9   Lowering the Bar

The tax shelter crisis almost certainly generated the largest number of criminal prosecutions against lawyers in connection with any set of events in United States history. At least twenty-nine lawyers were charged in an indictment or criminal information for their work on abusive tax shelters. Some were involved in private practice, while others worked in accounting or financial services firms. Eight were convicted, eleven pled guilty, two were acquitted, two had their convictions reversed on appeal, one is a fugitive from justice, and five had their indictments dismissed when KPMG terminated payment of their attorneys’ fees at the behest of the government.¹ Other lawyers who were not prosecuted were publically criticized because of their work on abusive shelters.

Although prosecutions have mainly focused on the activities of individual lawyers, their tax shelter activities were very much a product of the organizations in which they worked. Accounting firms, as previous chapters underscore, created organizational structures and incentives that rewarded shelter participation. In law firms, different organizational influences tended to operate. Jenkens & Gilchrist took on Paul Daugerdas and his tax shelter practice as a part of a strategy to get ahead in the increasingly competitive market for legal services. Firm leaders failed to appreciate the significant risks of the shelter work. What risks they did recognize they wrongly believed they could manage successfully.

At other firms, tax shelter activity was often seen and characterized as “rogue” behavior—the behavior of individual lawyers who had become involved in the market without the firm’s permission and knowledge. It was rogue behavior, however, that was facilitated by the loose oversight structure characteristic of law firms. In addition, it was behavior that inured to firms’ financial benefit. Designing tax shelters and writing shelter opinions brought in substantial fees that not only enriched firm partners but also enhanced firms’ profiles in the never-ending challenge to stay competitive. Under these circumstances it was not difficult for firm leaders to turn a blind eye to shelter activity.

Brown & Wood: “Opinions R Us”

Founded in 1914, New York-based Brown & Wood was a prestigious law firm well known for its representation of issuers and underwriters in securities offerings. From 1993 through the end of 1996, Brown & Wood ranked first among all law firms in the number of public debt and equity securities issues in which it had been involved. It ranked second in terms of the total dollar amount of securities issued in such transactions. The firm had an especially strong reputation for its technical expertise in structuring transactions involving complex financial securities, and was one of only four firms ranked in the top ten in six or more categories of capital markets work.

The lawyer who spearheaded shelter activity at Brown & Wood was the peripatetic R. J. Ruble, who had joined the firm as a partner in 1993. Between 1996 and 2003, Ruble issued more than seven hundred opinions on at least thirteen transactions that were listed as abusive by the IRS.

Ruble issued the vast majority of his opinions before Brown & Wood merged with Sidley & Austin in 2001. Ruble also wrote opinions after the merger, despite that fact that he had represented to the firm that he would cease doing so. The impact on tax revenues of the shelters in which Ruble participated was substantial. The government claimed that FLIP generated at least $1.9 billion in fraudulent tax losses, OPIS produced at least $2.3 million in such losses, and BLIPS generated a whopping $5.1 billion in fraudulent losses. Another shelter, SOS, resulted in bogus losses of at least $1.9 billion. In some circles, Ruble and Brown & Wood were known as “Opinions R Us.” As one shelter promoter observed, the firm would provide tax opinions “pretty much for any product. Any time anybody needed a tax opinion, it [would] be hard to find one that Brown & Wood didn’t participate in.”²

There is substantial evidence that Ruble operated as a classic rogue partner, concealing his most culpable activities from the firm and on occasion engaging in actual misrepresentation. He was able to do this because Brown & Wood did not have robust institutional mechanisms in place to prevent and detect such misbehavior, and whatever review of his work did occur was not especially thorough. Ruble did not act completely on his own. At least one other Brown & Wood partner was named as a defendant in a lawsuit by a taxpayer whose losses from a shelter were disallowed by the IRS.³ The firm profited handsomely from the shelter activity. For just three shelters, FLIP, OPIS, and BLIPS, the firm estimated that Ruble had issued 314 opinions and generated revenues of $23.1 million.

In 1996, Ruble was a partner in the firm’s New York office. He had earned an LLM in taxation from New York University Law School and had worked for several years at Rogers & Wells in New York advising corporations on international tax issues. Shortly after he joined Brown & Wood, he began devoting more of his time to work involving tax shelters for wealthy individuals. Ruble soon built up an expansive network of contacts who played various roles in shelter transactions. One group included tax shelter boutiques that specialized in designing “tax-advantaged” transactions. Another consisted of accounting firms that had both expertise and large client bases that could be mined for potential shelter customers. Still another group was comprised of banks and other financial institutions that could execute trades and provide funds that ostensibly financed investment activity. Ruble developed shelters with KPMG, Ernst & Young; Diversified Group, Inc. (DGI), PricewaterhouseCoopers, Bricolage/ICA, Arthur Andersen, BDO Seidman, Multi-National Strategies, Chenery Advisors, Presidio, Deutsche Bank, and Grant Thornton, among others.⁴As Ruble himself put it, “I do work for a number of people who have potentially complementary tax advantaged products. In addition, each of them has a relationship with one or more financial institutions who provide credit, derivative trades, etc. necessary to execute the product.”⁵ He added, “I’m beginning to feel like a dating service.”⁶

Ruble’s most lucrative connection was most likely the one that he formed with KPMG. The accounting firm was an attractive partner because of the scope of its activities and its organizational push to develop and market shelters. Ruble was valuable to KPMG because of his network of relationships, his ability to provide help in both designing shelters and issuing opinions for them, and Brown & Wood’s preeminent reputation in capital markets work. The result was a strong desire by both parties to establish a mutually beneficial partnership.

