1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 (PREPARED FROM VIDEO RECORDING) 10 11 NOVEMBER 14, 2017 12 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 13 APPEAL OF 14 BANK OF AMERICA CORPORATION AND ITS AFFILIATES 15 NO. 983272 16 AGAINST PROPOSED ASSESSMENT OF 17 ADDITIONAL INCOME TAX 18 19 20 21 22 23 24 25 26 27 Prepared by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board of Equalization: Diane L. Harkey 3 Chairwoman 4 Sen. George Runner (Ret.) Vice Chair 5 Fiona Ma, CPA 6 Member 7 Jerome E. Horton Member 8 Yvette Stowers 9 Appearing for Betty T. Yee, State Controller 10 (per Government Code Section 7.9) 11 Joann Richmond 12 Chief Board Proceedings 13 Division For Board of 14 Equalization Staff Grant Thompson Tax Counsel IV 15 Legal Department 16 For Franchise Tax Board: Thomas Lo Grossman 17 Tax Counsel 18 Craig Swieso Tax Counsel 19 For Appellant: Derick Brannan 20 Representative 21 Jon Sperring Representative 22 David Belk 23 Witness 24 Larry Smilie Witness 25 Lauren Hood 26 Witness 27 Karen Mirandi Representative 28 ---oOo--- 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 NOVEMBER 14, 2017 4 ---oOo--- 5 MS. RICHMOND: Our next case for today is 6 item B1 Bank of America Corporation and its 7 Affiliates. 8 And this case has been granted an extra 9 five minutes for the opening presentation. 10 MS. HARKEY: Thank you very much. 11 Mr. Epolite, will you please introduce the 12 issues of this case. 13 MR. THOMPSON: Good afternoon. It's 14 actually Grant Thompson for the Appeals Bureau. 15 MS. HARKEY: Grant, I'm sorry. 16 MR. THOMPSON: That's okay. 17 MS. HARKEY: I'm on auto pilot, so excuse 18 me, Grant. 19 MR. THOMPSON: Unless I say something 20 stupid, then in which case it's Anthony. 21 MS. HARKEY: You can blame him. You can 22 blame him. It's his fault, right? 23 MR. THOMPSON: Just one issue today, which 24 is whether dividend income received by appellant 25 from China Construction Bank constitutes business 26 income. 27 MS. HARKEY: Thank you. All right. 28 MR. BRANNAN: Good afternoon, Madam 3 1 Chairwoman and Members of the Board. 2 MS. HARKEY: I guess you know the routine. 3 MR. BRANNAN: I -- I do. I'm sorry. I'm 4 just anxious about the time. 5 MS. HARKEY: Thank you so much. 6 MR. BRANNAN: I don't want to miss those 7 few seconds at the beginning. 8 MS. HARKEY: Go ahead. You will not -- you 9 can go. 10 MR. BRANNAN: We're good. Thank you. 11 Good afternoon, Madam Chairwoman and 12 Members of the Board. Thanks for your time this 13 afternoon. 14 I'm Derick Brannan from 15 PricewaterhouseCoopers. Immediately to my right is 16 Jon Sperring, also from PwC. And to my left is Ms. 17 Karen Mirandi, the State Tax Director from Bank of 18 America. 19 I'm going to ask Ms. Mirandi to 20 introduce -- we have three witnesses today, and 21 she'll introduce those speakers, the remaining 22 members of our team. 23 MS. MIRANDI: David Belk is a Senior VP at 24 Bank of America with 22 years of experience. He's 25 an executive on our global corporate strategy team, 26 which manages our company investments and 27 divestitures. And he participated in the due 28 diligence prior to our investment in China 4 1 Construction Bank or CCB. 2 Behind me is Lauren Hood. Lauren is also a 3 Senior VP with 23 years of experience at the 4 company. Most importantly, she was the bank 5 executive that was charged with the execution of the 6 CCB's Strategic Assistance Agreement in 2008 to 7 2013. 8 And then also behind me is Larry Smilie. 9 Mr. Smilie is a Managing Director with over 30 years 10 of experience in our global leasing division. He is 11 responsible for corporate, commercial and business 12 leasing originations, as well as leasing 13 syndications in the United States, and he also 14 participated in the due diligence related to the 15 leasing JV with CCB. 16 MS. HARKEY: Thank you. 17 MR. BRANNAN: The issue before the Board 18 today is whether income from a minority investment 19 and a bank owned and controlled by the Chinese 20 government can give rise to a portionable business 21 income. The answer is a resounding no. 22 The facts are straightforward. Bank of 23 America or BAC exchanged expertise in capital for an 24 opportunity to invest in the fastest growing economy 25 in the world at that time. As part of the 26 transaction, the Chinese government and CCB imposed 27 multiple restrictions on BAC's investment. Those 28 limitations prevented the investment from ever 5 1 becoming a integral part of BAC's trade or business, 2 and therefore income from the investment is 3 nonbusiness income. 4 The law is clear. And I'll ask the Board 5 Members to look at the first page of the exhibits 6 that we handed out. Specifically, California 7 Revenue and Taxation Code section 25120 provides 8 that income from property is business income. The 9 acquisition, management and disposition of the 10 property constitute integral parts of the taxpayer's 11 trade or business. 12 MR. RUNNER: Hang on just a minute. 13 MR. BRANNAN: Yes, sir. 14 MS. HARKEY: You don't have yours? 15 MR. RUNNER: I'm missing a -- it's right 16 where? 17 Oh, here it is. I got it. I'm good. 18 MS. HARKEY: There you go. He's in 19 business now. 20 MR. RUNNER: I got it now. 21 MR. BRANNAN: Thank you. So that's just 22 page 1. 23 Page 2, in Hoechst Celanese, the California 24 Supreme Court set forth the standard for determining 25 whether property is integral to a trade or business 26 and whether income from that property should be 27 treated as apportionable business income under 28 California law. 6 1 And the provisions of that case are so 2 important I'm simply going to read from the slide 3 for emphasis, and you'll see some underlined 4 portions of the language from the case. 5 "Income from the property is business 6 income when the property is so interwoven 7 into the fabric of the taxpayer's business 8 operations that it becomes indivisible or 9 inseparable from the taxpayer's business 10 activities with both giving value to each 11 other." 12 We call that the two-way flow of value. 13 "Such a relationship exists when the 14 taxpayer controls and uses the property to 15 contribute materially to the taxpayer's 16 production of business income." 17 Consistent with that articulation of the 18 task, BAC's investment in CCB must be so interwoven 19 into the fabric of BAC's business operations that it 20 was indivisible or inseparable from BAC's trade or 21 business, with both BAC and CCB giving value to each 22 other. And further, BAC must have controlled and 23 used the CCB investment to contribute materially to 24 BAC's production and business income. 25 Now the facts are pretty straightforward as 26 well. In the early 2000s the Chinese government 27 recognized that its four state-owned national banks, 28 including CCB, had historically made loans based on 7 1 a customer's ties to the Chinese government and not 2 based on the more modern risk and loan assessment 3 practices. 4 Those loans were going bad at an alarming 5 rate, as high as 30 percent in one of the banks, and 6 threatened the integrity of the Chinese financial 7 system. The government needed both expertise and 8 capital to modernize and stabilize its banks. In 9 order to accomplish those goals, the government 10 allowed CCB to go public, a dramatic gesture in 11 China, and sell an equity interest to a 12 knowledgeable investor. 13 Enter Bank of America in 2005. Bank of 14 America, BAC, acquired -- agreed to acquire a 10 15 percent equity interest in CCB. As part of the 16 agreement, BAC agreed to provide strategic 17 assistance to CCB to help modernize its banking 18 systems. Through its equity ownership, Bank of 19 America sought to profit from the Chinese economy. 20 And aside from the failed effort to enter into a 21 credit card joint venture, BAC evidenced no desire 22 to gain operational value from the investment when 23 it joined or when it made the initial equity 24 investment. 25 The investment carried any number of 26 practical and contractual limitations with regard to 27 BAC. For example, following the initial investment, 28 BAC had one seat on the CCB Board of Directors and 8 1 no employees at CCB. In contrast, the Chinese 2 government owned roughly 70 percent of CCB, held the 3 remaining 14 to 18 Board of Director seats and 4 controlled CCB's Board of Supervisors and all senior 5 management at CCB. 6 The contracts executed as part of the 7 investment further limited BAC's ability to exert 8 control over any aspect of CCB or otherwise generate 9 operational value from the investment. 10 By contract, CCB maintained absolute 11 responsibility for making its own management 12 decisions concerning operations. 13 By contract, BAC had deceased all retail 14 banking operations in China as long as it held its 15 investment. 16 By contract, BAC could only maintain 17 corporate offices in China that were necessary to 18 support its existing corporate clients, thus 19 limiting BAC's ability to expand its corporate 20 client base in China. 21 By contract, any information learned about 22 CCB while providing services as part of the 23 Strategic Assistance Agreement could only be used to 24 benefit CCB, not BAC. 25 By contract, BAC was required to gain CCB's 26 approval for the content of its press releases. 27 By content -- excuse me -- by contract, BAC 28 could not compete with CCB for business in China so 9 1 long as it held the investment. 2 By contract -- there's a theme here -- the 3 contracts govern the interaction of the two parties 4 in this investment relationship. 5 By contract, neither BAC nor CCB could act 6 on the behalf of the other or otherwise bind the 7 party contractually. 8 By contract, BAC and CCB did not have any 9 common employees. 10 By contract, BAC needed permission from CCB 11 to sell its investment at any time during a 12 three-year lockup period immediately following the 13 acquisition of the equity interest. 14 Based on all of these limitations, the CCB 15 investment could not and did not become an integral 16 part of BAC's trade or business. 17 So what I'd like to do now is turn to 18 Mr. David Belk, our first witness here. And, 19 Mr. Belk, you were involved in the due diligence in 20 the initial Bank of America effort to look at the 21 investment in CCB; is that correct? 22 MR. BELK: That's correct. 23 MR. BRANNAN: And why did BAC make the 24 investment? 25 MR. BELK: We saw growth opportunity in the 26 Chinese economy, and we saw an investment in CCB as 27 a mechanism to take advantage of that economic 28 growth in China in exchange for strategic assistance 10 1 on our part. 2 MR. BRANNAN: Could BAC gain much from CCB 3 from an operational standpoint? 4 MR. BELK: Not really. CCB at the time had 5 a fairly rudimentary banking operation; they were 6 years behind, you know, an equivalent international 7 bank. And that's part of what they were after in 8 this investment is to learn and better their banking 9 operations. 10 MR. BRANNAN: Did BAC expect to conduct any 11 joint business operations with CCB when it made the 12 initial investment? 13 MR. BELK: At the time of the initial 14 investment, there was hope to do a credit card 15 venture with CCB, but the fact of the matter is that 16 Chinese law prevented that from happening. 17 There was an MOU that was entered around 18 the credit card joint venture, but the Chinese 19 government never changed the law. Ultimately, the 20 MOU was unwound and nothing ever came of it. 21 MR. BRANNAN: Now at some point during the 22 investment relationship BAC and CCB agreed to kind 23 of reciprocal free usage of their ATMs. Can you 24 talk about that, please? 25 MR. BELK: That's correct. There was a 26 reciprocal ATM agreement in place. It was not 27 unlike many other agreements that we have or had 28 with other international banks all around the world. 11 1 The terms were identical. It was something that was 2 quite easy for us to do and quite standard with 3 other financial institutions where we didn't have an 4 investment interest. 5 MR. BRANNAN: How would, uh -- how would 6 you expect, I mean, the BAC/CCB ATM arrangement to 7 impact BAC? 8 MR. BELK: Well, from BAC's perspective to 9 the extent we were waiving service charges either 10 from our customers or China Construction Bank's 11 customers, then that was an opportunity missed from 12 a revenue perspective. But then on the flipside our 13 customers certainly, to the extent they were using 14 the ATMs and were avoiding those charges, would 15 benefit from that. 16 MR. BRANNAN: Now according to some of the 17 press releases that have been discussed in this 18 proceeding, BAC also had an arrangement with CCB 19 that allowed for free wire transfer transactions. 20 Can you talk about that, please. 21 MR. BELK: Right. I understand that to be 22 similar to the ATM arrangement. It was something 23 that would have been relatively easy for us to put 24 in place. 