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[¶5268] In the Matter of Dennis Shollenburg, Hazel Hagy, Vicky Melton, Robert
Hagy, Brenda Knudson, and First Mountain Bank, Big Bear Lake,
California, Docket No. 00-88e (3-11-03).
The FDIC adopted the Recommended Decision and Order of the
Administrative Law Judge (ALJ), prohibiting Dennis Shollenburg, Hazel
Hagy, Vicky Melton, and Brenda Knudson from participating in the
affairs of any federally insured financial institution. The FDIC
dismissed from the proceedings Robert Hagy.
[.1] Violation of Law or Regulation
Respondents avoided paying federal and state income taxes, as well as
Social Security taxes.
[.2] Prohibition, Removal, or SuspensionMisconduct
Respondents violated Internal Revenue Code, Federal Deposit Insurance
Act, and engaged in unsound practices and breaches of fiduciary duty.
[.3] Prohibition, Removal, or SuspensionEffects RequirementLosses by
Bank
As a result of the respondents' activities, the bank sustained
financial losses, and reputational damage.
[.4] Prohibition, Removal, or SuspensionCulpability
The Board found the respondents acted willfully, and with continued
disregard for the possible consequences.
[.5] Prohibition, Removal, or SuspensionBank affairs, conduct of
denied
Respondents shall not participate in any conduct of the affairs of any
insured depository institution.
[.6] Prohibition, Removal, or SuspensionVoting rights, exercise
denied
Respondents may not exercise voting rights in any financial institution
without prior consent of FDIC.
In the Matter of
Dennis Shollenburg,
Hazel Hagy,
Vicky Melton,
Robert Hagy, and
Brenda Knudson.
individually and as institution-affiliated parties of
First Mountain Bank
Big Bear Lake, California
(Insured State Nonmember Bank)
DECISION AND ORDER TO PROHIBIT FROM FURTHER PARTICIPATION AND ORDER OF DISMISSAL
FDIC-00-88e
I. INTRODUCTION
This matter is before the Board of Directors ("Board") of
the Federal Deposit Insurance Corporation ("FDIC") following the
issuance on October 31, 2002, of a Recommended Decision and Proposed
Order ("Recommended Decision") by Administrative Law Judge Arthur
L. Shipe ("ALJ"). The ALJ recommended that Dennis Shollenburg
("Shollenburg" or "CEO Shollenburg"), Hazel Hagy
("H. Hagy" or "CFO Hagy"), Vicky Melton ("Melton")
and Brenda Knudson ("Knudson") (collectively referred to as
"Respondents") each be subject to an order of prohibition
pursuant to section 8(e) of the Federal Deposit Insurance Act
("FDI Act"), 12 U.S.C. §1818(e). The ALJ dismissed from
the proceedings Robert Hagy ("R. Hagy") who, having been
diagnosed with late stage throat cancer, was unable to testify at the
hearing. R. Hagy's conduct was, however, included in the discussion
and findings of the ALJ's Recommended Decision and is incorporated
herein as well. For the reasons discussed below, the Board affirms the
Recommended Decision and issues an Order of Prohibition as to
Respondents Shollenburg, H. Hagy, Melton, and Knudson, and issues an
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Order of Dismissal as to Respondent R. Hagy.
II. PROCEDURAL BACKGROUND
The FDIC initiated this action on August 9, 2001, pursuant to
section 8(e) of the FDI Act, 12 U.S.C. §1818(e), issuing a Notice of
Intention to Prohibit From Further Participation in the affairs of any
financially insured financial institution with accompanying Findings of
Facts and Conclusions of Law, and Notice of Hearing ("Notice")
against Respondents, individually and as institution-affiliated parties
of First Mountain Bank, Big Bear Lake, California ("Bank"). Each
of the Respondents was charged with engaging in unsafe and unsound
banking practices, breaches of fiduciary duty, and violations of law
and regulation in their roles as officers and/or directors of the Bank.
Specifically, the Notice alleged that, by their conduct, Respondents
engaged in and caused the Bank to engage in violations of the Internal
Revenue Code ("IRC") by causing the Bank to fail to withhold from
their compensation income taxes andwith the exception of R.
HagyFederal Insurance Contribution Act ("FICA") or Social
Security taxes (for ease of reference, FICA and Social Security taxes
will hereinafter be referred to as "Social Security taxes"). The
Notice charged that Respondents also engaged in and caused the Bank to
engage in violations of the FDI Act and the FDIC's Rules and
Regulations ("FDIC's Rules"), 12 C.F.R. §300 et seq. The
Notice alleged that this conduct resulted in a gain to Respondents,
prejudice to depositors and both a financial and reputational loss to
the Bank.
The parties engaged in protracted discovery and pre-hearing motions
culminating in a six-day hearing which commenced on May 13, 2002, in
Riverside, California, and concluded on May 20, 2002. FDIC Legal
Division Enforcement Counsel ("Enforcement Counsel") presented
evidence through eight witnesses. H. Hagy testified for Respondents.
Shollenburg testified for the Respondents but because he refused to
submit to cross-examination, his testimony was stricken from the
record. Respondents presented no other witnessed in their
defense.1
Following the parties' submission of post-hearing briefs and proposed
findings of fact and conclusions of law and reply briefs, the ALJ
issued his Recommended Decision. Both parties filed
exceptions2 to the Recommended Decision and Respondents'
counsel requested an Oral Argument in this matter.3
Request for Oral Argument
After considering Respondents' Request and the entire record in
this matter, the Board finds that (1) the factual and legal arguments
are fully set forth in the parties' voluminous submissions, (2) no
benefit will be derived from oral argument, and (3) Respondents will
not be prejudiced by the lack of oral arguments. The Board, therefore,
declines to exercise its discretion under section 308.40 of the
FDIC's Rules, 12 C.F.R. §308.40, and denies Respondents'
Request for Oral Argument.
III. DISCUSSION
A. Factual Overview
Because the ALJ provided a detailed and well-reasoned opinion
replete with citations to the record in support of his conclusions, the
Board finds it unnecessary to reiterate in full the contents of the
Recommended Decision. The discussion below, however, provides an
overview of Respondents' misconduct as found by the Bank's auditors,
tax counsel and FDIC supervisors and corroborated by the testimonial
and documentary evidence.
1. Respondents' Tax Avoidance Activity
During the period July 1997 to September 1999, each of the
Respondents was employed
1 Each of the five Respondents is represented
by the same counsel. FDIC Rule 308.8 (12 C.F.R. §308.8) requires
that counsel representing two or more parties certify in writing that
each party waives the right to assert conflicts of interest. Pursuant
to an order dated March 14, 2002, counsel for Respondents filed, on
April 5, 2002, Attorney Certification of Waiver of Conflict of Interest
certifying that each of the five Respondents waives their rights to
assert conflicts.
2 Pursuant to section 308.39(a) of the FDIC's
Rules, parties may file exceptions to the ALJ's Recommended Decision,
findings, conclusions and evidentiary decisions. 12 C.F.R.
§308.39(a). In this case, in response to the ALJ's Recommended
Decision, Respondents filed Respondents' General Objections to ALJ
Shipe's Recommended Decision and Respondents' Objections to Findings
of Fact, Conclusions of Law of Judge Shipe. The Board construes the
more specific pleading. Respondents' Objections to Findings of Fact,
Conclusions of Law of Judge Shipe as exceptions filed pursuant to Rule
308.39(a).
3 Respondents also filed, after the ALJ had
issued his Recommended Decision, two motions which are addressed
further at n. 6 and n. 8.
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by the Bank. Shollenburg served as president,
chief executive officer (CEO), and director of the Bank; H. Hagy was
the Bank's executive vice-president and chief financial officer (CFO);
Melton served as senior vice-president and loan officer; and R. Hagy,
H. Hagy's husband, was vice-president and branch manager. During the
same period, Knudson served initially as a new accounts officer and
subsequently as assistant vice president/business development officer.
R.D. 6; R.D. FOF ¶¶ 39.4
[.1] Starting in August 1997, Respondents, led by CEO Shollenburg and CFO
Hagy, began implementing a plan to avoid paying federal and state
income taxes, as well as Social Security taxes. R.D. at 3; R.D. FOF
¶ 16. Respondents were in large part influenced by a booklet called
Vultures in Eagle's Clothing by Lynn Meredith ("Meredith
booklet") which purports to provide a roadmap for "lawfully"
avoiding income tax payments. R.D. at 3; FDIC Exh. 118.
To that end, in August 1997, Shollenburg, H. Hagy, and R. Hagy
submitted a series of documents that caused the Bank to stop
withholding income taxes from their Bank compensation. R.D. at 5; R.D.
FOF ¶¶ 21, 23, 28, 32, 35, 51, 53, 63, 103, 105, 113, 115; FDIC
Exhs. 1, 3, 1012, 22, 114. Melton did the same in October 1997,
followed by Knudson in November 1997. R.D. FOF ¶¶ 7576, 87, 121,
123, 133, 26, 114. Each of the Respondents filed with the Bank
virtually identical forms to initiate the non-withholding process. All
of the forms appear to have been provided in or copied from the
Meredith booklet. R.D. at 15; R.D. FOF ¶¶ 172174. The documents
filed by Respondents included altered withholding exemption
certificates (Forms W-4) in which the Respondents claimed to be exempt
from income tax withholding, non-resident alien certificates (Forms
W-8) and affidavits of citizenship in which they claimed that they were
not citizens of the United States but were instead citizens of the
Republic of California. R.D. at 5; R.D. FOF ¶¶ 19, 2335, 5361,
7687, 105113, 123133; FDIC Exhs. 13, 10, 16, 22, 26, 114.
The Bank received each of the documents submitted by Respondents
through either Shollenburg or H. Hagy in their positions as bank
officers. R.D. at 6; R.D. FOF ¶¶ 22, 52, 75, 97, 121, 122; FDIC
Exhs. 1, 10, 16, 19, 26. However, neither Shollenburg or H. Hagy
forwarded the W-4 forms to the Internal Revenue Service ("IRS")
at the time the forms were received by the Bank. R.D. at 26; R.D. FOF
¶¶ 146, 295, 344; Tr. Vol. 1 at 7778; Tr. Vol. 3 at 124; Tr. Vol.
5 at 123124; FDIC Exh. 93. As a result of Respondents' submission to
the Bank of the documents described above, the Bank stopped the
withholding of income taxes from Shollenburg's compensation as of
August 30, 1997, from H. Hagy's and R. Hagy's compensation as of
August 15, 1997, from Melton's compensation as of October 15, 1997,
and from Knudson's compensation as of November 30, 1997. R.D. FOF
¶¶ 35, 61, 87; 113, 133; FDIC Exh. 114. The Bank continued to not
withhold income taxes from Respondents' compensation through July 31,
1999. R.D. FOF ¶¶ 36, 62, 88, 114, 144; FDIC Exh. 90.
After Respondents Shollenburg, H. Hagy, Melton, and Knudson succeeded
in the cessation of their income tax withholdings, they took their tax
avoidance activities a step further. In a December 22, 1997, letter to
H. Hagy at the Bank, Shollenburg requested that the Bank discontinue
withholding Social Security taxes from his compensation. R.D. at 6;
R.D. FOF ¶ 41; FDIC Exh. 4. Subsequently, each of the other
Respondents, except R. Hagy, wrote similar letters to the Bank. R.D. at
6; R.D. FOF ¶¶ 68, 94, 141; FDIC Exhs. 13, 18, 29. When Respondents
Shollenburg, H. Hagy, and Melton instructed the Bank to cease
withholding Social Security taxes on their behalf, they wrongly advised
the Bank that it was no longer required to pay matching contributions
for them. R.D. at 9; R.D. FOF ¶¶ 42, 69, 95; FDIC Exh. 4, 13, 18;
Tr. Vol. 5 at 5556.
4 Citations to the record shall be as follows:
Recommended Decision"R.D. at "
ALJ's Findings of Fact"R.D. FOF ¶"
ALJ's Conclusions of Law"R.D. COL ¶"
Transcript"Tr. Vol. at "
FDIC Exhibits"FDIC Exh. "
FDIC Exceptions"FDIC Except. at "
Respondents' Objections"Resp. Obj. ¶"
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Subsequently, apparently because their assertions of alien status were
rejected by the IRS, Respondents reversed their position on
non-citizenship. R.D. at 67; R.D. FOF ¶ 260; Tr. Vol. 2 at 8284;
FDIC Exh. 69. On September 1, 1998, Shollenburg submitted to the Bank a
Statement of Citizenship and Residence asserting that he was a citizen
of and did reside in the United States but that taxes could not legally
be withheld from his Bank salary because it did not constitute wages or
gross income under the applicable IRC provisions. R.D. at 7; R.D. FOF
¶¶ 38; FDIC Exh. 7. Each of the other Respondents followed
Shollenburg's lead by filing similar statements with the Bank, each of
them directing that the Bank forward the statement to the IRS office in
Philadelphia, Pennsylvania. R.D. at 7; R.D. FOF ¶¶ 6465, 9091,
116117, 137138. The Bank, through either CEO Shollenburg or CFO
Hagy, honored each Respondent's request. R.D. at 7; R.D. FOF ¶¶ 39,
66, 92, 118, 139.
Respondents began their tax avoidance activity without first informing
either the Bank's board of directors ("Bank's board") or the
Bank's outside counsel. R.D. at 8. The Bank's board and counsel first
learned of Respondents' income tax withholding issue in early 1998,
months after Respondents had stopped their state and federal income tax
withholding. R.D. FOF ¶¶ 163, 180; Tr. Vol. 2 at 170, 247; Tr. Vol.
3 at 15. After that, the Bank's counsel, Gary Findley
("Findley"), discussed the issue with Shollenburg and H. Hagy who
falsely informed him that all appropriate documents had been submitted
to the IRS and the California Franchise Tax Board. R.D. FOF ¶ 59.
Based on this incorrect premise, Findley advised the Bank's board at a
March 28, 1998, board meeting that the Bank should be protected from
liability. R.D. at 17, n. 3; R.D. FOF ¶ 187; FDIC Exhs. 40, 85; Tr.
Vol. 2 at 177. At the same meeting, however, Findley advised the
Bank's board that the Bank must withhold for Social Security taxes.
R.D. FOF ¶ 188; FDIC Exh. 85; Tr. Vol. 2 at 179.
Meanwhile, the issue of withholding Social Security taxes did not come
to the attention of Paychex, the Bank's payroll processor, until the
last quarter of 1998. R.D. FOF ¶ 150; FDIC Exh. 90. In November 1998,
H. Hagy, as CFO of the Bank, wrote letters to Paychex directing it to
stop Social Security withholding from the compensation of Shollenburg,
Melton and herself. R.D. FOF ¶ 151; FDIC Exh. 90. Paychex, however,
refused to comply with H. Hagy's instructions unless the Bank agreed
to hold Paychex harmless from possible liability for its role in the
plan. R.D. at 8; R.D. FOF ¶¶ 44, 70, 98, 157; FDIC Exhs. 90, 93.
In response, CFO Hagy, without prior approval from the Bank's board
and without consulting the Bank's counsel, provided to Paychex in
November and December 1998 letters of indemnification. R.D. at 8; R.D.
FOF ¶¶ 155156. In so doing, she violated statutory and regulatory
provisions restricting the Bank's authority to issue indemnification
agreements. R.D. at 8; R.D. FOF ¶¶ 446448. After receiving the
indemnification from H. Hagy, Paychex stopped withholding Social
Security taxes from the salary of Shollenburg, H. Hagy, Melton and
Knudson.
2. The Auditors' Advice
Respondents also disregarded the advice of the Bank's outside
auditor, the public accounting firm of Varinek, Trine, Day and Company
("VTD"), which by 1998 had served as the Bank's outside auditor
for at least ten years. R.D. at 9; R.D. FOF ¶¶ 207, 210. Karen Comer
("Comer"), a certified public accountant who served as VTD's
engagement partner to the Bank for many years, dealt principally with
CFO Hagy at the Bank. R.D. at 9; R.D. FOF ¶¶ 210, 214; Tr. Vol. 1 at
37, 40. Comer first learned of Respondents' position on tax issues in
the fall of 1998, when she was in contact with CFO Hagy regarding a
routine Bank Secrecy Act review of the Bank. R.D. FOF ¶¶ 216, 217;
Tr. Vol. 1 at 40. At that point, H. Hagy gave Comer a letter informing
her of Respondents' position on the tax issues and requested VTD's
response. R.D. at 9; R.D. FOF ¶ 217. H. Hagy did not, at that time,
inform Comer that Respondents had already stopped withholding taxes
from their Bank compensation. R.D. FOF ¶ 220; Tr. Vol. 1 at 4142.
Initially, and after discussing the subject with her firm's partners
and consulting with the firm's tax committee, Comer advised H. Hagy
that the firm disagreed with Respondents' position and that such
activity could result in legal action against H. Hagy and the Bank.
R.D. at 9; R.D. FOF ¶¶ 218, 221; Tr. Vol. 1 at 4044. H. Hagy,
however, declined to communicate Comer's message to
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the Bank's board.
R.D. at 9; R.D. FOF ¶ 222; Tr. Vol. 12021.
Comer was therefore surprised to learn, during an audit that VTD
conducted at the Bank beginning in late December 1998, that the Bank
had already stopped withholding for the Respondents. R.D. at 10; R.D.
FOF ¶¶ 228229; Tr. Vol. 1 at 4849. Comer informed her VTD
partners of her discovery, and they concluded that the Bank had acted
illegally in not withholding the taxes on behalf of the Respondents.
R.D. at 10; R.D. FOF ¶¶ 232233; Tr. Vol. 1 at 5052.
VTD, citing authoritative references, notified the Bank in writing of
its conclusions that the Bank was liable for payment of income taxes
required to be withheld from employee wages regardless of whether or
not it had collected the tax from the employee, that the Bank was
required to forward employee W-4 forms to the IRS, that altered W-4
forms were invalid, and that the Bank was liable for payment of
employees' Social Security taxes regardless of whether or not it had
collected the taxes from the employees. R.D. at 10; R.D. FOF ¶ 239;
Tr. Vol. 1 at 5354; FDIC Exh. 71.
Subsequently, on March 9, 1999, Comer and another VTD partner, David
Dayton ("Dayton"), met with Shollenburg and H. Hagy to discuss
the firm's findings. R.D. at 10; R.D. FOF ¶ 238; Tr. Vol. 1 at 53;
Tr. Vol. 2 at 49. Comer and Dayton informed H. Hagy that as CFO she had
not properly filed the Bank's payroll returns, including transmittal
to the IRS of W-4 forms for each of the Respondents. They further
advised H. Hagy and Shollenburg that the Bank had improperly reported a
significant portion of its payroll as exempt and did not properly
withhold a significant amount of income taxes from the Bank officers.
R.D. FOF ¶¶ 243, 248; Tr. Vol. 1 at 56, 58; Tr. Vol. 2 at 5254;
FDIC Exh. 71. Comer and Dayton also emphasized to H. Hagy and
Shollenburg that these tax issues were not a matter of Respondents'
individual rights but instead were part of their obligations as
officers of the Bank. R.D. FOF ¶¶ 249250; Tr. Vol. 1 at 58; Tr.
Vol. 2 at 5354.
The auditors also advised that the Bank should promptly file amended
payroll tax returns reflecting the income and Social Security taxes
that had originally been excluded. VTD further recommended that because
the existing W-4 forms had been altered, Respondents should, if they
wished to claim tax-exempt status, resubmit valid W-4 forms. R.D. at
11; R.D. FOF ¶¶ 244246; Tr. Vol. 1 at 5657, 6061; Tr. Vol. 2
at 52.
Shollenburg and H. Hagy, however, rejected VTD's advice by insisting
that the laws cited by the firm did not apply to them. R.D. FOF
¶¶ 247, 251; Tr. Vol. 1 at 5759; Tr. Vol. 2 at 53, 55. Also,
despite Shollenburg's statement to the auditors that he had
indemnified the Bank and escrowed sufficient funds to reimburse the
Bank should a tax problem arise, all of Respondents' written
indemnifications were in fact dated March 26, 1999after Shollenburg
had met with the auditors and after VTD had notified him in writing of
its view that his tax withholding conduct was illegal. R.D. FOF
¶¶ 196, 281282; Tr. Vol. 2 at 65; FDIC Exhs. 9, 15, 21, 25, 31.
Moreover, even though Respondents supplied the Bank with written
indemnifications, they never set up accounts with the Bank to cover
potential liabilities because according to H. Hagy, the Bank never
mandated that Respondents do so. R.D. FOF ¶ 198; Tr. Vol. 5 at 170.
Respondents further ignored a follow-up letter from VTD reiterating the
firm's position and recommending that the Bank seek further advice
from a tax expert in order to minimize potential liability on the part
of the Bank for back taxes. R.D. at 11; R.D. FOF ¶ 255; FDIC Exh. 72.
VTD also notified the Bank in writing that the Bank should disclose in
its financial statements the potential liability associated with its
failure to withhold taxes on behalf of Respondents. R.D. at 11; R.D.
FOF ¶ 252; Tr. Vol. 1 at 6162; Tr. Vol. 2 at 4950; FDIC Exh. 73.
On March 15, 1999, Shollenburg sent a letter to VTD stating in essence
that Respondents' rights to avoid paying taxes were paramount to the
Bank's legal obligations. He concluded the correspondence by noting
that: "You might be entering an arena where you do not want to
be." R.D. at 12; R.D. FOF ¶¶ 268272; Tr. Vol. 1 at 6364; FDIC
Exh. 75. Although Comer and Dayton construed Shollenburg's March 15,
1999, letter as a threat, they were not deterred. R.D. at 12; R.D. FOF
¶ 272; Tr. Vol. 1 at 69; Tr. Vol. 2 at 59. Instead, VTD, in its
response to Shollenburg, continued to reiterate its position that the
Bank's conduct was illegal and requested a meeting with the Bank's
audit committee.
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R.D. at 12; R.D. FOF ¶¶ 273276; Tr. Vol. 1 at
6971; Tr. Vol. 2 at 6062; FDIC Exh. 76.
At an April 26, 1999, meeting with the Bank's audit committee, Comer
and Dayton presented both orally and in a written memorandum VTD's
findings and recommendations. VTD notified the Bank's board of its
view that the Bank had acted illegally in 1) incorrectly reporting
taxable wages as exempt from Social Security taxes; 2) discontinuing to
withhold federal and state income taxes from employees' wages; 3)
accepting invalid W-4 forms from certain employees; 4) neglecting to
forward to the IRS W-4 forms claiming exempt status; and 5) agreeing to
indemnify Paychex from any liability relating to Respondents' tax
avoidance activity. VTD again advised the Bank to file amended payroll
tax returns, submit valid W-4's to the IRS and promptly pay all back
taxes and penalties. VTD also advised that the Bank retain an outside
tax consultant to help minimize its liability and future review by
federal and state authorities. The auditors further advised the audit
committee that the Bank should disclose its potential liability in its
financial statements. R.D. at 13; R.D. FOF ¶¶ 284289; Tr. Vol. 1
at 7677, 80; Tr. Vol. 2 at 6970; FDIC Exhs. 56, 77.
As a result of what it learned from the auditors, the Bank's board
decided to include in the Bank's financial statements a footnote on
potential liability for unpaid taxes. R.D. at 13; R.D. FOF ¶¶ 316,
318; Tr. Vol. 2 at 76; FDIC Exhs. 56, 59.5 The Bank's
board also agreed to hire attorney Barry Guterman ("Guterman") as
a tax consultant but decided not to take any further action to correct
the tax problems until completion of Guterman's investigation. R.D. at
14; R.D. FOF ¶¶ 316317; Tr. Vol. 2 at 76; FDIC Exhs. 56, 59.
On June 1, 1999, about a month after the meeting with the Bank board's
audit committee, VTD resigned as the Bank's auditor. VTD gave up the
Bank's business based on its conclusion that the Bank, in failing to
implement VTD's recommendations, was not meeting its corporate
responsibilities. R.D. at 14; R.D. FOF ¶¶ 322, 324325; Tr. Vol. 1
at 8587; FDIC Exh. 80.
3. The Tax Expert's Findings and Recommendations
Guterman, who was retained by the Bank on June 7, 1999,
madeafter a thorough investigationvirtually the same findings and
recommendations as VTD had. R.D. at 14; R.D. FOF ¶¶ 336338.
Guterman concluded that the Bank had no legal basis to stop withholding
income tax from Respondents' compensation because the W-4 forms
submitted by Respondents were altered and/or not signed under the
penalty of perjury. As such, the W-4 forms submitted by Respondents
were invalid. R.D. FOF ¶¶ 346350. According to H. Hagy,
Respondents intentionally submitted altered W-4s based apparently on
instruction in the Meredith booklet. R.D. at 15; R.D. FOF
¶¶ 172174; Tr. Vol. 5 at 40, 51, 145. Guterman stated that the W-4
forms submitted by Respondents should not have been accepted by CFO
Hagy and CEO Shollenburg on behalf of the Bank. R.D. FOF ¶ 347; Tr.
Vol. 3 at 14951; FDIC Exh. 90. Guterman also determined that the W-8
forms and Statements of Citizenship submitted by Respondents did not
constitute valid exemption certificates because they did not include
the requisite certifications as to income tax liabilities. R.D. FOF
¶ 348; FDIC Exh. 90; Tr. Vol. 3 at 149150. He similarly concluded
that Respondents Shollenburg, H. Hagy, Melton, and Knudson had no legal
basis for failing to withhold Social Security tax from their
compensation. R.D. FOF ¶¶ 357369; FDIC Exh. 90.
Guterman presented his preliminary findings and recommendations to the
Bank's board at a meeting on July 26, 1999. R.D. FOF ¶¶ 371372;
Tr. Vol. 3 at 133134, 137138. He found that the Bank was liable for
federal and state income taxes and both Respondents' and its own
portion of Social Security taxes that it had not collected from
Respondents. Guterman concluded that the Bank owed in excess of
$150,000 for back income and Social Security taxes. R.D. FOF
¶¶ 351369; FDIC Exh. 90. He also found that the Bank faced civil
and criminal exposure as a result of Respondents' tax withhold
conduct. R.D. FOF ¶ 370; Tr. Vol. 3 at 158159; FDIC Exh. 90.
At the July 26 meeting, however, Respondents
5 The auditors felt that it was not necessary
to accrue actual liability at that point in part because they believed,
based on Shollenburg's representation to them, that Respondents had
provided indemnification to the Bank. R.D. FOF ¶ 316, 2831; Tr. Vol.
2 at 6567.
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continued to assert that
they were not subject to either income tax or Social Security
withholdings. R.D. FOF ¶¶ 373; Tr. Vol. 3 at 135136; FDIC Exhs.
59, 90. During the meeting, Guterman advised Paychex to resume
withholding Social Security taxes for Shollenburg, H. Hagy, Melton, and
Knudson. R.D. FOF ¶ 376; Tr. Vol. 3. The Bank's board advised
Respondents that they should submit valid W-4 forms if they wished to
continue to claim exemption from income tax withholding. R.D. FOF
¶ 377; Tr. Vol. 3 at 138; FDIC Exh. 90. The following day, each of
the Respondents submitted new unaltered W-4 forms signed under the
penalty of perjury, in which they continued to assert that they were
exempt from income tax withholding. R.D. FOF ¶¶ 378379; Tr. Vol. 3
at 144146.
One month later, on August 23, 1999, after he had completed a draft of
his preliminary report, Guterman met again with the Bank's board to
address the Bank's and Respondents' liability for payment of the back
taxes. R.D. FOF ¶¶ 386389; FDIC Exh. 62. At the same meeting,
Shollenburg and H. Hagy continued to insist that they were exempt from
income tax withholdings for the first two quarters of 1999. R.D. FOF
¶¶ 390; Tr. Vol. 3 at 147148; FDIC Exhs. 62, 90.
The Bank authorized Guterman to assist in correcting the situation. On
September 8, 1999, the Bank sent a memorandum each to Shollenburg, H.
Hagy, Melton, and Knudson seeking reimbursement for back Social
Security taxes. Respondents Shollenburg, H. Hagy, and Melton each made
payment to the Bank for some back Social Security taxes, but each paid
less than the amount that Paychex had determined they owed. Knudson did
not reimburse the Bank at all. R.D. FOF ¶¶ 393398; Tr. Vol. 3 at
159, 174175; FDIC Exhs. 100102, 107. On September 29, 1999,
Guterman attended a meeting of the Bank's board held at the California
Department of Financial Institutions, at which point he learned from
FDIC examiners that the Bank had paid automobile allowances, consulting
fees and/or bonuses to certain of the Respondents for which taxes had
not properly been withheld. R.D. at 23; R.D. FOF ¶¶ 404; FDIC Exhs.
65, 90. Guterman presented his findings in a final report to the
Bank's board, dated October 11, 1999. R.D. at 14; R.D. FOF ¶ 339;
FDIC Exh. 90.
As a result of Guterman's recommendations, the Bank issued corrected
W-2 forms for each of the Respondents. R.D. FOF ¶¶ 414419; Tr.
