Tax Litigation Update: United States v. Clarke Tests Limits of IRS Summons Enforcement Power

On April 23, 2014, the United States Supreme Court heard oral argument in United States v. Clarke, a case which may affect every taxpayer subject to a future IRS examination.

At issue in the case is the extent to which a taxpayer may investigate the underlying reasons or motivations for the IRS’s issuance of a summons, a subpoena-like document that allows the IRS to demand documents, interview witnesses, and seek other information during the course of an examination.  Under IRC § 7602, the IRS may issue a summons to:

a person liable for the tax or required to perform the act, or any officer or employee of such person, or any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for tax or required to perform the act, or any other person the Secretary may deem proper, to appear before the Secretary at a time and place named in the summons and to produce such books, papers, records, or other data, and to give such testimony, under oath, as may be relevant or material to such inquiry.

IRS SUMMONS POWER

The IRS’s summons power is immense, and the limitations placed on it, either by statute or by the courts, are limited.  The basic limitations placed on the IRS summons power were set forth in a seminal case, United States v. Powell, 379 U.S. 48 (1964), in which the Supreme Court held that in order to enforce a summons against an uncooperative recipient, the IRS must establish that (1) the examination is being conducted for a legitimate purpose; (2) the information sought may be relevant to that purpose; (3) the IRS does not already possess the information sought; and (4) the IRS has followed all necessary administrative steps, particularly regarding notice and service of the summons.

The Service’s burden to prove these matters is “slight.” An affidavit from the examiner attesting to these facts is sufficient. United States v. Samuels, Kramer and Co., 712 F.2d 1342, 1345 (9th Cir. 1983).

Once the IRS makes it prima facie showing, the burden shifts to the party opposing the summons to either disprove one of the four Powell elements or convince the court that enforcement of the summons would constitute an abuse of the court’s discretion.

Appropriate defenses to summons enforcement include asserting that (1) the summons was issued after the IRS had recommended criminal prosecution to the Department of Justice; (2) the summons was issued in bad faith; (3) the materials sought are already in the possession of the IRS; and, (4) the materials sought by the IRS are protected by either the attorney-client privilege, the work-product doctrine, or other traditional privileges and limitations. United States v. Riewe 676 F.2d 418, 420 n.1 (10th Cir. 1982).

IMPROPER PURPOSE AND BAD FAITH

The IRS is authorized to use a summons for the purposes described in IRC §7602, which are generally related to tax determination and collection. When the IRS uses its summons power for an unauthorized purpose or for any purpose reflecting on the good faith use of its power, the Supreme Court has said that the summons will not be enforced. Reisman v. Caplin, 375 US 440 (1964). Further, in Powell the Supreme Court stated that an “improper purpose” includes harassing the taxpayer, pressuring the taxpayer to settle a collateral dispute, or any other purpose reflecting negatively on the good faith of the particular investigation. (See also IRM 5.17.6.2.2, which discusses summonses legal authority). In addition, case law and IRC §7602(c) make it clear that the IRS is not authorized to use this power to assist another agency by, for example, using a summons to investigate a matter already being investigated by a grand jury, or by gathering evidence for the Department of Justice in its prosecution of a criminal case. United States v. LaSalle Nat’l Bank, 437 US 298 (1978)..

In general, since it is the court’s process that the IRS invokes in an enforcement proceeding to obtain compliance with a summons, a court will not order compliance unless it is satisfied that the IRS has served the summons in a good faith pursuit of its summons authority.

Before 1982, the IRS’s authority to issue summons did not expressly include power to use a summons to investigate a criminal violation of the tax laws. As a result, there was much litigation over the question whether the IRS was using a summons for an improper criminal purpose. In 1982, IRC §7602 was amended to provide that the statutorily authorized purposes for which a summons may be issued include “the purpose of inquiring into any offense connected with the administration or enforcement of the internal revenue laws.” Accordingly, the IRS is permitted to use a summons to gather evidence of a criminal violation of the tax laws. IRC §7602 was further amended to prohibit the use of a summons when a Department of Justice referral for criminal prosecution or grand jury investigation is in effect.

Significantly, persons affected by a summons have made objections that the summons has been issued for improper purposes other than for gathering evidence for use in a criminal prosecution. In United States v. LaSalle Nat’l Bank, 437 US 298 (1978), the Supreme Court recognized that a summons might be unenforceable for reasons other than an improper criminal purpose. Further, in Pickel v. United States, 746 F2d 176 (3d Cir. 1984), the third circuit stated that it did not doubt that portions of the Powell and LaSalle discussions of bad faith retain vitality even after the 1982 amendment to IRC §7602  and that where the taxpayer can prove that the summons is issued solely to harass him, or to force him to settle a collateral dispute, or that the IRS is acting solely as an information-gathering agency for other departments, such as the Department of Justice, the summons will be unenforceable because of the IRS’s bad faith. Further, where a substantial preliminary showing of abuse of the court’s process has been made, a summoned party is entitled to substantiate his allegations by way of an evidentiary hearing. United States v. Millman, 765 F2d 27 (2d Cir. 1985) (at the hearing, the agents responsible for the investigation and other witnesses may be called). See also United States v. Church of Scientology, 520 F2d 818, 824 (9th Cir. 1975)(limited evidentiary hearing approved).

When the challenge to a summons is based on an improper purpose, discovery and an evidentiary hearing are critical to prove the challenge, and it is by no means certain that the moving party will obtain either one or both opportunities. The district court’s decision to deny discovery and an evidentiary hearing is reviewed by a court of appeals under an abuse of discretion standard—that is, only if the taxpayer demonstrates in the summons enforcement hearing that the district court abused its substantial discretion in denying discovery and an evidentiary hearing. Discovery on motivation of an audit is permitted by some circuit courts only when the movant has shown “extraordinary circumstances” that take the movant out of “the class of the ordinary taxpayer, whose efforts at seeking discovery, would if allowed universally, obviously be too burdensome” to the IRS. United States v. Fensterwald, 553 F2d 231, 231–232 (DC Cir. 1977), cited in United States v. Judicial Watch, Inc., 371 F3d 824 (DC Cir. 2004). Another statement of the showing that is required to be entitled to discovery and an evidentiary hearing is that the movant need only establish the possibility of an improper motive before obtaining further discovery. This standard is more rigid than the standard that must be met by a party opposing a motion for summary judgment. Under this standard, the moving party must have evidence sufficient to raise a genuine issue of fact material to whether the audit is an act of political retaliation, or some other improper purpose. Further, requiring a taxpayer to produce records already in the IRS’s possession is arguably an abuse of the court’s process (or a bad faith use of the summons power). However, courts generally have enforced a summons in this situation.

In Clarke, the taxpayer alleged that the IRS had an improper purpose in issuing the summons, and thus was not entitled to enforce its subpoena. Specifically, Clarke asserted that the IRS was retaliating against the Dynamo’s refusal to extend the statute of limitations for a third time and that the IRS was seeking to circumvent the limited discovery rules available to litigants in Tax Court proceedings (The scope of documents and information that can be requested in a summons is generally wider than that which is permitted in a Tax Court Request for Production.)  This allegation was supported by the fact that when the IRS conducted its investigation with regard to a summons that was not challenged, attorneys representing the IRS in the Tax Court proceeding, rather than the agent in charge of the examination of Dynamo, performed the investigation. In essence, Clarke argued that the IRS was attempting to use its summons power in bad faith – as if it was a grand jury proceeding – to be able to obtain information which it would not otherwise obtain under normal Tax Court discovery rules, and thus have the upper hand in the case.

UNITED STATES V. CLARKE

Clarke arises out of an examination conducted by the IRS of a partnership called Dynamo Holdings for tax years 2005-2007.  During the course of the examination, Dynamo agreed to extend the statute of limitations for assessment two times.  Generally, the IRS has three years from the later of the due date for a return or the date the return is actually filed to assess a tax.  A tax is not collectible unless it is first assessed.

When the IRS requested a third extension of time within which to complete the assessment, the partnership refused.  Soon thereafter, the IRS issued five summonses, including one to Michael Clarke, the CFO of two partners of Dynamo.  The focus of the IRS’s summonses was interest deductions of $34 million taken by Dynamo over the course of two of the years subject to the IRS’s examination.

The IRS issued a Final Partnership Administrative Adjustment (FPAA) in December 2010, three days before the expiration of the statute of limitations.  By issuing the FPAA, the IRS tolled the statute of limitations period, formally set forth the amount it claimed the partnership owed, and began the process of assessing the tax deficiency and collecting the tax from the partnership’s partners.  Notably, the FPAA issued by the IRS in December 2010 was dated and signed in August 2010, before the IRS had issued the at-issue summons to Clarke.

In February 2011, Dynamo challenged the FPAA in the Tax Court.  Meanwhile, Clarke had refused to obey the summons, and the IRS began summons enforcement proceedings.  In April 2011, well after commencement of the Tax Court case.

In the typical enforcement proceeding, the IRS submits an affidavit of an agent familiar with the case establishing the Powell factors.  From there, the burden shifts to the taxpayer to allege and prove that one or more of the factors has not been established.  The district court, the forum for summons enforcement litigation, has discretion to determine whether to hold an evidentiary hearing or permit discovery regarding the summons recipient’s allegation that one or more of the Powell factors has not been established.

