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UNITED STATES COURT OF FEDERAL CLAIMS

STOBIE CREEK INVESTMENTS, LLC., and JFW ENTERPRISES, INC., Plaintiffs, v. UNITED STATES, Defendant.

) ) ) ) ) ) ) ) ) ) )

Docket Nos. 05-748 07-520

Pages: Place: Date:

1 through 258 Chicago, Illinois April 9, 2008

HERITAGE REPORTING CORPORATION Official Reporters 1220 L Street, N.W., Suite 600 Washington, D.C. 20005-4018 (202) 628-4888 [email protected]

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1 IN THE UNITED STATES COURT OF FEDERAL CLAIMS

STOBIE CREEK INVESTMENTS, LLC., JFW ENTERPRISES, INC. Plaintiffs, v. UNITED STATES Defendant.

) ) ) ) ) ) Docket Nos. 05-748 ) 07-520 ) ) ) Courtroom 2266 219 S. Dearborn Chicago, Illinois 60604 Wednesday, April 9th, 2008

The parties met, pursuant to notice of the Court, at 10:08 a.m. BEFORE: HONORABLE CHRISTINE O.C. MILLER Judge

APPEARANCES: For the Plaintiffs: ROBERT E. KOLEK, Esq. COLLEEN FEENEY, Esq. MATT CROWL, Esq. Schiff Hardin, LLP 6600 Sears Tower Chicago, Ilinois 60606 (312) 258-5755 For the Defendant: CORY A. JOHNSON, Esquire STUART D. GIBSON U.S. Department of Justice Tax Division P.O. Box 403 Washington, D.C. 20044 (202) 307-6586 Heritage Reporting Corporation (202) 628-4888

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2 C O N T E N T S WITNESSES: David Herpe David Waterman DIRECT 78 153 CROSS 133 --REDIRECT ----RECROSS ----VOIR DIRE -----

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3 E X H I B I T S PLAINTIFFS EXHIBITS: 57 61 62 108 111 113 117 134 151 152 228 259 314 IDENTIFIED 131 165 176 231 108 106 118 187 214 218 190 241 169 RECEIVED 133 166 177 232 110 108 120 189 216 219 190 242 169 DESCRIPTION

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4 E X H I B I T S DEFENDANT'S EXHIBITS: 40 41 42 424 548 IDENTIFIED 143 145 148 136 135 RECEIVED 144 146 --137 136 DESCRIPTION

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5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 do? THE COURT: MR. KOLEK: Swecter and Jacob. Heritage Reporting Corporation (202) 628-4888 How do you do? And I have back here Thomas THE CLERK: P R O C E E D I N G S (10:08 a.m.) The United States Federal Court

of Claims is now in session, the Honorable Judge Christine Odell Cook Miller presiding. I'm calling

the cases of Stobie Creek Investments, LLC and JFW Enterprises, Inc., Case Nos. 05748 and 07520. rise. THE COURT: Good morning, everybody. Please All

be seated and -- joining me on the bench. for taking my advice. binders.

Thank you

Please plan on using smaller

I can guarantee that you'll find it easier.

Good morning, Mr. Kolek. MR. KOLEK: THE COURT: MR. CROWL: THE COURT: MS. FEENEY: THE COURT: MR. KOLEK: MR. WELLES: Good morning, Yours Honor. Mr. Crowl. Good morning, Judge. And you are? I'm Colleen Feeney. Ms. Feeney, how are you today? And this is Mr. Jeffrey Welles. Hi, Jeff Welles. How do you

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6 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the back. MS. MCGEE: THE COURT: Good morning. I'm handing Mr. -- as well. Are THE COURT: MR. GIBSON: THE COURT: MR. JOHNSON: THE COURT: MR. KOLEK: There they are. And Mr. Gibson?

Good morning, Your Honors. And Mr. Johnson. Good morning, Your Honor. Who else is here? We have David Enrohoe, who is a

paralegal with our office. MR. ENROHOE: MR. KOLEK: Good morning, Your Honor. And my assistant, Ken McGee in

there any preliminary matters? MR. CROWL: MR. GIBSON: THE COURT: None by us, thank you. Nothing, Your Honor. The government has invoked Rule

615 of the Federal Rules of Evidence which says that all witnesses who are going to testify other than party representatives will be excluded after opening statements -- counsel to place that rule. Tomorrow morning at 11:00 a.m. our time, I have an important matter to which I must attend to. We'll be breaking at 11:00 tomorrow. However, we'll

have an extended lunch for an hour for recognizing -So we're breaking at 11:00 tomorrow and Mr. Kedem will Heritage Reporting Corporation (202) 628-4888

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7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 let you know if -- the bench earlier and we're basically speaking of probably two hours. We are being evicted from the building every night at 6:00. Mr. Kedem will tell you we had a trial This just really

session at 9:00 p.m. in Newark. cramps our style. into a time issue.

We can also begin earlier if run What I'm going to try to do is

break at approximately 5:30 so I can leave at 6:00 p.m. With that in mind if you'd like to proceed. MR. KOLEK: Welcome to Chicago. Good morning, Your Honor. I hope your trip here was

pleasant and I hope your stay here is going to be enjoyable. THE COURT: of this courtroom. I want to apologize for the size

We are going to do our best, so,

close all the windows if I find people gazing out. I'd like to say something, this is a Court, no computers. phones. That means no Blackberries, no cell

If I see anybody use, especially a The problem with most

Blackberry, you're out of here.

Blackberrys and cell phones of course -- and that is strictly code. So, Mr. Kedem will keep his eyes open

wide and everybody can proceed. MR. KOLEK: Well, as soon as I finish my

opening statement, I will put my Blackberry away. Heritage Reporting Corporation (202) 628-4888

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8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 law? Yes. THE COURT: MR. KOLEK: Please proceed. Thank you, Your Honor. This is

a case about the Welles family, a civic minded, closely knit family. professional advisors. They trusted and relied on their The professional advisors, in

turn, trusted and relied on the status of the law. The Welles family is now seeking a refund of $46 plus million dollars of taxes, interest, and penalties imposed upon them by the Internal Revenue Service. Georgia. The Welles family began with David, Sr. and David died last year. David and Georgia had He's also

five children.

