On September 23, 2016, Robert Fackler, the husband and now co-defendant of former Tax Court Judge Diane Kroupa, pleaded guilty to corruptly impeding the IRS, a felony that carries a maximum three-year prison sentence. It is unclear whether the plea agreement calls for Fackler to cooperate with the government’s prosecution of his wife. Considering that the indictment charged him with six felony counts, five or which will be dismissed under the plea agreement, chances are good that he has agreed to testify against his wife if she goes to trial. She now occupies the exceedingly uncomfortable sole defendant’s chair. The Minneapolis Star-Tribune has a good recitation of the facts of the case here.
On Aug. 30, 2016, the Treasury Department, the Federal Reserve, the FDIC, the National Credit Union Administration and the Office of the Comptroller of the Currency issued guidance to U.S. banks that hold correspondent accounts for foreign financial institutions. The Joint Fact Sheet on Foreign Correspondent Banking seeks to clarify U.S. banks’ obligations when hosting these accounts. Among other things, the fact sheet emphasizes that “Under existing U.S. regulations, there is no general requirement for U.S. depository institutions to conduct due diligence on an FFI’s [a foreign financial institution’s] customers. In determining the appropriate level of due diligence necessary for an FFI relationship, U.S. depository institutions should consider the extent to which information related to the FFI’s markets and types of customers is necessary to assess the risks posed by the relationship, satisfy the institution’s obligations to detect and report suspicious activity, and comply with U.S. economic sanctions.”
As we have noted before in this blog, “Any bank in the world that wishes to allow its customers to hold U.S. dollar-denominated accounts and conduct transactions in U.S. dollars must have access to the U.S. banking system. This requires foreign banks to open accounts at banks in the U.S., known as correspondent banks.” Any clarification of U.S. banks’ obligations in this area will be welcomed by both U.S. banks and their foreign correspondent banking customers.
On August 8, 2016, Tennessee State Rep. Joseph Armstrong (D-Tenn.) was convicted by a federal district court jury of filing a false federal income tax return, and acquitted of tax evasion and conspiracy. Armstrong’s conviction arose from an ingenious but morally dubious scheme to profit personally from a tax increase that he helped push through the legislature. Armstrong supported and voted in favor of a cigarette tax increase from 20 cents to 62 cents per pack. Cigarette wholesalers place tax stamps on packs to show that the taxes have been paid. Knowing that the stamps would increase in value from 20 cents to 62 cents, Armstrong got together with a wholesaler, hoarded the stamps, and resold them after the tax increase took effect for a 300 percent profit, or roughly $321,000. The jury convicted Armstrong of willfully filing a false tax return by failing to report this income.
The lesson from this scandal, unsurprisingly, is that the cover up is often worse than the crime. Armstrong’s tax stamp scheme was not illegal; it was only distasteful in the extreme. His attempt to cover it up by failing to report the income on his tax return, though, was a felony. He now faces a maximum of three years in prison and is being ejected from the Tennessee Legislature.
On July 13, 2016, in Dynamo Holdings Limited P’ship v. Comm’r, the U.S. Tax Court strongly defended the taxpayer’s use of computer-assisted review in a dispute with the IRS. In a 2014 decision in the same case, the Tax Court had already endorsed computer-assisted review, namely predictive coding, as a general matter. “Predictive coding is an expedited and efficient form of computer-assisted review that allows parties in litigation to avoid the time and costs associated with the traditional, manual review of large volumes of documents.” Dynamo Holdings, 143 T.C. 183 (2014). Read more >>
The “Restraining Excessive Seizure of Property through the Exploitation of Civil Asset Forfeiture Tools Act” (tortuously abbreviated as the RESPECT Act) (H.R. 5523) continues to make its way through Congress, with a markup session held on July 7, 2016. The bill follows an IRS change of policy in October 2014 to correct perceived abuses in the seizure of the proceeds of criminal structuring of currency transactions. It is a crime to structure currency transactions with the intention of preventing a financial institution from reporting the transaction to the Treasury. Since banks must file a Currency Transaction Report with Treasury’s FinCEN for currency transactions greater than $10,000, people sometimes conduct multiple sub-$10,000 transactions to evade this reporting. In such cases, in addition to criminal charges, the IRS often civilly seizes the structured funds with the intention of forfeiting them. Controversy arose over the fact that the IRS lawfully seized structured funds even when the funds were not the proceeds of some other crime. To be clear, structuring “clean” currency is no less illegal than structuring illegal-source currency. Still, many people thought that such seizures went too far.
