Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 1 of 10 IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE ---------------------------------------------------------------x : In re: : Chapter 11 : WASHINGTON MUTUAL, INC., et al., 1 : Case No. 08-12229 (MFW) : : (Jointly Administered) Debtors. : : ---------------------------------------------------------------x DECLARATION OF BRIAN PEDERSEN I, Brian Pedersen, hereby declare as follows: 1. I am a managing director with Alvarez & Marsal Taxand, LLC ( Alvarez ). I lead the firm s State Income Tax Competency Team, and have over thirty years experience advising clients on state tax issues. Prior to joining Alvarez, I was a partner at KPMG, LLP, where I was the National Partner in charge of Income and Franchise Tax. Prior to KPMG, I was a partner at Arthur Andersen, LLP, where I led the firm s State and Local tax practice for the Pacific Northwest region. 2. I submit this declaration in support of the WMI Liquidating Trust s (the Trust ) supplemental objection to the (a) Motion of Grant Thornton for an Order to Show Cause Why Sanctions Should Not be Imposed Against Washington Mutual Liquidating Trust for Failure to Comply with the Court s Final Fee Order by Failing and Refusing to Pay Approved Professional Fees [D.I. 11994], and (b) supplemental motion filed by Grant Thornton in further support of its sanctions request [D.I. 12346]. Except as otherwise indicated, all facts set forth in this declaration are based on my personal knowledge, my review of relevant documents, or my 1 The Debtors in these chapter 11 cases are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The principal offices of WMI Liquidating Trust are located at 1201 Third Avenue, Suite 3000, Seattle, Washington 98101.
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 2 of 10 opinion based on my experience, knowledge, and information concerning the operations of the above-captioned debtors (the Debtors ). If called upon to testify, I would testify competently to the facts set forth in this Declaration. I am authorized to submit this Declaration on behalf of the Trust. Citations of A refer to page numbers in the Trust s Appendix filed contemporaneously herewith. A. My role in the bankruptcy case 3. The Debtors retained Alvarez in the bankruptcy case as their restructuring advisors. When the Debtors filed for bankruptcy in September 2008, the FDIC had seized the bank and sold it to JPMorgan Chase, so the Debtors had no tax employees. Among other things, Alvarez took over the Debtors tax matters. I led Alvarez s state and local tax team, and, during the case, I was the Debtors lead point-person when dealing with the California Franchise Tax Board (the FTB ). In that capacity, I have personal knowledge about the numerous issues between the Debtors and the FTB, and the roles of the professionals who handled those issues. 4. In late 2008, the Debtors hired Curt Brouwer as Tax Director, and he became the officer in charge of all tax issues for the Debtors. I reported to Brouwer and worked closely with him throughout the case. B. Grant Thornton s role was limited to the Treasury Interest Issue 5. The Debtors retained Grant Thornton in the bankruptcy case in June 2009. Grant Thornton had developed an income exemption theory that the parties referred to as the Treasury Interest Issue, which posited that the Debtors U.S. treasury interest income was exempt from tax. The Treasury Interest Issue was based on the principle that a state must tax federal and state bond interest similarly; a state cannot tax federal bond interest and exempt state bond interest it must tax both or exempt both. Grant Thornton had identified a municipal bond issuance in California that by its terms appeared to exempt bond interest income from tax. Because 2
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 3 of 10 California taxed federal bond interest income, Grant Thornton concluded that there was a basis to allege discriminatory treatment. Using this reasoning, the Debtors would contend that the only remedy was for the FTB to treat federal bonds similarly, exempt all federal interest income from taxation, and refund the taxes that the Debtors had previously paid on those exempt amounts. 6. Once developed, the Treasury Interest Issue allowed the Debtors to ask for an approximately $42 million refund from the FTB, plus interest. Other than assisting with the Treasury Interest Issue, Grant Thornton did not work on any other issues before the FTB throughout the engagement. 7. The Debtors had two other issues before the FTB that were much larger in scope. First, the Debtors were entitled to approximately $400 million in refunds from the FTB primarily as a result of certain federal audit adjustments. Second, the FTB was auditing the Debtors franchise tax returns and was in the process of assessing deficiencies against the Debtors. Grant Thornton did not work on either of these matters. 