Dixon v. Commissioner
This text of 1999 T.C. Memo. 101 (Dixon v. Commissioner) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
An appropriate order will be issued and decisions will be entered in docket Nos. 9382-83, 4201-84, 15907-84, 40159-84, 22783- 85, 30010-85, 30979-85, and 29643-86.
An appropriate order will be issued in docket Nos. 17646- 83, 7323-84, 20119-84, 35608-86, 19464-92, 621-94, 7205-94, 9532-94, 17992-95, and 17993-95.
In
The Court granted R's motions to vacate the decisions entered in the T and C cases, entered revised decisions in the T and C cases consistent with R's prior agreements with T and C, denied R's motion to vacate the decision in the X case, and denied R's request for an evidentiary hearing on the ground that the testimony, stipulated facts, and exhibits relating to the T and C cases had no material effect on the Court's opinion as it related to the remaining test case Ps.
On appeal, the Court of Appeals for the Ninth Circuit vacated the decisions in the remaining test cases and remanded them to this Court with directions "to conduct an evidentiary hearing to determine the full extent of the admitted wrong done by the government trial lawyers."
Ps argue (under various theories) that the Court's decisions in the remaining test cases should not be reinstated, or, in the alternative, that the piggyback agreements are not enforceable. R counters that the decisions in the remaining test cases should be reinstated on the ground that Ps were not prejudiced by the Government misconduct in the trial of the test cases and that the piggyback agreements remain in force.
HELD: The Government misconduct in the trial of the test cases did not result in a structural defect in the *121 trial. HELD FURTHER: The Government misconduct in the trial of the test cases resulted in harmless error. HELD FURTHER: The Government misconduct in the trial of the test cases does not provide any other basis for invalidating the Court's decisions in the remaining test cases or for setting aside the piggyback agreements. HELD FURTHER: As a sanction against R, program participants who have not been the subject of a final determination are not liable for time-sensitive additions to tax for negligence under
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An appropriate order will be issued and decisions will be entered in docket Nos. 9382-83, 4201-84, 15907-84, 40159-84, 22783- 85, 30010-85, 30979-85, and 29643-86.
An appropriate order will be issued in docket Nos. 17646- 83, 7323-84, 20119-84, 35608-86, 19464-92, 621-94, 7205-94, 9532-94, 17992-95, and 17993-95.
In
The Court granted R's motions to vacate the decisions entered in the T and C cases, entered revised decisions in the T and C cases consistent with R's prior agreements with T and C, denied R's motion to vacate the decision in the X case, and denied R's request for an evidentiary hearing on the ground that the testimony, stipulated facts, and exhibits relating to the T and C cases had no material effect on the Court's opinion as it related to the remaining test case Ps.
On appeal, the Court of Appeals for the Ninth Circuit vacated the decisions in the remaining test cases and remanded them to this Court with directions "to conduct an evidentiary hearing to determine the full extent of the admitted wrong done by the government trial lawyers."
Ps argue (under various theories) that the Court's decisions in the remaining test cases should not be reinstated, or, in the alternative, that the piggyback agreements are not enforceable. R counters that the decisions in the remaining test cases should be reinstated on the ground that Ps were not prejudiced by the Government misconduct in the trial of the test cases and that the piggyback agreements remain in force.
HELD: The Government misconduct in the trial of the test cases did not result in a structural defect in the *121 trial. HELD FURTHER: The Government misconduct in the trial of the test cases resulted in harmless error. HELD FURTHER: The Government misconduct in the trial of the test cases does not provide any other basis for invalidating the Court's decisions in the remaining test cases or for setting aside the piggyback agreements. HELD FURTHER: As a sanction against R, program participants who have not been the subject of a final determination are not liable for time-sensitive additions to tax for negligence under
[PART 1 OF 2]
SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION
BEGHE, JUDGE: *122 Eight of these consolidated cases -- with five petitioners represented by Joe Alfred Izen, Jr. (Mr. Izen), -- are test cases before the Court on remand from the Court of Appeals for the Ninth Circuit in
The other 10 consolidated cases -- with petitioners in one case represented by Mr. Izen and the other petitioners represented by Robert Alan Jones (Mr. Jones) and Robert Patrick Sticht (Mr. Sticht) -- are nontest cases that have been added to the consolidated group in order to effectuate the direction of the Court of Appeals "to consider on the merits all motions of intervention filed by parties affected by this case."
Unless otherwise indicated, section references are to the Internal Revenue Code, as amended, and Rule references are to the Tax Court Rules of Practice and Procedure.
INTRODUCTION
These consolidated cases are part of a group of more than 1,300 remaining cases -- more than 500 cases have settled -- arising from respondent's disallowance of interest deductions claimed by participants in various tax shelter programs promoted by Henry *123 F.K. Kersting (Mr. Kersting). The Kersting group of cases (hereinafter the Kersting project) was assigned to Judge William A. Goffe (Judge Goffe) for disposition. By agreement of the parties and the Court, the merits of the Kersting programs were to be litigated in a consolidated trial of 14 docketed cases of eight petitioners that had been designated as "test cases". The vast majority of the remaining Kersting project petitioners signed stipulations to be bound (sometimes referred to herein as piggyback agreements) in which they agreed with respondent that their cases would be resolved in accordance with the Court's opinion in the test cases.
Before the trial of the test cases, some test case petitioners argued that a 1981 search of Mr. Kersting's office had been illegal, that materials seized during the search should be suppressed in the test case proceedings, and that the burden of proof and burden of going forward with evidence should be shifted to respondent. In
Judge Goffe held the trial *124 of the test cases in Honolulu, Hawaii, during January 1989. The majority of the test case petitioners were represented at trial by Mr. Izen. However, test case petitioners John R. and Maydee L. Thompson (docket Nos. 19321-83, 31236-84, and 30965-85) were represented at trial by Luis C. DeCastro (Mr. DeCastro), and test case petitioners John R. and E. Maria Cravens (docket Nos. 16900-83 and 15135-84) appeared pro sese.
Following the trial of the test cases, the Court issued its memorandum opinion in
On March 13, 1992, the Court entered the following decisions in the Thompson and Cravens cases:
John R. and Maydee L. Thompson
| Additions to Tax | |||||
| Sec. | Sec. | Sec. | Sec. | ||
| Year | Deficiency | 6651(a) | 6653(a) | 6653(a)(1) | 6653(a)(2) |
| 1979 | $ 18,161.00 | --- | $ 908 | --- | --- |
| 1980 | 24,838.00 | --- | --- | --- | --- |
| 1981 | 36,294.52 | $ 4,934.32 | --- | $ 1,958.28 | 50 percent of |
| the interest | |||||
| due on the | |||||
| deficiency | |||||
John R. and E. Maria Cravens
| Additions to Tax | ||
| Year | Deficiency | Sec. 6653(a) |
| 1979 | $ 4,508.00 | $ 225.40 |
| 1980 | 5,893.45 | 294.67 |
On *125 June 9, 1992, respondent filed motions for leave to file motions to vacate the decisions entered against the Thompsons, the Cravenses, and another test case petitioner, Ralph J. Rina (Mr. Rina), docket No. 17640 83. Respondent's motions to vacate alleged that, before the trial of the test cases, respondent's trial attorney, Kenneth W. McWade (Mr. McWade), and his supervisor, Honolulu District Counsel William A. Sims (Mr. Sims), had entered into contingent settlement agreements with the Thompsons and the Cravenses that had not been disclosed to the Court or to the other test case petitioners or their counsel. Respondent asked the Court to conduct an evidentiary hearing to determine whether the undisclosed agreements with the Thompsons and the Cravenses had affected the trial of the test cases or the opinion of the Court.
On June 22, 1992, Judge Goffe granted respondent's motions to vacate filed in the Thompson and Cravens cases, vacated the decisions entered in those cases, ordered the parties to file agreed decisions with the Court, or otherwise move as appropriate, and denied respondent's request for an evidentiary hearing. By order dated June 22, 1992, Judge Goffe also denied respondent's *126 motion to vacate the decision entered against Mr. Rina, on the ground that the testimony, stipulated facts, and exhibits relating to the Thompson and Cravens cases had no material effect on the Court's Dixon II opinion as it related to Mr. Rina.
On July 22, 1992, the test case petitioners represented by Mr. Izen filed a motion for reconsideration of the Court's order denying respondent's motion to vacate the decision in the Rina case. By order dated August 4, 1992, Judge Goffe denied petitioners' motion for reconsideration.
In August 1992, the Court entered revised decisions in the Thompson and Cravens cases consistent with Mr. McWade's prior agreements with the taxpayers in those cases. Specifically, the Court entered the following decisions in the Thompson and Cravens cases:
John R. and Maydee L. Thompson
| Year | Deficiency | Additions to Tax |
| 1979 | --- | --- |
| 1980 | $ 15,000 | --- |
| 1981 | 15,000 | --- |
John R. and E. Maria Cravens
| Year | Deficiency | Additions to Tax |
| 1979 | $ 3,606.40 | --- |
| 1980 | 6,175.76 | --- |
The decisions entered in the Thompson and Cravens cases are now final. 2*127
Because of Judge Goffe's termination, on September 30, 1992, of his recall status as a Senior Judge of the Court, all cases in the Kersting project group were reassigned to Judge Renato Beghe.
The other test case petitioners, including Mr. Rina, appealed the decisions entered in their cases to the Court of Appeals for the Ninth Circuit. On appeal, those petitioners *128 argued that the trial of the test cases had been tainted by the Thompson and Cravens settlement agreements. The response of the Court of Appeals was to vacate the decisions in the remaining test cases and remand them to this Court with directions "to conduct an evidentiary hearing to determine the full extent of the admitted wrong done by the government trial lawyers."
On February 2, 1995, respondent filed a Motion for an Evidentiary Hearing. On September 14, 1995, the Court granted respondent's motion. To effectuate the direction of the Court of Appeals regarding intervention, the Court ordered that the cases of 10 nontest case petitioners, the majority of whom had previously signed piggyback agreements, be consolidated with the remaining test cases for purposes of the evidentiary hearing. 4*130 As a result, three groups of petitioners have participated in all subsequent phases of the evidentiary hearing: Test case and nontest case petitioners represented by Mr. Izen; nontest case petitioners represented by Mr. Jones; and nontest case petitioners represented by Mr. Sticht. 5 The positions taken by the various groups of petitioners during these proceedings have not been consistent in all respects and in some respects the positions of counsel -- primarily Messrs. Izen and Sticht -- have become adversarial. 6
Following pretrial conferences on the record in Los Angeles on July 17, 1995, and January 16, 1996, the evidentiary hearing *131 was held at special trial sessions of the Court conducted in Los Angeles on May 13 to 30 and June 10 to 26, 1996, and August 18, 1997.
In the interest of chronology and as an aid to understanding this opinion, the procedural history of the evidentiary hearing comes after the Court's detailed findings of fact and before the ultimate findings of fact.
FINDINGS OF FACT
Mr. Kersting began promoting tax shelter programs in Hawaii in the early 1970's. Mr. Kersting's early tax shelter programs included an "Auto-Leasing Plan" and an "Acceptance Corporation Plan." Those plans generally required participants to purchase stock in a subchapter S leasing corporation or an acceptance corporation and/or enter into a subscription agreement to purchase stock, all in connection with loans to the participants by various entities created by Mr. Kersting. The plans were primarily designed to generate income tax deductions for interest that the participants purportedly paid to the Kersting entities on the loans.
The Commissioner determined that participants in Mr. Kersting's auto-leasing and acceptance corporation plans were not entitled *132 to deduct: (1) "Interest" that participants claimed to have paid on either the Auto-Leasing stock purchase or leverage loans; (2) the participants' pro rata shares of losses or investment credits from the auto leasing companies; and (3) "interest" that participants claimed to have paid either on the acceptance corporation stock purchase or stock subscription loans.
In
While the Pike litigation was underway, Mr. Kersting continued to promote additional tax shelter programs, which came to be known as the stock purchase plan, the stock subscription plan, the leasing company plan, and the CAT-FIT plan. The Court's opinion in Dixon II describes the mechanics of these programs in detail. 7*133
On January 22, 1981, following an undercover criminal investigation, the Internal Revenue Service searched Mr. Kersting's offices in Hawaii pursuant to a search warrant issued by the U.S. District Court for the District of Hawaii. Seventy-seven boxes and two filing cabinets of records were seized from Mr. Kersting's office, including lists identifying, by name and address, approximately 1,800 participants in Mr. Kersting's programs, and schedules of the interest purportedly paid by each participant to one or more Kersting companies during the taxable years 1977, 1978, and 1979.
On January 24, 1981, Mr. Kersting wrote a form letter to the participants of his programs, one of his many "Dear Friend" letters, stating that he had been entrapped by an undercover Internal Revenue Service special agent into creating a backdated "tax deduction" of $ 21,600. 8 By letter dated February 15, 1981, Mr. Kersting provided participants in his programs with "tax reporting notices", presumably for the 1980 tax year, and encouraged them to "take full advantage of the deductions reported *134 to you." Mr. Kersting further informed participants that the Internal Revenue Service had "accomplished only a temporary disruption of our operations" and that his office was "back to almost normal workings". All records seized in the January 22, 1981, search were returned to Mr. Kersting by 1987.
In January 1983, Mr. Kersting filed suit in the U.S. District Court for the District of Hawaii (docket No. CV-83-0018- MP) against the United States, the Internal Revenue Service, and certain Internal Revenue Service agents alleging, inter alia, that the January 1981 search was illegal and that the defendants had abused the grand jury process by shopping for a favorable grand jury, by violating grand jury secrecy, and by using the grand jury as a civil investigation tool. Through a number of unpublished orders, the District Court and the Court of Appeals for the Ninth Circuit rejected Mr. Kersting's claims. See
Mr. Kersting's tax shelter activities did not lead to an indictment. However, in October 1989, *135 the Commissioner assessed promoter penalties of $ 1,545,201 and $ 2,330,000 against Mr. Kersting, pursuant to sections 6700 and 6701, respectively, for the years 1982 through 1988. 9 The District Court for the District of Hawaii sustained the Commissioner's assessments. See
The Commissioner sent Mr. Kersting a notice of deficiency determining deficiencies in and additions to his Federal income taxes for the taxable years 1982 through 1988. *136 The deficiencies were based upon the Commissioner's determination that cash payments of so-called leverage loan interest received by Kersting corporations, which were characterized by the District Court in the promoter penalty cases as "alter egos" of Mr. Kersting, and which the Court's Dixon II opinion characterized as fees paid to Mr. Kersting by program participants in exchange for tax deductions, were includable in Mr. Kersting's gross income. Mr. Kersting filed a timely petition for redetermination with this Court (assigned docket No. 7448-96), and the case was tried at a Honolulu special trial session that commenced January 27, 1999.
In 1982, respondent began to issue notices of deficiency to Kersting program participants, disallowing interest deductions claimed with respect to the stock purchase plan, the stock subscription plan, the leasing company plan, and the CAT-FIT plan for a number of taxable years.
The notices of deficiency issued by respondent to many Kersting program participants used a common format, stating in pertinent part as follows:
EXPLANATION OF ADJUSTMENTS
*137 1. It is determined that the following amounts claimed on your
________ income tax return as interest deductions are not
allowable:
Amount Purported Payee 10
______ _______________
$ _______ Any entity owned, associated with,
or controlled, either directly or
indirectly, by Henry Kersting
This disallowance is based on the determination that the
transactions giving rise to the claimed interest deduction are
shams. This disallowance is further based upon your failure to
establish that the above amounts were paid or properly accrued,
or that the transactions purportedly generating the claimed
amounts resulted either in any bona fide indebtedness or in any
enforceable and bona fide obligation to pay compensation for
use or forbearance of money on indebtedness within the meaning
of
Furthermore, if it is established that any portion of the
above disallowed "interest" is a properly allowable deduction,
it is further determined that such interest constitutes *138 interest
in investment indebtedness and deduction of such amounts is
limited under the provisions of
Further, and in support of a portion of the determined
deficiency, if you establish that you are entitled to the above-
mentioned interest deduction, it is determined that you
improperly failed to report the income resulting from the same
transaction.
2. It is determined that part of the underpayment of tax for the
taxable year _____ is due to your negligent of [sic) intentional
disregard of the rules and regulations. Consequently, the 5
percent addition to the tax is charged for ______ as provided by
B. THOMPSON NOTICES OF DEFICIENCY
John R. Thompson (Mr. Thompson) was a pilot with Continental Airlines from 1946 until his retirement in October 1982. Mr. Thompson became aware of Mr. Kersting's programs through a conversation with another pilot, Michael Provan (Mr. Provan), who had solicited other pilots to participate in Mr. Kersting's programs. 11 The Thompsons began participating in Mr. Kersting's programs in 1977. 12*140 In addition to their participation in certain programs that were the subject of *139 this Court's opinion in Dixon II, the Thompsons, along with some 40 other investors, including Mr. Provan, participated in a transaction arranged by Mr. Kersting in early 1978 to acquire First Savings and Loan Association of Hawaii (First Savings).
The Thompsons filed joint Federal income tax returns for 1979, 1980, and 1981 in which they claimed interest deductions attributable to their participation in certain Kersting programs. On May 5, 1983, June 13, 1984, and May 31, 1985, respondent mailed notices of deficiency to the Thompsons determining deficiencies in and additions to their Federal income taxes for the taxable years 1979, 1980, and 1981, as follows:
| Additions to Tax | |||||
| Sec. | Sec. | Sec. | Sec. | ||
| Year | Deficiency | 6651(a) | 6653(a) | 6653(a)(1) | 6653(a)(2) |
| 1979 | $ 18,161.00 | --- | $ 908 | --- | --- |
| 1980 | 24,838.00 | --- | --- | --- | --- |
| 1981 | 36,294.52 | $ 4,934.32 | --- | $ 1,958.28 | 50 percent of |
| the interest | |||||
| due on the | |||||
| deficiency | |||||
Respondent further determined that the Thompsons were liable for increased interest for 1981 pursuant to
John R. Cravens *141 was a pilot with American Airlines during 1979 and 1980. Mr. Cravens became aware of Mr. Kersting's programs through conversations with other pilots.
The Cravenses filed joint Federal income tax returns for 1979 and 1980 in which they claimed interest deductions attributable to their participation in certain Kersting programs. On April 15, 1983, and March 20, 1984, respondent mailed notices of deficiency to the Cravenses determining deficiencies in and additions to their Federal income taxes for the taxable years 1979 and 1980, as follows:
| Additions to Tax | ||
| Year | Deficiency | Sec. 6653(a) |
| 1979 | $ 4,508.00 | $ 225.40 |
| 1980 | 19,251.70 | 962.59 |
The notice of deficiency issued to the Cravenses for 1979, while disallowing interest deductions of $ 9,810, included a credit for personal exemptions of $ 4,000, resulting in a net adjustment of $ 5,810. The notice of deficiency issued to the Cravenses for 1980 included disallowed interest deductions of $ 19,620 and, as an alternative to the disallowance of such interest, the inclusion of $ 18,000 in unreported dividend income from a Kersting controlled entity known as Candace Acceptance Corp. (Candace). The notice of deficiency issued to the Cravenses for 1980 also *142 included the disallowance of two personal exemptions claimed for the Cravenses' children. The Cravenses filed timely joint petitions for redetermination contesting the above-described notices of deficiency.
The Cravenses' reporting position was unique among the test case petitioners insofar as the Cravenses had adjusted (reduced) their tax basis in their Candace stock by the amount of a "non- taxable distribution" from Candace in 1980. Having reduced the basis of their Candace stock, the Cravenses reported a capital gain of $ 7,200 on their 1980 tax return after surrendering the stock to Mr. Kersting in exchange for cancellation and return of the note evidencing their primary loan. 14*143
Denis Alexander (Mr. Alexander) is a broker and investor who first met Mr. Kersting in Los Angeles in the early 1960's. Mr. Alexander lent money to Mr. Kersting's subchapter S leasing corporations in the 1970's, participated in the acquisition of First Savings, and participated in some of the Kersting programs at issue in Dixon II.
1. 1974 AND 1975
Mr. Alexander and his wife, Freida, filed joint Federal income tax returns for the taxable years 1974, 1975, 1976, and 1977. Following an examination of their returns for 1974 and 1975, the Alexanders conceded certain adjustments proposed by respondent, resulting in agreed assessments of $ 2,133 and $ 811 for 1974 and 1975, respectively. 15*144 However, because the Alexanders declined to agree to other proposed adjustments, respondent, on November 29, 1979, issued a notice of deficiency determining deficiencies of $ 4,891.83 and $ 40,760.38, respectively, in their Federal income taxes for 1974 and 1975.
Respondent's deficiency determinations against the Alexanders for 1974 and 1975 were based, in part, on disallowance of interest deductions of $ 2,917 and $ 46,500, respectively, attributable to their participation in Kersting programs for those taxable years. Additional adjustments included disallowance of an $ 18,500 capital loss claimed by the Alexanders for 1974 on a sale of stock in Mendocino Financial Corp. and respondent's determination that they had failed to report a $ 59,080 capital gain for 1975 from a sale of real estate to the Cadillac Drive Apartments partnership.
On February 28, 1980, the Alexanders filed a timely petition with the Court, assigned docket No. 2758-80, contesting the notice of deficiency for 1974 and 1975.
2. 1976 AND 1977
Respondent also examined the Alexanders' joint income tax returns for 1976 and 1977. On April 17, 1986, respondent issued the Alexanders a notice of deficiency determining deficiencies in and additions to their 1976 and 1977 Federal income taxes, as follows:
| Additions to Tax | ||
| Year | Deficiency | Sec. 6653(a) |
| 1976 | $ 3,596 | $ 180 |
| 1977 | 876 | 44 |
Respondent *145 also determined that the Alexanders were liable for increased interest for 1976 pursuant to
The deficiencies that respondent determined against the Alexanders for 1976 and 1977 resulted, in part, from respondent's disallowance of interest deductions of $ 8,665 and $ 12,993, respectively, attributable to their participation in Kersting programs for those years. Respondent also disallowed a $ 5,149 partnership loss claimed by the Alexanders for 1976 on their investment in the Avista Epsilon and Sarbonne partnership.
On July 21, 1986, the Alexanders filed a petition through Mr. Kersting's office, assigned docket No. 30413-86, contesting the notice of deficiency for 1976 and 1977.
In Dixon II, the Court considered and rejected arguments by the test case petitioners represented by Mr. Izen that the notices of deficiency issued to them were invalid under
Although this Court rejected the argument that notices of deficiency issued to Kersting program participants were invalid, it is evident that some notices of deficiency issued to Kersting program participants did contain errors. For instance, in
Similarly, as observed in the Court's Dixon II opinion, respondent's alternative determinations in the notice of deficiency issued to the Cravenses overstated their deficiency for 1980. The Court ordered that the Cravenses' deficiency for 1980 be reduced to account for: (1) The elimination of respondent's alternative determination that the Cravenses failed to report $ 18,000 in dividends paid by Candace; and (2) respondent's failure to eliminate the capital gain of $ 7,200 reported by the Cravenses for 1980 on the disposition of their Candace stock.
1. OVERVIEW
The large volume of cases generated by the Commissioner's disallowances of deductions claimed by taxpayers participating in large tax shelter programs during the late 1970's and early 1980's created the largest inventory of cases ever docketed in the Tax Court. Among the responses of the Internal Revenue Service and the Tax Court *148 were the development of procedures that were intended to streamline the litigation process, economize on the use of administrative and judicial resources, and reduce the costs incurred by taxpayers in resolving disputes over tax shelter adjustments. The Internal Revenue Service, Office of Chief Counsel, created the Tax Shelter Branch in the National Office to oversee tax shelter litigation across the country and to organize individual tax shelter projects. Concurrently, the Tax Court began working with the Internal Revenue Service and private parties in tax shelter cases to create what became known as the test case procedure; i.e., the selection of representative or test cases from a particular tax shelter project for a single trial on the merits. See, e.g.,
The test case procedure is intended to streamline the litigation process. To this end, taxpayers who are not selected as test cases are encouraged to execute a piggyback agreement; i.e., a stipulation to be bound by the outcome of the test cases. As a practical matter, *149 the effectiveness of the test case procedure depends in large part upon the agreement of the taxpayers not selected as test cases to be bound by the outcome of the test cases. Normally, taxpayers in a tax shelter project who decline or otherwise fail to sign a piggyback agreement will either have their cases set for trial with the test cases or, after the trial of the test cases, will be ordered to show cause why their case should not be decided the same way as the test cases. See, e.g.,
2. NATIONAL OFFICE TAX SHELTER BRANCH FUNCTIONS
The Tax Shelter Branch, *150 established by the Office of Chief Counsel in the National Office, was given the responsibilities of coordinating the examination, appeals, and litigation functions and of overseeing tax shelter projects from the National Office perspective. The Tax Shelter Branch provided advice and prepared material for use by the field in tax shelter cases, reviewed legal briefs, monitored the status of tax shelter case inventory, and prepared reports for Internal Revenue Service executives.
The Tax Shelter Branch monitored tax shelter projects by reviewing and extracting information from quarterly tax shelter reports that were required to be submitted by the project attorney; i.e., the District Counsel trial attorney with primary responsibility for the project. Each project attorney was required to submit a quarterly tax shelter report providing an update on the status of the project, including a summary of the current project settlement offer and any recent court action affecting the project.
One of the goals of the tax shelter program was consistent treatment of similarly situated taxpayers. The Tax Shelter Branch monitored settlement offers in similar tax shelter projects for disparities and tried *151 to determine whether the project settlement offers should be similar. However, actual supervisory responsibility in a tax shelter project was left primarily in the Regional Counsel and District Counsel offices to which the project was assigned.
In or around June 1982, Mr. Kersting facilitated the filing of petitions with the Tax Court by Kersting program participants. In letters issued in June and July 1982, Mr. Kersting informed Kersting program participants that a joint petition was being prepared on behalf of a large group of taxpayers. On July 12, 1982, Lu N. Nevels, Jr., filed a consolidated Tax Court petition, assigned docket No. 17445-82, on behalf of 60 Kersting program participants. 18
In early 1982, Brian J. Seery (Mr.*152 Seery) began assisting Kersting program participants with issues arising from the audit of their income tax returns. On April 14, 1982, Mr. Kersting issued a letter to Kersting program participants informing them that they soon would receive a letter from the Commissioner proposing to disallow their Kersting program interest deductions. Mr. Kersting advised program participants that they should not remit any amount to the Internal Revenue Service until their liability was determined in court. On February 15, 1983, Mr. Kersting issued a letter to Kersting program participants stating in pertinent part: "I trust that you have placed the tax retrievals which we have accomplished for you over the years into profitable investments and that you are receiving a reasonable rate of return. You will not lose any ground if your funds earn at least a return equal to the interest charges imposed by the IRS from time to time."
On March 1, 1985, Mr. Kersting issued a letter to Kersting program participants stating that he had retained Mr. Seery to represent them in the Tax Court at no charge to the individual petitioners. 19 The letter requested that each Kersting program participant provide written *153 authorization for Mr. Seery's representation. In a letter to program participants dated August 11, 1986, Mr. Kersting recommended that program participants not attempt to resolve their cases on their own and instead rely on counsel that he had hired.
Mr. Seery subsequently entered his appearance in the Tax Court on behalf of several hundred Kersting petitioners, including the Thompsons and the Cravenses. Mr. Seery's compensation for legal services rendered to Kersting program participants was always paid by one of the corporations controlled by Mr. Kersting.
1. KENNETH W. McWADE
In 1970, Mr. McWade began his career as a trial attorney with the Office of Chief Counsel. Mr. McWade's duties with the Office of Chief Counsel included litigating tax cases.
In January 1982, Mr. McWade transferred from respondent's District Counsel office in Seattle, Washington, to respondent's District Counsel office in Honolulu, Hawaii. Mr.*154 McWade initially assisted with the Pike group of cases. On or about July 1, 1984, the Kersting project was officially established in the Honolulu Appeals Office, and Mr. McWade was appointed to serve as the project attorney. Wally Kobayashi was appointed to serve as the key Appeals officer for the Kersting project.
By late 1986, Mr. McWade had litigated 40 to 50 Tax Court cases. However, Mr. McWade had never litigated any cases that were part of a tax shelter project.
2. WILLIAM A. SIMS
In 1972, Mr. Sims began his career with the Office of Chief Counsel, General Litigation Division, National Office. Except for a 6-month assignment doing Tax Court work, Mr. Sims handled general litigation matters concerning collection, bankruptcy, and tax liens. Mr. Sims eventually became Assistant Director of the General Litigation Division in the National Office.
In February 1986, Mr. Sims was appointed District Counsel for Honolulu, Hawaii. Before his appointment as District Counsel, Mr. Sims had never worked on a tax shelter project in any capacity.
1. THE HONOLULU SESSION (JUNE 1985)
The Court set for trial the cases of approximately 375 Kersting *155 program participants at a Tax Court session scheduled to commence on June 10, 1985, in Honolulu, Hawaii (the June 1985 session).
Before the June 1985 session, Mr. McWade and Mr. Seery agreed to use the test case procedure in the Kersting project. During the June 1985 session, Mr. McWade and Mr. Seery discussed the use of the test case procedure with Judge Goffe during a chambers conference. During the conference, Mr. Seery informed Judge Goffe that, although he was representing petitioners who were Kersting program participants, he was being paid by Mr. Kersting. Judge Goffe indicated that he saw no conflict of interest as long as Mr. Seery had not participated in the planning or promotion of the Kersting programs. See Rule 24(f). 20
Consistent with counsels agreement to use the test case procedure in the Kersting project, Judge Goffe granted the parties' joint motions to continue the cases called at the June 1985 session. At the same time, the parties began filing piggyback agreements *156 (discussed in greater detail below), which they did in the vast majority of the Kersting project cases.
Mr. Seery reported the results of the June 1985 proceedings to Mr. Kersting and kept him abreast of developments. Mr. Seery relied upon Mr. Kersting to distribute correspondence from Mr. Seery to petitioners in the Kersting project.
2. TEST CASE PROCEDURE
Mr. McWade and Mr. Seery agreed to select test cases that would be representative of all the Kersting programs for all years in dispute, including the taxable years 1975 through 1983. At the time that Mr. Seery selected his test cases, he assumed that the test case petitioners would bear the burden of proof at trial.
In selecting test cases, Mr. Seery was not concerned with whether a case involved other tax issues. Mr. Seery was simply looking for cases "where someone did everything right." Mr. Seery selected two or three test cases, including the Cravenses and the Hongsermeiers.
In an effort to find the best cases for trial from petitioners' point of view, Mr. Seery selected test cases by reference to the manner in which the taxpayers had reported the transactions. Mr. Seery selected test cases that he thought he could win, but, as *157 he testified at the evidentiary hearing, he had difficulty identifying such cases in addition to the Cravenses and the Hongsermeiers. 21
Mr. Kersting and Mr. Cravens discussed having Mr. Cravens' case serve as a test case. Mr. Kersting told Mr. Cravens that Mr. Seery wanted to use him as a test case because, unlike other Kersting program participants, the Cravenses had reported a capital gain when they surrendered their stock in the Kersting holding company in conjunction with the annual termination of the Kersting program. The Cravenses' reporting position was consistent with Mr. Kersting's advice to program participants that distributions by Kersting holding companies used by program participants to pay the principal amount of leverage loans were tax-free returns of capital rather than taxable dividends. Mr. Seery viewed the Cravens cases as "unique" in this respect.
Mr. Cravens believed that he had a choice whether his case would serve as a test case. When Mr. Cravens agreed to have his case serve as a test case, he did so without condition. He believed that *158 he would win his case because he had correctly reported his tax liabilities, as reduced by reason of his participation in the Kersting programs.
Mr. Seery selected the Hongsermeier case because it was his impression that the Hongsermeiers had used their own funds to pay the principal of a Kersting leverage loan, rather than using a "nontaxable distribution" from a Kersting holding company. 22Mr. Seery also selected the Hongsermeiers because they had participated in the CAT-FIT program, which Mr. Seery viewed as the strongest Kersting program from the standpoint of sustaining the interest deductions claimed.
Mr. McWade analyzed between 400 and 500 project cases; he selected test cases that he thought would be representative of all Kersting programs for all years in dispute. Mr. McWade selected "clean" cases; i.e., cases that did not include issues other *159 than Kersting interest deductions. Mr. McWade tried to avoid cases that were unique or atypical of the Kersting programs. Although Mr. McWade selected at least five of the test cases, he could not recall the specific cases that he selected.
In June 1986, Mr. McWade and Mr. Seery agreed on the dockets that were to serve as the test cases. By letter dated June 10, 1986, Mr. McWade notified Judge Goffe that he and Mr. Seery had selected the following 14 dockets to serve as test cases with respect to the Kersting project:
| Case Name | Docket No. |
| Dixon v. Commission | 9382-83 |
| Cravens v. Commission | 16900-83 |
| Rina v. Commission | 17640-83 |
| Thompson v. Commission | 19321-83 |
| Young v. Commission | 4201-84 |
| Cravens v. Commission | 15135-84 |
| DuFresne v. Commission | 15907-84 |
| Thompson v. Commission | 31236-84 |
| Owens v. Commission | 40159-84 |
| Young v. Commission | 22783-85 |
| Young v. Commission | 30010-85 |
| Thompson v. Commission | 30965-85 |
| DuFresne v. Commission | 30979-85 |
| Hongsermeier v. Commission | 1 29643-86 |
With the exception of *160 the Cravens case assigned docket No. 16900-83, and the Hongsermeier case assigned docket No. 17445-82, each of the test case petitioners had filed pro se petitions. By August 1986, Mr. Seery had entered his appearance in each of the test cases with the exception of the Young cases assigned docket Nos. 4201-84, 22783-85, and 30010-85, the DuFresne case assigned docket No. 30979-85, and the Thompson case assigned docket No. 30965-85.
3. TEST CASE ARRAY
The test case petitioners had participated in Kersting programs during the taxable years 1975 through 1983 as follows:
| TAXABLE YEAR 1975 | |
| Program | Petitioner(s) |
| CAT-FIT | Owens |
| 1*161 MAURIER LEASING | Owens |
| NORWICK 20/20 | Owens |
| TAXABLE YEAR 1976 | |
| Program | Petitioner(s) |
| UNIVERSAL LEASING | Owens |
| FORBES 30/30 | Owens |
| TAXABLE YEAR 1977 | |
| Program | Petitioner(s) |
| CAT-FIT | Dixon |
| ESCON LEASING | Dixon |
| FARGO 30/30 | Dixon |
| NORWICK 20/20 | Owens |
| TAXABLE YEAR 1978 | |
| Program | Petitioner(s) |
| CAT-FIT | Hongsermeier |
| CAT-FIT | Dixon |
| UNIVERSAL LEASING | Hongsermeier |
| ESCON LEASING | Dixon |
| ESCON LEASING | Hongsermeier |
| MAHALO 30/30 | Owens |
| MAHALO 60/60 | Dixon |
| TAXABLE YEAR 1979 | |
| Program | Petitioner(s) |
| CAT-FIT | Hongsermeier |
| CAT-FIT | Dixon |
| UNIVERSAL LEASING | Hongsermeier |
| ANSETH LEASING | Rina |
| ANSETH LEASING | Young |
| ESCON LEASING | Hongsermeier |
| ESCON LEASING | Dixon |
| ESCON LEASING | Thompson |
| CANDACE 60/60 | Dixon |
| CANDACE 60/60 | Cravens |
| CANDACE 60/60 | Rina |
| CANDACE 60/60 | Thompson |
| CANDACE 60/60 | Young |
| CHARTER 80,000 | Rina |
| CHARTER 120,000 | Young |
| INVESTORS 80,000 | Rina |
| INVESTORS 120,000 | Young |
| TAXABLE YEAR 1980 | |
| Program | Petitioner(s) |
| CAT-FIT | Dixon |
| CAT-FIT | DuFresne |
| CAT-FIT | Hongsermeier |
| ANSETH LEASING | Hongsermeier |
| ANSETH LEASING | Rina |
| ANSETH LEASING | Young |
| ESCON LEASING | Dixon |
| ESCON LEASING | Hongsermeier |
| ESCON LEASING | Thompson |
| CANDACE 60/60 | Cravens |
| CANDACE 60/60 | Rina |
| DELTA 40/40 | Hongsermeier |
| DELTA 60/60 | Cravens |
| DELTA 60/60 | Dixon |
| DELTA 60/60 | DuFresne |
| DELTA 60/60 | Rina |
| DELTA 60/60 | Thompson |
| DELTA 60/60 | Young |
| CHARTER 40,000 | Rina |
| CHARTER 80,000 | Rina |
| CHARTER 120,000 | Dixon |
| CHARTER 120,000 | DuFresne |
| CHARTER 120,000 | Thompson |
| CHARTER 120,000 | Young |
| INVESTORS 80,000 | DuFresne |
| INVESTORS 80,000 | Rina |
| INVESTORS 80,000 | Thompson |
| INVESTORS 120,000 | Dixon |
| INVESTORS 120,000 | Young |
| TAXABLE YEAR 1981 | |
| Program | Petitioner(s) |
| ANSETH LEASING | Young |
| ESCON LEASING | Dixon |
| DELTA 60/60 | Young |
| CHARTER 120,000 | Dixon |
| CHARTER 120,000 | DuFresne |
| CHARTER 120,000 | Young |
| INVESTORS 80,000 | DuFresne |
| INVESTORS 120,000 | Dixon |
| INVESTORS 120,000 | Young |
| TAXABLE YEAR 1982 | |
| Program | Petitioner(s) |
| ANSETH LEASING | Young |
| CHARTER 120,000 | DuFresne |
| CHARTER 120,000 | Young |
| INVESTORS 80,000 | DuFresne |
| INVESTORS 120,000 | Young |
| TAXABLE YEAR 1983 | |
| Program | Petitioner(s) |
| ANSETH LEASING | Young |
| CHARTER 120,000 | DuFresne |
| INVESTORS 80,000 | DuFresne |
The notice of deficiency issued to the Thompsons for the taxable year 1981 states in pertinent part: "Based on examination information from the 1978, 1979, and 1980 returns, the investment interest is generated from the interest deduction tax shelter. The purported payees cannot be identified from the 1981 income tax return filed by the taxpayers." Respondent has not been able to identify specifically the Kersting programs that the Thompsons participated in during 1981. However, the record suggests that, in addition to the Kersting programs that the Thompsons participated in during 1979 and 1980, the Thompsons participated in the Anseth Leasing Program during 1981.
If the Thompson and Cravens cases had been removed from the test case array, there would have been no reduction in coverage of the test cases. In other words, each program in which the Thompsons and Cravenses participated during the years in issue was also a program before the Court in which one or more of the other test case petitioners had participated.
After Messrs. Seery and *162 McWade had selected the test cases, they initiated settlement negotiations and began to prepare the test cases for trial. 23 Their trial preparations included work on a proposed stipulation of facts and an attempt to take Mr. Kersting's deposition. During this period (June 1986 or thereabout), Mr. Seery and Mr. Kersting's attorney, L.T. Bradt (Mr. Bradt), discussed using the 1981 search of Mr. Kersting's office as a basis for filing a motion to shift the burden of proof to respondent in the test cases.
By letter dated July 30, 1986, Judge Goffe informed Messrs. Seery and McWade that the test cases would be set for trial during a special session of the Court commencing on February 9, 1987, in Wailuku, Maui, Hawaii (the Maui session). Judge Goffe's letter also informed Messrs. Seery and McWade that he intended to notify each Kersting petitioner who had not filed a piggyback agreement that his or her case would be set for trial during the Maui session.
In August 1986, the Court issued orders setting the 14 test cases for trial during the Maui session. By letter dated *163 August 5, 1986, Judge Goffe informed all Kersting petitioners who had not already executed piggyback agreements that their cases would be set for trial at the Maui session unless they executed piggyback agreements by September 29, 1986. Judge Goffe's letter states as follows:
August 5, 1986
Dkt #
Dear ___________:
Your case involves matters concerning promotions by Henry
Kersting. Cases with issues identical to the issues in your case
have been set for trial on February 9, 1987, at the courtroom of
the Circuit Court for the Second Circuit in Wailuku, Maui,
Hawaii.
In order to conserve the time and expense of the taxpayers,
the government and the Court, all of the cases with identical
issues will be tried at one time unless the parties agree in
advance, in writing, to be bound by the outcome of the cases set
for trial. In most of the pending cases, the parties have so
agreed to be bound.
