1 MICHAEL J.

YAMAGUCHI
United states Attorney
2
JOEL R. LEVIN
3 Chief, Criminal Division

4 RONALD D. SMETANA
Special Assistant U.S. Attorney
5 GEORGE D. HARDY
Assistant U.S. Attorney r ",
6
' . ·~t ., .":t':
. ~''''
''''"''
450 Golden Gate Avenue
7 San Francisco, CA 94102
Telephone: (415) 436-6851
8

9 UNITED STATES DISTRICT COURT

10 NORTHERN DISTRICT OF CALIFORNIA
11

12 UNITED STATES OF AMERICA, ) Criminal No. 94-0276-CAL

)
13 Plaintiff,) GOVERNMENT'S OPPOSITION
) TO ARMSTRONG'S MOTION TO
14 v. ) DISMISS AND/OR REQUEST
) FOR PRETRIAL INSTRUCTION
15 CONNIE C. ARMSTRONG, JR., and )
RICHARD A.FOWLES, ) Date: Nov. 8, 1996
16 ) Time: 1:30 p.m.
Defendants. ) Courtroom: 10
17 ) (Han. Charles A. Legge)
18

19 .L.. Introduction
\

20 Defendant Connie C. Armstrong, Jr., seeks (again) to

21 dismiss counts seven through twenty-one of the Indictment. In the

22 alternative, he seeks an instruction on the "law of the case." For

23 the reasons set forth below, the government opposes this motion.

24 II. Argument

25 ~ Statement of facts.

26 As set forth in the grand jury's Indictment, the charges

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 1 arise from defendant's operation of Hamilton Taft, a San Francisco
2 based company that provided payroll tax services to large
3 companies. Client companies transferred their payroll taxes to
4 Hamilton Taft and Hamilton Taft was obligated to pay the taxes to
5 the Internal Revenue Service and other taxing authorities on time.
6 At the time the defendant acquired Hamilton Taft the
7 company had a working capital deficit of more than $14 million.
8 Over a period of two years, as money was siphoned out and Hamilton
9 Taft accrued interest and penalties on money it did not have, the
10 withholding of tax payments grew from $19.4 million to $68.2
11 million per quarter. When Hamilton Taft ultimately collapsed,
12 approximately $85 million in taxes were unpaid.
13 Despite the fact that the defendant was aware that he
14 could not pay the taxes of his clients when due, he induced a
15 number of companies to contract with Hamilton Taft with
16 representations that Hamilton Taft had the ability to pay taxes
17 when due, was paying taxes when due and would continue to pay ~he

18 taxes when due.

19 As a further part of the scheme, the defendant concealed
20 the non-payment of taxes to induce the victims to continue sending
21 (on a weekly, biweekly or monthly basis) their tax payments and to
22 avoid the wholesale cancellation of contracts. Finally, when the
23 defendant's scheme was exposed, he sent out lulling letters denying
24 the existence of the scheme and encouraging )~tc::t;,i!Jl2- to continue
25 sending payments.

26 II
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 2

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 1 .a.... Defendant's Reliance on In re Hamilton Taft & Co. is
misplaced.
2

3 The litigation underlying In re Hamilton Taft & Co., 53

4 F.3d 285 (9th Cir. 1995), was between two parties over a fixed sum
5 of money whether the trustee in bankruptcy would be able to
6 reclaim for the larger group of victims funds paid to the IRS on
7 behalf of S & S Credit. The Ninth Circuit initially ruled that a
8 preferential payment had been made on behalf of S & S and that the
9 funds paid to the IRS on its behalf would have to be repaid by S &
10 S to the trustee. S & S petitioned for rehearing, and before the
11 matter could be heard, the case was settled, the appeal was
12 dismissed as moot, and the decision was vacated. In re Hamilton
13 Taft & Co., 68 F.3d 337 (9th Cir. 1995). The Ninth Circuit· s
14 vacation of the opinion nullifies and renders the judgment
15 inoperative. United States v. Munsingwear, 340 U.S. 36, 40-41
16 (1950). Arguably, the parties could now relitigate the issues.
17 340 U.S. at 40. In short, this Court is not bound by In re
18 Hamilton Taft & Co.
19 This conclusion is made more compelling by the fact that
\

20 the government was not a party to the litigation at the time the
21 opinion was rendered by the Ninth Circuit. When the petition for
22 rehearing was filed the Court obviously recognized that its opinion
23 could well interfere with the government·s right and ability to
24 collect employee taxes and thus invited the government to
25 participate in the case as an amicus curiae. The government did
26 file a brief advocating the theory that the funds were held by

