Tag Archives: Scheindlin

SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry

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.

Straight Arrow

December 25, 2014

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SEC v. Wyly: Judge Scheindlin Steps Back and Allows Bankruptcy Court To Function

In a brief Order issued December 2, 2014, Judge Shira Scheindlin dialed down her assertion of power in the Wyly case by allowing the Texas bankruptcy court to perform its statutory role in the bankruptcy of Charles Wyly’s widow, Caroline Wyly.  The SEC pressed its position that it was entitled to pursue the assets of Mrs. Wyly as a “relief defendant” even though she filed for bankruptcy before being added as a defendant.  Judge Scheindlin rejected that position, and also emphasized the limits of her freeze order in relation to the functions of the bankruptcy court.  A copy of her order is available here: SEC v Wyly Ruling on Motion by Caroline Wyly.

Mrs. Wyly argued that the applicability of the automatic bankruptcy stay to her was pending before the bankruptcy court, which was the appropriate venue, and that after filing her schedule of assets with that court, “the asset freeze no longer applies to the property of her bankruptcy estate.”  Judge Scheindlin agreed, over SEC objections, stating that “The Bankruptcy Court is the appropriate venue to adjudicate this question.”  She reasoned that “the asset freeze most likely no longer applies to any of Mrs. Wyly’s property, as her schedules of assets have been filed in Bankruptcy Court” and therefore “all her property is now under the Bankruptcy Court’s supervision.”

This willingness to allow the bankruptcy court to perform its statutory function is a welcome relief from earlier decisions in which Judge Scheindlin decided some of those functions should be kept within her jurisdiction.  See our earlier post here: SEC v. Wyly: Judge Scheindlin Ignores Bankruptcy Stay and 2d Circuit To Keep Wylys in Her Charge.  The rule of law survives.

Straight Arrow

December 3, 2014

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Wyly Family Members Seek Expedited Review of Asset Freeze Order

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.

Straight Arrow

November 19, 2014

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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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