They had David, Junior.

known as Deke; Virginia, Virginia's known as Jenny; there's Jeff, Peter and Kris. This is not the story of some overly aggressive taxpayer taking advantage of an egregious tax shelter or tax scheme. Instead this is a story of

a family that sought professional advice on minimizing their taxes. They acted upon the advice of their

counsel of almost 40 years. Did they take advantage of a loophole in the Undeniably, they did. But did they do

anything improper? no.

I think the answer is resoundingly

For more than a half century the law has been There is no requirement for a taxpayer

quite clear.

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9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 or anyone else to pay the most taxes. They can

arrange their affairs as they seek fit to pay the least amount of tax. We believe that the evidence will show that legacy of David and Georgia is multifaceted. above all, it is to do the right thing. But

I think the

character of the Welles children will show that. It is a legacy of philanthropy and of giving to the community, not only of money, that they have given a lot, but also of one self. the board of a nature conservancy. board of Anchor, Inc. Georgia sits on Jeff is on the

That's an organization that

works to maximize the potential of inner city youth. He's also in the board of the Buckley School. That's

a college preparatory day school that takes into account children from kindergarten to Grade 9. Jenny spends part of her year in Africa working with an organization called Deed for Life. That organization is helping to eradicate the extreme poverty in Uganda. Peter serves on the board of the

Land Alliance Trust that promotes voluntary private land conservation to benefit communities and natural systems. School. Kris is on the board of the Brookwood They all sit on the board of the Cricket That's the family foundation which

Island Foundation.

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10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 helps to develop the capacity and commitment of young people to improve their lives in the communities and the world around them. The evidence will show that the family business, Therma-Tru Corporation, grew from a very, very small ordinance. acorn to the oak tree. Almost like the proverbial In 1962, David, Sr. purchased

a lumberyard out of bankruptcy with the aid of an attorney by the name of Greg Alexander. He was an

attorney with the law firm of Shumaker, Loop & Kendrick. That acquisition forged a 40-year trusted

relationship between Shumaker, Loop & Kendrick and the Welles family that exists still today. That lumberyard became Therma-Tru Corporation. Therma-Tru, in turn, became vastly It became the

successful beyond anyone's imagination.

industry leader for the manufacture of residential entry doors. It did this through hard work in the

entrepreneurial spirit of David and his family. In 1987, David developed bone cancer. result, he sought to sell Therma-Tru. Bids were As a

solicited and received, including one from a company called Masco. That name will pop up again. That's

why I mention it now. supplies business.

Masco was also in the building

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11 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 However, in one of those rare black swan events, Black Monday, October 19, 1987 occurred. stock market dropped over 20 percent on that day. offers that had been received were cut. to hold on to Therma-Tru. As is frequently the case, what happened to be a dark day actually provided much greater opportunity, 12 years later in 1999, Therma-Tru was firmly positioned at the top of its industry. will you show Graph 40, sir? These are some of the doors that Therma-Tru manufactures. David Welles, still active in the Mike, The The

David decided

business, brought his son, Deke, in to run the company. Jeff Welles, by this time, was an investment

advisor and sat on the board of Therma-Tru along with David, Sr. and Deke. Greg Alexander, the attorney And now

from Shumaker, Loop & Kendrick, had retired.

David Waterman, the new managing partner of Shumaker, Loop & Kendrick was now the advisor to Therma-Tru and the members of the Welles family. Then and now, the Shumaker firm was the largest in Toledo. It had over 170 lawyers and they

had represented Therma-Tru for 37 consecutive years. It had also represented the Welles family on a continuous basis for that same 37 consecutive years. Heritage Reporting Corporation (202) 628-4888

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12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 family. Shumaker, who's the lead outside counsel for Therma-Tru as well as the principal attorneys for David and Georgia, Deke and his wife, Hopi, and other family members. By 1999, Jeff had had ten years of And he was now an He had gone from

experience at Goldman Sachs.

investment advisor at Lazard Freres.

a salesman, a securities salesman to now an investment advisor. Now, 1999 was a pivotal year for the Welles David, through effective tax buying, had

transferred a significant part of his Therma-Tru holdings to his children. wealthy. He had made them all

It was at this point that David and Georgia

decided that they wanted to focus their efforts more on philanthropy and on giving back to the community. In order to effect this plan, David recognized that he needed to bring liquidity to his estate. Therma-Tru was once again put on the market Masco became aware that Therma-

and put up for sale.

Tru was on the market and made a bid for the company. It proposed a stock for stock transaction in which the shareholders of Therma-Tru would receive approximately $825 million in Masco shares. The problem with that It was a tax-

was that they were restricted stock. free transaction, however.

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13 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 While bringing David closer to his objective of liquidity, this deal posed risks to David and the other shareholders of Therma-Tru, who by now included not only the family members but key nonfamily employees as well. David went to his son Jeff and asked him to explore ways of protecting the family interest should the Masco transaction go through and the family winds up owning a chunk of restricted stock that was very difficult to transfer. Jeff contacted an acquaintance

at Golden Sachs who Jeff knew from his days at Goldman. Stanley. In each instance, Jeff explored Wall Street mechanisms to limit the risk of holding restricted Masco shares. Through the summer and early fall of Jeff also contacted a colleague at Morgan

1999, it looked as though the Masco deal would close. However, the parties meant an insurmountable stumbling block. The management of Therma-Tru, following the acquisition, caused a problem. They couldn't reach

consensus of how the company would be managed subsequently. The deal cratered and Masco walked. In

the summer of 1999, while the Masco deal was still pending, Dave, Sr. and Jeff contacted David Herpe, a Heritage Reporting Corporation (202) 628-4888

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14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 partner in the estates and trust area at McDermott, Will, and Emery, where Mr. Kim is at now. They asked him to assist the family in forming a family foundation and an investment entity through the family office. Mr. Herpe had significant

experience in the establishment and operation of family offices. And Mr. Herpe was one of the few non-

non-Shumaker lawyers that the family relied upon. Herpe had been the architect of the qualified annuity trust that Dave, Sr. had used and established and effectively used to transfer Therma-Tru's ownership, a significant part of Therma-Tru's ownership over to his children. Now Dave's primary goal was that of philanthropy. A meeting was set up for Herpe to meet

with Dave, Sr., Georgia, Deke, and Jeff to discuss the proposed foundation and family office. At the meeting

