# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A659821ed002b159d ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 1999-407 UNITED STATES TAX COURT INVESTMENT RESEARCH ASSOCIATES, LTD., AND SUBSIDIARIES, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 1 43966-85, 712-86, Filed December 15, 1999. 45273-86, 1350-87, 31301-87, 33557-87, 3456-88, 30830-88, 32103-88, 27444-89, 16421-90, 25875-90, 26251-90, 20211-91, 20219-91, 21555-91, 21616-91, 23178-91, 24002-91, 1984-92, 16164-92, 19314-92, 23743-92, 26918-92, 7557-93, 22884-93, 25976-93, 25981-93.1 Cases of the following petitioners are consolidated herewith: Burton W. and Naomi R. Kanter, docket No. 712-86; Investment Research Associates, Ltd., and Subsidiaries, docket No. 45273-86; Burton W. and Naomi R. Kanter, docket No. 1350-87; Burton W. and Naomi R. Kanter, docket No. 31301-87; Burton W. and Naomi R. Kanter, docket No. 33557-87; Burton W. and Naomi R. Kanter, docket No. 3456-88; Investment Research Associates, Ltd., and Subsidiaries, docket No. 30830-88; Burton W. and Naomi R. (continued...) - 2 Randall G. Dick and Jeffrey I. Margolis, for petitioners in docket Nos. 43966-85, 712-86, 45273-86, 1350-87, 31301-87, 3355787, 3456-88, 30830-88, 32103-88, 27444-89, 25875-90, 26251-90, 23178-91, 24002-91, 19314-92, 26918-92, 25976-93, and 25981-93. Royal B. Martin and Steven S. Brown, for petitioners in docket Nos. 16421-90, 20211-91, 20219-91, 21555-91, 21616-91, 1984-92, 16164-92, 23743-92, 7557-93, and 22884-93. (...continued) Kanter, docket No. 32103-88; Investment Research Associates, Ltd., and Subsidiaries, docket No. 27444-89; Claude M. and Mary B. Ballard, docket No. 16421-90; Investment Research Associates, Ltd., and Subsidiaries, docket No. 25875-90; Burton W. and Naomi R. Kanter, docket No. 26251-90; Claude M. and Mary B. Ballard, docket No. 20211-91; Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, docket No. 20219-91; Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Coexecutors, docket No. 21555-91; Claude M. and Mary B. Ballard, docket No. 21616-91; Investment Research Associates, Ltd., and Subsidiaries, docket No. 23178-91; Burton W. and Naomi R. Kanter, docket No. 24002-91; Claude M. and Mary B. Ballard, docket No. 1984-92; Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, docket No. 16164-92; Investment Research Associates, Ltd., and Subsidiaries, docket No. 19314-92; Claude M. and Mary B. Ballard, docket No. 23743-92; Burton W. and Naomi R. Kanter, docket No. 26918-92; Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Coexecutors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, docket No. 7557-93; Claude M. and Mary B. Ballard, docket No. 22884-93; Investment Research Associates, Ltd., and Subsidiaries, docket No. 25976-93; and Burton W. and Naomi R. Kanter, docket No. 25981-93. - 3 Mark E. O'Leary, John J. Comeau, James M. Cascino, Jonathan P. Decatorsmith, James M. Klein, G. Roger Markley, and Pamela V. Gibson, for respondent. CONTENTS Issue 1. Whether Payments Made By the Five in the Prudential, Travelers, and Kanter Transactions During the Years at Issue Are Properly Taxable to Kanter, Ballard, and Lisle, and, if so, whether they are liable for the fraud additions to tax and penalty with respect to such income . . . . . . . . . . . . . . . . . . . . . 25 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 25 Background . . . . . . . . . . . . . . . . . . . . . . . A. Petitioners' Residences and Principal Place of Business . . . . . . . . . . . . . . . . . . . . . B. Kanter . . . . . . . . . . . . . . . . . . . . . . C. Ballard . . . . . . . . . . . . . . . . . . . . . . D. Lisle . . . . . . . . . . . . . . . . . . . . . . . II. The Kanter Enterprise . . . . . . . . . . . . . . . . . A. Overview . . . . . . . . . . . . . . . . . . . . . B. Investment Research Associates, Inc., and Its Subsidiaries . . . . . . . . . . . . . . . . . . . 1. IRA Stock . . . . . . . . . . . . . . . . . . 2. IRA Stockholders . . . . . . . . . . . . . . . a. Mildred Schott and Delores Keating . . . b. The Bea Ritch Trusts . . . . . . . . . . 3. IRA Officers and Directors . . . . . . . . . . 4. IRA Subsidiaries . . . . . . . . . . . . . . . C. Holding Co. . . . . . . . . . . . . . . . . . . . . D. Administration Co. and Principal Services: The Banking Corporations . . . . . . . . . . . . . . . E. The Other Lending Corporations . . . . . . . . . . 1. HELO . . . . . . . . . . . . . . . . . . . . . 2. Int'l Films . . . . . . . . . . . . . . . . . III. Transactions Involving the Five . . . . . . . . . . . . A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero Hotel Management Contract . . . . . . . . . . . . . B. The Frey Arrangement: Condominium Conversions. . . C. The Schaffel Arrangement: Real Estate Construction and Financing . . . . . . . . . . . . . . . . . . . 1. Schaffel/Prudential Transactions . . . . . . . 2. Schaffel/Travelers Transactions . . . . . . . 3. FPC Subventure Associates Partnership . . . . 25 I. 25 26 28 29 30 30 34 34 35 36 37 40 41 42 43 46 47 48 48 49 57 71 73 75 77 - 4 D. IV. The Schnitzer Arrangement: Sale and Repurchase of Property Management Systems Stock. . . . . . . . . 79 E. The Eulich Arrangement: Essex Hotel Management Co. . . . . . . . . . . . . . . . . . . . . . . . 88 1. Eulich's Background . . . . . . . . . . . . . 88 2. Prudential's Gateway Hotel . . . . . . . . . . 90 F. Diagram: Summary of Payments From the Five 1977 Through 1989 . . . . . . . . . . . . . . . . . . . 102 G. Changes in IRA and Subsidiaries Corporate Structure From 1974 Through 1988 . . . . . . . . . 103 H. Changes in Holding Co. & Subsidiaries Corporate Structure 12/76 Through 8/87 . . . . . . . . . . . 125 I. Holding Co. & Subsidiaries Returns . . . . . . . . 131 J. HELO 1979 Through 1983 . . . . . . . . . . . . . . 140 Flow of Money . . . . . . . . . . . . . . . . . . . . . 141 A. Payments to IRA and Subsidiaries: The Prudential Transactions . . . . . . . . . . . . . . . . . . . 141 1. Overview . . . . . . . . . . . . . . . . . . . 141 2. Flow of the Funds 1977 Through 1983 . . . . . . 142 a. Flow of Money From KWJ Corp. to IRA: 1978 Through 1983 . . . . . . . . . . . . 143 b. Flow of Money From Zeus: 1979 Through 1983 . . . . . . . . . . . . . . . . . . 146 c. Payments From Schnitzer-PMS, Essex, and Schaffel 1979 Through 1983 . . . . . . . 150 d. Funds Accumulated in IRA at Close of 1983 . . . . . . . . . . . . . . . . . . 150 3. 1984 Distributions to Carlco, TMT, and BWK, Inc. . . . . . . . . . . . . . . . . . . . . . 152 a. 1984 Distributions of Cash From IRA to Carlco, TMT, and BWK, Inc. . . . . . . 152 b. 1984 Distribution of Essex Partnership Interest to Carlco, TMT, and BWK, Inc. . 153 c. Transfer of Sherwood Partnership Interest From IRA to Carlco, TMT, and BWK, Inc. . . . . . . . . . . . . . . . . 155 d. 1984 Distributions to Carlco, TMT, and BWK, Inc. as Reflected on the Books of the Corporations . . . . . . . . . . . . 157 4. Flow of Payments by the Five 1985 Through 1989 . . . . . . . . . . . . . . . . . . . . . 158 a. Zeus 1984 Through 1988 . . . . . . . . . 158 b. Distributions of Schnitzer-PMS and Essex Payments Made During 1985 Through 1989 . 160 c. Loans From IRA to KWJ Partnership Through 1989 . . . . . . . . . . . . . . 163 d. Balance Sheets of Carlco, TMT, and BWK, Inc. 1983 Through 1989 . . . . . . . . . 163 - 5 B. C. D. E. Flow of the Funds Paid By the Five Through IRA and Its Subsidiaries to Kanter, Ballard, and Lisle . . 166 1. Overview . . . . . . . . . . . . . . . . . . . 166 2. Payments from IRA, KWJ Corp., and KWJ Co. Partnership . . . . . . . . . . . . . . . . . 166 a. 1982: IRA Payments to Ballard and Lisle . 166 b. Consulting Fees Paid to Ballard's and Lisle's Children . . . . . . . . . . . . 167 c. KWJ Partnership 1989 Payments to Lisle and Ballard . . . . . . . . . . . . . . . 168 3. Disposition of Funds out of Carlco, TMT, and BWK to Kanter . . . . . . . . . . . . . . . . 169 a. Creation of Carlco, TMT, and BWK, Inc. . 169 b. Control and Management of Carlco, TMT, and BWK, Inc. . . . . . . . . . . . . . . 171 c. Ballard: Disposition of Funds out of TMT . . . . . . . . . . . . . . . . . . 173 d. Lisle: Disposition of Funds out of Carlco . . . . . . . . . . . . . . . . . 178 e. Kanter: Disposition of Funds out of BWK, Inc. . . . . . . . . . . . . . . . . . . 180 4. Loans . . . . . . . . . . . . . . . . . . . . 181 a. IRA Loans to Kanter . . . . . . . . . . . 181 b. Loans to Ballard, Lisle, Their Family Members and Trusts . . . . . . . . . . . 181 5. Writeoff of Loans and Losses . . . . . . . . . 185 Payments to Holding Co. and Its Subsidiaries . . . 211 Distributions to Kanter . . . . . . . . . . . . . . 212 Examination of Petitioners' Returns . . . . . . . . 215 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 226 I. II. Position of the Parties . . . . . . . . . . . . . . . . 227 Omitted Income . . . . . . . . . . . . . . . . . . . . . 229 A. The Transactions . . . . . . . . . . . . . . . . . 230 1. The Hyatt Payments . . . . . . . . . . . . . . 230 2. The Frey Arrangement . . . . . . . . . . . . . 238 3. The Schaffel Arrangement . . . . . . . . . . . 240 4. The Schnitzer Arrangement . . . . . . . . . . 243 5. The Eulich/Essex Arrangement . . . . . . . . . 249 6. Conclusion . . . . . . . . . . . . . . . . . . 255 B. Overview of the Law . . . . . . . . . . . . . . . . 256 1. Sham Corporations . . . . . . . . . . . . . . 258 2. Assignment of Income . . . . . . . . . . . . . 271 3. Section 482 . . . . . . . . . . . . . . . . . 277 4. Conclusion . . . . . . . . . . . . . . . . . . 279 III. Fraud Additions to Tax and Penalties . . . . . . . . . . 286 A. Positions of the Parties . . . . . . . . . . . . . 286 - 6 B. C. D. E. F. Applicable Statutory Provisions . . . . . . . . . . 287 General Legal Principles Relating to Civil Fraud . 289 Underpayments of Tax . . . . . . . . . . . . . . . 290 Intent to Evade Tax . . . . . . . . . . . . . . . . 300 1. Lisle's Fraud . . . . . . . . . . . . . . . . 303 2. Ballard's Fraud . . . . . . . . . . . . . . . 307 3. Kanter's Fraud . . . . . . . . . . . . . . . . 311 Summary and Conclusions as to Fraud . . . . . . . . 318 Issue 2. Whether Certain Commitment Fees Paid to Century Industries, Ltd., Are Includable in Kanter's Income for 1981, 1982, 1983, 1984, and 1986 . . . . . . . . . . . . 320 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 320 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 326 Issue 3. Whether Kanter Received Unreported Income From HiChicago Trust for 1981, 1982, and 1983 . . . . . . . . . 331 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 331 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 338 Issue 4. Whether Kanter is Taxable on the Income of the Bea Ritch Trusts for 1986 and 1987 . . . . . . . . . . . . . 346 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 346 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 359 Issue 5. Whether Kanter Had Unreported Income for 1982, 1983, 1984, 1987, 1988, and 1989 From the CMS Investors Partnership . . . . . . . . . . . . . . . . . . . . . . 370 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 370 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 Issue 6. Whether Kanter had Unreported Income in 1983 From Equitable Leasing Co., Inc. . . . . . . . . . . . . . . 377 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 377 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 Issue 7. Whether Kanter Had Unreported Income in 1982 Based on the Bank Deposit Analysis Method . . . . . . . . . . 380 - 7 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 380 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 Issue 8. Whether Kanter Received Barter Income From Principal Services in 1988 and 1989 . . . . . . . . . . 385 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 385 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 386 Issue 9. Whether the Kanters Are Entitled to Certain Deductions Claimed on Schedule A and Schedule C for 1986 Through 1989 . . . . . . . . . . . . . . . . . . . 387 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 387 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 390 Issue 10. Whether Kanter, in 1983, Realized Capital Gains Under Section 357(b) and (c) From the Assumption by Cashmere Investment Associates, Inc., of Partnership Interests Having Negative Capital Accounts and Whether, Under Section 453, the Installment Method was Available for the Reporting of Such Gains . . . . . . . . . . . . 391 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 391 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 405 Issue 11. Whether Kanter Is Entitled to Research and Development and Business Expense Deductions From Immunological Research Corporation for 1979 . . . . . . 414 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 414 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 418 Issue 12. Whether Kanter had Unreported Partnership Income for 1978 . . . . . . . . . . . . . . . . . . . . . . . . 429 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429 Issue 13. Whether the Kanters Are Entitled to a Loss From GLS Associates for 1981 . . . . . . . . . . . . . . . . 429 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429 - 8 Issue 14. Whether the Kanters Are Entitled to a Loss From Computer Leasing Transactions Involving Equitec for 1983 and 1984 . . . . . . . . . . . . . . . . . . . . . 430 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430 Issue 15. Whether the Kanters Are Entitled to Investment Interest Expense Deductions for 1981 . . . . . . . . . . 430 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430 Issue 16. Whether the Kanters Are Entitled to an Investment Tax Credit Carryover for 1978 . . . . . . . . . . . . . 431 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 431 Issue 17. Whether the Kanters Are Entitled to an Interest Deduction for 1986 . . . . . . . . . . . . . . . . . . . 434 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 Issue 18. Whether the Kanters Received Unreported Interest Income from a Bank in 1988 . . . . . . . . . . . . . . . 435 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 435 Issue 19. Whether Kanter Is Entitled to a Business Loss Deduction in 1980 in Connection With the Sale of a Painting . . . . . . . . . . . . . . . . . . . . . . . . 435 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 435 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 Issue 20. Whether the Kanters Are Entitled To Deduct a Claimed Charitable Contribution of $15,000 to the Jewish United Fund in 1982 . . . . . . . . . . . . . . . 