WOLF
POPPER
LLP
2014 Public Safety Employees
Pension & Benefits Conference
The Long and Winding Saga
Of the Wyly Brothers
New Orleans, LA.
October 27, 2014
By
Chet B. Waldman, Esq.
Wolf Popper LLP
The Wyly Brothers’ Quest To Violate
Every White Collar Crime In The Book
by: Chet B. Waldman
1
Who are the Wyly Brothers?
•
Brothers Sam and Charles Wyly: inseparable from
childhood
– Grew up in rural Lake Providence, in East Carroll
parish, Louisiana
– Played H.S. football for Delhi High School on
team that won state championship, along the way
beating their cross-town rivals from Tallulah H.S.
– Moved to Texas where they spent 5 decades in
business together
– Lived in summer homes in Aspen, Colorado,
Pitkin County, so they could vacation together
2
Southern Charm
• Wylys were very proud of their southern
heritage
–
Maternal great-great-grandfather Edward Sparrow - was a Confederate
Senator who fought with Louisiana
regiments in the Civil War
–
In Sam Wyly’s home in Dallas he has a
painting called Moonlight and Magnolias
in which he and his wife #3 are dancing
with him wearing the gray uniform of a
Confederate General.
• Republicans to the core
3
Wyly Business Acumen
•
Early pioneers in computer software - built
Sterling Software into multi-billion-dollar+
company by buying up competitors, many through
hostile tender offers
•
Founded Datran, a forerunner to the internet which,
in the early 1970s, got computers talking to each
other through a series of microwave towers
•
Bought Michaels, a craft-store chain, in 1983 and
built it into a national chain
•
Opened the Maverick Capital hedge fund in early
1990s - $8 billion in assets
•
Founded power reseller Green Mountain Energy
prior to power deregulation occurring in Texas
4
All This Success Makes The Wylys Rich:
How Rich?
•
In 2010 Sam Wyly appeared on Forbes’ list of the
400 richest Americans with $1 billion net worth
•
In 2011 Forbes listed Sam as the 393rd richest man
in the world
•
Active philanthropists providing millions of dollars
to arts groups, colleges, literary programs and
animal shelters
- Theater in Dallas Arts District bears the names of
Charles and his wife
5
Political Contributions
•
The Wylys have contributed roughly $10 million to
192 Republican candidates and causes
•
Sam directed Richard Nixon’s election effort in the
State of Texas
•
Personal friends of George H.W. Bush and among
the bigger donors to George W. Bush during his
presidency
•
Democrats particularly hated the Wylys for various
attack ads:
- Funded TV ads of “Swift Boat Veterans for Truth”
Group that questioned John Kerry’s war record
6
The One Thing The Wylys Hated More
Than Democrats From The North: Taxes!
•
According to a business acquaintance: “Sam Wyly is
the most tax-averse bastard you’ve ever met”
•
“Protecting” the money they spent a lifetime earning
became an obsession for the Wylys
- In 1992 they enlisted the advice of tax attorney
David Tedder to help them avoid paying taxes
- Tedder later went to prison on unrelated tax and
money-laundering convictions
- Tedder introduced the Wylys to 2 key tax havens:
The Cayman Islands and the Isle of Man
7
Tax Haven/Heaven?
•
Cayman Islands
– Vacation resort hotspot
– International tax haven
♦ Low taxes
♦ Secret bank accounts allowed
•
Isle of Man
– Located in the middle of the Irish Sea
– 100 square miles smaller than Dallas
– Less than 80,000 people
– International tax haven
♦ No estate tax
♦ Highest tax bracket is 20%
♦ 10% corporate tax rate
•
These tax havens cost the U.S. government
hundreds of billions of dollars in tax revenue
8
Tax “Avoidance” or Tax “Evasion”?
•
How the Wylys got around paying taxes
–
Between 1992-1996 they created 17 offshore trusts in
the Isle of Man, each of which owned several subsidiaries
(41 dummy corporations)
–
The trusts were named after places in Louisiana where
Wylys grew up (e.g. “East Carroll”) or related to their
high-school days (e.g. “Delhi” and “Tallulah”) or their
summer homes in Colorado (e.g. “Pitkin”)
–
A Wyly-related entity in the Cayman Islands (the “Family
Office”) conveyed the Wylys’ investment recommendations to the trustees who always made transactions
based on these recommendations
9
Tax “Avoidance” or Tax “Evasion”?
