Khan v. Seidman

SUPREME COURT CASES

Laws-info.com » Cases » Illinois » 4th District Appellate » 2011 » Khan v. Seidman

Khan v. Seidman

State: Illinois

Court: 4th District Appellate

Docket No: 4-10-0504, 4-10-0583 Cons. Rel

Case Date: 03/16/2011

Preview:NOS. 4-10-0504, 4-10-0583 cons. IN THE APPELLATE COURT OF ILLINOIS FOURTH DISTRICT SHAHID R. KHAN; ANN C. KHAN; SRK WILSHIRE INVESTMENTS, LLC; SRK WILSHIRE PARTNERS; SRK WILSHIRE INVESTORS, INC.; THERMOSPHERE FX PARTNERS, LLC; and KPASA, LLC, Plaintiff-Appellants, v. (No. 4-10-0504) BDO SEIDMAN, LLP; PAUL SHANBROM; MICHAEL COLLINS; EQUILIBRIUM CURRENCY TRADING, LLC; SAMYAK VEERA; GRANT THORNTON, LLP; GRAMERCY ADVISORS, LLC; JAY A. JOHNSTON; and MARC HELIE, Defendants, and DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., d/b/a DEUTSCHE BANK ALEX. BROWN; and DAVID PARSE, Defendants-Appellees. ____________________________________ SHAHID R. KHAN; ANN C. KHAN; SRK WILSHIRE INVESTMENTS, LLC; SRK WILSHIRE PARTNERS; SRK WILSHIRE INVESTORS, INC.; THERMOSPHERE FX PARTNERS, LLC; and KPASA, LLC, Plaintiffs-Appellants, v. (No. 4-10-0583) BDO SEIDMAN, LLP; PAUL SHANBROM; MICHAEL COLLINS; DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., d/b/a DEUTSCHE BANK ALEX. BROWN; DAVID PARSE; EQUILIBRIUM CURRENCY TRADING, LLC; JAY A. JOHNSTON; and MARC HELIE, Defendants, and GRANT THORNTON, LLP, Defendant-Appellee. ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) Appeal from Circuit Court of Champaign County No. 09L140

Honorable Jeffrey B. Ford, Judge Presiding.

JUSTICE APPLETON delivered the judgment of the court, with opinion. Justices McCullough and Myerscough1 concurred in the judgment and opinion. OPINION In these two consolidated appeals, the plaintiffs are Shahid R. Khan (Khan) and Ann C. Kahn along with various business entities that Khan formed for the purpose of creating artificial losses, which he hoped would reduce his taxable income. Khan was not the one who came up with the tax-avoidance schemes. Rather, according to the complaint, he followed the advice of Paul Shanbrom at BDO Seidman, LLP, advice that was reinforced by a variety of co-conspirators, including the defendants in these two appeals. In one of the appeals, case No. 4-10-0504, the defendants are Deutsche Bank AG (Deutsche Bank); Deutsche Bank Securities, Inc., d/b/a Deutsche Bank Alex. Brown (Brown); and David Parse, an employee of Deutsche Bank (collectively, Deutsche defendants). According to the complaint, Shanbrom and Parse advised Khan to engage in some "investment strategies" in 1999 and 2000 in order to create ordinary losses, and Deutsche Bank and Brown helped implement these strategies. In the other appeal, case No. 4-10-0583, the defendant is Grant Thornton, LLP, which prepared the 2000 tax returns for one of the plaintiff corporations, Thermosphere FX Partners, LLC, claiming the fake losses. The Khans then used the information from this tax return in their own individual tax returns. The tax returns, however, were incorrect because, as the Internal Revenue Service (IRS) had warned in its

Justice Myerscough registered her concurrence with this opinion before she resigned from the Appellate Court of Illinois, Fourth District, in order to be sworn in as a judge of the United States District Court, Central District of Illinois. -2-