8. The $400 Million Refunds. The Debtors became entitled to approximately $400 million in refunds from the FTB primarily on account of certain federal audits conducted by the IRS. These audits found that the Debtors had overpaid their federal taxes in prior years. Like many states, California calculates franchise taxes using federal taxable income numbers as a starting point. Because these numbers were now lower, the Debtors had overpaid their state franchise taxes and were entitled to a refund. This was not a controversial or contentious refund, because it arose from formal IRS audit findings that the FTB had to accept. 9. The $400 million in refunds related to several years. Approximately $35 million related to the 1994 tax year of an acquired company. This refund would be paid once the 3
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 4 of 10 Debtors and IRS finalized the audit results for that year. For later years (2000-2007), the Debtors amended their franchise tax returns several times to claim the refunds from the FTB. In 2007, the Debtors amended their returns and asked for approximately $172 million in refunds. In 2008, the Debtors amended their returns and asked for approximately $80 million in refunds. In 2009, the Debtors amended their returns and reported approximately $52 million tax due (not paid due to the bankruptcy). In 2010, the Debtors amended their returns and asked for approximately $72 million in refunds. In 2011, the Debtors amended their returns and asked for approximately $45 million in refunds. Finally, overpayments (refunds) were reflected on the Debtors originally filed 2007 and 2008 returns that had not been paid by the FTB. These refunds were not the result of any IRS activity, but were instead the refunds reflected on the original returns due to estimated tax payments ultimately being larger than the years actual liabilities. For 2007 and 2008, these overpayments totaled approximately $50 million. The cumulative total of these refunds due to the Debtors was approximately $400 million. 10. The FTB accepted all of the above-described refunds, with some minor adjustments. In total, the FTB agreed that the Debtors were entitled to approximately $400 million in refunds. Grant Thornton played no role in the federal audit, or in amending the Debtors state tax returns to obtain the $400 million in refunds from the FTB, or in any of the originally prepared returns. 11. The FTB Audit. At the start of the bankruptcy case, the FTB was in the process of auditing the Debtors franchise tax returns. While the audit was underway, my team and I stayed in contact with the auditor, addressed any questions raised by her, and provided her with information or explanations when requested. 4
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 5 of 10 12. In 2010, the FTB concluded the audit and assessed approximately $320 million against the Debtors for alleged tax underpayments. The FTB raised over a dozen issues, some of which involved complex tax questions. The two largest issues were the Debtors tax treatment of their real estate investment trusts (REITs) and registered investment companies (RICs). Grant Thornton played no role in any of the issues that the FTB raised in its audit, or in the proof of claim that the FTB filed as a result of its audit. 13. Before the FTB finished its audit, it filed a precautionary proof of claim to comply with the bar date. I use the word precautionary because the claim asserted an unrealistically high amount as a placeholder. The FTB asserted $2.4 billion in claims, which was the product of the Debtors gross income for the years at issue, multiplied by the tax rate, applying no deductions, and applying California s apportionment rate. In other words, the FTB assumed that the Debtors paid no taxes and asserted the maximum conceivable amount that the Debtors could owe. I did not expect the claim to remain this high, and it did not. Upon concluding its audit, the FTB amended its proof of claim to $280 million. 14. I understand that Grant Thornton contends that it should be entitled to bill a contingency fee for this over $2 billion reduction in the FTB s proof of claim. I find this contention surprising and unreasonable, given that Grant Thornton had no involvement in the audit or the proof of claim. This reduction was the result of the FTB adjusting its claim to reflect its audit findings. Grant Thornton did not work on any audit issues. At the time, or at any time thereafter, none of its professionals expressed to me that they believed that Grant Thornton could bill a contingency fee for the FTB s claim amendments. 5
