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Fifth Circuit Voids Tax Scam Case Against One of Its Authors

If you've tired of hearing campaign promises about tax cuts, repeal of tax cuts, extension of tax cuts, tax cuts for the middle class, tax cuts for income over $250,000 a year, and the like -- relax.  Let Blawgletter tell you about an entirely other subject:  tax avoidance.

And not just any kind of tax avoidance.  This type involved buying an interest in a limited liability company and then claiming "losses" on option contracts that the LLC bought for the sole purpose of losing money.  The buyer would then deduct the losses on her income tax return.  Which sounds dumb, but not unlawful, so far.

But it gets worse.  The LLC also purchased option contracts that made profits equal to the losses.  Which does make the whole thing sound like a scam.

The accounting and consulting behemoth, KPMG, had pitched the scheme as an okay tax shelter, promising to provide from "several major national law firms" opinions that vouched for the legality of the plan.  Some people paid KPMG for helping them buy interests in the LLCs.  The buyers included AFFCO Investments 2001 LLC and others, which received an opinion letter from law firm A, Sidley Austin.

The story did not end well for AFFCO, et al.  After they bought their LLC interests but before they filed their tax returns, the Internal Revenue Service gave notice that it would challenge certain schemes as invalid.  Then law firm B -- Proskauer -- sent them an opinion letter saying that the LLC plan didn't look enough like the schemes the IRS mentioned to worry overmuch.  And so AFFCO, et al., claimed their LLC "losses" as deductions; the IRS contested the deductions; and AFFCO, et al., had to pay the IRS millions to settle the dispute.

AFFCO, et al., sued KPMG, Sidley Austin, and Proskauer, among others, under the Racketeer Influenced and Corrupt Organizations Act, section 10(b) of the Securities Exchange Act, and state (Texas) law.  They settled with all but Proskauer.  The district court dismissed the claims against Proskauer.  AFFCO, et al., appealed.

Today the Fifth Circuit affirmed.  It agreed with the district court that the Private Securities Litigation Reform Act of 1995 barred RICO claims that asserted "any conduct that would have been actionable as fraud in the purchase or sale of securities."  18 U.S.C. 1964(c).  Because the LLC interests qualified as "securities", AFFCO, et al.'s RICO claims had to go.  AFFCO Investments 2001 LLC v. Proskauer Rose L.L.P., No. 09-20734, slip op. at 5-8 (5th Cir. Oct. 27, 2010).

The panel also concluded that the securities fraud claims themselves couldn't survive either.  Proskauer, the court noted, might count as a "major national law firm" and did aid KPMG in putting together the tax avoidance plan.  But AFFCO, et al., didn't allege that Proskauer made any misrepresentations to them.  The materials that persuaded AFFCO, et al., to invest did not "attribute" any statements to Proskauer by name, the panel pointed out, and the lack of attribution meant Proskauer at most qualified as an aider and abetter.  And, as we all know, the Supreme Court in Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008), held that aiding and abetting doesn't run afoul of the Securities Exchange Act, at least not in private litigation.  AFFCO, slip op. at 12-15.

The panel dispatched an interesting point in a two-sentence footnote.  AFFCO, et al., argued that, if the panel decided to dismiss the securities fraud claim, its RICO claim didn't fall within the PSLRA's exception from RICO of "conduct . . . actionable as fraud in the purchase or sale of securities."  How could conduct not actionable as securities fraud under the Securities Exchange Act count as actionable securities fraud under the RICO carve-out?  The panel's footnote seemed a little short on the shrift.

Claim by Association: Lanham Act Bars Vendor You Don't Like from Saying You Do

You own stores that sell clothes.  A vendor persuades you to buy name-brand jeans from it.  You learn that the vendor fooled you.  The denims in fact came from a counterfeiter.  And so you cancel the contract.

Then you find out that the vendor has gone around telling people that it counts you as a "satisfied customer".  You don't like that.  But what can you do?

The Second Circuit held yesterday that you can sue the vendor's pants off.  Sections 32 and 43(a) of the Lanham Act create claims, respectively, for the vendor's using your trademark to mislead people about your happiness with the trousers and for its giving folks the false impression that you endorse its wares.  Section 43(a) also supported the store owner's claim for unfair competition due to the vendor's sales, in competition with the store owner, of counterfeit britches.  Famous Horse, Inc. v. 5th Avenue Photo, Inc., 08-4523-cv (2d Cir. Oct. 21, 2010).

