The opinion of the court was delivered by: KNAPP
AMENDED MEMORANDUM & ORDER
We are advised that this case represents the Government's first attempt -- at least in this District -- to use Sections 6700 and 7408 of the Internal Revenue Code to stamp out a peculiar type of tax fraud. Section 6700 defines an offense -- entitled "Promoting Abusive Tax Shelters" -- which may be injoined pursuant to Section 7408. In this law suit we are concerned only with tax advantage investment programs ("shelters") which are created by the advice of having the provider of the shelter lease supposedly productive assets -- here, "stamp masters" -- to taxpayers in circumstances where the lessor passes his investment tax credit ("ITC") on to the taxpayer so that the latter can use it in reducing his tax liability. The lessor's ITC (which is passed on to the taxpayer) is based on its own cost in acquiring the asset.
Section 6700 starts off with a rather complicated definition of the "persons" to whom it applies (§ 6700(a)(1); and proceeds to make it unlawful for any such person to make certain fraudulent statements in the course of selling a tax shelter (§ 6700(a)(A)), or to make a "gross valuation overstatement as to any material matter" in connection with such sale (§ 6700(a)(2)(B)). The Government has invoked only the second of those prohibitions and, so far as here relevant, a "gross valuation overstatement" is defined (in § 6700(b)(1)) as a statement fixing in asset's value at more than 200 percent of (i.e., more than twice) its actual value. Section 7408 authorizes a court -- in appropriate circumstances -- to issue an injunction against any person found to have violated Section 6700.
The defendants named in the complaint are: Philatelic Leasing, Ltd. ("Philatelic"), which in 1982 offered "stamp masters" for lease to the public; Hambrose Stamps, Ltd. ("Hambrose"), which had supposedly sold them to Philatelic; Global International, Ltd. ("Global"), which had supposedly sold them to Hambrose, having manufactured them pursuant to a license obtained from Crailheath, Ltd. ("Crailheath"), a British concern not named as a defendant; and Melvin Hersch ("Hersch") who in 1982 was president of Philatelic, having previously served as president of Hambrose. A consent judgment was entered against defendant Global. It accordingly did not participate in the trial, but -- as amicus curiae -- has continued to show an active interest in the proceedings.
It is common ground that all defendants are "persons" within the meaning of Section 6700. The Government, proceeding under subdivisiond (a)(2)(B) of that Section, contends that the actual value of the "stamp masters" here involved was minimal, and that Philatelic's asserted cost in acquiring them from Hambrose (which asserted cost established the ITC passed on to its taxpayer-lessees) was a great deal more than twice such actual value. The Government claims that this contention has been established by proof that the series of purported transactions between Global, Hambrose and Philatelic constituted a sham specifically designed to conceal the fact that the stamp masters were actually without substantial value. The Government also claims that the same lack of value is established by expert testimony showing that there is no real market for the stamps created by the "masters." Defendants' basic contention, on the other hand, is that Philatelic's asserted cost in acquiring the stamp masters from Hambrose was the product of arms-length bargaining between those two entities; and that Hambrose's own cost was, in turn, established by arms-length bargaining between it and Global. The defendants also dispute the Government's contentions as to the effect of the expert testimony. Defendants further contend that regardless of the value of the stamp masters, injunctive relief would be inappropriate; and defendant Hambrose contends that no case has been established as to it.
We find ourselves in a rather unusual position. The trial in this case consumed eight court days and generated a 1,468 page trial record. In addition, 122 exhibits and 602 pages of deposition testimony have been submitted for our consideration. Yet the testimony of just three witnesses -- Clive Feigenbaum, the president and owner of Crailheath; Herman Finesod, the owner of Hambrose; and the defendant Melvin Hersch -- has persuaded us that the entire "stamp master" scheme constituted a simple conspiracy by those men, and others mentioned in the evidence, to perpetrate a tax fraud; that the various corporate entities which are parties to this law suit and otherwise mentioned in the evidence were mere instruments in that conspiracy; and that the testimony of those three men was deliberately designed to conceal the existence of this conspiracy. For reasons which we shall elaborate, we further conclude that this conspiracy to conceal the truth -- initiated in 1979 and continuing to the present day -- justifies a finding that the "stamp masters" were indeed without substantial value.
THE BACKGROUND AGAINST WHICH THE TESTIMONY OF
FEIGENBAUM, FINESOD AND HERSCH SHOULD BE CONSIDERED
By way of definition, a "stamp master" is a photographic color separation used for producing postage and similar stamps.