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 3
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 1 Hamilton Taft in trust for the government. The case was settled
2 and the opinion vacated before the government's position could be
3 considered. To resolve the i;§sue nq~~lY: t;,o the~g£2~E]leJlt

4 which hC\s~r had thEL~~~gy: tQ b_t;.. heq.rcLi§,"",fundsIDWt:lllY

5 )£}is) r o •
6 The inescapable conclusion from this discussion is:
7 there is no "l,,!w oLth~.".Cas.e.." Rather, there remains a dispute of
8 fact that can be resolved only by the scheduled jury trial.
9 ~ Contrary To Defendant's Contention, Hamilton Taft Did Not
Comply with Its Contractual Duties.
10
The government will subsequently demonstrate why counts
11
7 through 21 should not be dismissed. However, fundamental to
12
defendant's argument is his premise that he complied with the
13
conditions of his contracts and thus did nothing wrong. Defendant
14
has again pummeled a straw man.
15
The trial evidence will show that, at a minimum, all of
16
Hamilton Taft's contracts required timely payment of taxes on or
17
before the statutory deadlines. 1 Some of the contracts also
18
specifically limited the short-term investments that could be made.
19
Thus, Scott Paper's contract stated that:
20
In order to satisfy Hamilton Taft's investment criteria
21 (Security of Principal, High Degree of Liquidity), Hamilton
Taft's investments are limited to investments collateralized
22 by United States Government securities and United States
Government sponsored obligations.
23

24 lContrary to defendant's assertion that he "occasionally" paid

the taxes late (Defendant's Memorandum 10:16), he intentionally
25 failed to make more than 300 payments aggregating more than $255
million, and the frequency of missed payments as well as .their
26 dollar amounts were increasing almost logarithmically.
GOVERNMENT'S OPPOSITION TO ARMSrRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 4
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1 Others limited Hamilton Taft to benefits accruing from temporary

2 use of client funds or benefits accruing from proper use of client
3 funds. Given the intentional failures to pay taxes on time, the
4 long-term use of client funds and the other than proper use,
5 defendant's assertion that he complied with the contracts is
6 nothing less than revisionist history.
7 Similarly erroneous is defendant's assertion that once
8 the money was paid over to Hamilton Taft that he could use it for
9 any purpose he wanted. He induced his clients to do business with
10 Hamilton Taft on the representation that he could and would pay the
11 taxes on a timely basis. His knowing and intentional use of the
12 funds otherwise clearly constitutes fraud, as the trial evidence
13 will amply demonstrate.
14 Defendant did not just commit fraud at the time the
15 contracts were executed, but on an ongoing basis in order to assure
16 continued payment. The only way to pay past due taxes with current
17 payments is to assure an adequate supply of current payments.
18 Defendant and his employees concealed the tax withholds as much as
19 possible. When discovered, they lied about the basis for missed
20 payments. Thus, each payment from each of the victims was directly
." 21 attributable to the fraud and a direct and intended consequence of
22 the ongoing fraud.
23 Defendant's argument that this was not a Ponzi scheme
24 (Defendant's Memorandum, 10:8-10) is similarly without merit. The
25 defendant is not before this court because he paid "Client A's

26 taxes with Client B's and Client C's money;" the government would

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 5

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 1 expect that all of A, Band C's payments would be made from the
2 collective contributions from A, Band C. Rather, defendant is
3 before the court, in part, because he bought a ranch with A's money
4 paid to Hamilton Taft for a January tax payment (while
5 intentionally failing to make A's tax payment), and then used Band
6 C's funds paid to Hamilton Taft in April for their April tax
7 payment to make A's January payment while failing to make Band C's
8 April tax payment.
9 Indeed, the description of a Ponzi scheme in In re United
10 Energy Corp., 944 F.2d 589, 590 at fn.l (9th Cir. 1991)2 describes
11 precisely what defendant was doing. Defendant made tax payments
12 for clients with monies obtained from later tax payments from other
13 clients. By funnelling later payments to earlier taxes defendant
14 created the illusion that taxes were being timely paid and that
15 (bankrupt) Hamilton Taft had the financial wherewithal to pay the
16 taxes, inducing continued use of Hamilton Taft's services, all the
17 while siphoning out funds for defendant's personal benefit. The
18 only sorcery involved was the defendant's sleight of hand;
19 unfortunately for him, the audience caught on to the trick!
,
20 IL.. There is no basis for the dismissal of Counts Seven through
Twenty-One.
21
Regardless of how the relationship between Hamilton Taft
22
23 2"A Ponzi scheme is a fraudulent arrangement in which an
entity makes payments to investors from monies obtained from later
24 investors The fraud consists of funnelling proceeds
received from new investors in guise of profits from the alleged
25 business venture, thereby cultivating an illusion that a legitimate
profit-making business opportunity exists and inducing further
26 investment.
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 6