441 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 441 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 443 Issue 21. Whether the Kanters Are Entitled to Claimed Capital Gains and Losses for 1987 . . . . . . . . . . . 446 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 446 - 9 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 453 Issue 22. Whether Respondent Correctly Made Adjustments to the Rental Income, Depreciation, Interest Expense, and Investment Tax Credits Claimed by Investment Research Associates, Ltd. (IRA) in Connection with Equipment Leasing Transactions for 1979, 1980, and 1982 Through 1989 . . . . . . . . . . . . . . . . . . . . . . . . . . 465 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 465 I. Background and Adjustments Made in Deficiency Notices . 465 A. IRA and Cedilla Investment . . . . . . . . . . . . 465 1. Schott . . . . . . . . . . . . . . . . . . . . 467 2. Mallin . . . . . . . . . . . . . . . . . . . . 467 B. Richard Uhl, Funding Systems Corp., and Funding Systems Asset Management Corp. . . . . . . . . . . 469 C. FSAM Partnership . . . . . . . . . . . . . . . . . 470 II. Equipment Leasing . . . . . . . . . . . . . . . . . . . 470 A. Equipment Leasing Generally . . . . . . . . . . . . 470 B. General Facts Relative to Lack of Economic Substance, Profit Motive and Residual Value . . . . 470 C. General Facts Relating to Invalid Indebtedness and Financing Circularity . . . . . . . . . . . . . . . 472 D. Miscellaneous Additional Facts Generally Applicable to the Transactions . . . . . . . . . . 476 III. The Specific Leasing Transactions . . . . . . . . . . . 476 A. Cedilla Invest.-1976 Domestic (O.P.M. Transaction) . . . . . . . . . . . . . . . . . . . 476 B. Cedilla Invest.-1977 Domestic Transaction Master Lease Transaction) . . . . . . . . . . . . . . . . 478 C. Cedilla Invest.-1979 Foreign Transaction (British Aerospace Transaction) . . . . . . . . . . . . . . 479 D. IRA-1980 Domestic Transaction ("Mini Computer Transaction") . . . . . . . . . . . . . . . . . . . 487 E. IRA-1980 Foreign/Domestic Transaction ("Alfred Teves Transaction") . . . . . . . . . . . . . . . 490 F. Cedilla Invest. "Lexet Transactions" . . . . . . . 492 G. Cedilla Invest. "Ben Energy Transactions" . . . . . 495 H. Cedilla Invest. "Dard Systems Transactions" . . . . 498 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 501 I. II. Leasing Transactions Generally . . . . . . . . . . . . . 501 Specific Leasing Transactions . . . . . . . . . . . . . 516 A. Cedilla Invest.-1976 Domestic (O.P.M. Transaction) . . . . . . . . . . . . . . . . . . . 516 - 10 B. C. D. E. F. G. Cedilla Invest. - 1977 Domestic Transaction (Master Lease Transaction) . . . . . . . . . . . . 518 Cedilla Invest.-1979 Foreign Transaction (British Aerospace Transaction) . . . . . . . . . . . . . . 519 IRA-1980 Domestic Transaction (Mini Computer Transaction) . . . . . . . . . . . . . . . . . . . 524 IRA-1980 Foreign/Domestic Transaction (Alfred Teves Transaction) . . . . . . . . . . . . . . . . 525 Cedilla Invest.-"Lexet Transactions", "Ben Energy Transactions", and "Dard Systems Transactions" . . 526 Equitable Leasing . . . . . . . . . . . . . . . . . 529 Issue 23. Whether IRA is Entitled to a Claimed Loss on Form 4797 of $1,073,835 for 1988 . . . . . . . . . . . . . . 536 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 536 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 540 Issue 24. Whether IRA Is Entitled to a Charitable Contribution Carryover Deduction for 1983 . . . . . . . 545 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 545 Issue 25. Whether IRA Is Entitled to Certain Claimed Capital Losses for 1985 . . . . . . . . . . . . . . . . 545 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 545 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 548 Issue 26. Whether IRA Is Entitled to Claimed Bad Debt Deductions for 1987 . . . . . . . . . . . . . . . . . . 556 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 556 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 558 Issue 27. Whether IRA Is Entitled to Claimed Ordinary Losses on Sales of Notes Receivable for 1987 . . . . . . 561 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 561 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 564 Issue 28. Whether IRA Is Entitled to Certain Capital Losses for 1987 . . . . . . . . . . . . . . . . . . . . . . . . 571 - 11 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 571 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 572 Issue 29. Whether IRA Is Entitled To Deduct as Business Expenses Amounts Paid to J.D. Weaver in 1979, 1981, and 1982 . . . . . . . . . . . . . . . . . . . . . . . . . . 574 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 574 Issue 30. Whether the Assessment and Collection of the Deficiency and Additions to Tax as to IRA for 1980 Are Barred by the Statute of Limitations . . . . . . . . . . 576 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 576 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 578 Issue 31. Whether IRA Is Liable for the Fraud Addition to Tax for 1987 . . . . . . . . . . . . . . . . . . . . . . 580 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 580 Issue 32. Whether Assessment and Collection of Federal Income Taxes of Kanter, Ballard, and Lisle Are Barred by the Statute of Limitations for Some Years . . . . . . 581 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 581 Issue 33. The Liabilities of Kanter, Ballard, and Lisle for Additions to Tax for Negligence . . . . . . . . . . . . 582 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 582 Issue 34. Whether the Kanters Are Liable for the Section 6659 Addition to Tax for 1981 . . . . . . . . . . . . . 586 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 586 Issue 35. Whether Kanter Is Liable for Section 6661 Additions to Tax for 1982 Through 1984, and 1986 Through 1988 . . . . . . . . . . . . . . . . . . . . . . 589 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 589 Issue 36. Whether Kanter Is Liable for Section 6621(c) Increased Interest for 1978, 1979, 1980 Through 1984, and 1986, and 1987, and 1988 . . . . . . . . . . . . . . 592 - 12 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 592 Issue 37. Whether IRA Is Liable for the Section 6651(a)(1) Addition to Tax for 1980 . . . . . . . . . . . . . . . . 596 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 596 Issue 38. Whether IRA Is Liable for the Section 6653(a) Additions to Tax for 1980, and 1982 Through 1988 . . . . 597 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 597 Issue 39. Whether IRA Is Liable for the Section 6659(a) Additions to Tax for 1982 and 1983 . . . . . . . . . . . 601 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 601 Issue 40. Whether IRA Is Liable for the Section 6661 Additions to Tax for 1983 Through 1988 . . . . . . . . . 602 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 602 Issue 41. Whether IRA Is Liable for the Section 6662(a) Accuracy-Related Penalty for 1989 . . . . . . . . . . . 606 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 606 MEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: These consolidated cases were assigned to Special Trial Judge D. Irvin Couvillion pursuant to Rules 180, 181, and 183.2 The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. 2 Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure. - 13 OPINION OF THE SPECIAL TRIAL JUDGE In these consolidated COUVILLION, Special Trial Judge: cases, respondent determined deficiencies in petitioners' Federal income taxes, additions to tax,3 penalties, and increased interest, as follows: Investment Research Associates, Ltd., and Subsidiaries Docket No. 43966-85: Year 1979 Deficiency $18,791 Addition to Tax Sec. 6659(a) $5,637 Docket No. 45273-86: Year 1982 3 Deficiency $174,225 Additions to Tax Sec. 6659(a) Sec. 6661 $49,154 $1,038 Sec. 6653 $8,711 With respect to the additions to tax under sec. 6653, as to all of the cases before the Court, for the years 1979 and 1980, the addition to tax is under sec. 6653(a). For the years 1981 through 1985, the addition to tax is under sec. 6653(a)(1). For the years 1981 through 1985, respondent also determined the addition to tax under sec. 6653(a)(2), which is 50 percent of the interest due on the underpayment of tax attributable to negligence or intentional disregard of rules or regulations. For the years 1986 and 1987, the addition to tax is under sec. 6653(a)(1)(A), and the determined 50-percent interest due on the underpayment is under sec. 6653(a)(1)(B). For 1988, the addition to tax is under sec. 6653(a)(1), and there is no corresponding addition to tax for 50 percent of the interest due on the underpayment. See Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, sec. 1015(b)(2)(A), 102 Stat. 3342, 3568, applicable to returns the due date for which, without regard to extensions, is after Dec. 31, 1988. - 14 Docket No. 30830-88:1 Year 1983 1984 Additions to Tax Sec. 6659(a) $16,767 -- Deficiency $595,838 410,317 Sec. 6653 $29,792 20,516 Sec. 6661 $134,987 102,579 1 In docket No. 30830-88 the deficiencies in tax determined in the notice of deficiency are $595,838 and $410,317, respectively, for 1983 and 1984. Page 2 of respondent's opening brief states the deficiencies to be $181,546 and $123,095, respectively, for 1983 and 1984. The Court assumes that the amounts stated in respondent's opening brief are in error. Docket No. 27444-89: Year 1985 Additions to Tax Sec. 6653 Sec. 6661 $20,024 $100,122 Deficiency $400,488 Docket No. 25875-90: Year 1986 Deficiency $2,110,643 Additions to Tax Sec. 6653 Sec. 6661 $105,532.15 $527,660.75 Docket No. 23178-91: Year 1987 Deficiency $5,739,249 Additions to Tax Sec. 6653 Sec. 6661 $286,962 $1,434,812 Docket No. 19314-92: Year 1980 Additions to Tax Sec. 6651(a)(1) Sec. 6653 $195,609.45 $65,203.15 Deficiency $1,304,063 Docket No. 25976-93: Year 1988 1989 Deficiency $768,025 878,898 Additions to Tax Sec. 6653 Sec. 6661 $38,401 $192,006 --- Penalty Sec. 6662(a) -$175,780 - 15 Burton W. and Naomi R. Kanter Docket No. 712-86 1350-87 31301-87 33557-87 3456-88 32103-88 26251-90 24002-91 26918-92 25981-93 Year 1981 1982 1978 1980 1979 1984 1983 1986 1987 1988 1989 Deficiency $340,578.00 2,086,913.00 476,999.00 454,396.00 183,809.37 3,825,078.00 1,150,652.00 897,224.00 1,434,529.00 523,234.00 835,847.00 Additions to Tax Sec. 6653 Sec. 6659 Sec. 6661 $17,029.00 $42,682 -104,346.00 -$208,691.00 ---22,720.00 --9,190.47 --191,254.00 -949,211.00 57,532.60 -287,663.00 44,861.00 -223,666.00 71,726.45 -358,632.25 26,162.00 -130,809.00 ---- Penalty Sec. 6662 ----------$167,169 Claude M. and Mary B. Ballard Docket No. 16421-90: Year 1982 Additions to Tax Sec. 6653 Sec. 6661 $2,766.90 $8,774 Deficiency $55,338 Docket No. 20211-91: Year 1984 1 Deficiency $981,072 Additions to Tax Sec. 6651(a)(1) Sec. 6653 1 $51,3311 $88,788.05 Sec. 6661 $245,268 On brief, respondent concedes this addition to tax. Docket No. 21616-91: Year 1987 Deficiency $208,449 Additions to Tax Sec. 6653 Sec. 6661 $10,422.45 $52,112.25 Docket No. 1984-92: Year 1975 1976 1977 1978 1979 1980 1981 Deficiency $23,453 34,024 11,502 3,923 21,630 92,481 193,743 Additions to Tax Sec. 6653 Sec. 6659 $1,173 -1,701 ---------9,687 $17,138 Docket No. 23743-92: Year 1988 Deficiency $125,136 Addition to Tax Sec. 6653 $6,257 - 16 Docket No. 22884-93: Year 1989 Penalty Sec. 6662 $35,985 Deficiency $179,924 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 Coexecutors Docket No. 20219-91 21555-91 16164-92 7557-93 Year 1984 1987 1988 1989 Deficiency $827,955 195,498 109,048 109,049 Additions to Tax Sec. 6653 Sec. 6661 $41,397.75 $206,988.75 9,774.90 48,874.50 5,452.00 27,262.00 --- Penalty Sec. 6662(a) ---$21,810 In the following cases, respondent determined in the notices of deficiency or asserted in amended answers that the underpayments in tax were subject to increased interest under section 6621(c), formerly section 6621(d):4 Investment Research Associates, Ltd., and Subsidiaries: Docket No. 43966-85 45273-86 4 Year 1979 1982 Sec. 6621(d)(1) was added by the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 144(a), 98 Stat. 682, and provides for interest of 120 percent of the adjusted interest rate due on any substantial underpayment of tax attributable to tax-motivated transactions. The increased interest is effective for interest accruing after Dec. 31, 1984. Sec. 6621(d) was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2744, and repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399, effective for tax returns due after Dec. 31, 1989, OBRA 89 sec. 7721(d), 103 Stat. 2400. - 17 Burton W. and Naomi R. Kanter: Docket No. 1350-87 33557-87 3456-88 32103-88 26251-90 24002-91 Year 1982 1980 1 1979 1984 1983, 1986 1987 1 On brief, respondent concedes that the underpayment attributable to the disallowed loss from Immunological Research Corp. is not subject to increased interest under sec. 6621(c), following Estate of Cook v. Commissioner, T.C. Memo. 1993-581. Claude M. and Mary B. Ballard: Docket No. 16421-90 20211-91 21616-91 1984-92 23743-92 Year 1982 1984 1987 1975, 1976, 1977, 1978 1979, 1980, 1981 1988 Estate of Robert W. Lisle, Deceased, etc.: Docket No. 20219-91 21555-91 16164-92 Year 1984 1987 1988 In amended answers, respondent alleged increases in the deficiencies in tax and additions to tax in the following cases: - 18 Petitioner Docket No. Year(s) Investment Research Associates, Ltd.,and Subsidiaries Burton W. and Naomi R. Kanter 45273-86 43966-85 712-86 1350-87 31301-87 33557-87 3456-88 32103-88 26251-90 24002-91 26918-92 25981-93 1982 1979 1981 1982 1978 1980 1979 1984 1983, 1986 1987 1988 1989 Claude M. and Mary B. Ballard 16421-90 20211-91 21616-91 1984-92 23743-92 22884-93 1982 1984 1987 1975, 1976, 1977 1978, 1979, 1980 1981 1988 1989 20219-91 21555-91 16164-92 7557-93 1984 1987 1988 1989 Estate of Robert W. Lisle, Deceased, etc. In the amended answers, respondent alleged that the underpayments in tax with respect to all or, alternatively, with respect to substantial portions of the increased deficiencies in tax were subject to the addition to tax for fraud pursuant to section 6653(b) or the penalty for fraud pursuant to section 6663(a) in the following cases:5 5 For the years 1976 through 1981, the addition to tax for fraud is under sec. 6653(b). For the years 1982 through 1985, the addition to tax for fraud is under sec. 6653(b)(1) and (2). For 1986 and 1987, the addition to tax for fraud is under sec. 6653(b)(1)(A) and (B). For 1988, the addition for fraud is under (continued...) - 19 Petitioner Investment Research Associates, Ltd. and Subsidiaries Burton W. and Naomi R. Kanter Docket No. Year(s) 23178-91 1987 712-86 1350-87 31301-87 33557-87 3456-88 32103-88 26251-90 24002-91 26918-92 25981-93 1981 1982 1978 1980 1979 1984 1983, 1986 1987 1988 1989 Claude M. and Mary B. Ballard 16421-90 20211-91 21616-91 1984-92 23743-92 22884-93 1982 1984 1987 1975, 1976, 1977 1978, 1979, 1980 1981 1988 1989 20219-91 21555-91 16164-92 7557-93 1984 1987 1988 1989 Estate of Robert W. Lisle, Deceased, etc. Introduction In each of the cases in which fraud is alleged, respondent alleged that, if the Court holds that the underpayments in tax are not subject to fraud additions, alternatively, the underpayments in tax are subject to additions to tax under sections 6653(a)(1) and (2) and 6659(a), and the increased interest under section 6621(c), or if the underpayment is for 1989, that it is subject to a penalty under section 6662. (...continued) sec. 6653(b)(1). 