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Dark Matter: When to Seal the Tax Court Record

Posted on Apr. 7, 2015

Today’s returning guest blogger is Sean Akins. Sean is special counsel at Covington & Burling, LLP whose practice includes representing corporations, partnerships, and individuals in tax controversy matters. Sean is a co-author of Kafka, Cavanagh & Akins: Litigation of Federal Civil Tax Controversies and a co-author of Effectively Representing Your Client Before the IRS, Chapter 7, Litigation in the Tax Court. Sean is also a Nolan Fellow (2014-2015) of the Section of Taxation of the American Bar Association, and an Associate Member of the J. Edgar Murdock American Inns of Court (U.S. Tax Court). He is an avid (albeit amateur) physics buff, for which he begs the readers’ indulgence. Keith

For most of the past century, one of the most challenging problems facing physicists has been explaining the existence and nature of dark matter and dark energy. Dark matter and dark energy are estimated to account for 95.1 percent of all the ‘stuff’ in the universe; with everything we see (i.e., galaxies, stars, planets, you and me, etc.) accounting for the remaining 4.9 percent.  Despite this, dark matter and dark energy are referred to as such because (i) we can only infer their existence, and (ii) physicists know very little about either despite decades of intense research.  The universe, it seems, holds onto its secrets very carefully.

Taxpayers, like the universe, are protective of their secrets.  Whether in the form of a taxpayer identification number, the names of minor children, or corporate trade secrets, taxpayers have an interest in keeping the public ‘in the dark’ about sensitive information.  The public, like physicists, has a countervailing interest in learning about America’s judicial system and having open trials.  These competing interests have most recently come to a head in the context of the Tax Court’s consideration of whether corporate trade secrets merit protection from public disclosure during the course of a trial.

Specifically, the Tax Court has recently sided with taxpayers, closing trials from public view in several high-profile transfer pricing cases where corporate trade secrets were at issue. See, e.g., Medtronic Inc. & Consolidated Subsidiaries v. Commissioner, Inc. & Subsidiaries v. Commissioner.  Several commentators have found this to be a “troubling practice” that “subordinat[es] the public interest in open trials.” See, e.g., Gupta, Ajay, Tax Court Continues with Secret Transfer Pricing Trials, Tax Notes (Feb. 23, 2015).  These concerns are understandable – the public’s interest in maintaining the openness of a public trial is a strong one.  But the Tax Court’s role is to find an appropriate balance between the competing interests of taxpayers and the public; a balance that each of the protective orders in the Amazon and Medtronic cases attempts to reach.

The Tax Court’s Protection of Sensitive Information

The Tax Court’s protection of corporate trade secrets is grounded in statute, the Tax Court’s rules (see rule 103(a)(7)), and the Tax Court’s jurisprudence.  More generally, the Tax Court has protected sensitive information in a variety of situations, including but not limited to corporate trade secrets.  Examples include:

  • Taxpayer Information – Protecting the disclosure of sensitive taxpayer information. See, e.g., Guidant LLC, F.K.A. Guidant Corporation, and Subsidiaries, et al. v. Commissioner, Order dated Nov. 21, 2013, Tax Court Docket Nos. 5989-11, 5990-11, 10985-11, 26876-11, 5501-12, 5502-12 (issuing a protective order that permitted the filing under seal of discoverable information constituting corporate trade secrets); Anonymous v. Commissioner, 127 TC 89 (2006) (permitting taxpayer to proceed anonymously and sealing the record where disclosure of information could subject taxpayer or his family to physical danger).
  • Whistleblowers – Permitting whistleblowers to proceed anonymously, but refusing to seal the record, where disclosure of the individual’s name could have subjected them to retaliatory action by a current employer, or preclude the individual from obtaining new employment. See, e.g., Whistleblower 10944-12W, Order dated July 11, 2012, Tax Court Docket No. 10944-12W; Whistleblower 14106-10W, 137 TC 183 (2011).
  • Commissioner’s Convention Information – Allowing the Commissioner to file documents constituting tax convention information, and thereby protected from disclosure under Code section 6105, under seal. See, e.g., Estate of Sanders v. Commissioner, Order dated Aug. 28, 2013, Tax Court Docket No. 4614-11; Coffey v. Commissioner, Order dated Oct. 12, 2012, Tax Court Docket No. 4720-10.
  • Third Party Information – Permitting the parties to file under seal sensitive third-party information relevant to the litigation. See, e.g., QinetiQ v. Commissioner, Order dated May 27, 2014, Tax Court Docket No. 14122-13; Manquen v. Commissioner, Order dated Nov. 10, 2014, Tax Court Docket No. 26666-12.

