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United States v. Zanfei

September 29, 2006

UNITED STATES OF AMERICA, PLAINTIFF,
v.
CARMELO ZANFEI; WILLIAM P. CROUSE, JR.; PARADIGM SOLUTIONS GROUP, LLC; AND SUPERIOR SOLUTIONS GROUP, INC. DEFENDANTS.



The opinion of the court was delivered by: Judge John A. Nordberg

MEMORANDUM OPINION AND ORDER

Sometime in late 1999 or early 2000, Carmelo Zanfei and William Crouse joined together to launch a series of business ventures. They began selling long distance phone service and then branched out into health insurance plans and medical reimbursement plans, the latter venture being the subject of this lawsuit. Along the way, they formed a number of companies of which they were co-owners but about which they now seem to know few details.

A few years later, they ran into legal troubles. In 2003, the Department of Labor filed a lawsuit in Indiana federal court accusing them of violating their fiduciary duties under ERISA by using employees' monthly health care premiums to take their families on European vacations, to buy expensive gifts, and to prop up some of their other ventures (including the one at issue here). The Indiana District Court granted summary judgment to the government and enjoined defendants from ever acting as an ERISA fiduciary again. See Chao v. Crouse, 346 F.Supp.2d 975 (S.D. Ind. 2004). Around this same time, defendants were pursued by the Insurance Commissioners in Hawaii, Texas, Kentucky, Nebraska, Arkansas, Ohio, Missouri, Kansas, and Florida, who sought injunctions or cease and desist orders preventing defendants from selling health insurance. In 2005, defendants plead guilty to racketeering charges in Florida where they are now serving a prison sentence.

The government filed this action in 2004 because it concluded that, despite the injunction already entered by the Indiana court, Crouse and Zanfei have continue to sell abusive tax shelters. The government now moves for summary judgment, making two principal contentions. First, it asserts that defendants knew that the first of these plans (the HI Plan) was illegal because it advised employers that they could reduce employees' taxable income by reimbursing employees for the cost of employer-paid health insurance and then excluding those payments from wages. Second, the government asserts that the HI Plan and a second plan (the Healthier Plan) were intentionally designed and operated in a way that encouraged employees to seek reimbursements for expenses -- such as swimming pools and home improvements -- that were only reimbursable under limited and rare circumstances. The upshot, according to the government, is that these employers and their employees likely have filed incorrect tax returns.

Defendants deny these allegations and argue that they were acting within a well-accepted tradition, dating back to the Stamp Act, in which taxpayers legitimately seek to avoid taxes by going as close to the legal line as possible. Defendants point to the fact that they sought the advice of two accountants and an attorney and maintain that these plans were legal when they were sold and that, after the IRS definitively declared in January 2002 that reimbursements for health insurance premiums were not excludable from income, they stopped selling the HI Plan and only sold the Healthier Plan.

Although defendants strongly believe that the Healthier Plan is legal "in theory," they admit that it has had some flaws in administration. But they blame these problems on others -- either the employers who were designated as plan administrators or on the employees who had the responsibility of keeping medical receipts or on the company that ran the processing center. Finally, defendants argue that an injunction is not need here because they already have been "rendered impotent" by the injunction entered by the Indiana court.

BACKGROUND

Two preliminary points before summarizing the facts. First, for purposes of this summary judgment motion, there are no disputed material facts. This is because the defendants have not disputed most of the 96 facts contained in the government's Rule 56.1 statement and because, as to the small amount they did dispute, they have either cited to no evidence to support their position or have cited to documents that fail to support their claims. The government has accurately described these deficiencies in its reply brief, and we agree with them. For these reasons, we will rely heavily on the government's statement of facts and the documents cited in support of them. See Federal Trade Comm'n v. Bay Area Business Council, Inc., 423 F.3d 627, 633 (7th Cir. 2005) ("Because of the important function local rules like Rule 56.1 serve in organizing the evidence and identifying disputed facts, we have consistently upheld the district court's discretion to require strict compliance with those rules.").*fn1

Second, the factual record in some places is murky, making it hard to set forth a smooth summary of events. But this murkiness is not a reason for denying the government's motion because the facts that are known with certainty are by themselves sufficient to warrant the injunction and because, as discussed further below, this murkiness is primarily due to the casual way that defendants chose to run their businesses.

