1994 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

7-12-1994

United States of America v. Wexler

Precedential or Non-Precedential:

Docket 93-5719

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Recommended Citation

"United States of America v. Wexler" (1994). 1994 Decisions. Paper 81.

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1 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

_______________ 

No. 93-5719 

_______________ 

UNITED STATES OF AMERICA 

 Petitioner 

v. 

VICTOR WEXLER 

 Respondent 

HONORABLE JOHN W. BISSELL 

 Nominal Respondent 

_______________ 

On Petition for a Writ of Mandamus or Prohibition 

 to the United States District Court 

for the District of New Jersey 

(Related to D.C. No. 91-00181) 

_______________ 

Argued February 4, 1994 

BEFORE: GREENBERG AND ROTH, Circuit Judges 

and POLLAK, District Judge0

(Filed: July 14, 1994) 

_______________ 

 Paul A. Weissman (Argued) 

 Edna B. Axelrod 

 Office of United States Attorney 

 970 Broad Street 

 Room 502 

 Newark, NJ 07102 

 Attorneys for Petitioner 

 Peter B. Bennett (Argued) 

 Picco, Mark, Herbert, Kennedy, 

 Jaffe and Yoskin 

 One State Street Square 

 50 West State Street, Suite 1000 

 Trenton, NJ 08607 

 

0Honorable Louis H. Pollak, Senior United States District Judge 

for the Eastern District of Pennsylvania, sitting by designation. 
2 

 Attorney for Respondent 

________________ 

OPINION OF THE COURT 

_______________ 

POLLAK, District Judge. 

 Before us is a petition from the United States for a 

writ of mandamus or prohibition directed to the Honorable John W. 

Bissell, United States District Judge for the District of New 

Jersey. The government's petition arises out of a pretrial order 

entered in a criminal tax fraud case against Victor Wexler which 

is to be tried before Judge Bissell. The order adopted a jury 

instruction on "genuine indebtedness" that, in the government's 

view, undermines a well-settled prohibition against deducting 

interest payments resulting from "sham transactions" -- i.e. 

transactions entered into with no purpose other than to generate 

tax benefits. The government argues that the instruction adopted 

by the district court is clearly erroneous under settled law, and 

that the government will be unable to proceed with the present 

prosecution and will be severely prejudiced in other tax fraud 

prosecutions if the order remains in force. Wexler, responding 

to the petition0, contends that the proposed instruction is a 

proper statement of the law and that, in any event, the 

extraordinary appellate intrusion on trial court proceedings 

 

0In formal terms, the judge of the district court is the person 

to whom the petition for mandamus is directed. But the defendant 

in the underlying criminal prosecution is of course the real 

party in interest. Accordingly, the caption of this case 

characterizes Victor Wexler as "respondent" and Judge Bissell as 

"nominal respondent". 
3 

sought by the government is unwarranted. We conclude that the 

petition should be granted. 

Background 

 Between 1980 and 1985, the defendant in the underlying 

tax prosecution, Victor Wexler, served first as chief financial 

officer and subsequently as managing partner of McMahan, Brafman, 

Morgan & Co. ("MBM"), a limited partnership engaged in securities 

trading. Wexler was initially indicted on March 19, 1992. 

Subsequently a superseding indictment was filed. The superseding 

indictment consists of eight counts, and charges Wexler with, 

under count 1, conspiring (i) to defraud the United States by 

obstructing the lawful government functions of the I.R.S. in 

violation of 18 U.S.C. § 371, and (ii) to aid and assist in the 

preparation of false tax returns in violation of 26 U.S.C. 

§7206(2); under count 2, aiding and assisting in the preparation 

of a U.S. Partnership Income Return, Form 1065, for MBM, for 

calendar year 1984, which falsely represented that MBM had 

incurred a loss of $75,491,898, in violation of 26 U.S.C. 

§7206(2); under count 8, making and subscribing a joint 

individual income tax return, Form 1040, falsely representing 

that Wexler was entitled to a deduction of $103,928 flowing from 

his MBM partnership interest, in violation of 26 U.S.C. § 

7206(1); under counts 3-7, aiding and assisting in the 

preparation by others of joint individual income tax returns, 

Form 1040, falsely representing that the taxpayers were entitled 

to deductions flowing from their MBM partnership interests, in 
4 

violation of 26 U.S.C. § 7206(2). Superseding Indictment, 

Appendix ("App.") at 5-21. The superseding indictment alleges 

that Wexler created over $160 million in fraudulent tax 

deductions for the MBM partnership from 1982 through 1986. 

According to the superseding indictment, the allegedly fraudulent 

deductions were the product of financial arrangements known as 

"repo to maturity" transactions. 

 "Repo" transactions: In order to be able to parse the 

charges against Wexler one needs to have a general understanding 

of what "repo" transactions are and how they work. In its brief 

in this court, as in its submissions to the district court, the 

government has described and provided examples of such 

transactions and their mechanics. Government Br. at 5-15. Since 

Wexler's brief does not quarrel with the government's exposition, 

we rely upon that exposition in this section of this opinion. 

 The word "repo" is an abbreviation for "repurchase 

agreement", the name given to a type of transaction commonly 

employed by firms dealing in government securities. The 

transaction -- which may be consummated in a matter of days but 

may also span weeks or even a few months -- is a sale of 

government securities, such as treasury notes, by one securities 

dealer to another, followed by their repurchase at a later date. 

But what is in form a sale and repurchase turns out in fact to 

constitute a loan for which the securities, during the interval 

between sale and repurchase, stand as collateral. An example may 

serve to illustrate how such a transaction works: 
5 

 Firm A sells Treasury notes with a face value of 

$1,000,000 to Firm B; the price paid by B to A -- the "repo 

principal" -- is a negotiated figure presumably geared to the 

market value of the notes at the date of sale; A concurrently 

contracts with B to buy the notes back at the same price at an 

agreed future date -- e.g. thirty days or sixty days hence --

which is earlier than the maturity date of the notes; on that 

future date B returns the securities to A, A repays the repo 

principal, and A also pays "repo interest", a sum negotiated 

along with the repo principal at the outset of the transaction, 

and presumably geared to the short-term interest rate then 

governing loans for the particular time-period -- thirty days, or 

sixty days, or whatever -- covered by the transaction. 

