Cca Selected 1996 Documents

(12/31/ 1995 )

FEDERAL BUREAU OF INVESTIGATION

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Hamilton .~aft Company, San Franclsco, Ca, FBW (A), Mall Fraud OO:SF Synopsis: Enclosed for receiving offices are the original and one copy of trial subpoenas to be served in connection with a forthcoming trial to be held in San Francisco federal district court. The trial will commence on September 9, 1996. Details: The above captloned sUbjects were indicted in June of 1994 at San Francisco in a twenty count indictment charging the~. with various cs ts of mail fraud and wire fraud in connection with their par~~~ipation in diverting $55,000,000 of client fun from Hamilton Taft Company, a tax service company formerly located in San Francisco. Receiving offices are reguested to expeditiously serve the enclosed trial subp e as to these prospective witnesses. .

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1 LAW OFFICES OF CHESTER L. BROWN 2 2450 Broadway, Suite 550 Santa Monica, CA 90404 3 (310) 315-6315 4 5

SOLOMON WOLLACK 388 Market Street, Suite 1080 San Francisco, CA 94111-5315 (415) 788-9000

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Attorneys for Defendant CONNIE ARMSTRONG, JR.

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UNITED STATES DISTRICT COURT

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FOR THE NORTHERN DISTRICT OF CALIFORNIA

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UNITED STATES OF AMERICA,

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) ) ) ) ) ) ) ) ) ) )

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-------------)

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\\\

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Plaintiff, vs.

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CONNIE ARMSTRONG, JR. and RICHARD A. FOWLES,

19 Defendants.

CR 94-0276 CAL MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT OF MOTIONTODISMISS COUNTS SEVEI' THROUGH TWENTY-ONE; AND/OR REQUEST FOR PRETRIAL INSTRUCTION AS TO LAW OF THE CASE

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INTRODUCTION

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On March 12, 1996, CONNIE ARMSTRONG, JR. filed with this court a Motion To Dismi

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Counts For Legal and Factual Insufficiency. In the March 12 motion, defense counsel asserted that t

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Ninth Circuit's opinion in In Re Hamilton Taft & Co. I commanded dismissal of certain counts of tl

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indictment. The Nmth Circuit opinion established that client monies, once transferred to Hamilton Ta

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became the property of Hamilton Taft -- leaving the clients with no beneficial interest in those monie

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other than their contractual remedies against Hamilton Taft. In the March 12 motion, Mr. ArmstroI

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sought to persuade this court that, under the Ninth Circuit's opinion, all counts speaking to "diversion

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or misuse of"client funds," or other post-acquisition improprieties by Mr. Armstrong, must be dismisse

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This court denied that motion.:

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Mr. Armstrong now brings the instant Motion To Dismiss Counts Seven Through Twenty-On

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based on the Nmth Circuit opinion or the logic contained thereina> To the extent that the instant motic

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overlaps with the March 12 motion, Mr. Armstrong asks this court to reconsider its earlier decisio

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Reconsideration ofthis matter is appropriate, on the grounds that: (1) New information has come to ligl

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which bears on the existence or non-existence of a scheme to defraud -- specifically, the fact that defen:

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counsel has now confirmed that Hamilton Taft paid all taxes, in compliance with its contractual duties

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(2) Because the indictment in this case pre-dated the Ninth Circuit opinion, there is a strong possibili1

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that counts seven through twenty-one are based on an erroneous premise oflaw -

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recognized by the government itself; which sought to get the Nmth Circuit opinion reversed; (3) Allowin

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lay jurors to believe that Hamilton Taft was a fiduciary for their withholding taxes is not only legall

a possibility eve

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In Re Hamilton Taft & Co. (Wyle v. S & S Credit Co., Real Parties in Interest), 53 F.3 285, vacated on other grounds, 68 F.3d 337 (1995) is attached as Exhibit A.

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Because the Ninth Circuit has vacated its opinion in In Re Hamilton Taft, the parties i the instant case disagree over the extent to which that opinion controls in this case. !vlJ Armstrong contends that, since the opinion exists and since it addressed a factual situatio identical to the one at issue in this cnminal case, its logic carmot be ignored -- regardles of the technical question of whether or not the opinion is still controlling per se.

3 .

Since the March 12 motion, defense counsel has had a chance to review the records 0 the Internal Revenue Service, as well as the schedules of the government's own forensi accounting expert, Lee Baly, which show that, except for the first quarter of 1991 whel the company was involuntarily shut down, Hamilton Taft paid all its clients' withholdin: . taxes for each quarter.

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incorrect, but would cause tremendous prejudice and would constitute reversible error; (4) ClarificatiOl

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of this issue, through dismissal of counts or, at a minimum, instructions to the jury, will save time, b:

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allaying defense counsel's need to put on evidence about the character of funds and preventing constan

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interruption of the proceedings with defense objections to the government's improper characterizatiOl

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ofthose funds; and (5) This court's recent comments at the September 12, 1996 hearing suggested tha

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further clarification may be warranted, concerning the applicability of the Ninth Circuit opinion to count

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seven through twenty-one of the instant case.

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STATEMENT OF FACTS

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A.

DESCRIPTION OF HAMILTON TAFT'S BUSINESS --

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Hamilton Taft was a California corporation which provided payroll services for large businesses,

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such as Federal Express, Scott Paper, and The State Bar ofCalifomia. Under the federal and state ta.~

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laws, employers are required, every pay period, to withhold from each employee the estimated amount

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which the employee owes in federal, state, and local taxes, for that pay period. This system, in which

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employers are charged with the duty of withholding and paying taxes on behalf of their employees, is

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believed to enhance the ability ofthe Internal Revenue Service to collect income taxes from all taxpayers.

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However, because ofthe complex and ever-changing laws and regulations which govern the withholding

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tax system, many companies choose to utilize the services of payroll processing firms, such as Hamilton

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Taft.

