Opinion
112732/2005.
Decided February 2, 2010.
Fensterstock Partners, LLP, Attorneys for Plaintiff, New York, NY, By: Blair C. Fensterstock. Eugene D. Kublanovsky, for Plaintiff.
Latham Watkins LLP, Attorneys for Presidio, New York, NY, By: Joseph M. Salama, Kasowitz, Benson, Torres Friedman, Attorneys for HVB, Broadway New York, NY, By: James E. D'Elicio, for Defendants.
Motion sequences 014 and 015 are consolidated for disposition.
In motion sequence 014, plaintiff John J. Shalam (Shalam) moves for summary judgment, on liability only, against the non-settling defendants. Shalam discontinued this action as against KPMG LLP, and its related individual defendants (collectively, KPMG), and as against Sidley Austin Brown Wood LLP and its related defendants (collectively, Sidley, after receiving a $2.1 million settlement in a class action in the United States District Court for the Southern District of New York ( Marvin Simon, et al v KPMG LLP, et al, Docket No. 05 cv 03189 [DMC]).
In motion sequence 015, defendant Bayerische Hypo-und Vereinsbank AG and its related entities (collectively, HVB) cross-move for summary judgment dismissing the second amended complaint (the complaint) as against them.
These summary judgment motions arise in an action for damages alleging fraud, in connection with Shalam's participation in a criminally fraudulent tax shelter described as a "bond linked issue premium structure" (BLIPS), that KPMG marketed to its accounting clients. Only KPMG is alleged to have made any representations directly to Shalam.
Shalam alleges that all defendants participated in a civil conspiracy to fraudulently induce him to invest $3.85 million in a BLIPS tax shelter for his 2000 tax year, and that by virtue of their participation in that civil conspiracy, all defendants are joint tortfeasors, each liable for the misrepresentations and failures to disclose material facts by all defendants.
According to the complaint, Shalam, a sophisticated businessman and graduate of the Wharton School of Business, relied upon his longstanding relationship of trust and confidence in KPMG in deciding to participate in BLIPS in order to shelter $55 million of the $57.7 million in capital gains that Shalam had realized from the sale of stock in Audiovox, Inc., of which he was a founder. In 2003, the IRS disallowed Shalam's deduction of losses from BLIPS.
Shalam cooperated with the IRS, and paid back taxes and interest, but no penalties. The IRS also permitted Shalam to deduct the fees he paid in connection with BLIPS.
This action continues against HVB and Presidio Advisory Services, LLC, and its related entities (collectively, Presidio). Presidio has not cross-moved, but opposes Shalam's motion on the ground that Shalam was a willing participant in the fraud against the tax authorities, was in pari delicto with defendants, and fully understood that BLIPS had no legitimate purpose other than to produce artificial capital losses to off-set gains and avoid taxes.
The complaint alleges that defendants each participated in a corrupt arrangement "to design, market and implement unregistered tax shelters, including BLIPS, for the purpose of receiving and splitting millions of dollars in fees" (complaint, ¶ 76). The evidence shows that principals of KPMG and Presidio devised a plan to use opinion letters issued by KPMG and Sidley as a marketing tool to induce KPMG's clients, including Shalam, to enter into the transaction.
The purpose of the opinion letters was to provide protection against the imposition of tax penalties in the event that the IRS or state tax authorities challenged the tax treatment of losses generated from BLIPS transactions. Both KPMG and HVB have admitted that they knew that the opinion letters, which opined that it was more likely than not that the tax treatment of the losses would withstand a challenge by the IRS, did not meet the requirements of being independent, because they were issued by promoters who were also interested in the transaction, and therefore would not be acceptable to the IRS.
Between 1999 and 2000, defendants allegedly solicited at least 186 individual taxpayers into entering BLIPS transactions, and generated $53 million in fees for KPMG, $13 million for Sidley, and $134 million for Presidio (complaint, ¶¶ 15, 25).
The complaint contains four causes of action. These motions involve the first and fourth causes of action. The second and third causes of action were stated only against the settling defendants. The first cause of action, which is against all defendants, alleges a civil conspiracy involving all defendants in furtherance of the fraudulent inducement of Shalam to pay the $3.85 million, which was calculated, as was the practice in BLIPS transactions, as 7% of the $55 million in losses to be generated. Shalam's payment was allegedly split among the co-conspirators, with Presidio taking at least $1,375,000, KPMG and HVB taking $687,500 each, and Sidley receiving at least $165,000. The balance was absorbed by costs. The fourth cause of action, which is stated against Presidio only, seeks recoupment of illegal and unethical fees paid to Presidio, under a theory of unjust enrichment.
