UNITED STATES TAX COURT
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T.C. Memo. 2007-21
UNITED STATES TAX COURT
ESTATE OF BURTON W. KANTER, DECEASED, JOSHUA S. KANTER,
EXECUTOR, AND NAOMI R. KANTER, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos.
1
712-86,
31301-87,
3456-88,
16421-90,
20211-91,
21616-91,
16164-92,
7557-93,
1350-87, Filed February 1, 2007.
33557-87,
32103-88,
26251-90,
21555-91,
1984-92,
23743-92,
22884-93.
Cases of the following petitioners are consolidated
herewith: Estate of Burton W. Kanter, Deceased, Joshua S.
Kanter, Executor, and Naomi R. Kanter, docket Nos. 1350-87,
31301-87, 33557-87, 3456-88, 32103-88, and 26251-90; Claude M.
and Mary B. Ballard, docket Nos. 16421-90, 20211-91, 21616-91,
1984-92, 23743-92, and 22884-93; and Estate of Robert W. Lisle,
Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent CoExecutors, and Estate of Donna M. Lisle, Deceased, Thomas W.
Lisle and Amy L. Albrecht, Independent Co-Executors, docket Nos.
21555-91, 16164-92, and 7557-93.
-2Matthew J. Gries, Randall G. Dick, and N. Jerold Cohen, for
petitioner Estate of Burton W. Kanter, Deceased, Joshua S.
Kanter, Executor, in docket Nos. 712-86, 1350-87, 31301-87,
33557-87, 3456-88, 32103-88, and 26251-90.
Karen L. Hawkins, for petitioner Naomi R. Kanter in docket
Nos. 712-86, 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and
26251-90.
Steven S. Brown and Royal B. Martin, for petitioners Claude
M. and Mary Ballard in docket Nos. 16421-90, 20211-91, 21616-91,
1984-92, 23743-92, and 22884-93, and for petitioners 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, in
docket Nos. 21555-91, 16164-92, and 7557-93.
John J. Comeau, Frederic J. Fernandez, James M. Klein, and
Mark J. Miller, for respondent.
CONTENTS
I.
Procedural History . . . . . . . . . . . . . . . . . . .
12
II.
Amendment to Rule 183
. . . . . . . . . . . . . . . . .
17
III. Notices of Deficiency
. . . . . . . . . . . . . . . . .
19
New Rule 183 and the Court’s Review and Adoption
Procedure . . . . . . . . . . . . . . . . . . . . . . .
26
IV.
V.
Standard of Deference Due to General Findings of Fact and
Credibility Determinations Contained in the STJ Report . 28
-3VI.
Structure of the Court’s Report
ISSUE I.
. . . . . . . . . . . .
35
Whether Kanter, Ballard, and Lisle Earned and Are
Taxable on the Income in Dispute . . . . . . . . . 37
FINDINGS OF FACT
I. Petitioners . . . . . . . . . . . . . . . . . . . . . . . 38
A. Burton W. Kanter . . . . . . . . . . . . . . . . . 38
B. Claude M. Ballard . . . . . . . . . . . . . . . . . 41
C. Robert W. Lisle . . . . . . . . . . . . . . . . . . 43
D. Additional Findings of Fact Regarding Ballard
and Lisle . . . . . . . . . . . . . . . . . . . . . 45
1. Ballard . . . . . . . . . . . . . . . . . . . . 45
2. Lisle . . . . . . . . . . . . . . . . . . . . . 46
E. Kanter-Related Entities . . . . . . . . . . . . . . 47
1. Investment Research Associates, Ltd.(IRA) . . . 47
a. IRA’s Shareholders . . . . . . . . . . . . 48
b. The Bea Ritch Trusts . . . . . . . . . . . 49
c. IRA’s Officers and Directors . . . . . . . 50
d. IRA’s Subsidiaries . . . . . . . . . . . . 52
e. IRA’s Business Activities . . . . . . . . . 53
2. Carlco, Inc., TMT, Inc., and BWK, Inc. . . . . 53
3. Additional Findings of Fact Regarding The
Holding Co. . . . . . . . . . . . . . . . . . . 56
a. THC’s Shareholders, Officers,
and Directors . . . . . . . . . . . . . . . 57
b. THC’s Tax Returns . . . . . . . . . . . . . 58
4. The Administration Co., Inc., and Principal
Services Accounting Corp. . . . . . . . . . . . 59
II. Introductory Statement and Brief Introduction of The
Five . . . . . . . . . . . . . . . . . . . . . . . . . . 66
A. The STJ Report . . . . . . . . . . . . . . . . .
66
B. Comments Regarding the Introductory Statement
and Brief Introduction of The Five . . . . . . . . 71
III. Details Regarding The Five . . . . . . . . . . . . . . 73
A. Certain Payments Made by The Five
. . . . . . . . 73
1. Hyatt Corp.’s Payment of a Share of Its
Profits on the Embarcadero Hotel’s Management
Contract to KWJ Corp. . . . . . . . . . . . . . 74
2. Bruce Frey’s Payments to IRA From 1980 Through
1985 and to THC in 1981, 1983, 1984, and 1987 . 91
a. The Frey/THC Agreement . . . . . . . . . . 100
b. The Frey/Zeus Agreement . . . . . . . . . . 102
c. BJF Partnership . . . . . . . . . . . . . . 104
d. Summary of Frey Payments to Zeus . . . . . 106
e. Summary of Frey Payments to THC . . . . . . 107
3. Payments From William Schaffel to IRA From
1979 Through 1983 and to THC From 1984
Through 1986 . . . . . . . . . . . . . . . . . 107
-4a.
b.
c.
d.
e.
f.
IV.
Sale of IBM Building . . . . . . . . . . . 110
Torcon Transactions With Prudential . . . . 110
Walters’s Transactions With Prudential . . 112
Walters’s Transactions With Travelers . . . 113
Schaffel’s Payments to IRA and THC . . . . 116
Four Ponds, FPC Subventure, and One River
Partnerships . . . . . . . . . . . . . . . 118
(i).
Four Ponds Partnership . . . . . 118
(ii).
FPC Subventure Partnership . . . 119
(iii). One River Partnership . . . . . . 119
(iv).
Meyers’s Memorandum Regarding
Four Ponds Partnership . . . . . 120
(v).
FPC Subventure’s Tax Returns . . 122
4. Schnitzer/PMS Payments From 1979 Through 1989 . 124
5. Payments from Eulich/Essex Partnership to
IRA and THC From 1982 Through 1989 . . . . . . 131
a. John Eulich . . . . . . . . . . . . . . . 131
b. Allen Ostroff . . . . . . . . . . . . . . 133
c. Hotel Management Industry Trends . . . . . 134
d. The Gateway Hilton and John Connolly . . . 135
e. Gateway Hotel Management Co. and Essex
Corp . . . . . . . . . . . . . . . . . . . 138
f. MHM and GHM Hotel Management Contracts . . 140
g. Essex Partnership . . . . . . . . . . . . 141
h. Essex Partnership Operations . . . . . . . 144
i. GHM’s and MHM’s Representation and
Marketing Agreements . . . . . . . . . . . 145
j. Transfer of IRA’s Essex Partnership
Interest . . . . . . . . . . . . . . . . . 151
k. Payments to Essex Partnership and Essex
Partnership Distributions . . . . . . . . 152
B. Certain Loans, Payments, and Other Benefits That
Ballard and Lisle and/or Their Family Members
Received . . . . . . . . . . . . . . . . . . . . . 153
Additional Findings of Fact: The Flow of Funds . . . . . 159
A. Payments Made by The Five to IRA and Its
Subsidiaries From 1977 to 1989 . . . . . . . . . . 160
1. Payments Made During 1977 Through 1983 . . . . 162
2. Payments Made During 1984 to 1989 . . . . . . . 164
B. Distribution of the Funds Paid by The Five in
Connection With the Various Prudential
Transactions to Kanter, Ballard, Lisle, and Their
Respective Family Members . . . . . . . . . . . . . 166
1. Additional Details Regarding Management and
Control of Carlco, TMT and BWK . . . . . . . . 166
a. Carlco . . . . . . . . . . . . . . . . . . 166
b. TMT . . . . . . . . . . . . . . . . . . . 167
c. BWK . . . . . . . . . . . . . . . . . . . 167
-52.
3.
IRA’s Transfers to Carlco, TMT and BWK of
Funds Paid by The Five
. . . . . . . . . . . 168
a. Funds Paid by The Five to IRA During 1977
Through 1983 Transferred to Carlco, TMT,
and BWK . . . . . . . . . . . . . . . . . 168
(i).
Transfers From Zeus to IRA . . . 169
(ii).
IRA’s Transfer of Its Interest
in Essex Partnership . . . . . . 170
(iii). IRA’s Transfer of Its Interest
in Sherwood Partnership . . . . . 171
(iv).
Accounting Treatment . . . . . . 172
(v).
Additional Capital Contributions
to Sherwood Partnership . . . . . 173
b. Transfer of Funds Paid by The Five During
1984 Through 1989 to Carlco, TMT, and BWK 174
(i).
Hyatt Corp. . . . . . . . . . . . 174
(ii).
Frey . . . . . . . . . . . . . . 176
(iii). Schnitzer/PMS . . . . . . . . . . 176
(iv).
Essex Partnership . . . . . . . . 176
c. Carlco, TMT, and BWK Capital Accounts . . 177
The Disposition of Funds From Carlco, TMT, and
BWK for the Benefit of Ballard, Lisle, Kanter,
and Their Families . . . . . . . . . . . . . . 178
a. Ballard’s Use and Enjoyment of TMT’s
Assets . . . . . . . . . . . . . . . . . . 178
(i).
TMT’s Various Accounts . . . . . 178
(ii).
Loans From TMT to Ballard and
Ballard Entities . . . . . . . . 178
(iii). TMT’s Property Transferred to
Ballard . . . . . . . . . . . . . 181
(iv).
Investment in Melinda Ballard’s
Company . . . . . . . . . . . . . 184
(v).
Ballard’s Disclosures to
Goldman Sachs . . . . . . . . . . 185
(vi).
TMT’s Assets . . . . . . . . . . 187
b. Lisle’s Use and Enjoyment of Carlco’s
Assets . . . . . . . . . . . . . . . . . . 188
(i).
Carlco’s Various Accounts . . . . 188
(ii).
Lisle’s Personal Use of Carlco’s
Funds
. . . . . . . . . . . . . 189
(iii). Carlco’s Assets
. . . . . . . . 189
c. Kanter’s Use and Enjoyment of BWK’s
Assets . . . . . . . . . . . . . . . . . . 190
(i).
Salaries and Officer Compensation
Paid to Kanter and His Son . . . 190
(ii).
Loans
. . . . . . . . . . . . . 190
(iii). Gifts
. . . . . . . . . . . . . 191
-6C.
V.
Other Means Used To Transfer Funds for the
Benefit of Ballard, Lisle, Kanter, and Their
Respective Families . . . . . . . . . . . . . . . . 191
1. Payments From IRA, KWJ Corp., and KWJ
Partnership . . . . . . . . . . . . . . . . . . 191
a. IRA Payments to Ballard and
Lisle in 1982 . . . . . . . . . . . . . . 191
b. Consulting Fees Paid by KWJ Corp.
and KWJ Partnership to Ballard’s
and Lisle’s Adult Children . . . . . . . . 192
2. Additional Loans . . . . . . . . . . . . . . . 194
a.
IRA Loans to Kanter . . . . . . . . . . . 194
b.
Loans to Ballard, Lisle, Their Family
Members, and Their Trusts
. . . . . . . 194
(i).
Ballard’s Grantor Trusts . . . . 194
(ii).
Lisle’s Grantor Trusts . . . . . 195
(iii). International Films, Inc. . . . . 196
(iv).
Harbor Exchange Lending Operation 196
(v).
Loans to Lisle and His Trusts. . 197
(vi).
Loans to the Ballards and
Their Trusts . . . . . . . . . . 197
(vii). Writeoff of Loans and Claimed
Losses. . . . . . . . . . . . . . 197
(viii). Loans to Lisle’s RWL Cinema
Trust During 1988 to 1990 . . . . 205
D. Summary of Funds Paid by The Five to IRA and
Disposition of Those Funds for the Benefit of
Kanter, Ballard, Lisle, and Their Families . . . . 205
E. Payments Made by The Five to THC and Its
Subsidiaries During 1981 Through 1989 . . . . . . . 207
F. Distribution of Funds From THC to Kanter . . . . . 208
G. The Flow of Funds From Four Ponds and One River
Through FPC Subventure to Kanter and Lisle . . . . 211
Additional Findings of Fact Regarding the Examination
Process and Summons Enforcement Proceedings . . . . . . . 213
A. Failure To Cooperate During the Audit . . . . . . . 213
B. IRS Summonses . . . . . . . . . . . . . . . . . . . 214
C. Summons Enforcement . . . . . . . . . . . . . . . . 215
D. Requests for Production of Documents . . . . . . . 219
OPINION
A. The Parties’ Positions . . . . . . . . . . . . . . 222
B. The Assignment of Income Doctrine . . . . . . . . . 224
C. Errors in the STJ Report . . . . . . . . . . . . . 228
1. The STJ Report Reflects a Misunderstanding of
Respondent’s Theory Regarding the Kickback
Scheme . . . . . . . . . . . . . . . . . . . . 229
2. Discussion Regarding Assignment of Income
. . 231
-73.
D.
E.
F.
G.
Failure To Address Respondent’s Flow-of-Funds
Argument . . . . . . . . . . . . . . . . . . . 232
4. Incomplete Discussion Regarding Loan
Arrangements . . . . . . . . . . . . . . . . . 232
5. Discussion Regarding Consulting Payments to
Ballard’s and Lisle’s Adult Children . . . . . 234
6. Manifestly Unreasonable Credibility
Determinations . . . . . . . . . . . . . . . . 235
a. Testimony Offered by The Five . . . . . . 235
b. Ballard’s Testimony Regarding the Hyatt
Transaction . . . . . . . . . . . . . . . 235
c. Kanter’s Testimony Regarding
Deconsolidation . . . . . . . . . . . . . 236
d. Kanter’s Testimony Regarding IRA . . . . . 237
e. Kanter’s, Ballard’s, and Lisle’s Denials
237
Summary of Kanter’s, Ballard’s and Lisle’s
Transactions With The Five . . . . . . . . . . . . 238
1. An Overview . . . . . . . . . . . . . . . . . . 238
2. The Hyatt Transaction . . . . . . . . . . . . . 244
3. Shaffel . . . . . . . . . . . . . . . . . . . . 249
4. Frey . . . . . . . . . . . . . . . . . . . . . 253
5. Schnitzer/PMS . . . . . . . . . . . . . . . . . 257
6. Eulich/Essex Partnership . . . . . . . . . . . 260
Flow-of-Funds Analysis . . . . . . . . . . . . . . 267
1. Payments to IRA: 1977 Through 1983 . . . . . . 268
2. Payments to IRA: 1984 Through 1989 . . . . . . 269
3. IRA Loans to Kanter, Ballard, and Lisle . . . . 270
a. IRA Loans to Ballard and Ballard’s Trusts 270
b. IRA Loans to Lisle and Lisle’s Trusts . . 270
c. Sale of Grantor Trust Notes for $1 . . . . 271
d. IRA Loans to Kanter . . . . . . . . . . . 271
e. Additional Loans to Lisle’s Grantor Trust 272
f. Consulting Payments to Ballard’s and
Lisle’s Adult Children . . . . . . . . . . 272
4. Payments to THC: 1981 to 1989 . . . . . . . . 273
a. FPC Subventure Partnership . . . . . . . . 274
b. THC Transfers to Kanter . . . . . . . . . 276
Kanter-Related Entities Were Shams . . . . . . . . 276
1. IRA and THC . . . . . . . . . . . . . . . . . . 276
2. Carlco, TMT, and BWK . . . . . . . . . . . . . 278
a. Diversification and Deconsolidation . . . 278
b. Use and Enjoyment of Carlco’s, TMT’s,
and BWK’s Assets . . . . . . . . . . . . . 282
(i).
Carlco . . . . . . . . . . . . . 282
(ii).
TMT . . . . . . . . . . . . . . . 283
(iii). BWK . . . . . . . . . . . . . . . 287
Cracks in the Kanter Facade . . . . . . . . . . . . 288
1. The Hyatt Transaction . . . . . . . . . . . . . 288
-82.
3.
4.
5.
6.
7.
Frey . . . . . . . . . . . . . . . . . . . . . 289
Schaffel . . . . . . . . . . . . . . . . . . . 290
Schnitzer/PMS . . . . . . . . . . . . . . . . . 291
Loans to Ballard . . . . . . . . . . . . . . . 292
Ballard’s Disclosures to Goldman Sachs . . . . 292
Kanters’s Letters to the Ballard and Lisle
Children . . . . . . . . . . . . . . . . . . . 293
Conclusion and Schedule of Income Adjustments . . . 295
H.
ISSUE II.
A.
B.
C.
D.
E.
F.
G.
H.
I.
Whether Kanter and Ballard Are Liable for
Additions to Tax for Fraud . . . . . . . . . . . . 298
OPINION
Failure To Report Substantial Amounts of Income . . 300
Concealment of the True Nature of the Income and
the Identity of the Earners of the Income . . . . . 301
Use of Sham, Conduit, and Nominee Entities . . . . 301
Reporting Kanter’s and Ballard’s Income on IRA’s
and THC’s Tax Returns . . . . . . . . . . . . . . . 302
Commingling of Kanter’s and Ballard’s Income With
Funds Belonging to Others . . . . . . . . . . . . . 303
Phony Loans . . . . . . . . . . . . . . . . . . . . 303
False and Misleading Documents . . . . . . . . . . 304
Failure to Cooperate During the Examination Process 304
Conclusion . . . . . . . . . . . . . . . . . . . . 306
ISSUE III.
A.
B.
C.
D.
ISSUE IV.
A.
B.
C.
ISSUE V.
A.
B.
Whether Commitment Fees Paid to Century
Industries, Ltd., During 1981 to 1984 and 1986
are Includable in Kanter’s Income . . . . . . . . 307
FINDINGS OF FACT
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 316
TEFRA Partnership Provisions . . . . . . . . . . . 317
The STJ Report . . . . . . . . . . . . . . . . . . 318
Analysis . . . . . . . . . . . . . . . . . . . . . 319
Whether Kanter Received Unreported Income From
Hi-Chicago Trust During 1981 to 1983 . . . . . . . 324
FINDINGS OF FACT
OPINION
The Assignment of Income Doctrine . . . . . . . . . 326
The Parties’ Arguments . . . . . . . . . . . . . . 327
Analysis . . . . . . . . . . . . . . . . . . . . . 327
Whether Kanter Is Taxable on Income Attributed
to the Bea Ritch Trusts for 1986 and 1987 . . . . . 330
FINDINGS OF FACT
The Bea Ritch Trusts . . . . . . . . . . . . . . . 330
Oyster Bay Associates Partnership . . . . . . . . . 332
-9A.
