Khan v. Deutsche Bank AG

Decision Date18 October 2012
Docket NumberNos. 112219,112221,112223.,s. 112219
Citation978 N.E.2d 1020,2012 IL 112219,365 Ill.Dec. 517
PartiesShahid R. KHAN et al., Appellees, v. DEUTSCHE BANK AG et al., Appellants.
CourtIllinois Supreme Court

2012 IL 112219
978 N.E.2d 1020
365 Ill.Dec.

Shahid R. KHAN et al., Appellees,
DEUTSCHE BANK AG et al., Appellants.

Nos. 112219, 112221, 112223.

Supreme Court of Illinois.

Oct. 18, 2012.

[978 N.E.2d 1022]

Thomas F. Falkenberg and Benjamin M. Whipple, Williams Montgomery & John Ltd., Chicago, and Kay Nord Hunt, Lommen Abdo, Cole, King & Stageberg, P.A., Minneapolis, Minnesota, for appellant Grant Thornton LLP.

Joel D. Bertocchi and JOshua G. Vincent, Hinshaw & Culbertson, LLP, Chicago, and Theresa Trzaskoma and Adam Hollander, New York, New York, and Christopher Wimmer, San Francisco, California, Brune & Richard, LLP, for appellant David Parse.

[978 N.E.2d 1023]

J. Timothy Eaton and Jonathan B. Amarilio, Shefsky & Froelich Ltd., Chicago, and Allan N. Taffet, Kirk L. Brett and Keith Blackman, Duval & Stachenfeld LLP, New York, New York, for appellants Deutsche Bank AG and Deutsche Bank Securities, Inc.

James D. Green, Thomas, Mamer & Haughey, LLP, Champaign, David R. Deary, J. Dylan Snapp and Carol E. Farquhar, Loewinsohn Flegle Deary, LLP, Dallas, Texas, and David C. Frederick, Brendan J. Crimmins and Emily T.P. Rosen, Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., Washington, D.C., for appellees.


Justice GARMAN delivered the judgment of the court, with opinion.

[365 Ill.Dec. 520]¶ 1 On July 6, 2009, plaintiffs Shahid R. Khan, his wife, Ann C. Khan, and various of their business entities filed a multicount complaint in the circuit court of Champaign County against defendants for losses incurred in connection with a series of investment strategies entered into in 1999 and 2000, a primary purpose of which was to create artificial tax losses for plaintiffs. Instead, the Internal Revenue Service (IRS) disallowed the resulting tax losses and determined that plaintiffs owed back taxes, penalties, and interest. Pertinent to this consolidated appeal, defendants Deutsche Bank AG, Deutsche Bank Securities, Inc., David Parse, and Grant Thornton filed motions to dismiss pursuant to sections 2–615 and 2–619 of the Code of Civil Procedure (Code) (735 ILCS 5/2–615, 2–619 (West 2008)). The section 2–619 motions alleged that plaintiffs' action was time-barred. The trial court granted the motions and entered an order under Supreme Court Rule 304(a), finding no just reason to delay enforcement or appeal of its rulings. Ill. S.Ct. R. 304(a) (eff. Feb. 26, 2010). The appellate court reversed and remanded. 408 Ill.App.3d 564, 350 Ill.Dec. 63, 948 N.E.2d 132. This court granted defendants' petitions for leave to appeal (Ill. S.Ct. R. 315 (eff. Feb. 26, 2010)) and consolidated the cases for review.


¶ 3 Plaintiffs' 11–count complaint sought damages for breach of fiduciary duty, negligence/professional malpractice, negligent misrepresentation, disgorgement, rescission, declaratory judgment, breach of the duty of good faith and fair dealing, fraud, violations of the Illinois Consumer Fraud and Deceptive Business Practices Act, breach of contract, and civil conspiracy. Plaintiffs alleged that defendants, pursuant to a common scheme, advised plaintiffs to undertake certain investment strategies, referred to as the 1999 Digital Options Strategy and the 2000 COINS Strategy. According to plaintiffs, defendants advised them that the investment strategies could yield a substantial profit and also legally minimize plaintiffs' federal and state income tax liability. Plaintiffs alleged that defendants knew or should have known that the investment strategies would not yield such profits or tax benefits because defendants knew that the IRS was investigating the same or substantially similar transactions and had concluded that the transactions were illegal tax shelters. Defendants did not inform plaintiffs of these facts; rather, plaintiffs alleged, defendants' primary motive in pitching their scheme was to exact significant fees and commissions from plaintiffs. Plaintiffs further alleged that they were unknowledgeable and unsophisticated concerning tax laws and tax-advantaged investment strategies and that they relied on their trusted legal, accounting, and tax advisors for comprehensive legal, accounting, tax, and investment advice.

[978 N.E.2d 1024]

[365 Ill.Dec. 521]¶ 4 Following is a brief summary of the factual allegations of plaintiffs' complaint. A fuller statement of the facts is contained in the appellate court opinion.

