U.S. v. Wexler
| Decision Date | 12 August 1994 |
| Docket Number | No. 93-5719,93-5719 |
| Parties | -5310, 94-2 USTC P 50,361 UNITED STATES of America, Petitioner, v. Victor WEXLER, Respondent, Honorable John W. Bissell, Nominal Respondent. |
| Court | U.S. Court of Appeals — Third Circuit |
Paul A. Weissman (Argued), Edna B. Axelrod, Office of U.S. Atty., Newark, NJ, for petitioner.
Peter B. Bennett (Argued), Picco, Mack, Herbert, Kennedy, Jaffe and Yoskin, Trenton, NJ, for respondent.
BEFORE: GREENBERG AND ROTH, Circuit Judges and POLLAK, District Judge *.
Before us is a petition from the United States for a writ of mandamus or prohibition directed to the Honorable John W. Bissell, United States District Judge for the District of New Jersey. The government's petition arises out of a pretrial order entered in a criminal tax fraud case against Victor Wexler which is to be tried before Judge Bissell. The order adopted a jury instruction on "genuine indebtedness" that, in the government's view, undermines a well-settled prohibition against deducting interest payments resulting from "sham transactions"--i.e. transactions entered into with no purpose other than to generate tax benefits. The government argues that the instruction adopted by the district court is clearly erroneous under settled law, and that the government will be unable to proceed with the present prosecution and will be severely prejudiced in other tax fraud prosecutions if the order remains in force. Wexler, responding to the petition 1, contends that the proposed instruction is a proper statement of the law and that, in any event, the extraordinary appellate intrusion on trial court proceedings sought by the government is unwarranted. We conclude that the petition should be granted.
Between 1980 and 1985, the defendant in the underlying tax prosecution, Victor Wexler, served first as chief financial officer and subsequently as managing partner of McMahan, Brafman, Morgan & Co. ("MBM"), a limited partnership engaged in securities trading. Wexler was initially indicted on March 19, 1992. Subsequently a superseding indictment was filed. The superseding indictment consists of eight counts, and charges Wexler with, under count 1, conspiring (i) to defraud the United States by obstructing the lawful government functions of the I.R.S. in violation of 18 U.S.C. Sec. 371, and (ii) to aid and assist in the preparation of false tax returns in violation of 26 U.S.C. Sec. 7206(2); under count 2, aiding and assisting in the preparation of a U.S. Partnership Income Return, Form 1065, for MBM, for calendar year 1984, which falsely represented that MBM had incurred a loss of $75,491,898, in violation of 26 U.S.C. Sec. 7206(2); under count 8, making and subscribing a joint individual income tax return, Form 1040, falsely representing that Wexler was entitled to a deduction of $103,928 flowing from his MBM partnership interest, in violation of 26 U.S.C. Sec. 7206(1); under counts 3-7, aiding and assisting in the preparation by others of joint individual income tax returns, Form 1040, falsely representing that the taxpayers were entitled to deductions flowing from their MBM partnership interests, in violation of 26 U.S.C. Sec. 7206(2). Superseding Indictment, Appendix ("App.") at 5-21. The superseding indictment alleges that Wexler created over $160 million in fraudulent tax deductions for the MBM partnership from 1982 through 1986. According to the superseding indictment, the allegedly fraudulent deductions were the product of financial arrangements known as "repo to maturity" transactions.
"Repo" transactions: In order to be able to parse the charges against Wexler one needs to have a general understanding of what "repo" transactions are and how they work. In its brief in this court, as in its submissions to the district court, the government has described and provided examples of such transactions and their mechanics. Government Br. at 5-15. Since Wexler's brief does not quarrel with the government's exposition, we rely upon that exposition in this section of this opinion.