 The extent to which the "repo" turns out to be 

financially advantageous to A depends on what happens, during the 

course of the transaction, to (a) the market value of the 

securities, and (b) short-term interest rates. A hopes that, at 

the transaction's closing date, the reacquired securities will be 

worth more and short-term interest rates will be lower than when 

the transaction began. Under that fortunate combination of 

circumstances A would have the capability of entering into a 

second repo on substantially more favorable terms than the 

first.0

 

0A might, of course, prefer to (a) sell the securities and 

harvest the gain, or (b) hold the securities with an eye to a 

further rise in market value. 
6 

 The particular repo just described is one in which, as 

already noted, the transaction terminates on a date, agreed upon 

by the parties, which is earlier than the maturity date of the 

securities. That transaction is called an "open repo". If the 

repo's date of termination is the maturity date -- the date on 

which the Treasury pays to the securities-holder the face value 

of the securities plus accrued coupon interest -- the transaction 

is called a "repo-to-maturity". This litigation involves the tax 

consequences of repo-to-maturity transactions. 

 At its commencement a repo-to-maturity looks like an 

open repo, in the sense that A (a) transfers its Treasury 

securities to B in exchange for an agreed sum of repo principal 

and (b) promises that at the maturity date it will pay B an 

agreed amount of interest. But at that point the resemblance to 

an open repo ends. For, in a repo-to-maturity, A will not, at 

the maturity date, recover the securities it has transferred to 

B. The securities will have matured, and in lieu thereof B will 

pay A what the Treasury owes B as securities-holder -- namely, 

the face value of the securities plus the accrued coupon 

interest. 

 In contrast with the open repo, in which A's profit or 

loss turns on what happens to the market value of the securities 

and to short-term interest rates while the transaction is 

pending, the repo-to-maturity dictates ex ante the payout at 

maturity. Indeed, from a profitability perspective A has no 

occasion to enter into a repo-to-maturity unless the coupon 

interest A will receive at maturity exceeds the interest it will, 
7 

at the inception of a repo-to-maturity, have to obligate itself 

to pay to B at maturity. If coupon interest is equal to or less 

than the market interest rate prevailing at the time A is 

considering a repo-to-maturity, A would normally eschew the repoto-maturity and either (a) hold the securities until they mature, 

or (b) sell them outright. 

 In this case, the government alleges that MBM, the firm 

of which defendant Wexler was, variously, chief financial officer 

and managing partner, entered into numerous repo-to-maturity 

transactions, designed by Wexler, in which MBM agreed to pay out, 

and in fact did pay out, more in market interest than it received 

in coupon interest. Moreover, according to the government's 

allegations, it was part of Wexler's design that his firm 

purchase the securities and "repo" them simultaneously. The 

entire purpose of the transaction, so the government contends, 

was to create interest expenses that could, for tax purposes, be 

treated as a cost of business to be offset against profits from 

other transactions.0

 Key to the effectuation of the scheme as described by 

the government was that the repo-to-maturity period was 

constructed to span two tax years. In the hypothetical example 

proffered by the government to the district court, and renewed in 

its brief to this court, the three-month repo-to-maturity 

 

0The repo interest rate was set at .01% above the 6.0% coupon 

interest rate, thus yielding the repo lender -- the other party 

to the repo -- a quite modest return (which the government 

characterizes as a "fee", Petition for Writ of Mandamus or 

Prohibition, at 3) for cooperating in establishing the repo. 
8 

transaction would run from November 1 in the first tax year, the 

date on which the securities were purchased and immediately 

repoed, to February 1 in the second tax year, the date on which 

the securities were to mature. This calendar arrangement would 

make it possible for the interest owed in November and December 

to be treated as a deductible expense in the first tax year, 

while the November-December-January coupon interest -- partially 

offset by the January interest payment -- would not need to be 

reported as income until the second tax year. Although in the 

aggregate two months of interest deductions in the first tax year 

would appear to be balanced by two months of interest income in 

the second tax year, the apparent symmetry is illusory from a 

revenue standpoint: it would not be until the filing of the 

return for the second tax year that the government would recoup 

the taxes not paid in the first tax year, with the result that 

the government would for a year lose the use of the sum 

ultimately recouped.0

 In sum, the government contends that the repo-tomaturity device illustrated above was the centerpiece of a 

conspiracy in which, according to ¶ 9 of the superseding 

indictment, Wexler and others undertook, between 1982 and 1986, 

"to generate more than $740 million ($740,000,000) in fraudulent 

interest expenses chargeable to MBM", which "fraudulent expenses 

were in turn used by WEXLER and his co-conspirators to create 

 

0Conversely, the taxpayer would, of course, gain the value of 

having the use of that money for the additional year. 
9 

more than $160 million ($160,000,000) in bogus tax deductions for 

the partners of MBM." 

 The November 30, 1993 Order: In October, 1993, the 

government moved for a declaration of various principles of tax 

law in order to preclude certain defenses that prosecutors 

anticipated from Wexler. The government's motion contained the 

following proposed jury instruction: 

I instruct you that, if [the government securities 

transactions in this case] were sham transactions, then 

interest and other expenses that MBM incurred as a 

result of the transactions were not deductible. Whether 

or not the transactions were shams is a question that 

is for you to decide. I instruct you, however, that 

you must find the transactions were sham transactions 

if you determine two things beyond a reasonable doubt: 

First, that MBM had no business purpose for entering 

into the transactions other than to obtain tax 

benefits; and 

Second, that there was no reasonable possibility that 

MBM could earn a profit on the transactions apart from 

tax benefits. 

