Swartz v. Kpmg Llp

Decision Date12 February 2007
Docket NumberNo. 05-35167.,05-35167.
Citation476 F.3d 756
PartiesTheodore C. SWARTZ, Plaintiff-Appellant, v. KPMG LLP, Defendant, and Presidio Advisory Services Inc.; Deutsche Bank AG; Deutsche Bank Securities, Inc., Defendants-Appellees.
CourtU.S. Court of Appeals — Ninth Circuit

Philip A. Talmadge, Anne E. Melley, Talmadge Law Group, Tukwila, WA, Brian G. Isaacson, The Isaacson Law Firm, Seattle, WA, for the plaintiff-appellant.

David H. Smith, Garvey Schubert Barber, Seattle, WA, Lawrence M. Hill, Seth C. Farber, Dianne F. Coffino, Dewey Ballantine LLP, New York, NY, for defendants-appellees Deutsche Bank AG and Deutsche Bank Securities, Inc.

Stephen C. Willey, Savitt & Bruce LLP, Seattle, WA, Steven M. Bauer, Karli E. Sager, Latham & Watkins LLP, San Francisco, CA, for defendant-appellee Presidio Advisory Services, Inc.

Appeal from the United States District Court for the Western District of Washington; Marsha J. Pechman, District Judge, Presiding. D.C. No. CV-03-01252-MJP.

Before DOROTHY W. NELSON and RICHARD A. PAEZ, Circuit Judges, and EDWARD RAFEEDIE,* District Judge.



This suit arises out of a failed tax shelter, which defendants allegedly sold to plaintiff-appellant Theodore Swartz, charging over a million dollars, even though they knew the scheme would be considered unlawful by the IRS. Among the named defendants were accounting firm KPMG, law firm Sidley Austin Brown & Wood ("B & W"), Deutsche Bank AG and Deutsche Bank Securities (collectively "DB" or "Deutsche Bank"), and Presidio Advisory Services ("Presidio"). Against all defendants, Swartz asserted claims (1) under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1964, (2) under the Washington Consumer Protection Act ("WCPA"), Wash. Rev. Code § 19.86.010 et seq., (3) for commonlaw fraud, and (4) for civil conspiracy. Swartz also sought a judicial declaration of defendants' liability for interest and penalties that might have arisen during an IRS audit, incomplete at the time he filed his lawsuit. Swartz advanced separate claims against KPMG and B & W for breach of contract, breach of fiduciary duty, and professional malpractice. In a published order,1 the district court dismissed all causes of action against Presidio and DB concluding both that Swartz's complaint failed to state any claims upon which relief could be granted and that it contained insufficient allegations to establish personal jurisdiction.2 Swartz sought leave to cure the substantive and jurisdictional defects in the complaint and to add alternative securities fraud claims. Believing amendment would be futile and that the request was procedurally improper, the district court denied leave to amend. Swartz appeals each of these rulings.3

With the exception of its holding that the allegations in the complaint ruled out "reasonable reliance" as a matter of law, the district court did not err in Swartz I and we adopt its decision in large measure. Specifically, we affirm the district court's dismissal with prejudice of the RICO and WCPA claims as well as the request for declaratory relief because each was properly resolved on grounds independent of the reasonable reliance inquiry and because amendment would be futile in each case.

However, we reverse the district court's denial of leave to amend the common-law fraud and conspiracy claims. Whether Swartz could demonstrate reasonable reliance on defendants' alleged misrepresentations was not properly settled as a matter of law under the allegations in the complaint. Furthermore, even if the original complaint otherwise failed to satisfy the heightened pleading requirements of Federal Rule of Civil Procedure 9(b), it would not have been futile for Swartz to amend. Additionally, although the original complaint failed to allege sufficient jurisdictional facts, Swartz should have been given an opportunity to cure this defect through amendment. Finally, Swartz should have been granted leave to add alternative claims for securities fraud.

A. Factual Allegations4

In 1999, Swartz sold a business and realized an approximately $18 million gain representing potentially taxable income. KPMG approached Swartz and "lured" him into purchasing a tax-reduction product called BLIPS (Bond Linked Issue Premium Structure), represented as a strategy that would allow Swartz to claim a loss sufficient to offset his capital gain. KMPG advised Swartz of the possibility of an audit, but assured him that KPMG and law firm B & W would provide tax "opinion letters" testifying to the legitimacy of the scheme to the satisfaction of the IRS. According to the complaint, the BLIPS transactions had been devised by KPMG and B & W as a means of charging unwarranted and excessive fees to a "`select audience' of individuals who had sold large businesses or otherwise incurred large capital gains." Swartz alleged Presidio and DB "were active participants in the conspiracy" and "knew that the series of BLIPS transactions were predetermined steps to generate sham losses for the purpose of obtaining tax benefits." Swartz further alleged that Presidio and DB knew that KPMG and B & W promoted the BLIPS transactions through the allegedly fraudulent representations outlined above and that the defendants acted in concert and as mutual agents.

