Opinion

Rochlis v. United States

Court: United States Court of Federal Claims
Filed: Jan 14, 2020
Status: Published
Cited by: 0 cases
Authority: More cited than 10.1%

“It is ‘undisputed’ that the Court of Federal Claims possesses the authority to adjudicate tax refund claims.”

How later courts described this case

“It is ‘undisputed’ that the Court of Federal Claims possesses the authority to adjudicate tax refund claims.”
“theft of services . . . [is] not . . . considered a criminal offense in the absence of special legislation”
The court acknowledges, however, that “[a]lthough decisions of the Tax Court are not binding on this court, the Tax Court ‘is a specialized court with expertise in tax matters.’”
“[I]n the context of tax refund suits, the [Supreme] Court has held that the Court of Federal Claims's Tucker Act jurisdiction is limited by the Internal Revenue Code, including 26 U.S.C. § 7422(a).”

Written by the judges who cited it.

The opinion

In the United States Court of Federal Claims

Nos. 16-200T; 16-201T; 16-210T

Filed: January 14, 2020

* * * * * * * * * * * * * * * *

JON A. ROCHLIS, ANNE R. LAVIN, *

JON ROCHLIS AS EXECUTOR OR * Trial; Tax; Federal Tax

THE ESTATE OF IRENE M. ROCHLIS * Deductions; Theft Loss; 165

(AKA WARREN), * U.S.C. § 165; Treas. Reg. 1.165;

KENNETH ISHII, and SHERYL A. * State law; Constructive Sale.

ISHII, *

Plaintiffs, *

v. *

UNITED STATES, *

Defendant. *

* * * * * * * * * * * * * * *

Brian G. Isaacson, Isaacson Law Firm, Seattle, WA for plaintiffs.

Benjamin C. King, Jr., Trial Attorney, Department of Justice, Tax Division, Court

of Federal Claims Section, Washington, D.C., for the defendant. With him were Mary M.

Abate, Assistant Chief, Court of Federal Claims Section, David I. Pincus, Chief, Court

of Federal Claims Section, and Richard E. Zuckerman, Principal Deputy Assistant

Attorney General, Tax Division, United States Department of Justice.

OPINION

HORN, J.

The plaintiffs, Jon A. Rochlis, Anne R. LaVin, Jon Rochlis as Executor of the Estate

of Irene M. Rochlis (aka Warren), Kenneth Ishii, and Sheryl A. Ishii, filed complaints in the

United States Court of Federal Claims, seeking a tax refund from an alleged theft loss in

2009 as a result of the purported investments by Derivium Capital, LLC (Derivium). After

all plaintiffs filed claims for refund with the Internal Revenue Service (IRS) in 2013 for the

tax year 2009, all plaintiffs subsequently filed complaints in each of the above captioned

cases. The complaints and amended complaints in Case Nos. 16-200T, 16-201T, and

16-210T are substantially similar except for the amounts plaintiffs allege they lost due to

the theft at issue and the amount they seek to recover. 1 A three day trial was held and

1The court refers to Jon A. Rochlis, Anne R. LaVin, Jon Rochlis as Executor of the Estate

of Irene M. Rochlis (aka Warren), Kenneth Ishii and Sheryl A. Ishii together as the

plaintiffs. All the plaintiffs were represented by the same counsel of record, Mr. Isaacson,

and the cases all were tried simultaneously. When addressing an individual plaintiff, this

post-trial briefings on the legal and factual issues raised in these cases were filed by all

parties. After review of the transcripts, the testimony, the exhibits entered into the record

and the submissions subsequently filed by the parties, the court makes the following

findings of fact.

FINDINGS OF FACT

Derivium Capital

The parties stipulate2 that Charles Cathcart, “a Ph.D. economist, developed the

concept for a 90% stock loan program in 1997, and in the same year began promoting a

variety of 90% Loan products through FSC First Security Capital (Texas), which he co-

owned with several individuals, including Kenneth Calvert, David Kekich, Rob Rawlings,

and Clifford Lloyd.” (internal references omitted). The joint stipulations provide that “[i]n

1998, [Charles] Cathcart relocated the 90% Loan Program to Charleston, South Carolina

in order to exercise more control over it. In Charleston, [Charles] Cathcart formed First

Security Capital, LLC (‘FSC’), and thereafter FSC Texas ceased operations.” According

to the joint stipulations, Charles Cathcart held a 50% ownership interest in FSC and he

served as President. The joint stipulations indicate that “[e]ffective January 1, 2000, FSC’s

name was changed to Derivium Capital, LLC,” and “Derivium eventually bought out Lloyd,

Calvert, Rawlings and Kekich’s interests. By 1998, ownership of FSC was allocated as

follows: [Charles] Cathcart 50%, [Yurij] Debevc 25% and Scott [Cathcart] 25%.”3

Opinion identifies the plaintiff by individual name. The court notes, however, that Irene M.

Warren is identified in a number of different ways in the filings and the documents in Case

No. 16-201T. The complaint and amended complaint in Case No. 16-201T identified the

plaintiff as “Irene M. Rochlis (aka Warren),” and the second amended complaint identified

the plaintiff as “Jon Rochlis as Executor of the Estate of Irene M. Rochlis (aka Warren).”

Other filings in Case No. 16-201T identify the plaintiff as as the “Estate of Irene M.

Rochlis,” still others as “Irene Rochlis.” The court notes that the Master Loan Agreement,

discussed below, was signed by “Irene M. Warren,” therefore, when referring to actions

taken by the plaintiff in Case No. 16-201T regarding the Derivium transaction, the court

refers to the plaintiff as “Irene M. Warren.”

2 The joint stipulations in the above captioned cases come not only from agreement by

the named parties for these cases, but also are stipulations to facts that were previously

stipulated to by Charles Cathcart and the United States Department of Justice in United

States of America v. Charles Cathcart, et al., N.D. Cal., Case No: C-07-4762 (filed Nov.

19, 2009), and which the parties also agreed to stipulate in these cases. The preamble to

the joint stipulations in the above captioned cases states: “The parties to the above-

entitled action, having met and conferred, and upon determining that good cause exists,

hereby stipulate to those facts that were stipulated by Charles Cathcart and the

Department of Justice in United States of America v. Charles Cathcart, et al [sic], N.D.

Cal., Case No: C-07-4762 PJH, document 398, filed 11/19/09.” (emphasis in original).

3Debevc refers to Yurij Debevc, Charles Cathcart’s former business associate who

Charles Cathcart brought “into the business to oversee operations,” and Scott refers to

“Throughout its operation, virtually all of Derivium’s business consisted of the marketing

and administration of the 90% Loan Program.”

The joint stipulations make clear that

[t]he 90% Loan Program was marketed as a way for customers to: (a) obtain

the benefit of cash in an amount equal to 90% of the value of their securities;

(b) defer paying capital gains on the transaction; and (c) be protected

against the risk that the securities would depreciate while at the same time

preserving their ability to take advantage of any possible appreciation in the

securities’ value.

The parties also stipulate that

Derivium’s marketing materials emphasized the customer’s ability to

recover their securities at the end of the transaction term, stating that the

customer would “retain beneficial ownership” of his securities, such that “if

your equities increase in value, you keep all the upside,” and “[b]ecause you

still own your stocks, you retain all the potential for further gains.” These

statements were false, since Derivium sold its customers’ securities prior to

the inception of the transaction.

(alternation in original). The joint stipulations indicate that “[u]pon Derivium’s receipt of

the securities, in every case, the securities were immediately sold.” The parties also

stipulate that:

The marketing materials state that Cathcart[4] is a “world-recognized expert

in building and preserving wealth for clients through the application of

sophisticated hedging strategies,” whose “proprietary structures and

models are the foundation of the products offered through Derivium

Capital.” Derivium’s marketing materials also state that Derivium will

engage in “hedging” transactions to protect the value of customers’

securities. These statements were also false. Derivium never engaged in

hedging transactions. Rather, it simply sold its customers securities,

remitted an amount equal to 90% of the proceeds back to its customers,

and kept the remaining 10% for its own purposes, including paying

operating expenses and fees to its owners.

The joint stipulations of fact point to an obvious untruth. According to the parties’ joint

stipulation of facts:

Charles Cathcart’s son, Scott Cathcart, who, according to the joint stipulations,

“spearhead[ed] the marketing of the 90% Loan Program.”

4 The court notes that the joint stipulations, the parties’ submissions, and the trial

transcript refer to Charles Cathcart generically as “Cathcart.”