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 1 and its clients is categorized, Counts Seven through Twenty-One
2 withstand attack.
3 Defendant appears to argue that the government can
4 proceed on counts One through Six, the fraud in the inducement, but
5 that proceeding on the other counts is "illogical, excessive and
6 totally prejudicial • • • " (Defendant's Memorandum 14:15-16) As he
7 has done throughout these proceedings, defendant has made a lengthy
8 and colorful argument all the while ignoring the one document
9 relevant to the inquiry -- the Indictment. It does not depend on
10 the existence of any particular relationship between defendant and
11 the victim companies. Rather it alleges a fraudulent course of
12 conduct in addition to and beyond the inducement to keep the money
13 flowing into Hamilton Taft. The Indictment alleges fraud on an
14 ongoing basis to keep money flowing into Hamilton Taft by a cover-
15 up3, false tax returns 4 , a change in cover-up methodology5, the

16 selection of specific clients for withholding and Armstrong's

17 attempt to disseminate a false account of what was happening to

18 client funds. All of these allegations are incorporated by

19 reference in each of the counts. (Indictment, paragraph 24.)
20
3"This concealment enabled Hamilton Taft to continue to
21
receive funds from its clients, to avoid massive cancellation of
its contracts, and to preserve the opportunity for new business."
22
4"The clients who received these returns were thereby falsely
23 led to believe that all their taxes had been paid."
24 5"By choosing to pay past due taxes instead of currently due
taxes, Armstrong was able to delay, for a much longer time,
25 discovery by the clients that their taxes had been paid late. At
the same time, he was able to create the false impression that
26 Hamilton Taft's business was running smoothly."
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUESr FOR
PRETRIAL INSTRUCTION 7

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 1 Defendant argues, however, that all allegations of the
2 Indictment, other than the fraud in the inducement allegations, are
3 legally insufficient to charge criminal activity because of the
4 Ninth Circuit opinion of In re Hamilton Taft & Co. which
5 establishes (or so defendant claims) the "law of the case" contrary
6 to the government's charging theory. The "law of the case" that
7 defendant sees in that opinion and on which defendant focuses his
8 argument is the conclusion that the relationship between Hamilton
9 Taft and its clients was one of "debtor-creditor", and not a trust
10 relationship. From that "law of the case", the defendant seeks to
11 extrapolate to the further conclusion that the defendant was free
12 to do with the clients' tax money whatever he wanted, because it
13 was Hamilton Taft's "property". Hence, he argues that any criminal
14 fraud allegations in the Indictment which describe what the
15 defendant did with client's tax money after the contracts were
16 signed must be legally insufficient, and therefore dismissed. His
17 argument is further based on the factual predicate that Hamilton
18 Taft complied w-ith the terms of the contracts with its clients.

19 Defendant's argument is factually and legally flawed •

•
20 As noted earlier, the Ninth Circuit opinion has no

21 precedential .or controlling effect on this Court (and therefore can

22 not be considered "the law of the case") because it was vaca'ted.

23 It should also have little, if any, persuasive effect on this Court
24 because it was vacated in the context of a motion for
25 reconsideration, before the Ninth Circuit had heard from the
26 government. Furthermore, even if this Court were to conclude that

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 8
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....

1 the legal relationship between Hamilton Taft and its clients was
2 one of "debtor-credi tor", the further coneIus ion that the defendant
3 could do whatever he wished with the tax money (send it to a secret
4 Swiss bank account?) does not logically, or legally, follow. Can
5 a debtor never defraud a creditor? The answer is obvious. In
6 fact, the defendant acknowledged as much when he said:
7 "For instance, had Mr. Armstrong s imply taken clients'
monies and opened a Swiss bank account, while totally
8 ignoring his contractual duty to pay their taxes, he
almost certainly could be charged with engaging in a
9 scheme to defraud." (Motion, p. 9)
10 The defendant asserts as a matter of fact that he complied
11 with his contractual duty to pay the taxes of the Hamilton Taft
12 clients. The government intends to prove that he did not comply
13 with his contractual dutiesl Jury trials are the vehicle by which
14 such factual disputes are resolved, not motions to dismiss. There
15 is no basis for this Court to dismiss counts Seven through Twenty-
16 One.

