Opinion
Docket No. 4783.
1945-06-18
SAMUEL M. FELTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Fred L. Rosenbloom, Esq., for the petitioner. Karl W. Windhorst, Esq., for the respondent.
Petitioner, as principal, deposited with one Boltz, as attorney in fact, $20,000 in 1938 under a written agreement. Boltz was to invest and reinvest the fund for profit. He made similar agreements with many others. In October 1940 Boltz disappeared. Petitioner then learned for the first time of irregularities. Boltz did not make any investments, but the manipulated all funds deposited with him so that he did repay principal and some ‘profits‘ to persons who requested payments. In 1940 he paid cash to depositors in the total amount of $192,627.41. Held: (1) That petitioner sustained a loss in 1940; (2) the amount which is deductible in 1940 is a net sum after small recoveries in 1942 and 1943 from a receiver. Schwabacker Hardware Co., 45 B.T.A. 669, followed. Fred L. Rosenbloom, Esq., for the petitioner. Karl W. Windhorst, Esq., for the respondent.
The respondent determined a deficiency in income tax for the year 1940 in the sum of $3,848.76. The only issue is whether petitioner is entitled to a loss deduction for the taxable year by reason of the embezzlement of certain funds belonging to him.
Petitioner filed his return for the taxable year with the collector for the first district of Pennsylvania.
Most of the facts have been stipulated.
FINDINGS OF FACT.
The petitioner resides in Merion, Pennsylvania. On November 21, 1938, he entered into an agreement with Robert J. Boltz under which petitioner deposited $20,000 with Boltz, who agreed to invest the same and for his services to receive a certain percentage of the profits. Boltz had an excellent reputation in Philadelphia as a shrewd and successful investor and stock market operator. He had commenced operations in 1933, acting as attorney in fact for investors. He continued to operate until October 20, 1940, when he absconded, and during this period he acted as attorney in fact for approximately 250 principals. He occupied a large suite of offices in Philadelphia, employed between four and six persons, and spent approximately $25, 00 annually in maintaining his business.
Petitioner designated Boltz as his attorney in fact. The agreements between Boltz and his principals, including petitioner, provided that principal's fund could be intermingled in one or more attorney bank accounts with no other funds held by Boltz under similar agreements, but with no other funds. The agreements further provided that Boltz could purchase securities for his principals and take delivery in his own name as attorney. They further provided that Boltz could take delivery of one or more certificates or bonds representing the aggregate of purchases made for several principals under identical agreements, without requiring the delivery of separate certificates or bonds representing the purchase made for each account. The part of each purchase so made for a particular principal under the agreement was to be immediately allocated on the books and records of Boltz to the account of such principal as the sole and several owner thereof. Boltz, however, in the usual case, did not comply with this provision of the agreement. In some instances he would purport to allocate securities which he did not buy and in others he would allocate a much larger amount than he actually purchased. The moneys received by Boltz from the principals were placed in his bank accounts and were intermingled. The $20,000 received from petitioner was treated in the same way, and, thereafter, could not be identified.
The agreements between Boltz and his principals further provided that a statement would be rendered to each principal not later than the fifteenth day of January, April, July, and October, showing all transactions entered into for the principal's account during the preceding quarter, the income actually received, and the securities on hand at the close of the quarter.
The petitioner regularly received his quarterly statements. The statement received by him for the quarter ended December 31, 1938, showed that Boltz had invested $18,679.50 of petitioner's $20,000 in securities shown on a schedule attached thereto, all of which were on hand, that commissions of $68.46 had been paid on the purchase of the said securities, and that $1,252.04 in cash also remained on hand.
The statement received by the petitioner from Boltz for the quarter ended June 30, 1939, showed no securities on hand, and cash on hand in the amount of $19,486.15. It further showed a net profit for the period of $185.62, which, credited against a loss of $699.47 carried over from the previous quarter, left remaining a net loss of $513.85 to date from the sale of securities.
