Source: https://securitiesdiary.com/2015/03/06/final-disgorgement-order-in-sec-v-wyly-is-far-from-final-because-of-unnecessary-pre-judgment-of-pending-tax-issues/
Timestamp: 2019-04-21 08:05:19+00:00

Document:
On February 26, 2015, Judge Shira Scheindlin issued a final disgorgement order in SEC v. Wyly, implementing her previous opinions in September and December 2014. We previously discussed those opinions here (Wyly Brothers Hit with More than $300 Million Securities Law Disgorgement Order for Unpaid Taxes) and here (SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry). The newest opinion can be read here: Final Disgorgement Opinion and Order in SEC v. Wyly, and the final judgment in the case can be found here: Final Judgment in SEC v. Wyly.
The new decision does not depart from the earlier opinions, it merely resolves disputes about how to implement them. As a result, the parties are left with a set of varying rulings contingent on what may happen (1) on appeal, and (2) in an ongoing Internal Revenue Service audit.
In September, the judge decided that the SEC was entitled to a “disgorgement” remedy that included payment of federal taxes that she found were avoided in the Wylys’ offshore trust transactions. Even though the transactions themselves violated no securities laws, and the Wylys’ tax returns violated no securities laws, she decided that because the Wylys’ nondisclosure of beneficial ownership in those trusts under section 13(d) of the Securities Act of 1934 may have caused the IRS to miscalculate taxes that were due, the taxes avoided were “causally related” to the securities violations.
In December, the judge considered SEC contentions on securities profits gained because of the nondisclosure, which was based on expert analysis founded on no generally accepted underlying theory or economic literature, but she nevertheless was inclined to accept that analysis as sufficient to satisfy the Second Circuit’s low threshold for ordering a disgorgement. But she decided that a disgorgement ordered on that basis would yield an inequitable result, and declined to issue that order. Obviously not keen on getting the case back on remand, she said that in the event the Second Circuit disagreed that she had the discretion to act as she did, she was ruling in favor of the SEC on the theory it presented. See SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry.
In the February 2015 opinion, Judge Scheindlin addresses specific proposed orders to implement the earlier decisions. The end result is a “final judgment” that is far from “final” – it includes multiple possibilities depending on what the court of appeals decides, and what taxes the Wylys may yet be required to pay to the IRS. You need a flow chart to get it all straight. But the contingent order-writing to take account of future tax determinations was unnecessary — and, in my view, wholly inappropriate – in a disgorgement order for securities law violations. That is because whatever happens in the future as to taxes owed, those determinations should fully and adequately assure that the Wylys retain no “ill gotten gains” in the form of taxes unlawfully avoided.
Judge Scheindlin’s stubborn insistence on making the tax issues part and parcel of the securities relief accomplishes nothing other than creating potential future headaches and possible injustices. As we previously wrote, what is the purpose of pre-judging the tax issues in the context of a securities enforcement action, knowing that the IRS is addressing them? The IRS is not obligated to, and may not, accept her ruling. Indeed, Judge Scheindlin acknowledges that the IRS is not bound by her view about how the disgorgement should be treated by tax authorities (“the IRS may take notice of this Court’s conclusion that there should be an offset for amounts paid to the SEC, even though the IRS is not a party here. Should the IRS disregard that language, the Wylys may return to this Court and move to vacate the final judgment….” Slip op. at 6-7.). That’s a future time bomb.
The prospect of disagreement goes both ways: she is not prepared to defer to a possible IRS decision that her analysis was wrong and taxes were not unlawfully avoided. She only allows the Wylys to “pursue all available remedies should another court determine that the IOM Trusts are tax-exempt.” Id. at 7 (emphasis added). In other words, if a tax court rules the taxes were not owed, the Wylys may (or may not) get their money back by seeking relief from Judge Scheindlin’s judgment, but they are not permitted to ask for that relief if the IRS decides no taxes were owed, and the issue never gets to court. The latter result seems blatantly unfair. It is inconsistent with the concept of “disgorgement” because it mandates that they “return” proceeds that were not unlawfully obtained. It could also be an improper judicial refusal to defer to an agency judgment in its own area of expertise. All of this nonsense could be avoided if the court did not take up live tax disputes as part of a securities enforcement proceeding.
[W]hichever way the tax process goes, it is wrong for the judge to jump the gun and order a tax-based disgorgement before the IRS acts. If the IRS agrees with the judge, the tax will be paid, and no disgorgement is appropriate because there will be no undue tax benefits remaining. If the IRS or a tax court disagree with the judge, no tax will have been unlawfully avoided, and there is no benefit to disgorge. Either way, Judge Scheindlin should limit a disgorgement order to unlawful proceeds derived from the securities violations found, not supposed tax avoidance based on underlying transactions that did not themselves violate the law (only the nondisclosure of stock ownership violated the law).
As we discussed earlier this week (see Let’s Get Real: When SEC “Disgorgement” Remedy Is Used as Punishment It Should Be Treated that Way), the legal standards governing the disgorgement remedy badly need serious thought and judicial leadership. The SEC will try to “shoot the moon” in almost every case, and courts need to exercise reasoned discretion over how far they are prepared to go with this “equitable remedy” which more and more often is used to try to get defendants to pay far more than a realistic and well-conceived return of their own “ill-gotten gains.” That is all that “disgorgement” should be. To her credit, Judge Scheindlin resisted the SEC’s “shoot the moon” efforts a couple of times in the Wyly case. But she lost her bearings on the tax-based disgorgement theory, leaving more than a little bit of a mess in the end.
This entry was posted in Disgorgement Issues, SEC Enforcement, Securities Law and tagged Charles Wyly, disgorgement, disgorgement of tax benefits, disgorgement order, Enforcement Division, Internal Revenue Service, IRS, Judge Scheindlin, Judge Shira Scheindlin, lawyer, legal analysis, offshore trusts, Sam Wyly, SDNY, SEC, SEC enforcement, SEC v. Wyly, Second Circuit, section 13(d), securities, Securities Exchange Act of 1934, securities fraud, securities law, securities litigation, Shira Scheindlin, Wyly, Wyly brothers, Wyly family on March 6, 2015 by Straight Arrow.

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