You’re a Victim of a Ponzi Scheme, But What About Your Taxes?

IRS_Logo

You missed the warning signs and got suckered into a Ponzi scheme. Can the IRS help by giving you some tax relief? This is a critical issue for long-term Ponzi scheme investors (like some of the Madoff victims) who have paid taxes on gains from the investment. After all, they have been paying real taxes on fictional gains.

The IRS has stepped up with guidance on what to do. They clarified the federal tax law governing the treatment of losses in Ponzi schemes. They also set out a safe harbor method for computing and reporting the losses.

The revenue ruling (2009-9) addresses the difficulty in determining the amount and timing of losses from Ponzi schemes and the prospect of recovering the lost money.  Some of the older guidance from the IRS on these losses is somewhat obsolete.

The revenue procedure (2009-20) simplifies compliance for taxpayers by providing a safe-harbor for determining the year in which the loss is deemed to occur and a simplified means of calculating the amount of the loss.

The first question is whether a loss from a Ponzi scheme is a “theft loss” or a “capital loss” under IRC §165? With the criminal intent of a Ponzi scheme, it is a theft loss. That also results in it being an itemized deduction that is not subject to the deduction limits in IRC §67 or IRC §68. You can read further in Revenue Ruling 2009-9 for more information.

Even with the clarification in the revenue ruling there many factual issues that have to be addressed to properly take the deduction. Given the ongoing investigations, it is hard to know the facts. So the safe-harbor in the revenue procedure draws some bright lines around what you need to take the deduction.

The first thing you need to determine is whether the Ponzi scheme was a theft. The revenue procedure provides that the IRS will deem the loss to be the result of theft if:

    • the promoter was charged under state or federal law with the commission of fraud, embezzlement or a similar crime that would meet the definition of theft; or
    • the promoter was the subject of a state or federal criminal complaint alleging the commission of such a crime, and
    • either there was some evidence of an admission of guilt by the promoter or a trustee was appointed to freeze the assets of the scheme.

      That seems to work very nicely with the facts for the Madoff scheme.

      Now that you can claim the theft loss, you need to calculate the amount of the loss. It may take years to find any assets and distribute them to the victims. Therefore, you have a problem figuring out the actual amount of the loss and the prospect of recovery. The revenue procedure generally permits taxpayers to take a deduction in the tax year they discover the loss and to deduct 95% of their net investment (less the amount of any actual recovery in the year of discovery and the amount of any recovery expected). If you are an investor suing persons other than the promoter (like the Madoff feeder funds), then your deduction is reduced by substituting “75%” for “95%”.

      This new guidance seems to address the phantom income concerns, but are predicated on the victims not filing amended returns for prior tax years. Are there other concerns that the IRS did not address?

      See:

      Can You Prevent Ponzi Schemes?

      Charles Ponzi
      Charles Ponzi

      With Madoff, Nadel and Stanford in the news, people are wondering why the government does not prevent Ponzi schemes. The government should protect us from these frauds.

      How can they?

      Ponzi scheme sponsors are thieves. Common criminals. They just wear suits instead of black masks.

      The government has not been able to prevent bank robberies, car-jackings or pick-pockets. (I lump Ponzi schemes in with these.) What government can do is deter and punish. An effective detection and prosecution program may deter some bad guys. If you feel certain you will get caught and punished then you are less likely to commit the bad act. On the other side, if you feel certain that you will not get caught or punished, then you are more likely to commit the bad act.

      The inspiration of this post is an article from Tresa Baldas summarizing some of the current steps being taken: Wave of anti-Ponzi laws coming — but will they work? The US Congress has already introduced two bills in the last few weeks trying to increase transparency and registration of private investment funds: The Hedge Fund Transparency Act and the Hedge Fund Adviser Registration Act of 2009.

      Don’t forget that Madoff and Stanford were both registered with the SEC and subject to some form of SEC oversight. Clearly registration and transparency were not effective at stopping them. They will increase the paperwork. They will make it harder for private investment funds to execute their business plans.

      I guess as a compliance professional more regulation would be good for me. More regulatory oversight means more work for compliance. But I would rather focus my efforts on helping my company execute its business plan and making sure that nobody is cutting any corners to achieve that execution.

      But with a new administration and issues in the financial marketplace, I expect to see some form of new regulatory requirements. Will they prevent Ponzi schemes? No, the government cannot prevent Ponzi schemes.

      Investors prevent Ponzi schemes. If it sounds too good to be true, it probably isn’t true. Guaranteed returns with no risk? It better be a bank with FDIC insurance (or the equivalent).

      Thanks to Bruce Carton of Securities Docket for pointing out the Baldas article in his post: Wave of “Anti-Ponzi” Legislation May be Coming.

