Ddra Capital, Inc. v. KPMG, LLP, 14-3139

DDRA CAPITAL, INC.,a Nevada Corporation; JOHN K. BALDWIN, Appellants v. KPMG, LLP, a Delaware Limited Liability Partnership

No. 14-3139

UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT

Submitted: September 23, 2016

September 6, 2017

NOT PRECEDENTIAL

On Appeal from the District Court for the Virgin Islands

(D.C. Civil No. 1-04-cv-00158)

District Judge: Honorable Anne E. Thompson

Submitted Pursuant to Third Circuit LAR 34.1(a)

September 23, 2016

Before: MCKEE^*, Chief Judge, SMITH^**, and SCIRICA, Circuit Judges

OPINION^***

SCIRICA, Circuit Judge.

Plaintiffs John Baldwin and DDRA Capital, Inc., appeal the grant of summary judgment in favor of defendant KPMG, LLP. We will affirm in part and reverse in part.

I.

Through his company, Sunset Management, Baldwin helped DDRA, a Nevada corporation whose president and sole shareholder was Shawn Scott, finance and purchase the Delta Downs Racetrack in Louisiana in 1999. After DDRA successfully sought a local referendum authorizing slot machines in the parish, it sold the track in 2001 for a profit of approximately $74 million. Baldwin earned a $10 million fee from DDRA and substantial interest from the $17 million in loans Sunset had extended.

Scott and Baldwin, experienced businessmen who had worked together before, considered several options to minimize the taxes they would pay on these gains. They considered reinvesting the profits in "like kind" exchanges under I.R.C. § 1031,¹acquiring companies with net operating losses, and pursuing various options proposed by Cornerstone Strategic Advisors and The Heritage Group. Ultimately, however, they chose a tax strategy suggested by Carl Hasting of KPMG.

The transaction Hasting proposed was unlawful, and KPMG knew it. (KPMG would later enter into a deferred prosecution agreement with the government for promoting such unregistered and fraudulent tax shelters.) The essential terms of the transaction, known as Short Option Strategy ("SOS"), had been flagged for disallowance by the IRS in August 2000. See Tax Avoidance Using Artificially High Basis, I.R.S. Notice 2000-44, 2000-2 C.B. 255.

SOS involved the purchase and sale of largely offsetting options on foreign currency so as to put at risk only the net premium paid to secure the options. (DDRA, for example, spent only $613,000 when it bought "long" options on Brazilian and Mexican currency for $49,238,000 and sold offsetting "short" options on the same currency for $48,625,000.²) Both the long and short options were then transferred to a partnership and, in purported reliance on an old Tax Court opinion, the taxpayer's basis in the partnership was calculated based solely on the value of the long options. See, e.g., Sala v. United States, 613 F.3d 1249, 1250-51 & n.2 (10th Cir. 2010). DDRA's basis in thepartnership, accordingly, was considered to be $49,238,000 rather than the actual net loss of $613,000 it had thus far accrued. Finally, all options would be disposed of for an amount near the actual net cost of the offsetting options, thus leaving the taxpayer claiming a tax loss in the vicinity of the value of the long options—in DDRA's case, about $48 million, "even though the taxpayer ha[d] incurred no corresponding economic loss." I.R.S. Notice 2000-44.

Because "a loss is allowable as a deduction for federal income tax purposes only if it is bona fide and reflects actual economic consequences" and "[a]n artificial loss lacking economic substance is not allowable," I.R.S. Notice 2000-44 (citing, inter alia, ACM P'ship v. Comm'r, 157 F.3d 231, 252 (3d Cir. 1998)), SOS clearly and categorically fails under I.R.C. §§ 165 and 752.³ Nonetheless, Hasting told Baldwin and DDRA that SOS was legal, and Baldwin and DDRA decided to use the SOS transaction to minimize their 2001 taxes. As a result, DDRA and Baldwin claimed ordinary loss deductions of nearly $48 and $22 million, respectively, on their 2001 tax returns.

After the government discovered KPMG's criminal promotion of SOS, plaintiffs accepted an IRS global voluntary settlement offer and paid the taxes the IRS demanded would have been due but for the specious SOS arithmetic ($8,554,685.00 for Baldwin and $17,121,602.00 for DDRA), plus interest ($1,288,449.96 for Baldwin and $3,328,297.01 for DDRA) and certain penalties ($855,468.50 for Baldwin and $1,712,160.20 for DDRA). Plaintiffs then sued KPMG for fraud, negligent misrepresentation, negligence, and breach of fiduciary duty, all under Nevada law, and for violation of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. § 1962. The District Court granted summary judgment in favor of KPMG on all claims.

II.

