T.C. M em o . 2 0 1 8 -1 0 1

UNITED STATES TAX COURT

GREGORY RAIFM AN AND SUSAN RAIFM AN, Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 3 8 9 7-1 4. Fi l edJ u l y 3 , 2 0 1 8.

Bri an G. Is aacs o n , fo r p et i t i on ers . Ai m ee R. Lo b o-Berg an dCat heri n e J . Cab al l ero , fo r res p o n d en t
.

M EM ORANDUM FINDINGS OF FACT AND OPINION NEGA, Jud g e: By n o t i ce o f d efi ci en cy d at edNo v em b er 2 1 , 2 01 3 , res p o n d en t d et erm i nedd efi ci en ci es i n th e Fed eral i n co m e t ax o f p et i t i o ners ,- 2
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[* 2 ] Greg o ry

an dSu s an Rai fm an , fo r t ax ab l e y ears 2 00 4 , 2 0 0 5, 2 0 06 , an d2 0 0 8 (y ears ati s s u e) an daccu racy -rel at edp en al ti es u n d er s ect i o n 6 6 6 2 as fo l l o ws : 1

Year Defi ci en cy Pen al t y s ec. 6 6 62 (a) 2 0 0 4 $ 8 4 9 ,0 2 9 $ 16 9 ,8 0 6 2 0 0 5 1 8 4 ,4 8 9 3 6,8 9 8 2 0 0 6 2 2 1 ,2 7 9 4 4,2 5 6 2 0 0 8 1 6,5 0 9 3 ,3 0 1 Th e Rai fm an s t i m el y

p et i t i on edth i s Co u rtfo r red et erm in at i o n . 2

1 Un l es s o t h erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de (Co d e) i n effect fo r t h e y ears ati s s u e. Al l Ru le referen ces are t o t h e Tax Co u rt Ru l es o f Pract ice an dPro cedu re. Al l m on et ary am ou n t s are ro u n dedt o th e n eares td o ll ar.

2 Th e Rai fm an s h av e a rel at edcas e b efo re t h i s Co u rt : Rai fm anv . Co m m i s s i o n er, d o ck etNo . 1 2 14 4 -1 1 L (CDP cas e). Th e CDP cas e res u lt s fro m res p o n d en t’ s at tem

ptt o co l l ectth e Rai fm an s ’ u npai dt ax fo r 2 0 0 3 . Th ere t h e Rai fm an s cl ai m eden t i tl em en tt o th eftl o ss d edu ct i o n s fo r 2 00 6 t hat , i f s u s t ai n ed , t h ey i nt en dt o carryb ack to 2 0 03 t o el i m i n at e t h ei r u np ai dt ax b al an ce. See, e.g ., s ec. 1 7 2(a), (b )(1 )(E), (d )(4 ). OnSep t em

b er 2 0 , 2 0 1 1 , res p on d en t fi l eda m o ti o n fo r s u m m ary ju d gm en t (m o t i o n ) i n th atcas e, arg u i n g, as rel ev an th ere, t h at t h e Rai fm an s ’ s al e o f s t o ck d i dn o t res u l ti n a d edu ct i b le t h eftl o s s. OnAu gu s t 7 , 2 0 1 2 , th i s Co u rtrel eas ed Rai fm anv . Co m

m i ss i o n er, T.C. M em o . 2 0 1 2 -2 2 8, wh erei n we d ecl i n ed t o g ran t res p o n d en t’ s m o t i o n an d h el d t h atd i s p u t edi s s u es o f m at eri al factn eces s i tat ed t ri al
. OnAp ri l 2 9 , 2 0 1 6, t he p art i es fi l eda jo i n ts t i p ul at io n t o b e b o un dwi t h res p ectt o t h e CDP cas e. In th e s t ip u l at i o n t o b e b o u ndth e p art i es ag reedth atth e o u t co m e o f t h e p res en t cas e wi l l res ol v e al l i s su es p res en tedi n the CDP cas e. (co n ti n u ed ...)- 3
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[* 3 ] Aft er co n ces si o ns an ds t i p u l at i o n s , 3 th e i s s ues rem ai n i n g fo r d eci s i o n are

2 (...co n t in u ed ) Acco rd in g ly , o n J u ne 2 0 , 2 01 6 , up o n due co n s i d erat i o n o f t h e p art i es ’ s t i p u l at i o n s , we o rd eredth atth e CDP cas e b e h el di n ab ey an ce p en d i n g the en t ry o f d eci s i o n i n t h e p res en tcas e.

3 Th e Rai fm an s h av e s t ip u l at edo r d i dn o tad dres s--at tri al o r o n b ri ef--a n u m b er o f ad ju st m en t s d et erm in edi n th e n o t i ce o f d efi ci en cy . Acco rd in g l y , th e Rai fm an s h av e, o r are d eem ed t o h av e, co n ced ed t he fo ll o wi n g i s s u es an d ad ju s t m en t s . See Ru l e 3 4 (b )(4 ); M en d es v . Co m m i ss i o n er, 1 2 1 T.C. 3 0 8 , 3 1 2 -3 13 (2 0 0 3); Leah y

v . Co m m is s i o n er, 8 7 T.C. 5 6 , 7 3 -7 4 (1 98 6 ). Fo r 2 0 0 4: a $ 4,9 7 0,7 4 3 i n creas e i n cap i t al g ai ns ; a $ 3 5 ,0 3 4 redu ct i o n i n a d educt i o n fo r m o rt g ag e i n t eres tcl ai m ed o n Sch edu l e A, It em i zedDeduct i o n s ; a $ 3 0 5 ,6 3 1 redu ct io n i n a cl ai m edd edu ct i o n fo r i n v es t m en t i n teres tcl ai m edo n Sch edu l e A; an dth e d en i al o f a d edu ct i o n o f $ 3 , 0 05 cl ai m edo n Sch edu l e F, Pro fi t o r Lo ss Fro m

Farm i n g . Fo r 2 0 0 5: a $ 51 ,7 49 redu ct io n i n a cl ai m edm o rt g ag e i n t eres td educt i o n an d a $ 5 9 3 ,7 8 4 redu ct i o n i n a cl ai m edi n v es t m en ti nt eres t d edu ct i o n . Fo r 2 0 0 6: a $ 66 4 ,3 8 4 redu ct i o n i n a cl ai m edi n ves t m en ti n t eres td edu ct i o n an d a $ 79 ,4 1 1 i n creas e t o i n co m e t o refl ectth e u n rep ort edrecei p to f a St at e t ax refu nd
. Fo r 2 0 0 8: v ari o u s co m

p u t at i o n al ad

ju s t m en t s . Th e Rai fm an s , h o wev er, d i dn otco n ced e t h ei r d i s p u t e wi t h res p ectt o th e s t atu to ry i n t eres td et erm in edi n th e n o t i ce o f d efi ci en cy . W e o b s erv e th atth i s Co u rt ’ s juri s d i ct i o n t o red et erm i n e a t ax d efi ci en cy d o es n o tp erm itth e Co u rtt o rev i ew o r ab at e s t atu t o ry

i n t eres tab sen tth e t ax p ay er fi rs tex h au s t i n g h i s o r h er o t h erwi s e av ai l ab le ad m in i s t rat i v e rem ed i es . Sec. 6 4 0 4 (h ); Ru l e 2 8 0 ; Bo u rek i s v . Co m m i s s i o n er, 1 1 0 T.C. 2 0 , 2 6 (1 9 9 8 ); cf. Ben n et tv . Co m m i s s i o n er, T.C. M em o . 2 0 1 7 -2 4 3 , at* 6-* 9. Th e Rai fm an s n ei t h er al l eg edrecei pto f, n o r en t eredi n t o ev i

d en ce, an y

fi nal d et erm i n at i o n wh erei n res p o n d en treject s t h ei r req ues tfo r ab at em en to f i n t eres t . Si m i l arl y , th e Rai fm an s n ei t h er al leg edn o r en t eredi n to ev i d en ce an y p ro o f th atth ey

h av e ev en fi l edfo r o r o t h erwi s e fo rm al l y req u es tedfro m res p o n d en t an ab at em en to f i n t eres t . Acco rd in g l y , we h o l dthatth i s Co u rt l ack s ju ri s d i ct i o n t o h ear t h e Rai fm an s ’ at t em p tt o s eeka red et erm i n at i o n o f i n t eres t u n d er s ec. 6 4 0 4 (h ). See Cart er v . Co m m i s s i o n er, T.C. M em o . 2 0 1 4 -1 4 2 , at* 5
.- 4
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[* 4 ] wh et h er t h e Rai fm an s are: (1 ) en ti t l edt o d edu ctth eftl o ss es t ot al i n g $ 1 0 ,7 9 8 ,0 6 1 fo r t h ei r 2 0 0 8 t ax y ear; 4 (2 ) en ti t l edt o a l o n g -t erm cap i t al l o s s d educt i o n o f $ 4 00 ,0 0 0 fo r t h ei r 2 0 0 8 5 t ax y ear; an d(3 ) l i ab le fo r th e s ect i o n 6 6 6 2 (a) accu racy -rel at edp en al t y fo r each o f th e y ears ati s s u e.

4 Th e n o ti ce o f d efi ci en cy d i s al lo wed a $ 1 5 ,1 60 ,6 0 7 t h eftl o s s d edu ct i o n fo r fo r t h e Rai fm an s ’ t ax y ear 2 00 8. In th ei r p et i t io n th e Rai fm an s rev i s edth ei r cl ai m edth eft l o s s es t o refl ectth e am ou n tab o v e. Th i s am o u n trem ai n i n g at i ss u e co m p ri ses a $ 3,7 5 0 ,0 0 0 l o s s ari s in g fro m

th ei r p art i ci p at i o n i n th e Deri v i u m p ro g ram ; a $ 2 , 4 7 5 ,0 0 0 l os s ari s i ng fro m th ei r p art ici p at i on i n th e Cl as s i cSt ar p ro g ram ; a $ 1 ,9 3 4,0 8 4 l o s s ari s i n g fro m t h ei r i n v es t m en t i n th e Real Retu rn Fu n d ; an da l os s o f $ 2 ,6 3 8 ,9 7 7 ari s in g fro m t h ei r i n v es t m en t i n th e Secu redLen d i n g Fu n d
.

5 Th e Rai fm an s i n i t i al l y

cl ai m edth i s $ 4 0 0 ,0 00 l o ss d edu ct i o n as a co m p o n en to f t h ei r $ 1 5 ,1 6 0 ,6 0 7 th eft l o ss d edu ct i o n cl ai m edfo r t ax y ear 2 0 0 8 . In t h e n o ti ce o f d efi ci en cy , res p o n d en td is al l o wedan y d edu ct i o n fo r t he fu l l am o u n t o f t h at t heft l o s s . Th e Rai fm an s n o warg ue t h i s $ 40 0 ,0 0 0 am o u nt was a p ro p erl y d educt i b l e cap it al l os s fo r t h ei r t ax y ear 2 0 0 9 . Th e Rai fm an s ’ 2 0 0 9 t ax y ear, h o wev er, i s n o tb efo re th e Co u rt . Ad d i t i o n al l y , we fi n d t h e reco rdl ack s fact s s u ffi ci en tt o en ab l e u s t o co n s id er t h e i m p l i cat i on s o f t h e Rai fm an s ’ 2 0 09 t ax y ear wi t h res p ect t o o u r red et erm i n at i o n o f t he d efi ci en ci es p ro p erl y b efo re t h i s Co u rt
. See Hi l l v . Co m

m i s s i o n er, 9 5 T.C. 4 3 7, 4 3 9-4 4 0 (1 99 0 ). Acco rd in g l y , o u r ju ri s d i ct i o n o v er t h is l o s s ex t en d s o n l y t o reach th e cl ai m

m ad e o n t h e Rai fm an s ’ 2 0 0 8 t ax retu rn . W e o b serv e t h atth e Rai fm an s h av e al s o cl ai m edth is l o s s d educt i o n i n a p aral l el refu nds u i t b ro u g h t b efo re t h e U.S. Co u rto f Fed eral Cl ai m s, wi th res p ect t o thei r t ax y ear 2 0 0 9 . OnM ay 1 5 , 2 0 1 4 , th e U.S. Co u rto f Fed eral Cl ai m s s t ay ed al l p ro ceed i n g s i n th atcas e u n ti l th i s Co u rt ren d ers a d eci s i on i n t h e p res en t m at t er.- 5
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[* 5 ] FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed an dare s o fo u n d. Th e s t ip u l at i o n o f fact s an dth e at t ach ed ex h i b i ts are i n co rp o rat ed h erei n b y th i s referen ce. Th e Rai fm an s 6 were m arri edan d res i d edi n Cal i fo rn i a atal l t i m es rel ev an tt o t h i s cas e. I. Th e Beg i n n i ng A. Back g ro u n d M r. Rai fm an i s a g radu at e o f t h e Un i vers i t y o f M i ch i g an an d t h e Geo rg et o wnUn i v ers i t y

Law Cen t er, wh ere h e earn eda b ach el o r o f art s d eg ree i n
eco n om i cs an dh i st o ry

an da ju ri s d o ct orat e, res p ect i v el y . M r. Rai fm an b eg an h i s p ro fes s i on al career as a ju d ici al l aw cl erks erv i n g th e U.S. Di s t ri ctCo u rtfo r t h e So u t hern Di st ri ct o f Geo rg i a. Fo l l owi n g h i s cl erk s h i p, M r. Rai fm an t o o k
s u cces s i v e p o s it i o n s atth e l aw fi rm s o f Lat h am an dW at k in s , an dSk ad d en , Arp s , M eag h er an dFl o m . Atth o s e fi rm s M r. Rai fm an g ai neds i g n i fi can tex p o s u re t o , an d p ract i cedi n , th e fi el d s o f h i g h -y i el dd eb tfi n an ci n g , “ h o s t i le t ak eo v ers ”, an d
co rp o rat e m erg ers an dacq ui si t i o n s . M r. Rai fm an d ev el o p eds k il l s i n thes e fi el d s,

6 Th e Rai fm an s en g ag edi n th e t ran s act i o n s d i s cu ss edh erei n b ot h p ers o n al l y an d b y way o f wh o l l y

o wn edp as s -th ro u gh en t i ti es , n o t ab ly Hel i co n Lt d
. (Hel i co n ), th ei r en t i t y

o rg an i zedi n th e Caym an Is l an ds , an d t h e Gek k o Gro up , LLC, o r Gek k o Ho l d i ng s, LLC (Gekk o ). Fo r cl ari t y we d i s t i n g u is h the i n d i v i du al Rai fm an s , Gekk o , an dHel i co n o n l y wh ere n eces s ary . W e o t h erwi s e refer t o al l as t h e Rai fm an s .- 6
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[* 6 ] an d i n du e t i m e h e p i v ot edh i s l eg al career t o fo cu s h i s wo rktherei n: fi rs tb y t ak i n g a p o s i t i o n as co un s el atM o n tg o m ery Secu ri t i es , wh ere h e s p eci al i zedi n faci li t at i n g i n i t i al an d seco n d ary p ub l i c o fferi n g s fo r h i s cl i en t s , an dl at er b y fo u n di n g h i s o wnl aw fi rm an dn u m ero u s v en tu re cap i t al i n v es t m en tan dad v i s o ry fi rm s p ri m ari l y

d ed icat ed t o i n v es t i n g i n co m p ut i n g an di n fo rm at i o n t ech n o l o g i es
an d t h e l eg al i s s u es ari si n g t h erefro m . It w as M r. Rai fm an ’ s wo rki n th e cap it al m ark et s an d t he t ech n o l og y fi el d t h atl edh i m

t o fo u n dM ed i ap l ex , In c. (M ed i ap lex ). M r. Rai fm an s erv edas p res i den t , CEO, an do ut s id e l eg al co u n s el o f M ed i ap l ex , an d i n each ro l e h e was
co m p en s at edb y

way o f s t o ckan do p ti o n s. M rs . Rai fm an g radu at edfro m Barn ardCo l leg e, wh ere s h e recei v ed a b ach el o r o f art s d eg ree i n En gl i s h . Sh e s ubs equ en t l y earn edm as t er’ s d eg rees i n b o t h b us i n es s ad m i ni s trat io n an du rb an p l an n i ng fro m th e Un i v ers it y

o f Cal i fo rn i a, Lo s An g el es . M rs . Rai fm an , l i k e h er h u s b an d , ex peri en ceds u cces s i n the
co rp o rat e wo rl d , wh ere s h e was an ex ecu t i v e i n m ark et i n g an dp ro m o t i o ns fo r a
n u m b er o f p ub li c co m

p an i es b efo re l at er t ak in g a s i m i l ar ro le atM ed i ap l ex . In th e fo u rt h quart er o f 1 9 9 9 M r. Rai fm ang u i d edM ed i ap l ex ’ s i ni t i al p ub l ic
o fferi n g. M ed i ap l ex s hares d eb u t edt o s i g n ifi can tm ark etd em an dan dwere ato n e p o i n tv al u edas h i g h as $ 1 0 4 p er s h are. Atth att i m e t h e Rai fm an s o wn ed ro u g h l y- 7
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[* 7 ] 4 6 .5 % o f M ed i ap l ex , an das a res u l t o f t h e m ark et ’ s v al u at io n o f M ed i ap l ex , t h e co up l e’ s weal th was s i g n i fi can tl y b ol s t ereddu ri n g t h ati n it i al o fferi n g p eri o d
. Th e Rai fm an s , h o wev er, were u n ab l e t o i m m ed i at el y cap i tal i ze o n M ed i ap l ex ’ s
s u cces s as th ei r h o l d in g s were res t ri ct edan dn o tread i l y m ark et ab le. Sh ort l y aft er M ed i ap l ex wen t p ub l i c, th e i n tern etan dt ech n o l o g y m ark et s tu m

b l ed , an das a
res u l t t h e p er-s h are v al u e o f M ed i ap l ex s t ockdro p p edb el o w a d o ll ar. In Oct o b er 2 0 01 Val u ecl i ck , In c., a co m p et i n g i n t ern etad v ert i s i n g fi rm , p u rch as edM ed i ap lex . As a res u l to f t h atp u rch as e, ap p ro x im at el y 2 m i l l i o n o f t h e Rai fm an s ’ M ed i ap l ex s h ares were co n v ert edt o i n t eres t s i n Val u ecl i ck
. Val u ecl i ck ret ai n ed M r. Rai fm an ’ s s erv i ces as a m em b er o f t h e Val u ecl ickb o ard o f d i rect o rs
an d , as p arto f h is co m

p en s at i o n fo r p erfo rm i n g i n th is ro l e, p ro v i d edh i m o v er 6 0 0 ,0 0 0 n o n qu al i fi edo p t i o n s fo r t h e p u rch as e o f Val u ecl icks t o ck
. By 2 0 0 3 th e co up l e’ s p ers o n al an dp ro fes s i o nal l i ves b eg an t o ev o lv e: M rs . Rai fm anh ad l eftth e wo rk fo rce, an dM r. Rai fm an h adres i gn edfro m h i s p o s i t i o n
o n th e Val u ecl i ckb o ard
. Int en d eri ng h i s res i g n at io n M r. Rai fm an ex erci s edh i s
n o n qu al i fi eds to cko p t i o n s , p u rch as i n g 6 68 ,3 6 3 s hares o f Val u ecl i cks t o ckat $ 1 .2 2 p er s h are. As th e m ark etp ri ce at thatt i m e was ro u g h l y $ 3 .4 3 p er s h are, t h e Rai fm an s real i zedo rd i n ary i n co m e o f $ 2.2 1 p er s h are, o r $ 1 , 4 7 6 ,4 8 0 t ot al
.- 8
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[* 8 ] M r. Rai fm an d i dn o tco n s u l twi t h an y p ro fes s i o n al ad v i s ers o r t ax p ro fes s i on al s b efo re ex erci s i ng h i s n o n qu al i fi ed o p t i o ns . B. Ob ject i v es Fo l l owi n g th e ex erci s e o f t h e Val u ecl i cko p t i o ns , th e Rai fm an s wi s h edt o
m an ag e t h ei r weal t h i n a s u s tai n ab l e m an n er th atwo u l d g en erat e an i n co m e s t ream
s u ffi ci en tt o s u s tai n th ei r t h en -cu rren tl i fes t y l e fo r t h e rem ai n d er o f t h ei r l iv es . To t h i s en d , th e Rai fm an s en vi s io nedth e as s em b l y o f a p o rt fo l i o th at wo u l d fu n ct i o n
as th ei r p ers o n al “ en d o wm en t ”, p ro v i d i n g them an n u al d i s p o sab l e i n co m e o f ap p ro x i m at el y $ 4 0 0,0 0 0 n eto f al l ex p en ses an dt ax es an dg en erat i n g 1 0 % an n ual g ro wth . Th e Rai fm an s were aware, h o wev er, o f t h e fact th atn earl y al l o f t h ei r weal t h was co ncen t rat edi n Val u ecl i cks t o ck . In fo rm ed b y th ei r earl i er ex p eri en ce wi t h M ed i ap l ex , th e Rai fm an s kn ew t h ata p ort fo l i o co m p o s edo f p o s i t i o ns
co n cen t rat ed i n a s i n g l e co m p an y p o s eda h azard t o o n e’ s weal t h an dth att o
m an ag e t h ei r weal t h i n a m an n er s uffi ci en tt o m eetthei r o b ject i v es th ei r i n v es t m en tp ort fo l io req u i redd i v ers i t y . Th e Rai fm an s b eg an t o seekh el p i n d ev el o p i ng th ei r co u rs e o f act i o n . In i t i al l y th ey

turn edt o fam i l y

fri en dan dn ei g h b o r St ev e Gl as er. M r. Gl as er was a fo rm er au d i t o r wh o was o p erat i n g a cat eri n g co m p an y wh i l e m o o nl i g h t in g as a fi nan ci al co n s ul t an t . M r. Gl as er i n fo rm edth e Rai fm an s th atth ey wo u l dn eedt o- 9
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[* 9 ] i n i t i al l y

fu n dth ei r “ en do wm en t ” wi th , at m i n i m u m , $ 1 0 m i ll i on . M r. Gl as er p o s s es s edn ei t her t h e m ean s n or wh erewi t h al t o d el i ver t hem t he s ub s t an ce o f t h ei r
o b ject i ves , b u tb el i ev ed h e kn ew s o m eo n e t h atd i d p o s s es s s u ch ab i l i t y an dm ean s : J o e Ram o s . Bo t h M r. Gl as er an d M r. Ram o s h ad p rev io u sl y wo rk edfo r Art h u r An d ers en , wh ere M r. Gl as er h ads up erv i sedM r. Ram o s ’ wo rkas an au d i t or. M r. Ram o s was a l icen s edcert i fi edp ub l i c acco u n t an t(C.P.A.) du ri ng h i s em p l o ym en t atArthu r An d ers en , b u tb y s u m m er 2 0 0 3 h i s career t raject o ry h adtu rn edt o ward t h e s ecu ri t i es b ro k erag e an d fi n an ci al p l an ni n g i n du s t ri es . Al t h o u g h M r. Ram o s h ad al l o wed h is C.P.A. l i cen ce t o l ap s e, h e was a cert i fi edfi nan ci al p l an n er an d
o p erat edh i s o wni nv es t m en tad v i s i n g fi rm : Ram o s Fi n an ci al d .b
. a. Pri vat e Cap it al M an ag em en t(Ram o s Fi n an ci al ). M r. Gl as er kn ew t h atM r. Ram o s ’ fi nan ci al p l an n i n g p ract i ce cat eredt o h i g h n etwo rt h i n di v i du al s an du s edu n i qu e
m ean s an dm eth o d s fo r m eet in g cl i en to b ject iv es . Fo r t h es e reas o n s M r. Gl as s er
reco m m en d edth atth e Rai fm an s m eetwi th M r. Ram o s. Wh i l e M r. Ram o s i n d ep en d en t l y o wn ed an d o p erat edRam o s Fi n an ci al , h e
was al s o a “ m an ag i n g d i rect o r”--an affi l i at e o r, fu n ct io n al l y , a fran ch i s ee--o f t h e Pri v at e Co n s u l t i n g Gro up (PCG). PCG was an i n v es t m en tad v i s ory an ds ecu ri t i es b ro k erag e fi rm

fo un d ed b y Ro b ertKey s i n t h e l at e n i n et i es . Ro b ertKey s d es i g n ed- 1 0 -

