waldman (wolf popper) on wyly

7/25/2019 Waldman (Wolf Popper) on Wyly

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October 27, 2014

ByChet B. Waldman, Esq.

Wolf Popper LLP

New Orleans, LA.

2014 Public Safety Employees

Pension Benefits Conference

The Long and Winding SagaOf the Wyly Brothers

WOLF

LLPPOPPER


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Who are the Wyly Brothers?

Brothers Samand CharlesWyly: inseparable fromchildhood

Grew up in rural Lake Providence, in East Carroll

parish, Louisiana

Played H.S. football for DelhiHigh School onteam that won state championship, along the waybeating their cross-town rivals from TallulahH.S.

Moved to Texaswhere they spent 5 decadesinbusiness together

Lived in summer homes in Aspen, Colorado,PitkinCounty, so they could vacation together


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Southern Charm

Wylys were very proud of their southernheritage

Maternal great-great-grandfather-

Edward Sparrow - was a ConfederateSenatorwho fought with Louisianaregiments in the Civil War

In Sam Wylys home in Dallas he has a

painting called Moonlight and Magnoliasin which he and his wife #3 are dancingwith him wearing the gray uniform of aConfederate General.

Republicans to the core


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All This Success Makes The Wylys Rich:How Rich?

In 2010 Sam Wyly appeared on Forbes list of the400 richest Americans with $1 billionnet worth

In 2011 Forbes listed Sam as the 393

rd

richestmanin the world

Active philanthropistsproviding millions of dollarsto arts groups, colleges, literary programs andanimal shelters

- Theater in Dallas Arts District bears the names ofCharles and his wife


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Political Contributions

The Wylys have contributed roughly $10 millionto192Republican candidates and causes

Sam directed Richard Nixonselection effort in theState of Texas

Personal friends of George H.W. Bushand amongthe bigger donors to George W. Bushduring hispresidency

Democrats particularly hated the Wylys for variousattack ads:

- Funded TV ads of Swift Boat Veterans for TruthGroup that questioned John Kerryswar record


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The One Thing The Wylys Hated MoreThan Democrats From The North:

According to a business acquaintance: Sam Wyly isthe most tax-averse bastard youve ever met

Protectingthe money they spent a lifetime earningbecame an obsession for the Wylys

- In 1992they enlisted the advice of tax attorneyDavid Tedder to help them avoid paying taxes

- Tedder later went to prisonon unrelated taxandmoney-launderingconvictions

- Tedder introduced the Wylys to 2 key tax havens:The Cayman Islandsand the Isle of Man

Taxes!


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Tax Haven/Heaven?

Cayman IslandsVacation resort hotspotInternational tax haven

Low taxes Secret bank accounts allowed

Isle of ManLocated in the middle of the Irish Sea100 square miles smaller than Dallas

Less than 80,000peopleInternational tax haven No estate tax Highest tax bracket is 20% 10% corporate tax rate

These tax havens cost the U.S. governmenthundreds of billions of dollars in tax revenue


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Tax Avoidance or Tax Evasion?

How the Wylys got around paying taxes

Between 1992-1996 they created 17 offshore trustsinthe Isle of Man, each of which owned several subsidiaries(41dummy corporations)

The trusts were named after places in Louisiana whereWylys grew up (e.g. East Carroll) or related to theirhigh-school days (e.g. Delhiand Tallulah) or theirsummer homes in Colorado (e.g. Pitkin)

A Wyly-related entity in the Cayman Islands (the FamilyOffice) conveyed the Wylys investment recommenda-tionsto the trusteeswho always made transactionsbased on these recommendations


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The Wylys were directors of 4public companies:

Michaels Stores

Sterling Commerce

As part of their compensation, Wylys received stockoptionsand warrantsfrom the 4 companies

Between 1992-1999, Wylys sold or transferred these stockoptions to their offshore entities in return for annuitiesthat would payout the valueof the securities over time

Between 1995-2005, the 58trusts and companiesexercised these options, separately acquired options andstock in all 4 companies, and sold the shares for total

profitscalculated to be $487,780,099!

Sterling Software

Scottish Re GroupLimited


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For many years, on paper, the Wylys were pauperswith 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 Rockwells original Rosie the Riveterpainting

purchased for$4.96 million

highest price ever paid for aRockwell

When Wylys needed cashit usually came in the form of tax- exempt loansfrom the trusts

Such an arrangement would be legal ifthe trusts were operatedindependentlyof the Wylys. However, if the Wylys directedallof the investment activityof the trusts and transferred proceedsinto their own bank accounts, that would be illegal


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The U.S. Government Learns of the WylysOffshore Holdings

The offshore entities securities were held in U.S.brokerage accounts including at Bank of America(BofA)

In early 2004, BofAs clearing firm flaggedthe Wylysoffshore accounts. In seeking to comply with anti-

money laundering provisionsof the PATRIOTACT (i.e. know your customer laws), BofA attempted

to learn the underlying beneficiaries of the trusts

The offshore trusts refused to comply, seeking tokeep hiddenthe Wylys beneficial interest

BofA closed the accounts and reportedthe offshoreentities tothe SECin November 2004


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The SEC Files a Lawsuit

For 6 years, mostly while Republicans were in the White Houseand controlled the SEC, the government steered clear of theWylys. However, 18 monthsafter Barack Obama was electedand then installed his own SEC Commissioner, the SEC

brought an action against the Wylys

On July 29, 2010, the SEC filed a 78-page Complaintinthe U.S. District Court in Manhattan against the Wylys, theirpersonal attorney, and their stockbroker

Perhaps an artful and legitimate attempt to avoidaTexasCourt since Washington regulatorshistoricallyare not embraced there