David Herpe explained the mechanics of establishing a private foundation and a family office. He had subsequent conversations with Jeff explaining that the structure for a family office and an investment would be to create two entities. One,

Stobie Creek, to hold the family's assets, and the other, North Channel, LLC to manage those assets. Dave Herpe explained the structure. Heritage Reporting Corporation (202) 628-4888

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15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Insulates the family from assets from creditors. Stobie Creek was not planned to be and today is not a special purpose entity. Stobie Creek continues to

invest the family's assets and currently has almost a half of billion dollars of assets that it invests for the Welles family. The family asked Mr. Herpe to

start work on establishing a family foundation and to begin the process of establishing the family office. Although, the Masco deal was off the table, they were still hopeful that they could find a buyer. A Therma-Tru board member suggested that they contact Kenner and Company, a private equity firm. contact was arranged. the Kenner principals. The

David, Deke, and Jeff met with Kenner expressed an interest Kenner, however,

in doing a deal with Therma-Tru.

needed to do its due diligence on Therma-Tru. Additionally, because Kenner was a private equity investor, it had to line up its own equity and capital financing for this transaction. A deal with Kenner,

while promising, was still anything but certain. The initial contact with Kenner was made in the fall of 1999. Negotiations commenced, initial Finally a

bids were negotiated and renegotiated.

tentative deal was struck in December of 1999. Unlike the Masco transaction, the Kenner Heritage Reporting Corporation (202) 628-4888

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16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 deal was to be structured as a simultaneous recapitalization of Therma-Tru and a redemption of part of the outstanding shares. Essentially, the deal

that was proposed had Kenner infusing cash into Therma-Tru for a 50-percent piece of the equity of Therma-Tru at the same time that the current shareholders would redeem 50 percent of their stock in the company. The first share offer increased from the Masco offer. The Kenner proposal valued 50 percent of Now, that

Therma-Tru between $425 to $435 million.

would equate to somewhere between $850 to $870 million. That's as compared with $825 that had come

from Masco. The deal was significant in another way. This was a taxable transaction. Now, a nonbinding

letter of intent was prepared and Kenner's due diligence began. During late '99, following a meeting at the Therma-Tru board, Deke, David, Sr. and Jeff approached David Waterman. David Waterman was then serving on

the board of directors, and inquired whether there were any opportunities to reduce federal and state tax exposure from a sale of Therma-Tru to Kenner. Waterman told them that a couple of other Heritage Reporting Corporation (202) 628-4888

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17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Shumaker clients had obtained tax advice from a firm down in Texas called Jenkins & Gilchrist on tax savings strategies. At that time Jenkins was a large

Texas-based firm with offices in several cities. Waterman, after checking with his partners on the deals that other Shumaker clients had engaged in, told the Welles family that his firm had fully vetted the Jenkins & Gilchrist ideas and that the Shumaker lawyers felt comfortable that the Jenkins' strategies worked. Now, responsibilities for all that was occurring were assigned to Deke and to Jeff. Deke

would have primary responsibility to advance the ball on the Kenner transaction and could call on Jeff's knowledge of Wall Street financial structuring to cut the best deal possible for the family. Jeff would

assist in negotiating the dollar terms of the Kenner transaction. Jeff also took hold of establishing the infrastructure for the family office, the family investment vehicle and the family foundation. Now in

the fall of 1999, David Waterman did arrange for Jeff to be introduced over the phone to Donna Guerin. Donna was a tax attorney at the Jenkins & Gilchrist firm. Jeff later arranged a personal meeting with Ms. Heritage Reporting Corporation (202) 628-4888

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18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Guerin. It took place in Chicago while Jeff was in

Chicago on other business. That initial meeting was no more than a goodwill meeting. described her firm. Ms. Guerin introduced herself and She said they had an outstanding That meeting led to

reputation in tax matters.

followup telephone conversations from Donna Guerin to Mr. Welles. And as this Kenner proposal started

gaining more momentum, the thought of taking advantage of the tax savings opportunity became more appealing. At about the same time, ideas for the family office and the family foundation started to also gain interest. David and Georgia, whose primary concern

was philanthropy, decided to call for a family meeting. Both Jeff and Deke saw this as an

opportunity to bring their siblings the details of the proposed Kenner deal and to explore the creation of a family office with their siblings. In anticipation of that meeting, Jeff contacted Donna Guerin. She told Jeff that before

Jenkins would disclose tax planning ideas, family members would have to create, I'm sorry, would have to execute a confidentiality agreement. Confidentiality No fee The

agreements were circulated among the family. was associated with any of the disclosures. Heritage Reporting Corporation (202) 628-4888

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19 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 confidentiality letters provided fees for any tax opinion, would have to be the subject of further negotiation between Jenkins and the Welles family. Your Honor, you will hear about the meeting at Dave and Georgia's Florida home. Beach meeting. That's the Vero

The meeting took place over two days.

Dave and Georgia addressed the children on the importance of philanthropy to them and the Welles family legacy and their desire to create a family foundation. Deke and Jeff described the status of the terms of the Kenner transaction at the time it was still open. In fact, Deke spent a lot of time during

that meeting negotiating with respect to specific terms. Jeff and Dave Herpes spoke about the benefits of the family office, while Dave, Sr. and Georgia and David Herpe and Jeff spoke on the creation of a family foundation. And in a separate session,

Dave Waterman came in and addressed the family about the mechanics of the Jenkins & Gilchrist tax savings proposal. At the Vero Beach meeting, Waterman was asked a seminal question, David, if you were in our situation, would you take advantage of the Jenkins tax Heritage Reporting Corporation (202) 628-4888

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20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 savings structure. And he responded that he would.

The family reached a consensus on creating a family charitable foundation, like this 45. That's

Cricket Island up here, Your Honor, in the corner. Now, and they also, the family investment vehicle. Now the family investment vehicle is right here in the center. That would be Stobie Creek. (Away from microphone.) Stobie Creek's ownership is written -individual family members' interests. And North

Channel (phonetic) is a manager and runs the family office. David, Sr. up until his death, and Georgia

are the only North Channel and Jeffrey Welles is the manager of North Channel. That's our structure.

