American court hearing recordings and interviews - Season 2. Episode 12. January 17, 2024. In re FTX Trading Ltd., et al., chapter 11 bankruptcy case number 22-11068, audio of hearing held in the FTX/Alameda et al. bankruptcy proceedings pending in Delaware, USA #crypto (hearing starts 3+ minutes in)

Episode Date: January 27, 2024

NOTICE OF AGENDA FOR HEARING SCHEDULED FOR JANUARY 17, 2024 AT 3:00 P.M. (ET), BEFORE THE HONORABLE JOHN T. DORSEY AT THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE, LOCATED AT 824 NORTH MARKET STREET, 5TH FLOOR, COURTROOM NO. 5, WILMINGTON, DELAWARE 19801 This hearing will be conducted by Zoom only. Parties may observe the hearing remotely by registering no later than January 16, 2024 at 4:00 p.m. To attend this hearing remotely, please register using the eCourt Appearances tool on the Court’s website at www.deb.uscourts.gov. MATTER GOING FORWARD: Pretrial Conference Regarding the Estimation of Claims Filed by the United States Department of the Treasury – Internal Revenue Service

Good afternoon. This is Judge Dorsey. We're on the record in FTX Trading Limited, case number 22-1-168. This is a status conference, I believe. I'll go ahead and turn it over to debtor counsel. Anybody. Thank you. Thank you, Your Honor. Adam Landis from Landis, Rath and Cobb, here on behalf of the debtors. As Your Honor noted, we're here for the pretrial of the status conference regarding the estimation of claims filed by the United States Department of the Treasury. I would hand over the virtual podium to Mark DeLue and my Sullivan and Cromwell colleagues to present argument today. Okay, thank you. You're muted.

Apologies, Your Honor. Good afternoon. Your Honor, Mark DeLoo from Sullivan and Cromwell. This is my first time appearing before you even if remotely. It's a pleasure to be before you. If Your Honor likes, I would present on the burden of proof issue that the person parties have submitted in briefs and then after the parties have discussed the proof issue, we're happy to talk about discovery, although I think the parties are largely in agreement on those subjects.

Okay, go ahead. Thank you. It's the court. It's worth looking back at why the court asked for additional briefs on the burden of proof issue that were ultimately submitted on January 5th. As Your Honor recalled, back last year, the debtors submitted a motion seeking an estimation herein. In its objection, the IRS raised the issue of burden of proof,

arguing that the debtors had the burden of proof. In our reply brief filed back in December, we explained why that argument was wrong, why the debtors didn't, in fact, have the burden of proof. The IRS had the burden of proof. In fact, because they had submitted an unexplained and unsupported claim, they weren't in time to the presumption of validity under bankruptcy law,

and because it was not an assessed claim under tax law, the IRS was not entitled to a presumption of correctness under underlying tax law. We submitted that brief on our reply, and Your Honor at the hearing in December, understandably, recognizing that this burden of proof issue had only been joined in our reply, wanted to give the IRS a chance to respond to our argument.

to our arguments and gave the parties a chance to put in briefs on this point. The parties agreed that they would submit supplemental briefs on this point on January 5th, nearly a month later. So both parties had the opportunity to look the law that had been cited in the briefs back in December, to look at the cases that were cited, to look at the arguments that both sides had made, and then respond accordingly to raise the issue with Your Honor. But in fact, what the IRS did in its January 5th brief is not respond at all to any of the arguments made by the debtors in its reply brief.

They didn't respond to any of the cases that the debtors cited. They didn't say that we had misdescribed any of the cases we cited. They didn't say that we had misdescribed or mischaracterized any of the cases that the IRS had cited that we explained didn't support the propositions that the IRS was arguing. They just simply read. recited the same law that they had cited back in their objection, and then they argued quite a bit about a statutory set in 26 U.S.C. 7491, a provision on which the debtors have never relied, and I'll explain a little while later, is not really relevant to what we're doing here.

So it seems as if the IRS had anything to say about the law or arguments that were raised back in the brief in December, the IRS would have included that in their brief in January. Having done so, I think it's apparent that the IRS had nothing to say, and with apologies for the cliche, the IRS's silence speaks volumes here. So with that as background, Your Honor, I'd like to go through the three points that were raised in our brief and respond to an argument made about 7491 in the IRS's brief. And then I think I'd make just a few observations about how I think this issue. You've finally broken loose from work.

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Find an agent at CINFIN.com. discuss the bankruptcy presumption of validity, which I think is largely beside the point here, but I'll briefly address that. And then I'll address the presumption of correctness and why the IRS is not entitled to a presumption of correctness because it is not issued an assessment under underlying tax law. And even if the IRS was to issue an assessment under regulatory guidance, that claim would not be entitled to a presumption of correctness because it was would be naked and arbitrary and excessive and therefore under well-settled law it would not be entitled to presumption of correctness and therefore the IRS bears the burden of proof for many

reasons. So we'll start very briefly on the presumption of validity in bankruptcy law. Rule 3,001 usually provides that the filing of a claim provides a presumption of validity to that claim. All that means is that the claimant is made out a prima facie case that satisfies its burden of going forward. But as we explained back in our brief in December and again in our brief in January, not every claim entitles a claimant to a presumption of validity. An unexplained claim without any explanation or support wouldn't give a presumption of validity.

