Free Published Opinion - District Court of Federal Claims - federal

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In the United States Court of Federal Claims
Nos. 05-956T, -971T & 06-285T (Filed August 22, 2007) *********************** DAVID S. and MALIA A. LITMAN, Plaintiffs-Counterdefendants, v. THE UNITED STATES, Defendant. __________________________________ ROBERT B. and MICHELLE S. DIENER, Plaintiffs-Counterdefendants, v. THE UNITED STATES, Defendant. __________________________________ HOTELS.COM, INC., and Subsidiaries (f/k/a HOTEL RESERVATIONS NETWORK, INC.), Plaintiffs, v. THE UNITED STATES, Defendant. *********************** * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Tax; tax refund; valuation of restricted stock options; judicial estoppel; judicial admission; liability for penalties.

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John W. Porter, Houston, TX, for plaintiffs-counterdefendants Litmans and Dieners. Stephanie Loomis-Price and J. Graham Kenney, Baker Botts, LLP, of counsel. Kim Marie K. Boylan, Washington, DC, for plaintiffs Hotels.com. Kari M. Larson and Jennifer S. Crone, Latham & Watkins, LLP, of counsel. Cory A. Johnson, Washington, DC, with whom was Acting Assistant Attorney General Richard T. Morrison, for defendant. Steven I. Fraham, Tax Division, of counsel. MEMORANDUM AND OPINION MILLER, Judge. This case, before the court after trial, arises from the failure of individual and corporate taxpayers to report one consistent value for almost 10 million shares of restricted stock issued in February 2000 to plaintiffs-counterdefendants David S. Litman and Malia A. Litman (collectively, the "Litmans") and Robert B. Diener and Michelle S. Diener (collectively, the "Dieners"). 1/ Messrs. Litman and Diener are the founders of Hotels.com,

1/ Although the court has considered the testimony of every witness, discussion of each is not necessary in order to render a comprehensive decision. The Litmans and the Dieners presented one expert witness, Mark L. Mitchell, CFA, ASA, Director of Valuation Services for Clothier & Head, P.S., an accounting firm. Mr. Mitchell holds an M.B.A. from Southern Methodist University in Dallas, TX, and was qualified to give an opinion regarding the fair market value of the subject Hotel Reservations Network, Inc. ("HRN") restricted stock. The following fact witness testified for the Litmans and the Dieners: (1) David S. Litman, CEO and a founder of the two predecessor companies of Hotels.com, Inc. & Subsidiaries (f/k/a Hotel Reservations Network, Inc.) ("Hotels.com"); (2) Robert B. Diener, President and a founder of Hotels.com's two predecessor companies; (3) John R. Bozalis, Jr., a Vice President at Donaldson Lufkin Jenerette, S.C. ("DLJ"), from 1997 to spring 2000, who focused on initial public offerings ("IPOs") and merger and acquisition advisory work; (4) Malia A. Litman, Esq., the wife of Mr. Litman; (5) Susan F. Weiss, an agent for the Internal Revenue Service (the "IRS"), who was assigned to audit the Litmans, the Dieners, and Hotels.com; (6) Brian Lidji, Esq., who represented Messrs. Litman and Diener in the sale of Hotel Reservations Network and the negotiations that resulted in the Amended and Restated Asset Purchase Agreement (the "ARAPA"); he also occasionally represented HRN; (7) Melville W. Robinson, Chief Financial Officer at HRN beginning in September 2000; and (8) Michelle S. Diener, the wife of Mr. Diener, who performed accounting services for 2

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Inc. & Subsidiaries's two predecessor companies, TMF, Inc. ("TMF") and HRN Marketing Corp. ("HRN Marketing").

1/ (Cont'd from page 2.) HRN until approximately 1999. The Litmans and the Dieners offered deposition testimony of the following individuals: (1) Eric DeGraw, Tax Director at InterActiveCorp since 1998; and (2) James L. Horan, who was Managing Partner in charge of tax and the Managing Partner of the South Florida Business Unit at KPMG, LLP ("KPMG"), from the late 1990s until his retirement in September 2002. Hotels.com and defendant counter-designated testimony that they introduced. Hotels.com offered one expert witness, Dr. Mukesh Bajaj, a Senior Managing Director of Finance and Damages Practice at LECG, LLC, an international consulting firm, who holds a Ph.D. in Business Administration from the University of California at Berkeley. Dr. Bajaj gave his expert opinion for Hotels.com regarding the fair market value of the HRN restricted stock. The following fact witnesses testified for Hotels.com: (1) Viren B. Ghandi, CPA, Senior Director of Finance at Hotels.com; (2) Dara Khosrowshahi, Vice President of Strategic Planning for USA Networks, Inc. ("USA Networks") from 1998 until January 2002 when he became Chief Financial Officer of InterActiveCorp (f/k/a USA Networks, Inc.) ("IAC"); in December 2004 he became Chief Executive Officer of IAC Travel; and, most recently, in 2005 he became Chief Executive Officer of a new publicly traded company, Expedia, Inc., the parent company of Hotels.com; and (3) Thomas J. Kuhn, Esq., who was Chief Legal Officer at IAC during the acquisition of the company that became known as HRN. Hotels.com offered deposition testimony of Christine Zeikel, CFA, a principal in the Financial Advisory Service practice at Deloitte & Touche LLP, an investment bank, who handled a valuation for USA Networks in 2001 of the restricted shares of HRN stock. The Litmans, the Dieners, and defendant counter-designated portions of this deposition. Testifying for defendant was one expert witness, Francis X. Burns, ASA, a Vice President of CRA International, a publicly traded consulting firm focusing on economic analysis, valuation work, and strategy consulting. Mr. Burns was defendant's expert regarding the fair market value of the HRN restricted stock. The following fact witnesses testified for defendant: Jean M. Wharton, a "90-day reviewer" with the IRS in 2004 in the Exam Division, Technical Services in Dallas, TX. Transcript of Proceedings Litman v. United States, Nos. 05-956T, -971T, & 06-285T, at 150 (Fed. Cl. Apr. 30-May 9, 2007) ("Tr."). Ms. Wharton prepared the Statutory Notice of Deficiency that was issued to the Dieners. 3

