THE MAGAZINE OF THE LOS ANGELES COUNTY BAR ASSOCIATION
DECEMBER 2016 / $5
EARN MCLE CREDIT PLUS NEW SOCIAL PARTNERSHIP MEDIA IN AUDIT RULES LITIGATION page 24 page 30
Estate Form 8971 page 12 On Direct: Eli Broad page 8 Ready Capital Los Angeles lawyer Mark Hiraide analyzes the regulatory regime and impact of the Jumpstart Our Business Startups (JOBS) Act page 18
FEATURES 18 Ready Capital BY MARK HIRAIDE The Jumpstart Our Business Startups Act provides new ways to conduct public offerings exempt from SEC registration thereby legalizing crowdfunding
24 Finding the PATH BY TERENCE FLOYD CUFF Designation of a partnership representative to handle IRS audits and distinguishing the review year from the adjustment year of the audit are key elements in new partnership audit rules found in the Protecting Americans From Tax Hikes Act Plus: Earn MCLE credit. MCLE Test No. 263 appears on page 27.
30 Damage Control in the TMZ Era BY MANNY MEDRANO AND RALPH FRAMMOLINO Long before the rise of social media, the U.S. Supreme Court decided that attorneys have not only the right but also the obligation to defend their clients in the court of public opinion
Los Angeles Lawyer DEPARTME NTS the magazine of the Los Angeles County 8 On Direct 12 Tax Tips Bar Association Eli Broad New rules for basis consistency December 2016 INTERVIEW BY DEBORAH KELLY reporting of inherited assets BY MEGAN FERKEL EARHART AND Volume 39, No. 9 10 Barristers Tips PAUL GORDON HOFFMAN Practical considerations in starting COVER PHOTO: TOM KELLER a solo practice 36 Closing Argument BY JOHN D. FOWLER Statutory transcription rates do not apply to private court reporters BY JEFFREY HURON, PHU NGUYEN, AND JYOTI AVILA
LOS ANGELES LAWYER (ISSN 0162-2900) is published monthly, except for a combined issue in July/August, by the Los Angeles County Bar Association, 1055 West 7th Street, Suite 2700, Los Angeles, CA 90017 (213) 896-6503. Period - icals postage paid at Los Angeles, CA and additional mailing offices. Annual subscription price of $14 included in the Association membership dues. Nonmember subscriptions: $38 annually; single copy price: $5 plus handling. Address changes must be submitted six weeks in advance of next issue date. POSTMASTER: Address Service Requested. Send address changes to Los Angeles Lawyer, P. O. Box 55020, Los Angeles CA 90055. 12.16 VISIT US ON THE INTERNET AT WWW.LACBA.ORG/LALAWYER E-MAIL CAN BE SENT TO [email protected]
EDITORIAL BOARD Chair TED M. HANDEL Articles Coordinator JOHN C. KEITH Assistant Articles Coordinator SANDRA MENDELL Secretary TYNA ORREN Immediate Past Chair DONNA FORD
JERROLD ABELES (PAST CHAIR) ETHEL W. BENNETT SCOTT BOYER CHAD C. COOMBS (PAST CHAIR) THOMAS J. DALY GORDON K. ENG STUART R. FRAENKEL MICHAEL A. GEIBELSON (PAST CHAIR) CHRISTINE D. GILLE STEVEN HECHT (PAST CHAIR) DENNIS F. HERNANDEZ JUSTIN KARCZAG MARY E. KELLY (PAST CHAIR) ERIC KINGSLEY KATHERINE KINSEY RENA KREITENBERG JENNIFER W. LELAND PAUL S. MARKS (PAST CHAIR) MICHAEL MAUGE COMM’R ELIZABETH MUNISOGLU CARMELA PAGAY GREGG A. RAPOPORT GARY RASKIN (PAST CHAIR) JACQUELINE M. REAL-SALAS (PAST CHAIR) LACEY STRACHAN THOMAS H. VIDAL
STAFF Editor ERIC HOWARD Art Director LES SECHLER Director of Design and Production PATRICE HUGHES Advertising Director LINDA BEKAS Administrative Coordinator MATTY JALLOW BABY
Copyright © 2016 by the Los Angeles County Bar Association. All rights reserved. Reproduction in whole or in part without permission is pro - hibited. Printed by R. R. Donnelley, Liberty, MO. Member Business Publications Audit of Circulation (BPA). The opinions and positions stated in signed material are those of the authors and not by the fact of publication necessarily those of the Association or its members. All manuscripts are carefully considered by the Editorial Board. Letters to the editor are subject to editing.
4 Los Angeles Lawyer December 2016 LOS ANGELES LAWYER IS THE OFFICIAL PUBLICATION OF THE LOS ANGELES COUNTY BAR ASSOCIATION 1055 West 7th Street, Suite 2700, Los Angeles CA 90017-2553 Telephone 213.627.2727 / www.lacba.org
LACBA EXECUTIVE COMMITTEE President MARGARET P. STEVENS President-Elect MICHAEL E. MEYER Senior Vice President PHILIP H. LAM Vice President TAMILA C. JENSEN Treasurer DUNCAN W. CRABTREE-IRELAND Assistant Vice President HON. SHERI A. BLUEBOND Assistant Vice President ANNALUISA PADILLA Assistant Vice President ROXANNE M. WILSON Immediate Past President PAUL R. KIESEL Barristers President DAMON A. THAYER Barristers President-Elect MARIANA ARODITIS Chief Executive Officer/Secretary SALLY SUCHIL Chief Financial & Administrative Officer BRUCE BERRA General Counsel & Chief Administrative Officer W. CLARK BROWN
BOARD OF TRUSTEES RONALD F. BROT HARRY W.R. CHAMBERLAIN NATASHA R. CHESLER REBECCA A. DELFINO KENNETH C. FELDMAN JO-ANN W. GRACE JOHN F. HARTIGAN MARY E. KELLY LAVONNE D. LAWSON F. FAYE NIA BRADLEY S. PAULEY ANGELA REDDOCK DIANA K. RODGERS MARC L. SALLUS EDWIN C. SUMMERS III DAVID W. SWIFT WILLIAM L. WINSLOW
AFFILIATED BAR ASSOCIATIONS BEVERLY HILLS BAR ASSOCIATION CENTURY CITY BAR ASSOCIATION CONSUMER ATTORNEYS ASSOCIATION OF LOS ANGELES CULVER MARINA BAR ASSOCIATION GLENDALE BAR ASSOCIATION IRANIAN AMERICAN LAWYERS ASSOCIATION ITALIAN AMERICAN LAWYERS ASSOCIATION JAPANESE AMERICAN BAR ASSOCIATION JOHN M. LANGSTON BAR ASSOCIATION THE LGBT BAR ASSOCIATION OF LOS ANGELES MEXICAN AMERICAN BAR ASSOCIATION PASADENA BAR ASSOCIATION SAN FERNANDO VALLEY BAR ASSOCIATION SANTA MONICA BAR ASSOCIATION SOUTH BAY BAR ASSOCIATION SOUTHEAST DISTRICT BAR ASSOCIATION SOUTHERN CALIFORNIA CHINESE LAWYERS ASSOCIATION WOMEN LAWYERS ASSOCIATION OF LOS ANGELES
Los Angeles Lawyer December 2016 5 t’s that time of the year again—time to reflect on the year that is drawing to a close and to ponder what the I new year will bring. In the midst of the hustle and bustle of the holidays, perhaps the most satisfying gift that we can give to ourselves is to set aside time to consider the lessons
we have learned this year and how we can best use them for growth and motivation in the year ahead. If we do make the time to reflect, we can take the opportunity to recognize and genuinely appreciate what we have accomplished both personally and professionally and how those accomplishments have benefitted us, our families, clients, and col- leagues, in the short term and down the road. It may also give us insight into how we can build on our accomplishments to create greater and more lasting value for ourselves and others. On a personal level, we can cherish the bonds that we enjoy with our significant other, children, family members, and friends, and strive to strengthen those bonds further in the coming year. Professionally, we can reinforce the relationships that we have established with our partners, associates, and administrative staff and perhaps foster a more collab- orative and collegial work environment. For our clients, we can identify ways to enhance the value of the services that we provide to help solidify those relationships and encourage them to make referrals. Depending on the focus of our respective practices, our perspectives will vary on what we hope to achieve next year. For example, some may be satisfied by closing more deals than the preceding year or having more wins than losses in their matters. Others may gain greater professional satisfaction by devising a new set of deal terms at the very moment when the parties were at an impasse and about to walk, and those terms convinced the parties to stay the course and finalize the transaction. For a litigator, the same may be attained by finding an overlooked precedent, developing a new argument in a case that otherwise seemed to be going south, or persuading the court to ultimately rule in favor of one’s client. Some of us may find that a sense of accomplishment also can be attained outside a daily practice. One opportunity is serving on a professional board or committee such as those established by the Los Angeles County Bar Association or the State Bar. Speaking at professional seminars is another. Last, but certainly not least, opportunities exist to write articles for Los Angeles Lawyer and other professional journals. Finally, many of us may find tremendous satisfaction in giving back to our com- munity. This can be accomplished through a variety of means, including contributing financially to LACBA’s Counsel for Justice, or volunteering with one of LACBA’s projects: Domestic Violence Legal Services, Veterans Legal Services, Immigration Legal Assistance, and AIDS Legal Services. You may also wish to provide financial support to a local nonprofit or serve as a director for an organization advancing a cause of personal interest. On behalf of the Los Angeles Lawyer Editorial Board and staff, we wish you a joyous holiday season and a new year that exceeds your expectations, both personally and professionally. n
Ted M. Handel is the 2016-17 chair of the Los Angeles Lawyer Editorial Board and Chief Executive Officer of Decro Corporation, a nonprofit housing developer, which develops and manages affordable multifamily housing projects for low-income families and seniors.
6 Los Angeles Lawyer December 2016 on direct INTERVIEW BY DEBORAH KELLY
Eli Broad Philanthropist and Entrepreneur
The Foundation also supports existing nonprof- We’ve been successful with that. its. How is a grant determination made? Most of what we do concerns things we create What is your favorite item at the gift shop? The ourselves, whether it’s in education, medical Collection catalog. research, or the arts. We do support other You have a personal art collection with nearly organizations, but they are opportunities we 600 works. What is your favorite piece? Jeff identify. We don’t accept unsolicited grant Koon’s Rabbit is one of our favorites. Jeff’s applications. a good friend. How do you decide where to create or to give? In 2012, your book, The Art of Being Unreason- We have three criteria: Will it happen with- able: Lessons in Unconventional Thinking, out us? If it is going to happen anyway, we debuted as a New York Times and Wall Street don’t get involved. Is it going to make a dif- Journal bestseller. What is the most unconven- ference in 20 years? And are there people tional thing you did? Taking a traditional life who can really make it happen? insurance company and making it a retire- What is misunderstood about being a philan- ment savings giant, then selling it for $18 thropist? People think that you have a hid- billion, which has allowed our family to den agenda, especially in education. All we have more money to make a difference ELI BROAD | After building two of the most suc- philanthropically. cessful Fortune 500 companies, KB Home and want to do is improve student achievement. Some parties think we have a different agen- SunAmer ica, Eli Broad and his wife Edye decided You are the only person to build two Fortune 500 da—to profit from what we are doing. I can to devote their lives to philanthropy. The Broads companies in two different industries—KB Home tell you unequivocally that we do not make established The Eli and Edythe Broad Foundation, and SunAmerica. What advice do you give to a dime from our philanthropy. which invests in improving K-12 public schools, young business graduates? Read my book, be advancing scientific and medical research, and At the Broad Center, the concern is urban educa- well-informed, and do a lot of research. expanding public access to the arts, as well as tion. What is your one wish for LAUSD? LAUSD What is the secret to success? The harder you The Broad Art Foundation, which serves as a has to be more cooperative with charter work, the luckier you get. lending library of contemporary art to museums schools. around the world. Kaufman & Broad streamlined the construction Cooperate how? LAUSD is not willing to process. How? We shortened the construction share empty classroom space and it is re- time from four months to 45 days by pre- quired by law to do so. fabricating elements of a home’s construc- What is the perfect day? A day in which I ac- The Broad Institute is the leading genomic medi- tion off-site and delivering to the building complish something and make a difference. cine institute. Is this the medical approach of the site exactly the materials necessary, almost like a model kit. You are the cofounder of the Eli and Edythe future? We are happy to be involved because it’s going to make a big difference. Broad Foundation, which focuses on three areas You are 83 years old and seem to always be on of philanthropy—education, science, and the The Broad has long lines around the block. Were the go. Why? I want to accomplish things. I arts. What are your duties? I’m the leader. you surprised by this success? We thought it don’t want to sit around and just do noth- ing. Were you thinking of the human mind, body, and would be 300,000 per year, but our first- year attendance was nearly triple what we spirit when you decided upon these categories? You were born in the Bronx, educated in Michi- expected. I haven’t thought of it that way. We’re in- gan, and live in California. Where’s home? Los volved in improving public schools, especial- Admission at The Broad is free, but MOCA Angeles. ly in our hometown of Los Angeles; we’re charges $12. Why is that? We are able to offer You have been called a man with Midwest can- involved in scientific and medical research free general admission because we have en- dor, such as “the buck stops here.” Do you see especially in the areas of genomics and stem dowed The Broad. We wanted it to be a gift yourself that way? I do. cells; and in the arts we’re involved in many to the people of Los Angeles. We especially ways, including The Broad Museum, which wanted to make it available to young people For decades, you were the youngest Michigan opened on September 20, 2015. and diverse visitors from all backgrounds. resident to attain the credentials of CPA. Would
8 Los Angeles Lawyer December 2016 you consider yourself an overachiever? I push myself pretty hard and I get others to achieve things they didn’t think they could achieve.
Through The Giving Pledge, you and your wife personally committed to give 75 percent of your wealth to charity. Some say you’ve given away enough. What do you say? Give more.
Has technology changed the way you are in- volved with your philanthropic interests? I use a smart phone and a computer, but I don’t text.
What was your best job? Creating The Eli and Edythe Broad Foundation.
What was your worst job? Selling women’s shoes.
You have said your wife has an eye for art. What characteristic do you most admire in her? She’s very frank, very caring, and has a very dif- ferent personality than I do.
You are credited with making Disney Hall hap- pen. What is your favorite kind of music? Jazz.
You have been called the father of DTLA. What is the biggest challenge facing our urban communi- ty? We have to improve our schools. Every family, regardless of their income or where they live, deserves access to a high-quality school.
Which magazine do you pick up at the doctor’s office? I bring my own papers; I spend two hours reading four papers per day—Los An- geles Times, New York Times, Wall Street Journal, and Financial Times.
You hired Chef Timothy Hollingsworth from the French Laundry for The Otium restaurant. What is your favorite dish? Cresti di Galli (Pasta Puttanesca).
What do you do on a three-day weekend? I sit in the sun and go out for dinner with friends. I used to play tennis but I never had the pa- tience for golf.
What is your favorite spectator sport? Football. I record the games, so I don’t have to watch all of the commercials.
What are the three most deplorable conditions in the world? The refugee crisis, terrorism, and hunger.
Who are your two heroes? President Obama and President Truman.
Which one person would you most like to take out for a beer? Bill Clinton.
What would you like written on your tombstone? He made a difference.