 Defendant also proposed a jury charge to the court, 

which included the following instruction: 

Assuming the Government has proven that the 

governmental security trades were sham transactions 

(i.e. no business purpose and devoid of economic 

substance), you cannot convict the defendant if you 

find that the interest expenses at issue were the 

product of a "genuine indebtedness". In other words, 

regardless of any conclusions you reach as to the 

motivation of the defendant or the lack of economic 

substance, the existence of a genuine debt between MBM 

and its trading partners, will permit the deduction of 

interest. Under the tax laws, even a sham transaction 

may have elements that have economic substance, and 

these elements of the transaction must be respected for 

tax purposes. Accordingly, if you find that the 

financing agreement to purchase the government 

securities is genuine and enforceable, the interest may 

be deducted. 
10 

 In its November 30, 1993, Order the district court 

adopted an instruction on sham transactions to be delivered to 

the jury. The court's instruction adopted both parties' central 

suggestions, including the "genuine indebtedness" paragraph, 

above, proposed by defendant. The court's instruction, in 

relevant part, is as follows: 

 I instruct you that, if these transactions in 

government securities were sham transactions, then 

interest and other expenses that MBM incurred as a 

result of the transactions were not deductible, with 

certain exceptions I will explain in a moment. Whether 

or not the transactions were economic shams is a 

question that is for you to decide. I instruct you, 

however, that you must find the transactions were sham 

transactions if you determine two things beyond a 

reasonable doubt: 

First, that MBM had no business purpose for 

entering into the transactions other than to 

obtain tax benefits; and 

Second, that there was no economic substance to 

the transaction, that is there was no reasonable 

possibility that MBM could earn a profit on the 

transactions apart from tax benefits. 

* * * 

Genuine Indebtedness

 Assuming the government has proven that the 

governmental security trades were sham transactions 

(i.e. no business purpose and devoid of economic 

substance), you may convict the defendant on the count 

you are considering only if you find that the interest 

expenses at issue were not the product of a "genuine 

indebtedness." In other words, regardless of any 

conclusions you reach as to the motivation of the 

defendant or the lack of economic substance in any 

transaction as a whole, the existence of a genuine debt 

between MBM and a trading partner, could permit the 

deduction of interest under the Internal Revenue Code. 

Under the tax laws, even an economic sham transaction 

may give rise to genuine indebtedness and could 

generate lawful interest deductions. 
11 

 Genuine indebtedness exists if the parties 

intended to create and enforce a binding obligation on 

the part of MBM to pay interest on a loan. In 

determining whether genuine indebtedness exists in a 

particular transaction, you must consider the substance 

of the transaction, as intended by the parties, not 

only the form that the transaction took. You may 

consider all relevant evidence bearing on the parties' 

intent. Among your duties as jurors, you must 

carefully analyze the evidence applicable to each count 

to see if one or more obligations generating a genuine 

indebtedness with actual, deductible interest was or 

was not present. The government must prove the lack of 

genuine indebtedness beyond a reasonable doubt. 

District court Order of November 30, 1993. 

 The government objected to the district court's order, 

and moved for reargument. The district court denied the motion 

and similarly denied a stay of trial while the government 

petitioned this court for mandamus or prohibition. We 

subsequently granted a stay pending decision on the petition. 

 The government seeks the extraordinary relief of 

mandamus or prohibition (which we will, hereafter, treat simply 

as a petition for mandamus) because it contends that (1) the 

district court's announced jury instruction on genuine 

indebtedness is clear legal error; (2) the government will be 

unable to proceed to trial in good faith within the rubric of 

that instruction and will, therefore, have to move to dismiss the 

indictment; (3) the error is unappealable; and (4) the district 

court's ruling, if allowed to stand, will affect other cases by 

virtue of setting an erroneous rule that makes tax cases 

involving sham transactions far more difficult to prosecute. 
12 

 Resolution of the petition before us hinges upon two 

questions: First, is the instruction on genuine indebtedness 

contained in the district court's November 30, 1993, Order 

clearly erroneous? Second, if the answer to the first question 

is "yes", is the error one whose probable consequences meet the 

strict standard for granting a writ of mandamus? 

The proposed instruction 

 The government's principal argument is that the 

district court's November 30, 1993, Order adopts an instruction 

that is patently contrary to the law. Specifically, the 

government argues that economic sham transactions cannot generate 

lawful deductions of interest expense, even if they involve the 

payment of interest on "genuine indebtedness". Gov't Br. at 27. 

 1) General rule on sham transactions: The general rule 

on sham transactions in this circuit is well-established: "If a 

transaction is devoid of economic substance . . . it simply is 

not recognized for federal taxation purposes, for better or for 

worse. This denial of recognition means that a sham transaction, 

devoid of economic substance, cannot be the basis for a 

deductible loss." Lerman v. Comm'r of Internal Revenue, 939 F.2d 

44, 45 (3rd Cir. 1991), cert. denied, 112 S.Ct. 1940 (1992). 

Lerman reflects the fundamental and long-standing rule that 

taxation depends on the substance, not the form, of transactions. 

See e.g. Gregory v. Helvering, 293 U.S. 465, 469-70 (1935). 

 Where a transaction has no substance other than to 

create deductions, the transaction is disregarded for tax 
13 

purposes. Knetsch v. United States, 364 U.S. 361, 366 (1960); 

Demartino v. Commissioner, 862 F.2d 400, 401 (2nd Cir. 1988). 

Deductions for expenses resulting from such transactions are not 

permitted. James v. Commissioner, 899 F.2d 905, 908 n.4 (10th 

Cir. 1990) ("transactions lacking an appreciable effect, other 

than tax reduction, on a taxpayer's beneficial interest will not 

be recognized for tax purposes"); Yosha v. Commissioner, 861 F.2d 

494, 499 (7th Cir. 1988) (where transactions "were devices whose 

only possible or contemplated effect was to avoid taxes, and a 

fortiori they were not engaged in for profit", resulting 

deductions violate the tax code). 

 Wexler does not challenge the sham-transaction doctrine 

in general. Rather, Wexler argues that the doctrine does not 

apply to deduction of interest payments pursuant to § 1630 of the 

tax code if the taxpayer's obligation to pay the interest is 

binding and enforceable. Wexler grounds his arguments in both 

the statute and the case law. First, he argues that § 163 

differs from other sections of the code by not requiring that the 

underlying transaction be motivated by profit. Second, he argues 

that a modern trend in the case law favors allowing deductibility 

of genuine debt, even when related to a sham transaction. We 

address these arguments in order. 

