Wednesday, March 7, 2007

Jim Clark, MyCFO Inc. & Tax Sheltering

March 6, 2007

Fling With Tax Shelters Haunts Silicon Valley
Funded by Tech Barons, MyCFO Inc. Sold Deal
The IRS Later Nullified

March 6, 2007; Page A1

John Doerr is the dean of Silicon Valley venture capitalists, one who helped launch tech icons like Google and Sun Microsystems. A billionaire, he works with rock star Bono to fight poverty in Africa and with others to increase aid for education and medical research.

Mr. Doerr is less well known for one investment that didn't pan out. Called myCFO Inc., the firm set out to provide rich people a full menu of financial services, from wealth management to estate planning. It succeeded with only one: tax shelters that helped clients shield hundreds of millions of dollars from taxes. Less than two years after myCFO began selling them in 2000, the Internal Revenue Service said they were bogus.


• Tax-Shelter Client of myCFO Goes to Court1


• Deposition of Kevin McAuliffe2, a former top accountant at myCFO, in which he testifies that he warned his bosses that myCFO was becoming too heavily involved in selling tax shelters. Plus, see emails3 shown as exhibits in the deposition.

• Emails from myCFO board member John Doerr4 to Frank DiFerdinando, the head of myCFO's tax-strategies group. Mr. Doerr was a leading proponent of the group.

• An admission of facts5 by one of the large banks that underwrote myCFO's main tax shelter. In it, the bank admits the deal's purported 30-year loan was a sham and only meant to help clients avoid taxes.

• A document myCFO prepared6 for an informal phone discussion after the IRS cracked down on one of its tax shelters in March 2002.

MyCFO ceased independent operations five years ago, but it still casts a shadow. A bank that underwrote some of its tax deals has admitted that they were shams. Former clients, hit with back-tax bills, are fighting the IRS. Two ex-clients have alleged that myCFO's tax deals were fraudulent.

Two lawyers who worked with myCFO are under tax-fraud indictment for their work on similar tax shelters. The Manhattan U.S. attorney's office, which has charged more than a dozen people in connection with tax shelters, said in a court filing last April that it had "an ongoing criminal investigation" involving "various former employees of myCFO."

The financial backers and board members of myCFO were Silicon Valley royalty. They included James H. Clark, co-founder of Netscape Communications and Silicon Graphics; John Chambers of Cisco Systems Inc.; Thomas Jermoluk, former chairman of Excite@Home; and former Netscape boss James Barksdale. The firm's outside legal counsel was Larry Sonsini, lawyer to Silicon Valley's stars.

The firm was Mr. Clark's idea. Mr. Doerr led its financing and took a leading role on the board. In typical Silicon Valley fashion, board members were closely involved with strategy and operations, according to company documents and legal papers reviewed by The Wall Street Journal. The documents show that directors pushed ahead with the tax-shelter business despite signs that all wasn't right with the product.

Mr. Doerr praised the head of the firm's tax-strategies group in a 2001 email for "not only delivering on your original [business] plan, but going beyond to make up the revenue shortfall from the recurring business." MyCFO "has my full support, and the full support of [my] partners" at Kleiner Perkins Caufield & Byers, the venture-capital firm that financed myCFO, he added.

MyCFO's story shows how the sudden wealth spawned by the technology boom had hidden impacts that still echo in Silicon Valley. "There were 30-year-old clients making hundreds of millions of dollars -- it was intoxicating," says James Phillips, myCFO's former chief investment officer. "The accountants and CPAs wanted their share, too."


• The Background: Prominent tech financiers set up myCFO in 1999 to provide financial services to the rich.

• What Went Wrong: Firm morphed into a purveyor of tax shelters, which the IRS in 2002 labeled invalid.

• The Hangover: A bank that worked on myCFO shelters admits they were a sham; prosecutor has said ex-myCFO employees are party to criminal probe.

At the time, tax shelters were a lively business. Dozens of national law and accounting firms sold these strategies -- Byzantine transactions that often involved foreign currencies and offshore middlemen. MyCFO selected a few tax shelters and refined them for a clientele dripping in capital gains.

Some of California's leading industrialists were customers. Ray Irani, chief executive of Occidental Petroleum Corp., did a tax deal through myCFO, company records show. So did Ariba Inc. co-founder Boris Putanec and Val Vaden, co-founder of financier Benchmark Capital.

Mr. Jermoluk, the former Excite@Home chairman, was both a founding financier of myCFO and a shelter customer. For fees of about $2.4 million, he acquired ostensible losses to offset as much as $50 million of taxable income, according to company documents and a deposition by his former accountant, Kevin McAuliffe.

Mr. Jermoluk declined to be interviewed about myCFO, as did Messrs. Doerr and Chambers. Messrs. Clark and Barksdale didn't respond to email and phone requests for interviews. A lawyer for the former directors told a tax client last October that they "categorically denied...misconduct or malfeasance of any sort." The lawyer, David York, predicted myCFO's main tax package ultimately "will survive a substantive tax law analysis" in court.

A spokeswoman for Mr. Sonsini said his law firm did basic legal work for myCFO that didn't include reviewing its tax offerings. Messrs. Vaden and Putanec declined to comment, while Occidental said Dr. Irani wouldn't comment "on what is clearly a personal matter."

MyCFO's main tax shelter, sold to 17 clients, was called Cards, for Custom Adjustable Rate Debt Structure. Each involved an ostensible 30-year bank loan to a foreign party for $50 million to $100 million. MyCFO's client then assumed the loan and, after some complex swapping of collateral, claimed a loss for tax purposes of nearly the full amount of the loan. Others besides myCFO also marketed Cards.

The IRS in March 2002 ruled Cards invalid. Largely as a result, myCFO sold its name and client list and liquidated its tax business.

The IRS said Cards failed a basic test of legitimacy: It lacked any real economic purpose other than to lower taxes. The agency added that clients were never really at risk for the supposed $50 million or more in loans.

Most myCFO shelter clients are challenging the IRS's action, in federal court in San Jose. But two broke ranks and alleged the shelters were fraudulent, in civil racketeering suits they filed against big banks that underwrote their Cards deals. They claim they were misled to believe the shelter's loan structure was actually a viable credit facility. (See adjoining article7.)

From the start, there were internal warnings. Mr. McAuliffe, a former Ernst & Young tax partner who was one of myCFO's first hires, said that when the firm was just gearing up in 1999, some of its accountants wanted to shun tax "elimination" deals. He warned Mr. Jermoluk and Chief Executive Art Shaw that myCFO was relying too heavily on tax shelters for revenue, Mr. McAuliffe said in a 2005 deposition for a tax client's lawsuit in San Francisco Superior Court. But he said the founders were talking about an initial public offering, and his warnings went unheeded amid IPO "fever." Mr. Shaw, CEO of advertising firm Netblue Inc., didn't return calls seeking comment.

MyCFO had obtained the Cards strategy from a San Francisco investment boutique called Chenery Associates, which also provided it to others. Chenery had done a Cards deal for an aircraft-leasing company, which registered it with the IRS as a tax shelter. The IRS requires corporations to register such tax-driven deals. Its rules for when individuals must register a deal they're using as a shelter are less strict.

MyCFO officials said their clients would never accept a transaction they had to register as a tax shelter, Chenery Associates owner Roy Hahn later testified in a deposition for San Francisco Superior Court. A lawyer for Chenery removed the obstacle. He wrote an analysis saying that Cards wasn't a tax shelter under relevant IRS rules.


• A lawsuit filed against Deutsche Bank8 over myCFO's tax shelter

• An arbitrator's ruling9 awarding $23 million to Reese Jones in his claim against what's left of myCFO

• The "fairness opinion,"10 written by an outside financial firm for myCFO, when myCFO's client list and some other assets were sold to Bank of Montreal. It includes a history of the deal, including the troubles myCFO had in finding a buyer because of its tax-shelter involvement.

• Employment agreement11 myCFO signed with Randall Bickham, a former employee of KPMG who was subsequently indicted in New York for federal tax crimes relating to his work at KPMG

• Documents sent to Ray Irani12, chairman and CEO of Occidental Petroleum, after he purchased a myCFO tax shelter

• Deposition of Margaret Thurmond13, a former myCFO CFO, in which she discusses how CEO Art Shaw manipulated finances

• A motion filed by the U.S. Attorney in Manhattan14 to stay court proceedings in San Jose concerning myCFO and the tax shelters. It mentions that some former myCFO employees are party to an "ongoing criminal investigation."

• An early, confidential myCFO business plan15

The lawyer, Graham Taylor, then at LeBoeuf, Lamb, Greene & MacRae, wore multiple hats. He also represented myCFO in refining the tax strategy, court documents show. And when myCFO signed up Cards clients, it arranged for them to hire Mr. Taylor as their lawyer. For fees of roughly $85,000 per client, he supplied many of them with letters saying that if the IRS found their deductions invalid, they shouldn't owe penalties because they had relied on "an opinion from reputable counsel."

That counsel, it turned out, was a co-inventor of Cards, Raymond J. Ruble, then at law firm Brown & Wood. The law firm got $250,000 each time a client used Cards. Chenery paid this out of its share of the tax client's fee.

Chenery also agreed to pay 20% of its own fee into a Ruble family trust, according to court records and Mr. Hahn's testimony.

MyCFO directors had several briefings about tax shelters, minutes of board meetings show. One in mid-2000 led to a marketing delay while the firm's general counsel reviewed the matter. Three months later, the IRS, in connection with a similar shelter, warned that "an artificial loss lacking economic substance is not allowable." Within weeks, myCFO decided to go ahead with marketing Cards.

It quickly signed up 10 clients for fees totaling $16 million. As those deals were closing in late 2000, Mr. Ruble from Brown & Wood emailed myCFO an article in which a prominent tax analyst called Cards a blatant tax dodge. Mr. Ruble said the analyst had "totally missed the boat on business purpose," which he said lay in financing opportunities.

As the tech bubble deflated, myCFO imposed layoffs and spending cuts, but not on the tax-strategies group. MyCFO's growing reliance on tax shelters for revenue was discussed at a board meeting in August 2001. At that meeting, the board's compensation committee, Messrs. Doerr and Clark, approved stock options for 94 employees -- giving a third of them to the firm's top two tax strategists.

One director asked if myCFO would have an obligation to refund clients' fees if the tax deals were unwound. "It was basically, 'Gosh, is this kosher?' " says someone who was there. "Then they read the attorneys' comfort letters and everyone shut up."

Mr. Doerr was a booster for the firm's tax strategists. In response to Mr. Doerr's 2001 email lauding the tax team for its performance -- which he sent on Sept. 11, 31 minutes before the first plane struck the World Trade Center -- the tax team's leader reported landing $4.5 million more in fees. Five days after 9/11, Mr. Doerr replied: "This is AWESOME news, particularly during a week marred by national tragedy.... Please keep me posted."

But some of myCFO's accountants and client-service people were in revolt, according to Mr. McAuliffe's deposition. In late 2001, he and several colleagues refused to sign shelter clients' tax returns until myCFO agreed to indemnify them for any personal liability. One client was claiming a tax loss greater than his net worth. "It was only a matter of time until the IRS came down pretty hard," Mr. McAuliffe testified.

In January 2002, the IRS offered a broad tax-shelter amnesty: It would waive penalties for any taxpayer who owned up to using a questionable shelter.

MyCFO staffers disagreed over what to tell clients about this and whether to discourage them from taking the amnesty. Ultimately, the firm sent out what General Counsel Steve Debenham, in an email about a draft to a colleague, called "a CYA letter," for "cover your a -- ." It said the IRS appeared to be focusing on the packages offered by major accounting firms, which "may be less credibly supported by a substantive economic justification...."

Mr. McAuliffe mocked that distinction in an email to colleagues. "Same law firms, similar or same promoters, same tax effect," he said, wondering if myCFO was "smoking our own dope again?"

He also dismissed the idea that myCFO's clients were penalty-proof for relying on reputable counsel. "You bought your opinion. You bought your comfort-level letter," he said later in his deposition. Mr. Debenham and Mr. McAuliffe both declined to be interviewed.

Two months later, the IRS ruled that Cards was an improper shelter. MyCFO's board discussed the ruling by phone. MyCFO by this time was little more than a tax-shelter brokerage, according to documents prepared for the meeting. If it closed its shelter business, it would forgo $10 million in revenue in the next three months and be in the red.

Instead of closing the tax business, myCFO tried to revive it by hiring a veteran of KPMG, an accounting firm that was especially active in selling tax shelters. The employee, Randall Bickham, brought a pipeline of tax deals worth a projected $7 million in fees.

The board also explored selling the company. MyCFO documents show Deutsche Bank AG, which had worked with myCFO on several Cards deals, expressed interest in acquiring the firm for $200 million to $300 million, but backed away, citing potential tax-shelter liability. Bank of Montreal agreed to buy myCFO for $90 million but it, too, backed out over the same concern, myCFO documents show. In October 2002 Bank of Montreal finally purchased just myCFO's name, client list and some other assets. It paid $30 million, about a third of the sums the Kleiner Perkins founders and others had put in. Bank of Montreal now has a private-banking unit called Harris myCFO Inc., which declined to comment.

Directors assigned the rest of myCFO to a liquidator. They gave Mr. Bickham, the former KPMG man, a $1.4 million contract, paid in advance, to maintain files and assist clients in "controversy issues" with the IRS.

In 2005, Mr. Bickham was among those charged by the Manhattan U.S. attorney with tax evasion and conspiracy to defraud the IRS. The charges relate to work he did while at KPMG. He has pleaded not guilty and declined to comment.

Also charged was Mr. Ruble, the Cards co-inventor. He was cited for tax-shelter work he did for others, mostly KPMG. Mr. Ruble's law firm had fired him, after discovering the deal he had with Chenery to funnel 20% of Chenery's fees into a Ruble family trust.

By that time, Mr. Ruble was at Sidley Austin, which had absorbed Brown & Wood. Sidley Austin and KPMG both faced civil litigation over tax shelters, which they settled last year for $179 million, including legal fees.

Mr. Taylor -- the lawyer who helped myCFO refine the shelters and assisted its shelter clients -- was indicted in a tax-shelter matter in Utah. Both he and Mr. Ruble have pleaded not guilty, and both declined to comment.

Federal prosecutors also investigated a German bank that helped arrange some of myCFO's tax shelters. In a deferred-prosecution deal reached last year, the bank, Bayerische Hypo-und Vereinsbank AG, or HVB, agreed to a $30 million penalty and admitted that the Cards deal contained "fraudulent and illegal elements."

The bank's confession didn't mention myCFO. But it said "all parties involved" knew the Cards credit facility wasn't a legitimate long-term loan and would be unwound in about a year to generate "the phony tax benefits sought." Said HVB, in a Statement of Admitted Facts: "The transactions were prearranged by the promoters... and had no purpose other than generating tax benefits for the clients involved."

Write to Peter Waldman at peter.waldman@wsj.com16

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