1

publications, such contrived losses lacked economic substance and therefore were not allowable. Consequently, plaintiffs ended up losing a lot of money. Not only were the substantial fees they paid to defendants a total waste, but plaintiffs incurred liability to the IRS for back taxes, interest, and penalties. All this is according to the complaint. The Deutsche defendants moved to dismiss the complaint pursuant to sections 2-615 and 2-619 of the Code of Civil Procedure (735 ILCS 5/2-615, 2-619 (West 2008)), asserting the legal insufficiency of the complaint and also invoking the statute of limitations in section 13-205 of the Code (735 ILCS 5/13-205 (West 2008)). Grant Thornton likewise moved to dismiss the complaint on the grounds that it was legally insufficient and time-barred. The trial court concluded that the statute of limitations in section 13-205 barred the actions against the Deutsche defendants and that the statute of limitations in section 13-214.2(a) (735 ILCS 5/13-214.2(a) (West 2008)) and the statute of repose in section 13-214.2(b) (735 ILCS 5/13-214.2(b) (West 2008)) barred the actions against Grant Thornton. Therefore, the court granted defendants' motions for dismissal. The court also found, pursuant to Rule 304(a) (Ill. S. Ct. R. 304(a) (eff. Feb. 26, 2010)), that there was no just reason to delay either enforcement or appeal of these rulings. In our de novo review in these two appeals, taking the well-pleaded facts of the complaint to be true and drawing reasonable inferences in plaintiffs' favor, we hold that the trial court erred by concluding that the claims against defendants are time-barred. Therefore, we reverse the trial court's judgments in the two cases, and we remand the cases for further proceedings. I. BACKGROUND

-3-

A. The 1999 Digital Options Strategy 1. Shanbrom and Parse Pitch the Strategy to Khan Beginning in approximately 1993, BDO performed auditing services for Chromecraft, a company of which Khan was part owner. Michael Collins, a partner at BDO, was in charge of auditing services for Chromecraft, and as of 1999, he had been one of Khan's trusted accountants and advisors for some six years. In 1999, Khan requested his own partner at Chromecraft to ask Collins if he knew anyone who could advise him on purchasing foreign currency. Khan needed Japanese yen because he was in negotiations to buy a Canadian company that manufactured plastic automobile bumpers and the Japanese owners of the company wanted to be paid in yen. Because Khan had no experience in foreign-currency trading, he needed guidance. Collins referred Khan to Paul Shanbrom, who was a member of BDO's Tax Solutions Group and reputedly an expert in foreign-currency trading, and in September 1999, Khan and one of his estate-planning advisors had a meeting with Collins and Shanbrom. The meeting went beyond the subject of simply purchasing the needed foreign currency. Shanbrom introduced Khan to an "investment strategy" involving the purchase and sale of digital options on foreign currency (the Digital Options Strategy), a strategy which, according to Shanbrom, not only gave Khan a chance to double his money but also allowed him to claim a tax loss if he happened to lose money on his investments in foreign currency. Shanbrom told Khan that BDO had designed the Digital Options Strategy in such a way that it had economic substance for tax purposes. It purportedly had economic

-4-

substance because Khan had a good chance of making a substantial return. According to the complaint, "Khan did not understand the intricacies of the investments, the tax code or the mechanism that allowed him to receive the tax benefits; however, he trusted BDO's expertise in this area and their representations." In other words, Khan had only a vague idea of what the 1999 Digital Options Strategy was all about. The "investment" part of the strategy involved the buying and selling of options in foreign currency. When someone buys an option, that person buys the right, but not the obligation, to buy or sell a given quantity of assets (in this case, foreign currency) at a fixed price, or "strike price," within a specified time, regardless of the market price, or "spot price," of the assets. (A "spot price" is the same thing as a "spot rate.") An option is "digital," or "binary," if the investor stands to win or lose a predetermined amount in full: in other words, the payout will be all of the predetermined amount or nothing (1 or 0, in binary terms). Essentially, a digital option is an all-or-nothing wager that the spot price will be at or above a given price on a certain date. Or it can be an all-or-nothing wager that the spot price will be at or below the given price on that date. If the investor is betting that the spot price will be at or above the given price on a certain date, the investor has a long option. On the other hand, if the investor is betting that the spot price will be at or below the given price on a certain date, the investor has a short option. Shanbrom recommended hiring David Parse of Deutsche Bank to assist Khan in acquiring these long and short options. Shanbrom arranged a conference call between himself, Parse, and Khan. In this conference call, Parse told Khan many of the same things

