Two men share securities regulation news

Breaking news and expert analysis on legal and compliance issues

[Back To Home][Back To Archives]

From Securities Regulation Daily, July 30, 2014

Judge rejects SEC's disgorgement theory of total trading profits

By Rodney F. Tonkovic, J.D.

The SEC's aim of seeking disgorgement of all profits earned by the Wyly brothers through trading in their own companies has been thwarted by a district court. The Commission sought disgorgement of all of the profits earned by brothers Charles and Samuel Wyly as a result of transactions made while they failed to disclose their beneficial ownership of a number of offshore entities. The court refused, finding that the Commission was unable to show that all of the profits were causally connected to the failure to disclose (SEC v. Wyly, July 29, 2014, Scheindlin, S.).

Background. In May 2014, a jury found the brothers liable for fraud and for violating reporting requirements for corporate insiders. The SEC prevailed on all 13 counts of its 2010 complaint describing a 13-year scheme in which the Wylys traded securities of public companies they had acquired or founded and on whose boards they sat, without disclosing their ownership and trading of the securities. The Wylys' Schedule 13D filings, when they were made at all, materially underreported the number of shares they beneficially owned or included other omissions and misrepresentations.

In June 2014, the Commission disclosed for the first time that it intended to seek disgorgement of all of the profits the Wylys earned through their securities transactions. The defendants moved to preclude this theory of "total profit" disgorgement as insufficient as a matter of law. The court granted the defendants' motion.

Total profit disgorgement. The court observed that appellate courts, including the Second Circuit, have upheld total profit disgorgement awards in a number of contexts, including insider trading and actions under Sec.13(d). The court said that it was bound by the jury's finding that the Wylys committed fraud, but noted that the unlawful conduct in this case differed from other fraud cases. This case, the court said, did not involve a market distortion directly caused by the defendants' unlawful conduct with profits flowing directly to the defendants.

The SEC, then, could not satisfy its burden of reasonably approximating the disgorgement amount merely by proving the violations and then calculating the total profits on each of the trades, the court said. There was no evidence of any market distortion, price impact, or profit tied to the defendants' scheme to hide beneficial ownership by failing to disclose transactions or that the scheme was motivated by the expectation of such profits. Without this proof, the court declined to speculate as to the impact of the Wylys' failure to disclose.

Continuing, the court pointed out that while the jury found that the Wylys engaged in a fraudulent scheme to his their beneficial ownership, it did not find that the trading itself was unlawful. There was no proof that the trades at issue were unlawful or constituted insider trading. As a matter of law, the court stated, the Commission could not show that all of the profits on all of the transactions during the relevant 13 years were reasonably connected to the Wylys' continuous failure to disclose beneficial ownership. The SEC’s proposed disgorgement "does not appear to arise from the violations and therefore smacks of punishment, not equity or deterrence," the court added.

The court then afforded the Commission a final opportunity to pursue disgorgement of the Wylys' trading profits. In light of this opinion, the court said, the Commission must provide a credible explanation as to how its new figure is a reasonable approximation of the profits causally connected to the violation. A remedies hearing is scheduled for August 4, 2014 regarding other theories of disgorgement, but the Commission must notify the court by August 12, 2014, if it wants to pursue disgorgement of trading profits.

The case is No. 10-cv-5760 (SAS).

Attorneys: Daniel Staroselsky for the SEC. Donald P. Lan, Jr. (Kroney Morse Lan PC) for Samuel E. Wyly.

MainStory: TopStory FraudManipulation NewYorkNews

Securities Regulation Daily

Introducing Wolters Kluwer Securities Regulation Daily — a daily reporting service created by attorneys, for attorneys — providing same-day coverage of breaking news, court decisions, legislation, and regulatory activity.

A complete daily report of the news that affects your world

  • View full summaries of federal and state court decisions.
  • Access full text of legislative and regulatory developments.
  • Customize your daily email by topic and/or jurisdiction.
  • Search archives for stories of interest.

Not just news — the right news

  • Get expert analysis written by subject matter specialists—created by attorneys for attorneys.
  • Track law firms and organizations in the headlines with our new “Who’s in the News” feature.
  • Promote your firm with our new reprint policy.

24/7 access for a 24/7 world

  • Forward information with special copyright permissions, encouraging collaboration between counsel and colleagues.
  • Save time with mobile apps for your BlackBerry, iPhone, iPad, Android, or Kindle.
  • Access all links from any mobile device without being prompted for user name and password.