Ruble was involved with KPMG’s shelters from the firm’s first foray into the shelter market with FLIP. As an internal KPMG email noted in the fall of 1997, “OUR DEAL WITH BROWN & WOOD IS THAT IF THEIR NAME IS USED IN SELLING THE STRATEGY THEY WILL GET A FEE. WE HAVE DECIDED AS A FIRM THAT B&W OPINION SHOULD BE GIVEN IN ALL DEALS.”⁷ To assist KPMG’s shelter efforts, Ruble sought to put the firm in touch with his network of contacts. “I am not trying to push any of these on KPMG,” he wrote, “but it might be useful if you are trying to get a repitoire [sic] of products jump started to talk to some or all of them.”⁸ Most of them, he indicated, knew one another and some used the others’ strategies for deals they could not do themselves. If KPMG was interested, Ruble could “give you direct exposure to people I have seen closing deals.”⁹

In order to embed himself in the accounting firm’s expanding shelter activities, Ruble made efforts to formalize the relationship. As KPMG was experiencing its early success with FLIP, Ruble wrote to Randy Bickham: “This morning my managing partner, Tom Smith, approved Brown & Wood LP working with the newly conformed tax products group at KPMG on a joint basis in which we would jointly develop and market tax products and jointly share in the fees, as you and I have discussed.”¹⁰ (Smith later testified that no such conversation occurred; nor is there other evidence suggesting that it did.) When Bickham received Ruble’s email, he forwarded it to Gregg Ritchie at KPMG with the note,

The B&W initiatives is [sic] moving ahead as you can see from the attached. I asked RJ about ABA constraints, etc. on joint ventures/fee splitting. His thought was that the only situation where a problem arises is when an opinion is involved, but he is following up with their person who specializes in the area on specifics. Today I will summarize my thought on the [sic] how the B&W relationship would be structured and the associated benefits.¹¹

Bickham followed up with a message entitled “Business Model—Brown & Wood Strategic Alliance.”¹² The message began, “The cornerstone of our business model is the development of strategic alliances to develop and market products for both high-wealth individuals and publicly-traded corporations.” Potential partners in such alliances included “‘Wall Street’ law firms that specialize in corporate finance (e.g., Brown & Wood).” Bickham noted, “we need to negotiate a formal alliance with Brown & Wood. Brown & Wood is unique in that it can make significant contributions to the product development process and would allow immediate brand recognition.” The firm could provide “market perception of technical excellence in the development of complex financial securities (from a branding perspective) and participation in the IPO market to enhance our distribution network.” The latter referred to contact with founders of high-tech start-ups who might be interested in sheltering the gains they received as a result of issuing stock to the public. While the firm had not done significant work to date in the IPO sector, “they are making a significant strategic investment by building up their San Francisco-based practice.”

Bickham continued, “The primary objective of the alliance between KPMG and Brown & Wood should be to build a mutually successful business based upon the products that are jointly developed.” KPMG needed to “identify an initial product that can be the focal point for negotiating a strategic alliance with Brown & Wood. The most promising candidate was the “LLC product currently under development,” which was OPIS. The goal would be to work with the law firm to get the new product out to customers by mid-January 1998, targeted at “large capital gain transactions where a co-branded product could potentially give us a competitive advantage.”

In late 1997, when Bickham sent his email, Ruble was already part of a joint working group with KPMG and Presidio that was developing a new shelter ostensibly designed to address the weaknesses in FLIP. This shelter would turn out to be OPIS.¹³ Ruble’s integral role in creating the shelter emerged as Bob Simon, who had raised many of the concerns that led to FLIP’s retirement argued with Ritchie about whether Simon was being sidelined during the successor shelter’s development. Noting an important meeting to which he hadn’t been invited at which Ritchie, Bickham, Larson, and Ruble had revised certain features of the shelter, Simon complained that he had not been kept in the loop on developments with OPIS.¹⁴ In response, Ritchie explained that “[a]s product owner of the OPIS product, I elicited input from a variety of sources, including Brown & Wood, Presidio, Rick Solway, Richard Smith, and others.”¹⁵ He emphasized that OPIS was not yet being marketed, and that he was not aware of anyone “outside of a very small group of people . . . who know anything about the product.”¹⁶

Ruble continued to participate as a member of the OPIS working group to design the shelter, assist in preparing documents necessary to implement it,¹⁷engage in discussions about whether to register the shelter,¹⁸and eventually issue opinions to taxpayers intended to protect them from the imposition of penalties in case the IRS disallowed tax losses resulting from the shelter. Handwritten notes of a March 4, 1998, meeting between KPMG and Ruble on OPIS also suggested that “B&W [could] play a big role in providing protection” for shelter materials under a claim of privilege.¹⁹

Even as Ruble worked closely with KPMG and Presidio on OPIS, the accounting firm sought further to “institutionalize the KPMG/B&W relationship.”²⁰ A March 2, 1998, email from Bickham to Ritchie focused on “the key profit drivers for our joint practice.”²¹ For KPMG, these included its customer list and financial commitment to invest in developing shelters. For Brown & Wood, these included “[i]nstitutional relationships within the investment banking community,” its name and goodwill, and “[m]ore panache in closing larger deals where the buyer brings in his Wall Street/D.C. tax advisor.”²² Bickham noted that in transactions in which Brown & Wood acted as a “co-venturer,” the law firm would not be able to write a concurring opinion.

