Court Opinion

ID: 2826760
Source: CourtListenerOpinion
Date Created: 2015-08-12 20:02:33.613636+00
Date Added: 2024-06-11T13:39:50.213777
License: Public Domain

In the United States Court of Federal Claims
                                No. 06-30T
                       (Consolidated with No. 06-35T)
                          (Filed: August 12, 2015)

**********************

RUSSIAN RECOVERY FUND LTD.,
RUSSIAN RECOVERY ADVISORS, L.L.C.,                Taxation of partnership;
Tax Matters Partner,                              bona fide partnership; 26
                                                  U.S.C. § 704; 36 U.S.C. §
                     Plaintiffs,
                                                  721; FPAA; economic
v.
                                                  substance; step transaction;
                                                  Culbertson; penalties;
THE UNITED STATES,                                reasonable reliance on tax
                                                  advice
                     Defendant.

**********************

       Loretta R. Richard, Boston, MA, with whom were B. John Williams,
Jr., Washington, DC, Alan J. J. Swirski, Washington, DC, Kathleen S. Gregor,
Boston, MA and Nathan P. Wacker, Washington, DC, for plaintiffs.

       Robert J. Higgins, United States Department of Justice, Tax Division,
Washington, DC, with whom were Richard T. Morrison, Acting Assistant
Attorney General, David Gustafson, Chief, Court of Federal Claims Section,
Steven I. Frahm, Assistant Chief, Court of Federal Claims Section, Bart D.
Jeffress, Trial Attorney, for defendant.

                                   _________

                                   OPINION
                                   _________

BRUGGINK, Judge.

       This is a Tax Equity and Fiscal Responsibility Act (“TEFRA”) action
seeking readjustment of partnership items involving what has come to be
known as a “DAD” transaction. That is a distressed asset/debt (“DAD”)
transaction in which losses suffered by a tax indifferent entity are transferred
to a partnership in exchange for an interest in that partnership, followed by the
sale of that partnership interest to a tax interested entity that subsequently
claims the loss. The present action is brought under 26 U.S.C. § 6226(a)
(2006)1 by Russian Recovery Advisors, LLC (“RRA” or “plaintiff”) as the tax
matters partner for Russian Recovery Fund, LTD (“RRF”). Plaintiff alleges
that the Internal Revenue Service (“IRS”) erred in its October 14, 2005 Notice
of Final Partnership Administrative Adjustment for the tax year ending
December 31, 2000 (“2000 FPAA”) when it disallowed approximately $50
million of the losses RRF claimed on its 2000 partnership return. Plaintiff also
has pending before the Tax Court a challenge to the FPAA disallowing RRF’s
partnership return for 2004, which claimed losses of $170 million from the
same type of assets at issue here.

        We have had occasion earlier in this proceeding to rule on a number of
procedural and substantive issues. See Russian Recovery Fund Ltd. v. United
States, 90 Fed. Cl. 698 (2009) (holding that satisfying jurisdictional deposit
requirement of IRC § 6226(e) requires inclusion of all potential increased tax
liability for tax years affected by the FPAA); 81 Fed. Cl. 793 (2008) (holding
it improper for a 2000 FPAA to adjust an individual partner’s amount at risk
in its distributive share of non-recourse partnership liabilities). In our most
recent opinion we held that the FPAA suspended the statute of limitations for
adjustment of Nancy Zimmerman’s 2001 individual tax return, or for any
partners she represents, while an extension agreement did not apply to James
(“Jim”) DiBiase’s return, which was filed beyond the FPAA’s three-year
window. 101 Fed. Cl. 498 (2011).

       Trial was held in Washington, DC, from March 30 until April 16, 2015,
on the merits of plaintiff’s challenge to the FPAA. The trial addressed the
merits of the FPAA, namely, whether RRF was entitled to claim built-in losses
on disposition of securities derived from Russian sovereign debt. At the time
those assets were placed into the partnership, they had built-in losses of
approximately $223 million. RRF claimed those losses for itself, relying, inter
alia, on IRC § 721. The FPAA asserts, in general, that the exchange of
partnership shares for those assets was not bona fide. Also at issue in the trial
was whether, assuming the FPAA is upheld, the IRS’s imposition of penalties

       1
        Unless otherwise indicated, all code section references will be to the
version of 26 U.S.C. in effect for the relevant time period.

                                       2
was correct. For the reasons set out below, we sustain the FPAA, both as to
the merits of the claimed loss and as to the imposition of a penalty.

                              BACKGROUND

       This case affords a fascinating window into the world of private hedge
funds, more particularly those operated to invest in non-equity instruments,
and even more particularly, one fund, RRF, established by Ms. Nancy
Zimmerman to capitalize on opportunities created by Russia’s 1998 default on
its sovereign debt. The court heard from nine fact witnesses and five experts
who made up an interesting array of individuals gifted in terms of insight into
finance and investments.

I.     The Transactions

        The star of the drama was Ms. Zimmerman, who made a name for
herself and a great deal of money for her employers or clients, while still at a
relatively tender age. She impressed the court, just as she must have impressed
investors, with the breadth of her knowledge about the operation of
international financial markets, the instruments for creating and transferring
obligations, and the opportunities afforded for making money on pricing
differentials. Just out of college, she worked for three years in Chicago for
O’Connor & Associates, an options trading company, where she made prices
on currency options on the floor of the Chicago Mercantile Exchange. From
there she went to New York City and took a position at Goldman Sachs. There
she priced and traded in Treasury bonds and options on U.S. debt instruments
as well as mortgages. She supervised a small staff of employees in New York
and overseas. She was later a vice president as well as an executive director
at Goldman Sachs International in London. Her immediate supervisor was Jon
Corzine. She developed an expertise in finding market opportunities and
exploiting them by constructing risk systems, basically exploiting pricing
inefficiencies in global fixed income markets. Eventually Ms. Zimmerman
decided to venture out on her own.

       Initially she partnered with an existing investment company called
Farallon Capital Partners, which provided seed funding in return for a minority
stake in a new management company, Farallon Fixed Income Associates, for
which Farallon did the accounting, legal work, and marketing. Ms.
Zimmerman was responsible for the investment program and for the
investment staff.

                                       3
        In 1998, Ms. Zimmerman and a partner, Gabriel Sunshine, decided to
buy out Farallon’s interest in Farallon Fixed Income Associates and distributed
that interest to Farallon Fixed Income Partners. On January 1, 1999, Ms.
Zimmerman and Mr. Sunshine parted ways with Farallon Capital Partners and
renamed their management company as Bracebridge Capital (“Bracebridge”),2
which eventually would become the management company for FFIP3 (a fund),
which in turn is one of a number of interconnected hedge funds. RRA was
later formed as a management group for the Russian Recovery Fund.
Bracebridge and its associated funds had approximately $600 million under
management at the end of its first year of operation and has approximately $10
billion under management today.

       One of Bracebridge’s key employees and someone who testified at
length on behalf of RRF was James DiBiase. He was hired by Bracebridge in
1998 to run all of the non-investment aspects of the firm. He became a partner
and ran the “back office” and held the title of CFO until 2007, when he ceased
being a partner and became an employee, which he remains to the present.

       In 1998, Bracebridge created several funds, one of which was RRF.
RRF was established as a Cayman Islands limited liability corporation, but it
elected to be taxed in the United States as a partnership. The purpose of RRF
was to extract value from distressed Russian assets.

       When the government of the Russian Federation defaulted on all of its
sovereign debt obligations in 1998, instruments issued by Russia, or derivative
of such instruments, lost virtually all of their value. The ruble also collapsed
and was no longer freely traded due to currency exchange limitations imposed
by the Russian Central Bank. Further complicating matters for holders of
Russian debt was that the Russian government only recognized a limited
number of large international banks, so-called “S account holders,” as
intermediaries to access the debt or to trade in rubles. In the wreckage, Ms.

       2
        Although Bracebridge technically did not exist prior to 1999, the
witnesses at trial referred to Ms. Zimmerman’s management company as
Bracebridge instead of Farallon Fixed Income Associates in the period after
she and Mr. Sunshine bought out Farallon’s interest.
       3
        FFIP was originally an acronym rooted in the naming scheme
developed by Farallon Capital Partners. However, in this context, FFIP is not
an acronym but the name of a Bracebridge fund.

                                       4
Zimmerman, who had experience with foreign currency instruments, including
Russian debt, saw an opportunity. As she explained:

      So all we were left with were these unhedged, completely
      crushed assets. And . . . it seemed best if we could give -- take
      all of the stock that was just a bet on will Russia recover, will
      you get more than four cents for these, and put them off to the
      one side and let investors, institutional investors, when we
      talked to them decide, you know, do you want these or not
      because, you know, maybe somebody could stand in your shoes
      and take these Russian assets because they’re not all in the RRF
      ....

              And we also thought that we’d have to -- there would be
      these Russian -- there would be ways to create value to get out
      of the S-accounts and that we probably could make some money
      doing that. We thought there was a lot of value there and that if
      we could -- you know, we were going to pay attention. Maybe
      we could get some people to give us cash and try and buy things
      or, better yet, to get people to just contribute in kind, to give us
      their problem assets, and then we would have scale, we’d have
      some economies of scale, in administrating and following the
      day in, day out developments around how to get out of the
      S-accounts and to come up with some techniques to leave the
      S-accounts.

      And you know, right at that moment, my best recollection is that
      a restricted ruble traded at about someplace around 25 percent
      of a fully trade -- a fully convertible ruble, so, you know, it
      seemed like that was a dislocation in that even if you could
      exploit that piece of it without the ruble being worth a lot more
      in the future that you could have a very handsome return.

Tr. 642-44.

       In sum, Ms. Zimmerman, who controlled Bracebridge, believed that she
could make money for herself and investors by obtaining devalued Russian
debt at pennies on the dollar in anticipation of a recovery of the ruble and
hence something approaching face value of debt instruments. Given the
depressed nature of the debt (most had lost over 90% of their value), even

                                       5
small increases would be highly leveraged. Bracebridge therefore created RRF
in late 1998 as a Cayman Islands limited liability company. Bracebridge also
created Russian Recovery Advisors as a separate management company to
guide RRF, through which Ms. Zimmerman also hoped to make money
through management fees.

       Most relevant to this litigation was a financial instrument known as a
“credit-linked note” or “CLN.” These instruments were derivative of Russian
sovereign debt and could only be issued by S account holders. Because non-
Russian hedge funds, such as RRF, were not eligible to own ruble-
denominated Russian Federation obligations directly, they could gain
economic exposure to Russian Federation debt instruments only through credit
derivative swap transactions memorialized in these credit-linked notes. The
authorized bank retained legal title to the bonds but would swap all of the
economic risk and benefit to a third party, such as a hedge fund, for cash or
some other form of consideration. DX 193 at 1-2 n.1 (letter summarizing
Christopher C. Lucas’s expert opinion).4

        Transactions in Russian debt and derivatives were handled by an
organized exchange known as the Moscow Interbank Currency Exchange, or
MICEX. Two of the types of instruments traded on the MICEX, and which
figured in the trial, were GKOs,5 discounted debt instruments issued by the
Russian Federation, and OFZs,6 which are floating rate, coupon-bearing bonds,
also issued by the Russian government.

