The Republic | azcentral.comSat May 4, 2013 2:14 PM

The biggest opponent facing two Arizona businessmen on trial last month for tax evasion was not the federal prosecutor.

It was their lawyer, the government’s star witness in the case against them.

Businessmen Stephen Kerr and Michael Quiel say the California lawyer who for years gave them legal advice also was supplying federal investigators with information used to indict them.

The case raises questions about legal procedures and attorney-client privilege, one of the most sacrosanct legal protections the law affords.

The case also provides insight into the way offshore shell companies are used to conceal revenue so that it isn’t counted as income, which the Internal Revenue Service says is one of the nation’s top ongoing tax scams.

The IRS for several years has been targeting people who are hiding income in offshore banks, brokerage accounts or corporations called nominee entities.

“Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose,” the IRS said in a bulletin called the “Dirty Dozen Tax Scams for 2013.”

Kerr, of Scottsdale, and Quiel, of Fountain Hills, were accused of setting up accounts tied to foreign companies and using stock transactions to avoid paying taxes on millions of dollars. They also were accused of moving money to the United States through their lawyer’s trust accounts.

Their former lawyer, Christopher Rusch, in San Diego, turned state’s evidence against his clients in exchange for a reduced sentence. He admitted conspiring with Kerr and Quiel to hide assets from the government.

“If your lawyer gets up on the stand and calls you a crook, you’ve got a problem,” said Houston attorney Michael Minns, who specializes in tax cases and now represents Quiel.

Minns said Quiel and Kerr were duped by Rusch into believing the transactions were legal. He said when federal authorities began investigating, Rusch secured a deal and provided them with documents and other information that were products of his legal work.

Courts typically afford attorney-client communication the same confidentiality given to husbands and wives, doctors and patients and clergy and their congregants. The purpose is to ensure that a client can discuss any legal issue with an attorney without fear that the information will be disclosed.

But there are exceptions, chiefly the “crime-fraud exception,” which does not allow the attorney-client privilege to be used to further a crime or in cases in which an attorney was hired to facilitate illegal activity.

Arizona U.S. District Court Judge James Tielborg, however, ruled the exception was moot since Quiel and Kerr used communications from Rusch to challenge the government’s case and show they were acting on their lawyer’s advice.

“Kerr cannot invoke the attorney-client privilege to deny the government the very communications and information it must refute in order to prove that defendants conspired to defraud the United States,” Tielborg said.

The government initially charged Quiel and Kerr with multiple counts of tax fraud, including conspiracy. A jury last month convicted them on two counts each of filing false income-tax returns in 2007 and 2008.

Kerr was convicted on two additional charges of failing to file a report disclosing foreign accounts.

United States residents with control of or interest in any account in a foreign country worth more than $10,000 are required to file a Foreign Bank and Financial Accounts Report.

Federal prosecutors said Rusch helped Quiel and Kerr set up bank accounts in Switzerland, the Caribbean and Panama, then created intermediary companies to move money and stock through them.

In court documents, prosecutors described how the transactions worked. For example, one of the Swiss companies was called Red Rock Investment AG. It was created in 2006. A year later, Kerr opened a bank account at UBS in Switzerland. Kerr was the beneficiary, and Rusch had signatory control over the account. The account held balances of more than $750,000.

According to court documents, Rusch and Kerr deposited 400,000 shares of stock into the Red Rock account in 2007. They directed the UBS account manager to sell the stock when the share price hit a certain point.

Quiel was involved in several similar transactions, according to prosecutors.

Prosecutors said Quiel and Kerr directed Rusch to transfer some of the money in the undeclared accounts back to the United States through trust accounts set up by Rusch.

These accounts, called Interest on Lawyer Trust Accounts, are used by lawyers to generate interest on client money. The revenue generated by the trusts often goes to establish low-income legal-aid grants.

Prosecutors said Rusch transferred approximately $2 million through his trust account so Kerr could buy a golf course in Erie, Colo. He also used the trust to transfer $955,000 for Quiel, writing checks that Quiel could cash at an Arizona bank.

In court filings, Kerr said Rusch advised them on how to set up the foreign companies and accounts and told them that U.S. reporting requirements were minimal.

He pointed to an October 2006 e-mail from Rusch “stating that they could own about 4 percent of the foreign company without reporting control over the … accounts.”

Kerr said Rusch told them that “because the Swiss company was making direct investments, and the defendants’ ownership interest was small,” they wouldn’t have to report most of the transactions.

“Rusch assured the defendants that the scenario was “very clean” and that any U.S. reporting would be based on the Swiss tax return,” Kerr said in court filings.

Sentencing in June

Quiel and Kerr face up to five years in prison on each count when they are sentenced in June.

Minns, however, said the case is not the victory that federal prosecutors would have the public believe.

Despite the government’s claims that his clients attempted to evade taxes, prosecutors could not point to any unpaid tax obligations, Minns said. He said prosecutors could not prove that Quiel or Kerr owed any taxes in 2007 and 2008.

In fact, he said, Quiel received a $500,000 tax return one year and never cashed the check. He said the check was offered to the jury as evidence.

If they didn’t owe taxes, then how can they be accused of tax fraud, Minns asked.

He said that explains why the jury failed to convict on the most serious of the charges, conspiracy.

The Department of Justice would not comment on the case Friday.

Brian Watson, spokesman for the IRS criminal division in Phoenix, also declined comment.

“The jury verdict speaks for itself,” he said.

Robert Anglen and Veronica Sanchez lead the Call 12 for Action team, focused on issues important to Arizona consumers. Contact the reporter at Follow him on Facebook and Twitter @robertanglen.