•
The Wylys were directors of 4 public companies:
Michael’s Stores
Sterling Software
Sterling Commerce
Scottish Re Group
Limited
•
As part of their compensation, Wylys received stock
options and warrants from the 4 companies
•
Between 1992-1999, Wylys sold or transferred these stock
options to their offshore entities in return for annuities
that would pay out the value of the securities over time
•
Between 1995-2005, the 58 trusts and companies
exercised these options, separately acquired options and
stock in all 4 companies, and sold the shares for total
profits calculated to be $487,780,099!
10
Tax “Avoidance” or Tax “Evasion”?
•
For many years, on paper, the Wylys were paupers with the offshore trusts “owning their assets,” which the Wylys were able
to use on loan. The trusts owned:
– 4 properties in Aspen, Colorado
– 100-acre horse farm outside Dallas
– $1 million painting of Ben Franklin
– $750,000 emerald necklace
– $622,000 ruby
– Norman Rockwell’s original “Rosie the Riveter” painting
purchased for $4.96 million – highest price ever paid for a
Rockwell
•
When Wylys needed cash it usually came in the form of taxexempt loans from the trusts
•
Such an arrangement would be legal if the trusts were operated
“independently” of the Wylys. However, if the Wylys directed all
of the investment activity of the trusts and transferred proceeds
into their own bank accounts, that would be illegal
11
The U.S. Government Learns of the Wylys’
Offshore Holdings
•
The offshore entities’ securities were held in U.S.
brokerage accounts including at Bank of America
(“BofA”)
•
In early 2004, BofA’s clearing firm flagged the Wylys’
offshore accounts. In seeking to comply with “antimoney laundering provisions” of the PATRIOT
ACT (i.e. “know your customer laws”), BofA attempted
to learn the underlying beneficiaries of the trusts
•
The offshore trusts refused to comply, seeking to
keep hidden the Wylys’ beneficial interest
•
BofA closed the accounts and reported the offshore
entities to the SEC in November 2004
12
The SEC Files a Lawsuit
•
For 6 years, mostly while Republicans were in the White House
and controlled the SEC, the government steered clear of the
Wylys. However, 18 months after Barack Obama was elected
and then installed his own SEC Commissioner, the SEC
brought an action against the Wylys
•
On July 29, 2010, the SEC filed a 78-page Complaint in
the U.S. District Court in Manhattan against the Wylys, their
personal attorney, and their stockbroker
–
•
Perhaps an artful and legitimate attempt to avoid a
Texas Court since Washington regulators historically
are not embraced there
Sam Wyly had a previous history with the SEC
–
In 1979 he was sued by SEC in connection with a bond deal
which was settled without admitting or denying wrongdoing
13
Insider-Transaction Reporting
Requirements
•
Holdings and every trade in a public company’s securities by
an officer or director of that company has to be disclosed on a
Form 4 filing with the SEC
•
Holdings and every trade by a beneficial owner of greater
than 5% of a public company’s stock has to be disclosed by
that owner on a Schedule 13D with the SEC
•
Purpose: The disclosure scheme requiring insiders to report
beneficial ownership and any changes in that ownership
reflects Congress’s judgment that public disclosures of
insiders’ ownership of, and trading in, company stock
provides valuable information to investors
–
“The very purpose of insider-transaction reporting
requirements . . . is to give investors an idea of the
purchases and sales by insiders which may in turn
indicate their private opinion as to prospects of the
company.” [SEC v. Wyly, 788 F. Supp. 2d 92, 123 (S.D.N.Y. 2011)]
14
The SEC Files a Lawsuit
•
Crux of SEC’s Allegations: Wylys engaged in a
“13- year fraudulent scheme to hold and trade tens of
millions of securities of public companies while they
were the members of the boards of directors of those
companies, without disclosing their ownership and
their trading of those securities.” [SEC v. Wyly, 950 F. Supp.