25 My understanding is that CCB wanted us to 26 put the wire transfer in place. We did that as a 27 pilot program in certain markets. It was never a 28 broad program; it was only run in a pilot stage, and 12 1 it was ultimately sunset. 2 We looked at some of the data. We were 3 able to look at some data between 2010 and 2013 just 4 to compare how the BAC customer used that wire 5 transferability relative to the China Construction 6 Bank customer, and during that time period there 7 were around 1600 Bank of America customers that 8 utilized that service. 9 And on the flipside there were some 350,000 10 China Construction Bank customers that utilized it. 11 So, to me, that's sort of an indication, you know, 12 they were interested in us providing this for them 13 and we did so through the pilot for a period of 14 time. 15 MR. BRANNAN: Now, in August and November 16 of 2011 BAC sold off the majority of its investment 17 interest; why did BAC make that decision? 18 MR. BELK: Well, we were in the height of 19 the financial crisis in the United States at that 20 time and we were divesting all of our noncore 21 investments, and it made sense for us to divest our 22 investment in CCB where we had a large gain and 23 therefore could generate capital and liquidity. At 24 the same time it was something that we could sell 25 that wouldn't really impact our operations. 26 MR. BRANNAN: Okay. I'd like to move on at 27 this point and obviously encourage any questions 28 from the Board Members during the open board time. 13 1 Obviously the witnesses will be available. 2 Ms. Lauren Hood. You know, Ms. Hood, if 3 you would, start -- I mean, you were the Strategic 4 Assistance Executive from 2011 through '13. Could 5 you describe what your responsibilities were there, 6 please? 7 MS. HOOD: Sure. I was responsible to be 8 the liaison between CCB and BAC to execute the 9 Strategic Assistance Agreement. So what that meant 10 was, when CCB had requests for us to deliver 11 training or assist them in some work that they were 12 doing, I found the appropriate expertise on the Bank 13 of America side and matched them up and helped 14 negotiate what that would look like. 15 MR. BRANNAN: So what was the purpose of 16 the Strategic Assistance Agreement? 17 MS. HOOD: It really was to help provide 18 CCB with best practices. As Mr. Belk mentioned, the 19 Chinese economy had been closed for about 20 years, 20 so the Chinese banking industry was about 20 years 21 behind international banking and they were looking 22 for advice on how they could accelerate their 23 progress. 24 MR. BRANNAN: So how did the Strategic 25 Assistance Agreement actually work from your 26 perspective? 27 MS. HOOD: So at the end of each calendar 28 year CCB would come to me with a list of requests of 14 1 areas that they would like training in and I would 2 identify whether or not we could support that based 3 on the personnel that would be required. It was 4 required that we only share public nonproprietary 5 information. So as long as it fit within those two 6 requirements, then I would again identify the 7 appropriate expertise on the Bank of America side 8 and we'd agree on what that would look like 9 throughout the following year. 10 MR. BRANNAN: The Strategic Assistance 11 Agreement, the original one indicated that BAC was 12 to provide 50 employees on an annual basis. How did 13 you work through the math on that? 14 MS. HOOD: We defined an employee as a 15 full-time equivalent, so based on hours agreed upon 16 on each side of what that looked like. And part of 17 my job was to track the number of hours supported on 18 the Bank of America side and add that up to about 50 19 each year. It was really kind of front-loaded 20 because at the start when we were creating our 21 processes it really took more personnel to support 22 it. 23 MR. BRANNAN: And were there any joint 24 business efforts that came out of the SAA that 25 you're aware of? 26 MS. HOOD: Not that I'm aware of. 27 MR. BRANNAN: What did BAC and its 28 employees get from the effort, those that 15 1 participated in the training exercises? 2 MS. HOOD: Really nothing. It was a 3 one-way exchange of information. So it was really 4 their taking their time to provide that expertise to 5 CCB. 6 MR. BRANNAN: Now, in September of 2011, 7 shortly after BAC sold, you know, basically a 8 meaningful portion of its investment in CCB and BAC 9 extended the Strategic Assistance Agreement, why did 10 that happen to your knowledge? 11 MS. HOOD: As I understood it, because we 12 were making such a substantial sale of our 13 investment, it was a show of goodwill. Both parties 14 were interested in having the investment continue to 15 be viewed in a positive light. And in the grand 16 scheme of things the investment was rather small, 17 less than $5 million a year for us to continue the 18 Strategic Assistance Agreement, and so we did. 19 MR. BRANNAN: Okay. Thank you very much. 20 And, again, Ms. Hood is certainly available 21 for any further questions that the Board Members 22 have. 23 Next, I'd like to bring up Mr. Larry 24 Smilie. And he's going to discuss the leasing joint 25 venture. And it's a little with some reluctance 26 here that we bring him up and kind of dignify this 27 issue, quite frankly. It's gotten a lot more 28 traction, if you will, in some of the briefings and 16 1 in the hearing summary than what we would have 2 expected for something wherein the bank contributed 3 a number that was only, you know, five percent to 4 the joint venture relative to its entire investment 5 in CCB. But nonetheless, because of the number of 6 questions, Mr. Smilie here is going to speak to the, 7 uh -- to the leasing joint venture. 8 Now you were involved in the due diligence 9 that BAC engaged in in connection with this leasing 10 JV; is that correct, Mr. Smilie? 11 MR. SMILIE: Yes. I was involved, like six 12 other executives, that went over to Beijing to kind 13 of teach them about the U.S. market and we were over 14 there to learn about the Chinese market and see how 15 it would work with regard to setting up a leasing 16 joint venture. 17 MR. BRANNAN: So why did BAC participate in 18 the joint venture? 19 MR. SMILIE: Well, my understanding was 20 that we had a Bank of America executive on the CCB 21 board and CCB strongly asked us to set up a leasing 22 joint venture. So we were basically asked to kind 23 of figure out a way to do this and move forward with 24 it. And our primary goals were trying to do this in 25 such a way to kind of protect our investment and 26 mitigate our risks. 27 MR. BRANNAN: Did you feel like BAC had 28 much of a choice to pursue the joint venture at that 17 1 time? 2 MR. SMILIE: Well, not with regard to what 3 we were doing. We were just instructed to kind of 4 go figure it out, you know, and find a way to make 5 this work if we could. 6 MR. BRANNAN: Why did CCB decide to pursue 7 a leasing joint venture? 8 MR. SMILIE: Well, I think they wanted to 9 learn about the leasing business. The Chinese laws 10 had recently changed, allowing the Chinese banks to 11 enter into the leasing business, and so they needed 12 some expertise to learn about it. And we're a 13 market leader, so we had a staff of people as far 14 as, you know, go over there and try to explain and 15 figure out, you know, what was available and what 16 they could do. 17 MR. BRANNAN: Why would BAC be 18 reluctant -- or maybe a better way to phrase the 19 question is how would you compare the leasing 20 environments between U.S. and even other countries 21 globally to what was going on in China at that time? 22 MR. SMILIE: Well, it was a big difference. 23 In the U.S. market, you know, the tax and the county 24 regimes were well developed. You have commercial 25 law to help protect your -- your collateral. And 26 there's also a very active used equipment market, 27 and none of those things existed in China, which 28 made it very hard just to move forward. 18 1 MR. BRANNAN: What did, uh -- what was 2 BAC's primary goal in participating in this leasing 3 joint venture? 4 MR. SMILIE: Yeah, as I mentioned, when we 5 were trying to set it up, you know, because of the 6 environment we were going into, we were very focused 7 on protecting our investment and trying to do 8 everything we could to mitigate our risk so we could 9 get our capital back down the road. 10 MR. BRANNAN: And with respect to BAC's 11 actual involvement, how many total employees did CCB 12 have relative to the number of employees for BAC? 13 MR. SMILIE: Yeah. CCB had 60-plus 14 employees, and Bank of America had three executives 15 over there and one of them was in a senior risk 16 role, related to risk. 17 MR. BRANNAN: Do you recall what customers 18 the joint venture focused on? 19 MR. SMILIE: Well, it was exclusively 20 focused on the CCB clients and a lot of them with 21 state-owned entities; and then they had other 22 clients that were not state-owned, but they were all 23 CCB clients. 24 MR. BRANNAN: So no BAC customers that 25 you're aware of? 26 MR. SMILIE: No, no. 27 MR. BRANNAN: Was there any ongoing 28 connections with BAC's global leasing operations and 19 1 the CCB leasing JV? 2 MR. SMILIE: No. The joint venture was set 3 up very much to be a stand-alone entity and focus on 4 the Chinese market. So there was, you know, little 5 to no connectivity with regard to other businesses 6 around the world. 7 MR. BRANNAN: Now, BAC earned some return 8 on the investment from the JV. How did that compare 9 with BAC's leasing business in general? 10 MR. SMILIE: Well, the returns were about 11 five percent on our investment and that would've 12 compared around a 30 percent investment return in 13 the U.S. market. So, you know, very modest. And 14 also the earnings we actually earned from the joint 15 venture would've been less than one percent of our 16 global earnings from the leasing business, very 17 small. 18 MR. BRANNAN: Why did BAC ultimately exit 19 the JV? I think you exited one year early; is that 20 correct? 21 MR. SMILIE: Well, we asked to exit early 22 because there was a divergence in the goals of the 23 joint venture. The CCB wanted to grow the business 24 dramatically and they were very focused on growing 25 fast. And as I mentioned earlier, we were focused 26 on mitigating the risks, so we had diverging 27 interests because the faster they were growing we 28 felt they were taking risks that were beyond our 20 1 appetite for risk and so we basically asked to exit 2 early as a result. 3 MS. RICHMOND: Time's expired. 4 MR. BRANNAN: If I may, one last question. 5 What did BAC learn from the leasing joint 6 venture, Mr. Smilie? 7 MR. SMILIE: Actually, little to nothing 8 because they were -- you know, there was no leasing 9 business over there and we had all the expertise 10 when we went over. 11 MR. BRANNAN: Thank you very much. 12 MS. HARKEY: Thank you. 13 Okay. Department, announce yourself for 14 the record and you're on. 15 MR. LO GROSSMAN: Good morning, Chairwoman 16 Harkey and Members of the Board. My name is Thomas 17 Lo Grossman. Accompanying me is Craig Swieso. 18 Together we are representing the Franchise Tax Board 19 in this appeal. 20 I'm going to provide a brief overview of 21 the legal issue on appeal, which is the application 22 of the functional test for business income. Then 23 I'll briefly go over the law which requires 24 appellant show that it did not have operational ties 25 with China Construction Bank. Then I will discuss 26 the evidence that shows appellant actually did have 27 operational ties with China Construction Bank. 28 The question before your Board is an issue 21 1 of business/nonbusiness income, specifically whether 2 the income from the strategic investment by a bank 3 in another bank is apportioned between the several 4 states because the income is derived from its 5 banking business, which is what FTB has concluded 6 after analyzing the evidence provided by appellant, 7 or whether the income is allocated to the single 8 state of its corporate headquarters because it is a 9 mere investment as claimed by appellant. 10 In California all income is business income 11 unless clearly classifiable as nonbusiness income. 12 Income which arises from the conduct of a trade or 13 business is business income. This includes the sale 14 of business assets. Where the asset is an interest 15 in stock, the main criteria for determining whether 16 there is business income is whether the taxpayer and 17 the entity represented by the stock at issue had an 18 operational business relationship of some 19 significance. 20 Appellant's operational business 21 relationship of significance with China Construction 22 Bank included: First, employee exchanges; second, a 23 Joint Venture Agreement for leasing activities; 24 third, reciprocal client referrals for banking 25 activities; fourth, reciprocal wire transfers that 26 benefited appellant's retail banking customers; and 27 fifth, reciprocal ATM fee waivers that benefited 28 appellants retail banking customers. 