The court sent the case back to the district court, which had dismissed the case, for another try.  The district court's mistake turned largely on its belief that the Lanham Act required the defendant to have caused "confusion" about the "origin" of goods, as where a seller puts a "Gucci" label on a fake Gucci handbag.  The Second Circuit clarified that the confusion element can relate to lots of things, including confusion about whether you endorsed a seller.

What Judges Want

An ex-judge friend of Blawgletter's said he expected lawyers to argue their clients' cases to him as hard as they could.  He had little patience with advocates who conceded points in hopes of pleasing, or placating, him.  And he told of instances where lawyers all but surrendered in the face of mild to moderate judicial reproach.

That gave us pause.  Sure, lawyers want to avoid making a judge mad at them or their clients.  Anger and irritation may translate into rulings that hurt our client's case.  But where do you draw the line between zealous advocacy and placation?  Do you need to?

Judges who trust you don't need much placating.  If any.  They may not like your arguments.  They may not like your client.  They may not have the warmest of feelings for you.  But they trust lawyers who don't waste their time, who give them candid answers, and who solve problems instead of creating them. 

Simple, right?

One of our favorite judges, Learned Hand, praised a lawyer thus:

With the courage which only comes of justified self-confidence, he dared to rest his case upon its strongest point, and so avoided that appearance of weakness and uncertainty which comes of a clutter of arguments.  Few lawyers are willing to do this; it is the mark of the most distinguished talent.

We don't know if the lawyer won.  But we suspect Judge Hand trusted the lawyer he deemed "of the most distinguished talent" due to his "courage . . . to rest his case upon its strongest point".  And we doubt the lawyer conceded anything important in hopes of currying favor with His Honor.

Your thoughts?

Foreclosure Non-Disclosure

Blawgletter listened this morning to part of a radio show on the home foreclosure mess.  It featured the executive director of the American Securitization Forum, an economics writer, and an ethics teacher in a graduate real estate studies program.

A woman called in to tell about how she and her husband lost their home to a lender.  She said she'd tried very hard to avoid foreclosure after her husband lost his job (she still had one) but that the lender wouldn't work with them on a plan to repay their debt.  She said that the lender told a court she never responded to the lender's efforts to cure a default but that the judge vacated the foreclosure when she showed the court her records of the opposite.  When the lender tried again, it succeeded -- this time because she never got notice of the hearing.

A sad story for sure.  But something more bothered us.  The show's host asked the guests who had the duty to give notice of the hearing to the woman.  One of them said the court, and not the lender, had that duty.  Nobody disagreed with him.  And so the world at large likely thinks that the court, and not the lender, may have done something wrong.

While we don't know all the ins and outs of judicial foreclosure proceedings -- in part because we live in a state that uses a non-judicial sale process -- we haven't heard of any state that puts a notice onus on the court and not on the party (lender) who asked for the hearing.  So we seriously doubt that the guest got the answer right.

What do you think?

Second Circuit Smokes Smokes Pact Attack

Today the Second Circuit upheld a judgment against cigarette makers who claimed that two New York statutes violated section 1 of the Sherman Act and the commerce clause of the U.S. Constitution.  Freedom Holdings, Inc. v. Cuomo, No. 09-0547-cv (2d Cir. Oct. 18, 2010).

The Empire State passed the laws -- which the court called the Escrow Statute and the Contraband Statute -- to enforce a 1998 Master Settlement Agreement between New York and other states, on the one hand, and more than 50 producers of smokes, on the other.  The MSA resolved the states' claims to recover billions and billions in health care costs resulting from the ill effects of smoking by their residents.

A renegage group -- the plaintiffs -- refused to join the MSA.  They alleged that the New York statutes created a cigarette cartel and enabled its members to make up for the billions they paid under the MSA by increasing prices.  They also asserted that the statutes penalized them by forcing them to pay to the states more than they would have if they had accepted the MSA's terms and hurt interstate commerce by controlling prices outside New York.

They lost after a three-day bench trial.

The Second Circuit panel affirmed.  It held that the renegades couldn't complain about higher prices, from which they benefited, because they suffered no "antitrust injury". 

The panel also found no clear error in the district court's findings that the statutes didn't coerce the plaintiffs into joining the MSA by forcing them to pay more per carton than the MSA signatories did (the district court found they actually paid less) and didn't delegate cartelish price-setting authority to the signatories.

The panel further concluded that the state action immunity doctrine protected the statutory scheme and that the New York laws didn't inhibit interstate commerce by dictating prices outside the state.