Los Angeles Lawyer December 2016 9 barristers tips BY JOHN D. FOWLER
Practical Considerations in Starting a Solo Law Practice
WHEN DECIDING WHETHER to start a solo practice, the devil is in specific programs that provide storage, calendaring, and organizational the details. An abundance of resources gives 10,000-foot overviews capacities all rolled into one, but for the price-conscious, there are of starting a solo practice—nuanced, seemingly mundane decisions other secure ways to achieve the same end. For instance, Google in hanging a shingle often among the most important. Business combines document storage, a calendar, and e-mail system First, however, is the importance of obtaining malpractice insur- that can easily be integrated into a practice. DropBox provides ance. Although not required in California, failure to obtain malpractice similar services for organizing cloud-based legal documents. Individual insurance can open the door to substantial personal liability. Also, programs that can assist with calendaring, legal research, presenta- clients must be informed of an attorney’s omission pursuant to tions, and other resources often can be used piecemeal in a way California Rules of Professional Conduct, Rule 3-410. that reduces price by eliminating unnecessary bells and whistles. Malpractice insurance varies widely company to company, and Upgrading systems has become easier thanks to consumer demand— a thorough investigation of options and price points should be performed. Some policies “burn down” and provide one maximum Strong branding can provide greater visibility when potential amount for coverage, which is allotted to both attorney fees and settlement. Others list the coverage limit to delineate maximum payment clients have an issue in a specific area. for settlement, while legal fees are covered separately (potentially saving hundreds of thousands of dollars). Policies typically list two numbers: the amount of coverage per and corporate desire to make products easier to use—so a decision claim and the amount of coverage overall. Failure to understand today does not have to be for the lifetime of a practice. Along with how this might apply may result in surprising and preventable costs. technology comes a responsibility for security. A platform for cloud In applying for insurance, attorneys receive a comprehensive storage should encrypt data, utilize two-step verifications for logging questionnaire about the details of the new practice. Answers to these in (for instance, a text to a mobile device or a secondary password) questions can substantially change the price of the policy. These and be wholly compliant with international standards, preferably inquiries range from the method by which the attorney intends to via the use of third-party audits and testing. maintain and back up documents to personal business background. Minimizing overhead once the practice is operational requires The best way to approach answering the questionnaire is to ensure constant vigilance but is made easier by, once again, utilizing the strict adherence to suggested requirements, exercising caution and various options for technology. It is important to take advantage of prudence in the realm of security, technology, and law firm mainte- special offerings aimed at new law firms. Virtually every type of nance. It also goes without saying to never mislead or embellish on resource has some sort of discount for a beginning practice. This the application. In fact, if malpractice insurance cannot be factored runs the gamut from legal research and paperless platforms to mal- into the budget, it may not be time to open a practice. practice insurance. Second, creating a solid business plan in conjunction with an Finally and ironically, the most important point is not to be so early niche focus can greatly assist the ability to immediately get solo in a solo practice. Avoiding swimming against the tide. Law is off the ground. It is much better to make potential clients and a fluid, evolving entity and maintaining constant awareness of the referral sources aware of strengths in specific areas of the law, par- landscape is crucial. Do not be afraid to ask for help by joining ticularly in Los Angeles which has an abundance of lawyers (thus organizations, seeking guidance from mentors, and posting questions making it more difficult to gain and maintain a competitive advan- on law-related message boards. These same resources can lead to tage). Clients and contemporaries are more likely to refer to an the formation of strategic alliances and partnerships on future cases. attorney with a defined focus than a general attorney who dabbles By the same token, always make yourself available to fellow attorneys. in different types of law. Strong branding can provide greater Developing case pipelines and referrals are achieved through tireless visibility when potential clients have an issue in a specific area. networking where actual relationships are forged, not just handing Lack of direction will inhibit business. Simply being a good attorney out business cards at networking happy hours. Recognizing the lim- is not enough. itations of your practice is almost as valuable as having the confidence A third crucial element is the efficient use of technology. The to open up in the first place. The law becomes much easier as a col- ability to access records and documents at any point in time, whether laborative endeavor rather than standing alone. n it be the courtroom or the boardroom, is now a standard part of any practice. It is virtually impossible to stay organized and prepared John D. Fowler is an entertainment and business litigator in Beverly Hills, without some type of digital platform. There are all-inclusive law- California.
10 Los Angeles Lawyer December 2016
tax tips BY MEGAN FERKEL EARHART AND PAUL GORDON HOFFMAN
New Rules for Basis Consistency Reporting of Inherited Assets
THE LATEST STEP IN CONGRESS’S effort to mandate the consistent reporting of basis of inherited assets is the Treasury’s issuance of temporary and proposed regulations, providing guidance on the new reporting requirements imposed on personal representatives of decedents’ estates. In 2015, Internal Revenue Code Sections 1014(f) and 6035 became law, requiring a personal representative of an estate to file (new) Form 8971 within 30 days after filing the U.S. estate (and generation-skipping transfer) tax return (estate tax return). Each beneficiary of the estate is to receive a new schedule (Schedule A) specific to that beneficiary, showing the estate tax value (i.e., the new basis) of the assets that beneficiary receives from the estate. The new law prohibits a beneficiary from using a higher basis than that shown on his or her Schedule A for income tax purposes (depreciation and capital gains). The new law was enacted to stop perceived abuses in basis reporting in which a personal representative reports a low value for an asset on the estate tax return to minimize estate taxes, but the beneficiary reports a basis higher than that value for income tax purposes. The beneficiary’s basis must be the same as that reported on Form 8971. Form 8971—Information Regarding Beneficiaries Acquiring Property from a Decedent—reports to the IRS the identities of the beneficiaries (including a Social Security number) who receive assets from the estate (other than cash and certain other excluded gifts), and the estate tax values of those assets. This information could be used by the IRS later when a beneficiary takes depreciation deductions or reports capital gain or loss upon sale of an inherited asset. filed with Form 8971, but each beneficiary is to receive only his or If a preparer does not comply with the requirements to file Form her specific Schedule A—not Form 8971 and not any other benefi- 8971 and Schedule A, there may be severe penalties. A beneficiary ciary’s Schedule A.4 that uses a basis that is inconsistent with the value reported on Form The assets that are required to be reported on (at least one) 8971 may also face penalties. Schedule A are all assets that increase the final amount of the estate tax.5 Since assets passing to a surviving spouse or to a charity do Filing Requirements not increase the estate tax if a marital or charitable deduction is In most cases, if an estate tax return is required, a Form 8971 will claimed, those assets need not be reported on Schedule A. Therefore, also be required. Usually, if an estate tax return is required because a personal representative could be required to file Form 8971— a decedent’s gross estate (including taxable lifetime gifts) exceeds because the estate’s gross value exceeds the estate tax exemption— his or her available estate tax exemption—currently $5,450,000 for even though there are no Schedules A, since all assets pass to a United States citizens and residents dying in 2016—the personal spouse or charity.6 However, penalties may still be assessed for failing representative must file Form 8971.1 If the decedent was a nonresident to file Form 8971 in that situation.7 alien, the filing requirement applies if the value of his or her U.S. The exclusion of marital deduction assets from the reporting assets exceeds $60,000 at the time of death.2 If Form 706-A is requirement is inconsistent with the new law’s objective: enforcing required to be filed for an estate holding special use valuation consistent basis reporting. A surviving spouse could sell an asset property (typically farm or ranch land) either because that property inherited from the deceased spouse, and gain or loss would be has been disposed of or because its special use has been discontinued, reported. If the same asset had been left to a child, for example, the the personal representative is required to file Form 8971.3 child would have received a Schedule A, which would have also The personal representative must prepare a separate Schedule A for each beneficiary who has received or will receive property from Megan Ferkel Earhart is an associate, and Paul Gordon Hoffman a partner, the estate. If the personal representative does not know which assets in the firm Hoffman, Sabban & Watenmaker APC. They practice in the areas will be distributed to a beneficiary at the time Form 8971 is due, of estate planning, trust and estate administration, and tax and charitable then all assets that could be distributed to the beneficiary must be planning. The authors wish to give special thanks to Erin L. Prouty, partner RICHARD EWING listed on that beneficiary’s Schedule A. All Schedules A are to be at Hoffman, Sabban & Watenmaker APC.
12 Los Angeles Lawyer December 2016 been attached to the Form 8971 filed with prior to distribution. This last exclusion reported on Schedule A to Form 8971. How - the IRS. makes sense as the seller would be the per- ever, the value (i.e., basis) reported to the Form 8971 is not required if: 1) an estate sonal representative, who should know the beneficiary may not be the true basis in the tax return is filed solely to preserve and report date of death value (basis). Also, this exclusion asset. While the value on Schedule A is the the deceased spouse’s unused exemption to could provide a personal representative a final value, the basis may change during the the surviving spouse, or 2) an estate tax convenient way to avoid reporting the value time the personal representative holds the return is filed solely to allocate generation- of certain assets to beneficiaries when there asset (due to audit by the IRS, depreciation, skipping transfer (GST) tax to a trust.8 A are privacy concerns. However, completing improvements, or adjustments as a result of trustee who files a 706-GS(T) to report a sales of assets before the reporting deadline a flow-through from a partnership, limited GST taxable termination is also excluded may prove impractical. liability company, or S corporation). Ac - from filing a Form 8971.9 This exception is cordingly, the basis in the hands of the ben- Reporting Values surprising because the assets subject to GST eficiary may not be the same as the final tax as a result of a taxable termination receive Section 1014(f) provides that the basis re- value reported on the initial Schedule A pro- a basis adjustment to fair market value, and ported on Form 8971 “shall not exceed” the vided to beneficiaries. the beneficiary will need to know the basis “final value” as determined for estate tax Practitioners might alert beneficiaries of the assets received for future income tax purposes, i.e., the value reported on the estate when transmitting Schedules A that the value reporting. tax return. The final value is 1) the value re- of an asset received from a decedent may Certain types of assets are excluded from ported on the estate tax return after the statute change, and the beneficiary will be informed being reported on Form 8971 and Schedule of limitations expires, generally three years,14 of the change in the form of a Supplemental A:10 1) cash11 does not have a basis that 2) the value determined by the IRS once the Schedule A. However, even if a Supplemental changes; however, if cash is a foreign currency, statute of limitations for assessments and Form 8971 and Supplemental Schedule A the determination of fair market value at claims has expired without that value having are filed to report changes in values, the basis death may be subject to dispute; 2) income been timely contested, 3) the value as deter- in the hands of the beneficiary still may be in respect of a decedent (IRD)12—these assets mined by a final and binding agreement on different from the amount reported. This do not receive a basis adjustment as a result all parties, or 4) the value determined by a inconsistency is at odds with the government’s of the decedent’s death; 3) tangible personal court, once the court’s determination is final.15 goal of informing beneficiaries of basis to property valued at less than $3,000, which This framework provides inherent prob- ensure consistency in reporting. is likely related to the estate tax return require- lems. Practically, it seems that the value Supplemental Form 8971 and Schedule A ment for an appraisal of personal property reported by a beneficiary on his or her income valued at more than $3,000;13 and 4) property tax return should be the value reported on A personal representative must file a Sup - sold, exchanged, or otherwise disposed of the estate tax return, and therefore, the value plemental Form 8971 and provide a benefi-
Los Angeles Lawyer December 2016 13 ciary with a Supplemental Schedule A if any its intended use.”20 It is likely that case law transferee.”22 A “related transferee” is defined changes occur that affect the final estate tax or other guidance will develop over time as in the proposed regulations as “any member value.16 This includes the discovery of addi- to how to apply this regulation to Form of the transferor’s family as defined in Section tional property, a change in the value of prop- 8971. 2704(c)(2), any controlled entity (a corpo- erty due to litigation or audit, and a change ration or any other entity in which the trans- Subsequent Transfers in the identity of a beneficiary (for example, feror and members of the transferor’s family due to death, disclaimer, or bankruptcy). A The need for basis consistency continues as defined in Section 2704(c)(2), whether Supplemental Form 8971 and Supplemental when an inherited asset is transferred by a directly or indirectly, have control within the Schedule A are also required to correct certain beneficiary in a transaction in which the basis meaning of Sections 2701(b)(2)(A) or (B)), errors, including a wrong taxpayer identifi- is determined in whole or part with reference and any trust of which the transferor is deem - cation number,17 an incorrect beneficiary’s to the transferor’s basis (i.e., by gift).21 The ed an owner for income tax purposes.”23 surname, an incorrect value of an asset being next recipient (or beneficiary) of the asset is Section 2704(c)(2) defines “member of fam- distributed to a beneficiary and reported on more removed from the estate proceedings ily” as the individual’s spouse, the individual Schedule A, or a beneficiary’s address.18 and thus less likely to know any basis infor- or the individual spouse’s ancestor or descen- A Supplemental Form 8971 may, but need mation than the original beneficiary. Ac - dant, any spouse of such an ancestor or not, be filed to correct an “inconsequential cordingly, the IRS has extended the new descendant, and the individual’s sibling and error or omission,” or to specify the actual reporting requirements to certain subsequent any sibling’s spouse. distribution of assets previously reported as transfers. This rule requires the filing of a Supple - being available to satisfy the interests of mul- To avoid potential penalties incurred by mental Schedule A if a beneficiary, who re - tiple beneficiaries.19 The proposed regulations beneficiaries, practitioners may warn bene- ceived property from a decedent, transfers give little guidance as to what qualifies as ficiaries of the possibility that they will also the asset to his or her revocable grantor an inconsequential error or omission, but be required to prepare and file a Supplemental trust.24 The same is not true for the transfer Treasury Regulation Section 301.6722-1(b)(1) Schedule A and provide it to a subsequent to a beneficiary’s nongrantor trust. For exam- may provide some guidance. This regulation beneficiary. Although not required, it may be ple, assume a niece receives property from deals with the failure to furnish correct payee a nice accommodation to a client’s benefi- her deceased uncle. The niece transfers that statements and defines an inconsequential ciaries. property to her revocable grantor trust. The error or omission as “any failure that cannot A beneficiary must provide a Supplemental personal representative of the deceased uncle’s reasonably be expected to prevent or hinder Schedule A—but not Supplemental Form estate filed a Schedule A to report the transfer the payee from timely receiving correct infor- 8971—to the IRS and the beneficiary’s trans- from the uncle to the niece upon the uncle’s mation and reporting it on his or her return feree within 30 days of the date of a subse- death. The niece is now required to file a or from otherwise putting the statement to quent distribution or transfer to a “related Supplemental Schedule A to report the con-
