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Shahid R. Khan; Ann C. Khan; Srk Wilshire v. Bdo Seidman

March 16, 2011

SHAHID R. KHAN; ANN C. KHAN; SRK WILSHIRE
INVESTMENTS, LLC; SRK WILSHIRE PARTNERS; SRK WILSHIRE INVESTORS, INC.; THERMOSPHERE FX PARTNERS, LLC; AND KPASA, LLC, PLAINTIFF-APPELLANTS,
v.
BDO SEIDMAN, LLP; PAUL SHANBROM; MICHAEL COLLINS; EQUILIBRIUM CURRENCY TRADING, LLC; SAMYAK VEERA; GRANT
THORNTON, LLP; GRAMERCY ADVISORS, LLC; JAY A. JOHNSTON; AND MARC HELIE, DEFENDANTS,
AND
DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., D/B/A DEUTSCHE BANK ALEX. BROWN; AND DAVID PARSE, DEFENDANTS-APPELLEES.
SHAHID R. KHAN; ANN C. KHAN; SRK WILSHIRE INVESTMENTS, LLC; SRK WILSHIRE PARTNERS; SRK WILSHIRE INVESTORS, INC.; THERMOSPHERE FX PARTNERS, LLC; AND KPASA, LLC, PLAINTIFFS-APPELLANTS,
v.
BDO SEIDMAN, LLP; PAUL SHANBROM; MICHAEL COLLINS; DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., D/B/A DEUTSCHE BANK ALEX. BROWN; DAVID PARSE; EQUILIBRIUM CURRENCY TRADING, LLC; JAY A. JOHNSTON; AND MARC HELIE, DEFENDANTS,
AND GRANT THORNTON, LLP, DEFENDANT-APPELLEE.



Appeal from Circuit Court of Champaign County Honorable Jeffrey B. Ford, Judge Presiding. No. 09L140

The opinion of the court was delivered by: Justice Appleton

No. 4-10-0504

JUSTICE APPLETON delivered the opinion of the court.

Justices McCullough and Myerscough*fn1 concurred in the judgment and opinion.

OPINION

In these two consolidated appeals, the plaintiffs are Shahid R. Khan (Khan) and Ann C. Kahn along with various business entities that Khan formed for the purpose of creating artificial losses, which he hoped would reduce his taxable income. Khan was not the one who came up with the tax-avoidance schemes. Rather, according to the complaint, he followed the advice of Paul Shanbrom at BDO Seidman, LLP, advice that was reinforced by a variety of co-conspirators, including the defendants in these two appeals.

In one of the appeals, case No. 4-10-0504, the defendants are Deutsche Bank AG (Deutsche Bank); Deutsche Bank Securities, Inc., d/b/a Deutsche Bank Alex. Brown (Brown); and David Parse, an employee of Deutsche Bank (collectively, Deutsche defendants). According to the complaint, Shanbrom and Parse advised Khan to engage in some "investment strategies" in 1999 and 2000 in order to create ordinary losses, and Deutsche Bank and Brown helped implement these strategies.

In the other appeal, case No. 4-10-0583, the defendant is Grant Thornton, LLP, which prepared the 2000 tax returns for one of the plaintiff corporations, Thermosphere FX Partners, LLC, claiming the fake losses. The Khans then used the information from this tax return in their own individual tax returns. The tax returns, however, were incorrect because, as the Internal Revenue Service (IRS) had warned in its publications, such contrived losses lacked economic substance and therefore were not allowable. Consequently, plaintiffs ended up losing a lot of money. Not only were the substantial fees they paid to defendants a total waste, but plaintiffs incurred liability to the IRS for back taxes, interest, and penalties. All this is according to the complaint.

