CPE Day December 5, 2013
Legal Issues
Sandra S. Benson, J.D.
Tax preparers routinely rely
on information furnished by
the client or third parties
to prepare tax returns.
Is the preparer responsible to verify the
accuracy of the information provided?
Does it matter if the preparer suspects
the client documentation is incorrect or
false but turns a blind eye or relies on
verbal assurances?
Is it possible that a tax preparer can be
either civilly or criminally liable if the
client supplies false information used to
prepare the return?
Legal Update 2013
Aiding and Abetting a Ponzi Scheme or other Fraud by Filing
False Tax Returns: Can a Tax Preparer be Liable?
Sandra S. Benson, J.D., Associate Professor*
Department of Accounting
Jones College of Business, MTSU
December 5, 2013
*I am grateful to Duresha S. Rice, Graduate Assistant, for
assistance in developing the PowerPoint slides from my
article.
‘Tis the Season
to Gear Up for Taxes
• According to the IRS, there are 690,000
Federal tax preparers.
• About 60% of taxpayers will use tax
professionals this year to prepare their
returns.
• Can the preparer safely rely on the client’s
documentation?
In re MuniVest Services, LLC, et al., v.
Metzler Locricchio Serra & Company, P.C.,
• Dante DeMiro founded MuniVest Services,
LLC. He falsely promised clients
(municipalities, credit unions, labor unions
and a school district) that he would invest
their funds in low-risk CDs.
• 2013 WL 5636706 (Bkrtcy, E.D.Mich.)
False Account Statements
• He prepared false account statements
showing the high rates of interest he
promised.
A Ponzi Scheming Client
• Instead of investing the funds, DeMiro used
those funds to gamble, purchase personal
luxury items, buy real property, make loans,
and make payments to other investors in the
scheme to continue the scheme.
IRS Audit
• The IRS audited the 2008 and 2009 tax returns
and assessed penalties against DeMiro
exceeding $2.6 million for understating tax
obligations.
Guilty Plea
• After his arrest in 2010, DeMiro admitted to
operating a Ponzi scheme and pleaded guilty
to bank fraud & wire fraud. He was sentenced
to 10 years in federal prison & ordered to
pay over $12m in restitution.
“Conservative” Investor Victims
• The largest victim, Mona Shores Public
School District, which had invested $3.5
million, filed involuntary Chapter 7
bankruptcy petitions on October 12,
2010, against both DeMiro and MuniVest
(Debtors).
Bankruptcy Trustee Lawsuit
• The Chapter 7 Trustee filed an adversary
proceeding to recover assets for the benefit
of the victims and creditors against the
accounting firm that had prepared the 2008
and 2009 tax returns for DeMiro and
MuniVest.
Bookkeeper’s Documentation
• MuniVest’s bookkeeper sent general
ledgers to the accountant who reviewed
them “line by line.”
• The general ledgers showed that funds
were used to pay business expenses of
MuniVest and personal luxury expenses
of DeMiro.
According to the
Bankruptcy Trustee:
• The firm was negligent by failing to comply
with AICPA standards.
• The firm’s filing of false tax returns
temporarily enabled the fraudster to evade
detection by the investors and the IRS.
Accounting Malpractice:
• Michigan law requires four elements:
1. THE EXISTENCE OF AN ACCOUNTANT/CLIENT
RELATIONSHIP;
2. NEGLIGENCE IN THE PERFORMANCE OF
SERVICES BY THE ACCOUNTANT FOR THE
CLIENT;
3. THAT THE NEGLIGENCE WAS THE PROXIMATE
CAUSE OF AN INJURY; AND
4. THE FACT AND EXTENT OF THE INJURY
ALLEGED.
Michigan Court held:
• VICTIMS WERE NOT THE CLIENTS OF THE FIRM
What if Tennessee Law Applied?
• Negligent Misrepresentation claim by a non-client:
One who supplies false information for the
guidance of others in their business transactions is
subject to liability for pecuniary loss caused to
them by their justifiable reliance upon the
information, if he fails to exercise reasonable care
or competence in obtaining or communicating
that information.
-Bethlehem Steel Corp v. Ernst & Whinney, 822 S.W. 2d 592,
596 (Tenn. 1991)
Bethlehem Steel Corp v.
Ernst & Whinney
• Liability is limited to loss suffered by the person
or one of a limited group of persons for whose
benefit and guidance he intends to supply the
information or knows that the recipient intends
to supply it; and through reliance upon it in a
transaction that he intends the information to
influence or knows recipient so intends or in a
substantially similar transaction.