The complaint alleges that KPMG made numerous misrepresentations to Shalam concerning BLIPS, and withheld significant facts. It demands return of the $3.85 million and additional compensatory damages, as well as punitive damages.
The sufficiency of the complaint has been upheld ( see Shalam v KPMG LLP, 13 Misc 3d 1205[A], 2006 Slip Op 51697[u][Sup Ct, NY County 2006] affd 43 AD3d 752 [1st Dept 2007]) (the prior decision). Familiarity with the prior decision and its detailed recitation of the facts is assumed.
As a result of criminal investigations of BLIPS tax shelter promoters, defendants KPMG and HVB, each entered into deferred prosecution agreements with the United States Attorney for the Southern District of New York, and paid civil fines of $456,000,000, and $29,635,125, respectively. Also, settling defendant Sidley, which issued fraudulent opinion letters in connection with Shalam's BLIPS transaction, settled with the IRS, paying a $39.4 million civil fine for its promotion of fraudulent tax shelters and failure to comply with tax shelter registration requirements.
While no document is submitted reflecting any criminal proceedings involving Presidio, its founders, former KPMG employees John Larson and Robert Pfaff were convicted in federal court of felony charges arising from BLIPS, as was David Makov (Makov), an employee of Presidio who designed the BLIPS structure for Presidio and Shalam.
Settling defendant Neil J. Tendler, a former partner of KPMG, Raymond J. Ruble, a former partner of Sidley, and defendant Domenick DeGeorgi (DeGeorgi), a senior vice-president and managing director of HVB's New York City office, who was co-head of HVB's financial engineering group, all stand convicted of federal crimes arising from BLIPS.
Both the corporate and individual defendants in the criminal proceedings involving BLIPS made detailed statements containing significant admissions of misrepresentation and fraudulent intent. Plaintiff seeks to use those statements in his summary judgment motion. Presidio and HVB challenge the admissibility of the statements as admissions on numerous grounds, primarily that the former employees were no longer employed at the time of the admissions.
Because Shalam has not established his justifiable reliance on the misrepresentations and failures to disclose material facts, as a matter of law, he has not met his burden of proving all the elements of fraud. Therefore, it is unnecessary to determine the admissibility of the admissions of the settling defendants, or whether Shalam has presented sufficient evidence to establish the other elements of a fraud case of action, or whether any defendant actively participated in a civil conspiracy in furtherance of the alleged fraud.
The elements of a fraud cause of action are that defendant made a material representation of existing fact, that was false and known by the defendant to be false when made, for the purpose of inducing plaintiff's reliance, that plaintiff justifiably relied upon those misrepresentations, and was damaged as a proximate result of such justifiable reliance ( Lama Holding Company v Smith Barney Inc., 88 NY2d 413, 421; Braddock v Braddock , 60 AD3d 84 , 86 [1st Dept 2009]).
A cause of action for fraud is subject to a heightened standard of proof, requiring clear and convincing evidence ( see Vermeer Owners v Guterman, 78 NY2d 1114, 1116). To prevail on his summary judgment motion, Shalam must submit clear and convincing evidence in admissible form establishing each element of the fraud cause of action as a matter of law (see JMD Holding Corp. v Congress Financial Corp. , 4 NY3d 373 , 384).
The Shalam BLIPS transaction, as described in the complaint, involved two distinct frauds — one against the tax authorities, in which Shalam was allegedly complicit, and the other against Shalam. Defendants argue that Shalam was a willing participant in the fraud against the government.
A review of the evidence of the details of the financial transactions that generated the claimed losses is necessary to determine the scope of the alleged misrepresentations and failures to disclose upon which such reliance is predicated. Evidence of the underlying transactions is also relevant to Shalam's claims in the fourth cause of action against Presidio. In the prior decision, I determined as a pleading matter that, upon proof of a civil conspiracy, as a result of the fiduciary role assumed by a Presidio entity in the BLIPS transactions "[a]ny distinction between omissions and misrepresentations in such instance is illusory" ( see Shalam v KPMG LLP, 13 Misc 3d 1205[A], 2006 Slip Op 51697[u], *9).
While there is no independent cause of action for a civil conspiracy in New York, "allegations of conspiracy are permitted to the extent of connecting the actions of separate defendants with an actionable injury, and to show that the actionable acts flowed from a common plan" [citation omitted] ( Tayebi v KPMG LLP, 18 Misc 3d 1139[A], 2008 NY Slip Op 50374[U], *7 [Sup Ct, NY County 2008]). The existence of a civil conspiracy is immaterial to the fourth cause of action, which is equitable in nature rather than sounding in tort.
