1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 MAY 24, 2011 10 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 11 APPEAL OF 12 ROYAL HOUSING, INC. 13 NO. 484677 14 AGAINST PROPOSED ASSESSMENT OF 15 ADDITIONAL INCOME TAX 16 17 18 19 20 21 22 23 24 Reported by: Juli Price Jackson 25 CSR No. 5214 26 27 28 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chair 3 Michelle Steel 4 Vice-Chairwoman 5 Betty T. Yee Member 6 George Runner 7 Member 8 Marcy Jo Mandel Appearing for John 9 Chiang, State Controller (per Government Code 10 Section 7.9) 11 Diane G. Olson Chief 12 Board Proceedings Division 13 14 For Board of Grant Thompson Equalization Staff: Staff Counsel 15 16 17 For Franchise Tax David Gemmingen Board: Tax Counsel 18 Bill Gardner 19 Tax Counsel 20 For Appellant: Donald L. Feurzeig 21 Attorney 22 Michael M. Stein Witness 23 24 ---oOo--- 25 26 27 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 MAY 24, 2011 4 ---oOo--- 5 MR. HORTON: Good morning. Let us call the 6 meeting of the Board of Equalization to order. Members, 7 we will work -- seek to take a break today around 12:30 8 and return around 1:30 to allow our Controller, Mr. John 9 Chiang, to join us for the State-Assessed property value 10 setting. And at the conclusion of that, we will seek to 11 take photos. 12 So, please plan accordingly. 13 Ms. Olson, what's our scheduled matter? 14 MS. OLSON: Our first item is B1, Royal 15 Housing, Incorporated. 16 Please come forward. Board Proceedings has 17 received contribution disclosure forms for this 18 morning's hearings from the parties, agents and 19 participants. 20 All forms were properly completed and signed. 21 All parties, agents and participants are on the alpha 22 listing provided to your office. 23 Each person sitting at the table will be asked 24 to introduce themselves and, if necessary, their 25 affiliation with the taxpayer for the record. 26 Ten minutes is allocated for the taxpayer's 27 opening presentation, followed by ten minutes for the 28 Franchise Tax Board presentation and five minutes 3 1 allocated to the taxpayer for rebuttal. 2 Mr. Horton? 3 MR. HORTON: Yes, good morning. Would the 4 taxpayer please introduce yourself for the record? 5 You have ten minutes to make your presentation, 6 upon which time we will go to the Department and return 7 back to you for rebuttal. 8 Please commence at your leisure. 9 MR. FEURZEIG: Donald Feurzeig, I'm the 10 attorney for the Appellant, Royal Housing. 11 MR. STEIN: Michael Stein, witness. 12 MR. HORTON: Okay, let's see if we can do 13 something about those mikes. 14 Okay, is that comfortable? 15 MR. FEURZEIG: It is. 16 MR. HORTON: All right. 17 MR. STEIN: Yes. 18 MR. HORTON: Good. Please commence. 19 MR. FEURZEIG: The issue that we have here is 20 whether there was unrealized appreciation when Royal 21 Housing, the Appellant, converted from a C corporation 22 to an S corporation. 23 The -- the main issue really, which depends on 24 this case, is what is the value of the residual interest 25 wrap notes at January 1st, 2003, which is the date -- 26 the valuation date, the date that the company converted 27 to an S corporation? 28 The Franchise Tax Board takes the position that 4 1 the sales price nine months later, on September 30th, 2 2003, sets the value as of January 1st, 2003. 3 But the Franchise Tax Board ignores five very 4 important factors. The first one is that valuation, 5 according to the US Supreme Court in the Ithaca case, 6 says that valuation is a prophecy. And if it's -- if it 7 is a prophecy, as Justice Holmes said, then if we know 8 the outcome already, if the sales price is the outcome, 9 then it's not really a prophecy. 10 The second factor is that there are only two 11 Internal Revenue Code cases on this issue, involving 12 built-in gain. One of them is Garwood Irrigation and 13 the other one is Ringgold. In both of those cases the 14 court did not determine a value on the basis of the 15 sales price of the asset, as the Franchise Tax Board is 16 doing here. The Franchise Tax Board is being very 17 inflexible and can only see that that is the value, even 18 though on the date of the conversion there was extensive 19 litigation going on, as my witness, Mike Stein, will 20 attest. 21 The third the -- the third factor that they 22 don't take into account is this litigation that was 23 ongoing. On January 1st, 2003, nobody would have ever 24 paid anything for these notes on January 1st, 2003. 25 Would you buy notes where there's a cloud on 26 title, where you don't have good marketability? You 27 can't even sell these notes. 28 And the fourth factor, which is the most 5 1 important factor, was that there was an unexpected, 2 intervening event that occurred on May 2003 which 3 changed the whole situation because there was an 4 investment in San Martin Twin Towers in Puerto Rico and 5 this triggered the negotiations to sell the notes. 6 We have two declarations, one by 7 Mr. Gotfredson, who is the business trial attorney for 8 the -- for Wilshire. Wilshire was an adversary and 9 would be a hostile witness, but Mr. Gotfredson, 10 nonetheless, gave a declaration. And he said that 11 triggered the sale. And the other is from Max Perry, 12 who is the house counsel for Wilshire, the buyer of the 13 notes. And he also said that triggered it. Not only 14 that, in his last paragraph in the declaration he said 15 there was no that they -- that Wilshire would have paid 16 anywhere close to the amount that it paid had it not 17 been for this event of the Twin Towers being invested at 18 that time. 19 I invite the Franchise Tax Board to address 20 that. They have never said anything about these two 21 declarations. These declarations are over a year old -- 22 or about a year old. And we have not heard from them as 23 to why they think that these are not crucial evidence. 24 And the fifth factor was that even though there 25 was a sale price of $2,700,000, the -- Royal held 26 Wilshire harmless on the Bancorp litigation. So, there 27 wasn't any closure in this situation until almost two 28 years after the sale, until the end of 2005, when there 6 1 was a resolution of the situation between Bancorp and 2 Royal Housing. 3 Now, we have two experts and I know that the 4 Franchise Tax Board has criticized our experts, but they 5 have not offered any experts of their own. And it's 6 very easy to criticize when you have nothing to offer 7 for yourself. 8 Also these experts have come up with almost the 9 same value, independently, of around $250,000. However, 10 even if the value is as high as $1,700,000, I've offered 11 an exhibit today that there still would be no built-in 12 gain tax because of the -- because of the fact of all of 13 the deductions that would take into account a zero 14 result. 15 Mr. Stein, I think, can -- 16 MR. STEIN: What I want to address is because 17 there has been a response by e-mail recently by the 18 Franchise Tax Board as to accept both the historical 19 setting and what were the on the ground facts as of 20 January 1, 2003, at which the value of these undivided 21 interests in these wrap notes is to be valued. These 22 were acquired by Royal in the FDIC sale and, thereafter, 23 we were engaged to try and see if they could be 24 collected upon. 25 Wilshire was the debtor on the properties and 26 had taken the position that the interest Royal had was 27 worthless and they actually treated them, the 28 properties, as if the notes didn't exist. 7 1 While the FDIC held the notes, they sold one 2 property and refinanced another without accounting for a 3 single penny to the FDIC. 4 We took the position that they had repudiated 5 the wrap notes and tried to institute a foreclosure 6 action on that, which led to Royal -- which led to 7 Wilshire suing to enjoin any actions by Royal. 8 The reason I mention this is because the 9 Franchise Tax Board has apparently misunderstood what 10 was going on in that case. 11 At that time I mentioned that Royal had an 12 undivided interest. And the other co-interest was owned 13 by Bancorp, headed by Mr. Sands, who is something of a 14 nefarious scoundrel that one finds in the -- populating 15 the contents of a Dickens novel. 16 Anyway, Royal entered into an arrangement to 17 jointly enforce them with him and, apparently, the State 18 Franchise Tax Board's concluded that Royal owned all of 19 the notes. They only owned an undivided interest. 20 At that point in time there was a hearing on 21 the injunction and Royal and Bancorp contended that in 22 order to get an injunction, Wilshire should post a bond 23 equal to the net debt, irrespective of value, which was 24 9 million, combined. The judge set a bond of one 25 million, which I think pretty much puts that issue to 26 rest. 27 Thereafter, one of the properties sold. And 28 the parties worked out a distribution of proceeds. They 8 1 continued to negotiate to settle the case. 2 In late 2002, those settlement negotiations 3 broke down and these are contained in declarations that 4 have been contested. 5 And by December of 2002, Wilshire had cranked 6 up the litigation and was going forward in full. At 7 that point in time, on January 1, Royal's posture was 8 this, Wilshire was taking the position that the original 9 sale of the notes by which the bank and Bancorp had 10 acquired had been rescinded because the bank and Bancorp 11 had defaulted in failing to complete the purchase. 12 We faced the problem at that point in time that 13 every percipient witness as to that transaction, 14 including the attorneys that represented the bank, were 15 adverse and taking Wilshire's side. 16 Had that case gone to trial, at the pre-trial 17 hearing when we exchanged witness lists, we would have 18 had to show Wilshire we had no single witness that could 19 testify contrary to their interpretation. 20 So, at that point in time, all that Wilshire 21 could do was perhaps litigate some of the minor issues 22 and try to negotiate any kind of bailout settlement. 23 Now, we've talked a lot about -- here about a 24 sale of the notes. There was really no sale because, as 25 Mr. Feurzeig said, whenever you sell property, the one 26 thing the seller warrants is clear title, clear and free 27 of all adverse claims. 28 And you had an adverse claim to ownership. The 9 1 only person they could deal with who had no concern with 2 that is the person holding that adverse claim. This 3 wasn't a sale, it was a settlement of litigation. 4 And anybody approaching January 1, 2003 to buy 5 Royal's position would have evaluated, 6 "How much do I think I can reasonably get after 7 costs from Wilshire?" 8 In my view, the amount, based on a review of 9 the evidence, would have been nominal, a small 10 settlement. If you could have got -- netted 300,000, 11 $250,000 at that point in time, you'd walk away. And 12 that's basically what's involved here. 13 But what happened after that was one of the 14 properties that was collateral, it was a property in 15 Puerto Rico, San Martin Twin Towers, was sold. And the 16 declarations point out, this was an unsolicited sale. 17 Wilshire wasn't marketing it. The property was sold 18 under the federal low income housing tax credit program. 