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

Case 1:05-cv-00231-EJD

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

No. 05-231 T (Chief Judge Damich)
JZ Buckingham Investments, LLC as Tax Matter Partner of JBJZ Partners, a South Carolina general partnership,
Plaintiff,
v.

United States of America,
Defendant.

DECLARA nON OF A. LAWRENCE KOLBE
ON

ECONOMIC IMPLICATIONS OF THE PLAINTIFF'S RESPONSE TO GOVERNMENT'S MOTION TO EXCLUDE EXPERT REPORT AND TESTIMONY OF MELVIN F. JAGER

Prepared tor the U.S. Department of Justice

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

May 16, 2008

gi

! GOVERNMENT'S

~ EXHIBIT

~ 2
¡¡

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Table of Contents
INTRODUCTION AND SUMMARY ................................................... i
Purpose of Summary of

Declaration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

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

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I. INTRODUCTION AND SUMMARY

My name is A. Lawrence Kolbe. My business address is Thc Brattle Group, 44 BrattJe Street,
Cambridge, Massachusetts 02138. I hold a B.S. in from the U.S. Air Force Academy (1968) and
a Ph.D. from the Massachusetts Institute of

Technology (1979), both in economics. I am a financial

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

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

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

7,2008.
A. Purpose of

Declaration
Melvin F. Jager," dated June 29,

I have been provided with two documents, the "Expert Report of

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

Response"). The latter

document indicates that at least part of

Mr. Jager's testimony is intended as rebuttal to parts of

the

Kolbe Report. 1 have been asked by counsel to the Tax Division of

the U.S. Department ofJustice

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

this

declaration is to respond to this request.

ODS

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B. Summary of Findings

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

if re-labeling the fees to advisors and attorneys in arrangements such as thc COBRA transactions
rendered the fees irrelevant to an analysis of

the transactions' profitability apart from tax, it would

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

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

were payments for intellectual propert in the form of a trade secret for how to save taxes, I would
have changed none of

my economic analyses or conclusions. Consequently, nothing in the Jager

Report is inconsistent with the economic analyses and conclusions in my report.
The remainder of this reply declaration analyzes the statements in the Plaintiff

Response.

II. ANALYSIS

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

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

... Plaintiff wil argue that fees should be allocated to the tax benefits of the
transactions and that any economic analysis of

the transactions that does not take into

account the tax benefits should likewise exclude the associated fees. In support of

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

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

the declaration.

Plaintiff Response, Section II, part A.

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

the realized

or potcntial tax benetits. This is precisely the compensation structure used in this
case.

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

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

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

It is true that the COBRA transactions' design included the possibility of an economic as
well as a tax benefit.5 However, it was not possible to enter

the COBRA transactions without paying

professional fees for both of

these types of potential benefit. Absent the fees, neither benefit could

bc obtaincd, because the transactions could not go forward.

In my report, I was asked to determine whether absent potential tax benefits, the COBRA

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

"tnnsaction costs." Hence the fees are an essential element of any economic analysis of the
Recall that the 1999 sets of transactions, which include the JBJZ and Tesoro disputes, all had tees to
attorneys and advisors equal to 4.5 percent of the stated cost of the long options (2003EYOO 1567,

001581 -82,007040; DOJ 049119-21), and the 2000 transactions, i.e., the Murphy farms disputes, had
fees equal to 2.5 percent of the stated cost of

the long options (DB-DOJ-COBRA-OOO i 3479, 3485,

3541,3547,3588,3594,3639,3645,3681,3687,3733, 3739, 3779, 3785, 3848, 3933, 3964, 3995,4083,9525,9526,9527,9626, 9632; DB-DOJ-COBRA-00240679 - 0024(799).
Recall that I have concluded that the COBRA transactions could not provide a reasonable possibility of profit, taxes aside. See the Kolbe Report, Section Il, part F.
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reasonableness of

the possibility of profit of

the COBRA transactions, regardless of

their label and

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

the fees as "compensation for

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

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

attorneys in arrangements such as the COBRA transactions rendered the fees irrelevant to an
analysis ofthe transactions' profitability apart from tax, it would essentially always be possible to
design such transactions so that their profitability apart from tax was no different from that of other

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

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

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

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

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

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

my report in any way.

The "essentially always" and "quite unlikely" parts of

this paragraph are present for safety's sake only.

As this is writtn, I cannot think of any way that the non-tax, no-transaction cost profitabilty of an

investment at market value but associated with a tax strategy could be economically different from that of an investment at market value but not associated with a tax strategy.
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J declare under penalty of perjury uoder the Jaws of

the United States that the foregoing is true and

correct. This declaration was executed in Cambridge, Massachusetts on May 13,200&.

d,~~
A. Lawrence Kolbe

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Appendix: QUALIFICATIONS OF A. LAWRENCE KOLBE

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

Technology, 1979.

EMPLOYMENT
U.S. Air Force, 1963-1977
Charles River Associates, 1978-1985 Putnam, Hayes and Bartlett, 1985-1990

The Brattle Group, 1990-

HONORS AN AWARS
Sears Foundation National Merit Scholarship, 1963 (declined). Fairchild Award, U.S. Air Force Academy, 1968 (for standing first in his class, academically). National Science Foundation Graduate Fellowship in economics, MIT, 1968-1971. Joint Service Commendation Medal, 1975.