22 1 I'm now going to go over the five points 2 identified indicating an operational business 3 relationship of significance between appellant and 4 China Construction Bank. Any one of these ties in 5 and of itself would be enough for a finding of 6 business income. 7 First, the employee exchanges. As 8 appellant's own documents make clear, 3100 of 9 appellant's employees went to China during the time 10 appellant held China Construction Bank stock and 11 engaged in dozens of technical projects in China in 12 order to strengthen the business activities of China 13 Construction Bank. 14 Second, the leasing venture. Appellant 15 participated in a money lending business with China 16 Construction Bank. Appellant's CEO attributed this 17 venture to its investment in China Construction 18 Bank. Therefore, appellant's stake in China 19 Construction Bank generated business income through 20 operational ties and appellant's stake in China 21 Construction Bank served an operational business 22 function. 23 Third, reciprocal client referrals. 24 Appellant's reciprocal client referrals with China 25 Construction Bank were an operational tie of 26 significance. Having clients is fundamental to a 27 business, and appellant's CEO said that appellant 28 was getting more clients because of its stake in 23 1 China Construction Bank. Therefore, appellant's 2 stake in China Construction Bank served an 3 operational business function. 4 Fourth, the reciprocal wire transfers. 5 Appellant had an agreement with China Construction 6 Bank that provided for reciprocal wire transfers and 7 allowed appellant's existing American retail banking 8 clients to send money to local ones in China. This 9 project was actually piloted in California. 10 Reciprocal wire transfers provided better customer 11 service to appellant's clients and allowed appellant 12 to use its existing business assets better. 13 Appellant's CEO attributed the reciprocal 14 wire transfers to appellant's stake in China 15 Construction Bank. Therefore, appellant's stake 16 allowed appellant to make better use of its existing 17 business assets. This shows appellant's stake in 18 China Construction Bank had an operational business 19 function. 20 Fifth, reciprocal ATM fees -- ATM fee 21 waivers. Appellant's ATM fee waiver program allowed 22 appellant's existing American retail banking clients 23 to withdraw money in China. The ATM fee waiver 24 program was attributed to appellant's stake in China 25 Construction Bank by appellant's CEO, and therefore 26 appellant's stake allowed appellant to make better 27 use of its existing business assets. This shows 28 appellant's stake in China Construction Bank had an 24 1 operational business function. 2 Each of the ties between China Construction 3 Bank and appellant indicates an operational business 4 relationship of significance. A benefit appellant 5 got out of this operational business relationship 6 was more banking business in China. 7 Appellant's cross-border loans into China 8 grew exponentially while appellant held a stake in 9 China Construction Bank. In fact, appellant's local 10 Chinese banking business also dramatically grew 11 during the time it held a stake in China 12 Construction Bank. Making loans is part of 13 appellant's trade or business, therefore those loans 14 generated business income in China. 15 The three connections between increased 16 loans in China and appellant's stake in China 17 Construction Bank are: One, appellant's annual 18 report statements that its stake in China 19 Construction Bank would lead to better customer 20 service for its existing corporate clients; two, 21 appellant's CEO statement that it and China 22 Construction Bank had reciprocal client referrals; 23 and three, appellant's press release that had 24 increasing brand awareness in China through its 25 relationship with China Construction Bank. 26 Finally, your Board's decision in this 27 appeal impacts both future and existing taxpayers. 28 A decision in favor of appellant that deems the 25 1 transaction before your Board nonbusiness income 2 would reduce the liabilities of taxpayers who have 3 corporate domicile outside of California since none 4 of the income or gains from transactions like the 5 one before your Board would be allocated to 6 California. Thus, if appellant wins and such 7 transactions are deemed nonbusiness income, 8 similarly situated taxpayers with California 9 corporate domicile would have 100 percent of the 10 income from transactions like this one allocated to 11 California. 12 The Department asks that its claim denial 13 be sustained. Mr. Swieso and I are here to answer 14 any of your questions. Thank you. 15 MS. HARKEY: You have rebuttal time. 16 Probably five minutes, I'd imagine. 17 MR. BRANNAN: Thank you, Madam Chairwoman. 18 It's always interesting to do rebuttal. I 19 mean, unfortunately, when there's not a lot to talk 20 about, we tend to place too much emphasis on the 21 things that we can talk about. And I think there's 22 a lot of that going on in this case unfortunately. 23 You heard the witnesses present earlier. 24 And, again, I'm going to bring them up. Of course 25 we may not have the full time to have them address 26 some of the statements. But, you know, the bottom 27 line is a couple of the examples provided, you know, 28 we talked about the wire transfer and the leasing 26 1 joint venture. The information already provided 2 indicates that that was requested by CCB. In 3 response to the question, yeah, it was related to 4 the investment. That's fine. But it was something 5 that we were asked to do and directed to do and in 6 both cases probably not something that we were all 7 that interested in doing. 8 We're also talking about, going back to the 9 test, this one-way flow of value. I -- I -- I 10 disagree strongly with the characterization or 11 Strategic Assistance Agreement as an employee 12 exchange. It's a training deal. It's a training 13 operation. And I am happy to bring Ms. Hood back up 14 here and explain in any amount of detail that 15 anybody's interested to say this is training only. 16 Further considerations, the ATMs, there's 17 suggestion after suggestion about expanding our 18 retail business, that just didn't happen. The ATM 19 example is such that it is the same sort of 20 arrangement we had with people whether we had an 21 engagement with them or not, whether we had an 22 investment with them or not. And so there's nothing 23 unusual about that. 24 With respect to the CEO comments, again, I 25 think Mr. Belk can speak to, you know, this 26 assertion of reciprocal client referrals. Yes, 27 there is a statement to that effect; it was by one 28 of the CEOs. However, when we tried to look into it 27 1 and locate it, there's no formal arrangement, 2 there's no formal program, there's no process built 3 about that. At best, it was probably a one-off 4 situation. 5 Continuing on, you know, really when we 6 talk about the statements that are attributable to 7 the CEO, when he talks about, you know, working 8 together with CCB and there is -- there are 9 statements in the records about a strategic 10 partnership -- really what we're talking about at 11 that point is they are, CCB and BAC did work 12 together. Well, the way they worked together is we 13 provided them with advice so that we could invest in 14 the economy. We helped them modernize their bank. 15 Everything that happened here is focused on doing 16 what we can to help CCB grow, to help CCB develop 17 into a modern bank in China. The return for BAC was 18 on the economy. The return was from its investment 19 and the ownership interest that it was able to trade 20 following the IPO. 21 I think Mr. Belk responded basically to the 22 comments about the wire transfers and also the ATM 23 usage. 24 I think the last point that I'd like to 25 make in rebuttal -- and, time permitting, may bring 26 up Mr. Belk and Ms. Hood to talk about some of the 27 comments -- but the expansion of the business as a 28 result of the investment, what -- what counsel has 28 1 suggested is that because of one comment in the 2 press about employee referrals or -- excuse me -- 3 about corporate client referrals that we're unable 4 to really pin down or establish any program, that 5 the loan portfolio attributable to China grew in a 6 dramatic fashion. 7 The bottom line is that during this same 8 window of time the loan portfolio in India grew from 9 $560 million to 4.7 billion. That growth was 10 attributable to the economy. That growth was not 11 attributable to our investment in CCB. Which, by 12 the way, the contract said we were unable to compete 13 with them; we could not grow our corporate client 14 base. 15 Also, if you look at China, the gross 16 domestic product for China during that same window, 17 it doubled. We're talking about the economy. When 18 the economy does that, numbers increase. China at 19 this time was preparing to enter, just about to 20 enter with the World Trade Organization. Now what 21 does that do to an economy? If you're trying and 22 you've been closed for 20 years and all of a sudden 23 the World Trade Organization requires that you have 24 an open market, that's one of the requirements. 25 What happens to the investment in your country when 26 you're about to join the World Trade Organization? 27 Well, what happens is investment -- investment in 28 the economy increases. It's kind of the rising tide 29 1 floats all boats. I mean that's really what's going 2 on with respect to those numbers. 3 Again, refer back to the contractual 4 provisions that limited the things that we could do 5 in the country. Very deliberately it was set up so 6 that we wouldn't compete with CCB. And that was the 7 goal. We were supposed to help them grow, help them 8 modernize, and that's what we did. That's what 9 everything was about. 10 If they wanted us to help them establish a 11 leasing joint venture, that's what we did. If they 12 wanted us to help establish this wire transfer, 13 that's what we did. We didn't have much choice in 14 that; that's what Mr. Smilie said. Because of the 15 larger investment, if CCB said do this, that's what 16 we did. 17 And really, taking a half step back, this 18 is where we need to focus on the actual evidence, 19 not supposition, not trying to link together this 20 statement to this number, that there's no obvious 21 connection to. What we need to do is to look at the 22 contracts. 23 We could not compete. We could not make 24 any portion of the CCB business integral to our 25 business operations. They were not interwoven, 26 inseparable to our operations. We couldn't do it as 27 a matter of contract. We couldn't do it because 28 their business and banking operations were 20 years 30 1 old. And we couldn't do it because the 70 percent 2 owner was the Chinese government. 3 That's the fundamental problem here. The 4 Chinese government was not going to allow one of its 5 four state-owned national banks with a critical role 6 in the economy, they were not going to allow any 7 portion of that bank to become an integral portion 8 of Bank of America's business operations. It simply 9 wasn't going to happen. 10 So that's the conclusion of my rebuttal. I 11 would really encourage any questions from the Board 12 Members with respect to the three witnesses that we 13 have. 14 MS. HARKEY: Thank you. 15 Okay, Members, do we have any questions? 16 Member Runner. 17 MR. RUNNER: I guess the core issue that 18 I'm trying wade through here is that did -- maybe 19 you can tell me if this is what the core issue is, 20 at least from my perspective, and that is did B of A 21 increase its banking footprint in its activities in 22 China? 23 MR. BRANNAN: I think that's a great 24 question, Mr. Runner. The annual report suggests 25 there was an increase in the loan portfolio in 26 China. We can't run from those numbers. 27 MR. RUNNER: Mm-hmm. 28 MR. BRANNAN: One of the questions is 31 1 whether that was in any way related to our 2 investment in CCB. 3 With respect to the leasing joint venture, 4 you heard Mr. Smilie say no connection. 