6663(a). For 1989, the penalty for fraud is under sec. - 20 In all of the amended answers in which respondent asserted increased deficiencies in tax, as well as increased additions to tax and penalties, respondent did not calculate or assert the amounts of the increased tax deficiencies or the amounts of the additions to tax or penalties. Respondent asserted only the amounts of increased income or the amounts of disallowed expenses that would result in increased deficiencies in tax and additions to tax. As a result of these amended answers, and as a result of numerous concessions and stipulations of settlement that were made by the parties before, during, and after the trial, as well as concessions of certain issues by respondent on brief, Rule 155 computations will be necessary in some of the cases.6 These cases are part of a larger group of cases that have also been identified by respondent as a litigation project. sobriquet for this project is "Levenfeld/Kanter". The These cases were selected for trial because, as the Court understands, they involve common issues that the other cases in this project do not have. References to Kanter, Ballard, and Lisle are to Burton W. Kanter, Claude M. Ballard, and Robert W. Lisle, respectively. Reference to the Kanters, Ballards, and Lisles are to Burton W. 6 In some of the cases, if petitioners are sustained on the fraud issue, respondent will be barred by the statute of limitations from assessment as to those petitioners. - 21 and Naomi R. Kanter, Claude M. and Mary B. Ballard, and Robert W. and Donna M. Lisle, respectively. The issues to be decided are: (1) Whether payments made by the Five in the Prudential, Travelers, and Kanter transactions during the years at issue are properly taxable to Kanter, Ballard, and Lisle, and, if so, whether they are liable for the fraud additions to tax and penalty with respect to such income; (2) whether certain commitment fees paid to Century Industries, Ltd., are includable in Kanter's income for 1981, 1982, 1983, 1984, and 1986; (3) whether Kanter received unreported income from Hi- Chicago Trust for 1981, 1982, and 1983; (4) whether Kanter is taxable on the income of the Bea Ritch Trusts for 1986, and 1987; (5) whether Kanter had unreported income for 1982, 1983, 1984, 1987, 1988, and 1989 from the CMS Investors Partnership; (6) whether Kanter had unreported income in 1983 from Equitable Leasing Co., Inc.; (7) whether Kanter had unreported income in 1982 based on the bank deposit analysis method; (8) whether Kanter received barter income from Principal Services in 1988 and 1989; - 22 (9) whether the Kanters are entitled to certain deductions claimed on Schedule A and Schedule C for 1986 through 1989; (10) whether Kanter, in 1983, realized capital gains under section 357(b) and (c) from the assumption by Cashmere Investment Associates, Inc., of partnership interests having negative capital accounts and whether, under section 453, the installment method was available for the reporting of such gains; (11) whether Kanter is entitled to research and development and business expense deductions from Immunological Research Corporation for 1979; (12) whether Kanter had unreported partnership income for 1978; (13) whether the Kanters are entitled to a loss from GLS Associates for 1981; (14) whether the Kanters are entitled to a loss from computer leasing transactions involving Equitec for 1983 and 1984; (15) whether the Kanters are entitled to investment interest expense deductions for 1981; (16) whether the Kanters are entitled to an investment tax credit carryover for 1978; (17) whether the Kanters are entitled to an interest deduction for 1986; - 23 (18) whether the Kanters received unreported interest income from a bank in 1988; (19) whether Kanter is entitled to a business loss deduction in 1980 in connection with the sale of a painting; (20) whether the Kanters are entitled to deduct a claimed charitable contribution of $15,000 to the Jewish United Fund in 1982; (21) whether the Kanters are entitled to claimed capital gains and losses in 1987; (22) whether respondent correctly made adjustments to the rental income, depreciation, interest expense, and investment tax credits claimed by Investment Research Associates, Ltd. (IRA) in connection with equipment leasing transactions for 1979, 1980, and 1982 through 1989; (23) whether IRA is entitled to a claimed loss on Form 4797 of $1,073,835 for 1988; (24) whether IRA is entitled to a charitable contribution carryover deduction for 1983; (25) whether IRA is entitled to certain claimed capital losses for 1985; (26) whether IRA is entitled to claimed bad debt deductions for 1987; (27) whether IRA is entitled to claimed ordinary losses on sales of notes receivable for 1987; - 24 (28) whether IRA is entitled to certain capital losses for 1987; (29) whether IRA is entitled to deduct as business expenses amounts paid to J.D. Weaver in 1979, 1981, and 1982; (30) whether the assessment and collection of the deficiency and additions to tax as to IRA for 1980 are barred by the statute of limitations; (31) whether IRA is liable for the fraud addition to tax for 1987; (32) whether assessment and collection of Federal income taxes of Kanter, Ballard, and Lisle are barred by the statute of limitations for some years; (33) the liabilities of Kanter, Ballard, and Lisle for additions to tax for negligence; (34) whether the Kanters are liable for the section 6659 addition to tax for 1981; (35) whether Kanter is liable for section 6661 additions to tax for 1982 through 1984, and 1986 through 1988; (36) whether Kanter is liable for section 6621(c) increased interest for 1978, 1979, 1980 through 1984, and 1986, and 1987, and 1988; (37) whether IRA is liable for the section 6651(a)(1) addition to tax for 1980; - 25 (38) whether IRA is liable for the section 6653(a) additions to tax for 1980, and 1982 through 1988; (39) whether IRA is liable for the section 6659(a) additions to tax for 1982 and 1983; (40) whether IRA is liable for the section 6661 additions to tax for 1983 through 1988; and (41) whether IRA is liable for the section 6662(a) accuracy-related penalty for 1989. For convenience and clarity, the Court's findings of fact and opinion are set forth under each issue. The findings of fact with respect to any issue incorporate by this reference the findings of fact as found in any preceding issue. Issue 1. Whether Payments Made By the Five in the Prudential, Travelers, and Kanter Transactions During the Years at Issue Are Properly Taxable to Kanter, Ballard, and Lisle, and, if so, whether they are liable for the fraud additions to tax and penalty with respect to such income FINDINGS OF FACT The parties have filed several stipulations of fact. The facts reflected in these stipulations, with the annexed exhibits, are so found and are incorporated herein by reference. I. Background A. Petitioners' Residences and Principal Place of Business At the time the petitions were filed, the principal place of business of Investment Research Associates, Ltd. (IRA), was in the State of Illinois, the Kanters' legal residence was in the - 26 State of Illinois, the Ballards' legal residence was in the State of Florida, and the Lisles' legal residence was in the State of Texas. Donna Lisle died on April 12, 1993, and Robert W. Lisle died on September 17, 1993. Their two children, Amy L. Albrecht and Thomas W. Lisle, are the coexecutors of the Estates of Robert W. Lisle and Donna M. Lisle. The estates have been substituted as parties and the two children as representatives of the estates. Amy Albrecht and Thomas Lisle were legal residents of the State of Texas at the time they were substituted as representatives of the estates of their deceased parents. B. Kanter Kanter is an attorney who has been engaged continuously in the practice of law in Chicago, Illinois, since about 1956. He received a J.D. degree from the University of Chicago in 1952. From 1952 to 1954, he was a teaching associate at the University of Indiana Law School. Chicago, Illinois. Since 1956, his law practice has been in and estate taxation. His primary expertise is in Federal income From 1964 to 1981, Kanter was a partner in the law firm of Levenfeld & Kanter, which later became Levenfeld, Kanter, Baskes & Lippitz. That firm was dissolved in 1981, and Kanter thereafter practiced with the firm of Kanter & Eisenberg. As of the time of trial, Kanter was of counsel with the Chicago firm of Neal, Gerber & Eisenberg. - 27 At the time of the trial and for the prior 10 years, Kanter taught courses in estate and gift taxation and estate planning at the University of Chicago Law School. Kanter has lectured and written extensively in the area of Federal tax law. He has also been an active participant in professional bar associations. For a number of years, Kanter has been a writer and contributor to the Journal of Taxation, a national monthly publication devoted exclusively to Federal taxation. One of the features of this publication is the Shop Talk section which he originated. At the time of trial, Kanter was a senior editor with the Journal of Taxation. field. Kanter is generally recognized as well known in his This recognition has resulted in a successful law practice, which has led to Kanter's being involved in consultation, development, and investments in a number of business fields and enterprises. For instance, Kanter has performed extensive legal work for the Pritzker family, majority owners of the Hyatt Corp., a major hotel company. Kanter also served as a director on the boards of several corporations and charitable organizations. Petitioner Naomi R. Kanter, Kanter's wife, was not involved in any of the activities giving rise to this litigation. However, she filed joint Federal income tax returns with Kanter for the years at issue. - 28 C. Ballard Ballard was an employee in the real estate department of The Prudential Insurance Co. of America (Prudential) from 1948 until his retirement in 1982. During the course of his career at Prudential, Ballard was assigned to several regional offices of Prudential, including Houston and Dallas, Texas, and beginning in 1966 in the corporate headquarters of Prudential at Newark, New Jersey, and then again, for a short time, at the Houston regional office. In 1973, he was reassigned to Prudential's Newark corporate headquarters, where he remained until his retirement in early 1982. At the time he left Prudential, Ballard was a senior vice president in charge of equities and worked under Donald Knab (Knab), who was in charge of all of Prudential's real estate operations. Ballard's work with Prudential in its real estate equity operations involved the purchase, development, management, and sale of property. Ballard supervised the staff of this department at Prudential's headquarters, as well as the real estate department staff at Prudential's regional and field offices throughout the United States. Ballard could influence the choice of builders and contractors for Prudential projects and could influence or prevent a project from going forward. Shortly after leaving Prudential, Ballard became a general partner with Goldman Sachs, an investment firm in New York City. - 29 In November of 1988, he retired as a general partner and became a limited partner with Goldman Sachs. In his position with Prudential, Ballard met and was in contact with attorneys, developers, businessmen, and contractors involved in or affected by Prudential's real estate activities. D. Lisle Lisle graduated from the University of Missouri with a B.S. degree in public administration. He attended law school at the University of Missouri, graduate schools of management and business at Columbia University, and the graduate school of management at Princeton University. Like Ballard, Lisle was employed by Prudential. Lisle worked for Prudential in real estate development and in mortgage financing from September 1950 to April 1982. Lisle headed the division responsible for lending money and buying and building real estate for Prudential. He had authority to commit any loan up to $20 million and to award construction contracts. The development aspect of his work was conducted through a subsidiary corporation of Prudential known as PIC Realty Corp. (PIC Realty).7 7 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. - 30 To a large extent, Lisle's career paralleled Ballard's. Like Ballard, Lisle worked in various regional offices of Prudential and ultimately was promoted to a senior executive position at Prudential's Newark corporate headquarters. The offices of Lisle and Ballard were next door to each other, and Lisle's supervisor at Prudential was also Donald Knab. extent, Ballard and Lisle's duties overlapped. To some At the time Lisle left Prudential in 1982, he was a vice president of Prudential. In April 1982, after leaving Prudential, Lisle began working for The Travelers Insurance Co. (Travelers), doing virtually the same kind of work he had done for Prudential. He worked for Travelers until April 1988. Donna M. Lisle, Lisle's wife, was not involved in any of the activities giving rise to this litigation, and her estate is a party to these proceedings solely by virtue of Mrs. Lisle's having filed joint Federal income