-5-

that Shanbrom had told him, including that the Digital Options Strategy was a good way to make money and, alternatively, a perfectly legal way to reduce taxable income. It was agreed that Deutsche Bank would handle the "investment" component of this strategy. Paragraph 63 of the complaint recounts the conference call as follows: "During this conference call, Parse, along with Shanbrom, reiterated the 'sales pitch' and reassured Khan that the Digital Options Strategy was completely legal. Parse, along with Shanbrom, further discussed the steps of the Digital Options Strategy and informed Khan that Deutsche Bank would handle all aspects of the investments in foreign currencies. According to Parse, Deutsch [sic] Bank had internal procedures to determine the proper amounts and types of the foreign currency investments that would be appropriate for Khan's circumstances. Parse told Khan that Parse would make all decisions with respect to the amounts and types of foreign currency investments since he was the expert. Parse again reiterated that Plaintiffs would have a good chance of making a profit on the foreign currency investments. Parse

represented to Khan that the foreign currency options that Khan would be executing were actual investments. Shanbrom and Parse never informed Khan that the foreign currency digital options were simply private bets with Deutsche Bank on

-6-

where the underlying currencies would be on a particular date and time and that Deutsche Bank controlled the outcome." According to the complaint, Deutsche Bank controlled the outcome in that, as the "calculation agent," Deutsche Bank had the contractual right to accept or disregard any spot price. Presumably, Deutsche Bank's role as calculation agent was stated in the form contracts between Deutsche Bank and Khan (who signed them in his capacity as partner or corporate officer of various plaintiffs). Khan, however, did not understand the import of this designation of Deutsche Bank as calculation agent. He did not understand that Deutsche Bank's performance under the so-called "contract" amounted to little more than setting the dice on the table with Deutsche Bank's winning number facing upward. Footnote 12 of the complaint says: "[T]he FX Contracts [(another name for the digital options contracts)] were not something traded on any recognized exchange but were simply a matter of private contract between the participants. Finally, neither party had any right to take possession of the 'underlying currency.' As a result, the FX Contracts amounted, in actuality, to a contractual wager (i.e., a 'bet') based on movements in foreign currency prices, without any real possibility of foreign currency ever changing hands between the parties. Of course, the Plaintiffs were unaware of these aspects of the FX Contracts." It would seem, then, that these transactions were not "investments" at all but

-7-

were merely rigged bets. Nevertheless, Parse referred to them as "investments." The complaint alleges that after the initial conference, Khan "had several additional telephone conversations with Parse in which Parse reiterated his prior statements and further discussed the purported 'investments.' " 2. The Legal Opinion From Jenkens on the 1999 Digital Options Strategy According to the complaint, the Deutsche defendants were in a conspiracy with BDO to deceive clients such as Khan into paying large fees for the Digital Options Strategy, a strategy that was useless for tax purposes--indeed, worse than useless because the losses it generated were clearly illegitimate and claiming them was likely to result in some expensive liability to the IRS. Part of this conspiracy was to refer clients to an "independent law firm," Jenkens & Gilchrist, P.C. (Jenkens), to confirm the legality of the 1999 Digital Options Strategy. But Jenkens really was not independent. Paragraph 70 of the complaint alleges as follows: "As part of their pre-planned conspiracy, the 1999 Strategy Defendants [(defined as BDO and the Deutsche defendants)] advised Plaintiffs that in the unlikely event the Internal Revenue Service ('the IRS') audited their tax returns as a result of the 1999 Digital Options Strategy, the Jenkens 'independent' opinion letter would confirm the propriety of the 1999 Digital Options Strategy and of claiming the resulting losses on Plaintiffs' tax returns. The 1999 Strategy Defendants and Jenkens--in furtherance of the conspiracy--further advised