5 With respect to the data, we know gross 6 domestic product increased two-fold. But I also 7 direct us back to the contractual provisions. We 8 had to sell off -- 9 MR. RUNNER: So what caused the increase 10 then? 11 MR. BRANNAN: It's -- honestly, from our -- 12 I'll tell you what -- 13 Mr. Belk, would you mind? 14 MR. BELK: Sure. Thank you. 15 With respect to the increase in loans, as 16 reflected in our annual report, you know it really 17 was driven by the economic growth. Mr. Brannan 18 referenced India, another country and Asia that had 19 similar growth at the same time. So there was 20 double digit GDP growth within China during the 21 timeframe under question and, therefore, you would 22 expect the growth to, uh -- to happen during that 23 time. 24 We also were able to connect with one of 25 our corporate banking leaders who was in the 26 country, or in Asia during 2010 time frame and, you 27 know, he was adamant that the growth in the 28 portfolio was not linked to the CCB investment. It 32 1 was just linked to the growth in the economy and the 2 general growth in the region at the time. 3 MR. RUNNER: So in your opinion those 4 things would have happened with or without the 5 contract with -- 6 MR. BELK: Yes, sir. I would say that the 7 increase or the growth there was driven by economic 8 activity, not funneled through our involvement with 9 CCB. 10 MR. RUNNER: Okay. Let me ask, back to -- 11 to FTB. What -- what is it that you would believe 12 took place in this agreement that they -- I think 13 you used a good word -- funneled this growth to B of 14 A as a result of this relationship. 15 MR. LO GROSSMAN: Oh, um -- first, I got 16 the microphone, right? 17 MR. RUNNER: Uh-huh. 18 MR. LO GROSSMAN: Okay. 19 The three connections that we have between 20 the increased banking business and appellant's 21 investment in China Construction Bank is appellant's 22 statements in its annual report and then appellant's 23 subsequent statements while they had that investment 24 from the CEO and the press release after all this 25 had gone on, talking about increased brand 26 awareness. That's the evidence -- those are all 27 appellant's own documents and that's what we have to 28 go on. That's why we -- that's the connections that 33 1 we can show. 2 MR. BRANNAN: Mr. Runner, perhaps -- 3 MR. RUNNER: Let me just say my observation 4 is, you know -- sometimes -- I'm trying to struggle 5 with sometimes what is stated in a -- in a -- in a 6 document where a bank, or anybody else for that 7 matter, is talking about their business to their -- 8 to -- to their investors and -- and oftentimes 9 it's -- not that this would take place -- that 10 sometimes there's a bit of hyperbole in terms of why 11 it is and how good things go and what you attribute 12 it to as for it actually mechanically being 13 involved. 14 MR. LO GROSSMAN: It sounds like you're 15 discussing puffery? 16 MR. RUNNER: Yeah. Yeah, yeah, yeah. 17 MR. LO GROSSMAN: The thing about puffery 18 is, puffery is, "This is the best car you're ever 19 going to drive and, you know, it growls like a 20 jaguar." 21 MR. RUNNER: Uh-huh. 22 MR. LO GROSSMAN: "It goes zero to 60 in 23 two seconds" is a statement of fact. So these are 24 more towards the statement of fact. 25 "We have reciprocal client referrals" is a 26 statement of fact. We are using this to increase 27 brand awareness. "We are using this to increase 28 brand awareness" is more of a statement of fact. 34 1 You can always say it's hyperbole. But 2 when you start giving, like, we are doing specific 3 activities, it's no longer puffery. 4 MR. RUNNER: Mm-hmm. 5 MR. LO GROSSMAN: And these are statements 6 that are actionable if they are false. 7 MR. RUNNER: Mm-hmm. 8 MR. LO GROSSMAN: That's why these press 9 releases have disclaimers on the bottom of them. So 10 if they make a representation of fact, you can rely 11 on them because it is actionable if they are false. 12 MR. RUNNER: Okay. Let me go back to the 13 taxpayers. 14 Why -- I mean what makes the difference 15 between the statements when the statements are so -- 16 seem to be so specific to the involvement that B of 17 A had with -- with CCB? 18 MR. BRANNAN: The one question Mr. Belk 19 might focus on -- 20 Yes, sir. 21 MR. RUNNER: Go ahead. 22 MR. BRANNAN: No, I -- I'm going to -- one 23 of the comments that's been made is about corporate 24 referrals. 25 MR. RUNNER: Uh-huh. 26 MR. BRANNAN: And I was going to ask 27 Mr. Belk to specifically address that. 28 MR. RUNNER: Well, I'd like a 35 1 broader answer. I'd like a broader answer as to why 2 it is that these would be -- would be seen as in 3 terms of documents -- in terms of institutional 4 documents that B of A had as to being so specific in 5 terms of describing the relationship. 6 MR. BELK: Well, again, I think they -- you 7 know, we did have an investment in CCB and those 8 statements talked about that in broad terms. So I 9 think we had mentioned earlier in terms of the 10 corporate referrals that were in fact mentioned in 11 the documents that were referenced. 12 MR. RUNNER: So would you -- 13 MR. BELK: Some of that would have likely 14 happened, but we haven't been able to determine, by 15 any means, any sort of material connection there. 16 There could have been a one-off referral here or 17 there between us to CCB or vice versa, but there was 18 no pervasive program that we've been able to 19 identify. 20 MR. RUNNER: Should we be able to try to 21 identify or I guess try to separate out what would 22 be relationships because of the investment versus 23 integral -- a more integral part of the operational 24 side? Is that -- is that a -- I mean just -- I mean 25 the issue, for instance, branding, did -- did -- 26 because B of A had an investment, did that increase 27 branding for B of A in China? 28 MR. BELK: I would say not directly. I 36 1 mean there could have been some indirect influence 2 here and there. But, again, it was not a pervasive 3 direct focused effort. 4 MR. RUNNER: There was not an operational 5 relationship. 6 MR. BELK: Right. 7 MR. BRANNAN: Mr. Runner, you would think 8 with having the Bank of America, one of the, you 9 know, worldwide industry standards for banking as 10 the investor for CCB would help CCB. So what I 11 think we're saying -- and again it's supposition is 12 that CCB wants -- 13 MR. RUNNER: Again, my assumption is that 14 your argument is it would help -- it would help CCB 15 therefore -- therefore enhance your investment. 16 MR. BRANNAN: Yes, sir. 17 MR. RUNNER: But not because of your 18 operational involvement. 19 MR. BRANNAN: Correct. The banking 20 business that BAC had before and after the 21 investment was essentially the same. There's no 22 change, there's no expansion, there's no meaningful 23 or material operational value that's equating or 24 accruing to BAC during the course of its 25 investment. 26 MR. RUNNER: Let me speak specifically or 27 ask specifically about the -- again, I'm just, 28 because it was called out, the ATM reciprocal 37 1 agreements or relationship. You would say that that 2 was not tied to or because of the investment. 3 MR. BRANNAN: I mean, David, I don't know 4 if you want to again -- 5 MR. BELK: Well, look, it happened at the 6 same time, right? 7 MR. RUNNER: Right. 8 MR. BELK: So it's unclear whether you can 9 tie it directly or not. 10 I think our point is it was the identical 11 terms that we had with other ATM relationships, with 12 other multi-national banks across the world that we 13 did not have an investment with. So it was the 14 exact same thing that we did with plenty of other 15 people, you know, at the same time. Whether it was 16 directly linked, it's hard to say. I mean it did 17 happen at the same time, so -- and obviously we're 18 talking with CCB. 19 MR. RUNNER: But it may or may not have 20 happened because of the investment. 21 MR. BELK: Correct. 22 MR. RUNNER: Or wasn't required or wasn't 23 there because of the investment. 24 MR. BELK: There was no -- to my knowledge 25 there was no requirement as part of the investment 26 to do the reciprocal ATM program. 27 MR. BRANNAN: It's not in any of the 28 documents that we were able to review at any point 38 1 in time. It's -- the only one that's in the 2 contract, ironically, is the credit card memorandum. 3 MR. RUNNER: As you've divested yourself of 4 the investment, what was the -- 5 See, I guess this is where I'm thinking 6 that if there was a big operational advantage that B 7 of A incurred or brought into their organization was 8 all of that, the divestment then would have a 9 negative effect then on the operational side. 10 Did you -- what was the experience at that 11 point? 12 MR. BELK: Well, again, I -- 13 MR. RUNNER: Did you lose customers? Did 14 you lose -- I mean did -- 15 MR. BELK: No, sir. I mean it was 16 literally -- I mean, as I mentioned, we were selling 17 our noncore investments -- 18 MR. RUNNER: Mm-hmm. 19 MR. BELK: -- during the financial crisis. 20 We obviously picked almost all of our noncore 21 investments. We picked those that, you know, we 22 didn't have a significant operational link with 23 because we could sell them. In this case we could 24 have a nice profit to help our capital liquidity, 25 which was needed at the time and really not have any 26 operational impacts from that exit. 27 MR. RUNNER: Okay, thank you. 28 I may come back. 39 1 MS. HARKEY: Thank you. 2 Any other Members? 3 Member Horton, I see you grabbing your mic. 4 Would you like to -- 5 MR. HORTON: Uh, yes. Thank you, Madam 6 Chair. 7 Question of the Department. Is there any 8 contractual relationship that you've been able to 9 find that links the two together? Links the various 10 reciprocal agreement, the ATM agreement, or is this 11 some inference because of a relationship that gave 12 them some advantage? 13 MR. LO GROSSMAN: Contractually, with the 14 agreements that we actually have contractually, only 15 the credit card joint venture was actually 16 contractually part of the agreement. The inference 17 is based on appellant's own statements, subsequent 18 statements that the two were connected. 19 I mean the exhibit we circulated this 20 morning, there's some discussion by -- on Ms. Hood's 21 LinkedIn account about letters of intent regarding 22 business cooperation that she negotiated and her job 23 to facilitate business collaboration, interface 24 between the two companies. But most of the 25 connections are there because appellant's CEOs said 26 that they were there. And we felt we could rely on 27 that. 28 MR. HORTON: Okay. So is there anything, 40 1 any governmental, legislative requirement on the 2 part of China, such as in the case of Mexico, that 3 would have linked these two together? 4 MR. LO GROSSMAN: Could -- not sure I 5 understand the question. 6 MR. HORTON: In Mexico you actually 7 require -- the Mexican government actually requires 8 that there is -- in order to do business in Mexico, 9 you have to have these sort of relationships. 10 I'm trying to link this relationship to a 11 growth in their footprint. 12 MR. LO GROSSMAN: We're not -- 13 MR. HORTON: Aside from the conversations 14 and the LinkedIn. 15 MR. LO GROSSMAN: Yeah. Well, I mean 16 there's China Construction Bank, and China 17 Construction Bank also has annual reports and they 18 consistently talk about more -- building more ties 19 with appellant. 20 So you have appellant -- appellant saying 21 they're going to seek all these additional strategic 22 ties. The use of the phrase strategic investment is 23 used throughout, notwithstanding what's in the 24 contractual language; it's in the annual reports, 25 it's in Ms. Hood's LinkedIn profile. I believe it's 26 in a few of the press releases as well. 27 So no, there doesn't -- as far as I know, 28 there's nothing statutory requiring these sorts of 41 1 ties. These sorts of ties were apparently agreed to 2 between the parties. And based on appellant's 3 statements, it was linked directly to their state -- 4 appellant's investment in China Construction Bank. 5 MR. HORTON: On the employee exchange, 6 share with me your thoughts on the mutual benefit, 7 and particularly the benefit to B of A. 8 MR. LO GROSSMAN: Well, let's see, 9 appellant -- appellant's press release said that 10 they got increasing experiences for the employees, 11 increasing brand awareness. That's what -- that's 12 from appellant's own documents. 13 MR. HORTON: From training their 14 employees. 15 MR. LO GROSSMAN: Mm-hmm. Well, it was a 16 mutu -- I think -- yeah, it was a -- appellant was 17 training CCB's employees and appellant's own people 18 were going abroad to do that. And they were getting 19 increasing connection -- they were getting 20 increasing exposure. And appellant's own documents 21 indicate that appellant thought that that was good 22 for its own employees. 23 MR. HORTON: Could this -- could this 24 training have taken place without the -- 25 MR. LO GROSSMAN: That was explicitly 26 linked. 27 MR. HORTON: Pardon? 28 MR. LO GROSSMAN: The training -- the 42 1 Strategic Assistant Agreement was explicitly linked 2 to the purchase. So the employee exchanges in that 3 manner were explicitly linked to the purchase of 4 stock because all three of the contracts reference 5 each other. 6 MR. HORTON: And so the link is the 7 training occurred, and as a result of that training 8 more people knew that the training was occurring so 9 therefore they did business with Bank of America. 