tax returns with Lisle for the years at issue. II. The Kanter Enterprise A. Overview Kanter met Ballard and Lisle sometime between 1968 and 1970. The three had numerous contacts and business dealings in succeeding years. Kanter entered into arrangements pursuant to which he would use his business and professional contacts, including his - 31 relationships with the Pritzkers, Ballard, and Lisle, to assist individuals and/or entities in obtaining business opportunities or in raising capital for business ventures. Kanter established a complex organization of corporations, partnerships, and trusts to receive, distribute, and disguise the payments from these arrangements. Some of these arrangements involved payments from a group of individuals referred to by the parties as "the Five". The Five made payments for Ballard's and Lisle's influence in awarding contracts with Prudential (the Prudential transactions), for Lisle's influence in awarding contracts with Travelers (the Travelers transactions), and for Kanter's influence in transactions that did not involve Prudential or Travelers (the Kanter transactions). The payments most often were made to corporations controlled by Kanter and then distributed through various means to Kanter, Ballard, and/or Lisle, their family members, or to entities established for the benefit of their families. Most of the payments made in the Prudential transactions were paid through IRA or one of its subsidiaries. Those made in the Travelers and Kanter transactions generally were made through another corporation controlled by Kanter, The Holding Co. (Holding Co.) or one of its subsidiaries. Funds received by IRA and its subsidiaries and Holding Co. and its subsidiaries, as - 32 well as funds of other Kanter entities and associates, were commingled in accounts administered by another Kanter controlled entity, The Administration Co. (Administration Co.) (and later Principal Services Corp.). Some distributions to Kanter, Ballard, and Lisle were characterized as commissions, consulting fees, or directors fees. Others were recorded as receivables or loans, many of which were traded or transferred between the various entities and eventually written off as uncollectible with IRA and/or Kanter taking deductions for the writeoffs. Some of the distributions that were treated as loans were made through two Kanter entities, International Films, Inc. (Int'l Films) and Harbor Exchange Lending Operation (HELO). Large portions of the payments made in the Prudential transactions eventually were distributed to three of IRA's subsidiaries; more specifically, 45 percent to Carlco, Inc. (Carlco) (controlled by Lisle), 45 percent to TMT, Inc. (TMT), (controlled by Ballard), and 10 percent to BWK, Inc. (controlled by Kanter). An overview of the Kanter enterprise is shown by the following diagram: - 33 - - 34 B. Investment Research Associates, Inc., and Its Subsidiaries IRA was originally incorporated in the State of Delaware on August 26, 1974, under the name of Cedilla Co. In 1979, the name of Cedilla Co. was changed to Investment Research Associates, Ltd. Reference hereinafter to IRA also refers to its predecessor, Cedilla Co. during years prior to the name change. 1. IRA Stock At the time of its incorporation in 1974, IRA was authorized to issue 1,000 shares of 10-cent par value common stock, 8,000 shares of $1 par value class A preferred stock, and 1,000 shares of 10-cent class B preferred stock. By 1977 IRA was also authorized to issue 1,000 shares of $5,000 par value class C preferred stock. IRA's annual franchise reports filed with the State of Delaware from 1975 to 1988 reported that the following shares of stock were issued and outstanding: - 35 Year Common 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 [blank] [blank] 1,000 1,000 none 1,000 [blank] none 1,000 [blank] [blank] 1,000 [blank] [blank] Class A Preferred Class B [blank] [blank] 1,000 1,000 1,000 1,000 [blank] none 1,000 [blank] [blank] -0[blank] [blank] [blank] [blank] 500 none 1,000 none [blank] none [blank] [blank] [blank] -0[blank] [blank] Class C [not authorized] [not authorized] [not authorized] none none none [blank] none [blank] [blank] [blank] -0[blank] [blank] IRA's end-of-year balance sheets from 1975 to 1989 indicate the following stockholder equity attributable to the preferred and common stock: Year 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 2. Preferred $1,050 1,050 1,000 1,000 1,000 1,000 1,000 1,000 -0-0-0-0-0-0-0- Common $100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 IRA Stockholders IRA's 1976 return reported that no individual, partnership, corporation, estate, or trust at the end of the year owned (or was attributed ownership under section 267(c)) 50 percent or more - 36 of the corporation's total voting stock. IRA's returns reported that from 1977 through 1982, Solomon Weisgal, trustee of the Bea Ritch Trusts, owned 50 percent of IRA's voting stock, and Mildred Schott owned the remaining 50 percent of IRA's voting stock. The Bea Ritch Trusts owned 1,000 shares of common stock, and Schott owned 1,000 shares of class A preferred voting stock. IRA's returns for 1984 through 1989 indicated that no individual, partnership, corporation, estate, or trust at the end of the year owned (or was attributed ownership under section 267(c)) 50 percent or more of the corporation's total voting stock. a. Mildred Schott and Delores Keating Mildred Schott (Schott) worked as a legal secretary and had a real estate broker's license. a mutual acquaintance. She was introduced to Kanter by Before she obtained her broker's license, she worked as a real estate sales person for Delores Keating (Keating). Prior to October 28, 1975, Keating owned 1,000 shares of common stock of Cedilla Co. On October 28, 1975, Keating's 1,000 shares of common stock were exchanged for 500 shares of the class B preferred stock, and 1,000 shares of common stock were issued to the Bea Ritch Trusts. By 1978, Keating's 500 shares of class B preferred stock were redeemed by the corporation. - 37 Schott held 1,000 shares of the class A preferred stock until 1982. She held the stock to enable IRA to hold a corporate real estate license. b. The Bea Ritch Trusts Twenty-five trusts known collectively as the Bea Ritch Trusts were established in 1969 and were named after Beatrice K. Ritch, Kanter's mother. Kanter's mother is the named grantor, ostensibly contributing $100 to each of the 25 trusts. Originally, when the 25 Bea Ritch Trusts were established in 1969, the beneficiaries of the trusts were Kanter, his family, and other relatives of Kanter. By about 1977, Kanter had formally renounced all of his interest as a beneficiary in the Bea Ritch Trusts. At some time, many additional trusts were added as beneficiaries to the trusts. The identities of the beneficiaries of the additional trusts are not in the record. The original individual and additional trust beneficiaries of the Bea Ritch Trusts are as follows: Trust Name BWK Trust Original Beneficiaries Burton Kanter Naomi Trust Naomi Kanter BN Trust Burton & Naomi Joel Trust Burton & Joel Kanter Burton & Janis Kanter Janis Trust Additional Beneficiaries JSK 1st Trust #5 JSK 2d Trust #5 JSK 3d Trust #5 JSK 3d Trust #19 JSK 1st Trust #20 JSK 1st Trust #4 JSK 2d Trust #4 JSK 3d Trust #4 JSK 1st Trust #17 JSK 2d Trust #17 JSK 3d Trust #15 JSK 1st Trust #16 - 38 Trust Name Joshua Trust Joel Children's Trust Janis Children's Trust Joshua Children's Trust JL-1 Trust JL-2 Trust JL-3 Trust JA-1 Trust JA-2 Trust JA-3 Trust JS-1 Trust JS-2 Trust JS-3 Trust Original Beneficiaries Burton & Joshua Kanter Burton, Naomi, Joel & Joel's children living from time to time Burton, Naomi, Janis & Janis children living from time to time Burton, Naomi, Joshua & Joshua's children living from time to time Burton, Joel, Harriet Blum & Joel's 1st child Burton, Joel, Debbie Blum & Joel's 2d child Burton, Joel, Jeff Blum & Joel's 3d child Burton, Janis, Henry Krakow & Janis' 1st child Burton, Janis, Helen Krakow & Janis' 3d child Burton, Janis, Helen Krakow & Janis' 3d child Burton, Joshua, Gerald L. Kanter & Joshua's 1st child Burton, Joshua, Ruth Kanter & Joshua's 2d child Burton, Joshua, Joshua's 3d child & all of the children of Gerald L. Kanter living from time to time Additional Beneficiaries JSK 2d Trust #18 JSK 3d Trust #18 JSK 3d Trust #17 JSK 1st Trust #18 JSK 2d Trust #16 JSK 3d Trust #16 JSK 1st Trust #19 JSK 2d Trust #19 JSK 3d Trust #11 JSK 1st Trust #12 JSK 2d Trust #12 JSK 3d Trust #12 JSK 1st Trust #13 JSK 2d Trust #13 JSK 1st Trust #9 JSK 2d Trust #9 JSK 3d Trust #9 JSK 1st Trust #10 JSK 2d Trust #10 JSK 1st Trust #11 JSK 2d Trust #11 JSK 3d Trust #13 JSK 1st Trust #14 JSK 2d Trust #14 JSK 3d Trust #14 JSK 1st Trust #15 JSK 2d Trust #15 - 39 Trust Name BK Children's Trust BK Descendant's Trust BK Grandchildren's Trust Lillian Trust J-1 Wife's Trust J-2 Husband's Trust J-3 Wife's Trust Original Beneficiaries Burton, Naomi and all of the children of the Grantor's son living from time to time Burton, Naomi and all of the descendants of the of the Grantor's son living from time to time Burton, Naomi and Burton's Grandchildren living from time to time Burton, Naomi and Lillian Walker Burton, Joel's Wife and the children of Carl I. Kanter living from time to time Burton, Janis' husband and the children of Aloysius B. and Helen M. Osowski Burton, Joshua's wife and Ruth & Philip Loshin Additional Beneficiaries JSK 1st Trust #1 JSK 2d Trust #1 JSK 3d Trust #1 JSK 1st Trust #2 JSK 2d Trust #2 JSK 3d Trust #2 JSK 1st Trust #3 JSK 2d Trust #3 JSK 3d Trust #3 JSK 2d Trust #20 JSK 3d Trust #20 JSK 1st Trust #6 JSK 2d Trust #6 JSK 3d Trust #6 JSK 1st Trust #7 JSK 2d Trust #7 JSK 3d Trust #7 JSK 1st Trust #8 JSK 2d Trust #8 JSK 3d Trust #8 Solomon Weisgal (Weisgal), an accountant and a longtime friend and business associate of Kanter, has been the sole named trustee of the Bea Ritch Trusts since 1969. As trustee of the Bea Ritch Trusts, Weisgal had broad power either to accumulate the Bea Ritch Trusts' income or to distribute (i.e., sprinkle) the trusts' income and assets among all or any of the trusts' beneficiaries in a manner he deemed appropriate. Weisgal did not - 40 act independently as a trustee. Rather, he acted as Kanter directed in all matters regarding the trusts. 3. IRA Officers and Directors Prior to October 27, 1975, Keating was president and secretary of IRA. On October 27, 1975, Keating resigned and Schott was elected as president and Sharon Meyers (Meyers) as secretary by the unanimous consent of the directors (Schott, Meyers, and Patricia Grogan (Grogan)). From 1977 to 1980, the president of IRA was Schott, and the vice president was Weisgal. Lawrence Freeman (Freeman), an attorney in Miami, Florida, was a friend and business associate of Kanter. At Kanter's request, Freeman served as IRA's president from 1980 to 1989. Although Freeman was not paid for serving as IRA's president, he and his law firm received significant legal business through referrals from Kanter. In 1989, Kanter became IRA's acting president. From 1976 through 1980, Schott, Weisgal, and Grogan served as IRA's directors. director. From 1981 through 1989, Freeman served as a For most of those years Freeman was the sole director. Although Ballard was not listed as a director, IRA paid Ballard $12,500 as directors fees in 1981. IRA deducted $12,500 as a director fee expense on its 1981 return. Meyers served as an officer or director of IRA at various times. Meyers originally worked as Kanter's secretary at - 41 Kanter's law firm. By the 1970's, her duties at the law firm evolved to her being an administrative assistant to Kanter. 1981, she was no longer an employee of the law firm. By During the years at issue, Meyers also served as an officer or director of many of Kanter's other corporations. At all times, IRA's officers and directors made decisions and performed their duties in accordance with Kanter's instructions. 4. IRA Subsidiaries IRA owned, from time to time, controlling interests in several subsidiary corporations. These subsidiary corporations included Brickell Enterprises, Inc., Cedilla Co., Cedilla Investment Co., IRA Florida Apartments, Inc., KWJ Corp., Zeus Ventures, Carlco, TMT, and BWK, Inc. IRA also, at one point, owned a majority stock interest in Int'l Films. Carlco, TMT, and BWK, Inc., were incorporated in the State of Delaware in 1982 but remained inactive until 1983. In December of 1983, IRA acquired 1,000 shares (100 percent) of the common stock of each of Carlco, TMT, and BWK, Inc. In December 1983 and January 1984, Carlco, TMT, and BWK, Inc., each issued shares of preferred stock. Carlco preferred shares were issued to the Christie Trust established by Kanter for the benefit of Lisle's family; TMT preferred shares were issued to the Orient Trust established by Kanter for the benefit of Ballard's family; - 42 and BWK, Inc., preferred shares were issued to the BK Children's Trust, the beneficiaries of which were members of Kanter's family. C. Holding Co. Holding Co. was incorporated on December 8, 1976. Holding Co. owned several subsidiary corporations, including the Citra Co., Active Business Corp., HELO, LBG Properties, Inc., The Nominee Corp., Oil Investments, Ltd., Tanglewood Properties, Inc., and Zion Ventures, Inc. Kanter, his family, and trusts established for the benefit of his family, including the Bea Ritch Trusts and the Everglades Trusts,8 owned substantially all of the stock in Holding Co. Kanter, Weisgal, Meyers, and Linda Gallenberger (Gallenberger) most often served as directors and officers of Holding Co. Holding Co.'s end-of-year balance sheets indicate the following stockholder equity attributable to the preferred and common stock: Year 1979 1980 1981 8 Common $23 23 23 Class A $775 775 775 Preferred Class B Class C $3 $50,000 3 50,000 3 50,000 Class D -1,500,000 -- Paid-in Capital $407,087 407,087 407,087 The Everglades Trusts 1-5, shareholders in Holding Co., were grantor trusts in which Kanter was the deemed owner under secs. 671 through 678. - 43 Prior to August 1981, another Kanter entity, Computer Placement Services, had a $1,729,300 loan outstanding to Holding Co. In August 1981, $1,500,000 of the loan was converted to Holding Co. class D preferred stock. In 1983, the stockholder equity of class D preferred stock was decreased by $1,499,999 and the paid-in capital was increased by the same amount. D. Administration Co. and Principal Services: The Banking Corporations The funds of the various Kanter entities (as well as the funds of some of Kanter's associates) were commingled in accounts held by Administration Co. and later the Principal Services Accounting Corp. (Principal Services), both of which were also controlled by Kanter. Administration Co. was incorporated in the State of Delaware on September 21, 1981, and was authorized to do business in the State of Illinois. Administration Co.'s offices were located either at Kanter's law firm offices or in close proximity thereto.9 The sole shareholder of Administration Co. was the Pyramid Trust. Weisgal was trustee of the Pyramid Trust, and Meyers was the sole beneficiary. 