April 28, 2004.
THOMAS DENNEY, R. THOMAS WEEKS, NORMAN R. KIRISITS, KATHRYN M. KIRISITS, TD CODY INVESTMENTS, L.L.C., RTW INVESTMENTS, L.L.C., NRK SYRACUSE INVESTMENTS, L.L.C., DKW PARTNERS, DKW LOCKPORT INVESTORS, INC., DONALD A. DESTEFANO, PATRICIA J. DESTEFANO, DD TIFFANY CIRCLE INVESTMENTS L.L.C., TIFFANY CIRCLE PARTNERS, DIAMOND ROOFING COMPANY, INC., JEFF BLUMIN, JB HILLTOP INVESTMENTS L.L.C., KYLE BLUMIN, KB HOAG LANE INVESTMENTS, L.L.C., L. MICHAEL BLUMIN, MB ST. ANDREWS INVESTMENTS, L.L.C., FAYETTEVILLE PARTNERS, and LAUREL HOLLOW INVESTORS, INC., on their own behalf and on behalf of all others similarly situated, Plaintiffs, -against- JENKENS & GILCHRIST, a Texas Professional Corporation, JENKENS & GILCHRIST, an Illinois Professional Corporation, BDO SEIDMAN, L.L.P., PASQUALE & BOWERS, L.L.P., CANTLEY & SEDACCA, L.L.P., DERMODY, BURKE, AND BROWN, CERTIFIED PUBLIC ACCOUNTANTS, PLLC, PAUL M. DAUGERDAS, PAUL SHANBROM, EDWARD SEDACCA, DEUTSCHE BANK AG, and DEUTSCHE BANK SECURITIES, INC., d/b/a DEUTSCHE BANK ALEX BROWN, A DIVISION OF DEUTSCHE BANK SECURITIES, INC., Defendants
The opinion of the court was delivered by: SHIRA SCHEINDLIN, District Judge
Plaintiffs allege in this putative class action that defendants
violated the Racketeer Influenced and Corrupt Organizations Act,
18 U.S.C. § 1962, and are liable for damages and other relief arising
from unjust enrichment, breach of contract, breach of the duty of good
faith and fair dealing, breach of fiduciary duties, fraud, negligent
misrepresentation, professional malpractice, "unethical, excessive and
illegal fees," and conspiracy.*fn1
The BDO Defendants, Pasquale
Defendants, and Deutsche Bank Defendants now move to compel arbitration. I. FACTS
This case arises out of tax and consulting services offered by several
professional law and accounting firms, and marketed to three groups of
investors. In the First Amended Class Action Complaint ("Compl."), the
plaintiff investors allege that in 1999, the Jenkens Defendants developed
a tax shelter known as Currency Options Bring Reward Alternatives, or
"COBRA."*fn2 Thereafter, the Jenkens defendants recruited the BDO
Defendants to market COBRA, and the BDO Defendants, in turn, asked the
Pasquale Defendants to assist BDO and Jenkens in directly marketing COBRA
to Pasquale's and Dermody's wealthy clients. See Compl. ¶
Because of their longstanding relationships with the individual
plaintiffs,*fn3 the Pasquale Defendants had intimate knowledge of the
individual plaintiffs' finances, and therefore knew that in 1999, the
plaintiffs expected substantial capital gains from certain stock holdings. See
id. ¶¶ 78-79. The Pasquale Defendants told the plaintiffs about a
"loophole" in the Internal Revenue Code that could reduce their taxes,
and recommended that plaintiffs meet with the BDO Defendants to learn
more about COBRA. The plaintiffs subsequently met with Paul Shanbrom of
BDO, who described the COBRA tax strategy. See id. ¶¶ 80-83.
Specifically, Shanbrom told plaintiffs that "by forming a partnership to
engage in foreign currency option transactions, it was possible to create
large capital and/or ordinary losses for tax purposes that would largely
eliminate or offset their expected substantial capital gain and/ordinary
income in 1999." Id. ¶ 83. Shanbrom assured plaintiffs that
BDO had an independent opinion letter from Jenkens & Gilchrist, a
major law firm, substantiating the legality and validity of the COBRA tax
shelter. See id. ¶ 82.
In October, 1999, the plaintiffs agreed to engage in COBRA
transactions. At the recommendation of the BDO and Pasquale Defendants,
plaintiffs retained Jenkens & Gilchrist to provide legal advice
relating to COBRA. See id. ¶¶ 92-93. And on the advice of the
Jenkens Defendants, the individual plaintiffs formed various corporate
entities (the "corporate plaintiffs") in order to carry out the COBRA transactions.*fn4 See id. ¶¶
The Jenkens Defendants provided various instructions to plaintiffs so
that plaintiffs could carry out the COBRA transactions. In particular,
the Jenkens Defendants referred plaintiffs to the Deutsche Bank
Defendants, and the Deutsche Bank defendants subsequently advised
plaintiffs to open accounts at DB Alex Brown. Thereafter, the Deutsche
Bank and Jenkens Defendants counseled plaintiffs with respect to the
COBRA transactions, and carried out the transactions on plaintiffs'
behalf. See id. ¶¶ 92-127.
