The suit was brought by the SEC (rather than by or on behalf of the IRS) under securities statutes authorizing disgorgement. I post first a very brief summary of the Conclusions and then a cut and paste of the Conclusions.
JAT SUMMARY OF KEY POINTS:
1. Ordering disgorgement does not violate the IRC's command that the Secretary assess and collect tax.
2. This action for disgorgement, although measured by unpaid tax, is not an action to collect the tax; it is an action for disgorgement, "a discretionary and equitable remedy aimed at preventing unjust enrichment."
3. The disgorgement equitably should be applied against any tax liabilities the IRS asserts. Here a key quotes:
While it would be equitable to credit the amount disgorged in this SEC enforcement action towards any tax liability assessed in the future arising out of the same conduct, treating such amount as an offset does not transform the disgorged amount into a tax.
* * * *
As I mentioned earlier, any amounts disgorged in this case should be credited towards any subsequent tax liability determined in an IRS civil proceeding as a matter of equity. n2054. The tax issues are not too difficult to resolve in a disgorgement case.
n205 In the event there is a judicial determination that contravenes the legal conclusions of this Opinion and Order — that is, if another court determines that the IOM Trusts are in fact, tax-exempt non-grantor trusts, defendants may pursue all available remedies in this Court, including a motion to vacate the final judgment under Rule 60(b) of the Federal Rules of Civil Procedure. But no such motion will be considered if the IRS, in exercising its discretion, chooses not to proceed with an administrative or civil action against the Wylys."
5. The Court then determines the tax issues. They are far too difficult to summarize here, but the details are included in the lengthy quote below. But essentially the offshore structures were treated as grantor trusts with the tax consequences being visited contemporaneously on the Wylys.
6. One issue was the role of the so-called independent offshore "trust protectors" which is a device frequently used to claim U.S. persons are not in control. (I encountered this gambit hawked by other lawyers when I first came to Houston in 1977; it was hokey and certainly illegal then also.) The Court said: "The Wylys, through the trust protectors who were all loyal Wyly agents, retained the ability to terminate and replace trustees. The Wylys expected that the trustees would execute their every order, and that is exactly what the trustees did."
7. There was a causal connection between the securities misbehavior and the tax avoided. In developing the analysis, the Court starts with:
The Wylys engaged in a thirteen year fraud, creating seventeen trusts and forty subsidiary companies, employing numerous IOM trustees, a veritable "army of lawyers," hiring an offshore accountant to hold records outside the United States, and delegating several domestic employees to handle the administration of the trusts. Reasonable and savvy businessmen do not engage in such activity unless it is profitable. Of course it was profitable — by transferring property, including valuable options and warrants, to the trusts, exercising the options and trading in secret, and using the proceed to reinvest in other ventures, the Wylys were able to accumulate tremendous tax-free wealth.[One may wonder whether the army of lawyers or some of them have some culpability in this misbehavior; just wondering.]
8. "There is ample evidence, however, that the driving purpose of the securities fraud was to conceal the Wylys' relationship to the IOM trusts and preserve the preferential tax treatment on secret offshore profits for as long as possible."
9. The Wylys should pay prejudgment interest because of their free use of the unlawful gains during the fraud.
10. The Wyly's "inability to pay argument is similarly futile." "Disgorgement, which includes the award of prejudgment interest, would have no deterrent value if defendants could avoid it by spending their unlawful gains before the government discovers the fraud."
11. Although awarded prejudgment interest at "the lower of the average LIBOR or IRS underpayment rate for each year."
12. Note that in at fn 217, the Court uses against the Wylys their own expert's publication. Ouch!
EXCERPTS FROM THE CONCLUSIONS: (Note that I do not indent but all of the following is a cut and paste excluding some of the footnotes.)
IV. CONCLUSIONS OF LAW
A. Disgorgement Based on Unpaid Taxes
The SEC arrives at its proposed measure of disgorgement by 1) calculating the total profits earned on the sale of the Issuer securities by the IOM trusts, and 2) approximating the amount of taxes that would have been paid on those profits had the Wylys accurately disclosed beneficial ownership of the securities. For the following reasons, I conclude that this is an appropriate measure.
1. Using Unpaid Taxes as a Measure of Disgorgement Does Not Violate Section 7401
On June 13, 2013, I held that the SEC was not foreclosed, as a matter of law, from seeking disgorgement in an amount equivalent to the federal income taxes the Wylys would have been required to pay if they properly disclosed beneficial ownership over the Issuer securities. "There is no explicit prohibition, either in the Tax Code or in the Exchange Act, on using tax benefits as a measure of unjust enrichment in other contexts" and no "express limitation on the SEC's authority to calculate and disgorge any "reasonable approximation of profits causally connected to the violation." n189 Defendants urge that I revisit this ruling and determine that ordering disgorgement measured by unpaid taxes is not permitted by the Tax Code.
n189 SEC v. Wyly, No. 10 Civ. 5760, 2013 WL 2951960, at *1 (S.D.N.Y. June 13, 2013) (quotations omitted).