The word "repo" is an abbreviation for "repurchase agreement", the name given to a type of transaction commonly employed by Firm A sells Treasury notes with a face value of $1,000,000 to Firm B; the price paid by B to A--the "repo principal"--is a negotiated figure presumably geared to the market value of the notes at the date of sale; A concurrently contracts with B to buy the notes back at the same price at an agreed future date--e.g. thirty days or sixty days hence--which is earlier than the maturity date of the notes; on that future date B returns the securities to A, A repays the repo principal, and A also pays "repo interest", a sum negotiated along with the repo principal at the outset of the transaction, and presumably geared to the short-term interest rate then governing loans for the particular time-period--thirty days, or sixty days, or whatever--covered by the transaction.
firms dealing in government securities. The transaction--which may be consummated in a matter of days but may also span weeks or even a few months--is a sale of government securities, such as treasury notes, by one securities dealer to another, followed by their repurchase at a later date. But what is in form a sale and repurchase turns out in fact to constitute a loan for which the securities, during the interval between sale and repurchase, stand as collateral. An example may serve to illustrate how such a transaction works:
The extent to which the "repo" turns out to be financially advantageous to A depends on what happens, during the course of the transaction, to (a) the market value of the securities, and (b) short-term interest rates. A hopes that, at the transaction's closing date, the reacquired securities will be worth more and short-term interest rates will be lower than when the transaction began. Under that fortunate combination of circumstances A would have the capability of entering into a second repo on substantially more favorable terms than the first. 2
The particular repo just described is one in which, as already noted, the transaction terminates on a date, agreed upon by the parties, which is earlier than the maturity date of the securities. That transaction is called an "open repo". If the repo's date of termination is the maturity date--the date on which the Treasury pays to the securities-holder the face value of the securities plus accrued coupon interest--the transaction is called a "repo-to-maturity". This litigation involves the tax consequences of repo-to-maturity transactions.
At its commencement a repo-to-maturity looks like an open repo, in the sense that A(a) transfers its Treasury securities to B in exchange for an agreed sum of repo principal and (b) promises that at the maturity date it will pay B an agreed amount of interest. But at that point the resemblance to an open repo ends. For, in a repo-to-maturity, A will not, at the maturity date, recover the securities it has transferred to B. The securities will have matured, and in lieu thereof B will pay A what the Treasury owes B as securities-holder--namely, the face value of the securities plus the accrued coupon interest.
In contrast with the open repo, in which A's profit or loss turns on what happens to the market value of the securities and to short-term interest rates while the transaction is pending, the repo-to-maturity dictates ex ante the payout at maturity. Indeed, from a profitability perspective A has no occasion to enter into a repo-to-maturity unless the coupon interest A will receive at maturity exceeds the interest it will, at the inception of a repo-to-maturity, have to obligate itself to pay to B at maturity. If coupon interest is equal to or less than the market interest rate prevailing at the time A is considering a repo-to-maturity, A would normally eschew the repo-to-maturity and either (a) hold the securities until they mature, or (b) sell them outright.
In this case, the government alleges that MBM, the firm of which defendant Wexler was, variously, chief financial officer and managing partner, entered into numerous repo-to-maturity transactions, designed by Wexler, in which MBM agreed to pay out, and in fact did pay out, more in market interest than it received in coupon interest. Moreover, according to the government's allegations Key to the effectuation of the scheme as described by the government was that the repo-to-maturity period was constructed to span two tax years. In the hypothetical example proffered by the government to the district court, and renewed in its brief to this court, the three-month repo-to-maturity transaction would run from November 1 in the first tax year, the date on which the securities were purchased and immediately repoed, to February 1 in the second tax year, the date on which the securities were to mature. This calendar arrangement would make it possible for the interest owed in November and December to be treated as a deductible expense in the first tax year, while the November-December-January coupon interest--partially offset by the January interest payment--would not need to be reported as income until the second tax year. Although in the aggregate two months of interest deductions in the first tax year would appear to be balanced by two months of interest income in the second tax year, the apparent symmetry is illusory from a revenue standpoint: it would not be until the filing of the return for the second tax year that the government would recoup the taxes not paid in the first tax year, with the result that the government would for a year lose the use of the sum ultimately recouped. 4
it was part of Wexler's design that his firm purchase the securities and "repo" them simultaneously. The entire purpose of the transaction, so the...
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