 2) Deductibility under § 163: Section 163(a) of the 

Internal Revenue Code, 26 U.S.C. § 163(a), states that "[t]here 

shall be allowed as a deduction all interest paid or accrued 

 

026 U.S.C. § 163, see infra. 
14 

within the taxable year on indebtedness."0 Wexler argues that 

"[i]n contrast to other sections of the Internal Revenue Code 

allowing for deductions, Section 163 does not require any profit 

motive or the conduct of a trade or business in order to claim 

the deduction for interest expense." Respondent's Br. at 20. The 

apparent thrust of the argument is that, unlike deductions taken 

pursuant to other sections of the Code, deductions under §163 are 

permitted for interest obligations resulting from sham 

transactions, so long as those obligations are "genuine" -- i.e. 

binding and enforceable. 

 It is true, as Wexler argues, that other code sections 

expressly require that the deductions they provide for arise from 

transactions having a business purpose or profit motive, whereas 

§ 163 does not.0 Nonetheless, the case law construing § 163 

clearly establishes that the sham transaction doctrine also bars 

interest deductions under that section of the code. In Knetsch 

v. United States, 364 U.S. 361 (1960), the Supreme Court held 

 

0Although subsequent subsections of § 163 contain various 

exceptions and qualifications to that rule, it is undisputed that 

an individual taxpayer is entitled to deduct a proportionate 

share of interest expense incurred by a business in which the 

taxpayer is a partner. 

0Among the examples cited by Wexler are the following: Section 

165(c) limits deductible losses under § 165(a) "to (1) losses 

incurred in a trade or business; (2) losses incurred in any 

transaction entered into for profit, though not connected with a 

trade or business . . .." Under § 167(a), a taxpayer may deduct 

depreciation "(1) of property used in a trade or business, or (2) 

of property held for the production of income." Likewise, § 212 

allows deductions of expenses "incurred during the taxable year 

(1) for the production or the collection of income; (2) for the 

management, conservation or maintenance of property held for the 

production of income . . .." 
15 

that interest deductions under the relevant language of § 163(a) 

of the 1954 Code (and the identical language of the predecessor 

provision, § 23(b) of the 1939 Code0) are not permissible when 

the underlying transaction is determined to have been a sham. 

Knetsch purchased $4,000,000 worth of 30-year, deferred annuity, 

bonds carrying a 2.5% interest rate. He borrowed the $4,000,000 

purchase price at a rate of 3.5%, pledging the bonds as security 

for the loan. In each of the two years at issue, Knetsch paid 

the interest on the loan balance, and received a loan in the 

amount of the increased value of the annuity bonds. The Court 

found that he paid a total of $294,570 in interest, and received 

$203,000 in loans. Knetsch's net out-of-pocket costs were thus 

$91,570. Meanwhile, the equity value of the annuity bonds -- the 

amount by which the value of the bonds exceeded Knetsch's debt --

was only $1000. The Court found that, apart from tax benefits, 

the only benefit from Knetsch's $91,570 out-of-pocket expenditure 

was "the relative pittance" of $1000. Id. at 366. The Court 

concluded that Knetsch's expenditures "did not appreciably affect 

his beneficial interest except to reduce his tax", and that there 

was "nothing of substance to be realized by Knetsch from this 

transaction beyond a tax deduction." Id. The Court therefore 

held that the loan transactions were shams and disallowed 

Knetsch's interest deductions. 

 

0The old § 23(b) is identical to the modern § 163, and was simply 

renumbered upon enactment of the 1954 Code. See Knetsch, 364 

U.S. at 362 & n.1. The language is unchanged in § 163 of the 

1986 Code. 
16 

 Wexler does not undertake to address Knetsch in his 

brief. Yet Knetsch plainly contradicts respondent's claim that a 

sham transaction can give rise to deductions under § 163. So do 

many other cases. The seminal sham-transaction case of Goldstein 

v. Commissioner, 364 F.2d 734 (2nd Cir. 1966), specifically 

addressed deduction of interest expenses pursuant to § 163(a). 

Id. at 736. The underlying transaction involved a sweepstakes 

winner who borrowed money at 4.0% to purchase bonds yielding 

1.5%, and then tried to deduct the interest payments on the loan 

from her taxable winnings. Notwithstanding the lack of an 

explicit requirement of a profit motive or business purpose in 

the text of § 163, the Second Circuit ruled the deduction invalid 

because the interest had arisen from a transaction entered into 

"without any realistic expectation of profit and 'solely' in 

order to secure a large interest deduction". Id. at 740. 

 In Lifschultz v. Commissioner, 393 F.2d 232 (2nd Cir. 

1968), the court disallowed interest deductions under § 163 for 

five transactions because the transactions were entered into 

without expectation of economic profit and had no purpose beyond 

creating tax deductions. The Second Circuit ruled that "the 

controverted payments did not constitute interest within the 

meaning of Section 163(a) and were not deductible." Id. at 234. 

Similarly, in Lukens v. Commissioner, 945 F.2d 92 (5th Cir. 

1991), the Fifth Circuit upheld denial of an interest deduction 

under § 163 where the trial court had reasonably found that 

"'petitioners did not have a profit objective, independent of tax 

savings'" for engaging in the underlying transaction. Id. at 100 
17 

(quoting trial court opinion); See also United States v. Manko, 

979 F.2d 900, 910-11 (2nd Cir. 1992) (approving, in dicta, jury 

instruction that would bar interest deduction if underlying 

transaction did not involve profit potential or market risk). 

 The Ninth Circuit has likewise held that a sham 

transaction cannot generate genuine indebtedness for § 163 

purposes. Shirar v. Commissioner, 916 F.2d 1414, 1417 (9th Cir. 

1990). The Shirar court stated that "ordinarily" § 163 permits 

interest paid on indebtedness to be deducted, but only if the 

interest is paid on genuine indebtedness. Id. Citing Knetsch, 

the court held that no genuine indebtedness can result from a 

sham transaction, which it defined as a transaction from which 

"there is nothing of substance to be realized beyond a tax 

deduction." Id. 