-Adopting §552 Restatement (Second) of Torts.
Fraud
• Michigan statute that allows a claim of
professional malpractice against a certified
public accountant where there is
“[A]N ACT, OMISSION, DECISION OR OTHER
CONDUCT OF THE CERTIFIED PUBLIC
ACCOUNTANT THAT CONSTITUTES FRAUD
OR INTENTIONAL MISREPRESENTATION.”
-Mich. Comp. Laws. Ann. § 600.2962(1) (b)
Elements of Fraud in Michigan
1) DEFENDANT MADE A MATERIAL REPRESENTATION
2) IT WAS FALSE;
3) DEFENDANT KNEW IT WAS FALSE WHEN MADE, OR
MADE IT RECKLESSLY WITHOUT ANY KNOWLEDGE
OF ITS TRUTH;
4) DEFENDANT MADE IT WITH THE INTENTION THAT IT
SHOULD BE ACTED UPON BY THE PLAINTIFF;
5) PLAINTIFF DID ACT IN RELIANCE UPON IT; AND
6) PLAINTIFF SUFFERED INJURY AS A RESULT OF SUCH
RELIANCE.
Aiding and Abetting FRAUD
• The court dismissed the fraud claim (no
reliance) but refused to dismiss the
aiding and abetting fraud claim. The
federal district court adopted § 876 (b) of
the Second Restatement of Torts.
§ 876 (b) of the Second
Restatement of Torts
Law:
• (1) KNOWLEDGE OF
THE WRONGFUL
CONDUCT BY THE
AIDER/ABETTOR
Allegations
• The firm “knew” that
the Debtors purported
to invest funds for
investors, but instead
used the funds to pay
for daily expenses of
the Debtors and for
personal luxury
expenses of DeMiro.
§ 876 (b) of the Second
Restatement of Torts
Law
• (2) SUBSTANTIAL
ASSISTANCE OF THE
WRONGFUL
CONDUCT BY THE
AIDER/ABETTOR.
Allegations
• Firm’s assistance case
was not just of ordinary
accounting services, but
instead consisted of
preparation & filing of
false tax returns that
enabled debtors to
evade detection.
Does Tennessee Recognize Aiding
& Abetting Tortious Conduct?
• Yes, in a recent case against a law firm, the Court
of Appeals said that the common law civil liability
theory of aiding and abetting, requires that “the
defendant knew that his companions' conduct
constituted a breach of duty, and that he gave
substantial assistance or encouragement to them
in their acts.”
- PNC Multifamily Cap. Institutional Fund XXVI LP v. Bluff City Cmty.
Dev. Corp., et al., 387 S.W.3d 525 (Ct.App. 2012)
Ignoring the Obvious Signs of
Fraud
• The firm instructed Debtors’ bookkeeper on
how to book funds received from the
investors.
Ignoring the Obvious Signs of
Fraud
• Some of Debtors’ employees told the firm
about their concerns about Debtors’ finances
and DeMiro’s constantly wanting and pulling
money out.
Ignoring the Obvious Signs of
Fraud
• The firm reviewed the general ledgers “line by
line” and these showed that the Debtors
(DeMiro & MuniVest) did not invest funds for
customers as promised, but instead showed
that the funds were repeatedly used to pay
business expenses of MuniVest and luxury
personal expenses of DeMiro.
Ignoring the Obvious Signs of
Fraud
• The firm was aware that the Debtors could not
identify the entity or entities they owed in
excess of $825,000 and said this was
“unusual.”
Ignoring the Obvious Signs of
Fraud
• The firm continued to provide accounting
services, including false tax returns, despite
“obvious signs of fraud.”
-In re MuniVest Services, LLC, 2013 WL 5636706 (Bkrtcy,
E.D.Mich)
Were the Signs of Fraud SO
Obvious?
• Video
-
Were the Signs of Fraud So
Obvious?
• Dana Miller, Lapeer County Treasurer, became
suspicious and triggered an investigation within 8
months into her job.
• DeMiro had had a 13-year relationship with the
county.
• Miller said “My gut told me within three months
of dealing with Dante DeMiro that he was not
trustworthy. ”
-Lynn Moore, “Dante DeMiro’s fall triggered by tenacious Lapeer County Treasurer Dana
Miller” 7/16/11 http:// blog.mlive.com
Feeling Based on:
Miller’s observations of
DeMiro:
• Lies,
unprofessionalism,
and sloppy
paperwork
According to Miller, DeMiro
• Never met deadlines.
• Was late for appointments.
