In the recent case of SEC v. Wyly (SDNY, no.
1:10-cv-05760, 2014 BL 267268), the US Securities and
Exchange Commission (SEC) successfully obtained a disgorgement
order against Samuel Wyly and the estate of Charles Wyly. The Wylys
committed securities fraud by trading the securities of
corporations on whose boards they sat and failing to disclose to
the SEC their beneficial ownership of the securities. This is the
first time that the SEC has sought and received a disgorgement
remedy for a securities fraud based mainly on taxes that would have
been clearly owed if the Wylys had disclosed the trades. (The IRS
had not pursued the Wylys for those taxes.)
The disgorgement remedy is equitable and therefore is not
subject to the statute of limitations; a government seeking to
enforce explicit statutory provisions can avail itself of this
remedy. "[T]he primary purpose of disgorgement is not to
compensate investors. Unlike damages, it is a method of forcing a
defendant to give up the amount by which he was unjustly
enriched." The SEC action was not "a civil action for the
collection or recovery of taxes . . . [but] 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. . . . Measuring unjust enrichment by
approximating avoided taxes does not transform an order of
disgorgement into an assessment of tax liability."
In the event that the IRS sought collection, "any amounts
disgorged . . . should be credited towards any subsequent tax
liability determined in an IRS civil proceeding."
Between 1992 and 1996, the Wylys created a number of trusts in
the Isle of Man; each trust owned several subsidiary companies. The
Wylys were directors of Michaels Stores, Sterling Software,
Sterling Commerce, and Scottish Annuity and Life Holdings. As part
of their compensation, the Wylys received stock options and
warrants, which they then sold or transferred to the Isle of Man
trusts in exchange for private annuities. The Wylys simultaneously
disclaimed beneficial ownership of the securities in public filings
with the SEC. Between 1995 and 2005, the Isle of Man trusts
exercised the options and warrants and separately acquired options
and sold those and other shares in all four companies without
filing SEC disclosures. The filings, Sam Wyly said, "could
trigger tax problems."
The trusts were found to be grantor trusts. A grantor trust is
created when the contributor of cash or property retains an
interest in the property: the contributor is treated as the
trust's owner unless the transfer is made at FMV. The Wylys
were found to have maintained their beneficial ownership in the
securities at all times even though the trusts were administered by
professional asset management companies located in the Isle of Man.
The protectors were deemed to be the Wylys' agents because they
received lucrative work from the Wylys. On several occasions, the
protectors and Sam Wyly bypassed the trustees and directly placed
The court cited Gould (139 TC 418, at 437 (2012)). In
that case, the Tax Court concluded that "[i]n determining the
settlors of a trust, [a court] look[s] beyond the named grantors to
the economic realities." The court in Wyly also cited
Gudmundsson (634 F. 3d 212, at 221 (2d Cir. 2011)):
"[I]n general, the term 'fair market value' is
understood to mean 'the price at which the property would
change hands between a willing buyer and a willing seller, neither
being under any compulsion to buy or to sell and both having
reasonable knowledge or relevant facts.'"
The court also applied the substance-over-form doctrine
established in Helvering v. Gregory (69 F. 2d 809, at 810
(2d Cir. 1934)), whereby the courts look to a transaction's
objective economic realities rather than to the particular form
employed by the parties. The court cited Close (107 TCM
(CCH) 1124; 2014 WL 521039), which said that the following facts
were critical in determining whether a trust had economic
(1) whether the taxpayer's relationship to the transferred
property differed materially before and after the trust's
creation; (2) whether the trust had an independent trustee; (3)
whether an economic interest passed to other trust beneficiaries;
and (4) whether the taxpayer respected restrictions imposed on the
trust's operation as set forth in the trust documents or by the
law of the trusts.
The court ordered the Wylys to pay $187,718,702.70 plus
prejudgment interest for the entire period of fraud to December 1,
2014. That amount mainly represents taxes avoided by the Wylys
relating to the exercise of options and the sale of stock in the
four companies in which they were influential insiders.
Previously published in Canadian Tax Highlights - Volume 23,
Number 3, March 2015
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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