I recently finished Wolf Hall by Hilary Mantel, a truly brilliant novel about the ascent of Thomas Cromwell to political and legal power in Tudor England. There is something of the intrigue and drama of that in Confidence Games: Lawyers, Accountants, and the Tax Shelter Industry by Tanina Rostain and Milton C. Regan. The book is a detailed investigation of a series of abusive tax shelters in the US between 1994 and 2004 whereby Rostain and Regan say, ‘law firms, accounting firms, and financial institutions involved in the shelter industry… perpetrated fraud not only on the government but also on their own clients.’
Rostain and Regan set out the role of a number of factors in the scandals: profit per partner metrics (e.g. one firm took a too good to be true partner into their fold for the income he extracted out tax schemes through ‘value billing’); legal professional privilege (notably, but not solely, its extension to accountants – coming to an ABS near you); confidentiality agreements (clients sometimes had to pay to entering into tax avoidance discussions which were then subject to confidentiality and tax litigation was often compromised on a confidential basis); mis-selling to clients; and so on.
The main role of the lawyers was in the design of dubious structures (either in-house at accountants firms or in collaboration with accountants from ‘prestigious firms’ in private practice) and in the provision of independent opinions that tax shelters ‘more likely than not’ met tax rules. These opinions were highly remunerative, and were designed to induce clients into purchasing the tax deals and then protecting them from liability should the deals turn sour. They were also fictions: based on facts which did not exist.
If a lawyer gave an opinion that it was ‘more likely than not’ that a deal met tax rules, then that provided clients with a ‘get out of jail card’. They could say they were advised it was legal. Interestingly, counterparties in the deals sometimes advised on different bits of the transaction: each sought to rely on the other’s assertions that part of the deal was ‘more likely than not’ legitimate to build the case that they could give an opinion. Each slightly de-responsibilised the other. Often ‘cookie cutter’ opinions were given by private practitioner firms that lacked any semblance of independence. The opinion givers were influenced by their own roles in the design of schemes and the hefty fees they were granted. One firm became known as ‘Opinions R Us’. Business imperatives for purely tax motivated transactions were invented. Clients were coached on these imperatives after the event to try and push back on IRS (the US inland revenue service) scrutiny. Aggressive, sometimes rogue, tax lawyers were allowed to grow significant practices on the back of this approach by firms who lacked the expertise to scrutinise, or perhaps inclination given the amount of money rolling into partnership coffers.
Lawyers and accountants also designed and managed processes to reduce the likelihood of tax shelters being audited (and so challenged) and helped massage client files in the hope that tax shelters looked like real investments not shonky deals. Incriminating documents were shredded. Marketing documents, making plain the motivation of tax schemes, were spirited away. These deals were sometime supported by loans from banks that were loans, ‘in name only, since the funds were not permitted to leave the bank.’
Entertainingly, acronyms used in the businesses promoting this kind of work were often built around snake machismo: Cobra and Viper and ‘Tax $ell$’. If culture eats strategy for lunch, as Drucker says, then the culture was cash and getting the deal done quick. Lunch was billions of dollars on the US deficit and millions in professional service fees charged on a percentage basis.
The authors emphasise:
Spanning the decade between 1994 and 2004, the abusive tax shelter crisis likely represents the most serious episode of lawyer wrongdoing in the history of the American bar….
Among the factors that contributed to the emergence of the abusive shelter market were a lax regulatory environment and a highly competitive market for professional services…
By charging a percentage of the supposed tax savings on a high volume of shelters, firms could escape the constraints on growth imposed by the hourly fee structure….
The accounting firms that were most deeply involved implemented organizational incentives that encouraged tax shelter development and marketing. Tax leaders at these firms also created organizational structures and cultures that celebrated tax shelter activities and channeled specialized expertise into devising transactions that involved hypertechnical interpretations of the tax code in order to help clients evade billions of dollars in taxes….
At law firms, tax shelter work was not institutionalized to the same degree. Loose partnership structures allowed tax shelter lawyers to work semiautonomously with little or no oversight by the rest of the firm….
At Jenkens & Gilchrist [a Texas based law firm who took on an aggressive lawyer, gave him a culture busting eat what you kill deal and marginalised the doubters ], repeated failure to appreciate the risks of a tax shelter practice led eventually to the demise of the firm. Other law firms survived but ended up paying substantial penalties
One of the interesting themes of the book is how a traditional ethos of professionalism, client focused but with restraint out of respect for the law, was undone by the profit motive of individual lawyers and, in particular, the large accounting firms. With a debate currently breaking out about the ethicality of reporting PEP it is a salutary to note that Jenkins & Gilchrist were partly undone by a desire to get their Am Law 100 rating to improve sufficiently for them to be able to open a New York office.
The traditional view is expressed in this way:
The value to clients of a lawyer’s advice rested on the lawyer’s capacity to provide independent judgment about how a court would treat the tax benefits claimed for a transaction. This judgment was informed by a sense of the internal coherence of the provisions at issue, the salience of judicially created standards, and an understanding of at least a general set of basic principles that animated the Internal Revenue Code.
Elite practitioners regarded the exercise of such professional judgment as the feature of their practice that distinguished them from mere technocrats who provided advice based simply on the literal terms of the tax code. The lawyer’s aim was for the client to take a position that didn’t raise concerns with tax authorities, rather than a position that on balance would be financially advantageous even if challenged by the government.
That view was challenged by accountants (or perhaps it might be more accurate to add by lawyers within accountants) with a more technocratic view; and incentives which saw tax work as a revenue generator rather than the icing on the cake at the end of a deal. Plus, ‘If lawyers in elite firms failed to give their blessing to a transaction, clients were prepared to shop around to find a lawyer who would.’
Rostain and Regan are careful to acknowledge that the ‘traditional’ tax bar was not uniform or to naively over-claim public spiritedness by the traditionalists. They plausibly argue for a constellation of factors which pushed tax practice significantly towards a client zeal model which violated professional and legal norms. In fact their client zeal was a masquerade: they put their businesses first and risked their clients’ interests. It’s a book which also gives a fascinating insight into how groups of professionals work together; pressurise each other; and let unethical practice slide under their radars. People within these organisations spoke out and were ignored, pressured or subverted. The money rolled in. And then it didn’t. And after that came a rather large storm cloud… luckily for of them, it was not Tudor-style.
Richard Moorhead is Professor of Law and Professional Ethics at UCL, you can read his blog here