Quatloos! > Report From Quatloosia > August-September 2005

Report From Quatloosia

By Tony-the-Wonder-Llama
(August-September 2005)

I like to go to seminars where new products and strategies are being introduced. Primarily, this is because the continuing education credits are free, and they usually offer you a free continental breakfast and lunch. This latter is not to be discounted, as it provides you a professional incentive to eat lots of high fat pastries and chicken florentine dishes that your spouse wouldn’t let you eat at home.

The other cool thing about product and strategy seminars is that they give you lots of shwag. if you don’t know, “shwag” is the term for the free promotional goodies that are given out by the promoters, such as golf shirts or pens or tote bags that have the promoter’s logo on them. Go to any seminar hosted by a life insurance company and you will walk out with more shwag than you can carry, although usually by the time that you make it back to your hotel room you have discarded everything but the logo pens and the logo baseball caps (you can never have too many of either, IMHO).

The purpose of shwag is to make you feel good about the promoter and their product or strategy, and to make you think that they are special. The better the shwag, the better you will feel about the promoter so their marketing gurus say. But at the end of the day, shwag is really ridiculous since you never really wanted it in the first place and it doesn’t do you any professional good. But it serves its purpose by making you think, to some degree or another, that maybe the promoter who gave you the shwag is maybe an iota better than another promoter who didn’t give you quite as good shwag (or maybe their muffins or chicken florentine wasn’t as tasty).

Lately at these seminars, I have been hearing various promoters – inevitably the cheesiest ones – talk about how their hot new legal strategy or financial product has either a patent application pending, or they have actually obtained a patent on whatever it is they are selling. I mention this in the context of shwag because having a patent in the legal and financial context has the precise same effect of shwag, insofar as it tries to make you think that their strategy or product is somehow better than everybody else’s without it actually doing anything professionally useful for you.

Indeed, I have come to consider the whole phenomena of promoters holding their strategies and products out as being patentable is at best sleazy, and at worst fraudulent. Yet, it seems to be a growing trend for promoters to claim that their pet strategy or product has either obtained a patent or has a patent pending. By this, the promoters seek to make you think that their strategy or product is super-special, for if it were not, the patent office wouldn’t even consider giving them a patent, right?

Patentability Doesn’t Mean It Works

Promoters attempt to play the patent card to make you think that because it is patentable, it is ipso facto a good idea. Wrong. There are lots of inventors who over the years have obtained patents on a lot of screwy stuff that were ridiculous ideas and flopped badly. It is not the job of the U.S. Patent Office to decide whether something is a good idea or not. Instead, they merely look to see whether somebody else has made an application on that particular idea before. If not, and all the paperwork is in good order and fees have been paid, then they issue the patent.

In other words, you could come up with the dumbest idea in the world, and the U.S. Patent Office would still give you a patent on it if all the other criteria were met. Indeed, there are several websites such as http://totallyabsurd.com that collect examples of incredibly stupid patents that have actually been issued by the U.S. Patent Office. For instance, patents have been issued on a shirt with plastic tubes so you can take your gerbil with you wherever you go, a plastic shield that allows you to kiss your loved one without getting kooties, and a “butt bra” that makes your cheeks stand out and look perky.

Nonetheless, some promoters have taken the professional low road by touting the fact that their pet strategy or product has been “patented” with the intent of making prospective clients think that their deal must “work” and is better than any similar strategies out there. Again, it is a sleazy practice at best and at worst it is outright fraud.

Prior Art

Even worse, some promoters have been obtaining patents on strategies that were either common, or their variation is so slightly different that it falls squarely into the category of “prior art”. This is a defense to patent infringement claims, and virtually all of the patented legal and financial deals that I have seen fall squarely into this category. Again, the U.S. Patent Office doesn’t check to see whether they actually invented something new, but rather whether somebody has applied for a patent on it or not. A promoter could, theoretically, apply for a patent on a common form for a will, living trust, or promissory note (or maybe just a slight variation thereon) and have a chance of getting the patent.

Better than that, the promoter could just claim that a “patent application is pending” which seems to have about the same marketing effect, i.e., it makes their product look special whether or not it actually is. Somebody could thus apply for a patent on the wheel and have their attorney keep the patent application alive for a couple of years (the Patent Office is notoriously backed up anyway), and thus imply to potential buyers that their wheel is special.

What are these patents worth? Other than the marketing effect, such patents on legal strategies and financial products have little more value than the paper they are written on, since any attempt by the promoter to actually enforce their patent would be met with the “prior art” defense.