To address this, the IRS announced in October 2014 that it “would no longer pursue the seizure and forfeiture of funds associated solely with ‘legal source’ structuring, unless there are exceptional circumstances justifying the seizure and forfeiture.” In June 2016, the IRS went further and “established a special procedure for people whose assets were involved in structuring to request a return of their forfeited property or funds.” Members of Congress apparently are uncomfortable with this being merely an internal IRS policy, and are seeking to give it the force of law.
Multiple news sources (for example, here and here) are reporting that the U.S. government is conducting an investigation into whether Goldman Sachs violated the so-called Bank Secrecy Act (real and less-Orwellian name: Currency and Foreign Transactions Reporting Act of 1970) by conducting a highly suspicious wire transfer and failing to file a Suspicious Activity Report with the U.S. Treasury.
The Bank Secrecy Act, among other things, requires financial institutions to file Suspicious Activity Reports with the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) when a customer’s transactions are, well, suspicious. Banks face serious penalties for failing to file Suspicious Activity Reports. Additionally, the electronically filed reports provide tips that often trigger IRS criminal investigations of the customers that engaged in the transactions. FinCEN closely guards the criteria for when a financial institution must file Suspicious Activity Reports to avoid tipping off would-be wrongdoers on how to avoid behaviors that might trigger the reports. Still, it’s not hard to see why the federal government might view the transaction at issue as suspicious. Continue Reading
On May 23, 2016, the U.S. Court of Appeals for the Second Circuit reversed a jury’s finding of civil fraud against Countrywide Home Loans and other lenders, finding that the government had failed to prove fraud in Countrywide’s sale of mortgages to Fannie Mae and Freddie Mac. Peter J. Henning wrote an excellent piece in the New York Times’ White Collar Watch pointing out just how difficult it can be to prove fraud. The Countrywide case, brought under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), showed that one person’s “brazen fraud,” as presiding District Court Judge Jed Rakoff called it, is another person’s merely distasteful intentional breach of contract. The Second Circuit took the latter viewpoint.
How does this relate to tax enforcement? If the burden of proving garden-variety fraud is high, the burden of proving tax fraud is higher still. To prove tax fraud, the government must prove not only that a taxpayer made a false statement but that the taxpayer understood the tax law well enough to know that he or she was violating it. In other words, there can be no conviction in the absence of an intentional violation of a known legal duty. This has been the law at least since the Supreme Court’s decision in the 1991 case of Cheek v. United States. Unlike what we learned in our high school civics classes, ignorance of the law is an excuse in the world of tax fraud.
On April 12, after four weeks of trial and one week of deliberations, a federal jury in the U.S. District Court for the District of Kansas returned a verdict of not guilty for a firm client accused of engaging in a conspiracy with his wife to defraud the U.S. government by impairing and impeding the IRS. One Assistant U.S. Attorney and two trial attorneys from the Department of Justice Tax Division represented the government. Counsel Jay Nanavati represented the client.
The client and his wife were alleged to have agreed to fabricate a repairs and maintenance contract between their two businesses to increase one of the businesses’ tax deductions and to divert money from the business to their personal use. In December 2010, the client’s wife’s business wrote a check to the client’s business pursuant to a prepaid two-year service contract. The client allegedly immediately used the money to buy gold coins that were shipped to the wife’s business.
According to the government, the service contract was a sham created to disguise a circular flow of funds from the wife’s business to the client’s business and back to the wife’s business in the form of gold coins. On the wife’s business’s 2010 corporate tax return, the wife allegedly fraudulently deducted the payment to the client’s business as a business expense for repairs and maintenance.
The government called approximately 117 witnesses, most of whom were connected to different charges against the client’s wife. The defense called approximately seven witnesses over two days.
Nanavati said the key to the defense was undermining the government’s witnesses’ credibility during cross-examination and pointing out to the jury during closing argument various logical flaws in the government’s theory of the case. “By the end of the government’s evidence, it was fairly clear that the government had not met its burden,” he said.
On January 13, 2016, the U.S. Treasury’s financial intelligence unit, known as the Financial Crimes Enforcement Network (FinCEN), announced the issuance of geographic targeting orders (GTOs) to certain unnamed real estate title insurance companies. These orders will require the subject title insurance company to find out who the true flesh-and-blood purchaser (“beneficial owner”) is when a legal entity buys real estate and to report that information to FinCEN. FinCEN issues GTOs to target certain behaviors in certain geographical areas for limited time periods in furtherance of its mission of enforcing the Bank Secrecy Act. In this case, the title insurance companies that receive these orders will be required to report to FinCEN any purchases of residential real estate in Manhattan or Miami when the purchase price exceeds $3 million, the buyer is a legal entity, there is no bank loan, and the purchase “is made, at least in part, using currency or a cashier’s check, a certified check, a traveler’s check, or a money order in any form.” The orders will remain in force for 180 days, beginning March 1, 2016, and expiring August 27, 2016.