The evidence shows that BLIPS was orchestrated by Presidio, which, through sleight of hand, created a $55 million fictitious basis in Arvon Strategic Investment Fund (Arvon). Presidio arranged for Shalam to form Congo Ventures LLC (Congo), of which he was the sole member, which in turn held a 90% interest in Arvon. Presidio then arranged for an HVB entity to make a $91.7 million loan to Congo at an annual interest rate of 19.257%. HVB maintained accounts for Congo and Arvon. Two Presidio entities owned interests in Arvon totaling 10%. One Presidio entity was the managing member of Arvon, hence, the fiduciary obligation and duty to disclose. HVB credited Congo's account with the $91.7 million principal of the loan and also $55 million (the loan premium), a total of $146.7 million (the combined proceeds). The loan premium is calculated by determining the difference between the present value of the payments on the loan at 19.257% interest, and what the payments would be at the prevailing market rate of approximately 8%. Makov testified in connection with his guilty plea, that he conspired with DiGeorgi, Larson and Pfaff to create the appearance of a legitimate business purpose in BLIPS by tacking on an investment component, and devising the concept of a loan premium to deceive the IRS (ex. 58 at 19). The real purpose of the loan was to enable the creation of the $55 million loan premium.
None of the funds in any of the Shalam BLIPS-related accounts ever left HVB, nor did HVB fund the loan by seeking funds in the market. Presidio devised collateral requirements and investment strategies that virtually eliminated all risk to HVB.
The combined proceeds were then converted into foreign currencies, and held in the HVB account, subject to repurchase obligations in 60 days. A Presidio entity, as managing member of Arvon, entered into agreements that had the effect of causing the HVB loan to become part of Congo's capital account, and constitute part of Congo's capital contribution as a Class B member of Arvon. On April 17, 2000, the $3.85 million was transferred from Congo's account at HVB to Arvon's account at HVB, and was used to finance the window dressing stock trades.
The losses were not generated by any foreign currency or other trading. None of the trading was leveraged, as KPMG had admittedly represented to Shalam that they would be. It was not a seven-year investment program as represented, but a 60-day transaction. The trading was entirely financed out of the $3.85 million, rather than the combined proceeds.
The losses were actually generated by transferring the duty to pay the loan and the loan premium among entities in a manner not unlike a shell game. The way it worked was that, on April 18, 2000, pursuant to an "Assignment and Assumption Agreement" (ex. 22 to plaintiff's mov. aff.), Arvon assumed Congo's duty to repay both the $91.7 million loan from HVB and the unamortized portion of the loan premium. Presidio, acting through Arvon, then entered into an interest rate swap contract with HVB that reduced the rate on the loan from a fixed 19.257% to a floating market rate of approximately 8%, effectively extinguishing the loan premium. Presidio then re-converted the foreign currency in Congo's accounts at HVB to dollars, and used those funds to pay off the balance remaining on the $91.7 loan to HVB, as well as a "prepayment penalty" representing the unamortized amount of the loan premium.
As a result of the unwinding of Congo's partnership interest in Arvon, and the pass-through to Shalam as the sole member of Congo, Shalam claimed a realized tax loss of $55 million, despite the fact that the loan and loan premium were no longer outstanding.
After Shalam's withdrawal from the BLIPS transaction, both Sidley and KPMG provided him with opinion letters regarding the tax viability of the BLIPS transaction. The evidence is not clear whether KPMG disclosed to Shalam the fact that the IRS had, prior to the issuance of the opinion letters, published IRS Bulletin No. 2000-44 (ex. 31 to plaintiff's mov. aff.), released on August 11, 2000, which specifically reiterated the IRS position that losses resulting from willful concealment of the amount of capital losses will be disallowed.
Shalam further alleges that Sidley did not independently research or analyze the BLIPS transaction, but worked in concert with KPMG, Presidio and HVB to market, design, and promote the tax shelters, and that as a result of their participation, and lack of independent analysis, the opinion letters provided by them were worthless.
In support of his motion for summary judgment, and in opposition to HVB's cross motion, Shalam relies upon HVB's Rule 19-a counterstatement of material facts as to which there are no genuine issues to be tried, and the significant quantity of evidence supporting the existence of a civil conspiracy involving the active participation of all defendants.
In paragraph 3 of its 19-a statement, HVB acknowledges that it participated with Presidio in a number of fraudulent tax shelters using the BLIPS structure, but qualifies the admission by stating that the activities included the knowing participation of Shalam and other clients, and acknowledges that it worked together and communicated extensively with KPMG and Sidley to structure and market BLIPS.