Congress has granted exclusive authority to the Secretary of the Treasury to assess and "collect the taxes imposed by the internal revenue laws," who has, in turn, delegated that authority to the IRS. n190 Section 7401 of the Tax Code states that "[n]o civil action for the collection or recovery of taxes, or of any fine, penalty or forfeiture, shall be commenced unless the Secretary authorizes or sanctions the proceedings and the Attorney General [of the United States] or his delegates directs that the action be commenced." n191
n190 26 U.S.C. § 6301.
n191 Id. § 7401.
As I previously held, "this is not a civil action for the collection or recovery of taxes . . . . Rather, this is a civil action for securities law violations, the remedy for which is measured by the amount of taxes avoided" as a result of the defendants' securities violations. n192 "[A] tax is an enforced contribution to provide for the support of the government." n193 Disgorgement is a discretionary and equitable remedy aimed at preventing unjust enrichment. Measuring unjust enrichment by approximating avoided taxes does not transform an order of disgorgement into an assessment of tax liability.
n192 Wyly, 2013 WL 2951960, at *1 (emphasis in original).
n193 United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 224 (1996) (quotation omitted).
Citing United States v. Helmsley, defendants argue that any money judgment based on a calculation of unpaid taxes is equivalent to an assessment of tax. n194 In Helmsley, the issue was whether restitution may be imposed in a criminal tax evasion case. The Second Circuit concluded that while "[i]t is true that the government may pursue a tax evader for unpaid taxes, penalties, and interest in a civil proceeding . . . any amount paid as restitution for taxes owed must be deducted from any judgment entered for unpaid taxes in such a civil proceeding. Restitution is in fact and law a payment of unpaid taxes." n195
n194 See Defendants' Response to the Statement of Interest of the United States of America ("Def. Resp. to U.S."), at 4-5 (citing United States v. Helmsley, 941 F.2d 71 (2d Cir. 1991)).
n195 Helmsley, 941 F.2d at 102.
Helmsley merely stands for the proposition that the government should credit any amount it recovered as restitution in a criminal tax case towards any subsequent tax liability assessed in a civil proceeding. But this action is not a civil or criminal tax case. While it would be equitable to credit the amount disgorged in this SEC enforcement action towards any tax liability assessed in the future arising out of the same conduct, treating such amount as an offset does not transform the disgorged amount into a tax.
Defendants contend that "no court has ever before approved the use of . . . any analogous indirect measure of unjust profits." But the Second Circuit recently held that defendants can be ordered to disgorge "direct pecuniary benefit[s]" and "illicit benefits" that happen to be "indirect." Disgorgement compels defendants to "give up the amount by which [they were] unjustly enriched." The measure of unjust enrichment for any given securities violation depends on the nature of the violations and the defendants' wrongful conduct. Thus, unlawful gains may be measured in any number of different ways. For example, courts commonly order defendants to disgorge not only the proceeds of a fraud or the profits of an unlawful trade, but also salary and bonuses earned during the period of a fraud, and amounts equivalent to losses avoided as a result of the securities violations. Disgorgement "is a remedy that gives courts flexibility" to determine the appropriate remedy "to fit the wrongful conduct."
Defendants raise two other arguments to urge this Court not to apply a tax-based measure of disgorgement. First, defendants argue that the "tax issues raised by the [d]efendants' offshore trusts are novel and complicated" and "even if section 7401 d[oes] not literally apply, the legislative concerns that [animated] section 7401 are magnified where someone other [than] the IRS seeks to litigate a highly complex tax issue." I disagree. This case, like many others litigated before this Court, involves statutory interpretation and application of common law doctrines. n203 To be certain, the grantor trust provisions are complicated, but the issues here are not so complex as to be unresolvable. Moreover, the remedies issues can be decided largely by the same evidence introduced to the jury during the liability phase. n204
n203 In its Statement of Interest, the United States represented its position that 1) calculating disgorgement by approximating avoided taxes "does not constitute a collection of tax liabilities that the Internal Revenue Code reserves solely to the Department of the Treasury;" and 2) that in awarding such disgorgement, this Court "should interpret the relevant [Internal Revenue] Code provisions and regulations concerning trust taxation, as well as the relevant common law tax doctrines. . . ." Statement of Interest of the United States of America, at 1 (emphasis added).
n204 See Wyly, 2013 WL 2951960, at *4, n.36 ("[I]f the securities fraud at issue significantly overlaps the distinction between grantor and non-grantor trusts in the Tax Code then no complex tax analysis will be required.").
Second, defendants argue that calculating disgorgement based on unpaid taxes creates the potential for duplicative recovery or conflicting orders because the Wylys are currently under an IRS audit covering some of the years of the securities fraud. As I mentioned earlier, any amounts disgorged in this case should be credited towards any subsequent tax liability determined in an IRS civil proceeding as a matter of equity. n205
n205 In the event there is a judicial determination that contravenes the legal conclusions of this Opinion and Order — that is, if another court determines that the IOM Trusts are in fact, tax-exempt non-grantor trusts, defendants may pursue all available remedies in this Court, including a motion to vacate the final judgment under Rule 60(b) of the Federal Rules of Civil Procedure. But no such motion will be considered if the IRS, in exercising its discretion, chooses not to proceed with an administrative or civil action against the Wylys.