Before the district court, Clarke argued that the IRS did not have a legitimate purpose in issuing the summonses because, among other reasons, they were (1) issued in retaliation for the partnership’s refusal to extend the statute of limitations period a third time and (2) designed to circumvent the U.S. Tax Court’s limitations on the scope of discovery.  United States v. Clarke, 111 AFTR 2d 2013-1697 (S.D. Fla. Apr. 16, 2012).

Clarke brought forth some evidence supporting the contention that the summon was designed to circumvent the U.S. Tax Court’s limitations on the scope of discovery, including (1) the fact that the IRS sought to continue the Tax Court proceeding on the ground that the summonses were still outstanding and (2) a declaration from the lawyer of the sixth summoned individual (who ultimately complied with the summons request) that her IRS interview was conducted exclusively by the two lawyers representing the IRS in the Tax Court proceeding and that the examining agent was not even in attendance.  Notably, when Powell was decided, lawyers representing the IRS in Tax Court proceedings were not allowed to interview summoned individuals, only examining agents could do that.

To further prove their contentions, the Respondents requested an evidentiary hearing to inquire into the government’s purposes for issuing and enforcing the summonses (and also requested pre-hearing discovery).  The district court, however, ordered enforcement of the summonses.  It rejected the first argument as a “naked assertion” unsupported by evidence.  It then dismissed the second contention because it determined that, even if the IRS had used the summons process to sidestep discovery limitations, such a finding was not a valid reason to quash a summons.  Cf. Mary Kay Ash v. Commissioner, 96 T.C. 459, 462, 472-73 (1991) (denying taxpayer’s motion for protective order barring IRS from using evidence obtained through a summons but emphasizing that it was not deciding the enforceability of the summons since that issue was in the district court’s jurisdiction).

The United States District Court for the Southern District of Florida denied Clarke’s request for an evidentiary hearing.  On appeal, the Eleventh Circuit Court of Appeals reversed and held that the district court had abused its discretion in refusing to hold an evidentiary hearing.  The Eleventh Circuit held that an allegation of improper purpose is sufficient to trigger a limited adversary hearing before enforcement is ordered, and that, at the hearing, the taxpayer may challenge the summons on any appropriate ground.  The Eleventh Circuit’s reasoning was based in part on a prior summons enforcement case, Nero Trading.  In that case, the Eleventh Circuit reasoned that requiring the taxpayer to provide support for an allegation of improper purpose without giving the taxpayer the opportunity to obtain such facts “saddles the taxpayer with an unreasonable circular burden.”

Given the clear structure applicable to deciding summons enforcement proceedings, the parties’ arguments before the Supreme Court focused on narrow issues dictated by the facts specific to the case and the standard of review applicable to a district court’s decision to allow, or deny, an evidentiary hearing. The goals of the parties, specifically to persuade the Supreme Court to either affirm or reverse the Eleventh Circuit’s judgment based on the narrow facts of the case, were somewhat at odds with the Supreme Court’s goal of providing instruction to the district courts across the country that regularly face summons enforcement proceedings.

The government argued, and Clarke seemed to concede, that merely alleging bad faith in response to a summons does not necessarily entitle a summons objector to an evidentiary hearing during which IRS personnel can be examined by the objector. The differences arose with regard to what type of showing, beyond a mere allegation, an objector must make before being entitled to an evidentiary hearing.  Clarke argued that the affidavits  he submitted highlighting the questionable actions of the IRS—the close proximity between Dynamo’s refusal to extend the statute of limitations and issuance of the summonses, the issuance of the summonses well after the date the FPAA was signed, and the IRS’s use of its Tax Court attorneys to conduct the summons investigation—were sufficient to require the district court to hold an evidentiary hearing during which he would be permitted to question IRS personnel.  The government countered that the district court’s decision, which took into account all of the reasons for improper purpose raised by Clarke before the Eleventh Circuit and Supreme Court, should be respected because the district court did not abuse its discretion.

The Court’s focus during argument seemed to be on fashioning a rule of more general applicability from the specific and somewhat unique facts of the Clarke case.  What is clear from the Court’s questioning during oral argument is that any type of “automatic hearing” rule, in which a mere allegation of bad faith or impropriety will allow a summons objector the opportunity to participate in an evidentiary hearing, will not be permitted.  What is not as clear is whether the Court will adopt a generally applicable standard, rather than deciding the case before it on narrow grounds, and, if a general standard is adopted, what it will be.

There were hints from some of the Justices that they need to provide guidance to the district courts, and that limiting their decision to the narrow facts presented in Clarke would not be helpful.  Furthermore, there were indications that some of the Justices could seek to adopt more familiar litigation standards for application in the summons enforcement process.  Specifically, Justice Sotomayor raised the question of whether the heightened pleading standards set forth in two fairly recent Supreme Court cases called Twombly and Iqbal is the proper guide or whether the more rigorous standard applicable to summary judgment motions—in which the litigants must set forth specific, admissible evidence to support or oppose a motion for summary judgment—is more appropriate.  Not surprisingly, the government argued that the more rigorous summary judgment standard is more analogous, while Clarke argued that the Court’s rule should more closely follow the scrutiny applied to pleadings facing a motion to dismiss.

CONCLUSION

As with all SCOTUS cases, it is virtually impossible to determine precisely how the Court will rule. If the questions posed by the Justices during oral arguments were any indication of how the Court will rule, it is likely the Justices will side with the IRS.  Further, it is probably safe to assume that the Court will err on the side of requiring some clear, probative evidence before permitting a summons objector to question IRS personnel in Court.  This is because a rule that is too lenient, i.e. one that requires an evidentiary hearing upon the objector’s proffer of any evidence tending to show an improper purpose, would be seen as too damaging to the IRS’s examination process.

Moreover, the IRS is in the process of implementing more efficient processes relating to information gathering in the process of auditing large businesses.  A rule that takes a permissive approach toward entitling summons objectors to an evidentiary hearing, particularly one in which the agent conducting the exam can be questioned, would contravene the IRS’s stated focus on efficiency in gathering information during exams.

The impact of the Clarke decision will be especially relevant to taxpayers in South Florida.  As we have blogged about previously, South Florida has been a focus of recent IRS summons issuance.  Under the language of Nero Trading, taxpayers residing in the Eleventh Circuit (Alabama, Georgia, and Florida) had seemingly the most accommodating appellate court in the country to hear their appeal when a district court had denied a request for an evidentiary hearing.  If the Supreme Court issues a broad decision, the Eleventh Circuit’s prior decision to taxpayers seeking an evidentiary hearing to support their claims of an improper motive in summons issuance may no longer be precedential.

Notably, on April 28, 2014 – only five days after the Supreme Court heard oral arguments on Clarke – the Tenth Circuit Court of Appeals, in Jewell v. United States, Nos. 13–7038, 13–6069(2014), quashed IRS summonses that were issued after the 23-day period required under IRC §7609(a)(1). IRC §7609(a)(1) requires the IRS to notify summons recipients that it will examine records at least 23 days before the date fixed in the summons as the date upon which such records are to be examined. In deciding whether to quash the summonses, the appeals court examined whether the IRS had complied with the Powell requirements and determined that the 23-day period is an administrative step required by statute. In doing so, the Court acknowledged that it was creating a split between circuits. However, the Tenth Circuit emphasized that the Supreme ruled clearly in Powell when it said that “if the IRS does not comply with the administrative requirements of the Internal Revenue Code, its summonses are unenforceable.” In this battle between taxpayers and the government regarding IRS summons power, the ruling in Jewell and the split that now exists only serve to add fuel to the fire, and make the upcoming Supreme Court’s decision in Clarke all the more significant.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  They will continue to monitor developments in this and similar cases. If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling 305.350.5690.

White Collar Criminal Defense Update: Third Circuit Court of Appeals Discusses “Willful Blindness” Jury Instruction and Burden Shifting

The following post, which was authored by Joseph DiRuzzo, originally appeared on the Federal Tax Crimes Blog on May 5, 2014. We re-post it here with permission.

 

On April 30, 2014, the Philadelphia based U.S. Court of Appeals for the Third Circuit issued its precedential opinion in United States v. Tai, ___ F.3d ___, 2014 U.S. App. LEXIS 8129 (3d Cir. April 30, 2014), here. A copy of the Tai decision is available here.

Before filing an appeal with the Third Circuit, Tai was convicted for mail and wire fraud related to the “Fen-Phen Settlement Trust” which was created to compensate victims who underwent surgery for heart valve replacement or primary pulmonary hypertension (PPH) after taking Fen Phen. The trust was established by the U.S. District Court for the Eastern District of Pennsylvania to administer all claims and benefit payments to Fen Phen victims who registered as part of the Nationwide Class Action Settlement Agreement with American Home Products Corporation.

Individuals wishing to make claims were required to submit a physician’s report from a cardiologist and the Trust would review the documents to ensure that the claims were legitimate. Tai was one of the cardiologists hired to prepare reports in support of individuals claims.  Tai admitted that in about 10% of his cases, he drafted reports that he knew were incorrect.  When Tai’s reports were audited, a substantial number were not only clearly incorrect, but included measurements which were “inconsistent with a human adult heart.” Slip op. at 6.