With respect to the tax savings structure suggested by David Waterman, the family asked Jeff to do further research. What they had been told by

Waterman was that the Jenkins proposal involved trading in foreign currency options. Jeff stated that

he would follow up on the economics of the foreign currency option trades suggested. If Jeff thought

that there was a reasonable possibility of profit on the trades, he would recommend that the family do them. In the case of Therma-Tru, the family Heritage Reporting Corporation (202) 628-4888

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21 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 deferred on all things to Deke's knowledge of the business and with Kenner. In financial matters, the They,

family deferred to Jeff's investment acumen.

again, defer it at this time to Jeff's good judgment. Following the meeting, Jeff conducted his own due diligence on the proposed foreign exchange trades. Jenkins & Gilchrist told Jeff that an

individual at Deutsche Bank by the name of David Parse, was familiar with the foreign exchange option trading concept. Now, this was significant information for Jeff for two reasons. First, when he had started

looking to establish an infrastructure for Stobie Creek, he had contacted several banking organizations, including Deutsche Bank. It had been highly

recommended to him as being reputable and being able to effect the type of investment opportunities that were necessary for Stobie Creek. Second, Jeff knew David Parse. They In

previously had worked together at Goldman Sachs. fact, when Parse was first hired by Goldman, Parse spent a short period of time assigned to Jeff's trading partnership.

And when Parse was reassigned to

Chicago, Jeff, from time to time, had conversations with David. Heritage Reporting Corporation (202) 628-4888

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22 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 What happened was that Jeff contacted Parse and after exchanging pleasantries and trying to learn about what they had been doing in the interim, he asked him about the foreign exchange option trades that were suggested by Jenkins. After learning what

the design was, Jeff once again reached out to his Wall Street connections at Goldman Sachs and Morgan Stanley to get information on the economics of the proposed FX trades. Jeff was looking at doing two spread trades. He had to analyze four separate options, a long and a separate short on the euro and a long and a separate short on the Swiss franc. These were digital options.

Digital options differ from U.S. style options in that digital options mature as of a specific date or only exercisable at a specific time. U.S. options are

exercisable anytime within a span of time. There were three payoff possibilities. could lose his investment. Jeff

He could double his money.

(A) is his options expired within a very narrow band of strike prices, he could make up 200 times his initial investment. Jeff's concern focused on the cost of the two spread positions. Parse had told Jeff that the

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23 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of the long option premium. Mr. Parse also advised

him that the odds on doubling his money were in the range of plus or minus 30 percent. Obviously, the

converse is that the odds of losing his investment were in the range of plus or minus 70 percent. Again,

obviously, the odds of hitting that narrow band, that narrow sweet spot on either the euro or the Swiss franc was far less certain. Jeff knew from his trading days at Goldman Sachs that foreign exchange options were speculative investments. He knew that in order to profit, one

needed to have a contrarian view from that of the market. One needed to look for a trigger event that

would cause an increase in the currency's volatility. Mr. Welles started reading Goldman and Deutsche Bank analyses on currency patterns and positions. Goldman and Deutsche Bank viewed the euro as underpriced and the Swiss franc as overpriced in relation to other currencies. Jeff knew that historically there was a correlation between the euro and the Swiss franc. But Each

he believed that there was a short-term opportunity to exploit a deterioration in the relationship between the euro and the Swiss franc. Jeff discussed with Deutsche Bank the Heritage Reporting Corporation (202) 628-4888

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24 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 trading ideas suggested and conversed with Goldman and what he then wound up doing is taking a look at some Goldman and Deutsche Bank articles, specifically relating to establishing the two spreads. The transaction that was suggested was that one position would anticipate a rise in the euro and the other would anticipate that the Swiss franc would fall. Jeff discusses his thoughts with his family.

They told him that he should use his best judgment. If there was a reasonable opportunity to make a profit on the trades, then he should make the investment. Jeff made arrangements with Deutsche Bank to represent his family in making the investment. order to obtain the funds to engage in these transactions, each of the members of the Welles family, through their separate LLC's, borrowed from the family trust. The trades were executed through In

those LLC's and their purpose to protect the individuals from liability. Jeff Welles formed a Delaware limited liability company named JFW Investments, LLC in March 3, 2000. On March 31, 2000, Jeff's LLC bought a long

option on the euro with an expiration date of April 17, 2000. option. He paid a premium of $9,662,500 for that He also sold a short digital option on the Heritage Reporting Corporation (202) 628-4888

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25 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 euro and received a premium of $9,565,875. Bank was the counterparty in both of those transactions. That option also had an expiration date Deutsche

of April 17th, 2000. Jeff believed that the euro would rise in relation to the dollar. That was a Euro bull spread.

In addition, Jeff's LLC sold a short digital option on the Swiss franc for which he received a premium of $9,565,875. That option also had an expiration date

of April 17, 2000. Jeff also bought a Swiss franc long digital option with an expiration date of April 17. option he paid a premium of $9,662,500. For that

With respect

to that transaction, Jeff anticipated that the Swiss franc would decrease in value in relation to the dollar. That was a Swiss bear spread transaction. Each member of the family through their LLC's also put on the same trade as Jeff's LLC, anticipating that the euro would rise in relation to the dollar and anticipating that over the short term the Swiss franc would decrease in relation to the dollar. Now, the spread transactions on the euro and Swiss franc allowed Jeff, through his LLC, to leverage his investment and at the same time control the amount Heritage Reporting Corporation (202) 628-4888

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26 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of risk that he was exposed to on the options. end game on these options was to anticipate a separation in the correlation between the Swiss franc and the euro. That is what was suggested in the The

readings that Jeff had done, in reviewing analysis from Goldman Sachs and Deutsche Bank. In the case of the euro spread, if at the expiration date the euro was trading at or above a specific amount, then Jeff would double his money. If, however, it was selling at less than another amount that was slightly lower, he would lose his premium. If at the expiration date the euro was

trading between those two spread numbers, so called sweet spot, Jeff would have a payoff of 200 times his premium on the euro options. Similarly, if the Swiss franc were trading at or below a specific rate, then Jeff would double his investment on the option transaction. If the

Swiss franc were valued at a rate slightly higher on April 17, Jeff would lose his investment. As in the

case of the euro, if an April 17 the Swiss franc were trading between that narrow range, the so called sweet spot, then he stood to gain 200 times his net premium in the transaction. Now all the while that Jeff was engaging in Heritage Reporting Corporation (202) 628-4888

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27 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the foreign exchange trades for himself and his family, Deke was managing the Kenner deal. diligence was still proceeding. Due

Kenner still hadn't The deal

arranged for financing on its transaction. was still open.

