Hernly v. U.S.

• Decision Date: 15 October 1987
• Docket Number: No. 85-2316,85-2316
• Citation: 832 F.2d 980
• Parties: -5774, 87-2 USTC P 9638 Miles A. HERNLY, Petitioner-Appellant, v. The UNITED STATES of America, Respondent-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 980

832 F.2d 980

60 A.F.T.R.2d 87-5774, 87-2 USTC P 9638

Miles A. HERNLY, Petitioner-Appellant, v. The UNITED STATES of America, Respondent-Appellee.

No. 85-2316.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 26, 1986.

Decided Oct. 15, 1987.

Robert B. Keene, Tabbert & Capehard, Indianapolis, Ind., for petitioner-appellant.

Gary D. Gray, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.

Before BAUER, Chief Judge, POSNER, Circuit Judge, and FAIRCHILD, Senior Circuit Judge.

FAIRCHILD, Senior Circuit Judge.

This is an appeal from an order of the District Court for the Northern District of Indiana quashing a subpoena requiring IRS Agent Johnson to be deposed in a civil action pending in the Southern District of Indiana. ¹

Appellant Miles Hernly is one of six defendants named Hernly in the civil action. The Hernly defendants wished to examine Agent Johnson concerning a statement in a Report that Johnson had prepared in an income tax investigation. The government moved to quash the subpoena, asserting that any relevant information known by Agent Johnson would have been obtained by him as a result of a grand jury investigation and that disclosure is prohibited by Rule 6(e)(2), F.R.Crim.P. ²

It appears that Agent Johnson had obtained access to the record of a Northern District grand jury investigation under a 1977 order of the district court. Judge McNagny had, pursuant to Rule 6(e), F.R.Crim.P., granted the IRS access to subpoenaed books and records and transcripts of the grand jury proceeding for the purpose of determining whether civil tax liabilities were due.

As Judge Moody noted in the present proceeding, the Supreme Court later held (affirming a judgment of this court) that disclosure for that purpose is not authorized by Rule 6(e)(3)(C)(i). United States v. Baggot, 463 U.S. 476, 103 S.Ct. 3164, 77 L.Ed.2d 785 (1983). Judge Moody reviewed the public policy reasons for preserving the secrecy of grand jury proceedings and the decisions requiring a showing of particularized need before such disclosure. He decided,

[w]hile Johnson's knowledge and use of the information cannot now be erased, it would be a grave mistake to allow such information to enter into the public domain through a trial deposition. The defendants may, of course, seek to obtain the information directly through a motion directed to the grand jury. If so, they must prove the requisite "particularized need"

....

When the Hernly defendants filed their opposition to the motion to quash their subpoena, they also filed what they entitled "Motion for Disclosure of Proceeding Before a Grand Jury." In the text, however, they requested only that Agent Johnson be authorized to disclose the information he had gathered. The order granting the motion to quash did not refer to the motion for disclosure, but it seems clear that it was impliedly found wanting and denied. Miles Hernly appealed.

It would be difficult to fault Judge Moody's conclusion that the disclosure to the IRS, authorized for a purpose later deemed inappropriate in Baggot, does not, in itself, warrant wider disclosure. Cf. United States v. Sells Engineering, Inc., 463 U.S. 418, 422 n. 6, 103 S.Ct. 3133, 3137 n. 6, 77 L.Ed.2d 743 (1983). It also seems clear, though by implication, that Judge Moody did not believe the Hernly defendants had shown particularized need for disclosure of grand jury materials.

Appellant contends, however, that they demonstrated that the need for disclosure to prevent injustice is greater than any remaining need for secrecy, and that the district court abused its discretion in quashing the subpoena. He argues, further, that the information requested does not constitute matters occurring before the grand jury. We consider, but reject, these arguments.

A. BACKGROUND

In 1980, Basic Earth Science Systems, Inc. (Basic) brought suit against the Hernly defendants and three others seeking $3,000,000 compensatory damages and $1,000,000 punitive damages. In June, 1972, by a stock-for-stock exchange, Hernly Brothers, Inc. and Fitzgerald & Stutz, Inc. had become wholly owned subsidiaries of Basic. Then and prior thereto, the Hernly defendants had been officers and directors of Hernly Brothers, Inc., and the other three defendants had been officers and directors of Fitzgerald & Stutz, Inc.