 The Tax Court has also disallowed § 163 deductions 

where the underlying transaction constituted an economic sham. In 

Sheldon v. Commissioner, 94 T.C. 738 (1990), the court addressed 

the question of whether interest obligations from repo 

transactions very similar to those Wexler allegedly engaged in 

could be deducted under § 163. The court acknowledged that under 

§ 163 deductibility is not expressly contingent upon a profit 

objective in the underlying transaction. Id. at 760. The court 

held, however, that interest is nonetheless not deductible when 

it has resulted from a transaction that lacked economic substance 

-- i.e. had no "'purpose, substance or utility apart from [its] 
18 

anticipated tax consequences.'" Id. at 761 (quoting Goldstein, 

364 F.2d at 740).0 

 While there is no case in this court that specifically 

addresses the deductibility under § 163 of interest payments on 

sham transactions, we have addressed whether economic shams could 

create deductible interest payments under § 23(b) of the 1939 

Internal Revenue Code, the predecessor of § 163. Weller 

v.Commissioner, 270 F.2d 294 (3rd Cir. 1959). The issue in 

Weller -- a case decided a year before Knetsch -- was the 

deductibility of prepaid interest on annuity contract loans. We 

found that "although in form the payments appear to constitute 

interest within the meaning of section 23(b) of the Internal 

Revenue Code of 1939, the entire transaction lacks substance." 

Id. at 296. We cited Gregory v. Helvering, 293 U.S. 465 (1935), 

for the general principle that no tax benefit could be created by 

a transaction entered into for no economic benefit other than tax 

avoidance. Weller, 270 F.2d at 296-97. Noting that Gregory

involved what the Supreme Court termed "an elaborate and devious 

form of conveyance masquerading as a corporate reorganization," a 

camouflage the Court declined to recognize for tax purposes 

 

0As the government notes, Sheldon actually expanded the sham 

transaction doctrine, because it barred interest deductions from 

arrangements motivated by tax benefits even if the transactions 

could have generated a profit. The dissent argued that repo 

transactions with profit potential should be recognized for tax 

purposes. Id. at 774-75. The dissent agreed with the majority, 

however, that repos-to-maturity that assure lack of profit do not 

give rise to deductible interest. Id. Thus, the Sheldon court 

was unanimous that the kind of transactions Wexler is charged 

with arranging cannot create tax deductions, regardless of 

whether there was "genuine indebtedness". 
19 

because to do so "would be to exalt artifice above reality." 293 

U.S. at 470. We said in Weller that "the principle laid down in 

the Gregory case is not limited to corporate reorganizations, but 

rather applies to the federal taxing statutes generally." Id. at 

297. We rejected the petitioners' argument that the deduction 

should be allowed because the interest obligation was real: "That 

there may be an obligation which is binding under local law is 

not determinative of whether there is a true indebtedness within 

the meaning of Section 23(b)." Id. at 298. 

 In Weller, we held that interest payments are not 

deductible where the underlying transaction has no purpose other 

than tax avoidance, despite the fact that § 23(b) -- now § 163(a) 

-- had no express business-purpose requirement. We also held in 

Weller that the existence of a real obligation to pay interest --

which is how Wexler defines "genuine indebtedness" -- does not 

change the result. Weller remains good law. Our recent 

treatment of the sham transaction doctrine in Lerman states that 

transactions with no economic significance apart from tax 

benefits lack economic substance. 939 F.2d at 48 & n.6. To be 

sure, Lerman did not involve § 163; but we stated in Lerman that 

"economic substance is a prerequisite to any Code provisions 

allowing deductions." 939 F.2d at 52 (second emphasis added). We 

thus find no merit in Wexler's argument that economic substance 

in the underlying transaction is not required for deductibility 

under § 163. 

 3) Alleged changes in the law: Wexler argues that 

recent decisions of the Fourth and Second Circuits and of the Tax 
20 

Court reflect a modern trend towards a genuine indebtedness 

exception for § 163 deductions -- an exception that the district 

court was correct to follow. In making this argument, Wexler 

relies heavily on Rice's Toyota World v. Commissioner, 752 F.2d 

89 (4th Cir. 1985), a Fourth Circuit opinion also relied on by 

the district court in fashioning the jury instruction to which 

the government has taken such strong exception. 

 Rice's Toyota, an automobile dealership, purchased a 

used computer from a leasing company by issuing a recourse note 

and two non-recourse notes to the seller. Rice's Toyota leased 

the computer back to the leasing company, and then declared tax 

deductions for depreciation of the computer and for interest paid 

on the recourse and non-recourse notes. The Fourth Circuit 

affirmed the Tax Court's finding that Rice's transaction was a 

sham because "Rice subjectively lacked a business purpose and the 

transaction objectively lacked economic substance." Id. at 95. 

After finding that in substance Rice had not purchased a 

computer, but rather had paid a fee in exchange for tax benefits, 

the court went on to examine whether any part of the overall 

scheme was economically substantive. Id. The court agreed that 

the capital depreciation and the interest on the non-recourse 

notes should not be deductible. Id. However, the Fourth Circuit 

disagreed with the Tax Court's disallowance of the interest paid 

on the recourse note. The appellate court held that, despite the 

sham nature of the underlying transaction, Rice's Toyota 

purchased "something of economic value", and characterized "the 

'cash payment' on the recourse note as a 'fee' for purchase of 
21 

expected tax benefits." Id. at 96. The court held that the 

installment payments on the recourse notes were "genuine 

obligations" and that the "interest due upon their payment was 

equally an obligation of economic substance." Id. at 96. Wexler 

argues that Rice's Toyota therefore allows deduction of interest 

so long as it was paid on an enforceable obligation. 

 We reject Rice's Toyota as authority for the 

instruction adopted by the district court for three reasons. 

 First, the Fourth Circuit did not hold that interest 

was deductible in the absence of economic substance. Rather, the 

court expressly based deductibility of the recourse note interest 

on a finding that the recourse debt was "an obligation of 

economic substance," Id. at 96 -- a finding which, if warranted, 

would of course mean that the interest paid on the recourse note 

was properly deductible. 

 Second, and more important, we are unable to reconcile 

the Fourth Circuit's finding that the recourse note was "an 

obligation of economic substance" with its definition of 

"economic substance". According to the Fourth Circuit, "economic 

substance" involves "a reasonable possibility of profit from the 

transaction . . . apart from tax benefits." Id. at 94. The 

court held, however, that the recourse note transaction had 

economic substance because Rice's payment on the note was a 

"purchase of something of economic value . . . a 'fee' for 

purchase of expected tax benefits." Id. at 96. By the Fourth 

Circuit's own definition of economic substance, we do not see how 
22 

the recourse note payment could possess economic substance given 

that the only purpose or gain was the tax benefit. 