The allegedly abusive shelters with which we are here concerned were made available to the public through a program run in 1982 by defendant Philatelic, in which Philatelic leased to taxpayers certain stamps masters pursuant to contracts authorizing them to produce defined numbers of stamps over a seven-year period. Philatelic purported to have purchased these stamp masters from Hambrose which, in turn, purported to have purchased them from Global.
The stamps produced by the masters here in question are local carriage labels or stamps for the islands, of Staffa, Bernera, Eynhallow and Grunay. Of these islands -- all of which are located off the coast of Scotland -- two are sparsely inhabited, while two are completely uninhabited but receive tourist trade. Staffa, in particular, is popular with tourists for its natural wonders, including Fingal's Cave which inspired -- among other works of art -- Mendelssohn's Hebrides Overture. The stamps here involved may be used for the carriage of mail (posted either by tourists or by inhabitants of the islands) between points on the islands, or to the British post office on the Isle of Mull, where additional British postage must be affixed if the mail is to travel further. The stamps bear images which can be categorized by "topic" -- birds, flowers, sporting events, etc.
A right to issue stamps was originally granted by the British Crown to the Laird of the mentioned Islands. Prior to 1979 the Laird had assigned that right to various persons in no way concerned with any of the events here at issue. In that year he revoked all previous assignments and then, through a series of agreements, assigned the right to two related British corporations, one of which Crailheath, authorized Global to issue stamps under terms and conditions which seem relevant to this law suit only to the extent that the Crailheath-Global contracts did not preclude Crailheath from granting similar licenses to competitors of Global (see Exhibits 241-244).
So far as the record indicates, stamps -- as opposed to stamp masters -- issued in the names of these Islands first appeared as collectors' items back in 1974 (prior to Crailheath's coming into the picture) when Staffa stamps printed on gold foil were offered to collectors both in the United States and abroad. These gold foil stamps seem to have been highly successful and to have achieved total retail sales of twenty-six and a half million dollars. Although each stamp contained only a few cents worth of gold, their prices tended to vary with the world price of gold, the highest price they achieved in the United States appearing to be about $20 a stamp.
The use of stamp masters as tax shelter instruments first surfaced in 1979.
In that year Herman Finesod (not a party to this lawsuit) organized defendant Hambrose which -- we are told -- purchased from defendant Global seventeen stamp masters, each of which entitled the purchaser to print 75,000 sets of stamps. Hambrose sold these stamp masters to a stamp company not a party to this lawsuit, which in turn sold them to seventeen different purchasers. The record does not disclose the prices at which these transactions occurred. In the following year Hambrose, acting through its then president, defendant Hersch, is said to have purchased from Global fourteen stamp masters and to have sold them directly to the public. In 1981 it sold to the public 253 stamps masters said to have been so purchased. These 1979, 1980 and 1981 transactions (referred to in the testimony as the 1979, 1980 and 1981 programs) are not here in issue, the statute under which the Government proceeds not having been enacted until September 3, 1982. The record, accordingly, does not disclose many details of these transactions, except that they were based on the sale (rather than lease) of stamp masters to taxpayers, which would make the purchasers' claimed tax advantage depend on their own claimed purchase price rather than upon a claimed investment credit related to their lessor's claimed acquisition cost. However, it does seem to appear that no purchaser of a stamp master from Hambrose in these years has as yet been able to show a profit on his investment.
The facts relative to Philatelic's 1981 program are set forth (mostly by stipulation) in more detail. Crailheath, for an insignificant sum, acquired from the Laird the exclusive right to issue stamps in the names of these islands and, at a price of about $3.60 each, gave Global the nonexclusive right to manufacture and sell up to 10,000 stamp masters. Global was able to manufacture these masters at an unspecified but inconsequential cost. It purported to sell them to Hambrose at prices ranging from $100,000 for a two stamp master to $207,000 for an eight stamp master (a mean price of $153,500). Hambrose immediately (without adding any value) purported to sell them to Philatelic at prices ranging from $150,000 for a two stamp master to $400,000 for an eight stamp master (a mean price of $275,000). No significant transfer of cash was involved in any of these sales, the alleged purchase prices being in the form of non-recourse notes and the transfer of cash being deferred until such time as it was acquired from taxpayers seeking shelter from IRS storms.
The defendants, at trial, sought to rebut the inferences seeming inexorably to flow from the foregoing stark facts by contending that Global, Hambrose and Philatelic were independent entities primarily concerned with their own well being, and that the quoted purchase prices had been arrived at by arms-length negotiation between them. Thus, for example, Point II-C of Philatelic's Pre-Trial Memorandum asserts (at p. 30): "The Arms-Length Purchases of the Stamp Masters Proves They Were Not Grossly Overvalued."
