INVESTMENT RESEARCH ASSOCS. v. COMMISSIONER

T.C. Memo. 1999-407

UNITED STATES TAX COURT

INVESTMENT RESEARCH ASSOCIATES, LTD.,

AND SUBSIDIARIES, ET AL.,1 Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 43966-85, 712-86, Filed December 15, 1999.

45273-86, 1350-87,

31301-87, 33557-87,

3456-88, 30830-88,

32103-88, 27444-89,

16421-90, 25875-90,

26251-90, 20211-91,

20219-91, 21555-91,

21616-91, 23178-91,

24002-91, 1984-92,

16164-92, 19314-92,

23743-92, 26918-92,

7557-93, 22884-93,

25976-93, 25981-93.1

1

Cases of the following petitioners are consolidated

herewith: Burton W. and Naomi R. Kanter, docket No. 712-86;

Investment Research Associates, Ltd., and Subsidiaries, docket

No. 45273-86; Burton W. and Naomi R. Kanter, docket No. 1350-87;

Burton W. and Naomi R. Kanter, docket No. 31301-87; Burton W. and

Naomi R. Kanter, docket No. 33557-87; Burton W. and Naomi R.

Kanter, docket No. 3456-88; Investment Research Associates, Ltd.,

and Subsidiaries, docket No. 30830-88; Burton W. and Naomi R.

(continued...)

- 2 -

Randall G. Dick and Jeffrey I. Margolis, for petitioners in

docket Nos. 43966-85, 712-86, 45273-86, 1350-87, 31301-87, 33557-

87, 3456-88, 30830-88, 32103-88, 27444-89, 25875-90, 26251-90,

23178-91, 24002-91, 19314-92, 26918-92, 25976-93, and 25981-93.

Royal B. Martin and Steven S. Brown, for petitioners in

docket Nos. 16421-90, 20211-91, 20219-91, 21555-91, 21616-91,

1984-92, 16164-92, 23743-92, 7557-93, and 22884-93.

(...continued)

Kanter, docket No. 32103-88; Investment Research Associates,

Ltd., and Subsidiaries, docket No. 27444-89; Claude M. and Mary

B. Ballard, docket No. 16421-90; Investment Research Associates,

Ltd., and Subsidiaries, docket No. 25875-90; Burton W. and Naomi

R. Kanter, docket No. 26251-90; Claude M. and Mary B. Ballard,

docket No. 20211-91; Estate of Robert W. Lisle, Deceased, Thomas

W. Lisle and Amy L. Albrecht, Independent Co-executors, and

Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L.

Albrecht, Independent Co-executors, docket No. 20219-91; Estate

of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L.

Albrecht, Independent Co-executors, and Estate of Donna M. Lisle,

Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-

executors, docket No. 21555-91; Claude M. and Mary B. Ballard,

docket No. 21616-91; Investment Research Associates, Ltd., and

Subsidiaries, docket No. 23178-91; Burton W. and Naomi R. Kanter,

docket No. 24002-91; Claude M. and Mary B. Ballard, docket No.

1984-92; Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and

Amy L. Albrecht, Independent Co-executors, and Estate of Donna M.

Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent

Co-executors, docket No. 16164-92; Investment Research

Associates, Ltd., and Subsidiaries, docket No. 19314-92; Claude

M. and Mary B. Ballard, docket No. 23743-92; Burton W. and Naomi

R. Kanter, docket No. 26918-92; Estate of Robert W. Lisle,

Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-

executors, and Estate of Donna M. Lisle, Deceased, Thomas W.

Lisle and Amy L. Albrecht, Independent Co-executors, docket No.

7557-93; Claude M. and Mary B. Ballard, docket No. 22884-93;

Investment Research Associates, Ltd., and Subsidiaries, docket

No. 25976-93; and Burton W. and Naomi R. Kanter, docket No.

25981-93.

- 3 -

Mark E. O'Leary, John J. Comeau, James M. Cascino, Jonathan

P. Decatorsmith, James M. Klein, G. Roger Markley, and Pamela V.

Gibson, for respondent.

CONTENTS

Issue 1. Whether Payments Made By the Five in the

Prudential, Travelers, and Kanter Transactions During

the Years at Issue Are Properly Taxable to Kanter,

Ballard, and Lisle, and, if so, whether they are liable

for the fraud additions to tax and penalty with respect

to such income . . . . . . . . . . . . . . . . . . . . . 25

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 25

I. Background . . . . . . . . . . . . . . . . . . . . . . . 25

A. Petitioners' Residences and Principal Place of

Business . . . . . . . . . . . . . . . . . . . . . 25

B. Kanter . . . . . . . . . . . . . . . . . . . . . . 26

C. Ballard . . . . . . . . . . . . . . . . . . . . . . 28

D. Lisle . . . . . . . . . . . . . . . . . . . . . . . 29

II. The Kanter Enterprise . . . . . . . . . . . . . . . . . 30

A. Overview . . . . . . . . . . . . . . . . . . . . . 30

B. Investment Research Associates, Inc., and Its

Subsidiaries . . . . . . . . . . . . . . . . . . . 34

1. IRA Stock . . . . . . . . . . . . . . . . . . 34

2. IRA Stockholders . . . . . . . . . . . . . . . 35

a. Mildred Schott and Delores Keating . . . 36

b. The Bea Ritch Trusts . . . . . . . . . . 37

3. IRA Officers and Directors . . . . . . . . . . 40

4. IRA Subsidiaries . . . . . . . . . . . . . . . 41

C. Holding Co. . . . . . . . . . . . . . . . . . . . . 42

D. Administration Co. and Principal Services: The

Banking Corporations . . . . . . . . . . . . . . . 43

E. The Other Lending Corporations . . . . . . . . . . 46

1. HELO . . . . . . . . . . . . . . . . . . . . . 47

2. Int'l Films . . . . . . . . . . . . . . . . . 48

III. Transactions Involving the Five . . . . . . . . . . . . 48

A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero

Hotel Management Contract . . . . . . . . . . . . . 49

B. The Frey Arrangement: Condominium Conversions. . . 57

C. The Schaffel Arrangement: Real Estate Construction

and Financing . . . . . . . . . . . . . . . . . . . 71

1. Schaffel/Prudential Transactions . . . . . . . 73

2. Schaffel/Travelers Transactions . . . . . . . 75

3. FPC Subventure Associates Partnership . . . . 77

- 4 -

D. The Schnitzer Arrangement: Sale and Repurchase of

Property Management Systems Stock. . . . . . . . . 79

E. The Eulich Arrangement: Essex Hotel Management

Co. . . . . . . . . . . . . . . . . . . . . . . . 88

1. Eulich's Background . . . . . . . . . . . . . 88

2. Prudential's Gateway Hotel . . . . . . . . . . 90

F. Diagram: Summary of Payments From the Five 1977

Through 1989 . . . . . . . . . . . . . . . . . . . 102

G. Changes in IRA and Subsidiaries Corporate

Structure From 1974 Through 1988 . . . . . . . . . 103

H. Changes in Holding Co. & Subsidiaries Corporate

Structure 12/76 Through 8/87 . . . . . . . . . . . 125

I. Holding Co. & Subsidiaries Returns . . . . . . . . 131

J. HELO 1979 Through 1983 . . . . . . . . . . . . . . 140

IV. Flow of Money . . . . . . . . . . . . . . . . . . . . . 141

A. Payments to IRA and Subsidiaries: The Prudential

Transactions . . . . . . . . . . . . . . . . . . . 141

1. Overview . . . . . . . . . . . . . . . . . . . 141

2. Flow of the Funds 1977 Through 1983 . . . . . . 142

a. Flow of Money From KWJ Corp. to IRA:

