile target and she did not handle the scrutiny of the transaction well.

Indeed, reasoned defenders of Martha do not defend her because they believe in a different standard for the rich than the poor. Rather, they defend her because the same standard should apply to both.

Turow should stick to writing novels.

This Wall Street Journal ($) article reports on the Justice Department’s decision to open a criminal investigation into Ernst & Young LLP’s promotions of potentially abusive tax shelters. This investigation follows on the heels of a separate criminal investigation into sales of certain tax shelters at KPMG LLP. Here are prior posts on Ernst and KPMG’s recent legal troubles.
The investigation of Ernst reflects the continuation of the Justice Department’s continued effort to crack down on tax evaders and their professional advisers, including accounting firms, law firms and financial institutions. A plethora of tax-shelter sales spurred by the late-1990s economic boom and stock-market rally is estimated to have reduced federal tax revenues by billions.
Earlier this year, the Manhattan U.S. attorney’s office notified KPMG that it had begun a criminal investigation into the firm’s promotion of certain tax shelters that the IRS has deemed potentially abusive. The initiation of a criminal investigation into Ernst’s similar activities comes at a time of growing concern in the business community that there already are too few major accounting firms (it’s the “Big Four” now) to audit the world’s largest companies.
The criminal investigation of Ernst is somewhat surprising in that Ernst last summer reached a civil settlement — which included payment of a $15 million penalty — with the IRS to resolve allegations that it failed to register its tax-shelter strategies with the government and maintain lists of investors who participated in them. Ernst disbanded the division that had been involved in developing and marketing its most aggressive tax shelters and, as part of the IRS settlement, Ernst also instituted organizational changes aimed at ensuring future compliance with federal and state tax laws. As a result, it was thought that the IRS settlement concluded the government’s action against Ernst for past shelter-related matters.

This Wall Street Journal ($) article is the most thorough report yet on the sad case of Jamie Olis, the 38 year old former Dynegy mid-level tax manager who was convicted and recently sentenced to over 24 years in federal prison for his role in the Project Alpha financial scheme that essentially masked loan proceeds as cash flow from operations. Here are the previous posts on Mr. Olis’ case.
The entire WSJ article is interesting reading, and provides the best background piece to date on how Mr. Olis finds himself in this position. As I suspected based upon previous rulings by U.S. District Judge Sim Lake in Mr. Olis’ case, his defense team made a serious tactical error (at least in my view) by electing not to rebut the government’s evidence at trial of the damage that the Project Alpha deal caused to Dynegy shareholders:

After eight days of prosecution testimony, Mr. Olis’s lawyers believed they had poked enough holes in the government’s case to win. They rested without putting Mr. Olis on the stand — or any other witness.

That decision meant that, in considering the length of Mr. Olis’ sentence, the only evidence that Judge Lake had on damages resulting from the deal was that which the government offered:

The new federal sentencing guidelines work on a kind of point system, with more points and more prison time given if the case involves more victims, larger losses or using special training to execute a fraud. The key issue was the size of the loss suffered by Dynegy investors from the scheme: Anything more that $100 million would garner the maximum number of points, lengthening the sentence.
After considering several options, U.S. District Judge Sim Lake settled on a loss estimate of $105 million — the amount the University of California retirement fund lost on Dynegy stock, a hit the fund attributed to Project Alpha. With that loss and other factors, the guidelines recommended a sentence of 292 to 365 months.

As the article relates, Mr. Olis remains convinced of his innocence and, thus, remains unwilling to assist the government in its investigation and possible prosecution of other Dynegy executives and outside lawyers who were implicated in the scheme during Mr. Olis’ trial:

But such cooperation seems unlikely. Though “facing years away from his wife and daughter, Jamie remains strong in his convictions,” close friend Joan E. Quinn wrote to Judge Lake before the sentencing.
Mike Shelby, the U.S. attorney for the southern district of Texas, who supervised the case, isn’t sympathetic. “We have been rebuffed at every turn” by Mr. Olis, said Mr. Shelby. “I would ask the question, ‘Why don’t you help us?’ “

My speculation: “Despite the tactical errors of his defense, maybe because Mr. Olis did not deserve 24 years in prison.”
I continue to maintain that the criminalization of questionable business practices — combined with the government’s sledgehammer approach of forcing executives to defend themselves only at the risk of what amounts to a life prison sentence if they lose — is an extremely unfair and unwise governmental policy. And this from an administration that touts itself as “business friendly?”
If you are interested in reviewing more on this topic, Professor Ribstein over at Ideablog has provided some of the best analysis of the Olis case and this troubling trend of the government criminalizing such things as bad accounting.

