Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 1 of 20 1 2 3 4 5 6 7 8 Scott H. Frewing (SBN 191311) Andrew P. Crousore (SBN 202195) Jay Cha-young Kim (SBN 266360) Brad Clements (SBN 310398) BAKER & McKENZIE LLP 660 Hansen Way Palo Alto, CA 94304-1044 Telephone: +1 650 856 2400 Facsimile: +1 650 856 9299 scott.frewing@bakermckenzie.com andrew.crousore@bakermckenzie.com jay.kim@bakermckenzie.com brad.clements@bakermckenzie.com Attorneys for Respondent Facebook, Inc. 9 UNITED STATES DISTRICT COURT 10 NORTHERN DISTRICT OF CALIFORNIA 11 SAN FRANCISCO DIVISION 12 13 UNITED STATES OF AMERICA, 14 Petitioner, 15 16 Case No. 3:16-cv-03777-LB FACEBOOK’S OPPOSITION TO AMENDED PETITION TO ENFORCE INTERNAL REVENUE SERVICE SUMMONSES v. FACEBOOK, INC. AND SUBSIDIARIES, 17 Respondent. 18 DATE: November 17, 2016 TIME: 9:30 am DEPT.: Courtroom 15-C 19 20 21 22 23 24 25 26 27 28 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 2 of 20 1 TABLE OF CONTENTS 2 Page(s) 3 I. INTRODUCTION................................................................................................................ 1 4 II. STATEMENT OF FACTS .................................................................................................. 2 A. The IRS Audit: 2011-2015......................................................................................... 2 B. The IRS Wound Down its Audit in Early 2015 ......................................................... 2 C. The IRS April 2015 Presentation and Facebook’s Response .................................... 3 D. From May 2015 to January 2016, The IRS Stood Still and Did Not Respond to Facebook’s Presentation ........................................................................................ 3 E. IRS Further Demand for Unconditional Extension of Statute of Limitations ........... 4 F. The April 2016 IRS Requests for Information .......................................................... 5 G. Facebook’s Proposed Approach to the April 2016 IDRs........................................... 6 H. IRS Issued Seven Summonses In the Midst of Meeting and Conferring with Facebook .................................................................................................................... 7 I. Facebook Has Taken Substantial Steps to Comply with the Summonses by the End of 2016 .......................................................................................................... 8 14 J. The IRS Has Delayed Facebook’s Production of Materials .................................... 10 15 K. The IRS Simultaneously Issued a Notice of Deficiency That Will Require Parallel Proceedings with Potentially Duplicative Discovery ................................. 10 5 6 7 8 9 10 11 12 13 16 III. 17 18 ARGUMENT ...................................................................................................................... 11 A. Following a Case Management Conference, the Court Should Issue a Case Management Order with a Production and Briefing Schedule ................................ 11 B. The Summonses Are Overbroad and Seek Privileged Information ......................... 12 19 1. An Overly Broad Summons Is Not Enforceable.......................................... 12 20 2. The Summonses Are Not Sufficiently Specific to Permit Facebook to Adequately Respond .................................................................................... 13 3. The IRS Is Not Entitled To Compel Production of Privileged Materials ...................................................................................................... 14 21 22 23 IV. CONCLUSION .................................................................................................................. 15 24 25 26 27 28 i Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 3 of 20 1 TABLE OF AUTHORITIES 2 Page(s) 3 Cases 4 Adamowicz v. United States, 531 F.3d 151 (2nd Cir. 2008)...................................................................................................... 14 5 6 Fisher v. United States, 425 U.S. 391 (1976) .................................................................................................................... 12 7 8 9 10 11 Gudenau v. United States, 98 A.F.T.R.2d (RIA) 6745 (D. Haw. Sep. 11, 2006)............................................................ 13, 14 Potter v. United States, 2002 U.S. Dist. LEXIS 20031 (S.D. Cal. 2002) ......................................................................... 13 Reisman v. Caplin, 375 U.S. 440 (1964) .............................................................................................................. 12, 15 12 13 14 15 16 17 18 19 20 21 22 23 United States v. Abrahams, 905 F.2d 1276 (9th Cir. 1990), overruled on other grounds, United States v. Jose, 131 F.3d 1325 (9th Cir. 1997) ........................................................................................... 13 United States v. Arthur Young & Co., 465 U.S. 805 (1984) .............................................................................................................. 12, 15 United States v. Beacon Fed. Sav. & Loan, 718 F.2d 49 (2nd Cir. 1983)........................................................................................................ 12 United States v. Coopers & Lybrand, 550 F.2d 615 (10th Cir. 1977) .................................................................................................... 12 United States v. Cox, 73 F. Supp. 2d 751 (S.D. Tex. 1999) .......................................................................................... 12 United States v. Dauphin Deposit Trust Co., 385 F.2d 129 (3rd Cir. 1968) ................................................................................................ 