Quote of the Day: Barrington D. Parker

Although Abbey and Kirby were no doubt on the stingy side when it came to compensating their brethren, we have not been convinced that the District Court abused its discretion in approving class counsel's allocation.

Victor v. Argent Classic Convertible Arbitrage Fund L.P. (In re Adelphia Communications Corp. Securities & Derivative Litig.), No. 08-4904-cv (2d Cir. Oct. 14, 2010) (per Parker, J.) (affirming district court's award of $155,610 to non-lead counsel law firm instead of $17,476,500 it requested).

Blawgletter notes that the complaining firm based its fee request on its inclusion of claims under sections 11 and 12 of the Securities Act of 1933 in the complaint it filed before the district court appointed two other firms as co-lead counsel.  That the idea of invoking the Securities Act in the context of a securities case shows lawyerly brilliance strikes us as a tad, well, dumb.  And we don't have words for the audacity of asking a court to award $17.5 million on the basis of a $156,000 lodestar.

Inventor Must Conceive in U.S.A., Federal Circuit Rules

Russian scientists come up with a way to make an ozone-friendly agent that helps prepare materials useful in making units that store hot or cold.  They tell the American company that hired them about the results of their study.  And the U.S. firm starts using the process that their Russian colleagues discovered.

Does the U.S. outfit qualify as an "inventor"?

No, the Federal Circuit held today. 

The context involved Company A (Solvay) accusing Company B (Honeywell) of patent infringement.  Honeywell defended on the ground, among others, that it, by virtue of its Russian connection, qualified as "another inventor" who "made" the invention "in this country" before Solvay did.  See 35 U.S.C. 102(g)(2) (providing that "[a] person shall be entitled to a patent unless . . . before such person's invention thereof, the invention was made in this country by another inventor who had not abandoned, suppressed, or concealed it").

Despite its role in receiving and adapting the Russian scientists' conception, the court noted, "Honeywell did not have, or formulate, a definite and permanent 'idea' of its own capable of being reduced to practice.  Rather, it reproduced the invention previously conceived and reduced to practice by RSCAC in Russia.  Such reproduction cannot be conception because, if it were, the result would be that one who simply followed another inventor's instructions to reproduce that person's prior conceived invention would, by so doing, also become an 'inventor.'"  Solvay S.A. v. Honeywell Int'l, Inc., No. 09-1161, slip op. at 17 (Fed. Cir. Oct. 13, 2010).

Honeywell did not conceive of the invention in the U.S. but rather depended on Russian colleagues.  It therefore didn't count under section102(g)(2) as "another inventor" that could defeat Solvay's infringement claim by virtue of co-inventor status.

First Circuit Okays Denial of Preliminary Injunction in Auction Rate Securities Case

You may remember that in February 2008 the "auctions" that gave "auction-rate securities" their liquidity seized up.  Lots of people who'd bought ARSs thought they could sell them about as easily as they could unload shares in money market funds.  The slightly higher rate of return made the ARSs more attractive.  So they believed.

The auctions evaporated.  And so the buyers learned, to their chagrin, that they'd in fact taken on much bigger risks than they'd expected.

The folks at Braintree Laboratories, Braintree Holdings, and Braintree Real Estate Management Company blamed their broker-dealer, Citigroup Global Markets, for their misfortune in buying $41 million in now-illiquid ARSs between June and August 2008.  They sued Citigroup for securities law violations and demanded their money back.  They also asked for a preliminary injunction.

Not just any preliminary injunction.  One that would require Citigroup to refund the $41 instanter.

The district court denied Braintree's motion and -- adding insult to injury -- ordered the parties to arbitrate.

The First Circuit today affirmed.  It held that Braintree hadn't shown a key requirement for injunctive relief -- irreparable injury:

On appeal, Braintree urges that its ongoing inability to liquidate its investments is generating incalculable losses from missed opportunities, including new product acquisitions, in-licensing activities, and research and development programs. . . . The district court did not abuse its discretion in rejecting this argument.  An investor could always claim that she could put money to better use than simply letting it accrue interest at the prevailing rate.  An asserted injury so ubiquitous cannot serve as the basis for the issuance of a preliminary injunction.

Braintree Laboratories, Inc. v. Citigroup Global Markets Inc., No. 09-2540, slip op. at 9 & 10 (1st Cir. Oct. 12, 2010).

The panel also held that it had no jurisdiction to consider a pro-arbitration order that stayed the case instead of dismissing it.

