STOBIE CREEK INVESTMENTS LLC, JFW ENTERPRISES, INC., v. USA

Filing 115

PUBLISHED OPINION AND ORDER granting defendant's 77 Motion in Limine, and plaintiffs may not introduce the expert reports and testimony of Prof. Ira B. Shepard and Stuart A. Smith. Signed by Judge Christine O.C. Miller. (smg)

ST O BIE CREEK INVESTMENTS LLC, JFW ENTERPRISES, INC., v. USA

Do c. 115

In the United States Court of Federal Claims
N o s. 05-748T & 07-520T (Filed April 1, 2008) *********************** STOBIE CREEK INVESTMENTS, LLC & JFW ENTERPRISES, INC., Plaintiffs, v. T H E UNITED STATES, Defendant. *********************** * * * * * * * * * * * * * * P le a d in g and practice; Fed. R. E v id . 702, 704; motion in limine to exclude expert testimony on le g a l issues.

R o b e rt E. Kolek, Chicago, IL, for plaintiffs. Thomas R. Wechter, Matthew C. Crowl, C o llee n M. Fenney, and Ayad P. Jacob, Schiff Hardin, LLP, of counsel. S tu a rt D. Gibson, Washington, DC, with whom was Assistant Attorney General N a th a n J. Hochman, for defendant. Cory A. Johnson and Jacob E. Christensen, U.S. D e p a rtm e n t of Justice, of counsel. M E M O R A N D U M OPINION AND ORDER ON MOTION IN LIMINE TO EXCLUDE THE EXPERT REPORTS AND TESTIMONY OF IRA SHEPARD AND STUART SMITH M I L L E R , Judge. D e f en d a n t on February 19, 2008, filed its Motion in Limine To Exclude the Expert R e p o rts and Testimony of Ira Shepard and Stuart Smith. Plaintiffs responded on March 19, 2 0 0 8 . See Order entered on Dec. 10, 2007, ¶ 2 (notifying parties that, pursuant to RCFC 7 .2 ( a ), motions in limine subject to ruling without reply briefs). BACKGROUND D e f en d a n t objects to plaintiffs' offer of the expert reports and testimony of Professor Ira B. Shepard and Stuart A. Smith, Esq. Professor Shepard is a member of the faculty of the U n iv e rsity of Houston Law Center, where he teaches federal income tax courses. Mr. Smith

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is a tax attorney practicing in New York City and formerly worked at the United States D e p a rtm e n t of Justice as Tax Assistant to the Solicitor General. Defendant seeks exclusion o f the reports and testimony of Professor Shepard and Mr. Smith because they intend "to te stif y about the law they want the Court to apply in this case, and how the Court should treat th e plaintiffs' tax shelter under that law." Def.'s Br. filed Feb. 19, 2008, at 2. Defendant a rg u e s that expert testimony is not admissible when it "impinge[s] on the role of this Court" b y testifying as to the law or the application of the law to facts. Id. at 5. D e f en d a n t characterizes Professor Shepard's report as "nothing but legal analysis and a p p lic a tio n of his view of the law to his view of the facts of this case." Id. at 7. According to defendant, the report "contains lengthy descriptions of numerous cases and sets forth in d e ta il the manner in which [Professor] Shepard would decide this case if he were the judge." Id . Similarly, defendant characterizes Mr. Smith's report as "legal argument dressed up as an opinion of an expert witness" that amounts to "[n]ot only . . . a legal conclusion, [but] a c o n c lu s io n based on the wrong law." Id. at 10. Plaintiffs rejoin that the reports and testimony of Professor Shepard and Mr. Smith " b e ar on ultimate issues of fact on which expert testimony is appropriate and will assist the C o u rt in determining issues central to this action." Pls.' Br. filed Mar. 19, 2008, at 1. The re p o rts and testimony of the two experts "satisf[y] the liberal requirements of Federal Rule o f Evidence 702." Id. at 2. Plaintiffs proffer the expert opinion evidence not as addressing "p u re questions of law," but, rather, mixed questions of fact and law "relevant to Defendant's a ss e rtio n of penalties and the potential application of the reasonable cause exception to P la in tif f s ." Id. at 6-7. The reasonable cause defense, recognized by 26 U.S.C. (" I.R .C ." ) § 6664(c) (2000), to imposition of penalties under I.R.C. §§ 6662 and 6663, does p re se n t mixed questions of fact and law, but the Supreme Court has held that "[w]hether the e le m e n ts that constitute `reasonable cause' are present in a given situation is a question of f a c t, but what elements must be present to constitute `reasonable cause' is a question of law." U n ited States v. Boyle, 469 U.S. 241, 249 n.8 (1985). P r o f e ss o r Shepard's expert report, after describing his compensation rate and relevant q u a lif ic a tio n s , first recounts the historical background that led to this litigation and the p rim a ry positions that the Internal Revenue Service (the "IRS") takes with regard to the S to b ie Creek partnership and the transactions at issue. The Shepard report then recounts the h is to ry of aggressive tax planning as a legitimate approach to minimizing taxes and over the n e x t sixteen pages surveys cases in which courts have upheld taxpayers' aggressive tax p la n n in g strategies. Fifteen pages of the report examine cases in which taxpayers prevailed ev en where a situation was "too good to be true" and where the IRS prevailed even where a situation was "too bad to be true." See Def.'s Br. filed Feb. 19, 2008, Ex. 1, at 29-43. The re m a in d e r of the report, over sixty pages, discusses cases concerning the economic substance 2

