UNITED STATES TAX COURT
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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 interest in SchnitzerPMS, Prudential became Schnitzer-PMS's biggest customer.
Pursuant to Schnitzer's discussions with Prudential's management
and corporate headquarters staff in 1974, Schnitzer-PMS
standardized its reports on the Prudential commercial real
properties that Schnitzer-PMS managed.
By 1977, Schnitzer-PMS
had expanded its property management operations to other cities
around the country, including Atlanta, Georgia, Los Angeles and
San Francisco, California, Newark, New Jersey, and Portland,
Oregon.
Schnitzer-PMS year-end balance sheets and profit/loss
statements for 1976 through 1978 showed the following:
- 86 Assets
Current
Property
Other
Total
Liabilities
Current
Long-term
Stockholder equity
Common
Preferred
Contributed capital
Retained earnings
Total
Earnings
Revenues
Property management
Cleaning
Other
Total
Costs & expenses
Property management
Cleaning
General
Interest
Total
Pretax earnings
Tax allocation
Net earnings
1976
$529,225
97,913
8,142
635,280
1977
$527,025
127,645
36,542
691,212
1978
$690,257
133,970
137,459
961,686
287,829
6,515
156,947
21,647
237,681
33,935
1,000
n/a
200,000
139,936
635,280
1,000
n/a
200,000
311,618
691,212
108
250,000
n/a
439,962
961,686
1,044,173
2,343,512
39,411
3,427,096
1,448,101
2,811,034
41,352
4,300,487
---5,977,383
255,824
1,986,343
864,715
2,599
3,109,481
266,794
2,483,019
1,095,499
4,117
3,849,429
4,064,014
317,615
143,163
174,452
451,058
155,527
295,531
831,828
---
1,078,503
3,037
5,145,555
By March 1979, Schnitzer had decided that Schnitzer-PMS
should have received more opportunities for new business from
Kanter and his associates and informed Kanter that he wanted to
repurchase the stock held by IRA.
Kanter and Schnitzer decided
that one party would set a price at which that party was willing
to either sell its stock to the other or buy the other's stock.
By letter dated July 17, 1979, Kanter informed Schnitzer that IRA
would sell its stock in Schnitzer-PMS or purchase Century
Development Corp.'s stock in Schnitzer-PMS for $3.1 million.
- 87 Schnitzer agreed to buy back IRA's stock for $3.1 million.
On
November 30, 1979, Century repurchased the 47.5-percent owned by
IRA in July 1979, for $3.1 million, payable over a 10-year period
with interest.
At the time of the repurchase, approximately
$700,000 remained outstanding on the loan from the original
purchase of the Fletcher Emerson assets.
Schnitzer-PMS balance sheets and profit/loss statements for
6 months ending June 30, 1978 and June 30, 1979 showed the
following:
6/30/78
6/30/79
Assets
Cash
Life insurance
Accounts receivable
Supplies
Prepaid expenses
Transportation equipment
Other equipment
Total
$124,632.16
41,968.71
555,308.63
3,450.04
13,877.99
14,101.56
116,190.70
869,529.79
$284,760.00
96,144.81
496,200.83
14,614.58
45,007.01
17,268.74
130,547.74
1,084,543.71
Liabilities
Accounts payable
Accrued payroll expense
Other accrued expenses
Total
6,569.23
97,763.69
109,892.85
214,225.77
-134,094.52
121,486.51
255,581.03
Stockholder's equity
Capital stock
Retained earnings
Funds to CDC
1977 net income
1978 net income
Total owner's equity
250,108.00
384,885.60
(431,036.94)
451,347.36
n/a
655,304.02
250,108.00
1,198,788.79
(955,412.90)
n/a
335,478.79
828,962.68
869,529.79
1,084,543.71
Total liabilities &
equity
- 88 -
Profit/Loss (6 months)
Gross income
Operating expenses
Operating income
Overhead expense
Income before acquisition
Acquisition expense
Net income
6/30/78
6/30/79
2,916,478.65
1,824,034.25
1,092,444.40
542,291.04
550,153.36
98,806.00
451,347.36
3,650,217.86
2,485,250.27
1,164,967.59
740,191.69
424,775.90
89,178.98
335,596.92
Around the end of 1979 or early 1980, Schnitzer discussed
the sale of Schnitzer-PMS to Minneapolis Honeywell for a price
between $12 million and $13 million.
Honeywell, however, decided
not to purchase Schnitzer-PMS.
In 1989, IRA accepted a reduced final payment for early
payment of the balance due on the sale of the stock.
IRA received the following payments of principal and
interest and reported the following gain on the installment sale
of the Schnitzer-PMS stock:
Year
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
Total
Payment
$150,000
533,425
534,696
361,692
361,692
361,692
361,692
361,692
361,692
361,692
840,423
4,590,388
Principal
$150,000
211,468
309,308
172,441
186,655
202,042
218,696
236,724
256,217
277,360
822,841
3,043,752
Interest
-$321,957
225,388
189,251
175,037
159,650
142,996
124,968
105,475
84,332
17,582
1,546,636
Gain
$142,740
201,233
294,338
164,094
177,621
192,263
208,111
225,266
243,816
263,936
783,016
2,896,434
E.
The Eulich Arrangement: Essex Hotel Management Co.
1.
