By Brett Barrouquere
A federal appeals court July 18 upheld a $65 million judgment against the operators of a horse breeding program that turned out to be fraudulent, finding that the sales and tax benefits were "dramatically oversold."
The U.S. 6th Circuit Court of Appeals found that the operators of a mare-lease program, ClassicStar Farms, GeoStar corporation and three owners, actively sought to mislead investors.
ClassicStar and GeoStar sold the mare-lease programs as tax shelters, but failed to tell prospective investors that the Internal Revenue Service was investigating the programs. In 2009, ClassicStar co-founders David and Spencer Plummer pleaded guilty in Oregon to $200 million in tax fraud in the IRS case.
"The evidence is pervasive that the GeoStar defendants were aware that the Mare Lease Program was dramatically oversold," Judge Eric Clay wrote for the court's majority.
Arbor Farms, Jaswinder and Monica Grover, MacDonald Stables, Nelson Breeders, and West Hills Farms sued ClassicStar and others. U.S. District Judge Joseph M. Hood in Lexington awarded $49.4 million in damages and $15.6 million in pre-judgment interest in 2011 to investors for a total of just over $65 million.
The IRS raided ClassicStar's Kentucky farm in 2006. The agency later alleged the operation had allowed its investors to file more than $500 million in false tax deductions.
In a mare-lease program, investors leased the reproductive capacity of specific Thoroughbred mares. If the mare had a foal during the time that the investor held the lease, the investor would own the foal.
Mare-lease program promoters told investors that they could take deductions on their federal income tax returns for the losses generated by the Thoroughbred horse breeding operation. These deductions reduced or eliminated the investors' taxes, and many received refunds, including for years prior to their investments.
Judge Gilbert Merritt dissented in part and said the court should have returned the case for trial. Merritt wrote that there is substantial evidence the investors were partly to blame for the losses they sustained.
"Specifically, there is evidence that would allow a reasonable jury to find that the plaintiffs invested not because of the defendant's misrepresentations but rather because of their own greed for tax deductions," Merrit wrote.
The mare-lease program generated more than $600 million between 2001 and 2005, Hood wrote, on the promise that investors would receive both high returns and significant tax benefits. But from the beginning the programs actually were designed to funnel investors' money from ClassicStar to its parent company, GeoStar, to fund its mineral and energy exploration interests.
"By 2004, the difference between the value of the mares owned by ClassicStar and the value of the mare leases sold to investors was approximately $270 million," Clay wrote.
To hide the inventory shortage, ClassicStar substituted less valuable Quarter Horse mares whose values were inflated and who were set up to support tax deductions then to be traded out for some other asset before breeding occurred, Clay wrote.
ClassicStar and GeoStar then encouraged investors to convert their mare-lease holdings to stock, and GeoStar then used those funds for its mineral and gas drilling. GeoStar moved about $330 million in mare lease program sales proceeds from ClassicStar accounts to its own bank accounts and used the funds to pay for ClassicStar's operations, oil and gas operations for itself, and its subsidiaries and related entities.
Without investors' knowledge, GeoStar arranged to pay commissions to some investors' attorneys who gave the mare-lease programs their stamp of approval and brought in new participants. ClassicStar and GeoStar also arranged financing for investors through National Equine Lending Co., but that was a shell company controlled by ClassicStar and headed by David Plummer's brother-in-law, Gary Thomson.
ClassicStar, once a leading buyer of high-end broodmares and broodmare prospects, filed for bankruptcy in 2007.
In 2011, GeoStar paid a $2 million settlement to ClassicStar's bankruptcy trustee, James D. Lyon, to settle litigation against Ferguson and other executives. In 2010, GeoStar's energy company spinoff, Gastar, settled with seven plaintiffs, paying $21 million.
By Brett Barrouquere