-8-

Plaintiffs that this 'independent' opinion letter would enable the Plaintiffs to satisfy the IRS auditors as to the propriety of the tax returns. Unfortunately and unbeknownst to Plaintiff, Jenkens--with full knowledge of BDO and Deutsche--had already prepared the 'canned' and 'prefabricated' opinion letter approving the 1999 Digital Options Strategy and needed only to fill in several blanks prior to issuing the opinion letter to Plaintiffs." In short, Jenkens was one of the co-conspirators, and its role in the conspiracy was to be the yes-man, issuing reassuring opinion letters that were not the product of an honest and conscientious legal analysis. The legal opinions by Jenkens were not specifically tailored to the client's particular financial situation "but were merely 'fill in the blank' boilerplate opinions provided to Plaintiffs as part of a 'pre-wired' scheme." Nevertheless, Jenkens collected a substantial fee from clients for these legal opinions. "In addition, Jenkens & BDO were involved in fee 'kickbacks' between themselves and with third parties who convinced clients to execute an Investment Strategy with Jenkens, Deutsche Bank, BDO, and others." On Shanbrom's recommendation, Khan went to Jenkens, and on March 20, 2000, Jenkens issued to Khan an opinion letter confirming the legality of the 1999 Digital Options Strategy. Specifically, the letter opined that plaintiffs' " 'basis in their interest in the Partnership after contribution of the Options [would] include the cost of the Long Option contributed, without adjustment for the Short Option.' " (The significance of this

-9-

advice will soon be clear, when we explain how the 1999 Digital Options Strategy worked.) Jenkens further opined that " '[t]he step transaction, sham transaction, and economic substance doctrines [would] not apply to disallow the results of the transactions described herein.' " Further, according to Jenkens, IRS Notice 1999-59 (I.R.S. Notice 1999-59, 1999-2 C.B. 761), which warned against transactions lacking economic substance and having no apparent purpose other than to generate a fake capital loss, was simply " 'inapplicable to the transactions described here.' " 3. Wanser's Affidavit In support of their combined motion for dismissal, Deutsche Bank and Brown submitted to the trial court an affidavit by one of their attorneys, Michael R. Wanser, and attached to that affidavit, as exhibits A through C, were copies of the form contracts Khan had signed with Deutsche Bank and Brown implementing the digital option trades. Exhibit A of Wanser's affidavit is a foreign-exchange digital-option transaction confirmation, dated November 29, 1999, between Wilshire Investments, LLC, and Deutsche Bank, signed by representatives of both companies. Paragraph 3 of exhibit A disclaims an agency

relationship, a fiduciary relationship, and any reliance by the parties on advice or representations by the other party. The paragraph reads as follows: "3. Representations Each party represents to the other party that it is entering into this Transaction as principal (and not as agent or in any other capacity, fiduciary or otherwise) and that (i) It has sufficient knowledge and

- 10 -

experience to

be

able

to

evaluate

the

appropriateness, merits and risks of entering into this Transaction and is acting in reliance upon its own judgment or upon professional advice it has obtained independently of the other party as to the appropriateness, merits and risks of so doing, including where relevant, upon its own judgement [ sic] of the correct tax and accounting treatment of such Transaction; (ii) It is not relying upon the views or advice of the other party (including, without limitation, any marketing materials or model data) with respect to this Transaction; and (iii) It acknowledges that, with respect to this Transaction, the other party is acting solely in the capacity of an arm's length contractual counterparty and not in the capacity of financial adviser or fiduciary." It would appear that insomuch as Parse, as an agent of Deutsche Bank, advised Khan that he could make a profit on the transaction, Parse gave "advice *** with respect to this Transaction." It also would appear that insomuch as Parse advised Khan that in the event he lost money on the transaction, he could claim the loss in his tax returns,

- 11 -

Parse likewise gave "advice *** with respect to this Transaction." By signing exhibit A of Wanser's affidavit, Khan represented to Deutsche Bank that he was not relying on any such advice from Deutsche Bank (or its agent, Parse). 4. Implementation of the 1999 Digital Options Strategy The 1999 Digital Options Strategy worked as follows. The Khans entered into a private contract with Deutsche Bank whereby the Khans, through SRK Wilshire Investments (Wilshire Investments), bought from Deutsche Bank a long option on foreign currency and sold to Deutsche Bank a short option. Thus, there came into existence an opposing pair of options, one long and the other short. These options were designed to cancel each other out. The strike prices of the two options were only a fraction of a penny apart, and the premium that the Khans paid Deutsche Bank for the long option, though large, was almost entirely offset by the premium Deutsche Bank agreed to pay the Khans for the short option (almost but not quite: the Khans paid a net premium to Deutsche Bank of $350,000, the difference between the $35 million that the Khans paid for the long option and the $34,650,000 that Deutsche Bank agreed to pay them for the short option). Because the strike prices of the opposing options were so close together and because Deutsche Bank, as the calculation agent, had the right to select the applicable spot rate from a range of currency rates, it was a virtual certainty that the transaction would be close to a wash--Deutsche Bank would see to that. So, pursuant to this scheme that was calculated to be a wash on the investment side (and, as we will explain, a loss on the tax side), the Khans formed the necessary business entities and transferred assets between them, all under the guidance of

