Former LTCM partner Myron Scholes's claim not be an expert on taxes does not enhance his credibility in the LTCM tax evasion trial:
Posted by DeLong at July 10, 2003 08:04 AM | TrackBackPartner Questioned on Tax Shelter Profits: ...the Internal Revenue Service disallowed a tax shelter that the economist, Myron S. Scholes, acquired for Long-Term Capital Management.... The government is seeking $40 million in taxes and $16 million in penalties and interest.... Under questioning by his own lawyer... Scholes... explained that he knew the tax shelter must have had real economic substance.... Given that the shelter could provide $375 million in tax benefits but cost the fund about $4 million, Dr. Scholes said, he worked hard to make it viable.... [A]fter he answered a question showing that the shelter could not have turned a profit, and with no question pending, Dr. Scholes revealed what was on his mind. "I'm being trapped here," he blurted out....
Mr. Hurley, a career Justice Department litigator, [had] opened an aggressive line of questioning aimed at impeaching Dr. Scholes's testimony the day before, in which he minimized his expertise about taxes. "I said I was not an expert with regard to taxes," Dr. Scholes said. Mr. Hurley held up a copy of "Taxes and Business Strategy," a $130 text used at Stanford's graduate school of business; the primary author is Dr. Scholes....
Many of Mr. Hurley's questions were framed to elicit a simple yes or no. Often Dr. Scholes would argue with the question, then navigate a maze of potentials, prospects, possibilities and expectations before coming to a one-word conclusion.... Dr. Scholes parsed a seemingly simple question into three parts, two of which had two subpoints each, and turned it all into a seamless soliloquy that lasted more than two minutes -- without a single pause or "um" -- before boiling his own words down to one: yes....
[Hurley] urged Dr. Scholes to put a figure of $900,000, maybe $1 million, on the potential profits apart from the tax benefits. Mr. Hurley's endgame began to emerge when he started asking about fees for opinion letters from lawyers saying that the tax shelter should survive an audit. The letters... cost more than $900,000.... [T]he bonus to one Long-Term executive, somewhere from $50,000 to $100,000.... And finally there was the big question, though it was asked so subtly that the first time Dr. Scholes answered without much argument. Yes, he testified, he had asked for and received a multimillion-dollar bonus from the other partners in Long-Term Capital for finding the tax shelter and strengthening it.... Add in the millions paid as a bonus to Dr. Scholes and the shelter could not show a profit apart from the tax benefits...
A book I read many years ago, "The Art of Cross-Examination", says (with a typical lawyer's double negative) that the first rule of cross-examination is "Never ask a question that you don't know the answer to". Sounds like Scholes is being questioned by someone who's following the rule...
Posted by: Matt on July 10, 2003 08:24 AMThe dog ate my homework, and besides everyone else has a tax shelter. Spend $4 million to save $375 million. Nice ring there.
Posted by: jd on July 10, 2003 08:48 AMI infer from this that this is not a jury trial:
"Testimony is scheduled to resume Thursday before Judge Janet Bond Arterton in Federal District Court."
So the theatrics may not be as important. Still, this is brutal.
Posted by: Tom Maguire on July 10, 2003 08:59 AMOf course, LTCM could have paid taxes. Nahhhhh.
Posted by: lise on July 10, 2003 09:05 AMA book I read many years ago, "The Art of Cross-Examination", says . . .that the first rule of cross-examination is "Never ask a question that you don't know the answer to".
A great book, recommended even to laypeople, although the examples are a little dated ( and sexist). A more contemporary example, don't ask OJ to try on the glove unless you know it fits . . .
:)
Scholes saying "I'm not an expert on taxes". God the prosecution lawyers must have raised a couple of glasses about that one in the evening.
For non-economist readers, this is roughly the equivalent of John McEnroe saying "I'm not an expert on tennis".
Posted by: dsquared on July 10, 2003 10:02 AMThis story could also go under Dr. DeLong's "why don't we have a better press corps?" rubric.
The lead, that prosecutors demonstrated there was no way for the shelter to show a profit after fees and expenses, was at the very end of the story.
And the comical notion that Scholes tried to pass himself off as a non-expert on taxes is right up there with the great courtroom howlers of all time.
Posted by: George Zachar on July 10, 2003 11:14 AMPlease!!! Does anyone want an opinion letter from me saying their tax shelter will survive an audit. Nine hundred thousand dollars an opinion? Wow. I've got opinions, just ask. Please, I do have opinions, and I work for less.
Posted by: emma on July 10, 2003 11:52 AMThis reminds me of nothing so much as Bill Gates' testimony during the antitrust trial: strange lapses of memory, unusual displays of modesty and incompetence ... I expect, if there is any justice in the world, that the outcome will be the same, i.e, guilty.
Posted by: Abiola Lapite on July 10, 2003 12:11 PMSmart witnesses are often the most difficult to prepare for cross examination. They think they can argue against the questions, making themselves look foolish in the process and providing the other side with more statements to use against them.
Posted by: nameless on July 10, 2003 12:25 PMWhatever Emma is selling her opinions for, I can go 10% under! Really, $900,000 and they didn't even come up with the right answer. Hey, it's a crap shoot - mebbe 'yes', mebbe 'no', mebbe just 'mebbe'.
