NO T R EC OM M EN DE D F OR F UL L TEX T P UB LIC AT ION F ile Nam e: 10a0726n.06 No. 09-2354 UN ITED STA TES C OU RT OF AP P EA LS F OR THE SI XT H C IR CU IT Ne w P hoe nix Sunr ise Co r por at ion and Su bsid iar ie s, ) ) P etitioner -Appellant, ) ) O N A P P EA L F RO M THE D EC ISI ON v. ) OF THE UNITE D STATE S TAX COURT ) Com m ission er of Internal Reve nue, ) ) Respondent-Appellee. ) BEF OR E: KEITH , K

EN NE DY , a nd C OOK , C ir c uitJudg e s. CO RN ELIA G. K

ENNEDY, Circ uit Jud ge. New Phoenix Sunrise Corporation (“Ne w Phoenix ”), the taxpay er a nd petition er below, appe als the dec ision of the tax court upholding the Commi ssioner’s a ssessment of a ta x defic iency of $3,355,906 and a

penalty of $1,298,284 base d on New Phoenix’s claim of a loss of ove r $10 million from a pair of swap c ontrac ts that caused it an economic loss of slight ly more than $100,000. The tax court found that the transa ction lacke d economic substanc e and that New Phoenix’s reliance on the advice of Jenkens & G ilchrist, the law fi rm that ha d p ro mot e d th e ta x sh e lte r, did no t pr e ve nt t

he a pp lic a tio n o f t

he pe na lti e s. Ne w Ph oe nix challeng es these r

ulings, a s well as the disclosure , admission into evidenc e, and tax court’s r eliance

on sever al documents that t he tax court deter mined wer e re lated to the tax opinion prepare d by J enkens & Gilchrist in support of the challeng ed transac tion. Be cause New Phoenix’s claims lack

me ri t, w e AF F I RM.B e c a us e Ol e nta

ng y wa s e sta

bli sh e d f or the so le pu rpo se of

e ng a g ingin t

he B L I SS 1 tr ans a c tio n, wa s a lmo st e nti re ly ow ne d by Ca pit a l, a nd wa s c on tr oll e d b y

Mr . Wr ay , ju st l ike Ca

pit a l, we r efe r to Olentang y

as Capital wher e possible. 2 F ACTUAL AND P ROCEDURAL BACK GR OUND New Phoenix originated in the 1970s as an A rizona corpor ation involved in the ag ricultural ind us tr y . Ca pit a l Po ly B a g , I nc . (“ Ca

pit a l” ), wh ic h man

uf a c tur e d pla sti c ba g s, wa s in c or po rate d in 19 72 and be c ame a wh oll y ow ne d s ub sid iary

of Ne w Ph oe nix in

19 86 . Ca

pit al pro sp ere d a

nd , in April 2001, sold its assets for over $15 milli on. Ti mot hy Wra y , the pres id ent a

nd CEO of Ne w Ph oe nix a s w e ll a s Ca pit a l’ s p re sid e nt, trea surer , and sole dire ctor, testified at trial that after Capital’s asset sale, he soug ht inve stments for the company . I n the fa ll of 2001, Gordon L itt, an attorney from New Phoenix ’s law f irm, Br icker & Ec k l e r , i n t r o d

u c e d M r . W r ay t o P a

u l D a u g e r d a s an d Jo h n B e e r

y o f t h e l aw f

i r m o f Je n k e n s & Gi lc hr ist . D a

ug e rd a s p ro po se d th a t Ca pit a l e ng a g e in a

se ri e s o f a c tions kn own as the “ B a sis L ever ag ed Investment Swap Spr e a d ” tr a n s a c ti o n , o r

th e B L I SS t ransa ction. The tra nsaction involved

curr ency speculation with the theoreti ca l ch ance of a larg e windfa ll, but which also allowed a partne rship eng ag ing in the speculation to write off larg e pape r losses on tax returns while suffe ring only small actual losses. Wray , actingfor Capital, opted to eng ag e in the B L I SS t ransa ction. New Phoenix ultimately

paid $500,000 to J enkens & Gilchrist, which Wray testified was f

or a le g al opinion on the tax conseque nces of the B L I SS t ransa ction and not for a ny other ser vices that Jenkens & G ilchrist perfor

med. To establish the foundations of the BL I SS t ransa ction, on or b ef o re No v ember

19, 2001, Ca pit a l di re c te d Jenke ns & Gi lc hr ist to se t up a par tne rs hip , Ole nta

ng y Part ne rs (“ Ol e nta

ng y ” ), in which Capital owned a 99% interest and Mr. Wray owned the rema ining 1% interest. Then, on or 1There is some dispute about when prec isely Mr. Wray , on behalf

of Capital, enter ed into the 2 transac tion. W ray

testified that he e ntere d into the transa ction on Dec ember 7, 2001. Howeve r, the parties stipulated that the documents setting up the transac tion we re not f axed to him unt il Dece mber 12 , a ndhe d i d n o t s i g n t h e m u n t i l D e c e mb e r 2 0

. W r ay d i d n o t d a t e t h e d o c u m e n t s , p u r s u ant t o advice from Jenkens & G ilchrist. De u tsche B ank g ave Mr . Wray a choic e of one of three curr encie s on which to speculate: 3 the J apane se y en, the B ritish pound, or the euro. Wra y , who at the time was pursuing a master ’s deg ree at S tanford U niversity ’s Gra duate School of B usiness as a Sloan F ellow, re sear ched the curr encie s and testified that he believed that the y en would lose va lue ag ainst the dollar. 3 a bo ut N ov e mbe r 3 0, 20 01 , Wr ay simult ane ou sly

op e ne d tw o s e pa

ra te br ok e ra g e a c c ounts wi th De uts c he B anc Al e x. B ro wn , a lic e ns e d b ro ke r- de a le r e ng a g e d in the se c ur iti e s br ok e ra g e bu sin e ss in the United States and a n indirect su b s i d i ar y

of De utsche B ank AG ( “De utsche B ank”) . One

a c c ount w a s o n b e ha lf

of Ol e nta ng y and the oth e r o n b e ha lf

of Ca pit a l. I n Dec ember

2001, Capital and the L ondon branc h of De utsche B ank entered into t wo swap contra cts in execution of the B L I SS t ransa ction. I n the first contra ct (a lso known as the “long 2 contra ct”) , Capital was to pay a premium of $10,631,250 to Deutsche Ba nk on Dec ember