19 And buyers were not buying properties outside of the 20 continental United States, particularly in Puerto Rico 21 with a lower standard of living and lower rents. It was 22 not an ideal property. They got a good price. 23 And suddenly, positions were reversed. Royal 24 was now the thorn in Wilshire's side. And they had to 25 buy off Royal's adverse claim. 26 MS. OLSON: Time has expired. 27 MR. STEIN: That was totally unanticipated. 28 And it -- and it came as a shock. 10 1 So, if you look at the facts in this case that 2 are uncontroverted, as of January 1, Royal had a nominal 3 situation. 4 I'm sure that if the parties had negotiated a 5 settlement for the price it was obtained in late 2003 at 6 the end of December of 2002 and then Wilshire walked and 7 later on the parties settled for a nominal sum, the 8 Franchise Tax Board would be pounding the table to say, 9 "The value on January 1 was the amount of the 10 settlement negotiated at that point in time and 11 what happened later is prophecy." 12 Thank you. 13 MR. HORTON: Thank you very much. We will 14 return to you on rebuttal. 15 Will the Department please introduce themselves 16 for the record? 17 You have ten minutes to make your presentation. 18 MR. GEMMINGEN: Good morning, Mr. Chairman -- 19 MR. HORTON: Good morning. 20 MR. GEMMINGEN: -- and Members of the Board, 21 I'm David Gemmingen, Tax Counsel with the Franchise Tax 22 Board. 23 And with me is Bill Gardner, also serving as a 24 Tax Counsel for the Franchise Tax Board. 25 In today's inquiry, we're only concerned with 26 the corporate tax liability that would arise if Royal 27 Housing, as the C corporation it was, sold its assets 28 immediately before it changed the characterization from 11 1 the C to S status. 2 Moreover, this case is the best possible 3 example to demonstrate why valuations manufactured years 4 after the transaction are inferior in valuation 5 proceedings and compared to reasonably contemporaneous, 6 bargained for purchase price. 7 You need to recognize that the amount of the 8 gain that the corporation would realize on the sale of 9 its assets would not change its valuation date, whether 10 the corporation was a C corporation or an S corporation. 11 And all we're doing is applying the correct tax rate to 12 that gain. 13 The policy behind the built-in gains tax is to 14 insure that appreciation in value of a corporation's 15 assets, which the corporation experienced while it was 16 conducting these activities as a C corporation, is taxed 17 at the appropriate C corporation tax rate. 18 Simply a matching exercise where a C 19 corporation tax rate's applied to C corporation gains 20 and that tax rates reflects the true substance of the 21 activities that gave rise to the gain, in order to 22 prevent the manipulation of tax rates by last minute 23 elections and to prevent the distortion of tax 24 liabilities that might otherwise arise due to the annual 25 accounting concepts. 26 Appellant decided the Ringgold Tax -- Telephone 27 opinion and in that opinion the court stated, 28 "In valuing unlisted securities, actual 12 1 length -- actual arm's length sales of such 2 securities in the normal course of business 3 within a reasonable time before or after the 4 valuation date are the best criteria of market 5 value." 6 The standard definition of fair market value is 7 the price at which property will change hands between a 8 willing buyer and a willing seller. 9 Appellant, while it was a C corporation, bought 10 the notes in 1997 and maintained its C corporation 11 status until 2003, a period of over five years. 12 During the time it was a C corporation, less 13 than two years after holding the notes, in July 1999, 14 Royal Housing determined the notes became due and 15 payable and entered into a collection action, initiated 16 the sale of collateral with respect to those notes. 17 Please turn to page 6 of my index, if you 18 would, please? At page 6 you'll see a statement by 19 Appellant's witness here that the amount outstanding and 20 due to Appellants is $9 million. That's already taking 21 into account the amounts that would have been paid to 22 HUD. 23 And, so, at that point in time, Mr. Stein made 24 the statement in court -- in the court proceedings that 25 there was an amount due and payable in 1999 of $9 26 million. 27 So, they were very well aware that these notes 28 were due and payable back then. They took action to 13 1 enforce collection. 2 And if you'll go over to pages 10 through 14, 3 you'll see that in 1999, July, they issued letters 4 stating that the notes are due and payable. 5 They sent these letters out with respect to 6 eight notes they owned. And at that point in time the 7 balance was 8 -- over eight and a half million dollars. 8 At page 14 you'll see that they undertook a 9 Notice of Disposition of Collateral, where they gave 10 notice that they were going to initiate a public sale in 11 September of 1999, enforce the collection of its 12 collateral with respect to these notes. 13 And, so, these notes did have a value back 14 then. And they have ignored these prior actions and 15 withheld this activity with respect to providing their 16 appraisers with the basis for a reasonable means of 17 valuing these notes. 18 And, so, also at page 13, you'll see 19 Appellant's instruction, the second to last sentence, 20 that $401,000 payment is immediately made -- immediately 21 due and should be made by check to Appellant with 22 respect to the Palmdale note. 23 Identical demands were made on the same day 24 with respect to these eight notes. And if the note 25 obligors had simply acquiesced to this first demand and 26 sent Royal Housing checks in that amount for eight and a 27 half million dollars, clearly, Royal Housing would have 28 paid its franchise tax liability at the tax rate 14 1 applicable to C corporations at that time, since Royal 2 Housing was a C corporation in 1999. 3 The matching of income, C corporate 4 characterization and C corporation franchise tax rate is 5 all the Franchise Tax Board has sought in this matter, 6 the built-in gains provisions are in no way a penalty 7 tax. 8 Both valuations submitted by Appellant 9 Housing -- Royal Housing are lacking in that neither 10 actually values the notes themselves, an admission that 11 both of the Appellant's evaluators are not shy in 12 admitting. 13 If you'd please turn to page 2 of our exhibit 14 book, you'll see a declaration by Appellant's witness 15 here, Mr. Stein. I have highlighted the statement where 16 he's -- he says he can testify completely to this and 17 says, 18 "I did not value a portfolio of undivided 19 interests in the notes." 20 All we're looking for here is to determine what 21 gain the corporation would have realized if it had sold 22 its assets on the day of conversion. 23 In other words, what were its assets and what 24 was the value of them? 25 Mr. Stein here has stated that he did not value 26 those assets. Likewise, as I'll show later, the 27 BizValPlus appraisal also admits it did not value the 28 notes. 15 1 So, both valuations submitted by Appellant 2 Royal Housing are lacking in that they -- that they 3 don't value the notes. And we are not here to not only 4 determine if our calculation of the built-in gain is 5 correct, but also Appellant bears the burden of proof to 6 substantiate a contrary finding. 7 The determination of built-in gain depends on 8 the statutory calculation of the amount to be realized 9 at the beginning of the first day of the recognition 10 period. The corporation had remained a C corporation 11 and sold its assets to an unrelated party. 12 Thus, the fair market value of the 13 corporation's assets is the principal inquiry here and 14 Appellant's experts fail to provide any evidence or 15 testimony of that value. 16 Moreover, the failure to produce evidence 17 within Appellant's control gives rise to the presumption 18 that such evidence is unfavorable to his cause. 19 With respect to items under Appellant's 20 control, as we saw at page 6, Mr. Stein stated that as 21 of December 21st, 1999, the amount due and outstanding 22 to Royal Housing was $9 million. 23 And when Mr. Stein prepared his declarations, 24 he was aware of this prior valuation and he failed to 25 adequately disclose this in Appellant's history with 26 respect to the notes and that -- that failure to 27 disclose discredits his appraisal. 28 If your Board were to allow these valuations to 16 1 stand and be recognized as a fair market value for -- 2 for fair market value purposes, then taxpayers and 3 appraisers would have absolutely no motivation to 4 provide credible, relevant valuations with respect to 5 the assets at issue in any future appeal. 6 Your Board is urged to strongly reaffirm its 7 opinion -- in its opinion the longstanding principle 8 that the best evidence of value, as stated in 9 Appellant's own cited Ringgold case, is the sales price 10 arising from reasonably contemporaneous arm's length 11 sale. 12 Simply to invite a battle of the experts can 13 cost both parties the undue expense of lining up experts 14 like chess pieces but also sacrifice all the parties' 15 ability to utilize and rely upon the best evidence of 16 the value, a bargained for sales price. 17 We would otherwise be denying ourselves the 18 best evidence of value and in all -- and in different 19 transactions we should both be willing to let the chips 20 fall and that the actual bargained for sales price 21 might, arguably, help or hurt one side or the other. 22 But by allowing the respective parties to -- to 23 rely on the true sales price will also foster 24 predictability in tax reporting because taxpayers will 25 then have the confidence that the price that they sold 26 the purchase at goods at will be respected. 27 In fact, we respect purchase price in almost 28 every other transaction that gives rise to tax 17 1 consequences. We base annual depreciation off the 2 taxpayer's purchase price, not the estimated value. We 3 base sales tax on the sales price of a good. 4 Your Board's familiar with the principle that 5 real property taxes for the first year following the 6 purchase are based on the purchase price. 7 And when a taxpayer sells stock in a company, 8 such as Intel or Ford, we determine gain by comparing 9 the amount realized to the original cost. And both 10 sides of that transaction rely on the actual sales 11 price. 12 Use of a timely purchase price provides 13 certainty to all of the parties and would also help us 14 avoid the word games, qualifications, unsupported 15 assumptions and mindless boilerplate that are frequently 16 found within contentious appraisals. 17 Respondent, in this instance, was fortunate to 18 find court evidence that Appellant's expert declared the 19 notes in question had a value of $9 million in 1999. 