B.
C.
D.
ISSUE VI.
A.
B.
OPINION
Grantor Trust Provisions of Sections 671 Through
678 . . . . . . . . . . . . . . . . . . . . . . . . 341
The Parties’ Arguments . . . . . . . . . . . . . . 343
The STJ Report . . . . . . . . . . . . . . . . . . 344
Analysis . . . . . . . . . . . . . . . . . . . . . 345
Whether Kanter Received Unreported Income From
CMS Investors Partnership for 1982 to 1984
and 1987 to 1989 . . . . . . . . . . . . . . . . . 349
FINDINGS OF FACT
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 352
Analysis . . . . . . . . . . . . . . . . . . . . . 354
1. Subject Matter Jurisdiction . . . . . . . . . . 354
2. Whether Kanter Improperly Assigned Income to
THC Through CMS Investors . . . . . . . . . . . 356
ISSUE VII.
Whether Kanter Received Unreported Income From
Equitable Leasing Co., Inc., During 1983 . . . . 357
FINDINGS OF FACT
OPINION
ISSUE VIII.
A.
B.
C.
D.
ISSUE IX.
Whether Kanter Received Unreported Income
for 1982 According to the Bank Deposits Method
of Income Reconstruction . . . . . . . . . . . . 361
FINDINGS OF FACT
OPINION
The Commissioner’s Use of the Bank Deposits
Method of Income Reconstruction . . . . . . . . . . 363
The Parties’ Arguments . . . . . . . . . . . . . . 364
The STJ Report . . . . . . . . . . . . . . . . . . 365
Analysis . . . . . . . . . . . . . . . . . . . . . 365
Whether Kanter Received Barter Income From
Principal Services Accounting Corp. During 1988
and 1989. . . . . . . . . . . . . . . . . . . . .
367
ISSUE X.
Whether the Kanters Received Unreported Interest
Income During 1988 . . . . . . . . . . . . . . . . 368
ISSUE XI.
Whether the Kanters Are Entitled to Certain
Deductions They Claimed on Schedules A and C
for 1986 to 1989 . . . . . . . . . . . . . . . . . 368
FINDINGS OF FACT
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 372
Analysis . . . . . . . . . . . . . . . . . . . . . 372
A.
B.
-10ISSUE XII.
A.
Whether Kanter Realized and Must Recognize
Capital Gains as a Result of Transactions
Involving Cashmere Investments Associates, Inc.,
During 1983 and Whether the Kanters May Use
the Installment Method To Report Gains . . . . . 374
FINDINGS OF FACT
Transfer of Real Estate Partnership Interests
to Cashmere . . . . . . . . . . . . . . . . . . . . 380
Sale of Cashmere Stock to Waco . . . . . . . . . . 383
Sale of Cashmere Stock From Waco to Zell . . . . . 386
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 387
Analysis . . . . . . . . . . . . . . . . . . . . . 389
1. Applicability of Section 357(b)(1) . . . . . . 391
2. Applicability of Section 357(c) . . . . . . . . 392
3. Kanter’s Use of the Installment Method . . . . 394
B.
C.
A.
B.
ISSUE XIII.
A.
B.
C.
Whether Kanter Is Entitled to Research and
Development and Business Expense Deductions
Related to Immunological Research Corp.
for 1979 . . . . . . . . . . . . . . . . . . . . 396
FINDINGS OF FACT
OPINION
Trade or Business Requirement of Section 174 . . . 404
The Parties’ Arguments . . . . . . . . . . . . . . 407
Analysis . . . . . . . . . . . . . . . . . . . . . 408
ISSUE XIV.
Whether Kanter Received Unreported Partnership
Income During 1978 . . . . . . . . . . . . . . . 415
FINDINGS OF FACT
OPINION
ISSUE XV.
Whether the Kanters Are Entitled to a Loss From
GLS Associates for 1981 . . . . . . . . . . . . . 417
OPINION
ISSUE XVI.
A.
B.
Whether the Kanters Are Entitled to Losses From
Equitec for 1983 and 1984 . . . . . . . . . . . . 420
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 420
Analysis . . . . . . . . . . . . . . . . . . . . . 421
ISSUE XVII.
A.
B.
Whether the Kanters Are Entitled to an Investment
Interest Expense Deduction for 1981 . . . . . . 421
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 422
Analysis . . . . . . . . . . . . . . . . . . . . . 422
-11ISSUE XVIII.
Whether the Kanters Are Entitled to an
Investment Tax Credit Carryover for 1978 . . . 423
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 423
Analysis . . . . . . . . . . . . . . . . . . . . . 424
A.
B.
ISSUE XIX.
Whether the Kanters Are Entitled to an
Interest Deduction for 1986 . . . . . . . . . . . 426
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 426
Analysis . . . . . . . . . . . . . . . . . . . . . 427
A.
B.
ISSUE XX.
Whether the Kanters Are Entitled to a Business
Deduction of $104,231 for 1980 . . . . . . . . . . 429
OPINION
The STJ Report . . . . . . . . . . . . . . . . . . 429
The Parties’ Arguments . . . . . . . . . . . . . . 429
A.
B.
ISSUE XXI.
A.
B.
C.
Whether the Kanters Are Entitled to a Deduction
for a Charitable Contribution to the Jewish
United Fund for 1982 . . . . . . . . . . . . . . 430
FINDINGS OF FACT
OPINION
The Parties’ Arguments . . . . . . . . . . . . . . 431
The STJ Report . . . . . . . . . . . . . . . . . . 432
Analysis . . . . . . . . . . . . . . . . . . . . . 432
ISSUE XXII.
Whether Kanter Is Liable for Self-Employment
Tax for 1982 . . . . . . . . . . . . . . . . . . 434
OPINION
ISSUE XXIII.
Whether the Kanters Realized Capital Gains
and Losses as Reported on Their 1987 Tax
Return . . . . . . . . . . . . . . . . . . . . 434
ISSUE XXIV.
Additions to Tax and Related Matters . . . . . . 435
OPINION
APPENDIXES
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Appendix 5
Appendix 6
Appendix 7
. . . . . . . . . . . . . . . . . . . . . . . . . 437
. . . . . . . . . . . . . . . . . . . . . . . . . 238
. . . . . . . . . . . . . . . . . . . . . . . . . 439
. . . . . . . . . . . . . . . . . . . . . . . . . 440
. . . . . . . . . . . . . . . . . . . . . . . . . 441
. . . . . . . . . . . . . . . . . . . . . . . . . 443
. . . . . . . . . . . . . . . . . . . . . . . . . 444
-12Appendix 8 . . . . . . . . . . . . . . . . . . . . . . . . . 445
Appendix 9 . . . . . . . . . . . . . . . . . . . . . . . . . 446
Appendix 10 . . . . . . . . . . . . . . . . . . . . . . . . . 447
Appendix 11 . . . . . . . . . . . . . . . . . . . . . . . . . 448
Appendix 12 . . . . . . . . . . . . . . . . . . . . . . . . . 449
Appendix 13 . . . . . . . . . . . . . . . . . . . . . . . . . 451
Appendix 14 . . . . . . . . . . . . . . . . . . . . . . . . . 452
Appendix 15 . . . . . . . . . . . . . . . . . . . . . . . . . 453
Appendix 16 . . . . . . . . . . . . . . . . . . . . . . . . . 454
Appendix 17 . . . . . . . . . . . . . . . . . . . . . . . . . 455
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge:
These consolidated cases are before the
Court on separate remands from the U.S. Courts of Appeals for the
Fifth, Seventh, and Eleventh Circuits2 for further proceedings
consistent with the Supreme Court’s opinion in Ballard v.
Commissioner, 544 U.S. 40 (2005), revg. 321 F.3d 1037 (11th Cir.
2003) and Estate of Kanter v. Commissioner, 337 F.3d 833 (7th
Cir. 2003).
I.
Procedural History
These cases, along with a number of cases instituted by
another taxpayer, Investment Research Associates, Ltd.,
originally were consolidated for trial, briefing, and opinion.
Special Trial Judge D. Irvin Couvillion tried the cases but was
statutorily prohibited from entering the decisions.
2
See sec.
See Estate of Kanter v. Commissioner, 406 F.3d 933 (7th
Cir. 2005); Ballard v. Commissioner, 429 F.3d 1026 (11th Cir.
2005); Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir.
2005).
-137443A(c).3
Special Trial Judge Couvillion prepared an initial
report that included his recommended findings of fact and opinion
(the STJ report).
The cases were then assigned to Judge Howard
A. Dawson, Jr., for adoption of the STJ report and entry of
decisions.
Under Rule 183 as in effect at the time, the STJ
report was not filed or otherwise entered into the record of the
cases.4
Special Trial Judge Couvillion subsequently collaborated
with Judge Dawson in preparing a final report, Inv. Research
Associates, Ltd. v. Commissioner, T.C. Memo. 1999-407, in which
the Court sustained, inter alia, respondent’s determinations that
petitioners Burton W. Kanter (Kanter),5 Claude M. Ballard
(Ballard), and Robert W. Lisle (Lisle)6 (collectively
petitioners) failed to report income from a kickback scheme and
were liable for additions to tax for fraud.
The Court also
sustained a number of adjustments respondent determined with
3
Unless otherwise indicated, section references are to
sections of the Internal Revenue Code, as amended, and Rule
references are to the Tax Court Rules of Practice and Procedure.
4
As discussed in greater detail below, Rule 183 was
amended effective Sept. 20, 2005. We shall refer to the amended
Rule as new Rule 183.
5
Burton W. Kanter died on Oct. 31, 2001--after he
testified at the trial in the consolidated cases. Thereafter,
his estate was substituted as a party in each of his dockets.
6
Robert W. Lisle died before the trial in the consolidated
cases, and his estate was substituted as a party in each of his
dockets.
-14regard to Kanter that were unrelated to the alleged kickback
scheme.
Following entry of decisions, Kanter, Ballard, and Lisle
appealed their cases to separate Courts of Appeals.7
In Ballard
v. Commissioner, 321 F.3d 1037 (11th Cir. 2003), and Estate of
Kanter v. Commissioner, 337 F.3d 833 (7th Cir. 2003), the Courts
of Appeals for the Eleventh and Seventh Circuits, respectively,
affirmed this Court’s holdings that (1) Ballard and Kanter failed
to report income from the alleged kickback scheme, and (2) each
was liable for additions to tax for fraud.8
The Courts of
Appeals also affirmed this Court’s earlier ruling that it was not
obliged to make the STJ report part of the record.
In Estate of
Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of
Appeals for the Fifth Circuit affirmed this Court’s holding that
7
In Inv. Research Associates, Ltd. v. Commissioner, T.C.
Memo. 1999-407, the Court sustained a number of adjustments
respondent determined with regard to the tax liability of
Investment Research Associates, Ltd. (IRA). The Court entered
decisions in all IRA dockets on Sept. 24, 2001. No appeal having
been filed, the Court’s decisions in the IRA cases are now final.
See secs. 7481(a)(1), 7483.
The Kanters did not appeal the decisions entered in their
cases at docket Nos. 24002-91 (taxable year 1987), 26918-92
(taxable year 1988), and 25981-93 (taxable year 1989). These
decisions were entered on Sept. 24, 2001, and are now final. See
secs. 7481(a)(1), 7483.
8
In Estate of Kanter v. Commissioner, 337 F.3d 833, 854857 (7th Cir. 2003), the Court of Appeals for the Seventh Circuit
also affirmed and reversed this Court’s holdings with regard to
several issues that related solely to Kanter.
-15the Estate of Lisle was liable for tax deficiencies related to
the alleged kickback scheme for the years 1987 to 1989 but
reversed this Court’s holding that the Estate of Lisle was liable
for additions to tax for fraud.
Ballard and Kanter filed petitions for certiorari with the
Supreme Court.
The Estate of Lisle did not file a petition for
certiorari.
In Ballard v. Commissioner, 544 U.S. 40 (2005), the Supreme
Court concluded (1) the collaborative process this Court employed
in the review of the STJ report and adoption of the Court’s
Memorandum Opinion in Inv. Research Associates, Ltd. v.
Commissioner, supra, was not warranted by or described in the
Court’s Rules of Practice and Procedure, and (2) the STJ report
was required to be included in the record to permit fully
informed appellate review regarding the question whether the
Special Trial Judge’s “credibility and other findings made in
that report were accorded ‘[d]ue regard’ and were ‘presumed . . .
correct’”.
Ballard v. Commissioner, supra at 60.
Thus, the
Supreme Court reversed the judgments of the Courts of Appeals for
the Seventh and Eleventh Circuits and remanded the cases for
further proceedings consistent with its opinion.
In Estate of Kanter v. Commissioner, 406 F.3d 933, 934 (7th
Cir. 2005), the Court of Appeals for the Seventh Circuit remanded
the Kanter cases to this Court “for further proceedings
-16consistent with the Supreme Court’s decision in Estate of Burton
W. Kanter v. Commissioner of Internal Revenue, No. 03-1034.”
In Ballard v. Commissioner, 429 F.3d 1026, 1027 (11th Cir.
2005), the Court of Appeals for the Eleventh Circuit remanded the
Ballard cases to this Court with the following instructions:
(1) The “collaborative report and opinion” of the Tax
Court is ordered stricken; (2) The original report of
the special trial judge is ordered reinstated; (3) The
Chief Judge of the Tax Court is instructed to assign
this matter to a regular Tax Court Judge who had no
involvement in the preparation of the aforementioned
“collaborative report;” (4) The Tax Court shall proceed
to review this matter in accordance with the dictates
of the Supreme Court, and with the Tax Court’s newly
revised Rules 182 and 183, giving “due regard” to the
credibility determinations of the special trial judge
and presuming correct fact findings of the trial judge.
* * *
The Court of Appeals also stated that Special Trial Judge
Couvillion’s findings of fact are to be presumed correct “unless
manifestly unreasonable”.
Id. at 1032.
In Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir.
2005), the Court of Appeals for the Fifth Circuit recalled its
earlier mandate and directed this Court to reexamine the question
whether the Estate of Lisle is liable for tax deficiencies
consistent with the instructions handed down by the Court of
Appeals for the Eleventh Circuit in Ballard v. Commissioner, 429
F.3d at 1027.9
9
The Court of Appeals for the Fifth Circuit’s mandate in
the Lisle cases includes a reference to the case filed with this
Court at docket No. 20219-91. However, the Court’s decision in
(continued...)
-17Following the remands, these cases were assigned to Judge
Harry A. Haines, a Judge who was not involved in the prior
proceedings in these cases.10
II.
Amendment to Rule 183
In response to the Supreme Court’s holding in Ballard v.
Commissioner, 544 U.S. 40 (2005), the Court amended Rule 183 to
provide a procedure for service on the parties of a Special Trial
Judge’s recommended findings of fact and conclusions of law and
the filing of objections and responses.
The pertinent portions
of new Rule 183 state as follows:
(c) Objections: Within 45 days after the service of
the recommended findings of fact and conclusions of
law, a party may serve and file specific, written
objections to the recommended findings of fact and
conclusions of law. A party may respond to another
party’s objections within 30 days after being served
with a copy thereof. The above time periods may be
extended by the Special Trial Judge. After the time
for objections and responses has passed, the Chief
Judge shall assign the case to a Judge for preparation
of a report in accordance with Code section 7460.
9
(...continued)
that case, i.e., that there is no deficiency and no addition to
tax due from the Lisles for the taxable year 1984, was entered
Nov. 20, 2003, and is otherwise final. See secs. 7481(a)(1),
7483. Although the Clerk of the Court notified the Court of
Appeals for the Fifth Circuit of this discrepancy, the Court has
received no further instruction from the Court of Appeals on this
point. Under the circumstances, the Court will assume that
docket No. 20219-91 was included in the Court of Appeals’ mandate
as the result of an inadvertent clerical error and docket No.
20219-91 shall remain closed.
10
Judges Mary Ann Cohen and Howard A. Dawson, Jr., and
Special Trial Judge D. Irvin Couvillion have taken no part in the
review of these cases on remand. See Ballard v. Commissioner,
429 F.3d at 1032 n.7.
-18Unless a party shall have proposed a particular finding
of fact, or unless the party shall have objected to
another party’s proposed finding of fact, the Judge may
refuse to consider the party’s objection to the Special
Trial Judge’s recommended findings of fact and
conclusions of law for failure to make such a finding
or for inclusion of such finding proposed by the other
party, as the case may be. [Emphasis added.]
(d) Action on the Recommendations: The Judge to whom
the case is assigned may adopt the Special Trial
Judge’s recommended findings of fact and conclusions of
law, or may modify or reject them in whole or in part,
or may direct the filing of additional briefs, or may
receive further evidence, or may direct oral argument,
or may recommit the recommended findings of fact and
conclusions of law with instructions. The Judge’s
action on the Special Trial Judge’s recommended
findings of fact and conclusions of law shall be
reflected in the record by an appropriate order or
report. Due regard shall be given to the circumstance
that the Special Trial Judge had the opportunity to
evaluate the credibility of witnesses, and the findings
of fact recommended by the Special Trial Judge shall be
presumed to be correct.
Consistent with new Rule 183(c), the parties were served
with copies of the STJ report.
In view of the recent amendment
to Rule 183, and the unique procedural posture of these cases,
the Court extended the dates within which the parties were
directed to file the objections and responses referred to in new
Rule 183(c).
report.
Respondent and Kanter filed objections to the STJ
Ballard and Lisle filed notices of no objection to the
STJ report.
Kanter, Ballard, and Lisle filed responses to
respondent’s objection to the STJ report, and respondent filed a
response to Kanter’s objection to the STJ report.
-19III.
Notices of Deficiency
Respondent issued notices of deficiency to petitioners as
summarized below:
Burton W. and Naomi R. Kanter
Year
Deficiency
Sec. 6653
1978
1979
1980
1981
1982
1983
1984
1986
1987
1988
1989
$476,999.00
183,909.37
454,396.00
340,578.00
2,086,913.00
1,150,652.00
3,825,078.00
897,224.00
1,434,529.00
523,234.00
835,847.00
-$9,190.47
22,720.00
17,029.00
104,346.00
57,532.60
191,254.00
44,861.60
71,726.45
26,162.00
--
Additions to Tax
Sec. 6659
Sec. 6661
---$42,682
--------
----$208,691.00
287,663.00
949,211.00
223,666.00
358,632.25
130,809.00
--
Penalty
Sec. 6662
----------$167,169
Claude M. and Mary B. Ballard
Year
Deficiency
Additions to Tax--Secs.