11, 2001. Additionally , Capital w as t o make two f ix ed pay ments of $63 million on December 14 and Dec ember

20. I n return, D eutsche Ba nk provided a

n option that required it to pay Capital $73,631,250 if the exchang e rate of the Japanese y en (the “spot rate” ) wa s above 127.75 y en per 3 dollar (the “ strike price ”) at 10:00 a.m. on De ce m b er 1 2 , and $73,631,250 if the rate wa s above 128.75 y en per

dollar at 10:00 a.m. on Dece mber 18. The second contract (the “short contra ct”) was very simil ar to the first, but the roles wer e reve rsed. Deutsche Ba nk was to pa

y a p re m i u m of $10,368,750 to Capital on Dece mber 11, 2 0 0 1 , a n d two fix ed pay

ments of $63,065,625 on Dec ember 14 and De cembe r 20. I n return, Capital ag ree d to pay $73,500,000 if the spot rate exceede d 127.77 y en per dollar at 10:00 a.m. on December 12, and $73,500,000 if the spot rate exceede d 128.77 y en4

per dollar at 10:00 a .m. on Dec ember 18. Thoug h the parties sty liz ed the two contra cts as “dig ital swap tra nsactions,” they

essentially

amounted to a sing le “dig ital option spre ad” consisting of two long- and-shor

t-option pairs: one pair e x piring on Dec ember 12, 2001 with digital leve ls of 127.75 y en per dollar (long ) and 127.77 yen per dollar (short) ; the ot her pair ex piring on Dec ember 18, 2001 with digital leve ls of 128.75 y en per d ollar (long ) and 128.77 y en per dollar (short) . Capital then

a s s i g n e d t h e c o n tr a c t s t o O l e n t an g y. Although the swap tra

nsactions see m to involve larg e sums of money , the offse tting mutual ob lig a tio ns re fl e c te d in

the c on tr a c ts we re lik e ly

to r e su lt i n th e e xch ang e of on ly re lativ e ly mod e st

a mou nts of mon e y . Cons ide r, fi rs t, t he pr e mium and

fi xed pa y me nts ow e d und e r b oth

c on tr a c ts. T h e p r e m i u m s o f

f s e t e x c e p t f

o r a $ 2 6 2 , 5 0 0 r e m a i n d e r o w e d b y C a p i t a l t o D e u t s c h e B an k

. S i m i l ar l y, the fi xed pa y me nts of fs e t to the e xten t of

$63 millio n e a c h, le a vin g De uts c he B ank sc he du le d to make two require d pay

ments of $65,625, for a total of $131,250. There fore , at t h e e n d o f t he contra ct per iod, Deutsche Ba nk ear ned a $131,250 net profit, not consideringthe potential value of the op tio ns the mse lve s. There wer e several theoretica lly possible outcomes under the di g ital option spread. As the Commi ssioner explained, the first possibl e o u t co m e would occur if both the longoption and the short option comprising e ach option pair expired “out of the money”—that is, if the spec ified spot rate w e r e le s s th an th e s tr ik e p r ic e o f 1 2 7

. 7 5 y e n p e r d o ll ar o n D e c e mb e r 1 2 an d 128.75 y en per dollar on De cembe r 18. In that case , Capital would lose its $131,250 net investment bec ause the re

wo uld be no a dd iti on a l ne t r e c e ipt s o n D e c e mbe r 1 4 a nd De c emb er 20. T he se c on d p os sib le

ou tc ome wo uld

oc c ur if bo th t he long o pti on

and the sh or t op tio n c omp ri sin g e a c h o pti on pa ir expired “in the money”—that is, if the specifie d spot rate wa s equal to or g reater than the strike price5

of 127.77 y en per dollar on Dec ember 12 and 128.77 y en per dollar on De cembe r 18. In that case , Capital wou l d ea rn a profit of $131,250 on its net investment of $131,250 bec ause it would have additional net re cei pts of $131,250 (the diff ere nce be tween Ca

pital's $73,631,250 option and De uts c he B ank ’s $7 3, 50 0, 00 0 o pti on ) o n b oth De c e mbe r 1 4 a

nd De c e mbe r 2 0. Th e thi rd

po ssi ble outcome would occ ur if both the long option and the short option c omprising one of the option pairs expired in the money , but the long option and the short option of the other option pair e x pired out of the money . Then, Capital would bre ak even on its $131,250 net investment beca use it would have ha d a n a dd iti on a l ne t r e c e ipt

of $131 ,2 50 on eit her

De c e mbe r 1 4 o r D e c e mbe r 2 0. Th e fo ur th possible outcome would occ ur if the spot ra te for o n e o f t h e opti on pairs “hit the swe et spot,” meaningthat the long option a nd the short option c omprising one of the option pairs expired in the money and out of

the money , respe ctively . This would happen if the spot rate on De cembe r 12 we re 127.75 or 127.76 y en per

dollar, or if the spot rate on De cembe r 18 we re 128.75 or 128.76 y en per do lla r. Th e n, Ca

pit a l w ou ld e arn

a pr of it o f $ 73 ,5 00 ,0 00 on its ne t inve stm e nt of $1 31 ,2 50 be c a

us e it would have an a dditional rece ipt of $73,631,250 on either De cembe r 14 or De cembe r 2 0. The final possible outcome would oc cur if both option pairs hit the swee t spot. Then, Capital would ear n

a pr of it o f $ 14 7, 13 1, 25 0 o n its ne t inve stm e nt o f $ 13 1, 25 0 b e c a us e it w ou ld h a ve a dd iti on a l r e c e ipt s or $73,631,250 on both Dec ember 14 and De cembe r 20. The pa rties ag ree that the s p o t price was be low the strike pric e on both Dec ember 12 and Dec ember