- 12 -

BDO. On November 17, 1999, the Khans formed Wilshire Investments and SRK Wilshire Partners (Wilshire Partners). On November 24, 1999, through Wilshire Investments, the Khans bought and sold the opposing options, which had expiration dates of December 23, 1999. On November 26, 1999, Wilshire Investments contributed its interest in the as of yet unexpired options to Wilshire Partners as a capital contribution. On December 10, 1999, Wilshire Partners purchased a quantity of Canadian dollars as an investment. On December 23, 1999, both the long option and the short option terminated "out of the money": the options became worthless, based on the spot rate that Deutsche Bank chose. Of course, both the Khans and Deutsche Bank got to keep the premiums they had paid each other, but Deutsche Bank's premium was $350,000 greater than the premium it had paid to the Khans (or Wilshire Investments). On December 27, 1999, the Khans

contributed their interest in Wilshire Partners to Wilshire Investments, causing the dissolution and liquidation of Wilshire Partners. As a distribution in liquidation of Wilshire Partners, all of the investments in foreign currency were distributed to Wilshire Investments. Consequently, for tax purposes, the Khans' interest in Wilshire Investments had a basis equal to the amount they had paid to Deutsche Bank for the long option, but that amount supposedly was not offset as a result of the assumption by Wilshire Investments of the Khans' obligation to Deutsche Bank on the short option, perhaps on the theory that the short option was only a contingent liability (see Stobie Creek Investments, LLC v. United States, 82 Fed. Cl. 636, 666 (2008)). In other words, the long option counted for purposes of the basis the Khans had in Wilshire Investments, but the short

- 13 -

option, which greatly reduced the economic significance of the long option, supposedly did not count. Upon the disposition of the Khans' partnership interest in Wilshire

Investments, the expensive long option had expired "out of the money" and had lost all its value, so the Khans claimed a tax loss equal to the premium they had paid for the long option, even though (because of the offsetting short option) they had not really incurred an economic loss in that amount. 5. The Preparation and Filing of Plaintiffs' 1999 Income Tax Returns After the publication of IRS Notice 1999-59 on December 27, 1999, which warned against transactions lacking economic substance and having no apparent purpose other than to generate a fake capital loss, BDO prepared and signed plaintiffs' 1999 federal and state income-tax returns. Specifically, on April 1, 2000, BDO signed the 1999 federal tax returns for Wilshire Investments and Wilshire Partners, and on April 1, 2000, BDO signed plaintiffs' 1999 federal individual tax returns. These tax returns contained the losses supposedly generated by the 1999 Digital Options Strategy. Advising plaintiffs that the tax returns were "properly prepared in accordance with professional standards," BDO recommended that plaintiffs add their signatures to the returns and file them with the IRS. Plaintiffs did so, relying on the representations and assurances that defendants had made to them during the promotion, sale, and implementation of the 1999 Digital Options Strategy and also relying on the opinion letter from Jenkens, which, Shanbrom had assured Khan, would provide "absolute penalty protection." The filing of these returns was the final step of the 1999 Digital Options Strategy. 6. The Publication of IRS Notice 2000-44

- 14 -

On August 11, 2000, before plaintiffs filed their 1999 individual federal tax returns, the IRS published IRS Notice 2000-44 (I.R.S. Notice 2000-44, 2000-2 C.B. 255), entitled "Tax Avoidance Using Artificially High Basis" and describing transactions similar to those described in IRS Notice 1999-59, transactions that " 'purport[ed] to generate tax losses for taxpayers.' " In fact, one of the examples that IRS Notice 2000-44 gave closely resembled the Digital Options Strategy: the taxpayer purchased call options and

simultaneously wrote (or sold) offsetting call options, transferred the option positions to a partnership, and claimed that the taxpayer's basis in the partnership interest was " 'increased by the cost of the purchased call options but [was] not reduced under [Internal Revenue Code]

Download Khan v. Seidman.pdf