1978 Through 1983 . . . . . . . . . . . . 143

b. Flow of Money From Zeus: 1979 Through

1983 . . . . . . . . . . . . . . . . . . 146

c. Payments From Schnitzer-PMS, Essex, and

Schaffel 1979 Through 1983 . . . . . . . 150

d. Funds Accumulated in IRA at Close of

1983 . . . . . . . . . . . . . . . . . . 150

3. 1984 Distributions to Carlco, TMT, and BWK,

Inc. . . . . . . . . . . . . . . . . . . . . . 152

a. 1984 Distributions of Cash From IRA to

Carlco, TMT, and BWK, Inc. . . . . . . 152

b. 1984 Distribution of Essex Partnership

Interest to Carlco, TMT, and BWK, Inc. . 153

c. Transfer of Sherwood Partnership

Interest From IRA to Carlco, TMT, and

BWK, Inc. . . . . . . . . . . . . . . . . 155

d. 1984 Distributions to Carlco, TMT, and

BWK, Inc. as Reflected on the Books of

the Corporations . . . . . . . . . . . . 157

4. Flow of Payments by the Five 1985 Through

1989 . . . . . . . . . . . . . . . . . . . . . 158

a. Zeus 1984 Through 1988 . . . . . . . . . 158

b. Distributions of Schnitzer-PMS and Essex

Payments Made During 1985 Through 1989 . 160

c. Loans From IRA to KWJ Partnership

Through 1989 . . . . . . . . . . . . . . 163

d. Balance Sheets of Carlco, TMT, and BWK,

Inc. 1983 Through 1989 . . . . . . . . . 163

- 5 -

B. Flow of the Funds Paid By the Five Through IRA and

Its Subsidiaries to Kanter, Ballard, and Lisle . . 166

1. Overview . . . . . . . . . . . . . . . . . . . 166

2. Payments from IRA, KWJ Corp., and KWJ Co.

Partnership . . . . . . . . . . . . . . . . . 166

a. 1982: IRA Payments to Ballard and Lisle . 166

b. Consulting Fees Paid to Ballard's and

Lisle's Children . . . . . . . . . . . . 167

c. KWJ Partnership 1989 Payments to Lisle

and Ballard . . . . . . . . . . . . . . . 168

3. Disposition of Funds out of Carlco, TMT, and

BWK to Kanter . . . . . . . . . . . . . . . . 169

a. Creation of Carlco, TMT, and BWK, Inc. . 169

b. Control and Management of Carlco, TMT,

and BWK, Inc. . . . . . . . . . . . . . . 171

c. Ballard: Disposition of Funds out of

TMT . . . . . . . . . . . . . . . . . . 173

d. Lisle: Disposition of Funds out of

Carlco . . . . . . . . . . . . . . . . . 178

e. Kanter: Disposition of Funds out of BWK,

Inc. . . . . . . . . . . . . . . . . . . 180

4. Loans . . . . . . . . . . . . . . . . . . . . 181

a. IRA Loans to Kanter . . . . . . . . . . . 181

b. Loans to Ballard, Lisle, Their Family

Members and Trusts . . . . . . . . . . . 181

5. Writeoff of Loans and Losses . . . . . . . . . 185

C. Payments to Holding Co. and Its Subsidiaries . . . 211

D. Distributions to Kanter . . . . . . . . . . . . . . 212

E. Examination of Petitioners' Returns . . . . . . . . 215

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

I. Position of the Parties . . . . . . . . . . . . . . . . 227

II. Omitted Income . . . . . . . . . . . . . . . . . . . . . 229

A. The Transactions . . . . . . . . . . . . . . . . . 230

1. The Hyatt Payments . . . . . . . . . . . . . . 230

2. The Frey Arrangement . . . . . . . . . . . . . 238

3. The Schaffel Arrangement . . . . . . . . . . . 240

4. The Schnitzer Arrangement . . . . . . . . . . 243

5. The Eulich/Essex Arrangement . . . . . . . . . 249

6. Conclusion . . . . . . . . . . . . . . . . . . 255

B. Overview of the Law . . . . . . . . . . . . . . . . 256

1. Sham Corporations . . . . . . . . . . . . . . 258

2. Assignment of Income . . . . . . . . . . . . . 271

3. Section 482 . . . . . . . . . . . . . . . . . 277

4. Conclusion . . . . . . . . . . . . . . . . . . 279

III. Fraud Additions to Tax and Penalties . . . . . . . . . . 286

A. Positions of the Parties . . . . . . . . . . . . . 286

- 6 -

B. Applicable Statutory Provisions . . . . . . . . . . 287

C. General Legal Principles Relating to Civil Fraud . 289

D. Underpayments of Tax . . . . . . . . . . . . . . . 290

E. Intent to Evade Tax . . . . . . . . . . . . . . . . 300

1. Lisle's Fraud . . . . . . . . . . . . . . . . 303

2. Ballard's Fraud . . . . . . . . . . . . . . . 307

3. Kanter's Fraud . . . . . . . . . . . . . . . . 311

F. Summary and Conclusions as to Fraud . . . . . . . . 318

Issue 2. Whether Certain Commitment Fees Paid to Century

Industries, Ltd., Are Includable in Kanter's Income for

1981, 1982, 1983, 1984, and 1986 . . . . . . . . . . . . 320

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 320

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 326

Issue 3. Whether Kanter Received Unreported Income From Hi-

Chicago Trust for 1981, 1982, and 1983 . . . . . . . . . 331

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 331

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 338

Issue 4. Whether Kanter is Taxable on the Income of the Bea

Ritch Trusts for 1986 and 1987 . . . . . . . . . . . . . 346

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 346

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 359

Issue 5. Whether Kanter Had Unreported Income for 1982,

1983, 1984, 1987, 1988, and 1989 From the CMS Investors

Partnership . . . . . . . . . . . . . . . . . . . . . . 370

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 370

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 370

Issue 6. Whether Kanter had Unreported Income in 1983 From

Equitable Leasing Co., Inc. . . . . . . . . . . . . . . 377

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 377

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

Issue 7. Whether Kanter Had Unreported Income in 1982 Based

on the Bank Deposit Analysis Method . . . . . . . . . . 380

- 7 -

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 380

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 381

Issue 8. Whether Kanter Received Barter Income From

Principal Services in 1988 and 1989 . . . . . . . . . . 385

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 385

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 386

Issue 9. Whether the Kanters Are Entitled to Certain

Deductions Claimed on Schedule A and Schedule C for

1986 Through 1989 . . . . . . . . . . . . . . . . . . . 387

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 387

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 390

Issue 10. Whether Kanter, in 1983, Realized Capital Gains

Under Section 357(b) and (c) From the Assumption by

Cashmere Investment Associates, Inc., of Partnership

Interests Having Negative Capital Accounts and Whether,

Under Section 453, the Installment Method was Available

for the Reporting of Such Gains . . . . . . . . . . . . 391

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 391

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 405

Issue 11. Whether Kanter Is Entitled to Research and

Development and Business Expense Deductions From

Immunological Research Corporation for 1979 . . . . . . 414

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 414

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 418

Issue 12. Whether Kanter had Unreported Partnership Income

for 1978 . . . . . . . . . . . . . . . . . . . . . . . . 429

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

Issue 13. Whether the Kanters Are Entitled to a Loss From

GLS Associates for 1981 . . . . . . . . . . . . . . . . 429

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

- 8 -

Issue 14. Whether the Kanters Are Entitled to a Loss From

Computer Leasing Transactions Involving Equitec for

1983 and 1984 . . . . . . . . . . . . . . . . . . . . . 430

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430

Issue 15. Whether the Kanters Are Entitled to Investment

Interest Expense Deductions for 1981 . . . . . . . . . . 430

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430

Issue 16. Whether the Kanters Are Entitled to an Investment

Tax Credit Carryover for 1978 . . . . . . . . . . . . . 431

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 431

Issue 17. Whether the Kanters Are Entitled to an Interest

Deduction for 1986 . . . . . . . . . . . . . . . . . . . 434

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

Issue 18. Whether the Kanters Received Unreported Interest

Income from a Bank in 1988 . . . . . . . . . . . . . . . 435

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 435

Issue 19. Whether Kanter Is Entitled to a Business Loss

Deduction in 1980 in Connection With the Sale of a

Painting . . . . . . . . . . . . . . . . . . . . . . . . 435

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 435

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 437

Issue 20. Whether the Kanters Are Entitled To Deduct a

Claimed Charitable Contribution of $15,000 to the

Jewish United Fund in 1982 . . . . . . . . . . . . . . . 441

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 441

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 443

Issue 21. Whether the Kanters Are Entitled to Claimed

Capital Gains and Losses for 1987 . . . . . . . . . . . 446

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 446

- 9 -

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

Issue 22. Whether Respondent Correctly Made Adjustments to

the Rental Income, Depreciation, Interest Expense, and

Investment Tax Credits Claimed by Investment Research

Associates, Ltd. (IRA) in Connection with Equipment

Leasing Transactions for 1979, 1980, and 1982 Through

1989 . . . . . . . . . . . . . . . . . . . . . . . . . . 465

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 465

I. Background and Adjustments Made in Deficiency Notices . 465

A. IRA and Cedilla Investment . . . . . . . . . . . . 465

1. Schott . . . . . . . . . . . . . . . . . . . . 467

2. Mallin . . . . . . . . . . . . . . . . . . . . 467

B. Richard Uhl, Funding Systems Corp., and Funding

Systems Asset Management Corp. . . . . . . . . . . 469

C. FSAM Partnership . . . . . . . . . . . . . . . . . 470

II. Equipment Leasing . . . . . . . . . . . . . . . . . . . 470

A. Equipment Leasing Generally . . . . . . . . . . . . 470

B. General Facts Relative to Lack of Economic

Substance, Profit Motive and Residual Value . . . . 470

C. General Facts Relating to Invalid Indebtedness and

Financing Circularity . . . . . . . . . . . . . . . 472

D. Miscellaneous Additional Facts Generally

Applicable to the Transactions . . . . . . . . . . 476

III. The Specific Leasing Transactions . . . . . . . . . . . 476

A. Cedilla Invest.-1976 Domestic (O.P.M.

Transaction) . . . . . . . . . . . . . . . . . . . 476

B. Cedilla Invest.-1977 Domestic Transaction Master

Lease Transaction) . . . . . . . . . . . . . . . . 478

C. Cedilla Invest.-1979 Foreign Transaction (British

Aerospace Transaction) . . . . . . . . . . . . . . 479

D. IRA-1980 Domestic Transaction ("Mini Computer

Transaction") . . . . . . . . . . . . . . . . . . . 487

E. IRA-1980 Foreign/Domestic Transaction ("Alfred

Teves Transaction") . . . . . . . . . . . . . . . 490

F. Cedilla Invest. "Lexet Transactions" . . . . . . . 492

G. Cedilla Invest. "Ben Energy Transactions" . . . . . 495

H. Cedilla Invest. "Dard Systems Transactions" . . . . 498

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 501

I. Leasing Transactions Generally . . . . . . . . . . . . . 501

II. Specific Leasing Transactions . . . . . . . . . . . . . 516

A. Cedilla Invest.-1976 Domestic (O.P.M.

Transaction) . . . . . . . . . . . . . . . . . . . 516

- 10 -

B. Cedilla Invest. - 1977 Domestic Transaction

(Master Lease Transaction) . . . . . . . . . . . . 518

C. Cedilla Invest.-1979 Foreign Transaction (British

Aerospace Transaction) . . . . . . . . . . . . . . 519

D. IRA-1980 Domestic Transaction (Mini Computer

Transaction) . . . . . . . . . . . . . . . . . . . 524

E. IRA-1980 Foreign/Domestic Transaction (Alfred

Teves Transaction) . . . . . . . . . . . . . . . . 525

F. Cedilla Invest.-"Lexet Transactions", "Ben Energy

Transactions", and "Dard Systems Transactions" . . 526

G. Equitable Leasing . . . . . . . . . . . . . . . . . 529

Issue 23. Whether IRA is Entitled to a Claimed Loss on Form

4797 of $1,073,835 for 1988 . . . . . . . . . . . . . . 536

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 536

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

Issue 24. Whether IRA Is Entitled to a Charitable

Contribution Carryover Deduction for 1983 . . . . . . . 545

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 545

Issue 25. Whether IRA Is Entitled to Certain Claimed

Capital Losses for 1985 . . . . . . . . . . . . . . . . 545

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 545

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 548

Issue 26. Whether IRA Is Entitled to Claimed Bad Debt

Deductions for 1987 . . . . . . . . . . . . . . . . . . 556

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 556

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 558

Issue 27. Whether IRA Is Entitled to Claimed Ordinary

Losses on Sales of Notes Receivable for 1987 . . . . . . 561

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 561

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 564

Issue 28. Whether IRA Is Entitled to Certain Capital Losses

for 1987 . . . . . . . . . . . . . . . . . . . . . . . . 571

- 11 -

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 571

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 572

Issue 29. Whether IRA Is Entitled To Deduct as Business

Expenses Amounts Paid to J.D. Weaver in 1979, 1981, and

1982 . . . . . . . . . . . . . . . . . . . . . . . . . . 574

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 574

Issue 30. Whether the Assessment and Collection of the

Deficiency and Additions to Tax as to IRA for 1980 Are

Barred by the Statute of Limitations . . . . . . . . . . 576

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 576

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 578

Issue 31. Whether IRA Is Liable for the Fraud Addition to

Tax for 1987 . . . . . . . . . . . . . . . . . . . . . . 580

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 580

Issue 32. Whether Assessment and Collection of Federal

Income Taxes of Kanter, Ballard, and Lisle Are Barred

by the Statute of Limitations for Some Years . . . . . . 581

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 581

Issue 33. The Liabilities of Kanter, Ballard, and Lisle for

Additions to Tax for Negligence . . . . . . . . . . . . 582

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 582

Issue 34. Whether the Kanters Are Liable for the Section

6659 Addition to Tax for 1981 . . . . . . . . . . . . . 586

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 586

Issue 35. Whether Kanter Is Liable for Section 6661

Additions to Tax for 1982 Through 1984, and 1986

Through 1988 . . . . . . . . . . . . . . . . . . . . . . 589

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 589

Issue 36. Whether Kanter Is Liable for Section 6621(c)

Increased Interest for 1978, 1979, 1980 Through 1984,

and 1986, and 1987, and 1988 . . . . . . . . . . . . . . 592

- 12 -

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 592

Issue 37. Whether IRA Is Liable for the Section 6651(a)(1)

Addition to Tax for 1980 . . . . . . . . . . . . . . . . 596

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 596

Issue 38. Whether IRA Is Liable for the Section 6653(a)

Additions to Tax for 1980, and 1982 Through 1988 . . . . 597

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 597

Issue 39. Whether IRA Is Liable for the Section 6659(a)

Additions to Tax for 1982 and 1983 . . . . . . . . . . . 601

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 601

Issue 40. Whether IRA Is Liable for the Section 6661

Additions to Tax for 1983 Through 1988 . . . . . . . . . 602

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 602

Issue 41. Whether IRA Is Liable for the Section 6662(a)

Accuracy-Related Penalty for 1989 . . . . . . . . . . . 606

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: These consolidated cases were assigned to

Special Trial Judge D. Irvin Couvillion pursuant to Rules 180,

181, and 183.2 The Court agrees with and adopts the opinion of

the Special Trial Judge, which is set forth below.

2

Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years at issue. All Rule

references are to the Tax Court Rules of Practice and Procedure.

- 13 -

OPINION OF THE SPECIAL TRIAL JUDGE

COUVILLION, Special Trial Judge: In these consolidated

cases, respondent determined deficiencies in petitioners' Federal

income taxes, additions to tax,3 penalties, and increased

interest, as follows:

Investment Research Associates, Ltd., and Subsidiaries

Docket No. 43966-85:

Addition to Tax

Year Deficiency Sec. 6659(a)

1979 $18,791 $5,637

Docket No. 45273-86:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6659(a) Sec. 6661

1982 $174,225 $8,711 $49,154 $1,038

3

With respect to the additions to tax under sec. 6653, as to

all of the cases before the Court, for the years 1979 and 1980,

the addition to tax is under sec. 6653(a). For the years 1981

through 1985, the addition to tax is under sec. 6653(a)(1). For

the years 1981 through 1985, respondent also determined the

addition to tax under sec. 6653(a)(2), which is 50 percent of the

interest due on the underpayment of tax attributable to

negligence or intentional disregard of rules or regulations. For

the years 1986 and 1987, the addition to tax is under sec.

6653(a)(1)(A), and the determined 50-percent interest due on the

underpayment is under sec. 6653(a)(1)(B). For 1988, the addition

to tax is under sec. 6653(a)(1), and there is no corresponding

addition to tax for 50 percent of the interest due on the

underpayment. See Technical and Miscellaneous Revenue Act of

1988, Pub. L. 100-647, sec. 1015(b)(2)(A), 102 Stat. 3342, 3568,

applicable to returns the due date for which, without regard to

extensions, is after Dec. 31, 1988.

- 14 -

Docket No. 30830-88:1

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6659(a) Sec. 6661

1983 $595,838 $29,792 $16,767 $134,987

1984 410,317 20,516 -- 102,579

1

In docket No. 30830-88 the deficiencies in tax determined

in the notice of deficiency are $595,838 and $410,317,

respectively, for 1983 and 1984. Page 2 of respondent's opening

brief states the deficiencies to be $181,546 and $123,095,

respectively, for 1983 and 1984. The Court assumes that the

amounts stated in respondent's opening brief are in error.

Docket No. 27444-89:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6661

1985 $400,488 $20,024 $100,122

Docket No. 25875-90:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6661

1986 $2,110,643 $105,532.15 $527,660.75

Docket No. 23178-91:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6661

1987 $5,739,249 $286,962 $1,434,812

Docket No. 19314-92:

Additions to Tax

Year Deficiency Sec. 6651(a)(1) Sec. 6653

1980 $1,304,063 $195,609.45 $65,203.15

Docket No. 25976-93:

Additions to Tax Penalty

Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662(a)

1988 $768,025 $38,401 $192,006 --

1989 878,898 -- -- $175,780

- 15 -

Burton W. and Naomi R. Kanter

Additions to Tax Penalty

Docket No. Year Deficiency Sec. 6653 Sec. 6659 Sec. 6661 Sec. 6662

712-86 1981 $340,578.00 $17,029.00 $42,682 -- --

1350-87 1982 2,086,913.00 104,346.00 -- $208,691.00 --

31301-87 1978 476,999.00 -- -- -- --

33557-87 1980 454,396.00 22,720.00 -- -- --

3456-88 1979 183,809.37 9,190.47 -- -- --

32103-88 1984 3,825,078.00 191,254.00 -- 949,211.00 --

26251-90 1983 1,150,652.00 57,532.60 -- 287,663.00 --

1986 897,224.00 44,861.00 -- 223,666.00 --

24002-91 1987 1,434,529.00 71,726.45 -- 358,632.25 --

26918-92 1988 523,234.00 26,162.00 -- 130,809.00 --

25981-93 1989 835,847.00 -- -- -- $167,169

Claude M. and Mary B. Ballard

Docket No. 16421-90:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6661

1982 $55,338 $2,766.90 $8,774

Docket No. 20211-91:

Additions to Tax

Year Deficiency Sec. 6651(a)(1) Sec. 6653 Sec. 6661

1

1984 $981,072 $51,3311 $88,788.05 $245,268

1

On brief, respondent concedes this addition to tax.

Docket No. 21616-91:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6661

1987 $208,449 $10,422.45 $52,112.25

Docket No. 1984-92:

Additions to Tax

Year Deficiency Sec. 6653 Sec. 6659

1975 $23,453 $1,173 --

1976 34,024 1,701 --

1977 11,502 -- --

1978 3,923 -- --

1979 21,630 -- --

1980 92,481 -- --

1981 193,743 9,687 $17,138

Docket No. 23743-92:

Addition to Tax

Year Deficiency Sec. 6653

1988 $125,136 $6,257

- 16 -

Docket No. 22884-93:

Penalty

Year Deficiency Sec. 6662

1989 $179,924 $35,985

Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L.

Albrecht, Independent Co-executors, and Estate of Donna M. Lisle,

Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-

executors

Additions to Tax Penalty

Docket No. Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662(a)

20219-91 1984 $827,955 $41,397.75 $206,988.75 --

21555-91 1987 195,498 9,774.90 48,874.50 --

16164-92 1988 109,048 5,452.00 27,262.00 --

7557-93 1989 109,049 -- -- $21,810

In the following cases, respondent determined in the notices

of deficiency or asserted in amended answers that the

underpayments in tax were subject to increased interest under

section 6621(c), formerly section 6621(d):4

Investment Research Associates, Ltd., and Subsidiaries:

Docket No. Year

43966-85 1979

45273-86 1982

4

Sec. 6621(d)(1) was added by the Deficit Reduction Act of

1984, Pub. L. 98-369, sec. 144(a), 98 Stat. 682, and provides for

interest of 120 percent of the adjusted interest rate due on any

substantial underpayment of tax attributable to tax-motivated

transactions. The increased interest is effective for interest

accruing after Dec. 31, 1984. Sec. 6621(d) was redesignated as

sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986,

Pub. L. 99-514, 100 Stat. 2085, 2744, and repealed by sec.

7721(b) of the Omnibus Budget Reconciliation Act of 1989 (OBRA

89), Pub. L. 101-239, 103 Stat. 2106, 2399, effective for tax

returns due after Dec. 31, 1989, OBRA 89 sec. 7721(d), 103 Stat.

2400.

- 17 -

Burton W. and Naomi R. Kanter:

Docket No. Year

1350-87 1982

33557-87 1980

1

3456-88 1979

32103-88 1984

26251-90 1983, 1986

24002-91 1987

1

On brief, respondent concedes that the underpayment

attributable to the disallowed loss from Immunological Research

Corp. is not subject to increased interest under sec. 6621(c),

following Estate of Cook v. Commissioner, T.C. Memo. 1993-581.

Claude M. and Mary B. Ballard:

Docket No. Year

16421-90 1982

20211-91 1984

21616-91 1987

1984-92 1975, 1976, 1977, 1978

1979, 1980, 1981

23743-92 1988

Estate of Robert W. Lisle, Deceased, etc.:

Docket No. Year

20219-91 1984

21555-91 1987

16164-92 1988

In amended answers, respondent alleged increases in the

deficiencies in tax and additions to tax in the following cases:

- 18 -

Petitioner Docket No. Year(s)

Investment Research Associates, 45273-86 1982

Ltd.,and Subsidiaries 43966-85 1979

Burton W. and Naomi R. Kanter 712-86 1981

1350-87 1982

31301-87 1978

33557-87 1980

3456-88 1979

32103-88 1984

26251-90 1983, 1986

24002-91 1987

26918-92 1988

25981-93 1989

Claude M. and Mary B. Ballard 16421-90 1982

20211-91 1984

21616-91 1987

1984-92 1975, 1976, 1977

1978, 1979, 1980

1981

23743-92 1988

22884-93 1989

Estate of Robert W. Lisle, 20219-91 1984

Deceased, etc. 21555-91 1987

16164-92 1988

7557-93 1989

In the amended answers, respondent alleged that the

underpayments in tax with respect to all or, alternatively, with

respect to substantial portions of the increased deficiencies in

tax were subject to the addition to tax for fraud pursuant to

section 6653(b) or the penalty for fraud pursuant to section

6663(a) in the following cases:5

5

For the years 1976 through 1981, the addition to tax for

fraud is under sec. 6653(b). For the years 1982 through 1985,

the addition to tax for fraud is under sec. 6653(b)(1) and (2).

For 1986 and 1987, the addition to tax for fraud is under sec.

6653(b)(1)(A) and (B). For 1988, the addition for fraud is under

(continued...)