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In 1999 TMF and HRN Marketing sold substantially all of their assets to HRN, Inc. ("HRN"), "a newly-created, wholly-owned subsidiary of USA Networks, Inc." ("USA Networks"). Hotels.com's Br. filed Feb. 26, 2007, at 6 (footnote omitted). In 2002 USA Networks changed its name to USA Interactive. In June 2003 USA Interactive again changed its name to InterActiveCorp. HRN changed its name to Hotels.com, Inc. & Subsidiaries ("Hotels.com") in 2002. As founders of the predecessor companies, when HRN completed its initial public offering (the "IPO"), Messrs. Litman and Diener received 9,999,900 restricted shares of HRN stock through TMF Liquidating Trust, an entity that the Litmans and the Dieners created to liquidate their former companies. On their 2000 personal income tax returns, the Litmans and the Dieners reported that the 9,999,900 restricted shares of HRN stock had an average weighted value of $4.54 per share. In contrast, on its 2000 tax return HRN reported that the approximately 10 million shares of restricted stock had a value of $16.00 per share. This figure was HRN's predicate for taking a goodwill amortization deduction. Defendant complains that the Litmans, the Dieners, and Hotels.com have "whipsawed the IRS," creating "a tax gap of approximately $115 million." Def.'s Br. filed Apr. 2, 2007, at 2. Defendant is seeking over $5.7 million in assessments and penalties from the Litmans and the Dieners. Defendant has reserved filing of a counterclaim for interest and penalties against Hotels.com pending the ultimate valuation of the stock. BACKGROUND AND FACTS Friends since Cornell Law School, Messrs. Litman and Diener have been business partners since the early 1980s. In the early 1990s the men saw an opportunity to enter the hotel market. In 1991 Messrs. Litman and Diener founded TMF, a Texas corporation, and HRN Marketing, a Florida corporation, and began doing business as Hotel Reservations Network. These men were impressive in their dedication and vision, although they, like USA Networks, Hotels.com's predecessor entity, entered legal agreements that did not achieve their anticipated objectives relating to the tax consequences of their transactions. Originally, Hotel Reservations Network's business model was simple: it took telephone calls from customers and found ways of getting them discounts on hotel rooms. As Mr. Diener, President of Hotel Reservations Network, explained: "For example, maybe there would be a AAA discount rate, or someone was retiring, you could get them a[n] AARP rate. And so we booked hotels . . . for a commission from the hotels." Transcript of Proceedings, Litman v. United States, Nos. 05-956T, -971T, & 06-285T, at 311 (Fed. Cl. Apr. 30-May 9, 2007) ("Tr."). Eventually, this model proved unworkable because Hotel Reservations Network collected only about 60% of its commissions. As a result, Messrs. Litman and Diener decided to change their business model to what eventually came to be 4

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known as the "merchant model." Id. at 54. In late 1992 Hotel Reservations Network began contracting with individual hotels for a low net rate on a group of hotel rooms and then selling those rooms to customers at a higher price. After sales to customers, Hotel Reservations Network would pay the hotels for rooms, thus avoiding the expenditure of time and money collecting commissions from the hotels. While the merchant model had been used previously, distinguishing Hotel Reservations Network from its competitors was the decision to use the model in a variety of different cities, starting in New York, NY; Washington, DC; and Boston, MA. In 1994 Hotel Reservations Network began developing a website, integrating the Internet into its business model. The website that was launched in 1995 was simple compared to the websites with which Internet users are familiar today. To book a room, a customer would send an e-mail request to Hotel Reservations Network and wait for a response. According to Mr. Litman, CEO of Hotel Reservations Network, the process was "clunky" because the "typical response time was between four and 12 hours . . . ." Id. at 52. Mr. Diener elaborated that "[s]omeone would request a booking; it may take a couple of days before we would actually respond. It may go back and forth, sometimes [it was] a week before we . . . confirmed the actual hotel . . . ." Id. at 312. Messrs. Litman and Diener, however, saw potential in the Internet. "[W]e recognized that, hey, this is an interesting method of business. It's getting us customers that we would not otherwise have gotten." Id. at 52-53 (testimony of Mr. Litman). By early 1998 Hotel Reservations Network's website became "interactive," and, selling from an inventory of hotel rooms, it was able to confirm hotel reservations immediately. Id. at 53, 312. Between 1992 and 1998, the company grew significantly, as reported earlier in a Confidential Information Memorandum dated June 1998 prepared by Donaldson, Lufkin & Jenrette, S.C. ("DLJ"). "Revenues increased by 113% to $9.0 million in the first quarter of 1998 from $4.2 million in the first quarter of 1997, primarily due to dramatically higher revenues generated from the Company's websites." HX 308 at 29. One of the factors expanding Hotel Reservations Network's business was recruiting affiliates to sell hotel rooms for the company's account. Typically, the affiliate contracts lasted one to three years. "[W]e became kind of a back end booking engine for other websites and other travel providers." Tr. at 56 (testimony of Mr. Litman). These affiliates included Cheap Tickets, Travelocity, airline reservation websites, the New York Convention and Visitors Bureau. By 1998 affiliate contracts with other providers of hotel rooms represented approximately twothirds of Hotel Reservations Network's business. Critical to the success of Hotel Reservations Network was the company's ability to obtain, first, a profitable margin from the hotels and, second, a sufficient allotment of hotel rooms. The margin is the difference between the price that hotels charged Hotel 5

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Reservations Network as a net rate and the price at which the company was able to sell the hotel rooms to the public. The ability of Hotel Reservations Network to secure a profitable margin depended on the hotels giving Hotel Reservations Network a net rate that was below the price that the hotels were offering to the public. Hotel Reservations Network's success also depended on its ability to get an allotment of hotel rooms ­ a group of rooms for "[Hotel Reservations Network's] exclusive use and sale, that [it] could sell in an automated way . . . ." Tr. at 57 (testimony of Mr. Litman). Hotel Reservations Network had to make sure that it had enough hotel rooms in its allotment to sell interactively on its website. Therefore, contracts were negotiated with individual hotel providers to ensure that Hotel Reservations Network received sufficient margins and allotments. Primarily, Mr. Diener and Andrew Pells, Senior Vice President of Hotel Reservations Network, and one of its key employees during the company's early years, worked to create "harmonious" relationships with hotel providers. Id. at 58 (testimony of Mr. Litman). The hotel contracts typically last a year, as Mr. Litman said, "[A]ll we sold was hotels. We were the butcher, . . . we were just one shop. So we had to have contracts with the hotels." Id. In 1998 Messrs. Litman and Diener received their first offer to sell Hotel Reservations Network to a public company. While they ultimately rejected the offer, it prompted Messrs. Litman and Diener to approach DLJ to represent them in the sale of their company. DLJ coordinated the sale of Hotel Reservations Network. Dara Khosrowshahi, who today is the CEO of Expedia, Inc., the parent company of Hotels.com, was the lead negotiator in the acquisition of Hotel Reservations Network. In 1998 Mr. Khosrowshahi was USA Networks's Vice President of Strategic Planning. In that role he was responsible for the "strategy of [USA Networks] in mergers and acquisitions." Id. at 758. Mr. Khosrowshahi set the stage for USA Networks's interest in Hotel Reservations Network: We owned Ticketmaster at the time, and Ticketmaster was a company which . . . transacted half their business over the phones and half their business in [a] retail outlet. . . . [Ticketmaster] started a website ticketmaster.com, and in ­ and it was a lark, but in a year or two, 5 percent of their transactions went on the web. And when you looked at where the transactions came from, they came from the phone. So almost all the transactions were moving from the phone onto the internet.