6651(a)(1)
6653
6659
1975
1976
1977
1978
1979
1980
1981
1982
1984
1987
1988
1989
$23,453
34,024
11,502
3,923
21,630
92,481
193,743
55,338
981,072
208,449
125,136
179,924
--------1
$51,331
----
$1,173.00
1,701.00
----9,687.00
2,766.90
88,788.05
10,442.45
6,257.00
--
------$17,138
------
6661
Penalty
Sec. 6662
-------$8,744.00
245,268.00
52,112.25
---
-----------$35,985
1
Respondent conceded the addition to tax under sec. 6651(a)(1) for
the taxable year 1984.
-20Estate 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 CoExecutors
Year
Deficiency
1984
1987
1988
1989
$827,955
195,498
109,048
109,049
Additions to Tax
Sec. 6653
Sec. 6661
$41,397.75
9,774.90
5,452.00
--
$206,988.75
48,874.50
27,262.00
--
Penalty
Sec. 6662
---$21,810
Respondent determined in the notices of deficiency or
asserted in amended pleadings that the underpayments in tax were
subject to increased interest under section 6621(c), formerly
section 6621(d),11 as follows:
Burton W. and Naomi R. Kanter for
the taxable years 1979,12 1980, 1982 to 1984, 1986, and 1987;
Claude M. and Mary B. Ballard for the taxable years 1975 to 1982,
1984, 1987, and 1988; and the Estates of Robert W. Lisle,
11
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. In the Tax Reform Act of 1986,
Pub. L. 99-514, sec. 1511(c), 100 Stat. 2744, sec. 6621(d)(1) was
redesignated sec. 6621(c)(1).
12
With respect to the Kanter case at docket No. 3456-88,
the applicability of sec. 6621(c) was asserted by respondent in
an amendment to answer and applies only to an underpayment in tax
of $206,239.63 attributable to a loss of $311,478 claimed by
petitioners from Immunological Research Corp., an S corporation,
which respondent disallowed. In a second amendment to answer,
respondent asserted the entire underpayment in tax for 1979 was
subject to increased interest under sec. 6621(c). On brief,
respondent concedes the underpayment attributable to the
disallowed loss from Immunological Research Corp. is not subject
to increased interest under sec. 6621(c) on the basis of Estate
of Cook v. Commissioner, T.C. Memo. 1993-581.
-21Deceased, and Donna M. Lisle, Deceased, for the taxable years
1984, 1987, and 1988.
In amended pleadings, respondent asserted increases in the
deficiencies in tax and additions to tax for the taxpayers and
years as follows:
Burton W. and Naomi R. Kanter for the taxable
years 1978 to 1984 and 1986 to 1989; Claude M. and Mary B.
Ballard for the taxable years 1975 to 1982, 1984, and 1987 to
1989; and Estates of Robert W. Lisle, Deceased, and Donna M.
Lisle, Deceased, for the taxable years 1984 and 1987 to 1989.
In the amended pleadings referred to above, respondent asserted
that (1) the underpayments of tax with respect to all or
substantial portions of the increased deficiencies in tax are
subject to the addition to tax for fraud pursuant to section
6653(b);13 and (2) in the alternative, if the Court holds that
petitioners are not liable for additions to tax for fraud, then
petitioners are liable for additions to tax under sections
6653(a)(1) and (2) and 6659(a) and increased interest under
13
For 1976 through 1981, the addition to tax for fraud is
set forth in sec. 6653(b). For 1982 through 1985, the addition
to tax for fraud is set forth in sec. 6653(b)(1) and (2). For
1986 and 1987, the addition to tax for fraud is set forth in sec.
6653(b)(1)(A) and (B). For 1988, the addition to tax for fraud
is set forth in sec. 6653(b)(1). For 1989, the penalty for fraud
is set forth in sec. 6663(a). By prior agreement among the
parties at a pretrial conference with the Court, respondent’s
amended pleadings and petitioners’ replies thereto were not filed
of record until the commencement of trial; however, the parties
exchanged these filings with each other well before the trial
date that was set by the Court.
-22section 6621(c), or if the underpayment was for 1989, subject to
a penalty under section 6662.14
In the amended pleadings referred to above, respondent did
not calculate or assert the amounts of the increased tax
deficiencies or the amounts of the additions to tax or penalties.
Respondent generally asserted 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 pleadings, and as a result of numerous concessions and
stipulations of settlement which were effected by the parties
before, during, and after the trial, as well as concessions of
14
As previously discussed, in Estate of Lisle v.
Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of Appeals
for the Fifth Circuit affirmed this Court’s holding that the
Estate of Lisle was liable for the deficiencies in dispute for
1987 to 1989 but reversed this Court’s holding that the Estate of
Lisle was liable for additions to tax for fraud (and therefore
assessment for the taxable year 1984 was barred by the period of
limitations). After the Lisle cases were first remanded to this
Court for entry of revised decisions (but before the Court of
Appeals recalled its mandate on Nov. 22, 2005), respondent
asserted the Court should sustain respondent’s alternative
determinations that the Estate of Lisle was liable for additions
to tax under secs. 6653(a)(1) and (2) and 6659(a), increased
interest under sec. 6621(c), and accuracy-related penalties under
sec. 6662. Petitioners disagreed and filed with the Court of
Appeals a document that was treated as a petition for writ of
mandamus. Although the Court of Appeals issued an order denying
the petition for writ of mandamus, the Court of Appeals intimated
that issues concerning alternative additions to tax were beyond
the scope of the remand. Consequently, the sole issue remaining
to be decided in the Estate of Lisle cases is whether the Estate
of Lisle is liable for the tax deficiencies determined in the
notices of deficiency for 1987 to 1989.
-23certain issues by respondent on brief, Rule 155 computations will
be necessary in these cases.15
The parties settled several issues in these cases before and
during the trial.
In addition, the parties’ objections and
responses to the STJ report narrowed the issues remaining in
dispute.
The issues left to be decided are:
(1) Whether payments received by various entities associated
with Kanter during the years at issue represent income earned by
and properly taxable to Kanter, Ballard, and Lisle;
(2) if the Court sustains respondent’s determinations that
Kanter, Ballard, and Lisle are taxable on the payments in
question, whether Kanter and Ballard are liable for additions to
tax for fraud;
15
In several of the cases in which respondent filed
amended pleadings seeking increased deficiencies in tax and
additions to tax, respondent left blank the amounts of additional
income as to which increased deficiencies were asserted, with
footnotes stating that such “amounts will be provided later”.
Petitioners filed motions to strike respondent’s assertions of
increased deficiencies where the amounts of increased income or
disallowed expenses were not specifically asserted. The Court
denied petitioners’ motions but ordered respondent to file
amended pleadings by a designated date asserting the amounts of
increased income or disallowed expenses. Respondent filed
amended pleadings to comply with the Court’s order in all
pertinent cases except two: Docket Nos. 31301-87 and 33557-87,
Burton W. and Naomi R. Kanter. An order will be issued on the
Court’s own motion in docket No. 31301-87 striking respondent’s
assertion of increased income to the Kanters from IRA for the
1978 tax year. No such order will be issued in docket No. 3355787 because the transaction as to which respondent asserted
increased income is an issue the parties have identified as
Cablevision Programming Investments, which the parties have
settled.
-24(3) whether commitment fees paid to Century Industries,
Ltd., during 1981 to 1984 and 1986 represent income earned by and
taxable to Kanter;
(4) whether Kanter received unreported income from HiChicago Trust during 1981 to 1983;
(5) whether Kanter is taxable on income attributed to the
Bea Ritch Trusts for 1986 and 1987;
(6) whether Kanter received unreported income from CMS
Investors Partnership for 1982 to 1984 and 1987 to 1989;
(7) whether Kanter received unreported income from Equitable
Leasing Co., Inc., during 1983;
(8) whether Kanter received unreported income for 1982
according to the bank deposits method of income reconstruction;
(9) whether Kanter received barter income from Principal
Services Accounting Corp. during 1988 and 1989;
(10) whether the Kanters received unreported interest income
during 1988;
(11) whether the Kanters are entitled to certain deductions
they claimed on Schedules A and C for 1986 to 1989;
(12) whether Kanter realized and must recognize capital
gains as a result of transactions involving Cashmere Investments
Associates, Inc., during 1983, and whether Kanter is entitled to
use the installment method for reporting purposes;
-25(13) whether Kanter is entitled to research and development
and business expense deductions related to Immunological Research
Corp. for 1979;
(14) whether Kanter received unreported partnership income
during the taxable year 1978;
(15) whether the Kanters are entitled to a loss from GLS
Associates for 1981;
(16) whether the Kanters are entitled to a loss from Equitec
for 1983 and 1984;
(17) whether the Kanters are entitled to an investment
interest expense deduction for 1981;
(18) whether the Kanters are entitled to an investment
credit carryover of $120,566 for 1978;
(19) whether the Kanters are entitled to an interest
deduction for 1986;
(20) whether the Kanters are entitled to a business
deduction of $104,231 for 1980;
(21) whether the Kanters are entitled to a deduction for a
charitable contribution to the Jewish United Fund for 1982;
(22) whether Kanter is liable for self-employment tax for
the taxable year 1982;
(23) whether the Kanters realized capital gains and losses
as reported on their tax return for 1987; and
-26(24) whether Kanter is liable for various additions to tax
and increased interest for the years at issue.
IV.
New Rule 183 and the Court’s Review and Adoption Procedure
In their responses to respondent’s objection to the STJ
report, petitioners assert that the Court should ignore
respondent’s objections to the extent respondent (1) failed to
make “specific, written objections” and merely rehashed proposed
findings of fact and legal arguments from respondent’s posttrial
briefs, and (2) proposed new findings of fact (not contained in
respondent’s posttrial briefs).
In connection with the
foregoing, petitioners assert:
Also, in many of his objections, respondent blockquotes directly from the now-tainted Stricken Opinion.
As this Court is well aware, the published opinion in
this case was found by the Supreme Court to be
violative of the Tax Court’s own rules and was stricken
from the record. Because the published opinion was the
result of a process that has been held by the Supreme
Court to be legally insufficient, it is manifestly
improper for respondent to base his objections upon
that opinion. Incredibly, however, respondent quotes
at length from the Stricken Opinion without
acknowledging that he is doing so. Also, in his
objections, respondent in many instances incorporates
his proposed findings which are extracted from the
Stricken Opinion and therefore legally insufficient.
As a result, this Court should not consider those
objections or proposed findings of fact. Moreover,
many of the findings from the Stricken Opinion have
already been directly criticized by the Fifth Circuit
in Estate of Lisle v. Commissioner, 341 F.3d 364 (5th
Cir. 2003).
We agree that new Rule 183(c) generally does not contemplate
that a party may propose new findings of fact in the party’s
-27objection to a Special Trial Judge’s recommended findings of fact
and conclusions of law.
Nevertheless, Rule 183(c) does not
provide a bar to new proposed findings of fact and leaves the
matter within the discretion of the reviewing Judge.
Moreover, a
Judge who is assigned a case under new Rule 183 is obliged to
review a Special Trial Judge’s recommendations against the entire
record in the case and determine whether the recommended findings
of fact and conclusions of law merit adoption.
In this regard,
new Rule 183(d) establishes a number of options that the
reviewing Judge normally may exercise during the review and
adoption process.16
Among these options, the reviewing Judge may
adopt, modify, or reject the Special Trial Judge’s
recommendations.
Thus, the Court does not feel constrained from
correcting manifestly unreasonable findings of fact or making
additional findings of fact, so long as any additional facts find
direct support in the case record.
With this understanding in
mind, we turn to the standard of deference to apply in reviewing
the recommended findings of fact and conclusions of law contained
in the STJ report.
16
Some of the options contemplated under new Rule 183(d),
such as receiving additional evidence or recommitting the
recommended findings of fact and conclusions of law with
instructions, are not available to the Court in these cases due
to limitations prescribed by the Courts of Appeals for the
Eleventh and Fifth Circuits when they remanded these cases.
-28V.
Standard of Deference Due to General Findings of Fact and
Credibility Determinations Contained in the STJ Report
It is well settled that findings of fact and credibility
determinations made by the judicial officer who presided over the
trial of a case are presumed to be correct.
Rule 183(d); Ballard
v. Commissioner, 544 U.S. 40 (2005) (and cases cited therein).
The axiom that deference must be given to the trial judge’s
findings of fact is rooted in the view that the trial judge (1)
is uniquely positioned to evaluate the credibility of witnesses,
(2) brings experience and expertise to the fact-finding process,
and (3) is normally the person most familiar with the record in a
case.
Anderson v. City of Bessemer, N.C., 470 U.S. 564, 575, 580
(1985); see Fed. R. Civ. P. 52(a), Advisory Committee Notes (1985
amendment).
As previously discussed, the Courts of Appeals for the
Eleventh Circuit and the Fifth Circuit remanded the Ballard and
Lisle cases to this Court and directed that the recommended
findings of fact in the STJ report are presumed to be correct
“unless manifestly unreasonable”.
Respondent concedes that,
although the Court of Appeals for the Seventh Circuit did not
articulate a particular standard for review in its remand of the
Kanter cases, the Court should apply the same “manifestly
unreasonable” standard in all of the cases consolidated herein.
Although respondent disagrees that the “manifestly unreasonable”
standard is the appropriate standard to be applied under new Rule
-29183, we need not address the point in the context of these cases.
We proceed with the review of the STJ report mandated by the
Courts of Appeals and apply the “manifestly unreasonable”
standard of deference as more fully described in the caselaw
discussed below.
In Ballard v. Commissioner, 544 U.S. at 54-55, the Supreme
Court addressed the deference that is due a Special Trial Judge’s
recommended findings of fact under Rule 183 as follows:
Rule 183(c)’s origin confirms the clear
understanding, from the start, that deference is due to
factfindings made by the trial judge. Commenting in
1973 on then newly adopted Rule 182(d), the precursor
to Rule 183(c), the Tax Court observed that the Rule
was modeled on Rule 147(b) of the former Court of
Claims. Tax Ct. Rule 182 note, 60 T.C. 1150, (Tax
Court review procedures were to be “comparable” to
those used in the Court of Claims). Rule 182(d)’s
“[d]ue regard” and “presumed to be correct”
formulations were taken directly from that earlier
Rule, which the Court of Claims interpreted to require
respectful attention to the trial judge’s findings of
fact. See Hebah v. United States, 456 F.2d 696, 698
(Cl. Ct. 1972) (per curiam) (challenger must make a
“strong affirmative showing” to overcome the
presumption of correctness that attaches to trial judge
findings). The Tax Court’s acknowledgment of Court of
Claims Rule 147(b) as the model for its own Rule,
indeed the Tax Court's adoption of nearly identical
language, lead to the conclusion the Tax Court itself
expressed: Under the Rule formerly designated Rule
182(b), now designated 183(c), special trial judge
findings carry “special weight insofar as those
findings are determined by the opportunity to hear and
observe the witnesses.” Tax Ct. Rule 182 note, 60 T.C.
1150 (1973); see Stone v. Commissioner, 865 F.2d 342,
345 (CADC 1989). [Fn. ref. omitted.]
We briefly examine the Hebah and Stone cases cited by the
Supreme Court above.
-30In Hebah v. United States, 197 Ct. Cl. 729, 456 F.2d 696,
698 (1972), the Court of Claims stated:
Under our rule, the [trial] commissioner’s findings of
fact are presumed to be correct because of his
opportunity to hear the witnesses and to determine the
weight to be accorded to their testimony. A party who
undertakes to overcome this presumption must make a
strong affirmative showing to the contrary. Wilson v.
United States, 151 Ct.Cl. 271 (1960) and Davis v.
United States, 164 Ct.Cl. 612 (1964).
Although the presumption does not extend to the
conclusions of law made by the trial commissioner, he
saw and heard the witnesses and had a much better
opportunity than the court to familiarize himself with
all of the circumstances involved. In the light of
this situation and a consideration of the record, we
find that under the peculiar facts and circumstances of
this case, his conclusions are not unreasonable or
unwarranted by the record. [Emphasis added.]
In Stone v. Commissioner, 865 F.2d 342 (D.C. Cir. 1989),
revg. Rosenbaum v. Commissioner, T.C. Memo. 1983-113, the Court
of Appeals for the District of Columbia Circuit addressed the
correct standard of deference to be applied by a Tax Court Judge
assigned to review a Special Trial Judge’s proposed findings of
fact under former Rule 182(d).17
In short, the Court of Appeals
rejected the proposition that a simple “preponderance of the
evidence” standard of review would suffice and instead held that
17
Former Rule 182(d), much like new Rule 183(d), provided
that “Due regard shall be given to the circumstance that the
commissioner had the opportunity to evaluate the credibility of
witnesses; and the findings of fact recommended by the
commissioner shall be presumed to be correct.” 60 T.C. 1150.
-31a “clearly erroneous” standard of review should be applied in
such cases.
Stone v. Commissioner, supra at 346-347.
Our understanding of the standard of deference to apply to
findings of fact and credibility determinations in the STJ report
is further informed by the Court of Appeals for the Eleventh
Circuit:
“Credibility determinations are entitled to great
deference, and must not be disturbed unless manifestly
unreasonable.”
Ballard v. Commissioner, 429 F.3d at 1031 (citing
Anderson v. City of Bessemer, N.C., supra at 575).
In Anderson, the Supreme Court granted certiorari to decide
whether a Court of Appeals correctly rejected the trial court’s
findings of fact in support of a judgment in favor of a plaintiff
in a sex discrimination case.
The Supreme Court held the Court
of Appeals misapplied the “clearly erroneous” standard of review
governing a Court of Appeals’ review of a District Court’s
findings of fact as set forth in rule 52(a) of the Federal Rules
of Civil Procedure.18
Quoting United States v. United States
Gypsum Co., 333 U.S. 364, 395 (1948), the Supreme Court stated
that “‘[a] finding is “clearly erroneous” when although there is
evidence to support it, the reviewing court on the entire
evidence is left with the definite and firm conviction that a
18
Fed. R. Civ. P. 52(a) states in pertinent part:
“Findings of fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and due regard
shall be given to the opportunity of the trial court to judge of
the credibility of the witnesses.”