Tai was charged with mail and wire fraud in violation of 18 U.S.C. sections 1341 and 1343; he was found guilty on all charges and sentenced to 6 years in prison.  Tai appealed his conviction arguing that, among other things, the jury instruction was “constitutionally infirm because it shifts the burden of proof to the defendant to disprove intent.”

As a threshold matter, because Tai did not raise his objection to the jury instruction at the trial level and thereby failed to preserve it, the Third Circuit employed a “plain error” test, which is a highly deferential standard of review. Under the “plain error” test, criminal defendants have the burden of establishing than any error was “plain” and he must show:  (1) an error; (2) that is plain; (3) that affects substantial rights; and (4) which seriously affects the fairness, integrity, or public reputation of judicial proceedings.Johnson v. United States, 520 U.S. 461, 466-67 (1997).

Regarding the instruction, the Third Circuit observed that a “willful blindness instruction is typically delivered in the context of explaining how the Government may sustain its burden to prove that a defendant acted knowingly in committing a charged offense.”  A jury instruction must track the applicable law, but District Court judges have substantial latitude in the actual wording of the jury instruction.  However, insofar as jury instructions related to the Fifth Amendment’s requirement that the Government prove its case beyond a reasonable doubt on each element of the offense, “a jury instruction violates due process if it fails to place squarely on the Government the full burden of proving beyond a reasonable doubt the required mental state for the offense.”  Slip op. at 10 citing Patterson v. New York, 432 U.S. 197, 204-07 (1977).

In other words, as Tai argued, shifting the burden of proof in a criminal case violates the Fifth Amendment and can often result in a conviction being overturned.  SeeMullaney v. Wilbur, 421 U.S. 684, 703–04 (1975) (due process does not permit shifting the burden of proof to the defendant by the use of conclusive or burden-shifting presumptions); see also Boles Trucking v. United States, 77 F.3d 236, 241 (8th Cir. 1996)(discussing in a civil case that “it is reversible error to place the burden of proof on the wrong party or to place an unwarranted burden of proof on one party.” (internal quotations and citations omitted)). However, because the “willful blindness instruction then explicitly explained that ‘the Government may prove’ this element through evidence that established beyond a reasonable doubt that Tai ‘deliberately closed his eyes to what would otherwise have been obvious to him,’” (slip op. at 11), there was no impermissible burden shifting.  Ultimately, the Third Circuit concluded that the “instructions told the jury when willful blindness does or does not exist, but did not imply in any way that Tai must present evidence concerning his own beliefs or knowledge.” Accordingly, “there was no implicit or explicit shifting of the burden of proof to Tai.” Id.

The Tai case is instructive in criminal tax and Bank Secrecy Act cases to the extent that it addresses the willful blindness jury instructions which often arise in those cases.  Since the mens rea requirement requires that the Government prove that a criminal defendant had the culpable mental state, often the defense strategy will be along the lines of ignorance, negligence, incompetence, or lack of sophistication, but falling short of being criminal. In order to rebut this defense, the Government will typically attempt to introduce evidence that when a defendant “sticks his head in the sand” such deliberate acts – i.e., the willful blindness – cannot be used to escape criminal liability.  This essentially pits the criminal defendant’s subjective belief against the jury’s belief as to what was reasonable under the circumstances.

One other, special point is also worth mentioning. The Government may attempt to argue in “willful blindness” cases that the defendant’s actions were not objectively reasonable and hence the jury can conclude that the defendant intentionally intended to be willfully blind to the facts.  This subjective versus objective tension will often dictate the outcome of the case, but will almost always require a criminal defendant to take the stand in his defense to assert a Cheek defense. In Cheek v. United States, 498 U.S. 192 (1991), the Supreme Court established that a genuine, good faith belief that one is not violating the Federal tax law based on a misunderstanding caused by the complexity of the tax law is a valid defense to a charge of “willfulness,” even though the defendant’s belief is objectively irrational or unreasonable.

More often than not, willful blindness cases boil down to one question:  does the jury believe the defendant?

False Claims Act Litigation Update: Bayer Decision Sheds Light on Pleading in False Claims Act Cases

A recent win for a large company in a False Claims Act suit (a seeming rarity as of late) alleging illegal off-label promotion could provide some helpful insight to similarly situated manufacturers and support dismissals of similarly defective lawsuits. Laurie Simpson, the relator and an employee at Bayer Corporation for seven years, helped market and promote Trasylol, a prescription drug approved by the FDA for patients undergoing coronary artery bypass graft using a cardiopulmonary bypass pump to prevent excess bleeding. In Simpson’s 131-page complaint containing 30 causes of action, she alleged that Bayer violated the False Claims Act by “engaging in a campaign of concealment and disinformation concerning Trasylol’s safety and efficacy.” Specifically, Simpson’s complaint alleged that Bayer promoted Trasylol for other types of surgeries and failed to provide safety and efficacy information about those other uses. Simpson alleged that such omissions resulted in the misbranding of Trasylol under the Federal Food, Drug, and Cosmetic Act (“FDCA”).

Generally, the False Claims Act is a federal law that imposes liability on corporations who defraud governmental programs. Notably, the Act includes a “qui tam” provision, which allows individuals not affiliated with the government to file actions on behalf of the government. There are two categories of false claims upon which a relator can base a qui tam complaint: factually false claims and legally false claims. While factually false claims are false as to a matter of fact, legally false claims involve false certifications of compliance with laws or regulations that are prerequisites to payment.

The allegations Simpson presented were legally false claims because they were based on the alleged misbranding of Trayslol in violation of the FDCA. In response to Simpson’s allegations, Bayer filed a motion to dismiss Simpson’s complaint. In its motion, Bayer argued that Simpson failed to adequately plead a false claim for payment, a critical element of a False Claims Act violation. Under the False Claims Act, to adequately plead a legally false claim, Simpson had to establish that Bayer made an implied certification that Trasylol complied with the FDCA restriction against misbranding, and that such compliance with the FDCA was a “condition of payment” from the government.

The U.S. District Court for the District of New Jersey reviewed each of the government programs that Bayer allegedly defrauded (i.e., Medicare, DOD, Tricare) to determine whether the government conditioned its payments for Trasylol on the limited on-label use of the drug.  On April 11, 2014, the court granted Bayer’s motion to dismiss Simpson’s complaint concluding that Simpson’s “bare legal conclusions” did not adequately plead the existence of a condition of payment. In other words, even assuming that Bayer marketed Trasylol for purposes other than those included on Trasylol’s FDA approved label, the District Court ruled that Simpson needed to allege more to properly state a claim under the False Claims Act. The court noted that the purpose of the False Claims Act “was not designed for use as a blunt instrument to enforce compliance with all medical regulations, but rather only those regulations that are a precondition to payment.” The court’s decision can be read here. This statement by the court will surely support dismissals of other complaints with similarly defective allegations.

The attorneys at Fuerst Ittleman David & Joseph, PL will continue to monitor developments in this and similar cases. Our attorneys have extensive experience in the areas of food and drug, administrative law, qui tam, regulatory compliance, and white-collar criminal defense.  If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling (305) 350-5690. Let FIDJ show you how we can help today.

Choked Out: Operation Choke Point seeks to eliminate financial services for “high risk” businesses

Since early 2013, the United States Department of Justice (“DOJ”) has been formally targeting banks that service a wide range of lawfully operating businesses that it and the Federal Deposit Insurance Corporation (“FDIC”) consider “high risk.” The probe, known as “Operation Choke Point,” was started as an outgrowth of the Financial Fraud Enforcement Taskforce and seeks banks’ assistance in choking off access to the financial services industry by shutting down the bank accounts of high risk businesses.

As described in the April 24, 2014 Wall Street Journal Op-ed article by American Bankers Association CEO Frank Keating:
Justice’s premise is simple: Fraudsters can’t operate without access to banking services, and so the agency is going after the infrastructure that questionable merchants use rather than the merchants themselves. Most of these merchants are legally licensed businesses on a government list of “risky profiles.”
 
