(CN) - The 5th Circuit refused to reinstate the securities fraud and racketeering claims of taxpayers who say a law firm falsely assured them that their participation in a KPMG tax scheme would not get them in trouble with the IRS.
A group of taxpayers took part in a complex tax-avoidance scheme in which they claimed tax losses through a mechanism of offsetting digital options. Buyers of digital options wager on whether the price of an underlying commodity, currency or security will be above or below a certain "strike price" at a given point in time.
If they "won," they got a payout; if they lost, they forfeited the cost of the option.
The accounting firm KPMG allegedly told investors that the scheme had been analyzed and approved by "several major national law firms."
Relying on this advice, investors participated in the scheme. Before they filed their tax returns, the IRS issued two notices addressing certain types of prohibited transactions.
The KPMG clients turned to Proskauer Rose LLP, asking the firm if the scheme was legal in light of the two IRS notices. Proskauer allegedly concluded that it was.
But the firm and the investors were wrong.
The IRS deemed the scheme an abusive tax shelter and forced the participants to pay millions of dollars in back taxes, interest and penalties.
The participants sued Proskauer and 16 others for racketeering, securities fraud and state-law violations. All but Proskauer settled.
The federal appeals court in New Orleans upheld a judge's dismissal of the racketeering claim as pre-empted by the Private Securities Litigation Reform Act. The Act bars plaintiffs from filing racketeering claims over actions stemming from securities fraud.
The 5th Circuit also affirmed dismissal of the securities fraud claim, saying the plaintiffs failed to show that they relied on Proskauer's advice when opting to participate in the tax scheme.
"While these allegations paint a clear picture of Proskauer's intimate involvement in the tax scheme, plaintiffs scrupulously avoid any explicit assertion that they had knowledge of Proskauer's role prior to their actual investment in the scheme," Judge Carolyn King wrote
"In short, plaintiffs do not allege that they knew of Proskauer's role in the tax scheme during the relevant time period when they were making their investment decisions."
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