9 Administration Co. was organized at the insistence of some of the members of Kanter's law firm who complained that law firm employees working under Kanter were performing extensive nonlegal services for which the law firm was not being compensated. - 44 Meyers was the sole director of Administration Co. and was its president from 1981 to 1985. Gallenberger was the vice president of Administration Co. and worked under the direction of Meyers. When Meyers left Administration Co. in 1985, Kanter briefly served as acting president of Administration Co., and, thereafter, Gallenberger became Administration Co.'s president from 1985 through 1988.10 Administration Co. had several employees, mostly clerical assistants, bookkeepers, and accountants. Meyers directed the staff and employees of Administration Co. until 1985. In 1983, Administration Co. paid $143,489 in employee compensation and distributed over $500,000 as nonemployee compensation, including $400,000 to the Rainbow Trusts (Rainbow Trust Nos. 1-25). Administration Co. administered funds that it collected from or on behalf of various Kanter entities and associates, referred to as clients. Administration Co. clients included individuals (including Kanter, Ballard, and Lisle), corporations (including IRA, Holding Co., and their subsidiaries), partnerships, trusts, various Kanter-related entities, and members of Kanter’s law firm. 10 Gallenberger was an accountant. Shortly after arriving in Chicago, Illinois, she passed the certified public accountant's examination. Gallenberger became an employee of Administration Co. in 1982. - 45 Administration Co. opened a bank account in Administration Co.'s name known as the Special E Account. The Special E Account functioned generally as a checking account for its various clients. Administration Co.'s books and records reflected each client's balance in the account and also reflected deposits or withdrawals affecting that client's account. Administration Co. also maintained at its bank a second account known as the Special Account that served more like a savings or money market account. The moneys in this account were used to buy certificates of deposit because a higher rate of return could be realized by aggregating the funds to purchase larger denomination certificates of deposit. Funds from both the Special E Account and the Special Account were lent to Administration Co. clients. Deposits to and withdrawals from the Special E Account and the Special Account were posted to the appropriate client accounts. If a client had a negative balance in the accounts, that debit amount was recorded as a receivable owed by the client to Administration Co. Any positive balance a client had in the accounts was considered money belonging to the client. Administration Co. issued annual tax statements and reports to its clients and the Internal Revenue Service (IRS) for the interest earned by each client on that client's funds in the Special E Account and the Special Account. - 46 Administration Co. maintained books and records for each of its clients and, in many instances, prepared clients' tax returns. Administration Co. prepared Kanter's income tax returns for all or some of the years at issue. Administration Co. charged a fee for its services. Administration Co. filed for bankruptcy in February 1988, and Principal Services was organized. All of Principal Services' outstanding shares of stock were initially owned by ARO Trust, of which trust Kanter was the trustee. Principal Services took over a number of Administration Co.'s clients, including Kanter, IRA, and Holding Co. Principal Services performed services for clients similar to those provided by Administration Co. Principal Services also established two accounts similar to the Special E Account and the Special Account. During the years at issue, Principal Services made loans to Holding Co. and BWK, Inc. In 1990, Gallenberger purchased from ARO Trust all of Principal Services's shares for $100. In October of 1993, Principal Services moved (along with all of its clients files) to Wisconsin. E. The Other Lending Corporations During the years at issue Kanter often used two additional entities, HELO and Int'l Films to distribute funds including - 47 distributions to Ballard and Lisle or trusts established for the benefit of their families. 1. HELO HELO's predecessor, Harbor Investments, Inc., was incorporated on July 21, 1978, and the stated business purpose was investments. The name was changed in fiscal year ending August 31, 1980, to Harbor Exchange Lending Operation. The Active Business Corp. (Active) owned 100 percent of the voting stock of HELO. Holding Co. owned 100 percent of the stock of Active and filed consolidated returns with HELO and Active. On August 31, 1984, all of the shares of HELO were transferred by Active to Kanter as the trustee of the ARO Trusts. At the time of the transfer, HELO's only significant assets were loan receivables totaling $2,331,326, and its liabilities included short-term loans of $2,518,589 and long-term loans of $10,557. Holding Co. also disposed of 100 percent of the voting stock of Active Corp. in 1984. Holding Co.'s consolidated returns reported the following income, net assets, and stockholder equity with respect to HELO:11 11 The record does not contain the information for 1982. - 48 - Income Deductions Total NOL Taxable Assets Cash Receivables Money market Pooled funds Intangibles Total Liabilities Short term Shareholder Long term Total Net assets 08/78 08/79 08/80 08/81 08/83 08/84 ------ -($115) (115) $1,485 (31,309) (29,824) (115) (29,939) $4,597 (149,974) (145,377) (29,939) (175,316) ------ $136 (30) 106 (198,135) (198,029) $500 ---- 131 ---151 382 4,294 2,871,082 718 -120 2,876,214 (879,704) 4,691,912 259 -89 3,812,556 $31 2,331,326 --27 2,331,384 322 1,320,059 -4,636 ----382 322,987 1,255,600 1,327,100 2,905,687 (29,473) 849,680 10,557 3,127,200 3,987,437 (174,881) 2,518,589 -10,557 2,529,146 (197,762) 1,522,700 -- 500 (118) 500 (29,973) 500 (175,381) 500 (198,262) 500 (198,183) 500 ----500 500 Capital stock Ret. earnings 2. 1,325,017 1,522,700 (197,683) Int'l Films Int'l Films was incorporated in September 1973. Although the record does not disclose who originally owned the stock of Int'l Films, on August 31, 1984, IRA owned 71 percent of the voting stock of Int'l Films. As of August 31, 1983, Int'l Films had loans receivable of $878,227. As of August 31, 1984, Int'l Films had loans receivable of $1,050,827. III. Transactions Involving the Five Prior to and during the years at issue, Prudential was one of the largest holders of commercial real estate in the United States. By the late 1970's, Prudential either held or was responsible for managing an estimated $20 billion in commercial real estate properties. Prudential also developed commercial - 49 real properties and provided financing to other real estate developers for various real estate projects around the country. As stated previously, Kanter entered into arrangements pursuant to which he would use his relationships with the Pritzkers, Ballard, and Lisle to assist individuals and/or entities in obtaining business opportunities or in raising capital for business ventures. Some of these arrangements involved payments by a group of individuals referred to by the parties as "the Five". The Five include J.D. Weaver (Weaver), Bruce Frey (Frey), William Schaffel (Schaffel), Kenneth Schnitzer (Schnitzer), and John Eulich (Eulich). A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero Hotel Management Contract Hyatt Corp. manages hotels in the United States, Canada, and the Caribbean. As indicated previously, members of the Pritzker family control Hyatt Corp. Kanter has represented the Pritzkers for years as their attorney. The Houston Hyatt Hotel was co-owned by Prudential and Tenneco Corp. (Tenneco) and managed by Hyatt Corp. executive with Tenneco. Weaver was an From 1968 through 1972, Ballard and Weaver were involved in the development of the Houston Hyatt Hotel, and Ballard negotiated the hotel's management contract with Hyatt Corp. During the early 1970's, Prudential was also a participant in a joint venture to develop and own the Embarcadero Hotel in - 50 San Francisco. The joint venture participants sought an experienced major hotel management company to operate the hotel under a long-term management contract. Del Webb (Webb), a well- known hotel operator and owner of a large hotel management company, and Intercontinental Co., another large hotel management company, were competing for the management contract. A.N. Pritzker wanted the Hyatt Corp. to obtain the management contract for the Embarcadero Hotel; the hotel would become the third or fourth Hyatt-operated hotel in the United States at which major conventions could be held. Lisle was supervising development of the Embarcadero Hotel for Prudential and was involved in the selection of a management company to manage the hotel. Although Hyatt Corp. was about to enter into the long-term management contract to operate the Houston Hyatt Hotel owned by Prudential and Tenneco Corp., Lisle was not interested in having the Hyatt Corp. manage the Embarcadero Hotel. Pritzker offered to pay Weaver, who had worked with Ballard in developing the Houston Hyatt Hotel, a portion of the management fees if Weaver helped Hyatt Corp. obtain the management contract for the Embarcadero Hotel. Weaver then persuaded Lisle to consider Hyatt Corp. for the Embarcadero Hotel's management contract. - 51 Since Ballard had negotiated the Houston Hyatt Hotel's management contract, Knab (Ballard and Lisle's superior at Prudential) directed Ballard to review and evaluate the terms of the proposed management contracts to be considered for the San Francisco Embarcadero Hotel. Subsequently, representatives of the Embarcadero joint venture participants met with Webb and Pritzker to obtain bids on the Embarcadero Hotel's management contract. Ballard and Lisle, as well as other Prudential employees, represented Prudential at the meeting. For reasons not fully shown in the record, representatives of Intercontinental Co. were not present at the meeting, and Webb refused to submit a bid during the meeting because he thought he had been promised the contract. Pritzker offered to have Hyatt Corp. enter into a management contract for the Embarcadero Hotel substantially similar to the Houston Hyatt Hotel's management contract. At the meeting Hyatt Corp. submitted the only bid, and the management contract was awarded to Hyatt Corp. Shortly after being awarded the contract, Hyatt Corp. entered into an agreement with KWJ Corp., an S corporation solely owned by Weaver. Under the written agreement dated February 25, 1971, Hyatt Corp. agreed to pay KWJ Corp. a commission generally equal to 10 percent of Hyatt Corp.'s fees under the Embarcadero Hotel management contract. The agreement acknowledged that "KWJ" - 52 was the principal factor in bringing Hyatt Corp. and the owners of the Embarcadero Hotel together and aiding in the negotiations. Over the period from about 1972 through 1994, Prudential eventually built a total of about 10 large, major-convention-size hotels that Hyatt Corp. managed for it. During discussions about Hyatt Corp.'s obtaining the management contract on one of the first of these other hotels built after the Embarcadero Hotel, Pritzker discussed Weaver's finder's fee with respect to the Embarcadero Hotel's management contract with Ballard and Lisle. Pritzker told Ballard and Lisle that Hyatt Corp.'s payment of this finder's fee was a one-time occurrence. Pritzker told them that no similar finder's fees would be paid with respect to future management contracts that Hyatt Corp. obtained for other Prudential hotels. The Embarcadero Hotel opened in May 1973. In early 1975, a dispute arose between Weaver and Hyatt Corp. with regard to the commission due for 1974. A Hyatt Corp. official informed Weaver that the Embarcadero Hotel did not generate a net profit for 1974. Weaver claimed that Hyatt Corp. was entitled to $623,201 under its agreement with Prudential and that he was entitled to 10 percent of those fees. Pritzker responded that Weaver's share of the fees should bear his share of the home office expenses. By November of 1975, Weaver and Hyatt Corp. had settled the dispute. - 53 During the period when Weaver and Hyatt were disputing the computation of Weaver's share of the management fees, Kanter and Weaver agreed that IRA would purchase the stock of KWJ Corp. In a letter to Kanter dated March 10, 1976, Weaver confirmed "our understanding regarding my granting to your client a right to purchase all of the outstanding shares of stock of KWJ Corp." for $150,000. The letter further provided that in addition to the purchase price for the KWJ Corp. stock, KWJ Corp. would continue to engage Weaver as its president and chief operating officer. In addition, Weaver was to receive 30 percent of all payments made by Hyatt Corp. under the contract with KWJ Corp. for as long as the contract was in existence, regardless of whether he performed any services for KWJ Corp. At that time, Hyatt Corp. was in the process of becoming privately owned, and Kanter did not want the transfer of the KWJ Corp. stock to take place until after Hyatt Corp. became privately owned. Therefore, the agreement was framed as an offer to sell the stock for a period of 4 years. On March 14, 1977, Hyatt Corp. paid KWJ Corp. $54,848 for fees earned during 1976. Sometime prior to November 1978, Hyatt Corp.'s management contract with the hotel was modified, and Hyatt Corp. wanted to revise its agreement with KWJ Corp. By letter dated November 14, 1978, Hyatt Corp. notified Weaver that, under the proposed change, KWJ Corp. would have been overpaid by - 54 $54,848 