d o c trin e , the imposition of penalties, and the reasonable cause defense. The report concludes th a t the transactions at issue in this case did not lack economic substance and that, in any e v e n t, plaintiffs fulfilled the requirements of the reasonable cause defense. M r. Smith's expert report is founded on his extensive experience as a tax lawyer for o v e r forty years. The Smith report concludes that the opinion letter provided to Jeffrey W elles by Jenkens & Gilchrist, P.C., is of the quality and character upon which taxpayers s u c h as Welles could reasonably rely in preparing their tax returns. The report includes an e x h a u stiv e analysis of Treasury Circular 230, 31 C.F.R. §§ 10.0-.93, and a recitation of how t h e Jenkens & Gilchrist opinion letter fulfills the requirements established by Treasury C irc u la r 230. The Smith report also includes a thorough description of the transactions and o p in io n letters that were the subject of Klamath Strategic Investment Fund, LLC v. United S tates, 472 F. Supp. 2d 885 (E.D. Tex. 2007), a case in which he testified as an expert w itn e s s . D IS C U S S IO N D e f en d a n t has moved for a ruling in limine. Generally speaking, in limine rulings are p r e li m i n a ry in character because they determine the admissibility of evidence before the c o n te x t of trial has actually been developed. Walter Kidde Portable Equip., Inc. v. Universal S e c . Instruments, Inc., 479 F.3d 1330, 1338 (Fed. Cir. 2007). The basic purpose of a motion in limine is "`to prevent a party before trial from encumbering the record with irrelevant, im m a te ria l or cumulative matters. Such a motion enables a court to rule in advance on the a d m is s ib ility of documentary or testimonial evidence and thus expedite and render efficient a subsequent trial.'" INSLAW, Inc. v. United States, 35 Fed. Cl. 295, 302-03 (1996) (quoting B a sk e tt v. United States, 2 Cl. Ct. 356, 367-68 (1983), aff'd, 790 F.2d 93 (Fed. Cir. 1986) ( ta b l e ) ) . F e d . R. Evid. 702, governing testimony by experts, provides, in full: If scientific, technical, or other specialized knowledge will assist the tr ie r of fact to understand the evidence or to determine a fact in issue, a witness q u a lif ie d as an expert by knowledge, skill, experience, training, or education, m a y testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of re lia b le principles and methods, and (3) the witness has applied the principles a n d methods reliably to the facts of the case. W h e n a court is considering the admission of expert testimony, the court first must determine to what extent the underlying specialized knowledge "will assist the trier of fact" in 3

