Chapter 63: Tax Evasion or Tax Avoidance?

March 19, 1997, Chicago, Illinois

“Maybe,” Ned Jenkins said. “The law Congress passed last year tried to close loopholes, but they did a very poor job of it, and this might pass legal muster. Did they actually set this up?”

We were in the ‘Lemieux’ room on a conference call including Jamie, Ned Jenkins in Pittsburgh, Ben van Hoek in Cincinnati, Ben Jackson in California, Neil Payette in Dallas, Karl in Italy, and Cindi, Elyse, Deborah, Kimmy, and me in Chicago.

“We don’t know,” Deborah replied. “What about the comments?”

“That’s where they’ll get into trouble,” Ben van Hoek said. “You CAN engage in tax avoidance, but when you say things like ‘hide the income from the government’ it creates an automatic suspicion of tax evasion, even if they simply meant ‘tax avoidance’. I think that’s Steve’s cue!”

“‘The difference between tax evasion and tax avoidance is: a) whatever the IRS says; b) 20 years in prison; c) a good lawyer; d) all of the above‘,” I said with a smirk.

“And my opinion about The Firm as a film notwithstanding,” Ned said, “there’s a point to what Avery Tolar is saying there. Even with last year’s changes, the tax code is still as clear as mud. As Ben in Cincinnati points out, SAYING you’re trying to hide it from the government is a real problem.”

“Steve,” Ben Jackson said, “when did you discover this?”

“We didn’t,” I said. “Neil caught it in Lone Star’s document production and called Deborah before she even had a chance to start going through the package Lone Star sent us.”

“Here’s an off-the-wall idea,” Ben continued, “what if YOU turn them in?”

“I’d wreck our business relationship with them,” I replied. “And isn’t there some kind of rule which prevents us from turning this over to the government? They sent it to lawyers, after all.”

“Remember,” Deborah said, “in a civil proceeding, everything is a matter of public record unless we convince the judge to seal something like trade secrets or our source code. But nothing in Dante’s claims touch on either of those areas. Remember what I told you about depositions - they are technically court hearings, and as such, open to anyone who wants to attend, barring a protective order.”

“So we defend ourselves by throwing our co-defendant under the bus?” I asked.

“As I think about it,” Neil said, “that would be the best way to protect ourselves from claims of collusion. Remember, that’s the key to Dante’s case. He has to prove collusion, and you can bet they’ll seize on this as evidence of underhanded dealings. As I recall from past discussions, your books are squeaky clean and you don’t use any, shall we say, ‘elaborate tax strategies’.”

I chuckled, “If you mean I avoid any whiff of tax evasion, you’re damned straight! The Feds are going to get their money whether or not I want to give it to them. I’d much rather avoid all the ‘imperial entanglements’ and not draw attention to us. We’re going to get some from this, though.”

“Oh, for sure,” Ned replied. “You’ll have a pack of IRS investigators yapping and braying like it was duck season.”

“Rabbit season!” I replied, mimicking Daffy Duck, causing everyone to laugh.

“I’m a bit reticent to cause this kind of rift between the companies,” Neil said. “They could do us a lot of harm if we don’t coordinate.”

“Deborah, when do we have to actually produce these to Dante’s team?” I asked.

“By April 18th.”

“But we could send it to him sooner, right?”

“Sure. Most people wait until close to the deadline because that gives them less time to read mountains of documents.”

“So producing EARLY says we have nothing to hide?” I asked.

“It could be read that way, and Neil would know better, but I don’t think Dante’s team would fall for that.”

“No, they won’t,” Neil said. “Discovery is all over the map. Sometimes companies do it piecemeal, sometimes all at once, and the timing is variable, too. If you’re going to play games, you over-produce so they have to read reams of unrelated, unresponsive documents to find what they’re looking for, in the hopes they’ll miss it. But that’s tricky, because the courts are savvy enough to grant more time when it appears that has happened.”

“There are two competing theories here,” Karl said. “Trying to look clean to Dante and the government, and trying to keep Lone Star on side. I almost hate to ask this, but what does your gut say, Steve?”

“That I’d rather take my chances with Dante than have Lone Star become the enemy within the gates. But how about I split the difference and get this to someone I know who can get it out, and we can issue a denial that we had anything to do with the tax scheme?”

“You think you can get this published somewhere?” Ben van Hoek asked.

“That would be the goal - get a copy of those emails to the right person and let them run with it. It wouldn’t even have to be a major story - even a column inch in a newspaper or magazine would be sufficient to attract the notice of the Empire, while making it look to Lone Star as if Dante is the source of the leak.”

“That might be a bit too cute,” Ben Jackson said. “I’m inclined to advise you to let Dante’s team stumble on this and ask about it in a deposition, which is how I would go about it if I were them. Try to elicit something which ties NIKA to the scheme and THEN get it to the government. After all, a complete IRS audit isn’t going to happen before discovery is complete, and the finding, if any, won’t come out for some time afterwards, including any potential criminal prosecution.”

“That actually makes sense,” I said. “If they want to use this against us, they have to develop it, not wait for the government. Heck, they’ll be happy to elicit denials and hope the Feds find something, which would put NIKA in a world of hurt.”

