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Economic Substance and Banking Aspects of Custom Adjustable Rate Debt Structure CARDS Tax Shelter Transactions

Expert Witness: Don Coker
Banking consultant, former high-level governmental banking regulator, and renowned banking expert witness consultant Don Coker explains some important economic substance and banking issues in CARDS tax shelter litigation.

The now-discredited Custom Adjustable Rate Debt Structure “CARDS” tax shelter transactions that were offered primarily to the super-wealthy (including a lot of Silicon Valley super wealthy) up until March 2002 when they were ruled invalid by the IRS have resulted in a great deal of high-stakes litigation.

These tax shelter transactions typically involved an ostensible 30-year bank loan to a foreign party generally for amounts of $50 million to $100 million. Sometime after loan origination, the client seeking the tax shelter would assume the loan; and after some intricate swapping of collateral, claim a loss
for virtually the full amount of the loan, and that could be used to offset other income.

The IRS said in March 2002 that the CARDS schemes lacked any real economic purpose, aside from lowering taxes (which is not considered a legitimate economic purpose by the IRS), and thus lacked any true economic substance.

For the IRS, another invalidating factor was their claim that CARDS “investors” did not really have money at risk for the large bank loans that were a part of the transaction structure.

Litigation has resulted in some of these CARDS cases regarding the basic questions of if the bank loan (my area of expertise) that was an integral part of the particular CARDS transaction was a true loan and originated in accordance with nationwide banking industry standard practices. In the cases that I have had occasion to examine, the answer is “Yes.”

Loan Structure

Quite often, a lender will originate a loan for an investor in a CARDS transaction structured with a possible loan term of thirty years and that can be called on any annual due date, making it in effect a thirty-year loan with an annual call feature, which is not an unusual term for a loan to contain. Nothing about this loan structure would violate any nationwide banking or lending industry standards.

The technique of setting up a loan with an original possible thirty-year term and then terminating the loan after only one or two years is certainly not a financing technique that defrauds anyone. If that were the case, then any homeowner who refinances their thirty-year home mortgage before maturity would be guilty of fraud. In fact, as this report is being written, there is a tremendous nationwide refinancing of thirty-year home mortgages taking place. Many of these mortgage loans that are being refinanced today were originated only a few years ago. It is an interesting fact that this refinancing trend is so strong that even in today’s poor economy, mortgage companies are hiring mortgage loan origination officers to originate this high volume of refinancings.

The fact that the loan structure just described contains within it the possibility that the loan could be called does not preclude the possibility that the borrower could obtain replacement financing elsewhere. This renders moot the issue of whether the financing is long-term or short-term when considering the economic substance of the transaction.

Some CARDS participants have contended that they were not told that their bank loan that was a part of their CARDS transaction would most likely be in existence for a term of only one year or so as opposed to the thirty-year term (actually a term of one year with twenty-nine annual renewals) stated in the loan documents and that there is no document that told him that. But the document that contains this information was simply the note itself, signed by the original borrower, which permitted the loan to be terminated on any of the annual renewal dates. Presumably, a sophisticated financial person, such as one who would be involved in a $50 million to $100 million transaction, would insist on seeing a copy of the note that they were assuming. It would be unreasonable to expect a lender to produce a separate document that tells a borrower his loan term since that typically is stated clearly in the loan documents, and lenders do not produce such a separate document. In addition to the loan documents, the legal opinions obtained by a typical CARDS borrower should state that their bank loan transaction could be terminated (basically, not renewed) at the end of each loan year. In my professional opinion, no further documents beyond the promissory note are required in order for a reasonable person to understand that their bank loan that is a part of their CARDS transaction could be terminated by either party annually on the anniversary date of the loan. Furthermore, it is my opinion that it is reasonable to assume that no additional document other than the note that was assumed is required to exist in order for the parties to understand the bank loan transaction.

Collateral for the Bank Loan

The bank loan documentation specifies that the proceeds from the bank loan must be invested in certificates of deposit, short term deposits, highly rated commercial paper or government securities that serve as collateral for the bank loan. It has been a principle of banking worldwide for centuries that a lender should always have more in collateral than it has outstanding as a loan to the borrower. In this regard as well, a bank loan that is a part of a CARDS transaction is like a standard loan offered by any bank. If the bank failed to have this collateral, they would be subject to being written up by banking examiners as well as by their external auditors.