2. Trading Profits Earned by IOM Trusts were Taxable Under Section 674
a. Bessie Trusts
Defendants must concede that if I conclude that the Wylys were the real grantors of the Bessie Trusts, then the profits earned on the sale of Issuer securities by those trusts are taxable to the Wylys, not the purported foreign grantors. n206 Because I conclude that the purported foreign grantors made no gratuitous contributions, "the trusts at issue [are] clearly grantor trusts taxable to the domestic grantors." n207
n206 See Def. Resp. to U.S. at 22 ("The fact that the purported foreign grantors made no [gratuitous] contributions is decisive in determining who the grantor is under 26 C.F.R. § 1.671-2(e)(1)."). See also 21 C.F.R. § 1.671-2(e)(1) ("[A] person who creates a trust but makes no gratuitous transfers to the trust [or] a person who funds a trust with an amount that is directly reimbursed to such person within a reasonable period of time and who makes no other transfers to the trust that constitute gratuitous transfers is not treated as an owner of any portion of the trust under sections 671 through 677 or 679.").
n207 Def. Resp. to U.S. at 21.
b. Bulldog Trusts
Section 674(a) provides that: "[t]he grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party." n208 Quoting a prominent tax treatise, defendants concede that the "power of disposition" includes "powers to 'effect such major changes in the enjoyment of a trust's income and corpus as the addition and elimination of beneficiaries' as well as 'minor and customary power[s]' over income and corpus distribution." n209 Because a non-beneficiary trustee is considered a non-adverse party under the statute, "[s]ection 674(a) captures virtually every trust, including the [IOM] trusts." n210 Thus, defendants concede that "[u]ltimate liability under [s]ection 674[] . . . turns on whether any of the statutory exceptions apply." n211
n208 26 U.S.C. § 674(a) (emphasis added).
n209 Def. Mem. at 8 (quoting Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts § 80.6.1).
n210 Id. In his treatise, defendants' expert confirms that the Wylys' had a power of disposition under this statute. See Robert T. Danforth, Norman H. Lane, and Howard M. Zaritsky, Federal Income Taxation of Estates and Trusts §9.04[1] ("A right to use trust funds without adequate compensation also affects beneficial enjoyment, because the holder can reduce the assets from which the named beneficiaries can benefit. Thus, a grantor's right to live rent-free in a house owned by the trust is a power of disposition under Section 674(a).").
n211 Def. Mem. at 9.
According to defendants, the Bulldog Trusts are not grantor trusts because they fall under the section 674(c) exemption. Under that exemption, section 674(a) does not apply to "certain powers that are exercisable by independent trustees." n212 According to the corresponding IRS regulation, which summarizes the statute,
n212 26 C.F.R. § 1.674(c)-1.
[t]he powers to which section 674(c) apply are powers (a) to distribute, apportion, or accumulate income to or for a beneficiary or beneficiaries, or to, for, or within a class of beneficiaries, or (b) to pay out corpus to or for a beneficiary or beneficiaries or to or for a class of beneficiaries (whether or not income beneficiaries). In order for such a power to fall within the exception of section 674(c) it must be exercisable solely (without the approval or consent of any other person) by a trustee or trustees none of whom is the grantor and no more than half of whom are related or subordinate parties who are subservient to the wishes of the grantor. n213To determine whether the Bulldog Trusts are covered by this exception, it is necessary to answer three questions: 1) Did the IOM trustees have the power to "distribute, apportion, or accumulate income" or "pay out corpus" to or for a beneficiary or beneficiaries?; 2) Were the IOM trustees a) the grantor, or b) a "related or subordinate" party as defined by the statute?; and 3) Were the trustees able to "exercis[e] [those powers] solely (without the approval or consent of any other person)"?
n213 Id.
The first two questions are straightforward. First, the IOM trustees certainly had the power, as set out in the trust deeds, to "distribute, apportion, or accumulate income" or "pay out corpus" to or for a beneficiary. Second, the IOM trustees were neither the grantor, nor one of the individuals on the exclusive list of "related or subordinate" parties defined by the statute. n214 The only remaining question is whether the IOM trustees were able to exercise those powers "solely" or "without the approval or consent of any other person."
n214 See 26 U.S.C. § 672(c) (defining "related or subordinate party" as "the grantor's spouse, if living with grantor," or "the grantor's father, mother, issue, brother or sister; an employee of the grantor; a corporation or any employee of a corporation in which the stock holdings of the grantor and the trust are significant from the viewpoint of voting control; [or] a subordinate employee of a corporation in which the grantor is an executive").
Defendants argue, citing a 1976 Tax Court case, that a grantor may only be taxed on "a power reserved by instrument or contract creating an ascertainable and legally enforceable right, not merely the persuasive control which he might exercise over an independent trustee who is receptive to his wishes." n215 As such, defendants contend that the Wylys did not share in the power to distribute, apportion, or allocate income, or to pay out corpus, because the trust deeds allocated those powers solely to the IOM trustees. Thus, the Bulldog Trusts fall within the shelter of 674(c)'s "independent trustees exception."
n215 Estate of Goodwyn v. C.I.R., T.C.M. 1976-238, 1976 WL 3423 (July 29, 1976).