for 1976 and would be due $12,095 for 1977. By letter dated November 21, 1978, Weaver informed Kanter of the proposed changes in the Hyatt arrangement. The letter indicated that Weaver would call Kanter to discuss the proposed change. In a letter to Hyatt Corp. dated November 30, 1978, Weaver stated that the KWJ Corp. contract would not be affected by any modifications to Hyatt Corp.'s Embarcadero Hotel contract. On December 12, 1978, Hyatt Corp. paid KWJ Corp. $60,739 for 1977. In February 1979, Hyatt Corp. had become a privately owned entity. By letter dated September 27, 1979, Kanter informed Weaver that Kanter wanted to proceed with the purchase of the KWJ Corp. stock, effective retroactively to November 1, 1978. IRA purchased 100 percent of KWJ Corp.'s outstanding shares of stock from Weaver. IRA was to pay $10,000 of the purchase price in November 1979 and the balance by August 1980. As a result of IRA's purchase of the KWJ Corp. stock, KWJ Corp. was included as a subsidiary on IRA's 1979 consolidated return. The 1979 consolidated return reported KWJ Corp.'s 1979 gross receipts of $171,027 and payment of the 30 percent fee to Weaver of $51,308. The 1979 consolidated return reflected KWJ Corp.'s assets, liabilities, and net worth as of January 1, 1979, as follows: - 55 Assets Cash 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 The commissions paid over by Hyatt Corp. attributable to operations from 1978 through 1982 were as follows: Operating Year 1978 1979 1980 1981 1982 Payment Year 1979 1980 1981 1982 1983 Payment -$171,027 128,671 246,717 245,843 Except for the $171,027 payment received in 1980 from operations of the Hyatt hotel during 1979 that it reported on its 1979 return, IRA included the payments as income on the returns for the years of payment. Hyatt Corp. was not informed about the sale of the KWJ Corp. stock to IRA and, therefore, continued to send the payments to Weaver, who then sent the check to IRA. IRA then paid Weaver his 30 percent and deducted the payments as a commission expense. A letter dated March 29, 1983, from Weaver to Kanter states: - 56 Attached is the check from the Hyatt Corporation in the amount of $245,843.00, which represents K.W.J.'s commission for the year ending December 31, 1982. Will you please deposit and issue appropriate checks to the participants. This represents approximately the same amount as last year, per the attached balance sheet. By August 1983, Weaver advised IRA that he wanted to modify his arrangement with KWJ Corp. The new arrangement provided that Weaver could retire from any and all activities with respect to KWJ at any time after December 31, 1983. Weaver would continue to receive 30 percent of any amount received by KWJ Corp. from Hyatt Corp. with respect to the management contract of the Embarcadero Hotel. Weaver's 30-percent interest would pass to his estate or such other specific persons as he might designate in writing. In December 1983, KWJ Corp. was liquidated, and its assets were distributed to IRA. On January 2, 1984, IRA's new subsidiaries BWK, Inc. (managed by Kanter), Carlco (managed by Lisle), and TMT (managed by Ballard) formed a partnership called KWJ Co. (KWJ Co. partnership). Carlco and TMT each had a 45- percent interest in the KWJ Co. partnership, and BWK had a 10percent interest in the partnership. Hyatt Corp. was not informed about the liquidation of KWJ Corp. or the formation of the KWJ Co. partnership at the time of the liquidation and - 57 formation. Hyatt Corp. continued to send payments to Weaver until Kanter notified Hyatt Corp. sometime around 1992. From 1984 through 1989, Hyatt Corp. paid the following commissions with respect to the Embarcadero Hotel that were reported as income of the KWJ Co. partnership: Operating Year 1984 1985 1986 1987 1988 1989 Payment Year 1985 1986 1987 1988 1989 1990 Payment $295,415 330,376 327,784 281,926 75,396 24,340 The KWJ Co. partnership paid Weaver his 30 percent and deducted the payment as a commission expense. B. The Frey Arrangement: Condominium Conversions. Bruce Frey (Frey), was a certified property manager, real estate broker, and insurance broker. Frey began working at the real estate firm of Downs, Mohl & Co. in 1965. Mohl & Co., Frey met Kanter. While at Downs, In the early 1970's, Frey formed D.M. Interstate, Inc., a real estate management company that was an S corporation. In 1975, James Wold (Wold), became a shareholder and employee of D.M. Interstate, Inc. Sometime later, Frey also formed BJF Development, Inc., a corporation that engaged in real estate development and management. sole shareholder of BJF Development, Inc. Frey was the Hereinafter, D.M. Interstate, Inc. and BJF Development, Inc., are each sometimes referred to as a Frey corporation. - 58 In 1978 or 1979, Frey began converting rental property into condominiums. Frey or a Frey Corporation purchased rental property, refurbished it, and then sold the individual units as condominiums. Frey or a Frey corporation earned development fees for managing and supervising the renovation and conversion work on the property. A condominium project typically involved the use of a limited partnership. As a partner in the partnership, Frey or a Frey corporation would also receive profit distributions that were based upon sales of condominiums. Frey or his Corporation also earned management fees for their services in managing the condominium units following the conversion. Frey's first condominium conversion project was called Moon Lake Village and involved an apartment building located in Hoffman Estates, Illinois. A joint venture limited partnership was formed to purchase the apartment building and convert it to condominiums. Frey was the general partner in the partnership and there were several investors who made contributions to the partnership. A Frey corporation received development fees, profit participation, and management fees in the Moon Lake Village project. Neither Kanter nor Prudential was involved in the Moon Lake Village project. After successfully engaging in the Moon Lake Village conversion in 1978, Frey met and consulted with Kanter to obtain tax advice in connection with that project. During their meeting - 59 or shortly thereafter, Frey and Kanter discussed Frey's need to raise capital for future condominium conversion projects. At that time, condominium conversions were occurring frequently in metropolitan areas throughout the country, and Frey was faced with having to raise capital to acquire and convert apartment building properties in which he and other competing condominium converters were interested. Although Frey generally could obtain financing from a bank for most of a condominium conversion project's cost, the bank usually required Frey and other investors to have a substantial investment in the project. Kanter said that he could help raise some of the capital Frey needed for the condominium conversion projects. In consideration for such assistance, Kanter required Frey to share the development and management fees that Frey earned from such projects. Frey agreed to pay Kanter a share of the development and management fees if Kanter caused a third party to invest money in a project. Furthermore, if Kanter invested in a conversion project, he would also share in the profit participation of the partnership. From 1978 to 1987, a number of condominium conversion projects were undertaken by limited partnerships that Frey and the Frey corporations formed with other investors. Frey or a Frey corporation often served as the general partner in such limited partnerships. In many instances, the limited - 60 partnerships acquired an apartment complex, renovated and converted it into condominium units, and sold the condominium units to individual purchasers. Beginning with Frey's second condominium conversion project, entities associated with Kanter received limited partnership interests in many of Frey's condominium conversion projects. The Kanter entities that received such partnership interests included Zeus Ventures, Inc. (Zeus), a subsidiary of IRA, and Zion Ventures, Inc. (Zion), a subsidiary of Holding Co. Kanter also brought other investors into some of Frey's condominium conversion projects for which Kanter entities received a share of development and management fees. Projects in which Kanter entities received fees or interests included the Lakewood Associates project and the 535 Michigan Avenue project. The first condominium conversion project that Frey undertook involving Prudential was a 1,000-unit townhouse apartment complex called Village of Kings Creek at Miami, Florida. About 1979, Frey approached a Prudential real estate department executive working in Prudential's Miami, Florida, regional office about purchasing the Village of Kings Creek apartment complex. The apartment complex was owned by a pension fund managed by Prudential. Frey offered to purchase the apartment complex for a cash price of about $20 million. He also advised the Prudential executive that Connecticut Mutual Life Insurance Co. would be - 61 joining Frey in purchasing the property. Prudential previously had considered selling the apartment complex, and Frey's $20 million offer for the property significantly exceeded the property's appraised market value. The Prudential executive consulted with Ballard about Frey's offer. Ballard thought that Prudential's refusal of such offer might constitute a breach of fiduciary duty as investment manager of the pension fund. Ballard advised the executive that Prudential should accept the offer. On January 16, 1980, the Village of Kings Creek partnership was formed for the purpose of purchasing the property from Prudential and converting it into condominiums. In 1980, the Village of Kings Creek apartment complex was sold by Prudential to the partnership. Zeus (a subsidiary of IRA) and Zion (a subsidiary of Holding Co.) became limited partners in this limited partnership. Kanter also brought in another investor, First Illinois Enterprises (an Illinois general partnership), that invested $1.5 million in the project. The financing for the Village of Kings Creek project came from the following sources: The First National Bank of Chicago was the first mortgage lender; Connecticut Mutual Life Insurance Co. and First Illinois Enterprises were the two primary equity participants. Under the partnership agreement, Zeus was required to make an initial contribution of $100,000 for its 6.14-percent interest - 62 in the partnership. Zion was required to make an initial contribution of $108,014 for its 6.66-percent interest in the partnership. In the event of certain circumstances, the partners agreed to make additional contributions to the partnership. The partnership agreement provided that the partnership would reimburse or credit the capital accounts of the Frey corporation, Frey, Wold, and Zion for "the advances made by them in negotiating, entering into and performing the terms and conditions of Purchase and Sale Contract and Contractual Commitments". Following Prudential's sale of the Village of Kings Creek property, the executive in the Miami regional office who had dealt with Frey in the sale approached Frey about converting another Prudential apartment property in Florida into condominiums. Beginning with this property, Prudential participated in a number of successful condominium conversion projects with Frey. Most of these projects that Frey and Prudential undertook were joint ventures. Frey did not have to raise much capital to engage in these joint venture projects with Prudential, because Prudential owned the apartment property to be converted and participated as coowner in a joint venture to convert and sell the property as condominium units. Prudential would contribute the property and receive (1) all initial condominium unit sale proceeds up to a - 63 specified amount based, in large part, on the property's appraised fair market value as a rental property, and (2) 50 percent of all other unit sale proceeds above the initial specified amount. A limited partnership received 50 percent of the proceeds above Prudential's initial specified amount of the proceeds from the sale of units. A Frey corporation was responsible for renovating and converting the property and selling the condominium units in exchange for development fees and management fees from the owners of the condominiums for managing the property after the conversion. Some of the Frey- Prudential agreements included the Calais and Chatham agreements, both dated August 1, 1981, the Valleybrook agreement dated October 1, 1981, Old Forge agreement entered into prior to October 12, 1981, and The Greens agreement entered into prior to December 30, 1981. Frey's agreement that he would share development and management fees with Kanter entities was formalized in two separate written agreements each dated October 12, 1981. One agreement was between Frey and IRA's subsidiary Zeus, and the other agreement was between Frey and Holding Co. The written agreement with Zeus covered development fees from projects in which Prudential apartment properties were being converted. The letter agreement, from Frey to Meyers (president - 64 of Zeus), referred to Zeus' "Participation in Proceeds on Prudential Conversions" and provided: As requested, we are writing to confirm our prior agreement regarding the participation in the amounts realized or to be realized on the condominium conversion of properties of or for The Prudential Insurance Company of America ("Prudential"). The terms of this letter agreement shall apply with respect to all conversions of Prudential properties heretofore and hereafter. As used in this letter agreement, the term "amounts realized" includes all amounts to be received by the converter as Developers' Fees and shares of assigned profits but excluding any management or other fees (which shall be retained by the Manager). * * * * * * * * * * Of the amounts received as a Developers' Fee on Prudential conversions, BJF (or its counterpart in any future conversion) shall retain 75% of the amount received in reimbursement for any costs and expenses paid or incurred by it. BJF shall retain this 75% amount without regard to the actual amount of its costs and expenses and without any need to account for the same. Of the remaining 25%, BJF SHALL RETAIN 80% and shall distribute the remaining 20% to you. Of the amounts received as shares of assigned profits, BJF shall distribute 20% to you and retain the balance. BJF shall retain amounts under this letter agreement for itself and for distribution to its affiliates in such percentages as they have agreed. BJF shall make all distributions to you not later than 30 days after the date of this letter or receipt from Prudential of the Developers' Fees and assigned profits (as the case may be). Pursuant to this letter agreement, the BJF corporation paid the following amounts to Zeus during the years 1980 through 1985: - 65 Year 1980 1981 1982 1983 Total Zeus $127,372 105,764 538,781 110,125 882,042 1984 1985 Total 103,500 128,763 232,263 The second letter agreement was from Frey to Kanter as president of Holding Co. and specifically excluded developers' fees from projects involving Prudential properties (covered in the Zeus agreement) but included other amounts related to projects involving Prudential. The letter agreement referred to "Participation in Condominium Conversions" and provided: As requested, we are writing to confirm our prior agreement regarding the participation by us and our affiliates in capital contributions, profits and losses and Developers' Fees (excluding Developers' Fees in condominium conversions of properties of or for The Prudential Insurance Company of America and excluding legal, management or any other fees, which shall be retained by the recipients) in condominium conversions of properties. The provisions of this letter agreement shall apply in the case of condominium conversions of those properties listed below and any other condominium conversions in which we agree to participate. Each of us may terminate this agreement at any time on 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: - 66 The Holding Company, a Delaware corporation, its nominees and/or affiliates - ("THC") 33% Bruce J. Frey and his nominee and/or affiliates - ("BJF") 67% The participation in Developers' Fees shall commence with respect to fees received after October 1, 1981, and shall be as follows: Holding Co. 