- 19 -

Petitioner Docket No. Year(s)

Investment Research Associates, Ltd. 23178-91 1987

and Subsidiaries

Burton W. and Naomi R. Kanter 712-86 1981

1350-87 1982

31301-87 1978

33557-87 1980

3456-88 1979

32103-88 1984

26251-90 1983, 1986

24002-91 1987

26918-92 1988

25981-93 1989

Claude M. and Mary B. Ballard 16421-90 1982

20211-91 1984

21616-91 1987

1984-92 1975, 1976, 1977

1978, 1979, 1980

1981

23743-92 1988

22884-93 1989

Estate of Robert W. Lisle, 20219-91 1984

Deceased, etc. 21555-91 1987

16164-92 1988

7557-93 1989

Introduction

In each of the cases in which fraud is alleged, respondent

alleged that, if the Court holds that the underpayments in tax

are not subject to fraud additions, alternatively, the

underpayments in tax are subject to additions to tax under

sections 6653(a)(1) and (2) and 6659(a), and the increased

interest under section 6621(c), or if the underpayment is for

1989, that it is subject to a penalty under section 6662.

(...continued)

sec. 6653(b)(1). For 1989, the penalty for fraud is under sec.

6663(a).

- 20 -

In all of the amended answers in which respondent asserted

increased deficiencies in tax, as well as increased additions to

tax and penalties, respondent did not calculate or assert the

amounts of the increased tax deficiencies or the amounts of the

additions to tax or penalties. Respondent asserted only the

amounts of increased income or the amounts of disallowed expenses

that would result in increased deficiencies in tax and additions

to tax. As a result of these amended answers, and as a result of

numerous concessions and stipulations of settlement that were

made by the parties before, during, and after the trial, as well

as concessions of certain issues by respondent on brief, Rule 155

computations will be necessary in some of the cases.6

These cases are part of a larger group of cases that have

also been identified by respondent as a litigation project. The

sobriquet for this project is "Levenfeld/Kanter". These cases

were selected for trial because, as the Court understands, they

involve common issues that the other cases in this project do not

have.

References to Kanter, Ballard, and Lisle are to Burton W.

Kanter, Claude M. Ballard, and Robert W. Lisle, respectively.

Reference to the Kanters, Ballards, and Lisles are to Burton W.

6

In some of the cases, if petitioners are sustained on the

fraud issue, respondent will be barred by the statute of

limitations from assessment as to those petitioners.

- 21 -

and Naomi R. Kanter, Claude M. and Mary B. Ballard, and Robert W.

and Donna M. Lisle, respectively.

The issues to be decided are:

(1) Whether payments made by the Five in the Prudential,

Travelers, and Kanter transactions during the years at issue are

properly taxable to Kanter, Ballard, and Lisle, and, if so,

whether they are liable for the fraud additions to tax and

penalty with respect to such income;

(2) whether certain commitment fees paid to Century

Industries, Ltd., are includable in Kanter's income for 1981,

1982, 1983, 1984, and 1986;

(3) whether Kanter received unreported income from Hi-

Chicago Trust for 1981, 1982, and 1983;

(4) whether Kanter is taxable on the income of the Bea

Ritch Trusts for 1986, and 1987;

(5) whether Kanter had unreported income for 1982, 1983,

1984, 1987, 1988, and 1989 from the CMS Investors Partnership;

(6) whether Kanter had unreported income in 1983 from

Equitable Leasing Co., Inc.;

(7) whether Kanter had unreported income in 1982 based on

the bank deposit analysis method;

(8) whether Kanter received barter income from Principal

Services in 1988 and 1989;

- 22 -

(9) whether the Kanters are entitled to certain deductions

claimed on Schedule A and Schedule C for 1986 through 1989;

(10) whether Kanter, in 1983, realized capital gains under

section 357(b) and (c) from the assumption by Cashmere Investment

Associates, Inc., of partnership interests having negative

capital accounts and whether, under section 453, the installment

method was available for the reporting of such gains;

(11) whether Kanter is entitled to research and development

and business expense deductions from Immunological Research

Corporation for 1979;

(12) whether Kanter had unreported partnership income for

1978;

(13) whether the Kanters are entitled to a loss from GLS

Associates for 1981;

(14) whether the Kanters are entitled to a loss from

computer leasing transactions involving Equitec for 1983 and

1984;

(15) whether the Kanters are entitled to investment

interest expense deductions for 1981;

(16) whether the Kanters are entitled to an investment tax

credit carryover for 1978;

(17) whether the Kanters are entitled to an interest

deduction for 1986;

- 23 -

(18) whether the Kanters received unreported interest

income from a bank in 1988;

(19) whether Kanter is entitled to a business loss

deduction in 1980 in connection with the sale of a painting;

(20) whether the Kanters are entitled to deduct a claimed

charitable contribution of $15,000 to the Jewish United Fund in

1982;

(21) whether the Kanters are entitled to claimed capital

gains and losses in 1987;

(22) whether respondent correctly made adjustments to the

rental income, depreciation, interest expense, and investment tax

credits claimed by Investment Research Associates, Ltd. (IRA) in

connection with equipment leasing transactions for 1979, 1980,

and 1982 through 1989;

(23) whether IRA is entitled to a claimed loss on Form 4797

of $1,073,835 for 1988;

(24) whether IRA is entitled to a charitable contribution

carryover deduction for 1983;

(25) whether IRA is entitled to certain claimed capital

losses for 1985;

(26) whether IRA is entitled to claimed bad debt deductions

for 1987;

(27) whether IRA is entitled to claimed ordinary losses on

sales of notes receivable for 1987;

- 24 -

(28) whether IRA is entitled to certain capital losses for

1987;

(29) whether IRA is entitled to deduct as business expenses

amounts paid to J.D. Weaver in 1979, 1981, and 1982;

(30) whether the assessment and collection of the

deficiency and additions to tax as to IRA for 1980 are barred by

the statute of limitations;

(31) whether IRA is liable for the fraud addition to tax

for 1987;

(32) whether assessment and collection of Federal income

taxes of Kanter, Ballard, and Lisle are barred by the statute of

limitations for some years;

(33) the liabilities of Kanter, Ballard, and Lisle for

additions to tax for negligence;

(34) whether the Kanters are liable for the section 6659

addition to tax for 1981;

(35) whether Kanter is liable for section 6661 additions to

tax for 1982 through 1984, and 1986 through 1988;

(36) whether Kanter is liable for section 6621(c) increased

interest for 1978, 1979, 1980 through 1984, and 1986, and 1987,

and 1988;

(37) whether IRA is liable for the section 6651(a)(1)

addition to tax for 1980;

- 25 -

(38) whether IRA is liable for the section 6653(a)

additions to tax for 1980, and 1982 through 1988;

(39) whether IRA is liable for the section 6659(a)

additions to tax for 1982 and 1983;

(40) whether IRA is liable for the section 6661 additions

to tax for 1983 through 1988; and

(41) whether IRA is liable for the section 6662(a)

accuracy-related penalty for 1989.

For convenience and clarity, the Court's findings of fact

and opinion are set forth under each issue. The findings of fact

with respect to any issue incorporate by this reference the

findings of fact as found in any preceding issue.

Issue 1. Whether Payments Made By the Five in the Prudential,

Travelers, and Kanter Transactions During the Years at Issue Are

Properly Taxable to Kanter, Ballard, and Lisle, and, if so,

whether they are liable for the fraud additions to tax and

penalty with respect to such income

FINDINGS OF FACT

The parties have filed several stipulations of fact. The

facts reflected in these stipulations, with the annexed exhibits,

are so found and are incorporated herein by reference.

I. Background

A. Petitioners' Residences and Principal Place of Business

At the time the petitions were filed, the principal place of

business of Investment Research Associates, Ltd. (IRA), was in

the State of Illinois, the Kanters' legal residence was in the

- 26 -

State of Illinois, the Ballards' legal residence was in the State

of Florida, and the Lisles' legal residence was in the State of

Texas. Donna Lisle died on April 12, 1993, and Robert W. Lisle

died on September 17, 1993. Their two children, Amy L. Albrecht

and Thomas W. Lisle, are the coexecutors of the Estates of Robert

W. Lisle and Donna M. Lisle. The estates have been substituted

as parties and the two children as representatives of the

estates. Amy Albrecht and Thomas Lisle were legal residents of

the State of Texas at the time they were substituted as

representatives of the estates of their deceased parents.

B. Kanter

Kanter is an attorney who has been engaged continuously in

the practice of law in Chicago, Illinois, since about 1956. He

received a J.D. degree from the University of Chicago in 1952.

From 1952 to 1954, he was a teaching associate at the University

of Indiana Law School. Since 1956, his law practice has been in

Chicago, Illinois. His primary expertise is in Federal income

and estate taxation. From 1964 to 1981, Kanter was a partner in

the law firm of Levenfeld & Kanter, which later became Levenfeld,

Kanter, Baskes & Lippitz. That firm was dissolved in 1981, and

Kanter thereafter practiced with the firm of Kanter & Eisenberg.

As of the time of trial, Kanter was of counsel with the Chicago

firm of Neal, Gerber & Eisenberg.

- 27 -

At the time of the trial and for the prior 10 years, Kanter

taught courses in estate and gift taxation and estate planning at

the University of Chicago Law School. Kanter has lectured and

written extensively in the area of Federal tax law. He has also

been an active participant in professional bar associations. For

a number of years, Kanter has been a writer and contributor to

the Journal of Taxation, a national monthly publication devoted

exclusively to Federal taxation. One of the features of this

publication is the Shop Talk section which he originated. At the

time of trial, Kanter was a senior editor with the Journal of

Taxation. Kanter is generally recognized as well known in his

field. This recognition has resulted in a successful law

practice, which has led to Kanter's being involved in

consultation, development, and investments in a number of

business fields and enterprises. For instance, Kanter has

performed extensive legal work for the Pritzker family, majority

owners of the Hyatt Corp., a major hotel company. Kanter also

served as a director on the boards of several corporations and

charitable organizations.

Petitioner Naomi R. Kanter, Kanter's wife, was not involved

in any of the activities giving rise to this litigation.

However, she filed joint Federal income tax returns with Kanter

for the years at issue.

- 28 -

C. Ballard

Ballard was an employee in the real estate department of The

Prudential Insurance Co. of America (Prudential) from 1948 until

his retirement in 1982. During the course of his career at

Prudential, Ballard was assigned to several regional offices of

Prudential, including Houston and Dallas, Texas, and beginning in

1966 in the corporate headquarters of Prudential at Newark, New

Jersey, and then again, for a short time, at the Houston regional

office. In 1973, he was reassigned to Prudential's Newark

corporate headquarters, where he remained until his retirement in

early 1982. At the time he left Prudential, Ballard was a senior

vice president in charge of equities and worked under Donald Knab

(Knab), who was in charge of all of Prudential's real estate

operations.

Ballard's work with Prudential in its real estate equity

operations involved the purchase, development, management, and

sale of property. Ballard supervised the staff of this

department at Prudential's headquarters, as well as the real

estate department staff at Prudential's regional and field

offices throughout the United States. Ballard could influence

the choice of builders and contractors for Prudential projects

and could influence or prevent a project from going forward.

Shortly after leaving Prudential, Ballard became a general

partner with Goldman Sachs, an investment firm in New York City.

- 29 -

In November of 1988, he retired as a general partner and became a

limited partner with Goldman Sachs.

In his position with Prudential, Ballard met and was in

contact with attorneys, developers, businessmen, and contractors

involved in or affected by Prudential's real estate activities.

D. Lisle

Lisle graduated from the University of Missouri with a B.S.

degree in public administration. He attended law school at the

University of Missouri, graduate schools of management and

business at Columbia University, and the graduate school of

management at Princeton University.

Like Ballard, Lisle was employed by Prudential. Lisle

worked for Prudential in real estate development and in mortgage

financing from September 1950 to April 1982. Lisle headed the

division responsible for lending money and buying and building

real estate for Prudential. He had authority to commit any loan

up to $20 million and to award construction contracts. The

development aspect of his work was conducted through a subsidiary

corporation of Prudential known as PIC Realty Corp. (PIC

Realty).7 Lisle was president of PIC Realty.

7

Prudential conducted its real estate equity and joint

venture operations in the name of PIC Realty in those States that

prohibited insurance corporations from directly engaging in real

estate development.

- 30 -

To a large extent, Lisle's career paralleled Ballard's.

Like Ballard, Lisle worked in various regional offices of

Prudential and ultimately was promoted to a senior executive

position at Prudential's Newark corporate headquarters. The

offices of Lisle and Ballard were next door to each other, and

Lisle's supervisor at Prudential was also Donald Knab. To some

extent, Ballard and Lisle's duties overlapped. At the time Lisle

left Prudential in 1982, he was a vice president of Prudential.

In April 1982, after leaving Prudential, Lisle began working

for The Travelers Insurance Co. (Travelers), doing virtually the

same kind of work he had done for Prudential. He worked for

Travelers until April 1988.

Donna M. Lisle, Lisle's wife, was not involved in any of the

activities giving rise to this litigation, and her estate is a

party to these proceedings solely by virtue of Mrs. Lisle's

having filed joint Federal income tax returns with Lisle for the

years at issue.

II. The Kanter Enterprise

A. Overview

Kanter met Ballard and Lisle sometime between 1968 and 1970.

The three had numerous contacts and business dealings in

succeeding years.

Kanter entered into arrangements pursuant to which he would

use his business and professional contacts, including his

- 31 -

relationships with the Pritzkers, Ballard, and Lisle, to assist

individuals and/or entities in obtaining business opportunities

or in raising capital for business ventures. Kanter established

a complex organization of corporations, partnerships, and trusts

to receive, distribute, and disguise the payments from these

arrangements.

Some of these arrangements involved payments from a group of

individuals referred to by the parties as "the Five". The Five

made payments for Ballard's and Lisle's influence in awarding

contracts with Prudential (the Prudential transactions), for

Lisle's influence in awarding contracts with Travelers (the

Travelers transactions), and for Kanter's influence in

transactions that did not involve Prudential or Travelers (the

Kanter transactions). The payments most often were made to

corporations controlled by Kanter and then distributed through

various means to Kanter, Ballard, and/or Lisle, their family

members, or to entities established for the benefit of their

families.

Most of the payments made in the Prudential transactions

were paid through IRA or one of its subsidiaries. Those made in

the Travelers and Kanter transactions generally were made through

another corporation controlled by Kanter, The Holding Co.

(Holding Co.) or one of its subsidiaries. Funds received by IRA

and its subsidiaries and Holding Co. and its subsidiaries, as

- 32 -

well as funds of other Kanter entities and associates, were

commingled in accounts administered by another Kanter controlled

entity, The Administration Co. (Administration Co.) (and later

Principal Services Corp.).

Some distributions to Kanter, Ballard, and Lisle were

characterized as commissions, consulting fees, or directors fees.

Others were recorded as receivables or loans, many of which were

traded or transferred between the various entities and eventually

written off as uncollectible with IRA and/or Kanter taking

deductions for the writeoffs. Some of the distributions that

were treated as loans were made through two Kanter entities,

International Films, Inc. (Int'l Films) and Harbor Exchange

Lending Operation (HELO).

Large portions of the payments made in the Prudential

transactions eventually were distributed to three of IRA's

subsidiaries; more specifically, 45 percent to Carlco, Inc.

(Carlco) (controlled by Lisle), 45 percent to TMT, Inc. (TMT),

(controlled by Ballard), and 10 percent to BWK, Inc. (controlled

by Kanter).

An overview of the Kanter enterprise is shown by the

following diagram:

- 33 -

- 34 -

B. Investment Research Associates, Inc., and Its Subsidiaries

IRA was originally incorporated in the State of Delaware on

August 26, 1974, under the name of Cedilla Co. In 1979, the name

of Cedilla Co. was changed to Investment Research Associates,

Ltd. Reference hereinafter to IRA also refers to its

predecessor, Cedilla Co. during years prior to the name change.