I disagree. "Such a rigid construction is unwarranted. It cannot be squared with the black-letter principle that 'tax law deals in economic realities, not legal abstractions.'" n216 As Professor Robert Danforth, the defendants' own expert, writes in his treatise, "[i]t would certainly violate the purpose of the independent trustee rule to require an independent trustee to act with the consent of the grantor or a related or subordinate person." n217 The Wylys, through the trust protectors who were all loyal Wyly agents, retained the ability to terminate and replace trustees. The Wylys expected that the trustees would execute their every order, and that is exactly what the trustees did.
n216 PPL Corp. v. C.I.R., 133 S.Ct. 1897, 1905 (2013) (quoting CIR v. Southwest Exploration Co., 350 U.S. 308, 315 (1956)).
n217 Danforth, et al., Federal Income Taxation of Estates and Trusts § 9.04[3][a].
The evidence amply shows that the IOM trustees followed every Wyly recommendation, whether it pertained to transactions in the Issuer securities, making unsecured loans to Wyly enterprises, or purchases of real estate, artwork, collectibles, and other personal items for the Wylys and their children. The trustees made no meaningful decisions about the trust income or corpus other than at the behest of the Wylys. On certain occasions, such as the establishment of the Bessie Trusts, the IOM trustees actively participated in fraudulent activity along with the Wylys. The Wylys freely directed the distribution of trust assets for personal purchases and personal use. Because the Wylys and their family members were beneficiaries, the IOM trustees were thus "distributing" income for a beneficiary at the direction of the grantors — the Wylys. n218
n218 Because I conclude that both the Bulldog and Bessie Trusts were grantor trusts under Section 674, I need not reach the issue of whether they were also grantor trusts under Section 679. Although the SEC contends that the trading profits on sales of Issuer securities should be taxed at the ordinary income rate, I decline to do so. Rather, I will approximate unpaid taxes by applying the rate the Wylys would have had to pay if they owned the shares personally, which requires applying the ordinary income or capital gains rate for the taxable year. Thus, the "reasonable approximation" of disgorgement is $111,988,622.76 for Sam Wyly and $58,896,281.97 for Charles Wyly when using the lower capital gains rate. See JX 9904A and JX 9904B ("Calculations Using the Ordinary and Capital Gains Tax Rates for All Transactions in Registered Securities Attributable to Sam and Charles Wyly").
3. Unpaid Taxes Were Causally Connected to the Securities Violations
The Wylys engaged in a thirteen year fraud, creating seventeen trusts and forty subsidiary companies, employing numerous IOM trustees, a veritable "army of lawyers," hiring an offshore accountant to hold records outside the United States, and delegating several domestic employees to handle the administration of the trusts. Reasonable and savvy businessmen do not engage in such activity unless it is profitable. Of course it was profitable — by transferring property, including valuable options and warrants, to the trusts, exercising the options and trading in secret, and using the proceed to reinvest in other ventures, the Wylys were able to accumulate tremendous tax-free wealth.
The SEC is not seeking disgorgement equivalent to the unpaid taxes for all profits earned by the IOM trusts. Rather, the SEC's disgorgement amount pertains specifically to the taxes avoided on profits relating to the exercise of options and sale of stock in four companies in which the Wylys were influential insiders. The jury found that the Wylys were beneficial owners of all of the Issuer securities — from the time the options were transferred to the trusts to the time the trusts exercised the options or otherwise acquired stock to the time they were sold. The jury also found that the Wylys' pervasive failure to disclose beneficial ownership constituted securities fraud. There is no evidence in the record that the purpose of this fraud was to manipulate or distort the market. There is ample evidence, however, that the driving purpose of the securities fraud was to conceal the Wylys' relationship to the IOM trusts and preserve the preferential tax treatment on secret offshore profits for as long as possible.
Defendants contend that such a motivation "would not establish a causal connection unless the concern had some real basis — i.e., that the SEC disclosures could in fact have triggered a tax liability." As such, defendants argue that to be causally connected, the misstatements or omissions in the SEC filings would have to reveal a fact that itself triggers taxation under the grantor trust rules. For example, defendants argue that even if the establishment of foreign grantor trusts by King and Cairns was fraudulent, "that issue has nothing whatsoever to do with any information that the jury found needed to be disclosed under the securities laws." Thus, any causal connection between the securities fraud and the avoided taxes is broken.
Under defendants' theory of causation, the only amounts than can be disgorged are those linked directly to a particular misstatement in a particular filing. I disagree. "The requirement of a causal relationship between a wrongful act and the property to be disgorged does not imply that a court may order a malefactor to disgorge only the actual property obtained by means of his wrongful act. Rather, the causal connection required is between the amount by which the defendant was unjustly enriched and the amount he can be required to disgorge."