18, leavingboth options worthless and costingCapital its ini tial investment of $131,250. Following the nex t step of t he BL I SS t ransa ction, Olentang y purcha sed 8,110 shar es of stock i nC i s co S y s t em s

— a p u

b l i cl y t ra d e d c o m p an y

— fo r $ 1 4 9 , 9 5 8 o nDe ce mb er 2 4 , 2 0 0 1

. Ol en t an gyThere wer e no tax consequenc es of this transfe r. See I .R.C. § 731(a). 4 6 tr ans fe rr e d th e se sh are s to Ca pit a l th re e da

y s late r a nd dis so lve d. Ca

pit a l so ld t

he sh are s alm os t 4 imm e diate ly

fo r $ 14 8, 46 7, a

$1 ,4 91 e c on omi c los s. Jenk e ns & Gi lc hr ist

pr ov ide d a

wr itt e n tax opinio n dat ed J anu ary 9, 20 02 , b ut a c tua lly prepa red June 26, 2002, in su p p o rt o f t h e BL I SS t ransa ction. This opinion was provided to the

a c c ounta nts wh o pre pa

re d Ne w Ph oe nix’ s tax re tur n f or 20 01 . T he op ini on

a ssume d th a t th e B L I SS tr ans a c tio n w a s e nte re d into f or no n- ta x re a so ns and

argue d th a t th e tr ans a c tio n h a d e c on omi c substance. It advised that it was prope r to tr eat the $10,631,250 premium paid to Deutsche Ba nk as

a c os t un de r t

he ta x co de , and the re fo re Ca pit a l’ s ba sis in the Cis c o s toc k, and its c or re sp on din g los s from the sa le of t h e s t o ck , co u ld be incre ased by that amount. I t also conclude d that eac h swap

co n t ra ct s h o u l d

b e t re at e d a s a s e p ar at e t ra n s ac t i o n , an d t h at t h e p ay

m en t s re ce i v edb y

Ol en t an gy fr om D e uts c he B ank

did no t ha ve to b e us e d to of

fs e t th e inc re a se d b a sis

. New Phoenix filed its c onsolidated tax re turn for 2001 on September 19, 2002. I n its return, Ne w Ph oe nix c la ime d a

los s of $1 0, 50 4, 46 2 on the sa le of the Cis c o s toc k b y Ca pit a l. N e w Ph oe nix

asser ted that Capital had a

basis of $10 , 6 5 2 , 9 3 6 i n the stock due to the $10,631,250 pr emium ostensibly paid to Deutsche Ba

nk for the unr ealized options. Capital did not reduc e this basis by the $1 0, 36 8, 75 0 p re miu

m it re c e ive d f

ro m D e uts c he B ank

fo r i ts o ff

se tti ngop tio n c on tr a c t. The De partment of the Trea sury is s u e d te mporary

regulations on Febr

uary 28, 2000 requiring corpor ate taxpay ers to disclose listed and othe r re portable tra nsactions. Temp. Tr eas. Reg . § 30 1. 61 11 -2 T, 65 F e d. Reg . 1 1, 21 5, 11 ,2 18 -1 1, 22 2 ( Ma r. 2, 20 00 ). On

Au g us t 11 , 2 00 0, the I RS issued Notice 2000- 44, which was published in the I nterna l Revenue Bulletin on September 5, 2000. I .R.S. Noti ce 2000- 44, 2000-36 I .R.B. 255. As the tax court stated, “ [t ]he notice war ned taxpay ers7

of transa ctions calling for the simultaneous purchase and sale of off setting options which we re the n transfe rre d to a par

tnership. The notice deter m ined that the purpor ted losses from such of

fsetting option transactions did not r epre sent bona fide losses ref lectingactua l economic c onsequenc es and that the purporte d losses were not allowable f or F eder al tax purposes.” T h e I R S i s s u eda n o t i ce o f d ef i ci en cy t o Ne w P h o en i x o nS ep t em b er 1 4 , 2 0 0 5 , al l egi n g a defic iency

of $3,355,906 and a

penalty under I .R.C. § 6662(a) of $1,298,284. I n the explanation attache d to the notice of de ficienc y , the I RS stated that Capital’s alleg ation of a $10,504,462 loss wa s improper both bec ause it wa s not actually sustained by Capital and beca use the B L I SS t ransa ction purportedly

g ener ating the loss was not for pr ofit u n d er I

. R.C. § 165(c); it attributed the pena lties to Capital’s improper use of a tax shelter to conduct the B L I SS t ransa ction. New P h o en ix filed a pe tition before the tax court on De cembe r 8, 2005 appe aling the Commi ssioner’s findingof def iciency and imposition of the $1.2 milli on penalty . The tax court tried the matter on January

22 and 23, 2008. Ove r Ne w Phoenix ’s asser tion of attorney -client and wor k product privileg e, the tax court compe lled disclosure of a nd admitted into evidence sever al documents i t conclude d wer e related to J enkens & Gilchrist’s tax opinion. Those ruling s were based on the tax court’s finding that New Phoenix had waived its privileg e over the subject matter of the tax opi nion from J enkens & Gilchrist by asser ting its relianc e on that opi n i o n as a def ense to the imposit ion of the penalty

. On April 9, 2009, the tax cour t issued its de cision in fa v o r o f t he Commi ssioner. The parties stipulated to have the appea l hear d by this court, see I .R.C. § 7482(b)(2),

and Ne w Ph oe nix ti me ly

e xer c ise d th is r ig ht.8 DI SCU SSIO N New Phoenix arg ues t h ree issues on appea l. First, New Phoenix asser

ts that the tax court

err ed in deter

mining that the B L I SS t ransa ction was an economic sham; instead, it claims that the BL I SS t ransa ction had economic s ubstance , rende ring the t ax defic iency finding improper. Sec ond, Ne w Ph oenix argue s th a t th e ta x co ur t e rr e d in its a pp lic a tio n o f t

he re a so na

ble c a us e de fe ns e in Trea sury Reg ulation § 1.6664-4. Acc ording to New P hoenix, because it re asonably relied on Jenkens & G ilchrist as to the t ax co n s eq u ences of the B L I SS t ransa ction, it should not be subjec ted to a $1 ,2 98 ,2 84 pe na lty