In the same vein, an August 30, 1998, KPMG email reported, “We have used the existing OPIS product as the mechanism for establishing close strategic relationships with Deutsche Bank and with Brown & Wood at both an institutional level and with key individuals within the organizations.”²³ The strategy was to “co-develop products with Deutsche Bank and Brown & Wood and sell into the $1 million to $5 million market segment on a joint basis. . . . The respective participants from each institution ha[ve] agreed to commit the resources to participate in our internal product development group as well as to become active participants in the marketing process.”²⁴ The same memo referred to Brown & Wood’s role as an “R&D function.”²⁵

Ruble continued to play this role as KPMG moved from OPIS to developing the shelter that became BLIPS. In a December 3, 1998, memo to KPMG recipients, Ruble discussed a technical issue that he had identified as a result of “looking at the bond premium rules in another context (i.e., a legitimate deal).”²⁶ He questioned whether a particular Treasury regulation could override another provision that he had been assuming would govern one step in the BLIPS transaction. Ruble provided this comment some three months before KPMG began its formal internal review and approval process for BLIPS. An email that same day from Randy Bickham to Ruble and several KPMG recipients noted that Bickham had spoken to Ruble about a “tax-focused meeting” the following week.²⁷ Bickham explained that he and Ruble had concluded that “we should first draft the base of an opinion letter in an outline format which will be circulated for comment before getting everyone together for an ‘all-hands’ meeting.”²⁸ He indicated that they planned to circulate a draft the following week.

Bickham’s email illustrates that Ruble’s legal opinions for KPMG shelter transactions were not independent in any sense of the word. This meant that the IRS would not regard his opinion as protecting any taxpayer from liability for a penalty if the agency disallowed losses resulting from a shelter. Aside from the fact that someone who helps design a shelter cannot provide a disinterested analysis of its legal merits, the evidence makes clear that KPMG and Ruble closely collaborated in preparing opinions that were almost identical. A December 1998 email from KPMG to a FLIP investor says that “[t]he Brown and Wood opinion is generally being issued based on (and subsequent to) the KPMG opinion.”²⁹ Another internal KPMG email a day later about the same transaction asked, “Can B&W be the sole issuer of a FLIP opinion? I have not heard of a situation where we did not write the opinion first.”³⁰ Similarly, Ruble was on the routing list for review of the opinion that KPMG would be delivering on the BLIPS shelter in February 1999.³¹

In September of that year, Ruble sent to Bickham a preliminary draft of the Brown & Wood opinion for BLIPS. Ruble noted, “It is also our policy to work with KPMG to develop a common factual statement, which has yet to be done. You’ll notice our approach in laying out the opinions is different from KPMG’s but that everything is there.”³² A Ruble email three weeks later to Bickham and Jeff Eischeid underscored the virtual identity of the two organizations’ opinions:

Here’s our opinion. In going through it I noticed some minor changes that need to be made to both. I have put in an assumption about functional currency, I don’t think yours has it and we probably both want it as a rep. There are a number of investor reps in the text that aren’t in the Reps section. I think that they should go in there. I also think that we should figure out whether we want more in the way of representations from the Investor’s single owner. We both need to get our aggregation opinions ready. Lastly, we probably both need a set of fresh eyes to go over the opinions one last time. At this point I’m not sure I have anyone. Do you and if so could I prevail on him/her to look at mine as well? A side-by-side is also a good idea to make sure we each cover everything the other has.³³

In the same vein, a May 2000 email within KPMG commenting on a draft Brown & Wood BLIPS opinion letter said, “As we discussed, the B&W opinion touches all the necessary bases. The fact and representation sections are almost identical to the ones in our Opinion and many analysis sections are exact copies of our Opinion.”³⁴

The average fee that Brown & Wood received for KPMG transactions was approximately $75,000.³⁵ On one occasion, a group of taxpayers insisted on participating in FLIP transactions even though KPMG had discontinued the shelter and would not issue an opinion. Ruble wrote the sole opinion for the transactions and was paid $100,000 per opinion, or double his usual rate. From December 10 through December 31, 1999, alone, Ruble issued sixty-five BLIPS opinions for fees totaling more than $9.2 million.³⁶ This was an average of almost three a day, at a fee of $142,000 per opinion. The firm estimated that Ruble spent about 2,500 hours preparing opinions for KPMG shelters. With about $23 million in fees from such work, this came to an hourly rate of more than $9,000 per hour.³⁷ At the same time, Ruble was issuing opinions for Ernst & Young’s COBRA shelter, which was sold to roughly fifty taxpayers in the last few months of 1999.

In addition to fees for opinions, Ruble periodically earned profits from participation in certain Presidio transactions that Pfaff and Larson made available to him.³⁸ Ruble had expressed an interest in joining Presidio so that he could enjoy the kind of income available from participation in a tax shelter boutique. Pfaff and Larson discouraged this idea. Ruble was more valuable to them at Brown & Wood than he would be at Presidio because of his ability to provide ostensibly independent legal opinions for Presidio shelters. The additional payments to Ruble were intended to encourage him to remain there. Pfaff emphasized to Presidio’s accountant that such payments were not to appear on Presidio’s tax returns, which could be accomplished by recording them as loans.³⁹ These “side payments” to Ruble came to about $500,000.⁴⁰

Ruble received additional fees through an arrangement with shelter promoter Chenery Associates in San Francisco to market a shelter that Ruble had developed known as Custom Adjustable Rate Debt Structure (CARDS). CARDS purported to provide a taxpayer with a line of credit from a foreign bank denominated in foreign currency that could be used to make investments. It was designed, however, simply to create paper losses to offset capital gains for tax purposes. In May 1998, Ruble, on behalf of an entity known as the Family Investment Statutory Trust, entered into an agreement with Chenery to license CARDS as a “proprietary technology that potentially yields users who purchase assets [to obtain] certain tax, financial accounting, or other commercial benefits.”⁴¹ Under the agreement, Chenery agreed to pay the Trust 20 percent of the gross fees earned from use of the shelter. An investor in one lawsuit against the CARDS promoters, International Air Leasing, indicated that it paid Chenery a fee of $14.75 million and that Chenery used part of this fee to pay Brown & Wood $500,000 for its opinion in the transaction. Under the licensing agreement, Ruble’s trust presumably would be entitled to as much as $2.95 million in addition to this.⁴² An investor in another lawsuit claimed that Brown & Wood received $250,000 for its opinion letter, and that Chenery received $1.5 million in fees. If 20 percent of the latter went to Ruble’s trust, that would amount to $300,000.⁴³

On Friday, December 11, 1998, Thomas Humphreys, the head of Brown & Wood’s tax practice group, came by Ruble’s office to discuss a concern. The firm had recently recorded the receipt of two separate fees of $900,000 and $650,000 from KPMG for work by Ruble. Fees of that size for tax work raised the question whether Ruble might be issuing opinions for transactions that could expose the firm to liability. The conversation was brief since Ruble was in the midst of attempting to close some transactions and preparing for a trip to London. He told Humphreys that he had issued no such opinions and handed him a memo that he had prepared that analyzed one of the KPMG shelters.