You should contact at your earliest convenience the lawyer for
the government in the Kersting cases if you decide to agree to
be bound. He is Mr. Kenneth McWade, PJKK Federal Building, Room
3304, Box 50089, 300 Ala Moana Boulevard, *164 Honolulu, Hawaii
96850. His telephone number is (808) 546-7333. If, however, you
do not wish to be bound, you should advise my office promptly,
in writing at the above address, in order that your case may be
set for trial on February 9, 1987. In either event, you must
advise Mr. McWade or me by September 29, 1986.
If you fail to advise Mr. McWade by September 29, 1986,
that you wish to be bound and have executed a stipulation to be
bound by that time and if you fail to advise me by September 29,
1986, that you wish to have your case set for trial, it will
automatically be set for trial on February 9, 1987. If your case
is set for trial and you do not appear for trial, your case will
likely be dismissed and you will be required to pay all of the
income tax which the government contends you owe, plus interest
thereon as provided by law.
William A. Goffe
Judge
In November 1986, the Court issued orders notifying Kersting petitioners who had not filed piggyback agreements that their cases were set for trial at the Maui session. As additional Kersting project cases were docketed and identified, the Court issued orders setting *165 them for trial at the Maui session, subject to being stricken if the parties executed a piggyback agreement.
As early as June 1985, Kersting program participants had begun executing piggyback agreements (1985 piggyback agreements), 24 drafted by Messrs. McWade and Seery, that stated as follows:
STIPULATION OF SETTLEMENT FOR TAX SHELTER ADJUSTMENTS
With respect to all adjustments in respondent's notice of
deficiency relating to the Kersting interest deduction tax
shelter(s), the parties stipulate to the following terms of
settlement:
1. The term Kersting programs refers to interest expense
deductions or other related deductions associated with various
programs promoted by Henry Kersting.
2. The Kersting program deduction adjustments shall be
redetermined on the same basis that the same program adjustments
are resolved with respect to taxpayers trying the same program
adjustments at the June 10, 1985 session of the Court in
Honolulu, Hawaii, or such session as these cases may be
adjourned or continued to by the Court (hereinafter "TRIED
CASE").
3. All issues involving the Kersting programs shall be
resolved as if the petitioner(s) *166 in this case is the same as the
taxpayers in the TRIED CASE;
4. A decision shall be submitted in this case when the
decision in the TRIED CASE is entered;
5. Following entry of the decision in this case,
petitioner(s) consents to the assessment and collection of the
deficiencies, attributable to the adjustments formulated by
reference to the Tax Court's opinion, notwithstanding the
restrictions contained in
6. The petitioner(s) in this case will testify or provide
information in any case involving the same tax shelter
adjustments, if subpoenaed; and
7. The petitioner(s) in this case consents to the
disclosure of all tax returns and tax return information for the
purpose of respondent's discovering or submitting evidence in
any case involving the same Kersting shelter adjustments.
The parties agree to this stipulation of settlement.
Piggyback agreements executed by Kersting program participants after 1985 differed from those executed in 1985. In particular, *167 post-1985 piggyback agreements stated as follows:
1. The Kersting interest deduction tax shelter adjustments
shall be redetermined on the same basis that the same tax
shelter adjustments are resolved with respect to taxpayers
trying the same shelter adjustments at the February 9, 1987
session of the Court in Wailuku, Maui, Hawaii, or such session
as these cases may be adjourned or continued to by the Court
(hereinafter "TRIED CASE").
2. All issues involving the Kersting interest deduction tax
shelter(s) shall be resolved as if the petitioner(s) in this
case is the same as the taxpayers in the TRIED CASE;
3. A decision shall be submitted in this case when the
decision in the TRIED CASE becomes final under I.R.C. section
7481;
4. Following entry of the decision in this case,
petitioner(s) consent to the assessment and collection of the
*168 reference to the Tax Court's opinion, notwithstanding the
5. The petitioner(s) in this case will testify or provide
6. The petitioner(s) in this case consents to the
disclosure of all tax returns and tax return information for the
purpose of respondent's discovering or submitting evidence in
any case involving the same shelter adjustments.
7. If the Court determines the
penalties are applicable in the test case controlling
petitioner's(s') case, then the petitioner(s) concedes that
determined in their case(s) attributable to the Kersting
interest deduction tax shelter(s), if such underpayment exceeds
$ 1,000.00 in any one taxable year.
8. With respect to adjustments in respondent's notice of
deficiency relating to additions to the tax under I.R.C. section
6653(a), the parties agree to the following:
(a) Respondent concedes that the petitioner(s) are not
liable for additions to tax under
the taxable year 1982.
In sum, whereas paragraph 4 of the 1985 piggyback agreements states that a decision will be entered in the piggyback case following entry of decision in the test cases, paragraph 3 of the post-1985 piggyback agreements states that a decision will be entered in the piggyback case once the decision in the test cases becomes final. 25*170 See
When Messrs. McWade and Seery drafted the piggyback agreements, Mr. Seery did not consider the possibility that a test case might be settled. 27
Nontest case petitioners *171 Ronald L. and Mattie E. Alverson (docket No. 17646-83) executed their piggyback agreement in June 1985. Nontest case petitioners Anthony E. and Carol A. Eggers (docket No. 7323-84), John L. and Terry E. Huber (docket No. 20119-84), Stanley C. and Sharon A. Titcomb (docket No. 17992-95), and Richard B. and Donna G. Rogers (docket No. 17993-95) executed piggyback agreements in late November 1986. Nontest case petitioners Norman W. and Barbara L. Adair (docket No. 35608-86) executed their piggyback agreement in March 1987. Nontest case petitioners Willis F. McComas, II and Marie D. McComas (docket No. 19464-92), Wesley Armand and Sherry Lynn Cacia Baughman (docket No. 621-94), Joe A. and JoAnne Rinaldi (docket No. 7205-94), and Norman A. and Irene Cerasoli (docket No. 9532-94) did not execute piggyback agreements for their cases on these dockets.
During late 1986 and early 1987, and shortly before the Maui session, Mr. Seery began to withdraw as counsel in the Kersting cases in the circumstances described below.
1. THE THOMPSONS
In 1985, the Thompsons had retained Samuel M. Huestis (Mr. Huestis) to prepare an estate plan for them. Eventually, the scope *172 of Mr. Huestis' representation was extended to include settlement of the Thompsons' 1978 tax liabilities and their dispute with Mr. Kersting, as described infra pp. 56-67.
One result of that dispute was Mr. Huestis' letter of September 10, 1986, to Mr. Seery, notifying him that the Thompsons were seeking substitute counsel and requesting the Thompson files. On September 15, 1986, Mr. Seery sent the Thompson files to Mr. Huestis and informed him that the Thompsons were test case petitioners. Mr. Seery indicated that he was withdrawing as the Thompsons' counsel in the Tax Court.
On October 28, 1986, Mr. Huestis wrote to Mr. Seery to express dissatisfaction with the sufficiency of the Thompsons' files and to warn Mr. Seery that his earlier representation of the Thompsons, while he was also apparently representing Mr. Kersting, could be viewed as a conflict of interest and lead to an action for "professional negligence".
On October 31, 1986, Mr. Seery filed motions to withdraw as counsel in the Thompsons' cases. 28*173 The Court granted Mr. Seery's motions in November 1986.
In the interim, Mr. Huestis assisted the Thompsons in locating and interviewing Mr. DeCastro to serve as their counsel in the Tax Court. 29 On November 15, 1986, Mr. Thompson and Mr. DeCastro's associate, Phillip Hoskins, executed a retainer agreement under which Mr. Thompson agreed to pay Mr. DeCastro $ 5,000 for his effort to negotiate a settlement of the Thompson tax cases. The agreement provided that the retainer fee was limited to settlement negotiations and did not include preparation for or representation at trial. In early January 1987, Mr. DeCastro filed an entry of appearance in the Thompson cases.
2. THE TEST CASES
On November 7, 1986, Mr. Seery filed a motion to change the place of trial of the test cases from Maui to Honolulu. Mr. Seery asserted that a trial in Maui would be inconvenient and a hardship to Mr. Kersting, who lived and operated a business in Honolulu. Mr. Seery's motion included the statement *174 that
4. Mr. Kersting is providing the financial support for the
litigation of this and the related cases and the additional
expense involved in transporting witnesses and staff to Wailuku
as well as paying for accommodations for the staff while in
Wailuku is a great financial burden to him.
On November 14, 1986, the Court issued an order denying Mr. Seery's motion to change the place of trial. In so doing, the Court noted that the motion "implies that * * * [Mr. Seery] represents not only petitioners but also Henry Kersting, the promoter of the tax shelters which are the subject of this litigation." The Court went on to observe that, if Mr. Seery were representing both Mr. Kersting and petitioners, the dual representation would constitute a conflict of interest. The Court attached to the order copies of several authorities concerning conflicts of interest, including
By letter dated December 12, 1986, Mr. Kersting *175 informed Kersting program participants that Judge Goffe had "inferred" that Mr. Seery might have a conflict of interest. Although Mr. Kersting denied that he was represented by Mr. Seery, he stated that he and Mr. Seery had decided that it would be prudent for Mr. Seery to withdraw as counsel. Mr. Kersting further stated that substitute counsel had been retained to represent test case and nontest case petitioners alike.
Following Mr. Seery's withdrawal, Mr. Bradt recommended that Mr. Kersting hire Mr. Izen to serve as counsel for the test cases. 30 However, Mr. Kersting, with his son-in-law, an attorney, Roger Moseley (Mr. Moseley), contacted Robert J. Chicoine (Mr. Chicoine) and Darrell D. Hallett (Mr. Hallett) (collectively Chicoine and Hallett), to determine whether they would represent the test case petitioners at the Maui session.
On November 22, 1986, Mr. Kersting sent Mr. Hallett a letter describing the Kersting programs. Shortly thereafter, Mr. Kersting interviewed Mr. Hallett in Hawaii. On December 9, 1986, Chicoine and Hallett reached an agreement with Mr. Kersting *176 to represent the test case petitioners (other than the Thompsons). On December 12, 1986, Mr. Kersting wrote to Kersting program participants informing them that Mr. Seery had withdrawn as counsel and that Chicoine and Hallett had been retained. At the same time, either Mr. Kersting or Chicoine and Hallett informed the test case petitioners that they would have to provide Chicoine and Hallett with written authorization to enter appearances in their cases.
Although Mr. Seery sent Chicoine and Hallett his files for the test cases, most of the documents that Mr. Seery had intended to use at trial remained in Mr. Kersting's possession. By letter dated December 19, 1986, Chicoine and Hallett reminded Mr. Kersting that they needed all documents in the possession of Mr. Kersting and Mr. Seery that pertained to the Kersting programs in dispute in the Tax Court.
By letter dated January 7, 1987, Chicoine and Hallett outlined the conditions underlying their agreement with Mr. Kersting to represent the test case petitioners in the Tax Court. Chicoine and Hallett's letter states in pertinent part:
Our representation is conditioned upon the following
however:
1. We will represent only the *177 individuals selected as test
cases and who request us to do so. We are not representing or
acting on behalf of any other taxpayers or litigants who have
invested in various companies in which you are affiliated and
who have stipulated to be bound by the outcome of the litigation
or desire legal advice with respect to whether they should
accept the Internal Revenue Service's settlement proposal.
2. All parties understand and agree that under the
circumstances, the Petitioners involved in the test cases who
have expressly authorized us to represent them will be our
clients and that we do not represent you individually, although
you have agreed with those Petitioners that you will pay the
legal fees to defer [sic] the costs of their defense. We will
discuss the fee arrangement with each of the Petitioners in the
test cases and their perception of any possible conflict of
interest which we would require that they waive.
3. It is understood that there will be no restrictions on
the advice which we may provide to our clients and after review
of the relevant facts and documents, we are free to propose such
settlements as we may deem appropriate. We *178 need not proceed with
trial in any situation if which we consider our position to be
indefensible or frivolous.
In early January 1987, Messrs. Chicoine and Hallett filed entries of appearance as counsel in each of the test cases other than the Thompson and Cravens cases.
As discussed in greater detail infra pp. 100-106, at the time of Mr. Seery's withdrawal from the Cravens cases, Mr. Cravens and Mr. McWade had agreed to a settlement of the Cravens cases. After reaching an agreement with Mr. McWade, Mr. Cravens did not authorize Chicoine and Hallett to enter an appearance in his cases.
E. EVIDENTIARY ISSUES
After undertaking to represent the test case petitioners, Chicoine and Hallett decided to challenge their deficiency notices on the ground that the search of Mr. Kersting's office in January 1981 had been illegal. Chicoine and Hallett thereupon filed motions for leave to file amendments to the petitions and lodged the amendments with the Court. The amendments included arguments that the materials seized by the Internal Revenue Service during the search of Mr. Kersting's office should be suppressed at trial of the test cases and that the burden of proof and burden of going forward *179 with evidence should be shifted to respondent. On January 14, 1987, the Court granted Chicoine and Hallett's motions for leave to file amendments to the petitions and subsequently directed respondent to file answers to the petitions as amended.
1. THE MAUI SESSION
Although the test cases were originally scheduled for trial at the Maui session, the trial was delayed by the need to use the Maui session to receive testimony and evidence on the evidentiary issues raised by Chicoine and Hallett.
Mr. McWade and Henry E. O'Neill (Mr. O'Neill), another trial attorney assigned to the Honolulu District Counsel Office, appeared on behalf of respondent at the Maui session. Mr. DeCastro appeared at the Maui session on behalf of the Thompsons. The Cravenses did not appear at the Maui session.
Following the Maui session, the Court ordered respondent and petitioners, by May 18 and June 17, 1987, respectively, to file opening and reply briefs addressing the evidentiary issues raised by Chicoine and Hallett. On motions by the parties, the Court extended the dates for the filing of opening and reply briefs to June 8 and August 10, 1987, respectively.
2. DIXON I OPINION
On February 11, 1988, the Court issued *180 its Dixon I opinion rejecting Chicoine and Hallett's evidentiary arguments. Specifically, the Court held that petitioners had failed to establish standing to contest the Kersting search.
By order dated July 1, 1988, the Court set the test cases for trial in San Diego, California, on January 9, 1989. By order dated October 24, 1988, the Court granted Mr. Izen's motion to reconsider and set the test cases for trial in Honolulu, Hawaii, on January 9, 1989.
Before the trial of the test cases, Mr. Kersting had disputes, summarized below, with the Thompsons and the Alexanders.
1. THE BAUSPAR PROGRAM
On August 13, 1979, the Thompsons purchased a condominium unit in Wahiawa, Hawaii (the Wahiawa property), from Pacific Universal Corp. (not a Kersting company). On April 24, 1981, the Thompsons entered a Kersting program known as Bauspar -- not one of the Kersting programs in dispute at the trial of the test cases -- to effect the payoff of seller-provided financing on the Wahiawa property. The Thompsons executed a first mortgage and promissory note reflecting a loan from Bauspar, Inc. (Bauspar), *181 in the principal amount of $ 80,000. The Thompsons agreed to repay the $ 80,000 Bauspar loan, with interest at 7 percent per year, through monthly payments of principal and interest of $ 532.24 for a 10-year period, followed by a balloon payment of $ 69,182.47. 31 In conjunction with the Bauspar loan, the Thompsons agreed to purchase $ 80,000 worth of Bauspar stock. The Thompsons borrowed $ 80,000 to purchase the Bauspar stock from another Kersting company, Paragon Investments, Inc. (Paragon), at an annual interest rate of 18 percent. The Thompsons further agreed to participate in a "savings program" by depositing $ 1,200 per month into an account with Citizen's Financial, Inc. (Citizen's Financial), another Kersting company.
On August 12, 1982, the Thompsons agreed to sell the Wahiawa property to Kevin and Ada Shea for $ 122,500 by an "Agreement of Sale" under which the Thompsons apparently took back a purchase money mortgage on the property. The Thompsons continued to participate in the Bauspar program until 1986 when the Sheas decided to sell the Wahiawa property to a third party.
On January 30, 1985, *182 Mr. Kersting sent Mr. Thompson a schedule listing the interest payments that Mr. Thompson had made during 1984 as follows:
| Payee | Amount |
| Bauspar, Inc. | $ 6,420.00 |
| Paragon Investments, Inc. | 9,611.04 |
| Citizens Financial, Inc. | 14,400.00 |
Upon sale of the Wahiawa property by the Sheas in 1986, Bauspar received a check in the amount of $ 75,511.74 in satisfaction of the principal amount remaining due on the Thompsons' loan from Bauspar.
2. DETERIORATION OF THOMPSON/KERSTING RELATIONSHIP
While working on the Thompsons' estate plan, Mr. Huestis asked Mr. Kersting for an accounting of the Thompsons' investments in Kersting programs. By letter dated March 3, 1986, Mr. Kersting responded by providing Mr. Huestis a summary list of the Kersting programs that the Thompsons had participated in during 1977, 1978, 1979, 1980, and 1981. By letter dated March 12, 1986, Mr. Huestis informed Mr. Kersting that the Thompsons wished to terminate their participation in all Kersting programs and obtain a complete accounting of their investments. Mr. Huestis also requested that all future communications regarding the matter be directed to Mr. Huestis rather than to the Thompsons.
By letter dated March 17, 1986, Mr. Kersting *183 complained to Mr. Huestis about his "assertive approach" and said he would continue to communicate directly with the Thompsons. By letter dated March 17, 1986, Mr. Kersting wrote to Mr. Thompson, confirmed that he would terminate Mr. Thompson's programs, and inquired whether Mr. Thompson still had any stock certificates issued in connection with his participation in Kersting programs. Mr. Kersting's letter also states that Mr. Thompson would incur tax liability for capital gains that would be realized upon the termination of his accounts in the Kersting programs.
On March 21, 1986, Mr. Huestis again wrote to Mr. Kersting, stating that the Thompsons were disappointed with Mr. Kersting's failure to respond to their requests or to assist them with the tax problems arising from their participation in his programs. By letter to the Thompsons dated March 25, 1986, Mr. Kersting confirmed that he would liquidate their investments, as discussed with Mr. Thompson in a recent telephone conversation. Mr. Kersting requested that Mr. Thompson endorse all relevant stock certificates and return them to Mr. Kersting so that the proceeds from the sale of stock represented by such certificates could be *184 used to retire Mr. Thompson's debts to Kersting companies.
By letter dated March 31, 1986, Mr. Kersting wrote to Mr. Thompson and admitted that he was having difficulty reconciling Mr. Thompson's Bauspar account because Earl LeMond, Mr. Kersting's son- in-law and the manager of the Bauspar program, did not keep reliable records. Nonetheless, Mr. Kersting prepared an accounting of Mr. Thompson's Bauspar account indicating that Mr. Thompson had paid $ 90,769.72 under the program and had received nontaxable dividends of $ 27,000 and Federal tax and State income tax savings (presumably from interest deductions) of $ 36,307.79 and $ 9,000, respectively. Mr. Kersting further indicated that, in light of Mr. Thompson's apparent dissatisfaction, he would waive the normal requirement that the Bauspar program run for a 10-year period, allow Mr. Thompson to terminate the program prematurely, and pay Mr. Thompson $ 27,000 reflecting 3 years of "equity build-up" in the program. On the basis of his accounting, Mr. Kersting concluded that Mr. Thompson would realize a net gain of $ 8,538.07 from the Bauspar program. Mr. Kersting advised Mr. Thompson to check his accounting carefully, and that, if necessary, *185 Mr. Kersting would make adjustments in Mr. Thompson's favor to avoid a legal dispute.
On March 31, 1986, Mr. Kersting wrote a second letter to Mr. Thompson stating that the Thompsons owed a total of $ 11,844 to Avalon Acceptance Corp., Aztec Acceptance Corp., Mahalo Acceptance Corp., Lombard Acceptance Corp., and Candace, for interest due on leverage notes during 1983 and 1984. Mr. Kersting's letter states in pertinent part:
I will assume that you will take the position that you
should not be paying interest on notes which produced deductions
which you might not have used. While this, of course, would not
go well with a bank or Credit Union (they would charge you
interest whether you use the deductions or not) I am willing to
make adjustments to your advantage. To get that underway I
suggest that you tell us which of the deductions were claimed by
you in 1983 and 1984.
* * * * * *
To keep the spirit of accommodation alive and to remove all
elements of dissatisfaction we are quite willing to lean over
into your direction. It has troubled me considerably that of all
people you would be displeased with our services.
On May 6, 1986, Mr. Thompson *186 wrote to Mr. Kersting requesting a full accounting for his participation in the Bauspar program. Mr. Thompson informed Mr. Kersting that the property subject to the Bauspar mortgage had been sold. Mr. Thompson also said that he was reminding Mr. Kersting that, upon his retirement in 1982, he had asked to terminate his participation in the programs for which Mr. Kersting was now seeking interest payments for leverage loans.
Beginning in June 1986, Mr. Thompson stopped making the $ 1,200 monthly deposits to Citizens Financial as required under the Bauspar program. At the same time, Mr. Thompson ignored Mr. Kersting's written requests to explain his failure to make the deposits. Further, on June 23, 1986, at the suggestion of Mr. Huestis, the Thompsons retained John A. Chanin (Mr. Chanin), an attorney practicing in Honolulu, to assist them in their dispute with Mr. Kersting. Mr. Chanin assigned the matter to his associate, Keith Y. Yamada (Mr. Yamada).
On August 1, 1986, Mr. Yamada spoke with Mr. Kersting by telephone and requested a detailed accounting of the amounts that the Thompsons had paid to Bauspar and Citizen's Financial, as well as a status report on the promissory notes executed *187 by the Thompsons in favor of Bauspar, Signet Financial, Inc., and Paragon. Following the telephone call from Mr. Yamada, Mr. Kersting called Mr. Thompson. During this conversation, Mr. Thompson reminded Mr. Kersting that the Wahiawa property had been sold. Mr. Kersting stated that he would provide Mr. Chanin with copies of the documents relating to Mr. Thompson's participation in the Bauspar program as soon as Mr. Thompson provided Mr. Kersting with a written authorization to release them.
By letter dated August 23, 1986, Mr. Kersting notified the Thompsons that he had turned their file over to Mr. Moseley for collection and that he sensed that litigation was imminent. Mr. Kersting's letter states in pertinent part:
Since the odds, however, are in favor of imminent litigation I
consider it to be my obligation to point out to you the
consequences:
The day after you have allowed your attorneys to file suit I
will declare all notes which you have executed to our companies
in default and begin collection proceedings. We will make an
effort to collect from you not only the $ 11,844.00 of interest
on promissory notes of which we have sent you billings several
times we will *188 also file suit to collect the principal of all
notes which we hold. The aggregate sum is well in excess of
$ 250,000.00, as you know.
I will also ask you to return to us the $ 40,000.00 we advanced
to you after the First Savings debacle. We will start collection
proceedings on the $ 75,000.00 note which you executed in favor
of FEDERATED FINANCE COMPANY to facilitate the acquisition of
your stock in First Savings & Loan Ass. We will ask you to pay a
pre-payment penalty on your mortgage on the house in Wahiawa.
We will NOT arrange for you a capital gain in your BAUSPAR
HOLDINGS INC. stock which I had considered -- even though not
due you because of premature withdrawal from the Plan -- and we
will NOT render assistance in saving you capital gains taxes on
the re-capture of basis in your stock holdings.
We will NOT provide legal assistance free of cost to you any
longer in US Tax Court proceedings. You will have to retain your
own attorney to make an appearance for you on February 9, 1987
in US Tax Court.
By letter dated August 24, 1986, Mr. Kersting notified Mr. Seery that he expected to be in litigation with the Thompsons and directed Mr. Seery not *189 to "render any services, at our expense," to the Thompsons.
By letter dated August 28, 1986, Mr. Huestis notified Mr. Moseley that he represented the Thompsons in connection with their Kersting transactions and the pending Tax Court litigation. Mr. Huestis advised Mr. Moseley to direct all future communications regarding the Thompsons to Mr. Chanin. 32
By letter dated September 5, 1986, Mr. Kersting again notified Mr. Seery of his dispute with the Thompsons and the likelihood of litigation. Mr. Kersting included a copy of Mr. Huestis' August 28, 1986, letter to Mr. Moseley. Mr. Kersting told Mr. Seery that he considered it "mandatory" that the Thompsons be removed as test case petitioners. On September 24, 1986, Mr. Kersting again wrote to Mr. Seery, reminding him of the need to remove the Thompsons from the list of test cases. During this period, Mr. Thompson began talking with other Kersting program participants about filing a class action *190 lawsuit against Mr. Kersting.
On January 1, 1987, Mr. Kersting wrote to Bill Witthorne, a Kersting program participant, requesting help in dealing with Mr. Thompson. Mr. Kersting's letter states in pertinent part:
Yet, I consider it important that someone would bring home to
Jack the dangers of the action he has in mind. He has been
hoodwinked by the attorneys out in California and I think he is
blind to the ramifications. Can you think of anyone in
California who is close to Jack and willing to talk to him?
That same day Mr. Kersting wrote to Benness M. Richards, another Kersting program participant, stating in pertinent part:
We have been unsuccessful over the last six months or so to
convince Jack that he will be better off with the legal
representation provided by us. Neither has anyone be [sic] able
to bring home to him that the IRS does NOT make him a better
deal than offered to all the other Petitioners.
On March 10, 1987, Mr. DeCastro and Mr. Huestis informed Mr. Thompson that Mr. Kersting would not return the Thompsons' promissory notes. Mr. DeCastro indicated that he wanted to discuss the possible involvement of his firm in bringing legal action against *191 Mr. Kersting.
On April 10, 1987, Mr. Thompson wrote a letter to other Kersting program participants, saying that Mr. Kersting had deceived him. In his letter, Mr. Thompson said that he had gone to Mr. Kersting to reduce his tax liabilities but that he now believed the cost to him would be great because the Internal Revenue Service was challenging Mr. Kersting's programs. Mr. Thompson suggested that the biggest worry for Kersting program participants was Mr. Kersting's "ultimate weapon", the promissory notes. Mr. Thompson enclosed a copy of a letter that he had received from Mr. Kersting as an example of what the others might face. 33*192 Mr. Thompson informed the other participants that, although Mr. Kersting had promised to cancel all promissory notes in exchange for the surrender of the Kersting company stock that was purchased with the proceeds of the primary loan, Mr. Thompson had tried to surrender his Kersting company stock but Mr. Kersting had refused to cancel Mr. Thompson's promissory notes. Mr. Thompson indicated that he no longer trusted Mr. Kersting, and that he had retained Mr. DeCastro.
By letter dated May 5, 1987, Mr. Yamada advised Mr. Thompson that a lawsuit against Mr. Kersting would have merit, and that a class action law suit should be considered. Around this time, Mr. DeCastro had proposed to file suit on behalf of the Thompsons against Mr. Kersting in Federal District Court.
On May 26, 1987, Mr. Huestis called Mr. DeCastro and learned that, after Mr. Kersting had obtained a copy of Mr. Thompson's April 10, 1987 letter, Mr. Moseley had written to Mr. DeCastro on behalf of Mr. Kersting and proposed a settlement of the Kersting/Thompson dispute. During a later meeting that day with Mr. Thompson, Mr. Huestis agreed to contact another lawyer in Honolulu, Charles R. Kozak (Mr. Kozak), to discuss whether Mr. Kozak might represent the Thompsons in a lawsuit against Mr. Kersting.
On May 27, 1987, Mr. Huestis contacted Mr. Kozak on behalf of the Thompsons. Mr. Kozak informed Mr. Huestis that he had represented two other Kersting participants (David L. Bigelow 34*194 and Michael Provan 35) and that he knew the Kersting programs and how to locate Mr. Kersting's assets. *193 36 On June 2, 1987, Mr. Huestis agreed to send a copy of the Thompson file to Mr. Kozak. On the same date, Mr. Huestis notified Mr. Yamada that the Thompsons did not plan to retain the Chanin firm to bring suit against Mr. Kersting.
Messrs. Bigelow, Provan, and Thompson all asked Mr. Kozak to investigate the filing of a lawsuit against Mr. Kersting. On August 6, 1987, Mr. Kozak wrote to Mr. Thompson and suggested that there was a good chance of obtaining a large judgment against *195 Mr. Kersting through a class action lawsuit, but that collection of any such judgment would be uncertain. In addition, Mr. Kozak's letter states in pertinent part:
As you know, Kersting is now embroiled with the IRS on
behalf of his clients. I recently had a conference with Ken
McWade, local counsel for the IRS. He tells me the trial of
these cases will be no sooner than late Spring 1988. I suspect
12-18 months is a more realistic date. Also McWade stated he is
100% sure Kersting will be unable to show any "purposive"
function of his corporations other than to avoid taxes. Several
witnesses including yourself are available to McWade to prove
Kersting never had any intention of enforcing the notes he had
his clients execute. Also, I am suspicious that Kersting's
representation that his companies are making loans, leasing cars
and factoring accounts in any meaningful business sense is
without any merit.
Further, I believe we will find that Kersting did not do
many of the "house keeping" accounting and legal matters which
needed to be done to qualify his schemes before the IRS, even if
there was an arguable business purpose position for his schemes
*196 under the tax code.
In my estimation, those clients of Kersting who continue to
be represented by Kersting's lawyers are headed towards a
nightmare. Interest continues to mount on the taxes due. By the
time the pilots finally get a decision from the tax court, they
will be in terrible financial condition. Of course, they will
still have to pay the tax since bankruptcy will not terminate
their tax liability.
Those who are smart enough should disassociate themselves
from Kersting's lawyers now, obtain their own counsel, offer
their testimony as part of their negotiations with the IRS and
buy out as cheap as they can now!
There is no evidence in the record that the Thompsons have ever filed a lawsuit against Mr. Kersting or that Mr. Kersting has ever filed a lawsuit against the Thompsons. There is no documentation in the record to support Mr. Thompson's statement to Mr. Kersting in 1986 that in 1982 he had asked Mr. Kersting to terminate Mr. Thompson's participation in the Kersting programs.
As previously mentioned, Mr. Alexander first met Mr. Kersting in Los Angeles in the early 1960's. In the mid-1970's, Mr. Alexander lent over $ 100,000 *197 to Mr. Kersting to assist him in the acquisition of Cosmopolitan Financial Corp. Mr. Alexander's creditor's interest in Cosmopolitan evolved into a stock interest in Charter Financial. Mr. Alexander also lent $ 80,000 to Mr. Kersting's subchapter S leasing corporations in the 1970's.
In 1977, Mr. Alexander, a minority shareholder of First Savings, met with Mr. Kersting to discuss the possible acquisition of the company. Mr. Alexander participated in the acquisition of First Savings and added to his First Savings stock holdings in the process. Mr. Alexander participated in certain Kersting programs at issue in Dixon II during the taxable years 1974 through 1977.
In 1980, Mr. Alexander brought suit against Mr. Kersting in Hawaii State court seeking the repayment or return of approximately $ 450,000 that Mr. Alexander claimed he had lent to or invested with Mr. Kersting. Mr. Kozak initially represented Mr. Alexander in this litigation. Mr. Kersting and/or his companies eventually filed counterclaims in excess of $ 4 million against Mr. Alexander. Mr. Moseley represented Mr. Kersting in the Alexander litigation.
In March 1982, Mr. Alexander received a telephone call from Internal Revenue *198 Service Special Agents George Scott and Mike Duncan, who were interested in questioning Mr. Alexander regarding Mr. Kersting's various programs. The record does not reflect whether Mr. Alexander ever agreed to be questioned by the agents.
The Alexander/Kersting litigation eventually was submitted to arbitration during a week-long proceeding in July 1987. During the arbitration proceeding, Mr. Kersting discovered that Messrs. Alexander, Kozak, and Matsumoto had contacted Mr. McWade to discuss whether the Government would pay a finder's fee for information pertaining to Mr. Kersting's programs. Mr. Alexander's discussions with Mr. McWade on the subject of a finder's fee are discussed in greater detail, infra pp. 106-115.
In a letter dated July 24, 1987, Mr. Kersting brought his dispute with Alexander to the attention of Chicoine and Hallett, stating as follows:
Dear Darrell:
I have spent the better part of this week in arbitration
hearings concerning a case whereby we are attempting to
accomplish an offset of debt owed us by a Mr. Denis Alexander
against certain obligations we have to him. The matter has been
going on for more than six years and has become sheer agony.
*199 During the course of the proceedings, however, certain matters
came to the surface which will become apparent to you as you
will read the enclosed material. The material will disclose a
conspiracy between McWade, DEnis [sic] Alexander, an accountant
by the name of Gilbert Matsumoto and an attorney by the name of
Charles Kozak.
Here are some short facts to illuminate the case:
DEnis [sic] Alexander was a long-time friend going back more
than 25 years, until we locked horns over the debt referred to
above.
Gilbert Matsumoto is an accountant who was for years the tax
preparer for our Finance Company in Aiea, Federated Finance
Company, and for about 10 to 14 of our clients which we had
referred to him. He had given me an opinion with respect to the
viability of the SubChapter S concept which we employed in the
mid-70s for our Leasing Companies. He, in fact, did the filing
of SubChapter S qualification forms for us with the IRS in
Fresno, Calif. and did some of the Tax Returns. I adapted the
SubChapter S principles on the strength of his advise [sic].
Charles Kozak is an attorney here in town who was at one time a
shareholder in one of our SubChapter *200 S Leasing Companies and
also a participant in other programs. He did some legal work for
us in the mid-70s in chasing a dead-beat by the name of
Feliciano and he obtained judgement for us. He became an
adversary after he had made no lease payments on a car which we
had leased to him which compelled us to repossess the car. He
was delinquent by more than one year. He has stirret [sic] up
trouble for me ever since.
These three characters now conspired with McWade to initiate
criminal proceedings again against me and, as you will read,
already discussed among themselves how to divide the "finders
fee" (more precisely the Judas ducats) which they expected to
receive from IRS. As we took Alexanders [sic] testimony this
week it became apparent to Kozak that he had acted unethically
and he read a statement into the records that "he had advised
his client (Alexander) not to engage in reporting me to the IRS
in order to extract from me a settlement of his claims" which,
of course, is self-defeating since he was an active participant
in the scheme.
I have reason to believe that all of this led nowhere. If even
entrapment and subsequent raid on our premises *201 did not yield the
evidence for the CID characters to take me out of circulation
the Kozak/Alexander/Matsumoto/McWade conspiracy had no prospect
of success. More than a year has gone by since these rats tried
to make money by setting me up for execution.
I will assume that this incident will become a piece of the
mosaic which should be made known to the US Tax Court Judge in
support of my contention that IRS and it's [sic] representatives
have conspired to ruin my business and inflict harm on me
personally, one way or another.
Following the arbitration hearing, Mr. Moseley filed a complaint with the Supreme Court of the State of Hawaii, Office of Disciplinary Counsel (HODC), accusing Mr. Kozak of conflict of interest and of attempting to extort money from Mr. Kersting in a civil suit. On March 17, 1988, Mr. Kozak submitted a written response to the HODC in response to Mr. Moseley's complaint. Mr. Kozak alleged that he had been offered inducements by the Internal Revenue Service in exchange for his cooperation in an Internal Revenue Service investigation of Mr. Kersting, suggested that HODC should contact Mr. McWade, denied that he used the threat of Internal Revenue *202 Service litigation against Mr. Kersting, and denied any conflict of interest. On April 12, 1988, Mr. Kozak wrote another letter to HODC stating that the Internal Revenue Service had agreed to pay Mr. Kozak and Mr. Alexander for their cooperation in an Internal Revenue Service investigation of Mr. Kersting. At the evidentiary hearing in this proceeding, Mr. Kozak testified that his statements to HODC that the Internal Revenue Service had agreed to pay him for cooperation in an investigation of Mr. Kersting were false.
On July 12, 1988, the arbitrator released his Arbitration Decision and Award denying all claims and counterclaims between Messrs. Alexander and Kersting. 37*203 The arbitrator's decision turned largely on the lack of credibility of both parties.
The record does not reflect the outcome of Mr. Kersting's complaint filed with HODC against Mr. Kozak.
In Dixon II, the Court described Mr. Kersting's 1980 dunning letter to more than 30 program participants and several lawsuits brought during the period 1983-86 in the names of Kersting corporations against Kersting program *204 participants to collect amounts purportedly due on promissory notes. See Dixon II, 62 T.C.M. (CCH) at 1466-1467, 1505-1506, 1991 T.C.M. (RIA), at 91-3007 to 91- 3008, 91-3048 to 91-3050. Summarized below are the Court's findings and conclusions in Dixon II regarding the collection lawsuits.
1. STEVE HANE
In 1983, a Kersting company, Atlas Funding, commenced an action on a $ 30,000 renewal primary note for a stock subscription plan against Kersting program participant Steve Hane. The Court noted that the Hane litigation was the only example in the record of litigation on a primary note. The Court concluded that the evidence of the Hane litigation was inconsequential because of the lack of any testimony about the matter and the fact that Atlas Funding dismissed the action voluntarily after obtaining a default judgment.
2. CARL MOTT, GEORGE VERMEF, AND ROBERT PETERSON
In Dixon II, the Court found that Kersting corporations pursued collection lawsuits in 1985-86 on leverage loans against Kersting program participants Carl Mott, George Vermef, and Robert Peterson. The Court noted that while Carl Mott had been sued only for interest on leverage loans, Messrs. Vermef and Peterson had been sued *205 for both interest and principal on leverage loans. The Court found that there was no explanation in the record how Messrs. Vermef and Peterson could have owed principal on leverage loans that would be consistent with the way the Kersting programs were intended to operate nor with the way that they apparently actually operated. Further, the Court found that the judgments entered against Mr. Vermef were vacated after the parties agreed to settle the cases and that a default judgment entered against Mr. Peterson later was set aside on Mr. Peterson's motion. The Court summarized its conclusions regarding collection activities and litigation as follows:
Five Kersting corporations commenced actions against Carl
Mott based upon a year of unpaid interest on 15 leverage notes,
but the principal amounts of the notes were not in issue. The
record is replete with copies of checks, drawn on personal bank
accounts other than Liberty Bank or Hawaii National Bank, that
petitioners used to pay interest on leverage notes. Respondent
does not dispute that Kersting insisted on these interest
payments, but maintains that to the extent they were made they
must be characterized as fees *206 to Kersting for providing tax
deductions. Consequently, that Carl Mott allegedly failed to pay
interest on leverage notes is of no significance to the
substance of his or anybody else's leverage loans.
* * * * * * *
As illustrated by Kersting's pay-or-else letter to over 30
clients on September 25, 1980, and his 1986 correspondence with
the Thompsons, his overriding concern was to be compensated by
means of leverage loan interest. It was this amount that even he
often referred to as a "fee" or a deductible "cost" of tax
deductions. In encouraging clients by means of the September 25,
1980, letter to "discharge the debt to which you are a party,"
he sought only small amounts that could not have represented
typical primary or leverage loans. His letters to the Thompsons
indicate that he only threatened or pursued collection of
principal obligations when the investor neglected or refused to
pay leverage loan interest. This rare occurrence, which Kersting
did not testify he either intended or expected, is not
sufficient to transform any of petitioners' loans from Kersting
corporations into genuine recourse indebtedness.
Dixon *207 II, 62 T.C.M. (CCH) at 1505-1506, 1991 T.C.M. (RIA), at 91-3049 to 91-3050.
1. NATIONAL OFFICE POSITION
After a tax shelter project is created and a project attorney and a project Appeals officer are appointed, an official project settlement offer is determined by the project Appeals officer, the project attorney, and District Counsel. The project attorney and project Appeals officer review the strengths and weaknesses of the particular tax shelter and evaluate the hazards of litigation to determine an appropriate project settlement offer. Upon determination of the project settlement offer, the terms of the offer are reported to the Tax Shelter Branch in the National Office for dissemination to Internal Revenue Service field offices (particularly the examination and appeals functions) throughout the country to ensure that similarly situated taxpayers are treated consistently.
Once a tax shelter project is assigned to a particular District Counsel office, that office has the authority to settle any individual case in the project. District Counsel generally is expected to adhere to the official project settlement offer. Nevertheless, District *208 Counsel has the authority in special circumstances to settle individual tax shelter project cases on a basis different from the project settlement offer. For example, District Counsel could deny a project settlement offer to the shelter promoter or a participant who had helped to market the program. In addition, District Counsel might eliminate an addition to tax (such as negligence) because of the participant's lack of education or sophistication in financial matters.