1. IRA Stock

At the time of its incorporation in 1974, IRA was authorized

to issue 1,000 shares of 10-cent par value common stock, 8,000

shares of $1 par value class A preferred stock, and 1,000 shares

of 10-cent class B preferred stock. By 1977 IRA was also

authorized to issue 1,000 shares of $5,000 par value class C

preferred stock.

IRA's annual franchise reports filed with the State of

Delaware from 1975 to 1988 reported that the following shares of

stock were issued and outstanding:

- 35 -

Year Common Preferred

Class A Class B Class C

1975 [blank] [blank] [blank] [not authorized]

1976 [blank] [blank] [blank] [not authorized]

1977 1,000 1,000 500 [not authorized]

1978 1,000 1,000 none none

1979 none 1,000 1,000 none

1980 1,000 1,000 none none

1981 [blank] [blank] [blank] [blank]

1982 none none none none

1983 1,000 1,000 [blank] [blank]

1984 [blank] [blank] [blank] [blank]

1985 [blank] [blank] [blank] [blank]

1986 1,000 -0- -0- -0-

1987 [blank] [blank] [blank] [blank]

1988 [blank] [blank] [blank] [blank]

IRA's end-of-year balance sheets from 1975 to 1989 indicate

the following stockholder equity attributable to the preferred

and common stock:

Year Preferred Common

1975 $1,050 $100

1976 1,050 100

1977 1,000 100

1978 1,000 100

1979 1,000 100

1980 1,000 100

1981 1,000 100

1982 1,000 100

1983 -0- 100

1984 -0- 100

1985 -0- 100

1986 -0- 100

1987 -0- 100

1988 -0- 100

1989 -0- 100

2. IRA Stockholders

IRA's 1976 return reported that no individual, partnership,

corporation, estate, or trust at the end of the year owned (or

was attributed ownership under section 267(c)) 50 percent or more

- 36 -

of the corporation's total voting stock. IRA's returns reported

that from 1977 through 1982, Solomon Weisgal, trustee of the Bea

Ritch Trusts, owned 50 percent of IRA's voting stock, and Mildred

Schott owned the remaining 50 percent of IRA's voting stock. The

Bea Ritch Trusts owned 1,000 shares of common stock, and Schott

owned 1,000 shares of class A preferred voting stock. IRA's

returns for 1984 through 1989 indicated that no individual,

partnership, corporation, estate, or trust at the end of the year

owned (or was attributed ownership under section 267(c)) 50

percent or more of the corporation's total voting stock.

a. Mildred Schott and Delores Keating

Mildred Schott (Schott) worked as a legal secretary and had

a real estate broker's license. She was introduced to Kanter by

a mutual acquaintance. Before she obtained her broker's license,

she worked as a real estate sales person for Delores Keating

(Keating).

Prior to October 28, 1975, Keating owned 1,000 shares of

common stock of Cedilla Co. On October 28, 1975, Keating's 1,000

shares of common stock were exchanged for 500 shares of the class

B preferred stock, and 1,000 shares of common stock were issued

to the Bea Ritch Trusts. By 1978, Keating's 500 shares of class

B preferred stock were redeemed by the corporation.

- 37 -

Schott held 1,000 shares of the class A preferred stock

until 1982. She held the stock to enable IRA to hold a corporate

real estate license.

b. The Bea Ritch Trusts

Twenty-five trusts known collectively as the Bea Ritch

Trusts were established in 1969 and were named after Beatrice K.

Ritch, Kanter's mother. Kanter's mother is the named grantor,

ostensibly contributing $100 to each of the 25 trusts.

Originally, when the 25 Bea Ritch Trusts were established in

1969, the beneficiaries of the trusts were Kanter, his family,

and other relatives of Kanter. By about 1977, Kanter had

formally renounced all of his interest as a beneficiary in the

Bea Ritch Trusts. At some time, many additional trusts were

added as beneficiaries to the trusts. The identities of the

beneficiaries of the additional trusts are not in the record.

The original individual and additional trust beneficiaries

of the Bea Ritch Trusts are as follows:

Original Additional

Trust Name Beneficiaries Beneficiaries

BWK Trust Burton Kanter JSK 1st Trust #5

JSK 2d Trust #5

JSK 3d Trust #5

Naomi Trust Naomi Kanter JSK 3d Trust #19

JSK 1st Trust #20

BN Trust Burton & Naomi JSK 1st Trust #4

JSK 2d Trust #4

JSK 3d Trust #4

Joel Trust Burton & Joel JSK 1st Trust #17

Kanter JSK 2d Trust #17

Janis Trust Burton & Janis JSK 3d Trust #15

Kanter JSK 1st Trust #16

- 38 -

Original Additional

Trust Name Beneficiaries Beneficiaries

Joshua Trust Burton & Joshua JSK 2d Trust #18

Kanter JSK 3d Trust #18

Joel Children's Burton, Naomi, JSK 3d Trust #17

Trust Joel & Joel's JSK 1st Trust #18

children living

from time to time

Janis Children's Burton, Naomi, JSK 2d Trust #16

Trust Janis & Janis JSK 3d Trust #16

children living

from time to time

Joshua Children's Burton, Naomi, JSK 1st Trust #19

Trust Joshua & Joshua's JSK 2d Trust #19

children living

from time to time

JL-1 Trust Burton, Joel, JSK 3d Trust #11

Harriet Blum & JSK 1st Trust #12

Joel's 1st child

JL-2 Trust Burton, Joel, JSK 2d Trust #12

Debbie Blum & JSK 3d Trust #12

Joel's 2d child

JL-3 Trust Burton, Joel, JSK 1st Trust #13

Jeff Blum & JSK 2d Trust #13

Joel's 3d child

JA-1 Trust Burton, Janis, JSK 1st Trust #9

Henry Krakow & JSK 2d Trust #9

Janis' 1st child JSK 3d Trust #9

JA-2 Trust Burton, Janis, JSK 1st Trust #10

Helen Krakow & JSK 2d Trust #10

Janis' 3d child

JA-3 Trust Burton, Janis, JSK 1st Trust #11

Helen Krakow & JSK 2d Trust #11

Janis' 3d child

JS-1 Trust Burton, Joshua, JSK 3d Trust #13

Gerald L. Kanter & JSK 1st Trust #14

Joshua's 1st child

JS-2 Trust Burton, Joshua, JSK 2d Trust #14

Ruth Kanter & JSK 3d Trust #14

Joshua's 2d child

JS-3 Trust Burton, Joshua, JSK 1st Trust #15

Joshua's 3d child JSK 2d Trust #15

& all of the

children of Gerald L.

Kanter living from

time to time

- 39 -

Original Additional

Trust Name Beneficiaries Beneficiaries

BK Children's Burton, Naomi and JSK 1st Trust #1

Trust all of the children JSK 2d Trust #1

of the Grantor's JSK 3d Trust #1

son living from

time to time

BK Descendant's Burton, Naomi and JSK 1st Trust #2

Trust all of the JSK 2d Trust #2

descendants of the JSK 3d Trust #2

of the Grantor's son

living from time to

time

BK Grandchildren's Burton, Naomi and JSK 1st Trust #3

Trust Burton's Grand- JSK 2d Trust #3

children living JSK 3d Trust #3

from time to time

Lillian Trust Burton, Naomi and JSK 2d Trust #20

Lillian Walker JSK 3d Trust #20

J-1 Wife's Trust Burton, Joel's Wife JSK 1st Trust #6

and the children of JSK 2d Trust #6

Carl I. Kanter JSK 3d Trust #6

living from time

to time

J-2 Husband's Burton, Janis' JSK 1st Trust #7

Trust husband and the JSK 2d Trust #7

children of JSK 3d Trust #7

Aloysius B. and

Helen M. Osowski

J-3 Wife's Trust Burton, Joshua's JSK 1st Trust #8

wife and Ruth & JSK 2d Trust #8

Philip Loshin JSK 3d Trust #8

Solomon Weisgal (Weisgal), an accountant and a longtime

friend and business associate of Kanter, has been the sole named

trustee of the Bea Ritch Trusts since 1969. As trustee of the

Bea Ritch Trusts, Weisgal had broad power either to accumulate

the Bea Ritch Trusts' income or to distribute (i.e., sprinkle)

the trusts' income and assets among all or any of the trusts'

beneficiaries in a manner he deemed appropriate. Weisgal did not

- 40 -

act independently as a trustee. Rather, he acted as Kanter

directed in all matters regarding the trusts.

3. IRA Officers and Directors

Prior to October 27, 1975, Keating was president and

secretary of IRA. On October 27, 1975, Keating resigned and

Schott was elected as president and Sharon Meyers (Meyers) as

secretary by the unanimous consent of the directors (Schott,

Meyers, and Patricia Grogan (Grogan)). From 1977 to 1980, the

president of IRA was Schott, and the vice president was Weisgal.

Lawrence Freeman (Freeman), an attorney in Miami, Florida,

was a friend and business associate of Kanter. At Kanter's

request, Freeman served as IRA's president from 1980 to 1989.

Although Freeman was not paid for serving as IRA's president, he

and his law firm received significant legal business through

referrals from Kanter. In 1989, Kanter became IRA's acting

president.

From 1976 through 1980, Schott, Weisgal, and Grogan served

as IRA's directors. From 1981 through 1989, Freeman served as a

director. For most of those years Freeman was the sole director.

Although Ballard was not listed as a director, IRA paid Ballard

$12,500 as directors fees in 1981. IRA deducted $12,500 as a

director fee expense on its 1981 return.

Meyers served as an officer or director of IRA at various

times. Meyers originally worked as Kanter's secretary at

- 41 -

Kanter's law firm. By the 1970's, her duties at the law firm

evolved to her being an administrative assistant to Kanter. By

1981, she was no longer an employee of the law firm. During the

years at issue, Meyers also served as an officer or director of

many of Kanter's other corporations.

At all times, IRA's officers and directors made decisions

and performed their duties in accordance with Kanter's

instructions.

4. IRA Subsidiaries

IRA owned, from time to time, controlling interests in

several subsidiary corporations. These subsidiary corporations

included Brickell Enterprises, Inc., Cedilla Co., Cedilla

Investment Co., IRA Florida Apartments, Inc., KWJ Corp., Zeus

Ventures, Carlco, TMT, and BWK, Inc. IRA also, at one point,

owned a majority stock interest in Int'l Films.

Carlco, TMT, and BWK, Inc., were incorporated in the State

of Delaware in 1982 but remained inactive until 1983. In

December of 1983, IRA acquired 1,000 shares (100 percent) of the

common stock of each of Carlco, TMT, and BWK, Inc. In December

1983 and January 1984, Carlco, TMT, and BWK, Inc., each issued

shares of preferred stock. Carlco preferred shares were issued

to the Christie Trust established by Kanter for the benefit of

Lisle's family; TMT preferred shares were issued to the Orient

Trust established by Kanter for the benefit of Ballard's family;

- 42 -

and BWK, Inc., preferred shares were issued to the BK Children's

Trust, the beneficiaries of which were members of Kanter's

family.

C. Holding Co.

Holding Co. was incorporated on December 8, 1976. Holding

Co. owned several subsidiary corporations, including the Citra

Co., Active Business Corp., HELO, LBG Properties, Inc., The

Nominee Corp., Oil Investments, Ltd., Tanglewood Properties,

Inc., and Zion Ventures, Inc.

Kanter, his family, and trusts established for the benefit

of his family, including the Bea Ritch Trusts and the Everglades

Trusts,8 owned substantially all of the stock in Holding Co.

Kanter, Weisgal, Meyers, and Linda Gallenberger

(Gallenberger) most often served as directors and officers of

Holding Co.

Holding Co.'s end-of-year balance sheets indicate the

following stockholder equity attributable to the preferred and

common stock:

Year Common Preferred Paid-in

Class A Class B Class C Class D Capital

1979 $23 $775 $3 $50,000 -- $407,087

1980 23 775 3 50,000 1,500,000 407,087

1981 23 775 3 50,000 -- 407,087

8

The Everglades Trusts 1-5, shareholders in Holding Co., were

grantor trusts in which Kanter was the deemed owner under secs.

671 through 678.

- 43 -

Prior to August 1981, another Kanter entity, Computer

Placement Services, had a $1,729,300 loan outstanding to Holding

Co. In August 1981, $1,500,000 of the loan was converted to

Holding Co. class D preferred stock. In 1983, the stockholder

equity of class D preferred stock was decreased by $1,499,999 and

the paid-in capital was increased by the same amount.

D. Administration Co. and Principal Services: The Banking

Corporations

The funds of the various Kanter entities (as well as the

funds of some of Kanter's associates) were commingled in accounts

held by Administration Co. and later the Principal Services

Accounting Corp. (Principal Services), both of which were also

controlled by Kanter.

Administration Co. was incorporated in the State of Delaware

on September 21, 1981, and was authorized to do business in the

State of Illinois. Administration Co.'s offices were located

either at Kanter's law firm offices or in close proximity

thereto.9

The sole shareholder of Administration Co. was the Pyramid

Trust. Weisgal was trustee of the Pyramid Trust, and Meyers was

the sole beneficiary.

9

Administration Co. was organized at the insistence of some

of the members of Kanter's law firm who complained that law firm

employees working under Kanter were performing extensive nonlegal

services for which the law firm was not being compensated.

- 44 -

Meyers was the sole director of Administration Co. and was

its president from 1981 to 1985. Gallenberger was the vice

president of Administration Co. and worked under the direction of

Meyers. When Meyers left Administration Co. in 1985, Kanter

briefly served as acting president of Administration Co., and,

thereafter, Gallenberger became Administration Co.'s president

from 1985 through 1988.10

Administration Co. had several employees, mostly clerical

assistants, bookkeepers, and accountants. Meyers directed the

staff and employees of Administration Co. until 1985. In 1983,

Administration Co. paid $143,489 in employee compensation and

distributed over $500,000 as nonemployee compensation, including

$400,000 to the Rainbow Trusts (Rainbow Trust Nos. 1-25).

Administration Co. administered funds that it collected from

or on behalf of various Kanter entities and associates, referred

to as clients. Administration Co. clients included individuals

(including Kanter, Ballard, and Lisle), corporations (including

IRA, Holding Co., and their subsidiaries), partnerships, trusts,

various Kanter-related entities, and members of Kanter’s law

firm.

10

Gallenberger was an accountant. Shortly after arriving in

Chicago, Illinois, she passed the certified public accountant's

examination. Gallenberger became an employee of Administration

Co. in 1982.

- 45 -

Administration Co. opened a bank account in Administration

Co.'s name known as the Special E Account. The Special E Account

functioned generally as a checking account for its various

clients. Administration Co.'s books and records reflected each

client's balance in the account and also reflected deposits or

withdrawals affecting that client's account.

Administration Co. also maintained at its bank a second

account known as the Special Account that served more like a

savings or money market account. The moneys in this account were

used to buy certificates of deposit because a higher rate of

return could be realized by aggregating the funds to purchase

larger denomination certificates of deposit.

Funds from both the Special E Account and the Special

Account were lent to Administration Co. clients. Deposits to and

withdrawals from the Special E Account and the Special Account

were posted to the appropriate client accounts. If a client had

a negative balance in the accounts, that debit amount was

recorded as a receivable owed by the client to Administration Co.

Any positive balance a client had in the accounts was considered

money belonging to the client.

Administration Co. issued annual tax statements and reports

to its clients and the Internal Revenue Service (IRS) for the

interest earned by each client on that client's funds in the

Special E Account and the Special Account.

- 46 -

Administration Co. maintained books and records for each of

its clients and, in many instances, prepared clients' tax

returns. Administration Co. prepared Kanter's income tax returns

for all or some of the years at issue. Administration Co.

charged a fee for its services.

