COURT DETAILS FINDINGS TO SUPPORT DENIAL OF PRELIMINARY INJUNCTION IN XéLAN CASE.

Plaintiff the United States of America was represented at the hearing by Stuart D. Gibson, Esq. The objecting defendants and interested third parties made appearances as follows: Pamela J. Naughton, Esq. and Frank J. Johnson, Esq. for the xélan Foundation, Inc.; Miram L. Fisher, Esq. and James N. Mastracchio, Esq. for Doctors Insurance Services, Inc.; Tom Pollack, Esq. for Doctors Benefit Insurance Company LTD; Michael L. Lipman, Esq. and Darrell D. Hallett, Esq. for Dr. L. Donald Guess; Bruce Zagaris, Esq. for Christopher G. Evans; C. James Frush, Esq. for David Jacquot; Gary B. Rudolph, Esq. for Viatical Liquidity; John Morrell, Esq, for xélan entities; Keith Rutman, Esq. for four frozen accounts of his former law firm; John W. Sunnen, Esq. for Carol Guess; and Donald G. Rez, Esq. and James P. Hill, Esq. for the Temporary Receiver, William A. Leonard.

The Court considered all the papers and oral argument, then denied preliminary injunctive relief, as is fully elaborated on the record, with the results briefly memorialized in an Order entered December 6, 2004. Dkt No. 110. This Order records salient findings and conclusions of law. in support of that ruling.

I. BACKGROUND

The first of the xélan companies was founded by Dr. L. Donald Guess approximately 30 years ago to provide mechanisms for doctors and dentists to invest excess earnings in a tax advantageous manner. Various xélan programs evolved over time, expanding in breadth and organizational structure, Today, the xélan-related companies offer retirement, investment, charitable, and insurance arrangements to xélan participants.

This is an action pursued by the Internal Revenue Service ("IRS") alleging wire fraud, mail fraud, and conspiracy in the marketing, administration, and treatment of contributions to certain xélan programs. The case is predicated on the assumption that some of xélan's offerings violate portions of the Internal Revenue Code by the manner in which the xélan entities report their products and programs, distribute contributions, and represent the purported tax advantages to participating doctors. The United States alleges defendants make inconsistent representations to plan participants and to the, government with respect to the administration and tax treatment of contributions and distributions from the various programs, and that some of the programs promise tax benefits to the subscribing medical professionals which do not in fact attach to xélan's investment, insurance, charitable, and retirement plans.

The initiation of this case does not mark the first time the xélan companies have come under civil and criminal scrutiny by the United States. During the past few years, the government has initiated tax audits of participating doctors around the country and issued administrative summonses to obtain records from certain xélan companies. See, e.g., Cohen v. United States, 306 F.Supp.2d 495 (E.D. Penn. 2004) (action to quash administrative summons seeking records of a xélan group disability income trust). No government agency or court appears to have ruled on the merits whether the xélan programs under investigation in fact violate tax laws. The issue whether DBIC supplemental disability insurance is real insurance, qualifying the premiums to be tax- deductible by the participating doctors' subchapter "C" corporations, is pending before the federal district court in a Wyoming case, Range & River Radiology, P.C. v. United States, No. O4cv0299 (D.Wy.) ("Pettinger"), filed October 21, 2004.³ The parties represent the Pettinger case will address the tax issues that are also presented in this case. In yet another concurrent effort to resolve the issue of deductibility, the parties acknowledge an 11 U.S.C. § 505 action challenging the government's claims as a creditor has been filed against the IRS in the xélan bankruptcy proceedings.

The declarations of Revenue Agent Marien and Postal Inspector France, submitted in support of the application for preliminary injunctive relief, trace the government's on-going investigations of the xélan entities and the individual defendants named in this action. The United States has paid particular adverse attention to xélan supplemental group disability insurance offered through Doctors Benefit Insurance Company, to a xélan 419 Welfare Trust program, and to certain options formerly available through the xélan Foundation. Defendants object that the injunctive reliefs ought in this case is an inappropriate means to resolve the various civil, tax, and criminal issues the government raises. They contend the government has already presented the same allegations in other, purportedly more appropriate, administrative and judicial proceedings where the issues will be addressed. The issues include whether the defendants mischaracterized the tax treatment of xélan products, allowing monies the government characterizes as income to be improperly called something else, resulting in unjustified tax benefits to the xélan doctors and their corporations.