In 1969, Hernly Brothers, Inc. and Fitzgerald & Stutz, Inc. had formed a joint venture to bid on a sewer construction project in East Chicago, Indiana. Corrupt activities in that connection resulted in the grand jury proceeding at issue here and in the indictment and conviction of Fitzgerald, of Fitzgerald & Stutz, Inc., the superintendent of the Board of Sanitary Commissioners, a friend of his with political influence, and two other persons. Miles Hernly, who was president of Hernly Brothers, was named as an unindicted conspirator, received immunity, and testified for the government. See United States v. Fitzgerald, 579 F.2d 1014 (7th Cir.1978). It appears from that opinion that Basic (referred to by its acronym BESSI) was involved in 1971 in an arrangement to transfer two of the shares of the sewer project profits. 579 F.2d at 1018.

In the present complaint, Basic alleged that defendants had conspired to defraud their corporations, East Chicago, and income taxing authorities by embezzling $3,000,000 received on the East Chicago contract; that Basic had first learned these facts when the indictment was returned in 1976; that the two corporations had treated the East Chicago contract as incomplete on June 20, 1972 when they became Basic's wholly owned subsidiaries; that Basic filed a consolidated return for the period from June 20, 1972 to March 31, 1973, including income of the subsidiaries on the East Chicago contract; that in June, 1978, the IRS informed Basic it intended to assert an income tax deficiency against it in excess of $2,800,000, plus interest and penalties thereon. It appears the assessment was made in 1981. Basic alleges defendants fraudulently concealed the embezzlements from Basic at the time Basic acquired the stock of the two corporations and that it has been damaged to the extent of the income tax deficiencies, penalty and interest. The complaint contains counts on theories of breach of warranty and agreed indemnity as well.

Among numerous defenses, the Hernly defendants allege that Count I of the complaint is barred by the Indiana six year statute of limitations, and allege that Basic knew all the facts it now alleges before it agreed to acquire the Hernly and Fitzgerald corporations as subsidiaries.

The Hernly defendants sought the grand jury materials as help in proving the knowledge of Basic's officers in 1972.

In support of their claim of right to depose Agent Johnson, the Hernly defendants asserted that in discovery they had obtained a copy of Agent Johnson's Revenue Agent's Report. In explaining assessment of a civil fraud penalty, the Report contained the following statement:

Basic Earth Science Systems, Inc. evaded its income tax when it filed a false and fraudulent 7303 consolidated tax return, Form 1120, wherein taxable income was knowingly and purposely understated. This fraudulent conduct was performed through the acts of its directors, officers, and substantial shareholders, Grant W. Breuer, George Kimmey, Charles Fitzgerald, and Miles Hernly.

The report went on to describe two methods used. One "understatement of earnings was accomplished by intentionally using false deductions totaling approximately $2,800,000 in arriving at the reported partnership profits from the East Chicago Sewer Project." A second method did not appear to involve the East Chicago project, but rather improprieties in accounting for an oil exploration venture, called Columbine Three, in which Basic was general partner and the two subsidiaries were limited partners.

Presumably Agent Johnson saw something in a grand jury transcript or a document from which he inferred that Breuer and Kimmey, officers of Basic in 1973, knew that the deductions referred to were false. We surmise that these deductions were those contrived to cover the embezzlements. See 579 F.2d at 1017. Testimony or documents supporting that inference would be relevant to the Hernly defense.

But one seeking disclosure of grand jury proceedings must demonstrate more than relevance; he must show necessity to prevent injustice. United States v. Procter & Gamble, 356 U.S. 677, 682, 78 S.Ct. 983, 986, 2 L.Ed.2d 1077 (1958).

Miles Hernly had personal knowledge of many relevant facts, and his testimony is available. He participated in many of the pertinent transactions, and testified at length in the trial of the criminal case. He is doubtless aware of others who have direct knowledge. Basic and Hernly Brothers, Inc. seem to have had a close relationship for a period of time before Basic became the parent. There was evidence at trial that during this period they were partners in a joint venture formed to transfer shares of the sewer project profits to two of the conspirators. 579 F.2d at 1018. Presumably the Hernly defendants had knowledge or information on which they based the allegation in their answer that Basic had knowledge of the pertinent facts before agreeing to acquire the stock of the Hernly and Fitzgerald corporations.

Nowhere in this proceeding, however, did the Hernly defendants indicate which relevant facts as to Basic's knowledge were outside Miles Hernly's personal knowledge. They did not suggest the identities of other persons with knowledge and show they were not available as witnesses. They did not describe the discovery undertaken in this area, nor its outcome. It was only in oral argument on appeal that Hernly indicated that Breuer and Kimmey had previously been deposed and had denied knowledge of fraud. If they were permitted to examine Johnson, he could guide them to the testimony or documents upon which he based his conclusions. It is...