Plaintiffs' COBRA transactions resulted in losses. The Pasquale and BDO
Defendants prepared plaintiffs' tax returns for 1999, and utilized the
COBRA losses to offset plaintiffs' capital gains in those returns.
Plaintiffs signed and submitted the returns to the Internal Revenue
Service ("IRS") and state taxing authorities. See id. ¶¶
152-65. Plaintiffs contend that at the time the BDO and Pasquale Defendants prepared the tax returns and advised plaintiffs
to sign the returns, they knew or should have known that on December 27,
1999, the IRS issued a notice indicating that losses arising from
"transactions wholly lacking in economic substance (e.g. COBRA)
are not properly allowable for Federal income tax purposes." Id.
In August, 2000, the IRS published a notice that "clearly and
unequivocally informed accountants and tax attorneys across the country
that [the IRS] believed the COBRA tax shelter was illegal . . . [and
that] the IRS believed it had  addressed transactions like COBRA in
[the December 27, 1999] notice . . . " Id. ¶ 171.
Nonetheless, the Jenkens Defendants continued to issue opinion letters
attesting to the validity and legality of the COBRA transactions, and
advising plaintiffs that the COBRA losses could properly be used as
capital and ordinary losses for tax purposes. Additionally, the Pasquale
Defendants prepared plaintiffs' 2000 tax returns to reflect the COBRA
losses, and on the advice of the Pasquale Defendants, plaintiffs signed
and submitted those returns to the IRS. See id. ¶¶ 175-81.
The DeStefano Plaintiffs completed their COBRA transactions in 2001.*fn5 The Pasquale and BDO defendants subsequently advised the
DeStefano Plaintiffs that they should retain the Cantley Defendants,
rather than the Jenkens Defendants, to provide an opinion letter with
respect to the propriety of utilizing the COBRA losses on the DeStefanos'
2001 tax returns. The Cantley Defendants provided such an opinion letter
in April, 2002. According to plaintffs, the Cantley Defendants knew the
letter was "bogus" at the time it was issued. Plaintiffs further allege
that the BDO and Pasquale Defendants advised the DeStefano Plaintiffs to
retain Cantley & Sedacca in late 2001 because the Jenkens Defendants
were unwilling to issue an opinion letter in light of the IRS notices.
See id. ¶¶ 184-91.
In December, 2002, the New York State Revenue Department notified
plaintiffs that the Tax Shelter Unit had selected their 1999 state income
tax returns for audit. The DeStefano Plaintiffs were further notified
that their 2000 income tax returns had also been selected for audit. The
IRS subsequently notified all plaintiffs that their 1999 federal tax
returns had been selected for audit, and notified the DeStefano
Plaintiffs that their 1999, 2000, and 2001 returns had been selected for
audit. See id. ¶ 201. Nonetheless, in January, 2003, the EDO Defendants advised plaintiffs not to participate in either the
federal or the New York State tax amnesty programs. See id.
In June, 2003, the IRS "formalized its position regarding CORE A . . .
by issuing new regulations  retroactive to October 18, 1999 . . . The
Regulations invalidate COBRA . . . " Id. ¶ 223. The IRS
further indicated that the COBRA transactions are invalid under both the
new regulations, and under two existing provisions of the Internal
Revenue Code. See id. ¶ 225.
In addition to the losses plaintiffs experienced in carrying out the
COBRA transactions, plaintiffs have incurred and will continue to incur
substantial damages in the form of fees paid to attorneys and accountants
retained to address the audits.*fn6 See id. ¶¶ 229-38. B. The Written Agreements
On October 8, 1999, plaintiff L. Michael Blumin, on behalf of Jefyle
Equipment Corp., Inc., entered into a consulting agreement with BDO (the
"Blumin Agreement"). The Blumin Agreement was effective through September
30, 2000, and included the following language:
WHEREAS, [Jefyle Equipment Corp.] is interested in
expanding its business operations into new
strategic markets (the "Expansion");
WHEREAS, BDO is in the business of providing
accounting and consulting services; and
WHEREAS, [Jefyle Equipment Corp.] desires BDO to
provide certain tax, financing and business
consulting services in connection with the
Expansion, and BDO desires to provide such
services . . .
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