That causal connection exists here in at least two ways. First, defendants' motivation to preserve tax benefits was important to their decision to misrepresent their beneficial ownership. Admitting beneficial ownership would have forced defendants to take conflicting positions with two separate government agencies. Even if admission of "beneficial ownership" on a schedule 13D would not immediately reveal a fact that would establish control of an offshore trust, it would at least be facially inconsistent with a tax reporting position that did not include the profits from trades made by that offshore trust. It would have been reasonable, and in fact, prudent, for the Wylys to be concerned about taking conflicting positions in public SEC filings and on their tax returns because that SEC filing could constitute an admission for purposes of future tax litigation. Given the Wylys' high profile background, tremendous wealth, and history of litigation with the IRS, the possibility of an IRS audit was not remote. In fact, it was highly likely. Thus, even if the Wylys had no reason to believe that SEC filings could trigger an audit, they certainly had reason to believe and fear that the IRS would consult all public filings in the event of an audit.
Second, the securities fraud was intimately connected to protecting the tax benefits in other ways. The Wylys took numerous steps to prevent the Issuers from issuing Forms 1099 to report income to either the Wylys in an individual capacity or to the offshore entities. The Issuers did not report income to the Wylys after the 1992 private annuity transaction because of the Wylys' misrepresentations about disclaiming beneficial ownership over the options, and French and Tedders' misrepresentations about the economic substance of that transaction. In 2001, nearly ten years later, the Wylys continued the fraud by convincing SBC not to issue 1099s based on the same misrepresentations. None of the four Issuers reported income to the Wylys in connection with the options granted as compensation and transferred to the trusts, even though the Wylys certainly enjoyed the benefit of those options once they were exercised and the stock was sold.
This measure of disgorgement reflects the unique circumstances of this case. The Wylys engaged in securities fraud to conceal their relationship to and control of the IOM trusts in order to maintain the secrecy of the offshore system and preserve their tax benefits. The unlawful gains causally related to the securities violations found by the jury, is an amount equivalent to the taxes avoided on the profits the Wylys realized on the sale of Issuer securities. n223
n223 See id. ("[D]isgorgement is an equitable obligation to return a sum equal to the amount wrongfully obtained, rather than a requirement to replevy a specific asset.").
B. Disgorgement of Profits Made on Sales of Unregistered Securities
The purpose of the section 5 registration requirement is "to protect investors by promoting full disclosure of information thought necessary to informed investment decisions." Because section 5 is a strict liability offense, the typical measure of disgorgement is all profits made on the sale of unregistered securities, minus the direct transaction costs of acquiring the shares. In many section 5 cases, this is an appropriate disgorgement amount because the sale of unregistered securities is commonly accompanied by misrepresentations about the investment, a lack of publicly available information about the company, and valueless shares.
The SEC is correct that the outer bounds of disgorgement for these violations is equivalent to all profits earned on the transactions because the defendants sold unregistered stock illegally and could not have received the profits made on sales of unregistered Michaels Stock but for their section 5 violations. However, defendants have a right to rebut that figure by arguing that the nature of their section 5 violations is different from the ordinary section 5 case.
As discussed above, these unregistered shares required a Form S-3 shelf registration statement that would have disclosed no additional information about the investment beyond the Wylys' beneficial ownership of the securities. Michaels Stores was a well-known and long-established company that had filed effective Form S-1 registration statements for millions of registered shares. Thus, "[t]his case involves neither (a) worthless, risky, or lightly traded shares; nor (b) failure to disclose the hundreds of pieces of information required by the regulations." The unregistered shares sold by the Wylys "were identical to all the other, registered shares that were trading in the market at the same time. The unregistered shares paid the same dividends[,] gave the same voting rights[,] and could be resold at the same price as the registered shares."
While I reject defendants' valuation of the appropriate disgorgement amount, I agree that it would be inequitable, in this case, to order disgorgement of total profits. Instead, I will calculate disgorgement based on the average discount received on unregistered securities. The Wylys obtained these shares at a discounted rate but were able to resell them, in secret, at the same price as other registered shares. As a result, the Wylys should disgorge twenty five percent of their total profits, which is within the range of the average discount received on unregistered securities.230 Thus, Sam Wyly is ordered to disgorge $11,848,336 and Charles Wyly is ordered to disgorge $4,985,462 with regards to the section 5 violations. n231
n231 Because I do not order disgorgement of all profits from the sale of unregistered securities, I also calculate an alternative measure of disgorgement based on the taxes avoided on these gains. Using the calculations jointly provided by the parties, Sam Wyly would disgorge $10,964,918.64 and Charles Wyly would disgorge $5,158,658.11. See JX 9903A and 9903B.
C. Prejudgment Interest
The SEC seeks an award of prejudgment interest in addition to disgorgement because the Wylys had free use of the unlawful gains during the fraud, and "used their ill-gotten gains to amass even greater wealth." Defendants argue that prejudgment interest is inappropriate because of "the inherent difficulty of ascertaining a particular amount to be disgorged" and because of the Wylys "financial circumstances and ability to pay."