20 The earlier positions taken by Appellant and 21 its expert were not only ignored in the valuations, they 22 were never addressed or properly disclosed. 23 In fact, Appellant's earlier representative in 24 this matter is shown at page 39 of our binder -- please 25 go there -- this letter from Respondent's auditor 26 mislead as to the nature of these notes. This was 27 Mr. Suarez's letter to our auditor. And at page 39 he 28 states, 18 1 "The notes did not have a due date. The 2 note's terms did not change since they were 3 acquired from the FDIC. And the notes are only 4 payable from the proceeds of a sale, an 5 exchange, or refinance. 6 In an opinion by your Board affirming the use 7 of actual sales price as the best evidence of value will 8 prevent these forms of misstatement and ensure the 9 accuracy of the fair market value determinations. 10 At pages 40 and 41, the relevant parts of the 11 San Martin note are found. And your Board will observe 12 at page 41 at Section 2.10, that there is a maturity 13 date. 14 Moving then to Appellant's representative's 15 next statement, that nothing had changed with respect to 16 the notes. As we saw at pages 10 through 14 of our 17 exhibits, Appellant had declared these notes immediately 18 due and payable in 1999. 19 So, they had when purchased these notes, they 20 not only appeared to be due in 2023 or 2003 or 2011, but 21 they were all deemed to be declared due and payable in 22 1999. 23 Remember that when explaining the notes' value 24 to FTB's auditor, Appellants represented and stated 25 nothing had changed since the note's acquisition. 26 As provided in the memorandum found at page 8 27 of our exhibit book, Mr. Stein is well aware of the 28 value of the notes and their underlying security, as 19 1 exhibited in his May 2nd, 2003 memorandum, when he names 2 two investments that were worth no less than $1,825,000. 3 This is an amount that is very close in time to 4 the effective date of the S corporation election and 5 before the Bancorp litigation which occurred in June. 6 In fact, that litigation would have, in any 7 sense, driven down the value of the notes because, as 8 Appellant's counsel stated, who wants to buy an item 9 that has cloud on title? 10 That cloud didn't appear until June and the 11 purchaser still paid $2.7 million. 12 MS. OLSON: Time has expired. 13 MR. HORTON: Would you like to wrap it up? 14 MR. GEMMINGEN: Sure, thank you. 15 So, as far as the BizVal statement, I would 16 just like to make one note, please, and that is at 17 page 17 and 19. 18 And at page 17 there's is a letter here to 19 Royal Housing from the appraiser and he states that, 20 "The auditor suggests that an individual 21 analysis of each of the notes face value, book 22 value or value of the underlying security 23 should have been done." 24 In other words, I should have done my job. And 25 goes to state that he didn't do so, rather he valued the 26 stock of the company, which allows for inappropriate 27 discounts. 28 MR. HORTON: Thank you very much. 20 1 On rebuttal? 2 MR. FEURZEIG: I'll reserve my time to 3 Mr. Stein. 4 But I can't believe that counsel for the 5 Franchise Tax Board cites the Ringgold case as -- as 6 stating what he does state because the conclusion in 7 Ringgold was that they only devoted one-third to the 8 selling price and two-thirds to other methodologies and 9 there was -- there was absolutely no change in the 10 circumstances from the -- from the valuation date until 11 the sales date. 12 Whereas, in our situation, we had the San 13 Martin Twin Towers event, which changed everything. So, 14 I think citing Ringgold is absurd, in my opinion, 15 because Ringgold supports our case. 16 Mr. Stein? 17 MR. STEIN: I am going to say again, I hope the 18 Franchise Tax Board hears, they continue to say that -- 19 that the Appellant owned -- had a $9 million debt. 20 At that time we were representing both the 21 Bancorp and Royal. The Bancorp, Sands, by 2003 and. 22 Before then, became an adverse party. They owned half 23 of the entire note. So, the debt was 4.5 million and it 24 was a partial interest. 25 Second, as to the valuation of the notes, I 26 think I made it clear that -- and they don't dispute -- 27 that no arm's length buyer would have bought these notes 28 with the pending litigation and the strength of 21 1 Wilshire's claim. If you want to value the notes, you 2 have a value of zero. 3 But an honest valuation here is to value the 4 value of Royal's claim. Royal didn't sell the notes to 5 a purchaser. They conveyed the notes in a settlement to 6 the one entity that was totally neutral as to the 7 adverse claim because it was the holder of the adverse 8 claim, Wilshire. 9 They were -- they were -- from Wilshire's point 10 of view, they were eliminating Royal's adverse claim. 11 So, that price is not an arm's length market purchase. 12 And the real issue, as I have brought forward 13 at the time of the valuation date, January 1, 2003, was 14 what was Royal's litigation potential? What was its 15 potential for settlement? 16 You have the declarations from Wilshire and the 17 facts at that time that Royal had a very weak case. And 18 my valuation was based on the fact that anybody who was 19 buying in would have felt that a settlement with 20 Wilshire at that time would have not been for any 21 significant sum that ultimately was realized. 22 That's the facts. I continue to wait to hear 23 some contrary opinion to that. And the reason I don't 24 is it doesn't exist. There's been a lot of talk about 25 the demand letters, about how much was due. Those 26 demand letters were sent out. How much was collected? 27 Nada. 28 Why? Because Wilshire's posture throughout was 22 1 they had rescinded the sale. And while the FDIC held 2 these notes, they sold one project, kept all the 3 proceeds, refinanced another, kept all the proceeds and, 4 but for the litigation that tied them up by Royal, would 5 have kept everything else. 6 That's the facts. You talk about what a 7 purchaser would pay, what a purchaser would pay would 8 have been what do I think I can get out of Wilshire on 9 this deal? And that's -- that's what we evaluated on. 10 Thank you. 11 MR. FEURZEIG: I have one final comment. I 12 still have not heard from the Franchise Tax Board about 13 two declarations from Wilshire's attorneys. These are 14 people who would have no reason to give testimony that 15 would not be true. And their testimony is crucial, I 16 think, to this case. 17 MR. HORTON: Thank you very much. 18 Member Yee? 19 MS. YEE: Thank you very much, Mr. Chairman. 20 I have several questions here. Let me see if I 21 can put some order to them. 22 The first one posed to the Appellants, but let 23 me see if I can put some context to it. And it speaks 24 to your statement that you made at the outset with 25 respect to how you characterize the $2.7 million, that 26 it was not a sale. 27 I'm going to start with agreeing with the 28 court's decision in Ringgold, that it is reasonable to 23 1 look at the selling price of an asset shortly after the 2 S corporation election as a reasonable way of putting 3 value to the asset. So, I'll start there and there may 4 be some disagreement about that. 5 I'm having a hard time bridging how you get to 6 the value of $270,000. There was ongoing activity. 7 There were also provisions in the stipulated judgment 8 and the settlement agreement that suggest that there 9 were dismissals of other complaints that were in place 10 at the time. I don't believe the 270,000 -- and if you 11 can help me back up and understand this -- takes into 12 account the disposition of two of the notes of the 13 400,000, I believe, that's attributable to the Thomas 14 Paine property and also the 1.7 million payout, I think 15 that's the San Martin property. 16 But you have all this activity going on. You 17 have provisions that were included in the stipulated 18 judgment and settlement agreement. You also had -- you 19 provided the book values for some of these wrap notes. 20 And I'm just having a hard time trying to get to the 21 270,000 that is your valuation. 22 I guess my question is how would you 23 characterize the $2.7 million that was received in 24 exchange for the ownership interest in the remaining 25 notes? 26 And, actually, maybe answer that first and then 27 I'll continue. 28 MR. FEURZEIG: I will go first then. 24 1 Ms. Yee, there was a situation on January 1st, 2 2003 in which the title of the wrap notes was in 3 question. So, January 1st, 2003, when the negotiations 4 broke down with Wilshire, we -- we were left, Royal 5 Housing was left with the -- with the litigation over 6 who owned these -- who owned these notes. 7 And I think this is really what we had. We had 8 a lawsuit, we'd have to litigate, we'd have to win, that 9 we -- that we, Royal Housing -- was the owner of these 10 notes. Because not only was Wilshire contesting that it 11 owned all of the notes, but Bancorp was also stating 12 that it owned a much larger percentage of the notes. 13 So, I think that's -- in my opinion, I didn't 14 do the appraisal, Mr. Stein is the one, I think, who 15 respond. 16 MR. STEIN: Again, let me explain. At that 17 point in the litigation you have the declarations. The 18 settlements had broken down. At that point we were 19 looking to going to trial in a case in which we could 20 not produce a single witness that would support our 21 position that the bank had purchased the notes from 22 Wilshire and had completed the purchase, had not 23 defaulted under the contract, and that Wilshire had not 24 rescinded the notes purchase. 25 We did not have a witness. Every witness that 26 would testify in that case, including the attorneys that 27 represented the bank in the original transaction, were 28 going to testify that the bank defaulted by not 25 1 completing both stages of purchase and that Wilshire had 2 validly rescinded. And Wilshire's conduct from that day 3 on, in not accounting to the FDIC, was perfectly 4 consistent. We were facing going to trial with a case 5 that was not winnable. 6 But when you talk about -- well, you go -- you 7 can skirmish around, maybe knock out a few weak defenses 8 and then you start negotiating. What would Wilshire pay 9 and what would a reasonable purchaser have been willing 10 to invest at that point to get a settlement out of 11 Wilshire? 12 I think that that's where -- that's where the 13 number came from. And it's totally supported by the 14 facts of the case as they exist at that point in time. 15 Wilshire was ready to go forward on trial. 16 Certainly if Royal came up with a nominal 17 offer, said, "We'll take 300,000, less our legal fees," 18 Wilshire would have paid that. Would they have paid 19 400? Maybe. 20 But, you know, once you start getting above 21 that, you already have your declaration. They had no 22 intention of paying anywhere near. 23 Had that San Martin sale -- and don't forget 24 that sale was unsolicited, they weren't even marketing 25 the property, that wasn't a property that was 26 marketable, that anybody would have believed was 27 marketable. 