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Sometimes the Truth is Stranger than Fiction – Update

Not quite a year ago, we wrote a blog post entitled Sometimes the Truth is Stranger than Fiction. There has been a recent development in the relevant case that we think is worthy of a short update.

A very brief summary of what the relevant case involved is as follows. Two former Sprint executives (Mr. LeMay and Mr. Esrey) participated in several tax shelters that had been promoted by Ernst & Young (“EY”) in the early 2000s. As a result of its promotion of these tax shelters, EY ended up settling with both the IRS and U.S. Attorney for the Southern District of New York for not quite $140 million.  It appears that EY also paid an undisclosed sum to the two former Sprint executives.   However, in LeMay and Esrey’s collective opinion, they were not made whole in their failed attempt to defraud the IRS (and thus, the honest, tax-paying U.S. population).   Accordingly, LeMay and Esrey sued the IRS for an astounding $159 million. 

What was their argument? In general, the two former executives claimed that the IRS aided and abetted a breach of fiduciary duty committed by EY against them.  More specifically, LeMay and Esrey claimed that because EY was representing them in an IRS audit addressing their involvement in the EY tax shelters, the IRS should have disclosed to the two former executives that EY was also being criminally investigated by the IRS for its role in promoting the tax shelters.  According to LeMay and Esrey, had they known about the criminal investigation, they claim that they may have successfully persuaded the Sprint Board to fire EY rather than LeMay and Esrey.  According to the two former executives’ complaint, all parties involved were aware of the inherent conflict of interest of EY being Sprint’s public accounting firm and also representing LeMay and Esrey personally in an IRS audit  relating to tax shelters promoted by EY.  However, according to LeMay and Esrey, the Sprint Board  decided that Sprint would suffer more negative publicity by firing EY rather than the two former executives in 2003.

What happened in court? As you know, the federal government may not be sued absent a specific waiver.  Congress granted such a waiver when it enacted The Federal Tort Claims Act (“FTCA”).  See 28 U.S.C. §§ 2671-2680.  Under the FTCA, the federal government may be sued for a tort committed by a federal government employee while acting in his or her capacity as such.  However, the FTCA does not cover claims arising out of misrepresentation or deceit.   LeMay and Esrey argued that the IRS aided and abetted EY’s breach of fiduciary duty.  However, the U.S. District Court for the Southern District of New York found that ultimately the executives’ argument boiled down to a claim that the IRS concealed information (i.e., was deceitful).  Thus, the court granted the IRS’ motion to dismiss the complaint for lack of subject matter jurisdiction.  In reaching this conclusion, the court pointed out that (a) one of the inappropriate concealments allegedly made by the IRS happened months after the two former Sprint executives had been fired, and thus was logically impossible to have harmed them in the way they claimed, and (b) their allegation that the IRS failed to follow its own procedures in resolving the conflict of interest between EY and the two former Sprint executives was irrelevant to the issue at hand.

In sum, although the truth may be stranger than fiction at times, at least sometimes the good guys win.

© Copyright 2017 Squire Patton Boggs (US) LLP

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About this Author

Cynthia Mog, Finance Attorney, Squire Patton Boggs Law Firm
Senior Attorney

Cynthia Mog focuses her practice on federal income tax matters. She has experience working on corporate, partnership and real estate transactions including acquisitions, reorganizations, restructurings and tax-free exchanges. She has also been involved with IRS audits and tax-exempt financing transactions.

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