Legal Opinions

Quite often, a lender would obtain a legal opinion regarding the legality of a CARDS tax shelter transaction that they were considering. However, it is not required that a lender obtain such a legal opinion for a proposed CARDS transaction. If a lender determines that it is desirable for the lender to obtain an independent legal opinion, then the legal opinion issued typically addressed the following issues:

1. A statement that the bank did not perform a comprehensive evaluation of the potential federal tax consequences for their borrower. In general, banks do not undertake this level of analysis where they are simply providing a loan that will be used for a tax-motivated transaction. Again, the bank is simply making a loan.
2. An opinion that the subject transaction does not constitute a tax shelter under the IRS’s rules and regulations.
3. The bank is not required to register the transactions as tax shelters
4. The bank should not be considered a “tax shelter organizer.”
5. The bank will not be a seller of an interest in a tax shelter.
6. The bank will not participate in organizing a tax shelter.
7. The bank should not be required to maintain an investor list.
8. The bank is not participating in the management of a tax shelter.

Due to the specialized nature of CARDS tax shelter transactions, it is my professional opinion that it is reasonable to assume that very few law firms possessed the expertise to provide legal counsel and meaningful legal opinions on such a narrow subject as CARDS transactions. Therefore, it is important to make sure that any law firm that did provide legal and tax advice on a CARDS transaction was truly qualified to render such advice.

It was typical for a borrower-investor in a CARDS transaction to seek the assistance of accounting and legal firms that have as one of their specialties “tax minimization,” and obtain a written analysis and report that could be used in structuring the transaction. Advice may have been obtained from both certified public accounting firms and law firms specializing in tax matters.

Any written reports that were obtained should have been shared with other parties involved in establishing the structure of the transactions.

These legal opinions obtained by a CARDS investor should have opined on the lawfulness of the transaction and its likely acceptability by the IRS.

A Bank’s Role in a CARDS Transaction

Quite often, the organizer of a CARDS transaction would present the investor with the option to finance their transaction through either of several banks. These were banks that had examined and were familiar with the structure of the proposed transactions and that were willing to provide financing for qualified borrowers.

In all of the CARDS transactions that I have seen, it is my opinion that the bank’s role in these transactions was as a lender, and nothing more. CARDS transactions are complex financial structures that require a bank loan, and the bank provided such a loan to the borrower-investor.

Bank is Not a Tax Advisor

Nothing in any of the bank loan or other CARDS transaction documents that I have ever seen has indicated that the bank ever held itself out as a tax advisor, investment advisor, or anything else other than a lender for a borrower-investor in a CARDS transaction. The borrower paid no money to the bank for any other service other than what he or she paid as interest or fees on his or her loan. The borrower did not pay any fees to the bank for tax advisory or investment advisory services, and the bank typically did not provide any tax advisory or investment advisory services to the borrower. The only profit that I have observed a bank making from its loan that is used as a part of a CARDS transaction was what it earned on the loan it made to the borrower, and my review of banks’ fees and profits for these transactions in the past leads me to the conclusion that the fees and profits were well within normal banking and lending industry practice.

Anyone that was considering entering into a CARDS transaction should have known that the only role that a bank could possibly perform in such a complex financial structure would be that of lender, and that they should look elsewhere for tax, legal, and any other advice required to make an intelligent decision about their investment plans; and it has been my experience that higher-income individuals typically did seek and obtain their tax and legal advice elsewhere, such as with a certified public accountant or a tax attorney.

No Fiduciary Duty

It should be without question that a bank making a loan that happens to be a part of a CARDS transaction has no fiduciary duty to its borrower. This lack of fiduciary duty to a borrower on the part of a lender is a long-standing legal principle of banking and lending that is recognized and applied nationwide.


CARDS transactions have been discredited by the IRS since March of 2002. However, the bank loans that were a part of those transactions appear to be stand-alone loans that contained many of the features and characteristics of other bank loans.

© 2010 by Don Coker.

ABOUT THE AUTHOR: Banking & Lending Expert Witness Don Coker
Expert witness and consulting services. Over 448 cases for plaintiffs & defendants nationwide, 107 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ. Clients have included numerous individuals, 60 banks, and governmental clients such as the IRS, FDIC. Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator. BA degree from the University of Alabama. Postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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