US v. Regan

• Citation: 726 F. Supp. 447
• Decision Date: 27 November 1989
• Docket Number: No. S 88 Cr. 517 (RLC).,S 88 Cr. 517 (RLC).
• Parties: UNITED STATES of America, v. James Sutton REGAN, Charles M. Zarzecki, Jack Z. Rabinowitz, Paul Berkman, Steven Barry Smotrich, Bruce Lee Newberg, Defendants.
• Court: U.S. District Court — Southern District of New York

726 F. Supp. 447

UNITED STATES of America, v. James Sutton REGAN, Charles M. Zarzecki, Jack Z. Rabinowitz, Paul Berkman, Steven Barry Smotrich, Bruce Lee Newberg, Defendants.

No. S 88 Cr. 517 (RLC).

United States District Court, S.D. New York.

November 27, 1989.

Otto G. Obermaier, U.S. Atty. S.D. New York, New York City, for U.S.; Mark C. Hansen, Neil Cartusciello, Peter G.A. Safirstein, Asst. U.S. Attys., of counsel.

Lowenstein Sandler Kohl Fisher & Boylan, Roseland, N.J., for defendant Regan; Theodore V. Wells, of counsel.

Morvillo, Abramowitz & Grand, P.C., New York City, for defendant Zarzecki; Paul Grand, Diana Parker, Lawrence S. Bader, of counsel.

Newman and Schwartz, New York City, for defendant Rabinowitz; Robert Hill Schwartz, of counsel.

Robinson Wayne & LaSala, Newark, N.J., for defendant Berkman; John D. Arseneault, of counsel.

Hayden, Perle and Silber, New York City, for defendant Smotrich; Joseph A. Hayden, Jr., Alan Silber, Paulette L. Pitt, of counsel.

Gerald B. Lefcourt, P.C., New York City, for defendant Newberg; Gerald B. Lefcourt, Joshua Dratel, of counsel.

Goldman & Hafetz, New York City, for defendant Newberg; Frederick P. Hafetz, Jeremy Gutman, Susan Necheles, of counsel.

ROBERT L. CARTER, District Judge.

Defendants James Sutton Regan, Jack Z. Rabinowitz, Charles M. Zarzecki, Paul A. Berkman, Steven B. Smotrich and Bruce Lee Newberg were brought to trial on June 19, 1989, on a superseding indictment charging conspiracy to commit securities, mail and wire fraud, to maintain false books and records, and to file fraudulent tax returns; substantive securities, mail and wire fraud, and tax violations; a RICO conspiracy; and substantive RICO violations. Defendants, except for Bruce Lee Newberg, are general partners or executives in Princeton/Newport Partners, L.P. ("PNP"). Newberg was a trader in the High Yield and Convertible Bond Department of Drexel Burnham Lambert, Inc. ("Drexel") in Beverly Hills, California. Prior to trial the court dismissed counts 49, 50 and 51, and predicate act 9 of the RICO counts. United States v. Regan, 713 F.Supp. 629 (S.D.N.Y.1989) (Carter, J.).¹ The indictment was then redacted and the remaining counts renumbered. The trial was bifurcated, with the jury being required to determine first defendants' guilt or innocence. When and if the jury returned verdicts of guilty on the RICO counts, proof and argument relevant to RICO forfeiture were then to be presented for the jury's determination.

Following the completion of the evidentiary phase of the trial but before submission to the jury, newly numbered counts 52, 53, 54 and 55 of the superseding indictment were dismissed. The remaining 64 counts were renumbered in a second redaction of the superseding indictment and presented to the jury on July 27, 1989. On July 31, 1989, the jury returned verdicts of guilty on all counts except count 54, which charged defendants Zarzecki and Newberg with securities fraud in connection with an April 15, 1985 transaction involving C.O. M.B. ("COMB") securities.

On August 1, 1989, proceedings to determine the RICO forfeitures commenced. The government submitted a stipulation listing the defendants' partnership shares, salaries and Newberg's W-2 forms for 1984-1986, and a redacted copy of Drexel's plea agreement.² Smotrich presented an affidavit attesting to the comparability of his salary to those of other officials in the industry performing his functions, and Newberg offered copies of his 1984-1985 tax returns. Defendants and the government then presented arguments to the jury on the forfeiture question. After deliberations, the jury found the government had sustained its burden of proof beyond a reasonable doubt that Regan, Rabinowitz, Zarzecki and Berkman had partnership interests in the enterprise, and that these defendants and Smotrich and Newberg had salaries and management fees. It determined the amount to be forfeited as follows: Regan $3 million, Rabinowitz, Berkman and Newberg $200,000 each, and Smotrich $1,245.85.