Mr. Keating’s Op-ed can be read here.
Operation Choke Point initially focused on online payday lenders operating in states that prohibit payday lending activity. However, Operation Choke Point has expanded its focus to a wide variety of areas that the FDIC has categorized as being “associated with high-risk activity.” According to the FDIC, such “high-risk” merchant activity includes ammunition, tobacco, fireworks, firearms, pornography, life-time membership clubs, and coin dealers, just to name a few. A complete list of the FDIC’s “high-risk” merchant categories can be found in its Summer 2011 Supervisory Insight entitled, Managing Risks in Third-Party Payment Processor Relationships.
In an effort to increase scrutiny of these so called “high-risk” activities, federal authorities are focusing on where these merchants receive financial services, particularly banks and payment processors. As a result, banks and payment processors have been forced between two difficult options: either discontinue servicing commercial customers which the federal government deems to be engaging in questionable although legal behavior, or continue and risk being the subject of heightened regulatory scrutiny and penalties.
Not surprisingly, Operation Choke Point has drawn harsh criticism from Congress due to the potentially devastating impact it has on millions of Americans’ access to legitimate nontraditional banking systems such as payday lenders and check cashers. As detailed in an August 22, 2013 letter from Congress to Attorney General Eric Holder, “[m]ore than one in four American households conducts some or all of their financial transactions outside the mainstream banking system.” Further, as explained by the House Committee on Oversight and Government Reform in its January 8, 2014 letter to Attorney General Holder, “[w]hile online leading, like all financial services, can be susceptible to fraud, the overwhelming majority of lenders fully comply with all applicable statutes, regulations, and industry-recognized best practices.” Thus, because Operation Choke Point “would eliminate the basic processing services that legitimate lenders rely upon to serve millions of Americans[,] [a] much more targeted approach is required.”
The banking industry has also voiced concern about Operation Choke Point because of the increased strain it has caused for banks’ anti-money laundering (“AML”) compliance programs. On April 8, 2014, the Independent Community Bankers of America (“ICBA”) described Operation Choke Point as “impos[ing] ill-considered and costly mandates on payment systems” and “threaten[ing] to close access to the financial system to law-abiding businesses, because the mere prospect of an enforcement action is sufficient to cause financial institutions to restrict access to their payment systems to only established companies that present low risks.” Thus, the ICBA requested that “DOJ suspend Operation Choke Point immediately and focus its resources directly on businesses that may be violating the law, rather than targeting banks providing payment services.” ICBA’s complete statement can be read here.
 
Similar thoughts were echoed by Frank Keating in his Wall Street Journal Op-ed:
[L]aw-enforcement agencies and courts, not banks, are responsible for determining criminal violations. The 1970 Bank Secrecy Act spells out the proper partnership for banks and law-enforcement agencies. The law established record keeping and reporting requirements for banks so that law-enforcement agencies would have the evidence needed to prosecute criminals effectively. That is the division of labor and responsibility envisioned by Congress: drawing upon each other’s strengths to fight crime.
 
Although Operation Choke Point was only formally launched in 2013, the purposes behind it are nothing new. Similar efforts have been launched in the past with respect to money services businesses (“MSBs”) and a variety of other “high risk” industries. For example, both the Office of the Comptroller of the Currency and FDIC have previously recommended that banks engage in enhanced due diligence, including ceasing the provision of services entirely, to MSBs due to the money laundering risks associated with such businesses. While Operation Choke Point is unquestionably damaging for banks and their “high risk” commercial customers, it will also hurt those individuals who utilize nontraditional financial services for their everyday banking needs.
The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, regulatory compliance, and litigation against the U.S. Department of Justice. If you are a financial institution seeking information regarding the steps your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Despite FinCEN and Department of Justice Guidance, Difficulties Remain for Financial Institutions Providing Services to Marijuana-Related Businesses

A. Introduction: The great divide between State and Federal law.

As more States move towards the legalization of marijuana in various forms and to various degrees, marijuana is quickly becoming a growing and profitable industry. Despite changing state legislation, the federal government still lists marijuana as a Schedule I controlled substance under the Controlled Substances Act (“CSA”) 21 U.S.C. § 801 et seq. As a result, the possession, use, and distribution of marijuana in an state remain crimes under federal law. In addition, as described in a February 14, 2014 Department of Justice (“DOJ”) Memorandum by Deputy Attorney General James Cole entitled, Guidance Regarding Marijuana Related Financial Crimes: “The provisions of the money laundering statutes, 18 U.S.C. §§ 1956, 1957 the unlicensed money remitter statute, 18 U.S.C. § 1960, and the Bank Secrecy Act (“BSA”), 31 U.S.C. §§ 5311-5330, remain in effect with respect to marijuana-related conduct.” A copy of the February 14, 2014 DOJ Memo can be read here.

Moreover, the United States Supreme Court has found that the federal government has the power under the Commerce Clause to regulate, prohibit, and criminalize the possession, sale, and use of marijuana regardless of whether such activities are legal under State law. As explained by Justice Scalia in his concurrence in Gonzalez v. Raich:

Not only is it impossible to distinguish ‘controlled substances manufactured and distributed intrastate’ from ‘controlled substances manufactured and distributed interstate,’ but it hardly makes sense to speak in such terms. Drugs like marijuana are fungible commodities. As the Court explains, marijuana that is grown at home and possessed for personal use is never more than an instant from the interstate market and this is so whether or not the possession is for medicinal use or lawful use under the laws of a particular State.

545 U.S. 1 (2005). Thus, the Court held that even small amounts of home grown marijuana legally grown pursuant to State law triggered the CSA because there was a threat of unwanted commodity diversion that could disrupt Congress’s control over interstate commerce.

However, on August 29, 2013, Deputy Attorney General Cole issued a memorandum to federal prosecutors regarding the DOJ’s enforcement priorities with respect to marijuana. The Cole Memo lists eight priorities that guide DOJ in its enforcement of the CSA against marijuana-related conduct in light of the growing number of States which have legalized its sale and use. These priorities include:

  • Preventing the distribution of marijuana to minors;
  • Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
  • Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
  • Preventing state-authorized marijuana activity from being used as a cover or pretext for trafficking of other illegal drugs or other illegal activity;
  • Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
  • Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
  • Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
  • Preventing marijuana possession or use on federal property.

A copy of the August 29, 2013 Cole Memo can be read here.

An example of DOJ’s exercise of prosecutorial discretion in CSA enforcement was the subject of an indictment recently unsealed in the Federal District Court in Denver. In November 2013, federal agents raided several Colorado medical marijuana dispensaries for alleged ties to international money laundering. The investigation has so far resulted in the indictment of four individuals on money laundering charges. According to the Indictment, the conspiracy centers around the defendants’ alleged creation of a shell corporation known as Colorado West Metal, LLC. The Indictment alleges that defendants opened a Wells Fargo bank account using the Colorado West Metal name to accept international money transfers from Columbia with the purpose of using that money to purchase marijuana warehouse facilities. The Indictment further alleges that the funds were then transferred out of the Colorado West Metal account and through the accounts and trusts of several other entities prior to the purchase of the dispensary property in an effort to conceal its source. The defendants also allegedly used the Colorado West Metal account to wire proceeds from the sale of marijuana in their dispensary internationally back to Columbia. As part of the ongoing criminal investigation, the defendants’ marijuana dispensary was again raided by federal agents on April 30, 2014. The Department of Justice press release detailing the indictment can be read here.

The Indictment is instructive in several respects. First, the Indictment highlights the difficultly banks face in establishing AML procedures for effectively complying with their responsibilities under the Bank Secrecy Act when dealing with the cash intensive business of marijuana as well as the ease with which criminally-derived funds can quickly become commingled with lawfully earned funds. The case also highlights how critical it is for the federal and state governments to resolve their marijuana-related differences.

B. Financial Institutions’ Responsibilities under the Bank Secrecy Act.

In addition to direct criminal penalties for drug trafficking and money laundering, marijuana-related businesses face additional legal barriers which make operation difficult. One such barrier is finding financial institutions to process the proceeds of marijuana sales due to the criminal status of marijuana sales under federal law.

Pursuant to the Bank Secrecy Act (“BSA”), financial institutions are required to create reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, federal law requires that financial institutions file Suspicious Activity Reports (“SAR”) if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320; see also 12 C.F.R. § 21.11; (more information on BSA requirements can be found on the Office of the Comptroller of the Currency’s website here).

Moreover, in addition to reporting requirements under the BSA, financial institutions also face the realistic possibility of federal criminal penalties for assisting in money laundering should they knowingly accept and process money received from dispensaries. Under a plain reading of the BSA and the money laundering statutes, banks cannot provide financial services to marijuana-related businesses without violating federal law. Consequently, financial institutions have been hesitant or have simply refused to allow marijuana dispensaries to maintain accounts or conduct business with them. Banks’ refusal to do business with marijuana-related businesses has been the subject of numerous articles including those by the New York Times and the Huffington Post.

As it applies to the proceeds derived from the sale of marijuana pursuant to state law, FinCEN has explained:

Because federal law prohibits the distribution and sale of marijuana, financial transactions involving a marijuana-related business would generally involve funds derived from illegal activity. Therefore, a financial institution is required to file a SAR on activity involving a marijuana-related business (including those duly licensed under state law), in accordance with this guidance and FinCEN’s suspicious activity reporting requirements and related thresholds.

(emphasis added). See FinCEN, FIN-2014-G001, BSA Expectations Regarding Marijuana-Related Businesses, (February 14, 2014), available here. Thus, because the sale of marijuana remains prohibited under federal law, financial institutions are placed in a position where, if they agree to service marijuana dispensaries, they would be required to report any transaction regardless of State law.

Financial institutions’ refusal to allow marijuana-related businesses to use their services and maintain bank accounts has made it extremely difficult for these businesses to operate. As a result, many legal marijuana businesses have resorted to all cash operations. Further, with the banking situation as it is, some marijuana-related businesses have sought “creative” solutions to their banking problems, including: 1) establishing shell companies to disguise marijuana proceeds; 2) funneling marijuana derived profits into accounts of other legitimate businesses; 3) placing marijuana derived profits into bank accounts of family members or personal accounts; and 4) flying cash out of country to locations such as the Cayman Islands. Our previous report regarding the potential criminal and civil liabilities associated with such activities can be read here. Kristen Wyatt of the Associated Press has highlighted several of these and other “creative” solutions on her Twitter feed which can be followed here.