Following the sale of a customer’s securities, however, Derivium and the

supposed lenders faced a countervailing risk, which was that stock values

would rise. Because customers’ securities were immediately sold in every

case, if a customer elected under the MLA[5] to recover his securities at the

end of the transaction term, Derivium had to repurchase the securities on

the open market to return those shares to the customer.

The parties’ joint stipulation of facts also indicate that “[i]n the event that prices for

more than a few of the securities submitted as collateral increased substantially during

the transaction term, Derivium faced an inherent risk of being unable to satisfy the

obligations to customers. Despite this known risk, Derivium never engaged in hedging

transactions.”

In total, “[t]he 90% Loan Program generated approximately 3100 transactions,

totaling more than $1 billion in sale proceeds, 90% of which was used to fund the

purported loans to customers, leaving at least $100 million as the difference between the

purported loan proceeds and the value of the securities (the ‘Net Proceeds’).” The joint

stipulations continue: “Derivium used the Net Proceeds for a variety of purposes. First,

Derivium (and later Derivium Capital USA and Veridia) kept approximately 20 to 25% of

the Net Proceeds for itself in the form of commissions. Throughout its operation,

Derivium’s only significant source of income was commissions from the sale of customer’s

securities.” The stipulations provide that “[t]he bulk of the Net Proceeds (approximately

$45 million) was used to fund various start-up companies owned indirectly by [Charles]

Cathcart, [Yurij] Debevc and Scott [Cathcart] and located in Orangeburg and

Summerville, South Carolina (the ‘Start-Up Companies’).” According to the joint

stipulations: “The purported ‘hedging’ model implemented by Cathcart involved the

immediate sale of the customer’s securities and investment of the Net Proceeds into

Start-Up companies owned and controlled by the Principals,” and “[i]n fact, the provision

of funds to the Start-Up Companies did not constitute a genuine hedge, but rather was

nothing more than a speculative gamble.” “To adequately and truly hedge Derivium’s risks

related to the 90% Loan Program, Derivium would have had to purchase call options

correlated with its customers’ securities. In fact, the Net Proceeds from the 90% Loan

Program would have been insufficient to purchase adequate call options,” and moreover,

“Derivium did not maintain reserves of capital that could be drawn upon if the supposed

‘hedges’ failed.”

As early as 2001, Derivium began defaulting on its obligations to its clients when

the first transactions engaged in by Derivium in 1998 began maturing. According to the

parties’ joint stipulations, “Derivium defaulted because Derivium had no genuine hedges

in place, had no reserves, and the proceeds from new 90% Loan transactions were

5 Although not defined in the parties’ joint stipulation of facts developed for the above

captioned cases, the first joint stipulation of facts incorporating the facts that were

stipulated by Charles Cathcart and the United States Department of Justice in United

States of America v. Charles Cathcart, et al., define MLA as a “Master Agreement to

Provide Financing and Custodial Services.” See United States of Am. v. Cathcart et. al,

No. C 07–4762 PJH.

insufficient to allow Derivium to purchase the replacement securities on the open market

for those customers who did seek a return of their highly appreciated stocks.” “At the end

of 2002, Cathcart ceased marketing and administering securities transactions through

Derivium due to litigation by customers whose securities Derivium had failed to return at

maturity and due to an investigation by the California Department of Corporations.”

“Derivium’s operations were then assumed and divided among two new entities. Derivium

USA, which is wholly-owned by Cathcart, assumed all marketing and sales functions for

the 90% Loan Program. Veridia Solutions, LLC which is wholly-owned by Debevc,

performed the related administrative functions.”6

The joint stipulations indicate that “[o]ver the next few years, Derivium racked up

tens of millions of dollars in judgments from defaults – yet Cathcart and his co-promoters

continued to market and administer the 90% Loan Program.”7 Also according to the joint

stipulations, “[b]y 2008, Derivium’s failure to perform on its obligations resulted in claims

against Derivium totaling approximately $150 million.”

The parties in the above captioned cases stipulate that “the claim that the 90%

Loan Program involved ‘hedging’ is false or fraudulent. No funds were used to hedge any

90% Loan transactions. Cathcart’s claim that the use of the 90% Loan proceeds . . .

constituted hedges against securities was pure fiction and constituted nothing more than

an economic gamble.” The joint stipulations continue:

The claim that 90% Loan transactions are non-taxable loans is a false

statement. Derivium and/or the purported lender immediately sold the

customers’ securities at the inception of the transaction – and thus

representations that the securities would be “held” as “collateral” were false

or fraudulent. Because no genuine “lending” occurred, Cathcart’s and

Derivium’s claims that a foreign “lender” existed were false or fraudulent.

(internal references omitted).

As the United States Tax Court in Raifman v. Commissioner noted, the Derivium

program was tailored toward individuals

who held concentrated positions in a single marketable stock and wished to

generate liquidity without triggering a taxable event. The Derivium program

facilitated this monetization of stock by “lending” program participants up to

6 The joint stipulations note that, for the purposes of the joint stipulations in the above

captioned cases, “Derivium, Derivium USA, and Veridia are collectively referred to as

‘Derivium’ unless otherwise noted.” This Opinion likewise generically refers to Derivium.

7 The joint stipulations provide that “[b]y 2003, the remaining available funds from new

90% Loan transactions were used to pay commissions to Derivium and its successor

entities and to keep the lights on in the Charleston office,” and that “[o]ver time the

liabilities of the 90% Loan Program increased dramatically.”

90% of their stock’s fair market value. In return participants would surrender

to Derivium the ostensibly leveraged stock as “collateral” and would accrue

interest on the loan principal over the life of the loan. Participants were

prohibited from making any payments before loan maturity and, similarly,

Derivium was prohibited from calling the loan before maturity. Most

importantly, the loans were nonrecourse to the participant. Because a

Derivium loan was nonrecourse, a participant had no personal liability for

principal or interest and could instead choose--for example, should the

value of the participant’s stock drop over the agreement’s term--to default

and cede the collateral to Derivium. Alternatively, upon maturity of the loan,

participants could pay their balance due and request return of their

collateral, or renew and refinance the loan for an additional term in order to

monetize any appreciation of the collateral that occurred during the initial

loan term.

Raifman v. Comm’r, T.C.M. 2018-101, 2018 WL 3268723, at *12-13 (July 3, 2018)

(footnote omitted).8

Regarding Charles Cathcart, the joint stipulations provide: “Charles Cathcart, as

founder, owner, President, and marketer of the program, participated directly in its

organization and sale. Cathcart has been involved in ‘the 90% Loan Program from the

beginning’ and ‘designed it.’” The joint stipulations also state that

Cathcart made and caused to be made several false or fraudulent

statements with respect to the tax benefits of the 90% Loan Program.

Cathcart oversaw and actively participated in Derivium’s marketing efforts.

As “president of Derivium Capital, LLC,” he “had overall responsibility for

the management of its role in the transaction which was the marketing and

sales and the loan administration.” Thus, among other things, Cathcart

participated in the training of Derivium’s sales staff and edited and approved

marketing materials and tax memos that were distributed to clients.

8The court notes that the plaintiffs in Raifman v. Commissioner, Gregory Raifman and

Susan Raifman, are the same plaintiffs as in the previously filed case of Raifman v. Wells

Fargo Advisors, LLC, Case No. C 11-02885 SBA, 2014 WL 12013436 (N.D. Calif. March

31, 2014). As explained by the United States Tax Court in Raifman v. Commissioner:

Following the complete collapse of Derivium and all associated entities, the

Raifmans, joined by a number of other former Derivium participants,

attempted to sue Wachovia for its role in facilitating the transfer of

participants' shares to Derivium. On March 31, 2014, the U.S. District Court

for the Northern District of California dismissed the participants’ claims. In

May of 2016, the Court of Appeals for the Ninth Circuit affirmed the

judgment of the District Court.

Raifman v. Comm’r, 2018 WL 3268723, at *10.

The joint stipulations further indicate that “[f]or over a decade, Cathcart presided over a

scheme marketed in significant part for its purported tax benefits. During this period,

Cathcart edited and even authored tax memos that falsely touted the scheme’s tax

benefits – even after he was advised by a law firm that the 90% Loan Program likely

violates the tax laws.”

The parties before this court stipulate that:

Cathcart knew that the 90% Loan scheme operated by selling the

customers’ securities immediately upon receipt (“on behalf of” sham

“lenders” Cathcart created), retaining 10% of the proceeds as income in

Derivium-controlled bank and brokerage accounts, and then distributing the

proceeds to Cathcart and his associates directly and to the Start-Up

Companies (which Cathcart and his associates owned and manage).

