Wyly Brothers Seek Bankruptcy Relief from Disgorgement Order from Offshore Shenanigans (9/18/15)

Keith Fogg, here, a professor at Villanova Law School, has this great posting on the Wyly brothers, one of whom is now deceased.  Issue Preclusion in Bankruptcy Case Where SEC Securities Enforcement Action Aids the IRS in Establishing a $2 Billion Claim (Procedurally Taxing Blog 9/18/15), here. I previously posted (blog postings listed below) about the SEC's novel theory on disgorgement to include the tax loss in the securities litigation.  The Wyly brothers now seek to contest the actual tax liability in bankruptcy and, presumably, thereby obtain relief from the restitution order.  I do recommend Keith's entire discussion but do "cut and paste" certain excerpts below.

The tax merits of the Wyly’s liability ends up being litigating in bankruptcy court because B.C. 505(a) permits debtors to litigate the merits of their tax liability while in bankruptcy if the merits have not been previously litigated. Even though the Wyly brothers did not previously litigate the merits of their tax liability, they did litigate about many of the underlying issues during the disgorgement phase of the SEC litigation. The findings of the court in the SEC litigation and how those findings impact the actual tax merits litigation becomes the focus of the tax merits case heard before the bankruptcy court. The SEC suit had two phases, the violation phase and the disgorgement phase. The bankruptcy court here notes that the opinion issued in the disgorgement phase “carefully sets forth the details of the creation and direction the Offshore Trusts based on the jury verdict (the violation phase), the undisputed facts, and the District Court’s own factual findings.” 

Between 1992 and 1996 Sam and Charles Wyly caused the establishment of offshore trusts and various subsidiary entities. Some of the trusts were settled for the benefit of their families and some charitable organizations (the Bulldog trusts) and some were nominally settled by a foreign citizen (the Bessie trusts). Between 1992 and 1999, Sam and Charles transferred securities to these trusts. “These securities were in the form of options and warrants in public companies for which Sam and Charles served as directors during part or all of the relevant time period.” The trusts and subsidiary companies exercised options and warrants and engaged in other activities regarding the securities between 1995 and 2005. The bankruptcy court, following on the district court opinion, found that the trusts could have lawfully deferred taxation on the income related to the securities if Sam and Charles had given up beneficial ownership of the securities. During this period Sam and Charles never disclosed beneficial ownership of the securities in the offshore trusts to the SEC making their actions toward the IRS and the SEC consistent. 

The jury found that, in fact, Sam and Charles controlled the securities throughout this period and beneficially owned the securities. Consequently, the jury found them liable on nine counts of securities fraud. “Disgorgement serves to remedy securities law violations by depriving violators of the fruits of the illegal conduct.” In the disgorgement phase the district court found that Sam and Charles maintained a consistent position with respect to the IRS and the SEC regarding the securities for the purpose of avoiding taxation and that the appropriate measure of damages should look to the income tax not paid as a result of the securities fraud. Because of the link between the securities case and the issues presented in the 505(a) litigation over the amount of the tax liability related to the offshore trusts, the government sought issue preclusion (collateral estoppel) on 64 issues decided during the securities litigation. Because the debtors did not point to any distinctions among the 64 issues, the bankruptcy court treated them as a unit.

Keith Then discusses the issue preclusion issue.

My previous blogs on the disgorgement proceedings are:

• Wylys Ordered to Disgorge Hundreds of Millions of Tax Benefits With Interest (Federal Tax Crimes Blog 9/27/14), here.
• Wyly Brothers' Use and Tax Abuse of Offshore Banks and Entities (Federal Tax Crimes Blog 8/5/14), here.
• SEC Suit for Disgorgement of Federal Income Tax Related to Securities Fraud (Federal Tax Crimes Blog 6/16/13), here.