However generally speaking, the use of shell companies or other accounts to mask the profits derived from the sale of marijuana could subject the owner of a marijuana-related business to a wide variety of federal criminal penalties, including bank fraud, 18 U.S.C. § 1344, wire fraud, 18 U.S.C. § 1343, and money laundering. Additionally, those who assist in such actions, for example the friend or family member who allowed for money to be transferred through his or her account, could also face similar criminal charges. Moreover, should such fraud occur, the financial institutions that process this money can still be held liable for money laundering and face criminal and civil fines and penalties, all of which are available regardless of whether marijuana is legal under State law. Regardless of whether marijuana is involved, if a company lies for the purpose of opening a bank account, the consequences can be incredibly severe.

C. The federal government’s attempt to create a compromise to allow for access to financial services: FinCEN’s “BSA Expectations” Guidance and the Department of Justice Cole Memorandums

FinCEN has made clear that a financial institution’s obligation to file a SAR is unaffected by any state law that legalizes marijuana-related activity. However, given the burgeoning marijuana industry, FinCEN recently undertook to explain how financial institutions can provide services to marijuana-related businesses while maintaining their responsibilities under the BSA by publishing its Guidance: BSA Expectations Regarding Marijuana-Related Businesses. FinCEN’s Guidance focuses on three areas: 1) increased due diligence; 2) new marijuana-related businesses SAR filing responsibilities; 3) “red flag” examples which may indicate a violation of state law or implicate a Cole Memo priority.

At the outset, it must be noted that FinCEN’s guidance should be read in conjunction with the August 29, 2013 and February 14, 2014 DOJ memorandums issued by Deputy Attorney General Cole to federal prosecutors regarding DOJ’s enforcement priorities with respect to marijuana. It is against this backdrop and with these priorities in mind that FinCEN drafted its guidance. FinCEN has explained that this Guidance furthers the objectives of the BSA “by assisting financial institutions in determining how to file a SAR that facilitates law enforcement’s access to information pertinent to a [enforcement] priority.”

1. Financial Institutions are required to engage in “thorough due diligence” prior to accepting marijuana-related businesses as clients.

FinCEN’s guidance makes clear that before providing financial services to a marijuana-related business, a financial institution must conduct a thorough customer due diligence. FinCEN noted that this due diligence should include: 1) verifying that the business is licensed and registered with state authorities; 2) a review of the state license application and supporting documents to operate as a marijuana business; 3) requesting available information about the prospective customer from state licensing and enforcement authorities; 4) obtaining an understanding of the nature of the business including the types of products sold and the customers to be served; 5) monitoring of publicly available sources for adverse information about the potential business customer; and 6) monitoring for suspicious activity, including whether the business implicates one of the DOJ enforcement priorities or violates state law. Further, financial institutions should continue their due diligence efforts and periodically refresh such information throughout the time they provide financial services to marijuana related businesses.

2. Financial Institutions New Marijuana-Related Businesses SAR filing responsibilities.

While the traditional filing of SARs has been limited to “suspicious” transactions, SARs for marijuana-related activity are more complex due to the conflict between state and federal law. Thus, while other businesses rarely trigger an SAR filing, every single marijuana-related business will trigger the filing of an SAR.

Towards that end, FinCEN has established three categories in describing a financial institution’s SAR filing responsibilities when engaging in services for marijuana-related businesses: 1) “Marijuana Limited” SAR filings; 2) “Marijuana Priority” SAR filings; and 3) “Marijuana Termination” SAR filings.

Regarding the first category, FinCEN explains that financial institutions should file a “Marijuana Limited” SAR when the institution reasonably believes, based on its due diligence, that the potential marijuana-related business customer does not implicate one of the DOJ Memo priorities or violate state law. It is important to note that this SAR filing should state “the fact that the filing institution is filing the SAR solely because the subject is engaged in a marijuana-related business,” and that no additional suspicious activity has been identified. Further, the financial institution must file continuing marijuana-related SARs which detail the amount of deposits, withdrawals, and transfers from the account since the previous SAR filing throughout the time that a financial institution provides services to a marijuana-related business. However, should a financial institution’s continued due diligence reveal a potential violation of state law or implicate a DOJ Memo priority, the financial institution should file a “Marijuana Priority” SAR.

A “Marijuana Priority” SAR is only to be filed when a violation of state law is suspected or when the activities of a marijuana-related business may implicate DOJ Memo enforcement priorities. A Marijuana Priority SAR will be substantially more detailed and should include: 1) identifying information of the subject and related parties; 2) addresses of the subject and related parties; 3) dates, amounts, and relevant details of the financial transactions involved; and 4) “details regarding the enforcement priorities that the financial institution believes have been implicated.”

Additionally, financial institutions must be aware that these filing obligations also apply when the institution provides “indirect services” to a marijuana-related business such as providing services to a another domestic financial institution which in turn services marijuana-related businesses or to a non-financial customer who provides goods or services to a marijuana-related business. (FinCEN uses the example of a commercial landlord who leases its property to a marijuana-related business). This naturally will require that financial institutions perform robust due diligence on all customers with potential indirect ties to marijuana-related businesses. However, FinCEN explains that “[i]n such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.”

The final category of SAR filings is the “Marijuana Termination” SAR. “If a financial institution deems it necessary to terminate a relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program, it should file a SAR and note in the narrative the basis for the termination.”

3. Red flag monitoring to indicate a violation of law or DOJ enforcement priority

In addition to making clear that prior to providing financial services to a marijuana-related business a financial institution must conduct a thorough customer due diligence, FinCEN has identified a series of red flags that would indicate that a marijuana-related business may be engaged in activity that implicates one of the Cole Memo priorities or violates state law. Such red flags include: that the business receives significantly more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates; that the business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law; a customer seeks to conceal or disguise involvement in a marijuana-related business activity; and that a business is unable to demonstrate the legitimate source of significant outside investments. The complete list of red flags can be found in FinCEN’s BSA Expectations Guidance.

However, FinCEN has also made clear that these red flags do not constitute an exhaustive list. As such, FinCEN has emphasized the importance of viewing any red flag(s) in the context of other indicators and facts, such as the financial institution’s knowledge about the underlying parties obtained through its customer due diligence.

D. Analysis of FinCEN’s new “protections” for financial institutions.

FinCEN’s guidance may in fact be a good faith attempt by the federal government to ease anxieties about providing financial services to marijuana-related businesses. However, the banking industry’s reaction has been lukewarm at best.

As explained by the Colorado Bankers Association:

Bankers had expected the guidance to relieve them of the threat of prosecution should the open accounts for marijuana businesses, but the guidance does not do that. Instead, it reiterates reasons for prosecution and is simply a modified reporting system for banks to use. It imposes a heavy burden on them to know and control their customers’ activities, and those of their customers. No bank can comply.

 (emphasis added). The Colorado Bankers Association’s statement is available in full here.

Similar thoughts were echoed by the American Bankers Association: “While we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.” The American Bankers Association’s statement is available in full here.

The sentiments of the CBA and the ABA were recently echoed by the Colorado State Senate in Senate Resolution 14-003 entitled, “Concerning Congressional Action to Facilitate Legal Financial Services for the Marijuana Industry.” In its resolution the Colorado Senate noted that both the Controlled Substances Act and the Bank Secrecy Act prohibit banks from providing financial services to marijuana businesses. The Colorado Senate further noted, among other things, that “[d]irectives from federal regulatory agencies such as the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency also prohibit bankers from accepting deposits from marijuana or hemp businesses.” Thus, the Colorado Senate passed a resolution stating:

Be It Resolved by the Senate of the Sixty-ninth General Assembly of the State of Colorado:

(1) That the ability of the federal executive branch to facilitate a reasonable regulatory structure for the marijuana industry is limited as long as federal law categorizes marijuana as an illegal substance.

(2) That the best solution to the problem of a lack of financial services for the legal marijuana industry will be comprehensive federal legislation authorizing banks and credit unions to serve legal marijuana and hemp businesses.

Be It Further Resolved, That copies of this Resolution be sent to all members of the Colorado delegation to the United States Congress, the speaker of the United States House of Representatives, the United States Senate majority leader, the United States Senate majority leader pro tempore, and the president of the United States.

Here, a careful reading of FinCEN’s guidance reveals that FinCEN’s red flags go above and beyond the anti-money laundering programs banks are required to keep. Further, these red flags may present more of a problem than a solution to financial institutions looking to provide services to marijuana-related businesses and to marijuana-related businesses looking to benefit from basic banking services. Asking a financial institution to dig deep into whether the business is receiving substantially more revenue than may be reasonably expected given the relevant limitations imposed by the state, what its competitors are making or what it reported on its income tax returns is essentially asking financial institutions to audit businesses they know nothing about in the first place. In effect, these red flags are totally impractical for typical banks looking to provide basic services to marijuana-related businesses because they raise more questions than they provide answers.