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 6 of 10 C. The Debtors could not get any traction out of the Treasury Interest Issue, and elected to withdraw it rather than pursue it 15. I was the Debtors lead point-person in their dealings with the FTB. As set forth below, throughout my dealings with the FTB, it never offered any concession on the Treasury Interest Issue. It consistently rejected the theory, and it gave detailed written explanations that exposed weaknesses in the claim that we could not adequately refute. Based on my experience and interactions with the FTB, I believe that the Treasury Interest Issue did not alarm the FTB, and that it was willing to fight the issue rather than settle because it believed it would prevail. I believe that the FTB would have likely prevailed in any litigation on the issue, which is why I agreed with the Debtors decision to concede the issue and focus on larger, more meritorious claims. 16. The Debtors formally asserted the Treasury Interest Issue in their post-bankruptcy amended tax returns, which the Debtors filed in 2010 and 2011. In total, the Debtors requested a Treasury Interest Issue refund of $42 million plus interest. 17. I did not expect the Treasury Interest Issue to yield anywhere near that maximum value. Grant Thornton had advised the Debtors that the FTB likely would deny a refund in the full amount, and that the goal would be to try to settle for a percentage of the treasury interest claim. 18. I understand that Grant Thornton has contended that the Treasury Interest Issue could yield more than its maximum value in benefit in other words, that the claim could yield more than 100 cents on the dollar. Based on my three decades of experience in the industry, I view this contention as completely unreasonable. I have never encountered a government agency that was willing to pay more than the maximum refund that the taxpayer was seeking. In 6
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 7 of 10 fact, Grant Thornton affirmatively told the FTB that the Debtors were looking for only a percentage of the refund claim. A241. 19. Despite our efforts, the FTB repeatedly offered nothing for the issue. It shared with us two written analyses that raised significant defenses. A590, A594. According to the FTB, the franchise tax was applied to all bond interest, even interest from tax-exempt bonds. The FTB cited case law upholding the FTB s authority to include tax-exempt bond interest in the franchise tax, due to the different nature of franchise taxes as compared to direct taxes. A590, A594. Because the FTB included interest from tax-exempt bonds (like the one the Debtors claimed was discriminatory) in the franchise tax, the FTB concluded that it was not treating those bonds any differently than federal bonds, and therefore was not discriminating. 20. I asked Grant Thornton to prepare a response that we could share with the FTB. The response emphasized the plain meaning of the words of the bond issuance that we were claiming was discriminatory, which on its face appeared to exempt bond interest from tax. The weakness in this response was that it did not address the core of the FTB s position, which was that, despite those words, the FTB nevertheless includes interest from these tax-exempt bonds in the franchise tax. 21. I viewed the FTB s technical position as a persuasive defense to the Treasury Interest Issue, and Grant Thornton provided no other bullets in raising a counter-argument. Nevertheless, it was my job to try to obtain some value from the Treasury Interest Issue. At this relatively early stage, there was no point in just conceding the issue. 22. Thus, after receiving these letters from the FTB, the Debtors continued to ask for a full treasury interest refund. But, when the FTB continued to reject the issue, despite yielding 7
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 8 of 10 on others, I convened with Grant Thornton by telephone to discuss the need to modify our strategy. 23. This conversation took place in early 2014. The call was attended by myself, Curt Brouwer, and Grant Thornton professionals Scot Grierson and Paul Bogdanski. I discussed my frank view of the merits of the Treasury Interest Issue. Based on my discussions with the FTB, I believed that the Treasury Interest Issue did not cause the FTB concern, and that the FTB likely would prevail if the Debtors chose to litigate the issue. At the very best, I thought that maybe the issue could have a 30% chance of winning if the Debtors committed to fully litigating it through the appeals stage. 24. Grant Thornton agreed that asking for a full refund no longer made sense. To try to induce movement from the FTB, we agreed that we would cut the claim in half, ask for $21 million, and see what happens. Perhaps the FTB would counter-offer with a number that would open up an avenue for negotiation. 