12, 14 United States v. Eaton Corp., 110 A.F.T.R. 2d 5638 (N.D. Ohio 2012) .................................................................................... 15 24 25 26 27 United States v. Harrington, 388 F.2d 520 (2d Cir. 1968).................................................................................................. 12, 14 United States v. Malnik, 489 F.2d 682, 686 n.4 (5th Cir. 1974) ........................................................................................ 13 28 ii Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 4 of 20 1 2 3 4 United States v. Powell, 379 U.S. 48 (1964) ................................................................................................................ 11, 12 United States v. Ryan, 402 U.S. 530 (1971) .............................................................................................................. 12, 14 5 United States v. Rylander, 460 U.S. 752 (1983) .................................................................................................................... 12 6 Constitutional Provisions 7 U.S. Const. amend IV ....................................................................................................................... 12 8 Federal Statutes 9 26 U.S.C. § 7525 ............................................................................................................. 11, 12, 14, 15 10 26 U.S.C. § 7525(a)(1) ...................................................................................................................... 15 11 12 26 U.S.C. § 7525(a)(3)(A) ................................................................................................................ 15 26 U.S.C. § 7602 ................................................................................................................................. 7 13 31 U.S.C. § 330 ................................................................................................................................. 15 14 15 16 17 Federal Rules Fed. R. Civ. P. 26(a)(1)(B)(v) ........................................................................................................... 11 Fed. R. Civ. P. 26(b)(1)..................................................................................................................... 11 18 Fed. R. Evid. 502 .............................................................................................................................. 10 19 Fed. R. Evid. 502(d) ................................................................................................................... passim 20 Fed. R. Evid. 502(e) ...................................................................................................................... 8, 10 21 Tax Ct. R. 38 and 70 ......................................................................................................................... 11 22 Tax Ct. R. 70 and 72 ......................................................................................................................... 11 23 Local Rules 24 Local Rule 16-7................................................................................................................................. 11 25 26 Other Authorities Internal Revenue Manual § 4.46.3 ...................................................................................................... 4 27 28 iii Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 5 of 20 1 I. INTRODUCTION 2 After auditing Facebook, Inc. for more than four years, the Internal Revenue Service 3 (“IRS”) ended its audit on July 26, 2016, when it issued a Statutory Notice of Deficiency. In its 4 Notice, the IRS disputes the amount of royalties paid to Facebook, Inc. by its Ireland subsidiary in 5 connection with certain licenses entered into in September 2010. Facebook has filed a formal 6 challenge to the IRS Notice in U.S. Tax Court, and that court ultimately will resolve this matter. 7 Instead of waiting for discovery to commence in the Tax Court, however, the IRS elected to 8 burden this Court to enforce seven extraordinarily broad summonses (the “Summonses”). The 9 Summonses seek hundreds of thousands of documents about virtually every aspect of Facebook’s 10 core business — documents which cannot inform the now-completed audit. The IRS served the 11 Summonses at the 11th hour of the audit, demanding that Facebook comply with production 12 deadlines that the IRS knew were impossible for Facebook to meet. 13 Any suggestion that Facebook failed to respond to IRS requests is simply untrue. During 14 the audit, Facebook produced thousands of pages of documents in response to more than 200 IRS 15 requests, voluntarily extended the statute of limitations five times, and made employees available 16 for interviews. Facebook also conferred multiple times with the IRS about the requests at issue 17 now, and stood ready to produce many of the documents within a reasonable amount of time. The 18 IRS, however, chose to convert its requests into the formal Summonses and rushed to court to seek 19 immediate enforcement. 20 Facebook remains ready to comply with the IRS requests, but Facebook believes the 21 production should proceed on a reasonable schedule that incorporates adequate time for the parties 22 (and the Court, if necessary) to resolve disputed issues that will inevitably arise relating to the 23 scope of production and privilege. Accordingly, Facebook respectfully requests that the Court 24 enter the proposed Case Management Order and Order Pursuant to Fed. R. Evid. 502(d) that it has 25 submitted with this Opposition. 