In April, each of the Welles families, each of the Welles LLC's contributed the digital options to Stobie Creek. At the same time, they individually

contributed to Stobie Creek one half of their shares in the stock of Therma-Tru. Now the contribution of the options and the shares of Therma-Tru constituted the very first step in the funding of Stobie Creek as a family investment vehicle. Also, if the transaction with Kenner did

close, they would be in a position to take advantage of the Jenkins & Gilchrist proposal. If the

transaction with Kenner didn't go forward, nothing happened. Through April 17, 2000, the expiration of the options, Jeff monitored the foreign exchange markets to determine whether the appropriate volatility was occurring in the markets and whether any announcements that were projected from either the Swiss National Bank or the european Central Bank had occurred. Heritage Reporting Corporation (202) 628-4888

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28 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 These were the types of events that could cause movement in both currencies. These are the You will

types of events that would cause volatility.

hear expert testimony that many factors can affect the currencies movement. them. In addition to Jeff's monitoring the trades, Bill Chung, who was an employee and worked in the office of North Channel at the time, was monitoring both the euro and the Swiss franc daily during that period if the options were outstanding. Both Mr. These were just a couple of

Welles and his employees actively monitored the trades to determine if there was a sufficient volatility to cause movement that would allow him to make a profit or to do some other things with the options. As things ultimately turned out, however, both trades expired out of the money. And Mr. Welles,

along with his family, lost their investment on the transaction, some $2 million. Stobie made an election

under section 754 to adjust the basis of its assets so that in the event of a sale or exchange of the members' interest, the basis of the partnership assets would increase or decrease to that of the basis of the member. THE COURT: You said that Mr. Welles, in the

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29 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 loans? MR. KOLEK: signed, Your Honor. There was no note that was It was a family transaction. To It matter, lost the investment -MR. KOLEK: Creek's investment. THE COURT: It would be Stobie Creek's. But this $2 Well, by then it would be Stobie

Stobie Creek lost the investment.

million, was it a loan, if I understand correctly, from the family trust? MR. KOLEK: The family trust had loaned $2

million to the LLC interests that acquired the foreign options. Those loans were subsequently repaid with

interest out of an allocation through Stobie Creek. THE COURT: What was the recourse on those

was treated as a transaction within the family.

the best of my knowledge, there was not a nonrecourse loan. Even in mid April, when the options expired, the Therma-Tru transaction with Kenner was still up in the air. On April 30, 2000, each of the members of

the Welles family transferred their individual limited liability company interests, which were the members of Stobie Creek, to separate S corporations, which each of them had established. As a consequence, Stobie

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30 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Creek terminated as an entity for federal income tax purposes pursuant to section 708 of the Code. Its assets had been distributed and recontributed back to Stobie Creek. Upon the deem

distribution of the shares of Therma-Tru to each LLC and in turn the S corporation, the shares picked up the basis of the interest in Stobie Creek, thereby increasing the basis of the Therma-Tru shares inside Stobie Creek. Now, it was about at this time that the transaction with Kenner was starting to come together. The financing of the acquisition was starting to take shape. However, the contract and the exhibits to the On May 9th, 2000,

contract still had to be finalized.

the transaction with Kenner was consummated in a simultaneous sign and close transaction. Kenner contributed cash to Therma-Tru in exchange for a new stock position. Each of the

existing shareholders of Therma-Tru received a cash distribution for Therma-Tru in redemption of their shares. Those funds went straight to Stobie. All of

this was consistent with the Internal Revenue Code, the regulations and existing case law at the time. Now, at this point no decision had been made as to whether or not Jenkins & Gilchrist would render Heritage Reporting Corporation (202) 628-4888

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31 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 an opinion and no agreement had been reached with respect to how much that opinion might cost. Now,

David Waterman had told the family earlier that year at the Vero Beach meeting that any opinion would be expensive. And based upon his prior experience, he

was aware that the fee generally was determined by reference to a percentage of the amount of stepped-up basis that the transaction generated. On August 14, 2000, however, the Internal Revenue Service issued Notice 2044. That notice

described two transactions in which the IRS contended that the losses generated were artificial and were not to be allowed as a deduction for the taxpayer. the examples in Notice 2044 was similar to the transaction that the Welles family had engaged in. It was a transaction that generated a loss as opposed to a transaction in which basis was enhanced. Although concluding that the loss was One of

artificial, the Internal Revenue Service chose not to make a broader statement with respect to the law. The

case law, Helmer in particular, allowed for a step-up in basis because the short position of the digital option that was contributed did not constitute a liability, an offsetting liability. As a result, there was no statement on the Heritage Reporting Corporation (202) 628-4888

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32 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 not apply. law. They just merely looked at the artificiality of Additionally, Notice 2044, the Now, as soon as

the transaction.

transactions related to corporations.

David Waterman learned of Notice 2044, he asked the Shumaker tax lawyers to examine it and determine whether or not it applied to the Welles' transaction. Waterman was told that Notice 2000-44 did Waterman wanted confirmation. He asked

that a conference call be set up with a representative of Jenkins & Gilchrist. At the same time, Waterman

contacted Jeff Welles, advising him of the fact that the notice had been issued and said that he had requested a conference call with the Jenkins firm, and in particular Donna Guerin. THE COURT: Was the basis of that opinion it

wouldn't apply because they were dealing with a partnership here? MR. KOLEK: Yes, that was one of the things

that they said, that this was not a corporate situation. This is a partnership situation, and

corporate law had really specific provisions under sections 356 and 357 dealing with liabilities. On that conference call, which Jeff was on, the attorneys described the facts of Notice 2000-44 and then indicated why they believed Notice 2000-44 Heritage Reporting Corporation (202) 628-4888

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33 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 attorney. MYU. wasn't applicable to the transactions that the Welles family had engaged in. At the conclusion of the conversation, David Waterman asked the Jenkins firm whether or not if they issued an opinion they would include their conclusions with respect to Notice 2000-44 in that opinion. The parties were told, yes, they would include an opined overt Notice 2000-44. When the

opinion was ultimately issued, that was included. We've spoken about the trades that were done and the legal advice that was received. But you

should know about two other individuals who assisted Jeff in reporting these transactions. In April 2000,