"u n d erstan d [in g ] the evidence" or "determin[ing] a fact in issue." Id. "A trial court's d e c is io n to admit or exclude expert testimony is reviewed for an abuse of discretion." S e a b o a rd Lumber Co. v. United States, 308 F.3d 1283, 1292 (Fed. Cir. 2002) (citing Gen. E le c . Co. v. Joiner, 522 U.S. 136, 138-39 (1997)). Expert testimony that testifies about what th e law is or directs the finder of fact how to apply law to facts does not "assist the trier of f a ct to understand the evidence or to determine a fact in issue" within the contemplation of F e d . R. Evid. 702. Expert testimony that amounts to an opinion of law is especially d is f a v o re d : A witness cannot be allowed to give an opinion on a question o f law . . . . In order to justify having courts resolve disputes between litigants, it must be posited as an a priori assumption that there is one, but only one, leg a l answer for every cognizable dispute. There being only one applicable le g a l rule for each dispute or issue, it requires only one spokesman of the law, w h o of course is the judge . . . . To allow anyone other than the judge to state th e law would violate the basic concept. S p e c h t v. Jensen, 853 F.2d 805, 807 (10th Cir. 1988) (omissions in original) (reversing trial c o u rt's admission of expert testimony on legal issues at trial). The United States Court of A p p ea ls for the District of Columbia Circuit is even less receptive to allowing expert te s tim o n y on the law, observing that "[e]ach courtroom comes equipped with a `legal expert,' c a lle d a judge, and it is his or her province alone to instruct the jury on the relevant legal stan d ard s." Burkhart v. Wash. Metro. Area Transit Auth., 112 F.3d 1207, 1213 (D.C. Cir. 1 9 9 7 ) (reversing trial court's admission of expert testimony on legal issues at trial). This h o ld s just as true when the finder of fact is the court, if not more so; the court is well e q u ip p e d to instruct itself on the law. The United States Court of Appeals for the Federal C irc u it holds the same view on expert testimony pertaining to questions of law. See Mola D e v . Corp. v. United States, 516 F.3d 1370, 1379 n.6 (2008) (affording no weight to affidavit o f former government official interpreting thrift regulations); Rumsfeld v. United Techs. C o rp., 315 F.3d 1361, 1369 (Fed. Cir. 2003) (reversing agency board's admission of expert te stim o n y by professors, former employees of Cost Accounting Standards Board, and g o v e rn m e n t contracts accounting consultant interpreting Cost Accounting Standards in fe d era l procurement). P la in tif f s charge defendant with mischaracterizing the expert reports and testimony. P la in tif f s assert that Professor Shepard "will address whether the opinion provided by J e n k e n s & Gilchrist to the Welles family was an appropriate `more likely than not opinion' a t the time that it was issued such that a taxypayer could reasonably rely on it." Pls.' Br. filed M a r . 19, 2008, at 1. "Mr. Smith will testify as to the quality of the Jenkens & Gilchrist o p in io n , which is relevant to the taxpayer's ability to rely in good faith on that opinion." Id. 4

C a se s in which courts have upheld exclusion of expert testimony on legal issues are legion, a n d defendant cites one such case decided by every court of appeals save the Federal C irc u it. */ See Def.'s Br. filed Feb. 19, 2008, at 6 n.4. Plaintiffs respond that "[w]hile it is tru e that `matters of law' have been excluded as inappropriate subjects for expert testimony in some cases, no per se rule exists as Defendant would have this Court believe," Pls.' Br. f ile d Mar. 19, 2008, at 3, because "[c]ourts have permitted expert testimony as to governing