We cited the mobile manufacturing case for that proposition. Again, the IRS didn't respond. But in any event, as I said, the presumption of validity only goes to the burden of going forward, and that can be – once there's a burden met for going forward, the debtors can respond by providing their own evidence, and then the issue is joined, and the real question is about the burden of proof on the merits. And so in the course of this proceeding, we expect the IRS has provided interrogatory responses, responses which provide some explanation for a new claim. Now it's $8 billion.

Your Honor may recall we started with $43 billion for the IRS claim. Then it was amended to $24 billion, and now it's $8 billion. We believe all of these are arbitrary, excessive, irrational, choose-your adjective. But in any event, the IRS at least tried to explain what they're talking about now. Obviously, the debtors have put in detailed tax returns,

schedules. They have the ability to testify and respond to information disclosure requests. So I think, Your Honor, will ultimately conclude the issue has been joined. And therefore, what we're really talking about is the burden of proof on the merits, which is really what both sides have focused on in their briefs.

Both parties agree that burden of proofs. on the merits is dictated by the underlying tax law. That's the Roley decision from the Supreme Court. Rawley holds that the underlying law is what supplies the burden of proof. Here, that's tax law. So that brings me to my second question, which is, who has the burden of proof

under underlying tax law? As both parties observed, in the typical IRS tax case, the IRS isn't entitled to a present presumption of correctness that shifts the burden of proof over to the taxpayer. But that's only because the IRS has made a formal assessment of the tax under its regulations. And that's what shifts the burden. If it hasn't made an assessment, it's not entitled to shift the burden, and the burden remains on the IRS, which is asserting a claim.

Many courts have made this very point. For instance, in a case I'm almost surely going to mispronounce. It's Anastasato from the Third Circuit. The Third Circuit said that, quote, the government's deficiency assessment is generally afforded a presumption of correctness. That's 794 F-second at page 886. The Third Circuit again made this point in a case called SADI, P-S-A-T-Y. The Third Circuit held that, quote,

the certification of the IRS Commissioner's assessment shifts the burden of proof. That's 442 F2 at 1159. The Tenth Circuit in the March decision actually explained the reasoning for this rule. The Tenth Circuit said, quote, the regulations governing the assessment process served to ensure both the efficiency and the accuracy of the IRS process. That's 335 F3rd at 1188. And we set out in our brief, very brief,

briefly, the regulatory process that the IRS needs to follow to do a formal assessment, something called a notice of deficiency. And there's no dispute here that the IRS has not done a formal assessment or notice of deficiency pursuant to its regulation. In its recently served interrogatory responses, we just got them on Friday, the IRS says explicitly these are estimates and it has not issued a notice of deficiency would only come at the end of an examination when the estimates may change if more information is learned. So we all agree there's no assessment that has been issued by the IRS.

And as I just stated, the law that we've provided holds clearly that it's the IRS assessment pursuant to the regulations that shifts the burden from the IRS to the taxpayer. So what does the IRS say about all this? Remember this was a point that was made in our reply brief in December. We explained that an unassessed tax claim is not entitled to shift the burden of proof. The IRS says literally nothing. Did not cite any, did that explain why we were wrong in our December briefs? They didn't explain what cases we had cited that were wrong or respond to our cases.

They literally put in the same cases that they cited back in December. So what cases have they cited? Well, the lead case that they cite, if on page four, they cited prime. as a case that allows them to do an estimate, is Greco versus United States? It's a Pennsylvania district court decision. Here's what Greco says. Quote, the presumption of correctness arises when the IRS submits a certification of the commissioner's assessment or an affidavit signed by an IRS officer detailing the tax liability.

That's at 380 F. Subsecond at 611. The Greco decision actually cites for that proposition, the Third Circuit's decision in Sadi, case I mentioned earlier. Again, Sadi makes this very same point. It says the following. Long quote, but several different places in the decision. The presumption of correctness afforded the commissioner's determination allows the government to establish a prima facie case of liability merely by offering into evidence a certified copy

the commissioner's assessment. Little later on, the machinery prescribed by Congress to determine the amount due to the government is the assessment of the amnitryate agency charged with its collection. Little later on, we hold, therefore, that when the government offers in evidence the certification of the commissioner's assessment

in support of the counterclaim, the presumption of correctness operates to place upon the taxpayer both the burden of going forward and the burden of persuasion. That's 442 F-second at 1159 to 1160. So all these cases stand that the IRS has cited stand for the same proposition. The IRS needs to go through with regulation

and issue an assessment in order to shift that burden of proof, to have that presumption of correctness. The other case in which the IRS relies most prominently is U.S. v. Islay, the Isley Brothers case. It's a non-procidental opinion. That case involved actually two assessments by the IRS. The IRS issued a first assessment, and then they actually, and the IRS points this out in their brief, it issued amended assessment.

And even at that, the Third Circuit said that the presumption of correctness, which was attached to the assessment, was, quote, very weak in this case because of the IRS's restatements of its computation. That's 203 federal appendix at page 409. So there's two different assessments, and even at that, the Third Circuit says it's a very weak presumption. So there's only one case that's cited by the IRS that it didn't have a formal assessment. That's the Fidelity American case that the IRS cited, both in its December brief and then again in its January break. And in our brief, in our reply brief back in December, we explained why the Fidelity America case doesn't apply here, didn't actually hold.

Didn't even decide the question of whether the IRS is entitled to a presumption of correctness when there's been no formal assessment. And in any event, isn't applicable here. Again, the IRS never responded. They knew we were addressing directly one of the prime cases they had cited. Again, didn't respond. As we explained in both our December brief and our January 5th brief, Sidelity was decided at a time. It was 1990.

At that time, the IRS was prohibited by the automatic stay from issuing an assessment against a debtor that was already in bankruptcy. At that point, there was no provision allowed the IRS to issue an assessment. The law changed in 1994 and allowed the IRS to issue a deficiency notice or an assessment. And so in that case, the rationale or at least the argument was, well, because the IRS can't issue an assessment, assessment, perhaps we should give this advantage in bankruptcy to give their calculations a presumption of correctness. But as I said, that's no longer the law. Now the IRS can issue a notice of deficiency or official assessment in bankruptcy and the IRS hasn't

done so. In any event, the Fidelity American case, as I said, didn't decide this issue. What the Fidelity American case said was we... The court said it expects about whether a presumption should apply where there's been no pre-petitioned IRS tax assessment. That's 1990 Westlaw 299-418 at page 6. And it went on to not decide the question because what the court found was that the IRS claims there were arbitrary and excessive, so it didn't need to decide the question of whether there was a presumption anyway. All this brings me to my third question.

If the IRS did issue a formal assessment or notice of deficiency, it still wouldn't be entitled to a presumption of correctness because the formal assessment, if it were to be these $8 billion worth of claims that the IRS now argues about, those wouldn't be entitled to a presumption of correctness because that would be a naked claim that's arbitrary and excessive. under Supreme Court and Third Circuit law, clearly naked and arbitrary and excess claims are not entitled to presumption of correctness, and so the IRS continues to have the burden of goods, and that law clearly applies here. Your Honor, I recognize the word naked assessment sounds like it's a very, very extreme

situation where you just put down a number and there's nothing else. It's not really as extreme as all of that. What a naked assessment means is that it's not supported by evidence that connects the taxpayer to specific sources of income. So, for instance, the Third Circuit, in that case I can't pronounce, Anastasato, the presumption, the presumption, the presumption only applies if the deficiency assessment is supported by foundational evidence connecting the taxpayer with the tax generating activity. That's at page 887. In short, the IRS needs to come up with some logical evidence that connects the taxpayers' profits to its tax assessment. It can't just say it's up to the taxpayer to prove the negative.

You didn't make any profits. You go prove that. The IRS needs to come up with some reasoned basis based on the taxpayer's records and the actual business of the taxpayer. It can't just say, well, there's a huge amount of money flowing for the entity and so therefore we're including all that money as profits. You tell us why that's wrong. Here's another case where the court found a naked assessment.

The Kohler case written by Judge Posner in the Seventh Circuit. It's another good example. In that case, the taxpayer had purchased Mexican-denominated bonds, and those bonds were going to be purchased by Mexico, the government. In pesos, but those pizzas were going to have. have certain restrictions, could only invest those pesos into certain government projects that were approved by the government. You couldn't exchange those pesos into dollars for some number of years, and those restrictions clearly would have an impact on the value of the pesos that the

taxpayer would receive. Instead of trying to determine what the appropriate discount was for the value of those pesos, the IRS just assessed the value of the value of those pesos, the IRS just assessed the as the full value of the pay set. And what Judge Bosner said is that assessment is naked and therefore the IRS's claims need to be rejected because the IRS had provided no evidence linking the valuation that it had done to the actual state of affairs.

It said, look, the IRS could have come up with a pre-official plausible number or had some evidence explaining what the discount was. Instead, it just relied on the full value of those pesos, and it was not entitled to do that, and so therefore it was a naked assessment. Separately, although it's related, courts have also held that arbitrary and excessive claims

are not entitled to the presumption of correctness. And again, those courts have made clear that what the IRS needs to do is come up with some reasoned basis connecting the taxpayers' records and its business for the claim tax liability. Can't just throw out big numbers and say, you prove to us that it's wrong. There's no dispute, I believe, between the parties

that the IRS can estimate tax liability in the appropriate circumstances, but it needs to connect that to the taxpayer's records, to leads drawn from those records, or to the taxpayer's actual business and state of affairs. It can't just, again, throw out big numbers and say, you prove the opposite. So here's an example.

example of what the IRS can do and that was supported by it was affirmed by the Supreme Court. The United States versus Florida Talia case. In that case, the IRS found that the FICA taxes that had been withheld by the taxpayer understated the employees' picks understated the amount of tips that were shown on credit cards. So the IRS saw, hey, you're providing FICA withholding for employees. employee tips, but the credit card slips show a significantly higher number. So the IRS then did an assessment and came up with a larger FICO withholding number. And what did it do?

It did something called an aggregate estimation method. What it did was it looked at the taxpayer's credit card slips and came up with an average tip amount for each year. So it went through 1991 was 14.5 percent, 1992 was 14. And then it used those tip percentages to estimate the amount of tips the employees had received for both credit cards and for cash on an aggregate basis. And the Supreme Court said that is sufficient. You've used the tax payers record, you've connected it in a reasonable logical way to an estimate. That's the kind of assessment the IRS has discretion committed.

It can use the taxpayers' records and reasonable leads from the records to get a logical and reasonable estimate of the taxpayer's profit. What it can't do, as I've been saying, is just take the biggest number it can find, the biggest revenues that come in, the biggest numbers that come in, and then say it's up to you the taxpayer to prove that these are not profit, or to say all of your deductions or all of your losses are zero because the unless you prove otherwise, we assume all of your losses are zero. The Fidelity case, again, this is a case cited by the IRS.

It's another very good example here. In fact, the factual circumstances of Fidelity are strikingly like what we have here, at least as the IRS presents it. In Fidelity, the parties all agree that there was a substantial lack of, there was missing documentation from the debtors. There had been embezzlement by the debtors, now it's being managed by the trustee. The debtors had done away a certain amount of documents before the company went bankrupt. The remaining documents were disorganized.

No question about it. And all agreed that the likely reason for this state of affairs, missing and disorganized documents, were that the debtors were trying to hide their embezzlement. their prior embezzled. So that's exactly what the IRS says is true here. And there's some amount of agreement between the parties. We agree that there's a disorganized state of certain records.

There's not no records, there's a substantial amount of records, but there are missing records somewhere, and there's some disorganized records. Our accountants, appointed by Your Honor, gone through those records and tried to come up with the best and most logical numbers. And when there's a missing number, they try to use the existence,

records to calculate the right number. Well, in any event, in the Fidelity case, what the IRS did was simply assumed that the taxpayer had made the same amount of profits as it had in prior years, where there was full record. And the court rejected this, said that was arbitrary and excessive, and concluded that the IRS was not entitled to a presumption of correctness, and therefore rejected the IRS claims. The court said, look, we understand that the IRS is entitled to use any reasonable means to reconstruct the taxpayer's income. But that reasonable needs must include investigation of reasonable leads furnished by the taxpayer.

It noted that the IRS is not entitled to calculate its assessment, quote, in any manner its agents chose. And it actually cited the Third Circuit. the Third Circuit in a statement that I think is absolutely applicable here, the absence of adequate tax records, as in the case here, does not give the Commissioner carte blanche for imposing draconian absolutes. So having failed to review the available information, having failed to use actual information provided by the debtors to come up with reasonable estimates instead of just using absolute numbers. Having failed to match it to the actual business of the acts payer, the IRS's claim was rejected in the fidelity case. And that applies exactly to what we're talking about here. The IRS has extreme claims. On each facet of its claim, what it does is it just takes the extreme number from whatever documents it can find that have been provided or the full amount of potential income or minimum amount of potential loss and says,

Those are the numbers unless you prove otherwise. But putting aside, I mean, this is obviously illogical to say that the debtors, oh, $8 billion in taxes, which would be, you know, multiple billions more in income, profits over this period, all agree that putting aside the fact that many of the debtors aren't even U.S. taxpayers, the debtors were only in existence for a few short years, and there was really only any significant amount of revenues coming in in the last year or two. And as we know, since we're all in bankruptcy, the debtors lost billions of dollars, and that's pretty clear from the state of affair.

So there's just no rational connection between the idea that the debtors owe $8 billion in taxes for some, you know, $20, $25 billion of profit for entities that lasted for only a few short, years and clearly lost billions of dollars. So before I move on to the observation of I think how this is going to play out, I would just like to respond to one argument made in the IRS's brief. The IRS spent a fair amount of time. You can see this on page one, page four, and five of their brief, arguing about 26 U.S. 740, 7491, because they,

They refer to the credible evidence standard in statute and certain record keeping requirements of that statute. The debtors have never requested burden shifting under Section 7491. Section 7491 applies to individual taxpayers and to entities that are worth less than $7 million. Because the IRS has never made an assessment of tax pursuant to its regulation and any assistance.

assessment it has now would be naked and arbitrary and excessive, there's no burden to shift, so we don't even need to get into the question of Section 7491. And that's the shame kind of observation. We cited this case, the Trans Support case, that the First Circuit noted the burden shifting exercise under 7491 entirely different than the burden shifting scheme for an arbitrary and excessive claim. So these are just two different burden shifting exercises. The debtors have not claimed burden shifting under 7491. So these arguments about credible evidence and record keeping and so forth, those just are not relevant to the issues here today. So, Your Honor, to go back to sort of where the law is and how I think this is going to apply. The law is clear. The IRS had a

chance to respond to it, to cite cases that said we were wrong to respond to. cases. Under settled law because the IRS had not issued a formal notice of assessment or notice of deficiency under its regulatory requirements, it's not entitled to a presumption of correctness and therefore retains the burden of proof. And even if the IRS were to do a formal assessment, any assessment for the multi-billion dollar planes that the IRS seeks to be asserting here would be naked and arbitrary in excesses. and therefore not entitled to the presumption. As we've engaged with the IRS,

and we've talked through some of the issues and looked at the interrogatory responses that the IRS recently served, I think I can now see how this issue really plays out in this case. There's a difference between what the IRS does in its audit process and an assessment that can hold up in court.

In the IRS's audit process, what does is it assigns the maximum number to any number it finds in the taxpayers' returns or records or the minimum number, depending on whether you're talking about revenues or losses. And then it says, you prove to us why those numbers

are not the maximum amount of profits and the zero of losses. So just by the number of, way of example, if an investment bank were to trade $10 trillion worth of securities for its customers and the $10 trillion comes into the investment bank and then it's traded and then of course value comes out, the IAW, it's an audit procedure would say that $10 trillion, that's income unless you show us that that's actually third-party assets and in fact that it's matched up to trading that goes out of the company.

You need to prove to us that that's not your $10 trillion. In fact, you only made commissions of $100 million or whatever the number would be. And then relatedly, the IRS would say, all the money flowing out, that's not a tied loss. And all of your deductions, all of your losses for trading losses and all of your expenses, there's a role zero until you show us evidence.

evidence that supports that these numbers are not zero. That may be a perfectly rational way to proceed in an audit that takes several years. I don't offer an opinion one way or the other whether that's right or not as a matter of audit procedure. But that's not what the law demands for an assessment or even here, a calculation, an estimate of the IRS's claims. The court in March needs to adjudicate an estimate of the IRS's claims. It can't, it has to deal with the IRS's claims as they exist. We're not a two or three year period where we can just go through a process of matching up every $10 trillion number and proving why that's not in fact processed.

Under well-settled law, the IRS has to come up with an assessment in order to shift the burden of proof. If it doesn't, it has the burden of proof to show why its tax claims. are reasonable based on reasonable leads and are matched up to the debtor's actual business. Unless the IRS makes that kind of assessment that's connected to the taxpayer's actual business, it's not sufficient for the IRS to say you haven't proved the negative to you have. You haven't proven that this huge number isn't income. You haven't proven that this amount isn't lost, is losses. So the IRS needs to do because it hasn't issued an assessment and it's not entitled to shift the burden of proof.

I'm up with a reasonable estimate calculation based on the actual records of the taxpayer, leads from those records, and or connection to the real business and actual revenues and profit generation of the business. It can't just say we see this huge amounts of numbers coming in to the debtors because you were trading for customers. And so therefore we are we're assuming the most extreme numbers and we're leaving it up to you to prove the negative So unless the court has any questions The remainder will just rely on our papers. Thank you no questions at this time. Thank you miss Bruce Good afternoon your honor. We would just like to note that from our perspective the primary

Yeah, your honor I second Hold on May I hope. Speaking with their microphone on. Sorry, go ahead, Ms. Bruce. Thank you, Your Honor. Yes, we believe the primary purpose of the briefing

was to address the specific issue of whether the estimation hearing and the procedures that we are now in the process of in any way changes the longstanding case law regarding the burden approved. And as we've cited in our case, It does not. So the estimation hearing does not change the fact that the burden of proof that exists in when a substantive tax

law issue still applies here. Touching first on the issue of the presumption of validity, the IRS did everything that was required under Rule 2001 to establish the presumption of validity. It was not unclear what its claim was for. It was for income taxes and employment taxes. It did not just list a number with no description whatsoever. And the debtors never asked us for more details before coming to this court

and asking for these estimation procedures. But that being said, it seems that the debtors agree that the issue is moved at this point because the IRS has provided more than enough detail regarding exactly what its claim is constituted, consist of. So it seems that that issue is moved at this point. On the merits of where the burden of proof lies, the case law is very clear that the burden of proof lies on the taxpayers because they are the ones that have the information. There is not an even 50-50, the IRS has some information the taxpayer has the rest and they go back and forth like the debtors keep indicating. The taxpayers are the ones with the information and with the burden to substantiate their numbers.

The debtors are correct that the IRS has not made an assessment yet, and they haven't made an assessment yet because the audit is still ongoing, and because they've come and ask for this estimation hearing in the middle of an audit process. So they can't now ask Your Honor to estimate this claim, and then also complain that there is no assessment. If there was an assessment, we wouldn't be having this estimation here. And the question now is, how does the burden of proof fall in an estimation hearing? We cited multiple cases in the Third Circuit where the courts held that even where there was not an assessment, even when there was an estimate, the IRS is still entitled to the burden of proof. Now, as the debtors pointed out in many of those cases, an assessment was made, but that's because

those cases were refund cases and collection cases. So, of course, assessments had ultimately been made. But the court's holding that even estimates aren't entitled to the burden of, um, are entitled to the presumption of correctness is still valid. And that's what the court should look to in this case for purposes of this estimation hearing, which is, um, a very uncommon proceeding. But those, those cases are still good and, and should be binding in this instance. Again, the IRS could issue a notice of deficiency. If the, the IRS could issue a notice of deficiency, if the debtors want them to, but they've asked the court to address the matter through this estimation hearing. It can't have both things. It can't have the IRS make an assessment and then also

have your honor estimated through this hearing. Those two things are inconsistent. Addressing their argument that this is a naked assessment, naked assessments involve assessments where the income cannot be connected to the assessment. That is not all what we have in this case. Here, the assessments are connected to the debtor's income. Just like in Fiordi, Italia, the IRS has a foundation for its estimates. It started with the debtor's tax returns and made adjustments to those returns. It asked the debtors to substantiate the deductions claimed on those returns, and the debtors did not do so. Despite the IRS asking them to, they have failed to substantiate them.

And you're not even heard at the last hearing when we spoke with the debtors representative from and why, they don't have the support. So they have made it clear to the IRS that they are not able to substantiate the expenses. The IRS assessments are further based on information that from the criminal trial regarding evidence of misappropriated funds that flow through the company. The debtors, again, have not challenged those facts.

So there is a foundation for the IRS assessments. To call them naked assessments is not an accurate representation at all. And it wasn't accurate at the beginning of these proceedings, and it certainly is not accurate now when we have provided to the debtors detailed calculations, detailed explanations of the amounts and the calculations that the IRS has provided. Again, they are not assessments because of how the debtors have done this. this process. So they brought us into court in the middle of an audit and asked, Your Honor, to estimate the amounts. That's why there is not an assessment. But

given where we are at the stage of the proceedings, the IRS has certainly gone far and above what wouldn't be involved with the naked assessment. And the burden of proof at this point is on the taxpayers to prove up their deductions and to explain why the activity that the IRS has evidence of is not should not be income to the company the burden is on them to do that they have all the information and they need to provide it if they have it case law is very clear on that your honor and we don't think that just because we're here for estimation hearing that the case law

case law should in any way be inapplicable. I'm happy to answer any specific questions Your Honor has, but otherwise we would rest in our arguments here today in our brief that we filed. Okay. Thank you. No questions. Mr. Zilloo? Mr. Bullitt.

Sure, Your Honor, I'll be brief. I think a few points in response to Ms. Bruce. Ms. Bruce said, I think mentioned in, it spoke, as she was making the argument, she said, We've cited multiple cases where there are no assessments made. But then she said later on, so I think she corrected herself. But in those cases, we agree assessments were made. In fact, in those cases that the IRS has cited, all the cases that they've cited, except for that one that I talked about

where the court didn't decide the interview. An assessment was made by the IRS. And there are cases, many, many cases that I've cited, that talk about the facts that it's the assessment that creates, that it gives rise to the presumption of correctness. The Janus case from the Supreme Court, the Anastasato, the Patsati case, the Greco case, and the Isley case, all the cases that were cited by the IRS. All of those mention, explain that it's the IRS assessment, notice of deficiency, that gives rise to this presumption of correctness.

And so in the absence of presumption of correctness, we don't say that therefore the IRS immediately loses. It's just that the IRS is not entitled to that presumption, and therefore it bears the burden of proof. Let me ask you a question about it, and address Ms. Bruce's argument that the IRS would do an audit and would then present an assessment in the due course. but because the debtors have asked for an estimation of the claim on an expedited basis, they can't do that. Well, there's two things, I would say, well, actually three. First, we've been doing this for quite some time.

Bruce said, well, we didn't ask for an explanation. I can assure, Your Honor, that my partner in the tax group and Bernstein Young have been engaged with the IRS's tax group and the Lord. for the IRS, the DOJ, for months trying to work for these details. So it's not as if this all of a sudden happened in November when we asked for an estimation hearing. We've been trying to engage for a long time. That's number one. I understand that, but it's, you know, the, I know from experience that, you know, an audit of a company of this size, especially when there's fraud involved,

is going to take more than a matter of months. It's going to take years. I understand, Your Honor, and so that leads to the two other points I would... One, this is a surprising argument from the IRS because the IRS actually says in its own brief that the burden of proof doesn't change just because it's an estimation procedure. This is on page three of their brief. They say, in an estimation procedure, the court is bound by legal rules, which may govern the ultimate value. the claim. So the rules don't change just because we're in an estimation proceeding. That's number

two. But the number three is the point I think I was trying to make before, which is we don't say that just because the IRS is not entitled to the presumption of correctness, that the IRS therefore lootses. That's the end. We can all go home. All this means is, as Fortwick said many times, that the IRS has to prove its claim just like any other claimant. And the court is estimating the claim. So in some sense, it doesn't need to prove its claim with exactitude. It needs to prove it, it has the burden of proof to show what an appropriate claim is, and the court can take the evidence with the IRS providing whatever evidence it has, and the debtors will submit evidence, and the IRS has the burden of proof.