North Channel hired Larry Goldstein as its Chief Financial Officer. Mr. Goldstein was and is a CPA and an He received his L.L.M. and Taxation from Larry

Larry's expertise was in tax compliance.

was on the phone with Jeff when Jenkins explained the Notice 2000-44 issues and he assisted the family's trusted accountant, Bob Floyd, in preparing the Stobie returns. Now, Bob Floyd had been the longtime accountant for the family. Mr. Floyd had worked for And

many years in public accounting at Arthur Young. Heritage Reporting Corporation (202) 628-4888

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34 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 in 1985, Mr. Floyd left Arthur Young and opened up his own accounting firm. For years he had been preparing

the tax returns for David and Georgia, Deke and Hopi and other family members. Given his relationship as the family's accountant, North Channel hired Mr. Floyd to prepare the Stobie tax returns for the year 2000 as well. Mr.

Floyd worked with attorneys at the Shumaker firm and cleared his draft tax returns with Larry Goldstein. At about the same time, Jeff Welles finalized his negotiations with Jenkins & Gilchrist with respect to the cost of an opinion. Jeff, who had

worked on Wall Street for almost 15 years and was accustomed to seeing large fees charged for things such as fairness opinions, innovative transactions, innovative financing techniques, large estate matters, discussed with Ms. Guerin the fees to be paid in this matter for Jenkins & Gilchrist's opinion. Jeff, on behalf of Stobie, ultimately agreed to pay approximately $6 million to Jenkins, of which $2 million would go to the Shumaker firm. Now, you will see as evidence a letter that was found in the files of the Shumaker firm that is addressed to each of the members of the Welles family. In that letter, David Waterman offered to forgo any Heritage Reporting Corporation (202) 628-4888

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35 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 fees with respect to this matter because of the amount of the fees and the long relationship that had existed between the Shumaker firm and the Welles family. Now, there is some question as to whether Mr. Waterman actually sent the letter. Although he

believes he did, none of the Welles family members recalls having received a copy of the letter and only one unsigned copy was located in the Shumaker firm files. Jeff Welles did have a conversation with David

Waterman in which Mr. Waterman offered to forgo receipt of any fees associated with the transaction. In Jeff's view, the Shumaker firm had acted as trusted counsel for the Welles family and for Therma-Tru for over 37 years. Jeff and his family

members looked at the fee as appropriate in light of all the years of faithful service the Shumaker firm had provided to the Welles family and to Therma-Tru. Following the filing of the tax return in this case, the Internal Revenue Service began an audit examination of the Jenkins firm. That examination led

to a disclosure of all of Jenkins' clients, including the Welles family. As a result of that examination, the IRS audited the Welles family. What the IRS did was they

disallowed the stepped-up basis resulting from the Heritage Reporting Corporation (202) 628-4888

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36 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 digital option transactions. So, where are we now? that Stobie Creek was a sham. The Defendant claims

A special purpose

entity designed solely to effectuate the Jenkins & Gilchrist tax strategy. that's just not the case. Well, the facts will show Stobie Creek was on the

drawing board in advance of any hint of a transaction involving digital options or any proposals by Jenkins & Gilchrist. It has engaged, over the years, in It provides a

billions of dollars of transactions.

latter investment opportunity for the Welles family to participate in the best financial advice available. It allows for the flexibility of investments, to take advantage of a full range of investments from the most secure to those with great risk and great reward associated with them. Did the Welles family have a legitimate nonbusiness purpose, excuse me, for the creation of Stobie Creek? I'm sorry. Did the Welles family have

a legitimate business purpose for the creation of Stobie Creek? that they did. Stobie Creek was formed for nontax business purposes and exists today and provides the family with opportunities that it would not otherwise have. Heritage Reporting Corporation (202) 628-4888 Did I think the only rational conclusion is

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37 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 things. Creek. MR. KOLEK: I think it is a combination of the Welles'es -(Nearby siren sound.) THE COURT: Did they focus -- beyond Stobie

I think that there's a business-purpose I

function that's associated with the transaction. also think that if one looks at the FPAA that was

issued in this particular case, that there is an issue with respect to whether or not Stobie Creek was formed for the right reasons. Now did the Welles family take advantage of a loophole in the law, as I said earlier, the answer is that they did. that. But there's nothing wrong with

Taxpayers are allowed to reserve pairs to pay There's no obligation,

the least amount of taxes.

patriotic or otherwise to pay the most. The government contends that Stobie was formed in connection with a transaction the principal purpose of which was to reduce substantially the present value of the taxpayer's tax liabilities. not the case. Stobie was formed as an investment It's

vehicle for the Welles family. (Away from microphone.) Additionally, the government contents that Heritage Reporting Corporation (202) 628-4888

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38 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the short positions, the written call options and the two split positions that Jeff Welles, through a couple option transfers, constituted a liability for purposes of Treas. Reg. § 1.752. This regulation was promulgated in 2003. It's application to the particular facts of this case is less than certain. How can the government argue

for the retroactive application of this regulation. Now that's somewhat akin to Dean Wormer in Animal House and his treatment of the Deltas with double secret probation. No one knew about it, especially at the time these transaction occurred. The Defendant had an

opportunity to announce his position in 2044, it didn't do that. It's unfair for the government to be

arguing the application of this retroactive regulation when the law was well settled at the time. The

government should not now be allowed to claim -rather it's the Welles family and all taxpayers, for that matter, that were misled. (Electronic interference.) THE COURT: Well -- Judge Easterbrook in

Cemco (phonetic) just rejected the argument that you made. What's your response to Cemco? MR. KOLEK: Well, I look at the Cemco case,

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39 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 I think in many respects the Cemco case is colored by particular facts of that case. loss generator case, number one. And I think that was a Number two, the

transactions that Mr. Daugerdas (phonetic) has been engaged in in the case do appear to be somewhat contrived with respect to how those transactions were ordered. But Judge Easterbrook's opinion goes off a and takes onto it something that I learned later on to the case. His judgment was not relevant or was not You

important to the ultimate decision in that case.

know, obviously this is an issue that we're going to talk further about with the Court. But we believe

that there are distinctions with Cemco and our facts. And I think we can make that, there's a distinction with respect to how Cemco should be applied. Now the government in its contentions that, that the Welles family did not answer to the digital option transaction with an appropriate objective profit motive. Defendant's experts spends pages analyzing the pricing of the option and profit potential as if it were the Zapruder film. THE COURT: (Laughter.) Heritage Reporting Corporation (202) 628-4888 You like movies.