 Third and finally, even if we were to accept 

respondent's interpretation of Rice's Toyota, Wexler's case is 

distinguishable from Rice's. The Fourth Circuit unbundled the 

sale-leaseback transaction and found that one small part of it, 

the recourse note, was economically substantive. Rice's 

transaction was unusual because the interest payments on the 

recourse note were separable from the interest payments and 

depreciation that would have created the principal tax benefits 

of the transaction. It appears that the Fourth Circuit did not 

view the interest expense on the recourse note as being, in 

itself, the purpose of Rice's transaction. The chief intended 

benefits of the sale-leaseback arrangement were the much larger 

deductions for depreciation and interest on the non-recourse 

notes. The court disallowed those larger deductions. 

 Wexler's case differs in a critical respect. There is 

no debt obligation that can be separated from the underlying repo 

scheme or that was undertaken for some reason other than the tax 

benefits of deducting interest on that obligation itself. The 

obligation that Wexler argues to be an economically substantive 

"genuine indebtedness", the loan secured by the government 

securities, is the very obligation that will generate the 

interest payments constituting the tax benefits of the entire 

transaction. Thus, if we were to follow Rice's Toyota, the 

transaction would be examined for a binding debt obligation even 

if the jury had found that Wexler's transaction was devoid of 
23 

business purpose or profit potential other than tax avoidance --

i.e. that, by the Fourth Circuit's own definition, the 

transaction was without economic substance. If such an 

obligation were found -- i.e. that the MBM partnership was 

obligated to pay interest on the loan secured by the government 

securities -- then the interest would be deductible because, 

under Rice's Toyota, it represents a fee paid for economically 

valuable tax benefits, thereby giving the transaction economic 

substance. We think such an outcome would undermine the sham 

transaction doctrine, for it would allow the MBM partnership to 

reap the entire tax benefit of its sham transaction simply 

because MBM was contractually obligated to make payments on the 

loan that was the centerpiece of the whole scheme. Such an 

outcome would be incompatible with the holdings of Weller, 

Knetsch, Gregory, Goldstein, and Lerman. This may explain why, 

five years after Rice's Toyota, the sixteen Tax Court judges 

deciding Sheldon v. Commissioner, 94 T.C. 738 (1990), all agreed 

that interest payments related to a sham transaction cannot be 

deducted under § 163.0

 Respondent argues that several recent decisions have 

followed Rice's Toyota on the genuine indebtedness issue, 

reflecting a current trend in the law. For example, Wexler cites 

Jacobson v. Commissioner, 915 F.2d 832 (2nd Cir. 1990), as 

evidence that the Second Circuit has abandoned Goldstein and now 

 

0The Tax Court was well aware of Rice's Toyota when it decided 

Sheldon. 94 T.C. 760 (citing Rice's Toyota and noting that the 

Fourth Circuit had allowed deduction of the interest paid on the 

recourse debt). 
24 

allows deductions of interest payments notwithstanding an 

underlying sham transaction. But the Jacobson opinion does not 

support Wexler's argument. 

 In Jacobson, the court stated that "[e]ven if the 

motive for a transaction is to avoid taxes, interest incurred 

therein may still be deductible if it relates to economically 

substantive indebtedness." 915 F.2d at 840 (citing Rice's 

Toyota). The government does not quarrel with that formulation 

here: indeed, the two-part definition of a sham transaction 

proposed by the government and adopted by the district court 

would require the jury, in order to "find the transactions were 

sham transactions," to "determine two things beyond a reasonable 

doubt:" 

First, that MBM had no business purpose for entering 

into the transactions other than to obtain tax 

benefits; and 

Second, that there was no economic substance to the 

transaction, that is there was no reasonable 

possibility that MBM could earn a profit on the 

transactions apart from tax benefits. 

Thus, what Jacobson holds is that interest will be deductible 

where the government proves lack of business purpose, but cannot 

prove lack of economic substance -- i.e. if the underlying 

transaction is not a "sham" as defined by the district court's 

order in Wexler's case.0 

 

0We find it difficult to believe that, had the Second Circuit 

intended anything more -- i.e. to allow deductions of any

interest that actually had to be paid -- it would have done so 

without explicitly addressing and overruling its oft-cited 

Goldstein decision. That it had no intention of doing so is 

evidenced by a Second Circuit case decided just six weeks before 

Jacobson, by a panel including two judges (Newman and Pratt, JJ) 
25 

 Respondent also relies heavily on the Tax Court's 

recent decision in Lieber v. Commissioner, 66 T.C.M. (CCH) 722 

(1993). In Lieber, the court addressed, inter alia, the 

deductibility of interest obligations incurred in connection with 

a computer purchase and lease transaction. The Tax Court first 

cited its own opinion in Rose v. Commissioner, 88 T.C. 386, 423 

(1987), aff'd. 868 F.2d 851 (6th Cir. 1989), in which it had 

stated that under § 163 a taxpayer may deduct interest payments 

even absent a tax-independent motive for the underlying 

transaction. The Tax Court in Lieber went on, however, to 

acknowledge that its Rose dictum was in conflict with its more 

recent ruling in Sheldon that transactions "give rise to 

deductible interest only if there is some tax-independent purpose 

for the transactions." Sheldon, 94 T.C. at 759. 

 Contrary to Wexler's argument, the Tax Court in Lieber

did not reject Sheldon in favor of Rose, but expressly decided 

not to resolve the tension between Rose and Sheldon. Rather, it 

decided that, because an appeal in Lieber would be to the Second 

Circuit, which in the Tax Court's view had adopted the Rose

dictum in Jacobson0, the Tax Court would follow Rose in Lieber. 

Thus, the Tax Court did not decide which position was correct, 

 

of the three judges who decided Jacobson, in which the court 

stated that "[t]hough . . . a 'repo to maturity' repurchase 

agreement, is legal, it provides no basis for claiming an 

interest expense deduction since no profit or loss can be 

realized in connection with the interest charges." United States 

v. Oshatz, 912 F.2d 534, 536 (2nd Cir. 1990). 