Upon reflection, Ruble felt the need to explain himself more fully. The following Tuesday morning, he sent an email to Humphreys, copying Thomas Smith, the firm’s managing partner. “When you came in to ask about the KPMG fees on Friday,” Ruble said, “I was fairly stressed” because of the closings and his travel preparations.⁴⁴ “When you pointed out the magnitude of the fees and asked whether I had issued any opinions for which we could get sued, I took your question as a criticism that I would knowingly expose the firm to risk, and I answered no.” Ruble said that he now wanted to “clarify what you could fairly interpret as a misstatement.” He said that he had answered based on his view that he had not issued any opinions for which the firm could successfully be sued. “There have been opinions, however,” Ruble said, and he wanted to provide some background for what he had done.

Ruble then described his history of working with KPMG on shelter transactions. In 1996, he said, a team from KPMG was marketing a “capital loss product” (which would have been FLIP) to its clients that was encountering some resistance from clients’ advisors. KPMG asked him if he would speak with the advisors about the product as “someone unrelated to KPMG.” Ruble said that he reviewed the product and KPMG’s legal opinion, and “conducted my own research.” He concluded that it was more likely than not that the shelter would withstand legal challenge, although it could be improved. Ruble said that he then “agreed to act as a sounding board for their clients’ advisors and we got paid by KPMG for rendering that advice on a fixed fee basis that was a premium to time.” He also agreed to help KPMG modify FLIP for its 1997 sales campaign and “worked with their products people and their national office tax partners to make some changes and improvements” (which would culminate in OPIS). He also agreed to play the “sounding board” role as he had in the previous year.

As KPMG sought to close transactions in the fall of 1997, Ruble said several clients asked for “a concurring opinion which confirmed the conversations I had with their advisors.” He explained:

Given that I had worked the development through very closely with KPMG, given my knowledge and understanding of the opinion process, and that based on my independent research believed their conclusion was correct on a more likely than not basis, I agreed to do so, but only if KPMG first issued their opinion on the deal. On that basis, KPMG agreed to pay us $50,000 per deal in which we were involved.⁴⁵

Ruble said that in 1998 he worked with KPMG, Presidio, and Deutsche Bank to develop a new shelter for 1998 (this would have been BLIPS). He also agreed to provide an opinion but requested that the fee be based on deal size.

Ruble then explained the unusually large payments of $900,000 and $650,000 the firm had received from KPMG. He said that in November he had asked KPMG if they could accelerate payment of all or a portion of fees so that the law firm could get the cash before the end of the year. KPMG agreed and identified each transaction for which Brown & Wood was due payment. The law firm’s accounting department “treated as one item all the KPMG bills issued on the same day, so that it appeared that there was a single $900,000 and a single $650,000 bill, when in fact these are the . . . aggregate sums of a few smaller deals.”

Smith later stated that when the revenues from Ruble’s practice “increased materially” in 1998, he asked Humphreys about it.⁴⁶ Humphreys followed up by asking Ruble about his work, which prompted the explanatory email by Ruble. Smith said that he asked four or five tax partners to review Ruble’s opinions, and that they said that “they were valid opinions under the then law.” According to Smith, when he and other members of management inquired into the firm’s role in providing opinions, Ruble told them that it was to “provide concurring opinions to taxpayers, and a lot of times to their financial advisors.” The understanding was that Ruble was not involved “in the design of these products, but that KPMG would approach him with a product and ask if he could render an opinion.” Smith conceded that if Ruble had seen a way to improve the product, he might have passed that information on to KPMG, but that his role essentially was to opine on what KPMG had created.

Ruble’s email is interesting for several reasons. First, it suggests that, contrary to Ruble’s December 1997 representation to KPMG, Smith had not authorized the firm to enter into an agreement with KPMG to jointly develop and market tax products. If he had, Ruble likely would not have felt the need to explain in detail how he had become involved with KPMG and the work that he had done in connection with its shelters. Second, Ruble’s email misrepresents the role he was playing. Shelter investors generally had to sign confidentiality agreements that prevented them from discussing the shelter with third parties such as independent advisors. It is unlikely that Ruble had many, if any, conversations with such advisors, so his opinions were not simply a reiteration of the points he had made in discussion with them. In addition, characterizing his role as that of a sounding board suggests that he was providing his assessment of products that KPMG first had developed and then brought to him. In fact, of course, Ruble was intimately involved from the outset in designing the shelters that KPMG marketed. To the extent that Brown & Wood based its understanding of Ruble’s work on this characterization, it therefore would have been misled.

At the same time, Ruble provided enough details about his involvement in the shelter development process to raise the question whether Brown & Wood was a shelter promoter and therefore had obligations to register the shelters and to maintain lists of investors in them. He describes working with KPMG to “make some changes and improvements” in its 1997 product, and with KPMG, Presidio, and Deutsche Bank to “come up with a new variant” for 1998. Indeed, after the IRS issued Notice 2000-44 in August of 2000, Brown & Wood, presumably through Ruble, entered into an October 31, 2000, agreement with several parties, including Diversified Group, that the agreement described as “involved in activities as organizers and/or sellers of investments that may be considered to be tax shelters by the Internal Revenue Service.”⁴⁷ The purpose of the agreement was to take advantage of an IRS regulation that provided that multiple organizers or sellers or both may designate one party to maintain a list of investors and to designate Diversified Group as that party. Ruble’s email, however, apparently did not prompt anyone at Brown & Wood to inquire into whether the firm might be considered a shelter promoter. At a minimum, Ruble’s involvement in the shelter design process should have raised a serious question about whether any investor could reasonably rely on his opinion to avoid a penalty.

