Jeppsen v. C.I.R.

• Decision Date: 31 October 1997
• Docket Number: No. 96-9002,96-9002
• Citation: 128 F.3d 1410
• Parties: -7710, 97-2 USTC P 50,878, 97 CJ C.A.R. 2732 Harv L. JEPPSEN, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1410

128 F.3d 1410

80 A.F.T.R.2d 97-7710, 97-2 USTC P

50,878, 97 CJ C.A.R. 2732

Harv L. JEPPSEN, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 96-9002.

United States Court of Appeals Tenth Circuit.

Oct. 31, 1997.

Bill Thomas Peters, Parsons, Davies, Kinghorn & Peters, Salt Lake City, UT, for Petitioner-Appellant.

Sarah K. Knutson, United States Department of Justice, Washington, DC (Teresa E. McLaughlin, United States Department of Justice, Washington, DC, with her on brief), for Respondent-Appellee.

Before EBEL, Circuit Judge, McWILLIAMS, Senior Circuit Judge, and KELLY, Circuit Judge.

EBEL, Circuit Judge.

In 1987, a stockbroker misappropriated $194,000 from petitioner-appellant Harv L. Jeppsen. Jeppsen claimed a deduction for this theft loss on his 1987 federal income tax return. In 1988, Jeppsen began a seven-year litigation campaign to recover his stolen money. In 1992, respondent-appellee Commissioner of Internal Revenue ("the IRS") disallowed Jeppsen's 1987 theft loss deduction, on the grounds that it was reasonably foreseeable by the end of 1987 that Jeppsen would recover the stolen money. Shortly thereafter, Jeppsen challenged this disallowance in tax court.

In March, 1995, Jeppsen's campaign to recover his stolen money achieved fruition, when Jeppsen was awarded almost $1,500,000 in general and punitive damages, interest, attorney's fees, and costs. Four months later, after learning of this award, the tax court agreed with the IRS that Jeppsen was not entitled to the theft loss deduction claimed on his 1987 tax return. Jeppsen appeals the decision of the Tax Court. Because we find that as of December 31, 1987, it could not be ascertained with reasonable

certainty that Jeppsen would not recover his stolen money, we affirm.

BACKGROUND

The facts of the present case are largely undisputed. In February or March of 1986, appellant Harv L. Jeppsen, a self-employed carpet installer and high school graduate, began investing money through George Barker, a securities dealer with the E.F. Hutton Group brokerage firm. Jeppsen v. Commissioner, 70 T.C.M. (CCH) 199, 199, T.C.M. (RIA) p 95,342 (1995), T.C. Mem. No.1995-342, 1995 WL 440435. At that time, Jeppsen had no prior experience investing in stocks or stock options.

Barker, who knew that Jeppsen was not experienced or sophisticated in securities investments, fraudulently established Jeppsen's E.F. Hutton account as a discretionary account in order to authorize Barker to transact securities trades in the account. Shortly thereafter, Barker began to "churn" Jeppsen's investments by purchasing and selling various call options.

In September, 1986, Barker left E.F. Hutton and began working at the brokerage securities firm of Piper, Jaffray and Hopwood, Inc. ("PJ & H"). In December, 1986, Jeppsen transferred his E.F. Hutton account to PJ & H so that Barker could continue to act as his broker. At that time, Barker fraudulently obtained Jeppsen's signature on documents needed to open a PJ & H margin account in Jeppsen's name. In addition, without Jeppsen's permission and without ever obtaining Jeppsen's signature, Barker established Jeppsen's primary PJ & H account as a discretionary account. Barker then invested much of the money in this account in certain "penny stocks" whose price was manipulated by Barker and an accomplice through repeated purchases and sales.

In July, 1987, Jeppsen became aware of Barker's activities, and ordered Barker to close his margin account immediately. Barker failed to close the account. When Jeppsen received his next monthly statement indicating that the margin account had not been closed, Jeppsen again ordered Barker to close the margin account. Barker again failed to close the account, and continued to execute new transactions in the account.

On October 7, 1987, Jeppsen specifically instructed Barker to immediately liquidate to cash the entire balance of Jeppsen's PJ & H account, except for a mutual fund. Barker did so slowly, forging Jeppsen's signature when necessary to liquidate certain high-risk derivative investments that Jeppsen had never authorized him to make.

On October 19, 1987, a date popularly known as "Black Monday," the Dow Jones Industrial Average decreased in value by 22.6 percent. As a result, Jeppsen's PJ & H account, which had not yet been liquidated, declined in value by approximately $194,000.

The following week, Jeppsen met with PJ & H's branch manager and Barker's supervisor, Don Larkin, to discuss the losses Jeppsen had suffered in his PJ & H account. Larkin initially told Jeppsen that because of the large negative balance in Jeppsen's margin account all securities in his discretionary account would have to be sold to pay Jeppsen's debt to PJ & H. When Jeppsen protested that the trading losses had been caused by Barker's unauthorized activities in Jeppsen's name, Larkin admitted to Jeppsen that Barker's activities had been improper. Larkin then formally reprimanded Barker for the unauthorized discretionary trading in Jeppsen's PJ & H account. Nonetheless, Larkin denied that PJ & H was liable in any way for Barker's actions.