Eulich's Background
For many years, Eulich had been a real estate developer of
office buildings, shopping malls, and warehouses in Houston and
- 89 Dallas, Texas.
1965.
Eulich had known Ballard and Lisle since at least
Eulich dealt with Ballard and Lisle in connection with
Prudential's financing his real estate development work, when
Ballard and Lisle worked in Prudential's Houston regional
office.14
Eulich was also a close personal friend of A.N.
Pritzker.
Eulich met Kanter through Pritzker in the late 1960's
or early 1970's.
Kanter and Eulich had many business dealings
with each other.
Kanter helped raise capital for some of
Eulich's business ventures.
Eulich's real estate development activities were primarily
conducted through Vantage, Inc., a corporation that he owned.
In
1968, Eulich acquired Rodeway Inns, a company that owned a small
chain of garden court motels.
Over the years,
increased the number of its motels.
Rodeway Inns
Rodeway Inns and Eulich
obtained financing from Prudential for the acquisition of many of
the additional motels.
From 1968 through about 1973, Eulich
dealt with Ballard in securing the financing from Prudential for
Rodeway Inns.
In about 1974, Eulich and Prudential became dissatisfied
with the performance of the hotel management company that was
managing and operating 16 Rodeway Inns motels that had been
financed by Prudential.
14
Eulich decided to establish his own
After Lisle began working for Travelers in 1982, he dealt
with Eulich in connection with the managing of Travelers'
properties.
- 90 hotel management company, Motor Hotel Management, Inc. (EulichManagement), to operate the motels.
Eulich-Management was
incorporated on January 1, 1975.
Eulich asked Robert James (James) who had substantial hotel
management experience, to serve as Eulich-Management's president
and to manage Eulich-Management's day-to-day operations.
Eulich-
Management's three shareholders eventually included Eulich (who
was the majority shareholder), James, and another longtime
business associate of Eulich.
By the end of 1975, Eulich-Management had 17 management
contracts that were part of the joint venture in which Prudential
was the lender and Eulich's company Vantage, Inc., was the
developer.
By the late 1970's, Eulich-Management had a good
reputation in providing hotel management services.
Prudential's
real estate department staff generally was satisfied with EulichManagement's management of a number of hotel properties in which
Prudential was involved.
By about the early 1980's, Eulich-
Management managed hotel properties nationwide in about 20 to 25
States.
At that time, however, Eulich-Management did not manage
large hotels.
2.
Prudential's Gateway Hotel
In about 1976, Ballard decided that Prudential's real estate
department needed to hire an individual possessing substantial
expertise in hotels and hotel operations.
Allen Ostroff
- 91 (Ostroff) had worked for a number of years for Hilton Hotels as a
hotel manager and executive.
Ballard hired Ostroff to serve as
Prudential's in-house consultant on hotels and hotel operations.
When Ostroff began working for Prudential, the real estate
department staff in Prudential's regional offices negotiated
hotel management contracts for Prudential's hotel properties on
an ad hoc basis.
By 1979, Ostroff had devised a model hotel
management contract that Prudential's real estate department
staff could use in negotiating such management contracts.
Ostroff also worked on various hotel projects with Knab, Ballard,
and Lisle.
One of Ostroff's first assignments at Prudential was to
improve the operating condition of the Gateway Hotel located a
few blocks from Prudential's corporate headquarters in Newark,
New Jersey.
Prudential had recently acquired the Gateway Hotel
through foreclosure, and the hotel was in shabby condition.
Moreover, Prudential wanted to upgrade the hotel because
Prudential executives and individuals transacting business at
Prudential's headquarters office frequently stayed at the hotel.
Ostroff first obtained a Hilton franchise for the Gateway
Hotel.15
15
Ostroff next hired a new hotel management company to
Although Hilton Hotels had been reluctant to grant
Prudential a franchise, Ostroff obtained the franchise by
pointing out to Hilton Hotels the other profitable business
dealings it had with Prudential.
- 92 take over the Gateway Hotel's management and operation.
The new
management company was owned by Stanley Cox (Cox), an experienced
hotel manager Ostroff had known during Ostroff's prior employment
with Hilton Hotels.
At some point, Cox assigned John Connolly
(Connolly) to be the Gateway Hotel's on-site manager.
Ostroff was extremely successful in turning around and
substantially improving the Gateway Hotel's operating condition.
Prudential executives made significant use of the hotel
facilities for meetings and entertainment and were very pleased
with the service that they and their guests received at the
hotel.
Cox did not spend much of his own time in actually running
the Gateway Hotel.
Over the years, he had delegated more and
more duties in the hotel's operation to Connolly.
Connolly
frequently interacted with Prudential executives, including
Ballard and Lisle.
Sometime in 1978 or 1979, Connolly met Kanter
at the Gateway Hotel.
In 1981, Connolly informed Ostroff that he was considering
leaving his position as on-site manager of the Gateway Hotel,
because he felt he was not being adequately compensated for his
services.
Ostroff attempted unsuccessfully to have Cox increase
Connolly's pay.
Ostroff and his superiors at Prudential,
including Ballard, decided to terminate Prudential's management
- 93 contract with Cox and to award the management contract to
Connolly.
Ostroff told Connolly that Prudential wanted him to manage
the Gateway Hotel.
Ostroff informed Connolly that he would have
to establish a management company of his own and that all hotel
employees would have to be employees of Connolly's hotel
management company.16
Establishing such a hotel management
company, however, presented a problem for Connolly.