District Counsel can alter or modify an official project settlement offer without prior approval of the National Office. However, District Counsel is required to notify the Tax Shelter Branch of any change or modification to the official project settlement offer in order to allow the Tax Shelter Branch to disseminate the revised offer to Internal Revenue Service offices throughout the country.
The National Office did not maintain a policy prohibiting the settlement of a test case. However, the Commissioner's practice of withdrawing project settlement offers once the project test cases have been set for trial would serve to bar settlements in test cases and nontest cases alike. 38*209
2. REGIONAL COUNSEL
Benjamin C. Sanchez (Mr. Sanchez) served as Regional Counsel for the Western Region during the period in question. His view of District Counsel's settlement authority in tax shelter cases differed from the National Office view. In Mr. Sanchez' view, District Counsel had authority to settle tax shelter project cases only on the basis of the official project settlement offer. Mr. Sanchez believed that District Counsel was obliged to adhere strictly to the official project settlement offer because of the overriding need to ensure consistent treatment of tax shelter project cases. Although Mr. Sanchez acknowledged that District Counsel technically had authority to settle a tax shelter project case on a basis different from the official project settlement offer, Mr. Sanchez believed that it would be improper to do so. In his view, disciplinary or other adverse career consequences might follow if District Counsel deviated from the official project settlement offer in settling a case.
Mr. Sanchez expected *210 that he would be informed by District Counsel of settlements in tax shelter project cases that deviated from the official project settlement offer.
B. OFFICIAL KERSTING PROJECT SETTLEMENT OFFER (7-PERCENT REDUCTION OF DEFICIENCY OR OUT-OF-POCKET EXPENSES)
Between January 1982 and mid-1986, the terms of the official Kersting project settlement offer were stated as follows:
You will be allowed your actual out-of-pocket expenses, in
essence, the interest you actually paid to Henry Kersting on the
prepayment loan, or leverage loan, which amount equals
approximately 7% of the determined deficiencies in most cases.
In addition, if you reported capital gain income from the
Kersting transactions, or recaptured the difference between your
adjusted basis in the stock and your outstanding indebtedness,
then an appropriate adjustment will be made to reflect this
fact. In addition, if you are involved in a leasing plan, to the
extent there are additional allowable
expenses which were not claimed on the return, an appropriate
allowance will be made for settlement purposes. If you were
involved in the Uniform Gift to Minors Act program, referred to
as *211 KAT-FIT (sic), to the extent you can establish compliance
with the Clifford Trust rules, then an appropriate allowance for
the deductions will be made. The government will concede the
negligence penalties,
interest.
The 7-percent reduction of the deficiency reflected a deduction equal to an average of the actual out-of-pocket expenses in approximately 25 Kersting project cases. For this purpose, the Commissioner treated the "interest" paid on Kersting leverage loans as the out-of-pocket expense. From respondent's perspective, the 7-percent settlement offer was equivalent to allowing a deduction for a theft loss in the year of payment. 39
[145] Under the 7-percent settlement offer, the Commissioner would: (1) Concede the negligence addition to tax and increased interest imposed on tax-motivated *212 transactions pursuant to
1. MODIFIED 7-PERCENT SETTLEMENT OFFER
[146] Between April and September 1986, Mr. McWade and Mr. Seery conducted settlement negotiations that led Mr. McWade to offer a settlement that deviated from the official project settlement offer in one significant respect. Specifically, by September 1986, Mr. McWade and Mr. Seery had agreed to modify the 7-percent settlement offer to incorporate a new feature they called the *213 "shelter burnout" that would apply in cases involving more than 1 taxable year. The shelter burnout feature grew out of Mr. Seery's contention that Mr. Kersting's programs could be viewed as a tax deferral mechanism. 40Mr. McWade agreed with Mr. Seery, for settlement purposes, to allow a shifting of the initial year's deficiency to a later year as a "shelter burnout". For example, in a case involving 2 taxable years, the taxpayer's liability for statutory interest under section 6601 was computed under the modified 7-percent settlement offer by treating the taxpayer's tax liability for the earlier of the 2 years as having been incurred on the due date for payment of tax for the later year. Under this approach, the total amount of the taxpayer's underlying tax deficiencies remained the same, but the taxpayer's liability for interest on the deficiencies was reduced by the amount of such interest that otherwise would have accrued on the deficiency for the earlier year of the 2-year period. Variations of this approach were used in cases involving more than 2 taxable years. The modified 7-percent settlement offer negotiated by Mr. Seery and Mr. McWade provided that the Commissioner would *214 settle any additions to tax for fraud on a case-by-case basis.
[147] By letter dated September 29, 1986, Mr. Seery informed Kersting program participants of the terms of the modified 7-percent settlement offer and suggested that they give serious consideration to the proposal. Mr. McWade informed Mr. Seery that, because the trial of the test cases had been set for February 1987, the modified 7-percent settlement offer would be withdrawn on December 31, 1986, and that Kersting program participants interested in accepting the settlement should contact Mr. McWade by November 10, 1986, in order to allow time to complete the necessary computations before the withdrawal of the offer.
[148] On October 10, 1986, Mr. Kersting issued a letter to Kersting program participants in which he characterized the modified 7-percent settlement offer as "grossly inadequate."
[149] Messrs. Sims and McWade *215 did not notify the National Office, Regional Counsel, or the Appeals Office that they had incorporated the burnout feature in their offer to settle Kersting project cases.
2. 20-PERCENT SETTLEMENT OFFER
[150] Between September and December 1986, Mr. McWade and Mr. Sims began to offer 20-percent settlements that were based on the same general approach as their modified 7-percent settlement offer that included the burnout feature. The 20-percent settlement approach originated in late 1986 in separate negotiations between Mr. Sims and Mr. Chicoine and between Mr. McWade and Mr. DeCastro. The enhanced 20-percent settlement offer reflected the perceptions of Messrs. Sims and McWade that the evidentiary issues raised by Chicoine and Hallett increased respondent's risks of litigation.
[151] The 20-percent settlement offer was not disseminated in writing by either Mr. Sims or Mr. McWade. The existence of the 20- percent settlement offer became known, if at all, through a combination of Mr. Kersting's letters to program participants and calls that Mr. McWade received from Kersting program participants. Messrs. Sims and McWade did not request approval from or otherwise inform the National Office, *216 Regional Counsel, or the Appeals office before making the 20-percent settlement offer.
[152] Following the February 1987 Maui session, the Honolulu Appeals Office once again began to offer Kersting program participants a deduction for their cash out-of-pocket expenses, or if substantiation was not available, a reduction of the deficiency by 7 percent, with a waiver of the additions under
3. NEGOTIATIONS FOR 50-PERCENT SETTLEMENT OFFER
[153] In January 1987, Messrs. Sims and Chicoine continued their efforts to negotiate a settlement of the Kersting project cases. Initially, their discussions concerned a higher percentage settlement if Mr. Kersting would agree to quit the tax shelter business. They eventually abandoned their discussions to link the settlement offer with Mr. Kersting's future conduct.
[154] By letter dated January *217 16, 1987, Mr. Chicoine notified Mr. Kersting that he believed he had arrived at an agreement with Mr. Sims to settle all the Kersting cases docketed in the Tax Court by allowing 50 percent of the claimed interest deductions. Mr. Chicoine's letter further states that Chicoine and Hallett would agree to represent Kersting program participants desiring to settle their cases on these terms for a flat fee of $ 550 per case.
[155] On January 19, 1987, Mr. Kersting wrote a letter to program participants stating that a 50-percent settlement had been negotiated. Mr. Kersting recommended that the 50-percent settlement be accepted; he included with his letter a form for program participants to use to authorize Chicoine and Hallett to represent them for purposes of settlement. As a result of Mr. Kersting's letter, approximately 300 Kersting program participants contacted Chicoine and Hallett seeking representation.
[156] In the meantime, Mr. Sims consulted Barbara Leonard, Deputy Regional Counsel for the Western Region. She directed him to terminate negotiations based upon a 50-percent settlement.
[157] Upon learning of Mr. Kersting's letter, Mr. DeCastro called Mr. Chicoine to inquire about the *218 terms of the purported 50- percent settlement. Mr. DeCastro stated that the terms of the purported settlement were better than the terms he had received for his clients and that he intended to attempt to obtain the same terms for his clients. During his conversation with Mr. Chicoine, Mr. DeCastro threatened to "make trouble" for Mr. Chicoine unless he referred clients residing in California to Mr. DeCastro for further representation. Mr. Chicoine flatly rejected Mr. DeCastro's proposal.
[158] Following the release of Mr. Kersting's January 19, 1987, letter, Mr. Sims received numerous telephone calls from Kersting program participants and attorneys seeking to accept the 50-percent settlement. Following his conversation with Mr. Chicoine, Mr. DeCastro called Mr. Sims to express concern that Mr. Chicoine's clients might obtain more favorable settlements than the settlements offered to Mr. DeCastro's clients.
[159] By letter to Mr. Chicoine dated February 4, 1987, during the week immediately preceding the Maui session, Mr. Sims denied that he had agreed to a 50-percent settlement of the Kersting project cases. Mr. Sims' letter states in pertinent part:
1. I HAVE NOT SETTLED ANY OF THE *219 KERSTING CASES WITH YOU.
2. THE GOVERNMENT HAS NOT MADE ANY NEW, BLANKET OFFER TO
SETTLE THESE CASES (OTHER THAN OUR OLD 7% OFFER); NOR HAS THE
GOVERNMENT MADE ANY OFFER TO WHOLLY OR PARTIALLY CONCEDE ANY OF
THE ISSUES PRESENTED BY THESE CASES. TO THE EXTENT THAT YOU MAY
DISAGREE WITH THIS STATEMENT, ANY SUCH OFFER OF CONCESSION THAT
YOU BELIEVE HAS BEEN MADE BY ME OR ANY OTHER GOVERNMENT OFFICIAL
IS HEREBY WITHDRAWN.
3. WE DO NOT HAVE A WORKABLE BASIS FOR SETTLEMENT OF ANY
CASE OR ANY GROUP OF CASES. IF YOU SHOULD ATTEMPT TO REPRESENT
TO THE COURT THAT YOU HAVE SUCH A BASIS, EITHER IN ORDER TO
OBTAIN A CONTINUANCE OF THE TRIALS IN THIS MATTER OR TO ATTEMPT
TO FORCE THE GOVERNMENT INTO UNAGREED-TO SETTLEMENTS OR
CONCESSIONS, I WILL DISPUTE THIS FIRMLY.
Before the start of the Maui session, Judge Goffe held a chambers conference with Messrs. Chicoine, Hallett, Sims, McWade, O'Neill, and DeCastro. Although Mr. Chicoine told Judge Goffe that the parties had reached a basis of settlement, Mr. Sims denied that there was a settlement. Mr. Sims said that he had "pulled the plug" on a proposed 50-percent settlement because Mr. Kersting had interfered with the *220 negotiations.
4. REVIVAL OF 20-PERCENT SETTLEMENT OFFER
[160] During spring 1987, Mr. Chicoine continued to explore with Mr. McWade the possibility of a global settlement. By letter dated April 13, 1987, Mr. Chicoine provided Kersting program participants with a detailed status report addressing developments at the Maui session as well as settlement negotiations. Mr. Chicoine's letter also stated that the firm's representation of nontest case taxpayers was not intended to extend to general representation in all matters but was limited to the acceptance of an Internal Revenue Service settlement offer.
[161] On April 16, 1987, Mr. Chicoine wrote to Mr. Kersting and confirmed that he would be meeting Mr. McWade in Hawaii the following week to discuss the possible settlement of six cases. Mr. Chicoine warned Mr. Kersting not to address the subject of the status of settlement negotiations in his letters to Kersting program participants, inasmuch as his comments could be detrimental to such negotiations. On or about April 27, 1987, Mr. Chicoine informed Mr. Kersting that he would recommend that Kersting program participants accept a 20-percent settlement offer.
[162] By letter dated May 22, *221 1987, Mr. Kersting provided Mr. Hallett with information pertaining to a purported 30-percent settlement negotiated by Mr. DeCastro on behalf of Benness M. and Jane Richards. 41*222 Mr. Kersting stated that he was attempting to obtain information respecting additional settlements negotiated by Mr. DeCastro. Between May 1987 and February 1988, Mr. Kersting wrote no fewer than seven letters to Chicoine and Hallett strongly objecting to their communication of a 20-percent settlement offer to Kersting program participants. In his May 22, 1987 letter, Mr. Kersting objected to Chicoine and Hallett's recommendation of a 20- percent settlement in pertinent part as follows:
As I have done several times now I ask you again NOT to
communicate to anyone of my friends a prospect of a 20%
settlement. The 50% flop has left a $ 40,000.00 to $ 50,000.00
scar with us. It was a lesson I will take with me to the other
side. I trust that you have reconsidered by now your position in
the matter and that you will NOT go into an adverse stance to me
and my enterprises. I assure you that the jolt of April 27th has
not worn off yet.
[163] On June 10, 1987, Mr. Kersting forwarded to Mr. Chicoine a letter that he had received from Mr. DeCastro pertaining to a settlement that Mr. DeCastro purportedly negotiated on behalf of Boyd S. and Jeannette F. Proctor. By letter dated June 16, 1987, Mr. Chicoine responded to Mr. Kersting, stating that he was satisfied that the Proctors did not receive a settlement in excess of 50 percent as Mr. Kersting had suggested because the figures in question did not include the Proctors' liability for statutory interest. Mr. Chicoine concluded that the settlement was in the range of a 14- percent reduction of the Proctors' deficiency.
[164] On November 4, 1987, Mr. Kersting sent Mr. Hallett a letter which states in pertinent part:
Here I asked you about a year ago to defend my friends,
here I had high hopes *223 and reasonable expectation that you would
work with us, that we would work on consensus and to the common
benefit of my friends and here I find that you not only do not
care to do that, you are actually moving into an adversary
position. And this after I have paid you an enormous amount of
legal fees and after I have disciplined myself over and over
again to keep my temper as I observe a widening rift between the
attorneys who are supposed to work for us and who are, instead,
looking after their strangly [sic] perceived protection from
liability. My interest in these proceedings and what I consider
to be the best interest of my friends is arrogantly overlooked
and we are, if your scheme of things would prevail, relegated to
onlookers to a spectacle for which we are compelled to pay but
in which we are not allowed to take part. It is simply absurd.
[165] On January 12, 1988, Mr. Kersting issued a letter encouraging nontest case Kersting program participants who had paid $ 550 to Chicoine and Hallett for representation in the settlement process to "recall your funds".
[166] By letter dated January 20, 1988, Mr. Chicoine notified the test case petitioners represented *224 by his firm that Mr. McWade was offering a 20-percent settlement. Mr. Chicoine's letter states in pertinent part:
Mr. McWade has stated that you may settle your case along the
grounds set forth above. Since you are a test case, however, you
will not be permitted to withdraw if you wish to enter into the
settlement proposed. Accordingly, we would enter into an
agreement with Mr. McWade that regardless of the outcome of the
trial, you would be allowed the settlement. Thus, if the case
were lost in its entirety, your tax deficiency would be
calculated in accordance with the settlement.
By letter dated January 22, 1988, Mr. Hallett informed Mr. Kersting that Chicoine and Hallett were seeking an opinion from an expert on legal ethics whether it would be appropriate for the firm to accept new clients seeking to settle Kersting project cases. However, Mr. Hallett stated that the firm would continue to inform its existing clients regarding the status of settlement discussions.
[167] By letter dated January 29, 1988, Mr. Chicoine sent Mr. Kersting copies of proposed stipulated decisions reflecting settlements that Mr. Chicoine had negotiated with Mr. McWade in three Kersting *225 cases. 42Mr. Chicoine stated that Chicoine and Hallett were obliged to inform all Kersting program participants who had retained his firm that Mr. McWade was continuing to offer settlements despite Mr. Kersting's misrepresentations in his letters to Kersting program participants that no settlement was being offered.
[168] By letter dated February 5, 1988, John A. Strait, Associate Professor of Law at the University of Puget Sound School of Law (Professor Strait), responded to Chicoine and Hallett's request for an expert opinion regarding their ethical obligations as counsel in the Kersting project. Professor Strait advised Chicoine and Hallett that the firm did not have an attorney/client relationship with, or owe attorney/client duties to, Mr. Kersting, but that Chicoine and Hallett did have an attorney/client relationship with the test case petitioners as well as the nontest case Kersting program participants who had sent Chicoine and Hallett the $ 550 retainer and authorization forms. Concerning the nontest case clients, Professor *226 Strait concluded that Chicoine and Hallett were obliged to "evaluate settlement proposals and to transmit to them your recommendation with the explanation of what the options might be as to the desirability of accepting any settlement proposal."
[169] On February 6, 1988, Mr. Kersting wrote to Mr. Hallett stating in pertinent part:
I take it from our phone conversation yesterday that you are
intent now to trigger the melt-down on me and our corporations
with which you have threatened me now for months. And if I have
absorbed all this correctly, you will do this mainly out of
concern that some of my friends might sue you at some time down
the line if you do not advise them of a "settlement" which you
perceive to be available.
The bitter irony of all this is that there was only a remote
possibility that anyone of my friends would sue you. If you go
through with your threat to cause a run on us you will have THE
CERTAINTY that there will be litigation. It will be hell after
this.
[170] On February 8, 1988, Mr. Kersting wrote a letter to Kersting program participants warning them that Chicoine and Hallett soon would circulate the details of a 20-percent settlement *227 offer. Mr. Kersting urged Kersting program participants not to hire Chicoine and Hallett for purposes of settlement and instead to await the Court's decision regarding the evidentiary issues raised by Chicoine and Hallett on behalf of the test cases. During this period, Mr. Kersting threatened to sue Chicoine and Hallett if they reported the settlement offer.
[171] On February 9, 1988, Mr. Chicoine issued two letters, one addressed to the firm's clients and one addressed to Kersting program participants who had contacted Chicoine and Hallett regarding representation. These letters served as status reports on the Tax Court case and settlement negotiations. Mr. Chicoine reported that Mr. McWade had offered to settle docketed Tax Court cases in accordance with the previously described 20-percent settlement offer, recommended that program participants seriously consider the settlement, and suggested that those who desired to settle on these terms should contact Chicoine and Hallett.
[172] On February 20, 1988, Mr. Kersting wrote to Chicoine and Hallett stating in pertinent part: "I hereby revoke your appointment as counsel for the test cases".
[173] On February 23, 1988, Mr. Chicoine wrote *228 to Mr. McWade seeking a 20-percent settlement on behalf of test case petitioners Terry D. and Gloria K. Owens. Mr. Chicoine's letter states in pertinent part:
Mr. Owens understands that not all cases will settle and you
wish to proceed to trial with some test cases. It is hoped that
under the circumstances he may be withdrawn as a test case. If
this is not possible, he still wishes to settle the case and
enter into an agreement which will permit him to settle the case
regardless of the outcome of the trial.
Mr. and Mrs. Owens subsequently decided that they would not continue efforts to settle their case.
[174] In early March 1988, Chicoine and Hallett began receiving requests from Kersting program participants for return of the $ 550 retainer fee. Although Chicoine and Hallett returned the full amount of the fee to all those who requested it, they were informed that they might be billed for a "minimal amount" reflecting the firm's costs associated with the opening of files and issuance of status reports.
[175] On March 9, 1988, Mr. Kersting issued a letter to program participants characterizing Chicoine and Hallett as "scoundrels", and stating that he had fired them and *229 retained Mr. Izen to represent the test cases (excluding the Thompsons and the Cravenses).
[176] By letter dated April 22, 1988, Mr. Chicoine notified Kersting program participants that the Court had ruled in the Government's favor in Dixon I; he restated his support for the 20- percent settlement offer described in his February 9, 1988, letter and revealed that, because of a disagreement with Mr. Kersting, Chicoine and Hallett would withdraw as counsel for the test cases. 43
[177] Mr. Kersting later carried out *230 his threat to sue Chicoine and Hallett for legal malpractice. Mr. Izen served as an expert witness for Mr. Kersting in his lawsuit against Chicoine and Hallett.
[178] By letter dated April 8, 1988, Mr. McWade notified Mr. DeCastro that, after June 15, 1988, respondent would no longer consider settlements, other than on the basis of allowing out-of- pocket expenses, and that out-of-pocket settlements would no longer be available after October 3, 1988. By memorandum dated October 19, 1988, the Acting Chief of the Tax Shelter Branch notified the Assistant Commissioner for Examination (with copies to the Director of the Appeals Office, Mr. McWade, and several National Office executives) that, because the Kersting test cases had been set for trial in January 1989, the Kersting project settlement offer would be withdrawn, effective October 28, 1988.
1. INITIAL THOMPSON SETTLEMENT AGREEMENT
[179] In early December 1986, Mr. McWade and Mr. DeCastro discussed settlement of the cases of a number of Mr. DeCastro's clients, including the Thompsons. Mr. Sims was aware of the McWade- DeCastro discussions when he also met with Mr. DeCastro in December 1986 at the Honolulu District *231 Counsel Office and generally discussed with Mr. DeCastro settlement arrangements for the Thompson cases.
[180] On December 23, 1986, Mr. McWade mailed a letter to Mr. DeCastro enclosing proposed decision documents for the Thompsons as well as several other taxpayers with cases before the Court. Mr. McWade's letter states in pertinent part:
Dear Mr. DeCastro:
Enclosed herewith are the Decision documents, as per our
conference, in the above-captioned cases. Please sign the
original and one copy of the Decision document, in the space
provided, and return them to this office for signing and filing
with the Court. The remaining copy is for your records.
As previously indicated, the Decision documents in John R.
and Maydee Thompson will not be filed with the Court until the
Decision becomes final in the test cases. In the interim, the
Thompsons can make an advance payment, as discussed at our
conference, and stop the accrual of any additional liability for
In response, on December 30, 1986, Mr. DeCastro executed three separate decision documents on behalf of the Thompsons agreeing to the following deficiencies:
| Year | Dificiency | Additions to Tax |
| 1979 | --- | --- |
| 1980 | $ 34,425 | --- |
| 1981 | 30,000 | --- |
*232 [181] The December 1986 settlements that Mr. McWade extended to Mr. DeCastro's clients differed from the 7-percent official Kersting project settlement offer used by respondent's Appeals Office. In particular, the Thompson settlement included the burnout feature and was based on a reduction of the deficiencies that respondent had determined against the Thompsons of approximately 19 percent as follows:
| Year | Adjustment | Deficiency | Settlement | % Reduction |
| 1979 | $ 39,477 | $ 18,161 | --- | |
| 1980 | 72,840 | 24,838 | $ 34,425 | |
| Total | 42,999 | 34,425 | 20% | |
| 1981 | $ 80,782 | 36,295 | 30,000 | 17 |
| All years total | 79,294 | 64,425 | 19 | |
The adjustments for each year consisted solely of the disallowance of deductions that the Thompsons had claimed with respect to Kersting programs.
[182] On December 30, 1986, Mr. Thompson sent a letter to Mr. McWade enclosing checks for $ 34,000 and $ 25,545 that were intended as payments of interest on the Thompsons' tax liabilities for the taxable years 1980 and 1981, respectively. 44*233
2. FIRST REVISION OF THOMPSON SETTLEMENT
[183] On January 27, 1987, Mr. Huestis sent a letter to Mr. DeCastro stating that Mr. Thompson did not understand the terms of his settlement. On February 3, 1987, Mr. DeCastro responded to Mr. Huestis as follows:
Dear Sam:
Thanks for your letter of January 27, 1987 indicating
questions which Jack Thompson has regarding the proposed
settlement. I will respond in the order of your questions:
1. The only years in dispute are 1979, 1980 and 1981.
2. For each year, the amounts claimed due by the I.R.S. by
category are:
| 1979 | 1980 | 1981 | Total | |
| Tax deficiency | $ 18,161 | $ 24,838 | $ 36,295 | $ 79,294 |
| Penalty | 908 | 1,242 | 19,757 | 21,907 |
| Interest | 19,977 | 24,838 | 27,976 | 72,791 |
| 39,046 | 50,918 | 84,028 | 173,992 |
3. By the terms of the proposed settlement, the following
amounts are due to be paid by Jack:
| 1979 | 1980 | 1981 | Total | |
| Tax deficiency | 0 | $ 34,425 | $ 30,000 | $ 64,425 |
| Interest | 0 | 35,275 | 24,270 | 59,545 |
| 0 | 69,700 | 54,270 | 123,970 |
As you can see, this amounts to a substantial reduction in
tax liabilities.
4. Jack correctly understands that his recent payment of
$ 59,545 *234 was entirely applied to interest.
5. The IRS is willing to settle with Jack only on the basis
that his test case remains active. The terms are not contingent
upon any specific testimony or degree of cooperation and will be
filed upon completion of the test case. Jack need only testify,
at the trial and is only technically a defendant. Unless some
dramatic changes in schedule occur, there will be no
depositions. Essentially, Jack need only testify, be protected
from Kersting, and does not need to prepare a full-blown
defense.
6. As indicated, the IRS insists upon Jack continuing as a
test case defendant for its own purposes. That is presently a
condition of the settlement. In addition, we simply do not trust
Kersting to act in accordance with his promises and staying in
the case appears to be wise insurance to obtain cancellation of
the notes, etc.
7. I enclose a copy of a letter we have sent to Kersting's
attorney regarding the notes issue for your information.
8. If we are unable to obtain a cancellation of notes and
recovery of funds invested for Jack through negotiation, we will
certainly look to retain John Chanin or other local counsel *235 for
that purpose.
On February 6, 1987, Mr. Huestis reviewed Mr. DeCastro's letter with Mr. Thompson and was satisfied that Mr. Thompson understood the status of his case.
[184] On March 13, 1987, following the Maui session, Mr. McWade sent Mr. DeCastro a revised decision for docket No. 31236-84 reducing the Thompsons' tax deficiency for 1980 from $ 34,425 to $ 33,000. Mr. Sims reviewed and approved Mr. McWade's letter to Mr. DeCastro. Although the record contains no explanation for this revision of the Thompson settlement, the revision effectively increased the Thompson settlement from 19 percent to approximately 20 percent. On April 7, 1987, Mr. DeCastro sent Mr. Thompson a letter informing him that the Internal Revenue Service had reduced his tax liability for 1980 by approximately $ 1,000. Mr. DeCastro also informed Mr. Thompson that this reduction would also save him approximately $ 1,000 in interest.
[185] On June 4, 1987, the Court granted respondent's Motion to Withdraw Stipulation of Settlement for Tax Shelter Adjustments in the Thompson cases at docket Nos. 19321-83 and 31236-84. 45Mr. McWade filed the motions on the stated ground that, because the Thompsons had been designated *236 as test cases, it was inappropriate for the Thompson piggyback agreements to remain in effect. Mr. McWade's motions stated that Mr. DeCastro did not object to the granting of the motions. Because Messrs. McWade and DeCastro had previously agreed to settle the Thompson cases, the above-referenced motion is the first instance in which the Court was misled by the failure of counsel who were in the know to disclose that the Thompson cases had been settled.
[186] On June 15, 1987, Mr. DeCastro sent a $ 63,000 cashier's check "in partial payment of the total amount due" to the Internal Revenue Service Center in Fresno, California, on behalf of the Thompsons. The remittance was made with respect to the Thompsons' three docketed cases and included a request that the matter *237 be referred to a problems resolution officer "so that we can determine the balance due and conclude this matter." On June 17, 1987, the Commissioner "transferred" $ 775 of the $ 63,000 payment to the Thompsons' account for 1988 and applied the $ 62,225 balance to the Thompsons' account for 1979. 46 As of June 1987, the Thompsons had paid a total of $ 121,770 towards their tax liabilities (tax and interest) for the taxable years 1979, 1980, and 1981.
[187] On July 10, 1987, Mr. DeCastro wrote to Mr. McWade transmitting a Notice of Overdue Tax received by the Thompsons with respect to their 1981 income tax liability. Mr. DeCastro asked Mr. McWade to contact him regarding the notice and to send him "copies of the decisions entered in this matter." On July 24, 1987, Mr. McWade sent Mr.*238 DeCastro copies of proposed decision documents for the Thompson cases. Mr. McWade informed Mr. DeCastro that "per our understanding, since the Thompsons are involved as a test case, the documents are being held in our files, and will be signed and filed with the Court when the test case litigation has been completed." The revised decision documents prepared by Mr. McWade set forth the Thompsons' tax liabilities as follows:
| Year | Deficiency | Additions to Tax |
| 1979 | --- | --- |
| 1980 | $ 33,000 | --- |
| 1981 | 30,000 | --- |
On August 5, 1987, Mr. DeCastro sent copies of the proposed decision documents to the Thompsons.
3. SECOND REVISION OF THOMPSON SETTLEMENT
[188] Before the trial of the test cases, Mr. DeCastro informed Mr. McWade that the Thompsons were having financial difficulties and that he did not think that it was fair to require the Thompsons to remain as test case petitioners. Mr. DeCastro expressed concern to Mr. McWade about the amount of legal fees the Thompsons would incur as test case petitioners and informed Mr. McWade that he would attempt to have the Thompsons removed from the list of test cases. Mr. McWade told Mr. DeCastro that he did not want the Thompsons to be removed as test case petitioners *239 because he did not want to change the test cases so close to trial. Mr. DeCastro thought that Mr. McWade's desire to retain the Thompsons on the list of test cases was caused by administrative or technical concerns.
[189] Mr. DeCastro and Mr. McWade resolved their respective concerns by further modifying the Thompson settlement. In particular, Mr. McWade agreed to reduce the Thompsons' deficiencies in an amount sufficient to compensate them for the cost of having an attorney represent them at the trial of the test cases. Mr. DeCastro estimated that his legal fees for representing the Thompsons at the trial of the test cases would be approximately $ 60,000. Under the revised settlement agreement, the Thompsons' tax deficiencies were reduced to the following:
| Year | Deficiency | Additions to Tax |
| 1979 | --- | --- |
| 1980 | $ 15,000 | --- |
| 1981 | 15,000 | --- |
By reason of the Thompsons' having previously remitted $ 121,770 to the Internal Revenue Service for the taxable years 1979, 1980, and 1981, Mr. DeCastro and Mr. McWade calculated that the above- described reductions of the Thompsons' deficiencies would generate refunds of tax and interest to the Thompsons of approximately $ 60,000. Mr. DeCastro and Mr. McWade understood *240 that the refunds generated by the reduced deficiencies would be used for the purpose of paying the Thompsons' attorney's fees to Mr. DeCastro.
[190] Although Mr. McWade and Mr. DeCastro agreed to revise the Thompson settlement in this manner before the trial of the test cases, the first written confirmation of their agreement appears after the trial, in the form of an April 10, 1989, memorandum from Mr. McWade to Tom Stevens (Mr. Stevens), Chief of Special Procedures in the Collection Division of the Honolulu District Director's Office, requesting that the latter process a refund to the Thompsons in the amount of $ 30,000. 47
[191] By letter dated September 29, 1986, Mr. Seery informed Mr. Cravens of the terms of the modified 7-percent settlement offer. On October 28, 1986, Mr. McWade disseminated the modified 7-percent settlement offer by form letter mailed to all known Kersting program participants, including the Cravenses. 48 Considering the nature and purpose of the form letter, it appears that issuance of the letter to the Cravenses, who had already been designated test case petitioners, *241 was inadvertent.
[192] On October 15, 1986, Mr. Cravens wrote to Mr. Seery asking him to explain how the proposed settlement offer affected him and to give him a recommendation. By letter dated October 23, 1986, Mr. Seery advised Mr. Cravens to consult a tax preparer or accountant because the offer was complicated in its application to his case. Mr. Seery also noted that Mr. Cravens could take advantage of the unlimited deduction for personal interest in effect for 1986 by paying the liability in full in 1986 whether or not he settled his case. 49
[193] On October 31, 1986, Mr. Cravens again wrote to Mr. Seery with questions about the settlement offer. In the letter, Mr. Cravens informed Mr. Seery that he had paid a cash bond against the deficiency for 1979 and felt "in good shape for that year." Mr. Cravens then asked whether respondent's determination to include a dividend in his income for 1980 would be eliminated to reduce the deficiency for that year. If so, Mr. Cravens indicated that he would pay *242 the amount that would be due, "and not take the gamble on the courts" since the amount due would be "catastrophic" if he lost. In closing, Mr. Cravens offered to pay Mr. Seery for the extra effort on his case, and reminded him that the deadline for accepting the settlement offer was drawing near.
[194] As previously mentioned, Mr. Seery began to withdraw as counsel for test case petitioners following the Court's November 14, 1986, order indicating that Mr. Seery might have a conflict of interest.
[195] Sometime after receiving Mr. Mcwade's October 28, 1986, letter, Mr. Cravens contacted Mr. McWade by telephone with the intent of settling his case. Mr. Cravens took notes of his conversation with Mr. McWade, which indicate that they discussed: (1) Eliminating the dividend adjustment for 1980; (2) eliminating all penalties for both 1979 and 1980; (3) backing out the tax already paid with respect to the capital gains that the Cravenses had reported for 1980; and (4) eliminating statutory interest for 1979. Mr. McWade told Mr. Cravens that he would call him back with figures reflecting "the amount due for the settlement." Mr. McWade called Mr. Cravens back on December 15, 1986.
[196] On December *243 16, 1986, Mr. Cravens wrote to Mr. McWade confirming the terms of his settlement as follows:
Dear Ken:
As per our telephone conversation 12/15/86, I am
enclosing a check for $ 10,678.67. According to the amount we
agreed on via telephone, the figures break down like this:
| Deficiency for 1979 and 1980 | $ 9,782.16 |
| Less cash bond | 4,508.00 |
| Total | 5,274.16 |
| Plus 1.02474 interest | 5,404.51 |
| Total due | 10,678.67 |
I wish to thank you for being so agreeable and
assisting me in settling this matter.
[197] Mr. Cravens' payment of $ 10,678.67 on December 16, 1986, was processed on December 31, 1986, pursuant to a payment posting voucher bearing Mr. McWade's initials. The payment posting voucher provided for the application of the funds as follows:
| Year | Advance Payment | Designated Interest |
| 1979 | $ 3,000.00 | $ 3,000.00 |
| 1980 | 2,274.16 | 2,404.51 |
| Total | 5,274.16 | 5,404.51 |
[198] Mr. Cravens believed his settlement assured that he could neither win nor lose at the trial of the test cases. At the time that he entered into his settlement, Mr. Cravens was not aware that Mr. McWade intended to allow the Cravenses the better of the above- described settlement or the outcome based upon the Court's opinion following the trial *244 of the test cases.
[199] Although Mr. Cravens intended to accept the modified 7- percent settlement offer, the Cravenses' settlement was less favorable to them than the modified 7-percent settlement offer. In particular, the Cravenses' correct tax liabilities for 1979 and 1980 were $ 4,508 and $ 5,893.45, respectively, for a total of $ 10,401.45. 50 Thus, the Cravens settlement in the amount of $ 9,782.16 represents a reduction of approximately 6 percent of the correct amount of the Cravenses' deficiencies. In addition, the Cravens settlement was not structured to include the burnout feature. At the time that Mr. Cravens settled his cases, Messrs. Sims and McWade were offering 20-percent settlements with the burnout feature to Mr. DeCastro's clients and Chicoine and Hallett's clients.
[200] Mr. McWade was aware *245 that Mr. Cravens was a test case when he spoke to Mr. Cravens about settling his cases. Mr. McWade told Mr. Cravens that the Cravenses would have to continue as test case petitioners as a condition of the settlement. Mr. McWade did not tell Mr. Cravens to cooperate with the Government in the trial of the test cases, or to keep his settlement a secret. Mr. McWade did not tell Mr. Cravens that he had to settle so-called open years, nor did Mr. McWade examine Mr. Cravens' returns for years still open under the applicable statute of limitations to determine whether he had claimed Kersting deductions for years not before the Tax Court.
[201] Mr. McWade initially told Mr. Cravens that his settlement assured that the Cravenses could not win or lose in the trial of the test cases. Mr. McWade also told Mr. Cravens that, by reason of the settlement, the Cravenses did not need an attorney. Mr. Cravens therefore concluded that he no longer needed legal representation. When Mr. Cravens asked Mr. McWade why he had to remain a test case despite his settlement, Mr. McWade responded that to remove the Cravenses from the group of test cases would cause a delay in the trial of the test cases while a replacement *246 test case was selected.
[202] After Mr. Seery's withdrawal from their cases, the Cravenses did not retain new counsel. When Mr. Kersting asked Mr. Cravens why the Cravenses had failed to authorize Chicoine and Hallett to represent them, Mr. Cravens informed Mr. Kersting that he had settled his cases.
[203] On December 13, 1988, within 1 month before the trial of the test cases, which began January 9, 1989, Mr. McWade forwarded to the Cravenses proposed decision documents fixing their tax liabilities for 1979 and 1980, to be signed and returned to Mr. McWade. The proposed decision documents provided as follows:
| Year | Deficiency | Additions to Tax |
| 1979 | $ 3,606.40 | --- |
| 1980 | 6,175.76 | --- |
The $ 3,606.40 figure for 1979 represents a 20-percent reduction of the $ 4,508 deficiency that respondent determined against the Cravenses for that year. However, the derivation of the $ 6,175.76 figure for 1980 is not known; it exceeded the correct deficiency of $ 5,893.45 for 1980, including adjustments eliminating both the capital gains that the Cravenses reported for that year and respondent's alternative determination that the Cravenses failed to report dividends paid to them by Candace. The sum of the two figures *247 ($ 9,782.16) is equal to the total tax deficiency Messrs. Cravens and McWade had previously agreed to, as shown by Mr. Cravens' letter of December 16, 1986, to Mr. McWade.
[204] Mr. Sims approved Mr. McWade's decision to forward decision documents to the Cravenses for their signature 1 month before trial of the test cases, believing that the Cravenses had accepted the 20-percent settlement offer. When Mr. Cravens testified at the trial of the test cases, Mr. Sims continued to believe that Mr. Cravens was entitled to the 20-percent settlement. On December 23, 1988, the Cravenses signed the decision documents and returned them to Mr. McWade.
[205] When Mr. Cravens appeared at the trial of the test cases, he was surprised and suspicious when Mr. McWade informed him that he would be entitled to the better of his settlement or the Tax Court's decision in the test cases.
[206] On June 3, 1986, Mr. Alexander wrote to Mr. Matsumoto, suggesting that they might "blow the whistle" on Mr. Kersting. Mr. Alexander's letter displays animosity and resentment against Mr. Kersting arising out of their unresolved dispute, which had not yet been submitted to arbitration. Shortly *248 after writing to Mr. Matsumoto, Mr. Alexander listened in on a telephone conference call between Mr. McWade and Mr. Matsumoto as confirmed in a subsequent letter that Mr. Alexander wrote to Mr. Kozak. Mr. Alexander's letter to Mr. Kozak, dated July 16, 1986, states:
Dear Chuck:
I just had a long phone conversation with Gilbert Matsumoto
relative to blowing the whistle on you know who. During this
long phone call Gilbert "patched" me in to his phone while he
called McWade, the attorney at the IRS. I must say Gilbert's
phone mechanism works very well, I heard every word McWade said
and he did not know I was on the line. Gilbert instructed me not
to say anything.
After the conversation with McWade Gilbert agreed to call you
and fill you in on the latest information. McWade will be now
talking to Myron Chang, the IRS attorney on the Criminal
Investigation side of the IRS. McWade also said to go ahead with
the Affidavits and then we can discuss with himself and with
Myron Chang what the next step will be. In the conversation with
McWade, Gilbert also discussed the amount of "finder's fee" and
method of payment to the person(s) supplying the information. It
*249 was very clear to me that the fees are negotiable and that they
could be on the amount assessed or the amount collected. This is
also negotiable and from their eagerness to get you know who I
believe the fees could be sizeable.
My suggestion to Gilbert was to go ahead with you and draft the
Affidavits, at least yours and mine and we (you, Gilbert and me)
would review the Affidavits before sitting down with McWade and
Myron Chang. The conversation with McWade ended with him saying
he would get back to Gilbert after another meeting with Chang,
however, we should go ahead with drafting the Affidavits.
Chuck, as Gilbert may have told you, this means blowing the
whistle on 1400 of you know who's [sic] clients, 10 or 12 of
which are Gilbert's clients. As you and I discussed, when the
Nazi knows that 1400 of his client's [sic] are going to be
clobbered and that he will have the Criminal Investigation
Division of the IRS coming down on him I think he will be
inclined to pay me my money.