28 MS. YEE: But you would have had to assent to 26 1 that sale before it occurred, yes? 2 MR. STEIN: The -- if it had gone in 2004, 3 after the trial, Royal could have been out. 4 If it had gone in 2004 and Royal had settled 5 for 300,000, we wouldn't be here. It was just a 6 fortuitous event out of the blue. 7 You have to look at where people were in 8 January 1, 2003 and nobody in their right mind would 9 have paid much more than what I valued this for the 10 Royal position. 11 MS. YEE: And because our task here is to 12 actually really determine the value of the assets upon 13 which the built-in gains tax was calculated. 14 I guess the market for us is what occurred in 15 September of 2003? There was $2.7 million paid. And at 16 that point in time, I believe all the complaints have 17 been dismissed at that point in time. And it wasn't all 18 that many months after the election date. And there was 19 still a lot of activity going on. 20 So, I'm -- how would you characterize kind of 21 that point in time, the September 2003 where the 22 2.7 million is -- 23 MR. STEIN: Well, it's a time frame, but it's a 24 total separate event. 25 I mean, you can look at major events in history 26 that changed the world but on one day's difference and 27 you can say, "It was only nine months away, you should 28 have anticipated that." 27 1 If you want to value it, you look at what a 2 willing purchaser would have paid for Royal's position 3 as of January 1, 2003. 4 MR. GEMMINGEN: May I respond to that, please? 5 MS. YEE: Let him finish and I'm going to want 6 to ask you the same question. 7 MR. STEIN: And that person there would have 8 never anticipated that there would have been any 9 realization of any substantial amount in the near 10 future, based on the facts as they existed at that date. 11 It isn't the fact that it was a short period of 12 time, it could have been a year, two years or three 13 years later that San Martin sold, if it had sold at all. 14 It just happened to happen that way. 15 But the facts, as they existed, were that any 16 purchaser looking at that situation would have evaluated 17 that litigation and the asset wasn't the notes. They 18 weren't buying the notes. They may take an assignment, 19 but they were buying the position in litigation. 20 And when you look at that, you have to talk to 21 experienced counsel and you've got to say, "What is our 22 shot here?" 23 And the answer is, "It's a -- it's a minimal 24 case. And it's one of those that you want to settle out 25 for a nominal sum and get out of there." 26 MS. YEE: Okay. I'm still stuck with the fact 27 that there was a $2.7 million payment that was made in 28 September '03. And all complaints and cause actions had 28 1 been dismissed at that point in time. 2 MR. STEIN: Well -- 3 MS. YEE: But hang on one second. 4 Let me hear from the Franchise Tax Board. 5 MR. GEMMINGEN: Actually, I apologize, but I 6 had been waiting about ten minutes because he had 7 talked -- spoken about the pending action and the -- 8 wilshire being ready to go to trial. 9 But, actually, as I've provided your Board and 10 provided counsel, I found at the LA County courthouse on 11 March 29th, 2002, there was a stipulation signed in 12 which the -- all claims alleged by Wilshire entities 13 against Royal were hereby dismissed without prejudice 14 and all claims alleged in cross-complaint by Royal 15 against Wilshire were dismissed. 16 And, so, nobody was going forward as of 17 March 20th, 2002 with anything, as far as any threat of 18 trial. 19 And, so that -- that period carried on over and 20 the stipulation was still in effect as of January 1st, 21 2003. 22 And your Board has this exhibit. 23 MS. YEE: Yeah, we do. 24 MR. FEURZEIG: Ms. Yee, that's contrary to the 25 declarations by both Mr. Gotfredson and Mr. Perry. They 26 say right in those declarations, and, again, they won't 27 comment on if -- they were prepared to litigate because 28 they believed they owned those notes on January 1st, 29 1 2003. That's in the declarations. 2 I wish the Franchise Tax Board would -- would 3 try to comment on those two declarations because it's 4 all in those declarations. They're not lying. These 5 people were hostile to Royal Housing's cause. 6 MR. STEIN: It was made in context of the cases 7 that were still pending. 8 MS. MANDEL: So, there were other cases -- 9 MR. STEIN: Yes. 10 MS. MANDEL: -- besides the one that Mr. -- I 11 can't even say your name. 12 MR. GEMMINGEN: Gemmingen. 13 MS. MANDEL: I'm sorry, Gemmingen -- 14 MR. GEMMINGEN: Gemmingen. 15 MS. MANDEL: -- is talking about? 16 Is that what you're saying, that there was 17 other litigation? 18 MR. STEIN: Absolutely. 19 And, you know, again I -- what happened at that 20 point in time, when you settle, you're just simply 21 settling with Wilshire over all claims that you had in 22 the -- with respect to the notes. And Wilshire was 23 releasing all claim. 24 This wasn't a sale, it was a settlement of the 25 litigation. And, so, it settled everything. That 26 was -- it wasn't a payment on San Martin, it was a 27 payment to get rid of Royal by Wilshire, triggered by 28 the need of Wilshire that they had a sale -- an 30 1 unanticipated sale of San Martin. 2 MS. YEE: So -- okay. 3 You also made some statement about the 4 settlement agreement that we -- actually, the one I'm 5 referring to in October of 2002. 6 You don't give any validity to that document 7 then? 8 MR. STEIN: There was -- there was a 9 negotiating settlement and the settlement negotiations 10 broke down and ceased. 11 MS. YEE: Okay, all right. Because this 12 agreement seemed to have been referenced within the 13 security agreement that was kind of the basis for the 14 $2.7 million payment. 15 MR. STEIN: They picked the number going 16 forward from what they had negotiated previously and 17 started talking the number because they -- Wilshire made 18 a proposal and it was accepted. That was it. 19 You know, I can't go to the motivation of what 20 dollar amount they put at that point in time, knowing 21 that they needed to get rid of Royal to close the San 22 Martin sale. 23 I don't know and they have not provided how 24 much they made out of the San Martin transaction. 25 MS. YEE: Okay. Then one last question, 26 Mr. Chairman. 27 This is to the Appeals staff. I was a little 28 surprised to see a suggestion for this Board that we may 31 1 want to assign our own value to the wrap notes. 2 And is there some doubt with respect to the 3 basis upon which we should assign a value to these 4 assets? 5 MR. THOMPSON: Well, I think the point of the 6 comment you referred to is just to raise the issue, so 7 that the parties seem to be talking past each other. 8 And in some of the court cases, the courts did 9 choose values different than those proposed by the 10 parties. And they would take -- they would say, "Look, 11 this party's got a good argument here, but I don't buy 12 their argument here," and make the same kind of 13 determinations with respect to the other argument. 14 And, so, we weren't trying to suggest that was 15 necessarily the result, but just that -- to get people 16 talking about the values. 17 MS. YEE: Okay, all right. I appreciate that. 18 Thank you, Mr. Chairman. 19 I don't believe the valuation is in question 20 here. There is a lot of activity, but I think we're 21 able to track what actually took place through the 22 various agreements and settlements with documents that 23 we have before us. 24 MR. HORTON: Thank you. 25 MS. YEE: Thank you. 26 MR. HORTON: Member Steel? 27 MS. STEEL: Thank you. I just want to figure 28 it out that what was the fair market value on January of 32 1 2003? 2 That's the most important part here, not the 3 sale of September of 2003 because it was under the 4 litigation. So, I really want to know then how much was 5 worth during the litigation? 6 And how people's going to buy -- people are 7 going to buy for that note at that point. So, let me 8 ask Franchise Tax Board that why didn't -- Franchise Tax 9 Board didn't hire experts to find out that what was the 10 value at that point while this taxpayer hired two 11 experts? 12 MR. GEMMINGEN: Because in a -- well, first of 13 all, we did not need to hire an expert because we have 14 the best evidence of value itself, we have an actual 15 sale. 16 MS. STEEL: No, actual sale was September -- 17 MR. GEMMINGEN: Right, but -- 18 MS. STEEL: -- of 2003, it was not January of 19 2003. 20 MR. GEMMINGEN: But the sale within a 21 contemporaneous, reasonable time, close to the valuation 22 date has been viewed by the courts as being the best 23 example. 24 Also, the taxpayer here, both of their 25 appraisals, while they have hired and submitted two 26 reports, neither of those reports values the actual 27 assets of the corporation. 28 Neither report values the notes, does not 33 1 identify the notes, does not identify the security for 2 the notes, the term of the notes, the underlying HUD 3 amount. 4 And, so, the taxpayer here has presented no 5 evidence at all as to the value, because neither of 6 their values pertain to the assets under inquiry. 7 And, so, we would be undergoing a needless 8 expense and getting drawn into presenting to your -- to 9 your Board estimates of value when we don't need to 10 because we actually have a close in time, bargained for 11 sales price. 12 And also the actions of the taxpayer's 13 bookended on both sides of the valuation date when they 14 were claiming that -- as he stated, while Royal Housing 15 did not have the entire $9 million amount of the notes 16 as of 1999, if you'll look at page 42 of the book here, 17 it's a declaration of William Harrison, who's the Vice 18 President of Royal Housing. And in the court 19 proceedings he presented -- if you go to the -- just 20 past the third page of his declaration, there is a 21 schedule here and he's clearly identified Royal's 22 interest, the interest that it took over from the bank, 23 as having an aggregate value, at that time, of 6 -- 24 MS. STEEL: Which page? 25 MR. GEMMINGEN: Just after page 42, there's a 26 declaration -- starting at page 42 there's a declaration 27 by Mr. Harrison. 28 And, so, he has a three-page declaration and 34 1 attached to it, immediately after that three pages, is 2 the revised bank court FDIC notes. 3 And, so, he lays out there the defendants' 4 interests and it's segregated between Bancorp's and 5 Royal's. 6 Now, if we look back at page 14 of the demand 7 letter, the parties that are demanding payment are both 8 Bancorp and Royal. So, we know that both parties are 9 involved in the assertion that the amounts are due and 10 payable. 