I __

1 LAW OFFICES OF
CHESTERL.
2 2450 Broadway, 550
Santa CA 90404 NOV - 4
3 (310)3 5

5
6
Attorneys for
7 CONNIE .JR.
8

9
10

11 UNITED
12 FOR THE OF CALIFORNIA
13

14
15 STATES OF )
) 94-0276 CAL
16 )
VS. ) :rvffiMORANDlThIf OF
17 ) AUTHORITIES OR T OF
) MOTIONTODISlv1ISS COUNTS SEVE
.JR. and ) THROUGH AND/OF
)
)
Defendants. )
)
------------------------------ )

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 1 INTRODUCTION

2 On March 12, 1996, CONNIE ARlvfSTRONG, JR. filed with this court a Motion To Dism

3 Counts For Legal and Factual Insufficiency. In the March 12 motion, defense counsel asserted that t

4 Ninth Circuit's opinion in In Re Hamilton Taft & Co. l commanded dismissal of certain counts of t

5 indictment. The Ninth Circuit opinion established that client monies, once transferred to Hamilton Tc

6 became the property of Hamilton Taft -- leaving the clients with no beneficial interest in those moni·

7 other than their contractual remedies against Hamilton Taft. In the March 12 motion, Mr. Annstro

8 sought to persuade this court that, under the Ninth Circuit's opinion, all counts speaking to "diversior

9 or misuse ofUclient funds," or other post-acquisition improprieties by Mr. Armstrong, must be dismissf

]0 This court denied that motion."

11 Mr. Armstrong now brings the instant Motion To Dismiss Counts Seven Through Twenty-Or

12 based on the NInth Circuit opinion or the logic contained therein.lP To the extent that the instant mati,

13 overlaps with the March 12 motion, Mr. Annstrong asks this court to reconsider its earlier decisic

14 Reconsideration of this matter is appropriate, on the grounds that: (1) New information has come to lig

15 which bears on the existence or non-existence of a scheme to defraud -- specifically, the fact that defer

16 counsel has now confirmed that Hamilton Taft p'aid all taxes, in compliance with its contractual dutie

17 (2) Because the indictment in this case pre-dated the Ninth Circuit opinion, there is a strong possibil

18 that counts seven through twenty-one are based on an erroneous premise of law - a possibility ev

19 recognized by the government itsel£ which sought to get the Nmth Circuit opinion reversed; (3) Allowi

20 lay jurors to believe that Hamilton Taft was a fiduciary for their withholding taxes is not only lega

21

22 In Re Hamilton Tait & Co. (Wyle v. S & S Credit Co., Real Parties in Interest). 53 F.
285, vacated on other grounds, 68 F.3d 337 (1995) is attached as Exhibit A.
2
Because the Ninth Circuit has vacated its opinion in In Re Hamilton Taft, the partie~
24 the instant case disagree over the extent to which that opinion controls in tills case. ~
Armstrong contends that, since the opinion exists and since it addressed a factual Sltuat:
25 identical to the one at issue in this cnminal case, its logic cannot be ignored -- regardJ
of the technical question of whether or not the opinion is still controlling per se.
26
3
Since the March 12 motion, defense counsel has had a chance to review the records
27 the Internal Revenue Service, as well as the schedules of the government's own farer
accounting expert, Lee Baly, which show that, except for the first quarter of 1991 wI
28 the company was involuntaJ.ily shut down, Hamilton Taft paid all its clients' withhold
taxes for each quarter.

2 000113
 1 incorrect, but would cause tremendous prejudice and would constitute reversible error; (4) Clarificatio

2 of this issue, through dismissal of counts or, at a minimum~ instructions to the jury, will save time, b

3 allaying defense counsel's need to put on evidence about the character of funds and preventing constar

4 interruption of the proceedings with defense objections to the government's improper characterizatio

5 of those funds; and (5) This court's recent comments at the September 12, 1996 hearing suggested the

6 further clarification may be warranted, concerning the applicability of the Ninth Circuit opinion to count

7 seven through twenty-one of the instant case.