The
management company would be required, among other things, to
employ a financial manager and an accounting staff to prepare and
issue the financial reports required by Prudential on the Gateway
Hotel's operations.
The full-time employment of such personnel
to perform these and other required services could well be
uneconomical, since Connolly's company would be managing only one
or two hotels.
Ballard introduced Connolly to Eulich.
Eulich also knew
Kanter from certain prior business ventures in which Kanter had
helped raise capital.
Kanter and Eulich were aware Connolly
would need assistance for his hotel management company.
Eulich
also wanted Eulich-Management's business to include the
management of a number of large hotels.
16
He believed that
Prudential did not want to have its employees involved in
operating the hotel and did not want any of the hotel's employees
to be Prudential employees.
- 94 Kanter's business contacts, including contacts with the Pritzker
family, could be beneficial to Eulich-Management.
Eulich, Kanter, and Connolly decided to organize several
entities to further their objectives.
A hotel management company
called Gateway Hotel Management Corp. (Gateway Corp.) was
incorporated in 1981.
Another corporation, Essex Hotel
Management Co. (Essex Corp.), was also formed.
A letter from Eulich to Connolly dated October 16, 1981,
indicated that Eulich provided $10,000 for the initial
capitalization of Gateway Corp.
The letter also indicated that
initially Essex Corp. owned 80 shares (80 percent) of the Gateway
Corp. stock, that Connolly owned 20 shares (20 percent), and that
Connolly had an option to purchase Essex Corp.'s 80 shares.17
17
The letter stated:
Per our telephone conversation today, I am enclosing
the following material:
1.
Your 20 shares of stock in Gateway
Hotel Management Company
representing 20% of the company.
2.
A xerox copy of 80 shares of stock owned
by Essex Hotel Management Company
representing 80% of the company.
3.
A copy of the minutes of the first
meeting of the Board of Gateway - the
original is being circulated for
signature and will be sent for signature
soon.
4.
A xerox copy of your option on the Essex
(continued...)
- 95 By March 2, 1982, however, Connolly owned 100 shares (100
percent) of the Gateway Corp. stock.
A stock option agreement
"made and entered into" September 18, 1981, but "executed as of"
March 2, 1982, recites that Connolly owned 100 shares of $1 par
value common stock of Gateway Corp.
Under the stock option
agreement, Connolly granted Essex Corp. a 10-year option to
purchase 80 shares of the common stock of Gateway Corp. for $100
per share.18
In consideration for the option, Essex Corp. agreed
to pay Connolly $1,000 per year for the term of the option.
Eulich, Kanter, and Connolly also formed a partnership
called Essex Hotel Management Co. (the Essex partnership or
Essex), which was organized effective January 1, 1982.
The
(...continued)
Hotel Management Company stock - the
original is being circulated for
signature currently.
As we discussed on the phone, we will be sending you a
check for $10,000.00 which represents the
capitalization of Gateway that should be used as the
corporation's initial bank deposit. When the first
profit distribution is made we would appreciate your
sending us a check for $2,000 representing 20% of this
capital.
If you have any questions about this transaction,
please let me know. We are looking forward to working
with you in what is hopefully a mutually pleasant and
profitable venture.
18
On Dec. 21, 1984, Essex Corp. assigned its option to
purchase the 80 shares of Gateway Corp. to the Essex partnership.
- 96 partners of Essex and their partnership interests were as
follows:
Partner
Eulich-Management
IRA
Holding Co.
Connolly
Partnership Interest
47.500
26.125
21.375
5.000
Although the Essex partnership agreement required its
partners to contribute any capital needed to operate the
partnership, very little, if any, actual capital contributions
were ever required from them.
The Essex partnership had no
office, equipment, or employees.
In late 1981, Gateway Corp. entered into a management
contract with Prudential to operate the Gateway Hotel and entered
into a second management contract effective February 1, 1982, to
operate another Hilton-franchised hotel that Prudential owned at
Midland, Texas (the Midland Hotel).19
The Essex partnership entered into "Representation and
Marketing" agreements with Eulich-Management and Gateway Corp.,
also effective January 1, 1982.20
At the time, Eulich-
19
Although Ostroff and Prudential ultimately awarded the
Midland, Texas, hotel's management contract to Gateway Corp.,
Gateway Corp. and Eulich-Management had each submitted bids on
the Midland hotel's management contract. During this time,
Prudential usually obtained bids from at least three hotel
management companies for a particular hotel's management
contract.
20
The Eulich-Management agreement indicates that, although it
was effective as of Jan. 1, 1982, it was executed as of July 5,
(continued...)
- 97 Management managed the Allentown Hilton and the Madison Hotel.
Although both were owned by third parties, Prudential had helped
finance the construction of the two hotels.
Essex's agreement
with Eulich-Management (the Eulich-Management/Essex agreement)
required Eulich-Management to pay to Essex 30 percent of its
management fees from the operation of the Madison Hotel and 43
percent of the fees from the operation of the Allentown Hilton.
The agreement with Gateway Corp. (the Gateway Corp./Essex
agreement) required Gateway Corp. to pay to Essex 75 percent of
Gateway Corp.'s management fees from the operations of the
Gateway Hotel and the Midland Hotel.
Employees of Eulich-Management performed record-keeping and
reporting services for Gateway Corp.
