Court Opinion

ID: 856738
Source: CourtListenerOpinion
Date Created: 2013-03-29 19:15:26.468076+00
Date Added: 2024-06-11T09:06:33.169213
License: Public Domain

UNPUBLISHED

                    UNITED STATES COURT OF APPEALS
                        FOR THE FOURTH CIRCUIT

                              No. 10-2072

ROBERT J. NAGY,

                  Plaintiff - Appellant,

           v.

UNITED STATES OF AMERICA,

                  Defendant - Appellee.

Appeal from the United States District Court for the District of
South Carolina, at Charleston. David C. Norton, District Judge.
(2:08-cv-02555-DCN)

Argued:   December 4, 2012                  Decided:   March 29, 2013

Before GREGORY, AGEE, and WYNN, Circuit Judges.

Affirmed in part, reversed in part, and remanded by unpublished
per curiam opinion.

ARGUED: John B. Kern, Charleston, South Carolina, for Appellant.
Anthony T. Sheehan, UNITED STATES DEPARTMENT OF JUSTICE,
Washington, D.C., for Appellee.     ON BRIEF: Kathryn Keneally,
Assistant Attorney General, Bridget M. Rowan, Tax Division,
UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C.; William
N. Nettles, United States Attorney, Columbia, South Carolina,
for Appellee.

Unpublished opinions are not binding precedent in this circuit.
PER CURIAM:

     Robert J. Nagy (“Nagy”) appeals from the district court’s

grant of partial summary judgment to the government, certain

evidentiary rulings at trial, certain of the jury instructions,

and the jury verdict against him imposing civil penalties under

§ 6700 of the Internal Revenue Code. 1 For the reasons set forth

below, we affirm the judgment of the district court in part,

reverse in part, vacate the jury verdict, and remand this case

for a new trial.

                                        I

     Nagy,     a     certified     public   accountant,   advised    Charles

Cathcart and his various Derivium companies (“Derivium”) in the

development and marketing of an investment scheme termed the

“90% Loan Program” (the “90% Loans”). 2 As part of this scheme,

customers of Derivium would transfer appreciated securities to

Derivium as “collateral” and receive in return a “loan” equal to

90% of the value of the securities. Derivium represented to its

customers     that    it   would    cause   hedging   transactions   to   be

     1
       All citations herein are to the Internal Revenue Code of
1986 as codified in volume 26 of the United States Code.
     2
       As best we can tell from the record, Nagy was a paid
accounting and tax consultant to Derivium and had no ownership
or equity interest in it.

                                        2
undertaken    so        as   to    protect      against        market      fluctuations           the

securities given as “collateral.” Further, Derivium represented

that the 90% Loan payments would be made by a separate offshore

entity   or       entities        that       would    also      engage     in    the        hedging

transactions.           Under     the    terms       of   the       90%   Loan    agreements,

Derivium could not demand repayment prior to the maturity date

of the “loan,” the customer could not repay the principal early,

and   Derivium          would      apply       any    dividends           received       on       the

“collateral”       securities           to    repayment        of    “loan”      interest.         At

maturity of the “loan,” the customer had the option to repay the

principal and recover the “collateral” securities, to renew the

loan, or to forfeit the stock without any further liability on

the “loan” even if the remaining principal balance and accrued

interest     of    the       “loan”      exceeded     the      value      of    the    forfeited

securities.

      In reality, upon consummation of a 90% Loan, Derivium would

not   hold    the        securities          received     as    collateral,           but     would

immediately sell the customer’s securities. Derivium thus funded

the 90% Loan payments out of the sales proceeds, while Derivium

principals kept the remaining 10% of the sales proceeds, which

they used for expenses and their own investments (which failed).

There was no separate offshore entity purchasing the “loans” or

performing        any    hedging        transactions.          Derivium        engaged       in    no

                                                 3
hedging    transactions       on     its     own    and    maintained      no    capital

reserves.

       By December 2005, Derivium had sold more than $1.25 billion

of its customers’ securities as part of the 90% Loan scheme. As

time    passed,      many     of     the     Derivium         customers’     securities

increased      in    value,        and     the     underlying      “loans”      matured.

Customers whose securities had increased in value repaid the

“loans” and demanded the return of their securities. As Derivium

no longer had the securities or any capital reserves, its entire

Ponzi-like scheme eventually collapsed.