26 27 28 1 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 6 of 20 1 II. STATEMENT OF FACTS 2 A. The IRS Audit: 2011-2015 3 In November 2011, the IRS initiated an audit of Facebook’s tax years ended December 31, 4 2008, and December 31, 2009. Declaration of Ronald Dong in Support of Facebook’s Opposition 5 to Amended Petition (“Dong. Decl.”) ¶ 3. In January 2013, the IRS expanded its audit to include 6 Facebook’s tax year ended December 31, 2010. Id.; Declaration of IRS Agent Nina Wu Stone 7 (“Agent Stone Decl.”) ¶ 15. As of June 2016, the IRS had been auditing Facebook for more than 8 four years. 9 During the course of the audit, the IRS requested, and Facebook produced, large volumes of 10 information. The IRS issued more than 240 Information Document Requests (“IDRs”), and in 11 response, Facebook produced thousands of pages of documents. Dong Decl. ¶ 4. In addition, 12 Facebook voluntarily made nine employees available for transcribed interviews. Id. In connection with the audit, the IRS requested six extensions to the statute of limitations. 13 14 Facebook agreed to the first five. Specifically: a. effective August 2, 2011, Facebook agreed to extend the statute of limitations for its 15 2008 tax year to September 15, 2013; 16 b. effective March 26, 2013 Facebook agreed to extend the statute of limitations for its 17 2008 and 2009 tax years to November 30, 2014; 18 c. effective March 25, 2014, Facebook agreed to extend the statute of limitations for 19 its 2008, 2009, and 2010 tax years to November 30, 2015; 20 d. effective February 23, 2015, Facebook agreed to extend the statute of limitations for 21 its 2008, 2009, and 2010 tax years to January 31, 2016; and 22 e. effective May 20, 2015, Facebook agreed to extend the statute of limitations for its 23 2008, 2009, and 2010 tax years to July 31, 2016. 24 25 Dong Decl. ¶ 5. 26 B. The IRS Wound Down its Audit in Early 2015 27 The IRS largely conducted its audit during 2013 and 2014. See Agent Stone Decl. ¶¶ 21- 28 22. In January 2015, the IRS issued 16 IDRs, the majority of which were follow-up questions to 2 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 7 of 20 1 topics that the IRS had previously discussed with Facebook. Facebook promptly responded. Dong 2 Decl. ¶ 6. At that point, it appeared that the IRS was concluding its audit. Id. 3 C. 4 On April 17, 2015, the IRS made a presentation to Facebook and set forth its preliminary 5 views regarding the transfer pricing valuation issues at the heart of the audit. Dong Decl. ¶ 7; 6 Agent Stone Decl. ¶ 22. The IRS April 2015 Presentation and Facebook’s Response 7 On May 27, 2015, Facebook responded to the IRS presentation and explained that the IRS 8 had made significant and arbitrary errors in its analysis. Dong Decl. ¶ 8. Facebook explained that 9 once the IRS errors were corrected, the IRS economic model yielded essentially the same value 10 that Facebook used to prepare its tax returns, or even that Facebook’s tax return position was 11 overly generous to the IRS. Id. 12 On June 22, 2015, the IRS responded to Facebook’s May 27 presentation and informed 13 Facebook that the IRS intended to issue additional IDRs related to Facebook’s presentation and 14 that the IRS was evaluating, for the first time, whether to engage an outside expert. Dong Decl. 15 ¶ 9; Agent Stone Decl. ¶ 26. 16 D. From May 2015 to January 2016, The IRS Stood Still and Did Not Respond to Facebook’s Presentation 17 18 Contrary to its assertion that it needed more information, from May 27, 2015 through 19 December 2015, the IRS did not issue any additional requests for information related to 20 Facebook’s May 27 presentation, nor did the IRS request or conduct a single interview of any 21 Facebook personnel. Dong Decl. ¶ 10. The IRS merely issued an IDR in July 2015 requesting 22 copies of a publicly available Facebook blog, and three IDRs on September 30, 2015, unrelated to 23 Facebook’s presentation and to which Facebook promptly responded on October 14, 2015. Id. 24 From September 30, 2015 through December 2015, the IRS limited its audit activities to routinely 25 scheduled meetings with Facebook tax personnel. Throughout this period, Facebook repeatedly 26 sought to conclude the audit. Id. ¶ 11. In January 2016, the IRS did finally issue several IDRs 27 28 3 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 8 of 20 1 related to Facebook’s May 27 presentation to which Facebook responded in February 2016. Id. 2 ¶ 10. 3 E. 4 On January 25, 2016, after months of inactivity, the IRS requested that Facebook agree to 5 extend the statute of limitations for yet a sixth time. Dong Decl. ¶ 12. The IRS requested a one- 6 year extension to July 31, 2017. Id. The IRS declined to provide Facebook an audit plan for the 7 extended period, despite such audit plans being required by IRS procedures. Id.; see IRS Internal 8 Revenue Manual § 4.46.3 (stating that IRS audit plans should at a minimum include detailed steps 9 for each selected issue, timeline(s) with milestone dates, and dates and decision points used to risk 10 assess issues being examined). The IRS justified its request for a sixth extension by stating that 11 after Facebook explained the errors in the proposed IRS adjustment, the IRS needed to continue 12 gathering more information from Facebook and to secure outside experts. Dong Decl. ¶ 12. As 13 noted above, the IRS had made no requests for information related to Facebook’s May 27 14 presentation during the eight months after the presentation and prior to asking for this extension. IRS Further Demand for Unconditional Extension of Statute of Limitations 15 Rather than grant an unqualified extension through July 31, 2017, Facebook asked the IRS 16 to consider a shorter extension to October 31, 2016. Dong Decl. ¶ 13. Facebook asked the IRS to 17 commit to issuing a 30-day letter (a necessary procedural step to allow a taxpayer to bring disputed 18 issues to a next-level review with IRS Appeals) by May 1, 2016. Id. The IRS declined Facebook’s 19 offer of an extension conditioned upon the IRS completing its examination in six months. Id. 20 Without any audit plan at all, and after five extensions over four years, Facebook sought reasonable 21 closure of the audit. 