The stated purpose of the GTOs is to gather information on “individuals attempting to hide their assets and identities by purchasing residential properties through limited liability companies [LLCs] or other opaque structures.” Recently, the news has been full of stories about corrupt foreign officials and their family members hiding their wealth in high-end U.S. residential real estate by creating layers of LLCs to act as the buyers. FinCEN seems to be using the GTOs to test the waters of luxury residential real estate to determine how much of a problem money laundering presents in that area. Presumably, if the GTOs yield evidence of a significant problem, FinCEN will use the information as the basis for the creation of a regulation requiring title insurance companies nationwide to collect beneficial owner information permanently.
I suspect that these GTOs will eventually lead to the creation of permanent bank-like anti-money-laundering/know-your-customer rules that close the real estate loophole that currently allows the concealment of purchasers’ identities.
At virtually every turn, courts have ruled against taxpayers who have asserted their Fifth Amendment privilege against self-incrimination to avoid turning over foreign account records to the government, citing the “Required Records Doctrine.” In a recent enforcement action in the U.S. District Court for the District of Oregon, the taxpayers tacked differently. In Cheri LaRue et vir v. United States, No. 3:15-cv-00705, the taxpayers tried to quash an IRS Formal Document Request (“FDR”) for “foreign trusts, entities, and accounts connected to the federal income tax liabilities of Petitioners for 1997 through 2009 and 2011 through 2013.” They argued, among other things, that they were “not in possession, custody, or control of any documents located outside the United States that are responsive to the Formal Document Request,” that they had “not had an interest in any foreign bank account, foreign brokerage or security account, ownership of a foreign entity or structure, or a foreign trust in at least the last five years,” and that turning over such information would violate their Fifth Amendment privilege against self-incrimination.
On December 22, 2015, the district court issued its decision. It dealt with the taxpayers’ lack-of-possession argument fairly quickly on burden-of-proof grounds. One might expect the court also to have disposed of any Fifth Amendment argument quite quickly by citing the Required Records Doctrine. The taxpayers were clever, though, in that they carefully pointed out that for the last five years, they had had no interest in any of the offshore vehicles at issue. Why did five years matter, when the IRS sought documents going back to 1997? The answer is that the regulations promulgated under the Currency and Foreign Transactions Reporting Act of 1970, commonly (but nonsensically) called the Bank Secrecy Act (“BSA”), only require holders of foreign accounts to maintain records of their foreign accounts going back five years:
31 C.F.R. §1010.420 Records to be made and retained by persons having financial interests in foreign financial accounts.
Records of accounts required by §1010.350 to be reported to the Commissioner of Internal Revenue shall be retained by each person having a financial interest in or signature or other authority over any such account. Such records shall contain the name in which each such account is maintained, the number or other designation of such account, the name and address of the foreign bank or other person with whom such account is maintained, the type of such account, and the maximum value of each such account during the reporting period. Such records shall be retained for a period of 5 years and shall be kept at all times available for inspection as authorized by law. In the computation of the period of 5 years, there shall be disregarded any period beginning with a date on which the taxpayer is indicted or information instituted on account of the filing of a false or fraudulent Federal income tax return or failing to file a Federal income tax return, and ending with the date on which final disposition is made of the criminal proceeding.
Since the regulations only require one to maintain records of the last five years, the Required Records Doctrine is unavailable to the IRS for records that are older than five years. So the IRS would appear to be out of luck. The DOJ Tax Division attorneys who litigated the case on behalf of the IRS came up with a trump card, though. They cited the “Foregone Conclusion Exception” to the Fifth Amendment privilege against self-incrimination, and this carried the day. The court cited a line of cases in holding that “Where the existence and location of the [account records] are a foregone conclusion and the taxpayer adds little or nothing to the sum total of the Government’s information by conceding that he in fact has the [account records], enforcement of the [Formal Document Request] does not touch upon constitutional rights.” Here, the IRS was able to show that it already knew a great deal about the taxpayers’ records and that the taxpayers’ act of producing the records (as opposed to the records themselves) would add little to the government’s case. Continue Reading