HVB states in paragraph 4 that it participated in: (1) transactions which purported to be loans but which were not in fact bona fide loans; (2) trading activity on instructions from promoters that was intended to create the appearance of investment activity but that had no economic substance; (3) creating documentation that contained false representations concerning the purpose and design of the transactions; and (4) engaging in activity with others directed toward the implementation of fraudulent tax shelters.
Also in paragraph 4, HVB acknowledges that the underlying loans were shams; that HVB would be considered promoters and that the opinion letters were based on false representations, and could not be relied upon by Shalam to protect him from an IRS audit. In paragraph 6, HVB states that it does not dispute that HVB, Presidio and their partners implemented BLIPS as a means to fraudulently eliminate or reduce the tax paid to the IRS.
In paragraph 12, however, HVB disputes that HVB and Presidio knew that because BLIPS had no economic substance, it was unlikely that BLIPS would withstand IRS scrutiny. HVB admits that it worked with KPMG to accelerate the introduction of BLIPS into the marketplace and accelerated steps in its loan approval process to meet KPMG and Presidio's timelines to complete BLIPS transactions. HVB admits that it knew in 1999 and 2000 that KPMG's legal opinion letter defending BLIPS contained inaccuracies and was inconsistent with how BLIPS transactions were actually executed at HVB, and that HVB continued to participate in BLIPS transactions after it became aware of the inaccuracies, and that HVB believed in 1999 and 2000 that BLIPS was fraudulent and had no economic substance; that BLIPS loans were not used to make foreign currency investments and sat in cash or cash equivalents at HVB; and that BLIPS was a "60-day tax shelter scheme," rather than a seven-year program as represented in its documentation.
Both HVB and Markov state that they knew that the BLIPS loans had no legitimate business purpose. Markov states that he knew in 1999 that BLIPS was a fraudulent, step transaction, and that the participants "agreed up front what the objective is and how its going to be done" (¶ 28, plaintiff's Rule 19-a statement).
Presidio employed Markov to give BLIPS the appearance of financial complexity. Markov stated that he knew that he was participating in a criminal fraud when he started creating the loan premium rationale for the sole purpose of deceiving the IRS.
In its Rule 19-a statement, Presidio states that it has not admitted to any wrongdoing, and contends that the evidence against it is inadmissible hearsay.
Shalam argues that he relied entirely upon KPMG in deciding to enter the tax shelter, and that KPMG had repeatedly assured him that he would not be liable for penalties to the IRS in the event that the BLIPS losses were disallowed, but he would have to pay back taxes and interest. This in fact is the way the matter turned out, and the record is not clear whether Shalam had to pay the full amount of interest to the IRS.
Shalam has not met his burden of submitting admissible evidence that meets the elevated standard of clear and convincing to establish each of the elements of a cause of action for fraud, because he has not submitted sufficient evidence to establish the element of justifiable reliance as a matter of law.
The issue of justifiable reliance is generally one of fact and is not amenable to determination as a matter of law ( see Talansky v Schulman , 2 AD3d 355 , 361 [1st Dept 2003]; see also Braddock v Braddock, 60 AD3d at 88). On this record, to put it simply, it cannot be determined as a matter of law that Shalam would have acted any differently had full disclosure and accurate representations been made.
Shalam's own testimony states that he entered the BLIPS tax shelter on the advice of KPMG at a meeting in December 1999, "that there was absolutely no financial exposure to me . . . [i]t was strictly an artificial transaction to create a capital loss that would offset the gain" (ex. 59 to mov. aff. at 104-106), and "[t]he investments that were being made in foreign exchange or stock were tied directly to make a tax shelter a reality and make it appear to be legitimate" ( id. at 247). Shalam knew "from the very first day . . . that this was strictly a tax shelter strategy" ( id.).
Shalam testified further that he was told by KPMG that "[t]he risk was minimal. The risk of having, of this being discovered or, I think they had told me in a worst-case scenario, the way they had structured it and with the letters and assurances and all that, that if it was picked up by the IRS . . . you could negotiate a settlement but it would probably be a lot less than the amount of the tax that you would have to pay, in the unlikely event" ( id. at 103-104). Shalam stated in his testimony that if the IRS accepted his 2000 return, he would not owe taxes on the amount represented by the loss, "[p]rovided the IRS didn't examine my tax return two, three or four years later and then make a claim against me" ( id. at 282).
Thus, Shalam's own testimony demonstrates a level of scienter and complicity from the inception.
What is not clear from the evidence of Shalam's discussions with KPMG is what he knew or was told after August 11, 2000, when the IRS bulletin specifically warning against BLIPS-style transactions was released.