With respect to the review of Ruble’s opinions by Brown & Wood tax partners, nothing on the face of the opinions necessarily would have alerted anyone to a problem. The transactions were all described as investment programs that relied on leverage in the pursuit of capital appreciation, selected by clients who had “reviewed the economics underlying the investment strategy and believed [they] had a reasonable opportunity to earn a reasonable profit from each of the transactions” beyond any fees and costs and without regard to any tax benefits.⁴⁸ The opinions also contained representations that each investor would make an individual decision about how long to continue participating in the various transactions. These portions of the opinion letters were all false, but someone reading them generally would have had to delve deeper into the facts of the transactions to discover this. An experienced tax lawyer presumably would know that the factual representations were critical to whether the opinion was defensible. It’s not clear, however, how deeply the Brown & Wood tax partners who reviewed the opinions probed these representations in the course of arriving at their conclusions. It’s also not clear how much motivation they had to do so, given the fees that Ruble was generating.

In any event, later updates from Ruble to Smith and Humphreys suggested that there were risks involved in Ruble’s practice. An email of June 1, 2000, to both men said that KPMG was trying to distance itself as a tax promoter because of the adverse publicity that PwC had received in connection with the BOSS shelter.⁴⁹ The accounting firm was planning to work with tax shelter boutiques to create products and to refer its clients to these firms so that they could decide which shelter they wanted to use. KPMG would be providing clients with a list of law firms from which to choose in seeking opinions. It would receive a fee for reviewing the deals and opinions, on the theory that this role “gives it better optics.” Ruble suggested that because there was market resistance to the fees that traditionally had been charged, pressure on fees likely would result in only about 25 percent of what Brown & Wood historically had collected. There might also be fewer deals altogether, Ruble said, because “there is a risk that the IRS will begin to focus on individual transaction[s] in the same way that it has on corporate shelters.”

On August 10, Ruble wrote to Humphreys and Smith to inform them that the IRS would be issuing Notice 2000-44. The subject line of the email said: “IRS to Issue Notice on Friday 8/11 to Shut Down KPMG, E&Y, and AA etc. deals.”⁵⁰ The notice, Ruble said, would be declaring that transactions “that were the core of these firms’ tax products for the past 2 years don’t work and are abusive.” Brown & Wood had given opinions in these transactions that accounted for a “substantial part of the revenues from these firms.” Ruble expressed his belief that the opinions were well reasoned and their bases well documented, “but there is going to be a certain amount of questioning, I’m sure.” He concluded by saying that he was “at meetings at KPMG” for most of the day “to come up with some new ideas”—a statement that clearly indicates his close involvement with KPMG in the development of tax shelters.

As a merger between Brown & Wood and Sidley & Austin approached in the spring of 2001, both firms agreed that the combined firm would no longer provide tax shelter opinions like the ones Ruble had been issuing. The managing partner of the merged firm later said that the decision “did not and does not reflect on the quality of the work performed earlier,”⁵¹ but it is not hard to imagine that firm leaders saw Ruble’s shelter practice as simply too risky. In any event, the firm later learned that Ruble had continued to issue opinions for some time after the merger, which he defended by claiming that he had premerger commitments to deliver them to investors. That work ultimately would be the basis for a criminal investigation of Sidley Austin Brown & Wood.

Law Firms Collaborating with E&Y

When several Ernst and Young (E&Y) partners were charged in 2007 in connection with promoting tax shelters, the indictment described the activities of four law firms, identified as Firms A through D, that had assisted in the shelter activities.⁵² Firm A was later revealed to be Locke Liddell & Sapp (later Locke Lord Bissell & Liddell). Firm B was Sidley Austin Brown & Wood. Firm C was Arnold & Porter and Firm D was Proskauer Rose.⁵³

As the indictment charged, Locke Liddell had written opinion letters for the Contingent Deferred Swap (CDS) and CDS Add-On Shelters and had “assisted the defendants in structuring, marketing, and implementing the CDS transaction.”⁵⁴ The firm’s fee for the CDS opinions, which stated that the client “should” prevail in case the transaction was challenged by the IRS, was $50,000 per opinion. The fee for the CDS Add-On opinions, which said that the client more likely than not would prevail, was $75,000 for each opinion. The opinion for each shelter falsely stated that the client was entering the transaction to achieve certain business objectives and that there was no predetermined outcome for the transaction. In the case of the CDS shelter, the opinion failed to disclose that it was being issued by an attorney who had participated in devising the transaction.

Brent Clifton was the attorney at Locke Liddell who spearheaded the firm’s involvement with the CDS and CDS Add-On shelters. The CDS was developed by David Smith in concert with Graham Taylor, who kept his involvement a secret from Pillsbury, Madison & Sutro, the firm at which he worked. After Pillsbury learned about the transaction, it declined to issue an opinion for it. Grady Dickens, a friend of E&Y’s Brian Vaughn at the law firm of Scheef & Stone in Dallas, suggested that Vaughn get in touch with Clifton.⁵⁵ Clifton wrote to another partner that he had been contacted about providing opinion letters for an “aggressive tax shelter proposal” being sold by Ernst & Young to “extremely high net worth corporate officers.”⁵⁶ Clifton indicated that the firm “will be asked to provide a ‘should opinion’” that would conclude that the taxpayer had a 70 percent to 80 percent likelihood of success if litigated.”⁵⁷ Clifton explained that he had been contacted “because Locke Liddell & Sapp was recognized as a large firm with reputable tax expertise.”