In the weeks that followed, Messrs. Alexander and Kozak prepared draft affidavits for submission to Mr. McWade.
[207] On August 12, 1986, Mr. Alexander sent copies of his draft *250 affidavit to Messrs. Matsumoto and Kozak by overnight mail. On August 15, 1986, Messrs. Alexander, Matsumoto, and Kozak held a conference call regarding the affidavits. In a letter to Messrs. Kozak and Matsumoto dated August 16, 1986, Mr. Alexander stated as follows:
Dear Chuck & Gilbert:
Following our conference call of yesterday, August 15th, I am
submitting the following for both of your considerations:
1. I suggest that we submit to the IRS AFFIDAVITS in DRAFT FORM
ONLY.
2. It is against my better judgment to submit executed and
notarized affidavits without having some idea what the IRS will
do and what they will pay.
3. They can make their determination(s) and eat up 30 days
based on drafts or I should say final drafts. We can agree
verbally to execute the final drafts when they tell us exactly
what else they want and what they will do for us.
4. With executed affidavits we would leave ourselves open to the
following:
a. They could investigate and audit all our past tax returns.
b. They could refuse immunity.
c. They could claim Alexander was an associate/conspirator with
Kersting.
d. They could claim Alexander was in violation of IRS
regulations *251 by not turning Kersting in years ago.
e. They could claim Alexander knew the notes were a "sham" tax
avoidance/evasion scheme early on and under IRS regulations
Alexander was obligated to report this to IRS early on.
4. [sic] I understand that Gilbert is not expecting a large fee
for his cooperation in this matter, however, I have told Gilbert
that if the IRS payment to me for this testimony is a large
amount that I will contribute something toward whatever amount
Gilbert's 8 or 10 clients will be forced to pay as a result of
my testimony.
5. What does Chuck expect for his role in this matter???
[208] On August 20, 1986, Mr. Kozak sent a letter to Mr. McWade, enclosing draft affidavits from both himself and Mr. Alexander. Mr. Kozak's letter states: "We are willing to negotiate an arrangement with the IRS, wherein we would execute the affidavits enclosed and provide testimony consistent with the affidavits or in clarification thereof." The draft affidavits that Mr. Kozak sent to Mr. McWade contained information regarding the various Kersting programs in dispute in the test cases. Mr. Kozak's draft affidavit alleged that Mr. Kersting refused to pay David Bigelow the *252 "equity" in a mortgage funding program and that Mr. Provan knew other airline pilots who were "shocked and angry that Kersting would attempt to collect these notes after he had assured them the notes would not be collectable." Both draft affidavits alleged that Mr. Kersting had sued Mr. Alexander for over $ 500,000 on the basis of promissory notes with respect to which Mr. Alexander "never received any money whatsoever or anything of value in exchange for the promissory notes." Mr. Alexander's draft affidavit alleged that: (1) Mr. Alexander was in litigation with Mr. Kersting "over funds Kersting supposedly was to invest in auto leasing and factoring at Universal Leasing and Federal Finance & Mortgage", and that "Kersting refused to pay the yield or return the funds"; (2) "no client of Kersting's has ever repaid a promissory note * * * with funds other than provided by Kersting through his closed circulation of funds from one Kersting controlled entity to another"; and (3) Mr. Alexander believed that Mr. Kersting's only legitimate business was the purchase of First Savings, in which Mr. Alexander was a shareholder.
[209] Mr. Alexander's affidavit reveals that Mr. Alexander expected *253 a "quid pro quo" for his testimony, as follows: "9. Affiant is ready and willing to testify to the above facts or any others within his knowledge concerning Kersting provided an agreement quid pro quo can be worked out through affiant's representatives, Charles R. Kozak and Gilbert Matsumoto."
[210] Mr. Kozak submitted his draft affidavit to Mr. McWade in August 1986 in an effort to have Mr. McWade eliminate the deficiencies in Mr. Kozak's case, assigned docket No. 25812-81, concerning the Kozaks' tax liabilities for 1973, 1974, and 1975, arising from their participation in Pike programs.
[211] Messrs. Alexander, Kozak, and Matsumoto met Mr. McWade in Hawaii in early September 1986. During the meeting, Mr. McWade informed Mr. Alexander that his authority was limited and that there were a number of prerequisites to payment of an informant's award or "finder's fee". The prerequisites that Mr. McWade mentioned included the submission of an affidavit, an Internal Revenue Service investigation, and an assessment resulting from the information provided. The amount of an award was not discussed during the meeting. Mr. McWade suggested that Mr. Alexander should see Myron Chang, head of the Internal *254 Revenue Service Criminal Investigation Division in Honolulu, to determine whether the Criminal Investigation Division was interested in Mr. Alexander's affidavit. Mr. McWade told Mr. Kozak that he could do nothing to reduce the Kozaks' tax deficiencies.
[212] Mr. Alexander's efforts to cooperate with the Internal Revenue Service remained dormant until Mr. Alexander again met with Mr. McWade in late 1988 to discuss his tax liabilities for the years 1974, 1975, 1976, and 1977. During this meeting, Mr. McWade told Mr. Alexander to search his records for documentation to support the Alexanders' reporting position for the years 1974 through 1977.
[213] On October 20, 1988, Mr. Alexander sent a letter to Mr. McWade enclosing copies of several documents purporting to substantiate the Alexanders' position that they realized a loss of $ 55,152.04 in 1975 on a sale of real estate to the Cadillac Drive Apartments partnership, as opposed to the $ 59,080 capital gain determined in the notice of deficiency.
[214] On December 8, 1988, Jean Samuels (Ms. Samuels), an Appeals auditor in the Honolulu Appeals Office, sent a two-page memorandum to Mr. McWade addressing Mr. Alexander's October 20, 1988, letter. *255 Ms. Samuels recommended one adjustment to the notice of deficiency for 1975 in the Alexanders' favor. Specifically, Ms. Samuels concluded that the Alexanders had substantiated a higher cost basis in the property that they sold to the Cadillac Drive Apartments partnership than had been used in the notice of deficiency. Giving effect to this higher basis would have reduced the Alexanders' capital gain on the sale by $ 23,084. Taking into account the corresponding adjustment to the section 1202 deduction previously allowed in the notice of deficiency, Ms. Samuels recommended a net decrease of $ 11,542 to the Alexanders' taxable income as determined in the notice of deficiency. However, Ms. Samuels referred to certain covenants in an agreement of sale in the file before her, and cautioned Mr. McWade that the consideration paid to the Alexanders on the sale may actually have been higher than the amount used in the notice of deficiency.
[215] If Ms. Samuels' recommended adjustment to the notice of deficiency issued to the Alexanders for 1974 and 1975 had been accepted, the total adjustments for 1975 would have been reduced from $ 127,562 to $ 116,020, but the deficiency would not have been *256 eliminated.
[216] Mr. McWade believed that Mr. Alexander was familiar with the operation of Mr. Kersting's various programs. Before the trial of the test cases, Mr. McWade arrived at a general understanding with Mr. Alexander that the Alexanders' tax liabilities for the taxable years 1974, 1975, 1976, and 1977 would be reduced in exchange for Mr. Alexander's agreement to serve as an undeclared consultant or assistant to Mr. McWade during the trial of the test cases. Mr. McWade's understanding with Mr. Alexander is reflected in decision documents that were executed by Mr. McWade on April 6, 1989, and approved by Mr. Sims. In particular, Mr. McWade executed a stipulated decision in docket No. 2758-80 conceding the deficiencies determined against the Alexanders for the taxable years 1974 and 1975 and allowing the Alexanders overpayments for the taxable years 1974 and 1975 in the amounts of $ 2,133 and $ 811, respectively. In sum, Mr. McWade completely eliminated all deficiencies determined against the Alexanders for the taxable years 1974 and 1975 and relieved the Alexanders of the concessions that they had made before the issuance of the notice of deficiency for those years. The stipulation *257 accompanying the decision document submitted to the Court in docket No. 2758-80 states as follows:
STIPULATION
It is hereby stipulated that the following statement shows
the petitioners' income tax liabilities for the taxable years
1974 and 1975:
NET TAX ASSESSED AND PAID $ 3,646.00
Payments: April 15, 1975 $ 1,513.00
December 15, 1984 2,133.00
________
Total payments $ 3,646.00
TAX LIABILITY $ 1,513.00
OVERPAYMENT $ 2,133.00
Return filed April 15, 1975
No claim filed
No agreement executed
Deficiency notice mailed November 29, 1979
NET TAX ASSESSED AND PAID $ 1,114.00
Payments: April 15, 1976 $ 303.00
December 15, 1984 811.00
Total payments $ 1,114.00
TAX LIABILITY $ 303.00
______
OVERPAYMENT $ 811.00
Return filed April 15, 1976
[217] At the time that Mr. McWade submitted the above-described decision document to the Court, respondent's legal file did not include any explanation of the elimination of the Alexanders' deficiencies for the taxable years 1974 and 1975. The Court entered the parties' stipulated decision in docket No. 2758-80 on April 13, 1989.
[218] On April 6, 1989, Mr. McWade also executed a stipulated decision in docket No. 30413-86, approved by Mr. Sims, conceding in full the deficiencies determined against the Alexanders for the taxable years 1976 and 1977 as follows:
ORDERED AND DECIDED: That there are no deficiencies in
income taxes due from, or overpayments due to, the petitioners
for the taxable years 1976 and 1977;
That there are no additions to the taxes due from the
petitioners for the taxable years 1976 and 1977, under the
provisions of
provisions of
[219] On April *259 6, 1989, Messrs. Sims and McWade signed a Counsel Settlement Memorandum relating to the Alexanders' case at docket No. 30413-86, which states as follows:
The above-entitled case is being settled on the basis that
there are no deficiencies in income taxes due from, nor
overpayments due to, the petitioners for the taxable years 1976
and 1977.
Discussion: The above-entitled case is part of the Kersting
interest deduction tax shelter program. The basis for settlement
represents allowance of petitioners' out-of-pocket expense,
approximately 7% of the deficiency, and concession of penalties
for settlement purposes.
If more than one year is involved, the settlement reflects
a shelter burn-out for the first half of petitioners'
participation, and a disallowed deduction for the later years.
Non-Kersting Issues: None.
The Counsel Settlement Memorandum signed by Messrs. Sims and McWade contains two false statements: (1) That the basis for settlement represents the Alexanders' out-of-pocket expenses; and (2) that the case did not include any non-Kersting issues. The Court entered the parties' stipulated decision in docket No. 30413-86 on April 13, 1989.
[220] *260 The stipulated decisions described above reflect Mr. McWade's general understanding with Mr. Alexander, made before the trial of the test cases, to reduce the Alexanders' tax liabilities, in exchange for Mr. Alexander's cooperation and assistance at the trial of the test cases.
[221] On July 23, 1981, the Commissioner issued a joint notice of deficiency to Mr. Kozak and his wife, Susan K. Kozak, disallowing subchapter S losses and interest deductions that the Kozaks claimed on their tax returns for 1973, 1974, and 1975 with respect to their participation in Kersting programs that were the subject of
[222] On May 12, 1986, Mr. McWade filed a motion for order to show cause why a decision should not be entered in the Kozaks' case consistent with the Court's opinion in the Pike case, less out-of- pocket expenditures. The Kozaks did not respond to the Court's order, and on September 30, 1986, the Court entered an Order and Decision against the Kozaks for deficiencies in tax in the amounts of $ 1,641, $ 1,844, and $ 902 *261 for the taxable years 1973, 1974, and 1975, respectively, reflecting approximately a 7-percent reduction of the deficiencies that respondent had determined against the Kozaks.
[223] On November 17, 1986, Mr. Seery and Mr. McWade signed a stipulation to take Mr. Kersting's deposition in Honolulu. On January 7, 1987, the day to which the deposition had been adjourned, Mr. Bradt and Mr. Moseley filed a motion for protective order with the Court on behalf of Mr. Kersting. Judge Goffe denied the motion in a telephone conference call with the parties on the morning of January 7, 1987.
[224] Mr. Seery did not appear at the deposition because he had withdrawn or was in the process of withdrawing from the Kersting project test cases. Mr. Moseley appeared at the deposition and stated that Mr. Kersting would not be deposed until Mr. Kersting was provided with copies of any prior statements he had made to the Internal Revenue Service. Although Mr. Kersting was not deposed on January 7, 1987, Messrs. McWade, Moseley, and Chicoine agreed on a procedure for respondent to review a large number of documents produced by Mr. *262 Kersting at that time.
[225] The following colloquy ensued upon Mr. DeCastro's appearance at the deposition, at a time when Mr. DeCastro had already executed and delivered the initial Thompson settlement agreement to Mr. McWade:
MR. McWADE: Let the record show that Mr. Luis DeCastro from
Los Angeles, who represents Mr. Thompson, has arrived.
(Off the record.)
MR. MOSELEY: Not to stray from the subject, but I could,
for the record, find out, you represent Mr. --
MR. DeCASTRO: Thompson.
MR. MOSELEY: Thompson. He's one of the test cases that were
designated?
MR. McWADE: Yes.
MR. MOSELEY: I would just like for the record to object to
Mr. DeCastro's appearance here. And the objection is on the
basis that I have been informed that Mr. DeCastro has informed
at least some of the petitioners' counsel that in fact they are
planning to settle Mr. Thompson's case, and if they are planning
to settle Mr. Thompson's case, then essentially his appearance
at a deposition of my client would not be appropriate. I just
want to enter that for the record. And I'm going to go on, then,
with the description of what I was talking about in terms of the
other *263 documents.
MR. McWADE: If we can take a break here, just so I can
advise Mr. DeCastro of where we are at this point.
There is no further mention of the possible settlement of the Thompson cases appearing in the transcript of the January 7, 1987, proceedings. As discussed below, Mr. Kersting eventually was deposed in October 1988.
[226] In early 1987, Mr. O'Neill, on behalf of the Honolulu District Examination Division, requested the Justice Department to initiate legal proceedings to serve Mr. Kersting with a John Doe Summons (summons). 51*264 The purpose of the summons was to compel Mr. Kersting to identify the participants in Mr. Kersting's programs during the taxable years 1984, 1985, and 1986, and to aid the Internal Revenue Service in developing a case against Mr. Kersting for so-called promoter penalties under sections 6700 and 6701.
[227] On May 15, 1987, the U.S. Attorney's Office filed a petition in the Federal District Court for Hawaii to serve Mr. Kersting with the summons. The summons requested production of all books and records in Mr. Kersting's custody and control relating to participants in Mr. Kersting's programs for 1984, 1985, and 1986. The summons specifically requested production of customer lists and similar documents containing the names, addresses, and other identifying information of the participants. Mr. Kersting moved to quash the summons.
[228] On July 1, 1987, the District Court granted the Government's petition to serve Mr. Kersting with the summons. Mr. Kersting produced some documents to Revenue Agent Larry Tahara in response to the summons but did not fully comply with the summons. *265 Mr. Kersting challenged the summons during protracted summons enforcement proceedings that followed.
[229] Following an August 1987 hearing, the District Court ordered Mr. Kersting to produce the summoned documents by February 1988. After another hearing in March 1988, the District Court, in May 1988, held Mr. Kersting in contempt and threatened him with fines if the summoned documents were not produced. During this period, Mr. Izen filed a motion to intervene in the summons proceedings on behalf of his test case petitioners. The District Court denied Mr. Izen's motion.
[230] Both Mr. Kersting and Mr. Izen appealed the District Court's decision enforcing the summons to the Court of Appeals for the Ninth Circuit. The Court of Appeals remanded the case to the District Court to determine whether Mr. Kersting had substantially complied with the summons so as to moot the appeals. See
[231] As previously mentioned
[232] By February 1988, Mr. Kersting's dissatisfaction with Chicoine and Hallett over evaporation of the 50-percent settlement and their promotion and reporting of 20-percent settlements led him to terminate their employment as counsel for the test cases and to encourage their other Kersting program clients to recall their settlement retainers. In April 1988, the Court granted Chicoine and Hallett's motions to withdraw their appearances as counsel for test case petitioners.
[233] In February 1988, Mr. Kersting retained Mr. Izen to represent the test case petitioners, other than the Thompsons and the Cravenses. At the time, Mr. Izen had no experience representing test case taxpayers in the Tax Court, although he did have experience representing taxpayers who had signed piggyback agreements to be bound by the outcome of test *267 cases in a tax shelter project.
[234] Mr. Izen filed entries of appearance as counsel for test case petitioners during February 1988 through January 1989. Mr. Izen examined the deductions claimed by the test case petitioners he represented to determine whether they were representative of the Kersting programs. Mr. Izen analyzed the various Kersting programs and documents regarding each of the test case petitioners that he represented. On the basis of his analysis, Mr. Izen determined that the test case petitioners that he represented would be representative of the nontest cases.
[235] On April 29, 1988, Mr. Izen filed a motion to compel Chicoine and Hallett to provide him with the client files and papers of certain test case petitioners he represented. On June 6, 1988, Mr. Chicoine filed an objection to Mr. Izen's motion, asserting that Chicoine and Hallett had returned to Mr. Izen's clients all original documents that had been provided to Chicoine and Hallett. By order dated July 11, 1988, the Court denied Mr. Izen's motion as moot.
[236] From the beginning of his representation of the test case petitioners until late 1995, Mr. Izen's fees were paid by check signed by Mr. Kersting and *268 written on bank accounts of corporations controlled by Mr. Kersting. Commencing December 1995, Mr. Izen's fees have been paid from a "pool" or "fund" contributed by a group of test and nontest case petitioners.
[237] On July 8, 1988, respondent served Mr. Kersting and the test case petitioners with a notice of deposition pursuant to Rule 75. On July 25, 1988, Mr. Kersting served Mr. McWade with an objection stating, inter alia, that Mr. Kersting should not be deposed because he had reason to believe that he was under criminal investigation. Mr. Kersting's objection included allegations that Mr. Alexander was assisting the Government in the criminal investigation.
[238] On August 25, 1988, Mr. McWade filed a motion to take Mr. Kersting's deposition in the test cases. Mr. McWade attached a number of documents to his motion for the purpose of refuting Mr. Kersting's allegations that he was under criminal investigation. In particular, Mr. McWade attached copies of the affidavits that Messrs. Alexander and Kozak had submitted to Mr. McWade in August 1986, as well as copies of the various documents and letters circulated between Messrs. Alexander, Matsumoto, *269 and Kozak during that same period. See
[239] During October 24 through 27, 1988, Mr. Kersting was deposed in Honolulu. Mr. Bradt represented Mr. Kersting at the deposition. Mr. McWade, along with Jeffrey A. Hatfield (Mr. Hatfield), and Thomas A. Dombrowski (Mr. Dombrowski), questioned Mr. Kersting on behalf of respondent. 52Mr. Izen and Mr. DeCastro questioned Mr. Kersting on behalf of their clients. Mr. Cravens did not participate in the deposition.
[240] Mr. Kersting did not bring any documents to the deposition; he claimed that the documents had already been produced in response to respondent's summons. During the deposition, the parties conducted a telephone conference call with Judge Goffe regarding Mr. Kersting's failure to produce the requested documents. As a result of the conference call, the parties *270 agreed that Mr. McWade could inspect documents that Mr. Kersting had produced in response to the summons. Mr. McWade's review of these documents was intended to satisfy Mr. Kersting's obligation to produce documents at his deposition. Mr. Kersting and Mr. Bradt agreed to this procedure.
VIII. TRIAL OF TEST CASES (JANUARY 1989)
[241] The trial of the test cases was conducted before Judge Goffe during January 9 through 27, 1989, at Honolulu, Hawaii. Respondent was represented at the trial by Messrs. McWade, Dombrowski, and Hatfield. Mr. Sims attended the trial but did not enter an appearance for respondent. Mr. Sims and Mr. McWade did not inform Judge Goffe, the National Office, the Regional Office, or Mr. Izen of the Thompson and Cravens settlements or the Alexander understanding before or during the January 1989 trial of the test cases.
[242] Respondent issued subpoenas duces tecum to all test case petitioners, directing them to appear, testify, and produce documents at the trial of the test cases. Each of the eight test case petitioners testified during the trial of the test cases. Mr. Hatfield conducted the cross-examination of test case petitioners Dixon, Owens, Young, DuFresne, Rina, *271 and Hongsermeier. Mr. McWade conducted the cross-examination of Messrs. Cravens, Thompson, Moseley, and Kersting, and the direct examination of Messrs. Kersting, Toyota, Ing, and Alexander. Mr. Dombrowski conducted the direct examination of Alice Combs and Margo Akamine, Mr. Kersting's bookkeepers.
[243] Following Mr. Seery's withdrawal from the Cravens cases in early 1987, Mr. Cravens did not retain substitute counsel because he regarded his cases as settled. Mr. Cravens arrived in Hawaii 1 day before he was scheduled to testify at the trial of the test cases. The Government paid Mr. Cravens' travel, food, and lodging expenses while he was in Hawaii. 53
[244] Mr. McWade prepared and submitted to the Court requested findings of fact respecting Mr. Cravens' participation in the disputed Kersting programs. When Mr. Cravens testified during the trial of the test cases, he made a brief statement to the Court about his participation in the Kersting programs, told the Court and the parties that he had absolutely nothing to hide, and *272 said that he would answer any questions to the best of his ability.
[245] Mr. McWade cross-examined Mr. Cravens at the trial and elicited testimony to support respondent's proposed finding of fact that Mr. Cravens' primary reason for participating in the Kersting programs was to obtain tax benefits. Mr. Cravens testified that he participated in Stock Subscription Plans in 1979 (Candace) and 1980 (Delta), and that he closed out his participation in the Kersting programs by endorsing his stock certificates and returning them to Mr. Kersting in exchange for the return of his promissory notes.
[246] Mr. McWade introduced exhibits at the trial pertaining to Mr. Cravens' participation in Kersting programs that were referred to in the stipulation of facts that had been signed by Mr. McWade and Mr. Cravens. Mr. Izen briefly cross-examined Mr. Cravens after Judge Goffe asked what right Mr. Izen had to question a test case petitioner who was not his client. In the absence of an objection from Mr. Cravens, and in light of Mr. McWade's assent to a brief cross-examination, Judge Goffe stated: "I'll permit a certain amount of questioning, but we'll just see where it goes." Mr. DeCastro did not question *273 Mr. Cravens, nor did the Court.
[247] Mr. Cravens never informed the Court that he had settled his case because he believed the matter was common knowledge. Mr. Cravens had no intention of having a secret settlement. Following the trial, the Cravenses did not file any briefs with the Court.
[248] Mr. Thompson appeared at the trial of the test cases and produced eight pages of documents in response to the subpoena duces tecum issued by Mr. McWade. 54*274 The Government paid Mr. Thompson's travel, food, and lodging expenses.
[249] Mr. DeCastro conducted direct and redirect examinations of Mr. Thompson. Mr. DeCastro questioned Mr. Thompson about his participation in the acquisition of First Savings as well as the Bauspar program to show that the Thompsons had financial dealings with Mr. Kersting other than through the programs at issue in the trial. Mr. Thompson testified that, following a forced merger between First Savings and First Federal Savings of Honolulu, Mr. Kersting returned the Thompsons' $ 20,000 initial investment in First Savings. Mr. Thompson further testified that he lost $ 80,000 in the Bauspar program.
[250] Mr. McWade cross-examined Mr. Thompson. Mr. Thompson had never met Mr. McWade until he was scheduled to testify. Pursuant to a stipulation of facts, Mr. McWade introduced exhibits at the trial of the test cases pertaining to the Thompsons' participation in the disputed Kersting programs. During Mr. McWade's cross-examination, Mr. Thompson made *275 the following statement:
Mr. McWade: When did you terminate your participation in
these plans, Mr. Thompson?
Mr. Thompson: In -- let's see -- 1984. No, wait a minute;
1982. I retired, and I went to my retirement party, came home,
and I had notice from the Internal Revenue Service regarding my
1978 taxes. And I went up to the house, called him up, and said,
"Henry, I've got a problem." And he said to just send it to him
and held take care of it.
Two and half years later he was still taking care of it. I
still didn't know what was wrong. And I was becoming very
disenchanted with his taking care of it. To be quite honest with
you, I went to an attorney over it.
And an agent actually came to our house and was interested
in my paying him $ 23,346, as I remember, on the spot.
In the interim period I had received no notice that our
house had a lien slapped on it from the Internal Revenue
Service, but I didn't know about this.
But anyway, this was all the thing that brought all my
investments with Mr. Kersting to a head. I got absolutely no
support that was effective from him. I wanted to know what the
problem was so that I could address *276 it -- not in a manner of
putting a band-aid on it; I wanted it settled. I was retired. I
couldn't go on with this business that, "Oh, we'll go to court
and they'll never get us," and all of this business that we had.
I was out money, lots of it: $ 80,000, on the one hand. And
$ 23,000 goes over 100 -- pretty easy, right then.
I was in the process of doing a trust. I went to the
attorney that was running that for me, and he wrote a letter to
Kersting wanting to know what he had done, and got a rotten
letter back from him. I tried to get him to do something for me
on the 1978 situation, and there wasn't anything happening.
The procedure went through a tax firm in Los Angeles known
as Loeb & Loeb, and I wound up with the DeCastro Law Corporation
by way of their direction, and made several discoveries that
were startling to me. And of course, I settled. To be quite
honest, I had to get out of this. I was not going to spend my
life --
Mr. McWade: Well, let me --
Mr. Thompson: -- doing all this.
Mr. McWade: Let me stop you here for a moment.
Mr. Thompson: Okay. I'm sorry. I beg your pardon.
Mr. McWade: Mr. Thompson, can you tell me: *277 have we been
successful in getting the lien removed from your house?
The subject of the Thompson settlement did not arise again during Mr. Thompson's testimony at the trial of the test cases. 55
[251] Mr. McWade followed the colloquy quoted above by asking Mr. Thompson whether he had ever tendered stock certificates to Mr. Kersting. Mr. Thompson responded that, contrary to Mr. Kersting's promises, he tried twice (through Mr. DeCastro and Mr. Chanin) to tender his stock certificates to Mr. Kersting in exchange for the cancellation of his promissory notes but had been refused.
[252] Mr. McWade prepared and submitted to the Court requested findings of fact respecting *278 the Thompsons' participation in the disputed Kersting programs. Mr. McWade relied upon Mr. Thompson's testimony at trial to support respondent's proposed findings of fact that Mr. Thompson "lost $ 80,000 maintained in the savings program with the Kersting company."
[253] Mr. Izen was permitted to cross-examine Mr. Thompson. Mr. Izen questioned Mr. Thompson about his purported $ 80,000 loss from the Bauspar program, Mr. Thompson's dispute with Mr. Kersting, and Mr. Kersting's threats to bring a lawsuit against the Thompsons. 56
[254] Mr. McWade subpoenaed Mr. Kersting to testify at the trial of the test cases. Mr. Kersting testified extensively at the trial of the test cases regarding the Kersting programs in dispute. As discussed in greater detail below, Judge Goffe concluded in Dixon *279 II that Mr. Kersting's testimony lacked credibility.
[255] Mr. Kersting testified about the First Savings acquisition. In particular, Mr. Kersting testified that the acquiring group of approximately 40 investors (including Mr. Thompson) had been required to pledge their First Savings stock to secure a loan from First Hawaiian Bank to provide partial financing for the acquisition. Mr. Kersting further testified that, following the initial acquisition, he arranged for the acquiring group to relinquish their interest in First Savings and become shareholders of a newly organized Kersting holding company known as Investors Financial Corp. (Investors Financial), which was to be a holding company for First Savings. Mr. Kersting testified that initially he had been erroneously informed that regulatory approval was not required for Investors Financial to serve as a holding company for First Savings. Mr. Kersting testified that the Federal Home Loan Bank Board eventually approved Investors Financial as a holding company for First Savings.
[256] Mr. McWade subpoenaed Mr. Alexander to testify at the trial of the test cases. The Government paid Mr. Alexander's travel, food, and lodging *280 expenses while he was in Hawaii. Unlike most witnesses, Mr. Alexander remained in Hawaii during the entire trial; this was pursuant to arrangement with Mr. McWade so that, as previously described, Mr. Alexander could serve as an undeclared consultant or assistant to Mr. McWade. The record does not reflect the extent to which Mr. McWade actually relied upon Mr. Alexander as an assistant or consultant during the trial of the test cases.
[257] Mr. McWade's direct examination of Mr. Alexander focused largely on the details of the First Savings acquisition. Mr. Alexander's testimony regarding the transaction differed from Mr. Kersting's testimony in one material respect. Specifically, contrary to Mr. Kersting's testimony, Mr. Alexander testified that the Federal Home Loan Bank Board denied Mr. Kersting's application for Investors- Financial to serve as a holding company for First Savings. 57Mr. Alexander further testified that Mr. Kersting "watered down" the First Savings shares by issuing additional Investors Financial shares to individuals other than the original acquiring group. Mr. Alexander testified that when he questioned Mr. Kersting about the matter, Mr. Kersting stated that there *281 was no problem with issuing additional Investors Financial shares because Mr. Kersting could have the shares returned at any time.
[258] Mr. Alexander testified that in February 1980, Federal banking authorities forced First Savings to merge with First Federal Savings of Honolulu. Mr. Alexander testified that, following the forced merger, Mr. Kersting returned the initial investments of some members of the original acquiring group but that Mr. Kersting did not return Mr. Alexander's investment of approximately $ 125,000.
[259] Under direct examination by Mr. McWade, Mr. Alexander admitted that he had filed a lawsuit against Mr. Kersting, which resulted in the arbitration proceeding in July 1987, and that he was not on good terms with Mr. Kersting. Under cross-examination by Mr. Izen, Mr. Alexander admitted that he had talked with Mr. McWade about submitting an affidavit concerning Mr. Kersting's programs. When asked by Mr. Izen whether he and Mr. McWade had *282 discussed a reduction of Mr. Alexander's tax liability in exchange for the affidavit, Mr. Alexander responded, "Specifically, no." 58Mr. Izen's cross- examination of Mr. Alexander included questions concerning Mr. Alexander's various dealings with Mr. Kersting, including First Savings and Mr. Alexander's participation in the Kersting programs at issue in the trial.
[260] After Mr. Izen had questioned Mr. Alexander about his participation in the Kersting programs at issue in the trial, Mr. McWade elicited testimony from Mr. Alexander (on redirect examination) that Mr. Kersting had represented to Mr. Alexander and others that the promissory notes underlying the interest expense deductions would not be called for payment.
[261] Mr. DeCastro attended *283 the trial of the test cases and conducted Mr. Thompson's direct examination. Following the trial, Mr. DeCastro filed an eight-page brief with the Court on behalf of the Thompsons. Mr. DeCastro's brief included an argument that the Thompsons entered into the Kersting programs in dispute with the intention of making a profit. This argument was based upon the Thompsons' prior investment experience with Mr. Kersting, including their participation in the First Savings acquisition. Mr. DeCastro's brief also acknowledged that "one of the primary motives for the stock purchase was to realize the substantial tax savings promised by the Kersting plan". Mr. DeCastro also argued, contrary to Mr. Thompson's testimony, that the promissory notes signed by the Thompsons "are valid and enforceable." Mr. DeCastro filed no reply brief on behalf of the Thompsons.
[262] The record in the trial of the test cases included evidence that Mr. Kersting had assured certain Kersting program participants, whom Mr. Kersting referred to as "nervous Nellies", that their primary loan obligations could be satisfied in full at any time by mere surrender of the associated stock certificates. In Dixon *284 II, the Court summarized the evidence as follows:
[Mr. Kersting) testified that he provided so-called "comfort
letters" only to those "nervous Nellies" who insisted on having
them, which did not include any of petitioners.
We do not doubt that Kersting only provided these
personalized comfort letters to investors who insisted and that
petitioners were not among that group. It does not necessarily
follow, however, that the policy embodied in the letters was
unknown or unavailable to petitioners or other investors. In
fact, the record contains several indications, covering a span
of several years, that Kersting applied this policy to everyone
whether they requested personalized comfort letters or not:
(1) Thompson testified that Kersting assured him of the
policy at the outset, and no other petitioner testified that he
tendered stock to Kersting and was refused. Kersting's refusal
to accommodate Thompson is reasonably attributed to the serious
falling out that occurred previously and to Thompson's apparent
refusal to pay leverage loan interest.
(2) Kersting described a 1976 Forbes Acceptance Stock
Subscription Plan to Mil Harr this way: "The *285 deal is self-
liquidating as you can retire all of your debt by simple
surrender of the stock certificate issued to you."
(3) Gabriele Kersting sent a form letter to Owens also
relating to the 1976 Forbes Acceptance Stock Subscription Plan,
in which she advised him to "Keep the [stock] certificate in a
safe place as you will need it later to retire the $ 30,000.00
note."
(4) In a form letter transmitting initiating documents for
the Leasing Corporation Plan of Universal Leasing, Kersting
stated: "All of your debt, except your monthly payment
obligation, can be discharged at any time at your option by
surrender of the stock certificate which will be issued to you
after we have received the executed documents from you."
(5) In a form letter marking the first anniversary of a
Leasing Corporation Plan for Anseth Leasing, Kersting noted that
"you do have the continuing option to retire the existing notes
by a sale to your corporation of the stock which you have
acquired."
(6) Although in the form of a personalized comfort letter,
Kersting wrote expansively in 1977: "there is, of course, no
problem to reassure you of the self-sustaining *286 and self-
liquidating aspects of the transaction. We would, in fact, issue
a letter to every participant in the deal outlining that
understanding if it would not weaken YOUR position with the
IRS."
(7) In another personalized comfort letter, this time from
1978, Kersting again wrote broadly: "As to the obligation under
the promissory notes and subscription agreements there is no
ongoing obligation as far as we are concerned. We will always
repurchase the stock issued at a price sufficient to allow a
borrower to discharge all of his debt."
(8) In a 1980 credit-reference letter to a third party,
Kersting wrote that the investor's "liabilities at * * * [the
time of his stock purchases] and from there on would be equal to
the assets acquired. His debt can be canceled at any time of his
choice by the sale of the assets in his possession."
(9) Dixon received a 1985 form letter that told him how to
terminate his participation in his Charter Financial stock
purchase plan by returning an endorsed stock certificate, after
which his notes and stock certificate would be canceled and
notes marked "paid" would be returned to him. The letter
contained *287 similar unused "cancellation" lines for leasing
corporation stock certificates and acceptance corporation stock
certificates.
Dixon II, 62 T.C.M. (CCH) at 1499-1500, 1991 T.C.M. (RIA), at 91- 3043 to 3044-91.
[263] During the trial of the test cases, Mr. Moseley testified (on direct examination by Mr. Izen) that he had represented several Kersting companies in collection litigation against several Kersting program participants. 59*288 When Mr. Izen attempted to offer collection litigation records into evidence through Mr. Moseley, Judge Goffe initially questioned why Mr. Izen had not obtained the documents before trial so that the documents could have been subjected to the stipulation process. Mr. Izen responded that, although he had requested the documents from Mr. Kersting earlier, ultimately he had relied upon the subpoena that respondent had served on Mr. Kersting, and he had only recently received the documents.
[264] During Mr. Moseley's testimony, Mr. Izen offered into evidence records from the bankruptcy case of Mr. Provan indicating that certain corporations controlled by Mr. Kersting were creditors of Mr. Provan. The Court sustained Mr. McWade's objections to admission of these records on grounds of relevance and incompleteness. 60 The Court also sustained Mr. McWade's objections to the admission of several documents pertaining to collection litigation against George Vermef, although these documents were later admitted into evidence through Mr. Kersting's testimony. 61*289
[265] Around the time of the Dixon II trial, Mr. DeCastro asked Mr. McWade to arrange for the Thompsons to receive a refund of $ 30,000 of their advance payments, in accordance with the second revision of the Thompson settlement. In a memorandum dated April 10, 1989, Mr. McWade requested Mr. Stevens to process a $ 30,000 refund to the Thompsons. Mr. McWade's April 10, 1989, memorandum states:
The above-named taxpayers are part of the Kersting Interest
Deduction Project. Because their case was designated as one of
the "test cases", the basis for settlement agreed to prior to
trial cannot be finalized until after the Court enters its
decision, projected to be after mid-year 1990.
The basis for settlement will result in approximate
deficiencies, as follows:
| Tax Year | Deficiencies | Interest | Total |
| 1980 | $ 15,000.00 | $ 19,241.66 | $ 34,241.66 |
| 1981 | $ 15,000.00 | $ 15,191.44 | $ 30,191.44 |
Based upon the enclosed transcript, the taxpayers have made
advance payments as follows:
| Tax Year | Advance Payment |
| 1979 | $ 63,000.00 |
| 1980 | $ 35,373.09 |
| 1981 | $ 145.88 |
In an effort to minimize the interest expense to the
government, *290 it is requested that $ 30,000.00 of advance payment
be refunded to the taxpayers, the allocations and/or inter-year
adjustments being made, as necessary.
Following the refund, there will be sufficient advance
payments to full pay the agreed deficiencies, plus accrued
interest, with a $ 4,085.87 reserve.
[266] Mr. McWade's memorandum apparently did not raise any concerns in the Special Procedures office. 62 On July 11, 1989, the Government issued a refund check to the Thompsons in the amount of $ 30,000. The Thompsons endorsed the check to DeCastro Law Corp. without depositing it in their own checking account.
[267] On August 3, 1989, Mr. DeCastro wrote a letter to Mr. McWade confirming the revision of the Thompson settlement that had been agreed to before the trial of the test cases. Mr. DeCastro's letter states in pertinent part as follows:
Re: Jack and Maydee Thompson
Please confirm following is our agreement with respect to
settlement of above taxpayer's cases for open years:
We have agreed that the total taxes due for all the open
years are $ 15,000 for 1980 and $ 15,000 for *291 1981.
Further, in the event a final decision in this case is more
favorable they are to receive the benefit of such decision.
Please sign below so I can have for my files.
Mr. McWade signed the letter and returned it to Mr. DeCastro.
[268] On August 24, 1989, Mr. DeCastro wrote to Mr. McWade requesting that Mr. McWade arrange for the Thompsons to receive the balance of their refund. Mr. DeCastro's letter states in pertinent part:
The following are my calculations of the refund due the
Thompsons:
| 1980 Deficiency: | $ 15,000 | |
| Interest on Deficiency: | 15,300 | $ 30,300 |
| (To 12-31-86) | ||
| 1981 Deficiency: | $ 15,000 | |
| Interest on Deficiency | 12,150 | 27,150 |
| Total Tax and Interest due to 12-31-86 | $ 57,150 | |
| Amount Paid 12-31-86 ($ 25,545 plus $ 34,269) | $ 59,814 | |
| Overpayment as of 12-31-86 | 2,664 | |
| Additional amount paid | ||
| on account 6-11-87 | 63,000 | |
| TOTAL OVERPAYMENT DUE TAXPAYER | $ 65,664 | |
Please calculate the interest due on the overpayment and
arrange to refund the balance due them (less the $ 30,000
recently received).
Thanks for your cooperation.
On October 3, 1989, Mr. DeCastro sent the Thompsons a letter reporting that Mr. McWade had confirmed that they were due a large refund, plus interest, *292 which would not be refunded until the Court issued its opinion in the test cases. Mr. DeCastro advised the Thompsons that, because the Internal Revenue Service would be paying interest, he believed it was fair to add interest to the Thompsons' bill.
[269] On or about November 6, 1989, Mr. McWade received an undated letter from Mr. Thompson which stated in pertinent part as follows:
Dear Mr. McWade:
There are some questions in mind that I feel you can help me
answer.
Owing to the fact that the Kersting hearing is behind and my
testimony is complete I ask; have I completed my portion of this
case? If in fact my portion is complete I question the
requirement for counsel any longer.
Secondly -- I received a check from IRS in the amount of thirty
thousand dollars -- ($ 30,000). I endorsed this over to DeCastro
Law Corp; this did not retire the billed amount. I am completely
amazed at the billings we are receiving. I am now in receipt of
additional billings that exceed realistic amounts. In fact the
total comes to sixty six thousand two hundred forty three and
66/100 dollars ($ 66,243.66). At some point I know a
reconciliation will come. Luis says don't be concerned. *293 I am
very concerned, I am the one being billed.