In the late 1990s, after working for other companies, Crouse and Zanfei began marketing and selling various products through a number of different companies that they created and generally co-owned as 50% shareholders. These companies included TRG Marketing; TRG Administration; The Redwood Group, LLC; defendant Paradigm Solutions Group, LLC; and defendant Superior Solutions Group, Inc. In this opinion, we will not attempt to keep careful track of each of these corporate entities for the simple reason that Crouse and Zanfei never did so in practice, operating them in a casual manner with fuzzy boundaries and little or no documentation or oversight. In their depositions, both men had trouble providing even rudimentary details about these entities. Zanfei was especially in the dark. With regard to defendant Paradigm, a company at the center of this lawsuit, Zanfei did not know or was uncertain about whether he was an officer, where the company was located, whether it had bank accounts, whether he was a signatory on any bank accounts, who did its tax returns, or even whether it filed any returns. For example, when asked whether he was an officer of Paradigm, Zanfei answered that he was a "manager." (Dep. at 61.) When asked whether he was a president, he first guessed that he was a "member" but then said that he didn't really know. (Id.) Although he received distributions from the company, albeit on a "sporadic" basis, he did not know who determined how much he got or how the determination was made. (Id. at 62.) To provide another example of his generally hazy recollection, Zanfei testified early in his deposition that one of his companies was TRG, LLC and that it was registered in Nevada (id. at 46), but later in the deposition, when he was asked what percentage interest he owned in this company, said: "I don't know if there's a company called TRG, LLC." (Id. at 90.) He also didn't know who owned Kuhlmann Enterprises but guessed maybe that Cindy Nordstrom "might be" one of them. (Id. at 124.) These are not isolated examples. In sum, we concur in the observation of the Indiana district court when it noted with regard to many of these same companies that it is "difficult to conclude" where one starts and another stops, a problem that the Indiana court blamed on defendants' "poor accounting practices." Chao, 346 F.Supp.2d at 984 n.3.

The HI Plan was developed by Zanfei before he met Crouse and was sold from 1999 until sometime around early 2002 when the IRS issued a Revenue Ruling making it clear that the plan was illegal. Defendants then modified this plan into the second one and called it the Healthier Plan.

Zanfei and Crouse marketed these plans with the help of an accounting firm located in Yankton, South Dakota. Members of this firm -- Wohlenberg, Ritzman & Co., LLC ("WRC") -- attended an insurance seminar in Colorado and became interested in the HI Plan after hearing Zanfei describe how it works. This eventually led to the formation of a long-term relationship with the firm with Blaine Meier, who is a CPA and one of the firm's three owners, becoming the primary contact person.

Although Meier did not attend the seminar, Zanfei later explained the HI Plan to him. Meier's initial assessment was that the plan was aggressive because it did not provide clear guidance in a few areas, the biggest one being "whether a certain type of medical expenses are reimbursable."

Nevertheless, on June 5, 2002, Meier's accounting firm entered into a formal agreement to provide technical and consulting services. (Meier Ex. 26.) The agreement provided that WRC would provide technical support that included preparing opinion lettters that the HI Plan was in compliance with the Internal Revenue Code and Treasury Regulations. The agreement also provided that the The Redwood Group would pay WRC a $2,500 retainer and $1 for each participant enrolled in the HI Plan. WRC would later enter into a similar agreement with Paradigm. (Meier Exs. 24, 25).