To take on this new industry, banks must acquire new tools for their anti-money laundering programs to comply with FinCEN’s Guidance. Full compliance will require both a comprehensive understanding of a bank’s requirements under the BSA and the intricacies of any given State’s marijuana dispensary and use laws. Compliance with FinCEN’s Guidance is possible, but banks willing to take on the new business must be cautious, flexible, and elegant in their approach. Without new tools, lack of access to the banking and financial services industry presents a potentially disastrous situation to the legal marijuana industry.

Fuerst Ittleman David & Joseph, PL will continue to watch for the latest developments in the regulation of financial services and the marijuana industry. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution or marijuana-related business, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Casino AML Compliance Update: Las Vegas Sands Corp. Places Macau Casino Junkets Under Increased Scrutiny.

On April 4, 2014, Bloomberg reported that the Las Vegas Sands Corp. (“Sands”) has increased its scrutiny of casino junket operators in Macau. The decision comes as casinos seek to meet the increased demands of federal regulators to prevent money laundering.

Macau’s casino industry relies heavily on junket operators to connect wealthy Chinese mainland gamblers with the casinos. However, as the U.S.-China Economic Security Review Commission notes, “[t]he main channel for money laundering [in Macau] is in the gaming sector through underregulated junket operators and their affiliates, which include the underground banking system, that supports their operations.” As described in 2013 Annual Report of the Congressional-Executive Commission On China, the “movement of money through Macau is fueled by a ‘junket’ system, which reportedly aids mainland VIP patrons in bypassing China’s limits on how much money can be taken out of China.” The 2013 Annual Report estimated that $202 billion in ill-gotten funds are laundered through Macau each year.

Although Sands has not disclosed how, exactly, it plans on conducting enhanced due diligence on junket operators, the measure no doubt comes as part of a designed series of steps that Sands has taken to increase its AML Compliance program. In January 2013, the Wall Street Journal reported that the Sands was bolstering its anti-money laundering compliance program, and ceased executing international money transfers for its high-rolling customers. Sands also reportedly limits the use of checks and money transfers from business accounts and restricts the amount of cash a customer can withdraw from their casino account on a given day.

Like banks and money services businesses (“MSBs”), federal law defines casinos as financial institutions. See 31 U.S.C. § 5312 (X). As financial institutions, casinos are required to maintain robust anti-money laundering compliance programs designed to protect against the unique money laundering and terrorist financing risks posed by each individual casino.

The minimum elements which must be included within any casino’s AML plan can be found at 31 C.F.R. § 1021.210. See also 31 U.S.C. § 5318(h). These include, at a minimum, the following:

(i) A system of internal controls to assure ongoing compliance;

(ii) Internal and/or external independent testing for compliance. The scope and frequency of the testing shall be commensurate with the money laundering and terrorist financing risks posed by the products and services provided by the casino;

(iii) Training of casino personnel, including training in the identification of unusual or suspicious transactions, to the extent that the reporting of such transactions is required by this part, by other applicable law or regulation, or by the casino’s own administrative and compliance policies;

(iv) An individual or individuals to assure day-to-day compliance;

(v) Procedures for using all available information to determine:

(A) When required by this part, the name, address, social security number, and other information, and verification of the same, of a person;

(B) The occurrence of any transactions or patterns of transactions required to be reported pursuant to § 103.21;

(C) Whether any record as described in subpart C of this part must be made and retained; and

(vi) For casinos that have automated data processing systems, the use of automated programs to aid in assuring compliance.

31 C.F.R. § 1021.210; see also 31 U.S.C. 5318(h). In addition, the casino’s AML Compliance program must be designed to protect against the unique money laundering and terrorist financing risks posed by the individual casino. Further, to the extent that a casino employee (including dealers and cage personnel) will confront money laundering activities, they must be included as part of the program and given instructions and training on how to report suspicious activity.

In addition, U.S. based casinos must ensure that these AML Compliance programs which are required under U.S. law are implemented in their Macau facilities due to the potential effects extraterritorial violations could have on the casinos’ domestic licenses. (U.S. Casino operators Sands, MGM Resorts International, and Wynn Resorts Ltd. each have subsidiaries operating in Macau.) For example, the Nevada Gaming Control Board has exercised its authority under Nevada law to oversee U.S. casinos’ Macau operations. As the Bloomberg article explains, “[r]ules in Nevada and other local jurisdictions require regulators to monitor licensees’ activities elsewhere to guard against cross-border violations and damage to the market’s reputation.”

Sands’ change in policy comes as the casino industry as a whole, and Sands in particular, has faced increased scrutiny from State and federal regulators regarding the industry’s AML compliance efforts. As we have previously reported here and here, both Sands and Caesars Entertainment Corp. have been the subjects of Department of Justice investigation into alleged violations of the Bank Secrecy Act. In the case of Sands, on August 27, 2013, Sands resolved its money laundering investigation and agreed to forfeit $47 million to the Department of Justice in order to avoid criminal prosecution based on the Sands’ relationship with a high-stakes gambler who was later linked to international drug trafficking. We assume that Sands’ enhanced responsibilities under its non-prosecution agreement played a critical role in its decision to increase scrutiny of Macau junket operators.

Fuerst, Ittleman, David & Joseph, PL will continue to monitor the Department of Justice and the casino industry for the latest developments. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

 

Florida Supreme Court Holds Statutory Cap on Non-Economic Wrongful Death Damages in Medical Malpractice Actions Violates the Equal Protection Clause of the Florida Constitution

In Estate of Michelle Evette McCall, et. al. v. United States of America, SC11-1148 (Fla. 2014), the Florida Supreme Court decided the following certified question:

DOES THE STATUTORY CAP ON WRONGFUL DEATH NONECONOMIC DAMAGES, FLA. STAT. §766.118, VIOLATE THE RIGHT TO EQUAL PROTECTION UNDER ARTICLE I, SECTION 2 OF THE FLORIDA CONSTITUTION?

Between 2005 and 2006, Michelle McCall received prenatal medical care at a U.S. Air Force clinic as an Air Force dependent.  She had a healthy and normal pregnancy until the last trimester.  On February 21, 2006, Ms. McCall’s medical condition required that labor be induced immediately. During delivery, Ms. McCall lost a significant amount of blood.  Following delivery, her blood pressure began to drop rapidly and remained dangerously low.  The attending physician never checked her vital signs and instead relied exclusively on inaccurate and/or incomplete information from the attending nurse. When the treating physician finished treating Ms. McCall, he ordered an immediate blood count and, if necessary a blood transfusion.  An hour after the physician’s order, a nurse presented to draw blood. The nurse found Ms. McCall unresponsive.  Ms. McCall never regained consciousness and subsequently passed away.

The Estate of Michelle E. McCall filed a lawsuit alleging medical malpractice against the United States of America under the Federal Tort Claims Act (“FTCA”).  In its simplest form, the FTCA constitutes a limited waiver of sovereign immunity and permits a private citizen to sue the United States in federal court for torts committed by persons acting on behalf of the United States.  See 28 U.S.C. §1346(b)

(…the district courts…shall have exclusive jurisdiction of civil actions on claims against the United State,, for money damages, accruing on and after January 1, 1945, for injury or loss of property, or personal injury or death caused by the negligent or wrongful act or omission of any employee of the Government while acting within the scope of his office or employment, under circumstances where the United States, if a private person, would be liable to the claimant in accordance with the law of the place where the act or omission occurred.).

The application of Florida Statute §766.118 (“Determination of noneconomic damages”) was triggered because FTCA “damages are determined by the law of the State where the tortious act was committed…, subject to the limitations that the United States shall not be liable for ‘interest prior to judgment or for punitive damages.’” Hatahley v. United States, 351 U.S. 173, 182 (1956).

Florida Statute §766.118 places a cap on noneconomic damages in personal injury claims arising out of medical malpractice.  For practitioners, noneconomic damages are limited to $500,000, unless the negligence results in a permanent vegetative state or death, in which case the total noneconomic damages are limited to $1,000,000.

At trial, the United States District Court for the Northern District of Florida determined that Petitioners’ economic damages totaled $980,462.40, while the noneconomic damages totaled $2,000,000 ($500,000 for Ms. McCall’s son and $750,000 for each of her parents).  Applying Fla. Stat. §766.118(2), the district court then limited the Petitioners’ recovery of wrongful death noneconomic damages to $1,000,000.

On appeal to the Eleventh Circuit, the Petitioners launched a constitutional challenge against Fla. Stat. §766.118(2) both on a state and federal level. While the Eleventh Circuit affirmed application of the statutory cap on noneconomic damages, it granted a motion filed by the Petitioners to certify four (4) questions to the Florida Supreme Court regarding Florida’s cap on noneconomic wrongful death damages in medical malpractice actions.  The Florida Supreme Court rephrased the first question as noted above and embarked on a constitutional analysis The court ultimately concluded that the remaining three (3) certified questions need not be addressed..