The sole question before the Court at this early stage of these proceedings is whether the government has made an adequate showing to warrant a continuation, in some form, of the restrictions imposed by the TRO. The Court finds the dispositive issue is whether any actual violation of the Internal Revenue Code has been substantiated with respect to the xélan programs sought to be enjoined. Unless a violation is identified, the United States cannot show a clear likelihood of success on the merits of its claims, a prerequisite to preliminary injunctive relief.

II. LEGAL STANDARDS

The purpose of a preliminary injunction is to preserve the status quo and prevent irreparable loss of rights prior to judgment. Sierra On-Line, Inc. v. Phoenix Software, Inc., 739 F.2d 1415, 1422 (9th Cir. 1984). Courts consider several factors in deciding whether provisional relief is warranted: (1) the likelihood of plaintiffs success on the merits, (2) the possibility of plaintiffs suffering irreparable injury if the relief is not granted; (3) the extent to which the balance of hardships favors the respective parties; and (4) in appropriate cases, whether the public interest will be advanced by the preliminary relief. United States v. Odessa Union Warehouse Co-op, 833 F.2d 172, 174 (9th Cir. 1987); see also Lockheed Missile & Space Co., Inc. v. Hughes Aircraft Co., 887 F. Supp. 1320, 1323 (N.D. Cal. 1995) (the standard for issuing a temporary restraining order is identical to the standard for issuing a preliminary injunction).

A party seeking Federal Rule of Civil Procedure ("Rule") 65 injunctive relief in the Ninth Circuit must make a "clear showing" of either (1) a combination of probable success on the merits and the possibility of irregarable harm, or (2) that serious questions are raised and the balance of hardships tips sharply in the moving party's favor. Connecticut Gen. Life Ins. Co. v. New Images of Bever] Hills, 321 F.3d 878, 881(9th Cir. 2003); Sun Microsystems, Inc. v. Microsoft Corp., 188 F.3d 1115, 1119 (9th Cir. 1999). "These two formulations represent two points on a Sliding scale in which the required degree of irreparable harm increases as the probability of success decreases." Roe v. Anderson, 134 F.3d 1400, 1402 (9th Cir. 1998); see United States v. Nutri- Cology, Inc., 982 F.2d 394, 397 (9th Cir. 1992).

Under the Fraud Injunction Statute (18 U.S.C. § 1345), the federal courts can enjoin schemes to defraud the United States involving mail and wire transmissions, Under that section and the Tax Injunction Statute (IRS Code 26 U.S.C. § 7402(a)), "for the enforcement of internal revenue laws," this Court is authorized, upon a proper showing, to grant all the injunctive relief the United States is seeking. When the government seeks an injunction based on a statute providing for pursuit of equitable relief, and the government has met the "probability of success" prong of the preliminary injunction test, "we presume it has met the 'possibility of irreparable injury prong because the passage of the statute is itself an implied finding by Congress that violations will harm the public." Miller v. California Pacific Medical Center, 19 F.3d 449, 459 (9th Cir. 1994); Odessa, 833 F.2d at 175-76 ("[T]he agency to whom the enforcement of the right has been entrusted is not required to show irreparable injury"). The government is not entitled to a presumption on their reparable harm element, however, unless it first satisfies the "probability of success" element of the test. Miller, 19 F.3d at 459.

Preliminary injunctive relief requires less formal and less complete evidentiary showings than a trial on the merits under strict rules of evidence. Republic of Philippines v. Marcos, 862 F.2d 1363 (9th Cir. 1988) ("It was within the discretion of the district court to accept . . . hearsay for purposes of deciding whether to issue the preliminary injunction"); Flynt Distributing Co., Inc. v. Harvey, 734 F.2d 1389, 1394 (9th Cir. 1984 ("The trial court may give even inadmissible evidence some weight, when to do so serves the purpose of preventing irreparable harm before trial"); Univ. of Texas v. Camenisch, 451 U.S. 390, 395 (1981) ("A party . . . is not required to prove his case in full at a preliminary injunction hearing"). Nevertheless, conditional inferences, innuendo, and even strong suspicions do not satisfy that burden,

III. THE GOVERNMENT'S SHOWING IS INSUFFICIENT TO SUPPORT PRELIMINARY INJUNCTIVE RELIEF

The Court finds the government's evidence is insufficient to carry its burden. The United States relies on the declarations of Postal Inspector Timothy D. France and of Revenue Agent John L. Marien to support its application. France states in his October 29, 2004 Declaration that he has been involved in the investigation of all the defendants, focusing on "whether L. Donald Guess . . ., Leslie Buck . . ., David Jacquot . . ., G. Thomas Roberts . . ., and others, have operated xélan, Inc. and its affiliated entities as a criminal enterprise" engaged in Conspiracy To Defraud The United States, Mail Fraud, Wire Fraud, "Unlawful Welfare Fund Payments -- 18 U.S.C. § 1954, and Money Laundering 18 U.S.C. §§ 1956 and 1957." France Decl. ¶¶ 1-4. He describes the investigation as jointly conducted by the Department of Homeland Security, Bureau of Immigration and Customs Enforcement, the California Department of Insurance, and the IRS Criminal Investigation Division. France declares he has personally reviewed documents that "describe the xélan tax reduction programs that lie at the heart of this investigation." France Decl. ¶ 4. The investigators have also interviewed "several witnesses who were either xélan customers or former employees of xélan," and have "conducted consensual recordings of xélan representatives including Guess." Id.

After all that investigation, France's strongest characterizations in support of the government's request for extraordinary and urgent injunctive relief is that he believes it is "more likely than not that Guess, Buck, Jacquot, Roberts, and others, through the xélan affiliated entities, have violated and are now violating federal law, including" mail fraud, wire fraud, money laundering, conspiracy to defraud the United States, and unlawful welfare (i.e., disability insurance coverage) fund payments.⁴ France Decl. paragraph 5 (emphasis added). In his opinion, "the evidence shows that it is more likely than not' that defendants are engaged in fraudulent activity, and he "believe[s] it is more likely true than not" that defendants are in possession of assets traceable to alleged fraud. Id. pp. 30, 32. He declares defendants "might" be in possession of documents that show allegedly fraudulent schemes. France alludes to no present or imminent dissipation of particular assets by any named defendant potentially acquired through xélan's suspected wrongdoing, yet the government seeks a preliminary injunction placing all personal and business assets of all the named individual and entity defendants under the control of a Receiver for the duration of this litigation.

Revenue Agent Marien states in his October 27, 2004 Declaration he is a National Technical Advisor assigned "to help Revenue Agents around the United States when they are dealing with issues involving the proper tax treatment of contributions to employee welfare benefit funds," including "examinations to determine the correct federal income tax liabilities of doctors -- and their wholly-owned corporations -- who have participated in various so-called supplemental insurance programs developed and sold by the xélan family of companies." Marien Decl. ¶¶ 2-3. In connection with his work on the xélan audits and investigation, Marien reviewed audio and video tapes of sales presentations by Guess, participated in interviews of Guess and others about xélan's supplemental insurance plans and the 419 Welfare Benefit Trust, and reviewed documents and testimony produced by third parties, including documents and testimony the IRS obtained from xélan doctors. Id. ¶ 4.

Marien declares xélan has not provided all the program information he needs to complete his work. Marien Decl. ¶ 18. The parties attribute the delays to their discovery disputes in other jurisdictions and for a which the Court finds are not material to this ruling. The Court is left with the fact that Marien has only "preliminary results" from his "work thus far" which cause him to suspect, for example, that the essential components of genuine insurance (i.e., risk shifting and risk distribution) are not present in the xélan supplemental disability insurance program, and that Guess' statements to the contrary to doctors and to the IRS are false and misleading. Id. ¶18.

Marien is unable to "draw final conclusions about whether xélan doctors are entitled to the tax benefits Guess and xélan have touted to them." Id. ¶ 17. He is able to draw only tentative and qualified conclusions. "If these conclusions are correct," then xélan doctors have improper deductions and will owe tax on "all or nearly all of their contributions . . . to, for example, the 419 Welfare Benefit Trust. Id. ¶ 25 (emphasis added). Marien identifies on-going, and as yet inconclusive, IRS investigations into whether the xélan disability, trust is providing insurance at all, or "simply a savings program" that attempts to defer recognition of taxable income, and the limits on deductibility in the event that the xélan disability trust is in fact providing insurance. Id. ¶ 16 (emphasis added). He further identifies as yet inconclusive IRS investigations into whether the xélan 419 Welfare Benefit Trust program provides "welfare benefits" at all, or whether it is "simply a deferred compensation or dividend program" improperly attempting to defer the recognition of wage or dividend income, with tax-free accumulations of earnings on that income, and whether that program" meets the requirements of Internal Revenue Code § 419A(f)(6). Id. ¶ 24.b (emphasis added). "If the IRS" eventually makes certain determinations, "it will likely make [necessary] substantial adjustments to the income tax returns filed by the doctors and their corporations who participated" in the plans. Id. ¶ 24.b (emphasis added). "The IRS is also examining whether the xélan 419 Welfare Benefit Trust is providing severance benefits at all, or whether it is simply a savings program . . ." Id. ¶ 24.c (emphasis added). Marien concludes: "Because the xélan doctors and their subchapter C corporations are likely not entitled to the tax benefits they claimed from participating in these xélan programs, they will owe substantial additional taxes, penalties and interest to the IRS." Id. ¶ 34 (emphasis added).