How Do Patents Help You?

All of which brings us to the next point, and our main complaint. The problem with patents on legal strategies and financial products is that, even if they are unenforceable, the mere threat of being bogged down in patent infringement litigation has the effect of chilling further development in that area. While that is good for the promoter, it is bad for everybody else. Your attorney or financial planner might not recommend a given strategy, even if it is good for you, because they don’t want to get bogged down in patent infringement litigation. This means that you may not get the fullest representation you deserve because some sleazy promoter has patented or applied for a patent on something that is either common or a slight variation thereof.

And how would the fact that the promoter has a patent help you anyhow? It doesn’t. Even if the promoter has obtained a patent, that is not going to be the least bit relevant to whether the legal strategy will be defensible in court against whomever or that the financial product will perform as promised in the markets. In other words, all the patent does is work against– not for – the best interests of the purchaser because it doesn’t do them any good but possibly limits their alternatives.

Because of this, the patenting of legal strategies and financial products is professionally reprehensible, in addition to being possibly fraudulent, and you should avoid like the plague any planner or firm who claims that they have such a patent or are in the application process.

Patented Tax Strategies are probably Tax Shelters

Under the new IRS regulations and notices relating to tax shelters and so-called “listed transactions”, as well as the revised Circular 230, a tax strategy which is patented is probably ipso facto a tax shelter, requiring tax shelter registration with the IRS. Thus, if saving or deferring taxes plays any role in a strategy that is claimed to be either patented or proprietary, you should avoid these strategies unless you have a burning desire to spend quality time in tax court.

Patented Legal Strategies Are Unethical

Model Rule of Professional Conduct 7.1 prohibits a lawyer from making a false or misleading communication about the lawyer’s services. As discussed above, the patenting of legal and financial strategies works to defraud clients since it creates unreasonable and unjustified expectations that the patented strategy “works” or is somehow special. We hope that the state bar associations will start disciplining lawyers who use the existence of their patent or patent application as part of their sales pitch to clients.

We similarly believe that financial firms that use the fact of their patented financial strategies to sell to clients probably violate the Securities Act of 1933, which prohibits false statements from being made in connection with the sale of a security. We hope that the SEC, NASD, and state securities commissioners will start taking actions against the firms, representatives and advisors who engage in this practice. Also, it wouldn’t surprise us to see class action lawsuits against those who sold patented financial products that failed to deliver.

Avoid Promoters with Patents or Patent Applications

The practice of patenting legal and financial strategies is a scummy one, and those who use the fact of their patents to sell to clients are arguably engaging in misleading and fraudulent conduct. At the very least, this is a very scummy practice and those who are pitched such strategies should probably avoid the use of those professionals and financial firms. Maybe“ probably avoid” is too light of a term, and “Run!” may be more appropriate. For in the end, it’s all just shwag.

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The following case represents one of the first convictions arising from the plea agreement of Terry Neal to cooperate against his clients.

FOR IMMEDIATE RELEASE WEDNESDAY, JULY 1, 2005 WWW.USDOJ.GOV

TAX (202) 514-2007 TDD (202) 514-1888

SHELBY COUNTY, ILLINOIS INSURANCE SALESMAN CONVICTED
OF TAX EVASION, WIRE FRAUD AND MONEY LAUNDERING

Defendant Ordered to Pay Restitution of Over $1.1 Million

URBANA, IL - Denny R. Patridge of Shelby County, Illinois was convicted today of tax evasion, wire fraud, and money laundering today in a U.S. District Court. Eileen O’Connor, Assistant Attorney General for the Justice Department’s Tax Division; Jan Paul Miller, United States Attorney for the Central District of Illinois, and Nancy Jardini, Chief of the Internal Revenue Service (IRS) Criminal Investigation Division.

After almost 13 days of evidence and approximately five and a half hours of deliberation, the jury convicted Denny R. Patridge, age 56, of evading the payment of his 1996 and 1997 personal income taxes; evading the assessment of his 1999 personal income taxes, two counts of wire fraud and two counts of money laundering. Patridge was acquitted on one charge of willfully filing a false tax return for 1998.

“People who develop and use schemes to hide income and assets from the IRS and who evade their tax obligations should expect to be prosecuted and convicted, and to serve time in federal prison,” said Assistant Attorney General O’Connor.

U.S. Attorney Miller stated, “Today’s jury verdict makes it clear that those who engage in “shell-games” to avoid paying their fair share in taxes will be held accountable.”