Administration Co. filed for bankruptcy in February 1988,

and Principal Services was organized. All of Principal Services'

outstanding shares of stock were initially owned by ARO Trust, of

which trust Kanter was the trustee.

Principal Services took over a number of Administration

Co.'s clients, including Kanter, IRA, and Holding Co. Principal

Services performed services for clients similar to those provided

by Administration Co. Principal Services also established two

accounts similar to the Special E Account and the Special

Account. During the years at issue, Principal Services made

loans to Holding Co. and BWK, Inc.

In 1990, Gallenberger purchased from ARO Trust all of

Principal Services's shares for $100. In October of 1993,

Principal Services moved (along with all of its clients files) to

Wisconsin.

E. The Other Lending Corporations

During the years at issue Kanter often used two additional

entities, HELO and Int'l Films to distribute funds including

- 47 -

distributions to Ballard and Lisle or trusts established for the

benefit of their families.

1. HELO

HELO's predecessor, Harbor Investments, Inc., was

incorporated on July 21, 1978, and the stated business purpose

was investments. The name was changed in fiscal year ending

August 31, 1980, to Harbor Exchange Lending Operation. The

Active Business Corp. (Active) owned 100 percent of the voting

stock of HELO. Holding Co. owned 100 percent of the stock of

Active and filed consolidated returns with HELO and Active.

On August 31, 1984, all of the shares of HELO were

transferred by Active to Kanter as the trustee of the ARO Trusts.

At the time of the transfer, HELO's only significant assets were

loan receivables totaling $2,331,326, and its liabilities

included short-term loans of $2,518,589 and long-term loans of

$10,557. Holding Co. also disposed of 100 percent of the voting

stock of Active Corp. in 1984.

Holding Co.'s consolidated returns reported the following

income, net assets, and stockholder equity with respect to

HELO:11

11

The record does not contain the information for 1982.

- 48 -

08/78 08/79 08/80 08/81 08/83 08/84

Income -- -- $1,485 $4,597 -- $136

Deductions -- ($115) (31,309) (149,974) -- (30)

Total -- (115) (29,824) (145,377) -- 106

NOL -- (115) (29,939) -- (198,135)

Taxable -- (29,939) (175,316) -- (198,029)

Assets

Cash $500 131 4,294 (879,704) $31 322

Receivables -- -- 2,871,082 4,691,912 2,331,326 1,320,059

Money market -- -- 718 259 -- --

Pooled funds -- -- -- -- -- 4,636

Intangibles 151 120 89 27

Total 500 382 2,876,214 3,812,556 2,331,384 1,325,017

Liabilities

Short term -- -- 322,987 849,680 2,518,589 1,522,700

Shareholder -- -- 1,255,600 10,557 -- --

Long term -- -- 1,327,100 3,127,200 10,557

Total -- -- 2,905,687 3,987,437 2,529,146 1,522,700

Net assets 500 382 (29,473) (174,881) (197,762) (197,683)

500

Capital stock 500 500 500 500 500

Ret. earnings (118) (29,973) (175,381) (198,262) (198,183)

2. Int'l Films

Int'l Films was incorporated in September 1973. Although

the record does not disclose who originally owned the stock of

Int'l Films, on August 31, 1984, IRA owned 71 percent of the

voting stock of Int'l Films. As of August 31, 1983, Int'l Films

had loans receivable of $878,227. As of August 31, 1984, Int'l

Films had loans receivable of $1,050,827.

III. Transactions Involving the Five

Prior to and during the years at issue, Prudential was one

of the largest holders of commercial real estate in the United

States. By the late 1970's, Prudential either held or was

responsible for managing an estimated $20 billion in commercial

real estate properties. Prudential also developed commercial

- 49 -

real properties and provided financing to other real estate

developers for various real estate projects around the country.

As stated previously, Kanter entered into arrangements

pursuant to which he would use his relationships with the

Pritzkers, Ballard, and Lisle to assist individuals and/or

entities in obtaining business opportunities or in raising

capital for business ventures. Some of these arrangements

involved payments by a group of individuals referred to by the

parties as "the Five". The Five include J.D. Weaver (Weaver),

Bruce Frey (Frey), William Schaffel (Schaffel), Kenneth Schnitzer

(Schnitzer), and John Eulich (Eulich).

A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero Hotel

Management Contract

Hyatt Corp. manages hotels in the United States, Canada, and

the Caribbean. As indicated previously, members of the Pritzker

family control Hyatt Corp. Kanter has represented the Pritzkers

for years as their attorney.

The Houston Hyatt Hotel was co-owned by Prudential and

Tenneco Corp. (Tenneco) and managed by Hyatt Corp. Weaver was an

executive with Tenneco. From 1968 through 1972, Ballard and

Weaver were involved in the development of the Houston Hyatt

Hotel, and Ballard negotiated the hotel's management contract

with Hyatt Corp.

During the early 1970's, Prudential was also a participant

in a joint venture to develop and own the Embarcadero Hotel in

- 50 -

San Francisco. The joint venture participants sought an

experienced major hotel management company to operate the hotel

under a long-term management contract. Del Webb (Webb), a well-

known hotel operator and owner of a large hotel management

company, and Intercontinental Co., another large hotel management

company, were competing for the management contract. A.N.

Pritzker wanted the Hyatt Corp. to obtain the management contract

for the Embarcadero Hotel; the hotel would become the third or

fourth Hyatt-operated hotel in the United States at which major

conventions could be held.

Lisle was supervising development of the Embarcadero Hotel

for Prudential and was involved in the selection of a management

company to manage the hotel. Although Hyatt Corp. was about to

enter into the long-term management contract to operate the

Houston Hyatt Hotel owned by Prudential and Tenneco Corp., Lisle

was not interested in having the Hyatt Corp. manage the

Embarcadero Hotel.

Pritzker offered to pay Weaver, who had worked with Ballard

in developing the Houston Hyatt Hotel, a portion of the

management fees if Weaver helped Hyatt Corp. obtain the

management contract for the Embarcadero Hotel. Weaver then

persuaded Lisle to consider Hyatt Corp. for the Embarcadero

Hotel's management contract.

- 51 -

Since Ballard had negotiated the Houston Hyatt Hotel's

management contract, Knab (Ballard and Lisle's superior at

Prudential) directed Ballard to review and evaluate the terms of

the proposed management contracts to be considered for the San

Francisco Embarcadero Hotel.

Subsequently, representatives of the Embarcadero joint

venture participants met with Webb and Pritzker to obtain bids on

the Embarcadero Hotel's management contract. Ballard and Lisle,

as well as other Prudential employees, represented Prudential at

the meeting. For reasons not fully shown in the record,

representatives of Intercontinental Co. were not present at the

meeting, and Webb refused to submit a bid during the meeting

because he thought he had been promised the contract. Pritzker

offered to have Hyatt Corp. enter into a management contract for

the Embarcadero Hotel substantially similar to the Houston Hyatt

Hotel's management contract. At the meeting Hyatt Corp.

submitted the only bid, and the management contract was awarded

to Hyatt Corp.

Shortly after being awarded the contract, Hyatt Corp.

entered into an agreement with KWJ Corp., an S corporation solely

owned by Weaver. Under the written agreement dated February 25,

1971, Hyatt Corp. agreed to pay KWJ Corp. a commission generally

equal to 10 percent of Hyatt Corp.'s fees under the Embarcadero

Hotel management contract. The agreement acknowledged that "KWJ"

- 52 -

was the principal factor in bringing Hyatt Corp. and the owners

of the Embarcadero Hotel together and aiding in the negotiations.

Over the period from about 1972 through 1994, Prudential

eventually built a total of about 10 large, major-convention-size

hotels that Hyatt Corp. managed for it. During discussions about

Hyatt Corp.'s obtaining the management contract on one of the

first of these other hotels built after the Embarcadero Hotel,

Pritzker discussed Weaver's finder's fee with respect to the

Embarcadero Hotel's management contract with Ballard and Lisle.

Pritzker told Ballard and Lisle that Hyatt Corp.'s payment of

this finder's fee was a one-time occurrence. Pritzker told them

that no similar finder's fees would be paid with respect to

future management contracts that Hyatt Corp. obtained for other

Prudential hotels.

The Embarcadero Hotel opened in May 1973. In early 1975, a

dispute arose between Weaver and Hyatt Corp. with regard to the

commission due for 1974. A Hyatt Corp. official informed Weaver

that the Embarcadero Hotel did not generate a net profit for

1974. Weaver claimed that Hyatt Corp. was entitled to $623,201

under its agreement with Prudential and that he was entitled to

10 percent of those fees. Pritzker responded that Weaver's share

of the fees should bear his share of the home office expenses.

By November of 1975, Weaver and Hyatt Corp. had settled the

dispute.

- 53 -

During the period when Weaver and Hyatt were disputing the

computation of Weaver's share of the management fees, Kanter and

Weaver agreed that IRA would purchase the stock of KWJ Corp. In

a letter to Kanter dated March 10, 1976, Weaver confirmed "our

understanding regarding my granting to your client a right to

purchase all of the outstanding shares of stock of KWJ Corp." for

$150,000. The letter further provided that in addition to the

purchase price for the KWJ Corp. stock, KWJ Corp. would continue

to engage Weaver as its president and chief operating officer.

In addition, Weaver was to receive 30 percent of all payments

made by Hyatt Corp. under the contract with KWJ Corp. for as long

as the contract was in existence, regardless of whether he

performed any services for KWJ Corp.

At that time, Hyatt Corp. was in the process of becoming

privately owned, and Kanter did not want the transfer of the KWJ

Corp. stock to take place until after Hyatt Corp. became

privately owned. Therefore, the agreement was framed as an offer

to sell the stock for a period of 4 years.

On March 14, 1977, Hyatt Corp. paid KWJ Corp. $54,848 for

fees earned during 1976. Sometime prior to November 1978, Hyatt

Corp.'s management contract with the hotel was modified, and

Hyatt Corp. wanted to revise its agreement with KWJ Corp. By

letter dated November 14, 1978, Hyatt Corp. notified Weaver that,

under the proposed change, KWJ Corp. would have been overpaid by

- 54 -

$54,848 for 1976 and would be due $12,095 for 1977. By letter

dated November 21, 1978, Weaver informed Kanter of the proposed

changes in the Hyatt arrangement. The letter indicated that

Weaver would call Kanter to discuss the proposed change. In a

letter to Hyatt Corp. dated November 30, 1978, Weaver stated that

the KWJ Corp. contract would not be affected by any modifications

to Hyatt Corp.'s Embarcadero Hotel contract. On December 12,

1978, Hyatt Corp. paid KWJ Corp. $60,739 for 1977.

In February 1979, Hyatt Corp. had become a privately owned

entity. By letter dated September 27, 1979, Kanter informed

Weaver that Kanter wanted to proceed with the purchase of the KWJ

Corp. stock, effective retroactively to November 1, 1978. IRA

purchased 100 percent of KWJ Corp.'s outstanding shares of stock

from Weaver. IRA was to pay $10,000 of the purchase price in

November 1979 and the balance by August 1980.

As a result of IRA's purchase of the KWJ Corp. stock, KWJ

Corp. was included as a subsidiary on IRA's 1979 consolidated

return. The 1979 consolidated return reported KWJ Corp.'s 1979

gross receipts of $171,027 and payment of the 30 percent fee to

Weaver of $51,308. The 1979 consolidated return reflected KWJ

Corp.'s assets, liabilities, and net worth as of January 1, 1979,

as follows:

- 55 -

Assets

Cash $40,626

Accrued income 108,521

Total assets 149,147

Liabilities

Mortgages, notes,

and bonds payable 19,400

Accrued expenses 14,663

Total liabilities 34,063

Net Worth 115,084

Common Stock 1,000

Retained earning

unappropriated 53,968

Previously taxed income 60,116

Total stockholder equity 115,084

The commissions paid over by Hyatt Corp. attributable to

operations from 1978 through 1982 were as follows:

Operating Year Payment Year Payment

1978 1979 --

1979 1980 $171,027

1980 1981 128,671

1981 1982 246,717

1982 1983 245,843

Except for the $171,027 payment received in 1980 from

operations of the Hyatt hotel during 1979 that it reported on its

1979 return, IRA included the payments as income on the returns

for the years of payment.

Hyatt Corp. was not informed about the sale of the KWJ Corp.

stock to IRA and, therefore, continued to send the payments to

Weaver, who then sent the check to IRA. IRA then paid Weaver his

30 percent and deducted the payments as a commission expense.

A letter dated March 29, 1983, from Weaver to Kanter states:

- 56 -

Attached is the check from the Hyatt Corporation in the

amount of $245,843.00, which represents K.W.J.'s

commission for the year ending December 31, 1982.

Will you please deposit and issue appropriate checks to

the participants.

This represents approximately the same amount as last

year, per the attached balance sheet.

By August 1983, Weaver advised IRA that he wanted to modify

his arrangement with KWJ Corp. The new arrangement provided that

Weaver could retire from any and all activities with respect to

KWJ at any time after December 31, 1983. Weaver would continue

to receive 30 percent of any amount received by KWJ Corp. from

Hyatt Corp. with respect to the management contract of the

Embarcadero Hotel. Weaver's 30-percent interest would pass to

his estate or such other specific persons as he might designate

in writing.

In December 1983, KWJ Corp. was liquidated, and its assets

were distributed to IRA. On January 2, 1984, IRA's new

subsidiaries BWK, Inc. (managed by Kanter), Carlco (managed by

Lisle), and TMT (managed by Ballard) formed a partnership called

KWJ Co. (KWJ Co. partnership). Carlco and TMT each had a 45-

percent interest in the KWJ Co. partnership, and BWK had a 10-

percent interest in the partnership. Hyatt Corp. was not

informed about the liquidation of KWJ Corp. or the formation of

the KWJ Co. partnership at the time of the liquidation and

- 57 -

formation. Hyatt Corp. continued to send payments to Weaver

until Kanter notified Hyatt Corp. sometime around 1992.

From 1984 through 1989, Hyatt Corp. paid the following

commissions with respect to the Embarcadero Hotel that were

reported as income of the KWJ Co. partnership:

Operating Year Payment Year Payment

1984 1985 $295,415

1985 1986 330,376

1986 1987 327,784

1987 1988 281,926

1988 1989 75,396

1989 1990 24,340

The KWJ Co. partnership paid Weaver his 30 percent and

deducted the payment as a commission expense.

B. The Frey Arrangement: Condominium Conversions.

Bruce Frey (Frey), was a certified property manager, real

estate broker, and insurance broker. Frey began working at the

real estate firm of Downs, Mohl & Co. in 1965. While at Downs,

Mohl & Co., Frey met Kanter. In the early 1970's, Frey formed

D.M. Interstate, Inc., a real estate management company that was

an S corporation. In 1975, James Wold (Wold), became a

shareholder and employee of D.M. Interstate, Inc. Sometime

later, Frey also formed BJF Development, Inc., a corporation that

engaged in real estate development and management. Frey was the

sole shareholder of BJF Development, Inc. Hereinafter, D.M.

Interstate, Inc. and BJF Development, Inc., are each sometimes

referred to as a Frey corporation.

- 58 -

In 1978 or 1979, Frey began converting rental property into

condominiums. Frey or a Frey Corporation purchased rental

property, refurbished it, and then sold the individual units as

condominiums. Frey or a Frey corporation earned development fees

for managing and supervising the renovation and conversion work

on the property. A condominium project typically involved the

use of a limited partnership. As a partner in the partnership,

Frey or a Frey corporation would also receive profit

distributions that were based upon sales of condominiums. Frey

or his Corporation also earned management fees for their services

in managing the condominium units following the conversion.