The Deutsche defendants moved to dismiss the complaint pursuant to sections 2-615 and 2-619 of the Code of Civil Procedure (735 ILCS 5/2-615, 2-619 (West 2008)), asserting the legal insufficiency of the complaint and also invoking the statute of limitations in section 13-205 of the Code (735 ILCS 5/13-205 (West 2008)). Grant Thornton likewise moved to dismiss the complaint on the grounds that it was legally insufficient and time-barred. The trial court concluded that the statute of limitations in section 13-205 barred the actions against the Deutsche defendants and that the statute of limitations in section 13-214.2(a) (735 ILCS 5/13-214.2(a) (West 2008)) and the statute of repose in section 13-214.2(b) (West 2008)) barred the actions against Grant Thornton. Therefore, the court granted defendants' motions for dismissal. The court also found, pursuant to Rule 304(a) (Ill. S. Ct. R. 304(a) (eff. Feb. 26, 2010)), that there was no just reason to delay either enforcement or appeal of these rulings.

In our de novo review in these two appeals, taking the well-pleaded facts of the complaint to be true and drawing reasonable inferences in plaintiffs' favor, we hold that the trial court erred by concluding that the claims against defendants are time-barred. Therefore, we reverse the trial court's judgments in the two cases, and we remand the cases for further proceedings.

I. BACKGROUND

A. The 1999 Digital Options Strategy

1. Shanbrom and Parse Pitch the Strategy to Khan

Beginning in approximately 1993, BDO performed auditing services for Chromecraft, a company of which Khan was part owner. Michael Collins, a partner at BDO, was in charge of auditing services for Chromecraft, and as of 1999, he had been one of Khan's trusted accountants and advisors for some six years.

In 1999, Khan requested his own partner at Chromecraft to ask Collins if he knew anyone who could advise him on purchasing foreign currency. Khan needed Japanese yen because he was in negotiations to buy a Canadian company that manufactured plastic automobile bumpers and the Japanese owners of the company wanted to be paid in yen. Because Khan had no experience in foreign-currency trading, he needed guidance.

Collins referred Khan to Paul Shanbrom, who was a member of BDO's Tax Solutions Group and reputedly an expert in foreign-currency trading, and in September 1999, Khan and one of his estate-planning advisors had a meeting with Collins and Shanbrom. The meeting went beyond the subject of simply purchasing the needed foreign currency. Shanbrom introduced Khan to an "investment strategy" involving the purchase and sale of digital options on foreign currency (the Digital Options Strategy), a strategy which, according to Shanbrom, not only gave Khan a chance to double his money but also allowed him to claim a tax loss if he happened to lose money on his investments in foreign currency. Shanbrom told Khan that BDO had designed the Digital Options Strategy in such a way that it had economic substance for tax purposes. It purportedly had economic substance because Khan had a good chance of making a substantial return. According to the complaint, "Khan did not understand the intricacies of the investments, the tax code or the mechanism that allowed him to receive the tax benefits; however, he trusted BDO's expertise in this area and their representations." In other words, Khan had only a vague idea of what the 1999 Digital Options Strategy was all about.

The "investment" part of the strategy involved the buying and selling of options in foreign currency. When someone buys an option, that person buys the right, but not the obligation, to buy or sell a given quantity of assets (in this case, foreign currency) at a fixed price, or "strike price," within a specified time, regardless of the market price, or "spot price," of the assets. (A "spot price" is the same thing as a "spot rate.") An option is "digital," or "binary," if the investor stands to win or lose a predetermined amount in full: in other words, the payout will be all of the predetermined amount or nothing (1 or 0, in binary terms). Essentially, a digital option is an all-or-nothing wager that the spot price will be at or above a given price on a certain date. Or it can be an all-or-nothing wager that the spot price will be at or below the given price on that date.

If the investor is betting that the spot price will be at or above the given price on a certain date, the investor has a long option. On the other hand, if the investor is betting that the spot price will be at or below the given price on a certain date, the investor has a short option.