-32mistake has been committed.’”
N.C., 470 U.S. at 565.
Anderson v. City of Bessemer,
The Supreme Court embellished the
“clearly erroneous” standard of review as follows:
If the district court’s account of the evidence is
plausible in light of the record viewed in its
entirety, the court of appeals may not reverse it even
though convinced that had it been sitting as the trier
of fact, it would have weighed the evidence
differently. Where there are two permissible views of
the evidence, the factfinder’s choice between them
cannot be clearly erroneous. United States v. Yellow
Cab Co., 338 U.S. 338, 342 (1949); see also Inwood
Laboratories, Inc. v. Ives Laboratories, Inc., 456 U.S.
844 (1982).
This is so even when the district court’s findings
do not rest on credibility determinations, but are
based instead on physical or documentary evidence or
inferences from other facts. * * * [Id. at 573-574;
emphasis added.]
Although the phrase “manifestly unreasonable” does not
appear in the Anderson opinion, the Supreme Court did discuss the
“special deference” to be paid to a trial judge’s credibility
determinations.
On this point, the Supreme Court stated:
When findings are based on determinations
regarding the credibility of witnesses, Rule 52(a)
demands even greater deference to the trial court’s
findings; for only the trial judge can be aware of the
variations in demeanor and tone of voice that bear so
heavily on the listener’s understanding of and belief
in what is said. See Wainwright v. Witt, 469 U.S. 412,
(1985). This is not to suggest that the trial judge
may insulate his findings from review by denominating
them credibility determinations, for factors other than
demeanor and inflection go into the decision whether or
not to believe a witness. Documents or objective
evidence may contradict the witness’ story; or the
story itself may be so internally inconsistent or
implausible on its face that a reasonable factfinder
would not credit it. Where such factors are present,
-33the court of appeals may well find clear error even in
a finding purportedly based on a credibility
determination. See, e.g., United States v. United
States Gypsum Co., supra, [333 U.S.] at 396. But when
a trial judge’s finding is based on his decision to
credit the testimony of one of two or more witnesses,
each of whom has told a coherent and facially plausible
story that is not contradicted by extrinsic evidence,
that finding, if not internally inconsistent, can
virtually never be clear error. Cf. United States v.
Aluminum Co. of America, 148 F.2d 416, 433 (CA2 1945);
Orvis v. Higgins, supra, at 539-540. [Id. at 575-576;
emphasis added.]
Consistent with the foregoing, and in the light of the
Courts of Appeals’ directions to this Court on remand, we are
obliged to review the recommended findings of fact and
credibility determinations set forth in the STJ report under a
“manifestly unreasonable” standard of review, and we may reject
such findings of fact and credibility determinations only if,
after reviewing the record in its entirety, we conclude that the
recommended finding of fact or testimony (1) is internally
inconsistent or so implausible that a reasonable fact finder
would not believe it, or (2) is not credible because it is
directly contradicted by documentary or objective evidence.
Id.
at 574-575; see Boyett v. Commissioner, 204 F.2d 205, 208 (5th
Cir. 1953) (a court may reject positive and uncontradicted
testimony as to a particular fact if the testimony “is inherently
improbable or manifestly unreasonable, even though no
contradictory testimony is offered” (emphasis added)), affg. a
Memorandum Opinion of this Court; Stone v. Commissioner, 865 F.2d
-34at 346 (where the Court of Appeals for the D.C. Circuit discussed
Montgomery Coca-Cola Bottling Co. v. United States, 222 Ct. Cl.
356, 615 F.2d 1318 (1980), and concluded the case stands for the
proposition that “reversal of the initial fact-finder is proper
if the objective evidence overwhelms the initial fact-finder’s
inferences from testimony and demeanor”).
A final point on the subject of deference.
In Ballard v.
Commissioner, 429 F.3d at 1031, the Court of Appeals for the
Eleventh Circuit stated that the Tax Court’s review and adoption
of a Special Trial Judge’s recommended findings of fact is
analogous to a District Court’s review of a magistrate judge’s
findings of fact, and, citing United States v. Cofield, 272 F.3d
1303, 1306 (11th Cir. 2001), it further stated that a magistrate
judge’s credibility determinations generally may not be rejected
without rehearing the disputed testimony.
Kanter’s response to
respondent’s objections, filed under new Rule 183(c), includes an
argument that the Court of Appeals for the Eleventh Circuit made
it clear that this Court cannot reject the credibility
determinations set forth in the STJ report.
We disagree.
We do
not understand the Court of Appeals’ statement to mean that we
are barred from rejecting credibility determinations set forth in
the STJ report without first rehearing the disputed testimony.
Instead, the Court of Appeals observed that the deaths of primary
witnesses in these cases foreclosed retrial.
Ballard v.
-35Commissioner, 429 F.2d at 1032.
Rather than treating the
credibility determinations as established on that account, the
Court of Appeals prescribed the standard under which they are to
be reviewed.
Thus, we conclude we are not barred in these cases
from rejecting credibility determinations recommended in the STJ
report under the “manifestly unreasonable” standard of review
described above.
VI.
Structure of the Court’s Report
After comparing the recommended findings of fact and legal
conclusions in the STJ report with the entire record in these
cases, and taking into account the parties’ posttrial briefs and
objections and responses filed pursuant to new Rule 183(c), we
have determined to reject some of the recommended findings of
fact in the STJ report because they are manifestly unreasonable
and to supplement others because they are incomplete.
In constructing the Findings of Fact portions of this
report, we have included many findings of fact drawn directly
from the STJ report, and we have made additional findings of fact
where necessary.
For clarity, the findings of fact drawn
directly from the STJ report appear in italics and are
accompanied by page references to the STJ report.19
19
Footnotes
Some reordering and minor additions and changes have
been inserted in the recommended findings of fact adopted from
the STJ report. These minor changes did not alter the substance
of the adopted findings of fact and are not otherwise noted in
(continued...)
-36taken from the STJ report likewise appear in italics but are
renumbered.
In contrast, the Court’s additional findings of fact
appear in bold type accompanied by supporting citations of the
trial transcript, trial exhibit(s), and/or the parties’ original
posttrial briefs, as appropriate.
Our departures from the
recommended findings of fact in the STJ report normally are
marked by a comment either in the text or in the margin
(including appropriate citations of the record).
Commissioner, 429 F.3d at 1031.
See Ballard v.
Any additions we have made in
the findings of fact portions of this report that do not
constitute findings of fact, such as headings and general
commentary, appear in normal type.
The Opinion portions of this report appear in normal type
and include (1) a summary of the legal analysis set forth in the
STJ report, (2) an evaluation of the credibility determinations
in the STJ report as weighed against the objective evidence drawn
from the entire record, and (3) a discussion and analysis of each
of the issues remaining in dispute.
19
(...continued)
the report.
-37Issue I.
Whether Kanter, Ballard, and Lisle Earned and Are
Taxable on the Income in Dispute
FINDINGS OF FACT (STJ report at 14)
With respect to the issues in dispute, the parties filed
several stipulations of facts.20 The facts reflected in these
stipulations, with the annexed exhibits, are so found and are
incorporated herein by reference.21
At the time the petitions were filed, the Kanters’ legal
residence was in the State of Illinois, the Ballards’ legal
residence was in the State of Florida, and the Lisles’ legal
residence was in the State of Texas.
The independent coexecutors
of the Estates of Robert W. and Donna M. Lisle, Amy L. and Thomas
W. Lisle, were also legal residents of the State of Texas at the
time they were substituted as representatives of the Estates of
their deceased parents.
20
The STJ report does not contain any recommended findings
of fact regarding the examination process and related summons
enforcement proceedings that preceded the trial in these cases.
These matters are relevant to the question of whether Kanter and
Ballard are liable for additions to tax for fraud and are
addressed in detail in additional findings of fact, infra pp.
213-222.
21
Unless otherwise clear from the context, the following
words, their derivatives, and related terms are used for
narrative convenience only to describe the forms of the various
transactions in dispute in these cases: “invest”, “purchase”,
“borrow”, “pay”, “distribute”, “promise”, “loan”, “sale”, “note”,
“agreement”, “obligation”, “interest”, “capital contribution”,
“paid-in capital”, “officer”, “director”, “shareholder”, and
“partner”. By our use of such terms, we do not mean to suggest
any conclusions concerning the actual substance or
characterization of the transactions for tax purposes.
-38I.
Petitioners22
A.
Burton W. Kanter (STJ report at 18-20)
Petitioner Burton W. Kanter is an attorney who has
continuously been engaged in the practice of law at 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.
From
1954 to 1956, he was an attorney-adviser with the U.S. Tax Court
at Washington, D.C.
Since 1956, his law practice has been at
Chicago, Illinois.
His primary expertise is in Federal income
and estate taxation.
From 1964 to 1981, Kanter was a name
partner in the law firm Levenfeld & Kanter, which later became
Levenfeld, Kanter, Baskes & Lippitz.
That firm dissolved in
1981, and Kanter thereafter practiced with the firm of Kanter &
Eisenberg.
As of the time of trial, Kanter was serving in an “of
counsel” capacity with the Chicago firm of Neal, Gerber &
Eisenberg.
At the time of trial and for the past 10 years, Kanter
taught courses in estate and gift taxation and estate planning at
22
The STJ report, at 15, opened with recommended findings
of fact concerning Investment Research Associates, Ltd. (IRA).
This report begins with findings of fact concerning the
backgrounds of Kanter, Ballard, and Lisle, followed by findings
of fact concerning IRA and other entities that Kanter employed in
the transactions in dispute (hereinafter sometimes referred to as
Kanter-related entities).
-39the 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 popular features of
this publication is the Shop Talk section, which was originated
and edited by Kanter.
At the time of trial, Kanter was a senior
editor with the Journal of Taxation.
Kanter is generally
recognized as renowned in his field.
All of this has resulted in
a successful and prolific law practice, which has led to Kanter’s
not only being engaged in the practice of law but also to his
being extensively involved in consultation, development, and
investments in a number of various business fields and
enterprises.
Commensurate with his reputation as a highly successful and
skillful tax lawyer, Kanter, over the years, has amassed an
impressive array of business and professional clients and
contacts in business and industry throughout the United States.
For instance, Kanter has performed extensive legal work for the
Pritzker family, majority owners of the Hyatt Corp., a major
hotel company in the United States.
He is and was a good friend
of certain of the Pritzker family members, including the late
A.N. Pritzker, the head of the Pritzker family, whom Kanter
-40personally represented.
Kanter also served as a director on
several corporate and charitable organization boards.
Kanter has made many investments through numerous entities,
including corporations, partnerships, and family trusts.
Some of
these family trusts are trusts the income of which is taxable to
Kanter pursuant to the grantor trust provisions of sections 671
through 678.
A number of Kanter’s family trusts own substantial
stock interests in The Holding Co., Inc., a corporation that made
extensive investments during the years at issue.
Additionally, on occasion, Kanter and/or entities associated
with him have entered into certain arrangements with various
individuals, pursuant to which Kanter would use his business and
professional contacts to assist such individuals either in
obtaining potential business opportunities or in raising capital
for business ventures.
In exchange for such assistance from
Kanter, these individuals agreed to share their profits or fees
payable to an entity or entities associated with Kanter.23
23
The STJ report incorrectly stated that entities Kanter
represented provided assistance to various individuals in
obtaining business opportunities or in raising capital. As
discussed in detail in the Court’s additional findings of fact,
infra pp. 51, n. 27 (Weisgal testimony), 91-107 (Frey), 107-124
(Schaffel), 124-131 (Schnitzer), and 131-152 (Eulich), there is
no evidence (1) anyone at any Kanter-related entity provided the
businessmen involved in the transactions in dispute (sometimes
referred to as The Five) with assistance in obtaining business
opportunities or in raising capital, or (2) any of these
businessmen were relying on anyone other than Kanter, in his
(continued...)
-41Petitioner Naomi R. Kanter, Kanter’s wife, was not involved
in any of the activities giving rise to this litigation.
She is
a petitioner in these proceedings solely because she filed joint
Federal income tax returns with Kanter for the years at issue.
After paying a small amount of tax in 1978, Kanter paid no
Federal income taxes during 1979 through 1989.24
Kanter filed
Federal income tax returns that reported adjusted gross income
and income tax as follows:
B.
Year
Adjusted Gross
Income (Loss)
Income
Tax Paid
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
($44,386)
(105,084)
(155,026)
(53,614)
(287,536)
(819,449)
(804,482)
(954,695)
(1,529,213)
(2,004,257)
(1,340,459)
(1,331,576)
$1,671
-0-0-0-0-0-0-0-0-0-0-0-
Exhibit
120
121
123
125
127
128
130
130A
131
132
133
134
Claude M. Ballard (STJ report at 20-22)
Ballard was an employee of Prudential.
He began his
employment with Prudential in 1948 in its real estate department.
23
(...continued)
individual capacity, to assist them in obtaining business
opportunities and/or in raising capital.
24
120.
Kanter paid small amounts of self-employment tax.
Exh.
-42He worked continuously at Prudential until his retirement in
early 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 an individual
named Donald Knab who was in charge of all of Prudential’s real
estate operations.
After leaving Prudential, Ballard became a
general partner with Goldman Sachs, a brokerage and/or an
investment firm in New York City.
Later, he became a limited
partner with Goldman Sachs.
Essentially, Ballard’s work with Prudential, in its real
estate equity operations, involved the purchase and sale of
existing properties, as well as the development of new
properties.
It included, additionally, the management of such
properties, including the negotiation and sale of properties,
where warranted.
Ballard supervised the staff of this department
at Prudential’s headquarters, as well as the real estate
department staff at Prudential’s regional offices throughout the
United States.
-43In his position with Prudential, Ballard met and was in
contact with attorneys, developers, businessmen, and contractors
involved in or affected by Prudential’s acquisition and/or
development, maintenance, operation, and financing activities.
Ballard first met Kanter sometime in 1972 at Houston, Texas, in
connection with the opening of the Houston Hyatt Hotel.
As
indicated previously, Kanter represented the Pritzker family, the
majority shareholder/owners of Hyatt Corp.
At the Houston Hyatt
Hotel’s opening, Ballard was introduced to Kanter by A.N.
Pritzker (the head of the Pritzker family), who told Ballard that
Kanter was A.N. Pritzker’s “everything”.
In the succeeding
years, Kanter and Ballard had numerous business and professional
contacts with each other.
Petitioner Mary B. Ballard, Ballard’s wife, was not
involved, except in a very limited way, in any of the activities
giving rise to this litigation.
She is a petitioner in these
proceedings solely because she filed joint Federal income tax
returns with Ballard for the years at issue.
C.
Robert W. Lisle (STJ report at 22-23)
Lisle was also an employee of Prudential from September 1950
to April 1982.
He was also employed in the real estate
department at Prudential, in real estate development and in
-44mortgage financing.
The development aspect of his work was
conducted under the umbrella of a subsidiary corporation of
Prudential, which was known as PIC Realty Corp. (PIC Realty).
Lisle was president of PIC Realty.
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.
To a large
extent, the career of Lisle paralleled that of Ballard.
Lisle
also worked in various regional offices of Prudential and
ultimately was promoted to a senior executive position at
Prudential’s Newark corporate headquarters.
and Ballard were next door to each other.
The offices of Lisle
At the time Lisle left
Prudential in 1982, he was a vice president of Prudential.
Lisle’s supervisor at Prudential was also Donald Knab.
After
leaving Prudential in April 1982, Lisle worked for The Travelers
Insurance Co. (Travelers) until April 1988, doing virtually the
same kind of work he had done for Prudential.
Lisle met Kanter sometime between 1968 and 1970.
The two
had numerous contacts with each other in succeeding years,
including the period after Lisle left Prudential and worked for
Travelers.
The record does not reflect what outside business
activity Lisle was involved with that would be relevant to these
cases between the time Lisle left Travelers in April 1988 until
his death in 1993.
-45Donna 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.
D.
She died in 1993.
Additional Findings of Fact Regarding Ballard and Lisle
Donald Knab (Knab) worked with Ballard and Lisle in
Prudential’s Houston regional office in the late 1960s and, after
being reassigned to Prudential’s corporate headquarters in Newark
in the early 1970s, Knab asked Ballard and Lisle to come to work
for him in the real estate investment department.
Knab, Transcr.
at 602-604.
Knab had very high regard for Ballard’s and Lisle’s
abilities.
Knab, Transcr. at 608.
1.
Ballard
Ballard considered it common in the real estate business for
intermediaries to introduce brokers to corporate real estate
owners and financiers, such as Prudential, and for such
intermediaries and brokers to share any fees arising from real
estate transactions related to such introductions.
Ballard,
Transcr. at 215-216.
Ballard’s high-ranking-executive position at Prudential
allowed him to exert significant influence over Prudential’s real
estate investment decisions, including awards of property
-46management contracts, financing transactions, and related
business.
Ballard, Transcr. at 215; Knab, Transcr. at 606-609;
Strum, Transcr. at 511, 521-522.
Ballard believed that his power
to reject or veto a proposed transaction was the most significant
power that he wielded at Prudential.
2.
Ballard, Transcr. at 215.
Lisle25
Lisle became president of PIC Realty in 1970.
2.
Exh. 2030, at
Lisle was first introduced to Kanter by A.N. Pritzker during
the period 1968 to 1970.
Id. at 10-11.
At that time, PIC Realty
was involved in the construction of what would become the Houston
Hyatt Hotel, and Kanter was representing the Pritzkers.
Ballard,
Transcr. at 119-120; Exh. 2030, at 11.
Lisle was authorized at both Prudential and Travelers to
commit up to $20 million to real estate financing transactions
and development projects.
Exh. 2030, at 2, 9-10.
Lisle’s
position at Travelers, senior vice president for the real estate
investment department, was higher than his position at
Prudential.
Id. at 9.
Lisle’s high-ranking-executive positions
at Prudential and Travelers allowed him to exert significant
influence over Prudential’s and Travelers’ real estate investment
25
As previously indicated, Lisle died before the trial was
held in these cases. Exh. 2030 is a transcript of an interview
that IRS agents conducted with Lisle on Jan. 10, 1990.
-47decisions, including awards of construction contracts, financing
transactions, development projects, and related business.
Ballard, Transcr. at 215; Strum, Transcr. at 511, 521-522; Knab,
Transcr. at 606-609.
E.
Kanter-Related Entities
1.
Investment Research Associates, Ltd. (IRA) (STJ report
at 15-17)
IRA was incorporated as a subchapter C corporation in the
State of Delaware on August 26, 1974, originally under the name
Cedilla Co.