Thirdly -- it was Maydee and me who stood up to be counted at
the hearing. In crossing paths with former friends I know not
whether they will be friendly or not. The percentage is still in
my favor. And soon now I feel that all will have to come to
grips with reality in this matter. So be it, it is a factor in
our lives.
Fourth -- I came forward to help bring about justice for Henry
Kersting. While it is true that I was aware that a measure of
direct animosity would result, and I accepted this. Maydee has
experienced additional illness this I am very sorry about.
Most emphatically I did not expect to be a channel through which
IRS funneled funds to any law firm. Certainly not in this
magnitude. I have the feeling at this point that I am correct in
this -- the bill is to [sic] much. I want to know the exact
legal position I occupy. We have been frustrated long enough. We
wish to close this chapter.
Ken we spent little time with you, however Maydee and I both
agree, we like you. I hope as Maydee does that you are on your
way out of the smoking habit. I truly hope that this will be
accepted in the *294 context I feel. I guess I am tired of this
matter. All the broken dreams the Kersting fraud has shattered
are everywhere I look. I only know a few by comparison.
Best regards, Jack
The payment of Mr. DeCastro's legal fees is also discussed in a
letter dated November 17, 1989, from Mr. DeCastro to Mr. Huestis
which states in pertinent part:
Thank you for your letter regarding the matter of the
Thompsons' fees. As I have told Jack, we are looking for
payment of his fees to the IRS, not him. I am enclosing a
copy of my letter to him in this regard for your
information.
I am not sure how there got to be any confusion on
this score, but hope this lays that to rest. We have been
told by the IRS that they will not release any additional
funds until after the judgment and in the meantime we give
Jack and Maydee our statements to keep them informed of the
balances.
Just to make it all very clear, we are looking only to
the payments from the IRS for our fees and do not expect
Jack and Maydee to come up with money on that score.
Mr. DeCastro sent a similar letter to the Thompsons on the same date.
[270] On January 23, 1991, *295 Mr. Izen filed a motion to reopen the record in the trial of the test cases to receive newly discovered evidence. In particular, Mr. Izen sought to introduce evidence that certain Kersting program participants had reported a capital gain upon the termination of their participation in a particular Kersting program and later filed a claim for refund based upon the Commissioner's determination that the transaction was a sham. Mr. Izen argued that the Commissioner's denial of the taxpayers' refund claims constituted an admission against interest. Respondent opposed Mr. Izen's motion on the grounds that the taxpayers in question had claimed Kersting interest deductions for the 3 taxable years before the year that they reported a capital gain, and that the Commissioner had accepted those tax returns as filed. Respondent asserted that under the circumstances it was not inequitable for the Commissioner to deny the taxpayers the claimed refunds. On February 26, 1991, the Court denied Mr. Izen's motion.
[271] Messrs. Sims and McWade did not inform Judge Goffe, the National Office, Regional Counsel, or Mr. Izen of the Thompson and Cravens settlements or the Alexander understanding *296 before the issuance of the Court's Dixon II opinion.
[272] On December 11, 1991, the Court filed its Dixon II opinion. In particular, the Court rejected Mr. Izen's contention that the cases should be dismissed for lack of jurisdiction on the ground that the notices of deficiency issued to his clients were invalid. The Court also sustained respondent's disallowance of the interest deductions claimed with respect to the Kersting stock purchase, stock subscription, leasing corporation, and CAT-FIT plans. The Court determined that the loans were sham transactions lacking economic substance and that the loans did not constitute genuine indebtedness. Finally, the Court sustained respondent's determinations against test case petitioners who had been charged with additions to tax for negligence, failure to file a timely return, and the increased rate of interest for substantial understatement of income tax attributable to tax-motivated transactions.
[273] On March 13, 1992, the Court entered decisions pursuant to its Dixon II opinion in each of the test cases. The Court entered decisions in the Thompson cases consistent with the notices of deficiency issued *297 to the Thompsons as follows:
| Additions to Tax | ||||
| Sec. | Sec. | Sec. | ||
| Year | Deficiency | 6653(a) | 6653(a)(1) | 6651(a)(1) |
| 1979 | $ 18,161.00 | $ 908 | --- | --- |
| 1980 | 24,838.00 | --- | --- | --- |
| 1981 | 36,294.52 | --- | $ 1,958.28 | $ 4,934.32 |
The decisions provided that the Thompsons were liable for 50 percent of the interest due on the deficiency for 1981 pursuant to
[274] By letter dated April 23, 1992, Mr. McWade forwarded to Mr. DeCastro waiver agreements which, if executed by Mr. DeCastro, would authorize the Internal Revenue Service to enter assessments against the Thompsons before expiration of the 90-day appeal period prescribed by section 7481. Mr. McWade's letter stated that, on the basis of the Thompsons' earlier payments, there would be due a refund of approximately $ 56,873.03 for 1979, 1980, and 1981. Finally, the letter stated that the Thompsons' refund was attributable to the resolution of Kersting interest deduction programs, including the Bauspar program. Mr. DeCastro signed the waivers and returned them to Mr. McWade on April 27, 1992. Mr. Sims and Mr. McWade initialed the waivers on May 1, 1992. By letter dated May 8, 1992, Mr. DeCastro wrote to *298 Mr. Thompson stating in pertinent part: "Finally I have been advised that the Infernal [sic] Revenue Service is processing a refund to you. I expect to be in excess of $ 55,000 [sic] so as I mentioned it will finally take care of my bill and leave some left over for you."
[275] During this same period, Mr. Sims informed Larry Martucci (Mr. Martucci), an Associate Chief of Appeals in the San Francisco Appeals Office, 63*299 that a Kersting test case petitioner had accepted the project settlement offer made to all Kersting petitioners, but, because the petitioner was one of the test cases, he had tried his case. Mr. Sims told Mr. Martucci that the Court had entered a decision in the case in accordance with its opinion. Mr. Martucci told Mr. Sims that he did not know what could be done. Mr. Martucci told Mr. Sims that, at a minimum, Mr. Sims should contact Mr. Sanchez, Regional Counsel for the Western Region, Office of Chief Counsel.
[276] During the week of April 13, 1992, Mr. Sims contacted Jerry Li (Mr. Li), another Associate Chief of Appeals in San Francisco, about the need to assess amounts in the Thompson cases that were less than the amounts set forth in the Tax Court's decisions. Mr. Sims did not mention the Thompsons' participation in the Bauspar program in his conversation with Mr. Li. Mr. Li told Mr. Sims that he would have to check with his superiors before processing the case. Mr. Li asked Mr. Sims for a memorandum explaining the situation.
[277] Mr. Sims and Mr. McWade sent Mr. Li a memorandum dated May 8, 1992, which states:
Forwarded herewith are the administrative files for the
above-entitled cases, which were part of the test cases in the
Kersting Interest Deduction Program. As per our discussion, the
petitioners indicated a desire to settle their cases, based upon
the then outstanding settlement offer, prior to the trial of the
test cases. Because of the stipulations of settlement of tax
shelter issues filed in the remaining non-test cases, we felt
settlement with petitioners, as test cases, without trial *300 was
inappropriate. In lieu of a stipulated settlement, we agreed to
allow petitioners the better of the settlement or trial results,
once the litigation was completed. Petitioners also established
their entitlement to additional actual losses associated with
another of Mr. Kersting's programs, Balspar [sic]. We agreed to
reflect the tax consequences of such transactions in the final
determination of their tax liability for the respective years.
The Court has now rendered its opinion in the Kersting test
case litigation and entered its decision. In accordance with our
agreement with petitioners, the tax liabilities to be assessed
in these cases, the decision notwithstanding, are as follows:
| I.R.C. Sections | |||||
| Year | Deficiency | 6651(a)(1) | 6653(a)(1) | 6653(a)(2) | 6621(c) |
| 1979 | -0- | N/A | -0- | N/A | -0- |
| 1980 | $ 15,000.00 | N/A | N/A | N/A | -0- |
| 1981 | $ 15,000.00 | -0- | -0- | -0- | -0- |
In order to expedite the closing of these cases,
petitioners, through counsel, have executed waivers of the
limitations contained in
which are included in the files. Immediate processing of
the assessments are [sic] therefore appropriate.
If you have any questions regarding the processing
*301 of this matter, pleased contact me at (808) 541-3350.
[278] Shortly after receiving this memorandum, Mr. Li called Gary Lipetzky (Mr. Lipetzky), an Appeals officer in Honolulu, who had begun to gather information about the Bauspar program. Mr. Lipetzky informed Mr. Li that he was the key Appeals officer on the Bauspar program and that he had not formulated any settlement offer for that program.
[279] Mr. Li subsequently contacted his supervisor, Ron Wise (Mr. Wise), Assistant Chief of Appeals in San Francisco, about Mr. Sims' request. On May 22, 1992, Mr. Wise talked to Mr. Sims about the Thompson cases. Mr. Sims told Mr. Wise that the Thompsons had been selected as Kersting test cases, the Thompsons had their own attorney, Mr. Kersting had threatened to sue the Thompsons, Mr. Kersting had denied the Thompsons the return on one of their investments, and Mr. Kersting considered Mr. Thompson to be a renegade. Mr. Sims told Mr. Wise that he and Mr. Thompson had worked out an informal arrangement that the Thompsons would receive the better of the Tax Court decision or the best settlement allowed to other Kersting program participants before the trial. Mr. Sims told Mr. Wise that he was *302 concerned about the piggyback cases because the Thompsons would be getting a better settlement and the Government had won all the test cases.
[280] Mr. Wise believed that Mr. Sims' request to make an assessment that differed from a Tax Court decision required higher level approval. On May 15, 1992, Mr. Wise forwarded Mr. Sims' May 8, 1992, memorandum to his supervisor, Christian G. Beck, Chief of the San Francisco Appeals Office. Mr. Wise told Mr. Sims that he did not have authority to process his request and indicated he was going to seek approval from Danny Cantalupo (Mr. Cantalupo), Regional Director of Appeals for the Western Region. On May 22, 1992, Mr. Cantalupo informed Peter D. Bakutes (Mr. Bakutes) Deputy Regional Counsel (Tax Litigation) for the Western Region, that the Appeals Office had received a request from Mr. Sims to make an assessment in a Kersting test case on a basis that differed from the Tax Court's decisions.
[281] Under the management structure of the Western Regional Counsel's Office, Mr. Bakutes reported directly to Mr. Sanchez. As Deputy Regional Counsel, Mr. Bakutes was responsible for general oversight of tax litigation in the Western Region, including tax *303 shelter cases, and for evaluating how such cases should be handled. Mr. Bakutes had experience with tax shelter procedures before becoming Deputy Regional Counsel. Mr. Bakutes expected that, in the Western Region, a project attorney and the attorney's manager would contact the Regional Office if they wished to settle a project case on grounds different from the official project settlement offer. Mr. Sanchez considered Mr. Bakutes his key executive staff person and had directed all District Counsel, including Mr. Sims, to discuss any unusual or novel matters with Mr. Bakutes.
[282] Mr. Bakutes and Mr. Cantalupo immediately informed Mr. Sanchez about the Thompson settlement. This was the first time Mr. Sanchez heard of the Thompson settlement. No one in the Western Regional Counsel's Office knew of the unusual settlement of Kersting cases before May 22, 1992. No one in the Western Regional Office had approved the settlements.
[283] Mr. Sanchez immediately called Mr. Sims, who admitted the basic facts regarding the Thompson settlement arrangement. Mr. Sims stated that his motivation for the settlement was to prevent Mr. Kersting from perpetrating a fraud on the Court. Mr. Sims stated that *304 the best way to do this was to have at least one attorney not paid by Mr. Kersting participate in litigating the test cases.
[284] After discussing the matter with Mr. Sims, Mr. Sanchez contacted Mr. DeCastro and learned more of the details surrounding the settlement. Mr. DeCastro informed Mr. Sanchez that Mr. Sims and Mr. McWade had agreed to a proposal to keep the Thompsons in the litigation by rebating to the Thompsons an amount sufficient to pay their legal fees. Mr. Sanchez told Mr. DeCastro that Mr. Sims had no authority to enter into such a settlement. 64*305
[285] Mr. Sanchez promptly notified David Jordan (Mr.Jordan), Acting Chief Counsel (National Office) of the basic facts surrounding the Thompson settlement. Mr.Jordan told Mr. Sanchez that Chief Counsel attorneys in the Tax Litigation Division in the National Office would be brought into the matter for two reasons: The gravity of the situation and the role of the Tax Litigation Division in the National Office as the prime liaison of the Internal Revenue Service with the Tax Court. Mr.Jordan and Mr. Sanchez agreed that the Tax Court had to be notified immediately.
[286] Mr. Sanchez assigned Mr. Bakutes to investigate the matter on behalf of Regional Counsel. Mr. Bakutes spent several weeks gathering facts, so that the matter could be reported to the Tax Court. Mr. Bakutes recognized that he needed to move quickly because the period for appealing the decisions entered in the Thompson cases would expire on June 11, 1992.
[287] On May 29, 1992, Mr. Sims sent a letter to Mr. DeCastro informing him that the Thompson settlement had been rejected by Regional Counsel, stating in pertinent part as follows:
As I'm sure you recall, on or about October, *306 1986, you
approached Ken McWade of this office with an offer to settle * *
* [the Thompson] cases based on the Government's then
outstanding settlement position for the Kersting project. At
that time, I informed you that, since the Thompsons' cases had
been designated as test cases in the Kersting project
litigation, I would not approve of any settlement of these cases
prior to trial. Nonetheless, I represented to you that I would
exert my personal best efforts to see that the Thompsons were
not disadvantaged by my decision not to settle. I also advised
you that I was not in a position to guarantee success inasmuch
as approval of a higher authority might be required. Finally, I
advised you that if the test case petitioners won, we would
allow you to enjoy that result. I am certain that both you and I
left with the clear understanding as a result of what I had
said, the [sic] we remained adversaries with respect to the
litigation.
Mr. Sims' letter further states that, absent an appeal, the Internal Revenue Service would assess the full deficiencies in the Thompson cases, consistent with the Court's Dixon II opinion, plus all applicable statutory additions *307 to tax. The total assessment, including interest, would have been $ 302,396.12.
[288] On June 1, 1992, Mr. Sims sent Mr. Sanchez a copy of Mr. DeCastro's August 3, 1989 letter, signed by Mr. McWade, acknowledging the second revision to the Thompson settlement. On June 2, 1992, Mr. Sanchez and Mr. Bakutes had a conference call with Messrs. Sims, McWade, and DeCastro. During the call, Mr. DeCastro claimed that Mr. Thompson had a profit motive and that Mr. Thompson's testimony was stronger on this point than that of any of the other test case petitioners. Mr. DeCastro also denied that the Thompson settlement was attributable in any way to the Thompsons' participation in the Bauspar program.
[289] On June 2, 1992, Mr. Bakutes directed Mr. Sims to send him immediately the files in the Kersting test cases.
[290] Mr. Bakutes assigned Mr. Dombrowski to assist him in formulating respondent's position with respect to the settlement arrangement. On June 3, 1992, Mr. Bakutes directed Mr. Dombrowski to prepare motions to vacate the decisions in the Thompson cases.
[291] *308 On June 3, 1992, Mr. Li prepared a memorandum summarizing his earlier conversations with Mr. Sims, stating in pertinent part as follows:
Per Bill Sims, the main reason for the lower deficiency to be
assessed was that the Thompsons wanted to settle their case,
based upon the then outstanding settlement offer prior to the
trial of the test cases. Sims stated that because of the
stipulations of settlement of tax shelter issues filed in the
remaining non-test cases, Honolulu District Counsel felt
settlement with the petitioners, as test cases, without trial
was inappropriate.
Bill then stated to me that also Mr. Thompson was taken by Mr.
Kersting and that Mr. Thompson was considered a traitor by all
of the other Kersting's investors. Mr. Thompson helped the
government's case against Mr. Kersting promotion with his
testimony about the Kersting promotion. Mr. Thompson was
cooperative with District Counsel and therefore District Counsel
will reduce the tax deficiency for all three years.
[292] On June 4, 1992, Mr. Sims informed Mr. Bakutes that "Except for the Thompson and Cravens cases, neither Ken nor I entered into any 'best of both worlds' settlements, agreements, *309 or understandings, oral or written, formal or informal, with any taxpayer or taxpayer's representative in any Kersting project case."
[293] On or about June 11, 1992, Mr. Sanchez decided that Messrs. Sims and McWade should no longer have any authority over the Kersting cases. At that time, Mr. Bakutes reassigned all 14 test case dockets to Mr. Dombrowski, and all the nontest cases in the Kersting project to Mr. O'Neill. On June 12, 1992, Mr. Sanchez informed Mr. Sims that he had withdrawn Mr. Sims' delegation of authority to settle any matters relating to the Kersting project, and that management of the Kersting project was reassigned to Mr. Bakutes.
[294] While Mr. Bakutes was carrying out his orders from Mr. Sanchez, Mr.Jordan directed two senior attorneys in the Tax Litigation Division in the National Office, Thomas J. Kane (Mr. Kane), and Steven M. Miller (Mr. Miller), to investigate the Thompson settlement on behalf of the National Office.
[295] Messrs. Kane and Miller conducted in-house depositions and interviewed various individuals who had participated in the test case trial and the Thompson settlement. Mr. Bakutes directed Mr. Dombrowski to provide information to aid Messrs. *310 Kane and Miller in their investigation.
[296] The Cravens case for the 1980 taxable year was the only test case that required a computation for entry of decision under Rule 155. The computation was required in order to account for the capital gain that the Cravenses had reported for 1980 on their surrender of their shares in Candace. An adjustment was also required in order to eliminate respondent's alternative determination that the Cravenses had unreported dividend income for 1980. The Cravens case was the only test case presenting these two issues.
[297] On January 14, 1992, Mr. McWade forwarded a decision document for the 1980 tax year to the Cravenses for their signature. The decision was formulated by reference to the Tax Court's December 11, 1991, opinion, as well as respondent's computation for entry of decision, together with a computation statement explaining how the decision was reached. Mr. O'Neill prepared the aforementioned computations. Mr. O'Neill was not aware at the time that Mr. McWade had entered into an agreement to settle the Cravens cases before trial. The computation statement accompanying respondent's computation for entry of *311 decision indicates that the proposed decision was based upon a complete disallowance of the interest deductions listed in the notice of deficiency issued to the Cravenses for 1980.
[298] On January 30, 1992, the Cravenses signed the decision documents and returned them to Mr. McWade. On February 4, 1992, Mr. McWade signed the same documents and submitted them to the Court. On March 13, 1992, the Court entered decisions in the Cravens cases as follows:
| Additions to Tax | ||||
| Sec. | Sec. | Sec. | ||
| Year | Deficiency | 6653(a) | 6653(a)(1) | 6651(a)(1) |
| 1979 | $ 4,508.00 | $ 225.40 | --- | --- |
| 1980 | 5,893.45 | 294.67 | --- | --- |
[299] The decisions entered in the Cravens cases did not give effect to the settlement between Mr. Cravens and Mr. McWade. Mr. Sims testified that he allowed the Court to enter decisions in the Cravens cases for the full amount of the deficiencies as computed by reference to the Court's opinion after the trial of the test cases because he intended to honor his agreement with the Cravenses by ensuring that a lower assessment would be processed by the Appeals Office.
[300] Mr. Sims spoke to Mr. Cravens about the difference between the numbers in his settlement agreement and the larger numbers in the Rule 155 computation *312 and the decision documents. Mr. Sims believed that Mr. Cravens understood that an assessment consistent with his settlement would be made administratively. However, when Messrs. Sims and McWade sent the Cravens cases to the San Francisco Appeals Office for closing and assessment, they did not request or instruct the Appeals Office to assess amounts in accordance with the arrangement reached with Mr. Cravens in December 1986.
[301] Shortly after Messrs. Sanchez and Bakutes discovered the Thompson settlement, Messrs. Sims and McWade disclosed the Cravens settlement to them.
[302] On June 9, 1992, respondent filed motions for leave to file motion to vacate the decisions that the Court had entered against the Thompsons, the Cravenses, and Mr. Rina. Respondent's motions included allegations that, before the trial of the test cases, Messrs. McWade and Sims had entered into contingent settlement agreements with the Thompsons and the Cravenses that were not disclosed to the Court or to the other test case petitioners or their counsel. Respondent requested the Court to conduct an evidentiary hearing to determine whether the agreements with the Thompsons and Cravenses *313 had affected the trial of the test cases or the opinion of the Court.
[303] On June 22, 1992, the Court granted respondent's motions to vacate filed in the Thompson and Cravens cases, vacated the decisions entered in those cases, and ordered the parties to file agreed decisions with the Court, or otherwise move as appropriate. The Court denied respondent's request for an evidentiary hearing. Also on June 22, 1992, the Court denied respondent's motion to vacate the decision entered against Mr. Rina, stating:
The Court has reviewed the testimony of Cravens, the
testimony of Thompson, the stipulated facts and stipulated
exhibits relating to the Cravenses and the Thompsons, and the
exhibits offered through Thompson as a witness. The Court finds
that these reviewed items had no material effect on the opinion
which the Court filed on December 11, 1991, as that opinion
relates to petitioner Rina. If the reviewed items were stricken
from the record, the Court would file an opinion in all material
respects like the opinion it filed on December 11, 1991 (with
the exception of certain portions relating specifically and
expressly to the Cravenses or the Thompsons), and *314 the Court's
findings, analyses, and conclusions relating to petitioner Rina
would remain the same. * * *
G. ATTEMPTED DISCOVERY BY COUNSEL FOR NONTEST CASE PETITIONERS
[304] By letters dated June 24 and August 12, 1992, Messrs. Jones and O'Donnell jointly requested that Mr. Dombrowski provide informal discovery regarding the Thompson and Cravens settlements. The earlier of the two letters included allegations that Mr. Kersting withheld documents from the test case petitioners that would have described "an underlying business of great substance" because Mr. Kersting feared that the information would increase his personal tax liability. Respondent declined to respond to the informal discovery requests and did not allow Messrs. Jones and O'Donnell to participate in any of the in-house investigations conducted by Messrs. Bakutes, Dombrowski, Kane, and Miller.
[305] In July 1992, Mr. DeCastro filed a motion for entry of decision in accordance with the terms of the Thompson settlement set forth in Mr. DeCastro's letter to Mr. McWade dated August 3, 1989; i.e., deficiencies of zero, $ 15,000, and $ 15,000 for the taxable years 1979, 1980, and *315 1981, respectively. On August 20, 1992, respondent filed objections, with respondent's Motions for Entry of Decision and respondent's Memoranda of Points and Authorities, to Mr. DeCastro's motion for entry of decision. Respondent's Motions for Entry of Decision described the facts discovered by Messrs. Miller, Kane, and Dombrowski in their investigation of the Thompson settlement. Respondent alleged that, sometime before the test case trial, Messrs. Sims and McWade had agreed to settle the Thompson cases by reducing the Thompsons' deficiencies in amounts sufficient to compensate the Thompsons for their projected attorney's fees. Respondent alleged that this "New Agreement" was designed -- and constituted an agreement by Messrs. Sims and McWade -- to pay Mr. DeCastro's legal fees. Respondent alleged that the "New Agreement" was unauthorized and had no legal basis. Consequently, respondent asked the Court to enter decisions in the Thompson cases consistent with the initial McWade-DeCastro agreement of December 1986, which had allowed the Thompsons a reduction of approximately 19 percent of their deficiencies with the burnout feature; i.e., deficiencies of zero, $ 34,425, and $ 30,000 *316 for the taxable years 1979, 1980, and 1981, respectively.
[306] On August 26, 1992, the Court granted Mr. DeCastro's motions for entry of decision and entered decisions in the Thompson cases as follows:
| Year | Deficiency | Additions to Tax |
| 1979 | --- | --- |
| 1980 | $ 15,000 | --- |
| 1981 | 15,000 | --- |
[307] In January 1993, respondent entered assessments against the Thompsons for the taxable years 1979, 1980, and 1981 based upon the decisions entered by the Court in August 1992. Shortly thereafter, the Thompsons received a refund check for $ 32,225, dated February 19, 1993, which the Thompsons endorsed to DeCastro Law Corp.
[308] The refund of $ 32,225 to the Thompsons was based upon the conclusion that, as of December 30, 1986, when the Thompsons first remitted a total of $ 59,545 as interest payments for the years 1979, 1980, and 1981, the Thompsons' total tax liability for those years, as reflected in the Court's decisions entered on August 26, 1992, was approximately $ 57,500 -- comprising $ 30,000 in tax and $ 27,500 in interest. Accordingly, the Thompsons' December 1986 remittance of $ 59,545 resulted in an overpayment of approximately $ 2,045. In addition to this overpayment, on June 17, 1987, the Thompsons *317 had made an additional payment of $ 62,225 towards their tax liability for 1979. The $ 32,225 refund paid to the Thompsons on February 19, 1993, represents the difference between the Thompsons' $ 62,225 payment and the $ 30,000 refund that the Thompsons had previously received in July 1989.
[309] Following the receipt of the $ 32,225 refund, Mr. DeCastro wrote to Mr. Dombrowski to complain that respondent had erred in computing the amount of the Thompsons' overpayment. After review of the matter, Mr. Dombrowski prepared a memorandum to Mr. Bakutes dated September 17, 1993, requesting approval to process an additional refund to the Thompsons of approximately $ 32,000. Mr. Dombrowski stated that, in calculating the prior refund of $ 32,225, respondent had erroneously treated the $ 62,225 payment that the Thompsons made in June 1987 as a cash bond rather than an advance payment of tax. Viewing the $ 62,225 payment as an advance payment of tax, Mr. Dombrowski concluded that the Thompsons were entitled to interest on the resulting overpayment.
[310] Mr. Bakutes approved Mr. Dombrowski's request. Shortly thereafter, Mr. Dombrowski requested the Fresno Appeals Office to adjust the Thompsons' *318 account, resulting in the Thompsons' receipt of a third refund check, dated October 22, 1993, for $ 32,116.68.
[311] In November 1993, the Thompsons received a fourth refund check for $ 4,107.93 with respect to their overpayment for the taxable years 1979, 1980, and 1981. Presumably this check reflected a refund of the overpayment of approximately $ 2,045 (with interest) that arose from the Thompsons' December 1986 payment of $ 59,545.
[312] In sum, the Thompsons were refunded $ 98,449.61 of the $ 121,770 that they paid for the taxable years 1979, 1980, and 1981. Of the $ 98,449.61 in refunds, the Thompsons assigned $ 62,225 to DeCastro Law Corp.
[313] As mentioned supra note 2, the Court of Appeals for the Ninth Circuit held that the Thompson decisions became final pursuant to section 7481(a)(1), despite the attempts by Messrs. Sticht and Izen to appeal those decisions on behalf of nontest case petitioners who sought to intervene.
[314] On July 1, 1992, Mr. Dombrowski wrote to the Cravenses enclosing documents that were intended to enable them to determine the proper decisions to be entered in their cases. Mr. Dombrowski stated that, upon receipt of the Cravenses' *319 response, he would coordinate the matter with Mr. Bakutes to determine the terms of agreed decisions that respondent would be willing to submit to the Tax Court. On July 3, 1992, Mr. Cravens responded to Mr. Dombrowski's letter with a written chronology of the events leading to the settlement of his cases in December 1986.
[315] On August 25, 1992, the Court entered agreed decisions in the Cravens cases consistent with the proposed decisions that Mr. McWade forwarded to the Cravenses in December 1988. The decisions provide that the Cravenses are liable for deficiencies for the taxable years 1979 and 1980 in the amounts of $ 3,606.40 and $ 6,175.76, respectively, and that the Cravenses are not liable for any additions to tax. The decision for 1979 includes a stipulation that the agreed deficiency does not take into account advance payments in the amounts of $ 4,508 and $ 6,000 that the Cravenses made in May 1983 and December 1986, respectively. The decision for 1980 includes a stipulation that the agreed deficiency does not take into account an advance payment in the amount of $ 4,678.67 that the Cravenses made in December 1986.
[316] On October 26, 1992, the Regional Director of Appeals *320 for the Western Region wrote a memorandum to the San Francisco Appeals Office requesting that the Cravens cases be closed in accordance with special closing instructions. The intent of these instructions as stated in the memorandum was "to cause the taxpayers' 1979 and 1980 accounts to zero out with no further amounts due." This was to be accomplished by adjusting the interest that would otherwise have become due on the assessments made in accordance with the stipulated decision previously entered by the Tax Court on August 25, 1992. The memorandum explained the proposed interest adjustment as follows:
The amount of interest being assessed has been adjusted
because the decision document tendered to petitioners and
subsequently filed with the Court in settlement of this case did
not comport with District Counsel's 1986 settlement offer. The
settlement offer provided that the first year deficiency would
be shifted to the second year. Accordingly, there would have
been no deficiency for 1979 and the deficiency for 1980 would
have been increased to $ 9,782 ($ 3,606 + $ 6,176). The amount of
interest being assessed has been adjusted because this provision
was not *321 included in the decision documents and because the
decision documents in this case were not promptly prepared and
filed with the Tax Court in December 1986 when the case was
settled. The balance of the adjustment relates to computational
errors in District Counsel's original computation of the amounts
due.
The authority stated in the memorandum for reducing the amounts due from the Cravenses was section 6404(a)(1), relating to excessive assessments, and section 6404(e)(1), relating to abatement of interest.
[317] As mentioned supra note 2, the Court of Appeals for the Ninth Circuit held that the Cravens decisions became final pursuant to section 7481(a)(1), despite the attempts by Messrs. Sticht and Izen to appeal those decisions on behalf of Kersting project nontest case petitioners who sought to intervene.
PROCEDURAL HISTORY OF EVIDENTIARY HEARING
A. REFERRAL OF THOMPSON AND CRAVENS SETTLEMENTS TO OFFICE OF INSPECTOR GENERAL
[318] When Mr. Sanchez learned of the Thompson and Cravens settlements, he decided to refer the matters to the Department of the Treasury, Office of the Inspector General (the OIG). 65 On June 30, 1992, Robert J. *322 Wilson (Mr. Wilson), Special Litigation Assistant, General Legal Services, Western Region, made a written referral to the OIG. In the referral, Mr. Wilson alleged that Messrs. Sims and McWade had entered into undisclosed, contingent settlements with the Thompsons and the Cravenses. The referral further alleged that the Thompsons' deficiencies had been reduced to pay their attorney's fees. Mr. Wilson's referral further alleged that Messrs. Sims and McWade had grossly violated procedures, and that Mr. McWade might have made false statements.
[319] Mr. Wilson served as the liaison between the Western Regional Counsel's Office and the OIG. Mr. Sanchez believed that the Region's referral to the OIG ended his investigatory authority *323 over the matter and that his only remaining responsibility was to assist the OIG with its investigation.
[320] Upon receipt of the referral, OIG assigned Senior Special Agent Leland D. Halleck (Mr. Halleck) to investigate the matter. Mr. Sanchez directed Mr. Dombrowski to provide Mr. Halleck with all documents in respondent's possession that Mr. Halleck might request and to answer Mr. Halleck's questions. As part of his investigation, Mr. Halleck considered whether there had been any bribery in violation of
[321] Mr. Halleck interviewed Messrs. Sims and McWade in October 1992. Messrs. Sims and Mcwade told Mr. Halleck that they would not allow any of the Kersting test case petitioners to settle because: (1) They did not want the test case litigation delayed; 66*325 (2) they would have had to find replacement cases with similar characteristics; and (3) they were concerned about the possible effect on the other Kersting project *324 cases. The OIG report includes Mr. Sims' affidavit, executed October 29, 1992, which states that it was his recollection that the final version of the Thompson settlement agreement was agreed to before the trial of the test cases. Mr. Sims' affidavit also includes the following statement: "I can recall numerous discussions with McWade concerning our own trial strategy as well as discussions concerning the anticipated strategies of both Izen and DeCastro, but no discussions whatsoever concerning any settlement."
[322] On December 9, 1992, the OIG report prepared by Mr. Halleck was completed. The OIG report concluded that Messrs. Sims and McWade had: (1) Agreed to special arrangements with the Thompsons and the Cravenses; and (2) provided a special arrangement for the Thompsons designed to compensate them for their attorney's fees. Mr. Halleck concluded that Messrs. Sims and McWade had not benefited financially or otherwise by agreeing to the special arrangements.
[323] In Mr. Halleck's opinion, Messrs. Sims' and McWade's agreement to arrange a refund to be used to pay the Thompsons' legal fees violated
[324] In January 1993, Mr. O'Neill notified all known Kersting nontest case petitioners that the Commissioner would settle their cases on a basis "consistent with the *326 original project settlement offer that was extended to Kersting investors before the trial of the test cases": A 7-percent reduction of the deficiency, elimination of all additions to tax, and interest imposed at the normal rate prescribed in
[325] On July 29, 1993, Mr. Sanchez sent Notices of Proposed Disciplinary Action to Messrs. Sims and McWade. The notices asserted that Messrs. Sims and McWade had violated: (1) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(2) (an employee shall avoid any action which might result in or create the appearance of giving preferential treatment to any person); (2) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(6) (an employee shall avoid any action that might adversely affect the confidence of the public in the integrity of the Government); and (3) Internal Revenue Service Rule of Conduct 214.5 (an employee will not intentionally make false or misleading verbal or written statements in matters of official interest). *327 The notices proposed to suspend both Messrs. Sims and McWade for 14 calendar days without pay.
[326] Mr. Sanchez' Notices of Proposed Disciplinary Action to Messrs. Sims and McWade listed the following reasons for the proposed disciplinary actions: (1) Negotiating an unauthorized settlement agreement with the Thompsons; (2) basing the Thompson settlement on unaudited and insufficiently documented losses from an unrelated shelter; (3) allowing the Thompsons a settlement that provided them more favorable treatment than other taxpayers; (4) compensating the Thompsons for their attorney's fees; and (5) not informing the Tax Court of the Thompson settlement arrangements.
[327] Mr. Sims responded in writing to Mr. Sanchez on September 14, 1993. Nonetheless, Mr. Sanchez sustained the Notice of Proposed Disciplinary Action issued to Mr. Sims.
[328] Mr. McWade retired from the Internal Revenue Service effective October 2, 1993, rather than accept a transfer to the Los Angeles District Counsel Office. On November 2, 1993, Mr.Jordan approved Mr. Sanchez' proposed disciplinary action. Mr. Sims was suspended from duty without pay for 14 days and was transferred to the San Francisco Regional Counsel *328 Office, where he was assigned nonsupervisory duties as a Special Litigation Assistant in the General Litigation area.
[329] On May 3, 1995, following an investigation by the Criminal Investigation Division of the Internal Revenue Service, a Federal grand jury indicted Mr. Izen on four counts of conspiracy and money laundering under
[330] On July 17, 1995, the Court held a pretrial conference on the record for the purpose of addressing various issues, including the scheduling of the evidentiary hearing, identification of the parties who would participate in the evidentiary hearing, and scheduling of discovery. The Court also commented *329 at the conference that the Thompson and Cravens settlements appeared to share some characteristics with so-called Mary Carter agreements.
[331] Respondent was represented at the conference by Mr. O'Neill and Mr. Dombrowski. During the conference, Mr. O'Neill questioned whether Mr. Izen should be disqualified as counsel because he would probably be called as a witness at the evidentiary hearing. During the conference, the Court questioned whether Mr. Dombrowski should represent respondent at the evidentiary hearing, in view of his participation as counsel in the trial of the test cases. 67
[332] On January 16, 1996, the Court held a second pretrial conference on the record to obtain oral status reports from the parties respecting discovery and the stipulation process, to establish the format for the evidentiary hearing, and to discuss possible conflicts of interest affecting counsel. 68*330 Specifically, the Court and the parties discussed possible conflicts of interest of Mr. Izen and Mr. DeCastro.
[333] On February 12, 1996, respondent filed a motion to disqualify Mr. Izen as counsel on the ground that he would be a necessary witness at the evidentiary hearing. 69 By order dated April 1, 1996, the Court noted that, because Mr. Izen was likely to testify at the evidentiary hearing, Mr. Izen's testimony might in some sense prove to be adverse to the interests of his clients. With these concerns in mind, and relying on ABA Model Rules of Professional Conduct rules 1.7(b) and 3.7(a), the Court directed Mr. Izen to contact each of his clients in writing and to inform them of the potential for a conflict of interest and to file a report with the Court revealing whether his clients consented to his remaining as counsel. 70*332 On April 22, *331 1996, Mr. Izen filed a report with the Court, attaching thereto a copy of a letter that he had written to each of his clients describing the possible conflict of interest along with executed waivers signed by his clients consenting to his continued representation of them at the evidentiary hearing. By order dated April 23, 1996, the Court denied respondent's motion to disqualify Mr. Izen, citing the consents of his clients to his continued representation of them and the financial hardship that his disqualification would impose on them. In so doing, the Court rejected the suggestions of Messrs. Sticht and Jones that Mr. Izen should associate himself with additional counsel for the conduct of the evidentiary hearing.
[334] By order dated April 3, 1996, the Court directed Mr. DeCastro to show cause why he should not be disqualified from serving as counsel or otherwise representing the Thompsons at the evidentiary hearing. 71*333 On April 10, 1996, the Court received a letter from Mr. DeCastro stating that he had withdrawn his representation of the Thompsons and that they would retain substitute counsel to represent them at the evidentiary hearing. By order dated April 11, 1996, the Court discharged as moot its order to show cause dated April 3, 1996. Mr. Huestis entered his appearance on behalf of the Thompsons at the evidentiary hearing.
[335] Shortly before commencement of the evidentiary hearing, the parties discovered that decisions had been entered in the Alexander cases eliminating their deficiencies for 1974, 1975, 1976, and 1977. 72 On May 10, 1996, Martha Sullivan (Ms. Sullivan), successor to Mr. Sanchez as Regional Counsel, Western Region, referred the matter to the OIG. The referral questioned whether the Alexanders had received a beneficial resolution of their tax cases that was inconsistent with the settlements offered to other Kersting program participants.
[336] Ms. Sullivan's referral to the OIG was assigned to Mr. Halleck. On July 29, 1996, the OIG informed Ms. Sullivan that the OIG would take no further action. The stated grounds were the expiration of the period *334 of limitations for criminal prosecution of any acts of wrongdoing by Messrs. Sims and McWade and the OIG's prior investigation and report.
J. MR. IZEN'S MOTION TO COMPEL PRODUCTION OF DOCUMENTS AND ISSUANCE OF PROTECTIVE ORDERS
[337] On April 26, 1996, the Court granted Mr. Izen leave to file a Motion to Compel Answers to Deposition Questions and Production of Documents. 73Mr. Izen argued that the Court should rule that the crime-fraud exception to the attorney-client privilege applies to these cases and that various witnesses, including Messrs. Thompson, DeCastro, Sims, McWade, and a number of additional Government attorneys, were barred from asserting the attorney-client privilege in response to outstanding discovery requests. 74 The Court initially ordered respondent, Mr. Thompson, and Mr. DeCastro to file responses to Mr. Izen's motion attaching thereto any documents alleged to be privileged for in camera inspection. However, on May 6, 1996, Mr. Sticht filed an objection to Mr. Izen's motion, arguing that it would be inappropriate and potentially harmful to petitioners' cases for the Court to review respondent's documents before the evidentiary hearing, and that Mr. Izen's motion *335 violated a private agreement between Messrs. Izen and Sticht concerning discovery matters. Mr. Sticht further stated that he could not support Mr. Izen's motion insofar as it pertained to Messrs. Thompson, DeCastro, and Huestis, without a privilege log describing the documents in dispute.
[338] On May 6, 1996, the Court issued an order amending its prior order directing respondent, Mr. Thompson, and Mr. DeCastro to submit documents to the Court for in camera inspection. On May 9, 1996, the Court issued an order directing Messrs. DeCastro and Huestis to appear at the call of the calendar at the commencement *336 of the evidentiary hearing and file with the Court written responses to Mr. Izen's motion to compel and privilege logs describing any disputed documents. Messrs. DeCastro and Huestis complied with the Court's order. In addition, Mr. Huestis filed motions to quash trial subpoenas duces tecum that Mr. Sticht had served on Messrs. Thompson and Huestis.