. Th ir d, Ne w Phoe nix con te nd s th a t th e ta x co ur t e rr e d in de te rm ini ngthat c e rt a in documents we re not prote cted unde r either the attorney -client privilege or t he wor k product doc trine, order ed their disclosure improperly , and incor rec tly permitted them t o be int roduce d as evidence at tr ia l. We c on sid e r e a c h o f t he se argume nts se ria tim

. I. Econom ic Sub stance New Phoenix f

irst c halleng es the tax cour t’s upholding of

the Commiss ioner’s a ssessment of th e tax d e f

ic ie n c y o n th e g r o u n d s th a t th e B L I SS tr an s a c ti o n la c k e d e c o n o mi c s u b s tance and should theref

ore be disreg arde d for feder al t ax purposes. The Commissi oner a rgued bef ore the tax court that Capital, af

ter it sold its ass et s at a substantial taxable g ain, attempted to avoid the tax conseque nces of that g ain by eng ag ing in the BL I SS transa ction, which it a sserted was a multi-step transac tion designe d solely to g ener ate a deductible but none conomic loss throug h manipulation of the partne rship basis rules. The tax court ag ree d, finding that “on the ba sis of industry prac tice the B L I SS tr ans a c tio n h a d n o r e a lis tic pr ob a bil ity of e arn ing a pr of

it” a nd wa s th e re fo re an e c on omi c sham. (Ta x Ct. Op. at 35, J A 389.) We reviewthe tax court’s ultimate conclusion that a tra nsactionThere is occa sional lang uag e in the tax court’s opinion sugg esting that it found that the 5 subjective motivation of New Phoenix ’s involvement in the B L I SS transac tion was tax avoidance and not for profit. Neve rtheless, the opinion clea rly states t hat i t is only deciding the first prong

. See Tax Ct . Op. at 33 (holding that the transac tion “ lacks economic substance and fa ils the first prong ”); id. at 38 (“ Be ca u s e we find that the transac tion at issue lacked e conomic substance , we do not consi d er M r. W ray ’s and Capital’s pr ofit motive in entering into the transac tion.”). Thus, the tax court’s musing s about Wray ’s motivations appear to be dicta. 9 is or is n ot a

n e c on omi c sh am de novo , while its factua l findings a re r eviewe d for c lear

err or. Dow Chemical Co. v. United States , 435 F.3d 594, 599 ( 6th Cir. 2006) (citations omitted).

“ Th e c ourt

e ng a g e s in

a tw o- pa rt inq uir y to d e termin e wh e the r a

n a sse rt e d d e du c tio n is valid.” Rink v. Comm’r , 47 F.3d 168, 172 (6th Cir. 1995)

. “The threshold question is whether the transac tion has economic substanc e. I f the answe r is yes, the question become s whether the taxpay er was motivated by

profit to participate in the transa ction.” Pasternak v . Comm’r , 990 F.2d 893, 898 (6th Cir. 1993) (citations omitted). The tax cour t did not de termine New Phoen i x ’s s u b jective

mo tivation for eng ag ing in the B L I SS t ransa ction beca use it decide d that the transa ction lacke d economic substanc e, so we may limit our revie w to this threshold inquiry . “[T] he Commissi oner 5 has the a uthority to find [a] transac tion or entity lacks e conomic substance and disreg ard it for tax p u rp o s es ” wh en t h at t ra n s ac t i o n “h as n o v al i d , n o n -t ax b u s i n es s p u rp o s e, [ s u ch as wh en i t ] b ri n gs about no re al cha

ng e in the ec onomic relation of the taxpay ers to the income in question.” Richardson v. Comm’r , 50 9 F .3 d 73 6, 74 1 (6 th Cir

. 20 07 ) (c itatio ns a nd qu otatio ns omi tte d) . T his is true eve n when the tr ansac tion is i n “for mal compliance with Code provisions.” Am. Elec . Power Co. v. United States , 3 2 6 F. 3 d 7 3 7 , 7 4 1 (6 t hC i r. 2 0 0 3 ) ( ci t i n g Knetsch v. United States , 3 64 U. S. 361, 366 (1960))

. I n rea ching its conclusion that the BL I SS t ransa ction l ac k ed economic substance , the tax

c ourt re lie d o n th e Com mis sio ne r’ s e vid e nc e that Ca pit a l c ou ld n ot p ro fi t f

ro m the tr ans a c tio n. F ir st,10

the C o m m i s s i o n e r o f

f e r e d t h e t e s t i m o n y o f t w o e xp e rt w i t n e s s e s w h o t e s t i f i e d t h a t t h e re wa s a probability

of 0.2% or

less that the price woul d b e wi t h i n t h e swee t spot on at least one day . Dr. Steven Pomerantz testified there was a 95.8% cha

nce that Capital would lose its $131,250 net inv e stm e nt, a

3. 4% c ha

nc e that Ca

pit a l w ou ld b re a k even, and a 0. 6% c ha

nc e that Ca

pit a l w ou ld

re a lize a $1 31 ,2 50 ne t pr of

it o n th e tr ans a c tio n. Th e Com mis sio ne r a rgue d th a t, a ft er tak in g int o

a c c ount t he $5 00 ,0 00 fe e pa id t o Jenke ns & Gi lc hr ist , Ca pit a l wo uld

los e mon e y

on e a c h o f t he se

scena rios, and the only

way that Capital would come out ahe ad was if spot price hit the sweet spot

on on e or bo th o f t he tw o d ay s. M o r e o v er , ac co rd i n g t o C o m m i s s i o n er ’s ev i d en ce , t h e t i n y t h eo re t i ca l ch an ce o f al ar ge pa y ou t w a s, in re a lity , illu so ry , be c a us e De uts c he B a