The parties’ joint stipulations also indicate that “Cathcart had actual knowledge that

the customers’ securities were not ‘held’ but were rather sold immediately,” and “Cathcart

also knew or had reason to know that no ‘hedging’ took place and that the 90% Loan

transactions were taxable sales. Cathcart is a Ph.D. economist who spent years working

on actual derivatives and hedging instruments before creating the 90% Loan Program.”

Moreover, “[b]ased on the absence of actual hedging, Cathcart had reason to know

Derivium would lack the funds to perform on (and thus would default on) its obligation to

return customers’ securities upon demand at maturity.” The parties further stipulate that:

Cathcart has taken repeated steps to obfuscate the true nature of and his

role in certain aspects of the scheme. He has falsified or caused to be

falsified documents from the purported lenders, created artificial foreign

entities to act as “lenders” and as the “owners” of the scheme’s proceeds,

and continues to deny any involvement in the “foreign lenders” participation

in the scheme.

The parties stipulate that “Cathcart knew or had reason to know that the 90% Loan

Program’s claims were false or fraudulent under Section 6700 [26 U.S.C. § 6700].” In

addition, the parties’ joint stipulations indicate that: “As the scheme’s founder, creator,

and President, and as the alter ego of all of the sham ‘foreign lenders,’ Cathcart knew

that several of the scheme’s claims were false or fraudulent.” (emphasis in original). As

the United States Tax Court in Raifman noted, “[o]n March 5, 2010, Mr. Cathcart, the

principal of the Derivium program, was permanently enjoined from promoting it, as it

constituted an abusive tax shelter.” Raifman v. Comm’r, 2018 WL 3268723, at *11.9

9 The Tax Court noted in a footnote that in “September 2005, Derivium had filed a

voluntary petition for chapter 11 bankruptcy protection.” Raifman v. Comm’r, T.C.M. 2018-

101, 2018 WL 3268723, at *11 n.26.

The Plaintiffs

Plaintiff Jon A. Rochlis testified that he attended the Massachusetts Institute of

Technology, and received a computer science/computer engineering degree in 1985. Jon

A. Rochlis testified that “I went to Boston University for a certificate in financial planning,

I think it was year 2000, late 1990s/2000. And I have a J.D. degree from the University of

New Hampshire Law School from 2011.” He testified that the between 1990 and 1991,

he purchased 225 shares of Cisco stock for approximately $10,000. At trial, he stated: “I

invested about $10,000 in Cisco that became about $2 million - worth about $2 million

about ten years later.” He further testified “I invested in a number of stocks. The ones

relevant to this case include Network Appliance, Internet Security Systems, Amazon.com,

Intel, Microsoft.”

In the second amended complaint in Case No. 16-200T, the Rochlises10 allege

“[i]n reliance on the false pretenses regarding Derivium's hedging strategy, the Rochlises

signed the Master Loan Agreement to Provide Financing and Custodial Services directly

with Charles Cathcart” in 2000. The Master Loan Agreement signed by Jon A. Rochlis11

stated in part:

10 Although the plaintiffs in Case No. 16-200T are Jon A. Rochlis and Anne R. LaVin, and

the plaintiffs’ complaint and amended complaints refer to Jon A. Rochlis and Anne R.

LaVin together as the “Rochlises,” the court notes, however, only Jon A. Rochlis signed

the Master Loan Agreement with Derivium. In addition, only Jon A. Rochlis testified for

the plaintiffs in Case No 16-200T, as Anne R. LaVin did not testify at the trial. Similarly,

as discussed below, although the plaintiffs in Case No. 16-210T are Kenneth Ishii and

Sheryl A. Ishii, and the plaintiffs’ complaint and amended complaints refer to Kenneth Ishii

and Sheryl A. Ishii together as the “Ishiis,” the court notes, however, only Kenneth Ishii

signed the Master Loan Agreement with Derivium. In addition, only Kenneth Ishii testified

for the plaintiffs in Case No 16-210T, as Sheryl A. Ishii did not testify at the trial. Regarding

Irene M. Warren, although Irene M. Warren signed the Master Loan Agreement with

Derivium, she passed away before suit was filed in this court, and the plaintiff in Case No.

201T is listed in the caption of the second amended complaint as “Jon Rochlis as

Executor of the Estate of Irene M. Rochlis (aka Warren),” and Irene M. Warren did not

testify at trial.

11 The Master Loan Agreement signed by Jon A. Rochlis is substantially similar to the

Master Loan Agreement signed by Irene M. Warren and Kenneth Ishii. As discussed

below, the termination provisions were different in all three Master Loan Agreements. The

other differences between the three Master Loan Agreements are the terms of the

Schedules attached to the Master Loan Agreements identifying the securities transferred

to Derivium. In addition, Kenneth Ishii’s Master Loan Agreement was entered into with

First Security Capital L.L.C, and not Derivium Capital, LLC.

1. SERVICES TO BE PROVIDED BY DC

DC [Derivium Capital, LLC] is hereby appointed Custodian of the Properties

and authorized to act on behalf of the Client with respect to the Properties

for the purposes of:

a) Providing or arranging financing by way of one or more loans (the

“Loan(s)”) in accordance with terms to be agreed upon by the parties and

set out in loan term sheets and attached hereto as Schedule(s) A.

b) Holding cash, securities, or other liquid amounts (the “Client Liquid

Assets”) on behalf of the Client and acceptable to DC as collateral.

c) Voting shares and receiving dividends or interest on securities held as

collateral.

2. AMOUNT & TERMS OF FINANCING

The terms of each Loan are hereby contained in the attached Schedule(s)

A. The exact loan amounts will be based upon loan-to-value considerations

and the results of due diligence. The net loan proceeds may be distributed

at one time or on sequential dates, as instructed by Client.

3. FUNDING OF LOAN

The contemplated Loan(s) will be funded according to the terms identified

in one or more terms sheets, which be labeled as Schedule A, individually

numbered and signed by both parties, and, on signing, considered part of

and merged into this Master Agreement. The Client understands that by

transferring securities as collateral to DC and under the terms of the

Agreement, the Client gives DC and/or its assigns the right, without

requirement of notice to or consent of the Client, to assign, transfer, pledge,

repledge, hypothecate, rehypothecate, lend, encumber, short sell, and/or

sell outright some or all of the securities during the period covered by the

loan. The Client understands that DC and/or its assigns have the right to

receive and retain the benefits from any such transactions and that the

Client in not entitled to these benefits during the term of a loan. The Client

agrees to assist the relevant entities in completing all requisite documents

that may be necessary to accomplish such transfers.

4. RETURN OF CLIENT COLLATERAL

DC agrees to return, at the end of the loan term, the same number of shares

of the same securities received as collateral (as conditioned in the next

sentence), as set out and defined in Schedule(s) A attached hereto, upon

the Client satisfying in full all outstanding loan balances, including accrued

interest. Said collateral shall reflect any and all stock splits, conversions,

exchanges, mergers, or other distributions, except cash dividends credited

toward interest due.

...

7. INDEMNITY

DC makes no warranties regarding DC’s ability to fund or find a funder. Final

terms of each Loan(s) shall be negotiated and set out in separate Loan term

sheets to be attached as Schedule(s) A. Neither party is bound to any one

Loan until both parties have i) executed both the MLA and the Schedule A

for that Loan; ii) the Client has delivered acceptable shares; and iii) DC has

initiated the establishment of hedging transactions for that Loan.

(capitalization and emphasis in original). A difference between the multiple plaintiffs’

Master Loan Agreements was the termination clause at paragraph 13. Jon A. Rochlis’

Master Loan Agreement12 at paragraph 13(b) stated:

This Agreement may be terminated by either party at any time prior to the

funding of a loan, in whole or in part and as cash or as credit to cover any

existing obligations. At any time the Client can request that any collateral

not yet committed in a DC hedging transaction be promptly returned

resulting in the reductions of the amount and terms of the loan.

Irene M. Warren’s termination clause stated at 13(b): “This Agreement may be terminated

by either party at any time prior to the funding of a loan, in whole or in part and as cash

or as credit to cover any existing obligations.” As indicated above, Irene M. Warren signed

the Master Loan Agreement with Derivium in 2000. Kenneth Ishii’s termination clause13

stated at 13(b):

This Agreement may be terminated by either party at any time prior to the

funding of a loan, in whole or in part and as cash or as credit to cover any

existing obligations. At any time the Client can request that any collateral

not yet committed in an FSC hedging transaction be promptly returned

resulting in the reduction of the amount and terms of the loan.