Sam Wyly had a previous history with the SEC

In 1979he was sued by SECin connection with a bond dealwhich was settled without admitting or denying wrongdoing


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Insider-Transaction ReportingRequirements

Holdingsand every tradein a public companys securities byan officer or directorof that company has to be disclosed on aForm 4filing with the SEC

Holdingsand every tradeby a beneficial ownerof greater

than 5%of a public companys stock has to be disclosed bythat owner on a Schedule 13Dwith the SEC

Purpose: The disclosure scheme requiring insidersto reportbeneficial ownershipand any changesin that ownershipreflects Congresss judgment that public disclosuresofinsiders ownership of, and trading in, company stock

provides valuable informationto investors

The very purpose of insider-transaction reportingrequirements. . . is to give investors an idea of thepurchases and sales by insiders which may in turnindicate their private opinion as to prospects of thecompany. [SEC v. Wyly, 788 F. Supp. 2d 92, 123 (S.D.N.Y. 2011)]


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The SEC Files a Lawsuit

Crux of SECs Allegations: Wylys engaged in a13- year fraudulent scheme to hold and trade tens ofmillions of securities of public companies while theywere the members of the boards of directors of thosecompanies, 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 requiringcorporateinsidersowning 5% or more of a company todisclosetheir holdingsand trades(i.e. failed tofile Form 4s and 13Ds)

2) Insider Trading


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Failure to File Form 4s and Schedule 13Ds

The SEC alleged that the Wylys spreadtheir stockholdingsin Sterling Software, Sterling Commerce,Michaels Stores and Scottish Re amongtheir 50+ offshore

entities. While each entity held a small percentageofshares in these companies, all the trusts combinedheld asignificant portionof the companies outstanding shares

E.g.At their peak, the trusts held 36.7%of Michaelsand 33.7%of Sterling Software

Because they did not file 13Ds or Form 4s, the publicdid not know of the Wylys significant ownershipinterestsin these companies


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The Insider Trading Claim

In September 1999, the Wylys, who led the Boards ofSterling Software and Sterling Commerce, decidedthatthey would pursue sellingboth companies and they

retained Goldman Sachsto evaluate potential buyers

In October 1999, the Wylys engaged in a large stock swapallowing them, in essence, to buyup millions of sharesinSterling Software through the offshore trusts. They alsohad Sterling Software changeits bylawsto increase

payoutsto the Wylys if the Company was bought

Negotiationsto sell Sterling Software did not beginuntilJanuary 2000and the Company was sold shortlythereafterallowing the Wylys to reap $31.7 millionfromthe trades they made in October 1999


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The Wylys Defenses to theSEC Action

Most of the factsalleged were notdisputed by theWylys

Statute of Limitations

Many of the events happened more than a decadeago

Failure to File Ownership Interest Information

Trusts were valid, and they, not Wylys, legally owned

the shares in the companies Relianceon advice of counseland accountants

Insider Trading

Sale of Sterling Software didnt occur until more than3 monthsafter Wylys acquired more shares


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The Death of Charles Wyly

In August 2011, Charles, at age 77, waskilled when he tried to cross a highway in

Aspen, Colo. and an SUV t-boned hisPorsche 911 Targa

5 months later, the SEC won anunprecedented Court decision to sue

Charles estate: Zombie Litigation. Anexecutor for his estate was substituted as adefendant


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Certain Claims are Time-Barred

SEC can sue for disgorgementof unlawfulprofitsand add civil penaltieson top inegregious circumstances (e.g.3X unlawful profits)

On June 6, 2013, the Court found that anypenalty claims for securities violations againstthe Wylys arising before February 1, 2001 (i.e.virtually all of them) were barredby the statute oflimitations. This barredany civil penaltiesfor the

1999 insider tradingviolations, among otherallegations

The Court, however, held that the SEC still hadclaims for disgorgementof illegal tradingprofitsrelating to the insider trading claims.


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The Jury Verdict

On an in limine motion immediately prior to trial theCourt dismissedthe remaining insider tradingclaim

Triallasted from March 31May 7, 2014

Jury returned a verdict againstboth Wylyson allnine remaining claims, including securities fraud,and failureto make various disclosures

Specifically, the jury found that the Wylys had engaged

in fraud over 13 years by failingto disclosenumerous trades which werehidden frominvestorsin the companies

The Court thereafter set a trial schedule for the

remediesphase of the litigation


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The Remedy?

The SEC contended that the Wylys derived $553 million inprofitsfrom their unlawful trades

On July 29, 2014, the Court rejected the SECs proposeddisgorgement of profits request, finding it unsupported byevidence, noting that not allthe profitscame from thefailures to disclose, as opposed to general market run-

ups and other factors. Court gave the SEC anotherchance 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 $187millionplus pre-judgment interest (total payment will bebetween $300-$400 million)


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How Does Insider Trading, Or A Directors Failure ToDisclose Holdings, Impact Your Funds?

1. Every time someone buys or sells shares on inside informationwithout disclosing it, the opposite sideof the tradeis beingdeceived and disadvantaged.

2. E.g., if your funds were sellingSterling Software stock at the endof 1999 and you did not know that the company was planning to be

sold at a significant premium, a fact known by the Wyly brotherswhich they did not disclose while they bought up shares of SterlingSoftware, you lost money while they made $ tens of millions.

3. Investors lose confidence in the stock market when they seeinsiders are gaming the system. Less investorsmeans lessliquidity, available capitalfor companies, etc.

4. Consequently, the federal securities laws allow disadvantagedshareholders harmed by insider trading and certain failures todisclose to sue for their losses against the wrongdoers.

How do you know if your fund may have a legal claim?A. Portfolio Monitoring


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WOLF

LLPPOPPER
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