Defendants' arguments are unavailing. Ascertaining the amount to be disgorged has indeed been difficult. But the Second Circuit has been clear that the "'risk of uncertainty in calculating disgorgement should fall upon the wrongdoer whose illegal conduct created that uncertainty.'" Furthermore, any difficulty or uncertainty does not weigh in favor of absolving the wrongdoer of his obligation to both disgorge his unlawful gains and pay prejudgment interest to reflect that he has otherwise benefitted from "what amounts to an interest free loan procured as the result of illegal activity."
Defendants' inability to pay argument is similarly futile. The Wylys' securities violations helped them establish the offshore system, conceal their trading profits, and use those trading profits to invest in other ventures and amass tremendous untaxed wealth. That defendants appear to have spent these gains should not preclude the court from requiring the payment of prejudgment interest. Disgorgement, which includes the award of prejudgment interest, would have no deterrent value if defendants could avoid it by spending their unlawful gains before the government discovers the fraud.
Because prejudgment interest is also equitable relief, it is appropriate to consider other issues of fairness. Here, depending on the date of the transaction, the SEC seeks prejudgment interest for a period as long as twenty-two years. The SEC has identified several other cases where courts have awarded prejudgment interest over extended periods of time. I will award prejudgment interest for the entire period of the fraud because the Wylys had use of the unlawful gains during the entire period and should not be permitted to benefit from the protracted nature of this litigation. However, I recognize, as the Supreme Court recently noted in Gabelli, that the SEC is, at least in part, responsible for the delay. For that reason, I decline to adopt the SEC's preferred IRS underpayment rate for the entire period. Rather, prejudgment interest is to be calculated at the lower of the average LIBOR or IRS underpayment rate for each year.
D. Civil Penalty
The SEC seeks a civil penalty against Sam Wyly equivalent to the total unlawful gains he received based on conduct after February 1, 2001. The SEC argues that "[i]n light of Sam Wyly's extensive fraud, disgorgement alone is an insufficient remedy, and would provide little deterrent because it would require only the return of ill-gotten gain." I disagree.
Courts can consider the other remedies already imposed in determining whether a penalty would be unduly harsh under the circumstances. By any reasonable measure, the disgorgement and prejudgment interest awarded in this proceeding will be staggering and among the largest awards ever imposed against individual defendants. I conclude that disgorgement of this magnitude is more than sufficient to deter future violations and, accordingly, I decline to impose additional penalties.
Jack,
ReplyDeleteOn a not too unrelated matter, one that probably applies to many people searching for information here, what would you see as the typical outcome and suggested path forward for the following situation:
-Emigrated to the US 10 years ago.
- Kept previous primary residence abroad on as a rental unit receiving about $30,000 a year in rent and after expenses a net profit of around $15,000.
- Regular salary income in the States of $100K.
- No FBAR’s filed until first one lastyear after becoming aware of the requirements.
- No foreign income declared in the States to date as did not realize it was due. All the profit was kept abroad and just used to pay the mortgage.
From reading on the subject, it would seem that this could either be:
- Quiet submittal revising tax returns and FBAR’s. Would this likely raise an audit with the suddenly appearing rental property or cause questions to be raised.
- Go forward with submitting FBAR’s and tax returns.
- Go the 5% penalty route. Would this likely meet the non willful test?
One critical question is what would be the asset base used, would that simply be maximum bank account balance, or would it also include the value of the real estate abroad that generated the income for assessing any penalty as some others suggest as this will make a vast difference to the penalty.
Any general insight here would be much appreciated by probably the many smaller time offenders here trying to work the best way out of the maze.
Thanks
Bob. If you go into the resident streamlined you will only be charged on the highest account balance on Dec 31st of the last 6 years if you failed to file a FBAR. You would need to pay any tax plus interest on the rental for the last 3 years with amended returns. Your situation is exactly the same as a friend of mine and she was ruled willful. You can't live in the USA and file taxes for 10 years and somehow fail to know about your world wide income needing to be reported. Yes you may not have know about FBAR filing, but the streamlined asks you to certify that you were not willful in excluding your income from foreign accounts and assets. Assets include real estate. If you join OVDP you are going to get a 27.5% penalty on the value of the real estate. In streamlined they do not include the value of the real estate on the 5% penalty. Frankly you stand a big chance of getting nailed if you go streamlined and they do not accept you. However if you go full OVDP, you will get the penalty on the house, and pay taxes on 8 years of amended returns and the 20% accuracy penalty. Then you can opt out and take your chances, without the house forming any penalty base., but you could get a willful FBAR penalty, based on your account balances over 6 six years . My friend was in the exact same position, but the 5% streamlined did not exist then .She joined OVDP and has regretted every second, but had no choice. She had a house worth 5 million , so she had to opt out to prevent it from being included in the penalty base. Unfortunately when she sold the house she deposited the money in her foreign account for 25 days, before bringing it to the USA, so the iRS are trying to included it in the penalty base for a willful assertion. If you are a risk taker you may want to consider coming into compliance on the current year and let the clock run and 6 years from now you will be free. My friend wishes she had taken that approach.
ReplyDelete........."You can't live in the USA and file taxes for 10 years and somehow fail
ReplyDeleteto know about your world wide income needing to be reported"..... I agree but as I have seen here on this blog there is a certain group of tax payer who thinks exactly that .