9 STATENfENT OF FACTS

10

11 A. DESCRIPTION OF HAMILTON TAFT'S BUSINESS --

12 Hamilton Taft was a California corporation which provided payroll services for large businesse~

13 such as Federal Express, Scott Paper, and The State Bar of California. Under the federal and state ta

14 laws, employers are required, every pay period, to withhold from each employee the estimated amoun

15 which the employee owes in federal, state, and local taxes, for that pay period. This system, in whic:

16 employers are charged with the duty of withholding and paying taxes on behalf of their employees, i

17 believed to enhance the ability of the Internal Revenue Service to collect income taxes from all taxpayer~

18 However, because of the complex and ever-changing laws and regulations which govern the withholdin

19 tax system., many companies choose to utilize the services of payroll processing finns, such as Hamilto

20 Taft.

21 Under the terms of Hamilton Taft's contracts, employers were required, each pay period, t·

22 deposit with Hamilton Taft an amount equal to the total amount of employee withholding taxes due fc

23 that pay period to federal, state, and local tax authorities. Hamilton Taft would then fill out all ofth

24 proper paperwork and write a check to the various taxing agencies, on behalf of its client. In additior

25 Hamilton Taft also prepared quarterly withholding tax return fOnTIS (Forms 941) o~ behalf of its client:

26 The 941 forms are due thirty days after the end of each quarter and declare, under penalty of perjury, th,

27 all employee withholding taxes have been paid for the previous quarter.

28

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3
 By the terms of its contracts, Hamilton Taft assumed responsibility for all penalties and inten

2 resulting from any late payment of client withholding taxes. In rerum for these services, Hamilton T~

3 would generally receive no fee, but would be entitled to any benefit obtained from the temporary use

4 these monies (often referred to as the Ufloat"), between the time that Hamilton Taft received the morn

5 and the time it paid them over to the appropriate taxing agencies. With but one or two exceptions. t

6 client contracts contained no language limiting the types of investments which Hamilton Taft was entitl

7 to make with funds deposited by clients.

10 B. HAMILTON TAFT BEFORE CONNIE ARMSTRONG --

11 Hamilton Taft was initially incorporated in July, 1979 as KnightsBridge Systems, Ltd., I:

12 changed its named to Hamilton Taft in 198 L In 1984, Hamilton Taft was acquired by CIGNA, a ma~

13 insurance company from Connecticut. Despite CIGNA's continuing efforts to pump its own funds if

14 its subsidiary company, Hamilton Taft continued to lose money under CIGNA's ownership. Finally,

15 Januazy, 1988, CIGNA sold Hamilton Taft to MaxPharma, a publicly held corporation from Dallas.

16 Under MaxPharrna' s ownership, Hamilton Taft's liabilities grew wo rse, hastened by the fact tl

17 MaxPharma's owners made unsecured loans to themselves, without the approval of MaxPharm

18 shareholders. Connie Annstrong, a shareholder in the parent company, brought a shareholder derivat

19 suit against MaxPhanna and its principles, alleging a breach of their fiduciary duty to shareholders.

20 March 29, 1989, Roberts and MaxPharma settled the suit, by transferring all stock in Hamilton Taft

21 Mr. Armstrong, who became sole owner of the company. At the time he took over the campa

22 Hamilton Taft's liabilities exceeded its assets by $18.9 million.

23

24 ·C. THE MISSED TAX DEPOSITS --

25 Because Hamilton Taft had approximately 250 corporate clients with varying payroll schedu

26 it received incoming funds from clients every day and, by the same token, had payroU tax deposits I

27 evezy day. Most of the time) Hamilton Taft paid these withholding tax deposits before the statutory

28 date. However, on one or two days per quarter, Hamilton Taft was forced to hold back client

4 000115
.-
1 deposits due to insufficient funds; as a result of these missed deposits, Hamilton Taft incurred intere

2 and penalties, for which it was liable. Hamilton Taft subsequently made up every missed tax deposit f

3 1989 and 1990 -- usually doing so just before 941 tax returns were due (thirty days after the quarter
4 end). In accordance with its contractual obligation, Hamilton Taft paid all penalties and interest ansi}

5 from its late payment of these client tax deposits.4

6 To make up the missed tax deposits, Hamilton Taft would generally use incoming monies, pa

7 by clients in the foUowing quarter. Because Hamilton Taft needed these newly incoming funds to mal

8 up the previous quarter's missed deposits, those same funds were unavailable for use in the quarter

9 which they were submitted. This, in tum, forced Hamilton Taft to hold back additional tax deposits

10 that quarter. However, at the time they deposited funds with Hamilton Taft, clients understood that tht

11 monies would not be segregated or earmarked for immediate payment to the IRS and further undersroc

12 that they would never be held liable for late payment of their withholding taxes.

