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From Securities Regulation Daily, September 26, 2014

Wyly brothers face disgorgement of over $188M

By Matthew Garza, J.D.

The federal district court in Manhattan ordered disgorgement of almost $188 million made by the Wyly brothers in a scheme that hid assets in offshore trusts, but the number fell far short of the $619 million the agency sought. The court ordered Sam Wyly to disgorge approximately $124 million, and Charles Wyly’s estate to disgorge approximately $64 million, plus prejudgment interest. The court left the case open, however, and another hearing will be held later this year to further examine the agency’s profit disgorgement theory (SEC v Wyly, September 25, 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 described a 13-year scheme in which the Wylys, operating through a group of offshore trusts and subsidiary entities in the Isle of Man, 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.

The court explained that the scheme began as a tax shelter. The brothers established the offshore trusts as a method of asset protection and tax deferral, but the securities laws were implicated when the brothers transferred to the entities stock options in publicly traded companies Sterling Software and Michaels Stores. The Wylys’ were advised that continuing filing obligations they would have as directors of the companies could threaten the tax benefits because it might alert the IRS. The court said it was logical to conclude that the brothers’ refusal to make the requisite Schedule 13D disclosures was part of their plan to maintain the appearance of separation and independence from the offshore trusts.

In July, Judge Scheindlin rejected the SEC’s attempt to obtain disgorgement of all profits earned by the brothers through trading in their own companies because the SEC was unable to show that all of the profits were causally connected to the disclosure failures. 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 court said that the SEC’s proposed disgorgement “does not appear to arise from the violations and therefore smacks of punishment, not equity or deterrence.”

SEC’s disgorgement measure. The 83-page opinion discussed the SEC’s proposed disgorgement with regard to violations involving registered and unregistered securities, and noted that the agency arrived at its measure of disgorgement by calculating the total profits earned on the sale of the issuer securities by the offshore trusts, and approximating the amount of taxes that would have been paid on those profits had the Wylys accurately disclosed beneficial ownership of the securities. The court said it agreed with this approach, but declined to order civil penalties as requested by the agency. “I conclude that disgorgement of this magnitude is more than sufficient to deter future violations and, accordingly, I decline to impose additional penalties,” wrote Judge Scheindlin.

More disgorgement possible. The judge left the record open to further examine a disgorgement theory posited by the SEC’s expert after the court rejected its “total profits” request. The expert’s opinion approximates unlawful gains by “calculat[ing] the difference between the Wylys’ gains from their offshore transactions in the Issuers’ securities, and the gains that an ordinary buy and hold equity investor would have earned in those securities.” The court scheduled a one-day hearing for November 17 in which the parties will have an opportunity to cross-examine the experts regarding this alternative measure of disgorgement.

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

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