Shanbrom recommended hiring David Parse of Deutsche Bank to assist Khan in acquiring these long and short options. Shanbrom arranged a conference call between himself, Parse, and Khan. In this conference call, Parse told Khan many of the same things that Shanbrom had told him, including that the Digital Options Strategy was a good way to make money and, alternatively, a perfectly legal way to reduce taxable income. It was agreed that Deutsche Bank would handle the "investment" component of this strategy. Paragraph 63 of the complaint recounts the conference call as follows:

"During this conference call, Parse, along with Shanbrom, reiterated the 'sales pitch' and reassured Khan that the Digital Options Strategy was completely legal. Parse, along with Shanbrom, further discussed the steps of the Digital Options Strategy and informed Khan that Deutsche Bank would handle all aspects of the investments in foreign currencies. According to Parse, Deutsch [sic] Bank had internal procedures to determine the proper amounts and types of the foreign currency investments that would be appropriate for Khan's circumstances. Parse told Khan that Parse would make all decisions with respect to the amounts and types of foreign currency investments since he was the expert. Parse again reiterated that Plaintiffs would have a good chance of making a profit on the foreign currency investments. Parse represented to Khan that the foreign currency options that Khan would be executing were actual investments. Shanbrom and Parse never informed Khan that the foreign currency digital options were simply private bets with Deutsche Bank on where the underlying currencies would be on a particular date and time and that Deutsche Bank controlled the outcome."

According to the complaint, Deutsche Bank controlled the outcome in that, as the "calculation agent," Deutsche Bank had the contractual right to accept or disregard any spot price. Presumably, Deutsche Bank's role as calculation agent was stated in the form contracts between Deutsche Bank and Khan (who signed them in his capacity as partner or corporate officer of various plaintiffs). Khan, however, did not understand the import of this designation of Deutsche Bank as calculation agent. He did not understand that Deutsche Bank's performance under the so-called "contract" amounted to little more than setting the dice on the table with Deutsche Bank's winning number facing upward. Footnote 12 of the complaint says:

"[T]he FX Contracts [(another name for the digital options contracts)] were not something traded on any recognized exchange but were simply a matter of private contract between the participants. Finally, neither party had any right to take possession of the 'underlying currency.' As a result, the FX Contracts amounted, in actuality, to a contractual wager (i.e., a 'bet') based on movements in foreign currency prices, without any real possibility of foreign currency ever changing hands between the parties. Of course, the Plaintiffs were unaware of these aspects of the FX Contracts."

It would seem, then, that these transactions were not "investments" at all but were merely rigged bets. Nevertheless, Parse referred to them as "investments." The complaint alleges that after the initial conference, Khan "had several additional telephone conversations with Parse in which Parse reiterated his prior statements and further discussed the purported 'investments.' "

2. The Legal Opinion From Jenkens on the 1999 Digital Options Strategy

According to the complaint, the Deutsche defendants were in a conspiracy with BDO to deceive clients such as Khan into paying large fees for the Digital Options Strategy, a strategy that was useless for tax purposes--indeed, worse than useless because the losses it generated were clearly illegitimate and claiming them was likely to result in some expensive liability to the IRS. Part of this conspiracy was to refer clients to an "independent law firm," Jenkens & Gilchrist, P.C. (Jenkens), to confirm the legality of the 1999 Digital Options Strategy. But Jenkens really was not independent. Paragraph 70 of the complaint alleges as follows:

"As part of their pre-planned conspiracy, the 1999 Strategy Defendants [(defined as BDO and the Deutsche defendants)] advised Plaintiffs that in the unlikely event the Internal Revenue Service ('the IRS') audited their tax returns as a result of the 1999 Digital Options Strategy, the Jenkens 'independent' opinion letter would confirm the propriety of the 1999 Digital Options Strategy and of claiming the resulting losses on Plaintiffs' tax returns. The 1999 Strategy Defendants and Jenkens--in furtherance of the conspiracy--further advised Plaintiffs that this 'independent' opinion letter would enable the Plaintiffs to satisfy the IRS auditors as to the propriety of the tax returns. Unfortunately and unbeknownst to Plaintiff, Jenkens--with full knowledge of BDO and Deutsche--had already prepared the 'canned' and 'prefabricated' opinion letter approving the 1999 Digital Options Strategy and needed only to fill in several blanks prior to issuing the opinion letter to Plaintiffs."

