Plaintiffs’ Notice That the ‘Taxman Cometh’ Was Sufficient to Trigger Statute of Limitations

Financial Services Regulatory   |   Life, Annuity, and Retirement Solutions   |   March 31, 2018

Todd M. Fuller

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In a November 16, 2017 ruling, a California appellate court affirmed a summary judgment ruling in favor of several financial advisors, and insurer American General Life Insurance Company, holding that plaintiffs’ fraud and negligence based claims relating to alleged faulty financial planning advice were time-barred.

In Choi v. Sagemark Consulting, plaintiffs alleged that in 2003 their financial advisors induced them to establish a defined benefit plan under § 412(i) of the Internal Revenue Code, funded with life insurance policies, based on alleged misrepresentations regarding the validity and favorable tax consequences associated with the plan and policies. According to the plaintiffs, although the defendants knew or should have known that the plan as structured would likely be scrutinized by the IRS and deemed an abusive tax shelter, they nevertheless represented that the plan was "bullet proof," and carried no substantial risk of adverse IRS action or negative tax consequences. In November 2010, plaintiffs filed their complaint, alleging that based on the faulty tax advice, they suffered damages beginning in 2008, and extending through the completion of the IRS audit and assessment of back taxes, interest, and penalties in 2009.

Defendants moved for summary judgment contending that the claims were time-barred because plaintiffs were on notice of indeterminate damages at the latest by September 2007. They argued that a November 2006 notice to plaintiffs by the IRS – which was auditing plaintiffs’ plan – identifying numerous defects in the plan, and the need to unwind or alter the plan, should have raised plaintiffs’ suspicion. Defendants further argued that a September 2007 email exchange between plaintiffs and defendants put plaintiffs on notice that there would be IRS penalties associated with their plan participation, although the amount and potential to offset options were unknown. Plaintiffs countered that there was no actual injury at that point, and that their claims had yet to accrue, because no penalty or tax assessment had been issued rendering any damages uncertain. The appellate court disagreed.

Specifically, the court recognized that the existence of appreciable actual injury for claim accrual did not depend on plaintiffs’ ability to quantify the sum of damages, but required only the suspicion that some wrongdoing injured them. It explained that, in this case, "by the time plaintiffs learned that the IRS’s adverse assessment of the 412(i) Plan would result in penalties, neither the lack of a numeric assessment nor the hope of offset by another source negated the fact that plaintiffs were on notice of actual injury." The court, thus, held that plaintiffs’ claims accrued in September 2007 because, by that point, "plaintiffs had knowledge of harm to their financial interest sufficient to trigger inquiry notice and to support a legally cognizable claim for damages."

Plaintiffs also argued that even if the September 2007 email exchange constituted notice of actual damages, the limitations periods should be tolled because defendants continued to advise and advocate on plaintiffs’ behalf in a fiduciary capacity during the pendency of the audit. The court again disagreed, noting that "the only conclusion to be drawn from the evidence leading up to and including the September 2007 e-mail is that plaintiffs were not shielded from the knowledge that the IRS was questioning the validity of 412(i) Plan, had identified multiple defects that would require unwinding or conversion to another type of plan," and had informed other professionals of forthcoming penalties. Thus, the court held that even assuming the existence of a fiduciary relationship, there was nothing to prevent or delay plaintiffs from discovering the wrongdoing beyond September 2007.