10 MR. LO GROSSMAN: That's what appellant's 11 press release would tend to indicate, yes. 12 MR. HORTON: Wow. 13 The leasing venture -- well, how about the 14 growth in the -- GDP growth in the economy. The 15 overall growth in the economy? 16 MR. LO GROSSMAN: Yes, that's undisputed 17 that China grew quite well during the period. 18 MR. HORTON: You don't dispute that? 19 MR. LO GROSSMAN: No. 20 MR. HORTON: And why wouldn't that have 21 something to do with the growth of any business, 22 Bank of America, Chase, any other business in China? 23 MR. LO GROSSMAN: Well, in order to 24 actually start a leasing business -- leasing venture 25 in China, it was necessary for it to enter into that 26 joint venture agreement with China Construction 27 Bank. China Construction Bank invited appellant 28 into a leasing joint venture. And according to the 43 1 statements we heard in appellant's case in chief, 2 they were China Construction Bank existing clients. 3 So appellant was getting a piece of the -- 4 a piece of these leases with China Construction 5 Bank's own clients that they were invited into by 6 China Construction Bank. And China Construction 7 Bank most certainly did view appellant as a 8 strategic partner. It's all over appellant's -- 9 it's all over China Construction Bank's annual 10 reports. 11 MR. HORTON: What is the appellant's view 12 of that? 13 MR. BRANNAN: Well, there's a number of 14 things with regard to growth in the loan and lease 15 portfolio. 16 The joint venture, the leasing joint 17 venture was not included in the numbers that we've 18 been talking about. It's reflected as an equity 19 investment, so it's kept in a separate place on the 20 books. There's no growth in the loan and lease 21 portfolio that's attributed to the leasing joint 22 venture. So that would be point one. 23 The second point, strategic partnership. 24 And the words, they mean what they say and there's a 25 couple of points. One is, it was a strategic 26 partnership. We invest, we give you expertise, you 27 bring your bank into the modern age. That's 28 strategic for both parties at that point. 44 1 The second point, there's actual language 2 in most of the contracts that talk about this -- 3 these agreements do not form a partnership or joint 4 venture in a legal sense. The contracts again 5 impose a bar or a fence between BAC and CCB which 6 prohibits any sort of kind of legal assertions of 7 this -- the relationship between the two. And it's 8 to protect both of the parties, and it also signals 9 very strongly to anybody that wants to know, What 10 are you doing together? 11 So there's really two responses to that 12 question. 13 MR. HORTON: To the -- to the, uh -- to the 14 position relative to the statements in the press and 15 so forth, we have witnesses here under oath 16 testifying that that's not the case. How do you -- 17 MR. LO GROSSMAN: Did you swear them in? 18 MR. BRANNAN: We're happy to do that if 19 that's required, Members of the Board. 20 MR. HORTON: I'm presuming if they're here 21 they understand their obligation to tell the truth. 22 MR. LO GROSSMAN: I would say that -- 23 MR. HORTON: You want them to be sworn in, 24 is that a request, in order for their testimony to 25 have -- could be valid? Is that the request of the 26 Department? 27 MR. LO GROSSMAN: Sure. Yeah. Please. 28 MR. HORTON: Madam Chair. 45 1 MS. HARKEY: Okay, I'm going to need some 2 wording here. What do we use to swear people in? 3 What is the appropriate manner? 4 MS. RICHMOND: Who are we swearing in? 5 MS. HARKEY: The three -- the three 6 witnesses. 7 If you would come up here and stand, 8 please. 9 MR. HORTON: I don't believe it's 10 necessary, but I mean the Department has made -- 11 MS. HARKEY: No, the Department wants it, 12 so let's just, let's just -- 13 MR. LO GROSSMAN: Okay, forgot about it. 14 Forget about it. It's fine. 15 MS. HARKEY: Are you okay? You're okay 16 with it? 17 MR. LO GROSSMAN: Yeah. I'm getting a lot 18 of shaking heads. Let's not waste time. 19 MS. HARKEY: Okay, thank you. 20 MR. HORTON: Shaking heads from where? 21 We're not -- 22 MS. HARKEY: Never mind. We're good. 23 We're good. 24 MR. HORTON: So let me make sure. You're 25 waiving your right to have the witnesses sworn in. 26 You believe that's not necessary; is that -- is that 27 what you're saying? 28 MR. SWIESO: We'll take them for their 46 1 word. 2 MR. HORTON: Yes or no? 3 MR. SWIESO: Yes, we take them for their 4 word. 5 MR. LO GROSSMAN: So what I would just go 6 and say is that we had written contemporaneous 7 documentation. And although I'm taking them at 8 their word now, memories -- you know, memories fade 9 over time. And it's after-the-fact, whereas what 10 we've been relying on was contemporaneous written 11 documentation. 12 MR. HORTON: Okay. Madam Chair, thank you 13 for that. 14 MS. HARKEY: Thank you. Anyone else want 15 to? No? 16 Okay. 17 MS. STOWERS: Just some follow-up. 18 MS. HARKEY: Ms. Stowers. 19 MS. STOWERS: To the Department, so you're 20 saying you have written contemporaneous 21 documentation; and it looks like it's mainly from 22 their CEO, and the annual reports and the press 23 statements. 24 MR. LO GROSSMAN: We have their press 25 statements, their annual reports, and their CEO 26 statements. 27 With regard to the leasing venture, those 28 are corroborated by China Construction Bank report, 47 1 annual reports. That's -- that's the evidence that 2 we've put forward. 3 MS. STOWERS: So is it your opinion that 4 these written documents should give more weight -- 5 MR. LO GROSSMAN: Absolutely. 6 MS. STOWERS: -- than the oral arguments? 7 MR. LO GROSSMAN: Because not only are they 8 written, they are contemporaneous. And again, as 9 appellant mentioned in its case in chief, those 10 press releases had to be counter-signed by China 11 Construction Bank. 12 MR. HORTON: Yeah, but the challenge is is 13 that, if I'm not mistaken, are those statements 14 subsequent to the actual agreement? 15 MR. LO GROSSMAN: The press release 16 statements are subsequent to the actual agreement, 17 yes. 18 MR. HORTON: So it's not part of the 19 agreement. No one really said -- 20 MR. LO GROSSMAN: No, they are not part of 21 the contract. 22 MR. HORTON: -- said before that we're 23 going to enter into this agreement for this 24 purpose. 25 MS. STOWERS: Except for -- 26 MR. HORTON: I don't know. I'm asking. 27 Did that exist somewhere? Is there evidence that it 28 was a condition of the agreement or that it was 48 1 prior to the agreement, these statements? 2 MR. LO GROSSMAN: No. 3 MR. HORTON: Then the statement becomes an 4 opinion as to what may have happened as a result of 5 not only that activity but any other activity that 6 may have taken place subsequent to the contract. 7 MR. LO GROSSMAN: Well, if you're relying 8 on the annual reports, that would be absolutely the 9 case. It would be purely aspirational. 10 MR. HORTON: Right. 11 MR. LO GROSSMAN: But what you have are the 12 annual reports which are aspirational, followed by 13 the actual statements about what was actually going 14 on subsequent. 15 MR. HORTON: And so -- 16 MR. LO GROSSMAN: And so then you have an 17 operational tie between the two businesses of 18 significance, which is what is required under the 19 law. 20 MR. HORTON: The ATM agreement -- question 21 of the appellant -- the ATM agreement, is it unique, 22 different from any other ATM agreement? 23 MR. BRANNAN: No. It's not -- let me -- 24 let me be very precise in the answer, Mr. Horton. 25 Not all ATM arrangements are the same. 26 MR. HORTON: Right. 27 MR. BRANNAN: The reciprocal use with CCB 28 for free was identical in every way to the 49 1 arrangement that BAC had with what we're labeling 2 the global ATM alliance, which was a group of 10 or 3 12 European banks. And that, from what we've been 4 able to understand, was the model for the 5 arrangement with CCB. 6 MR. HORTON: Was that -- was that 7 anticipated in any way that you had entered into 8 these agreements? 9 MR. BRANNAN: No. We -- we poked around, 10 and I can ask Mr. Belk to come back up. But we 11 tried to figure out where that came from and we 12 don't know. 13 MR. HORTON: To what extent subsequently 14 was it beneficial to B of A to enter into that 15 agreement? 16 MR. BRANNAN: I think that, you know, as 17 Mr. Belk indicated, there's an economic cost to the 18 bank because they're missing their transaction fee. 19 There is some value to the individual customers that 20 don't have to pay that fee. It does -- I mean I can 21 make the FTB's argument, I could expand their 22 network of ATMs around the country and that could be 23 conceived as value. 24 MR. HORTON: Did it increase access for 25 your customers? 26 MR. BRANNAN: It would because it -- well, 27 not necessarily. It increased free access. 28 MR. HORTON: Free access. They still had 50 1 the access. 2 MR. BRANNAN: Yes, sir. 3 MS. HARKEY: I have some questions while 4 we're thinking here. 5 What was -- just real simply. Why did B of 6 A do this? 7 MR. BRANNAN: To invest in the economy. So 8 when they acquired their equity interest -- going 9 back in 2005, before they went public, a 10 knowledgeable investor had the opportunity to take 11 out an equity interest. And when they go public we 12 know what happens to the value. But because of 13 their knowledge, they were able to invest. 14 And so the reason they invested is as soon 15 as it went public, they had a pretty good idea that 16 the value was going to go up. Further, their 17 training was in an effort to modernize the bank. 18 The more modern they became, the more people in the 19 economy that would use CCB, the greater CCB's 20 business -- 21 MS. HARKEY: I understand what CCB got out 22 of it. But what did BAC get out of it? 23 MR. BRANNAN: Ultimately we were able to 24 get dividends, that's what's really at issue in 25 2008, from our equity investment. And over time we 26 were able to acquire more. Our investment went from 27 10 to 19 percent, 19.9 for one period of time and 28 back down to 10. But when we were able to sell 51 1 those shares there was significant gains from those 2 sales on the open market. And then ultimately when 3 we sold out, it helped -- you know, it helped 4 increase kind of our capital requirements. And you 5 remember that window what was going on with the 6 banks. 7 MS. HARKEY: Oh, I remember. Everybody was 8 cratering. 9 MR. BRANNAN: Right. 10 MS. HARKEY: What, um -- what percentage of 11 your total bank was the investment in CCB? It says 12 it was 3 billion to purchase 9 percent. 13 MR. BRANNAN: Three billion was the 14 purchase. I'm not sure from a property standpoint. 15 Is that the kind of thing you might know? 16 MS. HARKEY: It's a trick question. Think 17 about -- no, I'm just wondering because it -- I'm 18 sure it's not, you know, 50 percent of the bank or 19 40 percent or 30 percent. 20 MR. BELK: From our balance sheet 21 (inaudible). 22 MS. HARKEY: That's what I thought. So 23 that's my point. It was a small investment. And it 24 seems like it was -- it seems like it was more of an 25 investment to me in the fact that -- in the fact 26 that you've got, you know, returns on it. You've 27 got, you know, your dividends, etcetera. 28 MR. BRANNAN: Your dividends and the gain 52 1 and the sale. 2 MS. HARKEY: So to the FTB, how does this 3 differ from making an investment anywhere else? 4 MR. LO GROSSMAN: Because of the 5 operational ties between appellant and China 6 Construction Bank, that's what makes the 7 difference. 8 MS. HARKEY: Okay. And you're saying that 9 the operational ties. Okay. They had -- they only 10 had one person nominated from BAC of CCB's 19-person 11 board, correct? 12 MR. LO GROSSMAN: That's true. 13 MS. HARKEY: Okay. And so I'm trying to -- 14 trying to figure out the big investment here and I'm 15 not -- what about -- I think the numerous statements 16 and whatnot may have shown B of A's intent. But do 17 they actually prove integration? 18 MR. SPERRING: And, Madam Chair -- 19 MS. HARKEY: Yes, go ahead, Mr. Sperring. 20 MR. SPERRING: May I talk about that 21 because that's something that's been giving me great 22 consternation here, right? We're hearing -- 23 MS. RICHMOND: Please state your name for 24 the record. 25 MR. SPERRING: Sure. This is Jon Sperring, 26 PricewaterhouseCoopers. 27 And you hear FTB talk about operational 28 tie, right, and they say if there's operational tie 53 1 that's enough. And the exact quote is, I'm going to 2 list five operational ties of some significance. 