*/ The body of this opinion cites two decisions of the Federal Circuit that were not c ite d by the parties, yet are consistent with defendant's survey. Defendant cites cases c o n c ern in g a variety of legal issues. The court substitutes its own assessment of the cases f o r defendant's: Nieves-Villanueva v. Soto-Rivera, 133 F.3d 92, 100 (1st Cir. 1997) (ruling in a d m is s ib le expert testimony regarding holdings of cases on statutory categorization of p u b lic employees, but upholding trial verdict as product of harmless error); Marx & Co. v. D in e rs ' Club, Inc., 550 F.2d 505, 509-10 (2d Cir. 1977) (reversing and remanding for trial co u rt's admission of expert testimony concerning legal obligations of parties to contract); U n ite d States v. Leo, 941 F.2d 181, 196 (3d Cir. 1991) (upholding trial court's limiting of ex p ert testimony regarding credibility and stating that "[w]hile it is not permissible for a w itn e ss to testify as to the governing law," trial court did not abuse discretion in allowing e x p e rt to testify on relevant industry practice); Adalman v. Baker, Watts & Co., 807 F.2d 3 5 9 , 365-68 (4th Cir. 1986) (reversing and remanding trial court's admission of expert te stim o n y on meaning and applicability of securities laws), abrogated on other grounds by P in te r v. Dahl, 486 U.S. 622, 650 (1988); Owen v. Kerr-McGee Corp., 698 F.2d 236, 240 (5 th Cir. 1983) (affirming trial court for properly overruling objection to expert's testimony o n factual cause of accident and admitting testimony which did not concern legal cause of ac cide n t); United States v. Curtis, 782 F.2d 593, 599 (6th Cir. 1986) (affirming lower court's g ra n t of a motion in limine to exclude expert testimony on unsettled nature of tax law re g a rd in g willfulness); Loeb v. Hammond, 407 F.2d 779, 781 (7th Cir. 1969) (finding no e r r o r in trial court's exclusion of expert testimony on legal significance of documents, a m atter of contract interpretation); Peterson v. City of Plymouth, 60 F.3d 469, 475 (8th Cir. 1 9 9 5 ) (finding reversible error in trial court's admission of expert testimony on whether police conduct violated standards of fourth amendment); Ward v. Westland Plastics, Inc., 651 F .2 d 1266, 1270 (9th Cir. 1980) (holding trial court judge correctly ruled inadmissible expert te stim o n y that plaintiff was discriminated against on account of sex); United States v. V ree k en , 803 F.2d 1085, 1091 (10th Cir. 1986) (ruling trial court properly excluded expert te stim o n y of complexity of tax and banking law); Montgomery v. Aetna Cas. & Sur. Co., 898 F .2 d 1537, 1541 (11th Cir. 1990) (finding abuse of discretion where trial court allowed e x p e rt testimony on legal duty to hire tax counsel); Burkhart, 112 F.3d at 1213 (reversing and re m a n d in g for error in trial court's admission of expert testimony on whether legal standards o f Americans with Disabilities Act satisfied). 5

la w and regulations in the areas of insurance, banking, and securities." Id. But see R u m s f e ld , 315 F.3d at 1369 (reversing agency board's admission of expert testimony interpre tin g Cost Accounting Standards). P lain tiff s marshal citations to an array of cases, but none addresses the type of expert rep o rts and testimony that plaintiffs are proffering. Many of the cases that plaintiffs cite are c rim in a l prosecutions where the trial court allowed a prosecution witness ­ often a g o v e rn m e n t agent ­ to testify as to how the defendant violated certain regulations. The trial c o u rts in these cases did not allow defendant to offer expert testimony to rebut prosecution w itn e ss e s, thereby raising concerns of equal treatment. See United States v. Riddle, 103 F.3d 4 2 3 , 430 (5th Cir. 1997) (ruling abuse of discretion in trial court's disallowing defense w itn e ss from testifying as to whether certain conduct violated regulations, but allowing p ro s e c u tio n witness to do so); United States v. Van Dyke, 14 F.3d 415, 422 (8th Cir. 1994) (s a m e ) . The appellate courts reversed the trial courts both in the interest of treating the p arties equally, especially in a criminal prosecution, and in the interest of allowing expert te stim o n y that would not have improperly invaded the province of the court. Although the e x p lic a tio n that the experts would offer in those trials necessarily required a discussion of the re le v a n t regulations, they did not present a comparably exhaustive legal analysis of case law, statu te, regulation, or IRS documents that Professor Shephard or Mr. Smith propose to offer. O th e r cases upon which plaintiffs rely similarly do not support admission of the p a rtic u la r legal opinions that plaintiffs proffer. In United States v. Mikutowicz, 365 F.3d 65, 7 2 (1st Cir. 2004), an IRS agent described in his testimony the IRS's audit of the defendant a n d the results of the audit, along with the rationale that led the IRS to reach its conclusions. T h e court observed, however, that the agent "offered no testimony concerning [defendant's] sta te of mind when claiming the challenged deductions," which was the legal standard to a ss e ss the taxpayer's conduct. Id. In United States v. Toushin, 899 F.2d 617, 620 & n.4 (7th C ir. 1990), an IRS agent testified about the tax consequences of money kept in a safe. The c o u r t ruled that this testimony was not an "improper legal opinion" because it did not address a question of law. Id. Instead, it helped the trier of fact understand how the IRS itself a n a lyz e d the transaction, "which necessarily precedes [its] evaluation of the tax c o n se q u e n ce s." Id. P la in tif f s contend that "[c]ourts have routinely held that `an expert should be p e r m itte d to testify to the substantive law applicable to the underlying proceeding, at least to the extent necessary to explain the expert's conclusions that the defendant did or did not e x e rc is e the appropriate standard of care.'" Pls.' Br. filed Mar. 19, 2008, at 7 (quoting M id d le Mkt. Fin. Corp. v. D'Orazio, 2002 U.S. Dist. LEXIS 17817, at *26 (S.D.N.Y. Sept. 2 3 , 2002)). This proposition actually is not as receptive to an application of the facts to the law as plaintiffs would suggest, and their reliance on this particular case is puzzling. Middle 6