nk c ou ld as sure that th e sp ot r a te wo uld no t hi t the swee t spot in either of two way s. First, Deutsche Ba nk was the ca lculation ag ent of the spot rate, and the c ontrac t did not specify how the rate was to be ca lculated. Ac cordingto Comm issioner’s expert witnesses, under

the marke t convention Deutsc he B ank would dete rmine the s p ot rate by asking a handf

ul of other ba

nks for their pr ice quotations and pickinga quote f rom amongthe ones g iven to it. Banks a lway s g ave the ir quotes as a rang e of .03 yen, the hig h number be ing the price

a t w hic h th e ba

nk wo uld se ll, and the low e r va lue be ing the pr ic e a t whic h th e ba nk wo uld buy . T his meant that, for

any g iven price quote, Deutsc he Ban k co uld alway s select a valuation that was outside of the tiny

“swe et spot,” which was onl y .02 y en wide. And, because D eutsche Ba nk had no fi du c iary duty to C a pit a l, a s a ratio na l a c tor

it w ou ld n e ve r se le c t the pr ic e in a wa y that w ou ld c a

us e it t o lo se $7 4 mi lli on . Se c on d, e ve n if De uts c he B ank

did no t ha ve dis c re tio n to se t th e numbe r, it could still manipulate the spot rate throug h marke t trading

. Dr. P omera ntz testified t hat i f the y en rate was not idea l for Deutsche Ba nk at 10:00 a .m., the trade r had 59 se conds to influence the marke tI n its reply brief, N ew Phoenix arg ues that the tax court’s fa ctual findingthat Deutsche Ba nk 6 had discre tion to calc ulate the spot r ate is er roneous be cause it ignore d the I SDA documents made b i n d i n g o n Deutsche Ba

nk by the contra ct conf

irmation. Following the def inition of “Spot R ate” in section 1.16(e) of the 1998 F X Def inition and the corre sponding se ction of the User’ s Guide, Ne w Phoenix claims that Deutsche Ba nk was req uired to dete rmine the rate either a) a s set by

the confirmation, or

b) in a c ommercia lly

rea sonable manne r. Howe ver, it appe ars that se ction 1.16(e) do e s n ot e ve n a

pp ly to t he ins tant t

ra ns a c tio n. Se c tio n 1 .1 6( e ) o nl y app li es to “n on -d e liv e ra ble tr ans a c tio ns ,” and

tr ans actio ns are de liv e ra ble un le ss t

he y sp e c if y “ No n- De liv e ra

ble ,” “ c a sh settlement,” or “ I n-the-Mone y Settlement,” B eca

use the c onfirmation here conta ins no such sp e c if ic a tio n it is de e me d to be a de liv e ra ble tr ans a c tio n, and the te rm s a pp lic a ble to n on -d e liv e ra

ble transac tions, including sec tion 1.16(e), a re irr eleva nt. Moreover , even if

Deutsche Ba

nk was bound 11 throug h larg e tra des. Ac cordingto him, it would not be diff i cu l t fo r De u t sche B ank to move an exchang e rate a f

ew ten- thousandths for a br ief pe riod of time. Thus, there was never a risk that the sp ot p ri c e a t 10 :00 a .m. wo uld be le ft wi thi n th e sw e e t sp ot. New Phoenix disput ed the Commission er ’s ev idence reg ardingthe B L I SS t ransa ction’s potential profitability

. Howeve r, the tax cour t r esolved this issue in f

avor of th e C o mmissi oner. Re g ard ingDe uts c he B ank ’s dis c re tio n to set the sp ot rate , Ne w Phoe nix’ s e xpe rt wi tne ss, Dr . Sc ott Haka la, testified that mar ket conve ntion was to use the off icial r at e as ca lculated by the Fe dera l Reserve Ba

nk in New Yor

k at 10:00 a.m., or, a lternatively , the rate as published by either Reute rs or Dow Jones. Dr. Ha

kala a rgued that De utsche B ank wa s constraine d by the definiti ons from two documents promulgated by the I nternational Swaps and Derivatives Association, I nc. (the “I SDA”) that wer e explicitly

incorporat ed by

the conf irmation of the contr acts. Dr . Haka la contende d that t h er e w as a p ar t i cu l ar

p ro v i s i o n

— p re s u m ab l y

s ec t i o n4

. 5 (e )( i ) o f t h e 2 0 0 0 An n ex

— re qu i ri n g a calc ulation ag ent to a

vera g e the quoted ask a

nd sell prices when dete rmining the spot rate, ther eby

e lim inatin g the .0 3- y e n r ang e . Se c tio n 4.5 (e )( i) a lso re qu ir e s that, i n th e c a se of mul tip le qu otatio ns , the c a lc ulatio n a g e nt m

us t a do pt the ave ra g e of

a ll t he pr ic e s q

uo te d, “ su

bje c t to an a dju stm e nt, if

an y , b y t h e C a l c u l a t i o nA g e n tt o r e d u c e t h e e f

f e c to f m o m e n t ar

y d i s p ar i t i e s i nt h e pr ic e s. ” ( JA 6by

se c tio n 1 .1 6( e ), it w a s n ot c le arl y e rr on e ou s to c on c lud e that D e uts c he B ank c ou ld s til l ma

nip ulate the sp ot r a te . The pla in me anin g of the c on fi rm a tio n d oe s n ot a pp e ar t o r e qu ir e that an o ff ic ia l r a te or any particula r cal culation m ethod be use d. Thoug h New Phoenix asserts that, bec ause the confirmation specified that the spot rate be c alculate d at 10:00 a.m., it impli citly require d Deutsche Ba nk to adopt the offic ial rate calc ulated by the Fe dera l Reserve in New York at prec isely that time, this contention is unavailing: just beca use i t would be convenient t o obtain a g overnme nt rate at the time of valuation does not imply that doing so is re quired. There fore , beca use there is no indication that th e pa