“Next question,” Karl said. “Do we warn Lone Star? Ethically, I almost think we have to.”

“None of us are in their employ, Karl,” Ben Jackson said. “And we all have to work to protect our client, not anyone else.”

“Sorry. I was thinking more Steve’s ethics, and business ethics in general, as a member of the Board of Directors, than legal ethics. It would, obviously, have to be one of the non-attorneys who made the call.”

“Karl is right,” I said. “I owe it to Brad Giesma and Manny Nuñez to at least call them and say what we found.”

“Have Deborah on that call, please,” Karl replied. “I’d say record it, but that runs the risk of running afoul of wiretapping laws, and asking to record it would seem unfriendly.”

“You know,” I said, “the idea that lawyers always tell the truth is almost as bad as the assumption in court that a police officer is always telling the truth.”

“We can discuss that one over a beer or bourbon when I get back to the States!” Karl laughed. “But having Deborah there to take notes protects you.”

“From other members of her profession,” I teased.

“Did you guys know,” Ben Jackson asked, “that two of our partners walked into the conference room at FJF to hear Steve telling bad lawyer jokes, which was their introduction to him?”

“An accurate, if unwise, introduction!” Karl laughed. “Obviously it went OK.”

“Ford and Finch have good senses of humor, so it did.”

“Ned,” I said, “is there a different tack I take if they actually did this from if it was just speculation?”

“In a sense, if they didn’t violate the letter of the license agreement, there isn’t anything you can do from a legal perspective. You’re calling them as a friend to warn them of a potential issue. Their attorney is going to have to advise them how to proceed. You shouldn’t.”

“He’s right,” Ben van Hoek said. “You just tell them what you found, as a courtesy among friendly business partners. Let them decide what to do. Don’t offer advice.”

“Is there anything I need to do?” Elyse asked.

“Not at this point,” Jamie said. “Well, I suppose prepare for the audit. You’ll want to get Bruce Grady involved right away.”

“OK,” she replied. “I’m probably going to start an internal review right away. I know the things the IRS will look for, and we’ll look ourselves first, and make sure we have all the necessary paperwork and documentation to back up our numbers. I’m sure we do, but I want to double-check.”

“Last question for now,” I said, “but how do we handle the PR on this one?”

“I’ll take that,” Ned said. “You have your CPA, tax attorney, and me, put out a joint statement certifying that NIKA does not, has never, and will never, take advantage of questionable tax strategies; that your books are regularly audited externally; and that you’re in compliance with all IRS regulations, to the best of your understanding.”

“Weasel words?” I asked.

“Remember what I told you about tax attorneys years ago?”

“That if I give my paperwork to three different ones, I’ll get three different returns and three different estimates of my tax liability because the laws are often vague and contradictory.”

“Exactly. And that’s why you decided to always follow the more reasonable, most defendable reading of any tax provision. You might get hit with small fines, but you’ll avoid prosecution for tax evasion or fraud because the tax courts do not, generally, hold you civilly or criminally liable for following the plain text of the law to the best of your ability. Intent is a big part of it, which is, of course, why we’re discussing Lone Star’s email.”

“Thanks everyone,” I said. “Deborah and I will place a call to Brad and Manny as soon as we finish this call. I’ll keep you all posted. Thank you, again.”

Kimmy disconnected the call, but I motioned everyone to stay put.

“I just had a thought,” I said. “I think I need to call Manny first. We don’t know if this scheme was implemented, and if it was implemented, who knows about it. Brad wasn’t copied on this particular email discussion, as far as we can tell, though obviously someone could have forwarded it to him, or BCC’d him individual messages.”

“BCC is evil,” Elyse said. “I’m glad you have that disabled on our server.”

“Says the woman for whom a computer is a glorified adding machine!” I chuckled.

“You do know that my work requires pretty much non-stop number-crunching, right? And I don’t have time to play D&D games online!”

I chuckled, “But the engineering team loves nethack! And you know I like playing Hold ‘Em by email, though getting reads on people is MUCH tougher than our face-to-face games. Kimmy, would you get Manny’s number?”

“I have my Palm Pilot with me, one sec.”

She used the stylus to look up the number then dialed Dallas Capital Partners on the conference phone. When the call was answered, I identified myself and asked for Manny, noting that the call was important. He was on the line about a minute later.

“What can I do for you?” he asked after I let him know he was on speaker and who was present.

“I’m calling about your document production for the Peach case. We found a potentially serious issue in an email chain between the Lone Star CFO and the VP of Sales.”

“What’s that?”

“A discussion of hiding revenue via an offshore corporation, specifically in Bermuda.”

“What the hell are you talking about?!” he demanded. “There is no such thing!”

“I hope that’s the case, but the email seems to indicate otherwise. If you look at document number 375, page 3, the second paragraph down, you’ll see what I’m talking about. I assume you don’t have it in front of you?”

“No. Can you read it to me?”

I did, and I could tell by his breathing he was extremely upset, and I was pretty sure, totally blindsided.

“Steve, I know NOTHING about that. Let me get to the bottom of it.”