The foregoing examples reflect a careful balancing act that the Tax Court must undertake each time it is requested to limit the public’s access to sensitive information. The best way to accomplish this balance is to issue a protective order or other ruling that is as narrowly crafted as possible.  In other words, the Tax Court can best achieve a balance of interests by limiting the public’s access to only that information that is sensitive in nature.

This standard was confirmed by the Judicial Conference of the United States, which in 2011 encouraged courts to seal entire civil case files only where “required by statute or rule or justified by a showing of extraordinary circumstances and the absence of narrower feasible and effective alternatives such as sealing discrete documents or redacting information, so that sealing an entire case file is a last resort.”

The Tax Court has taken care to follow this standard. In whistleblower actions, for example, the Court generally permits whistleblowers to proceed anonymously, but the Court will not seal the record from public inspection. See, e.g., Whistleblower 10944-12W, supra; Whistleblower 14106-10W, supra.  Similarly, in cases involving corporate trade secrets, the Court has engaged in a thorough review of thousands of pages of documents, requiring redaction of only certain pages, or excerpts thereof, that if open to the public could result in financial harm to the corporate party. See, e.g., Manquen, supra.  And, the Court has been careful not to extend its protection of corporate trade secrets where it is unwarranted, refusing to issue protective orders where good cause was lacking. See, e.g., Willie Nelson, supra.

The Medtronic and Amazon Protective Orders

The Medtronic and Amazon protective orders are somewhat novel, however.  The large majority of protective orders issued by the Tax Court apply to the filing of documents under seal, or the ability of a litigant to proceed anonymously.  In Medtronic and Amazon, the Court protected not only documentary evidence, but also closed large portions of the trials from public view and required redaction of those portions of the record that could result in the dissemination of corporate trade secrets.

Some have argued that this goes a step too far. These commentators contend that the Tax Court’s rules governing the protection of corporate trade secrets, or other sensitive information, do not extend beyond the protection of discoverable materials (e.g., documentation that may be filed under seal), and that at the very least, the public’s heightened interest in an open trial should require the Court to apply a standard of review greater than the ‘good cause’ standard the Court has applied to the protection of discoverable materials.

But if the Tax Court lacks the ability to protect sensitive information at trial, or if the Tax Court must apply a heightened standard to justify the protection of that information, litigants are presented a dilemma – they may have their sensitive information protected throughout pre-trial proceedings, but if they choose to try their case, their sensitive information is subject to disclosure. For corporations with trade secrets, the disclosure of which would subject them to significant financial harm, this amounts to toll charge that could eclipse the tax adjustment being litigated.

Accordingly, like the Tax Court’s protective orders that preceded them, the Medtronic and Amazon protective orders attempt to strike a balance between the protection of the taxpayers’ trade secrets and the public’s interest in access to the trial record.  Each of the orders limits the public’s access to the trial testimony of factual and expert witnesses.  But in doing so, the Tax Court requires the taxpayers to submit copies of the record that redact only that information that the taxpayer views as protected information.  These redactions are subject to objection by the Commissioner and review by the Tax Court.  This procedure helps ensure that only those portions of the record that are deemed protected information are excluded from public review.

Additionally, the Tax Court carefully defines ‘protected information’ in a limited way. For example, in Amazon, the Court orders that protected information includes, in part, “Business analyses, results, data, and reporting information less than five years old or otherwise still in use for business purposes at the time such material is designated as Protected Information….”  (emphasis added).  By employing an “in use” or five-year window standard, the Court helps ensure that stale information, the release of which could no longer financially harm the taxpayer, would be made available to the public.

This is not to say that the Medtronic and Amazon protective orders are perfect.  Although the definition of ‘protected information’ limits that information subject to protection, once a document or record excerpt satisfies the definition, there appears little means for the public to access the information in the future.  Both orders provide that the protections offered thereunder will continue after the trial concludes, ostensibly in perpetuity.  This means that even after information ceases to be sensitive in nature, it will remain subject to protection under the continuing terms of the protective orders.  Additionally, even if the Tax Court could be petitioned to lift the protections at some future date, this places the financial and resource burden on the public to do so.

One alternative the Tax Court could employ to alleviate this concern would be to place a time boundary on the protections offered by its protective orders. In other words, the protective orders could protect sensitive information after the conclusion of the trial, but only for a set number of months or years, unless otherwise requested by an interested party.  Such a limit could be further tailored so that different information would become public at different times.  Pricing information, for example, may be sensitive for a shorter period time than a long-term strategic corporate plan. Such a time boundary would help ensure that documents and trial records would become open to public review once the information was no longer of a sensitive nature.

For the time being, however, the Tax Court’s protective orders in Medtronic and Amazon have recognized those taxpayers’ interests in keeping their secrets hidden from view.  It is likely that physicists will continue to grapple with dark matter and dark energy for decades to come –  hopefully the public will not have to wait that long to review the full records in Medtronic and Amazon.

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