Attorney-Client Privilege Under Siege

Watch out – figuring out your taxes just got even more complicated…

On June 19, 2003, a U.S. District Court judge in Chicago ordered one of the largest U.S. law firms to disclose to the Internal Revenue Service the names of about 700 clients who received tax shelter advice from attorneys at the firm.

The IRS has in recent years greatly increased its use of such ‘John Doe’ summonses. Beginning in 2000, it employed them when seeking information on thousands of holders of offshore bank account credit cards from American Express, VISA and MasterCard. But the IRS has reportedly never used this highhanded tactic against a law firm.

The law firm, Jenkens & Gilchrist – one of the nation’s largest – has refused to comply with the unprecedented court order, saying it will fight it all the way to the U.S. Supreme Court. "Americans have a right to consult with an attorney in confidence, and only the clients themselves can waive that right," a spokesman for the firm said, adding that it expected the courts to uphold its position. The IRS position, of course, is that it is seeking evidence about tax shelters which its alleges are illegal.

In The United States, Canada, the United Kingdom and other common law nations, attorney-client privilege describes a well-established, traditional right. It encompasses the ethical duty of an attorney or solicitor not to divulge to others confidential communications with a client. It also includes the client’s right to refuse to disclose, and to prevent others from disclosing, such confidential communications with his or her attorney.

Attorney-Client Privilege: Speaking Without Fear

This important rule evolved as a means to encourage clients to make full disclosure to an attorney when seeking legal advice, without fear that the legal advisor would inform others. To do less might well hamper preparation of the client’s case, or prevent the attorney from giving the correct advice.

In the Chicago case, acting as prior judge and jury, the IRS simply branded certain types of tax-avoidance shelter plans (called COBRA) as illegal. It alleged the law firm was offering advice about these supposedly ‘illegal’ plans. That speculation, said the IRS, supposedly gives it the right to see COBRA client files. IRS officials said the transactions, which allegedly took place between 1998 and 2003, generated phony paper losses of about US$4 million each, or about US$2.4 billion in all.

If the IRS is successful in its demands against Jenkens & Gilchrist, there will remain almost no confidentiality for tax attorneys and their clients. A simple statement from the IRS that it believes a certain tax shelter or other plan to be ‘abusive’ will open the files of any client who may have discussed the plan with a lawyer, let alone adopted the plan as his own personal or business tax strategy.

This radical new course of judicial activism is the easy way out for the IRS. In the past, the agency had to proceed against each taxpayer individually, proving that his or her tax plan was somehow illegal or had been used in an abusive way. Now, if the IRS position is upheld, the agency can simply speculate that certain groups of people are engaging in alleged illegal tax avoidance schemes and grab their lawyers’ files.

Attorney-Client Privilege: Indicting Attorneys

In one sense, no one should be surprised that the IRS, backed by the U.S. Department of Justice, is playing this sort of legal hardball. Only a few years ago, the FBI raided the law offices of several criminal defense attorneys in south Florida that represented accused drug kingpins. Grabbing files and computers, the attorneys themselves eventually were indicted and some convicted of ‘conspiring’ with their clients, a far cry from simply ‘representing’ them.

Anti-money-laundering laws and more recently, anti- terrorism laws, have also been used to force attorneys to report ‘suspicious activities’ of clients, with mixed results. It has always been a requirement that attorneys report a client’s pending or planned future criminal acts, if the lawyer is aware of them. An attorney cannot knowingly assist a client in committing fraud or a criminal act. Indeed, attorneys today are wary of positioning themselves so as to be accused of any criminal conduct by a client whom may sell out the lawyer in negotiations with prosecutors. ‘Know your client’ is a modern attorney’s watchword and guide.

Attorney-Client Privilege: The Normal Practice of Law

But when a tax attorney discusses a tax avoidance plan with a client, and the client later adopts the approach based on that competent legal advice, that cannot, in my view, justify waiving attorney-client privilege. This does not constitute criminal conduct, but rather the normal practice of law.

These recent events mean you must take great care when hiring a tax or any other attorney. Don’t discuss confidential matters until you conclude a representation agreement in writing. This serves as the benchmark when privilege attaches and begins to run.

In some cases, it is best to have your domestic tax attorney hire an offshore trust attorney to handle matters in a foreign tax haven or other nation. This dual arrangement can add another protective layer of attorney- client privilege.

In the United States, an attorney has no duty to report that a client may have in the past been engaged in illegal conduct. However, in the United Kingdom, Switzerland and some other nations, an attorney must report suspicion of money laundering. In the United Kingdom, this includes reporting of suspected illegal tax evasion. Canadian attorney-client privilege is now under revision, with the government demanding to know all. This means you must find out about the status of attorney-client privilege in any offshore nation where you may decide to employ an attorney.

It’s your privilege. Protect it – and yourself.

Regards,

Robert E. Bauman
for the Daily Reckoning

August 05, 2003

Robert E. Bauman, JD is a former member of the U.S. House of Representatives from Maryland and the author of several books on offshore financial topics. Mr. Bauman serves as legal counsel to The Sovereign Society, an international group of citizens concerned with government encroachment on financial freedom.

Heat.

Europe is suffering through an inferno of heat. And here in rural France, people think of nothing else; they talk of nothing else. Who can keep his mind on stocks and bonds when it is 100 degrees outside, and no air conditioning inside? (Still we manage a little rumination, keep reading…)

"Another old person died in the village last night," said our gardener, yesterday morning. Damien keeps track of the dead better than we do; he works part-time for the commune and digs its graves.

"It was the heat that got her. And now Madame Lardeau is very sick. She’s 97 years old; they say she’s stopped eating. But I hope she can hold out until the heat wave is over. If I have to dig any more graves in this heat they’ll need one for me too!"

Gardeners in France – maybe the world over – are a colorful breed. They spend too much time alone with plants; talking to geraniums drives a man mad.

Our former gardener was a pleasure to have around. But then he reconciled with his wife and seemed to come to his senses. After that, we could never seem to synchronize our drinking. He was sober when we were drunk and drunk when we were sober; it just didn’t seem to work.

Damien has a wild look in his eye. And he, too, talks to vegetables. But he does his work well and saves his drinking for the village bar, where drunks are not only welcome, but needed. There used to 9 bars in town. That was before television…and before work lured the young people to the big cities. Now, there is only one bar left in a town full of sober, gray heads….and, in this heat, the old people drop like bonds.

"Did you hear?" asked Damien this morning. "Madame Lardeau died last night. If this heat keeps up, there won’t be anyone left.

"I’m going to wait until tomorrow morning, early, to dig the grave…before it gets too hot."

And with that little, heh heh, warm-up…we turn you over to our man in the city of dreams:

————-

Eric Fry, in mercifully 20-degrees-cooler Manhattan…

– Investors may be busy buying stocks, but they’re TALKING about bonds. The bond market’s scandalous behavior is the talk of the town…What has become of the well-mannered bond market we used to know? No self-respecting financial market should ever drop flat on its back in the presence of polite company.

– "Why is the bond market behaving so badly?" the alarmed lumpeninvestoriat is wondering. "And will its bad behavior influence other financial markets like – gulp – the stock market?"

– Yesterday, the Dow Jones Industrial Average gained 32 points to 9,186, after sliding as much as 105 points earlier in the session. The Nasdaq slipped nearly two points to 1,714. Meanwhile, the bond market selloff abated somewhat, as Treasury issues rallied for a second straight session. The 10-year Treasury note gained 24/32, dropping its yield to 4.29%, from 4.47% last Thursday. But the bond market’s two-day rally doesn’t change the fact that yields have been soaring for weeks.

– Yesterday, the Wall Street Journal finally picked up on the obvious notion that rising rates might be harmful to finance companies. Splashed across the front page of its "Money and Investing" section, three separate stories chronicled the woes of rapidly rising interest rates. The Journal, as usual, is late to the party. But at least it finally showed up. The Daily Reckoning has been rollicking at the bond bear party for weeks already…

– We would never risk arousing the ire of the financial market gods by saying, "We told you so." But it’s true that we’ve been highlighting the bond market’s feeble underpinnings for some time now. On May 21st, less than three weeks before the bond market peaked, we remarked, "The New York office of the Daily Reckoning steadfastly believes – wrongly, so far – that the U.S. bond market is one of the most compelling ‘sells’ in the world of global finance. It’s conceivable, of course, that the 10-year yield will plummet below 3% before marching higher. Nevertheless, your New York editor would take the bet (in small quantities) that one year from now, the 10-year Treasury yield will be higher than it is today."

– One month later – and only 10 days after the bond market’s peak – we quoted the work of Donald Straszheim of Straszhein Global Advisors when he wrote, "We think bonds have peaked. Investors would be wise to not get too greedy at these levels – the lowest yields in 40-50 years…The bond market during 2002-03 has begun to look like Nasdaq, June 1999 to March 2000 – a blow-off. Too far, too fast. Too good to last.

– "When memories and their lessons fade," Straszheim continued, "investors pay the price. The last double in the Nasdaq took just nine months (2524 on June 18, 1999, to the peak of 5,048 on March 10, 2000). The bond market move has been equally outsized…The 5-year Treasury yield is not 2.21%. From 6.35% in June 2000 and 4.34% in June 2002. What a move!…Looks like a top [in price] in bonds to us."

– Nice call, Donald! Bond prices have been plummeting ever since. "Twenty-one years, eight months, two weeks, two days. Thus marks what many are saying could be the end of a remarkable two-decade run in the U.S. bond market," the Wall Street Journal relates. "To get a sense of the scale of the decline, consider that the drop is greater than any three- month loss for bonds dating to 1927…Put another way: The Dow Jones Industrial Average would have to drop nearly 1,400 points from its current level – by Halloween – to match it."

– Has the bond market’s spectacular collapse converted your New York editor into a value-sensing bond bull? Ummm…no. Perhaps he is 120 basis points less bearish than he was when the 10-yield was yielding 3.09%. But he is certainly not bullish.

– The bond selloff looks like the real deal: the beginning of the end of America’s spectacular two-decade bull market in bonds. It is also, therefore, the beginning of the end of America’s epic mortgage refinance boom…and that could be a bit of a problem for the U.S. economy, or at least the 87% of the economy that relies upon consumer spending.

————-

Back in Ouzilly…

*** "Things really are getting better for investors," says an email message just received from Lou Dobbs.

How does he know?

"I just interviewed Bill Donaldson, the new SEC Commissioner, and I also had the pleasure of talking in- depth with the new Treasury Secretary John Snow…what they told me, both on the air and off, gave me a great deal of confidence that they are serious about cleaning up the climate of fraud that has tainted Wall Street over the past several years, and about generating real economic and job growth going forward."

Well, that does it for us, doesn’t it, dear reader? If the SEC commissioner and the Treasury Secretary say things are getting better, well…end of conversation.

Why didn’t we think of that? Why spend all this time trying to understand the winds and tides when we could just ask the weatherman?

Besides, in this case, these guys don’t just watch the weather – they make it! Like Greek gods, they can hurl thunderbolts wherever they want…or so they say. And if they’re serious about ‘cleaning up the climate of fraud’ and about ‘generating real economic and job growth going forward,’ what more do we need to know?

Well…well…I guess we might be a little curious about why they weren’t serious about it last year. Why didn’t they generate a little job growth going backwards, if you know what we mean? Alan Greenspan recently told Congress that he was sure that things were looking up for the 2nd half. Of course, his words were almost exactly the same as those he used the year before…and the year before that. And just to make sure the economy lived up to his forecasts, he knocked interest rates down 13 times in a row.

But where’s the job growth? We don’t see any…going forward, backwards, or sideways.

"One in 10 tech jobs may move overseas," says the Chicago Tribune. More than half a million tech jobs have already been lost. Businesses need profits before they’re willing to hire. The popular press reports that profits were up 13% in the first quarter. But a more accurate figure, from the national accounts, is only 2%. Nobody is going to do much hiring based on those feeble results.

Business profits as a percentage of GDP have been falling since the Dollar Standard system was put into place in the early ’70s. It is a deep structural problem, not a cyclical one. Americans spend…but the profits end up in the hands of people overseas, the people who make things. This is not a problem that is going to be solved by making short-term financing cheaper…nor by cleaning up a climate of fraud, whatever that may mean. It is a problem that will eventually be rectified, just as all big debts are settled: in pain and suffering. The dollar will fall, savings will increase, the stock market and bond markets will collapse, and Americans will have less money to spend. These are all things that are in the future, and they are things that Snow, Greenspan, Donaldson and the rest will never admit – even when they are in the midst of them.