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Under the terms of Hamilton Taft's contracts, employers were required, each pay period, to

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deposit with Hamilton Taft an amount equal to the total amount of employee withholding taxes due for

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that pay period to federal, state, and local tax authorities. Hamilton Taft would then fill out all of the

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proper paperwork and write a check to the various taxing agencies, on behalf of its client. In addition,

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Hamilton Taft also prepared quarterly withholding tax return forms (Forms 941) on behalf of its clients.

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The 941 forms are due thirty days after the end of each quarter and declare, under penalty of perjury, that

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all employee withholding taxes have been paid for the previous quarter.

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"

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By the terms of its contracts, Hamilton Taft assumed responsibility for all penalties and intere

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resulting from any late payment of client withholding taxes. In return for these services, Hamilton T,

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would generally receive no fee, but would be entitled to any benefit obtained from the temporary use

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these monies (often referred to as the "float"), between the time that Hamilton Taft received the moni

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and the time it paid them over to the appropriate taxing agencies. With but one or two exceptions, t:

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client contracts contained no language limiting the types of investments which Hamilton Taft was entitll

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to make with funds deposited by clients.

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B.

HAMILTON TAFT BEFORE CONNIE ARMSTRONG --

II

Hamilton Taft was initially incorporated in July, 1979 as KnightsBridge Systems, Ltd., b

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changed its named to Hamilton Taft in 1981. In 1984, Hamilton Taft was acquired by CIGNA, a majl

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insurance company from Connecticut. Despite CIGNA's continuing efforts to pump its own funds in

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its subsidiary company, Hamilton Taft continued to lose money under CIGNA's ownership. Finally,

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January, 1988, CIGNA sold Hamilton Taft to MaxPharma, a publicly held corporation from Dallas.

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Under MaxPharrna's ownership, Hamilton Taft's liabilities grew worse, hastened by the fact th

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MaxPharma's owners made unsecured loans to themselves, without the approval of MaxPharma

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shareholders. Connie Armstrong, a shareholder in the parent company, brought a shareholder derivati,

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suit against MaxPharrna and its principles, alleging a breach of their fiduciary duty to shareholders. C

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March 29, 1989, Roberts and MaxPharma settled the suit, by transferring all stock in Hamilton Taft 1

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Mr. Armstrong, who became sale owner of the company. At the time he took over the compan:

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Hamilton Taft's liabilities exceeded its assets by $18.9 million.

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24 . C.

THE MISSED TAX DEPOSITS --

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Because Hamilton Taft had approximately 250 corporate clients with varying payroll schedule,

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it received incoming funds from clients every day and, by the same token, had payroll tax deposits du

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every day. Most ofthe time, Hamilton Taft paid these withholding tax deposits before the statutory du

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date. However, on one or two days per quarter, Hamilton Taft was forced to hold back client ta

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tinds.

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deposits due to insufficient funds; as a result of these missed deposits, Hamilton Taft incurred intere,

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and penalties, for which it was liable. Hamilton Taft subsequently made up every missed tax deposit fa

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1989 and 1990 -- usually doing so just before 941 tax returns were due (thirty days after the quarter'

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end). In accordance with its contractual obligation, Hamilton Taft paid all penalties and interest arisin

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from its late payment of these client tax deposits. 4

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To make up the missed tax deposits, Hamilton Taft would generally use incoming monies, pai

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by clients in the following quarter. Because Hamilton Taft needed these newly incoming funds to mak

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up the previous quarter's missed deposits, those same funds were unavailable for use in the quarter i

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which they were submitted. This, in turn, forced Hamilton Taft to hold back additional tax deposits i

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that quarter. However, at the time they deposited funds with Hamilton Taft, clients understood that thei

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monies would not be segregated or earmarked for immediate payment to the IRS and further underslOo,

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that they would never be held liable for late payment of their withholding taxes.

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therea

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D.

THE TRANSFERS OF HM1ILTON TAFT FUNDS--

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The primary issue in the instant case involves Mr. Armstrong's wire transfers of approximatel:

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$55 million of Hamilton Taft monies to his Texas companies, in exchange for notes (and later a singll

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consolidated bond) of equal value. The Texas companies, whose payroll included experienced expert

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in real estate, construction development, oil, and investment financing, then invested these monies

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pledging these investments back to Hamilton Taft as collateral for the loans. Mr. Armstrong hoped tha

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after several years, these investments might be sold for substantial gain, which could then be put back inte

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Hamilton Taft and applied against the $18.9 million "hole" which he inherited.

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The government contends that Hamilton Taft's occasional missed tax deposits were brought OJ

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by Mr. Armstrong's inter-company transfers of Hamilton Taft funds. In counts seven through eighteeJ

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of the

indictm~nt,

they charge Mr. Annstrong with wire fraud, in connection with his supposedl)

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4

Though Hamilton Taft made up missed tax deposits just before filing the client's 941 t
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holding to have been broader than this court initially believed and, to the extent that this court has foun

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otherwise, he asks that it reconsider its decision.

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While the Ninth Circuit did make clear that § 7501's statutory trust vis a vis the IRS does nc

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extend to third party transferees, it then went on to examine the understanding which existed betwee

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Hamilton Taft and its clients: Nor does S & S attempt to show that it arranged with Taft for the transferred funds to be held in trust. While two of Taft's clients arranged to have their trust-fund tax payments kept in segregated accounts, S & S and the other clients did not. Instead, Taft extensively commingled all of the funds it received and treated the funds as its own assets, using them to pay its operating expenses and investing the funds for its own benefit. Therefore, under ordinary principles of trust, Taft did not hold the funds in trust.

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7 8 9 10 II

Id, at 288.

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The above language has nothing to do with the existence or non-existence of a trust, on beha

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of the IRS, but speaks only to the relationship between the contracting parties themselves.' Th.

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relationship, the court concluded, was not a trust, but was a traditional debtor-creditor relationship, undl

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which the monies, once transferred, became the property of the debtor, Hamilton Taft.

