Appeals from interlocutory orders of the United States District Court for the Southern District of New York, Richard Owen, Judge, imposing constructive trusts on moneys disgorged pursuant to consent decrees entered into in actions brought by Securities and Exchange Commission for alleged insider trading in violation of federal securities laws, and forbidding payment of state and federal tax claims from the disgorged funds. See 689 F. Supp. 317 (S.D.N.Y. 1988). Affirmed in part, reversed as to prohibition on payment of certain federal tax claims, and remanded.
Oakes, Chief Judge, Kearse and Mahoney, Circuit Judges.
These appeals by (1) Dennis B. Levine and Robert M. Wilkis, defendants in civil actions commenced by plaintiff Securities and Exchange Commission ("SEC" or "Commission"), (2) the United States of America, to wit, the Internal Revenue Service ("IRS"), and the New York State Department of Taxation and Finance (the "State"), which have claims against Levine and Wilkis, and (3) Arden Way Associates, et al. ("Arden Way" or the "Arden Way claimants"), who are plaintiffs in a related action, challenge orders of the United States District Court for the Southern District of New York, Richard Owen, Judge, which, inter alia, imposed constructive trusts on the assets disgorged by Levine and Wilkis in the SEC actions and forbade payment of federal or state tax claims from the disgorged assets. See 689 F. Supp. 317 (S.D.N.Y. 1988). On appeal, Levine, Wilkis, the IRS, and the State contend principally that the district court erred in refusing to require the SEC to pay the tax liabilities of Levine and Wilkis out of the disgorged assets; Arden Way contends that the court abused its discretion by approving a proposed distribution plan that does not provide for payments to Arden Way. For the reasons below, we conclude principally that the IRS is entitled to priority to the extent of approximately $8.5 million with respect to the assets disgorged by Levine; that in most other respects, the district court properly rejected the claims of Levine, Wilkis, and Arden Way; and that further proceedings are required for determination of certain additional claims advanced by the IRS.
The present appeals arise out of SEC civil actions against Levine and Wilkis, New York investment bankers accused of engaging in insider trading, in violation of §§ 10(b) and 14(e) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §§ 78j(b), 78n(e) (1982), and SEC Rules 10b-5 and 14e-3, 17 C.F.R. §§ 240.10b-5, 240.14e-3 (1988). The sequence of the procedural events does not appear to be in dispute.
A. The Civil Suit and Liens Against Levine; The Consent Judgment
On May 12, 1986, the SEC commenced its action against Levine and two of his companies (collectively referred to as "Levine"), and one Bernhard Meier for alleged violations of the above securities laws. The complaint charged that from May 1980 through May 12, 1986, Levine had purchased common stock of, or options for common stock of, 54 companies that were targets of potential tender offers or candidates for actual or contemplated mergers or other business combinations. It alleged that Levine had traded on the basis of material nonpublic information that he knew or should have known had been obtained through misappropriation or breach of fiduciary duty, and that he had thereby defrauded other investors. The complaint alleged that Levine had gained some $11 million in profits, and the SEC sought, inter alia, disgorgement by Levine and his companies of funds received as a result of his unlawful conduct.
On May 12, the day its complaint was filed, the Commission obtained a temporary restraining order prohibiting Levine from disposing of any of his assets. On May 29, the district court issued a preliminary injunction extending this temporary freeze order.
In the meantime, the IRS had been investigating Levine's federal income tax liabilities for the years prior to 1986. On May 23, 1986, it issued an assessment for 1983-1985 totaling some $11 million, including deficiencies, interest and penalties, and obtained a lien for some $8.5 million. In November 1987, the IRS issued an assessment against Levine totaling approximately $1.2 million for the years 1980-1982, obtaining an additional lien. By December 31, 1987, Levine's outstanding assessed federal tax liability for the years 1980-1985, including interest, totaled approximately $12.2 million. In December 1987, the State issued an assessment against Levine for approximately $3.8 million of state and New York City (hereafter included in State) income tax liability. All of these amounts were based on Levine's profits in the allegedly unlawful stock transactions during the years 1980-1985, profits he had not reported on his income tax returns.