A number of Eulich-
Management's personnel were instructed to do whatever they could
to help Connolly with Gateway Corp.'s operations.
For instance,
Eulich-Management employees helped perform the financial and
accounting services that Gateway Corp. required in connection
with its Gateway and Midland hotel management contracts.
In yet
another instance, a Eulich-Management employee helped Connolly
with union negotiations.
Also, after Prudential awarded the
Midland, Texas, hotel's management contract to Gateway Corp.,
Eulich-Management's employees helped Connolly find an on-site
(...continued)
1982.
- 98 manager for that hotel.
Corp. for these services.
Eulich-Management did not charge Gateway
IRA and Holding Co., in contrast to
Eulich-Management, provided no services to Gateway Corp.
The Essex partners agreed that Gateway Corp. and EulichManagement generally would pay the same fees to the Essex
partnership.
The partnership's specified percentage of fees
under each consulting and fee participation agreement could
easily be adjusted and modified, as each consulting and
participation agreement was cancelable by a 30- to 90-day notice.
As a result, if a significant change occurred with respect to the
compensation that Gateway Corp. or Eulich-Management received
under a particular hotel management contract, an offsetting
change then could be effectuated in the other consulting and fee
participation agreements Gateway Corp. and Eulich Management had
with Essex.
In late 1983, Eulich-Management received a hotel management
contract for Prudential's Hilton-franchised Twin Sixties Hotel at
Dallas, Texas.
A new Eulich-Management/Essex agreement was made
effective January 1, 1984, whereby Eulich-Management agreed to
pay to Essex 70 percent of the fees from the Madison Hotel, 57
percent of the fees from Allentown Hilton, and 57 percent of the
fees from Twin Sixties.21
21
The consulting and participation agreement for the Twin
Sixties hotel was entered into to replace the income that Essex
(continued...)
- 99 Effective January 1, 1986, a new Gateway Corp./Essex
agreement reduced Essex's share of Gateway Corp.'s fees from the
operations of the Gateway Hotel and the Midland Hotel from 75
percent to 40 percent.
Although Eulich-Management was sold by Eulich to an
unrelated company called Aircoa in 1986, Eulich-Management
continued to participate as a partner in Essex until about 1990.
In early 1990, Gateway Corp. lost the management contracts
on the Gateway and Midland hotels and ceased operating.
The
Essex partnership terminated by 1991.
During the years 1982 through 1988, Essex reported the
following amounts as received and/or accrued22 commission fee
payments from Gateway Corp. and Eulich-Management:
Year
1982
1983
1984
1985
1986
1987
1988
Total
Gateway
$234,170
222,557
268,663
225,487
68,000
172,963
142,761
1,334,601
Eulich-Mgt.
$104,121
235,718
242,116
230,847
123,089
388,632
238,889
1,563,412
(...continued)
would lose following the expected termination of EulichManagement's management contract for the Allentown Hilton, as the
Allentown Hilton was then in the process of being sold.
22
Essex reported its income on the cash method until 1987.
For the 1987 taxable year and thereafter Essex reported on the
accrual method.
- 100 For the 1989 taxable year, Essex reported $293,261 in total
income from consulting fees from Eulich-Management and Gateway
Corp.
For the taxable years 1982 through 1989, Essex made
distributions to IRA, Holding Co., Connolly, and EulichManagement in the following amounts:
Year
1982
1983
1984
1985
1986
1987
1988
1989
Total
IRA
$86,212
78,375
133,238
120,175
80,465
120,698
117,562
51,727
788,452
Holding
$70,538
64,125
109,013
98,325
65,835
98,752
96,118
42,322
645,028
Connolly
$16,500
15,000
25,499
23,000
15,400
23,100
22,500
9,900
150,899
Eulich-Mgt.
$156,750
142,500
242,250
218,500
146,300
219,450
213,750
94,051
1,433,551
The distributions to all partners from 1982 through 1989
totaled $3,017,930.
- 101 The following diagram illustrates the Essex arrangement:
- 102 F.
Diagram: Summary of Payments From the Five 1977 Through 1989
The following diagram shows the money paid by the Five to
IRA, Zeus, KWJ Corp. and Holding Co. from 1977 through 1989:
Most of the payments made by the Five were attributable to
Ballard's and Lisle's influence in awarding contracts with
Prudential (the Prudential transactions), some were attributable
to Lisle's influence in awarding contracts with Travelers (the
Travelers transactions), and some were attributable to Kanter's
influence in transactions that did not necessarily involve
Prudential or Travelers (the Kanter transactions).
- 103 G.
Changes in IRA and Subsidiaries Corporate Structure From
1974 Through 1988
IRA's predecessor, Cedilla Co., was incorporated in 1974.
Keating acquired 1,000 shares of the common stock, and Schott
acquired 1,000 shares of its preferred class A stock.
In 1975,
Weaver agreed to sell KWJ Corp. to Kanter's "client".
In 1975,
Keating's common stock was exchanged for 500 shares of class B
preferred stock, and Weisgal as trustee of the Bea Ritch trusts
acquired 1,000 shares of the common stock.
The Cedilla Co's.
1975 balance sheet at the end of 1975 reflected the following:
Assets
Cash
Loans receivable
Prepaid expenses
Total
Liabilities
Net assets
$564
21,100
89
21,753
5,000
16,753
Capital stock
Preferred
Common
Capital surplus
Retained earnings
1,050
100
50
15,553
The following series of diagrams illustrates the changes in
the IRA organizations during the years at issue to accommodate
the various transactions.