3 And by the way, one of those five is the 4 wire transfer where you heard that we had 1600 5 customers, okay, make wire transfers, right, so 6 that's one of their five significant operational 7 ties, okay. 8 But if you look at what the law says, 9 right, if you look at Hoechst Celanese, the 10 California Supreme Court, which basically follows 11 Board of Equalization opinions on it, okay, it -- 12 here's what the court said, it said, related to the 13 functional test: 14 Not surprisingly, the parties disagree 15 over the meaning of "integral." Hoechst contends 16 "integral" means necessary or essential. FTB 17 counters "integral" only means contributing to or in 18 other words an operational tie. 19 We, however, find both interpretations 20 inaccurate. And what do they say? They quote Holly 21 Sugar, Board of Equalization opinion, okay, for what 22 is an operational tie or what is integral, excuse 23 me. And what they say is the activities of the two 24 companies constitute one indivisible composite 25 whole, each portion giving value to the other 26 portion, okay. 27 So it's one company, Bank of America and 28 the China Construction Bank are an indivisible 54 1 whole, okay. And if you look at they're citing two 2 cases, okay -- they cite many Board of Equalization 3 cases, but two that I think are very helpful, okay, 4 because they're both California companies. They're 5 both cases -- it's Standard Oil and Occidental 6 Petroleum, okay, LA and San Francisco, right. 7 And in both those cases FTB wanted it to be 8 nonbusiness income. And in the case of Standard 9 Oil, okay, the investment, the joint venture that 10 Standard had, okay, that FTB characterized as 11 nonbusiness income was Saudi Aramco, okay. At this 12 time Chevron owned Saudi Aramco, right. And that 13 entity produced 52 percent of Chevron's worldwide 14 oil supply. 15 And in fact, okay, although Chevron owned 16 30 percent -- excuse me, Standard owned 30 percent 17 of Saudi Aramco, okay, if they didn't buy 30 percent 18 of the oil produced, they only got seven-and-a-half 19 percent of the profit. So the only way they could 20 get their full 30 percent share was they had to 21 purchase their full oil allotment. And in fact, 22 Saudi Aramco was precluded from selling to anyone 23 else, okay. Hence, you're seeing the integrated. 24 That's the integration that the court talked 25 about -- that your Board, excuse me, okay, that your 26 Board adopted and that the California Supreme Court 27 favorably cited. 28 Now let's go to Occidental Petroleum, 55 1 right, and the great Dr. Armand Hammer who bought 2 that company that was started in 1920. Occidental 3 Petroleum, before Dr. Hammer bought it in 1957 was a 4 hundred percent California Oil Company, right. So 5 it explored oil in the LA area, right, and refined 6 it. It was a hundred percent California. And 7 Dr. Hammer turned it into this international 8 goliath, okay, with holdings in Libya, okay, and it 9 was in all different types of investments. It was 10 becoming an energy company. They had coal, okay. 11 They had different investments, okay. 12 And one of the five investments that FTB, 13 okay, tried to assert as business income was an oil 14 patch in Kern County. So of course everyone would 15 think Occidental Petroleum, right, is buying an oil 16 patch in Kern County, okay, that's going to be 17 business income. 18 But your Board, okay, rightly said, 19 according to California Supreme Court, that is not 20 business income because it was -- they weren't able 21 to integrate it in. And why? Because although they 22 bought a minority interest in this Kern County land 23 company, Tenneco came in, they basically sold out to 24 Tenneco and Tenneco became the majority owner and 25 blocked Oxy from getting control of it, okay. And 26 therefore Oxy sold it as a gain. 27 So their whole purpose of buying Kern 28 County land was to get the oil to integrate into 56 1 their worldwide oil operation and -- and -- but they 2 were blocked because the management of Kern County 3 land sold out to Tenneco. 4 Okay. And so that's the type of 5 integration we're talking about, not some 6 operational tie. 7 And I go lastly to ASARCO, U.S. Supreme 8 Court case on the very same UDIPTA statute that 9 California's adopted in 25128. And in ASARCO, okay, 10 in southern Peru, okay, what you had was the U.S. 11 Supreme Court saying the closest question posed by 12 ASARCO's receipts of dividend are from southern 13 Peru. ASARCO is one of southern Peru's four 14 shareholders, owning 51 percent of the stock. 15 Southern Peru produces smelted, unrefined 16 blistered copper and 35 percent of their output is 17 sold to ASARCO, okay. But the court says it's 18 nonbusiness, okay, and that's because ASARCO's 19 majority interest, if asserted, could enable it to 20 control management over southern Peru but the 21 remaining shareholders would bail if they did that. 22 And as a result ASARCO didn't assert total control 23 over southern Peru, okay. 24 So now that's the standard. And we 25 basically have the Franchise Tax Board saying that 26 this arm of the People's Republic of China is 27 integral to the Bank of America. That's where we 28 are today. 57 1 MS. HARKEY: Thank you. You really 2 expend -- I mean there -- there might be intent, but 3 that doesn't necessarily prove integration. 4 MR. LO GROSSMAN: May I respond? 5 MS. HARKEY: You may. Yes, please. 6 MR. LO GROSSMAN: There were subsequent 7 cases to the ones he just mentioned. There was 8 Allied Signal, which came after ASARCO, which said 9 that the test is whether there is an operational 10 rather than an investment function. That was a 11 subsequent U.S. Supreme Court case. 12 Following that U.S. Supreme Court case, 13 your Board in its last word on minority business -- 14 on minority stock business income/nonbusiness income 15 cases -- this is not the first time this kind of 16 case has happened -- but the last published word 17 your Board has on this was CTS Keene, which came 18 after Occidental and Standard Oil, and it repeated 19 the Allied Signal test and it said that the test is 20 operational versus investment function. It also 21 explicitly rejected the contention that you need 22 control over the invest -- the company that the 23 taxpayer invests in. 24 MR. SPERRING: I'm happy to respond to that 25 if you'd like. 26 MS. HARKEY: All right. Our two attorneys, 27 go ahead. 28 MR. SPERRING: Thank you. I mean, the 58 1 quote that I think of Allied Signal that's most 2 helpful here is the mere fact that an intangible 3 asset was required pursuant to a long-term corporate 4 strategy of acquisitions and dispositions does not 5 convert an otherwise passive investment into an 6 integral one or an operational one. And that's what 7 this was. It was a passive investment. 8 The only reason why the People's Republic 9 of China allowed Bank of America to buy in -- 10 because they could have allowed anyone. They 11 could've allowed a Saudi oil sheik to buy in, but 12 they allowed Bank of America because they wanted 13 Bank of America, a sophisticated investor. They 14 wanted the knowledge from Bank of America. That was 15 part of the cash, essentially, the bank offered. 16 It would have brought to the table, besides 17 this 3 billion bucks was this strategic system 18 agreement, this unique knowledge of western banking. 19 That's what they got. That was part of the 20 investment, okay. 21 But other than that, this is a passive 22 investment for the bank that they were able to get 23 given the fact that they have, they're a world 24 leader, as we heard Mr. Belk say they're a world 25 leader in banking, in the banking business in the 26 west and China wanted them in there to teach their 27 bank. And so this is what they had to bring to the 28 table, along with the cash. 59 1 So we're perfectly -- you're perfectly 2 consistent with Allied Signal when you find that 3 this is nonbusiness income because this is a passive 4 investment. 5 MS. HARKEY: I do believe it's more of an 6 investment because of the dollars. It was not huge. 7 The dollars were not huge, the control was not 8 there. 9 If B of A would have pulled out, oh, a year 10 earlier, would that have mattered to CCB? I mean 11 would -- would -- would B of A have suffered for 12 that? 13 MR. BRANNAN: I -- I -- I always want to 14 answer the question. We had lock-up provisions that 15 governed when we could sell our investment interest. 16 MS. HARKEY: Right. 17 MR. BRANNAN: As a general rule we sold 18 very shortly after the expiration of those. It's a 19 three-year lock-up. We sold very shortly after that 20 three-year provision. 21 The window where we got rid of where we 22 sold, you know, very large portion of it we were in 23 financial straits. And as indicated by Mr. Belk and 24 also in the press releases, which I'm kind of loathe 25 to refer to because I want to look at the contracts, 26 but the press releases were pretty clear, we're 27 selling noncore assets because we need capital. 28 MS. HARKEY: Yeah. I think just there's so 60 1 many things that indicate it was an investment, and 2 actually not a really large one. It was an 3 investment for which you got a return. And then 4 when things cratered here, you sold it out, which -- 5 MR. SPERRING: And, Madam Chair -- 6 MS. HARKEY: Yes. 7 MR. SPERRING: Can I address CTS Keene if 8 you wouldn't mind? 9 MS. HARKEY: If you wouldn't mind, yes. 10 MR. SPERRING: Thank you. Thank you. 11 MS. HARKEY: Just be quick. 12 MR. SPERRING: So CTS Keene, right, CTS 13 Keene, an American company, okay, gave AB, okay 14 which was a British company, their entire license 15 agreement to market in Europe, okay. So, and they 16 originally had a German subsidiary that was selling 17 their products, okay, and they ended up closing it 18 down, okay, and in return AB allowed them to buy 19 minority interests, okay, and they issued a 20 licensing agreement, two separate licensing 21 agreements, to let them market all of their products 22 in Europe. Hence, it was vital; AB was vital for 23 their European operations. 24 They shut down their previous wholly owned 25 subsidiary, turned it over to AB. And once they got 26 the licensing agreement in place, then they sold. 27 And in fact what your Board said, CTS' real goal was 28 not to achieve a return on the stock, but rather was 61 1 to support AB's efforts under the licensing 2 agreements to help create a broader worldwide market 3 for various products developed by CTS Unitary Group. 4 There is no evidence of that here in the 5 record. There's no evidence that we were using an 6 arm of the People's Republic of China, okay to 7 service our global clients. That's not what was 8 going on here. 9 MS. HARKEY: No, that's not what appears to 10 be going on here, especially the fact that you 11 bailed and that was the end of it. 12 But I do see that you probably got some 13 benefit in the loan portfolio just by familiarizing 14 yourself with China, by having a name out there, 15 that was beneficial. But that doesn't mean that you 16 were integrated. And it doesn't mean that B of A, 17 that that was part of your normal course of 18 business. 19 Thank you. 20 Anyone else? 21 MS. STOWERS: Madam Chair? 22 MS. HARKEY: Yes. Member Stowers. 23 MS. STOWERS: To the appellants -- I don't 24 want to put words in your mouth -- but did you say 25 it was a passive investment, or just an investment 26 in general? 27 MR. SPERRING: I was quoting the Board, 28 which found that those investments were passive. 62 1 MS. STOWERS: Okay. So what would you say 2 about Bank of America's investment into China 3 Commercial Bank or CCB? 4 MR. SPERRING: I would say that we -- we 5 were a knowledgeable investor, okay, that we didn't 6 have -- if we hadn't had that ability to do the 7 Strategic Consulting Agreement, right, Assistance 8 Agreement, they probably would not have taken us. 9 They wanted us to share knowledge with them. But it 10 was never to help get them up to the ways of the 11 western banking system. But it was never to be 12 integrated. 13 MR. BRANNAN: I -- I -- if I may. 14 MS. STOWERS: Yes, please. 15 MR. BRANNAN: I think the distinction -- I 16 mean any sort of investment certainly falls on a 17 continuum. And I think the language quoted of the 18 idea of a passive investment is on one end where the 19 money goes in and we do nothing. But I think in the 20 case, the comparison between a passive investment 21 and the other type is when the investor, in this 22 case say BAC, is actively involved in the management 23 by inserting some of its people in the C-Suite, for 24 example, or they have a majority or a vocal piece of 25 the board of directors. That would be, again, my -- 26 my understanding of the case authorities, that's an 27 active investor. 28 And then you have a situation like this 63 1 where we really need to resort to the language of 2 Hoechst Celanese, the two-way flow of value, where 3 if we're in there and we're just training and 4 there's no true opportunity for us to learn or to 5 enhance our operations, then it clearly falls more 6 on the passive investment type situation, or at 7 least on that side of the fence when you're talking 8 about the biz/nonbusiness determination. 9 MS. STOWERS: I follow what you're saying. 