THE TESTIMONY OF CLIVE FEIGENBAUM
Clive Feigenbaum did not appear at the trail, but the parties submitted his 209-page deposition which had been taken at the office of the United States Attorney on February 2 and 3, 1984. Two lawyers for the defense were involved at that deposition: one represented the witness himself and defendant Global, while the other represented all other defendants, i.e., those now before us.
It may be said at the outset that despite constant intervention of counsel and despite the fact that on the day preceeding the deposition the wintess had had three hours of counseling with his own attorney, in which the attorney for the defendants now before us participated for "I guess an hour" (Deposition of Feigenbaum [hereinafter "Feig. Dep."] at 12-13), he exhibited an extraordinarily feeble memory, failing to remember matters as to which one would expect a clear recollection from a person in his purported position. It should also be noted that, in general, Feigenbaum -- with the concurrence of the defendants now before us -- adopted a policy of silence which had the effect of inhibiting the emergence of evidence having a bearing on the issues being litigated.
The substance of Feigenbaum's testimony may be conveniently divided into three categories: his general background in and knowledge of stamp collecting; his description of various of the corporate entities involved in this lawsuit; his purported representation of Global in its alleged negotiations with Hambrose, and his familiarity with the nature and needs of his alleged principal in that negotiation; and finally, his familiarity with the tax-shelter -- as opposed to the stamp collecting -- business.
Feigenbaum's experience in and knowledge of stamp collecting were impressive. He started dealing in stamps part-time at the age of 16 (25 years before the time of his deposition) and had dealt in stamps continuously ever since (Feig. Dep. 14). In 1961 he formed a stamp company which dealt in Middle Eastern stamps, and in 1964-65 began to specialize in topical stamps such as those commemorating the deaths of Kennedy and Churchill (Id. 14-15). By 1967-68 he began to observe a growing collectors' interest in "thematic" -- or "topical" -- stamps and, because he recognized a "demand for thematics wherever they came from," began specializing in "locals" (Id. 15).
From that time on he organized, or was associated with, a variety of firms specializing in local stamps (Id. 15-20, 51). He was also a member of several philatelic associations (Id. 16-17). He identified several catalogues which listed and priced local -- especially British local -- stamps (Id. 71-75), and spoke generally of an active market in such stamps. (Id. 77-86).
With respect to some of the entities involved in this law suit, he explained that Crailheath was a British corporation organized and owned by him which, together with another similarly organized and owned British corporation, had in 1979 and thereafter obtained from the Laird the exclusive right to issue stamps in the names of the four Scottish islands here involved. Global, to which Crailheath gave a non-exclusive right to issue certain numbers of such stamps (Id. 99) was apparently owned by one Michael Shine. (Id. 53, 59.) Although Shine is now a citizen of Israel, he had been born and brought up in England, where his parents had been close friends and neighbors of Feigenbaum's parents (Id. 54-55). It was through this familial relationship that the two men were thrown together (Id. 51-55). The witness also identified Norfolk Press, Limited, another Michael Shine company, which, pursuant to contracts negotiated by Feigenbaum on its behalf, printed for about $2,000 per stamp master such stamps as the various annual programs required (Id. 183-7). He was instructed not to give any information as to when or in what circumstances Global or Norfolk had been founded (Id. 53, 63, 64).
Turning to his purported negotitations with Hambrose on Global's behalf, Feigenbaum categorically asserted that he had negotiated the Global-Hambrose contracts in 1979, 1980, 1981 and 1982 (Id. 116, 118-19, 157, 165, 166); that, so far as he could recall, no other person had participated on Global's behalf in their negotiation (Id. 115); and that he could remember no occasion where a contract provision negotiated by him had been rejected by his principal (Id. 117). During all of these negotiations Hambrose was represented by Herman Finesod (Id. 111). Although Feigenbaum testified that he had conducted extensive negotiations with Finesod over a three-year period, search of his entire deposition does not disclose that he was able to remember a single word spoken by either negotiator (Id., passim).
The fifty-three page contract which is claimed finally to have emerged from these negotiations constituted in effect a refinement of contracts said to have been negotiated in previous years, and is an extraordinarily complex instrument (Plaintiff's Exhibits 11, 236, 237, 238). Five paragraphs are devoted to defining the purchase price and manner of payment (Exh. 11, 4-5), the principal feature of which being a NONNEGOTIABLE NONRECOURSE PROMISSORY NOTE annexed to the contract as Exhibit C. One paragraph of the contract obligates Global to suggest to Hambrose the names of two "appraisers" and to pay -- up to $140 for each master -- for two appraisals by persons selected by Hambrose, but does not obligate Hambrose to use any of the appraisals so provided (Id. 30).
