SEC v. Wyly: Judge Scheindlin Ignores Bankruptcy Stay and 2d Circuit To Keep Wylys in Her Charge

The Wyly saga continues.  With a bare nod (but certainly no bow) to contrary Second Circuit precedent on the impact of the automatic bankruptcy stay on SEC enforcement actions, Judge Scheindlin issued a freeze order against the Wylys for the specific purpose of allowing the SEC to take steps toward collecting an eventual money judgment in its favor.

On November 3, 2014, in an opinion you will find here (SEC v Wyly, 10-cv-5760 (Nov. 3, 2014) (“Freeze Opinion”), Judge Scheindlin acknowledged that the Wyly bankruptcy filings mandated a stay of the SEC proceedings apart from a narrow exception in the bankruptcy  statute for a governmental action to enforce “the police and regulatory power, including the enforcement of a judgment other than a money judgment. . . .”  Id., slip op. at 3.  She also acknowledged Second Circuit precedent applying this provision in SEC v. Brennan, 230 F.3d 65 (2d Cir. 2000).  In Brennan, the court said that for such proceedings “anything beyond the mere entry of a money judgment against a debtor is prohibited by the automatic stay,” and that this included “[s]teps preparatory to money collection.”  Id. at 71-72 (emphases in original).  Then, having quoted the language emphasized in Brennan, Judge Scheindlin went on to ignore it.

She issued the freeze order on the theory that “[t]hough the question is close,” the automatic stay does not apply because “there has been no final judgment” and “Brennan explicitly drew the line at entry of judgment, and explained that all actions taken by the government ‘up to the moment’ when judgment is entered are actions within the government’s police or regulatory capacity.”  Id., slip op. at 6-7.  Therefore, the exception “is only implicated after final judgment has been entered and the government is acting to ‘vindicate its own interest in collecting its judgment.’”  Id., slip op. at 7.  That, plainly and simply, ignores the specific language the Second Circuit emphasized in Brennan: “anything beyond the mere entry of a money judgment” is stayed, including steps “preparatory to money collection.”  The sole purpose of the freeze order, and the discovery the SEC sought into what happened to the Wyly assets, fits plainly within this description.  The notion that Brennan “explicitly drew the line at entry of judgment” is wrong; the appellate court’s reference to “steps preparatory to money collection” did not distinguish between steps before and after final judgment.  Indeed, the Brennan court gave as an example of proceedings that must be stayed under the bankruptcy law government a specific earlier Eighth Circuit EEOC case that involved post-bankruptcy proceedings before the entry of judgment.  See Brennan, 230 F.3d at 72.

Judge Scheindlin also sought to distinguish between efforts supposedly to preserve assets versus those to control assets.  Freeze Opinion, slip op. at 7-8.  But there is nothing in the Brennan language drawing this distinction.  In fact, Brennan invalidated an order to place assets into a court registry to protect them against dissipation, which would seem on its face to involve an effort to preserve, not control, those assets.  No doubt the appellate court recognized that steps “preparatory to money collection” would certainly include limits imposed on the debtor to preserve assets.  Moreover, it is naïve, at best, to view a freeze order, which deprives the debtor of any control at all over the assets, as implicating “preservation” but not “control.”  And Judge Scheindlin is anything but naïve.

Judge Scheindlin’s opinion departs from the reasoning of Brennan as well as its plain language.  She willfully blinds herself to the thrust of the appellate opinion.  The Second Circuit made it clear that the exception to the stay was narrow, and was focused only on permitting governmental proceedings to proceed to the extent needed to accomplish the purpose of deterring wrongful conduct.  See Brennan, 230 F.3d at 73.  That does not include “acts only to vindicate its own interest in collecting its judgment.”  Id.  Moreover, the most fundamental aspect of the Brennan decision was its emphasis on the importance of deferring to the bankruptcy court when trying to assure that a debtor’s assets were properly protected and distributed:

In the final analysis, the policies behind § 362 as a whole weigh strongly in favor of applying the automatic stay in these circumstances.  As noted, the general policy behind the automatic stay is “to grant complete, immediate, albeit temporary relief to the debtor from creditors, and also to prevent dissipation of the debtor’s assets before orderly distribution to creditors can be effected.” . . .  In addition, the automatic stay provision is intended “to allow the bankruptcy court to centralize all disputes concerning property of the debtor’s estate so that reorganization can proceed efficiently, unimpeded by uncoordinated proceedings in other arenas.” . . . .  Section 362(b)(4) carves out a limited exception to these policies . . . in order to prevent a debtor from “frustrating necessary governmental functions by seeking refuge in bankruptcy court.” . . .  Here, however, it is undisputed that the type of relief sought by the SEC is available through the Bankruptcy Court. . . .  Thus, it is hard, if not impossible, to argue that Brennan is “seeking refuge in bankruptcy court.” . . . .

Id. at 75.  The plain mandate of the Second Circuit was to defer to the bankruptcy court by complying with the stay except as necessary to allow a governmental proceeding to achieve its deterrent purpose.  Judge Schendlin did not even address this point in her opinion.

Judge Scheindlin ignored the automatic stay not only to approve a freeze order, but to grant the SEC expedited post-trial discovery that goes far beyond preservation of assets.  She approved continuing, and expensive, “steps” that are plainly “preparatory to money collection,” contrary to the instructions in Brennan.  Her final words in the section addressing this portion of the freeze order were that the automatic stay “does not apply to . . . a temporary asset freeze, expedited discovery, preservation of financial documents, and an accounting.”  Freeze Opinion, slip op. at 8.  And she later asserted that the very purpose of these steps was preparatory to the SEC’s enforcement of a disgorgement order: “I conclude that expedited discovery, preservation of financial documents, and an accounting are necessary to enable the SEC to ascertain the full extent of the Wylys’ assets and determine which of those assets would be subject to disgorgement.”  Id., slip op. at 10.  It would be hard to devise a more clear statement of “steps preparatory to money collection” that the Second Circuit held in Brennan were subject to the statutory bankruptcy stay.  And there can be no doubt that this order affirmatively does not allow, as the Second Circuit mandated, “the bankruptcy court to centralize all disputes concerning property of the debtor’s estate so that reorganization can proceed efficiently, unimpeded by uncoordinated proceedings in other arenas.”  Brennan, 230 F.3d at 75. 

All of the evidence suggests Judge Scheindlin is driven by a desire to maintain control over a case on which she has worked long and hard over the years.  But even a federal judge should accept when she is trumped by statute, and should not ignore appellate precedent to try to keep the deck in her hands.

Straight Arrow

November 4, 2014

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2 thoughts on “SEC v. Wyly: Judge Scheindlin Ignores Bankruptcy Stay and 2d Circuit To Keep Wylys in Her Charge

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