rt ie s a g re e d up on a va luatio n me tho d, se c tio n 1 .1 6( e ) w ou ld r e qu ir e De uts c he B ank to u se any c omm e rc ia lly

re a so na ble me tho d to de te rm ine the sp ot r a te. Th e Com mis sio ne r’ s e xpe rt s te s ti f ie d th a t p r e v a il in g c o mm e r c ia l n o r ms g a v e D e u ts c h e B an k c o n s id e r a b le lati tu d e to p ick a marke t quotation, and the tax court found this testimony to be cr edible. Fur ther supportingthe fa ct that it was a sham transac tion is t he fa ct that Mr. Wray did not 7 sign the paper

work until Dec ember

20— after

both valuation dates c ame a n d we n t
. W h en Wray signe d the confirmation, Capital had alre ady lost out on the contra ct, and ther e wa s never a cha nce that th e op tio ns wo uld

pa y out. 12 1112.) Dr. H akala

was a lso skeptical of De utsc h e Bank’s ability to manipulate the mar

ket price , descr ibing it as “l i m ited as best.” D r. Hakala f urther te stified that transac tions li ke that betwe en Ca pit a l and De uts c he B ank , w hil e “ no t ve ry c omm on ,” do ha

pp e n, “ g e ne ra lly” on be ha lf of a pa rt y who trade s in curre ncies. How ever , he had ne ver se en a tr ansac tion which had a sw eet spot as

narr ow and the pote ntial pay out as larg e as this one. I n light of the “g reat defe renc e” that we extend to “the Tax Court’s deter mination pertaining to the cre dibilit y

of witnesses,” Pasternak, 9 90 F .2 d a t 90 0 (c itatio ns omi tte d) , we fi nd no e rr or in the Tax Court’s cre diting the testimony of the Commissioner’s experts over the te stimony of Ne w Phoenix ’s expert. New Phoenix ag ree d that both of the Commi ssion’s e x perts wer e qualifie d to give

an ex pert opini on. Fur

thermore , both experts ag ree d that the proba bility of the pa rtnership making

a pr of it w a s ti ny

on pa pe r a nd no n- e xiste nt in pr a c tic e . With out the op po rt un ity to make a

pr of it, 7 the only conseque nce of

the transa ction to New Phoenix was a tax b en efit. This makes the tr ans a c tio n a

n e c on omi c sh am, a s the ta x c ourt pr op e rl y c on c lud e d. I nd e e d, oth e r c ourt s h a ve he ld13

that simil ar c urre ncy option swaps lack economic substance and the C ommissi oner ma y disreg ard them for tax purposes. E.g. Stobie Creek Inve stments LLC v. United States , 608 F.3d 1366, 1376- 77 (F ed. Cir. 2010). Without t he cla imed loss, Ne w Phoenix owed an additional $3,355,906 for the tax ye ar 2 0 0 1

. T h e t a x c o u r

tp r o p e r l y u

p h e l d t h e C o m m i s s i o n e r ’ s a s s e s s m e n to f a d e f i c i e n c y. II. Reasonable Cause Exception The Commissioner assessed a 40% under

pay ment penalty

applicable to valuation misstatements of m ore than 400% aga inst New Phoenix. See I .R.C. § 6662(h). Ne w Phoenix seeks to avoid this penalty

by invoking the r easona

ble ca use exception ou t l i n ed in Trea sury Reg ulation § 1.6664-4, ar guing that it reasonably and in g ood faith re lied on the tax opini on it rece ived from J enkens & Gilchrist in claiming the loss from the B L I SS t ransa ction on its tax returns. The tax court de te rm ine d th a t Ne w Ph oe nix c ou ld n ot i nv ok e the re a so na ble c a us e de fe ns e , c on c lud ingthat, beca use Jenkens & Gilchrist “ac tively participated i n the deve lopment, structuring , promotion, sale, and implementation of the BL I SS transa ction,” it was unre asonable for Ne w Phoenix to rely on the tax opi nion “in the fa ce of such a c onflict of intere st.” We reviewthe tax court’s findingon whether a taxpay er a cted with re asonable cause for clear err or. See I lles v. Comm’r , 9 82 F .2 d 1 63 , 1 66 (6 th Cir. 1992) (citations omitted). Trea sury Reg ulation § 1.6664-4 provides a defe nse to pena l t ies “upon a showing by

the taxpay er that there w as re asonable cause for, a nd the taxpay er a cted in good f aith with respec t to,” the un de rp ay

me nt. Tr e a s. Re g . § 1. 66 64 -4 ; see also I .R.C. § 6664(c)(1) . “‘[T]he determination of wh e the r a ta xpay e r a c te d wi th r e a so na ble c a us e and in g oo d f a ithis m a de on

a c a se -b y -c a se ba sis , taking into account a ll pertinent fac ts and circ umstances.’ ” Mo r t en s en v. Comm’r , 440 F.3d 375, 387 (6th Cir. 2006) (quoting Trea s. Reg . § 1.6664-4(b) (1)) . “The most im portant fa ctor in making14

this determination is the ext ent of the ta x pay er’ s eff ort to asce rtain h i s p ro p er t ax li ability .” Id. “When an a ccounta

nt or attorney

advises a tax pay er on a

mat t er of tax law, such as whe ther a liability exis ts, it is reasonable for the tax pay er to re ly on that advice .” Un ite d Sta te s v . B oy le , 469 U.S. 241, 251 (1985) (e mphasis omitt ed). The ref ore, “ g ood faith re liance on pr ofess i o n al advice

conce rning the tax laws” may establish a rea sonable cause defe nse to pe nalties. Mortensen , 440 F.3d at 387 (citations omitted). “In order for relianc e on profe ssional tax advi ce t o b e r easona ble, ho we ve r, the a dv ic e mus t ge ne ra lly be fr om a c omp e te nt a

nd ind e pe nd e nt a dv iso r u

nb ur de ne d w ith a conf lict of interest a

nd not from promoters of the investment.” Id. The tax pay er has the burde n of establishing that a re asonable person would have re lied on the profe ssional’s advice

