                             T.C. Memo. 2016-226



                       UNITED STATES TAX COURT



    AD INVESTMENT 2000 FUND LLC, COMMUNITY MEDIA, INC., A
   PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent*

 AD GLOBAL 2000 FUND LLC, WARSAW TELEVISION CABLE CORP., A
  PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9177-08, 9178-08.               Filed December 14, 2016.



            On account of Ps' postdecision challenges to one of R's expert
     witnesses, we will vacate our decisions, which were substantially for
     R, in order to reconsider our findings of fact and opinion. Upon
     reconsideration, disregarding the challenged expert's testimony, we
     reach the same conclusions and will reenter our decisions for R.




     *
       This opinion supplements our previously filed Memorandum Opinion, AD
Inv. 2000 Fund LLC, T.C. Memo. 2015-223.
                                          -2-

[*2] Elliot Silverman and Orrin Tilevitz, for petitioners.

      Veronica L. Richards and Daniel L. Timmons, for respondent.



                   SUPPLEMENTAL MEMORANDUM OPINION


      HALPERN, Judge: Petitioners brought these cases for us to review two

notices of final partnership administrative adjustment (FPAAs). We did so and

reported the results of our review in our Memorandum Findings of Fact and

Opinion (Memorandum Opinion) AD Inv. 2000 Fund LLC, T.C. Memo. 2015-

223, filed November 19, 2015. We entered decisions (substantially in

respondent's favor) on February 8, 2016. With our permission (because otherwise

such motions would have been untimely, see Rule 1621), petitioners moved on

March 29, 2016, to vacate those decisions on the grounds that newly discovered

evidence demonstrates that Thomas Murphy, one of respondent's expert witnesses,

lied in both his expert report and his trial testimony as to his expert qualifications.2



      1
          All Rule references are to the Tax Court Rules of Practice and Procedure.
      2
        On March 16, 2016, during a trial conducted by another Division of the
Court, in Tucker v. Commissioner, T.C. Dkt. No. 12307-04 (filed July 14, 2004),
voir dire of Mr. Murphy revealed that he had not updated his curriculum vitae with
respect to certain aspects of his employment history and the trials in which he had
                                                                        (continued...)
                                         -3-

[*3] Respondent does not object to our vacating our decisions in these cases. We

will vacate our decisions pursuant to Rule 162. At the suggestion of the parties,

we have reconsidered our findings and opinion, disregarding Mr. Murphy's expert

testimony.3 On the basis of that reconsideration, for the reasons discussed below,

we will reenter our decisions for respondent.

                                    Background

      These cases involve six corporations that entered simultaneously into

offsetting long and short currency options and then contributed the option spreads

to either AD Investment 2000 Fund LLC (ADI) or AD Global 2000 Fund LLC

(ADG) (collectively, LLCs). In less than a year, the corporations disposed of their

LLC interests and reported huge tax losses from their investments on the theory

that their tax bases in their LLC interests equaled the cost of the long option (or

options) that each had contributed to the LLC, unreduced by the offsetting short-

option liability (or liabilities) that the LLC had assumed.




      2
        (...continued)
testified in the prior four years. As a result, we did not permit Mr. Murphy to
testify in that case.
      3
       Although petitioners did not do so, we will treat petitioners as having made
an untimely motion pursuant to Rule 161 for us to reconsider our findings or
opinion. We grant petitioners leave to so move and hereby grant the motion.
                                        -4-

[*4] Respondent examined the LLCs' 2000 returns, and by the FPAAs he made

adjustments to partnership items that would eliminate the losses reported by the

corporations. He justified his adjustments in part on the ground that the LLCs had

been "formed and availed of solely for purposes of tax avoidance by artificially

overstating basis in the partnership interests of its purported partners." Because

the transactions and partnership had "no business purpose other than tax

avoidance", they "lacked economic substance", and so, respondent determined, he

would disregard them for tax purposes and disallow deductions for the related

losses.

      We conducted a trial in these cases, and the testimony at trial consisted

principally of expert testimony concerning the economics of option spreads.

Respondent called two expert witnesses, Thomas Murphy, who was accepted by

the Court as an expert in valuing and trading foreign currency options, and John B.

Finnerty, Ph.D., who was accepted by the Court as an expert in finance with a

particular expertise in derivatives. Petitioners called one expert witness, Scott D.

Hakala, Ph.D., who was accepted by the Court as an expert on the pricing of

currency options with some familiarity with industry practice.

      In our Memorandum Opinion AD Inv. 2000 Fund LLC v. Commissioner, at

*4, *29-*30, we held that the LLCs should not be recognized as entities for
                                        -5-

[*5] Federal tax purposes, and, on that basis, we sustained respondent's

adjustments that would eliminate the loss deductions claimed by the corporations.

We found:

      The evidence is overwhelming that the LLCs were created and the
      option spread transactions were executed exclusively for tax
      avoidance purposes: (1) Mr. Haber [the architect behind the LLCs
      and the transactions at issue] openly advertised the strategy as a way
      to generate tax losses, (2) the LLCs themselves engaged in no
      transactions besides the economic equivalent of putting money in a
      bank, (3) each corporation joined and resigned from the LLCs within
      the year, (4) participating in the transactions caused each corporation
      to completely offset what otherwise would have been a substantial tax
      liability, and (5) if foreign currency investing and diversification were
      the goal, there were simpler alternatives with a higher probability of
      generating profit. [Id. at *28-*29.]

                                    Discussion

I.    Findings on the Basis of Expert Testimony

      Of those five numbered findings, we made only two on the basis of expert

testimony, viz, "(2) the LLCs themselves engaged in no transactions besides the

economic equivalent of putting money in a bank", and "(5) if foreign currency

investing and diversification were the goal, there were simpler alternatives with a

higher probability of generating profit." Id. at *29. While Mr. Murphy's

testimony supports both of those findings, there is corroborating testimony from

one or both of the other expert witnesses.
                                            -6-

[*6] II.        Essentially Cash Deposits

       Mr. Murphy was of the opinion that the option transactions that the LLCs

entered into were equivalent to depositing cash in a bank: "The two ADG option

spreads [and likewise the two ADI option spreads] were so deep in the money that

they were essentially cash deposits." Dr. Finnerty was similarly of the opinion that

the option transactions that the LLCs entered into "were so deeply in the money

with fixed payoff amounts that they were effectively cash-equivalent positions."

Dr. Finnerty was a credible witness, and his testimony alone was sufficient for us

to make our finding that the LLCs engaged in no transactions besides the

economic equivalent of putting money in a bank. Upon reconsideration, we repeat

that finding.

III.   Simpler Alternatives

       Likewise, Dr. Finnerty corroborated Mr. Murphy's testimony that the option

pairs acquired by the corporations were not particularly good investments. As we

reported in our Memorandum Opinion AD Inv. 2000 Fund LLC v. Commissioner,

at *18, Dr. Finnerty "credibly testified that neither the option spreads nor their

contribution to the LLCs provided the corporations with any additional risk

diversification, hedging, or profit potential when compared to purchasing a single

long option and holding the option outside of the LLC." On the basis of his
                                         -7-

[*7] testimony, we found "that FXIS [Mr. Haber's foreign currency investment

strategy] was complex and unnecessary. Any actual diversification achieved was

minimal, and it could have easily been achieved without an LLC." Id. Also on the

basis of his testimony, we found "the yen, the euro, and the Canadian dollar [some

of the currencies used to implement FXIS] 'are obtained and traded with ease by

lay investors without the need for third-party investment management.'" Id.

      Dr. Hakala, petitioners' expert, did not explain why the corporations entered

into more complicated transactions when simpler ones with higher probabilities of

profit were available, even opining that he did not see anything that suggested an

"intent of really beating the market at [a] sophisticated level". Id. at *17-*18

(alteration in original). When asked whether he thought the purpose of the option

spreads was actually to profit from foreign currency markets in the light of the fact

that the purported tax benefits made profiting immaterial, he stated: "I understand

that to some extent, as I would say, the tail wagged the dog". Id. at *18.

      Petitioners called Ronald Buesinger as a fact witness. He is an experienced

option trader who had assisted Mr. Haber in implementing FXIS. He testified that

he had priced the option trades that were necessary to execute FXIS and was very

familiar with the economics of the trades. He further testified that he had

negotiated the terms of the trades with Lehman Brothers Commercial Corp.
                                        -8-

[*8] (Lehman), which was both the counterparty and the calculation agent for

those trades.4 He testified that Lehman was uncomfortable with the risk that the

option spreads would expire on the "sweet spot" (the remote possibility that, on

the expiration of an option pair, the long option is in the money but the short

option is not), which risk figured in setting the market spread to be taken into

account in determining whether the sweet spot was hit. He acknowledged that, if

Mr. Haber was concerned about the net payoff amount from options trades, then a

simpler strategy would have been to invest in single (we assume "unpaired")

option transactions.

      And while the existence of a sweet spot undoubtedly offered the

corporations and the LLCs at least the theoretical possibility of a huge payout, Mr.

Buesinger analogized the probability of hitting the sweet spot to "hitting the

lottery" (or "hitting the head of a pin"). Mr. Murphy was certain that the sweet

spot would never be hit. He testified that Lehman, as the calculation agent, had




      4
        As "counterparty", Lehman bought the options that the corporations sold (it
would receive payouts from the corporations if the options expired in the money)
and sold the options that the corporations bought (it would have to make payouts
to the corporations if the options expired in the money). As "calculation agent",
Lehman was responsible for determining the exchange rate price when the options
expired. See AD Inv. 2000 Fund LLC v. Commissioner, at *8 n.4.
                                          -9-

[*9] discretion to pick from a range of prices wider than the sweet spot5 and that,

under the terms of the relevant trade confirmations, neither Lehman or the

corporations owed a fiduciary duty to the other. He testified that it would be both

commercially reasonable and in its interest (as the counterparty to the transaction)

for Lehman to pick a price not at the sweet spot. Mr. Murphy convinced us that

Lehman would not have closed a transaction on the sweet spot, AD Inv. 2000

Fund LLC v. Commissioner, at *15, and we found that the option spreads at issue

"would never have expired on the 'sweet spot'", id. at *14. There is, however,

other testimony that (putting aside Mr. Murphy's testimony) leads us to the same

conclusion. Dr. Finnerty was of the opinion that the probability that the paired

options would have expired on the sweet spot is "essentially zero." His reasoning

was similar to Mr. Murphy's: "As the calculation agent and the counterparty

technically exposed to this risk [i.e., payoff if the sweet spot is hit], it seems very

unlikely that Lehman would allow the paired options to actually expire within the

sweet spot. Lehman would take advantage of the flexibility that it had in

determining terms." Dr. Hakala conceded that, as a practical matter, the option

      5
        More specifically, Mr. Murphy testified that the market spread on exchange
rates was three pips wide, and calculation agents such as Lehman would have
discretion to pick a price at least within that range. Because the sweet spot for all
of the option spreads was only one pip wide, it, in effect, gave Lehman discretion
to always pick a price outside of the sweet spot.
                                        - 10 -

[*10] spread would never actually expire on the sweet spot. Id. at *16. He added

that he had never seen it happen and that, if the option spread was close to being in

the money, the parties would close it out before expiration at an agreed price. Id.

And while that might mean that a spread owner could profit from a spread that was

not actually in the money if it were close to being in the money near to its

expiration date (or might enjoy an increased profit if the spread were already in the

money and close to the sweet spot near to its expiration date), Dr. Hakala did not

quantify the "price" (bonus) that would be agreed upon to avoid the possibility of

an option spread's expiring on the sweet spot. For that reason, we cannot do much

with his opinion that the parties would price away the risk of a sweet spot hit, and

we see no reason to change our fifth numbered finding; i.e., if foreign currency

investing and diversification were the goal, there were simpler alternatives with a

higher probability of generating profit. Disregarding Mr. Murphy's testimony does

not change our assumption expressed in that finding that there were simpler

alternatives with a higher probability of generating a profit.

      Upon reconsideration of the expert testimony, disregarding Mr. Murphy's

testimony, we make the same fifth numbered finding that we made in our

Memorandum Opinion AD Inv. 2000 Fund LLC v. Commissioner, at *29, viz, "if
                                        - 11 -

[*11] foreign currency investing and diversification were the goal, there were

simpler alternatives with a higher probability of generating profit."

IV.   Conclusion

      We will vacate our decisions in order to reconsider our Memorandum

Opinion. Upon reconsideration, we make the same five findings of fact (set forth

supra) on which we relied in our Memorandum Opinion. Id. at *28-*29. Also, we

reach the same conclusions that we reached in our Memorandum Opinion:

      The LLCs were created solely for tax avoidance purposes, and, for
      that reason, we do not recognize them as entities for Federal tax
      purposes. Since they are not tax-recognized entities, they are
      ineligible to be classified as partnerships for Federal tax purposes.
      See sec. 301.7701-3(a), Proced. & Admin. Regs. Because they
      cannot be classified as partnerships for Federal tax purposes, "there
      was no partnership loss, and there were no partnership deductions, no
      contributions to the purported partnership, and no distributions from a
      partnership to its purported partners. Adjustment of those
      [partnership] items to zero is appropriate." Tigers Eye Trading, LLC
      v. Commissioner, 138 T.C. at 107. Likewise, because the LLCs are
      not tax-recognized entities, neither the corporations nor DGI or Alpha
      could have any membership interest in the LLCs in which they could
      have any tax basis. See Logan Tr. v. Commissioner, 616 F. App'x at
      429 (emphasizing that a court "[is] not required to shut its eyes to the
      legal impossibility of any partner's possessing an outside basis greater
      than zero in a partnership that, for tax purposes, d[oes] not exist"
      (quoting United States v. Woods, 571 U.S. ___, ___, 134 S. Ct. 557,
      565 (2013))). Except with respect to the penalties and ADI's interest
      expense, we sustain respondent's partnership-item adjustments and
      partnership-level determinations. [Id. at *29-*30; alterations in
      original.]
                                       - 12 -

[*12] As stated, we will reenter our decisions for respondent.


                                                An appropriate order will be issued,

                                      and decisions will be entered for

                                      respondent.