11 And here they have broken it apart, what they 12 feel are the amounts due and also has the underlying 13 equity and the HUD debt. 14 And, so, here it lays out various amounts that 15 would be relevant for determining the value of each 16 note. They've provided no appraisals that go through 17 any of this material. And, so, their appraisals 18 aren't -- weren't given consideration. 19 And, so, that's why this case is distinguished 20 from Ringgold because in Ringgold -- 21 MS. STEEL: Those are not the fair market value 22 of -- January of 2000. 23 MR. GEMMINGEN: No, because those -- 24 MS. STEEL: Let me ask you another question. 25 MR. GEMMINGEN: Yes. 26 MS. STEEL: Do you know that -- if IRS examine 27 this issue or -- 28 MR. GEMMINGEN: No. 35 1 MS. STEEL: Okay, so, they didn't. 2 Then let's go to Max Perry, the in-house 3 counsel of Wilshire, and the outside attorney hired that 4 J. Gotfredson, the President of Wilshire, and litigation 5 against Appellant regarding the wrap notes. 6 Why you are not talking about those Wilshire 7 attorneys, that when they were against that, but now 8 when they are coming out that they are supporting this 9 taxpayers? 10 MR. GEMMINGEN: Well, it's -- I don't believe 11 it's relevant to the issue before the Board, what's the 12 value of the assets of the corporation. 13 And, so -- 14 MS. STEEL: Well, because we never hired expert 15 on your side. And you keep saying the sales of 2003, 16 September of 2003, that sales price, but we are talking 17 about January of -- January 2003 fair market value. 18 That's what I'm looking for. 19 But it was under the litigation. So, I really 20 don't know that people's going to buy -- people buy with 21 that price of September price when they got paid. 22 MR. GEMMINGEN: Well -- 23 MS. STEEL: Then I can relate that to for San 24 Marcos -- San Martin property that you have any evidence 25 that this taxpayer knew on January of 2003? 26 MR. GEMMINGEN: I don't -- I would say that the 27 evidence would be on this schedule here that they had 28 done a review of the San Martin property and found out 36 1 at that point in time -- 2 MS. STEEL: When was that? 3 MR. GEMMINGEN: -- this was 1999, but they are 4 aware of the project and they were tracking the project. 5 That's what -- 6 MS. STEEL: But -- let's go back. 7 That -- but at that point, the taxpayer knew 8 that San Martin property was worth a lot? That's -- 9 that's not what I heard, that when you were doing the 10 testifying that you said that price -- the rent was very 11 low and there is just nothing value at that point. 12 MR. STEIN: Let me go on here about just the 13 two things to say again. 14 They talk about value of the assets, value of 15 the notes. No hypothetical purchaser could have 16 purchased those notes because their ownership was in 17 contest. There wasn't a sale in September. There was a 18 settlement of litigation between competing owners of the 19 note. 20 And a value -- if you're going to value it as 21 of January 1, value the asset as it exists, which is 22 that claim. 23 MS. STEEL: When did you find out that San 24 Martin -- 25 MR. STEIN: Then as to San Martin, as I said 26 before, it was a Puerto Rican property. I wouldn't have 27 valued it at much. 28 The fact was it had a history of mortgage 37 1 defaults. I know that personally in the '70s I was sent 2 to negotiate a mortgage extension to Puerto Rico. 3 The day I arrived FALN, the Puerto Rican 4 Liberation Army, shot up the federal building and the 5 hotel I was staying at. And I left without ever going 6 to that meeting. 7 So, you know, these are things that affect 8 value. I would have never thought that San Martin -- by 9 the way, on that list -- 10 MS. STEEL: Can you just answer me when did you 11 find out? 12 MR. STEIN: About the San Martin sale? 13 MS. STEEL: Right. 14 MR. STEIN: We found out about it in May, when 15 they came back and said they're selling that property, 16 they want to settle. 17 MS. STEEL: So, May 2003? 18 MR. STEIN: Yeah, we didn't -- 19 MS. STEEL: And then September you settled with 20 that amount? 21 MR. STEIN: Yeah. 22 MS. STEEL: Well, Franchise Tax Board, can you 23 give me a little better answer that how fair market 24 value was 2.7 million on January of 2003 under the 25 litigation? 26 Because you going back to 1999, that what 27 bond -- that, you know, how much bond that they bought 28 or, you know, 1999 contract and then talking one of the 38 1 maturity date, it was September 5th, 2023. 2 So, you going back and forth with all -- a lot 3 of different times and -- 4 MR. GEMMINGEN: The primary litigation -- 5 MS. STEEL: -- I just want to know is how you 6 going to have -- find the fair market value without 7 expert on January of 2003? 8 Because that's the most important part for this 9 case. 10 MR. GEMMINGEN: Well, you mentioned litigation, 11 but the litigation that really -- 12 MS. STEEL: That was dismissed at September 13 2002. 14 MR. GEMMINGEN: Well, there's also 15 litigation -- they're bringing up -- in June of 2003. 16 And that's really the only litigation that came in later 17 that might have affected the value of the notes when 18 they were sold in 2000 -- in September of 2003. 19 And, so, that litigation in June is the one 20 that would have clouded the title. Because another 21 party said you didn't require ownership of that. But 22 back in January, that litigation was not present. 23 And, so, we have provided you a value. We 24 don't need to provide an expert in the sense when you do 25 have -- courts have recognized that the actual sales 26 price near in time to the valuation date is adequate. 27 MS. STEEL: Is nine months is near? 28 MR. GEMMINGEN: There's been no definitive 39 1 amount. But in the Ringgold case they looked at six 2 months afterwards and said that was no problem at all. 3 And in this case they have a memo in May, which 4 is only five months afterwards, that points to a value 5 of $1,800,000 for just two of the projects. 6 MS. STEEL: Thank you very much. 7 MR. HORTON: Mr. Runner? 8 MR. RUNNER: Yeah, a couple of -- a couple of 9 follow-up questions. 10 You know, to me, I guess this revolves around, 11 again, the date -- the date and the value of January in 12 terms of the change of organization, the change of the 13 corporation and trying to figure out then the value at 14 that point based upon what it is that the Appellants are 15 feeling versus -- versus what the State has established. 16 So, let me kind of just go through a couple of 17 questions in regards to that. 18 You've brought up the Ringgold case in that 19 issue, using that fact that there was a court case where 20 a sale was provided, which then became the value, 21 correct? 22 MR. GEMMINGEN: Yes. 23 MR. RUNNER: Okay. Can you tell me what was 24 the sale price on that case? 25 MR. GEMMINGEN: I -- offhand, I can't tell you 26 the -- 27 MR. RUNNER: My notes say it was like 5.9 28 million. 40 1 MR. GEMMINGEN: Okay. 2 MR. RUNNER: And what were they -- do you 3 recall what the amount was that was settled by the 4 court? 5 MR. GEMMINGEN: I want to say -- was it 2.2 6 million? 7 MR. RUNNER: Somewhere, but it wasn't the sale 8 price is my point. 9 MR. GEMMINGEN: Right. 10 MR. RUNNER: Can you help me understand then 11 what happened in there? 12 If your argument is the sale price is what 13 drove the value of that and yet in the court case, the 14 court did not find on the sale value, help me understand 15 then why it is that FTB uses that case to get all of the 16 way up to the sale price? 17 MR. GEMMINGEN: Well, the court, in that case, 18 looked at not only the sales price, which it utilized in 19 determining its value, it did utilize the sales price, 20 but it also looked at the experts that the taxpayer 21 provided, who was an expert in valuing 22 telecommunications equipment and also the interests 23 therein. 24 And the -- 25 MR. RUNNER: So, it wasn't just the sale price 26 that the court found? 27 MR. GEMMINGEN: No, the court found that the 28 taxpayer provided a credible and pertinent -- 41 1 MR. RUNNER: Okay. 2 MR. GEMMINGEN: -- valuation that was 3 attributable to the actual assets that are being valued. 4 MR. RUNNER: Okay. 5 MR. GEMMINGEN: And that was -- 6 MR. RUNNER: It's fine, I just -- the argument 7 seemed to be pretty simple from your -- from what you 8 were telling us. Gee, you know, there is a sale of 9 property here. You know, that's traditionally how sales 10 are made. 11 When you sell a piece of property, the value of 12 the -- of the asset is based on the sale price and all 13 that. 14 My point, I guess, is only that that's not what 15 the court really found then. 16 MR. GEMMINGEN: In that case, it did not. 17 But it -- 18 MR. RUNNER: Okay, that's fine. That's all I 19 need. Because I think I just needed to clarify that at 20 that point. 21 So, now we come down to the issue -- so, it's 22 not -- it wasn't exactly sale price is what -- is what 23 you're assigning to the Appellant at that point. 24 Because now you're assigning just the sale price to the 25 Appellant of the sale that took place a number of months 26 after the conversion of the -- of the corporation. 27 And in that process somehow you have determined 28 that the other issues to which the Appellants have 42 1 brought forward, just like the Appellants in the 2 Ringgold case had brought forward, some mitigating 3 issues. Their mitigating issue is appraisals, of which 4 there are two of them. 5 So, I guess I'd like to hear from your point 6 of view why those appraisals on that date -- not what 7 happened later, not what was going -- you know, on that 8 date -- why those appraisals should be not used and 9 construed at all? 10 Because, again, you're not giving them any 11 credit. You're going all the way to the full sale 12 price, when in the Ringgold case, they didn't go all the 13 way to the sale -- full sale price. 14 MR. GEMMINGEN: Okay. Well, let's look at 15 page 2, please, in your book. 16 And you'll see that Mr. Stein states that he 17 did not value the undivided interests in the notes. So, 18 he did not value the notes. 19 That's what we're here today to determine, the 20 value of the notes as of January 1st -- 21 MR. RUNNER: Just real quick -- 22 MR. GEMMINGEN: -- 2003. 23 MR. RUNNER: -- let me interrupt real quick. 24 I'm going to be asking you to rebut what it is 25 that he's saying, particularly the notes. So, I'd like 26 you to listen carefully because that's what I'm going to 27 be asking you to do. 28 Go ahead. 43 1 MR. GEMMINGEN: So, that's why this is an 2 opinion that's not relevant to the inquiry here. 3 If Royal Housing had sold its assets while it 4 was still a C corporation, what would have been the gain 5 it realized? 6 And, so, we would -- we need to determine the 7 amount of the sales price. 8 He does not provide a value of the notes. And, 9 so, this is an irrelevant opinion. So, we can't rely on 10 this at all. 11 The same thing goes with BizVal's statement. 12 As I showed -- as I pointed out pages 17 through 19 of 13 our exhibits, if we go over to page 19, it says, 14 "The auditor states the entire company is 15 valued and that a discount for built-in gains 16 was applied." 17 He states, "That's settled tax law." 18 They're valuing the stock in the hands of the 19 shareholders in order to acquire reductions of the 20 built-in gains tax. 21 The company did not sell its stock. It sold 22 assets that it held. This is not an appraiser -- 23 appraisal that relates to the value of the assets. In 24 fact, if you look again at page 17, we requested -- we 25 went back and said, 26 "Would you please do an individual analysis of 27 each RIWN's face value, its book value, 28 maturity or value of the underlying security?" 44 1 In other words, look at all of the notes, tell 2 us what the values are. And this is a letter addressed 3 to the appraiser, to Royal Housing. 4 So, Royal Housing knew it was deficient with 5 respect to the appraisal that was required. And, so, 6 this again doesn't -- misses the mark, doesn't address 7 the actual asset, it's just a red herring in a sense. 8 MR. RUNNER: Okay. Let me ask for your 9 response to that. 10 MR. STEIN: Yeah, I think -- again, it's this 11 conceptual issue of the sale that I even addressed to 12 Ms. Yee. 13 The transaction in September of 2.7 million is 14 purportedly evidence of what the property would have 15 sold -- 16 MR. RUNNER: Hold on, hold on, I'm asking you 17 to respond to the issue of the notes. 18 MR. STEIN: Okay, the notes? 19 MR. RUNNER: Okay, that's what I'm asking you 20 to respond to -- 21 MR. STEIN: Okay. 22 MR. RUNNER: -- the value of the notes. 23 MR. STEIN: Okay. We get to the notes and we 24 held them for sale on January 1, 2003, what would they 25 have brought on the market? 26 If you value them, they brought nothing because 27 no one could have bought them. 28 MR. RUNNER: Hold on, okay. 45 1 I'm asking you respond to the appraisals of 2 those notes. That's what I asked FTB and that's what I 3 you asked to you listen to -- 4 MR. STEIN: Okay, I'm sorry. 5 MR. RUNNER: -- and help me understand why it 6 is that their argument in regards to the appraisals' 7 opinions were incorrect. 8 MR. STEIN: Because the appraisers were looking 9 at -- in terms of one of the value -- as to the value 10 that my letter was what was the value of the assets? 11 MR. RUNNER: Uh-huh? 12 MR. STEIN: And I viewed the asset as not being 13 the notes, per se, because the notes were unmarketable. 14 They had an adverse claim to ownership that made them 15 unmarketable. 16 I could value the notes and value them zero, 17 but that would disingenuous. What Royal had was a claim 18 in litigation against the potential claimant to the 19 ownership of the notes. And I tried to value that 20 claim. 21 That was the real facts at issue then. I think 22 it's absurd to contend that a hypothetical buyer of that 23 claim, as of January 1, could be determined by the 24 settlement with the holder of the adverse claim because 25 that was the only party to whom that adverse claim was 26 meaningless. 27 So that what I valued was the real asset as of 28 that date. The notes were not marketable. 46 1 MR. RUNNER: So, in your opinion, at that 2 point, the appraisal had to be based on the 3 marketability of those notes based upon the litigation 4 to which those notes were attached to? 5 MR. STEIN: Precisely. 6 MR. RUNNER: Okay. So, how about the second 7 appraisal? 8 MR. STEIN: Well, the second appraisal valued 9 them on -- I did -- you know, I did not prepare the 10 second appraisal and that was based on an accounting 11 view of what the notes were worth, based on their 12 collectibility, enforceability. 13 These notes are -- 14 MR. RUNNER: Did you hear what the gentleman's 15 argument was as to what it is that that second appraiser 16 said about when he qualified his appraisal? 17 And what is your response to that? 18 MR. FEURZEIG: He did. But I think there was a 19 second -- he came up with a second appraisal, which 20 he -- he did try to quantify the notes. 21 I think we did -- we did submit that as an 22 exhibit. And he -- what he did was he discounted -- he 23 discounted the notes and he supported what he did in his 24 first appraisal. 25 And, so, he did value -- he did value the 26 notes. 27 MR. RUNNER: So -- so, at least in your 28 opinion, we have two different ways to value the asset? 47 1 MR. STEIN: Exactly. 2 MR. RUNNER: One is what Mr. Stein's appraisal 3 was, which was based on the value of the asset based 4 upon the litigation to which they were engaged in? 5 MR. STEIN: Correct. 6 MR. RUNNER: Nothing about the underlying value 7 of the note, in the sense of the face of the note versus 8 discount or anything, it's just the fact it doesn't have 9 this value because there is pending -- there is 10 litigation? 11 And then the second appraisal was based on the 12 discounted value of the note based upon, I assume, the 13 collectibility, all those other things that discount a 14 note. 15 Is that a fair analysis? 16 MR. FEURZEIG: It is -- it is, Senator Runner. 17 And not only that, but he -- he made a further 18 discount based on lack of marketability and a minority 19 interest because there were co-ownership of these notes. 20 So, he did value the notes in that second -- in 21 that second submission. 22 MR. RUNNER: Okay. One closing question to the 23 issue of the Ringgold case, which seems to be a kind of 24 a pivotal issue in your discussion and certainly in the 25 minds of some of the Board here. 26 In that particular case it wasn't 27 necessarily -- that case didn't necessarily direct 28 values to be based upon a sale, correct? 48 1 MR. GEMMINGEN: It didn't direct it. 2 MR. RUNNER: Okay, it just said it could be one 3 of the factors, correct? 4 MR. GEMMINGEN: Well, it said when the value of 5 an unlisted stock cannot be determined from the actual 6 sale price -- 7 MR. RUNNER: Right. 8 MR. GEMMINGEN: -- its value is generally then 9 to be determined by taking into consideration a host of 10 factors. 11 MR. RUNNER: Right. 12 MR. FEURZEIG: So, it says -- so, it first says 13 when you can't determine it first from an actual sales 14 price. 15 So, then you can look at other factors. 16 MR. RUNNER: Okay, let me -- 17 MR. GEMMINGEN: But you first have to have -- 18 if you have -- 19 MR. RUNNER: Okay. So, he said you could have 20 a number issues, of which sales price could be one of 21 those, of which the court itself then discounted the 22 sale price, correct? 23 MR. GEMMINGEN: That's right. 24 MR. RUNNER: Okay. Well, let me ask you this 25 then, if that's the case, would -- would you -- I guess 26 it would be FTB's opinion that, indeed, the value of 27 that asset on January 1st, not looking at a sale -- if 28 you didn't have -- if a sale didn't take place, how 49 1 would you have -- how you have determined the value of 2 that? 3 MR. GEMMINGEN: Which house are you referring 4 to, please? 5 MR. RUNNER: I guess -- I'm trying to figure 6 out the notes. 7 You have been driven to the fact that there's a 8 sale and, so, that's where you -- to the subsequent 9 sale. So, that's what gives you your value right now. 10 There is at least some evidence that has 11 been -- again you disagree with -- with parts of it or 12 all of it -- in regards to what it is the appraisal is. 13 And I guess I'm trying to figure out, you know, 14 if -- is there any -- in the court case they found 15 middle ground. In the court case they found, you know, 16 there was mitigating issues that said, hey, this value 17 is too high and the sale price -- there's mitigating 18 issues if we date back to the time of the -- to the time 19 of the -- the change of ownership -- 20 MR. GEMMINGEN: Right. 21 MR. RUNNER: -- or transition to a different 22 corporation. 23 MR. GEMMINGEN: Well, it looked -- 24 MR. RUNNER: And FTB has not decided that at 25 all. I guess -- so, you would contend that the value of 26 that sale on that date, January 1st, could have been the 27 $2.7 million? 28 MR. GEMMINGEN: Clearly. Because -- in fact, 50 1 earlier, as we've shown, they started taking action to 2 collect these debts. They gave specified amounts -- 3 MR. RUNNER: Let me ask you -- 4 MR. GEMMINGEN: -- they went forward. 5 MR. RUNNER: -- let me ask you this collection 6 of a debt, do you mean the collection on the face value 7 of the debt? 8 MR. GEMMINGEN: No, because there's an 9 underlying amount that was due HUD. So, they were -- 10 they were saying that they were entitled to the 11 differential between the HUD note -- 12 MR. RUNNER: Right. 13 MR. GEMMINGEN: -- and the amount of the note. 14 MR. RUNNER: Okay. But I mean -- okay, plus -- 15 I mean, again, people who take notes like that 16 oftentimes will go ahead and solicit the value of the 17 note from somebody, even though they're not going to get 18 the whole value of the note. 19 MR. GEMMINGEN: Well, these people -- 20 MR. RUNNER: That's why -- that's why -- that's 21 why they bought them all for $539,000, right? 22 MR. GEMMINGEN: They bought them because they 23 knew it was a bargain for purchase, they could make 24 money. 25 MR. RUNNER: Right. And why could they make 26 money? 27 MR. GEMMINGEN: Because they were able to crack 28 the code and claim that these were in default. 51 1 These notes were supposed to be existing for a 2 long period of time, but they acquired -- who claims to 3 be the preeminent expert on HUD notes and they're able 4 to go out there and within a year and a half, declare 5 these notes due and payable, actual due and payable. 6 And they took legal action, submitted court 7 documents saying that those notes are due payable. And 8 also Mr. Stein -- I've included an exhibit there -- 9 states that any argument as to the -- 10 MR. RUNNER: Because of the (unintelligible) 11 MR. GEMMINGEN: -- the ownership is specious. 12 He said they had ownership. 13 MR. RUNNER: But help me understand. 14 Because when he buys the note at a discounted 15 value and then turns around and tries to collect it then 16 at a face value or full value or anticipated value, 17 doesn't mean that they're going to get that money, 18 right? 19 MR. GEMMINGEN: Doesn't mean they're going to 20 get that money, it means they may get what they can 21 squeeze out of the person and maybe -- 22 MR. RUNNER: Right. 23 MR. GEMMINGEN: -- have the person buy them 24 off. 25 MR. RUNNER: It's a negotiation, right? 26 MR. GEMMINGEN: Uh-huh. 27 MR. RUNNER: Okay. So, again, you're not -- 28 you wouldn't assign -- you can't assign value to their 52 1 note based upon a letter that they wrote telling 2 somebody how much they owed them? 3 MR. GEMMINGEN: I think you can use that, 4 certainly, as the basis for value -- for assigning -- 5 for beginning for value. 6 MR. RUNNER: Is that -- is that -- is that in 7 Ringgold? 8 MR. GEMMINGEN: Ringgold says you should look 9 at events and factors. 10 MR. RUNNER: A letter of request on the value? 11 MR. GEMMINGEN: I think this is beyond a letter 12 of request, it was a demand. 13 MR. RUNNER: But it was never paid? 14 MR. GEMMINGEN: Because the parties entered 15 into a stipulation. 16 MR. RUNNER: Well, let me ask you this then -- 17 MR. GEMMINGEN: -- to allow the time to go 18 forward. 