Free Reply to Response to Motion - District Court of Federal Claims - federal

Case 1:06-cv-00245-EJD

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IN ruE UNITED STATES COURT OF FEDERAL CLAIMS
Nos. 06-245 T, 06-246 T, and 06-247 T (Consolidated)
MURF AM FARMS, LLC, By and Through Wendell H. Murphy Jr, a Parter Other Than the

Tax Matters Partner,

PSM FARMS, LLC, By and Through Stratton K. Murphy, a Partner Other Than the Tax Matters Partner,

MURPHY PORK PARTNRS, LLC, By and Through Wendell H. Murphy, Jr., a Partner Other
Than the Tax Matters Parter,

Plaintiffs,
v.

United States of America,
Defendant.

DECLARATION OF A. LAWRENCE KOLBE
ON

ECONOMIC IMPLICATIONS OF THE PLAINTIFF'S RESPONSE TO GOVERNMENT'S MOTION TO EXCLUDE EXPERT REPORT AND TESTIMONY OF MELVIN F. JAGER
Prepared for the
U.S. Department ofJustice

The Brattle Group 44 Brattle Street Cambridge, MA 02138-3736 617.864.7900 voice
617.864.1576 fax

May i 6, 2008

'"

! GOVERNMENT'S

~ 2
ft

é EXHIBIT '"

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Table of Contents

INTRODUCTION AND SUMMARY ............................. . . . . . . . . . . . . . . . . . . . . . . i
Purpose of

Declaration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Summary of Findings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

ANALYSIS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

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i. INTRODUCTION AND SUMMARY

My name is A. Lawrence Kolbe. My business address is The Brattle Group, 44 Brattle Street,
Cambridge, Massachusetts 02138. I hold a B.S. in from the U.S. Air Force Academy (1968) and
a Ph.D. from the Massachusetts Institute ofTechnülogy (1979), both in economics. I am a financial

economist with three decades of experience in the field. I am co-author of three books and author

or co-author of a number of articles. I have testified on financial and regulatory issues in many
Federal
forums in the U.S. and other countries, including U.S. District Courts and the U.S. Court of

Claims. The appendix to this reply declaration provides more detail on my professional
qualifications. My Expert Report in this matter was submitted on June 1,2007 ("Kolbe Report"),
and my Rcbuttal Report on July 2, 2007 ("Kolbe Rebuttal"). My deposition in this matter was taken
on August 23,2007. I prepared a Declaration in this matter on another

topic that was fied on March

7,2008.
A.
Purpose of

Declaration

I have been provided with two documents, the "Expert Report of Melvin F. Jager," dated June 29,

2007 ("Jager Report") and the "Plaintifts Response to Government's Motion to Exclude Expert
Report and Testimony of Melvin F. Jager," dated April 21,2008 ("Plaintiff

Response"). The latter

document indicates that at least part ofMr. Jager's testimony is intended as rebuttal to parts ofthe

Kolbe Report. I have been asked by counsel to the Tax Division ofthe L.S. Department ofJustice

("001") to provide my views as to whether, from an economic perspective, the Jager Report is
inconsistent in any way with the analyses and conclusions in the Kolbe Report. Thc purpose ofthis

declaration is to respond to this request.

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B. Summary of Findings

Factually, the fees paid to the COBRA advisors and attorneys are a "transaction cost" regardless of
i Moreover, as a practical matter,
what they are called, why they are paid, or how they are computed.

if rc-Iabcling the fccs to advisors and attorneys in arrangements such as the COBRA transactions
rendered the fees irrelevant to an analysis ofthe transactions' profitability apart from tax, it would

essentially always be possible to design such transactions so that their profitability apart from tax
was no different from that of other investments.

Thus, had I been informed before writing my report that the fees to advisors and attorneys

were payments for intellectual propert in the form of a trade secret for how to savc taxcs, I would

have changed none of my economic analyses or conclusions. Consequently, nothing in the Jager
Report is inconsistent with the economic analyses and conclusions in my report.
The remainder of this reply declaration analyzes the statements in the Plaintiff

Response.