22 Subsequently, on two separate occasions, Facebook offered alternatives for an extension of 23 the statute of limitations, and the IRS rejected each one. Dong Decl. ¶ 14. As recently as May 24 2016 Facebook proposed an extension to January 31, 2017, which Facebook had offered subject to 25 similar reasonable conditions. Id. The IRS rejected Facebook’s May 2016 offer. Id. 26 The IRS claims that it wished to continue the audit, and that its delay was justified by 27 “budgetary constraints” that prevented it from being able to retain an expert. Agent Stone Decl. 28 4 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 9 of 20 1 ¶ 26. The IRS submission fails to acknowledge, however, that (a) the IRS conducted nine 2 interviews of Facebook employees between 2013-2014; (b) the IRS had already issued and 3 received responses to over 200 IDRs between 2013-2015; (c) Facebook made multiple 4 presentations to the IRS about the Facebook business; and (d) Facebook was willing to provide a 5 reasonable extension of the statute of limitations if the IRS agreed to provide Facebook an audit 6 plan and committed to allow Facebook to proceed to IRS Appeals if an issue remained disputed. 7 F. 8 On April 7, 2016, the IRS issued IDRs IE-178 through IE-187, 1 which included more than 9 100 requests for documents, including electronically stored information (“ESI”), about virtually all 10 aspects of Facebook’s business during a five-year period (“April 2016 IDRs”). Dong Decl. ¶ 15; 11 Agent Stone Decl. ¶ 30. The information requested in these IDRs largely forms the basis of the 12 Summonses at issue in this matter. The IRS did not provide Facebook drafts of IDRs IE-178 13 through IE-187, contrary to its own internal procedures requiring that the IRS do so to permit the 14 taxpayer to confer about the scope of the requests and the timetable for responding. Dong Decl. 15 ¶ 15 see also IRS Directive LB&I-04-0214-004 (requiring IRS examination teams to consult with 16 taxpayers prior to issuing IDRs). The April 2016 IRS Requests for Information 17 The IRS gave Facebook only three weeks to respond to the April 2016 IDRs. Dong 18 Decl. ¶ 16. Most of the IRS requests sought “any and all documents” related to broadly-worded 19 topics. For example, two of the questions requested the following: 20 All Documents constituting or reflecting discussions or communications by 21 any of the Taxpayer’s executives or managers, including, but not limited to, 22 any of the managers overseeing Taxpayer’s finance, sales and marketing, 23 growth, product development and/or engineering divisions, of any of the 24 barriers to the growth of Taxpayer’s social networking community of 25 users. Please provide all such documents created, obtained or circulated in 26 27 28 1 IDRs are informal IRS information requests issued during an audit. The “IE” designation in IRS IDRs refers to IDRs issued by an IRS International Examiner. Other IRS IDRs may be issued by domestic IRS agents, economists, or engineers. As a result, IDRs IE-178 through IE-187 are a subset of the more than 240 IDRs issued during the audit. 5 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 10 of 20 2008-2012. 1 2 See Agent Stone Decl., Summons 2, Question 18 (emphasis added). 3 All Documents constituting and reflecting any communications made to or 4 by any of Taxpayer’s business executives or managers including, but not 5 limited to, any managers overseeing Taxpayer’s finance, sales and 6 marketing, growth, product development and/or engineering divisions, that 7 refer to the value, importance or significance of the acquisition, retention, 8 and/or satisfaction to Taxpayer of users in its social networking 9 community through products, tools, or features. Please provide all such documents created, obtained or circulated in 2008-2012. 10 11 See Agent Stone Decl., Summons 4, Question 1 (emphasis added). 12 On their face, just these two questions require Facebook to identify and produce tens of 13 thousands of documents from among tens of millions of emails. The questions require “any and all 14 documents” regarding “barriers to growth” and the “importance” of users from among all of the 15 ESI held by Facebook, including multiple years of employee email. Neither the April 2016 IDRs 16 nor the Summonses provide any guidance for identifying such documents. Almost all of the 17 questions in the April 2016 IDRs were equally as broad. 18 G. 19 Facebook worked diligently to respond to the April 2016 IDRs by identifying potential 20 locations and custodians of responsive documents and developing search terms. Dong Decl. ¶¶ 17- 21 21. 22 Summonses (collectively “Non-Email Records”). 23 (immediately after receiving the April 2016 IDRs), Facebook identified potential custodians, 24 located potentially responsive materials, and manually reviewed the records for responsiveness and 25 privilege. Id.; Declaration of Jay Cha-young Kim in Support of Facebook’s Opposition to 26 Amended Petition To Enforce Internal Revenue Service Summonses (“Kim Decl.”) ¶ 9. As of Facebook’s Proposed Approach to the April 2016 IDRs First, Facebook identified documents other than email that may be responsive to the Dong Decl. ¶ 20. Beginning in April 27 28 6 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 11 of 20 1 August 19, 2016, Facebook had substantially completed its review of Non-Email Records and 2 offered to produce the responsive documents to the IRS. Kim Decl. ¶ 14. 