Posted by: Dave on July 10, 2003 01:03 PM...with no question pending, Dr. Scholes revealed what was on his mind. "I'm being trapped here," he blurted out....
~~~
Good! Kudos to my brothers at the bar.
That's what we do to economists. ;-)
Posted by: Jim Glass on July 10, 2003 01:09 PMThe mind-bending part is that the $900,000 spent on the legal opinions that stated the transaction had economic substance in the IRS sense, may have actually stripped the transaction of economic substance. Perversely, the more time the lawyers billed, the less the opinion was worth.
Posted by: Sequoia on July 10, 2003 02:15 PM(sigh) Reading all of this soooo personally depressing...
I took tax writing and research with a professor who was tax matters partner for a $25 Billion holding company. As our written assignment, I wrote two sample opinion letters. I got an "A" on both, and the prof wrote in the margins, "Good work, you will go far." But after passing the bar, I lost my way and decided to go into legal aid: Now I make less than $50K in salary and benefits helping poor people.
There is some serious market failure going on here. I could spend one month working on such an opinion and charge $100K. The client would save $800K, get an opinion just as good as Dr. Scholes', and I could work as a volunteer at legal aid for the rest of the year, allowing that $50K to hire another attorney to help even more poor people.
Why can't I find this job?
(sigh)
With the evil inspiration of Mr. Glass provoking me, I will observe that a lot of water has passed under the bridge since someone NOT named Scholes said this:
"This is, I think, the reason that we economists regard most lawyers like cats regard small birds: Flighty things. Unable to keep their minds focused on what matters. And our lawful prey."
Posted by: Tom Maguire on July 10, 2003 05:22 PMDuring his video taped deposition I heard Bill Gates actually say he did not know what that term “market share” means! Here’s another. The Treasurer of Orange County, Robert Citroen pranced around the country touting himself as the greatest investor because Orange County was enjoying a 10% return while other counties were getting by on a mere 3%. But when the Fed raised interest rates in 1994, all those structured notes and inverse floaters he borrowed heavily to buy blew up, the richest county in the US went bankrupt. Nevertheless, Citroen told a special committee of the California Senate that he was an “inexperienced investor.” Orange County then tried to blame Merrill Lynch for their financial debacle. However, Merrill had sent several letters to Citroen warning him that his positions were risky. Now we have chutzpah squared when Scholes claims he is not an expert on corporate taxation! Lessons learned. We seem to be in an age where people are incapable of feeling embarrassed. Say anything and see if you can get away with it. Perhaps they learned from the master: “That depends on what the meaning of ‘is’ is.”
Posted by: A. Zarkov on July 10, 2003 08:54 PMThis story gives me a big attack of schadenfreude. A nobel laureate economist who must make a six figure income from his professor's salary alone, uses his genius not for the advancement of knowledge but to abet shady tax evasion schemes.
Posted by: Phil P on July 11, 2003 07:09 AM"Perversely, the more time the lawyers billed, the less the opinion was worth."
Please please please read "Bleak House." Charles Dickens knew corporate law before corporate law.
That's not entirely fair. Scholes' schemes for LTCM were absolutely incredibly clever, and a lot of his academic work on tax wedges and incentives has advanced knowledge quite a long way. In principle, thanks to Scholes' work, one could design a much better taxation system than we have now.
Posted by: dsquared on July 11, 2003 09:37 AMLTCM is the tip of the iceberg. Tax attorneys all the time set up elaborate tax shelter schemes and then ask some economist to say it has "economic substance". The problem is that tax attorneys are good at twisting the clear meaning of economic terms. For an economist to say it has "economic substance" and then turn around and say - "gee, I didn't really know how this concept was being defined" may sad like "the dog ate my homework" but it happens a lot. Two parties are at fault - the economist for being too eager to make a buck and the attorney for playing wordsmith games. But if anyone suggests Dr. Scholes did something novel, they don't realize how big this iceberg truly is.
Posted by: Hal McClure on July 11, 2003 01:17 PM>
He could have continued his work on that rather than on tax "schemes".
Maybe I have an idealistic view of scholarship. I don't mind a professor making outside income. I don't insist they use their talents for the public good if they don't want to - I just hate it when they use it for the public bad.
>
He could have continued his work on that rather than on tax "schemes".
Maybe I have an idealistic view of scholarship. I don't mind a professor making outside income. I don't insist they use their talents for the public good if they don't want to - I just hate it when they use it for the public bad.
Dare I suggest Mr. Scholes, hemmed in by carefully-plotted lines of questioning ... simply ran out of OPTIONS???
Posted by: RonK, Seattle on July 12, 2003 01:33 PMOh, the irony. The same LTCM had the stones to ask the Treasury for a bailout was unwilling to shoulder its fair tax burden.
Posted by: Kevin on July 15, 2003 05:56 PMOh, the irony. The same LTCM had the stones to ask the Treasury for a bailout was unwilling to shoulder its fair tax burden.
Posted by: Kevin on July 15, 2003 05:58 PM