[* 1 0 ] PCG t o cat er t o th e i n t eres t s o f h i gh n etwo rt h i n d iv i du al s an dd id s o b y
o fferi n g, i n ad di t i o n t o s t an d ardb ro k erag e an dad v i s i n g s erv i ces , acces s t o d es i g n er o p p o rtu n i t i es fo r t h e em p o werm en to f o n e’ s “ t ru e weal t h ”. No t ab l y , PCG p ro vi d edi t s cl i en t s acces s t o n u m ero us o p p o rtu n i t i es th aten ab ledcl i en t s t o

“ redu ce, d efer, an di n s o m e cas es av o i d ” t ax an dt o tran s fo rm th es e t ax effi ci en ci es i n t o ad d i t i o n al s o urces o f i n co m e, weal t h , an dequ i t y . 7

7 To th i s en d , PCG o ffered a v ari et y o f t ax effi ci en cy s t rat eg i es each t ai l o red t o ad dres s th e s p ect ru m

o f i s s u es t h atPCG h ad fo un dt o ro u t i n el y cau s e cl i en t co n cern . Fo r t h e cl i en t i n t eres t edi n l iqu i d at i n g ap p reci at eds t o ck , PCG o ffered t ax -effi ci en tm et h o ds o f as s etm o n et i zat io n th atco u l dco n v ertth e cl i en t ’ s “ p ap er p ro fi ts ” t o cu rren cy . Fo r t h e cl i en tco n cern edwi t h ret i rem en t , PCG o ffered acces s t o a “ t ax -t o -eq u i t y

co n vers i o n” p l an d es i g n edt o reco v er t h e cl i en t ’ s i n co m e t ax p ai dfo r p ri o r y ears an dp lace t hatreco v eredt ax i n t o “ ex cl u s iv e v eh i cl es ” t o fu n d t h e cl i en t ’ s ret i rem en t . Fo r th e cl i en tco n cern ed ab o u tes t at e t ax an d as s et p ro t ect i o n , PCG o ffered acces s t o l ead ers i n t h e fi el do f es t ab li s hi n g o ffs ho re “ t ax -ad v an t ag ed ” v eh i cl es d es i g n edt o p ro t ectan i n d iv i du al ’ s weal t h fro m “ u n s crup u l o u s cred i t ors an dfri v o l o u s l aws u i t s” an dm i n i m i ze i f n o tel i m i n at e t ax . Sh o u l dth es e s t rat eg i es ap p ear s u s p ectt o s kep ti cal p o t en t i al cl i en t s , PCG o ffered co m fo rt , n o t i n g t h at“ m an y ” o f i ts tru e weal t h s trat eg i es h adrecei v eda “ s h o u l d ” o r “ m o re l i kel y

th an no t ” t ax o p in i o n fro m a “ m ajo r” acco u n t i n g fi rm o r l aw fi rm . Ad d i t io n al l y , PCG b o as t edth atth e “ weal t h d es i gn ” p ro fes s i o n al s i n i t s affi l i at edn et wo rk --ad v i s ers , l awy ers , an d acco u nt an t s--were i n t i m at el y fam i l i ar wi t h s u cces s fu l l y

i m p l em en t i n g PCG’ s tru e weal th s t rat eg i es , an dwo u l db e atth e i m m ed i at e d i s po s al o f PCG, i t s fran ch i s ees , an dth ei r cl i en t s as n eces s ary .- 1 1 -

[* 1 1 ] C. M r. Ram o s an dHi s Pl an s

1
. Th e Deri v i u m

Pro g ram Befo re m eet i n g th e Rai fm an s , M r. Ram os h adb een b ri efedb y M r. Gl as er wi t h res p ect t o th e Rai fm an s ’ o b ject i v es . Acco rd i n g l y , M r. Ram o s p rep areda
cu s t o m izedp res en t at i o n i den t i fy i n g th e s t rat eg i es h e b el i ev edb es t s ui t edt o p ro v id e t h e d es i redres u l t s . InJ u l y 2 0 0 3 M r. Ram o s , arm edwi t h th i s p res en t at i o n
an d h i s PCG-affi l iat e m ark et in g m at eri al s, m etwi t h t h e Rai fm an s an dp it ch edt o t h em a v ari et y o f p ro p o s al s an di n v es t i n g s t rat eg ies th at ran g edfro m th e
co n serv at i ve t o t h e n o n t rad it io n al
. M r. Ram o s rev i ewedeach p ro po s al i n d et ai l wi t h M r. Rai fm an an dM r. Gl as er, an dth e t h ree co l l ab o rat ed i n wei g hi n g t h e ri s ks
an d reward s o f each p ro p o s ed s t rat eg y . Of th es e Ram o s p ro p o s al s , M r. Rai fm an
was p art i cu l arl y

i nt ri gu edb y

a n o nt rad i t i o nal “ l o an ”-b as eds t rat eg y p ro p o s edb y M r. Ram os : th e 9 0 % s t o ck“ l o an ” p ro gram (Deri vi u m 8 p ro g ram ). M r. Ram o s was i n t ro du cedt o th e Deri v i u m p ro g ram th ro u gh h i s affi l i at i o n wi t h PCG. Deri v iu m

was o n e o f PCG’ s s trat eg i c al l i an ce p art n ers , an d

8 Deri v i u m

Cap i tal , LLC, Deri v i u m

USA, Ban cro ftVen tu res , W i t co Serv i ces , Lt d ., an dOp t ech , Lt d ., were en t it i es d i rect l y rel at edt o Ch arl es Cat h cart an d were t h e b ran d n am es u n d er wh i ch M r. Cat h cart p ed d l ed t h e 9 0 % s t ockl o an p ro g ram . See Gray s on Co n s u lt i n g , In c. v . W ach ov i a Sec., LLC (In re Deri v i u m Cap it al , LLC), 7 1 6 F.3 d 3 5 5 , 3 5 9 (4 t h Ci r. 2 0 1 3 ); Gen eral Ho l d in g , In c. v . Cat h cart , 2 0 0 9 U.S. Di s t . LEXIS 1 3 0 7 77 , at* 1 2-* 1 4 (D.S.C. J u ly 2 9 , 2 0 09 ). Fo r cl ari t y we refer t o al l as Deri vi u m .- 1 2 -

[* 1 2 ] i m p l em en t i n g th e Deri vi u m p ro g ram ’ s as s etm o net i zat io n s t rat eg y was i n t eg ral t o effect i n g a t ax -effi ci en t, tru e weal t h o p t i m i zat io n p l an fo r PCG’ s cl i en ts
. Th e Deri v i u m p ro g ram

was t ai lo redt o w ardi n d i vi du al s , s u ch as th e Rai fm an s , wh o h el d co n cen t rat edp o s i t io n s i n a s in g l e m ark et ab l e s t o ck an d wi s h edt o g en erat e l i qu i d i t y wi t h o uttri g geri n g a t ax ab l e ev en t. Th e Deri v i u m p ro g ram faci li t at ed t h i s m o n et i zat i o n o f s t o ck b y “ l en d i ng ” p ro g ram

p art i ci p an t s
up t o 9 0 % o f th ei r s t o ck ’ s fai r m ark etv al u e. In retu rnp art ici p an t s wo ul d
s u rren d er t o Deri vi um

th e o s t en s i b l y

l ev erag eds t o ckas “ co l l at eral ” an d wo u l d
accru e i n t eres to n th e l o an p ri n ci p al o v er th e l i fe o f t h e l oan . 9 Part i ci p an t s were p ro h ib i t edfro m

m ak in g an y

p aym en t s b efo re l o an m atu ri ty an d , s im il arl y , Deri v i u m was p ro h i b i t edfro m cal l i n g th e l oan b efo re m atu ri t y . M o s ti m p o rt an t l y , t h e l o an s were n o n reco u rs e t o t h e p art i ci p an t
. Becau s e a Deri v i u m

l o an was n o nreco u rs e, a p art i ci p an th ad n o p ers o n al l i ab i l i t y fo r p ri n ci p al o r i n t eres tan dco u ldi n s t eadch o o s e--fo r ex am p l e, s h o u l dth e

9 Acco rd i n g l y , th e t erm s o f t h e p ro g ram ag reem en tp ro vi dedDeri v i u m th e u n fet t eredri gh tan dp o wer t o “ as s i g n , tran s fer, p led g e, rep l ed g e, h y p ot h ecat e, reh y p o t h ecat e, l en d , en cu m

b er, s h o rts el l , an d/o r s el l o u t ri gh t s om e o r al l o f” t h e co l l at eral du ri ng th e l o an t erm . To th e ex t en trel ev an t , the reco rdb efo re u s es t ab li s hes th atDeri vi u m ’ s h ed gi n g s t rat eg y

co n s i st edo f i n v es t i n g i n s t artup s fo un d edo r ru n b y i n d i v i du al s rel at ed t o the p ri n ci p al s o f Deri v i u m . Th es e s t artup s ev en tu al ly fai l ed
.- 1 3 -

[* 1 3 ] v al u e o f t h e p art ici p an t’ s s t o ckdro p o v er t he ag reem en t ’ s t erm --t o d efau l t
an d ced e t h e co ll at eral t o Deri v i u m . Al t ern at i v el y , up o n m aturi t y o f t h e l oan , p art i ci p an t s co ul dp ay

th ei r b al an ce du e an dreq u es t retu rn o f t h ei r co l l at eral , o r
ren ew an drefi n an ce t h e l o an fo r an ad di t i o n al t erm i n o rd er t o m o n et i ze an y ap p reci at i o n o f t h e co l l at eral th ato ccu rreddu ri ng th e i n i t ial l o ant erm . (W e wi l l refer co l l ect i v el y

t o th es e t hree ch o i ces as th e al t ern at iv es t o p aym en t .) M r. Rai fm an an d M r. Gl as er reco g ni zedth atth e Deri v i u m p ro g ram feat u red
an i n h eren tri s k , s p eci fi cal l y , th e s u st ai n ab i l i t y o f i t s o p erat io n s an d i t s ab i l i t y t o p erfo rm o n i t s p o t en t i al o bl i g at i o n s rel at edt o t h e Rai fm an s ’ al t ern at i v es t o p aym en t
. M r. Ram os ex p l ai n edth ath e, t o o , was i n it i al l y s k ep t ical wi t h res p ectt o Deri v i u m ’ s p ro p ri et ary

h ed g i n g “ s t rat eg y ” an dread i l y ad m i t t edh e was n o tp ri v y t o an y s p eci fi c d et ai l s o r m ech an i cs o f Deri v i u m ’ s p ro p ri et ary h ed g i n g s t rat eg y , b u th e n ot edth at , al l s us t ai n ab i l i t y ri s ks co ns i d ered , th e p res en tv al ue o f t he t ax
s av i n g s an drat e arb i t rag e 1 0 p ro m i s edb y th e Deri v iu m

p ro g ram fu n ct io n al l y el i m i n at edth e Rai fm an s ’ ex p o s u re t o ri s k.

1 0 Th ati s , th es e p res u m ab l y t ax -free l o an p ro ceed s wo u l den ab l e t h e Rai fm an s t o cu rren t l y

m o n et i ze 9 0 cen t s o n the fai r m ark etv al u e d o ll ar o f th ei r Val u ecl i ck s to ck , far b et t er t han th e es t i m at ed7 5 cen t s o f t h e s am e res u l t i n g fro m a m ark ets al e.- 1 4 -

[* 1 4 ] Al t h ou g h the Rai fm an s ch o s e t o i m p l em en t a d i v ers e s eto f s t rat eg i es t o ach i ev e t h ei r o b

j ect i v es , they

u l t i m at el y

al s o ch o s e t o p art i ci p at e i n a s eri es o f Deri v i u m tran s act i o n s i n o rd er t o ju m p-s t artth ei r p lan n i n g . Befo re en g ag i n g i n t h ei r fi rs tDeri v i u m tran sact i o n , th e Rai fm an s d irect ed M r. Ram os an dM r. Gl as er t o m eetan es t at e p l an n in g at t o rn ey an dC.P.A. wi t h wh o m th e Rai fm an s h ad p rev i o u s l y wo rk ed , t o s o li ci t h i s o p in i o n wi th res p ectt o th e cl ai m edt ax b en efi t s o f t h e Deri v i u m p ro g ram . 1 1 Th e at t o rn ey d ecl i n edt o p ro v id e t h em

wi t h h i s ap p ro v al o f t h e Deri v iu m tran s act i o n ’ s p u rp o rt edt ax ch aract eri zat i o n b u ts k ep t i cal l y reco m m en dedth at , s h ou l dth e Rai fm an s ch o o s e t o p art i ci p at e i n t h e Deri v i u m p ro g ram , th ey l i m i tth e ex t en t o f th ei r p art i ci p at i o n an d
ex ecu t e t h es e tran s act i on s i n a p i ecem eal fas h i o n . Th e Rai fm an s s ou g h tn o fu rt h er l eg al o r t ax ad v ice wi t h res p ectt o t h e Deri v i u m p ro g ram an dn ev er m eto r o t h erwi s e en g ag edwi t h an y ag en t , rep res en t at i v e, o r o t h er em pl o y ee o f Deri v i u m . In Au g u s t 2 0 0 3 , ro u g h ly

a m o n t h aft er fi rs t m eet i n g M r. Ram o s an dh eari n g h i s i n i ti al p i t ch , th e Rai fm an s d eci d edt o g o fo rwardwi t h t h ei r fi rs t Deri v i u m

1 1 Th e reco rdap p ears t o in d i cat e t h atth i s at t o rn ey was Arn o l dZi p p el , wh o m t h e Rai fm an s h adp rev io u s l y en g ag edi n o rd er t o es t ab li s h a t ru st . Th e reco rd co n tai n s n o fu rt her fact s wi t h res p ectt o t h e Rai fm an s ’ rel at i o ns h ip wi t h M r. Zi p p el
.- 1 5 -

[* 1 5 ] tran s act i on an dtran s ferred 1 5 9 ,0 0 0 s h ares o f Val u ecl i cki n ex ch an g e fo r $ 1 ,2 6 0 ,3 3 6 , an am o u n t rep res en t i n g 9 0 % o f t h ats t o ck ’ s fai r m ark etv al u e. OnSep t em

b er 4 , 2 00 3 , th e Rai fm an s fo rm al l y ret ai n edM r. Ram o s as th ei r i n v es t m en tad v i s er. Lat er t h atm o n t h t h e Rai fm an s en gag edi n thei r s eco n d Deri v i u m tran s act i o n , th i s t i m e ex ch an g in g 1 6 1 ,0 0 0 s hares o f Val uecl i ckfo r $ 1 ,3 6 2 ,8 0 4 , an am o u n t rep res en t i n g 9 0 % o f t h e s t o ck ’ s fai r m ark etv al u e. In J u l y 2 0 0 4 t h e Rai fm an s en t eredi n t o a t h irdDeri v i u m tran s act io n b y t ran s ferri n g 3 0 0 ,0 0 0 s h ares o f Val u ecl icki n ex ch an g e fo r $ 2 , 8 1 0 ,4 7 6 , an am o u n t rep res en t i n g 8 6 % o f t hats t o ck ’ s fai r m ark etv al u e. 1 2 In No v em

b er 2 0 0 4 t h e Rai fm an s en g ag ed i n thei r fi n al Deri vi u m t ran s act io n , thi s t i m e ex ch an gi n g 2 0 0 ,0 0 0 s hares o f Val u ecl i ck fo r $ 2 ,1 6 0,2 6 7
.

1 2 Th e Rai fm an s ex ecu tedth i s Deri v i u m t ran s act i o n th ro u g h th ei r wh o l l y o wn edCaym an Is l an d s en t i t y , Hel i co n . Th i s Deri v i um tran s act i o n was p arto f an o ffs h o re t ax -ad van t ag ed as s etp ro t ect io n p lan arran g edth ro u gh M r. Ram o s b y Ti m Scran t o m , a PCG-affi l i at ed weal t h -d es ig n p ro fes s i o n al an dat t o rn ey . Th e Rai fm an s o rg an i zedHel i co n an d co n t ri b u t edt o t h aten t it y 3 00 ,0 0 0 s h ares o f Val u ecl i ck s to ck . Th e Rai fm an s th en cau s edHel i co n t o en g ag e i n a Deri v i u m tran s act i o n an dro u t e t h e p ro ceed s o f t h attran s act i o n t o a d o m es t i c en t i t y , Kh ro n o s Cap i t al , In c. (Kh ro n o s ). Kh ro n o s then l en tth e Rai fm an s $ 2 ,7 9 5 ,0 0 0 ; i n ex ch an ge, t o s ecu re t h i s l o an , th e Rai fm an s p ro v id edKh ro n o s a d eed of t ru sto ver t h ei r h o m e. Th e Rai fm an s s ub s equ en t l y ro u t edth i s m o ney

b ack t o Hel i co n , al o n g wi th t h e p ro ceed s o f a m o re co n v en t i o nal h o m e eq ui ty l o an p ro v id edb y

W el l s Farg o .- 1 6 -

[* 1 6 ] 2
. Th e Cl as s i cSt ar Pro g ram Du ri n g h i s i n i t i al J u l y

m eet i n g s wi t h th e Rai fm an s , M r. Ram o s u n d ert o o ka
rev i ew o f th e Rai fm an s ’ 2 0 0 3 t ax i t em s an dth e i n co m e t ax retu rn s t h ey h adfi l ed fo r y ears p as t . Fro m

thi s rev i ew M r. Ram o s as cert ai n ed t hatth e ex erci s e o f M r. Rai fm an ’ s n o n qual i fi edVal u ecl i cko p t io n s ex p o s edth e Rai fm an s t o a p ot en t i al $ 4 0 5 ,6 7 0 i n co m e t ax l i ab il i t y fo r t h e 2 0 0 3 t ax y ear. Hi s d i s co veryo f t h i s p o t en t i al l i ab i l i t y ledM r. Ram o s t o p ro p o s e t h atth e Rai fm an s ex p l o re p o t en t i al

“ t ax -t o -eq u i t y ” s t rat eg i es th atm i g h ten ab le t h em t o d efer reco g n it i on o f t h i s
o rd i n ary i n co m e an d al l o w th em

t o recap tu re i n co m e t ax p ai dfo r y ears p as t
. M r. Ram o s b eg an t o i n t ro du ce t h e Rai fm an s t o a s eri es o f h i s fav o redt ax t o -eq u i t y s t rat eg i es , n ot ab l y

th e Cl as s i cSt ar m are l eas i n g p ro g ram . Th e Cl as s i cSt ar p ro gram

o ffered i n d i v i du al s an o p po rtu n i ty t o en ter t h e t h o ro u gh b red h o rs e b reed i ng an draci n g b u si n es s es b y en ab l i n g t h em

t o l eas e t h e rep ro du ct i v e cap aci t y o f Cl as s i cSt ar’ s m ares fo r t h e du rat i o n o f a t h oro u g h b redb reed i n g
s eas o n . Duri n g t h e t erm

o f t h e l eas e Cl as s i cSt ar wo ul dm at e t h es e l eas edm ares , an d an y res u l t i n g fo al s wo u l d beco m e th e p ro p ert y o f t h e p art ici p at in g l es see. Al t h ou g h Cl as si cSt ar d i s cl ai m edth e n o t i o n thatp as tres u l t s were i n d i cat i v e
o r a g u aran t y

o f fu tu re p erfo rm an ce, i t s p ro m o t i o n al m at eri al s b o as t edth atth e s al e
o f an y res u l t i n g fo al ty

p i cal l y y i el d edp art i ci p an t s a s i g n i fi can tretu rn o n t h ei r- 1 7 -