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40 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 relate to. THE COURT: MR. KOLEK: Okay. But that type of analysis Defendant proceeds MR. KOLEK: It's something that people can

doesn't take into account reality.

from the assumption that there is but one method of analyzing a transaction's profit potential. If

taxpayer does not do all the things that the Defendant claims is reasonable and appropriate, then according to the Defendant, the taxpayer did not have an appropriate profit objective. Defendant would have all taxpayers analyze each and every investment they make on a strict probability of profit basis. According to the

government, unless there is a significant probability of profit, then there can be no valid profit motive. The Defendant would apply this test irrespective of taxpayer's financial condition or whether taxpayer had views contrary to the market. a taxpayer's appetite for risk is greater than the average person, the taxpayer fails the Defendant's test. If a taxpayer seeks to speculate on the market, then the taxpayer fails the Defendant's test. On the Defendant's approach, an investment in a Heritage Reporting Corporation (202) 628-4888 If

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41 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 restaurant or an oilwell or gaswell or in a new startup, would not satisfy the Defendant's objective profit test. If you apply the government's objective

profit test, as rigidly as it wants it applied, then the entrepreneurial spirit, the risk-taking that made our country so vibrant, also fails this test. The facts are that the Welles family had considerable resources and they had the wherewithal to take an educated chance with respect to the some of that wealth, on a speculative investment. None of them were venturing their last investment dollar. prospective trades. Jeff Welles had analyzed the There was a basis for a

contrarian view that the euro would rise in value in relation to the dollar and that the Swiss franc would fall in relation to the dollar. The Welles family took that risk. investment failed. Didn't work. They lost. The That

does not make the investment unreasonable or a sham. It was a speculative risk for which the Welles family could double their money or if they hit that sweet spot, could reap enormous profits that they could use to fund their charitable endeavors. Jeff Welles devoted appropriate attention to analyzing the trades. There was a reasonable

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42 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 opportunity to profit. Additionally, the Defendant

argues that the long and the short options are part of a single transaction and it should be integrated. Expert testimony, however, will establish that the long and short positions are separate and distinct transactions. instruments. These positions of section 988 transactions and under the Code are not to be integrated. The They're separate and distinct

documents confirm that they are separate transactions and were intended to be separate. Finally the Court acknowledges that a taxpayer can hold both long and short transactions, positions rather, at the same time and they will be treated as separate. THE COURT: The government's position seems

to be that because they were offsetting premiums, if you will, was going to be having almost a substantial exposure to Stobie Creek, that Stobie Creek avoided having to come up to satisfy margin requirements that would have been excessive and because of this structure that mitigated any real risk, the primary purpose of the transaction was not business purpose related. MR. KOLEK: Well I think that's a false

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43 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 premise on the part of the Defendant. I think that

does not take into account what happens in the reality of the market on a daily basis. People enter into

spread transactions on a continual basis. There's no, nothing wrong with a spread transaction. It is two definitive transactions. One

was a sale of an option, they used the premium from that particular sale to then, plus some additional dollars, to take a long position, to go out long. It's done every day. It's done by traders every day It is a

on the Chicago Merc, Chicago Board of Trade. standard-type transaction. THE COURT: MR. KOLEK: Okay.

In this case, Jeff Welles

instructed the sale of the stock in Therma-Tru so he could fund the family office with proceeds of the sale. The structure used was well designed to provide He also entered

maximum protection from liabilities.

into foreign exchange option transactions that were designed to profit from perceived opportunities and currency values. Those foreign options also allowed him to take advantage of a well-settled law, the Helmer case. Jeff entered into the option transactions. He

structured his transactions with the advice of counsel Heritage Reporting Corporation (202) 628-4888

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44 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 place. to give him the greatest flexibility of ownership of his shares of the family office. All the entities that were used are still in His S corporation allows him the flexibility

to make gifts of his interest in Stobie Creek without affecting the allocations of Stobie. It's a

flexibility that all of the members of the Welles family currently enjoy. The S corporation structure

also provided for some Ohio State tax benefits for each of David and Georgia and for Deke and his wife, Hope. Finally -THE COURT: Have you had occasion to read

about the Allison decision of Judge Wolski that was issued on -MR. KOLEK: Yes, I did. I took a brief look

at the Allison decision. THE COURT: MR. KOLEK: THE COURT: Did you like that verdict? I did. I realize the burden has shifted

but in terms of his canvassing the law and saying that the Tenth Circuit approach probably is the best one to apply in terms of the reasonableness or reliance on investment advisor's view recommended? (Traffic noise nearby.) MR. KOLEK: Yes. I think one of our former

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45 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 witnesses, Stuart Smith, was the attorney -THE COURT: MR. KOLEK: Right. -- in the Allison case. I

would, you know, I'd be more than happy to prepare some type of a brief on that. THE COURT: go forward. MR. KOLEK: of penalties. Okay. Finally, on the question No. I'm just querying you as we

No penalties should be imposed where a

taxpayer reasonably relied on the advice of tax professionals and acted in good faith with respect to the particular item in question. teaches us. The evidence will show that Jeff consulted multiple tax professionals prior to making any action. He wanted to do things right, not only for himself but for his family. When it came to forming a family That's what Boyle

office and establishing a family foundation, he sought the advice of David Herpe, a family office and an estates and trust expert at McDermott, Will & Emery. When Jeff was looking for tax advice on the sale of stock in Therma-Tru, he consulted David Waterman, a trusted advisor with Shumaker, Loop & Kendrick. David sat on the board of Therma-Tru. Mr.

Waterman was the managing partner and served, from Heritage Reporting Corporation (202) 628-4888

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46 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 this, served Therma-Tru and Welles family for almost four decades. The evidence will show that Mr.