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Ofcourse, the fact that Hamilton Taft's contractual relationship with clients was debtor-credito

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rather than trust, does not nullify the possibility of criminal fraud. For instance, had Mr. Armstror

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simply taken clients' monies and opened a Swiss bank account, while totally ignoring his contractual duo

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to pay their taxes, he almost certainly could be charged with engaging in a scheme to defraud. 8 Howeve

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the debtor-creditor nature ofHamilton Taft's relationship does have inescapable implications, for certa

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in trust for the benefit of the IRS, not the employees. Therefore, the monies whi( employers contractually agreed to transfer to Hamilton Taft were never trust monies the first place vis a vis the tax-paying employees.

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It is worth pointing out that, under § 7501, employers hold their employees' tax moni

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The Nmth Circuit has held that a scheme to defraud is completed at the moment that tl money at issue changes hands. United States v. Cusino, 694 F.2d 185, 187 (9th C 1982). Given this rule oflaw, even if Mr. Armstrong had wired Hamilton Taft moni overseas, it is not at all clear whether such conduct would constitute mere evidence of: intent never to perform his contractual duties or, as the government apparently WOll contend, an independent criminal act. 9

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counts in this case.· First, it meant that, as a matter oflaw, client monies, once delivered to Hamiltc

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Taft, became the property ofHamilton Taft. This, in turn, meant that Hamilton Taft was free to use tl

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money for operating expenses or to invest it for its own benefit, in any manner it wished -- whi

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remaining cognizant of the fact that the company also owed a contractual duty to pay the client

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withholding taxes. Second, the debtor-creditor relationship meant that Hamilton Taft could free

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commingle the tax monies of any particular client with the monies of all other Hamilton Taft clients;

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was not necessary that any single client's monies be placed in a separate, segregated account. Henc

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what the government calls a "Ponzi" scheme -

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Client C' s money -- was not only permissible, but was exactly what Hamilton Taft's clients bargained fc

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Third, the debtor-creditor relationship meant that clients retained no beneficial interest in the money, on,

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delivered to Hamilton Taft -- having only their contractual rights against Hamilton Taft on which to reI

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The clients' contractual rights in this case were quite simple; Hamilton Taft was obligated to p,

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all client withholding taxes and to assume liability for any penalties and interest resulting from la

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payment. Hamilton Taft complied with these contractual duties for every quarter of 1989 and 1990

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occasionally paying the taxes late, but assuming the penalties and interest for so doing. In the fir

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quarter of 1991, Hamilton Taft missed certain taX deposits, just as it had done in previous quarters. Ju

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as in previous quarters, Hamilton Taft had every intention of making up these missed payments ar

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would have done so, but for two key events: (1) the public allegations made by Steve Solodoffwhic

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caused the bulk of Hamilton Taft clients to simultaneously breach their contractual duties, theret

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suddenly and completely cutting off all cash flow to Hamilton Taft; and (2),jhe March, 1991 appointme

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of Fred Wyle as trustee in bankruptcy, and the subsequent shutting down of Hamilton Taft's busine:

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operations. This double-barreled assault left Hamilton Taft unable to make up approximately $50 millie

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in overdue tax liabilities, which were to have been paid in April, 199

the payment of Client A's taxes with Client B' s aI

..

U

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In view of the debtor-creditor nature of Hamilton Taft's contracts, coupled with the fact th

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Hamilton Taft perfonned its contractual duties without fail (when allowed to do so by the clients), it

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Indeed, the government itself seems to recognize that the Ninth Circuit's decisie negatively impacts their criminal case against Mr. Annstrong. This would explain wt IRS attorneys consulted Michael Yamaguchi himself, in an "of counsel" capacity, wh€ the IRS was preparing its amicus brief seeking to reverse the Ninth Circuit's decision. 10

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difficult to see exactly what aspect of Mr. Armstrong's conduct the government views as fraudulent.

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Counts seven through fourteen speak of "diversions" -- a term which implies misuse of monie

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However, Hamilton Taft was certainly free to lend its own money to sister corporations or to invest

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for its own benefit, provided it paid the clients' taxes. Hamilton Taft's contracts did not hold M

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Annstrong to any "prudent investor standard" and did not, in any way, set parameters on the range (

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permissible investments which Hamilton Taft could make. That Mr. Annstrong's companies may ha'

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incurred excessive operating costs (in the government's view), or that some of his investments may ha'

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depreciated in value, do not amount to criminal conduct; in fact, absent a failure to pay client

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withholding taxes, this conduct does not even constitute a breach of Hamilton Taft's contractu

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obligations.

II

Similarly, counts fifteen through twenty-one allege improper diversions and a "cover-up" of the:

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improper diversions -- conduct which, again, might arguably constitute evidence of Mr. Armstrong

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intent never to perform, but which cannot itself be criminal conduct. If monies, once delivered

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Hamilton Taft, became Hamilton Taft property, there can be no "misuse" of such property vis a vis clie

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companies who have already surrendered all proprietary rights in those monies. Rather, the sole questic

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for the jury to decide is whether Mr. Armstrong fraudulently induced clients to do business with Hamiltc

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Taft; by making representations which he never intended to honor.

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B.

TillS WAS NOT A "PONZI" SCHEME-

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Since Hamilton Taft fulfilled its every contractual duty -- to the extent that clients allowed the

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to do so -- one might well ask: Wherein lies the so-called scheme to defraud? The government seer

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to be of the opinion that Mr. Armstrong was operating a "Ponzi" scheme. "Not so," says the casela'

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Counts one through six allege that Mr. Annstrong fraudulently induced clients to ( business with Hamilton Taft, by misrepresenting the ways in which Hamilton Taft WOll invest its monies. While Mr. Armstrong intends to prove his innocence of these charg at trial, he acknowledges that the Nmth Circuit opinion does not require dismissal of the counts, as a matter of pure law. The Ninth Circuit's conclusion that monies were t property of Hamilton Taft means that, while Mr. Armstrong may be charged wi improprieties in the acquisition of such monies, he should not be charged in connecti' with conduct that post-dates his allegedly fraudulent acquisition of monies. 11

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"A Ponzi scheme is a fraudulent arrangement in which an entity makes payments to investors fro 2

monies obtained from later investors rather than from any 'profits' of the underlying business venture

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hlTe United Energy Corp. 944 F.2d 589 (9th Cir. 1991). The term stems from the late Charles Pon;

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a colorful and flamboyant swindler of the 1920s. Ponzi induced would-be investors to give himmone

5

in order to buy foreign postal coupons, which he would then purportedly sell in other countries at 100

6

gain. In return for their money, Ponzi gave "investors" 90-day notes, which he would promise to rep

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at 150% of face value. Though no foreign postal coupons actually existed, Ponzi continued to hon

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these 90-day notes as promised, using other investors' monies to do so, and thereby causing his

9

debts to spiral exponentially. See Cunningham v. Brown, 44 S.Ct. 424 (1924).

