56 F. Supp. 3d 394
S.D.N.Y.2014Background
- The SEC sued Samuel and Charles Wyly for a long-running scheme (1992–2005) in which the Wylys established Isle of Man (IOM) trusts and affiliated companies, used those offshore vehicles to exercise options and sell shares of four public issuers on whose boards they sat, and failed to disclose beneficial ownership and required filings. A jury found both Wylys liable on nine claims including securities fraud, disclosure violations, aiding-and-abetting, and sales of unregistered securities.
- The court bifurcated liability and remedies; after the jury verdict the bench remedies trial addressed disgorgement, prejudgment interest, civil penalties, and injunctive relief (except for an alternative trading-profits disgorgement theory left for limited further proceedings).
- The SEC sought disgorgement of $619M+ (comprised largely of unpaid U.S. tax on offshore trading profits plus prejudgment interest, and profits on unregistered Michaels Stores sales). The SEC’s primary disgorgement measure approximated the income taxes the Wylys avoided by concealing beneficial ownership.
- Key factual findings: IOM trustees followed Wyly recommendations without meaningful independent decision-making; purported foreign settlors of certain trusts (the “Bessie Trusts”) did not make gratuitous transfers; the Wylys directed or bypassed trustees on trades; issuers did not issue Forms 1099/W‑2 because of Wyly misrepresentations and outside tax opinions.
- The court concluded the IOM trusts were grantor trusts (section 674 analysis and substance-over-form), so trading profits were taxable to the Wylys; disgorgement measured by the taxes avoided on issuer-related profits was an appropriate equitable approximation of unjust enrichment. The court awarded disgorgement to Sam Wyly of $123,836,958.76 and to Charles Wyly of $63,881,743.97 plus prejudgment interest (with final interest recalculation directed).
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Appropriate disgorgement measure for offshore trading profits | SEC: disgorge amount equivalent to federal taxes the Wylys avoided by concealing beneficial ownership (reasonable approximation of unjust enrichment) | Wylys: tax assessment is exclusive IRS function; disgorgement measured by unpaid taxes unlawfully converts court into tax collector and is novel/duplicative | Court: disgorgement measured by taxes avoided is a permissible equitable approximation of unjust enrichment here; not a tax collection; disgorgement awarded based on unpaid taxes tied to issuer trades |
| Were the IOM trusts grantor trusts (so trading income taxable to Wylys)? | SEC: substance-over-form; trustees were not independent; protectors and trustees followed Wylys; purported settlors did not genuinely contribute -> grantor trust under §674 | Wylys: trusts fall within §674(c) independent‑trustee exception; some foreign settlors made gratuitous transfers; formal trust documents control | Court: trusts were grantor trusts (both Bulldog and Bessie groups); protectors/trustees were subject to Wyly control; alleged settlors’ transfers were sham/non‑gratuitous; §674(c) exception does not apply |
| Disgorgement for sale of unregistered Michaels shares (Section 5) — measure | SEC: disgorge all profits from illegal sales of unregistered stock (typical section 5 remedy) | Wylys: these were registry‑identical, well‑known securities; awarding all profits is inequitable; economic benefit limited to value of nondisclosure | Court: full profits are maximum but inequitable here; ordered disgorgement equal to a reasonable marketability discount (25% of profits) as fair measure |
| Civil penalty and injunction | SEC: seek tier‑two penalties and permanent injunction against Sam Wyly | Wylys: penalties/injunction unnecessary or excessive given age/health and already severe remedies | Court: declined to impose additional civil penalty (disgorgement + interest sufficiently deterrent); entered permanent injunction against Sam Wyly based on scheme’s scope and risk of recurrence |
Key Cases Cited
- SEC v. Contorinis, 743 F.3d 296 (2d Cir. 2014) (disgorgement is remedial, not a penalty, and district court has broad discretion)
- SEC v. DiBella, 587 F.3d 553 (2d Cir. 2009) (but‑for causal standard for disgorgement; unjust enrichment need only be causally connected to violation)
- SEC v. Razmilovic, 738 F.3d 14 (2d Cir. 2013) (district court may approximate disgorgement and need not trace specific funds; disgorgement limited to gains causally tied to fraud)
- SEC v. Cavanagh, 445 F.3d 105 (2d Cir. 2006) (SEC enforcement actions differ from private torts; SEC need not prove reliance or proximate cause)
- United States v. Helmsley, 941 F.2d 71 (2d Cir. 1991) (restitution in tax evasion treated as payment of unpaid taxes — discussed and distinguished)
- Gabelli v. SEC, 568 U.S. 442 (2013) (limits on SEC delay; noted in discussion of prejudgment interest and SEC’s investigative role)
- Ralston Purina Co. v. Central Mutual Insurance Co., 346 U.S. 119 (1953) (stated purpose of registration requirement: investor protection via full disclosure)