Schedule A to Jon A. Rochlis’ Master Loan Agreement provides that the Rochlises

transferred the following securities to Derivium between February and May of 2000:

12 As indicated above, only Jon A. Rochlis signed his Master Loan Agreement.

13 As indicated above, in the exhibits provided by the parties, only Kenneth Ishii signed

his Master Loan Agreement.

Stock14 Transfer Date Shares Value as Assigned by Derivium

AMZN As of February 23, 2000 2,000 $140,870.00

CSCO As of February 23, 2000 4,000 $554,500.00

CSCO As of May 23, 2000 15,000 $758,203.00

INTC As of May 23, 2000 1,200 $131,850.00

ISSX As of February 25, 2000 2,000 $198,250.00

MSFT As of May 23, 2000 1,500 $94,781.00

NTAP As of February 25, 2000 1,000 $205,438.00

Total Securities $2,083,892.00

In response to plaintiffs’ counsel’s question “in 1999, 2000, why was a hedging

strategy important to you?” Mr. Rochlis testified

you asked me about did I believe that these companies would continue to

increase in value, and I certainly did believe that, but they had increased in

value so much, as you can see from the numbers, so recently, that I was

concerned that the volatility would be high, that we might see a downturn

for a while, we might see an up - I didn’t really know how to judge it, but I

had such - such gains that I felt I needed to try to secure those, but I also

wanted to participate in what I saw as the Internet future.

Mr. Rochlis testified that he first learned of Derivium Capital in “an advertisement

in the Wall Street Journal for their 90 percent stock loan.” He testified that “Randolph

Anderson was the person who responded to me and was the sales/marketing person at

Derivium” and that he received “brochures and emails from Mr. Anderson in January of

1999.”15 Mr. Rochlis testified as to what he believed was the advantage of pursing the

stock loan with Derivium,

one of their attributes that they touted was that you own the stock. You still

own your stock. You transfer it to them in escrow, and they hold it, but you

still own it. Therefore, you - you benefit from - from - from an unlimited

14 AMZN is the stock symbol for Amazon.com, Inc. CSCO is the stock symbol for Cisco

Systems, Inc. INTC is the stock symbol for Intel Corporation. ISSX is the stock symbol for

Internet Security Systems. MSFT is the stock symbol for Microsoft Corporation. NTAP is

the stock symbol for NetApp Inc.

15 Mr. Rochlis testified that one of the emails between Mr. Rochlis and Mr. Anderson

referred to Mr. Rochlis’ mother because she was “also interested in a Derivium

transaction and was - was considering that, and this is asking Derivium to work up

whether they can do it for these stocks and the terms and the like for - for actually two

different loan scenarios. She only actually entered into one later” in 2000. As the parties

jointly stipulate, “Irene M. Rochlis (aka Warren) passed away on March 13, 2011. Jon A.

Rochlis, her son, was appointed as the Executor of her Estate.” “Jon A. Rochlis as the

Executor of the Estate of Irene M. Rochlis (aka Warren)” is listed as the plaintiff in the

second amended complaint in Case No. 16-201T.

upside potential, which, of course, is marketing-speak, but you gain from

the upside potential, again, minus the cost of the loan, but you have upside

potential. It’s designed that way.

Mr. Rochlis continued: “So the Derivium hedge worked in that you gave them security for

a loan that was in the amount of 90 percent of the value when you transferred the

securities, and they promised to deliver those securities to you in three years if you paid

off the loan plus - plus interest.” Regarding the arrangement with Derivium, Mr. Rochlis

believed “[t]here was a term - there was a term of the agreement that said until they

performed the hedge, we could demand our collateral back. Once they had done the

hedge, we couldn’t do it. Then we were locked into the three years.”

Mr. Rochlis explained at trial why he decided to move forward with Derivium, first,

indicating that he “wouldn’t have done it without the marketing brochures, particularly

Charles Cathcart’s experience in creating derivatives, because you couldn’t just buy this

off the shelf.” In response to plaintiffs’ counsel’s question: “So what were the advantages

of the model proposed by Charles Cathcart?” Mr. Rochlis testified

the advantages are you have got downside protection of 90 percent, you

had upside potential if the stock rose above 120 percent of the value when

you went into it, which, as you - as I have said, the stocks had certainly done

- shown their ability to do that in the past. It was also somewhat less

expensive than publicly traded options, and the term was for three years,

and it was easy to do, where you didn't have three-year options, and so you

had to keep rolling over the stock - the options, rather, when they expired

every six months or something like that, which was a - would have been a

lot of work and possibly more expensive as the stock prices would - would

fluctuate.

Regarding the failure of Derivium to complete the transaction, plaintiffs’ counsel

asked Mr. Rochlis, “[w]hen did you find out that they hadn’t done the hedge?” and Mr.

Rochlis responded that “[y]ou and some other attorneys contacted me in late 2012, early

2013.” Mr. Rochlis testified that “Randolph Anderson represented to me that they would

not sell the stock without hedging it. As a matter of fact, I think he said they would be

crazy or insane. That's a conversation I remember pretty well for how long ago it was.”

Mr. Rochlis continued: “And similarly, I got comfortable with Derivium doing that because

they were the derivatives and hedging gurus and experts, and they admitted that it would

be crazy to sell the stock without putting a hedge in place.” Mr. Rochlis testified in

response to the question, “[w]hy did you file your theft loss claim [with the IRS] in 2009?”

“because that was the first year, given the stipulations, that we could have known that

there was actual - there was an actual mens rea, there was an actual intent, scienter on

the part of Cathcart to steal - to fraudulently deprive us of our property.” Mr. Rochlis

testified that “Derivium never told us that they had assigned, pledged, sold, or anything

to the collateral. They gave us statements every quarter for the duration showing how

many shares they were holding for us. In fact, those were adjusted for splits. They showed

dividends. That reduced interest.” Mr. Rochlis continued:

They expressly promised to me that they would not sell my securities

without a hedge, but they did, and so they robbed me of the upside potential

of my stocks, and they did that the first day when they sold my shares in

order to give me the 90 percent. They led me to believe that they would hold

those shares or that they would hedge them. They didn’t do that.

Regarding the tax implications, Mr. Rochlis testified that in

2003, when - when we defaulted on the loans, we reported a capital - a

gain, a recognition event, with gross proceeds of the 90 percent that we had

received, plus the roughly 30 percent - a little bit more because it was 10

1/2 percent a year - of interest as part of the gross proceeds, as cancellation

of debt income, as Attorney Byrnes advised us and also advised us that it

would be of capital gain character.

Mr. Rochlis also testified at the trial that he consulted an attorney about the

Derivium transaction, Mr. Daniel Byrnes, “in late 1999.” Mr. Byrnes conveyed to Mr.

Rochlis that

in his opinion, they were not constructive sales; they were loans. He advised

us that - because I wanted to understand what our obligations were and our

obligations, in the event that we wound up eventually defaulting on the

loans, what also - what we would report when that happened, and he

advised that at that point we would have a recognition event that was - with

a gross proceeds of the 90 percent that we had obtained in cash, plus the

accrued interest that we had not paid as a cancellation of debt income.

On cross-examination, Mr. Rochlis testified that the only personal property that he

owned that was transferred to Derivium was the stock. In response to the government’s

question: “But you never made any attempt to get any of your collateral back at any time

until the end of the loan term?” Mr. Rochlis responded: “That’s correct.”

In addition, regarding the upside potential if the stock rose above 120 percent of

the value of the securities,16 defendant’s counsel asked Mr. Rochlis on cross-

examination, “[a]nd, in fact, you never sought to exercise that right under the contract,

correct?” To which Mr. Rochlis responded: “I did not.” Defendant’s counsel continued:

“And that’s because, in your case, none of the stocks were worth - had appreciated more

than 120 percent of their original value.” Mr. Rochlis responded that “at the end of the

term, that was the case. The first day, when they stole the stock, that was not the case.”

Mr. Rochlis statement at trial about stealing led to this exchange with defendant’s counsel:

“But if they stole the stock on day one, then there is no potential appreciation, is there?