At the end of October, 1987, Jeppsen retained an attorney to investigate Barker's actions with regard to Jeppsen's brokerage accounts at E.F. Hutton and PJ & H. This attorney's inquiries spurred PJ & H's legal counsel to send Jeppsen a letter dated December 21, 1987. The letter denied that PJ & H was in any way responsible for Jeppsen's losses in his PJ & H account, and claimed that Jeppsen was merely a frustrated investor who had lost money as a result of the October 19, 1987 fall in the stock market.

In December, 1987, a Salt Lake City law firm agreed to represent Jeppsen in an action to recover his losses, but required Jeppsen to pay on an hourly rather than contingency fee basis. The law firm told Jeppsen that he had a chance to win, but that the lawsuit would be long and costly. Jeppsen On March 5, 1988, Jeppsen filed suit against Barker, PJ & H, and E.F. Hutton in federal district court in Utah. Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F.Supp. 1130, 1132-33 (D.Utah 1995). On May 9, 1988, PJ & H moved to stay proceedings pending arbitration and to compel arbitration.

responded that he would nonetheless like to proceed with some type of legal action.

In July, 1988, while PJ & H's motion was under consideration by the district court, Jeppsen filed his 1987 federal income tax return. On his return, Jeppsen claimed a theft loss deduction in the amount of $166,627 relating to the losses he incurred in 1987 in his E.F. Hutton and in his PJ & H brokerage accounts. ¹

On December 26, 1989, the district court granted PJ & H's motion to stay proceedings pending arbitration and to compel arbitration. Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F.Supp. 1130, 1133 (D.Utah 1995). On December 11, 1991, Jeppsen settled his claims against E.F. Hutton. Around that time, and after Jeppsen had already paid them $180,000, Jeppsen's law firm changed its fee arrangement to a contingency basis.

On August 31, 1992, the IRS mailed Jeppsen a Notice of Deficiency regarding Jeppsen's 1987 federal income tax. (R. Vol. III Doc. J Exh. 2-B). The claimed deficiency of $61,297.78 ² resulted from the IRS's disallowance of Jeppsen's $166,627 theft loss deduction. The IRS disallowed the deduction on the ground that Jeppsen had a reasonable prospect of recovering his loss as of the close of 1987. On November 25, 1992, pursuant to I.R.C. § 7442, Jeppsen filed a petition in the United States Tax Court, challenging the Notice of Deficiency.

On March 17, 1993, before his tax case was tried, Jeppsen filed his Statement of Claim with the National Association of Securities Dealers, which was to preside over the compelled arbitration against Piper, Jaffray and Barker & Larkin. Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F.Supp. 1130, 1133 (D.Utah 1995). A five-day arbitration hearing was held in November, 1993 in Salt Lake City, Utah. On January 20, 1994, the arbitration panel awarded Jeppsen damages of $603,000 (treble damages) plus attorneys' fees and costs of $388,541.55 against PJ & H, Barker, and Larkin, jointly and severally, plus $250,000 each in punitive damages against Larkin and Barker separately and individually. This award, however, was subject to appeal to the federal district court which had ordered the arbitration.

On March 17, 1994, Jeppsen's challenge to the IRS's Notice of Deficiency was tried before the United States Tax Court in Salt Lake City, Utah. At that proceeding, the tax court was apprised that Jeppsen had won an award from the arbitration panel, but that the award was not final because the arbitration defendants still had until April 18, 1994 to appeal the award to the district court. ³ At the conclusion of the two-hour hearing, the tax court requested further briefing from the parties and took the case under advisement.

On March 6, 1995, while Jeppsen's tax case was still under advisement, the arbitration panel's award in Jeppsen's case against PJ & H, Barker, and Larkin was confirmed by the United States District Court for the District of Utah. Jeppsen v. Piper, Jaffray & Hopwood, Inc., 879 F.Supp. 1130, 1140 (D.Utah 1995). The defendants appealed to the Tenth Circuit, but settled the case in June, 1995, before the appeal was heard. Jeppsen v. Commissioner, 70 T.C.M. (CCH) 199, 201, T.C.M. (RIA) p 95,342 (1995), T.C. Mem. No.1995-342; (Aplt.'s App. at 74). The details of the settlement were confidential.

Shortly thereafter, an IRS attorney notified Jeppsen that the tax court had inquired as to whether a settlement had been reached On July 24, 1995, the tax court denied Jeppsen's Motion to Strike. In a brief Order, the court stated that it had requested information regarding the current status of Jeppsen's lawsuits "solely for purposes of completeness." It also noted that "the terms of the settlement of the lawsuit...