A week after this agreement was signed, Meier issued an opinion letter in which he concluded that the central objective of the HI Plan was legal -- namely, he concluded that "the employee should be allowed to reduce taxable compensation by the amounts elected under the Salary Reduction Agreement and enjoy the intended benefit of paying health/medical insurance and eligible expenses with pre-tax dollars." The opinion letter did not disclose Meier's financial interest in the HI plan.*fn2

On April 18, 2001, Zanfei obtained a second opinion letter for the HI Plan. This one was from Stuart Sobel, an accountant in Carmel, Indiana. (Ex. 6.) Sobel was more skeptical. His analysis was based on a review of both the relevant documents and Meier's opinion letter. For Sobel, the most controversial issue about the HI Plan was the reimbursement for the health insurance premiums as opposed to reimbursement of out-of-pocket health care expenses. Id. at 8. Although Sobel noted that a difference of opinion existed on the issue, he pointed out that the prevailing opinion -- i.e. the opinion espoused by the "professional community, including CPAs and attorneys, who deal in tax matters" -- was that these premiums were not excludable. Sobel described these arguments as being "strong." (Id. at 8-9.) Translated in plainer terms, he thought that the central objective of the plan was most likely illegal.

At some point during this general time, Zanfei and Crouse also consulted with an attorney John Markham who helped them prepare one of the key documents in the administration of both of these plans. This was a two-page worksheet entitled "My Family's Health Expenses" that contains a list of possible reimbursable expenses and was given to all employees, along with a plastic bag to keep medical receipts. Employees were supposed to check off the box for each expense they incurred. The worksheet instructed as follows:

Tracking your family's health expenses is easy! Simply (1) keep your receipts in a bag, (2) put an "X" beside each of your out-of-pocket expenses, (3) write the total amount of your expenses in the box (at the bottom of the other side of this form), (4) fill-in the beginning and ending dates of your Plan Year (for example "from 1/1/02 to 12/31/02"), (5) sign and date the form and, (6) give it to your Plan Administrator. (Crouse Ex. B.) The specific expenses listed include things such as automobile modification, athletic shoes and athletic wear, socks, electrolysis, fees for memberships, fees for health clubs and programs, cotton swabs, specially equipped telephones, air conditioning, reclining chairs, other insurance, diapers, wipes, masks, AAA, tape, alcohol, shampoo, soaps, lotions, day care, tutoring, and swimming pools or spas "for treatment." Attorney Markham and the defendants developed this list after reviewing the annotated code of § 213(d) and related IRS revenue rulings. (Crouse Aff. ¶ 8.)

The way these plans were supposed to work is that the employer would collect these worksheets from each employee at year end and send them to defendants' "processing center" (more on this below), which would then authenticate these expenses and send the employer a year-end adjustment report. It is unclear whether the employees were supposed to attach their medical receipts to the worksheet. The form of the worksheet attached to Crouse's affidavit merely contains the instructions set forth above, which by negative implication do not require receipts.*fn3

Marketing Of The Plans

Important to the legal analysis below is the question of how the plans were marketed and specifically what representations were made in the written documents, promotional materials, and oral statements. The government has submitted affidavits, with attached documents, from seven employer-clients.*fn4 The plans were sold through The Redwood Group and later Paradigm which developed written training materials and tested agents on their knowledge of these materials. A multi-level sales and commission structure was used to pay the agents.

The written documents are a mixture of formal legal documents designed to implement the plan and promotional documents designed to sell them, the latter include brochures and Powerpoint presentations. Again, due to the loose way in which defendants operated these companies and due to their failure to retain documents in any systematic way, we do not know the specific details regarding every individual client. Nevertheless, we have sufficient information from these seven to discern defendants' general approach. Moreover, defendants have not argued that any of the representations described by these companies are atypical.

With regard to the HI Plan, employers were given a collection of documents labeled the "HI Plan Administrator Kit." See, e.g., Dion Ex. A. Various representations were made in this Kit. Pertinent here, defendants made numerous promises to the effect that they would take care of all of the administrative aspects of the plan. For example, the Kit states that The Redwood Group would perform, among other things, "On going reconciliation of Health Incentive Plan contributions," "Quarterly audits to ensure compliance with existing plan document," and "Adjudication of qualified medical expenses ...


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