The statement received by the petitioner from Boltz for the quarter ended September 30, 1939, showed no securities on hand and cash on hand of $20,285.03. It further showed that during that quarter trading operations and dividends had produced a net profit of $798.88, thus wiping out the accumulated loss of $513.85 shown on the statement for the previous quarter and leaving a balance of $285.03 in the income account.
The statement received by the petitioner from Boltz for the quarter ended March 31, 1940, showed that no securities had been purchased or sold during that quarter, that $144.75 had been received in dividends, and that there had been paid to petitioner in cash on January 19, 1940, the sum of $414.53, which was the net income shown by the account to December 31, 1939.
The agreements between Boltz and his principals also provided that each principal had the right to withdraw on ten days' notice the whole or any portion of his fund, including any increment thereto. The $414.53 of purported earnings paid to the petitioner on January 19, 1940, was not requested by the petitioner. It was paid to him by Boltz without request. At no time did petitioner make any request for the withdrawal of cash or securities and, except for the $414.53, he received none.
During the period beginning January 1, 1940, and ending October 21, 1940, 117 principals withdrew in cash from their respective accounts a total of $192,627.41. Forty-three of the principals withdrew in cash, in sums of $1,000 or more, a total of $174,091.30, and 11 of them withdrew in cash, in sums of $5,000 or more, a total of $102,659.58. The largest sum withdrawn from any one account by any single principal during this period was $28,000. This amount was withdrawn in two sums of $14,000 each, on April 27, 194 , and August 13, 1940. Some principals had an arrangement with Boltz whereby they withdrew a stipulated amount each month. One such principal withdrew $500 from her account on the first day of each month, including October 1940. Other principals withdrew large and small sums at their discretion. From the time the accounts were first established until Boltz absconded, money was available to any principal who requested it.
During the period beginning January 1, 1940, and ending October 21, 1940, 39 principals deposited in the accounts they maintained with Boltz cash in the sum of $118,402.50 and securities which were sold by Boltz soon after receipt for $81,207.23. Thus, there was deposited by principals in their accounts during the period January 1 to October 20, 1940, in cash or equivalent, a total of $199,609.73. Nineteen of these principals deposited a total of cash and securities amounting to $114,087.50 and 12 alone accounted for deposits of $78,479.51. The largest sum deposited in any one account by a single principal during this period was $35,000 in cash. One of the principals deposited $16,500 in cash between September 16 and October 24, 1940. Another principal deposited $6,568.93 on October 7, 1940. On October 5, 1940, Boltz himself deposited in cash in his bank account the sum of $17,526.95, the proceeds of a mortgage on his farm.
Petitioner was unaware that Boltz had been guilty of any irregularities in the operation of his account until he was so notified on October 25, 1940. On that day he and other principals were notified by letter that Boltz had disappeared and had not been heard from since October 22, 1940, and that a preliminary survey of his accounts indicated that there had been irregularities in their operation.
Immediately after Boltz's disappearance, independent accountants made an examination of his books and records. This examination revealed that, except as to the receipt of cash and securities from principals, the books and records were completely false and fictitious and that it was impossible to trace the purpose for which any principal's money was expended. The records did disclose that virtually all of the funds with which Boltz had been entrusted by his principals had been lost by him in security transactions, dissipated in paying mythical profits, office and operating expenses, and personal and living expenses, or repaid to certain of the principals. The records further disclosed that the quarterly statements sent to petitioner were completely false and fictitious except as to the payment of $414.53 to petitioner on January 19, 1940. Boltz did not purchase or sell any of the securities listed on said statements.
During the years 1938 and 1939 and up to the time of Boltz's disappearance in 1940, the amounts so lost, dissipated, or repaid to principals exceeded the receipts from principals and from all other sources. It was a chronic condition during said years for Boltz to expend money as quickly as he received it. Boltz was completely insolvent at all times during said years.