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

~crved as Referee for The Rand Journal of Economics, ¡,and Economics, The Journal of Industrial Economics

PAPERS AN PUBLICA nONS IN THE LAST TEN YEARS
"Hn\" to Value a Lost Opportunity: Defining and Measuring Damages from Market Foreclosure," (with Willam B. Tye and Stephen H. Kalos), The Economics or Antitrust Injùry and Firm-Specifc Damages, Kevin S. Marshall, ed., Tucson, Arizona: Lawyers & Judges Publishing Company, Inc. (2008). (Republication of a 1995 article.)
"Measuring Return on Equity Correctly: Why current estimation models set alloweù ROE too low," Public Utilties Fortnightly (with Michael J. Vî1bert and Bente Viladsen), August 2005.
"The Effect of Debt on the Cost of

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

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Investment and Valuation, (with Richard A. Brealey and Stewart C. Myers, with "The Capital Brattk Group" listed as third author), New York: McGraw-HilllIrwin (2003).

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

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

and Boaz Moselle) Brattle report submitted to the Offce of Gas Access Regulation, Western
Australia (October i 999).

"Compensation tor Asymmetric Risks," (with others) Brattle report prepared for GPU PowerNet, Melbourne, Australia (October 1999).

Capital Estimation," (with others) Brattle report prepared for GPU PowerNet, Melbourne, Australia (June i 999).
"A Non-Practitioner's Guide to the State of the Ar in Cost of "A Note on the Pre-tax Weighted Average Cost of

Capital in a Regulatory Context with Australian

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

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

Return for Electric Utilities: Theory and Regulatory Economics Vol. i 3 (1998),255-275.

TRIAL TESTIMONY AND DEPOSITIONS IN LAST FOUR YEARS
2004
Case: Party: Forum: Case:
Coltec Industries, Inc. v. The United States of America, Fed. C1. No. 0 i -72T
The United States Court of

The United States of America Federal Claims

Part:
Forum:
Case: Party: Forum:

Liberty Digital, Inc. v. AT&T Broadband, LLC and Comcast Corporation, Civil Action No. 03-CV -95 AT&T Broadband, LLC and Comcast Corporation Colorado District Court, County of Arapahoe, 18th Judicial District
West Virginia-American Water Company, Case No. 04-0373-W-42T West Virginia-American Water Company West Virginia Public Service Commission of
Koch Industries, Inc., and Subsidiaries v. The United States, Fed. Cl. No. 028T Thc United States 'of Federal Claims The United States Court
A-2

Case:

Part:
Forum:

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Case: .

United States of America v. Anne (Sandy) Batchelor-Robjohns, alaJ

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

Party: Forum:

BenageslBrown United States of America

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

2005
Case:

Part : Forum:
Case: Party: Forum: Case:

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

Pennsylvania

Part:
Forum:
2006
Case:

Jade Trading, LLC, by and through Robert W. Ervin and Laura Kavanaugh Ervin Capital, LLC, Parners Other than the Tax Matters Ervin on Behalf of Partner, v. The United States, Case No. 03-2164T The United States Federal Claims The United States Court of

Part : Forum:
Case:

Arizona-American Water Company, Inc., for Utility Service by its Paradise Valley Water District, Docket No. WS-01303A-05-0405 Arizona-American Water Company, Inc. Arizona Corporation Commission

K2 Trading Ventures, LLC, New Vista, LLC, Tax Matters Partner, v. The United States of America, by and through the Internal Revenue Service, Case
No. 04-141 9T The United States of America Federal Claims The United States Court of

Party: Forum:
Case: Party: Forum:

Garco Investments LLP, et at. v. Sprint Corporation, Case No. 04 CV 017 14
Garco Investments LLP, et aL.

District Court of Johnson County, Kansas, Civil Court Department

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2007
Case:

Party: Forum:

JZ Buckingham Investments, LLC as Tax Matters Partner of JBJZ Partners, a South Carolina general partnership, v. United States of America, Case No. 05-231 T United States of America Federal Claims The United States Court of

Case:

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

SA Tesoro

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

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

Texas, San Antonio

Division
Case:
MUR AM FARMS, LLC, By and Through Wendell H. Murphy Jr., a

Partner

Other Than the Tax Matters Parter; PSM FARS, LLC, By and Through

Stratton K. Murphy, a Partner Other Than the Tax Matters Partner;
MURPHY PORK PARTNERS, LLC, By and Through Wendell H. Murphy, Jr., a Partner Other Than the Tax Matters Partner, v. United States of
America, Case Nos. 06-245 T, 06-246 T, and 06-247 T (Consolidated).

Part : Forum:

United States of America
The United States Court of

Federal Claims

Case:

Part:
forum:
2008
Case: Part : Forum:

Fidelity International Currency Advisor A Fund, L.L.C., by the Tax Matters Partner, v. United States of America, Case No. 05-40151-FDS. United States of America Massachusetts United States District Court for the District of

Northwestern Energy, Docket No. 2007.7.82 Northwestern Energy
Department of Public Service Regulation, Montana Public Service

Commission

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