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So we looked around and said, what other businesses look like Ticketmaster where you're making advance reservations for seats. You've got a product that you don't have to touch and feel. . . . And then we saw this company Hotel Reservations Network, which was a hotel consolidator that had a phone business that was developing an internet channel really quickly. So we saw the same dynamics as we saw in Ticketmaster[], and we thought that it could be something that was really, really interesting. . . . Id. at 760-61. While Mr. Khosrowshahi recommended the acquisition of Hotel Reservations Network, any decision to bid on Hotel Reservations Network or acquire the company ultimately was subject to the approval of Barry Diller, CEO and Chairman of USA Networks, and Victor A. Kaufman, Vice Chairman of USA Networks. The sale of Hotel Reservations Network in 1999 to USA Networks was structured so that HRN, a wholly-owned subsidiary of USA Networks, bought "substantially all of the assets, properties, rights and business of" TMF and HRN Marketing, d/b/a Hotel Reservations Network, as reflected in the April 13, 1999 Asset Purchase Agreement (the "Asset Purchase Agreement"). The original agreement entitled Messrs. Litman and Diener, as the shareholders of TMF and HRN Marketing, to $150 million and potentially additional purchase payments, depending on the company's performance in the future with Messrs. Litman and Diener retained at the helm. Asset Purchase Agreement § 3. The Asset Purchase Agreement was primarily negotiated between Messrs. Litman and Diener, acting for themselves, and Mr. Khosrowshahi, for USA Networks. Brian Lidji was the attorney representing the Litmans and the Dieners, while Paul, Weiss, Rifkind, Wharton & Garrison, LLP, represented USA Networks. Thomas J. Kuhn, Senior Vice President and General Counsel of USA Networks from approximately 1997 through 2000, was responsible for overseeing the transaction "as it related to both the acquisition of HRN and the subsequent public offering." Tr. at 885. Mr. Kuhn described himself as involved in "every detail" of the negotiations and acquisition of Hotel Reservations Network. Id. at 890. According to Mr. Khosrowshahi, one of the important terms of the sale of Hotel Reservations Network from USA Networks's perspective, was a "deal structure which would permit [USA Networks] to amortize the purchase price for tax purposes." HX 304; see Tr. at 768-69 ("[T]his deal was a bit unusual in that we were able to structure it in a way that would allow us to take the purchase price and amortize the purchase price for tax purposes over some period of time. . . . so the amortization really was cash that we would avoid paying 7

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in taxes over a number of years, and the net present value of that was very, very significant. . . . I think over $50 million value . . . ."). The structure allowed USA Networks to pay more cash up front. The Asset Purchase Agreement, which encapsulated the final agreement between the parties as to the sale of Hotel Reservations Network, defined Purchase Price, as follows: 3.1 Purchase Price. The aggregate purchase price for the Purchased Assets (the "Purchase Price") shall be an amount equal to (I) $150 million (as adjusted pursuant to Section 3.3 below); (ii) the Quarterly Deferred Payments, if any, provided in Section 7.10; (iii) the Additional Purchase Payment, if any, provided in Section 7.9; (iv) the Participation Payment, if any, provided in Section 7.11 and (v) the aggregate amount of the Assumed Liabilities on the Closing Date. Asset Purchase Agreement § 3.1. Under the terms of the Asset Purchase Agreement, Messrs. Litman and Diener could earn Additional Purchase Payments, Quarterly Deferred Payments, 2/ and Participation Payments, depending on how HRN performed in the future. Section 7.9 of the Asset Purchase Agreement set forth the methodology for determining the Additional Purchase Price to be paid to the Litmans and the Dieners: 7.9.2 1999 Additional Purchase Price Payment. . . . [F]ollowing the final determination of the 1999 Adjusted EBT and Adjusted Gross Profit in accordance with paragraph 7.9.1 above, the Buyer [HRN] shall pay to the Sellers [TMF, Inc. and HRN Marketing Corp.], by wire transfer of

2/ Subject to limitations, the Asset Purchase Agreement provided also for Quarterly Deferred Payments to be made if the Adjusted Gross Profit for such fiscal quarter as so determined exceeds 25% of the target Adjusted Gross Profit for such quarter as reflected on Schedule 7.10 attached hereto (the "Target Adjusted Gross Profit"), the Buyer shall pay to the Sellers by wire transfer of immediately available funds, an amount equal to (x) $12.5 million times (y) the Deferred Payment Adjuster (as defined below) (the "Deferred Payment"). Asset Purchase Agreement § 7.10.1(c). 8

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immediately available funds, an amount equal to the greater of (I) the product of (x) the amount, if any, by which the 1999 Adjusted EBT exceeds 1998 Adjusted EBT times (y) 2.5, and (ii) if 1999 Adjusted Gross Profit is at least 50% greater than 1998 Adjusted Gross Profit, (x) the amount by which the 1999 Adjusted Gross Profit exceeds 1998 Adjusted Gross Profit times (y) 1.44. Asset Purchase Agreement § 7.9.2. The Asset Purchase Agreement used similar formulas for calculating the Additional Purchase Price Payments for 2000 and 2001 that the Litmans and the Dieners were entitled to as part of the sale. 3/ Pursuant to Section 7.11.1 the Asset Purchase Agreement provided for Messrs. Litman and Diener to receive Participation Payments using the following formula:

3/ The following was set forth as the formula for calculating the 2000 Additional Purchase Price Payment: [A]n amount equal to the greater of (I) the product of (x) the amount, if any, by which the 2000 Adjusted EBT exceeds the greater of (A) 1999 Adjusted EBT and (B) 1998 Adjusted EBT times (y) 2, and (ii) if 2000 Adjusted Gross Profit is at least 35% greater of (A) 1999 Adjusted Gross Profit and (B) 1998 Adjusted Gross Profit, (x) the amount by which the 2000 Adjusted Gross Profit exceeds the greater of (A) 1999 Adjusted Gross Profit and (B) 1998 Adjusted Gross Profit times (y) 1.18. Asset Purchase Agreement § 7.9.3. The formula for calculating the 2001 Additional Purchase Price Payment was also similar: [A]n amount equal to the greater of (I) the product of (x) the amount, if any, by which the 2001 Adjusted EBT exceeds the greater of (A) 2000 Adjusted EBT, (B) 1999 Adjusted EBT and (C) 1998 Adjusted EBT times (y) 1.5, and (ii) if 2001 Adjusted Gross Profit is at least 20% greater than the greater of (A) 2000 Adjusted Gross Profit, (B) 1999 Adjusted Gross Profit and (C) 1998 Adjusted Gross Profit, (x) the amount by which the 2001 Adjusted Gross Profit exceeds the greater of (A) 2000 Adjusted Gross Profit, (B) 1999 Adjusted Gross Profit and (C) 1998 Adjusted Gross Profit times (y) .87. Asset Purchase Agreement § 7.9.4. 9

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(a) Unless a payment has been made under Section 7.11.2 [Sale of the Business] or 7.11.3 [Participation in Event of IPO], as soon as practicable, . . . Buyer shall pay to the Sellers, by wire transfer of immediately available funds, an amount equal to the product of (x) (I) The Participation Multiplier . . . times 2003 EBT minus (ii) Net Debt Capital . . . times (y) 10% (the "2003 Payout"). Asset Purchase Agreement § 7.11.1(a). Section 7.11.3 entitled Messrs. Litman and Diener participation in the event of an IPO. Section 7.11.3, states, in full: 7.11.3 Participating in Event of IPO. If, prior to the payment of the 2004 payout by the Buyer pursuant to Section 7.11.1 or a payment in connection with the sale of the Business of the Buyer pursuant to Section 7.11.2 above, the Buyer consummates an initial public offering of shares of its common stock (an "IPO"), the Buyer shall issue to the Sellers a number of shares of common stock of the Buyer having an aggregate value (based on the price per share in the IPO) equal to the product of (x) (I) the total issued and outstanding shares of the Buyer immediately prior to the IPO times the IPO price minus (ii) the Net Debt Capital multiplied by (y) 10%. Sellers hereby agree to enter into "lock up" indemnity or other customary agreements reasonably requested by the underwriters in connection with an IPO. Asset Purchase Agreement § 7.11.3. These provisions for additional consideration flowing to Messrs. Litman and Diener were referred to generally by the parties at trial as earn-out rights. Mr. Diener related his understanding of these provisions, in plain language: [T]he offer was . . . for $150 million in cash, and I believe $5 million of that was going to be put in escrow, and then there were contingencies in the agreement and if we met certain hurdles, then there would be additional consideration and earn-outs, as well as percentage participation if there were to be at some point an IPO. .... . . . [T]here were three years of earn-outs. . . . [I]n the first year, we had to exceed our earnings of the prior year, and to the extent we exceeded the earnings of the prior year, then we received a multiple of those incremental earnings. And then every year, it got tougher; so they really gave us tough hurdles to jump over. 10