3 Second, Facebook began identifying relevant documents in its archive database of 4 employee email (“Email ESI”). Dong Decl. ¶ 21. Because of the volume of Email ESI and the 5 search capabilities of the system, searching and exporting email takes a considerable amount of 6 time and resources. Id. ¶ 27. Facebook promptly identified potential custodians by functional 7 areas. Id. Facebook also developed a list of search terms based on the April 2016 IDRs. Id. ¶ 21. 8 Facebook determined that searches of Email ESI related to April 2016 IDRs would yield 9 hundreds of thousands of documents. Kim Decl. ¶ 12. Facebook began an active review of the 10 documents for responsiveness and privilege and was ready to commence production to the IRS on 11 a rolling basis. Id. ¶¶ 11-12 12 H. IRS Issued Seven Summonses In the Midst of Meeting and Conferring with Facebook 13 14 Facebook also sought to confer with the IRS about the April 2016 IDRs. Dong Decl. ¶ 23. 15 On April 27, 2016, Facebook provided the IRS a detailed 60-page letter providing a list of email 16 custodians and proposed search terms for responding to the April 2016 IDRs. Dong Decl. ¶ 22; see 17 Agent Stone Decl. ¶ 31. Cognizant that the IRS might convert the IDRs to summonses, and that 18 any dispute would come before this Court, Facebook’s letter and proposed process sought to 19 comply with the Northern District of California’s Guidelines for the Discovery of Electronically 20 Stored Information. 2 21 Facebook and the IRS met in person on three occasions, on May 10, 2016, May 13, 2016, 22 and June 14, 2016, for a total of more than 15 hours to discuss search terms. Dong Decl. ¶ 23. 23 After three days of meetings in May and June 2016, the IRS had not made any proposals in writing 24 to narrow its requests. Id. 25 26 27 28 2 IRS authority to issue an administrative summons is codified in 26 U.S.C. § 7602. In corporate tax audits it is reasonably common for the IRS to issue a summons when the IRS and the taxpayer cannot promptly resolve informal IRS IDRs. During the audit, Facebook responded to more than 200 IRS IDRs without the IRS issuing a summons. See Dong Decl. ¶ 4. 7 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 12 of 20 1 On June 1, 2016, in the midst of meeting and conferring with Facebook about the April 2 2016 IDRs, the IRS issued six summonses due 16 days later (June 17, 2016). Dong Decl. ¶ 24. On 3 June 8, 2016, the IRS issued a seventh summons due 21 days later (June 29, 2016). 4 Collectively, these Summonses generally demand the same information as the more than 100 5 requests in the April 2016 IDRs. Id. ¶ 25; Agent Stone Decl. ¶¶ 33-37. On July 6, 2016, the United States filed its Petition to Enforce compliance with the first six 6 7 Id. Summonses. Subsequently, the government amended its petition to include the seventh summons. 8 I. Facebook Has Taken Substantial Steps to Comply with the Summonses by the End of 2016 9 10 Facebook has taken substantial steps to comply with the Summonses. Kim Decl. ¶¶ 3-14. 11 On August 19, 2016, Facebook offered to produce approximately 7,000 responsive, non-privileged 12 Non-Email Records if the IRS agreed that the Non-Email Records would be subject to an 13 agreement pursuant to Fed. R. Evid. 502(e) and any court order entered pursuant to Fed. R. Evid. 14 502(d). Kim Decl. ¶ 14. On September 20, 2016, Facebook offered to produce to the IRS by 15 October 7, 2016, approximately 50,000 documents of Email ESI responsive to Summonses 1 and 16 2, 3 again subject to a court order pursuant to Fed. R. Evid. 502(d). Facebook reiterated that offer 17 on September 29, 2016. Id. ¶¶ 15-16. 18 Facebook has also made substantial progress towards complying with the remainder of the 19 Summonses, but its review and production will still require several months. Dong Decl. ¶ 27; Kim 20 3 21 22 23 Facebook and the IRS previously agreed to a numbering system for the six Summonses. The summons questions corresponding to IDRs 171-173 would be known as Summons 1. Because there were seven questions in Summons 1, the numbering for the questions is Summons 1.01-1.07. A similar numbering system was applied to all six Summonses as follows: Summons No. 24 1 2 3 4 5 6 25 26 27 IDR Number Groupings in Each Summons 171-173 178-179 180-181 182-183 184-185 186-187 Total Number of Questions Corresponding Summons Numbering 7 20 29 17 33 15 1.01-1.07 2.01-2.20 3.01-3.29 4.01-4.17 5.01-5.33 6.01-6.15 28 8 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 13 of 20 1 Decl. ¶¶ 12-13. For each summons, Facebook must (1) select appropriate search terms, custodians, 2 and date ranges; (2) search for, export, and process the Email ESI from Facebook’s email database; 3 and (3) review the Email ESI documents for responsiveness and privilege. Kim Decl. ¶ 9. 4 Facebook has completed the first step and is currently carrying out the second and third 5 steps on a rolling basis, summons by summons. Kim Decl. ¶¶ 11-12. This sequencing allows 6 attorney review of documents potentially responsive to one summons to occur while searching and 7 processing of email potentially responsive to other summonses continues. Id. 8 For the second step, Facebook applies search terms and date ranges to each custodian’s 9 emails and exports the identified emails to an e-discovery tool for further searching and review. Id. 10 As an example, Summons 2, consisting of 20 questions, required almost three weeks to complete 11 the targeted searches and export the results. Id. During this time, no attorney review of the 12 documents was possible. Id. Facebook uses a third-party service provider to process documents 13 and is charged based on certain hourly fees and the volume of data. Id. Facebook estimates the 14 total third-party data processing costs for compliance with the seven Summonses will likely exceed 15 one million dollars. Dong Decl. ¶ 27. 