First, a brush up on the Equal Protection Clause.  Article I, Section 2 of the Florida Constitution states as follows:

Basic rights.—All natural persons, female and male alike, are equal before the law and have inalienable rights, among which are the right to enjoy and defend life and liberty, to pursue happiness, to be rewarded for industry, and to acquire, possess and protect property; except that the ownership, inheritance, disposition and possession of real property by aliens ineligible for citizenship may be regulated or prohibited by law. No person shall be deprived of any right because of race, religion, national origin, or physical disability.

In other words, “everyone is entitled to stand before the law on equal terms, with, to enjoy the same rights as belong to, and to bear the same burden as are imposed upon others in a like situation.”  Caldwall v. Mann, 26 So. 2d 788, 790 (Fla. 1946).

Next, the Court moved its analysis towards the rational basis test. In order to satisfy the rational basis test, a statute must “bear a rational and reasonable relationship to a legitimate state objective, and it cannot be arbitrary or capriciously imposed.”  Dep’t of Corr. v. Florida Nurses Ass’n, 508 So. 2d 317, 319 (Fla. 1987).

Ultimately, the Florida Supreme Court held that the “cap on wrongful death noneconomic damages provided in section 766.118, Florida Statute, violates the Equal Protection Clause of the Florida Constitution.”

In reaching its conclusion, the Court engaged in a detailed analysis of the alleged facts and circumstances which warranted implementation of Fla. Stat. §766.118, namely, the alleged medical malpractice insurance crisis in Florida.  The Court found that the so-called “crisis” was not, in fact, a crisis and that the alleged facts supporting such a crisis were either readily contradicted or questionable, at best. The Court stated that the available evidence failed to establish a rational relationship between a cap on noneconomic damages and the alleviation of the purported crisis.  In other words, the rational basis test had not been satisfied.  Instead, the Court noted that the cap on noneconomic damages served no purpose other than to arbitrarily punish the most grievously injured or their surviving family members.  The result:  Fla. Stat. 766.118 has now been ruled unconstitutional.

Health care providers must remain knowledgeable of the ever-changing landscape of laws and regulations affecting the field of medicine.  FIDJ, P.L. has extensive experience not only defending health care providers in negligence lawsuits, but also keeping them apprised of such changes in the law.  If we can be of assistance to you, email us at contact@fidjlaw.com  or call 305.350.5690.

Your Expectation of Privacy in Your Cell Phone is Currently Governed by the Law of the State in Which You are Arrested

Last year the Washington State Supreme Court considered two cases addressing the expectation of privacy one has when sending a text message. On February 27, 2014, the Washington State Supreme Court ruled in two parallel 5-4 decisions that text messages are private and that law enforcement agencies must obtain a search warrant prior to reading them. The decisions can be read here and here.

The decisions stem from the arrest of two men in 2009 by Longview police after a third man, Daniel Lee, was arrested for possession of heroin. After his arrest, Police seized Lee’s cell phone and, without consent or a search warrant supported by probable cause, read an incoming text message from Shawn Hilton that read: “Hey whats up dogg can you call me i need to talk to you.” The police detective, pretending to be Lee, replied and arranged a drug deal in a parking lot. When Hilton arrived at the meeting location, police arrested and charged Hilton with attempted possession of heroin.

Police also found old text messages from another man, Jonathan Roden, on Lee’s cell phone. Again, pretending to be Lee, a Longview police detective started a new text message conversation and arranged a drug deal with Roden in a parking lot. When Roden arrived, he was arrested and charged with attempted possession of heroin. Both Hilton and Roden were ultimately convicted.

On appeal, Hilton claimed that the detectives violated his rights under Article I, section 7 of the Washington State Constitution and his Fourth Amendment right against unreasonable searches and seizures. Roden further argued that Washington’s privacy act was violated by his conviction when the police searched the text messages without a warrant. Hilton argued that text messages are the equivalent of letters, which are protected by the Fourth Amendment. In response, the State argued that there is an “inherent risk in a text message” that someone else might read it after the text message is sent. The State continued and exclaimed that privacy ends the moment the letter is delivered””the sender has no control over what happens next. The State further argued that the text messages were in “plain view” of the detective and thus qualified as an exception to Hilton’s Fourth Amendment protections.

The Washington State Supreme Court vacated Hilton’s and Roden’s convictions. Whether individuals have an expectation of privacy in the contents of the text messages under state law was an issue of first impression in Washington. Justice Gonzalez resolved these cases under the Washington State constitution, which provides broader privacy protections than the Fourth Amendment. Specifically, the Washington State Constitution “protects citizens from government intrusion into their private affairs without the authority of law.” Justice Gonzales explained that text messages can enclose the same intimate subjects as phone calls or sealed letters and even though text messages make communication “more vulnerable to invasion, technology advancements do not extinguish privacy interests that Washington citizens are entitled to hold.”

This determination by the Washington State Supreme Court is the latest in a series of rulings that have extended privacy expectations in cell phones and the content stored on them. Courts in Texas, Massachusetts, New Jersey, and Rhode Island, which have been presented with the issue of the right to privacy surrounding technology advancements, have ruled in the same fashion as the Washington State Supreme Court. Moreover, on April 29, 2014, in United States v. Wurie, the Supreme Court of the United States is due to hear arguments about whether police are allowed under the United States Constitution to search a suspect’s cell phone without a warrant while making an arrest or soon thereafter. This is a critical question. Indeed, today’s cell phones have the potential to reveal an unprecedented level of detail about an individual’s “familial, political, professional, religious, and sexual associations” because the cell phone is often carried everywhere, at all times. See United States v. Jones, 132 S. Ct. 945, 955 (2012).

Under current Florida law, during a lawful arrest police are permitted to confiscate and search a suspect’s cell phone. Florida’s Fifth District Court of Appeal held in Florida v. Glasco, 90 So. 3d 905 (Fla. 5th DCA 2012), that a cell phone is the same as a container or piece of property on the suspect, which can be searched incident to a lawful arrest. However, given these recent decisions from other states, Florida judges may reexamine the issue. Like Washington State’s Constitution, the Florida Constitution’s right to privacy provision provides greater protections than the Fourth Amendment. Specifically, Article I, section 23 of the Florida Constitution states in part that “every natural person has the right to be let alone and free from governmental intrusion into the person’s private life except as otherwise provided herein.” The Supreme Court of the United States will soon provide courts a binding answer to whether the Fourth Amendment permits the police, without obtaining a warrant or consent, to search a cell phone found on a person who has been lawfully arrested. But states, like Florida, could always provide greater protections under their respective state laws regardless of the Supreme Court’s decision in United States v. Wurie.

The attorneys at Fuerst Ittleman David & Joseph, PL will continue to monitor developments in this and similar cases. Our attorneys have extensive experience in the areas of tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  If you have any questions, an attorney can be reached by emailing us atcontact@fidjlaw.com or by calling 305.350.5690.

 

Complex Litigation Update: SCOTUS Allows Plaintiffs’ State-Law Class Actions Against Law Firms, Financial Firms, and Others to Proceed

On Wednesday of last week, the Supreme Court of the United States issued a 7-2 decision affirming a Fifth Circuit ruling permitting four state-law class actions to proceed against two New York law firms and others in a matter stemming from a $7 billion Ponzi scheme orchestrated by Allen Stanford. The scheme involved the sale of bogus certificates of deposit by Stanford’s bank, Stanford International Bank, based in Antigua. Stanford was sentenced in 2012 and is serving 110 years in prison.

Investors in this scheme brought suit against two law firms, Chadbourne & Parke LLP and Proskauer Rose LLP, an insurance brokerage, Willis Group Holdings Plc, a financial services firm, SEI Investments Co, and an insurance company, Bowen, Miclette & Britt. The investors, as four sets of plaintiffs, filed civil class actions under state law contending that these defendants assisted Stanford in perpetrating the Ponzi scheme by falsely representing that uncovered securities (the bogus certificates of deposit) that plaintiffs were purchasing were backed by covered securities. The District Court dismissed these four cases under the Securities Litigation Uniform Standards Act of 1998 (the “Litigation Act” or “Act”).

The Litigation Act prohibits plaintiffs from bringing securities class actions under state law in matters in which plaintiffs claim “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” 15 U.S.C. 78bb(f)(1). The Litigation Act defines a “covered security” to mean “only securities traded on a national exchange.” 78bb(f)(5)(E). The District Court held that the “Bank’s misrepresentation that its holdings in covered securities made investments in its uncovered securities more secure provided the requisite ”˜connection’ (under the Litigation Act) between the plaintiffs’ state-law actions and transactions in covered securities.” The Fifth Circuit reversed that decision determining that the connection between the Bank’s misrepresentations regarding its holdings in covered securities and the fraud was too tenuous to trigger the Litigation Act. The Supreme Court agreed with the Fifth Circuit holding that the plaintiffs are not precluded for their state-law class actions under the Litigation Act.