Frey's first condominium conversion project was called Moon

Lake Village and involved an apartment building located in

Hoffman Estates, Illinois. A joint venture limited partnership

was formed to purchase the apartment building and convert it to

condominiums. Frey was the general partner in the partnership

and there were several investors who made contributions to the

partnership. A Frey corporation received development fees,

profit participation, and management fees in the Moon Lake

Village project. Neither Kanter nor Prudential was involved in

the Moon Lake Village project.

After successfully engaging in the Moon Lake Village

conversion in 1978, Frey met and consulted with Kanter to obtain

tax advice in connection with that project. During their meeting

- 59 -

or shortly thereafter, Frey and Kanter discussed Frey's need to

raise capital for future condominium conversion projects. At

that time, condominium conversions were occurring frequently in

metropolitan areas throughout the country, and Frey was faced

with having to raise capital to acquire and convert apartment

building properties in which he and other competing condominium

converters were interested. Although Frey generally could obtain

financing from a bank for most of a condominium conversion

project's cost, the bank usually required Frey and other

investors to have a substantial investment in the project.

Kanter said that he could help raise some of the capital Frey

needed for the condominium conversion projects. In consideration

for such assistance, Kanter required Frey to share the

development and management fees that Frey earned from such

projects. Frey agreed to pay Kanter a share of the development

and management fees if Kanter caused a third party to invest

money in a project. Furthermore, if Kanter invested in a

conversion project, he would also share in the profit

participation of the partnership.

From 1978 to 1987, a number of condominium conversion

projects were undertaken by limited partnerships that Frey and

the Frey corporations formed with other investors. Frey or a

Frey corporation often served as the general partner in such

limited partnerships. In many instances, the limited

- 60 -

partnerships acquired an apartment complex, renovated and

converted it into condominium units, and sold the condominium

units to individual purchasers.

Beginning with Frey's second condominium conversion project,

entities associated with Kanter received limited partnership

interests in many of Frey's condominium conversion projects. The

Kanter entities that received such partnership interests included

Zeus Ventures, Inc. (Zeus), a subsidiary of IRA, and Zion

Ventures, Inc. (Zion), a subsidiary of Holding Co. Kanter also

brought other investors into some of Frey's condominium

conversion projects for which Kanter entities received a share of

development and management fees. Projects in which Kanter

entities received fees or interests included the Lakewood

Associates project and the 535 Michigan Avenue project.

The first condominium conversion project that Frey undertook

involving Prudential was a 1,000-unit townhouse apartment complex

called Village of Kings Creek at Miami, Florida. About 1979,

Frey approached a Prudential real estate department executive

working in Prudential's Miami, Florida, regional office about

purchasing the Village of Kings Creek apartment complex. The

apartment complex was owned by a pension fund managed by

Prudential. Frey offered to purchase the apartment complex for a

cash price of about $20 million. He also advised the Prudential

executive that Connecticut Mutual Life Insurance Co. would be

- 61 -

joining Frey in purchasing the property. Prudential previously

had considered selling the apartment complex, and Frey's $20

million offer for the property significantly exceeded the

property's appraised market value.

The Prudential executive consulted with Ballard about Frey's

offer. Ballard thought that Prudential's refusal of such offer

might constitute a breach of fiduciary duty as investment manager

of the pension fund. Ballard advised the executive that

Prudential should accept the offer.

On January 16, 1980, the Village of Kings Creek partnership

was formed for the purpose of purchasing the property from

Prudential and converting it into condominiums. In 1980, the

Village of Kings Creek apartment complex was sold by Prudential

to the partnership. Zeus (a subsidiary of IRA) and Zion (a

subsidiary of Holding Co.) became limited partners in this

limited partnership. Kanter also brought in another investor,

First Illinois Enterprises (an Illinois general partnership),

that invested $1.5 million in the project. The financing for the

Village of Kings Creek project came from the following sources:

The First National Bank of Chicago was the first mortgage lender;

Connecticut Mutual Life Insurance Co. and First Illinois

Enterprises were the two primary equity participants.

Under the partnership agreement, Zeus was required to make

an initial contribution of $100,000 for its 6.14-percent interest

- 62 -

in the partnership. Zion was required to make an initial

contribution of $108,014 for its 6.66-percent interest in the

partnership. In the event of certain circumstances, the partners

agreed to make additional contributions to the partnership. The

partnership agreement provided that the partnership would

reimburse or credit the capital accounts of the Frey corporation,

Frey, Wold, and Zion for "the advances made by them in

negotiating, entering into and performing the terms and

conditions of Purchase and Sale Contract and Contractual

Commitments".

Following Prudential's sale of the Village of Kings Creek

property, the executive in the Miami regional office who had

dealt with Frey in the sale approached Frey about converting

another Prudential apartment property in Florida into

condominiums. Beginning with this property, Prudential

participated in a number of successful condominium conversion

projects with Frey. Most of these projects that Frey and

Prudential undertook were joint ventures.

Frey did not have to raise much capital to engage in these

joint venture projects with Prudential, because Prudential owned

the apartment property to be converted and participated as co-

owner in a joint venture to convert and sell the property as

condominium units. Prudential would contribute the property and

receive (1) all initial condominium unit sale proceeds up to a

- 63 -

specified amount based, in large part, on the property's

appraised fair market value as a rental property, and (2) 50

percent of all other unit sale proceeds above the initial

specified amount. A limited partnership received 50 percent of

the proceeds above Prudential's initial specified amount of the

proceeds from the sale of units. A Frey corporation was

responsible for renovating and converting the property and

selling the condominium units in exchange for development fees

and management fees from the owners of the condominiums for

managing the property after the conversion. Some of the Frey-

Prudential agreements included the Calais and Chatham agreements,

both dated August 1, 1981, the Valleybrook agreement dated

October 1, 1981, Old Forge agreement entered into prior to

October 12, 1981, and The Greens agreement entered into prior to

December 30, 1981.

Frey's agreement that he would share development and

management fees with Kanter entities was formalized in two

separate written agreements each dated October 12, 1981. One

agreement was between Frey and IRA's subsidiary Zeus, and the

other agreement was between Frey and Holding Co.

The written agreement with Zeus covered development fees

from projects in which Prudential apartment properties were being

converted. The letter agreement, from Frey to Meyers (president

- 64 -

of Zeus), referred to Zeus' "Participation in Proceeds on

Prudential Conversions" and provided:

As requested, we are writing to confirm our prior

agreement regarding the participation in the amounts

realized or to be realized on the condominium

conversion of properties of or for The Prudential

Insurance Company of America ("Prudential").

The terms of this letter agreement shall apply

with respect to all conversions of Prudential

properties heretofore and hereafter.

As used in this letter agreement, the term

"amounts realized" includes all amounts to be received

by the converter as Developers' Fees and shares of

assigned profits but excluding any management or other

fees (which shall be retained by the Manager). * * *

* * * * * * *

Of the amounts received as a Developers' Fee on

Prudential conversions, BJF (or its counterpart in any

future conversion) shall retain 75% of the amount

received in reimbursement for any costs and expenses

paid or incurred by it. BJF shall retain this 75%

amount without regard to the actual amount of its costs

and expenses and without any need to account for the

same. Of the remaining 25%, BJF SHALL RETAIN 80% and

shall distribute the remaining 20% to you.

Of the amounts received as shares of assigned

profits, BJF shall distribute 20% to you and retain the

balance. BJF shall retain amounts under this letter

agreement for itself and for distribution to its

affiliates in such percentages as they have agreed.

BJF shall make all distributions to you not later

than 30 days after the date of this letter or receipt

from Prudential of the Developers' Fees and assigned

profits (as the case may be).

Pursuant to this letter agreement, the BJF corporation paid

the following amounts to Zeus during the years 1980 through 1985:

- 65 -

Year Zeus

1980 $127,372

1981 105,764

1982 538,781

1983 110,125

Total 882,042

1984 103,500

1985 128,763

Total 232,263

The second letter agreement was from Frey to Kanter as

president of Holding Co. and specifically excluded developers'

fees from projects involving Prudential properties (covered in

the Zeus agreement) but included other amounts related to

projects involving Prudential. The letter agreement referred to

"Participation in Condominium Conversions" and provided:

As requested, we are writing to confirm our prior

agreement regarding the participation by us and our

affiliates in capital contributions, profits and losses

and Developers' Fees (excluding Developers' Fees in

condominium conversions of properties of or for The

Prudential Insurance Company of America and excluding

legal, management or any other fees, which shall be

retained by the recipients) in condominium conversions

of properties.

The provisions of this letter agreement shall

apply in the case of condominium conversions of those

properties listed below and any other condominium

conversions in which we agree to participate. Each of

us may terminate this agreement at any time on forty-

five (45) days or more prior written notice. The

termination, however, shall be effective only with

respect to new condominium conversions (i.e.

conversions of properties not under discussion between

us or otherwise in process on the last day of the

forty-five (45) day period).

The participation in capital contributions and

profits and losses shall be as follows:

- 66 -

The Holding Company, a Delaware corporation,

its nominees and/or affiliates - ("THC") 33%

Bruce J. Frey and his nominee and/or

affiliates - ("BJF") 67%

The participation in Developers' Fees shall commence

with respect to fees received after October 1, 1981,

and shall be as follows:

Holding Co. 5%

BJF 95%

100%

As used herein, the terms capital contributions,

profits and losses and Developers' Fees refer to those

items allocated or allocable to us and our affiliates.

The properties presently subject to this letter

agreement are those properties which we are converting

as consultant to the Prudential Insurance Company of

America. As you know, we are, of course, also

participating as partners in various other condominium

conversions (e.g. 535 N. Michigan Ave. Condominium,

Lake Howell Condominium, etc.), but our agreements in

those instances are subject to the terms of various

limited partnership agreements.

Pursuant to this second letter agreement, the Frey

corporation paid to Holding Co. $80,616 as a distribution in 1981

and $16,200 from participation in fees in 1983. Payments made in

1982 are not in the record.

On June 15, 1984, BJF Development, Ltd. (the Frey

partnership), an Illinois limited partnership, was formed. Frey,

Wold, and the Frey corporation were the general partners of the

Frey partnership. The limited partners were TSG Holdings, Inc.,

FWID, Ltd., and Holding Co. Under the partnership agreement

Holding Co. was entitled to distributions of 13.125 percent of

- 67 -

available cash-flow. Generally, the purpose of the partnership

was to conduct business activities related to development of

condominiums and cooperatives and property management.

TSG Holdings, Inc. contributed $750,00 to the Frey

partnership. Transcontinental Services Group, N.V., a

Netherlands Antilles corporation and TSG Holdings, Inc.'s parent

corporation, lent $1.75 million to the Frey partnership.

In addition to other assets contributed to the Frey

partnership, the remaining partners assigned their right to

receive fees under other management, consulting, and/or

partnership agreements, including the Village of Kings Creek,

Lakewood, Calais, Chatham, Valleybrook, The Greens, and Galaxy

Towers that had previously been subject to the letter agreement

between Holding Co. and the Frey corporation. The partnership

agreement also listed two participation agreements with "Burton

J. Kanter" regarding certain condominium conversions. The

agreement indicated that the two participation agreements had

been canceled with respect to new condominium conversions.

A letter dated June 20, 1984, to Kanter described Holding

Co.'s obligation to contribute to the capital of the partnership

as follows:

- 68 -

With the recording of the Certificate of Limited

Partnership, The Holding Company should:

a. make its cash capital contribution of

$29,913.80 to the Partnership;

b. pay FWID, Ltd. ("FWID"), $86,789.57 for

contributing cash equivalents to the Partnership

on its behalf;

c. issue a $88,387.46 secured note to FWID for

contributing other assets to the capital of the

Partnership on its behalf; and

d. confirm its agreement to remit to FWID its

share of Partnership distributions resulting from

the Partnership's realization of the fees and

profits shown on Part II of Appendix A.

The parties contributed a total of $170,936 in

cash to the capital of the Partnership. See item 8 of

Part 1 of Appendix A. Of this amount, The Holding

Company is responsible for 17-1/2 percent or, as shown

above, $29,913.80.

The parties contributed a total of $495,940.31 in

cash equivalents to the Partnership. The Holding

Company's share of this amount is, as noted above, 17-

1/2 percent or $86,789.54. The cash equivalents

consist of the items shown as numbers 6, 7, and 9 on

Part I of Appendix A. The items are:

6. October 31, 1983, Agreement with

Lazard Freres & Co. $273,547.00

7. April 14, 1983, Real Estate Sale

Agreement as amended with Norman

Rudenberg and Edna Davidson 211,082.00

9. Furniture, fixtures, and

equipment 11,311.31

Total $495,940.31

As shown in the enclosed chart, The Holding

Company's remaining obligation for capital

contributions to the Partnership was $145,798.66. Of

this amount, The Holding Company satisfied $57,409.20

- 69 -

by the transfer to the Partnership of a 20 percent

interest in the $287,046 of purchase money mortgages

relating to the condominium units at 535 North Michigan

Avenue. Accordingly, after satisfying its share of the

cash capital contributions, The Holding Company's

remaining obligation to FWID is $88,387.46.

The Holding Company now should satisfy its

obligation for the cash contribution to the Partnership

by transferring $29,913.80 in cash to it. The Holding

Company should satisfy its obligation to FWID for the

transfer of the cash equivalents by paying FWID

$86,789.54. In addition, The Holding Company should

satisfy its responsibility for the balance of

$88,387.46 by signing a note for this amount payable to

FWID and pledging as security either third-party paper

or other acceptable collateral.

The note should provide for cash payments as the

Partnership realizes cash from the capital

contributions to it. I believe that you should discuss

the procedures regarding the issuance of the $88,387.46

secured note with Jim Wold or, in my absence, my

associate, Claire Pensyl.

The remaining item is, as noted above, for The

Holding Company to confirm its agreement to remit its

share of Partnership distribution to FWID. The Holding

Company's agreement is to remit distributions (a) only

after The Holding Company has received Partnership

distributions equal to The Holding Company's original

capital contribution of $262,500 and (b) then only in

an amount equal to 13.125 percent of the amount

realized by the Partnership from all the items shown on

Part II of Appendix A. The 13.125 percent equals The

Holding Company's share of all Partnership

distributions under Section 3.2 of the Agreement of

Limited Partnership.

In January 1985, approximately 6 months after the formation

of the partnership, TSG Holdings purchased additional interests

in the Frey partnership for $1,382,575, of which $241,950 was

payable to Holding Co. The purchase price was paid to Holding

- 70 -

Co. in two installments. The letter dated January 8, 1985,

accompanying the first installment provided as follows:

Enclosed is FWID, Ltd. check number 113 in the

amount of $66,507.00. This check represents your

allocable share of the above-mentioned transaction

after reducing your loan from Bruce Frey by one-half,

or $44,194.00.

The following is a brief analysis of the

transaction, your allocable share and a calculation of

the manner in which check number 113 was derived:

1. Gross Sales Price $1,382,575

2. Ownership Percentage of

BJF Development, Ltd.

(11.1895 divided by 63.94 percent) 17.5

3. Allocable Share of Gross Sales

Proceeds 241,950

4. Sales Proceeds Received to Date 632,575

5. Allocable Share of Sales Proceeds

Received to Date 110,701

6. Less: One-Half of Outstanding Loan

from Bruce Frey

($88,388.00 divided by 2) 44,194

7. Check Number 113 $66,507

The letter dated January 24, 1985, accompanying the second

installment provides as follows:

Enclosed please find check number C 1148 in the

amount of $131,250.00. This check represents the

second and final installment payment with regard to

your sale of partnership interest in BJF Development,

Ltd. to TSG Holdings.

- 71 -

The entire second installment payment to the

selling partners was $750,000.00. Your allocable share

of the transaction was 17.5 percent, thus equaling the

$131,250.00.