In short, Jenkens was one of the co-conspirators, and its role in the conspiracy was to be the yes-man, issuing reassuring opinion letters that were not the product of an honest and conscientious legal analysis. The legal opinions by Jenkens were not specifically tailored to the client's particular financial situation "but were merely 'fill in the blank' boilerplate opinions provided to Plaintiffs as part of a 'pre-wired' scheme." Nevertheless, Jenkens collected a substantial fee from clients for these legal opinions. "In addition, Jenkens & BDO were involved in fee 'kickbacks' between themselves and with third parties who convinced clients to execute an Investment Strategy with Jenkens, Deutsche Bank, BDO, and others."

On Shanbrom's recommendation, Khan went to Jenkens, and on March 20, 2000, Jenkens issued to Khan an opinion letter confirming the legality of the 1999 Digital Options Strategy. Specifically, the letter opined that plaintiffs' " 'basis in their interest in the Partnership after contribution of the Options [would] include the cost of the Long Option contributed, without adjustment for the Short Option.' " (The significance of this advice will soon be clear, when we explain how the 1999 Digital Options Strategy worked.) Jenkens further opined that " '[t]he step transaction, sham transaction, and economic substance doctrines [would] not apply to disallow the results of the transactions described herein.' " Further, according to Jenkens, IRS Notice 1999-59 (I.R.S. Notice 1999-59, 1999-2 C.B. 761), which warned against transactions lacking economic substance and having no apparent purpose other than to generate a fake capital loss, was simply " 'inapplicable to the transactions described here.' "

3. Wanser's Affidavit

In support of their combined motion for dismissal, Deutsche Bank and Brown submitted to the trial court an affidavit by one of their attorneys, Michael R. Wanser, and attached to that affidavit, as exhibits A through C, were copies of the form contracts Khan had signed with Deutsche Bank and Brown implementing the digital option trades. Exhibit A of Wanser's affidavit is a foreign-exchange digital-option transaction confirmation, dated November 29, 1999, between Wilshire Investments, LLC, and Deutsche Bank, signed by representatives of both companies. Paragraph 3 of exhibit A disclaims an agency relationship, a fiduciary relationship, and any reliance by the parties on advice or representations by the other party. The paragraph reads as follows:

3. Representations

"Each party represents to the other party that it is entering into this Transaction as principal (and not as agent or in any other capacity, fiduciary or otherwise) and that

(i) It has sufficient knowledge and experience to be able to evaluate the appropriateness, merits and risks of entering into this Transaction and is acting in reliance upon its own judgment or upon professional advice it has obtained independently of the other party as to the appropriateness, merits and risks of so doing, including where relevant, upon its own judgment [sic] of the correct tax and accounting treatment of such Transaction;

(ii) It is not relying upon the views or advice of the other party (including, without limitation, any marketing materials or model data) with respect to this Transaction; and

(iii) It acknowledges that, with respect to this Transaction, the other party is acting solely in the capacity of an arm's length contractual counterparty and not in the capacity of financial adviser or fiduciary."

It would appear that insomuch as Parse, as an agent of Deutsche Bank, advised Khan that he could make a profit on the transaction, Parse gave "advice *** with respect to this Transaction." It also would appear that insomuch as Parse advised Khan that in the event he lost money on the transaction, he could claim the loss in his tax returns, Parse likewise gave "advice *** with respect to this Transaction." By signing exhibit A of Wanser's affidavit, Khan represented to Deutsche Bank that he was not relying on any such advice from Deutsche Bank (or its agent, Parse).

4. Implementation of the 1999 Digital Options Strategy

The 1999 Digital Options Strategy worked as follows. The Khans entered into a private contract with Deutsche Bank whereby the Khans, through SRK Wilshire Investments (Wilshire Investments), bought from Deutsche Bank a long option on foreign currency and sold to Deutsche Bank a short option. Thus, there came into existence an opposing pair of options, one long and the other short. These options were designed to cancel each other out. The strike prices of the two options were only a fraction of a penny apart, and the premium that the Khans paid Deutsche Bank for the long option, though large, was almost entirely offset by the premium Deutsche Bank agreed to pay the Khans for the short option (almost but not quite: the Khans paid a net premium to Deutsche Bank of $350,000, the difference between the $35 million that the Khans paid for the long option and the $34,650,000 that Deutsche Bank agreed to pay them for the short option). Because the strike prices of the opposing options were so close together and because Deutsche Bank, as the calculation agent, had the right to select the applicable spot rate from a range of currency rates, it was a virtual certainty that the transaction would be close to a wash--Deutsche Bank would see to that.