• Talked on multiple cell phones
when meeting.
• Balked when Miller said she
wanted to cash in CD and said
he’d already renewed it. He
backpedaled when Miller said
she would call an attorney.
• Sent computer screen shots for
documentation of CD
purchases.
Why allow the claim to go
forward?
• Consider MuniVest and McLean
bankruptcies and Trustee’s powers to file
lawsuits to recover funds for victims.
-
Tax Standards: IRS Circular 230
• A practitioner must exercise due diligence 1.
2.
3.
IN PREPARING OR ASSISTING IN THE PREPARATION OF,
APPROVING, AND FILING TAX RETURNS, DOCUMENTS,
AFFIDAVITS, AND OTHER PAPERS RELATING TO INTERNAL
REVENUE SERVICE MATTERS;
IN DETERMINING THE CORRECTNESS OF ORAL OR WRITTEN
REPRESENTATION MADE BY THE PRACTITIONER TO THE
DEPARTMENT OF TREASURY; AND
IN DETERMINING THE CORRECTNESS OF ORAL OR WRITTEN
REPRESENTATIONS MADE BY THE PRACTITIONER TO CLIENTS
WITH REFERENCE TO ANY MATTER ADMINISTERED BY THE
INTERNAL REVENUE SERVICE.
-31 C.F.R. §10.22(a).
IRS Circular 230
• Reliance on othersExcept as provided in §§ 10.34, 10.35 and 10.37, a
practitioner will be presumed to have exercised due
diligence for purposes of this section if the
practitioner relies on the work product of another
person and the practitioner used reasonable care in
engaging, supervising, training, and evaluating the
person, taking proper account of the nature of the
relationship between the practitioner and the person.
-31 C.F.R. §10.22(b).
IRS Circular 230 Section 10.34(d)
• Relying on information furnished by clientsA practitioner advising a client to take a position on a tax
return, document, affidavit or other paper submitted to
the Internal Revenue Service, or preparing or signing a tax
return as a preparer, generally may rely in good faith
without verification on information furnished by the client.
The practitioner may not, however, ignore the implications
of information furnished to, or actually known by, the
practitioner, and must make reasonable inquiries if the
information as furnished appears to be incorrect,
inconsistent with an important fact or another factual
assumption, or incomplete.
-31 C.F.R. § 10.34(d).
AICPA Statement on Standards
for Tax Services No. 3
Introduction
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AICPA Statement on Standards
for Tax Services No. 3
Statement
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AICPA Statement on Standards
for Tax Services No. 3
Statement (cont’d)
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AICPA Statement on Standards
for Tax Services No. 3
Statement (cont’d)
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Technology in Partnership, Inc.
(TIP) v. Rudin
• The plaintiff - President with 60%
ownership. Defendant–VP with day-today responsibility and 40% ownership.
• In May 2010, the plaintiff asked the
Defendant-VP for financial
documentation, and when he was denied,
he locked the VP out and located the
financial records.
- Technology in Partnership, 2011 SL 4575237 (S.D.N.Y.)
TIP Case
• The plaintiff claimed the VP received excessive
compensation and diverted TIP funds in
various ways by sending checks to relatives.
TIP Case
• The plaintiff sued two accounting firms which
provided tax services for TIP for malpractice,
breach of fiduciary duty, fraudulent
concealment, and civil Racketeer Influenced
and Corrupt Organizations Act (RICO).
Accounting Malpractice
• In New York, the plaintiff must prove
• (1) THE ACCOUNTANT’S
DEPARTURE FROM THE
ACCEPTED STANDARDS OF
PRACTICE, AND
• (2) THAT THE DEPARTURE WAS
THE PROXIMATE CAUSE OF THE
INJURY.
Alleged Errors
• Firm allegedly failed to
• Would performance of
verify the identity of the
these things have
corporation’s officers
prevented the funneling
and the extent of their
of TIP funds to the VP
ownership in the
defendants?
company for TIP’s tax
• Yes, according to the
returns and did not
plaintiff' complaint
provide copies of the
alleging defendants
returns to the plaintiff.
were grossly negligent,
but
The Court Disagreed
• The Court cited the AICPA Professional
Standards § T.S. 300.02 (2011) and
concluded:
• Relying on the information furnished by
the VP, who was the director and officer
responsible for TIP’s financial filings, was
not a departure from accepted practice.
Shaiman v. Carpet One of the
Hamptons
• An accounting firm sued a client for unpaid
services in connection with two audits by the
New York State Department of Taxation and
Finance.