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Tr. at 319. In addition to the contingency payments, Messrs. Litman and Diener had "a residual interest in the company[,] which was 10 percent of the company." Id. at 774; see Asset Purchase Agreement, Section 7.11.1. Mr. Khosrowshahi explained that to the extent that there was a liquidity event of the company, to the extent that the company was sold, or the company was taken public, they would receive whatever consideration that [USA Networks] . . . would receive as part of that liquidity event. If there was no liquidity event for some period of time, I think it was five years, there was a buy out structure so that in 2004 they would be bought out of this residual interest, based on the performance of the company at that time. Tr. at 774-75. Following the sale of their company, Messrs. Litman and Diener continued as employees of HRN and served on the new company's Board of Directors, although they did not control it. Mr. Litman was CEO of HRN and Mr. Diener, President. "I really did the same tasks I did before; however, they were quite a few new tasks, . . .[F]or example, there had to be an accounting system set up. . . [T]hey had various meetings with us where we would have to go through our budgets, go through our strategic directions." Id. at 323 (testimony of Mr. Diener). After working as independent entrepreneurs for fifteen years, Messrs. Litman and Diener soon chafed under the parent company's control. The men particularly were frustrated by the parent's demands on their time; the control the parent company had over HRN, including hiring; strategic decision-making; and reporting requirements. Messrs. Litman and Diener felt stymied by the slower decisionmaking process, which required all financial and tax decisions to be reviewed by USA Networks's legal and tax departments. The Asset Purchase Agreement further exacerbated the day-to-day tension between Messrs. Litman and Diener and the parent company USA Networks. As Mr. Diener noted, "[USA Networks] would obviously have an incentive for us not to reach [the incremental earning goals], and we would have an incentive to reach them." Id. at 322. And Mr. Khosrowshahi conceded that the earn-out caused problems between the two sides: Because of the earn-out payments, the earn-out was paid as a multiple of EBITDA cash flow. So what it translated into was if [Messrs. Litman and Diener] spent 11

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. . . an extra million dollars let's say in marketing during a year, they would get paid two times, so $2 or $2.5 million less in an earn-out. . . . [I]f we wanted [Messrs. Litman and Diener] to do something, they'd say, well I'm going to get less in my earn-out if I invest in the company. And we were all trying to grow the company. Id. at 784. On November 5, 1999, the Board of Directors of HRN authorized the IPO of HRN stock. The authorization came only seven months after the sale of Hotel Reservations Network, to Messrs. Litman and Diener's chagrin. According to Mr. Khosrowshahi, the decision to go public was based, at least in part, on the fast-paced industry in which HRN was involved and how quickly the landscape of the Internet travel industry was changing. [A]t the time these internet companies ­ the other internet companies were spending millions and millions of dollars on marketing to build their brand name in order to hopefully bring business in, [Messrs. Litman and Diener] built what we call the affiliate business. And with the affiliate business you had other travel companies spending the millions of dollars to bring in customers, and because [Messrs. Litman and Diener] had negotiated such good deals with hotels, . . . they powered the hotels behind these other internet companies, they were able to pay commissions to these internet companies to source the traffic, and make a bunch of money on the back end as well. This affiliate business started getting very competitive because other people saw what HRN was doing and tried to copy it. . . . And we thought that a key for the company was to lock in big affiliates for a long term basis. One of the biggest, for example, was Travelocity, which is now a big competitor of ours. And the way that we were able to lock them up was to give them equity in the company, to give them options in the company. Id. at 780-81. Mr. Khosrowshahi noted also that the availability of stock would also allow the company to use stock for acquisitions in the future, if that option ever became necessary.

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As part of the IPO process, Messrs. Litman and Diener entered into discussion with USA Networks to exchange their earn-out rights from the Asset Purchase Agreement for additional shares of stock in HRN. Mr. Diener related, "We were having so many conflicts with the company that being a public company, continuing to have these conflicts was just not a good idea. . . . [I]f there was a way to align our interests where we were both going in the same direction, it would be a good thing." Id. at 325-26. Mr. Litman's reasoning was broader: "It was very difficult to take the company public when we had these earn-outs that would detract . . . cash from the company, and then we . . . had different incentives than the public shareholders." Id. at 75-76. From USA Networks's perspective, its executives became concerned about Messrs. Litman and Diener's outstanding rights to potential earn-out payments because the underwriters of the IPO raised concerns about the "accounting consequence of these fairly large sums going out of the company . . . three or four years out." Id. at 898 (testimony of Mr. Kuhn). As a result, Mr. Kuhn explained, "[I]t was decided, in consultation with the underwriters, that a cleaner way of presenting this IPO would be to have [the earn-out rights] converted to equity, and then the public stockholders and the founders would have had essentially the same economic interest, which is to see the stock price increase as the company performed." Id. at 899. On February 2, 2000, HRN; USA Networks; TMF Liquidating Trust; TMF; HRN Marketing; and Messrs. Litman and Diener entered into the Amended and Restated Asset Purchase Agreement (the "ARAPA"). The ARAPA converted the earn-out provisions to which Messrs. Litman and Diener had been entitled under the Asset Purchase Agreement for HRN restricted stock (the "Section 7.15 Shares"). The ARAPA also provided that, in the event that HRN "consummate[d] an initial public offering," Messrs. Litman and Diener would be entitled to an additional block of shares based on a formula that considered the number of outstanding shares and the net debt capital of HRN. ARAPA § 7.11.3 (the "Section 7.11.3 Shares"); JX 4 at 21. Section 7.11.3 of the ARAPA provides: 7.11.3 PARTICIPATION IN EVENT OF IPO. If, prior to the payment of the 2004 payout by the Buyer pursuant to Section 7.11.1 or a payment in connection with the sale of the Business of the Buyer pursuant to Section 7.11.2 above, the Buyer consummates an initial public offering of shares of its common stock (an "IPO"), the Buyer shall issue to the Sellers a number of shares of common stock of the Buyer having an aggregate value (based on the price per share in the IPO) equal to the product of (x) (I) the total issued and outstanding shares of the Buyer immediately prior to the IPO (which shall include the shares issued under Section 7.15 simultaneous with the IPO) times the IPO price minus (ii) the Net Debt Capital multiplied by (y) 10%. Sellers 13