13

14 D. THE TRANSFERS OF HAMILTON TAFT FUNDS --

15 The primary issue in the instant case involves Mr. Armstrong's wire transfers of approximatt

16 $55 million of Hamilton Taft monies to his Texas companies, in exchange for notes (and later a sinE

17 consolidated bond) of equal value. The Texas companies, whose payroll included experienced expel

18 in real estate, construction development, oil, and investment financing, then invested these mOrnl

19 pledging these investments back to Hamilton Taft as collateral for the loans. Mr. Armstrong hoped tf

20 after several years, these investments might be sold for substantial gain, which could then be put back if

21 Hamilton Taft and applied against the $18.9 million "hole" which he inherited.

22 The government contends that HarrUlton Taft's occasional missed tax deposits were brought

23 by Mr. Armstrong's inter-company transfers ofHanulton Taft funds. In counts seven through eightc
24 of the indictm~nt, they charge Mr. Armstrong with wire fraud, in connection with his supposel

25

26 4
Though Hamilton Taft made up missed tax deposits just before filing the client) s 941 .
returns, it did not nonnally make up penalties and interest until receiving notice from
27 IRS requesting such payment -- a process which usually did not occur until about t
quarters later. As a -result, Hamilton Taft was technically about two quarters delinqu
28 on interest and penalties, at the time of its shutdown -- though it had not yet, at that til
received notice from the IRS as to these penalties.

5 000116
 1 improper "diversions" of client funds. Counts nineteen through twenty-one further allege a "cover-u

2 'by Mr. Armstrong afhis supposed misuse of client monies .

..,
..)

4 E. THE RIJN ON THE BANK--

5 On March 8, 1991, Steve Solodoff, a disgruntled ex-employee, called a clandestine meeting

6 Hamilton Taft clients, at which he alleged that Mr. Armstrong had "diverted" millions of dollars

7 Uclient" monies, that Mr. Armstrong was running a massive "Ponzi" scheme with other people's monit

8 and that Mr. Armstrong was likely preparing to leave the country, taking the rest of Hamilton Taft

9 money with him. (See memorandum presented to Hamilton Taft clients, entitled, "Hamilton Taft

10 Company, Description of Fraud," attached as Exhibit B).

l1 As a result of Solodoff's tortious allegations, Hami1ton Taft's clients simultaneously breachl

12 their contractual duties to Hamilton Taft, by ceasing to deposit funds with the company, without givil

13 the contractually required thirty-day notice of termination. This sudden and massive breach by virtua.

14 aU of its clients, followed shortly thereafter by the involuntary bankruptcy proceedings and forced shl

15 down of Hamilton Taft's business by trustee, Fred Wyle, left Hamilton Taft with approximately $:

16 million in overdue taxes, which it was unable to make up.

17 After his appointment, Wyle shut down all of Hamilton Taft's business activities and sold all

18 the assets pledged back to Hamilton Taft. Because most of these assets were sold at a firesale value, a·

19 never given a chance to mature to their potential value, the proceeds were insufficient to make I

20 Hamilton Taft's existing tax liabilities.

21

22 PROCEDURAL mSTORY OF NINTH CIRCUIT DECISION

23 In March, 1991, shortly before being placed in involuntary Chapter 11 receivership, Hamilton T
24 paid $7.6 million in taxes, on behalf of its client, S & S Credit. During the subsequent bankrupt

25 liquidation, trustee Fred Wyle sued S & S Credit, seeking to set aside this pre-bankruptcy transfer,

26 the grounds that the monies paid were the "property of the debtor {Hamilton Taft}," and theref(

27

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 recoverable under the bankruptcy preference laws. S S & S opposed the suit, arguing that the money w

2 not property of the debtor, since Hamilton Taft held client monies in a statutory trust, for the benefit

3 the United States, under Internal Revenue Code § 7501. 6 The Bankruptcy Court ruled in favor of S

4 S Credit and was affinned by this court, in a February 18, 1993 opinion stating that, "The payments we

5 as a matter of law funds held in trust for the Internal Revenue Service and were not the property of t:
6 debtor Hamilton Taft & Company," (See written opinion of this court, attached as Exhibit C). Betwe,

7 the time of this court's opinion and the time of the subsequent reversal by the Ninth Circuit, IV

8 Armstrong was indicted by a federal grand jury on twenty-one counts of fraud.

9 On May 2, 1995, the Ninth Circuit issued a published opinion, reversing this court and holdil

10 that, under common law trust principles, the statutory trust created by § 7501 dissolves when the trust

11 transfers trust property to a third party -- in this case, Hamilton Taft. Furthermore, the Ninth CirCt

12 refused to impute to Congress an intent to abrogate these common law principles, through enactment

13 § 7501. The court, therefore, concluded that Hamilton Taft did not hold these momes in trust, for t

14 benefit of the m.S.