14 Los Angeles Lawyer December 2016 tribution of that asset to her revocable grantor Internal Revenue Service Center, Mail Stop dies first, and the trust divides into a sur- trust (which only benefits the niece during #824G, Cincinnati, OH 45999.30 vivor’s trust and bypass trust. Both spouses’ her lifetime). However, if she transferred the interests in the home receive a step-up in Penalties same asset to an irrevocable nongrantor trust, basis to fair market value to $1 million as no Supplemental Schedule A would be re - Potentially harsh penalties may be incurred of the husband’s death. The personal repre- quired. The requirement to report transfers by a personal representative for 1) failing to sentative reports a 50 percent interest in the to a grantor trust, but not a nongrantor trust, timely file a Form 8971 and Schedule A31 home on Schedule A to Form 8971. The seems arbitrary and nonsensical. and 2) failing to provide Schedule A to each trustee of the living trust allocates 100 per- beneficiary.32 The penalties range significantly cent of the home to the bypass trust and Mailing and Due Dates from $50 per Form 8971, if it is filed within assets of equivalent value to the survivor’s The new filing requirement is effective for 30 days after the due date, to $260 per Form trust. Should the trustee report the value of estates filing an estate tax return after July 8971, if it is filed more than 30 days after the entire home on Schedule A? Until the 31, 2015.25 The IRS has since issued transi- the due date, or not at all.33 The maximum IRS issues guidance, it may be advisable to tional guidance making June 30, 2016, the penalty is $3,193,000 per year.34 These penal- report the 100 percent value on Schedule A due date for all Forms 8971 required to be ties do not apply to any failure that is shown with a notation that 50 percent is attributed filed after July 31, 2015, and before June 1, to be due to reasonable cause.35 to the husband and 50 percent to the wife. 2016.26 For all estate tax returns filed on or A beneficiary who reports his or her basis Concerning unknown answers to ques- after June 1, 2016, the deadline is 30 days in an asset that is inconsistent with the value tions on Form 8971, it may be impossible after the earlier of the due date of the estate listed on Schedule A may be liable for a 20 to avoid penalties unless reasonable cause tax return (including extensions) or the date percent accuracy-related penalty applied to can be shown. Per instructions on Form 8971 the estate tax return was actually filed.27 For the amount of tax not paid.36 As discussed the IRS will not accept a form with blanks example, if a personal representative files the above, the beneficiary’s basis may be different or with “unknown” typed in a field. One of estate tax return on extension but before the from the basis as reported on Form 706 due the items that must be filled in is the Social extended due date, the preparer must file to depreciation and improvements, for exam- Security number of the decedent and each Form 8971 within 30 days after the estate ple. A pending Technical Corrections Act beneficiary. What should a preparer do if a tax return is filed, not 30 days after the will remove the penalty where the beneficiary decedent did not have a Social Security num- extended due date. properly reports a basis that is adjusted from ber (for example, because he or she was pre- A Supplemental Form 8971 and Schedule the value reported on Form 706 and Schedule sent in the United States on a visa that does A are due 30 days after 1) the final value is A.37 It may be useful for practitioners to not permit the holder to work)?38 The instruc- determined, 2) the incorrect or incomplete include an explanation on an income tax tions to Form 8971 provide that the personal information is discovered by the personal return to account for the seemingly incon- representative must obtain a Social Security representative, or 3) a supplemental estate sistent basis reporting to avoid potential number for the decedent. However, the Social tax return is filed reporting additional penalties. Security Ad min istration generally will not assets.28 If one of these events occurs before Another severe consequence of failing to issue a Social Security number to a person the property is distributed to the beneficiary, comply with Form 8971 is that if an asset is who is not authorized to work in the United Form 8971 and Supplemental Schedule A not included on Form 706 before the statute States.39 are due 30 days after distribution. If an of limitations on assessment has expired and A personal representative has more op- asset was previously listed on Schedule A therefore not reported on Form 8971, the tions when a beneficiary does not have a as an asset a beneficiary may receive, no basis of the unreported asset will be zero. Social Security number. A personal represen- Supplemental Form 8971 or Schedule A is This punitive result could cause a significant tative may alternatively use either a benefi- required, unless the final value has changed. income tax bill for an innocent beneficiary. ciary’s Employer Identification Number, an The personal representative must also file For a California resident, the income tax Individual Taxpayer Ident if i cation Number, a Supplemental Form 8971 and Schedule A could approach 38 percent on capital gains or any other number used by the IRS in the within 30 days of locating a beneficiary pre- or over 50 percent on ordinary income, if administration of tax law. However, the per- viously listed as “unknown” on Form 8971 the asset is later sold. sonal representative cannot force a beneficiary and Schedule A.29 to obtain one of these numbers, and cannot Outstanding Issues All Schedules A (and Supplemental Sched - obtain one for a beneficiary. A similar prob- ules A) must be attached to the original Form Although some guidance has been provided lem may arise when a beneficiary cannot be 8971 (or Supplemental Form 8971) filed with in the proposed regulations to Sections 1014 located; the preparer may not be able to the IRS. A copy of each Schedule A must be and 6035, many preparers are left with ques- obtain the beneficiary’s address or Social delivered to the beneficiary to whom the tions. Two pressing issues are 1) reporting Security number to report on Form 8971. Schedule A applies, and the preparer must community property assets on Schedule A To reduce the risk of penalties, practitioners show the date of mailing to each beneficiary and 2) responding to questions on Form 8971 should explain on Form 8971 the efforts on Form 8971. A beneficiary can be provided when the answer is unknown. made to obtain any missing information and Schedule A in person, by e-mail, by U.S. mail With regard to reporting community the reason they are not able to complete the to the beneficiary’s last known address, or property, the IRS indicated that only the Form. by private delivery service (e.g., FedEx, UPS). decedent’s assets (as reported on the estate Potential Changes to Form 8971 To avoid potential penalties, a preparer should tax return) should be included on Form complete a proof of service and maintain a 8971. The question arises then as to how President Barack Obama’s 2017 Greenbook copy in the file as proof of timely mailing the personal representative should report proposal would expand the property subject Schedule A to a beneficiary. assets allocated between spouses on a non- to the basis consistency requirement under Form 8971 and Schedule A—and the sup- pro rata basis. For example, suppose a mar- Section 1014(f) to include 1) property dis- plemental documents—must be filed at the ried couple creates a living trust to hold a tributed to charity or a spouse, if an estate following address: Department of Treasury, community property home. The husband tax return is required for a decedent, and 2)
16 Los Angeles Lawyer December 2016 property reported on a gift tax return.40 Much remains to be seen as to how the IRS will process the recently filed Forms 8971, Schedules A, and whether the IRS will provide practitioners with additional guidance. n
1 I.R.C. §§6035(a), 6018(a), 2010(c). 2 I.R.C. §§6035(a), 6018(a). 3 See Instructions for Form 8971 and Schedule A (Jan. 2016) [hereinafter Form 8971 Instructions]. 4 Id. 5 Id.; I.R.C. §1014(f)(2). 6 I.R.C. §1014(f)(2); Prop. Treas. Reg. §1.1014-10(b)(2) (although Prop. Treas. Reg. §1.1014-10 is not yet final, §1.1014-10(f) provides that these rules may be relied upon before the rules have been adopted as final). 7 See I.R.C. §6721 regarding penalties. 8 See Prop. Treas. Reg. §1.6035-1(a)(2). 9 See Form 8971 Instructions. 10 Prop. Treas. Reg. §1.6035-1(b)(1). 11 Coin collection or bills with numismatic value are excluded from the definition of “cash.” It seems that virtual currencies (such as Bitcoin) also are not “cash” for this purpose. See I.R.S. Notice 2014-21 (IRB 2014- 16). 12 I.R.C. §691. 13 See Schedule F of Form 706 (U.S. Estate (and Gen - eration-Skipping Transfer) Tax Return); Treas. Reg. §20.2031-6(b). 14 I.R.C. §6501. 15 Prop. Treas. Reg. §1.1014-10(c)(1). 16 Prop. Treas. Reg. §1.6035-1(e)(1), (2). 17 Note that if this is due to “reasonable cause” under I.R.C. §6724, there should not be a penalty. Cf. Chief Counsel Advice Memorandum 201615012 (Feb. 23, 2016). 18 See Prop. Treas. Reg. §1.6035-1(e); Form 8971 Instructions. 19 Prop. Treas. Reg. §1.6035-1(e)(3)(i)(A). 20 Treas. Reg. §301.6722-1(b)(1). 21 Prop. Treas. Reg. §1.6035-1(f). 22 Id. 23 Id. 24 Id. 25 Form 8971 Instructions; see also Treas. Reg. §1.6035-1(i). 26 Form 8971 Instructions; I.R.S. Notice 2015-57. 27 Prop. Treas. Reg. §1.6035-1(d). 28 Prop. Treas. Reg. §1.6035-1(e)(4)(i). 29 Prop. Treas. Reg. §1.6035-1(c)(4). 30 Form 8971 Instructions. 31 I.R.C. §6721; Form 8971 Instructions. 32 I.R.C. §6722; Form 8971 Instructions. 33 I.R.C. §§6721, 6722. 34 I.R.C. §6721(a)(1); Form 8971 Instructions. 35 See Form 8971 Instructions, “In general, it must be shown that the failure was due to an event beyond the taxpayer’s control or due to significant mitigating factors. It must also be shown that the executor or other person required to file acted in a responsible manner and took steps to avoid the failure.” 36 I.R.C. §6662. 37 Technical Explanation of the Technical Corrections Act of 2016, Joint Committee on Taxation (JCX-16- 16) (Apr. 11, 2016). 38 See Form 8971 Instructions. 39 See Social Security Numbers for Noncitizens, Social Security Administration, available at https://www .ssa.gov/pubs/EN-05-10096.pdf (last visited Oct. 18, 2016). 40 General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals, Department of the Treas ury February 2016, available at https://www .treasury.gov (last visited Oct. 18, 2016).
Los Angeles Lawyer December 2016 17 PART ONE OF TWO
by Mark Hiraide READYCAPITAL
While the JOBS Act makes it possible for nearly anyone to raise venture capital, it also raises the stakes for business attorneys as gatekeepers
THE FINAL ventures using other people’s money (OPM). of small investors now may directly fund stages However, lawyers must remain vigilant as startup businesses that pique their interest. of a major shift in federal securities laws regulators view lawyers as the gatekeepers Yet there is concern that the new regime for took place in May 2016 when entrepreneurs who will fill in the regulatory void. raising capital from unsophisticated investors and companies gained unprecedented access The JOBS Act legalized equity crowd- lacks sufficient investor protections.4 to capital. For the first time in the history of funding,2 fostered private peer-to-peer lending, The JOBS Act’s elimination of the regu- federal securities regulation in the United created a new regime for regulating mini- latory burdens on private offerings, and the States, businesses may raise capital from the IPOs, and paved the way for the SEC to associated reduction in cost, will make public general public without registering a securities create new sources of liquidity for early-stage capital markets attractive to many. No longer offering with the Securities and Exchange investors through secondary “venture mar- will equity financing be reserved for those Commission and state securities regulators. kets.” The law already has spawned new and few with the resources to attract and engage This expansion of the funding universe is innovative financial intermediaries dispensing Wall Street investment bankers and lawyers. due to the Jumpstart Our Business Startups capital to startup and growing businesses. It (JOBS) Act of 2012,1 designed to spur job has been heralded as “democratizing” access Mark Hiraide is a partner in the Los Angeles office creation by easing regulations governing “pri- to capital by “disintermediating” Wall Street of Mitchell Silberberg & Knupp LLP. He defends vate” securities offerings to help early-stage from the process of selling securities.3 Many dir ectors and officers in securities litigation and companies grow. The JOBS Act removed pre- hail the JOBS Act, in particular its provisions counsels companies in corporate financing trans - vious restrictions on advertising securities for equity crowdfunding, as allowing every- actions. He is the author of Crowdfunding (Thom - offerings. Under the new law it is significantly day people to invest in an asset class previ- son Reuters). He would like to thank his paralegal,
easier for entrepreneurial clients to fund their ously reserved for venture capitalists. Crowds Kay Cooperman Jue, for her assistance. MICHAEL CALLAWAY
18 Los Angeles Lawyer December 2016
This “Uberization” of capital markets5 will advertising the offering. The SEC and the Changes in market regulation, including the make capital more readily accessible to every courts had long interpreted the nonpublic decimalization and deregulation of commis- budding entrepreneur, and it will have sig- offering exemption to prohibit any form of sions, shrinking profits of smaller investment nificant ramifications for the practice of busi- general solicitation.7 They did not, however, banking firms, increased regulation of those ness law. set forth clear guidelines for determining investment banking firms by the Financial A growing awareness of access to capital what constituted a general solicitation. The Industry Regulatory Authority (FINRA) in by the public will lead to a demand for legal Supreme Court in 1953 outlined the contours response to microcap stock frauds, and other services. Lawyers have an opportunity to of what constitutes a private offering for pur- structural changes to the industry, resulted expand their business practices, but they will poses of the exemption. In SEC v. Ralston in the exodus of regional investment banking need to better understand the specialized field Purina Co., the Court examined the knowl- underwriters to small public offerings.11 of securities law. The new laws and rules edge of the investor and its relationship with The Securities Act’s restrictions on solic- raise many new questions, the answers to the issuer as a basis for distinguishing a iting investors—well-intentioned in the after- which often are informed by years of old private offering from a public offering.8 The math of the stock market crash of 1929 and interpretations and customary practices in boundaries, however, were far from clear. the Great Depression—made the ambition the law of corporate financing transactions. Prior to the SEC’s promulgation of Regulation of successfully raising capital for startups Today’s business lawyers must have at least D in 1982, many members of the securities unattainable for most people. It relegated a working knowledge of the new methods bar were uncomfortable rendering “no reg- entrepreneurs to raising seed capital from and rules for raising capital under Regulation istration” opinions. Even after Regulation friends, family, and others with whom the CF (crowdfunding), Regulation D, and D, until the enactment of the JOBS Act, entrepreneur had the requisite relationship.12 Regulation A under Titles II, III, and IV of issuers, who in litigation bear the burden of Small issuers were frequently unable to com- the JOBS Act. They must understand the proving an exemption from registration, typ- ply with Securities Act provisions because of interplay between federal and state securities ically restricted their unregistered offerings a combination of exorbitant costs, unwork- laws. They must advise clients about the to prospective investors with whom they able resale provisions, ambiguity, and taint often draconian statutory liabilities under could demonstrate a “pre-existing substantive of prior illegal stock sales. those laws. And they must be clear about business relationship.”9 Consequently, an entrepreneur’s parents, their role as securities lawyers and the lia- In recent years, organized groups of indi- family, and friends, and the geographic neigh- bilities they assume. viduals with high net worth (angel investors) borhood in which one lived were significant When Congress enacted the Securities Act have been a source of early-stage capital, but factors in determining who received funding, of 1933 (Securities Act) and Securities Ex - attracting the attention of angel investors is who became owners of a business, and what change Act of 1934 (Exchange Act) and nearly impossible without some initial seed demographic eventually accumulated capital created the Securities and Exchange Com - capital to validate or prove a business model and wealth in this country. To close the capital mis sion, the business of raising investment or product. The only other alternative for gap for early-stage financing, stimulate job capital—taking OPM—became subject to raising capital—soliciting the public—required growth, and address issues of unequal access extensive regulation. The federal securities registering the securities offering with the to capital, in 2012, President Obama signed laws, and each state’s “blue sky” securities SEC, the same process undertaken by com- into law the JOBS Act. In relaxing the restric- laws, mandate that all offers and sales of panies going public through an initial public tions on soliciting investors, the new law securities be registered with the SEC and offering (IPO). Registration is cost-prohibitive reflects the advent of the Internet, modern qualified with state securities regulators unless for most early-stage companies.10 Even if a communication technology, and social media, exempt from such registration. company could afford the legal and audit which made the 90-year-old restrictions on Prior to the JOBS Act, the most common fees charged for public offerings, after the advertising securities offerings increasingly exemption from registration was for non- dot-com crash in the early 1990s, the public impractical. public securities offerings,6 which placed equity markets became inhospitable for early- The JOBS Act dramatically changed the strict limitations on soliciting investors and stage small (less than $50 million) IPOs. rules relating to private securities offerings by creating three new methods of conducting State Blue Sky Laws public offerings that are exempt from SEC registration. These offering exemptions are found in Titles II, III, and IV of the JOBS “Blue sky laws” are state laws regulating the offer and sale of securities. The term originated from the Act and are often referred to by these JOBS Supreme Court’s description of fraudulent securities as “speculative schemes which have no more Act titles. The differences among the three basis than so many feet of ‘blue sky.’”1 Although many states have adopted some form of the Uniform exemptions relate to the size of the offering, Securities Act drafted by the National Conference of Commissioners of Uniform State Laws, others, investor qualifications, and manner in which including California, have not adopted the uniform act and have their own unique securities law. Many the securities may be offered. The new exemp- of these state securities laws provide the state securities regulator with the authority to deny a tions from registration afforded by Title II securities offering based on the merits of the terms of the securities. California is one such “merit and Title IV allow unrestricted general solic- review” state, and the commissioner of the Department of Business Oversight must make a finding itation of investors; in effect, they permit that an offering is “fair, just and equitable” before she will issue a permit to allow sale of the securities unregistered public offerings. Title III provides in California. A principal feature of the JOBS Act is its preemption of blue sky laws for certain securities a new exemption for selling securities through offerings. However, federal preemption under the JOBS Act is limited. In most cases, it does not crowdfunding. All three exemptions preempt preempt state regulation of offers and sales by shareholders (i.e., secondary transactions) or state certain aspects of state blue sky securities broker-dealer registration requirements. Similarly, each state blue sky statute provides investors with law regulation. statutory civil rescission remedies that are not subject to federal preemption. Title II: Rule 506(c) of Regulation D 1 Hall v. Geiger-Jones Co., 242 U.S. 539, 550 (1917). Title II of the JOBS Act dramatically changed the rules for raising capital from accredited