So, pursuant to this scheme that was calculated to be a wash on the investment side (and, as we will explain, a loss on the tax side), the Khans formed the necessary business entities and transferred assets between them, all under the guidance of BDO. On November 17, 1999, the Khans formed Wilshire Investments and SRK Wilshire Partners (Wilshire Partners). On November 24, 1999, through Wilshire Investments, the Khans bought and sold the opposing options, which had expiration dates of December 23, 1999. On November 26, 1999, Wilshire Investments contributed its interest in the as of yet unexpired options to Wilshire Partners as a capital contribution. On December 10, 1999, Wilshire Partners purchased a quantity of Canadian dollars as an investment. On December 23, 1999, both the long option and the short option terminated "out of the money": the options became worthless, based on the spot rate that Deutsche Bank chose. Of course, both the Khans and Deutsche Bank got to keep the premiums they had paid each other, but Deutsche Bank's premium was $350,000 greater than the premium it had paid to the Khans (or Wilshire Investments). On December 27, 1999, the Khans contributed their interest in Wilshire Partners to Wilshire Investments, causing the dissolution and liquidation of Wilshire Partners. As a distribution in liquidation of Wilshire Partners, all of the investments in foreign currency were distributed to Wilshire Investments.

Consequently, for tax purposes, the Khans' interest in Wilshire Investments had a basis equal to the amount they had paid to Deutsche Bank for the long option, but that amount supposedly was not offset as a result of the assumption by Wilshire Investments of the Khans' obligation to Deutsche Bank on the short option, perhaps on the theory that the short option was only a contingent liability (see Stobie Creek Investments, LLC v. United States, 82 Fed. Cl. 636, 666 (2008)). In other words, the long option counted for purposes of the basis the Khans had in Wilshire Investments, but the short option, which greatly reduced the economic significance of the long option, supposedly did not count. Upon the disposition of the Khans' partnership interest in Wilshire Investments, the expensive long option had expired "out of the money" and had lost all its value, so the Khans claimed a tax loss equal to the premium they had paid for the long option, even though (because of the offsetting short option) they had not really incurred an economic loss in that amount.

5. The Preparation and Filing of Plaintiffs' 1999 Income Tax Returns

After the publication of IRS Notice 1999-59 on December 27, 1999, which warned against transactions lacking economic substance and having no apparent purpose other than to generate a fake capital loss, BDO prepared and signed plaintiffs' 1999 federal and state income-tax returns. Specifically, on April 1, 2000, BDO signed the 1999 federal tax returns for Wilshire Investments and Wilshire Partners, and on April 1, 2000, BDO signed plaintiffs' 1999 federal individual tax returns. These tax returns contained the losses supposedly generated by the 1999 Digital Options Strategy. Advising plaintiffs that the tax returns were "properly prepared in accordance with professional standards," BDO recommended that plaintiffs add their signatures to the returns and file them with the IRS. Plaintiffs did so, relying on the representations and assurances that defendants had made to them during the promotion, sale, and implementation of the 1999 Digital Options Strategy and also relying on the opinion letter from Jenkens, which, Shanbrom had assured Khan, would provide "absolute penalty protection." The filing of these returns was the final step of the 1999 Digital Options Strategy.

6. The Publication of IRS Notice 2000-44

On August 11, 2000, before plaintiffs filed their 1999 individual federal tax returns, the IRS published IRS Notice 2000-44 (I.R.S. Notice 2000-44, 2000-2 C.B. 255), entitled "Tax Avoidance Using Artificially High Basis" and describing transactions similar to those described in IRS Notice 1999-59, transactions that " 'purport[ed] to generate tax losses for taxpayers.' " In fact, one of the examples that IRS Notice 2000-44 gave closely resembled the Digital Options Strategy: the taxpayer purchased call options and simultaneously wrote (or sold) offsetting call options, transferred the option positions to a partnership, and claimed that the taxpayer's basis in the partnership interest was " 'increased by the cost of the purchased call options but [was] not reduced under [Internal Revenue Code] §752 as a result of the partnership's assumption of the taxpayer's obligation.' " IRS Notice 2000-44 warned 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) [were] not allowable as deductions for Federal income tax purposes.' "