       Nagy’s role in the Derivium saga was to give Derivium his

opinion, as a CPA, that the 90% Loans were bona fide loans and

not    sales   of   securities,          which     would   have    been    subject    to

federal    (and     state)    income       tax     at   the    time   of   the    sales.

Derivium used Nagy’s tax advice in its marketing to customers

(it would have had few takers for a taxable transaction) that it

offered a tax-free “loan” program. Nagy reviewed and commented

on the Derivium marketing materials before their publication to

customers with an eye to minimizing any mention of an income tax

risk related to the 90% Loans.

       The Internal Revenue Service (“IRS”) conducted audits of

Derivium beginning in late 2001 that concluded with the issuance

of no-change letters to Derivium. In 2004, however, both the IRS

and California tax authorities began audits of Derivium’s 90%

                                             4
Loan       customers,    eventually     determining          that    the   Derivium      90%

Loans were sales for income tax purposes and therefore taxable

to the customer at the time the securities were transferred. The

IRS assessed         penalties     under    I.R.C.       §   6700    against     Nagy    and

others who participated in the marketing of the 90% Loans. 3

       Nagy paid 15% of the assessed penalties and filed refund

claims pursuant to I.R.C. § 6703(c)(1), which the IRS denied. He

then    filed the        present     action       in   the   United    States      District

Court for the District of South Carolina, claiming, among other

things, refund of the penalties paid. The government filed a

counterclaim against Nagy, asserting Nagy’s liability for the

unpaid balance of its assessed penalties.

       The district court bifurcated the trial into two phases—a

liability phase and a penalty amount phase. During the liability

phase, the government moved for partial summary judgment on the

limited issue of whether the 90% Loans were bona fide loans or

sales       for    tax   purposes.    The     district       court     granted      partial

summary judgment in favor of the government, concluding that the

90% Loans were sales for tax purposes.

       The case then proceeded to trial by jury. On June 30, 2010,

the    jury       rendered   its   verdict        on   liability      in   favor    of   the

       3
       I.R.C. § 6700 authorizes civil penalties against certain
persons “[p]romoting abusive tax shelters.”

                                              5
government, finding by a preponderance of the evidence that Nagy

was subject to the I.R.C. § 6700 penalty. By separate verdict,

the jury set the amount of the penalty at $2.636 million.

     Nagy timely appealed, and we have jurisdiction under 28

U.S.C. § 1291.

                                    II

     We review a district court’s grant of summary judgment de

novo. Maracich v. Spears, 675 F.3d 281, 291 (4th Cir. 2012). We

review a district court’s evidentiary rulings for an abuse of

discretion. Creekmore v. Maryview Hosp., 662 F.3d 686, 690 (4th

Cir. 2011). We review the adequacy of a district court’s jury

instructions for an abuse of discretion, while we review the

statements of law contained in jury instructions de novo. United

States v. Jefferson, 674 F.3d 332, 360 (4th Cir. 2012).

                                    III

        Nagy raises six issues on appeal: (A) whether the district

court     erred   in   granting   partial   summary   judgment   to   the

government on the limited issue of whether the 90% Loans were

sales for tax purposes and not loans, (B) whether the district

court erroneously instructed the jury that Nagy’s tax advice to

Derivium that the 90% Loans were loans and not sales was a

“false or fraudulent” statement as a matter of law for purposes

                                     6
of § 6700, (C) whether the district court abused its discretion

in excluding certain evidence submitted by Nagy, (D) whether the

district      court   abused     its    discretion     in    admitting       certain

evidence offered by the government, (E) whether the district

court erroneously admitted certain of Nagy’s personal tax return

information into evidence, and (F) whether the district court

erroneously instructed the jury regarding the calculation of the

penalty.

                       A.      Partial Summary Judgment

      We first conclude that the district court properly granted

summary judgment to the government on the issue of whether the

90%   Loans    were    sales    and    not   loans    for   tax    purposes.       The

district court correctly applied the doctrine of substance over

form and concluded that the 90% Loans were in substance sales

for tax purposes because the “benefits and burdens of ownership”

had passed from the 90% Loan customers to Derivium. Nagy v.

United    States,     No.   2:08-cv-2555-DCN,        2009   WL    5194996,    at   *3

(D.S.C. Dec. 22, 2009). 4

      4
       As the district court properly found in its partial
summary judgment opinion: the 90% Stock Loan Program did not
generate genuine indebtedness because:

     (a) Derivium had to sell the securities to fund the
     “loan”; (b) the customer could not repay his “loan”
     prior to maturity and Derivium could not force a
(Continued)
                                         7
                  B.       Liability Phase Jury Instruction

      Next,   Nagy     argues       on   appeal    that     the    following      jury

instruction at the liability phase of his trial was erroneous:

“In   December    2009,      this   court      determined   that     the    90%   Loan

transaction      was   a    sale,    and    not    a   loan.      Thus,    statements

indicating that the 90% Loan transactions were loans are false.”

(J.A. 210.) Yet Nagy made no objection to this jury instruction

at trial. We conclude that, as Nagy failed to “make timely and

sufficient objections” to these jury instructions at trial, he

failed to preserve the issue for appeal. See Belk, Inc. v. Meyer

Corp., U.S., 679 F.3d 146, 153 n.6 (4th Cir. 2012). Moreover, it

is worth noting that the district court twice instructed the

jury that it could find Nagy liable under § 6700 regarding the

false sale/loan statement only if they found “Nagy knew or had

      repayment; (c) the customer was never required to
      repay the “loan proceeds” he received; (d) the only
      collateral Derivium ever retained, if any, was 10% of
      the value of the sale of the securities; (e) the
      customer retained a contractual return-of-stock right;
      and (f) because a customer would only repay his “loan”
      and get his securities back (securities Derivium would
      have to purchase on the open market) if their value
      had increased, Derivium would only lose if the
      customer repaid the “loan,” which stands in stark
      contrast to the ordinary risk assumed by a lender,
      i.e., not being repaid by the borrower.

Nagy, 2009 WL 5194996, at *3.

                                           8
reason to know that these statements were false at the time they

were made.” (J.A. 210 (emphasis added).)

         C.     Exclusion of Certain Evidence Submitted by Nagy

      Nagy      also       argues    that     the        district      court    abused        its

discretion in sustaining the government’s objections to certain

evidence       he    sought     to   present       to     the    jury.    At    trial,    Nagy

attempted to introduce the expert testimony of Mark Altemose, a

former IRS tax auditor; a letter written by B. John Williams, a

tax   attorney;          and   various      internal       IRS     communications.        Nagy

argues    these      items      of   evidence       should      have     been   admitted      to

disprove that he knew or had reason to know that his tax advice

was   false.        We    do   not   believe       the    district     court     abused       its

discretion in excluding this contested evidence.

      Neither            the   Williams      letter         nor     the     internal          IRS

communications were in existence at the time Nagy gave his tax

advice    to    Derivium        so   he   could      not    have    relied      upon     it    in

forming his advice. Therefore neither the Williams letter nor

the IRS communications were relevant to show what Nagy knew at

the time he gave his tax advice. While Nagy could have offered

testimony from Mr. Altemose for a relevant purpose, he chose to

offer that expert testimony only regarding the legal import of

an IRS no-change letter as well as IRS audit procedures, neither

of which have any relevance to show what Nagy knew or should

                                               9
have known at the time he gave his tax advice and would have

likely confused the jury. We conclude the district court did not

abuse   its     discretion            in     excluding        the     foregoing        from

consideration as evidence in this case.

                              D.     Pfleiderer Testimony

     Nagy     also      contends      that    the     district      court    abused     its

discretion    in     admitting        into    evidence       the    testimony    of    Paul

Pfleiderer, an expert on behalf of the government, regarding the

economic     effect      of    the    90%    Loans.     To    the    extent     Nagy    has

presented a challenge to Pfleiderer’s testimony, we find it to

be   meritless,       and      the       district   court      did     not    abuse     its

discretion in admitting Pfleiderer’s testimony.

                   E.       Nagy’s Personal Tax Information

     At trial, the government sought to put before the jury, as

part of its case-in-chief, evidence that Nagy failed to timely

file his personal income tax returns in certain years while he

was giving the 90% Loan tax advice to Derivium and timely pay

the tax due for some of those years. Nagy timely objected to the

introduction of that evidence as general bad acts evidence that

was not relevant to the § 6700 penalty determination and should

be excluded under Rule 404(b) and/or Rule 403 of the Federal

Rules   of     Evidence.           The     district     court        overruled    Nagy’s

                                             10
objections      and    permitted            the    information      regarding      Nagy’s

failure to timely file and pay his taxes in certain tax years to

come before the jury. Under the circumstances of this case, we

conclude      that    the   district          court   abused       its   discretion      in

permitting this evidence before the jury and that its effect was

highly   prejudicial.       We    also       conclude       that   the   error   was     not

harmless.