      See :

      France Decides Not to Criminalize International Bribery

      eiffel tower

      “France has severely restricted its jurisdiction and its ability to prosecute cases with an international dimension, which, given the country’s importance in the international economy and the scale of many of its companies, is very regrettable,” according to a report by GRECO. The Group of States against Corruption (GRECO) was established in 1999 by the Council of Europe to monitor States’ compliance with the organization’s anti-corruption standards.

      In June of 2000, France introduced legislation related to the OECD Convention. However in the GRECO report the evaluation team wonders “why, despite the economic weight of France and its close historical links with certain regions of the world considered to be rife with corruption, it has not yet imposed any penalties for bribing foreign public officials.” (¶ 76)

      France ratified the Criminal Law Convention on Corruption (ETS 173) on April 25, 2008 with an effective date of August 1, 2008. France entered two reservations as part of enacting the law.

      France’s Reservation on the Offense:

      “In accordance with Article 37, paragraph 1, of the Convention, the French Republic reserves the right not to establish as a criminal offence the conduct of trading in influence defined in Article 12 of the Convention, in order to exert an influence, as defined by the said Article, over the decision-making of a foreign public official or a member of a foreign public assembly, referred to in Articles 5 and 6 of the Convention.”

      France’s Reservation on Jurisdiction:

      “In accordance with Articles 17, paragraph 2, and 37, paragraph 2, of the Convention, the French Republic declares that it reserves the right to establish its jurisdiction as regards Article 17, paragraph 1.b, of the Convention, only when the offender is one of its nationals and the offences are punishable under the legislation of the country where they have been committed, and that it reserves the right not to establish its jurisdiction regarding the situations referred to in Article 17, paragraph 1.c, of the Convention.”

      In my reading of the GRECO report, it sounds like France dropped the international bribery charge because it is too hard to prove and obtain conviction. (¶ 83)

      To be fair to France, GRECO has not yet completed the Third Evaluation Round for all 46 members. So other countries many take a similar position. But the 11 made public so far have not excluded bribery of foreign officials.

      France causes other problems with compliance programs. France blocks traditional SOX whistleblower programs because of concerns abut worker’s privacy.  If you want a whistleblower program in France, you need to register it with the CNiL and it must be limited to reports about the “vital interests of the company or it its employee’s physical or mental integrity”

      See:

      Approaching the Sphinx: The DOJ’s Opinion Release Procedure under the FCPA

      wrageblogAlexandra Wrage of the WrageBlog shares her experiences using the Department of Justice’s opinion release procedure under the Foreign Corrupt Practices Act: Approaching the Sphinx: The DOJ’s Opinion Release Procedure.

      Ms. Wrage takes us through the experiences of TRACE International in obtaining FCPA Opinion Procedure Release 08-03.

      The opinion release procedure for the Foreign Corrupt Practices Act is fairly unique for a criminal law. You can ask the government if your proposed action is potentially criminal.

      Betting the Corporation: Compliance or Defiance

      Lawrence D. Finder, Ryan D. McConnell & Scott L. Mitchell drafted a paper surveying the sixteen corporate deferred prosecutions and non-prosecution agreements entered into by the Department of Justice in 2008.

      Betting the Corporation: Compliance or Defiance? Compliance Programs in the Context of Deferred and Non-Prosecution Agreements – Corporate Pre-Trial Agreement Update – 2008

      In 2008, every agreement contained some sort of corporate compliance reform provision – continuing a trend we have seen over the last few years. This trend is the focus of this update. Aside from building on prior observations, this piece attempts to draw empirical observations about the types of compliance programs that come out of corporate pre-trial agreements. The authors recognize there is no one-size fits all template for corporate compliance programs. But by examining compliance programs in the context of DPAs and NPAs, the authors strive to provide a picture of what types of compliance measures are negotiated by the DOJ and corporate targets to resolve internal control and other business deficiencies that resulted in criminal wrongdoing. We hope that this will provide some guidance for attorneys and other professionals who deal with compliance issues.

      The authors note that one of the big changes in 2008 was the DOJ’s implementation of a new charging policy. (You can find it at 9-28.000 of the U.S. Attorney’s Manual.) Although the policy is no longer associated with a particular person (like the 2006 McNulty memo, the  2003 Thompson memo and the 1999 Holder memo), the nine factors for charging a corporation are still the same:

      1. the nature and seriousness of the offense;
      2. pervasiveness of wrongdoing;
      3. the company’s history of similar conduct;
      4. the company’s timely and voluntary disclosure;
      5. the existence and effectiveness of a pre-existing compliance program;
      6. the company’s remedial actions;
      7. the collateral consequences (including harm to shareholders) of a conviction;
      8. the adequacy of prosecution of individuals; and
      9. the adequacy of civil or regulatory remedies

      There is a new statement in USAM 9-28.200:” In certain instances, it may be appropriate, upon consideration of the factors set forth herein, to resolve a corporate criminal case by means other than indictment. Non-prosecution and deferred prosecution agreements, for example, occupy an important middle ground between declining prosecution and obtaining the conviction of a corporation.”