0As our discussion of Jacobson suggests, typescript, supra, text 

at p.23, and n.11, we are not at all clear that Jacobson should 

be regarded as building in some significant sense on Rose. 
26 

but rather decided the question with reference to what the Tax 

Court perceived the law to be in the relevant circuit court of 

appeals. Thus, the only relevance of Lieber to the instant case 

is to indicate that, were the instant case one that had arisen in 

the Tax Court, that court would have decided the issue at bar 

with reference to the prevailing law of the this circuit. And in 

this circuit, under Weller and Lerman, the interest arising from 

Wexler's transaction is not deductible if the underlying repo 

transaction is a sham. 

 We are convinced that there is no basis for finding 

that interest payments arising from the repo-to-maturity 

transactions allegedly arranged by Wexler should be deductible as 

"genuine indebtedness". Rice's Toyota, Jacobson and Lieber

indicate that, in some circumstances, a sham transaction may have 

separable, economically substantive, elements that give rise to 

deductible interest obligations.0 Yet in each of those cases a 

key requirement is that the interest obligation be economically 

substantive, defined in every decision except Rose to mean that 

the transaction have a potential non-tax benefit. The jury 

instruction that the district court adopted in its November 30, 

1993, Order goes even further: if, pursuant to the sham 

transaction instruction, the jury were to find beyond a 

reasonable doubt both "no business purpose . . . other than to 

obtain tax benefits" and "no economic substance [because] there 

 

0Wexler cites no case in which the very interest comprising the 

entire tax benefit of a sham transaction has been ruled 

deductible as "genuine indebtedness". 
27 

was no reasonable probability [of] a profit . . . apart from tax 

benefits," deductibility would still follow unless the government 

proved beyond a reasonable doubt the "lack of genuine 

indebtedness."0 We find that this instruction would render the 

sham transaction doctrine inert, and that the instruction is at 

odds with the overwhelming weight of the relevant case law. 

 4) Clear error in the November 30, 1990, Order: On the 

basis of the foregoing discussion, we find that the "genuine 

indebtedness" instruction adopted by the district court 

constitutes clear error under established law. This circuit held 

in Weller that interest payments arising from a sham transaction 

are not deductible. 270 F. 2d at 296-98. Our rule of 

disregarding sham transactions for federal taxation purposes 

continues in full force today, with no exception for § 163 

deductions. Lerman, 939 F.2d at 48 & n.6, 52 ("economic 

substance is a prerequisite to any Code provisions allowing 

deductions") (second emphasis added); see also Peerless 

Industries v. United States, 1994 U.S.Dist. LEXIS 411 *17, 94-1 

U.S. Tax Cas. (CCH) ¶50,043 (E.D.Pa. 1994), (§ 163 "deduction is 

proper if there is some substance to the loan arrangement beyond 

. . . the deduction."). The jury instruction adopted by the 

district court in its November 30, 1993, Order conflicts with the 

established law of this circuit, and with the dominant line of 

precedent following the Supreme Court's ruling in Knetsch and the 

Second Circuit's ruling in Goldstein. 

 

0"Genuine indebtedness" being defined by the district court as 

simply "a binding obligation . . . to pay interest on a loan." 
28 

Whether a writ of mandamus should issue 

 The standard for issuing a writ of mandamus is 

stringent. As a threshold matter, the petitioner must prove that 

the district court committed a "clear abuse of discretion", 

Mallard v. U.S. District Court, 490 U.S. 296, 309 (1989), or a 

"clear error of law", In Re Bankers Trust Co., 775 F.2d 545, 547 

(3rd Cir. 1985). We have found that the government has met that 

burden in this case. 

 In addition to demonstrating clear error, however, the 

petitioner must generally show that, other than mandamus, it has 

no means of adequate relief, Bankers Trust, 775 F.2d at 547, and 

that the error will cause irreparable injury, Cippolone v. 

Liggett Group, Inc., 785 F.2d 1108, 1118 (3rd Cir. 1986). 

 We find in this case that the government has no 

alternative avenue of relief. The government sought rehearing on 

the intended jury instructions, but rehearing was denied. For 

double-jeopardy reasons, no appeal will be possible once trial 

begins. The government will not be able to interrupt the trial 

by filing an appeal or a renewed petition for mandamus when the 

district judge commences to give the erroneous instruction. And 

if -- as the government anticipates, and Wexler does not contest 

-- jury deliberations guided by the erroneous instruction end in 

an acquittal, the injury to the government will be irremediable.0

 

0This would be so even if the district court, without submitting 

the case to the jury, granted a motion by defendant, pursuant to 

Fed. R. Crim. P. 29(a), for acquittal after the close of the 

government's evidence. 
29 

 We are mindful of respondent's argument that mandamus 

is an extraordinary remedy, reserved for rare circumstances. We 

believe, however, that this case presents an appropriate occasion 

for exercise of the writ. Not only do we find clear error, 

likelihood of irreparable harm, and lack of alternatives, but we 

also note the absence of certain factors that would weigh against 

mandamus. A principal concern with mandamus is that it not be 

used as a substitute for appeal. In Re School Asbestos 

Litigation, 977 F.2d 764, 772 (3rd Cir. 1992). Indeed, 

"[m]andamus is disfavored because its broad use would threaten 

the policy against piecemeal appeals." Id. In the case at bar, 

issuance of the writ will neither substitute for appeal nor bring 

this case piecemeal to this court, for the simple reason that 

appeal from the erroneous instruction is not an option for the 

government.0

 

0Wexler also argues that issuance of a writ in this case would 

contravene the Criminals Appeals Act, 18 U.S.C. § 3731, and Will 

v. United States, 389 U.S. 90 (1967), which mandates that 

"mandamus may never be employed as a substitute for appeal in 

derogation of the" principle that the "Criminal Appeals Act is 

strictly construed against the Government's right of appeal." Id. 

at 96-97. Will, however, does not preclude the use of mandamus 

to review an interlocutory order that expresses an erroneous, 

preliminary jury instruction. In Will, the Court states that it 

would not "say that mandamus may never be used to review 

procedural orders in criminal cases." Id. at 97. Moreover, the 

Court stated that "it need not decide under what circumstances, 

if any," a court may review "an interlocutory procedural order . 