0"

l O I n United Energy, the principles sought to induce investors to purchase shares of solar enerj 11

modules, by way of a down payment and annual or semi-annual installments. Though the modul

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actually produced only a negligible amount of energy, the principles paid investors occasional sums

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money, which they represented to be returns on investment. This, in tum, caused the initial investors

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continue making payments to United Energy, while also causing new investors to finance the phOl

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project. This new money could then be used to partially pay back the old investors, in order to make

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appear that the venture was a success.

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The schemes in both Cunningham and United Energy, while holding themselves out to 1

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legitimate business ventures, were nothing more than textbook Ponzi schemes, in which no investme

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ever existed. Conversely, Hamilton Taft's stated purpose was to provide payroll services, and it did s

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Ofcourse, given the $18.9 million hole which he inherited, as well as the continuing interest ar

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penalties attributable to that hole, it was inevitable that Mr. Armstrong would have to use newly incomir

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monies to payoff pre-existing liabilities -- holding back more tax deposits in the process. Moreove

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unlike CIGNA, which had been able to dip into its own abundant coffers to cover Hamilton Taft

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escalating liabilities, Mr. Armstrong did not have this luxury. As a result, his only chance of fillir

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Hamilton Taft's pre-existing hole, was to invest a small percentage of Hamilton Taft funds in investmen

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which, while containing some element of risk, also had the potential for tremendous returns. H

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decisions to hold back checks and to payoffold liabilities with incoming funds did not constitute a Pon

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scheme, but were simply business decisions which were not only contractually permitted, but weI

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contemplated by the clients at the time they entered the contracts.

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In a Ponzi scheme, the victims believe they are putting their monies into an investment, althouE

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no investment exists at all. In the instant case, clients believed that Hamilton Taft would pay their taxe

5

as well as any penalties and interest, and Hamilton Taft did so -- until the clients themselves complete

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shut offHamilton Taft's cash flow, based on the unconfinned allegations ofa disgruntled ex-employe

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Indeed, it is downright remarkable that Mr. Armstrong now faces federal felony charges for missing ti

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payments which his own clients (the supposed victims in this case) left him totally unable to make. Tl

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$50 million in unpaid 1991 taxes is an artificial creation of the clients themselves -- brought about by the

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own sudden and unilateral decision to freeze Hamilton Taft's cash flow. These clients have stolen JV

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Armstrong's keys and pushed his car into a ditch, yet are now complaining that Mr. Armstrong cann

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drive them to the show.

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The government's "evidence" of a Ponzi scheme stems solely from the fact that, in continuing

14

hold back tax deposits to pay off their pre-existing debt, Hamilton Taft was incurring more and mo

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penalties and interest, thus creating the need to hold more and more future tax deposits. At worst, tl

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conduct constitutes profligate money management by Mr. Armstrong -- the stuff of shareholder pro:

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battles, but not of criminal indictments. If Mr. Armstrong can be criminally charged for running

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increasing bills for his company, then so too can every home owner who defaults on his loan, or eve

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corporation whose debts exceed its assets.

1

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The truly arbitrary nature of this case is best captured by a rhetorical question: Would ]'v

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Armstrong be facing criminal charges today if one or two of his investments had reaped grand retun

22

enabling him to fill Hamilton Taft's pre-existing hole? Surely Mr. Armstrong's is not the first busim

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ever to make risky investments, with monies paid to it by clients. Nor is it the first business to perf01

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some of its contractual duties late. And Mr. Armstrong is not the first CEO ever to enjoy a bounti

25

lifestyle while his company struggles to become profitable. What, then, elevates this case from a me

26

civil dispute to a 21-count federal fraud indictment? Hamilton Taft's clients, with more than a little hi

27

from Fred Wyle and the Bankruptcy Court, arbitrarily chose to shut down the company before

28

investment program had reached fruition. With Hamilton's Taft's business activities frozen in time, 1

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000124

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government then called on its high-priced accountants, who summoned their mystical powers '

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projections, spread sheets, and mathematical assumptions, to create a loss where none actually existe

3

Aided by such sorcery, the government was able to transform Hamilton Taft from a mere non-profitab

4

business into a criminal "Ponzi" scheme.

5

In short, Hamilton Taft contracted to perform a service for its clients and it did so. If the clien

6

believe Hamilton Taft's late performance to be a contractual breach, let them sue Mr. Annstrong in ci'

7

court. If Congress wishes to expand the common law of trusts to include payroll processing companie

8

let them change the law. If the government believes Mr. Annstrong committed fraud in the induceme

9

(as alleged in counts one through six), let them prove it at trial. However, to allege that Mr. Armstror

10

was "diverting" funds which were his own property; or committing a Ponzi scheme, while giving h

11

clients the very service they contracted for; or that he "covered up" a scheme which, by definition, wou

12

have been completed at the moment clients signed their contracts, is illogical, excessive, and total

13

prejudicial to Mr. Annstrong's right to a fair trial. Counts seven through twenty-one should be dismissed.

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II.

AT A MINIMUM, THIS COURT SHOULD DECLARE THE NINTH CIRCUIT HOLD IN TO BE THE "LAW OF THE CASE" IN MR. ARMSTRONG'S CRIMINAL TRIAL

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Even if this court does not view the NInth Circuit's opinion as dispositive of certain counts of tl

19

indictment, defense counsel at least urges that this court issue an order declaring the Ninth Circuit's leg

20

conclusions to be the law ofthis criminal case. Such an order would mean, inter alia, that:

21

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1.