According to one attorney who had been asked to review a Locke Liddell opinion by a client, “the transaction appears to be a classic ‘sham’ tax shelter that would be successfully challenged on audit by IRS. The transaction apparently has little, or any, economic significance outside the tremendous tax breaks promised to the investors and is apparently highly tax motivated.”⁵⁸ As his analysis continued, “The opinion provided to me did not discuss the relevant facts, as I understand them. There was little discussion of the hedging within the transaction that will protect the investors against risk of loss or the high level of tax motivation behind the concept. The analysis of the downside to the transaction was weak and often irrelevant.”⁵⁹

The biggest problem with both the transaction and the opinion, the attorney noted, was that the partnership would not be engaged in business as a trader, “which is critical to claim the deductions discussed in the opinion.” The opinion “wrongly states that the Fund Manager’s activities will be attributed to the partnership,” and relies on a “50 year old case that has nothing to do with trader vs. investor status.” It also “fails to address the relevant case law,” particularly a U.S. Tax Court decision explicitly holding that the trading activities of others are not attributed to the taxpayer. That decision “unequivocally states that the taxpayer must personally ma[ke] the trading decisions and cannot delegate this task to others.” This analysis underscored the multiple deficiencies in the CDS shelter that negated any plausible claim that it had any economic substance.

As it turned out, the involvement of Locke Liddell in tax shelter work proved to be an embarrassment for the Bush administration when the President nominated White House Counsel Harriet Miers, a former Locke Liddell managing partner, for the Supreme Court in October 2005. A report earlier that year by the Senate Permanent Subcommittee on Investigations had mentioned the firm as among those that provided opinion letters for potentially abusive shelters. Upon Miers’s nomination, Senator Norm Coleman of Minnesota, chair of the Committee, said, “I have a high standard for the ethics of a Supreme Court justice. These were very questionable transactions, and the volume of work done on this was substantial—in the millions of dollars.”⁶⁰ Senator Max Baucus, the ranking Democrat on the Finance Committee, sent the firm a five page letter requesting detailed explanations about Locke Liddell’s work on the CDS shelter.

Locke Liddell partner John McElhaney confirmed that the firm had issued 132 opinions on the CDS shelter for revenues of about $5.4 million. Just over half of the transactions were done while Miers was still at the firm. McElhaney conceded that it was a “fair assumption” that Miers was aware of the activity in light of the amount of income that it generated. He stated, however, that no court had ever ruled that the transaction was unlawful and maintained, “Just because there’s been an opinion by the IRS doesn’t mean it’s illegal.”⁶¹ Among the lawsuits by investors that the firm eventually settled was one by several Cisco Systems executives who claimed that they paid the IRS more than $20 million in back taxes, penalties, and interest. The White House eventually withdrew Miers’s nomination in light of criticism that she had insufficient experience to serve on the Court.

The fourth law firm identified in the indictment of the former Ernst & Young employees was Proskauer Rose. Investors in E&Y’s Personal Investment Corporation (PICO) shelter in 2000 and 2001 were given a choice of obtaining an opinion either from Proskauer or Arnold & Porter, with fees for the opinions ranging from $50,000 to $100,000 depending on the size of the transaction. The opinions falsely stated that the taxpayer had formed an S corporation to engage in investment activity and to protect its assets in connection with estate planning, and that the trading was not designed to result in a predetermined outcome.

Lawyers from Proskauer also helped eleven E&Y partners generate tax losses to offset income from the accounting firm’s sale of its global consulting business in 2000 to Cap Gemini. The firm helped partners form an entity known as Tradehill Investments to carry out a short option strategy similar to COBRA. Ira Akselrad, a member of the firm’s executive committee, worked from December 2000 through mid-April 2001 with Martin Nissenbaum, one of the E&Y partners using the shelter, to prepare a legal opinion that the partners could use to protect themselves from a penalty if the government refused to recognize the tax losses from the transaction. In connection with this, Nissenbaum helped prepare a “Certificate of Facts” that stated that the partners engaged in the purchase and sale of options to pursue investment returns and that their decision to withdraw from the trading entity was based on several factors, including their assessment of likely future market conditions.

In April 2001, Proskauer issued a backdated opinion letter that incorporated the Certificate of Facts and said that all relevant facts regarding the transaction had been disclosed in the opinion. The eleven partners then filed their returns in 2001 using the losses generated by Tradehill to eliminate most of their tax liability for the income they received from the sale to Cap Gemini.

In May 2003, the IRS notified the partners that their returns were being audited and sent information document requests (IDRs) to each of them. Akselrad worked with Nissenbaum to draft responses to the IDRs on behalf of each partner. Those responses stated that the Tradehill transactions were motivated by the desire to pursue investment returns and to hedge investments, and that there was no expectation or referral of any future business to Proskauer.

Ernst & Young was not the only tax shelter promoter with whom Proskauer worked. The firm also provided opinion letters to KPMG in connection with the sale of Son of BOSS shelters and, in some cases, helped design the shelter. A lawsuit brought by Richard Egan, former ambassador to Ireland and “one of the most successful businessmen in the history of the United States,”⁶² provides insight into the firm’s role in these transactions. Egan used a shelter devised by shelter boutiques Helios and Diversified Group International (DGI) to claim almost $160 million in ordinary losses in 2001, and $1.7 million in ordinary losses and $167.1 million in capital losses in 2002. Proskauer and Sidley Austin provided legal opinions in connection with the transactions. When the IRS disallowed his losses, Egan challenged the government’s position. In a 357-page opinion upholding the IRS, Judge Saylor of the Court of Claims declared that “[n]one of the participants in these complex transactions believed that they were real business transactions, with any purpose other than tax avoidance.” Indeed, Judge Saylor suggested, “It is highly doubtful that any participants believed, even for a minute, that the transactions would withstand legal scrutiny if discovered.” Rather, the participants “were simply following a script—a script that had little or no connection to any underlying business or economic reality.”

