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Hudson v. Deutsche Bank AG

March 30, 2007


The opinion of the court was delivered by: Judge Virginia M. Kendall


Plaintiffs, Arless Hudson and the ACH Sunrise Trust (collectively "Plaintiffs"), filed suit in the Circuit Court of Cook County alleging that the defendant professional advisors provided her improper and fraudulent tax counseling.*fn1 At issue is Hudson's participation in a tax shelter strategy based on the purchase of foreign currency options. This strategy, allegedly designed, marketed and executed by Defendants, resulted in Hudson being audited by the IRS and paying substantial interest and penalties.

Defendants Deutsche Bank AG and Deutsche Bank Securities ("Deutsche Bank") removed this case to federal court. Subsequently, Deutsche Bank, Craig Brubaker and David Parse ("the DB Defendants") and Defendant White and Case filed motions to compel arbitration and to stay the proceedings pursuant to the Federal Arbitration Act, ("FAA"), 9 U.S.C. et seq. Defendants J.P. Morgan Chase & Co., J.P. Morgan Chase Bank and J.P. Morgan Investment Advisors, Inc. ("JP Morgan") and Matthew Colnon, Scott Deichman, John Ohle III and Jeffrey Conrad ("former Bank One Employees") (together "the JP Morgan Defendants")*fn2 filed a motion to stay these proceedings pending arbitration of Plaintiffs' claims against the DB Defendants and pending the resolution of a class action against the DB Defendants and other individuals and entities involved in the design, marketing and execution of the tax shelter strategy.

Since the filing of Defendants' motions, this Court granted Plaintiffs' Motion to Dismiss With Prejudice the DB Defendants and White and Case. The sole issue therefore is whether the JP Morgan Defendants are entitled to a stay of these proceedings. Because the claims against the JP Morgan Defendants are not parallel to the impending arbitration or the pending class action, no exceptional circumstances warrant abstention and the doctrine of equitable estoppel is not applicable to the JP Morgan Defendants' request for a stay, this Court declines to stay the exercise of its jurisdiction.

Plaintiffs' Allegations

In 2001, Hudson realized a substantial gain from the sale of a family business. (Compl. ¶ 52.) In October of 2001, Colnon of Bank One contacted Hudson's advisor, Ron Comm, regarding a tax strategy that he believed could reduce her tax liability from the sale. (Id.) Colnon urged Comm to meet with representatives of Deutsche Bank and Bank One to discuss the strategy. (Id.) Hudson's advisor, Wayne Cooper, and Hudson's son, Craig Hudson, met with Ohle, Deichmann and Conrad of Bank One to discuss the details of the so-called HOMER tax strategy. (Id. at ¶ 53.) The HOMER strategy creates a tax deduction for an individual by using loans to purchase two partially offsetting European-style digital foreign currency options, and then moving the funds through a trust and limited partnership. (Id. at ¶ 63.) The individual records a significant "loss" from this transaction that can be offset against the individual's potential tax liability, but he or she suffers no (or a relatively small) actual economic loss. (Id.) The HOMER strategy was quite similar to the COBRA strategy that the DB Defendants and Paul Daugerdas of the law firm Jenkens & Gilchrist developed in the mid-to-late 90s. (Id. at ¶ 28.) The IRS issued two Notices in 1999 and 2000 which described the transactions involved in the COBRA strategy and declared that "[t]he purported losses from these transactions (and from any similar arrangements designed to produce non-economic tax losses by artificially overstating basis in partnership interest) are not allowable as deductions for Federal income tax purposes." (Id. at ¶ 36, quoting IRS Notice 2000-44.)

In January 2001, Trey Die of Bank One approached Daugerdas about a transaction called BART that Bank One had developed. (Id. at ¶ 41.) BART, like COBRA, was designed to increase a taxpayer's basis in an asset without the taxpayer actually incurring any economic loss. (Id. at ¶ 42.) Over the next couple of months, Daugerdas, Bank One, the DB Defendants and White and Case further refined the BART strategy. (Id. at ¶ 43.) The new strategy was given the name HOMER in reference to BART and the popular "Simpsons" television show. (Id. at ¶ 44.)