. . which did not have the effect of a dismissal." Id. at 98. 

While it might be difficult to characterize a jury instruction as 

procedural, still under Will the mandamus door is open far enough 

to include jury instructions. 

 Accordingly, while we do not attempt to set forth the exact 

parameters of when mandamus is available to address interlocutory 

orders in criminal cases, we do find that on the facts of this 
30 

 Wexler would cabin our discretion to order mandamus to 

situations in which a district court either exceeded its lawful 

jurisdiction or declined to exercise a non-discretionary power. 

While those two situations constitute traditional reasons for the 

writ, they are not exclusive. Indeed, we have observed that 

"courts have not confined themselves to any narrow or technical 

definition of the term 'jurisdiction'" in using the writ to 

regulate proceedings in the district court. United States v. 

Santtini, 963 F.2d 585, 594 (3rd Cir. 1992). Accordingly, 

mandamus may issue to correct clear abuses of discretion, to 

further "supervisory and instructional goals", and to resolve 

"unsettled and important" issues. In Re School Asbestos 

Litigation, 977 F.2d at 773. While appellate courts must be 

parsimonious with the writ, it is also true that "[s]ome 

flexibility is required if the extraordinary writ is to remain 

available for extraordinary situations." Id. 

 We find that the adoption of a clearly erroneous jury 

instruction that entails a high probability of failure of a 

prosecution -- a failure the government could not then seek to 

remedy by appeal or otherwise -- constitutes the kind of 

 

case mandamus is appropriate. Accepting the government's 

assertion that our failure to exercise mandamus review over the 

order would hamper the government's ability to enforce the tax 

laws, we find that this interlocutory order presents a special 

situation which militates in favor of mandamus review. We must 

acknowledge, however, that our granting the writ in this context 

does not authorize the use of mandamus whenever the government 

objects to criminal jury instructions. Rather, our decision is 

limited to the facts of this case. 
31 

extraordinary situation in which we are empowered to issue the 

writ of mandamus. Accordingly, the petition for a writ of 

mandamus is granted, the district court is directed to vacate its 

order of November 30, 1993, and the proceedings in the underlying 

case shall be consistent with this opinion. 
32 

United States v. Wexler, No. 93-5719 

GREENBERG, Circuit Judge, concurring: 

 I join in the opinion of the court because I believe 

that it correctly states the substantive tax law and because I 

further believe that it is appropriate for us to exercise our 

mandamus jurisdiction to direct the correction of the error in 

the proposed charge. Nevertheless I do so with some reluctance 

because I have difficulty reconciling Wexler's prosecution with 

the principles underlying Cheek v. United States, 111 S.Ct. 604 

(1991). In its petition for mandamus the government tells us 

that "the district court's order adopts an erroneous jury 

instruction predicated on a fundamentally incorrect reading of 

the tax law [which] if not corrected by this Court . . . will 

force the government to dismiss the charges . . . ." Petition at 

1. Thus, the government explains, the "incorrect instruction 

would virtually preclude the government from obtaining a 

conviction [as] it would leave [it] with no means of proving a 

critical element of its case -- that the interest deductions at 

issue were invalid." Petition at 2. The government adheres to 

this position in its reply brief, asserting that the district 

court's error "will force the government to dismiss the criminal 

charges." Reply brief at 4. In the circumstances, it is evident 

that the government's trial problem is that the district court 
33 

intends to charge the jury that the deductions involved in this 

case were not unlawful, and the government quite understandably 

feels that in the face of that charge it cannot be successful at 

trial. 

 What bothers me in the government's position is that it 

is challenging a conclusion reached by the district court in a 

carefully crafted formal, though unpublished opinion, rendered 

after the court considered the appropriate authorities, including 

some of the very cases we cite, e.g., Lerman v. Comm'r, 939 F.2d 

44 (3d Cir. 1991), cert. denied, 112 S.Ct. 1940 (1992). 

Furthermore, the district court adhered to its conclusion on 

reconsideration. Therefore, Wexler is being prosecuted in a case 

in which the government intends to demonstrate that he acted in 

what the district court believed was a lawful manner. This 

circumstance almost has caused me to vote to deny the 

government's petition. 

 In Cheek the Supreme Court noted that "[t]he 

proliferation of statutes and regulations has sometimes made it 

difficult for the average citizen to know and comprehend the 

extent of the duties and obligations imposed by the tax laws." 

111 S.Ct. at 609. Thus, "[i]n the end [in a criminal case] the 

issue is whether, based on all the evidence, the Government has 

proved that the defendant was aware of the duty at issue, which 

cannot be true if the jury credits a good-faith misunderstanding 

and belief submission, whether or not the claimed belief or 

misunderstanding is objectively reasonable." Id. at 611. The 

Supreme Court's formulation throws into question the fairness of 
34 

Wexler's prosecution for even the district court did not believe 

that Wexler violated "the duty at issue." Thus, I have 

considered whether, notwithstanding the government's 

demonstration of a prima facie case for the issuance of a writ of 

mandamus, we should not exercise our discretion by denying its 

application. See In re School Asbestos Litig., 977 F.2d 764, 772 

(3d Cir. 1992). 

 However, I ultimately do join in the opinion for I do 

not question the government's good faith in instituting the 

criminal case as I have no doubt that it was surprised by the 

legal conclusions reached by the district court, and, on the 

limited record before us, I do not know all the circumstances 

which led the government to seek Wexler's indictment. 

Furthermore, I cannot possibly fault the government for seeking a 

writ of mandamus from this court as I accept its representation 

that, unless corrected, the district court's unreported opinion 

will be circulated and will stand as an impediment to the 

enforcement of the tax laws. Of course, now that the government 

has obtained its goal of overcoming the district court's opinion, 

the determination whether this criminal case should be continued

must be made by the prosecuting authorities and not by this 

court. 

 I close, however, by pointing out that our opinion is 

narrow. We only give directions with respect to the charge to 

the jury. Accordingly, we do not address the possibility that 

Wexler may in some way be able to bring to the jury's attention 

the district court's opinion to support a contention that he 
35 

acted in good faith with respect to the transactions and the 

deductions involved. That issue, however, is not before us and 

consequently I express no opinion with respect to it.