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As taxpayers file their returns this week, it’s doubtful that many have been shopping for tax shelters. Shielding capital gains is a problem the economy has eliminated for most people. But a few years ago, when the economy was booming, tax shelters were hot. They looked good to investors who cashed out before the bubble burst, and they were big revenue producers for accounting firms, financial institutions and select law firms. Now some of those shelters are hot again-but not in the same sense. This time it’s the kind of heat that has convinced Reese Jones to pay $7 million to the Internal Revenue Service (IRS), as his lawyer said he will do this week. It’s the kind that has generated lawsuits around the country. And the defendants are the same institutions that helped put the shelters together�including the law firms. At least eight firms have been sued: Altheimer Gray (now defunct); Cantley & Sedacca (also defunct); Chamberlain, Hrdlicka, White, Williams & Martin of Houston; Curtis, Mallet-Prevost, Colt & Mosle of New York; Jenkens & Gilchrist of Dallas; LeBoeuf, Lamb, Greene & MacRae of New York; Pillsbury Winthrop; and Sidley Austin Brown & Wood. Jenkens has tentatively settled the cases against it. A lawyer who represents Cantley said: “We have filed a motion to dismiss, and we are confident the court will grant it.” Bob Waters, executive director of Chamberlain Hrdlicka, said the claim against his firm involves work done in 1997 and had nothing to do with the “listed transactions” later identified by the IRS as problematic. The complaint doesn’t call the work erroneous, “and so we’re obviously prepared to defend our work.” The other firms declined to comment or did not return phone calls. Plaintiffs’ lawyers say a lot more lawsuits can be expected in the next six months. Most of the firms stand accused of writing opinion letters stating that allegedly fraudulent tax shelters were more likely than not to pass muster with the IRS. Some firms allegedly helped design and/or market the shelters. They were known by acronyms: FLIP, COBRA, BLIPS and many others. The structures differed, but their alleged purpose was the same. Taxpayers shielded capital gains by investing in complex vehicles that looked like legitimate investments designed to make a profit. Instead, they guaranteed quick, large losses. What made them shams, the IRS said in notices released in 1999 and 2000, was that their sole purpose was to generate the losses. The U.S. Senate Governmental Affairs Committee’s Permanent Subcommittee on Investigations held hearings and issued a report on the tax shelter industry last November. The subcommittee estimated that from 1993 to 1999, losses to the U.S. Treasury attributable to “abusive tax shelters” ranged from $11 billion to $15 billion annually. The total loss could be as high as $85 billion. The Jones suit A lawsuit filed by Jones-the gentleman with the big tax bill-seems fairly typical and illustrates many of the issues. Jones is founder and chairman of Netopia, a company near San Francisco that develops and sells broadband equipment. In 1999, according to the complaint, Jones had a substantial capital gain. “Although he has been extremely successful as a businessperson, thanks to his communications inventions,” the complaint says, “he is unsophisticated in complicated business matters.” He hired a company called myCFO, which offered the full spectrum of financial services-from bill paying to tax planning. In 2000, the company introduced him to a shelter called CARDS (custom adjustable rate debt structure). The concept was developed and promoted by Chenery Associates, investment consultants, assisted by the San Francisco office of LeBoeuf. The firm wrote opinion letters “as to the securities implications, margin regulations, and potential tax penalty consequences of the CARDS” shelter, the complaint says. While LeBoeuf “actively participated in the marketing, promotion, development and facilitation of the CARDS scheme,” Brown & Wood (now Sidley Austin Brown & Wood) provided letters opining that the shelter would likely be viewed favorably by the IRS. Jones put up $8 million in collateral, which was eventually returned, said William Lukens, Jones’ lawyer. Jones paid myCFO more than $1.9 million, LeBoeuf $83,000 and Chenery $1.5 million for a total of $3.5 million in fees. In return he was able to record short-term losses of more than $21 million in 2000 and more than $15 million in 2001. “I don’t sue law firms very often,” Lukens of Lukens Law Group in San Francisco said in an interview. “But just a rudimentary investigation of the facts by the law firms involved would have revealed that this was a complete sham.” The claims include fraud, breach of contract and professional negligence. Jones v. Chenery Assocs., No. CGC-04-429571 (San Francisco Co., Calif., Super. Ct.). Other suits have included Racketeer Influenced and Corrupt Organizations Act (RICO) claims, but Lukens avoided them. Sidley and myCFO have forced him to arbitrate because their contracts contained arbitration clauses. He couldn’t prevent that, but he was concerned that a claim of conspiracy would allow Chenery and LeBoeuf also to force him to arbitrate. That was the result in a recent case when an accounting firm had an arbitration clause and RICO was alleged. Camferdam v. Ernst & Young Int’l, No. 02 CIV 10100 (S.D.N.Y.). He also avoided another trap for the unwary, said Lukens. Cases have been dismissed because they weren’t ripe. Absent a decision by the IRS-and many taxpayers are fighting or negotiating-damages are unclear, some courts have ruled. That’s why on April 15 Jones will plunk down $7 million-the tax he owes from the shelter, plus interest. (An amnesty program