2d 547, 550-51 (S.D.N.Y. 2013)]
•
2 primary allegations:
1)
The Wylys traded 14 million shares via the offshore
vehicles in violation of rules requiring corporate
insiders owning 5% or more of a company to
disclose their holdings and trades (i.e. failed to
file Form 4s and 13Ds)
2)
Insider Trading
15
Failure to File Form 4s and Schedule 13Ds
•
The SEC alleged that the Wylys spread their stock
holdings in Sterling Software, Sterling Commerce,
Michaels Stores and Scottish Re among their 50+ offshore
entities. While each entity held a small percentage of
shares in these companies, all the trusts combined held a
significant portion of the companies’ outstanding shares
–
E.g. – At their peak, the trusts held 36.7% of Michaels
and 33.7% of Sterling Software
–
Because they did not file 13Ds or Form 4s, the public
did not know of the Wylys’ significant ownership
interests in these companies
16
The Insider Trading Claim
•
In September 1999, the Wylys, who led the Boards of
Sterling Software and Sterling Commerce, decided that
they would pursue selling both companies and they
retained Goldman Sachs to evaluate potential buyers
•
In October 1999, the Wylys engaged in a large stock swap
allowing them, in essence, to buy up millions of shares in
Sterling Software through the offshore trusts. They also
had Sterling Software change its bylaws to increase
payouts to the Wylys if the Company was bought
•
Negotiations to sell Sterling Software did not begin until
January 2000 and the Company was sold shortly
thereafter allowing the Wylys to reap $31.7 million from
the trades they made in October 1999
17
The Wyly’s Defenses to the
SEC Action
•
Most of the facts alleged were not disputed by the
Wylys
•
Statute of Limitations
–
•
Failure to File Ownership Interest Information
–
–
•
Many of the events happened more than a decade
ago
Trusts were valid, and they, not Wylys, legally owned
the shares in the companies
Reliance on advice of counsel and accountants
Insider Trading
–
Sale of Sterling Software didn’t occur until more than
3 months after Wylys acquired more shares
18
The Death of Charles Wyly
• In August 2011, Charles, at age 77, was
killed when he tried to cross a highway in
Aspen, Colo. and an SUV t-boned his
Porsche 911 Targa
• 5 months later, the SEC won an
unprecedented Court decision to sue
Charles’ estate: “Zombie Litigation.” An
executor for his estate was substituted as a
defendant
19
Certain Claims are TimeBarred
•
SEC can sue for disgorgement of unlawful
profits and add civil penalties on top in
egregious circumstances (e.g. 3X unlawful profits)
•
On June 6, 2013, the Court found that any
penalty claims for securities violations against
the Wylys arising before February 1, 2001 (i.e.
virtually all of them) were barred by the statute of
limitations. This barred any civil penalties for the
1999 insider trading violations, among other
allegations
•
The Court, however, held that the SEC still had
claims for disgorgement of illegal trading
profits relating to the insider trading claims.
20
The Jury Verdict
•
On an in limine motion immediately prior to trial the
Court dismissed the remaining insider trading claim
•
Trial lasted from March 31 – May 7, 2014
•
Jury returned a verdict against both Wylys on all
nine remaining claims, including securities fraud,
and failure to make various disclosures
•
Specifically, the jury found that the Wylys had engaged
in fraud over 13 years by failing to disclose
numerous trades which were hidden from investors
in the companies
•
The Court thereafter set a trial schedule for the
“remedies” phase of the litigation
21
The Remedy?
•
The SEC contended that the Wylys derived $553 million in
profits from their unlawful trades
•
On July 29, 2014, the Court rejected the SEC’s proposed
disgorgement of profits request, finding it unsupported by
evidence, noting that not all the profits came from the
failures to disclose, as opposed to general market runups and other factors. Court gave the SEC another
chance to prove the amount of profits stemming from the
violations of law
•
On August 4, 2014, the Court held a remedies hearing
•
On September 24, 2014, the Court awarded the SEC $187
million plus pre-judgment interest (total payment will be
between $300-$400 million)
22
How Does Insider Trading, Or A Directors’ Failure To
Disclose Holdings, Impact Your Funds?
1.
Every time someone buys or sells shares on inside information
without disclosing it, the opposite side of the trade is being
deceived and disadvantaged.
2.
E.g., if your funds were selling Sterling Software stock at the end
of 1999 and you did not know that the company was planning to be
sold at a significant premium, a fact known by the Wyly brothers
which they did not disclose while they bought up shares of Sterling
Software, you lost money while they made $ tens of millions.
3.
Investors lose confidence in the stock market when they see
insiders are gaming the system. Less investors means less
liquidity, available capital for companies, etc.
4.
Consequently, the federal securities laws allow disadvantaged
shareholders harmed by insider trading and certain failures to
disclose to sue for their losses against the wrongdoers.
–
How do you know if your fund may have a legal claim?
A. Portfolio Monitoring
23
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