CCA Selected 1996 documents

(12/31/
1995
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FEDERAL BUREAU OF INVESTIGATION
b7C
Precedence: ROUTINE
To: Baltimore
Boston
Chicago
Charlotte
Denver
Dallas
Memphis
Milwaukee
Philadelphia
Sacramento
New haven
Oklahoma City
From: San Francisco
jt1.
Squad 20
/if{ contact}"""""'-__----J
ff", oved By: SSA [
r----'=========;--
Drafted By: 1 --1
Date: 07/12/1996
case ID I: 196A-SF-93255 (Pending)
"
Title: I Gpop 1 e cb in Armstrong Jf·;
Hamilton Company, San
Franclsco, Ca, FBW (A), Mall
OO:SF
Fraud
Synopsis: Enclosed for receiving offices are the original and
one copy of trial subpoenas to be served in connection with a
forthcoming trial to be held in San Francisco federal district
court. The trial will commence on September 9, 1996.
Details: The above captloned sUbjects were indicted in June of
1994 at San Francisco in a twenty count indictment charging
with various cs ts of mail fraud and wire fraud in connection
with their in diverting $55,000,000 of client fun
from Hamilton Taft Company, a tax service company formerly
located in San Francisco. Receiving offices are reguested to
expeditiously serve the enclosed trial subp e as to these
prospective witnesses. .
/%/l-5F932
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1 LAW OFFICES OF
CHESTER L. BROWN
2 2450 Broadway, Suite 550
Santa Monica, CA 90404
3 (310) 315-6315
4 SOLOMON WOLLACK
388 Market Street, Suite 1080
5 San Francisco, CA 94111-5315
(415) 788-9000
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Attorneys for Defendant
7 CONNIE ARMSTRONG, JR.
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UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
)
) CR 94-0276 CAL
)
) MEMORANDUM OF POINTS AND
) AUTHORITIES IN SUPPORT OF
) MOTIONTODISMISS COUNTS SEVEI'
) THROUGH TWENTY-ONE; AND/OR
) REQUEST FOR PRETRIAL
) INSTRUCTION AS TO LAW OF THE
) CASE
)
-------------)
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15 UNITED STATES OF AMERICA,
16 Plaintiff,
vs.
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18 CONNIE ARMSTRONG, JR. and
RICHARD A. FOWLES,
19
Defendants.
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1 INTRODUCTION
2 On March 12, 1996, CONNIE ARMSTRONG, JR. filed with this court a Motion To Dismi
3 Counts For Legal and Factual Insufficiency. In the March 12 motion, defense counsel asserted that t
4 Ninth Circuit's opinion in In Re Hamilton Taft & Co. I commanded dismissal of certain counts of tl
5 indictment. The Nmth Circuit opinion established that client monies, once transferred to Hamilton Ta
6 became the property ofHamilton Taft -- leaving the clients with no beneficial interest in those monie
7 other than their contractual remedies against Hamilton Taft. In the March 12 motion, Mr. ArmstroI
8 sought to persuade this court that, under the Ninth Circuit's opinion, all counts speaking to "diversion
9 or misuse of"client funds," or other post-acquisition improprieties by Mr. Armstrong, must be dismisse
10 This court denied that motion.:
11 Mr. Armstrong now brings the instant Motion To Dismiss Counts Seven Through Twenty-On
12 based on the Nmth Circuit opinion or the logic contained thereina> To the extent that the instant motic
13 overlaps with the March 12 motion, Mr. Armstrong asks this court to reconsider its earlier decisio
14 Reconsideration ofthis matter is appropriate, on the grounds that: (1) New information has come to ligl
15 which bears on the existence or non-existence ofa scheme to defraud -- specifically, the fact that defen:
16 counsel has now confirmed that Hamilton Taft paid all taxes, in compliance with its contractual duties
17 (2) Because the indictment in this case pre-dated the Ninth Circuit opinion, there is a strong possibili1
18 that counts seven through twenty-one are based on an erroneous premise oflaw - a possibility eve
19 recognized by the government itself; which sought to get the Nmth Circuit opinion reversed; (3) Allowin
20 lay jurors to believe that Hamilton Taft was a fiduciary for their withholding taxes is not only legall
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In ReHamilton Taft & Co. (Wyle v. S & S Credit Co., Real Parties in Interest), 53 F.3
285, vacated on other grounds, 68 F.3d 337 (1995) is attached as Exhibit A.
Because the Ninth Circuit has vacated its opinion in In Re Hamilton Taft, the parties i
the instant case disagree over the extent to which that opinion controls in this case. !vlJ
Armstrong contends that, since the opinion exists and since it addressed a factual situatio
identical to the one at issue in this cnminal case, its logic carmot be ignored -- regardles
ofthe technical question ofwhether or not the opinion is still controlling per se.
Since the March 12 motion, defense counsel has had a chance to review the records 0
the Internal Revenue Service, as well as the schedules ofthe government's own forensi
accounting expert, Lee Baly, which show that, except for the first quarter of 1991 whel
the company was involuntarily shut down, Hamilton Taft paid all its clients' withholdin:
taxes for each quarter. .
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1 incorrect, but would cause tremendous prejudice and would constitute reversible error; (4) ClarificatiOl
2 of this issue, through dismissal of counts or, at a minimum, instructions to the jury, will save time, b:
3 allaying defense counsel's need to put on evidence about the character of funds and preventing constan
4 interruption ofthe proceedings with defense objections to the government's improper characterizatiOl
5 ofthose funds; and (5) This court's recent comments at the September 12, 1996 hearing suggested tha
6 further clarification may be warranted, concerning the applicability of the Ninth Circuit opinion to count
7 seven through twenty-one of the instant case.
8
9 STATEMENT OF FACTS
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11 A. DESCRIPTION OF HAMILTON TAFT'S BUSINESS --
12 Hamilton Taft was a California corporation which provided payroll services for large businesses,
13 such as Federal Express, Scott Paper, and The State Bar ofCalifomia. Under the federal and state t a . ~
14 laws, employers are required, every pay period, to withhold from each employee the estimated amount
15 which the employee owes in federal, state, and local taxes, for that pay period. This system, in which
16 employers are charged with the duty of withholding and paying taxes on behalf of their employees, is
17 believed to enhance the ability ofthe Internal Revenue Service to collect income taxes from all taxpayers.
18 However, because ofthe complex and ever-changing laws and regulations which govern the withholding
19 tax system, many companies choose to utilize the services of payroll processing firms, such as Hamilton
20 Taft.
21 Under the terms of Hamilton Taft's contracts, employers were required, each pay period, to
22 deposit with Hamilton Taft an amount equal to the total amount of employee withholding taxes due for
23 that pay period to federal, state, and local tax authorities. Hamilton Taft would then fill out all of the
24 proper paperwork and write a check to the various taxing agencies, on behalf of its client. In addition,
25 Hamilton Taft also prepared quarterly withholding tax return forms (Forms 941) on behalf of its clients.
26 The 941 forms are due thirty days after the end ofeach quarter and declare, under penalty of perjury, that
27 all employee withholding taxes have been paid for the previous quarter.
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1 By the terms of its contracts, Hamilton Taft assumed responsibility for all penalties and intere
2 resulting from any late payment of client withholding taxes. In return for these services, Hamilton T,
3 would generally receive no fee, but would be entitled to any benefit obtained from the temporary use
4 these monies (often referred to as the "float"), between the time that Hamilton Taft received the moni
5 and the time it paid them over to the appropriate taxing agencies. With but one or two exceptions, t:
6 client contracts contained no language limiting the types ofinvestments which Hamilton Taft was entitll
7 to make with funds deposited by clients.
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10 B. HAMILTON TAFT BEFORE CONNIE ARMSTRONG --
II Hamilton Taft was initially incorporated in July, 1979 as KnightsBridge Systems, Ltd., b
12 changed its named to Hamilton Taft in 1981. In 1984, Hamilton Taft was acquired by CIGNA, a majl
13 insurance company from Connecticut. Despite CIGNA's continuing efforts to pump its own funds in
14 its subsidiary company, Hamilton Taft continued to lose money under CIGNA's ownership. Finally,
15 January, 1988, CIGNA sold Hamilton Taft to MaxPharma, a publicly held corporation from Dallas.
16 Under MaxPharrna's ownership, Hamilton Taft's liabilities grew worse, hastened by the fact th
17 MaxPharma's owners made unsecured loans to themselves, without the approval of MaxPharma
18 shareholders. Connie Armstrong, a shareholder in the parent company, brought a shareholder derivati,
19 suit against MaxPharrna and its principles, alleging a breach oftheir fiduciary duty to shareholders. C
20 March 29, 1989, Roberts and MaxPharma settled the suit, by transferring all stock in Hamilton Taft 1
21 Mr. Armstrong, who became sale owner of the company. At the time he took over the compan:
22 Hamilton Taft's liabilities exceeded its assets by $18.9 million.
23
24 . C. THE MISSED TAX DEPOSITS --
25 Because Hamilton Taft had approximately 250 corporate clients with varying payroll schedule,
26 it received incoming funds from clients every day and, by the same token, had payroll tax deposits du
27 every day. Most ofthe time, Hamilton Taft paid these withholding tax deposits before the statutory du
28 date. However, on one or two days per quarter, Hamilton Taft was forced to hold back client ta
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tinds.
1 deposits due to insufficient funds; as a result of these missed deposits, Hamilton Taft incurred intere,
2 and penalties, for which it was liable. Hamilton Taft subsequently made up every missed tax deposit fa
3 1989 and 1990 -- usually doing so just before 941 tax returns were due (thirty days after the quarter'
4 end). In accordance with its contractual obligation, Hamilton Taft paid all penalties and interest arisin
5 from its late payment of these client tax deposits.
4
6 To make up the missed tax deposits, Hamilton Taft would generally use incoming monies, pai
7 by clients in the following quarter. Because Hamilton Taft needed these newly incoming funds to mak
8 up the previous quarter's missed deposits, those same funds were unavailable for use in the quarter i
9 which they were submitted. This, in turn, forced Hamilton Taft to hold back additional tax deposits i
10 that quarter. However, at the time they deposited funds with Hamilton Taft, clients understood that thei
11 monies would not be segregated or earmarked for immediate payment to the IRS and further underslOo,
12 that they would never be held liable for late payment of their withholding taxes.
13
therea
14 D. THE TRANSFERS OF HM1ILTON TAFT FUNDS--
15 The primary issue in the instant case involves Mr. Armstrong's wire transfers of approximatel:
16 $55 million of Hamilton Taft monies to his Texas companies, in exchange for notes (and later a singll
17 consolidated bond) of equal value. The Texas companies, whose payroll included experienced expert
18 in real estate, construction development, oil, and investment financing, then invested these monies
Though Hamilton Taft made up missed tax deposits just before filing the client's 941 t<l)
returns, it did not normally make up penalties and interest until receiving notice from the
IRS requesting such payment -- a process which usually did not occur until about twe
quarters later. As a reSUlt, Hamilton Taft was technically about two quarters delinquen
on interest and penalties, at the time ofits shutdown -- though it had not yet, at that time
received notice from the IRS as to these penalties.
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19 pledging these investments back to Hamilton Taft as collateral for the loans. Mr. Armstrong hoped tha
20 after several years, these investments might be sold for substantial gain, which could then be put back inte
21 Hamilton Taft and applied against the $18.9 million "hole" which he inherited.
22 The government contends that Hamilton Taft's occasional missed tax deposits were brought OJ
23 by Mr. Armstrong's inter-company transfers of Hamilton Taft funds. In counts seven through eighteeJ
24 of the i n d i c t m ~ n t , they charge Mr. Annstrong with wire fraud, in connection with his supposedl)
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I holding to have been broader than this court initially believed and, to the extent that this court has foun
2 otherwise, he asks that it reconsider its decision.
3 While the Ninth Circuit did make clear that § 7501's statutory trust vis a vis the IRS does nc
4 extend to third party transferees, it then went on to examine the understanding which existed betwee
5 Hamilton Taft and its clients:
6 Nor does S & S attempt to show that it arranged with Taft for the
transferred funds to be held in trust. While two of Taft's clients arranged
7 to have their trust-fund tax payments kept in segregated accounts, S & S
and the other clients did not. Instead, Taft extensively commingled all of
8 the funds it received and treated the funds as its own assets, using them
to pay its operating expenses and investing the funds for its own benefit.
9 Therefore, under ordinary principles of trust, Taft did not hold the funds
in trust.
10
II Id, at 288.
12 The above language has nothing to do with the existence or non-existence of a trust, on beha
13 of the IRS, but speaks only to the relationship between the contracting parties themselves.' Th.
14 relationship, the court concluded, was not a trust, but was a traditional debtor-creditor relationship, undl
15 which the monies, once transferred, became the property of the debtor, Hamilton Taft.
16 Ofcourse, the fact that Hamilton Taft's contractual relationship with clients was debtor-credito
17 rather than trust, does not nullify the possibility of criminal fraud. For instance, had Mr. Armstror
18 simply taken clients' monies and opened a Swiss bank account, while totally ignoring his contractual duo
19 to pay their taxes, he almost certainly could be charged with engaging in a scheme to defraud.
8
Howeve
20 the debtor-creditor nature ofHamilton Taft's relationship does have inescapable implications, for certa
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It is worth pointing out that, under § 7501, employers hold their employees' tax moni
in trust for the benefit of the IRS, not the employees. Therefore, the monies whi(
employers contractually agreed to transfer to Hamilton Taft were never trust monies
the first place vis a vis the tax-paying employees.
The Nmth Circuit has held that a scheme to defraud is completed at the moment that tl
money at issue changes hands. United States v. Cusino, 694 F.2d 185, 187 (9th C
1982). Given this rule oflaw, even ifMr. Armstrong had wired Hamilton Taft moni
overseas, it is not at all clear whether such conduct would constitute mere evidence of:
intent never to perform his contractual duties or, as the government apparently WOll
contend, an independent criminal act.
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1 counts in this case.· First, it meant that, as a matter oflaw, client monies, once delivered to Hamiltc
2 Taft, became the property ofHamilton Taft. This, in turn, meant that Hamilton Taft was free to use tl
3 money for operating expenses or to invest it for its own benefit, in any manner it wished -- whi
4 remaining cognizant of the fact that the company also owed a contractual duty to pay the client
5 withholding taxes. Second, the debtor-creditor relationship meant that Hamilton Taft could free
6 commingle the tax monies of any particular client with the monies of all other Hamilton Taft clients;
7 was not necessary that any single client's monies be placed in a separate, segregated account. Henc
8 what the government calls a "Ponzi" scheme - the payment of Client A's taxes with Client B' s aI
9 Client C' s money -- was not only permissible, but was exactly what Hamilton Taft's clients bargained fc
10 Third, the debtor-creditor relationship meant that clients retained no beneficial interest in the money, on,
11 delivered to Hamilton Taft -- having only their contractual rights against Hamilton Taft on which to reI
12 The clients' contractual rights in this case were quite simple; Hamilton Taft was obligated to p,
13 all client withholding taxes and to assume liability for any penalties and interest resulting from la
14 payment. Hamilton Taft complied with these contractual duties for every quarter of 1989 and 1990
15 occasionally paying the taxes late, but assuming the penalties and interest for so doing. In the fir
16 quarter of 1991, Hamilton Taft missed certain taX deposits, just as it had done in previous quarters. Ju
17 as in previous quarters, Hamilton Taft had every intention of making up these missed payments ar
18 would have done so, but for two key events: (1) the public allegations made by Steve Solodoffwhic
19 caused the bulk of Hamilton Taft clients to simultaneously breach their contractual duties, theret
..
20 suddenly and completely cutting off all cash flow to Hamilton Taft; and (2),jhe March, 1991 appointme
21 of Fred Wyle as trustee in bankruptcy, and the subsequent shutting down ofHamilton Taft's busine:
22 operations. This double-barreled assault left Hamilton Taft unable to make up approximately $50 millie
23 in overdue tax liabilities, which were to have been paid in April, 199U
24 In view of the debtor-creditor nature of Hamilton Taft's contracts, coupled with the fact th
25 Hamilton Taft perfonned its contractual duties without fail (when allowed to do so by the clients), it
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Indeed, the government itself seems to recognize that the Ninth Circuit's decisie
negatively impacts their criminal case against Mr. Annstrong. This would explain wt
IRS attorneys consulted Michael Yamaguchi himself, in an "of counsel" capacity, wh€
the IRS was preparing its amicus brief seeking to reverse the Ninth Circuit's decision.
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I difficult to see exactly what aspect ofMr. Armstrong's conduct the government views as fraudulent.
2 Counts seven through fourteen speak of "diversions" -- a term which implies misuse of monie
3 However, Hamilton Taft was certainly free to lend its own money to sister corporations or to invest
4 for its own benefit, provided it paid the clients' taxes. Hamilton Taft's contracts did not hold M
5 Annstrong to any "prudent investor standard" and did not, in any way, set parameters on the range (
6 permissible investments which Hamilton Taft could make. That Mr. Annstrong's companies may ha'
7 incurred excessive operating costs (in the government's view), or that some of his investments may ha'
8 depreciated in value, do not amount to criminal conduct; in fact, absent a failure to pay client
9 withholding taxes, this conduct does not even constitute a breach of Hamilton Taft's contractu
10 obligations.
II Similarly, counts fifteen through twenty-one allege improper diversions and a "cover-up" of the:
12 improper diversions -- conduct which, again, might arguably constitute evidence of Mr. Armstrong
13 intent never to perform, but which cannot itself be criminal conduct. If monies, once delivered 1
14 Hamilton Taft, became Hamilton Taft property, there can be no "misuse" of such property vis a vis clie
15 companies who have already surrendered all proprietary rights in those monies. Rather, the sole questic
16 for the jury to decide is whether Mr. Armstrong fraudulently induced clients to do business with Hamiltc
17 Taft; by making representations which he never intended to honor.
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19 B. TillS WAS NOT A "PONZI" SCHEME-
20 Since Hamilton Taft fulfilled its every contractual duty -- to the extent that clients allowed the
21 to do so -- one might well ask: Wherein lies the so-called scheme to defraud? The government seer
22 to be of the opinion that Mr. Armstrong was operating a "Ponzi" scheme. "Not so," says the casela'
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Counts one through six allege that Mr. Annstrong fraudulently induced clients to (
business with Hamilton Taft, by misrepresenting the ways in which Hamilton Taft WOll
invest its monies. While Mr. Armstrong intends to prove his innocence of these charg
at trial, he acknowledges that the Nmth Circuit opinion does not require dismissal of the
counts, as a matter of pure law. The Ninth Circuit's conclusion that monies were t
property of Hamilton Taft means that, while Mr. Armstrong may be charged wi
improprieties in the acquisition of such monies, he should not be charged in connecti'
with conduct that post-dates his allegedly fraudulent acquisition of monies.
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"APonzi scheme is a fraudulent arrangement in which an entity makes payments to investors fro
2 monies obtained from later investors rather than from any 'profits' of the underlying business venture
3 hlTe UnitedEnergy Corp. 944 F.2d 589 (9th Cir. 1991). The term stems from the late Charles Pon;
4 a colorful and flamboyant swindler of the 1920s. Ponzi induced would-be investors to give himmone
5 in order to buy foreign postal coupons, which he would then purportedly sell in other countries at 100
6 gain. In return for their money, Ponzi gave "investors" 90-day notes, which he would promise to rep
7 at 150% of face value. Though no foreign postal coupons actually existed, Ponzi continued to hon
8 these 90-day notes as promised, using other investors' monies to do so, and thereby causing his 0"
9 debts to spiral exponentially. See Cunningham v. Brown, 44 S.Ct. 424 (1924).
lOInUnited Energy, the principles sought to induce investors to purchase shares of solar enerj
11 modules, by way of a down payment and annual or semi-annual installments. Though the modul
12 actually produced only a negligible amount of energy, the principles paid investors occasional sums
13 money, which they represented to be returns on investment. This, in tum, caused the initial investors
14 continue making payments to United Energy, while also causing new investors to finance the phOl
15 project. This new money could then be used to partially pay back the old investors, in order to make
16 appear that the venture was a success.
17 The schemes in both Cunningham and United Energy, while holding themselves out to 1
18 legitimate business ventures, were nothing more than textbook Ponzi schemes, in which no investme
19 ever existed. Conversely, Hamilton Taft's stated purpose was to provide payroll services, and it did s
20 Ofcourse, given the $18.9 million hole which he inherited, as well as the continuing interest ar
21 penalties attributable to that hole, it was inevitable that Mr. Armstrong would have to use newly incomir
22 monies to payoff pre-existing liabilities -- holding back more tax deposits in the process. Moreove
23 unlike CIGNA, which had been able to dip into its own abundant coffers to cover Hamilton Taft
24 escalating liabilities, Mr. Armstrong did not have this luxury. As a result, his only chance of fillir
25 Hamilton Taft's pre-existing hole, was to invest a small percentage ofHamilton Taft funds in investmen
26 which, while containing some element of risk, also had the potential for tremendous returns. H
27 decisions to hold back checks and to payoff old liabilities with incoming funds did not constitute a Pon
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scheme, but were simply business decisions which were not only contractually permitted, but weI
contemplated by the clients at the time they entered the contracts.
In a Ponzi scheme, the victims believe they are putting their monies into an investment, althouE
no investment exists at all. In the instant case, clients believed that Hamilton Taft would pay their taxe
as well as any penalties and interest, and Hamilton Taft did so -- until the clients themselves complete
shut offHamilton Taft's cash flow, based on the unconfinned allegations ofa disgruntled ex-employe
Indeed, it is downright remarkable that Mr. Armstrong now faces federal felony charges for missing ti
payments which his own clients (the supposed victims in this case) left him totally unable to make. Tl
$50 million in unpaid 1991 taxes is an artificial creation of the clients themselves -- brought about by the
own sudden and unilateral decision to freeze Hamilton Taft's cash flow. These clients have stolen JV
Armstrong's keys and pushed his car into a ditch, yet are now complaining that Mr. Armstrong cann
drive them to the show.
The government's "evidence" of a Ponzi scheme stems solely from the fact that, in continuing
hold back tax deposits to pay off their pre-existing debt, Hamilton Taft was incurring more and mo
penalties and interest, thus creating the need to hold more and more future tax deposits. At worst, tl
conduct constitutes profligate money management by Mr. Armstrong -- the stuff of shareholder pro:
battles, but not of criminal indictments. If Mr. Armstrong can be criminally charged for running 1
increasing bills for his company, then so too can every home owner who defaults on his loan, or eve
corporationwhose debts exceed its assets.
The truly arbitrary nature of this case is best captured by a rhetorical question: Would ]'v
Armstrong be facing criminal charges today if one or two of his investments had reaped grand retun
enabling him to fill Hamilton Taft's pre-existing hole? Surely Mr. Armstrong's is not the first busim
ever to make risky investments, with monies paid to it by clients. Nor is it the first business to perf01
some of its contractual duties late. And Mr. Armstrong is not the first CEO ever to enjoy a bounti
lifestyle while his company struggles to become profitable. What, then, elevates this case from a me
civil dispute to a 21-count federal fraud indictment? Hamilton Taft's clients, with more than a little hi
from Fred Wyle and the Bankruptcy Court, arbitrarily chose to shut down the company before
investment program had reached fruition. With Hamilton's Taft's business activities frozen in time, 1
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government then called on its high-priced accountants, who summoned their mystical powers '
projections, spread sheets, and mathematical assumptions, to create a loss where none actually existe
Aided by such sorcery, the government was able to transform Hamilton Taft from a mere non-profitab
business into a criminal "Ponzi" scheme.
In short, Hamilton Taft contracted to perform a service for its clients and it did so. If the clien
believe Hamilton Taft's late performance to be a contractual breach, let them sue Mr. Annstrong in ci'
court. IfCongress wishes to expand the common law of trusts to include payroll processing companie
let them change the law. Ifthe government believes Mr. Annstrong committed fraud in the induceme
(as alleged in counts one through six), let them prove it at trial. However, to allege that Mr. Armstror
was "diverting" funds which were his own property; or committing a Ponzi scheme, while giving h
clients the very service they contracted for; or that he "covered up" a scheme which, by definition, wou
have been completed at the moment clients signed their contracts, is illogical, excessive, and total
prejudicial to Mr. Annstrong's right to a fair trial.
Counts seven through twenty-one should be dismissed.
Even ifthis court does not view the NInth Circuit's opinion as dispositive of certain counts of tl
indictment, defense counsel at least urges that this court issue an order declaring the Ninth Circuit's leg
conclusions to be the law ofthis criminal case. Such an order would mean, inter alia, that:
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II. AT A MINIMUM, THIS COURT SHOULD DECLARE THE NINTH CIRCUIT HOLDIN
TO BE THE "LAW OF THE CASE" IN MR. ARMSTRONG'S CRIMINAL TRIAL
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5.
Defense counsel may refer to the monies at issue, in both opening and closing statement
as the property ofHamilton Taft or Hamilton Taft cash flow.
The government may not refer to those monies as "client monies" or "client funds" an
may not state or imply that Hamilton Taft held those monies in trust.
The government may not present evidence of any advice which Mr. Annstrong receivel
from lawyers or other experts, to the extent that such advice was inconsistent with tr
state ofthe law, as set forth in the Ninth Circuit's opinior:.
This court will instruct the jury that monies, once delivered to Hamilton Taft, became tf
property of Hamilton Taft. .
This court will instruct the jury that Hamilton Taft was free to use its cash flow to COVI
its operating expense or to Invest those monies for its own benefit and in any way
wished.
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6. This court will instruct the jury that Hamilton Taft's sole duties to its clients were tho
duties stated contractually but that clients were free to sue for breach, if Hamilton T,
ever failed to live up to those duties. '
3 "The law ofthe case doctrine 'ordinarily precludes a court from re-examining an issue previoUE
4 decided by the same court, or a higher appellate court, in the same case.'" United States v. Catenno, :
5 F.3d 1390,1395 (9th Cir. 1994) {citations omitted). The doctrine "refers to a family of rules embodyil
6 the general concept that a court involved in later phases of a lawsuit should not re-open questions decid,
7 ... by that court or a higher one in earlier phases." Crocker v. Piedmont A viation, Inc., 49 F.3 d 73
8 739 (D.c. Cir. 1995). {emphasis added}. Law of the case is primarily an equitable principle and, unli
9 the principles of collateral estoppel and res judicata, is applied at the discretion of the court. Howevl
10 as the Ninth Circuit has observed, it is a principle which "should not be applied woodenly in a w
11 inconsistent with substantial justice." United States v. Miller, 822 F.2d 828 (9th Cir. 1987).
12 In the instant case, there are arguable technical reasons why the Ninth Circuit decision should n
13 constitute the law of Mr. Armstrong's criminal case. The first such reason is that the decision w
14 vacated after the parties settled out of court. The second is that the parties to the instant case are not t
15 same as the parties to the civil dispute from which the Ninth Circuit's opinion arose. Putting aside the
16 technicalities, it is hardly a matter of dispute that the Ninth Circuit decision arose from the exact sar
17 facts, circumstances, and issues as those that will be presented in this case. While the opinion has be
18 vacated, it continues to stand as both a scholarly, lucid, and unassailable explication of the cornmon I,
19 of trusts, as well as a "cheat sheet," which allows this court to see how the Ninth Circuit will rule, shoL
20 this issue comes before it again. Under these circumstances, it flies in the face of common sense to refu
21 to acknowledge the Nmth Circuit's reasoning and to pretend the opinion does not exist.
22 To simply leave this matter as a factual free-for-all, to be sorted out by the jury, is not only lega
23 erroneous, but also grossly prejudicial to Mr. Armstrong. The character of the funds at issue is a k
24 component of this case and is a matter of pure law, as even this court acknowledged in its Februal
25 1993 opinion; were this merely a factual issue, the Nmth Circuit never would have addressed it in the fil
26 place. Because these funds were Hamilton Taft property, as a matter oflaw, the jury should be instruct
27 that this is the case. Simply allowing the defense to present evidence that these were not trust funds \\
28 leave in the hands oflay-jurors the task of dissecting and applying subtle nuances of law, on which ev
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1 Mr. Armstrong's own attorneys could not find consensus. After hearing the government refer to the:
2 funds as "client funds," "trust funds," or "withholding funds," lay-jurors surely cannot be expected 1
3 understand defense counsel's highly technical arguments about commingling of funds, statutory trust
4· and third party transferees. Without a clear instruction to this court that funds transferred to Hamilt(
5 Taft became Hamilton Taft property, the jury will be only too ready to wrongly believe that these fun'
6 were withholding monies, and that Hamilton Taft was held to the same fiduciary duty that their ov
7 employers have.. To allowjurors to make such an inference would be grossly prejudicial and devastatil
8 to Mr. Armstrong's case.
9 While Mr. Armstrong was not himself a party to the Ninth Circuit's case, that case was:
10 adversary proceeding which arose out ofthe same bankruptcy as the one which led to this criminal ca!
11 By the same token, the facts which led to the Nmth Circuit's conclusions of law (that no trust existed al
12 that Hamilton Taft's relationship with clients was debtor-creditor) are the identical facts now at issue
13 this criminal case. Adopting the Nmth Circuit's opinion as the law of this criminal case is consistent wi
14 the principles offlexibility and efficiency with which the law of the case doctrine is customarily applie
15 Should this court be reluctant to dismiss counts seven through twenty-one, pursuant to the Ninth eircl
16 opinion, Mr. Armstrong requests that it at least take the lesser step of declaring the Ninth Circuit's lef
17 conclusions to be the law of Mr. Armstrong's criminal case -- with all of the ramifications which tt
18
finding would entail.
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DEFENDANT ARMSTRONG'S PROPOSED SPECIAL mSTRUCTION 5
With respect to the funds paid to Hamilton Taft by the client companies, with the exception of
two clients who arranged to have their payments kept in separate accounts, the funds paid to Hamilton
Taft became the property of Hamilton Taft and could be commingled by Hamilton Taft, treated by
Hamilton Taft as its own assets, used to pay Hamilton Taft's operating expenses, and invested by
Hamilton Taft for itsown benefit. Hamilton Taft did not hold the funds in trust as your employer might
hold your withholding taxes. In other words, Hamilton Taft was entitled to the use ofthe funds until
the taxes were due to be paid, pursuant to the terms of the contract.
Based on: In Re Hamilton Taft &- Co., 53 F.3d 285,288 (9th Cir., 1995), vacated due to mootness,
68 F.3d 337 (1995); Restatement (Second) of Trusts § 283 (1959); Austin W. Scott & William
Fratcher, The Law ofTrusts § 283 (4th ed. 1989).
000169
1 MICHAEL J. YAMAGUCHI
United states Attorney
2
JOEL R. LEVIN
3 Chief, Criminal Division
4
5
6
7
8
RONALD D. SMETANA
Special Assistant U.S. Attorney
GEORGE D. HARDY
Assistant U.S. Attorney
450 Golden Gate Avenue
San Francisco, CA 94102
Telephone: (415) 436-6851
r ",
'. · ~ t ., .":t':
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''''"''
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UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
12 UNITED STATES OF AMERICA, )
)
13 Plaintiff,)
)
14 v. )
)
15 CONNIE C. ARMSTRONG, JR., and )
RICHARD A.FOWLES, )
16 )
Defendants. )
17 )
18
Criminal No. 94-0276-CAL
GOVERNMENT'S OPPOSITION
TO ARMSTRONG'S MOTION TO
DISMISS AND/OR REQUEST
FOR PRETRIAL INSTRUCTION
Date: Nov. 8, 1996
Time: 1:30 p.m.
Courtroom: 10
(Han. Charles A. Legge)
19 .L..
20
Introduction
\
Defendant Connie C. Armstrong, Jr., seeks (again) to
21 dismiss counts seven through twenty-one of the Indictment. In the
22 alternative, he seeks an instruction on the "law of the case." For
23 the reasons set forth below, the government opposes this motion.
24 II. Argument
25 ~ Statement of facts.
26 As set forth in the grand jury's Indictment, the charges
000156
1 arise from defendant's operation of Hamilton Taft, a San Francisco
2 based company that provided payroll tax services to large
3 companies. Client companies transferred their payroll taxes to
4 Hamilton Taft and Hamilton Taft was obligated to pay the taxes to
5 the Internal Revenue Service and other taxing authorities on time.
6 At the time the defendant acquired Hamilton Taft the
7 company had a working capital deficit of more than $14 million.
8 Over a period of two years, as money was siphoned out and Hamilton
9 Taft accrued interest and penalties on money it did not have, the
10 withholding of tax payments grew from $19.4 million to $68.2
11 million per quarter. When Hamilton Taft ultimately collapsed,
12 approximately $85 million in taxes were unpaid.
13 Despite the fact that the defendant was aware that he
14 could not pay the taxes of his clients when due, he induced a
15 number of companies to contract with Hamilton Taft with
16 representations that Hamilton Taft had the ability to pay taxes
17 when due, was paying taxes when due and would continue to pay
18 taxes when due.
19 As a further part of the scheme, the defendant concealed
20 the non-payment of taxes to induce the victims to continue sending
21 (on a weekly, biweekly or monthly basis) their tax payments and to
22 avoid the wholesale cancellation of contracts. Finally, when the
23 defendant's scheme was exposed, he sent out lulling letters denying
24 the existence of the scheme and encouraging to continue
25 sending payments.
26 II
J
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 2
0001.57
1 .a....
2
Defendant's Reliance on In re Hamilton Taft & Co. is
misplaced.
3 The litigation underlying In re Hamilton Taft & Co., 53
4 F.3d 285 (9th Cir. 1995), was between two parties over a fixed sum
5 of money whether the trustee in bankruptcy would be able to
6 reclaim for the larger group of victims funds paid to the IRS on
7 behalf of S & S Credit. The Ninth Circuit initially ruled that a
8 preferential payment had been made on behalf of S & S and that the
9 funds paid to the IRS on its behalf would have to be repaid by S &
10 S to the trustee. S & S petitioned for rehearing, and before the
11 matter could be heard, the case was settled, the appeal was
12 dismissed as moot, and the decision was vacated. In re Hamilton
13 Taft & Co., 68 F.3d 337 (9th Cir. 1995). The Ninth Circuit· s
14 vacation of the opinion nullifies and renders the judgment
15 inoperative. United States v. Munsingwear, 340 U.S. 36, 40-41
16 (1950). Arguably, the parties could now relitigate the issues.
17 340 U.S. at 40.
18 Hamilton Taft & Co.
In short, this Court is not bound by In re
19 This conclusion is made more compelling by the fact that
\
20 the government was not a party to the litigation at the time the
21 opinion was rendered by the Ninth Circuit. When the petition for
22 rehearing was filed the Court obviously recognized that its opinion
23 could well interfere with the government·s right and ability to
24 collect employee taxes and thus invited the government to
25 participate in the case as an amicus curiae. The government did
26 file a brief advocating the theory that the funds were held by
J
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 3
000158
1 Hamilton Taft in trust for the government. The case was settled
2 and the opinion vacated before the government's position could be
3 considered. To resolve the i;§sue t;,o
4 which had tQ b_t;.. heq.rcLi§,"",fundsIDWt:lllY
5 )£}is) ro •
6 The inescapable conclusion from this discussion is:
7 there is no "l,,!w Rather, there remains a dispute of
8 fact that can be resolved only by the scheduled jury trial.
11
9
10
has again pummeled a straw man.
The trial evidence will show that, at a minimum, all of
defendant's argument is his premise that he complied with the
conditions of his contracts and thus did nothing wrong. Defendant
However, fundamental to
Contrary To Defendant's Contention, Hamilton Taft Did Not
Comply with Its Contractual Duties.
The government will subsequently demonstrate why counts
Hamilton Taft's contracts required timely payment of taxes on or
before the statutory deadlines.
1
Some of the contracts also
specifically limited the short-term investments that could be made.
Thus, Scott Paper's contract stated that:
7 through 21 should not be dismissed.
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In order to satisfy Hamilton Taft's investment criteria
21 (Security of Principal, High Degree of Liquidity), Hamilton
Taft's investments are limited to investments collateralized
22 by United States Government securities and United States
Government sponsored obligations.
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lContrary to defendant's assertion that he "occasionally" paid
the taxes late (Defendant's Memorandum 10:16), he intentionally
failed to make more than 300 payments aggregating more than $255
million, and the frequency of missed payments as well as .their
dollar amounts were increasing almost logarithmically.
GOVERNMENT'S OPPOSITION TO ARMSrRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 4
J
000159
....
payments is to assure an adequate supply of current payments.
continued payment. The only way to pay past due taxes with current
contracts were executed, but on an ongoing basis in order to assure
the money was paid over to Hamilton Taft that he could use it for
any purpose he wanted. He induced his clients to do business with
Hamilton Taft on the representation that he could and would pay the
will amply demonstrate.
Defendant did not just commit fraud at the time the
taxes on a timely basis. His knowing and intentional use of the
funds otherwise clearly constitutes fraud, as the trial evidence
1 Others limited Hamilton Taft to benefits accruing from temporary
2 use of client funds or benefits accruing from proper use of client
3 funds. Given the intentional failures to pay taxes on time, the
long-term use of client funds and the other than proper use,
defendant's assertion that he complied with the contracts is
nothing less than revisionist history.
Similarly erroneous is defendant's assertion that once
Defendant and his employees concealed the tax withholds as much as
possible. When discovered, they lied about the basis for missed
payments. Thus, each payment from each of the victims was directly
attributable to the fraud and a direct and intended consequence of
22 the ongoing fraud.
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23 Defendant's argument that this was not a Ponzi scheme
24 (Defendant's Memorandum, 10:8-10) is similarly without merit. The
25 defendant is not before this court because he paid "Client A's
26 taxes with Client B's and Client C's money;" the government would
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 5
000160
1 expect that all of A, Band C's payments would be made from the
2 collective contributions from A, Band C. Rather, defendant is
3 before the court, in part, because he bought a ranch with A's money
4 paid to Hamilton Taft for a January tax payment (while
5 intentionally failing to make A's tax payment), and then used Band
6 C's funds paid to Hamilton Taft in April for their April tax
7 payment to make A's January payment while failing to make Band C's
8 April tax payment.
9 Indeed, the description of a Ponzi scheme in In re United
10 Energy Corp., 944 F.2d 589, 590 at fn.l (9th Cir. 1991)2 describes
11 precisely what defendant was doing. Defendant made tax payments
12 for clients with monies obtained from later tax payments from other
13 clients. By funnelling later payments to earlier taxes defendant
14 created the illusion that taxes were being timely paid and that
15 (bankrupt) Hamilton Taft had the financial wherewithal to pay the
16 taxes, inducing continued use of Hamilton Taft's services, all the
17 while siphoning out funds for defendant's personal benefit. The
18 only sorcery involved was the defendant's sleight of hand;
19 unfortunately for him, the audience caught on to the trick!
,
20 IL..
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There is no basis for the dismissal of Counts Seven through
Twenty-One.
Regardless of how the relationship between Hamilton Taft
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2"A Ponzi scheme is a fraudulent arrangement in which an
entity makes payments to investors from monies obtained from later
investors The fraud consists of funnelling proceeds
received from new investors in guise of profits from the alleged
business venture, thereby cultivating an illusion that a legitimate
profit-making business opportunity exists and inducing further
investment.
J
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 6
000161
1 and its clients is categorized, Counts Seven through Twenty-One
2 withstand attack.
3 Defendant appears to argue that the government can
4 proceed on counts One through Six, the fraud in the inducement, but
5 that proceeding on the other counts is "illogical, excessive and
6 totally prejudicial ••• " (Defendant's Memorandum 14:15-16) As he
7 has done throughout these proceedings, defendant has made a lengthy
8 and colorful argument all the while ignoring the one document
9 relevant to the inquiry -- the Indictment. It does not depend on
10 the existence of any particular relationship between defendant and
11 the victim companies. Rather it alleges a fraudulent course of
12 conduct in addition to and beyond the inducement to keep the money
13 flowing into Hamilton Taft. The Indictment alleges fraud on an
14 ongoing basis to keep money flowing into Hamilton Taft by a cover-
15 up3, false tax returns
4
, a change in cover-up methodology5, the
16 selection of specific clients for withholding and Armstrong's
17 attempt to disseminate a false account of what was happening to
18 client funds. All of these allegations are incorporated by
19 reference in each of the counts. (Indictment, paragraph 24.)
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3"This concealment enabled Hamilton Taft to continue to
receive funds from its clients, to avoid massive cancellation of
its contracts, and to preserve the opportunity for new business."
4"The clients who received these returns were thereby falsely
led to believe that all their taxes had been paid."
5"By choosing to pay past due taxes instead of currently due
taxes, Armstrong was able to delay, for a much longer time,
discovery by the clients that their taxes had been paid late. At
the same time, he was able to create the false impression that
Hamilton Taft's business was running smoothly."
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUESr FOR
PRETRIAL INSTRUCTION 7
000162
1 Defendant argues, however, that all allegations of the
2 Indictment, other than the fraud in the inducement allegations, are
3 legally insufficient to charge criminal activity because of the
4 Ninth Circuit opinion of In re Hamilton Taft & Co. which
5 establishes (or so defendant claims) the "law of the case" contrary
6 to the government's charging theory. The "law of the case" that
J
7 defendant sees in that opinion and on which defendant focuses his
8 argument is the conclusion that the relationship between Hamilton
9 Taft and its clients was one of "debtor-creditor", and not a trust
10 relationship. From that "law of the case", the defendant seeks to
11 extrapolate to the further conclusion that the defendant was free
12 to do with the clients' tax money whatever he wanted, because it
13 was Hamilton Taft's "property". Hence, he argues that any criminal
14 fraud allegations in the Indictment which describe what the
15 defendant did with client's tax money after the contracts were
16 signed must be legally insufficient, and therefore dismissed. His
17 argument is further based on the factual predicate that Hamilton
18 Taft complied w-ith the terms of the contracts with its clients.
19 Defendant's argument is factually and legally flawed •
•
20 As noted earlier, the Ninth Circuit opinion has no
21 precedential .or controlling effect on this Court (and therefore can
22 not be considered "the law of the case") because it was vaca'ted.
23 It should also have little, if any, persuasive effect on this Court
24 because it was vacated in the context of a motion for
25 reconsideration, before the Ninth Circuit had heard from the
26 government. Furthermore, even if this Court were to conclude that
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 8
000163
....
1 the legal relationship between Hamilton Taft and its clients was
2 one of "debtor-credi tor", the further coneIus ion that the defendant
3 could do whatever he wished with the tax money (send it to a secret
4 Swiss bank account?) does not logically, or legally, follow. Can
5 a debtor never defraud a creditor? The answer is obvious. In
6 fact, the defendant acknowledged as much when he said:
7 "For instance, had Mr. Armstrong s imply taken clients'
monies and opened a Swiss bank account, while totally
8 ignoring his contractual duty to pay their taxes, he
almost certainly could be charged with engaging in a
9 scheme to defraud." (Motion, p. 9)
10 The defendant asserts as a matter of fact that he complied
11 with his contractual duty to pay the taxes of the Hamilton Taft
12 clients. The government intends to prove that he did not comply
13 with his contractual dutiesl Jury trials are the vehicle by which
14 such factual disputes are resolved, not motions to dismiss. There
15 is no basis for this Court to dismiss counts Seven through Twenty-
16 One.
17 .L. The Court should not make a finding of "the law of the case."
18 The government is persuaded by defendant's eloquence in
19 arguing that this court should not follow In re Hamilton Taft & Co.
20 (Defendant's Memorandum, 15:16-18), but cannot agree that the
21 vacated opinion is "a scholarly, lucid, and unassailable
22 explication of the common law of trusts" (Id. at 21-22) since the
23 court sought to implicate the government's rights without giving
24 the government an opportunity to be heard. Regardless of how
25 "scholarly" or "lucid" the opinion may be on the common law of
26 trusts, as noted above it is not "the law of the case", and clearly
I
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GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 9
000164
1 should not be used to justify making a ruling on an issue that is
2 nothing but a red herring.
3 It is clear what the defendant is attempting to do. He
4 wants the jury not to hear relevant evidence. He doesn't want the
5 jury to hear about the Ranch acquisition, or the limousine rides,
6 or the luxury jet purchase. He also doesn't want the jury to hear
7 what his lawyers and senior management were telling him--that he
8 couldn't use client tax money for long-term personal investments.
9 He also doesn't want the jury to hear about the lies he told his
10 employees regarding the source of funds for his ranch and other
11 purchases. He doesn't want the jury to hear about the lies he told
12 the victim companies in order to lull them into a false sense of
13 security. But all of this evidence is relevant to prove the
14 charges in the Indictment.
15 To his credit, the defendant spells out the remarkable
16 ramifications of a decision to declare that In re Hamilton Taft &
17 Co. represents the "law of the case". He wants:
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1.
2.
3.
4.
Defense counsel to be able to refer to monies at
issue, in both opening and closing statements as the
property of Hamilton Taft or Hamilton Taft cash
flow;
The government not to refer to those monies as
"client monies" or "client funds" and not to state
or imply that Hamilton Taft held those monies in
trust;
The government not to present evidence of any advice
which Mr. Armstrong received from lawyers or other
experts, to the extent that such advice was
inconsistent with the "law of the case";
The court to instruct the jury that monies, once
delivered to Hamilton Taft, became the property of
J
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 10
000165.
..
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Hamilton Taft;
The court to instruct that Hamilton Taft was free to
use its cash flow to cover its operating expense or
to invest those monies for its own benefit and in
anyway it wished;
The court to instruct the jury that Hamilton Taft's
sole duties to its clients were those duties stated
contractually but that clients were free to sue for
breach, if Hamilton Taft ever failed to live up to
those duties.
J
8 Nothing in the language, logic, or holding of the vacated
9 opinion in In re Hamilton Taft & Co. comes close to justifying such
10 a gutting of the government's case.
11 The defendant's motion to characterize, as a matter of law,
12 the nature of the relationship between Hamilton Taft and the victim
13 clients, in the form of a pretrial ruling should not be granted.
14 The characterization has not been settled as a matter of law. The
15 characterization, even if accepted as "debtor-creditor", does not
16 negate the presence of a fraudulent scheme or support in any way
17 the six conclusions cited above. The characterization would only
18 confuse the jury, leaving them to wonder about the illogical
19 technicalities of the law.
20 II
21 II
22 II
23 II
24 II
25 II
26 II
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 11
000166
•
1 III. Conclusion
2 For the foregoing reasons, the government respectfully
3 submits that the motion to dismiss be denied and that the Court
4 deny the request to make In re Hamilton Taft & Co. the law of the
5 case.
6 DATED:
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November 5, 1996 Respectfully submitted,
YAMAGUCHI
.. __

RONALD D. SMETANA
Special Assistant U.S. Attorney
J
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 12
HOnlG1