Defense counsel may refer to the monies at issue, in both opening and closing statement as the property of Hamilton Taft or Hamilton Taft cash flow.

2.

The government may not refer to those monies as "client monies" or "client funds" an may not state or imply that Hamilton Taft held those monies in trust.

3.

The government may not present evidence of any advice which Mr. Annstrong receivel from lawyers or other experts, to the extent that such advice was inconsistent with tr state of the law, as set forth in the Ninth Circuit's opinior:.

4.

This court will instruct the jury that monies, once delivered to Hamilton Taft, became tf property of Hamilton Taft. .

5.

This court will instruct the jury that Hamilton Taft was free to use its cash flow to COVI its operating expense or to Invest those monies for its own benefit and in any way wished.

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This court will instruct the jury that Hamilton Taft's sole duties to its clients were tho duties stated contractually but that clients were free to sue for breach, if Hamilton T, ever failed to live up to those duties. '

3

"The law ofthe case doctrine 'ordinarily precludes a court from re-examining an issue previoUE

4

decided by the same court, or a higher appellate court, in the same case.'" United States v. Catenno, :

5

F.3d 1390,1395 (9th Cir. 1994) {citations omitted). The doctrine "refers to a family of rules embodyil

6

the general concept that a court involved in later phases of a lawsuit should not re-open questions decid,

7

... by that court or a higher one in earlier phases." Crocker v. Piedmont A viation, Inc., 49 F.3 d 73

8

739 (D.c. Cir. 1995). {emphasis added}. Law of the case is primarily an equitable principle and, unli

9

the principles of collateral estoppel and res judicata, is applied at the discretion of the court. Howevl

10

as the Ninth Circuit has observed, it is a principle which "should not be applied woodenly in a w

11

inconsistent with substantial justice." United States v. Miller, 822 F.2d 828 (9th Cir. 1987).

1

6.

12

In the instant case, there are arguable technical reasons why the Ninth Circuit decision should n

13

constitute the law of Mr. Armstrong's criminal case. The first such reason is that the decision w

14

vacated after the parties settled out of court. The second is that the parties to the instant case are not t

15

same as the parties to the civil dispute from which the Ninth Circuit's opinion arose. Putting aside the

16

technicalities, it is hardly a matter of dispute that the Ninth Circuit decision arose from the exact sar

17

facts, circumstances, and issues as those that will be presented in this case. While the opinion has be

18

vacated, it continues to stand as both a scholarly, lucid, and unassailable explication of the cornmon I,

19

of trusts, as well as a "cheat sheet," which allows this court to see how the Ninth Circuit will rule, shoL

20

this issue comes before it again. Under these circumstances, it flies in the face of common sense to refu

21

to acknowledge the Nmth Circuit's reasoning and to pretend the opinion does not exist.

22

To simply leave this matter as a factual free-for-all, to be sorted out by the jury, is not only lega

23

erroneous, but also grossly prejudicial to Mr. Armstrong. The character of the funds at issue is a k

24

component of this case and is a matter of pure law, as even this court acknowledged in its Februal

25

1993 opinion; were this merely a factual issue, the Nmth Circuit never would have addressed it in the fil

26

place. Because these funds were Hamilton Taft property, as a matter oflaw, the jury should be instruct

27

that this is the case. Simply allowing the defense to present evidence that these were not trust funds \\

28

leave in the hands oflay-jurors the task of dissecting and applying subtle nuances of law, on which ev

15

000126

1 Mr. Armstrong's own attorneys could not find consensus. After hearing the government refer to the: 2

funds as "client funds," "trust funds," or "withholding funds," lay-jurors surely cannot be expected

3

understand defense counsel's highly technical arguments about commingling of funds, statutory trust

1

4· and third party transferees. Without a clear instruction to this court that funds transferred to Hamilt( 5

Taft became Hamilton Taft property, the jury will be only too ready to wrongly believe that these fun'

6

were withholding monies, and that Hamilton Taft was held to the same fiduciary duty that their ov

7

employers have.. To allow jurors to make such an inference would be grossly prejudicial and devastatil

8

to Mr. Armstrong's case.

9

While Mr. Armstrong was not himself a party to the Ninth Circuit's case, that case was:

10

adversary proceeding which arose out ofthe same bankruptcy as the one which led to this criminal ca!

11

By the same token, the facts which led to the Nmth Circuit's conclusions of law (that no trust existed al

12

that Hamilton Taft's relationship with clients was debtor-creditor) are the identical facts now at issue

13

this criminal case. Adopting the Nmth Circuit's opinion as the law of this criminal case is consistent wi

14

the principles offlexibility and efficiency with which the law of the case doctrine is customarily applie

15

Should this court be reluctant to dismiss counts seven through twenty-one, pursuant to the Ninth eircl

16

opinion, Mr. Armstrong requests that it at least take the lesser step of declaring the Ninth Circuit's lef

17

conclusions to be the law of Mr. Armstrong's criminal case -- with all of the ramifications which tt

18

finding would entail.

19 20

\\\

21

\\\

22

\\\

23

\\\

24

\\\

25 26 27 28 16

000127

1

DEFENDANT ARMSTRONG'S PROPOSED SPECIAL mSTRUCTION 5

2 3

With respect to the funds paid to Hamilton Taft by the client companies, with the exception of

4

two clients who arranged to have their payments kept in separate accounts, the funds paid to Hamilton

5

Taft became the property of Hamilton Taft and could be commingled by Hamilton Taft, treated by

6

Hamilton Taft as its own assets, used to pay Hamilton Taft's operating expenses, and invested by

7

Hamilton Taft for its own benefit. Hamilton Taft did not hold the funds in trust as your employer might

8

hold your withholding taxes. In other words, Hamilton Taft was entitled to the use of the funds until

9

the taxes were due to be paid, pursuant to the terms of the contract.