      A second change in 2008 was the issuance of the Morford Memo that addresses the use of corporate monitors, providing guidance on issues that may arise in the selection of a monitor and the monitor’s duties.

      2008 STATISTICS:

      Total Number of Agreements: 16
      Number of Privilege Waivers: 2   (13%)
      Number of Agreements with Compliance Monitors: 6   (38%)
      Number of Agreements With Compliance Reforms: 16 (100%)

      The link above is to a draft copy of the paper. The final version is scheduled to be published in the South Texas  Law Review in May 2009.

      Let’s Get Ethical!, Ethical!, I Want To Get Ethical…

      Those of you that watch NBC’s “The Office” see some of the best examples of what NOT to do in business every week. They also tackled what not NOT to do in an Ethics Training course. The clip shows some of the worst training skills (reading from the binder, HR-speak, etc.).

      It also provides an unusual example of a compliance problem, with Meredith sleeping with a supplier in exchange for a discount.

      Unfortunately, the ethical lapses are not limited to the rag-tag Scranton office, but also exist in the main office. The response to Meredith’s confession from the home office?: “I’m not sure that these circumstances warrant any action…this seems like a grey area.”

      Twitter and Presentations

      Follow me on Twitter
      Follow me on Twitter

      At President Obama’s State of the Union address, there was a fair amount coverage by the media and by the Congressman in attendance. Several dozen Congressmen have twitter accounts and many were sending out messages during the address.

      Is this Good or Bad?

      What about people in the audience when you are giving your next presentation?

      Is this Good or Bad?

      At my recent presentation with Bruce Carton, Web 2.0 – Leveraging New Media to Maximize Your Securities & Compliance Practice, Bruce and I kept an eye on the Twitter backchannel. I had published the #SecuritiesD hashtag and publicized it on a blog post and Twitter. There were a handful of twitter users during the presentation asking questions and publishing notes about the webinar to their followers. One tweet corrected an outdated statistic I cited. David Hobbie of Caselines used Twitter to keep his notes about the webinar and to capture soundbites from me and Bruce.

      I also had the experience of participating in a conference through Twitter. I did not attend LegalTech New York this year, after having attended it the last few years. Fortunately, several people I know and several people I follow on Twitter did attend. They were able to relay their thoughts about the speakers, relay soundbites and communicate with each other during the conference. I even asked a question on Twitter that got relayed to speaker, answered and relayed back to me through Twitter. The use of Twitter spread the conference beyond the four walls of the convention hall. That is very powerful.

      Is Twitter a good thing during presentations? Yes!

      Try integrating it during your next presentation. I will.

      See also:

      Waiving the Attorney-Client Privilege By Seeking Tax Advice

      john-adams-courthouse for the Mass SJC

      The Massachusetts Supreme Judicial Court focused on the issue of whether the attorney-client privilege protected  communications between an in-house corporate counsel and outside tax accountants. Commissioner of Revenue v. Comcast Corporation, et al., SJC-10209 (March 3, 2009). The general rule is that the voluntary disclosure of privileged information to a third party consultant for the company’s business purposes will be deemed to waive the privilege.

      We saw a similar issue addressed in the context of SEC filings in the case of  Roth v Aon. In the Roth case, they were trying to compel the release of draft SEC filings. That court rejecting the request and recognized that the process of preparing SEC filings involves legal judgments throughout, even where the disclosure in question concerns operational rather than legal matters.

      In Comcast, Corporate counsel retained two Massachusetts-based Arthur Andersen partners to provide Massachusetts tax law advice in connection with a proposed stock sale. The Andersen partners spoke with in-house counsel and prepared several memoranda discussing options for the company relating to the stock sale. Litigation ensued concerning the tax implications of the stock sale. The Commissioner of Revenue sought production of the Arthur Andersen memoranda, which Comcast withheld on the basis of the attorney-client privilege and/or work product doctrine.

      The SJC held that the memoranda were not protected by the attorney-client privilege.

      In addressing whether the attorney-privilege exists, Comcast bears the burden of proof and needed to show:

      “(1) the communications were received from a client during the course of the client’s search for legal advice from the attorney in his or her capacity as such; (2) the communications were made in confidence; and (3) the privilege as to these communications has not been waived.”

      Comcast argued that the memoranda fell within the “derivative privilege” recognized in United States v. Kovel, 296 F.2d 918 (2d Cir.1961). In the Kovel decision, the Second Circuit held that the attorney-client privilege is not waived when disclosure to a third party consultant is necessary to facilitate communication between the attorney and the client and assist the attorney in rendering legal advice to the client. One example of the derivative privilege is that of an interpreter brought in to translate for a client and his attorney who speak different languages.