       Nagy    first    contends        that       I.R.C.     § 6103(h)(4)       did     not

authorize the disclosure of Nagy’s personal income tax return

information     as     evidence        in    the    § 6700     penalty     case.       While

§ 6103(h)(4)(A) was clearly satisfied (Nagy was a party to the

§ 6700 proceeding), the applicability of subsections (B) and (C)

is much more problematic. But we will assume, without deciding,

that the § 6103(h)(4) restrictions can be applied disjunctively.

See Mallas v. United States, 993 F.2d 1111, 1118, 1121–22 (4th

Cir. 1993) (applying § 6103(h)(4) disjunctively); see also Rice

v. United States, 166 F.3d 1088, 1092 (10th Cir. 1999) (holding

that § 6103(h)(4) allows the disclosure of a person’s tax return

information when that taxpayer “is a party to the proceedings”);

Tavery v. United States, 32 F.3d 1423, 1430 (10th Cir. 1994)

(“The exceptions in § 6103 are stated in the disjunctive.”).

       Even if § 6103 does not bar the evidence at issue, however,

that   conclusion      does      not    resolve       the    underlying     evidentiary

issue. The § 6103(h)(4) exceptions operate only as a gatekeeper

                                              11
device that allows the disclosure of taxpayer information in

certain situations. If a § 6103(h)(4) exception applies, that

determination removes only the statutory disclosure barrier; it

does not resolve the independent evidentiary determinations of

relevance or prejudice.

       Rule    404(b)    prohibits         the   admission       of    evidence      of   “a

crime, wrong, or other act . . . to prove a person’s character

in order to show that on a particular occasion the person acted

in accordance with the character.” Fed. R. Evid. 404(b)(1). Such

evidence      may   be    admissible,        however,     to     show,       among   other

things,    “knowledge”      and      “absence      of   mistake.”       Id.    404(b)(2).

Evidence is admissible under Rule 404(b) only when that evidence

is     “(1)    relevant         to    an     issue       other        than     character;

(2) necessary; and (3) reliable.” United States v. DeLeon, 678

F.3d    317,    330      (4th    Cir.      2012)     (internal        quotation      marks

omitted). Nagy argued to the district court that the evidence of

his failure to meet personal tax obligations was not relevant to

the    determination       of    liability       under    § 6700       and     served     no

purpose other than to cast Nagy’s character in a negative light.

The government argues that the evidence of Nagy’s failure to

timely file and pay his taxes in certain years during which he

was advising Derivium was relevant to show an absence of mistake

in his tax advice. Yet the government does not explain, or even

                                            12
attempt to explain, how this evidence was relevant to Nagy’s

state of mind in the rendering of opinions on the 90% Loans.

     The government presented no evidence linking Nagy’s failure

to file or pay certain personal taxes to his work for Derivium.

Nothing in the record connects Nagy’s failure to timely file or

pay his personal taxes to any knowing act of fraud or fraudulent

intent in giving tax advice to Derivium. There simply is no

record evidence linking the two. Indeed, Nagy argues that his

failure to file or pay his personal taxes was related to severe

family medical situations and his lack of assets: acts which

would subject Nagy to, at most, negligent failure to file or pay

penalties under § 6651.

     The government contends that the evidence of Nagy’s failure

to timely file or pay his personal taxes was relevant to Nagy’s

state    of   mind   at    the    time   he    was    rendering     tax   advice    to

Derivium. But the government completely fails, as noted above,

to make any remote connection between Nagy’s failure to timely

file and pay his own taxes and his provision of tax advice to

Derivium. Nagy was not a Derivium principal or customer, and the

record    contains    no    evidence      that       his   personal    tax   returns

depended in any way upon the Derivium scheme.