20 Los Angeles Lawyer December 2016 investors who, in the case of an individual, is a person with 1) an individual income in Tackling the Resale Problem excess of $200,000 in each of the two most recent years or joint income with that person’s By preempting state blue sky regulation of tier 2 Regulation A+ offerings, the SEC paved the way for the spouse in excess of $300,000 in each of those creation of secondary trading in Regulation A+ securities in markets recently coined “Venture Exchanges.” years and has a reasonable expectation of However, further regulatory action will be required to make an active market for Regulation A+ securities reaching the same income level in the current a reality. To facilitate a secondary market, the SEC amended Exchange Act Rule 15c2-11 to permit an year, or 2) a net worth in excess of $1 million issuer’s ongoing reports filed under tier 2 of Regulation A+ to satisfy a broker-dealer’s obligations to excluding home equity.13 Title II amended review and maintain certain information about an issuer’s quoted securities. However, because all offers Rule 506 of Regulation D by adding new and sales of securities, even those by shareholders, are regulated by federal and state securities laws, paragraph c, which eliminated completely the secondary offer and sale by the shareholder must also comply with state blue sky laws unless such the prohibition on general solicitation. This state laws are preempted. Regulation A+ preempts the primary sale of securities by the issuer. The sec- means that a company can widely advertise ondary sale by the shareholder is not subject to preemption. The Fixing America’s Surface Transportation its offering as long as it takes “reasonable Act, enacted in December 2015, provides a partial solution for secondary sales to accredited investors. It 1 steps to verify” that investors are accredited, codified a resale exemption, commonly known as the “Section 4(1 ⁄2)” exemption, for private resales of “using such method as determined by the restricted securities to accredited investors, and it preempted state blue sky law regulation of these Commission.”14 Issuers must have a reason- secondary transactions. able belief that all purchasers are accredited investors.15 Prior to Title II of the JOBS Act, which went into effect in September 2014, to use the safe-harbor methods of verification. under the principles-based approach as long issuers customarily relied on self-certifications, In assessing whether an issuer has taken rea- as the issuer has a reasonable basis to rely or check-the-box certifications as to accred- sonable steps to verify that investors are on such third party.19 itation. Self-certifications will not satisfy the accredited, the SEC takes a principles-based Securities sold pursuant to Rule 506 of new verification requirement applicable to approach that does not depend on bright- Regulation D must contain restrictions on public offerings under Rule 506(c). line rules but relies rather on the particular transferability, and the issuer must exercise Rule 506 of Regulation D has become facts and circumstances of each purchaser reasonable care to assure that the purchasers the cornerstone of the regulatory regime for and transaction to determine whether the of the securities do not intend to act as under- nonregistered offerings. The rule provides steps taken are “reasonable.” Under this prin- writers by engaging in a distribution of the bright line “safe harbor” rules to establish ciples-based approach, the documentation, securities purchased.20 Issuers should affix an exemption from SEC registration. In 1996, if any, that an issuer should obtain from a a legend on the share certificates setting forth Congress addressed the duplication of dual potential investor will depend on answers to the restrictions on transferability and make federal and state securities regulation in the questions such as: reasonable inquiry to determine if the investor National Securities Markets Improvements • How much information about the prospec- is acquiring the securities for himself and not Act of 1996,16 and preempted state blue sky tive purchaser does the issuer already have? for other persons.21 The JOBS Act Title II registration or qualification of federal covered The more information the issuer has indi- amendments to Regulation D also imple- securities, i.e., those offered in compliance cating that the person is an accredited investor, mented a provision of the Dodd-Frank Wall with Rule 506 of Regulation D. In addition the fewer verification steps it may have to Street Reform and Consumer Protection Act to federal preemption, the absence of any take to comply with the rule’s requirements. that directed the SEC to make the Rule 506 limitation in Rule 506 on the offering amount For example, membership in an established exemption unavailable for offerings in which and number of investors as well as absence angel investor group is information that may certain disqualified persons (“bad actors”) of specific disclosure requirements for ac - affect the likelihood of the person being an participate, subject to a “reasonable care” credited investors made Rule 506 the most accredited investor. exception.22 There is no dollar limit on offer- commonly used private offering exemption. • How did the issuer find the prospective ings under Rule 506 and very few other lim- Today, 99 percent of all private offerings investor? A person that the issuer located itations. under Regulation D are conducted pursuant through publicly accessible and widely dis- The old Rule 506, which prohibits general to Rule 506. Moreover, amounts raised seminated means of solicitation may need to solicitation but allows issuers to include up through unregistered securities offerings have undergo a greater level of verification scrutiny to 35 nonaccredited investors, remains avail- outpaced the level of capital formation than a person who may have been prescreened able in paragraph (b) of Rule 506. Issuers through registered securities offerings during as an accredited investor by a reasonably relying on the old rule also need not verify recent years. In 2014, there were 33,429 reliable third party. that investors are accredited, as required by Regulation D offerings reported on Form • Are the terms of the offering such that only new Rule 507(c). Moreover, recently issued D filings, accounting for more than $1.3 tril- a person who is truly an accredited investor Compliance and Disclosure Interpretations lion raised.17 The JOBS Act adds securities could participate? The ability of a purchaser by the staff of the SEC Division of Corpor- offered pursuant to Title III and Title IV to to satisfy a minimum investment amount ation Finance expand the availability of the the list of securities preempted from state requirement that is sufficiently high such that old rule. These interpretations clarify that in regulation. only accredited investors, using their own appropriate circumstances communications The new rules provide a nonexclusive safe cash, could reasonably be expected to meet in a closed network among members of an harbor for an issuer to satisfy its verification it is relevant in deciding what other steps are informal, personal network of individuals requirement by obtaining tax returns to veri - needed to verify accredited investor status.18 with experience investing in private offerings fy income, or bank or brokerage statements Lastly, the SEC envisioned a role for third will not be deemed to be a general solicitation. and a credit report to verify net worth. How- parties that may wish to enter into the busi- Issuers may now conduct offerings on angel ever, many investors are unwilling to furnish ness of verifying the accredited investor status investor networks and make presentations confidential tax returns and brokerage state- of prospective investors on behalf of issuers at demo days and venture fairs without risk ments. Fortunately, the issuer is not required and allowed for such third-party verification that such activities will be deemed to be a
Los Angeles Lawyer December 2016 21 general solicitation.23 On the other hand, the ici tation, and no federal restriction on trans - the-waters materials. Through a social media staff also clarified that one method of estab- fer ability of the securities. Effective since June campaign, for example, companies may ask lishing the absence of a general solicitation— 2015, it amends the former SEC Reg ulation potential investors for their contact infor- showing a preexisting “substantive business A by increasing the old offering limit of $5 mation and the dollar amount of their invest- relationship” with prospective investors— million to $50 million. An offering under ment interest by asking them to reserve shares requires that the issuer possess sufficient the new Regulation A requires an offering for purchase when, and if, the SEC qualifies information to evaluate the offeree’s financial circular containing specific disclosures similar the offering. If there is sufficient interest, circumstances and sophistication. Self-certi- to those made in an IPO prospectus, and the upon qualification of the offering by the SEC, fication, without any other information about offering is subject to SEC review and quali- the issuer may then formally offer and accept the prospective offeree, is not enough to be fication of the offering circular. The offering subscriptions from those prospective investors considered substantive. circular must include financial statements who had previously expressed interest in the Despite the staff’s recent efforts to provide consisting of the prior year’s balance sheet offering. guidance on issues arising under the JOBS and income statements for the most recent Regulation A+ has two tiers: tier 1, with Act, answers to many questions require resort- two years. The SEC review process for a maximum offering limit of $20 million, ing to years of SEC staff interpretation and Regulation A+ offerings is similar to the reg- and tier 2 with a maximum offering limit of judicial precedent. For example, in response istration process for a registered IPO. The $50 million. The principal difference between to the question, “What information can an staff of the SEC’s Division of Corporation them is that tier 2 offerings preempt state issuer widely disseminate about itself without Finance reviews all Regulation A+ offering securities laws. The SEC left intact state blue contravening Regulation D’s prohibition on circulars and approximately 30 days from sky regulation of tier 1 offerings under Reg - general solicitation?” the staff responded that the filing date of the offering circular on ula tion A+. Another difference between the factual business information that “does not Form 1-A, the staff will issue its written com- two tiers is tier 2 offerings require a financial condition the public mind or arouse public ments. The company responds to these staff statement audit, and the issuer must file with interest in a securities offering” will not comments by filing a series of amendments the SEC ongoing annual, semiannual, and violate the rule. 24 To understand the response, to the offering circular until all staff comments current reports. Also, nonaccredited investors however, one must look to the SEC staff’s are resolved. Only then will the SEC declare in a tier 2 offering may not invest more than long-time guidance on when such commu- the offering statement “qualified.” No sales the greater of 10 percent of their net worth nications will be deemed an “offer”25 and of securities may be made until the SEC or annual income in any single Regulation be aware that courts have interpreted the declares the statement qualified. In most A+ offering. Finally, because there is no pre- term for securities law purposes broadly cases, the time period from SEC filing to the emption of state securities laws with tier 1 beyond the common law concept of an offer.26 effective date is at least 60 days and in many offerings, audited financial statements in cases much longer. most cases will be necessary even though the Title IV: Regulation A+ A principal benefit of Regulation A+ is SEC does not require financial statements to Title IV of the JOBS Act is commonly known its “test the waters” provisions. An issuer be audited in tier 1 offerings. This provision as “Regulation A+” and has also been dubbed may solicit indications of interest before and is necessary because many states require a “mini-IPO.” Once qualified, the offering after an offering circular is filed. While no audited financial statements in order to qual- may be sold to anyone. There is no require- sale commitments may be accepted until the ify the offering in the state. ment that the investor be accredited or sophis- offering circular is qualified by the SEC, there The ongoing SEC reporting required of ticated, no restriction on the means of sol - are few restrictions on the content of test- companies conducting tier 2 Regulation A+ offerings is considered to be a “lite” form of the periodic reporting required of companies Solving the Facebook Problem that conduct registered offerings. Unlike com- panies registering their securities offerings A privately held company automatically becomes subject to the full SEC regulatory regime under the under the Securities Act on Form S-1, an Exchange Act once it elects to register its initial public offering under the Securities Act. A privately held issuer selling securities under the Regulation company may also be required to register under the Exchange Act, if its assets and shareholder base A exemption from registration does not grows to a certain size. One of the more important changes included in the JOBS Act was to increase become subject to the full regulatory regime these Exchange Act registration thresholds to mitigate what has been known as the Facebook problem, under Section 12 of the Exchange Act, which a problem confronting many startups with large numbers of stockholders. Prior to the JOBS Act, Section automatically applies to issuers register ing 12(g) of the Ex change Act required that a company with more than $10 million in total assets register an offering under the Securities Act.27 Com - any class of securities held by more than 500 shareholders of record, whether accredited or not. This panies conducting registered offerings must Exchange Act registration triggers all of the SEC’s regulations governing publicly traded companies, file periodic reports—annual reports on Form including, among others, periodic reporting, insider security transaction reporting, proxy statement fil- 10-K, quarterly reports on Form 10-Q, and ing, and short-swing insider trading prohibitions. The JOBS Act raised the thresholds for registration current reports on Form 8-K—proxy state- (and termination) of registration for a class of securities under the Exchange Act. As a result, an issuer ments and beneficial ownership reports by that is not a bank, bank holding company, or savings and loan holding company is required to register the company’s officers, directors and 10-per- a class of equity securities if it has more than $10 million total assets and the securities are held of cent shareholders. record by either 2,000 or 500 persons who are not accredited investors. The JOBS Act also directed the The annual financial statement audit SEC to revise the definition of “held of record” to exclude securities held by persons who received the required of tier 2 Regulation A+ issuers need securities under an employee compensation plan in transactions exempted from registration under the not be performed by auditors who are regis- Securities Act. This last requirement addressed the Facebook problem. Prior to its IPO, Facebook, hav- tered with the Public Company Accounting ing more than $10 million in assets and more than 500 stockholders, decided to register its IPO under Board, which is a requirement for audits of the Securities Act because it would have been required to register its common stock under the SEC-registered companies. The six-month Exchange Act in any event. semiannual report required of Regulation A+ issuers need only contain financial state-
22 Los Angeles Lawyer December 2016 ments that management certifies are prepared .sec.gov (last visited Oct. 26, 2016). persons that the issuer reasonably believes come within in accordance with generally accepted ac - 4 See, e.g., Robert C. Pozen, JOBS Act: Jumpstarting the specified categories). Business or Bilking Investors?, BROOKINGS INST. (Apr. 16 National Securities Markets Improvements Act of counting principles in the United States. There 3, 2012), available at https://www.brookings.edu; The 1996, Pub. L. No. 104-290,110 Stat. 3416 (1996). is no requirement that the six-month financial JOBS Act Fails Investors and Entrepreneurs, N. Am. 17 Scott Baugess, et al., Capital Raising in the U.S.: statements in the semiannual report be re - Sec. Admins. Ass’n (Apr. 5, 2012) http://www.nasaa.org. An Analysis of the Market for Unregistered Securities viewed by an independent auditor, as required 5 The Uberization of Money, WALL ST. J., Nov. 4, 2015, Offerings, 2009-2014, SEC Div. of Econ. and Risk for quarterly reports of SEC-registered com- available at http://www.wsj.com. Analysis (Oct. 2015), available at https://www.sec.gov. 6 18 panies. The ongoing reporting regime for tier 15 U.S.C. §77d(a)(2). Keith F. Higgins, Dir., Div. of Corp. Fin., Keynote 7 SEC v. Ralston Purina Co., 345 U.S. 119 (1953); Final Address at the 2014 Angel Capital Association Summit, 2 Regulation A+ issuers also includes a “lite” Rule: Nonpublic Offering Exemption, SEC Release Wash., D.C. (Mar. 28, 2014), available at https://www current events requirement to report certain No. 33-4552 (Nov. 6, 1962). .sec.gov. specified events, including fundamental 8 Ralston Purina, 346 U.S. 119. 19 Final Rule: Eliminated the Prohibition Against changes in the issuer’s business, changes in 9 David B.H. Martin, Jr. and L. Keith Parsons, The General Solicitation and General Advertising in Rule control of the issuer, a departure of the prin- Preexisting Relationship Doctrine Under Regulation 506 and Rule 144A Offerings, SEC Release No. 33- D: A Rule Without Reason?, 45 WASH. & LEE L. REV. 9415 (July 10, 2013). cipal executive officer, principal financial 1031 (1988). 20 15 U.S.C. §77b(a)(11). officer, or principal accounting officer, and 10 Two surveys cited by the SEC last fall concluded 21 17 C.F.R. §230.502(d). any unregistered sales of 10 percent or more that the average initial compliance cost associated 22 17 C.F.R. §230.506(d). of outstanding equity securities.28 with conducting an IPO is $2.5 million, followed by 21 See Compliance and Disclosure Interpretations Restrictive securities laws in effect for the an ongoing compliance cost for issuers, once public, (CDIs), Securities Act Rules, §§256.23 – 256.33 (Aug. of $1.5 million per year. The SEC staff notes that 6, 2015), available at https://www.sec.gov/divisions 90 years prior to the JOBS Act made it diffi- these estimates should be interpreted with the caveat /corpfin/guidance/securitiesactrules-interps.htm [here- cult to start and finance businesses for those that most firms in the IPO Task Force surveys likely inafter CDIs]. For information regarding policies and who did not have access to capital sources raised more than $1 million. See IPO TASK FORCE, procedures for establishing a preexisting substantive or friends and family to provide funding. REBUILDING THE IPO ON-RAMP (Oct. 20, 2011), avail- relationship with prospective offerees over the Internet, The JOBS Act enables anyone to reach out able at http://www.sec.gov. see Citizen VC, Inc., SEC No-Action letter (Aug. 6, 11 available at to capital sources and raise equity capital. See David Weild and Edward Kim, Market structure 2015), http://www.sec.gov/divisions/corpfin is causing the IPO crisis—and more, GRANT THORNTON /cf-noaction/2015/citizen-vc-inc-080615-502.htm. But the “disintermediation” of Wall Street (June 2010), available at http://www. weildco.com. 24 See CDIs, Question 256.24. . places a heavier burden on the business attor- 12 See, generally, Rutherford B Campbell, Jr., The 25 See 17 C.F.R. §230.169; Securities Offering Reform, ney. Without professional financial interme- Plight of Small Issuers Under the Securities Act of SEC Release No. 33-8591 (July 19, 2005) [70 FR diaries, such as investment bankers, it will 1933: Practical Foreclosure from the Capital Market, 44722 (Aug. 3, 2005)] at 44731. 26 be up to business attorneys to navigate the DUKE L.J. 1139 (1977). See, e.g., Diskin v. Lomasney & Co., 452 F. 2d 871 13 17 C.F.R. §230.501. (2d. Cir. 1971). new securities rules and regulations to ensure 14 JOBS Act, §201(a)(1). 27 See 15 U.S.C. §78o(d); 15 U.S.C. §78m. that they and their clients follow the right 15 See 17 C.F.R. §230.501(a) (accredited investors are 28 See 17 C.F.R. §230.257. path. n [Editor’s note: In a subsequent issue of Los Angeles Lawyer, Part 2 of this article on the JOBS Act will discuss Title III Crowd - funding and how attorneys can counsel clients to raise capital while managing the securities law liability to their clients and themselves.]