[* 1 7 ] i n v es t m en t . Bu tm o re i m p o rt an tth an t h o s e ret u rn s were t h e o s t en s ib l e t ax b en efi t s Cl as s icSt ar cl ai m edwo u l dres u l tfro m p art i ci p at i on i n i t s p ro g ram . No t ab l y , Cl as s icSt ar p ro m o t edi t s l eas e fees as a fu l l y d edu ct ib l e farm

b u si n es s
ex p en s e t h atco u l ds h i el d cu rren t -y ear i n co m e fro m t ax at i o n an d , s ho u ldth at d educt i o n ex ceed the p art i ci p an t ’ s cu rren t -y ear i n co m e, co ul db e carri edb ackt o
reco v er t ax p ai dfo r p ri o r y ears . Cl as s i cSt ar n o t edth atthi s s h iel d in g o f o rd i n ary i n co m e i n th e cu rren ty ear p ro v i d eda fu ture t ax b en efi tt o p art ici p an t s up o n th e
s al e o f an y

res u lt i n g fo al s , as th o se g ai n s real i zedwo u l db e t ax ed o nl y at t he p referen t i al cap it al g ai ns rat e. As an al tern at i v e, Cl as si cSt ar al s o o ffered p art i ci p an t s th e o p p o rtu ni t y t o p erp etu al l y d efer t ax b y way o f l ik e-k i n d
ex ch an g es . Cl as si cSt ar p art i ci p an t s were g i v en a “ Du e Di l i g en ce” b o o k l et t h atp ro v i d ed t h em wi th g ui d an ce fo r d raft i n g b u s i n es s p l an s an dp art i ci pat i o n l o g s an d
co n tai n eda DVD an da s eto f t ax o p i n i o ns fro m acco u n ti n g fi rm

Karren , Hen dri x & As s o ci at es , P.C. (Karren ), an dl aw fi rm Han d ler, Th ay er & Du g g an , LLC (Han d l er), each ex p l ai ni n g th e t ax b en efi t s o f th e p ro g ram . Ho wev er, b o t h Cl as s i cSt ar’ s m ark et i n g m at eri al s an dth e du e d i l i g en ce b o o k l eten co urag edal l p art i ci p an t s t o s eeki nd ep en d en tt ax ad v i ce wi t h res p ectt o th e b en efi t s thatm i g h t ari s e fro m

p art i ci pat i o n i n th e Cl as s i cSt ar p ro g ram .- 1 8 -

[* 1 8 ] M r. Ram o s cal cu lat edth ati f t h e Rai fm an s p u rch as ed$ 3
. 4 m i ll i o n o f m are l eas es , then th ey

co u ldco m

p let el y o ffs etth e en t i re t ax l iab i l i ty ari s i n g fro m

M r. Rai fm an ’ s o p t i o n ex erci se an dal s o recap tu re ap pro x i m at el y $ 7 0 0 ,0 0 0 o f i nco m e t ax th ey h adp ai d fo r p ri o r y ears . M r. Ram o s ex pl ai n ed t o th e Rai fm an s h i s b el i ef t h atth e o n l y

ri s k p o sed , i n th i s res p ect , was i n es t ab l i s h i n g t h atth e Rai fm an s ’ p art i ci p at i o n i n th e p ro g ram co n s t i tu teda b on a fi d e b u s i n es s v en tu re. 1 3 M r. Ram o s p ro v i d edth e Rai fm an s a co py o f t h e du e d i l i g en ce b o ok l etfo r t hei r rev i ew. Th e Rai fm an s rev i ewedth es e m at eri al s an dd eci d edt o p art i ci p at e i n th e Cl as s i cSt ar p ro gram . OnNo vem

b er 2 4, 2 0 0 3 , th e Rai fm an s ex ecu teda l et t er o f u n d ers t an d i n g wi t h Cl as s i cSt ar. In t h e week s th atfo l l o w edth ey p ai dCl as s i cSt ar $ 3 .4 m i l l i o n t o p art i ci p at e i n t h e p ro g ram . 1 4 OnJ an u ary 2 , 2 0 0 4 , Cl as s i cSt ar p ro v i dedth e

1 3 M r. Ram os recei v eda co m m i ss i o n fro m Cl as s i cSt ar fo r p l aci n g cl ien t s wi t h th e p ro g ram . M r. Rai fm an was aware o f t hi s fact . M r. Rai fm an d i s cu s s edth e p o s s i b i l i ty

o f referri ng p o t en t i al cl i en t s t o M r. Ram o s fo r t h e p u rp o se o f p l aci n g t h em wi th Cl as s i cSt ar an ds p l i tt i n g an y co m m i s s i o n s ari s i n g th erefro m . 1 4 Fro m Decem b er 1 5 -1 9 , ro u g h l y

th ree week s aft er s i g n in g t h e l et t er o f u n d ers t an d i n g fo rm al i zi ng th ei r p art i ci p at i o n i n th e Cl as s icSt ar p ro gram , M rs . Rai fm anat t en d eda Cl as s i cSt ar s em i nar i n St
. Cro i x wh ere t h e t op i c o f d i s cu s s i o n was p ri m ari l y

th e t ax i m

p li cat i o n s o f h av i n g a h o rs e b reed i n g b u s in es s . M rs . Rai fm an ’ s co n t em

p o ran eo u s n o t es fro m

thes e s em i n ars s u g g es tth e s em i n ar’ s p red o m i n an tt o p i c was h o w t o g en erat e m at eri al p art i ci p at i on i n o rd er t o en s u re t h e p res erv at i o n o f a t ax d edu ct i o n fo r t h e cu rren t y ear. (co n ti n u ed ...)- 1 9 -

[* 1 9 ] Rai fm an s wi t h thei r m are l eas i n g ag reem en t s an da b reed i n g s ch edu l e, al l b ack dat edt o refl ectex ecu t i o n o n Decem b er 3 1 , 2 0 03 . Th e Rai fm an s ’ l eas es b eg anret ro act iv e t o Decem b er 1 , 2 0 0 3 , an d wo u l dex p i re J u l y 1 , 2 0 0 4 , an d p ro ject edth atan y res u lt i n g fo al s wo u l d b e d el i v eredi n s p ri n g 2 0 0 5
. Th e Rai fm an s ’ l eas es ex p l i ci t l y warn ed t h atth e l es s ees (i .e., th e Rai fm an s ) b o re al l
eco n om i c ri s ko f l o s s s h o ul dthei r l eas es fai l t o res u l ti n a fo al an dth atb y en t eri n g i n t o th i s l eas i n g ag reem en tth e l es s ees rep res en t edth atthey h adev al u at edan d fu l l y ackno wl ed g e t h e s ubs t an ti al fi n an ci al ri s ki n h eren tt o p art i ci p at i o n i n th e
m are l eas i n g p ro g ram . Befo re en g ag i n g i n th e p ro g ram the Rai fm an s n ev er m et , o r o t h erwi s e d i s cu s sed t h e p ro g ram wi t h , an y Cl as s i cSt ar em

pl o y ee, ag en t , o r
o t h er rep res en tat i v e, n o r d i dth ey s eekl eg al o r t ax co u n s el wi t h res p ectt o th ei r p art i ci p at i o n th erei n . Du ri n g th e fi rs tqu art er o f 2 0 0 4 M r. Ram os u rg ed t he Rai fm an s t o s ecu re a p ers o n al i zedt ax o p in i o n wi t h res p ectt o th ei r p art i ci p at i on i n Cl as s i cSt ar, an dth e

1 4 (...co n t i nu ed ) Up o n h er ret u rn , th e Rai fm an s as s em b ledth ei r p art i ci p at i o n l o g fo r 2 0 0 3 . It rep o rt edth atth ey en g ag edi n 1 3 9 h o u rs o f act i v it y wi t h res p ectt o th ei r p art i ci p at i o n i n th e Cl as si cSt ar p ro g ram . A t ot al o f 6 2 h o u rs was at t ri bu t edt o p rep art i ci p at i o n d i l i g en ce wo rk (e.g ., v is i ti n g l o cal Cal i fo rn i a farm s an drev i ewi n g t h e du e d i l i g en ce b o o k l et ). A t o t al o f 2 4 h o u rs was at t ri bu t ed t o read i ng “ Bl o o d Ho rs e” m ag azi n e. A t o t al o f 3 9 h o u rs was at t ri bu t edt o M rs . Rai fm an ’ s at t en d en ce atthe St . Cro i x s em i n ar. A t o tal o f 1 4 h o u rs was at t ri b u t ed t o th e co up le’ s v i ewi n g o f s i x o n l i n e h o rs e b reed i n g p res en tat i o n s o n Decem b er 3 0 an d3 1 , 2 0 0 3
.- 2 0 -

[* 2 0 ] Rai fm an s d i rect ed M r. Ram o s t o d o s o . M r. Ram os d i ds o b y co n t act i n g Han dl er, t h e l aw fi rm

th ath adp ro v i d edth e g en eri c t ax o p i n i o n i n cl u d edi n th e Cl as s i cSt ar du e d i l ig en ce b i n d er. OnM arch 2 4 , 2 0 0 4 , Han d l er p ro v i d edth e Rai fm an s wi t h a g en eri c t ax op i n i o n , n earl y i d en t i cal t o t h e o n e i n t he Cl as s i cSt ar du e d i li g en ce b i n d er. Th i s t ax o p i n i o n o p en edwi t h an en g ag em en tl et t er d i s cl os i n g t o th e Rai fm an s Han d l er’ s co nfl i ct s o f i n t eres t , n o tab l y th atHan d l er
s erv edas g en eral co u n s el t o Cl as s i cSt ar an d t h atCl as s icSt ar h ad p ai dfo r t h e p ro duct i o n o f t h i s “p ers o n al i zed ” t ax o p i n i o n. By J u l y 2 0 0 4 o n l y

two o f t h e Rai fm an s ’ l eas ed m ares h adb eco m e p reg n an t , an d t h ei r l eas eh o l d o n th ei r rem ai n i ng m ares h adex p i red
. 1 5 In J an uary2 0 0 5 rep res en t at i v es o f Cl as s i cSt ar co n t act edM r. Rai fm an t o p ro p os e a t rad e: Th e Rai fm an s wo u l dex ch an ge t h ei r cl ai m t o th e two i n u t ero

1 5 In No vem

ber 2 0 0 4, m on t h s aft er t h e Rai fm an s ’ m are l eas es h adex p i red , Cl as s i cSt ar i s s uedthe Rai fm an s a rev i s eds ch edu l e o f t h ei r m are b reed i n g p ai rs . Th e rev i s eds ch edu l e redu cedth e n u m ber o f l eas es th atth e Rai fm an s h ad p u rp ort ed l y

h el dan drev i s edth e i d en t i t i es o f t h e b reed i n g p ai rs as s oci at edwi t h t h e Rai fm an s ’ fai l edm are l eas es . Th e rev i s eds ch edu l e al s o ad ju s t edth e l eas e an d b reed i n g co s t s fo r t h e Rai fm an s ’ two p reg n an t m ares . Th e rev i s eds ch edu l e d i d n o tex ten dan y

l eas in g p eri o d s . Th e reco rdd o es n o t ad equ at el y rev eal wh atp reci p i tat ed t h i s rev i si o n . Nei t h er d o es i t ex p l ai n h o wth i s rev i s eds ch edu l e m i g h th av e o t h erwi s e al t eredth e Rai fm an s ’ ri g h t s as l es s ees as , ag ai n , atth e t i m e o f m od i fi cat i o n the Rai fm an s ’ l eas es h adex p i red . W e o b serv e t h atth i s rev i s i o n o ccu rred , ro u g h l y , atth e s am e t i m e t h e Rai fm an s fi n al izedan dfi l ed t h ei r 2 0 0 3 t ax retu rn i n No v em b er 2 00 4
.- 2 1 -

[* 2 1 ] fo al s , as wel l as t h ei r o t h er ex p ired , u n fru it fu l l eas es , fo r t he ri g h t s t o 2 5 qu art er h o rs e p ai rs t o b e b redi n s p ri n g 2 0 05 , wi t h res u l t i n g fo al d el i v ery p ro ject ed fo r s p ri n g 2 0 06 . Ad d it i on al l y , Cl as s i cSt ar o ffered t o m ak e i n cen t iv e p aym en t s t o t h e Rai fm an s an dp ro v id e t hem an o p t i o n t o “p u t ” al l res u l t i n g fo al s t o Cl as s i cSt ar ata g u aran t eedp ri ce o f $ 4 ,0 8 0 ,0 00 . (W e wi l l refer co l l ect iv el y t o th i s tran s act i on
as th e qu art er h o rs e s wap .) M r. Rai fm an d i rect edCl as s i cSt ar t o co nt actM r. Ram o s , an dCl as s i cSt ar d i d
s o . OnJ an u ary

4 , 2 0 0 5, M r. Ram o s co n t act edth e Rai fm an s an dex p res s ed
en t h u s i as m

fo r t h e s wap an dn o t edth at , i n o rd er t o en s u re t h atth e t ax ad v an t ag es
o f t h e s wap wo u l db e h o n o red , th e Rai fm an s o u g h tt o k eep up t h ei r “ act i v e” p art i ci p at i o n . 1 6 OnJ an u ary

7 , 2 0 0 5 , th e Rai fm an s ’ ex ecu tedth e qu art er h ors e s wap ag reem en t
. 1 7 3
. Th e Ram o s In v es t m en ts Th e Rai fm an s tu rn edo v er t h e p ro ceed s fro m t h ei r v ari o u s Deri v i u m t ran s act io n s t o M r. Ram os , wh o th ey th en en t ru s t edwi t h m an ag i n g t h atm o n ey i n

1 6 Th e p art i es co n s id eredth i s a l i k e-k i n dex ch an g e. 1 7 Th e reco rdi n d i cat es , h o wev er, t h atthe Rai fm an s d i d n o tp ro v i d e Cl as s i cSt ar wi t h th i s ex ecu t ed ag reem en tu n t i l s o m et i m e aft er Feb ru ary 2 2 , 2 0 0 5
.- 2 2 -

[* 2 2 ] a m an ner s uffi ci en t t o m eetth ei r o b ject i v es . Th e Rai fm an s were M r. Ram o s ’ l arg es tcl ien t s , an dh e affo rd edth em th e at t en t i o n s u ch a s t atu s d es erv ed , m eet i n g wi t h t h em reg u l arl y t o d i s cu s s p o t en t i al i n v es t m en t s an d t o rev i ew t h e p erfo rm an ce o f t h ei r p ort fo l i o.

a. Th e Secu redLen d i ng Fu n d M r. Ram o s reco m

m en d edth atth e Rai fm an s i n v es ti n th e Secu redLen d i ng Fu n d(SLF). SLF was a fu ndo rg an i zedb y Ro b ertKey s , th e CEO o f PCG, 1 8 an d Lee Bro wer, a PCG affi l i at e. SLF was i n t h e b u si n es s o f m ak i ng “ h ardm o n ey ” o r

“ b ri d g e” l o an s t o real es t at e d ev el o p ers wh o h adex h au s t ed , o r o t h erwi s e co u l dn o t
s ecu re, fi n an ci n g fro m t rad i t i o nal l en d ers . Th ro ug h a rel at edco m p an y , SLF
wo u l dv etp o t en ti al b o rro wers an dth e as s o ci at edu n d erl y i n g p ro p ert y . Ho w ev er, SLF t y pi cal l y es ch ewedfo rm al ap prai s al s o f t he u n d erl y i n g p ro pert y an dwo u l d i n s t eadl o o ko n l y

t o p as tap prai s al s o r rel y o n i n fo rm al rep res en t at i o ns m ad e b y real es t at e p ro fes s i o n al s fam i l i ar wi t h th e p ro p ert y an dth e s u rro u n d in g area. SLF d i dn o t l en d d i rect ly b uti n s t eadfaci li t at edi t s l en d i n g o p erat i o n s t h ro u g h a s eri es o f l i m i t edl i ab i l i t y co m p an ies (s ub-SLFs ). Each s ub -SLF wo u l d

1 8 By l at e 2 0 0 3 , al t h o u g h h e ret ai n edo wn ers h i p an d h i s p o s i t i o n as PCG’ s CEO, Ro b ertKey s’ p ri m ary fo cu s was o n h i s p ers o n al b o o ko f cl i en t s an d i n v es t m en to pp o rtu n i t i es ; h e h add el eg at edm o s t o f t h e co m pan y ’ s d ay -t o -d ay o p erat i o n s t o o t h er PCG ex ecu t i v es .- 2 3 -

[* 2 3 ] p ro v i d e i t s b o rro wer an y req u es t edfu n d i n g i n ex ch an g e fo r a s ecu ri t y i n t eres ti n th e b o rro wer’ s u n d erl y i ng real es tat e d ev el o p m en t . Gen eral l y , each
s ub -SLF was fu n d ed b y

s el li n g i t s d eb tt o th i rdp art i es (s ub -SLF i n ves t o rs ). Sub

SLF i nv es t o rs wo ul drecei v e a n o t e p ro m i s i n g ab o ve-m ark et y i el d s an dp u rp o rt i n g t o m ak e a “ co l l at eral as s i gn m en t ” o f t h e s ub -SLF’ s s ecu ri t y i n t eres ti n th e
u n d erl y i n g real es t at e d ev el o p m en t . No t wi t h s t an d i n g t he n o m en cl atu re, t h i s
co l l at eral as si g n m en td i dn o tco n v ey , n or en t i tl e s ub -SLF i n v es t ors t o recei p to f o r t h e ri gh tt o reco rd , an y

s ecu ri t y i n s t ru m en t ; t h e co l l at eral as s i g nm en td i dn o t p u rp ortt o co nv ey

t o an y s ub -SLF i n v es t o rs a d eedo f t ru s t, m o rt g ag e, o r an y o t h er
reco g n izab l e s ecu ri t y

i n t eres t. In s t ead , th e i nt en d edfu n ct i o n o f t h i s p urp o rt ed
co l l at eral as si g n m en twas t o es t ab l i s h th ateach l o an m ad e b y a s ub -SLF was i t s el f
s ecu redan dt o rep res en tt o s ub -SLF i n v es t o rs th at , i f n eces s ary , th e s ub -SLF co u l d fo recl o s e o n an ds el l the u n derl y i n g real es tat e d ev el op m en t i n o rd er t o rep ay i t s i n v es t o rs . M r. Ram o s erro n eo u s l y

b el i ev edth i s m ean t t h at each n o t e h o ld er’ s i n v es t m en twas a “ s ecu red ” i n t eres ti n th e u nd erl y in g real es t at e d ev el o p m en t
. M r. Ram os rep res en tedh is erro n eo u s b el i ef wh en s el l i n g M r. Rai fm an o n i n v es t i n g wi t h SLF. M r. Ram o s p res en t ed M r. Rai fm anwi t h t h e p ri v at e- 2 4 -

[* 2 4 ] p l acem en t m em o ran du m (PPM ) d es cri b i n g t h e SLF o p erat i o n . 1 9 Th e Rai fm an s i n v es t edap p ro x i m at el y $ 1 .5 m il l io n i n s ub -SLF n o tes , wh i ch th ey l eft
u n d er t h e m an ag em en to f M r. Ram o s . 2 0

1 9 Th e SLF PPM d es cri b edth e p u rp o rt ed“ co l l at eral as s i g n m en t ” as s ecu ri t y fo r t h e s ub -SLF n o t es , as fo l l o ws : Al t h ou g h the No tes wi l l b e l i m i t edreco u rs e o b l i g at i o n s o f * * * [SLF, an deach s ub -SLF] , each No te wi l l al s o b e s ecu redb y o n e o r m o re co l l at eral as si g nm en t s m ad e b y * * * [SLF an d each s ub -SLF]
. Each co l l at eral as si g n m en twi l l as s i g n t o * * * [i nv es t o rs ] o n a p ari p as s u an dp ro rat edb as i s , al l o f t h e co ll at eral that* * * [SLF an d each s ub -SLF] recei v e[] fro m * * * [t h ei r b o rro w ers ]
. Each s ub -SLF b o rro wer wi l l p led ge real es t at e i n ad d i ti o n t o o t h er accep t ab l e co l lat eral t o s ecu re Bri d g e Lo an s m ad e b y * * * [SLF an d each s ub -SLF]
. * * * [SLF an d each s ub -SLF] wi l l co ll at eral l y as s i gn al l o f t h e co l l at eral t h at* * * [SLF an deach s ub -SLF] recei ve[] fro m * * * [t h ei r b o rro wers ]
. Th e PPM , wi t h res p ectt o th e p urp o s e an di nt en to f th e co l l at eral as s i g n m en t , i s equ al l y ab s t ru s e, p ro v i d i ng th at t h e co l l at eral as s i g n m en t“ i s i n t en d edt o m ak e * * * [i n v es t o rs ] s ecu redcred i to rs o f * * * [SLF an d each s ub

SLF] i n th e u n l i kel y

ev en to f a * * * [SLF o r s ub -SLF] b an krup t cy .”
2 0 M r. Ram os es t ab l i s hedth e Real Retu rn Fu n di n l at e 2 00 5 as a l i m i t ed p art n ers hi p . Gen eral l y , M r. Ram o s wo u l dreq ues tth ath i s cl i en t s co nt ri bu t e t h o s e as s et s u n d er h i s m an ag em en ti nt o th e fu ndb ecau s e t h i s wo u l db en efi tal l h i s cl i en ts as th e co l l ect i v i zat i o n o f ri skredu cedth e ex p o s u re o f each i n di v i du al cl i en t. Up o n co n tri b u ti o n , each o f h i s cl i en ts wo u l d b eco m e a p art ner i n th e p art n ers hi p . Th e Rai fm an s ag reed t o th i s co l l ect i v i zat i o n o f ri s kan d p u t ap p ro x i m at el y $ 2 .1 6 m i ll i o n o f th ei r Ram o s-m an ag edi n v es t m en t s an d o t h er as s et s (co n ti n u ed ...)- 2 5 -

[* 2 5 ] Ul t i m at el y , b ecau s e o f t h e h i g h -ri s kn atu re o f t h e l o an s m ad e an d a d o wn tu rn i n th e real es t at e m ark et , th e s ub -SLFs were fo rced t o fo recl o s e o n al m o s tal l o f t h e real es t at e d ev el o pm en ts t o wh i ch th ey h adex t en d edl o an s . Th es e fo recl o s u res , h o wev er, were o ft en m i redi n d i s pu t e an d rarel y res u l tedi n i n v es t o r rep aym en t
.

b
. A St ro k e o f Gen i u s : Pri n t s an dAdv ert is i n g Deb t M r. Ram o s al s o p res en t edth e Rai fm an s wi t h an o p p o rtun i t y t o i n v es ti n d eb t i s s u edfo r t h e p ri n tan dad v ert i s i n g cam pai g n (P&A) o f a feat ure-l en g t h
m o ti o n p ictu re, Bo b b y J on es : A Stro k e o f Gen i u s. Al t h o u gh h e l ack edan y fam i l i ari t y

wi t h m o ti o n p i ctu re fi n an ci n g an du n d ers t o odth at t h i s d eb twas
u n s ecu redan d ri s ky , M r. Ram o s fel tth is i n v es t m en twas a “ can ’ tm i s s”
o p p o rtu ni t y

as t h e d eb tcarri eda 1 2 % i n t eres trat e an dfeat u red a b ack -en d

“ s weet en er” t h atp ro m i s edP&A i n v es t o rs an equ i t y s t ak e i n th e fi l m

s h o u l di t
s u cceed atth e b o x offi ce. 2 1 M r. Ram o s i n fo rm edth e Rai fm an s th atb o t h h e an d M r. Gl as er h adp ers o nal l y i n v es t edi n the P&A d eb t . M r. Ram o s p ro v i d edM r.