19 But they went forward and authorized the public 20 sale. 21 MR. RUNNER: -- let me ask you this, then, I 22 guess in conclusion then, because I'm trying to figure 23 out the value here. 24 If, indeed, the face value of these notes were 25 like $9 million, is that what they were approximately? 26 MR. GEMMINGEN: In '99, yes -- in 1999. 27 MR. RUNNER: In 1999, $9 million, the total 28 sale that we're talking about, they sold them that for 53 1 2.7? 2 MR. GEMMINGEN: No, about 3 million, because 3 there was an earlier sale of one other note. 4 MR. RUNNER: What was their total? $3 million 5 total? 6 MR. GEMMINGEN: Roughly total is what their 7 proceeds were, roughly. 8 MR. RUNNER: Okay. So, clearly, they did not 9 have full face value, even when they sold them, right? 10 I mean, if they were -- if they were valued at 11 what it is that they wrote the letter for back earlier, 12 it was -- it was not near $9 million. 13 I mean, it might have been $9 million, but, 14 ultimately, in the final sale, they never got the $9 15 million? 16 MR. GEMMINGEN: Well, also Appellant's counsel 17 says that they had a 37 percent interest in those. So, 18 if you take about a third of $9 million, $3 million, 19 we're right there. 20 MR. RUNNER: And do you agree with their third 21 interest? 22 MR. GEMMINGEN: It's been a floating interest. 23 If you look in the BizVal concept, it says it's 24 50 percent. 25 MR. RUNNER: All right. 26 MR. GEMMINGEN: So, it's all -- 27 MR. RUNNER: Have you factored in their third 28 interest in your -- in FTB's analysis? 54 1 MR. GEMMINGEN: I factored in the -- 2 MR. RUNNER: In terms of what they owe? 3 MR. GEMMINGEN: -- I'm sorry, what they owe? 4 MR. RUNNER: In what they owe, yeah? 5 Their -- in terms of what they owe, their 6 obligation did you figure out -- did you -- did you 7 calculate their third interest? 8 MR. GEMMINGEN: I am sorry, I don't understand 9 what you mean by -- 10 MR. RUNNER: They only had a third interest in 11 terms of their obligation? 12 MR. GEMMINGEN: They're the beneficiaries, 13 they're not the obligor. 14 MR. RUNNER: Okay, you're right. 15 I forgot, the sale itself would end that -- end 16 that question. 17 Again, I -- I'm just struggling with this idea 18 of the value on that date. 19 And, you know, I think the conflicting issues 20 that we've got is an appraisal on a certain date, two 21 different kinds of ways to do the appraisal, Ringgold, 22 even in the case you cite, didn't attempt to assign the 23 full sale value, using other -- other issues of discount 24 when the -- when the value was assigned. 25 So, I'm struggling with that as the example 26 because they brought at least -- the court at least 27 brought in some mitigating issues and the very least, I 28 would think, is their appraisal should mitigating 55 1 something -- something, as opposed to being totally, you 2 know, not looked at. 3 So, that would be kind of my thought of the 4 world. 5 Thanks. 6 MR. HORTON: Question of the Department -- the 7 Ringgold case, can you tell us what the difference is 8 between that case and the case before us? 9 MR. GEMMINGEN: Very easily. 10 The Ringgold case had an appraisal by an expert 11 that pertained to the asset that was under valuation. 12 MR. HORTON: At what time? 13 MR. GEMMINGEN: Well -- 14 MR. HORTON: I mean, is that relevant? 15 MR. GEMMINGEN: -- it's relevant because the 16 court based, in part, its valuation. 17 MR. HORTON: No, I mean the point in time in 18 which the appraisal was taken? 19 MR. GEMMINGEN: Well, the appraisal was 20 undertaken in preparation for trial. So, it was 21 a subsequent, later appraisal, not done at the time of 22 the conversion from C to S. 23 MR. HORTON: How soon after was the appraisal 24 done? 25 MR. GEMMINGEN: I'm not sure, but I'm sure it 26 was a couple years afterwards. 27 MR. HORTON: Okay, continue. 28 MR. GEMMINGEN: And, so, in that case, since 56 1 the taxpayer's appraiser was able to identify and 2 quantify special attributes of the purchaser at that 3 point in time, of Bell South, as well as the actual 4 assets that were being sold, it was a relevant appraisal 5 that was able to surpass the general standard of just 6 looking at actual sales price. 7 In this case, as I have demonstrated, both of 8 the appraisals here miss the mark. They do not address 9 the assets that we're reviewing for sale. 10 So, they have absolutely nothing to add or 11 provide any of us with relevance as to the value of the 12 assets. 13 And, so, we are just simply left with only the 14 sales price, which as the court in Ringgold stated, it's 15 the best standard of valuation. 16 MR. HORTON: But the sales price is subsequent 17 to the conversion date -- conversion date being 18 January 1st, 2003. And it is subsequent to quite a bit 19 of activity that seems to imply a number of different 20 values as it relates to the settlement at that time. 21 So, maybe you can help us -- or help me, if you 22 will. 23 Let me ask the Appellant a question. In -- I 24 believe it was in 2002 there was a negotiated settlement 25 of some sort. Do you happen -- we don't seem to have 26 that information. Can you share with us what the 27 settlement value was? 28 MR. STEIN: I don't have off the top of my head 57 1 the settlement. It was approaching the number that was 2 ultimately resolved for. 3 And it was just -- the negotiations were 4 proceeding and they went into -- 5 MR. HORTON: I'm not -- it's not clear what you 6 are sharing with me. 7 In 2002 there was a settlement or negotiated 8 settlement, it wasn't resolved. However, there was a 9 settlement amount. And you said it was approaching -- 10 are you saying that it was approaching the ultimate 11 amount that was settled in 2003? 12 MR. STEIN: Yes, that is correct. 13 MR. HORTON: And what was that amount? 14 MR. STEIN: Again, the settlement was 2.7 15 million in 2003. 16 I don't have, off the top of my head, the 17 number. 18 MR. HORTON: So, in 2002, prior to the 19 conversion, there was a settlement agreement between the 20 parties -- 21 MR. STEIN: There was negotiation towards a 22 settlement. 23 MR. HORTON: -- you were negotiating towards a 24 settlement? 25 And why was that value set? I mean, what -- 26 and let me -- let me clarify. 27 I -- I agree with your position that the market 28 value is not the valuation that we should be looking at 58 1 and that -- that the sales value, relative to the 2 Ringgold case, has to be taken under consideration, but 3 only in light of the extenuating circumstances during 4 the time of the conversion. 5 And, so, I'm trying to delineate those 6 extenuating circumstances as it relates to the 7 conversion and the settlement price. 8 So, maybe you can answer the question in light 9 of that? 10 MR. STEIN: The numbers were negotiated amounts 11 that Wilshire had proposed that were acceptable at that 12 point in time. 13 MR. HORTON: Acceptable to both parties? 14 MR. STEIN: Acceptable to both parties. 15 MR. HORTON: So, it was an arm's length 16 negotiation, both -- 17 MR. STEIN: That was -- 18 MR. HORTON: -- parties agreeing? 19 MR. STEIN: That is correct. 20 But what we're trying to make clear here is 21 that after the negotiations were reached, Wilshire made 22 a determination that they did not want to settle the 23 case, that they felt that they were going to go ahead 24 and litigate it. That is the sum and substance of the 25 Gotfredson and Perry declarations. 26 We know, in fact, that they started serving 27 papers with respect to the litigation that was ongoing 28 in December. 59 1 MR. HORTON: And in the litigation, what was -- 2 what was the Appellant's position as far as value in the 3 litigation? 4 MR. STEIN: Well, the Appellant's position at 5 that point -- 6 MR. HORTON: And you never went to litigation, 7 but in the -- 8 MR. STEIN: No, it was ongoing litigation. 9 MR. HORTON: -- onset. 10 MR. STEIN: They had served some papers. At 11 that point in time, negotiations had broken -- there was 12 no negotiations going forward at that time. 13 And Royal was faced, at that point, with trying 14 to prepare a case for trial that it didn't have any 15 witnesses. 16 MR. HORTON: But in the preparation, what would 17 have happened is that Royal would have said -- I mean, 18 the opposing party would have said, 19 "We don't believe that the value at this point 20 is 2.7 and we believe it is less." 21 And the Royal would have said, "No, I believe 22 it is more." 23 I mean, that seems to be the -- I believe it is 24 actually 2.7. 25 MR. STEIN: No, at that point -- 26 MR. HORTON: These are hypotheticals that we're 27 sharing. 28 MR. STEIN: Hypothetical -- settlement would 60 1 have been initiated. Royal would have come in with a 2 very, very low number, in the hopes of getting out with 3 something around the -- you know, the net perhaps near 4 what I valued it at. 5 Because that's all -- they couldn't take the 6 case to trial. I mean, ignoring the litigations costs, 7 the risk was so high that basically the case had become 8 a nominal one, it was a nuisance value case at that 9 point. 10 MR. HORTON: So, what happened subsequent to 11 September 19th of 2002 that gave it this value? 12 MR. STEIN: That -- it was after that 13 happened -- 14 MR. HORTON: What circumstances? What did -- 15 MR. STEIN: We were talking about the value -- 16 MR. HORTON: -- new information? 17 MR. STEIN: -- in September 2003? 18 MR. HORTON: Yes -- no, no, I am speaking of 19 September of 2002. 20 MR. STEIN: At that point in time -- 21 MR. HORTON: When the tentative settlements 22 were cancelled. 23 You cancelled the settlements, September of 24 2002, for 2.7, which was the agreed valuation as far as 25 settlements was concerned. 26 And, so, the opposing party said, "We want to 27 litigate. We don't believe that it's worth that." 28 And at some point they decided not to litigate. 61 1 And what happened to cause that? 2 MR. STEIN: That was the -- they got an 3 unsolicited and unexpected offer on the San Martin 4 project, which the dollar amount involved -- 5 MR. HORTON: How much -- what was the dollar 6 amount? 7 MR. STEIN: We don't know. They would never 8 disclose that. 9 MR. HORTON: I mean, all of this would have 10 been taken into consideration in your appraisal, right? 11 MR. STEIN: Well, at that -- 12 MR. HORTON: Or tried to? 13 MR. STEIN: -- as of January 1, 2003, San 14 Martin would have looked as a candidate for anybody to 15 purchase. 16 MR. HORTON: So, San Martin -- at what point 17 did that happen? 18 I'm sorry. 19 MR. STEIN: It happened, in -- it happened in 20 2003. Their communication was in May that they had an 21 offer to sell San Martin and they wanted to settle. 22 MR. HORTON: In May of 2003 they contacted you 23 and said they were prepared to settle? 24 MR. STEIN: Yes. 25 MR. HORTON: And you were aware that they were 26 offered this value for the San Martin? 27 MR. STEIN: We don't know what they were 28 offered. They were -- 62 1 MR. HORTON: But you were aware that it 2 existed? 