Readers of the Securities Diary are by now familiar with the newest Bleak House wannabe, SEC v. Wyly. You can search for our earlier posts on the Wyly case. As we previously reported here, Judge Shira Scheindlin issued an ill-considered order against Sam Wyly, the Estate of Charles Wyly, and numerous Wyly family members added to the case as purported “relief defendants,” freezing their assets, with some exceptions. The purpose of the order was supposedly to avoid the dissipation of Wyly brother assets that are subject to a so-called “disgorgement” order. But those assets were already protected from dissipation because of a pending bankruptcy proceeding in Texas. For reasons discussed in our earlier post, the freeze order flies in the face of Second Circuit precedent almost directly on point, which holds that the automatic bankruptcy stay prevents a court from taking steps to assist the SEC in efforts to assure it can collect monetary relief in an enforcement action.
The SEC, exhibiting its usual “bull in a china shop” approach to litigation, sought to freeze not only the assets of the Wyly brothers, but also 15 family members whom the SEC wanted to subject to their power. As is typical, the SEC assumed it was entitled to such relief and barely tried to support the request with a showing of need. It asserted that these family members must have received “ill-gotten gains” from the Wyly brothers because they received distributions from overseas trusts created by the Wylys, but provided no basis for such a finding, and never tried to identify any such assets. Judge Scheindlin, normally not a pushover for such an SEC “bull rush,” blithely accepted its arguments, probably because she was so miffed that the Wylys had removed assets from her control by filing for bankruptcy. She issued a freeze order against the family members because the “trusts have made distributions to the Family Members” and therefore “the Family Members are likely in possession of ill-gotten funds.”
The family members (other than one who filed for bankruptcy) are appealing Judge Scheindlin’s order against them. On November 14, 2014, they sought expedited treatment of their appeal from the Second Circuit, in a filing you can see here: Wyly Family Motion for Expedited Appeal. The submission provides a brief outline of flaws in Judge Scheindlin’s freeze order.
Particularly appealing (no pun intended) is the discussion of how the freeze order against the family members is completely inconsistent with Judge Scheindlin’s own previous treatment of the SEC’s numerous novel, but plainly invalid, “disgorgement” theories. The judge rejected some of these theories, but finally accepted the SEC theory that it was entitled to disgorgement by the Wylys of federal taxes allegedly avoided by not treating offshore trusts as being beneficially owned by the Wylys in SEC filings about their stock ownership. So the only “ill gotten gain” ordered returned by the court was taxes the Wylys did not pay. (How a tax avoidance could possibly be an “ill-gotten gain” derived from an inaccurate SEC filing is an issue for a later appeal.) The family members point out, however, that no portion of the trust distributions to family members, which are the only potential “ill-gotten funds” cited by Judge Scheindlin, could possibly be taxes avoided by the Wylys, since those tax benefits were personal to the Wylys and did not inure to the benefit of the offshore trusts.
The blunderbuss approach of both the SEC and Judge Scheindlin in asserting power over innocent persons and circumventing the bankruptcy laws may yet force an appeals court to impose a rule of law on this case. Although the Wylys are not exactly poster child victims, their family members, who have been accused of no wrongdoing whatsoever, and have yet to see an iota of evidence that they possess “ill-gotten funds,” deserve judicial intervention to protect them from what is essentially a temporary taking of their assets by the district court.
November 19, 2014
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