2 0 (...co n t i nu ed ) i n t o th e Real Ret u rn Fu n d . Fo r co n v en i en ce, we d i s t i n g u is h b et ween SLF i n v es t m en t s an dth e Real Ret u rnFu ndo n l y wh ere n eces s ary . 2 1 Id eal l y , M r. Ram o s n o t ed , th e fi l m o n l y n eed ed t o g ro s s $ 10 m il l i o n i n o rd er t o en su re t h ati n ves to rs recei v ed t h e d es i redres u l ts
.- 2 6 -

[* 2 6 ] Rai fm an wi t h t h e p ri vat e p l acem en to fferi n g m at eri al s fo r t h e P&A d eb t . In M arch 2 0 0 4 t h e Rai fm an s ag reedt o p u rch as e $ 4 0 0 ,0 0 0 o f n o t es i s s u edb y P&A. Th e fi l m u n d erp erfo rm edatth e b o x o ffi ce. OnJ an u ary 6 , 2 0 0 6, M r. Ram o s
wro te t o h i s cl ien t s t o i n fo rm th em th ath e co n si d eredth e P&A d eb two rth l es s an d t o ackn o wl ed g e erro rs i n hi s ju d g m en t . Acco rd i n gl y , M r. Ram os refu n d edt o h i s cl i en ts al l m an ag em en tfees h e h adco l l ect edwi t h res p ectt o t h e P&A d eb tan d
reco m m en d edth ath i s cl i en t s wri t e o ff t h ei r en t i re i n v es tm en t
. II. Th e Rai fm an s ’ 2 0 0 3 Ret u rn an dSub s equ en tAu d it A. Sh o p p in g fo r an Ad v i s er In earl y 2 0 04 th e Rai fm an s d i rect edM r. Ram o s t o m eet wi t h Ti m J o rs t ad , t h ei r l o n g t i m e C.P.A., t o d i scu ss th e t ax effect s o f t hei r p art i ci p at i o n i n th e Cl as s i cSt ar p ro gram . Fo ll o w i ng th atm eet i n g t h e Rai fm an s i n fo rm edM r. Ram o s t h atth ey h add i sm i s s edM r. J o rs t ad , an dthey req u es t edth atM r. Ram os refer t h em t o an o th er C.P.A t o b eg i n p rep ari n g thei r 2 00 3 t ax retu rn . M r. Ram os referred t h e Rai fm an s t o , an dth e Rai fm an s s ub s equ en t l y en g ag ed , Do n Sh aw, a l i cen sed C.P.A. an dth e fat h er-i n -l aw o f o ne o f M r. Ram o s’ em p l o y ees . 2 2

2 2 Th e Rai fm an s h i redM r. Sh aw ap p ro x i m at el y fo u r m on t h s aft er t h ey

h ad en g ag edi n th e Cl as s i cSt ar p ro g ram . M r. Sh aw’ s co n t ract wi th th e Rai fm an s s p eci fi cal l y

l im i ts th e s co pe o f h i s du t i es an dres p o n s i b i l i t i es as th ei r return p rep arer.- 2 7 -

[* 2 7 ] Fo l l owi n g a co n v ers at i o n wi t h M r. Ram o s an dag en t s o f Cl as s i cSt ar, 2 3 M r. Sh aw accep t edth e rep res en t at i o n th atth e Rai fm an s were en g ag edi n a b o n a fi d e h o rs e b reed i ng trad e o r b u s i n es s , d es p i t e l ack i n g an y p art i cu l ar b el i ef t h atth e Rai fm an s h adan y

b u s i n es s p u rp o s e fo r p art i ci p at i n g i n t h e Cl as s i cSt ar p ro g ram b ey o n d cap tu ri n g t h e p ro g ram ’ s t ax b en efi t s. Acco rd i n g l y , M r. Sh aw rep o rt edth e Rai fm an s Cl as s icSt ar b u y -i n as a d edu ct i b l e $ 3 .4 m i l l i o n ag ri b u si nes s ex p en s e fo r t ax y ear 2 0 0 3
. Rel y i n g o n M r. Ram o s ’ rep res en t at io n t h atth e Deri v iu m tran s act i o n s
co n st i tu t edb o n a fi de l o an s , M r. Sh aw d i dn o trep o rtas i n co m e an y o f t h e p ro ceed s recei v edth erefro m , an dfo r t he s am e reas o n h e d i dn otrev i ew an y o f t h e rel at ed
co n tract s o r o th er rel ev an tm at eri al s. M r. Sh aw p ro ceed edi n a s i m i l ar fas h i o n wi t h res p ect t o d edu ct i n g Deri v i u m i n t eres tex p en s es o n the Rai fm an s ’ t ax retu rn s fo r t h e y ears ati s su e. OnNo vem

b er 1 6, 2 0 0 4 , M r. Sh aw co m p l et edthe Rai fm an s ’ retu rn fo r t ax y ear 2 0 0 3 , an dM r. Ram o s i n fo rm edth e Rai fm an s t h atth ey s ho u ldex p ecta p ro m p t Fed eral i n co m e t ax refu n do f h al f a m il li o n d ol l ars .

2 3 M r. Sh aw t es t i fi ed th ath e p ri n ci p al l y an dd i rect l y

d eal t wi th M r. Ram o s -- “ p ro b ab l y 9 0 p ercen t ” o f t h e t i m e--wi t h res pect t o an y m at t ers rel at edt o th e Rai fm an s ’ retu rn s .- 2 8 -

[* 2 8 ] M r. Sh aw rem ai n edth e Rai fm an s’ retu rn p rep arer t hro u g h t ax y ear 2 0 1 4
. M r. Sh aw u s edth e s am e ap p ro ach t o co o rd i n at i n g an d co m pl et i n g th os e ret u rn s as h e h adwi t h th e 2 00 3 retu rn . B. Au d it i ng th e Rai fm an s ’ 2 0 0 3 Tax Retu rn In 2 0 0 5 th e In t ern al Rev en u e Serv i ce (IRS) b eg an an ex am i nat i o n o f t h e Rai fm an s ’ t ax retu rn fo r 2 0 0 3 . Th e IRS i ni t i al l y s el ect edth e Rai fm an s ’ retu rn fo r
ex am i n at i o n b ecau s e M r. Sh aw fai l ed t o rep ortan y t ax co n s equ en ce as s o ci at ed wi t h th e ex erci s e o f M r. Rai fm an ’ s n o n qual i fi edVal u ecl i cko p t i o n s ; o n ce t h e
ex am i n at i o n b eg an , h o wev er, t h e IRS s o o n ex p an dedi t s s co p e t o i ncl u d e rev i ew
o f t h e Rai fm an s ’ p art i ci p at i o n i n th e Deri vi u m an dCl as s i cSt ar p ro g ram s . M r. Sh aw i n it i al l y

rep res en t edth e Rai fm an s du ri n g t h i s ex am i n at i on an d cl o s el y co o rd i n at edh i s rep res en t at i o n wi t h M r. Ram os . As th e ex am i n at i o n p ro g res s ed , M r. Sh aw an dM r. Ram o s b ecam e i n creas i n g l y co n cern edwi th p res erv i ng the t reat m en to f t h e Rai fm an s ’ p art i ci p at io n i n t h e Cl as s i cSt ar p ro g ram
an d t h ei r as s o ci at edm

ul t i y ear refu n d cl ai m . Acco rd i n gl y , M r. Sh aw b eg an t o
co o rd i n at e d i rect l y wi t h Cl as s i cSt ar rep res en t at i v es . Sp eci fi cal l y , as th e
ex am i n at i o n co n t i n u ed , the IRS b eg an t o qu es ti o n M r. Sh aw wi t h res pect t o th e Rai fm an s ’ qu art er h o rs e s wap . Earl i er, Cl as s i cSt ar h add i rect ed M r. Sh aw t o refrai n fro m

p ro v i d i n g th e au d it o r an y d ocu m en t at i o n o r i nfo rm at i o n wi t h res p ect- 2 9 -

[* 2 9 ] t o th e qu art er h o rs e s wap , i n th e h o p e o f p res erv i n g i t s treat m en t as a l i k ek i n dex ch an g e. Sen s i n g th atth e au d i to r’ s i nt eres ti n thi s i s s u e co u l dfu rt h er
co m p l icat e t h e ex am i n at i o n , M r. Sh aw co nt act edCl as s icSt ar t o d ev el o p a
co o rd i n at edres p o ns e t o th e IRS’ n o w-ex p an d i n g i n qui ry . Th e Cl as s i cSt ar
s o l u t i on , h o wev er, l edt o M r. Sh aw’ s ro ut i n el y p res en t i n g t h e IRS ex am i n er wi t h fab ri cat edan d o t herwi s e u n co rro b o rat edrep o rt s wi th res p ectt o th e Rai fm an s ’ p u rp ort edh o rs e b reed in g b us i nes s . Sub s equen t l y , atth e reco m m en d at i o n an d, i ni t i al l y , 2 4 th e ex p en s e o f Cl as s i cSt ar, t h e Rai fm an s en g ag eda l aw fi rm t o rep res en tthem

b efo re t h e IRS
ex am i n er. Th e ex am i n at i o n o f t h e Rai fm an s ’ 2 0 0 3 t ax retu rn cl o s edwh en t h e Rai fm an s en t eredi n t o a cl o si n g ag reem en t 2 5 wh erei n t hey co n ced edl i ab i l it y

fo r a $ 1 ,0 2 5 ,6 4 0 d efi ci en cy

i n t ax an dag reedth at t h ei r p art i ci p at i o n i n th e Cl as s i cSt ar p ro g ram was a n o n dedu ct ib l e ex p en s e. Th e ex am i n at io n o f t h ei r retu rn s fo r t h e y ears ati s su e, co n t i n u ed , h owev er. OnNo v em

b er 2 1, 2 0 1 3 , res p o nd en t i s s u eda n o t ice o f d efi ci en cy d et erm i n i n g th e

2 4 Cl as s i cSt ar ceas edt o p ay fo r t h e Rai fm an s ’ l eg al rep res en t at i o n s om et i m e i n m i d -Au gu s t2 0 06 . Atth att i m e t h e Rai fm an s i n d ep en d en tl y ret ai n edth e s am e fi rm t o co n t i n u e t o rep res en tth em b efo re t h e IRS.
2 5 Th e Rai fm an s’ fai l u re t o p ay th e t ax as s es s edp u rs u an t t o t h i s cl o s i n g ag reem en tg av e ri s e t o t h ei r as s o ci at ed CDP cas e, d i scu s s eds up ra n o t e 2
.- 3 0 -

[* 3 0 ] Rai fm an s h adi n co m e t ax d efi ci en ci es fo r t h e y ears ati s s u e. Th e d efi ci en ci es refl ect ed , as rel ev an th ere, res p o n d en t ’ s d i s al l o wan ce o f i nt eres t
ex p en s e d educt i o ns rel at edt o Deri v i um tran sact i o n s fo r t ax y ears 2 0 0 4-0 6 , d educt i o n s fo r ad d i t i o nal Cl as s i cSt ar ex p en s es fo r t ax y ear 2 0 0 4, a t h eftl o s s d educt i o n ex ceed i n g $ 1 5 m i l l i o n fo r t ax y ear 2 0 0 8 , an da d et erm i n at io n th atth e Rai fm an s h adu n d errep o rt edth ei r cap i tal g ai n i nco m e fo r t ax y ear 2 0 0 4 fro m th ei r p art i ci p at i o n i n th e Deri v i u m p ro g ram . III. Co l l ap s e an dAft erm ath A. Deri v i u m As th e ex am in at i o n o f t h e Rai fm an s ’ 2 0 0 3 retu rnco n t i n u ed , th ei r fi rs t Deri v i u m tran s act i o n n eared “ m atu ri t y ”. Deri v i u m co n t act edth e Rai fm an s t o
n o t i fy th em o f t h is ap p ro ach i n g m atu ri t y d at e an dt o rem i n dth em o f t h ei r p o s s i b l e al t ern at i v es t o rep aym en t . Atth att i m e, Sep t em b er 2 00 6 , Val u ecl ickh ad ap p reci at eds i g n i fi can t l y , t o th e ex t en tth atth e Rai fm an s real i zedthatth e v al u e o f t h e s h ares th ey

h ad o ri g i n al l y

tran s ferred n o w ex ceed ed t h e “ p ri n ci p al ” an d

“ i n teres t ” du e o n th ei r “ lo an ”. Acco rd in g l y , th e Rai fm an s d irect edM r. Ram o s t o p u rs u e t h ei r av ai l ab l e al t ern at i ves t o p aym en t , s p eci fi cal l y t o req u es tth at Deri v i u m return t o th em

an am o u n to f Val u ecl i cks h ares equ i v al en tt o t h e ex ces s
o f ap p reci at i o n o f t h e “ co l l at eral i zed ” Val u ecl i cks t o cko ver t h ei r b al an ce du e.- 3 1 -

[* 3 1 ] Deri v i u m , h owev er, fai l edt o h o n or t h i s req u es t . Deri v i um al so fai l edt o h o n o r t h e Rai fm an s ’ s eco nd ary req u es t : t o ex t en d t h e t erm o f t h e ag reem en t , t o

“ refi n an ce” i n ex ch an g e fo r cas h p ro ceed s eq u al t o t h e as -y etu n cap tu red ap p reci at i o n o f t h e “ co l l at eral i zed ” Val u ecl icks t ock
. Th e Deri v i u m -rel at ed
en t i t i es were reg u l arl y

co ll ap s i n g o r d i s s o l v in g . 2 6 OnM arch 5 , 2 01 0 , M r. Cat h cart , th e p ri n ci p al o f th e Deri v iu m p ro g ram , was p erm an en t l y

en jo i n edfro m

p ro m o t i n g i t, as i tco n s ti tut edan ab u s i v e t ax
s h el t er. Fo l l owi n g th e co m

p l et e co l l ap s e o f Deri v i u m an dal l as s o ci at eden t it i es , th e Rai fm an s , jo i n edb y

a n um b er o f o t h er fo rm er Deri v i u m p art i ci p an t s, at t em

p t edt o
s u e W ach o v i a fo r i ts ro l e i n faci l i t at i n g th e t ran s fer o f p art i ci p an ts ’ s h ares t o Deri v i u m . On M arch 3 1 , 2 0 1 4 , th e U.S. Di s t ri ctCo u rtfo r t h e No rt h ern Di s t ri cto f Cal i fo rn i a d is m i s s ed t h e p art i ci p an t s ’ cl ai m s . InM ay o f 2 0 1 6 , th e Co u rto f Ap p eal s fo r t h e Ni n t h Ci rcu i t affi rm edth e ju d g m en to f t he Di s t ri ctCo u rt
.

2 6 A y ear earl i er, i n Sep t em b er 2 0 0 5 , Deri v i u m

h adfi l eda v o l u n t ary p et i t i o n fo r ch ap t er 1 1 b an krupt cy p ro tect i o n . OnOct o b er 1 0 , 2 0 0 5 , No el M u rp hy , Do n Sh aw’ s s o n -i n -l aw, b ro u g h tt o M r. Ram o s ’ at t en t i o n a Fo rb es art icl e d et ai l i n g th e co l l ap s e-i n -p ro g res s o f Deri v i u m an di t s rel at eden ti t i es .- 3 2 -

[* 3 2 ] B. Cl as si cSt ar In Feb ru ary

2 0 0 6 Go v ern m en tag en ts rai d edthe o ffi ces o f Cl as si cSt ar o n t h e s u s p i ci o n th atCl as s icSt ar was i n th e b u s i n es s o f o p erat in g ab u s i v e t ax
s h el t ers . 2 7 M ean wh i l e, t h e IRS ex am i n at i o n o f th e Rai fm an s ’ p art i ci p at i o n i n th e Cl as s i cSt ar p ro gram

was ex p an d i n g . M r. Rai fm an b eg an p res s i n g M r. Ram o s t o p u rs u e t h e i n cen t i v e p aym en t s p ro m i s edi n th e qu art er h o rs e s wap an dt o fu rt h er p res s u re Cl as s icSt ar t o p ro vi d e t h e Rai fm an s a refu n do f t hei r o ri g in al $ 3
. 4 m i l l i o n p art i ci p at i o n fee. On J u n e 2 0 , 2 0 0 6 , Cl as s i cSt ar wi redth e Rai fm an s $ 70 ,0 0 0 as p arto f t he i n cen t i ves p aym en t s ari s i n g fro m th e qu art er h o rs e s wap . Aware t h at t h e Rai fm an s ’ IRS ex am i ner was b eg i n n i ng t o ex p an d h er i nqu iry t o i n cl u d e
rev i ew o f th e qu art er h o rs e s wap , M r. Ram os al s o b eg an d em an d i n g t h at Cl as s i cSt ar p ro vi de d o cu m en t at i o n , s p eci fi cal l y p ro of o f b irt h an dreg i s t rat i o n , wi t h res p ect t o th e h o rs es as s o ci at edwi t h th e s wap . Cl as s i cSt ar fai l ed t o p ro du ce

2 7 Th e reco rds u gg es t s t h atth e Rai fm an s d i s co v ered t hatCl as s i cSt ar was u n d er i n v es t i g at i o n o n l y

wh en th ey

were co n t act edb y t h e Dep art m en t o f Ju s t i ce (DOJ ) i n Au g u s to f 2 0 0 6 . Pu rs u an tt o th ati n i t i al co n tact , th e Rai fm an s were o ffered i m

m u n i t y fro m p ro s ecu t i o n fo r an y Fed eral cri m e, o n the b as is o f s t at em en t s th ey

p ro v i d edp u rs u an tt o an i m m u n i t y ag reem en t , i n cl u d i n g b u tn o t l i m i ted t o v i o l at io n s o f s ecs . 7 2 0 1 an d 7 20 6 , cri m i n al t ax ev as io n , an dcri m i n al fal s e s tat em en t s t o th e t ax i n g au t h o ri t i es , res p ect i v el y . Th e Rai fm an s accep t edth es e o ffers o f i m m u n i ty ro u gh l y a y ear l at er, i n Sep tem b er 2 0 0 7
.- 3 3 -

[* 3 3 ] th i s i n fo rm at i o n . Cl as si cSt ar an d i t s at t o rn ey s d i d , h o wev er, co nt i n u e t o
wo rkwi t h b o t h M r. Ram o s an dth e Rai fm an s t o arri v e atan accep t ab l e s et t l em en t t o co m p en s at e t h e Rai fm an s fo r Cl as s i cSt ar’ s fai l u res . A nu m b er o f t he p ri n ci p al s o f t h e Cl as si cSt ar p ro g ram were i n d i ct edfo r,
an d p l ead ed g u i l t y

t o , co n s p i racyt o d efrau d t h e U.S. Go v ern m en tth ro ug h th ei r
o p erat i o n an dp ro m o ti on o f t he Cl as s i cSt ar p ro g ram . In a rel at ed ci v i l l aws u i t , th e Rai fm an s an d n um ero u s o th er Cl as s i cSt ar p art i ci p an t s were co l l ect i vel y award edd am ag es i n ex ces s o f $ 5 0 m il l io n , res u l t i n g fro m Cl as s i cSt ar’ s frau d . See W es tHi ll s Farm s , LLC v . Cl as i cSt ar Farm s , In c. (In re Cl as s i cSt ar M are Leas e Li t i g.), 7 2 7 F.3 d4 7 3 (6 t h Ci r. 2 0 1 3 ). Purs u an tt o th at d i s p o s i t i on th e Rai fm an s , b et ween 2 0 0 8 an d2 0 1 2 , s et t l eda n u m ber o f as s oci at ed cl ai m s ag ai n s to t h er p art i es wh o h add i rect l y faci l i t at edo r ai d edi n the Cl as s i cSt ar p ro g ram ’ s frau d , recei v in g s et t l em en t s o f $ 5 0 , 0 0 0 fro m Han dl er i n 2 0 0 8 , $ 2 0 ,7 5 4 fro m Karen Hen dri x i n 2 0 0 9 , an d$ 9 1 8 ,9 7 5 , co l lect i v el y , fro m Gas St ar, Cl as s i cSt ar’ s p aren t co m

pan y , an das s oci at edi n d iv idu al s. C. M r. Ram o s an dM r. Key s As th e ex am in at i o n o f t h ei r retu rn s co n ti nu edi n to J u ly 2 0 0 7, t he Rai fm an s d i s m i s s edM r. Ram o s, g en eral ly , fro m h i s i n v es t m en tad v is o ry

du t i es . Ho w ev er, t h ey d i dn o tco m

pl et el y rem o v e t h ei r as s et s fro m h i s m an ag em en t , b el i ev i n g th ere- 3 4 -