A petition in involuntary bankruptcy was filed against Boltz on October 20, 1940, and an order issued appointing receiver. Boltz was adjudicated a bankrupt on November 13, 1940. On March 25, 1941, the receiver was appointed trust of the bankrupt estate. Claims in excess of $1,000,000 were filed by the principals and duly allowed by the referee. The claim of the petitioner was filed and allowed in the sum of $19,585.47. The trustee paid a preliminary dividend of 2 percent on July 30, 1942, and a final dividend of 1.04165 percent on December 17, 1943. The petitioner received on those dates the respective amounts of $391.71 and $204.01.
An examination of the bankrupt's books and records by accountants appointed by the court to make such examination showed, inter alia, that except in rare instances Boltz had failed to make any investments but had used the cash and securities received to pay mythical earnings and profits to principals, to repay principals who requested repayment of their investments, for office and operating expenses, and for personal and living expenses. The books and records, except with respect to the receipt and disbursement of cash and securities in connection with his principals, were false and fictitious. They did show conclusively, however, that the total amounts of cash, securities, and other investments held by Boltz exceeded $20,000 as at the close of each of the years 1938 and 1939. They also showed that from July 1, 1933, to the date of the bankruptcy he was not solvent at any time. On July 1, 1933, he was insolvent to the extent of approximately $260,000, virtually all of which was owing to principals. Boltz's insolvency grew progressively larger year by year, until at the time of his adjudication it was in excess of $1,000,000, virtually all of which was owing to principals.
Soon after his disappearance Boltz was indicted in the criminal courts of Philadelphia County. He was charged with ‘unlawful dealing in securities, etc., without first having registered with Pennsylvania Securities Commission, etc.; embezzlement by broker and agent; embezzlement by attorney-in-fact; fraudulent conversion.‘ He was finally apprehended and arrested in Rochester, New York, on February 13, 1941, and, when arraigned, he pleaded guilty to all the bills of indictment.
Prior to imposing sentence the court received testimony from numerous witnesses and Boltz testified in his own behalf. Boltz testified that for some years prior to his absconding he had made no profits and few investments, merely paying those principals who requested their money, and expenses and mythical profits out of funds collected from other principals. He admitted it was a matter of ‘robbing Peter to pay Paul.‘ He further testified that he had kept his own books of original entry; that he had personally made all trades, operated the bank accounts, and kept all books with respect to receipt and disbursement of all securities; and that he opened his own mail. On his plea of guilty, Boltz was sentenced to serve not less than 20 nor more than 40 years in the Pennsylvania Eastern State Penitentiary.
The $19,585.47 claimed as a deduction by petitioner as a result of Boltz's embezzlement is the $20,000 originally invested, less the $414.53 paid to him by Boltz on January 19, 1940, as heretofore set forth.
OPINION.
HARRON, Judge:
Petitioner has suffered a loss under the written contract he made with Boltz in 1938. He deducted the claimed loss in his return for 1940 as a bad debt. When the return was audited, respondent determined that the loss was ‘a loss due to embezzlement,‘ and it was disallowed, no explanation being given. Upon brief, both parties devote their respective arguments to the proposition that the loss was one due to embezzlement occurred prior to 1940, and respondent contending that the embezzlement occurred in 1938, the year when petitioner deposited $20,000 with Boltz. Whether or not the loss should be treated as a loss from embezzlement depends upon the facts, which are unusual.