1 Jumpstart Our Business Startups (JOBS) Act, Pub. L. No. 112-106, §§301–05, 126 Stat. 306, 315–23 (2012) (codified in scattered sections of 15 U.S.C.). 2 Equity crowdfunding involves investments in “secu- rities,” as the term is defined under the Securities Act of 1933 (Securities Act) and Securities Exchange Act of 1934 (Exchange Act). See §2(a)(1), 15 U.S.C. §77b(1); §3(a)(10), 15 U.S.C. §78c(a)(10). A “security” includes not only stocks, bonds, limited partnership and limited liability company membership interests, but also any “investment contract” that is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party….” SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). Prior to the JOBS Act, private offering exemptions from the Securities Act’s registration requirement did not allow for equity crowdfunding, which, by definition, involves a public offering to the crowd. 3 See, e.g., Chance Barnett, SEC Democratizes Equity Crowdfunding With JOBS Act Title IV, FORBES (Mar. 25, 2015), available at http://www.forbes.com; Crowdfunding: Decentralizing, Disintermediating, Disrupting, CROWDFUNDER INSIDER (Apr. 28, 2013), available at http://www.crowdfundinsider.com; Jumpstart Our Business Startups Act Frequently Asked Questions About Crowdfunding Intermediaries, U.S. Sec. & Exchange Comm’n (May 7, 2012), https://www
Los Angeles Lawyer December 2016 23 MCLE ARTICLE AND SELF-ASSESSMENT TEST By reading this article and answering the accompanying test questions, you can earn one MCLE credit. To apply for credit, please follow the instructions on the test answer sheet on page 27.
by TERENCE FLOYD CUFF Finding the PATH New partnership audit rules to be enacted in 2018 provide important changes to existing regulations that need to be considered in drafting current partnership agreements
IN 2015, President Barack than 100 partners.4 Obama signed in- Reacting to the IRS’s difficulty with audit- to law the Protecting Americans From Tax ing large partnerships, Congress passed the Hikes Act, which replaces the consolidat - new partnership audit rules in November ed partnership audit rules under the Tax 2015.5 However, these rules are not limited Equity and Fiscal Responsibility Act of 1982 to large partnerships but apply to practically (TEFRA).1 This act sets forth certain correc- all partnerships. They grew out of a bill that tions to the new partnership audit rules. languished in committee in Congress, but These rules, which become effective for most the impact of enforcing the new partnership partnerships beginning in 2018, impact not audit rules had a large revenue estimate and only audit procedures but the very essence they were attached to a budget bill, which of how partnerships are taxed. The delayed passed quickly. Consequently, the new rules effective date provides existing partnerships did not receive the benefit of extensive com- and limited liability companies taxed as part- mittee hearings, a written committee report, nerships the opportunity to amend their orga- and extensive comments. nizational documents—namely their partner- The new partnership audit rules are impor- ship or LLC agreements—in order to take tant for anyone who drafts partnership agree- the new partnership audit rules into account. ments or is a partner in a partnership (such Partnership and LLC agreement drafters as a law firm or accounting firm organized as should now take the new partnership audit a partnership). These rules generally go into rules into account in drafting new partnership effect in January 2018;6 however, currently and LLC agreements.2 drafted partnership agreements should take The risks of a general partnership, limited the new partnership audit rules into account. partnership, or limited liability company Current audit rules (the TEFRA audit rules)7 being audited by the Internal Revenue Service will remain in effect until the effectiveness of are low. For example, in fiscal year 2015, the new partnership audit rules.8 only 19,212 partnerships were audited.3 Three terms and three features are par- Moreover, IRS partnership audits are often superficial. The IRS has identified particular Terence Floyd Cuff practices partnership tax law difficulty auditing partnerships with more at Loeb & Loeb, LLP in Los Angeles.
24 Los Angeles Lawyer December 2016 ticularly important un - nership tax return and der the new partnership the partner’s Schedule K- audit rules. The terms 1.20 The IRS then can are: 1) a partnership use an expedited proce- representative is the per- dure to assess and collect son designated by the a resulting underpay- partnership to handle ment from the partner the partnership audit, as a math error.21 2) the reviewed year is The IRS audits the the year under audit, partnership at the part- and 3) the adjustment nership level rather than year is the year in which auditing the partners the IRS audit is con- individually on partner- cluded. ship matters.22 The new The first important rules provide that any feature of the new part- audit adjustment must nership audit rules is be made in a partnership that they provide for an audit.23 The IRS assesses IRS audit of the part- the deficiencies in tax, nership as an entity interest and penalties rather than for audits against the partnership of partner operations rather than the part- at the individual part - ners.24 Moreover, the IRS ner level.9 Partners are assesses the deficiency bound by the result of against the partnership the partnership audit. at an assumed tax rate.25 The new rules, how ever, The IRS assesses an may result in fewer part- underpayment of tax nership audits as many against the partner ship more partnerships may in the adjustment year, elect out of the new not in the reviewed partnership audit rules. year.26 This revolution- Second, the new ary development can re - partnership audit rules sult in adjustment-year provide for a partner- partners bearing the tax ship representative.10 effects of mistakes that The partnership repre- the partnership made in sentative is the tax audit the reviewed-year return. czar. The partnership A skillfully drafted part- representative is the sole nership agreement can representative of the partnership in the IRS drafter. The drafter should deal with the require reviewed-year partners to reimburse audit.11 The partnership representative can problem that the partnership may be paying the partnership for the tax that the IRS agree to an audit settlement that binds the taxes that in theory should be paid by the assesses against the partnership. partnership and all the partners. The part- reviewed-year partners. The new partnership audit rules calculate nership representative is the only one who The new partnership audit rules create the imputed underpayment—the partnership’s can agree to this settlement. Also, the part- three classes of partnerships. Some partner- tax liability resulting from audit adjust- nership representative can extend the part- ships will elect out of the new partnership ments—at the highest individual or corporate nership’s statute of limitations.12 The part- audit rules.16 Some partnerships rules will tax rates.27 The imputed underpayment can nership and every partner is bound by actions be subject to consolidated partnership audits, be reduced on account of tax-exempt partners taken under the new partnership audit rules and the partnership will pay tax on account and other adjustments.28 The partnership by the partnership acting through the part- of audit adjustments.17 Some partnerships may seek further to reduce the imputed under- nership representative.13 The partnership and will be subject to consolidated partnership payment amount 1) by providing information every partner is bound by any final decision audits, but these partnerships will push out about the tax status of partners (such as tax- in a proceeding brought under the new part- adjustments to reviewed-year partners.18 The exempt partners) and about the nature and nership audit rules.14 reviewed-year partners will pay the resulting amount of items of income or gain, 2) by Third, the IRS assesses any tax deficiency tax in the tax years in which they receive reviewed-year partners filing amended returns at the end of the audit—the imputed under- notice of the adjustments. with payment of the adjusted tax, or 3) on payment—against the partnership rather than Under the new partnership audit rules, the basis of other factors in future regulations against the partners.15 This can transfer the each partner is required to report partnership or guidance.29 burden of tax audit adjustments from re- items on the partner’s personal return in a Future U.S. Treasury regulations will clar- viewed-year partners to adjustment-year part- manner that is consistent with the treatment ify the precise rules for calculating imputed ners. Dealing with fairly apportioning this of the item on the partnership return.19 A underpayments. The rules may take into burden among the partners can be an impor- partner nevertheless may report partnership account types of persons who are partners
RICHARD EWING tant task for the partnership agreement items in a manner inconsistent with the part- and their maximum tax rates, tax-exempt
Los Angeles Lawyer December 2016 25 partners, foreign partners, partners that are idated audit rules.36 “Small partnerships” were ed as part of an individual partner audit. flow-through entities, character of income defined as partnerships that passed two tests. That audit is difficult for the IRS to under- (tax-exempt, ordinary, capital gains), loss First, the partnership must have 10 or fewer take. limitations of various types (at-risk, passive partners at all times during the tax year.37 A The IRS may try to audit all partners. An losses, and so forth), and other adjustments married couple filing jointly and their estates IRS audit of the partnership through separate as provided in regulations.30 are treated as one partner.38 Second, all part- individual audits of the partners may be prac- Many uncertainties still exist about how ners must be U.S. persons, resident aliens, C tical if all partners live in the same IRS district. regulations will compute the imputed under- corporations (not an S corporation), or estates Then, IRS partner audits can be assigned to payment. One of the harsher rules for com- of deceased partners.39 the same auditor. The IRS audit may proceed puting imputed underpayments applies when The new partnership audit rules expand as a lead audit of a partner, with audits of the IRS audit reallocates income or loss from the class of partnerships that can elect out other partners suspended until the lead audit one partner to another.31 The reallocation of the new partnership audit rules to include is resolved. Coordinating IRS individual part- does not result in a new income increase to many partnerships with 100 or fewer quali- ner audits is more difficult if partners live in the partnership. The imputed underpayment fying partners.40 The nonconsolidated IRS different IRS districts, which is often the case. is based on the increased income (or decreased audit of this type of partnership creates great Each partner (or the partner’s accountant loss) allocation to the partner to whom difficulties for the IRS.41 No single person or the partner’s counsel) represents himself income is reallocated and does not provide speaks for the partnership in a nonconsoli- in the partner’s individual IRS audit. Each an offset for the decreased income (or in - dated audit. partner may take the partner’s own tax posi- creased loss) allocated to another partner.32 The nonconsolidated IRS audit may pose tion on partnership tax issues. Each partner The new partnership audit rules also fail difficulties for the partners and the partner- may make the partner’s own arguments to to clarify whether capital account adjustments ship. An audited partner may believe that the IRS. The IRS reaches a settlement on a for audit adjustments are made in the re- the partnership should contribute to funding partner-by-partner basis. Individual partner viewed year or in the adjustment year. Audit the partner’s audit expenses. Also, the part- audits can lead to inconsistent audit results adjustments presumably are usually allocated nership may fail to cooperate with the part- or inconsistent court decisions. to partners in accordance with partners’ inter- ner’s information requests. The partnership Election out of the new partnership audit ests in the partnership.33 The new rules do may deny the partnership partners access to rules will be the solution for many partner- not clarify whether audit adjustments to part- partnership records or employees. The part- ships. However, the new partnership audit ners’ bases in their partnership interests are nership agreement drafter may appropriately rules also permit the partnership to push out made in the reviewed year or in the adjust- address these issues. adjustments to the tax returns of reviewed- ment year. Furthermore, they do not clarify A partnership of 100 or fewer qualifying year partners for the year in which they how to account for the partnership’s payment partners42 may elect out of the new partner- receive statements of the adjustments. The of the imputed underpayment. ship audit rules if each partner is an individual, re viewed-year partners then pay the additional a deceased partner’s estate, a C corporation, tax resulting from the audit adjustments in Election Out a foreign entity that would be required to be the year in which the partners receive state- Many partnerships with 100 or fewer qual- treated as a C corporation if it were a domestic ments of the adjustments.47 ifying partners will be able to elect out of entity, or an S corporation.43 The push-out election requires the part- the new partnership audit rules.34 The election This list of permitted partners does not nership to be diligent. The partnership has out can result in partnership activities being contain trusts or partnerships. Certain trusts, 45 days after receiving the final notice of included as part of a partner audit. These and perhaps some partnerships, may be per- partnership adjustments within which to audits will be conducted under the partner- mitted as qualifying partners under future make the push-out election.48 The partnership level audit rules that applied to pre-TEFRA regulations. The law has not yet resolved must issue a statement of adjustments to the audits. whether disregarded entities are qualifying reviewed-year partners showing their revised Many partners will prefer this IRS part- partners.44 Any partner who is not on this distributive shares as determined in the ner-level audit to a partnership-level audit. list and not permitted by future regulations audit.49 The reviewed-year partners then will Election out will mean that the partnership may disqualify the partnership from electing include the audit adjustments in computing will not be audited in a consolidated pro- out of the new partnership audit rules. tax liability for their tax years in which they ceeding. The IRS then can audit partnership The election out of the new partnership receive the statement of adjustments from activities only as part of a partner-level audit. audit rules must be made with a timely filed the partnership.50 Auditing the partnership through separate return for the taxable year.45 Election out is The election to push out adjustments is partner audits is considerably more cumber- made on a year-by-year basis. The partnership likely to be popular for partnerships that some for the IRS than a consolidated part- must include the name and taxpayer identi- cannot elect out of the new partnership audit nership audit; an IRS partner-level audit is fication number of each partner of the part- rules. Any partnership may make the push- not likely to include a comprehensive audit nership in the election out.46 out election. Under this alternative, the part- of partnership activities. Partners may look A partnership agreement may impose nership furnishes each reviewed-year partner to the election out as a practical manner in transfer restrictions on partners to ensure a statement of the reviewed-year partner’s which to escape effective IRS audit of part- that every transferee partner qualifies for the share of the audit adjustments—similar to nership activities. Indeed, TEFRA was intro- partnership to make the election out under Schedule K-1.51 Each reviewed-year partner duced in significant part on account of the the new partnership audit rules. These transfer increases its tax on account of the pushed- difficulty that the IRS had in auditing part- restrictions may be an important part of a out adjustments for the year in which the part- nerships through partner-level audits. The well-drafted partnership agreement. ner receives the statement of adjustments.52 IRS indicated that it needed to audit part- An election out of the new partnership Many questions linger concerning how nerships on a consolidated basis.35 audit rules may give the partnership practical the push-out election will work, particularly TEFRA provided for the ex clusion of cer- immunity from an effective IRS audit. The when a partner is in a tiered partnership. tain small partnerships from TEFRA-consol- partnership activities technically can be audit - The first-tier partner may have to pay tax
26 Los Angeles Lawyer December 2016 MCLE Answer Sheet #263 MCLE Test No. 263 FINDING THE PATH
The Los Angeles County Bar Association certifies that this activity has been approved for Minimum Continuing Name Legal Education credit by the State Bar of California in the amount of 1 hour. You may take tests from back issues online at http://www.lacba.org/mcleselftests. Law Firm/Organization