Jack,
ReplyDeleteI got my 906 4 months ago. Did not sign it yet. Considering transitioning SDOP. I have read some posts about a 4.5% interest due. Does this 4.5% start counting from the day one gets the 906 or from the date one signs it an returns (if payment is not made). Thanks.
Interest does not start running on the offshore penalty (the miscellaneous or in lieu of penalty) until the Form 906 is completely signed and the penalty assessed.
ReplyDeleteJack Townsend
I think most U.S. taxpayers would have known that a directly owned foreign account would require that the interest / earnings on the account be included in the Form 1040. After that, it gets a bit dicier -- say the account is owned by an offshore corporation where, normally, the earnings are not taxed until repatriated (but then you get into somewhat complex CFC / Subpart F rules, and the corporation in some cases would be shams anyway).
ReplyDeleteSo, blanket statements in this area just don't have the nuance required.
Jack Townsend
Thanks Jack, I m sorry to be so unknowing…I understand what you said, interest does not start running till the 906 is signed. But what does it mean "and the penalty is assessed". Is this some step happening after the 906 is signed?
ReplyDeleteJack,
ReplyDeletecouldn't foreign account holders, who haven't/couldn't repatriate their foreign account interest incomes (like in the offshore corporation scenario you described), also argue that their earnings should not be taxed in the US (until repatriated)?
In order for the argument to work, the taxpayer will have to credibly claim that that is why he or she did not report the income on the 1040. If the taxpayer can say that credibly -- and avoid a willful blindness conclusion -- that taxpayer should not have civil or criminal consequences other than perhaps the accuracy related penalty (if a QAR is not filed).
ReplyDeleteThat credibility (and nonwillful blindness) determination is the key. Whether the IRS will agree is another issue and may require ultimately that the taxpayer have to litigate the issue.
Jack Townsend
RON,
ReplyDeleteAssessment is an act independent of the execution of the Form 906. I assume that IRS procedures contemplate that the assessment occur soon after the execution of the Form 906, but it could take several days and, in some cases, I suppose, even longer. I just have not paid enough attention to the lapse of time between the final signed Form 906 and the assessment date.
Keep in mind that, inside the OVDP,if the taxpayer can make the payment, it accompanies the Form 906 signed by the taxpayer. So the IRS will have the money even before the Form 906 is signed by the IRS. So interest will not be an issue. (I am aware of cases where the offshore penalty was sent in with the original package, so the taxpayers in those cases made interest free loans to the IRS until the assessment was made (or at least until the taxpayer sent in the signed form 906)).
Jack Townsend
Thanks so so much. I did not have any knowledge of this sequence. Very clear now.
ReplyDeleteJack, on the credibility issue above plus on something I posted a couple days and did not get a response from you. (Not sure if you did not see it or if i was asking too much - I DO RESPECT your time and devotion to us all and apologize if I did. Do let me know so I can moderate my questions/comments).Other than that: I had omitted 6 years of rental income where I paid 24% gross to the country where the property was. You said that would come out to no tax deficiency to the IRS and to go for the SDOP,it would be nonwilfull in the IRS eyes given no tax due to them. (I am transitioning from OVDP) I responded unfortunately it came up to $10K owed though, given some other US related credits (I think my CPA said). There was also about $5K yearly undeclared which were contributions by my previous employer to a retirement fund not taxable in the country of origin. I paid the rental taxes of 24% based on my reading (misinterpreted it I have learned) of a tax treaty. I did not declare the employer contributions as they were nontaxable abroad and never occurred to me it would be here. ON THE CREDIBILITY ISSUE, this is as true as daylight, yet I am concerned to sound "willfully blind" Your take if possible (or instruct me otherwise) thanks so much :)
ReplyDeleteBlackseal,
ReplyDeleteIn your post you said: "Your situation is exactly the same as a friend of mine and she was ruled willful."
Was she a straight/new SDOP/SFOP filer? or was it an OVDI-Streamlined transition case? Thanks.
I just like to add something for readers to take away here with pension issues. It is an issue for Form 8833 a treaty based position. If we’re discussing the taxation of contributions being made to a pension prior to distribution, then the treaty Article may come into play. For example, it is accepted amongst even the most stringent tax professionals in the UK that contributions to a ‘final benefit, UK Registered company pension’ will not be subject to reporting, although it is agreed that the individual may wish to declare annually during the contribution period (on a US 1040) all payments made by both themselves and the company in order to establish a US ‘basis’ in the pension. This may also include yearly gains made by the scheme.
ReplyDeleteRON,
ReplyDeleteI did not ignore your earlier post. It is just that, with limited time, there is a lot more complexity and uncertainty in any answer I could give that, in my judgement, would be helpful to you or to other readers.
Therefore, I must decline to respond.
Jack Townsend
Jack, I do appreciate your response and I am grateful for it. And I can understand!
ReplyDelete"However, if you go full OVDP, you will get the penalty on the house". We've never included the value of real estate held directly in the penalty computation. The FAQs even state that an account for which there was no unreported income would not be included in the penalty computation. I'm not sure why the value of the house is at issue.