10 The issue that I am having is that you do -- you did 11 have those agreements, the SSA; which, to me, is 12 different than any other investment and it was a 13 condition of B of A. In order to acquire the stock, 14 they had to enter into those agreements. So they 15 definitely went hand-in-hand. 16 So, to me, it's different than your typical 17 investment. And I realize that what BOA invested 18 was small compared to their overall assets. 19 MR. BRANNAN: Yes. 20 MS. STOWERS: But I don't think that's 21 really important to determine whether or not we have 22 business or nonbusiness income. 23 MR. BRANNAN: There is -- there is a 24 materiality requirement in the Hoechst Celanese 25 case, but I don't want to ignore the point that 26 you're trying to make. 27 MS. STOWERS: -- I'm trying to make. No, 28 no. I'm following it. 64 1 MR. BRANNAN: Okay. 2 MS. STOWERS: Definitely there has to be 3 integration and there has to be value both ways. 4 MR. BRANNAN: Mm-hmm. 5 MS. STOWERS: I'm going to ask the 6 Department, you guys are relying a great deal on 7 annual reports and press statements where they 8 basically said we entered into -- I don't have it up 9 right now -- we did the ATM arrangement or we did 10 the lease arrangement or we did -- they defaulted on 11 the credit card. But several, at least four 12 arrangements they did, and when they made those 13 press announcements they referenced their investment 14 with the Chinese bank. 15 MR. LO GROSSMAN: Yes. 16 MS. STOWERS: And I'm kind of paraphrasing. 17 So can you help me out? So is it your argument that 18 this -- 19 MR. LO GROSSMAN: Because these -- 20 MS. STOWERS: -- does show the operational 21 integration and the value back and forth and that 22 BOA, Bank of America, would not have had the 23 opportunity to make these arrangements had they 24 not -- 25 MR. LO GROSSMAN: What we -- what we have 26 are these operational ties and we're relying on 27 appellant's own statements to -- to attribute those 28 to appellant's investment in China Construction 65 1 Bank. We can establish that those operational ties 2 exist and we can establish that the appellants had 3 an investment in China Construction Bank, and 4 fitting the two together ultimately comes down to us 5 believing appellant's contemporaneous statements. 6 Is that the -- I'm sorry if I -- 7 MS. STOWERS: I'm just trying to work this 8 out through my -- through my head. 9 To Mr. Sperring, I think you wanted to add 10 onto something. 11 MR. SPERRING: Thank you, yeah, Madam 12 Stowers. You bring up a great point. And I guess I 13 would steer you to the Appeal of Mark Controls, 14 right. So in Mark Controls the, uh -- the American 15 company had directors, right, in Weir and they were 16 not happy with the way Weir was managing their 17 operations, right. So you have two valve companies 18 and they want to use Weir, which is based in 19 Scotland, to sell their products in Europe. 20 And so they have their directors, right, 21 become executives in the company to help steer the 22 management of the company. 23 Okay, so that occurs. Those directors were 24 unsuccessful in turning the company around to the 25 way that Weir thought it would be managed. 26 Therefore -- or, excuse me, the way CTS wanted Weir 27 managed. Therefore, CTS sold out, they gave up, got 28 a -- and had a gain. Your Board held nonbusiness 66 1 income even though those corporate officers were 2 there and were active in the company. 3 MS. STOWERS: I understand. And I 4 understand Mark Control and that would kind of track 5 for me, especially when you look at the desired 6 credit card arrangement that did not take place. 7 But we still have the leasing arrangement. 8 We still have the ATMs, we still have the wire free. 9 So there are some other programs that they entered 10 into with them that did come to life. 11 MR. SPERRING: Right. 12 MS. STOWERS: So I'm not really convinced 13 that Mark Control is controlling. 14 MR. SPERRING: I -- I hear you. I hear 15 you. On those three points, I think, are valid. 16 And then I would go to Hoechst where they said some 17 connection is not enough. 18 MS. STOWERS: Okay. To the Department, did 19 you want to respond to that? 20 MR. LO GROSSMAN: Well, with Mark Controls 21 that's exactly our position. Yes, that would be 22 very pertinent to the credit card venture and not to 23 anything else. 24 With respect to Celanese, we would just 25 point out that what they did -- what they say is 26 there has to be material production of business 27 income and has to materially contribute to the 28 production of business income. 67 1 We know that there was business income from 2 the leasing venture. We know that exploiting the 3 Chinese market was certainly material to their 4 business. This -- this was a plan to get money from 5 more banking in China, and it succeeded. The 6 leasing venture was a part of that. 7 We have shown that there is an oper -- that 8 there are operational ties. We have appellant's 9 officers saying -- connecting that to the 10 investment, and that's all that's required. 11 MS. STOWERS: Do you think there's some 12 type of disconnect that they treated the leasing 13 income as business income, but yet the overall 14 investment is, they're saying is nonbusiness? 15 MR. LO GROSSMAN: Well, on the original 16 return everything was business income. And so, you 17 know, on the claim we don't -- I mean we think 18 it's -- we think it was always -- we think they were 19 right on the original return, so we don't really see 20 a disconnect. 21 I think what they're trying -- if what 22 you're getting at is, you know, how can you have the 23 leasing venture be nonbusiness or business and have 24 the gains from the stock be something different, 25 yes, we think that because the leasing venture is 26 clearly business income; they are talking about how 27 it wasn't a very good business for them and they 28 wanted to get out. And leasing is clearly part of 68 1 the bank's core business, that makes that business 2 income. Since the stock is part -- since the stock 3 was responsible for the leasing venture, we think 4 that that brings in the stock as well. 5 I don't think they've ever actually claimed 6 that the stock -- that the leasing venture was ever 7 nonbusiness income. They've cert -- or I don't -- I 8 don't believe they've presented that argument. 9 MS. STOWERS: Go ahead. 10 MR. BRANNAN: No, I think there's a few 11 points to make. And I appreciate your question 12 because certainly that was something raised in the 13 hearing summary. 14 One, the statute requires us to evaluate 15 income based on its -- I'm going to be very 16 nontechnical -- source. Where did the money come 17 from? It came from the property. So we have to 18 evaluate the income from the leasing joint venture 19 differently or separately -- who knows what the 20 answer's going to be when you start down that 21 path -- from the income that came to us either as 22 dividend or gains on sale from the CCB investment. 23 So we look at those separately. That's 24 what the law requires. And so there's really two 25 things then that are set up. Did we properly 26 evaluate the nature of the income from the leasing 27 joint venture? And I'll tell you, Ms. Mirandi here 28 is going to walk through why we got to that 69 1 conclusion. But we're doing the best we can and if 2 we follow the law and we evaluate them separately, 3 which is what we're required, I mean that's -- 4 that's what happens here. 5 And then the second question, which I'll 6 get to after Karen speaks, is really, Does it have 7 any bearing at all on how we treat CCB? So there's 8 two layers of questions here. 9 So why did we file the way we did with 10 regard to the leasing joint venture? 11 MS. MIRANDI: Sure, Derick, I'm happy to 12 address that. 13 So under the terms of the leasing JV 14 agreement there were several provisions that were 15 different than what was under the investment 16 agreement for the CCB stock. So first of all, and I 17 think Mr. Smilie may have mentioned this before, we 18 had three employees that were seconded from BAC to 19 the leasing joint venture; there was a Chief 20 Operating Officer, a Chief Risk Officer and then a 21 more junior level marketing executive that was 22 involved. 23 Second, through the terms of the Chief 24 Operating Officer's responsibilities we, BAC, had 25 the right to request that CCB actually guarantee 26 some of the specific lease transactions. So we had 27 some level of control there. 28 Third -- and this one is, to me, of 70 1 particular importance -- BAC held a super majority 2 vote over some of the more substantial provisions 3 within the leasing JV, which included deciding the 4 business plan, deciding the investment plan, and 5 also being part of the preparation of the annual 6 financial budget for the leasing JV. 7 And then, again, BAC was entitled to a pro 8 rata share of the income from that joint venture 9 based on their ownership percentage. 10 So these provisions taken together appear 11 to -- to -- to suggest a level of control and 12 decision making in the leasing JV that was not 13 inherent in the investment in the CCB stock. And so 14 when we looked at that and we were looking at filing 15 our refund claim, we took that into consideration. 16 And, quite honestly, the amount of income that was 17 coming out of the leasing JV, I think, was over the 18 course of several years -- of the time, four or five 19 years, was like $25 million. So given the 20 immateriality of the amount in conjunction with the 21 additional provisions that were in the leasing JV 22 agreement, we just decided to take a more 23 conservative approach on that and we did not include 24 that as part of our nonbusiness refund claim that we 25 filed. 26 MR. BRANNAN: Here's what's interesting 27 about that discussion -- 28 MS. HARKEY: If you could speak in the 71 1 microphone. 2 MR. BRANNAN: I'm sorry. 3 Here's what's interesting about that 4 discussion. All of the things that Ms. Mirandi just 5 described, or should I say none of the things that 6 Ms. Mirandi just described were present in the 7 investment relationship with CCB. And those are the 8 things that are important. They're important under 9 the law; what sort of control, what sort of input. 10 And -- and -- and so it's a -- you know, 11 it's a facts and circumstances test at the end of 12 the day. And we have a taxpayer who's trying to do 13 the best we can. And to suggest that somehow a 14 decision made, an honest evaluation here should 15 somehow hang us up over here on the other side, I 16 think it's -- it's not really the way the analysis 17 is supposed to work. 18 So we did what we did. Honestly we look at 19 it today, we still think it's the right call. But 20 with regard to the impact of the leasing JV in 21 connection or its impact on the rest of the 22 investment, we had the person we're investing in 23 telling us, "We want you to join us." Mr. Smilie. 24 We didn't think we had much choice. Who's helping 25 who in that situation? I mean we're just stuck at 26 that point. It's not what we wanted. It's not why 27 we started the investment. It's really just 28 something that was kind of foisted upon us during 72 1 the course of business. 2 MR. SPERRING: It was just emphasized, 3 right, it was 5 percent. So kick in another 5 4 percent, if you will. 5 MR. BRANNAN: Right. I mean the amount of 6 the investment was roughly 5 percent of that, you 7 know the larger initial investment. So it's -- you 8 know, it's part of -- it's part of the deal with 9 them. They took expertise, and in exchange we got a 10 chance to invest in the market. It always comes 11 back to the same thing, it really does. 12 MS. STOWERS: Thank you. 13 MS. HARKEY: Member Ma? 14 MS. MA: Okay. So I think, you know, the 15 Franchise Tax Board, as I hear, you're basing the 16 case on operational ties. 17 MR. LO GROSSMAN: Yes. 18 MS. MA: Right. And the taxpayer is really 19 basing it on whether it's integral, inseparable, 20 right? 21 MR. BRANNAN: Interwoven. 22 MS. MA: Integral parts, interwoven with 23 the company's trade or business. 24 MR. SPERRING: Yeah, the Hoechst Celanese 25 language. 26 MS. MA: Right. 27 So, how is this different from, like, a 28 equity investor where the equity investor invests, 73 1 takes a certain percentage, puts someone on a board 2 of directors, you know, is actively engaged in the 3 operations and the management of the company because 4 they have a stake in the company? 5 I think -- I mean, in my opinion it's 6 almost like it's like a equity investor, except 7 there's a little twist in it in that the equity 8 investor really just goes in just for the investment 9 and doesn't have any sort of relationship with the 10 company that they're investing in. 11 And in this case, because you both are 12 banks, you know, I think it's a little different 13 because there is operational ties, I think, in why 14 you did what you did in terms of investing, 15 expanding, you know, your footprint. 