16 Mr. Rochlis testified at trial that he had the option to have his stock returned to him if

he had paid the principal plus interest, or approximately 120 percent of the value of the

stock. Schedule A to the Master Loan Agreements provides that the interest rate for the

loans was “10.50%, compounded annually, accruing until and due at maturity.”

Your property has been stolen. You would have the right to get your property back. The

potential appreciation would only exist with regard to what might happen down the road.”

Mr. Rochlis responded:

That’s - well, that’s - no, the contractual obligation is to provide the financial

equivalent of a call option, and they didn’t do that. They didn’t do that. Why

didn’t they do that? They didn’t do that because they sold the stock without

engaging in the hedging transactions that they represented they would. Had

they done that, they could have delivered.

At trial, Mr. Rochlis and defendant’s counsel discussed at some length the decision to

exercise the option to surrender the various stocks.17 Defendant’s counsel identified for

Mr. Rochlis four documents that Mr. Rochlis had signed, in each one, choosing the option

“I/we hereby officially surrender my/our collateral in satisfaction of my/our entire debt

obligation,” instead of “I/we will be paying off my/our loan and request the return of my/our

collateral,” or “I/we would like to renew or refinance this transaction for an additional term

of 3 years.” For the three loans with maturity dates of March 16, 2003, Mr. Rochlis

exercised the surrender option on February 3, 2003, and for the loan with the maturity

date of March 23, 2003, Mr. Rochlis exercised the surrender option on March 11, 2003.

Although Mr. Rochlis signed the various documents selecting the option “I/we hereby

officially surrender my/our collateral in satisfaction of my/our entire debt obligation,” at

trial Mr. Rochlis contended “I will point out that I didn't voluntarily surrender it, as you

maintain, because they had already stolen it. I mean, you can't surrender something that

someone stole under false pretenses.”

Mr. Rochlis also testified that his mother, Ms. Irene M. Warren, “only wound up

doing one transaction with Derivium for about 3000 shares of Cisco stock, about $200,000

worth of Cisco stock.” Pursuant to the Master Loan Agreement, Irene M. Warren

transferred approximately $200,000 of Cisco stock to Derivium on June 7, 2000. In the

second amended complaint in Case No. 16-201T, alleges that “[i]n reliance on the false

pretenses regarding Derivium’s hedging strategy, Irene M. Rochlis signed the Master

Loan Agreement to Provide Financing and Custodial Services directly with Charles

Cathcart. Irene M. Rochlis parted with the following security by transferring it to Derivium

on June 7, 2000.”

Stock Transfer Date Shares Value as Assigned by Derivium

CSCO As of June 7, 2000 3,148 $197,931.00

Plaintiff Kenneth Ishii also testified at the trial. He testified that he attended the

Massachusetts Institute of Technology, and joined the company Accordance, and that “I

was around employee number 12.” Mr. Ishii received stock options and after he joined

Accordance it merged with Software.com in the “fall of 1986.” As a result, his Accordance

17 Mr. Rochlis testified: “That was for all of my loans, and my mother would have done the

same thing, and I’m sure you have a document in here about that as well, but if you don’t,

I'm sure she did.”

options “got rolled over into new options in Software.com.”18 At the time of his first

transaction with Derivium, Mr. Ishii testified that the value of the Software.com stock “was

probably on the order of 10 million [dollars] at that point.”

In the amended complaint in Case No. 16-210T, the Ishiis allege “[i]n reliance on

the false pretenses regarding Derivium’s hedging strategy, the Ishiis signed the Master

Loan Agreement to Provide Financing and Custodial Services directly with Charles

Cathcart. The Ishiis parted with the following securities by transferring them to Derivium.”

Stock Transfer Date Shares Value as Assigned by Derivium

SWCM As of December 21, 1999 50,000 $4,800,000.00

SWCM As of January 10, 2000 28,000 $2,567,250.00

SWCM As of March 16, 2000 7,353 $944,861.00

SWCM As of September 20, 2000 11,024 $1,760,395.00

Total Securities $2,083,892.00

Mr. Ishii entered into an agreement with Derivium in December of 1999, and

explained at trial why the Derivium approach appealed to him:

Well, all of my net worth was tied up in Software.com, and I really - you

know, I had a young family and one on the way, and I wanted to protect

that. And, you know, I just - you know, we just couldn’t predict the future,

and so we wanted to make sure that we - you know, as - as the pitch was,

it was, you know, protect your downside and retain your upside. And that

sounded just - you know, just like what I wanted.

Mr. Ishii testified that, to his knowledge, there was not a hedge available to him for

Software.com, indicating that “my belief is that there – the stock was so new and so

volatile that there really wasn’t a market for it yet.”

Mr. Ishii testified that he learned of Derivium “[e]arly in 1999, Mr. Rochlis told me

about them,” and Mr. Ishii explained that he and Mr. Rochlis have been good friends since

approximately 1985. Mr. Ishii also testified “I also talked to Mr. Rochlis about, you know,

what he had done and what my options there were, and it didn't really sound like, sort of

on the public options market, there was any market for, you know, a brand new startup

like Software.com, so that didn't really seem to be a possibility.”

Regarding Derivium, Mr. Ishii explained, “I got standard marketing literature, and

then eventually I - I don’t remember how it was arranged, but I had a phone call with

Randolph Anderson, and we talked about the different programs they had available and

how - how they applied to my situation, and he described them, and - you know, and we

moved forward from there.” Mr. Ishii emphasized that Mr. Anderson explained “the tax

consequences of the event, and he said there were none. He also discussed how the 90

percent was an important number, because the 10 percent made it a significant risk, and

so it wasn't deemed a sale by the IRS.”

18 The stock symbol for Software.com, Inc. is SWCM.

At trial, Mr. Ishii gave his view on how the Derivium hedge would work:

My understanding was that they - they had someone - you know, they would

get the money together, and I would give them the stock, and they would

hedge however they were going to do, and whatever the value of that hedge

was, I would get 90 percent of that value as a loan for the - for three years.

And it was, you know, locked up for those three years, and it was

nonrecourse, and that over that time, it would be 10 1/2 percent interest per

year.

Mr. Ishii reiterated his belief that “I still continued to own the stock even though they held

it, and, you know, so there was no sale. There was - and at the end of the loan period, I

could pay back the loan, and I would get my stock back, and - and, you know, if it

increased in value, I would - you know, I would have that gain.” At trial, plaintiffs’ counsel

had Mr. Ishii read portions of the Master Loan Agreement between Mr. Ishii and Derivium.

Specifically, Mr. Ishii read paragraph 13(b) which stated:

This Agreement may be terminated by either party at any time prior to the

funding of a loan, in whole or in part and as cash or as credit to cover any

existing obligations. At any time the Client can request that any collateral

not yet committed in an FSC hedging transaction be promptly returned

resulting in the reduction of the amount and terms of the loan.

Mr. Ishii testified that “I believe this - this meant that they had to be able to return the stock

to me and up until the time it was hedged. So a hedge had to exist.” Mr. Ishii testified that

he entered four total hedges with Derivium. For each one he testified that he “believed

that they [Derivium] had hedged my stock, that they had entered into some contract

protecting it.”

In response to the question from plaintiffs’ counsel: “So what do you believe that

Derivium stole from you?” Mr. Ishii responded, “I believe they stole the upside on my

stock, that they really - you know, by selling it with no guaranteed way of getting it back,

at that point, it was - you know, if it had taken off, they were - I was - there was no way

for them to get it back for me.” In response to the question, “[d]o you recall having any

knowledge of any court decisions that have been entered or judgments entered in any of

the litigation against Derivium prior to 2009 that - where the Court found that Derivium

had committed fraud with respect to the 90 percent loan transaction?” Mr. Ishii responded:

“I do not believe I ever - I ever heard those - those things, so no.”

On cross examination, Mr. Ishii agreed that one of the advantages that Mr.

Anderson highlighted for Mr. Ishii was the ability to defer capital gains tax, and Mr. Ishii

further agreed he was able to defer capital gains tax with regard to the 90 percent cash

he received. Mr. Ishii also had the following exchange with defendant’s counsel on cross

examination:

Q. And then it’s protect your wealth, and this refers to significant losses can

come quickly and - in other words, that's the downside protection by cashing

out 90 percent of the value of your stock.

A. That looks like what that point’s about.

Q. And, in fact, you did get the downside protection, because you did cash

out 90 percent of the value of your stock.

A. Yes.

Q. Okay. And, in fact, there was volatility and there were, in fact, significant

losses incurred with respect to the Software.com stock that you transferred

to Derivium.