And that's what courts have said. We cited some in our brief, the Desert Capital case, the Serubin case, Goldston case. If you're in a situation where there's no assessment or the IRS is not relying on an assessment, then the IRS is just proceeding as an ordinary claimant. It bears the burden of proof. It doesn't mean that the case is over. It just means that it bears the burden of proof like an ordinary claimant. And that makes sense.

Ms. Bruce says, well, we could just stamp it with assessment. But that's not what the courts have noted is the reason for the presumption of correctness. The reason for the presumption of correctness is not just because the IRS comes up with some number, but it's gone through the formal regulatory process approved and signed by the commission. So I recognize that there's a timing issue here, but the burden of proof issue doesn't mean that the debtors immediately win. It only means that the IRS is not entitled to do what it's trying to do here, which is to just shift everything to the debtors. You need to prove why your profits are not billions of dollars.

You need to prove why your losses are more than zero. And that's the process going on to my next point, that Ms. Bruce was describing. After saying, well, we've cited many, many cases, all of which she acknowledges our assessment cases, she said, well, we've explained our claims. We've gone through a process. We took the numbers from the debtors.

Then we made adjustments. I didn't hear or argue otherwise. The adjustments amount to about $8 billion. 43, now 24, then 24, now 8 billion. It's quite disconnected to reality type claims. Because what the IRS says is, here's the $8 billion of claims. Now you tell us why that $8 billion, which is related to $20 billion or so of revenue and no losses, why all of that number is not true.

And that's what she said. She said, we laid out our claim this $8 billion number. Now, you, the debtors, substantiate otherwise. And that's exactly what the courts have said over and over again. What Judge Posner said in the Kohler case, what the Fidelity America case said in the case cited by the IRS, what many cases have said is not available. It can't be the debtor's burden to prove the negative. It has to be connected to.

some real actual profits, real business, real record. You have to look at the actual business records and do the best you can with the actual records and with the reality of the situation. And so conclusion, I think the law here is clear. Without an assessment, there's no presumption of correctness. The IRS says we proceed here according to the rules under the tax law, and we agree with that.

The Raleigh decision says that. It's the burden of proof under tax law. And under tax law, it's very clear that if there is no assessment, the burden doesn't shift to the taxpayer. The IRS just has the burden as a normal claimant, and that's exactly what we have here. Thank you, Your Honor. Is there any cases that address this issue in the context of an estimation hearing?

Your Honor, we couldn't find any. What we did find, and we found cases that stand for the same proposition that the IRS cited, which is in estimation proceedings, you follow the same rules as if you were adjudicating a claim. So just because we're doing this in a few months and we're doing it for estimation purposes as opposed to a final adjudication on the claim, it's the same rules and the same burden of proof.

But we didn't find a case that matches both the law that I've found, which is in the absence of assessments, the IRS bears the burden of proof with an estimation proceeding that we didn't find that combination. And the IRS didn't cite any either. Okay. Thank you. Thank you, Your Honor.

All right. I'm going to take a matter under advisement. I will issue a bench ruling at the January 31st hearing so that the parties will have an understanding of how we're going to proceed once we get to March. Thank you, Your Honor. Originally, you would ask to discuss discovery at this. conference, I'm not sure there's a whole lot to discuss because I think the parties are

largely in agreement in the scope of discovery. We have obviously some to do in the next few weeks to complete that. I could give Your Honor an update or if there's no disputes that the IRS wants to raise. I'm happy to just continue meeting and conferring what the IRS as your honor pleases. Well, let me just give me a brief update on how things are going so far because I know there was a deadline for the debtors to produce documents? Sure. So as your honor may recall, with the objection

that the IRS submitted back in December, they provided a draft set of document requests. Soon as your honor ruled that we would have an estimation proceeding, we got immediately to responding to those document interrogatory. and, well, it was a request to admit, interrogatories and document requests. We responded to those at the end of December,

just before the new year. We produced the documents the following Friday. So we, I think if I'm getting my dates right, it's December 29th. We responded to the written discovery, and then we produced the associated documents on January 5th. There was one large database that we produced the following week.

We've produced all the documents that the IRS has requested. The IRS is, I understand, is still processing those documents, and they may have additional questions, and I've told them, of course, we're happy to talk to them about that. On our side, we issued interrogatories to set forth the nature of the IRS's claims with some explanation. I mentioned, I think, during the argument that the IRS responded to that on Friday, so we just got the explanation. We're going through that. We've conferred a little bit yesterday. We're going to confer tomorrow a little bit about those responses, what needs to be done specifically on those responses.