15 The Ninth Circuit also rejected any suggestion that Hamilton Taft held monies in trust for t

16 benefit of either the client or the tax-paying employee:

17 Nor does S & S attempt to show that it arranged with Taft for the
transferred funds to be held in trust. Whil e two of Taft's eli ents arranged
18 to have their trust-fund tax payments kept in segregated accounts, S & S
and the other clients did not. Instead, Taft extensively commingled all of
19 the funds it received and treated the funds as its own assets, using them
to pay its operating expenses and investing the funds for its own benefit.
20 Therefore, under ordinary principles oftruStl Taft did not hold the funds
in trust.
21

22 Jd., at 288.

24
25 5
11 U.S.C. § 547(b) allows the bankruptcy trustee to avoid transfers to or for the be
of a creditor and made within 90 days of the bankruptcy, when such transfers invo
26 "an interest of the debtor in property,"

27 (;
IRe § 7501 states that, cCWhenever a person is required to collect or withhold any inti
revenue tax from any other person and to pay over such tax to the United States
28 amount of the tax so collected or withheld shall be held to be a special fund in tru!
the United States."

7
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...

1 Thus, the court concluded that the transferred funds were indeed the property of Hamilton Ta

2 with all of the correlative rights that property ownership entails. As a result, the court held it prop'
3 under § 547, to set aside the pre-bankruptcy transfer and return the transferred funds to the Hamilt

4 Taft bankruptcy estate. S & S Credit promptly petitioned the court for rehearing.

5 On May 23, 1995, the Nmth Circuit ordered the United States to file an amicus brief, addressi

6 I the limited issue of whether the May 2, 1995 opinion might adversely affect the ability of the IRS

7 co1Ject federal taxes. In August, 1995, the United States filed its amicus brief: siding with S & Scree
8 and arguing that Hamilton Taft held monies in statutory trust, for the benefit of the IRS. The brief v

9 submitted by three attorneys out of the Tax Division of the United States Department of Justice

10 Washington D.C., but also indicated that Michael Yamaguchi, United States Attorney for the North!

11 District of California, had been consulted in an Hof counsel" capacity. (See excerpts of United Sta

12 amicus brief, attached as Exhibit D).

13 The Ninth Circuit neither granted nor denied the Petition for Rehearing, as the case settl.ec
14 September, 1995. On October 12, 1995, the court dismissed the entire appeal as moot and vacated

15 earlier published opinion.

16

17 ARGUMENT

18 I. TIlE NlNTH CIRCUIT'S LEGAL CONCLUSION ABOUT THE CHARACTER OF Fill

HELD BY HA1vlIL TON TAFT REQUIRES DIS:rvnSSAL OF COUNTS SEVEN THROl
19 TWENTY-ONE OF THE INDICTIvlliNT.

20 A. HA.MU, TON TAFT fULFrr.LED ALL OF ITS CONTRACTUAL DLTTIES -

21 At the hearing on Mr. Armstrong's previous motion to dismiss counts, and more recently, a
22 September 12 hearing, this court expressed skepticism about the relevance of the Ninth Circuit's op

23 to the issues in the instant case. At the September 12 hearing, this court expressed its concern the
24 Ninth Circuit decision merely held that Hamilton Taft did not hold funds in trust, vis a vis the 1R~

25 that the opinion took no position on whether those funds were held in trust, as to the client com~

26 themselves. However, after subsequent discussion, this court seemed to acknowledge that perhaps

27 remains a need to clarify the precise meaning of the Nmth Circuit opinion, as well as its possible i:

28 on Mr. Armstrong's criminal case. With alJ due respect, Mr. Annstrong believes the Ninth (

8 000119
 holding to have been broader than this court initially believed and, to the extent that this coun has four

2 otherwise, he asks that it reconsider its decision.

3 While the Ninth Circuit did make clear that § 7501 IS statutory trust vis a vis the IRS does nc

4 extend to third party transferees, it then went on to examine the understanding which existed betwef

5 Hamilton Taft and its clients:

6 Nor does S & S attempt to show that il arranged with Taft for the
transferred funds to be held in trust. While two of Taft's clients arranged
7 to have their trust-fund tax payments kept in segregated accounts, S & S
and the other clients did not. Instead, Taft extensively commingled all of
8 the funds it received and treated the funds as its own assets, using them
to pay its operating expenses and investing the funds for its own benefit.
9 Therefore, -under ordinary principles of trust, Taft did not hold the funds
in trust.
]0

]1 Jd., at 288.

12 The above language has nothing to do v..rith the existence or non-existence of a trust, on behc

13 of the IRS, but speaks only to the relationship between the contracting parties themselves. 7 Th

14 relationship, the court concluded, was not a trust, but was a traditional debtor-creditor relationship, und

15 which the monies, once transferred, became the property of the debtor, Hamilton Taft.