[339] On May 15, 1996, pursuant to the Court's directive and in response to trial subpoenas duces tecum that Mr. Sticht had served on Mr. Huestis and Mr. Thompson, Mr. Huestis filed a response, attaching thereto a privilege log. On May 17, 1996, Mr. Huestis filed a supplemental privilege log. On May 24, 1996, following an in camera review of the documents that Mr. Huestis claimed were privileged, the Court ruled that the majority of the documents in question were not protected from disclosure. In response to the Court's ruling, Mr. Huestis made an oral motion for a protective order on behalf of Mr. Thompson requesting that the parties maintain the confidentiality of all documents identified in Mr. Huestis' privilege logs. On June 10, 1996, the Court issued an order granting Mr. Huestis' oral motion for protective order. In particular, the *337 Court placed under seal Exhibits 943-AMD through 975-ANJ, 978-ANM, and 979-ANN, and directed the parties to maintain the confidentiality of the documents. By order dated June 26, 1996, the Court placed additional exhibits under seal, including Exhibits 995-ANO through 1015-AOI and 1018. The Court's order also placed under seal a relevance memorandum filed by Mr. Sticht on June 24, 1996. The Court indicated that the affected parties would be given notice and an opportunity to respond before the Court lifted its protective orders with respect to these documents. 75
[340] By order dated May 2, 1996, the Court announced that it would defer ruling on assignment of the burden of proof and standard of proof to be applied with respect to the evidentiary hearing. Nevertheless, the Court prescribed a structure for the orderly presentation of witnesses at the evidentiary hearing. *338 In particular, consistent with the Court's view that respondent was in the best position in the first instance to present the Court with the facts critical to an understanding of the misconduct of respondent's attorneys in the trial of the test cases, the Court directed that respondent's case would be put on first. Respondent's witnesses were to be called to testify in turn, subjected to direct examination by respondent, and then passed to Mr. Sticht, Mr. Izen, and Mr. Jones, respectively, for additional direct or cross-examination. 76*339 Following the examination of respondent's witnesses, Mr. Sticht's remaining witnesses would be called to testify in turn, subjected to direct examination by Mr. Sticht, and then passed to respondent, Mr. Izen, and Mr. Jones, respectively, for additional direct or cross- examination. This process would be repeated for Mr. Izen's and Mr. Jones' witnesses.
[341] In the same order, the Court invoked
[342] The evidentiary hearing in these cases was conducted in Los Angeles on May 13 to 30, 1996, June 10 to 26, 1996, and August 18, 1997. The Court heard testimony from 29 witnesses during the evidentiary hearing and received approximately 500 exhibits. The transcripts of the proceedings consist of more than 6,700 pages. In addition, between May 13, 1996, and October 6, 1997, the parties filed with the Court a stipulation of facts and first through sixth supplemental stipulations of facts.
1. MR. CRAVENS
[343] Mr. Cravens appeared at the evidentiary hearing and confirmed and expressly adopted every aspect of his prior testimony at the Dixon II trial. Mr. Cravens testified that he did not intend to have a secret settlement, that he did not change his testimony at the original trial even though he had settled his case, that he would not have "sold out" the other *341 pilots for money or a greater settlement offer, and that he had no disputes with Mr. Kersting when he testified at the original trial. Mr. Cravens testified that his testimony at the trial of the test cases was incomplete insofar as he had failed to testify that he believed that the promissory notes that he had signed were valid and enforceable.
[344] Mr. Cravens testified that he did not keep the fact that he had settled his case a secret before the trial of the test cases. He discussed his settlement with Mr. Kersting several times before the trial. Mr. Kersting was concerned that Mr. Cravens' settlement would affect his testimony. Mr. Cravens told Mr. DeCastro that he was representing himself at the trial because he had settled and did not need to incur the legal expense. Mr. Cravens was uncertain whether he informed Mr. Izen of his settlement.
[345] Mr. Cravens understood that he would testify at the trial of the test cases "that I sold the stock and received a profit off the stock, and * * * that I paid taxes on the sale of the stock." These are the two reasons he recalls being selected as a test case by Mr. Seery. Mr. Cravens assured Mr. Kersting that he was going to testify truthfully *342 regardless of his settlement.
[346] Between the time of his December 1986 settlement and the trial of the test cases in January 1989, Mr. Cravens received "reams of documents" relating to the trial that he paid no attention to and did not question. Before the trial of the test cases, Mr. Cravens did not know the identities of the remaining test case petitioners. Mr. Cravens had never met any of the other test case petitioners, and he never participated in any joint strategy sessions to prepare for trial. Mr. Cravens did not understand the difference between being a witness and allowing his case to serve as a test case.
[347] Upon his arrival in Hawaii, Mr. Cravens met Mr. McWade in person for the first time. Until Mr. Cravens arrived at the trial, he was not sure of his exact role in the process, although he believed that his testimony would be very important to the outcome. Mr. Cravens became surprised and suspicious when Mr. McWade told him that he would receive a refund of the money he had paid pursuant to his settlement if the petitioners in test cases prevailed at trial. Mr. Cravens was not prepared for this "change" in his settlement. Mr. Cravens asked Mr. McWade about the change, *343 but did not get a satisfactory answer. Mr. Cravens had the impression that Mr. McWade did not want to discuss the subject. Mr. Cravens denied that he had an added incentive to testify at the trial because he was told he could get his money back if the taxpayers won. He thought that all he could do was testify truthfully to the matters that had caused his case to be selected as a test case.
[348] Mr. Cravens recalled that Mr. DeCastro's demeanor outside the courtroom was "very anti-taxpayer * * * at least Kersting taxpayers." Mr. Cravens had lunch with Mr. McWade and a group of other persons before testifying at the trial of the test cases. The group did not discuss Mr. Cravens' testimony during lunch. After lunch, Mr. McWade informed Mr. Cravens that he would have to make a statement to the Court because he was not represented by an attorney who could ask him questions. Mr. McWade did not tell Mr. Cravens what to say in his statement to the Court, or how to respond to Mr. McWade's questions.
2. MR. THOMPSON
[349] Mr. Thompson appeared at the evidentiary hearing and testified that he retained Mr. DeCastro to negotiate a settlement in his tax cases and that it was his understanding in December *344 1986 that his cases were settled for a fixed amount although he would receive a refund if the test case petitioners prevailed at trial. Mr. Thompson further testified that, by virtue of his settlement, he had informed Mr. DeCastro that he would not pay attorney's fees for representation at the trial of the test cases.
[350] Mr. Thompson testified that the testimony that he provided at the trial of the test cases was completely truthful, that his testimony was not coached by either Mr. DeCastro or Mr. McWade, and that he wanted to testify in part to influence Mr. Kersting to withdraw his threats. Mr. Thompson testified that the $ 80,000 Bauspar loss that he mentioned in his testimony at the trial of the test cases was not an out-of-pocket loss but the loss of the returns he expected as a result of his participation in the Bauspar program.
3. MR. ALEXANDER
[351] Mr. Alexander appeared at the evidentiary hearing only after Mr. Sticht made several unsuccessful attempts to serve him with a subpoena. Mr. Alexander's credibility as a witness at the evidentiary hearing was severely impaired by his evasive testimony and total lack of recall of the circumstances that led to the decisions eliminating *345 his tax liabilities for 1974, 1975, 1976, and 1977. Mr. Alexander testified that he did not receive a "finder's fee" for the information or assistance that he provided to Mr. McWade during the trial of the test cases, nor would he admit that he had arrived at an understanding with Mr. McWade for any reduction of the tax liabilities on his joint returns for the years 1974, 1975, 1976, and 1977.
4. MR. MCWADE
[352] Mr. McWade appeared at the evidentiary hearing and testified that, when settlement discussions first arose in the Thompson and Cravens cases, he believed he had a problem with conflicting Government policies. In particular, Mr. McWade testified that while he was obliged by Internal Revenue Service policy to treat similarly situated taxpayers alike, the Internal Revenue Service also had a policy against settling test cases. 79Mr. McWade did not confer with anyone in the National Office or the Regional Counsel's office regarding resolution of the conflict that he perceived; Mr. Sims was the only person with whom Mr. McWade discussed the alleged conflicting policies. Mr. McWade did not feel any obligation to coordinate the Thompson settlement arrangement with the National Office *346 or Regional Counsel because he had discussed the arrangements with Mr. Sims.
[353] Mr. McWade testified that the Thompson settlement was revised in the summer of 1989 in order to dispose of the Bauspar issue. Mr. Mcwade denied that the Thompson settlement was revised to provide a means for the Thompsons to pay Mr. DeCastro's attorney's fees.
[354] Mr. McWade initially testified that he informed Messrs. Dombrowski and Hatfield about the Thompson and Cravens settlement agreements before the trial of the test cases. However, Mr. McWade later testified that he may have not informed Messrs. Dombrowski and Hatfield of the agreements. Mr. McWade testified that he had no recollection that he had informed Mr. O'Neill about the Thompson and Cravens settlement agreements. 80
[355] Mr. McWade denied offering Mr. Alexander any inducements to either cooperate with the Government or testify at the *347 trial of the test cases. Mr. McWade acknowledged that Mr. Alexander provided assistance to him in understanding certain aspects of the Kersting programs during the trial of the test cases. Mr. McWade did not provide the Court with any credible explanation or justification of the decisions entered in the Alexander cases for the taxable years 1974 through 1977, which completely wiped out the deficiencies previously determined on the statutory notices. 81
[356] Mr. McWade denied that Mr. DeCastro passed information to him regarding Mr. Izen's trial strategy or that Mr. DeCastro otherwise acted as a "mole" or "plant" for respondent with respect to the Kersting test cases.
5. MR. SIMS
[357] Mr. Sims testified that he approved the Thompson and Cravens settlements with the understanding that he would do his best to process the proposed decisions but that he did not guarantee the outcome. Mr. Sims testified that Mr. McWade's letters *348 to Mr. DeCastro stating that the decisions would be filed with the Court later indicate that Mr. McWade misunderstood Mr. Sims' intentions. Mr. Sims further testified that decisions could not be entered in the Thompson and Cravens cases before the trial of the test cases out of concern that taxpayers who had signed piggyback agreements would argue that they were entitled to similar settlements. Mr. Sims characterized as an oversight his approval of Mr. McWade's decision to forward decision documents to the Cravenses for their signature 1 month before trial of the test cases.
[358] With regard to the Thompson settlement, Mr. Sims testified that he felt it was important to keep Mr. DeCastro in the case because, unlike Mr. Izen, Mr. DeCastro was not being paid by Mr. Kersting. However, Mr. Sims testified that he was aware, as early as December 1986, that Mr. DeCastro did not believe that Kersting interest deductions could be defended in court. Mr. Sims further testified that he felt sympathy for Mr. Thompson because of Mr. Kersting's threats and that he suggested that Mr. Thompson's participation in the Bauspar program could be used to offset or reduce the Thompsons' tax liability. Mr.*349 Sims was unable to confirm that he reviewed Mr. Thompson's Bauspar records as a basis for revising the Thompson settlement agreement. Mr. Sims testified that he and Mr. McWade had reached an agreement in principle with Mr. DeCastro before the trial of the test cases to further reduce the Thompsons' tax liabilities.
[359] Mr. Sims testified that he did not know the basis upon which the Alexander cases were settled and that he never discussed the settlements with either Mr. McWade or Mr. Alexander.
[360] Mr. Sims denied that Mr. DeCastro passed information to the Government regarding Mr. Izen's trial strategy or that Mr. DeCastro otherwise acted as a "mole" or "plant" for respondent with respect to the Kersting test cases.
6. MR. DeCASTRO
[361] Mr. DeCastro testified that the settlement agreement that he negotiated with Mr. McWade assured the Thompsons of the better of the pretrial settlement or the outcome in the trial of the test cases and that the agreement was not contingent on Mr. Sims' best efforts.
[362] Mr. DeCastro testified that the final revision to the Thompson settlement was agreed to before the trial of the test cases, that the revision was made to account for the attorney's *350 fees that Mr. Thompson would incur in the trial of the test cases, and that Mr. Thompson's participation in the Bauspar program was not the basis for the revision.
[363] Mr. DeCastro testified that Mr. McWade considered various elements in negotiating settlements in Kersting cases, including the level of the taxpayer's participation in the Kersting programs and whether the taxpayer had escaped liability in other years by virtue of the expiration of the period of limitations.
[364] Mr. DeCastro denied passing any information to Messrs. McWade or Sims regarding Mr. Izen's trial strategy or that he otherwise acted as a "mole" or "plant" for respondent with respect to the Kersting test cases.
7. MR. IZEN
[365] Mr. Izen was the first witness to testify at the evidentiary hearing.
[366] Mr. Izen testified that he had several discussions with Mr. DeCastro, beginning with Mr. Kersting's deposition in October 1988 through the eve of the trial of the test cases, during which he revealed his trial strategy to Mr. DeCastro. Mr. Izen testified that he attempted to "enlighten" Mr. DeCastro, who was openly pessimistic regarding the chances for success in the trial of the test cases.
[367] Mr. Izen testified *351 that Mr. DeCastro was upset on the eve of trial of the test cases that all documentation needed to support the test case petitioners' position had not been made available to petitioners. Mr. Izen testified that he did not serve a subpoena on Mr. Kersting before the trial of the test cases because he had relied upon the subpoena that Mr. McWade had served on Mr. Kersting.
[368] Mr. Izen testified that he met Mr. DeCastro, with Mr. Hongsermeier and Mr. Bradt, in a hotel room on the eve of trial of the test cases. Mr. Izen testified that he discussed confidential matters with Mr. Hongsermeier in Mr. DeCastro's presence that he would not have revealed to Mr. DeCastro had he known of the settlement that Mr. DeCastro had negotiated on behalf of the Thompsons. Mr. Izen testified that he was aware that respondent planned to rely on the so-called comfort letters at the trial of the test cases, inasmuch as some of the letters were included in stipulations of fact filed with the Court, and that he informed Mr. DeCastro that he would offer evidence of collection actions brought by various Kersting companies against Kersting program participants to counter the comfort letters.
[369] Mr. Izen testified *352 that Mr. DeCastro grabbed notes out of his hand during the trial of the test cases, that Mr. DeCastro was in a position to overhear Mr. Izen's conversations with his witnesses during the trial of the test cases, and that Mr. Izen observed Mr. DeCastro conducting a "private" conversation with Mr. McWade during the trial of the test cases. Mr. Izen testified that his allegations in oral argument before the Court of Appeals for the Ninth Circuit in the DuFresne appeal that Mr. DeCastro was a "mole" or "plant" for respondent during the trial of the test cases were not based upon personal knowledge but that Mr. Izen only wanted the opportunity to prove the point. Mr. Izen did not provide any further evidence that Mr. DeCastro was a mole or plant who passed Mr. Izen's trial strategy to Messrs. Sims or McWade.
[370] Mr. Izen denied having personal knowledge, at the time that Messrs. Thompson and Cravens testified at the trial of the test cases, that Messrs. Thompson and Cravens had entered into settlement agreements with Mr. McWade.
[371] During the evidentiary hearing, following the testimony of Lois Fisher (Ms. Fisher) on June 12, *353 1996, Mr. Sticht made the following statement to the Court:
But if there's any intention to obstruct or interfere with
the presentation of any of my clients' cases in this trial, in
this courtroom, or even to interfere with their presentation by
outside harassment, intimidation or other means that are
normally used to influence or attempt to influence the
independent presentation of the case in any trial, and I want to
go on record today, stating that I reserve the right to revisit
this day in much the same way that has been alleged in the past
with respect to the 1989 trial.
* * * * *
So, I will also state to the Court, along these lines, and
I use Ms. Fisher as the segue to this final point, that at least
two, possibly three of my clients, have received what I believe
are properly characterized as potential intimidation for their
presentation of this case. Now, that is something I'm going to
leave at that point, without specifics and details, today.
Following Mr. Sticht's remarks, the Court stated that, while the Court would respect Mr. Sticht's request not to pursue the matter immediately, Mr. Sticht was "obligated to put it *354 to rest or to present it in a way that will enable it to be resolved". Mr. Sticht did not return to the subject of potential witness intimidation during the remainder of the evidentiary hearing, which, as described below, eventually led to a further evidentiary hearing held on August 18, 1997.
[372] Mr. Bradt first testified at the evidentiary hearing on June 10, 1996. Mr. Bradt testified that he had no direct knowledge that Mr. DeCastro passed Mr. Izen's trial strategy to Mr. McWade, but that he suspected the same by virtue of Mr. McWade's opposition to Mr. Izen's efforts to introduce evidence concerning collection litigation through Mr. Moseley. See
[373] Mr. Jones recalled Mr. Bradt to testify on June 14, 1996, for the purpose of rebutting testimony by Mr. O'Neill on the propriety of the summons issued by respondent to Mr. Kersting in 1987. During Mr. Sticht's examination of Mr. Bradt, Mr. Sticht offered into evidence a one-page facsimile of a letter that Mr. Bradt had sent Mr. Kersting in Hawaii at 10:15 a.m. on June 12, 1996, which apparently was then inadvertently forwarded by Mr. Kersting's secretary to Mr.*355 Sticht's office in Los Angeles at 10:52 a.m. on the same day. Mr. Bradt's letter includes a discussion of testimony presented by Mr. Sticht's witness, Ms. Fisher, on June 10 and 11, 1996, and testimony presented by Mr. O'Neill. Mr. Bradt's letter refers to a letter that Mr. Sticht wrote to Ms. Fisher. Mr. Bradt's letter also includes disparaging remarks regarding Mr. Sticht's trial strategy and tactics.
[374] Mr. Bradt asserted that his letter to Mr. Kersting was subject to the attorney-client privilege. Mr. Bradt declined to disclose how he had obtained a copy of Mr. Sticht's letter to Ms. Fisher.
[375] Pursuant to the Court's order excluding witnesses from the courtroom, Mr. Bradt had not been in the courtroom when either Ms. Fisher or Mr. O'Neill had testified. 82*356 Mr. Izen admitted that he had disclosed Ms. Fisher's testimony to Mr. Bradt so that he could prepare Mr. Kersting to testify in rebuttal of Ms. Fisher's testimony. Similarly, Mr. Jones admitted that he had disclosed Mr. O'Neill's testimony to Mr. Bradt in order to prepare Mr. Bradt to testify in rebuttal. Mr. Sticht suggested that Mr. Bradt's letter would tend to inflame Mr. Kersting against Ms. Fisher. 83*357
D. DENIAL OF MR. IZEN'S MOTION TO REFER THOMPSON AND CRAVENS SETTLEMENTS AND ALEXANDER AGREEMENT TO DEPARTMENT OF JUSTICE (PUBLIC INTEGRITY SECTION)
[376] On June 26, 1996, Mr. Izen filed a Motion to Refer the Thompson and Cravens Settlements and the Alexander Agreement to the Department of Justice (Public Integrity Section) for prosecution. Mr. Izen identified approximately 17 alleged crimes associated with the Thompson and Cravens settlements and the Alexander understanding and asked the Court to refer those matters to the Department of Justice for prosecution. By order dated June 26, 1996, the Court denied Mr. Izen's motion.
A. DENIAL OF RESPONDENT'S MOTION FOR FURTHER HEARING REGARDING POTENTIAL WITNESS INTIMIDATION
[377] On October 28, 1996, after completion of the bulk of the evidentiary hearing, respondent filed a motion to take additional evidence concerning Mr. Sticht's unresolved allegations at the *358 evidentiary hearing of potential witness intimidation. During this same period, the parties filed with the Court third, fourth, and fifth supplemental stipulations of facts that did not comply with the Court's Rules concerning stipulations and amounted to little more than a proffer of documents subject to an extensive list of objections.
[378] In a response to respondent's motion, Mr. Sticht alleged (and the record now shows) that Mr. Sticht's clients received unsolicited phone calls and written communications from Mr. Kersting and from Joseph A. Peterman (Mr. Peterman), a Kersting program participant and nontest case petitioner, 84*359 throughout these proceedings encouraging them to ask Mr. Sticht to cooperate and otherwise present a unified case with the test case and nontest case petitioners represented by Messrs. Izen and Jones, promising financial assistance in the form of disbursements from a "legal defense fund" in exchange for such cooperation, and ridiculing Mr. Sticht's representation of his clients. 85
[379] On January 30, 1997, the Court issued an order denying respondent's motion. Although the Court expressed concern over Mr. Sticht's allegations, the Court was not persuaded that the activities in question satisfied the legal definition of witness intimidation. See, e.g.,
[380] Mr. Sticht subsequently filed a report with the Court identifying Mr. Kersting, Richard B. Rogers (Mr. Rogers), and JoAnne Rinaldi (Ms. Rinaldi) as persons who were scheduled to, but did not, testify at the evidentiary hearing and providing a summary of the testimony expected from each witness. At approximately the same time, respondent filed a response with the Court stating that the parties were unable to eliminate many of the objections raised with respect to the documents attached to the parties' fourth and fifth supplemental stipulations of facts.
[381] With a view to completing the record in these cases, the Court ordered a further evidentiary hearing for the purpose of receiving the testimony of Mr. Kersting and Ms. Rinaldi. It was hoped that Mr. Kersting's *361 testimony would eliminate some or all of the parties' objections to the documents attached to the parties' fourth and fifth stipulations of fact, and that having Ms. Rinaldi testify would complete the record insofar as she might have declined to testify at the initial evidentiary hearing because of perceived intimidation. However, the Court rejected Mr. Sticht's request to call Mr. Rogers to testify on the grounds that: (1) Mr. Rogers' testimony was not related to the documents attached to the parties' fourth and fifth stipulations of fact; (2) there was no indication that Mr. Rogers had declined to testify during the initial evidentiary hearing because of perceived intimidation; 86 and (3) Mr. Sticht's proffer of Mr. Rogers' testimony revealed that the testimony, which primarily concerned the First Savings acquisition, would amount to an attempt to retry the Dixon test cases on the merits or would concern a transaction that was not in issue in the trial of the test cases.
[382] On July 24, 1997, Mr. Kersting filed a Motion for Protection or to Quash asserting that the supplemental evidentiary hearing and production of the documents identified in the subpoena that Mr. Sticht had served on him in May 1996 (before the initial evidentiary hearing) would amount to an attempt to retry the test cases. By order dated July 25, 1997, the Court denied Mr. Kersting's motion as moot on the ground that Mr. Sticht's subpoena had expired on June 26, 1996 -- the date of adjournment of the original evidentiary hearing.
[383] Mr. Sticht was unable to locate Mr. Kersting for purposes of service of a new subpoena directing him to appear and testify at the evidentiary hearing. Nevertheless, on August 7, 1997, Mr. Kersting filed a Second Motion for Protection or to Quash Subpoena asserting that he was too ill to travel from Hawaii to Los Angeles for the evidentiary hearing because of recent cancer surgery. Because Mr. Kersting did not appear at the supplemental evidentiary hearing, the Court later denied Mr. Kersting's motion as moot.
[384] On August 18, 1997, the Court conducted a supplemental evidentiary hearing in these cases in Los Angeles. *363 Ms. Rinaldi was the sole witness at the supplemental evidentiary hearing. Ms. Rinaldi testified that she participated in the Kersting programs during the taxable years 1980 and 1983-91 with her husband, a flight engineer for American Airlines, with a view towards profiting as a stock holder and for the tax benefits. 87 Ms. Rinaldi testified that she believed that Kersting promissory notes were enforceable against her. Ms. Rinaldi testified that she relied upon and was assured by the various "Dear Friend" letters that Mr. Kersting sent to her during the period 1981 to 1992. Ms. Rinaldi did not consult with a certified public accountant regarding her tax liability until after the Court released its opinion in Dixon II.
[385] On August 29, 1997, Mr. Izen submitted to the Court a document that the Court filed as a supplement to Mr. Izen's motion to compel filed April 26, 1996. Relying on a recent case,
[386] By order dated September 4, 1997, the Court denied Mr. Izen's motion to compel. The Court denied Mr. Izen's motion as moot insofar as Mr. Izen sought to compel the testimony of Messrs. Thompson, DeCastro, Sims, and McWade, and to compel Messrs. Thompson and DeCastro to produce documents. In so ruling, the Court noted that Mr. Thompson had waived the attorney-client privilege, produced the documents requested in discovery, and testified at the evidentiary hearing. In addition, the Court had heard testimony from Messrs. DeCastro, Sims, McWade, and additional Government witnesses. Further, the Court denied Mr. Izen's motion insofar as Mr. Izen moved to compel respondent to produce documents. Specifically, although the Court declined to decide whether the admitted Government misconduct in the presentation and trial of the test cases in Dixon v. Commissioner, docket No. 9382-83, et al., amounted to fraudulent or criminal conduct, the Court did conclude that the disputed documents did not contain material subject to the crime-fraud exception, i.e., legal advice obtained *365 in the furtherance or in aid of a future fraudulent scheme or criminal activity. Moreover, the Court rejected Mr. Izen's contention that respondent's activities since May 1992 amounted to an effort to "cover up" what Mr. Izen alleged to be fraudulent or criminal conduct. On the basis of a review of respondent's privilege log and supplemental privilege log, the Court held that the documents described therein qualified for protection from disclosure pursuant to the corresponding privilege(s) relied upon by respondent.
[387] On October 10, 1997, Mr. Sticht filed a Motion to Reopen the Record seeking to submit to the Court a written offer of proof comprising a written declaration by Mr. Rogers, a nontest case petitioner, along with numerous documents that purport to describe some connection or link between the series of transactions underlying Mr. Rogers' participation in the First Savings acquisition and his related participation in the Investors Financial stock purchase plan. Mr. Sticht's motion included allegations that Messrs. Thompson, Alexander, DeCastro, Kozak, and McWade compromised the trial of the test cases "by making an incomplete *366 an inaccurate presentation" of the First Savings acquisition. 88
[388] By order dated November 24, 1997, the Court denied Mr. Sticht's motion on the ground that the materials that Mr. Sticht was seeking to submit to the Court should have been offered into evidence during the initial evidentiary hearing in May and June 1996, where all of the implicated parties had been called to testify. Insofar as Mr. Sticht was arguing that there was a meaningful link or connection between the First Savings acquisition and the Investors Financial stock purchase plan, the Court further observed that the First Savings acquisition was not among the Kersting programs at issue in the trial of the test *367 cases, and that petitioners' theory of a link between the two transactions would be ripe for consideration only if respondent were to move for entry of decision based in part on adjustments attributable to the First Savings acquisition.
[389] On April 9, 1998, Mr. Izen filed a Motion to Take Judicial Notice, asserting that the Court is obliged by
[390] On November 2, 1998, Mr. Izen filed a Petition for Mandamus with the Court of Appeals for the Ninth Circuit for a writ of mandamus directing this Court to grant Mr. Izen's Motion to Take Judicial Notice. By order filed December 16, 1998, the Court of Appeals denied Mr. Izen's petition.
[391] All materials attached to Mr. Izen's motion, which concern Kersting program participant Carl Mott, 89 were received in evidence *368 at the trial of the test cases and considered by Judge Goffe in Dixon II. See discussion of collection cases
F. DENIAL OF MR. STICHT'S MOTIONS FOR RELEASE FROM PIGGYBACK AGREEMENTS
[392] On June 9, 1998, Mr. Sticht filed Motions for Release from Piggyback Agreement on behalf of nontest case petitioners *369 Richard B. and Donna G. Rogers, Anthony E. and Carol A. Eggers, and John L. and Terry E. Huber. Mr. Sticht contends that Mr. Seery's apparent conflict of interest, at a time when Mr. Seery represented the Rogerses, the Eggerses, and the Hubers, provides an independent basis for releasing nontest case petitioners from their piggyback agreements. In the alternative, Mr. Sticht contends, in light of respondent's misconduct in the trial of the test cases, that the Court should conclude that respondent did not comply with the terms of the piggyback agreements.
[393] On June 9, 1998, Mr. Sticht filed a Motion to Sever Case and for Entry of Decision; Or Alternatively to Sever Case and Set for Trial on behalf of Joe A. and JoAnne Rinaldi in docket No. 7205-94. The Rinaldis' case at docket No. 7205-94 concerns the Rinaldis' tax liabilities for 1990 and 1991 and is based upon a notice of deficiency issued after the disclosure of the misconduct in the trial of the test cases. Because the Rinaldis did not sign a piggyback agreement in docket No. 7205-94, Mr. Sticht contends that the Court's opinion in Dixon II does not bind the Rinaldis. Mr. Sticht contends, relying upon the misconduct of respondent's *370 attorneys in the trial of the test cases, that the Court should either enter a decision in the Rinaldis' favor or sever the Rinaldis' case from the consolidated cases and set the case for trial.
[394] On July 7, 1998, respondent filed objections to Mr. Sticht's motions. Respondent contends that the validity of the piggyback agreements in dispute is not affected by either events occurring during the trial of the test cases or Mr. Seery's alleged conflict of interest.
[395] On July 10, 1998, Mr. Jones filed an opposition to Mr. Sticht's motions asserting that it would be premature to grant the motions. 90
[396] As discussed in greater detail infra pp. 284-295 and pp. 300-302, we will deny Mr. Sticht's motions.
[397] By order dated August 27, 1998, the Court directed Messrs. Huestis and Sticht to file reports with the Court detailing any objection to the lifting of the Court's protective orders dated June 10 and 26, 1996. Mr. Huestis filed a report with *371 the Court objecting to the lifting of the Court's protective orders on the ground that Mr. Kersting might attempt to use the records in question to harass the Thompsons. Mr. Sticht and respondent filed separate reports with the Court indicating no objection to the lifting of the protective orders. As discussed in greater detail infra pp. 302-305, we will lift the protective orders.
ULTIMATE FINDINGS OF FACT
[398] Messrs. Sims and McWade negotiated a series of contingent settlement agreements with Mr. DeCastro in respect of the Thompsons' tax liabilities in advance of the trial of the test cases. The final Thompson settlement agreement provided for a reduction in the Thompsons' tax liabilities for 1979, 1980, and 1981 for the purpose of generating refunds of tax and interest that were used to pay Mr. DeCastro's attorney's fees. The refunds actually made were more than sufficient for this purpose; the excess was received and retained by the Thompsons. The Thompson settlement was not based upon or influenced by the Thompsons' participation in the Bauspar program.
[399] Messrs. Sims and McWade negotiated a contingent settlement agreement with Mr. Cravens in respect of the Cravenses' tax *372 liabilities for 1979 and 1980 in advance of the trial of the test cases. Messrs. Sims and McWade misled Mr. Cravens as to the nature and legal effect of his settlement and the need for counsel at the trial of the test cases. In so doing, they foreclosed the possibility that the Cravenses would become clients of Chicoine and Hallett, and later, of Mr. Izen. They thereby reduced the effectiveness of Mr. Cravens' presentations to the Court from the point of view of all petitioners; the likelihood that Mr. Cravens would have informed counsel for test case petitioners that his cases had been settled was also reduced.
[400] Messrs. Sims and McWade were the only persons in the Honolulu District Counsel Office with knowledge of the Thompson and Cravens settlements before and during the trial of the test cases. Other than Mr. Stevens, no one else within the Internal Revenue Service was aware of the Thompson and Cravens settlements before or during the trial of the test cases through the times that the Court issued its Dixon II opinion and entered the initial decisions in the test cases.
[401] Before the trial of the test cases, Mr. McWade intentionally misled the Court, with the complicity of *373 Mr. DeCastro, by not disclosing the settlement of the Thompson cases when he moved to set aside the Thompson piggyback agreements. At the trial of the test cases, Messrs. Sims, McWade, and DeCastro intentionally misled the Court regarding the status of the Thompson cases by not disclosing the settlement of the Thompson cases. At the trial of the test cases, Messrs. Sims and McWade intentionally misled the Court in similar fashion regarding the settlement of the Cravens cases.
[402] Mr. McWade allowed Mr. Alexander to offer misleading testimony to the Court during the trial of the test cases regarding his understanding that his tax liabilities would be reduced in exchange for providing assistance to Mr. McWade.
[403] Mr. DeCastro did not act as a Government "mole" during the trial of the test cases or convey any of Mr. Izen's trial strategies or confidential information to the Government. Cf.
[404] Mr. Izen had no knowledge, before and at the trial of the test cases through the times that the Court issued the Dixon II opinion and entered the initial decisions in the test cases, that Messrs. Thompson and Cravens had entered into settlement *374 agreements with Mr. McWade.
OPINION
[405] The Court of Appeals for the Ninth Circuit vacated this Court's decisions in Dixon II and remanded the test cases for an evidentiary hearing "to determine the full extent of the admitted wrong done by the government trial lawyers."
[406] While the parties have primarily addressed the specific issues posed by the mandate *375 of the Court of Appeals, whether the Government misconduct constitutes a structural defect or harmless error, our analysis is not limited to these issues. At the inception of this proceeding, the Court raised the issue whether the Thompson and Cravens settlements share significant characteristics with improper "Mary Carter" agreements; Mr. Izen has consistently maintained throughout this proceeding that the Government misconduct amounted to fraud on the Court; and Mr. Sticht has asserted that nontest case petitioners were not only harmed by the Government misconduct, but also by Mr. Kersting's interference in the attorney- client relationships between test case petitioners and their counsel. In an effort to spread the blame, respondent has asked the Court to find that Mr. Izen, as well as Mr. Kersting, was aware of the Thompson and Cravens settlements at or before the trial of the test cases.
[407] Before turning to our analysis of the foregoing issues, we will address the burden of proof in this proceeding.
[408] The Court deferred ruling on the parties' requests for assignment of the burden of proof and the fixing of the standard of proof for purposes of the evidentiary *376 hearing. The Court nevertheless placed on respondent the initial burden of coming forward with evidence and prescribed a structure for the orderly presentation of witnesses at the evidentiary hearing.
[409] The burden of proof consists of two burdens -- the burden of production of evidence and the burden of persuasion. See Wigmore, Evidence in Trials at Common Law, secs. 2485 to 2488 (Chadbourn rev. 1981). Assignment of the burden of proof and fixing the standard of proof serve a procedural function by delineating the parties' obligations respecting the presentation of evidence at trial.
[410] Although assignment of the burden of proof was not resolved before the evidentiary hearing, the Court is satisfied that the evidentiary hearing has produced a record that contains all relevant facts necessary for the Court to discharge its obligations under the mandate. The parties' versions of the facts as set forth in their respective proposed findings of fact generally are in accord, 91*377 with one immaterial exception discussed infra pp. 209-211. Consequently, from a purely procedural standpoint, assignment of the burden of proof and fixing the standard of proof are not necessary.
[411] We likewise are convinced that assignment of the burden of proof is not necessary for the Court to decide whether the Sims- McWade misconduct resulted in a structural defect in the trial of the test cases. The structural defect question raises a legal issue requiring the Court to apply a settled body of case law to essentially agreed facts.
[412] In contrast, assignment of the burden of proof and fixing the standard of proof have greater substantive significance with respect to harmless error analysis. As discussed in greater detail infra pp. 233-236, harmless error analysis ultimately requires the Court to consider whether the Sims-McWade misconduct affected the outcome in the trial of the test cases. Because the assignment of the burden of proof, and particularly the standard of proof, could influence the outcome of the Court's harmless error analysis, we will decide the issue.
[413] Proper placement of the burden of proof in these cases *378 for purposes of the evidentiary hearing is not easily resolved and raises some perplexing questions.
[414] There is a well-recognized exception to the normal placement of the burden of proof in cases where the Commissioner determines that the taxpayer is liable for an addition to tax for fraud. In such cases, the Commissioner bears the burden of proving fraud by clear and convincing evidence. See
[415] The Court has also recognized an exception to the normal rule respecting the placement of the burden of proof in motions practice. For example, in
[416] Because these cases are not now before the Court in the normal posture of a deficiency case, the parties agree that the Court should disregard
[417] Respondent contends that, because petitioners "now seek to affirmatively invalidate the Court's Dixon II opinion", petitioners bear the burden of proof as the moving parties. Further, relying on cases such as
[418] Relying on virtually the same authorities, petitioners counter that respondent should bear the burden of proof and that *382 the standard of proof is clear and convincing evidence. Petitioners reason that respondent should bear the burden of proof insofar as it was respondent who moved for an evidentiary hearing before the appeal of the test cases and again after the Court of Appeals remanded the test cases to the Court for an evidentiary hearing on the significance of the misconduct of respondent's attorneys.
[419] We note that the decisions entered by the Court in the test cases have not become final. Timely appeals were taken and the test cases are before the Court pursuant to the mandate of the Court of Appeals, which vacated the decisions for further proceedings.
[420] We disagree with petitioners' contention that respondent should bear the burden of proof on the technical ground that respondent is the moving party. Nonetheless, the unusual aspects of these cases persuade us that it would be inappropriate to place the burden of proof on petitioners. First, we observe that in
[421] For purposes of completeness, we briefly address the *384 immaterial exception alluded to above. That exception arises from respondent's requests for findings of fact and argument that Mr. Izen was aware of the Cravens and Thompson settlements at the time of the trial before Judge Goffe. 94*385 Placing the burden of proof on respondent -- for reasons discussed above -- we have found that Mr. Izen was not aware of the settlements. However, the record contains evidence, such as Mr. Kersting's, Mr. Moseley's, and Mr. Bradt's knowledge of the settlements, Mr. Bradt's prior partnership with Mr. Izen and their cooperation and sharing of information during the evidentiary hearing, and statements by Mr. Cravens -- which he ultimately recanted on grounds of uncertainty and lack of clear recollection -- from which it could be inferred that Mr. Izen had been informed or had become aware of the settlements at or before the trial of the test cases. 95 Although such evidence does not suffice to require a finding to that effect, we might have found, if petitioners had to bear the burden of proof on that question, that petitioners had not carried that burden. 96*386
[422] We regard the exception as immaterial because we are satisfied that our conclusions and the outcome would remain the same, even if we were to conclude that Mr. Izen had been aware of the settlements. We would so conclude on essentially the same grounds on which we reject Mr. Sticht's argument over Mr. Kersting's interferences with the attorney-client relationships of the attorneys whom he employed to represent the test case petitioners. See infra pp. 230-232.
[423] The Court of Appeals for the Ninth Circuit vacated this Court's decisions in the test cases and remanded *387 the cases with directions "to conduct an evidentiary hearing to determine the full extent of the admitted wrong done by the government trial lawyers" and to consider "whether the extent of misconduct rises to the level of a structural defect voiding the judgment as fundamentally unfair, or whether, despite the government's misconduct, the judgment can be upheld as harmless error."
[424] The term "structural defect" normally refers to the violation of a fundamental constitutional right occurring during a criminal trial that affects the very framework within which the trial proceeds, so that the trial cannot reliably serve its function as a vehicle for determination of guilt or innocence. See
[425] Significantly, not all constitutional errors occurring during a trial result in a structural defect in the proceedings. To the contrary, there are a number of constitutional errors, characterized *388 as lesser "trial errors", that are susceptible to harmless error analysis.
[426] In
[427] The Supreme Court described the distinction between a constitutional violation that may be characterized as a trial error as opposed to a structural defect as follows:
Since this Court's landmark decision in Chapman v.
California, 386 U.S. 18,
rule *389 that a constitutional error does not automatically require
reversal of a conviction, the Court has applied harmless-error
analysis to a wide range of errors and has recognized that most
constitutional errors can be harmless. See, e.g., Clemons v.
Mississippi, 494 U.S. 738, 752-754,
overbroad jury instructions at the sentencing stage of a capital
case);
evidence at the sentencing stage of a capital case in violation
of the
erroneous conclusive presumption); Pope v. Illinois, 481 U.S.
497, 501-504,
the offense);
instruction containing an erroneous rebuttable presumption);
of defendant's testimony regarding the *390 circumstances of his
confession);
(1986)(restriction on a defendant's right to cross-examine a
witness for bias in violation of the
and n.2 (1983)(denial of a defendant's right to be present at
trial);
comment on defendant's silence at trial, in violation of the
giving a jury instruction on a lesser included offense in a
capital case in violation of the
v.
the presumption of innocence);
232 (1977)(admission of identification evidence in violation of
the
States, 411 U.S. 223, 231-232, *391
court statement of a nontestifying codefendant in violation of
the
v.
U.S. 42, 52-53,
violation of the
1, 10-11,
violation of the
The common thread connecting these cases is that each
involved "trial error" -- error which occurred during the
presentation of the case to the jury, and which may therefore be
quantitatively assessed in the context of other evidence
presented in order to determine whether its admission was
harmless beyond a reasonable doubt. In applying harmless-error
analysis to these many different constitutional violations, the
Court has been faithful to the belief that the harmless-error
*392 doctrine is essential to preserve the "principle that the
central purpose of a criminal trial is to decide the factual
question of the defendant's guilt or innocence, and promotes
public respect for the criminal process by focusing on the
underlying fairness of the trial rather than on the virtually
inevitable presence of immaterial error."