16 Third, Facebook will conduct attorney review of the Email ESI responsive to the searches 17 for each summons. Facebook’s searches for just Summons 2, again consisting of 20 questions, 18 produced approximately 210,000 potentially responsive documents for review. Kim Decl. ¶ 12. 19 Extrapolating from these 20 questions to the total of 135 questions in all seven Summonses 20 suggests that Facebook may need to review more than one million documents for responsiveness 21 and privilege. Id. ¶ 13. By any measure, this will be a considerable undertaking. Facebook is 22 devoting substantial resources to the attorney review process and has informed the IRS that it will 23 produce responsive, non-privileged Email ESI on a rolling basis, summons by summons. Id. ¶ 14. 24 Facebook expects to produce to the IRS substantially more than 100,000 thousand documents over 25 the next three months, and this number may increase as Facebook completes its review by January 26 2017. 27 28 9 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 14 of 20 1 J. The IRS Has Delayed Facebook’s Production of Materials 2 The IRS itself has delayed Facebook’s production in three ways. First, the IRS could have 3 requested the documents at any time during an audit that began in November 2011. The IRS 4 elected to wait until April 2016 to issue the April 2016 IDRs (which, in June, became the 5 Summonses). 6 Second, prior to September 23, 2016, the IRS did not provide written comments to 7 Facebook’s proposed Email ESI search terms. Kim Decl. ¶¶ 7, 16. If the IRS had proposed its 8 own search terms in April, or promptly replied to Facebook’s proposed search terms, Facebook 9 could have begun searching using agreed search terms substantially earlier. 10 Third, from April 2016 through September 2016, the IRS repeatedly declined to enter into 11 an agreement or stipulate to a court order pursuant to Fed. R. Evid. 502. 4 Kim Decl. ¶ 15; see 12 Agent Stone Decl. ¶ 31. The purpose of a Rule 502(e) agreement is to allow Facebook to produce 13 responsive documents pursuant to the broad requests in the Summonses, while still allowing 14 Facebook to retain its privilege claims, without waiver, in the event privileged communications are 15 unintentionally produced. Facebook has separately filed a motion seeking an order pursuant to 16 Fed. R. Evid. 502(d). K. 17 The IRS Simultaneously Issued a Notice of Deficiency That Will Require Parallel Proceedings with Potentially Duplicative Discovery 18 19 On July 26, 2016, the IRS issued a Statutory Notice of Deficiency proposing adjustments to 20 Facebook’s 2010 tax year. This notice completed the IRS audit prior to the statute of limitations 21 for the 2008-2010 tax years expiring five days later on July 31, 2016. On October 11, 2016, 22 Facebook filed a petition with the U.S. Tax Court disputing the IRS’s deficiency determination. 23 The Summonses provide an early discovery device for the IRS in the Tax Court proceeding. 24 Discovery will not commence, without leave of the Tax Court, until 30 days after the IRS answers 25 26 27 28 4 Beginning in August 2016, Facebook has had substantially more constructive discussions with the U.S. Department of Justice regarding search terms and a potential order pursuant to Fed. R. Evid. 502(d). These discussions have not yet resolved the issues between the parties, but Facebook is confident they will continue and lead to some constructive resolutions. In an effort to address the issue of an order pursuant to Fed. R. Evid. 502, Facebook has simultaneously filed a motion asking this Court to issue such an order. 10 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 15 of 20 1 Facebook’s petition, which is not due until 60 days after the petition is served. See Tax Court 2 Rules 38 and 70. The Tax Court significantly limits IRS access to taxpayer materials, including 3 ESI, more than typical summons enforcement proceedings. See Tax Court Rule 70, 72; 5 see also 4 Fed. R. Civ. P. 26(b)(1) (limiting discovery “proportional to the needs of the case”). 5 III. ARGUMENT 6 Facebook does not challenge the IRS’s nominal ability to enforce the seven Summonses 7 pursuant to United States v. Powell, 379 U.S. 48, 57-58 (1964) (providing factors for enforcement 8 of IRS summons), but Facebook does oppose the scope of the requests and the compliance 9 timetable the IRS demanded. As explained below, Facebook respectfully asks this Court to set a 10 reasonable timetable for reviewing and producing documents and for dealing with disputed issues 11 related to scope and privilege. 12 A. Following a Case Management Conference, the Court Should Issue a Case Management Order with a Production and Briefing Schedule 13 14 Concurrent with this Opposition, Facebook has filed a motion requesting the Court to 15 schedule a Case Management Conference on the same date and time as the hearing on the IRS’s 16 Petition. See Civil L. R. 16-7. 6 Facebook respectfully requests that the Court issue a Case 17 Management Order setting forth a reasonable schedule for the production of documents and 18 relating to the resolution of disputes over scope and privilege. 