       Bracebridge began marketing efforts at the end on 1998 to try to obtain
investors that were willing to contribute either assets in kind or cash in
exchange for an interest in the RRF partnership. The person primarily
responsible at Bracebridge for doing this marketing was Jonathan Grenzke,

       4
         “DX” refers to defendant’s trial exhibits. “PX” stands for plaintiff’s
trial exhibits. “JX” refers to those exhibits offered by the parties jointly. The
page citations follow the internal pagination scheme for each exhibit, most of
which are Bates numbers.
       5
        An acronym for the transliterated Russian, “Gosudarstvennoye
Kratkosrochnoye Obyazatyelstvo.”
       6
           An acronym for the transliterated Russian, “Obligatsyi Federal’novo
Zaima.”

                                       6
who testified at trial. Although the government seeks to cast doubt on the
bona fides of the marketing effort, we are persuaded that Mr. Grenzke did in
fact undertake a serious campaign, at least initially, to bring in investors. The
marketing campaign, was not much of a success, however. With the exception
of the Tiger transaction which we will examine shortly, there were only a
relatively small number of investments into RRF, and those were principally
by Bracebridge-controlled entities and a few colleges.7

       The offering memorandum RRF used to solicit potential investors
required participants to agree to stay in the fund for at least three years unless
the fund appreciated over 100%, in which case a partial redemption was
possible. Investors were warned that the fund was only suitable for those
“who have no need for liquidity with respect to their investment.” JX 32 at
219. They were also warned that shares could not be transferred without
approval of the Board of Directors, which could be withheld for any reason.

       The serious marketing efforts lasted about six months, from the end of
1998 until June 1999. At that point, although RRF continued to exist,
proactive marketing seems to have come to an end. Defendant argues that
what happened in May and June 1999, events we explore below, account for
the loss of interest in marketing.

        Two other actors must be introduced. Tiger Management, LLC
(“Tiger”), was one of the world’s largest managers of hedge funds in 1998-
1999, with over $20 billion under management. It was run by Julian
Robertson. Two of the funds that Tiger managed, Jaguar and Ocelot, figure
in this action. Both were hedge funds organized as foreign partnerships that
did not pay taxes in the United States (Cayman Islands and Netherlands
Antilles, respectively). Before the Russian collapse, Jaguar and Ocelot had
purchased CLN’s which were derivatives of OFZs8 for the combined sum of
over $230 million. Collectively, we refer to these two funds as “Tiger” or the

       7
         The court is left with the distinct impression that these smaller
investors were window-dressing in the sense that the large target investors
would have been reluctant to be the first to invest.
       8
         At this time, Jaguar and Ocelot also purchased other Russian-based
securities, which do not feature in the issues of this case. Likewise, the Tiger
fund itself, as well as other Tiger-controlled hedge funds also invested in
Russian securities during this period.

                                        7
“Tiger funds,” and the securities as the “Tiger securities.” As an S account
holder authorized to do business on the MICEX, Deutsche Bank brokered
those purchases as Tiger’s counter-party.9 Among the particular series of
OFZs that plaintiff ultimately obtained from Tiger were the series OFZ 25023
(“25023s”), which had a maturity date of September 12, 2001. After the
collapse, these assets were worth less than 10% of what Tiger had originally
invested. Because Tiger was a foreign company, however, it could not take
advantage of United States tax laws that permit a deduction against income in
the amount of claimed losses on the 25023s.

        Two Deutsche Bank employees who figure in the transactions relevant
to this suit are Jay Johnston, a salesman for Deutsche Bank with respect to
“emerging market” instruments, and Laurence Schreiber, who at the time was
managing director of Deutsche Bank’s emerging markets derivatives
structuring business. Deutsche Bank put RRF in touch with Tiger, and later
served as the liaison between RRF and Tiger to consummate the transfer of the
OFZ 25023s and to secure issuance of RRF partnership shares.

       An email string between Messrs. DiBiase and Grenzke dated March 9,
1999, relates to a potential contribution of assets to RRF. JX 15. This was at
a time when the fund had no assets. Interest was expressed in the views of
Citco, RRF’s Cayman Islands transfer agent, and Ernst & Young (“E & Y”),
RRF’s accountants, about the fund. At one point Mr. Grenzke makes
reference to Deutsche Bank contributing shares of unspecified securities in
kind to RRF. The question raised was whether the contributor would be
concerned about the absence of other partners. Mr. Grenzke proposed that it
would be easy to have FFIP become a partner, along with, perhaps, one other
Bracebridge-controlled entity. This email foreshadowed events to come
because FFIP did in fact contribute the first assets to RRF in April 1999.

        Mr. DiBiase professed no recall about the subject of this series of
emails. We find this lack of recall implausible. The concerns expressed in
these emails plainly relate to the transactions culminating in Tiger’s later
contribution of Russian assets to RRF, facilitated by Deutsche Bank, and his
recall on later elements of the transaction was extensive. Mr. DiBiase was

       9
        Only certain entities licensed by the Russian government were
permitted to transact business in ruble-denominated instruments in their own
name. Deutsche Bank was such an entity. The Tiger funds were not.

                                      8
prepped over 16 hours for his trial testimony. He has been a certified public
accountant, and began his career working in the tax division of Price
Waterhouse, where he eventually became a senior accountant and later a
manager. Throughout his seven years at the firm, he was responsible for
preparing corporate and individual income tax returns. After leaving Price
Waterhouse, he spent eight years at Scudder Stevens, an investment firm,
beginning as a tax manager and ending as a director. Throughout his time
there, he worked on tax-related matters. He plainly was well-versed in the tax-
related interests of partners in hedge funds, and he had good recall about
events on direct examination. In short, we are persuaded he was familiar with
the subject of these emails.

        Mr. DiBiase denied knowledge of any involvement between Tiger and
Bracebridge in March of 1999. He was then shown DX 9, a telephone list
defendant obtained from plaintiff during discovery. It was circulated on
March 10, 1999, and contains the names of fourteen individuals, all of whom
figure in a series of transactions that unfolded in May and June between Tiger,
RRF, and General Cigar Corporation (“General Cigar”). DX 9. The list
contained contact information for three key Bracebridge players (Ms.
Zimmerman, Mr. Grenzke, and Mr. DiBiase); two Deutsche Bank
representatives (Mr. Schreiber and Francesco Piovanetti); the lawyers
representing RRF, Citco (RRF’s Cayman Island transfer agent), and Tiger
Funds; along with the name of Anu Murgai, a trade executor for Tiger. Once
again we are not persuaded by Mr. DiBiase’s disavowal of knowledge.

      In a March 11, 1999 instant message to Mr. Piovanetti of Deutsche
Bank, Laurence Schreiber asked Mr. Piovanetti to inquire of Jim DiBiase
when RRF would be launched. JX 19. As Mr. DiBiase testified, Mr.
Piovanetti would call periodically during this time frame to see if RRF had
launched.

        In March of 1999, Deutsche Bank prepared a tax shelter registration
under its own name for an entity to be called “Preferred Stock Financing
Transaction,” a generic name place holder. DX 11 at 43. The source of the
assets for the transaction was to be a company in the Cayman Islands. Id. at
45-46. The assets would be heavily depreciated and would be acquired in
exchange for common or preferred shares of stock. The transaction was
anticipated to occur before the end of May 1999.

                                      9
       Shortly thereafter, on April 4th, Mr. Piovanetti sent a message to Ms.
Zimmerman, indicating that he would be sending details shortly about an
unspecified transaction. Mr. Piovanetti did not testify at trial, and Ms.
Zimmerman testified she did not recall what the subject was of the message.
On April 7th, Mr. Piovanetti sent an email message to his Deutsche Bank
colleague, Jay Johnson, mentioning an upcoming conference call, after which
representatives of General Cigar would be visiting the Deutsche Bank offices
to discuss “the Russian trade.” DX 15.

        We know that General Cigar was in the market as early as April 1999
for investments in depreciated Russian assets and that it had been approached
that month by both Deutsche Bank representatives and by Ms. Zimmerman.10
Moreover, the minutes of the Board of Directors of General Cigar, dated April
20, 1999, DX 20, reflect a decision to invest up to $25 million in deeply
discounted, high-yield instruments and show that the company was looking at
strategies to generate tax benefits for the company through these investments.
During this time period, Mr. Schreiber began sending Janet Krajewski, the
Vice President of Taxes at General Cigar, periodic updates on the MICEX
price for the OFZ 25023s. DX 23. It is undisputed that the company shortly
thereafter invested approximately $3 million in other Russian securities and
later, in June, spent approximately $21 million to acquire RRF’s Tiger
securities (the OFZ 25023s).

       On April 30, 1999, an email from Mr. DiBiase to Ms. Zimmerman
inquired whether RRF was planning to take its typical 2% up-front
management fee in connection with the assets that Deutsche Bank or its client
was planning to invest. Apparently, Deutsche Bank was under the impression
that no up-front fee would be charged, although Ms. Zimmerman had quoted
a figure of $1 million. Deutsche Bank was willing to pay $300,000, which
would be 2% of $15 million. When asked about the email, Mr. DiBiase once
again said the email did not ‘ring a bell,’ and that he had no recollection that
Deutsche Bank was going to put assets into RRF.

        Later that same day, in an email to Ms. Zimmerman, Mr. DiBiase
reflects concern about the composition of investors in RRF: “We will need to

       10
         An email dated April 21, 1999, from Ms. Zimmerman to Mr. Grenzke
seeks contact information for General Cigar: “Did the Cigar guys give you
cards[?] I only have tax ladies.” JX 28.

                                      10
[represent] as to what % of RRF (i.e., FFIP) is owned by individuals. Needs
to be a high number, like 70-80%. This means we cannot put FYI or S assets
into RRF until after the db [Deutsche Bank] deal.” DX 25. Mr. DiBiase’s
purported ignorance of the import of “the db deal” in this and other emails
from this period is unconvincing.

        DX 29 is an email dated May 14, 1999, from Mr. DiBiase to Ms.
Zimmerman concerning the composition of partners in RRF. The question
addressed is whether corporations could join. Apparently Deutsche Bank
wanted some assurances that corporations would not be included in RRF out
of a concern for preserving the tax characteristics of assets contributed to the
fund. Mr. DiBiase writes, “Nothing in the docs prevents us from putting in
corps [sic] but it could possibly impair one of our most valuable assets.” DX
29. Mr. DiBiase testified that the “most valuable asset” referred to was the
built-in losses in Russian depreciated assets that might end up in RRF. Even
before the transfer by Tiger, in other words, Mr. DiBiase was aware that
acquiring the Tiger assets would produce value in excess of the nominal
pricing of the transaction because of the tax benefits of the imbedded losses.
There can be no mystery about RRF’s intentions at this point, which was to
obtain Tiger’s depreciated assets for their tax value.