]6 I Of course, the fact that Hamilton Taft's contractual relationship with clients was debtor-crediv

17 rather than trust, does not nullify the possibility of criminal fraud. For instance, had Mr. Armstro

18 simply taken clients' monies and opened a Swiss bank account, while totally ignoring rus contractual d'
19 to pay their taxes, he almost certainly could be charged with engaging in a scheme to defraud. 8 Howe,

20 the debtor-creditor nature of Hamilton Taft's reiationsrup does have inescapable implications, for cer1

21

22
23
It is worth pointing out that, under § 7501, employers hold their employees' tax mo
24 in trust for the benefit of the IRS, not the employees. Therefore, the monies w
employers contractually agreed to transfer to Harrlllton Taft were never trust mOrlll
25 the first place vis a vis the tax-paying employees.
26 The Nmth Circuit has held that a scheme to defraud is completed at the moment tha
money at issue changes hands. United States v. Cusmo, 694 F.2d 185, 187 (9th
27 1982). Given this rule of law, even if Mr. Armstrong had wired Hamilton Taft me
overseas, it is not at all clear whether such conduct would constitute mere evidence·
28 I

intent never to perfonn his ~ontractual duties Of, as the government apparently \\
contend, an independent criminal act.

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..

counts in this case. 9 First, it meant that, as a matter of law, client monies, once delivered to Hamill

2 Taft, became the property of Hamilton Taft. This, in tum, meant that Hamilton Taft was free to use t

3 money for operating expenses or to invest it for its own benefit, in any manner it wished -- wh

4 remaining cognizant of the fact that the company also owed a contractual duty to pay the dien'

5 withholding taxes. Second, the debtor-creditor relationship meant that Hamilton Taft could fret

6 commingle the tax monies of any particular client with the monies of ali other Harnilton Taft clients,

7 was not necessary that any single client's monies be placed in a separate, segregated account. Hem

8 what the government calls a "Ponzil! scheme - the payment of Client A's taxes with Client B's a

9 Client C's money - was not only penrussible, but was exactly what Hamilton Taft's c1ieI!ts bargained f{

10 Third, the debtor-creditor relationship meant that clients retained no beneficial interest in the money, on

11 delivered to Hamilton Taft - having only their contractual rights against Hamilton Taft on which to re

12 The clients' contractual rights in this case were quite simple; Hamilton Taft was obligated to p

13 all client withho1ding taxes and to assume liability for any penalties and interest resulting from [,

14 payment. Hamilton Taft complied with these contractual duties for every quarter of 1989 and 1990

15 occasionally paying the taxes late, but assuming the penalties and interest for so doing. In the fi

16 quarter of 1991, Hamilton Taft missed certain taX deposits, just as it had done in previous quarters. ]
]7 as in previous quarters, Hamilton Taft had every intention of making up these missed payments,

18 would have done SO, but for two key events: (1) the public allegations made by Steve Solodoff wh

19 caused the bulk of Hamilton Taft clients to simultaneously breach their contractual duties, ther·

20 suddenJy and completely cutting off all cash flow to Hamilton Taft; and (2Ube March, 1991 appointrr

21 of Fred Wyle as trustee in bankruptcy, and the subsequent shutting down of Hamilton Taft's busir

22 operations. This double-barreled assault left Hamilton Taft unable to make up approximately $50 mil

23 in overdue tax liabilities, which were to have been paid in April, 199~~i

24 In view of the debtor-creditor nature of Hamilton Taft's contracts, coupled with the fact

25 Hamilton Taft perfonned its contractual duties without fail (when allowed to do so by the clients),

26

27 9
Indeed, the government itself seems to recognize that the Ninth Circuit's dec:
negatively impacts their criminal case against Mr. Armstrong. This would explain
28 IRS attorneys consulted Michael Yamaguchi himself, in an "of counsel" capacity, ,
the IRS was preparing its amicus brief seeking to reverse the Ninth Circuit's decisi

10 nnn1t)1
 difficult to see exactly what aspect of Mr. Armstrong's conduct the government views as frauduiem

2 Counts seven through fourteen speak of "diversions" -- a term which implies misuse of mOrnl

3 However, Hamilton Taft was certainly free to lend its own money to sister corporations or to invesi

4 for its own benefit, provided it paid the clients' taxes. Hamilton Taft's contracts did not hold Iv

5 Armstrong to any LLprudent investor standard" and did not, in any way, set parameters on the range

6 pennissible investments which Hamilton Taft could make. That Mr. Armstrong's companies may ha

7 incurred excessive operating costs (in the govemmenf s view), or that some of his investments may ha

8 depreciated in value) do not amount to criminal conduct~ in fact, absent a failure to pay dien

9 withholding taxes, this conduct does not even constitute a breach of Hamilton Taft's contractl

10 obligations.