681 (citations omitted).
* * * * * * *
The admission of an involuntary confession--a classic
"trial error" -- is markedly different from the other two
constitutional violations referred to in the Chapman footnote
[
subject to harmless-error analysis. One of these violations,
involved in
total deprivation of the right to counsel at trial. The other
violation, involved in
judge who was not impartial. These are structural defects in the
constitution of the trial mechanism, which defy analysis by
"harmless-error" standards. The entire *393 conduct of the trial from
beginning to end is obviously affected by the absence of counsel
for a criminal defendant, just as it is by the presence on the
bench of a judge who is not impartial. Since our decision in
Chapman, other cases have added to the category of
constitutional errors which are not subject to harmless error
the following: unlawful exclusion of members of the defendant's
race from a grand jury,
the right to self-representation at trial, McKaskle v. Wiggins,
constitutional deprivations is a similar structural defect
affecting the framework within which the trial proceeds, rather
than simply an error in the trial process itself. "Without these
basic protections, a criminal trial cannot reliably serve its
function as a vehicle for determination of guilt or innocence,
and no criminal punishment may be regarded as fundamentally
fair."
[428] The Court of Appeals for the Ninth Circuit recently relied upon the Supreme Court's opinion in
[429] Messrs. Izen and Jones argue that the Government misconduct in these cases resulted in a structural defect on the ground that their clients, both test case and nontest case petitioners, were deprived of a fair trial. Messrs. Izen and Jones argue that the Government misconduct included the illegal search of Mr. Kersting's office, the issuance of erroneous notices of deficiency intended *395 to pressure taxpayers, secret settlements with the Thompsons, Cravenses, and Alexanders, the use of Mr. Thompson as a conduit for the payment of Mr. DeCastro's attorney's fees, Mr. McWade's misrepresentations to Mr. Cravens regarding the terms and effect of his settlement, and respondent's denial of Mr. Jones' request to participate in the discovery/investigation process that respondent undertook in 1992. Messrs. Izen and Jones contend that the confluence of all of these factors amounted to Government misconduct so egregious as to prevent the test case petitioners from fully developing their positions at trial.
[430] In the alternative, but in reliance upon the same factors, Messrs. Izen and Jones contend that the Government misconduct resulted in reversible error in the trial of the test cases. Mr. Izen further asserts that: (1) The Government misconduct resulted in a fraud upon the Court; and (2) respondent's use of Mr. DeCastro to "infiltrate" petitioners' camp requires a new trial. We will address separately the latter two contentions.
[431] Mr. Izen contends that the proper remedy in these cases is entry of decision in favor of all petitioners. In the alternative, Mr. Izen contends *396 that all petitioners should be awarded a new trial. Mr. Jones contends that the Court should order respondent to show cause why respondent should not be barred from further proceedings against all Kersting petitioners. 97
[432] Mr. Sticht also contends that the Government's misconduct resulted in a structural defect in the trial of the test cases, but he characterizes the defect differently. Mr. Sticht asserts that the Court effectively was precluded from supervising the trial process because Judge Goffe was not informed of the Thompson and Cravens settlement agreements. In conjunction with this argument, Mr. Sticht maintains that nontest case petitioners were deprived of procedural due process insofar as their decisions to execute piggyback agreements, as opposed to accepting one of the Government's settlement offers before the trial, *397 were made without knowledge that two test case petitioners had decided to settle their cases. Mr. Sticht relies on
[433] In response to respondent's contention that the Government misconduct did not result in a structural defect because Mr. Izen was not inhibited in fully and fairly presenting his clients' cases, Mr. Sticht asserts that nontest case petitioners nevertheless *398 were harmed by Mr. Kersting's firing of Chicoine and Hallett at a time when they were attempting to settle the Kersting project cases. Mr. Sticht further suggests (in very general terms) that Mr. Izen's performance at the trial of the test cases was deficient and that the trial of the test cases should have included an attorney who was not being paid by Mr. Kersting.
[434] Our first step in deciding whether the Government misconduct resulted in a structural defect in the trial of the test cases is to describe and characterize the Government misconduct.
[435] Messrs. Sims and McWade negotiated a series of contingent settlement agreements in the Thompson and Cravens cases in advance of the trial of the test cases under which the Thompson and Cravens would receive the more favorable of: (1) The Tax Court's decision if the test case petitioners should prevail in the Tax Court; or (2) the agreed decisions based on the settlements of their test cases.
[436] Messrs. Sims and McWade were the only persons in the Honolulu District Counsel Office with knowledge of the Thompson and Cravens settlements before and during the trial of the test cases. Other than Mr.*399 Stevens no one else within the Internal Revenue Service was aware of the Thompson and Cravens settlements before or during the trial of the test cases up to the times that the Court issued its Dixon II opinion and entered the initial decisions in the test cases.
[437] Before the trial of the test cases, Mr. McWade intentionally misled the Court, with the complicity of Mr. DeCastro, by not disclosing the settlement of the Thompson cases when he moved to set aside the Thompson piggyback agreements. Messrs. Sims, McWade, and DeCastro intentionally misled the Court regarding the status of the Thompson cases at the trial of the test cases. When Mr. Thompson alluded to his settlement during his testimony at the trial of the test cases, Mr. McWade interrupted Mr. Thompson in order to divert him from the subject and thus intentionally prevented Judge Goffe from learning about the Thompson settlement. Messrs. Sims and McWade also intentionally misled the Court regarding the status of the Cravens cases at the trial of the test cases.
[438] The decisions entered in the Thompson cases provided for agreed reductions in the Thompsons' tax liabilities for 1979, 1980, and 1981 that generated refunds *400 of tax and interest that in turn were used to pay Mr. DeCastro's attorney's fees. The refunds actually made were more than sufficient for this purpose; the excess was received and retained by the Thompsons. Contrary to McWade's testimony at the evidentiary hearing, the Thompson settlement was not based upon or influenced by the Thompsons' participation in the Bauspar program.
[439] Although the contingent aspect of the secret settlement agreements provided an ostensible incentive for Messrs. Thompson and Cravens to defend vigorously the Kersting interest deductions that they had reported on their tax returns, the record shows that the secret settlements had the effect of diluting the adversarial character of the Thompsons' and Cravenses' presentations of their cases to the Court.
[440] Mr. Thompson's testimony at the trial of the test cases reveals that he strongly defended the position that he had participated in the Kersting programs with the objective of making a profit. However, Mr. Thompson was the only test case petitioner to testify that Mr. Kersting had assured him that his promissory notes would not be enforced. Although Mr. Thompson's testimony on this point merely served to *401 corroborate Mr. Kersting's statements to other Kersting program participants in the comfort letters, the circumstances indicate that Mr. Thompson participated in the trial of the test cases in part to lay the groundwork for a defense against Mr. Kersting's earlier threats to collect on Mr. Thompson's promissory notes. 98 Considering Mr. Thompson's mixed motivations, Mr. Thompson was not fully representative of the class of Kersting program participants interested in contesting the Commissioner's determinations disallowing Kersting interest deductions.
[441] Mr. Thompson's testimony aside, Mr. Thompson's settlement agreement placed his counsel, Mr. DeCastro, in a conflict of interest. In particular, Mr. Thompson's settlement agreement was altered so that Mr. DeCastro's attorney's fees in effect would be paid out of tax refunds that were guaranteed to be paid to the Thompsons. In short, with Mr. Thompson serving as a conduit, Messrs. *402 Sims and McWade arranged for the Government to pay Mr. DeCastro's attorney's fees to ensure that Mr. Thompson would ostensibly remain a test case petitioner. As observed by the Court of Appeals, Mr. DeCastro "was the main beneficiary of the [Thompson] settlement".
[442] The record indicates that Mr. DeCastro had concluded before the trial of the test cases that Kersting program participants did not have a viable case. He candidly admitted as much to Mr. Izen on the eve of the trial. Consistent with this view, Mr. DeCastro had advised his clients, including the Thompsons, to try to obtain the best settlements they could get and not abide the outcome of the trial of the test cases. Before the final sweetening of the Thompson settlement, Mr. DeCastro had effectively represented his clients, including the Thompsons, in obtaining a number of settlements (with the burnout feature) on the order of 20 percent.
[443] Against *403 this background, Mr. DeCastro's conflict in the Thompson cases became acute when he agreed, in the context of the final sweetening of the Thompson settlement to provide the wherewithal to pay his legal fees, to continue to participate in Messrs. Sims' and McWade's scheme to keep the Thompsons among the test cases petitioners and to provide the masquerade of trial representation for the Thompsons as one of the test cases. Before the trial of the test cases, Mr. DeCastro had written to Mr. Huestis that Mr. Thompson's participation in the trial "appears to be wise insurance to obtain cancellation of the notes".
[444] Mr. McWade, with the knowledge of Mr. Sims, negotiated a contingent settlement agreement with Mr. Cravens in advance of the trial of the test cases. However, Mr. McWade intentionally misled Mr. Cravens as to the nature and legal effect of his settlement and the need for counsel at the trial of the test cases. Mr. McWade improperly advised Mr. Cravens that, by virtue of his settlement, Mr. Cravens could not win or lose and would not need an attorney to represent him at the trial of the test cases. In so doing, Mr. McWade foreclosed the possibility that the Cravenses would become *404 clients of Chicoine and Hallett, and later, of Mr. Izen, and thereby reduced the effectiveness of Mr. Cravens' presentations to the Court from the point of view of all petitioners. The likelihood that Mr. Cravens would have informed counsel for test case petitioners that his cases had been settled was also thereby reduced.
[445] Mr. Cravens relied upon Mr. McWade's advice and appeared at the trial of the test cases without counsel, whereupon he was informed by Mr. McWade that he would enjoy the better of the Tax Court decision in the trial of the test cases or the previously arranged settlement agreement. We have no doubt that Mr. Cravens would have been better prepared and would have offered a more complete case had he been represented by counsel at the trial of the test cases. At a minimum, counsel could have assisted Mr. Cravens in completing his testimony regarding his motivations for participating in Kersting programs and his belief that his promissory notes were valid.
[446] During the trial of the test cases and thereafter, Messrs. Sims and McWade intentionally misled the Court and the remaining test case petitioners regarding the status of the Thompson and Cravens cases. Messrs. *405 Sims and McWade consciously continued their efforts to mislead the Court during the evidentiary hearing by denying that the Thompson settlement was a vehicle for paying Mr. DeCastro's legal fees for representing the Thompsons at the trial of the test cases, by testifying that the Thompson settlement was attributable to the Thompsons' participation in the Bauspar program, and by trying to cover up the bases for the stipulated decisions that were entered by the Court in the Alexander cases.
[447] Mr. McWade also failed to disclose to the Court his understanding with Mr. Alexander and allowed Mr. Alexander to offer misleading testimony to the Court during the trial of the test cases. Although we are unable to find that Mr. McWade and Mr. Alexander agreed before the trial to a specific reduction of the Alexanders' tax liabilities in exchange for Mr. Alexander's assistance to Mr. McWade during the trial of the test cases, we are convinced that Mr. McWade and Mr. Alexander had a general understanding that the Alexanders' tax liabilities would be reduced. In this regard, Mr. Alexander misled the Court when he ambiguously answered "Specifically, no." to Mr. Izen's question at trial whether *406 Mr. Alexander had an agreement with Mr. McWade to reduce his tax liabilities. 99
[448] In sum, the record in these cases reveals a scheme by Messrs. Sims and McWade to mislead the Court and manipulate the test case procedure in a misplaced effort to enhance the already overwhelming likelihood that respondent would prevail on the merits of the Kersting adjustments and their continuing efforts at the evidentiary hearing to cover up what they had done.
[449] Petitioners unanimously advance the view *407 that the Government misconduct should be considered a structural defect. We are convinced that Messrs. Sims' and McWade's misconduct diluted the adversarial character of the presentation of what the Court and the other petitioners were led to believe were the Thompson and Cravens test cases. To conclude, however, that the Government misconduct resulted in a structural defect in the trial of the test cases, one also must accept the proposition that the harm caused by the Government misconduct pervaded and altered the basic constitution of the trial mechanism in all the test cases.
[450] As previously indicated, Messrs. Izen and Jones contend that the Government misconduct in these cases includes the alleged illegal search of Mr. Kersting's office and the issuance of erroneous notices of deficiency. However, Messrs. Izen and Jones disregard the fact that every court considering the matter has rejected the contention that the search of Mr. Kersting's office was illegal. See
[451] The impact of the Government misconduct in these cases must be evaluated in the context in which it occurred. Specifically, whereas the typical structural defect case arises in a trial of a single criminal defendant, *409 the test case procedures employed in these cases concern the tax liabilities of more than 1,300 Kersting program participants who agreed to be bound by the outcome in a trial of eight test case petitioners, six of whom were represented by Mr. Izen.
[452] Although we are convinced that the Thompson and Cravens settlements had the effect of diluting or diminishing the adversarial character of the presentation of their cases, we are equally convinced that the Thompson and Cravens settlements neither prevented Mr. Izen from fully and fairly presenting his clients' cases to the Court nor resulted in any reduction in the effectiveness of his presentation on their behalves. There is no indication in the record that the Thompson and Cravens settlements affected Mr. Izen's trial preparation or trial strategy, or his trial tactics or presentation. Although Mr. Thompson's testimony at the trial of the test cases that Mr. Kersting had orally assured him that his promissory notes would be canceled in exchange for the return of Kersting stock may have surprised Mr. Izen, the record reveals that Mr. Izen was well aware that respondent intended to rely on the so-called comfort letters to establish *410 the same point. Mr. Izen's strategy -- conceived before the trial of the test cases and continuing through the evidentiary hearing -- was to rebut the comfort letters with evidence that Kersting corporations had initiated collection litigation against Kersting program participants who failed to make loan payments. In addition to developing the testimony of the test case petitioners that he represented, Mr. Izen cross-examined Messrs. Thompson, Cravens, and Alexander during the trial of the test cases. Considering all the facts and circumstances, we are convinced that the misconduct of Messrs. Sims and McWade in connection with the Thompson and Cravens settlements and the Alexander understanding did not alter the basic framework within which the trial of the test cases was conducted. We are convinced that the trial of the test cases served its fundamental function as the vehicle for redetermining the tax liabilities of the broad array of test case petitioners represented by Mr. Izen.
[453] We are not persuaded by Mr. Sticht's argument that the Court effectively was precluded from supervising the trial of the test cases because Judge Goffe was not informed of the Thompson and Cravens *411 settlement agreements. Judge Goffe was aware that Messrs. Thompson and Alexander were hostile towards Mr. Kersting. Although a disclosure of the Thompson and Cravens settlements and the Alexander understanding would have given Judge Goffe a more comprehensive basis for weighing their credibility, we do not equate Judge Goffe's lack of knowledge of the settlements with the proposition that he was precluded from supervising the trial of the test cases. To the contrary, the record in the trial of the test cases and the evidentiary hearing shows that Judge Goffe accurately assessed the credibility of Messrs. Thompson, Cravens, Alexander, and Kersting and maintained firm control of the proceedings.
[454] The Ninth Circuit cases that Mr. Sticht relies upon for the proposition that the nondisclosures to the Court precluded Judge Goffe from supervising the trial of the test cases are readily distinguishable from the facts at hand. In
[455] We likewise reject Mr. Sticht's argument that a structural defect occurred by reason of respondent's failure to inform nontest case petitioners who signed piggyback agreements that two test case petitioners had received contingent settlements. Although Mr. Sticht characterizes this failure as a structural defect, Mr. Sticht's argument amounts to little more than a breach of contract theory -- a matter we address more fully below. In any event, we restate our earlier conclusion that the trial of the test cases served its fundamental function as the vehicle for redetermining the *413 tax liabilities of Mr. Izen's test case petitioners to embrace the broader proposition that the nontest case petitioners who signed piggyback agreements received what they bargained for, an opinion and a series of decisions on the merits in Dixon II that covers a broad array of Kersting programs for the taxable years 1975 through 1983.
[456] Mr. Sticht contends that Mr. Izen's representation of test case petitioners does not provide a sound basis for concluding that the Government misconduct did not cause a structural defect in the trial of the test cases. In particular, Mr. Sticht points to Mr. Kersting's interference in the Chicoine and Hallett settlement negotiations and his eventual firing of Chicoine and Hallett, and Mr. Izen's alleged lack of preparation for the trial, as evidence that nontest case petitioners were not afforded due process.
[457] Mr. Kersting, the shelter promoter, had the incentive and initially the resources to finance the test case litigation. By so doing, Mr. Kersting positioned himself to influence or determine the choice of counsel hired to represent the test case petitioners, creating the potential for conflicts of interest. Mr. Kersting repeatedly used *414 his control of the purse strings to interfere in the attorney-client relationships of participants in his programs, as evidenced by his attempts to initiate Mr. Seery's withdrawal as test case counsel for the Thompsons and his efforts to forestall dissemination to Kersting program participants of Internal Revenue Service settlement offers solicited by Mr. Seery and by Chicoine and Hallett. The pattern of interference continued in Mr. Kersting's firing of Chicoine and Hallett as counsel for test case petitioners and encouraging nontest case petitioners to recall their settlement retainers from Chicoine and Hallett. 101*415 *416 The record of the evidentiary hearing contains evidence that Mr. Kersting participated in and perhaps orchestrated efforts to create disaffection among Mr. Sticht's clients.
[458] It is also ironic -- if true -- that Mr. Kersting did not inform Mr. Izen of the Thompson and Cravens settlements at or before the trial of the test cases. If Mr. Kersting had informed Mr. Izen and Mr. Izen had informed Judge Goffe, the trial might have been somewhat delayed, but the tax liabilities of the nonsettling Kersting test case and nontest case petitioners would have been finally resolved long ago, with attendant avoidance or reduction of interest costs, legal fees, and expenditure of private party, administrative, attorney, and judicial resources.
[459] Nevertheless, Mr. Kersting's misconduct does not somehow tip the scale in favor of finding a structural defect in the trial of the test cases. While Mr. Kersting endeavored to keep all the nontest case petitioners under his wing through his numerous "Dear Friend" letters and through the hiring and firing of counsel for test case petitioners, nontest case petitioners should have been alerted to the potential for and presence of conflicts between their interests and those of Mr. Kersting by Mr. Seery's withdrawal as counsel, as well as by the firing of Chicoine and Hallett. However, neither Mr. Kersting's *417 payment of Mr. Izen's fees, nor our review of the record in Dixon II, suggests that Mr. Izen's representation of the test case petitioners was inadequate, in the sense that there is anything more that he or any other attorney could have done that would have led to a different outcome.
[460] At the end of the day, the Government misconduct in these cases is not readily comparable to any of the fundamental constitutional violations that the Supreme Court has identified as a structural defect, e.g., denial of the right to counsel or the right to self-representation, the right to an impartial judge, or the right to a public trial. In this regard, we are mindful of the Supreme Court's statement in
[461] Although we have concluded that the Sims-McWade misconduct did not result in a structural defect in the trial of the test cases, we must consider whether petitioners are entitled to a new trial on the ground that the misconduct resulted in reversible error as opposed to harmless error. See
[462] The Court's Rules of Practice and Procedure set forth the principle of harmless error as follows:
No error *419 in either the admission or exclusion of evidence,
and no error or defect in any ruling or order or in anything
done or omitted by the Court or by any of the parties, is ground
for granting a new trial or for vacating, modifying, or
otherwise disturbing a decision or order, unless refusal to take
such action appears to the Court inconsistent with substantial
justice. The Court at every stage of a case will disregard any
error or defect which does not affect the substantial rights of
the parties.
[463] In civil cases, an error related to admission of evidence or attorney misconduct is considered harmless if there is no prejudicial effect and/or the error did not affect the judgment. See
[464] The Supreme *420 Court has adopted a similar standard for reviewing errors associated with prosecutorial misconduct in criminal cases. See
[465] Consistent with the approach of the cases on harmless error in both the civil and criminal contexts, our inquiry is not focused on the merits of the matter or the correctness of the result in Dixon II, as such, but on what Justice Roger Traynor, in his seminal essay, "The Riddle of Harmless Error" (1970), called the "effect on the judgment" test of harmless error.
[466] Although our task has been made onerous by the magnitude of the record of the original trial and the evidentiary hearing, the task has *422 been facilitated by the Court's detailed and discriminating findings of fact and discussion of law in Dixon II, as required by section 7459(a). We are not confronted by the opacity of a jury general verdict or cursory findings by a trial judge sitting without a jury. See Traynor, supra at 22-25. We reject Mr. Sticht's assertions that we are engaging in sheer speculation or embarking on uncharted waters in proceeding with the reversible error versus harmless error analysis mandated by the Court of Appeals. The road map provided by the Court's findings and opinion in Dixon II could not be more detailed and specific in relation to the record of the trial and the evidentiary hearing.
[467] We therefore will first review the Court's Dixon II opinion and then consider the relative importance of the testimony and evidence of Messrs. Thompson, Cravens, and Alexander to the Court's holdings in Dixon II.
[468] The Court's opinion in Dixon II contains a detailed description of the various Kersting programs and a comprehensive analysis in support of the Court's determination to sustain respondent's disallowances of Kersting interest deductions. In Dixon II, the Court held that *423 the Kersting loans were sham transactions lacking economic substance, that the loans did not constitute genuine debt, and that interest was not "paid" on Kersting loans within the meaning of section 163.
1. MR. KERSTING'S LACK OF CREDIBILITY
[469] In Dixon II, the test case petitioners bore the burden of proof and were required to show by a preponderance of the evidence that respondent's determinations disallowing Kersting interest deductions were erroneous. See
[470] Judge Goffe made it abundantly clear in Dixon II, on the bases of both his observations of Mr. Kersting at trial and his review of the record, that Mr. Kersting lacked credibility, particularly his testimony having a bearing on the tax viability of his programs. Examples cited by Judge Goffe as evidence of Mr. Kersting's lack of credibility included his false testimony regarding: (1) The filing of tax returns for Kersting corporations; (2) the reasons behind the closing of Kersting accounts at Hawaii National Bank; (3) the level *424 of Gabriele Kersting's participation in daily corporate operations; (4) the reasons for the frequent creation of new acceptance corporations; and (5) the methods used to value Kersting stock. See Dixon II, 62 T.C.M. (CCH) at 1482, 1484, 1487, 1991 T.C.M. (RIA), at 91-3024 to 91-3025, 91-3026 to 91-3027, 91-3029 to 91-3031.
2. SHAM ANALYSIS
[471] The Dixon II opinion reveals that Judge Goffe relied upon evidence that was both qualitatively and quantitatively substantial in support of the conclusion that the Kersting stock transactions in dispute were shams. Although acknowledging that some Kersting corporations engaged in businesses unrelated to the disputed Kersting programs, Judge Goffe concluded that the viability and activities of the various Kersting corporations were not determinative of whether the specific Kersting transactions in dispute were shams. See id. at 1485-1486, 1991 T.C.M. (RIA), at 91-3028; see also
[472] Judge Goffe reviewed the relevant testimony and particular circumstances of each test case petitioner and concluded that the presence of several factors common *425 to all of them invariably required the finding that petitioners had no subjective business purpose for engaging in the Kersting programs other than tax avoidance. In particular, Judge Goffe found that the test case petitioners entered into the Kersting programs without specific knowledge about the Kersting corporations involved, the industries in which they operated, and the impact of prevailing economic conditions on their investment decisions, and without obtaining the assistance of an independent adviser. Judge Goffe further found that the test case petitioners entered into the Kersting programs without regard to whether the purchase price for the stock that they purported to purchase was reasonable and appropriate. See Dixon II, 62 T.C.M. (CCH) at 1486-1491, 1991 T.C.M. (RIA), at 91-3027 to 91-3034. Indeed, Judge Goffe found that Mr. Kersting had failed to explain clearly, consistently, or credibly how he had determined the value of Kersting stock upon both its sale and reacquisition from test case petitioners and other Kersting program participants. See id. at 1487, 1991 T.C.M. (RIA), at 91-3030.
[473] Judge Goffe noted that Mr. Cravens had testified that his purpose for entering *426 into the Kersting programs was "mainly" for tax shelter, that Mr. Cravens had failed to offer any other reason for his participation in the Kersting programs, and that Mr. Cravens had opened and closed two Kersting programs (stock subscription plans) during a 2-year period (1979 and 1980) without any economic profit or loss other than being out-of-pocket the cash payments on his leverage notes. See id. at 1488, 1991 T.C.M. (RIA), at 91-3031.
[474] As with several other test case petitioners, Judge Goffe disregarded Mr. Thompson's testimony that he expected to profit from his participation in the Kersting programs on the ground that Mr. Thompson's testimony was vague and not supported by the record. Judge Goffe rejected Mr. Thompson's argument that his participation in the First Savings acquisition contributed to his profit motive for participating in the Kersting programs at issue. See id. at 1489-1490, 1991 T.C.M. (RIA), at 91-3032 to 91-3033.
[475] Judge Goffe further concluded that the test case petitioners failed to show that the Kersting programs had economic substance beyond the creation of tax benefits. Relying primarily upon the manner in which Mr. Kersting actually operated *427 the programs, Judge Goffe found that there was little if any likelihood of either corporate profitability or shareholder profitability. Even assuming some level of corporate profitability and a related increase in the value of Kersting stock, Judge Goffe found it significant that no evidence was offered either through Mr. Kersting or the test case petitioners that Kersting program participants were ever in a position to sell their stock at an increased value relative to the purchase price of the stock. Finally, Judge Goffe found that Mr. Kersting routinely disregarded standard corporate practices. See id. at 1491-1494, 1991 T.C.M. (RIA), at 91-3034 to 91-3038.
[476] Consistent with his findings that the test case petitioners had no business purpose for entering into the Kersting programs other than tax avoidance and that the transactions lacked economic substance, Judge Goffe held that the stock transactions were shams.
3. LACK OF GENUINE DEBT/WALTZ OF FUNDS
[477] After concluding that the stock transactions were shams, Judge Goffe went on to consider whether the primary and leverage loans constituted genuine debt that qualified for deduction under section 163(a). Judge Goffe independently *428 examined each of the Kersting programs and loans in dispute.
i. SUBSCRIPTION INTEREST
[478] Relying upon the specific language in the stock subscription agreements underlying the stock subscription plan and the leasing corporation plan, Judge Goffe held that the agreements, standing alone, did not create an unconditional debt obligation. See id. at 1494-1496, 1991 T.C.M. (RIA), at 91-3038 to 91-3040.
[479] Judge Goffe further denied deductions for subscription interest under the Stock Subscription and Leasing Corporation Plans on the ground that such interest was not "paid" within the meaning of section 163(a). In so holding, Judge Goffe focused on Mr. Kersting's practice of carrying out a circular flow of checks among Kersting corporations and investors at the same bank on the same day -- the so-called waltz of funds. See, e.g.,
ii. PRIMARY LOANS
[480] Judge Goffe determined that several features of the primary loans prevented them from being genuine debt in substance. First, Judge Goffe found that Mr. Kersting and program participants had an understanding at the commencement of a program, as reflected in a number of so-called comfort letters, that a primary loan obligation could be satisfied in full at any time by a mere surrender of the associated stock certificate. In so finding, Judge Goffe rejected Mr. Kersting's testimony that he did not represent to program participants that they could exchange their stock for cancellation of a primary note at any time. To the contrary, Judge Goffe listed the following nine items in support of his conclusion that Mr. Kersting applied the policy outlined in his so-called comfort letters to all program participants: (1) Mr.*430 Thompson's testimony that Mr. Kersting assured him of the exchange policy; (2) Mr. Kersting's description of a stock subscription plan to Mil Harr; (3) Gabriele Kersting's form letter to test case petitioner Terry D. Owens describing a stock subscription plan; (4) Mr. Kersting's form letter describing a leasing corporation plan; (5) Mr. Kersting's form letter issued on the first anniversary of a leasing corporation plan; (6) Mr. Kersting's acknowledgment in a comfort letter that such a letter would be issued to "every participant * * * if it would not weaken YOUR position with the IRS"; (7) Mr. Kersting's broad statement in a later comfort letter that "We will always repurchase the stock issued at a price sufficient to allow a borrower to discharge all of his debt"; (8) Mr. Kersting's statements in a credit-reference letter written on behalf of a program participant; and (9) a form letter issued to test case petitioner Jerry R. Dixon describing the process for the termination of his participation in a stock purchase plan. See id. at 1499-1500, 1991 T.C.M. (RIA), at 91- 3043 to 91-3044.
[481] Continuing his analysis, Judge Goffe concluded that, even assuming that there was no prearranged *431 understanding between Mr. Kersting and program participants, neither Mr. Kersting nor the program participants ever contemplated that the principal obligation on a primary loan would be paid except by a surrender of the underlying stock. Judge Goffe reached this conclusion after finding that: (1) No evidence was produced of a primary note ending up in the hands of anyone not associated with Mr. Kersting; (2) primary loans issued during later years included an express notation that they were nonnegotiable and nonassignable; and (3) primary loans were unsecured, with the primary notes failing to list even the purchased stock as collateral. See id. at 1500, 1991 T.C.M. (RIA), at 91-3044. Judge Goffe further concluded that program participants would not have assumed liability for the high level of debt that the primary loans represented, considering their lack of understanding of the Kersting corporations in which they were purportedly investing, "unless they had no expectation or intention of ever paying off those loans with cash". Id.
[482] Judge Goffe found additional support for his conclusion that the primary loans did not constitute genuine debt in Mr. Kersting's backdating of documents *432 relevant to the loan transactions and the apparent waltz of primary loan funds under the stock purchase plan and the leasing corporation plan. See id. at 1500-1502, 1991 T.C.M. (RIA), at 91-3044 to 91-3046.
[483] Judge Goffe held in the alternative that, even assuming that the primary loans represented genuine debt, the test case petitioners had failed to show that they actually "paid" interest on the primary loans within the meaning of section 163(a) inasmuch as Mr. Kersting apparently waltzed leverage loan funds that were used to pay interest on primary loans. See id. at 1502, 1991 T.C.M. (RIA), at 91-3046.
iii. LEVERAGE LOANS
[484] Judge Goffe determined that leverage loans did not represent genuine debt because of several factors, including the waltzing of funds, backdating of documents, substance not following form, and mutual expectations that program participants would not incur personal liability for the principal amounts of the leverage loans. See id. at 1502-1503, 1991 T.C.M. (RIA), at 91-3046 to 91- 3047.
4. COLLECTION LITIGATION
[485] As previously discussed, Mr. Izen offered evidence on behalf of test case petitioners that various Kersting corporations initiated collection *433 actions against Kersting program participants in an attempt to rebut respondent's evidence that there was a mutual understanding between Mr. Kersting and his program participants that primary and leverage loans would not be enforced. Judge Goffe rejected the collection litigation evidence as a basis for sustaining the validity of the Kersting loans as follows:
clients on September 25, 1980, and his 1986 correspondence with
the Thompsons, his overriding concern was to be compensated by
means of leverage loan interest. It was this amount that even he
deductions. In encouraging clients by means of the September 25,
1980, letter to "discharge the debt to which you are a party,"
typical primary or leverage loans. His letters to the Thompsons
principal obligations when the investor neglected or refused to
pay leverage loan interest. This rare occurrence, which Kersting
sufficient *434 to transform any of petitioners' loans from Kersting
Id. at 1506, 1991 T.C.M. (RIA), at 91-3049 to 91-3050.
5. CAT-FIT PLAN
[486] Judge Goffe found that the record in the trial of the test cases did not provide a basis for the Court to understand fully how the CAT-FIT program operated or how Mr. Kersting intended the program to operate. 105 In any event, Judge Goffe concluded that: (1) The CAT-FIT program was a sham transaction that provided no economic benefit other than the creation of tax losses; (2) the CAT-FIT primary loan did not constitute genuine debt because the parties never contemplated that such loans would be paid except by means of a redemption of the investment certificate; 106 (3) CAT-FIT participants did not pay interest on primary loans insofar as Mr. Kersting waltzed leverage loan funds; (4) the CAT-FIT leverage loan did not constitute genuine debt inasmuch as (a) Kersting program participants failed to demonstrate how the leverage loan principal obligations were satisfied or intended to be satisfied; 107 and (b) Mr. Kersting waltzed leverage loan funds; and (5) the CAT-FIT primary and leverage loans did not result *435 in allowable interest deductions under the rationale of
6. ADDITIONS TO TAX
i. NEGLIGENCE
[487] Judge Goffe sustained respondent's *436 determinations that the test case petitioners were liable for additions to tax for negligence. In particular, Judge Goffe found that the test case petitioners failed to show that they were unsophisticated taxpayers, that they relied upon independent return preparers or tax advisers, the nature of any professional advice that they may have received, or that any such professional advice was based upon a disclosure of all of the relevant facts. See id. at 1512-1513, 1991 T.C.M. (RIA), at 91-3056 to 91-3057. 108
ii. LATE FILING
[488] Judge Goffe sustained respondent's determination that the Thompsons were liable for the addition to tax for late filing under section 6651(a)(1) for 1981 on the ground that they did not contest the matter and were deemed to have conceded the point. 109*437 See id. at 1513, 1991 T.C.M. (RIA), at 91-3057.
iii. SUBSTANTIAL UNDERSTATEMENT
[489] Judge Goffe sustained respondent's determination that the Youngs and the DuFresnes were liable for additions to tax for substantial understatements of their income tax liabilities for the taxable years 1982 and 1983 at a rate equal to 10 percent of the underpayment. In short, the Youngs and the DuFresnes had contested the addition to tax only insofar as their liabilities depended upon respondent's prevailing on their deficiencies to a sufficient extent to exceed the substantial understatement threshold of section 6661(b)(1)(A) (deficiency must exceed greater of 10 percent of the tax required to be shown on the return, or $ 5,000). See id. at 1513-1514, 1991 T.C.M. (RIA), at 91-3058.
iv. INCREASED INTEREST
[490] Judge Goffe sustained respondent's determinations that the Thompsons were liable for interest computed at the increased rate prescribed in
[491] Whether the Government misconduct in these cases constitutes reversible error as opposed to harmless error does not turn on the "culpability of the prosecutor" but on whether nondisclosure of the Thompson and Cravens settlements and the Alexander understanding was material to the outcome in Dixon II. See
[492] Mr. McWade's settlement agreement with Mr. Cravens placed a cap on the Cravenses' tax liabilities for 1979 and 1980. *439 However, we have found that Mr. McWade deliberately misled Mr. Cravens regarding the nature and effect of his settlement. In particular, Mr. McWade initially misinformed Mr. Cravens that he could neither win nor lose at the trial of the test cases as the basis for advising him that he need not retain counsel. Relying on this misinformation and bad advice, Mr. Cravens appeared at the trial of the test cases without counsel. Mr. Cravens was surprised when Mr. McWade informed him immediately before his testimony at the trial of the test cases that he would receive the better of his earlier settlement or a Tax Court decision in favor of the test case petitioners.
[493] Mr. Cravens' testimony at the trial of the test cases was brief. Mr. Cravens testified that he participated in stock subscription programs in 1979 (Candace) and 1980 (Delta). Mr. Cravens testified that he participated in the Kersting programs mainly for the tax benefits; he did not offer any other motivation for his participation. Mr. Cravens did not testify regarding the validity of his promissory notes or his level of sophistication as an investor. Mr. Cravens testified that he closed out his participation in the Kersting *440 programs by endorsing his stock certificates and returning them to Mr. Kersting in exchange for his promissory notes.
[494] Although we believe that Mr. Cravens' testimony at the trial of the test cases was truthful in all material respects, we do believe that counsel could have assisted Mr. Cravens in presenting a more detailed and better organized case, particularly with regard to Mr. Cravens' motivation for participating in Mr. Kersting's programs and Mr. Cravens' view of the validity of his promissory notes.
[495] We have also found that Messrs. Sims and McWade misled the Court and the remaining parties to these cases by not disclosing the Cravens settlement before the trial of the test cases. We recognize that Judge Goffe might have removed the Cravens cases from the test case array had he been informed of their settlement before the trial. Indeed, an argument can be made that Judge Goffe would have removed the Cravens cases from the test case array, inasmuch as the remaining test cases provided full coverage of the Kersting programs and taxable years in dispute.
[496] Under the circumstances, we must weigh the impact of the Government misconduct in the Cravens cases on two levels. *441 First, because Mr. McWade led Mr. Cravens to believe that he did not need counsel at the trial of the test cases, we must consider whether Mr. Cravens' pro se status (and attendant lack of preparation and organization) was material to the outcome in the trial of the test cases. Second, because Judge Goffe might have removed the Cravens cases from the test case array if he had known that they had been settled, we must consider whether Mr. Cravens' testimony was material to the outcome in Dixon II. As discussed in greater detail below, we are convinced that the outcome in Dixon II would not have been different irrespective of whether Mr. Cravens had been represented at trial by competent counsel or whether Judge Goffe would have excluded Mr. Cravens' testimony in its entirety.
i. SHAM ANALYSIS
[497] We will assume that, but for Mr. McWade's interference, Mr. Cravens would have appeared at the trial of the test cases with counsel and testified (consistent with the testimony of the other test case petitioners) that he participated in the Kersting programs with a view towards making a profit and that his promissory notes constituted genuine indebtedness. Nevertheless, on the basis of our *442 review of Dixon II, we are convinced that Mr. Cravens' testimony would not have changed Judge Goffe's conclusion that the test case petitioners had no business purpose for participating in the Kersting programs. Judge Goffe relied upon factors common to all test case petitioners in rejecting their testimony that they had entered into the Kersting transactions with a view towards making a profit on stock appreciation. Specifically, Judge Goffe found that the test case petitioners participated in the Kersting programs without regard to whether the purchase price for the stock that they purported to purchase was reasonable and appropriate, and without specific knowledge about the Kersting corporations involved, the industries in which they operated, or the impact of prevailing economic conditions on their investment decisions. Under the circumstances, we are convinced that Mr. Cravens' pro se status was not material to Judge Goffe's holding that the test case petitioners had no business purpose for participating in the Kersting transactions.
[498] We are also convinced that Mr. Cravens' testimony was not material to Judge Goffe's holding that the test case petitioners lacked a business *443 purpose for participating in the Kersting programs. In particular, although Mr. Cravens testified that he participated in the Kersting programs mainly for the tax benefits, we are convinced, upon the basis of Judge Goffe's comprehensive analysis of the test case petitioners' lack of business purpose, that Mr. Cravens' testimony on this point was cumulative of other evidence in the record and was not material to Judge Goffe's holding.
[499] Judge Goffe also concluded that the test case petitioners failed to prove that the Kersting programs had economic substance beyond the creation of tax benefits. Relying primarily upon the manner in which Mr. Kersting actually operated the programs, Judge Goffe found that there was little if any likelihood of either corporate profitability or shareholder profitability, that there was no evidence that Kersting program participants were in a position to sell their stock at an increased value relative to the purchase price of the stock, and that Mr. Kersting routinely disregarded standard corporate practices. Because Judge Goffe focused on the manner in which Mr. Kersting actually operated the programs, we are convinced that Mr. Cravens' pro se status *444 was not material to Judge Goffe's holding that the Kersting programs lacked economic substance.
[500] Similarly, we are convinced that Mr. Cravens' testimony was not material to Judge Goffe's holding on this point. Although Mr. Cravens had terminated his participation in consecutive stock subscription plans in 1979 and 1980 without any economic benefit, we note that none of the test case petitioners presented any evidence that they enjoyed any economic benefit from their participation in the Kersting programs in dispute. In this light, we are convinced that Mr. Cravens' testimony was cumulative of other evidence and was not material to Judge Goffe's holding that the test case petitioners failed to prove that the Kersting programs had economic substance beyond the creation of tax benefits.
ii. LACK OF GENUINE DEBT/WALTZ OF FUNDS
[501] Judge Goffe also concluded that the test case petitioners failed to show that Kersting promissory notes constituted genuine debt or that interest was actually "paid" on the loans within the meaning of section 163(a). As previously mentioned, Mr. Cravens participated in consecutive stock subscription plans in 1979 and 1980. Relying upon the specific language *445 used in stock subscription agreements underlying the stock subscription plan and the leasing corporation plan, Judge Goffe held that the agreements, standing alone, did not create an unconditional debt obligation. Judge Goffe further denied deductions for subscription interest under the Stock Subscription Plan and the leasing corporation plan on the ground that such interest was not "paid" within the meaning of section 163(a) by virtue of Mr. Kersting's waltz of funds. In particular, Judge Goffe identified two specific instances in which Mr. Kersting waltzed funds affecting stock subscription plans. In one instance, the waltz concerned primary loan funds, while in the other the waltz concerned leverage loan funds. Considering the bases for Judge Goffe's analyses on these points, we are convinced that neither Mr. Cravens' pro se status nor his testimony was material to Judge Goffe's holdings that the test case petitioners failed to show that Kersting promissory notes constituted genuine debt or that interest was actually "paid" on Kersting loans within the meaning of section 163(a).