In the annual franchise tax report for IRA filed
with the State of Delaware, dated March 1, 1979, the name of
Cedilla Co. was changed to Investment Research Associates, Ltd.
To avoid confusion, we refer to the corporation at all times as
IRA.
IRA consistently filed annual franchise tax reports with the
State of Delaware.
Between 1974 and 1977, IRA was authorized to
issue both common stock and several classes of preferred stock.
Exhs. 4, 9071.
IRA’s annual franchise reports filed with the
State of Delaware from 1975 to 1988 often were not accurate in
reporting the shares of its stock that were issued and
outstanding.
Exhs. 4, 9071.
IRA has always had a board of directors and a full slate of
officers.
It has consistently filed Federal income tax returns.
-48During 1977 through 1989, IRA reported consolidated total
income, taxable income/losses, and net operating losses as set
forth in the following table:
Table 1
Year
Total Income
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
$234,790
1,004,475
1,944,332
3,557,198
5,158,583
4,536,122
3,849,742
3,606,785
3,118,893
2,345,762
299,794
(526,393)
1,011,577
Taxable Income (Loss)
($271,394)
(18,673)
406,771
65,094
(615,852)
(121,501)
(425,538)
(175,946)
96,363
(327,854)
(16,942)
(637,842)
(116,521)
Exhs. 10 to 24, 9668, 9669.
taxable year 1979.
a.
Net Operating Losses
($7,954)
(271,394)
(18,673)
--(143,987)
(121,501)
(89,235)
(175,946)
-(111,843)
(10,550)
(1,057,468)
IRA paid tax of $94,618 for the
Exh. 10.
IRA’s Shareholders
Before October 28, 1975, Delores Keating (Keating), a real
estate broker, held 1,000 shares of IRA’s common stock.
9051.
Exh.
In 1973 or 1974, Mildred Schott (Schott) began working
with Keating.
Schott, Transcr. at 2122-2123.
Schott previously
worked as a legal secretary and had a real estate brokerage
license.
of theirs.
She was introduced to Kanter by a mutual acquaintance
-49On October 28, 1975, Keating’s 1,000 shares of IRA common
stock were exchanged for 500 shares of class B preferred stock.
Exh. 9051.
Although she did not recall the fact, Schott held
1,200 shares of IRA class A preferred stock until 1982.
Transcr. at 2113, 2129; Exhs. 10, 12, 14, 17.
Schott,
Schott held IRA
stock to enable the company to hold a corporate real estate
license.
Schott, Transcr. at 2119; Exh. 4022.
On October 28, 1978, IRA issued 1,000 shares of common stock
in equal shares to 25 trusts known collectively as the Bea Ritch
Trusts.
Exh. 9051; Exh. 135, at 23.
By 1978, IRA redeemed
Keating’s 500 shares of class B preferred stock.
Exh. 4.
During the examination of IRA’s returns, an IRS agent
recalled being presented with IRA corporate minutes for 1983
which indicated that IRA’s shareholders at the time included the
Bea Ritch Trusts, Schott, a Ballard family trust, and a Lisle
family trust.
b.
Batory, Transcr. at 3151-3152.
The Bea Ritch Trusts
The Bea Ritch Trusts were established in 1969 and were named
after Beatrice K. Ritch, Kanter’s mother.
After 1982, IRA had
only common stock outstanding, and the Bea Ritch Trusts were
IRA’s sole shareholders.
Originally, when the 25 Bea Ritch Trusts were established in
1969, the beneficiaries of the Bea Ritch Trusts were Kanter,
-50Kanter’s family, and other relatives of Kanter.
By about 1977,
Kanter had purportedly renounced all of his interest as a
beneficiary in the Bea Ritch Trusts.26
Solomon Weisgal
(Weisgal), an accountant and a longtime friend and business
associate of Kanter, has been the sole trustee of the Bea Ritch
Trusts since 1969.
As trustee of the Bea Ritch Trusts, Weisgal
has an extremely 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 virtually any manner he deemed appropriate.
c.
IRA’s Officers and Directors
Before October 27, 1975, Keating was IRA’s president and
secretary.
Exh. 9050.
IRA’s president.
On October 27, 1975, Keating resigned as
Id.
On October 27, 1975, Schott was elected IRA’s president,
and Sharon Meyers (Meyers) was elected IRA’s secretary.
Meyers had originally worked as Kanter’s secretary.
26
Id.
Meyers,
Whether Kanter’s alleged renunciations were shams is a
factual question raised infra Issue V. In any event, numerous
additional trusts were later added as beneficiaries to the Bea
Ritch Trusts. Exhs. 135, 9187, 9269, 9270, 9271. See app. 17 to
this report. Additional trusts (and groups of trusts) for the
benefit of Kanter’s family members included the Everglades Trusts
(5), the T.C. Family Trust, the Egandale-Vine Trust, the Beach
Trust, the Baroque Trusts (3), the Softy Trusts (10), the
Pillpoppers Trusts (3), and the Chamber Trusts (3). Exhs. 92139220.
-51Transcr. at 2890-2891.
By the 1970s, Meyers’s position at
Kanter’s law firm evolved to that of Kanter’s administrative
assistant.
Meyers, Transcr. at 2894-2899.
Meyers served as an
officer and/or director of IRA at various times.
Exh. 4.
From 1975 to 1980, Schott remained the president of IRA and
Weisgal was vice president.27
From 1980 to 1989, the president
of IRA was Lawrence Freeman (Freeman), an attorney in Miami,
Florida, and a friend and business associate of Kanter.
Although
Freeman was not paid for serving as IRA’s president, Freeman and
his law firm received significant legal business by referrals
from Kanter.
Although Freeman was IRA’s president and director
for most of the 1980s, he characterized his role as primarily
that of a bookkeeper/accountant and administrator.
Freeman,
Transcr. at 1819.
In 1989, Kanter became IRA’s acting president.
Kanter had never been an officer or employee of IRA.
27
Until 1989,
Exhs. 4,
Solomon Weisgal (Weisgal) had little recall regarding
his activities as either an officer or a director of IRA or The
Holding Co. (THC). Weisgal, Transcr. at 434-437, 443, 445, 458460. Weisgal believed the Bea Ritch Trusts were IRA’s sole
shareholders from its original organization through 1989.
Weisgal, Transcr. at 440. Weisgal had no recollection of the
person or persons at IRA or THC who would have generated business
opportunities for The Five or the persons at IRA or THC who would
have performed services for The Five under various agreements
that he executed on behalf of IRA or THC during the years at
issue. Weisgal, Transcr. at 444-446 (Schaffel), 462 (Essex).
-529071, 9085.
IRA.
Kanter and his law firm provided legal services to
Gallenberger, Transcr. at 1990.
From 1976 through 1980, Schott, Weisgal, and Patricia Grogan
(Grogan) served as IRA’s directors.
Exh. 4.
Grogan was an
accountant who began working at Kanter’s law firm in the mid1970s.
Grogan, Transcr. at 1395-1396.
Freeman served as IRA’s director.
From 1981 through 1989,
Exhs. 4, 9071.
Ballard and Lisle were never shareholders, officers,
directors, or employees of IRA.
Exh. 4.
However, in December
1981, IRA issued a check to Ballard in the amount of $12,500–-an
amount identified in the memo section of the check as a
director’s fee.
Exh. 3007.
Ballard cashed the check, and IRA
deducted the payment as a director’s fee on its 1981 tax return.
Id.; Ballard, Transcr. at 218; Exhs. 14, 9071.
d.
IRA’s 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 (Zeus),28 Carlco, Inc. (Carlco), TMT, Inc. (TMT), and
BWK, Inc. (BWK).
28
Carlco, TMT, and BWK are discussed in
Zeus Ventures (Zeus), is discussed with regard to the
Frey transactions described infra pp. 91-107.
-53substantial detail below.
IRA also, at one point, owned a
majority stock interest in International Films, Inc.
e.
IRA’s Business Activities
IRA’s principal activity was making investments, either for
itself or through its subsidiaries.
It maintained bank accounts
and books and records of its activities.
In connection with its
investment activities, IRA utilized the services of its officers,
employees, advisers, and consultants, among whom was Kanter.
IRA was primarily a vehicle for holding passive investments
and generally had no paid employees.
Meyers, Transcr. at 2911-
2912; Petitioners’ Reply Brief at 66.
During the period 1983 to
1989, IRA did not claim any deductions for salaries, wages, or
compensation paid to its officers.
2.
Exhs. 18-24.
Carlco, Inc., TMT, Inc., and BWK, Inc. (STJ report at
17-18)
Kanter was a beneficiary of a trust called the Morkan Trust
No. 1.29
Exh. 56.
On October 17, 1983, Kanter exercised a
limited power of appointment under the Morkan Trust No. 1 and
directed the trustee, Roger Baskes,30 to transfer $2,500 to each
of two newly formed trusts:
Christie Trust and Orient Trust.
29
Morkan Trust No. 1 was named after Kanter’s father,
Morris Kanter. Exh. 56.
30
Roger Baskes was a lawyer employed at one time at
Kanter’s law firm. Baskes, Transcr. at 542-543.
-54Exhs. 56, 79.
Meyers was named trustee of the Christie and
Orient trusts.
Id.
Members of Lisle’s family were named as
beneficiaries of the Christie Trust, and members of Ballard’s
family were named as beneficiaries of the Orient Trust.
Id.
Carlco, TMT, and BWK were so-called shelf corporations that
Kanter first incorporated in 1982 but remained dormant until late
1983.
Kanter, Transcr. at 3604-3605.
In December 1983, IRA
acquired 1,000 shares or 100 percent of the common stock of each
of Carlco, TMT, and BWK.
Exh. 18, at 7.
IRA paid $6,000 to each
of the corporations for the shares of stock.
Exhs. 68, 92, 113.
In December 1983 and January 1984, Carlco, TMT, and BWK each
issued preferred shares of stock.
Carlco preferred shares were
issued to the Christie Trust (Lisle’s family trust); TMT
preferred shares were issued to the Orient Trust (Ballard’s
family trust); and BWK preferred shares were issued to the BK
Children’s Trust (one of the Bea Ritch Trusts).
As a result of
those trusts’ ownership of these preferred shares, Carlco, TMT,
and BWK no longer qualified to be members of IRA’s consolidated
group of corporations for tax purposes and were not included in
the consolidated returns IRA filed.
For 1984 and thereafter,
Carlco, TMT, and BWK, each filed separate Federal corporate
income tax returns.
The record does not include a complete set
-55of Carlco’s, TMT’s, or BWK’s corporate minutes books, stock
ledgers, or stock registers after 1984.
During this period, Kanter recommended and proposed to
Freeman (IRA’s president) and Weisgal (trustee of the Bea Ritch
Trusts, which held 100 percent of IRA’s common stock) that
generally Carlco and TMT should each receive a 45-percent share
of IRA’s available investment funds and that BWK should receive
the remaining 10 percent of IRA’s available investment funds.
Kanter testified that the distribution of IRA’s funds to
Carlco, TMT, and BWK in a 45/45/10 percent split represented (1)
a “free-cashflow asset allocation” he and Freeman devised, and
(2) an effort to diversify IRA’s investments.
at 3663-3666, 3690-3691, 3694-3695.
Kanter, Transcr.
The diversification of
investments was to be achieved by having Lisle manage Carlco and
invest principally in municipal bonds, Ballard manage TMT and
invest principally in real estate, and Kanter manage BWK and make
miscellaneous investments.
Id.; Ballard, Transcr. at 222.31
Kanter, in fact, did not have time to manage BWK’s investments.
Kanter, Transcr. at 3695.
31
As shown in additional findings of fact regarding the
flow of funds, see infra pp. 162, 187-188: (1) IRA did not
allocate all of its free cashflow to Carlco, TMT, and BWK during
the period in question, and (2) in addition to real estate
investments, Ballard invested substantial amounts of TMT’s funds
in cash and municipal bonds.
-56Kanter also testified that he recommended Carlco, TMT, and
BWK be removed from IRA’s consolidated group for tax-reporting
purposes because (1) he was concerned that Carlco’s earnings from
tax-exempt municipal bonds might imperil IRA’s interest
deductions, and (2) he wanted to shelter Ballard and Lisle from
“second-guessing” by Freeman or another IRA officer.
Kanter, Transcr. at 3685-3686.32
Pursuant to Kanter’s proposal,
from 1984 through 1989, IRA transferred substantial funds and
other assets to Carlco, TMT, and BWK in the respective
45-percent, 45-percent, 10-percent allocation.
From 1984 through
1992, Ballard managed TMT’s investments, and Lisle managed
Carlco’s investments.
3.
Additional Findings of Fact Regarding The Holding Co.
Other than identifying The Holding Co. (THC) as a Kanterrelated entity that held investments, the STJ report did not
include any detailed findings of fact regarding the organization
and operation of THC.
Inasmuch as THC and its subsidiaries
received some of the disputed payments from The Five, and THC is
32
Kanter did not explain how removing Carlco and TMT from
IRA’s consolidated group of corporations for tax reporting
purposes would serve to shelter Ballard and Lisle from secondguessing by an officer of IRA, given that IRA purportedly
continued to own all of Carlco’s and TMT’s common stock and
Carlco and TMT remained IRA’s “legally controlled” subsidiaries.
See Petitioners’ Reply Brief at 3.
-57discussed in the flow-of-funds analysis below, additional
findings of fact are warranted.33
THC was incorporated as a subchapter C corporation on
December 8, 1976.
Exh. 153.
THC owned several subsidiary
corporations including the Citra Co., Active Business Corp.,
Zion Ventures, Inc.,34 Harbor Exchange Lending Operation (HELO),35
LBG Properties, Inc., The Nominee Corp., Oil Investments, Ltd.,
and Tanglewood Properties, Inc.
Exhs. 153, 154, 156-160.
THC held numerous partnership interests during the period in
question.
a.
Id.
THC’s Shareholders, Officers, and Directors
The shareholders statement on each of THC’s tax returns
shows that Kanter owned THC’s voting stock as follows:
1977--75
percent; 1978--76 percent; 1979--76 percent; 1980--76 percent;
1983 to 1986--not more than 50 percent.36
Exh. 153, at 25; Exh.
154, at 14, l. 10; Exh. 156, at 13, l. 10; Exhs. 157-160. THC’s
shareholders between 1981 and 1983 included Kanter, his immediate
33
Payments THC received from The Five (in this case
Schaffel, Frey, and Eulich) are summarized infra pp. 207-208.
34
Zion Ventures, Inc. (Zion), is discussed with regard to
the Frey transactions described infra pp. 91-107.
35
Harbor Exchange Lending Operation (HELO) is discussed
with regard to the flow-of-funds analysis infra pp. 196-205.
36
The record does not include a complete set of THC’s
corporate minutes books, stock ledgers, or stock registers.
-58family members, and a large number of Kanter family trusts.
152, at
Exh.
1, 2, 6, 7; Exh. 454.
Kanter did not report on his tax returns any sales of THC
stock during the years at issue.
Exhs. 120-134.
During 1981 to 1983, THC’s officers and directors included
Kanter, Weisgal, Meyers, Gallenberger, and Joshua Kanter.
Exh.
152.
b.
THC’s Tax Returns
THC filed consolidated Federal income tax returns (and
amended returns) reporting taxable income or losses for the years
and in the amounts as follows:
TYE
Aug. 31
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
Exhs. 153-160.
Losses
($132,095)
(973,792) [amd.]
38,351
–––(7,552,865)
(5,930,863)
(5,652,815)
(6,166,172)
THC’s tax returns for 1981 to 1983 are not
part of the record.
-594.
The Administration Co., Inc., and Principal Services
Accounting Corp. (STJ report at 28-32)
The Kanter-related entities described above, particularly
IRA and THC, required a clerical staff to assist in bookkeeping
and ministerial tasks.
Meyers, Transcr. at 2890-2892; Grogan,
Transcr. at 1396-1397, 1410.
During the mid-1970s to early
1980s, these ministerial tasks were performed by clerical
assistants and bookkeepers, such as Meyers and Grogan, who were
employees of Kanter’s law firm (Levenfeld & Kanter) but who
worked for Kanter nearly full time.
Id.
By 1981, bookkeeping for IRA, THC, and other Kanter-related
entities had become so voluminous that The Administration Co.,
Inc. (TACI), was organized for that purpose.
2901, 2908-2909.37
Meyers, Transcr. at
TACI was incorporated in the State of
Delaware on September 21, 1981, and was authorized to do business
in the State of Illinois.
Its articles of incorporation stated
that it was “to engage in any lawful act or activity for which
corporations may be organized under the General Corporation Law
of Delaware.”
In TACI’s application to do business in the State
of Illinois, a more comprehensive statement of TACI’s purpose was
37
The Administration Co., Inc. (TACI) 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.
-60that the corporation would engage in consultant and advisory
work, including investment, management, and advisory services.
On the date TACI was incorporated, Weisgal, as trustee of the
Pyramid Trust, subscribed to the total number of shares
authorized to be issued by the corporation.
the Pyramid Trust’s sole beneficiary.
Sharon Meyers was
Sharon Meyers was the sole
director of TACI and was its initial president and treasurer from
1981 through 1985.
TACI was organized to assist its clients in their financial
and investment activities.
TACI’s clients included individuals,
corporations, partnerships, trusts, various clients of Kanter,
and members of his law firm.
However, not all of the clients of
TACI were clients of Kanter’s law firm.
At various times, TACI
had hundreds of clients, including Kanter, IRA, and
THC.
From 1981 through 1988, TACI had between 200 to 500
clients.
TACI had several employees at any given time, mostly
clerical assistants, bookkeepers, and accountants.
TACI received
moneys for and on behalf of clients and paid out moneys
either to clients or to third parties on behalf of clients.
TACI
maintained books and records for each of these clients and, in
many instances, prepared clients’ tax returns.
fee for its services.
TACI charged a
-61With respect to moneys TACI collected and held for its
clients, instead of having a separate bank account for each
client, at the suggestion of the bank where TACI did business,
a single bank account was opened, in TACI’s name, which served as
a common depository fund for all of TACI’s clients.
was known as the TACI Special E Account.38
That account
TACI’s books and
records reflected each client’s balance of money in the account
and also reflected the deposits or withdrawals by each client
affecting that client’s balance in the account.
TACI also
maintained at its bank another similar account known as the TACI
Special Account, which was also for the benefit of TACI’s
clients.
This account was not used as an operating account for
TACI’s clients but rather was used to pool or aggregate idle
funds of TACI’s clients.