On June 4, 1986, Levine executed a Consent and Undertaking ("Consent") in which, without admitting or denying any of the allegations in the complaint, he consented to the entry of a "Final Judgment of Permanent Injunction and Other Equitable Relief" ("Proposed Judgment"), as annexed to the Consent. In the Consent, which was "Approved As To Form" by the SEC, Levine agreed to the entry of a permanent injunction prohibiting him from, inter alia, buying or selling securities while he was in possession of material nonpublic information, in violation of the securities laws. Levine also agreed to cooperate fully with the Commission in any other investigation conducted by or on behalf of that body. Most importantly for purposes of the present appeal, in para. 8 of the Consent, Levine agreed to "disgorge assets of a value of approximately $11.5 million dollars [sic] to [a receiver] to be available for satisfaction of any and all claims against the defendants arising out of the purchase and sale of securities by [Levine and his companies] as alleged in the COMPLAINT or by the defendants through Bank Leu International, Ltd. [sometimes referred to as "BLI"], pursuant to a Court approved plan to be proposed by the COMMISSION." The Consent provided that the Consent and the final judgment were to be incorporated in each other.
The Proposed Judgment noted that Levine had consented to the entry of the judgment "without admitting or denying the allegations of the COMPLAINT [and] without . . . adjudication of any issue of fact or law." It provided for the appointment of a receiver to control the disgorged assets and to "distribute the assets to claimants with claims arising out of the purchase and sale of securities by Defendants as alleged in the COMPLAINT or by the Defendants through BLI, as ordered by this Court." It provided that none of the assets in the receivership estate would in any event be returned to Levine or his wife Laurie.
Under the Consent, Levine and his wife retained, inter alia, a cooperative apartment on Park Avenue, a 1983 automobile, an Individual Retirement Account, and the monies on deposit in two bank accounts. The Consent provided that Levine and his companies
will forever disclaim all right, title and interest in [the assets transferred to the receiver] except: (1) the Defendants and Laurie Levine retain the right to be heard as to the disposition of the assets held by the receiver pursuant to the FINAL JUDGMENT and (2) to the extent that any distribution of assets held by the receiver may have the effect of satisfying any claims against the defendants or Laurie Levine arising out of the purchase or sale of securities as alleged in the COMPLAINT or through BLI.
Levine acknowledged that "no promises or threats have been made by Plaintiff COMMISSION or any member, officer, agent, employee or representative thereof to induce him to enter this CONSENT except as provided herein." Consent para. 4.
On June 5, 1986, the court signed the Proposed Judgment, and it was entered as the judgment of the court ("Judgment"). The Judgment ordered Levine to comply with the terms of the Consent and to disgorge the sum described in the Consent.
On June 5, the SEC sent a letter to Levine's counsel ("SEC side letter") stating that, with respect to para. 8 of the Consent, the SEC interpreted the references to "claims arising out of the purchase and sale of securities" as including federal and state tax claims. The letter stated, in pertinent part, as follows:
[Please] be advised that the Commission interprets the phrase "claims arising out of the purchase and sale of securities by [Levine] as alleged in the COMPLAINT or by the Defendants through Bank Leu International Ltd." to include: (1) claims for taxes due, penalties or interest thereon asserted by the Internal Revenue Service or New York State or New York City revenue authorities, based upon the securities transactions alleged in the Commission's Complaint or conducted by [Levine] through accounts at Bank Leu International Ltd., (2) any other claims, fines or penalties which may be asserted based upon the securities transactions alleged in the Commission's Complaint or conducted by [Levine] through accounts at Bank Leu International Ltd. Further, the Commission will assert all claims for disgorgement or penalties which are based upon the securities transactions conducted by the Defendants through accounts at Bank Leu International Ltd. solely against the sums to be disgorged to the receiver.
On June 19, 1986, Levine turned over approximately $10.6 million worth of assets to a receiver and transferred the remainder of the $11.5 million within a short period thereafter.
B. The Criminal Proceedings Against Levine
On June 5, 1986, the government filed a four-count information against Levine, Levine having waived indictment. Count one charged him with having used material nonpublic information to defraud his employer in connection with the purchase and sale of the stock of Jewel Companies, Inc. ("Jewel"), in violation of the federal securities laws. The remaining counts charged him with perjury and income tax evasion.
On June 11, 1986, Levine pleaded guilty to all four counts. In February 1987, he was sentenced to concurrent two-year prison terms on each count and to fines totaling $362,000.
C. The Proceedings Against Wilkis
The proceedings by the SEC, the IRS, and the State against Wilkis were roughly similar to those against Levine. In late June 1986, Wilkis signed a Consent and Undertaking ("Wilkis Consent"), pursuant to which he was to "disgorge all assets in which he . . . [had] a beneficial interest, except for [certain enumerated assets]. . . . Wilkis [estimated] the disgorged assets to be of a value of approximately $3.3 million dollars [sic]." Wilkis retained, inter alia, an Upper West Side cooperative apartment, a 1983 automobile, five Individual Retirement Accounts, a money market account, and the sum of $60,000. The proposed judgment incorporated in the Wilkis Consent paralleled the final judgment entered against Levine. By letter dated June 29, 1986, the Commission sent Wilkis a side letter similar to the June 5 letter it had sent Levine, construing the phrase "claims against the Defendant arising out of the purchase and sale of securities . . .," to include claims for taxes due and penalties or interest thereon.
On July 1, 1986, the Commission filed its complaint against Wilkis, together with the Wilkis Consent and proposed judgment. The complaint alleged that since 1978, Wilkis had, inter alia, misappropriated and used material nonpublic information in order to trade in the stock of more than 52 issuers and had disclosed such information to Levine. On July 2, the district court adopted the proposed judgment and entered a Final Judgment of Permanent Injunction and Other Equitable Relief ("Wilkis Judgment").
On July 3, 1986, Wilkis turned over approximately $2.2 million worth of assets to a receiver, and an additional $1 million shortly thereafter.
On December 22, 1986, the government filed a four-count information against Wilkis, Wilkis having waived indictment. Count one charged him with having misappropriated material nonpublic information and having used it to defraud his employer in connection with the purchase and sale of the stock of Textron Inc. ("Textron"), in violation of the federal securities laws. This count also charged that Wilkis passed the information to Levine, who used it to trade in Textron stock. The remaining counts charged Wilkis with mail fraud, income tax evasion, and failure to report certain money transactions.
On December 24, 1986, Wilkis pleaded guilty to all four counts of the information. He was sentenced to various prison terms and probation.
Beginning in April 1987, the IRS obtained liens against Wilkis for federal tax liability for the years 1980-1986 totaling some $2.8 million, including deficiencies, interest, and penalties. In October 1987, the State issued an assessment against Wilkis for state and New York City (hereafter included in State) tax liabilities in the total amount of $595,000.
D. The SEC's First Proposed Plans and the Objections to Them
In November 1987, pursuant to the consents and the judgments, the SEC submitted to the district court its proposed plans for the distribution of the disgorged assets. Under these plans, each defendant's receivership fund was to be divided into two categories, to be distributed to different groups of claimants.
With respect to the assets disgorged by Levine, approximately 42% of the fund, or $4.87 million (the "Tax Fund"), was to be distributed between the taxing authorities, i.e., the IRS and the State, in proportion to their tax claims against Levine. Approximately 58% of the Levine fund, or $6.63 million (the "Investor Fund"), was to be distributed to the so-called "Eligible Investor Claimants," defined principally as persons who sold stock in the 54 companies on the days that Levine made his alleged purchases or who suffered losses on call options they sold on the stock of those companies contemporaneously with Levine's purchases of such options.
The plan proposed for distribution of the assets disgorged by Wilkis was similar. The principal difference was that the Commission designated approximately 49% of the fund for the authorities that had asserted tax claims against Wilkis, and 51% for investor claimants.
Both plans were opposed in some aspect by virtually every interested person, including Levine, Wilkis, the IRS, the State, Arden Way, and class action plaintiffs in other lawsuits. Levine and Wilkis, relying principally on the SEC side letters, asserted that the SEC had promised to devise plans paying all of the federal and state tax claims before paying any fraud claims of private parties. Levine also contended that his criminal fines and penalties were to be satisfied out of the disgorged assets.
The IRS and the State objected to each proposed plan on the ground that they enjoyed statutory preferences requiring them to be paid before other creditors. The IRS invoked principally 26 U.S.C. §§ 6321 and 6322 (1982), under which federal tax liens are given priority in the distribution of receivership assets.
The Arden Way claimants, who were limited partners in an entity affiliated with Ivan F. Boesky whom they had sued with Levine, alleging that Levine had aided and abetted Boesky in a fraudulent scheme, also objected to the SEC's proposed plan. The plan did not include Arden Way among the investors to whom distributions were to be made, and they objected on the ground that Levine would be insolvent as a result of his disgorgement and thus unable to satisfy their claims against him.
The representatives of a plaintiff class of allegedly defrauded investors to whom the Investor Fund would be distributed supported the plans in large part. These investors, who had brought suits against Levine, Wilkis, and Boesky, took issue with the proposed method of calculation of a given ...