Conrad, Ohle and Deichmann assured Hudson's representatives that the HOMER strategy already had survived IRS scrutiny. (Id. at ¶¶ 54, 88.) They also told Hudson's representatives that HOMER was a propriety strategy of Bank One offered only to select clients. (Id. at ¶ 54.) Conrad, Ohle and Deichmann then referred Hudson's representatives to Daugerdas, whom Hudson's representatives were told would prepare an independent opinion letter that would insulate Hudson from penalties in the unlikely event of an IRS audit. (Id.) In November 2001, the former Bank One employees and Daugerdas set up a phone call with the DB Defendants. (Id. at ¶ 58.) The DB Defendants confirmed the legitimacy of the HOMER strategy and specifically discussed the options of German bonds that were involved. (Id.) After agreeing to participate in the tax strategy, Hudson executed an Account Agreement with Deutsche Bank on November 17, 2001. The Account Agreement contained the following arbitration agreement:

I understand that: (1) Arbitration is final and binding on the parties.

(2) The parties are waiving their right to seek remedies in court, including the right to a jury trial . . .

I agree to arbitrate with you any controversies which may arise, whether or not based on events occurring prior to the date of this agreement, including any controversy arising out of or relating to any account with you, to the construction, performance or breach of nay agreement with you, or to transactions with or through you, only before the New York Stock Exchange or the National Association of Securities Dealers Regulation, Inc., at my election. Neither you nor I waive any right to seek equitable relief pending arbitration. No person shall bring a putative or certified class action to arbitration, nor seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action; or who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the putative class action until (1) the class certification is denied; or (2) the class is decertified; or (3) the customer is excluded from the class by the court. Such forbearance to enforce an agreement to arbitrate shall not constitute a waiver of any rights under this agreement except to the extent stated herein. (Id., Ex. 1, 2.) On or about November 20, 2001, Hudson, through the ACH Trust formed to carry out the HOMER strategy, entered into four private contracts with Deutsche Bank involving foreign options positions on German Government Bonds. (Id. at ¶¶ 69, 71.) Over the next month, the Options were passed through a series of trusts and partnerships with proceeds in the amount of $103,545,553.83 eventually being paid to Hudson. (Id. at ¶¶ 71-83). The strategy was completed on December 21, 2001 when Hudson repaid Deutsche Bank $103,545,553.83, the amount of the loan used to purchase the positions. (Id. at ¶ 83.)

In March 2004, Jenkens & Gilchrist notified Hudson that they, or another promoter of the HOMER strategy, likely would disclose her participation in the strategy to the IRS. (Id. at ¶ 94.) Hudson amended her 2001 tax returns on March 23, 2004. (Id. at ¶ 95.) Shortly thereafter, the IRS audited her 2001 tax return. (Id.) In early 2005, Hudson accepted a settlement offer from the IRS and paid the IRS and State of Illinois back taxes as well as approximately $3 million in interest and penalties. (Id. at ¶¶ 102-103.) In 2002, the IRS had offered the "Tax Amnesty Program," a voluntary disclosure program for individuals and entities that participated in tax strategies like the HOMER strategy. (Id. at ¶ 93.) Under the Amnesty Program, taxpayers who disclosed their involvement in such strategies would avoid any penalties without conceding liability for back taxes or interest. (Id.)

In addition to this suit, a class action involving the same tax shelter strategy is pending in the Southern District of New York. See Denney v. Jenkens & Gilchrist, No. 03 C 5460 (S.D.N.Y). Plaintiffs are members of several putative classes in Denney, including a class that reached a settlement with Jenkens & Gilchrist. The JP Morgan Defendants are not named in the Denney action. Deutsche Bank appealed the district court's approval of the settlement class based upon two provisions of the settlement agreement that allegedly impacted the rights of non-settling defendants. The Second Circuit vacated the settlement and remanded on those limited issues. See Denney v. Deutsche Bank AG, 443 F.3d 253, 276 (2d Cir. 2006). A separate appeal addressing the district court's denial of Deutsche Bank's motion to stay the proceedings pending arbitration has been argued and is waiting an opinion from the Second Circuit. In ...

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