Appeal from the Order of the United States Tax Court No. 16985-83 Mary Ann Cohen, Chief Judge.
Before COFFEY, MANION and KANNE, Circuit Judges.
The petitioners-appellants, Sheldon and Anita Drobny, are husband and wife. During the late 1970's, Sheldon Drobny, a former IRS agent, was a partner in the accounting firm of Adler & Drobny, Ltd., based near Chicago, Illinois. Drobny promoted (and he and his wife invested in) two "research and development" programs purportedly designed to develop the substance known as "aloe vera" for commercial purposes. "Aloe vera" is an extract of the Aloe Barbadensis plant, and today is used in many skin-care and personal hygiene products. The Drobnys, on their joint federal income tax return for 1979 (prepared by Sheldon Drobny), claimed certain losses as deductions in connection with their investment in the aloe vera research and development programs. In 1983, the Illinois District Director of the IRS (based in Chicago, Illinois) disallowed these deductions, after determining through investigation that they were part of an impermissible "tax shelter" scheme, and informed the Drobnys that they were liable for a $10,877 tax deficiency. The District Director also notified Sheldon Drobny that he was liable for a civil fraud penalty (or "addition to tax") in the amount of $5,439. The Drobnys petitioned the Tax Court for a re-determination of the deficiency and the addition to tax. Following a trial, the United States Tax Court ruled in favor of the Commissioner. Drobny v. C.I.R., 86 T.C. 1326 (1986) ("Drobny I"). The Drobnys failed to file a timely notice of appeal *fn1 or a timely motion to vacate or revise the decision, which became final on September 24, 1986 (90 days after the decision was entered). Fed.R. App.P. 13(a); 26 U.S.C. sec. 7481(a)(1). In February of 1994, more than seven years after the decision became final, the Drobnys filed a motion to vacate the 1986 decision in Drobny I, arguing that the Tax Court should set aside its previous decision because the Commissioner, through his agents and attorneys, *fn2 had allegedly engaged in conduct that amounted to a "fraud upon the court." After a lengthy hearing, the Tax Court found that the petitioners had fallen short of demonstrating a "fraud upon the court" that would warrant vacating an otherwise final decision and denied the motion on May 17, 1995. Drobny v. C.I.R., 69 T.C.M. (CCH) 2600 ("Drobny II"). We affirm.
Petitioner Sheldon Drobny, a Certified Public Accountant, worked for the Internal Revenue Service ("IRS") from 1967 until 1971, when he entered the private practice of accounting in the Chicago, Illinois area. During the 1970's, Drobny began to promote tax shelters, often working closely with a Chicago attorney named Marvin Kamensky, who specialized in the formation of research and development tax shelters.
In November of 1979, Kamensky and one of his associates, Marc Z. Samotny, came to Drobny to enlist his support in the promotion of two enterprises (a partnership and a joint venture) that were ostensibly designed to develop products based on the substance aloe vera. *fn3 These alleged business enterprises are referred to in the briefs and in case law as "tax shelters," for they were structured to take advantage of the tax laws by allowing the investor to deduct his proportional share of losses incurred by the program (e.g., money devoted to research and development) on his personal income tax return. The higher the income-tax bracket of the investor, the greater the value of the deduction. *fn4 Kamensky and Samotny, the tax attorneys, persuaded Drobny, the certified public accountant, to solicit his clients and associates who might be interested in participating in the aloe vera tax shelters as investors. Drobny agreed, and was listed in the offering materials as a promoter and referred to as a member of an accounting firm that specialized in financial and tax consultation. Drobny and his wife, petitioner-appellant Anita Drobny, also became investors in the two programs, along with 21 others. On their joint income tax return for 1979, the Drobnys deducted approximately $28,000 as their pro rata share of "research and development" losses incurred by the two aloe vera programs. *fn5
In 1981 or 1982, the office of the District Director for the Illinois District of the IRS, based in Chicago, Illinois, commenced an investigation of the two aloe vera programs and Sheldon Drobny's involvement in them. Revenue Agent Noreen Rosen was in charge of this investigation, but she received assistance from Irving Feinglass, a former colleague of Drobny's at the IRS. Rosen concluded that the "research and development" losses incurred by the aloe vera enterprises would not be allowed as deductions on the investors' returns, and prepared a report (dated November 23, 1982) summarizing the basis for her recommendations. On December 16, 1982, Agents Rosen and Feinglass met with Sheldon Drobny in his office to discuss the report and the possibility of settling the dispute, but no agreement was reached.
On April 15, 1983, the District Director for the Illinois District of the IRS sent a notice to the Drobnys formally disallowing the deductions claimed on their 1979 return in connection with the aloe vera promotions, and stating that Sheldon Drobny was liable for a civil fraud penalty (or "addition to tax") in the amount of $5,439, pursuant to 26 U.S.C. sec. 6653(b). The Drobnys filed a petition with the Tax Court contesting the notice of deficiency as well as the civil penalty, pursuant to 26 U.S.C. sec. 6213(a).