     In short, we are at a loss to see any relevance for Rule

404(b)    purposes    for        the   admission      of   Nagy’s     personal     tax

information other than “to prove [Nagy]’s character in order to

                                          13
show that on a particular occasion [Nagy] acted in accordance

with the character.” See Fed. R. Evid. 404(b). While Rule 404(b)

is a rule of evidentiary inclusion, United States v. Smith, 441

F.3d 254, 262 (4th Cir. 2006) (“This court has recognized that

Rule 404(b) is primarily a rule of inclusion, not exclusion.”),

any evidence must satisfy the threshold of relevance to an issue

other than character that we find lacking here.

     Moreover, for Rule 403 purposes, the admission of Nagy’s

personal tax information was highly prejudicial and quite likely

to   influence       the     jury     against       him.       Had     the     personal       tax

information        had     some     semblance        of       relevance       (which       proper

evidence    in      some     other     case        may    well       show),     a    different

balancing for prejudice purposes would be required. But in the

absence of relevance, we conclude that the district court abused

its discretion to admit Nagy’s personal tax information into

evidence, particularly as it bears all the indicia of garden-

variety    “bad     acts”     evidence        with       no    other    purpose        than    to

emotionally inflame the jury against the defendant.

     Further, we conclude that the admission of Nagy’s personal

tax information was not a harmless error. Under harmless error

analysis,     we    will     not     reverse        if    we     can    “say,       with    fair

assurance, after pondering all that happened without stripping

the erroneous action from the whole, that the judgment was not

substantially swayed by the error.” Kotteakos v. United States,

                                              14
328 U.S. 750, 765 (1946). Nagy presented a cognizable defense as

to his state of mind for the knowledge purposes of § 6700 that

would   have    permitted       a    reasonable         jury     to    have      rendered     a

verdict in his favor. The prejudicial effect on the jury of the

personal     tax     information            about       Nagy,     however,         and      the

possibility that it swayed their judgment in their consideration

of this case, cannot be ignored. As the error was not harmless,

the liability verdict must be vacated.

               F.    Penalty Amount Phase Jury Instruction

     Reversal       of   the    liability         verdict       also   invalidates          the

penalty    determination        in     so    much       as   there     is    no    longer     a

liability finding upon which it could be based. However, in view

of the likelihood, that a penalty calculation issue will arise

again upon     remand,     we       exercise      our    discretion         to    address    an

assignment of error that Nagy raises. See United States ex. rel.

Drakeford v. Tuomey Healthcare Sys., Inc., 675 F.3d 394, 406

(4th Cir. 2012) (noting that “our precedent is clear that we may

address issues that are likely to recur on remand”).

     Nagy contends that the district court erred in its jury

instruction for the calculation of the § 6700 penalty amount for

any § 6700 liability prior to October 23, 2004, the date of an

amendment to the statute, by instructing the jury to “multiply

the total number of transactions for which [Nagy] is liable for

                                             15
each     year       by    $1000”    for    all      transactions          occurring          before

October       23,     2004.     (J.A.     217–18.)     The    statute       plainly          states

that, with respect to transactions occurring before October 23,

2004, any person who violates § 6700 “shall pay, with respect to

each activity described in paragraph (1), a penalty equal to the

$1000    or,     if      the    person    establishes        that    it    is     lesser,       100

percent of the gross income derived (or to be derived) by such

person        from       such    activity.”         I.R.C.        § 6700(a).           Any     jury

instruction given in a penalty amount determination trial upon

remand        should      follow    the    plain       language      of     the       applicable

portion of the statute.

                                               IV

        For    the       aforementioned        reasons,      we     affirm       the    district

court’s grant of partial summary judgment to the government on

the issue of whether the 90% Loans were sales for federal income

tax purposes. We also affirm the district court’s giving of the

jury instruction relating to whether a statement that the 90%

Loans    were       not    sales    for    tax    purposes        would     be    a    false     or

fraudulent statement for § 6700 purposes. Further, we hold that

the district court did not abuse its discretion in excluding the

evidence        from      Altemose       and   Williams       and     the        internal      IRS

communications.            Neither       did     the    district       court          abuse    its

discretion in admitting the evidence of Mr. Pfleiderer.

                                               16
     The district court did abuse its discretion, however, in

admitting Nagy’s personal tax information and the liability and

penalty    verdicts    are   therefore   vacated.   The    case    is   hereby

remanded    to   the    district    court    for    further       proceedings

consistent with this opinion.

                                                          AFFIRMED IN PART,
                                                          REVERSED IN PART,
                                                               AND REMANDED

                                    17