“This conviction confirms that the IRS is determined to stop abusive tax schemes. Promoters as well as those who knowingly invest in the use of abusive trust schemes for the purpose of evading taxes will be pursued by the IRS,” stated Nancy Jardini, Chief of the IRS Criminal Investigation Division. “We will continue to investigate and recommend for prosecution those individuals who willfully disobey the tax laws.”

Denny Patridge operated an insurance business known as Patridge Insurance Services, Inc. from an office in his Strasburg home. The evidence presented at trial established that Patridge established “trusts” which he used to conceal his earnings, hide the origin of his income, deceive the Internal Revenue Service, and circumvent personal income taxes. Patridge placed funds in bank accounts which bore the names of his “trusts” and claimed on trust tax returns that the funds had been distributed to an offshore trust. At all times, however, Patridge retained full control over funds in the trust bank accounts and enjoyed the beneficial use of those funds, which made the income taxable to him personally.

The trial evidence also established that Patridge did not report a substantial amount of his income on returns he filed for 1996 and 1997. In 2000, after the IRS notified Patridge that it had made a formal assessment of the 1996 and 1997 back taxes he owed, Patridge liquidated his investment accounts, set up an “offshore” account, and placed approximately $200,000 in the offshore account. Patridge also evaded approximately $19,523 in taxes for calendar year 1999 on taxable income of approximately $76,796. He evaded those taxes by, among other things, transferring money he earned as income to a foreign account, concealing that money from the IRS, using the money to pay personal expenses, and failing to file an individual income tax return.

According to the evidence presented at trial, shortly after the IRS informed Patridge that a lien could be placed on his property if he failed to pay his 1996 and 1997 income taxes, Patridge set up a system to hide his assets from the IRS. He began to move his money offshore to an account that was under his control but not under his name. He established a new account at Edgar County Bank and Trust in Paris, Illinois, in his own name, through which funds could be directed offshore. In October, 2000, he wired approximately $200,000 in funds from the account at Edgar County Bank to an account at a bank in St. Kitts held in the name of Nevis American Trust Company, an entity which maintained the funds on behalf of Sultan Services, Ltd. Sultan was under Patridge’s direction.

After he transferred $200,000 to St. Kitts, Patridge then took steps to prevent the IRS from obtaining a first lien on his real estate. He caused the mortgage on his home in Strasburg to be recorded with the clerk of Shelby County, Illinois, with a $100,000 “loan” from a corporation controlled by Patridge. In October 2000, Patridge wired $100,000 from an offshore location to a corporation he controlled in the U.S. The purpose of the transfer was to provide the corporation with sufficient funds to “loan” Patridge $100,000, using his home in Strasburg as security for the loan. Then, after Patridge transferred $100,000 from offshore to the U.S. and established a false mortgage, he transferred the money back offshore and was able to use the money as he personally desired.

The evidence also showed that Patridge had obtained the sham trusts that he used to conceal assets and evade taxes from an entity known as Aegis, located in Palos Hills, Illinois, and that Patridge assisted in the sale of at least one Aegis trust package. Eight individuals associated with Aegis are currently under indictment in the Northern District of Illinois for various offenses related to the sale and promotion of these trusts. Three tax preparers associated with Aegis have also been indicted in the Northern District of Illinois, and two of those preparers have pleaded guilty.

Patridge also utilized a business, known occasionally as Offshore Consulting Services (OCS) and Laughlin, Inc., run by Terry Neal out of Portland, Oregon to set up a nominee company in St. Kitts, and Nevis and one in Reno, Nevada. At least three individuals associated with OCS and Laughlin, Inc., have been indicted in the District of Oregon.

Sentencing is set for Monday, November 21, 2005 before U.S. District Judge Michael P. McCuskey in Urbana, Illinois.

Patridge faces maximum statutory penalties of up to three and five years imprisonment respectively and fine of up to $250,000 for each count of tax evasion. The maximum statutory penalty for the offenses of wire fraud and money laundering is up to 20 years in prison and fines of $250,000 to $500,000.

The charges were the result of an investigation by the Criminal Investigation Division of the Internal Revenue Service. The case was prosecuted by Hilary W. Frooman, Assistant U.S. Attorney in the Urbana Division, and Lea A. Carlisle, Trial Attorney, of the Justice Department’s Tax Division.

Quatloosian Updates

Tax protestor Larken Rose, one of the leading proponents of the so-called “ 861 argument” got to test his theory in court, and was convicted of all six counts. He faces up to five years in prison.