1. The new partnership audit rules apply to all part- character and then are taxed at a specified tax rate Address nership audits for taxable years beginning after that can be modified by the IRS. City December 31, 2015. True. State/Zip True. False. False. E-mail 12. If the partnership elects out of the new partnership Phone 2. The scope of the new partnership audit rules is lim- audit rules, the partners must cooperate and agree State Bar # ited to partnerships with more than 100 partners. on the tax arguments that they will make in audit. True. True. INSTRUCTIONS FOR OBTAINING MCLE CREDITS False. False. 1. Study the MCLE article in this issue. 3. If a partnership elects out of the new partnership 13. If the partnership makes the push-out election, it 2. Answer the test questions opposite by marking audit rules, the IRS audit must be conducted under must do so within 60 days of the partnership’s receiving the appropriate boxes below. Each question the TEFRA audit rules. notice of institution of the partnership audit. has only one answer. Photocopies of this True. True. answer sheet may be submitted; however, this False. False. form should not be enlarged or reduced. 4. Any partnership with 100 or fewer partners can elect 14. The partnership must inform reviewed-year partners 3. Mail the answer sheet and the $20 testing fee ($25 for non-LACBA members) to: out of the new partnership audit rules. of their partnership audit adjustments as a condition True. to the partnership making the push-out election. Los Angeles Lawyer MCLE Test False. True. P.O. Box 55020 False. 5. The new partnership audit rules provide for the Los Angeles, CA 90055 partnership representative to receive reasonable com- 15. Under the new partnership audit rules, an audit Make checks payable to Los Angeles Lawyer. pensation for his services in the partnership in the settlement agreement with the IRS must be approved 4. Within six weeks, Los Angeles Lawyer will partnership audit. by the partnership and the partnership representa- return your test with the correct answers, a True. tive. rationale for the correct answers, and a False. True. certificate verifying the MCLE credit you earned through this self-assessment activity. False. 6. The partnership’s accountant or attorney can be 5. For future reference, please retain the MCLE selected as the partnership representative. 16. TEFRA rules cease to apply to existing partnership test materials returned to you. True. audits after 2017. ANSWERS False. True. False. Mark your answers to the test by checking the 7. The new partnership audit rules provide that the appropriate boxes below. Each question has only general partner of a limited partnership has the right 17. The new partnership audit rules require that a one answer. to remove the partnership representative. partner report his partnership tax items in accordance True. with the treatment of those tax items on the partnership 1. n True n False False. return. 2. n True n False True. 8. The new partnership audit rules permit the part- 3. n True n False False. nership to elect to push out audit adjustments to 4. n True n False adjustment-year partners, who then are required to 18. The election out of the new partnership audit rules 5. n True n False pay tax on the audit adjustments. must be made within 30 days of notice of institution 6. True False True. of an IRS audit. n n False. True. 7. n True n False False. 8. n True n False 9. The new partnership audit rules clarify that the partnership can push out audit adjustments to the 19. The IRS can use an expedited procedure to assess 9. n True n False ultimate taxpaying partners through tiers of partner- a partner’s tax liability as a math error if the partner 10. n True n False ships that are partners in the audited partnership. reports an item in a manner inconsistent with the part- 11. n True n False True. nership return. 12. n True n False False. True. False. 13. n True n False 10. Under the new partnership audit rules, the IRS 14. n True n False has the option of making adjustments in a partner’s 20. A partnership under audit under the new partner- share of partnership items either in the audit of the ship audit rules may be able to reduce its imputed 15. n True n False partnership or in an audit of the partner. underpayment by reviewed-year partners filing 16. n True n False True. amended returns with payment of the adjusted tax. 17. n True n False False. True. 18. n True n False False. 11. In computing the imputed underpayment, income 19. n True n False and losses are netted together without considering 20. n True n False
Los Angeles Lawyer December 2016 27 on account of pushed-out adjustments, or aging member is not necessarily the best litigation budget, engagement and supervision perhaps the first-tier partner may be able to choice for partnership representative, al - of accountants and counsel for the IRS audit, push out the audit adjustments through suc- though the general partner or managing and indemnification of the partnership rep- cessive tiers of partners that are partnerships. member should be a common choice. resentative. Also, a partnership or LLC agreement may An LLC manager, an officer, or an em - Drafters of partnership agreements should bind the partnership to push out partnership ployee could serve as the partnership repre- also consider a provision that requires the adjustments to reviewed-year partners under sentative. If so, the partnership agreement partnership representative to propose audit the new partnership audit rules. These ques- should impose reasonable controls over the and litigation strategy guidelines for approval tions will have to wait for regulations for partnership representative so that he or she in advance by the partnership management resolution. truly serves the interests of the partnership. and to undertake the audit and litigation in The drafter of a partnership agreement The professional partnership representa- accordance with those audit and litigation for a partnership that plans to elect out of tive may emerge from within the ranks of strategy guidelines. The partnership agreement the new partnership audit rules should con- the partnership. For example, accountants could also provide that the partnership rep- sider whether the partnership should make or attorneys may serve as partnership repre- resentative must make written filings with a financial contribution to audit defense and sentatives. Serving as partnership represen- the IRS or with a court only after seeking whether partners and the partnership should tative will create new challenges for accoun- prior review and approval by partnership agree to cooperate with the audited partner tants and attorneys. management. in the audit. The Internal Revenue Code provides the In addition, the partnership agreement A partnership agreement for a partnership partnership representative with broad deci- could require that the partnership represen- that plans to make a push-out election should sion-making power.56 More over, the part- tative give partnership management prior address: 1) how the partnership will approve nership representative is not necessarily a notice of meetings with or appearances before the push-out election; 2) funding the audit simple agent of the partnership.57 Yet, for the IRS or other governmental authorities, (including funding after dissolution of the these reasons a partnership representative court appearances, and filing dates. The part- partnership); 3) appointing, removing, and should confirm that his or her errors and nership agreement could require that the replacing the partnership representative; 4) omissions policy will cover the activities per- partnership representative make regular and responsibilities of the partnership representa- formed in this role. as-needed written and oral reports to part- tive; 5) limitations and controls on the part- The partnership representative should be nership management and written reports to nership representative; 6) expenses of the part- someone with integrity who can interact in a the partners on audit status, trial status, legal nership representative; and 7) indemnification professional manner with the IRS and under- research, expert reports, witnesses, deposi- of the partnership representative. The part- stand the tax laws or should at least have the tions, electrically stored information issues, nership agreement also might require partner capacity to learn enough about the tax laws discovery assessment, discovery disputes, cooperation with the partnership audit. to direct the audit intelligently. The partnership motions, answers, opening and closing state- representative also should be someone who ments, jury instructions, proposed facts and Partnership Representative will follow directions from the partnership conclusions or law, proposed orders, conduct The partnership acts through its partnership management. In general, because the part- of the trial or audit, settlement negotiations, representative. The partnership representative nership representative has broad discretion settlement conferences, and appeal activity. has the sole authority to act on behalf of the in the partnership audit and subsequent court The partnership agreement should address partnership in the partnership audit, in par- proceedings, the partnership should select how to fund the audit, including after a liq- ticular to enter into agreements with the IRS someone who is reliable and able to direct uidation of the partnership. The partnership in connection with the audit.53 The settlement partnership tax litigation as well as possesses agreement could allocate partnership audit agreement between the partnership represen- the temperament and knowledge to be a suc- expenses among both reviewed-year partners tative and the IRS binds the partnership and cessful leader in an audit. and adjustment-year partners, and address the partners.54 Finally, since partnership audits and sub- how the partnership will fund audit expenses The partnership representative in theory sequent administrative and judicial proceed- and any imputed underpayment. Also impor- may be anyone who has “a substantial presence ings can take many years to resolve, the part- tant is partner cooperation with partnership in the United States.”55 While uncertainty nership representative should be someone audits. A partner otherwise may fail to pro- exists concerning what this means, the concept young enough that he or she will be effective vide needed information to the partnership presumably will be clarified in regulations. through the term of the audit. during an audit. The partnership representative typically will A partnership agreement for a partnership A partnership agreement could merely be a managing partner, managing member, that may be subject to IRS audits under the provide that the partnership will elect out of general partner, another partner or LLC mem- new partnership audit rules should contain the new partnership audit rules. The part- ber, or the LLC manager. The partnership rep- provisions that specifically address the part- nership agreement also may restrict transfers resentative also may be a partnership employee. nership representative. In addition to stating of partnership interests to qualifying partners Some partnerships will choose counsel or an the partnership representative’s qualifications, who will permit an election out of the new accountant as a partnership representative. these provisions may address rules for the partnership audit rules. Further, this agree- The partnership also may appoint a profes- position, including the partnership represen- ment may provide for a partnership call on sional partnership representative. tative’s selection, resignation, removal, and a transfer of a partnership interest not com- The natural selection of partnership rep- replacement; compensation;58 powers and plying with requirements for permitted trans- resentative for many partnerships will be the limitations on these powers; and the relation- ferees, and even provide for forfeiture of the general partner or managing member. How - ship between the partnership representative partnership interest transferred in defiance ever, passive investors should consider the and partnership management. The partnership of partnership transfer restrictions. The part- possibility of conflicts that may develop agreement also might address man agement nership agreement should also require the between partners and the partnership repre- approval of decisions of the partnership rep- partnership and the partner to cooperate sentative. Thus, the general partner or man- resentative, preparation and approval of a with a partner under audit.
28 Los Angeles Lawyer December 2016 The proposed regulations on the new Representatives James B. Renacci (R-Ohio) and Ron 29 Id. partnership audit rules may not appear for Kind (D-Wisconsin). 30 See id. 6 Bipartisan Budget Act of 2015 (Pub. L. No. 114-74) 31 I.R.C. §6225(b)(2). months. However, enough information is §1101(g) (2015). While the new partnership audit 32 Id. currently available that partnership agreement rules generally go into effect in January 2018, the 33 Treas. Reg. §1.704-1(b)(2)(iv), (3). drafters can address partnership agreement Treasury has published regulations that permit a part- 34 I.R.C. §6221(b). provisions to govern partnership audits. nership to elect into the new partnership audit rules 35 See JOINT COMMITTEEON TAXATION, GENERAL Agree ing to these provisions well in advance prior to the normal effective date in 2018. T.D. 9780, EXPLANATION OF THE REVENUE PROVISIONS OF THE TAX of 2018 may make it easier for the partners 81 Fed. Reg. 51795-51798 (Aug. 5, 2016). EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982 (JCS- 7 TEFRA rules are found at I.R.C. §6221-55. 38-82), at 268 (Dec. 31, 1982). to reach agreement than waiting until an IRS 8 The new partnership audit rules, found in I.R.C. 36 I.R.C. §6231 (under TEFRA). audit has been instituted. n §§6221-35, replace the prior rules under TEFRA found 37 I.R.C. §6231(a)(1)(B)(i) (under TEFRA). in I.R.C. §§6221-55. Citation to these I.R.C. sections 38 Treas. Reg. §301.6231(a)(1)-1(a)(1) (under TEFRA). 39 1 See Bipartisan Budget Act, Pub. L. No. 114-74, are to the new partnership audit rules except as stated I.R.C. §6231(a)(1)(B)(i) (under TEFRA). 40 §1101, 129 Stat. 584 (2015). Section 1101 repeals otherwise. I.R.C. §6221(b)(1)(B). 9 41 the current rules governing partnership audits with I.R.C. §6221(a). See JOINT COMMITTEEON TAXATION, GENERAL 10 a new centralized partnership audit regime that, in I.R.C. §6223. EXPLANATION OF THE REVENUE PROVISIONS OF THE TAX 11 general, assesses and collects tax at the partnership Id. EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982 (JCS- 12 level. On the new audit provisions generally, see Id. 38-82), at 268 (Dec. 31, 1982). 13 42 New York State Bar Association, Tax Section, Report I.R.C. §6223(b)(1). The partnership is required to furnish 100 or fewer 14 No. 1347, “Report on the Partnership Audit Rules I.R.C. §6223(b)(2). statements under Section 6031(b) to its partners. 15 43 of the Bi partisan Budget Act of 2015” (May 25, I.R.C. §6225. I.R.C. §6221(b)(1)(C). 16 44 2016). The prior audit rules are contained in I.R.C. I.R.C. §6221(b). See I.R.C. §6221(b)(2)(C). 17 45 §§6221–55. I.R.C. §§6221, 6225. I.R.C. §6221(b)(1)(D) 18 46 2 References herein to partnerships include LLCs treated I.R.C. §§6221, 6225, 6226. Id. 19 47 as partnerships for federal income tax purposes. I.R.C. §6222(a). See I.R.C. §6226. 20 48 3 See TREAS. INSPECTOR GEN’L FOR TAX ADMIN., TRENDS The partner's Schedule K-1 is an information return I.R.C. §6226(a)(1). 49 IN COMPLIANCE ACTIVITIES THROUGH FISCAL YEAR 2015, that the partnership gives the partner each year to I.R.C. §6226(a)(2). 50 No. 2016-30-073 (Sept. 8, 2015). One in every 196 report the partner's distributive share of partnership I.R.C. §6226(b)(1). 51 partnership returns was examined in fiscal year 2015. income and loss. I.R.C. §6226(a)(2). 21 52 This table shows the IRS’s rate of audit of partnership I.R.C. §6222(b). I.R.C. §6226(b). 22 53 tax returns: I.R.C. §6221(c). I.R.C. §6223. Fiscal Number of Percentage of 23 I.R.C. §6221(a). 54 Id. Year Returns Partnership Audited 24 Id. 55 I.R.C. §6223(a). 2011 13,770 0.42% 25 I.R.C. §6225. 56 I.R.C. §6223(b)(1). 2012 16,691 0.48% 26 I.R.C. §§6225, 6232. 57 See id. 2013 14,870 0.42% 27 I.R.C. §6225. 58 The new partnership audit rules do not address 2014 15,779 0.36% 28 I.R.C. §6225(c). compensation of the partnership agreement. 2015 19,212 0.40% 4 See Statement of James R. White, Director, Strategic Issues, Government Accounting Office, Large Part - nerships: Growing Population and Complexity Hinder EMPLOYMENT LAW REFERRALS Effective Internal Revenue Service Audits, GAO-14- 746T, 2014 TNT 141-30 (Jul. 22, 2014); Government Paying Highest Referral Fees (Per State Bar Rules) Accountability Office, Large Partnerships: With Growing
Number of Partnerships, IRS Needs to Improve Audit Efficiency, GAO-14-732, at 19, 2014 TNT 182-27 (Sept. 18, 2014); Government Account ability Office, Honored to receive regular employment referrals from Part nerships and S Corporations: IRS Needs to Improve over 100 of Californiaʼs fi nest attorneys Information to Address Tax Non compliance, GAO- 14-453, 2014 TNT 115-47 (May 2014); letter, dated Stephen Danz 877.789.9707 March 19, 2014, from James R. White, Director, Tax & Associates Issues, Strategic Issues, Gov ernment Accountability Main offi ce located in Los Angeles and nearby offi ces in Pasadena, Office, to The Honorable Ron Wyden, Chairman, Orange County, Inland Empire & San Diego Committee on Finance, United States Senate, The Stephen Danz, Senior Partner 11661 San Vicente Boulevard, Suite 500, Los Angeles, CA 90049 Honorable Carl Levin, Chairman, The Honorable John McCain, Ranking Member, Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, United States Senate, re: Large Partnerships: Char acteristics of Population and IRS Audits, GAO-14-379R, 2014 TNT 75-13 (Mar. ROSS MEDIATION SERVICES 19, 2014); written testimony of IRS Commissioner John A. Koskinen before the Senate Finance Committee on Integrity Commitment Success IRS Budget and Current Operations, 2016 TNT 28 SPECIALTY AREAS (Feb. 3, 2015); Depar tment of the Treasury, General Explanations of the Administration’s Fiscal Year 2015 • Real Estate • Business/Commercial Revenue Proposals (Mar. 2014). • Mortgage & Lending • Escrow/Title/Agency 5 These rules are contained in I.R.C. §§6221–35. These • Trusts & Estates • Workplace provisions were passed as part of the Bipartisan Budget • Construction • Multi-Party Act of 2015 (H.R. 1315). These rules are based on Personal Injury Professional Liability earlier proposals by Ways and Means Committee • • Chair Dave Camp included in the Tax Reform Act of BARRY ROSS,ESQ., MBA 2014 (H.R. 1) and Senator Carl Levin included in the Partnership Auditing Fairness Act (S. 3018). Partnership (818) 840-0950 audit reform proposals were included in the Partnership www.ROSSmediation.com Audit Simplification Act (H.R. 2821) proposed by