M a rk e t concerned a legal malpractice action; a fuller quotation from that court's opinion p ro v id e s relevant context: I conclude that the foregoing authorities and logic dictate that in a legal m a lp r a c tic e action an expert should be permitted to testify to the substantive law applicable to the underlying proceeding, at least to the extent necessary to e x p la in the expert's conclusions that the defendant did or did not exercise the a p p ro p ria te standard of care. Id . at *25-26 (emphasis added). Significantly, the court prefaced its discussion of the law w ith the general observation that "[e]xpert witnesses are not ordinarily permitted to testify to matters of domestic law." Id. at *21 (footnote omitted). A legal malpractice action, h o w ev er, involves the alleged deviation from acceptable legal practice; therefore, the court re c o g n ize d , the finder of fact must be informed of those standards: [I]n a legal malpractice action, the law applicable in the underlying action and th e state of that law at the time of the alleged malpractice is almost always a c o n sid e ra tio n relevant to determining whether the malpractice plaintiff would h a v e prevailed in the underlying action but for the alleged malpractice and w h e th e r the alleged malpractice did, in fact, constitute a departure from a c c e p ta b l e professional standards. Id . at *21-22; see also Nieves-Villanueva v. Soto-Rivera, 133 F.3d 92, 100-01 (1st Cir. 1997) ("F u rth er, there may be particular areas of law, such as legal malpractice, where expert te s tim o n y on legal matters is admissible where it would normally be excluded."). The case a t bar does not involve legal malpractice. Expert testimony is not prohibited merely because it "embraces an ultimate issue to b e decided by the trier of fact." Fed. R. Evid. 704(a). Nonetheless, expert testimony that c o n stitu te s legal analysis or application of the law would not assist the court ­ the trier of fact ­ in understanding the evidence or determining a fact in issue. "[T]he admissibility of o p in io n testimony that may involve legal conclusions ultimately rests upon whether that tes tim o n y helps the jury resolve the fact issues in the case." 29 Charles Alan Wright & V i c to r James Gold, Federal Practice & Procedure § 6284 (2008) ("Wright & Gold"). The ad v isory committee's note to Rule 704 provides an illustrative example. Asking an expert w itn e ss whether someone "had the capacity to make a will" calls for a legal conclusion and w o u ld properly be excluded as not assisting the trier of fact in understanding the evidence o r determining a fact in issue. Fed. R. Evid. 704 advisory committee's note. By contrast, ask ing an expert witness whether someone had "sufficient mental capacity to know the nature a n d extent of his property and the natural objects of his bounty and to formulate a rational 7