[* 3 4 ] was s t i l l v al u e i n al l o wi n g th ei r i n v es t m en t s i n SLF t o m ature; acco rd i n g l y , t h ey ret ai n edM r. Ram os t o co n t i n u e m an ag i ng s u ch u n t i l 2 0 0 8 , wh en M r. Ram o s
res i gn ed . At t h e t i m e o f h i s res i g n at i o n M r. Ram o s i n fo rm edth e Rai fm an s th ati t
m i g h tt ak e as l o ng as fi v e y ears t o u n wi ndan d l iqu i d at e t h ei r rem ai n i n g i n v es t m en t s b ecau s e o f i s s u es wi t h p art i cu l ar as s et s , b u t m o s tn o t ab l y b ecau s e o f t ax co n cern s ari si n g fro m t h e Rai fm an s ’ o ffs h o re i n v es t m en tv eh i cl es . In Sep tem

b er 2 00 7 t h e Rai fm an s en t eredarb i trat i o n wi t h M r. Ram o s , PCG
an d M r. Key s , al l eg i ng , am on g o t h er t h i n g s , nu m ero u s b reach es o f fi du ci ary du t y , i n cl u d i n g s el f-d eal i n g an dn o n d i s cl o su re; b reach o f co nt ract ; n eg l i g en ce; frau d ;
an d m i s rep res en tat i o n . Aft er 1 8 d ay s o f h eari n g s , th e arb i t rat o r d et erm i n edth at M r. Ram os h adfai ledt o ad equ at el y d i s cl o s e referral fees an d co m m i ss i o ns h e h ad recei v edfro m

the o p erat o rs an d p ro m o t ers o f m an y o f t h e i n v es t m en t s an d p ro g ram s th ath e h ads o ldth e Rai fm an s an d t h e fee s h ari n g as p ect s o f h is rel at i o n s h i p wi t h PCG. Th e arb i t rat o r al s o d et erm i nedth atRo b ertKey s, i n h i s
ro l e as CEO o f PCG, h ada co n fl i cto f i n t eres ti n t h ath e en co u rag edPCG an di t s affi l i at es t o p ro m o t e i n v es t m en tv eh i cl es h e h adfo u n d edo r wh ich wo u ldres u l ti n t h e l arg es tco m

m i s si o n s t o h i m

p ers o nal l y . 2 8

2 8 Th e arb i t rat o r al so l ai do u tth e d efi ci en ci es i n M r. Ram o s ’ co m preh en s i o n o f t h e n atu re o f t h e SLF n o tes i n wh i ch h e h aden co urag edth e Rai fm an s t o i n v es t , (co n ti n u ed ...)- 3 5 -

[* 3 5 ] Acco rd i ng l y , o n Sep t em b er 2 3, 2 0 09 , th e arb i t rat or ru ledth atM r. Ram o s
an d PCG were l iab l e fo r, am o n g o t h er t h i n g s , b reach i n g thei r fi du ci ary du t i es t o t h e Rai fm an s . Th e arb i trat or d i dn o t , h o wev er, h o ldth atM r. Ram o s an dM r. Key s h ad co m m i t t edco m

m o n l aw frau d . In s t ead , o w i n g t o th ei r b reach es o f du t y an d care, t h e arb i t rat o r h el dth atth ey were l i ab l e fo r h av i ng wo rk eda co n s tru ct i v e frau d o n t h e Rai fm an s , as t h e arb i t rat o r s p eci fi cal l y fo un dthatn ei t h er M r. Key s
n o r M r. Ram o s act edwi t h an y i n t en tt o d ecei v e o r d efrau dth e Rai fm an s . Acco rd in g ly , th e arb i t rat o r g en eral l y award edth e Rai fm an s d am ag es ari s i ng fro m , am on g o t h er t h i n gs , th ei r p art i ci p at io n i n the Cl as s i cSt ar ($ 5 m i l l i o n ) an d Deri v i u m ($ 7 ,5 0 0 , 0 0 0 ) p ro gram s an dth ei r i n v es t m en t s i n th e P&A an dSLF n o t es ($ 5 0 0,0 0 0 an d$ 2 ,5 00 ,0 00 , res p ect i v el y ). M r. Ram o s , Ram o s Fi n an ci al , M r. Key s , an d PCG were h el djo in tl y an ds ev eral l y

l i ab le fo r t h o s e d am ag es . Sh o rt l y aft er t h e arb i t rat o r d el i v eredh i s d eci si on , M r. Ram os fi l edfo r b an krup cy

p ro t ect i on . Th e Rai fm an s i n t erv en edan ds ecu reda s et t l em en t ag reem en twi t h M r. Ram o s , wh erei n h e p ro m is edt o p ay th em $ 90 0 ,0 0 0 p u rs u an t

2 8 (...co n t i nu ed ) an d t h e d efi ci en ci es i n SLF’ s b o rro wer v et t i n g an dl o ani ss u an ce p ro cedu res . At t h e t i m e o f t h e arb i t rat i o n p ro ceed i n gs SLF h adb eg u n t o fo recl os e o n n earl y al l o f t h e p ro p ert i es fo r wh i ch i th adex t en d edl o an s. Th e reco rdatarb it rat i o n rev eal ed t h atSLF h adreg u l arl y fai l edt o ad equ at el y ev al uat e t h e p ro p ert i es i t s el f an dh ad i n s u ffi ci en tcap i t al t o en s u re i tco u l dad equ at el y s ei ze t h e t ro ub l edp ro pert i es .- 3 6 -

[* 3 6 ] t o th e arb i t rat i o n an dag reedt o t es ti fy o n th ei r b eh al f i n an y

fu rth er act i o n s b ro u gh t ag ai n s tM r. Key s o r i n an y fu rt her p ro ceed i n g s wi t h th e t ax i n g au th o ri t i es . OnNo vem

b er 1 9, 2 0 0 9 , th e Rai fm an s fi l ed a s u i ti n th e Sup eri or Co u rto f Cal i fo rn i a, Co u n ty

o f San Fran ci s co , n am in g as d efen d an t s , am o n g o t h ers , M r. Key s , SLF, an drel at eds ub -SLF en t it i es . Th e Rai fm an s al l eg edth e d efen dan t s h ad , am o n g o t h er t h i ng s , p erp etrat eds ecu ri t i es frau dan d act ual frau d . Th e Rai fm an s m o v edt o v o l u n t ari l y d i s m i s s thi s act i o n o n Decem b er 1 7 , 2 01 0
. OnM ay 1 1 , 2 0 1 0 , M r. Key s fi l edfo r ch ap t er 7 b an krup tcy p ro tect i o n . M r. Key s s ubs equ en t l y p l ead edg ui l t y t o wi re frau dan d m o n ey l au n d eri n g o ffen s es wi t h res p ect t o a $ 1 .1 m il l i o n l o an h e b ro k eredb et w een a l o n g t im e cl i en tan da
recen tb u s i n es s as s oci at e, an d b an krupt cy frau d
. OPINION I. Th e Th eft Lo s s es A. Th e Natu re o f t h e Part i es ’ Co n t en t i on s Th e Rai fm an s d o n otd i sp u t e res p on d en t ’ s d et erm i n at i o n s as s etfo rt h i n th e
n o t i ce o f d efi ci en cy

wi t h res p ectt o th ei r p art i ci pat i on i n the Deri v i u m an d Cl as s i cSt ar p ro gram s . In s t ead , th ey arg u e t h atth e fact s an d ci rcu m s t an ces
s u rro u n d i n g th ei r p art ici p at i o n i n th o s e p ro g ram s , as wel l as th ei r i n v es t m en ti n- 3 7 -

[* 3 7 ] t h e SLF n ot es , o ug h tt o en t i t l e t h em t o d edu ctth eftl o s s es fo r t ax y ear 2 0 0 8
. 2 9 Th e Rai fm an s arg u e a u n i qu e t h eo ry wi t h res pect t o each l os s . Th es e t h eo ri es are as fo l l ows . W i t h res p ect t o th ei r Deri v i u m tran s act i on s , th e Rai fm an s arg ue t h ateach t ran s act io n was tw o s ep arat e t ran s act io n s : th e s al e o f t h ei r s t ockt o Deri v i u m , an d t h ei r p urch as e o f an“ o p t i o n” t o reacq u i re fro m Deri v i u m an i d en t i cal am o u n to f
s t ockatm atu ri t y

fo r a s tri k e p ri ce eq u al t o th ei r b al an ce du e. 3 0 In t h i s res p ect , th e Rai fm an s al l eg e t h at Deri vi u m ’ s fai l u re t o h o no r t h es e “ o p t i o ns ” atth e m atu ri t y o f t h ei r fi rs tag reem en t , an dDeri v i u m ’ s s ub s equ en t co l l ap s e b efo re t h e m atu ri t y o f t h ei r s eco n dan dthi rdag reem en t s , co ns t i tu te t h e t h efto f t h o s e o p t io n s b y fal s e p ret en s es . Th e Rai fm an s ap p ear t o s p eci fi cal l y al leg e t hatth ey

were i n t en t i o n al l y d efrau d edb y Deri v i u m ’ s p ri n ci p al , M r. Cat h cart
.

2 9 Al t h o u g h i n t h ei r o ri g i nal 2 0 0 8 retu rnthe Rai fm an s cl ai m eda $ 1 5 ,1 6 0 ,6 0 7 t h eft lo s s , th ey

n o w ap p ear t o cl ai m

o n l y a $ 1 0 ,7 9 8,0 6 1 theft l os s . Th i s l o s s co m p ri s es i n d i v i du al l o s s es o f $ 2 , 4 7 5 ,0 0 0 rel at edt o th ei r p art i ci p at i o n i n th e Cl as s i cSt ar p ro gram , $ 3 ,7 5 0 ,0 0 0 rel at ed t o th ei r d i recttran s act i o n s wi th th e Deri v i u m p ro g ram , $ 2,6 3 8,9 7 7 rel at edt o thei r Deri v i um tran s act i on ro u t ed t h ro u g h Hel ico n , an d$ 1 ,9 3 4,0 8 4 wi t h res p ectt o th ei r i n v es t m en t s i n SLF n o t es an d as as s o ci at edwi t h th e Real Retu rn Fu n d
.

3 0 Th e Rai fm an s’ arg u m en tap p ears t o rel y o n Cal l o w ay

v . Co m m i s s i o n er, 1 3 5 T.C. 2 6 (2 0 10 ), aff’ d , 6 9 1 F.3 d1 3 1 5 (1 1 t h Ci r. 2 0 1 2 ). Th ere, t h i s Co u rt ch aract eri zedth e al t ern at i v es t o p aym en tas b ei n g “ at b es t ” an “ o pt i o n ” t o p u rch as e fro m

Deri v iu m

an equ i v al en tam ou n to f s to ckfo r a p ri ce equ al t o t h e p ri n ci p al an d accru edi n teres to n th e p u rp o rt edl o an . Id . at3 5 -3 7
.- 3 8 -

[* 3 8 ] W i t h res p ect t o Cl as s i cSt ar, n o t i n g th atres p o n d en t h as co n ced edth atan actu al th efto ccu rred , th e Rai fm an s al l eg e t hatth e Cl as s i cSt ar p ro g ram co n s t i tu t ed a “ p o n zi ” s ch em e an d s eekt o av ai l th em s el v es o f t h e s afe h arb o r p ro vi s i o n s p ro v id edb y

Rev . Pro c. 2 0 0 9-2 0 , 2 0 0 9 -1 4 I.R.B. 7 4 9
. W i t h res p ect t o th ei r i n v es t m en t s i n SLF n o t es , th e Rai fm an s al l eg e th atM r. Key s an d o t her p ri n ci p al s o f SLF d efrau d edth em b y m i srep res en t i n g th e n atu re o f t h ei r i n v es t m en t i n SLF, n o t ab l y th atth e n o t es d idn o t co nv ey t o th e Rai fm an s an y
s ecu ri t y i n t eres ti n an y u n d erl y i n g p ro p ert i es . 3 1 W i t h res p ect t o Deri v i um an d SLF, res p on d en tal l eg es th atth e Rai fm an s fai l edt o es t ab l i s h th atan actu al th efto ccu rred , n ot ab l y b ecau s e th e Rai fm an s h av e fai l edt o es t ab l i s h th e cri m i n al i n t en to f M r. Cat h cart o r M r. Key s . W it h res p ectt o t h ei r p art i ci p at io n i n t h e Cl as s icSt ar p ro g ram , res po n d en targ u es t hatth e Rai fm an s h av e fai l edt o es t ab l i s h th e ap p ro p ri at e am o u n t o f t h ei r t h eftl os s an dth e ap p ro p ri at e y ear o f i t s d edu ct i on . Res p o n d en tad d i ti o n al l y co n t en ds th atth e Rai fm an s are i n el ig i b l e fo r s afe-h arb o r t reat m en tu n der Rev . Pro c. 2 0 0 9 -2 0 , s up ra,

3 1 Th e Rai fm an s d o n otal l eg e p ri v i ty wi t h M r. Key s o r an y o t h er ag en to r p ri n ci p al o f SLF; rat h er t h ey al l eg e t h atth e m i s rep res en t at i on s m ad e b y t h o s e i n d i v i du al s t o M r. Ram o s an ds ub seq u en t ly co m m u n i cat edt o t h e Rai fm an s b y M r. Ram o s , res u lt edi n a t h eftb y fal s e p ret en s es .- 3 9 -

[* 3 9 ] b ecau s e t h ey

d o n otco ns t i tu t e “ qual i fi edi n v es to rs ” an dth e Cl as si cSt ar p ro g ram d oes n o t co n s t i tut e a “ s p eci fi edfrau du l en tarran g em en t”, as d efi n ed
. B. Th eftLo s s An al y si s Sect io n 1 6 5 g en eral l y

p erm it s t ax pay ers t o d edu ctag ai n stth ei r o rd i n ary i n co m e th e am o un to f an y u n co m pen s at ed l o s s res u l t i n g fro m th eftfo r t he y ear i n wh i ch th e t ax p ay er s u s t ai n s th atl o s s . See s ec. 1 65 (a), (c), (e). To qu al ify fo r a t h eft lo s s d edu ct i o n , t ax p ay ers m u s tp ro v e: (1 ) t h e o ccu rren ce o f a th eft , (2 ) t h e
am ou n to f t h e t h eft l o s s , an d (3 ) t h e y ear i n wh i ch th e t ax pay ers d is co v er th e t h eft l o s s . Id . Th e t ax p ay er b ears the b u rd en o f p ro v i n g en t i t l em en tt o a t h eftl o s s d educt i o n . Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 1 5 (1 9 3 3 ). In o rd er t o as cert ai n wh et h er t h efth as o ccu rred , th i s Co u rtap p l i es th e l aw
o f t h e St at e wh ere t h e l o s s was s u s t ai n ed . Bel l i s v . Co m m i s s i o ner, 5 4 0 F.2 d4 4 8 , 4 4 9 (9 th Ci r. 1 9 76 ), aff’ g 6 1 T.C. 3 5 4 (1 9 7 3). Becau se t h e al l eg edth eftt oo k p l ace i n Cal i fo rn ia, we ap p l y Cal i fo rn i a l aw. Un d er Cal i fo rn i a Pen al Co de s ect i on 4 8 4 , an y p ers o n wh o s h al l “ fel o n i o u s l y s t eal , t ak e, carry , l ead , o r d ri ve awayth e p ers o n al p ro p ert y

o f an o t her, * * * o r wh o s h al l kn o w i n g ly an dd es i g n ed l y , b y

an y fal s e o r frau du l en trep res en t at io n o r p ret en s e, d efrau dan y o t h er p ers o n o f m o n ey
* * * o r real o r p ers o nal p ro p ert y ” wi l l b e h el dacco u n t ab l e fo r t h eft . Cal . Pen al Co d e s ec. 4 8 4(a) (Deeri n g 2 0 0 0 ). Wh i le t h i s s t atu t e en d eav ors t o co n so l i d at e al l- 4 0 -

[* 4 0 ] th efto ffen s es wi t h i n i t s t erm s , th e St at e o f Cal i fo rn i a s t i l l reco gn i zes th atth e i n d i v i du al el em en t s o f each p erm u t at i o n o f th eft --s u ch as l arcen y , fal s e p ret en s es , em bezzl em en t --h av e rem ai n edu n ch an g ed . Peo p l e v . Go n zal es , 3 9 2 P.3 d4 3 7 , 4 4 1 -4 4 5 (Cal . 2 0 1 7 ); Peo p l e v . As h l ey , 2 6 7 P.2 d2 7 1, 2 7 9 (Cal
. 1 95 4 ). In s o far as th e Rai fm an s al l eg e t h eftthro u g h frau du l en tm is rep res en t at i o n s , t h ey al l eg e t h eftb y fal s e p ret en s es . Th eftb y fal s e p ret en s es co n s i s t s o f t h ree
co n j u n ct i v e el em en ts : (1 ) t h e p erp et rat o r m u s t, kno wi n g l y

an d wi t h t he s p eci fi c i n t en tt o d efrau dthe p ro p ert y o wn er, (2 ) h av e m ad e a fal s e rep res en t at i o n o r p ret en s e wh i ch (3 ) m at eri al l y i n fl u en cedth e o wn er t o p art wi t h h i s o r h er p ro p erty i n rel ian ce o n th o s e rep res en t at i o n s . Peo p l e v . W i ll i am s , 3 0 5 P.3 d1 2 41 , 1 2 4 8 (Cal . 2 0 1 3 ). Im

p li ci ti n t h es e el em en t s i s a rel at i o n s h i p o f p ri v i t y b et ween th e p erp et rat o r an d hi s o r h er v ict i m . Cro wel l v . Co m m i s s i o n er, T.C. M em o . 1 9 8 6
- 3 1 4
. 3 2

3 2 In cert ai n n arro w ci rcu m s t an ces a t h eftl o s s d edu ct io n h as b een al lo wed wh ere t h e t ax p ay er l ack s p ri v i ty wi t h t h e al l eg edth ief. See Bo o t he v
. Co m m i s s i o n er, 7 6 8 F.2 d1 1 4 0 (9 t h Ci r. 1 98 5 ), rev ’ g 8 2 T.C. 8 04 (1 9 8 4 ). Th e Rai fm an s d o n otal leg e p ri v i t y wi t h M r. Cat h cart , M r. Key s , o r an y o t h er ag en to r p ri n ci p al o f Deri v i u m

o r SLF. In s t ead , th e Rai fm an s arg u e t hato u r an al y s i s o u g h t t o l oo kb ey o n dp ri vi ty

an dt o ap p l y

a “ feed er” t h eo ry

t o o u r t h eftl o s s an al y s i s , as s u g g es t edi n Pai ne v . Co m m i s s i o n er, 6 3 T.C. 7 36 (1 9 7 5 ), aff’ dwi t h o u t p ub l i s h ed o p i n i o n , 5 2 3 F.2 d1 0 5 3 (5 t h Ci r. 1 9 7 5 ), an dJ en s env . Co m m i s s i o n er, T.C. M em o . 1 9 9 3 -3 9 3 , aff’ d wi t h o ut p ub li s h edo p i n io n , 7 2 F.3 d1 3 5 (9 t h Ci r. 1 99 5 ). As we reach o u r h o l d i n g o n the q u es t io n o f i nt en t , h o w ev er, we n eedn o t an d d o n o t (co n ti n u ed ...)- 4 1 -

[* 4 1 ] In t en tt o d efrau di s a qu es t i o n o f fact t o b e d et erm i n edfro m al l th e ci rcu m s t an ces o f t h e cas e an du s u al l y m us tb e p ro v en ci rcu m s tan t i al l y . Peo p l e v . Fu ji ta, 1 1 7 Cal . Rp tr. 7 5 7 , 7 6 5 -7 6 6 (Ct . Ap p . 1 9 7 4 ). Co u rt s m u s tex am i n e th e
ev i d en ce t o d et erm i n e wh eth er an al l eg ed t h i ef b eh av edi n a m an n er co ns o n an t wi t h an i n t en tt o d efrau d ; a reco rdes t ab l i s h in g a m ere o rd i naryb reach o f co n t ract
o r fi du ci ary

du t y wi l l b e i ns u ffi ci en tt o s up p orta fi n d i ng o f a p art y ’ s i n t en tt o d efrau d . See As h ley , 2 6 7 P.2 dat2 6 5
. C. Deri v i u m Th e Rai fm an s arg u e t h ey are en t i t l edt o a t h eft l o s s d educt i o n ari s i n g fro m t h ei r p art i ci p at io n i n t h e Deri v i u m p ro g ram . As th e Rai fm an s s ee i t , th e al l eg ed t h eft rel at es t o Deri v iu m ’ s fai l u re t o h o n o r th e “ o p t i o n s ” ari s i ng fro m th e ag reem en t s ’ al t ern at i v es t o p aym en t . To es t ab l i s h th e req ui s i t e cri m in al i nt en t wi t h res p ect t o th i s th eftcl ai m , th e Rai fm an s rel y n earl y ex cl u s i v el y

o n a p erm an en ti n

j u n ct i o n en

jo i n i n g M r. Cat h cart , th e Deri vi u m p ri n ci p al , fro m
co n ti n u i n g t o p ro m ot e an do perat e t hatp ro g ram . Th e Di s t ri ctCo urtfo r t h e No rt h ern Di s t ri cto f Cal i fo rn i a en t eredth i s p erm an en t i n ju n ct io n ag ai n s tM r. Cat h cartp u rs u an t t o s ect i o n 7 4 0 8
.