The moneys in this account were
utilized generally to buy certificates of deposit because a
higher rate of return could be realized for TACI’s clients
through aggregating their funds to purchase larger-denomination
certificates of deposit.
to other TACI clients.
Funds from this account were also lent
Deposits to and withdrawals from the TACI
Special E Account and the TACI Special Account were posted to the
38
The bank insisted that TACI have a single bank account,
as opposed to hundreds of bank accounts for separate clients,
because this saved the bank considerable administrative expenses.
During this period, the bank did not charge account holders
banking fees either for checks deposited to their accounts or for
checks written on their accounts.
-62appropriate client accounts.
TACI issued annual tax statements
and reports to its clients and the Internal Revenue Service on
the interest income earned by each client on that client’s funds
in the TACI Special E Account and the TACI Special Account.
Kanter, as a client of TACI, had funds of his own in both
the TACI Special E Account and the TACI Special Account.
TACI,
as part of its services and acting on Kanter’s behalf, paid some
of Kanter’s business and personal expenses out of Kanter’s funds
in these accounts.
All checks issued by TACI on behalf of a
client were debited against the balance such client had in the
accounts.
If a client had a negative balance in the accounts,
that debit amount was considered an indebtedness by the client to
TACI.
Any positive balance a client had in the accounts was
considered money belonging and owed to said client.
Included among the services provided by TACI were
bookkeeping services for its clients.
This included keeping
books and records for clients and the preparation of individual
income tax returns.
TACI prepared Kanter’s income tax returns
for all or some of the years at issue.
TACI’s offices were located either at the law firm offices
of Kanter or in close proximity thereto.
Meyers, who was president of TACI, directed the staff and
employees of TACI until 1985.
Linda Gallenberger (Gallenberger),
a C.P.A., became vice president of TACI in 1982 and worked under
-63the direction of Meyers.
When Meyers left TACI, Kanter briefly
served as acting president of TACI and, thereafter, Gallenberger
became TACI’s president from 1985 through 1988.
TACI employed several other clerical assistants,
bookkeepers, and accountants, including Lisa Klopman Shanker
(Shanker, Transcr. at 998), Sharon Bayers (Bayers, Transcr. at
1005-1006), Rosemary Snedden (Bayers, Transcr. at 1010), Rosaline
Weiss (Weiss, Transcr. at 796), Phyllis Dassinger (Dassinger,
Transcr. at 629-630), and Kim Moxely Roehn (Roehn, Transcr. at
967-968).
Kanter sometimes instructed Meyers, Gallenberger, and other
TACI staff on how a particular transaction should be recorded,
where a particular check should be deposited, or to whom moneys
should be paid.
Meyers, Transcr. at 2900, 2911 2934;
Gallenberger, Transcr. at 1939, 1957.
Grogan maintained the books and records and prepared tax
returns for IRA and THC.
1417, 1476.
Grogan, Transcr. at 1400-1403, 1415-
Grogan also prepared Kanter’s tax returns.
Transcr. at 1479-1480.
Grogan,
Kanter instructed Grogan on how THC’s
assets were to be invested and how the tax returns for IRA and
THC should be prepared.
Grogan, Transcr. at 1421, 1479-1480.
-64TACI filed for bankruptcy in February 1988.39
Korrub served as TACI’s bankruptcy attorney.
1805.
Lawrence
Korrub, Transcr. at
During TACI’s 1988 bankruptcy proceedings, the records
that TACI maintained for Kanter and Kanter-related entities were
not turned over to Korrub.
Korrub, Transcr. at 1807-1808.
The
only documents that Korrub received were copies of TACI’s tax
returns.
Id.
During TACI’s bankruptcy, Gallenberger sent TACI’s
books and records, including the bank statements and canceled
checks related to the TACI Special E and TACI Special Accounts,
to Kanter.
Gallenberger, Transcr. at 1970-1973.
At the time of TACI’s bankruptcy, a new corporation,
Principal Services Accounting Corp. (PSAC), was organized.
All
of PSAC’s outstanding shares of stock were initially owned by ARO
Trust, of which trust Kanter was the trustee.
Gallenberger became the president of PSAC.
Transcr. at 1978-1980.
In 1989,
Gallenberger,
In 1990, Linda Gallenberger purchased
from ARO Trust all of PSAC’s shares for $100 and her assumption
of PSAC’s outstanding debts, which totaled over $100,000.
Prior to TACI’s filing for bankruptcy, PSAC took over a
number of TACI’s clients, including Kanter, IRA, and THC.
39
PSAC
The STJ report, at 32 n.14, incorrectly stated that the
record was not clear as to why TACI went bankrupt. TACI filed
for bankruptcy after the Internal Revenue Service (IRS) assessed
a number of tax return preparer penalties against the firm for
various infractions. Gallenberger, Transcr. at 1973-1974.
-65performed services for clients similar to those which TACI had
provided to TACI’s clients.
For a short period in 1989, PSAC
also established two accounts similar to the TACI Special E
Account and the TACI Special Account.
The fees PSAC received from its clients were not sufficient
to fund PSAC’s operations.
From the time PSAC came into
existence in 1989 until the time Gallenberger purchased the stock
of PSAC from the ARO Trust in 1990, PSAC borrowed over $100,000
from BWK and THC to pay its employees’ salaries.
Transcr. at 1980-1982, 1987, 2041.
Gallenberger,
BWK lent the money to PSAC
either directly or through the TACI Special E Account.
Gallenberger, Transcr. at 1983-1984.
Beyond 1990, PSAC did not generate enough fees to cover its
operational costs, continued to operate at a loss, and borrowed
money from BWK.
Gallenberger, Transcr. at 1985-1986.
At the
time the record in these cases was closed, PSAC had not repaid
the loans from BWK.
Id.
When borrowing money, Gallenberger
either contacted Kanter about the loan or went ahead and borrowed
the money herself.
Gallenberger, Transcr. at 1986-1987.
PSAC’s bookkeeping procedures and return preparation
procedures were essentially the same as TACI’s.
Transcr. at 1988-1989, 2078.
Gallenberger,
Any questions that Gallenberger had
-66regarding accounting matters were answered by Kanter or Freeman.
Id.
PSAC was located at Kanter’s law firm, Neal, Gerber &
Eisenberg.
George, Transcr. at 1282-1283.
simultaneously with Kanter’s law firm.
PSAC moved
George, Transcr. at 1283-
1284.
II.
Introductory Statement and Brief Introduction of The Five
(STJ report at 24-28)
A.
The STJ Report
A certain group of persons and/or entities has been referred
to by the parties collectively as “The Five”.
The Five, for the
most part, play a prominent role in connection with the
additions to tax for fraud.
Respondent contends that The Five
made payments over a number of years to Kanter, Ballard, and/or
Lisle that were kickbacks or payoffs devised by Kanter, Ballard,
and/or Lisle.
These various transactions or activities involving
The Five and the payments by them have been identified and
referred to by respondent as the “Prudential scheme”, the
“Travelers transaction”, and the “Kanter transaction”.
For
instance, under the Prudential scheme, respondent contends that
Ballard and Lisle used their positions at Prudential to influence
and cause Prudential to award business to individual members of
The Five.
In return for Ballard’s and Lisle’s services, each
member of The Five made payments to an entity or entities owned
-67or controlled by Kanter.
In turn, Kanter and/or entities under
Kanter's control transferred some or all of those payments to one
or more entities, and, through a succession of transfers, the
moneys ultimately filtered down to Ballard, Lisle, and Kanter,
either as corporate capital contributions or in the form of
loans, which were never repaid and later written off as
uncollectible.
Respondent variously characterized the operation
as “schemes” by which payments by The Five went figuratively into
a “black box” from which there was a “drop down” to and through
various entities until the moneys reached Ballard, Lisle, and
Kanter.
In actuality, respondent argues, the payments under the
Prudential scheme constituted kickback income to Kanter, Ballard,
and Lisle, which Kanter, Ballard, and Lisle fraudulently failed
to report on their respective income tax returns.
As the Court understands the case, respondent’s claim of
fraud is not based, per se, on the payments by The Five to Kanter
or any of the other entities to which such payments were
directed.
The record is clear, and respondent does not challenge
the fact, that all payments made by The Five were reported as
income on the Federal income tax returns of the entities
receiving such payments.
Respondent’s claim of fraud essentially
is based upon (1) the failure of Ballard, Lisle, and Kanter to
report, as income, amounts that were “dropped down” to them as
loans that were never repaid, and (2) as to Kanter, for moneys he
-68personally earned that he directed be paid to IRA or other
entities he controlled and, as to which, Kanter failed to report
on his individual income tax returns.
Respondent maintains that the failure of Kanter, Ballard,
and Lisle to report the Prudential scheme, Travelers transaction,
and Kanter transaction income constituted fraud under section
6653(b), for 1978 through 1989.
The entities that make up The
Five and a brief description of each follows:
(1) Hyatt Hotels Corp., a subsidiary of Hyatt Corp. (Hyatt).
Hyatt manages hotels in the United States, Canada, and the
Caribbean.
As indicated previously, members of the Pritzker
family control the ownership of Hyatt.
Kanter represented the
Pritzkers for years as their attorney.
In 1979, IRA acquired KWJ
Corp., a corporation that had been receiving certain “commission”
payments from Hyatt on the management fees Hyatt earned in
operating the Hyatt Embarcadero Hotel at San Francisco,
California.
The Hyatt Embarcadero Hotel had been developed and
was owned by a joint venture in which Prudential was a
participant.
The commission payments, respondent contends,
constituted part of the kickback scheme.
(2) Bruce J. Frey, D.M. Interstate, the B.J.F. Development
Co. Partnership, and BJF, Inc.
Bruce J. Frey was the principal
in each of these latter entities.
Mr. Frey, through these
entities, managed apartments, office buildings, and commercial
-69properties.
He and these entities were also heavily involved in
a number of condominium conversion projects in various cities
around the country, in many of which Prudential held interests.
Mr. Frey and his related entities shared certain fees with Kanter
and his related entities, which respondent also contends
constituted part of the kickback scheme.
(3) William D. Schaffel.
and real estate developer.
Mr. Schaffel was a mortgage broker
Mr. Schaffel also assisted a New
Jersey general contracting company to obtain certain construction
contracts.
From 1979 through 1986, he had extensive business
dealings on behalf of individuals he represented with Prudential
and Travelers.
Mr. Schaffel shared with Kanter and his related
entities brokerage and development fees, which respondent claimed
was part of the kickback scheme.
(4) Property Management Systems, Inc. (PMS).
The chairman
and chief executive officer of PMS was Kenneth Schnitzer.
PMS
managed office buildings and other commercial real estate for
others pursuant to property management contracts.
A relatively
small portion of its business included contract cleaning or
janitorial services on some Texas commercial properties it
managed.
At one point, IRA acquired and owned a 47.5-percent
stock interest in PMS.
Certain fees of PMS were also shared with
-70Kanter and his related entities, which respondent claimed was
part of the kickback scheme.40
(5) Essex Hotel Management Co. (Essex Partnership).
The
Essex Partnership had the following partners holding the
partnership interests indicated:
Percentage
partnership interest
Partner
IRA
THC
Motor Hotel Management Co.(MHM)
John Connolly
26.125
21.375
47.500
5.000
John Eulich was the majority shareholder of Motor Hotel
Management Co. (MHM), a corporation, that was engaged in the
hotel management business.
John Connolly’s hotel management
company managed two hotels that were owned by Prudential.
The
partnership agreement for the Essex Partnership is dated January
l, 1982.
One of the Essex Partnership’s purposes was to provide
consulting and liaison services to some of its partners in
connection with their management of certain hotels.
A
substantial portion of the management fees earned by John
Connolly and MHM was paid to the Essex Partnership, which
respondent contends was a part of the kickback scheme.
40
There is no evidence that any PMS fees were shared with
Kanter and his related entities.
-71B.
Comments Regarding the Introductory Statement and Brief
Introduction of The Five
The first two paragraphs of the introductory statement in
the STJ report regarding The Five do not include findings of fact
but rather represent a statement of the Special Trial Judge’s
understanding of respondent’s theory of the cases.
A review of
respondent’s posttrial briefs reveals that the Special Trial
Judge misunderstood and/or misstated respondent’s position.
As an initial matter, the STJ report stated that it was
respondent’s contention The Five made payments “In return for
Ballard’s and Lisle’s services”.
This statement suggests that
respondent asserted The Five were aware Ballard and Lisle were
using their influence to steer business to them and The Five
intended to compensate Ballard and Lisle for their actions.
To
the contrary, respondent’s theory regarding the manner in which
the kickback scheme was carried out is articulated in
respondent’s Opening Brief at 568-567, as follows:
Suppose A says to B, “If I introduce you to C, and you
do business with C’s company, then I want 50% of
whatever money you make on the deal.” If B did
business with C, and, in turn, paid A 50% of what he
made, that is not a kickback. A received a finder’s
fee. However, further suppose, A went to C and said,
“Whatever business you give to B, I will give you a
percentage of the money B gives to me.” In this
situation, B may not even know about the arrangement
between A and C. B may believe he is getting business
from C because he does good work. Nevertheless,
respondent maintains that when C gives business to B
with the understanding that he will eventually receive
money generated by that business from A, that is a
kickback.
-72Thus, respondent argued in his posttrial briefs that Schaffel,
Frey, Schnitzer, and Eulich generally were unaware Ballard and
Lisle were using their influence at Prudential to steer business
opportunities to them, and they generally believed they were
compensating Kanter for his influence.
As discussed in greater
detail, see infra pp. 229-235, in the light of respondent’s
theory the STJ report gave undue weight to testimony by The Five
that they did not participate in a kickback scheme.
The STJ report also incorrectly stated:
“respondent’s claim
of fraud is not based, per se, on the payments by The Five to
Kanter or any of the other entities to which such payments were
directed.”
Respondent clearly asserted in his opening brief that
Kanter’s, Ballard’s, and Lisle’s actions were fraudulent because
(1) they knew all the payments from The Five to IRA and THC
represented income that was taxable to each of them individually,
and (2) Kanter, Ballard, and Lisle intentionally used IRA and THC
to (a) shelter the payments from The Five from taxation, and (b)
to channel the payments to themselves disguised as capital
contributions, loans, and payments to family members.
Respondent’s Opening Brief at 556-557.
In addition, the statement in the STJ report limiting
respondent’s theory of fraud to the failure of Kanter, Ballard,
and Lisle to report as income amounts “dropped down” to them in
the form of loans is inaccurate and incomplete.
In fact,
-73respondent claimed that Carlco, TMT, and BWK were owned by Lisle,
Ballard, and Kanter, respectively, and, therefore, a much larger
portion of the payments from The Five, a total of some $6.7
million, was transferred to Kanter, Ballard, and Lisle through
so-called capital contributions to Carlco, TMT, and BWK.
459-473, 598-601.
Id. at
Though not to be ignored, the loans
represented relatively small amounts of the moneys that
respondent alleged were passed along from The Five, through
Kanter-related entities, to Kanter, Ballard, and Lisle.
III.
Details Regarding The Five
A.
Certain Payments Made by The Five (STJ report at 32-33)
Prior to and during the years at issue, Prudential was
perhaps the largest holder of commercial real estate in the
United States.
By the late 1970s, it either held or was
responsible for managing an estimated $20 billion in commercial
real estate properties.
In addition to its extensive commercial
real estate holdings in numerous cities throughout the United
States, since the 1960s, Prudential also was involved in
developing commercial real properties and in extending financing
to other real estate developers on various real estate projects
around the country.
As indicated previously, by the middle of 1982, Ballard and
Lisle each had left Prudential.
After leaving Prudential, Lisle
obtained a similar position at Travelers.
Respondent’s case for
-74fraud is based upon payments made over several years from several
entities and/or individuals that have been collectively referred
to by respondent as The Five.
The following narrative describes
The Five and the nature of their payments.
1.
Hyatt Corp.’s Payment of a Share of Its Profits on the
Embarcadero Hotel’s Management Contract to KWJ Corp.
(STJ report at 33-37)
From 1968 through 1972, Ballard and J.D. Weaver (Weaver), an
executive with Tenneco Corp. (Tenneco) played instrumental roles
in their respective employers’ joint development of what would
become the Houston Hyatt Hotel.
Weaver was president of
Tenneco’s real estate development subsidiary.
at 115.
Ballard, Transcr.
Ballard negotiated the Houston Hyatt Hotel’s management
contract with A.N. Pritzker of Hyatt Corp.
A.N. Pritzker and his
sons had reputations as tough negotiators.
Ballard, Transcr. at
125.
Hyatt Corp. was awarded the management contract for the
Houston Hyatt Hotel no later than 1970.
Ballard, Transcr. at
114-120, 126.41
Lisle also worked on the Houston Hyatt Hotel project for
Prudential.
41
Friend, Transcr. at 767-768, 772-777.
A.N. Pritzker
Hugo M. Friend, Jr. (Friend), a Hyatt Corp. vice
president, met Ballard and assisted Lisle and Tenneco
representatives in the selection of architects and contractors
for the Houston project during 1968 or 1969, a fact which
suggests that Hyatt Corp. was awarded the management contract for
the Houston Hyatt Hotel well before 1970. Friend, Transcr. at
750, 767-768, 773.
-75first introduced Kanter to Lisle as one of Hyatt Corp.’s
representatives during the period 1968 to 1970 in connection with
the Houston Hyatt project.
Exh. 2030, at 10-11.
Beginning in
1970, Lisle oversaw the development and construction of the
Houston Hyatt Hotel as president of PIC Realty.
Ballard,
Transcr. at 115, 119; Exh. 2030, at 2.
During the early 1970s, before the Houston Hyatt Hotel was
completed, Prudential was also participating in a joint venture
to develop and own the Embarcadero Hotel in San Francisco.
Along
with Prudential, the other partners in the Embarcadero Hotel
project were David Rockefeller, Trammel Crow, and John Portman
(an architect).
759.
Ballard, Transcr. at 130; Friend, Transcr. at
As none of the joint venture participants possessed the
experience, knowledge, and skill needed to manage and operate the
hotel, they endeavored to have an experienced major hotel
management company operate the hotel under a long-term management
contract.
Lisle was supervising the Embarcadero Hotel’s development
for Prudential and was involved with Prudential and the other
joint venture participants in the selection of a management
company to manage the hotel.
Del Webb, a well-known hotel
operator and owner of a large hotel management company, and
-76Intercontinental Co., another large hotel management company,
were competing for the management contract.
A.N. Pritzker also was interested in having the Hyatt Corp.
manage the hotel because the Embarcadero Hotel then would become
the third or fourth Hyatt-operated hotel in the United States at
which major conventions could be held.