25. The FTB rejected paying $21 million, but, as importantly, it would not negotiate. It wrote that it would offer no concession on the issue. A343. We had no avenue to try to open up discussions. At this point, we were negotiating other issues and nearing agreement. The prospect of settlement was near, but the Treasury Interest Issue was providing no traction and we had no new or different counter-arguments to create any traction. In my view, the Treasury Interest Issue also was creating negative circumstances for the Debtors in their discussions with the FTB on other of the Debtors issues. For example, the Debtors had strong positions on the audit issues involving their real estate investment trusts (REITs) and registered insurance companies (RICs) because the FTB had other live cases involving those same issues, and risked suffering an adverse ruling that would serve as bad precedent in those pending cases. The 8
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 9 of 10 Debtors also had strong substantive positions on each of those issues and had made progress with the FTB in reducing its assessments of those issues. By contrast, the FTB had a strong defense to the Treasury Interest Issue, and I did not believe that the Treasury Interest Issue was meritorious enough to stand on its own. Accordingly, in my view, the Treasury Interest Issue did not present any basis for the Debtors to continue to assert it. The Trust in its business judgment could not justify the incurrence of litigation costs to litigate the issue. 26. Curt Brouwer was the primary decision maker about whether to continue seeking a treasury interest refund. After the decision to concede the issue, I told the FTB s lead negotiator, Bill Hilson, that the Debtors would no longer continue asking for a treasury interest refund and that we could stop talking about that issue. All further negotiations from this point did not include the Treasury Interest Issue. 27. The Debtors ultimately reached agreement with the FTB to reduce the FTB s $320 million audit assessments to $140 million. When netted against the $400 million refund that the FTB owed the Debtors, this lead to a net refund to the Debtors of $260 million. Approximately $225 million of this amount was paid shortly after the settlement was finalized. The remaining $35 million was paid in November 2016. 28. The Debtors did not recover anything on account of the Treasury Interest Issue. Prior to conceding the issue, the FTB refused to offer any value to settle the issue. The FTB did not offer any value in exchange for conceding the issue. And after conceding the issue, the Debtors stopped asking for any value to settle the issue. In my experience, no taxing authority ever would gratuitously offer value for a conceded issue. Further, in my negotiations with the FTB, I did not trade off the issue to reduce an audit issue. The FTB was always consistent in its 9
Case 08-12229-MFW Doc 12352 Filed 02/09/17 Page 10 of 10 refusal to negotiate or offer any value for the Treasury Interest Issue right up to the point when we stopped pressing the claim. D. Post-Settlement discussions with Grant Thornton 29. I was involved in some of the discussions between Curt Brouwer and Grant Thornton professionals in the Summer of 2014 about whether Grant Thornton had earned a contingency fee. All of the discussions I participated in focused on determining what value, if any, the Treasury Interest Issue yielded. Prior to the involvement of Grant Thornton s outside counsel, no one from Grant Thornton ever suggested that Grant Thornton could apply its contingency fee to other issues. 30. In my thirty years experience in the industry, including as the lead engagement partner on several contingency engagements, I have never encountered a contingency fee that was not based on the success of the underlying claim. Such a fee would be far beyond the norm. I also have never seen a firm ever suggest that a contingency fee relates to more than the issue it was hired to address. Under 28 U.S.C. 1746, I declare under penalty of perjury that, to the best of my knowledge and after reasonable inquiry, the foregoing is true and correct. Executed within the United States February 9, 2017. /s/ Brian Pedersen Brian Pedersen 10
Case 08-12229-MFW Doc 12352-1 Filed 02/09/17 Page 1 of 1 CERTIFICATE OF SERVICE On February 9, 2017, I caused a copy of the following documents to be served on the parties listed below. Documents Served WMI Liquidating Trust s Supplemental Objection to Grant Thornton s Motion for Sanctions. Declaration of Curt Brouwer. Declaration of Brian Pedersen. WMI Liquidating Trust s Appendix in Support of Supplemental Objection to Grant Thornton s Motion for Sanctions. By email and hand delivery: Joseph Grey, Esq. CROSS & SIMON, LLC 1105 North Market Street, Suite 901 Wilmington, DE 19806 By email and U.S. first class mail: Ian S. Landsberg, Esq. Casey Z. Donoyan, Esq. LANDSBERG LAW, APC 9300 Wilshire Boulevard, Suite 565 Beverly Hills, California 90212 /s/ Cory D. Kandestin Cory D. Kandestin (No. 5025) RLF1 16905518v.1