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. Pursuant to this second letter agreement, the Frey corporation paid to Holding Co. $80,616 as a distribution in 1981 and $16,200 from participation in fees in 1983. Payments made in 1982 are not in the record. On June 15, 1984, BJF Development, Ltd. (the Frey partnership), an Illinois limited partnership, was formed. Frey, Wold, and the Frey corporation were the general partners of the Frey partnership. The limited partners were TSG Holdings, Inc., FWID, Ltd., and Holding Co. Under the partnership agreement Holding Co. was entitled to distributions of 13.125 percent of - 67 available cash-flow. Generally, the purpose of the partnership was to conduct business activities related to development of condominiums and cooperatives and property management. TSG Holdings, Inc. contributed $750,00 to the Frey partnership. Transcontinental Services Group, N.V., a Netherlands Antilles corporation and TSG Holdings, Inc.'s parent corporation, lent $1.75 million to the Frey partnership. In addition to other assets contributed to the Frey partnership, the remaining partners assigned their right to receive fees under other management, consulting, and/or partnership agreements, including the Village of Kings Creek, Lakewood, Calais, Chatham, Valleybrook, The Greens, and Galaxy Towers that had previously been subject to the letter agreement between Holding Co. and the Frey corporation. The partnership agreement also listed two participation agreements with "Burton J. Kanter" regarding certain condominium conversions. The agreement indicated that the two participation agreements had been canceled with respect to new condominium conversions. A letter dated June 20, 1984, to Kanter described Holding Co.'s obligation to contribute to the capital of the partnership as follows: - 68 With the recording of the Certificate of Limited Partnership, The Holding Company should: a. make its cash capital contribution of $29,913.80 to the Partnership; b. pay FWID, Ltd. ("FWID"), $86,789.57 for contributing cash equivalents to the Partnership on its behalf; c. issue a $88,387.46 secured note to FWID for contributing other assets to the capital of the Partnership on its behalf; and d. confirm its agreement to remit to FWID its share of Partnership distributions resulting from the Partnership's realization of the fees and profits shown on Part II of Appendix A. The parties contributed a total of $170,936 in cash to the capital of the Partnership. See item 8 of Part 1 of Appendix A. Of this amount, The Holding Company is responsible for 17-1/2 percent or, as shown above, $29,913.80. The parties contributed a total of $495,940.31 in cash equivalents to the Partnership. The Holding Company's share of this amount is, as noted above, 171/2 percent or $86,789.54. The cash equivalents consist of the items shown as numbers 6, 7, and 9 on Part I of Appendix A. The items are: 6. October 31, 1983, Agreement with Lazard Freres & Co. $273,547.00 7. April 14, 1983, Real Estate Sale Agreement as amended with Norman Rudenberg and Edna Davidson 211,082.00 9. Furniture, fixtures, and equipment 11,311.31 Total $495,940.31 As shown in the enclosed chart, The Holding Company's remaining obligation for capital contributions to the Partnership was $145,798.66. Of this amount, The Holding Company satisfied $57,409.20 - 69 by the transfer to the Partnership of a 20 percent interest in the $287,046 of purchase money mortgages relating to the condominium units at 535 North Michigan Avenue. Accordingly, after satisfying its share of the cash capital contributions, The Holding Company's remaining obligation to FWID is $88,387.46. The Holding Company now should satisfy its obligation for the cash contribution to the Partnership by transferring $29,913.80 in cash to it. The Holding Company should satisfy its obligation to FWID for the transfer of the cash equivalents by paying FWID $86,789.54. In addition, The Holding Company should satisfy its responsibility for the balance of $88,387.46 by signing a note for this amount payable to FWID and pledging as security either third-party paper or other acceptable collateral. The note should provide for cash payments as the Partnership realizes cash from the capital contributions to it. I believe that you should discuss the procedures regarding the issuance of the $88,387.46 secured note with Jim Wold or, in my absence, my associate, Claire Pensyl. The remaining item is, as noted above, for The Holding Company to confirm its agreement to remit its share of Partnership distribution to FWID. The Holding Company's agreement is to remit distributions (a) only after The Holding Company has received Partnership distributions equal to The Holding Company's original capital contribution of $262,500 and (b) then only in an amount equal to 13.125 percent of the amount realized by the Partnership from all the items shown on Part II of Appendix A. The 13.125 percent equals The Holding Company's share of all Partnership distributions under Section 3.2 of the Agreement of Limited Partnership. In January 1985, approximately 6 months after the formation of the partnership, TSG Holdings purchased additional interests in the Frey partnership for $1,382,575, of which $241,950 was payable to Holding Co. The purchase price was paid to Holding - 70 Co. in two installments. The letter dated January 8, 1985, accompanying the first installment provided as follows: Enclosed is FWID, Ltd. check number 113 in the amount of $66,507.00. This check represents your allocable share of the above-mentioned transaction after reducing your loan from Bruce Frey by one-half, or $44,194.00. The following is a brief analysis of the transaction, your allocable share and a calculation of the manner in which check number 113 was derived: 1. Gross Sales Price 2. Ownership Percentage of BJF Development, Ltd. (11.1895 divided by 63.94 percent) 3. $1,382,575 17.5 Allocable Share of Gross Sales Proceeds 241,950 4. Sales Proceeds Received to Date 632,575 5. Allocable Share of Sales Proceeds Received to Date 110,701 Less: One-Half of Outstanding Loan from Bruce Frey ($88,388.00 divided by 2) 44,194 Check Number 113 $66,507 6. 7. The letter dated January 24, 1985, accompanying the second installment provides as follows: Enclosed please find check number C 1148 in the amount of $131,250.00. This check represents the second and final installment payment with regard to your sale of partnership interest in BJF Development, Ltd. to TSG Holdings. - 71 The entire second installment payment to the selling partners was $750,000.00. Your allocable share of the transaction was 17.5 percent, thus equaling the $131,250.00. From 1984 through 1987, the Frey partnership paid a total of $403,954 to Holding Co. ($113,827 in 1984, $256,557 in 1985, and $33,570 in 1987). Of the $113,827 paid in 1984, $98,437 was identified as a distribution and $25,391 as Holding Co.'s share of fees. Of the $256,557 paid in 1985, $197,757 was Holding Co.'s share of proceeds from the sale of the additional partnership interest to TSG Holdings, $55,950 as a distribution, and $2,850 represented participation in developers' fees. C. The Schaffel Arrangement: Real Estate Construction and Financing Schaffel was a mortgage broker and a real estate developer. In the summer of 1979, Kanter invited Schaffel to dinner at a New York City restaurant to discuss a business proposition. He told Schaffel that Ballard and Lisle would also be joining them for dinner. Schaffel accepted Kanter's invitation. In addition to learning more about the potential business opportunity that Kanter had mentioned, Schaffel was eager to meet and socialize with Ballard and Lisle, as he knew that they were senior Prudential real estate executives. During the dinner, Kanter asked whether Schaffel would be interested in arranging the financing for a casino hotel to be built in Atlantic City, New Jersey. Prudential was not involved - 72 in that project. Kanter offered to introduce Schaffel to the people who wanted to build the casino hotel provided Schaffel would agree to pay to one of Kanter's entities 50 percent of Schaffel's brokerage fee earned in the transaction. Schaffel agreed to pay the fee to an entity that held a real estate brokerage license. The casino hotel project, however, never materialized. Although the casino hotel project fell through, Schaffel agreed to share certain finder's fees with Kanter in other projects. With Kanter's "concurrence", Schaffel negotiated a finder's fee arrangement with Benedict Torcivia (Torcivia),12 the sole shareholder of Torcon, Inc. (Torcon). At the time, Torcon was probably the largest general contracting company in New Jersey. By letter agreement dated July 23, 1979, Torcivia agreed to pay Schaffel a fee for any construction projects that Schaffel helped obtain for Torcon. The agreement reached between Kanter and Schaffel as applied to Schaffel's arrangement with Torcon was set forth in a letter agreement with IRA dated August 2, 1979, as follows: The purpose of this letter is to confirm that I will pay you fifty (50%) percent of any fees received by me with respect to construction jobs obtained for Torcon, Inc. in which I determine that you or your associates have been instrumental or helpful. My arrangement with Torcon, Inc. concluded with your 12 Prior to 1979, Schaffel had rented office space from Torcivia. - 73 concurrence that said Company will pay to me one (1%) percent based on the gross amount of the contract price of any such construction job. It is our understanding that you will receive payment ordinarily over a period of time depending on draws under the construction job. Accordingly, you will expect to receive payment only as I am paid. It is further understood that the foregoing pertains only to negotiated contract situations and should any bid situation arise, the amount of your participation will be negotiable. Schaffel also entered into a finder's fee arrangement with William Walters (Walters), a real estate developer in Denver, Colorado, similar to the one with Torcivia, and agreed to share those fees with IRA. 1. Schaffel/Prudential Transactions As a result of his introduction to Lisle and Ballard, Schaffel began doing millions of dollars' worth of business with Prudential. These business dealings included construction contracts that he helped obtain for Torcon and financing for a number of large commercial real properties being developed by Walters, as well as transactions involving others. The first transaction Schaffel negotiated with Prudential was the sale of the IBM headquarters building in Lexington, Kentucky. The property was brought to Schaffel's attention by Transatlantic Consultants (Transatlantic), the company brokering the sale. to Ballard. Schaffel introduced the Transatlantic representative After the initial meeting with Ballard, Transatlantic dealt with Prudential's local office in Kentucky. - 74 Seven months after the initial meeting with Ballard, Prudential bought the building. Schaffel received a fee from brokering the sale of the building and paid half of the fee to IRA. Some of the projects Schaffel assisted Torcivia in obtaining with Prudential included the Parsippany Business Campus, the Parsippany Hilton Hotel (located outside of Newark, New Jersey), the Gateway (located in Newark, New Jersey), and the Interplex Complex (located in Princeton, New Jersey). Walters agreed to pay Schaffel a finder's fee with respect to two joint ventures that Walters helped negotiate with Prudential. Schaffel entered into separate written agreements dated October 19, 1981, with Cherry Creek Place Associates II (Prudential funding of $15.6 million) and Aurora Plaza & Conference Center, Ltd. (Prudential funding of $17 million), with respect to the joint ventures. In each agreement, the partnership acknowledged that Prudential's participation in the venture was primarily the result of Schaffel's efforts and that Schaffel was entitled to be compensated. From 1979 through 1983, pursuant to his arrangement with Kanter, Schaffel shared with IRA fees from these business deals with Prudential. Schaffel paid the following amounts from Prudential transactions to IRA from 1979 through 1983: - 75 Year 1979 1980 1981 1982 1983 Total Amount $100,000 244,920 361,525 447,450 30,981 1,184,876 After Ballard and Lisle left Prudential, Schaffel no longer negotiated any transactions with Prudential. 