II Similarly, counts fifteen through twenty-one allege improper diversions and a "cover-up" of the

12 improper diversions -- conduct which, again, might arguably constitute evidence of Mr. Annstron!

13 intent never to perfonn, but which cannot itself be criminal conduct. If monies, once delivered

14 Hamilton Taft, became Hamilton Taft property, there can be no "misuse~' of such property vis a vis eli·

15 companies who have already surrendered all proprietary rights in those monies. Rather, the sole quest

16 for the jury to decide is whether Mr. Armstrong fraudulently induced clients to do business with HamJ I-

17 Taft, by making representations which he never intended to honor.

18

19 B. TIllS WAS NOT A uPONZltI SCHE1v1E-

20 Since Hamilton Taft fulfilled its every contractual duty -- to the extent that clients allowed tt-
21 to do so -- one might well ask: Wherein lies the so-called scheme to defraud? The government sel

22 to be of the opinion that Mr. Armstrong was operating a uponzi" scheme. IINot so, If says the easel

23

24

25 10
Counts one through six allege that Mr. Armstrong fraudulently induced clients tc
business with Hamilton Taft, by misrepresenting the ways in which Hamilton Taft WI
26 invest its monies. While Mr. Armstrong intends to prove his innocence of these cha
at tri~ he aclmowledges that the Nmth Circuit opinion does not require dismissal of f
27 counts, as a matter of pure law. The Ninth Circuif s conclusion that monies wen
property of Hamilton Taft means that, while Mr. Armstrong may be charged
28 improprieties in the acquisition of such monies, he should not be charged in connec
with conduct that post-dates his allegedly fraudulent acquisition of monies.

11 nO{)1r)f')
 1 "A Ponzi scheme is a fraudulent arrangement in which an entity makes payments to investors fn

2 monies obtained from later investors rather than from any 'profits' of the underlying business ventur

3 In re United Energy Corp. 944 F.2d 589 (9th Cir. 1991). The term stems from the late Charles Par

4 a colorful and flamboyant swindler of the 1920s. Ponzi induced would-be investors to give him man

5 in order to buy foreign postal coupons, which he would then purportedly sell in other countries at ] O(
6 gain. In return for their money, Ponzi gave "investors" 90-day notes, which he would promise to re~

7 at 150% of face value. Though no foreign postal coupons actually existed, Ponzi continued to hor

8 these 90-day notes as promised, using other investors! monies to do so, and thereby causing his o'

9 debts to spiral exponentially. See Cunningham v. Brown, 44 S.Ct. 424 (1924).

l O i n United Energy, the principles sought to induce investors to purchase shares of solar enel

11 modules, by way of a down payment and annual or semi-annual installments. Though the modu

12 actually produced only a negligible amount of energy, the principles paid investors occasional sums

13 money, which they represented to be returns on investment. This, in tum, caused the initial investor~

14 continue making payments to United Energy, while also causing new investors to finance the ph(

15 project This new money could then be used to partially pay back the old investors, in order to mak

]6 appear that the venture was a success.

]7 The schemes in both Cunningham and United Energy, while holding themselves out to

18 legitimate business ventures, were nothing more than textbook Ponzi schemes, in which no investrr

19 ever existed. Conversely, Hamilton Taft's stated purpose was to provide payroll services, and it did

20 Of course, given the $18.9 million hole which he inherited, as well as the continuing interest

21 penalties attributable to that hole, it was inevitable that Mr. Annstrong would have to use newly incon

22 monies to payoff pre-existing liabilities -- holding back more tax deposits in the process Moreo'

23 unlike CIGN~ which had been able to dip into its own abundant coffers to cover Hamilton I.e

24 escalating liabilities, Mr. Armstrong did not have this luxury. As a result, his only chance of til
25 Hamilton Taft's pre-existing hole, was to invest a small percentage of Hamilton Taft funds in investm

26 which, while containing some element of risk, also had the potential for tremendous returns.

27 decisions to hold back checks and to payoff old liabilities with incoming funds did not constitute a P

28

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1 scheme, but were simply business decisions which were not only contractually permitted, but We

2 contemplated by the clients at the time they entered the contracts.

3 In a Ponzi scheme, the victims believe they are putting their monies into an investment, althou

4 no investment exists at all. In the instant case, clients believed that Hamilton Taft would pay their taxi

5 as well as any penalties and interest, and Hamilton Taft did so -- until the clients themselves completl

6 shut off Hamilton Taft's cash flow, based on the unconfirmed allegations of a disgruntled ex-employ,

7 Indeed, it is dowruight remarkable that Mr. Armstrong now faces federal felony charges for missing 1

8 payments which his ovm clients (the supposed victims in this case) left him totally unable to make. T

9 $50 million in unpald 1991 taxes is an_artificial creation of the clients themselves -- brought about by th

10 own sudden and unilateral decision to freeze Hamilton Taff 5 cash flow. These clients have stolen 1\

11 Armstrong's keys and pushed his car into a ditch, yet are now complaining that Mr. Armstrong cam

12 drive them to the show.

