Gregory Nelson Miller, Esq., Alan M. Lieberman, Esq., John David Worland, Jr., Esq., Martin Louis Zerwitz, Esq., United States Securities and Exchange Commission, 100 F Street, N.E., Washington, DC 20549, (202) 551-4469, for the SEC.
William Andrew Brewer, III, Esq., Michael J. Collins, Esq., James S. Renard, Esq., Michael L. Smith, Esq., Bickel & Brewer, 767 Fifth Avenue, 50th Floor New York, NY 10153, (212) 489-1400, for Samuel E. Wyly.
Stephen D. Susman, Esq., Mark H. Hatch-Miller, Esq., Susman Godfrey, LLP, 560 Lexington Avenue, 15th Floor, New York, NY 10022, (212) 336-8330, Terrell W. Oxford, Esq., David D. Shank, Esq., Susman Godfrey, LLP, 901 Main Street, Suite 5100, Dallas, TX 75202, (214) 754-1900, for Donald R. Miller, Jr.
Martin Joel Auerbach, Esq., Law Offices of Martin J. Auerbach, 1185 Avenue of the Americas, 31st Floor, New York, New York 10105, (212) 704-4347, Laura Elizabeth Neish, Esq., Zuckerman Spaeder, LLP, 1185 Avenue of the Americas, 31st Floor, New York, New York 10105, (212) 704-9600, for Louis J. Schaufele, III.
Joshua Klein, Esq., Nelson A. Boxer, Esq., Petrillo Klein & Boxer LLP, 655 Third Avenue, 22nd Floor, New York, NY 10017, (212) 370-0330, for Michael C. French.
OPINION AND ORDER
SHIRA A. SCHEINDLIN, District Judge.
In an Opinion and Order dated June 6, 2013 ("June 6 Opinion"), I held, among other things, that the Securities and Exchange Commission's ("SEC") penalty claims against defendants in this case were time barred insofar as they accrued more than five years before tolling agreements with the SEC took effect. Therefore, for those claims against the Wylys that accrued prior to February 1, 2001, the only monetary relief available is disgorgement. For the Wylys' alleged failure to disclose their beneficial ownership of certain securities in SEC filings, the SEC contends that the measure of disgorgement is the amount of federal income taxes that the Wylys allegedly avoided by transferring stock options to the Offshore Corporations and failing to disclose their control over the options. The sole issue addressed in this Opinion is whether the SEC has the authority to seek disgorgement measured as the amount of federal income taxes it claims the Wylys would have been required to pay if they had disclosed their beneficial ownership of the securities in question, or whether such relief impermissibly impinges upon the Secretary of the Treasury's ("Secretary") exclusive authority to assess and collect taxes.
A detailed factual background of the case is set forth in the March 31, 2011 Motion to Dismiss Opinion and the June 6 Opinion. Only the background relevant to disgorgement is discussed here. The factual predicate for the disgorgement of unpaid taxes is that "[t]he Wylys set up their overseas trusts to create the appearance of non-grantor' trusts, which would make them separate taxable entities and provide favorable tax treatment of capital gains on transactions involving the trust-held securities... [when, in fact, ] the trusts were grantor trusts because the Wylys exercised dominion and control over them." As non-grantor trusts, the tax rates on the trusts' capital gains would be "Isle of Man rates, which are essentially zero[, ]" whereas as grantor trusts, they would be taxed at the rate of the beneficial owner, making capital gains from the sale of overseas shares income to the Wylys and taxable at the applicable U.S. capital gains rate. "By misrepresenting the beneficial ownership of the trusts, and by misrepresenting the dominion and control over the trust assets, the Wylys created an unjust tax benefit for themselves."
A Wyly family employee, Keeley Hennington, recognized the relationship between the non-disclosure of beneficial ownership of securities and the Wylys' tax avoidance measures. When, as a part of a proxy battle, Samuel Wyly desired to disclose his ownership of the stock held through the Wyly family's Offshore System, Hennington warned in a February 26, 2002 memorandum:
[T]here needs to be an answer [for the increase in shares from what was previously publicly represented] that does not jeopardize the offshore system... Our friendly IRS agent is still looming around and although he has verbally agreed not to look further at any foreign entities or trusts, I would not want to give him any fresh ammunition.
In August 2003, the Wylys approached the IRS about a potential settlement of issues regarding tax treatment of the Offshore Trusts. A memorandum sent to the IRS by Wyly family employees in advance of the August 12 meeting stated, in relevant part, that "1992 Trusts were formed under foreign law by Individual and were intended to be foreign non-grantor trusts" and the "1994 and 1995 Trusts were formed under foreign law and were intended to be treated as foreign grantor trusts." As to tax treatment, "based upon the position that the 1992 Trusts were not grantor trusts where Individual was the grantor and the 1994 and 1995 Trusts were foreign grantor trusts, no U.S. person included in income any amount... with respect to the 1992, 1994 and 1995 Trusts."
One IRS official, Ronald Pinsky, expressed concern at the meeting with the Wylys' "reporting [to the SEC] of the initial transactions." Meeting minutes reflect that Pinsky asked "[h]ave you checked SEC filings, " "[w]ere [the Wylys] significant enough shareholders that their holdings would be listed ...