II. ANALYSIS

In a section entitled "Statement of Facts," the Plaintiff Response quotes the Kolbe Report to the
effect that I was asked to analyze transactions independently of any tax benefit and taking account

all transaction costs, and that that is what I did in my analyses.2 It then states that3

... Plaintiff wil argue that fees should be allocated to the tax benefits of the
transactions and that any economic analysis ofthe transactions that does not take into
account the tax benefits should likewise exclude the associated fees. In support of

its position that professional fees should be attributed solely to the tax benefits,

The statements in this section are summaries of detailed discussions in the body of

the declaration. It is

prepared only for the convenience ofthe reader, and this section cannot and is not intended to replace the subsequent, more detailed discussions. For this rea50n, this summary does not contain references to the information on which I rely appear documents or data sources. Footnotes that provide the sources of in the body of the declaration.

Plaintiff Response, Section II, part A.
Plaintiff

Response, Section II, part B, citation footnote omitted.
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Plaintiff has produccd the expcrt testimony of Mr. Jager. The Jager Report
concludes that the transactions at issue had the characteristics of a trade secret and, because they wcre valued as such in the market, an appropriate way to compensate the realized the transaetions was to charge a percent of for use ofthe tax aspects of

or potential tax benefits. This is precisely the compensation structure used in this
case.

I have two observations about this statement.
The first observation is that, as a factual matter, the fees paid to advisors are a "transaction
cost" of a set of COBRA transactions regardless of what they are called, why they are paid, or how

they are computed. All of the sets of COBRA transactions analyzed in my report had sueh fees
(although their magnitude varied depending on the year).4 It would be economically irrational for

the advisors to the COBRA transactions to work for free, and economically irrational of the
participants to pay fees for which they received nothing in return.

It is true that thc COBRA transactions' design included the possibility of an economic as
well as a tax benefit.s Howevcr, it was not possible to cnter the COBRA transactions without paying
professional fees for both of these types of

potential benefit. Absent the fees, neither benefit could

be obtained, because the transaetions could not go forward.

In my report, 1 was asked to determine whether absent potcntial tax benefits, the COBRA

transactions produced a reasonable possibility of profit taking into account all transaction costs.
Since, as just discussed, the fees are inextricably linked to the COBRA transactions, they are plainly

"transaction costs." Hence the fees are an essential element of any economic analysis of the

Recall that the i 999 sets of transactions, which include the JBJZ and Tesoro disputes, all had fees to
EYOO 1567,
attorneys and advisors equal to 4.5 percent of the stated cost of the long options (2003

00 i 58 1-82,007040; DOJ 0491 19-21), and the 2000 transactions, i.e., the Murphy Farms disputes, had
fees equal to 2.5 percent of

the long options (DB-DOJ-COBRA-00013479, 3485, 3541,3547,3588,3594,3639,3645,3681,3687,3733, 3739, 3779, 3785, 3848, 3933, 3964,
the stated cost of

3995,4083, 9525, 9526, 9527, 9626, 9632; DB-DOJ-COBRA-00240679 - 00240799).
Recall that I have concluded that the COBRA transactions could not provide a reasonable possibility of profit, taxes aside. See the Kolbe Report, Section II, part F.
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reasonableness of

the possibility of

profit ofthe COBRA transactions, regardless of

their label and

regardless of whether they are viewed as costs associated with the tax-benefit component rather than
the economic-benefit component ofthe transactions. Are-labeling of

the fees as "compensation for

a trade secret for how to save taxes" does not contradict the economic analyses and conclusions in

my report.

My second observation is that, as a practical matter, ifre-labeling the fees to advisors and

attorneys in arrangements such as the COBRA transactions rendered the fees irrelevant to an
analysis of

the transactions' profitability apart from tax, it would essentially always be possible to

design such transactions so that their profitability apart from tax was no different from that of other

investments. All that would be required would be (1) to insure that all transaction costs, including
any unusual fees going to any investment bank or banks involved, were biled as a fee of the

irrelevant sort, and (2) to conduct all other transactions at market value. Transactions at market
value without any transaction costs involved are quite unlikely to produce any abnormal measures
of non-tax profitability.6

Tn short, had I been informed before writing my report that the fees to advisors and attorneys

were payments tor intellectual propert in the form of a trade secret for how to save taxes, I would

have changed none of my economic analyses or conclusions, although I presumably would have
used different words to describe the fees. Thus, nothing in the Jager Report is inconsistent with the

economic analyses and conclusions in my report. Put another way, the Jager Report does not rebut

my report in any way.