Los Angeles Lawyer December 2016 29 by MANNY MEDRANO and RALPH FRAMMOLINO
DAMAGE CONTROL IN THE TMZ ERA
In the digital age, managing the public opinion aspects of legal disputes is integral to an overall litigation strategy
HOURS after three people opinion-laced news websites—threatened to With judges, clerks, and potential jurors died in an Arizona overwhelm their case and leave their client’s armed with smartphones, attorneys now find sweat lodge, attorney Luis Li saw the news career and reputation forever ruined.3 themselves in a courtroom without walls. flash across the elevator video feed as he was “High-stakes cases are often fought be - Only in these halls of cyber “justice,” impres- riding to his 35th floor office at Munger, fore a judge or jury and in the court of public sions prevail over arguments and instant Tolles & Olson in downtown Los Angeles. opinion,” said Li, a former assistant U.S. karma trumps due process, making it more By then, CNN, ABC, Dateline NBC, and the attorney who specializes in white-collar de - important than ever that attorneys engage usual news outlets had gathered the available fense and corporate crisis management. “To and step up to represent clients in the court facts and produced a narrative that went effectively advocate on behalf of a client— of public opinion, as well as in the court of viral on social media: the dead had been vic- whether it is a business or an individual— law. tims of a bizarre new-age ritual conducted lawyers must focus on winning both battles. This also applies to lesser-known clients, by James Arthur Ray, identified in the stories And today, that court of public opinion is who in the past may have escaped the scrutiny as a new age cult leader.1 highly skewed by social media.”4 of traditional media. Today’s social media That “cult leader”—a motivational speaker As the Ray case illustrates, lawyers now, and New York Times bestselling author, who more than ever, have to factor in how the Manny Medrano is a former assistant U.S. attorney was featured in the 2006 documentary film Internet and social media affect their clients and Emmy award-winning television journalist The Secret2—became Li’s client. For the next long-term, as well as the case at hand. Never who specializes in criminal defense as a partner 18 months, as they prepared a legal defense, before has it been so easy to contaminate a in the Los Angeles law firm of Medrano & Carlton. Li and his colleagues found themselves bat- jury pool, shame an opponent into settling Ralph Frammolino, a former Los Angeles Times tling to neutralize a public narrative that— a case, or discredit an opponent’s argument investigative reporter and Pulitzer Prize finalist, amplified through Facebook, Twitter and before court is called to order. is a senior executive at G.F. Bunting + Co. KEN CORRAL
30 Los Angeles Lawyer December 2016
Furies are notorious for plucking mere mor- practice, which Friedberg added, is thriving about their clients.21 tals from obscurity and ravaging them for thanks to an influx of hunting sympathizers Conceived in a pre-TMZ era of relative real or perceived injustices. as new clients.14 media innocence, this compromise worked Just ask Walter Palmer, who had enjoyed Friedberg’s blanket “no comment” policy well as long as newspapers, television, and a quiet existence as a Minneapolis dentist long had been considered industry-best prac- radio dominated legal coverage. Attorneys and recreational hunter until he bagged Cecil tices for attorneys, no matter the case. Then could go about their business, stepping outside the lion during an African safari last year. came Gentile v. State Bar of Nevada,15 a their advocate role in court if and when they News of Cecil’s death exploded over the watershed U.S. Supreme Court decision that had to exercise damage control or correct Internet and by the time a Zimbabwean court first articulated the theory that a lawyer has the public record in high-profile cases. The concluded three months later that Palmer a duty to protect his or her client’s reputation O. J. Simpson case, however, raised the media did nothing illegal, it almost did not matter. outside the courtroom. stakes.22 The slow-speed freeway chase of The cyber mob had passed judgment, raining The 1991 case involved a Las Vegas crim- the white Ford Bronco marked the tabloidiza- down death threats, destroying Palmer’s Yelp inal defense attorney who called a press tion of legal coverage. With it came the rise reviews with posts calling him a “disease” conference to denounce a pending indictment of a new class of talking heads—attorneys- and “piece of filth,” driving him into hiding of his client for allegedly stealing drugs and turned-commentators. Daily coverage of the for weeks and harassing his family. 5 Palmer’s $300,000 from a police safe. The attorney, legal twists and turns stoked the public’s infamy was enshrined in a Wikipedia page Dominick Gentile, assembled reporters to appetite for news about court cases, with dedicated to Cecil’s death. 6 It inspired a ban say his client was a “scapegoat” and that trial reports delivering enormous ratings for on the transport of hunting trophies by three the real culprits were “crooked cops.”16 His newly launched 24-hour news channels and major airlines,7 calls by one congresswoman client was acquitted at trial six months later, Court TV. for a federal investigation,8 the addition of but the Nevada State Bar sanctioned Gentile Then came Twitter, Facebook, TMZ, the lion subspecies to the U.S. Endangered for violating a Nevada Supreme Court rule Wikipedia, Google, WordPress, YouTube, Species list,9 and passage of a nonbinding against making extrajudicial statements that Bing, Myspace, Yelp, and Tumblr. New Web- resolution by the United Nations General risked prejudicing a court proceeding. Gen- based platforms and social networking chan- Assembly calling for greater controls on illicit tile appealed. The Nevada Supreme Court nels began vying for public attention, chal- game hunting.10 upheld the ruling, but the U.S. Supreme lenging legacy media for dominance, and It also generated nasty telephone calls to Court reversed, finding Nevada’s rule uncon- forever changing journalism—including even his attorney, Joseph S. Friedberg, who has stitutionally vague.17 In a powerful four- routine coverage of the law. What for decades practiced law for more than 50 years.11 “I member minority opinion,18 Justice Anthony was a fairly genteel, if somewhat tense, dance can represent five baby killers and not get Kennedy articulated a new standard for between lawyers and reporters devolved into the kind of reaction I got from this,” he said, lawyers, writing: the equivalent of a United Fighting Cham - adding that the public fallout was so “incom- An attorney’s duties do not begin inside pionship brawl—with the crowd pouring prehensible” that even one local crisis com- the courtroom door. He or she cannot into the ring. With the cost of publishing munications specialist backed out of a ignore the practical implications of a reduced to the price of a cellphone, armies promise to help “because the public relations legal proceeding for the client. Just as of bloggers and “citizen journalists” un - would be bad for his PR firm.”12 an attorney may recommend a plea leashed deluges of blogs and posts that mixed Friedberg said he stayed with the tradi- bargain or civil settlement to avoid news with opinion, analysis with outrage. tional advice of urging his client to keep quiet the adverse consequences of a possible As satirist and political commentator Stephen until the court of public opinion went on to loss after trial, so too an attorney may Colbert wryly noted, the facts are no longer another matter. “As much as it takes longer take reasonable steps to defend a important in journalism: Truth was out, for the social media and Internet to calm client’s reputation and reduce the “truthiness” is in.23 down, and there’s an indelible record made, adverse consequences of indictment, Social media also transformed news gath- the foam goes away rapidly as soon as there’s especially in the face of a prosecution ering from an inclusive process, in which another tragedy in the world,” said Friedberg, deemed unjust or commenced with reporters sought responses from all sides who regards the digital echo chamber as just improper motives. A defense attorney before submitting their stories to an iterative a quicker way for lawyers and clients to get may pursue lawful strategies to obtain one with journalists racing to post short sto- themselves in trouble by making ill-advised dismissal of an indictment or reduction ries first, then adding details and quotes statements.13 of charges, including an attempt to throughout the day. These various platforms It was Palmer himself who eventually demonstrate in the court of public tended to reward those who spoke quickly, demanded breaking the silence with a bit of opinion that the client does not deserve not necessarily accurately. Mistakes, mis- remedial public relations. “He was quite con- to be tried.19 quotes, and malevolent stories that once cerned about his reputation and the people In 1994, the American Bar Association lasted a news cycle became enshrined forever who knew him, loved him, and supported followed suit. Rule 3.6 of its code of profes- in online search results. him—what they would think if he never said sional conduct had prohibited any out-of- These cultural and technological shifts anything,” said Friedberg, who reluctantly court statements by counsel, fearing that any have scrambled the news cycle, replacing it helped his client find a fair-minded Min - and all extrajudicial utterances might fan with a gusher of mashed-up “content.” Much neapolis Star-Tribune reporter for Palmer’s media coverage that compromised a defen- of it is benign, such as cat videos, or enlight- only media availability. Even then, Friedberg dant’s Sixth Amendment rights.20 Following ening, like cellphone videos of Arab Spring permitted the interview to take place only Gentile, the ABA amended the rule in two protests. Some of it, however, is dicey material when it became clear Palmer would face no important ways. First, it narrowed the pro- that—amplified by Twitter, Facebook, and criminal charges in the United States or Africa. hibition to apply only to those attorneys others—creates an instant scandal capable of Since his single media availability, the dentist involved in the proceedings in question. bringing a reputable company to its knees. has turned down “very, very friendly national Second, it allowed those attorneys the right Washington-based crisis consultant Eric TV interviews” and quietly returned to his to reply to correct negative publicity generated Dezenhall calls this the “glass jaw” effect,
32 Los Angeles Lawyer December 2016 similar to when a seemingly invincible fighter According to a survey of more than 1,000 making a career comeback with a personal is knocked out by a sucker punch from a Chicago residents, 62 percent believed a com- narrative that embraced his fall from grace weaker opponent.24 pany accused of wrongdoing in a lawsuit as a transformative event—told on a website A case in point is the Lennar Corporation, was guilty if it issued a statement of “no that also offered audio books, life coaching, the nation’s second largest homebuilder. In comment.” If, however, the company pro- and his services as a motivational speaker.36 January 2009, executives watched in horror vided a “clear, timely and detailed explana- With the complexities of today’s media as the stock price went into freefall after a tion” of its behavior and position, 81 percent landscape, some firms hire outside consul- San Diego outfit called the Fraud Discovery said they would keep an open mind about tants to help shape the public narrative as Institute issued a press release and two the company’s culpability.29 part of the legal strategy. Similar to accoun- YouTube videos accusing the Fortune 500 In the Arizona sweat lodge case, Li and tants and voir dire experts, consultants help firm of being a pyramid scheme riddled with his partners on the defense team faced a plot, execute, and support litigation strategy Enron-like fraud.25 Within minutes, these Yavapai County attorney who had lined up through media relations. They work as part fake “news bulletins” reached mainstream a cult expert to testify that James Arthur Ray of the legal team by participating in brain- media, which quoted Lennar’s shocked CEO was in effect exercising mind control over storming sessions, suggesting journalist- denying the rumors. But the narrative had the three people who died during an October friendly language for court filings, preparing been set, and within two weeks Lennar stock- 2009 purification ritual at the conclusion attorneys for press interviews, providing holders lost $500 million in value.26 Then of a “Spiritual Warrior” retreat. Ray was strategic advice for drafting media statements, there was the reputational carnage. As CEO charged with three counts of reckless man - working with reporters on background to Stuart Miller later told a Bloomberg Business slaughter and when he went to trial 18 explain legal procedure, and handling the reporter: “To our shock, all of the credibility months later, only one of the 350 potential logistics of issuing press releases and fielding we’d built over the years of our existence jurors had not heard of the case.30 Half reporter questions. had gone by the wayside.”27 Those news thought he was guilty of murder. The fact Attorneys for Martha Stewart hired a releases turned out to be an extortion attempt that half of the potential jurors did not, said crisis public relations firm to help them bat - engineered by two Southern California men Li, was attributable to a media “ground war” tle the deluge of negative press when the armed with nothing but a laptop and a that he and his defense teammates ran to homemaking diva faced a criminal indict - grudge. It took several years and millions in neutralize the cult-leader narrative. While Li ment for securities fraud in 2003. Although legal fees for Lennar to repair the damage, spoke on background to reporters, Munger Stewart ultimately was indicted and convict - winning a $1 billion judgment against the Tolles colleague Brad Brian appeared on ed, a federal judge found the public relations former business partner who was behind the CNN’s Larry King Live, and the team offered firm’s work served a legitimate litigation cyber smear campaign and putting his accom- attendees of other Ray retreats for press inter- purpose because it tried to correct what plice—convicted conman Barry Minkow— views to create a more charitable view of Stewart’s lawyers described as the “‘unbal- back in prison. To complete its reputational their client.31 anced and often inaccurate press reports.’” restoration, Miller and other Lennar execu- “Our main purpose was to show that Mr. The PR “Firm’s ‘primary responsibility was tives went on television to tell the story of Ray ran a business,” Li said. “He provided to…neutralize the environment in a way their battle with Minkow for CNBC’s “Amer - people with self-help advice and helped people that would enable prosecutors and regulators ican Greed.”28 accomplish things they couldn’t accomplish. to make their decisions and exercise their Given the high reputational stakes and And that’s not a cult....” Li said that by dis- discretion without undue influence from neg- client expectations, one could argue that it abusing people of the cult-leader narrative, ative press coverage.’”37 As a result, the judge borders on malpractice for any attorney to the defense could put the case “in the world agreed, in a “somewhat unprecedented” de - ignore media inquiries, brush aside trending of a guy who ran an outdoor rafting company, cision, that the vast majority of the firm’s Internet chatter, or fail to generate a crisis a survival company, mountain climbing. Then work was protected under the attorney-client communications plan as part of the overall he made a mistake. The trial is about how privilege and as attorney work product.38 representation of a client. It would seem bad the mistake was, or about business risks, The courts in other cases have protected the astounding when experienced trial lawyers as opposed to a cult leader who killed his confidentiality of public relations work be - advise a “no comment” approach, even as people.”32 cause the consultants acted as the functional public opinion, magnified through social In addition to front-ending the message, equivalent of the client in their direct dealings media, destroys their clients and opposing Li said the defense team monitored tweets with the attorneys and the press.39 Since then, counsel is more than happy to address the and Facebook posts during the televised trial some courts have chipped away at that pro- media to stake out his or her position. as a “feedback mechanism” to gauge how tection, holding that such public relations Indeed, the social media revolution has well the lawyers were making their points. tasks are within the privilege only if they favored a number of players in the judicial “We read them (tweets and posts) because “have a nexus with counsel’s representa- system. Various social media—e.g., Facebook, we wanted to know how audiences were per- tion.”40 To enhance the chance the court will Twitter, and others—now give plaintiffs’ ceiving what is being said,” Li said. “If a see it that way, some attorneys advise hiring attorneys more potent tools to troll for clients Tweet is capturing what our main point is, outside public relations consultants directly, and wring settlements from corporate defen- even if it is negative, at least they know what and making sure that all correspondence, dants. Today’s hunger for gossip-cum-news we’re fighting about.”33 especially e-mail, is marked as confidential also can increase the influence that police In the end, the prosecution never called and goes through the law firm.41 and prosecutors exert on the court system— its cult expert, and the jury acquitted Ray of Of course, few attorneys belong to law as well as put additional pressure on them three counts of manslaughter, convicting him firms or represent clients with the resources to act. For the rest of the bar, indications are instead on the lesser charges of negligent to hire media consultants. They also don’t that keeping mum outside the courtroom homicide.34 Rather than the 37 years in prison know how—or have the inclination or time may hurt an attorney’s case inside it, no mat- the prosecutors had sought, Ray served less during trial—to engage the mainstream ter on which side of the aisle the client is. than two years in jail before he was released media and activate social networks on a This is especially true for corporations. in March 2015.35 A year later, Ray began client’s behalf. This is not taught in law