. Illes , 982 F.2d at 166. Th e ta x c ourt pr op e rl y up he ld the a sse ssm e nt o f a pe na lty . T he op ini on

le tte r o f Je nk e ns & Gi lc hr ist on wh ic h Ne w Ph oe nix r e lie d w a s p ro du c e d b y pr of e ssi on a ls who re a so na

bly a pp e are d to b e kn o w l e d g e a

b l e a b o u tt h e t a x l aw . H o w e v e r , t h e t a x c o u rtm a d e a f a c tu a l f i n d i n g t h a tt h e a t t o r

n e ys of Jenk e ns & Gi lc hr ist

“ we re pr omo tin g ” the ta x she lte r whe n th e y me t Mr

. Wra y . T he a tto rn e y s’ invo lv e me n t i nth e p r e p ar a ti o no f ma n y o f th e d o c u me n ts n e e d e d

to im p le me n t t h e tr an s a c ti o ns

su pp or ts this fi nd ing . B e c a

us e “ re lia nc e on the pr omo te rs of

the inv e stm e nt [i s] i ns uff ici ent to support a g ood faith def

ense,” Mortensen , 440 F.3d at 387, New Phoenix cannot rely on the J enkins & G ilchrist tax opinion to avoid the pay ment of pena lties and the tax court properl y u p h eld t he C o m m i s s i o n e r ’ s a s s e s s m e n to f a $ 1 , 2 9 8 , 2 8 4 p e n a l t y.T h e t ax co u rt generally follows the ru l es o f e v i d en ce ap p l i cab l e t o n o n -j u ry ci v i l p ro ce ed i n gs 8 in fede ral district cour

t, meaning the Fe dera l Rules of Evidence . Tax Ct . R. 143(a). New Phoenix also contends that the exhibi ts w ere admitted without pr oper a uthentication. 9 See Fe d. R. Evid. 901. Alth o u gh Ne w P h o enix objected to the a dmission of the ex hibits on t he g rounds of attorney -client privileg e or work product prote ction, it did not obj ect on the g rounds of a u th e n ti c a ti o n . T h e r e f

o r e , it h a s w a iv e d an y s u c h o b je c ti o n , an d w e r e v ie w it f o r plain err or, s ee F e d. R. Ev id. 10 3( a )( 1) , and c on c lud e that any e rr or did no t a ff e c t N e w Ph oe nix’ s su

bs tanti a l r ig hts

. See Fe d. R. Evid. 103(d). 15 III. Disclosure and Ad m ission of Docume nts New Phoenix’s final ar gu m en t on appea l is that the tax court improper ly require d the disclosure of c erta in doc uments, later a dmitted into evidence, that it claims are subje ct to protec tion 8 as attorne y

work produc t or u nder the attorney -client privileg e. New Phoenix asserts that by 9 requiring disclosure of those documents and by admitting them into e vidence , th e t ax co urt

c omm itt e d r e ve rs ibl e e rr or be c aus e the ta x co ur

t r e lie d o n th e se do c ume nts in d isr e g ard ingits defe nses to penalties. The tax court admitted the documents af ter c oncluding that they

wer e encompa ssed in New Phoenix’s “subject-matter” w aiver of any priv i l ege s appli cable to material rela ted t o th e Je n k in s & G il c h r is t t a x o p in io n , b y r e a s o no f

N e w Ph o e n ix’ s a s s e rti o no f the

rea sonable c ause de fense . We review de novo both the issue of whe ther a party has wa ived an evidentiar y privileg e and the scope of any valid waiver

. See In re Grand Jury Procee dings Oct. 12, 1995 , 78 F.3d 251, 253- 54 (6th Cir. 1996). Both th e a tt o r

n e y - c li e n t p r iv il e g e an d

w o r k

- p r o d u c t p r o te c ti o nar e w a iv e d b y v o lu n ta ry disclosure of pr ivate communications to t hird parties. Un ite d Sta te s v . D ak ota , 197 F.3d 821, 825 (6t h Cir . 1 99 9) ; In re Columbia/HCA Corp. , 2 9 3 F

. 3 d 2 8 9 , 3 0 6 ( 6 th

Ci r . 2 0 0 2 ) ( “ [T ]h e r e is no compelling re as o n for differe ntiating wa iver of w ork produc t from waive r of attorney -client privileg e.”)

.16

When the disclosure is made in a Fe dera l pr ocee ding or to a Fe dera l office or ag ency and wa ives the attorne y -client privileg e or w ork-pr odu ct p rot ection, the wa iver e xten ds to an un dis c los e d c omm un ic a tio n o r i nf

or matio n in a F e de ra l or

State proce eding only

if: (1 ) t he wa ive r i s in te nti on a l; (2) the di s c lo s e d

a n d u n d isclosed communications or infor mation conce rn the same subjec t matter; and (3) they oug ht in fairness to be c onsidered tog ether

. F e d. R. E vid . 5 02 (a ); se e als o U nite d S tates v . Co lli

s , 128 F.3d 313, 320 ( 6th Cir. 1997). New Phoenix first argues t hat “ther e is no evidenc e that Jenkens’ [sic] opinion [ in support of the B L I SS t ransa ction] was ever privileg ed,” a

nd there fore its disclosure did not waive any privileg es protec ting other documents. The attorney -clien t p ri vileg e attac hes to confide ntial

c omm un ic a tio ns re latin g to a

ny le g a l a dv ic e so ug ht f

ro m a pr of e ssi on a l le g a l a dv ise r i n h is c a pa c ity as such. See R eed v . Baxter , 1 3 4 F. 3 d 3 5 1 , 3 5 5

– 5 6 (6 t hC i r. 1 9 9 8 ) ( ci t i n g Fa us e k v . W hite , 965 F.2d 12 6, 12 9 ( 6th