- 104 1976-77
Cedilla Co. acquired Cedilla Investment Co. (engaged in
equipment leasing transactions) in December 1976.
During 1976
Kanter negotiated IRA's purchase of KWJ Corp. from Weaver and
began discussing the purchase of Schnitzer-PMS from Schnitzer.
In 1977 Keating's preferred stock was redeemed.
IRA's consolidated returns for 1976 and 1977 reported
consolidated net losses23 of $7,954 in 1976 and $271,394 in 1977,
a net loss for Cedilla Investment Co. of $174,003 in 1976 and
$345,950 in 1977, and reflected the following income and end-ofyear balance sheets with respect to IRA (unconsolidated):
23
During the years at issue the consolidated net losses did
not equal the total of the net losses of the consolidated group
because of special deductions.
- 105 Income
Gross receipts
Dividends
Interest
Partnership
Total
Deductions
Compensation/officers
Salaries/wages
Commissions
Other
Total
Net Income
Special deductions
Taxable Income
Assets
Cash
Loans receivable
Securities
Marketable
Non-marketable
Investment in sub.
Investment in pship
Cedilla trust
Other
Total
Liabilities
Payables
Short term
Long term
Other
Total
Net assets
Capital stock
Preferred
Common
Capital surplus
Retained earnings
Cost of treasury stock
1976
1977
$640,000
-9,525
(260,934)
388,591
$112,982
9,217
9,409
5,214
136,822
--213,333
9,209
222,542
166,049
166,049
19,300
986
12,000
22,866
55,152
81,670
(7,114)
74,556
301,401
40,000
134,270
370,500
15,663
-15,000
(185,834)
-361
186,591
290,213
65,000
15,000
(180,620)
5,000
2,213
701,576
---6,900
6,900
179,691
2,000
65,000
370,000
3,182
440,182
261,394
1,050
100
50
178,491
--
1,000
100
260,344
(50)
- 106 1978
In January 1978, IRA purchased the Schnitzer PMS stock.
In
1978, Cedilla Co. changed its name to Investment Research
Associates, Ltd. (IRA).
In April 1978, IRA acquired 1,000 shares
(100 percent) of the voting stock of Arba Investments, Inc., and
changed Arba's name to Cedilla Co.
IRA's consolidated return for 1978 reported consolidated net
losses of $18,673 and a net loss for Cedilla Investment Co. of
$605,992 and reflects the following income and end-of-year
balance sheets with respect to IRA and Cedilla Co.
(unconsolidated):
- 107 IRA
Income
Gross receipts
Dividends
Interest
Capital gain
Partnership
Total
Deductions
Compensation--officers
Salaries/wages
Consulting Fees
Commissions
Other
Total
Net income
Special deductions
Taxable income
Assets
Cash
Loans
Stockholders
Others
Securities
Marketable
Nonmarketable
Investment in sub.
Investment in pship.
Cedilla trust
Other
Total
Liabilities
Payables
Short term
Long term
Other
Total
Net assets
Capital stock
Preferred
Common
Capital surplus
Retained earnings
Cost of treasury stock
Cedilla Co.
$777,499
20,572
38,885
69,715
4,829
911,500
$10,697
-18
--10,715
15,000
5,051
51,900
207,237
18,565
297,753
613,747
(16,910)
596,837
7,500
4,287
--8,446
20,233
(9,518)
-(9,518)
28,600
70,996
287,900
734,350
-6,385
318,197
215,000
34,024
(180,703)
4,511
1,051
1,442,930
-----2,060
79,441
197,575
370,000
1,211
568,786
874,144
70,000
--555
70,555
8,886
1,000
100
873,094
(50)
-1,000
18,024
(10,138)
- 108 1979
Although IRA acquired 100 shares (100 percent) of KWJ Corp.
in November 1978, IRA first included KWJ Corp. on its 1979
consolidated return.24
During 1979, IRA sold its Schnitzer-PMS
stock back to Century Development.
began in 1979.
Schaffel's payments to IRA
Frey's arrangement began in 1979 and, in December
1979, IRA acquired 1,000 shares of Zeus Ventures, Inc. (Zeus).
IRA's consolidated return for 1979 reported a consolidated
net loss of $20,728, a net loss for Cedilla Investment Co. of
$320,425, and net taxable income from KWJ Corp. of $119,646 and
reflects the following income and end-of-year balance sheets with
respect to IRA and Cedilla Co. (unconsolidated):
24
IRA's 1978 return reported $1,442,930 total assets as of the
close of the year, $34,024 of which was the amount of its
investment in subsidiaries. The 1979 return reported $1,592,930
of total assets as of the beginning of the year, $184,024 of
which was the amount of its investment in subsidiaries. The
$150,000 difference is the amount IRA agreed to pay for the KWJ
Corp. stock.
- 109 IRA
Income
Gross receipts
Dividends
Interest
Gross rents
Capital gain
Partnership
Management fees
Consulting fees
Total
Deductions
Compensation--officers
Salaries/wages
Depreciation
Consulting fees
Commissions
Other
Total
Net income
Special deductions
Taxable income
Assets
Cash
Loans
Stockholders
Others
Treasury bills
Securities
Marketable
Nonmarketable
Investment in sub.