13 The government's "evidencel1 of a Ponzi scheme stems solely from the fact that, in continuing

hold bac~ tax deposits to pay off their pre-existing debt, Hamilton Taft was incurring more and me
14

15 penalties and interest, thus creating the need to hold more and more future tax deposits. At worst, t

16 conduct constitutes profligate money management by Mr. Armstrong -- the stuff of shareholder pre

17 battles, but not of criminal indictments. If Mr. Armstrong can be criminally charged for running

18 increasing bills for ills company, then so too can every home owner who defaults on his loan, or ev

19 corporation whose debts exceed its assets.

20 The truly arbitrary nature of this case is best captured by a rhetorical question: Would:

21 Armstrong be facing criminal charges today if one or two of his investments had reaped grand retu

22 enabling him to fill Hamilton Taft's pre-existing hole? Surely 1v1r. Annstrong' s is not the first busiJ

23 ever to make risky investments, with monies paid to it by clients. Nor is it the first business to perf

24 some of its contractual duties late. And Mr. Armstrong is not the first CEO ever to enjoy a boun

25 I lifestyle while his company struggles to become profitable. What, then, elevates this case from a I

26 civil dispute to a 21-count federal fraud indictment? Hamilton Taft's clients, with more than a little

27 from Fred Wyle and the Bankruptcy Court, arbitrarily chose to shut down the company befoT

28 investment program had reached fruition. With Hamilton' s Taft's business activities frozen in time

13 000124
-
government then called on its high-priced accountants, who summoned their mystical powers

2 projections, spread sheets, and mathematical assumptions, to create a loss where none actually exist!
.., Aided by such sorcery, the government was able to transfonn Hamilton Taft from a mere non-profital
.J

4 business into a criminal "Ponzi" scheme.

5 In short, Hamilton Taft contracted to perform a service for its clients and it did so. If the die1

6 believe Hamilton Taft's late performance to be a contractual breach, let them sue Mr. Armstrong in ci

7 court. If Congress wishes to expand the common law of trusts to include payroll processing compani

8 let them change the law. If the government believes Mr. Annstrong committed fraud in the inducem{

9 (as alleged in counts one through six), let them prove it at trial. However, to allege that Mr ..A.rmstro

10 was '<diverting" funds which were his own property; or committing a Ponzi scheme. while giving I

11 clients the very service they contracted for; or that he "covered up" a scheme which, by defirution, WOt

12 have been completed at the moment clients signed their contracts, is illogical, excessive, and tota

13 prejudicial to Mr. Armstrong' 5 right to a fair trial.

14 Counts seven through twenty-one should be disnussed.

15

16 II. AT A MINIM1JM, THIS COURT SHOULD DECLARE THE NINTH CIRCUIT HOLDI1'
TO BE THE "LAW OF THE CASE" IN MR. ARMSTRONG'S CRllv1INAL TRIA..L.
17
18 Even if this court does not view the Nmth Circuit's opinion as dispositive of certain counts of 1

19 indictment, defense counsel at least urges that this court issue an order declaring the Ninth Ci~cuit's.le:

20 conclusions to be the law of this criminal case. Such an order would mean, inter alia, that:

21 1. Defense counsel may refer to the monies at issue, in both opening and closing statemer
as the property of Hamilton Taft or Hamilton Taft cash flow.
22 ll
2. The goverrunent may not refer to those monies as "client monies" or "client funds (;

23 may not state or imply that Hamilton Taft held those monies in trust.
..,
24 J. The government may not present evidence of any advice which Mr. Armstrong receiv
from la-wyers or other experts, to the extent that such advice was inconsistent with
25 state of the law, as set forth in the Ninth Circuifs opinior:.

26 4. This court will instruct the jury that monies, once delivered to Hamilton Taft, became
property of Hamilton Taft. .
27
5. This court will instruct the jury that Hamilton Taft was free to use its cash flow to co
28 its operating expense or to mvest those monies for its own benefit and in any wa
wished.