A. Yes, but I didn't know that at the time.

Q. But you were protected. If you had held your stock and it had gone down,

you would have lost a substantial portion of the gain that was built into that

stock, correct; in other words, your appreciation?

A. Yeah, well, depending on when I sold, I would have either gotten some

appreciation or lost some, depending.

Q. Okay. And if you had just sold it, you would, of course, had to have paid

tax on it at the time of that sale, correct?

A. Of course.

Like Mr. Rochlis, Mr. Ishii elected to surrender the collateral rather than pay the principal

and interest due on his loan. Defendant’s counsel asked Mr. Ishii on cross examination,

“because the stock was worth a tiny fraction of what the loan - the principal and interest

due on the loan was, you elected to surrender your stock and walk away from the deal?”

Mr. Ishii responded: “Yeah, I elected to - to surrender the collateral.” In response to the

question, “as a result of surrendering the collateral and walking away from the loan, you

were not required to make any payment to Derivium at the end of the transaction,” Mr.

Ishii responded: “Correct.” Mr. Ishii confirmed he repeated this process with all four of the

transactions, and agreed with defendant’s counsel that in “all the other instances, the

value of the stock was substantially less than what you would have had to have paid to

get it back.”

The plaintiffs all allege “they discovered that on November 19, 2009 Derivium’s

president, Charles Cathcart entered into a stipulation with the United States Department

of Justice that he acted with scienter in making false representations about the hedging

transaction and the 90% Stock Loan.” Regarding the Rochlises, the second amended

complaint in Case No. 16-200T alleges:

The Rochlises timely filed their protective claim on a 2009 1040X . . . to

report to the Derivium theft loss on July 22, 2013 under the three year

statute of limitations under I.R.C. § 6511(a). Once they received the expert

report from Moss Adams, they timely filed their 2009 1040X on September

9, 2014 to report their theft loss of $896,308. On their 2009 1040X the

Rochlises requested a tax refund of $4,873.00

Regarding Irene M. Warren, the second amended complaint in Case No. 16-201T

similarly alleges that

The Estate of Irene M. Rochlis timely filed a protective claim on a 2009

1040X . . . to report to the Derivium theft loss on July 22, 2013 under the

three year statute of limitations under I.R.C. § 6511(a). Once the estate

received the expert report from Moss Adams, the Executor timely filed a

2009 1040X on September 9, 2014 to report theft loss of $75,672. The

Estate of Irene M. Rochlis requested a tax refund of $19,519.

Regarding the Ishiis, the amended complaint in Case No. 16-210T alleges, “[t]he

Ishiis timely filed their protective claim on a 2009 1040X . . . to report to the Derivium theft

loss on July 22, 2013 under the three year statute of limitations under I.R.C. § 6511(a),”

and “[t]he Ishiis have satisfied the requirements of I.R.C. § 7422(a) because more than

six months have elapsed since said Claim for Refund was filed and said Claim has neither

been allowed nor disallowed by the Internal Revenue Service.” The amended complaint

in Case No. 16-210T indicated that the Ishiis also engaged Moss Adams LLP “to provide

an expert opinion on the valuation of the options to repurchase the stock.”

All plaintiffs argue that they can prove they are victims of theft loss, because

Charles Cathcart made false statements which he knew were false, he made those false

statements with the intent that the plaintiffs should rely on them, that the plaintiffs did rely

on them, and plaintiffs parted with their personal property as a result. In the amended

complaints, separate from the lower amounts they claimed on their 2009 Forms 1040X,

the Rochlises sought judgment in the amount of $68,703.00,19 the Ishiis sought a

19The Rochlises included the following table in the second amended complaint for Case

No. 16-200T:

Tax Year Refund

2009 $4,873

2006 $21,645

2007 $10,161

2008 $8,885

2010 $2,063

2011 $0

2012 $19,598

2013 $1,478

$68,703

judgment in the amount of $208,344.00,20 and the Estate of Irene Rochlis sought

judgment in the amount of $19.519.00.21

As indicated above, trial was held, the parties submitted post-trial briefs and the

court held closing argument. The parties subsequently submitted supplemental briefs to

address the issues the court identified at closing argument.

DISCUSSION

Plaintiffs seek tax refunds for alleged theft losses for the Derivium fraud.22 As noted

above, the plaintiffs sought to amend their 2009 taxes by filing Forms 1040X in 2013. The

Rochlises seek a cumulative tax refund in the amount of $68,703.00, Irene M. Warren

seeks a tax refund of $19.519.00, and the Ishiis seek a cumulative tax refund in the

amount of $208,344.00. The United States Supreme Court has stated that: “A taxpayer

seeking a refund of taxes erroneously or unlawfully assessed or collected may bring an

action against the Government either in United States district court or in the United States

Court of Federal Claims.” United States v. Clintwood Elkhorn Mining Co., 553 U.S. 1, 4

(2008) (citing both 28 U.S.C. § 1346(a)(1) and EC Term of Years Trust v. United States,

550 U.S. 429, 431, & n.2 (2007)); see also Manor Care, Inc. v. United States, 89 Fed. Cl.

20 The Ishiis included the following table in the amended complaint for Case No. 16-210T:

Tax Year Refund

2009 $0

2006 $27,076

2007 $62,329

2008 $30,353

2010 $7,635

2011 $38,925

2012 $42,026

Total Tax Refund $208,344

21Unlike the Rochlises and the Ishiis, Irene M. Warren did not include a table in the

second amended complaint in Case No. 16-201T, and only requested a tax refund in the

amount of $19.519.00 for tax year 2009.

22 Plaintiffs Jon A. Rochlis, Anne R. LaVin, and Irene M. Warren filed one, common post-

trial brief and plaintiffs Kenneth Ishii and Sheryl Ishii filed a separate post-trial brief. As

defendant notes in its post-trial brief, “[a]n examination of the two briefs reveals that other

than the factual statements and different stock values used in the expert’s reports, the

arguments advanced in each of the two briefs are the same.” This is consistent with the

plaintiffs’ approach to the trial. As noted above, the court generically refers to all the

plaintiffs as “the plaintiffs,” but specifically identifies individual plaintiffs by name when

discussing specific transactions, or when otherwise appropriate.

618, 622 (2009) (citing Flora v. United States, 362 U.S. 145, 177, reh’g denied, 362 U.S.

972 (1960)); Shore v. United States, 9 F.3d 1524, 1527 (Fed. Cir. 1993) and 28 U.S.C. §

1346(a)), aff’d, 630 F.3d 1377 (Fed. Cir. 2011); Strategic Hous. Fin. Corp. v. United

States, 86 Fed. Cl. 518, 530 (citing United States v. Clintwood Elkhorn Mining Co., 553

U.S. at 4), motion to amend denied, 87 Fed. Cl. 183 (2009), aff’d in part, vacated in part

on other grounds, 608 F.3d 1317 (Fed. Cir. 2010), cert. denied, 131 S. Ct. 1513 (2011);

Buser v. United States, 85 Fed. Cl. 248, 256 (2009) (“It is ‘undisputed’ that the Court of

Federal Claims possesses the authority to adjudicate tax refund claims.”) (citations

omitted); RadioShack Corp. v. United States, 82 Fed. Cl. 155, 158 (2008) ("This Court

has jurisdiction to consider tax refund suits under 28 US.C. § 1491(a)(1).”) (citations

omitted), aff’d, 566 F.3d 1358 (Fed. Cir. 2009).

Section 1346 of Title 28 of the United States Code provides that:

(a) The district courts shall have original jurisdiction, concurrent with the

United States Court of Federal Claims, of: (1) Any civil action against the

United States for the recovery of any internal revenue tax alleged to have

been erroneously or illegally assessed or collected, or any penalty claimed

to have been collected without authority or any sum alleged to have been

excessive or in any manner wrongfully collected under the internal revenue

laws. . . .

28 U.S.C. § 1346(a)(1) (2018).

For this court to exercise its jurisdiction over plaintiffs’ federal tax refund claim, a

petitioning party must first satisfy the tax refund schematic detailed in Title 26 of the

Internal Revenue Code, which establishes that a claim for refund must be filed with the

IRS before filing suit in federal court, and establishes strict deadlines for filing such claims.