[502] In sum, we conclude that the Government misconduct relating to the Cravens cases constituted harmless *446 error with respect to Judge Goffe's holdings that the Kersting transactions were shams, that the loans underlying the various Kersting programs did not constitute genuine indebtedness, and that interest was not paid on Kersting loans within the meaning of section 163(a).
[503] Mr. McWade's settlement agreement with Mr. Thompson placed a cap on the Thompsons' tax liabilities for the taxable years 1979, 1980, and 1981, and ensured that the Thompsons would receive refunds of tax and interest previously remitted to respondent for those years. The Thompson settlement was amended shortly before the trial of the test cases to assure that the refunds that the Thompsons would receive would be more than sufficient to pay Mr. DeCastro's attorney's fees. The Thompson settlement created conflicts of interest for Mr. Thompson and Mr. DeCastro. 111*447
Footnotes
1. Cases of the following petitioners are consolidated herewith: Ronald L. Alverson and Mattie L. Alverson, docket No. 17646-83; Hoyt W. and Barbara D. Young, docket Nos. 4201-84, 22783- 85, 30010-85; Anthony E. and Carol A. Eggers, docket No. 7323-84; Robert L. and Carolyn S. DuFresne, docket Nos. 15907-84, 30979-85; John L. and Terry E. Huber, docket No. 20119-84; Terry D. and Gloria K. Owens, docket No. 40159-84; Richard and Fidella Hongsermeier, docket No. 29643-86; Norman W. and Barbara L. Adair, docket No. 35608-86; Willis F. McComas, II and Marie D. McComas, docket No. 19464-92; Wesley Armand and Sherry Lynn Cacia Baughman, docket No. 621-94; Joe A. and JoAnne Rinaldi, docket No. 7205-94; Norman A. and Irene Cerasoli, docket No. 9532-94; Stanley C. and Sharon A. Titcomb, docket No. 17992-95; Richard B. and Donna G. Rogers, docket No. 17993-95.↩
*. This opinion supplements our previously filed Memorandum Findings of Fact and opinion in Dixon v. Commissioner, T.C. Memo 1991-614, vacated and remanded per curiam sub nom. DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994).↩
2. Mr. Izen and Mr. Sticht filed separate motions with the Court to intervene in the Thompson and Cravens cases. The Court denied these motions to intervene. Although Mr. Izen and Mr. Sticht filed separate appeals in the Thompson and Cravens cases with various courts, including the Courts of Appeals for the Second, Ninth, and Tenth Circuits, all appeals in the Thompson and Cravens cases eventually were dismissed. In an unpublished opinion filed June 15, 1994, the Court of Appeals for the Ninth Circuit stated:
The Tax Court's August 25 and 26, 1992 decisions entering
settlement in the Cravens and Thompson cases, respectively, are
final.
26 U.S.C. section 7481(a)(1) ;Fed. R. App. P. 13 . The TaxCourt lacks jurisdiction to vacate those decisions. Billingsley
v.
CIR, 868 F.2d 1081, 1084 (9th Cir. 1989) . Because there is nocase remaining in which the taxpayers can intervene, this appeal
is moot. [
Adair v. Commissioner, No. 92-70812, 26 F.3d 129 (9thCir. 1994).]↩
3. The appellate panel in
DuFresne v. Commissioner, 26 F.3d 105, 107 (9th Cir. 1994) , vacating and remanding per curiamDixon v. Commissioner, T.C. Memo 1991-614, 62 T.C.M. (CCH) 1440 , T.C.M. (RIA) 91,614 (Dixon II), issued an order stating that the panel would retain jurisdiction over any subsequent appeal.4. On June 13, 1995, test case petitioner Mr. Rina conceded his case in full, resulting in entry of a stipulated decision in docket No. 17640-83 that was identical with the decision originally entered in that case on the basis of the Court's opinion in Dixon II.
5. The group of cases that were consolidated for purposes of the evidentiary hearing initially included the case of William D. and Karen S. Booth, docket No. 28950-88, in which Declan J. O'Donnell (Mr. O'Donnell) had entered his appearance. However, at the start of the evidentiary hearing, the Court granted Mr. O'Donnell's motion to sever the Booth case from the cases consolidated for the evidentiary hearing. Mr. O'Donnell argued that, in light of the theory underlying a Motion for Summary Judgment that he had filed on behalf of the Booths, they had no need to participate in the evidentiary hearing. In
Gridley v. Commissioner, T.C. Memo 1997-210↩ , the Court rejected the argument, raised in the Booths' Motion for Summary Judgment, that Kersting petitioners who signed stipulations to be bound to Dixon II were entitled to entry of decisions in their cases consistent with the decision entered by the Court in the Thompson case at docket No. 19321-83.6. See infra pp. 168-169, 171-172, and
187-188 ↩.7. The Kersting programs involved a number of corporations (hereinafter Kersting corporations). Mr. Kersting served as both a director and president of most of these corporations and also sometimes owned stock. For those corporations in which he served as president during the years in issue, he had exclusive management authority.
8. The record in these cases contains no fewer than 38 "Dear Friend" letters.↩
9. Sec. 6700 provides for imposition of a penalty of a percentage of the gross income derived from promoting an abusive tax shelter, and sec. 6701 provides for imposition of a penalty of $ 1,000 (per incident) upon a person who knowingly aids or assists another in understating his tax liability.↩
10. In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee".↩
11. Mr. Provan, who was at one time the president of one of the Kersting companies, eventually became an adversary of Mr. Kersting. See infra p. 66.↩
12. Although the Thompsons participated in one of Mr. Kersting's programs during 1977, the Thompsons did not claim any Kersting-related interest deductions on their 1977 return because their accountant-return preparer refused to include them on the return.
The record suggests that the Thompsons' 1978 tax return was prepared by Phil Scheff (an accountant recommended by Mr. Kersting) and that the Thompsons claimed Kersting program interest deductions on their return for that year. The Thompsons experienced audit problems with their 1978 tax return that were due, in part, to their failure to attach to the return a Form W-2 showing the amount of tax that Continental Airlines had withheld from Mr. Thompson's wages. In early to mid-1986, the Thompsons' counsel, Samuel M. Huestis, negotiated a settlement of their tax liability for 1978. The record does not disclose the terms of the settlement.
13.
Sec. 6621(d) was redesignatedsec. 6621(c) by sec. 1511(c)(1)(A)-(C) of the Tax Reform Act of 1986 (TRA), Pub. L. 99- 514, 100 Stat. 2744. We will hereinafter refer to the provision assec. 6621(c)↩ .14. Although the Cravenses' reporting position was unique insofar as they had reported a capital gain in a taxable year in dispute before the Court, we note that test case petitioners Robert L. and Carolyn S. DuFresne had also reported a capital gain (albeit in a year subsequent to the years in dispute) upon the surrender of stock in Charter Financial Corp. to Mr. Kersting. Like the Cravenses', the DuFresnes' capital gain was attributable to their reduction of the tax basis of their stock as opposed to an increase in its value.
15. The Alexanders were represented during the audit by their accountant, Gilbert Matsumoto (Mr. Matsumoto). Mr. Matsumoto had served as the accountant for some of Mr. Kersting's subchapter S leasing corporations, and Mr. Kersting had recommended that program participants use Mr. Matsumoto, among others, to prepare their tax returns.
16. Although Luis C. DeCastro had negotiated the settlement on behalf of Mr. and Mrs. Richards, he did not participate in the filing or prosecution of Mr. Jones' motion to vacate the decision entered in their case.↩
17. Test case petitioners Terry D. and Gloria K. Owens alleged in their petition that respondent disallowed legitimate interest deductions in their notice of deficiency. However, it appears that the allegation was not pursued by or on behalf of the Owenses, inasmuch as the decision entered by the Court in their case, following the issuance of the Court's opinion in Dixon II, was consistent with the deficiency determined by respondent.
18. Lu N. Nevels, Jr., had represented the test case taxpayers in
Pike v. Commissioner, 78 T.C. 822 (1982) , affd. without published opinion732 F.2d 164 (9th Cir. 1984) . For an example of the problems created by using one petition on behalf of so many different petitioners, seeAaronson v. Commissioner, T.C. Memo 1985-131↩ , involving the Hongsermeier petitioners in what is now docket No. 29643-86. See infra p. 38.19. Initially, Mr. Kersting or the entities that he controlled paid the legal fees associated with the Tax Court litigation. Later, however, some Kersting program participants began paying $ 100 per month to a legal defense fund managed by Mr. Kersting.↩
20. Rule 24(f), which became effective on July 1, 1990, see
93 T.C. 857 , addresses conflicts of interest in Tax Court litigation. Rule 24(f) was redesignated Rule 24(g) effective Aug. 1, 1998. See109 T.C. 542↩ .21. Mr. Seery's testimony: "I was having trouble selecting cases beyond those two that I thought would be good vehicles for that."↩
22. Mr. Seery's impression was not quite right. The Court found in Dixon II that the Hongsermeiers were unique insofar as they paid $ 250 per month out-of-pocket (rather than use the proceeds from a leverage loan) to satisfy the INTEREST due on a CAT-FIT PRIMARY loan. See Dixon II, 62 T.C.M. (CCH) at 1480, 1991 T.C.M. (RIA), at 91-3023.↩
1. By order dated Aug. 13, 1986, the Court severed the Hongsermeiers from docket No. 17445-82 (the Aaronson con-solidated petition filed by Mr. Nevels) and assigned them new docket No. 29643-86. See supra note 18 and accompany-ing text.↩
1. Maurier Leasing, a subch. S leasing program, was considered by the
Pike v. Commissioner, 78 T.C. 822↩ (1982) .Court in23. Settlement negotiations between Mr. McWade and Mr. Seery are discussed in greater detail infra pp. 78-80.↩
24. Before 1987, there was no uniform format for piggyback agreements. In 1987 or early 1988, respondent's Tax Shelter Branch issued a standard form of piggyback agreement.↩
25. Despite this distinction, respondent did not move for entry of decision -- upon entry of decisions in the Kersting test cases in early 1992 -- in any of the cases in which Kersting petitioners had executed the 1985 version of the piggyback agreement. Respondent has taken the position that no decisions should be entered in any of the piggyback cases until the decisions in the test cases become final. Cf.
Abatti v. Commissioner, 859 F.2d 115 (9th Cir. 1988) , affg.86 T.C. 1319↩ (1986) .26. Although the record does not reveal why post-1985 piggyback agreements limit respondent's concession of additions to tax for negligence to taxable years before 1982, a plausible explanation for selecting 1982 as the line of demarcation would be that the Tax Court had released its opinion in
Pike v. Commissioner, 78 T.C. 822↩ (1982) , in May 1982, putting taxpayers on notice for 1982 and later taxable years that Mr. Kersting's programs did not generate legitimate interest deductions.27. A piggyback agreement that binds the piggyback case to the outcome of the test case, whether by litigation or settlement, is not unprecedented. See, e.g.,
Fisher v. Commissioner, T.C. Memo 1994-434↩ .28. Mr. Seery had entered his appearance only in the Thompson cases assigned docket Nos. 19321-83 and 31236-84, not docket No. 30965-85.
29. Mr. Huestis had initially referred the Thompsons to a law firm, Loeb & Loeb, in Los Angeles, California. The Loeb firm declined to represent the Thompsons because of the short time to prepare for the Maui session and the incompleteness of the Thompson files.↩
30. Mr. Bradt and Mr. Izen had been law partners from 1978 to 1981.↩
31. It appears that the Thompsons actually made monthly payments of $ 535 to Bauspar.↩
32. As previously mentioned, this was around the time that Mr. Seery began the process of withdrawing as counsel for the Thompsons, following Mr. Huestis' notification to Mr. Seery that the Thompsons were in the process of retaining substitute counsel.↩
33. Although the Court's copy of Mr. Thompson's Apr. 10, 1987, letter does not include a copy of a letter from Mr. Kersting, we assume that Mr. Thompson circulated Mr. Kersting's letter of Aug. 23, 1986.
34. David L. Bigelow and Patricia L. Bigelow had participated in the CAT-FIT program during the taxable years 1975 and 1976. In Bigelow v. Commissioner, T.C. Summary 1983-6 (docket No. 3147-78S), the Court held that the Bigelows were entitled to interest deductions that they had claimed under the CAT-FIT program, partly on the basis of evidence that the Bigelows had successfully sued a related Kersting finance company in State court. Because the Bigelows' case was tried under the small tax case procedure, the case was not subject to appeal and is not treated as precedent for any other case. See sec. 7463(b).
Mr. Kozak had represented Mr. Bigelow in a lawsuit against Mr. Kersting for payment of the "equity build-up" in a mortgage funding program (presumably Bauspar) following Mr. Bigelow's termination of the program. Mr. Bigelow won the suit and collected damages. According to Mr. Kozak, Mr. Bigelow had prevailed by virtue of Mr. Kersting's promise not to enforce notes that Mr. Bigelow had signed in connection with his participation in other Kersting programs. Mr. Bigelow used Mr. Kersting's written promise that he would not enforce promissory notes to prevent Mr. Kersting from asserting the principal on the notes as a defense or offset to Mr. Bigelow's claim to the equity buildup in the mortgage funding program.
35. Mr. Kozak had represented Mr. Provan when he had been sued as a director of First Savings. The representation ended with a settlement with the company that provided First Savings' officers and directors liability insurance. Mr. Kozak did not represent Mr. Provan in any tax controversies with the Internal Revenue Service related to the Kersting programs.↩
36. As discussed in greater detail, infra pp. 115-116, Mr. Kozak and his wife, Susan K. Kozak, had participated in one or more of the Kersting programs that were the subject of this Court's opinion in
Pike v. Commissioner, 78 T.C. 822↩ (1982) .37. Following the issuance of the arbitration decision, the Alexanders claimed a net operating loss (NOL) on their 1988 tax return in the amount of $ 321,000 identified as amounts "expended for the purpose of starting new businesses deemed to be unretrievable by the American Arbitration Association". The Alexanders later claimed an NOL in the amount of $ 360,260 on their 1990 tax return and an NOL carryforward of $ 201,955 and a loss "due to fraud" in the amount of $ 129,000 on their 1991 tax return. The Alexanders' 1991 tax return included the following statement:
The loss was $ 450,000. $ 321,000 was claimed on the 1988 returns.
$ 129,000 was not claimed because recovery was expected in the
future. In 1991 the assets on which the recovery was anticipated
disappeared because the corporation was absorbed and ceased to
exist.
Upon examination of the Alexanders' returns for 1990 and 1991, the Commissioner disallowed the claimed NOL's and fraud loss. After the Alexanders agreed to these adjustments, the Commissioner issued a notice of deficiency to the Alexanders determining accuracy-related penalties attributable in part to the disallowed losses. In Alexander v. Commissioner, T.C. Summary 1997-80 (docket No. 8948-95S), the Court sustained the Commissioner's determinations↩
38. Of course, District Counsel might be reluctant to settle a test case at a time that removal of the case from the test case array would require delay in the trial to allow the parties to select a replacement case.
39. Respondent's position represented a concession insofar as the allowance as a deduction of a theft loss of payments induced by misrepresentation is postponed until the year of discovery. See sec. 165(e);
Bellis v. Commissioner, 61 T.C. 354, 357 (1973) , affd.540 F.2d 448↩ (9th Cir. 1976) .40. In Dixon II, the Court considered and rejected the argument that Mr. Kersting's programs resulted in mere tax deferral. The Court arrived at this conclusion through a detailed analysis of the Cravenses' tax returns for 1979 and 1980. See Dixon II, 62 T.C.M. (CCH) at 1483-1484, 1991 T.C.M. (RIA), at 91-3026.↩
41. In
Richards v. Commissioner, T.C. Memo 1997-149 , supplemented byT.C. Memo 1997-299 , affd. without published opinion165 F.3d 917 (9th Cir. 1998) , we observed that the settlement may have been detrimental to Mr. and Mrs. Richards insofar as the original deficiency had been computed using an excessive tax rate (70 percent) and may have been based in part upon the disallowance of legitimate non-Kersting interest deductions. Seesupra p. 27↩ .42. Mr. Chicoine's letter identified the taxpayers as Muller, Lipsky, and Mellows. The record does not reflect the terms of the settlements in these cases.↩
43. Coincidentally, on Apr. 20, 1988, Mr. DeCastro wrote a letter to a client, James Losey, expressing similar sentiments in favor of settlement of the Kersting cases. After outlining the deadlines that Mr. McWade had set for the acceptance of outstanding settlement offers, Mr. DeCastro's letter states in pertinent part:
There is now an urgent need for your friends and
acquaintances to consult their legal counsel and seriously
consider settling their case with the IRS. The evidence
continues to build against the taxpayers in these cases and
despite Mr. Kersting's assurances, we feel the trial will be won
by the IRS. The result would be very serious for the taxpayers.↩
44. Many Kersting program participants, like the Thompsons, made interest payments on or immediately before Dec. 31, 1986, in order take advantage of the full deductibility of interest in 1986. The deductibility of payments of personal interest was subject to phase-out for taxable years beginning after Dec. 31, 1986, pursuant to TRA sec. 511(b), 100 Stat. 2246.
45. The Thompsons had not signed a piggyback agreement for their case at docket No. 30965-85. The only other test case petitioners who had signed piggyback agreements were the Dixons, in their case at docket No. 9382-83, and Mr. Rina, in his case at docket No. 17640-83. All the piggyback agreements signed by test case petitioners had been signed in June 1985 and were in the form of the 1985 agreement set forth
supra pp. 44-45↩ .46. The record does not reflect the basis for the Commissioner's transfer of $ 775 of the payment to the Thompsons' account for 1988. Because the 1988 tax year had not even started on the date of the transfer, there can be no reasonable explanation for the transfer; perhaps it was a typographical error and was intended to refer to the taxable year 1978, which Mr. Huestis had settled on the Thompsons' behalf.↩
47. The full text of Mr. McWade's memorandum is set forth infra p. 137.↩
48. Mr. McWade's letter included a statement that the modified 7-percent settlement offer would be withdrawn on Dec. 31, 1986.↩
49. See supra note 44 regarding the Thompsons' interest payment.↩
50. The $ 4,508 figure for 1979 is consistent with the deficiency notice issued to the Cravenses for that year. The $ 5,893.45 figure for 1980 represents the Cravenses' correct tax liability after eliminating the dividend adjustment set forth in the notice of deficiency for 1980 and backing out the tax on the capital gain that the Cravenses had reported on their 1980 tax return.↩
51. Sec. 7609(f) provides that the Secretary may issue a John Doe summons, i.e., a summons that does not identify the person with respect to whose liability the summons is issued, only with court approval after the Secretary establishes that: (1) The summons relates to the investigation of a particular person or ascertainable group or class of persons; (2) there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law; and (3) the information sought to be obtained and the identity of the person or persons with respect to whose liability the summons is issued are not readily available from other sources.
52. Messrs. Dombrowski and Hatfield were both trial attorneys with the Office of Chief Counsel assigned to the San Diego District Counsel Office. In September 1988, Messrs. Dombrowski and Hatfield were assigned to assist Mr. McWade in the trial of the Kersting test cases.↩
53. Inasmuch as respondent subpoenaed all the test case petitioners, it is assumed that they were all reimbursed for their expenses. See sec. 7610.↩
54. When Mr. McWade moved to have the Thompson documents admitted as evidence during Mr. Thompson's testimony, Mr. Izen objected on the grounds that he had not had an opportunity to review them. Although Judge Goffe initially questioned whether Mr. Izen should be permitted to object to the admission of the Thompson documents, Mr. DeCastro indicated that he had no objection. Judge Goffe then called a brief recess to allow Mr. Izen to review the documents and indicated that he would allow Mr. Izen to subject Mr. Thompson to a voir dire examination. Following the recess, Mr. Izen raised a limited objection to the admissibility of the documents insofar as they contained statements of Mr. Kersting's opinion of the tax laws. Judge Goffe↩ overruled Mr. Izen's objection and admitted the documents in evidence as respondent's exhibit SL. Mr. Izen was allowed to cross-examine Mr. Thompson without limitation.
55. In Dixon II, Judge Goffe↩ interpreted Mr. Thompson's remarks concerning settlement as pertaining to the resolution of Mr. Thompson's tax liability for 1978 -- a year for which the Thompsons had not been issued a notice of deficiency. See Dixon II, 62 T.C.M. (CCH) at 1472-1473, 1991 T.C.M. (RIA), at 91-3014 to 91-3015. In retrospect, and in the light of what has come out, it is more likely that Mr. Thompson in his above-quoted testimony was referring to the settlement on his behalf that Mr. DeCastro had negotiated with Mr. McWade.
56. Mr. Thompson testified that the $ 80,000 loss arose from Mr. Kersting's failure to remit to the Thompsons the buildup in the forced savings leg of the Bauspar transaction under which the Thompsons had paid $ 1,200 per month to Citizen's Financial, Inc. Mr. Thompson testified that Mr. Kersting treated the $ 1,200 payments as interest payments, rather than as contributions to a savings plan.↩
57. In Dixon II, the Court found that Investors Financial was not approved as a holding company for First Savings and that Investors Financial had no other assets. See Dixon II, 62 T.C.M. (CCH) at 1447, 1991 T.C.M. (RIA), at 91-2987.↩
58. Mr. Izen questioned Mr. Alexander as follows:
Mr. Izen: Have you ever offered * * * Mr. McWade, or any
other person connected with the Internal Revenue Service, an
affidavit concerning your testimony concerning these tax
shelters?
Mr. Alexander: We talked about it.
Mr. Izen: Did you ever offer to them to testify in return
for reducing your own personal taxes? The amount of.
Mr. Alexander: Specifically, no.↩
59. Before the trial of the test cases, Mr. McWade became aware of the Kersting collection cases through settlement discussions with Kersting program participant Lou Galli. Mr. McWade subsequently discovered that certain corporations controlled by Mr. Kersting had obtained collection judgments against no fewer that 10 Kersting program participants. In addition, Mr. McWade issued a subpoena to Mr. Kersting requesting the production of records of any other collection actions against Kersting program participants.
60. The documents in question did not reveal the particular debts that the Kersting corporations had apparently asserted against Mr. Provan.↩
61. Judge Goffe's treatment of the collection litigation evidence is summarized
supra pp. 72-74 . Mr. Izen's bringing up the collection litigation again, following the evidentiary hearing, is described infra pp. 196-197.62. Mr. Stevens was not called to testify at the evidentiary hearing.↩
63. From November 1988 through March 1992, Mr. Martucci supervised the Appeals officers assigned to the Honolulu Appeals Office, including Gary Lipetzky and Mel Iwane. Mr. Martucci first became aware of the Kersting tax shelter project in 1988 or 1989 when the project was in District Counsel jurisdiction and no longer with the Appeals Office.
64. Mr. Sanchez believed that Mr. Sims was acting outside the scope of his employment and authority when he deviated from the terms of the official project settlement offer in the Thompson cases, and when he purportedly used as a basis for settlement a transaction (Bauspar) that had occurred in a tax year over which he, as District Counsel, had no jurisdiction. We observe that the Thompsons, participation in the Bauspar program apparently originated in 1981 -- one of the years that the Thompsons had pending before the Court-- although the record does not detail the deductions, if any, claimed by the Thompsons with respect to the Bauspar program on their 1981 return.
65. The Office of the Inspector General (Dept. of the Treasury) was established under the Inspector General Act Amendments of 1988, Pub. L. 100-504, 102 Stat. 2515, codified as amended at 5 U.S.C. app. at 1381 (1994). The Inspector General's duties include the conduct, supervision, and coordination of audits and investigations to prevent and/or detect fraud and abuse in the Treasury Department and the reporting of possible criminal violations to the Attorney General.↩
66. As indicated
supra pp. 41-42 , removal of the Thompson and Cravens cases from the test case array in January 1987 would not necessarily have caused a delay in the trial of the test cases insofar as the Kersting programs in which the Thompsons and Cravenses had participated during the years in issue were before the Court in other test cases. On the other hand, removal of the Cravens cases might have caused the remaining test case petitioners to argue that the Cravens cases should be replaced because Mr. Cravens was the only test case petitioner to report capital gains upon the termination of his Kersting program. In any event, the nearly 2-year delay in the trial of the test cases after Chicoine and Hallett were allowed to file amendments to petitions raising evidentiary issues provided ample time for Messrs. Sims and McWade to disclose the Thompson and Cravens settlements to the Court and to reach agreement with test case petitioners' counsel for selection of replacement cases.67. While both Messrs. Dombrowski and O'Neill testified at the evidentiary hearing, neither of them served as respondent's counsel at the evidentiary hearing.↩
68. By order dated May 2, 1996, the Court indicated that it would defer ruling on the assignment of the burden of proof and the standard of proof to be applied in these cases. Nevertheless, the Court established a procedure for the orderly presentation of evidence at the evidentiary hearing.↩
69. On Oct. 4, 1995, respondent had filed a motion to disqualify Mr. Izen as counsel on similar grounds. By order dated Oct. 17, 1995, the Court had denied respondent's motion without prejudice to renew pending the completion of discovery.↩
70. ABA Model Rules of Professional Conduct rule 1.7(b) states in pertinent part that a lawyer shall not represent a client if the representation may be materially limited by the lawyer's own interests unless that lawyer reasonably believes the representation will not be adversely affected and the client consents after consultation. ABA Model Rules of Professional Conduct rule 3.7(a) states in pertinent part that a lawyer generally shall not act as advocate at a trial in which the lawyer is likely to be a necessary witness. See
Ewing v. Commissioner, 91 T.C. 396, 397 n.2 (1988) , affd. without published opinion940 F.2d 1534 (9th Cir. 1991) ;Para Techs. Trust v. Commissioner, T.C. Memo 1992-575↩ .71. Again, the Court relied primarily upon ABA Model Rules of Professional Conduct rules 1.7(b) and 3.7(a) as the bases for its order.
72. It appears that the Alexander correspondence that had been attached to Mr. McWade's motion to take Mr. Kersting's deposition, filed in the test cases on Aug. 25, 1988, piqued Mr. Sticht's curiosity and led him to request discovery of the Alexander files of the Internal Revenue Service for the taxable years 1974-77.↩
73. Leave to file the motion to compel was necessary insofar as the motion was filed beyond the Mar. 29, 1996, deadline for completing discovery as set forth in the Court's order dated Sept. 14, 1995, as amended by order dated Dec. 28, 1995.↩
74. The documents that the Government declined to produce were listed in a privilege log and supplemental privilege log that were attached to Mr. Sticht's Supplement to Petitioners' Motion for Court Order Permitting Department of Treasury to Disclose Information Pursuant to Privacy Act and Response to Objections to Notice of Deposition filed Apr. 8, 1996.↩
75. By order dated Aug. 27, 1998, the Court directed the parties to file reports with the Court stating in detail any objection to the lifting of the Court's protective orders. As discussed in greater detail below, the Court will lift its protective orders dated June 10 and 26, 1996.↩
76. Because each of the parties listed many of the same witnesses in their trial memoranda, the Court ruled that those witnesses would be subjected to direct examination by each party's counsel who had listed the witness in his trial memorandum, regardless of the order in which the witness was passed to the party.
77.
Rule 145(a) is designed to prevent witnesses from tailoring their testimony to that of prior witnesses and to minimize altered testimony. SeeThompson v. Commissioner, 92 T.C. 486, 494↩ (1989) .78. The following summaries of the testimony of various witnesses at the evidentiary hearing are provided for the sake of convenience and are not part of the Court's findings of fact. Also, these summaries do not cover the testimony of all witnesses who testified at the evidentiary hearing.
On the basis of our observations at trial and our review of the record, we conclude that the testimony of Messrs. Sims and McWade lacks credibility, particularly their testimony regarding the reasons for and circumstances surrounding the Thompson and Cravens settlements and the Alexander understanding. Mr. Alexander's testimony lacks credibility because of its evasiveness, particularly his misleading response at the original trial concerning his understanding with Mr. McWade regarding reduction of the Alexanders' tax liabilities. See supra note 58.↩
79. Contrary to Mr. McWade's testimony, we found that the Internal Revenue Service did not maintain a policy prohibiting the settlement of a test case. See
supra p. 76↩ .80. Messrs. Dombrowski, Hatfield, and O'Neill denied having any knowledge of the Thompson and Cravens settlements before their discovery in 1992.↩
81. Contrary to the Court's Dixon II opinion, the decisions in the Alexander cases for 1974 and 1975 reflected overpayments of $ 2,133 and $ 811, respectively, while the decisions in the Alexander cases for 1976 and 1977 reflected no deficiencies. See
supra pp. 112-115↩ .82. The Court had ruled that Mr. Bradt would not be allowed in the courtroom until Mr. Kersting had testified.
83. Mr. Sticht's receipt and disclosure to the Court of Mr. Bradt's letter to Mr. Kersting raise interesting questions concerning the professional responsibilities of attorneys. Compare Committee on Professional Responsibility, Ethical Obligations Arising Out of an Attorney's Receipt of Inadvertently Disclosed Information, 50 The Record of the Association of the Bar of the City of New York 660 (1995), with Committee on Professional Responsibility, The Attorney's Duties to Report the Misconduct of Other Attorneys and to Report Fraud on a Tribunal, 47 The Record of the Association of the Bar of the City of New York 905 (1992). The disclosures by Messrs. Izen and Jones that were prompted by the introduction of Mr. Bradt's letter also raise questions of possible conflict between the operation of
Rule 145 and the need to prepare a witness to testify and bring documents in response to a subpoena duces tecum. CompareBerry Petroleum Co. v. Commissioner, 104 T.C. 584, 609-611 (1995) , affd. on other issues without published opinion142 F.3d 442 (9th Cir. 1998) , withSmith v. Commissioner, 92 T.C. 1349 (1989) , andThompson v. Commissioner, 92 T.C. 486↩ (1989) . None of these questions have been resolved; they became moot with respect to Mr. Kersting and Mr. Bradt by reason of Mr. Kersting's failure to testify at the evidentiary hearing.84. Mr. Peterman currently has eight cases docketed with the Court all of which appear to involve Kersting adjustments: docket Nos. 1676-84, 36324-85, 19467-86, 23493-90, 12628-91, 7155-92, 15005- 93, and 3029-94. Mr. Peterman executed piggyback agreements in the first five dockets listed above.
85. Mr. Kersting's various letters to Mr. Sticht's clients are included within the exhibits associated with the parties' fourth supplemental stipulations of facts, filed Nov. 27, 1996.
On Aug. 11 and Aug. 18, 1997, Mr. Sticht filed a Status Report and a First Supplemental Status Report, respectively, attaching thereto copies of letters, some of which contain obscene and inflammatory statements, that Mr. Peterman had sent to Mr. Stict and his client.↩
86. On June 17, 1997, at the initial evidentiary hearing, Mr. Sticht stated on the record that he was reconsidering whether Mr. Rogers' testimony was necessary in light of other evidence already in the record.↩
87. Ms. Rinaldi testified that she legally separated from her husband in 1994.↩
88. The bulk of the testimony presented at the trial of the test cases concerning the First Savings acquisition was offered by Messrs. Kersting and Alexander. Although their testimony concerning the transaction generally was consistent, the Court in Dixon II apparently accepted Mr. Alexander's testimony that Federal regulators rejected Investors Financial as a holding company for First Savings despite Mr. Kersting's testimony to the contrary. See Dixon II, 62 T.C.M. (CCH) at 1447, 1991 T.C.M. (RIA), at 91-2987.↩
89. Mr. Izen's continued reliance on the collection litigation concerning Carl Mott indicates that Mr. Izen regards the collection litigation as a complete rebuttal to all evidence in the record that Mr. Kersting and program participants did not intend or expect that promissory notes would be enforced in accordance with their purported terms. In so doing, Mr. Izen ignores the Court's conclusion in Dixon II, 62 T.C.M. (CCH) at 1505-1506, 1991 T.C.M. (RIA), at 91-3048 to 91-3050, that, even if an obligation to pay leverage loan "interest" were enforceable, it would properly be characterized as a nondeductible "fee" for creating tax deductions rather than as "interest".↩
90. On July 20, 1998, Mr. Sticht filed a Motion to Strike allegedly scandalous and impertinent matters from Mr. Jones' opposition. On Aug. 6, 1998, the Court denied Mr. Sticht's motion to strike.↩
91. In those instances where the parties have not agreed with respect to a particular fact, or the record does not clearly reflect the date of a particular event, the Court generally has adopted the finding of fact proposed by the test case and nontest case petitioners.
92. Under sec. 3001 of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. 105-206, 112 Stat. 726, Congress enacted new
sec. 7491 , which provides, effective with respect to examinations commenced after July 22, 1998, that the burden of proof shifts to the Commissioner when the taxpayer produces credible evidence in opposition to the Commissioner's determination of a deficiency and satisfies other requirements.93.
Rule 1(a)↩ states that, where there is no applicable rule of procedure, "the Court or the Judge before whom the matter is pending may prescribe the procedure, giving particular weight to the Federal Rules of Civil Procedure to the extent that they are suitably adaptable to govern the matter at hand."94. Respondent has not carried through and addressed the significance for these cases of Mr. Izen's awareness or lack of awareness of the settlements. We do not believe that Mr. Izen's awareness of the settlements would have any bearing on our conclusion that the Court's decisions on the tax deficiencies of the test case petitioners should be reinstated. Although nondisclosure of the settlements by Mr. Izen -- if he had been aware of them -- would have amounted to misconduct on his part, we would not regard such misconduct as having any bearing on the reinstatement of the decisions in the test cases. See discussion infra pp. 230-232 of Mr. Kersting's misconduct.
95. We recognize that there is circumstantial evidence that Mr. Izen was not aware of the Thompson and Cravens settlements. If Mr. Izen had been aware of the Thompson settlement, it does not seem likely that he would have allowed Mr. DeCastro to attend the meeting that he held with Mr. Hongsermeier on the eve of the trial of the test cases or shared other information with Mr. DeCastro. It is also likely that Mr. Izen would have brought the settlements to the Court's attention before respondent did.↩
96. This would have been made even more likely by Mr. Kersting's failure to appear and testify at the evidentiary hearing, which might have brought into play the doctrine of
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946) , affd. on other grounds162 F.2d 513↩ (10th Cir. 1947) , that the failure of a party to introduce evidence within his possession or control which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable. Mr. Kersting's assertions in his motion to quash subpoena that he was too sick to attend the evidentiary hearing might have been well taken, but consideration could have been given to alternative means of obtaining his testimony.97. Our research does not disclose any case in which this Court has invoked such an extraordinary remedy, and petitioners have brought no such case to our attention. A new trial normally is the proper remedy in the case of a structural defect or reversible error in a trial. See
Arizona v. Fulminante, 499 U.S. 279, 113 L. Ed. 2d 302, 111 S. Ct. 1246↩ (1991) .98. Although Judge Goffe was not informed of Mr. Thompson's settlement, Mr. Thompson's dispute with Mr. Kersting was disclosed to Judge Goffe through Mr. Thompson's testimony. Consequently, Judge Goffe↩ was able to weigh Mr. Thompson's credibility on this point.
99. Mr. Alexander's response could be understood as a statement (consistent with the Court's finding in these cases) that, although Mr. Alexander did not reach an agreement with Mr. McWade for a specific reduction in the amount of his tax deficiencies, he and Mr. McWade had a general understanding that Mr. Alexander's tax liabilities would be reduced. Considering the ambiguity in Mr. Alexander's response, it seems surprising that Mr. Izen did not pursue the matter further. In any event, by virtue of Mr. McWade's duty of candor toward the Court, see ABA Model Rules of Professional Conduct rule 3.3, Mr. McWade was obliged to disclose his understanding with Mr. Alexander to the Court.↩
100. There is no evidence in the record that such errors as have been discovered in Kersting project statutory notices were attributable to an improper intention of pressuring taxpayers. However, the existence of such errors, see, e.g.,
Richards v. Commissioner, T.C. Memo 1997-149 , supplemented byT.C. Memo 1997-299 , affd. without published opinion165 F.3d 917↩ (9th Cir. 1998) , should alert nontest case petitioners and their counsel in nontest cases not yet disposed of to review their notices and carefully compare them with their return positions for the taxable years in question.101. A lawyer who planned or helped to promote a tax shelter or is otherwise under the control of a tax shelter promoter has a conflict of interest in representing participants in the tax shelter because he will not (or may not) give disinterested advice regarding settlement offers that may conflict with his original advice or the interests of the promoter. See
Ewing v. Commissioner, 91 T.C. at 397 n.2 ;Para Techs. Trust v. Commissioner, T.C. Memo 1992-575 .Chicoine and Hallett, in their retainer agreements with the test case petitioners and by their actions, made clear that although they were not averse to obtaining additional business, they had no conflict of interest and that their primary loyalty was to their clients. Mr. Kersting fired Chicoine and Hallett when, on the basis of their independent appraisal of the weakness of the Kersting programs, they tried to obtain the most favorable settlements available on behalf of as many participants, test case and nontest case petitioners, as possible. Because of his potential personal liability for both promoter penalties and Federal income taxes, and his financial interest in trying to vindicate himself and his programs, Mr. Kersting scuttled the settlements, fired Chicoine and Hallett, and found another attorney to represent the test case petitioners in the trial of the test cases. Mr. Kersting's lack of sensitivity to the conflict issue and counsel's obligation to issue disinterested advice to clients is exemplified by his misplaced emphasis in mischaracterizing Chicoine and Hallett's actions as primarily stemming from fear of suit by their clients.
102. See generally Traynor, "The Riddle of Harmless Error" (1970).↩
103. Although these criminal cases concern the prosecutor's use of false testimony, as well as the prosecutor's suppression of exculpatory and impeachment evidence, we believe they are sufficiently analogous to the cases at hand where, at a minimum, the Thompson and Cravens secret settlements and the Alexander understanding could be viewed either as evidence that was improperly admitted or impeachment evidence that was improperly excluded.
104. For a more recent espousal of the same test in a discussion limited to criminal cases see Edwards, "To Err Is Human, But Not Always Harmless: When Should Legal Error Be Tolerated?",
70 N.Y.U.L. Rev. 1167↩ (1995) .105. The test case petitioners who participated in the CAT-FIT program included the Dixons, DuFresnes, Owenses, and Hongsermeiers. See Dixon II, 62 T.C.M. (CCH) at 1507, 1991 T.C.M. (RIA), at 91-3050 to 91-3051.↩
106. Judge Goffe↩ further concluded that the CAT-FIT primary loan did not constitute genuine debt insofar as the record indicated that Mr. Kersting had waltzed primary loan funds. See Dixon II, 62 T.C.M. (CCH) at 1508, 1991 T.C.M. (RIA), at 91-3052.
107. In this regard, Judge Goffe↩ rejected the test case petitioners' attempt to show that CAT-FIT leverage loans were genuine recourse debt through evidence of collection litigation brought against George Vermef. See Dixon II, 62 T.C.M. (CCH) at 1509, 1991 T.C.M. (RIA), at 91-3053.
108. Although Judge Goffe sustained respondent's determinations that the test case petitioners were liable for additions to tax for negligence, nontest case petitioners who signed post-1985 piggyback agreements were to be relieved of liability for such additions to tax for tax years before 1982. See
supra pp. 43-45↩ .109. We note that the Thompsons had no need to contest this addition to tax by virtue of their settlement agreement.
110. Nontest case petitioners who signed post-1985 piggyback agreements agreed to be bound by the Court's determination in the test cases regarding the applicability of
sec. 6621(c)↩ .111. Mr. DeCastro's conflict in the Thompson cases became acute when he agreed, in the context of the final revision to the Thompson settlement, to participate in Messrs. Sims and McWade's scheme to keep the Thompsons among the test cases petitioners and to provide the masquerade of trial representation for the Thompsons as one of the test cases.
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