As a result of Ballard’s
experience in negotiating 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 Embarcadero Hotel.
Kanter addressed some tax issues on behalf of Hyatt Corp. with
regard to the Embarcadero Hotel.
Kanter, Transcr. at 3669.
The Embarcadero Hotel was considered a spectacular property,
and both Del Webb and A.N. Pritzker wanted the management
contract for their respective companies.
135-137, 142.
Ballard, Transcr. at
Initially, Lisle was not interested in having
Hyatt Corp. manage the Embarcadero Hotel.
Lisle opposed Hyatt
Corp.’s participation in the bidding on the Embarcadero Hotel
management contract because A.N. Pritzker had recently paid John
Portman to prepare a set of plans for another hotel in the Nob
Hill area of San Francisco.
Ballard, Transcr. at 135-137.
However, Weaver, the Tenneco executive who had worked with
Ballard in developing the Houston Hyatt Hotel, eventually
-77persuaded Lisle to allow Hyatt Corp. to be considered for the
Embarcadero Hotel's management contract.42
Weaver intervened
with Lisle on behalf of Hyatt Corp. because A.N. Pritzker
promised Weaver a 10-percent share of the “retained profits”
Hyatt Corp. might earn managing the Embarcadero Hotel if Weaver
could persuade Lisle to allow Hyatt Corp. to bid on the contract.
Ballard, Transcr. at 127, 135-137;43 Exh. 362.
42
Tenneco Corp., Weaver’s employer, apparently did not
have any equity or other interest in the Embarcadero Hotel
project. The record does not fully disclose the circumstances
that caused and led Mr. Weaver to persuade Lisle to allow Hyatt
Corp. to compete for the Embarcadero Hotel’s management contract,
nor does the record disclose what specific past dealings Mr.
Weaver may have had with Lisle. While both Lisle and A.N.
Pritzker died before the trial of the instant cases, Mr. Weaver’s
testimony was not offered by the parties. As Lisle had
previously worked in Prudential’s Houston regional office, Lisle,
in all likelihood, had already been acquainted with Mr. Weaver,
as Mr. Weaver had been employed in Tenneco’s real estate
operations for some time and, beginning in about 1968, had worked
with Ballard in putting together the development project for the
Houston Hyatt Hotel. (Emphasis added.)
The first clause emphasized above is incorrect. The
circumstances that led Weaver to influence Lisle to allow Hyatt
Corp. to bid on the Embarcadero Hotel management contract are set
forth in additional findings of fact in the text that follows.
The second clause emphasized above is notable. Ballard
denied ever meeting Weaver. Ballard, Transcr. at 247. Ballard’s
testimony on this point was not credible.
43
Ballard testified: “Mr. Weaver was bugging Mr. Lisle to
let Pritzker bid on the hotel.” Ballard, Transcr. at 127.
-78Ballard recognized that Lisle alone held the power to bar
Hyatt Corp. from bidding on the Embarcadero Hotel management
contract, and there is no suggestion the other partners in the
Embarcadero Hotel project had any direct input regarding the
bidding process.
Ballard, Transcr. at 130, 135-137.
Subsequently, Ballard, Lisle, other Prudential employees,
and representatives of the other joint venture participants met
with Del Webb and A.N. Pritzker to obtain their respective bids
on the Embarcadero Hotel’s management contract.
The third
bidder, Intercontinental Co., unexpectedly did not attend the bid
meeting.
Ballard, Transcr. at 136, 269.
Ballard considered it
unusual for Del Webb to attend such a meeting in person, as
opposed to sending a representative.
Ballard, Transcr. at 138.
During the meeting, Mr. Webb refused to submit a bid on
behalf of his hotel management company, as Mr. Webb claimed that
it was his understanding that Mr. Webb’s company was to receive
the management contract.
Although Lisle and other
representatives of the joint venture participants then asked Mr.
Webb how he believed this was so, Mr. Webb refused to elaborate.
A.N. 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.
As Hyatt Corp.
submitted the only bid, A.N. Pritzker’s proposal was accepted,
-79and a management contract for the Embarcadero Hotel along those
lines was ultimately entered into by Hyatt Corp., Prudential, and
the other joint venture participants.
Hyatt Corp. was awarded
the Embarcadero Hotel management contract without any competing
bid.
Ballard, Transcr. at 136.
KWJ Corp. was an S corporation solely owned by Weaver.
In
early 1971, shortly after winning the Embarcadero Hotel
management contract, Hyatt Corp. entered into a “Memorandum Of
Agreement” with KWJ Corp. (the Hyatt/KWJ agreement), whereby
Hyatt Corp. agreed to pay KWJ Corp. an annual commission
generally equal to 10 percent of Hyatt Corp.’s “net cash profits”
from the Embarcadero Hotel management contract.
agreement stated:
The Hyatt/KWJ
“KWJ has been the principal factor in bringing
the parties together and aiding in the negotiations” with regard
to the Embarcadero Hotel management contract.
Exh. 362, at 2.
The Hyatt/KWJ agreement purportedly was authorized by Hyatt
Corp.’s executive officers under a document entitled “Certificate
of Secretary”, which bore the signature of Hugo M. Friend, Jr.
(Friend), an executive vice president, secretary, and director at
Hyatt Corp. during the period in question.
Transcr. at 748-749, 753.
Exh. 362; Friend,
Friend’s sister was married to Jay
Pritzker, one of A.N. Pritzker’s sons.
Friend, Transcr. at 750.
-80The Certificate of Secretary stated that a special meeting
of Hyatt Corp.’s executive committee of the board of directors
had been held, and a resolution was adopted authorizing Hyatt
Corp. to enter into an agreement with KWJ Corp. “for KWJ’s
services rendered in connection with * * * [Hyatt Corp.’s]
entering into a lease” with regard to the Embarcadero Hotel.
Exh. 362.
Friend first learned of the Hyatt/KWJ agreement well
over a year later, in June 1972, and he was surprised to see that
his name had been signed on the document.
752-755.
Friend, Transcr. at
Friend investigated further and learned that Donald
Pritzker, another of A.N. Pritzker’s sons and president of Hyatt
Corp. at the time, had his secretary, Joanne Brown, sign Friend’s
name on the document.
Friend, Transcr. at 754.
Friend also
learned the agreement was entered into because of Weaver’s
substantial influence in obtaining the Embarcadero Hotel
management contract for Hyatt Corp.
Friend, Transcr. at 764.
Another Hyatt Corp. document, a “Memorandum To The Files”,
prepared by Leonard W. Stoga, Hyatt Corp.’s chief financial
officer, dated February 27, 1982, stated that Weaver earned the
fee “as a result of arranging the management agreement between
Hyatt * * * and Prudential.”
807.
Exh. 464; Stoga, Transcr. at 804-
-81Following the Embarcadero Hotel deal, Hyatt Corp. abandoned
the Nob Hill hotel project.
Ballard, Transcr. at 135-137.
Prudential later built 8 to 10 Hyatt hotels in cities including
New Orleans, Cambridge (Massachusetts), Indianapolis, Nashville,
Chicago, and Oahu, Hawaii.
Transcr. at 770-771.
Ballard, Transcr. at 135; Friend,
Friend often conferred with Ballard and/or
Lisle when Hyatt Corp. contemplated replacing a hotel manager at
a Prudential-financed hotel.
Id.
Kanter purportedly met Ballard and Weaver for the first time
in the fall of 1972 at the opening of the Houston Hyatt Hotel.
Kanter, Transcr. at 3602-3603, 3652; Friend, Transcr. at 759.44
Kanter testified he first learned of Hyatt Corp.’s agreement
to share its fees on the Embarcadero Hotel’s management contract
with KWJ Corp. in about 1973, when A.N. Pritzker asked Kanter to
review the agreement.
Ballard testified he learned of the Hyatt/KWJ agreement from
A.N. Pritzker, after the fact and in connection with discussions
regarding the other Prudential-financed hotels mentioned above.
Ballard, Transcr. at 134-135.
Ballard testified that A.N.
Pritzker volunteered that Hyatt Corp. paid a finder’s fee to
44
The record strongly suggests Kanter met Ballard and
Weaver during the period 1968 to 1970--the same time A.N.
Pritzker introduced Kanter to Lisle in connection with the
Houston Hyatt Hotel project. Exh. 2030, at 10-11.
-82Weaver on the Embarcadero Hotel, but A.N. Pritzker sought to
assure Ballard that Hyatt Corp. did not pay finder’s fees on its
management contracts.
Id.
In early 1975, a dispute arose between Weaver and Hyatt
Corp. with regard to the commission due to KWJ Corp. for 1974.
Friend informed Weaver that the Embarcadero Hotel did not
generate a net profit for 1974.
Exh. 9101.
Weaver wrote to
Friend and claimed that Hyatt Corp.’s revenue from the
Embarcadero Hotel for 1974 under its management contract with
Prudential was $612,201 and that KWJ Corp. was entitled to 10
percent of that amount.
Id.
A.N. Pritzker responded to Weaver
by letter and asserted that KWJ Corp.’s share of the fees would
have to be reduced by a share of Hyatt Corp.’s home office
expenses.
Exh. 9102.
Weaver wrote back to A.N. Pritzker
disagreeing with this approach.
Exh. 9103.
During 1975, A.N. Pritzker brought the Hyatt/Weaver dispute
to Kanter’s attention and requested his advice.
at 3646-3650.
Kanter, Transcr.
During this period, Kanter and Weaver discussed
and negotiated Mr. Weaver’s sale of KWJ Corp. to Kanter’s
“client”, IRA.
Following these negotiations, in his letter to
Kanter dated March 10, 1976, Mr. Weaver confirmed “our
understanding regarding my granting to your client a right
[option] to purchase all of the outstanding shares of stock of
-83KWJ Corp.” for $150,000 and Mr. Weaver’s continuing right to
receive an amount equal to 30 percent of the payments KWJ Corp.
received from Hyatt Corp. on the Embarcadero Hotel’s management
contract.45
Kanter testified that Weaver agreed in the mid-1970s to sell
KWJ Corp. to IRA for $150,000 because he needed the money.
Kanter, Transcr. at 3652-3653.
There is no indication in the
record that the option Weaver granted to Kanter had any
independent value--Weaver simply granted IRA an open-ended option
to purchase KWJ Corp. for $150,000.
Exh. 9103.
As discussed
below, IRA’s purchase of KWJ Corp. was delayed until 1979 after
Hyatt Corp. had become a privately held corporation.46
45
Hyatt Corp.’s fees under the Embarcadero Hotel’s
management contract were based, in substantial part, on the
hotel’s operational profits. The Embarcadero Hotel opened for
business in 1973. During the first few years of the hotel’s
operation, the “commissions” KWJ Corp. received from Hyatt Corp.
were less than Mr. Weaver had expected. According to Kanter, at
the time he and Mr. Weaver negotiated KWJ Corp.’s sale to IRA,
Mr. Weaver needed money. Beginning in about the late 1970s the
Embarcadero Hotel’s profits increased significantly. Part of
this increased profitability was attributable to improvements
that Hyatt Corp. helped to finance by lending about $1 million to
the Embarcadero Hotel’s owners for certain improvements to the
hotel.
46
Although Hyatt Corp. often did pay finder’s fees or
commissions to individuals helping it to obtain valuable business
contracts, Hyatt Corp. also did not want to publicize the
specific payment amounts. It believed that such public
disclosure would cause other individuals to demand similar
compensation for future business opportunities to Hyatt Corp.
-84In the meantime, correspondence from Hyatt Corp. to Weaver
shows that (1) Hyatt Corp. revised its Embarcadero Hotel
management contract with Prudential sometime in late 1975, (2) a
question arose whether KWJ Corp.’s commission would be computed
under the old Embarcadero Hotel management contract or the new
Embarcadero Hotel management contract, (3) Hyatt Corp. paid KWJ
Corp. $54,848 for 1976 and $60,739 for 1977,47 and (4) Weaver was
informed in 1978 that the Embarcadero Hotel’s performance was
improving and commission payments to KWJ Corp. would be
increasing.
Exh. 364; Exh. 9103, at 12; Exh. 4003.
By letter dated September 27, 1979, Kanter informed Weaver
that IRA wanted to proceed with the purchase of KWJ Corp.,
effective retroactively to November 1, 1978.
Exh. 365.
In 1979,
IRA purchased 100 percent of KWJ Corp.’s outstanding shares of
stock from Mr. Weaver.
Specifically, IRA issued to Weaver a
$150,000 promissory note which provided that Weaver was to be
paid $10,000 on or before November 30, 1979, and $140,000 (with
interest at 12 percent) on or before July 31, 1980.
at 29.
Exh. 9103,
On November 26, 1979, 4 days before IRA was obliged to
pay Weaver $10,000 in cash on the note, Grogan, on behalf of IRA,
47
Hyatt Corp.’s payments to KWJ Corp. normally were
remitted in the spring of the year immediately following the
contract year. Exh. 4003.
-85sent Weaver a letter requesting that Weaver accept “a note of a
third party, International Films, Inc.” (IFI), one of IRA’s
subsidiaries, reflecting an obligation due from IFI to IRA in
full payment of the $10,000 amount due.
Exh. 9103, at 30.
Weaver agreed to this proposal. On November 30, 1979, Grogan, on
behalf of IRA, sent Weaver a document purporting to be an IFI
note payable to IRA for $10,000 which was assigned to Weaver.
Exh. 9103, at 31-32.
On March 12, 1980, Meyers, on behalf of
IFI, sent a letter to Weaver requesting that he agree to extend
to July 1, 1980, the time in which IFI had to pay him $10,000.
Exh. 9103, at 36.
On July 2, 1980, IFI purportedly paid Weaver
$10,907.37 by check signed by Grogan.
Exh. 9103, at 37.
(The
record does not reflect whether this check was negotiated.)
On
August 1, 1980, Kanter sent Weaver a letter purportedly
forwarding a check in the amount of $154,176.44 for the stock of
KWJ Corp.
Exhs. 9103, 38.
(The record does not reflect whether
this check was negotiated.)
The fact that Weaver did not receive payment on his sale of
KWJ Corp. to IRA until August 1980 casts serious doubt on
Kanter’s testimony that Weaver agreed to sell KWJ Corp. for
$150,000 in 1976 because he needed the money.
at 3652-3653.
Kanter, Transcr.
-86As a result of IRA’s purchase, KWJ Corp. was included as a
subsidiary on IRA’s 1979 consolidated tax return.
7, 19.
Exh. 10, at
IRA’s 1979 consolidated return reflected KWJ Corp.’s
assets, liabilities, and net worth as of January 1, 1979, as
follows:
Assets
Amount
Cash
Accrued income
Total assets
$40,626
108,521
149,147
Liabilities
Mortgages, notes, and bonds payable
Accrued expenses
Total liabilities
19,400
14,663
34,063
Net Worth
115,084
Common stock
Retained earning unappropriated
Previously taxed income
Total stockholder equity
1,000
53,968
60,116
115,084
Exh. 10.
KWJ Corp.’s accrued income of $108,521 as of January 1,
1979, nearly equaled the sum of the $54,848 and $60,739
($115,587) payments that KWJ Corp. received from Hyatt Corp. in
1976 and 1977, respectively.
Exh. 9103, at 12; Exh. 4003.
IRA’s
1979 consolidated return reported that KWJ Corp. had gross
receipts of $171,027 for 1979, and $51,308 of that amount (the 30
percent paid to Weaver) was deducted as a commission expense.
-87Exhs. 10, 4003.
IRA’s share of the 1979 Hyatt Corp. payment
alone provided IRA with nearly the full $150,000 purchase price
for KWJ Corp.
KWJ Corp.’s contract with Hyatt Corp. was worth
millions of dollars.
Exh. 4003.
By selling KWJ Corp. to IRA,
Weaver gave up 70 percent of his contract rights under the
Hyatt/KWJ agreement.
Neither Weaver nor Kanter immediately informed Hyatt Corp.
that IRA had purchased KWJ Corp.
1137.
Handelsman, Transcr. at 1136-
Consequently, Hyatt Corp. continued to send to Weaver
checks made payable to KWJ Corp.
1137; Stoga, Transcr. at 813.
Handelsman, Transcr. at 1136-
From 1977 through 1994, Hyatt
Corp. paid KWJ Corp. approximately $2.5 million pursuant to the
Hyatt/KWJ agreement.
Exhs. 4003, 465, 466, 467, 378, 380, 381;
Stoga, Transcr. at 808-811; Handelsman, Transcr. at 1141, 11431144.
Kanter.
Weaver forwarded each of the Hyatt Corp. payments to
Exhs. 4003, 373, 9103 (e.g., Weaver letters to Kanter
dated March 29, 1983, and March 12, 1984).
Kanter then returned
30 percent of the Hyatt Corp. fees to Weaver, and IRA deducted
those payments as a commission expense.
Exh. 10, at 16; Exh. 14,
at 7; Exh. 17, at 15-16; Exh. 18, at 20; Ex. 9103 (e.g., TACI
check to Weaver dated March 27, 1984).
-88By letter dated March 29, 1983, Weaver forwarded to Kanter
the most recent payment from Hyatt Corp.
Weaver’s letter stated
in pertinent part:
Dear Burt:
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. [Exh. 373].
In December 1983, IRA liquidated KWJ Corp., and IRA’s
subsidiaries, BWK, Carlco, and TMT received its assets.
BWK,
Carlco, and TMT then formed a partnership called KWJ Co. (KWJ
Partnership), to which they contributed all of the assets they
received from KWJ Corp.’s liquidation.
Carlco and TMT each had a
45-percent interest in KWJ Partnership; BWK had a 10-percent
interest in the partnership. On January 10, 1984, Carlco, TMT,
and BWK made capital contributions to KWJ Partnership in the
respective amounts of $2,745, $2,745, and $610.
Exh. 69, at 8;
Exh. 93, at 9; Exh. 114, at 6; also Exh. 9104, at 10.
Neither Weaver nor Kanter immediately informed Hyatt Corp.
that KWJ Corp. had been liquidated.
Transcr. at 1136-1137.
Exh. 9104; Handelsman,
Consequently, Hyatt Corp. continued to
send to Weaver checks made payable to KWJ Corp.
Id.
-89Beginning in 1984, the Hyatt Corp. payments that Weaver
continued to forward to Kanter were no longer reported on IRA’s
consolidated returns.
Rather, Carlco, TMT, and BWK reported
their distributive shares of this money passed through to them
from KWJ Partnership.
Exhs. 69-74 (Carlco general ledgers);
Exhs. 93-98 (TMT general ledgers); Exhs. 114-119 (BWK general
ledgers).