10 11

12 13 14 15 16 17 18 19 20 21 22 23 24 25

J

26

Based on: In Re Hamilton Taft &- Co., 53 F.3d 285,288 (9th Cir., 1995), vacated due to mootness,

27

68 F.3d 337 (1995); Restatement (Second) of Trusts § 283 (1959); Austin W. Scott & William

28

Fratcher, The Law ofTrusts § 283 (4th ed. 1989).

000169

1

MICHAEL J. YAMAGUCHI United states Attorney

2

3 4

5

JOEL R. LEVIN Chief, Criminal Division RONALD D. SMETANA Special Assistant U.S. Attorney GEORGE D. HARDY Assistant U.S. Attorney

r ",

' . ·~t

6

.,

.":t':

.

~''''

450 Golden Gate Avenue San Francisco, CA 94102 Telephone: (415) 436-6851

7

''''"''

8 9

UNITED STATES DISTRICT COURT

10

NORTHERN DISTRICT OF CALIFORNIA

11

12

UNITED STATES OF AMERICA,

)

Criminal No. 94-0276-CAL

)

13

Plaintiff,) )

v.

14

) )

15 16 17

CONNIE C. ARMSTRONG, JR., and ) RICHARD A.FOWLES, ) ) Defendants. ) )

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION Date: Nov. 8, 1996 Time: 1:30 p.m. Courtroom: 10 (Han. Charles A. Legge)

18 19

.L..

Introduction \

20

Defendant Connie C.

Armstrong,

Jr.,

seeks

(again)

to

21

dismiss counts seven through twenty-one of the Indictment.

22

alternative, he seeks an instruction on the "law of the case."

23

the reasons set forth below, the government opposes this motion.

24

II.

Argument

25

~

Statement of facts.

26

In the For

As set forth in the grand jury's Indictment, the charges

000156

1

arise from defendant's operation of Hamilton Taft, a San Francisco

2

based

3

companies.

4

Hamilton Taft and Hamilton Taft was obligated to pay the taxes to

5

the Internal Revenue Service and other taxing authorities on time.

6

At the time the defendant acquired Hamilton Taft the

7

company had a working capital deficit of more than $14 million.

8

Over a period of two years, as money was siphoned out and Hamilton

9

Taft accrued interest and penalties on money it did not have, the

company

that

provided

tax

services

to

large

Client companies transferred their payroll taxes to

10

withholding

11

million per quarter.

12

approximately $85 million in taxes were unpaid.

of

tax

payments

grew from

$19.4

million

to

$68.2

When Hamilton Taft ultimately collapsed,

Despite the fact that the defendant was aware that he

13

14

could not pay the taxes of his clients when due, he

15

number

16

representations that Hamilton Taft had the ability to pay taxes

17

when due, was paying taxes when due and would continue to pay

18

taxes when due.

of

companies

to

contract

with

Hamilton

induced a Taft

with

~he

19

As a further part of the scheme, the defendant concealed

20

the non-payment of taxes to induce the victims to continue sending

21

(on a weekly, biweekly or monthly basis) their tax payments and to

22

avoid the wholesale cancellation of contracts.

23

defendant's scheme was exposed, he sent out lulling letters denying

24

the existence of the scheme and encouraging

25

sending payments.

26

II GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

J

payroll

Finally, when the

)~tc::t;,i!Jl2-

to continue

2

0001.57

1

.a....

Defendant's misplaced.

Reliance

on

In

re

Hamilton

Taft

& Co.

is

2

3

The litigation underlying In re Hamilton Taft & Co., 53

4

F.3d 285 (9th Cir. 1995), was between two parties over a fixed sum

5

of money

6

reclaim for the larger group of victims funds paid to the IRS on

7

behalf of S & S Credit.

8

preferential payment had been made on behalf of S & S and that the

9

funds paid to the IRS on its behalf would have to be repaid by S &

whether the trustee in bankruptcy would be able to

The Ninth Circuit initially ruled that a

10

S to the trustee.

11

matter

12

dismissed as moot, and the decision was vacated.

13

Taft

14

vacation

15

inoperative.

16

(1950).

17

340 U.S.

18

Hamilton Taft & Co.

&

could

Co.,

be

S & S petitioned for rehearing, and before the heard,

the

68 F.3d 337

of

the

case was

(9th Cir.

opinion

nullifies

United States v.

settled,

1995). and

the

appeal was

In re Hamilton

The Ninth Circuit· s renders

Munsingwear,

the

340 U.S.

judgment 36,

40-41

Arguably, the parties could now relitigate the issues. at 40.

In short,

this Court

is not bound by In

re

19

This conclusion is made more compelling by the fact that

20

the government was not a party to the litigation at the time the

21

opinion was rendered by the Ninth Circuit.

22

rehearing was filed the Court obviously recognized that its opinion

23

could well interfere with the government·s right and ability to

24

collect

25

participate in the case as an amicus curiae.

26

file a brief advocating the theory that the funds were held by

\

employee

taxes

and

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

J

thus

3

When the petition for

invited

the

government

to

The government did

000158

1

Hamilton Taft in trust for the government.

2

and the opinion vacated before the government's position could be

3

considered.

4

which

5

)£}is) r o •

hC\s~r

The

6

To resolve the i;§sue had

nq~~lY:

thEL~~~gy:

inescapable

The case was settled

t;,o

the~g£2~E]leJlt

tQ b_t;.. heq.rcLi§,"",fundsIDWt:lllY

conclusion

from

this

discussion

7

there is no "l,,!w

8

fact that can be resolved only by the scheduled jury trial.

9

~

10

oLth~.".Cas.e.."

is:

Rather, there remains a dispute of

Contrary To Defendant's Contention, Hamilton Taft Did Not Comply with Its Contractual Duties. The government will subsequently demonstrate why counts

11

7 through 21 should not be dismissed.

However, fundamental to

12

defendant's argument is his premise that he complied with the 13 conditions of his contracts and thus did nothing wrong.

Defendant

14

has again pummeled a straw man. 15

16 17

The trial evidence will show that, at a minimum, all of Hamilton Taft's contracts required timely payment of taxes on or before the statutory deadlines. 1 Some of the contracts also

18

specifically limited the short-term investments that could be made. 19

Thus, Scott Paper's contract stated that: 20

21 22

In order to satisfy Hamilton Taft's investment criteria (Security of Principal, High Degree of Liquidity), Hamilton Taft's investments are limited to investments collateralized by United States Government securities and United States Government sponsored obligations.