      With respect to accountants, the Court in Kovel held that the privilege is waived unless the communication is made for the specific purpose of the client obtaining legal advice from the lawyer. The privilege is waived if  (a) what is sought is not legal advice but only accounting services, or (b) if the advice sought is the accountant’s rather than the lawyer’s . In Comcast, the SJC agreed that the Kovel doctrine applies only when the accountant’s role is to clarify or facilitate communications between attorney and client. The majority of courts take the same position.

      Lesson? Tax advice from your accountant is unlikely to be protected by attorney-client privilege.

      Before disclosing attorney-client communications to a third party, ask yourself whether the third party is being consulted in order to (a) simply to provide her own advice, or (b) facilitate communication between the attorney and the client. If your answer is (b), disclosure of the confidential information will likely waive the attorney-client privilege.

      See also:

      Madoff Goes From His Penthouse to the Big House

      madoff

      Bernie Madoff filed past a sea of reporters and camera flashes to enter his guilty plea in front of Judge Denny Chin. Several victims spoke, asking the judge to reject the plea and force a trial. They want grueling trial to make Madoff suffer and to bring more facts out to the public.

      Since he turned himself in to authorities back in December, Mr. Madoff has been living in his multi-million dollar penthouse. Back in December, the magistrate ruled that Mr. Madoff was not a flight risk and allowed him to stay confined in his palatial home.

      But now Mr. Madoff is guilty. Mr. Madoff’s attorney, Ira Sorkin, tried to argue for bail. But Judge Chin would have none of it. Judge Chin revoked Madoff’s bail, calling him a “flight risk” in light of the severity of the charges for which he just entered a guilty plea. He granted the government’s request for remand. The prosecution did not even have to rebut Mr. Sorkin’s argument for bail.

      According to the New York Law Journal’s Mark Hamblett, Mr. Madoff was taken out of court in handcuffs. I have not seen pictures of that yet, but I am sure there are many people looking to get a copy of that picture to frame. In handcuffs, he was delivered to Manhattan Correctional Center. (If you were thinking of sending some money to Bernie to help his cause, you should take a look at the Bureau of Prison’s Inmate Money Policy.”The deposit must be in the form of a money order.”)

      Fox Business takes us on a tour of his new home until his June 16 sentencing hearing:

      Presumably, Mr. Madoff’s lawyer will appeal the bail revocation. The chances of Mr. Madoff being released on bail are slim and none, and slim’s 401(k) has turned into a 201(k). After all, the appellate court gives lots of deference to the district court on bail decisions.

      The next question will be how much time will Mr. Madoff serve and where. Lets add up the charges:

      • Count 1: Securities fraud. Maximum penalty: 20 years in prison; fine of the greatest of $5 million or twice the gross gain or loss from the offense; restitution.
      • Count 2: Investment adviser fraud. Maximum penalty: Five years in prison, fine and restitution.
      • Count 3: Mail fraud. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 4: Wire fraud. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 5: International money laundering, related to transfer of funds between New York-based brokerage operation and London trading desk. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 6: International money laundering. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 7: Money laundering. Maximum penalty: 10 years in prison, fine and restitution.
      • Count 8: False statements. Maximum penalty: Five years in prison, fine and restitution.
      • Count 9: Perjury. Maximum penalty: Five years in prison, fine and restitution.
      • Count 10: Making a false filing with the Securities and Exchange Commission. Maximum Penalty: 20 years in prison, fine and restitution.
      • Count 11: Theft from an employee benefit plan, for failing to invest pension fund assets on behalf of about 35 labor union pension plans. Maximum penalty: Five years in prison, fine and restitution.

      That’s a maximum penalty of 150 years. Some of these may end up being concurrent sentences. But given that Mr. Madoff is 70, it would be a good guess that he will end up spending the rest of his life in prison.

      Where will he be spending that time? Jeff Chabrowe of the Blanch Law Firm told Esquire that he thinks it will be the Federal Correctional Institute in Otisville, New York because it is one of the few with a kosher kitchen. Sounds like a wild guess to me.

      It is good to see justice happening swiftly and effectively. After all the fear of prosecution is one of the better ways to stop Ponzi schemes. It seems like Mr. Madoff just wants this to end and accept his punishment.

      The compliance officer in me wants to hear more about the underlying facts of what made Madoff go bad. In his allocution Madoff states that:

      When I began the Ponzi scheme, I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible.

      What made him begin the scheme? What would have stopped him from starting the scheme? What lessons can learn from Mr. Madoff to deter the next Madoff from going to the dark side? How did he think he could extricate himself?

      See: