BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 5901 Green Valley Circle, Room 207 Culver City, California REPORTER'S TRANSCRIPT JUNE 16, 2010 ITEM B12 FRANCHISE AND PERSONAL INCOME TAX HEARING APPEAL OF DAVID LAIL and KAREN LAIL (No. 439458) AGAINST PROPOSED ASSESSMENT OF ADDITIONAL TAX Reported by: Beverly D. Toms CSR No. 1662 1 1 2 P R E S E N T 3 For the Board Betty T. Yee of Equalization: Chair 4 Jerome E. Horton 5 Vice-Chair 6 Bill Leonard Member 7 Michelle Steel 8 Member 9 Marcy Jo Mandel Appearing for John Chiang 10 State Controller (per Government Code 11 Section 7.9) 12 Diane Olson Chief, Board 13 Proceedings Division 14 For Board of Grant Thompson 15 Equalization Staff: Tax Counsel 16 For Franchise Tax Natasha Page 17 Board: Tax Counsel 18 Terry Collins Tax Counsel 19 For Appellant: Christopher Manes 20 Attorney at Law 21 David Lail Taxpayer 22 Michael Davis 23 Witness 24 ---oOo--- 25 26 27 28 2 1 Culver City, California 2 June 16, 2010 3 ---oOo--- 4 MS. YEE: Okay, Ms. Olson, what's our next 5 matter, please? 6 MS. OLSON: Our next matter is B12, David Lail 7 and Karen Lail. Please come forward. 8 MS. OLSON: Do you need a third chair? 9 MR. MANES: It would be nice to have a third 10 chair, yes. 11 MS. YEE: Sure. We'll get one for you. I see 12 everybody getting cozy here. Okay. 13 MR. MANES: I'm Chris Manes. 14 MS. YEE: Hang on one second, we're going to 15 have Appeals introduce your matter and then we'll give 16 you time to begin. 17 Okay, Appeals. Good morning. 18 MR. THOMPSON: Good morning. Grant Thompson 19 for the Appeals Division. 20 The issues in this appeal are whether income in 21 the amount of approximately 8.8 million received by 22 Appellants in 2000 should be classified as wages or 23 royalties. 24 And the second issue is whether the Board has 25 jurisdiction to abate the proposed amnesty penalty. 26 MS. YEE: Right. Thank you very much, 27 Mr. Thompson. Let's see. Members, we're on item B12, 28 David Lail and Karen Lail. 3 1 Good morning, gentlemen. 2 MR. LAIL: Good morning. 3 MS. YEE: If you'll each introduce yourselves 4 for the record you have ten minutes for your 5 presentation. 6 MR. MANES: Good morning. I'm Chris Manes. 7 I'm tax counsel for David and Karen Lail. Mr. Lail is 8 here with me and is available to testify. 9 Also here is Mike Davis. Mike Davis is an 10 investment banker who has extensive experience with Mr. 11 Lail during the period at issue. 12 MS. YEE: Very well. Please proceed. 13 MR. MANES: I know time is brief. I want to 14 say that despite the voluminous pleadings in this case, 15 and they are voluminous, I think one fact remains 16 unrefuted, and that is that David Lail developed a 17 financing structure that helped reinvigorate the bond 18 market that had dwindled because of tax law changes. 19 And as a result of that cities were able to build 20 hospitals and schools and airports. And so Mr. Lail can 21 be proud of that. 22 The core issue facing the Board today is was 23 these -- the payments to my clients with respect to 24 those bond issuances, were they payments for services 25 rendered? Were they payments for royalties relating to 26 his creation of that idea. 27 The simple way to put it is what did Mr. Lail 28 get paid for, which is what we're really talking about 4 1 here. Did he get paid for work? Or did he get paid for 2 developing this new financial product? 3 Respondent claims that it was for work done. 4 The problem with this is inconsistent with the facts. 5 By any standard -- by any standard what Mr. Lail did as 6 far as work was minimal. He was involved in some 7 bidding which involved sending some faxes out and some 8 hand-holding of some attorneys who asked questions about 9 the -- the financial documents. 10 That was the extent of his work, and he's here 11 and he can talk about that as -- as can -- as Mr. Davis. 12 The problem with that is -- is inconsistent 13 with the amount of payment he actually got. We know 14 that Mr. Lail got a modest salary. And that salary is 15 set forth in Exhibit 2 of the -- of the exhibits I gave 16 you. These come from George Baum. These are not 17 documents that I created. And he had a modest salary. 18 He got some -- a modest bonus, a discretionary bonus, as 19 they called it. 20 The payments we're talking about here are 50 21 times that, and it doesn't sound like something you 22 would get as a bonus. It sounds like a royalty, 23 something he got because he had an interest in this --- 24 in these financial -- financial structures. 25 Further, we find out that he only worked on 26 bond issuances that had the financial structure that he 27 created. That's either because he had an interest in 28 those financial structures or it's a remarkable 5 1 coincidence. And I don't think the FTB has explained 2 why that has happened. Mr. Lail is here and he can 3 explain what was going on. 4 Further, George Baum never claimed an interest 5 in this financial structure -- this financial -- this 6 proprietary financial structure. He -- they -- and 7 Exhibit 7, through the -- through the entirety of his 8 appeal they were communicating with the FTB and the 9 auditor, and they never said this was our idea, we own 10 it. That would have resolved the matter. They never 11 said that. In fact, I think we can show that they said 12 just the opposite. 13 But if you look at their financial statements, 14 and that's Exhibit 7, you won't find anything there that 15 says they -- they owned this financial structure. So, 16 that's more evidence of that. It's more inconsistent 17 evidence. 18 And, finally, if you -- if you look at how J -- 19 George Baum explained this and, you know, George Baum is 20 a big organization. And they -- I'm an attorney. I 21 would not have been engaged in these -- in these -- in 22 these transactions without -- without contracts and 23 without written stipulations, all kinds of things. 24 They don't -- it's not how the industry works 25 and -- and you can talk to the investment bankers here 26 to see that. They do things on handshakes. And they 27 call things compensation and they call things bonuses 28 but in fact when they were asked by the FTB what is -- 6 1 what was this payment, if you look at Exhibit 4 they 2 explain it. 3 Now, Exhibit 4 is a letter that was elicited -- 4 I didn't elicit this letter, it was elicited by the FTB 5 from George Baum and Company. And they asked -- they 6 were asked what -- what was going on. What were these 7 payments about? 8 And we find out, if you look at paragraph 2, he 9 said -- they said, "We had no formal written employment 10 contract with Mr. Lail." This was called unusual by the 11 auditor, but that's how they do things in this industry. 12 I find -- I find it strange as an attorney, but that's 13 how they do it. 14 And his bonuses, they call it, are paid based 15 on the type of bond issue per a verbal agreement. And I 16 think that's critical. It's the type of bond he was 17 paid for, not the work he did. They didn't say for the 18 work he did on these bond issuances. They said for the 19 type of bond. 20 The only way to interpret that is he had an 21 interest in this because he came up with the idea of 22 this financial structure and therefore when this type of 23 bond sold and there was an issuance, he got a percentage 24 interest, and that's a royalty. 25 And -- and Mr. Lail is here to discuss that in 26 more detail. I would further note that in respect to 27 the hearing summary and the comments of the staff, which 28 I think are very cogent and to the point, one of the 7 1 issues that's raised is, well, you know, how should -- 2 what kind of apportionment should we do here if in fact 3 we have a royalty and some work. 4 And there was work involved. Though I think 5 it's clear -- and I don't think it's really at issue, 6 this work was diminimus. This work was minimal. 7 And it seems to me that under common cause this 8 remains -- the common cause case, this remains a royalty 9 even though he did some work. 10 But I guess the next issue is, is there some 11 kind of apportionment? I can see apportioning -- you 12 have to understand, if you look at Exhibit 4 -- not 13 Exhibit 4, excuse me -- Exhibit 2, and once again this 14 is from George Baum -- you can see the salary that 15 Mr. Lail made. He paid every dime of tax relating to 16 the salary that he got while a California resident. He 17 reported that on his 540. 18 And then when he ceased being a resident he 19 didn't -- he ceased paying income taxes on that. I can 20 see an argument being made that the work he did relating 21 to his salary should be -- the formula used by the FTB 22 should apply to his salary. That I can see. But -- and 23 that my -- my client will be willing to do that. 24 But as far as applying it to the royalty, 25 itself, to the 8 -- to the $8 million that clearly is 26 not within the same realm of what we're talking about 27 here, that doesn't make sense. 28 And so, I think what we're talking about here 8 1 mostly is a factual issue and that's why I brought Mr. 2 Davis here and Mr. Lail, and if there's any questions 3 that you have about what he did and when he did it and 4 what the industry practices are, they're here to answer 5 those questions. 6 MS. YEE: All right. Thank you, Mr. Manes. 7 Would you gentlemen like to make any comments 8 at this point? 9 MR. LAIL: Sure. My name is David Lail. I'm 10 the taxpayer in question. I was managing the Houston, 11 Texas office for this firm in '96 and '97, and this was 12 not the first time that I've been compensated that way. 13 In fact, most of my -- I was kind of the guy who dreamed 14 up these ideas and Mr. Davis was representative over a 15 group of bankers who processed the deals and did -- you 16 know, did what you would call the real work on the -- on 17 the deals. 18 Prior to this transaction my group -- I 19 principally developed an idea for mortgage-backed 20 securities called premium mortgage bonds. We actually 21 probably did some out of our Sacramento office here. 22 And -- and whenever any banker in the firm would use 23 that financing structure, and I rarely worked on the 24 deals -- but if they used my idea the firm would 25 compensate me in a pre-agreed amount. 26 And so there was a precedent for this. '96 and 27 '97, after that mortgage bond issue had sort of resolved 28 itself, we developed -- I developed this idea for 9 1 helping states and local authorities develop pool loan 2 financings for hospital authorities and airports and 3 school districts. 4 So, the agreement again was with the firm, 5 George K. Baum and Company, that if any banker in the 6 firm brought a client in the firm and wanted to use my 7 idea, whether I worked on the transaction or not, and 8 I -- I never did, actually -- and none of them were my 9 clients -- that that banker in the firm would pay me a 10 fixed percentage of the revenues in that transaction. 11 And that was just my -- my arrangement with George K. 12 Baum and Company. 13 I subsequently moved to California. I was a 14 resident for 18 months. I moved to Florida. During 15 that time some of these transactions closed with other 16 bankers at the firm and per my agreement with George K. 17 Baum I received my percentage, whether I worked on the 18 deal or not. And so I think that's the fact issue here. 19 And Mr. Davis worked -- 20 MR. MANES: But I would like if -- if you could 21 explain what work did you actually do relating to these 22 bond issuances. 23 MR. LAIL: Well, because -- I'm a tax attorney 24 by training, and so they're really technical tax 25 questions. So there was a -- there was a process where 26 we would bid some investments about a week before the 27 deal would close. And typically when we did that the 28 attorneys for all the banks who were receiving these 10 1 would call George K. Baum with very technical tax 2 questions on this multi-page document of a bidding 3 document. And I just -- after a while none of the other 4 bankers could answer the question. I said, "Just tell 5 them to call me." And so a few days before the 6 transaction would close I would actually send these bid 7 specs that other bankers, usually Mr. Davis, had drawn 8 up -- I would send them out an a fax machine and put my 9 telephone number on there for their attorneys to call me 10 with questions. 11 And that was probably the majority of the work 12 I would do. Other times, during a period of the 13 transaction if a banker or an attorney -- typically an 14 attorney, 99 percent of the time it was another tax 15 attorney -- I would tell the banker if he's got a really 16 complex question you're not comfortable answering, tell 17 them to call me in Florida or California, wherever I was 18 at the time. I was all over the country. 19 And -- and so that was really the extent of the 20 work I did on the transaction. None of those types of 21 work or incidents affected my compensation deal I was to 22 receive, a fixed percentage of that transaction if it 23 used my idea without regard really to whatever work I 24 did or not. It was in my interest though to make sure 25 the transaction ran smoothly, and -- and to answer 26 questions like I did. 27 So, you know, that -- that was really it in a 28 nut shell. 11 1 MS. YEE: Okay. Thank you, Mr. Lail. 2 MR. LAIL: Sure. 3 MS. YEE: Great. Mr. Davis, anything at this 4 point? 5 MR. DAVIS: I guess the -- in terms of the 6 transactions that were -- they were in question, you 7 know, the basic structure of the compensation as -- as 8 Mr. Lail indicated, was just as such. I was -- either 9 served as lead banker, as a support banker with another 10 banker in these transactions in question. We developed 11 the client relationship with the issuer, as well. We 12 processed the transactions and relied on Mr. Lail simply 13 for the -- the bidding of the investment agreement 14 component, which was the -- the basis for the structure, 15 itself. 16 It provided the benefits to the borrowers that 17 resulted in hospitals being built and airports, you 18 know, being constructed. So -- 19 MS. YEE: Okay. Very well. Thank you very 20 much. We're going to give you time on rebuttal. 21 MR. MANES: Sure. 22 MS. YEE: Okay. Franchise Tax Board. 23 MS. PAGE: Madam Chairperson, Members of the 24 Board, again I'm Natasha Page. And with me is Terry 25 Collins of the Franchise Tax Board. 26 This has one question, really. Is this 27 compensation for services, which is sourced to the place 28 where the services were performed, or this is a royalty 12 1 payment. In other words, a licensing for the use of an 2 intellectual property product that you have licensed out 3 to someone, in this case George K. Baum, to pay you for 4 their use of it. 5 There is nothing in the record or -- let's 6 take -- this is compensation for services. This -- this 7 structure was developed while Mr. Lail was an employee 8 of George K. Baum. He was paid on a percentage. But 9 that does not turn it into a royalty. 10 We have many employees across the State that 11 work on a commission. They maybe get a small base 12 salary or perhaps no salary at all, and then they get 13 paid when a deal comes through. And that does not 14 convert it into a royalty. 15 There's been no evidence presented that shows 16 what Mr. Lail claimed to own as an intellectual property 17 and what George K. Baum was paying him a royalty on. 18 Now, I have no problem with handshake 19 agreements. I only have a problem with the fact that 20 once you pay taxes on it and we audit you, you need to 21 be able to provide some showing of what it is you owned 22 that you licensed. 23 And ever -- in this case we have travel records 24 that show that Mr. Lail traveled to these various 25 municipal areas months before the transaction went 26 through. He got paid a large bonus, but that often 27 happens when you're a salesperson or perhaps a banker. 28 Even in the declarations of various other 13 1 bankers they almost all say that he was necessary to 2 manage or process the transaction. So it may be true 3 that he did a little work, but I don't think that you 4 can measure how much we think a little bit of work may 5 be worth. 6 A little bit of work might be worth $8 million 7 as a bonus. In the documents provided even by the 8 taxpayer under number -- tab 2 he has a listing of a 9 salary and a listing of his bonus on one sheet of paper 10 listing it as his compensation. No -- nowhere in the 11 George K. Baum documents does it talk about a licensing 12 or a royalty payment. It always talks about it as 13 compensation. 14 They -- they reimbursed him for his travel 15 expenses. This is all consistent with an employee that 16 developed an idea on the job, but that doesn't mean that 17 he owns it. His boss may be very pleased that he 18 created this idea and says "I'm going to pay you a large 19 bonus," but that doesn't turn it into a royalty payment. 20 Further, there is a W-2, and although the 21 Appellant objects that we would rely on a W-2 so much, 22 it is important that all this income was reported on a 23 W-2 in Box 1 as wages and nowhere has George K. Baum 24 discredited that W-2 or repudiated it. Nowhere has 25 George K. Baum issued a 1099, which would be the 26 mechanism on which you would report a royalty payment, 27 and indeed George K. Baum withheld and matched MediCare 28 payments and such, indicating that this was an 14 1 employment payment. 2 Employment payments are subject to tax where 3 you perform the services. We found in audit and it's 4 been undisputed that he worked about 33 percent of his 5 time. So we are not trying to tax the entire bonus 6 payment. We are only trying to tax approximately 33 7 percent, representing the amount of time he spent in 8 California working on -- for the company. 9 MS. YEE: Thank you very much, Ms. Page. 10 Gentlemen, take five minutes on rebuttal. 11 MR. MANES: Of the W-2 issue, I just want to 12 point out, we can longer be amended. And -- and so if 13 you look at Exhibit -- we asked them about that. 14 First of all, my client is not responsible for 15 how George K. Baum characterizes income. I don't 16 understand this industry, to tell you the truth. It 17 doesn't make any sense. Clearly they don't care about 18 things like this. They don't care about FICA, probably 19 because it's such an enormous industry. 20 My client didn't ask for this benefit and 21 they -- they did get a -- they did get the W-2 as they 22 did the W-2. But it's too late to amend it now. But we 23 did ask them to explain what they did and so did the 24 FTB. 25 If you look at Exhibit 9, this is from James 26 Rue, who is the attorney for J. K. Baum (sic) and they 27 describe what Mr. Lail got as compensation for 28 development of a financing structure. 15 1 Now, again, I wish they would have just said 2 a -- a royalty. They don't -- they keep beating around 3 the bush as far as how they characterize things, but the 4 fact is if you look at -- if you look at the underlying 5 facts, the fact that they didn't claim this as their 6 financing structure, they didn't claim it anywhere as 7 something they owned. Mr. Lail can -- can discuss what 8 happened in Texas, and he can show that he was not -- 9 although he worked for J. K. Baum, he was working for J. 10 K. Baum during this entire period. 11 He did not develop this as something owned by 12 J. K. Baum. It's just not what happened. This is 13 something that he owned himself. 14 As to the declarations, Mr. Davis is here. He 15 can tell you that the people who processed the paper on 16 these transactions was not Mr. Lail. 17 Mr. Davis was the guy who -- who did the -- the 18 processing. So the -- the work of putting these deals 19 together was done by other investment bankers. And 20 Mr. Lail, the only work he did was to send out some 21 faxes and to answer some questions. And that doesn't 22 equate to the magnitude of the kind of payment you have 23 here. It -- it simply doesn't. 24 And when -- when the FTB says the declarations 25 say that he was central to every transaction, I don't 26 believe any of the declarations say that. They merely 27 say that he was compensated for a -- a financial 28 structure is what they say. 16 1 And so -- and so the issue is -- as to the 2 licensing issue, this is something of a red herring. 3 You don't have to have a license in order to show that 4 there's a royalty. That's just not how the law works. 5 You just look at all the facts and 6 circumstances and that's the case here. 7 As to Mr. Lail's work, like I say, we have two 8 percipient witnesses here. Obviously you're not -- 9 you're going to take what Mr. Lail says with a grain of 10 salt. But you have Mr. Davis here, and Mr. Davis is -- 11 is a disinterested party. And he can say exactly what 12 kind of work Mr. Lail did in this case. And he's 13 willing to testify that it was simply minimal. He was 14 not central to actually putting these deals together 15 and -- and doing the paperwork that made them work. 16 MS. YEE: Okay. Let me pose one question, then 17 I want to go to Ms. Steel. 18 So what would you point to as substantiating -- 19 and I mean this question for Mr. Lail -- substantiating 20 your proprietary right to the program? (inaudible) 21 MR. LAIL: If this were never -- if this were a 22 formal evidentiary hearing the evidence would be 23 uncontroverted and -- and overwhelming as to that issue. 24 The -- the President of the company would come in and 25 testify as to other agreements just like this that they 26 had with me and countless other bankers. 27 Other investment banking firms would come in 28 and go, gee, this is very common in our industry, though 17 1 it sounds strange. We -- we very, very often make 2 arrangements with the bankers who come up with ideas 3 that are proprietary and unique to compensate them for 4 our use -- our firm's use of that idea. 5 Generally in investment banking there are three 6 components to every investment banking transaction. 7 Bankers are paid if they have the client. If -- if the 8 City of Los Angeles has a relationship with this banker 9 and he says, "They're my client," the firm will pay them 10 for that, for a transaction that's done with the City of 11 Los Angeles. 12 The second one is bankers like me, who develop 13 financing ideas, that's what we do, that's how we make 14 our -- our living. When other bankers in the firm see 15 our idea, they pay us what I wish I had called a 16 royalty. Whether we work on the transaction or not -- 17 and that's what's important. When I was in California 18 for those -- one-third of that year I -- I wasn't 19 working on these transactions. 20 My compensation arrangement was already set a 21 year -- a decade earlier in Texas, that when these ideas 22 were used I would be paid 40 percent generally of the 23 revenue of the firm without regard to whether I worked 24 on it or not or even, you know, knew the client. 25 And then the third way bankers are paid are 26 like Mr. Davis, the ones who actually do the real hard 27 day-to-day work of all the document review. And -- and 28 so I was in that second category. I was the guy that 18 1 got paid for his ideas. And I got paid what -- what 2 really is properly, legally characterized, I think, as a 3 royalty. Whether I worked on it or not I got paid the 4 same amount. 5 MS. YEE: Okay. I guess what I'm having a hard 6 time with is just really how do we I guess trace or 7 attribute the income at issue here. 8 MR. LAIL: Well, that would be on this exhibit. 9 MS. YEE: In return -- well, no, I get the 10 actual amounts, but in return for George K. Baum -- its 11 ability to market and sell the -- 12 MR. LAIL: Right. 13 MS. YEE: -- the products under your -- 14 MR. LAIL: That's -- that's what they call it. 15 They -- they have the amount of money attributable to 16 ideas. 17 MS. YEE: No, and I -- and I get the amounts 18 but -- 19 MR. LAIL: Oh. 20 MS. YEE: -- there's no tie to kind of the 21 income that you're receiving for -- and I'm trying to 22 establish kind of -- 23 MR. LAIL: Oh. 24 MS. YEE: -- proprietary rights. 25 MR. LAIL: Oh, the percentage of income. 26 That -- that would -- I -- I guess the -- the Chairman 27 of the Board is the one who -- who entered into that 28 arrangement with me and other bankers, and he would 19 1 testify, as -- as he did in his certificate that, yes, I 2 entered into those arrangements with Mr. Lail. Our 3 general arrangement is he would receive 40 percent of 4 the revenue of every transaction that used his 5 proprietary idea. 6 MR. MANES: I think we should -- just to draw 7 the -- the Board's attention to Exhibit 3, and -- and 8 Mr. Lail's attention to Exhibit 3, there we talked -- 9 it's talked about financing fees. And once again, this 10 is a J. K. Baum document. This was -- was elicited from 11 the -- from the FTB. 12 And maybe you could discuss this where you 13 have -- I assume this is a swat (phonetic) here -- 14 MR. LAIL: Right. 15 MR. MANES: Maybe you can discuss what the 16 meaning of this is, when -- 17 MR. LAIL: What exhibit -- is this Exhibit 3? 18 MR. MANES: Exhibit 3. 19 MR. LAIL: Yeah, it goes down and has the 20 percent -- it has my payout as a percentage of the 21 management fee. And all of these would -- would 22 generally represent that percentage agreement that the 23 firm had entered into with me. 24 And -- and you can see off to the left it 25 describes, okay, this was a -- a fee Mr. Lail received 26 for his idea on this structure. And then it gives you 27 the pay code, and that was my agreement, 50 percent. 28 And so that -- their -- their internal documents, while 20 1 they don't have it neatly, you know, in a bowtie for 2 this hearing, you -- you could easily deduce what I'm 3 saying from, you know, parsing through the admittedly 4 kind of C.P.A.-like presentation here. 5 But the pay code is my agreement, 50 percent. 6 Some of them say 44 percent. It's whatever agreement I 7 had with respect to that product. And it -- so it's not 8 for the work I performed, it was for the agreement that 9 I had entered into many years before with the firm. 10 MS. YEE: Okay. But as you say, not unlike 11 others -- 12 MR. LAIL: This -- this is common practice in 13 the industry. Again, if this were a normal evidentiary 14 hearing there would be a parade of people who go, oh, 15 yes, this is very common in the investment banking 16 industry. Common for Mr. Lail. This is not his first 17 agreement, and common within this firm. 18 MS. YEE: Okay. And is it also common that as 19 these types of I guess programs or ideas are developed 20 that they get licensed or recognized somehow by some 21 formal body or -- 22 MR. LAIL: It is common that they do not. 23 MS. YEE: -- financial body? 24 MR. LAIL: In fact, I know of no occasion in 25 my career where that -- where that has been the case. 26 It's simply a matter internal to that firm. 27 MS. YEE: Okay. 28 MR. LAIL: How they deal with their investment 21 1 bankers. 2 MS. YEE: Okay. Thank you, Mr. Lail. 3 Ms. Steel. 4 MS. STEEL: Franchise Tax Board is saying that 5 it's bonus for point 8, it's a compensation for 6 services. That amount is the -- way too high. But at 7 the same time I have a question to the taxpayer that you 8 actually -- the company gave you revised W-2C, still it 9 was W-2 form, that you are tax attorney, you could have 10 gone to ask at that time the revised 1099 instead of -- 11 if it's royalty instead of 1099 -- I mean W-2 form that 12 you can get 1099. Why you didn't ask that? 13 MR. LAIL: I was afraid someone would -- would 14 ask me that question, as a tax attorney why I didn't -- 15 I -- I absolutely had no idea that years, you know, 16 later we would have an issue as to whether this was 17 legally more favorable to me to be characterized as a 18 royalty or -- or some other name. 19 MS. STEEL: So it was just -- it was a regular 20 practice so you didn't even think about that, you know, 21 has to be changed? 22 MR. LAIL: I -- never in a million years would 23 I have thought of that. And the firm I -- I was 24 unaware, I don't think the firm had ever characterized 25 any -- any bankers' salaries anything other than 26 compensation. Again, probably not as precise as it 27 should be but it's just the way that they do it in this 28 industry. 22 1 MS. STEEL: Thank you. 2 MR. LAIL: That they're not real detail 3 oriented in that respect. 4 MS. STEEL: Okay. 5 MS. YEE: Thank you, Ms. Steel. Other 6 questions, Members? 7 Mr. Horton. 8 MR. HORTON: Thank you, Madam Chair. 9 A question of the taxpayer. What would happen 10 if they decided not to pay you? 11 MR. LAIL: Hmm. Well, I suppose I would have 12 pursued a legal remedy against the firm, based on the -- 13 based on the very agreement I've described to you, which 14 would have been incontrovertible. There were a number 15 of people who were percipient witnesses to that 16 agreement and probably e-mails back and forth. 17 But -- also a course of dealing with -- with 18 which they had paid me pursuant to this agreement over 19 many, many years. 20 MR. HORTON: I mean, if they -- if they 21 submitted that our relationship is terminated -- 22 MR. LAIL: Uh-huh. 23 MR. HORTON: -- therefore we no longer will 24 compensate you, what would be your response, legally? 25 MR. LAIL: It's a good question. My response 26 would be -- 27 MR. HORTON: I mean contractually -- 28 MR. LAIL: Yeah. 23 1 MR. HORTON: -- would you defend your case? 2 MR. LAIL: Yeah, I -- I think -- I don't know 3 the -- the specific law on oral contracts for 4 compensation, in this case probably governed by the laws 5 of Denver where the home office would have been, but I 6 certainly would have asserted my rights -- you know, I 7 would have proven a contract existed through course of 8 dealing and -- and shown the terms of the contract 9 through various other payments for identical 10 transactions, and would have asserted they owed me the 11 same percentage of money since clearly and without 12 contravention I could prove that they used my idea. 13 They -- they -- all of these ideas and 14 financings are a matter of public record. As you know, 15 I'm sure, from being in the Legislature, these are all 16 public -- offering documents for public bond issues. 17 MR. HORTON: Is there anything that would have 18 restricted another institution from using your idea? 19 MR. LAIL: Not at all. And -- and as I've 20 often said, these ideas don't have a long shelf life. 21 But this idea -- as a tax attorney I kind of prided 22 myself on making these products pretty tricky. In other 23 words, pretty technical and -- and in that sense 24 proprietary. 25 And I would spend most of my time before these 26 agreements were made, it would take me about a year to 27 go around the country talking to different law firms. 28 And I had to get five or ten nationally recognized law 24 1 firms and their tax partners on board with these things 2 so that they would agree to give their legal opinions. 3 So -- so there was a period of time I did work, 4 but that would have been back in the '90s, the late '90s 5 on this. 6 MR. HORTON: So after -- let's say it was used 7 the first time -- 8 MR. LAIL: Uh-huh. 9 MR. HORTON: -- and someone saw it, thought it 10 was a great idea -- 11 MR. LAIL: Uh-huh. 12 MR. HORTON: -- decided to use it themselves. 13 MR. LAIL: If they could have duplicated it, 14 there's probably absolutely no legal recourse I would 15 have had against them. 16 I can tell you that over a period of three 17 years I guess I'm proud to say no other investment 18 banking firm was able to successfully duplicate this. 19 MR. HORTON: Thank you. 20 MS. STEEL: Can I have a -- 21 MS. YEE: Thank you, Mr. Horton. Ms. Steel. 22 MS. STEEL: -- followup question? 23 MS. YEE: Yes, please. 24 MS. STEEL: You said that if you don't get -- 25 you don't get this royalty or, you know, compensated -- 26 MR. LAIL: Uh-huh. 27 MS. STEEL: -- then you can sue that company. 28 You kind of mention you had the agreement but your 25 1 attorney said there is nothing -- 2 MR. LAIL: It was -- 3 MS. STEEL: -- it was just a handshake. 4 MR. LAIL: That's right. 5 MS. STEEL: So how you going to sue company 6 without any base? 7 MR. LAIL: You know, the first -- as an -- as 8 an attorney the first thing that comes to mind is course 9 of dealing, is a term of art in the legal community 10 for -- for one way to prove an oral contract. 11 In other words, the firm had done this 12 agreement with me and paid me pursuant to this 13 agreement, had paid me royalties. 14 MS. STEEL: If they didn't pay anything. 15 MR. LAIL: If they -- if they had never paid 16 anything? 17 MS. STEEL: Right. 18 MR. LAIL: If they had never paid anything and 19 it was the first transaction, then I would have had to 20 have brought in witnesses to that agreement. And there 21 were plenty of people who were familiar with that. 22 MS. STEEL: So you don't have any written 23 agreement? 24 MR. LAIL: No written agreement. 25 MS. STEEL: But you had a witness. 26 MR. LAIL: And that -- that also, as strange as 27 that sounds, that is common practice in the industry. 28 Common practice -- I've -- after 20 years I'm personally 26 1 unaware of any banker that has a written agreement with 2 respect to anything like I'm talking to you about today. 3 MS. STEEL: Thank you. 4 MR. MANES: But if I might add, I -- I believe, 5 and Mr. Lail and Mr. Davis can talk about this, I don't 6 believe banks want to do that. That would be cutting 7 their own throat. They want -- they want people to come 8 in with these ideas. And if -- and this is a handshake 9 industry, if people could in with these ideas and 10 somebody -- and -- and they -- and they mess with them 11 and don't -- and don't live to the -- they're not going 12 to get those people coming to that bank again. 13 And so I think, and they can testify to this, 14 not me, but I think that's what's going on here. 15 MS. YEE: Okay. Thank you very much. Other 16 questions, Members? 17 Okay, hearing none may I have a motion, please? 18 MR. HORTON: Move to take it under submission. 19 MS. YEE: Motion by Mr. Horton to take this 20 matter under submission. 21 Second by Ms. Alby. Without objection, that 22 motion carries. 23 Thank you very much, gentlemen, for coming 24 forward. 25 MR. MANES: Thank you very much. 26 MR. LAIL: Thank you. 27 MS. YEE: We'll discuss your matter later today 28 and send you written notice of our decision. 27 1 ---oOo--- 2 REPORTER'S CERTIFICATE 3 4 State of California ) 5 ) ss 6 County of Sacramento ) 7 8 I, BEVERLY D. TOMS, Hearing Reporter for the 9 California State Board of Equalization certify that on 10 June 16, 2010 I recorded verbatim, in shorthand, to the 11 best of my ability, the proceedings in the 12 above-entitled hearing; that I transcribed the shorthand 13 writing into typewriting; and that the preceding 27 14 pages constitute a complete and accurate transcription 15 of the shorthand writing. 16 17 Dated: July 6, 2010. 18 19 20 ____________________________ 21 BEVERLY D. TOMS 22 Hearing Reporter 23 24 25 26 27 28 28