“I was going to call Brad, but I think I’ll leave that to you.”

“Does Jake Brown know about this?”

“I have no idea. Our attorneys know, obviously, because Deborah is in the room, and we just got off the phone with our outside counsel, both for this case, as well as our tax and business counsel. I don’t know if Scott Carlson is aware, either.”

“OK. First, I’m going to talk to Jake and figure out how to handle this. Where can I reach you?”

“At the office today, by cell phone tonight, and in the office tomorrow until about 2:00pm. I’m heading to Europe for a wedding and business and I’ll be gone about a week. Kimmy will be able to get in touch with me, night or day, during my trip.”

“Thanks. I’ll be in touch very soon.”

We said ‘goodbye’ and Kimmy disconnected the call.

“I think Lone Star is going to get new senior management very soon,” I said.

“DCP has a tough choice,” Deborah countered. “Replacing them is an admission of guilt, but keeping them is risky. Well, assuming they did it.”

“I think they did,” I replied quietly.

“Why?”

“Manny’s reaction. HE thinks they did it, or is at least highly suspicious.”

“So now what?” Elyse asked.

“We go back to work and prepare for the IRS to send ‘hither swarms of Officers to harass our people and eat out their substance‘.”

“Now what are you quoting?”

“Seriously?” I asked, shaking my head. “The Declaration of Independence! I could have also said ‘for imposing Taxes on us, without our Consent‘. I think I may make the Declaration required reading for new employees!”

“Oh, Bob will LOVE that!” Deborah laughed.

“What?” I asked with an evil grin, “Reading the foundational document of our entire system of government somehow violates people’s rights?”

“When you have that conversation, I want to observe!” she laughed.

“So you like to watch?” Elyse smirked.

“And on THAT note, we’re adjourned!” I grinned.

We left the conference room and I followed Elyse to her office.

“I need a favor,” I said.

“Here?” she asked sexily.

“Not THAT kind of favor! For your audit preparation, you’re at least going to need some temps, right?”

“Yes to go through the physical documents and compare them with the entries in the computer. Why?”

“I’d like you to consider hiring Monica Gerhardt, even if it’s only for a temporary position. She has an Associate’s in accounting, albeit from the late 60s, and she hasn’t worked in over twenty-five years.”

“You’re not doing a good sales job.”

“I’m making sure you know the situation. She needs a break, Elyse, and I want to give her one. If you hire her as a temp and she doesn’t work out, then she doesn’t work out. If she does, then she gets that first job, which at age 50, and with no current experience, is going to be flat-out impossible.”

“True. That’s a shitty situation, but you know a lot of divorced women in their fifties have that problem. That generation still had a lot of housewives and moms who never worked outside the home.”

“Exactly. And while I can’t fix every situation, this one I can. Will you do me that favor?”

“Of course. Have her get me her CV. I’ll handle Bob.”

I smiled, “Thanks.”

That evening, the entire family went to see Matthew in H.M.S. Pinafore. He did a fantastic job and everyone enjoyed the show.

March 20, 1997, Chicago, Illinois

“So, NOW what?” I asked my legal ‘Dream Team’ at the start of our conference call on Thursday morning.

“You can’t be involved in DCP’s decision in any way,” Karl said. “Not even advice to Manny on how to proceed. In fact, at this point, I think the only contact between the firms should be between Neil and Scott Carlson.”

“I have to agree with Karl,” Ben Jackson said. “Whatever DCP and the Lone Star Board decide to do about the CFO, it has to be their decision.”

“I’m also reluctant to believe that this entire scheme was cooked up by the CFO and that Brad Giesma knew nothing about it,” Karl said.

Elyse laughed, “You do know Cindi and I could do that and Steve would never know, right? He doesn’t get down in the weeds, if you will.”

“You’re missing a point,” Karl said. “How did they set up the foreign corporation without the CEO, the Board of Directors, or the VC who owns controlling interest in the company knowing about it?”

“You’re saying either Brad knew about it, or the CFO and VP of Sales committed fraud?” I asked.

“I don’t see another alternative. We don’t know what Scott Carlson knew, but he’s a litigator, not their tax attorney.”

“Now I have a good idea on how they became profitable so quickly after the buyout fiasco - they aren’t paying any federal income taxes. Cindi never could figure that out. She always assumed DCP was simply infusing more funds. But that forces me to ask how DCP and Brad didn’t know what was going on.”

“That is a very good point,” Ned said. “DCP should have at least been suspicious about zero taxes.”

“What if they showed flat EBITA?” Elyse asked. “If you think about it, DCP wasn’t expecting a profit during recovery, so zero taxes would be realistic. Though by now they should be expecting some profit.”

“Except that if I understand the recapitalization deal, they set up a fee structure which, while not identical to what we helped Melissa set up for her patents, would have the same effect.”

“That would work,” Ned said. “It’s unconventional, but there would be ways to structure it so it was compliant with tax laws. And as a private firm, you can do a lot of things a public firm could never do.”

“OK, so it’s possible Manny and the DCP Board are in the dark,” I said. “But I still can’t believe Brad didn’t know about this, but knowing Brad, I can’t believe he’d go along with it, either.”