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hereby agree to enter into "lock up" indemnity or other customary agreements reasonably requested by the underwriters in connection with an IPO. Simultaneously with the issuance of the of the shares to be issued to the Sellers pursuant to this Section 7.11.3, the Sellers shall execute and deliver to the Buyer a Representations Letter (substantially in the form attached hereto as Exhibit E) with respect to such shares. Id.; JX 4 at 21. Section 7.15 provides, in relevant part: 7.15 2000 INITIAL PUBLIC OFFERING. If the initial closing of the proposed initial public offering (the "2000 IPO") of the Class A Common Stock, par value $0.01 per share (the "CLASS A COMMON STOCK"), of the Buyer occurs prior to March 31, 2000, the following provisions shall apply: 7.15.1 Simultaneously with the initial closing of the 2000 IPO: (I) In full satisfaction of its obligations under Section 7.9.3 and 7.9.4, the Buyer shall issue to the Trust the number of shares (the "SECTION 7.15 SHARES") of Class A Common Stock equal to the number that can be found by dividing (x) $81.6 million . . . by (y) the price at which each share of Class A Common Stock is initially sold to the public in the 2000 IPO (the "IPO PRICE"); PROVIDED THAT, (I) if the IPO Price is less than $11.00 per share, the price used for purposes of this clause (y) shall be $11.00 and (ii) if the IPO Price is greater than $16.25 per share, the price used for purposes of this clause (y) shall be $16.25. The issuance of the Section 7.15 shares shall result in a share-for-share reduction in the number of Class B Common Stock, par value $0.01 per share (the "CLASS B COMMON STOCK"), of the Buyer to be issued to USA in the recapitalization of the Buyer that will occur immediately prior to the completion of the 2000 IPO; Id. § 7.15; JX 4 at 22-23 (the "Section 7.15 Shares"). Section 7.15.2 4/ imposed the following restrictions on the sale of HRN stock:

4/ The ARAPA incorrectly numbers Section 7.15.2 as Section 7.5.2. 14

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17.[1]5.2 Without the advance written consent of Buyer (to be given or withheld in its sole discretion and, approved by its board of directors), the Trust shall not directly or indirectly sell, assign, transfer, gift, exchange or otherwise dispose of, or grant a lien, encumbrance, pledge or other security interest in (each, a "TRANSFER") any of the 2000 IPO Shares until after the fourth anniversary of the initial closing of the 2000 IPO, subject to the following exceptions: (vi) The Trust may Transfer (I) after the first anniversary of the initial closing of the 2000 IPO, all or any portion of the 2000 IPO Shares to (x) a Shareholder, an immediate family member of a Shareholder, which shall include only the spouse (except for a spouse with whom such Shareholder has entered into any divorce or separation agreement), or a child of such Shareholder (collectively, the "FAMILY"), or (y) a trust, all of the beneficial interests in which shall be held by such Shareholder or one or more members of such Shareholder's Family, and (ii) up to 5% of the number of Section 7.11.3 Shares and 5% of the number of Section 7.15 shares originally issued to the Trust to a former executive of the Sellers consistent with the terms of a letter agreement dated May 7, 1999, from TMF, Inc. to that former executive (a copy of which the Trust has delivered to the Buyer) in each case provided that such transferee delivers a written instrument, reasonably acceptable to the Buyer, agreeing to be bound by the terms of this Agreement to the same extent as the transferor. All persons and entities to whom the Trust may Transfer Class A Stock under this Section 7.15.2(a) are hereinafter referred to as "PERMITTED TRANSFEREES." (vii) The Trust (and its Permitted Transferees) may Transfer in the aggregate a number of Section 7.11.3 Shares not to exceed the following percentages of the number of Section 7.11.3 Shares originally issued to the Trust (adjusted for any stock splits, stock dividends, or similar recapitalization), after the dates indicated: After first anniversary of the 2000 IPO After second anniversary of the 2000 IPO After third anniversary of the 2000 IPO After fourth anniversary of the 2000 IPO Id. § 7.15.2; JX 4 at 23-24. 40% An additional 10% An additional 10% All remaining

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Insofar as the parties agreed on the tax consequences of the ARAPA, Section 3.4(ii) carried forward the agreement to agree from the Asset Purchase Agreement: (ii) For all Tax purposes, the Buyer and the Sellers agree (A) to report the transactions contemplated by the Agreement in a manner consistent with the terms of this Agreement, and (B) that none of them will take any position inconsistent therewith in any Tax Return. Id. § 3.4(ii); JX 4 at 5. The concept of using a formula to determine the number of shares that Messrs. Litman and Diener would receive in the exchange originated with USA Networks. Although they requested a fixed number of shares, Messrs. Litman and Diener ultimately agreed to the formula. According to Mr. Litman, who recounted the terms of the arrangement, Mr. Khosrowshahi proposed the formula with $81.6 million as the numerator. By e-mail dated January 23, 2000, from Mr. Khosrowshahi to Messrs. Litman and Diener, USA Networks proposed a formula with $81.6 million as the numerator and the following justification: Following, please find my calcs based on the high projections, the low projections, and an average of the two. The spread is not insurmountable and the result will be somewhat self-correcting: if you exceed the projections by a wide margin, then the equity will be worth much more, so the amount that you lose in the earnout will be exceeded by the earnout you gain in equity, etc. Same goes if you miss projections ­ the stock will get killed. JX 3 at 1. Mr. Khosrowshahi explained that the proposal was based on two sets of projections: There was a high and a low set of projections, which would result in various earn-out payments. And what I was proposing here was that I would go to [Victor Kaufman and the other executives at USA Networks] . . . with an average number, something in between the high and the low. And the average will refer to again taking the value of how much the earn-out payments would be and taking that value and using that as a basis for the value of the equity that [Messrs. Litman and Diener] would get in the IPO. So you would take the cash that they would earn, and you would say, well, we'll give you this much stock. Tr. at 783. 16

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On May 10, 1999, before the ARAPA was executed or HRN became a public company, Messrs. Litman and Diener assigned their rights under the Asset Purchase Agreement to an entity called TMF Liquidating Trust for the purpose of estate planning and dissolution of TMF. After Messrs. Litman and Diener entered into the ARAPA, on February 21, 2000, the TMF Liquidating Trust Agreement was amended, which allowed Messrs. Litman and Diener the ability to assign a portion of their beneficial interests in TMF Liquidating Trust to immediate family members. TMF Liquidating Trust, with Messrs. Litman and Diener as trustees, held the rights to acquire "a large number of shares of Class A common stock of HRN." HX 114A at 1. On February 22, 2000, Messrs. Litman and Diener entered into contracts entitled Agreement for Sale of "Special Tracking Interest" with each of their respective families. The contracts sold HRN Tracking Interests ­ beneficial interests in TMF Liquidating Trust with respect to the restricted HRN stock ­ to their respective family members. The Agreement for Sale of "Special Tracking Interest" provides: "[The] shares of Class A common stock of HRN which are subject to certain 4-year contractual transfer restrictions . . . have a total fair market value under the Appraisal [provided by Business Valuation Services] of $3,000,000." Id., art. 1.1; HX 114B, art. 1.1 (same). Consequently, the purchase price for the HRN Tracking Interest, which was sold to the Diener Family GS-Trust, was set at $3 million. HX 114A, art. 1.2. The HRN Tracking Interests were sold to the trusts of Mr. Litman's three children for a combined price of $3 million. Mr. Diener testified that the beneficial interests in TMF Liquidating Trust were sold at a fixed-dollar amount, signifying that TMF Liquidating Trust sold shares worth a specific dollar amount. If the value of the shares held by TMF Liquidating Trust changed "the percentage of the beneficial interest that would be transferred [would change], but the fixed dollar amount would not change." Tr. at 348. For the purpose of the preliminary prospectus documents and what is known in the industry as a "road show," the stock price of HRN was set between $11.00 and $13.00 per share. John R. Bozalis, Jr., a cautious, conservative witness, who served as a Vice President for DLJ from 1997 through 2000 and was involved in HRN's IPO. After setting the preliminary price of the stock, the lead underwriter and seller's agent, DLJ, and the management team from HRN, including Messrs. Litman and Diener, launched the "road show." Id. at 611 (testimony of Mr. Bozalis). During the road show, which lasted from February 7, 2000, through February 24, 2000, the lead underwriter and management team from HRN attended meetings with investors, mostly institutional investors, throughout the United States. At the meetings the investors were presented the "story" of HRN and the IPO. Id. Both before and after the road show, institutional salesmen followed up with the investors in order to gauge their reaction to the IPO and encouraged investors to place an order for HRN stock.