this paragraph are present for safety's sake only. As this is written, I cannot think of any way that the non-tax, no-transaction cost profitability of an investment at market value but associated with a tax strategy could be economically different from that of an investment at market value but not associated with a tax strategy.
The "essentially always" and "quite unlikely" parts of

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I declare under penalty of

perjury under the laws ofthe United States that the foregoing is true and

correct. This declaration was executed in Cambridge, Massachusetts on May l3, 2008.

ar~
A. Lawrence Kolbe

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Appendix: QUALIFICATIONS OF A. LAWRENCE KOLBE

EDUCATION
B.S. in International Affairs (Economics), U.S. Air Force Academy, 1968.
Ph.D. in Economics, Massachusetts Institute of

Technology, i 979.

EMPLOYMENT
U.S. Air Force, 1963-1977
Charles River Associates, i 978-1985 Putnam, Hayes and Bartlett, 1985- i 990

The Brattle Group, 1990-

HONORS AN AWARDS
Sears Foundation National Merit Scholarship, 1963 (declined). Fairchild Award, U.S. Air Force Academy, 1968 (for standing first in his class, academically). National Science Foundation Graduate Fellowship in economics, MIT, 1968-l971. Joint Service Commendation Medal, 1975.

PROFESSIONAL AFFILIA nONS
American Economic Association American Finance Association
The Econometric Society

Served as Referee for The Rand Journal of Economics, Land Economics, The Journal of Industrial Economics

PAPERS AN PUBLICATIONS IN THE LAST TEN YEARS
"How to Value a Lost Opportnity: Defining and Measuring Damages from Market Foreclosure,"

(with William B. Tye and Stephen H. Kalos), The Economics of Antitrust Injury and Firm-Specifc Damages, Kevin S. Marshall, ed., Tucson, Arizona: Lawyers & Judges Publishing Company, Inc. (2008). (Republication of a 1995 article.)
"Measuring Return on Equity Correctly: Why current estimation models set allowed ROE too low," Public Utilities Fortnightly (with Michael J. Vilbert and Bente Villadsen), August 2005.
"The Effect of

Equity in a Regulatory Setting," (with Michael J. Vilbert and Bente Viladsen, and with "The Brattle Group" listed as author), published by the Edison Electric Institute (dated January 2005, issued April 2005)
Debt on the Cost of

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Investment and Valuation, (with Richard A. Brealey and Stewaii C. Myers, with "The Brattle Group" listed as third author), New York: McGraw-HilI/Irwin (2003).
Capital

"The True Hourly Rate for Private Counsel in the State of Louisiana Tobacco Lawsuit," (with
August J. Bakcr and Bin Zhou), Brattle report prepared for private counsel to the Louisiana Attorney General in the state's lawsuit to recover health care costs from the tobacco industry (July 2000).
"The Cost of

Capital for the Dampier to Bunbury Natural Gas Pipeline," (with M. Alexis Maniatis

and Boaz MoselIe) Brattle report submitted to thc Office of Gas Access Regulation, Western
Australia (October 1999).

"Compensation for Asymmetric Risks," (with others) Brattle report prepared for GPU PowerNet, Melbourne, Australia (October 1999).
"A Non-Practitioner's Guide to the State of

Capital Estimation," (with others) Brattle report prepared for GPU PowerNet, Melbourne, Australia (June 1999).
the Art in Cost of "A Note on the Pre-tax Weighted Average Cost of

Capital in a Regulatory Context with Australian

Dividend Tax Credits and Alternative Debt Refinancing Policies" (with M. Alexis Maniatis),
Working Paper in Progress.
"The Impact of Stranded-Cost Risk on Required Rates of

An Example" (with Lynda S. Borucki). Journal of

and Regulatory Economics Vol. 13 (1998), 255-275.
Return for Electric Utilities: Theory

TRIAL TESTIMONY AND DEl'OSITIONS IN LAST FOUR YEARS
2004

Casc: Party: Forum: Case:

Coltcc Industries, Inc. v. The Unitcd States otAmerica, Fed. CI. No. 01-72T The United States of Ameriea
The United States Court of

Fedcral Claims

Part:
Forum:
Case:

Libert Digital, Inc. v . AT&T Broadband, LLC and Comcast Corporation, Civil Action No. 03-CV-95 AT&T Broadband, LLC and Comcast Corporation Colorado District Court, County of Arapahoe, 18th Judicial District
West Virginia-American Water Company, Case No. 04-0373-W-42T West Virginia-American Water Company West Virginia Public Service Commission of
Koch Industries, Inc., and Subsidiaries v. The United States, Fed. CI. No. 028T The United States Federal Claims The United States Court of
A-2

Pary:
Forum:
Case:
Part : Forum:

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Case: United States of

America v. Anne (Sandy) Batchelor-Robjohns, a!aI

Anne O'Neil Batchelor; Daniel J. Ferraresi; Marvin C. Gutter; and Father Patrick O'Neil, Co-Personal Representatives ofthe Estate of
George E. Batehelor, Case No. 03-20164-CIV-Ungaro-

Party: Forum:

Benages/Brown United States of America

United States District Court for the Southern District of Florida, Miami
Division

2005
Case:

Part:
Forum:
Case: Party: Forum:

TransCanada PipeLines Limited 2004 Mainline Tolls and Tariff (Phase 2), RH-2-2004 TransCanada PipeLines Limited (Canadian) National Energy Board
Polymer Dynamics, Inc. v. Bayer Corporation Polymer Dynamics, Inc.
U.S. District Court for the Eastern District of

Pennsylvania

Case:

Part:
Forum:
2006
Case:

Jade Trading, LLC, by and through Robert W. Ervin and Laura Kavanaugh Ervin on Behalf of Ervin Capital, LLC, Partners Other than the Tax Matters Partner, v. The United States, Case No. 03-2l64T The United States Federal Claims The United States Court of

Part:
Forum:
Case:

Arizona-Ameriean Water Company, Inc., for Utility Service by its Paradise Valley Water District, Docket No. WS-01303A-05-0405 Arizona-American Water Company, Inc. Arizona Corporation Commission
K2 Trading Ventures, LLC, New Vista, LLC, Tax Matters Parter, v. The United States of America, by and through the Internal Revenue Service, Case No. 04-l4 i 9T The United States of America The United States Court of Federal Claims
.

Part : Forum:
Case: Party: Forum:

Garco Investments LLP, ct al. v. Sprint Corporation, Case No. 04 CY 0 i 714 Garco Investments LLP, et al. District Court of Johnson County, Kansas, Civil Court Department

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2007

Case:

JZ Buckingham Investments, LLC as Tax Matters Partner of .IDJZ Partners,
a South Carolina general partership, v. United States of America, Case No.

Part:
Forum:
Case:

05-231 T United States of America
The United States Court of

Federal Claims

Gary Woods, as Tax Matters Partner of Tesoro Drive Partners, a Texas
general partnership, and Gary Woods, as Tax Matters Partner of

SA Tesoro

Investment Partners, a Texas general partnership, v. United States of
Party: Forum:

America, Case Nos. SA-05-CA-0216-XR. United States of America
United States District Court for the Western District of

Texas, San Antonio

Division
Case:
MURF AM FARMS, LLC, By and Through Wendell H. Murphy Jr., a Partner Other Than the Tax Matters Partner; PSM FARMS, LLC, By and Through

Stratton K. Murphy, a Partner Other Than the Tax Matters Partner;
MUHY PORK PARTNRS, LLC, By and Through Wendell H. Murphy,

Jr., a Partner Other Than the Tax ~atters Parter, v. United States of

Part:
Forum:

America, Case Nos. 06-245 T, 06-246 T, and 06-247 T (Consolidated). United States of America Federal Claims The United States Court of
Fidelity International Currency Advisor A Fund, L.L.c., by the Tax Matters Partner, v. United States of America, Case No. 05-40151-FDS. United States of America Massachusetts United States District Court for the District of

Case:
Party: Forum:

2008
Case:
Northwestern Energy, Docket No. 2007.7.82

Part:
Forum:

Northwestern Energy
Department of Public Service Regulation, Montana Public Service

Commission

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