Investment in pship.
Depreciable assets
Less accumulated dep.
Cedilla trust
Deferred expenses
Other
Total
Liabilities
Payables
Short term
Long term
Deferred income
Total
Net assets
Capital stock
Cedilla Co.
$73,280
3,125
112,804
225
141,519
1,157,861
-100,000
1,588,814
$101,274
-1,038
---2,750
--638,550
125,000
209,440
60,911
1,033,901
554,913
(2,055)
542,858
26,800
4,100
---19,470
50,370
54,692
-54,692
962,964
11,806
1,200
3,725,675
--177,951
65,000
234,024
130,907
5,108,573
(638,550)
4,511
91,640
1,029
9,864,924
-21,885
24,308
----1,800
----2,060
61,859
309,795
5,319,924
2,807,260
8,436,979
1,427,945
----61,859
105,062
- 110 Preferred
Common
Capital surplus
Retained earnings
Cost of treasury stock
1,000
100
-1,426,895
(50)
-1,000
18,024
42,835
--
1980
In January 1980, IRA acquired 1,000 shares (100 percent) of
Brickell Enterprises, Inc. (Brickell).
IRA's consolidated return for 1980 reported consolidated
taxable income of $65,094, a net loss for Cedilla Investment Co.
of $145,887, net taxable income for Zeus of $118,269, a net loss
for KWJ Corp. of $2,620, and net taxable income from Brickell of
$90,225 and reflects the following income and end-of-year balance
sheets with respect to IRA and Cedilla Co. (unconsolidated):
Income
Dividends
Interest
Gross rents
Capital gain
Partnerships
Commissions & fees
Total
IRA
Cedilla Co.
$15,467
578,031
581,180
217,981
1,448,542
244,920
3,086,121
-$2,373
300
--38,311
40,984
- 111 Deductions
Compensation--officers
Salaries/wages
Interest
Depreciation
Commissions/fees
Other
Total
Net income
Special deductions
Taxable income
Assets
Cash
Trade receivables
Loans
Stockholders
Others
Installment receivable
Securities
Marketable
Nonmarketable
Investment in sub.
Investment in pship.
Depreciable assets
Less accumulated dep.
Cedilla trust
Deferred expenses
Other
Total
Liabilities
Payables
Short term
Long term
Deferred gain
Other
Total
Net assets
Capital stock
Preferred
Common
Capital surplus
Retained earnings
--916,507
2,115,376
-14,226
3,046,109
40,012
(13,147)
26,865
19,800
6,918
-2,294
-33,705
62,717
(21,733)
-(21,733)
1,399,085
703
1,510
--
1,200
1,896,320
2,738,532
-15,885
--
411,481
348,024
-326,072
12,468,476
(2,753,926)
4,511
91,640
1,325
16,933,443
----22,937
(2,294)
--2,060
40,098
118,756
606,000
12,258,949
2,606,029
2,869
15,592,603
1,340,840
------40,098
1,000
100
-1,000
18,024
21,074
1,339,740
- 112 1981-82
During 1981, Essex Corp. and Gateway Corp. were organized.
In November 1981, IRA acquired 1,000 shares of IRA Florida
Apartments, Inc. (IRA Flor. Apts.).
partnership was organized.
During 1982, the Essex
During 1982, Ballard and Lisle
retired from Prudential; Lisle began employment with Travelers,
and Ballard began employment with Goldman-Sachs.
IRA's consolidated returns for 1981 and 1982 reported
consolidated net losses of $615,852 and $121,501, respectively,
which included a net loss of $25,057 in 1981 and net taxable
income of $72,407 for Cedilla Investment Co., net income of
$107,887 in 1981 and $448,691 in 1982 for Zeus, net income of
$91,118 in 1981 and $155,842 in 1982 for KWJ Corp., net income of
$5,954 in 1981 and a net loss of $19,184 in 1982 from Brickell,
and net losses of $6,568 in 1982 from IRA Florida Apts. and
reflects the following income and end-of-year balance sheets with
respect to IRA and Cedilla Co. (unconsolidated):
- 113 IRA
Income
Dividends
Interest
Gross rents
Capital gain
Partnerships
Commissions
Parking income
Management fees
Other fees
Miscellaneous
Total
Deductions
Compensation--officers
Directors fees
Salaries/wages
Bad debts
Interest
Depreciation
Consulting fees
Commissions
Other
Total
Net Income
NOL
Special deductions
Taxable income
1981
Cedilla Co.
IRA
1982
Cedilla Co.
$2,306
673,674
2,484,330
304,883
725,964
205,275
--156,250
91
4,552,773
-1,747
8,550
--62,585
823
2,375
--76,080
$333,611
354,531
2,437,715
-(483,219)
325,000
-5,832
447,450
1,514
3,422,434
–7,587
4,828
--112,958
---478
125,851
–12,500
9,969
395,600
2,164,579
2,561,361
-115,400
85,284
5,344,693
(791,920)
–(1,960)
(793,880)
26,300
-9,361
--5,047
--30,678
71,386
4,694
–-4,694
--26,079
162,200
1,872,881
1,610,457
29,000
-58,580
3,759,197
(336,763)
(793,880)
(322,569)
(1,453,212)
--9,231
–32
5,047
-66,776
34,764
115,850
10,001
-–10,001
1,885
8,684
57,110
43,885
104
14,065
Assets
Cash
28,671
Money market
107,379
Receivables
Notes & accounts
2,429,224
Rents
3,570
Loans
Stockholders
366,350
Others
3,066,284
Securities
Short term
1,030,000
Marketable
405,293
Nonmarketable
200,700
Investment in sub.