Waterman suggested that Jeff seeks the counsel of Jenkins & Gilchrist. Jenkins was a large firm with a

fine reputation for tax matters. Jeff acted on Mr. Waterman's suggestion and met with the attorneys at Jenkins. He learned of the

techniques they suggested and discussed it with Mr. Waterman. He gained greater confidence when Mr.

Waterman advised him that his firm had other clients that engaged in this similar transactions, that the Shumaker's own tax lawyers had researched the techniques and that Mr. Waterman, himself, if presented with the opportunity, would engage in the transaction. Upon learning that engaging in foreign exchange options were part of the strategy, Jeff satisfied himself that there was an appropriate opportunity for profit as well that fit well within the risk parameters of his family. Still, he did more. He made certain that

the new chief financial officer of Stobie Creek, Larry Goldstein, an attorney and CPA was brought into the loop. In short, I think Jeff Welles received and

reasonably relied upon the advice of trusted Heritage Reporting Corporation (202) 628-4888

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47 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 now. (Whereupon, a short recess was taken.) THE COURT: MR. GIBSON: THE COURT: claimant's table? Please proceed. Thank you, Your Honor. Is everybody here from professionals. Thank you. THE COURT: Thank you very much. May we And that's where we're at today.

take a short break before you begin? MR. GIBSON: That would be very helpful and

we could get our easel set up here. THE COURT: Okay. I have 11:05, we'll break

We have, for the record we have a

very large and powerful chart that took some mastery to make. I'm very impressed. We saw critical path

charts that were as large. MR. GIBSON: We wanted to make it so I And

wouldn't need my glasses to read it, Your Honor.

we'll see if I need my glasses to read my own notes. Your Honor, I need to talk about what the case is about and what the case is not about. case is not about whether the Welles family are philanthropists. This case is not about whether the The

Welles family did due diligence when they sold their company. This case isn't about whether Stobie Creek Heritage Reporting Corporation (202) 628-4888

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48 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 has a valid business purpose for having been formed. It's not in our pretrial memo. What this case is about is whether the particular transactions that generated the tax benefit that they claimed, that is an artificial increase in basis of more than a fifth of a billion dollars had economic substance. And so I need to go back and redo or at least cover a little of the glam and the timeline to put a little em-pha'sis on the right syl-lab'les. Because, obviously, our case differs a bit. Your Honor, this is a case about a family that sold their business and made inquiries about how to pay the lowest amount of taxes they could to eliminate taxes on the income that they would get from selling the business, $204 million. And I don't think it's ironic, although one might think it is, that this is not the first time that the Welles family has been in this courthouse arguing about this tax shelter. Three and a half

years ago, the IRS issued a summons to Jenkins & Gilchrist for information about their development, marketing, promotion and implementation of Son of BOSS tax shelters. And lo and behold, the Welles family members Heritage Reporting Corporation (202) 628-4888

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49 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Court? intervened in that lawsuit. They filed affidavits

from two of their lawyers, Mr. Waterman and Mr. Ivsan, and unfortunately we will not be hearing from Mr. Ivsan during this trial because he's declined to testify and reliance on his rights under the Fifth Amendment. And they came in and what did they tell the They told the Court, in the Northern District

of Illinois, that the IRS should not be able to have access to the communications between their lawyers at Shumaker, Loop & Kendrick and the lawyers at Jenkins & Gilchrist because those were privileged. And they came in and they said, we went and we sought out tax strategies and that's the first thing, that was their first contact with the Court system involving this transaction. And I don't think

that that should be lost on the Court. Now, in our view, all of the rest, pretty pictures of the doors, the abortive sale, what happened, the tragic death or Mr. Welles, Sr., that's all aside. That's all on the side. That's not what

this case is about. What this case is about is a series of preplanned, orchestrated steps that Jenkins & Gilchrist designed for hundreds and hundreds of Heritage Reporting Corporation (202) 628-4888

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50 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 taxpayers that Jenkins & Gilchrist got compensated for. That Deutsche Bank assisted in implementing for hundreds and hundreds of taxpayers, that Deutsche Bank got compensated for. That Shumaker, Loop &

Kendrick assisted in implementing for some taxpayers, that Shumaker, Loop & Kendrick got compensated for. And it's about, to borrow a phrase from Mr. Kolek, this is about reality. And in reality, in the

cold light of reality, what they did made no economic sense whatsoever. And we will prove that. And what

they did was designed, was designed from the start to produce a prearranged result using a series of steps. And I'd like to just go through the timeline that we have here, Your Honor, because I think it's best to see it laid out. In December of 1999, Therma-Tru agreed to the buyout deal with Kenner. The details aren't

particularly important except they knew that they were going to have to pay tax on about $204 million worth of gain. The very same day that they accepted the offer, their lawyer at Shumaker, Loop & Kendrick, John Ivsan, wrote to Donna Guerin and said I have new clients, can you send me confidentiality agreements so Heritage Reporting Corporation (202) 628-4888

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51 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 I can talk about this tax shelter with you. What's interesting is, and this is ironic, that e-mail is one of the documents that the Welles family tried to prevent the IRS from finding when they intervened in the summons lawsuit here in Illinois three and a half years ago. About three and a half weeks go by, David Sr., Deke and Jeff Welles sign confidentiality agreements so that Jenkins & Gilchrist could disclose the details of their confidential tax strategy to the Welles family. And on January 24, you heard Mr. Kolek refer to the meeting in Vero Beach, and at that meeting, David Waterman told the Welles'es about the basisenhancing derivative structure using foreign exchange options, or the BEDS Shelter. Now one of the documents we obtained from Jenkins & Gilchrist in discovery in this case, what's interesting is we never got a copy of the BEDS memo from the Welles'es in discovery. We did get one from

David Herpe and we did get a whole bunch of them from Jenkins & Gilchrist. And what happened was they laid out this plan and the plan has seven steps. Now the seven

steps are dependent, Your Honor, on a bunch of things Heritage Reporting Corporation (202) 628-4888

Case 1:05-cv-00748-CCM

Document 121

Filed 05/15/2008

Page 53 of 259

52 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 happening, the formation of particular entities, individual limited liability companies, the formation of the Stobie Creek partnership, et cetera. And so what did they do? Creek on March 3rd. They formed Stobie

Three days later David Waterman

wrote and said Shumaker will get a portion