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At the time of HRN's public offering, IPOs were priced with the intent that there will be a big "pop" on the first day of trading. Id. at 794 (testimony of Mr. Khosrowshahi). HRN was no exception. As explained by Mr. Kuhn, when DLJ presented the plan on how an offering such as HRN should be brought to the public, one of the strategies of the IPO was to "step up over time . . . the value attributed to the business as you go through the offering process." Id. at 901. The suggestion, according to Mr. Kuhn, was that the first set of filings with the Securities Exchange Commission (the "SEC") include a range for the IPO price. "The idea would be then in the second filing, when you file your amended registration statement, to step that [price] up a little bit . . . to build some good buzz in the market." Id. at 901-02. Mr. Kuhn testified that from the outset the plan, as contemplated by DLJ, was gradually to increase the IPO price. After the road show, when the full book of orders was in place, and the company is pricing the IPO, "assuming it's successful and over subscribed, you again try to step it up a little bit more . . . so the process of going through the SEC, because that's a public fact, required some communication with the market about value expectation." Id. at 902. According to Mr. Bozalis, the underwriters would perform various analyses to establish the initial IPO price, including: (1) looking at comparable companies that were publicly traded, both in terms of "how those shares were valued based on their current trading price," Id. at 608, and how the growth rates of the companies compared; and (2) "performing discount cash flow analysis on the . . . contemplated . . . future earning stream and discounting that back to present day at an agreed-upon discount rate." Id. at 608-09. During the second week of the road show and especially during the last two business days before the final pricing of an IPO is when "the vast majority of the orders actually come in and become final." Id. at 612 (testimony of Mr. Bozalis). In Mr. Bozalis's view, the HRN IPO was "nicely oversubscribed, but not wildly oversubscribed as some other dot-com companies experienced at the time." Id. at 613. On February 24, 2000, the final IPO price was set at $16.00 per share. The Pricing Committee, composed of Mr. Kaufman and Mr. Khosrowshahi, set the price for the 5,400,000 shares of Class A Common Stock that were offered to the public and an additional 810,000 shares of Class A Common Stock that were issued to cover an over-allotment that was granted to the underwriters of the public offering. The public offering price was set at $16.00 per share, with $1.12 per share going to underwriting fees and $14.88 per share in proceeds to HRN, yielding total proceeds of $80,352,000 for the new company. See Prospectus for the 5,400,000 Shares of Class A Common Stock of HRN, dated Feb. 25, 2000, at cover; JX 7 at 1.

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Ultimately, it was the Equity Capital Markets Group within DLJ that was responsible for setting the $16.00 price per share. Mr. Bozalis testified that USA Networks would not have a significant role in the pricing of the stock: "[T]hey would either have accepted it or not. . . . Or they might have postured and negotiated . . . . And then we would have had to make a determination of whether or not we were willing to go [up]." Tr. at 616. The price was derived by a process which Mr. Bozalis compared to an "art," rather than a "science." Id. at 615. The Capital Markets Group within DLJ would look at its list of orders, or the book of orders, and "make [an] assessment over the hundreds of names on your list that [DLJ has] collected." Id. For example, "Entity X over here, if they've normally put [in] an order for 100,000 shares, does that mean that they really want to own 100,000. Or do they want to [own] 50- or 25-." Id. The offering price distilled to a judgment call made by DLJ. Given the mechanics of this process, the court does not credit Messrs. Litman's and Diener's assumptions that USA Networks had given assurances or otherwise had committed to a lower price. Their distress at the $16.00 per share IPO price was genuine and reported by other witnesses, but it was misplaced. On March 1, 2000, the IPO of the 6,210,000 shares of Class A Common Stock of HRN closed. This public offering did not include the 5,100,00 shares of HRN Class A Common Stock, which was issued to TMF Liquidating Trust in exchange for extinguishing HRN's obligation to make contingent cash payments for the twelve-month periods ending March 31, 2001 and 2002. Nor did the IPO include the 4,899,900 shares of Class A Common Stock "equal to 10% of [HRN's] outstanding common stock immediately prior to the completion [of HRN's] offering." JX 7 at 54. As a result of the ARAPA, the Litmans and the Dieners through TMF Liquidating Trust received 9,999,900 shares of HRN Class A Common Stock subject to contractual restrictions. Mr. Khosrowshahi testified that the "IPO was very successful, and as we went on the road show, there was a lot of investor interest in the company. And, frankly, at the beginning we weren't sure if there would be because this was a very unusual company, it was highly profitable, but it was also termed an internet company by some." Tr. at 793-74. The stock ended up "popping" once the company went public on February 25, 2000. Id. at 795 (testimony of Mr. Khosrowshahi). On February 24, 2000, Mr. Litman wrote to Chase Mellon Shareholder Services, the transfer agent handling his issuance of the Class A Common Stock of HRN, directing the transfer agent to deliver the two certificates for TMF Liquidating Trust to Salomon Smith Barney, Inc. On March 14, 2000, Chase Mellon Shareholder Services confirmed the receipt of stock certificate number HRN 0006 for 4,654,905 shares of HRN Class A Common Stock dated February 24, 2000; stock certificate number HRN 0007 for 5,100,000 shares of HRN