Both sides have issued 30B6 deposition notices to each other. We issued one to the IRS a few weeks ago. The IRS just issued one to us on Friday. And I think the parties agree that what What we're going to do is probably going to have to divide that up among multiple witnesses because, as you might suspect, there are some people at the IRS who deal with domestic, some people who deal with international, and some people who deal with employment tax. The same thing is true at Ernst & Young, so we'll probably divide it up the same way. We'll probably each have three witnesses who will be deposed. And I think both parties have agreed that those depositions can be limited or focused on

the issues that are now in dispute. The IRS has provided five or six, depending on how you count, specific issues on which it disputes the debtor's position, so the depositions will be addressing those issues. In parallel, as I think Your Honor knows, as Your Honor saw the Ernst & Young witness on the stand, The IRS audit team, the team from Nebraska, has been issuing information disclosure requests or information document requests to Ernst & Young on an ongoing basis. Ask a question.

I see this tax return says this. This tax return says this. Can you tell us this? Can you give us these documents? That's been going on an ongoing basis. I think Mr. Shea said that all but one request was going to be produced by December 15th. That was produced by December 15th. The one outstanding request was produced, I think, more recently, as he said out in the stand.

There has been, as we understand it, continuing information disclosure requests or IDRs that have been propounded by the IRS team. And so Ernst & Young has been continuing to respond to those and providing those. So I understand they've produced, they've provided IDR responses as late as last week because there are more recent IDRs, and I understand that there are some more that have just been issued recently that Ernst & Young is doing.

And I should also mention, I think Mr. Shea testified on the stand and he was in his declaration, that there were some adjustments that needed to be made on the earlier tax returns. He didn't think there were going to be such that they would have any impact

on the tax liability, but there needed to be some adjustments. That's been a subject of discussion between Ernst & Young and the IRS for some number of weeks. It was an information disclosure response served last week that addressed that topic in writing. I actually provided it to the Department of Justice yesterday,

and those adjustments to the prior year tax returns are going to be done later this week or early next week. Okay, thank you. Have we utilized the services of Judge Fitzgerald? as a mediator? Your Honor, we have not. In fact, the topic was discussed briefly yesterday, and we expect to discuss the subject tomorrow.

I think we're still discussing the question of whether it makes some sense to just have discussions between the lawyers, perhaps with some of the financial representatives of the debtors and or IRS agents, rather than engage a mediator who would have to get up to speak, There'd be a lot of submissions given the time at issue. We think it made sense to have direct discussion But that's a discussion we we anticipate having with the Department of Justice tomorrow That's fine. I just want to make sure that everyone's aware that it's available if you want

So but parties are talking there's you know there's no need to To use a mediator with the parties are still discussing so miss Bruce any thing from your end on the discovery issues or mediation or anything else Yeah, we are you know you know in favor of mediation, Your Honor, I think it could be useful. You know, even if we didn't arrive at a overall number, it has the potential to narrow some of the issues for trial. I think logistically right now, one of our biggest concerns is that I, given the categories of adjustments and what we have to discuss at the stage and we haven't stipulated

to anything yet, but we would think probably we'd need at least three days for trial particularly given a number of witnesses we have three on each side you know that that it does not seem feasible that it could be accomplished in one day so potentially mediation could be an avenue for allowing us to stipulate to some issues that might save time at trial so that is one thought from from our side and then I just would like to address one other concerns that Mr. DeLue brought up regarding the amended returns. That had certainly been a major concern that we've had since the prior hearing,

just that there is no finite universe of data for us. And we would ask, Your Honor, to give the debtor some type of deadline by which they're going to provide us the information that will be used at the estimation hearing. understand the audit is ongoing and so that may be separate but we need to know we have no idea the extent of these amendments on the returns that that could be a huge change if they're amending two years at least two years worth of tax returns that could change all the adjustments and you know we don't have those any information on that yet and we will get that until Friday or Monday and we only have a couple weeks left to discovery so I mean, we'd ask that the debtors just need to be done by practice when they amend the return.

Then that needs to be the closed universe of everything we're going to be looking at for purposes of this estimation hearing. Because I understand the debtors are unwilling to extend the time out. But if they keep amending their production, it's just not going to be feasible to get reasonable numbers for. purposes of this hearing. All right, well, why don't, I think Mr. DeLue indicated you're going to have a meeting confer tomorrow when you discuss it at that and see if you can come up with an agreed upon schedule for when discovery will be completed. If you can't, just contact chambers and I can jump back on a call with a status conference

at any time to discuss discovery issues. So that's not a problem. As far as the mediator goes, if you are going to use the mediator, I was picking up on what Mr. DeLu said I would I would recommend you do it sooner rather than later if you think you're going to need a mediator because it is going to take time for Judge Fitzgerald to get up to speed on the issues and you have to make submissions and so forth so I would recommend you start that process as quickly as possible if you are going to use the mediator because that's not going to slow down the estimation process we're still going to go forward on the estimation anything else Nothing from day. Nothing from us, Your Honor. Okay, thank you all very much. I appreciate the updates.

And as I said, I'll give my ruling on the burden of proof on the 31st. Thank you, Your Honor. Thank you. Thank you, Your Honor.