        The May 14 email, as well as Mr. DiBiase’s somewhat reluctant
explanation of its meaning, suggests that RRF principals were keenly aware
of the need to structure the Tiger acquisition in such a way that it did not
impair the ability of downstream buyers to obtain the built-in losses. The
presence of corporations, according to Mr. DiBiase, might preclude later resale
to tax-interested buyers. This is made crystal clear in an email dated July 23,
1999. In recapping events for Jon Grenzke, Mr. DiBiase writes that “we didn’t
want rrf to have significant level of corporate ownership since people
interested in buying tax losses don’t want to transact with corporations.” DX
111. Mr. DiBiase was thus less than candid when asked during cross
examination what the structural reasons were for the statement in JX 73;
“[Deutsche Bank’s] clients would only sell to a domestic partnership such as
FFIP, or one similarly structured.” His answer, “I don’t recall,” is not credible.
Tr. 463. In other words, at the time Tiger joined the fund, RRF was already
planning to use the built-in tax losses it stood to gain from the Tiger assets.

      Three transactions occurred within quick succession in May and June
of 1999. The first occurred some time between May 20 and May 25, 1999.
This was the transfer by Tiger of OFZ 25203’s to RRF in exchange for shares

                                       11
in the hedge fund worth approximately $14.9 million. At trial, there was
conflicting evidence about the precise date of the transaction. Plaintiff takes
the position that it was May 20, 1999; defendant argues that the transaction
was not consummated until May 25. Nothing of formal legal consequence
turns on this issue, but the optics for plaintiff are even less attractive if Tiger
was only a partner for ten days instead of fourteen,11 particularly when one

       11
          Jaguar and Ocelot each submitted to RRF a signed subscription
agreement that bore the date of May 20, 1999. JX 65 at 522; JX 66 at 581.
Also on May 20, 1999, Tiger and RRF executed the assignment and
assumption agreement that transferred ownership of the Russian securities
from Tiger to RRF. JX 52; JX 53; JX 54; JX 55; JX 56. A Bloomberg
message and RRF’s internal documents show that Tiger contributed the assets
on May 20, 1999, and from that date RRF viewed itself as the owner. JX 121;
PX 33 at 2530. The Tiger funds’ internal documentation reflects a
contribution date of May 24.
        While the documents show that Jaguar and Ocelot executed the
assignment and assumption agreement, transferred their ownership in the
Russian assets, and signed the subscription agreement on May 20, 1999, these
actions alone did not fulfill the conditions of becoming a partner as described
in the subscription agreement. By the terms of that agreement, “This
subscription may be rejected by [RRF] in whole or in part in the sole discretion
of the Board of Directors . . . at any time prior to acceptance. . . . The
undersigned understands that for [RRF] to consider its subscription, the
undersigned must complete fully this Subscription Agreement and . . .
promptly return them . . . .” JX 65 at 506; JX 66 at 565. Although Jaguar and
Ocelot each signed its subscription agreement on May 20, those subscription
agreements were not completed by Jaguar or Ocelot until May 21, 1999, which
is the date that both entities initialed a previously missing certification. DX
38; compare JX 58 at 109 with JX 65 at 517 (Ocelot); compare JX 59 at 156
with JX 66 at 576 (Jaguar). Although plaintiff takes the view that May 20 is
the proper date for treating the Tiger funds as members of the partnership, a
May 21 email from Margery Neale, an attorney for Swidler Berlin, who
represented RRF, to Mr. DiBiase indicates that a vote of all the partners had
not yet been taken on accepting the Tiger Fund entities as new partners.
Further delaying the execution of the subscription agreement, RRF and its
Administrator did not sign and accept the subscription agreement or side letters
until May 25, 1999. See JX 63; JX 64. Thus, although Tiger began the
                                                                    (continued...)

                                        12
considers that the process of selling its interests—the next step in the series of
transactions—had begun, as we shall see below, no later than June 1.

        Tiger had been sent a standard RRF offering memorandum spelling out
the terms under which RRF invited an entity like Tiger to become a partner.
This included the three year limitation on redemption mentioned above along
with restrictions on transferability of shares. It also received a subscription
agreement by which Tiger and RRF would agree to entry into the partnership
by Tiger, subject to those same limitations. The testimony of William Goodell,
counsel for Tiger, makes it clear that Tiger would not sign the subscription
agreement unless it received a dispensation from the three year waiting period.
To solve that problem, Tiger and RRF executed a “side letter” on May 25,
1999, by which Tiger was given unique redemption rights. Instead of having
to wait three years, the side letter allowed Tiger to redeem its shares on or after
July 1, 1999, in exchange for cash or assets “in kind.” This change had been
the subject of back and forth negotiations, during which Tiger specifically
rejected RRF’s proposed compromise date of April 15, 2000.

        Tiger also refused to certify, as required in the subscription agreement,
that its purpose for entering into the fund was “investment.” Accordingly,
with RRF’s agreement, the final subscription agreement omits the standard
language: “the Shares subscribed for hereby are being acquired by the
undersigned for investment purposes only, . . . and not with the view to any
resale or distribution thereof . . . .” JX 24 at 469 (standard subscription
agreement). Tiger signed the modified subscription agreement12 on May 20,
1999, and RRF approved its entry some time on or before May 25, 1999.

       The subscription agreement required Tiger to represent its basis in the
Russian assets it transferred. These were shown to be approximately $230
million. The final subscription agreements also contained a representation by
RRF that it would not make a section 754 election, which would have resulted
in a change of basis to fair market value.

       11
            (...continued)
process of joining the RRF partnership on May 20, 1999, it was not accepted
into the partnership until May 25, 1999.
       12
         There were actually two versions of all the entry documents, one for
the Jaguar Fund and another set for the Ocelot Fund. Both were controlled by
Tiger Fund and we refer to them both as “Tiger.”

                                        13
       The second transaction was Tiger’s sale of its RRF shares to FFIP. As
early as May 24, 1999, Tiger had made it clear, at least internally, that it
planned to sell its RRF shares for cash:

       [W]e sold all of our sep 2001 bonds (that we had . . . with
       deutsche bank) in return for equity in the russian recovery fund.
       [T]he value of the equity at the time we received it was 14mm
       dollars. [H]owever, we plan to sell in equity in 2 weeks to
       hopefully receive cahs [sic].

DX 43. There is no question that this email from Ms. Murgai, dated May 24
(arguably before the day the transaction was complete) was referring to the
OFZ 25023s. In another internal communication the next day, Robert Bastone
of Tiger records that:

       Jaguar and Ocelot Cayman have assigned their interests in
       Russian 9/12/01 OFZ’s (held with Deutsche Bank) to a private
       fund called the Russian Recovery Fund. . . . The current value
       of the fund is approximately $14 million dollars. We hope to
       have private fund shares sold, vs. cash, in approximately two
       weeks. Update to follow.

DX 46.

        Tiger’s efforts to dispose of its new partnership shares began almost
immediately. On June 1, 1999, Jim DiBiase sent a memo to RRF’s files
documenting a conversation with Laurence Schreiber, in which he reports that
Mr. Schreiber informed him that the Tiger funds were “offering their shares
of RRF at a slight discount to their original subscription price (roughly $14.09
million versus $14.81 million). He asked if FFIP, L.P. (“FFIP”), one of the
current shareholders of RRF, would be interested in purchasing these shares
at this price level.” JX 73. Mr. DiBiase testified that he assumed this contact
must have been preceded by a conversation between Ms. Zimmerman and Mr.
Schreiber. The memo goes on to ascribe to Deutsche Bank the instruction that,
“for certain structural reasons, his clients would only sell to a domestic
partnership such as FFIP, or one similarly structured . . . .” Id.

                                      14
       Even a cursory review of a fax dated June 1, 1999, from Laurence
Schreiber of Deutsche Bank to Jim DiBiase shows that Mr. DiBiase’s
characterization of Mr. Schreiber’s instruction in the memo, JX 73, is false.
See DX 54. Mr. Schreiber makes clear in this fax that it was RRF, not Tiger,
that would have had an interest in an entity like FFIP purchasing the shares.
Mr. Schreiber states, with no other explanation, that “for structural reasons it
is important that FFIP (or a similarly structured partnership) acquire at least
$12.50 mm of the outstanding shares of Russian Recovery Fund LLC (“RRF”).
This ownership structure will facilitate future transactions that the RRF may
wish to do.” DX 54 (emphasis supplied). In light of RRF’s interest in muting
its own involvement in the subsequent sale to FFIP by Tiger, we do not think
this mischaracterization is inadvertent.

        Not only does Mr. DiBiase’s mischaracterization call into question his
candor, but Mr. Schreiber’s solicitude to facilitate RRF’s future transaction is
equally odd, as his client was Tiger. The logical inference is that he was
guiding the parties through a structured transaction, begun earlier, which had
as its goal the preservation to FFIP, a tax-interested entity, of Tiger’s losses,
and we can assume this is the future transaction to which Mr. Schreiber was
referring. In other words, to preserve the tax benefits of the Tiger transaction,
a Bracebridge controlled entity interested in acquiring losses should buy out
Tiger’s interest in RRF. This is precisely what happened, of course, on June
3, 1999.13

       On June 3, 1999, Tiger sold all of its RRF partnership shares to FFIP,
a Bracebridge-controlled fund and partner within RRF, for a net amount of
$14,088,196, which is approximately $800,000 less than the sales price of the
shares roughly one to two weeks earlier.14 It is undisputed, but we think
noteworthy, that the market for derivative Russian securities like the OFZs had

       13
          We do not ascribe any sinister intent to Mr. Schreiber in this regard,
although we also suspect that his interest was in preserving the losses at a later
date for General Cigar, with whom he had been in contact beginning at least
in April, 1999. General Cigar had recorded a gain of over $200 million in
1998 and was looking for investment opportunities, including ways of “having
capital losses to offset the gain.” Tr. 954 (Ms. Krajewski).
       14
         This represents a price per share in RRF of $47,555. Internally, RRF
valued its shares shortly before the sale date at $58,868. JX 94; Tr. 486 (Mr.
DiBiase).

                                       15
gone up in that interim period. The effect of this sale was that, pursuant to
IRC § 721, FFIP could move into Tiger’s shoes with respect to its contribution
of Russian securities to RRF. Whatever basis was attributable to Tiger at the
time of the initial exchange in May was now traceable to FFIP upon the sale
of the Tiger securities.

       A letter agreement between RRF and Deutsche Bank concerning this
sale was signed on June 24, 1999. DX 88. By the terms of that letter,
Deutsche Bank agreed not to register the sale with the IRS as a tax shelter and
in exchange, RRF agreed not to do anything to jeopardize the rights of future
buyers from FFIP to step into its shoes for purposes of claiming FFIP’s tax
basis. If RRF did anything to jeopardize the tax status of the transaction, it
agreed to hold Deutsche Bank harmless for the consequences.

       The third transaction concerns the purchase of the majority of the Tiger
securities, now held by RRF, by General Cigar. That sale occurred on June 22,
1999. Once again, it was preceded by activities orchestrated by Laurence
Schreiber. An option executed on June 8th by RRF gave a fifteen day period
to Deutsche Bank to sell up to 80% of RRF’s OFZ 25023s at a strike price
equal to a pro rata share of $14.5 million. JX 87. Deutsche Bank paid $50,000
for the option.15 On June 8th, Mr. Schreiber wrote to Ms. Krajewski and
Joseph Aird, the CFO of General Cigar, that Deutsche Bank understood that
“you are interested in acquiring a position in local Russian instruments for
your investment portfolio. . . . We have received a mandate from a holder of
such assets to find buyers for their position.” DX 62 at 64.

       DX 68 is a fax from Mr. Schreiber to Ms. Krajewski certifying that the
Russian securities that General Cigar was about to buy from RRF (80% of the
Tiger securities RRF held) for approximately $21 million through the good

       15
          Defendant’s experts devoted significant time trying to undercut the
bona fides of this price. Mr. Lucas argues that it was worth closer to $5
million, given the significant increase in the value of the assets, which in turn
triggered the counter testimony of rebuttal expert, Nathalie Moyen. We need
not resolve whether Ms. Zimmerman was genuinely surprised and snookered
by Deutsche Bank in the transaction, as she suggests, or was aware of the mis-
pricing, as defendant suggests. The balance of the evidence of RRF’s
knowledge of what was really happening is so overwhelming that it is
immaterial to the outcome.

                                       16
offices of Deutsche Bank would come with a built in tax loss of approximately
$178 million.

        The transaction between RRF and General Cigar was consummated on
June 23-24, 1999, when Deutsche Bank exercised the option. In abbreviated
form, it resulted in the sale of approximately 77% of RRF’s holdings of OFZ
25023s to General Cigar for over $21 million. Ms. Krajewski testified that
General Cigar was willing to pay all cash for the OFZs. Instead, Deutsche
Bank made it clear that part of the purchase price should be paid in stock. The
cost to General Cigar of $21.18 million thus consisted of cash in the amount
of $17.950 million and preferred stock in General Cigar valued at $3.234
million. From this, Deutsche Bank ended up receiving a fee of $9,993,000,
and RRF received the balance, $11.191 million, plus stock. As we shall see,
the use of stock for part of the purchase price was used by RRF much later to
assert additional losses on the transaction.

       RRF sold its remaining 22.8% of the Tiger securities on the open
market over four sales in 2000. Although it showed a profit of over
$7,470,000 in appreciation in value from the acquisition in 1999, it claimed a
loss on its 2000 partnership return on the sales of the securities in the amount
of $49,786,826, reflecting 22.8% of the loss built into the exchange with Tiger.
Later, in 2004, it claimed the balance of the loss ($170,909,000) on its
redemption of its preferred stock in General Cigar.

       In the fall of 1999, after the sale to General Cigar had concluded, Mr.
Dibiase began working with Ernst & Young to prepare the 1999 tax forms for
RRF. Two accountants, Henry (“Hank”) Connelly and Joseph Bianco, worked
closely with Mr. DiBiase. JX 118 is a February 1, 2000 fax from Mr. Connelly
to Steve Shay, a tax attorney with Ropes and Gray, forwarding notes generated
by Mr. DiBiase and Mr. Connelly during their conversations concerning
DiBiase’s “challenge” to get the losses to FFIP. In his notes of a conversation
between himself, Mr. DiBiase, and Jim Nix, an attorney with Swidler &
Berlin, who represented Bracebridge and RRF, Mr. Connelly records that the
“Play to Tiger was that it got some cash whereas it would not have been able
to receive any value.” JX 118 at 17. We think a fair inference from this
comment is that Tiger had been induced to do something. A “play” suggests
an effort to attract someone. We also think that a fair inference is that the
“something” was not the sale of RRF shares to FFIP, but the initial
contribution of assets to RRF. The evidence regarding Tiger’s sale of RRF
shares, on the other hand, is that Tiger initiated the sale, and, according to

                                      17
Nancy Zimmerman, this was an unwelcome surprise.16 If this was a surprise,
then the “play” can only refer to the initial effort to line up Tiger’s in-kind
contribution. Mr. Connelly’s explanation of the play was that his
“understanding was that Tiger had distressed assets that were very low in
value, and Bracebridge has an expertise in dealing with distressed Russian
assets. Tiger contributed those assets to a Bracebridge fund so that
Bracebridge could manage those assets and extract the most value from them.”
Tr. 1293. This makes no sense and bears no correspondence to the short
statement, “play to Tiger was that it got cash, whereas it would not have been
able to receive any value.”17

       We are entitled to presume that Mr. Connelly’s contemporaneous notes
are a more candid statement than Mr. DiBiase’s about what it took to involve
Tiger in the swap. There is absolutely no evidence that Tiger was looking to
RRF to help “manage” its Russian assets. As explained by some of
defendant’s experts, quite the contrary was the case.

II.    The Expert Witnesses

        Five expert witnesses offered opinion testimony at trial, three for
plaintiff and two for defendant.18 These individuals were uniformly highly

       16
          As discussed earlier, not long after contributing assets to RRF, Tiger
approached Bracebridge about possibly selling its interest in RRF to a third
party. Ms. Zimmerman testified that on the Tuesday following Memorial Day
weekend, she “was told that Tiger was prepared to offer their shares in our
fund at a discount in the market or to us. . . . [Tiger] intimated they had a
buyer.” Tr. 735-36. We believe that the evidence clearly establishes that Ms.
Zimmerman’s state of surprise and displeasure was not due to Tiger’s plan to
exit the fund, but how quickly it wanted to execute that plan.
       17
          In his deposition, Mr. Connelly was repeatedly asked if he was able
to recollect what he meant by his note. He was not able.
       18
          Defendant also offered the testimony of Dr. John M. Lacey, a
professor of accountancy at California State University at Long Beach. We
did not allow him to testify. Our concern had nothing to do with his
qualifications as an expert. He is obviously highly qualified as an accountant
and in evaluating financial statements, particularly of hedge funds. We were
                                                                  (continued...)

                                      18
qualified. Much of their testimony, however, while not irrelevant, we find is
ultimately not helpful in resolving the issues presented. We summarize the key
portions below.

        Dr. Steve Hanke has a PhD in economics and currently teaches at Johns
Hopkins University. He is specialized in commodity and currency markets,
and equity markets. In addition to teaching, he has been involved in managing
hedge funds and advising foreign governments, including Russia, on managing
their currencies. He was very knowledgeable, in particular, about the Russian
currency collapse. He served on the President’s Council of Economic
Advisors in 1981 and 1982 as a senior economist. There is no question that he
is a brilliant economist and well-placed to discuss the markets in sovereign
debt in the late 1990’s.

        Dr. Hanke was called by plaintiff to explain the background to and
effects of the 1998 Russian debt default and currency collapse. On August 15,
1998, the Russian banking system was suspended and payments were not made
on outstanding sovereign debt. Capital controls were imposed on holders of
S accounts (foreign debt owners). Their deposits were frozen initially so that
rubles were not freely exchangeable for dollars. In March of 1999, rules were
announced by the Russian central bank with respect to how debt holders could,
using cumbersome means, eventually liquidate their Russian holdings. It was
not until the end of 1999, after the government began to make arrangements
for rescheduling the payment of sovereign debt, that markets began to
normalize. In the interim, holders of Russian debt, or instruments derivative
of Russian debt, such as the OFZ 25023 series at issue here, found it very
difficult to convert their holdings into dollars.

        Dr. Hanke endorsed RRF’s strategy for trying to marshal Russian debt
derivatives and manage them long-term with the hope of buying low and
selling high. Although neither RRF nor any Bracebridge affiliate was itself an
S account holder, he felt that Ms. Zimmerman’s contacts with financial entities
like Deutsche Bank, Credit Suisse, and others that did have access to the
Russian exchanges enabled her to follow the market intelligently and perhaps

       18
            (...continued)
simply never given a satisfactory explanation as to what he was being offered
to opine about of relevance here, except perhaps as to the ultimate legal issue
of economic substance, on which we are content to omit his evidence.

                                      19
take advantage of mis-pricing. He also thought that accumulating assets in-
kind made sense for RRF, rather than buying them with contributed cash.

         Dr. Hanke testified on a number of other subjects, including the
difficulty of pricing the OFZs and rubles, but in essence his contribution to
plaintiff’s presentation was that RRF had a legitimate business model. We do
not accept, however, his suggestion that Tiger was a logical customer for
RRF’s services. As numerous witnesses testified, Tiger was one of the largest,
if not the largest, operator of hedge funds during this time. Its assets were over
$20 billion. It had no need of RRF’s services.

        In addition, the suggestion that Tiger needed to invest in RRF to
diversify its Russian debt holdings also makes no sense. At the time Tiger
invested in RRF, there were only a handful of small investors. When Tiger put
its securities into RRF, they dwarfed RRF’s other holdings. RRF was left then
with a portfolio composed almost entirely of OFZs of a single maturity date,
September 12, 2001.

        Dr. Hanke also did a “Monte Carlo” mathematical analysis to answer
the question of whether Tiger’s investment in RRF was “at risk.” This
addresses the legal question of whether Tiger truly was a partner within RRF.
The result of Dr. Hanke’s analysis suggests that Tiger stood to gain or lose,
even in the brief period of time it was invested in the fund. We have no reason
to doubt the correctness of Dr. Hanke’s calculations, but they have a highly
artificial ring. No one suggests that Tiger actually went through such an
analysis to decide whether to invest. Rather, the facts on the ground establish
that Tiger was looking to get rid of its exposure to Russian debt by getting cash
for its deflated asset as quickly as it could. In addition, as Dr. David F.
DeRosa, one of defendant’s experts, points out, Tiger would have faced the
possibility of gain or loss without turning over the Russian securities to RRF.
In fact, Tiger would have had a higher rate of return and lower loss by not
incurring the fees attendant on joining RRF.

       Dr. Hanke did not disagree with the major premise behind the testimony
of defendant’s experts, who, as we consider below, were of the view that Tiger
would have been much better off simply holding on to the OFZs and riding
them up in value. This is exactly the way the market began moving right
before Tiger contributed the OFZ 25023s to RRF. This is not merely post hoc
reasoning. Tiger’s actions were counterintuitive at the time it received its RRF
shares. If it made sense for Tiger to invest in RRF (something we reject),

                                       20
then, when Russian sovereign debt began to recover in value, Tiger should not
have bailed out, particularly when it settled unnecessarily for cashing out at a
loss.

       It is no answer to suggest, as Dr. Hanke does, that Tiger’s “revealed
intent” merely changed. We are entitled to ask whether any economic
rationale suggests itself for the sudden shift in investment intent. We see none,
other than a preconceived interest in cashing out its Russian assets.

        Mr. Leon Metzger also testified on behalf of plaintiff. Mr. Metzger has
an undergraduate degree from the University of Pennsylvania in economics
and an MBA from Harvard University. His area of expertise is management
of hedge funds. He has taught the subject and has been Vice President of a
large hedge fund. We have no reservations about his qualifications to speak
about the management of hedge funds. He began his testimony by endorsing
the structure of RRF as a legitimate hedge fund. According to Mr. Metzger,
nothing that RRF did in its organic documents was out of the ordinary,
including its formation as a Cayman Islands partnership and its election to be
treated for US tax purposes as a partnership. This allowed it to create
opportunities for non-US entities as well as both tax indifferent and tax-
interested US entities. He also endorsed RRF’s scheme to compensate RRA
for management services and the idea that a desire for receiving in-kind
contributions was not unusual. Mr. Metzger also calculated RRF’s rate of
return at a very respectable 225% for 1999 and 105% for 2000.

      In rebuttal to Mr. Christopher Lucas’ testimony, which we discuss
below, that Tiger merely wanted to cash out of its Russian position, Mr.
Metzger testified that, if Tiger wanted cash, it simply would have kept its
Russian debt instruments and tried to sell them itself.

        The balance of Mr. Metzger’s testimony amounted to a response to the
testimony of Mr. Lucas or Dr. David DeRosa, two expert witnesses for
defendant. Without questioning their qualifications, we do not rely on most
of the points they made concerning RRF, except as considered below. Thus,
it is unnecessary to lay out Mr. Metzger’s responses.

      The same can be said for virtually all of the testimony of Dr. Nathalie
Moyen, a professor of finance at the University of Colorado. She is well
acquainted with the world of derivatives and, like all of the other experts and
a few of the fact witnesses, was able to explain the world of hedge funds,

                                       21
derivatives, and sovereign debt. Indeed, an edited compilation of their
testimony would make a fascinating textbook. Nevertheless, she was
responding to testimony from Mr. Lucas and Dr. DeRosa that $50,000 was an
artificially low price for the option purchased by Deutsche Bank to sell up to
80% of RRF’s Tiger assets. Without questioning the quality of the points each
made in their academic debate over using the Black-Scholes or Binomial Tree
method of pricing options, it is unnecessary to resolve their disagreements in
order to decide that Tiger was not a partner in RRF. In any event, their
disagreements over option pricing must have amused Laurence Schreiber, who
seems to be able to make lots of money without resort to such precise pricing
methodologies.

       Mr. Lucas testified for defendant. His primary opinion was that RRF
was structured more as a tax shelter than as a legitimate hedge fund. He also
was of the view that the option sale to Deutsche Bank was, in effect, bogus and
not driven by real business considerations on the part of RRF. His third
opinion was that RRF’s marketing plan was too anemic to be credible. His
fourth opinion was that the losses claimed by RRF ($223 million in total) are
so disproportionate to its investment in Tiger assets (roughly $14 million) as
to be unreasonable. We found Mr. Lucas to be a persuasive and
knowledgeable witness. Even though he was not an academic—his business
expertise is in hedge funds—he knew what he was testifying about.
Nevertheless, to be clear, we find it unnecessary to accept any of these
opinions in order to reach our findings below. The background he sets out for
his opinions goes further into the transactions involved than we feel is
necessary. The events here, including the formation of RRF, the transfer of
Tiger’s assets into RRF, the sale of RRF shares to FFIP, the option agreement,
and finally the partial sale to General Cigar, may indeed have been
orchestrated from beginning to end. However, we are prepared to assume that
RRF was formed and marketed for legitimate business purposes, and we are
prepared to ignore the details of the sale to General Cigar because we think
that consideration of the Tiger-RRF portion of the transaction is sufficient to
conclude that the loss cannot be recognized.

        Mr. Lucas did, however, offer an opinion on a matter we believe to be
highly relevant: Tiger’s real interest in purchasing shares of RRF. Mr. Lucas
testified that, in his view, this was a disguised sale. He explained that Tiger
had sustained heavy losses in 1998, not just in Russian debt, but on an
investment in US Airways and in Asian debt. Tiger shrank from a high of $22
billion in 1998 to approximately $6 billion in 2000, when it ceased operating

                                      22
as a hedge fund. Tiger needed cash to redeem investors who wanted to exit the
fund. Beyond that, the evidence he relied on to conclude that all Tiger wanted
in mid-1999 was cash for its Russian debt is the evidence he heard at trial,
which is evidence that the court is in the same position to evaluate, and which
is evidence itemized above and summarized below. In short, although Mr.
Lucas is much better informed about business matters than the court, the
evidence here, including Tiger’s financial circumstances, is fully accessible by
the court. It is some comfort to have him on the same page as our ultimate
conclusion, but we are reluctant to defer to an expert conclusion when we
would not credit Mr. Lucas’s conclusion without understanding and agreeing
with the discrete elements of his inductive reasoning.

       We also recognize one significant exception to our reluctance to rely on
Mr. Lucas, however. Mr. Lucas opined that RRF should have known, given
its almost certain knowledge about Tiger’s financial situation, that Tiger
needed cash. The uncertainty generated by this circumstance meant that
Tiger’s presence would make investment decisions more difficult. Ms.
Zimmerman should have been put on guard as well by Tiger’s failure to do its
due diligence about RRF. She had reason to know, in other words, that the
transfer for partnership shares, along with insistence on early redemption rights
and a disavowal of investment intent, was a disguised sale. None of plaintiff’s
experts responded directly to this testimony.

        Finally, we have Dr. David DeRosa, who has a PhD in economics and
finance from the University of Chicago, where he studied under Milton
Friedman. He has taught, written, and consulted in the fields of hedge funds,
derivatives, and currency exchanges. Dr. DeRosa has also been involved in
setting up and running hedge funds himself. He is highly qualified in these
fields and well acquainted with Dr. Hanke, whose expert report he was hired
to rebut, but who endorsed one of Dr. DeRosa’s books, “In Defense of Free
Capital Markets.” Dr. DeRosa offered two primary opinions: first, that the
Tiger entities did not enter into the RRF transaction with the intention of
holding the RRF interest as a long-term investment; and second, that a direct
sale of the Russian securities would have been more desirable for the Tiger
entities. In addition, he offered associated opinions on more focused issues,
such as the valuation of Tiger’s contribution to the partnership and the
valuation of the option obtained by Deutsche Bank.

       Dr. DeRosa made plain his deep skepticism of the bona fides of the
transaction, and we have no reason to question his skepticism. We can agree

                                       23
with him that Tiger did not enter into RRF with the intent of making a long-
term investment. Also, Tiger would have been better off keeping the securities
and trying to sell them independently. Dr. DeRosa may also be correct that the
valuation of the assets was questionable and that Tiger did not do a meaningful
due diligence prior to the trade. We are reluctant to place much reliance on
these opinions, however. Ultimately, they only amount to skepticism. They
are not sufficiently pointed, and they all generated responses from plaintiff’s
experts. In the end, Dr. DeRosa’s points amount to circumstantial evidence
that Tiger and RRF had another agenda.

        Where we are more attuned to Dr. DeRosa’s testimony, however, is
with respect to his observation that Tiger gained nothing from the swap for
RRF shares. If that is true, and we believe that it is, then the facade falls off
the transaction. Dr. DeRosa explained, as did Mr. Lucas, that Tiger would
have been better off if it had kept the shares because it had the ability to do its
own market and asset analysis. In addition, Tiger would have known up front
that it would be paying fees to RRA to manage the assets, plus it would have
shared with RRA any increase in value. These would have been unnecessary
expenses because Dr. DeRosa persuades us that RRF did not offer any
management skills that Tiger itself did not already possess.

                                 DISCUSSION

        Normally, when an asset is sold or otherwise disposed of, loss or gain
is determined at the time of disposition as the difference between the adjusted
basis and the amount recovered. See 26 U.S.C. § 1001 (a), (c) (2012).
Unstated but obvious is the assumption that the loss is claimed by the owner
of the asset at the time of disposition.

        An exception to this approach to claiming a loss, however, arises when
assets are exchanged in-kind for an interest in a partnership. The statutory and
regulatory19 means by which the loss on an in-kind contribution is preserved

       19
          In 2004, Congress changed the legal landscape somewhat in order to
put a halt to perceived abuse of distressed asset transfers by amending section
704 to limit the basis of the property contributed to its fair market value at the
time of contribution. See Superior Trading, LLC v. Comm’r, 137 T.C. 70, 79
(2011) (citing American Jobs Creation Act of 2004, Pub. L. No. 108-357, §
                                                                    (continued...)

                                        24
to the contributing partner is succinctly laid out by Judge Posner in Superior
Trading, LLC v. Commissioner, 728 F.3d 676 (7th Cir. 2013):

       When an asset is contributed to a partnership, the contributor
       receives in exchange a partnership interest. The partnership
       formally owns the contributed asset, but the contributor owns a
       slice of the partnership in recognition of his contribution, and so
       hasn’t really parted with the asset. In the hands of the
       partnership the asset’s basis is the contributor’s original basis,
       which (with adjustments that we can ignore) is the asset’s
       original cost. 26 U.S.C. §§ 723, 1012. Recognition for tax
       purposes of gain or loss attributable to any change in the asset’s
       value before the asset was contributed to the partnership is
       deferred until the partnership sells the asset. See 26 U.S.C. §
       721(a). So if the asset is worth less than the contributor paid for
       it, that loss in value (what is termed “built-in loss”) will be
       recognized, and thus usable to reduce taxable income, only
       when the partnership sells the asset. See 26 U.S.C. §
       704(c)(1)(A) . . . . If the contributing partner sells his
       partnership interest before the partnership sells the contributed
       asset, the buyer of the partnership interest steps into his shoes
       and so recognizes built-in loss or gain if and when the
       partnership sells the asset. Treas. Reg. § 1.704–3(a)(7).

Id. at 679.

        Plaintiff contends that the transactions at issue here properly followed
this legal format. In other words, Jaguar and Ocelot sustained massive
unrealized losses on their Russian assets and transferred those assets, along
with their negative bases, in exchange for partnership interests in RRF. The
losses did not need to be recognized on that exchange and became associated
with the assets then acquired by RRF. Even then, only Tiger could have
benefitted from those losses, as the contributing partner, but for the fact that
its partnership interests were acquired by FFIP. FFIP then stood in Tiger’s
shoes when those losses were later dispersed when the assets were sold, in part

       19
            (...continued)
833, 118 Stat. 1418, 1589 (codified as amended at 26 U.S.C. § 704 (2006))).

                                       25
to General Cigar and in part on the open market. The validity of each step in
this process, according to plaintiff, can be traced to provisions of the code.

       The parties agree, however, that strict adherence to the procedural steps
necessary to trigger the exception to immediate recognition of losses will not
necessarily achieve the desired result of shifting the loss away from the tax-
indifferent entity. Courts have developed analytical filters to test whether a
taxpayer should really benefit from certain statutory provisions. Those
inquiries or filters have evolved or have been applied in connection with many
code provisions, including the sections involved here. Because these inquiries
are judicially-created overlays to the code, they are somewhat amorphous and
in some respects overlap. The FPAA and the government’s argument here
summon three of them: sham partnership under the Culbertson test; lack of
economic substance; and step transaction.

       Judge Posner has neatly summarized how the sham partnership inquiry,
for example, has been applied in DAD transactions:

               A genuine partnership is a business jointly owned by two
       or more persons (or firms) and created for the purpose of
       earning money through business activities. If the only aim and
       effect are to beat taxes, the partnership is disregarded for tax
       purposes. . . . “[T]he absence of a nontax business purpose is
       fatal.” ASA Investerings Partnership v. Commissioner, 201 F.3d
       505, 512 (D.C. Cir. 2000).

              ....

               A transaction that would make no commercial sense were
       it not for the opportunity it created to beat taxes doesn’t beat
       them. Substance prevails over form. . . . . The question is
       “whether the partners really and truly intended to join together
       for the purpose of carrying on business and sharing in the profits
       or losses or both.” Commissioner v. Tower, 327 U.S. 280, 287
       (1946) . . . .

728 F.3d at 680 (citations omitted). The sham partnership inquiry is also
frequently cited to Commissioner v. Culbertson, 337 U.S. 733 (1949). The
Court there held that it can be appropriate to ask whether what appears to be
a partnership was really just a matter of convenience for tax purposes: The

                                      26
court should inquire into whether “the parties in good faith and acting with a
business purpose intended to join together in the present conduct of the
enterprise.” Id. at 742. If not, then the partnership is ignored. What is
noteworthy about the Culbertson facts is that the Court remanded for a
determination on a partner-by-partner basis whether the enterprise was bona
fide. The question, in other words, is not exclusively focused on the
legitimacy of the partnership when it was formed; the entry of particular
partners can also be questioned.

       The Court of Appeals for the Federal Circuit in Coltec Industries, Inc.
v. United States, explained the rationale behind the economic substance test:

                The economic substance doctrine represents a judicial
       effort to enforce the statutory purpose of the tax code. From its
       inception, the economic substance doctrine has been used to
       prevent taxpayers from subverting the legislative purpose of the
       tax code by engaging in transactions that are fictitious or lack
       economic reality simply to reap a tax benefit. In this regard, the
       economic substance doctrine is not unlike other canons of
       construction that are employed in circumstances where the
       literal terms of a statute can undermine the ultimate purpose of
       the statute.

              ....

              The Supreme Court, various courts of appeals, and our
       predecessor court, have identified a number of different factors
       pertinent to the determination of whether a transaction lacks
       economic substance and thus should be disregarded for tax
       purposes. We understand the economic substance doctrine to
       incorporate the following principles.

               First, although the taxpayer has an unquestioned right to
       decrease or avoid his taxes by means which the law permits, the
       law does not permit the taxpayer to reap tax benefits from a
       transaction that lacks economic reality. This principle emerged
       early on in Gregory [v. Helvering, 293 U.S. 465 (1935)], where
       the Supreme Court disregarded intermediate transfers of stocks
       as falling outside the tax code because the transfers had “no

                                      27
business or corporate purpose” and performed no “function”
other than to reduce taxes. 293 U.S. at 469. . . .

        While the doctrine may well also apply if the taxpayer’s
sole subjective motivation is tax avoidance even if the
transaction has economic substance, a lack of economic
substance is sufficient to disqualify the transaction without proof
that the taxpayer’s sole motive is tax avoidance.

       Second, when the taxpayer claims a deduction, it is the
taxpayer who bears the burden of proving that the transaction
has economic substance. In describing the history of the
economic substance doctrine, our predecessor court in
Rothschild stated, “Gregory v. Helvering requires that a taxpayer
carry an unusually heavy burden when he attempts to
demonstrate that Congress intended to give favorable tax
treatment to the kind of transaction that would never occur
absent the motive of tax avoidance.” 407 F.2d at 411 (quoting
Diggs v. Comm’r of Internal Revenue, 281 F.2d 326, 330 (2d
Cir.1960)). . . .

        Third, the economic substance of a transaction must be
viewed objectively rather than subjectively. The Supreme Court
cases and our predecessor court’s cases have repeatedly looked
to the objective economic reality of the transaction in applying
the economic substance doctrine. While the taxpayer’s
subjective motivation may be pertinent to the existence of a tax
avoidance purpose, all courts have looked to the objective reality
of the transaction [in] assessing its economic substance. . . .

       Fourth, the transaction to be analyzed is the one that gave
rise to the alleged tax benefit. . . . [I]n economic substance
cases, the focus is on “the specific transaction whose tax
consequences are in dispute,” [Black & Decker Corp. v. United
States, 436 F.3d 431, 441 (4th Cir. 2006)], and the Second
Circuit has stated that “[t]he relevant inquiry is whether the
transaction that generated the claimed deductions . . . had
economic substance,” Nicole Rose Corp. v. Comm’r of Internal
Revenue, 320 F.3d 282, 284 (2d Cir. 2003). . . .

                                28
              Finally, arrangements with subsidiaries that do not affect
       the economic interest of independent third parties deserve
       particularly close scrutiny.

454 F.3d 1340, 1353-57 (Fed. Cir. 2006) (select citations omitted).

       The third test defendant relies on to disallow the losses is the step
transaction inquiry. This is laid out in Commissioner v. Clark, 489 U.S. 726
(1989), as follows:

       Under this doctrine, interrelated yet formally distinct steps in an
       integrated transaction may not be considered independently of
       the overall transaction.       By thus “linking together all
       interdependent steps with legal or business significance, rather
       than taking them in isolation,” federal tax liability may be based
       “on a realistic view of the entire transaction.”

Id. at 738 (citing 1 B. Bittker, Federal Taxation of Income, Estates and Gifts
¶ 4.3.5, p. 4-52 (1981)).

       As is obvious, the three tests (sham partnership, economic substance,
and step transaction) are closely related, and courts frequently use similar
language in implementing them.

        In addition to this judicial gloss on the statutes on which plaintiff must
rely to claim the loss, defendant points to regulations of the Internal Revenue
Service that address the same concerns. In 1994, the agency adopted the
Subchapter K Anti-Abuse Rule, 60 Fed. Reg. 23 (Jan. 3, 1995) (codified at 26
C.F.R. § 1.701-2). They provide, in essence, that the partnership must be bona
fide and entered into for a substantial business (i.e., not purely tax) purpose.
See Treas. Reg. § 1.701-2. Not only must the partnership be bona fide, but
each partnership transaction or series of transactions must be entered into for
a substantial business purpose. Id. § 1.701-2(a)(1)-(3). A series of
transactional steps that independently make no economic sense do not, by a
gestalt process, result in one larger legitimate transaction.

        Defendant contends that Tiger had no business purpose in acquiring
shares through a contribution in kind to RRF, that it was never a real partner
in RRF, and that the swap of assets for partnership shares should be ignored
so that what emerges is simply a sale of the OFZ 25023s by Tiger to FFIP. If

                                       29
any of these related criticisms are correct, then RRF could not claim Tiger’s
original basis in the Russian securities.

        The government also questions the original formation of RRF, the bona
fides of the option agreement between Deutsche Bank and RRF, and the
subsequent sale to General Cigar. If it is correct in its challenge to the bona
fides of the Tiger-RRF transaction, it becomes unnecessary to examine
activities prior or subsequent to that transaction. If RRF did not acquire the
Tiger assets through a legitimate section 721 contribution, then RRF acquired
a new and lower basis in the securities and had no built in losses to use or pass
along. When a horse is dead, there is no point flogging it further. In our
judgment, this is a dead horse.

I.     Tiger’s Contributions to RRF Were Not Valid Under Section 721

       To summarize, on May 19, 1999, Tiger owned Russian securities that
had lost approximately $223 million in value.20 By June 24, 1999, those assets
were owned either by Russian Recovery Fund (22%) or General Cigar (78%).
Those two entities later sold the Tiger assets at a gain, but claimed between
them losses on disposition of approximately $360 million. It does no injustice
to plaintiff to observe that, in substance, Tiger suffered the loss but even
greater losses were claimed by RRF and General Cigar, which both gained on
the sales. As it turns out, sometimes things really are too good to be true.

       The limited question before us is whether the FPAA adjusting RRF’s
partnership return for 2000 was correct in its conclusion that the claim of
approximately $49 million in losses for a portion of these Tiger assets was
inappropriate. To state the question different, did Tiger’s losses travel intact
through the series of transactions at issue and legitimately flow to RRF’s
partners by way of the K-1 forms,21 or, as defendant asserts, did the built-in
loss vanish immediately at Tiger’s transfer to RRF because this was a

       20
         If it had sold those assets in May, Tiger would have realized a loss of
approximately $223 million, but as a non-U.S. taxpaying entity, it would not
have been able to utilize those losses to offset income as is permissible under
the U.S. tax code.
       21
         For completeness, we could enlarge the question to include whether
the losses also passed to General Cigar, but that is not directly implicated in
this RRF partnership adjustment challenged by the complaint in this case.

                                       30
disguised sale. Although section 721(a) allows non-recognition of gain or loss
at the time of an in-kind contribution “in exchange for an interest in the
partnership,” we agree with the government that Tiger had no real intention of
becoming a partner in RRF, and that RRF had reason to know that. A review
of the evidence demonstrates that Tiger and RRF were not partners and their
transaction was a sham, that the transaction lacked economic substance, that
the contribution can be ignored, and that the transaction should be
characterized as a sale.

        The Supreme Court in Culbertson held that the test for whether a
genuine partnership was formed is whether “the parties in good faith and
acting with a business purpose intended to join together in the present conduct
of the enterprise.” 337 U.S. at 742. We believe that this test applies not just
to the initial formation of RRF, but to the subsequent acquisition by Tiger of
a partnership interest in RRF.

       This matters because Ms. Zimmerman persuaded the court that she had
a legitimate business interest in creating RRF. Her explanation of her
evolution as a fund manager was a tour de force, which reflected real
knowledge of a wide range of investment strategies and vehicles. She has
obviously been very successful in the formation of funds and in their
performance. Her explanation of the opportunities she saw after the collapse
of the Russian bond market and associated securities was not contrived. We
find that she was genuinely interested in putting together a fund to attract
investors that already owned or were interested in owning devalued Russian
assets because she saw the potential for making money for Bracebridge as a
fund manager.

        We are prepared to accept, in other words, the bona fides of RRF as an
entity and that its marketing efforts in the first half of 1999 were probably a
genuine effort to find investors in the “macro play” of capitalizing on a hoped-
for increase in value of distressed Russian assets. Thus far, so good. The
wheels fall off, however, when we come to the Tiger transaction.

        We believe the evidence is clear that Tiger was interested in the spring
of 1999 in selling its position in OFZ 25023s. Anu Murgai, a Tiger employee
in 1998 and 1999, testified by deposition. DX 205. Her position was that of
an execution trader, which meant she executed the orders of others to buy or
sell securities on Tiger’s account. When asked to characterize the transactions
at issue, i.e., Tiger’s transfer of Russian assets to RRF, she referred to them as

                                       31
sales.22 We recognize that she had no independent authority to make decisions
about Tiger’s trades and that her recall of events in 1999 was weak.
Nevertheless, we deem her testimony relevant because it is her candid
characterization of what she thought she was being directed to do.

       Similarly, we have the deposition testimony of Michael Treisman,
current general counsel to Tiger.23 PX 62. He made the following statements
concerning Tiger’s desire to liquidate its Russian holdings:

       1)      I think the goal of the contribution [exchange of Tiger’s
               assets for shares in RRF] was at some point to receive
               cash value for the interests . . . .

       2)      Tiger was considering . . . how to as quickly as possible
               realize cash consideration for its investments in the
               Russian-linked instruments . . . . Tiger was looking to
               receive cash for its interests on as fast as or as in quick a
               possible manner as that could be provided. . . .

       3)      [I]n 1999 Jaguar and Ocelot did contribute [their] shares
               of interests in some of these instruments to the Russian
               Recovery Fund which would constitute a sale from my
               perspective.

PX 62 at Dep. Tr. 133, 135, 138.