B. The 2000 COINS Strategy

1. Shanbrom and Parse Pitch the 2000 COINS Strategy From his conversations with Khan, Shanbrom was aware of Khan's unhappiness that he had made no money in the foreign-currency market through the 1999 Digital Options Strategy (Khan did not understand that the options had been specifically designed to expire "out of the money"). So, in approximately June 2000, Shanbrom told Khan that BDO had developed another investment strategy, one that offered a better chance of making a profit. He introduced Kahn to the 2000 COINS Strategy (it is unclear what "COINS" stands for, if it stands for anything).

As with the 1999 Digital Options Strategy, Shanbrom referred Khan to Deutsche Bank to execute the investment component of the 2000 COINS Strategy, telling him that "Parse and Deutsche Bank were the experts in foreign currency investments and they worked closely with BDO to implement this and other tax-advantaged strategies for BDO clients." Khan subsequently had several telephone conversations with Parse and Donna Guerin, a partner at Jenkens, and both of them "reiterated Shanbrom's representation that the foreign currencies digital options were designed in a way to provide Khan with a good chance of making a profit and at the same time legally reducing his taxes."

In reality, though, the 2000 COINS Strategy was not much different from the 1999 Digital Options Strategy. As the calculating party, Deutsche Bank still got to select the spot rate on expiration of the digital options. "The range of currency rates available to the calculating party [made] the selection of that spot rate subject to the pleasure of the calculating party." Consequently, it was exclusively the calculating party, Deutsche Bank, who determined whether a digital option paid out. Khan did not understand any of this. Instead, Shanbrom and Parse led him to believe, erroneously, that he could make a profit in the 2000 COINS Strategy. On the advice of Shanbrom and Parse, Khan decided to use this new moneymaking and tax-reducing strategy.

2. Implementation of the 2000 COINS Strategy

The 2000 COINS Strategy was merely a variation on the 1999 Digital Options Strategy. Here is how it worked. On September 29, 2000, using Deutsche Bank as the counterparty, Wilshire Investments bought and sold offsetting pairs of options tied to foreign-currency exchange rates during specified periods in the future, with extremely close strike prices and a spot rate to be chosen by Deutsche Bank in its sole discretion. The cost of the long option, though large, was mostly (but not entirely) offset by the premium Wilshire received on the sale of the short option. On October 18, 2000, pursuant to the BDO's instructions, Wilshire Investments made a capital contribution of these option positions to a partnership formed specifically for purposes of the 2000 COINS Strategy, Thermosphere FX Partners, LLC (Thermosphere). Supposedly, the long option counted toward the basis, without any offset by the short option. On December 6 and 11, 2000, the strike prices on the opposing options were met, with the result that the gain on one option was, roughly speaking, matched by the loss on the other option. The options now were worthless, requiring an adjustment in plaintiffs' basis in Thermosphere. On December 15, 2000, Thermosphere purchased foreign currency. Plaintiffs requested to be redeemed out of Thermosphere, and on December 18, 2000, plaintiffs' entire capital balance was redeemed, and a portion of the foreign currency that Thermosphere had purchased was distributed to them. On December 27, 2000, plaintiffs sold the foreign currency and subsequently claimed an ordinary loss.

3. The Legal Opinion From Jenkens on the 2000 COINS Strategy

As with the 1999 Digital Options Strategy, Shanbrom told Khan that it would be necessary to obtain an "independent" legal opinion before actually implementing the 2000 COINS Strategy and using it in plaintiffs' income tax returns. According to Shanbrom, only two law firms had the necessary expertise and experience with this type of investment strategy, either Sidley Austin LLP or Jenkens, and he advised Khan to select one of those two firms. Khan chose Jenkens because he had a prior relationship with Jenkens in connection with the 1999 Digital Options Strategy.