19 As described above, the Summonses require Facebook to search and export millions of 20 documents. Even with reasonable search terms, the process will require considerable time to 21 identify and review documents for responsiveness and privilege. Facebook also believes the IRS 22 may object to Facebook’s production of Email ESI, including challenging Facebook’s search 23 24 25 26 27 28 5 The Tax Court can limit discovery if (a) it is unreasonably cumulative or duplicative; (b) it is obtainable from some other source that is more convenient, less burdensome, or less expensive; (c) the party seeking discovery had ample opportunity by discovery in the action to obtain the information sought; or (d) it is unduly burdensome or expensive, taking into account the needs of the case, or the amount in controversy. 6 An action to enforce an administrative summons is exempt from the initial disclosure obligations under Fed. R. Civ. P. 26(a)(1)(B)(v). But under Local Rule 16-7, the Court may schedule a Case Management Conference or issue a Case Management Order without such conference. Civil L. R. 16-7. 11 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 16 of 20 1 terms, custodians, and privilege assertions. As the document review process continues and Email 2 ESI production begins, this Court will likely need to resolve disputes regarding scope, burden, and 3 privilege. 4 Facebook will confer with the government in hopes of arriving at a Joint Case Management 5 Statement that the Court will be able to adopt as its Case Management Order. See Civil L. R. 16- 6 9(a). In the event the parties are unable to reach an agreement, Facebook asks that the Court adopt 7 Facebook’s [Proposed] Case Management Order. See id. 8 B. 9 The Summonses Are Overbroad and Seek Privileged Information 1. An Overly Broad Summons Is Not Enforceable 10 Not only must the IRS comply with the elements for summons enforcement established in 11 Powell, 379 U.S. at 48, the IRS may not enforce a summons that is overly broad or seeks 12 information protected by a legal privilege. See Reisman v. Caplin, 375 U.S. 440, 449 (1964); 13 United States v. Beacon Fed. Sav. & Loan, 718 F.2d 49, 53-55 (2nd Cir. 1983); United States v. 14 Cox, 73 F. Supp. 2d 751, 758 (S.D. Tex. 1999); see also Fisher v. United States, 425 U.S. 391, 401 15 n.7 (1976) (Fourth Amendment limits scope of IRS summonses). “The IRS is not entitled to go on 16 a fishing expedition…[and] must identify with some precision the documents it wishes to inspect.” 17 United States v. Dauphin Deposit Trust Co., 385 F.2d 129, 131 (3rd Cir. 1968); United States v. 18 Coopers & Lybrand, 550 F.2d 615, 619 (10th Cir. 1977) (“IRS does not, as it appears to assume on 19 this appeal, have carte blanche discovery.”). 20 Although the IRS is entitled to obtain information that may be relevant to the correctness of 21 Facebook’s return, United States v. Arthur Young & Co., 465 U.S. 805, 814 (1984), it is not 22 entitled to every bit of information about Facebook and every document about every aspect of 23 Facebook’s business over its history. See United States v. Harrington, 388 F.2d 520, 524 (2d Cir. 24 1968) (relevance must be a “realistic expectation rather than an idle hope”). And while a summons 25 requires an individual to make a good faith “reasonable” effort to obtain records, United States v. 26 Ryan, 402 U.S. 530, 534 (1971), she cannot be required to do the impossible. See United States v. 27 Rylander, 460 U.S. 752, 757 (1983). 28 12 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 17 of 20 1 In the Ninth Circuit, “overbreadth” has been construed as addressing “concerns about 2 excessive burden and lack of specificity, rather than relevance.” See United States v. Abrahams, 3 905 F.2d 1276, 1281 n.6 (9th Cir. 1990), overruled on other grounds, United States v. Jose, 131 4 F.3d 1325 (9th Cir. 1997). Hence, district courts in the Ninth Circuit interpret an overbreadth 5 challenge as an allegation that a summons lacks the required specificity. See, e.g., Gudenau v. 6 United States, 98 A.F.T.R.2d (RIA) 6745, 6751 (D. Haw. Sep. 11, 2006) (citing and applying 7 United States v. Malnik, 489 F.2d 682, 686 n.4 (5th Cir. 1974) for the proposition that “[t]he 8 documents must be described only with ‘reasonable particularity’ so as to give the witness 9 sufficient information to determine which records are to be produced.”); Potter v. United States, 10 2002 U.S. Dist. LEXIS 20031, *24 (S.D. Cal. 2002) (partially granting taxpayer’s motion to quash 11 with respect to documents protected by the attorney-client privilege, after also conducting an 12 independent review to determine if summonses were overbroad). 13 2. The Summonses Are Not Sufficiently Specific to Permit Facebook to Adequately Respond 14 15 Many of the requests in the Summonses are worded so broadly that they do not provide 16 Facebook with sufficient guidance to determine which documents are, or are not responsive. The 17 following is an illustrative example of one of the IRS requests: 18 All Documents constituting or reflecting the actual growth numbers or 19 growth data of the online social networking community of users. Please 20 provide all such documents created, obtained or circulated in 2008-2012. 21 See Agent Stone Decl., Summons 3, Question 3. 22 The question requires production of any document, over a five-year period, mentioning 23 Facebook’s growth data. As a company focused intently on the satisfaction, retention, acquisition, 24 and, ultimately, growth, of people using Facebook during this time period, almost any Facebook 25 employee could conceivably have referred to growth data in one or more communications. 26 Facebook could not produce “all” responsive documents unless it examined almost every document 27 sent or received by every Facebook employee between 2008 through 2012. Facebook had 28 13 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 18 of 20 1 approximately 2,127 employees as of December 31, 2010 and 3,200 as of December 31, 2011. 