16 But, you know, I'm trying to -- you know, 17 I'm not convinced that this is like an integral, 18 interwoven, indivisible, inseparable from Bank of 19 America's business, because it wasn't initially part 20 of, you know, the market. It was like an 21 investment. It didn't turn out necessarily to do 22 much because China controls all of their business 23 operations in China. 24 And so in terms of, you know, having it be 25 interwoven into the fabric, I'm trying to get there 26 and I'm trying to figure it out. But it doesn't -- 27 it's not rising to that level in my opinion. 28 So, Franchise Tax Board. 74 1 MR. LO GROSSMAN: Well, I would say that 2 the operational tie language that we used was all 3 the Board opinions from the '80s and '90s were 4 affirmed with approval in Celanese. So the Celanese 5 court was endorsing the position of your Board in 6 CTS Keene, which requires operational ties. 7 I should also point out that with the whole 8 "interwoven, integral, complete" language, that's 9 like at the top of page 532 of Celanese. And if you 10 go, like, two paragraphs down, they say that, we 11 conclude that forming these interpretations of the 12 statutory language into a cohesive whole, we 13 conclude that income is business income under the 14 functional test if the taxpayer's acquisition, 15 control, and use of the property contribute 16 materially to the taxpayer's production of the 17 business income. 18 So that's where Celanese ac -- that's where 19 Celanese ends up after they talk about that language 20 about interweaving and interwoven. They end up 21 going back to language very similar to CTS Keene 22 which is contributing materially to the production 23 of business income, operational function, that sort 24 of language. 25 MS. MA: Okay. Okay. So let's go back to 26 material. How is the investment material to the 27 overall Bank of America -- 28 MR. LO GROSSMAN: In Celanese -- 75 1 MS. MA: -- portfolio? 2 MR. LO GROSSMAN: Sorry. 3 In Celanese they use materiality in a 4 qualitative sense. They're talking about the 5 pension reversion being part -- a material part of 6 Celanese business because employees are material to 7 the business of Celanese. 8 Here we're talking about market 9 exploitation, and markets are clearly -- you know, 10 markets are clearly material to any business. So 11 there was never a quantitative materiality test. 12 And if you end up -- and as in the 13 hearing -- as the hearing summary discussed, if you 14 use a quantitative test for materiality, you can end 15 up in a situation where nothing that ever happens 16 for Wyoming is ever material because it's such a 17 small part of any company's business. 18 MS. MA: It's a judgment. 19 MR. LO GROSSMAN: So material -- 20 MS. MA: A judgment. 21 MR. LO GROSSMAN: Materiality has to be 22 qualitative. 23 MS. MA: Okay. 24 MR. LO GROSSMAN: Yeah, it's qualitative. 25 MS. MA: Qualitative, okay. 26 MR. BRANNAN: If I may. 27 MS. MA: Yeah. 28 MR. BRANNAN: The problem with what the FTB 76 1 counsel just said is he's focusing on language from 2 one aspect of the decision, specifically the 3 materiality language. 4 Well, the case also defines materiality. 5 To say that we have that sort of material 6 contribution, when the business is inseparable and 7 interwoven -- and I apologize, I'm sure I'm getting 8 one of those words wrong. But going to the 9 qualitative discussion, I think it's, you know, 10 first point qualitative is good, but it's got to be 11 informed at some level by the metrics. 12 And second part, when we talk about what 13 the court says, it's defining the word integral and 14 it sets out basically three parts. For the 15 functional test you have to have control in use over 16 the property, that it has to contribute materially 17 to the production of business income, and then it 18 has to be integral. Which it then goes on to 19 decide -- you know, define -- 20 Again, there's too many words, that's why I 21 had to write it down at the beginning, I'm sorry. 22 But the property is integral when it's so interwoven 23 into the fabric of the taxpayer's business. Again, 24 we keep going back to the same thing and it becomes 25 indivisible and inseparable. 26 What the court's trying to say is we want 27 it to be part of the business because that's the 28 test at the end of the day. If it's part of the 77 1 business California has the unitary method. If it's 2 part of the business, we apportion it amongst the 3 states or amongst the countries, you know worldwide, 4 all that good stuff. But that's what's not here. 5 You know, Mr. Smilie testified on the 6 leasing joint venture and I appreciate that that's 7 problematic. I mean we're not hiding from anything. 8 I got the right people here. They can talk about it 9 as long as we want, but at the end of the day it was 10 set up as a stand-alone business. It wasn't part of 11 our global leasing operations. We treated it as 12 equity investment. We held it separately. We 13 didn't want to be there. I mean it was never going 14 to be part of our business. 15 If it had really taken off, I mean put in a 16 hypothetical, if it had really taken off, I'm gonna 17 just go out on a limb and say the Chinese government 18 and CCB would have wanted us out. And in fact 19 that's kind of what happened. They wanted to 20 improve the revenues to grow the numbers so that 21 when they showed their leasing operations against 22 those of the other banks, "Look how we're doing, 23 we're doing great, look at our numbers," ignoring 24 the risk. 25 Well, let's go back to the initial 26 introduction of the case. That's what got them in 27 trouble in the first place, twenty years of making 28 friendly loans and artificially inflating kind of 78 1 those numbers. And all of a sudden they needed that 2 outsider to come in and provide the training and 3 help modernize and stabilize their banking system. 4 It's -- it is a little different from the 5 traditional invest money in the market so to speak, 6 no question. But we didn't get that opportunity. 7 It goes to John's earlier example. We were the 8 bank. We had the knowledge. And so there's a short 9 population of investors that really would meet those 10 qualifications. We gave them money, we gave them 11 expertise, and in exchange we got the opportunity to 12 invest in the market. 13 So I'm trying to respond to many of the 14 points that you just kind of walked through, and 15 hopefully I just did that. 16 MS. MA: I get it. No, I understand China 17 very well. And I understand their business model 18 and how they operate. 19 MR. BRANNAN: I understand. Understood. 20 MS. MA: I get it. 21 MR. BRANNAN: Understood. 22 MS. HARKEY: Ms. Ma -- 23 MS. MA: I'm glad you -- 24 MS. HARKEY: -- you understand China? 25 MS. MA: I do, unfortunately, yes. 26 MR. BRANNAN: My apologies. 27 MS. MA: I've taken delegations back since 28 1999. 79 1 MR. BRANNAN: Perfect. 2 MS. MA: So yes. And I understand that's 3 their business model. And that's where I'm having a 4 little difficulty because when you invest in China, 5 it'll never be integral to your business. It is 6 China's business. That's how it is. It is their 7 business and they need you for their intellectual 8 expertise until they get to that level where they 9 don't need you anymore. That's how it works. 10 MS. HARKEY: Anymore questions? 11 MR. HORTON: Question of the Department, 12 Madam Chair. 13 MS. HARKEY: Yes. Member Horton. 14 MR. HORTON: You seem to distinguish the 15 measurement of materiality from the definition in 16 Hoechst Celanese. Relative to the definition, the 17 use of the term interwoven, indivisible, 18 inseparable, why do you believe that's there? 19 MR. LO GROSSMAN: That's -- what happened 20 in Celanese is the court was affirming a bunch of 21 precedent that had been created by your Board over 22 the course of decades. And the language of 23 interwoven and inseparable actually came from Holly 24 Sugar, which was the very first case. And they -- 25 they were affirming everything that had happened, 26 and they just used that nice language from the very 27 beginning. And at the same time they then said but 28 we're also in accord with everything that the Board 80 1 has done from the '80s and '90s. 2 And if you look back at Holly Sugar, it was 3 actually a unitary case. The cases that we would 4 see as business income/nonbusiness income really 5 came much later. So they were affirming -- they 6 were actually taking language from old, old unity 7 cases and applying it, applying it to a 8 business/nonbusiness income case and then saying 9 "and by the way, everything your Board has decided 10 on business/nonbusiness income cases over the last 11 20 years is very good." 12 So that's how that language got in there. 13 But as they affirmed the Board decisions of the '80s 14 and '90s, not all those cases actually requires, you 15 know, profound interweaving. If you look at CTS 16 Keene, which was the last decision your Board had on 17 minority stock cases, it's about material 18 contribution and operational value and operational 19 ties. 20 MR. HORTON: So let's -- let's -- let's 21 take a look at material contribution and operational 22 ties. The dividend transaction. 23 MR. LO GROSSMAN: The taxable transaction? 24 MR. HORTON: Right. How did that give B of 25 A any control over or any contractual influence over 26 the operations in China? 27 I understand the relationship. I mean I 28 understand the relationship that was developed as a 81 1 result of the partnership. Is that sufficient in 2 your mind because they now have a relationship, that 3 that relationship stems to other relationships? 4 MR. LO GROSSMAN: That would be consistent 5 with your Board's precedent that where an -- I mean 6 because ultimately in the functional business test, 7 and I'm sure this is undisputed -- 8 MR. HORTON: I'm speaking of a relationship 9 if I loaned you $5 -- 10 MR. LO GROSSMAN: Okay. 11 MR. HORTON: -- you know, we would have 12 some sort of a relationship. But I couldn't tell 13 you what to do, and you certainly couldn't tell me 14 what to do. 15 MR. LO GROSSMAN: No, sir. 16 The question -- we're talking about the 17 functional test, and ultimately the question is 18 about the asset at issue, so that would be the 19 stock. 20 MR. HORTON: Controlling the asset in order 21 to influence the business activity. 22 MR. LO GROSSMAN: Yeah. The question is -- 23 the test is, does that asset serve an operational 24 function to the taxpayer before you? And 25 appellant -- Bank of America -- so the question is 26 whether -- what is Bank of America getting out of 27 its stock interest in China Construction Bank, and 28 does it have an operational value to China 82 1 Construction Bank? And appellant's officers say 2 that it did. And their press releases say that it 3 did. And we believe appellant's contemporaneous 4 documentation. And we've put our case forward on 5 that basis. 6 Did you have a different question? 7 MR. HORTON: No. 8 MS. HARKEY: Okay, Members, do I hear a 9 motion? 10 Member Runner? 11 MR. RUNNER: Yeah, I am, at least from my 12 observation that I would see that B of A's 13 involvement, I guess I see as incidental to their 14 investment, does not come up to the controlling 15 aspects and what I would understand as certainly the 16 operational ties. 17 So, you know, I think obviously there's 18 some -- there's some involvement. The question is, 19 to what degree is that involvement? And to me, 20 especially the issue that how easily it was to just 21 divest of the involvement indicates to me that it 22 was not a very integral part of their portfolio -- 23 not their -- shouldn't say their portfolio, but 24 their -- but their operation. So I would make a 25 motion for a claim -- or approve their claim for 26 refund. 27 MS. HARKEY: Is there a second? 28 I will second. 83 1 Is there objection? 2 MS. STOWERS: Objection. 3 MS. HARKEY: An objection. 4 Please call the roll, Ms. Richmond. 5 MS. RICHMOND: Chairwoman Harkey. 6 MS. HARKEY: Aye. 7 MS. RICHMOND: Mr. Runner. 8 MR. RUNNER: Aye. 9 MS. RICHMOND: Mr. Horton. 10 MR. HORTON: Aye. 11 MS. RICHMOND: Ms. Ma. 12 MS. MA: Aye. 13 MS. RICHMOND: Ms. Stowers. 14 MS. STOWERS: No. 15 MS. RICHMOND: Motion carries. 16 MS. HARKEY: 4-1. Thank you. 17 MR. BRANNAN: Thank you, Board Members. 18 ---oOo--- 19 20 21 22 23 24 25 26 27 28 84 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, Kathleen Skidgel, Hearing Reporter for 8 the California State Board of Equalization, state 9 that I transcribed from recorded video/audio, to the 10 best of my ability, the proceedings in the 11 above-entitled hearing; and that the preceding pages 12 1 through 84 constitute my transcription of the 13 proceedings. 14 15 Dated: January 30, 2018 16 17 18 ____________________________ 19 Kathleen Skidgel, CSR #9039 20 Hearing Reporter 21 22 23 24 25 26 27 28 85