From 1984 through 1987, the Frey partnership paid a total of

$403,954 to Holding Co. ($113,827 in 1984, $256,557 in 1985, and

$33,570 in 1987). Of the $113,827 paid in 1984, $98,437 was

identified as a distribution and $25,391 as Holding Co.'s share

of fees. Of the $256,557 paid in 1985, $197,757 was Holding

Co.'s share of proceeds from the sale of the additional

partnership interest to TSG Holdings, $55,950 as a distribution,

and $2,850 represented participation in developers' fees.

C. The Schaffel Arrangement: Real Estate Construction and

Financing

Schaffel was a mortgage broker and a real estate developer.

In the summer of 1979, Kanter invited Schaffel to dinner at a New

York City restaurant to discuss a business proposition. He told

Schaffel that Ballard and Lisle would also be joining them for

dinner. Schaffel accepted Kanter's invitation. In addition to

learning more about the potential business opportunity that

Kanter had mentioned, Schaffel was eager to meet and socialize

with Ballard and Lisle, as he knew that they were senior

Prudential real estate executives.

During the dinner, Kanter asked whether Schaffel would be

interested in arranging the financing for a casino hotel to be

built in Atlantic City, New Jersey. Prudential was not involved

- 72 -

in that project. Kanter offered to introduce Schaffel to the

people who wanted to build the casino hotel provided Schaffel

would agree to pay to one of Kanter's entities 50 percent of

Schaffel's brokerage fee earned in the transaction. Schaffel

agreed to pay the fee to an entity that held a real estate

brokerage license. The casino hotel project, however, never

materialized.

Although the casino hotel project fell through, Schaffel

agreed to share certain finder's fees with Kanter in other

projects. With Kanter's "concurrence", Schaffel negotiated a

finder's fee arrangement with Benedict Torcivia (Torcivia),12 the

sole shareholder of Torcon, Inc. (Torcon). At the time, Torcon

was probably the largest general contracting company in New

Jersey. By letter agreement dated July 23, 1979, Torcivia agreed

to pay Schaffel a fee for any construction projects that Schaffel

helped obtain for Torcon. The agreement reached between Kanter

and Schaffel as applied to Schaffel's arrangement with Torcon was

set forth in a letter agreement with IRA dated August 2, 1979, as

follows:

The purpose of this letter is to confirm that I

will pay you fifty (50%) percent of any fees received

by me with respect to construction jobs obtained for

Torcon, Inc. in which I determine that you or your

associates have been instrumental or helpful. My

arrangement with Torcon, Inc. concluded with your

12

Prior to 1979, Schaffel had rented office space from

Torcivia.

- 73 -

concurrence that said Company will pay to me one (1%)

percent based on the gross amount of the contract price

of any such construction job. It is our understanding

that you will receive payment ordinarily over a period

of time depending on draws under the construction job.

Accordingly, you will expect to receive payment only as

I am paid.

It is further understood that the foregoing

pertains only to negotiated contract situations and

should any bid situation arise, the amount of your

participation will be negotiable.

Schaffel also entered into a finder's fee arrangement with

William Walters (Walters), a real estate developer in Denver,

Colorado, similar to the one with Torcivia, and agreed to share

those fees with IRA.

1. Schaffel/Prudential Transactions

As a result of his introduction to Lisle and Ballard,

Schaffel began doing millions of dollars' worth of business with

Prudential. These business dealings included construction

contracts that he helped obtain for Torcon and financing for a

number of large commercial real properties being developed by

Walters, as well as transactions involving others.

The first transaction Schaffel negotiated with Prudential

was the sale of the IBM headquarters building in Lexington,

Kentucky. The property was brought to Schaffel's attention by

Transatlantic Consultants (Transatlantic), the company brokering

the sale. Schaffel introduced the Transatlantic representative

to Ballard. After the initial meeting with Ballard,

Transatlantic dealt with Prudential's local office in Kentucky.

- 74 -

Seven months after the initial meeting with Ballard, Prudential

bought the building. Schaffel received a fee from brokering the

sale of the building and paid half of the fee to IRA.

Some of the projects Schaffel assisted Torcivia in obtaining

with Prudential included the Parsippany Business Campus, the

Parsippany Hilton Hotel (located outside of Newark, New Jersey),

the Gateway (located in Newark, New Jersey), and the Interplex

Complex (located in Princeton, New Jersey).

Walters agreed to pay Schaffel a finder's fee with respect

to two joint ventures that Walters helped negotiate with

Prudential. Schaffel entered into separate written agreements

dated October 19, 1981, with Cherry Creek Place Associates II

(Prudential funding of $15.6 million) and Aurora Plaza &

Conference Center, Ltd. (Prudential funding of $17 million), with

respect to the joint ventures. In each agreement, the

partnership acknowledged that Prudential's participation in the

venture was primarily the result of Schaffel's efforts and that

Schaffel was entitled to be compensated.

From 1979 through 1983, pursuant to his arrangement with

Kanter, Schaffel shared with IRA fees from these business deals

with Prudential. Schaffel paid the following amounts from

Prudential transactions to IRA from 1979 through 1983:

- 75 -

Year Amount

1979 $100,000

1980 244,920

1981 361,525

1982 447,450

1983 30,981

Total 1,184,876

After Ballard and Lisle left Prudential, Schaffel no longer

negotiated any transactions with Prudential.

2. Schaffel/Travelers Transactions

Lisle left Prudential in late 1981. He was employed by

Travelers from April 1982 until April 1988. After Lisle began

working for Travelers, Schaffel met with Lisle and others from

Travelers. Thereafter, Schaffel began brokering substantial

business dealings with Travelers on behalf of Torcon and Walters.

The first project Walters entered into with Travelers was

Stanford Place II. By check dated November 9, 1983, Schaffel

paid IRA $213,750 of the fee earned from Stanford Place II.

After that payment, Schaffel stopped paying IRA a share of the

fees earned on business deals with Travelers. Sometime during

1984, Kanter contacted Schaffel and asked why IRA was not

receiving 50 percent of Schaffel's fees on Travelers

transactions. Schaffel took the position that the August 2,

1979, agreement did not apply to deals with Travelers after Lisle

had left Prudential. Kanter disagreed and maintained that the

August 2, 1979, agreement continued to apply.

- 76 -

In a letter dated August 28, 1984, to Schaffel, Kanter

stated:

I am bothered by your failure to respect what I would

have considered the essential intent of the agreement

you entered into vis-a-vis the introduction of you to

Prudential and the arrangement under which you would

share the benefits of that introduction in connection

with real estate transactions from which you were able

to earn commissions, as well as the other construction

contracts won by Ben [Torcivia].

I appreciate that there may be some technical

difficulty with the previous agreements as to whether

they extend in the new circumstances to Travelers.

However, in my view Travelers has replaced Prudential

as a principal source of transactions because of the

very personnel to whom you were first introduced.

Accordingly, I am inclined to believe that the

arrangement should have been continued.

Lisle and Schaffel discussed the dispute between Schaffel

and Kanter. Lisle feared a lawsuit might result, and because

such a lawsuit might cause some embarrassment for Lisle at

Travelers, he urged Schaffel to settle the dispute.

Schaffel agreed to resume paying 50 percent of his fees on

business deals with Travelers. Those fees, however, were paid to

Holding Co. rather than IRA.

For some of the Walters projects brokered by Schaffel,

Travelers entered into joint venture agreements with Walters'

company pursuant to which Walters' company contributed the

property and Travelers provided the financing. Travelers entered

into joint ventures with Walters' company for the permanent

financing of Stanford Place II (Travelers provided $15 million

- 77 -

plus a $31.5 million loan), Cherry Creek National Bank (Travelers

provided $8.25 million plus a $19.95 million loan), the Stanford

Corporate Center (Travelers provided $43,612,622), and Boettcher

Building (a.k.a the Boston Building) (Travelers' contribution to

this project is not reflected in the record). For other Walters

projects brokered by Schaffel, Travelers provided financing

without becoming a partner in the underlying joint venture.

These projects included Orchard Place VIII (Travelers provided a

$9 million loan), Orchard Place VII (Travelers provided a $8.5

million loan), and Cherry Creek Place III (Travelers provided a

$10.8 million loan).

From 1984 through 1986, Schaffel paid a share of his fees on

Walters-Travelers transactions to Holding Co. in the following

amounts:

Year Amount

1984 $600,000

1985 1,160,000

1986 1,003,500

Total 2,763,500

3. FPC Subventure Associates Partnership

On March 21, 1980, Kanter acquired an 8-percent limited

partnership interest in Four Ponds Center Associates (Four

Ponds), a joint venture involving Schaffel and Torcivia. On his

1980 Federal income tax return, Kanter reported his share of the

partnership's losses.

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The FPC Subventure Associates partnership (FPC Subventure)

was formed as of January 1, 1981. The partners of FPC Subventure

and their respective interests were: Lisle, 90 percent; the

Everglades Trust (Roger Baskes, trustee), 9 percent; and Burton

W. Kanter Revocable Trust (Kanter trustee), 1 percent. On

January 1, 1981, Kanter transferred his 8-percent interest in

Four Ponds to FPC Subventure, effectively transferring 90 percent

of his interest in Four Ponds to Lisle in exchange for a

receivable of $2,880 from Lisle.

A joint venture called One River Associates (One River) was

formed as of November 16, 1981. Schaffel and Torcivia were the

general partners. Kanter held an 8-percent interest in One

River. On January 1, 1982, Kanter transferred his interest in

One River to FPC Subventure in exchange for a $2,000 receivable

from FPC Subventure. Beginning in 1982, the 8-percent interest

in One River held by Kanter was treated as held by FPC

Subventure, and 90 percent of the income, loss, and distributions

were allocated to Lisle.

On April 5, 1982, Four Ponds distributed $400,000 to Kanter.

Kanter treated the distribution as a distribution to FPC

Subventure. FPC Subventure retained $5,000 and distributed

$395,000 to the partners, 90 percent to Lisle and 10 percent to

the Kanter trusts. An additional $33,600 was distributed by Four

Ponds to FPC Subventure through Kanter during 1982. During 1982

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Lisle received total distributions of $384,840 from FPC

Subventure. Kanter and Lisle reported on their tax returns their

respective distributive shares of the FPC Subventures'

partnership's income and losses.

D. The Schnitzer Arrangement: Sale and Repurchase of Property

Management Systems Stock.

During the 1960's and 1970's, Schnitzer was a major real

estate developer in the Houston, Texas, area. Schnitzer met

Ballard and Lisle when they worked in Prudential's regional

office in Houston, probably in the late 1960's.

Schnitzer had been involved in developing and managing high-

rise office buildings through Century Development Co., Inc.

(Century Development), a subsidiary of Century, Inc. (Century),

Schnitzer's family holding company.

The real estate development business, however, typically was

cyclical. In 1974, to diversify its operations and to secure a

steady source of earnings, a subsidiary of Century acquired for

$1.3 million the assets of a small real estate management company

called Fletcher Emerson Co., Inc. (Fletcher Emerson).13 Fletcher

Emerson managed office buildings and other commercial real

estate. A relatively small portion of its business included

13

The $1.3 million purchase price was roughly based on a

multiple of five times net earnings. At the time, the company

had before-tax net income of $250,000.

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cleaning or janitorial services on some Texas commercial

properties it managed.

Shortly after Century's subsidiary acquired the assets of

Fletcher Emerson, the subsidiary's name was changed to Fletcher

Emerson Co. and then to Property Management Systems, Inc. For

convenience Property Management Systems, Inc., is hereinafter

referred to as Schnitzer-PMS. Schnitzer became the chairman and

chief executive officer of Schnitzer-PMS.

Originally, Schnitzer-PMS's property management business was

conducted primarily in Houston and Dallas, Texas. Schnitzer-PMS

usually managed office buildings and other commercial real estate

owned by others under property management contracts on a month-

to-month basis. Schnitzer wanted to expand the size of

Schnitzer-PMS's property management business, as Schnitzer-PMS

typically earned only a relatively modest profit margin on its

individual property management contracts. Schnitzer felt that

the only way to increase Schnitzer-PMS's profits was having a

large volume of such management contracts.

Fletcher Emerson had been managing a relatively small number

of Prudential's commercial real properties when Century acquired

its assets in 1974. Schnitzer wanted to develop business from

Prudential and American Building Maintenance Industries (AMBI).

To that end, Schnitzer offered AMBI the opportunity to acquire 50

percent of the company. AMBI, however, declined the offer.

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In 1974, Schnitzer approached Ballard (who Schnitzer had

known for many years and previously had dealt with in developing

office buildings in Houston, Texas) and offered to have Century

give Prudential a 50-percent stock interest in Schnitzer-PMS.

Although Prudential would not be required to pay for the 50-

percent Schnitzer-PMS stock interest, Schnitzer hoped Prudential

would award Schnitzer-PMS a large number of additional property

management contracts. Ballard informed his superiors at

Prudential of Schnitzer's offer.

Initially, Prudential was interested in Schnitzer's offer

and invited Schnitzer to Prudential's Newark, New Jersey,

corporate headquarters for further meetings and discussions with

Prudential's management. Schnitzer met with Prudential's senior

executives and corporate headquarters staff, including

Prudential's chairman, and with Knab (who headed Prudential's

real estate department). Prudential was particularly interested

in standardizing the reports it received on the operation of its

various commercial real properties around the country. However,

Prudential ultimately declined Schnitzer's offer because of the

substantial number of pension plans whose real estate investment

accounts Prudential managed. Prudential believed that having an

ownership interest in Schnitzer-PMS might be a potential conflict

of interest and might present problems under the pension laws.

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Ballard introduced Schnitzer to Kanter sometime between the

early and mid-1970's. At some time prior to September 1976,

Schnitzer and Kanter began discussing the sale of a stock

interest in Schnitzer-PMS to Kanter. Kanter indicated that,

through his business contacts, including the Pritzker family, he

could obtain additional property management business for

Schnitzer-PMS. Before Schnitzer made the offer to Kanter,

Schnitzer had a conversation with Ballard to confirm that Kanter

could bring in business for Schnitzer-PMS.

The initial proposal contemplated that Schnitzer-PMS would

be recapitalized in order to provide for the issuance of two

classes of stock, common and preferred. The preferred stock

would be $1,000 par value per share, one vote per share, priority

as to dividends, when, if, and as declared out of available

earnings and profits up to a maximum of 8 percent of the par

value in the year of declaration, and priority on liquidation.

The common stock would be no par common stock carrying one vote

per share. Kanter's client (IRA) would purchase 50 percent of

the common stock for $50,000 and closing would be set for October

1, 1976.

Because of difficulties in finalizing the agreement,

however, closing did not take place in 1976. In a letter dated

April 12, 1977, to Melvin Dow, Kanter stated:

As you know, the president of The Cedilla Company is

Mildred D. Schott and The Cedilla Company is actively

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engaged in certain phases of real estate activity. We

are hopeful that the sooner the acquisition of * * *

[Schnitzer-PMS] shares can be closed, the sooner that

serious efforts can begin to create that synergism that

could result in a sharply expanded business for * * *

[Schnitzer-PMS] in its property management through the

extensive contacts Schott maintains, the broad scope of

opportunity that may be available to Solomon A. Weisgal

and the opportunities that may arise in the course of

my practice which involves representation of numerous

very wealthy groups holding large property interests.

By letter agreement dated November 7, 1977, Kanter and

Schnitzer agreed that Schnitzer-PMS would be recapitalized and

reorganized as a Delaware corporation with an authorized

capitalization of 250 voting preferred shares of $1,000 par value

each and 108 voting common shares of $1 par value each. Each

preferred share would be entitled to a cumulative preferred

dividend of $80 per year, plus a special one-time dividend equal

to 1/250 of the indebtedness of Schnitzer-PMS to American General

Investment Corp. existing at the time the special dividend was

declared. The special dividend was to be declared when the

assets of the corporation available for payment of dividends

equaled the remaining amount outstanding on the loan. At the

time of the reorganization, $1.1 million that Century Development

had borrowed to purchase Fletcher Emerson was still owing. The

purpose of the special dividend was to permit Century Development

to recover its initial investment. Kanter's client (IRA) had the

option to purchase 51.3 shares of common stock (47.5 percent of

the common stock) in Schnitzer-PMS for $150,000.