s c h e m e of distribution" could be useful in assisting a trier of fact in understanding the re le v a n ce of some evidence and its application to the facts presented at trial. Id. A s a general proposition, expert testimony "that merely tell[s] the trier of fact what re su lt to reach or state[s] a legal conclusion in a way that says nothing about the facts [is] still o b je c tio n a b le ." 29 Wright & Gold § 6284. Such testimony does not "assist" as required by R u le 702. See id. Plaintiffs attempt to counter defendant's characterization of the expert re p o rts and testimony as pure legal analysis by arguing that their experts "will provide an e x p e rt evaluation of the contents of the Jenkens & Gilchrist opinion to standards and p ra c tic e s regarding tax opinions." Pls.' Br. filed Mar. 19, 2008, at 2. This characterization p r e c is e ly encapsulates the problem. The expert reports are lengthy legal analyses of past p re c ed e n t, complemented by arguments attempting to persuade the court that plaintiffs rea so n ab ly relied on the legal opinions in a law firm's tax opinion letter. P la in tif f s suggest that "[d]efendant attempts to straddle both sides of this issue, d e p e n d in g on which position yields some marginal benefit." Id. at 5. Plaintiffs attached as E x h ib it 1 to their brief a portion (two pages) of the Government's brief opposing the e x c lu s io n of certain expert testimony in Fidelity International Currency Advisor A Fund, L .L .C . v. United States, No. 05-40151 (D. Mass.). According to plaintiffs, that lawsuit is a ls o an action seeking readjustment of partnership items pending before the United States D is tric t Court for the District of Massachusetts. In Fidelity the Government opposed the e x c lu s io n of experts that were offering "a legal opinion on the `income tax consequences of e a ch step' of the transaction at issue by applying applicable `tax law to the facts of each tra n sa c tio n .'" Pls.' Br. filed Mar. 19, 2008, at 5 (quoting Pls.' Br. filed Mar. 19, 2008, Ex. 1 , at 21). Yet, the brief portion of the Government's opposition that plaintiffs cite belies this a ss e rtio n . The experts that the Government offered in Fidelity were non-attorney financial e x p e rts . Their testimony would involve the "application of complex tax or accounting c o n c e p ts," id., Exhibit 1, at 21 (emphasis added) (footnote omitted), not tax law. By contrast, th e experts that plaintiff offers in this case are lawyers by training. Their reports or testimony a re not based on any such financial or accounting expertise. Their testimony embraces not a financial characterization of the underlying tax transactions, but a legal analysis. See Def.'s B r. filed Feb. 19, 2008, at 8 & n.7 ("Mr. Shepard candidly acknowledged during his d ep o sition that he does not possess the requisite expertise in economics to otherwise support su ch an `expert' opinion."). T h e court is not swayed by plaintiffs' argument that Mr. Smith's expert report and tes tim o n y should be admitted because Mr. Smith offered similar expert testimony in K la m a th , 472 F. Supp. 2d at 901, and the trial court deemed his testimony admissible and p e rs u a siv e . It is also irrelevant that in Klamath the Government filed no motion to exclude M r. Smith's testimony or that the Government was represented by the same counsel as in this 8

c a se . The Klamath court did not address any of the authorities that this court regards as d ispo sitiv e, nor does defendant's later epiphany in this lawsuit to object to Mr. Smith's te stim o n y detract from its right to seek exclusion. It is unfortunate that the question of the admissibility of this expert testimony comes so late in the pre-trial process. Plaintiffs undoubtedly have expended substantial monetary re so u rc e s in retaining Professor Shepard and Mr. Smith to produce their reports. Plaintiffs a lm o s t assuredly would have benefitted from confirming the admissibility of such legal o p in io n testimony earlier in the proceeding though an early motion in limine to introduce the c o n te m p la te d expert opinions or oral proffer during a status conference. Fed. R. Evid. 104(a) (a d m is s ib ility of evidence generally) and Fed. R. Evid 103(a)(2), (b) (offer of proof) can se rv e as the predicate for ascertaining at an early stage whether it would be worth re q u isitio n in g the type of expert legal testimony that plaintiffs now sponsor. Plaintiffs would h a v e preserved their objection should the court have ruled against the proffer, and, if the te stim o n y had not been excluded on the early motion, defendant still could have moved in lim in e to exclude after the reports had been submitted and depositions taken. The advantages o f this prophylactic procedure would have been both to limit significant trial preparation e f f o rts , as well as to remit plaintiffs to development of alternative avenues of proof. P lain tiff s' legal experts are applying the law to the facts, rather than permissibly e x p la in in g law in a manner that could inform or assist the finder of fact. Their testimony th e re f o re cannot be admitted under Fed. R. Evid. 702. C O N C L U SIO N A c c o rd in g ly, based on the foregoing, I T IS ORDERED, as follows: D e f en d a n t's motion is granted, and plaintiffs may not introduce the expert reports and te stim o n y of Professor Ira B. Shepard and Stuart A. Smith.

s / Christine O.C. Miller ______________________________ C h r is tin e Odell Cook Miller Judge

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