• The client countersued the firm for
malpractice in connection with the tax returns
prepared by the firm.
- Shaiman, 911 N.Y.S.2d 696 (2010)
Court’s Findings of Facts:
• Firm utilized the sales figures and
financial information prepared by the
Defendant’s bookkeeper without
independently verifying the numbers.
Court’s Findings of Facts:
• Accountant was concerned with the large %
of non-taxable sales the client declared for
capital improvement projects.
• However, he asked only for oral explanations.
Audits
• The client was selected for audit. Audits
showed
– Client routinely issued Capital Improvement
Certificates in error
– Under-reported its sales by nearly $4 million
– Did not charge sales tax but included an additional
charge for “padding” equal to the sales tax rate on
some sales
Stealing the tax?
• Shaiman gave the opinion that the client was
“stealing” the tax on the latter transactions.
• Shaiman was assured by the client that this
practice would stop.
• Shaiman continued to represent the client.
Court’s holdings:
• Firm’s claim:
– Court awarded $15,000 for services in connection
with the two audits.
• Client’s counterclaim:
– Court found that the firm was negligent by failing
to discover the $1.3 million discrepancy in
reported sales on the 2000 State sales tax and
Federal income tax returns.
Court Opined:
• Firm had knowledge of, or at least a reason to
believe, the figures presented were
inaccurate and incomplete and its failure to
demonstrate that it made reasonable inquiry
and/or request back-up documentation.
Court Concluded that
• The firm could not ignore an apparent inaccuracy or
turn a blind eye to an obvious discrepancy ($1.3
million difference on 2000 State and Federal
tax returns).
• Firm failed to make reasonable necessary
inquiries to verify the accuracy of the data
which, on the tax returns themselves, appeared “to
be incorrect, inconsistent, or incomplete.”
• Firm deviated from then generally accepted
accounting principles (See 10 C.F.R. §10.34).
Aiding and Abetting Filing False
Returns: Criminal Concerns
• It is a criminal offense to file a false return or
aid or assist in preparation of a false return
(26 U.S.C. § 7206(1)-(2)).
• Akaoula argued on appeal from her criminal
conviction that she was entitled to rely upon
the signatures of the parties to verify the
information contained therein based upon §
10.34(a)(3).
- U.S. v. Akaoula, 1999 WL 61396 (C.A.10, Utah)
Aiding and Abetting Fraud:
Criminal Concerns
• The appeals court held that this argument was
meritless.
– IRC § 10.34(a)(3) does not allow a return preparer
to “ignore the implications of the information
furnished to, or actually known by, the
practitioner.”
• The preparer must inquire if the information
appears incorrect, inconsistent or incomplete.
Aiding and Abetting Filing False
Returns: Criminal Concerns
• The AICPA has prepared a practice guide with
very helpful considerations.
• See AICPA Tax Division, Client Criminal Matters
and the CPA: Practice Guide, January 2011.
What did the Madoff Tax Preparers’
Know?
Criminal Charges Against Madoff
Accountants
Update on Robert W. McLean
Ponzi Scheme
• McLean worked as a broker until the late
1980’s when he started using other
people’s money for his day-trading
enterprise.
• His business grew through trust.
The Business Model
• Obtain cash from “investors” in exchange for
unsecured promissory notes (avoids regulatory
oversight).
• Pay a high and steady rate of interest ( majority of 10%
or more), with no mention of compensation.
• Tell investors the accounts are pooled in futures
trading. Keep the “strategy” proprietary (be evasive or
tell some investors it will “go away” if it is explained).
• Keep operations tightly controlled.
• Give no prospectus. Prepare bogus Statements of
Account upon request.
Expanding the Network
• Citizen of the Year
• Extravagant lifestyle
• McLean was a passionate giver (of other
people’s money)
The Sinking Ship
• By early 2000s, McLean’s situation was DIRE.
• The scheme crashed in 2007 when investors
demanded large payments.
Final Closing of the McLean
Bankruptcy Estate
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Practical Tips
• Consider whether to engage in a relationship
or continue a relationship with a client based
on information received during client in-take
or when preparing the tax return.
Practical Tips
• Make reasonable inquiries if the information
appears to be incorrect, inconsistent or
incomplete.
• Cross-reference other tax returns for
inconsistencies.
Practical Tips
• Do not ignore the IMPLICATIONS of the
information provided, or actually known to
you.
• Do not ignore your intuition.
Practical Tips
• Besides keeping up with required standards,
consider Circular 230 Section 10.33 which sets
forth best practices for tax advisors.