We exercise plenary review over the entry of summary judgment. E.g., Miller v. Eichleay Eng'rs, 886 F.2d 30, 35 (3d Cir. 1989). Summary judgment is proper if a moving defendant "shows that there is no genuine dispute as to any material fact and [it] is entitled to judgment as a matter of law," Fed. R. Civ. P. 56(a)—that is, if "there exists no genuine issue of material fact that would permit a reasonable jury to find for" plaintiffs, Miller v. Indiana Hosp., 843 F.2d 139, 143 (3d Cir. 1988). We view the evidence in the light most favorable to plaintiffs, and draw all inferences in their favor, e.g., Interstate Outdoor Adver., L.P. v. Zoning Bd., 706 F.3d 527, 530 (3d Cir. 2013), and "may not weigh the evidence or make credibility determinations," Boyle v. Cnty. of Allegheny, 139 F.3d 386, 393 (3d Cir. 1998). But summary judgment may be granted "if the motion and supporting materials—including the facts considered undisputed—show [thedefendant] is entitled to it," Fed. R. Civ. P. 56(e)(3). Summary judgment is also appropriate "[i]f the evidence is merely colorable, or is not significantly probative." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249-50 (1986) (citations omitted). If plaintiffs' version of the facts, as a matter of law, do not entitle them to relief, that is, "[w]here the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no genuine issue for trial." Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) (citation and internal quotation marks omitted).

For the following reasons, we will affirm the grant of summary judgment on plaintiffs' fraud and negligent misrepresentation claims because a reasonable jury could not find plaintiffs justifiably relied on Hasting and KPMG's misrepresentations. But we will reverse the entry of judgment on plaintiffs' negligence claims because plaintiffs have produced sufficient evidence of proximate cause. We will also reverse the dismissal of plaintiffs' RICO claims. In addition, we will affirm the entry of summary judgment on plaintiffs' breach of fiduciary duty claims because a reasonable jury could not find a confidential or special relationship between plaintiffs and KPMG.

A.

1.

Under Nevada law, both fraud and negligent misrepresentation claims require proof of justifiable reliance. E.g., Collins v. Burns, 741 P.2d 819, 821 (Nev. 1987) (fraud); Barmettler v. Reno Air, Inc., 956 P.2d 1382, 1387 (Nev. 1998) (negligent misrepresentation). While justifiable reliance does not normally require the recipient ofmaterial statements to investigate their veracity, that is not the case when the relying party knows of "facts to alert [him] his reliance is unreasonable." Collins, 741 P.2d at 821. Although negligence is not a defense to fraud, "[t]he test is whether the recipient has information which would serve as a danger signal and a red light to any normal person of his intelligence and experience." Id. "If the [recipient] is aware of facts from which a reasonable person would be alerted to make further inquiry, then he or she has a duty to investigate further and is not justified in relying on" the statements. Woods v. Label Inv. Corp., 812 P.2d 1293, 1298 (Nev. 1991) (per curiam) (discussing Collins, 741 P.2d at 821) (real property transaction).

2.

Like the District Court, although for different reasons,⁴ we conclude plaintiffs have failed to point to evidence that they justifiably relied on Hasting or KPMG's assertions that the proposed transaction was legal after they ignored red flags that it was not. Accepting as true the evidence plaintiffs have adduced, and drawing all reasonable inferences in their favor, we find no dispute of fact material as to whether plaintiffs justifiably relied on Hasting and KPMG's misrepresentations. Accordingly, we will affirm the grant of summary judgment on plaintiffs' fraud and negligent misrepresentation claims.

Although plaintiffs may not have understood the minute details of the transaction Hasting proposed, they knew and were aware—by their own admission—that there was a crucial red flag that should have prompted them to conduct further investigation. That red flag was not that they were led to believe that they might not have to pay much in taxes, or, as the district court reasoned, that plaintiffs knew the transaction was "too good to be true." A838. The red flag was the knowledge that, under the proposed transaction, plaintiffs did not believe they or their entities would suffer actual losses but still planned to claim those losses as deductions. Plaintiffs did not need to know the intricacies of tax law to see this red flag.

We are compelled to conclude from the undisputed evidence, even while drawing all reasonable inferences in plaintiffs' favor, that they knew the proposed SOS transaction, rather than actually losing them money, would instead generate artificial losses they would claim for tax purposes. Plaintiffs knew the SOS transaction KPMG proposed operated by purporting "to generate losses, generate enough losses to shelter most or all the income," as DDRA's in-house accountant put it. A7009. KPMG promoted the transaction as, and plaintiffs understood it to be, a "turnkey product," A7013, that would mitigate "more than 75 percent" of their income, A4651, for what they knew was the...