As noted in this earlier post, U.S. District Judge James B. Moran of the Northern District of Illinois refused to dismiss a Justice Department lawsuit government lawsuit that seeks to force Dallas-based law firm Jenkens & Gilchrist to turn over the names of hundreds of clients who bought tax shelters that the firm allegedly promoted.
Now, Judge Moran issued a May 14 order for Jenkens & Gilchrist to turn over documents the Internal Revenue Service sought in five administrative summonses. In the order, Judge Moran said the law firm’s clients can raise claims of attorney-client privilege concerning the documents, but that few of such privilege assertions will prevail and he warned that clients could face sanctions for making frivolous privilege claims.
As noted here a couple of months ago, Jenkens & Gilchrist agreed to pay $75 million to settle civil claims from clients concerning tax-shelter legal opinions. Here are the other recent posts concerning the legal challenges facing Jenkens & Gilchrist in regard to the firm’s tax shelter advice.

This NY Times article reports on the unusual order issued yesterday in which a Third Circuit Court of Appeals panel ordered U.S. District Judge Alfred M. Wolin of Newark, N.J. to withdraw from three of the five important asbestos-related bankruptcy cases that are pending in his court. The basis of the order is the appearance of bias.
In a 2-to-1 decision, the 3rd Circuit ordered Judge Wolin to withdraw from overseeing the bankruptcy cases involving W. R. Grace, Owens Corning and U.S. Gypsum. The appellate court will decide later whether to remove him from a fourth case involving Armstrong World.
Lawyers for the creditors objected to meetings that Judge Wolin conducted with plaintiffs’ lawyers and other parties to the case without a record being made for those who were absent. The 3rd Circuit agreed, holding that such meetings “were flawed because no opportunity existed for their adversaries to know precisely what was said” and what effects might result. The creditors also contended that Judge Wolin had appointed advisers who were not impartial because they represented plaintiffs in the G.I Holdings, Inc. bankruptcy case, and the appellate court noted that two of them had a conflict of interest in the five cases because they represented individuals with asbestos claims against G.I. Holdings.
Asbestos-related personal injury litigation has been controversial for years. Some economists estimate that companies have already paid more than $70 billion in asbestos claims with insurance companies paying one-third to one-half of the total. A RAND Corporation study estimates that there have been 8,400 defendants in thousands of asbestos-related lawsuits over the past 15 years.
Legislation to create a no-fault trust fund to compensate victims of asbestos-related diseases is stalemated in Congress. Proponents of the legislation say that asbestos-related litigation risk has forced more than 70 companies into bankruptcy.

Canadian computer giant Nortel Networks, which has its U.S. base in Richardson just outside of Dallas, announced that a federal grand jury in Dallas has subpoenaed financial documents from the company as part of a criminal investigation. The SEC and Canadian securities regulators are already investigating Nortel in regard to Nortel’s restatements of its earnings dating back to 2000 and an executive bonus program.
Nortel’s announcement refused to comment on whether the subpoenaed documents were linked to the three top Nortel executives — chief executive, Frank A. Dunn; its chief financial officer, Douglas A. Beatty; and its controller, Michael J. Gollogly — who the company fired last month. Nortel’s board fired those executives after the company reported that it earned half as much in 2003 as it initially reported and that it had smaller losses in 2001 and 2002 than it stated in those years. As you might expect, the three former executives have been named as defendants in nearly two dozen investor class-action lawsuits.

This Begging the Question post provides an appellate law clerk’s handy list of reminders for appellate lawyers in what not to do in advocating your client’s position. Hat tip to Evan Schaeffer over at the Illinois Trial Practice Blog for the link to this post.
By the way, Evan’s blog is one of the best in cyberspace in providing insightful and practical information for trial lawyers. I particularly enjoy the way he has organized his posts into various subjects relating to trial work. This is a great resource for trial lawyers, and a great example of how a blog can provide specialized information in a creative and effective manner.