236,024
Investment in pship.
2,607,473
Depreciable assets
12,478,152
Less accumulated dep. (5,315,286)
Other
-Total
17,643,834
Liabilities
Short term notes
585,000
Long term notes
13,754,966
Loan from stockholder
262,400
Deferred gain
2,311,689
Other
-Total
16,914,055
Net assets
729,779
---
2,256,783
--
---
-26,860
340,930
3,002,131
-37,600
-----24,550
(7,341)
447
55,085
1,460,000
492,663
312,700
268,924
2,149,204
10,270,651
(6,000,765)
1,190
14,655,406
-----24,550
(12,388)
1,380
65,311
9,600
---693
10,293
44,792
1,038,099
11,259,516
2,400
2,147,594
914
14,448,523
206,883
9,600
---981
10,581
54,730
- 114 Capital stock
Preferred
Common
Capital surplus
Retained earnings
1,000
100
-728,679
-1,000
18,024
25,768
1,000
100
–205,783
-1,000
18,024
35,706
1983
IRA reported that it liquidated Brickell, IRA Florida Apts.,
and KWJ Corp. under section 332 during 1983.
In December 1983,
IRA acquired 1,000 shares (100 percent) of the common stock of
Carlco, TMT, and BWK, Inc.
IRA's 1983 consolidated return and adjusting journal entries
show that Schott's shares of IRA preferred stock were redeemed in
1983 in exchange for IRA's 1,000 shares of Cedilla Co. common
stock.
IRA reported that its shares of Cedilla Co. were redeemed
for $1,000 in April 1983 and reported a long-term capital loss of
$18,024 on the sale.
IRA's consolidated income also included a
$35,000 net operating loss from Cedilla Co.
Cedilla Co. had no
- 115 income and claimed a deduction of $35,000 for commission
expenses.
Cedilla Co.'s 1983 adjusting journal entry indicates
that the $35,000 due to Schott was paid by offsetting amounts
owed by Schott to Cedilla Co.
IRA's consolidated return for 1983 reported a consolidated
net loss of $425,538, net income of $140,065 for Cedilla
Investment Co., net income of $149,128 for Zeus, net income of
$139,783 for KWJ Corp., a net loss of $21,567 from Brickell, and
a net loss of $18,356 from IRA Florida Apts. and reflects the
following income and end-of-year balance sheets with respect to
IRA (unconsolidated):
IRA
Income
Dividends
Interest
Gross rents
Capital gain
Partnerships
Commissions
General fees
Consulting fees
Total
Deductions
Bad debts
Interest
Depreciation
Commissions/fees
Other
Total
Net Income
NOL
Special deductions
Taxable Income
$343,080
402,022
2,581,652
314,855
(689,461)
244,732
26,000
3,222,880
22,075
1,834,892
1,636,137
88,311
3,581,415
(358,535)
(1,453,212)
(336,303)
(2,148,050)
- 116 Assets
Cash
Pooled funds
Notes Receivable
Loans
Stockholders
Others
Securities
Short term
Marketable
Nonmarketable
Investment in sub.
Investment in pship.
Depreciable assets
Less accumulated dep.
Other
Total
Liabilities
Payables
Short term
Long term
Deferred gain
Other
Total
Net assets
Capital stock
Preferred
Common
Capital surplus
Retained earnings
110,281
38,250
2,070,128
292,260
1,592,983
3,776,000
564,827
192,700
83,000
1,640,284
11,286,020
(7,636,902)
2,365
14,012,196
1,341,617
11,060,633
1,969,973
14,372,223
(360,027)
100
(360,127)
- 117 1984-87
IRA distributed cash accumulated from Prudential
transactions, including cash received from Zeus and the
liquidation of KWJ Corp. and its interests in the Essex and
Sherwood partnerships, in the ratio of 45 percent each to Carlco
and TMT and 10 percent to BWK, Inc.
Carlco, TMT, and BWK, Inc.,
contributed the Hyatt contract rights to a new partnership called
KWJ Co.
IRA's consolidated returns for 1984 to 1987 reported the
following consolidated net losses, net income or loss for Cedilla
Investment Co. and Zeus, and income for IRA, and reflect the
following end-of-year balance sheets with respect to IRA
(unconsolidated):
- 118 1984
Consolidated
income(loss)
($175,946)
Cedilla Invest.
331,263
Zeus
(96,473)
IRA
Income
Dividends
113,505
Interest
247,230
Gross rents
2,689,177
Capital gain
247,929
Partnerships
24,821
Loss notes
-Commissions/fees
-Other
356
Total
3,323,018
Deductions
Bad debts
-Interest
1,778,953
Depreciation
1,748,335
Consulting fees
-Commissions
-Other
20,752
Total
3,548,040
Net income
(225,022)
NOL
(89,235)
Special ded.
(96,479)
Taxable income
(410,736)
Assets
Cash
53,976
Pooled funds
38,250
Notes Receiv.
1,868,086
Loans
Stockholders
292,479
Subsidiaries
-Others
1,543,454
Securities
Short term
422,000
Marketable
230,451
Nonmarketable
4,430,107
Invest. sub.