Because the Supreme Court has previously held that “aiding and abetting” claims cannot be made under federal law, the plaintiffs in these class action suits are eager to pursue state law remedies against these law firms and other companies that had secondary roles in their transactions with Stanford. In Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), the Supreme Court held that “Section 10(b) [of the Securities Exchange Act of 1934 (”˜Exchange Act’)] does not support aiding and abetting liability stating that the “the statute prohibits only the making of a material misstatement (or omission) or the commission of a manipulative or deceptive act.” The Court would not impose Section 10(b) liability on a third party that did not itself commit a deceptive act. The Court decided that knowing about the primary violation was not enough to turn a third party (like a law firm) into a violator. Further, more recently, in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 153, 155, 166 (2008), the Court held that a private right of action does not apply to suits against “secondary actors” who had no “role in preparing or disseminating” a stock issuers fraudulent “financial statements.” Based on the holdings of Central Bank and Stoneridge, if the defendants in the four class actions were able to block the plaintiffs’ state-law claims, the defendants could not be held liable for their roles in Stanford’s fraudulent transactions.

The Supreme Court’s Conclusion 

Writing for the majority, Justice Breyer stated that the Court based its conclusion on five factors that it deemed supportive of the contention that “misrepresentation of a material in fact in connection with the purchase or sale of a covered security” only extends to misrepresentations that are material to the decision-making of those (other than the fraudsters) to purchase or sell a covered security (as opposed to an uncovered secured). The factors cited by the Supreme Court supporting this conclusion are:

  1. This is “consistent with the Act’s basic focus on transactions in covered, not uncovered securities.” The plain language of the Act supports this conclusion. The Act states a “material fact in connection with the purchase or sale” and the Court interprets that the “connection” here between the material fact and the purchase or sale is a “connection that matters.” There must be an impact on an individual’s choice to buy or sell a covered security, not an uncovered security.
  2. In securities cases where the Supreme Court has found there to be the requisite connection between the fraud and the purchase or sale under the Act, there have been “victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition.”
  3. The Supreme Court viewed the Act in light of the Securities Exchange Act of 1934 and the Securities Act of 1933 regarding those engaged in securities transactions that result in the taking of ownership positions and which make it illegal to deceive an individual when she is doing so. The Court recognized that the purpose of these statutes is to protect investor confidence. Nothing in any of these statutes endeavors to protect those “whose connection with the statutorily defined securities is more remote than buying or selling.”
  4. The Supreme Court expressed wariness in applying a broader statutory interpretation than necessary as such broad interpretation of the “connection” could interfere with the various states’ efforts “to provide remedies for victims of ordinary state-law frauds.” The Court recognizes that the Litigation Act seeks to avoid that outcome, allowing the individual states authority over matters primarily of state concern.

The Defendants’ and Government’s Argument for Broad Interpretation

First, the defendants and the Government staged a precedence argument, pointing out that the Supreme Court has suggested that the phrase “in connection with” be given broad interpretation. However, the Court disagreed stating that in all cases in which the Court found the requisite connection between the misrepresentation and the sale or purchase, the security involved was “a statutorily defined ”˜security” or “covered security.’” The Court states that is could not find any case in which it ruled involving “a fraud ”˜in connection with’ the purchase or sale of a statutorily defined security in which the victims did not fit” into the relevant statutory definition.

Next, the Government expressed concern that narrowly interpreting the Litigation Act would diminish the SEC’s authority under the Securities Exchange Act, which uses the same “in connection with the purchase or sale” language. The Supreme Court disposed of this contention by stating that the authority of the SEC and Department of Justice covers all “securities,” not just those traded on national exchanges. The Court pointed out that the SEC successfully prosecuted Stanford based on his Bank’s fraudulent sales of certificates of deposit, which are “securities” even if they are not “covered securities.”

Two Justices Dissent 

Joined by Justice Alito, Justice Kennedy wrote the dissent, stating that because these investors purchased the certificates of deposit based on the false statements that these certificates of deposit were backed by covered securities there was requisite connection between the misrepresentation and the purchase or sale of a covered security. The dissent stresses that, in light of the precedent, even though those cases dealt with much less complex transactions, if the fraud depends on the purchase or sale of securities or the promise to do so, the connection is made. Therefore, these class actions under state law must be precluded by the Litigation Act. The dissent cautions that the majority opinion creates a new rule that departs from the precedent. Furthermore, agreeing with the Government, Justice Kennedy wrote that the Court’s decision will negatively impact the SEC’s enforcement authority as it is inconsistent with Congress’s intent and “casts doubt on the applicability of federal securities law to cases of serious securities fraud.”

Conclusion and Consequences

The Supreme Court held that the requisite “connection” between the materiality of the misrepresentations and the required “purchase or sale of a covered security” was not made in this case. Therefore the Litigation Act did not preclude the plaintiffs’ class action suits under state law. There is no allegation that the material misrepresentations were “in connection with” the buying or selling of covered securities. The Court held that “at most, they allege misrepresentations about the Bank’s ownership of covered securities. But the Bank is the fraudster, not the fraudster’s victim; nor is it some other person transacting in covered securities.”

The holding of this case allows these class actions based on state law against various law firms and others to go forward, widening the net of those potentially liable for the consequences of Stanford’s Ponzi scheme. Furthermore, this decision leaves questions as to the purported narrowness of the interpretation of the Litigation Act. As Ponzi schemes become more sophisticated and complex, involving varying schemes and players, it will be interesting to see how courts apply the Court’s interpretation.

Fuerst Ittleman David & Joseph, PL will be monitoring this case as it returns to the lower court, as well as the effects of this decision on subsequent cases. Our attorneys are experienced in complex litigation and would be happy to address any questions about these or similar legal issues. Please do not hesitate to contact us via email at contact@fidjlaw.com or by telephone at (305) 350-5690.

Marijuana Taxation Update: State Sanctioned Marijuana Industry Must Keep the Federal Anti-Drug Trafficking Tax Code in Mind

As we have previously reported, despite the growing number of States that have authorized the use of marijuana in various forms, the federal government has continued to crack down on dispensaries. (Our recent articles discussing these efforts can be read here, here, and here.) In addition to direct criminal prosecution for drug trafficking, federal authorities have used various other techniques in an effort to quash the growing marijuana industry. One such technique disallows marijuana dispensaries from taking business deductions on their federal income taxes pursuant to I.R.C. § 280E, and this statute remains in effect in spite of the efforts of numerous states and FinCEN to at least partially legitimize the sale of marijuana.

I.R.C. § 280E states:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

As we have previously explained, because the sale of marijuana remains listed as a controlled substance under the Controlled Substances Act (CSA), state authorized marijuana dispensaries are still deemed by federal authorities to violate federal law. Therefore, pursuant to I.R.C. § 280E, federal income tax deductions for business expenses are not available.  In fact, the United States Supreme Court has concluded that there is no medical necessity defense to the federal law prohibiting cultivation and distribution of marijuana – even in states which have created a medical marijuana exception to a comparable ban under state law. U.S. v. Oakland Cannabis Buyers Co-op., 532 U.S. 483 (2001).

In the District of Columbia and the 20 states that have either decriminalized or legalized marijuana in one form or another, state sanctioned medical marijuana dispensaries have attempted to pay their fair share of taxes to the government – federal, state and local – like any other business. However, because their business primarily involves a product deemed to be criminal under federal law, they are denied deductions for the costs of doing business that any other ordinary business can take.

When it comes to state taxation, an additional problem faced by state sanctioned marijuana dispensaries is that most of the states which have legalized the use of marijuana “piggy-back” their state corporate income tax on the federal income tax. That is, after the federal income tax has been calculated based on federal law, these states will impose a tax of a percentage of the federal corporate income tax (with certain adjustments in most instances). In those cases, not only is the federal government denying the benefits of claiming certain business deductions that any other business would have, but the state governments are equally denying these tax benefits despite the businesses being situated in a state that has legalized the use and sale of marijuana.

As we have previously reported, the effect of I.R.C. § 280E can be drastic on dispensaries. According to a 2013 CNNMoney report, the inability of dispensaries to take business deductions has resulted in dispensaries paying an effective tax rate as high as seventy-five percent (75%). The practical effect of this massive tax burden makes business operations difficult, if not impossible.

However, there is currently some hope for marijuana dispensaries in two respects. First, I.R.C. § 280E is limited to the sale of (or “trafficking in”) marijuana. Thus, if a taxpayer is engaged in selling medical marijuana and also in another business, such as care-giving to health patients, the taxpayer may be able to deduct business expenses in connection with the care-giving function. See Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 14 (2007). Note, however, that “the taxpayer’s characterization will not be accepted when it appears that the characterization is artificial and cannot be reasonably supported under the facts and circumstances of the case.”Id. Second, while I.R.C. § 280E disallows any business deduction for a marijuana seller’s ordinary and necessary business expenses, costs of goods sold – that is, the carrying value of goods sold during a particular period – are excluded from this rule. To be sure, while marijuana businesses are disallowed ordinary and necessary business expenses deductions, they are allowed a deduction for the costs incurred for the purchase, conversion, materials, labor, and allocated overhead incurred in bringing the marijuana inventories to their present location and condition. Therefore, marijuana businesses have an incentive to capitalize as inventory all costs associated to the purchase of marijuana and then in future years successfully deduct these costs as costs of goods.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense.  They will continue to monitor developments in this and similar cases. If you have any questions, an attorney can be reached by emailing us at contact@fidjlaw.com or by calling 305.350.5690.