¶ 5 The 1999 Digital Options Strategy

¶ 6 In 1999, plaintiff Shahid Khan was involved in negotiations to purchase a Canadian company owned by Japanese investors. The investors requested that Khan pay them the sale proceeds in Japanese yen. As Khan had no experience with foreign currency, he sought a referral to any potential advisors with foreign currency trading experience. He was referred to Paul Shanbrom, a tax partner at BDO Seidman (BDO). At a meeting, Shanbrom suggested that Khan invest in the 1999 Digital Options Strategy. Shanbrom advised Khan that BDO's tax professionals had devised tax-advantaged investment plans that would provide an above-average rate of return and minimize tax obligations and that the 1999 Digital Options Strategy was completely legal. Shanbrom recommended defendants David Parse and Deutsche Bank to execute the options, representing that Parse and Deutsche Bank had special expertise in foreign currency investments. He also told Khan that he would receive a legal opinion from an independent law firm that would confirm the propriety of the 1999 Digital Options Strategy, protect Khan in the event of an IRS audit, and prevent the IRS from assessing plaintiffs with penalties in the unlikely event of an audit. Shanbrom recommended the law firm of Jenkens & Gilchrist to provide this opinion. Shanbrom set up a conference call in which he, Khan, and Parse discussed foreign currency trading. During the call, Shanbrom and Parse reiterated what Shanbrom had earlier told Khan about the legality of the 1999 Digital Options Strategy. Neither Shanbrom nor Parse informed Khan that the foreign currency digital options were simply private bets with Deutsche Bank as to where the underlying foreign currencies would be on a particular date and time and that Deutsche Bank controlled the outcome. Plaintiffs alleged that, unbeknownst to them, Deutsche Bank was able to control the outcome of the options because the contract with plaintiffs gave Deutsche Bank the power to choose the particular spot rate it wished to use on the designated date and time. According to plaintiffs, Deutsche Bank designed the options so that they would expire “out of the money” and be rendered worthless. Thus, plaintiffs lost the $350,000 premium they paid to Deutsche Bank, which plaintiffs alleged was defendants' plan all along. Based upon the representations of Shanbrom and Parse, Khan decided to invest in the 1999 Digital Options Strategy. To that end and in accordance with defendants' instructions, Khan formed various legal entities to carry out the investment strategy.

¶ 7 Plaintiffs alleged that defendants made material misrepresentations and omissions on which plaintiffs relied to their detriment and that defendants intentionally deceived plaintiffs for the purpose of persuading them to invest in the 1999 Digital Options Strategy.

¶ 8 We quote below the appellate court's explanation of how the 1999 Digital Options Strategy worked:

“The Khans entered into a private contract with Deutsche Bank whereby the Khans, through SRK Wilshire Investments (Wilshire Investments), bought from Deutsche Bank a long option on foreign currency and sold to Deutsche Bank a short option. Thus, there came into existence an opposing pair of options, one long and the other short. These options were designed to cancel each other out. The strike prices of the two options were only a fraction of a penny apart, and the premium that the [365 Ill.Dec. 522]

[978 N.E.2d 1025]

Khans paid Deutsche Bank for the long option, though large, was almost entirely offset by the premium Deutsche Bank agreed to pay the Khans for the short option (almost but not quite: the Khans paid a net premium to Deutsche Bank of $350,000, the difference between the $35 million that the Khans paid for the long option and the $34,650,000 that Deutsche Bank agreed to pay them for the short option). Because the strike prices of the opposing options were so close together and because Deutsche Bank, as the calculation agent, had the right to select the applicable spot rate from a range of currency rates, it was a virtual certainty that the transaction would be close to a wash—Deutsche Bank would see to that.

So, pursuant to this scheme that was calculated to be a wash on the investment side (and, as we will explain, a loss on the tax side), the Khans formed the necessary business entities and transferred assets between them, all under the guidance of BDO. On November 17, 1999, the Khans formed Wilshire Investments and SRK Wilshire Partners (Wilshire Partners). On November 24, 1999, through Wilshire Investments, the Khans bought and sold the opposing options, which had expiration dates of December 23, 1999. On November 26, 1999, Wilshire Investments contributed its interest in the as-of-yet unexpired options to Wilshire Partners as a capital contribution. On December 10, 1999, Wilshire Partners purchased a quantity of Canadian dollars as an investment. On December 23, 1999, both the long option and the short option terminated ‘out of the money’: the options became worthless, based on the spot rate that Deutsche Bank chose. Of course, both the Khans and Deutsche Bank got to keep the premiums they had paid each other, but Deutsche Bank's premium was $350,000 greater than the premium it had paid to the Khans (or Wilshire Investments). On December 27, 1999, the Khans contributed their interest in Wilshire Partners to Wilshire Investments, causing the dissolution and liquidation of Wilshire Partners. As a distribution in liquidation of Wilshire Partners, all of the...

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