65,000
Invest. pship.
1,129,898
Deprec. assets 11,286,020
Less acc. dep. (9,385,237)
Other
2,365
Total
11,976,849
Liabilities
Payables
-Short term
81,250
Long term
11,258,179
Defer. gain
1,777,711
Other
-Total
13,117,140
Net assets
(1,140,291)
1985
1986
1987
$96,363
376,929
(153,108)
($327,854)
(1,148,003)
(151,122)
($16,942)
(704,460)
(181,747)
97,206
177,236
2,689,177
-(202,702)
--1,000
2,761,917
87,079
164,843
1,175,346
(62,833)
373,779
--(546)
1,737,668
31,960
238,396
1,271
604,750
186,845
(1,176,670)
--(113,448)
-1,477,807
1,222,686
-4,000
22,784
2,727,277
34,640
(410,736)
(82,625)
(458,721)
-543,077
316,192
--29,683
888,952
848,716
(458,721)
(86,412)
303,583
132,013
274
3,228
--37,094
172,609
(286,057)
-(31,960)
(318,017)
11,933
-1,649,390
322,645
-2,528,266
1,241,888
-1,156,439
-292,569
1,146,668
-345,869
1,186,973
--620,594
415,000
-4,848,613
65,000
1,041,875
11,286,020
(10,607,923)
2,365
10,151,510
--5,291,069
65,000
1,194,093
23,721
(20,494)
2,365
10,939,507
--5,718,826
65,000
345,491
23,721
(23,721)
2,365)
9,150,603
-122,925
9,995,705
1,569,599
-11,688,229
(1,536,719)
-45,490
9,495,319
2,459,893
-12,000,702
(1,061,195)
-45,490
9,495,280
1,100,516
-10,641,286
(1,490,683)
- 119 Capital stock
Preferred
Common
Capital surplus
Retained earn.
-100
-100
-100
-100
(1,140,391)
(1,536,819)
(1,061,295)
(1,490,783)
1988-89
In December 1988, IRA acquired 850 shares (85 percent) of
Decisions Holding Corp. in a section 351 exchange for all of its
shares of Cedilla Invest. and Zeus, plus $60,000.25
Zeus
continued to hold an $807,028 receivable from Holding Co. plus
$64,000 of receivables (exchanged during 1988 for a $64,000
receivable from HELO).
No payments were made by Holding Co. or
the others on the receivables, and no efforts were ever made to
collect on the receivables.
25
On IRA's 1988 consolidated return, IRA reported that it
contributed $60,000 to Decisions Holding Corp. in the sec. 351
transaction in exchange for 85 percent of the stock of Decisions
Holding Corp. The return, however, also reported the transfers
of IRA's stock in Cedilla Invest. and Zeus to Decisions Holding
Corp. See infra Issue 23.
- 120 IRA's consolidated returns for 1988 and 1989 reported
consolidated net losses, and net income or loss for Cedilla
Investment Co., Zeus, and Decisions Holding Corp. and reflected
the following income and end-of-year balance sheets with respect
to IRA (unconsolidated):
Consolidated income (loss)
Cedilla Invest.
Net
NOL
Taxable
Zeus
Net
NOL
Taxable
Decisions Holding Corp.
Net income
NOL
Taxable income
IRA
Income
Dividends
Interest
Gross rents
Capital gain
Partnerships
Commissions/fees
Total
Deductions
Commissions/fees
Other
Total
Net income
NOL
Special deductions
Taxable income
1988
($637,842)
1989
($116,521)
52,446
(704,460)
(652,014)
11,702
(652,014)
(640,312)
(163,987)
(181,747)
(345,734)
(18,419)
(345,734)
(364,153)
(1,066,348)
(1,066,348)
(3,394)
(1,066,348)
(1,069,742)
65,093
180,828
188
293,593
106,970
-120,555
-780,343
110,087
646,672
1,010,985
44,001
44,001
602,671
(311,625)
(52,074)
238,972
59,927
59,927
951,058
(419,626)
-531,432
- 121 Assets
Cash
Notes Receivable
Loans
Stockholders
Others
Securities
Marketable
Nonmarketable
Investment in sub.
Investment in pship.
Other
Total
Liabilities
Payables/notes
Short term
Long term
Deferred gain
Other
Total
Net assets
Capital stock
Preferred
Common
Capital surplus
Retained earnings
1988
1989
$1,320,716
879,079
$611,752
--
-554,969
--
-1,309,744
--
6,145,610
125,000
390,091
2,365
9,417,830
6,806,346
125,000
478,847
2,365
9,334,054
-9,495,280
836,581
-9,495,280
--
10,331,861
(914,031)
9,495,280
(161,226)
-100
-100
(914,131)
(161,326)
IRA's records show the following assets (unconsolidated) for
the years 1983 through 1989:
- 122 IRA Assets
Cash and CD's
Amer. Natl Bank
Skylark Bank
Perinne Bank
Administration Co.
CD's
Special E
Principal Services
Total
Notes Rec.
PMS Note
Aura
Kanter
Funding Sys.
The Holding Co.
Int'l Films
HELO
Tanglewood
Cedilla Invst.
B. DiLanciano
Larry Freeman
KWJ Co.
Landing
Forest Activity
Hyatt Corp.
Cablevision Sys.
Bea Ritch Trust
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