3 MR. STEIN: -- they communicated that fact. 4 MR. HORTON: And that was the stimuli for 5 settling? 6 MR. STEIN: Absolutely. 7 MR. HORTON: Okay, maybe -- I'm going to throw 8 a general question out there to both sides. 9 The Ringgold case is actually very, very 10 informative in this situation and similar in many ways. 11 It just appears to me that all of the variables have not 12 necessarily been taken into consideration. 13 So, the tentative settlement in September of 14 2002, there seems to be an agreed value at that point of 15 2.7 million, let's say, somewhere around there. 16 And then the conversion takes place some few 17 months later -- three, four months later, three to four 18 months later. And in that three to four-month period of 19 time, the value went from 2.7 down to -- 20 MR. STEIN: Zip. 21 MR. HORTON: -- zip, zero because the 22 methodology of valuation changed or -- 23 MR. STEIN: No, I think -- there is sort of a 24 conceptual thing here. 25 Maybe I can just step back? 26 MR. HORTON: What I'd like for you to help me 27 with is to stay consistent with the settlement value. 28 At what point did your client decide from a 63 1 settlement perspective that this -- this asset is no 2 longer worth anything, in light of the fact that wrap 3 notes are -- they're very controversial. Litigation is 4 normal and holding out. And this is the way that you 5 typically settle the value is through the litigation, 6 unfortunately, because of the controversial nature of 7 the instrument. 8 So, it seems to me that there was a settlement 9 value that -- not the market value, I don't want to go 10 back to the market value, I want to stay consistent with 11 the settlement value -- and I'm trying to extract what 12 your thoughts were at that time. 13 I mean, there is documents here that seem to 14 imply somewhere around $1.5 million or between the 15 parties, these documents that are going backwards and 16 forwards, I am going to go to the Department and see if 17 they can bring some clarity to this. 18 But, based on the settlement negotiations, what 19 was the value? 20 MR. STEIN: Well, based on the settlement 21 negotiations as they were, the parties were willing to 22 walk away for 2.7 million. 23 At that point in time and during the period 24 leading up to that, Royal was not looking at the 25 litigation in terms of, "What is our trial strategy? 26 How do we prepare? Where are we?" 27 It was it in negotiations for settlement and 28 that was where -- where it was proceeding. 64 1 Then the settlements fall apart. Wilshire 2 takes an active position in litigation. And at that 3 point, without any settlement prospects, and Wilshire, 4 as they indicated in their declarations, regrets even 5 pushing litigation because they did not -- they felt 6 they had a case. 7 In reviewing -- 8 MR. HORTON: Now, if Wilshire knew January 1st, 9 2003 that you were ready to walk away -- 10 MR. STEIN: I wouldn't say walk away, I'd say 11 they would get, you know, a nuisance value settlement 12 with the -- you know, they could have gotten -- 13 MR. HORTON: -- so, it's your testimony that 14 January 2003 your client would have settled for nothing 15 or 250,000? 16 MR. STEIN: No, no, they wouldn't have settled 17 for nothing. 18 They would have and should have settled without 19 -- assuming we don't know about San Martin -- 20 MR. HORTON: Right. 21 MR. STEIN: -- knowing what they know, that 22 they can't go to trial, the smart thing to do was to 23 take -- figure what you can get from Wilshire and they 24 threw out a number, "We want a half a million," and hope 25 you get 300,000. 26 MR. HORTON: They threw -- how did throw it -- 27 was there a document where they threw that number out? 28 Was it -- did they send them a letter or something? 65 1 MR. STEIN: No, they hadn't reached that point 2 yet. They didn't -- at that point, you know, the idea 3 was, to be perfectly honest, we were going to pick two 4 of the weaker positions, two or three of the weaker 5 positions in Wilshire's case -- 6 MR. HORTON: Now, you earlier testified -- 7 MR. STEIN: -- make a motion for summary 8 adjudication, win those and then, "Hey, come on, give us 9 some money here." 10 So, we hadn't gotten that far. 11 MR. HORTON: So, you were still striving to get 12 as much as you can possibly get? 13 MR. STEIN: Yes. 14 MR. HORTON: Wasn't a zero value? 15 MR. STEIN: Well, it was -- 16 MR. HORTON: You could have -- 17 MR. STEIN: -- if it went to trial. 18 MR. HORTON: -- could have eliminated of their 19 -- let's hypothetically say that there were five issues 20 here, if you could have eliminated two, that would have 21 given you some leverage and would have established a 22 value at that point relative to settlement? 23 MR. STEIN: Right, this is what the number -- 24 MR. HORTON: And what -- what did you estimate 25 that would be? 26 MR. STEIN: At that point, I think, you know, 27 my view would be go out and say I would settle for 500 28 to 600,000 and see if you can get 300 -- 3, 400 and take 66 1 a walk and, you know, then get out of it. 2 You can't -- you can't try the case. 3 MR. HORTON: Okay. I'm going to ask the 4 Department to take me through this same timeline. 5 But I want to share with the Appellant, this is 6 -- it's a little challenging for me, for you to -- for 7 Wilshire to have knowledge of value, not share that 8 knowledge, and not make the same evaluation from the 9 litigation perspective and prior to making you aware or 10 anyone becoming aware that there's a value to this 11 asset, offer you a settlement of 200,000. 12 Why not? From 2.7 million, why not say, "Let's 13 settle this."? 14 And then they would simply be the wiser 15 subsequent because they controlled the knowledge about 16 value, if that's the case. 17 MR. STEIN: They could have adopted that tactic 18 and gotten out cheaper. 19 MR. HORTON: I mean, that's the normal tactic. 20 That's -- that's not something new, that's what you do 21 when you control and you have access to knowledge that 22 controls value, an established value greater than the 23 value in the litigation case. 24 And, evidently, there's knowledge that Royal is 25 prepared to walk because of their tactics of trying to 26 eliminate two of the issues in order to create value. 27 It's a little challenging for me, but I'm going 28 to go to the Department and see if they can kind of help 67 1 me out here. 2 I -- there is -- there is a lesser value, in my 3 mind, but I don't know what it is. I mean -- and I 4 really don't know the basis for it. 5 And in the absence of that, I am sort of stuck 6 with this 2.7 as the sales price and that it was the 7 price that was established, not only in September of 8 2003, but it was also established in September of 2002. 9 And what happened in between seems to actually 10 establish a value that is greater than 2003 on the sales 11 prices, especially if you had knowledge of the valuation 12 of this asset. 13 Can you help me out? 14 MR. GEMMINGEN: Well, I think we're talking 15 about two different things. We're talking about 16 settlement value and fair market value. 17 MR. HORTON: Well, let's just -- let me just 18 bring some clarity here. 19 The only thing I want to talk about is 20 settlement value. 21 MR. GEMMINGEN: Okay. 22 MR. HORTON: Okay. 23 MR. GEMMINGEN: But settlement value also takes 24 into account what does a person think that the asset is 25 inherently worth and what are they willing to relinquish 26 it for? 27 So, first of all, before you get to a 28 settlement value, it's dependent upon getting in one's 68 1 mind a true fair market value of what that asset's worth 2 so then you know whether to take the settlement offer or 3 not. 4 Because, let's not forget, these are notes 5 which could be held to maturity and then, ultimately 6 they'll be paid off. 7 So, there's no compulsion to settle these notes 8 at this time. They had gone through court proceedings 9 and were able to get accounting requirements and ensure 10 that their interests were protected. 11 MR. HORTON: What was the term of the note? 12 MR. GEMMINGEN: I beg your pardon? 13 MR. HORTON: What was the term of the note? 14 MR. GEMMINGEN: Some notes were going to -- one 15 was going to mature in 2003, some in 2011 and some in 16 2023. 17 MR. HORTON: What was the value of the ones 18 maturing in 2003? 19 MR. GEMMINGEN: That is found at your book at 20 page 12 and 13. And that was the Palmdale note. And at 21 page 13, it says, 22 "Based on the undivided interest due and owing 23 to the --" 24 Well, it talks about the -- excuse me, 25 according to our calculations, the present balance due 26 and owing on the all inclusive note is $1,538,000 with 27 interest at the rate of 12 percent per annum, less the 28 outstanding balance of the HUD note -- the HUD note of 69 1 $579,000. The amount due and payable to the undersigned 2 is $401,000. 3 So, the amount that -- once this HUD note was 4 satisfied and all other parties are satisfied, this 5 note -- the 2003 note was stated by the parties here as 6 worth $401,000. 7 MR. HORTON: Okay. 8 MR. GEMMINGEN: So, you know, we can contrast 9 that statement by the taxpayers -- 10 MR. HORTON: And the other two notes? 11 MR. GEMMINGEN: Well, there were eight other 12 notes that -- 13 MR. HORTON: Eight other? 14 MR. GEMMINGEN: -- and, so, I have -- I can go 15 through them right now. 16 They were -- let's see, it added up to 17 approximately $8.6 million at that time when you add up 18 the -- 19 MR. HORTON: 8.6 million -- 20 MR. GEMMINGEN: -- as far as the amount due 21 to -- 22 MR. HORTON: -- which would have been 23 collectible at the end of the term, is that your -- 24 MR. GEMMINGEN: Well, that amount plus 12 25 percent interest per annum. So, that amount would have 26 grown exponentially. 27 MR. HORTON: So, it had value? 28 MR. GEMMINGEN: It had a great amount of value. 70 1 It had value that would only rise as time went on. 2 MR. HORTON: All right, thank you very much. 3 Further questions, Members? 4 Is there a motion? 5 MS. YEE: Move to take the matter under 6 submission. 7 MR. FEURZEIG: Mr. Chairman -- 8 MR. HORTON: It's been moved to take the matter 9 under submission. 10 Is there a second? 11 MS. STEEL: Second. 12 MR. HORTON: Second by Ms. Steel. 13 Without objection, Members, such will be the 14 order. 15 Thank you very much for your presentation here 16 today. We will take the matter under consideration 17 later on this evening and send you a written report of 18 our conclusions. 19 Thank you. 20 ---o0o--- 21 22 23 24 25 26 27 28 71 1 . 2 REPORTER'S CERTIFICATE 3 4 State of California ) 5 ) ss 6 County of Sacramento ) 7 8 I, JULI PRICE JACKSON, Hearing Reporter for the 9 California State Board of Equalization certify that on 10 MAY 24, 2011 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 pages 1 14 through 71 constitute a complete and accurate 15 transcription of the shorthand writing. 16 17 Dated: June 9, 2011 18 19 20 ____________________________ 21 JULI PRICE JACKSON 22 Hearing Reporter 23 24 25 26 27 28 72