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The reorganization was completed on January 31, 1978, and

51.3 shares of the common stock of Schnitzer-PMS were issued to

IRA on February 14, 1978. All shares of Schnitzer-PMS (including

those issued to IRA) were pledged to secure Century Development's

loan balance.

In conjunction with the sale of the Schnitzer-PMS stock to

IRA, IRA and Century entered into a stock agreement. Article III

of the agreement gave Century an option to purchase the

Schnitzer-PMS stock upon the death of last to die of Kanter,

Weisgal, and Schott. Section 3.03 of the stock agreement

provided that the purchase price for IRA’s shares of Schnitzer-

PMS stock would be an amount equal to the sum of:

(a) Eight (8) times the average annual pretax

operating income of the Corporation for the five (5)

full fiscal years of the Corporation ending on or

immediately preceding the Option Date or such lesser

number of full years of operation of the Corporation as

shall have expired from the date of this Agreement;

plus

(b) The difference (but not less than zero) between

(i) the book value of the assets of the Corporation

used in its business of building management, consulting

and cleaning and (ii) the lesser of Three Hundred

Thousand Dollars ($300,000) or one and one-half (1-1/2)

times the Corporation’s average receipts for one (1)

month, computed for the twelve (12) month period

immediately preceding the Option Date; plus

(C) The fair market value of any other assets of the

Corporation.

The computation of operating income in Subsection (a)

hereof shall be computed solely with reference to the

Corporation’s business of building management,

consulting and cleaning. The computation of the

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purchase price shall be made by the certified public

accountants regularly retained by the Corporation.

By late 1977, Schnitzer-PMS's property management business

had increased substantially. Although Prudential had declined

Schnitzer's offer to give Prudential an interest in Schnitzer-

PMS, Prudential became Schnitzer-PMS's biggest customer.

Pursuant to Schnitzer's discussions with Prudential's management

and corporate headquarters staff in 1974, Schnitzer-PMS

standardized its reports on the Prudential commercial real

properties that Schnitzer-PMS managed. By 1977, Schnitzer-PMS

had expanded its property management operations to other cities

around the country, including Atlanta, Georgia, Los Angeles and

San Francisco, California, Newark, New Jersey, and Portland,

Oregon.

Schnitzer-PMS year-end balance sheets and profit/loss

statements for 1976 through 1978 showed the following:

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Assets 1976 1977 1978

Current $529,225 $527,025 $690,257

Property 97,913 127,645 133,970

Other 8,142 36,542 137,459

Total 635,280 691,212 961,686

Liabilities

Current 287,829 156,947 237,681

Long-term 6,515 21,647 33,935

Stockholder equity

Common 1,000 1,000 108

Preferred n/a n/a 250,000

Contributed capital 200,000 200,000 n/a

Retained earnings 139,936 311,618 439,962

Total 635,280 691,212 961,686

Earnings

Revenues

Property management 1,044,173 1,448,101 --

Cleaning 2,343,512 2,811,034 --

Other 39,411 41,352 --

Total 3,427,096 4,300,487 5,977,383

Costs & expenses

Property management 255,824 266,794 4,064,014

Cleaning 1,986,343 2,483,019

General 864,715 1,095,499 1,078,503

Interest 2,599 4,117 3,037

Total 3,109,481 3,849,429 5,145,555

Pretax earnings 317,615 451,058 831,828

Tax allocation 143,163 155,527 --

Net earnings 174,452 295,531 --

By March 1979, Schnitzer had decided that Schnitzer-PMS

should have received more opportunities for new business from

Kanter and his associates and informed Kanter that he wanted to

repurchase the stock held by IRA. Kanter and Schnitzer decided

that one party would set a price at which that party was willing

to either sell its stock to the other or buy the other's stock.

By letter dated July 17, 1979, Kanter informed Schnitzer that IRA

would sell its stock in Schnitzer-PMS or purchase Century

Development Corp.'s stock in Schnitzer-PMS for $3.1 million.

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Schnitzer agreed to buy back IRA's stock for $3.1 million. On

November 30, 1979, Century repurchased the 47.5-percent owned by

IRA in July 1979, for $3.1 million, payable over a 10-year period

with interest. At the time of the repurchase, approximately

$700,000 remained outstanding on the loan from the original

purchase of the Fletcher Emerson assets.

Schnitzer-PMS balance sheets and profit/loss statements for

6 months ending June 30, 1978 and June 30, 1979 showed the

following:

6/30/78 6/30/79

Assets

Cash $124,632.16 $284,760.00

Life insurance 41,968.71 96,144.81

Accounts receivable 555,308.63 496,200.83

Supplies 3,450.04 14,614.58

Prepaid expenses 13,877.99 45,007.01

Transportation equipment 14,101.56 17,268.74

Other equipment 116,190.70 130,547.74

Total 869,529.79 1,084,543.71

Liabilities

Accounts payable 6,569.23 --

Accrued payroll expense 97,763.69 134,094.52

Other accrued expenses 109,892.85 121,486.51

Total 214,225.77 255,581.03

Stockholder's equity

Capital stock 250,108.00 250,108.00

Retained earnings 384,885.60 1,198,788.79

Funds to CDC (431,036.94) (955,412.90)

1977 net income 451,347.36 n/a

1978 net income n/a 335,478.79

Total owner's equity 655,304.02 828,962.68

Total liabilities & 869,529.79 1,084,543.71

equity

- 88 -

6/30/78 6/30/79

Profit/Loss (6 months) 2,916,478.65 3,650,217.86

Gross income 1,824,034.25 2,485,250.27

Operating expenses 1,092,444.40 1,164,967.59

Operating income 542,291.04 740,191.69

Overhead expense 550,153.36 424,775.90

Income before acquisition 98,806.00 89,178.98

Acquisition expense 451,347.36 335,596.92

Net income

Around the end of 1979 or early 1980, Schnitzer discussed

the sale of Schnitzer-PMS to Minneapolis Honeywell for a price

between $12 million and $13 million. Honeywell, however, decided

not to purchase Schnitzer-PMS.

In 1989, IRA accepted a reduced final payment for early

payment of the balance due on the sale of the stock.

IRA received the following payments of principal and

interest and reported the following gain on the installment sale

of the Schnitzer-PMS stock:

Year Payment Principal Interest Gain

1979 $150,000 $150,000 -- $142,740

1980 533,425 211,468 $321,957 201,233

1981 534,696 309,308 225,388 294,338

1982 361,692 172,441 189,251 164,094

1983 361,692 186,655 175,037 177,621

1984 361,692 202,042 159,650 192,263

1985 361,692 218,696 142,996 208,111

1986 361,692 236,724 124,968 225,266

1987 361,692 256,217 105,475 243,816

1988 361,692 277,360 84,332 263,936

1989 840,423 822,841 17,582 783,016

Total 4,590,388 3,043,752 1,546,636 2,896,434

E. The Eulich Arrangement: Essex Hotel Management Co.

1. Eulich's Background

For many years, Eulich had been a real estate developer of

office buildings, shopping malls, and warehouses in Houston and

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Dallas, Texas. Eulich had known Ballard and Lisle since at least

1965. Eulich dealt with Ballard and Lisle in connection with

Prudential's financing his real estate development work, when

Ballard and Lisle worked in Prudential's Houston regional

office.14 Eulich was also a close personal friend of A.N.

Pritzker. Eulich met Kanter through Pritzker in the late 1960's

or early 1970's. Kanter and Eulich had many business dealings

with each other. Kanter helped raise capital for some of

Eulich's business ventures.

Eulich's real estate development activities were primarily

conducted through Vantage, Inc., a corporation that he owned. In

1968, Eulich acquired Rodeway Inns, a company that owned a small

chain of garden court motels. Over the years, Rodeway Inns

increased the number of its motels. Rodeway Inns and Eulich

obtained financing from Prudential for the acquisition of many of

the additional motels. From 1968 through about 1973, Eulich

dealt with Ballard in securing the financing from Prudential for

Rodeway Inns.

In about 1974, Eulich and Prudential became dissatisfied

with the performance of the hotel management company that was

managing and operating 16 Rodeway Inns motels that had been

financed by Prudential. Eulich decided to establish his own

14

After Lisle began working for Travelers in 1982, he dealt

with Eulich in connection with the managing of Travelers'

properties.

- 90 -

hotel management company, Motor Hotel Management, Inc. (Eulich-

Management), to operate the motels. Eulich-Management was

incorporated on January 1, 1975.

Eulich asked Robert James (James) who had substantial hotel

management experience, to serve as Eulich-Management's president

and to manage Eulich-Management's day-to-day operations. Eulich-

Management's three shareholders eventually included Eulich (who

was the majority shareholder), James, and another longtime

business associate of Eulich.

By the end of 1975, Eulich-Management had 17 management

contracts that were part of the joint venture in which Prudential

was the lender and Eulich's company Vantage, Inc., was the

developer. By the late 1970's, Eulich-Management had a good

reputation in providing hotel management services. Prudential's

real estate department staff generally was satisfied with Eulich-

Management's management of a number of hotel properties in which

Prudential was involved. By about the early 1980's, Eulich-

Management managed hotel properties nationwide in about 20 to 25

States. At that time, however, Eulich-Management did not manage

large hotels.

2. Prudential's Gateway Hotel

In about 1976, Ballard decided that Prudential's real estate

department needed to hire an individual possessing substantial

expertise in hotels and hotel operations. Allen Ostroff

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(Ostroff) had worked for a number of years for Hilton Hotels as a

hotel manager and executive. Ballard hired Ostroff to serve as

Prudential's in-house consultant on hotels and hotel operations.

When Ostroff began working for Prudential, the real estate

department staff in Prudential's regional offices negotiated

hotel management contracts for Prudential's hotel properties on

an ad hoc basis. By 1979, Ostroff had devised a model hotel

management contract that Prudential's real estate department

staff could use in negotiating such management contracts.

Ostroff also worked on various hotel projects with Knab, Ballard,

and Lisle.

One of Ostroff's first assignments at Prudential was to

improve the operating condition of the Gateway Hotel located a

few blocks from Prudential's corporate headquarters in Newark,

New Jersey. Prudential had recently acquired the Gateway Hotel

through foreclosure, and the hotel was in shabby condition.

Moreover, Prudential wanted to upgrade the hotel because

Prudential executives and individuals transacting business at

Prudential's headquarters office frequently stayed at the hotel.

Ostroff first obtained a Hilton franchise for the Gateway

Hotel.15 Ostroff next hired a new hotel management company to

15

Although Hilton Hotels had been reluctant to grant

Prudential a franchise, Ostroff obtained the franchise by

pointing out to Hilton Hotels the other profitable business

dealings it had with Prudential.

- 92 -

take over the Gateway Hotel's management and operation. The new

management company was owned by Stanley Cox (Cox), an experienced

hotel manager Ostroff had known during Ostroff's prior employment

with Hilton Hotels. At some point, Cox assigned John Connolly

(Connolly) to be the Gateway Hotel's on-site manager.

Ostroff was extremely successful in turning around and

substantially improving the Gateway Hotel's operating condition.

Prudential executives made significant use of the hotel

facilities for meetings and entertainment and were very pleased

with the service that they and their guests received at the

hotel.

Cox did not spend much of his own time in actually running

the Gateway Hotel. Over the years, he had delegated more and

more duties in the hotel's operation to Connolly. Connolly

frequently interacted with Prudential executives, including

Ballard and Lisle. Sometime in 1978 or 1979, Connolly met Kanter

at the Gateway Hotel.

In 1981, Connolly informed Ostroff that he was considering

leaving his position as on-site manager of the Gateway Hotel,

because he felt he was not being adequately compensated for his

services. Ostroff attempted unsuccessfully to have Cox increase

Connolly's pay. Ostroff and his superiors at Prudential,

including Ballard, decided to terminate Prudential's management

- 93 -

contract with Cox and to award the management contract to

Connolly.

Ostroff told Connolly that Prudential wanted him to manage

the Gateway Hotel. Ostroff informed Connolly that he would have

to establish a management company of his own and that all hotel

employees would have to be employees of Connolly's hotel

management company.16 Establishing such a hotel management

company, however, presented a problem for Connolly. The

management company would be required, among other things, to

employ a financial manager and an accounting staff to prepare and

issue the financial reports required by Prudential on the Gateway

Hotel's operations. The full-time employment of such personnel

to perform these and other required services could well be

uneconomical, since Connolly's company would be managing only one

or two hotels.

Ballard introduced Connolly to Eulich. Eulich also knew

Kanter from certain prior business ventures in which Kanter had

helped raise capital. Kanter and Eulich were aware Connolly

would need assistance for his hotel management company. Eulich

also wanted Eulich-Management's business to include the

management of a number of large hotels. He believed that

16

Prudential did not want to have its employees involved in

operating the hotel and did not want any of the hotel's employees

to be Prudential employees.

- 94 -

Kanter's business contacts, including contacts with the Pritzker

family, could be beneficial to Eulich-Management.

Eulich, Kanter, and Connolly decided to organize several

entities to further their objectives. A hotel management company

called Gateway Hotel Management Corp. (Gateway Corp.) was

incorporated in 1981. Another corporation, Essex Hotel

Management Co. (Essex Corp.), was also formed.

A letter from Eulich to Connolly dated October 16, 1981,

indicated that Eulich provided $10,000 for the initial

capitalization of Gateway Corp. The letter also indicated that

initially Essex Corp. owned 80 shares (80 percent) of the Gateway

Corp. stock, that Connolly owned 20 shares (20 percent), and that

Connolly had an option to purchase Essex Corp.'s 80 shares.17

17

The letter stated:

Per our telephone conversation today, I am enclosing

the following material:

1. Your 20 shares of stock in Gateway

Hotel Management Company

representing 20% of the company.

2. A xerox copy of 80 shares of stock owned

by Essex Hotel Management Company

representing 80% of the company.

3. A copy of the minutes of the first

meeting of the Board of Gateway - the

original is being circulated for

signature and will be sent for signature

soon.

4. A xerox copy of your option on the Essex

(continued...)

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By March 2, 1982, however, Connolly owned 100 shares (100

percent) of the Gateway Corp. stock. A stock option agreement

"made and entered into" September 18, 1981, but "executed as of"

March 2, 1982, recites that Connolly owned 100 shares of $1 par

value common stock of Gateway Corp. Under the stock option

agreement, Connolly granted Essex Corp. a 10-year option to

purchase 80 shares of the common stock of Gateway Corp. for $100

per share.18 In consideration for the option, Essex Corp. agreed

to pay Connolly $1,000 per year for the term of the option.

Eulich, Kanter, and Connolly also formed a partnership

called Essex Hotel Management Co. (the Essex partnership or

Essex), which was organized effective January 1, 1982. The

(...continued)

Hotel Management Company stock - the

original is being circulated for

signature currently.

As we discussed on the phone, we will be sending you a

check for $10,000.00 which represents the

capitalization of Gateway that should be used as the

corporation's initial bank deposit. When the first

profit distribution is made we would appreciate your

sending us a check for $2,000 representing 20% of this

capital.

If you have any questions about this transaction,

please let me know. We are looking forward to working

with you in what is hopefully a mutually pleasant and

profitable venture.

18

On Dec. 21, 1984, Essex Corp. assigned its option to

purchase the 80 shares of Gateway Corp. to the Essex partnership.

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partners of Essex and their partnership interests were as

follows:

Partner

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