If you wonder how Braintree could complain about illiquidity in a market the froze up a few months before it bought the ARSs in question, we wondered the same thing.

MDL Panel Starts Moving Cases from Sept. Session

The seven federal judges on the Judicial Panel on Multidistrict Litigation have issued the first two transfer orders from their September 30 session in Nashville. 

The Panel sent cases relating to the recall of McNeil Consumer Healthcare and Johnson & Johnson medicines (think Tylenol, Motrin, Zyrtec, and Benadryl) for children and infants to the Eastern District of Pennsylvania.  In re McNeil Consumer Healthcare, et al., Marketing and Sales Practices Litig., MDL No. 2190 (J.P.M.L. Oct. 8, 2010). 

It centralized lawsuits concerning performance of Apple's iPhone4 -- its propensity to drop calls -- to the Northern District of California.  In re Apple iPhone4 Products Liability Litig., MDL No. 2188 (J.P.M.L. Oct. 8, 2010).

The Panel heard argument on 10 new motions to centralize cases from multiple districts.  Transfer orders put similar lawsuits before a single judge for pretrial purposes.  The transferee judge must return cases to the districts whence they came after pretrial proceedings end -- assuming of course they survive the pretrial phase.

The JPML next sits in Durham, North Carolina (Nov. 18, 2010) and then in New Orleans (Jan. 27, 2011) and San Diego (Mar. 31, 2011).  It holds six, bi-monthly sessions each year.

Visa and MasterCard Cut Antitrust Deal with Enforcers; AmEx Balks; Will Card Use Fees Fall?

The attorneys-general of eight states plus the Antitrust Division of the U.S. Department of Justice have settled antitrust claims against Visa and MasterCard over their restrictions on merchants' freedom to steer customers away from cards that carry high acceptance charges. 

They also sued American Express after it declined to settle.

The pact with Visa and MasterCard will force them to let merchants:

• Offer consumers an immediate discount or rebate or a free or discounted product or service for using a particular credit card network, low-cost card within that network or other form of payment;

• Express a preference for the use of a particular credit card network, low-cost card within that network or other form of payment;
• Promote a particular credit card network, low-cost card within that network or other form of payment through posted information or other communications to consumers; and
• Communicate to consumers the cost incurred by the merchant when a consumer uses a particular credit card network, type of card within that network, or other form of payment.

Antitrust Division press release here; remarks by Division head Christine Varney here; complaint against American Express in the E.D.N.Y. here.

AmEx said the lawsuit would hurt competition:

The government’s new legal theory ignores a key point that the Justice Department previously made and that the courts have already decided: American Express does not have the ability to force merchants to accept its products or pricing.

“In today’s action, the Department has sued a party proven not to have market power,” said Kenneth I. Chenault, chairman and chief executive officer. “It represents an extraordinary retreat by the antitrust division. Instead of promoting competition, it now seeks to promote regulation that would ultimately limit competition.”

“We have no intention of settling the case,” said Mr. Chenault. “We will defend the rights of our cardmembers at the point of sale and our own ability to negotiate freely with merchants. We are confident that the courts will recognize the perverse anti-competitive nature of the government’s case and that we will continue providing a competitive, superior service to cardmembers and merchants.”

“Whatever the intent, the government’s new approach would hand an unfair advantage back to Visa and MasterCard,” Mr. Chenault said. “The Justice Department would, in effect, be undoing its own six year fight (1998-2004) to allow smaller payment networks like American Express to provide a competitive choice to consumers and merchants.”

The press release suggests that the fight will come down to whether AmEx has "market power" by virtue of its 24 percent share in General Purpose Cards and 37 percent in the Travel & Entertainment segment.  Paragraphs 55-68 of the complaint allege that AmEx does wield market power, citing "direct evidence" of it in the form of increasing card acceptance charges despite falling costs and discriminatory (higher) pricing to travel and entertainment vendors.

Will the deal with Visa and MasterCard produce lower charges for cardholders, who pay card acceptance charges when merchants pass them along in purchase prices?  Probably, at least with price-sensitive consumers, who'll whip out a cheaper card at the cash register and demand a discount.  But the outcome depends largely on whether merchants actually promote use of cards that carry lower acceptance charges and on whether Visa and MasterCard continue to impose widely varying acceptance charges from card to card.

The market power of Visa and MasterCard remains intact.  Which means they retain the ability and incentive to reap monopoly profits.  They may just do it some other way.