In August 1992, after the IRS began its examination in these
cases, Kanter informed Hyatt Corp. that IRA had purchased and
later liquidated KWJ Corp., and that KWJ Corp.’s assets were
transferred to Carlco, TMT, and BWK and then contributed to KWJ
Partnership.
Exh. 9104.
As of the time of trial, Hyatt Corp.
continued to send its payments to Weaver in the form of checks
made payable to KWJ Corp.
Handelsman, Transcr. at 1137.
During the period 1977 to 1994, Hyatt paid to KWJ Corp. the
amounts set forth in the following table.48
48
Hyatt Corp.’s records are inconsistent with IRA’s
records with regard to the years in which the payments listed
above were paid. We rely on Hyatt Corp.’s records regarding the
timing of the payments for purposes of these cases.
-90Table 2
Year
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
Total
Exh. 4003.
Amount
$54,848
60,739
-171,027
128,671
246,717
245,843
265,846
295,415
330,376
327,784
281,926
75,396
24,340
23,288
21,332
21,251
14,911
2,589,710
Although Hyatt Corp. was unable to find a record of
any payment to KWJ Corp. for the 1978 contract year, Harold S.
Handelsman, Hyatt Corp.’s general counsel, believed that a
payment was made to KWJ Corp. for 1978.
Handelsman, Transcr. at
1142.
As discussed in detail in additional findings of fact, infra
pp. 192-194, KWJ Corp., and later KWJ Partnership, paid
substantial amounts to Ballard’s and Lisle’s adult children
during the period 1982 to 1989, and those amounts were deducted
as consulting fees.
-912.
Bruce Frey’s Payments to IRA From 1980 Through 1985 and
to THC in 1981, 1983, 1984, and 1987 (STJ report at 3742)
Bruce Frey was a certified property manager, real estate
broker, and the principal in D.M. Interstate Management, Inc.
(D.M. Interstate), a real estate property management company that
was an S corporation.49
By January 1980, Frey organized a
corporation, BJF Development, Inc. (BJF, Inc.), to engage in the
business of condominium conversions.
at 653-654.
Exh. 5800; Frey, Transcr.
As discussed in detail below, Frey, his business
associate, James Wold (Wold), and BJF, Inc. (as general
partners), organized a number of limited partnerships for the
purpose of carrying out condominium conversion projects, selling
the condominium units, and providing ongoing management services
for the condominium association.
Exh. 5800; Frey, Transcr. at
659-660, 663.
On June 15, 1984, Frey, Wold, and BJF, Inc., as general
partners, and TSG Holdings, Inc., FWID, Ltd., and THC formed a
limited partnership known as BJF Development, Ltd. (BJF
Partnership), to engage in condominium conversion projects and
49
The second, third, and fourth sentences in the opening
paragraph of the STJ report describing business entities operated
by Bruce Frey (Frey) are incorrect. A correct statement of those
facts is set forth in additional findings of fact in the text
that follows.
-92related business.
Exh. 223.
BJF Partnership is discussed in
greater detail below.
In many instances, Frey’s limited partnerships acquired an
apartment complex, renovated and converted it into condominium
units, and sold the condominium units to individual purchasers.
Frey explained that he purchased apartment buildings at their
rental value and, after refurbishing and converting the
apartments to condominium units, he was able to turn a profit by
selling the units to individual owners.
Frey, Transcr. at 659.
Frey and/or another entity owned by him also typically earned
certain development and management fees on condominium
conversions.
The development fees were for Frey’s and/or his
entity’s services in managing and supervising the renovation and
conversion work on the property, and the management fees were
paid for their services in assisting the property’s condominium
association manage the property following the property’s
conversion.
After successfully engaging in his first condominium
conversion project in Illinois in 1978 known as Moon Lake
Village, Frey consulted with Kanter to obtain tax advice in
connection with that project.
Kanter was not involved as an
investor or partner in the Moon Lake Village project.
Transcr. at 662-663.
Frey,
During their meeting or shortly thereafter,
-93Frey and Kanter discussed Frey’s pressing need to raise capital
for future condominium conversion projects.
At that time, a
condominium conversion craze was occurring in a number of major
metropolitan areas throughout the country, and Frey was faced
with having to raise large amounts of 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 typically would
require Frey and other investors to have a substantial investment
in the project.
Kanter indicated that he could help raise large
portions of the capital that Frey needed for such condominium
conversion projects.50
However, Kanter stated, in return for
such assistance, he would have to receive a share of any
development and management fees that Frey earned from such
projects.
Kanter made it clear to Frey that he would bring additional
investors and capital to Frey’s projects only if Frey agreed to
50
The STJ report included statements in this sentence and
the next that “Kanter and/or entities associated with him” could
provide assistance to Frey in raising capital. As discussed in
the text that follows, Frey was relying solely on Kanter to raise
capital for his condominium conversion projects. Frey, Transcr.
at 666-674. Aside from limited partner investments discussed
below, there is no evidence that anyone acting on behalf of a
Kanter-related entity, such as IRA or THC, provided any
assistance or services to Frey.
-94pay Kanter a share of the fees that Frey earned for a given
project.
you.
Kanter told Frey:
“I want to be on the same basis as
Whatever fees you participate in, I don't want you to have
an edge; if I am going to bring capital in and add value to these
partnerships, I don't want anyone to have an edge and I want to
participate in those fees.”
Frey, Transcr. at 671.
Frey
acknowledged that Kanter “had a role of more than just a passive
investor.
His role was bringing in capital into the venture.”
Frey, Transcr. at 668.
Beginning in 1979-80 with Frey’s second and third
condominium conversion projects known as Lakewood and 535 North
Michigan Ave., respectively, entities associated with Kanter
invested, as limited partners, in a number of Frey’s condominium
conversion projects.
The entities associated with Kanter that
invested in these condominium projects included Zeus Ventures,
Inc. (Zeus), a subsidiary of IRA, and Zion Ventures, Inc. (Zion),
a subsidiary of THC.
Following through on his oral agreement
with Frey, Kanter also brought other investors and capital to the
Lakewood and 535 North Michigan Ave. projects.51
at 663-674; Wold, Transcr. at 2880.
51
Frey, Transcr.
Kanter brought in the Marmon
In November 1979, D.M. Interstate Management, Inc.,
entered into an agreement to manage the Lakewood condominium
property. Exh. 223, app. A, pt. II, item 11.
-95Trust as a major investor in the 535 North Michigan Ave. project.
Frey, Transcr. at 666, 673.
In return for Kanter’s bringing investors and capital to the
Lakewood and 535 North Michigan Ave. projects, Frey paid Kanter
10 to 20 percent of the development and management fees Frey
earned on those projects.
Transcr. at 2865.
Frey, Transcr. at 665-668; Wold,
Frey remitted these payments to Kanter-related
entities as directed by Kanter.
Transcr. at 2861.
Frey, Transcr. at 674; Wold,
At the same time, Zeus and Zion received
normal profits interests as limited partner investors in these
projects.
Frey, Transcr. at 666.
Prudential was not involved in either the Lakewood or the
535 North Michigan Avenue conversion projects.
Frey, Transcr. at
663-677.
The first condominium conversion project that Frey undertook
involving Prudential was in connection with a 1,000 unit
townhouse apartment complex called Village of Kings Creek at
Miami, Florida.
In late 1979 or early 1980, 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
-96million.
He also advised the Prudential executive that another
insurance company, Connecticut Mutual Life Insurance Co., would
be joining Frey in purchasing the property.
Prudential had
already 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 advised the executive that Prudential, acting on
the pension fund's behalf, should accept the offer, as Ballard
felt that Prudential’s refusal of such an offer might constitute
a breach of fiduciary duty as investment manager of the pension
fund.
In 1980, Prudential sold the Village of Kings Creek
apartment complex to a limited partnership Frey organized to
undertake conversion of the property to condominiums.
Zeus and
Zion participated as limited partners in this partnership,
contributing $100,000 and $108,014, respectively, to the Village
of Kings Creek partnership.
Exh. 5800.
Kanter also brought in
another investor, First Illinois Enterprises, that made a
substantial investment in the project.
Wold, Transcr. at 2854.
During the Village of Kings Creek conversion process,
Ballard visited the property “to see what was going on down
there”, and he met Wold.
Ballard, Transcr. at 178.
During this
-97same period, Kanter introduced Frey to Ballard at Prudential’s
headquarters in Newark.
Ballard, Transcr. at 173-175.
The Village of Kings Creek condominium conversion project
was successful.
The Village of Kings Creek partnership made a
distribution to its partners to cover the partners’ share of tax
liabilities.
Wold, Transcr. at 2854-2855.
In addition, Kanter
received a share of development fees earned on the project by way
of checks made payable to THC.
2860-2861.
Exh. 457; Wold, Transcr. at 2855,
Wold believed Kanter directed that the checks should
be written to THC.
Wold, Transcr. at 2861.
Following Frey’s success with the Village of Kings Creek
project, the Miami regional office Prudential executive who Frey
had dealt with in purchasing that property approached Frey about
acquiring another Prudential apartment property in Florida.
Beginning with this property, Prudential ultimately participated
in a number of successful condominium conversion projects with
Frey.
However, many, if not almost all, of these projects that
Frey and Prudential undertook were joint ventures.
Entities
associated with Kanter, including Zeus and Zion, also were
investors in a number of these joint venture condominium
conversion projects of Frey and Prudential.
Frey did not have to raise as much capital to engage in
these joint venture projects with Prudential, as Prudential
-98already owned the apartment property to be converted and sold to
individual condominium unit owners.
Rather than Prudential’s
selling an apartment property to Frey and other investors,
Prudential elected to participate 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 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.
Frey and other
investors would usually form a limited partnership and were
responsible for renovating and converting the property and
selling the condominium units.
The limited partnership that
included Frey and other investors received the other 50-percent
share of all unit sales proceeds above initial specified amount
of the sales proceeds.
Frey and/or an entity owned by him also
earned development and management fees from the project.
Frey/Prudential joint venture projects included condominium
conversions known as The Greens, Chatham, Calais, Valleybrook,
and Old Forge.
Frey, Transcr. at 677; Wold, Transcr. at 2868.
Prudential and BJF, Inc., entered into a series of consulting
agreements with regard to these projects between August 1, 1981,
and December 1981.
Exh. 223, app. A, pt. II, items 13, 16, 19;
-99Exhs. 221, 5814.
Kanter received a share of development fees in
connection with each of the Prudential joint venture condominium
conversion projects listed above through checks made payable to
Zeus.
Exh. 457; Wold, Transcr. at 2868-2870.
Kanter (through payments to Zeus) also received a share of
the fees Frey earned with respect to a Prudential condominium
project known as Galaxy Towers, a building that Lisle’s PIC
Realty had constructed.
Exh. 457, at
2, 4, 8; Exh. 2030, at 25.
Although Prudential converted the Galaxy Towers to condominiums
on its own, Prudential hired Frey to serve as a consultant for
the conversion and to begin a marketing plan to sell the
condominiums.
Frey, Transcr. at 684-685.
In exchange for these
services, Frey’s company received consulting fees.
Id.
In
January 1982, Prudential and BJF, Inc., executed a consulting
agreement regarding the Galaxy Towers.
Exh. 223, app. A, pt. II,
at 8, No. 22.
In the interim, on October 12, 1981, the existing agreement
that Frey had to share development and management fees with
Kanter was formalized in two separate written agreements.52
52
One
The statement in the STJ report that Frey agreed to
share his fees with “Kanter and/or entities associated with
Kanter” is manifestly unreasonable. Frey agreed to share fees
with Kanter, and Frey entered into the participation agreements
and remitted payments to Kanter-related entities only because
Kanter directed him to do so. Frey, Transcr. at 671-674.
-100agreement was between BJF, Inc., and IRA’s subsidiary, Zeus, and
the other agreement was between BJF, Inc., and THC.
These
written agreements covered projects in which Prudential apartment
properties were being converted, as well as other projects not
involving Prudential’s apartment properties.
a.
The Frey/THC Agreement
On October 12, 1981, Frey sent a participation agreement to
Kanter, as president of THC, regarding THC’s “Participation in
Condominium Conversions” which provided, in part:
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 properties [sic] 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 fortyfive (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:
The Holding Company, a Delaware corporation,
its nominees and/or affiliates--(“THC”)
33%
-101Bruce 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:
THC
BJF
5%
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. [Exh. 222.]
In sum, the Frey/THC agreement provided that, as to condominium
conversion projects involving Prudential properties, and any
future condominium conversion projects not involving Prudential,
properties, THC and Frey would participate in capital
contributions and profits and losses as 33-percent and 67-percent
partners, respectively.
In addition, after October 1, 1981, THC
would receive 5 percent of any development fees derived from any
condominium conversion projects not involving Prudential properties.
-102b.
The Frey/Zeus Agreement
On October 12, 1981, Frey sent a participation agreement to
Meyers (as president of Zeus, IRA’s subsidiary) regarding
“Participation in Proceeds on Prudential Conversions” which
provided, in part:
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
-103Prudential of the Developers’ Fees and assigned profits (as
the case may be). [Exh. 221.]
In sum, the Frey/Zeus agreement provided that Frey would pay to
Zeus (1) the equivalent of 5 percent (20% x 25%) of development
fees earned on Prudential condominium conversion projects, and
(2) 20 percent of “assigned profits” on Prudential condominium
conversion projects excluding any management fees.
The Frey/Zeus
agreement stated that the term “assigned profits” was intended to
cover all compensation paid to BJF, Inc., by Prudential under
certain condominium conversion consulting agreements (citing as
an example a BJF/Prudential consulting agreement on a project
known as Old Forge).
Id.
The Frey/Zeus participation agreement formalized Frey’s and
Kanter’s prior oral agreement to share development fees and
extended that agreement to cover assigned profits on Prudential
projects.
Consistent with Frey’s oral agreement with Kanter, as
subsequently formalized in the Frey/THC agreement and the
Frey/Zeus agreement, BJF, Inc., remitted monthly, and later
quarterly, payments to Kanter during the period December 1981 to
late 1984, representing THC’s and Zeus’s shares of development
fees and assigned profits arising from condominium conversion
projects at Village of Kings Creek, Calais, Chatham, and
-104Valleybrook.
Exhs. 224, 225, 228 (checks written against a D.M.
Interstate Management, Inc. account).
A letter to Kanter from BJF, Inc., dated October 31, 1983,
stated in pertinent part:
Dear Mr. Kanter:
Please find enclosed our check #8135 for $15,000.00.
This represents your 5% participation of our
$300,000.00 incentive fees received from Prudential for
50% of units closed at Calais, Chatham and Valleybrook.
[Exh. 225.]
The accompanying check, made payable to Kanter, was later voided
and a replacement check was issued to Zeus.
Exh. 229; Exh. 456
at 16; Busse, Transcr. at 735-736.
c.
BJF Partnership
As previously mentioned, in June 1984, BJF Partnership was
formed.
Exh. 223.
The partnership agreement provided that THC
was entitled to 13.125 percent of the partnership’s cash
distributions, but THC was obliged to remit 17.5 percent of the
partnership’s capital contributions.
Id. at 12; Exh. 5802.
Article II of the partnership agreement recited that the partners
assigned or transferred to the partnership the items specified in
part II of appendix A.
Exh. 223, at 8.
Part II of appendix A of
the partnership agreement listed 24 items transferred to the
partnership including (1) various management and consulting
agreements between BJF, Inc., and Prudential related to
-105condominium conversion projects at Calais, Chatham, Valleybrook,
and Galaxy Towers, and (2) “Two Participation Agreements with
Burton J. Kanter regarding certain condominium conversions.
These agreements have been terminated with respect to new
conversions.”
Exh. 223, app. A., pt. II, at 5-8.
The BJF
Partnership agreement included representation and warranty
clauses under which Kanter stated that (1) he did not need any
consent, authorization, or approval to contribute the
participation agreements to the partnership, (2) the terminations
of the participation agreements were valid, binding, and
effective, and (3) THC is a corporation owned by a trust all the
beneficiaries of which are Kanter family members.
Id. at 65, 70,
par. 8.4(c).
THC did not make any direct cash contributions to BJF
Partnership when it acquired its limited partnership interest.
A
June 20, 1984, letter to Kanter from a law firm involved in the
matter indicated (1) THC was obliged to make a $29,913 cash
contribution to the partnership, (2) THC owed $86,789 to FWID for
making cash equivalent contributions on THC’s behalf, and (3) THC
should issue a secured note to FWID in the amount of $88,387 for
contributing other assets to the partnership’s capital on THC’s
behalf.
Exh. 5802.
On December 31, 1984, however, TSG Holdings
purchased additional interests in BJF Partnership from THC and
-106the other partners.
Exhs. 5804, 5806, 5808.
THC’s share of the
payments made by TSG Holdings totaled $241,951, and THC actually
received $197,757 of that amount (with $44,194 having been
remitted to Frey in repayment of a portion of the amount that
Frey had contributed to the partnership on THC’s behalf.)
Exhs.
5809, 5811.
During the period October 1984 to July 1987, BJF
Partnership issued separate checks to THC representing (1) shares
of development fees for Village of Kings Creek, and (2)
partnership distributions attributable to its limited partnership
interests.
Exhs. 226, 457.
During the same period, BJF
Partnership issued checks to Zeus representing (1) shares of
development fees and incentive payments attributable to
Prudential condominium conversion projects at Galaxy Towers,
Calais, Chatham, and Valleybrook.
d.
Exhs. 227, 457.
Summary of Frey Payments to Zeus
During 1980 through 1985, Frey (through BJF, Inc., and BJF
Partnership) paid to IRA’s subsidiary, Zeus, the amounts set
forth in the following table.53
53
For a more detailed breakdown of the payments from Frey
to Zeus, see app. 1 to this report.
-107Table 3
Year
Amount
Exhibits
1980
$127,372
1981
105,764
1982
538,781
Exh. 12, stmts. 7 and 25, at 7,
Kuck, Transcr. at 3371-3373
Exh. 14, at 7, ll. 2, 6, 7;
Exhs. 5814, 5817;
Kuck, Transcr. at 3378-3384
Exh. 17, at 16, l. 4; Kuck,
Transcr. at 3409
Exhs. 18, 224, 456, 5815, 5818
Exhs. 19, 225, 456, 457, 5819
Exhs. 20, 457
1983
1984
1985
Total
e.
110,125
103,500
128,763
1,114,305
Summary of Frey Payments to THC
During 1981 to 1987, Frey (through BJF, Inc., and BJF
Partnership) paid to T
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