Vol. 3 at 168173; FDIC Exh. 106. On October 15, 1999, Guterman sent a
demand letter to each of the Respondents seeking reimbursement of back
taxes owed or, in the case of 1998 income tax liabilities,
certification of payment of tax liabilities. R.D. FOF ¶ 420; FDIC
Exhs. 107111; Tr. Vol. 3 at 173. None of the Respondents complied
with Guterman's directive. R.D. FOF ¶¶ 421430; Tr. Vol. 3 at
174179. On November 2, 1999, the Bank paid a total in excess of
$200,000 to various taxing authorities representing the amount
Respondents owed for back income and Social Security taxes as well as
the Bank's employer share of Social Security taxes. R.D. FOF ¶ 431;
Tr. Vol. 3 at 17778; FDIC Exh. 112. Guterman's legal fees to the
Bank for his services in connection with Respondents' tax avoidance
activity amounted to $41,050. R.D. FOF ¶ 436; Tr. Vol. 3 at 193.
4. The FDIC Examination
On July 19, 1999, the FDIC commenced a safety and soundness
examination of the Bank as of March 31, 1999. R.D. FOF ¶ 438; Tr.
Vol. 4 at 1314; FDIC Exh. 115. During the course of the examination,
the FDIC examiners discovered various violations of tax and banking law
and regulations. The FDIC determined that Respondents were responsible
for the Bank's tax law violations. In its 1999 Report of Examination,
the FDIC cited the Bank for these violations and reported income tax
liability as a contingent liability in the amount of $131,000. The FDIC
gave the Bank an overall unsatisfactory rating that resulted in the
Bank being considered a problem Bank. R.D. FOF ¶¶ 438448; Tr. Vol.
4 at 1318, 2429, 3362, 217219; Tr. Vol. 5 at 181182; FDIC
Exh. 115. At a September 29, 1999, exit meeting, FDIC Assistant
Regional Director J. George Doerr informed the Bank's board that the
FDIC was seriously contemplating permanent removal actions against the
five Respondents. R.D. FOF ¶ 451; FDIC Exh. 65.
B. Legal Analysis: Section 8(e) Prohibitions Are Warranted
As noted in the Recommended Decision, the Boardto meet its
burden in a prohibition actionmust show that Respondents engaged in
prohibited conduct (misconduct), the effect of which was to cause the
Bank to
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suffer financial loss or damage, to prejudice or potentially
prejudice the Bank's depositors, or to provide financial gain or other
benefit to the Respondents (effects). The Board must also demonstrate
that such misconduct evidences personal dishonesty or a willful or
continuing disregard for the safety and soundness of the Bank
(culpability). 12 U.S.C. §1818(e)(1); R.D. at 21; See In the
Matter of Ramon M. Candelaria, 1 FDIC Enforcement Decisions and
Orders, ¶ 5242, A-2837, A-2839 (1997), 1997 WL 211341, at *3;
In the Matter of Leuthe, 1 FDIC Enforcement Decisions and
Orders, ¶ 5249, A-2915, A-29612963 (1998), 1998 WL 438323, at *11,
aff'd, 194 F.3d 174 (D.C. Cir. 1999). As discussed below,
the Board finds that the activities of Respondents during the pertinent
time period overwhelmingly satisfy the three standards necessary to
impose a prohibition.
[.2] 1. Misconduct
The record overwhelmingly establishes Respondents' misconduct:
multiple violations of the IRC, the FDI Act and Regulations, and unsafe
and unsound practices and breaches of fiduciary duty. Tax misconduct is
an appropriate basis for enforcement actions brought under the FDI Act.
See, e.g., In the Matter of Edward Towe and Thomas E. Towe,
83 Fed. Res. Bull. 849 (1997), 1997 WL 689309 (Respondents, to avoid
IRS wage levies, disguised directors' fees as travel expenses,
subsistence or consulting fees); In the Matter of Anonymous,
1 FDIC Enforcement Decisions and Orders ¶ 5082 (1987), 1987 WL 451206
(Respondent's overly aggressive tax planning which harmed the bank and
the public served as the basis for his removal); In the Matter of
Thomas K. Benshop, 2 FDIC Enforcement Decisions and Orders
¶ 5192 (1993), 1993 WL 853264 (Improper income tax payments were part
of the misconduct in the case); In the Matter of Stanley R.
Hendrickson, FDIC Enforcement Decisions and Orders ¶ 5235
(Transfer Binder) (1996), 1996 WL 496757, aff'd, 113 F.3d
98 (7th Cir. 1997) (Respondent's plea of guilty to willfully failing
to file a currency transaction report required by the Internal Revenue
Code is sufficient basis for section 8(e) action).
As described above, during the period August 1997 through July
1999, the Respondents took multiple steps to stop withholding income
taxes from their Bank compensation. As a result of this conduct, the
Respondents caused, participated in, and/or aided or abetted violations
of U.S. tax laws. Section 3402 of the IRC requires that every employer
making payment of wages shall deduct and withhold taxes from such
wages. 26 U.S.C. §3402. Section 3403 of the IRC further provides
that the employer shall be liable for the payment of the amount of
income tax required to be deducted and withheld. 26 U.S.C. §3403.
R.D. COL ¶ 6.
Under circumstances where the employer incurred no tax liability the
preceding year and expects that he will incur none in the current tax
year, the IRC permits an employee to file a Form W-4 or in Lieu of Form
W-4 claiming complete exemption from income tax withholding.
See 26 U.S.C. §3402(n). A valid withholding certificate
must include the requisite certifications contained in section 3402(n)
of the IRC and cannot contain alterations or unauthorized additions. As
the auditors and Guterman testified, the W-4 forms that were submitted
by Respondents were invalid because they were altered and/or not signed
under penalty of perjury. In each case, Respondents, using forms
provided in the Meredith booklet, either deleted a jurat or added
language to it. In every case, Respondents added the phrase "without
prejudice, UCC-1-207" to the forms. R.D. FOF ¶¶ 172, 346; Tr.
Vol. 1 at 57; Tr. Vol. 2 at 110; Tr. Vol. 3 at 148149, 221222; Tr.
Vol. 5 at 147148; FDIC Exhs. 90, 118.
Likewise, as Guterman stated at the hearing, the other documents
included in the first package of withholding documents submitted by
Respondents to the Bankthe Citizenship Affidavits, Forms W-8 and
Forms 590were not valid exemption certificates because they did not
contain the requisite certifications as to income tax liabilities. The
same was true for the Statements of Citizenship and Residence included
in the second set of documents filed by Respondents, in which they
reversed their position regarding citizenship and residency. R.D. FOF
¶ 348; Tr. Vol. 3 at 149150; FDIC Exh. 90.
As a result, CEO Shollenburg and CFO Hagy acted improperly in accepting
the invalid tax forms on behalf of the Bank. R.D. FOF ¶ 347; Tr. Vol.
3 at 149150; FDIC Exh. 90. Instead, the Bank, upon receipt of the
invalid documents, should have advised each of the Respondents that it
could not accept them and provided them with an opportunity to submit a
valid withholding exemption
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certificate. Based on the foregoing,
Respondents had no legitimate basis for causing the Bank to fail to
withhold income taxes from their compensation and, therefore, caused
the Bank to violate sections 3402 and 3403 of the IRC. R.D. FOF
¶¶ 349350; R.D. COL ¶¶ 67; Tr. Vol. 3 at 151153.
Respondents also committed violations of law with respect to
withholding of Social Security taxes. R.D. at 22; R.D. COL ¶¶ 67.
The Federal Insurance Contributions Act imposes a tax on employees and
employers which is measured by the amount of wages paid with respect to
employment. Section 3102 of the IRC, 26 U.S.C. §3102,
provides that the employer shall collect taxes imposed by section
3101(a) (i.e., the old age, survivors, and disability
component of FICA or Social Security taxes), 26 U.S.C.
§3101(a), and section 3101(b) (i.e., the hospital
insurance (Medicare) component of FICA or Social Security taxes), 26
U.S.C. §3101(b), by deducting the amount of taxes from
wages as and when paid. The employer is liable for the employee portion
of the tax (in addition to the employer portion of the tax) regardless
of whether or not the tax is collected from the employee.
As discussed above, between December 1997 and May 1998, each of the
Respondents, except for R. Hagy, began instructing the Bank to stop
withholding Social Security and Medicare taxes from their compensation
at the Bank based on their claim that payment of Social Security tax is
voluntary. Contrary to Respondents' contentions, however, it is well
established that Social Security taxes are not voluntary and are not
dependent upon employees' receipt of benefits under Social Security.
See United States v. Lee, 455 U.S. 252, 25859 (1982)
("[M]andatory participation is indispensable to the fiscal
vitality of the social security system"). R.D. FOF ¶¶ 357359;
Tr. Vol. 3 at 154158. As a result of the conduct of Respondents
Shollenburg, H. Hagy, Melton and Knudson, the Bank was liable for
Social Security taxes which it did not collect from them as well as for
the employer share of these taxes. R.D. FOF ¶¶ 362369; R.D. COL
¶¶ 67; Tr. Vol. 3 at 158; FDIC Exh. 90.
In addition to the violations discussed above, each of the Respondents,
except for Knudson, caused the Bank to fail to report income and
properly withhold income and Social Security taxes from approximately
$34,400 in automobile allowances, $50,000 in bonuses, and $11,000 in
Year 2000 compensation received from the Bank in 1998 and/or 1999. R.D.
FOF ¶¶ 404411; FDIC Exhs. 65, 90, 104105.
By indemnifying Paychex, Respondents also committed violations of
section 24 of the FDI Act and its implementing regulations, Part 362 of
the FDIC's Rules, 12 C.F.R. §362. Section 24 provides that an
insured State bank may not, without the consent of the FDIC, engage in
any activity that is not permissible for a national bank. 12 U.S.C.
§1831a. Under the rules for national banks, a letter of
indemnification may be issued only under circumstances where a) the
bank has a substantial interest in the performance of the transaction;
or b) the transaction is for the benefit of a customer and the bank
obtains a segregated deposit from the customer sufficient to cover the
bank's total liability. 12 C.F.R. §7.1017. When H. Hagy caused the
Bank to provide indemnification to Paychex for the benefit of herself
and Shollenburg, Melton, and Knudson, neither of the threshold
requirements of 12 C.F.R. §7.1017 had been met. And because the Bank
never requested or received the FDIC's consent to indemnify Paychex,
the issuance of the indemnification letter constituted a violation of
section 24 of the FDI Act and section 362 of the FDIC's Rules. R.D. at
8; R.D. FOF ¶¶ 155, 156.
The Board also finds that Respondents' activities in connection with
their tax avoidance plan, including their violations of provisions of
the IRC and the FDI Act, demonstrated unsafe or unsound practices
contrary to prudent practice which exposed the Bank to an abnormal risk
of loss or harm. See Landry v. FDIC, 204 F.3d 1125, 1138
(D.C. Cir. 2000), cert. denied, 531 U.S. 924 (2000);
Van Dyke v. Board of Governors of the Fed. Reserve Sys., 876
F.2d 1377, 1380 (8th Cir. 1989). The failure to withhold income and
Social Security taxes, as well as granting an unauthorized
indemnification, is an unsafe and unsound practice. See, e.g.,
Seidman v. OTS, 37 F.3d 911, 928 (3d. Cir. 1994) ("Obliging
one's institution to transactions that might be illegal is not in
accord with `generally accepted standards of prudent
operation'").
Moreover, as the Ninth Circuit observed in FDIC v. Hoffman,
self-dealing breaches of fiduciary duty by bank officials are
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inherently unsafe and unsound practices. 912 F.2d 1172, 1174 (9th Cir.
1990). In this case, Respondents, by implementing their tax protesting
plan, clearly put their own interests ahead of the interest of the
Bank. Such conduct is a classic example of self-dealing. Id., see
also First National Bank of Lamarque, 610 F.2d 1258, 1265 (5th
Cir. 1980); Independent Banks Ass'n of America v. Heimann,
613 F.2d 1164, 1168 (D.C. Cir. 1979), cert. denied, 449 U.S.
823 (1980).
In addition, Respondents' tax withholding misconduct and submission of
the unauthorized indemnification letter constitute a breach of
fiduciary duty in that, as officers of the Bank, they did not fulfill
their obligation to see that the Bank operated in compliance with state
and federal law. See, In the Matter of Ronald J. Grubb, FDIC
Enforcement Decisions and Orders, ¶ 5181, A-2006, A-2008 (1992), 1992
WL 813163, at *28, aff'd on other grounds. Grubb v. FDIC,
34 F.3d 956 (10th Cir. 1994). Significantly, H. Hagythe one
Respondent who offered testimonial evidence in this casetold Guterman
that as an officer she did not adopt the position of the Respondents,
including herself, that their Bank compensation did not constitute
"wages" and "gross income" under the IRC. R.D. FOF
¶ 343; Tr. Vol. 3 at 223225; Tr. Vol. 5 at 136137; FDIC Exh. 96.
As noted in a previous ALJ opinion endorsed by the Board, "given the
paramount importance of a credible and safe and sound banking system,
there can be no question that officers and directors of banks are held
to the very highest standard of fiduciary duty." In the Matter
of Robert Stoller, 2 FDIC Enforcement Decisions and Orders
§5174, A-1880 (1992), 1991 WL 789616, at *7. If Respondents had been
diligent in carrying out their responsibilities, they would have, at a
minimum, consulted with the Bank's board before they undertook their
tax avoidance activities. Instead, their conduct suggests that they
deliberately withheld critical information and, in some instances,
intentionally misled the Bank's board, counsel and auditors. R.D. at
8; R.D. FOF ¶¶ 59, 281282; Tr. Vol. 2 at 65; FDIC Exhs. 9, 15, 21,
25, 31. In fact, the Bank's board and counsel did not learn about some
of Respondents' activity until the Bank's auditors met with the
board's audit committee in April 1999. R.D. FOF ¶¶ 306309; Tr.
Vol. 2 at 187189. Other IRC violations were not brought to the Bank
board's attention until the FDIC examiners did so in September 1999.
R.D. FOF ¶¶ 438448; Tr. Vol. 4 at 1318, 2429, 3362,
217219; Tr. Vol. 5 at 181182; FDIC Exh. 115.
[.3] 2. Effects
Besides demonstrating misconduct, the record also establishes
satisfaction of the "effects" test. As a direct result of
Respondents' activities, the Bank had to pay $152,799.85for which it
has not been reimbursedto satisfy the tax responsibilities of
Respondents for 1998 and 1999. R.D. at 24; R.D. FOF ¶ 432. In
addition, the Bank, in order to bring itself back into compliance with
the tax laws, hired Guterman and paid him fees in excess of $40,000.
R.D. ¶ 436; Tr. Vol. 3 at 193. It is also likely that the Bank
incurred additional auditor fees as a direct result of Respondents'
tax avoidance activity. R.D. at 24; FDIC Exh. 121. These types of
expenditure are recognized as losses for purposes of section 8(e).
See, In the Matter of Billy Proffitt, FDIC Enf. Dec.
(Transfer Binder) ¶ 5251, A-2977, n. 11 (1998), 1998 WL 850087, at
*10, petition for review denied, Proffitt v. FDIC, 200 F.3d
855 (D.C. Cir. 2000).
By the same token, Respondents' conduct benefited them financially in
that they have not fully reimbursed the Bank for their tax liabilities.
R.D. FOF ¶¶ 394398, 420. Even though Respondents may ultimately
have to pay their back taxes to the IRS and the California Franchise
Tax Board, they have had the use of these funds in the interim and, as
such, have reaped financial gain from their misconduct. See
Candelaria, 1 FDIC Enforcement Decisions and Orders, ¶ 5242,
A-2847 (1997), 1996 WL 880606, at *7 (even though respondent reimbursed
the bank for entire amount of two straw loans, ALJ found that he had
nonetheless received financial gain as a result of misconduct).
In addition to financial loss, the Bank suffered reputational damage as
the result of Respondents' misconduct. As one of the auditors
observed, a bank must have a good business reputation to maintain
customer confidence. R.D. FOF ¶ 329; Tr. Vol. 2 at 15051. The
Bank's directors also became concerned for the Bank's reputation as
word of Respondents' tax withholding issues filtered into the
community. R.D. ¶¶ 164169; Tr. Vol. 2 at 247248, 255256; Tr.
Vol. 3 at 2526. As the Board has noted in the past, loss of
confidence by an institution's board of directors and its depositors
has an overall
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effect contrary and prejudicial to the interest of
depositors. In the Matter of James G. Welk, 2 FDIC
Enforcement Decisions and Orders ¶ 5186, A-2105 (1992), 1992 WL
813217, at *13.
[.4] 3. Culpability
The term "personal dishonesty" as it is used in 12 U.S.C.
§1818(e)(1) has been held to mean "a disposition to lie, cheat,
defraud, misrepresent, or deceive. It also includes a lack of
straightforwardness and a lack of integrity." In the Matter of
Allan Hutensky, 1 FDIC Enforcement Decisions and Orders, ¶ 5224,
A-2566 (1995), 1994 WL 812351, at *26, aff'd. 82 F.3d 1234
(2nd Cir. 1996). The Board finds the record laden with instances of
Respondents' deceitful behavior. For example, Respondents stopped the
withholding of their income and Social Security taxes without notifying
the Bank's board or its counsel. R.D. at 8; R.D. FOF ¶¶ 163, 180.
They further misled the Bank's board and counsel into believing that
they had filed all the appropriate forms with the IRS. R.D. FOF
¶ 182; Tr. Vol. 2 at 176, 204. Moreover, with neither authority from
nor notice to the Bank's board or the FDIC, H. Hagy granted
indemnification to Paychex. R.D. at 8; R.D. FOF ¶¶ 155156.
Respondents disregarded the Bank's auditor's advice to discontinue
their tax avoidance activity and failed to notify the Bank's board of
the auditor's advice. R.D. at 9; R.D. FOF ¶¶ 218, 221; Tr. Vol. 1
at 4044. In connection with their submission to the Bank of tax
withholding certificates, they deliberately provided false information
and they purposefully declined to submit their W-4 forms to the IRS
because the IRS, in all likelihood, would have rejected their forms
(and, as a result, throw a roadblock in their plans). R.D. FOF
¶¶ 297, 344; Tr. Vol. 1 at 78; Tr. Vol. 2 at 125; Tr. Vol. 3 at 124.
Shollenburg also misrepresented to the Bank's auditors that he had set
aside funds to reimburse the Bank when, in fact, he had not done so.
R.D. FOF ¶¶ 281282; Tr. Vol. 2 at 65; FDIC Exhs. 9, 15, 21, 25,
and 31.
The Board finds that Respondents' conduct exemplifies the "willful
or continuing disregard" standard. Although proof of either willful
or continuing disregard is enough to meet the culpability threshold for
purposes of section 8(e) of the FDI Act, in this case Respondents'
conduct was sufficiently egregious to meet both tests. See, e.g.,
Brickner v. FDIC, 747 F.2d 1198, 12021203 (8th Cir. 1984).
("`Willful disregard' refers to that conduct which is
practiced deliberately with full knowledge of the facts and risks, and
which potentially exposes a bank to abnormal risk of loss or harm.")
Respondents, knowing very well and being fully forewarned that their
activities were illegal, "turned a blind eye" to the Bank's
interests so that they could pursue their own agenda. See
Cavallari v. OCC, 57 F.3d, 137, 145 (2nd Cir. 1995).
"Continuing disregard" refers to that conduct which is
voluntarily engaged in over time, with heedless indifference to the
possible consequences. Grubb v. FDIC, 34 F.3d 956, 962 (10th
Cir. 1994); In the Matter of Henry P. Massey, FDIC
Enforcement Decisions and Orders ¶ 5204, A-2330 (1993), 1993 WL
853749, at *21; In the Matter of Constance C. Cirino, 1 FDIC
Enforcement Decisions and Orders ¶ 5261, A-3166 (2000), 2000 WL
1131919, at *5354. As shown, over a two-year period, Respondents
knowingly violated tax laws and took steps to conceal their behavior.
They ignored counsel's advice and disregarded the Bank auditors' and
Guterman's repeated advice and warnings that their tax avoidance
activity was illegal. R.D. FOF ¶¶ 218, 221222, 247251, 255,
373390. See, e.g., Candelaria ¶ 5242 at A-2842, 1997 WL
211341, at *6 ("continuing disregard" found by two nominee loans
over a period of six months); In the Matter of Frank E.
Jameson, FDIC Enforcement Decisions and Orders, ¶ 5154A,
A-15411542.1, 1542.6 (1990), 1990 WL 711218, at *8.
aff'd. 931 F.2d 290 (5th Cir. 1991) (Two incidents of
falsifying loan records to hide self-serving transactions occurring
within three months held to be "continuing disregard").
Respondents, any one of them, had many opportunities during this period
to acknowledge that their positions were erroneous and accordingly to
limit the Bank's and their own liability. Instead, at each fork in the
road, Respondents, acting in their own self-interest and in complete
disregard for the Bank and its depositors, steadfastly maintained their
untenable positions.
C. Exceptions
1. Respondents' Exceptions
Respondents filed hundreds of objections challenging
virtually every factual finding and
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legal conclusion made by the
ALJ.6 At many points, because Respondents' objections
take the form of a rambling narrative, their key complaints are
difficult to discern. In any event, Respondents' objections, which can
be reasonably read to attack every aspect of this proceeding (including
the integrity of the ALJ) are by and large frivolous, repetitious, and,
in just about all instances, simply reargue merits of matters raised
below which were adequately addressed by the ALJ.
In many instances, in the course of their submission, Respondents argue
facts not in evidence or issues that are irrelevant to this proceeding.
They also attempt to dispute facts that were amply supported by
evidence at the hearing. For instance, Respondents attack Guterman's
credibility and his calculations of back taxes owed, yet they did not
offer their own expert to rebut his conclusions. See Resp.
Obj. ¶¶ 35356. Respondents also make bald assertions which flatly
contradict the law. For instance, although the FDI Act and implementing
regulations provide otherwise, Respondents assert that H. Hagy did not
need the Bank's board or FDIC permission to issue the indemnification
to Paychex. Resp. Obj. ¶ 448. Respondents also claimed, contrary to
the IRC, that they were not required to pay taxes on the automobile
allowances. Resp. Obj. ¶ 402. Respondents also brazenly argue that
their altered W-4 forms were not invalid because the IRS never notified
them as suchwhen in fact their altered forms were never submitted to
the IRS. Resp. Obj. ¶ 346. Although properly disposed of below, the
Board will address briefly what appear to be the primary themes of
Respondents' objections to this proceeding.
a. First Amendment Issue
Time and again throughout this proceeding, Respondents have
charged that the FDIC's initiation of these proceedings against them
constitutes an infringement of their rights under the First Amendment
of the U.S. Constitution. See, e.g., Resp. Obj. ¶¶ 16,
331, 357. In essence, they argue that their political beliefsin this
case the belief that they should not have to pay taxes and participate
in the U.S. Social Security systemsomehow trump their obligations to
comply with the tax laws and their fiduciary duties to the Bank. As the
ALJ made clear in his Recommended Decision, the courts have soundly
rejected this proposition. See, e.g., Coleman v.
Commissioner, 791 F.2d 68, 69 (7th Cir. 1986) ("The government
may not prohibit the holding of these beliefs, but it may penalize
people who act on them").
Respondents cite, in their objections, a long line of cases which
purportedly support their position. See, e.g., Brandenburg v.
Ohio, 395 U.S. 444 (1969); Hess v. Indiana, 414 U.S.
444 (1969); Resp. Obj. ¶ 16. Yet the cases citedwhich deal
primarily with the issue of the advocacy of illegal actsdo
not pertain to the present situation because in this case Respondents
did more than simply promote illegal conductthey engaged, and caused
the Bank to engage, in violations of federal law. As the ALJ observed,
it is Respondents' actionsnot their beliefsthat are the bases for
this proceeding. R.D. at 5.
b. Enforcement Counsel's Use of Respondents' Tax Records
Respondents have, throughout these proceedings, argued that the
FDIC illegally obtained various tax records from Respondents and that
such records cannot be used as evidence of Respondents' misconduct.
Resp. Obj. ¶ 16. Respondents' claim is, however, without merit
because as Enforcement Counsel has explained repeatedly throughout this
proceeding, the documents at issue, consisting primarily of W-4 and
related forms, were obtained by the FDIC during its 1999 examination of
the Bank. These documents were submitted by Respondents to the Bank and
remained in the Bank's files.
6 Respondents' Motion to Strike All
Allegations Citing Word for Word From Tax Documents of Respondents,
filed on December 23, 2002, is discussed and disposed of
infra at n. 8. On December 20, 2002, Respondents also filed
a Motion to Dismiss and/or Strike Parag. 81 of Notice For Lack of
Evidence. Paragraph 81 of the Notice charges that Respondents engaged
in unsafe and unsound banking practices involving recordkeeping and
Bank Secrecy Act ("BSA") violations when they opened "Pure
Trust" accounts that purported to shelter assets from seizure or
levy. Enforcement Counsel did not oppose this motion. The Board finds,
after a de novo review of the entire record in this case,
that the ALJ made passing reference to the pure trust and BSA issues in
his findings. R.D. FOF ¶¶ 175, 185, and noted that the FDIC in its
1999 Report of Examination cited the Bank for recordkeeping violations
regarding these issues. R.D. FOF ¶ 444. The Board further finds,
however, that it does not appear that Enforcement Counsel offered any
documentary or testimonial evidence in support of this charge. In any
event, the ALJ made no legal findings on this issue in his Recommended
Decision. In the absence of any party's exception to the ALJ's lack
of treatment or reliance on this issue in support of his Recommended
Decision, the Board deems the charge in Paragraph 81 of the Notice to
be no longer part of this case.
{{5-31-03 p.A-3265}}
Enforcement Counsel has established and Respondents have not disputed
that the records at issue were not obtained from the IRS. In fact, a
convincing argument might be made that some of the forms in question
are not, strictly speaking, "tax forms"; the altered W-4 forms,
for example, had not been submitted to the IRS at all during the
relevant time period. See, e.g., R.D. at 1618; R.D. FOF
¶¶ 146, 287, 290, 294, 295, 344, 345. In the Ninth Circuit, the law
is clear that only tax return information in the IRS's possession is
protected from disclosure by federal statute. 26 U.S.C.
§6103. See Stokwitz v. United States, 831 F.2d 893
(9th Cir. 1987). cert. denied. 485 U.S. 1033 (1988), where
the Ninth Circuit adopted the district court's holding that section
6103 "applied only to disclosure of information received by the IRS
from the taxpayer, and not obtained directly from the taxpayer and
others." 831 F.2d at 894.
In this case, FDIC Exhibits 115 and 1731 concerning Respondents'
taxes were obtained by the FDIC in the normal course of the FDIC's
business. Specifically, the records were obtained by the FDIC in
conjunction with its powers to examine federally-insured financial
institutions. Pursuant to section 10(b)(6) of the FDI Act, 12
U.S.C. §1820(b)(6), FDIC bank examiners have the power to
thoroughly examine any insured depository institution or its affiliate.
Based on the foregoing, these records, which were obtained during a
routine examination of the Bank, were properly admitted into evidence
by the ALJ. Tr. Vol. 2 at 22.7 Respondents' recurring
claim that Enforcement Counsel inappropriately used their tax records
is without merit.8
c. Selective Enforcement and Retaliation
Respondents argue in their objections and elsewhere during the
course of these proceedings that they have been singled out by the FDIC
in retaliation for their lawsuit filed in 2000 in federal district
court against certain FDIC employees in connection with their
termination from the Bank.9 Resp. Obj. ¶ 451. In this
case, Respondents' charge is flatly contradicted by the chronological
evidence. As FDIC Assistant Regional Director George Doerr testified
and as was confirmed in the Minutes of the Special Meeting of the Board
of Directors of the Bank, the FDIC, as of at least September 29, 1999,
was strongly considering instituting section 8(e) removal proceedings
against each of the five Respondents. R.D. FOF ¶ 451; Tr. Vol. 4 at
158159; FDIC Exh. 65. Respondents, however, were not terminated from
the Bank until October 1999 and did not file their lawsuit in federal
district court until February 8, 2000.
Using the same argument, Respondents also claim that the FDIC did not
initiate proceedings against other Bank employees who engaged in
similar tax avoidance activities. Resp. Obj. ¶¶ 243, 443, 279, 283.
Without regard to the merit of Respondents' contention, the Board
notes that agency decisions not to prosecute are judicially
unreviewable, see Heckler v. Chaney, 470 U.S. 821 (1985),
and Respondents have put forward no convincing reason why the Board
should second guess the judgment in this case. The FDIC has discretion
as to whether to initiate removal proceedings against
institution-affiliated parties of the banks. 12 U.S.C. §1818(e).
Each of the Respondents, regardless of their relative position within
the Bank, meets the definition of institution-affiliated parties. 12
U.S.C. §1813(u). R.D. COL ¶ 3.
Thus, the only issue for consideration in this regard is whether
Enforcement Counsel has established the necessary elements for removal
under section 8(e) as to each of the Respondents. As discussed above,
Enforcement Counsel has met its burden. See also Leuthe
¶ 5249, A-2923, 1998 WL 438323, at *7 ("[T]he decision to
proceed with this
7 In addition, because the Stokwitz
holding is equally applicable to documents obtained through civil
discovery (id. at 894), Respondents have no basis for
objecting to Enforcement Counsel's reliance on any of the tax records
received into evidence. See, e.g., R.D. FOF ¶ 437; Tr.
Vol. 3 at 270; FDIC Exh. 124.
8 The Board's decision finding that
Enforcement Counsel properly relied on and the ALJ properly admitted
into evidence Respondents' tax records also disposes of Respondents'
Motion to Strike All Allegations Citing Word for Word From Tax
Documents of Respondents which Respondents submitted on December 20,
2002.
9 On February 8, 2000, Respondents, in a case
styled Hazel Hagy et al. v. United States, et al., Nos. EDCV
00-0065-RT (RZx) and EDCV 00-0113-RT (RZx) (C.D. Cal.), filed in the
U.S. District Court for the Central District of California a
Bivens action alleging constitutional and common law tort
claims. In addition to the United States, the case names as defendants
the FDIC, the California Department of Financial Institutions, the Bank
and employees of all three entities. In essence, plaintiffs
(Respondents) claim that they were wrongfully terminated and otherwise
harmed because of their political beliefs regarding federal income
taxation. They seek back and front pay, compensatory and special
damages in the amount of $25 million and unspecified punitive
damages.
{{5-31-03 p.A-3266}}
matter was an appropriate exercise of the FDIC's
discretion and wholly consistent with the legal requirements for the
remedies applied.")
2. Enforcement Counsel's Exception
Enforcement Counsel raised one exception to the Recommended
Decision requesting that the Board reconsider the ALJ's dismissal of
Respondent R. Hagy from the proceedings. At a minimum, Enforcement
Counsel asks that, if the Board agrees that R. Hagy should be dismissed
from the proceedings, it be on a basis other than his inability to
testify. FDIC Except. at 12. Based on testimonial evidence supplied
by Respondent H. Hagy, the ALJ concluded that R. Hagy was too sick to
testify and should therefore be dismissed from the proceedings. R.D. at
2; Tr. Vol. 5 at 111. The Board notes that R. Hagy's misconduct is
well established in the record and, as such, his removal from the
industry would be fully justified. However, while R. Hagy's inability
to testify might not be reason alone to dismiss him from the
proceeding, it is clear that the ALJ rested his ruling on Hagy's
medical condition which, in the Board's view, is an acceptable basis
for dismissing him from the proceedings on the facts represented. For
this reason, the Board declines to disturb the ALJ's ruling on this
issue.
IV. CONCLUSION
After a thorough review of the record in this proceeding, and for
the reasons set forth above, the Board finds that an Order of
Prohibition is warranted against each of the four Respondents remaining
in the case.
In this case, the record plainly shows that, time and again,
Respondents ignored the law and the advice of the Bank's auditors and
attorneys with respect to their tax avoidance conduct. Instead, in a
clear breach of their fiduciary duties as officers and employees of the
Bank and in violation of federal law, the Respondents engaged over a
two-year period in an unlawful tax avoidance scheme which exposed the
Bank to serious risk.
As shown, during the course of their illegal activities, Respondents
single-mindedly and recklessly pursued their own quest for tax
"relief" at the expense of the Bank and in the face of dire
warnings from the auditors, the tax expert, and, finally, the FDIC
supervisors. In view of Respondents' continuing misconduct and, in
particular, their intransigence, the Board is persuaded that
Respondents should be permanently barred from the banking industry.
Based on the foregoing, the Board affirms the Recommended Decision of
the ALJ and adopts in full the findings of fact and conclusions of law
included therein and issues the following Orders implementing its
Decision.
ORDER TO DISMISS
Respondent Robert Hagy is hereby dismissed from this proceeding.
ORDER TO PROHIBIT
The Board of the FDIC, having considered the entire record of this
proceeding and finding that Respondents Dennis Shollenburg, Hazel Hagy,
Vicky Melton, and Brenda Knudson, formerly officers of the Bank,
violated laws and regulations, engaged in unsafe or unsound banking
practices, and breached their fiduciary duty, causing financial loss to
the Bank and resulting in personal benefit to themselves, and that
their actions involved personal dishonesty and willful and continuing
disregard for the safety and soundness of the Bank, it is hereby
ORDERED and DECREED that:
[.5] 1. Dennis Shollenburg, Hazel Hagy, Vicky Melton, and Brenda Knudson
shall not participate in any manner in any conduct of the affairs of
any insured depository institution, agency or organization enumerated
in section 8(e)(7)(A) of the FDI Act, 12 U.S.C. §1818(e)(7)(A),
without the prior written consent of the FDIC and the appropriate
federal financial institutions regulatory agency as that term is
defined in section 8(e)(7)(D) of the FDI Act, 12 U.S.C.
§1818(e)(7)(D).
[.6] 2. Dennis Shollenburg, Hazel Hagy, Vicky Melton, and Brenda Knudson
shall not solicit, procure, transfer, attempt to transfer, vote, or
attempt to vote, any proxy, consent or authorization with respect to
any voting rights in any financial institution, agency, or organization
enumerated in section 8(e)(7)(A) of the FDI Act, 12 U.S.C.
§1818(e)(7)(A), without the prior written consent of the FDIC and
the appropriate federal financial institutions regulatory agency, as
that term is defined in section 8(e)(7)(D) of the FDI Act, 12 U.S.C.
§1818(e)(7)(D).
3. Dennis Shollenburg, Hazel Hagy, Vicky Melton, and Brenda
Knudson shall not violate any voting agreement with respect to
{{10-31-03 p.A-3267}}
any insured depository institution, agency, or organization enumerated
in section 8(e)(7)(A) of the FDI Act, 12 U.S.C. §1818(e)(7)(A),
without the prior written consent of the FDIC and the appropriate
federal financial institutions regulatory agency, as that term is
defined in section 8(e)(7)(D) of the FDI Act, 12 U.S.C.
§1818(e)(7)(D).
4. Dennis Shollenburg, Hazel Hagy, Vicky Melton, and Brenda Knudson
shall not vote for a director, or serve or act as an
institution-affiliated party, as that term is defined in section 3(u)
of the FDI Act, 12 U.S.C. §1813(u), of any insured depository
institution, agency, or organization enumerated in section
8(e)(7)(A) of the FDI Act, 12 U.S.C. §1818(e)(7)(A),
without the prior written consent of the FDIC and the appropriate
federal financial institutions regulatory agency, as that term is
defined in section 8(e)(7)(D) of the FDI Act, 12 U.S.C.
§1818(e)(7)(D).
5. This ORDER shall be effective thirty (30) days from the date of its
issuance.
The provisions of this ORDER will remain effective and in force except
to the extent that, and until such time as, any provision of these
ORDERS shall have been modified, terminated, suspended, or set aside by
the FDIC.
IT IS FURTHER ORDERED that copies of this Decision and Orders shall be
served on Dennis Shollenburg, Hazel Hagy, Vicky Melton, Robert Hagy,
Brenda Knudson, Enforcement Counsel, the ALJ and the Superintendent of
Banks for the State of California.
By direction of the Board of Directors.
Dated at Washington, D.C., this 11th day of March 2003.
Robert E. Feldman
Executive Secretary
10-31-03A-3267
{{10-31-03 p.A-3267}}
RECOMMENDED DECISION
IN THE MATTER OF
DENNIS SHOLLENBURG,
HAZEL HAGY,
VICKY MELTON,
ROBERT HAGY AND
BRENDA KNUDSON,
individually, and as institution-affiliated parties
FIRST MOUNTAIN BANK
BIG BEAR LAKE, CALIFORNIA
(Insured State Nonmember Bank)
FDIC-00-88e
Appearances:
For the Federal Deposit Insurance Corporation:
Ms. JoAnna A. Gekas, Esq.
Ms. Frances L. Johnston, Esq.
Mr. Rex Taylor, Esq.
For Respondents:
Ms. Patricia J. Barry, Esq.
Mr. Frank Sanes, Jr., Esq.
Authur L. Shipe, Administrative Law Judge
This proceeding was instituted on August 9, 2001, by the issuance of a
"Notice of Intention to Prohibit From Further Participation." The
FDIC seeks an order prohibiting the Respondents from participating in
the conduct of banking and related institutions. Respondents oppose the
order sought by the FDIC.
Oral hearings were held in the matter at Riverside, California on May
13, 14, 15, 16, 17, and 20, 2002.
The FDIC presented its evidence through eight witnesses. Respondent
Hazel Hagy testified for Respondents. Although Respondent Shollenburg
gave direct testimony for Respondents, he refused to submit to cross
examination. Therefore, his testimony was stricken from the
record.1
Respondent R. Hagy, husband of H. Hagy, was recently diagnosed with
Stage IV throat cancer, and was not able to testify. Ts. Vol. V, p.
111. It is my conclusion that he should be dismissed from the
proceeding on grounds of his inability to testify, although he is
included in the discussions and findings that follow.
1 Mr. Shollenburg made the following statement
in explanation of his refusal to submit to cross-examination:
Your Honor, I would my statement is that Ms. Barry represents
the All Capital Letter Straw Man Corporate Entity, Dennis Shollenburg.
I stand here as the live man, secured party to Dennis Shollenburg,
corporate entity, Straw man. I have documentation to show me at that
position.
And I accept these total and complete procedures for value, you Honor.
Everybody has been involved in these proceedings for value, and I will
not testify. I will not be part of this kangaroo court sham any
further.
Ts. VI, p. 12.
{{10-31-03 p.A-3268}}
Post-hearing briefs, initial and reply, have been filed. The FDIC
states in its Reply Brief that Respondents' Proposed Findings should
be rejected because they do not comply with Rule 308.37(a)(2), which
requires that such findings be "supported by citation to any
relevant authorities and by page references to any relevant portions of
the record." Respondents' Proposed Findings clearly do not conform
to this Rule, but they will not be rejected.
Based upon the entire record, including exhibits, the testimony and
demeanor of witnesses, the following Discussion of Facts and Law;
Findings of Fact, Conclusions of Law, and Order, are entered.
DISCUSSION OF FACTS AND LAW
Respondents' Tax Avoidance Activity
Beginning in August 1997, the Respondents, individually, and as a
group, came to the fixed conclusion that there were ways by which they
could lawfully avoid paying federal and state, as well as Social
Security and Medicare, taxes. The latter are hereinafter referred to as
Social Security taxes for brevity purposes. Respondents' views were
largely derived from a booklet entitled, Vultures in Eagle's
Clothing, written by one Lynne Meredith. FDIC Ex. 118.
The flavor of the booklet is provided in the following statement:
The premise of this book is not how to "beat the tax system."
It is a book about freedom, rights and truth! WE ARE NOT TAX
PROTESTERS. We do not disagree with or protest the law. The Law, the
Income Tax Regulations and the supreme (sic) Court all concur:
"Compensation for labor, earned by an American Citizen, in any of
the 50 American states, exercising an occupation of common right, is
not taxable! THE GRADUATED INCOME TAX is 100% VOLUNTARY FOR THESE
CITIZENS!" We agree, so there's no law to protest!
FDIC Ex. 118, p. 13
Emblazoned on the cover of the booklet is the blurb: "Lawfully
Stop!!! Paying Income Taxes."
Respondents' counsel describes the booklet as "amusing in part and
informative in other parts," and argues the "whether any of the
respondents read or relied on this book is clearly with their First
Amendment rights to do so." Respondents Proposed Findings of Fact
and Conclusions of Law, para. 19.
Manifestly, one may lawfully read about many activities, including
crime, that one cannot carry out in daily life; the right to read about
a subject does not necessarily convey the right to rely upon what is
read for conduct. The relevance of this book here is that Respondents
became so fervently devoted to its teachings that they disregarded, in
the performance of their duties as bank officers and employees, all
advice of professional tax experts that did not jibe with those
teachings. Their disputed conduct is inexplicable apart from their
zealous adherence to the doctrines put forward in the Meredith
publication.
As pertinent here, the argument that a taxpayer's claimed political
beliefs can immunize him from compliance with the tax laws has not been
accepted by the courts. For example, the Seventh Circuit in
Coleman v. Commissioner, 791 F. 2d 68, 69 (7th Cir. 1986)
stated:
Some people believe with great fervor preposterous things that just
happen to coincide with their self-interest. "Tax protesters"
have convinced themselves that wages are not income, that only gold is
money, that the Sixteenth Amendment is unconstitutional, and so on.
These beliefs all lead so tax protesters think to the elimination
of their obligation to pay taxes. The government may not prohibit the
holding of these beliefs, but it may penalize people who act on them.
The Respondents in this proceeding seek to carry the reasoning
rejected by that court a step beyond not paying their taxes as
individuals. They declined, as Bank officers, to follow tax laws
applying to the Bank, and now offer in defense of their conduct, what
are claimed to be First Amendment rights to believe that wages are not
taxable income, and to act accordingly. It is their actions that are in
issue here, not their beliefs.
Respondents Tax Withholding Activity
In pursuit of their anti-tax objectives the Respondents submitted,
beginning in August 1997, to the First Mountain Bank, as their
employer, various forms and documents requesting that income and Social
Security taxes no longer be withheld from their compensation. Each of
the Respondents submitted similar forms and documents, on various
dates, including: a Form W-8, Certificate
{{10-31-03 p.A-3268.1}}
of Foreign Status; a
California Form 590 Nonresident Withholding Exemption Certificate; Form
6450, a Questionnaire To Determine Exemption
From Withholding; and an In Lieu of Form W-4, or a Form W-4. Most of
the forms were copied from the Meredith booklet, pp. 198, 199, 200,
201, 202, 204.
Originally, the Respondents claimed to be exempt from paying income tax
on the grounds that they were not citizens of the United States. For
instance, Mr. Shollenburg submitted to the Bank an Affidavit of
Citizenship and Domicile, dated August 11, 1997, which states, in part:
I hereby certify that I, Dennis Shollenburg, was born in the Oregon
Republic. I was not born in a territory over which the
United States is Sovereign and I am, therefore, not subject to its
jurisdiction and I am not a citizen of the United States, subject to
its jurisdiction, as defined in 26 CFR 1.1-1(c). I am not liable for
the Title 26, Internal Revenue Code (IRC), Subtitle A, Sect. I
graduated income taxes for reasons of my alienage.
(Underlining appears in the original)
Each of the other Respondents filed virtually the same statements
with the Bank. Other documents were submitted by all of the Respondents
containing similar averment of non-citizenship.
By letter of December 22, 1997, Mr. Shollenburg requested that the Bank
"discontinue the withholding of Social Security Tax from [his]
compensation immediately as [he] no longer wish[ed] to participate
in the voluntary program due to being fully vested at maximum
earnings." FDIC Ex 4. All of the other Respondents, with the
exception of Robert Hagy, wrote similar letters on various dates.
All of the described documents were received at the Bank by either Mr.
Shollenburg or Ms. Hagy in their positions of Bank officers. In
response to the requests, they caused the Bank to cease withholding
federal and state income taxes, as well as Social Security taxes, from
the Respondents' compensation.
Respondents' Positions at the Bank
Mr. Shollenburg was then president and chief executive officer of
the Bank; Ms. Hagy was the Bank's executive vice president and chief
financial officer; Respondent Melton was the senior vice president and
senior loan officer of the Bank; Respondent Robert Hagy was a branch
manager; and Respondent Knudson2 was a new accounts
representative. In May 1999, she became assistant vice president and
business development officer. The Respondents were terminated from
their positions at the Bank in the fall of 1999.
Respondents' Reversal of Position on Citizenship
Subsequent to their first submission of documents, Respondents
reversed positions on their citizenship status, and filed documents
with the Bank declaring that they were U.S. Citizens. (There
is evidence that the alienage argument had been rejected by the IRS.)
For example, Mr. Shollenburg submitted to the Bank a Statement of
Citizenship and Residence on September 1, 1998, which states, in part:
I, Dennis L. Shollenburg am a citizen of the United States by
birth, born in Medford, Jackson County, Oregon on April 22, 1946. My
present home residence is as specifically stated above within the
United States of America and not abroad as defined and delineated
within the Internal Revenue Code.
This statement further asserts;
My remuneration paid by First Mountain Bank is excluded from
gross income under §911 of the Internal Revenue Code, entitled
"CITIZENS OR RESIDENTS OF THE UNITED STATES LIVING ABROAD" and is
therefore not defined as "wages" as defined in 26 U.S.C.
§3401(a)(8)(A)(I).
Another paragraph of the statement reads:
This Statement of U.S. Citizenship and Residence is signed and
Witnessed as a genuine document verifying my protected status and
rights as a U.S. Citizen all remuneration paid to me is not included in
gross income under §911 of the Internal Revenue Code and thus is not
Subject to
2 Respondents' counsel has argued that the
FDIC has no jurisdiction over Respondent Knudson because she was an
employee, not an officer, when the disputed conduct occurred. That
argument may now be abandoned. In any case it is not correct; agencies
may prohibit any institution affiliated party, including employees. 12
U.S.C. §1813(u) and §1818(e).
{{10-31-03 p.A-3268.2}}
The other Respondents submitted similar statements to the Bank.
The writer of each statement ordered the Bank to send his or her
statement to the IRS office in Philadelphia, Pennsylvania, which was
done. That office is primarily concerned with U.S. citizens working
abroad and foreign taxpayers. It did not respond to the documents sent
there by Respondents.
All of these documents and requests were honored by Mr. Shollenburg or
Ms. Hagy, on behalf of the Bank, whether they asserted, under oath,
that the writer was, or was not, a U.S. citizen.
Consequence of Respondents' Tax Avoidance Activity For Bank
Respondents argue that their tax avoidance activities were of no
proper concern to the Bank, or to the regulators, and that those
activities were rather matters strictly between them and the IRS.
However, this is manifestly not the case. At every step in
Respondents' efforts to avoid paying taxes, the Bank's responsibility
was defined by them solely in terms of their demands and interests, all
of which were sorely misguided. The Bank, as an employer, as more fully
discussed below, has legal obligations in tax matters other than
complying with the demands of its employees. These obligations were
either ignored, or deliberately violated by Respondents.
The Respondents did not obtain outside professional advice on behalf of
the Bank to determine what obligations the Bank had in the
circumstances before the onset of their endeavor. They commenced this
dubious program within the Bank without disclosure to the Bank's
board, and without seeking the advice of the Bank's counsel.
When Respondents sought to end their participation in Social Security,
the Bank's payroll processor, Paychex, declined to comply with
instructions to cease withholding these taxes from the Respondents'
compensation, unless the Bank agreed to hold Paychex harmless from
possible liability for its role in the scheme.
In order to effectuate its Social Security objectives, Ms. Hagy
provided Paychex with hold harmless letters of indemnification. This
was also done without Board approval, and without consultation with the
Bank's outside counsel. It violated statutory and regulatory
provisions restricting the authority of a Bank to issue indemnification
agreements. These letters exposed the Bank to liability in unknown and
unlimited amounts with no discernible benefit to the Bank.
Paychex had also informed Ms. Hagy that the Bank should seek the advice
of accountants and tax counsel before putting this program into effect.
That was not done.
When the Respondents instructed the Bank to stop withholding Social
Security taxes from their compensation, they informed the Bank that it
would no longer be responsible for paying matching contributions on
Respondents' behalf. This was erroneous advice; an employer is liable
for remitting all Social Security taxes, including its share thereof,
regardless of its failure to withhold the employee's share. This seems
to be now conceded by Respondents' counsel. See e.g., Respondents
Rebuttal To Proposed Findings of Fact and Conclusions of Law of FDIC.
para. 434.
Respondents' Disregard of Advice of Outside Auditors
The accounting firm of Varinek, Trine, Day and Company (VTD) had
by 1998, served as the Bank's outside accountants for 10 years, or
more. Karen Comer acted as the firm's engagement partner for many
years, and Ms. Hagy was her contact at the Bank.
In the fall of 1998, Ms. Hagy gave Ms. Comer a letter that set forth
Respondents' position on the considered tax questions, and requested
VTD's response thereto. Ms. Comer reviewed the letter, and some other
such materials provided to her by Ms. Hagy. Ms. Comer also discussed
the subject with other partners, and ran it by the firm's tax and
administrative committees. Ms. Comer informed Ms. Hagy that the firm
did not agree with the views contained in the material. Ms. Comer told
Ms. Hagy that she was very concerned for her, that "it could mean
the end of her career, or some legal action against her and the
bank." Ts. Vol. I. p. 43, 44. Despite the dire nature of these
warnings Ms. Hagy did not convey them to the Bank's board. Based on
her own research, she disagreed with VTD.
In an ensuing audit in late December 1998 and January 1999, Ms. Comer
performed a more thorough than normal review of the Bank's payroll
records. She was surprised to discover that withholdings for
Respondents had already been discontinued. Although she
{{10-31-03 p.A-3268.3}}
had discussed
the subject with Ms. Hagy, Ms. Comer did not think that Ms. Hagy and
the other Respondents would actually go through with it without the
Bank auditors' advice. Ts. Vol. I, p. 49. VTD performed an audit of
the Bank for 1997, but had not discovered that withholding had stopped
in late 1997.
Ms. Comer showed the actual withholding documents and information
obtained during the audit to other partners and the firm's governing
administrative committee. The firm reached the conclusion that illegal
acts within the terms of the Statement of Accounting Standards had been
committed by the Bank related to its role in the tax withholding
program of Respondents.
Ms. Comer and a partner, Mr. David Dayton, met with Respondents
Shollenburg and Hagy on March 9, 1999, to discuss the firm's findings.
Prior to the meeting VTD sent them a written statement containing
VTD's findings on the tax issues and the Bank's responsibilities in
this activity. FDIC Ex. 71.
VTD provided authoritative references for the following propositions of
law, which the Bank, through Respondents had ignored or violated:
1) An employer has a duty to withhold income tax from all
remuneration paid to employees.
2) The employer is liable for the payment of income tax required to be
deducted and withheld from wages paid to an employee, whether or not
the employer collects the tax from the employee.
3) If any employee claims exemption from income tax withholding, the
employer must obtain from the employee a Form W-4, and forward it to
the IRS.
4) Any alteration of a Form W-4 invalidates the form.
5) An employer has an obligation to collect Social Security taxes from
the employee, and is liable therefore regardless if it has
collected the taxes from the employee.
VTD recommended that the Bank immediately file amended payroll tax
returns reflecting Social Security and income taxes that were not
included in the original returns. VTD, finding that the existing W-4
forms had been altered, and were, therefore, invalid, further
recommended that Executive Officers wishing to claim tax exempt status
should resubmit valid Form W-4's.
VTD's advice was flatly rejected by Mr. Shollenburg and Ms. Hagy at
the March 9, 1999 meeting. They claimed that the law cited by the
accountants did not apply to them, and that they had individual rights
not to have any taxes withheld. Ts. Vol. I, p. 58, 59.
VTD sent a memorandum to Mr. Shollenburg and Ms. Hagy following the
March 9 meeting, reiterating the points at issue, and recommended that
the Bank seek an outside consultant or expert in the tax field to help
minimize the Bank's exposure for back taxes owed, related penalties,
and future scrutiny by federal and state agencies. FDIC Ex. 72. A
subsequent memorandum indicated that disclosure of the Bank's possible
liability should be contained in the Bank's financial statement.
The Bank's management (Respondents) continued to be totally
unresponsive to VTD's recommendations. On March 15, 1999, Mr.
Shollenburg sent a letter to VTD stating, in part, "the Bank is
being held hostage, you are withholding our F/S until certain employees
comply with your wishes, against their personal wishes and beliefs."
The letter concludes:
Although you do not agree with what myself and various bank
personnel are doing I believe you cannot infringe on our right to
proceed.
Although some of us are officers of First Mountain Bank, this does not
mean that we loose (sic) our rights when it comes to the definition of
gross income.
You might be entering an arena where you do not want to be.
FDIC Ex. 75.
The essence of these statements is that the Bank cannot comply with its
tax withholding obligations under the law without infringing on the
Respondents rights to carry out their tax avoidance activities, and
their rights trump the Bank's legal obligations. That is the nub of
their defense here. That position has been rejected by every tax expert
that has reviewed the matter, including the payroll specialists at
Paychex, several accountants and a tax specialist at VTD, and a tax
attorney later engaged by the Bank board to investigate the entire tax
imbroglio
{{10-31-03 p.A-3268.4}}
in which the Bank had become enmeshed because of
Respondents' activities.
VTD was not intimidated by Mr. Shollenburg's threatening letter, and
in response reiterated its position, and stated that it would need a
meeting with the Bank's Audit Committee to discuss the matter in more
detail because it had found that the activity of the Bank via
Respondents constituted an illegal act.
A meeting of the Bank's audit committee and the board was held with
Ms. Comer and Mr. Dayton of VTD on April 26, 1999. At the meeting VTD
presented their findings and recommendations in a memorandum provided
to the board. FDIC Ex. 77. Mr. Shollenburg spoke in opposition to
VTD's position.
The board was informed that VTD believed that the Bank had committed
the following illegal acts:
1) Incorrectly reported taxable wages as exempt from Social
Security and Medicare taxes.
2) Incorrectly discontinued withholding federal and state income taxes
from employee's wages.
3) Accepted invalid Form W-4's from selected employees.
4) Neglected to transmit Form W-4's claiming exempt status to the IRS.
5) Agreed to indemnify the Bank's payroll processor from any liability
in preparing the payroll tax returns that included the periods during
which the above items had occurred.
VTD again recommended that the Bank file amended payroll tax
returns to include taxes not included in the original returns, that
valid W-4's be submitted for employees claiming exemption from the
withholding of taxes, and that all back taxes and penalties be paid as
soon as possible.
VTD also recommended again that the Bank engage an outside tax expert
to help it minimize its liability and future scrutiny by federal and
state agencies. The necessity of including a footnote to the Bank's
financial statement disclosing its possible liability for additional
taxes was also discussed at the meeting. The meeting was not totally
successful; Mr. Shollenburg did most of the talking. Ts. Vol. I, p. 80.
The board did accede to the inclusion of a footnote to the Bank's
financial statement, disclosing its possible liability for unpaid
taxes, and accepted the recommendation that it hire an outside tax
expert to assist it in assessing the situation. But rather than acting
immediately to clear up the matter, the board determined to have the
outside expert investigate the entire tax problem before it, and to
defer further action until the tax expert's investigation was
completed.
On June 1, 1998, VTD resigned as the Bank's accountants because it had
concluded that the Bank was not meeting its corporate responsibilities
by failing to implement VTD's recommendations. FDIC Ex. 80. VTD
believed that its reputation could be harmed by being associated with a
client who failed to carry out its lawful responsibilities.
Investigation Of Tax Expert
On June 7, 1999, the Bank hired Barry Guterman, an experienced tax
attorney to conduct a complete investigation of its tax withholding
situation.
After a very thorough investigation, he came to virtually the same
conclusions and made virtually the same recommendations as VTD, and
prepared an extensive report on his findings. FDIC Ex. 90. He found,
among other things, that the Bank had no legal basis to cease
withholding income taxes from Respondents' compensation because the
W-4 forms submitted by Respondents' claiming their exemption from
income taxes had been altered, and were therefore invalid.
For example, Mr. Shollenburg had submitted an "In Lieu of Form
W-4," on which he wrote above his signature the words "without
prejudice UCC-1-207." He also struck out "the" before United
States, and added "these." Other Respondents had made like
alterations in their forms.
Ms. Hagy submitted an "In Lieu of Form W-4" on which she struck
out the words "under penalty of perjury."
These alterations were made for a purpose. Ms. Hagy testified that it
was her understanding that when you signed a document with the verbiage
"without prejudice UCC-1-207" that you are retaining to yourself
all your rights that are guaranteed to you under the Constitution of
the United States." Ts. Vol. V, p. 40. She described these rights as
those that "might be under the Fourth and Fifth Amendment in the
Constitution, your right to privacy and your right not to have
things that you've signed used against you
{{10-31-03 p.A-3268.5}}
in a court of law." (Emphasis supplied) Ts. Vol, p. 145.
Ms. Hagy explained that she scratched out the phrase "under penalty
of perjury" in her In Lieu of Form W-4 "because the IRS really
does not have jurisdiction to put even a clause in there, because
you're not testifying in court or anything else. So they can't
hold you to perjury." (Emphasis supplied) Ts. Vol. V, p. 51.
Respondents seemed to have also derived these ideas from the Meredith
booklet, p. 166.
Regardless of the soundness of their legal reasoning, it is evident
that while Respondents sought to hedge their personal liability for
their statements, they deemed those statements sufficient, as officers
of the Bank, to implicate the Bank in a position fraught with serious
legal consequences.
As stated, Mr. Guterman found these altered forms invalid with the
result that the Bank had no legal basis to cease withholding taxes from
Respondents' compensation. Both VTD and Mr. Guterman agreed that the
only lawful basis for not withholding income taxes by an employer from
compensation paid to an employee is the submission of a valid unaltered
Form W-4. Respondents' counsel also now seems to concede as much.
An employee claiming exemption from tax withholding must certify under
penalty of perjury on a Form W-4 that she incurred no liability for
income tax for the preceding taxable year, and that she anticipates
that she will incur no liability for income tax in the current taxable
year. The other forms submitted by Respondents, including those sent to
IRS Philadelphia office, did not contain these requisite certifications
and therefore were legally ineffective to control tax withholding.
Failure to File W-4 Forms with IRS
The employer is required to file with the IRS any Form W-4,
claiming exemption from tax liability. Not only were the forms
submitted by the Respondents altered, and therefore invalid, they were
not filed with the IRS when received, as required by law.
Ms. Hagy testified that she had assumed that her payroll clerk had sent
these forms to Paychex, and that the latter had filed them with the
IRS. FDIC Ex. 96 at 1117; Ts. 4445, 92, 121123, 171. There is
fairly conclusive evidence that this is not what happened.
Although Ms. Hagy informed Mr. Guterman that she first learned in May
1999, that the forms had not been filed with the IRS, she had told Ms.
Comer in February or March 1999, that they had not been so filed. Ms.
Comer stated that "Hazel was very open about that." Ts. Vol. I,
p. 78; Vol. V. p. 123124. There is nothing in this statement to
suggest that Ms. Hagy had ever erroneously assumed that the forms had
been remitted to the IRS, only to later discover the error. The
suggestion is that Ms. Hagy considered it unnecessary or inappropriate
to send these forms to the IRS. This is confirmed in a memorandum
entitled "Rebuttal on Possible Audit Exception," written by Ms.
Hagy to Ms. Comer on March 15, 1999, following the unsuccessful meeting
involving Mr. Shollenburg, Ms. Hagy, Mr. Dayton, and Ms. Comer on March
9, 1999. FDIC Ex. 74.
The general thrust of the "Rebuttal" is that the Bank would be
subject to legal exposure from possible law suits by the employees,
such as Respondents, for failing to follow the employees' wishes in
tax matters, rather than exposure for violating tax laws, as VTD
believed.
The memorandum states, in relevant part; "Chief Financial Officer
[Hagy] has legally and fully complied with all Federal and State
Codes and regulations re: proper filing of Bank payroll tax returns,
including transmittal of Form W-4 where applicable." Id. at 2. The
operative words here are "where applicable."3 Since
Ms. Hagy had just confirmed with Ms. Comer days before that the W-4
forms of Respondents had not been transmitted to
IRS, it is apparent that she did not consider the transmittal
requirement applicable to those forms.
This position is made more specific in the following statements
contained in the memorandum:
The law absolutely prohibits employers from sending an Exempt Form
W-4 to the IRS if it does not involve wages earned by
3 Ms. Hagy had informed the Bank's outside
counsel, Mr. Gary Findley, in early 1998 that all appropriate forms had
been filed with the tax agencies. In reliance on that representation,
Mr. Findley advised the Bank that it had no legal exposure for
Respondents' activities.
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one who is
subject to the tax. [CFR 31.3402(f)(2)-1(g)]. FDIC Ex. 74 at 2.
Since a company cannot legally demand the completion or submission of a
Form W-4 from a work eligible individual, it may rely upon the
individual's Statement of citizenship or resident as proof the
individual is not subject to withholding, or the mere showing of a
Passport (current or expired) Id. at 56.
The company has resources to learn that the revenue laws apply only to
those who are engaged in revenue taxable activities or privileged
entities. Our officers are neither, therefore not subject to the scope
of 26 U.S.C. Id. at 2.
The unequivocal view expressed in these statements is that
Respondents did not earn wages subject to the income tax at the Bank,
and therefore, the law absolutely prohibited the Bank from sending an
Exempt Form W-4 to the IRS. Again, there is no claim that the failure
to remit the forms to the IRS was an oversight.
Moreover, Ms. Hagy did not, in fact, file Respondents' W-4 forms with
the IRS until July 1999, when she was ordered to do so by the board.
According to her testimony, she was then of the opinion, and remains of
the opinion, that it was unnecessary to make the filing because the
Respondents had filed a Statement of Citizenship with the IRS
Philadelphia office. Ts. Vol. V, p. 125127.
My conclusion on this matter is that Mr. Shollenburg and Ms. Hagy,
because of their personal views and interests, caused the Bank to
violate a statutory obligation to file with the IRS all W-4 forms
submitted by employees claiming exemption from tax withholding. It was
not an oversight. Mr. Guterman's conclusions on this as on other
matters were amply warranted.
Resubmitted W-4's by Respondents
Following Mr. Guterman's report and recommendations, he was
authorized by the Bank to assist in correcting the situation. The Bank
began withholding Social Security taxes from Respondents'
compensation. Respondents' claims that payment of Social Security
taxes was voluntary were completely baseless. All due back taxes were
paid by the Bank. The Respondents were required to, and did, submit
unaltered W-4 forms.
Mr. Guterman was of the opinion that the Bank could rely upon the
resubmitted unaltered W-4 forms that claimed exemption from income tax
withholding, unless the Bank had knowledge, or was told by the
employee, that the information in a form was false.
Mr. Guterman had no personal knowledge that the forms submitted by
Respondents were false, and therefore, advised the Bank that those
unaltered forms could be relied upon by the Bank to exempt Respondents
from the withholding of income tax from their compensation.
Therefore, commencing with the payroll paid on August 15, 1999, he
instructed the Bank that federal and state income taxes should not be
withheld from the Respondents' wages, "until such time as the IRS
advises the Bank differently, or the bank received information that the
form submitted is false." FDIC Ex. 90 at 0411.
The FDIC, in recognition of Mr. Guterman's conceded expertise in tax
matters does not dispute his conclusions here. However, there is a
serious question of whether the revised forms, despite their being
facially valid, became legally invalid because the Bank may have
received information that the forms were false.
Mr. Guterman recognized that if the Respondents submitted such forms
just because they had no intention of paying any kind of taxes, and the
Bank knew this, the forms would not be legally valid. He stated,
"that would indicate that there was no valid withholding certificate
and the bank had knowledge of it and the bank should be withholding on
the basis of single and zero immediately." Ts. Vol. III, p. 217.
As noted, the revised forms were deemed effective for the payroll paid
on August 15, 1999.
On September 15, 1999, Mr. Hagy wrote a letter to the Chairman of the
Board of Directors reasserting her claim that she had not received any
gross income from taxable sources, and therefore, did not owe any
income taxes. Resp. Ex. G.
The letter further states:
The Exempt W-4 submitted in July 1999 was intended to replace the
Statement of Citizenship that was presented to the Bank. I firmly
believe that the Statement of Citizenship presents the correct
information to the Bank as to my exempt status regarding income taxes.
***However, since legal tax counsel has advised the Board of Directors
to refuse to honor this statement,
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I have no choice but to present the
Bank with an exempt W-4.
The Statement of Citizenship, which the refiled W-4 is said to
have replaced, claimed that the remuneration paid by the Bank to
Respondents did not constitute taxable wages, thus rendering
inappropriate any withholding of taxes from such remuneration. The
considered letter makes explicit that the new W-4 forms rest on
precisely the same claim. According to Mr. Guterman's testimony this
is not acceptable and renders the forms invalid.
Thus, the H. Hagy letter, dated September 15, 1999, far from showing
that the Respondents were finally prepared to accommodate the interests
of the Bank, as their counsel argues, plainly demonstrates their
continued efforts to embroil the Bank in the machinations of their tax
protest activities by casting into doubt any legal basis for their
renewed claims of exemption from income tax withholding, while exposing
the Bank to continuing liability for its role in those activities. Ts.
Vol. VI, p. 5556.
Mr. Guterman's final report to the Bank's board is dated October 15,
1999, but there is no indication that he had seen the discussed
September 15th letter, or determined the Bank's responsibility in
light of the information it contains. In the circumstances, it seems
doubtful if the Bank could lawfully have given continuing effect to the
W-4 forms. Respondents were terminated from employment by the Bank
shortly thereafter, rendering the issue moot.
Statutory Standards For Prohibition
In order to prohibit institution-affiliated persons from further
participation in the affairs of a federally insured depository
institution under 12 U.S.C. §1818(e), as relevant here, the
following must be shown:
a) Misconduct. Violation of any law or regulation, or
the commission of, or participation in any unsafe or unsound practice,
or a breach of a fiduciary duty.
b) The misconduct must have the effect of a financial loss,
or other damage to the institution, or actual or possible prejudice to
the depositors of the institution or the party must have received a
financial gain or other benefit as a result of the misconduct; and
c) The misconduct must involve culpability in the form of
personal dishonesty, or willful and continuing disregard for the safety
and soundness of the institution.
All of the statutory factors are shown here; misconduct, effect of
the misconduct, and culpability.
Misconduct-Violations of Law
The activities of Respondents caused the Bank to fail to withhold
income taxes from their compensation without a valid basis in violation
of section 3402 of the Internal Revenue Code, 26 U.S.C. §3402. As
discussed, the forms relied upon to claim exemption from tax
withholding submitted by Respondents were altered by them, and were,
therefore, invalid. Moreover, the W-4 forms were not submitted to the
IRS, as required by law.
Respondents Shollenburg, H. Hagy, Melton and Knudson caused the Bank to
fail to withhold Social Security taxes from their compensation in
violation of Section 3102 of the Internal Revenue Code, 26 U.S.C.
§3102.
Respondent H. Hagy, for her benefit, and that of Respondents
Shollenburg, Melton and Knudson, violated the law in providing an
indemnification agreement to the payroll processor in connection with
their demands for it to cease withholding Social Security taxes from
their compensation.
All of the Respondents caused, brought about, and participated in the
violations of the income tax laws, and with the exception of R. Hagy,
the same can be stated for the non-withholding of Social Security
taxes. Section 3(v) of the FDIC Act defines a violation to include
"any action (alone or with another or others) for or toward causing,
bringing about, participating in, counseling, or aiding or abetting a
violation." 12 U.S.C. §1813(v). Plainly, all Respondents
committed these violations, although Respondents Shollenburg and H.
Hagy were the pivotal actors in the matter.
As succinctly stated by the FDIC:
Within three months of each other, they each submitted a similar letter
request to initially stop the withholding of income taxes from their
compensation. They each submitted the same documents in support of this
request. They made similar alterations to the forms submitted. They
each obtained these documents from the same book. In some cases, they
witnessed the
{{10-31-03 p.A-3268.8}}
documents on behalf of each other. Within six months of
each other, they each changed their position on why they did not feel
that they had to pay income taxes. They submitted the same documents in
support of this new position. All of the documents were submitted to
the same two officers of the Bank, Respondents Hazel Hagy and
Shollenburg. These acts suggest a joint course of conduct among all of
the Respondents.4
Brief, pp. 20, 21.
As discovered by FDIC examiners during their examination of the Bank,
Respondents Shollenburg, H. Hagy Melton and R. Hagy had received
automobile allowances, bonuses, and year 2000 compensation which was
not reported as income, and no Social Security or income taxes were
withheld from this compensation. This constituted additional violations
of the tax laws by those Respondents.
Misconduct-Breach of Fiduciary Duty
Respondents' view of their fiduciary duties to the Bank is
revealed in their answer to the allegation in the Notice, paragraph 50,
that the original Form W-4's by which Respondents claimed exemption
from income tax should not have been accepted by the Bank. Their answer
was: "Maybe, but that is [the Bank's] problem as is this entire
proceeding." Answer, paragraph 50. It hardly needs to be reiterated
that the forms were accepted by Respondents Shollenburg and H. Hagy on
behalf of the Bank.
Respondents breached their fiduciary duty to the Bank in a number of
ways, including: a failure to assure that the Bank was in compliance
with applicable tax laws; by violation of the banking requirement for
indemnification agreements; by the failure to obtain or follow
professional advice on the course of conduct into which they led the
Bank; by their failure to disclose their activities to the Bank's
Board of Directors and outside counsel; and by their embroilment of the
Bank into tax disputes and violations for their purposes without
benefit to the Bank.
In a meeting with the Bank's board in 1998, Mr. Shollenburg and Ms.
Hagy promised the board that they would pay into their bank accounts an
amount equivalent to their possible tax liability so that money would
be available to pay their taxes if the IRS denied their claimed
exemptions. They did not do this, thereby breaching their promise to
the board.
Ms. Hagy received correspondence from the IRS rejecting her claims of
non-liability for income taxes, but she did not convey that information
to the Bank's board. She testified that "It was none of their
business," and "It was between me and the IRS." Ts. Vol. V, p.
164. It is not accepted that a fiduciary may refuse to disclose
information vital to her principal's compliance with the law on the
grounds asserted by Ms. Hagy.5
Effect-Financial loss of the Bank and gain to Respondents
The Bank suffered financial loss in the amount of $152,799.85 to
satisfy the tax liabilities of Respondents for 1998 and 1999, for which
it has not been reimbursed. The Bank was required, when Respondents
refused to follow the advice of the Bank's auditors, to hire an expert
tax attorney to advise it and to correct the entire situation created
by Respondents' conduct. His fees exceeded $40,000. Although the
amount is not determinable, it is evident that some of the auditor's
billable hours in 1999 were attributable to the tax questions, and
thereby created additional losses to the Bank. FDIC Ex. 121, VTD
Letter, dated July 7, 1999. ("Time was also spent by our tax
department in March and April regarding tax withholding issues.")
Clearly, all of this was a loss to the Bank, and all of the Respondents
have reaped a financial gain by retaining funds that should have been
spent to satisfy their tax obligations.
Respondents' counsel argues that the payment of their taxes by the
Bank was unnecessary in that no demand therefore had yet been made to
the Bank by IRS. It is suggested by Respondents' counsel that the
payment was coerced by the FDIC examiners. However, the auditors as
well as Mr. Guterman, had reached their conclusions and made their
recommendations before the FDIC's involvement in the matter. As
Respondents' counsel state on Brief, Respondents were
4 Respondents submitted a motion after the
hearing to reopen the record to show that other Bank employees did not
have taxes withheld from their compensation. That motion was denied by
order of June 7, 2002. Respondents' subsequent filings make repeated
references to the other employees. The prior ruling on the issue is
affirmed for the reasons stated therein.
5 The described violations of law and breaches
of fiduciary duty were also, per se, unsafe and unsound practices.
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ordered to pay
back taxes in July two months before the FDIC got in the
act," para. 37. The FDIC was alerted to the considered tax
problem when it learned of VTD's resignation as the Bank's auditor.
Payment of the income taxes was not made by the Bank until early
November 1999.
It is noted by their counsel that there has been no case cited where
the IRS has held an employer liable for non-withholding of taxes based
on exemption forms ultimately determined by IRS to be invalid. Mr.
Guterman could find no such case.
However, the violations of tax law by the Bank as a result of
Respondents' activities were flagrant, as determined by the auditing
firm and Mr. Guterman, though Respondent Shollenburg persistently
contended that the advice of these professionals should not be
followed.
The Board declined to act upon all of the auditor's recommendations,
over the objections of one board member, Ronald Clark who testified at
the hearing. Instead it sought a second opinion. Thereafter, with that
opinion in the form of a report from Mr. Guterman in its lap, detailing
the violations, and the possible penalties and criminal prosecutions
that could follow, it would have been foolhardy for the board to have
ignored the situation, and taken no action, as Mr. Shollenburg
continued to advocate. See Findings of Fact 370. By acting in
accordance with Mr. Guterman's advice severe penalties seem to have
been averted. There is a certain dissimulation in Respondents'
argument that the Bank should have waited until the IRS came calling
before paying up, in view of Respondents unlawful failure to remit the
W-4 forms to the IRS that would have provided it with notice of what
was going on.
Respondents argue that if the board had followed VTD's advice, they
would not have needed to hire Mr. Guterman. It was, of course, the
intransigence of Respondents in refusing to follow the auditor's
recommendation that placed the board in the middle of this situation
between the auditors and its management, which was, apart from their
tax cause, apparently successful and quite acceptable to the board. Mr.
Shollenburg, because of the force of his personality, and his
manipulation of information presented to the board, was very
influential with the board. In deference to management (Respondents)
the board sought a second opinion. This is not a mitigating factor for
Respondents.
Culpability
In order for prohibition to result from violations, breaches of
fiduciary duty, or unsafe and unsound practices there must be involved
personal dishonesty, or a willful or continuing disregard for the
safety and soundness of the institution.
These Respondents committed acts and made statements that were
personally dishonest. Their course of dealing with the Bank's board
was, as discussed,. marked by a lack of candor. The commencement of
their practice of not withholding taxes was not disclosed to the board.
Ms. Hagy was not truthful in her representation to outside counsel that
all "appropriate" forms had been filed with the taxing
authorities. Information pertaining to the position of IRS on their
claims was concealed from the board. The statements by Respondents,
later retracted, that they were not U.S. citizens were false. Their
sworn statements made in 1997 that they had incurred no liability for
taxes in 1996 were false. The failure to establish bank accounts to
cover their possible tax liability after promising to do so was
dishonest. Respondents evinced an awareness of the falsity of their
claims by altering the forms so as not to be held to them in a court of
law, or not to be "held to perjury."
As discussed, Respondents' contentions that these non-disclosures, as
well as the falsely sworn, and contradictory statements are based on
their "private political beliefs," and are therefore somehow
justified, are not accepted. Respondents' tax avoidance activities,
insofar as they legally implicated the Bank should have been disclosed
to the Bank's board and professional advice thereon should have been
followed.
As indicated, the Respondents' conduct was willful in that it was
carried out in defiance of professional advice provided to the Bank by
numerous professional tax experts. Respondents' conduct occurred over
an extended period of time, and was undertaken in complete disregard
for the safety and soundness of the Bank, particularly as it involved
the Bank's reputation, and its need for trust in its community that
could only be undermined by being involved in an anti-tax scheme that
could subject it to tax penalties,
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and possible criminal prosecution.
See Findings of Fact 164170, 190191, 328329.
FINDINGS OF FACT
The Respondents, as well as FDIC Enforcement, submitted Proposed
Findings of Fact and Conclusions of Law, although as indicated above
Respondents' submission is seriously deficient. It does not contain
required citations to record, and relies heavily on argument and
conjecture of counsel, which are frequently though not in all
instances, unsupported by or contrary to, the evidence of record.
The FDIC's Proposed Findings of Fact are amply supported by references
to the record. They are succinct, accurate, and thorough. Respondent
has taken no exception to many of them, and only nominal exception to
others. For these reasons my Findings of Fact, with a few minor
amendments, are adopted from those proposed by the FDIC Enforcement.
1. At all times pertinent to this proceeding, First Mountain Bank
("Bank") was a corporation existing and doing business under the
laws of the State of California, having its principal place of business
at Big Bear Lake, California. Respondents' Answers ("Resps.
Ans.") ¶1.
2. The Bank is and has been, at all times pertinent to this proceeding,
an insured State nonmember bank. Resps. Ans. ¶2.
3. As of July 1997, Dennis Shollenburg ("Shollenburg") was the
president and chief executive officer of the Bank and a director of the
Bank and continued to serve in those capacities until September 1999.
Resps. Ans. ¶4.
4. As of July 1997, Hazel Hagy ("H. Hagy") was the executive vice
president and chief financial officer of the Bank and continued to
serve in that capacity until October 1999. Resps. Ans. ¶5.
5. As of July 1997, Vicky Melton ("Melton") was the senior vice
president and senior loan officer of the Bank and continued to serve in
that capacity until October 1999. Resps. Ans. ¶6.
6. As of July 1997, Robert Hagy ("R. Hagy") was vice president
and branch manager of the Running Springs branch of the Bank and
continued to serve in that capacity until October 1999. Resps. Ans.
¶7.
7. As of July 1997, Brenda Knudson ("Knudson") was employed by
the Bank as a new accounts representative. Respondents' Response to
FDIC's Request for Stipulations, Set. No. 3, dated April 10, 1992
("Resps. Stips.") ¶1.
8. Knudson continued to serve in the capacity of new accounts
representative, until she was promoted to the position of assistant
vice president and business development officer of the Bank in May
1999, at the latest. FDIC Exh. 116; Starin, vol. 4, p. 21, lines 46 &
o, 23, lines 25; Hagy, vol. 5, p. 24, lines 1525.
9. Knudson continued to serve in the capacity of assistant vice
president and business development officer of the Bank until September
1999. Resps. Stips. ¶3.
10. As the chief financial officer of the Bank, H. Hagy was responsible
for the oversight of all personnel payroll matters. Findley, vol. 2, p.
203, lines 38.
11. Shollenburg and H. Hagy together constituted the personnel
department of the Bank. Hagy, vol. 5, p. 153, lines 1113.
12. In addition to Shollenburg, H. Hagy and Melton attended meetings of
the Bank's board of directors. FDIC Exhs. 3365; Jasperson, vol. 2,
p. 245, lines 49.
13. Paychex served as the Bank's payroll data processing service
provider from January 1, 1998 through July 31, 1999. Resps. Stips. ¶8;
Joint Stips, Section II, ¶5.
14. From January 1, 1998 through July 31, 1999, the Bank input its
payroll data to Paychex via computer modem. Resps. Stips. ¶10; Joint
Stips, Section II, ¶6.
15. At all times pertinent to the charges herein, Respondents were and
are citizens of the United States and permanent residents of either
Riverside County or San Bernardino County, State of California. Resps.
Ans. ¶12; Hagy, vol. 5, p. 146, lines 2122.
16. In July 1997, H. Hagy and Shollenburg began to study the United
States' income tax and Social Security laws and regulations and they
developed certain views thereon. H. Hagy and Shollenburg discussed
their views and participated in meetings with R. Hagy, Knudson and
Melton, who essentially came to share the same views on these tax
matters as H. Hagy and Shollenburg. Resps. Ans. ¶13.
17. Prior to August 1997, the Bank withheld federal and state income
taxes and Social Security and Medicare taxes from Bank employees'
compensation and the Bank paid its share of the Social Security taxes
attributable
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to its employees, all in accordance with the guidelines
and instructions furnished by its payroll tax servicer and its
accountants. Resps. Ans. ¶14.
18. It was the policy of the Bank's board of directors that
employees' salaries have withholding for Social Security (FICA),
Medicare, federal and state income taxes, and the Bank had previously
withheld these items from bonus checks. FDIC Exh. 32; FDIC Exh. 83;
FDIC Exh. 119, p. 1; Jasperson, vol. 2, pp. 25455.
19. Beginning on or about August 10, 1997, the Bank received various
correspondence and documentation concerning income tax and Social
Security and Medicare tax withholding from the Respondents, including
the following:
a. Withholding Exemption Certificate ("Form W-4").
b. Questionnaire to Determine Exemption from Withholding ("Form
6450").
c. Certificate of Foreign Status ("Form W-8").
d. Affidavit of Citizenship and Domicile.
e. Statement of Citizenship and Residence.
Resps. Ans. ¶15.
20. In the correspondence and documentation described in the
preceding paragraph, Respondents asserted various reasons as to why the
Bank should cease withholding of income taxes and/or Social Security
and/or Medicare taxes from each Respondent's individual compensation.
FDIC Exh. 90.
21. On August 12, 1997, Shollenburg sent a letter to H. Hagy in which
he requested that the Bank no longer withhold Federal and/or State
income taxes from his compensation at the Bank. FDIC Exh. 1.
22. H. Hagy acknowledged receipt of Shollenburg's request to stop
withholding Federal and/or State income taxes from his compensation at
the Bank. FDIC Exh. 1.
23. As part of Shollenburg's request to stop the withholding of
Federal and/or State income taxes from his compensation at the Bank,
Shollenburg submitted the following documents: Affidavit of Citizenship
and Domicile, dated August 11, 1997; Form W-8 Certificate of Foreign
Status, dated August 11, 1997; and Form 590 Nonresident Withholding
Exemption Certificate, dated August 11, 1997. FDIC Exh. 1.
24. On the Affidavit of Citizenship and Domicile, dated August 11,
1997, that Shollenburg submitted to the Bank and signed under penalty
of perjury, Shollenburg declared, among other things: ". . . I am not a citizen of
the United States . . ." and ". . . I am a `Nonresident Alien' . . ."
Further, "I am a Citizen of the contiguous California
Republic . . ." FDIC Exh. 1, p. 2.
25. The Affidavit of Citizenship and Domicile, dated August 11, 1997,
that Shollenburg submitted to the Bank was witnessed by Knudson. FDIC
Exh. 1, p. 2.
26. On the Form W-8 Certificate of Foreign Status, dated August 11,
1997, that Shollenburg submitted to the Bank, Shollenburg checked boxes
signifying his agreement with the following statements:
"For INTEREST PAYMENTS, I am not a U.S. citizen or resident (or
I am filing for a foreign corporation, partnership, estate, or
trust)."
"For DIVIDENDS, I am not a U.S. citizen or resident (or I am filing
for a foreign corporation, partnership, estate, or trust)."
"For BROKER TRANSACTIONS or BARTER EXCHANGES, I am an exempt foreign
person as defined in the instructions below."
FDIC Exh. 1, p. 3.
27. Shollenburg altered the jurats on the Form W-8 Certificate of
Foreign Status, dated August 11, 1997, and the Form 590 Nonresident
Withholding Exemption Certificate, dated August 11, 1997, that he
submitted to the Bank by adding the phrases "citizen of California
republic" and "without prejudice UCC-1-207." FDIC Exh. 1, pp.
34.
28. On August 12, 1997, Shollenburg submitted an In Lieu of Form W-4
Withholding Exemption Certificate to the Bank. FDIC Exh. 2.
29. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
August 12, 1997, that Shollenburg submitted to the Bank, Shollenburg
claimed to be exempt from income tax withholding. FDIC Exh. 2.
30. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
August 12, 1997, that Shollenburg submitted to the Bank, Shollenburg
certified that: "I incurred no liability for income tax imposed
under subtitle A of Title 26 of the Internal Revenue Code for the
preceding taxable year." FDIC Exh. 2.
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31. Shollenburg altered the jurat of the In Lieu of Form W-4
Withholding Exemption Certificate, dated August 12, 1997, that he
submitted to the Bank by crossing out the word "the" and
replacing it with the word "these," and by adding the phrase
"without prejudice UCC-1-207." FDIC Exh. 2.
32. On August 12, 1997, Shollenburg submitted a Form 6450 Questionnaire
to Determine Exemption from Withholding to the Bank. FDIC Exh. 3.
33. On the Form 6450 Questionnaire to Determine Exemption from
Withholding, dated August 12, 1997, that Shollenburg submitted to the
Bank, Shollenburg checked a box signifying his agreement with the
following statement: "Last year, I had a right to a refund of ALL
income tax withheld because I did not have any Federal income tax
liability." FDIC Exh. 3.
34. Shollenburg altered the jurat on the Form 6450 Questionnaire to
Determine Exemption from Withholding, dated August 12, 1997, that he
submitted to the Bank by adding the phrase "without prejudice
UCC-1-207." FDIC Exh. 3.
35. As a consequence of the documentation provided by Shollenburg to
the Bank, the Bank stopped the withholding of Federal and State income
taxes from Shollenburg's compensation at the Bank as of August 30,
1997. Resps. Stips. ¶12; FDIC Exh. 114.
36. The Bank continued to stop the withholding of Federal and
State income taxes from Shollenburg's compensation at the Bank through
July 31, 1999. Resps. Stips. ¶12; Joint Stips, Section II, ¶7; FDIC
Exh. 90, p. 2.
37. On September 1, 1998, Shollenburg submitted a letter to H. Hagy in
which he provided notice to the Bank that he was a citizen and resident
of the United States, and that he was not a non-resident alien. FDIC
Exh. 7, p. 2.
38. On September 1, 1998, Shollenburg submitted a Statement of
Citizenship and Residence to the Bank, in which he declared that he was
a citizen and resident of the United States, and that the remuneration
paid to him by the Bank could not be legally withheld because it did
not constitute "wages" under section 3401(a) and did not
constitute "gross income" under section 911. FDIC Exh. 7, pp.
46.
39. H. Hagy forwarded Shollenburg's Statement of Citizenship and
Residence, dated September 1, 1998, to the Internal Revenue Service's
Philadelphia, Pennsylvania office on September 29, 1998. FDIC Exh. 7.
40. Shollenburg submitted a tax return to the Internal Revenue Service
for the tax year 1996 in which he declared that he had incurred tax
liability. Guterman, vol. 3, p. 270, lines 118.
41. On December 22, 1997, Shollenburg submitted a letter to H. Hagy in
which he requested that the Bank discontinue the withholding of Social
Security tax from his compensation by stating: "I request that my
employer, First Mountain Bank, discontinue the withholding of Social
Security Tax from my compensation immediately as I no longer wish to
participate in the voluntary program due to being fully vested at
maximum earnings." FDIC Exh. 4.
42. In his December 22, 1997 letter to H. Hagy at the Bank, Shollenburg
also stated: "An Additional positive note is that you, as my
employer, will no longer be responsible for paying matching
contributions on my behalf." FDIC Exh. 4.
43. On December 22, 1997, Shollenburg submitted to H. Hagy a copy of a
letter dated December 22, 1997 to the Social Security Administration,
in which he requested the Social Security Administration to send him
appropriate forms to obtain a refund of payments made subsequent to the
date that he became fully vested. FDIC Exhs. 4 & 5.
44. Paychex did not stop the withholding of Social Security and
Medicare taxes from Shollenburg's compensation until after November
13, 1998, when it received letters from H. Hagy, holding Paychex
harmless for complying with the request. FDIC Exh. 90, p. 3.
45. After receiving the hold harmless letters from H. Hagy, Paychex
prepared amended payroll tax returns for the first three taxable
quarters of 1998, which reported no Social Security and Medicare wages
and taxes pertaining to Shollenburg's compensation for calendar year
1998. It is unclear whether the amended payroll tax returns were filed.
FDIC Exh. 90, pp. 34.
46. As a consequence of the documentation provided by Shollenburg to
the Bank, the Bank stopped withholding Social Security and Medicare
taxes from Shollenburg's salary as of January 1998. Resps. Stips.
¶17; Joint Stips., Section II, ¶12.
47. On December 2, 1998, Shollenburg submitted a letter to H. Hagy in
which he
{{10-31-03 p.A-3268.13}}
declared that the documentation submitted to him by the Bank
to stop all withholding from Federal, State, Social Security and
Medicare taxes eliminated the issuance of a W-2 wage statement to the
IRS at year end 1998. FDIC Exh. 8.
48. In the December 2, 1998 letter Shollenburg sent to H. Hagy,
Shollenburg stated: "I do not take this matter lightly and I request
that First Mountain Bank take the proper steps to inform the Payroll
Department and Paychex to implement my request without further
delay." FDIC Exh. 8.
49. In January 1999, through Paychex, the Bank issued a Wage Statement
(Form W-2) for 1998 for Shollenburg reporting no federal or state
income tax withholdings, Social Security or Medicare wages, or Social
Security or Medicare tax withholdings. FDIC Exh. 90, p. 4; FDIC Exh.
106.
50. The Bank continued to refrain from withholding Social Security and
Medicare taxes from Shollenburg's compensation and the paying of its
matching share of Social Security and Medicare taxes attributable to
Shollenburg through July 31, 1999. Resps. Stips. ¶18; Joint Stips.,
Section II, ¶13; FDIC Exh. 90, p. 2.
51. On August 10, 1997, H. Hagy submitted a letter to Shollenburg in
which she requested that the Bank no longer withhold Federal and/or
State income taxes from her compensation at the Bank. FDIC Exh. 10.
52. On August 12, 1997, Shollenburg acknowledged receipt of H. Hagy's
request to stop withholding Federal and/or State income taxes from her
compensation at the Bank. FDIC Exh. 10.
53. As part of H. Hagy's request to stop the withholding of Federal
and/or State income taxes from her compensation at the Bank, H. Hagy
submitted the following documents: Affidavit of Citizenship and
Domicile, dated August 10, 1997; In Lieu of Form W-4 Withholding
Exemption Certificate, dated August 10, 1997; Form 6450 Questionnaire
to Determine Exemption from Withholding, dated August 10, 1997; Form
W-8 Certificate of Foreign Status, dated August 10, 1997; and Form 590
Nonresident Withholding Exemption Certificate, dated August 10, 1997.
FDIC Exh. 10.
54. On the Affidavit of Citizenship and Domicile, dated August 10,
1997, that H. Hagy submitted to the Bank and signed under penalty of
perjury, H. Hagy declared, among other things: ". . . I
am not a citizen of the United States . . ." and ". . . I am a `Nonresident
Alien' . . ." Further, "I am a Citizen of the contiguous California Republic
. . ." FDIC Exh. 10, p. 2.
55. The Affidavit of Citizenship and Domicile, dated August 10, 1997,
that H. Hagy submitted to the Bank was witnessed by R. Hagy and
Shollenburg. FDIC Exh. 10, p. 2.
56. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
August 10, 1997, that H. Hagy submitted to the Bank, H. Hagy claimed to
be exempt from income tax withholding. FDIC Exh. 10, p. 3.
57. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
August 10, 1997, that H. Hagy submitted to the Bank, H. Hagy certified
that: "I incurred no liability for income tax imposed under subtitle
A of Title 26 of the Internal Revenue Code for the preceding taxable
year." FDIC Exh. 10, p. 3.
58. On the Form 6450 Questionnaire to Determine Exemption from
Withholding, dated August 10, 1997, that H. Hagy submitted to the Bank,
H. Hagy checked a box signifying her agreement with the following
statement: "Last year, I had a right to a refund of ALL income tax
withheld because I did not have any Federal income tax liability."
FDIC Exh. 10, p. 4.
59. H. Hagy altered the jurats on the In Lieu of Form W-4 Withholding
Exemption Certificate, dated August 10, 1997, and the Form 6450
Questionnaire to Determine Exemption from Withholding, dated August 10,
1997, that she submitted to the Bank by crossing out under penalty(ies)
of perjury and adding the phrase "without prejudice UCC-1-207."
FDIC Exh. 10, pp. 35.
60. H. Hagy altered the jurat on the Form 590 Nonresident Withholding
Exemption Certificate, dated August 10, 1997, that she submitted to the
Bank by adding the phrase "without prejudice UCC-1-207." FDIC
Exh. 10, p. 7.
61. As a consequence of the documentation provided by H. Hagy to the
Bank, the Bank stopped the withholding of Federal and State income
taxes from H. Hagy's compensation at the Bank as of August 15, 1997.
Resps. Stips ¶11; FDIC Exh. 114.
62. The Bank continued to stop the withholding of Federal and State
income taxes
{{10-31-03 p.A-3268.14}}
from H. Hagy's compensation through July 31, 1999. FDIC
Exh. 90, p. 2.
63. On August 20, 1997 and September 9, 1997, H. Hagy provided the same
set of documents to Shollenburg authorizing the Bank to no longer
withhold Federal and/or State income taxes that she had provided on
August 10, 1997. FDIC Exhs. 11 & 12.
64. On November 17, 1998, H. Hagy submitted a letter to Shollenburg at
the Bank in which she provided notice to the Bank that she was a
citizen and resident of the United States, and that she was not a
non-resident alien. FDIC Exh. 14, pp. 23.
65. On November 17, 1998, H. Hagy submitted a Statement of Citizenship
and Residence to the Bank, in which she declared that she was a citizen
and resident of the United States, and that the remuneration paid to
her by the Bank could not be legally withheld because it did not
constitute "wages" under section 3401(a) and did not constitute
"gross income" under section 911. FDIC Exh. 14, pp. 48.
66. Shollenburg forwarded H. Hagy's Statement of Citizenship and
Residence, dated November 17, 1998, to the Internal Revenue Service's
Philadelphia, Pennsylvania office on December 1, 1998. FDIC Exh. 14.
67. H. Hagy submitted a tax return to the Internal Revenue Service for
the tax year 1996 in which she declared that she had incurred tax
liability. FDIC Exh. 124; Guterman, vol. 3, p. 270, lines 118; Hagy,
vol. 5, pp. 14043.
68. On December 30, 1997, H. Hagy submitted a letter to Shollenburg in
which she requested that the Bank discontinue the withholding of Social
Security tax from her compensation, by stating: "I therefore request
that my employer, First Mountain Bank, discontinue the withholding of
Social Security Tax from my compensation immediately as I no longer
wish to participate in the voluntary program due to being fully
vested." FDIC Exh. 13.
69. In her December 30, 1997 letter to Shollenburg at the Bank, H. Hagy
stated: "An additional positive note is that you, as my employer,
will no longer be responsible for paying matching contributions on my
behalf." FDIC Exh. 13; See also H. Hagy, vol. 5, pp.
5556.
70. Paychex did not stop the withholding of Social Security and
Medicare taxes from H. Hagy's compensation until after November 13,
1998, when it received letters from H. Hagy on behalf of the Bank,
holding Paychex harmless for complying with the request. FDIC Exh. 90,
p. 3.
71. After receiving the hold harmless letters from H. Hagy, Paychex
prepared amended payroll tax returns for the first three taxable
quarters of 1998, which reported no Social Security and Medicare wages
and taxes pertaining to H. Hagy's compensation for calendar year 1998.
It is unclear whether the amended tax returns were filed. FDIC Exh. 90,
pp. 34.
72. As a consequence of the documentation provided by H. Hagy to the
Bank, the Bank stopped withholding Social Security and Medicare taxes
from H. Hagy's salary as of January 1998. Resps. Stips. ¶17; Joint
Stips., Section II, ¶12.
73. In January 1999, through Paychex, the Bank issued a Wage Statement
(Form W-2) for 1998 for H. Hagy reporting no federal or state income
tax withholdings, Social Security or Medicare wages, or Social Security
or Medicare tax withholdings. FDIC Exh. 90, p. 4; FDIC Exh. 106, p. 3.
74. The Bank continued to refrain from withholding Social Security and
Medicare taxes from H. Hagy's salary and the paying of its matching
share of Social Security and Medicare taxes attributable to H. Hagy
through July 31, 1999. Resps. Stips. ¶18; Joint Stips., Section II,
¶13; FDIC Exh. 90, p. 2.
75. On October 1, 1997, Melton submitted a letter to H. Hagy in which
she requested that the Bank no longer withhold Federal and/or State
income taxes from her compensation at the Bank. FDIC Exh. 16.
76. As part of Melton's request to stop the withholding of Federal
and/or State income taxes from her compensation at the Bank, Melton
submitted the following documents: Affidavit of Citizenship and
Domicile, dated October 1, 1997; In Lieu of Form W-4 Withholding
Exemption Certificate, dated October 1, 1997; Form 6450 Questionnaire
to Determine Exemption from Withholding, dated October 1, 1997; Form
W-8 Certificate of Foreign Status, dated October 1, 1997; and Form 590
Nonresident Withholding Exemption Certificate, dated October 1, 1997.
FDIC Exh. 16.
77. On the Affidavit of Citizenship and Domicile, dated October 1,
1997, that Melton
{{10-31-03 p.A-3268.15}}
submitted to the Bank and signed under penalty of
perjury, Melton declared, among other things: ". . . I
am not a citizen of the United States . . ." and ". . . I am a `Nonresident
Alien' . . ." Further, "I am a Citizen of the contiguous California Republic
. . ." FDIC Exh. 16, pp. 78.
78. The Affidavit of Citizenship and Domicile, dated October 1, 1997,
that Melton submitted to the Bank was witnessed by H. Hagy. FDIC Exh.
16, p. 8.
79. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
October 1, 1997, that Melton submitted to the Bank, Melton claimed to
be exempt from income tax withholding. FDIC Exh. 16, p. 6.
80. On the In Lieu of Form W-4 Withholding Exemption Certificate, dated
October 1, 1997, that Melton submitted to the Bank, Melton certified
that: "I incurred no liability for income tax imposed under subtitle
A of Title 26 of the Internal Revenue Code for the preceding taxable
year." FDIC Exh. 16, p. 6.
81. On the Form 6450 Questionnaire to Determine Exemption from
Withholding, dated October 1, 1997, that Melton submitted to the Bank,
Melton checked a box signifying her agreement with the following
statement: "Last year, I had a right to a refund of ALL income tax
withheld because I did not have any Federal income tax liability."
FDIC Exh. 16, p. 4.
82. On the Form W-8 Certificate of Foreign Status, dated October 1,
1997, that Melton submitted to the Bank, Melton checked boxes
signifying her agreement with the following statements:
"For INTEREST PAYMENTS, I am not a U.S. citizen or resident (or
I am filing for a foreign corporation, partnership, estate, or
trust)."
"For DIVIDENDS, I am not a U.S. citizen or resident (or I am filing
for a foreign corporation, partnership, estate, or trust)."
"For BROKER TRANSACTIONS or BARTER EXCHANGES, I am an exempt foreign
person as defined in the instructions below."
FDIC Exh. 16, p. 2.
83. Melton altered the jurat on the In Lieu of Form W-4
Withholding Exemption Certificate, dated October 1, 1997, that she
submitted to the Bank by crossing out the word "the" and
replacing it with the word "these" and adding the phrase
"without prejudice UCC-1-207." FDIC Exh. 16, p. 6.
84. Melton altered the jurat on the Form 6450 Questionnaire to
Determine Exemption from Withholding, dated October 1, 1997, that she
submitted to the Bank by adding the phrase "without prejudice
UCC-1-207." FDIC Exh. 16, p. 5.
85. Melton altered the jurat on the Form 590 Nonresident Withholding
Exemption Certificate, dated October 1, 1997, that she submitted to the
Bank by crossing out the phrase "resident of California" and
adding the phrase "Citizen of California Republic", and adding
the phrase "without prejudice UCC-1-207." FDIC Exh. 16, p. 3.
86. Melton altered the jurat on the Form W-8 Certificate of Foreign
Status, dated October 1, 1997, that she submitted to the Bank by adding
the phrases "I am a Citizen of California Republic" and
"without prejudice UCC-1-207." FDIC Exh. 16, p. 2.
87. As a consequence of the documentation provided by Melton to the
Bank, the Bank stopped the withholding of Federal and State income
taxes from Melton's compensation at the Bank as of October 15, 1997.
Resps. Stips. ¶¶ 12, 13; FDIC Exh. 114.
88. The Bank continued to stop the withholding of Federal and State
income taxes from Melton's compensation through July 31, 1999. Resps.
Stips. ¶¶12, 13; Joint Stips., Section II, ¶8; FDIC Exh. 90, p. 2.
89. On January 31, 1998, Melton submitted another Form W-8 Certificate
of Foreign Status to the Bank in which she claimed that she was not a
U.S. citizen or resident, and on which she altered the jurat to add the
phrase "without prejudice, UCC-1-207." FDIC Exh. 17.
90. On March 24, 1999, Melton submitted a letter to Shollenburg at the
Bank in which she provided notice to the Bank that she was a citizen
and resident of the United States, and that she was not a non-resident
alien. FDIC Exh. 20, pp. 23.
91. On March 24, 1999, Melton submitted a Statement of Citizenship and
Residence to the Bank, in which she declared that she was a citizen and
resident of the United States, and that the remuneration paid to her by
the Bank could not be legally withheld because it did not constitute
"wages" under section
{{10-31-03 p.A-3268.16}}
3401(a) and did not constitute "gross
income" under section 911. FDIC Exh. 20, pp. 48.
92. H. Hagy forwarded Melton's Statement of Citizenship and Residence,
dated March 24, 1999, to the Internal Revenue Service's Philadelphia,
Pennsylvania office on March 25, 1999. FDIC Exh. 20.
93. Melton submitted a tax return to the Internal Revenue Service for
the tax year 1996 in which she declared that she had incurred tax
liability. Guterman, vol. 3, p. 270, lines 118.
94. On February 1, 1998, Melton submitted a letter to the Bank in which
she requested that the Bank discontinue the withholding of Social
Security tax from her compensation, by stating: "I therefore request
that my employer, First Mountain Bank, discontinue the withholding of
Social Security Tax from my compensation immediately as I no longer
wish to participate in the voluntary program due to being fully
vested." FDIC Exh. 18.
95. In her February 1, 1998 letter to the Bank, Melton stated: "An
additional positive note is that you, as my employer, will no longer be
responsible for paying matching contributions on my behalf." FDIC
Exh. 18.
96. Melton's letter to the Bank, dated February 1, 1998, requesting
the discontinuance of withholding of Social Security tax from her
compensation was witnessed by H. Hagy and Shollenburg on February 3,
1998. FDIC Exh. 18.
97. On December 1, 1998, Melton submitted a letter to H. Hagy in which
she indicated that she had provided the Bank with the proper
documentation, including a Statement of U.S. Citizenship, to stop
withholding of Federal, State, Social Security and Medicare taxes,
thereby eliminating the issuance of a W-2 wage statement to the IRS for
year end 1998. FDIC Exh. 19.
98. Paychex did not stop the withholding of Social Security and
Medicare taxes from Melton's compensation until after November 13,
1998, when it received letters from H. Hagy, on behalf of the Bank,
holding Paychex harmless for complying with the request. FDIC Exh. 90,
p. 3.
99. After receiving the hold harmless letters from H. Hagy, Paychex
prepared amended payroll tax returns for the first three taxable
quarters of 1998, which reported no Social Security and Medicare wages
and taxes pertaining to Melton's compensation for calendar year 1998.
It is unclear whether the amended payroll tax returns were filed. FDIC
Exh. 90, pp. 34.
100. As a consequence of the documentation provided by Melton to the
Bank, the Bank stopped withholding Social Security and Medicare taxes
from Melton's salary as of January 1998. Resps. Stips. ¶17; Joint
Stips., Section II, ¶12.
101. In January 1999, through Paychex, the Bank issued a Wage Statement
(Form W-2) for 1998 for Melton reporting no federal or state income tax
withholdings, Social Security or Medicare wages, or Social Security or
Medicare tax withholdings. FDIC Exh. 90, p. 4; FDIC Exh. 106, p. 4.
102. The Bank continued to refrain from withholding Social Security and
Medicare taxes from Melton's salary and the paying of its matching
share of Social Security and Medicare taxes attributable to Melton
through July 31, 1999. Resps. Stips. ¶18; Joint Stips., Section II,
¶13; FDIC Exh. 90, p. 2.
103. On August 20, 1997, R. Hagy submitted a letter to Shollenburg in
which he requested that the Bank no longer withhold Federal and/or
State income taxes from his compensation at the Bank. FDIC Exh. 22.
104. Shollenburg acknowledged receipt of R. Hagy's request to stop
withholding Federal and/or State income taxes from his compensation at
the Bank. FDIC Exh. 22.
105. As part of R. Hagy's request to stop the withholding of Federal
and/or State income taxes from his compensation at the Bank, R. Hagy
submitted the following documents: Affidavit of Citizenship and
Domicile, dated August 10, 1997; In Lieu of Form W-4 Withholding
Exemption Certificate, dated August 12, 1997; Form 6450 Questionnaire
to Determine Exemption from Withholding, dated August 12, 1997; Form
W-8 Certificate of Foreign Status, dated August 12, 1997; and Form 590
Nonresident Withholding Exemption Certificate. FDIC Exh. 22.
106. On the Affidavit of Citizenship and Domicile, dated August 10,
1997, that R. Hagy submitted to the Bank, R. Hagy declared, among other
things: ". . . I am not a citizen of the United States
. . ." and ". . . I am a `Nonresident
Alien' . . ." Further, "I am a Citizen of the
contiguous California Republic . . ." FDIC Exh. 22, p.
2.
{{10-31-03 p.A-3268.17}}
107. The Affidavit of Citizenship and Domicile, dated August 10, 1997,
that R. Hagy submitted to the Bank was witnessed by H. Hagy and Melton.
FDIC Exh. 22, p. 2.
108. On the In Lieu of Form W-4 Withholding Exemption Certificate,
dated August 12, 1997, that R. Hagy submitted to the Bank, R. Hagy
claimed to be exempt from income tax withholding. FDIC Exh. 22, p. 3.
109. On the In Lieu of Form W-4 Withholding Exemption Certificate,
dated August 12, 1997, that R. Hagy submitted to the Bank, R. Hagy
certified that: "I incurred no liability for income tax imposed
under subtitle A of Title 26 of the Internal Revenue Code for the
preceding taxable year." FDIC Exh. 22, p. 3.
110. On the Form 6450 Questionnaire to Determine Exemption from
Withholding, dated August 12, 1997, that R. Hagy submitted to the Bank,
R. Hagy checked a box signifying his agreement with the following
statement: "Last year, I had a right to a refund of ALL income tax
withheld because I did not have any Federal income tax liability."
FDIC Exh. 22, p. 4.
111. R. Hagy altered the jurats on the In Lieu of Form W-4 Withholding
Exemption Certificate, dated August 12, 1997, and the Form 6450
Questionnaire to Determine Exemption from Withholding, dated August 12,
1997, that he submitted to the Bank by crossing out "under
penalty(ies) of perjury" and adding the phrase "without prejudice
UCC-1-207." FDIC Exh. 22, pp. 3, 5.
112. R. Hagy altered the jurat on the Form W-8 Certificate of Foreign
Status, dated August 12, 1997, that he submitted to the Bank by adding
the phrase "without prejudice UCC-1-207." FDIC Exh. 22, p. 6.
113. As a consequence of the documentation provided by R. Hagy to the
Bank, the Bank stopped the withholding of Federal and State income
taxes from R. Hagy's compensation at the Bank as of August 15, 1997.
Resps. Stips. ¶11; FDIC Exh. 114.
114. The Bank continued to stop the withholding of Federal and State
income taxes from R. Hagy's compensation through July 31, 1999. FDIC
Exh. 90, p. 2.
115. On September 9, 1997, R. Hagy provided the same set of documents
to Shollenburg authorizing the Bank to no longer withhold Federal
and/or State income taxes that he had provided on August 20, 1997. FDIC
Exh. 23.
116. On February 18, 1999, R. Hagy submitted a letter to Shollenburg at
the Bank in which he provided notice to the Bank that he was a citizen
and resident of the United States, and that he was not a non-resident
alien. FDIC Exh. 24, pp. 23.
117. On February 18, 1999, R. Hagy submitted a Statement of Citizenship
and Residence to the Bank, in which he declared that he was a citizen
and resident of the United States, and that the remuneration paid to
him by the Bank could not be legally withheld because it did not
constitute "wages" under section 3401(a) and did not constitute
"gross income" under section 911. FDIC Exh. 24, pp. 48.
118. Shollenburg forwarded R. Hagy's Statement of Citizenship and
Residence, dated February 18, 1999, to the Internal Revenue Service's
Philadelphia, Pennsylvania office on March 12, 1999. FDIC Exh. 24.
119. R. Hagy submitted a tax return to the Internal Revenue Service for
the tax year 1996 in which she declared that he had incurred tax
liability. FDIC Exh. 124; Guterman, vol. 3, p. 270, lines 118.
120. R. Hagy chose not to stop the withholding of Social Security and
Medicare taxes because he was older and felt that at some point he
wanted to avail himself of Social Security benefits. H. Hagy, vol. 5,
p. 172, lines 1221.
121. On November 17, 1997, Knudson submitted a letter to Shollenburg in
which she requested that the Bank no longer withhold Federal and/or
State income taxes from her compensation at the Bank. FDIC Exh.
26.
122. On November 24, 1997, Shollenburg acknowledged receipt of
Knudson's request to stop withholding Federal and/or State income
taxes from her compensation at the Bank. FDIC Exh. 26.
123. As part of Knudson's request to stop the withholding of Federal
and/or State income taxes from her compensation at the Bank, Knudson
submitted the following documents: Affidavit of Citizenship and
Domicile, dated November 17, 1997; Form W-4 Employee's Withholding
Allowance Certificate, dated November 17, 1997; Form 6450 Questionnaire
to Determine Exemption from Withholding, dated November 17, 1997;
{{10-31-03 p.A-3268.18}}
Form W-8 Certificate of Foreign Status, dated November 17, 1997;
and Form 590 Nonresident Withholding Exemption Certificate, dated
November 17, 1997. FDIC Exh. 26.
124. On the Affidavit of Citizenship and Domicile, dated November 17,
1997, that Knudson submitted to the Bank, Knudson declared, among other
things: ". . . I am not a citizen of the United States
. . ." and "I am a `Nonresident Alien' . . ." Further, "I am a Citizen of the contiguous California
Republic . . ." FDIC Exh. 26, p. 2.
125. The Affidavit of Citizenship and Domicile, dated November 17,
1997, that Knudson submitted to the Bank was witnessed by H. Hagy and
Melton. FDIC Exh. 26, p. 2.
126. On the Form W-4 Employee's Withholding Allowance Certificate,
dated November 17, 1997, that Knudson submitted to the Bank, Knudson
claimed to be exempt from income tax withholding. FDIC Exh. 26, p. 3.
127. On the Form W-4 Employee's Withholding Allowance
Certificate, dated November 17, 1997, that Knudson submitted to the
Bank, Knudson certified that she had a right to a refund of all income
tax withheld the preceding year because she did not have any Federal
income tax liability. FDIC Exh. 26, p. 3.
128. On the Form W-4 Employee's Withholding Allowance Certificate,
dated November 17, 1997, that Knudson submitted to the Bank, Knudson
certified that she expected to have a right to a refund of all income
tax withheld during the current year because she did not expect to have
any Federal income tax liability. FDIC Exh. 26, p. 3.
129. On the Form 6450 Questionnaire to Determine Exemption from
Withholding, dated November 17, 1997, that Knudson submitted to the
Bank, Knudson checked a box signifying her agreement with the following
statement: "Last year, I had a right to a refund of ALL income tax
withheld because I did not have any Federal income tax liability."
FDIC Exh. 26, p. 4.
130. On the Form W-8 Certificate of Foreign Status, dated
November 17, 1997, that Knudson submitted to the Bank, Knudson checked
a box signifying her agreement with the following statement: "For
INTEREST PAYMENTS, I am not a U.S.citizen or resident (or I am filing
for a foreign corporation, partnership, estate, or trust)." FDIC
Exh. 26, p. 6.
131. Knudson altered the jurats on the Form W-4 Withholding Exemption
Certificate, dated November 17, 1997, the Form 6450 Questionnaire to
Determine Exemption from Withholding, dated November 17, 1997, and the
Form W-8 Certificate of Foreign Status, dated November 17, 1997, that
she submitted to the Bank by adding the phrase "without prejudice
UCC-1-207." FDIC Exh. 26, pp. 36.
132. Knudson altered the jurat on the Form 590 Nonresident Withholding
Exemption Certificate, dated November 17, 1997, that she submitted to
the Bank by changing "penalties" to "penalty," changing
"resident of California" to "citizen of California
republic," and adding the phrase "without prejudice
UCC-1-207." FDIC Exh. 26, p. 7.
133. As a consequence of the documentation provided by Knudson to the
Bank, the Bank stopped the withholding of Federal and State income
taxes from Knudson's compensation at the Bank as of November 30, 1997.
Resps. Stips. ¶¶12, 14; FDIC Exh. 114.
134. The Bank continued to stop the withholding of Federal and State
income taxes from Knudson's compensation through July 31, 1999. Resps.
Stips. ¶¶12, 14; Joint Stips., Section II, ¶9; FDIC Exh. 90, p. 2.
135. On January 8, 1998, Knudson submitted another Form W-8 Certificate
of Foreign Status to the Bank on which she altered the jurat to add the
phrase "without prejudice UCC-1-207." FDIC Exh. 27.
136. On January 15, 1998, Knudson submitted another Form W-4
Employee's Withholding Allowance Certificate to the Bank in which she
claimed to be exempt from income tax withholding, and on which she
altered the jurat to add the phrase "without prejudice
UCC-1-207." FDIC Exh. 28.
137. On November 1, 1998, Knudson submitted a letter to H. Hagy at the
Bank in which she provided notice to the Bank that she was a citizen
and resident of the United States, and that she was not a non-resident
alien. FDIC Exh. 30, pp. 23.
138. On November 1, 1998, Knudson submitted a Statement of Citizenship
and Residence to the Bank, in which she declared that she was a citizen
and resident of the United States, and that the remuneration paid to
her by the Bank could not be legally withheld because it did not
constitute "wages" under section 3401(a) and did not constitute
"gross income" under section 911. FDIC Exh. 30, pp. 48.
139. H. Hagy forwarded Knudson's Statement
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of Citizenship and
Residence, dated November 1, 1998, to the Internal Revenue Service's
Philadelphia, Pennsylvania office on December 2, 1998. FDIC Exh. 30.
140. Knudson submitted a tax return to the Internal Revenue Service for
the tax year 1996 in which she declared that she had incurred tax
liability. Guterman, vol. 3, p. 270, lines 18.
141. On May 26, 1998, Knudson submitted a letter to Shollenburg in
which she requested that the Bank discontinue the withholding of Social
Security tax from her compensation, by stating: "Please continue
with no withholding of Federal and/or State income taxes
from my compensation for labor. Also do not withhold Social Security
from my compensation." FDIC Exh. 29.
142. Paychex did not stop the withholding of Social Security and
Medicare taxes from Knudson's compensation until after November 13,
1998, when it received letters from H. Hagy, on behalf of the Bank,
holding Paychex harmless for complying with the request. FDIC Exh. 90,
p. 3.
143. As a consequence of the documentation provided by Knudson to the
Bank, the Bank stopped withholding Social Security and Medicare taxes
from Knudson's salary in 1998. Resps. Stips. ¶19; Joint Stips.,
Section II, ¶14.
144. In January 1999, through Paychex, the Bank issued a Wage Statement
(Form W-2) for 1998 for Knudson reporting no federal or state income
tax withholdings, partial Social Security or Medicare wages, and
partial Social Security or Medicare tax withholdings. FDIC Exh. 106.
145. The Bank refrained from withholding Social Security and Medicare
taxes from Knudson's salary and the paying of its matching share of
Social Security and Medicare taxes attributable to Knudson through July
31, 1999. Resps. Stips. ¶20; Joint Stips., Section II, ¶15; FDIC Exh.
90, p. 2.
146. No Forms W-4 submitted by Shollenburg, H. Hagy, Melton, R. Hagy
and Knudson were filed by H. Hagy or Shollenburg with the IRS until
July 14, 1999. FDIC Exh. 93, pp. 12.
147. The IRS office in Philadelphia, Pennsylvania is responsible for
processing filings of tax returns by foreign taxpayers and United
States citizens residing abroad. Guterman, vol. 3, p. 126, lines
1523.
148. None of the filings by the Respondents with the Philadelphia,
Pennsylvania office of the IRS contained Forms W-4, Guterman, vol. 3,
p. 127, lines 48.
149. The IRS found the March 1999 documents filed by Melton and R. Hagy
to be invalid Forms W-4. FDIC Exhs. 122 & 123; Guterman, vol. 3, pp.
26064.
150. The issue of withholding Social Security taxes did not come to the
attention of Paychex until the fourth quarter of 1998. FDIC Exh. 90, p.
3.
151. In November 1998, on behalf of the Bank, H. Hagy wrote letters to
Paychex, the Bank's payroll processor, in which she directed Paychex
to block Social Security and Medicare withholding from the compensation
of Shollenburg, H. Hagy and Melton. Resps. Stips. ¶15; Joint Stips.,
Section II, ¶10; FDIC Exh. 90, p. 3.
152. Linda Hoisington of Paychex believed that the Bank could not claim
that Shollenburg, H. Hagy, Melton and Knudson were exempt from Social
Security taxes. FDIC Exh. 90, p. 3.
153. Linda Hoisington suggested to Kathy McCoy, the Bank's payroll
supervisor, and H. Hagy that the Bank verify the correctness of its
actions with respect to Social Security withholding with its
accountants or a tax attorney. FDIC Exh. 90, p. 3.
154. None of the Respondents verified the correctness of their actions
with the Bank's accountants or a tax attorney. To the contrary, the
Bank's accountants rejected the Respondents' position, and the
Bank's corporate attorney, who was not a tax attorney, had advised
that the Bank must withhold for Social Security and Medicare taxes. In
addition, Melton and Knudson relied on the actions of Shollenburg and
H. Hagy in this regard. Resps. Stips. ¶¶2125; Comer, vol. 1, pp.
3944; Findley, vol. 2, pp. 16364 & p. 179, lines 1724; Hagy, vol.
5, p. 113, lines 721 & pp. 11619.
155. On November 13, 1998, H. Hagy sent a letter to Mike Lujan of
Paychex, in which H. Hagy agreed that the Bank would hold Paychex
harmless for complying with the request that Paychex cease the
withholding of Social Security and Medicare taxes from the compensation
of H. Hagy and Melton. Resps. Stips. ¶16; Joint Stips., Section II,
¶11; FDIC Exh. 93, p. 6.
156. On December 7, 1998, H. Hagy sent
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a memorandum to Teri of Paychex,
in which H. Hagy enclosed a letter agreeing that the Bank would hold
Paychex harmless for complying with the request that Paychex cease the
withholding of Social Security and Medicare taxes from the compensation
of Shollenburg, H. Hagy and Melton. FDIC Exh. 95.
157. Paychex required the hold harmless letters executed by H. Hagy
before it would "code these employees exempt for Social
Security." FDIC Exh. 93, p. 3.
158. In another November 13, 1998 letter from H. Hagy to Mike Lujan of
Paychex, H. Hagy requested that Paychex not issue a W-2 to Shollenburg.
FDIC Exh. 93, p. 5.
159. On February 27, 1999, H. Hagy sent a letter to Paychex in which
she advised Paychex of Shollenburg's request to remove his Social
Security number from all records in the Bank's payroll system. FDIC
Exh. 94.
160. In March 1999, Paychex advised the Bank that filing payroll tax
returns without Shollenburg's Social Security number did not make
Shollenburg exempt from state or federal tax withholding and could
subject the Bank to penalties for filing returns with missing
information. FDIC Exh. 90, p. 4.
161. On March 26, 1999, by letter from the Bank signed by either
Shollenburg or H. Hagy, each individual Respondent was asked to provide
indemnification to the Bank should the Internal Revenue Service and/or
the California Franchise Tax Board claim that the Bank was required to
pay taxes on behalf of each individual Respondent. FDIC Exhs. 9. 15,
21, 25 & 31.
162. Each individual Respondent signified his or her assent to the
Bank's request for indemnification by signing and returning the
Bank's March 26, 1999 letter. Resps. Ans. ¶72.
163. The first time the Bank's board of directors heard of the
employee income tax withholding issue was in January 1998. Jasperson,
vol. 2, p. 247, lines 614; Clarke, vol. 3, p. 15, lines 610.
164. Upon learning that employees had caused the Bank to not withhold
for income taxes, at least one of the directors Ms. Sharon Jasperson,
who testified at the hearing, became concerned for the Bank's
reputation and that the Bank would incur additional liabilities.
Jasperson, vol. 2, pp. 24748.
165. The Bank's reputation in the Big Bear Lake area came under
scrutiny and people in the community voiced their concern that the Bank
was involved in the tax withholding issues. Clarke, vol. 3, p. 26,
lines 522.
166. At least one director, Mr. Ronald E. Clark, testified that he was
concerned that the Bank might be taken over by government bank
regulators. FDIC Exh. 82; Tr. vol. III, p. 26.
167. Mr. Clarke was concerned that the Bank's financial solidarity
might be questioned which might result in regulatory problems or a
lowered bank examination rating. Clarke, vol. 3, pp. 2526; FDIC Ex.
82.
168. Bank employees were very concerned that the Respondents'
actions would cause the Bank to lose accounts, lose its image in the
community and possibly cause the Bank to be closed. Jasperson, vol. 2,
pp. 25556.
169. Bank director Ron Clarke ("Clarke") was concerned that the
income tax situation was "coming out of the Bank." When Clarke
expressed his concerns to Shollenburg in February 1998, Shollenburg
attempted to hand him the book Vultures in Eagle's
Clothing. Shollenburg told Clarke that he had bought $2,000 worth
of the books, and told Clarke to read it, that it might change his
mind. Clarke, vol. 3, p. 12, lines 321.
170. Clarke declined to accept a copy of Vultures in Eagle's
Clothing from Shollenburg because he "did not think it was
something that should happen within the bank's area of operation or
especially on the bank's premises." Clarke, vol. 3, p. 12, lines
2021 & p. 13, lines 612.
171. Clarke equated Vultures in Eagle's Clothing to
"UFO-type of reports." Clarke, vol. 3, pp. 7172.
172. H. Hagy admitted that the In Lieu of W-4 Forms, Forms 6450
Questionnaires, Forms W-8 and Forms 590 which were submitted to the
Bank were obtained from Vultures in Eagle's Clothing. FDIC
Exh. 118; Hagy, vol. 5, pp. 14748.
173. The Affidavit of Citizenship and Domicile submitted by all of the
Respondents in which they claimed to be nonresidents of the United
States is virtually identical to page 201 of Vultures in Eagle's
Clothing. FDIC Exh. 118, p. 201.
174. Vultures in Eagle's Clothing recommends reserving
one's rights under UCC §1-207 any time a document is executed. FDIC
Exh. 118, pp. 16566.
175. Vultures in Eagle's Clothing advocates the use of
"pure trusts" as a tax-avoidance
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mechanism. FDIC Exh. 118, pp.
22023.
176. Lynne Meredith, the author of Vultures in Eagle's
Clothing was subsequently indicted for violating tax laws.
Respondents' Motion for Clarification and Request for Dismissal, pp.
45; Hagy, vol. 5, p. 148, lines 2125.
177. H. Hagy knew that Lynne Meredith was under IRS scrutiny prior to
her indictment, but still used the document in Vultures in
Eagle's Clothing for her submission of tax documents to the Bank.
Hagy, vol. 5, p. 182, lines 1221.
178. Gary Findley ("Findley") was the Bank's counsel for
corporate and regulatory issues, but not for criminal or tax issues.
Findley, vol. 2, pp. 16364.
179. Legal issues outside of Findley's area of practice were referred
to other attorneys. Findley, vol. 2, pp. 163164.
180. Findley first learned of the employee income tax withholding issue
from Dennis Shollenburg in the early part of February 1998. Findley,
vol. 2, p. 170, lines 13.
181. Findley was not informed that the Respondents planned to stop
withholding income taxes for 1997. Findley, vol. 2, p. 172, lines
1113.
182. H. Hagy told Findley that all the necessary paperwork had been
filed with the Internal Revenue Service and the Franchise Tax Board.
Findley, vol. 2, p. 176, lines 320 & p. 204, lines 614.
183. A meeting of the Bank's board of directors was held on March 28,
1998. FDIC Exh. 41.
184. There is no record of the issue of income tax withholding being
raised at a meeting of the Bank's board of directors prior to March
28, 1998. FDIC Exhs. 3339.
185. On March 23, 1998, prior to the March 1998 board meeting, Findley
prepared a memorandum to the Bank's board of directors on the subject
of pure trusts and employee income tax withholding. FDIC Exh. 85.
186. Findley's March 23, 1998 memorandum was discussed at the March
28, 1998 board meeting. Findley, vol. 2, p. 174, lines 1825.
187. At the time of the March 28, 1998 board meeting, Findley advised
the Bank's board of directors that if all the necessary paperwork had
been filed by the Bank with the Internal Revenue Service and the
Franchise Tax Board, then the Bank had taken the appropriate action.
FDIC Exh. 85, p. 2; Findley, vol. 2, p. 175, lines 1824.
188. At the time of the March 28, 1998 board meeting, Findley advised
the Bank's board of directors that the Bank must withhold for Social
Security and Medicare taxes. FDIC Exh. 85, p. 44; Findley, vol. 2, p.
179, lines 1722.
189. At the time of the March 28, 1998 board meeting, Findley advised
the Bank's board of directors, including Shollenburg, that if an
individual employee misused employee income tax withholding then the
Internal Revenue Service or the Franchise Tax Board may take action.
FDIC Exh. 85, p. 2; Findley, vol. 2, p. 177, lines 515.
190. At the time of the March 28, 1998 board meeting, Findley advised
the Bank's board of directors that the Bank would suffer a
reputational risk if there was some action taken against an employee of
the Bank by the Internal Revenue Service or the Franchise Tax Board.
FDIC Exh. 85, p. 2; Findley, vol. 2, pp. 17778.
191. When Findley recommended to the Bank's board of directors at the
time of the March 28, 1998 board meeting that "individual employees
minimize their visibility in the community with regard to this
particular [tax] issue," he was concerned with reputational risk
to the Bank. FDIC Exh. 85, p. 2; Findley, vol. 2, pp. 17778.
192. At the time of the March 28, 1998 board meeting, Shollenburg told
Findley that he would indemnify the Bank for any expenses, costs or
taxes that were due that were not appropriately paid. FDIC Exh. 85, p.
44; Findley, vol. 2, p. 177, lines 1620.
193. At the March 28, 1998 board meeting, the Respondents that were
present told the concerned board of directors that they would never do
anything that was going to harm the Bank. Jasperson, vol. 2, p. 248,
lines 1118.
194. Shollenburg stated on numerous occasions that he would never do
anything to harm the Bank. Jasperson, vol. 2, p. 257, lines 511;
Clarke, vol. 3, p. 27, lines 412. See, e.g.,
FDIC Exh. 65, p. 6 ("President Shollenburg responded that he never
had and never would intentionally do anything to hurt the Bank.")
{{10-31-03 p.A-3268.22}}
195. H. Hagy made statements on numerous occasions that she would never
do anything to harm the Bank. Jasperson, vol. 2, p. 257, lines 511;
Clarke, vol. 3, p. 27, lines 416.
196. The Respondents that were present at the March 28, 1998 board
meeting also told the Bank's board of directors that they would set up
their own accounts and deposit the amount of taxes that would normally
have been taken from their salaries into those accounts so that funds
would be available to pay the taxes should the Respondents be notified
by the Internal Revenue Service or the Franchise Tax Board that they
had to pay the taxes. FDIC Exh. 85, p. 44; Findley, vol. 2, pp.
17879; Jasperson, vol. 2, p. 248, lines 1124.
197. The directors believed that the separate accounts to be maintained
by the Respondents would protect the Bank from liability. Jasperson,
vol. 2, pp. 24849.
198. H. Hagy testified that the separate accounts were never set up
because the Respondents were never mandated by the Bank's board of
directors to do so. H. Hagy, vol. 5, p. 170, lines 819.
199. The Bank's board of directors requested Findley to get a
representation that all appropriate documents had been filed with
respect to the employee March income tax withholding. FDIC Exh. 41, p.
4; Findley, vol. 2, pp. 18081.
200. H. Hagy represented to Findley that all the appropriate documents
that were required to be filed with the Internal Revenue Service and
the Franchise Tax Board had been submitted. Findley, vol. 2, p. 180,
lines 1123.
201. On or about July 24, 1998, Findley requested H. Hagy to retain all
of the payroll records showing that the necessary forms were filed with
the Internal Revenue Service and the Franchise Tax Board so the Bank
would have them for future reference. Findley, vol. 2, pp. 8384.
202. As of July 24, 1998, Findley thought that the employee income tax
withholding issue was taken care of by the filing of all of the
necessary documents with the Internal Revenue Service and the Franchise
Tax Board. Findley, vol. 2, p. 184, lines 1420.
203. After July 24, 1998, the next time the employee income tax
withholding issue was discussed with Findley and the Bank's board of
directors was at a board meeting on April 26, 1999 when the results of
an external audit of the Bank by the accounting firm of Vavrinek,
Trine, Day & Company, LLP ("Vavrinek Firm") were reported.
Jasperson, vol.2, p. 249, lines 714; Findley, vol. 2, pp. 18586.
204. There is no record of the income tax withholding issue being
discussed at any meetings of the Bank's board of directors between
March 28, 1998 and April 26, 1999. FDIC Exhs. 4255.
205. The Vavrinek Firm is a public accounting firm that, by size, is in
the top 100 accounting firms in the nation. Dayton, vol. 2, p. 28,
lines 25 & p. 32, lines 911.
206. Karen Comer ("Comer"), a Certified Public Accountant (Comer,
vol. 1, p. 32, lines 918), was the partner at the Vavrinek Firm who
was responsible for the Bank's audit engagement. Comer, vol. 1, p. 37,
lines 213.
207. The Vavrinek Firm provided various services to the Bank, including
preparation of the year-end audited financial statements. Comer, vol.
1, pp. 3637.
208. David Dayton ("Dayton"), a Certified Public Accountant with
a Master's of Business Taxation degree (Dayton, vol. 2, pp. 2829),
was the managing partner of the Vavrinek Firm's Orange County office.
Dayton, vol. 2, pp. 3334.
209. The Vavrinek Firm's Orange County office has a specialty of
providing services, including auditing financial statements, preparing
tax returns and other regulatory services, to community banks. Dayton,
vol. 2, pp. 3233.
210. Comer had been involved in audits of the Bank for approximately
ten years, with six years as responsible partner. Comer, vol. 1, p. 37,
lines 28.
211. The Vavrinek Firm had prepared the Bank's audited year-end
financial statements for 1997 and Comer was the partner responsible for
the audit. Nothing concerning the failure to withhold taxes had come to
her attention in connection with the preparation of the audited
year-end financial statements for 1997. Comer, vol. 1, p. 65, lines
918.
212. There is no specific audit test for determining whether an audit
client is withholding taxes. There is analysis in connection with
expenses, but the audit did not identify anything for 1997. Comer, vol.
1, p. 65, lines 1525.
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213. Tax withholding is generally considered a very low risk area for
community banks. Comer, vol. 1, p. 66, lines 113.
214. From Comer's experience, the payroll tax area is not something
that has ever been a problem in community banks. Comer, vol. 1, p. 66,
lines 113.
215. H. Hagy was Comer's contact for the BSA review. Comer, vol. 1, p.
40, lines 68.
216. In the course of the BSA review, H. Hagy raised the subject of
income and payroll tax withholding. Comer, vol. 1, p. 40, lines 920.
217. H. Hagy gave Comer a letter from which all identifying information
had been removed, which discussed withholding of payroll and income
taxes. Comer, vol. 1, pp. 4041.
218. Comer later gave H. Hagy her professional opinion on these
materials provided by H. Hagy. Comer's opinion was that she did not
agree with the position expressed on the withholding of payroll and
income taxes. Comer, vol. 1, p. 41, lines 724.
219. H. Hagy admitted that she had received advice from Comer that, in
the opinion of the Vavrinek Firm, H. Hagy's position that she could
legally stop withholding income taxes was not supportable. Hagy, vol.
5, p. 113, lines 711.
220. At no time in the fall of 1998 did H. Hagy advise Comer that
certain employees of the Bank had stopped withholding of taxes from
their Bank compensation. Comer, vol. 1, pp. 4142 & p. 43, lines
1719.
221. Comer discussed the materials that H. Hagy had given to her with
members of the tax department at the Vavrinek Firm. Comer, vol. 1, p.
42, lines 410. They concurred with Comer's opinion that the position
expressed in these materials was wrong. Comer, vol. 1, pp. 4243.
222. H. Hagy never advised the Bank's board of directors of the
Vavrinek Firm's verbal conclusion in December 1998 that the submission
of the types of Forms W-4, Citizenship Affidavits and Forms W-8 that
were being submitted by the Respondents was not legal. Hagy, vol. 5,
pp. 12021.
223. At the end of December 1998, Comer went to the Bank to start the
interim auditing for the Bank's 1998 year-end audited financial
statement. Comer, vol. 1, p. 42, lines 1320.
224. H. Hagy was Comer's contact for the interim audit of the Bank's
1998 year-end audited financial statement. Comer, vol. 1, pp. 4344.
225. During the interim audit, Comer had a conversation with H. Hagy in
which she advised her that to go forward with non-withholding of income
taxes could mean the end of her career or some legal action against her
and the Bank. Comer, vol. 1, pp. 4243.
226. Comer asked to see the Bank's payroll runs and related documents
as a part of the audit of the Bank's 1998 year-end audited financial
statement. Comer, vol. 1, pp. 4748.
227. Comer used the Bank's payroll run and related documents to do a
more extensive payroll audit than she would normally do with a bank.
Comer, vol. 1, p. 47, lines 1116.
228. In the course of the payroll audit, Comer was surprised to
discover that certain employees at the Bank were not having payroll and
income taxes withheld from their Bank compensation. Comer, vol. 1, pp.
4849.
229. Comer confirmed with H. Hagy that certain Bank employees
were not having taxes withheld from their Bank compensation, including
Shollenburg, H. Hagy, Melton, R. Hagy and Knudson. Comer, vol. 1,
p. 49.
230. Comer formed the opinion that the Bank had not taken the proper
steps to stop withholding of taxes from the employees' Bank
compensation. Comer, vol. 1, p. 50, lines 1015.
231. Comer was concerned, among other things, about the Bank's failure
to meet its corporate responsibilities. Comer, vol. 1, pp. 4950.
232. Comer took her concerns about the non-withholding at the Bank to
the Vavrinek Firm's administrative committee, now called the executive
committee, which is in essence the management committee of the firm.
Comer, vol. 1, pp. 5051.
233. The Vavrinek Firm agreed that what had occurred at the Bank
constituted an illegal act and that the Vavrinek Firm had to
communicate with the Bank's audit committee and perhaps disclose a
contingent liability in the Bank's financial statements. Comer, vol.
1, pp. 5152.
234. Dayton at that time was a member of the Vavrinek Firm's executive
committee. Dayton, vol. 2, pp. 3334 & pp. 3738.
{{10-31-03 p.A-3268.24}}
235. Dayton formed the opinion that the Bank had improperly applied the
rules of withholding to get around the system and block tax
withholding. Dayton, vol. 2, pp. 4243.
236. Statements of Auditing Standards are promulgated by the American
Institute of Certified Public Accountants and are considered
authoritative guidance for auditors. Dayton, vol. 2, pp. 4748.
237. Statement of Auditing Standard 54 specifically states that failure
to file tax returns or pay government duties or similar fees common to
the entity's industry or the nature of its business is an example of
specific information that may raise questions about the existence of
illegal acts. FDIC Exh. 70.
238. Comer and Dayton met with H. Hagy and Shollenburg on March 9, 1999
in Big Bear Lake. Comer, vol. 1, p. 53, lines 1117; Dayton, vol. 2,
p. 49, lines 1119.
239. Comer prepared a discussion draft for the March 9, 1999 meeting
entitled "First Mountain Bank, Discussion Memorandum on Possible
Audit Exception." The discussion draft was provided to H. Hagy and
Shollenburg before the meeting. FDIC Exh. 71; Comer, vol. 1, pp.
5354.
240. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton advised that the Bank had improperly failed to withhold
income and FICA taxes from several executive officers of the Bank. FDIC
Exh. 71; Dayton, vol. 2, p. 51, lines 69.
241. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton advised that H. Hagy, as chief financial officer of the
Bank, had not properly filed Bank payroll tax returns, including the
transmittal of IRS Forms W-4. FDIC Exh. 71; Comer, vol. 1, p. 55, lines
1016; Dayton, vol. 2, pp. 5152.
242. H. Hagy denied that she had been influenced by other executive
officers in the process of not properly filing the Bank's payroll tax
returns. Comer, vol. 1, pp. 5556.
243. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton advised that the Bank had incorrectly reported a significant
portion of its payroll as exempt and did not properly withhold a
significant amount of income taxes from its officers. FDIC Exh. 71;
Comer, vol. 1, p. 56, lines 914.
244. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton recommended that the Bank should immediately file amended
payroll tax returns and include FICA and income taxes that were not
withheld in the original returns. FDIC Exh. 71; Comer, vol. 1, p. 56,
lines 1520; Dayton, vol. 1, p. 52, lines 916.
245. In essence, Comer and Dayton were recommending that the Bank
should immediately pay the taxes and penalties associated with the
amended returns. FDIC Exh. 72; Comer, vol. 1, pp. 5657 & pp. 6061;
Dayton, vol. 2, p. 52, lines 1722.
246. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton recommended that executive officers wishing to claim exempt
status should resubmit valid Forms W-4. FDIC Exhs. 71 & 72; Comer, vol.
1, p. 57, lines 711 & p. 60, lines 2224; Dayton, vol. 2, p. 52,
lines 916.
247. H. Hagy and Shollenburg did not agree with any of the points or
conclusions that Comer and Dayton discussed with them in the March 9,
1999 meeting. Comer, vol. 1, p. 57, lines 2125; Dayton, vol. 2, p.
53, lines 1620.
248. In the March 9, 1999 meeting with H. Hagy and Shollenburg, Comer
and Dayton also discussed the "Corporate Responsibilities for
Withholding" portion of the discussion draft entitled "First
Mountain Bank, Discussion Memorandum on Possible Audit Exception."
That section of the discussion draft discussed the employer's
responsibility for withholding and remitting income and FICA taxes; the
requirement to transmit Forms W-4; and the invalidation of Forms W-4 by
deleting or changing language. FDIC Exh. 71; Comer, vol. 1, p. 58,
lines 15; Dayton, vol. 2, pp. 5254.
249. Comer and Dayton presented their viewpoint that these matters that
the auditors were raising were corporate responsibility and the law. It
was not a matter of individual rights. Comer, vol. 1, p. 58, lines
117.
250. In the March 9, 1999 meeting, Comer and Dayton reiterated several
times that H. Hagy and Shollenburg had responsibilities as corporate
officers of the Bank. Specifically, Comer and Dayton reiterated that
the Vavrinek Firm was not concerned with the officers' personal
returns, personal filing preferences or personal tax beliefs, but
rather their responsibilities as corporate officers to
{{10-31-03 p.A-3268.25}}
follow the rules
and regulations that applied to corporations. Dayton, vol. 2, pp.
5354.
251. At the conclusion of the March 9, 1999 meeting, the position of H.
Hagy and Shollenburg versus Comer and Dayton's position was complete
disagreement as to the appropriateness of what had been done. Dayton,
vol. 2, pp. 5455.
252. Dayton advised H. Hagy and Shollenburg that they had to either
follow the recommendations of the Vavrinek Firm with respect to
correcting the tax withholding situation or they had to disclose it in
the financial statement. Dayton, vol. 2, p. 55, lines 421.
253. Comer prepared a one-page memorandum entitled "First Mountain
Bank, Discussion Memorandum on Possible Audit Exception, VTD
Professional Requirements," which was provided to Shollenburg and H.
Hagy at the same time as the "First Mountain Bank, Discussion
Memorandum on Possible Audit Exception." The discussion memorandum
included a proposed footnote to the Bank's financial statement. FDIC
Exh. 73; Comer, vol. 1, pp. 6162; Dayton, vol. 2, pp. 4950.
254. Comer and Dayton advised Shollenburg and H. Hagy that Comer and
Dayton had a professional obligation to meet with the Bank's Audit
Committee given that they had found an illegal act. They had a duty to
describe the illegal act and the circumstances surrounding it and to
provide an evaluation of the effect of the illegal act on the financial
statements. FDIC Exh. 73; Comer, vol. 1, pp. 6162.
255. Comer prepared a document entitled "First Mountain Bank,
Memorandum Concerning Withholding Taxes," which was provided to
Shollenburg and H. Hagy and which gave specific recommendations as to
what the Bank should do based on the matters that she and Dayton had
discussed in the March 9, 1999 meeting. FDIC Exh. 72; Comer, vol. 1,
pp. 5960.
256. In the "First Mountain Bank, Memorandum Concerning Withholding
Taxes," Comer recommended the following:
a. Since all wages are subject to Social Security and Medicare
taxes even if an employee claims to be "exempt" from taxes, all
Social Security and Medicare taxes, including the employer portion
should be paid;
b. New W-4 forms should be obtained from employees and any forms in
which the employee claims to be exempt, but is earning more than
$200/week should be sent to the IRS;
c. If a valid W-4 is not obtained, the Bank should withhold as if the
employee were single and claimed no withholding allowance; and
d. Since valid W-4's were not prepared for 1998, the Bank should amend
payroll tax returns for 1998 and remit tax as if the employees without
valid W-4's were single. The employees should reimburse the Bank for
the withholdings. FDIC Exh. 72.
257. Comer and Dayton recommended that all back taxes and
penalties be paid as soon as possible because, the longer you wait, the
more penalties that accrue. Comer, vol. 1, p. 61, lines 28.
258. In the course of the audit of the Bank's year-end 1998 financial
statements, Dayton was provided with a letter to the IRS dated February
18, 1999 in which all identifying information, including name, address,
Social Security number and signature of the author was removed. FDIC
Exh. 69; Dayton, vol. 2, pp. 7779.
259. The letter to the IRS dated February 18, 1999 was copied to United
States Senator Barbara Boxer, United States Senator Dianne Feinstein
and United States Representative Jerry Lewis. FDIC Exh. 69.
260. The letter to the IRS dated February 18, 1999 indicates that it
was in response to a letter from the IRS dated February 5, 1999. From
looking at the letter, Dayton can conclude that the author was a Bank
employee who had claimed to be a non-resident alien on his or her 1997
income tax return and that the IRS had rejected the claim of
non-resident alien status. FDIC Exh. 69; Dayton, vol. 2, pp. 8284.
261. Dayton discussed the letter to the IRS dated February 18, 1999
with Shollenburg who provided it as support for Shollenburg's position
that he was exempt and did not have to have taxes withheld. FDIC Exh.
69; Dayton, vol. 2, p. 84, lines 1218.
262. H. Hagy admitted that she had written a letter to the IRS which
was either similar to or was the actual letter to the IRS dated
February 18, 1999 provided by Shollenburg to Dayton. Hagy, vol. 5, pp.
15862.
{{10-31-03 p.A-3268.26}}
263. H. Hagy never advised the Bank's board of directors that as of
February 1999 the IRS had rejected the non-resident alien status
asserted by H. Hagy, Shollenburg, Melton, R. Hagy and Knudson in the
Forms W-4, Citizenship Affidavits and Forms W-8 submitted to the Bank
from August 1997 through January 1998. FDIC Exh. 69; Hagy, vol. 5, pp.
16164.
264. There is no record of the disclosure of any correspondence between
any of the Respondents and the IRS, including the letter to the IRS
dated February 18, 1999, in the minutes of meetings of the Bank's
board of directors. FDIC Exhs. 3365.
265. On March 15, 1999 Comer received a document entitled "First
Mountain Bank, Rebuttal on Possible Audit Exception" from H. Hagy.
This was a response to the Vavrinek Firm's "First Mountain Bank,
Discussion Memorandum of Possible Audit Exception" (FDIC Exh. 71).
Nothing that was said in the rebuttal document caused Comer or Dayton
to question the conclusions that they had reached on the tax
withholding situation at the Bank. FDIC Exh. 74; Comer, vol. 1, pp.
6263; Dayton, vol. 2, p. 56, lines 823.
266. At the same time that H. Hagy had sent the Vavrinek Firm her
response citing the IRS code and the CFR, she and Shollenburg started a
search for another accounting firm. Hagy, vol. 5, pp. 9697.
267. The minutes of meetings of the Bank's board of directors do not
reflect that the Bank's board of directors was informed in the time
period of March 1999 to April 1999 that Shollenburg and H. Hagy were
looking for a new auditing firm. FDIC Exhs. 55 & 56.
268. Shollenburg wrote Comer a letter dated March 15, 1999 about the
tax withholding situation at the Bank. FDIC Exh. 75; Comer, vol. 1, pp.
6364.
269. In his March 15, 1999 letter, Shollenburg alleged that the
Vavrinek Firm had known about "our situation" back in August of
1998. Comer testified that she had not known about the tax withholding
situation at the Bank in August of 1998. FDIC Exh. 75; Comer, vol. 1,
p. 64, lines 2125.
270. In his March 15, 1999 letter, Shollenburg stated that "[t]his
process" had been ongoing since September 1997. Comer testified that
she had not learned about the failure to withhold taxes at the Bank
until 1999. In fact, it was Shollenburg's letter that first alerted
her that the failure to withhold had actually begun in 1997. FDIC Exh.
75; Comer, vol. 1, p. 65, lines 18.
271. In his March 15, 1999 letter, Shollenburg alleged that withholding
the Bank's financial statement amounted to extortion and blackmail.
Comer and Dayton denied this allegation. FDIC Exh. 75; Comer, vol. 1,
p. 67, lines 17; Dayton, vol. 2, p. 57, lines 58.
272. Comer and Dayton both interpreted the March 15, 1999 letter from
Shollenburg as a threat or intimidation. FDIC Exh. 75; Comer, vol. 1,
p. 69, lines 68; Dayton, vol. 2, p. 59, lines 821.
273. In response to Shollenburg's request for a letter on Vavrinek,
Trine, Day & Co. letterhead explaining why the Vavrinek Firm was
withholding the audited financial statement and what needed to be added
to the approved draft copy, Dayton wrote and sent a letter dated March
15, 1999 to Shollenburg. FDIC Exh. 76; Comer, vol. 1, pp. 6970;
Dayton, vol. 2, p. 60, lines 517.
274. In the letter from the Vavrinek Firm dated March 15, 1999, Dayton
advised that the Bank had incorrectly filed in quarterly payroll tax
returns, incorrectly allowed several executive officers to avoid
withholding of federal and state income taxes and incorrectly reported
a significant amount of compensation as exempt from Social Security and
Medicare withholding. FDIC Exh. 76; Comer, vol. 1, pp. 7071; Dayton,
vol. 2, pp. 6061.
275. The Vavrinek Firm advised in its March 15, 1999 letter that the
conduct that the Bank had engaged in constituted illegal acts under its
professional standards. This opinion was joined in by Dayton, Comer,
other Vavrinek Firm partners and the Vavrinek Firm's administrative
committee. FDIC Exh. 76, p. 3; Comer, vol. 1, p. 70, lines 312;
Dayton, vol. 2, pp. 6162.
276. The Vavrinek Firm advised in its March 15, 1999 letter that it was
required by its professional guidelines to communicate directly with
the Bank's Audit Committee or full board of directors an overview of
the issue, its professional judgment on the issue and its
recommendations for resolution of the issue. FDIC Exh. 76, p. 3;
Dayton, vol. 2, pp. 6162.
277. A meeting was required with the Bank's Audit Committee so that
the tax withholding issue could be raised to a level beyond
{{10-31-03 p.A-3268.27}}
management
who was involved in the conduct. Dayton, vol. 2, p. 61, lines 914.
278. The size of the contingent liability had the potential to increase
over time because as additional funds were not withheld, the amended
returns would require more and more payment of back taxes. Dayton, vol.
2, p. 64, lines 17.
279. The contingent liability had to be disclosed in the year-end 1998
financial statement because it had the potential to accrue in the near
future after the date of the audit. This contingent liability met the
standards for disclosure. Dayton, vol. 2, p. 63, lines 725.
280. The Vavrinek Firm stated in its proposal footnote included in its
March 15, 1999 letter that "[t]he officers and employees involved
have indemnified the Bank from any loss in this matter." FDIC Exh.
76.
281. Shollenburg had represented to the auditors that he had
indemnified the Bank and that he had set aside funds sufficient to pay
his taxes if a problem should arise. Dayton, vol. 2, p. 65, lines
118.
282. All of the officers and employees' written indemnifications, in
fact, were dated March 26, 1999, after the date of the Vavrinek Firm's
March 15, 1999 letter. FDIC Exhs. 9, 15, 21, 25 & 31.
283. Part of the reason why the auditors did not accrue an actual
liability for the non-withheld income taxes was because of the
indemnifications from the officers that they had been told existed.
Dayton, vol. 2, pp. 6567.
284. Comer and Dayton met with the Bank's audit committee on April 26,
1999. FDIC Exhs. 56 & 77; Comer, vol. 1, pp. 7677; Dayton, vol. 2, p.
69, lines 611.
285. The entire board including Shollenburg, but excepting director
Kenneth Wood, was in attendance at the April 26, 1999 meeting. H. Hagy
and Melton were also in attendance at the meeting. FDIC Exh. 56.
286. In advance of the April 26, 1999 meeting with the Bank's board of
directors, Comer and Dayton prepared a letter on the Vavrinek Firm's
letterhead addressed to the Bank's audit committee. The letter was
signed by Dayton and distributed at the April 26, 1999 meeting. FDIC
Exh. 77; Comer, vol. 1, pp. 7677; Dayton, vol. 2, p. 69, lines 114.
287. In the April 26, 1999 memorandum that was distributed to the
Bank's board of directors, the Vavrinek Firm stated that the Bank had
not met its corporate responsibilities with respect to withholding and
payment of payroll taxes. Specifically, the Bank had:
a. Incorrectly reported taxable wages as exempt from Social
Security and Medicare taxes;
b. Incorrectly discontinued withholding federal and state income taxes
from employee's wages;
c. Accepted invalid Forms W-4's from selected employees;
d. Neglected to transmit Form W-4's claiming exempt status to the IRS;
and
e. Agreed to indemnify the Bank's payroll processor from any liability
in preparing the payroll tax returns that include the periods the above
items occurred.
FDIC Exh. 77.
288. The Vavrinek Firm stated that, in its opinion, the matters
that it had itemized in the April 26, 1999 letter constituted
"illegal acts." The Vavrinek Firm relied on Statement of Auditing
Standard 54 in arriving at this opinion. FDIC Exh. 77; Dayton, vol. 2,
p. 69, lines 1522.
289. The Vavrinek Firm further stated that it believed that the Bank's
position on these matters was not valid and could result in the
assessment of significant back taxes, interest and penalties against
the Bank. H. Hagy and Shollenburg had told Dayton what the Bank's
position was on these matters. FDIC Exh. 77; Dayton, vol. 2, p. 70,
lines 1425.
290. Tax expert Barry Guterman ("Guterman") testified that he
agreed with all five of the points that the Vavrinek Firm had made in
the April 26, 1999 letter. FDIC Exh. 77; Guterman, vol. 3, pp. 19293.
291. H. Hagy did not agree with any one of the five points that the
Vavrinek Firm had made in its April 26, 1999 letter. FDIC Exh. 77;
Hagy, vol. 5, pp. 8990.
292. The Vavrinek Firm recommended that:
a. The Bank file amended payroll tax returns, including all Social
Security, Medicare and income taxes that were not included in the
original returns;
b. All executive officers and employees wishing to claim exempt status
should resubmit valid Form W-4's and that the Form
{{10-31-03 p.A-3268.28}}
W-4's should be
submitted to the IRS as required; and
c. All back taxes and applicable penalties should be paid as soon as
possible.
FDIC Exh. 77.
293. The Vavrinek Firm also recommended that the Bank hire an
outside consultant or expert in the field to help minimize the Bank's
liability for back taxes, related penalties and future scrutiny by
federal and state agencies. FDIC Exh. 77.
294. The Vavrinek Firm's statement that the Bank had neglected to
transmit Form W-4's claiming exempt status to the IRS was based on H.
Hagy's representation to Comer. H. Hagy was very open about that
subject. FDIC Exh. 77; Comer, vol. 1, pp. 7778; Dayton, vol. 2, p.
127, lines 925.
295. At the time of the Vavrinek Firm's year-end 1998 audit of the
Bank, H. Hagy knew that the Forms W-4 submitted by Shollenburg, H.
Hagy, Melton, R. Hagy and Knudson had not been filed with the IRS.
Comer, vol. 1, pp. 7778; Hagy, vol. 5, pp. 12324.
296. There is no record in the minutes of meetings of the Bank's board
of directors reflecting that the board of directors was informed that
the Forms W-4 had not been submitted to the IRS. FDIC Exhs. 4255.
297. In Dayton's experience, when a Form W-4 is submitted to the IRS
in which an employee claims to be exempt, if the employee has filed tax
returns in the past that showed taxable income, the Form W-4 would be
kicked out immediately. Dayton, vol. 2, p. 125, lines 413.
298. The Vavrinek Firm's statement in the April 26, 1999 letter that
the Bank had agreed to indemnify the Bank's payroll processor from any
liability in preparing the payroll tax returns was based on discussions
with H. Hagy and Shollenburg. FDIC Exh. 77; Dayton, vol. 2, p. 71,
lines 524.
299. Comer also saw H. Hagy's memorandum to the Bank's payroll
processor, Paychex, which granted the indemnification. Comer, vol. 1,
pp. 7879.
300. Comer believed that H. Hagy did not have the authority to grant an
indemnification to Paychex on behalf of the Bank. Comer, vol. 1, p. 79,
lines 811.
301. Comer believed that it was not a good idea for H. Hagy to obligate
the Bank to indemnify Paychex. Comer, vol. 1, p. 79, lines 1215.
302. In Dayton's opinion, several of the items that he and Comer
brought up at the April 26, 1999 meeting were a surprise and that the
Bank's board members had not been aware of them. They believed that
the situation had been resolved or approved and that was not what the
Vavrinek Firm was telling them. Dayton, vol. 2, pp. 7475.
303. The Bank's board of directors, like Findley, was under the
impression that Paychex had filed all appropriate forms. Comer and
Dayton informed the Bank's board of directors that appropriate Forms
W-4 had not been filed for the employees claiming to be exempt.
Further, Comer and Dayton informed the Bank's board of directors that
a Statement of Citizenship, which was not applicable, had been filed
instead of Forms W-4 and they had been filed in Philadelphia. FDIC Exh.
68, p. 3.
304. There is no record in the minutes of meetings of the Bank's board
of directors reflecting that the Respondents had filed Statements of
Citizenship with the IRS to Philadelphia. FDIC Exhs. 4255.
305. At the April 26, 1999 meeting, Findley specifically denied that he
had looked at the income tax withholding situation and approved it. He
said that it was outside the scope or area of his expertise. Dayton,
vol. 2, pp. 7576.
306. Findley learned at the April 26, 1999 meeting of the Bank's board
of directors with the Vavrinek Firm that all five Respondents had
submitted improper W-4's. Findley, vol. 2, pp. 18788.
307. Findley learned at the April 26, 1999 meeting of the Bank's board
of directors with the Vavrinek Firm that the Bank was not appropriately
withholding for taxes and that the practice could create a contingent
liability. Findley, vol. 2, p. 190, lines 37.
308. Findley learned for the first time at the April 26, 1999 meeting
of the Bank's board of directors with the Vavrinek Firm that the Bank
was not withholding for Social Security and Medicare taxes. Findley,
vol. 2, pp. 18889 & p. 209, lines 1625.
309. Findley learned for the first time at the April 26, 1999 meeting
of the Bank's board of directors with the Vavrinek Firm that the Bank
had issued an indemnification to Paychex, the Bank's payroll
processor. Findley, vol. 2, p. 189, lines 613.
310. No one at the Bank discussed with Findley the indemnification of
Paychex by
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the Bank before the Bank indemnified Paychex. Findley, vol.
2, p. 189, lines 1417.
311. The Bank's board of directors was not informed of and did not
authorize H. Hagy to send the November 13, 1998 letter holding Paychex
harmless. FDIC Exh. 82; Clarke, vol. 3, pp. 2425.
312. There is no record in the minutes of meetings of the Bank's board
of directors of the Respondents' intention to issue the November 13,
1998 indemnification letter to Paychex. FDIC Exhs. 3355.
313. Had the Bank's management asked Findley if it was permissible to
indemnify Paychex, the Bank's payroll processor, Findley would have
told them that the Bank's management could not indemnify anyone, that
only the Bank's board of directors could indemnify someone, and that
an indemnification could not be issued for this type of action.
Findley, vol. 2, pp. 18990.
314. Findley believes that Shollenburg and the other Respondents did
not provide him with all the information necessary to adequately
represent the Bank. Findley, vol. 2, pp. 19495.
315. Upon learning from the accountants that the Bank's management had
not given him the correct information on the employee tax withholding
issue, Findley advises the Bank's board of directors to obtain an
independent investigation of the issue by an attorney with expertise in
tax matters. Findley, vol. 2, p. 191, lines 518.
316. The Bank's board of directors did not adopt the Vavrinek Firm's
recommendation for resolving the tax withholding situation. Rather, the
Bank's board of directors decided: 1) to issue the 1998 year-end
financial statement with footnote disclosure of the contingent
liability; and 2) to hire a tax expert. FDIC Exh. 56, pp. 12; Dayton,
vol. 2, p. 76, lines 924.
317. The Bank's board of directors requested that Findley and the
Bank's accounting firm find a legal expert in tax matters and the
Bank's board of directors subsequently hired Guterman. Findley, vol.
2, p. 67 & pp. 19294.
318. The failure of the Bank to withhold income and Social Security
taxes was discussed in the following footnote to the Bank's 1998
year-end audited financial statement:
"Several officers and employees of the Bank have determined that
they are exempt from the payment of federal, Social Security, and
Medicare tax and have requested the Bank discontinue withholding such
taxes from their income. The Bank believes they have properly complied
with the applicable Internal Revenue Service (IRS) regulations in
honoring these requests. Should the IRS challenge the Bank's
interpretation of these regulations and prevail, the Bank could be
liable for significant penalties, interest, and improperly withheld
taxes. The officers and employees involved have indemnified the Bank
from any loss in this matter. As of December 31, 1998, the IRS has not
instituted any audit or investigation into this matter."
FDIC Exh. 79, p. 15.
319. By adopting the footnote to the Bank's financial statement,
the Bank's board of directors was not endorsing the Respondents'
position. Jasperson, vol. 2, p. 252, lines 124; Hagy, vol. 5, p. 139,
lines 915.
320. The Bank's board of directors first put the footnote in, then
consulted with legal counsel in order to determine exactly what they
had to do to repay the taxes and to figure out what the dollar amounts
were that were owed. Jasperson, vol. 2, p. 268, lines 710.
321. After the April 26, 1999 meeting, Comer and Dayton determined that
Bank management was not following the Vavrinek Firm's recommendation.
Comer, vol. 1, p. 84, lines 1224.
322. On June 1, 1999, Comer, on behalf of the Vavrinek Firm, wrote to
the Bank to resign as the independent accountants for the Bank. The
letter was sent to the chairman of the Audit Committee, the chairman of
the Bank's board of directors, Shollenburg and H. Hagy. FDIC Exh. 80;
Comer, vol. 1, p. 85, lines 318.
323. Director Clarke was deeply concerned about the status of the Bank
after the Vavrinek Firm resigned. He understood that the Vavrinek Firm
had resigned because the Bank and/or its officials were engaged in
illegal acts and he felt action was necessary. Clarke, vol. 3, p. 23,
lines 621.
324. The reason for the Vavrinek Firm's resignation was the Bank's
position in regard to its corporate responsibility for withholding and
paying payroll and employee income taxes. Specifically, the Bank had
not
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changed its position with respect to meeting its corporate
responsibilities and had not implemented the Vavrinek Firm's
recommendations in its April 26, 1999 letter to the Bank's Audit
Committee. FDIC Exh. 80; Comer, vol. 1, pp. 8586.
325. In resigning, the Vavrinek Firm reaffirmed its position that the
Bank's actions were illegal acts, were not valid, and could result in
the assessment of significant back taxes, interest and penalties
against the Bank. FDIC Exh. 80.
326. In her experience with the Vavrinek Firm, Comer had never had to
resign an auditing engagement. Comer, vol. 1, pp. 8485.
327. The Vavrinek Firm's decision to resign was a partnership
decision. Comer, vol. 1, p. 86, lines 38.
328. Dayton believed that the Bank was not moving quickly enough to
resolve the tax withholding situation, which was an indication that
this was the type of client that the Vavrinek Firm did not want to be
associated with. The Vavrinek Firm felt strongly about the
recommendation that it had made. The potential harm to the Vavrinek
Firm's reputation for being associated with a client who did this was
not acceptable as a business decision. Dayton, vol. 2, pp. 8788.
329. One of the major issues in banking is reputational risk because
banking is a business of confidence. A bank must have a good business
reputation to maintain contacts and customers. Dayton, vol. 2, pp.
15051.
330. Comer discussed the potential for criminal liability for the
illegal acts that were uncovered during the year-end 1998 audit of
financial statements with H. Hagy in more than one conversation. Comer,
vol. 1, p. 89, lines 1121.
331. Comer discussed the difference between fiduciary duty and personal
beliefs several times with both H. Hagy and Shollenburg. Comer, vol. 1,
pp. 8990.
332. Comer shared her opinion with both H. Hagy and Shollenburg on the
difference between fiduciary duty and personal beliefs; to wit, that as
management they had fiduciary responsibilities to the Bank and their
individual beliefs had nothing to do with their corporate
responsibilities under the law. Comer, vol. 1, p. 90, lines 313.
333. It is Dayton's opinion that the Respondents, as corporate
officers, had a responsibility to follow the rules and regulations and
file proper returns and they did not fulfill those obligations. Dayton,
vol. 2, pp. 8991.
334. On or about June 7, 1999, the Bank's board of directors retained
Barry L. Guterman to provide advice and counsel concerning certain
federal and state employment tax matters. FDIC Exh. 90, p. 1; Guterman,
vol. 3, p. 109, lines 621.
335. Guterman was asked to review whether the Bank had a legal
obligation to account for, collect and pay over to the United States
and State of California income withholding taxes and FICA contributions
from compensation paid to employees who had instructed the Bank not to
withhold taxes from them. FDIC Exh. 90, p. 1; Guterman, vol. 3, p. 109,
lines 1521.
336. From June 1999 through mid-July 1999, Guterman conducted an
investigation of the federal and state employment tax matters at issue.
Guterman, vol. 3, pp. 11033.
337. As part of his investigation, Guterman reviewed all documents
provided to him by Findley and H. Hagy. FDIC Exhs. 59, p. 1, & 91;
Guterman, vol. 3, pp. 11115.
338. As part of his investigation, Guterman interviewed H. Hagy and
Linda Hoisington of Paychex. FDIC Exh. 90; Guterman, vol. 3, pp.
11518.
339. Guterman's final findings are contained in his report of
investigation to the Bank's board of directors, dated October 11,
1999. FDIC Exh. 90; Guterman, vol. 3, p. 118, lines 1020 & p. 148,
lines 1419.
340. H. Hagy told Guterman that she did not learn that the Forms W-4
had not been sent to the IRS until May 1999. FDIC Exh. 96, p. 1; Hagy,
vol. 5, pp. 12223.
341. H. Hagy told Guterman that she discussed the employment tax
withholding issues with the accountants, and that the accountants had
responded negatively. FDIC Exh. 96, p. 1; Guterman, vol. 3, p. 117,
lines 1222; Hagy, vol. 5, pp. 11213.
342. H. Hagy told Guterman that she, through her own research and
analysis of laws and regulations, ascertained what the Bank's
withholding obligations were. FDIC Exh. 96, pp. 12; Guterman, vol. 3,
p. 117, lines 1922; Hagy, vol. 5, p. 113, lines 1721.
343. H. Hagy told Guterman that as an officer she did not adopt the
position of the officers/employees, including herself, that
compensation paid them was not "wages"
{{10-31-03 p.A-3268.31}}
and not "gross
income" under the Internal Revenue Code. FDIC Exh. 96, p. 2;
Guterman, vol. 3, pp. 22325; Hagy, vol. 5, pp. 13637.
344. Guterman was never provided any documentation which reflected that
the Forms W-4 submitted by Shollenburg, H. Hagy, Melton, R. Hagy and
Knudson were transmitted to the IRS at or about the time they were
received by the Bank. Guterman, vol. 3, p. 124, lines 715.
345. Guterman was never provided any documentation which reflected that
the Forms W-4 submitted by Shollenburg, H. Hagy, Melton, R. Hagy and
Knudson were transmitted to the Bank's payroll processor. Guterman,
vol. 3, p. 124, lines 1619.
346. The Withholding Exemption Certificates (Forms W-4) that were
submitted to the Bank by Shollenburg, H. Hagy, Melton, R. Hagy and
Knudson after July 1997 and before July 1999 were not valid W-4's
because they contained alterations and/or unauthorized
additions, 26 C.F.R. §31.3402(f)(2)-1(e), and/or were not signed
under penalty of perjury. 26 U.S.C. §6065. FDIC Exh. 90, p. 15;
Comer, vol. 1, p. 57, lines 1220; Dayton, vol. 2, p. 110, lines
810; Guterman, vol. 3, pp. 14849 & pp. 22122.
347. The Forms W-4 that were submitted to the Bank by Shollenburg, H.
Hagy, Melton, R. Hagy and Knudson in which they claimed to be exempt
from income tax withholding, should not have been accepted by H. Hagy
and Shollenburg on behalf of the Bank. FDIC Exh. 90, p. 15; Guterman,
vol. 3, pp. 14951; Answer of Shollenburg ¶ 50; Answer of H. Hagy
¶ 50.
348. The Forms W-8, Citizenship Affidavits and Statements of
Citizenship and Residence submitted by Shollenburg, H. Hagy, Melton, R.
Hagy and Knudson did not constitute valid exemption certificates
because they did not contain the requisite certifications as to income
tax liabilities. FDIC Exh. 90, p. 15; Guterman, vol. 3, pp. 14950.
349. The Bank could not rely on the invalid Forms W-4 submitted by
Shollenburg, H. Hagy, Melton, R. Hagy and Knudson to legally stop
income tax withholding from the Respondents' compensation. Guterman,
vol. 3, pp. 15152.
350. Shollenburg, H. Hagy, Melton, R. Hagy and Knudson had no legal
basis for causing the Bank to fail to withhold income taxes from their
wages. Guterman, vol. 3, pp. 15253.
351. The Bank was liable for federal and state income withholding taxes
which it did not collect from the Respondents for the period commencing
January 1, 1998 through July 31, 1999. FDIC Exh. 90, p. 16; Guterman,
vol. 3, p. 153, lines 415.
352. The Bank was liable for $71,831.31 in federal and state income
withholding taxes which it did not collect from Shollenburg for the
period commencing January 1, 1998 through July 31, 1999. FDIC Exh. 90,
Schedule 2; Guterman, vol. 3, pp. 17980.
353. The Bank was liable for $26,007.05 in federal and state income
withholding taxes which it did not collect from H. Hagy for the period
commencing January 1, 1998 through July 31, 1999. FDIC Exh. 90,
Schedule 2; Guterman, vol. 3, p. 183, lines 1319.
354. The Bank was liable for $10,081.56 in federal and state income
withholding taxes which it did not collect from R. Hagy for the period
commencing January 1, 1998 through July 31, 1999. FDIC Exh. 90,
Schedule 2; Guterman, vol. 3, p. 184, lines 914.
355. The Bank was liable for $30,117.36 in federal and state income
withholding taxes which it did not collect from Melton for the period
commencing January 1, 1998 through July 31, 1999. FDIC Exh. 90,
Schedule 2; Guterman, vol. 3, p. 185, lines 49.
356. The Bank was liable for $5,374.18 in federal and state income
withholding taxes which it did not collect from Knudson for the period
commencing January 1, 1998 through July 31, 1999. FDIC Exh. 90,
Schedule 2; Guterman, vol. 3, p. 186, lines 810.
357. Shollenburg, H. Hagy, Melton and Knudson had not legitimate legal
basis for causing the Bank to fail to withhold FICA or Social Security
taxes from their wages. Guterman, vol. 3, p. 158, lines 510 & p. 226,
lines 112.
358. Shollenburg, H. Hagy, Melton and Knudson did not fit within any of
the classes of employees whose wages are exempted from Social Security
taxes. Guterman, vol. 3, pp. 15455.
359. Contrary to the assertions of Shollenburg, H. Hagy and Melton,
FICA taxes are not voluntary and they are not dependent upon the
employee's receipt of benefits under Social Security. FDIC Exh. 90, p.
18; Guterman, vol. 3, pp. 15657.
{{10-31-03 p.A-3268.32}}
360. Shollenburg, H. Hagy, Melton and Knudson erred in determining that
Social Security taxes were voluntary in nature. FDIC Exh. 90, p. 18.
361. Shollenburg and H. Hagy erred in instructing Paychex not to
withhold Social Security taxes from the wages of Shollenburg, H. Hagy,
Melton and Knudson. FDIC Exh. 90, p. 18.
362. The Bank was liable for FICA contributions which it did not
collect from Shollenburg, H. Hagy, Melton and Knudson. Guterman, vol.
3, p. 158, lines 1118.
363. The Bank was also liable for $27,804.27, which represented the
employer's portion of the FICA tax pertaining to the compensation of
Shollenburg, H. Hagy, Melton and Knudson. FDIC Exh. 90, pp. 1617 &
Schedule 1.
364. The Bank was liable for $12,181.26 in FICA taxes which it did not
collect from Shollenburg for the period commencing January 1, 1998
through July 31, 1999. Guterman. FDIC Exh. 90, Schedule 3.
365. The Bank was liable for $9,656.86 in FICA taxes which it did not
collect from H. Hagy for the period commencing January 1, 1998 through
July 31, 1999. Guterman. FDIC Exh. 90, Schedule 3.
366. The Bank was liable for $9,565.57 in FICA taxes which it did not
collect from Melton for the period commencing January 1, 1998 through
July 31, 1999. Guterman. FDIC Exh. 90, Schedule 3.
367. The Bank was liable for $841.50 in FICA taxes which it did not
collect from R. Hagy for the period commencing January 1, 1998 through
July 31, 1999. Guterman. FDIC Exh. 90, Schedule 3.
368. The Bank was also liable for $2,877.20 in FICA taxes which it did
not collect from Knudson for the period commencing January 1, 1998
through July 31, 1999. Guterman. FDIC Exh. 90, Schedule 3.
369. The Bank was liable for $7,144.70 and $20,659.57 in 1998 and 1999
respectively, in FICA employer taxes which the Respondents caused the
Bank to fail to pay for the period commencing January 1, 1998 through
July 31, 1999. FDIC Exh. 90, Schedule 1.
370. The Bank faced the following potential civil and criminal
penalties, for each taxable quarter at issue, if it did not correct its
employment tax returns:
a. Statutory interest computed from the due date of each employment
tax return;
b. A failure to deposit penalty under IRC Section 6656 for failure to
deposit the correct amount of employment taxes equal to 10 percent of
the amount of the unpaid employment taxes;
c. An accuracy-related penalty under IRC Section 6662 for negligence or
substantial understatement of tax equal to 20 percent of the amount of
underpaid employment taxes;
d. A criminal penalty under IRC Section 7201, a felony, for tax
evasion, punishable by a penalty not to exceed $500,000;
e. A criminal penalty under IRC Section 7206(1), a felony, for false
statement on a return, punishable by a penalty not to exceed $500,000;
f. A criminal penalty under IRC Section 7206(2), a felony, for aiding
and assisting in the preparation of a false return, punishable by a
penalty not to exceed $500,000;
g. A criminal penalty under IRC Section 7207, a misdemeanor, for
delivering a false statement or return to the IRS, punishable by a
penalty not to exceed $50,000; and
h. Corresponding civil and criminal penalties under the California
Revenue and Taxation Code and Unemployment Code.
FDIC Exh. 90, pp. 2021; Guterman, vol. 3, pp. 15859.
371. On July 26, 1999, Guterman attended a meeting of the Bank's
board of directors. FDIC Exhs. 59 & 90, p. 6; Guterman, vol. 3, p. 133,
lines 1318.
372. At the July 26, 1999 meeting, Guterman presented his tentative
fact findings and recommendations regarding the Bank's failure to
withhold income taxes and FICA taxes from Shollenburg, H. Hagy, Melton,
R. Hagy and Knudson. FDIC Exhs. 59 & 90, p. 6; Guterman, vol. 3, pp.
13334 & pp. 13738.
373. At the July 26, 1999 board meeting, Shollenburg's
representatives, Vera Louise Kleinfeld Pfeiffer and Lynda Wall, made a
presentation concerning why they believed Shollenburg, H. Hagy, Melton,
R. Hagy and Knudson were not subject to withholding for either state
and federal income taxes or Social Security taxes. FDIC Exhs. 59, p. 1,
& 90, p. 6; Guterman, vol. 3, pp. 13536.
374. At the July 26, 1999 board meeting, Ms. Pfeiffer conceded that IRC
Section 911
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(Citizens or Residents of United States Living Abroad) does
not apply to exempt Shollenburg, H. Hagy, Melton, R. Hagy and Knudson
from income tax withholding. FDIC Exh. 90, p. 6; Guterman, vol. 3, p.
136, lines 1023.
375. At the July 26, 1999 board meeting, the Bank's board of directors
passed a resolution instructing officers of the Bank to commence
withholding income taxes based on new Forms W-4 to be obtained from
Shollenburg, H. Hagy, Melton, R. Hagy and Knudson and not claim any
exemptions for Social Security taxes for the five Respondents. FDIC
Exhs. 59, p. 2, & 90, p. 6; Guterman, vol. 3, pp. 13738.
376. After the July 26, 1999 board meeting, Guterman, on behalf of the
Bank's board of directors, advised Paychex that, commencing with the
Bank's payroll due August 15, 1999, Shollenburg, H. Hagy, Melton and
Knudson were not to be treated as exempt from FICA taxes. FDIC Exh. 97;
Guterman, vol. 3, p. 141, lines 123.
377. After the July 26, 1999 board meeting, the Bank's board of
directors requested that Shollenburg, H. Hagy, Melton, R. Hagy and
Knudson prepare and submit new Forms W-4. FDIC Exh. 90, p. 6; Guterman,
vol. 3, p. 138, lines 1123.
378. On or about July 27, 1999, Shollenburg, H. Hagy, Melton, R. Hagy
and Knudson submitted new Forms W-4 to the Bank, claiming to be exempt
from income tax withholding. FDIC Exhs. 90, p. 6, & 99; Guterman, vol.
3, p. 144, lines 413.
379. Guterman reviewed the Forms W-4 submitted by Shollenburg, H. Hagy,
Melton, R. Hagy and Knudson to the Bank on July 27, 1999, and found
them to be valid Forms W-4 since they contained no alterations and were
signed under penalty of perjury. FDIC Exh. 90, p. 6; Guterman, vol. 3,
pp. 14446.
380. Guterman found that the Bank had no choice but to accept the new
Forms W-4 as long as they were not altered and the Bank had no
knowledge that they were false. Guterman, vol. 3, pp. 14546.
381. The new Forms W-4 were transmitted to the IRS on August 18, 1999.
FDIC Exh. 115, p. 36.
382. On August 11, 1999, Guterman completed a draft of his report of
investigation. FDIC Exh. 120, Bate Stamp ## 604496511. This draft
was circulated to the Bank's board of directors, as well as H. Hagy,
Melton, R. Hagy and Knudson. FDIC Exh. 62, p. 1.
383. Guterman's advice to the Bank's board of directors was
essentially the same as the Vavrinek Firm's, that the Bank should
request valid W-4's from the Respondents and submit them to the
Internal Revenue Service, that proper withholding should commence, and
that back taxes should be paid. FDIC Exhs. 77 & 120, Bate Stamp
## 60450203; Findley, vol. 2, p. 194, lines 1623.
384. In his draft memorandum, Guterman recommended to the Bank's board
of directors that the Bank amend its payroll tax returns and pay any
taxes shown to be due. FDIC Exh. 120, Bate Stamp # 604503.
385. In his draft memorandum, Guterman also advised the Bank's board
of directors that the Bank was potentially liable for additional civil
and criminal penalties and sanctions as a result of failing to withhold
taxes. FDIC Exh. 120, Bate Stamp # 604511.
386. On August 23, 1999, Guterman attended another meeting of the
Bank's board of directors. FDIC Exhs. 62 & 90, p. 7; Guterman, vol. 3,
p. 147, lines 116.
387. At the August 23, 1999 board meeting, Guterman reported that for
Social Security taxes, the Bank and employee responsibility for 1998
and the first two quarters of 1999 amounted to $58,933. FDIC Exh. 62,
pp. 12.
388. At the August 23, 1999 board meeting, Findley indicated that on
August 13, 1999, he had reminded Shollenburg, H. Hagy, Melton and
Knudson that they would be required to reimburse the Bank for Social
Security taxes which should have been deducted and withheld from their
wages. FDIC Exh. 62, p. 2.
389. At the August 23, 1999 board meeting, Guterman reviewed the status
of the state and federal income tax withholding issues for 1998 and
1999. In particular, Guterman discussed relief from tax withholding
liabilities for 1998 by Shollenburg, H. Hagy, Melton and Knudson
certifying to the board of directors on appropriate forms that they had
filed their 1998 tax returns. FDIC Exhs. 62, pp. 23, & 90, p. 7;
Guterman, vol. 3, pp. 21516.
390. At the August 23, 1999 board meeting, Shollenburg and H. Hagy
continued to
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present materials with respect to whether the Statements
of Citizenship and Residence submitted in January and February 1999
exempted them from income tax withholding for the first two quarters of
1999. FDIC Exhs. 62, p. 2, & 90, p. 7; Guterman, vol. 3, pp. 14748.
391. Guterman concluded that Shollenburg and H. Hagy refused to accept
the legal authority cited in his memorandum. FDIC Exh. 90, p. 7;
Guterman, vol. 3, p. 148, lines 46.
392. At the August 23, 1999 board meeting, H. Hagy computed and
Shollenburg approved, the Bank's liability for FICA withholding tax
liabilities for calendar year 1998 and calendar year 1999 through July
31, 1999. These schedules computed a lower amount of Social Security
withholding taxes due than the draft schedules prepared by Paychex.
FDIC Exh. 90, p. 7.
393. On September 8, 1999, the Bank sent a memorandum each to
Shollenburg, H. Hagy, Melton, and Knudson, requesting reimbursement of
Social Security and Medicare taxes based on the management prepared
schedules. FDIC Exhs. 100, 101 & 102; Guterman, vol. 3, p. 159, lines
1021.
394. On September 9, 1999, Shollenburg reimbursed the Bank in the
amount of $10,014.08, which was $2,167.18 less than the amount
calculated by Paychex. FDIC Exh. 101.
395. On September 10, 1999, H. Hagy reimbursed the Bank in the amount
of $8,161.95, which was $1,494.91 less than the amount calculated by
Paychex. FDIC Exh. 100.
396. H. Hagy only reimbursed the Bank in this amount in an attempt to
keep her job. Respondents' Exh. G; H. Hagy, vol. 5, pp. 7576.
397. On September 10, 1999, Melton reimbursed the Bank in the amount of
$7,358.32, which was $2,207.25 less than the amount calculated by
Paychex. FDIC Exh. 102.
398. Knudson failed to reimburse the Bank in any amount. FDIC Exh. 107;
Guterman, vol. 3, pp. 17475.
399. As a member of the Vavrinek Firm's audit committee, Comer wrote
letters to clients to update them on the tax laws and other accounting
changes. Comer, vol. 1, pp. 3435 & p. 38, lines 517.
400. Comer wrote a letter to the Bank addressed to H. Hagy and dated
January 20, 1998 in which she updated the Bank on certain tax matters,
including the reporting of automobile allowances on employee W-2's.
FDIC Exh. 66; Comer, vol. 1, pp. 3739.
401. H. Hagy initialed the January 20, 1998 letter from Comer,
signifying that she had received it. FDIC Exh. 66; H. Hagy, vol. 5, pp.
8282.
402. In the January 20, 1998 letter, Comer advised that an automobile
allowance paid to an employee is considered wages and must be included
on the employee's W-2 if the employee is not required to account for
the business miles traveled. FDIC Exh. 66; Comer, vol. 1, pp. 3839.
403. On September 29, 1999, Guterman attended a meeting of the Bank's
board of directors held at the office of the California Department of
Financial Institutions. FDIC Exhs. 65 & 90, p. 8.
404. At the September 29, 1999 board meeting, the FDIC's examiners
advised the Bank's board of directors that automobile cash allowances,
Year 2000 consulting fees, and/or bonuses had been paid to Shollenburg,
H. Hagy, Melton and R. Hagy in 1998 and 1999, and had not been reported
on appropriate tax filings, nor had employment taxes been deducted or
paid over to the IRS. FDIC Exhs. 65, pp. 12, & 90, p. 8.
405. After the September 29, 1999 board meeting, Guterman contacted H.
Hagy with respect to the issues raised by the FDIC concerning
automobile cash allowances, Year 2000 consulting fees, and bonuses.
FDIC Exh. 103; Guterman, vol. 3, p. 161, lines 918.
406. Guterman determined that automobile allowances totaling $20,000 in
1998 and $15,200 in 1999 had been paid to employees without the proper
amount of employment taxes being reported by the Bank, deducted from
compensation or paid over to the IRS. FDIC Exh. 90, p. 8.
407. Of the automobile allowances at issue, H. Hagy received $4,800 and
$4,000 in unreported automobile allowances in 1998 and 1999,
respectively, Melton received $4,800 and $4,000 in unreported
automobile allowances in 1998 and 1999, respectively, and Shollenburg
received $9,600 and $7,200 in unreported automobile allowances in 1998
and 1999, respectively. FDIC Exhs. 104 & 105.
408. Guterman determined that R. Hagy
{{10-31-03 p.A-3268.35}}
received additional Year 2000
compensation of $6,000 in 1998 and $5,000 in 1999 without the
compensation being reported by the Bank, employment taxes deducted from
his compensation or paid over to the IRS. FDIC Exhs. 90, p. 8, 104 &
105.
409. Guterman determined that bonuses totaling $50,000 were paid to
Shollenburg, H. Hagy and Melton during January and February 1999
without being reported by the Bank, employment taxes deducted from
their compensation or paid over to the IRS. FDIC Exh. 90, p. 8.
410. Of the unreported bonuses paid, H. Hagy received $13,000, Melton
received $12,000, and Shollenburg received $25,000. FDIC Exhs. 104 &
105.
411. Shollenburg received a bonus for 1990 that was paid in January
1991, and FICA, state and federal income taxes were withheld by the
Bank. FDIC Exh. 83.
412. Shollenburg, H. Hagy, Melton and R. Hagy failed to bring the issue
of unreported automobile allowances, bonuses and Year 2000 compensation
to Guterman's attention prior to the FDIC's examination findings
being reported at the September 29, 1999 board meeting. Guterman, vol.
3, p. 165, lines 59.
413. As of October 11, 1999, the date of Guterman's final report,
Guterman determined that the Bank's potential federal and California
employment tax liability was $211,774.49, plus penalties and interest.
FDIC Exh. 90, p. 8, & Schedule 1; Guterman, vol. 3, pp. 16566.
414. As a result of Guterman's findings, the Bank issued corrected
Form W-2 wage statements for Shollenburg, H. Hagy, Melton, R. Hagy and
Knudson for the year 1998. FDIC Exh. 106; Guterman, vol. 3, p. 168,
lines 39.
415. Knudson's Form W-2 for 1998 was corrected to reflect the
following:
a. An increase from $0 in Federal income tax withheld to the
correct amount of $2,997.64 in Federal income tax withheld;
b. An increase from $7,670.95 in Social Security wages to the correct
amount of $26,434.28 in Social Security wages;
c. An increase from $475.59 in Social Security tax withheld to the
correct amount of $1,638.93 in Social Security tax withheld;
d. An increase from $7,670.95 in Medicare wages and tips to the correct
amount of $26,434.28 in Medicare wages and tips;
e. An increase from $111.23 in Medicare tax withheld to the correct
amount of $383.29 in Medicare tax withheld; and
f. An increase from $0 in State income tax to the correct amount of
$767.94 in State income tax.
FDIC Exh. 106, p. 2; Guterman, vol. 3, pp. 16870.
416. H. Hagy's Form W-2 for 1998 was corrected to reflect the
following:
a. An increase from $86,593.16 in Wages, tips and other
compensation to the correct amount of $91,393.16 in Wages, tips and
other compensation;
b. An increase from $0 in Federal income tax withheld to the correct
amount of $11,573.09 in Federal income tax withheld;
c. An increase from $0 in Social Security wages to the correct amount
of $68,400 in Social Security wages;
d. An increase from $0 in Social Security tax withheld to the correct
amount of $4,240.80 in Social Security tax withheld;
e. An increase from $0 in Medicare wages and tips to the correct amount
of $95,593.16 in Medicare wages and tips;
f. An increase from $0 in Medicare tax withheld to the correct amount
of $1,386.10 in Medicare tax withheld; and
g. An increase from $0 in State income tax to the correct amount of
$6,351.38 in State income tax.
FDIC Exh. 106, p. 3; Guterman, vol. 3, pp. 17071.
417. Shollenburg's Form W-2 for 1998 was corrected to reflect the
following:
a. An increase from $144.324.33 in Wages, tips and other
compensation to the correct amount of $153,924.33 in Wages, tips and
other compensation;
b. An increase from $0 in Federal income tax withheld to the
correct amount of $33,439.75 in Federal income tax withheld;
c. An increase from $0 in Social Security wages to the correct amount
of $68,400 in Social Security wages;
d. An increase from $0 in Social Security tax withheld
{{10-31-03 p.A-3268.36}}
to the correct
amount of $4,240.80 in Social Security tax withheld;
e. An increase from $0 in Medicare wages and tips to the correct amount
of $155,924.33 in Medicare wages and tips;
f. An increase from $0 in Medicare tax withheld to the correct amount
of $2,260.90 in Medicare tax withheld; and
g. An increase from $0 in State income tax to the correct amount of
$11,555.20 in State income tax.
FDIC Exh. 106, p. 3; Guterman, vol. 3, p. 171, lines 2123.
418. Melton's Form W-2 for 1998 was corrected to reflect the
following:
a. An increase from $75,246.46 in Wages, tips and other
compensation to the correct amount of $80,046.46 in Wages, tips and
other compensation;
b. An increase from $0 in Federal income tax withheld to the correct
amount of $14,242.41 in Federal income tax withheld;
c. An increase from $0 in Social Security wages to the correct amount
of $68,400 in Social Security wages;
d. An increase from $0 in Social Security tax withheld to the correct
amount of $4,240.80 in Social Security tax withheld;
e. An increase from $0 in Medicare wages and tips to the correct amount
of $88,926.46 in Medicare wages and tips;
f. An increase from $0 in Medicare tax withheld to the correct amount
of $1,289.43 in Medicare tax withheld; and
g. An increase from $0 in State income tax to the correct amount of
$5,731.38 in State income tax.
FDIC Exh. 106, p. 4; Guterman, vol. 3, pp. 17172.
419. R. Hagy's Form W-2 for 1998 was corrected to reflect the
following:
a. An increase from $33,900 in Wages, tips and other compensation
to the correct amount of $39,900 in Wages, tips and other compensation;
b. An increase from $0 in Federal income tax withheld to the correct
amount of $4,550.62 in Federal income tax withheld;
c. An increase from $39,600 in Social Security wages to the correct
amount of $45,600 in Social Security wages;
d. An increase from $2,455.20 in Social Security tax withheld to the
correct amount of $2,827.20 in Social Security tax withheld;
e. An increase from $39,600 in Medicare wages and tips to the correct
amount of $45,600 in Medicare wages and tips;
f. An increase from $574.20 in Medicare tax withheld to the correct
amount of $661.20 in Medicare tax withheld; and
g. An increase from $0 in State income tax to the correct amount of
$1,372.45 in State income tax.
FDIC Exh. 106, p. 4; Guterman, vol. 3, pp. 17273.
420. On October 15, 1999, Guterman sent a demand letter to each of
the Respondents, Shollenburg, H. Hagy, Melton, R. Hagy and Knudson, in
which he demanded on behalf of the Bank that the Respondents take the
following action:
a. Either make reimbursement of the income tax withholding
liabilities incurred by the Bank for 1998 or certify to filing 1998
federal and California income tax returns and payment of income tax
liabilities for 1998 by completing and signing the enclosed Form 4669
and Form DE938P;
b. Make reimbursement of the income tax withholding liabilities
incurred by the Bank for 1999; and;
c. Make reimbursement of the amounts of FICA and/or Medicare
withholding liabilities incurred by the Bank for 1998 and 1999.
FDIC Exhs. 107111; Guterman, vol. 3, p. 173, lines 225.
421. In his October 15, 1999 letter to Knudson, Guterman demanded
reimbursement on behalf of the Bank from Knudson of $5,374.18 in income
withholding taxes and $2,877.20 in Social Security withholding taxes.
FDIC Exh. 107; Guterman, vol. 3, p. 174, lines 1018.
422. Knudson did not make reimbursement to the Bank of any of the
amounts demanded in the October 15, 1999 letter, nor did she provide
the necessary certification with respect to the payment of her 1998
income taxes. Guterman, vol. 3, pp. 17677 & p.179, lines 27.
423. In his October 15, 1999 letter to Melton, Guterman demanded
reimbursement on behalf of the Bank from Melton of $30,117.36 in income
withholding taxes and $2,207.25 in Social Security withholding
{{10-31-03 p.A-3268.37}}
taxes. FDIC Exh. 108; Guterman, vol. 3, p. 175, lines 812.
424. Melton did not make reimbursement to the Bank of any of the
amounts demanded in the October 15, 1999 letter, nor did she provide
the necessary certification with respect to the payment of her 1998
income taxes. Guterman, vol. 3, pp. 17677 & p. 179, lines 27.
425. In his October 15, 1999 letter to Shollenburg, Guterman demanded
reimbursement on behalf of the Bank from Shollenburg of $71,831.31 in
income withholding taxes and $2,167.18 in Social Security withholding
taxes. FDIC Exh. 109; Guterman, vol. 3, p. 176, lines 38.
426. Shollenburg did not make reimbursement to the Bank of any of the
amounts demanded in the October 15, 1999 letter, nor did he provide the
necessary certification with respect to the payment of his 1998 income
taxes. Guterman, vol. 3, pp. 17677 & p. 179, lines 27.
427. In his October 15, 1999 letter to H. Hagy, Guterman demanded
reimbursement on behalf of the Bank from H. Hagy of $26,007.05 in
income withholding taxes and $1,494.94 in Social Security withholding
taxes. FDIC Exh. 110; Guterman, vol. 3, p. 176, lines 915.
428. H. Hagy did not make reimbursement to the Bank of any of the
amounts demanded in the October 15, 1999 letter, nor did she provide
the necessary certification with respect to the payment of her 1998
income taxes. Guterman, vol. 3, pp. 17677 & p. 179, lines 27.
429. In his October 15, 1999 letter to R. Hagy, Guterman demanded
reimbursement on behalf of the Bank from R. Hagy of $10,081.56 in
income withholding taxes $841.50 in Social Security withholding taxes.
FDIC Exh. 111; Guterman, vol. 3, p. 176, lines 1621.
430. R. Hagy did not make reimbursement to the Bank of any of the
amounts demanded in the October 15, 1999 letter, nor did he provide the
necessary certification with respect to the payment of his 1998 income
taxes. Guterman, vol. 3, pp. 17677 & p. 179, lines 27.
431. On or about November 2, 1999, the Bank paid a grand total of
approximately $209,502.85 in employment taxes to the various taxing
authorities, which represented the taxes that should have been, but
were not, withheld from the Respondents' compensation for the years
1998 and 1999, and the Bank's employer share of FICA taxes. FDIC Exh.
112; Guterman, vol. 3, pp. 17778.
432. The Bank paid a total amount of $152,799.85 to state and federal
taxing authorities on behalf of Respondents, including $116,325.28 paid
to federal taxing authorities alone, as
follows:
|
TOTAL |
FEDERAL |
Shollenburg |
$74,033.69 |
$56,578.43 |
H. Hagy |
$27,519.36 |
$19,082.33 |
Melton |
$32,340.91 |
$24,602.58 |
R. Hagy |
$11,037.81 |
$9,142.40 |
Knudson |
$7,868.08 |
$6,919.54 |
433. The sums that the Bank paid to federal taxing authorities on
behalf of Respondents did not include any amounts for 1997 taxes. The
Bank's potential 1997 tax withholding liabilities equaling $17,280.11
in federal income withholding taxes and $4,876.98 in state income
withholding taxes was mitigated due to the adoption of a "fact of
filing" approach. FDIC Exh. 113; Guterman, vol. 3, p. 162, lines
612 & pp. 18889.
434. As of the date of the hearing, the Bank had paid no interest or
penalties to the IRS, and had paid only minimal interest to the
California Franchise Tax Board. Guterman, vol. 3, p. 187, lines 710 &
p. 256, lines 717.
435. If the Bank had not paid the IRS and the California Franchise Tax
Board the amounts paid on November 2, 1999, the Bank would have faced
penalties and interest from the IRS and California Franchise Tax Board.
Guterman, vol. 3, p. 187, lines 46.
436. The Bank incurred $41,050 in legal fees for Guterman's services
to the Bank in this matter. Guterman, vol. 3, p. 193, lines 1720.
437. Guterman's subsequent review of federal tax returns filed by
Shollenburg, H. Hagy, Melton, R. Hagy and Knudson revealed that
contrary to the certification that they had incurred no liability for
federal income tax for the preceding year contained in the initial
employer withholding documents submitted by the Respondents to the Bank
in 1997, Shollenburg, H. Hagy, Melton, R. Hagy and Knudson had declared
income tax liabilities
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abilities for the prior year 1996. FDIC Exh. 124; Guterman, vol. 3, p.
270, lines 118.
438. The FDIC commenced a safety and soundness examination of the Bank
on July 19, 1999, utilizing financial information as of March 31, 1999.
FDIC Exh. 115; Starin, vol. 4, pp. 1314.
439. The Bank was given a composite rating of "4" at the FDIC's
1999 examination, indicating an overall unsatisfactory condition and
resulting in the Bank being considered a problem bank. FDIC Exh. 115,
p. 2; Doerr, vol. 4, pp. 21719.
440. The FDIC's 1999 examination of the Bank detailed various
violations of tax laws, financial recordkeeping requirements, Bank
Secrecy Act and Part 362 of the FDIC's FDIC's Rules and Regulations
("Part 362"). FDIC Exh. 115, pp. 2737; Starin, vol. 4, p. 24,
lines 1318.
441. The Bank was cited for apparent violations of tax laws for failing
to properly withhold payroll and income taxes from the compensation of
Shollenburg, H. Hagy, Melton, R. Hagy and Knudson. FDIC Exh. 115, pp.
3436; Starin, vol. 4, pp. 2425.
442. The FDIC's 1999 Report of Examination of the Bank reported the
income tax liability as a contingent liability in the amount of
$131,000, and adversely classified $127,000 of this amount as
"Substandard" and the remaining $4,000 of "Loss." FDIC Exh.
115, p. 51; H. Hagy, vol. 5, pp. 18182.
443. Shollenburg, H. Hagy, Melton, R. Hagy and Knudson were
individually and jointly responsible for the violations of tax laws
cited at the FDIC's 1999 examination of the Bank. Starin, vol. 4, pp.
3362.
444. The Bank was cited for violations of financial recordkeeping
requirements and the Bank Secrecy Act with respect to the establishment
and/or opening of "Pure Trust" accounts, accounts that purported
to shelter assets from seizure or levy, at the Bank. FDIC Exh. 115, pp.
3033.
445. The Bank was cited for violations of Part 362 for the issuance of
an indemnification to Paychex, the Bank's payroll processor, by H.
Hagy, for the benefit of Shollenburg, H. Hagy, Melton and Knudson to
insure that Paychex would cease withholding of Social Security and
Medicare taxes from these Respondents' wages. FDIC Exh. 115, pp.
3637; Starin, vol. 4, pp. 2526.
446. The Bank had no substantial interest in the performance of the
transaction involved (i.e., failure to withhold taxes) and there were
no Bank customers who provided segregated deposits. FDIC Exh. 115, pp.
3637; Starin, vol. 4, pp. 2829.
447. The indemnification granted to Paychex would not have been
permissible for a national bank and, hence, was not permissible for the
Bank without the FDIC's consent. FDIC Exh. 115, pp. 3637; Starin,
vol. 4, pp. 2729.
448. The Bank never requested or received the FDIC's consent to
indemnify Paychex under Part 362 of the FDIC's Rules and Regulations.
FDIC Exh. 115, pp. 3637; Starin, vol. 4, p. 29, lines 69.
449. An exit meeting was held between the FDIC, the California
Department of Financial Institutions and the Bank's board of directors
on September 29, 1999, in Los Angeles, California. FDIC Exh. 65.
450. At the September 29, 1999 exit meeting, the FDIC examiners
discussed the "Substandard" classification of the contingent
liability for the tax withholding matter. FDIC Exh. 65, p. 3.
451. At the September 29, 1999 exit meeting, FDIC Assistant Regional
Director J. George Doerr disclosed that the FDIC was seriously
considering possible management removal, including permanent ban on
serving in the banking industry, against Shollenburg, H. Hagy, Melton,
R. Hagy and Knudson. FDIC Exh. 65, p. 11.
CONCLUSIONS OF LAW
1. The Bank is subject to the FDI Act, 12 U.S.C. §18111831y,
the Rules and Regulations of the FDIC, 12 C.F.R. Chapter III, and the
laws and regulations of the United States of America and State of
California. 12 U.S.C. §§ 1813(e)(2), 1813(q)(3), 1814(a)(1) & 1819.
2. The FDIC has jurisdiction over the Bank. 12 U.S.C. §§ 1813(e)(2)
& 1813(q)(3).
3. Respondents were "institution-affiliated parties" of the Bank.
12 U.S.C. §1813(u).
4. The FDIC has jurisdiction over the subject matter of this
proceeding. 12 U.S.C. §1818(e)(1).
5. The Bank was subject to the Internal Revenue Code, Title 26 of the
United States Code, including specifically sections 3101, 3102, 3121,
3402, 3403, and 6065, 26 U.S.C. §§ 3101, 3102, 3121, 3401, 3402,
3403, & 6065, and supporting regulations. 26 U.S.C.
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§§ 3101, 3102,
3121, 3401, 3402, 3403 & 6065; Guterman, vol. 3, pp. 15354.
6. Respondents Shollenburg, H. Hagy, Melton, R. Hagy and Knudson
caused, brought about, participated in and/or aided and abetted
violations of the tax laws and regulations of the United States. FDIC
Exhs. 90 & 115, pp. 3436; Guterman, vol. 3, pp. 14953; Starin,
vol. 4, pp. 2425 & pp. 3362.
7. By virtue of Respondents' conduct alone and with each other in
causing the Bank to fail to comply with federal tax withholding laws
and federal banking laws and regulations, Respondents caused, brought
about, participated in or aided or abetted violations of law. 12 U.S.C.
§1818(e)(1)(A)(i)(I).
8. By virtue of Respondents' participation in the tax withholding
misconduct, Respondents engaged in unsafe or unsound practices in
connection with the Bank. 12 U.S.C. §1818(e)(1)(A)(ii).
9. By virtue of Respondents' participation in the tax withholding
misconduct, Respondents breached their fiduciary duty as officers, and
in the case of Shollenburg, as an officer and director of the Bank. 12
U.S.C. §1818(e)(1)(A)(iii).
10. By reason of these violations, unsafe or unsound practices
and breach of fiduciary duty, the Respondents received financial gain
or other benefit. 12 U.S.C. §1818(e)(1)(B)(iii).
11. By reason of these violations, unsafe or unsound practices and
breach of fiduciary duty, the Bank suffered financial loss or other
damage. 12 U.S.C. §1818(e)(1)(B)(i).
12. By reason of these violations, unsafe or unsound practices
and breach of fiduciary duty, the interests of the Bank's depositors
were prejudiced. 12 U.S.C. §1818(e)(1)(B)(ii).
13. Respondents' actions and omissions demonstrate a willful or
continuing disregard for the safety or soundness of the Bank and
evidence the Respondents' personal dishonesty. 12 U.S.C.
§1818(e)(1)(C).
PROPOSED ORDER
1. This proceeding is hereby dismissed as to Respondent Robert
Hagy.
2. Respondents Dennis Shollenburg, Hazel Hagy, Vicky Melton, and Brenda
Knudson, are hereby, without the prior written approval of the FDIC and
the appropriate Federal financial institutions regulatory agency, as
that term is defined in section 8(e)(7)(D) of the Act, 12 U.S.C.
§1818(e)(7)(D), prohibited from:
(a) participating in any manner in the conduct of the affairs of
any financial institution or organization enumerated in section
8(e)(7)(A) of the Act, 12 U.S.C. §1818(e)(7)(A);
(b) soliciting, procuring, transferring, attempting to transfer, voting
or attempting to vote any proxy, consent or authorization with respect
to any voting rights in any financial institution enumerated in section
8(e)(7)(A) of the Act, 12 U.S.C. §1818(e)(7)(A);
(c) violating any voting agreement previously approved by the
appropriate Federal banking agency; or
(d) voting for a director, or serving as an institution-affiliated
party.
IT IS FURTHER ORDERED that this ORDER will become effective thirty
(30) days after issuance. The provisions of this ORDER will remain
effective and enforceable except to the extent that, and until such
time as, any provision of this ORDER shall have been modified,
terminated, suspended, or set aside by the FDIC.
Dated this 31st day of October, 2002.