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Class A Common Stock dated February 24, 2000; and stock certificate number HRN 0008 for 244,995 shares of HRN Class A Common Stock dated February 24, 2000. Messrs. Litman and Diener knew that they were required to pay federal income taxes on the shares of HRN stock that they were receiving pursuant to the ARAPA. "[W]e were in a situation where we would be receiving restricted shares and no cash, but we'd have to pay tax on it." Id. at 98 (testimony of Mr. Litman). Retained by Messrs. Litman and Diener, on February 24, 2000, Mark L. Mitchell, CFA, ASA, a principal with Business Valuation Services, Inc. ("BVS"), determined the "appropriate marketability discount applicable to the common stock of [HRN,] as of February 24, 2000, giving consideration to relevant resale restrictions," (the "BVS Valuation"). L/DX 58 at 2. The BVS Valuation opined that the marketability discount to be applied to the market price of the [HRN] stock to reflect the fair market value of the stock giving consideration to relevant resale restrictions, as of February 24, 2000, is reasonably stated as: Restriction Period One year Two years Three years Four years Id. at 4. Mr. Mitchell and BVS had been recommended to the Litmans and the Dieners by their attorney in Dallas, Jim Mincey. According to Mr. Diener, "[BVS] had a great reputation. [Mr. Mincey] told us that they do a lot of work for the [IRS]. . . . We used [BVS] for a previous valuation, so we had some experience with them. They were somewhat familiar with the company, and we were very comfortable [with them.]" Tr. at 346-47. Messrs. Litman and Diener used the BVS Valuation in reporting the value of their shares for income tax purposes and estate-planning purposes. KPMG, LLP ("KPMG"), prepared TMF Liquidating Trust's 2000 tax return, which listed a long-term gain of $45,437,822 for the sale of TMF stock. The IRS received the tax return on May 27, 2001. Mr. Diener testified that the gross sales price and the long-term gain for the sale of TMF and HRN Marketing were calculated using Mr. Mitchell's appraisal: We took the $16 IPO price and we looked at each tranche, because every tranche had a different discount, so we took the BVS appraisal and we took the amount of shares that were given to us that had a one-year restriction and we 20 Discount 49.5% 61.5% 63.5% 79.0%

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applied the discount for the one-year restriction . . . . We did the same for the two-year, the three-year, [and] the four year. Id. at 350-51. KPMG was selected to prepare TMF Liquidating Trust's 2000 tax return during the period when Messrs. Litman and Diener were in the process of selling Hotel Reservations Network. James Lucien Horan, CPA, managing partner for the South Florida Business Unit and the partner in charge of tax for the South Florida Business Unit at KPMG, was the Dieners' primary contact at KPMG. After consulting with Mrs. Diener, an accountant with a masters in tax and former accountant at KPMG, Mr. Horan was selected to handle TMF Liquidating Trust's 2000 federal tax return. Mr. Diener viewed Mr. Horan as "the reputed expert in corporate[] . . . mergers and complex corporate transactions." Id. at 352. In preparation for the filing of TMF Liquidating Trust's 2000 tax return, KPMG reviewed the BVS Valuation. On April 3, 2001, Madeline Fernandez of KPMG wrote a memorandum to the TMF Liquidating Trust file entitled "Various Tax Discussions Relating to TMF Liquidating Trust." The memorandum noted the following about KPMG's review of the BVS Valuation: 100% of the stock received by the sellers (both the 10% pre IPO Stock and the Earn out Exchange Shares) was valued by an independent third party. The valuation was reviewed by the KPMG Valuation group in Atlanta purely for reasonableness and concurred that proper valuation methods were used. while KPMG concurred as to the methods used and reasonability of discounts, it did not perform the valuation and this should not be construed that the valuation is KPMG's. L/DX 89 at 4. Mr. Horan testified by deposition on July 24, 2006, that the review of the BVS Valuation was conducted by Ray Nicholson of KPMG Valuation Services: I am not a valuation expert, I sent [the BVS Valuation] to [Mr. Nicholson] just to validate whether or not this was prepared in a reasonable way, that the methodologies used were accurate, that it met the standards of the industry. And he concurred that it did. ....

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. . . [T]his was standard procedure[]. I don't know how long he's been in [the Valuation group], but anything that's done that requires an expertise has to be reviewed by someone who has that expertise before it can be relied upon, if it's prepared outside of the firm. Horan Dep. at 16. Mr. Horan related that Mr. Nicholson telephoned him and informed him orally that the BVS Valuation was appropriate and that Mr. Horan could rely on it. Before signing and filing TMF Liquidating Trust's 2000 tax return on May 22, 2001, Mr. Diener reviewed it. On May 27, 2001, the IRS received TMF Liquidating Trust's tax return. Under the terms of the trust instrument, all income is taxable to the grantor as set forth under 26 U.S.C. §§ 671-678 (2000). The IRS received the Litmans' individual tax return on October 18, 2001. The Litmans' individual tax return was prepared by Lisa Florentino of Vink, Pier & Teague, PC. The Litmans reported a capital gain in the amount $49,810,323. The Litmans arrived at this value by applying the BVS Valuation discounts for each restriction period to the $16.00 IPO price. On January 6, 2005, the IRS sent, via certified mail, a Notice of Deficiency addressed to the Litmans at 10710 Strain Lane, Dallas, TX 75229-5427. The Notice of Deficiency asserted that the Litmans underpaid their taxes by $12,584,993 and owed $2,516,998.60 in penalties pursuant to I.R.C. § 6662(a). The IRS attributed the tax adjustment to the Litmans' failure to "correctly report the fair market value of the HRN stocks received upon the sale of the assets and liabilities of TMF Incorporation and HRN Marketing Corporation. Accordingly, we have adjusted the net gain reported from the receipt of the stocks . . . ." JX 26 at 10. Similarly, the IRS received the Dieners' self-prepared individual income tax return for 2000 on October 18, 2001. They reported a capital gain of $50,504,297. The Dieners arrived at this value by applying the BVS Valuation discounts for each restriction period to the $16.00 IPO price. On October 8, 2004, the IRS mailed the Dieners a Notice of Deficiency to their home address at Champlain Towers North, 8877 Collins Avenue, PH A, Surfside, FL 33154-3524. The IRS attributed the tax adjustment to the Dieners' failure to "correctly report the fair market value of the HRN stocks received upon the sale of the assets and liabilities of TMF Incorporation and HRN Marketing Corporation. Accordingly, we have adjusted the net gain reported from the receipt of the stocks . . . ." JX 27 at 10. On October 1, 2001, the IRS received HRN's 2000 corporate income tax return. The tax return was signed by Viren B. Ghandi, Senior Director of Finance at HRN, and prepared by Ernst & Young, LLP ("Ernst & Young"). HRN's 2000 tax return reported $159,998,400 in goodwill associated with the 9,999,900 shares of HRN stock transferred to TMF Liquidating Trust. HRN amortized the goodwill for the 2000 tax year at a value $9,543,434. 22

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In connection with its preparation of HRN's 2000 tax return, Ernst & Young prepared a Form 8594, Asset Acquisition Statement, for the 9,999,900 shares of HRN stock. The Form 8594 reported an increase in goodwill in the amount of $205,982,713. The reason provided for the increase in goodwill, as drafted by Ernst & Young, was as follows: 1. $78,398,400 in additional common stock issued to original sellers when HRN, Inc. entered into an IPO at the end of February 2000. 2. $81,600,000 in additional common stock issued to predecessor business for release of contingent payment obligations based on performance at the end of February 2000. 3. Payment of $45,984,313 to original sellers based on operating performance for 12 months ended 3/2000. JX 23 at 5. Ernst & Young calculated the value of the goodwill of the additional common stock issued to the original sellers ­ Messrs. Litman and Diener through TMF Liquidating Trust ­ as $159,998,400 ($78,398,400 + $81,600,000) for the 9,999,900 shares, or $16.00 per share. The reasons for the increase in goodwill as stated by Ernst & Young on Form 8594 were never submitted to the IRS. Part III of Form 8594 was erased using white-out. In place of the information supplied by Ernst & Young, Mr. Ghandi wrote: "Information is being gathered. Will be supplied at a later date." JX 16 at 27; see Tr. at 783 (testimony of Mr. Ghandi). Despite these changes to the tax return before filing, the $159,998,400 value for goodwill purposes was reported elsewhere in the tax return. Mr. Ghandi testified plausibly that he wrote the notation on Form 8594 at the instruction of someone at Ernst & Young or HRN: Q How did it come to pass that you provided this information on that page of the form? A Whatever I've written down must have been based upon instructions either from E&Y or somebody else at HRN. Certainly I'm not a tax expert. So I didn't even know what to write or whether there should be something written there. I'd say it was based upon instructions from somebody Q Do you recall specifically who those instructions came from? A I don't recall who exactly it came from[.] Tr. at 738. On September 19, 2001, Ernst & Young had forwarded to Mr. Ghandi's attention the federal income tax return for HRN for the short year which ended on December 31, 2000. The cover letter accompanying the tax return stated, in pertinent part: 23