Defendants, as a group, now move for judgments of acquittal or a new trial. In addition, separate motions to this effect have been filed by Smotrich, Newberg and Zarzecki. A supplemental letter motion seeking dismissal of the RICO counts has been filed on behalf of all defendants. The government contends that the jury was required to order forfeiture of all defendants' interests in PNP and all fees (management and salary) received therefrom by any defendant, and moves to enforce mandatory forfeiture of all defendants' interests in the enterprise and all of their salaries and/or management fees received therefrom.

I.

A.

Defendants spend considerable effort arguing that the tax parks were valid transactions, even on the assumption "that sales and purchases were prearranged, not subject to market risk and solely tax motivated."³ Defendants' Memorandum in Support of Motion for Judgments of Acquittal or for a New Trial ("Def. Mem. for Acquittal") at 2. Viewing the evidence in the light most favorable to the government, as the court must, United States v. Martino, 759 F.2d 998, 1002 (2d Cir.1985), the jury had sufficient evidence to conclude that the tax parks were not bona fide sales or transfers but sham transactions with no possible gains or losses to PNP except the minimum administrative fees charged by the accommodating brokerage firm for holding the securities and returning them back to PNP at the end of the agreed upon period. As I understand the controlling law of this circuit, since these tax parks were not subject to market or other economic risks and were bogus purchases and sales in which the purported seller retained its proprietary interest in the security which had been allegedly bought by the accommodating brokerage firm, the transactions were mere pretenses and a fraud on the government. United States v. Atkins, 869 F.2d 135, 146 (2d Cir.), cert. denied, ___ U.S. ___, 110 S.Ct. 72, 107 L.Ed.2d 39 (1989); United States v. Ingredient Technology Corp., 698 F.2d 88, 94-95 (2d Cir.), cert. denied, 462 U.S. 1131, 103 S.Ct. 3111, 77 L.Ed.2d 1366 (1983).

Defendants point out that what constitutes a "bona fide sale" is often a matter of debate and that a taxpayer is allowed to take a tax position, even if the taxpayer realizes that such position is unlikely to receive a favorable ruling, so long as a "reasonable basis" exists for such position. This is a correct statement of tax law, but misses the point. This is not a case about an honest effort to advance a tax argument unlikely to succeed. The jury found that defendants had fraudulent intent, and, therefore, the claim that there was a "reasonable basis" for defendants' tax position was rejected. Unless the jury's finding lacks substantial evidence to support it, United States v. Wiley, 846 F.2d 150, 153 (2d Cir.1988); United States v. Buck, 804 F.2d 239, 242 (2d Cir.1986), it remains undisturbed.

Defendants also make much of the fact that PNP was a profitable investment company which held securities that had declined in market value, and was not simply a tax-shelter factory. While this is true, it again misses the point. Defendants ignore the fact that the jury found them to have fraudulent intent in respect of the tax parks, and, therefore, statements about the bona fides of their business operations as a whole are irrelevant.

As they did at trial, defendants undertake a sophistical treatment of 26 U.S.C. § 1058 (1988) to support their unsound position. Section 1058 and the regulations thereto⁴ provide rules for the income tax treatment of securities lending transactions. If the provisions of § 1058 and the regulations are met, the lender does not recognize a gain or loss on the transfer of securities or the return of identical securities. In order to meet § 1058 requirements,⁵ there must be an agreement which: (1) provides for the return of identical securities to the transferor; (2) requires that payments be made to the transferor in amounts equivalent to all interest and dividends paid on the lent securities; (3) does not reduce the risk of loss or opportunity for gain of the transferor of the securities, and, therefore, such agreement must provide that the lender may terminate the loan upon notice of not more than five business days.

Defendants argue that § 1058 draws a bright line between sales and loans of securities, and that under § 1058 the transactions in question should be treated as bona fide sales. Def. Mem. for Acquittal at 13. In particular, defendants argue that in the absence of a right to reacquire securities within five business days and a written loan agreement, a transaction in which securities change hands is a bona fide sale as a matter of law. Id. at 14-16.

Although no cases or rulings could be found which interpret § 1058, the relevant legislative history is contained in Senate Report No. 95-762 (April 25, 1978) (reprinted at 1978 U.S.Code Cong. & Admin.News 1286). According to the Senate Report, § 1058 was enacted because of uncertainty regarding securities lending transactions. Id. at 1289. Apparently, the I.R.S. had declined to issue rulings as to whether securities lending transactions constituted a sale or exchange, and consequently there was some concern that transactions intended to be loans would be classified as sales. Id. at 1290. This concern discouraged the holders of securities from making such securities available for loans to brokers. Id. at 1289.

Because "it is generally thought to be desirable to encourage organizations and individuals with securities holdings to make the securities available for such loans since the greater the volume of securities available for loan the less frequently will brokers fail to deliver a security to a purchaser within the time required by the relevant market rules," § 1058 was enacted to encourage the lending of securities to brokers to enable them to make timely deliveries of securities to purchasers. Id...