3 2 (...co n t i nu ed ) ad dres s th e Rai fm an s’ “ feed er” t h eo ry o r o t herwi s e an al y ze an y i s s u e p ert ai n i n g t o m at t ers o f p ri v it y .- 4 2 -

[* 4 2 ] Sect io n 7 4 0 8 au th o ri zes th e Fed eral Di s tri ctCo u rt s t o en jo i n i n d i vi du al s wh o h av e en g ag ed , as rel ev an th ere, i n the p ro m o t i on o f ab us i v e t ax s h el ters wh en i t is s h o wn th atan i n d i v idu al o rg an i zedo r s o l d , o r p art i ci p at edi n th e o rg an i zat i o n
o r s al e o f, an arran g em en t , an dm ad e o r cau s ed t o b e m ad e fal s e s t at em en t s
co n cern in g th e t ax b en efi t s t o b e d eri v ed fro m th atarran g em en twh i l e kno wi n g , o r h av in g reas o n t o kn o w, th e fal s i t y an dm at eri al i t y o f t h o s e fal s e s t at em en t s . See, e.g ., Un i t edSt at es v . Es t at e Pres . Serv s ., 2 0 2 F.3 d1 0 9 3 , 1 0 9 8 (9 t h Ci r. 2 0 0 0 ). W e d o n o tfi ndth is i nju nct i o n, an d t h e as so ci at edm at eri al s , t o b e d i s p o s i t i ve wi t h res p ectt o th e Rai fm an s ’ th eftcl ai m . Wh i l e t he i n ju n ct i o n m ay

b e h i g h l y p ro b at i v e wi t h res p ectt o M r. Cat h cart ’ s i n t en t t o d ev el o p an d m ark etan ab u si v e t ax s hel t er, i td o es n o tfo l l ow t h atM r. Cat h cart co n cei vedan d i m p l em en t edth e p ro gram “ o pt i o n s ”, t h e al tern at i v es t o p aym en t , wi t h th e s p eci fi c i n t en tt o d efrau dthe Rai fm an s , o r an y o t h er p art i ci p an t o f h i s t ax s h el t er, o f t h ei r p ro p erty . 3 3

3 3 Th e Go v ern m en t was g ran t eds u m m ary ju d g m en twi t h res p ectt o th e fal s it y o f t h e Deri v iu m

p ro g ram ’ s p urp o rt edt ax b en efi t s . Tri al was t o b e h el di n o rd er t o res o l v e, p ri m ari ly , th e d i s p u t edfact u al qu es t i o n o f wh et h er M r. Cat h cart kn o wi n g l y m i s rep res en t edth o se t ax b en efi t s . Attri al h e d ecl i n edt o co n tes tth i s rem ai n i n g fact u al al l eg at i o n. Acco rd i n g l y , h e was en jo i n ed fro m

p ro m o t i n g th e Deri v i u m p ro g ram o r an y o t h er p ro g ram

s i m i l ar t h eret o .- 4 3 -

[* 4 3 ] Rat h er t h e i n

ju n ct i o n g i ves ri s e t o a s t ro n g i n feren ce t h at M r. Cat h cart ’ s i n t en twas t o d ev el o p an dm ark eta t ax s h el t er t hatm i g h t d i sg u i se s al es as a l en d i n g arran g em en t
. 3 4 Ino rd er t o en s u re t h at t h e s al es wo u l d b e h o n o redas th e
n o n reco urs e l o an s t hey

p u rp o rt edt o b e, t h e t ran s act i o n n eces s i t at edp ro fo rm a d o cu m en t at i o n th atwo u l ds u g g es tth e ex i st en ce o f b o n a fi d e i n deb ted n es s . Acco rd in g ly , M r. Cat h cart d ev el o p ed t h e “ l oan ” ag reem en t s , s p eci fi cal l y th e al t ern at i v es t o p aym en tat i s s u e h ere, i n a m an n er t h ath e b el i ev edwo u l dp ro v i d e h i s p ro g ram

th e v en eer n eces s ary

t o h el p i ts u rv iv e s cru t i n y an d d el i v er h i s cl i en t s t h e t ax b en efi ts h e p ro m i s ed . Th e ag reem en tan di t s t erm s , the al tern at i v es t o p aym en t , were p artan dp arcel o f t h e Deri v i u m tran sact i o n ’ s n atu re as a d i s g u i s ed
s al e. To th e ex t en twe fi n dth e i n ju n ct i o n an dth e o t her Deri v i u m -rel at ed
m at eri al s i n d i cat i v e o f an y i n t en t , we fi n do n ly

th atM r. Cat h cart i nt en d edt o
m ark eta t ax s h el t er an dt o ai d an dab eti n th e d efrau d i n g o f t h e U.S. Treas u ry . On t h e reco rdb efo re u s , we d o n otfi n dev id en ce s u ffi ci en tt o es t ab l i s h th ath e i n t en d edt o d efrau d an y

i n d i v i du al Deri v i u m

p art i ci p an t t hro u g h a fai l u re t o

3 4 Th e co n tract s cl earl y i n d i cat edt o th e p art i ci p an t s t h at i n tu rn i n g o v er t h ei r p ro p erty t o Deri v iu m , th ey

were t ran s ferri n g t h eret o al l th e b en efi t s an d b u rd en s o f, an d co m

p l et e d o m i ni o n o ver, t he s t o ck . Th e l o an was n on reco u rs e t o t he p art i ci p an tan dco u l dn o tb e cal l edb efo re m atu ri t y . Si m i l arl y , th e p art i ci p an t s were p ro hi b i t edfro m

p rep ay i n g an y

i n t eres to r p ri nci p al
.- 4 4 -

[* 4 4 ] p erfo rm

o n t h e p ro g ram ’ s i l l -co n cei v ed“ o p ti o n s”, t h e al t ern at i v es t o p aym en t
. Acco rd in g l y , the Rai fm an s h av e fai l edt o es t ab l i s h t h e req u i s i t e i n t en t
n eces s ary t o s u s t ai n th ei r Deri v i u m -rel at edth eftcl ai m . 3 5 D. Secu red Len di n g Fu n d Th e Rai fm an s arg u e t h ey are en t i t l edt o a t h eft l o s s d educt i o n ari s i n g fro m t h ei r i n v es t m en t i n SLF. Th e Rai fm an s al l eg e t h atM r. Key s m i s rep res en t ed , an d
cau s ed o t h ers t o i n t en t i o n al l y m i s rep res en t , th e n atu re o f t h e “ co l l at eral
as s i g n m en t ” i n t eg ral t o th e s ub -SLF n o tes an dth atM r. Key s d i ds o wi t h th e i n t en t
o f d ep ri v i n g i n v es t o rs o f t h ei r m o n ey . To es t ab l i s h th e req u i s i t e i nt en t o f M r. Key s , th e Rai fm an s rel y o n th e t es t i m o n y o f M r. Ram os an d an ex p ertrep o rt
. M r. Ram o s rep eat ed ly

t es t i fi edth atM r. Key s l i edt o h i m wi t h res pect t o th e
n atu re o f SLF an dth e as s oci at edco l l at eral as si g n m en t . Th e wei g h to f t he en t i re
reco rd , h o wev er, es t ab l i sh es th atM r. Key s h ad l i t t l e co n t actwi t h M r. Ram o s an d

3 5 Th e Rai fm an s h av e en t ered i n t o th e reco rdan ex p ertrep o rtp urp o rt i n g t o p ro v id e a v al u at io n o f t h es e t h eo ret i cal “ o p ti o n s”, t o es tab l i s h th e fai r m ark et v al u e t h ereo f. Ad d i t i o n al ly , th e Rai fm an s arg u e t h atth ey are en t i tl edt o a s t ep -up i n b as i s b ecau s e t h e Deri v i u m tran s act i o n d i dn o tco n s t i tu t e a l i teral s al e b u trat h er a “ co n s t ru ct i v e s al e” u n d er s ec. 1 0 5 8 . Becau s e we d eci d e th e i ss u e o f t h efto n th e ex i s t en ce o f i n t en t , we d ecl i ne t o ex p l o re t h es e as pect s o f t h e Rai fm an s ’ cl ai m . W e o b s erv e, h o w ev er, t hatres po n d en t ’ s i n i t i al d et erm i n at i o n wi t h res p ectt o th e p ro p er t ax treat m en to f the Deri v i um tran s act i o n ap p ears t o h av e al read y acco u n t edfo r t h e 1 0 % o f t h e m ark etv al u e o f t h ei r Val u eCl i cks t o ckwh i ch was n o tm o n et i zedi n th e Deri v i u m s al e. See Cal l o w ay

v . Co m m i s s i o n er, 1 35 T.C. at 5 3 (Hal p ern , J ., co n cu rri n g ).- 4 5 -

[* 4 5 ] d o es n o tes tab l i s h that , i n t h ei r l i m i t edco m m un i cat i o n s , M r. Key s ev er wi l l fu l l y co m m u n icat ed an y

m at eri al m i srep res en t at io n wi t h res p ectt o SLF an d i t s p u rp ort edco l l at eral as s i g n m en twi t h an i n t en tt o d efrau dM r. Ram o s o r h i s cl i en ts
. 3 6 W e o b s erv e th atth e PPM d et ai l s th e n atu re an do p erat i o n o f t h e
co l l at eral as si g n m en tan d t h atth e t erm s i t em p l oy s i n d oi n g s o are arg u ab l y
am bi g uo u s . Th e reco rdb efo re u s d o es n o t , h o w ev er, es t ab li s h th atM r. Ram o s , M r. Key s , o r an y

o t h er i nd i v i dual s as s o ci at edwi t h SLF were at o d d s wi th res p ect t o h o w th ey

i nt erp ret edth e t erm

“ co l lat eral as s i g nm en t ” an dh o w s uch a co l l at eral
as s i g n m en twas t o o p erat e. Th e reco rdes t ab l i s h es th at t he p ri n ci p al s o f SLF
u n d ers t o o dth atth ey

were o b l i g at edt o “ co l l at eral l y as s i g n ” an y

“ co l l at eral recei v ed ” fro m

th ei r b o rro wers t o SLF i n v es t o rs . Th e p ri n ci p al s o f SLF
u n d ers t o o dth i s t o m ean t h at SLF i n v es t o rs wo u l db e en t i t l edt o rep aym en to f t h ei r

“ l i m i t edreco u rs e” n o t es fro m th e p ro ceed s o f fo recl o s u re. Th e reco rds i m i l arl y
es t ab l i s h es th atM r. Ram o s , h av i n g read t h e PPM an dd o n e t h e du e d i l i g en ce req u i redo f h i m , arri v edata s im i l ar u n ders t an d i n g . Th at M r. Ram o s an do t h ers t h en b eg an d es cri b in g th e n o tes i s su edb y SLF as “ s ecu red ” ap p ears t o b el i e t h ei r

3 6 As res p o n d en t n o t es , i n Cal i fo rn i a th e m i s rep res en t at io n o r o m i s s i on o f a m at eri al facti n th e o fferi n g o r s el l i ng o f a s ecu ri ty m ay b e u n l awfu l . Cal . Co rp . Co d e s ec. 2 5 40 1 (Deeri n g 2 0 1 4 ). Su ch a m i s rep res en tat i o n , h o wev er, wi l l b e co n si d eredcri m i n al o n l y

wh en i ti s m ad e wi l fu l l y (i .e., i n t en ti o n al l y ). Id . s ec. 2 5 5 4 0 (b ); Peo p l e v . Sal as , 1 2 7 P.3 d4 0 , 4 9 (Cal
. 2 00 6 ).- 4 6 -

[* 4 6 ] co m

preh en s i o n as t o th e act u al m ean in g, fu n ct i o n an d o p erat i o n o f a s ecu ri t y i n t eres t . Bu t i tcert ai n l y

d o es n o tg i v e ri s e t o an i nferen ce o f wi l l fu l
m i s rep res en t at i o n wi t h th e i n t en tt o d efrau di n v es to rs . Acco rd i n g ly , we fi n dth at t h e t es ti m o n y

o f M r. Ram o s l ack edcred i b i l i t y an d rel i ab i li t y an d fai l edt o
es t ab l i s h t h atM r. Key s , o r an y o t h er SLF p ri nci p al , ex h i b i tedth e i n t en tn eces s ary t o s u s t ai n th e Rai fm an s’ al l eg at i o n s o f t h eft
. 3 7 Th e ex p ertrep o rto fferedb y th e Rai fm an s re-i n t erp ret s th e fact u al fi n d i n g s
an d h o l d i n g s o f t h e Rai fm an s ’ arb i t rat i o n wi t h M r. Ram o s an dM r. Key s i n o rd er t o arri v e at t he d et erm i n at i o n th atth e act i o n s o f M r. Key s were “ cat eg o ri cal l y frau du l en t ” an d t h atth e “ en t i ret y o f t h e Rai fm an ’ s [s ic] ex peri en ce” wi th M r. Key s , an das s oci at eden t i t i es , was b as edo n frau d. Th e rep o rtp urp o rt s t o arri v e at t h i s co n cl u s i o n t h ro u g h an ap p l i cat i o n o f t he i n dus t ry s tan d ard s o f care fo r i n v es t m en tad v i s ers . To th e ex t en tth e ex p ertrep o rti s m ean tt o s up p o rta co n cl u s i on th at M r. Key s d efrau d edth e Rai fm an s , i ti s u n h el p fu l. Th e rep o rtd o es n o t i n v i t e o u r at t en ti o n t o an y

p art i cu l ar i n di ci a o f t h e wi l l fu l i nt en to f M r. Key s t o d efrau dth e

3 7 W e o b serv e t h atthe Rai fm an s h av e en t eredi n t o th e reco rdn u m ero u s d o cu m en t s rel at edt o g u i l t y p l eas en t eredb y

M r. Key s wi t h res p ectt o u n rel at ed cri m es . To th e ex t en tthe Rai fm an s i n v i t e u s t o i n fer, b y way o f p ro pen s i t y ev i d en ce, t hatM r. Key s i nt en d edt o d efrau dth em , we d ecl i ne t o d o s o .- 4 7 -

[* 4 7 ] Rai fm an s , o r an y

o t h er SLF i n v es t o r. M o reo v er, t h e rep o rtp ri m ari l y
s u m m ari zes th e arb i t rat i o n o p i n i o n an d , i n d o i n g s o , ap p ears t o co n fl at e b reach es
o f fi du ci ary

du t i es an di n dus t ry

s t an dard s o f care wi t h th e rel ev an t Cal i fo rn i a l aw g erm an e t o o u r an al y s i s u n d er s ect i o n 1 6 5
. 3 8 W e reco g n i ze t h at frau dm ay t ak e
m an y fo rm s , b u t t h e d efect s an dredu n d an cy o f t hi s rep o rtl eadu s t o acco rdi tv ery l i tt l e wei g h twi t h res p ectt o es tab l i s h i n g t hatM r. Key s , o r an y o t her p art y

rel at ed t o the SLF i n v es t m en t s, act edwi t h an i n t en tt o d efrau dth e Rai fm an s. E. Cl as si cSt ar 1
. Co n ces s i o n , Po s i t i o ns , an dth e Rem ai ni n g El em en t s In a res p o n s e t o a m ot io n fo r s u m m ary ju d g m en t fi l edb y

th e Rai fm an s , res p o n d en t co nced ed t h at t h e Rai fm an s s u ffereda t h eftp u rs uan t t o t h ei r p art i ci p at i o n i n th e Cl as si cSt ar p ro g ram . Reco g n i zi n g res p on d en t ’ s co n ces s i o n , o u r an al y s i s tu rn s t o th e rem ai n i n g t wo el em en t s o f a t h eft l o s s : (1 ) t h e co rrect y ear o f a d edu ct io n an d(2 ) t h e co rrectam o u n to f t he d edu ct io n . Th e Rai fm an s , h o wev er, arg u e t hatth e Cl as s i cSt ar p ro g ram co n s t itu t eda p o n zi s ch em e an d rel y

ex cl u si v el y

o n Rev
. Pro c. 2 0 0 9 -2 0 , s upra, i n i n v i t i n g th i s Co u rtt o h o l dthe s am e i n acco rd an ce wi t h Rev . Ru l . 2 0 0 9 -9 , 2 0 0 9 -1 4 I.R.B. 7 3 5
.

3 8 Th i s i s , p erh ap s, t o p rev en t t h e rep o rtfro m ap p eari n g t o o ffer an i m p erm i s s i b le l eg al co n cl u si o n. See Nat i o n wi d e Tran s p . Fi n. v . Cas s In fo . Sy s ., In c., 5 2 3 F.3 d1 0 51 , 1 0 5 8 (9 t h Ci r. 2 0 0 8 ).- 4 8 -

[* 4 8 ] Acco rd i n g l y , th e Rai fm an s arg u e t h atth ey are en t i t l edt o a t h eftl os s d educt i o n o f $ 2 , 4 7 5 ,0 0 0
. 3 9 Th e Rai fm an s d o n o t , h o wev er, al l eg e a s p eci fi c
co n tex tfo r t h e t h efth ere co n ced ed , an d t h ey d o n o ti d en t i fy t h e n atu re o f t h e p ro p erty s t o l en . Si m i larl y , th ey

d o n o tat t em

p tt o es tab l i s h th e fai r m ark etv al u e
o f, o r t h ei r b as i s i n, t he u n i d en t i fi eds t o len p ro p ert y .

2
. Th e Pro v i s i o n s o f Rev . Pro c. 2 0 0 9 -2 0 Th e Rai fm an s al l eg e t h e Cl as s i cSt ar p ro g ram co n s t i tu teda p o n zi s ch em e
an d as k t h i s Co u rtt o ap pl y Rev . Pro c. 2 0 0 9-2 0 , s upra, t o affo rdth em a t h eftl o s s d educt i o n i n acco rd an ce wi t h th e Co m m i s s i o n er’ s d i s p o s i t i o n i n thatrev en u e p ro cedure. W e o b serv e t h atrev en u e p ro cedu res an d rev en u e ru li n g s are n o t
n eces s ari l y

b i n d i n g o n t h i s Co u rt , s ee Es t at e o f Lan g v . Co m m i s si o n er, 6 1 3 F.2 d 7 7 0 (9 th Ci r. 1 9 80 ), aff’ g i n p art , rev ’ g i n p art6 4 T.C. 4 0 4 , 4 0 6 -4 0 7 (1 9 7 5 ), an d
n o t e t h att o th e ex t en tth i s Co u rtm i g h tap p l y th i s rev en u e p ro cedu re, we wo u l d
n o th o ldth atth e Rai fm an s qual i fy fo r b en efi ci al t reat m en tth ereu n d er. As p ert i n en th ere, Rev . Pro c. 2 0 09 -2 0 , s up ra, p ro v i d es a s afe h arb o r fo r a t ax p ay er wh o i s a “ qu al i fi edi n v es t o r” t h atu n wi tt i n g l y ex p eri en ced l o s s es b y

way
o f p art i ci p at i o n i n cert ai n s p eci fi edfrau du l en tarran gem en t s . Th i s p ro cedu re

3 9 Th i s am o u n t ap p ears t o rep res en t t h e Rai fm an s ’ i ni t i al Cl as s i cSt ar p art i ci p at i o n fee, red uced i n ackn o wl ed g m en t o f t h ei r recei p to f v ari o us i n cen t i v e an d s et t l em en tp aym en t s .- 4 9 -

[* 4 9 ] g en eral l y

rel ax es th e s h o wi n g req u i redo f a t ax p ay er wi t h res p ectt o th e t i m i ng an dam o un to f a t h eftl o s s . Wh ena t ax p ay er q ual i fi es fo r th e s afe h arb o r t reat m en t , th e Co m

m i s s i o n er wi l l n otch al l en ge t hatt ax p ay er’ s t h eftl o s s d educt i o n o f t h e fu l l am ou n to f th e t ax p ay er’ s i n v es t m en t , fo r t he t ax y ear i n wh i ch th e t h eftwas “ d i s co v ered ”. A qu al i fi edi nv es t o r i s a t ax p ay er wh o d idn o t h av e act u al kn o wl ed g e o f t h e frau du l en t n ature o f t h e arran g em en tb efo re i t s b eco m i n g kn o wnt o t h e g en eral p ub l i c; ad d i t i o n al l y , th e arran g em en tm us tn o tco n s ti tu t e a t ax s hel t er, as d efi n ed i n s ect io n 6 6 6 2 (d )(2 )(C)(i i ). As rel ev an th ere, s ect i o n 6 66 2 (d )(2 )(C)(i i ) d efi n es a t ax s h el t er as an y

i n v es t m en tp l an o r o th er arran gem en t wh o s e s i g n i fi can t p u rp o s e i s t he av o i dan ce o r ev as i o n o f Fed eral i n co m e t ax . Ani n v es t m en tp l an o r o t h er
arran g em en twi l l b e co n s id eredp ri n ci p al l y , s i g n i fi can t l y , m o ti v at edt o av o i d t ax at io n i f t h atp u rp o s e ex ceed s an y o t h er p u rp o s e. Sec. 1 .6 6 62 -4 (g )(2 ), In co m e Tax Reg s . Th e ex i s t en ce o f an eco n o m i c m o t iv at o r wi l l n o t, i t s el f, es t ab li s h th ata t ran s act io n ’ s p ri n ci p al p u rp o se i s n o tth e s h el t eri n g o f i n co m e fro m t ax at i on i f
o b ject i ve ev id en ce i nd icat es o th erwi s e. Id
. M r. Ram o s i n t ro du ced t h e Rai fm an s t o t he Cl as s i cSt ar p ro g ram p ri n ci p al ly b ecau s e M r. Ram os b el i ev edi tco u l d o ffs etth e Rai fm an s’ “ph an t o m ” t ax l i ab i l i t y ari s in g fro m

th ei r ex erci s e o f M r. Rai fm an ’ s n o n qu al i fi edVal u ecl i ck o pt i o n s . M r.- 5 0 -

[* 5 0 ] Ram os d et erm i n ed , wi th ex act i tu d e, t h e am o u n to f m o n ey th atth e Rai fm an s’
wo u l dn eedt o b u y

i n t o th e Cl as s i cSt ar p ro g ram i n o rd er t o o ffs etth atl i ab i l i t y , an d p ro v id e t h em

a n eto perat i n g l o s s l arg e en o u g h t o s ecu re a refu n do f t h ei r Fed eral i n co m e t ax p ai d fo r p ri o r y ears . 4 0 M o reo ver, t h e reco rdi s rep l et e wi t h d ep os i t i o n s
an d t es t i m o n y

wh erei n M r. Ram o s , M r. Sh aw, an d M rs . Rai fm an s t at edth atth e Rai fm an s ’ p ri n ci pal p u rp o s e fo r p art i ci p at i n g i n th e Cl as s icSt ar p ro g ram was t o
av o idi n co m e t ax fo r 2 0 03 an dreco v er i nco m e t ax p ai d fo r p rev i o u s y ears . Th e wei g hto f t h e ev id en ce b efo re u s fai l s t o es t ab l i s h t h atthe Rai fm an s p art i ci p at edi n the Cl as s i cSt ar p ro g ram fo r an y s i g n i fi can tp u rp os e o th er th an th e
av o id an ce o f Fed eral i n co m e t ax . W e fi ndth at t he Rai fm an s d o n o tco n st i tu t e qu al i fi edi n v es t o rs an d , acco rd i n g l y , th ey co u ldn o tqu al i fy

fo r th e s afe h arb o r p ro v is i o n s o f Rev . Pro c. 2 0 0 9 -2 0 , s up ra.