In January 2001, Shanbrom telephoned Khan and informed him that the legal opinion from Jenkens was ready. Shanbrom told Khan that he himself had reviewed the legal opinion and had made revisions to it (the complaint does not allege that Shanbrom is an attorney) and that with those revisions, the legal opinion was in final form and ready to go but that Khan would have to send Jenkens a check before Jenkens would release a copy of the legal opinion to Khan. Khan sent the check to Jenkens, and on January 12, 2001, Jenkens issued him an opinion letter confirming that the 2000 COINS Strategy was "a legal tax-advantaged investment strategy."

According to the opinion letter from Jenkens (as revised by Shanbrom), plaintiffs' basis in their interest in the partnership (Thermosphere), after their contribution of the options, would include the cost of the long option without adjustment for the short option. An adjustment to plaintiffs' basis would be required as a result of the termination of the options, and their disposition of the foreign currency that they had received in redemption of their partnership interest would result in an ordinary loss. The opinion letter asserted that " 'the alleged limitations of [IRS] Notice 2000-44 are more likely than not legally inapplicable to the [2000 Coins Strategy].' "

4. The Preparation and Filing of Plaintiffs' 2000 Income-Tax Returns

Grant Thornton, which allegedly was in the conspiracy with BDO and Deutsche Bank, prepared and signed the 2000 federal and state income tax returns for Thermosphere. These tax returns claimed the artificial losses created by the 2000 COINS Strategy. These losses "flowed through" to the partners, i.e., the Khans. See Adler & Drobny, Ltd. v. United States, 9 F.3d 627, 628 n.3 (7th Cir. 1993) ("A partnership return is a Form 1065. This form reports partnership gains and losses in a given taxable year. Form 1065 contains two additional documents that detail the partnership's financial activity: a Schedule K that computes the partnership's profit or loss and a Schedule K-1 that allocates the partnership's profit or loss among the partners. Because a partnership is not a taxable entity for federal income tax purposes, its profits and losses flow through to the partners where they are recognized for tax purposes on an individual basis.").

BDO prepared and signed the Khans' 2000 individual tax returns, both the federal and state returns, as well as the 2000 federal tax return for Wilshire Investments. The Khans' individual returns contained the losses from the 2000 COINS Strategy.

BDO and Grant Thornton assured Khan that the returns they had prepared were "properly prepared in accordance with professional standards" and that the losses generated by the 2000 COINS Strategy were legitimate and usable. On the basis of those assurances, the opinion letter from Jenkens, and defendants' advice during the promotion, sale, and implementation of the 2000 COINS Strategy, plaintiffs signed and filed the returns.

5. The Tax Amnesty Program

In late 2001 and early 2002, the IRS offered the "Tax Amnesty Program," a program in which taxpayers who had participated in illegal tax-avoidance schemes such as the 1999 Digital Options Strategy and 2000 COINS Strategy could voluntarily come forward, disclose their involvement, and thereby avoid any penalties for their underpayment of taxes. BDO advised plaintiffs, however, not to participate in the amnesty program.

According to the complaint, it was for BDO's own benefit, rather than plaintiffs' benefit, that BDO steered plaintiffs away from the amnesty program. BDO wanted to avoid attracting any suspicion toward its tax department. If plaintiffs had talked to the IRS, the IRS would have launched an investigation of BDO and would have required BDO to disclose the names of all its clients who had used the Digital Options Strategy or anything similar to it.

6. The IRS Audit

In 2003 and 2004, plaintiffs received notices of audit from the IRS for their 1999-2001 tax returns. In May 2003, they hired counsel to represent them in the audit.

7. The IRS Disallows the Losses Created by the 1999 Digital Options Strategy and the 2000 COINS Strategy In 2008, the IRS disallowed the losses created by the 1999 Digital Options Strategy and the 2000 COINS Strategy, concluding that the transactions lacked economic substance. As a result, plaintiffs not only lost the benefit of the considerable fees and premiums they had paid to defendants in connection with the 1999 Digital Option Strategy and the 2000 COINS Strategy, but the IRS also determined that ...


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