       22
          See, e.g., DX 205 at Dep. Tr. 67 (“Q. Do you recall what Tiger did
with its Russian bonds after the default? A. We sold them.”); Dep. Tr. 86 (“Q.
Do you recall what you discussed [with Nancy Zimmerman]? A. I think this
is something about whether we were looking to sell Russian bonds.”); Dep. Tr.
115 (“Q. After the default by Russia . . . was it Tiger’s intent to liquidate their
Russian holdings? [Objection omitted.] . . . . A. Yes, I think . . . we were
liquidating. . . . [S]elling them.”).
       23
         Mr. Treisman was not employed by Tiger during the relevant time
period. He prepared himself for his deposition on behalf of Tiger by
consulting various knowledgeable individuals and the parties agreed to use his
deposition in lieu of live testimony. See Rules of the Court of Federal Claims
(“RCFC”), Rule 30(b)(6).

                                        32
       Tiger’s insistence on negotiating an early exit and its refusal to certify
an investment intent are further proof that it had no real interest in becoming
a partner in RRF. Tiger’s intent was also made clear by its statements
following the contribution of assets. On May 24, virtually simultaneous with
getting into RRF, Tiger was planning to sell its RRF shares for cash:

       [W]e sold all of our sep 2001 bonds (that we had . . . with
       deutsche bank) in return for equity in the russian recovery fund.
       [T]he value of the equity at the time we received it was 14mm
       dollars. [H]owever, we plan to sell in equity in 2 weeks to
       hopefully receive cahs [sic].

DX 43 (email from Ms. Murgai to other Tiger employees). Another internal
communication written on May 25th, indicates that:

       Jaguar and Ocelot Cayman have assigned their interests in
       Russian 9/12/01 OFZ’s (held with Deutsche Bank) to a private
       fund called the Russian Recovery Fund. . . . The current value
       of the fund is approximately $14 million dollars. We hope to
       have private fund shares sold, vs. cash, in approximately two
       weeks. Update to follow.

DX 46 (internal Tiger posting memorandum). Tiger was looking to cash out
of its position in OFZ 25023s as quickly as possible, and from Mr. Treisman’s
perspective, the transaction amounted to a sale.24

       Also, defendant’s experts persuade the court that Tiger’s entry into RRF
made no sense as an investment, and its exit made no sense in terms of timing.
Both Dr. DeRosa and Mr. Lucas testified that Tiger had more in-house
capability to deal with sovereign debt, including Russian debt, than RRF.
Tiger had no need to buy RRF’s expertise when it was already paying its own
experts. As Dr. DeRosa put it, “anything that [RRF] could have done for
[Julian Robertson,] he could have done in his own portfolio.” Tr. 2577. It was

       24
         This is consistent with the testimony of William R. Goodell, Tiger’s
prior general counsel, who agreed that “the intent of Tiger was to liquidate the
Russian investments and obtain cash.” DX 206 at Dep. Tr. 24. It is also in
line with Mr. Schreiber’s testimony at trial when he agreed that “Tiger was
looking to sell its Russians bonds.” Tr. 3278.

                                       33
paying for nothing, in other words. It was gaining nothing in terms of
economies of scale or diversification because even the remotest due diligence
would have disclosed that the OFZ 25203’s would constitute the vast bulk of
RRF’s portfolio. Finally, as Dr. DeRosa pointed out, by joining RRF,
whatever lockup period that Tiger was subject to, even if negotiated down
from three years, was a lockup period to which it was not subject prior to
joining RRF. We accept his opinion that Tiger had no practical reason to join
the partnership and that, in the final analysis, “the Tiger entities’ actions were
consistent with those of a seller of the at-issue securities, not a long-term
investor.” Tr. 2586. We note, moreover, that as Mr. Lucas explained, all of
the momentum with respect to Russian debt in May and June of 1999 was in
the direction of recovery of value. It would have made no sense to sell the
shares at that time unless it was part of a pre-arranged deal to cash out Tiger’s
OFZ 25023s. The only conclusion is that Tiger had no real interest in
becoming a partner in RRF and that it was using the exchange as a way to
dispose of its Russian assets for cash, as quickly as possible.

        Plaintiff’s response to this evidence amounts to a retreat to formalism:
“The central question in this case is whether the Tiger Funds were partners in
RRF.” Pl.’s Post-Trial Mem. Law 24. It takes the position that the court is
obligated to accept at face value the paperwork executed by RRF and Tiger
because these documents mean that “[t]he Tiger Funds contributed the Tiger
Assets in exchange for RRF Shares.” Id. Plaintiff also asserts that “[d]uring
the period they held their investment, the Tiger Funds obtained the benefits
and suffered the burdens of owning a partnership interest in RRF [and] . . . .
[u]nder Federal Circuit law, that makes the Tiger Funds the owners of RRF
partnership interests for U.S. federal income tax purposes.” Id. Essentially,
plaintiff argues that Tiger and RRF were partners because they observed the
formalities. If Tiger was a partner, then no matter how long it stayed in RRF,
its investment was at risk because its investment could have dropped in value,
or alternatively, it could have gone up.

      Plaintiff makes no real effort to address the large body of case law
which requires a look beyond these formalities. Instead, it relies heavily on
IRC § 704(e)(1):

       e) Family partnerships.--

              (1) Recognition of interest created by purchase or
              gift.--A person shall be recognized as a partner for

                                       34
               purposes of this subtitle if he owns a capital interest in a
               partnership in which capital is a material
               income-producing factor, whether or not such interest
               was derived by purchase or gift from any other person.

       Plaintiff views this statutory provision as supporting an inquiry
independent of the judicially created challenges to over-reliance on formalism.
We disagree for two reasons. First, although admittedly there is some debate
on the question, we believe that the provision, as its name suggests, is directed
at preventing the IRS from undoing intra-familiar partnership transactions,
something far afield from the Tiger-RRF transaction.25 Second, even if the
provision is of broader application, there is no reason to think Congress
intended to insulate taxpayers from decades of judicial scrutiny into abusive
reliance on formalism.

        As defendant correctly points out, the IRS has adopted regulations
interpreting section 704(e)(1) that preserve the traditional inquiries into
whether the creation of a partnership interest was a sham transaction. Treas.
Reg. § 1.704-1(e)(1)(iii) (“A . . . purchaser of a capital interest in a partnership
is not recognized as a partner under the principles of section 704(e)(1) unless
such interest is acquired in a bona fide transaction, not a mere sham for tax
avoidance or evasion purposes . . . .”). Section 704(e)(1) plainly does not
insulate plaintiff from the assertions made in the FPAA.

       We conclude, in sum, that the FPAA adjustments were correct. Tiger
was never a bona fide partner in RRF. The economic substance of what it did,
if the interim step of becoming a partner in RRF is ignored as window
dressing, is sell its securities to FFIP. This means that FFIP did not inherit
Tiger’s basis with its built-in losses. Accordingly, the taxpayer owes the
disputed taxes.

       Our conclusion that Tiger was never a real partner in RRF is arguably
sufficient by itself to undo the loss carryover. We would not recognize the
transaction as anything other than a sale because that is what Tiger intended

       25
         In that respect it was a reaction to Culbertson, which did involve a
family partnership. See S. Rep. 82-781, at 38-40 (1951) (noting that IRC §
704(e)(1) was intended to “harmonize” the rules regarding family partnerships,
particularly in light of the confusion caused by Culbertson and its progeny).

                                        35
it to be. However, there is a massive amount of circumstantial evidence that
RRF was aware early on that Tiger had no real interest in becoming a partner,
and was a willing participant at some point in facilitating the transfer of assets
through the sham partnership.

       The quickest means of seeing the events in focus is to step back and
look for the actions of the common denominator, Deutsche Bank. It was the
broker who helped Tiger acquire its Russian assets. It linked Tiger with the
Bracebridge funds. It helped arrange the transfer of the Tiger assets to RRF.
It brokered the sale of Tiger’s partnership interest in RRF to FFIP, in the
process making certain that the form of that sale did not jeopardize the
subsequent transfer of the built-in losses to a third party. It then obtained an
option to sell the OFZ 25023s from RRF and finally arranged a sale to General
Cigar. The evidence clearly indicates that RRF was a knowing and willing
participant in these activities, at least as of April 1999.

       Bracebridge funds had been a client of Deutsche Bank before the
creation of RRF. Tr. 3286-87 (Schreiber). Jon Grenzke contacted Deutsche
Bank in December 1998, during the initial marketing effort for RRF, so we
know that two key players were acquainted from the time RRF was formed.
In addition, when asked to explain a rather suggestive email discussed below,
Mr. DiBiase testified that:

       [S]tarting probably early in 1999, we were having conversations
       with counter[-]parties . . . like . . . Deutsche Bank . . . and we
       were hearing from them that . . . there may be potential buyers
       for these depreciated Russian assets in the market because they
       were attracted to the fact that these securities had these large
       built-in losses and that perhaps there could be a trade structured
       in some way to transfer some of the tax characteristics, which
       these buyers were attracted to, . . . to extract some value from
       those trades related to the tax characteristics of those assets. . .
       . [T]here was this theme at the time that there may be – there
       may be some value embedded in these assets over and above
       sort of the pure . . . investment valuation that we were attributing
       to . . . the MICEX price divided by the exchange rate. . . .

Tr. 208-09. Mr. DiBiase explained that RRF “never really pursued this
specifically,” Tr. 210, however, and that the subsequent trades between Tiger
and RRF, and then RRF and General Cigar, were not conceived with built-in

                                       36
losses in mind. We find this assurance implausible. We know that Mr.
DiBiase and Ms. Zimmerman, despite their modest disavowals of knowledge
of tax laws, were more than aware of the basics necessary to move tax losses
around, that they were aware of the issue, and that they had tax lawyers from
whom they were seeking advice on this issue from the inception of RRF.

       Ms. Krajewski of General Cigar testified that, in the spring of 1999, her
company was being courted by unsolicited suggestions of investment
opportunities, not just to put over $200 million to work for General Cigar, but
also possibly to shield that gain with acquired losses. Nancy Zimmerman
visited General Cigar that spring, and she recalled that her purpose was to
persuade General Cigar to invest directly in a Bracebridge fund. She was
unsuccessful.

        Nevertheless, someone was pressing Russian bonds on General Cigar
in the spring of 1999, presumably Deutsche Bank, and one of the reasons was
for “tax benefits,” specifically to “acquire the higher tax basis.” Tr. 966
(Krajewski).26 Ms. Krajewski recalls that the bonds being considered are the
ones later purchased from RRF. On April 20, the General Cigar board of
directors approved the idea of buying $25 million in “Russian bonds.” Tr. 961
(referring to DX 20). On April 27, 1999, Mr. Schreiber emailed Ms.
Krajewski with pricing information about Russian bonds, including
specifically OFZ 25023s.

        The emails of April 30, 1999, from Mr. DiBiase to Ms. Zimmerman,
only make sense as part of the plan (of which they were fully aware) to move
highly depreciated assets to RRF via Deutsche Bank in a way that preserved
their tax characteristics. Mr. DiBiase’s email of May 14, before the Tiger
transaction was consummated, candidly refers to “one of our most valuable
assets” as the built-in losses. He retrospectively stated in the July 23 email that
“we didn’t want rrf to have significant level of corporate ownership since
people interested in buying tax losses don’t want to transact with
corporations.” DX 111. This was an equally candid admission that preserving
tax losses was a RRF goal prior to Tiger’s entry into the partnership.

