You Can't Cheat an Honest Man - James Walsh [71]
Jerome was able to keep the scheme going for about two years. (Basically, until the oldest notes started maturing.) A few investors got their money out; but, by the latter part of 1982, The Fund started missing monthly interest payments. Some investors were having difficulty reaching Jerome. In a few cases, he’d failed to return principal amounts at the end of the investment term.
By the end of the year, Jerome’s Ponzi scheme had collapsed. Numerous civil lawsuits followed, with burned investors seeking the return of their money plus damages. Between 1983 and 1985, several dozen of these lawsuits resulted in judgments against Jerome. When he didn’t pay these damages, criminal charges followed.
In 1986, Jerome was charged with 24 felony counts related to the scheme. He eventually pleaded guilty to three felony counts involving the willful and unlawful taking of money from others. He was sentenced to a prison term of one to three years.
One of the ugly facts that emerged from the investigations: Jerome and a former wife had been sued in the 1960s for fraud connected to the sale of tax shelter investments. The Fund was actually Jerome’s second failed Ponzi scheme.
Beginning in early 1986, IRS agents attempted to discuss the Ponzi scheme and related income tax matters with Jerome, but he was uncooperative. So, the IRS pieced together a history of The Fund from interviews with investors and local law enforcement authorities—and research into evidence used in Jerome’s trials. The difference between funds received and disbursed by Jerome was considered to be taxable income. His total take during the life of the scheme was $1,120,551.
Because the Feds considered the Berenbeims a married couple filing their taxes jointly during Jerome’s fraud, they tried to hold Phyllis jointly liable for his debt. At this point, she made her innocent spouse argument.
The earnings of either spouse during marriage are both spouses’ community property. However, according to the tax code, the innocent spouse doctrine excludes items of community income from a spouse’s taxable income where all of the following four requirements are met: 1) the spouse seeking relief did not file a joint return for any taxable year;
2) the income item omitted from the gross income of the spouse seeking relief is treated as the income of the other spouse;
3) the spouse seeking relief establishes that she did not know of and had no reason to know of such item of community income; and
4) under the facts and circumstances, it is inequitable to include such item of community income in the income of the spouse seeking relief.
To meet this standard, it’s not enough to show a lack of knowledge. An innocent spouse must also show that he or she had no reason to know about an understatement. In order to do this, he or she must convince a court that a reasonably prudent person—with a comparable level of education and experience and with equal knowledge of the circumstances—would not have known about the wrongdoing.
Jerome had kept Phyllis from knowing about the fraudulent nature of his scheme. And he didn’t do this to protect her; he did it because he was stealing from her. Between 1978 and 1983, Phyllis loaned Jerome $76,590 to help him pay some old debts and get his business started. He repaid a few thousand dollars to her directly...but convinced her that he was investing money for her in The Fund.
In 1983, as The Fund was approaching collapse, Phyllis became suspicious because of inquiries from various friends and acquaintances concerning Jerome’s failure to make monthly payments. She asked him about The Fund and his other investment activities. He said he was having some probems—but that The Fund was basically sound. She believed him.
She trusted Jerome and permitted him to manage their financial and tax matters. She was prone to accept his explanations without question.
The IRS didn’t care how naive the woman was. Its lawyers argued that Phyllis didn’t meet the burden of proving all of the necessary elements of an innocent spouse claim. Specifically,