ReplyDeleteES and specially Jack, I think you are doing the readers of this blog a disservice when you make blanket statements such as " You cant live in the USA and file taxes for 10 years and somehow fail to know about your worldwide income needing to be reported" . This is an irresponsible statement, it may cause readers to make the wrong decisions even when they are innocent thinking the IRS will not believe them. What if the software the taxpayer used automatically ticked 'no' to the question on foreign accounts? What about the inadvertence, negligence etc. ?
ReplyDeleteAlso, when only 700K people file FBARs out of approx 14 million that should be filing FBARs ( per various TAS reports )- are you trying to say that 13.3M people are willfully blind ? This makes no sense to me.
I am sorry, I think this is the first disagreement I have had with Jack's positions on this blog in 3 years, hopefully, there is a misunderstanding in my interpretation
If you depend on a tax professional who does not ask you about foreign income, and you are already paying foreign taxes on this income, it is entirely possible you don't realize you need to show foreign income in the US. This is true in my case.
This is not just my perception, it is backed up by an actual case reported on Jack's blog who Opted out AND GOT A NON- WILLFUL PENALTY.
http://ovdioptingout.blogspot.com/2014/06/summary-of-my-ovdi-2011-case.html
How on earth can anyone argue that a taxpayer is supposed to understand his tax payment obligations when even the CPA does'nt understand how to handle pensions. Form 8833- really ?
ReplyDeleteES, since you have educated us to this, I can only assume you are with the IRS. Please stand up and admit it- nothing to be ashamed of, we love to see how you think
ES, thanks sfor your response/explanation of treaty based position taking. I guess my question is this: In order for someone to claim that employer contributions and interest appreciation in a retirement account is not taxable in the US (since it is not taxable in the other country), the tax treaty between the US and that other c country should provide specifically that those amounts are not taxable int he US?
ReplyDeleteThe Professor concludes, "It is often hard to compare sentencing factors from one defendant to another. However, to the extent one can compare Warner and Engle,
ReplyDeleteI offer the following observations: (i) if Engle's original
sentencing deserved reversal and remand, then so should Warner's; and
(ii) if there is a remand, Warner might be concerned about a sentence in
the Guidelines range -- which was 46-57 months." Warner and Engle are not comparative, as are most any case or defendant except through personal biases, on nearly any level. My confession: I was personally very, very displeased by the resulting sentence in the Warner case, particularly because I had clients sentenced in the same district months before to around 4 years for something I'd argue was not even as egregious. I've read the documents, and listened to the oral arguments. Paul Clement, not yet an elder statesman, buried the government. Moreover, a an important factor the Professor seems to seldom if ever touch on is that there is substantial empirical data showing incarceration for white collar criminals, particularly tax cheats, is of little deterrence value in general, to the defendant.Ty Warner is a bit "odd" in my opinion - I do regularly see his personal 727 jet driving by DuPage airport - but when the government says 1 year and 1 day and he gets probation, give me a break. It wasn't the best, most inquisitive 7th Circuit panel in my opinion, but this is just a case where the guy is pretty decent, decided to make a (relative to his wealth) very, very stupid mistake, and let him go do good.
I think Congress does not care if you disagree with Jack or others here. You are repeating constantly the same old arguments which have been already discussed here numerous times over the last 3 years.
ReplyDeleteFor amended returns to comply with OVDP would can you continue to use your same accountant in spite of the fact that you once answered no on foreign accounts? or should you simply find a new accountant with no earlier obligations? If you use your original accountant what would be his liabilities and obligations to report on years outside of the OVDP reporting years.
ReplyDeleteI am not a lawyer but I would think that years older than the ones prior to the OVDP period would be beyond the statute of limitations (if fraud is absent.) Thus there would be no obligation to amend those returns. Furthermore the FBAR SOL is 6 years. So I see old/new accountant as a matter of personal preference.
ReplyDeleteI've used the same CPA. My understanding is that if you are in OVDP the "crimes" related to offshore assets reporting that happened before the years covered by OVDP are excused.
ReplyDeleteThis is a common misunderstanding. There is no guarantee that you will not be pursued criminally even if your OVDP is accepted. However, generally there will be a recommendation that you are not pursued criminally.
ReplyDeleteThere are some benefits to having your attorney engage the CPA on your behalf so as to protect communications you have with your CPA.
There is also a 6 year statute on a 25% (or more) omission of unreported income and no statute of limitations on fraud. But, there is no statute of limitations on an unfiled return either. Therefore, if you never filed the FBAR returns, the statute remains open.
ReplyDeleteThanks, Guest Esq.
ReplyDeleteJust one correction. For FBAR, there is a 5 years criminal statute and a 6 year civil statute. There is no extended limitations period either for a false FBAR or for no FBAR.
Jack Townsend
Thanks, Guest Esq.
ReplyDeleteActually, the way the song and dance routine works is that the IRS will not recommend for criminal prosecution those who do a good voluntary disclosure, including in the offshore account context, a good OVDI/P.
Jack Townsend
MeHere,
ReplyDeleteI think that is the general practitioner understanding as well.
Jack Townsend