See 26 U.S.C. §§ 6511, 7422 (2018).23 In United States v. Clintwood Elkhorn Mining Co.,

the United States Supreme Court indicated that:

A taxpayer seeking a refund of taxes erroneously or unlawfully assessed or

collected may bring an action against the Government either in United

States district court or in the United States Court of Federal Claims. The

23 The statute at 26 U.S.C. § 7422(a) states:

No suit or proceeding shall be maintained in any court for the recovery of

any internal revenue tax alleged to have been erroneously or illegally

assessed or collected, or of any penalty claimed to have been collected

without authority, or of any sum alleged to have been excessive or in any

manner wrongfully collected, until a claim for refund or credit has been duly

filed with the Secretary, according to the provisions of law in that regard,

and the regulations of the Secretary established in pursuance thereof.

26 U.S.C. § 7422(a).

Internal Revenue Code specifies that before doing so, the taxpayer must

comply with the tax refund scheme established in the Code. That scheme

provides that a claim for a refund must be filed with the Internal Revenue

Service (IRS) before suit can be brought, and establishes strict timeframes

for filing such a claim.

United States v. Clintwood Elkhorn Mining Co., 553 U.S. at 4 (citations omitted); see also

RadioShack Corp. v. United States, 566 F.3d 1358, 1360 (Fed. Cir. 2009) (“[I]n the

context of tax refund suits, the [Supreme] Court has held that the Court of Federal

Claims's Tucker Act jurisdiction is limited by the Internal Revenue Code, including 26

U.S.C. § 7422(a).”); United States v. Dalm, 494 U.S. 596, 609-10, reh’g denied, 495 U.S.

941 (1990); Buser v. United States, 85 Fed. Cl. at 256. Moreover, for a refund claim, the

court only may hear claims for which the petitioning taxpayer has fulfilled all of his or her

tax liabilities for the tax year in question before the refund claim is heard. Flora v. United

States, 357 U.S. 63, 72-73 (1958) (Flora I), aff’d on reh’g, 362 U.S. 145 (Flora II), reh’g

denied, 362 U.S. 972 (1960). In Flora II, the United States Supreme Court reiterated that

28 U.S.C. § 1346(a)(1) requires “payment of the full tax before suit. . . .” Flora II, 362 U.S.

at 150-51; see also Computervision Corp. v. United States, 445 F.3d 1355, 1363 (Fed.

Cir.), reh’g and reh’g en banc denied, 467 F.3d 1322 (Fed. Cir. 2006), cert. denied, 549

U.S. 1338 (2007); Shore v. United States, 9 F.3d at 1526 (“The full payment requirement

of Section 1346(a)(1) and Flora applies equally to tax refund suits brought in the Court of

Federal Claims. . . .”) (citations omitted).

Essentially, section 7422(a) functions as a waiver of the government’s sovereign

immunity in tax refund suits. Chicago Milwaukee Corp. v. United States, 40 F.3d 373, 374

(Fed. Cir. 1994), reh’g and reh’g en banc denied, 141 F.3d 1112 (Fed. Cir.), cert. denied,

525 U.S. 932 (1998); see also Gluck v. United States, 84 Fed. Cl. 609, 613 (2008).

“[S]ection 7422(a) creates a jurisdictional prerequisite to filing a refund suit.” Id. (citing

Chicago Milwaukee Corp. v. United States, 40 F.3d at 374 (citing Burlington N., Inc. v.

United States, 231 Ct. Cl. 222, 684 F.2d 866, 868 (1982))). Once a party has established

compliance with 26 U.S.C. § 7422(a), the party may, if successful, also recover interest

for its refund claim. See Deutsche Bank AG v. United States, 95 Fed. Cl. 423, 427 n.3

(2010) (citing Brown & Williamson, Ltd. v. United States, 231 Ct. Cl. 413, 688 F.2d 747,

752 (1982)) (“There is no question, however, that this court has subject matter jurisdiction

under the Tucker Act, 28 U.S.C. § 1491 (2006), over claims, such as the present one,

seeking to recover statutory interest on income tax refunds.”).

Furthermore, as noted above, in order for a tax refund case to be duly filed in a

federal court pursuant to section 7422(a), the filing must comply with the timing

requirements set forth in 26 U.S.C. § 6511(a):

The basic rule of federal sovereign immunity is that the United States cannot

be sued at all without the consent of Congress. A necessary corollary of this

rule is that when Congress attaches conditions to legislation waiving the

sovereign immunity of the United States, those conditions must be strictly

observed, and exceptions thereto are not to be lightly implied. When waiver

legislation contains a statute of limitations, the limitations provision

constitutes a condition on the waiver of sovereign immunity.

Block v. North Dakota ex rel. Bd. of Univ. and School Lands, 461 U.S. 273, 287 (1983);

see also Buser v. United States, 85 Fed. Cl. at 257. The applicable language of section

6511(a) states:

Claim for credit or refund of an overpayment of any tax imposed by this title

. . . shall be filed by the taxpayer within 3 years from the time the return was

filed or 2 years from the time the tax was paid, whichever of such periods

expires the later, or if no return was filed by the taxpayer, within 2 years

from the time the tax was paid. . . .

26 U.S.C. § 6511(a); see also Treas. Reg. § 301.6511(a)-1 (2019) (“In the case of any

tax. . . . If a return is filed, a claim for credit or refund of an overpayment must be filed by

the taxpayer within 3 years from the time the return was filed or within 2 years from the

time the tax was paid, whichever of such periods expires the later.”). As articulated by the

United States Supreme Court in Commissioner v. Lundy, 516 U.S. 235 (1996):

A taxpayer seeking a refund of overpaid taxes ordinarily must file a timely

claim for a refund with the IRS under 26 U.S.C. § 6511. That section

contains two separate provisions for determining the timeliness of a refund

claim. It first establishes a filing deadline: The taxpayer must file a claim for

a refund “within 3 years from the time the return was filed or 2 years from

the time the tax was paid, whichever of such periods expires the later, or if

no return was filed by the taxpayer, within 2 years from the time the tax was

paid.” 26 U.S.C. § 6511(b)(1) (incorporating by reference 26 U.S.C. §

6511(a)). It also defines two “look-back” periods: If the claim is filed “within

3 years from the time the return was filed,” ibid., then the taxpayer is entitled

to a refund of “the portion of the tax paid within the 3 years immediately

preceding the filing of the claim.” 26 U.S.C. § 6511(b)(2)(A) (incorporating

by reference 26 U.S.C. § 6511(a)). If the claim is not filed within that 3-year

period, then the taxpayer is entitled to a refund of only that “portion of the

tax paid during the 2 years immediately preceding the filing of the claim.” 26

U.S.C. § 6511(b)(2)(B) (incorporating by reference § 6511(a)).

Comm’r v. Lundy, 516 U.S. at 239-40 (footnote omitted); see also United States v.

Clintwood Elkhorn Mining Co., 553 U.S. at 8 (determining that the language of section

6511(a) clearly states that taxpayers “must comply with the Code's refund scheme before

bringing suit, including the requirement to file a timely administrative claim.”). The

Supreme Court in Lundy also noted that a timely filing was a prerequisite for the United

States Court of Federal Claims to have jurisdiction for a refund claim. See Comm’r v.

Lundy, 516 U.S. at 240.

In sum, Congress has provided strict statutory guidelines laying out the statute of

limitations for the filing of a federal tax refund claim:

Read together, the import of these sections is clear: unless a claim for

refund of a tax has been filed within the time limits imposed by § 6511(a), a

suit for refund, regardless of whether the tax is alleged to have been

“erroneously,” “illegally,” or “wrongfully collected,” §§ 1346(a)(1), 7422(a),

may not be maintained in any court.

United States v. Dalm, 494 U.S. at 602.

Under the United States Tax Code, at 26 U.S.C. § 165, titled: “Losses,” “[t]here

shall be allowed as a deduction any loss sustained during the taxable year and not

compensated for by insurance or otherwise.” 26 U.S.C. § 165(a) (2018). The Tax Code

specifically provides for a theft loss, and states that “[f]or purposes of subsection (a), any

loss arising from theft shall be treated as sustained during the taxable year in which the

taxpayer discovers such loss.” 26 U.S.C. § 165(e). Treasury Regulations § 1.165-8(a),

titled: “Theft losses,” states:

Allowance of deduction. (1) Except as otherwise provided in paragraphs (b)

and (c) of this section, any loss arising from theft is allowable as a deduction

under section 165(a) for the taxable year in which the loss is sustained. See

section 165(c)(3).

(2) A loss arising from theft shall be treated under section 165(a) as

sustained during the taxable year in which the taxpayer discovers the loss.