in 2002 allowed him to avoid penalties.) The payment should answer the ripeness question, Lukens said. The law firm that has the most to worry about is Jenkens & Gilchrist. By firm Chairman Thomas Cantrill’s reckoning, it has participated in 607 transactions involving disputed tax shelters. The reason Jenkens has so many cases has a lot to do with Paul Daugerdas. In 1997, while he was at Altheimer Gray, Daugerdas helped design the COBRA shelter, according to The American Lawyer, a sister publication of the NLJ. When he jumped to Jenkens the following year to open its Chicago office, he brought the design with him. He also worked with accounting firms and banks to market his shelter aggressively to individuals they knew had netted large capital gains. Daugerdas is still at Jenkens, but no longer Chicago’s managing partner. He’s now “of counsel,” Cantrill said. Daugerdas responded through a spokesman: “All the tax work performed by Mr. Daugerdas was completely consistent with the tax law at the time. This . . . advice was vetted by other tax experts inside and outside the law firm. We are confident . . . [it] will stand up as appropriate.” Jenkens’ settlement Plaintiffs’ lawyer David Deary recently negotiated a $75 million settlement for all Jenkens cases-he estimated a class of about 1,200-but it’s far from a done deal. The class must be certified, and then the proposed settlement must be accepted by the court. And, say Deary and Cantrill, if any class members opt out, Jenkens can pull out. Some lawyers and clients are watching and waiting. Robert Nelson, a partner at San Francisco’s Lieff Cabraser Heimann & Bernstein, has clients (he won’t say how many) who have participated in shelters and used Jenkens. None has filed suit yet, and Nelson hasn’t seen the settlement. But the numbers aren’t encouraging, he said. Class members are likely to recover only a fraction of the money that they’re out of pocket for-as even the settlement’s proponents admit. Blair Fensterstock of Fensterstock & Partners in New York is even less enthusiastic. Fensterstock, who is working with Lukens on the myCFO arbitration and has “dozens” of clients of his own, doesn’t feel these cases are even amenable to class certification. There are too many individual questions of fact and law, and lawyers are likely to land large fees while clients recoup little. “The $75 million, after attorney fees, won’t pay for the fees paid to Jenkens,” he said. The transactions brought Jenkens partners “a ton of money,” he said. According to Texas Lawyer, Jenkens will only have to kick in $5.25 million while Daugerdas would pay almost $4 million and two of his Chicago partners a total of $2.3 million. The balance would be covered by insurance. Fensterstock doesn’t understand why Jenkens partners shouldn’t be held individually liable. “This is a hell of a deal for Jenkens,” he said. “They’ve hit the lottery.” “I can tell you that during our negotiations,” Deary responded, “one of our biggest concerns was that, absent a class resolution as opposed to hundreds of lawsuits around the country, Jenkens & Gilchrist would be bankrupt . . . .But Jenkens is not the only defendant. There are other defendants with deeper pockets,” he said, referring to co-defendants that include a bank and an accounting firm. “And we believe the settlement”-which would ensure the firm’s cooperation with plaintiffs-”will significantly strengthen the class’s case against those deeper pockets.” Without a settlement, he added, many plaintiffs might well be left with an unsecured claim against a bankrupt firm with no insurance. The settlement is the fairest solution to all who were harmed, said Cantrill. Under Texas law, he added, lawyers not personally involved cannot be held liable. He expressed confidence that the settlement will be approved and the firm will survive. Without it, he isn’t so sure. The other firm embedded deepest in the mire is Sidley. “Sidley . . . is under investigation by the IRS for issuing more than 600 legal opinion letters supporting 13 questionable tax products.” noted the Senate subcommittee report. The firm has also been named in several lawsuits. Last November, during the Senate hearings, two lawyers were called to answer questions about the firm. The first was former partner Raymond Ruble, who is also a defendant in some suits. Ruble invoked his Fifth Amendment right to remain silent. The subcommittee report identified Ruble as the primary coordinator of the firm’s tax shelter business-one not limited to opinion letters. “Information obtained by the Subcommittee indicates that Sidley Austin Brown & Wood, through the efforts of Mr. Ruble, did more than simply draft opinion letters supporting KPMG tax products; the law firm formed an alliance with KPMG to develop and market these tax products,” the report said. Ruble also helped design two shelters, the subcommittee concluded. A lawyer representing him didn’t return calls. The firm declined comment. The second witness was Sidley partner Thomas Smith, who was Brown & Wood’s managing partner at the time of the questionable transactions. Smith testified that Ruble was fired in October “for accepting undisclosed compensation” and refusing to answer questions about it. He also continued to write opinion letters after he was asked to stop, Smith added. “I understand that no court has decided that Mr. Ruble’s tax opinions are wrong much less that they were issued in bad faith,” Smith testified. Senator Norm Coleman, R-Minn., the subcommittee chairman, asked Smith whether Ruble acted alone when he wrote 600 letters (for which, it was established earlier, clients paid $50,000 each). “That’s a good question,” Smith answered. His firm is reviewing, he said.

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