Los Angeles Lawyer December 2016 33 school and, with so many diverse and often dous pressure to post immediately; they don’t for every reporter to find and repeat in sub- hostile options available for generating cov- have time to wade through paragraphs of sequent stories. This means attorneys and erage, the possibility of failure is daunting. turgid legalese to get the point. Clever attor- and their media consultants must adopt a Yet given the mandate to promote the image neys make it easy for journalists by writing “won’t-take-no-for-an-answer” policy to get and reputation of clients, as well as their clearly and concisely, offering a narrative as a correction or clarification, which then will legal claims, there are steps that even sole an opening section and using headline-worthy be appended to the online story, casting doubt practitioners can and should take if there is phrases that will sum up arguments and prove on the original reporting. even the slightest possibility of traditional irresistible to bloggers, commentators, and, Know when to hold ‘em. Being media or social media attacks. truth be told, the judge. It’s easy to scorn savvy also means knowing when to dodge Think worst case. Attorneys with major “sound bites”—it is far wiser to use them. the spotlight. This is especially true when corporations or high-profile individuals as One such example surfaced in the unsuc- settlement or plea-bargain discussions, which retainer clients should urge them to think cessful challenge of former Viacom CEO might have been spurred by public pressure, frankly about their public relations vulnera- Sumner Redstone’s health directive brought reach a delicate stage. Such was the case with bilities and draw up a crisis communications by Manuela Herzer, his former girlfriend and a Los Angeles grade school teacher who was plan that will include decision trees, proposed confidante. In challenging Redstone’s mental charged with multiple counts of lewd conduct, holding statements, and steps for countering capacity, her attorneys described the media making him one of the most reviled figures bad press as coverage unfolds. This needs to mogul as a “living ghost,” a phrase that made in the community. From the beginning, a be done before a disgruntled former employee headlines in Variety and The Guardian, and plea disposition appeared to be a viable option takes to Twitter or a New York Times inves- was repeated in more than 5,300 other stories, but it required lengthy and substantive plea tigative reporter leaves a message. posts, and online news sites.42 The epigram negotiations with the district attorney’s office. Pick your battles. Don’t react—respond. launched a vicious power struggle within the Had word leaked out—even unintention- Part of crisis communications planning company.43 ally—those discussions would have collapsed, involves identifying the most strategic or Get media training. Lawyers who write so both sides kept mum until a plea deal was important issues for a client or during litiga- as if they are paid by the word need to take reached that was acceptable to the client and tion, and addressing those in the media push- a dramatically different approach to media the prosecutor. back. Let the other issues go. interviews, which get edited down to seven- These are basic tools that attorneys need Write a holding statement. Often the initial second TV sound bites and a sentence or as they grapple with how the Internet and media surge happens before a client can delib- two in print. The interview subject needs to social media have created a sea change in erate over a statement. An attorney should be prepared for likely questions and, above the way legal news is generated, covered, be prepared to step into breach and answer all, to be brief. The key to both is practice and received. The legal system no longer lives the first wave of questions from reporters, and more practice through media training in a bubble. Attorneys who do not try to usually upon the disclosure of some allegation from someone who knows, preferably from harness the new media as part of a litigation or the filing of a lawsuit. At the first inkling experience, what reporters will ask, what strategy are not only shortchanging their of trouble, attorneys should write a short trick questions to avoid, and how to hone clients, they are hurting themselves. n holding statement of no more than three lines answers into phrases. A number of former that 1) acknowledges the client is aware of journalists and media firms provide media 1 Interviews with attorney Luis Li, Partner, Munger, the issue, crisis, or lawsuit and 2) is looking training. A Google search of media training Tolles & Olson LLP. (July 7 and Sept. 14, 2016) [here- into the matter or is prepared to vigorously in Los Angeles will turn up names. inafter Li]. 2 See, e.g., The Secret, Full Cast & Crew, IMDB, defend against the allegations. Then he or Use social media as feedback. Once an http://www.imdb.com (last visited Oct. 28, 2016); she should practice it—over and over—before attorney or client engages in the court of James Arthur Ray, I wish I could trade places with 3 taping it to the phone. A holding statement public opinion, monitoring how it appears that died at my sweat lodge, CNN (Nov. 26, 2013), like this serves a number of important pur- on news websites and social media is helpful, http://www.cnn.com. poses: 1) it avoids the temptation to reflexively especially after filing an important brief or 3 Li interviews, supra note 1. 4 issue a “no comment,” 2) it assures the client’s making a court appearance. Instead of looking Id. 5 William Cummings, Airlines ban hunters’ big-game constituencies that it is paying attention and for approval, the attorney should see if even ‘trophies’ after uproar over Cecil the lion, USA TODAY doing something constructive to address the the detractors are getting the point. (Aug. 4, 2015) available at http://www.usatoday.com problems, and 3) more practically, it gives Best face forward. Consider that the lead [hereinafter Cummings]. the attorney on the media firing line a script lawyer on the litigation team might not be 6 Killing of Cecil the lion, WIKIPEDIA, https://en to read —and stick to—until more becomes the best talking head. What makes someone .wikipedia.org (last visited Oct. 28, 2016). 7 Cummings, supra note 5. known. great at verbal judo in the courtroom may 8 Sam Brodey, McCollum calls for federal investigation Speak up—now. When it is necessary to doom him or her before the cameras. If the of lion-killing Minnesota dentist, MINNPOST (July 29, speak up, it is important not to hesitate. It is attorney has the luxury or is not a sole prac- 2015), https://www.minnpost.com. imperative that attorneys get their clients’ titioner, it is best to pick a member of the 9 Erica Goode, After Cecil Furor, U.S. Aims to Protect side of the story into the first wave of blog legal team who is photogenic, articulate, pas- Lions Through Endangered Species Act, N.Y. TIMES (Dec. 21, 2015), available at http://www.nytimes.com. posts or online stories. Otherwise, the attor- sionate, and speaks succinctly. Since all that 10 Michelle Nichols, U.N. tackles illicit wildlife poaching ney and client will miss the chance to shape matters is what is best for the client, it is amid Cecil the lion uproar, REUTERS (July 30, 2015), the narrative up front so their storyline imperative not to be shy about appointing a available at http://uk.reuters.com. becomes part of the public conversation. junior member of the team to face the micro- 11 Telephone interview with attorney Joseph S. Fried - Trying to change the narrative after that is phones. berg, Joseph S. Freidburg Chartered, Minneapolis, MN (Aug. 30, 2016). extremely difficult, time-consuming, and Fight hard for corrections. Gone are the 12 Id. expensive. days when embarrassing stories or reporting 13 Id. Write smartly. Court filings are still the mistakes lasted only a day before heading to 14 Id. best way for attorneys to make press state- the bottom of the birdcage. Now, bad jour- 15 Gentile v. State Bar of Nevada, 501 U.S. 1030 ments, but reporters today are under tremen- nalism lives forever on the Internet, available (1991).
34 Los Angeles Lawyer December 2016 16 Id. at 1034. 17 Id. at 1033-34. 18 See id. at 1032, 1037-1048. 19 Id. at 1043. 20 ABA MODEL RULES OF PROF’L CONDUCT R. 3.6. 21 Mattei Radu, The Difficult Task of Model Rule of Professional Conduct 3.6: Balancing the Free Speech Rights of Lawyers, the Sixth Amendment Rights of Criminal Defendants, and Society’s Right to the Fair Administration of Justice, 29 CAMPBELL L. REV. 497, 519-20 (2007). 22 State v. Simpson, No. BA 097211 (L.A. Super. Ct. 1994). 23 See Initial Episode, The Colbert Report, (Oct. 17, 2005), http://www.cc.com/episodes/jnv7om/the-colbert-report -october-17—2005—-stone-phillips-season-1-ep-01001. 24 DEZENHALL, ERIC, GLASS JAW: A MANIFESTO FOR DEFEND ING FRAGILE REPUTATIONS IN AN AGE OF INSTANT SCANDAL 4 (2014). 25 Paul M. Barrett, American Hustle: The CEO, the Ex-Partner, the Pastor, and the $1 Billion Shakedown, BLOOMBERG BUSINESSWEEK, (Dec. 19, 2013), available at http://www.bloomberg.com/news/articles/2013 -12-19/how-lennar-fought-an-extortion-attempt-and -won-a-1-billion-judgment. 26 Id. 27 Id. 28 Listings of CNBC’s “American Greed,” CNBC (Feb. 5, 2015), available at http://www.cnbc.com/2015 /listings-for-cnbcs-american-greed.html. 29 Julia Hood, ‘No comment’ Won’t Cut It, Finds Sur - vey, PR WEEK (Aug. 5, 2002), available at http://www .prweek.com. 30 Li interviews, supra note 1; see also State v. Ray, No. V-1300-CR-201080049 (Yavapai Super. Ct. 2011), available at http://courts.yavapai.us/su periorcourt. Click on “case information” and provide the case number or defendant’s name, James Arthur Ray. 31 Li interviews, supra note 1. 32 Id. 33 Id. 34 Ray, No. V-1300-CR-201080049, supra note 30. 35 Li interviews, supra note 1. 36 See, e.g., My Story, James Arthur Ray, available at http://www.jamesray.com (last visited Oct. 27, 2016). 37 In Re: Grand Jury Subpoenas Dated Mar. 24, 2003, 265 F. Supp. 2nd 321, 322-23 (S.D. N.Y. 2003). 38 Id. at 332. See also Michael Jay Hartman, Yes, Martha Stewart Can Even Teach Us About the Consti - tution: Why Constitutional Considerations Warrant an Extension of the Attorney-Client Privilege in High- Profile Criminal Cases,10 JOURNAL OF CONSTITUTIONAL LAW 867, 868-69 (May 2008)[hereinafter Hartman]. 39 See e.g., Federal Trade Comm’n v. Glaxosmithkline, 294 F. 3d 141, 148 (D.C. Cir. 2002) and Viacom, Inc. v. Sumitomo Corp. (In re Copper Mkt. Anititrust Litg.) 200 F.R.D.213, 219 (S.D. N.Y. 2001). See also Hartman, supra note 35, at 887-97. Kathryn M. Fenton & Kristiana A. Garcia, Participation of Non-Lawyers in Antitrust Matters—Recognizing and Avoiding Privilege Waiver Pitfalls, THEANTITRUSTSOURCE (Aug. 2010), available at http://www.antitrustsource.com [Hereinafter Fenton & Garcia] . 40 Meaghan G. Boyd & Sarah T. Babcock, The Attorney- Client Privilege and Communications Between Counsel and Publice-Relations Consultants, 22 THE ENVTL. LITIGATOR 6,8 (2010). 41 Fenton & Garcia, supra note 39. 42 James Rainey, Ailing Sumner Redstone Has Become ‘a Living Ghost,’ Ex-Girlfriend Alleges in Lawsuit, VARIETY, Nov. 25, 2014, available at variety.com; Sam Thielman., ‘A living ghost’: Health questions haunt reclusive mogul Sumner Redstone, THE GUARDIAN, Jan. 18, 2016, available at http://www.theguardian.com [hereinafter Thielman]. 43Thielman, supra note 42.
Los Angeles Lawyer December 2016 35 closing argument BY JEFFREY HURON, PHU NGUYEN, AND JYOTI AVILA
Statutory Transcription Rates Do Not Apply to Private Court Reporters
TO COPE WITH THE UNPRECEDENTED budget cuts beginning in 2008, intended to regulate rates for all transcripts prepared by pro tempore some California courts, including Los Angeles, have limited the avail- reporters in the trial courts ordered by the respective parties to the ability of official reporters for civil proceedings. In these courts, parties proceedings.9 Finally, the court rejected the plaintiff’s argument that are free to arrange for private reporters as long as the reporters are public policy supports regulating the transcription rates of private appointed as “official reporters pro tempore.”1 Unlike official reporters court reporting firms. Unlike criminal cases, civil litigants do not have employed by the court, official reporters pro tempore do not receive a constitutional, statutory, or common law right to court reporting employment benefits such as paid time off or health insurance. Their services.10 Further, the Rules of Court provide for alternative procedures compensation is generally limited to appearance and transcript fees. for making a record for appeal. 11The court expressed concern that In May 2014, attorney Tara Burd filed a class action complaint government regulation of private court reporting firms “compromises against Barkley Court Reporters alleging violations of Government strong countervailing public policies favoring free enterprise and com- Code Sections 69950 (Transcription Fees) and 69954 (Transcripts Prepared with Computer Assistance Fees), which limit the transcription Article 9 of the Government Code was enacted when the courts rates that official reporters may charge.2 Burd contended that these sections are not limited to official reporters but also apply to private were fully staffed with salaried court reporters. court reporters or official reporters pro tempore, such as the Barkley court reporters she hired. In January 2016, Los Angeles Superior Court Judge Amy D. Hogue rejected Burd’s arguments and granted Barkley’s petition,” which may in turn disincentivize highly qualified private motion for judgment on the pleadings. The court noted that Article 9 reporters from agreeing to serve as official reporters pro tempore.12 of the Government Code was enacted when the courts were fully Finally, the court noted: “With taxpayers no longer providing official staffed with salaried court reporters. The provisions, when written, court reporting services to all litigants and private reporters generating did not anticipate that salaried court reporters would be eliminated their own salaries, insurance and benefits, it is difficult to justify reg- and replaced by private reporters hired by litigants on a case-by-case ulating private reporter rates as a matter of public policy.” basis. Nevertheless, a plain reading of Article 9 indicates that the Burd has appealed the court’s order so the final word has yet to statutory rates govern only court reporters employed by the courts. be reported. n Section 69947, which governs the fees set forth in Sections 69950 and 69954, states that “the official reporter shall receive for his 1 See, e.g., Los Angeles Superior Court Policy re: Normal Availability of Official services the fees prescribed in this article.”3 By referring only to the Court Reporters and Privately Arranged Court Reporters (May 1, 2012), avail able official reporter, the legislature intended for the statutory fee provisions at http://www.lacourt.org/generalinfo/courtreporter/pdf/CourtReporterPolicy.pdf. [hereinafter LASC Policy] to apply only to salaried official reporters and not to private reporters 2 Burd v. Barkley Court Reporters, Inc., No. BC556703 (L. A. Super. Ct. Sept. 12, 4 pro tempore. In coming to this conclusion, the court recited six 2014). 5 sections of Article 9 that distinguished between official reporters 3 GOV’T CODE §§69947, 69950, 69954. and official reporters pro tempore, observing that “[t]he use of these 4 See Klein v. United States, 50 Cal. 4th 68, 80 (2010). two distinct terms indicates that the Legislature intentionally used 5 See GOV’T CODE §§69941, 6944, 69946, 69952(b), 6955(a), 69957. 6 the term ‘official reporter pro tempore’ to distinguish privately See Order Granting Def’s Motion for Judgment on the Pleadings at 5, Burd, No. BC556703 (Jan. 8, 2016) [hereinafter Order]; see also Pasadena Police Officers Assn’ employed court reporters appointed pro tempore from official v. City of Pasadena 51 Cal. 3d 564, 576 (1990). 6 reporters employed by the court.” 7 CAL. R. CT. 8.130(f)(2). The Advisory Committee Comments provide that “[t]he The court also rejected the plaintiff’s argument that California fee for re porter’s transcripts are established by Government Code sections 69950 Rule of Court 8.130 is rendered ineffective if Sections 69950 and and 69554.” 8 69954 do not apply to official reporters pro tempore. Rule 8.130 CAL. R. CT. 8.130(a)(4). 9 See Order, supra note 5, at 9. governs the filing of reporters’ transcripts on appeals. Among other 10 See LASC Policy, supra note 1. things, it provides that when a transcript is completed, a reporter 11 See CAL. R. CT. 8.134, 8.137. must bill each party at the statutory rate.7 However, this rule also 12 See Order, supra note 5, at 10. provides for the court of appeal, on its own or the respondent’s motion, to order the record augmented to include the transript and Jeffrey Huron, Phu Nguyen, and Jyoti Avila practice business and real estate makes the appellant responsible for its costs.8 Such a rule, therefore, litigation in the Los Angeles office of Dykema Gossett LLP. They, together reasonably sets a cap for transcripts that may be compulsory. The with Marc Allaria of Litchtfield Cavo LLP, represented Barkley Court Reporters court stated that it “does not follow, from this rule, that the Legislature in Tara R. Burd v. Barkley Court Reporters, Inc.
36 Los Angeles Lawyer December 2016