3
. Th e Am o u nto f t h e Cl as s icSt ar Th eftLo s s es Th e am ou n to f a t h eft lo s s i s l i m i tedt o the l es s er o f (1 ) th e fai r m ark etv al u e
o f t h e p ro p ert y

i m m ed i at el y b efo re t h e t h eft o r (2 ) t h e ad ju s t edb as is o f t h e s t o l en

4 0 W e al s o o b s erv e t h at , i n th i s m an n er, th e Cl as s icSt ar p ro g ram was d es i g n edt o o p erat e as an “ art fu l d ev i ce” t haten ab l ed i t s p art i ci p an t s t o s h el t er o rd i n ary i n co m e fro m

t ax at io n fo r a cu rren ty ear an dt o co n vert o rd i naryi n co m e i n t o cap i t al g ai n i nco m e a s h o rtt i m e l at er. See, e.g
. , Co m m i s s i o n er v . P.G. Lak e, In c., 3 5 6 U.S. 2 6 0 , 2 6 5 (1 9 5 8 ) (ci t i n g Co rn Pro d s . Ref. Co . v . Co m m i s s i o n er, 3 5 0 U.S. 4 6 , 5 2 (1 95 5 )).- 5 1 -

[* 5 1 ] p ro p ert y . Sec. 1 6 5 (b ); s ecs . 1 .1 6 5 -7 (b )(1 ), 1 .1 65 -8 (c), In co m e Tax Reg s . A t ax p ay er m ay

n o t , h o wev er, d edu cta t h eftl o s s t o th e ex ten th e o r s h e h as
reco v eredo r b een co m

p en sat edfo r t h atl o s s . Sec. 1 6 5 (a); s ee Do u dv . Co m m i s s i o n er, T.C. M em o . 1 9 8 2 -1 5 8
. To th e ex t en tes t ab l i sh edb y t h e reco rdb efo re u s , we fi n dth atthe Rai fm an s
were v i ct i m s o f a t h eftari s i n g ex cl u s i v el y i n t h e co nt ex to f t h e m at eri al
m i s rep res en t at i o n s m ad e b y Cl as s i cSt ar t o i n du ce t h ei r accep t an ce o f t h e qu art er h o rs e s wap ag reem en t . Si m il arl y , we fi n dth at t h e p ro p ert y t he Rai fm an s
co n vey edi n rel i an ce o n th o s e m i s rep res en t at i o n s was thei r i n t eres ts i n t he t wo
u nb o rn fo al s an d an y

ri g h t s ari s i n g fro m t h ei r u n fru i tfu l m are l eas es th ath ad p rev i o u s l y ex p i redo n J u l y 1 , 2 0 0 4 . Th e reco rdes t ab l i sh es b as es 4 1 fo r t h es e t wo i n
u t ero fo al s o f $ 28 1,8 6 5 an d$ 4 8 0 ,7 0 0
.

4 1 W i t h res p ectt o th e am o u n to f t hei r t h eftl o ss th e Rai fm an s rel i ed ex cl u s i v el y

o n Rev . Pro c. 2 00 9 -2 0 , 2 0 0 9 -1 4 I.R.B. 7 4 9 , as d i s cu s s edab o ve. Acco rd in g ly , th ey

d ecl i n edt o o ffer an y

d at a o r cal cu lat i o n s i n di cat iv e o f t h e fai r m ark etv al u e o f t h e ri g h t s ari s i n g fro m th ei r ex p iredl eas es , d i dn o t i n v i t e o u r at t en ti o n t o an y

d at a o r cal cu l at i o n wi t h res p ectt o an y co l l at eral ex p en s es i n cu rred p u rs u an t t o th ei r at t em

p ts t o reco v er t h ei r p ro p ert y , an dh av e ad v an cedn o as s o ci at ed arg u m en twi t h res p ectth eret o . See An d er v . Co m m i s si o n er, 4 7 T.C. 5 9 2 , 5 9 5 (1 9 6 7)- 5 2 -

[* 5 2 ] 4
. Th e Year o f Lo s s Gen eral ly , t ax p ay ers m ay d edu cta l o s s o n ly

fo r t h e y ear s u ch l o s s i s
s u s t ai n ed . Sec. 1 6 5 (a). W i t h res p ectt o t h eftl o s s es , h o wev er, t ax p ay ers are p erm i t t edt o treat th e t h eftl o s s as b ei n g s u s t ai n eddu ri n g t h e t ax ab l e y ear i n wh i ch t h e t ax p ay er d is co v ers th e t h eft . Sec. 1 6 5 (e). Tax p ay ers m ay n ot , h o wev er, cl ai m a t heft lo s s d edu ct i o n fo r a y ear i n wh i ch h e o r s h e m ay s t il l h av e a cl ai m

fo r rei m b u rs em en t , wi t h res p ectt o wh i ch there i s a reas o n ab l e p ro s p ect o f reco v ery . Sec. 1 .1 6 5 -1 (d )(2 ) an d(3 ), In co m e Tax Reg s . A reas o n ab le p ro s p ecto f reco v ery wi l l p o s tp o n e t h e t h eftl o ss d edu ct i o n u n t i l s u ch t i m e as t h atp ro s p ectn o l o n g er
ex i s t s. Sec. 1 .1 6 5 -1 (d )(3 ), In co m e Tax Reg s . Th e Rai fm an s , am o n g o t h er i n v es t o rs , co n cl u d ed l i t i g at i on ag ai n st Cl as s i cSt ar an d i ts p aren tco rp o rat i o n s i n 2 0 13 an dh av e b een ro u t i n el y reco v eri n g fro m rel at edp art i es s i n ce i n i t i at i n g l i t i gat i o n wi t h Cl as s i cSt ar i n 2 0 0 8
. Acco rd in g ly , we rejectth e Rai fm an s ’ cl ai m th at2 0 0 8 i s th e p ro p er y ear fo r th em t o reco g n i ze t hei r t h eftl o ss as s o ci at edwi t h th ei r p art i ci p at i o n i n t h e Cl as s icSt ar p ro g ram . II. Th e In v es t m en t i n P&A No t es as a W o rth l es s Secu ri ty Cap i t al Lo s s Th e Rai fm an s arg u e t h atth ey o u g htt o b e al l o wedt o d edu cta l o n g -t erm cap i t al l o s s fo r t ax y ear 2 0 0 8 wi t h res p ectt o thei r i nv es t m en ti n the P&A n o t es . If- 5 3 -

[* 5 3 ] a s ecu ri t y

wh ich i s a cap it al as s etb eco m es wo rt h l es s du ri n g th e t ax ab l e y ear,
s ect i on 1 6 5 (g ) al l o ws a t ax p ay er t o d edu ctth e l o s s res ul t i n g t herefro m as a cap i t al l o s s . A s ecu ri t y , fo r t h es e p u rp o s es , co n s t i tu t es a b o n d , a n o t e, o r o t h er ev i d en ce
o f i n d eb t ed n es s, i s s u edb y a co rp o rat i o n . Sec. 1 6 5 (g )(2 ). In d i v idual s m ay d edu ct cap i t al l o s s es t o t h e ex t en t o f cap i t al g ai n s p l us $ 3 ,0 0 0 o f o rd i n ary i n co m e. Sec. 1 2 1 1 (b ). A t ax p ay er s eek i n g a d edu ct i o n fo r a wo rt h les s s ecu ri t y m u s t , am o n g o t h er t h i n g s , p ro v e t h e act u al wo rt h l es s n es s o f t h e s ecu ri t y . A t ax p ay er m ay cl ai m s u ch a d educt io n o n l y

fo r t h e fi rs ty ear i n wh ich th ere i s n o reas o n ab l e ch an ce o f
reco v ery . Sec. 1 .1 6 5 -4 (a), In co m e Tax Reg s .; s ee Vi n cen t i n i v . Co m m i s s io n er, T.C. M em o . 2 00 8 -2 7 1 , s l i p o p . at1 7 -1 9 , aff’ d , 4 2 9 F. Ap p’ x 5 6 0 (6 t h Ci r. 2 0 1 1 ); Fav ia v . Co m

m i s s i o n er, T.C. M em o . 2 0 02 -1 5 4 . If, i n t h e y ear o f d i s co v ery , th ere
ex i s t s a cl ai m

fo r rei m bu rs em en twi t h res pect t o wh i ch th ere i s a reas o n ab l e p ro s p ecto f reco v ery , n o p o rt i o n o f t h e l o s s fo r wh i ch rei m b u rs em en tm ay

b e recei v edm ay

b e d educt edu n t i l th e t ax ab l e y ear i n wh i ch i tcan b e as cert ai n edwi t h
reas on ab l e cert ai n t y

wh eth er o r n o tthe rei m

b urs em en twi ll b e recei v ed , fo r
ex am p l e, b y a s et t l em en t , ad

ju d i cat i o n , o r ab an d o nm en to f t h e cl ai m . Secs
. 1 .1 65 -1 (d ), 1 .1 6 5 -5 , 1 .1 65 -8 (a)(2 ), In co m e Tax Reg s . As wi th th eftl os s es ,- 5 4 -

[* 5 4 ] t ax p ay ers m ay

d edu cta wo rt h l es s s ecu ri t y l o s s o n l y t o th e ex t en t n o t
co m p en s at ed . Sec. 1 6 5(a). Th e reco rdes t ab l i s hes t h atth e Rai fm an s i n v es t ed$ 4 0 0 ,0 0 0 i n th e P&A
n o t es . Th es e n o t es are a s ecu ri t y wi th i n t h e m ean in g o f s ect i o n 1 6 5 (g ). Th e
m o ney o wedth e Rai fm an s o n th o s e n o t es i s u n l i k el y t o ev er b e p ai d . In Sep tem b er 2 0 0 9 t h e Rai fm an s were award ed$ 5 0 0,0 0 0 wi t h res p ectt o t h i s i n v es t m en t , p u rs u an tt o th ei r arb i t rat i o n i n v o l v i n g M r. Ram o s, M r. Key s, an d PCG. Acco rd in gl y , th e p ro p er y ear o f l o s s i s n o t2 0 0 8 , as t h e Rai fm an s cl ai m , b u t a l at er y ear t h atth e reco rdd oes n o tes t ab l is h
. III. Sect io n 6 6 6 2 Accu racy -Rel at edPen al t i es Res p o n d en td et erm i n edth at fo r al l y ears ati s s u e t h e Rai fm an s were l i ab l e fo r accu racy -rel at ed pen al t ies u n d er s ect i o n 6 6 6 2 (a) an d(b )(1 ) an d(2 ) fo r
n eg li g en ce, d i s reg ardo f ru l es o r reg u lat i o ns , o r s ub s t an t i al u n d ers tat em en t s o f i n co m e t ax . Th e Rai fm an s co n t es tth e i m p o si t io n o f t h es e p en al t i es . A t ax p ay er i s l i ab l e fo r a s ect i o n 6 6 6 2(a) accu racy -rel at edp en al t y wi t h
res p ectt o an y

p ort i on o f anu n d erp aym en tat t ri bu t ab le t o n eg l i g en ce o r d i s reg ard
o f ru l es an d reg ul at i o n s , o r a s ub s t an t i al u n d ers t at em en to f i nco m e t ax . Sec. 6 6 6 2 (a) an d (b )(1 ) an d(2 ). Neg l i g en ce o ccu rs wh en th e t ax p ay er fai l s t o m ak e a
reas on ab l e at t em

p tt o co m p l y wi t h th e p ro vi s i o n s o f th e Co de wh il e d i sreg ardo f- 5 5 -

[* 5 5 ] ru l es an dreg u l at i o n s m ean s an y carel es s , reck l es s , o r i n t en t io n al d is reg ard t h ereo f. Sec. 6 6 62 (c); s ec. 1 .6 6 6 2 -3 (b )(1 )(i i ), In co m e Tax Reg s . (s t at i n g t hata t ax p ay er ex h i b i ts n eg l i g en ce wh en h e o r s h e “ fai l s t o m ak e a reas o n ab l e at t em p tt o
as cert ai n th e co rrect n es s o f a d edu ct i o n , cred i t o r ex cl u s i o n wh i ch wo u l ds eem t o a
reas on ab l e an dp ru d en t p ers o n t o b e ‘ t o o g o o dt o b e t ru e’ u nd er t h e ci rcu m s t an ces ”). A s ub st an t i al u n d ers t at em en to f i n co m e t ax ex i s t s wh en th e
am ou n to f t h e u nd ers t at em en tex ceed s th e g reat er o f 1 0 % o f t h e t ax req u i redt o b e
s h o wno n t h e ret u rn fo r t he t ax ab l e y ear o r $ 5 ,0 0 0
. Sec. 6 6 6 2 (d )(1 )(A). Th e Co m m is s i o n er b ears th e b u rd en o f p ro du ct i o n wi t h res p ectt o th e
accu racy -rel at edp en al ty

u n d er s ect i o n 6 6 62 . Sec. 7 4 91 (c); Hi g b ee v . Co m m i s s i o n er, 1 1 6 T.C. 4 3 8 , 4 4 6 (2 0 0 1). A. Graev Im

p li cat i o n s Th i s cas e was tri ed du ri n g th e Co u rt ’ s Oct o b er 2 5 , 2 0 1 6 , tri al s es s i o n i n San Fran ci s co , Cal ifo rn i a. Th e reco rdrem ai n ed o p en u n t i l J u ne 1 , 2 0 17 . Befo re t h e
co u rtcl o s edth e reco rdi n thi s cas e, n ei t h er p art y at t em p tedt o i nt ro duce ev i d en ce wi t h res p ect t o th e wri t t en s up erv i s o ry ap p ro v al req u i rem en to f s ect io n 6 75 1 (b )(1 ). Bri efi n g was co m

p l et edo n Decem

b er 1 , 2 01 7
. 4 2

4 2 Sh o rt l y aft er t h e co n cl u s i o n o f t ri al , th i s Co u rtrel eas edGraev v . Co m m i s s i o n er (Graev II), 1 4 7 T.C. 4 6 0 (2 0 1 6 ), s up p l em en t edan do v erru l edi n (co n ti n u ed ...)- 5 6 -

[* 5 6 ] OnDecem

b er 2 0, 2 01 7 , th i s Co u rt rel eas edGraev v . Co m m i s s i o n er (Graev III), 1 4 9 T.C. _

_ (Dec. 2 0 , 2 0 1 7 ), s up p l em en ti n g an d o v erru l i n g i n p art1 4 7 T.C. 4 6 0 (2 01 6 ). In Graev III, 1 49 T.C. at_ _ (s l i p o p . at1 4 ), as p ert i n en t h ere, t h i s Co u rth el dfo r t h e fi rs t t i m e t h atas p art o f h is b u rd eno f p ro du ct io n t h e Co m m i s s i o n er m

u s to ffer i nt o th e reco rdev i d en ce o f h i s co m pl i an ce wi t h th e wri t ten s up erv is o ry

ap p ro v al req u i rem en to f s ect i o n 6 7 5 1 (b )(1 ). OnJ an uary2 3, 2 0 1 8 , we o rd eredth e p art ies t o ad dres s th e effect o f Graev III o n th i s cas e an dt o fi le an y as s o ci at edm o ti o n s b y Feb ru ary 1 5 , 2 0 1 8. 4 3 OnFeb ru ary 9 , 2 0 1 8 , res p o n d en tfi leda m o ti o n t o reo pen th e reco rdan d t h e d ecl arat io n o f Th eres a Al varez i n s up p o rto f t hatm ot i o n (co l l ect iv el y , res p o n d en t’ s m o t i o n). Rev en u e Ag en tTh eres a Al v arez (RA Al v arez) was t as k ed wi t h ex am in i ng th e Rai fm an s ’ retu rn s fo r th e y ears at i s su e. Res p o n d en t’ s m o t i o n

4 2 (...co n t i nu ed ) p artb y Graev v . Co m

m i s s i o n er (Graev III), 1 4 9 T.C. _

_ (Dec. 2 0 , 2 0 1 7 ), wh ere we h el dth atth e Co m

m i s s i o n er was o n ly

req u i red t o co m

p l y wi t h t h e wri t ten s up erv i s o ry

ap p ro v al req u i rem en to f s ec. 6 7 5 1 (b )(1 ) b efo re t h e act u al as s es s m en t o f ap p li cab l e p en al t i es . Atth e cl o s e o f t h e reco rd , an d t h ro u gh th e co m p l et i o n o f b ri efi n g , Graev II was co n t ro ll i n g i n th i s cas e.

4 3 OnJ an u ary

2 9 , 2 0 1 8 , res p o n d en tfi l ed a res p o n s e t o o u r o rd er d at ed J an u ary 2 3 , 2 0 1 8, n o t i fy i n g th e Co u rtth ath e h adi n fo rm ed t h e Rai fm an s ab o u tth e p en al t y ap p ro v al fo rm

o n J an u ary

2 3 , 2 0 18 , an d i n fo rm i ng th e Co u rtan dthe Rai fm an s o f h i s i n t en tt o fi l e a m o t i o n t o reo p en th e reco rd . See Fed . R. Ev i d
. 9 0 2 (1 1 ).- 5 7 -

[* 5 7 ] s eek s t o reo p en th e reco rdt o ad dd o cu m en taryev i d en ce t h atm ig h tes t ab l i s h h i s co m pl i an ce wi t h th e wri t t en s up erv i s o ry ap p ro val req u i rem en to f s ect i o n 6 7 5 1 (b )(1 ). Res p o n d en t ’ s m ot i o n i n cl u d es a “ Pen al t y Ap pro v al Fo rm ” an d “Neg l i g en ce
o r Di s reg ardo f th e Ru l es o r Reg u l at i on s LeadSh eet6 6 6 2 (c)” (co l lect iv el y , p en al t y ap p ro v al fo rm ). Th e p en al t y ap pro v al fo rm

i nd i cat es th ati twas p rep ared b y RA Al v arez wi t h res p ectt o h er ex am i n at i o n o f t he Rai fm an s ’ retu rn s fo r t h e y ears ati s s u e. A s i g n ature d at edM arch 1 8 , 2 0 1 3 , ap p ears o n th e p en al t y ap p ro v al fo rm i n th e s p ace p ro v i d edfo r “ Gro up M an ag er Ap p ro v al t o As ses s Pen al t i es Id en t i fi edAb o v e”. In h er d ecl arat i o n RA Al varez s t at es th at t h i s s i g n ature i s th at
o f h er t hen -i m

m ed i at e s up erv i s o r, Ro b ert Gee, an dth at s he i s al read y fam i l i ar wi t h t h e s i g n atu re o f M r. Gee, wh o reg u l arl y s i g n edd o cu m en t s s h e h adp rep areddu ri n g h i s t en u re as h er i m

m ed i at e s up erv i s o r. RA Al v arez ad d i t i o nal l y s t at es t h atth i s p en al t y ap p ro v al fo rm

was draft edco nt em

p o ran eo u s l y

wi t h h er ex am i nat i o n o f t h e Rai fm an s ’ retu rn s fo r th e y ears ati s s u e an dth atth es e fo rm s are o f t h e t y p e t h at
em pl o y ees o f t h e IRS reg ul arl y creat e an dk eep i n th e co urs e o f o rd i n ary b u s i n es s . OnFeb ru ary 1 5 , 2 0 1 8, t he Rai fm an s fi l eda co m p et i n g m o t i o n t o reo p en th e
reco rd(Rai fm an s ’ m o t i o n ). Th e Rai fm an s ’ m o t i o n o b ject s t o res p o nd en t ’ s m o t i o n
o n l y i ns o far as the Rai fm an s req u es tth atan y reo p en i n g o f t h e reco rdal s o affo rd- 5 8 -

[* 5 8 ] th em

th e o p p ortun i t y

t o cro ss -ex am i n e M r. Gee an dt o ag ai n cro s s -ex am i n e RA Al v arez. To th i s ex ten t , th e Rai fm an s ’ m o t i on arg u es th atthe p en al t y ap p ro v al fo rm

fai l s t o es t ab l i s h th atRA Al v arez an dM r. Gee ad equ at el y
co n si d eredth ei r reas o nab l e cau s e d efen se t o t h e accu racy -rel at edp en al t i es u n d er
s ect i on 6 6 6 2 fo r t h e y ears at i s s u e. OnFeb ru ary 2 3 , 2 0 1 8, we o rd eredthe p art i es t o res p o ndt o t h es e co m p et i n g
m o ti o n s t o reo pen th e reco rd , an dth e p art i es co m p l i ed
. Th e d eci s io n t o reo p en th e reco rdt o ad m i tad d it i o n al ev i d en ce i s a m at t er wi t h i n th e d i s cret i o n o f t h e t ri al co u rt . Zen it h Rad i o Co rp . v . Hazel t i n e Res earch , In c., 4 0 1 U.S. 3 2 1 , 3 3 1 (1 9 7 1 ); s ee al s o No r-Cal Ad ju s t ers v . Co m

m i s s io n er, 5 0 3 F.2 d3 5 9 , 3 6 3 (9 t h Ci r. 1 9 7 4 ), aff’ g T.C. M em o . 1 97 1 -2 00 . Th i s Co u rt , h o wev er, wi l l n o tex erci s e s u ch d i s cret io n u nl es s th e ev id en ce t h ata p art y s eek s t o ad m i tt o t h e reco rdi s m at eri al an d wi l l ai dth e Co u rti n d et erm i n in g t h e o u t co m e o f t h e
cas e; the reco rdwi l l n o tb e reo p en edt o ad m i tev i d en ce t hati s m erel y cu m u l at i v e
o r i m p each i n g. Bu t l er v . Co m m i s s i o n er, 1 1 4 T.C. 2 7 6 , 2 8 7 (2 0 0 0 ), ab ro gat edo n
o t h er g ro u n d s , Po rt er v . Co m m i s s i o n er, 1 3 2 T.C. 2 0 3 (2 0 0 9 ); s ee SEC v . Ro g ers , 7 9 0 F.2 d1 4 50 , 1 4 6 0 (9 t h Ci r. 1 9 8 6 ). Si m i l arl y , th i s Co u rtwi l l wei g h th e d i l i g en ce o f, an dan y

p reju d i ce t o , th e p art i es wh en d i s po s in g o f m o t i o n s t o reo p en t h e reco rd . See Es t at e o f Freed m an v . Co m m is s i o n er, T.C. M em o . 2 0 0 7-6 1 , s l i p- 5 9 -

[* 5 9 ] o p . at2 6 -2 8; s ee al s o Pu rex Co rp . v . Pro ct er & Gam b l e Co ., 6 6 4 F.2 d1 1 0 5 , 1 1 0 9 (9 t h Ci r. 1 98 1 ) (ci t i n g Sk eh an v . Bd . o f Tru s t ees , 5 9 0 F.2 d4 7 0 , 4 7 8 (3 dCi r. 1 9 7 8 )). Th e Rai fm an s ’ m o t i on ch al l en g edn ei t h er t h e au th en t i ci t y o r ad m i s s i b i l i t y

o f t h e p en al t y

ap p ro v al fo rm

as a b u s i n es s reco rd n o r th e as s o ci at edd ecl arat i o n o f RA Al v arez. 4 4 Ad d i t i o n al l y , th e Rai fm an s d o n o targ u e t h atth e g ran to f
res p o n d en t’ s m o t i o n wo u l db e i m p ro p er i n th atth e p en al t y ap p ro v al fo rm

i s i m m at eri al , cu m

u l at iv e, o r i m

p each i n g . 4 5 In s t ead , th e Rai fm an s ap p ear t o arg u e t h atth ey wo u l d b e p reju di cedi f we ad m i t tedth e p en al t y ap p ro v al fo rm wi th o u t g i v i n g th em

an o p p o rtu n i t y

t o cro s s -ex am i n e RA Al v arez an dM r. Gee. To th i s
ex t en t , the Rai fm an s arg u e t h e p en al t y ap p ro v al fo rm

i s i n su ffi ci en tt o es t ab l i s h

4 4 As a p rel i m in ary

m at ter, we h o l dth atth e p en al t y ap p ro v al fo rm i s ad m i s s i b l e i n th atth e fo rm i s an ad m i s s i b l e b u s i n es s reco rdu n der Fed . R. Ev i d
. 8 0 3 (6 ). See Fed . R. Ev i d . 9 0 2 (1 1 ); s ee al s o Cl o ug h v . Co m m i s s i o n er, 1 1 9 T.C. 1 8 3 , 1 9 0 -1 9 1 (2 0 02 ). By th e s am e m eas u re, we h o l dth atRA Al v arez s u ffi ci en t l y i d en t i fi edan des t ab l i s hedh er fam il i ari t y wi t h t he s i g n ature o f M r. Gee. See Fed
. R. Ev i d . 9 0 1 (b )(2 ).

