Isaacson v. Comm'r

• Decision Date: 23 January 2020
• Docket Number: T.C. Memo. 2020-17,Docket No. 29484-14.
• Parties: LON B. ISAACSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

LON B. ISAACSON, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

T.C. Memo. 2020-17
Docket No. 29484-14.

UNITED STATES TAX COURT

January 23, 2020

Joseph A. Broyles, for petitioner.

Cassidy B. Collins, Andrea M. Faldermeyer, Christine A. Fukushima, and Priscilla A. Parrett, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: Petitioner seeks redetermination of his income tax liability for tax year 2007. Respondent determined a deficiency of $2,583,374 and

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a civil fraud penalty of $1,937,531 under section 6663.¹ After concessions,² the remaining issues for decision are whether petitioner (1) failed to report taxable income for tax year 2007 and (2) is liable for the civil fraud penalty under section 6663.

This case centers on a $12.75 million settlement petitioner secured for his former clients who were abused by Catholic clergy when they were children. Specifically, this case turns on whether petitioner earned a 60% contingency fee for his services in 2007. Several other tribunals have dealt with controversies involving these funds over the years. In those prior proceedings petitioner consistently maintained, produced evidence in support of, and convinced other tribunals to accept as true that his former clients were satisfied with his services as an attorney when he secured this settlement in 2007 and that those clients never disputed his right to his asserted fee. Now, however, he asserts that his fee was always in dispute.

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FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulated facts and facts drawn from the stipulated exhibits are incorporated herein by this reference. Petitioner resided in California when he petitioned this Court.

A trial attorney for 38 years, petitioner specialized in, among other practice areas, tax fraud litigation. On May 10, 2013, petitioner was disbarred for willfully violating rule 4-100 of the California Rules of Professional Conduct (rule 4-100), which requires attorneys to place client funds into trust accounts, imposes various recordkeeping requirements, and bars attorneys from commingling funds.³ Before his disbarment, however, petitioner maintained an active litigation practice that included the representation of four individuals who had been sexually abused as

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children by members of the Catholic clergy (clergy lawsuit). Specifically, petitioner represented four individuals whom he knew personally and who considered him to be both their attorney and a trusted friend.

I. Petitioner's Clients and Fee Arrangements

Petitioner's clients in the clergy lawsuit were Clients 1 through 4. Clients 3 and 4 are brothers (Brothers).⁴

The record does not contain copies of retainer agreements for Clients 1 and 2, but the parties stipulated that both men agreed to retain petitioner at a 60% contingency fee. The record does contain copies of the Brothers' retainer agreements. The agreements' terms are largely identical and provide that petitioner would receive "50% if the case settles prior to 120 days before the first arbitration or trial date, or 60% of the present value of all amounts recovered from any source, if the case settles or is adjudicated on or after 120 days before the first mediation, arbitration or trial date is set." The Brothers' retainer agreements also provide that they would reimburse petitioner 110% of his costs and purport to allow petitioner to deposit funds held for their benefit in a "non-IOLTA" (Interest on Lawyers' Trust Account) account, with petitioner retaining any interest earned

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on amounts held in the account. Any disputes arising from the Brothers' contingency fee agreements were to be submitted to binding arbitration.

In the course of retaining petitioner, the Brothers and Client 2 made clear that they did not want any future settlement funds deposited at the Union Bank of Switzerland (UBS) and that they did not want petitioner to manage their investment activities with respect to any future settlement funds.

II. Petitioner's Investment Account at UBS and Account Activity Before the Clergy Lawsuit Client Settlement Funds Were Deposited Into the Account

Petitioner had banked with UBS since the mid-1980s and relied on the financial advice of Richard Frankel, who had worked in the financial industry since 1971. On December 21, 2006, petitioner opened an account at UBS ending in 6151, which later was renumbered to end in 9638 (UBS account). On the documents opening the account, petitioner indicated that the account was for a sole proprietorship, listed himself as the principal officer and beneficial owner of the account, and handwrote the word "Trustee" after his law firm's typed name on the line listing the account owner's information. Petitioner did not indicate that this account was a client trust account. When opening the account, petitioner indicated that the account's investment objectives were "capital appreciation", with a "moderate" primary risk profile and an "aggressive/speculative" secondary

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risk profile. Petitioner did not indicate that the source of the account's funds would be client trust funds; instead, petitioner indicated that the source of funds would be "income from the business/organization." In opening the account petitioner agreed that any dispute relating to the UBS account would be submitted to arbitration.