23 24 25 26

lContrary to defendant's assertion that he "occasionally" paid the taxes late (Defendant's Memorandum 10:16), he intentionally failed to make more than 300 payments aggregating more than $255 million, and the frequency of missed payments as well as .their dollar amounts were increasing almost logarithmically. GOVERNMENT'S OPPOSITION TO ARMSrRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

4

000159 J

....

1

Others limited Hamilton Taft to benefits accruing from temporary

2

use of client funds or benefits accruing from proper use of client

3

funds.

4

long-term use of client

5

defendant's

6

nothing less than revisionist history.

Given the intentional failures to pay taxes on time, the

that

he

and the

other

complied

with

than proper use, the

contracts

is

7

Similarly erroneous is defendant's assertion that once

8

the money was paid over to Hamilton Taft that he could use it for

9

any purpose he wanted.

He induced his clients to do business with

10

Hamilton Taft on the representation that he could and would pay the

11

taxes on a timely basis.

12

funds otherwise clearly constitutes fraud, as the trial evidence

13

will amply demonstrate.

14

."

assertion

funds

His knowing and intentional use of the

Defendant did not

just commit

fraud at

the

time

the

15

contracts were executed, but on an ongoing basis in order to assure

16

continued payment.

17

payments

18

Defendant and his employees concealed the tax withholds as much as

19

possible.

When discovered, they lied about the basis for missed

20

payments.

Thus, each payment from each of the victims was directly

21

attributable to the fraud and a direct and intended consequence of

22

the ongoing fraud.

23

is

The only way to pay past due taxes with current

to assure an

adequate supply of current payments.

Defendant's argument that this was not a Ponzi scheme

24

(Defendant's Memorandum, 10:8-10) is similarly without merit.

25

defendant is not before this court because he paid "Client A's

26

taxes with Client B's and Client C's money;" GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

The

the government would

5

000160

1

expect that all of A, Band C's payments would be made from the

2

collective contributions from A, Band C.

3

before the court, in part, because he bought a ranch with A's money

4

paid

5

intentionally failing to make A's tax payment), and then used Band

6

C's funds

7

payment to make A's January payment while failing to make Band C's

8

April tax payment.

to

Hamilton

Taft

for

a

paid to Hamilton Taft

January

in April

Rather, defendant is

tax

for

payment

(while

their April

tax

9

Indeed, the description of a Ponzi scheme in In re United

10

Energy Corp., 944 F.2d 589, 590 at fn.l (9th Cir. 1991)2 describes

11

precisely what defendant was doing.

12

for clients with monies obtained from later tax payments from other

13

clients.

14

created the illusion that taxes were being timely paid and that

15

(bankrupt) Hamilton Taft had the financial wherewithal to pay the

16

taxes, inducing continued use of Hamilton Taft's services, all the

17

while siphoning out funds for defendant's personal benefit.

18

only

19

unfortunately for him, the audience caught on to the trick!

20

IL..

Defendant made tax payments

By funnelling later payments to earlier taxes defendant

sorcery

involved

was

the

defendant's

sleight

of

The hand;

,

There is no basis for the dismissal of Counts Seven through Twenty-One.

21 Regardless of how the relationship between Hamilton Taft 22 23 24 25 26

2"A Ponzi scheme is a fraudulent arrangement in which an entity makes payments to investors from monies obtained from later investors The fraud consists of funnelling proceeds received from new investors in guise of profits from the alleged business venture, thereby cultivating an illusion that a legitimate profit-making business opportunity exists and inducing further investment. GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

J

6

000161

1

and its clients is categorized, Counts Seven through Twenty-One

2

withstand attack. Defendant

3

appears

to

argue

that

the

government

can

4

proceed on counts One through Six, the fraud in the inducement, but

5

that proceeding on the other counts is "illogical, excessive and

6

totally prejudicial • • • " (Defendant's Memorandum 14:15-16)

7

has done throughout these proceedings, defendant has made a lengthy

8

and colorful

9

relevant to the inquiry -- the Indictment.

argument all

the while

As he

ignoring the one document It does not depend on

10

the existence of any particular relationship between defendant and

11

the victim companies.

12

conduct in addition to and beyond the inducement to keep the money

13

flowing into Hamilton Taft.

14

ongoing basis to keep money flowing into Hamilton Taft by a cover-

15

up3,

16

selection

17

attempt to disseminate a false account of what was happening to

18

client

19

reference in each of the counts.

Rather it alleges a fraudulent course of

The Indictment alleges fraud on an

false tax returns 4 , a change in cover-up methodology5, of

funds.

specific

All

of

clients

these

for

withholding

allegations

are

and

the

Armstrong's

incorporated

by

(Indictment, paragraph 24.)

20 21

22 23 24 25 26

3"This concealment enabled Hamilton Taft to continue to receive funds from its clients, to avoid massive cancellation of its contracts, and to preserve the opportunity for new business." 4"The clients who received these returns were thereby falsely led to believe that all their taxes had been paid." 5"By choosing to pay past due taxes instead of currently due taxes, Armstrong was able to delay, for a much longer time, discovery by the clients that their taxes had been paid late. At the same time, he was able to create the false impression that Hamilton Taft's business was running smoothly." GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUESr FOR PRETRIAL INSTRUCTION

7

000162

1

Defendant

argues,

however,

all

allegations

of

the

2

Indictment, other than the fraud in the inducement allegations, are

3

legally insufficient to charge criminal activity because of the

4

Ninth

5

establishes (or so defendant claims) the "law of the case" contrary

6

to the government's charging theory.

7

defendant sees in that opinion and on which defendant focuses his

8

argument is the conclusion that the relationship between Hamilton

9

Taft and its clients was one of "debtor-creditor", and not a trust

Circuit

opinion

of

In

re

Hamilton

Taft

Co.