2. Schaffel/Travelers Transactions Lisle left Prudential in late 1981. He was employed by Travelers from April 1982 until April 1988. After Lisle began working for Travelers, Schaffel met with Lisle and others from Travelers. Thereafter, Schaffel began brokering substantial business dealings with Travelers on behalf of Torcon and Walters. The first project Walters entered into with Travelers was Stanford Place II. By check dated November 9, 1983, Schaffel paid IRA $213,750 of the fee earned from Stanford Place II. After that payment, Schaffel stopped paying IRA a share of the fees earned on business deals with Travelers. Sometime during 1984, Kanter contacted Schaffel and asked why IRA was not receiving 50 percent of Schaffel's fees on Travelers transactions. Schaffel took the position that the August 2, 1979, agreement did not apply to deals with Travelers after Lisle had left Prudential. Kanter disagreed and maintained that the August 2, 1979, agreement continued to apply. - 76 In a letter dated August 28, 1984, to Schaffel, Kanter stated: I am bothered by your failure to respect what I would have considered the essential intent of the agreement you entered into vis-a-vis the introduction of you to Prudential and the arrangement under which you would share the benefits of that introduction in connection with real estate transactions from which you were able to earn commissions, as well as the other construction contracts won by Ben [Torcivia]. I appreciate that there may be some technical difficulty with the previous agreements as to whether they extend in the new circumstances to Travelers. However, in my view Travelers has replaced Prudential as a principal source of transactions because of the very personnel to whom you were first introduced. Accordingly, I am inclined to believe that the arrangement should have been continued. Lisle and Schaffel discussed the dispute between Schaffel and Kanter. Lisle feared a lawsuit might result, and because such a lawsuit might cause some embarrassment for Lisle at Travelers, he urged Schaffel to settle the dispute. Schaffel agreed to resume paying 50 percent of his fees on business deals with Travelers. Those fees, however, were paid to Holding Co. rather than IRA. For some of the Walters projects brokered by Schaffel, Travelers entered into joint venture agreements with Walters' company pursuant to which Walters' company contributed the property and Travelers provided the financing. Travelers entered into joint ventures with Walters' company for the permanent financing of Stanford Place II (Travelers provided $15 million - 77 plus a $31.5 million loan), Cherry Creek National Bank (Travelers provided $8.25 million plus a $19.95 million loan), the Stanford Corporate Center (Travelers provided $43,612,622), and Boettcher Building (a.k.a the Boston Building) (Travelers' contribution to this project is not reflected in the record). For other Walters projects brokered by Schaffel, Travelers provided financing without becoming a partner in the underlying joint venture. These projects included Orchard Place VIII (Travelers provided a $9 million loan), Orchard Place VII (Travelers provided a $8.5 million loan), and Cherry Creek Place III (Travelers provided a $10.8 million loan). From 1984 through 1986, Schaffel paid a share of his fees on Walters-Travelers transactions to Holding Co. in the following amounts: 3. Year Amount 1984 1985 1986 Total $600,000 1,160,000 1,003,500 2,763,500 FPC Subventure Associates Partnership On March 21, 1980, Kanter acquired an 8-percent limited partnership interest in Four Ponds Center Associates (Four Ponds), a joint venture involving Schaffel and Torcivia. On his 1980 Federal income tax return, Kanter reported his share of the partnership's losses. - 78 The FPC Subventure Associates partnership (FPC Subventure) was formed as of January 1, 1981. The partners of FPC Subventure and their respective interests were: Lisle, 90 percent; the Everglades Trust (Roger Baskes, trustee), 9 percent; and Burton W. Kanter Revocable Trust (Kanter trustee), 1 percent. On January 1, 1981, Kanter transferred his 8-percent interest in Four Ponds to FPC Subventure, effectively transferring 90 percent of his interest in Four Ponds to Lisle in exchange for a receivable of $2,880 from Lisle. A joint venture called One River Associates (One River) was formed as of November 16, 1981. general partners. River. Schaffel and Torcivia were the Kanter held an 8-percent interest in One On January 1, 1982, Kanter transferred his interest in One River to FPC Subventure in exchange for a $2,000 receivable from FPC Subventure. Beginning in 1982, the 8-percent interest in One River held by Kanter was treated as held by FPC Subventure, and 90 percent of the income, loss, and distributions were allocated to Lisle. On April 5, 1982, Four Ponds distributed $400,000 to Kanter. Kanter treated the distribution as a distribution to FPC Subventure. FPC Subventure retained $5,000 and distributed $395,000 to the partners, 90 percent to Lisle and 10 percent to the Kanter trusts. An additional $33,600 was distributed by Four Ponds to FPC Subventure through Kanter during 1982. During 1982 - 79 Lisle received total distributions of $384,840 from FPC Subventure. Kanter and Lisle reported on their tax returns their respective distributive shares of the FPC Subventures' partnership's income and losses. D. The Schnitzer Arrangement: Management Systems Stock. Sale and Repurchase of Property During the 1960's and 1970's, Schnitzer was a major real estate developer in the Houston, Texas, area. Schnitzer met Ballard and Lisle when they worked in Prudential's regional office in Houston, probably in the late 1960's. Schnitzer had been involved in developing and managing highrise office buildings through Century Development Co., Inc. (Century Development), a subsidiary of Century, Inc. (Century), Schnitzer's family holding company. The real estate development business, however, typically was cyclical. In 1974, to diversify its operations and to secure a steady source of earnings, a subsidiary of Century acquired for $1.3 million the assets of a small real estate management company called Fletcher Emerson Co., Inc. (Fletcher Emerson).13 Fletcher Emerson managed office buildings and other commercial real estate. 13 A relatively small portion of its business included The $1.3 million purchase price was roughly based on a multiple of five times net earnings. At the time, the company had before-tax net income of $250,000. - 80 cleaning or janitorial services on some Texas commercial properties it managed. Shortly after Century's subsidiary acquired the assets of Fletcher Emerson, the subsidiary's name was changed to Fletcher Emerson Co. and then to Property Management Systems, Inc. For convenience Property Management Systems, Inc., is hereinafter referred to as Schnitzer-PMS. Schnitzer became the chairman and chief executive officer of Schnitzer-PMS. Originally, Schnitzer-PMS's property management business was conducted primarily in Houston and Dallas, Texas. Schnitzer-PMS usually managed office buildings and other commercial real estate owned by others under property management contracts on a monthto-month basis. Schnitzer wanted to expand the size of Schnitzer-PMS's property management business, as Schnitzer-PMS typically earned only a relatively modest profit margin on its individual property management contracts. Schnitzer felt that the only way to increase Schnitzer-PMS's profits was having a large volume of such management contracts. Fletcher Emerson had been managing a relatively small number of Prudential's commercial real properties when Century acquired its assets in 1974. Schnitzer wanted to develop business from Prudential and American Building Maintenance Industries (AMBI). To that end, Schnitzer offered AMBI the opportunity to acquire 50 percent of the company. AMBI, however, declined the offer. - 81 In 1974, Schnitzer approached Ballard (who Schnitzer had known for many years and previously had dealt with in developing office buildings in Houston, Texas) and offered to have Century give Prudential a 50-percent stock interest in Schnitzer-PMS. Although Prudential would not be required to pay for the 50percent Schnitzer-PMS stock interest, Schnitzer hoped Prudential would award Schnitzer-PMS a large number of additional property management contracts. Ballard informed his superiors at Prudential of Schnitzer's offer. Initially, Prudential was interested in Schnitzer's offer and invited Schnitzer to Prudential's Newark, New Jersey, corporate headquarters for further meetings and discussions with Prudential's management. Schnitzer met with Prudential's senior executives and corporate headquarters staff, including Prudential's chairman, and with Knab (who headed Prudential's real estate department). Prudential was particularly interested in standardizing the reports it received on the operation of its various commercial real properties around the country. However, Prudential ultimately declined Schnitzer's offer because of the substantial number of pension plans whose real estate investment accounts Prudential managed. Prudential believed that having an ownership interest in Schnitzer-PMS might be a potential conflict of interest and might present problems under the pension laws. - 82 Ballard introduced Schnitzer to Kanter sometime between the early and mid-1970's. At some time prior to September 1976, Schnitzer and Kanter began discussing the sale of a stock interest in Schnitzer-PMS to Kanter. Kanter indicated that, through his business contacts, including the Pritzker family, he could obtain additional property management business for Schnitzer-PMS. Before Schnitzer made the offer to Kanter, Schnitzer had a conversation with Ballard to confirm that Kanter could bring in business for Schnitzer-PMS. The initial proposal contemplated that Schnitzer-PMS would be recapitalized in order to provide for the issuance of two classes of stock, common and preferred. The preferred stock would be $1,000 par value per share, one vote per share, priority as to dividends, when, if, and as declared out of available earnings and profits up to a maximum of 8 percent of the par value in the year of declaration, and priority on liquidation. The common stock would be no par common stock carrying one vote per share. Kanter's client (IRA) would purchase 50 percent of the common stock for $50,000 and closing would be set for October 1, 1976. Because of difficulties in finalizing the agreement, however, closing did not take place in 1976. In a letter dated April 12, 1977, to Melvin Dow, Kanter stated: As you know, the president of The Cedilla Company is Mildred D. Schott and The Cedilla Company is actively - 83 engaged in certain phases of real estate activity. We are hopeful that the sooner the acquisition of * * * [Schnitzer-PMS] shares can be closed, the sooner that serious efforts can begin to create that synergism that could result in a sharply expanded business for * * * [Schnitzer-PMS] in its property management through the extensive contacts Schott maintains, the broad scope of opportunity that may be available to Solomon A. Weisgal and the opportunities that may arise in the course of my practice which involves representation of numerous very wealthy groups holding large property interests. By letter agreement dated November 7, 1977, Kanter and Schnitzer agreed that Schnitzer-PMS would be recapitalized and reorganized as a Delaware corporation with an authorized capitalization of 250 voting preferred shares of $1,000 par value each and 108 voting common shares of $1 par value each. Each preferred share would be entitled to a cumulative preferred dividend of $80 per year, plus a special one-time dividend equal to 1/250 of the indebtedness of Schnitzer-PMS to American General Investment Corp. existing at the time the special dividend was declared. The special dividend was to be declared when the assets of the corporation available for payment of dividends equaled the remaining amount outstanding on the loan. At the time of the reorganization, $1.1 million that Century Development had borrowed to purchase Fletcher Emerson was still owing. The purpose of the special dividend was to permit Century Development to recover its initial investment. Kanter's client (IRA) had the option to purchase 51.3 shares of common stock (47.5 percent of the common stock) in Schnitzer-PMS for $150,000. - 84 The reorganization was completed on January 31, 1978, and 51.3 shares of the common stock of Schnitzer-PMS were issued to IRA on February 14, 1978. All shares of Schnitzer-PMS (including those issued to IRA) were pledged to secure Century Development's loan balance. In conjunction with the sale of the Schnitzer-PMS stock to IRA, IRA and Century entered into a stock agreement. Article III of the agreement gave Century an option to purchase the Schnitzer-PMS stock upon the death of last to die of Kanter, Weisgal, and Schott. Section 3.03 of the stock agreement provided that the purchase price for IRA’s shares of SchnitzerPMS stock would be an amount equal to the sum of: (a) Eight (8) times the average annual pretax operating income of the Corporation for the five (5) full fiscal years of the Corporation ending on or immediately preceding the Option Date or such lesser number of full years of operation of the Corporation as shall have expired from the date of this Agreement; plus (b) The difference (but not less than zero) between (i) the book value of the assets of the Corporation used in its business of building management, consulting and cleaning and (ii) the lesser of Three Hundred Thousand Dollars ($300,000) or one and one-half (1-1/2) times the Corporation’s average receipts for one (1) month, computed for the twelve (12) month period immediately preceding the Option Date; plus (C) The fair market value of any other assets of the Corporation. The computation of operating income in Subsection (a) hereof shall be computed solely with reference to the Corporation’s business of building management, consulting and cleaning. The computation of the - 85 purchase price shall be made by the certified public accountants regularly retained by the Corporation. By late 1977, Schnitzer-PMS's property management business had increased substantially. Although Prudential had declined Schnitzer's offer to give Prudential an inte [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A659821ed002b159d. Public record. Not legal advice.