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Goldman v. KPMG LLP

April 22, 2009

STEVEN J. GOLDMAN ET AL., PLAINTIFFS AND RESPONDENTS,
v.
KPMG LLP ET AL., DEFENDANTS AND APPELLANTS.
JEFFREY R. HAINES ET AL., PLAINTIFFS AND RESPONDENTS,
v.
KPMG LLP ET AL., DEFENDANTS AND APPELLANTS.



APPEALS from orders of the Superior Court for the County of Los Angeles. Susan Bryant-Deason and Paul Gutman, Judges. Affirmed. (Los Angeles County Super. Ct. Nos. BC339722 & BC340400).

The opinion of the court was delivered by: Rubin, Acting P. J.

CERTIFIED FOR PUBLICATION

SUMMARY

The plaintiffs in two lawsuits, consolidated on appeal, seek millions of dollars in damages in connection with allegedly fraudulent tax shelter schemes developed, marketed and implemented by their former accountants, lawyers and investment advisers. In one of the tax shelter schemes, a step in the process included the formation of limited liability companies in which the plaintiffs and their investment advisers became members. The limited liability companies had standard operating agreements containing broad arbitration clauses. When plaintiffs sued the accountants, lawyers and investment advisers, the accountants and lawyers, who were not parties to the operating agreements, sought an order compelling arbitration. Relying on the doctrine of equitable estoppel, they argued that plaintiffs, as signatories to an arbitration agreement with the investment advisors, should be equitably estopped from asserting the right they otherwise would have had to pursue their claims against the accountants and lawyers in court.

The trial court in each case denied the motions to compel arbitration (in one case, in part only), and the accountants and lawyers appealed. We conclude the doctrine of equitable estoppel has no application in these cases. The sine qua non for allowing a nonsignatory to enforce an arbitration clause based on equitable estoppel is that the claims the plaintiff asserts against the nonsignatory are dependent on or inextricably bound up with the contractual obligations of the agreement containing the arbitration clause. Because the contractual obligations in the operating agreements were unrelated to the plaintiffs‟ claims against the nonsignatory accountants and lawyers, there is no basis in equity for preventing the plaintiffs from suing the accountants and lawyers in court. Accordingly, we affirm the orders of the trial court denying the motions to compel arbitration.

FACTUAL AND PROCEDURAL BACKGROUND

In the 1990s and continuing into the next decade, KPMG LLP, a major accounting firm, assisted high net worth individuals to evade federal income taxes on billions of dollars in capital gains and ordinary income by developing, promoting and implementing fraudulent tax shelters. KPMG entered into a deferred prosecution agreement with the United States Department of Justice in August 2005, admitting to its conduct and agreeing to pay $456 million in fines, restitution to the IRS and penalties.*fn1 These appeals involve different versions of similar tax shelters.

A. The Complaints

In September 2005, several months after being informed of the then-pending criminal probe into fraudulent tax shelters, Respondents Steven J. Goldman, his wife and a limited liability company of which Goldman was the sole member (collectively, Goldman) sued KPMG, Sidley Austin Brown & Wood LLP (now Sidley Austin LLP) (Sidley)), and others.*fn2 The others included The Diversified Group, Incorporated (DGI), a registered investment advisor; DGI‟s principal, James Haber; and Alpha Consultants, LLC (Alpha). (Unless the context shows otherwise, further references to "DGI" include DGI, Haber and Alpha, collectively.) Goldman sought to recover millions of dollars he ultimately paid to the government in taxes and interest as a result of disallowed deductions claimed in connection with investments in the tax shelters marketed by KPMG.

Goldman‟s complaint, so far untested, alleged the following.

Goldman engaged KPMG to provide tax planning and tax strategy advice. In the 1990s, KPMG created "Son of Boss" investment schemes, which were generic tax avoidance products it marketed to clients with significant taxable income. KPMG, Sidley and promoters such as DGI induced Goldman and hundreds of others to invest millions of dollars in Son of Boss investments. A KPMG partner pitched a Son of Boss investment (the Plan) to Goldman, telling him that in exchange for payments of about $2.1 million, Goldman would generate a tax loss of as much as $61 million in about 60 days. The Plan involved buying options and related instruments on the foreign currency market, and would be handled by DGI, which would prepare the necessary legal documents and arrange for the formation of a limited liability company to generate the tax loss. KPMG and Sidley each would independently provide Goldman an opinion letter stating it was "more likely than not" that a deduction taken for losses generated by the Plan investment would be upheld if challenged in court by the Internal Revenue Service. The defendants knew but did not disclose to Goldman that several KPMG tax partners had repeatedly warned KPMG management that the IRS would likely succeed in challenging any deductions generated by the Plan.

Relying on the representations from KPMG and Sidley, Goldman decided to invest in the Plan in 2000. KPMG introduced Goldman to Haber of DGI; Haber then formed AD Managed Equity Fund LLC (AD Managed Fund) as the limited liability company through which Goldman would make the investment, with DGI and Alpha as the founding and co-managing members. Goldman purchased four options involving the NASDAQ 100 Index at a cost of $1.2 million, and contributed the four options to AD Managed Fund as his capital investment in AD Managed Fund. DGI charged Goldman $2.1 million in fees for arranging the transaction, including a $600,000 advisory fee remitted to KPMG. A month or so later, Goldman withdrew from AD Managed Fund, pursuant to prior directions of KPMG and DGI, understanding that as a result, he would incur a tax loss of about $61 million. Sidley provided Goldman with a lengthy opinion letter, as promised, and "pursuant to a prior conspiracy" between KPMG, DGI and Sidley, KPMG paid or caused DGI to pay Sidley a fee in excess of $300,000 for providing the opinion letter. Sidley did not independently research or analyze whether the Plan would withstand a legal challenge, but merely attached its signature to a form opinion letter drafted by KPMG. Goldman claimed a tax deduction for the losses generated by AD Managed Fund on his 2000 federal and state tax returns. In November 2004, Goldman agreed to pay the State of California and the federal government tens of millions of dollars in taxes and interest as a result of the deductions claimed for losses generated by the investment in AD Managed Fund.

Goldman‟s complaint asserted claims of breach of fiduciary duty, fraud, fraudulent nondisclosure, negligent misrepresentation, and negligent nondisclosure against KPMG and Sidley (as well as professional negligence against KPMG). In addition, Goldman alleged causes of action for conspiracy to commit fraud against KPMG, Sidley and DGI, and for aiding and abetting fraud and aiding and abetting breach of fiduciary duty against Sidley and DGI. Goldman alleged DGI conspired with KPMG and Sidley "to fraudulently induce [Goldman] to invest in AD Managed." In sum, KPMG would locate likely investors, assuring them the transaction would more likely than not withstand an IRS challenge; DGI would act as the investment advisor "to structure and document the Son of Boss scheme"; DGI "would form the limited partnership required for the transaction"; Sidley "would assist KPMG in securing investors" by providing an opinion letter; and the fees received would be divided between KPMG, Sidley and DGI.

Respondents Jeffrey Haines and his wife (collectively, Haines) filed a lawsuit, also in September 2005, against KPMG, Sidley and DGI, alleging substantially the same facts and causes of action as the Goldman complaint. Haines was induced to invest in another variation of the "Son of Boss" tax shelter, and was told by KPMG that in exchange for payments of approximately $1.0 million, Haines would generate a tax loss of approximately $16 million in about 60 days. The players and the scenario were the same as in the Goldman transaction, except that the limited liability company through which Haines would make his investment was called the AD FX Investment Fund LLC (AD FX Fund).

Both Goldman and Haines sought damages of not less than $10 million, plus punitive damages.

B. The Motions to Compel Arbitration

In both the Goldman and Haines cases, KPMG and Sidley filed motions to compel arbitration. Neither had arbitration agreements with any of the plaintiffs. However, the limited liability companies through which the Goldman/Haines tax losses were generated -- AD Managed Fund and AD FX Fund, respectively -- both had standard operating agreements containing broad arbitration clauses, and Goldman and Haines signed those operating agreements to become members of the Funds. Consequently, Goldman and Haines agreed to arbitrate any disputes with DGI and Alpha "arising out of or relating to" the operating agreements. KPMG and Sidley were not parties to those agreements, but argued Goldman and Haines were equitably estopped from avoiding arbitration of their claims against KPMG and Sidley. The doctrine of equitable estoppel applied, they claimed, in either of two circumstances, both of which were asserted to exist in their cases: (1) when the plaintiffs‟ claims rely upon or are intimately founded in and intertwined with an agreement to arbitrate, or (2) where the signatories raise allegations of substantially interdependent and concerted misconduct by both nonsignatories (KPMG and Sidley) and one or more signatories (DGI and Alpha).

In the Goldman case, the trial court (Judge Susan Bryant-Deason) denied both motions. As to KPMG, the court found Goldman and KPMG had several written engagement letters, none of which contained an arbitration clause, and that KPMG was not entitled to invoke equitable estoppel to supersede a written express agreement containing no arbitration clause. Sidley‟s motion was denied because of the possibility of conflicting rulings on common issues if arbitration were to take place only between Goldman and Sidley.

In the Haines case, the trial court (Judge Paul Gutman) granted the motions in part and denied them in part. The court granted the motions to compel arbitration of the conspiracy and aiding and abetting causes of action. The other causes of action, the court found, "sound... in common law tort duties and the specific duties which arise from the separate professional relationships between KPMG and [Haines] and Sidley Austin and [Haines]" and should be litigated, as the conduct alleged "is unconnected to the arbitration agreement in any necessary sense." The court stayed the latter causes of action, pending the outcome of the arbitration of the conspiracy and aiding and abetting claims.

KPMG and Sidley Austin filed timely appeals, which were consolidated for purposes of briefing, oral argument and decision.*fn3

DISCUSSION

We begin with our conclusion, which is this: the sine qua non for application of equitable estoppel as the basis for allowing a nonsignatory to enforce an arbitration clause is that the claims the plaintiff asserts against the nonsignatory must be dependent upon, or founded in and inextricably intertwined with, the underlying contractual obligations of the agreement containing the arbitration clause. In this case, the Goldman/Haines claims against KPMG and Sidley are unrelated to any of the obligations in the operating agreements, which were merely a procedural and collateral step in the creation of the fraudulent tax shelters. The complaints do not rely on or use any terms or obligations of the operating agreements as a foundation for their claims; indeed, the operating agreements are not even mentioned in the complaints. Consequently, as we shall see, the rationale for requiring parties to arbitrate, despite the fact they have not agreed to do so, is entirely absent.

We first summarize KPMG and Sidley‟s contentions with respect to the proper application of equitable estoppel, and why their formulation is incorrect. We then describe the general legal principles in play, the rationale underlying the application of equitable estoppel, the precedents informing our conclusion as to the proper standards for application of the doctrine, and the specific application of those standards to the circumstances of these cases.

A. The KPMG/Sidley Contentions and the Proper Standard

KPMG and Sidley Austin argue, as they did to the trial courts, that the law of equitable estoppel requires arbitration under either of two circumstances: (1) when a signatory‟s (Goldman/Haines) claim against a nonsignatory (KPMG/Sidley) "makes reference to or presumes the existence of" an agreement containing an arbitration clause, or(2) when a signatory alleges interdependent and concerted misconduct by signatories and nonsignatories. While this formulation uses terms that appear in ...


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