Feigenbaum's deposition testimony does not suggest familiarity with any provision of the contract. For example, with respect to the last mentioned provision about appraisals, he didn't seem to remember how it had found itself in the contract (or how similar provisions had found themselves in previous contracts), or which of the parties had requested it (Feig. Dep. 147-9). With respect to payment of the purchase price, Feigenbaum was "not sure" that he knew "what a nonrecourse note was" (Id. 158-59).
With respect to Feigenbaum's knowledge about the affairs of his supposed principal and the circumstances in which he undertook to represent it in its negotiations with Hambrose, Feigenbaum "thought" Global's only office was in Tel Aviv, but was not sure (Id. 57-58); he did not know who its officers or directors were, except that -- at the suggestion of his counsel -- he corrected his answer to say that Michael Shine was its president (Id. 58); he had never been an officer of Global and had no power of attorney to evidence his authority to represent it in negotiations with Hambrose (Id. 64-66, 69); he had no recollection of any conversation with Shine in which such authority was conferred upon him, except that he remembered that "the understanding was the discussion be left to me" (Id. 111-12).
With respect to his knowledge of tax shelter problems, Feigenbaum admitted -- when pressed -- that at Finesod's request he had attended "quite a few" tax shelter seminars in a number of cities, including Miami, Los Angeles, Phoenix and Honolulu (Id. 167-75); and that at least by 1980 he was generally aware that stamp masters were being used in tax shelter programs (Id. 111). Despite these admissions he contended that his knowledge of tax shelter problems was only peripheral, and that he really didn't have "a full understanding of the tax aspects even now" (Id. 111). However, when asked what dealings he had had with a certain firm of attorneys, Feigenbaum testified (Id. 118, lines 7-10):
I was asked to meet them and again to explain to them --
I think I explained to Mr. Greenberg at one point about the tax shelter at the request of --
He then continued (Id., lines 10-17):
sorry. I am sorry, I made a mistake. I described my British local business to Mr. Greenberg about the middle of '79 for some reason.
I made a slip of the tongue before.
It is a frequent occurrence for the idea one wants to withhold to be precisely the one which forces its way through in the form of a slip of the tongue.
We accept the witness' original testimony that he explained to Mr. Greenberg "about the tax shelter," and reject his recantation.
TESTIMONY OF HERMAN FINESOD
The Government's direct examination of Finesod was relatively brief. With respect to his negotiations with Feigenbaum it was brought out that while he was aware that Feigenbaum represented Global, he could not recall how he came by that knowledge; "he [Feigenbaum] must have told me something like that" (Tr. 207). He never dealt with anyone else with respect to Global, although he believed that he had met Shine "one time very, very briefly, just a matter of minutes" (Tr. 208, lines 14-16, cf. id. lines 9-13). Although familiar with Hambrose's 1979 Offering Memorandum which identified Feigenbaum as owner of Crailheath (Tr. 204), he was "not sure" that Feigenbaum did own Crailheath; he "believed he did," but was "not positive," and did not remember "exactly when [he] realized it" (Tr. 211). In any event, he never raised any question with Feigenbaum with respect to the possibility of conflict of interest growing out of his ownership of Crailheath and representation of Global (Ibid). With respect to the Finesod-Hersch negotiations which resulted in the establishment of Philatelic, the principal point developed on direct examination was that although these negotiations were "long and arduous" Hambrose's regular corporate counsel was the only attorney consulted (Tr. 215-17).
Cross-examination of Finesod was opened by counsel for Hambrose. After bringing out that Finesod and Hersch had first met in 1976 or '77 and that between 1978 and '81 Hersch had worked for various Finesod corporations in a "management capacity" (Tr. 243), counsel announced that he was going to deal largely with the Hambrose-Philatelic (Finesod-Hersch) relationship, leaving the Global-Hambrose relationship to counsel for Philatelic and Hersch (Tr. 243). As established by stipulation, Hersch was the president of Hambrose in 1981. In that year Finesod, for reasons that are not altogether clear,
decided it might be useful to separate Hambrose from his other holdings (Tr. 245-7). This idea apparently made Finesod hospitable to a Hersch suggestion of the possibility of his "taking over the selling of stamp masters and handling that separately" (Tr. 247). When asked what Hersch had said in the conversation in which such suggestion was made, Finesod testified (Tr. 248):
Well, he said he would like to be -- to own the company and sell the stamp masters in the similar fashion to the way it was sold in 1981 and devote his full efforts to it, which he had been doing before anyway. I thought that that was a good idea, but we didn't go into a lot of detail at that time because it is a busy time of the year for us, the end of the year.
Turning to the conversations which ultimately ensued after the "end of the year," counsel ...