2 Dong Decl. ¶ 16. 3 unreasonable. As drafted, this summons question (and many like it) is impractical and 4 Facebook nevertheless has sought to respond to this question (and all the others) by 5 conducting searches within the files of a reasonable number of custodians using targeted terms 6 such as “grow” and “active user,” as well as abbreviations like “DAU” (daily active users) and 7 “MAU” (monthly active users) regularly used by Facebook. Facebook discussed these proposed 8 search terms, custodians, and date range with the IRS. Id. ¶ 23. The IRS only offered verbal 9 suggestions of modifications that would further broaden (not narrow) the search terms and 10 custodians. Id. Prior to September 23, 2016, the IRS had not reduced to writing its proposed 11 search terms, custodians, and date ranges. Id. 12 Facebook’s Email ESI search strategy is a good faith “reasonable” effort to provide records. 13 See Ryan, 402 U.S. at 534. A strict reading of the IRS’s overly broad Summonses would be asking 14 Facebook to do the impossible. See Harrington, 388 F.2d at 524. Facebook intends to use 15 reasonable search terms to provide much-needed definition and precision to the scope of the 16 Summonses, so Facebook can adequately respond. See Adamowicz v. United States, 531 F.3d 151, 17 157-58 (2nd Cir. 2008); Dauphin Deposit Trust Co., 385 F.2d at 131; Gudenau, 98 A.F.T.R.2d 18 (RIA) at 6751. 19 The IRS, however, did not provide any feedback on Facebook’s search strategy for the first 20 four summonses, and it only recently provided comments on Facebook’s proposed approach to 21 responding to the fifth summons. Despite Facebook’s substantial efforts and the expected volume 22 of the production, Facebook expects that the IRS may raise objections. As a result, the Court will 23 likely need to resolve the parties’ disputes. 3. 24 The IRS Is Not Entitled To Compel Production of Privileged Materials 25 IRS summons authority may be appropriately challenged by privilege claims, including the 26 attorney-client privilege, work product, and the tax practitioner privilege under section 7525 of the 27 28 14 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 19 of 20 1 Internal Revenue Code. 7 See Arthur Young & Co., 465 U.S. at 814; Reisman, 375 U.S. at 449. An 2 IRS summons that seeks information protected by a legal privilege is not enforceable. See Arthur 3 Young & Co., 465 U.S. at 814; Reisman, 375 U.S. at 449; United States v. Eaton Corp., 110 4 A.F.T.R. 2d 5638 (N.D. Ohio 2012) (describing the federally authorized tax practitioner privilege). 5 As written, the overly broad Summonses would require the production of numerous 6 documents protected by these privileges. Preliminary searches of potentially responsive documents 7 for the Summonses demonstrate that hundreds of thousands of documents will need to be reviewed 8 for privileges, and Facebook will indeed assert privileges for a significant number of documents. 9 Kim Decl. ¶ 11. The full extent of privileged communications is not yet known at this time. Id. 10 The IRS is not entitled to all of the documents it has requested in its broad Summonses. 11 Facebook is allocating ample resources to properly conduct a privilege review of the potentially 12 responsive Email ESI records. Kim Decl. ¶¶ 10-12. Facebook estimates that it will take until at 13 least January 2017 to fully complete the review of the potentially responsive documents for all 14 seven Summonses. Dong Decl. ¶ 27; Kim Decl. ¶ 13. The Case Management Order should set a 15 production and briefing schedule that provides Facebook sufficient time to complete its document 16 review, create a privilege log, and allow the Court and parties to revisit issues relating to privilege 17 and overbreadth at a later date if the IRS challenges Facebook’s production. 18 IV. CONCLUSION 19 Facebook has cooperated throughout the IRS audit and intends to comply with the 11th- 20 hour barrage of Summonses, even though they are overbroad and ultimately unnecessary in light of 21 the Statutory Notice of Deficiency that the IRS issued and the parallel proceedings in the Tax 22 Court. Facebook has identified custodians, run searches using reasonable search terms, and has 23 24 25 26 27 7 The tax practitioner privilege under 26 U.S.C. § 7525 is a relevant privilege in this matter. Section 7525(a)(1) provides that “[w]ith respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.” A “federally authorized tax practitioner” is “any individual who is authorized under Federal law to practice before the Internal Revenue Service if such practice is subject to Federal regulation under section 330 of title 31, United States Code.” 26 U.S.C. § 7525(a)(3)(A). 28 15 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864 Case 3:16-cv-03777-LB Document 10 Filed 10/11/16 Page 20 of 20 1 offered to produce documents immediately upon the issuance of an order pursuant to Fed. R. 2 Evid. 502(d). Facebook requests the Court facilitate the production process by convening a Case 3 Management Conference and providing a Case Management Order that sets a reasonable timetable 4 for review and production of documents and for briefing of potentially disputed issues. 5 6 Dated: October 11, 2016. BAKER & McKENZIE LLP 7 8 /s/ Scott Frewing Scott H. Frewing 9 10 /s/ Drew Crousore Andrew P. Crousore 11 Attorneys for Respondent FACEBOOK, INC. 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 16 Baker & McKenzie LLP 660 Hansen Way Palo Alto, CA 94304 +1 650 856 2400 Case No. 3:16-cv-03777-LB Facebook’s Opposition to Amended Petition to Enforce Internal Revenue Service Summonses 597864