TAX FRAUD INVESTIGATIONS – A PROCEDURAL ROADMAP Part II

*Read Part I here if you haven’t already* 

I. Introduction

In the last issue of the Corporate Criminal Liability Reporter, Spring 1988, we described the process involved in IRS criminal investigations — how they begin, the cast of players, the investigatory techniques used, and the manner in which evidence is summarized for subsequent use in reviewing and prosecuting the case. In this second of two articles we will attempt to identify those techniques which counsel can use to attempt to identify those techniques which counsel can use to gather the information necessary to make an informed decision regarding two critical questions:

First, to what degree should the company cooperate with the government’s investigation?

Second, at what point should counsel present facts and arguments in an attempt to dissuade the government from bringing criminal charges.

This article will also discuss the various stages of review through which criminal tax cases must pass, beginning with the Criminal Investigation Division (“C.I.D.”) of the IRS and ending with the local U.S. Attorney’s office, where such cases are indicted and tried.

As we stressed in the first article, information is the key to the successful defense of a criminal tax case. Depending upon the circumstances of the particular case, success may be defined as a determination by the government to decline prosecution, a favorable plea bargain, or acquittal at trial. At each stage of the investigative and review process, counsel’s negotiating and litigating strength and success will be directly proportional to his/her command and effective use of the facts.

II. The Administrative Investigation

In the first article we outlined the difference between administrative investigations conducted solely by the IRS and grand jury investigations in which the Service cooperates with the U.S. Attorney’s Office during the investigative stages of the case. Most criminal tax cases begin as administrative investigations, and although the government is increasingly utilizing grand juries to investigate tax crimes, most of these grand jury investigations involve narcotics trafficking or organized crime. It is therefore likely that in the absence of these kinds of extreme problems or allegations, counsel for a corporate taxpayer will, at least initially, be dealing solely with C.I.D.

The chances of stopping a criminal tax investigation decrease markedly as the case proceeds from the investigative state at CID, through the review process at IS District Counsel and the Department of Justice, and, finally, indictment and trial. The chart set out below illustrates the diminishing probability that a prosecution will be terminated as it moves through the system.

Criminal Tax Investigations and Prosecutions Fiscal Year 1987 [1]

Given a 53% declination rate, counsel’s best opportunity to avoid prosecution is at the administrative investigation stage. At that point, the case has little institutional momentum. Once, however, the Special Agents have spent two years investigating a particular matter, inevitably there will be greater resistance to any argument that the analysis of the applicable facts or law is wrong or that significant exculpatory evidence has been overlooked.

As will be discussed in more detail below, the formal conference opportunities given to taxpayers by C.I.D. and District counsel usually involve a ritualized procedure in which each side closely guards its own position while trying to obtain as much evidence as possible from the other. While conferences at the Tax Division of the Justice Department may be more productive, the rate of declination by the Tax Division has diminished in the last five years, and it is highly questionable whether counsel can afford to regularly postpone making a presentation until the case arrives at the Justice Department.

The pace of an administrative investigation is slower and less dramatic than in a grand jury case. This gives counsel the opportunity to identify and locate helpful witnesses or evidence and, should strategy so dictate, to channel those toward the investigating agents. An administrative investigation is typically conducted by one or two Special Agents and a cooperating revenue agent. Their only form of compulsory process is the IRS administrative summons. A grand jury will be run by one or more Department of Justice trial attorneys or Assistant United States Attorneys, who will have at their disposal not only a number of CID, FBI, or Postal Service Agents, but also the power of the grand jury subpoena, by which they can demand production of documents or witnesses on relatively short notice.

It is also at this early stage of an investigation that witnesses who will provide the basis of affirmative defenses (e.g. reliance on professionals, such as lawyers or return preparers) are most likely to be willing and able to assist in developing the defense. Three years later, after the case has been indicted and is awaiting trial, it is often too late to approach prior counsel or the accounting firm that prepared the returns to remind them of all of the advice they gave and to ask them to testify on the defendant’s behalf. The passage of time erodes a witness’s ability to remember the very conversations which are crucial to a successful reliance defense. Moreover, it is extremely important to check a witness’ memories against contemporaneous correspondence, memoranda of conversations, and other corroborative materials such as telephone logs, appointment books, records of meetings, conversations, etc. Over time, these materials will be lost or misplaced; hence, they should be gathered and preserved as early as possible.

The relatively slow pace and low-key atmosphere surrounding many CID investigations sometimes allows for the development of a working relationship with the Special Agents. Because of the absence of a Fifth Amendment privilege for a corporation, or even act of production immunity for those producing corporate records,[2] counsel will usually have little choice but to respond to reasonable document requests from the Service. Where possible, it is in the client’s best interest for counsel to maintain an attitude of professional respect towards the agents. Under such circumstances, the investigators may feel more comfortable in discussing the direction, strengths, and perhaps even weaknesses in their case, thus allowing counsel to identify and pursue more efficiently exculpatory information. In this regard, one of counsel’s first acts should be to inform the Special Agent that all contact with corporate employees should be through counsel. The Special Agent must accede to this request, except under the most exigent of circumstances.[3]

III.Gathering Information During The Administrative Investigation

Relevant information can come from many sources. Depending on the size of the company and the scope and gravity of the potential problem, an internal investigation by in-house or outside counsel may be the best way to determine the facts initially. While the intricacies and pitfalls of the internal corporate investigation are beyond the scope of this article,[4] such an investigation must be sufficiently thorough to allow counsel to identify the potential problem areas and to develop leads to exculpatory evidence. Great care must be taken to protect the confidentiality of the report, because disclosure to a single individual or entity outside of the corporation may result in a complete loss of the privilege.[5] The report could thus become available to the government through a summons or grand jury subpoena, providing a virtual blueprint for building a prosecution.

In any complicated tax case, the assistance of expert accounting and investigative assistance is invaluable. However it may not be prudent to use either the in-house accounting staff or the outside accountants who were involved in preparing the returns in question, or any other ongoing work for the company. Such individuals are likely to be witnesses for the prosecution and/or defense. Instead, defense counsel should use new accountants and investigators who may be brought within the attorney-client privilege, thereby allowing for full and candid discussion of all applicable facts and theories of defense.

There is no federally recognized accountant-client privilege. Accordingly, counsel’s ability to extend the attorney-client privilege to such non-lawyer experts would have to be based on U.S. v. Koval, 296 F.2d 918 (2d Cir. 1961). The accounting firm must be hired by counsel, and be employed specifically to assist counsel in the defense of the company. To preserve the confidentiality of the communications between the client, lawyer and accountant, the accountant must observe the same strictures to maintain a client’s confidence as those imposed upon attorneys.

[1] Based upon statistics disclosed by Hon. Anthony Longone, Assistant Commissioner, Criminal Investigation, IRS, during an address the A.B.A. Tax Section’s Committee on Civil and Criminal Penalties on May 13, 1988.

[2] See U.S. v. Braswell, U.S. Sup. Ct. June 22, 1988; See also the article analyzing this opinion in the Case Analysis section of this issue.

[3] Special Agent’s Handbook, IRM 9781 section 342.19.

[4] “The Corporation Criminal Investigation.” Crop. Crim. Rptr. Premiere Issue, 1986, publ’d by Federal Litigators Group.

[5] See In re Continental Illinois Securities Litigation, 732 F.2d 1302, 1314 (7th Cir. 1984); Permian Corp. v. U.S., 665 F.2d 1214 (D.C. Cir. 1981); but see Diversified Industries, Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1977).