Posted on 08/30/2004 5:33:07 AM PDT by TigerLikesRooster
Experts Assess the Influence of Long-Term Capital's Loss
By LYNNLEY BROWNING
Published: August 30, 2004
In the end, the Nobel prizes, doctoral degrees and dizzying financial transactions could not obscure what Long-Term Capital Management was doing, according to a court ruling on Friday. And that, the judge said, was dodging taxes.
Still, leading tax lawyers, economists and tax executives who digested the decision over the weekend are focusing less on why Long-Term Capital's brainpower chose to skirt the law and more on what the decision means for future cases.
The judge, Janet Bond Arterton of Federal District Court in New Haven, ruled in a civil action that Long-Term Capital, the huge hedge fund that collapsed in 1998, acted in bad faith for the two years before its meltdown, when it took $106 million in tax deductions to avoid paying $40 million in taxes.
The decision, which follows a yearlong trial, is thought to be the most significant test case yet of how the Internal Revenue Service will combat sophisticated tax avoidance schemes. The I.R.S. moves on to a civil action against Black & Decker, scheduled to go to trial this fall, according to a senior lawyer in Washington. Black & Decker has sued the government, claiming it is owed a refund of $57 million plus interest on taxes it already paid. The government claims the company engaged in an abusive tax shelter from 1995 to 2000 and owes more taxes plus penalties.
Timothy J. McCormally, executive director for the Tax Executives Institute in Washington, said in an e-mail message yesterday that the Long-Term Capital decision "cannot help but give taxpayers and their advisers pause by underscoring the potency of the tools the I.R.S. has (and has had all along) to attack suspect transactions."
Judge Arterton upheld two large penalties against Long-Term Capital, which is defunct - one totaling 20 percent of its $40 million tax bill, the other 40 percent. The larger number is expected to be the only one that applies, raising the amount the hedge fund owes to federal coffers to about $56 million.
The judge also wrote that the fund's partners could not claim that they were legally protected by favorable opinions that they had bought from two law firms, Shearman & Sterling and King & Spaulding, as blessings for the tax dodges. Such letters have been at the heart of the proliferation of tax shelters since the mid-1990's.
Long-Term Capital's collapse, prompted by Russia's default on its sovereign debt, a big investment for the fund, sent tremors through global markets and prompted a $3.6 billion bailout from Wall Street banks, many of which had invested in the fund.
Long-Term Capital paid part of its tax bill after an audit, but sued the government in 2001 to demand a refund, claiming that it could prove the transactions in question were legitimate even though it knew they were not. The judge noted that Myron S. Scholes, one of the firm's founders and a 1997 winner of the Nobel in economic science, had internally described one transaction as essentially a government handout.
"If we are careful, most likely we will never have to pay long-term capital gains on this 'loan' from the government," Dr. Scholes wrote in a 1996 memorandum cited in the ruling.
Over the weekend, in e-mail responses to written questions, Dr. Scholes said that "the law firms gave strong opinions."
"Without this advice and opinions we would not have gone forward with the transactions," he wrote.
One lawyer who asked not to be identified said Long-Term Capital's partners might sue the two law firms. Dr. Scholes declined to comment on that issue.
Joseph Stiglitz, a Nobel economist, who testified against Long-Term Capital, said, "The opinion letters were supposed to be insurance" that the transactions would stand up in the eyes of the I.R.S.
"I think they hoped that with an opinion letter, the I.R.S. wouldn't impose penalties," Mr. Stiglitz said.
Larry Langdon, a former senior lawyer at the Internal Revenue Service who is now in private practice at Mayer, Brown, Rowe & Maw in Palo Alto, Calif., said Judge Arterton's decision signaled a new chapter in the war on tax cheats. Mayer, Brown represented the government in its case against Long-Term Capital.
Until now, Mr. Langdon said, "the government has not aggressively used their imposition of penalties as a way of curtailing abusive transactions."
Forced out of Goldman Sachs in the debacle that was Long Term Capital.
Here is an idea. Get rid of ALL forms of income taxation and go to a national sales tax. That way even the drug dealers get taxed.
I thought that for once the NYTimes got a headline correct! Alas, it did not read "Expert Asses".
Clinton's lapdog, Rubin.
Legalize it, and they get taxed either way.
Of course, with legalization you get the added effect of removing the violent drug dealers.
/threadjack
How about holding politicians from both parties responsible when it comes to spending? (Haha, I'm dreaming, I know.)
The NRST only taxes drug consumers.
The drug dealers are investors.
The income they receive from peddling their poison will become legally tax-free.
Excuse me, but are you implying that drug dealers don't eat or buy clothes or food or cars?
LTCM really was too big to fail. If they had collapsed, it would have inflicted serious damage to the financial system, which is this country's biggest and most important industry.
They collapsed anyways, though, didn't they?
They collapsed as an entity capable of expanding or continuing their business, but not in the sense that their assets all vanished, deleting tens of billions of dollars from circulation. The Fed floated them long enough to wind down and get out of all their hedge positions, to a large extent for the sake of all the people to whom they'd written puts or sold to short. If all those transactions had suddenly gone up in smoke, chaos would have resulted, because the volume was so tremendous.
I studied Sholes' work in business school. He won the Nobel Prize for co-discovering the Black-Sholes Theorem, which explains how the options market works; LTCM was him putting his money where his mouth was. Brilliant guy, but he never reckoned on the Russian government defaulting on its debt.
I guess the problem I have is, should govt money have gone to do this? I know, the govt floated Chrysler back in 1980 and that worked, and in many ways this was a loan that they knew they would get back... but IMHO they should have let it collapse.
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