Cir . 1 99 2) ). De sp ite Ne w Ph oe nix’ s c on te nti on , th e ta x opin ion c on sti tut e s ju st this

so rt of c on fi de nti a l c omm

un ic a tio n: i t re c ite s fa c ts c omm un ic a te d by Ne w Pho e nix fo r that pu rp os e of obtaining leg al advice , and it contains a pr ominent headi n g on the first pag e indicating “CONF I DENTIAL ” and “ ATTORNEY- CL I ENT PRI VI L EGED.” New Phoenix ’s ar g ument that it alway s int en d ed t o d i s close this document to its acc ountants and auditors doe s not chang e the document’s c onfidential and privilege d nature , beca use i t could m ake suc h a disclosure consistent with the privileg e. Se e Un ite d S tates v . D e loi tteLLP , 610 F.3d 129, 139-4 1 (D

. C

. C ir. 2010) (holding that there was no waiver if disclosed to auditor). N or is this ruling inconsistent with the tax court’s de cision that the tax opi nion was not the produc t of a ne utral advis o r. The fac t that the advice of the attorney s cannot be relied upon f or the purpose of evading a pena lty does not mean that there was not an attorney -client re lationship between N ew Phoenix and J enkens & Gilchrist. I n other17

words, the f

act that a n attorney has a c onflict of intere st does not me an t h at t he client forf eits the benef it of the attorney -client privileg e. H a v in g d e te r

mi n e d th a t t h e tax o p in io n w a s s u

b je c t to th e a tt o r

n e y - c li e n t pr iv il e g e , th e n e xt question is whether N ew Phoenix int entionally waived that privileg e with re spect to the opinion and any “disclosed a

nd undisclosed communications or infor mation conce rn[ing] the s ame subjec t matter” that “oug ht in fairness . .

. be considered” with the t ax opinion. Fe d. R. Evid. 502(a). The ta x co ur t c or re c tly he ld t hat N e w Ph oe nix ha d v olu nta ri ly wa ive d its p ri vil e g e by ra isi nga re a so na ble

cause defe nse pre mised on a cla im of rea sonable re liance on the J enk en s & Gi lchrist tax opi nion. By asser ting this defe nse, Ne w Phoenix has put the subject matter of the tax opinion at iss ue, making its disclosure appropr iate: “[L ]i tiga nts c annot hide behind the privileg e if they are re l y i n g upon privileg ed communications to m ake the ir ca se. ‘The attorney -client privileg e ca nnot at once be used as a shield a

nd a sword.’ ” In re L ott , 4 2 4 F. 3 d 4 4 6 , 4 5 4 (6 t hC i r. 2 0 0 5 ) ( qu o t i n g United States v. Bilzerian , 92 6 F .2 d 12 85 , 1 29 2 ( 2d Cir . 1 99 1) ; see also Glenm ede Trust Co. v. Thompson , 56 F.3d 476, 486 ( 3 d

Ci r . 1 9 9 5 ) ( h o ld in g th a t t h e a tt o r n e y - c li e n t p r iv il e g e ma

y b e w a iv e d

b y a c li e n t w ho

a sse rt s r e lia

nc e on the a dv ic e of

c ouns e l a s an affi rma tiv e de fe ns e ); In re G- I Holdings, Inc. , 218 F .R. D. 42 8, 43 3 ( D. N. J. 20 03 ) ( ho ldi ngthat de bto rs ha d a lr e a dy pla c e d th e ir

c on su ltatio ns wi th

c ouns e l a t iss ue thr ou g h dis c ov e ry re sp on se s and c ou ld no t su bs e qu e ntl y a sse rt any

pr ivi le g e s w ith respe ct to that subje ct). There fore , New Phoenix ’s asser tion of the rea sonable c ause de fense waives its claims of work-pr oduct protec tion and attorney -client privileg e with re s p ec t to any materia l

conce rning the subject matter of the tax opinion. Neve rtheless, Ne w Phoenix asser ts that this s ubject-matter wa iver doe s not ap p l y t o all of the do c ume nts or de re d to be dis c los e d a nd the n a dmi tte d into e vid e nc e by th e tax c ourt
.18

Un qu e sti on a

bly , th e ma

jor ity of the c ha lle ng e d d oc ume nts we re re late d to t he Jenk e ns & Gi lc hr ist tax opinion in support of the BL I SS transa ction. As such, any privileg e attache d to the m w as wa ived by the re liance on that opinion to avoid the assessment of pena lties. To the extent that som e of the do c ume nts we re unre late d to this sub je c t matt e r, we ne e d n ot r e so lve wh e the r t he ta x co ur

t pr op e rl y found the attorney -client privileg e and w ork produc t protection wa ived bec ause w e conc lude that their admission was cle arly harmless. See Fe d. R. Civ. P . 61; Fed. R. Evid. 103(a ). Mo st i mpo rt antl y , a ll o f t

he do c ume nts su

bje c t to the ta x c ourt ’s dis c los ur e or de r r e late d to the s ubjective knowle dg e and motivations of Ne w Phoenix ’s ag ents during the execution of the B L I SS tr ans a c tio n a

nd the pr e pa

ratio n a nd fi lin g of Ne w Ph oe nix’ s 2 00 1 tax re tur n. Th e se

c on sid e ratio ns we re wh oll y ir re le va nt to the po rt ion s of the ta x c ourt ’s de c isi on that N e w Ph oe nix now cha lleng es on appe al. The ta x court’s f inding that BL I SS t ransa ction was a n economic sha

m was ba sed solely on its conclusion that the tra nsaction lac ked ec onomic substance. T he holding that the re a so na

ble c a us e e xce pti on did no t ne g a te the a sse ssm e nt of pe na lti e s a g a ins t N e w Ph oe nix is supported by

the tax court’s deter

mination that J enkens & Gilchrist’s conf lict of interest re ndere d New Phoenix’s relianc e on the tax opinion unreason able. For these rea sons, the tax court’s dis c los ur e or de r a

nd c or re sp on din g e vid e nt iar y de c isi on s d o n ot p ro vid e g ro un ds to r e ve rs e its decision. CO NC LU SION The judg ment of the United States Tax Court is AFF I RMED.