After petitioner opened the UBS account, one of Mr. Frankel's partners discussed auction rate securities with him.⁵ After learning about these securities, petitioner deposited $800,000 into the UBS account.⁶ On December 27, 2006, petitioner directed UBS to invest these funds in auction rate securities.

In November 2007 petitioner told Mr. Frankel that he expected to receive a large sum of money from the settlement of the clergy lawsuit. Mr. Frankel told petitioner that the money should be invested in low-risk Treasury bills, but petitioner instead directed that once deposited in the UBS account, the settlement funds were to be invested in auction rate securities, which provide a higher potential return than Treasury bills.

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III. Clergy Lawsuit Settlement and Funds Management

In 2007 the Archdiocese of Los Angeles and other clerical organizations entered into a global settlement under which the payors agreed to pay approximately $660.1 million to resolve the cases of 508 victims of childhood sexual abuse by Catholic clergy. On July 11, 2007, as part of this global settlement, petitioner appeared at an informal settlement conference in the Superior Court of California of the County of Los Angeles (Los Angeles County Superior Court) and secured a collective settlement of $12.75 million for his four clients in satisfaction of their pending claims.

To apportion this settlement among the four clients, petitioner prepared documents allocating the funds before attorney's fees were paid, as set out below, according to the level of harm suffered by each client and to which each client agreed.

Client	Settlement allocation
1	$1,590,000
2	1,156,950
3	5,751,329
4	4,251,721
Total	12,750,000

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Petitioner charged Clients 1 and 2 a 60% fee, to which both men agreed and which they never disputed. Petitioner charged the Brothers a 60% fee as well, but the Brothers informed petitioner that they disagreed that this was the appropriate fee amount. Instead, they felt that petitioner was entitled only to a 40%-50% fee based on the timing of the settlement and their respective retainer agreements. The Brothers' concerns, however, did not lead them to arbitrate a fee dispute with petitioner, as their retainer agreement would have required. Nor did petitioner construe their statement regarding his fee as requiring him to submit the issue to arbitration.

IV. Petitioner's Management of the UBS Account After Settlement Funds Were Deposited

After the settlement funds were deposited in the UBS account, petitioner treated the account as if it were a personal account and not an account held in trust for the benefit of his clients. For example, on December 12, 2007, petitioner had an imminent and personal need for liquidity and directed UBS to sell off $1.85 million of the auction rate securities on December 18, 2007, which UBS did. That same day petitioner again contacted UBS and stated that he no longer needed to show liquidity and directed UBS to repurchase the $1.85 million of securities just sold.

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Also on December 18, 2007, petitioner emailed UBS asking for clarification of which auction rate securities were "purchased for my benefit", the "amount of my present holdings, and the interest I have earned to date". Once UBS informed him of the interest earned, petitioner authorized UBS to transfer $50,000 of earned interest to his personal trainer and social acquaintance as a gift. Later, on December 27, 2007, petitioner sent UBS handwritten instructions to transfer $600,000 from the UBS account into his law firm's Bank of America bank account, and UBS transferred the funds that day.

After the new year petitioner continued to use and manage the funds in the UBS account. On January 11, 2008, petitioner withdrew $100,000 from the UBS account and deposited the money into his law firm's Bank of America bank account. On January 29, 2008, petitioner withdrew $1.3 million from the UBS account and deposited the money into another bank account he controlled at California Bank & Trust. On January 29, 2008, petitioner paid Client 1 his portion of the clergy lawsuit settlement funds.

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V. Petitioner's Lawsuit Against UBS, Subsequent Interpleader, and Various Arbitrations

A. Background

In February 2008 the market for auction rate securities froze. This market failure was but one part of the larger financial crisis of 2008. As an international bank, UBS faced significant exposure relating to, among other lines of business, its role in the collapse of the auction rate securities market. By March 2008 the Securities and Exchange Commission (SEC)...