In fall 1999, Swartz entered into various BLIPS-related contracts including an "engagement letter," executed September 4, 1999, between himself and KPMG. The letter outlined KPMG's role in the transactions, disclosed that the IRS might question the BLIPS losses, and stated that KPMG "would not guarantee tax results, but would provide that ... there is a greater than 50 percent likelihood ... that [the promised tax benefits] would be upheld if challenged by the[IRS]." Despite this caveat, Swartz alleged that he reasonably relied on KPMG's oral representations that BLIPS would succeed in eliminating his income tax liability.

The transactions comprising the BLIPS strategy occurred between September 30 and December 13, 1999. Because the details are largely irrelevant, they are recounted here in very rough form. KPMG and Presidio facilitated the extension of a multi-million dollar line of credit from DB to Swartz. Swartz created a new limited liability company, Longs Strategic Investment Fund ("Longs"), and engaged Presidio as its manager. The credit facility was contributed to Longs. Longs held various assets including a number of shares of Microsoft common stock. After engaging in two foreign currency transactions intended to give Longs the appearance of a legitimate business, Presidio directed that Longs be dissolved. On December 13, 1999, the company was dissolved and the Microsoft stock was transferred to Swartz as part of his ownership assets.

The intended effect of these transactions was to artificially inflate Swartz's basis in the Microsoft stock so that he could sell it and claim a capital "loss" in the amount of the difference between his inflated basis and the value of the stock. In this case, KPMG represented that "the sale of 364 shares of Microsoft stock would trigger a purported 1999 capital loss of [approximately $18 million]." Swartz paid significant fees to defendants to implement these transactions including a $550,000 management fee to Presidio and more than $800,000 in fees and interest to DB.

According to the complaint, on December 27, 1999, the IRS issued a notice concluding that BLIPS did not produce bona fide losses for income tax purposes. Nevertheless, on December 31, 1999, KPMG and B & W issued opinion letters that purported to confirm the propriety of the scheme.

On August 25, 2000, before Swartz filed his 1999 tax return, his independent tax preparation firm, Moss Adams, questioned the validity of the scheme, informing Swartz it believed the IRS would consider the BLIPS losses to be improper. On September 5, 2000, the IRS issued an additional notice reiterating its opinion that BLIPS losses were illegitimate and warning that criminal penalties might attach to individuals who attempted to use them on their tax returns. On October 4, KPMG advised Swartz that the promised tax benefits might be disallowed by the IRS. In response, Swartz sought recision of the BLIPS agreements and a monetary refund. The defendants refused. On October 10, Moss Adams resigned from its engagement. KPMG then assisted Swartz in preparing his 1999 return, which reflected deductions for BLIPS "losses."

At some point thereafter, the IRS commenced an audit of Swartz's 1999 tax return.5 Swartz did not amend his 1999 tax return in 2001 or 2002.

On February 21, 2002, KPMG informed Swartz that it was under IRS investigation in connection with the BLIPS scheme and that the IRS had announced an amnesty from certain penalties for individual tax filers who disclosed their involvement. KPMG advised Swartz to make a full disclosure to the IRS. B & W sent a similar letter on March 5. The complaint does not indicate whether Swartz took advantage of the IRS initiative.

B. Proceedings Below

On June 6, 2003, Swartz initiated this lawsuit. On February 13, 2004, the district court issued Swartz I granting several Federal Rule of Civil Procedure 12(b)(6) motions including Presidio's and DB's. As to each cause of action, the court held there was no conceivable set of facts which could justify relief and dismissed with prejudice. The court also found Swartz had not met his burden of pleading personal jurisdiction and dismissed Presidio and DB from the lawsuit under Rule 12(b)(2). The court added, "[b]ecause[Presidio and DB] were only named in regard[ ] to causes of action which are being dismissed with prejudice, there is no point in permitting plaintiff to amend and plead sufficient jurisdictional facts." Swartz I, 401 F.Supp.2d at 1149.

On March 9, 2004, Swartz sought leave to amend. In support, he proposed an amended complaint adding...

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