The legal opinions “were just additional acts of stagecraft. The lawyers were not in the slightest rendering independent advice; the promoters of the tax shelters had arranged favorable opinions from those firms well in advance, and as part of their marketing strategy.” The opinions also were not independent because Akselrad and R. J. Ruble had actively assisted DGI and Helios in designing, marketing, and implementing the shelter, while the two shelter boutiques “played a substantial role in the drafting and the delivery” of the opinions. The opinions “were themselves fraudulent; they were premised on purported ‘facts’ that Egan and the law firms knew were false, and reached conclusions that everyone involved knew could not possibly be correct.” Proskauer provided at least twenty-eight opinions, as well as legal advice to DGI and Helios, and Akselrad himself participated in a DGI shelter transaction in 2000.

Judge Saylor noted that the Proskauer opinion letter assumed that the transaction to which it referred would be upheld if the taxpayer subjectively was motivated by a nontax business purpose, even if the transaction had no economic substance. The opinion letter then accepted as dispositive the taxpayers’ representations that this was their motive. “No reasonable tax attorney,” said the court, “would assume that a transaction of that nature would be recognized and upheld by the courts simply because the taxpayer made a self-serving statement about his or her supposed business purpose.” The opinion contained “virtually no analysis of the actual facts of the transaction.”

Serving Shelters

The participation of several other lawyers at various law firms in designing, marketing, or issuing opinion letters for tax shelters has also come to light. Graham Taylor was a tax lawyer who practiced in San Francisco with Pillsbury, Madison & Sutro from 1981 to 1999; with LeBouef, Lamb, Greene & MacRae from 1999 until 2003; and then with Altheimer & Gray and Seyfarth Shaw. Over the course of his career Taylor wrote almost two hundred opinions for eight different types of shelters, for fees totaling between $9 million and $10 million.⁶³ He began in 1994 by working with David Lippman (Smith), then with Quadra, on a “redemption trade” shelter.⁶⁴ Taylor issued between thirty and forty “more likely than not” opinions, at a price of $50,000 per opinion,⁶⁵ without the knowledge of anyone in the firm that the transactions were designed principally to reduce or eliminate taxes.

In 1998, when he was at Pillsbury, Taylor began discussing a contingent deferred swap (CDS) shelter with Smith that would be marketed by Ernst & Young. He traded several drafts of an opinion with Smith but told no one in the firm that he was working on the project. In early summer 1999, someone from E&Y called Pillsbury to discuss the CDS shelter when Taylor was out of the office. Tax partner Julie Divola took the call instead. This prompted a vigorous debate inside the firm about whether it should be involved in issuing opinions in connection with tax shelters.⁶⁶ Eventually, the answer was no. As a result, Smith and E&Y turned to Dallas-based Locke Liddell to provide opinions on the CDS shelter. In the fall, Taylor left Pillsbury to join the San Francisco office of LeBoeuf Lamb, a firm based in New York, where he remained until 2003.

Over the next several years, Taylor also issued about thirty opinions for the CARDS shelter at between $85,000 and $150,000 per opinion; thirty opinions for a distressed debt shelter at between $100,000 and $150,000 per opinion; and twenty opinions for another shelter known as ICA. In contrast to his time at Pillsbury, Taylor worked with other partners and associates on his opinions while at LeBoeuf Lamb but testified that he did not believe that any of his colleagues knew that the opinions contained any false statements or representations.⁶⁷ Nor is there any evidence that Taylor’s colleagues at Altheimer & Gray or Seyfarth Shaw were aware of his work on abusive shelters.

Peter Cinquegrani, a partner at Arnold & Porter, collaborated in 2000 and 2001 with promoters at Ernst & Young and others to develop and write opinions for the shelter known as Personal Investment Corporation (PICO). Approximately 150 individuals participated in 96 PICO transactions during this period. Cinquegrani received fees of between $50,000 and $100,000 for each letter. He also prepared a phony consulting contract between E&Y and shelter promoter Bricolage that was intended to disguise the fact that the accounting firm’s fees for the shelter were based on a percentage of the tax loss that the client wanted to generate.⁶⁸

Jay Gordon, former head of the tax practice at Greenberg Traurig, issued legal opinions for abusive shelters between 2000 and 2003, charging between $10,000 and $30,000 for each opinion. These letters contained false representations that the taxpayers had entered into the shelter transactions with a reasonable expectation of realizing a significant pretax profit, as part of an overall investment strategy.

In addition, Gordon engaged in tax evasion in connection with referral fees he received for steering clients to tax shelter promoters. He received more than $400,000 in such fees in 1999 but did not disclose those to Greenberg Traurig or the IRS. In 2001, he received an additional $268,000 in referral fees. He did not disclose those to his firm but did so on his tax returns. He participated in an abusive tax shelter, however, that enabled him to evade taxes on this and other income. In addition, Gordon claimed over $10,000 in false deductions on his income tax returns for the period 1999 through 2002.

In November 2004, Gordon resigned from Greenberg Traurig when a prominent real estate developer client complained to the firm that the IRS had disallowed losses from a shelter Gordon recommended. The outside lawyer hired by the firm to investigate the matter learned that the shelter promoter had paid Gordon almost $300,000 to refer the client to it. The firm refunded fees that this and other clients had paid for shelters and referred the matter to the state bar disciplinary committee.⁶⁹ Two years later, Gordon resigned from the New York bar after admitting that he earned $1.3 million in referral fees between 1999 and 2002 in connection with tax shelters without informing his clients or firm.⁷⁰

John Campbell was the managing partner of the Kalamazoo, Michigan, office of Miller, Canfield, Paddock & Stone. From 1999 through 2006, he worked closely with four tax shelter promoters and employees of an insurance company in the U.S. Virgin Islands to sell clients a tax shelter that involved the use of ostensible insurance premium payments. His client, Oskar Rene Poch, used the shelter to improperly deduct more than $3.9 million in premiums from 1999 through 2001, which resulted in fraudulent tax savings of over $1.63 million.