14 0001?S
 6. This court will instruct the jury that Hamilton Taft's sole duties to its ciients were the
duties stated contractual1y but that clients were free to sue for breach, if Hamilton T
2 ever failed to live up to those duties. '

....
..)
liThe law of the case doctrine 'ordinarily precludes a court from fe-examining an issue previou

4 decided by the same court, or a higher appellate court, in the same case.· 11 United States v. Catenn 0,

5 F.3d 1390, 1395 (9th eir. 1994) (cita.tions omitted). The doctrine refers to a family of rules embadyi
II

6 the general concept that a court involved in later phases of a lawsuit should not re-open questions decic

7 ... by that court or a higher one in earlier phases." Crocker v. Piedmont A viation, Inc., 49 F.3 d 7:

8 739 (D.C. Cir. 1995). {emphasis added}. Law of the case is primarily an equitable principle and, unL

9 the principles of collateral estoppel and res judicata, is applied at the discretion of the coun. Howev

]0 as the Ninth Circllit has observed, it is a principle which ushould not be applied woodenly in a \\

11 inconsistent with substantial justice. 1I

United States v. MJJler, 822 F.2d 828 (9th Cir. 1987).

12 In the instant case, there are arguable technical reasons why the Ninth Circuit decision should r

13 constitute the law of Mr. Annstrong's criminal case. The first such reason is that the decision v

14 vacated after the parties settled out of court. The second is that the parties to the instant case are not

15 same as the parties to the civil dispute from which the Ninth Circuit's opinion arose. Putting aside th

16 technicalities, it is hardly a matter of dispute that the Ninth Circuit decision arose from the exact sa

J7 facts, circumstances, and issues as those that will be presented in this case. While the opinion has h

18 vacated, it continues to stand as both a scholarly, lucid, and unassailable explication of the common

19 of trusts, as well as a "cheat sheet," which allows this court to see how the Ninth Circuit will rule, she

20 this issue comes before it again. Under these Clrcumstances it flies in the face of common sense to ref
1

21 to acknowledge the Ninth Circuit's reasoning and to pretend the opinion does not exist.

22 To simply leave this matter as a factuaJ free-for-all, to be sorted out by the jury, is not o~ly leg

23 erroneous, but also grossly prejudicial to Mr. Armstrong. The character of the funds at issue is a

24 component of this case and is a matter of pure law, as even this court acknowledged in its Febru

25 1993 opinion; were this merely a factual issue, the Nlllth Circuit never would have addressed it in the

26 place. Because these funds were Hamilton Taft property, as a matter of law, the jury should be instru

27 that this is the case. Simply allowing the defense to present evidence that these were not trust funds

28 leave in the hands of lay-jurors the task of dissecting and applying subtle nuances of law, on which

15
IIIiI

Mr. Armstrong's own attorneys could not find consensus. After hearing the government refer to tht

2 funds as "client funds," "trust funds," or "withholding funds," lay-jurors surely cannot be expected

3 understand defense counsel's highJy technical arguments about commingling of funds, statutory trus

4' and third party transferees. Without a clear instruction to this court that funds transferred to Hamilt

5 Taft became Harnilton Taft property, the jury wilJ be only too ready to wrongly believe that these fur

6 were withholding monies, and that Hamilton Taft was held to the same fiduciary duty that their 0'

7 employers have.· To allow jurors to make such an inference would be grossly prejudicial and devastati

8 to Mr. Armstrong's case.

9 While Mr. Annstrong was not himself a party to the Ninth Circuit's case, that case was

10 adversary proceeding which arose out of the same bankruptcy as the one which led to this criminal ca

11 By the same token, the facts which led to the Nmth Circuit's conclusions of law (that no trust existed,

12 that Hamilton Taft's relationship with clients was debtor-creditor) are the identical facts now at issuE

13 this criminal case. Adopting the Nmth Circuit's opinion as the law of this criminal case is consistent \\

14 the principles of flexibility and efficiency with which the law of the case doctrine is customarily appli

15 Should this court be reluctant to dismiss counts seven through twenty-one, pursuant to the Ninth eire

16 opirrion,:Mr. Armstrong requests that it at least take the lesser step of declaring the Ninth Circuit's le

17 conclusions to be the law oflvlr. Armstrong's criminal case -- with all of the ramifications which t

18 finding would entail.

19

20 \\\

21 \\\

22 \\\

23 \\\

24 \\\

25

26
27

28

16 000127
r' , ' 1 I PROPOSED 5
2

3 paid to Hamilton by of
4 two to have their payments to Hamilton

5 treated by

6 to pay nVP':rpt"l by

7 Hamilton Taft did not FTnrllrlVI".f" might

8 hold your withholding taxes. In other words, funds until

9 the taxes were due to be paid, pursuant to tenns contract

10

11

12

13

14

15

16

17
18

19

20

21

22
23

24
25

26 on: &- Co., F,3d (9th eir., 1995). vacated du(: to LLJUULH

27 68 Ke5~U:men[ (Second) of Trusts § 283 (1959); Austin W.

28 (4th ed. 1989),

I
.....
00016