On December 19, 2014, Judge Shira Scheindlin issued yet another opinion in SEC v. Wyly, addressing yet another SEC theory of disgorgement against the Wyly brothers. The opinion is available here: SEC v Wyly Opinion on New SEC Disgorgement Theory. It is unusual because it covers many pages ruling that a new disgorgement calculation proposed by the SEC is, for the most part, consistent with Second Circuit law, but then decides to disregard that approach because she believes her previous disgorgement calculation is more appropriate. The earlier disgorgement opinion can be seen here: SEC v Wyly September 25 Disgorgement Order.
The previous disgorgement analysis led to an order that the Wylys pay just short of $200 million plus prejudgment interest for the securities law violations found by the jury. It was based on benefits directly flowing from the Wylys’ use of offshore trusts for their trading in securities of companies they controlled, those benefits being the avoidance of taxes they should have paid (according to the court) if they Wylys owned up to the fact that they controlled those offshore trusts for taxation purposes. In an earlier post, I questioned the propriety of using a securities disgorgement award to cause the payment of taxes, especially when there is ongoing IRS consideration of that very same issue. See here: Wyly Brothers Hit with More than $300 Million Securities Law Disgorgement Order for Unpaid Taxes. The SEC’s new disgorgement theory called for an additional disgorgement (beyond the taxes avoided) of about $200 million plus prejudgment interest.
The newest opinion lays out an extensive review of the status of the law of the so-called disgorgement remedy. The effective end point of this review is that courts have great discretion to decide what amounts to “disgorgement of ill gotten gains,” largely unencumbered by traditional considerations of causation. Once Judge Scheindlin establishes that the only standard guiding this process is that there must be a “reasonable” basis to find “but for” causation of a benefit, the sky is essentially the limit.
Based on this standard, the judge examines a new disgorgement calculation proposed by an SEC expert. She conducted an extended hearing on this proposal, including testimony from the SEC expert and a defense expert. In essence, the new approach put forward by the SEC was to calculate purported profits the Wyly brothers obtained from undisclosed stock trading activity greater than the profits that would have been realized by a hypothetical uninformed “buy and hold” investor. The Wylys’ trading was never found to be unlawful, however. The violation of law that occurred was the failure to comply with disclosure requirements under SEC Rule 13D by not filing Schedules 13D for securities held by offshore trusts that the jury found they controlled. The SEC’s theory was that the 13D violations enabled the Wylys to do their trades secretly, which allowed them to garner more profits than the hypothetical “buy and hold” investor. This, the SEC argued, was sufficient to satisfy the meager “but for” causation requirement render the gains “ill gotten,” and justify a disgorgement of those profits, which would not have been obtained “but for” the 13D violations.
You can read the opinion to see how Judge Scheindlin handles this novel theory. It was novel both as a disgorgement theory and as a matter of expert testimony – it was acknowledged by the SEC’s expert that her calculation had never been accepted in the field of economics or econometrics. It was unsupported by any generally-accepted form of economic or statistical analysis for determining excess stock profits. The judge nevertheless found that what the expert did was “reasonable” and, therefore, under Second Circuit law, agreed it could form the basis for a disgorgement calculation under a “but for” causation theory. She rejected a portion of the analysis, but otherwise accepted the approach as a valid disgorgement calculation under Second Circuit law.
Judge Scheindlin then took an unusual step: she decided not to issue an order following that approach, saying she was “confident that the remedy already imposed” in her earlier September 25, 2014 disgorgement order (see here) was “the best measure of the Wylys’ ill-gotten gains.” Slip op. at 56. She accepted the alternative calculation “only in the event that a higher court disagrees with the measure of disgorgement calculated in the September 25 Order.” Id. In other words, she appears to be saying to the Second Circuit: “accept this if you want to under the law you have laid out in other cases, but I don’t think it really think it is a just and fair result as an order of disgorgement in this case.”
Judge Scheindlin was right to reject the proposal as an inappropriate “disgorgement” of ill-gotten gains by the Wylys. Without saying so, she seems to have — properly in my view – balked at the application of the “but for” concept to deprive a violator of profits with only an attenuated relationship to the violations of law found by the jury.
“But for” causation is essentially a meaningless concept in the context of awarding a remedy because it is almost infinitely flexible, making it a standardless standard. One need not have attended law school and studied the concept of proximate causation to understand that “but for” arguments can launch absurd chains of causation that are purposeless other than for metaphysical ruminations. Without some directness requirement, one can spin a “reasonable” theory of “but for” causation that borders on the absurd. If someone intentionally breaks the speed limit to get to a Seven-Eleven before the deadline for buying a lottery ticket, and buys a ticket that wins a $500 million prize, is the $500 million an “ill-gotten gain,” making disgorgement of the $500 million for speeding an appropriate remedy? Of course not (even if the violator intentionally violated the speed limit with this purpose in mind). There is no real nexus between winning the lottery — a random event — and the speeding violation, even though there plainly is “but for” causation.
For disgorgement to serve as a reasonable form of “remedial” relief in law enforcement actions, there must be a limiting theory on the concept of “ill gotten gain” beyond the non-standard of “but for” causation. Without some form of directness analysis – some way of tying the profits obtained to the substance of the violation found – the disgorgement remedy is so amorphous that it will, in many cases, swamp the formal remedies prescribed for these violations (i.e., schedules of penalties adopted by Congress), yielding equitable relief that truly shocks the conscience, as I believe it did for Judge Scheindlin.
December 25, 2014
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