       26
         See also Tr. 965 (Krajewski) (reflecting that the court asked Ms.
Krajewski to explain a reference in DX 20 to a transaction that would provide
tax benefits, specifically asking, “What would the potential tax benefit be?,”
to which she replied, “Well, . . . The bonds were highly discounted”).

                                        37
        We find it more likely than not that Laurence Schreiber orchestrated the
series of transactions in a way that the Bracebridge organization and General
Cigar would not only get the OFZ 25023s but would obtain them in such a way
that Tiger’s losses would flow from Tiger to those entities. His fax of June 1
is illuminating. In it, Mr. Schreiber told Mr. DiBiase that, “for structural
reasons it is important that FFIP (or a similarly structured partnership) acquire
at least $12.50 mm of the outstanding shares of Russian Recovery Fund LLC
(“RRF”). This ownership structure will facilitate future transactions that the
RRF may wish to do.” DX 54. The only plausible reading of this instruction
is that Deutsche Bank was eager to preserve the losses for a planned future sale
to General Cigar. Mr. DiBiase apparently needed no explanation for what Mr.
Schreiber had in mind, and the purchase by FFIP was obviously arranged to
preserve the losses intact. In sum, Deutsche Bank was not acting alone, at
least as early as April, 1999.

       Tiger and RRF thus collaborated in a scheme to use the tax laws to their
advantage. While we can express a grudging admiration for the cleverness
involved in stringing together these transactions to track the tax code, we are
not obligated to give them effect when their sole intent was to avoid treating
the May transaction as what it was, a sale. Whether RRF is also liable for
penalties, we address below.

II.    Penalties

       The FPAA disallowed approximately $50 million in losses claimed by
RRF on its 2000 partnership return. In addition, the IRS levied a 40% penalty
for, among other things, “gross valuation misstatement,” pursuant to IRC §
6662. Plaintiff has the burden of challenging this penalty, and does so here,
in principal part, by arguing that it reasonably relied on tax advice. See §
6664(c)(1) (“No penalty shall be imposed under section 6662 . . . with respect
to any portion of an underpayment if it is shown that there was a reasonable
cause . . . and that the taxpayer acted in good faith . . . .”).

       Plaintiff received auditing and tax preparation services from Ernst &
Young (“E & Y”). Mr. Connelly, an accountant at E & Y, had been preparing
returns for Bracebridge for several years before he was contacted in October
1999 by Jim DiBiase who asked him to prepare a return for RRF as well. Mr.
Connelly’s specialty is the taxation of hedge funds, and more particularly,
taxation of hedge funds operating as partnerships. He prepared RRF’s 1999

                                       38
and 2000 form 1065’s. Mr. Connelly was the senior manager assigned to the
returns, meaning he signed them on behalf of E & Y, although he operated
under Dom LaValla, the partner assigned to Bracebridge. Joseph Bianco, an
attorney and manager at E & Y, assisted Mr. Connelly in preparing the returns.
At trial, Mr. Bianco testified that he preformed the initial review of documents
and financial statements provided by Bracebridge. Mr. Connelly recalled that
he relied on Mr. Bianco to gather information and do the initial calculations.

       During the information gathering stage, Messrs. Connelly and Bianco
worked closely with Mr. DiBiase, who provided the documents and facts that
would collectively lay the foundation upon which the accountants would
prepare RRF’s returns. The trial exhibits bear out this relationship.

        JX 101 is an email dated October 7, 1999, in which Mr. Connelly
solicited help from Mr. Bianco in addressing the RRF return. Attached is a
memorandum containing a list of events relevant to the relationship between
RRF and the Tiger funds. Id. at 54. As with this and all subsequent
information about the transactions, the E & Y accountants relied on Mr.
DiBiase for the facts. We note here that, despite his reticence in claiming any
extensive understanding of tax matters, we believe Mr. DiBiase was being
unduly modest. He had extensive experience in preparing tax returns for
former employers and showed a remarkable interest in and understanding of
the relevant factors in moving Tiger’s tax losses to FFIP. We believe that the
list of working “facts” behind E & Y’s preparation of RRF’s tax return were
orchestrated by Mr. DiBiase to achieve a desired result and were not critically
evaluated by either Mr. Connelly or Mr. Bianco.

       JX 104, for example, an email in the continuing evolution of the “facts”
supporting the tax deduction, forwards an attached chronology of RRF events,
including the following:

       2. Tiger contributes assets in kind to RRF. May 20, 1999 Non
       taxable (721(a))

       3. FFIP buys Tiger’s shares in RRF. June 4, 1999 FFIP’s
       basis = Cost (1012)

       4. In exchange for 80% of the assets contributed by Tiger, RRF
       receives stock and cash from [General Cigar]. June 23, 1999
       Nontaxable (351)[.]

                                      39
Id. at 56. Mr. Connelly testified that the underlying chronology was prepared
by Mr. DiBiase. When asked whether the notations in bold concerning non-
taxability were added by E & Y, Mr. Connelly answered, “We didn’t provide
information to Mr. DiBiase” and that he received the attachment in the precise
form it was introduced at trial. Tr. 1265. Mr. DiBiase, in other words, was
thoroughly familiar with the finer workings of the code and was taking no
chances in guiding the E & Y team along. Mr. Connelly testified consistently
that all the information upon which E & Y relied came from Mr. DiBiase.
Despite E & Y’s non-involvement in the formation of RRF, Messrs. Connelly
and Bianco did not ask for basic information about how the fund was
organized or how Tiger became a partner.

       Similarly, on November 9, 1999, Mr. DiBiase sent Mr. Connelly an
email composed of six background facts, of which item three was the purchase
of Tiger’s RRF shares by FFIP and items four through six concerned other
dealings between Bracebridge entities ending with the contribution by FFIP of
its RRF shares to FFI Fund. JX 118 at 15. Mr. DiBiase ended with a
“challenge” to the accountants: “Get tax losses from 25023 to FFIP. Don’t
want any of such losses to be allocated to other entities which will get no
benefit from them.” Id.

        In September 2000, Mr. DiBiase sent a final version of the background
facts to Mr. Connelly, who had apparently been asking for this information for
at least six months. See JX 124. When asked what recitations he was looking
for to confirm the non-taxability of the Tiger contribution, Mr. Connelly
explained that he wanted assurances that Tiger had made a contribution, that
there was an economic reason for the contribution, and that the subsequent
transfer to FFIP was not related to or premised on the contribution.
Nevertheless, the communications between E & Y and Mr. DiBiase, along
with the trial testimony, suggests an uncritical acceptance by E & Y of the
information provided by Mr. DiBiase. The memo authored by Mr. Dibiase
provides virtually no information about the economic “reason” for Tiger’s
contribution or about the independence of the subsequent transfer. Id. at 8. E
& Y simply took at face value Mr. DiBiase’s self-interested summary and
utilized these “facts” to prepare the tax forms.

       The facts, however, should have given the accountants at least some
cause for concern. The difference between the sales price ($14.9 million) and
the built-in losses ($223 million) should have triggered some conversation

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about the bona fides of Tiger’s brief sojourn within RRF. Mr. Connelly wrote
himself a note at the time to prompt himself to ask Mr. DiBiase “why buyout
of Tiger.” JX 118 at 15. At trial he testified that he did not recall what answer
he received from Mr. DiBiase to that very relevant question. Also in his notes
of the conversation he had with Messrs. DiBiase and Shay were the following
comments: “Presumed not to be a prearranged transaction,” and “Shay –ACM
concern.” Id. at 19. “ACM” was a reference to a case issued by the Court of
Appeals for the Third Circuit in 1998 that upheld in part the Commissioner’s
FPAA challenge to a partnership transaction for lack of economic substance.
See ACM P’ship v. Comm’r, 157 F.3d 231 (3d Cir. 1998). While one would
expect to see legal memoranda, advice letters, or other work papers addressing
these issues, nothing was produced at trial to show how E & Y resolved these
concerns. Mr. Connelly testified that he did nothing other than accept Mr.
DiBiase’s representation that the contribution by Tiger and sale to FFIP were
presumed not to have been prearranged transactions.

       E & Y did not investigate the motivations for the sale by Tiger to FFIP
within two weeks of Tiger’s initial contribution, by which Tiger took an
$800,000 loss at a time of rising markets for Russian securities. Additionally,
there is no evidence that E & Y asked for or critically read the papers
describing the circumstances behind Tiger’s contribution to RRF, specifically
the side agreement with its negotiated change of Tiger’s commitment from
three years to six weeks or the subscription agreement with its disavowal of
any investment intent.

        Although there is no evidence that the tax accountants at E & Y
performed an independent investigation into the transactions at issue, plaintiff
asserts that Bracebridge, including RRF, also employed the auditing division
at E & Y to inspect the records and books of the partnership. Plaintiff makes
much of the fact that RRF was given an “ok” in an E & Y audit and that the
audit division was supposed to share its findings with the tax division. There
is no such evidence in the record; however, and, in any event, we would have
no better basis for assuming that the audit division scrutinized the formation
documents. In short, the tax division at E & Y relied virtually exclusively on
Mr. DiBiase’s characterization of the facts.

       Finally, the only record plaintiff offers of “advice” given to RRF
concerning the propriety of taking the losses is the returns themselves. There
are no backup memos or records of conversations concerning the propriety of
claiming the built-in losses. We are simply asked to accept that, by signing off

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on the returns for 1999 and 2000, E & Y was giving its considered advice on
whether it was appropriate to take the loss deduction.

        We are satisfied that neither Mr. Connelly or Mr. Bianco did any
independent investigation into the validity of the critical assumption
underlying FFIP’s claim to the built-in losses suffered by Tiger—that Tiger
was a bona fide partner. They simply accepted Mr. DiBiase’s well-
orchestrated plan for having the firm endorse the losses. In a field of tax law
that is laden with judicial exceptions to the nominal application of statutes,
including cases that specifically question the use of carryover bases in
distressed asset sales, E & Y did not consider the application of judicial
precedent.

        The accountants were entitled to rely on information coming from the
client in filling out the tax returns, but this is not what the law contemplates as
due diligence when it comes to thwarting a penalty for gross underpayment of
taxes. See Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381-82
(Fed. Cir. 2010). Plaintiff is liable for the penalty because it did not
reasonably rely on objective advice from a tax professional based on all of the
pertinent laws, facts, and circumstances.

                                CONCLUSION

       We reject RRA’s challenge in case number 06-30 to the IRS’s
disallowance of the Tiger losses. In addition, we sustain the imposition of
penalties. Therefore, plaintiff is not entitled to a correction of the 2000 FPAA.
Case number 06-35, which contains the same allegations asserted by a second
and alternative tax matter partner, is likewise dismissed with prejudice. The
complaints are, accordingly, dismissed. The Clerk is directed to enter
judgment for defendant. No costs.

                                             s/ Eric G. Bruggink
                                             ERIC G. BRUGGINK
                                             Judge

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