Shalam testified that he learned from Larry Waldman (Waldman) of KPMG, after he had entered the BLIPS transaction, but before he filed his return containing the BLIPS losses, that the way the losses would be reported to the IRS was "in a separate section in the back of the return," in such a way that the transaction would be "disguised" so that "[i]t would not be apparent unless somebody went through it carefully, and that chances were that the IRS, unless I were examined for that year would never pick it up" ( id. at 86). The evidence is not clear whether Waldman told him this before or after the IRS issued its August 2000 bulletin specifically proscribing BLIPS losses.
An internal HVB e-mail from Richard Pankuch to HVB employees working on the Congo loan, alerting them to Notice 2000-44, states: "[w]hat we know as of this moment is that no new transactions will be closed and that early unwinds of existing transactions might take place, depending upon the preference of the individual taxpayer" ( ex. 32 to mov. aff.). Ted Wolf, one of the recipients, responded by e-mail dated August 14, 2000: "[s]orry to hear that the gravy train has ended" ( ex. 33 to mov. aff.).
The circumstances surrounding Shalam's decision to go forward with filing his 2000 tax return and include the deductions for BLIPS, after the August 11, 2000 IRS bulletin, are not at all clear from the evidence submitted. It is not clear whether KPMG told Shalam before or after the IRS bulletin, that he "could negotiate a settlement [with the IRS] but it would probably be a lot less than the amount of tax that you would have to pay, in the unlikely event" (ex. 59 at 104) that they discovered the BLIPS losses. This is significant, because, if Shalam knew, after August 11, 2000 — a full eight months before he filed his 2000 tax return — that the BLIPS losses would be disallowed if discovered, and chose to go ahead and claim the improper deductions rather than to unwind them, then Shalam has clearly not demonstrated, as a matter of law, his justifiable reliance on KPMG's misrepresentations or failures to disclose the underlying defects of BLIPS, but rather his reliance on KPMG's assurances that "if it was picked up by the IRS . . . you could negotiate a settlement but it would probably be a lot less than the amount of the tax that you would have to pay, in the unlikely event" ( id. at 103-104).
Shalam maintains that he simply relied on the advice of his trusted accountants, and signed whatever they told him to sign: "I didn't really pay any attention to details . . ." ( id. at 240).
Although Shalam testified that he understood that BLIPS was a tax shelter transaction and not an investment, and that he did not expect to make money from the transaction, he nonetheless executed a letter in which he represented that he believed that he had a reasonable expectation of earning a pre-tax profit from the BLIPS transaction in excess of his fees and costs ( id. at 195-196).
"As a matter of law, a sophisticated plaintiff cannot establish that it entered into an arm's length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available" [internal quotation marks and citation omitted] ( Ventur Group, LLC v Finnerty, 68AD3d 638, ___ [1st Dept 2009]).
Shalam's business sophistication is beyond dispute. While some degree of reliance upon the advice and judgment of expert tax professionals in the arcane field of taxation is certainly justifiable, when something is too good to be true — a virtually risk-free program that avoids taxes on a $55 million capital gain — a sophisticated businessman is charged with a duty to at least read a letter containing representations that he personally signs. The obvious falsity of those representations should then trigger a duty of further inquiry.
With respect to HVB's cross motion for summary judgment, the extensive admissions contained in its Rule 19-a statement preclude any finding as a matter of law that it did not participate in a civil conspiracy to defraud Shalam, or that no issue of fact is presented on any of the elements of Shalam's fraud cause of action. Thus, HVB has not demonstrated its entitlement to judgment as a matter of law dismissing the complaint as against it.
Shalam also moves for summary judgment on the fourth cause of action for return of fees paid to Presidio based on a theory of unjust enrichment. To prevail on a claim of unjust enrichment, a plaintiff must establish that the defendant benefitted at the plaintiff's expense and that equity and good conscience require restitution" ( Whitman Realty Group Inc. v Galano , 41 AD3d 590, 591 [2d Dept. 2007]).
As a matter of discretion, the motion is denied. The determination of what equity requires in this situation must await a more complete record, especially with respect to Shalam's alleged complicity in the tax fraud scheme.
Where, as here, neither Shalam nor HVB has met the initial burden of setting forth evidentiary facts sufficient to establish entitlement to judgment as a matter of law, the motions are denied and there is no necessity to consider the sufficiency of any evidence submitted by the parties opposing the motions ( see Roman v Hudson Telegraph Associates, 15 AD3d 227, 228 [1st Dept 2005]).
Accordingly, it is
ORDERED that Shalam's motion for summary judgment is denied; and it is further
ORDERED that HVB's cross motion for summary judgment is denied.