The question is primarily a fact question. Most of the facts have been stipulated and there is no real dispute about the facts. The problem is one of interpreting the facts. A fair and reasonable interpretation of the facts is as follows:
In 1938 petitioner deposited $20,000 with Boltz for investment and reinvestment, under a written agreement. Boltz was dishonest, but that was not known. Many people had made and were making similar contracts and deposited with him. He simulated compliance with his obligations to his clients by making reports to them, including petitioner, in which he stated that he had made for their accounts purchases and sales and had received dividends and profits. In fact he did not. He also simulated good faith by complying with one provision in his contracts, namely, that a principal could withdraw all or part of his fund, plus the increment, on ten days' notice. In 1940, until he disappeared, Boltz paid cash to clients totaling $192,627.41. Later, upon investigation, it was found that Boltz had been insolvent at all times since July 1, 1933. The parties have stipulated that as a fact, but it is understood to mean that after that date the liabilities of Boltz exceeded his assets. However, the fact did not prevent the repayment of very substantial sums to clients, as set forth above, as long as all his creditors and principals did not make their demands simultaneously, and they did not. Boltz was exceedingly clever in manipulating his scheme so that he had on hand very large sums of cash after July 1, 1933, up until the time when he disappeared in October 1940. Therefore, the fact that he was insolvent over a long period is not a determinative fact. He intermingled all his receipts and deposits from clients. The contracts permitted him to intermingle the funds of one client with those of another client in an attorney bank account. Without doubt, Boltz kept his dishonest scheme going through this commingling of funds. Since he did not keep the funds of any client separate from the funds of others, it is impossible to find as a fact that petitioner's deposit in the general fund vanished at any particular time before October of 1940.
Boltz was like a juggler throwing many balls in the air. When he ceased throwing the balls out, the aerial pattern fell to earth. As long as he kept funds circulating back to his clients, he succeeded in getting money advanced to him, and, also, petitioner's chance of getting his money back was as good as that of any of the clients who actually were repaid. Petitioner's chance of getting his money back lasted up to and during 1940. Under these facts, the identifiable event which determined petitioners's loss was the disappearance of Boltz in 1940. The juggler stepped back into the wings of the stage and the curtain went down. The act was an illusion; the finis was real.
The facts in this proceeding differ from the facts in the usual situation of embezzlement. In many instances of embezzlement, it is the money of one person which is taken from time to time under cover. There is no problem relating to the identity of the ownership of the funds. Such is not the case here. Boltz, in one sense, offered to the public a plan resembling that of an investment trust, even though he did not issue trust certificates. Petitioner entered into the plan for profit. For example, the agreement with Boltz provided that Boltz could take delivery of one certificate or bond representing the aggregate of purchases made for several accounts under identical contracts without the delivery to the investor of separate certificates or bonds. The parts of each purchase so made for several clients were to be allocated on Boltz' books to the accounts of the respective clients. Petitioner, until October 25, 1940, believed he had a good contract and that his money was invested or held for investment under that contract. If petitioner had withdrawn his money from Boltz' plan during the period it was in operation, petitioner would not have known that the plan and the operation thereof were a sham. We think much weight should be given in this case to the fact that petitioner advanced his money under a contract which permitted commingling of funds, and that during 1940 the contract was still in effect as part of a network of similar contracts.
Under the unusual facts, petitioner should not be compelled to make such strict proof as respondent insists upon the matter of establishing the exact year in which his own advance of money to Boltz was lost. such proof is impossible. It can not be found definitely that petitioner's money was embezzled, stolen, or lost prior to October 1940. Until sometime in October 1940 the contract with Boltz was in effect, and the entire venture was in operation. During 1940 Boltz had a large amount of cash. Clients deposited with Boltz during 1940 cash and securities totaling $199,609.73. We think it would be an unreasonable conclusion to say that petitioner could not have received from Boltz the full amount of his $20,000 deposit out of the above fund during 1940, just as many other clients received back their deposits. As has been pointed out above, it was the abandonment of the manipulations by Boltz in 1940 which determined, conclusively, that petitioner sustained a loss. Under such view petitioner's claim is sustained. It has been found as a fact that the loss was sustained in 1940.
In so holding, we reject the view, upon which respondent's argument rests, that the loss was sustained prior to 1940 because of the general insolvency of Boltz.
Respondent points out that petitioner recovered $595.72 from the receiver in 1942 and 1943, and contends that petitioner is entitled to deduct only the net amount of his loss in 1940, if he is entitled to a deduction in that year. This contention is sustained. See Schwabacher Hardware Co., 45 B.T.A. 599. The deduction allowable is $18,989.75.
Decision will be entered under Rule 50.