17 .L. The Court should not make a finding of "the law of the case."
18 The government is persuaded by defendant's eloquence in

19 arguing that this court should not follow In re Hamilton Taft & Co.
20 (Defendant's Memorandum, 15:16-18), but cannot agree that the

21 vacated opinion is "a scholarly, lucid, and unassailable

22 explication of the common law of trusts" (Id. at 21-22) since the
23 court sought to implicate the government's rights without giving
24 the government an opportunity to be heard. Regardless of how
25 "scholarly" or "lucid" the opinion may be on the common law of

26 trusts, as noted above it is not "the law of the case", and clearly

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 9

I
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 1 should not be used to justify making a ruling on an issue that is
2 nothing but a red herring.
3 It is clear what the defendant is attempting to do. He
4 wants the jury not to hear relevant evidence. He doesn't want the
5 jury to hear about the Ranch acquisition, or the limousine rides,
6 or the luxury jet purchase. He also doesn't want the jury to hear
7 what his lawyers and senior management were telling him--that he
8 couldn't use client tax money for long-term personal investments.
9 He also doesn't want the jury to hear about the lies he told his
10 employees regarding the source of funds for his ranch and other
11 purchases. He doesn't want the jury to hear about the lies he told
12 the victim companies in order to lull them into a false sense of
13 security. But all of this evidence is relevant to prove the
14 charges in the Indictment.
15 To his credit, the defendant spells out the remarkable
16 ramifications of a decision to declare that In re Hamilton Taft &
17 Co. represents the "law of the case". He wants:
18 1. Defense counsel to be able to refer to monies at
issue, in both opening and closing statements as the
19 property of Hamilton Taft or Hamilton Taft cash
flow;
20
2. The government not to refer to those monies as
21 "client monies" or "client funds" and not to state
or imply that Hamilton Taft held those monies in
22 trust;
23 3. The government not to present evidence of any advice
which Mr. Armstrong received from lawyers or other
24 experts, to the extent that such advice was
inconsistent with the "law of the case";
25
4. The court to instruct the jury that monies, once
26 delivered to Hamilton Taft, became the property of

GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 10
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..
1 Hamilton Taft;
2 5. The court to instruct that Hamilton Taft was free to
use its cash flow to cover its operating expense or
3 to invest those monies for its own benefit and in
anyway it wished;
4
6. The court to instruct the jury that Hamilton Taft's
5 sole duties to its clients were those duties stated
contractually but that clients were free to sue for
6 breach, if Hamilton Taft ever failed to live up to
those duties.
7

8 Nothing in the language, logic, or holding of the vacated

9 opinion in In re Hamilton Taft & Co. comes close to justifying such
10 a gutting of the government's case.
11 The defendant's motion to characterize, as a matter of law,
12 the nature of the relationship between Hamilton Taft and the victim
13 clients, in the form of a pretrial ruling should not be granted.
14 The characterization has not been settled as a matter of law. The
15 characterization, even if accepted as "debtor-creditor", does not
16 negate the presence of a fraudulent scheme or support in any way
17 the six conclusions cited above. The characterization would only
18 confuse the jury, leaving them to wonder about the illogical
19 technicalities of the law.
20 II
21 II
22 II
23 II
24 II
25 II
26 II
GOVERNMENT'S OPPOSITION TO ARMSTRONG'S
MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 11
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•

1 III. Conclusion
2 For the foregoing reasons, the government respectfully
3 submits that the motion to dismiss be denied and that the Court
4 deny the request to make In re Hamilton Taft & Co. the law of the
5 case.
6 DATED: November 5, 1996 Respectfully submitted,
7 MICH~~J. YAMAGUCHI

unite~ ta~~s i~~/rn:;, . __

By~I{)~
8
9
10 RONALD D. SMETANA
Special Assistant U.S. Attorney
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GOVERNMENT'S OPPOSITION TO ARMSTRONG'S

MOTION TO DISMISS AND/OR REQUEST FOR
PRETRIAL INSTRUCTION 12

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