The Drobnys' case came to trial during a particular time period when the IRS and the Tax Court were experiencing a tremendous increase in their respective caseloads, partly as a result of the popularity of "tax shelter" schemes similar to Drobny's. Sometime during 1983, Harmon Dow, then an Assistant Illinois IRS District Counsel, telephoned Tax Court Judge Charles R. Simpson, an acquaintance who was serving as Chairman of the Tax Court's Rules Committee, to discuss the large number of pending cases and how the court might best facilitate the handling of them. Dow was of the opinion that special procedures would be required to deal with the large number of cases. At Judge Simpson's request, Dow forwarded a computerized print-out of some 2,500 pending cases (including the Drobnys') to the judge. Subsequently, the Chief Judge of the Tax Court assigned the Drobnys' case and 14 others involving the aloe vera tax shelters to Judge Simpson, who set a hearing date for January 16, 1984 so that the court could identify several "test cases" that could proceed to trial during a special session of the court. *fn6 At the January hearing, the Drobnys' case was selected as a "test case" and set for trial on April 30, 1984. Counsel for the Drobnys did not object to the assignment of the case to Judge Simpson for the Chicago special session, nor did they challenge the selection of the case as a "test case," nor did they protest the scheduled trial date.
When the Drobny case was called for trial, the Government was represented by William C. Sabin, Jr., who worked under the direction of Harmon Dow in the Office of the District Counsel for the Illinois District of the IRS. Sabin informed the Judge, in open court, that a criminal investigation of Drobny was pending. *fn7 Samotny, one of the potential defense witnesses in the civil case, was in the courtroom when this announcement was made. *fn8 The court granted the parties' joint oral motion for a continuance of the civil action until June 25, 1984. During the month of May, preceding the civil trial, the District Director for the IRS's Illinois District decided to discontinue the criminal investigation of Drobny, and confirmed this decision in a letter to Drobny's counsel.
The Drobnys' civil trial commenced in late June, after the District Counsel for the Illinois District had informed the Drobnys' attorney in writing of the IRS's decision not to proceed with the criminal investigation of Sheldon Drobny. Apart from Samotny, potential witnesses at the trial included Kamensky, the attorney who structured the aloe vera tax shelters, and Benjamin Rosenberg, an accountant and one of those whom Drobny had persuaded to invest in the tax shelters. Prior to trial, the Tax Court had ordered that the parties submit trial memoranda, which were to include, inter alia, a list of each side's prospective witnesses. The trial memorandum submitted by the Drobnys on the opening day of the trial identified five individuals whom the defense intended to call as witnesses, but the list included neither Kamensky nor Rosenberg as defense witnesses.
On the evening before Marvin Kamensky was scheduled to appear as a Government witness in the trial, Kamensky spoke by telephone with Sabin, the IRS's counsel. The following day, when the Government called Kamensky to the stand, he refused to answer questions concerning the aloe vera tax shelter programs, invoking his Fifth Amendment right not to testify. The Drobnys maintain that Sabin threatened Kamensky during the course of the phone conversation the night before his trial testimony; specifically, they claim that Sabin told Kamensky that if he "did not testify as the Government believed he should testify, the IRS could open a case against him and charge him with perjury." Sabin also stated (again according to the petitioners) that "he could give Mr. Kamensky no assurances that he was not the target of any investigations" by the IRS in connection with the aloe vera tax shelters. *fn9 These alleged threats, according to the Drobnys, were part of a "fraud upon the court" perpetrated by the IRS, and provide a basis for vacating the Tax Court's 1986 decision.
When Kamensky invoked his Fifth Amendment right not to testify, the Government asked leave of the court to direct the witness to answer the questions put to him. The court then inquired of Kamensky the basis for his assertion of the Fifth Amendment privilege. The court heard testimony from both Kamensky and Sabin concerning the phone conversation of the previous night. Kamensky asserted that Sabin had threatened him during the phone conversation, saying that if he did not give testimony favorable to the IRS's case, the Government would file perjury charges against him. Kamensky also stated that he feared the Government was "out to get him" (i.e., that it would make him the target of a criminal investigation). Sabin denied that he had, at any time during this phone conversation, referred to a perjury charge and further stated: "[Kamensky]--to the best of our knowledge--well, I would say categorically, that he is not under any criminal investigation at this time [n]or does one appear imminent." *fn10 The court excused Kamensky from giving testimony concerning the tax shelters, concluding that although there was no pending criminal investigation of Kamensky, "there may be some basis for [Kamensky] to fear that any testimony by him might lead to . . . criminal action against him."
In November of 1994, more than ten years after the 1984 trial, the Tax Court (Chief Judge Mary Ann Cohen, presiding) conducted a hearing on the petitioners' motion to vacate the decision in Drobny I (the denial of that motion is, of course, the subject of this appeal). Testifying before Chief Judge Cohen at this 1994 hearing, Kamensky addressed the allegedly threatening phone conversation with Sabin that had occurred some ten years previously, stating that he was "frightened" as a result of this conversation and immediately consulted an attorney, who advised him not to testify. From the vantage point of more than a decade, Kamensky recalled the substance of the conversation as follows:
[Sabin] then said, and this is many years ago, but he said something to the effect that, We have information about this transaction, and if you don't--this is the way I remember it was meant, not necessarily the way it was said--If you don't say what we want, we are going to get you on perjury. Or we--no, we could--I still--I remember the word he ...