This lawsuit does not name as a defendant any participating doctor who may have tax, liabilities for claiming unjustified tax deductions associated with xélan programs. Defendants are exclusively the third-party xélan affiliates, potentially responsible for the doctors' potential under reporting, The government argues it is essential to freeze all the assets controlled by the defendants, to confirm the appointment of the Receiver, and to continue the other provisions of the TRO "so that the xélan - doctors for whose benefit the funds are held may have access to the funds to pay anticipated tax, deficiencies," and so the IRS can collect those revenues. Compl. ¶ 43. It characterizes the injunctive relief as needed to "aid in the administration of the internal revenue laws, and to prevent the continuing and substantial injury to the United States and to members of the public." Compl. ¶ 44. Receivers appointed pursuant to 26 U.S.C. § 7402(a) are authorized to take control of property, to have an accounting performed, and to preserve the property for tax administration purposes. However, the powers conferred through 26 U.S.C. § 7402(a), based on the authority presented by the United States, do not appear to include the appointment of a Receiver to take possession of all the assets of a party against whom there has been no finding of a tax law violation and who, even assuming a tax liability were eventually determined, is not clearly responsible for paying such liability.⁵

Defendants argue the government's theory that they conspired to defraud the doctors and the United States depends entirely on a determination whether their financial plans are devised and implemented permissibly under the Internal Revenue Code and, if not, then whether the defendants knew them to be impermissible. The government itself has yet to make the first of those determinations; thus, it cannot at this time impute culpable knowledge to the defendants. Defendants persuasively challenge the "probability of success on the merits" element of the preliminary injunction showing because the IRS has not made foundational determinations essential to prove the xélan programs, or some of them, are not entitled to receive the tax treatment, or the degree of favorable tax treatment, defendants claim. The government produced no evidence that any agency, court, or other authority has definitively ruled that any of the xélan programs in fact runs afoul of the Internal Revenue Code. The IRS is investigating xélan doctors, but does not appear to have had a case successfully assessing tax deficiencies, or one contested to a final administrative ruling or in United States Tax Court. Any damages liability of the xélan defendants would be derivative of the outcome of those processes. The extremely large sums the government predicts xélan doctors will owe similarly depends on a determination whether the challenged xélan programs violate tax laW. Without expressing any opinion on the ultimate merits of this action, the Court finds a clear showing of probable success on the merits requires some such evidence.

The Court also finds that the government has not substantiated any immediate harm that will arise if the Court dissolves the extremely broad TRO. The government acknowledges not all the xélan programs are suspect. The Could does not find an urgent need to preserve an enormous pool of funds through seizure of all assets from third-party xélan entities and xélan-affiliated individuals from which speculative tax obligations might at some future time be collectable. Further, there is no principled way to narrow the seizure to apply only to assets traceable to the suspected underlying wrongdoing. The Court declines to impute fraudulent intent to defendants when the expert IRS witness is unable himself to say definitively whether any of the xélan programs violate internal revenue regulations. That lacuna in the government's evidence is dispositive of the result. No "clear showing" of likely success on the merits can be made on the present record. Unless and until a probability of success on the merits is established, the government does not benefit from a presumption of irreparable injury. Miller, 19 F.3d at 459; Nutri-Cology, 982 F.2d at 398; Odessa, 833 F.2d at 174-75.

Even had the government made a clear showing of probable success on the merits, the Court finds the balance of hardships tips decidedly in defendants' favor. The TRO effectively closed down the entities and profoundly intruded on the personal and professional interests of the individual defendants. The extraordinary bread the of that injunction swept much broader than was reasonable and necessary, even if portions of the xélan arrangements are ultimately recharacterized as taxable.

IV. FINDINGS

In consideration of the evidence, the Court makes specific findings, including:

1. The government conceded it can produce no evidence at this time that the IRS has ruled any particular xélan program violates internal revenue statutes or regulations. The United States identifies no definitive finding by any court or other authoritative agency in support of its contention the suspect xélan products or programs actually violate tax law.

2. The government must show defendants are disposing of property traceable to criminal activity to warrant seizure of the property. The government produced no evidence that any of the defendants are dissipating their assets or that any of the assets seized under the TRO are traceable to criminal activity.

3. The Receiver will be unable to trace any portion of defendants' seized assets to criminal activity unless and until the government substantiates xélan doctors underpaid taxes through impermissible xélan tax avoidance schemes,

4. The defendants' evidence refuted the governments assertion that the xélan entities lack adequate funds or reserves to cover their outstanding obligations.

5. The Temporary Receiver's own Initial Preliminary Report identified either no discrepancies, or only immaterial discrepancies, between the available reserves and what would be needed to cover xélan entity obligations to participants, defeating the asset dissipation claim.

6. The findings regarding the xélan entities' actual financial holdings demonstrate the government's allegations of a "Ponzi scheme" are without merit.

7. The government's evidence that some of the xélan programs are not actually administered as the arms length or legitimately tax insulated arrangements they purport to be is speculative at this point. The government has not shown that the tax implications of any particular xélan product were mischaracterized.

8. The present lack of evidence that defendants actually violated any tax laws is dispositive of the "likelihood of success on the merits" showing required to obtain preliminary injunctive relief.

9. The government concedes the fraction of xélan activities targeted by the IRS does not extend to all the programs or all the assets it asks the Court to transfer to the Receiver's control. In particular, the xélan Foundation administers legitimate and important charitable work, nationally and internationally. It presently controls approximately $42 million for those purposes. The TRO froze all the Foundation's assets, although only a small percentage of those funds are associated with suspect arrangements.⁶

10. Even if the government had shown a clear possibility of success on the merits, the scope of the remedy far exceeds defendants' tax liability exposure should the government prevail on the merits. That disproportionality coupled with the extreme hard ship on the xélan entities, the individual defendants, and innocent third parties, weighs against a grant of preliminary injunctive relief.

VI. CONCLUSION AND ORDER

For the foregoing reasons, and those recited on the hearing record, and after careful consideration of the papers and oral argument, the Court DENIES the motion for entry of a Preliminary Injunction and terminates the injunctive relief granted in the TRO.

IT IS SO ORDERED.

DATED: December 14, 2004

² The United States indicated at the hearing it is no longer pursuing the writ relief and has no objection to return of the confiscated passports and lifting of all travel restrictions.

³ An insured doctor sued to establish the legitimacy of the premium deductions, after the IRS made its only actual deficiency assessment against a DBIC insured (according to DBIC), following exhaustion of IRS remedies with DBIC's assistance.

⁴ France identifies the mechanisms for this purported fraud as: selling specifically-identified programs as legitimate tax reduction strategies, while knowing that as designed and operated, the xélan programs do not produce the tax benefits they touted to xélan doctors; preventing the doctors and law enforcement officials from learning all the underlying facts about xélan's programs; obstructing IRS audits; preventing or dissuading xélan doctors from seeking their own independent financial and legal advice; committing perjury in connection with IRS summons enforcement actions; and making false statements in connection with the pending bankruptcy proceedings involving some of the xélan affiliated entities. France Decl. ¶ 6

⁵See In re Gerwig, 461 F.Supp. 449 (C.D. Cal. 1978), stating that applications by the government for ex parte, unnoticed proceedings to result in the seizure of property apply to the IRS, requiring that a judge must independently determine whether probable cause exists to believe; (1) an assessment of tax has been made against the taxpayer; (2) notice and demand were properly made; (3) the taxpayer neglected or refused to pay the assessment; and (4) property subject to seizure presently exists at the premises sought to be searched and belongs to the taxpayer or is property subject to lien for payment of the taxes. The Gerwig factors were cited with approval in United States v. Condo, 782 F.2d 1502 (9th Cir. 1986). Defendants analogize the seizure case to a Receiver taking possession of their assets without an underlying assessment of tax made against any taxpayer, without notice or demand for payment, without a prior refusal to pay any tax demanded, with the property frozen or made subject to the receivership neither subject to a tax lien nor belonging to the "likely" taxpayers with "anticipated" tax deficiencies, i.e., the xéan doctor-participants. See Buck & DIS P&A pp. 21-22 discussion of cases.

⁶ The government does not dispute the xélan Foundation has twice been approved for 501(c)(3) status and is presently registered as such, although counsel for the Foundation represents that, in other proceedings, the government is presently challenging whether the Foundation should be designated a tax exempt 501(c)(3) charitable organization.