See section 165(e). Thus, a theft loss is not deductible under section 165(a)

for the taxable year in which the theft actually occurs unless that is also the

year in which the taxpayer discovers the loss. However, if in the year of

discovery there exists a claim for reimbursement with respect to which there

is a reasonable prospect of recovery, see paragraph (d) of § 1.165–1.

(3) The same theft loss shall not be taken into account both in computing a

tax under chapter 1, relating to the income tax, or chapter 2, relating to

additional income taxes, of the Internal Revenue Code of 1939 and in

computing the income tax under the Internal Revenue Code of 1954. See

section 7852(c), relating to items not to be twice deducted from income.

Treas. Reg. § 1.165-8(a) (2019).24

24 Treasury Regulation § 1.165-8(b)-(c) provide:

(b) Loss sustained by an estate. A theft loss of property not connected with

a trade or business and not incurred in any transaction entered into for profit

which is discovered during the settlement of an estate, even though the theft

actually occurred during a taxable year of the decedent, shall be allowed as

a deduction under sections 165(a) and 641(b) in computing the taxable

income of the estate if the loss has not been allowed under section 2054 in

computing the taxable estate of the decedent and if the statement has been

filed in accordance with § 1.642(g)–1. See section 165(c)(3). For purposes

of determining the year of deduction, see paragraph (a)(2) of this section.

According to the definition of theft loss, Treasury Regulation § 1.165-8, provides

“[f]or purposes of this section the term ‘theft’ shall be deemed to include, but shall not

necessarily be limited to, larceny, embezzlement, and robbery.” Treas. Reg. § 1.165-8(d).

The term “theft” does not have a more specific definition in the Tax Code or in the

Treasury Regulations. See Adkins v. United States, 113 Fed. Cl. 797, 804 (2013)

(“Neither IRC § 165 nor its implementing regulations provide any further guidance for

what constitutes a theft.”) (footnote omitted). As noted by a Judge of this court:

The regulations, however, stop there in terms of providing any further

guidance on how to determine whether particular conduct amounts to “theft”

or any one of these other enumerated crimes. Like the parties here, many

cases seek further guidance on this point from state law, often citing

Edwards v. Bromberg, 232 F.2d 107, 111 (5th Cir. 1956), for the proposition

that “whether a loss from theft occurs within the purview of [section

165(c)(3)] . . . depends upon the law of the jurisdiction where it was

sustained.” From this point, many courts embark on an extended analysis

of whether the actions that occasioned the loss of funds constituted one of

the requisite theft crimes under state criminal laws.

Goeller v. United States, 109 Fed. Cl. 534, 539-40 (2013) (alterations in original) (footnote

omitted).

The parties agree that the burden of establishing that a deductible loss, including

that a theft loss occurred, rests with the plaintiffs. See Boehm v. Comm’r, 326 U.S. 287,

294 (1945) (“Here it was the burden of the taxpayer to establish the fact that there was a

deductible loss in 1937.”), reh’g denied, 326 U.S. 811 (1946); Krahmer v. United States,

810 F.2d 1145, 1147 (Fed. Cir. 1987) (recognizing the difficulty to prove intent using

circumstantial evidence in a theft loss deduction case, but holding that the United States

Claims Court did not place too high a burden of proof on a taxpayer to establish that a

deductible loss occurred); Jeppsen v. Comm’r, 128 F.3d 1410, 1418 (10th Cir. 1997)

of a theft loss shall be determined consistently with the manner prescribed

in § 1.165–7 for determining the amount of casualty loss allowable as a

deduction under section 165(a). In applying the provisions of paragraph (b)

of § 1.165–7 for this purpose, the fair market value of the property

immediately after the theft shall be considered to be zero. In the case of a

loss sustained after December 31, 1963, in a taxable year ending after such

date, in respect of property not used in a trade or business or for income

producing purposes, the amount deductible shall be limited to that portion

of the loss which is in excess of $100. For rules applicable in applying the

$100 limitation, see paragraph (b)(4) of § 1.165–7. For other rules relating

to the treatment of deductible theft losses, see § 1.1231–1, relating to the

involuntary conversion of property.

Treas. Reg. § 1.165-8(b)-(c).

(noting that the plaintiff bears the burden of proving entitlement to a theft loss deduction),

cert. denied, 524 U.S. 916 (1998); Howard v. United States, 497 F.2d 1270, 1272 n.4 (7th

Cir. 1974) (“Plaintiffs, of course, had the burden of establishing that a theft occurred.”). If

a taxpayer is unable to establish the elements of the crime of theft under the applicable

state law, the taxpayer cannot be allowed a deduction under 26 U.S.C. § 165. The Federal

Circuit in Krahmer concluded that under 26 U.S.C. § 165, the “appropriate burden is proof

by a preponderance of the evidence.” Krahmer v. United States, 810 F.2d at 1147; see

also Bunch v. Comm’r, T.C.M. 2014-177, 2014 WL 4251136, at *6 (T.C. Aug. 28, 2014);

Marine v. Comm’r, 92 T.C. 958, 976 (1989); Allen v. Comm’r, 16 T.C. 163, 166, 1951 WL

73 (1951).

While a theft conviction may establish conclusively the existence of a theft under

26 U.S.C. § 165(e), the lack of such a conviction does not necessarily preclude a theft

loss deduction pursuant to 26 U.S.C. § 165(e), provided that the requisite specific intent

to deprive is present. See Vietzke v. Comm’r, 37 T.C. 504, 510 (1961) (holding that a theft

had occurred for purposes of 26 U.S.C. § 165(e), even though the alleged perpetrator of

the theft was not convicted of a theft crime).

The Treasury Regulations for theft loss provide that a plaintiff is not entitled to a

theft loss deduction until the plaintiff cannot demonstrate with reasonable certainty if a

possibly of recovery exists. Treasury Regulation § 1.165–1(d)(3) provides that

if in the year of discovery there exists a claim for reimbursement with respect

to which there is a reasonable prospect of recovery, no portion of the loss

with respect to which reimbursement may be received is sustained . . . until

the taxable year in which it can be ascertained with reasonable certainty

whether or not such reimbursement will be received.

Treas. Reg. § 1.165–1(d)(3) (2019); see also Jeppsen v. Comm’r, 128 F.3d at 1418 (10th

Cir. 1997) (noting taxpayers are “not entitled to take the theft loss deduction” in a year if

the “prospect of recovery was simply unknowable”); Adkins v. United States, 113 Fed. Cl.

at 807. The Treasury Regulations also state that “[w]hether a reasonable prospect of

recovery exists with respect to a claim for reimbursement of a loss is a question of fact to

be determined upon an examination of all facts and circumstances.” 26 C.F.R. § 1.165–

1(d)(2)(i); see also Adkins v. United States, 113 Fed. Cl. at 807; United States v. Elsass,

978 F. Supp. 2d 901, 915 (S.D. Ohio 2013) (“The Government . . . contends that the theft

losses claimed by the Defendants on behalf of their ABFS [American Business Financial

Services] customers were improper and ignored the legal requirements for § 165 theft-

loss deductions that the loss involve criminal intent and that the loss be claimed only after

the taxpayer can establish with reasonable certainty that no recovery will be made. The

Court agrees.”), aff’d, 769 F.3d 390 (6th Cir. 2014).

In addition to proving the loss, the plaintiffs are required to prove of the amount of

the loss. See Washington Mut., Inc. v. United States, 130 Fed. Cl. 653, 686-87 (2017)

(citing United States v. Janis, 428 U.S. 433, 440 (1976)) (“[P]laintiffs bear the burden to

prove, by a preponderance of the evidence, that they are entitled to the tax deductions at

issue in this case and the correct amount of the tax refund due.”), aff’d sub nom., WMI

Holdings Corp. v. United States, 891 F.3d 1016 (Fed. Cir. 2018). As indicated in

Washington Mutual, “plaintiffs will not recover in a tax refund case if they cannot prove

the amount of the refund due.” Id. at 687.

As noted above, regarding the Rochlises, the second amended complaint in Case

No. 16-200T alleges:

The Rochlises timely filed their protective claim on a 2009 1040X . . . to

report to the Derivium theft loss on July 22, 2013 under the three year

statute of limitations under I.R.C. § 6511(a). Once they received the expert

report from Moss Adams, they timely filed their 2009 1040X on September

9, 2014 to report their theft loss of $896,308. On their 2009 1040X the

Rochlises requested a tax refund of $4,873.

Regarding Irene M. Warren, the second amended complaint in Case No. 16-201T

alleges that: