Senators from both parties are pressing Supreme Court nominee Harriet Miers about her former Texas law firm's lucrative business helping to promote tax shelters that were subsequently deemed abusive by the Internal Revenue Service.
The actions of the firm Locke Liddell and Sapp, which Miers headed for much of the 1990s, received glancing scrutiny early this year, when the Senate Permanent Subcommittee on Investigations released a scathing report on the tax shelter industry. The report quoted the legal adviser of a potential investor as blasting the firm for effectively signing off on a "classic 'sham' tax shelter."
Now that the firm's former co-managing partner has been nominated to the Supreme Court, senators are zeroing in on Locke Liddell's efforts.
Sen. Norm Coleman (R-Minn.), the chairman of the investigations subcommittee, said yesterday he is "very seriously concerned" about the firm's sale of cookie-cutter legal opinions, attesting to the legitimacy of tax shelters promoted by accounting giant Ernst and Young. He said he will raise it personally with Miers today.
"I have a high standard for the ethics of a Supreme Court justice," Coleman said. "These were very questionable transactions, and the volume of work done on this was substantial -- in the millions of dollars."
In the late 1990s, as the stock market boomed and the rich accumulated wealth at unprecedented rates, the major accounting firms went into business developing and selling intricate ways to shelter income from taxation. They would then refer clients to prominent law firms such as Locke Liddell, which would issue opinion letters that individuals could present to the IRS as a defense for their actions. The tax shelters involved funneling income through short-lived business partnerships that could be written off as losses.
Sen. Max Baucus (Mont.), the ranking Democrat on the Finance Committee, sent the firm a five-page letter last week, demanding detailed explanations about Locke Liddell's activities on behalf of Ernst and Young's Contingent Deferred Swap tax shelter, which fell under IRS scrutiny in 2000 and was designated as abusive in 2002.
Such an inquiry could spell still more trouble for a nominee already facing questions about her credentials and political beliefs. White House spokesman Dana Perino said the matter was not relevant to Miers's nomination because she was not involved.
"Harriet Miers had nothing to do with the tax shelter transactions at issue, nor did she work with the clients involved. The majority of the relevant transactions took place after Ms. Miers had left the firm," Perino said.
In fact, just over half of the transactions involving Locke Liddell were done while Miers was with the firm, according to John H. McElhaney, a lawyer at the firm. Miers is not a tax lawyer, but as co-managing partner, she should have been aware of such a lucrative part of the firm's business, Senate investigators from both parties said. McElhaney agreed in an interview yesterday that given the flow of money involved -- an average of $1.8 million a year between 1999 and 2001 -- "it's a fair assumption that she was aware" of the activity.
Ernst and Young began work on the Contingent Deferred Swap shelter in 1998, and then enlisted Miers's firm to provide clients with a letter indicating that the shelter "should" be upheld in court, according to the investigations subcommittee.
Typically, Ernst and Young would receive $250,000 per sale. Locke Liddell would get $50,000 or $75,000 a letter, McElhaney said. From 1999 to April 2002, 74 such transactions were sold to 142 taxpayers, with Locke Liddell issuing 132 opinions worth as much as $5.4 million, McElhaney said.
Miers was elected president of the firm Locke, Purnell, Rain and Harrell in 1996 and was made co-managing partner in 1999 when Locke Purnell merged with another firm to create Locke Liddell and Sapp. She served in that position until 2001, when she joined the White House staff.
Under the tax shelter arrangement, the client would create a business partnership and transfer income in the form of payments to that partnership. Those payments would then be written off as losses to offset taxable income, according to the investigations subcommittee. The following year, the partnership would be dissolved. Its funds would be treated as capital gains, and thus would be taxed at a lower rate than ordinary income.
McElhaney yesterday stood by the firm's opinion and said no court has ruled the transaction illegal because the federal government has never prosecuted a case to judgment.
"Just because there's been an opinion by the IRS doesn't mean it's illegal," he said.
But Locke Liddell's legal opinion was repeatedly questioned when it was for sale, not just by prospective clients but also by some at Ernst and Young. In September 1999, a client of Ernst and Young was troubled by the firm's legal opinion.
"I have reviewed the materials you provided to me," the client's lawyer wrote in an e-mail to the accounting firm after examining the Locke Liddell opinion letter, "and from all indications, the transaction appears to be a classic 'sham' tax shelter."
On Sept. 8, 1999, one Ernst and Young tax professional complained that the Locke Liddell letter did not comport with Ernst and Young's own opinion about the deal's legitimacy. The shelter could not even be considered "more likely than not" to be upheld in court, let alone that it "should" be upheld, according to the e-mail.
The tax shelter is not the only Locke Liddell-related issue under scrutiny by senators who must consider Miers's nomination.
In 2000, the firm agreed to pay $22 million to settle a lawsuit stemming from the firm's representation of Russell Erxleben, a former University of Texas star football kicker whose foreign currency trading company was alleged to be a Ponzi scheme. Erxleben had bragged that he had the same law firm as then-Texas Gov. George W. Bush, according to Senate investigators.
In 2001, Locke Liddell settled a class action suit for $8.5 million with investors who alleged they were defrauded in a fake bond scheme operated by firm client Brian Stearns, a Texas businessman sentenced to 30 years in prison after he was found guilty on 80 charges, including money laundering and securities fraud.