4 5 Onth e b as i s o f thi s Co u rt ’ s h o ld i n g s i n Graev II an dGraev III, s ee s up ra n o t e 4 2, t h e reco rdb efo re u s l ack s an y ev id en ce up on wh i ch we m ay as cert ai n wh et h er t h e Co m

m i s s i on er co m

p l i edwi t h the wri t t en s up erv i s o ry ap pro v al req u i rem en to f s ec. 6 7 5 1(b )(1 ). Acco rd i ng l y , the p en al t y ap p ro v al fo rm

i s b y i t s n atu re m at eri al an dm an i fes t l y n o tcu m u l at iv e, as ad m is s i o n o f t h e p en al t y ap p ro v al fo rm

i n t o ev i den ce wo u l ds t an d t o i n fl uen ce t h i s cas e’ s o u t co m e b y b ei n g t h e o n ly reco rdi n ev id en ce t h atm i g h tes t ab l i s h wh et h er t h e Co m m is si o n er actu al l y co m p li edwi t h t h e req ui rem en to f s ec. 6 7 5 1 (b )(1 ).- 6 0 -

[* 6 0 ] wh et h er RA Al v arez o r M r. Gee ad equ at el y co n s id eredth e ap p l i cab i l i t y o f
an y reas o n ab le cau s e p en al t y d efen s e av ai l ab l e t o t h e Rai fm an s an dth atth e o n l y
m ean s o f es t ab l i s h i n g s u ch i s thro u g h cro s s -ex am i n at i o n . Sect io n 6 7 5 1 (b )(1 ) req u i res o n l y th at“ t h e i n i t ial d et erm i n at i o n * * * [o f t h e
accu racy -rel at edp en al ty

b e] p ers o n al ly

ap p ro v ed(i n wri t i n g) b y th e i m m ed i at e
s up erv i s o r” o f t he i n di v i du al wh o d et erm i n edth atthe p en al t y i s ap p l icab l e. W e
are n o tp ers u ad edb y

th e Rai fm an s ’ arg u m en tth atad d it i o n al cro s s -ex am i n at i o n i s
n eces s ary t o av o i dp reju d ice. Fi rs t , th e p en al t y

ap p ro v al fo rm , as d o cu m en taryev i d en ce o fferedas p art o f
res p o n d en t’ s m o t i o n, wi l l i n d i cat e t hatres p o n d en tei t her d i do r d i dn o t co m p l y wi t h th e wri t t en s up erv i s o ry ap p ro val req u i rem en to f s ect i on 6 7 5 1(b )(1 ). W e ag ai n n o t e t h atth e Rai fm an s ’ m o t i o n an ds ub s equ en tres p o n s e fai l edt o ch al l en g e t h e p en al t y

ap p ro v al fo rm

o r i t s at t ach edd ecl arat i o n i n an y res p ect , ev i d en t i ary

o r
o t h erwi s e. Ab s en t s uch a p ri m a faci e ch al l en ge we are l eftwi t h t h e co n v i ct i o n t h atad m i s s i o n o f t h e p en al t y fo rm wo u l dn o tp reju d ice t h e Rai fm an s , an dth at fu rt her cro s s -ex am in at i o n i s u n n eces s ary . Seco n d , t o th e ex ten tth e Rai fm an s req u es tth e o pp o rtu n i t y t o cro s s -ex am i n e RA Al v arez an dM r. Gee wi t h res p ectt o wh et h er t h ey ad equ at el y

co n t em p l at ed t h e Rai fm an s ’ reas on ab l e cau s e d efen s e, we d et erm in e t h ats u ch a l i n e o f- 6 1 -

[* 6 1 ] qu es t i o n i n g wo u l db e i m m at eri al an d wh o l l y

i rrel ev an tt o as cert ai n i ng wh et h er res p on d en tco m

p l i edwi t h t h e wri t t en s up erv is o ry ap pro v al req u irem en t
o f s ect i o n 6 7 51 (b )(1 ) o r t he m eri t s o f t h e Rai fm an s ’ reas on ab l e cau s e d efen s e t o
accu racy -rel at edp en al ti es u n d er s ect i o n 6 6 6 2 fo r t h e y ears ati s s ue. Th e wri t t en
s up erv i s o ry

ap p ro v al req u i rem en to f s ect i on 6 7 5 1(b )(1 ) req u i res ju s tth at : wri t t en
s up erv i s o ry

ap p ro v al . W e d ecl i n e t o readi n t o s ect i on 6 7 5 1 (b )(1 ) t h e s ubt ex tu al req u i rem en tad v ocat edb y th e Rai fm an s i n th ei r req u es tfo r ad d i t i o n al cro s s ex am i n at i o n . Si m i l arl y , we b el i ev e i two u l db e i m p ru d en tfo r t h i s Co u rtt o n o w b eg in ex am i n i n g t h e p ro p ri ety o f t h e Co m

m i s s i o ner’ s ad m i n i s trat i v e p ol i cy o r p ro cedure u n d erl y i n g h i s p en al t y d et erm i n at i o n s . See Green b erg ’ s Ex p res s , In c. v . Co m m i s s i o n er, 6 2 T.C. 3 24 , 3 2 8 -3 2 9 (1 9 7 4 ). 4 6 Thu s , we can n otco n cl u d e t h atth e Rai fm an s wo u l db e p reju d iced
. Acco rd i ng l y , res p on d en t’ s m o t i o n wi l l b e g ran t edan d t h e p en al t y ap p ro v al fo rm i s recei v edi n to ev id en ce. Th e Rai fm an s ’ m o t i o n wi l l b e d en i ed
. Reco g n i zi n g the p art i es co n ces s i o n s , an di n t h e l i g h to f o u r h o ld i n g s ab o v e an d

4 6 Th e ru l e s t at edb y

th is Co u rti n Green b erg ’ s Ex p res s , In c. v . Co m m i s s i o n er, 6 2 T.C. 3 24 (1 9 7 4 ), p red at es th e ad di t i o n o f t h e wri t t en s up erv i s o ry

ap p ro v al req u i rem en to f s ec. 6 7 5 1 (b )(1 ) t o t he Co d e. Co n g res s u n d ers t o o dth e l o n gs t an di n g ru l e o f Green b erg ’ s Ex p res s wh eni t en act eds ec. 6 7 5 1 (b )(1 ) an datth att i m e d idn o t d eem i tn eces s ary

t o ex p an do ur ju ri sd i ct i o n o r o v ertu rn o u r p reced en t , as th e Rai fm an s ad vo cat e h ere. See Lo ri l l ardv . Po n s , 4 3 4 U.S. 5 7 5 , 5 8 0 (1 9 7 8 ).- 6 2 -

[* 6 2 ] o u r d i s cu s si o n b el o w , we h o l dth atres p o n d en t h as s at i sfi edh i s b u rd en o f p ro duct i o n . B. Reas on ab l e Cau s e, J u s ti fi edRel i an ce On ce t h e Co m

m i s s io n er m eet s h i s b u rd en , th e b u rd eno f p ro o f i s o n t h e t ax p ay er t o p ro v e t h at t h e ap p l i cat i o n o f t he p en al t y i s i n ap pro p ri at e. See Hi g b ee
v . Co m m i s s i o n er, 1 1 6 T.C. at4 4 6 -4 4 7
. Th e Rai fm an s arg u e t h atth e accu racy rel at ed p en al t i es are i n ap p ro p ri at e, as th ey act edwi th reas on ab l e cau s e an di n g o o dfai t h i n rel y i n g o n t h e t ax ad v ice o f M r. Ram os an d M r. Sh aw. Th e accu racy -rel at edp en al t y wi ll n o tap pl y

t o an y p o rt i o n o f t he
u n d erp aym en t fo r wh i ch a t ax p ay er es t ab l i s h es t hath e o r s h e h adreas o nab l e cau s e
an d act edi n g o od fai t h . Sec. 6 6 6 4 (c)(1 ). Th e d et erm i n at i o n o f wh et h er a t ax p ay er act edwi t h reas o n ab l e cau s e an di n g o o dfai t h i s m ad e o n a cas e-b y -cas e b as i s , t ak i n g i n t o acco u n t al l th e p ert i n en tfact s an dci rcu m s t an ces , i n cl u d i n g h i s o r h er effo rt s t o as s es s the p ro p er t ax l i ab i l i t y , th e kn o wl ed g e an dex p eri en ce o f t h e t ax p ay er, an dth e ex t en t t o wh ich h e o r s h e rel i edo n th e ad v i ce o f a t ax p ro fes s i on al . See s ec. 1
. 6 6 6 4-4 (b )(1 ), In co m e Tax Reg s . A t ax p ay er act s wi t h reas o nab l e cau s e wh en h e o r s h e ex erci s es o rd i n ary b u s i n es s care an dp ru d en ce wi t h res p ectt o a d i s pu t ed t ax i t em . Neo n at o l o g y As s ocs ., P.A. v
. Co m

m i ss i o n er, 1 1 5 T.C. 4 3 , 9 8 (2 0 0 0 ), aff’ d, 2 9 9 F.3 d 2 2 1 (3 d- 6 3 -

[* 6 3 ] Ci r. 2 0 0 2). Go o d -fai th rel i an ce o n t he ad v i ce o f an i n d ep en d en t , co m p et en t p ro fes s i on al as t o t h e t ax treat m en to f an i t em m ay m eetthi s req ui rem en t . See s ec. 1 .6 66 4 -4 (b )(1 ), In co m e Tax Reg s . A t ax p ay er act s i n g oo d fai t h wh en h e o r s h e act s up o n h o n es tb el i ef an dwi t h i n t en tt o p erfo rm al l l awfu l o b l i g at i o ns . See Ru t ter v . Co m

m i s s i o n er, T.C. M em o . 2 0 1 7-1 7 4 , at* 4 5
. A t ax p ay er al l eg i ng reas o n ab l e, g o o d -fai th rel i an ce o n th e ad v i ce o f an i n d ep en den t , co m

p et en tp ro fes s i o n al m

u stp ro v e th at(1 ) th e ad v i s er was a
co m p et en tp ro fes s i o n al wh o h ads u ffi ci en tex p ert i s e t o ju st i fy rel ian ce, (2 ) t h e t ax p ay er p ro v i d edn eces s ary an daccu rat e i n fo rm at i o n t o th e ad v is er, an d (3 ) t h e t ax p ay er act u al l y

rel i edi n g o o dfai t h o n th e ad vi s er’ s ju d g m en t . Neo n at o l og y As s ocs , P.A. v . Co m

m i s s io ner, 1 15 T.C. at9 9 . A t ax p ay er’ s u n co n d i ti o n al rel i an ce o n an o t h erwi s e qu al i fi edp ro fes s i o nal d o es n o tco ns t i tu t e reas on ab l e rel i an ce i n g o od fai t h fo r p urp os es o f s ect io n 6 6 6 4(c)(1 ). See St o ug h v . Co m m i s s i o n er, 1 4 4 T.C. 3 0 6 , 3 2 3 (2 0 1 5). A t ax p ay er as s ert i n g reas o n ab l e rel i an ce m

us ts h o wth atth e o p i n i o n o f a qu al i fi ed ad v i s er t o o k i n t o acco u n tal l fact s an dci rcu m s t an ces an dwas n o tb as edo n u n reas o n ab l e fact s o r l eg al
as s u m pt i o n s . Sec. 1 .6 6 6 4 -4 (c)(1 ), In co m e Tax Reg s . Si m i l arl y , a t ax p ay er can n o t
reas on ab l y

rel y o n th e p ro fes s io n al ad v i ce o f an i n d i v idu al th e t ax p ay er kn o ws , o r
s h o u ldkn o w, t o b e an i n s i d er o r a p ro m o t er o f a p art i cu l ar t ax s ch em e, o r t o h av e- 6 4 -

[* 6 4 ] an i n h eren tco n fl i cto f i n t eres t . New Ph o en i x Su n ri s e Co rp . v . Co m m i s s i o n er, 1 3 2 T.C. 1 6 1 , 1 9 3 -1 9 5 (2 0 0 9), aff’ d , 4 08 F. Ap p’ x 9 0 8 (6 t h Ci r. 2 0 1 0 ); M ari ne v . Co m

m i s s i o n er, 9 2 T.C. 9 5 8 , 9 9 2 -9 9 3 (1 9 8 9), aff’ d wi t ho u t p ub l i s h edo p i n i o n, 9 2 1 F.2 d2 8 0 (9 t h Ci r. 1 9 91 ). Fi rs t , we o b s erv e th atth e Rai fm an s jet t i s o n edth ei r fo rm er C.P.A. aft er el ect in g t o en g ag e i n the Cl as s i cSt ar an dDeri v i u m p ro g ram s an ds h o rt l y

aft er M r. Ram o s h adp res en t edthatC.P.A. wi t h m at eri al s reg ard i n g th e Rai fm an s ’ p art i ci p at i o n i n th e Cl as si cSt ar p ro g ram . Fo l l o wi n g th i s p art in g o f way s th e Rai fm an s tu rn edt o M r. Ram o s fo r referral t o a ret u rn p rep arer. M r. Ram o s , th e i n d i v i du al wh o s o l d t h e Rai fm an s o n th e t ran s act i o n s ati s s u e, h ad a p ro fes s i o n al i n t eres ti n d el i v eri n g th e Rai fm an s a retu rnp rep arer wh o wo u l d res pect tho s e t ran s act io n s , p art i cu l arl y

as they h ad n ots o u g h t o r s ecu redan y l eg al o r t ax ad v i ce b efo re en g ag i n g i n t h em . Acco rd i n g l y , M r. Ram o s referred th e Rai fm an s t o M r. Sh aw, wh o th ey

h i reds i g h tu n s een . Seco n d , as M r. Sh aw’ s t es t i m o n y an dth e rem ai n d er o f t he reco rdi l l u s t rat e, M r. Sh aw d i dn o t p ro v i d e t h e Rai fm an s wi t h an y actu al i n d ep en d en tan do b ject i v e t ax ad v i ce. M r. Sh aw d i d n o tex am i n e t h e s ub s t an ce o f an y o f t h e t ran s act i o n s wh i ch th e Rai fm an s h adh i red h i m t o rep o rto n . In d eed , M r. Sh aw’ s en g ag em en t wi t h th e Rai fm an s ex p res s l y l i m i t edthe s co p e o f h i s res p o n s i b i l i t i es . An y- 6 5 -

[* 6 5 ] i n d ep en den tad v i ce t h at M r. Sh aw m ay h av e ren d eredwas n o tb as edo n h is
o wnrev i ew o f al l p ert i n en tfact s an dci rcu m s t an ces . M r. Sh aw, i n s t ead , cl o s el y
co o rd i n at edwi t h M r. Ram o s , an do t h er p ro m o ters , i n h is p rep arat i o n an dd efen s e
o f t h e Rai fm an s ’ retu rn s fo r th e y ears ati s s u e an das s u m edthe v eraci ty o f t h e fact ual an dl eg al rep res en t at i o ns o f t h o s e i n d i v i du al s . 4 7 Ad d it i on al l y , we o b s erv e t h atth e Rai fm an s are s o p h is ti cat ed i n d i v idu al s wh o s e ex p eri en ce an d s av v y o u g h t t o h av e cl u ed t hem i n, earl y o n , t o t h e real i t y t h atth e t ax b en efi t s t o ut edb y th e Deri v iu m

an dCl as si cSt ar p ro g ram s were t o o g o o dt o b e t ru e. W i t h res pect t o th e Deri v i u m t ran s act i o n , th e Rai fm an s d i rect ed M r. Ram os t o rev i ew t h e p ro gram wi t h an o u t s i d e ad vi s er, a l i cen sedC.P.A. an d at t o rn ey , an at t o rn ey

wh o d ecl i n edt o en g ag e i n an y s u ch rev i ew. Un d au n t ed , th e Rai fm an s s o u g h tn o fu rt h er ex pert i s e, co n s u l t ed n o o t h er p ro fes s io n al s , an d
en g ag edi n a s eri es o f Deri v i u m tran s act i o n s d es p i t e t h ei r o wnm i sg i v i n g s . M o re eg reg i o u s l y , th e Rai fm an s s o u g h tn o o ut s i d e co un s el , wi t h res p ectt o t h e t ax b en efi t s o f t h e Cl as s icSt ar p ro g ram b efo re ch o o s in g t o p art i ci p at e i n th e p ro g ram .

4 7 W i t h res p ectt o th e Rai fm an s ’ o ri g i nal l y cl ai m edd edu ct i o n fo r a $ 15 m i l l io n t heft l o s s fo r t ax y ear 2 0 0 8 , M r. Sh aw t es t i fi ed , wi t h o u tel ab o rat i o n , th at h e d et erm i n edth i s d edu ct i o n wo u ldb e p ro p er p u rs uan tt o t h e arb i t rat i o n d eci s i o n . W e o b s erv e t h atM r. Sh aw’ s d et erm i n at i o n i n th i s reg ards i m i l arl y rel ies o n u n reas o nab l e as s u m

p t io ns wi t h res p ectt o t h e d edu ct i o n cl ai m edo r co m p l et el y d i s reg ard s ru l es an d reg u l at i o n s wh i ch p ro s cri b e d edu ct i o n s fo r t h eftl o s s es u n ti l n o reas o nab le p ro s pect o f reco v ery ex i st s .- 6 6 -

[* 6 6 ] To t h i s ex t en t , th e Rai fm an s ’ as s ert i o n o f rel i an ce o n th e ad v i ce o f M r. Sh aw i s ag ai n u n reas o nab l e, as th ei r act io n s rev eal a l acko f reas o n ab l e b u s i n es s care
an d p ru d en ce o n th ei r p art . See Neo n at o l o g y As s oci at es , P.A. v . Co m m i s s i o n er, 2 9 9 F.3 dat2 3 4 (“ Wh en , as h ere, a t ax pay er i s p res en t edwi t h wh atwo u l dap p ear t o b e a fab u l ou s o p p o rtu n it y t o av o i d t ax o b l i g at i o n s , h e s h o u l d reco g ni ze t h ath e p ro ceed s ath i s o wnp eri l .”); New Ph oen i x Su n ri s e Co rp . v . Co m m is s i o n er, 1 3 2 T.C. at1 9 5
. Onth e reco rdb efo re u s , an y o b ject i v e an d i nd ep en d en tad v i ce t h e Rai fm an s
m ay h av e recei v edd idn o t co m e fro m M r. Sh aw. Th e Rai fm an s en g ag edM r. Sh aw as a s t ri ct l y

p ro p h y lact i c m eas u re. To th e ex t en tM r. Sh aw ren d eredan y ad v ice, t h e Rai fm an s ei t her k n ew, o r s h o u l dh av e kno wn , th ats u ch ad v i ce was
m o oredt o th e rep res en t at io n s o f M r. Ram o s an d o t h ers ri d d l edwi t h co n fl i ct s
s t em m i n g fro m th ei r ro l es as p ro m o ters an d i n s i d ers o f t h e tran s act i o ns ati s s u e. Th u s, an y rel i an ce o n M r. Sh aw i s o b j ect i vel y u n reas o nab l e. Acco rd i n g l y , we
s u s t ai n res p o n den t ’ s d et erm i nat i o n t h atp et i t i o n ers are l i ab l e fo r accu racy -rel at ed p en al t i es fo r t h e y ears ati s s u e, co n s i s t en t wi th o u r h o l d i n g s ab o v e.- 6 7 -

[* 6 7 ] To refl ectthe fo reg o i n g , Anap p ro p ri at e o rd er wi ll b e i s s u ed , an dd eci s i on wi l l b e en t ered
u n der Ru l e 1 5 5
.