&

which

The "law of the case" that

10

relationship.

11

extrapolate to the further conclusion that the defendant was free

12

to do with the clients' tax money whatever he wanted, because it

13

was Hamilton Taft's "property".

14

fraud

15

defendant did with client's tax money after the contracts were

16

signed must be legally insufficient, and therefore dismissed.

17

argument is further based on the factual predicate that Hamilton

18

Taft complied w-ith the terms of the contracts with its clients.

19

Defendant's argument is factually and legally flawed •

20

From that "law of the case", the defendant seeks to

allegations

As

•

noted

in

the

earlier,

Hence, he argues that any criminal

Indictment

the

Ninth

which

describe

Circuit

opinion

what

has

the

His

no

21

precedential .or controlling effect on this Court (and therefore can

22

not be considered "the law of the case") because it was vaca'ted.

23

It should also have little, if any, persuasive effect on this Court

24

because

25

reconsideration,

26

government.

it

was

vacated before

in

the

the Ninth

context Circuit

of had

a

motion

heard

from

for the

Furthermore, even if this Court were to conclude that

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

J

that

8

000163

....

1

the legal relationship between Hamilton Taft and its clients was

2

one of "debtor-credi tor", the further coneIus ion that the defendant

3

could do whatever he wished with the tax money (send it to a secret

4

Swiss bank account?) does not logically, or legally, follow.

5

a debtor never defraud a creditor?

6

fact, the defendant acknowledged as much when he said:

9

10

The defendant asserts as a matter of fact that he complied

11

with his contractual duty to pay the taxes of the Hamilton Taft

12

clients.

13

with his contractual dutiesl Jury trials are the vehicle by which

14

such factual disputes are resolved, not motions to dismiss. There

15

is no basis for this Court to dismiss counts Seven through Twenty-

16

One.

17

.L.

8

The government intends to prove that he did not comply

The Court should not make a finding of "the law of the case."

18

The government is persuaded by defendant's eloquence in

19

arguing that this court should not follow In re Hamilton Taft & Co.

20

(Defendant's

21

vacated

22

explication of the common law of trusts" (Id. at 21-22) since the

23

court sought to implicate the government's rights without giving

24

the government an opportunity to be heard.

25

"scholarly" or "lucid" the opinion may be on the common law of

26

trusts, as noted above it is not "the law of the case", and clearly

Memorandum,

opinion

is

15:16-18),

"a

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

I

In

"For instance, had Mr. Armstrong s imply taken clients' monies and opened a Swiss bank account, while totally ignoring his contractual duty to pay their taxes, he almost certainly could be charged with engaging in a scheme to defraud." (Motion, p. 9)

7

~

The answer is obvious.

Can

scholarly,

but

cannot

lucid,

agree

and

that

the

unassailable

Regardless of how

9

000164

1

should not be used to justify making a ruling on an issue that is

2

nothing but a red herring. It is clear what the defendant is attempting to do.

3

He

4

wants the jury not to hear relevant evidence.

He doesn't want the

5

jury to hear about the Ranch acquisition, or the limousine rides,

6

or the luxury jet purchase.

7

what his lawyers and senior management were telling him--that he

8

couldn't use client tax money for long-term personal investments.

9

He also doesn't want the jury to hear about the lies he told his

10

employees regarding the source of funds for his ranch and other

11

purchases.

12

the victim companies in order to lull them into a false sense of

13

security.

14

charges in the Indictment.

He also doesn't want the jury to hear

He doesn't want the jury to hear about the lies he told

But all of this evidence is relevant to prove the

15

To his credit, the defendant spells out the remarkable

16

ramifications of a decision to declare that In re Hamilton Taft &

17

Co. represents the "law of the case".

18

He wants:

1.

Defense counsel to be able to refer to monies at issue, in both opening and closing statements as the property of Hamilton Taft or Hamilton Taft cash flow;

2.

The government not to refer to those monies as "client monies" or "client funds" and not to state or imply that Hamilton Taft held those monies in trust;

3.

The government not to present evidence of any advice which Mr. Armstrong received from lawyers or other experts, to the extent that such advice was inconsistent with the "law of the case";

4.

The court to instruct the jury that monies, once delivered to Hamilton Taft, became the property of

19 20

21

22 23 24

25 26

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

10

000165. J

.. Hamilton Taft;

1 2

5.

The court to instruct that Hamilton Taft was free to use its cash flow to cover its operating expense or to invest those monies for its own benefit and in anyway it wished;

6.

The court to instruct the jury that Hamilton Taft's sole duties to its clients were those duties stated contractually but that clients were free to sue for breach, if Hamilton Taft ever failed to live up to those duties.

3

4

5 6 7

8 9 10

Nothing in the language, logic, or holding of the vacated opinion in In re Hamilton Taft & Co. comes close to justifying such a gutting of the government's case.

11

The defendant's motion to characterize, as a matter of law,

12

the nature of the relationship between Hamilton Taft and the victim

13

clients, in the form of a pretrial ruling should not be granted.

14

The characterization has not been settled as a matter of law.

15

characterization, even if accepted as "debtor-creditor", does not

16

negate the presence of a fraudulent scheme or support in any way

17

the six conclusions cited above.

18

confuse

19

technicalities of the law.

20

II II II II II II II

21

22

23 24 25 26

the

jury,

J

The characterization would only

leaving them to wonder

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

The

about

the

illogical

11

000166

•

1

III. Conclusion

2

For the foregoing reasons, the government respectfully

3

submits that the motion to dismiss be denied and that the Court

4

deny the request to make In re Hamilton Taft & Co. the law of the

5

case.

6

DATED:

November 5, 1996

7

Respectfully submitted, MICH~~J.

YAMAGUCHI

unite~ ta~~s i~~/rn:;,

. __

By~I{)~

8 9 10

RONALD D. SMETANA Special Assistant U.S. Attorney

11

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 GOVERNMENT'S OPPOSITION TO ARMSTRONG'S MOTION TO DISMISS AND/OR REQUEST FOR PRETRIAL INSTRUCTION

J

12

HOnlG1