Matthew Krane, a Los Angeles lawyer, served as tax counsel for entertainment industry billionaire Haim Saban. In 2001, Saban had $1.5 billion in capital gains from the sale of his stake in the Fox Family Channel to Walt Disney. Krane steered him to the investment fund Quellos to participate in a shelter transaction known as Portfolio Optimized Investment Transaction (POINT). Krane, along with Jeffrey Greenstein and Charles Wilk of Quellos, drafted documents that made it appear that Saban was paying the fund $46 million to participate in the shelter. Unbeknownst to Saban, $36 million of that payment went to Krane for his referral of Saban to Quellos. That money was deposited by Greenstein and Wilk in an offshore account controlled by Krane.

The Long-Term Capital Tax Shelter

Two other law firms were the target of sharp criticism for their involvement in tax shelter work. On July 24, 2004, the federal district court in Connecticut upheld the IRS’s disallowance of $106 million in tax losses claimed by partners in the Long-Term Capital hedge fund for the 1997 tax year.⁷¹ The hedge fund, run by prominent economists, including Nobel Prize winners Robert Merton and Myron Scholes,⁷² had been the beneficiary of a bailout by banks arranged by the federal government when its prospective demise in 1997 prompted fears of a system-wide financial crisis.⁷³

Scholes, who is the author of a widely adopted textbook on business taxes, had designed the tax strategy. At trial, Scholes initially denied that he was an expert in business tax. After the government showed him his own textbook in the field, he reluctantly acknowledged that he had expertise in the area. He also acknowledged that for the tax benefits of the transaction to be upheld it needed to have economic substance. During cross-examination, Scholes admitted that he had used the Black-Scholes formula he had developed for pricing options to ensure that other investors in the transaction were not at risk of losing money. Scholes eventually conceded that once the substantial payment he received for creating the transaction was taken into account in determining the costs of entering into the transaction, the possibility of making a profit disappeared. After trial, Judge Janet Bond Arterton held that any analysis of whether there were realistic expectations of profit from the transaction had to include the costs and fees incurred to participate in it. Because the costs of the transaction exceeded the prospective profit, Judge Arterton concluded that it lacked economic substance.

Judge Arterton further ruled that the hedge fund partners were liable for penalties because they could not establish that they reasonably relied in good faith on opinions provided by Shearman & Sterling and King & Spalding that different aspects of the transaction “should” serve to support the tax treatment that the taxpayers sought. Judge Arterton found that Long-Term Capital paid Shearman & Sterling $500,000 for five virtually identical opinions that “contain[ed] no legal reasoning or analysis.”⁷⁴ When a separate memorandum was offered to show “part of the analysis” that the firm conducted for the opinions, the court observed: “Notably absent [was] any analysis of the step transaction doctrine, [of whether certain ostensibly independent companies] were alter egos, and sham transaction theories.”⁷⁵

The court was even more critical of King & Spalding’s work. The court did not find credible the testimony of Mark Kuller—who had coauthored the King & Spalding opinion—that he had performed and discussed at length with Long-Term Capital’s in-house tax counsel a calculation of the hedge fund’s expected profits before taxes. (Kuller had written an opinion for the transaction that was struck down in ACM.) Emphasizing the absence of any contemporaneous records, Judge Arterton found that the tenor of Kuller’s testimony “had the distinct quality of advocacy, not an effort to just accurately report recollection.”⁷⁶ As to the written opinion, which the Long-Term Capital partners received after they had claimed the loss from the transaction, the court observed that it “contain[ed] no citation to any decisions of the Second Circuit Court of Appeals whose case law would apply to any appeal related to Long Term Capital’s tax return.”⁷⁷ As the court remarked acerbically, “With hourly billing totals exceeding $100,000 there could not have been research time constraints.”

The court’s overall assessment was harsh:

In essence, the testimony and evidence offered by Long Term regarding the advice received from King & Spalding amounted to general superficial pronouncements asking the Court to “trust us; we looked into all pertinent facts; we were involved; we researched all applicable authorities; we made no unreasonable assumptions; Long Term gave us all information.” The Court’s role as fact finder is more searching and with specifics, analysis, and explanations in such short supply, the King & Spalding effort is insufficient to carry Long Term’s burden.⁷⁸

Judge Arterton’s opinion made clear that highly respected law firms had been earning outsized fees providing legal opinions that gave questionable transactions a patina of legitimacy—and assumed they would be able to get away with it.

Lawyers who helped design and sell abusive tax shelters were a caricature of the fiduciaries they purported to be. They wrote opinion letters on behalf of “clients” they never met and with whom they never spoke, and used boilerplate language to describe the supposedly personal intentions of each “investor.” They claimed to protect taxpayers from penalties in cases in which they knew that their opinions would be worthless for that purpose because they had helped design the shelter on which they were opining. Other lawyers who were not involved in designing shelters issued opinions containing elaborate and lengthy analysis that one court described as “incomplete, incorrect, and misleading in multiple respects,” which failed to meet basic standards of professional competence.

Lawyers involved in abusive shelters eschewed any responsibility to promote respect for the tax system. They helped further activity that they knew would be successful only because it probably would never be detected, not because it conformed to the requirements of the law. They adopted a purely adversary stance toward the government in a setting in which the integrity of the law depends crucially on the integrity of taxpayers. In these ways, they helped undermine allegiance to the basic duties of citizenship.

For several years, it seemed as though nothing could stop the boom in abusive tax shelters. Little by little, however, government officials were beginning to take steps to combat the activities of promoters, professionals, and taxpayers who fueled the boom. As the next three chapters describe, these efforts gradually coalesced into an all-out assault on the abusive tax shelter industry.