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In accordance with our discussion, Form 8594, Asset Acquisition Statement, as attached to Form 1120, was prepared on the assumption that the seller, HRN Marketing Corporation, agrees to the allocation as reflected on the form. Please let us know immediately if the seller expectation is contrary to ours. L/DX 37. Melville W. Robinson III, Chief Financial Officer and Strategic Officer of HRN, was carbon-copied on the letter. Mr. Robinson, a well-spoken executive who obviously was fond of Messrs. Litman and Diener, testified that normal procedure was for either Mr. Ghandi or Mr. Robinson to provide Mr. Diener with a copy of the draft tax return. "[A]lmost immediately" upon sending the draft return to Mr. Diener, Mr. Robinson became aware that Messrs. Litman and Diener disagreed with the valuation. Tr. at 496 (testimony of Mr. Robinson). On Monday, September 24, 2001, Mr. Diener e-mailed Mr. Ghandi, carbon-copying Messrs. Litman and Robinson. The e-mail stated, as follows: This is to confirm that TMF [i]s not in agreement with the amounts on the 8594 of the HRN tax return for 2000. TMF has received a valuation and has filed a return that has a significant valuation discount on stock issued to TMF based on significant restrictions and limitations contractually and otherwise on the stock. We are therefore filing the HRN return since it must be filed today with "To be determined" on the Form 8594 per the advise of KPMG. JX 22. Mr. Diener testified that he did not direct Mr. Ghandi to white-out any portion of the Form 8594. Instead, Mr. Diener maintained, and the court deemed him credible on point, that he discussed the issue of the inconsistent valuations of the HRN stock with Mr. Robinson soon after the problem was brought to his attention and provided USA Networks and financial advisors at HRN a copy of the BVS Valuation. After learning of the inconsistent values, Mr. Robinson testified that he met with the audit committee of HRN's Board of Directors, comprised of the outside directors of the board. Mr. Robinson also met with Mr. DeGraw, Tax Director for IAC (formerly USA Networks), and William Severance, Comptroller of USA Networks. The result of these discussions, as related by Mr. Robinson, was that "the company needed to have an appraisal of the stock done . . . to establish our own position for tax purposes. I ended up taking the recommendation of Eric DeGraw that Deloitte and Touche be used for that, since there was

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an issue about whether E&Y's advice was proper." Tr. at 498. 5/ Although not detrimental to explicating this episode in the chronology, Mr. DeGraw's deposition testimony overall did not serve Hotels.com's interests in this litigation. Untainted by prior document review, he left the opaque tracks of the customary uninformed discovery deponent, but he was equally ineffective for Hotels.com when the deposition was entered as his testimony at trial. On October 18, 2001, Deloitte & Touche forwarded Mr. DeGraw the Deloitte & Touche Valuation Report: Discount Study ­ Consideration Shares in Hotel Reservations Network, Inc. (the "Deloitte & Touche Valuation Report"), which valued the 9,999,900 shares of HRN stock as of February 25, 2000. It calculated the following discounts: Date of Exercise After first anniversary of IPO After second anniversary of IPO After third anniversary of IPO After fourth anniversary of IPO Percent of shares 40% 10% 10% 40% Applicable Discount 25% 30% 35% 40%

Weighted average discount

33%

L/DX 51 at 25. The 2000 tax return was never amended to reflect a lower value based on the Deloitte & Touche Valuation Report. Each of the 2001, 2002, and 2003 tax returns, however, took positions with regard to the 9,999,900 shares of stock based on the Deloitte & Touche Valuation Report. On February 10, 2006, the IRS sent, by certified mail, to Hotels.com a Notice of Deficiency for the tax year ending on December 31, 2000. The IRS determined that Hotels.com owed an additional $2,776,456 in increased tax and assessed an additional $491,338 in penalties. In its Explanation of Adjustments, the IRS provided the following rationale for the increase in taxes owed for the 2000 tax year:

5/ Mr. Robinson noted that Messrs. Litman and Diener were not involved in the process of obtaining the Deloitte & Touche appraisal. "I certainly told them that the process ­ that the valuation process was commencing, but that was the extent of their involvement." Tr. at 501. 25

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The value of goodwill attributable to the issuance of restricted stock has been decreased to reflect the value of the restricted stock issued for the purchase of TMF, Inc. and HRN Marketing Corporation, and amortization for the goodwill has been reduced accordingly. In addition to the above goodwill, the amortization of goodwill for an asset that was incorrectly computed due to an error of placed-in-service date, and the amortization of goodwill for an asset omitted from the return have been allowed. JX 28 at 8. Hotels.com has also filed a Protective Refund Claim for the tax years ending December 31, 2001, and December 31, 2002, in order "to protect Hotels.com's right to a refund pending the final outcome of Hotels.com, Inc. and Subsidiaries[(f/k/a Hotel Reservations Network, Inc. v. United States, U.S. Court of Federal Claims Docket No. 06285T] as to the proper amount of amortization deductions to which Hotels.com is entitled." JX 30 at 1; JX 29 at 1 (similar). PROCEDURAL HISTORY The Litmans filed their complaint in the United States Court of Federal Claims on August 30, 2005, alleging that they are entitled to a refund of the $12,584, 993.00 in income tax and the $2,516,998.60 in penalties assessed and paid, plus any allowable interest. See Compl. at 23, David S. and Malia S. Litman v. United States, No. 05-956T (Fed. Cl. Aug. 30, 2005), assigned to Judge Mary Ellen Coster Williams. Defendant filed its answer on November 1, 2005, which included a counterclaim against the Litmans seeking interest on penalties in the amount of $2,877,415.86 plus costs. On September 7, 2005, the Dieners filed their complaint in the Court of Federal Claims, alleging that they are entitled to a refund of the $12,664,612 in income tax and the $2,532,922 in penalties assessed and paid, plus allowable interest. See Compl. at 23, Robert B. and Michelle S. Diener v. United States, No. 05-971T (Fed. Cl. Sept. 7, 2005), assigned to the undersigned. Defendant filed its answer on November 7, 2005, which included a counterclaim in the amount of $2,895,619.82, plus costs. On November 10, 2005, defendant filed an unopposed Notice of Directly Related Case in both Nos. 05-956T & 05-971T. On November 17, 2005, with the consent of the undersigned, Judge Williams entered an order granting defendant's motion in Litman, No 05-956T. Although RCFC 40.1(b) and RCFC 40.2(a)(2) provide that the later-filed case be handled with its predecessor, Litman No. 05956T, was transferred t